The Fed–or, technically, the Federal Open Market Committee, abbreviated FOMC–came out with its June 20, 2012 monetary policy statement an hour and a half ago. I want to offer a review of the statement. This will be as much about parsing what the FOMC means as it is a critique. This review should be read in the context of my monetary policy post “Going Negative: The Virtual Fed Funds Rate Target,” and the rest of my monetary policy thread. (See the previous and first buttons at the bottom of this and other posts for the rest of my monetary policy thread.) There are three things I noticed in the FOMC statement.
First, the FOMC thinks the economy needs more monetary stimulus:
To support a stronger economic recovery and to help ensure that inflation, over time, is at the rate most consistent with its dual mandate, the Committee expects to maintain a highly accommodative stance for monetary policy.
The key words for that interpretation are “To support a stronger economic recovery …” where I have added the italics. If they want a stronger recovery, they must think it is not strong enough. The FOMC particularly mentions jobs and housing (earlier in the statement) as areas where the economy is not strong:
However, growth in employment has slowed in recent months, and the unemployment rate remains elevated…. Despite some signs of improvement, the housing sector remains depressed.
In addition to wanting a “stronger economic recovery,” the FOMC thinks the economy needs more monetary stimulus because of the European debt crisis. This is how they say it:
Furthermore, strains in global financial markets continue to pose significant downside risks to the economic outlook.
Since monetary policy only affects the economy with about a six to nine month lag, steering the economy with monetary policy is like steering a giant ocean liner. The FOMC needs to look not only at where the economy is now, but where it might be during the next six to nine months. And one place the economy might be in the next six months is reeling from the European debt crisis. Extra monetary stimulus now is an insurance policy.
Second, the FOMC has not yet heeded my warning against appearing (at least to some audiences) to be promising to keep interest rates lower in the future than they otherwise would think was best, in order to stimulate the economy now. (See “Going Negative: The Virtual Fed Funds Rate Target,” which also offers an alternative communications strategy.) Again, let me emphasize that I do not think they are saying that. I am only saying that they will be interpreted by many observers to be saying that. Fortunately, as long as they are not really saying that, and remember in the future that they were not saying that, the harm will be quite contained. Just below are the words at issue. See if you think the (mis)interpretation I am worrying about is a danger:
In particular, the Committee decided today to keep the target range for the federal funds rate at 0 to ¼ percent and currently anticipates that economic conditions–including low rates of resource utilization and a subdued outlook for inflation over the medium run–are likely to warrant exceptionally low levels for the federal funds rate at least through late 2014.
Third, the FOMC declares that it does not believe in Wallace neutrality. (See “Is Monetary Policy Thinking in Thrall to Wallace Neutrality?” and the rest of my monetary policy thread.) Here is what they say:
The Committee also decided to continue through the end of the year its program to extend the average maturity of its holdings of securities. Specifically, the Committee intends to purchase Treasury securities with remaining maturities of 6 years to 30 years at the current pace and to sell or redeem an equal amount of Treasury securities with remaining maturities of approximately 3 years or less. This continuation of the maturity extension program should put downward pressure on longer-term interest rates and help to make broader financial conditions more accommodative.
I have italicized the key sentence that implies that the FOMC as a body does not believe in Wallace neutrality, as applied to the real world. Wallace neutrality would imply that changing the maturity structure of Treasury securities (selling relatively short-term government bonds and buying relatively long-term government bonds) could not affect interest rates or “make broader financial conditions more accomodative." Note that it is not easy to interpret the FOMC statement as changing the maturity of Treasury securities in order to signal a lower path of the fed funds rate in the future, since it already talked about the future path of the fed funds rate earlier in its statement (as quoted above). I applaud the FOMC’s clear rejection of Wallace neutrality as a good description of the real world.