The Dreaded Fed Reaction Function Strikes Again

The Labor Department announced today that the US economy added (a better-than-expected) 195,000 new jobs in June, while also revising upwards its estimates of job growth in April and May. Good news, right? Yes, it was good new, but there was also bad news. What was the bad news? Why, it was the good news, of course!

One hour after the Labor Department announcement, the NYSE opened with the S&P 500 10 points above its Wednesday close, and immediately started to fall. Here’s a picture of the S&P 500 so far today.


What happened? The good news about job creation signals a strengthening economy that could be poised to start a real recovery as opposed to the pseudo-recovery of the past four years. But, as I explained last week, thanks to the Fed’s promise to start tapering off its asset purchases as soon as the economy starts to improve, the market now greets good news with fear and trepidation. So the good news about the economy is cancelled out by the bad news about Fed policy.

That explains why the yield on the 10-year Treasury note shot up this morning by 20 basis points today to its highest level in two years. And here’s a picture of what happened to the dollar/euro exchange rate today after the jobs announcement.Image

Well the sky is not falling — yet. But I just don’t know how much more good news like this the economy can stand.


19 Responses to “The Dreaded Fed Reaction Function Strikes Again”

  1. 1 Marcus Nunes July 5, 2013 at 10:58 am

    David, At 2PM the S&P is up again (1625), and inflation expectations also rose. Those things together with higher long yields and appreciating dollar are not inconsistent with higher growth expectations (the giveaway I think was the rise in inflation expectations after many weeks falling).
    I took a less short run look at the employment numbers. The conclusion is that MP has been found (and still is) wanting.


  2. 2 maynardGkeynes July 5, 2013 at 6:00 pm

    July 5 is one of the lightest trading days of the year, marked by massive short covering if there is the least shred of positive news. Make nothing of today’s moves. Totally meaningless.


  3. 3 PeterP July 5, 2013 at 6:20 pm

    The upside is that monetarism is irrefutable: whether markets react to good news by going up, down, up and then down (and I guess vice versa) – it is all consistent with monetarism.


  4. 4 Benjamin Cole July 5, 2013 at 11:45 pm

    I also would not read too much into any one day.

    The market needs the fed to say, “We will taper down, or taper up, as necessary, given prevailing inflation and employment figures.’

    Bernanke, and other loose-cannon FOMC members, are ever intoning about cutting QE. Why? Inflation is at 0.7 percent, PCE y-o-y, and there is slack galore in the economy.

    This sentiment that QE is something “active” that must be curtailed ASAP is a terrible signal to send to the markets.

    A better signal is that the Fed will be pro-growth as long as inflation does not get too far out of control.

    And if inflation comes in at 0.7 percent—maybe time to taper up.


  5. 5 W. Peden July 6, 2013 at 3:18 am


    It’s true that monetarism is irrefutable, but the reason it is irrefutable is because it’s true.


  6. 6 PeterP July 6, 2013 at 6:10 am

    W. Peden

    Read up on Popper. “True” theories (like “the Earth is round”) are perfectly refutable. Only religion is irrefutable.


  7. 7 maynardGkeynes July 6, 2013 at 7:11 am

    Still, it disturbs me to see all the Fed officials running around making mea culpas because the knee jerk reactions of market traders for a few days. The traders are not economists, they are video-gamers with fast fingers who know nothing, yet the Fed takes them seriously. EMT works, but it takes more than 5 days and a bunch of day traders.


  8. 8 W. Peden July 7, 2013 at 4:02 am


    I’m not sure what ‘true’ means when it’s put in inverted commas, but I do know that Popper was very bad at conflating ‘unfalsifiable’ with ‘irrefutable’. They don’t mean the same thing: ‘irrefutable’ just means “cannot be refuted or disproven”, whereas ‘unfalsifiable’ (in Popper’s sense) means “consistent with any observation statement”.

    Plenty of scientific theories are unfalsifiable, including Darwinism and Newtonian physics. It’s not an important quality for a theory to have.

    Even more scientific theories are irrefutable. In particular, if a theory is true, like monetarism, then it cannot be refuted, because a theory can only be refuted if it’s false; contrary to some who use it to mean ‘rebutted’, ‘refuted’ is a success-word like ‘winner’, ‘know’ and ‘disproven’ (the last of which is a synonym for ‘refuted’).

    One of Popper’s many bad legacies is to encourage the misuse of a perfectly good logical word like ‘refute’, as well its modifications.


  9. 9 Tom Brown July 10, 2013 at 11:32 am

    @ W. Peden,

    You write:

    “Plenty of scientific theories are unfalsifiable, including Darwinism and Newtonian physics. It’s not an important quality for a theory to have.”

