Contrary to earlier expectations, the Federal Open Market Committee meeting on 19-20 September is shaping up to be a sleepy gathering. Markets overwhelmingly expect the FOMC to keep rates on hold in September. Relatively subdued inflation and labour market data have boosted the soft-landing camp, undoubtedly putting a smile on the faces of FOMC members. Committee speakers have practically reaffirmed the market’s view.
The FOMC faces a September communications challenge, though. Markets now anticipate an unchanged federal funds rate well into next year. The FOMC will want to welcome the most recent data, without showing sufficient satisfaction to foreclose another hike if needed or dissuade markets from adhering to the higher-for-longer expected rate trajectory. The US August inflation data, coming in a bit higher than expected, will facilitate that task. Focus will be on the dot plot, especially as the 2023 growth projection is likely to be marked up, while the June median 2023 FFR was above 5.5%.
But the Federal Reserve also faces a more serious, longer-term communications challenge. US public discourse focuses heavily on the Fed and creates an exaggerated sense of what monetary policy alone can deliver. The Fed itself and the wider economic community bear considerable responsibility. The Fed should be more vocal in underscoring that it singlehandedly can’t do the job of stabilisation and that the US policy mix overburdens monetary policy. Otherwise, its own independence could ultimately be compromised at the hands of America’s inept and irresponsible political class.
Fed Chair Jerome Powell is forever fond of saying at his press conference, ‘Price stability is the responsibility of the Federal Reserve.’ That is certainly true as price stability is one of the two pillars of the Fed’s mandate. But the overstatement can create an exaggerated impression that the Fed is solely responsible and can master price dynamics.
Factors outside of the Fed’s control
Recent years have vividly underscored that supply shocks and a wealth of exogenous factors affect prices. These have included the pandemic and shutdown, technological innovations, Russia’s barbaric invasion of Ukraine, Organization of the Petroleum Exporting Countries dynamics, supply chains, changing relative goods and services prices, fragmentation and Chinese developments.
Fiscal and structural policies are extremely consequential for price trends and broader economic performance. Unsustainable fiscal trajectories weigh upon the conduct of monetary policy. These are all factors beyond the Fed’s remit.
One might still argue that, regardless, it’s the Fed’s job to use monetary policy to keep aggregate demand in line with aggregate supply and meet its inflation target. But that is far easier said than done, especially given lags, surprises, what it might mean for employment and that the Fed lacks a crystal ball.
The excess monetary policy focus is reinforced by the perpetual torrent of pre-FOMC meeting speeches by Fed governors and regional bank presidents. These keep monetary policy at the forefront of much economic reporting, perhaps falsely creating the idea in the public’s mind that a decision to hike by 25 basis points or not will have a Goldilocks impact in determining the economy and inflation’s future.
More specialised, esoteric monetary policy questions, though important, are being publicly seized upon: is the inverted yield curve still a meaningful recession predictor? Will the neutral rate be higher in the future? Is quantitative tightening having a meaningful restrictive impact?
Taken together, monetary policy coverage swamps economic and financial policy communications, creating unrealistic expectations of what the Fed can deliver. This could prove ultimately unhealthy for America and the Fed.
Ultimate compromises to Fed independence
Despite the welcome practice of the George W. Bush, Barack Obama and Joe Biden administrations not to comment on the Fed, which Donald Trump woefully disregarded, a polarised political system can look for scapegoats, rather than accepting responsibility for its own policy failure. It might seek to put pressure on the Fed to keep rates low, especially in the face of the Fed’s current stance and America’s highly adverse, long-term fiscal trajectory and large fiscal deficits.
Such developments could compromise the Fed’s independence and the ability of monetary policy to serve as a flexible tool for stabilisation. It would be highly damaging to America if Congress and/or the executive branch made a hash of monetary policy, as they have generally done with fiscal policy in the last decades.
For the Fed’s own good, the US economic policy debate needs to be broadened. In addition to nuanced monetary policy communications, Fed officials should speak candidly and forcefully to the public about the influence of other policies on the dual mandate and how these forces can compromise attainment of monetary policy objectives. This might uncomfortably cause Fed officials to go beyond their perceived remit. But it would be salutary if America steered towards a more balanced macroeconomic policy mix and realistic understanding of the economic forces that can shape domestic outcomes. Economic commentaries should also emphasise a similar broader focus.
The Fed can’t do it alone.
Mark Sobel is US Chair of OMFIF.
Image source: Federal Reserve