Focus on the Fed

June 1st, 2016 by

There is hardly any subject that receives more attention in the business news media than the de facto U.S. central bank, the Federal Reserve. This institution is routinely at the center of virtually any discussion about the economy.

FOMC-Fed-examination-magnifying-glassIncreasingly, this “Fed watching” has grown from a morbid fascination into a more critical scrutiny into the effectiveness of the central bank’s policies.

Losing Credibility

Narayana Kocherlakota

Narayana Kocherlakota

In fact, Narayana Kocherlakota, a former Fed official who served as the president of the Minneapolis branch of the Federal Reserve up until 2015, even published an op-ed criticizing his former employer for destroying its own credibility by not sticking to its promise to target economic outcomes.

Instead, the Fed has consistently seemed more worried about its own internal circumstances (such as getting its balance book back to normal). While these goals may not necessarily be bad for the Fed to pursue, they are a distraction from its broader imperatives, which would seem to take precedence in a fragile, post-financial-crisis period like the one we’re currently in.

“The Fed, however, promised to focus on actual economic outcomes such as inflation, not on” its internal objectives, Kocherlakota reproves. “It can’t break that promise without undermining people’s faith in its willingness to keep promises in the future.”

The situation continues to deteriorate. It can be seen in the Treasurys market: “This erosion of faith is visible in Treasury bond prices, which suggest that traders have been lowering their expectations of long-term inflation,” Kocherlakota says.

bondsAddressing a counter-argument, he continues, “Some say that investors are just requiring less compensation for bearing inflation risk, rather than expressing expectations of low inflation. Even that, though, should be a troubling signal for the Fed: It suggests that investors doubt the central bank will be responsive in bad times (when growth is low and unemployment is high).” No matter the conclusion you draw, there is scant confidence in the Federal Reserve to accomplish its congressional mandate for currency stability and full employment.

Kocherlakota offers an ominous closing: “In other words, the Fed’s willingness to renege on its promises seems likely to make the next recession worse than it otherwise would be.”

Busy Week Ahead

With an array of important data being released to close out this week, the Fed will have to decide how much it is willing to hew to its claim to be “data-dependent.” (Of course, nobody knows how much the Fed weighs each set of data in its decisions, nor how it assesses the risks thereof.)

payroll-targetOn Thursday, the European Central Bank (ECB) will make its latest policy decisions public. As the Fed’s largest counterpart overseas, the ECB’s monetary strategy could have an impact on how the Fed evaluates the global landscape. Further, major employment data will be released in Friday’s payrolls report.

If the Federal Reserve sticks to its recent hawkish rhetoric (a dubious notion, it should be pointed out), the incoming data will either confirm its plans or give it pause. An utter reversal of its stance on the economic outlook being strong enough for a rate hike (or two), however, would be a monumental display of its caprice as an institution.


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