Home » Business » Biz Commentary
Fed's wordplay to cast little impact
By Caroline Baum |
January 18, 2012, Wednesday
|
Print Edition
Print Edition
A forecast is a forecast. In many cases, it's not worth the paper it's printed on.
Some forecasts are more important than others, which is not to say they're more accurate, just that they matter more. The US Federal Reserve's forecasts belong in this category.
Unlike the average Wall Street prognosticator, the Fed has the unique ability to make its forecast become reality through its manipulation of the federal funds rate and control of the monetary base. That's why the Fed's forecasts, and what's required to achieve them, matter.
Starting with the January 24-25 meeting, we will learn for the first time what funds rate is associated with the Fed's projections for inflation, unemployment and real gross-domestic-product growth in the current year, the next few calendar years and "over the longer run," according to minutes of the December 13 meeting.
Opposite effect
"Over the longer run" can only mean the rate that will keep the economy growing at its non-inflationary potential in perpetuity, otherwise known as the neutral funds rate. It will be an interesting academic exercise to see what neutral rate the Fed expects to yield real GDP growth of 2.4 percent to 2.7 percent; an unemployment rate of 5.2 percent to 6 percent; and inflation of 1.7 percent to 2 percent - the central bank's current long-term targets. How this will affect investment and spending decisions in the short run remains to be seen.
The argument in favor of greater transparency on the expected interest-rate path is that it provides greater clarity and certainty for business investment.
It could have the opposite effect. If the Fed projects slow growth, elevated unemployment, benign inflation and a funds rate of zero to 0.25 percent through 2014, businesses might be lulled into inaction. Why invest now? What's the rush? My widgets aren't flying off the shelf, and everything I read says consumers don't have the wherewithal to spend.
Transparency is better than the alternative. Still, one can envision potential landmines down the road.
For starters, forecasting is an art, not a science. What happens when the Fed is forced to reverse its accommodative policy quickly because inflation isn't behaving as it's supposed to, inflation expectations lose their mooring, the US economy gathers steam, or signs of froth appear in some asset market, the product of years of near-zero interest rates? Goodbye, certainty; hello, volatility.
Second, even in the normal course of the business cycle, projecting a higher funds rate may have untoward consequences.
"It's a tricky situation going forward, when the time comes to start normalizing policy and the Fed reveals projections of a rising funds rate," says Dana Saporta, a US economist at Credit Suisse in New York. "We could get an outsized, undesirable market response: one of the risks of enhanced transparency."
Would other short-term rates adjust instantaneously? What about long-term rates?
"The markets are looking at the same data as the Fed," says Scott Sumner, a professor of economics at Bentley University in Waltham, Massachusetts.
In other words, the Fed will be behind the curve.
Finally, the Fed is opening itself up to increased political pressure. Some members of US Congress may not see the need for higher interest rates, telegraphed by the Fed, at a time when unemployment is unacceptably high.
That said, it's "a tiny baby step forward and better than what the Fed did in August," which was to make an unconditional pledge to hold the funds rate near zero at least until mid-2013, Sumner says.
Under the new procedure, which is "not a very precise or effective tool," the promise about the funds rate is at least "contingent on an outcome for the economy."
The biggest problem with the Fed's elevation of communication to the level of policy tool is that it's a poor substitute for the real thing. Just because short-term rates are close to zero doesn't mean the Fed is out of bullets.
As I wrote in a column two months ago, the Fed has a powerful tool in the printing press. If policy makers determine that more stimulus is warranted, and I'm not saying it is, they should crank up the presses.
Everything else is window dressing - and some of it more effective than mere talk.
Focusing on the rudder
Want banks to lend? Stop paying them 0.25 percent interest on the US$1.5 trillion they're holding on deposit at the Fed as excess reserves. Better yet, charge them a fee for holding those deposits.
David Beckworth, an economist at Texas State University in San Marco, compared the new strategy to a ship's captain focusing on the rudder instead of the destination. Both he and Sumner advocate targeting nominal GDP. The decline in NGDP in 2008 and 2009, the biggest since the Great Depression, was a sign that monetary policy was too tight.
When the economy experiences a deep contraction, the presumption is that for any given increase in nominal income, the split between growth and inflation will favor the former.
For the moment, the Fed seems content to tinker around the edges.
"Why did the Fed put all this effort into this maybe-it-adds-something policy" when it could do something that really makes a difference? Beckworth asks.
Answer: Transparency is good. Talk is cheap. It won't do much harm. The unintended consequences can be dealt with later.
Caroline Baum is the author of "Just What I Said." She is a Bloomberg View columnist.
Some forecasts are more important than others, which is not to say they're more accurate, just that they matter more. The US Federal Reserve's forecasts belong in this category.
