The Fed's Next Moves
Look at the data instead of a datebook.
For most of the past year, investors were asking when the U.S. Federal Reserve would start raising interest rates. With that question answered, attention has turned to the likely pattern of increases over the coming months and years: How high will rates rise, and how quickly?
The answer, one hopes, is that the Fed doesn't know -- because the policy should depend on how the economy behaves over the coming months, which is itself uncertain. Communicating this policy, however, is a problem.
So much is riding on the profile of future interest-rate changes that analysts examine every utterance of Fed Chair Janet Yellen and her colleagues for hidden meanings, accidental disclosures and pre-formed intentions that the Fed is (for some reason) keeping to itself. To cope with this, the Fed should keep the emphasis on developments in the economy and dispel any notion of a schedule.
At the moment, keeping an open mind matters even more than usual. Aspects of this expansion are troubling, and the causes aren't yet clear. Growth is steady but slow. The economy is back at full employment, as conventionally measured, yet there's little sign of inflation in wages or prices. Broader measures, such as the number of people working part-time who'd prefer full-time jobs, point to continuing slack in the labor market.
The Fed was right to start tightening monetary policy before inflation has begun to rise, because the policy works with a lag. Waiting too long is risky, because it would call for bigger and more abrupt increases in interest rates later. Nonetheless, the Fed should be careful not to get too far ahead of what's happening to prices.
A main factor in deciding what "too far" means is how willing the Fed would be to let inflation rise temporarily above its 2 percent target. The more relaxed it is about a brief overshoot, the more patient it can afford to be about the profile of interest-rate increases.
Yellen has said the Fed's target is just that, not a ceiling -- implying that brief overshoots will be tolerated, just as persistent undershoots have been. But the inflation projections bundled with the Fed's policy announcements don't appear to back that up. Inflation comes very slowly back up to target, but not beyond.
Mixed messages of this kind aren't helpful. And the signaling of the Fed's inflation expectations isn't the only such case. Yellen has often said that interest-rate policy will be "data-dependent," rather than following a pre-determined schedule. Yet Dennis Lockhart, president of the Atlanta Fed, just told an interviewer something else. "Moving up gradually means not every meeting, in all likelihood," he said. "The rate of rising interest rates will be more like every other meeting."
"Every other meeting" isn't data-dependent.
Falling unemployment justified the Fed's move on Dec. 16. Yet here too the calendar clearly played a role: The Fed had long hinted at a rise by the year's end, leaving investors almost certain it was coming. From now on, data, not dates, should guide the policy -- and comments suggesting anything else would be better left unsaid.
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