The Fed Is Losing Focus of Its Primary Mandates

Core leadership at the Federal Reserve appears determined to normalize policy via interest-rate hikes and balance-sheet reduction. But they have run up against a significant roadblock because the inflation data stubbornly refuse to cooperate with their forecast. Don’t expect that to deter leaders of the U.S. central bank just yet. They generally view the inflation weakness as transitory. A labor market circling around full employment serves as the justification they need to keep their foot on the brake.

And if that weren’t enough, they can pivot their focus toward financial stability. Indeed, that’s already under way. But be warned: That road will almost certainly lead to excessive tightening. In it you can see one path by which this expansion comes to an end.

The inflation data has disappointed in recent months, pulling the annual rate lower and away from the Fed’s target. But that did not stop the bank from raising rates in June, setting the groundwork for balance-sheet reduction, or holding steady the projected path of future rate increase in their summary of economic projections. Instead, they dismissed the inflation shortfall as a temporary setback and focused on the medium-term forecast. A helpful focus given that the inflation forecast always reverts to 2 percent.