Janet Yellen will speak to reporters in her first press conference as chair of the Federal Reserve this afternoon, at an important moment for the nation's central bank. As the official unemployment rate gradually approaches 6.5 percent, the threshold that the Federal Open Market Committee set about a year ago, investors and economists are wondering what the Fed under Yellen will do after that goal is achieved -- and whether it still represents a good gauge for the economy.
The important question is whether Yellen and her colleagues think that the economy can still improve and whether they will try to stimulate more growth by continuing relatively accommodative policies. But a hawkish minority at the Fed is arguing that the financial crisis has more or less permanently damaged the economy, and that further improvement isn't possible. They want the central bank to signal that its work is nearly done and that it is ready to begin withdrawing support for the economy.
Most observers seem to think that the committee will announce another $10 billion reduction in the rate of new bond purchases, and that the announcement will include some creative way of indicating their commitment to low interest rates for the long term that doesn't involve the goal of 6.5 percent for unemployment:
#FOMCGuesses $10B taper. Evans rule dropped. Touchy-feely guidance.
— Ed Bradford (@Fullcarry) March 19, 2014
A statement along these lines would be, more or less, a continuation of current policy.
Yet Matthew Boesler at Business Insider suggests that as the unemployment rate approaches the Fed's target, the central bank will not try to set a new goal for the economy. If so, today's statement might indicate they're ready to raise interest rates sooner. Some analysts feel that "full employment," defined as the point beyond which competition among firms over employees will lead to rising prices, is higher now than in the past. Like a patient who has recovered from a grave illness but remains maimed or blinded, the economy on this view just cannot recover the capacity for growth it had before the financial crisis, not anytime soon, anyway.
On the other hand, Karl Smith, Cardiff Garcia and others think that rising prices and inflation are worth enduring to encourage more workers back into the economy. Smith even suggests that the Fed explicitly increase its target for inflation for a short time. Yet the Fed has been very clear in the past about its commitment to holding inflation at or around 2 percent, as Tim Duy notes, so it is unlikely that the central bank will endorse such a policy now.
That previous commitment may make Yellen's job now more difficult. Wall Street might think that her and her colleagues have misjudged inflation, believing that it will increase sooner than the Fed anticipates. If so, they are less likely to take any commitment the Fed makes in its statement today seriously if that commitment is merely qualitative, in other words, if it isn't associated with a quantifiable goal of some kind, like the threshold of 6.5 percent for unemployment.
That's why the precise wording of today's statement is very important. If the Fed maintains its current threshold of 6.5 percent, that could mean members of committee are worried about increasing prices. But this could also be a sign that officials want to wait for more information or for input from two new members who are likely joining the committee soon.
If their statement is more qualitative, then pay attention to how the market responds: rising stock prices or falling bond yields will indicate that investors take the Fed at its word, and that they are confident in Yellen's ability to persuade the hawks on the committee to go along with a more aggressive program, despite the possibility of rising prices.
The economic forecasts included with the statement will show how the committee is thinking about the relationship between inflation and unemployment. Reporters might ask Yellen about winter weather as well, and her response could also reveal something about committee's view . If members think that poor economic performance in the past month or two has been due to the weather rather than fundamental weakness, that essential optimism could incline them to raising rates sooner. On the other hand, it now seems likely that the discouraging data was something more serious than a meteorological anomaly.