Federal Reserve policymakers talk too much

OPINION:

The Federal Reserve has a tough job, and its communications strategy isn’t helping.

The Fed Open Market Committee, consisting of seven governors and 12 regional bank presidents, has a mandate to achieve price stability and maximize employment. It pursues these goals by setting the federal funds rate — the rate banks pay one another to borrow reserves overnight.

According to former Chairman Alan Greenspan, “Price stability is that state in which expected changes in the general price level do not effectively alter business or household decisions.”

A tolerable pace of inflation is not so high that households rush purchases of big items, such as home appliances and automobiles, ahead of when needed or desired, in anticipation that those will be appreciably more expensive. It is not so low that businesses won’t invest owing to fears that prices will fall too much when demand slacks, making debt service unduly burdensome.

That’s hardly an observable range, but central bankers in major advanced economies have settled on 2% as a reasonable target.

In 2020, the Fed indicated it would tolerate periods above 2% to compensate for periods below that level. Still, recent experience indicates that its ability to manage expectations and keep inflation from cycling up too much is limited.

As price stability best encourages sound investment decisions, getting to 2% and staying there would most optimally encourage a healthy jobs market in the long run.

Also, the FOMC seeks to encourage prudent business decisions through forward guidance about future policy moves.

It meets eight times a year to set rates and issues a general statement about its reasoning. Every other meeting publishes anonymously the forecasts of the 19 members for annual gross domestic product growth, inflation and the federal funds rate.

Much can change between meetings — new jobs, inflation and GDP data — and the Fed repeatedly states that decisions will be based on incoming data.

Financial markets closely watch members’ testimony, frequent speeches and public statements to discern differences in their views and how the consensus is evolving and may affect future interest rate decisions.

Unfortunately, all this speechmaking can get in the way of good policymaking.

At the September and November meetings, FOMC cut the fed funds rate by half and a quarter points. Chairman Jerome Powell and committee members clarified that they felt the economy was on track to accomplishing 2% inflation and established the expectation that they would further cut interest rates.

Financial markets take that kind of talk seriously, influencing the direction of stock prices.

At the Dec. 17-18 meeting, the FOMC members raised their median forecast for consumer price inflation in 2025 to 2.5% from 2.1% in September.

The committee’s consensus was that inflation was headed in the wrong direction. Yet, they voted to lower interest rates another quarter point to not disappoint investors still expecting a rate cut.

The Fed should not cater to equity investors rather than pursue its stated goal of bringing inflation to 2%.

The problem is there is no Fed voice other than the statement issued after meetings, and FOMC members disagree a lot.

The December forecasts for 2025 inflation range from 2.1% to 3.1%, and where the federal funds rate should settle once 2% inflation is accomplished from 2.4% to 3.9%.

The Fed’s credibility is damaged by raising its expectations for inflation yet moving policy in a contrary direction to avoid rattling stock prices.

Despite a full percentage point cut in the federal funds rate since Sept. 18, the two-year and 10-year Treasury, which are influenced by expectations for future Fed policy, are not down but up about 0.7% and 1%. That indicates investors’ skepticism about getting inflation to 2% and more rate cuts.

FOMC statements and Mr. Powell consistently remind us that incoming data will govern Fed decisions, but that surely did not apply in December.

Examining recent inflation data, prices for goods, which are importantly influenced by international markets, where China and most of Europe are in a funk, have been falling. Still, prices for services, largely determined by domestic demand and labor market conditions, have been rising at an alarming pace — about 3.8%.

President Trump ran on immigration curbs, tax cuts and tariffs. However far he goes, those will tighten labor markets, raise aggregate demand and make lowering inflation to 2% even tougher.

The Fed has initiated its quinquennial review of monetary policy strategy, tools and communications.

It should set a hard goal for inflation to be at or below 2%, publish FOMC forecasts for inflation after each meeting, justify its decision whether to raise, lower or leave unchanged interest rates against those forecasts and do a lot less public speaking.

• Peter Morici is an economist and emeritus business professor at the University of Maryland and a national columnist.