Fed Overhauls Communications, Raises Bar for Future Policy Tightening
by Craig Dismuke, Dudley Carter
Monetary Policy Unchanged, Official Statement Overhauled: In their first policy decision after formally adopting an inflation averaging scheme, the FOMC voted to hold its target rate range unchanged at 0.00-0.25% and continue purchasing securities at the same rate. The Official Statement was overhauled to reflect their newly defined objective. The Statement now reads, “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.”
Long-Term Policy Implications – Higher Bar for Future Tightening: Applying this new framework to policy, “The Committee expects to maintain an accommodative stance of monetary policy until these outcomes are achieved.” In a shift that could either be interpreted as less dovish or the result of the new policy scheme, the Committee removed language from the Statement saying they will use their “tools to act as appropriate to support the economy.” The word “act” has recently been associated with pending policy changes. The wording was replaced with less specific language saying, “the Committee would be prepared to adjust the stance of monetary policy as appropriate if risks emerge…”. Regardless of the short-term implications, the longer-term implications of today’s policy decision clearly raise the bar for any future tightening of policy. Not only will inflation need to appear to be returning to 2 percent, it will now need to convincingly average 2 percent over some period of time before Fed officials will be open to tightening policy.
Continue QE with Option to Increase for Smooth Functioning of Markets: In the implementation note, Fed officials continued to say they will increase their holdings of Treasurys and agency mortgage-backed securities (MBS) at the current pace, approximately $80 billion in Treasurys and $40 billion in MBS each month. However, they amended that plan to also say they will “increase holdings of Treasury securities and agency MBS by additional amounts… as needed to sustain smooth functioning of markets for these securities.”
SEP – Majority of Officials Expect Rates to Remain Unchanged through 2023: The Summary of Economic Projections reflect the higher bar for future policy tightening. The Dot Plot shows just one participant who believes conditions will allow for a rate increase by the end of 2022, down from two participants in June. Moreover, even through the end of 2023, only four participants believe conditions will allow for rate increases. The economic projections were revised to reflect less contraction in 2020 than projected in June. Initially forecast to contract 6.5%, officials now expect the economy to contract 3.7% this year. However, the pace of growth in future years was lowered. With the unemployment rate already down to 8.4%, officials revised their year-end 2020 forecast down from 9.3% to 7.6%. By year-end 2023, participants project the unemployment rate will decline to 4.0%, below their longer-run NAIRU rate of 4.1%. However, even with the labor market improving more quickly than previously projected and beyond full employment by 2023, participants do not anticipate inflation running above 2.0%. Looking at the range of forecasts, there are, at most, only three officials who believe inflation will be above 2 percent for any year in the forecast horizon.
Dissenting Opinions: Two officials dissented to the policy decision. Dallas Fed Bank President Kaplan provided a nuanced dissent to the forward guidance, preferring to “retain greater policy rate flexibility beyond” the point that their goals are met. Minneapolis Bank President Kashkari preferred to specify an objective of “core inflation” reaching “2 percent on a sustained basis.”
Bottom Line: Today’s policy announcement reflects an overhaul of the Fed’s monetary policy framework. While any near-term easing of policy appears less likely, the adoption of inflation averaging raises the bar for future tightening of policy as reflected in the Summary of Economic Projections.