Magazine article Economic Trends

The Economy in Perspective

Magazine article Economic Trends

The Economy in Perspective

Article excerpt

I am extraordinarily patient provided I get my own way in the end.

--Margaret Thatcher

At the conclusion of its January 28 meeting, the Federal Open Market Committee issued a press release stating that it "could be patient in removing its accommodative policy stance." Stock and bond markets, which had placed heavy odds against such a message, immediately sold off.

Not surprisingly, certain talking heads initially pronounced some harsh words about the Fed on the evening news, but quickly enough, other voices pointed out that the FOMC had not, in fact, increased interest rates. The real news lay in the change of tone regarding how much time the FOMC expects to elapse before it acts. Instead of repeating its earlier language that it would be "accommodative for a considerable period of time," the FOMC said that "with inflation quite low and resource use slack, the Committee believes it can be patient in removing its policy accommodation."

That the FOMC eventually must hike the federal funds rate seems obvious. At 1 percent, the rate is likely to be several hundred basis points below its natural rate--the rate consistent with price stability, in an expanding economy whose productive resources are fully employed. By holding the funds rate very low for a long period of time, the FOMC has been accommodating liquidity requirements, stimulative fiscal policies, and natural market forces working to repair imbalances and propel the economy forward. As these forces increasingly take hold, the need for monetary and fiscal policy "scaffolding" should lessen. Indeed, in the case of monetary policy, maintaining an easy stance too long could ultimately accelerate inflation.

Although market participants and policymakers recognize that extremely accommodative monetary policy cannot be maintained indefinitely, judging when and how to throttle back involves elements of the unknowable. Central bank actions affect inflation most importantly several years into the future. In the shorter run, the inflation process is governed by millions of decentralized wage and price decisions that themselves depend heavily on inflation expectations. With actual and expected inflation very low, businesses facing slack labor markets and idle industrial capacity might find that price increases will not stick--in fact, expectations of such failures might keep businesses from even trying. …

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