Body
By the standards of recent Federal Open Market Committee (FOMC) meetings, today's meeting and press conference were packed with interesting news. The main policy action was a widely expected increase in the federal funds rate by 0.25 percent to a range of 1.00 to 1.25 percent. Three other items were less expected.
First, Chair Janet Yellen pointed to "one-off" price reductions in mobile phone service plans in March as the main reason the FOMC's preferred measure of inflation has moved away from its 2 percent target to 1.5 percent as of April.1 She also mentioned declines in pharmaceutical prices. Is the FOMC revisiting the bad old days of the 1970s, when it tried to explain away inflation that was too high by pointing to a seemingly endless stream of one-off factors? The Fed's preferred measure, core personal consumption expenditures (PCE) inflation, already excludes volatile food and energy prices. We certainly do not want to get on the slippery slope of excluding ever more categories with price movements the FOMC does not like.
A quick check of my own preferred gauges—nominal GDP growth and inflation as measured by the GDP deflator—provides some reassurance that the FOMC is not ignoring deflationary pressures. GDP includes all economic transactions and is thus broader in scope than core PCE. The first-quarter estimate of GDP includes the mobile phone price drop in March, yet GDP inflation was 2.0 percent and nominal GDP growth—which effectively adds growth and inflation—was 4.1 percent. Both numbers are right where the FOMC wants to see them to be consistent with trend growth of around 2 percent and target inflation of 2 percent. Moreover, the declines in bond yields and the dollar over recent weeks should support growth and inflation going forward, suggesting that the FOMC decision to continue its gradual normalization is a reasonable one.
Second, the FOMC announced the details of how it would begin to gradually shrink its balance sheet and said the process likely would start sometime this year. In response to a question, Yellen went a bit further and said the process might start "relatively soon" if data come in as expected. Yellen refused to say whether the FOMC would hike rates and start the balance-sheet runoff at the same meeting. My own guess is that the balance-sheet runoff may begin in September and another rate hike may wait until December, assuming the economy lives up to the forecast.
Third, Yellen was asked about a letter signed by several economists—including me—asking the FOMC to consider a higher inflation target or a change in its policy framework to avoid undershooting the current target as it has over the past few years. Yellen was surprisingly open to this suggestion, saying that it was a very important issue that the FOMC would be studying. She welcomed the contributions of outside researchers.
Note
1. As is standard, growth and inflation rates in this post are based on 12-month or 4-quarter changes. Data are from the Bureau of Economic Analysis.
