What the Fed Really Meant to Say
The gap between what the Federal Reserve says about monetary policy and what investors think it's saying would be funny if it weren't so important. Most of this gap is the listeners' fault -- but not all. The Fed could do a better job of explaining itself.
Last week, for instance, commentators pored over the minutes of June's meeting of the Fed's policy-making committee and decided that the Fed had, for the first time, committed itself to end its quantitative easing program in October. Moreover, some concluded, this would hasten a rise in interest rates that investors had not been expecting until next year.
Here's the relevant passage from the minutes:
While the current asset purchase program is not on a preset course, participants generally agreed that if the economy evolved as they anticipated, the program would likely be completed later this year. ... If the economy progresses about as the Committee expects, warranting reductions in the pace of purchases at each upcoming meeting, [the] final reduction would occur following the October meeting.
As binding commitments go, and remembering that the economy rarely evolves as anyone expects, that's pretty weak. By the way, the minutes also noted that most participants thought the decision about the last installment of QE had "no substantive macroeconomic consequences" and no bearing on the decision about when to raise interest rates.
This disconnect between plain words and the zeal to unearth their author's true intent is a problem. If investors get too settled on a particular idea of what will happen and when, then the Fed may feel obliged to validate that forecast, despite its better judgment. It knows that if it chooses not to, this might come as a shock and could have bad results.
What should the Fed say to make it even clearer that it's running monetary policy not on a schedule but with its eyes on changing conditions in the economy? It tried to do just this when it began including a threshold for unemployment in its announcements in 2012. But that experiment in greater clarity was short-lived because the unemployment figures haven't behaved as expected. They're no longer seen as a reliable indicator of economic conditions.
Two things would help. First, the Fed should tell the markets more plainly that its 2 percent inflation target is a target, not a ceiling -- and that it will be no more concerned about a temporary overshoot than it has been about the recent undershoot.
Second, it should say more about how it assesses inflation prospects and less about peripheral matters. A good indicator to emphasize is wages. The Fed's main concern should be to avoid the emergence of an inflationary prices-and-wages spiral. As long as wage inflation is not a concern -- and for the moment it isn't -- keeping monetary policy loose makes sense.
Giving due weight to those points argues, in fact, for continuing to buy assets beyond October. If conditions in the labor market are any guide, it's too soon to be even thinking about higher interest rates.
That would be a good message to send. But it's also important that the Fed should have a message, any message, and deliver it in simple terms, less apt to be misunderstood. In this, others can help -- by not trying so hard to misunderstand.
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