Comment On The Federal Open Market Committee (FOMC) Meeting/Statement Of January 24-25, 2012
By Chandrashekar (Chandra) Tamirisa, (On Twitter) ;@c_tamirisa
As we suggested soon after the publication of the Bloomberg news report of January 04, 2012 about the Federal Reserve’s intention to reveal its interest rate forecast, the Fed’s monetary policy making Federal Open Market Committee (FOMC), together with the interest rate forecast, has also released its forecast of two variables comprising the Fed’s mandate: inflation and unemployment. It has not, however, discussed the yield curve and the long term rate forecast, the third component of its mandate.
Fed’s longer term is the period beyond its forecast horizon of 3 years where its inflation target of 2 per cent is expected to be met. Current inflation is at 2.2 core to 3.0 per cent headline, higher than the Fed’s projections and the long run target. In the same breath, the salient decision of the latest FOMC statement is to extend the current federal funds rate through late-2014, more than a year longer than previously announced.
While stating that money growth raises inflation, it is unclear how the Fed expects to meet its long run inflation target after 2014 without raising the rate sharply at some point should inflation be high. From the Fed’s interest rate forecast charts, the sentiment of a minority FOMC participants is to gradually raise the rate and of the majority to sharply raise the interest rate after 2014.
The Fed may not be correct in attributing inflation only to money supply. It is unclear by how much the level of unemployment should be given an economic structure at its potential growth rate. Past data is only an approximate yard stick because of the inter-temporal variations in the level of technology and its adoption by the production processes. Meaning, if the steady state growth rate without structural change or war is 1.5 per cent at potential, growth higher than that rate will lead to higher inflation absent higher population growth rates from immigration (higher fertility lowers women’s workforce participation), because growth rates are real. If growth continues to be 1.5 per cent and inflation keeps rising, only then can that portion of inflation be unbundled and attributed to money supply because there are no new capital investments, that money supply typically going toward wage increases in the services sector.
Current growth rate is 1.8 per cent and the Fed forecast appears to suggest that it will rise to its central tendency while constraining inflation within its Fed forecast central tendency.
Interest rate forecast is a function of the potential economic output and unemployment. Fed’s output forecast is far too optimistic unless the institution is expecting accelerated structural change or war (2012 State of the Union on Iran in the context of the November election). Its unemployment forecast is pessimistic vis-a-vis its optimistic growth forecast, unless it expects the inflation to be contained in all time horizons by unemployment.
We forecasted growth to be 1.5 per cent and unemployment to decline to 7.5 per cent by the end of 2012, barring any downside geopolitical risks, which have already begun to surface, materializing.
