Must-read: Tim Duy: “Fed Yet to Fully Embrace a New Policy Path”

Must-Read: Tim Duy: Fed Yet to Fully Embrace a New Policy Path: “The Fed will take a pause on rate hikes. An indefinite pause…

…The sooner they admit this, the better off we will all be. Indeed, the sooner they admit this, the sooner financial markets will calm and the sooner they would be able to resume hiking rates. Federal Reserve Chair Janet Yellen had two high profile opportunities this week to make such an admission. Yet she failed to do so….

By the end of 2015, the economy was near full-employment…. A combination of factors would work in tandem to slow activity… higher dollar, higher inflation, higher wages, and higher short term interest rates (tighter monetary policy). How much monetary policy tightening is consistent with the new equilibrium depends on the evolution of the other prices. A reasonable baseline at the end of last year was that 100bp of tightening would be consistent with achieving full-employment. That was the Fed’s starting point as well….

A key factor in keeping the US economy on the rails is acknowledging that tightening financial conditions via the dollar obviates the need to tightening conditions via monetary policy…. But the Fed has yet to fully embrace this story. And that leaves them sounding relatively hawkish…. Yellen & Co. don’t need to emphasize the direction of rates. They just can’t stop themselves. Worse yet, they feel compelled to describe the level of future rates via the Summary of Economic Projections. A level entirely inconsistent with signals from bond markets, no less. They don’t really know what the terminal fed funds rate will be, so why keep pretending they do? The ‘dot plot’ does nothing more than project an overly-hawkish policy stance that leaves market participants persistently fearful a policy error is in the making. It is time to end the ‘dot plot.’ 


Brad DeLong


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