Fed minutes reveal officials unlikely to cut rates again

What do changes in the Fed’s longer-run goals and monetary strategy statement mean?

Fed minutes reveal officials unlikely to cut rates again

The Federal Open Market Committee (FOMC)—the Federal Reserve governors in Washington and the presidents of the 12 regional Fed banks—first published a Statement on Longer-Run Goals and Monetary Policy Strategy in 2012. That statement included the Fed’s first formal and public commitment to an inflation target of 2 percent.

In 2019, three key economic developments  drove the FOMC to review that framework: First, estimates of the neutral level of interest rates—the level associated with full employment and inflation at target—continued to fall around the world. Second, inflation and inflation expectations continued to remain below the Fed’s 2 percent target.

And third, unemployment fell to a 50-year low. The lower neutral rate means that the short-term interest rates that the Fed influences will generally be closer to (and more often hit) zero than had been previously contemplated—and that gives the Fed little room to cut interest rates in a recession.

The inability to reach the inflation target is one indication that the Fed has insufficient firepower.

The fact that unemployment has reached low levels without inflation is good news, since a strong labor market has widespread benefits, but the lack of an inflation response to low unemployment is another indication that reaching the inflation target might take longer than previously thought.

The Fed released an updated statement at the end of August 2020.

The statement gives Congress, the public, and the financial markets a sense of how the FOMC currently interprets its congressional mandate—to aim for maximum employment and price stability—and the framework it will use to make decisions on short-term interest rates and other monetary policy tools. To compare the old and new Fed statements of long-term goals, see this guide. Going forward, the Fed plans to conduct a review of the statement every five years.

What major change did the Fed make to the statement and its framework regarding inflation?

Congress has given the Fed a mandate to aim for maximum employment and price stability.

Previously, the Fed said its definition of price stability was to aim for 2 percent inflation, as measured by the Personal Consumption Expenditures price index. It described that goal as “symmetric,” suggesting that it was equally concerned about inflation falling below or above that target.

In the new version of the statement, the Fed says it “will ly aim to achieve inflation moderately above 2 percent for some time” after periods of persistently low inflation. Fed Chair Jerome Powell called this strategy “a flexible form of average inflation targeting”—which Fed officials are calling FAIT—in an August 2020 speech at the Fed’s Jackson Hole conference.

Average inflation targeting implies that when inflation undershoots the target for a time, then the FOMC will direct monetary policy to push inflation above the target for some time to compensate.

With this new approach, the Fed hopes to anchor the expectations of financial markets and others that it can and will do what’s needed to get and maintain inflation at 2 percent on average over time.

The new statement does not specify over what period of time the Fed will seek to have inflation average 2 percent or how much over 2 percent it intends to push inflation as part of this “make-up” strategy. Nor does it provide much guidance on the tools or methods that will be used to achieve an inflation target overshoot.

Asked why the Fed hadn’t provided specifics at a Peterson Institute for International Economics event, Fed Board Vice Chair Richard Clarida said: “The statement of longer-run goals and monetary strategy within the Fed is thought of as basically a constitutional—quasi-constitutional document, sort of at the 30,000-foot level of the parameters and objectives.”

What changes did the Fed make regarding its ‘maximum employment’ mandate?

The Fed has long monitored the unemployment rate relative to its projections of the long-run rate of unemployment, also known as the natural rate of unemployment or the non-accelerating inflation rate of unemployment (NAIRU).

The previous consensus statement included a numerical estimate of the NAIRU.

However, given the uncertainty of real-time NAIRU estimates and the fact that the unemployment rate is only one measure of labor market tightness, the NAIRU estimate is no longer included in the statement.

The quarterly Summary of Economic Projections will continue to show FOMC members’ long-run estimates of unemployment (effectively their projections of the NAIRU), but Powell suggested that these estimates will have less impact on policy decisions going forward.

The old statement said the Fed would adjust policy “deviations from its maximum level.” The new one says the Fed will base its decisions on “assessments of the shortfalls of employment from its maximum level.” The change in wording “may appear subtle, but it reflects our view that a robust job market can be sustained without causing an outbreak of inflation,” Powell said.

