Morning Must-Read: Tim Duy: While We Wait For Yet Another FOMC Statement

Given the inability of the Federal Reserve to attain traction at the ZLB, its current frame of mind–which appears to be doing certainty-equivalence policy–makes no sense to me. Certainty-equivalence is appropriate only with a symmetric loss function and a symmetric ability to compensate for deviations on either side of the target. We do not have either of those.

Has there been an explanation of why the Federal Reserve’s policy is appropriate given the asymmetry of the loss function and the asymmetry of the control levers that I have missed? If so, where is it?

…to ‘give them room’ in the next recession is of course self-defeating. They are not going to invite a recession simply to prove they have the tools to deal with another recession. The reasons the Fed wants to normalize policy are, I fear, a bit more mundane: (1) They believe the economy is approaching a more normal environment with solid GDP growth and near-NAIRU unemployment. They do not believe such an environment is consistent with zero rates. (2) They believe that monetary policy operates with long and variable lags. Consequently, they need to act before inflation hits 2% if they do not want to overshoot their target. And they in fact have no intention of overshooting their target. (3) They do not believe in the secular stagnation story. They do not believe that the estimate of the neutral Fed Funds rate should be revised sharply downward. Hence 25bp, or 50bp, or even 100bp still represents loose monetary policy by their definition. I am currently of the opinion that there is a reasonable chance the Fed is wrong on the third point, and that they have less room to maneuver than they believe.