'Good Luck Fed:' MIT Professor Olivier Blanchard Sees Central Bank Facing 2 Tricky Scenarios

MIT Professor Olivier Blanchard has explained the dilemma faced by the Federal Reserve in the current economic environment as akin to avoiding ‘Charybdis and Scylla' — the proverbial notion of choosing the lesser of the two evils.

According to the Labor Department’s report, the U.S. economy added 517,000 jobs in January, far exceeding economist estimates of 187,000 new jobs. Wage growth dropped to just 4.4% in the month, and the unemployment rate hit a 50-year low of 3.4%.

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Two Scenarios: Blanchard noted that following the jobs report, the central bank will have to deal with two different potential scenarios, navigating which would require great skills.

One would be that inflation is dramatically lower and it is time to stop tightening, he said. The second is that the economy is not slowing down while unemployment keeps decreasing and hence there is a need to tighten more, he explained.

According to Blanchard, neither scenarios are right and are both dangerous.

“The decrease in the CPI reflects a turnaround of energy and food prices, which is good but will come to an end. Those prices will eventually settle. Underlying inflation is still positive and higher than [the] target,” he explained.

At the same time, the lag in the monetary policy transmission is also concerning, Blanchard believes.

“There are long and variable lags in the transmission of monetary policy. There is a lot of tightening already is in the pipeline. Based on historical evidence, this could be enough. Navigating between the two is going to require great skills. Good luck Fed,” he tweeted.

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