Policymakers wrestle with ‘new normal’

As the Federal Reserve grapples with an economy that isn’t behaving as expected, policymakers are having a rethink on the public stage.

Growth has slowed, productivity has slumped and inflation is taking longer than expected to accelerate, prompting Chair Janet Yellen to refer to the “new normal.” At the same time, Fed interest-rate hikes projected to be “gradual” are looking glacial, and market rates remain very low. As policymakers have tried to adjust, they’ve repeatedly cut estimates for the pace of future tightening, with investors consistently calling them out for being too optimistic.

“This mismatch between what we’re saying and what we’re doing is arguably causing distortions in global-market financial pricing, causing unnecessary confusion for future Fed policy and eroding credibility,” St. Louis Fed President James Bullard said June 17, as he explained a new strategy to talking about the outlook.

The fact that the economy has been slow to respond to rock-bottom borrowing costs is drawing attention to a possible decline in the long-run equilibrium, or neutral, rate that’s consistent with an economy at full employment and stable prices.

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Bullard’s comments followed the end of the traditional blackout period after the June 15 meeting of the FOMC. They were the latest to question the Fed’s approach to setting and communicating its policy path.

Chicago Fed chief Charles Evans on June 3 said it was worth thinking about jettisoning plans to raise rates until inflation reaches the Fed’s 2 percent target. Yellen made the “new normal” reference on June 15 during her post-FOMC press conference, after officials held the target range for the policy benchmark unchanged at 0.25 percent to 0.5 percent.

“There’s some shifting in real time of her view – that the world is not working out the way she’s thinking,” said Tim Duy, a professor at the University of Oregon and a contributor to Bloomberg Businessweek.

One theme that seems consistent across the board: Rates are going to be lower than they have historically been, and where they’ll settle is highly uncertain.

Bullard’s decision not to submit a long-run rate forecast, displayed in a so-called dot plot, marks a departure from Fed orthodoxy. Officials have used the dots to communicate how they see policy shaping up over time, and to give hints at how they might react to economic developments. They were introduced in 2012.

It is better at this point to forecast just for the short-term, Bullard said, and to acknowledge that different economic conditions could change the longer-run outcome.

There are doubts of how much Bullard’s initiative will ultimately persuade other Fed officials.

“I’m not sure that it makes sense” for “individuals in the committee to decide to change the rules unilaterally,” Bank of America’s Harris said. “It just adds more noise.” •

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