The FOMC is essentially saying it will not raise interest rates just because the projected unemployment falls below its estimate of the NAIRU unless there are signs of inflation increasing to unwelcome levels.

In practice, this means that the FOMC will allow recoveries to go on unimpeded by monetary policy—even if unemployment rates get very low—as long as inflation remains subdued.

This more inclusive definition of the employment mandate is thought to be especially beneficial to minority groups and low- and moderate-income communities. Research shows that these groups get disproportionate gains from very low unemployment rates.

What does the new Fed statement suggest about the future course of interest rates?

Both major revisions point to easier monetary policy over the next couple of years.

Allowing for low rates of unemployment and inflation overshooting makes it highly unly that the Fed will raise interest rates before inflation has been above 2 percent for some time.

Under the previous framework, projections of unemployment rates below the estimated NAIRU or inflation headed above 2 percent may have each been reasons for the FOMC to hike rates.

Indeed, in his press conference that followed the December 2018 FOMC meeting—the last meeting at which the committee raised interest rates—Powell stated that going into 2018, strong growth had been “predicted to push the unemployment rate down to near historic lows, and the increasingly tight labor market was expected to help push inflation up to 2 percent.

” This expectation, and stronger than expected growth in 2018 in part because of tax cuts, spurred the committee into four rate hikes in 2018.

In a September 2020 speech at the Hutchins Center,  Fed Governor Lael Brainard suggested that the Fed may have acted differently in the post-crisis period under the new statement: “[H]ad the changes to monetary policy goals and strategy we made in the new statement been in place several years ago, it is ly that accommodation would have been withdrawn later, and the [employment] gains would have been greater.” But Janet Yellen, who was Fed Chair during the post-crisis normalization, said, “I think it would have made a small difference. I don’t think it would have made a huge difference.”

A New York Fed survey of primary dealers in July 2020 found that they don’t expect the Fed to raise interest rates until 2024.

What does the revised statement say about financial stability?

In August 2020 , Powell noted the trend that in recent years, “a series of historically long expansions had been more ly to end with episodes of financial instability, prompting essential efforts to substantially increase the strength and resilience of the financial system.”

Given this history, the new statement explicitly addresses financial stability concerns as an important part of the Fed’s mandate. “[S]ustainably achieving maximum employment and price stability depends on a stable financial system.

Therefore, the Committee’s policy decisions reflect its longer-run goals, its medium-term outlook, and its assessments of the balance of risks, including risks to the financial system that could impede the attainment of the Committee’s goals.”

This change elevates financial stability in the Fed’s hierarchy of goals and suggests that, depending on the circumstances, the Fed may consider tightening monetary policy in response to financial stability risks if other tools (such as macroprudential regulatory policies) are inadequate.

However, Brainard prioritized the use of regulatory policy over monetary policy to avoid instability.

“It is vital to use macroprudential as well as standard prudential tools as the first line of defense in order to allow monetary policy to remain focused on achieving maximum employment and 2 percent average inflation,” she said.

What did the Fed not do?

In May 2019, Clarida suggested that the framework review was “more ly to produce evolution, not a revolution, in the way we conduct monetary policy.” This proved accurate.

When it launched the review, the Fed said it would not reconsider the wisdom of a 2% inflation target. Some economists have argued for a higher target.

The Fed did not embrace any of the more far-reaching proposals for an alternative framework, such as nominal GDP targeting, price level targeting, or an inflation target range.

  It ended up instead with something akin to proposals for temporary price level targeting.

The Fed currently relies on three main tools of monetary policy: adjustments to short-term interest rates, forward guidance, and quantitative easing.

Adjustments to the policy interest rate, the federal funds rate, have long been the standard instrument for tightening or loosening the supply of money in circulation, and thus incentivizing economic participants to either save and curtail spending or to borrow and boost spending.

With the policy rate anchored at the effective lower bound, forward guidance—promises about the future path of short-term interest rates—and quantitative easing—large-scale asset purchases by a central bank to put downward pressure on longer-term interest rates—have become integral parts of the FOMC’s attempts to make monetary policy more accommodative. The new statement acknowledges that the future path of monetary policy in the U.S. is ly to be constrained by the effective lower bound with greater frequency.

