Hello Discretion

Today, the much-anticipated first Fed policy statement of the Yellen era came out. FOMC statement, here.

Some interesting tidbits:

The Committee will closely monitor incoming information on economic and financial developments in coming months and will continue its purchases of Treasury and agency mortgage-backed securities, and employ its other policy tools as appropriate, until the outlook for the labor market has improved substantially in a context of price stability. ... asset purchases are not on a preset course, and the Committee's decisions about their pace will remain contingent on the Committee's outlook for the labor market and inflation as well as its assessment of the likely efficacy and costs of such purchases. 

In determining how long to maintain the current 0 to 1/4 percent target range for the federal funds rate, the Committee will assess progress--both realized and expected--toward its objectives of maximum employment and 2 percent inflation. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments. 

With the unemployment rate nearing 6-1/2 percent, the Committee has updated its forward guidance. 

In other words, the committee will do whatever it feels like doing, whenever it feels like doing it, based on whatever information it decides is relevant. The Committee updated its forward guidance by throwing it under a bus, or at least by clarifying that it is of the form "here is what we think now we will want to do in the future, but we can change our minds at any time."

The larger context is the debate between commitment or rules and discretion. Discretion wins.

You might expect me to be fulminating. I'm not. (Though I'm waiting for a rules vs. discretion blast from John Taylor! (Update: here it is.)  I regard this as simply stating reality.

Our Fed will operate with complete discretion. On this basis, I was pretty critical two years ago of various proposals that the Fed announce ex-ante that it would keep interest rates lower for longer than it would desire ex-post; to just state some new "rule" or "commitment" that would lower interest rate expectations. I argued, there is no way anyone will believe such a purely voluntary commitment. If it's going to be full discretion, we might as well be upfront about it and stop the charade. Rules where every day is a special exception are not rules. If it's going to be a rule, setting one up requires a lot more than just FOMC statements and "guidance."

Voting against the action was Narayana Kocherlakota, who supported the sixth paragraph, but believed the fifth paragraph weakens the credibility of the Committee's commitment to return inflation to the 2 percent target from below and fosters policy uncertainty that hinders economic activity.

Narayana is always interesting. The fifth and sixth paragraphs are the ones I quoted above. Narayana wants more rules and commitments. But... from the dovish side!  He's worried people don't know the Fed wants more inflation.

But he is right. The problem with full discretion is that it's a lot harder to "anchor" expectations. The Fed is going to dig itself deeper and deeper into this world in which markets hang on every whisper. Maybe full bore discretion isn't such a good idea after all.

 Fiscal policy is restraining economic growth,

This must be a joke. Oh, no, I get it, the Fed has woken up to the growth-sapping effects of high marginal tax rates and a chaotic code. I wish.