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| Fed Brief™ |
Dec 13 2005 - No Longer Accommodative But Still Rising:
The Fed voted unanimously to raise the federal funds policy rate for a 13th consecutive FOMC meeting Tuesday. The 'measured' pace of 25 bp leaves a 4.25% overnight federal funds rate target and a 5.25% discount rate. The market was watching for changes in thepolicy statement and that's what it got but without much clarity on the extent of the tightening ahead.
The change in the policy wording was the removal of the phrasing that policy was 'accommodative'. The 4.25% policy rate demanded the change as it has at least entered the range of policy rate 'neutrality' (or at least as we define it below). The statement retained the signal for future tightening by noting that 'some further measured policy firming is likely to be needed' in order to keep economic and inflation risks roughly in balance.
While the statement again noted that economic prospects will led the Fed policy direction the underlying tone argues for another 25 bp hike at Greenspan's final meeting on Jan 31 and possibly another as Ben Bernanke takes on the leadership of the policy setting committee at the March 28 meeting. The pace of economic growth and core inflation are the best indicators for the extended view.
The statement noted the relatively low core rate of inflation in recent months but also the inflation risks associated with increased resource utilization and elevated energy prices. While the 5% unemployment rate (labor utilization) provides a warning bell for rising labor costs the data show back to back quarterly declines in unit labor costs -- at least interrupting the upward trend earlier seen. Moreover, to date there has been no obvious effect on core inflation from the spike in energy prices as Winter heating costs will pressure homeowners but is unlikely to significantly add to core inflation pressures. Benign inflation could bring an end to the tightening by the end of the first quarter.
Looking further ahead the Fed Chairman-to-be sees 'constrained discretion' (yup, Bernanke-speak) as the heart of his inflation-targeting approach (Bernanke, March 2003). 'Constrained discretion attempts to strike a balance between the inflexibility of strict policy rules and the potential lack of discipline and structure inherent in unfettered policymaker discretion' in order to anchor inflation expectations. Bernanke wrote of 'the possibility of using [constrained discretion] to get better results in terms of both inflation and employment'. Any change in the policy setting regime will take time to implement given differing perspectives among the policy makers and even Congress if a larger legislated change is sought -- which we strongly doubt.
A 'Neutral Rate' Benchmark
A simple benchmark for the 'neutral' policy rate uses the average real (inflation adjusted) policy rate and adds the current inflation or inflation expectation rate to provide an approximation. Fed Chair Greenspan favors core PCE price growth as the primary inflation index. Since 1990 the real funds policy rate has averaged 2.1% using core PCE to deflate. Add the current 1.8% yoy core PCE price growth to the 15 year average real funds rate (2.1%) to estimate a neutral nominal policy rate near 4%.
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| Fed Economic Projections (central tendencies of July 2005) * * * * Fed Calendar and FOMC Voting Presidents
While the seven Federal Reserve Governors always retain voting statusalong with the NY Fed president (who is also the FOMC vice chairman), theremaining four seats on the 12 member voting committee are shifted at the startof each year. The table below reviews the rotation -- see their biographies inthe links at the bottom of the page.
Questions, comments or feedback may be e-mailed to the author: Timothy E. Rogers | |||||||||||||||||||||||||||||||||||||||||||||||||||||
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