    I would state than “unfalsifiable” (which in science means “untestable”) is DEFINITELY a quality you DON’T want a theory to have. Otherwise it’s not within the realm of science. If a scientific theory is untestable it’s useless.

    So I’m not sure if you made a typo there or not..

    Assuming you didn’t, then both evolution (which is what you mean by “Darwinism” I suppose) and Newtonian physics are falsifiable. Newtonian physics has already been falsified with experiments in both quantum physics and special & general relativity. Although proven false, Newtonian physics is still a useful theory in many circumstances because it provides a useful approximation. That’s the best a theory in the natural sciences (i.e. a theory about reality) can do for us: provide a simple and useful approximation for reality. Newtonian physics has been superseded in this regard by better (but more complex) approximations. As for evolution, to quote J.B.S. Haldane, when asked what would disprove evolutionary theory, he responded:

    “fossil rabbits in the Precambrian era”

    So far as I know these fossils remain to be found ;^)

    If by “Darwinsim” you are instead referring to Darwin’s proposed mechanism of natural selection (which did not include Mendelian genetics) then that is a very narrow definition of “Darwinism.” The genetics were not included until later, during the “neo-Darwinist synthesis.”

    Natural science (the study of reality) relies on the testability (falsifiability) of it’s theories. Untestable theories about reality are useless.


  10. 10 Tom Brown July 10, 2013 at 11:38 am

    “That’s the best a theory in the natural sciences (i.e. a theory about reality) can do for us: provide a simple and useful approximation for reality.”

    Delete “simple and” from the above.


  11. 11 Tom Brown July 10, 2013 at 12:04 pm

    … and BTW, the only “irrefutable” theorems are in the field of Mathematics (so far as I know), where you start with axiomatic truths and use logical deductions to arrive at other truths which are irrefutable given your starting axioms.

    Science (the study of physical reality) isn’t like that. Science relies on inductive reasoning. No theory in science is irrefutable. It’s impossible to tell when a better approximation will come along and supersede our current ones.

    So if you’re saying the theory of “monetarism” is “irrefutable” that is a nonsensical claim!… unless you’re using some kind of a mathematical definition of monetarism that I’m not aware of. Far from having the the certitude of mathematical deductive proofs, economics has AT BEST the weak evidence of a soft science to support it’s theories. For one thing, it has human brains in the loop, and we do not have good models of human brains yet. It’s still difficult to predict with much accuracy what a group of humans will do.


  12. 12 W. Peden July 10, 2013 at 4:29 pm

    Tom Brown,

    ‘Unfalsifiable’ does not mean ‘untestable’. To test a theory is to make some difference to the probability of whether or not it is true. A theory can be unfalsifiable, yet still have variations in the likelihood it is true. For example, “The probability of a human birth being male is 0.4” is unfalsifiable (it is logically consistent with any observations) but it is testable.

    Darwinism is not the only theory of evolution, just the best, so I don’t regard them as synonyms. Evolutionary explanations of the origins of life and its forms go back to Anaximander in Ancient Greece, but it wasn’t until Darwin that we got a really good evolutionary theory.

    Fossil rabbits in the Precambrian era may be inconsistent with certain theories of how evolution progressed, but it’s not inconsistent with evolution as such (rabbits may have developed and then become extinct, or may be exceptions from another world or whatever- logical consistency is a very cheap thing) and it’s definitely not inconsistent with Darwinism as it is usually understood i.e. the claim that speciation is a product of evolution and evolution usually results from natural selection via survival of the fittest.

    I agree that science depends on inductive reasoning (contrary to what Popper thought: his whole philosophy of science is based on the premise that there is no such thing as reasonable induction!) but I disagree that scientific theories are necessarily ‘irrefutable’, in the normal sense of the term, because any theory that is true cannot be refuted.

    If by ‘irrefutable’ you mean ‘unfalsifiable’, then I also disagree, for reasons already covered.

    If by ‘unfalsifiable’ you mean ‘untestable’, then I agree and I think it would be a bad thing for monetarism if it was untestable, but it is testable. Fortunately, monetarism is testable e.g. we can conduct statistical examinations of the likelihood of propositions like “a change in the level of the money supply is non-neutral in the short-run and neutral in the long-run”, “the money supply is correlated with prices in the long-run”, and “most fluctuations in the rate of change of RGDP outside of very short-term changes are caused by fluctuations in MV”, provided that these are operationalized a bit.

    It is precisely because economics (and social science generally) is so hard that unfalsifiability is an absurdly high standard, considering even our best theories in the natural sciences don’t all meet it. Instead, what we can realistically hope for are theories that can be made more or less likely by testing. And you are correct that any particular market reaction is consistent with monetarism, but wrong that this is a problem.


