Explicit Fed
The Fed has shocked some people today. I don’t think it shocking at all. I see today’s announcements as the continuance of a trend, so the shock is not so significant as others seem to think. Still things are different now.
The shift people are focusing on is the explicit nature of the Fed’s targeting. From here on out we are all clearly aware of what will drive Fed activity: it’s goals are an unemployment rate of 6.5% or less, and an inflation rate of 2.5%. Not only this but the Fed has made it clear that it will work to keep interest rates at their current low levels until the unemployment rate gets to that 6.5% level, which is not expected to be until sometime in 2015.
From my point of view, the Fed has been edging towards this kind of policy clarity for while. I think Bernanke’s legacy at the Fed will be more about his willingness to be transparent than anything else. After all he was one of those mistaken about monetary policy and the economy before the crisis: his abject adulation of Milton Friedman is a fitting epitaph for a who generation of failed economists.
But the shock being expressed in some quarters, notably on Wall Street, is out of order.
In those circles the Fed is being seen as suddenly siding with the unemployed while abandoning its time honored pursuit of stable prices to boot. It’s as if the Fed were going to allow inflation to rise suddenly.
This is nonsense for two reasons.
First, the Fed has a dual mandate. It was always supposed to be pursuing full employment – however that is calculated, and it was always supposed to pursue stable prices. Both at once. In recent decades, though, the Fed, like most central banks, forgot the unemployed and focused relentlessly on inflation. This meant quite often that it looked as if it were ignoring half its mandate. So, by being explicit about its unemployment target, the Fed is merely being true to its charter. There is no news other than the Fed has finally woken up to its social mission.
Second, and this is more practical, there is no threat of inflation. This must be driving ‘austerian’ and orthodox economists nuts. In their world, all the Fed’s extravagant support of the economy ought to be showing up as inflationary pressure. All that new money is supposed to be causing hyperinflation. This is a common claim from the right and is often used to try to dampen down efforts to stimulate the economy. It is also laughable. At some point, no doubt, the endless cries of imminent inflation from this crowd will prove to be correct. Whether that is any time in this century I have no idea. But like the proverbial broken clock they’ll get it right at least once. At the moment, though, they lack any credibility. Their theories have been so thoroughly debunked by circumstances that it is a wonder they are employed at all. Still they infest Wall Street where, as we know, being incorrect or ignorant is no barrier to profit or career progression.
So the Fed hasn’t abandoned the fight against inflation because there isn’t any to fight against. Nor has it suddenly lurched into the arms of the unemployed because it as always supposed to be on their side anyway.
No.
The boldness of today’s Fed actions is simply that it’s being clear about its intentions, its actions, and its operations. It is thus helping clarify the environment for business community, who as we all know, prattles on endlessly about how vague everything is and how that vagueness prevents them from doing anything – like investing in America.
Calling that bluff is a good thing for all of us. Well done Fed.
Our newly explicit Fed.
