Policymakers believe open communication and transparency about future policy changes are critical to the Fed's price-targeting framework. Nowadays, policymakers only make changes at regularly scheduled meetings, telegraph the decisions often before the meetings, and offer a road map for future policy changes.
Transparency and open communication are double-edged swords. They work when the forecast is close to the mark, but can create problems when they're off and financial markets follow the wrong policy path. Are policymakers sending the "false" signal of an easier policy stance ahead when the data on the economy, jobs, and inflation suggest more tightening is needed?
A few years back, policymakers kept communicating that inflation was transitory. Yet, that forecast proved off the mark, resulting in policymakers tackling the inflation problem much later than they should have, lifting official rates by over 500 basis points. And the inflation problem is yet to be solved three years later.
At the Federal Open Market Committee in December, policymakers penciled in three official rate cuts for 2024 even though they admitted the fight against inflation still needed to be finished. The financial markets ran with the idea of an easy money policy far ahead of the actual event. Also, at the press conference following the January FOMC, Fed Chair Jerome Powell stated that almost all members expected lower official rates in 2024.
In both instances, transparency resulted in easier financial conditions, the opposite of what the Fed needs in its attempt to squash inflation.
Policymakers also believe open communication and transparency about future policy changes are critical to the Fed's price-targeting framework as they anchor inflation expectations. Yet, is there any proof that it does?
Are there any examples of businesses or companies citing the Fed's 2% target when they announce price increases? Are there any examples of businesses or companies saying they wanted to lift prices by X amount, but in the spirit of the Fed's price target framework, they are limiting the price increase to X-minus?
When the UAW and the US auto companies announced the most significant wage gains in several decades in Q4 2023, did the companies or unions say the Fed's inflation target influenced the outcome? After the UAW agreement, did the non-union companies (Honda, Toyota, and Tesla) balk at increasing wages because of the Fed's inflation target, or did they follow to remain pay-competitive?
The evidence shows that the economy's dynamics determine inflation and not the arbitrary inflation target of the Fed. It is too early to conclude with any confidence how the structure of the economy changed following the pandemic, but the economy is producing a lot more inflation compared to what it was before the crisis in 2020.
Back in 2003, the symposium at the Federal Reserve Conference at Jackson Hole was titled " Monetary Policy and Uncertainty: Adapting To a Changing Economy." Former Chairman Alan Greenspan said, "When in doubt, be vague." Yet, nowadays, policymakers no longer have that option of waiting, as they publish quarterly forecasts and offer a dot-plot of future policy rates.
The recent data on jobs and inflation tells the Fed that their message of an easier policy ahead is wrong and misleading. Soon, they will have to backtrack because the financial markets are creating conditions that will boost growth, the opposite of what they Fed needs to hit its inflation target.