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Here’s What Needs to Be Fixed at the Fed

Board Of Governors Of The Federal Reserve System Holds Open MeetingBoard Of Governors Of The Federal Reserve System Holds Open Meeting
Janet Yellen, chair of the U.S. Federal Reserve, right, gives the stink eye to Stanley Fischer, vice chairman of the U.S. Federal Reserve.Photograph by Andrew Harrer—Bloomberg

Federal Reserve Chair Janet Yellen will give a speech Friday on the state of the “monetary policy toolkit,” during the Kansas City Fed’s annual symposium at Jackson Hole.

Of course, Yellen’s speech will itself be a tool in that toolkit, as Fed communication policy has been a strategy that the Yellen Fed, like the Bernanke Fed before her, has increasingly relied on to help guide the American economy.

But central bank watchers are growing more concerned that internal divisions at the FOMC will start to dilute the power of Fed communication, and even sew confusion that might ultimately harm growth.

Neil Dutta, Chief Economist for Renaissance Macro Research says that these divisions are apparent in a speech given by Yellen’s vice Chair, Stanley Fischer on Sunday. In a research note to clients, Dutta pointed to Fischer’s assertion that “monetary policy is not well equipped to address long-term issues like the slowdown in productivity growth,” as evidence that he was at odds with Yellen’s view of the economy.

While Fischer was putting forth the theory that weak productivity growth is the fault of a lack of innovation, a problem that the central bank can’t solve, Yellen “sees a greater role for monetary policy to boost productivity.” He continues:

If she thinks that productivity is the result of weak capital investment in response to weak expectations of future growth than policy can aim to run the economy hot to promote more capital spending. This can in turn boost productivity in the longer run. We suspect Yellen strikes a more dovish tone relative to Fischer at her upcoming Jackson Hole speech.

Vincent Reinhart, Chief Economist at Standish Mellon, agrees that there are signs of disunity among FOMC members. He argues that Janet Yellen is a “reluctant warrior” whose instinct is to keep rates lower for longer but can be “slowly and fitfully” convinced to continue with rate hikes if enough of her fellow board members demand it.

And it appears to Reinhart that FOMC members like Fischer and William Dudley are doing just that. Following the release of the last FOMC meeting minutes these officials raised concerns about the fact that the market was placing such a low probability on the Fed raising rates again this year, despite the Fed indicating the contrary. “That suggests to me that Yellen has not put her stamp on a specific policy plan for the remainder of the year and they are trying the case in public to get her to commit,” says Reinhart.

The problem with this debate occurring in public is that it undercuts the theory of using frequent communication with the public as a means for amplifying the effect of policy. An divided FOMC, playing out those divisions with public speeches, is only going to confuse market participants, with each clinging the words of board members whose views align most closely with their own.

We may already be seeing the results of this confusion with the evidence that the Fed funds futures markets do not believe that there will be another rate hike this year, despite the Fed’s continued signalling that there will be. And while that might not be a problem just yet, as inflation remains low despite monetary policy being a bit looser than what the Fed is aiming for, there’s no guarantee that this will always be the case.

In other words, Janet Yellen might need to wrangle more than just market participants with her speech Friday, but also round up her fellow board members and convince them to speak with a unified voice.