Believe those who are seeking the truth. Doubt those who find it. Andre Gide

Thursday, December 18, 2014

Considerable Time and Patience a Decade Ago

According to USA Today:
Wall Street cheered as the Federal Reserve used a new word — "patient" — to basically let the market know that it isn't in a rush to hike short-term rates next year.
So, "patient" is the new buzzword. In other words, the Fed evidently ran out of patience with "considerable time." 

But just how new are these buzzwords? They're not new at all. Consider this from the December 09, 2003 FOMC statement, for example.
However, with inflation quite low and resource use slack, the Committee believes that policy accommodation can be maintained for a considerable period.
This "considerable period" language was also used in the August 12, September 16, and October 28 FOMC statements leading up to the December statement. The FF target rate at that time was 1%. Headline PCE inflation was running at about 2% (year-over-year), and the unemployment rate was about 5.5%.

Then, at the next FOMC meeting, the Fed switched from "considerable period" to "patient." From the January 28, 2004 FOMC statement
With inflation quite low and resource use slack, the Committee believes that it can be patient in removing its policy accommodation.
Note that "inflation quite low" in January 2004 was 2%. The FOMC continued to express "patience" in its March 16 statement. In its May 4 statement, "patience" was replaced with:
At this juncture, with inflation low and resource use slack, the Committee believes that policy accommodation can be removed at a pace that is likely to be measured.
Note that the "with inflation still low" statement now corresponds to PCE inflation running around 2.5%. 

It wasn't until the June 30 statement that the FOMC finally raised the FF target rate by 1/4%. And for the next 17 meetings, the FOMC raised its policy rate by 25 basis points. 

Should the Fed at that time exhibited less patience, both in the the timing and pace of "lift off?" Certainly John Taylor seems to think so

And what about the situation today? While the unemployment rate today (5.8%) is not far from where it was eleven years ago, the policy rate is at 1/4% (instead of 1%) and the PCE inflation rate is at 1.5% (instead of 2%). At the risk of oversimplifying, there are basically two views on the matter.

The dovish argument is that with inflation and inflation expectations low (relative to target) and unemployment still elevated somewhat, keeping the policy rate at its floor seems like the right thing to do right now. What this has to do with "considerable time" or "patience," I'm not sure. It is a state-contingent policy. (Adding "considerable time" or "patience" to the statement simply reveals the FOMC's own assessment of the probabilities associated with future states of the world.)

The hawkish argument is that the real economy is basically back to normal, that while inflation and inflation expectations are currently low, this is largely transitory. And in any case, the welfare cost/benefit of 1.5% inflation vs. 2% inflation is virtually nil. So, with inflation and unemployment at close to normal levels, why shouldn't the policy rate also start moving closer to normal levels? (There are also other concerns relating to low interest rates and financial instability--look at what happened the last time we had a "patient" Fed.) 

Stay tuned, folks.

1 comment:

  1. Yellen was asked about measured pace in the press conference. Her response was unequivocal: (paraphrasing) "no way, we learned the hard way not to do that". I was surprised that she was so adamant about it given that the economics jury is still out on whether measured pace contributed to the housing bubble (btw my chapter in David Beckworth's book argues otherwise).

    On the other hand, everything else Yellen said during the conference would have led the market to believe that measured pace is de facto policy. This is one explanation for why asset prices shot up. I wonder if the FOMC was pleased with this development. I suspect the market's stubborn optimism over Fed intentions is both a blessing and a curse for the Committee.