Ending an Unhealthy Obsession With the Fed
Why are markets and the media so obsessed with the timing of the Federal Reserve’s next interest-rate increase? The sheer intensity of their attention, I think, reveals a deeper problem: They don’t understand what the Fed is ultimately trying to achieve.
In Fed-watching lately, the calendar is king. Investors are focused on what will happen at the central bank’s next policy-making meeting in June -- and minutes from the April meeting, released last week, have led many to expect a quarter-percentage-point rate increase. Fed officials, when they speak at public events, inevitably face questions about the likely number of interest-rate hikes in 2016 and 2017.
Timing alone, though, hardly merits so much attention. To understand why, consider two possible scenarios. In one, the Fed starts raising rates in June and then adds another quarter percentage point at every second policy-making meeting (once every three months) for the next three years. In the other, the Fed waits until the second half of 2017 and then adds a quarter percentage point at each of the next 12 meetings. The second path represents slightly easier monetary policy, but most economic models would suggest that there would be almost no difference in the effect on employment or inflation.
The obsession with when the Fed will act, then, most likely has another motivation: Outsiders are seeking clues to the central bank’s broader goals for monetary policy.
The Fed’s stated aim is to keep inflation at 2 percent over the longer term, but its actions send a different signal. It has, for example, removed stimulus over the past three years even as inflation and inflation expectations have slipped downward. Fed officials’ economic projections, too, suggest that they don’t see getting inflation back up to target quickly as a primary determinant of monetary policy.
Apparently, the Fed is balancing the pursuit of its inflation target with other objectives. In speeches, officials have offered various ideas of what those objectives might be. Some worry that low interest rates are causing risks and distortions to build in the financial system. Some say they don’t want the unemployment rate to fall to an unsustainably low level. Some think that raising rates at every meeting, as opposed to every other meeting, could be too much of a shock for the economy.
How policy makers weigh these considerations against the inflation objective will influence their decision-making not only in June, but also at future meetings and whenever an economic challenge arises. A Fed official concerned about financial market distortions, for example, might not support aggressively lowering interest rates in response to a future recession. It’s hard to know which objectives will dominate policy in the longer run. Hence, markets are parsing the June decision for whatever information they can get.
This kind of uncertainty -- about which goals will define the Fed’s policies -- is not healthy. Consumers and businesses can’t make good decisions if they don’t have a strong enough sense of how the central bank will act in any situation. Fed officials must have -- or be given -- a much clearer set of shared objectives for managing the economy.
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