Popular Economics Weekly
The moment that the Federal Reserve's FOMC meeting ended, and its comments were released, interest rates rose. Why? Because bond-holders and currency traders in particular (the dollar exchange rate rose, also), believed that the Fed could raise interest rate guidance sooner, when in fact Fed Chair Yellen meant just the opposite.
The press release and her press conference were meant to clarify under what conditions interest rates may rise, other than when the 6.5 percent unemployment rate was reached, which should be this year.
"When the Committee decides to begin to remove policy accommodation, it will take a balanced approach consistent with its longer-run goals of maximum employment and inflation of 2 percent," said the press release. But the key wording was, "The Committee currently anticipates that, even after employment and inflation are near mandate-consistent levels, economic conditions may, for some time, warrant keeping the target federal funds rate below levels the Committee views as normal in the longer run."
It then added,
"With the unemployment rate nearing 6-1/2 percent, the Committee has updated its forward guidance. The change in the Committee's guidance does not indicate any change in the Committee's policy intentions as set forth in its recent statements."
But the markets took her meaning to be the opposite -- that interest rates may rise sooner, since the criteria were no longer anchored to one specific indicator--the unemployment rate. But that was a misread of the Fed's intentions. Yellen clearly stated that the unemployment rate was a very imperfect indicator of economic health, since the declining ratio of workers employed -- due to an older work force, more retirees and the like -- meant that it could take much longer to reach full employment.
Meanwhile, very low current inflation that is in the one percent range means lots of output slack, since it indicates less demand for goods and services. The inflation rate is therefore as good, or maybe a better indicator of economic health than the unemployment rate.
So Chairperson Yellen and her Fed governors seem now to be focusing much more on the current inflation rate, which has been falling. And that is not a good sign for any industry. Falling inflation means at the very least that companies cannot raise their prices, and may even have to lower them. In which case we are returning to recessionary conditions, needless to say.
And if such a downturn is the greater danger, as Yellen hinted in her comments, then keeping interest rates this low is the more prudent response.
Harlan Green © 2014
Follow Harlan Green on Twitter: https://twitter.com/HarlanGreen
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