The Fed's Messaging Dilemma : Planet Money Right now the economy looks good, but inflation is lower than the Federal Reserve would like. A future rate cut could juice prices, but the messaging has to be right.
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The Fed's Messaging Dilemma

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The Fed's Messaging Dilemma

The Fed's Messaging Dilemma

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CARDIFF GARCIA, HOST:

Hey, everyone, it's Cardiff. Real quick before today's show - NPR experienced a technical glitch that affected a lot of its podcast feeds, including the feed of THE INDICATOR yesterday. It is in the process of fixing that glitch, so please don't unsubscribe. Don't go anywhere. It'll be resolved shortly. Thanks for listening, and now on with today's show.

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STACEY VANEK SMITH, HOST:

Hey everyone. Cardiff and Stacey here. And we know - we just know - that you cannot wait to discuss interest rates and what Federal Reserve chair Jerome Powell said today at the end of the two-day meeting of the Federal Open Market Committee, or just the FOMC, which is kind of like FOMO except nobody really worries about missing out on it. The FOMC is the committee within the Fed that meets every six weeks to vote on how to manage the economy.

GARCIA: Oh, the anticipation.

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JEROME POWELL: We reviewed economic and financial developments in the United States and around the world and decided to leave our policy interest rate unchanged.

GARCIA: OK. Look; the tone and the language used by chair Powell are not super excited.

VANEK SMITH: By design?

GARCIA: Yes, on purpose because the language does matter. See; the Fed is in kind of a tricky situation not because of what's happening right now but because of what might happen for the rest of this year.

VANEK SMITH: Today on THE INDICATOR from Planet Money, we speak to someone who used to be a member of the Fed. And she explains why, if the Fed wants to navigate its way out of this tricky situation, it will have to choose its words so very carefully.

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VANEK SMITH: The Federal Reserve manages the economy by adjusting interest rates. So, for example, if the Fed wants to boost the economy, it will lower interest rates so people will take out more loans because interest rates are cheaper. And then they'll use that money from those loans to buy things, like houses or cars, and that boosts the economy.

GARCIA: And here is what the Fed is dealing with right now. On the one hand, unemployment is relatively low at the moment, and the economy is growing at a healthy pace. So you would not think that the Fed would be planning to boost the economy any more than it already is. And in fact, the Fed chose today not to further boost the economy. It kept interest rates right where they are.

VANEK SMITH: On the other hand, the Fed is also responsible for keeping inflation going up by 2% a year - not much lower than 2% percent and not much higher. It's like their Goldilocks number.

GARCIA: Sweet spot.

VANEK SMITH: And normally, when the economy is growing fast enough and unemployment is low enough, you would expect inflation to also be rising because when the economy is growing, it means the people have jobs and more money to buy things. And so they start spending more money, and then prices of those things go up a little. That's inflation.

GARCIA: But since the middle of last year, even though the economy has been growing, inflation has been falling. And it is now well below the Fed's 2% target. In fact, let's make that the Planet Money indicator. Inflation right now is rising at 1 1/2 percent. Maybe that falling inflation is just a blip and it'll start going back up later in the year. But if it does not start going back up towards 2% - and remember, it is the Fed's job to make sure it does get back up to 2% - then the Fed would have to consider boosting the economy even more to bring inflation back up.

VANEK SMITH: And so now we can discuss the Fed's dilemma. If the Fed is not careful in explaining why it is boosting an economy that already seems to be healthy, it could send a confusing message to the public. It might even backfire. So we called up someone who understands how this all works firsthand.

SARAH BLOOM RASKIN: I am Sarah Bloom Raskin. I was a governor on the Federal Reserve Board and the Federal Open Market Committee. I am currently a Rubenstein fellow at Duke University.

VANEK SMITH: Sarah was on the Federal Reserve from 2010 to 2014. And as a governor, she was one of the people at the Fed who always voted on monetary policy. And she said there are a bunch of different ways that the public might interpret a Fed decision to boost the economy later this year.

