Wednesday, January 25, 2012

More on the Fed and Monetary Policy

Besides announcing that it has adopted a policy of inflation targeting, there was other interesting news from the Fed today.  In a continuation of the increased transparency introduced since Ben Bernanke became chair, the Fed released the forecasts of the expected future target for the federal funds rate.  Believe it or not, back in the early 1990s, the Fed didn't even inform the public of the current federal funds rate (financial markets had to figure it out on their own).  Alan Greenspan increased information somewhat, but Bernanke came in with a goal of increasing transparency so both the public and financial markets can better understand the Fed's policy.  Of course he didn't expect to have to deal with the worst financial crisis since the 1930s, which required a nontraditional, complex response.

The Fed also released the consensus forecasts of the Federal Reserve District Banks (click here).  In the past, the Fed was overly optimistic about the future state of the economy.  This time, it lower its forecasts, indicating a modest recovery for years to come.  Inflation is expected to be at or below its target for the next several years while unemployment is expected to decline only slowly due to moderate economic growth.  Given this forecast, the Fed indicated that it expects to keep the federal funds rate exceptionally low through late 2014 (emphasizing this was conditional on their forecast; that is, if the economy turns out to be stronger than expected, interest rates would increase sooner).

Of course the Fed continues to be criticized from both sides.  Some complain that it should be doing more given the relatively weak economic recovery while others think it's doing too much.  Personally, I enjoy being able to comment on the policy instead of being the one responsible for implementing the best policy, given all that's going on in the global economy!  As mentioned in previous posts, the biggest unknown is the severity of the European Debt Crisis.  If it leads to financial contagion, expect the Fed to loosen policy even further in an attempt to cushion the US economy from the financl fallout.