I will be traveling today, so limited blogging (and yes, I’m still in Yurp, so “today” is Thursday). But I did want to weigh in briefly on the Fed’s latest, in which Bernanke confirmed that the Fed is getting significantly more hawkish — based on relatively optimistic forecasts.
My reaction is, this is not good. They might get away with it, but there’s also a serious chance that this will end up looking like a historic mistake.
Bear in mind, first, that the US economy is still deep in the hole, which is especially obvious if you look at employment rather than unemployment:
Aging of the population accounts for some but not much of the fall in the employment ratio; the fact is that we are still a very long way from acceptable employment levels. Meanwhile, inflation remains below the Fed’s target. Maybe the Fed believes that the situation will improve — but as everyone points out, the Fed has been consistently over-optimistic since the crisis began. And for now the economy still needs all the help it can get.
How can the Fed help? With short-term rates up against the zero lower bound, mainly through expectations — by conveying the message that it will wait to tighten, that it will let the economy recover and allow inflation to rise before hiking rates. To use my old phrase, it must credibly promise to be irresponsible.
And what it has just done, instead, is signal that it’s still a conventionally minded central bank.
So what if recovery stalls, and inflation expectations fall even further? Can the Fed turn on a dime, and send a credible message that it really isn’t so conventional-minded, after all? It’s hard to believe; having already shown itself inclined to start snatching away the punch bowl before the party even starts, it has arguably already given away the game.
I know that the latest had overwhelming support on the FOMC; I’m surprised and a bit shocked by that, and worry that we may have seen incestuous amplification at work.
I really hope that the real economy recovers at a pace that makes my fears groundless. But if it doesn’t, I fear that the Fed has just done more damage than it seems to realize.