Never underestimate the myopia of the men and women who dictate the debate over United States monetary policy. Case in point: Federal Reserve chair Janet Yellen, at a press conference in Washington Wednesday, answered nine questions about the U.S. economy before anyone asked her about Greece.
The current fixation of the U.S. financial press currently is when the Fed will lift its benchmark interest rate. That’s partly a function of the way the news business works. The U.S. central bank hasn’t raised the federal funds rate since 2006. Therefore, the eventual increase will be an event—the same way wins by the Edmonton Oilers or the Toronto Maple Leafs became occasions this season.
But the fans of those teams knew scattered, late-season upsets did nothing to change the glum story of the 2014-15 season overall. Same with the Fed. The real story is the trajectory of borrowing costs in the months and years ahead—not whether the Fed will raise interest rates in September, December or March. “Sometimes too much emphasis is put on the timing,” Yellen said in response to the first question she received Wednesday.
You could tell the issue is important to her because she went out of her way to address it. Yellen’s questioner hadn’t asked about whether there is too much emphasis put on the timing of the first increase in more than eight years. The reporter wanted to know why the Fed appeared intent on shifting the fed funds rate higher this year. Why not wait until 2016?
It didn’t seem to matter that the Fed’s policy committee had just answered that question in its new policy statement. Policy makers noted that the economy had been “expanding moderately” in recent months after stalling in the first quarter. That was a material change; an expression of confidence that the U.S. economy is rolling again after a tough winter. The Fed reckons U.S. gross domestic product could expand by as much as 2.7% in 2016, which would be considerably faster than the rate of growth—roughly 2%—that policy makers think the American economy can handle without stoking inflation. Given interest rate increases bite with a lag, any central bank that is serious about keeping a lid on price increases must stay ahead of the curve. Therefore the time to act—unless something changes—is nigh.
The crucial point is that the first increase likely won’t be followed by a second one at the next policy meeting six weeks later and a third one after that.
U.S. monetary policy used to work that way. In the years ahead of the financial crisis, Alan Greenspan, the former Fed chairman, systematically raised the benchmark rate a quarter point every time he gathered the Federal Open Market Committee. Yellen said explicitly Wednesday that Greenspan’s approach was a mistake. It created a one-way bet that made Wall Street complacent. Yellen said the Fed should have been raising interest rates faster in those years, and with less predictability.
Yellen won’t be providing guidance on when interest rates will rise. Each decision will depend on the most recent data, and she reminded reporters that just because a policy maker saw things one way in June, doesn’t mean he or she will see things the same way six weeks or three months later.
But Yellen is offering guidance on how high borrowing costs will rise over the next couple of years. She stated repeatedly Wednesday that her march to a more normal interest-rate setting will be “gradual,” and that she likely will stop well short of the rate that traditionally has been associated with a neutral policy rate. More than half of the members of the Fed’s policy committee predict the fed funds rate will be no higher than 2% at the end of next year.
That’s still very low by historical standards. And that’s what everyone should keep in mind when evaluating where interest rates are headed globally. The Fed is the benchmark of the world; when it moves, others will follow. But only gradually. There is no reason for monetary policy to be an impediment to growth. Low for longer—much longer—remains the story.
Kevin Carmichael is a journalist and senior fellow at the Centre for International Governance Innovation. He has written about economic policy and the men and women who make it for almost two decades from Ottawa, Washington and, currently, Mumbai. Follow him @CarmichaelKevin