On Wednesday, Federal Reserve Chair Janet Yellen shared her vision regarding monetary policy, suggesting that while a rate hike might be on the horizon, it certainly won’t happen anytime soon. The overarching message is that there’s no immediate rush to alter the federal funds rate, which has remained near zero for over six years now.
The Federal Reserve appears to believe that the economy is on the uptick. However, this perceived strength is not yet sufficient for them to change the rates, as doing so might deflate the stock market—a situation they wish to avoid. After all, an inflated stock market creates a sense of wealth, making people feel richer and more confident.
Following the recent Federal Open Market Committee meeting and the subsequent statement, stock prices surged, with the DOW gaining 180 points initially. However, this momentum faded quickly; by the end of the day, the DOW had only risen 31 points from its opening value. Yet, the next day, the market rebounded, closing up 180 points and breathing life back into trader enthusiasm.
The most entertaining moments emerged during the post-meeting news conference, where Yellen meticulously chose her words, making it somewhat difficult to grasp her true meaning. Here are several highlights, along with some translations…
Aiming for Inflation
“Once we begin to remove policy accommodation we continue to expect that, as we say in our statement, even after employment and inflation are near mandate consistent levels, economic conditions may for some time warrant keeping the target federal funds rate below levels the committee views as normal in the longer run.”
This translates to the Fed’s desire for positive inflation to be a core goal of their policies. They plan to maintain the federal funds rate at ultra-low levels for the foreseeable future, and even when they decide to raise it, the increases will be gradual.
The key question remains: Will they raise the federal funds rate this year?
“And clearly most participants are anticipating that a rate increase this year will be appropriate. Now, that assumes, as you can see, that they are expecting a pick-up in growth in the second half of this year, and further improvement in labor market conditions. And we will all be – we will be making decisions, however, that depend on the actual data that we see in the months ahead…”
“But again the important point is no decision has been made by the committee about what the right timing is of an increase. It will depend on unfolding data in the months ahead. But certainly an increase this year is possible; we could certainly see data that would justify that.”
The Fed acknowledges that there are expectations of a rate increase this year, but they emphasize the necessity of seeing more inflation first. Despite their efforts over the past six years to stimulate inflation, they have yet to achieve their desired results.
Failed Efforts in Transmission
The established theory, as presented by Yellen and her colleagues, is that keeping interest rates artificially low will encourage borrowing and spending, ultimately stimulating the economy and reducing unemployment. They believe that by maintaining low rates for an extended period, they can reignite economic growth. However, this approach has largely fallen short.
The anticipated robust recovery post-Great Recession never truly materialized. Many workers have seen their wages decrease over the past five years, while those at the top have enjoyed substantial asset appreciation. This disconnect between economic growth and stock market performance highlights the failure of the Fed’s credit expansion policies, as these strategies have not effectively translated into broader economic recovery.
The expected price inflation has not manifested as a result of these extreme monetary policies. Instead, the affordable credit supplied by the Fed primarily flows into financial markets without adequately penetrating the real economy. Consequently, gross domestic product growth remains sluggish, struggling like a pet in poor health.
In essence, the channels intended to distribute Yellen’s created money are malfunctioning. Rather than circulating through the economy, this new capital remains trapped on bank balance sheets. This inadequacy in the monetary transmission mechanism is often termed “pushing on a string” in central banking discussions.
The central bank pushes on one end of the string by expanding the money supply, but the other end—representing money’s influence on the economy—remains stationary. Thus, the hoped-for inflation becomes lost in transmission.
In closing, it remains to be seen how the Fed will maneuver in the months ahead. As they juggle economic indicators and market expectations, the true impact of their policies will unfold in time.
Sincerely,
MN Gordon
for Economic Prism
