Monetary Policy May Be Already Tightening

Ben Bernanke
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Ben Bernanke

Our survey of Wall Street economists reveals that expectations about monetary policy have been shifting.

Last month, the survey found that Wall Street expected the Fed to halt asset purchases when the unemployment rate reached 6.5 percent. The expectations in the latest survey rose to 6.8 percent.

That could be because since the December survey the Fed provided more guidance in its monetary policy statement, pegging a 6.5 percent unemployment rate to interest rate hikes. This suggests to markets that the end of asset purchases would be somewhere above that unemployment rate.

The market also sees the Fed halting assets purchases at a 2.6 percent inflation rate, down from 3.4 percent in the prior survey.

This is extremely important because the Fed is now heavily reliant on what Ben Bernanke describes as "signaling." That is to say, the Fed believes it can change economic behavior by using its public statements to change expectations about policy moves.

Here's how Bernanke put it last year in Jackson Hole:

Clear communication is always important in central banking, but it can be especially important when economic conditions call for further policy stimulus but the policy rate is already at its effective lower bound. In particular, forward guidance that lowers private-sector expectations regarding future short-term rates should cause longer-term interest rates to decline, leading to more accommodative financial conditions.

Bernanke also noted that one of the effects of Fed asset purchases is to "signal that the central bank intends to pursue a persistently more accommodative policy stance than previously thought, thereby lowering investors' expectations for the future path of the federal funds rate and putting additional downward pressure on long-term interest rates, particularly in real terms."

What seems to have happened over the course of the past month is that expectations have shifted in a slightly more hawkish direction on unemployment and a far more hawkish direction on inflation. That is to say, Wall Street now believes that the central bank will pursue a less accommodative policy stance than previously thought, which puts pressure on longer-term rates to rise. In other words, we're already in a tightening phase as far as signaling is concerned.

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