By John Kell and Alan Murray
March 30, 2016

If the U.S. economy is doing fine, why has the Federal Reserve pared back plans for interest rate hikes this year?

 

That’s the question Columbia Business School Dean Glenn Hubbard asked Fed Chief Janet Yellen after her speech to the Economic Club of New York yesterday. It’s a question that’s been banging about financial markets in recent days. Has the Fed’s economic outlook changed? Or if not, has its “reaction function” – how it reacts to economic data – changed?

 

Neither, said Yellen. Her explanation is that slower growth overseas caused market disruption early this year, which led market participants to assume the Fed would slow rate increases, which drove down market interest rates, which helped stabilize markets and keep the Fed’s economic outlook largely intact. Follow that? “That may look like a shift in the reaction function,” she said, “but it really isn’t.”

 

The bottom line is that the Fed has turned a bit dovish. The funds rate is now expected to end the year at 0.75%, rather than 1%, even though the Fed’s economic outlook is largely unchanged. (Fortune’s Chris Mathews thinks the Fed is still overstating the risk of inflation. Read his analysis here.)

 

Yellen’s carefully scripted message, delivered to a ballroom packed with financial executives, cheered global markets. One ebullient economist told Bloomberg it was “her best performance since she has been chair.” Her effort to be transparent and about the central bank’s ever-changing intentions shows how much Fed-speak has evolved since I was a cub reporter three decades ago, when I chased down Paul Volcker to ask about rumors that the Fed was intervening in currency markets and was told: “We did what we did, we didn’t do what we didn’t do, and the result was what happened.”

 

Separately, former Fed Vice Chair Alan Blinder asked Yellen yesterday why U.S. productivity growth – which ultimately drives growth and living standards – has been a slim 0.5% for the past five years – far below historical averages. “It’s a source of huge concern,” she said. “We really don’t know.” That’s an honest answer.

 

Alan Murray
@alansmurray
alan.murray@fortune.com

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