A Few Takeaways from Today’s Federal Reserve Actions

June 18, 2014

The formal FOMC statement revealed almost nothing really useful.  Most of the text was repeated language, and the modifications were unsurprising.  The economic assessment of rebounding activity and a further improvement of the labor market were predictable.  So was the decision to scale back asset buying by another $10 billion per month.  Nobody dissented, the same result as at the April 29-30 meeting only this time there were a few new members.  It’s rare for a new person to dissent, and there was nothing done that was controversial.

Future policy is a terribly wide open exercise.  Nailing the timetable down correctly would be a lucky shot in the dark.  Decisions will be data driven, but actual concurrent trends are not the only inputs that will count.  Equally important will be how at any given time the members expect the trends to evolve in the future.  Economists now are expressing widely different opinions on whether the U.S. economic outlook will show improvement, more of the same sub-trend expansion, or deterioration.  The further out in time, the more scattered opinions become, and this is also reflected in the scattered dot representation of individual FOMC members.  Data almost always are mixed, so it’s a vain hope that another month or so of information will dispel all uncertainty. 

There has been a view by many for decades that optimal monetary policy-making would be achieved by adopting and mechanistically following a formula like the Taylor Rule.  Fed officials are not so inclined to take the robotic approach.  Removing all elements of human discretion might enforce consistent discipline and eliminate errors but at a cost, which would escalate at those times when monetary decision-making becomes multi-dimensional and most difficult.

Fed officials worry about a breakdown in financial market stability but haven’t figured out a way to incorporate such risk factors into basic monetary policy.  Getting from a Fed funds rate that’s pinned below 0.25% at present to a median expectation among present policymakers of 3.75% within the next 2-1/2 years would entail a fifteen-fold increase.  For two decades, the Bank of Japan has been unable to even double its short-term rate target without dire consequences.  It takes a leap of faith to accept that the U.S. economy can handle all the repercussions of rate normalization without financial market swings that will exert great stress on the U.S. and world economy.  Without the innovative monetary policy to combat the financial meltdown of 2007-9, a depression almost certainly would have ensued.  Getting from 2014 or 2015 back to 2006 is apt to be a turbulent ride, even if one accepts that the new longer run neutral interest rate level lies below the old norm.

Nothing emerged today regarding how the inclusion of new personnel on the Board of Governors will impact future policy. 

Copyright 2014, Larry Greenberg.  All rights reserved.  No secondary distribution without express permission.



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