Other central banks have used additional tools such as negative interest rates and yield curve control to deal with the constraint of the effective lower bound. Current FOMC members believe that negative interest rates are not a desirable option for the Fed.

Yield curve control remains in the toolkit, but not for right now, Fed officials have said. Expanding the Fed’s authority so it can buy corporate bonds in ordinary times, as the European Central Bank and Bank of England can,  would require Congressional approval.

What have been the reactions to the new framework?

The changes in the Fed’s goals statement were consistent with expectations—in part because the process of developing them was so public—so there was little immediate financial market reaction.

There was some disappointment that the committee did not provide information about any new tools to accomplish its goals. As former Fed Governor Larry Meyer put it, “There was essentially no innovation in terms of the FOMC’s tools.

The previous statement said nothing about the Fed’s tools, and the new one says little more.

” On their Money, Banking and Financial Markets blog,  Stephen Cecchetti and Kermit Schoenholtz questioned the credibility of the Fed’s new goals: “Having consistently fallen short of the 2% inflation target since it was announced, why should anyone believe that they can boost inflation above 2% anytime soon?”

At a Hutchins Center event, former Fed Chairs Janet Yellen and Ben Bernanke praised the Fed’s revisions to the framework.

“I think it will strengthen monetary policy,” Bernanke said, because long-term interest rates will reflect market understanding of what the Fed intends to do when the economy recovers from the COVID-19 pandemic. “Makeup policies create a lower-for-longer dynamic.

That, in turn, adds accommodation even while rates remain at zero,” he said.

As for the lack of specificity in the Fed’s new strategy, Bernanke said he expects the Fed to elaborate in the near future: “[T]he statement that they have agreed upon can be thought of as a constitutional statement. I expect that sometime this fall the Fed will come out with explicit forward guidance that will give us some more sense of how they imagine meeting this standard.”

Yellen endorsed the adjustments to both the inflation and employment goals of the Fed, but also acknowledged “they still need to translate this into something more operational. They need some forward guidance about the path of rates and asset purchases.” Yellen also emphasized the importance that the FOMC unanimously endorsed the statement, adding to its credibility.

Given that inflation is below the Fed’s 2-percent target and unemployment is so high due to the COVID-19 pandemic, the changes that the Fed made are not ly to have any big, immediate impact on monetary policy decisions—though it could affect the wording of the Fed’s forward guidance on rates and asset purchases in the near term. But as the economy recovers, the restatement will become more important—and suggests that the Fed will be holding off on tightening monetary policy even if the unemployment rate falls back to where it was before the pandemic and even if inflation is projected to rise above 2 percent.

Источник: https://www.brookings.edu/blog/up-front/2020/09/02/what-do-changes-in-the-feds-longer-run-goals-and-monetary-strategy-statement-mean/

Preview Of The Fed Meeting: 3 Themes To Watch As Economy Moves Past Pandemic

Fed minutes reveal officials unlikely to cut rates again

The Federal Reserve spent last March un any other, axing interest rates to zero at the fastest pace in history and unfurling an unprecedented suite of emergency loans — remarkable moves that symbolized just how crushing the coronavirus pandemic would be for the job market and financial system.

One year later, however, and the U.S. economy looks it’s on track to chart a dramatic reversal, thanks to three vaccines and a second near-$2 trillion stimulus package. The brightest of estimates pencil in a rapid rebound that could be twice as fast as expected.

But as the Federal Open Market Committee (FOMC) gathers for its March 16-17 policy meeting, officials’ main job will be convincing consumers and markets that the work isn’t over and that the tune won’t change, even as the times do.

Fed Chairman Jerome Powell is ly to reiterate in a post-meeting press conference that the bar will still be high for raising interest rates from their rock-bottom levels, to give the economy ample time to run even as some corners of the market fret over rising inflation.

Here’s three main themes that are going to be important for officials (and Fed watchers keeping close tabs on them) as they seek to not only steer the economy past the crisis, but back to the buzzing labor market backdrop that prevailed before the pandemic began.

