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Fed Up: Yellen’s Mouth Is Moving But She’s Not Telling Us Anything

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Federal Reserve chair Janet Yellen spoke to Congress yesterday. She talked. But she didn’t say a whole lot.

Most analysts seemed to view Yellen’s speech as “more dovish.” She expressed concerned that inflation my not be rising fast enough to meet the mythical 2% target, and that could slow the pace of rate hikes.

It’s premature to reach the judgment that we’re not on the path to 2% inflation over the next couple of years. We’re watching this very closely and stand ready to adjust our policy if it appears the inflation undershoot will be persistent.”

The Fed chair also hinted that we may be close to the end of the interest rate tightening cycle.  In a written statement released before her congressional testimony,  Yellen said the Fed would not need to raise rates “all that much further” to reach current low estimates of the neutral fed funds rate. (More on this in a moment.)

Just a day before, Fed Governor Lael Brainard foreshadowed Yellen’s comments, backing off talk of numerous future rate hikes. She said the Fed “may not have much more to do” in terms of raising the interest rate.

In light of recent policy moves, I consider normalization of the federal funds rate to be well under way.”

So, a few weeks ago we were ratcheting up rates at breakneck speed. Today it looks like the Fed might take its foot off the accelerator. This is typical Fed-speak. The central bankers shift back and forth like the ocean tides. Vague statements and lack of any firm consistent direction are by design. By keeping everything open-ended, the Fed can pretty much do as it pleases and justify any move based on whichever past statement happens to be convenient. “We told you so!” But they never really told us anything.

Back to this idea of a “neutral” interest rate. Ryan McMaken at the Mises Institute focused in on this idea of a “natural” or “neutral” interest rate that Yellen mentioned in her remarks. This is one of the smokescreens the Fed throws up to justify its low-rate policy. The theory is that there exists this natural rate of interest and it has fallen to a lower level in recent years.  This means the interest rates we saw in in the past at around 3 to 5% would be way to high today.

So, what the point? McMaken explains.

Politically speaking, identifying this ‘natural rate’ as being very low allows the Fed to create the perception that its very-low target rates aren’t really all that stimulative at all. They’re practically neutral! Just look at the natural rate, they’ll tell us. The problem however, is that all good economic theory tells us that the Fed has no idea what the natural rate actually is.”

In other words, the whole thing is smoke and mirrors.

Make no mistake; Yellen and company love smoke and mirrors. It muddies the water and keeps everybody wondering. That bodes well for central planners who really have no idea what they’re doing, but want to give the impression of having everything under control. McMaken puts the whole thing into proper perspective.

All this talk about the natural/neutral interest rate thus provides political cover for the Fed, and allows the FOMC to claim that they’re using economic science in determining the ‘correct’ target rate. In truth, the Fed has no idea what the natural rate is but is really just proceeding with great caution because the Fed’s leadership knows that allowing interest rates to increase beyond the current low levels would upset the fragile economy.”

So, what will the Fed do? Will it keep raising rates? Will it hold relatively steady? Or as some have predicted, will there be a crash that forces the Fed to lower rates again and launch more quantitative easing?

We really have no clue. We should be ready for anything.

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