Federal Reserve Policy Shift

The FOMC shifted into a contractionary monetary policy at this week's meeting. Their target interest rate was raised by 0.25% (or 25 basis points) to a range of 0.25-0.50%.

This move was expected. However, the repercussions of the war in Ukraine are broadly expected to have a contractionary effect too. I think this made some members a little leery of taking this step (the vote was 8-1, with the no vote wanting a bigger 0.5% increase). (In a post yesterday for my principles classes, I put the odds on a 0.50% increase at 20%, 50% on the 0.25% increase they chose, and 30% on no change at all).

Even so, inflation is a problem, and the Fed is the institution primarily responsible for addressing this. The underlying idea is that inflation results from more willingness to spend than ability to produce. Raising interest rates will discourage some spending.

I describe monetary policy in the U.S. as a sequence of baby steps. In this chart you can see extended periods where rates are raised or lowered several times in a row.

This is intentional, so we can probably expect rates to be raised many times over the next couple of years.

The FOMC releases an extensive report after its meetings. One of the items in there is the forecasts of where the individual members think interest rates will be in the future (at year's end):

There is a little bit of a trick here. The FOMC is composed of the 7 Governors from the Board of Governors in D.C., and the Presidents of the 12 Federal Reserve Banks around the country. That's 19 people in the meeting. But not all of them vote:

• 7 Governors always vote
• 1 President, of the Federal Reserve Bank of New York, always votes
• 4 out of the other 11 Bank Presidents vote on a rotating basis (for a year, roughly every third year)

The thing is, sometimes there are vacancies, particularly amongst the Governors (there are vacancies amongst Bank Presidents, but they have day-to-day local duties, so those jobs aren't open for long). Currently there are 3 vacancies amongst Governors. So, 16 people were in the meeting (and there are 16 dots in each group on the graph), while 9 people voted. 

FOMC meetings are scheduled in advance. There are 6 more this year. The dot that's lowest on the left, the member that expects the least rate increases) is forecasting 4 more increases of this size for this year. The median forecast is 6 for 6. 

On the top chart, some of the steps are wider, and that indicates ac couple of meetings in a row in which they voted for no change. 

Of course, they could always go for a bigger increase at some meeting, but the top chart shows they haven't done this any time in the past 25 years. They have brought their target down in big steps a few times.

Also, the FOMC can have emergency meetings between scheduled ones. For example, two years ago, just before the lockdowns, they dropped interest rates twice between meetings, in anticipation of the economy going downhill rapidly.

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There are fairly serious arguments made by academic macroeconomists that the FOMC was not aggressive enough at raising interest rates after the 2001 recession, and that this encouraged the formation of an asset price bubble that contributed to the financial crisis of 2006-9. The argument here is that interest rates that were too low encouraged people to buy assets they could not afford later on.

The same argument was made 4-10 years ago about the Fed's behavior then. However, we did not end up with a price bubble or financial crisis.

Yesterday, in a strongly worded opinion piece, the Wall Street Journal emphasized the position that the Fed is too timid about fighting demand pressures.

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You may be wondering why I emphasize this topic less than the popular media does. This is because the time series portion of this course teaches us that it's just not as big a deal as it's made out to be. Look for that message when we start covering in class what's called Case 5 in my text.