Average Inflation Targets, GDP and Interest Rates

Fed minutes around the summer of 2019 addressed the concept to allow Inflation to run above and below the 2% target yet this idea was never formalized as a policy until last week’s announcement. The policy of Inflation Targets began as a formal adoption with the RBNZ then Canada, Sweden and a long list of nations. Greenspan and the United States never adopted Inflation Targets. Today, the new concept is Average Inflation Targets.

Average Inflation Targets won the day as an all encompassing policy instead of targeting the Price level. Canada and the BOC for example uses the 2% Target as a midpoint from overall Inflation running from 1 to 3%.

The new policy to Average Inflation Targets is another tool to Keynesian Economics as adopted by Central Banks after the 2008 crash because stimulus and rising balance sheets remains the order of the day.

The Austrians would counter the Keynesian argument by adding and subtracting weekly money into the banking system and allow the Fed Funds rate to roam and trade freely. The ancillary effect is Inflation would remain low and become a true number. What then drives overall Inflation is Money Vs the Fed Funds rate.

Under the stimulus concept and Keynes, central banks add money to the system but never subtract. Central banks faced with piles of money under Inflation to never reach its target and an artificially low overnight rate then began buying bonds. Then came stock purchases to raise inflation then yield control and now Inflation Averages. Soon the central banks will own every market instrument on the planet and become the controller to markets more than has ever been seen in history.

Under Inflation above and below the 2% target or just the 2% target alone, the Fed Funds rate is held artificially low and non moveable. The Fed’s overnight rate or known as the Effective Fed Funds rate has hovered in the 0.08 to 0.10 vicinity for practically everyday for the past year. This explains all central banks as an artificially low overnight rate allows stimulus from now to eternity.

The trap for the fed and central banks after 12 years of Keynesian Economics and stimulus is to allow overnight rates to trade freely. A change to an overnight rate at just 2 and 3 points would cause market volatility and wide price swings to currency prices. Market volatility is contradictory to central banks. Yet stimulus can’t run forever otherwise the economic system will eventually crash.

Traditionaly, Inflation and overnight rates run counter to each other. Low Inflation leads to higher overnight rates and higher GDP. Employment and Wages follow.

Note this relationship.

GDP -5%
Fed Funds 0.08 or headline 0.25.
Inflation rate 1.0 or PCE 1.3.
10 year Yield 0.74
2 year yield 0.13.
Employment Rate 10.2.

Normal arrangement is GDP and overnight rates trade above Inflation rates. Lower goes Inflation then higher for interest rates and GDP. Central banks are working the system backwards by forcing Inflation to trade above interest rates and today, Inflation trades above GDP. In the 1970’s Stagflation, Inflation traded above GDP and interest rates. By forcing Inflation higher leads to lower interest rates and GDP.

From 2008 to current day, Inflation traded above Fed Funds and GDP for the vast majority of time traded below Inflation. Inflation since 2014 trades higher than GDP and Fed Funds. Rather than move the interest rate to rectify the Interest rate Vs GDP situation to allow both to trade higher and contain Inflation at lower levels, Stimulus is added. Add stimulus lowers interest rates and GDP.

Stagflation is defined as Inflation rates above GDP or prices trade higher than output which means a wage earner can’t afford the means to sustain wages to their lifestyle. Items and needs are to expensive. The enemy to GDP, interest rates and economic prosperity is stimulus.

Data was run since Inflation targets began 28 years ago in 1992. The data covers 1992 to 2019 using yearly averages. For Inflation was used average inflation.

The Fed Funds rate average is located 2.61 and oversold at 0.08. The range runs from 0.5 to 4.72.

Inflation averages 2.27 and is oversold from last at 1.0. The range is 1.33 to 3.21.

GDP average is 2.59, oversold and ranges from 1.01 to 4.17.

Fed Funds Vs Inflation correlates to +52%. This means raise or lower Inflation then Fed Funds must follow.

Fed Funds Vs GDP correlates +37%. Raise or lower GDP then Fed Funds follows.

Inflation Vs GDP Correlates +0.007. Under correct positioning, GDP rises forces Inflation lower.

Economies require lower Inflation to 1%, rescind stimulus and allow GDP and Interest rates to rise so allow booming economies.

 

 

Brian Twomey

 

 

 

 

 

 

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