Don’t blame Janet Yellen for what she said. Blame her for what she’s doing.
Last week, Yellen had her first news conference since becoming chair of the Federal Reserve. She said, in answering a question, that the Fed would probably raise interest rates “around six months” after its quantitative-easing program ends. The remark is being called a “gaffe” that caused stocks to fall. The Standard & Poor’s 500 Index fell 1 percent in the seconds after she made the comment.
Some of Yellen’s critics fault her for being too forthright and specific. The Fed often gets knocked for being unclear, they say, but opacity has its virtues. This critique seems off the mark. If the Fed really does intend to tighten monetary policy six months after QE ends — or roughly next spring, if present trends continue — the market will have to adjust to that event soon enough. In that case, specificity would be no sin.
But Yellen’s other remarks at the news conference suggest that the Fed doesn’t desire to be ruled by the calendar. Economic conditions will guide its decisions. It expects those conditions to justify tightening early next year, but it isn’t committed to tightening if conditions develop in some unexpected way.
To the extent Yellen’s remarks were problematic, then, it was not because they made the Fed more transparent, but because they made it less so. They may have been misleading about the central bank’s intentions, making it seem as though the Fed were more eager to tighten money than it is.
The Fed’s communications strategy is important, and not just because it can produce short-term swings in the stock market. Fed policies work in part — many economists would say in large part — through their effect on market expectations. So when the Fed leads the market to think that it’s going to tighten monetary policy in the future, it tightens money in the present. A Fed that doesn’t want tighter money, but misleads people into thinking that it does, is accidentally tightening it.
In this case, though, the muddled communications aren’t a gaffe. They reflect a muddled policy. The markets are obsessed with every syllable Yellen utters because they’re so unsure about what the Fed is going to do. Its behavior is difficult to predict. It has acted in an ad hoc way for the past several years and has never bound itself to any rule.
The Fed has not said, for example, that it would take undershooting its 2 percent inflation target as seriously as overshooting it. It has not said, to take another example, that it would seek to keep spending throughout the economy growing at a 4.5 percent rate each year. Either rule would make the Fed’s behavior under various circumstances predictable, and make it easy to see whether it had succeeded or failed in hitting its target.
What the Fed instead said last week is that its policies “will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments.” There is nothing here that constrains the Fed’s decisions or offers much guidance to those seeking to predict them. The statement might as well have added “the price of gold” or “the gut feelings of the Fed’s open market committee” to its list of indicators.
Tim Duy, an economics professor at the University of Oregon, notes that the statement contains evidence of both “dovish” and “hawkish” intentions. The dovish side of the statement says that interest rates will stay lower than normal even after unemployment and inflation reach levels near the Fed’s goals. The hawkish side is that the statement seems to treat 2 percent inflation as a ceiling. Narayana Kocherlakota, the president of the Minneapolis Fed, dissented from the statement in part because it didn’t outline steps to bring inflation up to that level.
Adopting a clear rule would make it easier for the Fed to communicate its policies — which, again, is part of executing them. What the Fed wants, whether it is moving in a more or less hawkish direction, would be clear.
But lack of clarity isn’t the only or the worst thing about the Fed’s policy that Yellen’s comment revealed. The Fed, by statute, is supposed to keep both inflation and unemployment low. By the Fed’s own definitions of “low,” inflation is below the target, and unemployment is above it. Neither measure points to a need for tighter money; they suggest instead that money has been too tight. Under the circumstances, the Fed is spending too much time thinking and talking about when it will tighten. The entire conversation surrounding monetary policy is skewed toward tightness.
Before her term began, speculation had Yellen as a dove. In the first controversy of her chairmanship, however, she erred on the side of hawkishness. Which goes to show, once again, that the Fed is an opaque and unpredictable institution.
