The Monetary Policy Outlook
By Scott Brown
February 22, 2011
Fed Chairman Bernanke is set to deliver his monetary policy testimony next week. There’s not much suspense. The release of the FOMC minutes from the January 25-26 policy meeting included senior Fed officials’ revised projections of growth, unemployment, and inflation, as well as a thorough discussion of the uncertainties. No change in monetary policy is expected for some time. However, the Fed will have to consider when to lose the “extended period” language and eventually move to a more normal policy position. That doesn’t look likely for 2011.
At the January 25-26 FOMC meeting, in preparation for the semi-annual Monetary Policy Report to Congress, senior Fed officials submitted revised forecasts for the next couple of years. The central tendency forecast of GDP (which excludes the three highest and three lowest of the forecasts of the six Fed governors and 12 district bank presidents) was raised to 3.4% to 3.9% (4Q11-over-4Q10), vs. a range of 3.0% to 3.6% seen in November. Despite the improved growth outlook, the unemployment rate was expected to edge down grudgingly in 2011 (8.8% to 9.0% in 4Q11), with a larger decline beyond that.
There was a wide range of uncertainty in inflation projections, but most Fed officials expected core inflation to trend in the lower part of the comfort range (1% to 2%). According to the FOMC minutes, “many participants expected that, with significant slack in resource markets and longer-term inflation expectations stable, measures of core inflation would remain close to current levels in coming quarters.” However, “the importance of resource slack was debated, and some participants suggested that other variables, such as current and expected rates of economic growth, could be useful indicators of inflation pressure.” Following the disinflationary trend in 2010, some increase in inflation is welcome. However, despite worries about higher commodity prices, consumer price inflation is not expected to get out of hand anytime soon.
Prior to the mid-year slowdown, Fed officials spent the first half of 2010 testing the exits. The Fed has a number of tools (such as reverse repos and time deposits for depository institutions) to remove reserves from the banking system when appropriate. However, a sharp tightening in monetary policy is unlikely. The Fed will eventually have to take the foot off the gas pedal (not necessarily “hitting the brakes”) as a “normalization” of monetary policy. Removing the conditional commitment to keep short-term interest rates near zero for “an extended period” will depend on a change in the Fed’s stated conditions: low rates of resource utilization (equivalently, an elevated unemployment rate); a low underlying trend in inflation; and well-anchored inflation expectations.
The Fed has been criticized for its asset purchase program (“quantitative easing”), partly by those who don’t understand that the Fed’s asset purchase program is merely a way to ease policy when up against the zero interest rate bound, and partly by those who fear that easy monetary policy will fuel inflation more generally. The Fed’s asset purchase program will end on schedule, but there’s no need to raise rates anytime soon.
(c) Raymond James