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December 21, 2012

Try, Try Again

As a regular, satisfied customer of The Wall Street Journal's "Heard on the Street" feature, I was a bit distressed to read this, from an item titled "Bonds Beware Central Bank Regime Change":

In the U.S., the Federal Reserve has announced that future monetary policy tightening will depend on a hard target for falling unemployment and a softer target for rising inflation expectations. That looks like a tilt toward growth as the priority over inflation.

When The Financial Times and The Wall Street Journal in quick sequence publish articles that seem to misinterpret Fed communications, I have to surmise that the message isn't getting through and bears repeating and further explaning.

Earlier this week, in response to the alluded-to FT article, I addressed the charge of a "tilt toward growth as the priority over inflation," noting that Fed Chairman Ben Bernanke clearly indicated in last week's press conference that there has been no "change in our relative balance, weights towards inflation and unemployment...."

It is true that the Committee's threshold for considering policy action was expressed in terms of a realized value for unemployment and a forecast value for inflation. But that choice, as the Chairman explained in that press conference, was motivated by the nature of the two different statistics:

... the Committee chose to express the inflation threshold in terms of projected inflation between one and two years ahead, rather than in terms of current inflation. The Committee took this approach to make clear that it intends to look through purely transitory fluctuations in inflation, such as those induced by short-term variations in the prices of internationally traded commodities, and to focus instead on the underlying inflation trend.

More importantly, the plan is not to ignore the incoming data and rely solely on internal Committee forecasts:

In making its collective judgment about the underlying inflation trend, the Committee will consider a variety of indicators, including measures such as median, trimmed mean, and core inflation; the views of outside forecasters; and the predictions of econometric and statistical models of inflation. Also, the Committee will pay close attention to measures of inflation expectations to ensure that those expectations remain well anchored.

Even more important, in my view, this broad approach to assessing price-stability conditions is also the approach the Chairman described in thinking about the allegedly hard target for the unemployment rate:

... the Committee recognizes that no single indicator provides a complete assessment of the state of the labor market and therefore will consider changes in the unemployment rate within the broader context of labor market conditions.

It is fair to point out the difficulties that can arise in implementing this policy strategy in the real time, real messy world. And if you doubt that the Committee is as good as its word, there is probably not much I can say that will convince you otherwise. But we ought to at least take care in being clear what the Committee's word actually is.

Dave AltigBy Dave Altig, executive vice president and research director at the Atlanta Fed

 


December 21, 2012 in Federal Reserve and Monetary Policy, Monetary Policy | Permalink

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Comments

David: Think about that headline "Bonds Beware Central Bank Regime Change".

That is precisely the message we want the bond market to hear. We want the people holding bonds and money to sell their bonds and money and buy real goods instead, to increase Aggregate Demand. So if the Fed is not saying that, then the Fed ought to be saying that. And if the bond market has indeed misinterpreted the Fed, we ought to be very glad it has misinterpreted the Fed.

Posted by: Nick Rowe | December 22, 2012 at 07:16 AM

Note their words of "softer inflation target". Despite the fact that the Fed has been saying for some time that the 2% target was symmetric, everyone on Wall Street considered the target to be a 2% inflation *ceiling*. The 2.5% threshold of the new rule is an explicit ceiling.

If the Fed was telling the truth before about the previous target being symmetric, then you are correct that the Fed isn't changing its priorities. But if 2% really was a ceiling, then it really is a change.

Posted by: Redwood Rhiadra | December 22, 2012 at 01:56 PM

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