Will The Fed Follow Its Rhetoric Or Its Rule?

Stock Exchange, Courses, Shares, Trading, Forex

In recent years, the Fed has increasingly adopted the rhetoric of 1960s Keynesianism. Go for growth. Don’t worry about a bit more inflation. Jobs are much more important. Given that 1960s Keynesianism gave us the Great Inflation, should we be worried about today’s rhetoric?

Oddly, at roughly the same time that they adopted all this expansionary rhetoric, the Fed switched to average inflation targeting, which makes 1960s-style expansionary monetary policy totally impossible to implement.

So what will the Fed do in the 2020s? Will inflation average 2%, or will it average 4%, 6%, or 8%? I don’t know, but my hunch is that a portion of this Keynesian rhetoric is just the Fed trying to be PC, trying to keep up with a generally leftward shift in public opinion on stimulus. Another part might be the Fed’s perceived need to create “credibility” for its 2% inflation target, given that inflation ran below 2% over the previous decade, and given that (until recently) market indicators have been skeptical that we’d reach 2% inflation, on average.

One way or another, we’ll soon find out.

Some people seem concerned by the fact that the markets expect interest rates to rise faster than the Fed itself current predicts.

But this isn’t actually a problem at all, at least if you take the Fed’s 2% average inflation target seriously. At the moment, markets expect a modest overshoot of inflation over the next 5 years, to make up for the undershoot during 2020. Then roughly 2% inflation for as far as the eye can see. But that’s exactly what the Fed says it wants. If the markets think that this good outcome will require higher interest rates than the Fed currently expects, that’s not a lack of policy credibility, it’s just a difference of opinion on the future path of the natural rate of interest. A lack of policy credibility would occur if the markets didn’t expect inflation to average 2% during the 2020s. More likely, rising rates reflect increased confidence that the Fed will achieve its goals.

1 2
View single page >> |
How did you like this article? Let us know so we can better customize your reading experience.


Leave a comment to automatically be entered into our contest to win a free Echo Show.