Informational Easing: A Change In F.O.M.C. Expectations

August 10, 2011
By

(This article was first published on The Dancing Economist, and kindly contributed to R-bloggers)



Let's analyze the latest FOMC policy move.
The FOMC met yesterday and changed up the communications strategy.  How so? Well, until yesterday the statement has been saying as of June 22, 2011:
"The Committee continues to anticipate that economic conditions--including low rates of resource utilization and a subdued outlook for inflation over the medium run--are likely to warrant exceptionally low levels for the federal funds rate for an extended period." 
And now...
"The Committee currently anticipates that economic conditions–including low rates of resource utilization and a subdued outlook for inflation over the medium run–are likely to warrant exceptionally low levels for the federal funds rate at least through mid-2013."
Notice the subtle difference? If not heres a hint: "Extended Period" to "At least through mid-2013". So something is happening here. First, the Fed is always getting accused (by New Classicals) of creating uncertainty for businesses and thus disrupting equilibrium.  What they are doing is making it clear (or more explicit) that short -term interest rates will be well anchored & for sometime.  In this way they are also signaling that they may be more focused on growth and unemployment figures than any inflation pressures.  


Why was this controversial? Well within the F.O.M.C. we saw three dissents (Richard W. Fisher, Narayana Kocherlakota and Charles I. Plosser) whom believed that including such explicit language limited the Fed's flexibility and thus presented a potential independence problem since action deviating from the language opens the Fed to criticism. Additionally, two of these votes (Richard W. Fisher & Charles I. Plosser) may have been reacting to their hawkish tendencies- clearly seeing a comment to low interest rates as a threat to inflation fighting credibility.


Keep Dancin'


Steven J.

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