[DRAFT] How not to think about monetary policy

From The Tantri Files — verbatim writing from Prof. Tantri’s WhatsApp messages, with his blessing.

On September 18, 2024, the US Federal Reserve cut rates by 50 basis points — its first cut of the cycle. By the next morning the WhatsApp group was a wall of hot takes: Sahm rule has triggered, recession incoming, this is dovish, no this is hawkish, last time this happened in 2009 it was 10%…

Tantri’s reply, sent in a series of short messages over a couple of hours, is as close as he gets to a manifesto on what learning macro is actually for. It is reproduced here in order, with light context.

“Folks, please first learn before predicting”

Several classmates, predicting recession by analogy to 2009 and 2020.

Tantri. Folks, please first learn before predicting, commenting etc. Please be aware that what we have covered in class is absolute basics. There are lot more nuances which I cannot cover. My suggestion is first read these two documents and understand what the Fed is saying.

He linked the Federal Reserve’s September 18, 2024 statement and the Summary of Economic Projections, and continued:

This kind of thing — like, “when last time this happened, that happened” etc — is not knowledge. Non-finance folks, don’t get fooled by this. Ask why?

There is no science behind such statements. When last time it rained four times in a row, I got married. So what?

These things do not mean anything. Do not waste your time.

If you are really interested in macro, go to MIT open courseware and do this course by Ricardo Caballero. Learn frameworks and use your brain to decide.

Gyaan baatne se pehle gyaan urjan karo.

“Let me take up one media discussion you will see constantly”

A few minutes later, line by line — short messages building into a single argument:

Let me take up one media discussion you will see constantly.

“When Fed cuts rates there will be recession.” Does this mean lower rates cause recession?

Wrong.

Go back to Phillips curve. Fed cuts rates after taking the real rate high, bringing down inflation expectations. This also takes GDP below the natural level.

This happens with long and variable lags — as Friedman famously put it.

This means we have not yet fully realised the impact of rate hikes.

When Fed thinks that risks to growth is high, they will start cutting rates.

However, the lag effect of their earlier actions sometimes continues even after the rate cut.

It takes time for rate cuts to show impact. That is why it looks like rate cut and recession are related. They are not.

He added:

This time action is mostly driven by expectations. So I am not that pessimistic. You should worry more about India — by the time these guys wake up, it may be too late.

Let’s hope for a higher inflation here in the meanwhile.

On the Sahm rule

The next day — a classmate had posted an Economic Times piece arguing the Fed cut because the Sahm rule had triggered.

A classmate: “But the Sahm rule is just a heuristic…”

Tantri. There is no such scientific rule. Please don’t fall to these things after learning so much. This is also rule-of-thumb which people stop citing once they stop working.

If you are interested, do that MIT course that I suggested.

A classmate: But finance influencers cite it everywhere.

Tantri. This is how finance folks fool non-finance folks by creating illusion of knowledge. Truth is, if you go and ask a finance guy on the street, they will not be able to explain how monetary policy transmits.

Please read books and not such kind of shortcuts.

He pointed at the day’s market reaction:

Yesterday these guys were saying all kinds of doom and gloom — fed rate cut == recession etc. Today, the market is up, they have changed the story.

This is not knowledge.

Knowledge is not equal to prediction.

And finally

A classmate: Prof, the MIT course?

Tantri. Macroeconomic MIT OpenCourseware. Name of faculty: Ricardo J. Caballero. It is just 25 hours. He is one of the topmost scholars in the world. Also there is a course on microeconomics by Jonathan Gruber.

A classmate: Could you teach this to us, in India?

Tantri. After you are all placed, I can do this exact same course with exact syllabus, customised to India. Lets do in January. The course will not count either for students nor for me. After you pass the OB course.

It will not show in your transcript. Yes, everyone will have to bring dosa for me. That is the fee.

Editor’s notes

This thread ran across September 19–20, 2024 in the Finance Enthusiasts WhatsApp group, in the immediate aftermath of the Fed’s first rate cut of the cycle. Verbatim throughout, with sub-headings added for readability and student names removed. The “MIT course” in question is 14.02 Principles of Macroeconomics.

If you take only one thing from this thread, take this: knowledge is not equal to prediction.