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Waiting for the Fed Rate Rise: Beware Careless Talk

August 29, 2015 in Economics

By William Poole

William Poole

Last week, William Dudley, president of the Federal Reserve Bank of New York, was widely quoted as saying that the case for a September interest rate increase has grown “less compelling,” apparently as a consequence of turmoil in stock markets around the world. Is Dudley saying that monetary policy is dependent on the stock market?

“Data dependence” has become a mantra of Federal Open Market Committee (FOMC) policy discussion. For example, Chairwoman Janet Yellen’s statement at her June press conference says, “…although policy will be data dependent….”

It is long past time for the FOMC to make sense of what it means by “data dependence.” Dudley is not the first FOMC participant to react to events in a way that continues to muddle communication of policy strategy.

Early in my tenure as St. Louis Fed president, I gave a speech entitled “Data Dependence,” and across the years I tried to convey a sense of what this term ought to mean. The FOMC’s setting of the federal funds rate should depend in a predictable, systematic way on data available at the time of each FOMC meeting.

I wish that current FOMC participants would stop trying to predict policy actions and instead concentrate on defining a sensible and understandable long-run policy strategy.”

I followed events—especially economic news—closely. As I observed the daily flow of news and market reactions to it, I tried to think through whether the markets had it right. Markets continuously assess and reassess.

Day by day, I thought about what my policy position might be were the next FOMC meeting to be the next day. Eight times each year, the meeting was indeed the next day. And sometimes the chairman called a meeting between the regular meetings.

I was almost always opposed to policy action between regular meetings, because taking the market by surprise was a poor idea most of the time. A surprise meeting inevitably put more emphasis on the latest news than was justified. That is, a surprise meeting conveyed to the market that the news of that day had special importance to the FOMC. This is a risky way to conduct Fed policy.

An excellent example is the telephone conference call meeting on January 22, 2008, which was Martin Luther King Jr. Day. The FOMC cut its target fed funds rate that evening by 75 basis points. The U.S. markets had been closed, but European markets were down …read more

Source: OP-EDS

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