The Fed's Comments Last Week, and the Market's Reaction Since

(MoneyWatch)  The Bernanke era of the Federal Reserve will be remembered by economists and investors for many reasons, but the most flattering is that the Bernanke regime avoids mumbo-jumbo in explaining what it's up to. In its statement last week on the recent Federal Open Market Committee (FOMC) meeting, the Fed clearly stated -- or at least as clearly as it could, given the current murky conditions -- the three changes in the status quo that would trigger a tightening of monetary policy. The Fed's clarity is the good news; the bad news is that we are still so far away from the calls to action: threats of inflation or squeezes on capacity, the signs of a busy economy.

The FOMC released its latest findings last Wednesday, and while the Board did not change its stance on monetary policy -- leaving interest rates at near zero -- it did pin down just what sorts of conditions will cause it to tighten, and raise rates.

The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels of the federal funds rate for an extended period.

The economic writer community agrees that "an extended period" means six months or more. And Krishna Guha of the Financial Times sees the Board's disclosure as an act of candor, not a signal of intent:

It seems to me this is really an exercise in transparency and clarifying the Fed reaction function and as such is not really dovish or hawkish.

On the economic data themselves, he adds:

With unemployment now at 10.2 per cent, and probably peaking nearer 10.5 per cent, "resource utilization" is unlikely to be the trigger for an early rate increase. Indeed, if unemployment alone decided interest rate policy, we could see near-zero rates for a very long time: Fed unemployment forecasts are about 8 per cent two years from now.

The Fed could keep rates on hold well beyond six months if growth is subdued, inflation expectations continue and the expected further disinflation materializes...

Expectations for longer-term inflation, that is, over the next 10 years, are subdued indeed. The graph below compares the yields on 10-year nominal Treasury bonds to inflation-protected bonds of a similar maturity. The difference between the two is the market's expectation of the average annual inflation rate.


Since July, inflation expectations are up, but only a little -- from 1.77% in July 2009 to 1.97% in the last 30 days. The day's trading of November 5^th brought the yield differential up to 2.2 percent.

As for progress against the Fed's other criteria, strengthening economic growth and higher levels of resource utilization, readers of these pages need no reminders of where the economy stands. (But if you do need a nudge, click on one of these three links to superb MoneyWatch posts... 1 2 3 .)

The writer of the Free Exchange blog at Economist.com is irked that the Fed seems satisfied with U.S. economy's progress (in that they are not doing more):

The Fed recognizes that job loss is ongoing. It agrees that economic activity is likely to remain weak "for a time", which would seem to indicate that they don't believe growth will rush back as it has during previous recessions, which would in turn suggest that the Fed accepts the idea that recovery will be jobless. Indeed, it is counting on "substantial resource slack" to continue to dampen cost pressures...

[T]ell me whether the Fed seems particularly anxious to get the economy back to full employment.

I must say, I don't understand it. All signs indicate that inflation poses no threat whatsoever. Most signs indicate that unemployment will linger near 10% for another 12 months, if not more... Why is the Fed content to allow this level of cyclical unemployment?

But aside from commit to interest rates at zero, and expecting banks to follow up with more expansive lending, what else can the Fed do? Drop dollar bills out of helicopters?

More on the expansive lending tomorrow.