Vice chairman of the Federal Reserve Stanley Fischer spoke on Monday at a meeting of the Economics Club of New York. (Fischer’s full speech is here).
Throughout the speech and the following Q&A, Fischer’s underlying point was this: US monetary policy is going back to normal.
The Old Normal.
It will take a while to get there, but that’s where we’re headed. It seems that the recovery, in the eyes of the Fed, is taking hold and bringing the unconventional, crisis-era policies towards their last breaths.
What does that mean?
It means, basically, that not only will the Fed raise interest rates soon — likely sometime in 2015, although Fischer wouldn’t specify a date — but also that forward guidance is more or less dead.
“The FOMC will continue to set out as clearly as it can the basis on which it makes its decisions,” said Fischer, but people should expect less explanation about what the Fed is thinking ahead of time.
Fischer’s comments also nudged people toward asking new questions. We know, more or less, when the Fed will start raising interest rates (sometime in 2015, with Wall Street consensus settling on the FOMC’s September meeting). But what happens after that?
One of the things that he reminded the room, which seems both intuitive and easy to forget, is that as interest rates begin to normalize, the market should expect some volatility, because Fed policy isn’t made in a vacuum.
Here’s the relevant part of the speech:
Standard interest rate projections might incline one to believe that the path of the federal funds rate after liftoff will consist of a steady rate of increase from zero to the longer-run normal nominal federal funds rate, which will be equal to the natural real rate of interest plus our 2 per cent inflation goal … I know of no plans for the FOMC to behave that way. Why not? Isn’t that what the calculation of optimal control paths shows? Yes. But a smooth path upward in the federal funds rate will almost certainly not be realised, because, inevitably, the economy will encounter shocks–shocks like the unexpected decline in the price of oil, or geopolitical developments that may have major budgetary and confidence implications, or a burst of greater productivity growth, as the Fed dealt with in the mid-1990s.
Further, he underlined the fact that even after the first hike in the federal funds rate (what people are talking about when they talk about interest rates), rates are likely going to continue to be unusually low for a long time.
In Fischer’s words: “We will be moving from an ultra expansive monetary policy to an extremely expansive monetary policy.”
At that, the room, obviously, laughed.