Newly minted Federal Reserve chief Janet Yellen is on Capitol Hill this week expounding on the economy. But the more exciting action for Fedwatchers is happening across the pond.
The Bank of England is the first major central bank to cross its line in the sand for hiking interest rates. Gov. Mark Carney publicly addressed that dilemma Wednesday, and what he said could provide some clues about how the Fed will confront the same problem.
The BOE had promised to keep interest rates at record lows until the unemployment rate hit 7 percent. But the country’s jobless rate may have already hit that mark – even though the economy has yet to clock enough growth to satisfy the central bank. That puts the BOE in the uncomfortable position of moving the bar.
In fact, some argue that Carney brushed away the bar altogether in his remarks Wednesday. He said that the central bank wants to “absorb all the spare capacity in the economy,” a much more nebulous criteria that encompasses not just the unemployment rate but business surveys, hours worked, and -- we suspect -- a gut feeling that things are better.
If all of this sounds familiar, it’s because the Federal Reserve is facing the same challenge at home. Like the BOE, it had set a threshold of 6.5 percent unemployment for raising interest rates. In December, the Fed added that rates would likely remain low “well past” that point. But investors are seeking more clarity about what that means with the jobless rate sitting a hairsbreadth from meeting the threshold.
Yellen hinted at a similar approach to the BOE during her testimony before a House committee on Tuesday, stating that “We shouldn’t focus only on the unemployment rate.” She pointed to the high number of long-term unemployed and the folks working part-time for economic reasons as indications that the labor market remains too weak.
The moves by central banks away from concrete measures amount to an about-face on forward guidance. Officials went out of their way during the crisis and its immediate aftermath to assure investors and the public that interest rates would remain low for a very long time – resulting in a series of increasingly definitive (and wordy) promises:
"The Committee anticipates that weak economic conditions are likely to warrant exceptionally low levels of the federal funds rate for some time." Federal Reserve, December 2008
"[E]conomic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period." March 2009
"The Committee currently anticipates that economic conditions--including low rates of resource utilization and a subdued outlook for inflation over the medium run--are likely to warrant exceptionally low levels for the federal funds rate at least through mid-2013." August 2011
"[T]he Committee decided today to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that economic conditions--including low rates of resource utilization and a subdued outlook for inflation over the medium run--are likely to warrant exceptionally low levels for the federal funds rate at least through late 2014." January 2012
"In particular, the Committee also decided today to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that exceptionally low levels for the federal funds rate are likely to be warranted at least through mid-2015." September 2012
"In particular, the Committee decided to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that this exceptionally low range for the federal funds rate will be appropriate at least as long as the unemployment rate remains above 6-1/2 percent, inflation between one and two years ahead is projected to be no more than a half percentage point above the Committee’s 2 percent longer-run goal, and longer-term inflation expectations continue to be well anchored." December 2012
But the strategy seems to be less effective now that central banks are starting to think about reversing course. The recovery is entering a new phase, and the old rules no longer seem to fit.
As St. Louis Fed President James Bullard told Bloomberg: “We have to go back to more traditional forms of policy where we have more qualitative judgments because we’re getting much closer to a more normal economy."
Expect plenty of trial and error as officials search for ones that do.