Economic Outlook by Alan Blinder
Alan S. Blinder
Vice Chairman and Co-Founder, Promontory Interfinancial Network
Professor of Economics and Public Affairs, Princeton University
It was time--or so the Federal Open Market Committee decided on Wednesday.
The Fed surprised approximately no one by raising the target range for the federal funds rate from 0-25 basis points, where it had been for seven years, to 25-50 basis points. Also, as widely expected, it described its likely future rate hikes as “gradual”—a word Chair Janet Yellen repeated several times in her press conference. And it emphasized that “the actual path of the federal funds rate will depend on the economic outlook as informed by incoming data.” Yes, gradual and data-dependent, just as we thought.
The famous “dots” diagram tacitly defined the meaning of “gradual” as 100 bps per year for three years (using the medians for each year)—if the Fed’s forecast pans out. But, just as in the recent past, the most notable feature of the dots was how spread out they are. The most dovish members of the committee (four of them) think the fed funds range should be 0.75-1.0% a year from now; the most hawkish member thinks it should be 2.0-2.25%. That’s a 125 basis point gap! Looking two years ahead, the range of opinion is a bit wider: from 1.75-2.0% to 3.25-3.5%. So don’t be misled by the unanimous vote. The FOMC is still deeply divided—though a bit less divided than it was in September.
Why start raising rates now? The Committee took pains to explain that its two tests for a rate hike have now been satisfied: “The Committee judges that there has been considerable improvement in labor market conditions this year, and it is reasonably confident that inflation will rise, over the medium term, to its 2 percent objective.” It also reminded us that the long lags in monetary policy mean that you don’t wait until you see the whites of inflation’s eyes: “Recognizing the time it takes for policy actions to affect future economic outcomes,” it is time to start now.
Finally, the Committee continued to not surprise us by stating that it is in no rush to shrink the Fed’s huge balance sheet. The statement told us, for the first time, that it expects to keep replacing maturing securities in its portfolio “until normalization of the federal funds rate is well underway.” You figure out what “well underway” means. (They probably haven’t.) To me, it suggests a delay of a year or more.
The market reactions to all this was... well, pleasant. By the end of the trading day Wednesday, stock prices were up 1-1.5%, the 10-year Treasury yield rose just 2 bps, exchange rates were mixed, and Janet Yellen was probably smiling.