Fed Thoughts: Without Wings

“I can still imagine circumstances in which at least one policy move could take place, and possibly two.”
—Federal Reserve Bank of Atlanta President Dennis Lockhart

“The man who has no imagination has no wings.”
—Muhammad Ali

Another meeting of the Federal Open Market Committee (FOMC) will come and go next week, briefly noted by the media and market participants who will have turned their attention to the Democratic National Convention. The headlines for both are foreordained. Secretary Clinton will be nominated at one and Chairwoman Yellen will keep monetary policy unchanged at the other. And with both, the more interesting drama plays out over the remainder of the year.

For now, Fed officials must be relieved that no bad thing happened. When they last met in June in advance of the UK referendum on European Union membership, they believed that “…it was prudent to wait for additional data regarding labor market conditions as well as information that would allow them to assess the consequences of the UK vote for global financial conditions and the US economic outlook.” 1 In the event, a strong reading on June payrolls lent some confidence that domestic economic momentum had not flagged. Indeed, data have mostly surprised on the upside for a change, with a widely followed tally of releases relative to expectations emerging into positive territory of late. This good news is not all good news in that a positive may owe to a negative: An increasing number of people are coming to the realization that the growth of potential output has slowed in many advanced economies, the US included. A more appropriate understanding that economic expansion will be more subdued makes it more likely that data surprises will not be so one-sided. It also means that people appreciate that there is less economic capacity to work down, sustainable gains in payrolls are decidedly lower than the performance over the prior few years, and the equilibrium real short-rate—to which policy ultimately has to revert—is lower.

1 From the minutes of the June 14th-15th FOMC meetings at https://www.federalreserve.gov/monetarypolicy/files/fomcminutes20160615.pdf accessed on July 20, 2016.

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