The Fed and Considerations from Jackson Hole

July 17, 2014

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We had the pleasure of traveling to Jackson Hole, Wyoming this past week to speak at the Rocky Mountain Economic Summit. Also giving talks were Fed Presidents Charles Evans, Charles Plosser, and Dennis Lockhart. The bottom line from the Fed speeches was that U.S. monetary policy should (and will) respond to improving data, as we move toward next year.

As we’ve noted previously, during the crisis the Fed had a conceptually easy but technically hard job. In a crisis, the economics literature is consistent in what to do, i.e., you ease and ease a lot. But easing in a crisis is hard, since in a crisis the “plumbing” in the economy is broken. So, Fed members spent lots of time coming up with new tools (i.e., new acronyms: TAF, TALF, CPFF, MMMF, QE, etc.). This is conceptually easy, but technically very difficult.

Today, we have hit an inflection point: Now we have to start talking more about Fed tightening. So, today the Fed’s job is technically easy (the Fed has the tools to tighten, i.e., reverse repos, interest on excess reserves, etc.). The tools exist and have been tested, and the FOMC is actively setting up a plan to determine the mix of tools to be employed. The key question is: when to use those tightening tools? This is technically easier, but conceptually very difficult (especially with the historical example of Japan showing what can happen if the central bank tightens too early).

A year ago, FOMC members were driving home the idea that highly accommodative monetary policy was necessary for the foreseeable future. Easy policy is still likely for the balance of 2014 (the Fed really cannot tighten until it is done tapering QE, which the Fed minutes noted was an October event).

Also a year ago, the FOMC seemed happy that the bond market had stabilized at roughly 2.6 percent on the 10-year Treasury yield, after the “taper tantrum.” At a minimum, it showed that the Fed was having some success communicating that tapering QE was not tightening. We are still around that level on bond yields. But now, the Fed needs to talk about actual tightening, i.e., raising short-term interest rates.

The timely economic data suggest the U.S. labor market continues to look better. Initial jobless claims fell to 304,000 last week, pulling the four week average down to 312,000. The JOLTS data continue to support a bounce in the labor market. The next set of employment reports should tell us 1) how much of a bounce-back (especially in GDP) we’re likely to see in the second and third quarters of 2014, and 2) how much of the first quarter strength in payrolls (if any) was due to temporary factors around the start of the year (e.g., jobless benefits expiring).

The Fed wants to move slowly. But the market tends to move quickly (i.e., “over-shooting”). If the Fed wants the precision of a rifle, the market may come closer to an automatic weapon. Even after the first Fed rate hike, FOMC members have noted that their moves to tighten policy are likely to be slow. They want to move at a measured pace. But the market may not move at a measured pace – no one wants to be last out the door, especially in places where that door is small.


The ideas and opinions expressed in this blog are those of the author, and they should not be perceived as investment advice or as any other kind of advice.


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