Kenneth Rogoff
Kenneth Rogoff, Professor of Economics
and Public Policy at Harvard University and recipient of the 2011
Deutsche Bank Prize in Financial Economics, was the chief economist of
the International Monetary Fund from 2001 to 2003. His most recent book,
co-authored with Carmen M. Reinhart, is This Time is…
CAMBRIDGE – Nothing
describes the United States Federal Reserve’s current communication
policy better than the old saying that a camel is a horse designed by
committee. Various members of the Fed’s policy-setting Federal Open
Markets Committee (FOMC) have called the decision to keep the base rate
unchanged “data-dependent.” That sounds helpful until you realize that
each of them seems to have a different interpretation of
“data-dependent,” to the point that its meaning seems to be “gut
personal instinct.”
In
other words, the Fed’s communication strategy is a mess, and cleaning
it up is far more important than the exact timing of the FOMC’s decision
to exit near-zero interest rates. After all, even after the Fed does
finally make the “gigantic” leap from an effective federal funds rate of
0.13% (where it is now) to 0.25% (where is likely headed soon), the
market will still want to know what the strategy is after that. And I
fear that we will continue to have no idea.
To be fair,
deciding what to do is a very tough call, and economists are deeply
divided on the matter. The International Monetary Fund has weighed in
forcefully, calling on the Fed to wait longer before raising rates. And
yet central bankers in the very emerging markets that the IMF is
supposedly protecting have been sending an equally forceful message: Get
on with it; the uncertainty is killing us.
Personally,
I would probably err on the side of waiting longer and accept the very
high risk that, when inflation does rise, it will do so briskly,
requiring a steeper path of interest-rate hikes later. But if the Fed
goes that route, it needs to say clearly that it is deliberately risking
an inflation overshoot. The case for waiting is that we really have no
idea of what the equilibrium real (inflation-adjusted) policy interest
rate is right now, and as such, need a clear signal on price growth
before moving.
But
only a foaming polemicist would deny that there is also a case for
hiking rates sooner, as long as the Fed doesn’t throw random noise into
the market by continuing to send spectacularly mixed signals about its
beliefs and objectives. After all, the US economy is at or near full
employment, and domestic demand is growing solidly.
While
the Fed tries to look past transitory fluctuations in commodity prices,
it will be hard to ignore rising consumer inflation as the huge drop of
the past year – particularly in energy prices – stabilizes or even
reverses. Indeed, any standard decision rule used by central banks by
now dictates that a hike is long overdue.
But
let’s not make the basic mistake of equating “higher interest rate”
with “high interest.” To say that 0.25%, or even 1%, is high in this
environment is pure hyperbole. And while one shouldn’t overstate the
risks of sustained ultra-low rates to financial stability, it is also
wrong to dismiss them entirely.
With
the decision about raising rates such a close call, one would think
that the Fed would be inclined to do it this year, given that the chair
and vice chair have pretty much told the market for months that this
will happen. The real reason for not hiking by the end of the year is
public relations.
Let’s
suppose the Fed raises interest rates to 0.25 basis points at its
December meeting, trying its best to send a soothing message to markets.
The most likely outcome is that all will be fine, and the Fed doesn’t
really care if a modest equity-price correction ensues. No, the real
risk is that, if the Fed starts hiking, it will be blamed for absolutely
every bad thing that happens in the economy for the next six months to a
year, which will happen to coincide with the heart of a US presidential
election campaign. One small hike and the Fed owns every bad outcome,
no matter what the real cause.
The
Fed of course understands that pretty much everyone dislikes
interest-rate hikes and almost always likes rate cuts. Any central
banker will tell you that he or she gets 99 requests for interest-rate
cuts for every request for a hike, almost regardless of the situation.
The best defense against these pressures is to operate according to
utterly unambiguous criteria. Instead, however good its intentions, the
net effect of too much Fed speak has been vagueness and uncertainty.
So
what should the Fed do? My choice would be to have it explain the case
for waiting more forthrightly: “Getting off the zero bound is hard, we
want to see inflation over 3% to be absolutely sure, and then we will
move with reasonable speed to normalize.” But I also could live with,
“We are worried that if we wait too long, we will have to tighten too
hard and too fast.”
Throwing
out the rulebook made sense in the aftermath of the 2008 financial
crisis. It doesn’t anymore. And today’s lack of clarity has become a
major contributor to market volatility – the last place the Fed should
want to be.
It’s
wrong to vilify the Fed for hiking, and it’s wrong to vilify it for not
hiking; if it is such a close call, it probably doesn’t matter so much.
But, at this critical point, it is fair to ask the Fed for a much
clearer message about what its strategy is, and what this implies for
the future. If Fed Chair Janet Yellen has to assert her will over the
FOMC for a while, so be it. Somebody on the committee has to lead the
camel to water.
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