Dovish FOMC Statement But No Fresh Policy Initiatives

September 21, 2010

A new goal-oriented theme was introduced into the language of today’s FOMC Statement, and it is expressed twice to underscore that the shift was not a mere after-thought.  The change concerns inflation, specifically that such is presently too low and that policymakers will not tolerate this condition persisting.

Paragraph #2 in the June statement had introduced the point that “underlying inflation has trended lower,” and the August statement added the words “in recent quarters” to that clause.  Today’s restatement modifies the language more substantively and connects the condition of inflation to the Fed’s responsibility to promote price stability:

Measures of underlying inflation are currently at levels somewhat below those the Committee judges most consistent, over the longer run, with its mandate to promote maximum employment and price stability.

Previous statements had promised to “employ policy tools as necessary to promote economic recovery and price stability.”  This time, the subjective term of “price stability” is replaced by language that suggests greater policy automaticity. 

The Committee……  is prepared to provide additional accommodation if needed to support the economic recovery and to return inflation, over time, to levels consistent with its mandate.

So there it is.  The status quo is not acceptable, and sometime in the past, because monetary policy impacts the economy with long and variable lags, policy settings must have been inappropriate to produce this variance from the environment embodied in the Fed’s mandate.  Blame of course is shared with many other public and private decision makers, and history is history.  The Fed’s job is to prevent the problem from enduring.  The new new of sub-1% inflation will not be tolerated, but the critical words “over the longer run” in the first passage above and “over time” in the second endows Fed officials with the flexibility to decide subjectively, not objectively, when it looks like inflation will not rise to an acceptable floor without additional policy stimulus.

The new language is aimed at influencing inflation expectations.  Ten-year Treasury yields one hour after the announcement were 7 basis points lower, indicating the market had understood the message.  If the Fed had a formal inflation target, which Chairman Bernanke favored when he took the job, there would be less wiggle room.  Sub-target inflation would carry an obligation to act.  But without formal targets, officials are only saying that the current mix of employment and inflation puts both variables below mandated goals.  So long as FOMC officials believe that only time is needed for both to rise back to desired ranges, officials can wait.  But if the “longer run” span of time needed for that to happen appears to lengthen instead of shorten, the central bank would be morally remiss if it failed to modify policy.

Thomas Hoenig of the K.C. Fed, which sponsors the Jackson Hole Symposiums, again dissented as he had done at all earlier policy meetings in 2010.  Hoenig believes the pace of recovery has been moderate, thus more dynamic than other FOMC members who call the pace modest.  Hoenig objects to the conditional forecast that exceptionally low levels of the fed funds rate are likely to persist “for an extended period.”  In August, he said such could limit the FOMC’s ability to adjust policy when needed but reverted this month to his previous concern that it might promote a build-up of future imbalances.  Hoenig is acting here like an Alamo economist.  Flip-flopping is ideologically impure, and having differentiated one’s view from the majority, Alamo economists will retain their opinion to the end regardless of any disproving information that might arise along the way.

Copyright Larry Greenberg 2010.  All rights reserved.  No secondary distribution without express permission.

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