Like many other central banks around the world these days, the US Federal Reserve gives itself high marks for the quality of its external communication. So what, I wondered, did the Fed have to say about the innocuous sounding phrase "medium term," which has taken a heightened importance in recent weeks on account of its careful placement in the 18th March Federal Open Market Committee monetary policy statement:
"The Committee anticipates that it will be appropriate to raise the target range for the federal funds rate when it has seen further improvement in the labor market and is reasonably confident that inflation will move back to its 2 percent objective over the medium term."
By the way, be warned before we go any further, and by no one other than Fed Chairwoman Janet Yellen herself (in a January 2009 FOMC conference call), that the small differences in phraseology just might matter:
"I think that the distinction between long term and medium term is not semantic - it is substantive."
Here we go, then, on a tour of Fed phraseology: both to see if we can pin down a more concrete definition of the phrase "medium term," and perhaps also even to tally it up with a current Fed forecast. After all, when the relevant forecast hits 2%, it's time to tighten, right? Yeah, right.
"Longer term" is 5-6 years, according to the SEP
Starting in October 2007, and after a lot of prior debate, the Fed began to publish a summary of the quarterly forecasting exercise undertaken by FOMC participants, which is called Summary of Economic Projections (SEP). About a year later, the exercise was refined so that, in addition to giving forecasts out two years, FOMC participants were also polled about their "longer-term" view of the key variables (GDP growth, unemployment and inflation). In an earlier conference call in December 2008 presaging the new refinements to the process, Fed Governor Don Kohn had the following to say about what "longer term" would be taken to mean:
"We thought that the questionnaire should ask each participant to provide 'your best assessment of the rate to which each variable would converge over the longer term (say, five to six years from now) in the absence of shocks and assuming appropriate monetary policy.'"
It isn't "medium term," of course, but at least it's a start. In Fed-speak, "longer term" means from five-to-six years.
Medium term is 2 years, according to the Fed staff, while long term is 5 years
Scheduled modern day meetings of the FOMC have typically included an updated forecast and presentation from the Fed's staff, known as the Greenbook. Including because the FOMC transcripts and presentation materials are only released with a five year lag, the latest available Greenbook on the Fed's website dates from December 2008. Historically, the Greenbook has been divided into "Near-Term," "Medium-Term," and "Long-Term" sections, which equate - respectively - to the current quarter, the next two years, and the next five years.
So, "medium term" in Fed staff-speak means two years. Eureka?
One complication: Janet Yellen has her own view on what the "medium term" is
"Medium term" means two years as far as the Fed staff in 2008 was concerned. But not so fast! Because tucked away in the entrails of a January 2009 FOMC communication discussion was the following interjection by Janet Yellen:
"From macroanalysis, I consider short term as referring to less than, say, a year or two, medium term as ranging from around two to six years, and long term as anything beyond around six."
So, "medium term" in Janet Yellen-speak means from two-to-six years, not the two years that the Fed staff projections refer to, and not the five-to-six years that the "longer-term" SEP forecast refers to. And in a discussion with the Fed staff and her fellow FOMC members, I wouldn't mind betting that Janet Yellen mostly gets her way these days.
The missing Fed forecast that really matters
I don't know if it is an accident or not - I doubt it, frankly - but the "two to six year" time frame that Fed Chairwoman Yellen has historically referred to as the medium term is the one forecast horizon for which no published Fed forecasts exist.
Well, not quite, perhaps. Because the outer limit of the current SEP exercise is a central tendency inflation forecast of 1.9-2.0% for Q4 '17, the midpoint of which is two years and eight months way.
And let's not forget the "longer-term" SEP projection. Or should we? Because, in reality, the "longer-term" inflation forecast published in the SEP exercise is just the Fed's own 2% inflation objective. How do I know? Well, of the 246 longer-term inflation forecasts made by FOMC members since the exercise was introduced (14 of them were penned by Janet Yellen herself), each and every one of them was exactly 2%. By the way, if that doesn't count as "reasonably confident," I don't know what would. Except, in Janet Yellen's mind, and according to her logic (and luckily for her), the "longer-term" forecast doesn't cut it as a medium-term forecast.
Let's have another look at what it is the Fed says it is after here with respect to the inflation part of what needs to be in place for a first policy tightening:
"…reasonably confident that inflation will move back to its 2 percent objective over the medium term."
The limits of transparency
On as close an inspection as I can muster, I've concluded that - cleverly, deviously, and/or otherwise - the Fed has left itself a medium-term window to adjudge the future inflation outlook that is virtually unoccupied by anything it has said, or any implied commitments it has made. It can do what it wants, when it wants, and nobody will be able to point the finger to past pronouncements and say they have been misled. And it's probably all no accident, of course. Read, for example, what Fed Chairwoman Janet Yellen had to say about transparency in an August 2006 Federal Open Market Committee (FOMC) meeting discussion on communications:
"First, I want to endorse the point that Don [Kohn] made that we should not put in our list of goals that our objective is to maximize transparency for the sake of greater transparency. The research in this area provides very ambiguous advice about how much transparency is optimal."
If that wasn't enough, she continued with the following:
"As I think about the question of unity versus diversity in our communications, I am moving to the conclusion that it's probably better to err on the side of preserving the advantages of the diversity of views at the cost of somewhat less of the clarity."
I suppose you've got to give the Fed credit for achieving its external communication goals, particularly with respect to "somewhat less of the clarity." Will the first policy tightening be in June, or September, or even later? Is it right that it all comes down to "data dependence" and the next three unemployment rate readings? I can't for the life of me figure out what will make the Fed's inflation forecasts go back up, other than higher inflation (which is roughly what happened the last time the Fed embarked on a big tightening cycle, back in 2004). I thought monetary policy acted with a two-year lag. Maybe that was in the old days, before 24 hour news. I kind of hope so, because if it doesn't, big monetary policy decisions are getting blown around by awfully little (in the big scheme of things) monthly data points. And that really is asking for trouble in the medium term. My medium term, by the way. Two years from now. Because if the Fed isn't careful, that's my current estimate of when the next recession is going to begin.
As regards the first policy tightenings, I'm left feeling distinctly Black Eyed Peas about it all, which isn't cockney rhyming slang, but rather merely that "I gotta feeling." I gotta feeling that we're still being set up for an earlier tightening, but a slower progression thereafter.
Then again, maybe - on those grounds - the Fed has done its communication job brilliantly! How maddening. Time, as ever, will tell.