Source: Fed Reserve Bank of St. Louis, “Perspectives on the Current Stance of Monetary Policy”
The job of the Federal Reserve is ‘to take away the punch bowl just as the party gets going’ as one Fed Chairman once said. Typically the process has started with a hike in short-term interest rates, a step toward the exit with the punch bowl in hand indicating the economic party was getting raucous. Never in the past has the Fed sounded a bell or yelled ‘last call!’ before the bar closed. The concept of exit in a zero interest rate environment is a different beast, however, and St. Louis Fed President James Bullard just gave us the equivalent of a last call in his remarks last week in New York.
A couple of takeaways from Bullard’s comments that are meaningful:
- The Fed decided to remove dates in favor of threshold values of inflation and unemployment for policy guidance because the board was concerned forward dates were sending an unintentionally pessimistic signal. That is, the economy is more robust than the Fed has been signaling.
- “Ordinary” monetary policy would justify a rate hike in August 2013 if the Fed were working strictly from the Taylor rule (only accounting for inflation, the output gap and unemployment). That is, the Fed seems to be indicating that markets should prepare for the back end of the yield curve (where the Fed has distinctly less control over rates) to back up sooner than later.
- In order to achieve optimal monetary accommodation during a period of zero interest rates, the Fed will soon enter a ‘Woodford Period,’ whereby policy will remain low far past the point ordinary Fed behavior would dictate a hike. This is just another way of saying the Fed believes the economy needs to be chugging along fast enough for interest rate changes to actually work (think wind resistance and parachutes):
We’ve combined this data with the shifting projections of Fed participating board members to better show why else guidance may have shifted from the ‘unintentionally pessimistic’ time frame of mid-2015 to something more specifically likely to occur well before that. Depicted below are participant’s projections of unemployment and inflation, from both September and December 2012 meetings; in light of these views, we’re not surprised the Fed – the taker-in-chief of the punchbowl – just issued the last call for drinks:
Figure 1 – Distribution of FOMC participants’ projections for unemployment rate, 2012-15
Source: Federal Reserve Board, “Monetary Policy Report,” February 2013
Figure 2 – Distribution of FOMC participants’ projections for PCE inflation, 2012-15
