Sometimes no change is a change.
This week the Fed released its regularly scheduled statement following its regularly scheduled meeting. While it was possible to read the entrails as being those of either a dove or a hawk, the markets came down squarely on the side of the doves. Gold went up immediately following the meeting, as did Bitcoin. Stocks also responded positively, and the dollar fell.
I think that the markets are right. Yes, the policy announcement was consistent with the new normal. The statement read:
The Committee seeks to achieve maximum employment and inflation at the rate of 2 percent over the longer run. With inflation running persistently below this longer-run goal, the Committee will aim to achieve inflation moderately above 2 percent for some time so that inflation averages 2 percent over time and longer-term inflation expectations remain well anchored at 2 percent.
But sometimes no change is a change. The Fed raised its inflation forecast for this year, seeing the PCE inflation rate (the Fed’s self-chosen, easy grader for monetary discipline purposes) hitting 2.4 percent by the end of the year. It also raised its growth forecast and lowered its unemployment outlook. And yet despite this, it showed no signs of wanting to change its policy.
William McChesney Martin, who served as the Fed’s chairman between 1951 and 1970, famously compared the Fed’s job to “that of the chaperone who has ordered the punchbowl removed just when the party was really warming up.” But this week the Fed signaled something slightly different: It said, in essence, that the party looks like it will be warming up more than we had previously thought, but that we’re not changing our liquor-distribution schedule.
The statement strongly suggests that the Fed will tolerate more inflation before taking away the punch bowl, and that it will demand even lower unemployment and higher growth before ending the party.
Neil Irwin, senior economics correspondent for the New York Times, put it this way:
An old metaphor holds that the Fed’s job is to take away the punch bowl just as the party gets going. The official view of the central bank’s leaders now is that it has been an overly stingy host, taking away the punch bowl so quickly that parties were dreary, disappointing affairs.
The job now is to persuade the world that it really will leave the punch bowl out long enough, and spiked adequately — that it will be a party worth attending. They insist punch bowl removal will be based on actual realized inebriation of the guests, not on forecasts of potential future problematic levels of drunkenness.
The Times isn’t always wrong.
The Fed is moving the goal posts, giving itself more permission to keep the game going. Gold, crypto, forex, and inflation-protected treasury bonds all were up in response, though there were reversals subsequently, especially on Thursday when markets reacted to other news, including an unexpectedly weak jobless-claims report and rising concerns about global supply chains. Markets sifted through the new data and sold off treasuries (raising yields) and stocks, particularly tech stocks that tend to be more interest-rate sensitive because of long time horizons. Perhaps investors are looking at both the Fed and the economy and realizing that there are limits to how much real economic good money creation can accomplish.
I think that, in making their initial reflationary bet, the markets had things right and may even be underestimating the radical nature of the Fed’s policy agenda. The Fed made it clear last year that it intended to keep “inflation moderately above 2% for some time.” It also reiterated this week that it “will aim to achieve inflation moderately above 2 percent for some time so that inflation averages 2 percent over time.” In other words, the goal isn’t just to get PCE inflation above 2 percent, but also to raise the average above that level. That average includes the past two years of PCE inflation averaging only 1.3 percent, and only 1.5 percent since the end of the Great Recession.
The math is pretty clear. If the Fed aims for four years of average PCE inflation of 2 percent, and the past two years averaged only 1.3 percent, then the next two years will have to average 2.7 percent. And to add fuel to the fire (or is it firewater to the punchbowl?), that target is a PCE target. But CPI inflation runs about one-third higher. So, if the Fed is giving itself permission for a PCE party of more than 2.7 percent, it is giving itself permission for a CPI party of more than 3 percent “for some time.”
And all of that just includes the inflation it wants, not inflationary policies foisted upon it by the implications of yet more Biden spending, or, for that matter, possible minimum-wage-hike effects on unemployment that will force the Fed to adjust its policies to accommodate the NAIRU jacket in which it has now wrapped itself.
This punch bowl is going to lead to quite a hangover.