The FOMC voted unanimously to raise the federal funds rate target on Tuesday to 4.50 percent. This was the 14th increase in the fed funds rate target and perhaps the last one that is not a surprise to the financial markets in this interest rate cycle. When Greenspan took over the helm of the Federal Reserve in 1987, Board decisions were not announced and policy changes were a question of debate - even after they took place! Times changed and the Federal Reserve Board became more willing to disclose its policy actions. As Greenspan hands over the reins to Ben Bernanke, monetary policy has indeed become significantly more transparent.
However, over the past few years, one didn't need to be a stellar forecaster to have predicted that the federal funds rate target was too low for too long and needed to be raised to a more neutral range in which the interest rate level neither had a stimulative nor a restrictive effect on the economy. Outgoing chairman Alan Greenspan never admitted what target he had in mind for a neutral fed funds rate target. He claimed he would know it when he saw it. In contrast, San Francisco Fed President Janet Yellen offered a target ranging from 3.5 to 5.5 percent. At one time or another over the past six months, several Federal Reserve district presidents have indicated whether or not they believe the Fed's current fed funds rate target was at or near the neutral rate.
Federal Reserve officials may not want to admit whether the current target rate is the mid-point, the bottom or top end of the neutral zone. Market players however can generally agree that the fed funds rate target, now at 4.5 percent, is somewhere in the neutral zone. The question turns into one of nuance. Will an additional 25 or 50 basis points be needed to keep the core inflation rate under 2 percent? This is a question that will be answered by the incoming chairman, Ben Bernanke. Alan Greenspan never did have to pin point an ideal target rate after all.
I was watching CNBC in the few minutes before the FOMC announcement and was amused at the remarks made by former Fed vice chairman Alan Blinder, former Dallas Fed president Robert McTeer, PIMCO bond guru William Gross and CNBC economics correspondent Steve Liesman. These men were asked about their expectations on the post-meeting statement. Would the statement give Ben Bernanke wiggle room to do what he chose at the March meeting? Would it allow him to either pause or raise rates by an additional 25 basis points? Generally, the consensus was that indeed there would be wiggle room, but after the statement was read, some of the pundits felt that the statement offered an indication that another rate hike was in the offing - and that it did not give Ben Bernanke as much wiggle room as he "needed".
Basing the post-meeting statement on "wiggle room" for Ben Bernanke is poor policy making. I hardly think (and certainly hope) that Fed officials, including outgoing chairman Alan Greenspan, based their statement without "wiggle room" in mind. At each Federal Reserve meeting, one expects the Fed to consider all knowable information and make policy decisions on the facts. It is irrelevant that a new chair will take over the subsequent day. If outgoing Fed chairman Alan Greenspan was supposed to also worry about Ben Bernanke's view of the world, then the new chairman should have been at the meeting.
The wiggle room concept is also faulty in that market players are expecting Bernanke to have a completely different view of the state of the economy than not only Alan Greenspan but also the remaining Board members and the district bank presidents. It is truly unlikely that his views are at odds with all other Fed officials. Now, it is true that it would be problematic if Bernanke faced the members of the Federal Open Market Committee in March along with the Fed's economic staff and set forth a policy prescription that was at odds with their collective wisdom.
The fact is that the Fed - with its new chairman - will determine whether or not the Fed raises rates at the March meeting, or any subsequent meeting for that matter, based on current economic conditions including inflation prospects. The Fed could pause in March; a few economists are predicting as much. The majority of economists expect that economic conditions will be such that the Fed will choose to raise the fed funds rate target an additional 25 basis points. At this point, the majority of economists are looking for only one more Fed rate hike, but some expect the Fed to bring the funds rate target all the way up to 5 percent before year end. Again, it will depend on the state of the economy and inflation prospects.
Will the Bernanke Fed be different from the Greenspan Fed? Chances are that it will. Bernanke has indicated his interest in a more democratic Fed. He has also indicated his interest in greater transparency and he promotes inflation-targeting. At his confirmation hearings, he suggested that his near term goal was to not make any changes from the Greenspan way of doing things. But when Bernanke achieves the credibility earned by the outgoing chairman, he may choose to actively promote inflation-targeting. Keep in mind that an inflation-targeting policy tool would not preclude the Fed's dual mandate of promoting price stability and full employment.
THE BOTTOM LINE
Fed officials voted unanimously to raise the fed funds rate target by 25 basis points to 4.50 percent. They changed the post-meeting statement slightly and even removed the term "measured". Some pundits discussed the possibility that the post-meeting statement would give incoming chairman Ben Bernanke "wiggle room" in determining a rate hike at the March meeting. In my view, the whole wiggle room concept smacks of poor policymaking and is an insult to the current members of the FOMC. They are making decisions on current knowable information. When Ben Bernanke chairs his first FOMC meeting in March, he will take part in the decision making. And once again, the members of the FOMC will make the best possible choice on all knowable information at that time no matter what the January 31 statement "said".
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