The rules of US monetary policy have changed: the Fed has revised its reporting procedures in a potentially significant way. The first set of the more detailed minutes of FOMC meetings that Ben Bernanke promised last week was published on Tuesday, covering the meeting that took place on October 30-31.
I'm still unsure whether it is correct to regard the new regime as de facto inflation-targeting, as many Fed-watchers are suggesting. The case for this interpretation is that (a) the Fed is now publishing three-year-ahead inflation forecasts; (b) these forecasts are conditioned on "appropriate monetary policy"; and (c) three years is long enough for "appropriate monetary policy" to get inflation to the desired rate. But there are a couple of complications. One is that the Fed publishes a range of inflation forecasts, encompassing the individual projections of FOMC members. For 2010 the range is 1.5 percent to 2 percent. But this does not quite mean that the FOMC collectively regards a range of 1.5-2.0 as appropriate. Even assuming that all the members agree with (c), which they may not, it means that at least one member thinks a rate of 1.5 percent is appropriate in 2010 under expected circumstances whereas at least one other thinks that a rate of 2.0 percent is appropriate.
Well, since the range is narrow, one could overlook this--especially if the spread continues to be just half a point in future. We will see about that. But I would still hesitate to call this even a de facto inflation-target regime. The big thing that is missing is accountability. There is no real pressure on the Fed to hit its supposed "target". When the Bank of England overshoots its inflation target, it has to explain itself, and it cannot tell the Treasury, "Well, it was only a forecast." If inflation in 2010 is less than 1.5 percent or more than 2.0 percent, I'm willing to bet that that is exactly what the Fed will say. Unless, of course Bernanke tweaks the rules again in the meantime.
James Hamilton has questions, too, though he definitely leans towards the inflation-target interpretation. I found his comments enlightening--and note that they have an actionable corollary.
[T]he FOMC is saying that, if the Fed...does what they [the FOMC] think it should, GDP is going to be growing
more slowly and inflation is going to be lower three years from now
than a forecast that did not condition on the assumption of such Fed
behavior would have anticipated. I believe the spirit of this exercise
is to communicate to us that if GDP is growing at 3% in 2010 but
inflation is not under 2%, they intend to raise interest rates to bring
For comparison, the 10-year expected CPI inflation implicit in the nominal-TIPS yield spread
is over 2.3%. Taken at face value, the Fed is trying to warn us that it
intends to be tougher on inflation than markets currently are betting
on, and, as I commented last week,
the market at the moment appears if anything to be surprisingly
confident in the Fed's ability and commitment to keep inflation low.
Now, that raises the question-- If at some point in the future the
Fed is going to surprise the market with a more hawkish policy than is
currently anticipated, when will that surprise come? One obvious answer--
at the coming December 11 FOMC meeting, for which fed funds options and
futures presently seem to be betting pretty heavily on seeing another
cut in the fed funds target. If the Fed means what it says with these
just-released minutes, the market is wrong to assume that the fed funds
target will be lowered to 4.25% on December 11.
We will see what happens on December 11.
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