“Entre les deux, mon coeur balance”

This is the imaginary scale that hangs over the center of the FOMC´s meeting table.

Entre les deux

Unemployment and inflation are the two objects on the scale. The Fed wants to keep the scale “balanced”. For that purpose, it has a policy framework best described as “gradual normalization”.

As Janet Yellen said last September, telegraphing a rate increase in the near future:

“But we are getting closer. The labor market has improved. And as I’ve said in the past we don’t want to wait until we’ve fully met both of our objectives to begin the process of tightening policy given the lags in the operation of monetary policy.”

In other words, it wants to be able to “normalize gradually”. The “link” between the two plates of the scale is the Phillips Curve/NAIRU subscribed by several FOMC members, according to which, “too little” rate of unemployment will shift the inflation plate up, maybe abruptly, forcing the FOMC to abandon the “gradual” half of the framework!

But there are tensions. According to this Binyamin Appelbaum piece in the NYT:

One wing of the Fed sees an undiminished case for raising rates.

Esther L. George, president of the Federal Reserve Bank of Kansas City and one of the 10 Fed officials voting on the direction of policy this year, said this week that the Fed “should continue the gradual adjustment of moving rates higher to keep them aligned with economic activity and inflation.”

She also played down concerns about the economic impact of recent market volatility. “While taking a signal from such volatility is warranted,” she said, “monetary policy cannot respond to every blip in financial markets.”

Loretta J. Mester, president of the Federal Reserve Bank of Cleveland and another voter, said on Thursday in New York that it was “premature” to change her economic outlook.

“At this point, solid labor market indicators, including strong payroll growth, and healthy growth in real disposable income, suggest that underlying U.S. economic fundamentals remain sound,” Ms. Mester said. “Until we see further evidence to the contrary, my expectation is that the U.S. economy will work through the latest episode of market turbulence and soft patch to regain its footing for moderate growth.”

Other Fed officials, however, say the volatility has given them pause.

William C. Dudley, president of the Federal Reserve Bank of New York and a close adviser to Ms. Yellen, said in an interview with Market News International this week that he was worried about the economic impact of jittery markets.

“If those financial conditions were to remain in place by the time we get to the March meeting, we would have to take that into consideration in terms of that monetary policy decision,” Mr. Dudley said.

And Lael Brainard, a Fed governor who has been particularly outspoken in warning that global pressures will weigh on domestic growth, told The Wall Street Journal this week that “recent developments reinforce the case for watchful waiting.”

Investors, oddly, have walked away from this debate feeling confident that the Fed will not raise rates in March. Indeed, asset prices tied to expectations about the future level of short-term interest imply only about a 50 percent chance of any rate increase this year.

That contrasts sharply with the Fed’s own prediction in December that it planned to raise rates by about one percentage point in 2016, most likely in four discrete steps.

Many analysts have taken a more measured position, predicting that the Fed is less likely to move in March, but that it will still raise rates two or three times this year.

Michael Gapen, chief United States economist at Barclays, said on Friday he now expected the Fed to raise rates twice, instead of three times, and to start in June, instead of March.

Michael Feroli, chief United States economist at JPMorgan Chase, said the continuation of low inflation probably meant Fed policy makers would hesitate at their next session.

“Were the meeting held tomorrow, we still think the Fed would stay on hold — primarily because of concerns about inflation and inflation expectations,” he said. “But it would be an uncomfortable hold.

Uncomfortable, indeed! But that has to do with the policy framework adopted.

4 thoughts on ““Entre les deux, mon coeur balance”

  1. Pingback: Ester and Mester Are The Fed – NGDP Advisers

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