Everything we thought we knew about the Fed just changed
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On Wednesday, the Federal Reserve kept interest rates at 0.25%-0.50%. The Fed also cut its outlook for the economy and the future path of interest rates.
But it is this final projection, the so-called dot plot, that caught the attention of economists and Fed-watchers alike.
Notably, this plot contained two mysterious dots that forecast just one additional rate hike for the Fed over the next two years.
Other forecasts called for as many as a dozen rate hikes over the next couple years.
And on Friday, the identity of the low dot was revealed: St. Louis Fed president James Bullard.
But revealing the author of the dot (who also declined to give a forecast for rates over the longer term), is not nearly as big a deal as what the St. Louis Fed said in a paper outlining its new framework for understanding policy forecasts.
And with Bullard putting two outside-the-box projections on the latest dot plot, we now know someone inside the Fed will be advocating for an entire rethink of how the Fed conducts policy.
Here's the St. Louis Fed (emphasis mine):
The hallmark of the new narrative is to think of medium- and longer-term macroeconomic outcomes in terms of regimes. The concept of a single, long-run steady state to which the economy is converging is abandoned, and is replaced by a set of possible regimes that the economy may visit. Regimes are generally viewed as persistent, and optimal monetary policy is viewed as regime dependent. Switches between regimes are viewed as not forecastable.
So whereas traditional monetary-policy forecasts assume a single terminal interest rate the policy goals should strive for, the St. Louis Fed's framework says all we can know is what kind of current economic regime we're under and target a terminal rate accordingly.
In other words: All we know is what we know, the future is inherently uncertain, and most significantly, there is no natural state of the economy.
In the St. Louis Fed's world of 2% output, unemployment rates roughly unchanged from current levels, and inflation edging up toward the Fed's 2% target but only slowly, benchmark interest rates simply will not need to go but 0.25% higher from here.
The near-term impact here is obvious: The Effective Fed Funds rate is unlikely to go higher rendering all this talk about when the Fed will raise rates next more or less moot.
Again, on Wednesday the Fed did cut its outlook for future interest-rate increases significantly, but the upshot of St. Louis Fed's analysis is that this doesn't really matter. All that matters is what regime we're in. And right now, that regime means lower rates.
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