RASKIN: So the communication becomes critical. How does the Fed talk about a rate cut? Why exactly is the Fed doing it? How are they going to communicate the reason for that move? And the words they choose are going to be really important in determining what path the economy actually takes.

VANEK SMITH: This communication happens in press conferences like the one today with chair Powell and also in speeches that members of the Fed give to the public. That communication influences how the public interprets any decision made by the Fed.

GARCIA: And in our conversation with Sarah, she identified four different ways the public might interpret a decision to further boost the economy. First, the public might think that the Fed is panicking, that it is boosting the economy because it thinks the economy is about to collapse.

RASKIN: And I think if the Fed were to take such an action, that could itself unsettle markets and potentially tip the economy into a place that the Fed didn't intend it to go.

GARCIA: And what she means is that if people start believing that the economy is in trouble, it could become almost like a self-fulfilling prophecy. People stop spending money because they want to make sure they have enough money to hold them over during the upcoming hard times. But if everyone stops spending money all at once, that will itself bring on the hard times because the economy needs people to spend their money in order to keep going. Obviously, the Fed would like to avoid this particular interpretation of its decision.

VANEK SMITH: The economy is a flat circle.

GARCIA: (Laughter) Yeah.

VANEK SMITH: Which brings us to the second possible interpretation - that the Fed is boosting a healthy economy just in case things get bad later, especially since any decision by the Fed normally takes a little while to affect the economy.

RASKIN: Monetary policy acts with a lag. It doesn't act immediately. So these people are going to say let's lower rates now because we're going to be getting into choppy waters later.

VANEK SMITH: So that is the second interpretation. If the Fed decides to boost the economy later this year, it's not because the Fed is panicking but because it wants to pre-empt a recession before it can start.

GARCIA: The third possible interpretation basically is why not? Why not boost the economy? So what?

VANEK SMITH: Woo.

GARCIA: Yeah.

VANEK SMITH: Let's see what this baby can do.

GARCIA: Yeah. Who cares if it's already growing fast? Let it keep growing even faster. That would be great. It means more jobs. It means more people getting raises. Remember; it's been a long slog since the recession ended in 2009. And since inflation is too low anyways, boosting the economy would be perfectly consistent with the Fed's job. It's not like boosting the economy a little more will send inflation skyrocketing way above the Fed's target. And Sarah at least thinks that is a plausible case.

RASKIN: I think that is a completely appropriate argument, one that is absolutely possible and that there is space, actually, for more stimulation to occur and that that stimulation can happen without doing anything super dangerous to the inflation rate.

GARCIA: And finally, there is a fourth way that the public might interpret a decision by the Fed to stimulate the economy. And that is that the Fed caved to political pressure and specifically political pressure from President Donald Trump. See; the president has aggressively called for the Fed to cut interest rates and stimulate the economy because, of course, he wants his presidency associated with a super strong economy.

VANEK SMITH: But the Fed is supposed to make decisions based only on what is good for the economy, not on what is good for a politician or a political party. And so traditionally, the president does not comment that much on monetary policy. President Trump has broken with that tradition, and it means that the Fed will have to convince the public that it is not being influenced by the president's words, that it is still acting independently.

GARCIA: How do you think you would have responded to it if some kind of pressure like this had been coming from the White House while you were on the FOMC?

RASKIN: Well, we would try very hard to not respond to it.

VANEK SMITH: So basically, the Fed will try to tune out the president, but more importantly, it will need to convince the public that it has tuned out the president.

GARCIA: So, look; this is all still hypothetical, but if inflation remains low or even goes lower, the Fed eventually will have to decide whether or not it wants to stimulate the economy by lowering interest rates. The message coming from the Fed, if it does make that choice, will have to be crystal clear because, as Sarah points out, just lowering rates might not be enough. How the Fed explains its decision will matter, too, because rates are not the only tool that the Fed has for managing the economy. Its other tool is the language it uses. And like any tool, it can be used, and it can be misused.

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GARCIA: This episode of THE INDICATOR was produced by Darius Rafieyan and edited by Paddy Hirsch. Our intern is Willa Rubin, and THE INDICATOR is a production of NPR.

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