Do Fed doves and hawks get their aviary classifications based on their cold, hard analysis of data, or is it the reverse – do they select data points to justify their dovish or hawkish perspectives?
The history of the Fed’s post-crisis focus on unemployment suggests the latter. After June of 2013, as the figure above shows, the Fed’s estimate of the natural long-term unemployment rate begins declining in sync with the decline in the actual unemployment rate. This suggests that FOMC members are lowering their estimates of the natural rate of unemployment to justify keeping interest rates at zero longer than they could if they stuck by their initial estimates, the 6% consensus upper bound of which is now above today’s actual 5.9% rate.
We cannot test this hypothesis directly, by checking each member’s estimate history, because the estimates are anonymous. But we can check whether the phenomenon can be explained merely by a change of FOMC composition: it cannot. The distribution of participants’ estimates shows conclusively that some of them have indeed revised their estimates lower. Given that these are supposed to be estimates of the "long-term" natural unemployment rate, this is more than curious.
With core PCE inflation, the Fed’s preferred inflation measure, running at 1.5%, still comfortably below the Fed’s 2% long-run target, there is little compelling reason to begin hiking rates immediately. But given its upward trajectory from 1.2% at the start of the year, there is surely now reasoned cause for bringing forward the Fed’s old September 2012 calendar-guidance of zero rates through mid-2015 – which the Fed doves are still strongly wedded to.
Our observations suggest that monetary dovishness and hawkishness are often fixed states of mind, rather than artifacts of a consistent approach to data analysis. If so, there is reason to fear that the Fed’s exit from monetary accommodation will be too late and too tepid – with the result being higher future inflation than the market is pricing in right now.
Read about Benn’s latest award-winning book, The Battle of Bretton Woods: John Maynard Keynes, Harry Dexter White, and the Making of a New World Order, which the Financial Times has called “a triumph of economic and diplomatic history.”