Discretion in action
Understanding the Fed’s inaction
This week the Fed stood pat on their interest rate target. For some, such inaction may have been a surprise. Real GDP contracted last quarter and inflation has not, as of yet, shown signs of increasing (at least not on a widespread scale).
Given those macroeconomic data readings, it was not unreasonable to expect that the Fed might lower their interest rate target. Last September, they cut their interest rate target by 50 basis points. They did so after real GDP had expanded the first half of 2024, while inflation had stayed calm, on average. At the time, Macrosight guessed the Fed might make a cut, but was still surprised by the size of it.
However, negative GDP growth notwithstanding, as anyone watching the economy is aware, both markets and policy makers alike have been spooked by the uncertainty surrounding tariff policy. The Fed, in fact, cited exactly that in their press release, and Jerome Powell affirmed as such in his press conference.
In the former, the Fed noted that,
“Uncertainty about the economic outlook has increased further. The Committee is attentive to the risks to both sides of its dual mandate and judges that the risks of higher unemployment and higher inflation have risen.”
The key phrase in the above quote is dual mandate. That, dear readers, is the guiding light of monetary policy. How the Fed responds and attempts to execute that dual mandate is a function of history, trial and error, and discretion.
For those interested in that history, trial and error, and use of that discretion—all the basis for the Fed’s decision this week—this post collates a number of Macrosight posts on the topic of the Fed and monetary policy.
To understand the Dual Mandate, check out “The Fed’s Conundrum,” and “Why does the Fed get to manipulate the Economy?”
To understand why the Fed has the independence to carry out the Dual Mandate, read about “The Werewolf Problem,” and “Street ‘Cred.”
To understand how the Fed uses their discretion in doing so, read “The Phantom Menace.” To get a sense of the pros and cons of the Fed using their discretion, read “The Great Moderation vs The Epic Fail,” and “The First Rule of Monetary Policy.”
If you want some background on the persons entrusted with this process, check out “Who is the Fed.”
And finally, to understand some of the ins and outs of monetary policy, read “Hacking the Fed’s Forecast of GDP;” “Why the interest rate, Fed?;” and “PCE, you complete me.”