  13. 13 maynardGkeynes July 10, 2013 at 6:04 pm

    “The probability of a human birth being male is 0.4″ is unfalsifiable;”

    Huh? What if I said that the probability of a human birth being male was 2%? You think Popper would call that unfalsifiable?


  14. 14 Tom Brown July 10, 2013 at 7:18 pm

    W. Peden,

    Re: “unfalsifiable” and “untestable”: I maintain those are synonyms for the most part in the scientific community: or nearly so. A quick search found some evidence for that, but also the common appearance of the phrase “testable and falsifiable” as if they are two separate things. Regarding your population example, I see your point, but in a practical sense this hypothesis could be tested with a high degree of precision (yes, that might mean making some other assumptions about the statistics of the sex of babies). Thus I’d bet you could test (and subsequently falsify) this claim about male birth rates with empirical evidence and satisfy many many practicing scientists and statisticians that you’d done so. So yes, I’ll continue to use “unfalsifiable” and “untestable” as synonyms in my comments here.

    Re: the rest: I’m still confused by some of your statements and still suspect some typos. For example, you wrote:

    “but I disagree that scientific theories are necessarily ‘irrefutable’,”

    I wasn’t saying that scientific theories are irrefutable. Quite the opposite! I’m saying that outside of mathematics, there are NO “irrefutable” scientific theories.

    Then there’s this:

    “It is precisely because economics (and social science generally) is so hard that unfalsifiability is an absurdly high standard, considering even our best theories in the natural sciences don’t all meet it.”

    I’m not claiming that “unfalsifiability” is a standard to shoot for in ANY branch of science! Unfalsifiability is a BAD thing for a theory… it means a theory is cut off from science and reality and exists in a fantasy world. Every time I’ve heard a scientist use the term “unfalsifiable” in relation to a theory it’s always a BAD thing. Theories should absolutely strive to BE falsifiable! The more falsifiable the better (i.e. it’s better for a theory if there are many easy ways to falsify it). If a theory is highly falsifiable AND YET it remains unfalsified… that’s the best you can hope for! In contrast, a theory that is falsifiable and then goes on to actually be falsified is a false theory (of course!) but it’s still a cut above an unfalsifiable theory! At least a false theory is a well formed theory. Unfalsifiable theories are mal-formed theories which can’t even be tested. They have no place in science (or anything else, IMO).

    Popper: I’m not terribly familiar with his work, but after a quick looking over some articles about him, it seems to me he was just playing semantic games. His ideas are largely ignored by scientists now days (apparently). Some claim he was just trying to sneak induction in the back door by renaming it.

    So, I remain confused about some of your statements, but I suspect that you and I are mostly on the same page here (based on the bulk of your statements)…. perhaps outside of some semantics.

    Last complaint: you write:

    “And you are correct that any particular market reaction is consistent with monetarism, but wrong that this is a problem.”

    I’m not saying that! I don’t know enough about monetarism to make such a claim. And I’m not saying that evidence consistent with monetarism is a problem. I was merely cautioning you that “irrefutable” is a suspect claim for ANY theory outside of mathematics… but then based on some of your previous statements I *think* you’d agree with that.


  15. 15 W. Peden July 11, 2013 at 12:37 am

    Tom Brown,

    My advice would be to just always use untestable, because (a) an untestable theory doesn’t really tell one anything about the world and (b) ‘unfalsifiable’ has a very specific meaning for those of us who work in the philosophy of science and logic.

    As for ‘irrefutable’, that was a typo. Sorry: I meant “I disagree that scientific theories are necessarily refutable”, in the ordinary sense of ‘refutable’ as in “an irrefutable argument” or “irrefutable reasoning”. If I say “his reasoning is irrefutable” as a complement to someone, I don’t mean that it’s unfalsifiable, but rather that I can’t find anything wrong with it because it’s true.

    Also, for ‘unfalsifiable’ in that paragraph, read ‘falsifiable’. It was really too late here to be posting about such things!

    ‘Falsifiability’, for Popper (to whom PeterP referred quickly) means “inconsistent with some observation statement” i.e. it must be inconsistent to believe both the theory and some statement describing (successful) observation. So, for example, “All ravens are black” is inconsistent with “This raven is white”.

    Statisticians may (and should!) be convinced that the male birthrate among humans is not 0.4, because past observations tell us that this hasn’t been the case in the past and we can conclude that it probably won’t be the case in the future. However, the male birthrate COULD be 0.4 and all statements describing our past observations be true. Unlikely? Absolutely. Logically impossible? No.

