Can words take the place of actions? The Federal Reserve hopes so. On Wednesday it issued a policy statement promising to get inflation above 2%. In their accompanying projections, officials indicated that would mean keeping interest rates near zero at least until 2024 and until unemployment falls to 4%.
“This very strong forward guidance, very powerful forward guidance that we have announced today will provide strong support for the economy,” Chairman Jerome Powell told reporters. To drive the point home, he used the word “powerful” 10 times in the press conference.
This forward guidance was a logical consequence of the central bank’s announcement last month that it was now targeting average inflation of 2%. Since inflation is now below 2%, that will mean getting it above 2% and keeping it there for some time to come.
For forward guidance—words, as opposed to policy actions—to work, it has to persuade investors that the Fed will keep interest rates at some preset level, which should then ripple through to other financial prices such as bond yields, boosting economic growth and eventually inflation.
The Fed’s words before Wednesday were having some effect, but you have to squint to see it. Since July, expected inflation has risen modestly and inflation-adjusted bond yields have dropped by a similar amount.
The reason for that modest impact is that with short-term interest rates already at zero and long-term rates below 1%, persuading investors short term rates will stay at zero even longer doesn’t pack a lot of punch.
Mr. Powell insisted the Fed isn’t “out of ammo. We do have lots of tools. We’ve got the lending tools.” That’s putting a brave face on it. It has already exhausted its short-term interest-rate ammo and is buying more than $100 billion of debt per month. That leaves lending, but even that has come up short. Congress and the Treasury provided the Fed with $75 billion of capital to backstop up to $600 billion of loans to small and medium sized businesses, but it has so far lent only about $2 billion.
The Fed’s lending powers are aimed at liquidity crises—to keep fundamentally healthy banks and companies from collapsing because of a temporary shortage of cash. Unlike 2008 when the financial system suffered a liquidity crisis, companies today are facing a solvency crisis: a prolonged collapse in revenue because of the pandemic. Even with Congress covering loan losses, the Fed has to believe it is lending to a solvent company, Mr. Powell noted.
So despite the Fed’s “powerful” words and plentiful tools, Mr. Powell once again pleaded for Congress and the administration to pump more fiscal aid into the economy. The absence of fiscal support “will show up in things like evictions, and foreclosures, and…things that will scar and damage the economy.”
For now, Mr. Powell’s words may prove most powerful not by influencing investors, but by influencing Congress.
Write to Greg Ip at firstname.lastname@example.org
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