By Steven K. Beckner
(MaceNews) – The economy may be at “an inflection point,” as Federal Reserve Chairman Jerome Powell has said, but monetary policy remains more reflexive than anything, which is to say he and his fellow Fed policymakers are still very much in emergency response mode, concentrating on helping the economy recover from the pandemic.
At some point, that will change, but for now members of the Fed’s policymaking Federal Open Market Committee seem sure to stay entrenched in the aggressively stimulative stance they’ve been in for more than a year when they gather toward the end of the month. That means keeping the federal funds rate in the zero to 25 basis point target range it’s been in for more than a year. And it means continuing to buy $120 billion per month of Treasury and agency mortgage-backed securities until there is “substantial further progress” toward the FOMC’s employment and inflation goals.
Powell and many of his colleagues have declared themselves to be “outcome,” rather than forecast-based. They have repeatedly said they need to see ”actual data” showing the economy is in the process of achieving “maximum employment” and 2% average inflation before considering any policy shifts.
Yet, although the data are looking increasingly promising, Fed officials have thus far given no indication they are anywhere near ready to consider scaling back the massive asset purchases they’ve been making to hold down long-term interest rates, much less raising the short-term interest rates they more directly control. They remain in a Covid risk-management mindset.
That the economy has been emerging from lockdown in a big way is undeniable. Consider the March data:
- Non-farm payrolls leaped by 916,000, and prior months were revised sharply higher;
- The unemployment rate, which went as high as 14.7% last April, dipped another two tenths to 6.0%;
- The Institute for Supply Management’s purchasing managers index of of manufacturing activity jumped by 3.9 percentage points to 64.7%;
- The ISM’s services PMI jumped 8.4 percentage points to an all-time high of 63.7%;
- Manufacturing output increased a less impressive 2.7%, and
- The consumer price index rose 2.6% (1.6% core).
Meanwhile, the housing industry is booming, and home prices have reached a 15-year high.
Fed policymakers have welcomed these and other indications of a robust recovery, but it seems not to have made a dint in their policy thinking. Lingering worries about the impact of the pandemic predominate.
Powell said last Wednesday the economy seems to be “at an inflection point.” Citing the March jobs numbers, he told the Washington Economic Club, “I think we’re going into a period of faster growth and higher job creation,”
But Powell was quick to add that “there are still risks” that “we have to be careful about.”
The next day, voting San Francisco Federal Reserve Bank President Mary Daly said she is expecting “a big, big rebound in the second half,” but thereafter she predicted growth will “moderate” and noted, “almost 9 million people are out on the sidelines … who had jobs before” the pandemic.
The day after that, new Fed Governor Christopher Waller said “the economy is ready to rip.” The former top advisor to St. Louis Fed President James Bullard projected 6.5% real GDP growth and 5% unemployment this year, but said the Fed is still a long way from reaching its goals.
Similarly upbeat, but leery comments have come from other Fed officials.
There was a time when the kind of data we’ve been seeing lately would have caused some rethinking at the Fed. By now, the erstwhile FOMC would have started to at least think about “normalizing” policy – not tightening really, just tapping the brakes a bit to guard against “overheating.”
Not anymore. Such concerns are all but dismissed, if not derided these days.
The central bank is operating under a totally different policy regime. Under the revised Statement on Longer-Run Goals and Monetary Policy Strategy – issued in late August last year and implemented at subsequent meetings – the FOMC let it be known it would henceforth focus on “shortfalls” from “maximum employment,” rather than “deviations” from the estimated longer run “natural” rate as previously.
What’s more, “maximum employment” must also now be “broad and inclusive.”
Just as importantly, the new monetary “framework” redefined the “price stability” mandate to mean “average” 2% inflation, to be achieved by letting inflation overshoot “for some time.”
Hitherto, the inflation target was considered “symmetric;” the Fed wanted inflation to neither exceed nor fall short of 2%. Now, it is now openly “asymmetric.” As Vice Chairman Richard Clarida told the Shadow Open Market Committee last Wednesday. “The goal of monetary policy after lifting off from the ELB (effective lower bound) is to return inflation to its 2% longer-run goal, but not to push inflation below 2%.”
