The Federal Reserve Retires to Its Tent…: Morning Note on Tim Duy

October 30, 2014

A very interesting piece by Tim Duy on the recently-concluded Federal Reserve FOMC meeting. The precis: the Federal Reserve does not view itself as moving to tighten policy, but rather as moving to a policy that is still extraordinarily stimulative–especially considering the level of the unemployment rate.

If the unemployment rate were the only piece of information we had available, I would understand the FOMC’s position. But I see 2%/year wage growth. I see a prime-age employment-to-population ratio that is still extremely low, I see Japan where Abenomics hangs in the balance and a Eurozone where a triple dip is a 50-50 chance, I see the continued failure of the Obama Administration to fill Governor slots and the resulting rightward bias of the FOMC voices…

Either the FOMC consensus or I am greatly misreading the current macroeconomic situation. It may well be me. But I do not think so…

Tim Duy: FOMC Recap: “To the extent there were any surprises, they were on the hawkish side…. The Fed dismissed the decline in market-based inflation expectations. They clearly believe financial markets over-reacted to the decline in oil prices, and that that decline would ultimately prove to be a one-time price shock rather than the beginning of a sustained disinflationary process. This is why we watch core-inflation. And note that the Fed sent a pretty big signal… they do not hold market-based measures of inflation expectations as the Holy Grail. Especially with unemployment below 6%, pay more attention to survey-based measures. And recognize they will discount even those if they feel they are unduly affected by energy prices….

I have trouble imagining a scenario in which the Fed is content to watch unemployment fall below 5.5% without at least beginning the rate hike cycle. Remember that they think that even as they increase rates, they believe that policy will continue to be accommodative. In other words, they do not fear raising rates as necessarily a tightening of policy. They will view it as a necessary adjustment in financial accommodation in response to a decline in labor market slack. Hence the line:

The Committee currently anticipates that, even after employment and inflation are near mandate-consistent levels, economic conditions may, for some time, warrant keeping the target federal funds rate below levels the Committee views as normal in the longer run…

October 30, 2014

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