Why Fed policy is hurting the economy
The above chart uses the same data as Taylor's original chart, but includes data going back to 1960 (his only went back to 1990). The interpretation of the chart remains the same. There is a strong inverse relationship between fixed investment as a share of GDP (fixed investment includes private residential and nonresidential construction, and private investment in equipment and software) and the unemployment rate, which is a good proxy for the health of the economy. He is careful to note that while the correlation is strong, we cannot infer the direction of causality. But this does illustrate how a lack of investment could go a long way to explaining why the recovery has been so weak.
As the chart above shows, Fed policy is indeed highly correlated to fixed investment (even more so than the unemployment rate is). This fits hand and glove with the first chart, which links fixed investment to the unemployment rate. The red line in the above chart is the real Federal funds rate (using the Core PCE deflator), since that is a good proxy for the degree to which monetary policy is "tight" or "easy."
This puts some meat on the bones of Taylor's WSJ article. The Fed's unusually accommodative monetary policy stance, which promises extremely low interest rates (negative in real terms) for a long time to come, does appear to be a factor in limiting the amount of funds available for investment, and in reducing aggregate demand, and that in turn helps to explain why the recovery has been so weak.
How else to explain the fact that fixed investment is almost always very strong when monetary policy is very tight, and weak when monetary policy is easy? How else to explain how a decade of extremely low interest rates have failed to stimulate Japan's economy?
Food for thought and controversy...
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