Since its founding in 1913, the US Federal Reserve has fought to achieve three goals: maximum employment, stable prices and moderate long-term interest rates. But that's about all that's remained consistent in the central bank's 109-year legacy of monetary policy.
Economists at the Fed work hard to maintain the institution's reputation as a stoic pillar of economic wisdom — unperturbed by politics or the whims of the day, all-knowing and, most importantly, effective. This image obsession serves an important purpose: The central bank's dependability hinges on Americans believing that it's … dependable.
That's no secret. In their June meeting minutes, officials noted strong credibility and communication had "been helpful in shifting market expectations of future policy and had already contributed to a notable tightening of financial conditions that would likely help reduce inflation pressures by restraining aggregate demand."
If Fed Chair Jerome Powell says the Fed will reduce historically high inflation rates, Americans believe him and change their behavior to reflect that. It's a self-fulfilling prophecy, the Fed's version of The Secret.
But perception doesn't always line up with reality, and the economists at the Federal Reserve are as susceptible to capricious economic shifts as you and I. There is no official rulebook to follow; they make their monetary policy through trial-and-error, and there have been errors.
The Fed, much like Madonna, is constantly evolving. This institution that aims to project an aura of stability is not beyond surprising us.
The goals of the Fed are relatively ambiguous and subject to interpretation, said Vincent Reinhart, chief economist at Dreyfus-Mellon. The definitions of those three objectives — maximum employment, stable prices and moderate interest rates — are "unidentified flying objects," he said. Right now it's clear that employment is strong and that prices are high but as interest rates continue to grow, there may be more ambiguity and room for digressive monetary recommendations.
The Fed as we know it gradually moves interest rates up and down at pre-designated meetings. They explain their decision-making with as much communication as possible and release their economic projections to give Americans an idea of what's coming in the future.
That wasn't the case in 1980, when inflation soared to 14.6%, the highest level on record.
Under the leadership of Paul Volcker, Fed officials hiked and cut their benchmark rates sharply at unscheduled meetings without corresponding policy statements. The fed funds rate didn't have a tight target range like today's — it regularly spanned 5 percentage points. It wasn't until Alan Greenspan took over in the 1990s that the Fed started adjusting rates at FOMC meetings and it wasn't until the 2000s that the central bank began cyclically tightening and loosening rates.
Big changes also occurred in 2008 under the leadership of Ben Bernanke. That's when the Fed responded to the Great Recession by enacting a policy that was previously unfathomable: Interest rates were slashed by 100 basis points to near-zero. They remained there until 2015.
These actions were "experimental and unprecedented," said Christopher Leonard, author of The Lords of Easy Money, an upcoming book on the history of the Fed. "They pushed boundaries."
Today's Fed has undergone a "huge shift towards transparency and trying to clearly communicate policy in advance so as to not surprise markets," said Brian Rehling, head of Global Fixed Income Strategy at the Wells Fargo Investment Institute. They're more transparent in their goals and their policy setting. Beyond that, Powell's impact on the annals of monetary policy has yet to be defined.
Powell appears to be loosely following the monetary playbook set by Volcker in the high-inflation days of the 1980s, but each chair has to play to their own strengths, said Reinhart. "Greenspan could dive deeply into the data. Volcker had a personal authority about his understanding of markets and banking that was intimidating," he said. Powell seems to be interested in coming off as plain-spoken; he's shifted the focus and attention of the Fed to all Americans instead of just economists and investors, he added.
But this central bank will face a new set of challenges when "the economy is not feeling so good and inflation still isn't back down to the target level," said Rehling. Powell will have to decide whether the Fed stays the course on hawkish rate hikes while facing political and public pressure about the state of the overall economy. Perhaps that's when the Fed will enter its 'Material Girl' era.
The FOMC will meet in Washington next week and is widely expected to announce another interest rate hike of 75 basis points.
Comments
Post a Comment