The Federal Reserve’s Open Market Committee is meeting this week for the first time since the U.S. economy bottomed out and financial markets stabilized. Earlier, it moved twice outside of scheduled meetings cut short-term interest rates to near zero and implement a host of emergency measures to ease the economy’s descent into recession, which was affirmed by the National Bureau of Economic Research on Monday. Here are three things to look for in Wednesday’s policy announcement:
Even if the worst is over for the U.S. economy—and things could worsen if the emergency measures passed earlier in the year are allowed to expire—the situation is still grim. Job growth in May was unexpectedly robust, but even if another 2.5 million jobs are added each month through year’s end, which is far from certain, there would still be fewer employed Americans at the end of 2020 than there were in February. That’s why Fed officials will want to keep doing whatever they can for as long as necessary to support the recovery.
America’s central bankers have shown that they won’t wait for a scheduled meeting to act decisively, so any new policies unveiled Wednesday will more likely be tweaks to existing programs rather than genuine innovations. Directly targeting long-term borrowing costs, for example, probably won’t be on the menu until officials have gotten substantially more pessimistic about the pace of recovery.
The most obvious adjustments will likely take the form of commitments about the future. For example, it could replace its current pledge to buy bonds “in the amounts needed to support the smooth functioning of markets for these securities” with specific targets for monthly purchases.
Similarly, the Fed may provide some additional indications about what it would take for officials to consider raising short-term interest rates. No one expects rate increases soon, but expectations of higher rates in the next few years are starting to affect medium and longer-term borrowing costs, according to Guggenheim’s Scott Minerd. Explicit thresholds for unemployment, inflation, or other measures would be one way for the Fed to respond.
How long to recover?
Every few months, the Fed publishes its Summary of Economic Projections that reveal what officials believe will happen to growth, unemployment, inflation, and short-term interest rates under “appropriate monetary policy.” Last time around, the Fed chose not to do so, but most analysts expect it will return to form on Wednesday.
The SEP is both a forecast and a declaration of intent. It’s tough to read because each official’s forecasts are bundled together in ways that make it difficult to tell what anyone is actually thinking, which matters because not everyone votes on policy. Nevertheless, the SEP is worth studying if you want to understand what Fed officials hope to achieve.
This time around, the focus should be on gross domestic product and the unemployment projections. (The short-term interest-rate forecasts will almost certainly be stuck at 0% through the end of 2022 and nobody really knows what the virus will do to the inflation numbers.) Do Fed officials think the economy should recover quickly or do they think we need to take several years to get back to where we were?
If the latter, Fed Chairman Jerome Powell’s Wednesday press conference can hopefully clarify whether this reflects Fed officials’ preferences, perhaps because they are concerned that a too-rapid recovery could stoke unwanted inflation, or whether it reflects the limitations of what the central bank can accomplish without additional support from Congress. In the past, Fed officials have often noted that “monetary policy is not a panacea.” Powell has echoed that sentiment recently, but it would be interesting to know if there are people at the Fed who think more could be done yet choose not to do so because they believe the risks outweigh the potential benefits.
Finally, it’s worth looking to see if Fed officials believe the coronavirus will have longer-term consequences for the U.S. economy. Past research suggests the trauma we’ve already experienced will make America poorer for years to come. The SEP may provide clues to whether America’s central bankers agree, and if so, what they think they need to do about it.
In addition to projections for the next few years, officials are asked for their “longer-run” estimates of GDP growth, inflation, unemployment, and the level of short-term interest rates. Don’t look for changes in the inflation forecast, because that’s a fixed target that officials agreed at the beginning of the year.
But slower trend GDP growth, higher unemployment, and—most importantly—lower short-term interest rates would imply that Fed officials believe there will be permanent consequences from the virus. In this view, the American economy, like many victims of the virus itself, would end up suffering long-term damage.
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