“If financial-market conditions do not tighten much in response to higher short-term interest rates, we might have to move more quickly. In contrast, if financial conditions tighten unduly, then this will likely cause us to go much more slowly or even to pause for a while.” NY Federal Reserve President Dudley, April 6 2015.
At first, this sounds like a reasonable statement. Think twice, and the statement is absurd. If Dudley’s comments truly reflect the US Federal Reserve’s approach to policy then it is a rudderless, reactive functionary which is afraid to keep the markets informed. Let me elaborate…
First, and foremost, Dudley fails to tell us exactly what the Fed wants. One of the key underpinnings of modern finance is informational efficiency – that is, the ability for financial markets to accurately reflect the fair values of asset prices, instantly and without the necessity for any trading at all. Dudley could easily have said that the Fed’s objective, for example, is to see a 1% cash rate in one year’s time and a 3% 10 year bond yield. That would have been something solid that the markets could kick around and digest. But he didn’t do that. Instead, he elected to threaten the markets for under/over shooting the Fed’s objectives, without telling us what those objectives are. WHAT ARE WE, MIND READERS?
Second, this sounds like experimental, reactive policy rather than a confident, rule based one. “Lets raise rates by 15bp and see what happens…”. Surely, someone, somewhere in the Fed has a policy benchmark to measure what their desired effect is going to be? If so, why not tell us?
Or is the Fed just going to raise rates for the sake of it? Because it ‘feels right’? If the cart isn’t broken, don’t fix it.
Its time for some openness and honesty on the part of our policymakers. If they don’t know what they are doing, just tell us..