Wednesday, August 18, 2010

How Confident Should You Be That the Fed Knows What It Is Doing?

As Michael Derby points out, up, down or sideways, you can find someone at the Fed holding your view:
Kansas City Fed President Thomas Hoenig continues to believe rates need to rise, which leaves him in opposition to the decision made just over a week ago to maintain the size of the Fed’s balance sheet. St. Louis Fed President James Bullard, meanwhile, has talked of going even further than what’s been done thus far, suggesting the Fed could again expand its balance sheet if the recovery falters further. Minneapolis Fed leader Narayana Kocherlakota thinks it’s all a tempest in a tea cup, describing the Fed actions as technical and misunderstood by markets as a sign of growing worry over the outlook.
What this means is that the Fed operates by the seat of its pants. There is no coherent theory by which the Fed operates. The members just watch the data and react to it. During a period like the present when there appears to be conflicting signals, different Fed members focus on different data and, viola, you have conflicting policy talk all over the Fed.

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