Fault Lines Are Growing at the Fed

(Bloomberg View) -- Don't be fooled.

Janet Yellen's next to last meeting as chair of the policy-making Federal Open Market Committee was anything but a nonevent and foreshadowed tensions to come.

Granted, the Federal Reserve acted as expected, nudging up its benchmark rate by a quarter point and keeping its projections for three increases next year. Fed officials also didn't anticipate a massive boost to the American economy from tax cuts likely to pass Congress soon. And that is fine. One of the pluses of this often maligned eight-year expansion is its solid-but-steady nature. That's given it durability.

But just under the surface, changes to the Fed's labor-market forecasts and renewed dissent by a long-time dove showed fault lines growing ahead of Jay Powell's term as chair, which will begin early next year. (He needs to be confirmed by the Senate as Yellen's successor; that is a done deal.)

Let's take jobs first. The Fed has rightly taken some flak for overly optimistic forecasts since the economy began growing again. One area where it hasn't been optimistic enough is unemployment, which grinds lower year after year. The FOMC said in its projections Wednesday that the jobless rate will decline to 3.9 percent next year and hold that level in 2019. It's 4.1 percent now, already below the level the Fed considers sustainable in the long run. 

Even 3.9 percent looks pretty conservative at this point. But it's the direction that's important. It's not unreasonable to think that the rate could close in on 3.5 percent next year, and there's got to be a chance that a labor market that tight starts to generate enough inflation and wage growth to make a difference. If that's the case, just three interest-rate moves next year seems a little timid. Watch for the famous dots to start signaling four hikes next year.

That said, inflation has defied projections pretty consistently. Yellen famously called its relative absence a “mystery,” a term Powell quietly used a little earlier. Some doves at the Fed have sounded increasingly concerned this year as price increases have actually retreated from the central bank’s 2 percent target. The explanations offered – such as changes to cell-phone and drug pricing -- aren't really convincing this crowd. This week, Chicago Fed President Charles Evans cast a dissenting vote reflecting that skepticism, joining Neel Kashkari. 

Kashkari has consistently voted against rate increases, but Evans held his fire until now. True, Evans has long been considered a dove, but saying nay in the last meeting of the year sends a signal. Although Evans doesn't vote on the FOMC next year, symbolism is everything. He may reflect a new sense of activism among the central bank's dovish wing. 

Let the 2018 debate be joined. Dissent is a good thing: Groupthink in important institutions is never healthy. Jay Powell, the first chair in a while without a PhD in economics, may be just the person to adjudicate. In any case, he will own the results.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Daniel Moss writes and edits articles on economics for Bloomberg View. Previously he was executive editor of Bloomberg News for global economics, and has led teams in Asia, Europe and North America.

To contact the author of this story: Daniel Moss at dmoss@bloomberg.net.

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