Monday, July 27, 2015

FOMC Report July 28-29, 2015; Transparency Gets Cozy with Data Dependence




There is little reason to think the Fed will surprise with a policy firming at the July FOMC meeting.  Virtually everyone expects they will pass until September at the earliest, though a majority does expect a September start to monetary policy ‘normalization’.  The question being asked is ‘how obvious does the Fed need to be in signaling its first policy rate firming in more than a decade?

It may be enough that a majority currently believes that the Fed will reduce policy accommodation in September.  However, the Fed might want a stronger majority to understand its intention and so thwart any unwanted volatility.      

Data Dependent Does Not Mean Secrecy

The Fed need not collect every last bit of available data prior to meetings before deciding if the timing is right to normalize monetary policy.  Clearly there is a trade-off however between certainty and timeliness; The longer the Fed waits, the more confident they can become that they should (shouldn’t) have normalized earlier.  But that is driving by using the rearview mirror.  They can never know with certainty today that a policy move will prove correct.  What they can do is rely on the progress of data and make assumptions.  In the end, that is all that can be expected.  

Data dependency and transparency are not mutually exclusive.  The Fed can be data dependent and give ample guidance that a policy firming is forthcoming.  The Fed may have already collected enough information to be confident that a policy firming in September is appropriate.  If the Fed is relatively comfortable that enough quality data has been collected in order to decide that a September ‘lift-off’ is appropriate, then they would not gain by making economic agents guess what their intentions were. 

The benefit derived from Fed transparency should out way the cost of taking flack from those who would argue that the Fed had abandoned its ‘data dependent’ promise.  Market participants need not assume the Fed has discarded data dependency as a guide.  The Fed can make clear that it expects data to conform.    

Dana Saporta at Credit Suisse offered a smart way for the Fed to advance its data dependent interests while making a stronger case for the Fed to move in September; "If economic activity unfolds as expected, it may become appropriate to diminish slightly the very high degree of accommodation currently in place.”  Even stronger, the Fed could say “If economic activity unfolds as expected, it ‘would’ become appropriate to diminish…”

In Summary

A large majority already expect the Fed to adjust its main policy rate at the September FOMC meeting.  Unless the Fed has good reason to postpone that move until December (or later), it would benefit from providing additional clarity about its intentions at the conclusion of the July FOMC meeting.  In doing so, the Fed would not be abandoning its stated intention of being data dependent, but would help to facilitate the adjustment with added transparency during this transition period.     

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