A Fed Deficit on Guidance

The Federal Reserve's doves must have gotten the memo this week with suggested talking points on the likelihood of tapering. 

The Federal Reserve's doves must have gotten the memo this week with suggested talking points on the likelihood of tapering. Both the Chicago Fed's Charles Evans and Atlanta's Dennis Lockhart said they wouldn't rule outa decision to start cutting back on asset purchases in September.

Asset purchases are one of the Fed's two policy tools; the other is forward guidance. The premise of forward guidance is the idea that if the central bank is crystal clear about its objectives -- about what it plans to do when, or under what circumstances -- it can shape the public's expectations and help deliver the desired results.

But there's more to forward guidance than clear speech. Consistency matters. Almost everything the Fed cares about -- be it economic growth, unemployment, inflation or bond yields -- has deteriorated since the Fed announced a third round of quantitative easing, known as "QE infinity" because it was open-ended, in September. The unemployment rate has come down from 7.8 percent to 7.4 percent, but part of the decline is a result of individuals dropping out of the labor force, not robust hiring.

For all the talk about data dependency, the Fed seems to be hanging on to a fiction.

"They laid out the parameters -- 2.5 percent/6.5 percent -- and appear not to be following them," said Jim Bianco, president of Bianco Research in Chicago, referring to the Fed's medium-term inflation and unemployment thresholds.

St. Louis Fed President James Bullard dissented at the June meeting for that very reason and explained his thinking in a statement posted on the bank's website. The gist of it, as paraphrased by Bianco, is: "We downgraded GDP, we downgraded inflation, and we announced we're getting out."

It's clear from public comments that Fed officials want to be done with QE and return to conducting monetary policy the old-fashioned way: by adjusting the federal funds rate. It isn't hard to understand why, given all the unknowns connected with the Fed's $3.6 trillion balance sheet.

What's confusing is the disconnect between the Fed's stated objectives and its stated intent to start tapering. Some guidance, either forward or backward, would help.

This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.

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    Caroline Baum

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