Alan Blinder Bio Photo

Economic Outlook by Alan Blinder

December 2016
Alan S. Blinder

Vice Chairman and Co-Founder, Promontory Interfinancial Network
Professor of Economics and Public Affairs, Princeton University

Markets can be funny beasts. When Federal Reserve watchers and traders woke up Wednesday morning, virtually all of them expected the Fed to raise its range for the federal funds rate by 25 basis points. That’s exactly what the Fed did. It also made only minimal changes in its statement and it barely moved its multi-year forecast. You could almost hear Chair Janet Yellen mumbling to herself, “Let’s make as little news as possible.” Yet markets reacted as if they’d been hit by a hawkish surprise: stock fells, the dollar rose, and bond yields ratcheted up. Odd.

So what hawkish “news” did the market perceive and react to? Well, one possibility is embedded in the so-called dot plot, which indicates where each member of the Federal Open Market Committee sees rates going from now until the end of 2019. It now shows one more 25-basis-point move, coming in 2017, than it did in September. Not a big deal, but it does point in the hawkish direction.

Another possibility is that the new statement says that “Market-based measures of inflation compensation have moved up considerably…” whereas last time they had only “moved up.” Is the new adverb meaningful? Maybe. But right after the word “considerably,” the FOMC statement added the qualifying phrase: “but still are low.” That doesn’t sound like a central bank consumed by inflation fears.

A third possibility——and this is an intriguing one——is that under questioning at her press conference, Yellen uttered an obvious, but perhaps impolitic truth: that the U.S. economy does not need fiscal stimulus right now. She’s right. But Trump and the Republicans are determined to deliver fiscal stimulus anyway. Might a clash between monetary and fiscal policy, which would drive rates higher, be in the offing?

When fiscal policy came up, Yellen hastened to add that the Fed cannot yet know what the new administration will propose, nor what the new Congress will do with those proposals. Right again. My personal guess is that the fiscal stimulus will be large, will be mainly tax cuts, will come quickly, and will be a budget buster. But Yellen’s guess might be quite different. More important, while I’m free to speculate about such things, the chair of the Fed is not——and won’t. Yellen and the Fed will, however, watch carefully to see what happens with fiscal policy. Stay tuned.