Eight Takeaways From This Week’s Fed Meeting
Here are eight takeaways from the Federal Open Market Committee meeting that took place on Sept. 19 and 20.
- Balance-sheet reduction will be as unexciting as possible, and for good reason. In announcing that the process will begin next month, central bankers hope that a highly gradual and highly predictable approach will lower the risk of market disruptions that could harm economic growth. This would be another element of the ongoing “beautiful normalization” of unconventional monetary policy, in which the reversal of quantitative easing would be presented to markets as the equivalent of watching paint dry.
- Quantitative easing is no longer an active policy tool, but it remains in the toolbox. Chair Janet Yellen said large-scale asset purchases would no longer be viewed as a front-line instrument for the Fed. Nonetheless, she reminded markets -- and will continue to do so -- that the tool would remain available in the event of a serious economic downturn or severe financial dislocations.
- The possibility of a December rate hike is higher than markets had priced in. By reiterating that several FOMC members still have another hike in 2017 on their radar screens, the central bank succeeded in moving up the markets’ implied probability of a year-end rate increase by more than 20 percentage points (to more than 60 percent). Bond yields and the dollar followed.
- The Fed is more comfortable about the state of the labor market. In welcoming continued solid job creation, Yellen suggested that the persistence of the labor participation rate at a relatively low historical level is more an indication of structural changes than of cyclical slack. As such, and as important as it is for both economic and social reasons to increase the rate, labor participation is now seen as less sensitive to the influence of loose monetary policy. With that, and on the assumption that higher wage growth will follow, the Fed is very close to declaring victory on the “maximum sustainable employment” component of its dual mandate.
- It’s less worried about global risks. With a synchronized, albeit still relatively subdued, growth pickup in Asia and Europe, and with lower political risk in France and Germany, Fed officials no longer think of international developments as constituting a major headwind to U.S. economic well-being and financial stability.
- The inflation puzzle remains. Like others, Fed officials have yet to come up with a good explanation of lowflation, defined as unusually low inflation in the context of significant declines in the unemployment rate and persistently loose financial conditions. Yet the central bank continues to place a lot of policy focus on the shortfall in actual and expected inflation relative to the 2 percent target.
- The Fed remains reluctant to talk openly about the risks to financial stability. Consistent with the conventional view that financial stability considerations should be left to macro-prudential measures, the Fed continues to sidestep the notion that a protracted period of monetary stimulus may increase the risk of unsettling financial instability that would threaten economic well-being.
- Structural factors weigh on the long-term neutral interest rate: While the Fed is working on raising short-term market expectations for interest-rate levels, it is converging its medium projection for the equilibrium neutral rate closer to where markets are. In doing so, it is acknowledging the impact of durable structural changes whose implications go well beyond monetary policy.
As important as these eight takeaways are, they should not detract from the broader “unusual uncertainty” that the Fed and other central banks face. These include an insufficiently robust understanding of key economic relationships, with important gaps not only with respect to inflation dynamics, but also the determinants of productivity and wages. There are also growing questions about both the risk of financial instability and whether 2 percent remains the appropriate target to specify for the “price stability” component of its dual mandate. But these deeper issues will be left for subsequent articles.
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