June 26, 2016

What will the Fed do? (June 2016, update!) By Jon Faust

My previous post described the well-disguised, steady predictability of recent FOMC policy. All that’s out the window now. (No.) Brexit changes everything! (We’ll see.) Will the Fed’s intermeeting rate cut go negative? (Get ahold of yourself.)

But Brexit is putting a wrinkle in this blog: I had promised that the next post would be entitled ‘Why has transparency been so damn confusing?’ Instead I’ll interrupt that plan with a brief account of what the steady-predictability story means post-Brexit. Indeed, Brexit provides a dramatic example of why focusing on the evolution of the Fed’s consensus can be so useful. (more…)

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June 12, 2016

What will the Fed do? (June 2016 edition) By Jon Faust

Over the last several weeks, we’ve seen what Michael Mackenzie in the FT called a renewal of the market’s tortured dance with the Fed. The basic story seems to be that the Fed “moved policy to the sidelines” at its March meeting, causing market participants to discount any risk of a near-term rate increase. The Fed’s March minutes and a series of Fed speeches then returned a summer rate increase to the discussion. But just as the markets began to follow that lead, the bad jobs report led to a pirouette, dashing hopes/fears of near-term rate increases, and completing a bruising turn around the dance floor. (more…)

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May 10, 2016

Six Degrees of Separation between Jobs and Inflation By CFEGuru

By Bob Barbera and Jon Faust

Friday’s reported increase of 160,000 in nonfarm payrolls was less than the recent average. This doesn’t mean much for the macroeconomic outlook and, therefore, shouldn’t and probably won’t mean much for the path of monetary policy.

Monthly nonfarm payroll gains bounce around a good deal and are substantially revised. Moreover, weather-especially winter weather–can dramatically affect the numbers. Remember that seasonal adjustment accounts for the typical effect of winter, not for the particular winter we experience. The CFE’s Jonathan Wright, one of the leading experts on this topic, regularly publishes a weather adjusted payrolls series. By his reckoning (reported here), this winter’s weather, including that nasty April in much of the country, may fully explain the weakness in today’s report. (more…)

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March 26, 2016

Beyond the dots By Jon Faust

Since the last FOMC meeting, we have again heard cries of lost Fed credibility and of general confusion. In contrast, my colleagues and I at the CFE have been arguing for many months now that we would likely see what has in fact transpired. In our view, the Fed’s actions, including those at the March meeting, are consistent with a credible and consistent commitment to begin interest rate normalization while continuing to support continued improvement in the labor market with inflation moving back toward two percent. We suspect this may sound, well, nuts to some readers, but the case is fairly brief, so we invite you to take a look. (more…)

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March 14, 2016

U.S. Monetary Policy: Three Hard Questions By Jon Faust

Since the market turmoil began early this year, Fed officials across the spectrum have been emphasizing that incoming U.S. macroeconomic data have remained broadly consistent with the baseline outlook that prevailed at year end. The economy is on track to create between 160,000 and 260,000 jobs a month and, once those nagging transitory disturbances abate, inflation will head slowly back to 2 percent. Given the excessive focus market volatility sometimes commands, Fed officials are right to emphasize this point about the baseline.

But the baseline outlook is the easy part of policy at present. The hard part is assessing upside and downside risks and how they should affect the near-term path of policy. (more…)

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February 20, 2016

Improving conventional unconventional policy By CFEGuru

By Bob Barbera, Jon Faust, and Jonathan Wright

The Fed has taken the position that the distressing signals from around the world do not clearly warrant a large and definitive downward shift in the outlook for the U.S. While some folks might argue that point, let’s accept it. There is, nonetheless, a heightened probability of some sort of downturn, and policymakers and others are considering what responses to that dark outcome are available. The metaphors are not pretty: Is the cupboard bare? The ammunition chest empty? With some central banks around the world targeting negative nominal interest rates, analysts are questioning whether that particular ammunition is more likely to blow up in our faces than to hit the target.

From the U.S. perspective, we think the debate is missing a key element: policy options in the U.S. look substantially different from those in the euro area or Japan. Specifically, the 5-year Treasury yield in the U.S. is now about 120 basis points, while these yields are negative for Japan and Germany. The U.S. 10-year yield is near 175 basis points, while those yields for the other two nations are near zero. The U.S. has room for more than 100 basis points of accommodation in longer-term yields that is not available elsewhere.

