Reading the Federal Reserve’s
Tea Leaves Dot Plots
It is always instructive to look at the materials that the Federal Reserve’s Federal Open Market Committee pumps out, especially their semi-anonymized (hi, Charlie Evans, with your 3% longer-run value) estimates of what the appropriate federal funds rate would be.
Thus we can see, comparing January 2012 when the Federal Reserve began publishing its dot-plots to today, the Federal Reserve collectively and slowly come to recognize current reality. Back at the start of 2012 the FOMC participants all thought that in the “longer run”–which at the beginning of 2012 I take to be next year, 2016–the federal funds rate ought to be back at its normal mid-expansion level, which they all took to be in the 3.75%-4.5% per year range. Today, of course, only one participant (Charles Plosser?) still thinks the federal funds rate ought to be in that range next year, and at the very bottom of it.
And we can see, comparing November 2013 to today, the Federal Reserve stick to its guns as to the anticipated pace of policy tightening set in motion with Ben Bernanke’s mid-2013 announcement that it was time to stop searching for further extraordinary monetary policy actions to boost the economy. The median FOMC participant in November 2013 thought that by the end of 2015 the federal funds rate should by 0.75%, and by the end of next year 1.75%. The median FOMC participant today thinks that by the end of 2015 the federal funds rate should be 0.5-0.75%, and by the end of next year 1.75%-2.00%.
This staying-the-course on the pace of tightening is interesting and somewhat surprising because of two facts. First, only one of the three key cyclical indicators–only the unemployment rate of the triple that is unemployment, labor-force participation, and production relative to projected past trends–has improved at anything like the rate expected. Second, the FOMC’s view of the Wicksellian “neutral” or “natural” nominal short-term safe rate of interest has fallen from a medium value of 4.25% in January 2012 to 4.0% in November 2013 to 3.75% today. If one thinks, as one should, of monetary ease or tightness as deviations from the Wicksellian “neutral” rate, an 0.75% rate as of today is thought to be about the same as a 1.25% rate back three and a quarter years ago.
And, of course, back in 2007 we firmly believed that for a healthy economy near but not beyond full employment, with a 2% per year target inflation rate, the appropriate federal funds rate would be 5%–as it as in 2996-7, as it had been from 1995-1998, before the 1998 decision to ease and the 2000 decision that the economy was overheated. 3.75% is far below that level.
Yet I find myself frustrated by one lack: the meeting participants fail to give their estimates of what the 10-year Treasury bond yield associated with their preferred funds path would be. I don’t know how they think the shifts since 2007 both in the economy and in how we view the economy have affected the “neutral” or “natural” long-term safe interest rate in relation to the short-term rate. So the thinking of FOMC participants remains more opaque to me than I would wish. What is their expectation of the gearing from the short to the long-term interest rate? And at what short-term interest rate do they expect the yield curve to invert? (Of course, even if I knew their implicit appropriate 10-year bond yield forecasts, much of their thinking would still remain opaque–only less opaque).