The September FOMC minutes are out today and let us know that “A couple of members noted that they would prefer to change the Committee’s forward guidance to provide greater clarity about the economic conditions that would be likely to warrant maintaining exceptionally low levels of the target federal funds rate, but no decision was taken on this point.”
This couple of members is correct. They’re correct for two reasons — sensible guidance would boost the economy, and non-sensible guidance would clarify the situation for the rest of us.
Sensible guidance would indicate that the Fed is prepared to allow for some “catch-up” inflation until the unemployment rate drops substantially. This would help spur investment in a variety of ways. It’s perhaps best illustrated with an example. Right now, I might look at the economic situation and say, “if the economy grows a bit, new household formation will resume and rents will go way up so I should invest in building new multi-family structures.” But I also might look at the economic situation and say, “if the economy grows a bit, new household formation will resume and rents will go way up so the Fed will raise interest rates so I should stand pat.” Sensible guidance puts us onto path one where I invest in the new apartment buildings, and the increased investment becomes the impulse that creates the potentially inflationary situation.
Non-sensible guidance would let people know who to blame. Suppose the Fed says this: we expect the economy to stay super-weak for a while but if by some miracle growth picks up and then rising demand for gasoline pushes inflation up to 2.5 percent we’re going to raise interest rates to nip it in the bud. That’d be nuts. But then we could at least debate this plan, as a democratic society, and understand that the Fed’s forward-looking guidance makes rapid reductions in the unemployment rate impossible. If the only kind of growth the Fed will tolerate is the kind that doesn’t put any upward pressure on energy prices or rents, then the Fed is mandating slow growth.
Either way, the people deserve to know.