Pushing longer-term rates down using asset purchases has, over the past 8 years, become the conventional form of unconventional policy. And, while debates continue about how much stimulus comes from such policies, most reasonable estimates suggest that the effect is modest, but positive. (The magnitude and sign of the net effect of negative rates is less clear.)

Moreover, if times become truly desperate, the Fed could opt to employ what is likely to be an even more potent form of conventional unconventional policy: directly capping some longer-term yields. (more…)

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February 10, 2016

Are the Saudis Thinking Clearly? And Should We? By Bob Barbera

Saudi Arabia slashed oil production in the mid-1980s as prices plunged. Not so Today:

Fig. 1. Saudi Arabia Oil Production, 1,000 bbl/day. Source: EIA Monthly Energy Review via Jim Hamilton’s Econbrowser.

Given Saudi Arabia’s long-standing commitment to act as swing producer to stabilize prices, current Saudi behavior raises big questions. Why is Saudi Arabia pumping at historic rates in the face of a collapse in the oil price? And, as President Obama’s state of the union message highlights, what should be the U.S. policy response?

Let’s take it as given that the Saudis remember how to cut production by two-thirds as they did when oil prices fell by about two-thirds in the early 1980s. This time they have increased production in the face of a similar fall. Indeed, the Saudi’s are now pumping more oil than they did in 2008 when the oil price was well over $100 per barrel. What’s so different today?

Perhaps we should start with what’s been the same since the 1970s. (more…)

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February 6, 2016

Still Crazy After All These Years By Jon Faust

For the past several years, the Congressional Budget Office has been offering frightening forecasts about government debt growing out of control unless strong action is taken. While these forecasts have played a prominent role in policy debates, the CFE’s Jonathan Wright and Bob Barbera have for several years been arguing that those forecasts are, well, crazy. Or as the headline on Bob’s 2014 FT piece put it: “Forecasts of U.S. Fiscal Armageddon are Wrong.” The key to their argument—in the FT, here, and here —is that the CBOs economic growth and interest rate projections jointly make no sense. For the more complete argument see their pieces, but the gist is that under the CBO’s projected tepid growth projection, interest rates were highly unlikely to rise to the assumed levels.[1]

Jonathan discussed these issues with CBO forecasters in early 2014, arguing that it was implausible that government borrowing rates would rise to the levels CBO was projecting in the main scenario. Checking back today, same story. The CBO is projecting that the Treasury 10-year yield will rise above 3 percent in Q4 this year. Taking bets on that? The implausibly high rates continue to greatly exaggerate the debt problem.[2]

We were glad to read in Greg Ip’s recent column that Doug Elmendorf, the CBO director responsible for those forecasts until recently, now agrees. Elmendorf and Louise Scheiner of the Hutchins Institute make the argument that,[3]

…the fact that U.S. government borrowing rates are at historical lows and likely to stay low for some time, implies spending cuts and tax increases should be delayed and smaller in size than widely believed.

It was Elmendorf’s CBO that helped stoke those widely-believed views now labelled as misguided. And as noted above, the CBO is still stoking.

For the sake of coherent public policy, we hope that the CBO will listen to Elmendorf and Scheiner.


1. The interest rates were plausible, perhaps, but only if growth rebounded. In either case—low interest rates and growth or higher rates and higher growth—the budget picture looks much better. [back]

2. We are arguing, like Elmendorf and Scheiner discussed in the text, that the fiscal issues are far less severe and less pressing than they’ve been portrayed. We can still have a lively discussion regarding just how much of a problem, if any, remains once we take this fact on board. [back]

3. Hutchins Working Paper 18[back]

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January 29, 2016

Lunch and Tea with the Forecasters Club of NY By Jon Faust

If you had your TV set tuned to CNBC… August 21, 2001, two commentators were watching Alan Greenspan get out of a car and head to his office. They discussed the color of his tie (maroon) and the brand of shoes he appeared to be wearing (Rockports).’
         Danny Hakim, New York Times[1]

Yesterday, I had a great visit with the Forecasters Club of New York. Here are my slides. As we were chatting, a question came up about the Fed’s change in its strategy statement. This question has surfaced many places since the FOMC meeting, and my view about it flows directly from the no tea leaves approach to interpreting Fed communication that I’ve been pushing.

