Disagreement is mounting at the Federal Reserve over the path of monetary policy, and that stands to reason given uncertainty about the economy’s future. The lags in policy transmission suggest a weaker economy looms, yet inflation is still running at more than twice the Fed’s targetand the labor market remains sturdy. At times like these, history shows that skipping an interest-rate increase at a meeting is a prudent option that policymakers can rally behind.
In recent years, Fed watchers have taken as a given that the central bank would move in steady and regular increments and that, once it stopped doing so, the next step would be a move in the opposite direction. But it hasn’t always worked that way; in fact, former Chair Alan Greenspan regularly skipped increaseswhile managing monetary policy through the 1990s, when the “Maestro” famously engineered the only soft landing in recent Fed history.
That period serves as a useful analogue for today’s Fed. Until recently, most Fed chatter has focused on whether the central bank was close to the end of its policy rate increases,but the Greenspan exampleshows that a temporary hiatusneedn’t signal that policymakers are done — and it’s probably the most sensible course of action.
Then, as now, the rationale for the skip was relatively straightforward. By the summer of 1994, policymakers had raised interest rates by 125 basis pointsand the economic data was inconclusive. It made sense to give the policy moves time to work and wait for more information. Practically speaking, what was the difference anyway? A 50-basis-point move every two meetings is the same as two consecutive 25-basis-pointones, and that’s roughly how the Fed ended up moving from mid-1994 through early 1995.
• July: skip
• August: +50 basis points
• September: skip
• November: +75 basis points
• December: skip
• January: +50 basis points
The comparison to today isn’t perfect,(1)but it’s instructive nevertheless. Greenspan faced much lower observed inflation at the time of his rate increases, yet real gross domestic product was expanding quickly at around 4% in 1994, and economists generally believed that higher and more volatileprices lurked. A Phillips curve analysis — premised on the idea that too-low unemployment tends to pushinflation higher — called for firmer policy, yet Greenspan wasn’t so sure. He was cognizant of the lagged effects of his past policy moves, and he thought subdued growth in credit and the money supply could mean that inflation might defy the Phillips curve logic. Here’s Greenspan waxing poetic at a meeting of the rate-setting committee in September 1994:
I’m beginning to suspect that we are going to find out whether or not the extraordinarily still muted money and credit aggregates really matter. In other words, we are approaching a point where we will get interesting tests as to whether inflation is a Phillips curve phenomenon or a monetary phenomenon.
Throughout the rest of that real-word experiment, Greenspan gave each policy move extra time and observed the data. Eventually, the considerable uncertainty around the economy waned to policymakers’ satisfactionto the extent that they could finally suspend rate increases in early 1995. By the time thatthe Fed pressed pause for the last time in March 1995, markets were celebrating what looked like a soft landing.(2)
In the past couple weeks, a number of officials on the Fed’s rate-setting committee have openly mused about a skip at the next meeting on June 13-14, and the 1990s experience shows that Chair Jerome Powell should take the idea seriously. Here’s Federal Reserve Bank of Dallas President Lorie Logan on May 18 speaking to the Texas Bankers Association in San Antonio:
The data in coming weeks could yet show that it is appropriate to skip a meeting. As of today, though, we aren’t there yet.
And here’s Federal Reserve Bank of Minneapolis President Neel Kashkari on CNBC on Monday:
It’s a close call, either way, versus raising another time in June or skipping. What’s important to me is not signaling that we’re done.
Much like the 1990s, the current period feels a lot like a real-life laboratory for economic theory, and it’s possible to infer a number of stories about the US economy from the data. On the surface, inflation still looks bad, but the breadth of concerning categories is clearlynarrowing, and it’s conceivable that the Fed just needs to give it time. Meanwhile, the extent to whichinflation is a “Phillips curve phenomenon,” as Greenspan referred to it, still isn’t settled.Before the pandemic, even Phillips curve advocateswould have acknowledged that it had become extremely “flat,” meaning the change in inflation for a given change in unemployment was very weak and basically imperceptibleto the naked eye. More recent data seem to suggest it has steepened —the inverse relationship has seemingly become more pronounced —but it’s not entirely clear why. In a speech in March, Federal Reserve Governor Christopher Waller gave an overview of some prevailingtheoriesbut ultimately concluded that the central bank would just have to let the data speak. “We will need more data to conclude which story is right — which is what a data-dependent central bank does to implement appropriate monetary policy,” he said.The next three weeks will bring key data on US payrolls and the consumer price index, and policymakers needn’t pre-commit now to a given policy next month. But knowing what we know now, a skip looks increasingly like the right compromise for the hazy economic outlook. As the committee’s hawks will rightly point out, inflation has proved more stubborn than economists projected earlier this year. The job market, though objectively cooler than it was early last year, has hardly provided much evidence that the Fed’s full employmentmandate is in question.
Yet surveys of banks and small businesses suggest borrowing conditions are poised to tighten soon. Partially as a result, the median forecast in a Bloomberg survey of economists predictsthe economy is heading for two consecutive quarters of contracting real GDPstarting in July. As in the 1990s, policymakers face a considerable challenge as to how much to weight the relatively sanguine story that current economic data seem to tell against concerning forecasts about the future. The Greenspan experience supports moving slowly and trusting the data.
Of course, the Fed’s policy in 1994 and 1995 wasn’t without collateral damage. Among other things, it contributed to Mexico’speso crisis, which required a $50 billion bailout and sent ripple effects across Latin America. What’s more, debates still rage about whether Greenspan truly deserves credit for the 1990s economic boom, as suggested by Bob Woodward’s mostly glowing book, Maestro: Greenspan’s Fed and the American Boom.Or maybe he was the beneficiary of good economic luckin a decade marked by fewer economicshocks than other Fed chairs have faced, as economist Greg Mankiw has pointed out.
Either way, Powell is probably going to need a measure of good fortune himself to replicate Greenspan’s soft landing in today’s uncertain economy. He can help his chances by considering a skipat the next policy meeting and leaving some room for luck to come his way.
More From Bloomberg Opinion:
• Biden’s Fed Pick Is Not What the Economy Needs: Allison Schrager
• Reading the Entrails for a Fed Pause Versus Cuts: John Authers
• Predictably Bad Inflation Gives Fed a Breather: Jonathan Levin
(1) To be sure, Fed communication was still drastically different in 1994 and slowly evolving. In February of that year, the Fed had just begun issuing statements with policy decisions, but they were extremely terse. If no change was made, no communication would be issued. Until 1994, it was also common for the Fed to change the target between meetings.
(2) A number of members of the committee had already agreed by March 1995 that a soft landing was looking more likely. But Greenspan was cautious about fanning too much optimism in markets. He said: “We are looking at the possibility that there is an element of euphoria about a soft landing that probably mitigates against it happening.”
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Jonathan Levin has worked as a Bloomberg journalist in Latin America and the U.S., covering finance, markets and M&A. Most recently, he has served as the company’s Miami bureau chief. He is a CFA charterholder.
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