1. Pay close attention to the Fed’s updated economic projections, then (maybe) throw them out

The Fed’s meeting is expected to be absent of major rate or policy changes, but the most important news will be where officials see the economy — and rates — heading over the next few years.

For the first time since December, the Fed will be updating its Summary of Economic Projections, which contains forecasts for unemployment, inflation and gross domestic product (GDP). A lot of important economic news has happened since then.

That includes President Joe Biden taking office and passing the massive $1.9 trillion American Rescue Plan at the top of his list. Also up there is the $900 billion supplemental coronavirus relief bill. The Fed’s forecasts will illustrate just how much those two bills might shift the outlook.

If private sector commentary is any indication, the impact will be substantial. Morgan Stanley equity strategist Michael Wilson wrote in an early March note to clients that the “recession is effectively over” thanks to the bill’s passage, while a Goldman Sachs report foreshadowed a hiring boom that cut push unemployment down to 4.1 percent.

It wouldn’t be surprising if Fed officials echoed that confidence, upgrading their GDP estimates and lowering their unemployment rate forecasts.

Fed’s dot plot: Will more officials expect a rate hike?

The Fed’s median rate forecast indicates that it isn’t expecting a rate hike through at least 2023. But if four more officials join the five officials who were previously penciling in an increase two years from now, that would shift the median up and essentially become the Fed’s first official forecast of how soon markets could expect them to lift rates.

Market participants won’t, of course, know which dot belongs to whom. But it would still be a remarkable shift, and perhaps more than anything, a powerful display of growing confidence.

A December survey from Bankrate showed that experts are expecting the Fed to hold rates at zero until 2024.

Remember: The Fed doesn’t have a crystal ball

But take those words with a grain of salt. For one, the U.S. economy is in uncharted territory, and the rebound could play out a lot differently than officials expect. Those forecasts show only what the Fed knows right now.

Meanwhile, Powell has underscored relentlessly that the U.S. economy is currently “a long way away” from requiring a rate hike. A new U.S. central bank mandate is also leading officials to prioritize lowering unemployment over curbing inflation.

“It will take some time to get back to maximum employment,” Powell said in a March 4 question-and-answer at a Wall Street Journal symposium. “It took us many years to get there before. And that’ll really just depend on how strongly the economy picks up once we do get past the pandemic and once economic activity picks up and hiring picks up.”

“Just because the economy is going to grow faster than initially expected this year, that doesn’t change that this economic rebound is being driven by stimulus,” says Greg McBride, CFA, Bankrate chief financial analyst. “The Fed has to look beyond just the short-term stimulus influence timeframe to what the economy is going to look on the other side of that.”

Inflation picture: Will the markets and the Fed be off base?

Up in the air, however, is whether the Fed might also upgrade their inflation forecasts — and whether it might lead to jittery investors.

Markets are betting that a faster rate of growth and vaccinations, coupled with massive government spending and rock-bottom interest rates, might be the perfect ingredients.

The 10-year Treasury yield has been steadily rising since the start of 2021.

The rate, which is a benchmark for other types of consumer borrowing (such as the 30-year fixed-rate mortgage) ended February on a high note that many didn’t want to hit: 1.41 percent.

The Fed is saying: Not so fast. To be sure, Powell has been very clear that he does expect prices to rise on some level, but he expects that those increases are ly to be more temporary than sustained.

“If we do see what we believe is ly a transitory increase in inflation where longer-term inflation expectations are broadly stable at levels consistent with our framework and goals, I expect that we will be patient,” Powell said.

2. The Fed might not be ready to provide investors with more clues on how they’re going to calm Treasury yield volatility

Treasury yields kicked off March on the same roller coaster as February.

Investors will naturally be looking for more clarity on whether the Fed might be willing to adjust its bond-buying plans or roll out new emergency steps to keep rates low.

Investors already know that the rate moves caught Powell’s attention, but he said the Fed would be more worried about a persistent tightening in financial conditions rather than an interest rate or price move on one asset.