When there is a significant change in the Fed’s assessment of the outlook or in its likely reaction to the outlook, in this view, the Fed will probably attempt to tell you that directly. Because the world is complicated and communication is hard, those statements won’t be as clear as anyone would like—we’ll still need those Fed analysts. Important news will not, however, be signaled by obscure signals and signs.

Of course, the life of a tea-leaf-watcher is far more entertaining. The FOMC’s projections alone are a veritable vat of soggy tea leaves, and then there’s the Chair’s tie (or scarf). As of Wednesday, it looks like we can add the annual revision or nonrevision of the strategy statement to the list of tea leaves to be pondered.

Since 2012, the Fed has followed the tradition of reaffirming each January, possibly with revisions, its Statement of Longer-run Goals and Policy Strategy. In this year’s version, the FOMC added language clarifying that the 2 percent inflation goal was symmetric: “The Committee would be concerned if inflation were running persistently above or below this objective.[2] ” I can just imagine the dialog leading to this dramatic change:

Chair: How can we signal our dovishness?

Fresh-faced staffer: We could attempt to say something straightforward in the FOMC statement.

Chair: Who’s the new person? How about some serious ideas?

Savy staffer: I’ve got it. January is the month we revise our goals and strategy statement. We could slip something in there.

Chair: Brilliant. What scarf should I pair with that?

The symmetry now embedded in the strategy statement has always been FOMC policy. Symmetry has regularly been asserted by policymakers, and I suspect that no current or recent FOMC member has ever said anything to the contrary. This January may have been an appropriate time for the FOMC to be sure the public understood this point, but I don’t think it reflects any change in views or signal about the near-term course of policy.[3]

In the no-tea-leaf interpretation, the FOMC on Wednesday said that this year’s macro data and market moves have the FOMC’s attention, but are still too recent to warrant a definitive and pronounced shift in the U.S. outlook. As the presence or absence of a significant change in the outlook becomes clearer, the FOMC will, as always, adjust policy as appropriate.

What I’d like to hear from the FOMC is a clearer statement about their assessment of the likelihood of recession[4] and about how policy would likely respond. And by the way, the ‘balance of risks’ statement—or absence of such a statement—is a grossly inadequate vehicle for conveying that information. But that’s a subject for another day.


1. Quoted in All the People, Joy Hakim, 2003, p231. [back]

2. The use of the subjunctive tense here is entirely appropriate, but it does kind of invite a waggish lad to add, “You know, for example, if persistently low inflation were ever to happen.” [back]

3. So why was it not explicit before? Not sure, but we can speculate. Perhaps it was not included because between the original penning of the statement and the 2015 revision, questions over symmetry were not so pressing in practice, and the FOMC was not so aware of public confusion on this point. Policymakers, in this view, included the clarification so that they didn’t have to keep answering questions on the topic. [back]

4. And throw in the likelihood of a substantial overshoot of 2 percent inflation. [back]

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January 26, 2016

The Pause that Refreshes By Jon Faust

How will the Fed respond to the recent drops in the stock market? We might get a hint from the Fed’s conduct after last August’s turbulence, which now looks like a dress rehearsal for the current problems. In that event, the Fed chose to forgo the widely-signaled liftoff in September, but then implemented liftoff amid quieter markets in December. The lesson? In my view, the main lesson is that market distress may lead to a pause in policy plans, but unless macro fundamentals soon echo the market distress, the Fed will not meaningfully alter the course of policy.

I think there are two keys to understanding this lesson. First is Paul Samuelson’s quip that the market has called 9 out of the last 5 recessions.[1] Second is the fact, often repeated in the run up to liftoff, that the precise timing of any given policy action is of almost no importance.

Samuelson’s wisecrack is often taken to imply that the market gives highly unreliable signals about the state of the economy. But you don’t have to be Nate Silver to realize that calling 9 out of 5 recessions would indicate impressive predictive value. Taking Samuelson’s statement literally, more than half the time when the market signals recession, a recession ensues. In reality, the stock market probably is not as good a predictor as suggested by Samuelson, but stock market drops nonetheless reliably signal a heightened risk of recession.[2]

Given all the false signals, a market drop probably should not change ones view of the modal—that is, most likely—scenario much, but such drops can still suggest a significant rise in the probability of less likely, but far darker, scenarios.

Here is where the second point comes in: if the Fed has in place a policy trajectory that is appropriate for the modal scenario, there is essentially no cost briefly pausing the implementation of that trajectory to reassess macro fundamentals in light of a worrisome market signal. The effect of policy on the macroeconomy depends mainly on the expected course of policy over the next several quarters and years. Shifting the timing of any given policy move forward or backward a couple of FOMC meetings will have implications so small we cannot hope to measure them.

