The guest commentary below was written by Benn Steil and Benjamin Della Rocca from the Council on Foreign Relations. Click here to read the original article. 

The Fed Should Peg Rates to Reality, Not Stale Forecasts - 01.12.2018 FED process cartoon

Last week we learned that August core PCE inflation, the Fed’s preferred inflation measure, hit 3.6 percent for the third consecutive month.

Yet as the evidence mounts that current inflation is not merely “transitory,” and the Fed raises its inflation forecasts in consequence, the Fed’s guidance as to when it will raise its policy rate above 0-0.25%, where it has been stuck since March 2020, has barely budged.

As we explained recently in the Wall Street Journal, past Fed behavior—as exemplified by a close correlation between the Fed’s inflation forecasts and its rate guidance—suggests that its policy rate should already be at 1.9%. So why is the Fed still signaling near-zero rates well into 2022?

Observations of past and present Fed officials, whom we quoted in our piece, suggest the answer.

Whereas Fed officials cannot make their inflation forecasts come true, they can make their rate forecasts come true—since they themselves control those rates.

It is therefore increasingly clear that Fed officials are trying to maintain “credibility” by doing what they predicted they would do—even though current inflation data no longer validate those predictions.

Such behavior is, however, a recipe for bad long-run macroeconomic outcomes—meaning lower future growth and higher unemployment.

The Fed Should Peg Rates to Reality, Not Stale Forecasts - graphic v2


This is a Hedgeye Guest Contributor piece written by Benn Steil and reposted from the Council on Foreign Relations’ Geo-Graphics blog. Mr Steil is director of international economics at the Council on Foreign Relations and author of The Battle of Bretton Woods and The Marshall Plan: Dawn of the Cold War. It does not necessarily reflect the opinion of Hedgeye.