Greg Ip has an article in today's Wall Street Journal (page A2) that kindly explains what the Federal Open Market Committee is really up to. Here's the skinny.
If the Federal reserve raises interest rates next week as expected, it will be nearing completion of the first stage of what appears to be a two-stage campaign to return interest rates to normal levels.
In the first phase, the Fed is moving to quickly raise the federal-funds rate target from the "emergency" level of 1%, where it stood for a year through June and was the lowest in 46 years. The objective is to push the rate to a still-low, but no excessively so, level -- probably 2%...
In the second stage of tightening monetary policy, the Fed will seek to raise the federal-funds rate to a more neutral level -- probably between 3% and 5% -- where it neither stimulates nor restrains growth. But the pace of its increases will be more subject to new economic data, in particular the impact of oil prices.
Hmm. That sounds pretty sensible. In fact, sounds a lot like my boss:
What do I mean by “neutral”? Well, in simple terms this means a federal funds rate that is no longer either accommodative or restraining.
Ip, does in fact, quote from the speech -- which I also referred to an earlier post -- that contains the preceeding quotation:
...Sandra Pianalto, president of the Federal Reserve Bank of Cleveland, said Friday: "I am convinced that the current 1.5% funds rate lies below neutral," which she puts at 3% or 5%." (Bold emphasis added)
Oops. Almost. I think the part that I bolded is a bit misleading. Here's is exactly what she said:
There is not one specific value for the federal funds rate that always equals a neutral policy stance. It’s a little like aiming at a moving target, and one that can seem a bit blurry at times.
The neutral range for the federal funds rate during the next several quarters and beyond will depend on how economic conditions unfold, but our experience suggests that during extended periods of reasonably sound and sustained economic performance, the neutral federal funds rate will almost certainly be above today’s level of 1.5 percent.
In fact, historical experience suggests that when our economy is operating soundly and when resources are at high levels of capacity utilization, the neutral range is likely to be 3 to 5 percent. (Emphasis added)
So what's the difference between what President Pianalto said and Ip's interpretation? Ip seems to suggest that our position is that neutral is currently in the 3% to 5% range. Our position is actually that it is likely that neutral will eventually rise into that range. How fast we get there will, of course, "depend on how economic conditions unfold."
Glad I could clear that up.