Westfield High School - 2015 Fed Challenge - Round 2

1. Are we there yet? Conundrum warrants poise.
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“For every complex problem
there is an answer that is
clear, simple, and wrong.” –
H.L. Mencken.
So while there is no
substitute for considering a
variety of theories, we offer
a reasonable framework for
timing consideration for
reducing accommodative
policies.

2. Output: Few Recent Concerns, But Dollar Strength May Slow Positive
Momentum
Source: FRED.
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3. Output: Manufacturing-related Data Trends Likely More Volatile in 2015,
but expect Consistent Rise in Post-Recession Household Formation
ISM
HOUSEHOLD
FORMATION
Sources: Bloomberg and U.S. Census Bureau.
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4. Labor: Unemployment Improvement Since 2009; Quits Rate Rising
Gradually, but Still Below Pre-Recession Level
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5. Labor: “Adjusted” U-3 as a key policy factor?
5Sources: F.O.M.C. and estimates (see Slide 14).
Adjusted U-3 could provide a
more stable NAIRU indicator for
policy discussions, decisions and
communications.
One current data set suggests a
baseline NAIRU achievement
timeframe of mid-2016, with
expansionary upside of late-2015,
and global economic downside
risk of early-2017.

6. Labor: Upward Wage Trajectory, Below Pre-Recession Levels,
Controlled by LFPR Level
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7. Currency: Net Exports likely suppressing real GDP growth by
0.25%-0.75%
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Given the roughly 10-15%
weighting of international
trade in the the U.S.
economy according to the
Chamber of Commerce, the
recent roughly 15% strength
in the U.S. dollar may
depress real GDP growth by
0.25%-0.75%. See slide 14
for calculation.
Source: N.Y. Times.

8. PCE: Core Lagging 2% target; LFPR and strong dollar partly to blame.
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Source: Barron’s, March 30, 2015.

9. Inflation: Subdued expectations likely until ‘adjusted’ U-3 NAIRU in
mid- or late-2016; expect inflation ‘wiggles’ with dollar weakness.
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10. Balance Sheet: Despite “Tantrum,” Tapering Has Been Right
F.O.M.C. Adjustment; Strong U.S. asset demand may offer opportunities
for securities sales in later stages of policy normalization process
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11. Preferred Sequence of Normalization Actions
1. Cease reinvestment of maturing bonds.
2. Fed Funds Rate target increases as ‘adjusted’ U-3 approaches NAIRU.
• Consistent with Taylor Rule principles (see Appendix III on Slide 15)
• Implemented with scheduled communications and Interest-On-Excess-
Reserves and Over-Night-Reverse-Repurchase-Agreements
3. Controlled, opportunistic, limited, periodic Treasury bond sales during
peak financial markets demand periods for U.S. Dollar-denominated
assets – initial sales should favor shorter maturities to keep mortgage
rates attractive.
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12. Recommendation: Data-Driven “When” on FFR
Summary: (1) consistent U.S. output recovery, albeit below historical
trend; (2) ‘adjusted U-3” suggests little urgency to FFR change; (3)
global economies and currencies weakness limiting U.S. inflation
expectations; (4) domestic wages and loan growth controlled, but
upwardly biased; and (5) FFR target increases historically problematic
when USD demand high
Key Tools: (1) “Opportunistic Overheating” in absence of target PCE
data and when LFPR below historical norms; (2) Employment and
output trends solid, with wage trends controlled due to LFPR; and (3)
focus on global economic stability, not currency fluctuations. 12

13. Appendix I: Calculation of ‘adjusted U-3” at 65% LFPR
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14. Appendix II: Estimated Impact of U.S. Dollar Strength on Reported
Real G.D.P.
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15. Appendix III: Synthesis of Taylor Rule principles, ‘adjusted U-
3’ and Okun’s Law
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