The Fed Policy Statement
Here is the statement I would like to see the Federal Open Market Committee issue on January 28 on conclusion of its first meeting of 2015:
Information received since the FOMC met in December confirms that economic activity is expanding at a moderate pace. Inflation has continued to run below the Committee's longer-run objective, primarily reflecting a decline in energy prices. That decline appears to be principally a consequence of improving technology in oil and natural gas production and is, thus, a change in relative prices that has no long-term implications for the aggregate rate of inflation.
Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. To support continued progress toward these goals, the Committee today reaffirmed its view that the current 0 to 1/4 percent target range for the federal funds rate remains appropriate.
To minimize uncertainty over the course of policy, the Committee judges that the process of normalizing interest rates should begin in June. However, the exact timing is data dependent and might be adjusted as necessary.
The Committee also judges that it is now appropriate to begin the process of normalizing its open market portfolio. Effective immediately, the Federal Reserve will cease to reinvest interest on the portfolio and maturing principal.
Several FOMC members have suggested that midyear will be the appropriate time to begin to raise policy rates. The FOMC itself has been vague. No member of the leadership team--which I would define as Chair Janet Yellen, Vice Chair Stanley Fischer, and William Dudley, President Federal Reserve Bank of New York--has ruled out the midyear timing. In general, it is not good practice to announce a future date for a policy change, but such an approach makes sense at this time given that policy rates have been near zero since December 2008. Announcing a June date will not be a shock to the market, as market commentary widely suggests that June is the time the FOMC will act. It is, of course, always possible that economic conditions will change dramatically before June, requiring a change of plan. Nonetheless, it is time for the FOMC to clear the air by stating a plan.
By beginning the process of letting the portfolio run off, the FOMC will dispose of that issue. This part of the plan should not be subject to revision, because any revision would send a confused signal about the direction of policy. If the portfolio is left to a future decision, the matter will become entangled with signals about future interest-rate policy. Dealing with the problem of defining the appropriate course of policy rates and helping to set corresponding market expectations on that course will be difficult. The FOMC does not need to complicate interest-rate policy with implicit announcements—possibly intended, possibly not—flowing from decisions on the portfolio.
The U.S. economy is growing in a balanced fashion. Employment growth has exceeded most forecasts from a year ago. Inflation is below the two percent target but will rise once oil prices stop falling. Treasury and corporate bond rates are almost 100 basis points below where they were a year ago. The stock market has been volatile day-to-day but without a clear trend.
It would be easy to recite additional data. but the bottom line is that the economy is doing fine and is not fragile. The FOMC is unlikely to face more benign circumstances in which to address its policy challenges than it faces today. The Committee should act in a preemptive fashion, leading the markets rather than being led by them.
Further FOMC patience on policy is indecision on leadership. What is the Committee waiting for?
My statement does away with statement bloat—the profusion of meaningless sentences and phrases that, over the past few years, have made the FOMC statement increasingly long, obscure, and difficult to interpret. The final policy statement of the Greenspan era contained 120 words, excluding the final paragraph reporting the vote. Measured the same way, a year before Bernanke left office, the January 2012 statement contained 348 words. The final statement of the Bernanke era contained 563 words. The December 2014 FOMC statement had 564 words.
My statement has 190 words. It is longer than the last Greenspan statement for two reasons. First, it makes the important point, which the FOMC has not yet made, that the decline in energy prices reflects a relative price change with minimal significance for long-run inflation. Second, it announces the policy decision to begin to wind down the portfolio. There would be no need to repeat this language in future statements unless that decision were changed.
Every word in the statement ought to convey useful information to the markets. The Committee seems to have lost sight of the fact that the market reads each statement for changes against prior statements. It used to be that observers would print the statement and hold it up to the light against the previous statement. Now we rely on powerful features in the word processor to spot the changes. Even that approach fails when the Committee changes the order of sentences, or similar sentences. We can spot word changes where a synonym is substituted for a word in the prior statement but that often creates mystery. Synonyms rarely have exactly the same meaning, but differ in nuance or some other way. The question then is whether the FOMC is trying to send a signal of some sort, or has decided for stylistic reasons to change words. The Committee’s current approach is not a recipe for clarity.
Perhaps the policy statement has grown because the Committee is attempting to provide a summary on policy, very broadly defined. That cannot be done in a few paragraphs. The summary as it stands is a profusion of platitudes.
Consider a couple of examples. The December 2014 statement says, “... the Committee judges that it can be patient in beginning to normalize the stance of monetary policy. The Committee sees this guidance as consistent with its previous statement ... .” If there is no change in policy, then why change the language? In this same statement, we learn that, “The Committee continues to monitor inflation developments closely.” Isn’t that something we already know?
Here is a sentence in the December statement that does provide information: “The Committee currently anticipates that, even after employment and inflation are near mandate-consistent levels, economic conditions may, for some time, warrant keeping the target federal funds rate below levels the Committee views as normal in the longer run.” However, this sentence is also a trap. When the time comes in the future to take the sentence out of the statement, doing so will be read as a signal of forthcoming rate increases. Will that be a sound way of sending such a signal? Or, does the FOMC simply leave the sentence in the statement until it becomes irrelevant?
The Committee has set such traps for itself in the past. There are many examples. Here is one of my favorites: “Although the downside risks to growth have increased somewhat, the Committee's predominant policy concern remains the risk that inflation will fail to moderate as expected.” (From statement issued on August 7, 2007) The statement language would seem to indicate that the FOMC was trying to tell the market that the next policy adjustment might be an increase in the fed funds target rate. The transcript of that meeting is publically available, along with staff documents. From these, it is clear that no member of the Committee was advocating a rate increase, or a signal of a rate increase. The markets were shaky, and this was the beginning of the financial crisis.
Why was this language in the August 7, 2007 statement? A year earlier, in August 2006, the FOMC ended its string of 17 straight fed funds rate increases. However, the Committee did not want to signal to the market that the job was done. Thus, this sentence: “Nonetheless, the Committee judges that some inflation risks remain. The extent and timing of any additional firming that may be needed to address these risks will depend on the evolution of the outlook for both inflation and economic growth, as implied by incoming information.” Similar language appeared in every statement until the financial crisis started to become acute, shortly after the meeting of August 7, 2007. The Committee did not want to take such language out for fear of sending a signal that it was preparing to reduce rates.
Going forward, the Committee will have to deal with its current posture that, “... economic conditions may ... warrant keeping the target federal funds rate below [normal] levels ... .” Moreover, this language may become inconsistent with FOMC economic projections published after meetings of March, June, September and December. What the Committee ought to do is to remove this trap from its statement language and let its quarterly projections carry the burden.
The statement I propose has the virtue of addressing all these matters. It is short and focused on changes in the stance of policy. It contains the decision to begin to address the winding down of the Fed’s huge portfolio—it gets that issue out of the way. It announces a tentative decision to begin normalizing interest-rate policy in June, which corresponds to the stated views of several FOMC members and widespread market expectation. By shortening the statement dramatically, the approach clears away underbrush and will make future communication easier.
