The Fed’s Statement in Track Mode: Looser Guidance re Unemployment

March 19th, 2014 at 3:26 pm

If I’m a doctor trying to take your temperature and it becomes clear to me that the thermometer isn’t working quite right, I’d better stop depending on that thermometer, right?

To quote Yenta, “Of course right!”

That’s what the Fed’s Open Market Committee announced today, vis-à-vis a 6.5% unemployment rate as a guide post for raising the fed funds rates (the also shaved another $10 billion off of their asset buys, as expected).  Thanks to the WSJ, you can compare the statement the FOMC release today to that of their last meeting, in track mode (the stuff that’s crossed out was in the last statement; the underlined stuff is new).

To support continued progress toward maximum employment and price stability, the Committee today reaffirmed its view that a highly accommodative stance of monetary policy will remains appropriate for a considerable time after the asset purchase program ends and the economic recovery strengthens. The Committee also reaffirmed its expectation that the current exceptionally low target range for the federal funds rate of 0 to 1/4 percent will be appropriate at least as long as the unemployment rate remains above 6-1/2 percent, inflation between one and two years ahea. In determining how long to maintain the current 0 to 1/4 percent target range for the federal funds rate, the Committee will assess progress–both realized and expected–toward its probjected to be no more than a half percentage point above the Committee’s 2 percent longer-run goal, and longer-term inflation expectations continue to beives of maximum employment and 2 percent inflation. This assessment weill anchored. In determining how long to maintain a highly accommodative sttake into account a wide rancge of monetary policy, the Committee will also consider other information, including additional measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments. The Committee continues to anticipate, based on its assessment of these factors, that it likely will be appropriate to maintain the current target range for the federal funds rate well past the time that the unemployment rate declines below 6-1/2 percentfor a considerable time after the asset purchase program ends, especially if projected inflation continues to run below the Committee’s 2 percent longer-run goal. When the Committee decides to begin to remove policy accommodation, it will take a balanced approach consistent with its longer-run goals of maximum employment and inflation of 2 percent, and provided that longer-term inflation expectations remain well anchored.

Source: WSJ

As you can see, while they were of course also looking at “additional measures of labor market conditions,” the unemployment rate was a prime indicator.  The problem is that it’s awfully close to their benchmark of 6.5% (it was 6.7% in February) yet both inflation and inflationary expectations remain well below their price benchmark of 2%.  Also, as I’ve stressed many times on these pages, the unemployment rate remains biased down due to labor force exits, many of which have been driven by weak demand.  So broader guidance, as in the revised statement, seems warranted.

As the FOMC put it:

With the unemployment rate nearing 6-1/2 percent, the Committee has updated its forward guidance. The change in the Committee’s guidance does not indicate any change in the Committee’s policy intentions as set forth in its recent statements.

Markets didn’t like any of this one bit—looser guidance, i.e., guidance not tied to one measure, is more ambiguous and harder to track, I guess.  Nor were they pleased to see committee members coalescing around 2015 for when they’ll start lifting the federal funds rate off the floor (both S&P and the Dow down 0.8% right now).

But nothing too surprising here, including the market reaction, as traders continue to experience pretty severe skittishness.  Though Congress is doing less harm in terms of fiscal drag, the Fed knows they’re the only game in town targeting ongoing employment and output gaps.  Meeting their dual mandate means they must target those gaps while watching prices.  It doesn’t mean they have to slavishly stick with an unreliable thermometer.

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2 comments in reply to "The Fed’s Statement in Track Mode: Looser Guidance re Unemployment"

  1. Robert Buttons says:

    Traders already knew the fed would throw out any quantitative endpoints (6.5%) to keep ZIRP in place longer. Market reaction was based on hopes the fed would say more about leaving out the punch bowl (QE). This, despite the fact Yellen made a point of re-affirming that the fed is still increasing the size its balance sheet.

    With traders running into defensive mode (The bond market moves were particularly telling) based on anticipations of less accommodation, what will happen when the fed actually raises rates? Or worse, what will happen if they are FORCED (Volker style) to raise rates?

  2. Tom in MN says:

    I hope you are reading Tim Duy as he seems to nail the FOMC every time. To me, his last two posts:


    clearly show how they have been ratcheting down long term rates, which I think is also related to never getting to full employment and all the other related problems you discuss. The plot on the first post indicates to me that other stimulus is needed when the Fed Funds rate is below the long term rate or else long term rates also fall and as the plot shows we are heading to be completely stuck at the ZLB. But it appears we are going to have to repeat Japan’s experience first. I fear that when they raise the funds rate the first time the economy will stall and put us right back at the ZLB because the long term rate is so low that any increase in the Funds rate has a magnified effect. The only way out I see is to raise the inflation target to get wages and long rates ratcheting up instead of down.