The Treasury yield pick up is partially happening for good economic reasons. Before the pandemic ripped through the labor market, the 10-year yield hovered around 1.8 percent. Strong economic data might only permit some normalization of rates, which are still very low by historical standards (Back in 2018, for instance, the 10-year yield kicked off at 2.46 percent).

“Powell has apparently disappointed markets by not voicing a willingness to jump into the fray right away,” McBride says.

“The Fed is just going to emphasize that the run-up in yields is consistent with a better outlook for the economy and the prospect for higher inflation, but they’ll continue to be laser-focused on the fact that we have a labor market that is a long way from its pre-pandemic level.”

If officials want the economy to run hot, they might not want to let rates rise too much further, though the threshold at which they’d be uncomfortable is anyone’s best guess. Experts say that’s most ly somewhere around 2 percent.

In those circumstances, the Fed could choose to shift its asset purchases to more longer-dated bonds, which would have more of a stimulative effect on the economy. A more unconventional tool known as “yield curve control” could also be on the agenda, though experts say that’s less ly at this point.

The Fed might also want to preserve the remaining ammunition it has left to stimulate the economy when it’s truly desperate, not to calm investors’ tantrums who, some experts say, might be addicted to being rescued.

“We’ve been conditioned to believe ‘mom and dad’ will bail us out,” says Dominic Nolan, CFA, senior managing director at Pacific Asset Management, referring to the Fed. “2008 is where it started, and in multiple situations since. It wasn’t Bank of America rescuing liquidity, but the Fed.”

3. In the Fed’s eyes, monetary policy is going to be all about looking underneath the economy’s hood

Even if officials do strike a more confident tune, the main message will be that it isn’t time for the Fed to bow the game.

Illustrating perhaps just how hot an economy Powell and Co. might be looking for, the chief central banker in his most pointed remarks yet suggested in a March 4 speech that the Fed won’t be relying on headline numbers when assessing just how strong the economy and labor market is.

“Four percent would be a nice unemployment rate to get to, but it will take more than that to get to maximum employment,” Powell said, adding that officials have a “high standard” for what constitutes full employment. He said officials will also pay close attention to labor force participation rates, the ratio of how many of the working-age labor force is currently employed and then wage growth.

During a semiannual congressional testimony to Congress in February, Powell also preached to lawmakers that actual joblessness was ly twice as high as the headline number, when you take into account just how many have stopped looking for work because of the recession.

Another troubling sign: Rising long-term unemployment. Individuals who’ve been without a job for 27 weeks or more now make up 41.5 percent of the total unemployed, and history suggests that those figures will only keep rising as the labor market remains weak while it climbs the pandemic.

“The labor market is a flat tire, and the little warning light on our dashboard keeps flashing.

We need to put air in the tires,” says William Spriggs, chief economist at the American Federation of Labor and Congress of Industrial Organizations.

“We’re supposed to run the economy at full potential, because every time you don’t reach full potential, it compounds. You compound a smaller economy moving forward.”

What this means for you

Homeowners and those considering refinancing might be fretting the recent pick up in yields, but you haven’t entirely missed your chance to refinance. You should, however, consider whether it’s time to jump on the train now, given the prospect of higher yields down the road with a brighter economic recovery.

Meanwhile, you still have time on your side to take advantage of historically low interest rates by paying off debt, particularly high-cost credit-card borrowing. Those interest rates aren’t as sensitive to short-term fluctuations and are based off of the Fed’s short-term benchmark, the federal funds rate.

Take advantage of key forbearance programs if you’re in rough financial shape. Biden extended a federal student loan forbearance and interest waiver program through September and a federal foreclosure moratorium through June.

When you get your stimulus check, consider using it to fund your emergency savings, pay bills or cover existing debts.

“It’s abundantly clear that short-term rates aren’t going up anytime soon,” McBride says. “Seeing faster economic growth, that’s proof that low rates are working.

Business has to be there before people are going to hire. As the economy continues to grow and expand, that should improve the fortunes of the labor market.

The risk of raising rates is that you curtail that labor market improvement too soon.”

Learn more:

Источник: https://www.bankrate.com/banking/federal-reserve/fomc-what-to-expect/

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