I think it's very simple.
They know something bad is going to happen. It could be a deflationary recession, it could be out of control inflation. In a world awash in liquidity and debt, in which the US Fed has limited effective control over the quantity of money and the quality of claims, either possibility is plausible.
The Fed doesn't want to be blamed. Feds are historically blamed first for pushing interest rates too high (causing a deflationary recession), and second for letting inflation get out of hand. So, the Fed's first priority is not being blamed for acting too aggressively and causing a recession. They can avoid blame by pausing the rate hike cycle, if it seems decent to do so, or by moving 25 bp per meeting, if inflation numbers run high. That "measured pace" is now a kind of default, not a blame magnet, and anyway, it's a Greenspan Fed strategy, so if contiguous 25 bp moves precede a recession, most of the blame goes to Bernanke's predecessor. But the Fed also doesn't want to be blamed for failing at its core mission of keeping inflation under control. So, in "jaw-jaw" mode — speeches, informal comments, etc. — Fed officials come off as hawkish, hoping to maintain their credibility as inflation fighters, and thereby reduce self-fulfilling expectations of increased inflation.
This is a fairly optimal strategy for avoiding blame. If a recession hits, blaming the Fed for being too aggressive will have limited traction. After all, the Fed only continued its predecessors policy of gently tightening, and only when inflation numbers clearly forced continued tightening. Blaming the Fed because Bernanke talked about inflation numbers exceeding his comfort levels in some speech is not going to take. The formal record will be one of very measured interest rate rises, and very moderate statements and minutes. If there's a recession, it won't be the Fed's fault. If inflation continues to pick-up, the Fed can try to maintain its credibility by talking tough and continuing the 25 bp hikes. If the Fed really is "behind the curve" on inflation, and prices accelerate, eventually they might be blamed. But that involves incremental and subtle attributions of blame. They can always, actually "shock the market", if things get out of hand and the blame for inflationary pressires gets palpable. But much better to threaten to do something radical (deniably, through third parties and rumors) than to take the risk of actually doing something, until something absolutely must be done, and the risk of serious blame can no longer be avoided.
I do think some kind of bad economic period is inevitable, though whether it looks like recession or stagflation or just modest inflation and sluggish real growth is uncertain. I'm not sure that I blame the Fed for avoiding blame. But I do blame the Greenspan Fed, and current administration, and the ossification of economic ideas into stale ideologies over a longer period of time, for getting the US economy into an obvious, big mess, while the best and brightest debated whether a garbage dump wasn't the optimal outcome if something resembling a market happened to produce it.
|Steve Randy Waldman — Friday June 30, 2006 at 12:29pm||permalink|