Tie me up
No one expects the Federal Reserve to raise interest rates any time soon. Even if Chairman Ben Bernanke and his colleagues had not tipped investors off months ago that they planned to keep a lid on rates until at least 2013, a sky-high unemployment rate and relatively benign inflation outlook make tighter policy a nonstarter for a long time.
So, markets did very little with the disclosure on Tuesday that the Fed will publish forecasts on the likely long-term path of interest rates. Such forecasts are sure to hammer home the point the Fed wants to deliver: it will do whatever it takes to keep rates low, boring and dependable until the economy can recover.
But then what happens? If growth begins to pick up and inflation gathers steam, boring and dependable is hardly what’s desirable from a central bank. On the contrary, the Fed should be in a position to move quickly and creatively, just as it did in 2008 when it opened the floodgates to keep the global economy afloat. That will be a lot harder if central bankers implicitly tie themselves to raising rates in some far-off future.
First, inflection points will be more volatile and harder to manage since investors are sure to misinterpret forecasts as promises. If economic data improve faster than expected, Fed officials will have to re-crunch their numbers just like any other economist on Wall Street. The difference is the Fed actually sets interest rates. Such changes, therefore, could be just as powerful as tightening policy itself.
Second, orchestrating an eventual exit from today’s highly accommodative policy is going to be hard enough. Not only does the Fed have to raise rates, it has a bloated balance sheet to slim down. It will need all the flexibility it can muster to reverse course. The Fed hardly wants markets to push interest rates higher before it’s good and ready, but neither can it stick with stale forecasts if it wants to keep its credibility intact. Maybe keeping a little mystery in policy-making isn’t such a bad idea after all.