Takeaways From The FOMC Meeting

As expected, the Federal Open Market Committee (FOMC) raised its target federal funds rate to 0.50-0.75%. There wasn’t much substantive change in the language of the statement. Economic activity was judged to be expanding at a moderate pace, with a declining unemployment rate. Measures of inflation were said to have “moved up considerably” but still remain low, which seems to be contradictory. All FOMC members voted in favor of raising the target federal funds rate at this meeting.

Looking forward to 2017, some media reports have touted that the Fed’s “dot plots” point to the potential for three rate hikes in 2017. That possibility has a few things working against it. First, the Fed is watching closely to see what other central banks are doing. If the European Central Bank, Bank of England, and Bank of Japan maintain loose monetary policy, the Fed will find it tough to raise rates unilaterally. Secondly, the FOMC membership is switching up again as it does every year. For those who are unfamiliar, here’s the Federal Reserve’s description of the FOMC:

The Federal Open Market Committee (FOMC) consists of twelve members–the seven members of the Board of Governors of the Federal Reserve System; the president of the Federal Reserve Bank of New York; and four of the remaining eleven Reserve Bank presidents, who serve one-year terms on a rotating basis. The rotating seats are filled from the following four groups of Banks, one Bank president from each group: Boston, Philadelphia, and Richmond; Cleveland and Chicago; Atlanta, St. Louis, and Dallas; and Minneapolis, Kansas City, and San Francisco. Nonvoting Reserve Bank presidents attend the meetings of the Committee, participate in the discussions, and contribute to the Committee’s assessment of the economy and policy options.

Next year the four Federal Reserve Bank Presidents rotating onto the FOMC are: Charles Evans of Chicago, who has a dovish reputation; and Patrick Harker of Philadelphia, Robert Kaplan of Dallas, and Neel Kashkari of Minneapolis, all of whom are recently-hired and will be voting on the FOMC for the first time. Dallas and Philadelphia have reputations for being more hawkish, but it remains to be seen whether the new Presidents will maintain that reputation.

Kaplan has at least mentioned his desire to “take action to remove some amounts of accommodation.” Harker has been much more circumspect so it’s hard to get a read on him. And Kashkari, one of the architects and implementers of the 2008 bank bailouts and the successor to Narayana “Negative Rates” Kocherlakota, should probably be assumed to be dovish. That’s not a great outlook for rate hikes next year. The wild card, however, are the two open Governor slots that could be filled by President Trump’s nominees, whoever those may be. Assuming that President Trump is able to get nominees through the Senate confirmation process, they could provide a counterbalance to Chairman Yellen and result in some actual debate or even policy changes, not just the customary largely ceremonial vote punctuated by occasional dissents.

The financial press is making much of the dot plots from the most recent FOMC meeting that seem to point to a projected two to three interest rate hikes in 2017. Indeed, the breakdown of the 17 FOMC participants (5 Governors + 12 Reserve Bank Presidents) shows that by the end of 2017:

  • 1 participant expects the federal funds rate to be at 2.0-2.5%
  • 1 participant expects the federal funds rate to be at 1.75%
  • 3 participants expect the federal funds rate to be at 1.5-1.75%
  • 6 participants expect the federal funds rate to be at 1.25-1.5%
  • 4 participants expect the federal funds rate to be at 1.0-1.25%
  • 2 participants expect the federal funds rate to be at 0.75-1.0%
  • If you average those out, the expected target rate is about 1.37%, or between 1.25 and 1.50%. That would indicate three rate hikes next year of 25 basis points each.

    But wait! Let’s look at the dot plots from the December 2015 FOMC meeting and the projections for 2016. If you average those out, it comes to an expected 1.29%, or once again between 1.25 and 1.50%, but by the end of 2016. That would indicate four rate hikes in 2016, yet we only got one. And today’s overall outlook for the federal funds rate by the end of 2017 is almost exactly the same as the FOMC was predicting last year for 2016. That doesn’t exactly inspire confidence in those hoping for rate hikes. And if we take a look at the projections from the December 2014 FOMC meeting, we see that the projected federal funds rate was 2.54% by the end of 2016, or between 2.50 and 2.75%. Yet here we are at 0.50-0.75%. But long memories and sound analysis of the Fed’s predictions don’t make for tantalizing headlines, increased readership, or greater ad revenues for the financial press, so we hear breathless reporting of how the Fed has finally turned a corner and next year will bring markedly higher rates. We’ll believe it when we see it.

    The best that we can say about the Fed’s economic projections is that they are pretty bad at predicting the year ahead, and their projections for two years ahead are completely pie in the sky. And these aren’t projections about data out of their control. These are the projections of their own decisions, the rate that they vote on every six weeks. The FOMC members literally can’t predict what they themselves will do within the next year, yet their predictions on rate hikes, unemployment data, inflation, and other economic forecasts are taken seriously by markets and observers. Better yet, their economic data is probably derived from models that are claimed to be used because of their predictive capacity. Would you trust someone who claims to be able to predict the results of the actions of 300 million people working independently to further their aims, but who can’t predict the simple actions of himself and his eleven other colleagues?

    Anyone who looks at the Fed seriously or with any sort of inquisitiveness should be able to see these problems. Not to see them would indicate that the observer is willfully overlooking them. Perhaps that explains why so much trust is being placed in a dozen people to manage the economy. It’s just the way things have been done for over a hundred years, so most people trust that that’s the best way possible and don’t question the status quo. It is a trust that is completely misplaced, but those who propose alternatives to the Federal Reserve System, no matter how much better those alternatives would work than the current system, are constantly derided as being non-serious, impractical, or worse. All the more reason to continue harping on the Fed’s inabilities and inadequacies, in the hopes that eventually they will become apparent before it’s too late.

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