The Fed Loses 'Patience'

Not entirely impatient either.

Photographer: Chip Somodevilla/Getty Images

The Federal Reserve's policy-making committee is no longer saying it will be "patient" about returning to a more normal monetary policy. Does this mean the U.S. has moved a step closer to its first increase in interest rates since the recession? It shouldn't -- and Chair Janet Yellen said it doesn't.

Vocabulary aside, the Fed's main message and the uncertainties surrounding it haven't really changed. It wants to start lifting interest rates early enough to keep inflation from rising above its 2 percent target, but not so early that it brakes the recovery prematurely. That sounds simple, but it's a tough call because the economy is still behaving strangely.

QuickTake Full Employment

Unemployment has already fallen to 5.5 percent -- a level where you'd expect to see the labor market tightening and clear signs of wage inflation. So far, though, this hasn't happened. The main index of employment costs increased by 2.2 percent in 2014, barely higher than the rise of 2 percent the previous year.

Recent economic signals have been mixed in other ways as well. While figures for output and employment have been encouraging, statistics on retail sales and consumer confidence point to renewed sluggishness. Productivity is growing slowly, suggesting that wage inflation, when it arrives, will push up prices faster than usual. That would reduce the Fed's margin for error. But what if the recession has suppressed productivity only for a while? If productivity recovers as the economy does, the Fed shouldn't be in any hurry to raise rates.

The rise in the dollar, powered by Europe's belated adoption of quantitative easing (which is driving down the euro), is yet another complication. In effect, it's an unintended tightening of U.S. monetary conditions: Other things equal, keeping U.S. rates at zero for longer would seem to make sense. But other things aren't ever equal.

What's a central bank to do? First, say more clearly than it has up to now that economic indicators, rather than the calendar, will guide its decisions. In getting away from saying it will be "patient" about raising rates -- which investors have seen as guidance about timing -- the Fed has taken a step in this direction.

For the same reason, deleting "patient" shouldn't be read as indicating higher rates in June regardless of what the data say between now and then -- a connection that some investors had begun to infer. The Fed's statement today was careful to stress that data, as it comes in, will drive the decision.

Second, and more controversially, the Fed should be willing to err on the side of a bit too much inflation. Leaning against the recovery before wage pressures are plainly in sight would guard against an inflation overshoot, which is good -- but if that means missing out on income and jobs, then the price is too high. Since the recession, the Fed has tolerated an inflation undershoot. Now it should be equally willing, if need be, to let inflation move briefly above the 2 percent ceiling.

To contact the senior editor responsible for Bloomberg View’s editorials: David Shipley at davidshipley@bloomberg.net.