We just had our avalanche–albeit stronger and faster than desirable. Now we brace for the feedback effects, against backdrop of an anemic ROW and structurally low domestic growth. And we hope it doesn’t push us into recession.
Feedback loops matter. Media, social media, technology and globalization have amplified the echo chamber, making these loops much more emotional and powerful than they used to be. They are highly path dependent and behavioral in nature, further complicating analysis. International linkages–both real and financial—play a larger role in today’s world too.
Yet, these dynamics notwithstanding, the absence of the real-economy optimism on which economic cycles die suggests to me that the US will avoid recession. But reducing financial stability risk increases financial volatility and the risks to my view are to the downside.
One final consideration is the counterfactual: had the FOMC waited until later to shake the tree with the first rate hike, odds are the avalanche would have been yet larger. And larger avalanches mean larger feedback loops.
Keeping financial stability risks from rising without damaging the long, sub-par domestic economic cycle is a challenging balancing act, but this is what Yellen’s FOMC wants.