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A Note On Fed Communications Policy

 February 24, 2012 06:55 PM

One of the things we try to teach our freshman is the distinction between a change in the economy's equilibrium resulting from a shift of a curve and one resulting from a movement along a curve.

For example, if future interest rates were going to be lower because the Federal Reserve had changed its monetary rule and thus shifted its monetary policy response curve in an expansionary direction, that would make spenders today more optimistic and boost real GDP today.

By contrast, a future interest rates we're going to be lower because the economy in the future was going to be even worse than expected and the Federal Reserve would respond by keeping interest rates low according to its standard monetary policy rule, that would be contractionary.

[Related -The S&P 500’s Worrisome Downturn In Drawdown]

The first would be a promise by the Fed that it would be cheaper to borrow and more profitable to invest in businesses had previously expected. The second would be a warning by the Fed and it would be less profitable to invest in businesses had previously expected because demand was likely to be lower than the forecast.

David and Christina Romers' point in red at the bottom of the last slide in the deck link to in the previous post is that the Federal Reserve's declarations of future policy have all taken the second form, rather than the first,

If the Fed communication strategy is in fact intended to boost the economy today, the Fed is, from the Romers' perspective and mine, simply doing it wrong.

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