The Fed Tests the Market's Patience
Patience has its limits.
Rarely has the policy announcement of a central bank commanded such close attention. For weeks, investors and analysts have been talking about little else but whether the U.S. Federal Reserve would raise interest rates this week, or wait awhile longer. On Thursday, it gave its answer: not quite yet.
In one sense, the decision matters less than the fever of anticipation would suggest. The precise timing of a small rise in interest rates -- this month, next month or soon after that -- is no big deal. More important is the longer-term schedule of interest-rate changes as monetary policy gets back to normal, and whether the Fed explains itself clearly as this process unfolds.
The case for a first rise this month was finely balanced. The economy continues to strengthen, if slowly, and spare capacity is gradually declining. In August, the unemployment rate fell to 5.1 percent. A year ago, that would have been seen as "full employment" -- the point at which the demand for workers starts to push wages up, with prices of goods and services right behind.
In addition, the Fed has to take account of lags in monetary policy. If it waits until inflation is moving briskly toward its 2 percent target before acting, it will be too late to stop an overshoot. It would also have to raise rates more abruptly, causing greater turmoil in financial markets. As Fed Chair Janet Yellen said during her news conference, a certain amount of anticipation is necessary.
And there is this: The financial world is hungry for leadership, and a dysfunctional Congress has failed to provide it. The central bank needs to be in command -- and be seen to be in command. Any suspicion that it's dithering is dangerous.
The Fed was not without reason to stay the course. The recent stock-market corrections have reduced demand: They amount to a financial tightening in their own right. Consumer confidence, a good indicator of future demand, has fallen. Dig deeper into the unemployment figures and there's a bit more slack than the headline rate suggests. That's why there's little sign yet of mounting wage pressure. Core inflation is still below target, and expectations of inflation are also low.
For nine of the Federal Open Market Committee's members (Jeffrey Lacker of the Richmond Fed dissented), a further delay was warranted. Most of the policy makers, though, still expect rates to lift off before the end of this year. Yellen explained that the decision will continue to depend on the data.
And that's the real problem: Which data, exactly? The confusion that preceded this meeting doesn't speak well of the Fed's forward guidance. The longer the economy stays at the so-called zero lower bound, even as output and employment continue to expand, the more potential there is for confusion -- and the greater the risk on that account to financial stability. Patience has its limits.
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