The Federal Open Market Committee (FOMC) moved forward with an anticipated 25-basis-point increase in its federal funds rate target on Wednesday. It no longer, however, “anticipates that ongoing increases in the target range will be appropriate in order to attain a stance of monetary policy that is sufficiently restrictive to return inflation to 2 percent over time.” Now, the FOMC “anticipates that some additional policy firming may be appropriate.” In the post-meeting press conference, Chair Powell called attention to the words “some” and “may.”
Why did the FOMC soften its language? It is certainly not because the FOMC has tamed inflation.
Inflation remains high and shows little sign of moderating. The consumer price index (CPI) grew at a continuously compounding annual rate of 4.4 percent in February. Core CPI, which excludes volatile food and energy prices and is therefore thought to be a better indicator of future inflation, has risen in recent months. In November, core CPI inflation was just 3.7 percent. It increased to 4.8 percent in December, 4.9 percent in January, and 5.4 percent in February. That suggests the Fed still has some work to do on the inflation front.
The softer language cannot be due to the FOMC’s getting its target into the sufficiently restrictive range, either — because it hasn’t. The most recent 25-basis-point hike raises the nominal target range to 4.75 to 5 percent. With core inflation greater than 5 percent, the real (inflation-adjusted) interest rate target range is still negative! Despite this, the FOMC left its terminal rate projection for 2023 unchanged at 5.1 percent, which would be consistent with a target range of 5.0 to 5.25.
The FOMC softened its language not because its job is done, but because it expects to get some help from financial markets going forward.
As Powell explained in the Q&A:
The intermeeting data on inflation and the labor market came in stronger than expected and, really, before the recent events, we were clearly on track to continue with ongoing rate hikes. In fact, as of a couple weeks ago, it looked like we would need to raise rates — over the course of the year — more than we’d expected at the time of our SEP in December. […] So, we also assess, as I mentioned, that events of the last two weeks are likely to result in some tightening of credit conditions for households and businesses and thereby weigh on demand, on the labor market, and on inflation. Such a tightening in financial conditions would work in the same direction as rate tightening. In principle, as a matter of fact, you can think of it as being the equivalent of a rate hike—or, perhaps more than that. Of course, it’s not possible to make that assessment today with any precision whatsoever. So our decision was to move ahead with the 25 basis point hike and to change our guidance, as I mentioned, from ‘ongoing hikes’ to ‘some additional hikes may be — some policy firming may be appropriate.’ So, going forward, as I mentioned, in assessing the need for further hikes we’ll be focused as always on the incoming data and the evolving outlook — and, in particular, on our assessment of the actual and expected effects of credit tightening.
In other words, FOMC members believe the recent bank failures are a sign that credit conditions are tightening, and will continue to tighten in the near term. But they don’t yet know how much credit will tighten and, correspondingly, how much nominal spending will slow. The more credit tightens on its own, the less the Fed will need to do to bring down inflation.
It is difficult to ignore the parallels between the FOMC’s view today and its position throughout most of 2021. That’s worrisome.
Throughout 2021, FOMC members were convinced that inflation was primarily driven by supply constraints, and would decline on its own as those constraints eased up. In each post-meeting statement from March 2021 to September 2021, the FOMC said inflation had risen or was elevated, “largely reflecting transitory factors.” In late summer and early fall 2021, however, the incoming data suggested the members were wrong: prices accelerated as real output recovered. And, yet, Fed officials seemed reluctant to revise their beliefs. The FOMC did not soften its post-meeting statement until November 2021, when it said the high inflation largely reflected “factors that are expected to be transitory.” Powell would retire the term transitory by the end of the month. And, in December 2021, the FOMC revised its statement to acknowledge demand-side factors.
Even then, the FOMC was slow to act — suggesting that it had not given up on the supply-side transitory inflation view entirely. It did not raise its federal funds rate target until March 2022. It did not raise rates by 50 basis points or more until May 2022.
Instead of acting quickly and decisively in 2021, FOMC members waited around for some help. That help never came, and inflation was much worse than it otherwise might have been.
Then they were looking for help from recovering supply chains. Now, they are looking for help from tight financial markets. It’s time FOMC members help themselves — or, God help us all.