The Fed tightens and then is surprised with the outcome!

Tim Duy has a nice summary:

But what I think is often missing is a recognition that through all of the ups and downs of last year, the Fed has sent a very consistent signal: The ongoing improvement in the US economy justifies the steady removal of monetary accommodation. To be sure, we can quibble over the timing of the first move, but consider the path since last May:

  1. In May of 2013, then-Federal Reserve Chair Ben Bernanke opens the door for tapering of asset purchases.

  2. The actual tapering begins in December of that year, two meetings later than expected. I think it is heroic to believe those 12 weeks were materially important. By that point, the underlying expectation was well established.

  3. Although they claimed that the pace of tapering was data dependent, they proceeded on a very methodical path of $10 billion cuts at each meeting. They proceeded on this path despite persistent below target inflation.

  4. They clearly established that this month’s meeting is very, very likely to be the end of the asset purchase program. Again, they stated this expectation despite low inflation.

  5. Despite the current turmoil, I still expect the asset purchase program to end. I think hawks and doves alike want out of that program. They want to return to interest rate-based policy.

  6. Even as inflation bounces along below target, they formulated and announced the path of policy normalization. That normalization includes the expectation that the expansion of the balance sheet was temporary and thus will be reversed.

  7. Even as inflation has bounced along below trend, they have repeatedly warned via the Summary of Economic Projections that rate hikes are just around the corner, and that market participants should plan accordingly.

  8. And while New York Federal Reserve President William Dudley foreshadowed the minutes and a week of Fedspeak that was generally interpreted dovishly, the key takeaway was although the US economy was not expected to accelerate further, the current path was sufficient to believe in the “consensus view is that lift-off will take place around the middle of next year.  That seems like a reasonable view to me”  even “if it were to cause a bump or two in financial markets.” Those remarks were seconded by San Francisco Federal Reserve President John Williams. So the moderates and hawks both continue to send signal rates hikes by the middle of next year, leaving the voices of doves Minneapolis Federal Reserve President Narayana Kocherlakota and Chicago Federal Reserve President Charles Evans sounding very lonely. Fed Chair Janet Yellen has been somewhat absent from the current debate, although we suppose she sympathizes more with the dovish position.

Ryan Avent wonders “When will they learn“:

My question for the Fed is: what happens when disinflation continues in November and December after the Fed has terminated its asset purchase programme? Is it prepared to start purchases up right away, or will it wait to see whether things turn around? If so, how long is it prepared to wait? What is the plan here? Employment growth is not going to continue at current rates for very long if inflation expectations continue to behave this way while interest rates are at zero.


When Bernanke started the “taper talk” in May 13 inflation expectations came down and stayed down. Following the June 14 FOMC meeting, dedicated to discussions of “policy normalization” inflation expectations dived!

How can they be surprised with the consequences?

Since early 2010, NGDP growth had progressed at a stable 4% clip. After May 13 it´s only churning at 3.5%! And NGDP growth expectation, according to Justin Irving´s “Efficient Forecast”, is coming down.The world economy “thanks” the Fed!

About the Author

Marcus Nunes
João Marcus Marinho Nunes is a partner of Phynance Estratégias Quantitativas e Investimentos and a professor of Economics at Fundação Getúlio Vargas in São Paulo, Brazil. He also blogs here:

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