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Wednesday, September 20, 2006

Fed Watch: Unsatisfying

Tim Duy is unhappy with today's statement from the FOMC concerning their decision to leave the target interest rate unchanged:

Unsatisfying, by Tim Duy: Like almost everyone, I was expecting policy to remain essentially unchanged at the conclusion of today’s FOMC meeting. Still, I was left unsatisfied by the accompanying statement, posted by Mark Thoma. At best, its brevity makes it look straightforward. At worst, it looks like something cobbled together because FOMC members were unable to reach a uniform opinion on the state of the economy.

First, note the single sentence paragraph describing the state of the economy. In August, the FOMC concluded that “growth has moderated.” That was a definitive conclusion about the state of activity. Now the “moderation appears to be continuing. [emphasis added]” Not so definitive, and suggests that not everyone on the FOMC believes that the second quarter slowdown will intensify or even continue – despite the growing housing slowdown, which they acknowledge by dropping the “gradual” modifier. Moreover, they only mention the housing slowdown in explaining why the economy “appears” to be moderating. If that was the only factor they are looking at, wouldn’t you expect a more definitive forecast? As Jim Hamilton reminds us, you can’t exactly miss the relationship between housing and recessions. If housing is your focus, cut rates now! They didn’t cut rates, so there must be more. So where is the rest of their analysis? What are the factors that offset the housing slowdown? Inquiring minds want to know.

OK, so they don’t completely know which way the economy is headed; not entirely unexpected, given that the US economy is almost certainly at an inflection point (although I like to see a bit more confidence from my central bankers, or at least another explanatory sentence). But I would expect the Fed to have a better handle on the inflation situation. Unfortunately, the third paragraph doesn’t leave me very confident on that front either. In the first sentence, energy prices have the “potential to sustain inflation pressures.” In the second sentence, inflation pressures are likely to moderate due to the “reduced impetus from energy prices.” What? WHAT!?! Are energy prices contributing to inflation or not? Shouldn’t the FOMC have an opinion on the impact of energy prices on inflation?

I think the FOMC is trying to say that high energy prices are worrisome, but with oil prices down, or at least stabilizing, the amount of pass through should be easing. That is the generous interpretation, and they could have said it a bit more directly. But it could be that some members do not believe that stabilizing energy prices will have a moderating impact on inflation – Richmond Fed President Jeffrey Lacker is holding firm to his conviction that rates need to be even higher. Presumably, he doesn’t agree with the FOMC statement. I doubt he is alone. In any event, this mixed message stuff is not exactly credibility enhancing.

Interestingly, the early comments from economists at the Wall Street Journal website do not mention the mixed message on energy. I understand that it is in vogue to cut the Fed slack over their communication “strategy,” but I would prefer that someone was willing to hold the Board’s feet over the fire.

Bottom line: The Fed remains on hold, on average more worried about inflation and less worried about growth than market participants. I believe the statement is muddled and reflects a lack of consensus; more to the point, this statement is simply a minor league effort. The more I read it, the more irritated I get.

Am I just irritable and over-reacting? Maybe I should just be happy that rates were held steady.

Update: William Polley and New Economist have more on the information value of the FOMC statement.

    Posted by on Wednesday, September 20, 2006 at 02:17 PM in Economics, Fed Watch, Monetary Policy | Permalink  TrackBack (1)  Comments (11)


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    Judging by their reaction, markets were disppointed by yesterday's FOMC statement. Sure it left the US Fed funds rate unchanged at 5.25%, as expected - but the statement gave no clear indication of future direction. FT investment editor John Authers di... [Read More]

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