The Largest and Most Rapid Shift in Expected U.S. Monetary Policy since 1994. The Largest and Most Rapid Contractionary Shift since 1981
Not since 1994--or possibly 1982-3--have we had such a large and rapid shift in the market's beliefs about what the Federal Reserve's reaction function is. Not since 1991 have we had such a large and rapid contractionary shift in the market's belief about what the Federal Reserve's reaction function is:
When ten-year expected inflation rises and ten-year real interest rates rise alongside, that is good news about future economic growth coupled with a neutral monetary policy--a Federal Reserve expected to respond according to its known reaction function.
When ten-year expected inflation falls and ten-year real interest rates fall alongside, that is bad news about future economic growth coupled with a neutral monetary policy--a Federal Reserve expected to respond according to its known reaction function.
When ten-year expected inflation rises and ten-year real interest rates fall alongside, that is a shift toward monetary expansion--a Federal Reserve that is now expected to respond according to a reaction function with greater tolerance for inflation in the future.
When ten-year expected inflation falls and ten-year real interest rates rise alongside, that is a shift toward monetary contraction--a Federal Reserve that is now expected to respond according to a reaction function with lower tolerance for inflation in the future.
All who thinks that at the start of this year the Federal Reserve had too great a tolerance for inflation, and thus that it was appropriate for the Federal Reserve to trigger this contractionary shift in what the market sees as its reaction function, please raise their hands…
Ian Talley:
IMF’s Blanchard Notes Fed Faces Communication Challenge: Olivier Blanchard, the International Monetary Fund’s chief economist, said Tuesday the Fed and markets are on a steep learning curve as the central bank pilots through unprecedented monetary policy…. “I think the Fed is doing a relatively good job of it, but I’m sure that they’ll improve their communication over time as they learn how markets react,” Mr. Blanchard said. “They’ve probably learned something from the last three weeks,” he said…. Fund officials have recently criticized the Fed, saying its communication could have been clearer. The IMF, which acts as the world’s emergency lender and economic counselor, also said the U.S. central bank should keep its $85 billion-a-month cash injections going until at least the end of the year, and only slightly let up on the easy-money accelerator in early 2014. The IMF hopes the wild market gyrations will cool…