The FOMC will reveal the outcome of this week's meeting later today. I think Calculated Risk hits the high points - "patient" is in, "considerable time" is completely out. Beyond this, we will be looking for clues on how the Fed is interpreting the current economic environment. I suspect little change in the overall tenor of the statement as they will want to leave June open as an option. I reiterate my position: The Fed needs to see an acceleration in wage growth to be confident that inflation will return to trend if they intend to raise rates in June.
Why is the Fed focused on normalizing policy? This is one explanation I see tossed around, from Jeffrey Gunlock via Reuters:
"The Fed seems to want to raise interest rates simply because they don't want to be at zero when the next recession occurs," he said.
A similar statement from the Economic Cycle Research Institute:
In this context, ECRI explains the reasons for the declines in both measures, but also why they may ultimately not be that important to the timing of rates hikes. Above all, the Fed wants to remain relevant in case the economy is hit by recessionary shocks that require interest rates to return to the zero-lower-bound (ZLB). By definition, once on the ZLB, they need to rise before they can fall again.
I don't think these are accurate representations of Fed thinking. The Fed recognizes that hiking rates prematurely to "give them room" in the next recession is of course self-defeating. They are not going to invite a recession simply to prove they have the tools to deal with another recession.
The reasons the Fed wants to normalize policy are, I fear, a bit more mundane:
- They believe the economy is approaching a more normal environment with solid GDP growth and near-NAIRU unemployment. They do not believe such an environment is consistent with zero rates.
- They believe that monetary policy operates with long and variable lags. Consequently, they need to act before inflation hits 2% if they do not want to overshoot their target. And they in fact have no intention of overshooting their target.
- They do not believe in the secular stagnation story. They do not believe that the estimate of the neutral Fed Funds rate should be revised sharply downward. Hence 25bp, or 50bp, or even 100bp still represents loose monetary policy by their definition.
I am currently of the opinion that there is a reasonable chance the Fed is wrong on the third point, and that they have less room to maneuver than they believe. If so, they will find themselves back at the zero bound in the next recession, very quickly I might add. This is not their expectation. They expect to remain relevant in the next recession and do not believe they need to quickly raise rates to achieve relevance. Again, they know this is self-defeating.
Whether or not they can maintain their mid-year target is of course the topic du jour. But the logic of those who believe the Fed will not have what it needs in June and thus expect the first hike much later is more convincing than those who argue that they will raise rates due to some pressing need to prepare for the next recession.