    Popper, like Hume, got about half-way to the truth about induction: it’s true that induction (even with loads and loads and loads of observations) never gives us certain proofs of our conclusions. No matter how many white swans we observe, it’s always logically possible that a black swan exists. However, they concluded from this that induction (i.e. reasoning from the observed to the unobserved) is never reasonable, but it is reasonable and indeed it is unreasonable not to believe that “It will be hotter in the Sahara than in Greenland tomorrow” on the basis of our past observations.

    That last bit was something I misascribed to you by confusing you with PeterP. Sorry about that: as I say, much too late to be posting about this stuff.


  16. 16 Tom Brown July 11, 2013 at 12:27 pm

    W. Peden. OK, I think we cleared most of that up. I think we are on the same page mostly. My background is engineering: not science, logic, economics or philosophy… but most of us engineers frequently do use the scientific method… we just don’t use it to do basic research.


  17. 17 David Glasner July 14, 2013 at 7:40 pm

    Marcus and maynardGkeynes, You are right. I got a bit carried away with myself even though I think that there was a germ of truth in my intuition. But that was only one factor in a much more complicated array of forces.

    PeterP, That can be true of almost any theory if one wants to protect the theory against any conflicting evidence. Sometimes, there are good reasons for protecting a promising theory against seemingly contradictory evidence, and that’s why there are arguments between scientists about how to interpret evidence. Usually, as evidence accumulates, it becomes clear that a theory is not measuring up, and it loses adherents. In the social sciences, there is usually a lot more room for interpretation, so it’s hard to dispose of a theory once and for all. At any rate, I can’t really tell what you mean when you refer to “monetarism.” It’s a very elastic term.

    Benjamin, Ten days after Bernanke sounded off, it looks as if he did not correctly anticipate how his words would be interpreted, and he has since tried to correct the impression that the FOMC was eager to start tapering off QE. Of course, from the perspective that you and I share, policy should still be moving in the opposite direction, toward increased expansion.

    W. Peden, Irrefutable is an ambiguous term, because it can refer either to evidence, in which case one is saying that the evidence is solid and beyond question, or it can refer to logical reasoning in which case one is saying that all the steps in a chain of logical reasoning are valid inferences, or it can refer to a theory in which case one is saying that the theory could not be refuted by any evidence whatsoever, because the theory would be consistent with whatever evidence were found. Popper’s point was that an irrefutable theory is a bad scientific theory, because it has no empirical content; it excludes nothing. Newton’s theory of gravity is refutable, even though it’s true (at least as a first approximation), because it excludes the possibility that when I drop a ball from the top of the Empire State Building, it will fall toward the moon instead of toward the earth. Refutability is a property of the empirical content of a theory, not its truthfulness. It seems that you do understand this, but are criticizing Popper’s use of terms. I am not bothered by his terminology, but can see why others might be, though sometimes it seems to me that such criticisms are made out of annoyance with Popper on other grounds.

    Tom Brown, I think that untestable theories are not necessarily useless, and I think Popper also felt that untestable theories could be useful. He said that untestable theories are not scientific, but he denied that they are meaningless. He called them metaphysical, but he believed that metaphysical theories could be useful.

    On the difference between testability and refutability, a theory is refutable if one can specify an observation that would be inconsistent with the theory. If one has a method by which to determine whether that observation will either be made or not made, the theory is made both refutable and testable.


  18. 18 Tom Brown July 15, 2013 at 4:59 pm

    David thanks for the response. So how does “falsifiable” fit into the testable /refutable spectrum? It sound like “refutable” (the way you’ve used it in your last paragraph) is a synonym for the way I’ve used “falsifiable.”

    Regarding metaphysics… How it it useful? Do you have an example?


  19. 19 David Glasner July 21, 2013 at 3:18 pm

    Tom, Yes, I am using falsifiable and refutable as synonyms, and I believe that that is the usual understanding of the terms in the philosophy of science and scientific methodology.

    As for metaphysics, it may or may not be useful. I am just saying that there is no a priori basis for asserting that metaphysics is either meaningless or absurd or useless. A case in which metaphysics clearly has been useful is when it has served as a precursor to scientific theories. The idea of evolution was around long before Darwin (or his followers) turned it into a scientific theory. Similarly for atomism.


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About Me

David Glasner
Washington, DC

I am an economist in the Washington DC area. My research and writing has been mostly on monetary economics and policy and the history of economics. In my book Free Banking and Monetary Reform, I argued for a non-Monetarist non-Keynesian approach to monetary policy, based on a theory of a competitive supply of money. Over the years, I have become increasingly impressed by the similarities between my approach and that of R. G. Hawtrey and hope to bring Hawtrey’s unduly neglected contributions to the attention of a wider audience.

My new book Studies in the History of Monetary Theory: Controversies and Clarifications has been published by Palgrave Macmillan

Follow me on Twitter @david_glasner


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