What will the Fed do? March 2017 edition

After the December FOMC, I posted that I was sticking with a baseline, near-term-rosy Trump outlook, in which a robust economy is greeted by a Fed happily rising rates three or more times. Then as now, I had no great confidence that the rosy scenario would continue to unfold, but forecasting 3 or more rate increases conditional on the outlook, that’s easy.

How? Well, let’s consider the Survey of Economic Projections (SEP) that we had in hand going into the March FOMC meeting the last couple of years. Heading into the March 2015 and 2016 meetings, the FOMC statement was promising gradual rate increases, and the SEP showed the same picture of what that might mean: the dot-plot showed a median of 4 rate increases for the next year, and this was accompanied by projections of accelerating growth and rising inflation.[1]

The Fed and many others[2] repeatedly (and futilely) remind folks that the dot-plot does not reflect policy intentions; rather, it presents a ‘what if.’ In 2015 and 2016, the Fed was basically saying that if it could have favorable macro outcomes and four rate increases, it would gladly deliver.

Many (most?) folks outside the Fed back then, thought it was highly unlikely that the favorable macro outcomes could be attained in the face of 4 rate increases. And both years, it was clear by March that the economy was not on a path that would support favorable outcomes and 4 rate increases. But I emphasized, nonetheless, that the Fed would happily deliver those increases if a robust economy accommodated that pace.

This year may be different. If we stay on the rosy Trump path, the FOMC will finally confirm that it was sincere all these years in writing down those ‘what ifs’ in the SEP. We are clearly on the rosy path so far, and a rate increase at today’s meeting is a natural outcome.

Some folks are writing as if a rate increase in March signals a sea change on the FOMC. ‘Out of nowhere,’ the Fed seems more hawkish.[3] Nope. Out of nowhere, the economy is (for now) playing out a scenario the FOMC has been talking about for years.

Other analysts perceive an FOMC showing ‘greater confidence that they know where the economy is heading.’[4] If so, we should all head for the exits. Forecasting is always hard, and right now forecasters have to fold in profound political weirdness that could deliver great stimulus, great instability, or both. I would be shocked if the FOMC perceives its forecasts to be unusually precise right now.

The FOMC surely is confident that, after many years climbing out of the depths, we now face real two-sided risks. We could get budget-busting deficits in an economy near maximum sustainable employment, and/or the scary prospect of a disruption of the world economy with the policy interest rate still only a couple of cuts away from zero.

The FOMC is probably confident that raising the federal funds rate target today is the prudent way to position policy in light of the two-sided risks.

Let’s turn to some burning questions about what the FOMC may communicate after today’s meeting.

What policy intention will the dot-plot reveal? None. The dot-plot never shows policy intentions or plans. I suspect that a shift to 4 rate increases in the median dot-plot would be taken as surprising and hawkish, but it will mean no more or less than it did in the past: if the economy cooperates, they’ll happily deliver.

If the FOMC gave us dot-plots for other scenarios, you’d see that if inflation and activity accelerate more than expected, you’ll get more than 4 increases. If the economy stalls, the rate path will be much flatter.

Will the FOMC modify any truisms in the FOMC statement? The FOMC regularly inserts truisms in the FOMC statement as a way to signal concern. The current statement offers: ‘The Committee continues to closely monitor inflation indicators and global economic and financial developments.’ Inclusion of such phrases always raises the question of what to say when the worries subside. Perhaps, ‘we will no longer closely monitor …’, ‘we are shifting to cursory monitoring …’? In the present case, the heightened worries about the rest of the world, which flared early last year, have clearly waned. The heightened scrutiny of inflation originally signaled concerns about excessively low inflation, and those fears have waned as well.

The FOMC tends to be cautious in removing these truisms, and so their removal is usually a trailing indicator of changes in perceived risks. It should not be news when\if this sentence disappears or morphs into some other truism.

In short, today’s meeting is likely to be one more chapter in what I’ve been calling the well-disguised, steady predictability of Fed policy. Policy has continued to react steadily and predictably to the economy, and it is reacting in a manner consistent with a straightforward interpretation communication on behalf of the consensus. That steadiness has continued to appear disguised to many who fail to take account of the well-documented,[5] confusing nature of other communications such as those in the SEP and the FOMC minutes.

Addendum: Shortly after posting the above, Craig Torres correctly pointed out to me that the language in the FOMC statement that the inflation rate will ‘rise to 2 percent over the medium term’ is clearly in need of an update. Without getting into the more complete revisions the statement is needing, I suspect that the FOMC will gravitate toward something mundane such as: ‘Under appropriate adjustments to policy, the FOMC anticipates that inflation will remain near the FOMC’s 2 percent objective.’

Notes:

1. The SEPs can be found here[back]

2. including me in several pieces such as here and here[back]

3. Richard Moody[back]

4. e.g., Neil Irwin[back]

5. My most thorough attempt to document these confusing features, and cites to other attempts, can be found in the paper prepared for the recent event on Fed transparency[back]