Stay Tuned for the Fed's Admission of Failure
Today the Federal Open Market Committee, which decides American monetary policy, will issue its bi-quarterly statement. Odds are the Fed will extend its promise of "exceptionally low levels of the federal funds rate" through 2015. (The committee is also likely to announce further asset purchases.)
Should the future fulfill this forward guidance, the U.S. will have seen seven full years of the nominal short-term interest rate sitting at the zero lower bound.
And it will be the fourth time the committee has changed the forward guidance period.
When the rate was first cut to zero in December 2008 amid the crisis, the Fed told markets to anticipate low rates "for some time." That language changed to "for an extended period" in March 2009, and in the obscure and finicky diction of monetary policy, that marked the first extension. The wording changed again in August 2011, as the recovery flagged, to "at least through mid-2013." The Fed became more specific; it also, as judged by the market expectations implied in federal funds futures, pushed out the period of low rates farther. The most recent punt came in January 2012, this time "at least through late 2014."
The Fed's long vacation on the zero lower bound, combined with its serial extensions of forward guidance, are the signature of tight money and collapsing credibility.
How can a zero short-term nominal interest rate be tight? The best explanation is that interest rates are ambiguous indicators of the stance of monetary policy. A 4 percent federal funds rate, for instance, could be entirely warranted under normal economic conditions, yet far too loose or far too tight under others.
To judge the state of monetary policy, one has to look at the market's expectations for future nominal income. It’s akin driving to a car: You don't look solely at the dashboard and feel the turn of the steering wheel to judge whether you're headed in the right direction; you look at the road ahead of you and consider whether you have the pedal and wheel in the right position.
That the Fed is pushing on four years of zero interest rates and extending forward guidance out farther only suggests that policy is all the tighter. It doesn't want to be here still, but it is -- because it hasn't figured out any better options. The root problem is that policy focused on interest rates -- the wheel of monetary policy -- is leading it farther and farther astray from its stable pre-recession path for nominal income.
Today's statement serves as another grim reminder of the Fed's failure to establish sufficiently robust expectations of nominal income so that it can, without fear of real contraction, normalize interest rates.
(Evan Soltas is a contributor to the Ticker. Follow him on Twitter.)
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Tobin Harshaw at firstname.lastname@example.org