Interest Rates Are Not a Leading Indicator

This article was first published by me on Talkmarkets: http://www.talkmarkets.com/content/economics--politics-education/interest-rates-are-not-a-leading-indicator?post=133305&uid=4798

Interest rates are not a leading indicator. Or at least they are not a dependable leading indicator. Scott Sumner posts that that bond market was a leading indicator of the 1st quarter GDP decline to .7 percent. He went on to comment about hard data. More on that later.

However, we should take a look at the graph showing the overlapping 10 year and the real GDP:

Real GDP in Blue. Interest Rates on 10 Year T Bond in Red

It is certainly true that in the Great Recession and in other recessions, the decline in real GDP was in no way preceded by a decline in the 10 year yield. And it is true that in in the Great Recession, the decline in the 10 year was a lagging indicator. And, the decline in the 10 year yield between 1980 and 1998 took place while real GDP was actually increasing.

Sumner would have difficulty making a case for the 10 year yield being a leading indicator. In fact, even in his view that the 10 year forecast a poor GDP, yield pushed up again right before the announcement. Some may have got a small insight but it is not something trustworthy, based on history.

However, Dr Sumner is correct that hard data based assessment of GDP by the Atlanta Fed was superior to soft data predictions of GDP by the New York Fed. The Atlanta Fed predicted .2 percent growth and the New York Fed was way off base, predicting a 2.7 percent growth. That prediction makes you wonder about central banking in general.

But Scott Sumner does not like either data based predictions. He wants forecasts, like an NGDP futures market. Whether that would work is anyone's guess. Some have posted on the Sumner blog that it could be subject to manipulation. Others say it could be too complex. Others say it would put the Fed in a box, or maybe make it behave. The Fed will never behave. It has too much interest in liquidation every 75 or so years to really behave.

But we can leave the economists to sort out the merits and the likelihood of an NGDP Targeting (Nominal GDP Targeting) Futures Market. Certainly, watching NGDP is worthwhile as it declined in the Great Recession way before inflation declined. The Fed should watch it carefully.

Also, I have argued that hard data on inflation is superior to inflation expectations, a form of soft data.

Leading indicators include things like capacity utilization, retail sales, keeping an eye on nominal GDP, Effective Demand Limit, loan demand, broad money supply, real GDP, building permits, etc.

Watching inflation go up or go down is thought to be a leading indicator, but it was not in the Great Recession.  Inflation held steady in the first half year (2008) of the Great Recession.

One prediction Scott Sumner makes is that GDP under Trump will be range bound, 1.2 to 1.5 percent. That would indicate Donald Trump's efforts to fix the flyover population's economic malaise will be a big fail. Dr Sumner has a great disdain for Donald Trump and his boasting with no real policy to back it up. In the article I cited above from Sumner, he said this about POTUS and his economic team:

I don’t know how they’ll reconcile this GDP report with their dreamy predictions of 4% growth as far as the eye can see, but I’m sure they’ll think of something......Core PCE is up 2% over the past year, so the Fed is hitting both its price and employment targets.  For the moment, they are fulfilling their dual mandate. That’s a problem for Trump, who needs some Arthur Burns-style recklessness to paper over his personal incompetence when it comes to developing supply-side policy reforms.

It is hard to argue with that analysis, at least so far into the new presidency.  

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