The best way to describe Fed actions over the past few years is that of an asymmetrical policy. Slash rates when the economy was faltering and the financial system was facing extraordinary stress and keep them at zero even after the emergency has passed and the economy has stabilized, however fragile. This begs the question of when does the Fed raise rates. Will the timing be up to them or will the bond market force their hand. A key component of the Fed’s comfort with keeping rates so low is their belief that “with substantial resource slack likely to continue to dampen cost pressures and with longer term inflation expectations stable” inflation will remain subdued for some time, according to their last FOMC statement. The Fed’s Plosser in a speech given today doesn’t fully agree. He believes there is evidence “that finds that economic slack or low resource utilization is not a very reliable predictor of inflation” and “ultimately, inflation is a monetary phenomenon and there is no question that current monetary policy is extraordinarily accommodative.” He said with “competing views of the economic forecast and the underlying structure of the economy driving that forecast” it will be a challenge to “withdraw or restrict the massive amount of liquidity that we have made available to the economy.” Getting back to the when question on hiking rates, Plosser said as the economy grows and real interest rates rise (market rates), “the fed funds rate should be permitted to rise with them.” In other words, he believes the bond market should dictate when the fed should act, maybe leaving less subjectivity to the process and I believe in contrast to many other Fed members who likely will want to wait until well after market rates have shifted in response to an improved economy and/or higher inflation.
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