 | The Fed Flies with the Doves |
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As everyone expected, the Federal Reserve made no direct changes to the stance of monetary policy today, leaving the target range for the federal funds rate at 0% to 0.25%. Also as expected, it made no changes to its commitment to keep short-term interest rates at this level for an "extended period."
Minor changes to the statement suggest the Fed is, on net, more concerned about economic growth and less concerned about inflation than at the last meeting April. Regarding the pace of economic growth, the changes versus the statement in April, include the following:
(1) The economic recovery is "proceeding" rather than "continued to strengthen."
(2) The labor market is "improving gradually" rather than "beginning to improve."
(3) Commercial construction is "weak" rather than "declining."
(4) Housing starts are at a "depressed level" rather than have "edged up."
(5) Financial conditions are "less supportive of economic growth" rather than "remain supportive of economic growth."
On inflation, the Fed acknowledged that commodity prices have declined and went out of its way to say that "underlying inflation has trended lower." It is true that core consumer prices, which exclude food and energy, are up 0.9% in the past twelve months while this number was 1.1% as of the Fed meeting two months ago. But in the past three months these same core prices are up at a 0.8% annual rate compared to a decline at a 0.2% annual rate as of the meeting in April. In other words, the Fed did not have to add the language about a drop in the underlying trend in inflation to this meeting's statement. That they did anyhow suggests very little concern by Chairman Bernanke about inflation.
The one "hawkish" element in today's statement was that, despite recent financial concerns regarding Europe, Kansas City Fed Bank President Thomas Hoenig repeated his three prior dissents, saying not only that the "extended period" language is no longer warranted but also that continuing to use such language could limit the Fed's flexibility to raise rates.
Despite a recent spate of tepid data that seems to have influenced the Fed, we believe that the recovery will remain robust. Real GDP grew at a 3.9% annual rate in the second half of 2009 and is likely to grow at about that rate again in the first half of 2010. Nominal GDP – real GDP growth plus inflation – grew at a 4.3% rate in the second half of 2009 and is likely to accelerate further. A federal funds rate of essentially 0% is not appropriate for an economy with positive and rising nominal GDP growth.
However, the Fed has made it abundantly clear, through what it has said and what it has not said, that rates are going nowhere at least through the end of this year. At present, we do not expect any change in the federal funds rate until March 2011. A more prolonged period of extremely loose monetary policy will generate more real economic growth in 2011. However, once again, like in the decade just ended, the Fed looks committed to stay too loose for too long. We will eventually pay a price for the Fed's unwillingness to raise rates sooner rather than later. That price will include higher inflation and faster rate hikes in 2011-12, as well as an ultimate peak for rates that is higher than it could have been.
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