As part of that policy, the Fed wants to boost inflation expectations to 2% or above.
The new framework also calls for monetary policy to “remain accommodative for some time after the conditions to commence policy normalization have been met,” as Clarida put it.
Those strategy changes have had very meaningful policy implications. The Fed has swung sharply to being a reactive, rather than a preemptive central bank.
As Powell explained earlier this year, the revisions reflect “our view that employment can run at or above our real-time estimate of the maximum level without causing concern unless accompanied by signs of unwanted increase in inflation or other risks that could impede the achievement of our goals.”
The current FOMC consensus is that it need not act to head off wage-price pressures in the face of tightening labor markets and increased capacity utilization. On the contrary, the aim is to test the economy’s limits, if not exceed them.
Officials pay lip service to threats of inflation and financial instability, but almost as an afterthought.
Atlanta Federal Reserve Bank President Raphael Bostic, a 2021 voter, for instance, recently said he and his colleagues have “really taken on board the experience of the last 10 years where inflation has just not been at forefront of our problems. We’ve been able to run the economy very, very hot… We didn’t see inflation spike, which suggests we weren’t on the cusp of letting the economy overheat.”
Daly echoed that sentiment last Thursday. Asked about the risk of an inflationary overheating, she scoffed, “We’re so far away from that scenario.“
Guided by what they have openly called a “lower for longer” strategy, policymakers have been inclined to minimize the economic progress made so far and to downplay the optimistic outlook, including the FOMC’s own 2021 median forecasts of 6.5% real GDP growth and 4.5% unemployment.
So, although the unemployment rate has been more than cut in half, Powell and Co. emphasize that at least 8 ½ million people who had jobs before the pandemic remain out of work.
And although prices have been rising more rapidly, they are convinced this will prove “transitory,” attributable to statistical “base effects,” temporary supply “bottlenecks” and pent-up demand surges that won’t be sustained.
After years of below-target inflation, the Fed has become quite cozy with the idea of above target inflation.
The FOMC says it wants inflation to run “moderately” above target, and Powell has said he would not like “troubling” inflation, but that’s a nebulous standard, and some of his colleagues have some pretty tolerant ideas about that as they lean very heavily on a long record of disinflation and undershooting.
When Evans was asked recently about the risk that expansionary monetary and fiscal policies will spark excessive inflation, he said he is “very confident the Fed will be adjusting policy if we see that,” but “that’s well into the future.”
Meanwhile, he said inflation of “2 ½%, even 3% would be welcome frankly.”
Evans told reporters, “We really have to be patient and be willing to be bolder than most conservative central bankers be…if we’re going to get inflation expectations up.”
As part of its compensatory plan to boost inflation, the Fed also wants to lift inflation expectations.
It has had mixed success. The five-year breakeven rate has jumped from 1.98% at the start the year to 2.56% recently, but the Fed has been less happy that various surveys of consumer inflation expectations have been much more muted.
Clarida, whose monetary economist credentials make him an influential voice on the Board of Governors and the larger FOMC, said he’s going to be paying particular attention to the Board staff’s own index of common inflation expectations (CIE), which takes into consideration not just survey findings and spreads between conventional and inflation protected Treasury securities (TIPS), but a host of other indicators.
“Other things being equal, my desired pace of policy normalization post liftoff to return inflation to 2% would be somewhat slower than otherwise if the CIE index at the time of liftoff is below the pre-ELB level,” he said. “If I were to see that measure drift up persistently (in a way) not consistent with that goal that would indicate to me that policy needed to be adjusted.”
Powell and his colleagues have promised to communicate any policy shift well ahead of time, but so far there are no clear signals. The nearly uniform assessment is that the Fed is far from its goals and, hence, monetary policy needs to stay very accommodative.
As Daly told the Money Marketeers three times last Thursday. “We’re not there yet.”
