Future Communications Easing

Given that the Federal Reserve seems to have decided it wants to try to ease monetary conditions by changing its communications rather than taking concrete action, here’s a suggestion for further easing. At the last meeting they switched from the commitment to keep interest rates low for an “extended period” to the observation that “[t]he Committee currently anticipates that economic conditions — including low rates of resource utilization and a subdued outlook for inflation over the medium run — are likely to warrant exceptionally low levels for the federal funds rate at least through mid-2013.”

At the next meeting they should edit that statement to say “the Committee currently anticipates that low rates of resource utilization are likely to warrant exceptionally low levels for the federal funds rate at least through mid-2013.” In other words, strike the reference to inflation. Rates will stay low at least through mid-2013, in other words, even if inflation spikes. Later text can explain that the Fed will continue to monitor inflation conditions and has plenty of tools in its kit to curb inflation starting in late 2013 if that seems warranted. But no tightening no matter what until then, even if growth causes a commodity price spike or something else. You want market participants to know that if the economy unexpectedly improves, which leads to an unexpected surge in household formation which leads to a spike in rents, that the Fed’s not going to say, “Inflation! time to tighten!” Instead, the Fed should say and should commit in advance to saying that the result of an unexpected growth surge creating an unexpected household formation surge creating an unexpected rent surge should be a surge in new homebuilding putting us on track to sustained recovery.

Right now, you’re bound to be nervous that any good news will lead to offsetting tightening, so your expectations are colored by downside risks. Different, clearer communications can reassure people that good luck will not be punished.