Fed Governor Stephen Miran: I do think uncertainty potentially explains first half weakness

Key Concepts

• Tail Risk: The risk of an event occurring at the extreme "tails" of a probability distribution, often referring to low-probability, high-impact events. The speaker notes the "left tail has become a little fatter," indicating an increased probability of negative outcomes.
• Neutral Policy Rate: The theoretical interest rate at which monetary policy is neither stimulating nor restricting economic growth. It's the rate at which the economy is "just coasting along," not "slamming the gas" or "slamming the brakes."
• Restrictive Policy: Monetary policy that aims to slow down economic growth, typically through higher interest rates, to combat inflation or prevent overheating.
• Accommodative Policy: Monetary policy that aims to stimulate economic growth, typically through lower interest rates.
• Summary of Economic Projections (The Dots): A quarterly publication by the Federal Reserve that summarizes the economic projections of individual Federal Open Market Committee (FOMC) participants, including their forecasts for GDP growth, unemployment, inflation, and the federal funds rate.
• Transmission Channel of Monetary Policy: The mechanisms through which changes in monetary policy (e.g., interest rates) affect the real economy (e.g., investment, consumption, housing). The housing market is cited as a major channel.
• Population Growth Shocks: Rapid and significant changes in population growth rates, often due to factors like immigration policy, which can have a substantial impact on the neutral policy rate.

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Economic Weakness and Policy Uncertainty in H1

Stephen Myron explains that the labor market weakened in the first half of the year, attributing part of this to policy uncertainty. Firms were holding off on investing due to the potential for "the biggest tax hike in history" and the "biggest rearrangement to global trading policy in half a century." The negotiation of trade deals and uncertainty over tariff rates led businesses to delay decisions. Myron had assumed this uncertainty had dissipated after the tax bill became law and trade deals were made with most large trading partners.

Re-emerging Downside Risks: China's Actions

However, this assumption was challenged when China decided that earlier trade deals made in Geneva, London, and Madrid "no longer bound them." This action reintroduces significant uncertainty and downside risks to the growth outlook. Myron states that "the left tail has become a little fatter," meaning the probability of negative economic outcomes has increased. He emphasizes that policymakers must recognize this shift and adjust policy accordingly. He argues that there are "now more downside risks than there were a week ago."

The Urgency for Policy Adjustment

Myron believes it is "even more urgent that we get to a more neutral place in policy quickly, as opposed to sort of waiting for downside data to materialize." He views current policy as "quite restrictive," which makes the economy "vulnerable to shocks." If the economy is hit with a shock while policy is restrictive, the reaction will be different than if policy were less restrictive. His urgency stems from a belief that moving quickly to a neutral stance is crucial given the increased risks.

Divergent Views on Policy Stance

Myron acknowledges that his view is "in some ways out of consensus" with his colleagues, particularly regarding the speed at which the policy rate should move to neutral. He bases his conclusions on "analysis of data" and "economic models." While he differs on the pace, he notes that on the "dots" (Summary of Economic Projections), the "only real material divergence" is on how quickly to reach neutral. He desires to get to neutral "relatively quickly" because he is "less concerned about upside inflation in the near future," which provides "flexibility and the freedom to get there more quickly."

Understanding the "Neutral Policy Rate"

Myron defines the neutral policy rate as the rate at which monetary policy is "neither restrictive nor accommodative"—it's "just coasting along." He admits that "you can't observe neutral" directly, and models that estimate it tend to have "wide confidence bands," making it difficult to know its exact level at any given moment.

However, he argues it's easier to reason about changes to neutral. Economic factors push neutral higher or lower. While neutral typically moves "very slowly" (at a "glacial pace") because its drivers (like population growth) also change slowly, recent events have been exceptional. Myron highlights that "due to the sharp changes in immigration policy, we experienced the largest population growth shocks in our lifetimes in both directions, upside and downside, in rapid succession." He states, "We experienced population growth shocks in three years that normally would have taken 30 to 40 years." Other drivers of neutral include fertility rates, medical technology, and deficits.

Evidence of Restrictive Policy

Myron points to several indicators suggesting current policy is restrictive:

• Economic Weakness: The economy was weaker in the first half of the year compared to the previous year, beyond just trade-related issues, with "other elements of core underlying domestic demand" also being weaker.
• Labor Market: The labor market "has clearly weakened somewhat over the course of the year," and the unemployment rate "has been moving up gradually in the recent past."
• Housing Market: The housing market, a major "transmission channel of monetary policy into the real economy," has been "rather moribund for a while now," largely due to "high rates, mortgage rates."

Market Reaction and Policy Effectiveness

Myron contrasts the current situation with last year's rate cuts. He believed last year's cuts were a "mistake" because he thought the neutral rate was much higher then (due to factors like higher population growth and wider deficits). If policy was here and neutral was much higher, policy wasn't very restrictive. However, if the neutral rate has since come down, and the nominal rate has remained similar, "the distance between them has grown," making policy more restrictive. This explains why he believes cutting rates this year is the "right move."

He cites market reaction as evidence:

• This year (after September cut): In 8-18 trading sessions, long yields were "4 or 5 basis points down."
• Last year (after September cut): In the same 18 sessions, long yields were "up by approximately 30 basis points," eventually rising to "about 110 basis points up." This difference suggests that this year's rate cut is "working" as intended by the market, unlike last year's.

Conclusion

Stephen Myron argues that recent economic weakness, coupled with the re-emergence of significant downside risks due to China's actions, necessitates an urgent shift to a more neutral monetary policy stance. He believes current policy is restrictive, evidenced by a weakening labor market and a moribund housing sector. While his view on the speed of adjustment may be out of consensus, he supports it with analysis of economic data and models, particularly highlighting the rapid, unprecedented shifts in the neutral rate's drivers like population growth. He contrasts the market's positive reaction to this year's rate cuts with the negative reaction to last year's, reinforcing his conviction that cutting rates now is the appropriate policy response.