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Federal Reserve to debate new language on interest rates

Federal Reserve building, Washington.
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Federal Reserve building, Washington.

The US Federal Reserve's forward guidance on future interest rates has come up for debate after a stream of central bank officials declared the current wording needs to change.

In the past few days, officials from every part of the rate-setting Federal Open Market Committee – hawks and doves, regional presidents and Washington governors – have called for new language.

Their remarks could mean a move at the September FOMC meeting in 10 days, although there is little consensus yet on new wording, so a shift might have to wait until next month.

A particular issue is the Fed's guidance of low rates for a"considerable time" after it stops buying assets in October. A chunk of the FOMC feels that is a dangerous hostage to fortune, after steady economic progress that could yet require rate rises early next year.

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"Significant parts of the FOMC statement need to change," said Jerome Powell, a Fed governor, in a question-and-answer session on Thursday evening. "I believe it is...time for the Committee to reformulate its forward guidance," said Loretta Mester, president of the Cleveland Fed, in a speech earlier the same day.

Mr Powell and Ms Mester are two of the four members of a new Fed sub-committee on communications policy. Their concern about forward guidance is reflected across the spectrum of hawks and doves on the FOMC.

"I actually hold the view that as we approach levels of unemployment that many consider 'full employment', the Fed should no longer issue guidance on the approximate timing of any monetary policy changes," said Eric Rosengren of the Boston Fed, a strong advocate of Fed stimulus, in a speech on Friday. His opposite number, the hawkish Charles Plosser of the Philadelphia Fed, dissented in July because of "considerable time".

The Fed still views the timing of a first rate rise as entirely dependent on the economy's progress. But many Fed officials have grown concerned about a market tendency to fixate on calendar dates, often in the second half of 2015, rather than update the odds of a rate rise as the data changes.

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The Fed's own communications have evolved steadily this year, with chair Janet Yellen warning in June that strong data could lead to earlier rate rises, and giving a more neutral assessment of the labor market at Jackson Hole in August.

FOMC officials will refresh their economic forecasts in September– with some upgrades possible despite August's weaker jobs number – and they may also lay out technical details of their exit strategy. Ms Yellen's press conference statement would be a natural place to do that.

Replacing "considerable time" is likely to be a challenge, however, because the last thing the Fed wants is for markets to anticipate rate rises too early. One option would be to add a qualifier – a considerable time "unless progress in the labor market is more rapid than anticipated", for example –although that could quickly be become outdated.

Another route would be vague but reassuring language. Mr Rosengren said the Fed should be "patient" about removing stimulus.

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What many officials really want is a way to tie rate rises directly to progress on the Fed's goals of maximum employment and 2 percent inflation.

"My preference is for forward guidance to convey that changes in the stance of policy will be calibrated to the economy's actual progress and anticipated progress toward our dual-mandate goals, and to the speed with which that progress is being achieved," said Ms Mester.

Turning that idea into a usable form of words is a puzzle for the FOMC to solve. What is clear, though, is that a rare spell of quiet at the Fed since its taper of asset purchases began last December is starting to come to an end.