INSUBCONTINENT EXCLUSIVE:
By Tim DuyThe Federal Reserve this month is widely expected to raise interest rates for the eighth time in the current hiking cycle that
G et ready for tensions within the Fed to spill over into the public as monetary policy moves closer to estimates of the neutral rate.
The
Fed staff will likely push harder for policy makers to follow a model-based approach with fairly hawkish implications that would result in
rates rising beyond what is considered a neutral level
That means policy will become less predictable in 2019
estimate values of key exogenous policy variables, such as the longer-run values for unemployment, that provide a gravitational pull for the
Over time, the economy should settle into equilibrium, with actual values the same as the estimated natural values
As such, altering policy rates will impact the time it takes to reach equilibrium, but not the level of equilibrium.
The Fed, however, can
choose the rate of inflation
In these models, the success or failure of policy ultimately falls on the deviation of the inflation rate from target because that is the
Consequently, central bankers should not become distracted by things such as uncertainty over inflation persistence or the natural rate of
See recent Fed staff research here and here as well as related news reporting here and here.
Under the current projections as embodied by
the median of the dot plot estimates, policy rates need to rise above equilibrium rates to guide the economy into equilibrium
But this underweights the risk of recession from raising rates above neutral
Recessions are just simply very rare events
of the appropriate policy path
During normal economic periods, market participants should consider that view as hawkish in the sense that they imply a heightened concern
about inflation and are excessively complacent about the risk that Fed action (or inaction) triggers a recession.
But does Powell share a
In that speech, he discussed the challenges of making policy when key variables such as the natural rate of unemployment are uncertain
Combined with this research, the implication is that the Fed is about to take a hawkish turn.
Perhaps Powell, who is not a trained
macroeconomist, is not married to the models and sees their biased outcomes
That is where policy succeeds or fails
The models are something of a sideshow
As I wrote recently, this means that the Powell does not appear committed to any firm policy guidelines, leaving me with an unsettling
feeling that he plans to continue hiking until something breaks and a recession occurs.
Alternatively, Powell may be less complacent about
the risk of recession than his staff, and hence more dovish, leading him to push for an extended pause when policy hits neutral
between Powell, the Fed staff and his more model-focused colleagues
It would yield an increasingly chaotic environment for market participants as Fed-speak becomes more discordant
But it leaves us guessing as to what his judgement is telling him to do from one day to the next
(This column does not necessarily reflect the opinion of economictimes.com, Bloomberg and its owners)