It is also important to note that no variable, not even the stock market, sends a reliable signal about recessions very far in advance—the stock market signal tends to be roughly contemporaneous. Thus, the Fed can get a reading on the validity of the stock market signal fairly quickly. If the stock market signal turns out to be a false alarm, the Fed can return to the previous course. The pause will have essentially no implications for the macroeconomy.[3]

In the world I’m discussing, the overall stance of policy is determined by macro fundamentals, with financial market signals occasionally putting wrinkles in the near-term timing. Chair Yellen’s explanation for the failure to liftoff at the September meeting squares with this view:

[I]n light of the heightened uncertainties abroad and a slightly softer expected path for inflation, the Committee judged it appropriate to wait for more evidence, including some further improvement in the labor market, to bolster its confidence that inflation will rise to 2 percent in the medium term. Now, I do not want to overplay the implications of these recent developments, which have not fundamentally altered our outlook. The economy has been performing well, and we expect it to continue to do so. [cite]

Here Yellen reiterates statements made by several policymakers before the September FOMC meeting that the U.S. outlook had not significantly changed. Some analysts take this fact as implying that policy should be unaffected, which then leads to the logic that the policy delay was a loss of nerve. Edward Luce put it this way just after Yellen’s September press conference:

So that is cleared up then. The Federal Reserve wanted to raise rates in September but then lost its nerve over China’s stock market crisis. Instead, it will probably move in December. No harm done.

The return to normal is on course barring a minor hiccup in the schedule. That, at least, was the gist of Janet Yellen’s message. Yet she also hinted she could simply repeat last week’s line in December.[cite]

Under this logic, the “gist of Janet Yellen’s message” must have amounted to Yellen making a tentative forecast of greater FOMC courage in December. My account (for better or worse) depends less on serial mood switching of the FOMC.

The modal outlook had not changed much, but the Fed was altering the near-term timing of liftoff—a move of little consequence—in order to reassess macro fundamentals in light of the market signal. If the market signal was not followed by the bottom falling out of the macro data, the previously signaled path would be resumed.

So what does this mean for policy in coming months? As in the weeks before September’s FOMC, policymakers have been out noting that near-term volatility has not greatly altered the modal outlook. It basically never does, which is Samuelson’s point. But pausing to assess whether macro fundamentals are turning seems even more clearly warranted than at the time of last September’s meeting.[4]

Let me add two forecasts. First, after the FOMC statement is released tomorrow, commentators will stumble over themselves in a race to divine whether hawks or doves have taken over the FOMC and will guide policy going forward. In our view, the FOMC statement and discussion thereafter is unlikely to imply any fundamental change, instead it may signal a pause to refresh the view on the macro fundamantals. If things quiet down and the macro economy continues to chug along, policy will also chug along, fundamentally unaltered, after a brief delay.

Second, as Bob Barbera and I have emphasized in a series of recent posts, we are not so sanguine about things chugging along. Instead, we see a darker picture for China and a weaker inflation outlook than seem consistent with the FOMC policy projections. If something like our forecast comes to pass, any pause will evolve into a much slower pace of rate increases than are implied by the FOMC’s December rate projections. Information arriving since we wrote this in December has nudged us further in the same direction.


1. “Science and Stocks,” Newsweek, September 19, 1966, p. 92 [back]

2. Much research supports the basic facts about the stock market lying behind Samuelson’s point. A nice recent piece on this is Bluedorn, et al., Do Asset Price Drops Foreshadow Recessions? IMF working paper 13/203. [back]

3. In this post, I am not arguing that the pause-tactic is optimal in any sense. I am arguing that it is a reasonable tactic and is how the FOMC seems to be behaving. For readers interested in formal optimality, I think it is clear that if properly communicated the conventional costs and or benefits of pausing would be second order. If I were attempting to build an interesting optimality argument, I’d include nonlinearities in the market signal, inherent nonlinearities in recessions which are magnified at the zero bound. Additionally, I’d take a world of imperfect information in which a pause might provide for more effective signal of conditional support for the economy in the event of recession than, say, would a simple Fed announcement conveying conditional support. [back]

4. The market signal is stronger and there are more negative hints showing in the U.S. macro data. [back]

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