Guidance about guidance
Janet Yellen, the Federal Reserve chairwoman, testified to the US Senate yesterday and is returning to Capitol Hill for a grilling in the House today. Here is a half-time update.
There is a disproportionate amount of attention to what Yellen's words may reveal about when interest rates may rise. This, as Gavyn Davies explains, is "intrinsically unimportant for the economy as a whole". What really matters is the medium-term path of rates, and what that says about the health of the economy. But a lot of money can be made or lost by betting on when rates are first raised from zero.
This means Yellen has to engage in a lot of meta-guidance, that is to say guidance about the Fed's guidance itself. For Davies, the Fed did itself a disservice when it swapped "considerable time" for "patient" in its December statement to indicate that a rate rise is still not imminent, but more imminent than before ("patient" is taken to mean "at least two meetings away"). To manoeuvre itself into a place where it can raise rates without violating what it has led markets to expect, the Fed needs eventually to drop the "patient" language, but in a way that does not in turn make markets think an immediate rise is a sure thing. Hence Yellen's guidance about guidance. The WSJ lists the key quotes from her testimony, which signal that the Fed will soon simply want to let the data guide its decision from each meeting to the next. As Davies suggests, this may be where it should have been all along. The FT has an in-depth write-up of the testimony.
Lost in all the word-weighing are the real economic issues. The general tenor here is that things are looking good, which is why it may just be a question of months before the tightening cycle begins. But as my colleague James Mackintosh's excellent guide shows, the economic situation facing the Fed is a lot more complicated than that. In particular, deflation is as strong in the US as in the eurozone when measured on a like-for-like basis. Here is James's chart of inflation in both economies with housing costs stripped out (the standard measure in Europe, and perhaps a good guide to where US inflation is headed given the slowdown in the house price recovery):
James also points to the various indicators suggesting that wages are about to take off. The unemployment rate, for example, is heading into territory that historically is associated with much stronger wage growth than the US has seen since the financial crisis broke:
That's good for workers. But the combination of weak price inflation and possibly imminent wage rises makes it hard for the Fed to time its tightening. As Nick Butler pointed out on Monday, however, while the low unemployment rate hints at wage pressures just around the corner, the unusually low employment rather suggests that they are still far off. If that's the case, the Fed's task is easy: sit back and wait.
Don't audit the Fed
Unsurprisingly, Yellen was confronted with Senator Rand Paul's proposal to "audit" the Fed. As Free Lunch explained two weeks ago, that really means putting monetary policy under direct congressional control, which is a very bad idea. Unsurprisingly, Yellen smacked the proposal down. The real shame is that Senator Paul's fringe crusade distracts from more serious proposals for Fed reform. Dallas Fed president Richard Fisher's call to shift power away from the New York Fed to the other regional reserve banks has now gained the support of the community bank lobby. It's a proposal well worth considering.
- Matthew Klein usefully points out that Japan's net public debt held by the private sector is small and falling: the central bank is now buying JGBs faster than the government is issuing them.
- The New York Times finds inequality rearing its head in a Cuba creeping towards a market economy.
- Stephen Cecchetti and Kim Schoenholtz tell you everything you need to know about the Big Mac Index.
- Germany has for the first time been paid by investors to take their money for five years.
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