Fed Says What It Means -- No Interest Rate Cut
By John M. Berry
April 13 (Bloomberg) -- The Federal Reserve has demonstrated over the past three weeks that even with the best of intentions, communicating the nuances of monetary policy decisions often isn't easy.
It took the Fed three attempts after the March 20-21 Federal Open Market Committee meeting -- the FOMC statement issued the day of the meeting, congressional testimony by Fed Chairman Ben S. Bernanke on March 28 and release of the minutes on April 11 --before investors and traders finally understood that an interest rate cut isn't in the cards.
``What the Fed is telling us in these minutes is that it has no thoughts at all about easing interest rates at the moment,'' Lyle Gramley, a former Fed governor and senior economic adviser at the Stanford Washington Research Group, said in an April 11 interview.
The Fed ``is not worried about the economy going into recession,'' Gramley said. ``It is more concerned about inflation. It is quite happy to sit where it is now to see how things work out.''
Those three failed attempts by the Fed, with many investors and traders initially misinterpreting its intentions, highlight the importance of the discussions at the Fed about how to improve transparency in its actions and communications with the public.
According to the March minutes, FOMC participants ``expressed a range of views'' on whether the Fed should set ``a numerical price objective'' for monetary policy. The role of Fed officials' periodic economic forecasts in communications was also discussed, with no decisions made on either issue.
Some effort to improve communications is likely to be announced before the end of the year. What that might be is far from certain at this point.
If adoption of an inflation target in any form were to be agreed upon, the minutes said, ``Participants emphasized that any such move would need to be consistent with the committee's statutory objectives for promoting maximum employment as well as price stability.''
That's certain, given the deep skepticism of that point by some members of Congress, including Representative Barney Frank, the Massachusetts Democrat who is chairman of the House Financial Services Committee.
The fundamental problem last month was that some forward- looking language that had been in the previous four FOMC statements, no longer reflected officials' thinking.
The language, which was first used last August when the FOMC decided to leave its 5.25 percent target for the overnight lending rate unchanged after 17 consecutive increases, said, ``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 incoming economic data.
That wording was intended to convey that a majority of the committee was pretty sure the next policy move would be a resumption of rate increases. After all, Bernanke had described the decision to keep the target unchanged as only a ``pause.''
By March, core inflation was still ``elevated'' while other economic data had become ``mixed,'' primarily as a result of significant weakness in housing and some less-robust numbers for business investment. So officials decided that keeping the wording about ``additional firming'' wouldn't be consistent with the committee's thinking.
The trick was to figure out how to change the January FOMC statement to reflect the greater uncertainty in the outlook without causing anyone to jump to the conclusion that the committee now regarded the risk of excessive economic weakness to be as great a risk as core inflation not coming down.
In the end, the FOMC decided to say that core inflation was still ``somewhat elevated,'' and that while ``inflation pressures still seem likely to moderate over time,'' that might not happen.
``In these circumstances, the committee's predominant policy concern remains the risk that inflation will fail to moderate as expected. Future policy adjustments'' will depend on incoming economic data, the March 21 statement said.
The new language actually was pretty straightforward. Nevertheless, the deletion of the ``additional firming'' phrase caused some to jump to the conclusion that the Fed had moved to a neutral position -- that is, that the FOMC regarded the inflation and growth risks as equal.
Some analysts also overlooked that Fed officials are growing more concerned that inflation, while not getting worse, might just not come down.
As Jeffrey M. Lacker, president of the Richmond Federal Reserve Bank, told reporters after a speech in Charlotte, North Carolina, on April ll, ``If inflation doesn't moderate, I believe additional firming will be needed.''
Much of the markets' expectation of easing was dispelled in Bernanke's testimony when he emphasized that the FOMC hadn't moved to a neutral position. It still had its ``inflation bias,'' he said.
The minutes removed any lingering doubts, as Tom Gallagher of International Strategy & Investment's Washington office told clients in a policy report yesterday.
``The Fed is now saying it intends to accomplish its inflation objective by not easing, rather than by tightening,'' Gallagher said. ``And it has removed a potential hurdle to easing if the economy moves in a direction they do no expect it to"
``We think the Fed is open to easing, but only under certain circumstances,'' which Gallagher described as ``a drop in core inflation and a worsening growth outlook.''
I'm not sure what the Fed could have done to improve the market's comprehension in this case. Somehow a lot of people got hung up on the words that were removed instead of paying attention to those that were there.