Voting Chicago Fed President Charles Evans put it this way: “We, as the monetary policy authority, still have some ways to go before we reach our dual mandate goals of maximum and inclusive employment and inflation that averages 2%. We also face many uncertainties and risks on the road ahead.”
“Even though the economy is recovering, we still have a long way to go before economic activity returns to its pre-pandemic vibrancy,” he elaborated. “Even after the very strong March employment report, at 6.0%, the unemployment rate is well above the 3.5% we saw on the eve of the pandemic. And many other workers have stopped looking for a job and exited the labor force.”
In March, FOMC participants on average projected no rate hike before 2024, and not until after the Fed starts tapering asset purchases. That in turn will require vaguely defined “substantial further progress.”
Asked about rate hikes, Powell said, “We would expect to keep interest rates where they are today until three particular outcomes are achieved in the economy: The first is that the recovery in the labor market is effectively complete. The second is that inflation has reached 2%…and really reached it, not just sort of … but has reached it sustainably … and the third thing is that inflation is on track tor run moderately above 2% for some time. Those are the tests.”
“So we are really focused on the progress of the economy toward those goals and not on a particular time frame,” he continued. “When we get those three boxes checked that’s when we’ll consider raising interest rates, and that’s when we will raise interest rates. Until then we won’t.”
As for scaling back quantitative easing,” Powell said bond buying will “continue at the current pace until we see substantial further progress toward our goals. And that will really mean actual progress. … .We’re not looking at forecasts for this purpose. We’re looking at actual progress toward our goals.”
To Daly, “substantial further progress” means “we we need to see things moving toward the goals we have. We’re not there yet.”
With so many people still out of work, “We’re pretty far away from substantial further progress” toward maximum employment, she said. Likewise, with inflation rising “only temporarily,” “we’re far away from that (average 2% inflation target) as well.”
“We need to get closer to our goals,” Daly went on, adding that the FOMC needs to “see that we’re well on our way toward our goals before we start thinking about withdrawing any kind of accommodation.”
It’s all somewhat alarming to some observers. The Fed “has the tools” to beat back inflation if it starts to get out of hand, we keep being reminded by officials. But as SOMC member and IES Abroad President Gregory Hess reminded us last week, after a long period of quiescence, inflation proved very hard to rein in once it took root in the 1970s. Former Fed Chairman Paul Volcker succeeded in doing so, but at great cost.
For all the dovish talk from policymakers, a caveat or two may be in order.
Just as the Fed has a way of “looking through” the “noise” in inflation and other data Fed watchers might be well advised to look through some of the Fed rhetoric about the economic and policy outlook.
True, one official after another has said that, while the economy is in the process of a strong recovery, it’s not ready for a less accommodative policy. But in so saying, are they not laying the groundwork for eventual policy firming? Are they not setting the conditions for tapering and then liftoff?
However vague “substantial further progress” is, policymakers are giving themselves a potential trigger for an eventual reduction in the pace of asset purchases, which in turn will be a prerequisite for leaving the zero lower bound. They have established the parameters within which they can adjust communications to signal that policy adjustments are getting closer.
Fed officials have been doing a good job of trying to convince us — and the markets (and maybe themselves) — that they intend to hold rates down for an indefinite period, but don’t think they’re not contemplating when and under what circumstances to exit.
Clarida said the Fed staff is “thinking and working hard” on such things as models that tie the timing of liftoff to the behavior of inflation and inflation expectations. Hmmm.
The upcoming meeting provides another opportunity for such discussions.
Read into it what you will, but perhaps it was significant when Powell, in something of a departure, seemed to go out of his way to backdate the measurement of progress to late last year. “If you look at the sense of our guidance, we will reach the time when we will taper asset purchases when we’ve made substantial further progress toward our goals, from last December when we announced that guidance.”
This came during an interview when he made a point of saying the economy was “at an inflection point.” Just straws in the wind maybe, but then that’s what Fed watching is all about.
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Contact this reporter: steve@macenews.com.
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