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April 27, 2006
Transparency and data dependence
The FOMC will continue to monitor the incoming data closely to assess the prospects for both growth and inflation. In particular, even if in the Committee's judgment the risks to its objectives are not entirely balanced, at some point in the future the Committee may decide to take no action at one or more meetings in the interest of allowing more time to receive information relevant to the outlook. Of course, a decision to take no action at a particular meeting does not preclude actions at subsequent meetings, and the Committee will not hesitate to act when it determines that doing so is needed to foster the achievement of the Federal Reserve's mandated objectives.
The only thing that would be more clear would be if he had a timeline for "some point in the future." June or August are, of course, the obvious possibilities.
From the blog archives, after the March 28 (last FOMC meeting) I said,
Nothing in the press release surprises me (or changes my outlook), but I look forward to the next round of "Fedspeak" to see which way some committee members will be heading as they go forward. Another increase in May appears very likely. After that it's hard to say. "Some further policy firming" allows some flexibility. Just remember, a pause doesn't mean that it's over. As we near the top, there is something to be said for putting twelve weeks between rate increases rather than six. (Sort of like letting up the pressure on the brake pedal of a car as you come to a stop.) But for the moment, the timing of the inevitable pause is still unknown. Stay tuned for the next round of speeches by FOMC members.
I still like my brake pedal analogy.
And from a Wall Street Journal Econoblog with Tim Duy last November, Tim said:
...Although there may be pressure to establish his [Mr. Bernanke's] inflation-fighting credentials, he will have to weigh this against the actual and projected state of the economy. Regardless of the pressures he faces, over-tightening in the face of deteriorating economic data could be as damaging to his credibility and that of the institution as a whole, as failing to tighten sufficiently as inflationary forces mount. So no, I don't believe that Mr. Bernanke is destined act in deference to his critics.
Still, even if Mr. Bernanke is immune from his critics' pressure, there remains a risk of policy error. As the federal-funds rate is pushed further into the 4% range, we will be closing in on the neutral point for monetary policy. A considerable amount of accommodation has been removed, and recent and expected rate hikes have yet to work their way into the economy. With the Fed seemingly locked on a higher rate trajectory, there will be a risk that past rate hikes will be slowing economic activity even as more tightening is implemented.
The Fed is cognizant of this risk and, I believe, will likely require a higher bar for rate hikes at some point early next year. The real trick for Mr. Bernanke might be the need to communicate the transition to a new policy direction at the same time the Fed is transitioning to new leadership.
and I replied...
If incoming data forces us to redefine "neutral" as something higher, then (all other things being equal) I am slightly less worried than I was this summer about policy error. What concerns me more is, as you suggest, the need to communicate the transition to a new policy, especially if the economy begins to slow and the Fed is forced into some tough choices. If GDP growth slows at the same time that the recent increases in energy prices finally feed through and increase core inflation, the Fed must decide which objective is the most critical. If you advocate inflation targeting (or price-level targeting -- Angry Bear and macroblog have a couple of good posts discussing the difference), your choice is clear. I sense that some of the more vocal opposition to Mr. Bernanke is coming from ardent proponents of price-level targeting who fear that he may not be tough enough.
Still true. Incoming data has pushed the definition of "neutral" higher than it was in November when we wrote this. Sustained increases in energy prices are beginning to show evidence of feeding core inflation. In the morning, perhaps by the time you read this, we'll know how the GDP numbers change this landscape.
Barry Ritholtz is worried that the Fed could get behind the inflation curve. Though I acknowledge the risk, I'm a bit less concerned. Remember, there are two months, and therefore two inflation data points, before the June meeting. I'll be the first to say that if those two points yield unhappy news, I'd call for (and expect) more increases in June and August. Ditto if the morning news reports robust GDP growth. But that's what "data dependent" means. And I reiterate what I said in March. I would not want a pause to mean a stop. I'm definitely not advocating (or expecting) "one-and-done". I'm still of the mind that talk of rate increases will be on everyone's lips well into the fall, even if rates are not raised at every single meeting between now and then. Bernanke's comments today were, I think, a necessary step to pave the way for a pause, but not sufficient to guarantee that it will come in any definite time frame.
I must say though, Bernanke's comments notwithstanding, I can't envision a pause in June if inflation numbers for April and May are what they were for March. But I am on the edge of my seat waiting for the GDP numbers in the morning--more than I have been in some time. Such is life in a "data dependent" environment. Though you'll probably first read this after the morning news, I figured I'd set this out now to give you a clear "before and after."
See you in the morning.
Posted by William Polley at April 27, 2006 10:21 PM
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