Unlike the average Wall Street prognosticator, the Fed has the unique ability to make its forecast become reality through its manipulation of the federal funds rate and control of the monetary base. That's why the Fed's forecasts, and what's required to achieve them, matter.
Starting with the January 24-25 meeting, we will learn for the first time what funds rate is associated with the Fed's projections for inflation, unemployment and real gross-domestic-product growth in the current year, the next few calendar years and "over the longer run," according to minutes of the December 13 meeting.
Opposite effect
"Over the longer run" can only mean the rate that will keep the economy growing at its non-inflationary potential in perpetuity, otherwise known as the neutral funds rate. It will be an interesting academic exercise to see what neutral rate the Fed expects to yield real GDP growth of 2.4 percent to 2.7 percent; an unemployment rate of 5.2 percent to 6 percent; and inflation of 1.7 percent to 2 percent - the central bank's current long-term targets. How this will affect investment and spending decisions in the short run remains to be seen.
The argument in favor of greater transparency on the expected interest-rate path is that it provides greater clarity and certainty for business investment.
It could have the opposite effect. If the Fed projects slow growth, elevated unemployment, benign inflation and a funds rate of zero to 0.25 percent through 2014, businesses might be lulled into inaction. Why invest now? What's the rush? My widgets aren't flying off the shelf, and everything I read says consumers don't have the wherewithal to spend.
Transparency is better than the alternative. Still, one can envision potential landmines down the road.
For starters, forecasting is an art, not a science. What happens when the Fed is forced to reverse its accommodative policy quickly because inflation isn't behaving as it's supposed to, inflation expectations lose their mooring, the US economy gathers steam, or signs of froth appear in some asset market, the product of years of near-zero interest rates? Goodbye, certainty; hello, volatility.
Second, even in the normal course of the business cycle, projecting a higher funds rate may have untoward consequences.
"It's a tricky situation going forward, when the time comes to start normalizing policy and the Fed reveals projections of a rising funds rate," says Dana Saporta, a US economist at Credit Suisse in New York. "We could get an outsized, undesirable market response: one of the risks of enhanced transparency."
Would other short-term rates adjust instantaneously? What about long-term rates?
"The markets are looking at the same data as the Fed," says Scott Sumner, a professor of economics at Bentley University in Waltham, Massachusetts.
In other words, the Fed will be behind the curve.
Finally, the Fed is opening itself up to increased political pressure. Some members of US Congress may not see the need for higher interest rates, telegraphed by the Fed, at a time when unemployment is unacceptably high.
That said, it's "a tiny baby step forward and better than what the Fed did in August," which was to make an unconditional pledge to hold the funds rate near zero at least until mid-2013, Sumner says.
Under the new procedure, which is "not a very precise or effective tool," the promise about the funds rate is at least "contingent on an outcome for the economy."
The biggest problem with the Fed's elevation of communication to the level of policy tool is that it's a poor substitute for the real thing. Just because short-term rates are close to zero doesn't mean the Fed is out of bullets.
As I wrote in a column two months ago, the Fed has a powerful tool in the printing press. If policy makers determine that more stimulus is warranted, and I'm not saying it is, they should crank up the presses.
Everything else is window dressing - and some of it more effective than mere talk.
Focusing on the rudder
Want banks to lend? Stop paying them 0.25 percent interest on the US$1.5 trillion they're holding on deposit at the Fed as excess reserves. Better yet, charge them a fee for holding those deposits.
David Beckworth, an economist at Texas State University in San Marco, compared the new strategy to a ship's captain focusing on the rudder instead of the destination. Both he and Sumner advocate targeting nominal GDP. The decline in NGDP in 2008 and 2009, the biggest since the Great Depression, was a sign that monetary policy was too tight.
When the economy experiences a deep contraction, the presumption is that for any given increase in nominal income, the split between growth and inflation will favor the former.
For the moment, the Fed seems content to tinker around the edges.
"Why did the Fed put all this effort into this maybe-it-adds-something policy" when it could do something that really makes a difference? Beckworth asks.
Answer: Transparency is good. Talk is cheap. It won't do much harm. The unintended consequences can be dealt with later.
Caroline Baum is the author of "Just What I Said." She is a Bloomberg View columnist.
- About Us
- |
- Terms of Use
- |
-
RSS - |
- Privacy Policy
- |
- Contact Us
- |
- Shanghai Call Center: 962288
- |
- Tip-off hotline: 52920043
- 沪ICP证：沪ICP备05050403号-1
- |
- 互联网新闻信息服务许可证：31120180004
- |
- 网络视听许可证：0909346
- |
- 广播电视节目制作许可证：沪字第354号
- |
- 增值电信业务经营许可证：沪B2-20120012
Copyright © 1999- Shanghai Daily. All rights reserved.Preferably viewed with Internet Explorer 8 or newer browsers.
