COMMENTARY | COLUMNISTS | MARK J. RIEDY

Tighter monetary policy is a year away

Instincts tell me that despite recent Federal Reserve "jawboning," a significant shift toward monetary policy restraint will not be justified by inflation or economic prospects before mid-2016. Further, a major move toward higher interest rates will not be implemented until after the November 2016 elections.

Occasionally, events get in the way of the Fed’s preferred approach to implementing shifts in monetary policy, but absent such occurrences, the Fed tries to avoid significant changes in policy whose impact would be noticeable during the months immediately before presidential elections.

My interest rate and monetary policy expectations are based on gut instinct and what I see as important factors relied upon by the Fed in conducting monetary policy. Among the most important factors taken into account by the Fed’s Open Market Committee are:

• Global demand for goods and services remains relatively weak, providing little help to a strengthening U.S. recovery

• Inflation measures at the consumer level remain less than 2 percent, almost closer to recession than recovery. Recall that historically, the Fed became concerned about inflation when it exceeded 3 percent on a sustained basis, not 2 percent

• Employment growth is encouraging, but the unemployment rate is still high, indicating excess labor market capacity. Historically, the Fed interpreted a 4 percent unemployment rate as reflecting full employment; today the Fed accepts 6 percent.

Fed officials appear to be trying to time-shift the move toward monetary policy restraint. That is, we will get to a sustained 2 percent inflation rate quicker than we get to 3 percent. And hitting a 6 percent unemployment rate target certainly can occur sooner than 4 percent.

In effect, if you can’t reach your targets when you want to, either extend the deadline or change the targets! The Fed changed the targets.

Occasionally, events gets in the way of the Fed’s preferred approach to implementing shifts in monetary policy. Even if a major turn of events does occur, however, most likely it will be a negative rather than a positive.

For example, an unexpected default on sovereign debt by one or more nations is not out of the question. Such an occurrence would not help strengthen U.S economic growth.

I can’t think of an unexpected turn that would help boost the American economy into territory justifying Fed intervention with higher interest rates, but would welcome readers’ thoughts.

“Jawboning” describes the Federal Reserve’s current monetary policy vehicle. The Fed uses “jawboning,” or its bully pulpit, to try to forewarn lenders, investors and borrowers that higher interest rates are ahead.

As a policy tool, its value, if any, is the power of persuasion. Whereas the two other major tools of monetary policy — reserve requirement changes and open market operations (the buying and selling of Treasury and U.S. Government Agency securities) — can have direct and meaningful impacts on financial markets, jawboning is merely symbolic. It cannot force lenders, investors and borrowers to do anything.

What jawboning will do in this instance is illustrate the old joke about economists. If one forecasts interest rate increases for a long enough period of time, eventually the prediction will come true.

The Federal Reserve is a creature of Congress and reports to the legislative branch of the federal government. To its credit, Fed chairs have historically tried to avoid politicizing monetary policy in order to assure the Fed’s continued independence from the executive branch.

Toward that goal, the Fed seeks to avoid making significant policy shifts well in advance of presidential elections because experience shows that the effects of Fed policy maneuvers occur with a lag.

So what we have as summertime 2015 approaches is:

• The Fed adjusting measures of its targets for inflation and unemployment rates to make it easier to justify possible accelerated implementation of tighter monetary policy.

• The Fed using its least effective policy tool, jawboning, to try to “talk” interest rates upward now by forewarning lenders, investors and borrowers that higher rates are just over the horizon.

• And the November 2016 presidential elections looming at what might turn out to be when the Federal Reserve really would be justified in raising interest rates, but hesitates to do so.

For those whose business fortunes depend in part on future changes in interest rates and financial conditions, therefore, the question is whether the Fed will act to increase rates before this time next year, or will it wait until early 2017?

P.S. The Fed is not a Grinch. It will not raise rates between the presidential election on Nov. 8, 2016, and Christmas.


Riedy is former executive director of the Burnham-Moores Center for Real Estate at the University of San Diego.

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