MW Memo to the Fed: Focus on inflation, not the stock market

By Peter Morici

Officials' speechmaking can get in the way of effective policymaking

Catering to the stock market, instead of pursuing its stated goal of getting inflation to 2%, is not what the Fed should be doing.

The U.S. Federal Reserve has a tough job - and the way it communicates with the markets only makes it tougher.

Financial markets closely watch Fed officials' testimony, frequent speeches and public statements to discern how the consensus may be evolving and anticipate future interest-rate decisions.

Unfortunately, all this Fed speechmaking can get in the way of effective policymaking.

The Federal Open Market Committee (FOMC), consisting of the governors and regional-bank presidents, has a mandate to accomplish price stability and maximize employment. According to former Fed Chair Alan Greenspan, "Price stability is that state in which expected changes in the general price level do not effectively alter business or household decisions."

A tolerable pace of inflation is not so high that households accelerate major purchases, and not so low that businesses fear deflation that would make debt service too burdensome.

Central bankers in major advanced economies have settled on 2% inflation as a reasonable target. In 2020, the Fed indicated it would tolerate periods above 2% to compensate for periods below that level, but the Fed seems challenged to bring inflation down to 2%.

Price stability encourages sound investment decisions. Getting U.S. inflation to 2% and keeping it there would foster healthy jobs growth and stronger stock-market performance.

Communication breakdown

In an effort to accomplish price stability, the FOMC regulates access to credit by adjusting the federal-funds rate. It encourages prudent household, business and investor decisions through forward guidance about anticipated policy changes.

After its eight rate-setting meetings each year, the FOMC issues a consensus statement about its reasoning. At every other meeting, it publishes anonymously the individual forecasts of its 19 members for annual GDP growth, unemployment, inflation and fed-funds rate.

Much happens between meetings - unexpected changes in data about employment, inflation and GDP - and the Fed repeatedly states that decisions will be based on incoming data.

This creates an obvious tension between forward guidance and ultimate FOMC decisions. At its September and November meetings, for example, the FOMC cut the fed-funds rate by a half-point and one-quarter point, respectively. Fed Chair Jerome Powell and committee members made clear that the economy was on track to accomplishing 2% inflation and established the expectation that they would further cut interest rates.

Then, at the Dec. 17-18 meeting, the FOMC raised its median forecast for consumer price inflation for 2025 to 2.5% from 2.1%. Clearly, the consensus of the committee was that inflation was headed higher. Yet members voted to lower interest rates another quarter-point, so as not to disappoint investors who were still expecting a rate cut.

Such talk seriously influences the direction of stock prices. Catering to the stock market, instead of pursuing its stated goal of getting inflation to 2%, is not what the Fed should be doing.

The problem is there is no single Fed voice other than the statement issued at the conclusion of meetings, and FOMC members disagree a lot. Forecasts for 2025 inflation currently range between 2.1% and 3.1%. Consensus on where the federal-funds rate should be with 2% inflation ranges between 3.9% and 2.4%.

FOMC statements and Powell consistently remind that future Fed decisions will be governed by incoming data. That clearly did not apply in December. The Fed damaged its credibility by raising expectations for inflation, yet moving policy in a contrary direction to avoid rattling the stock market. Despite a full percentage-point cut in the federal-funds rate since last September, yields on both the 2-year BX:TMUBMUSD02Y and 10-year BX:TMUBMUSD10Y Treasurys - which are influenced by expectations for future Fed policy - are actually up about 0.7% and 1%. That indicates investors' skepticism about the Fed getting inflation to 2%.

Examining recent U.S. inflation data, prices for goods - many of which are imported - have been falling, with China and much of Europe in a funk. But prices for services minus shelter, which are largely determined by domestic demand and labor-market conditions, have been rising at an alarming pace - about 4.1%.

President Trump promises curbs on immigration, tax cuts and tariffs. However far he goes, these policies will tighten labor markets, raise aggregate demand and make getting U.S. inflation down to 2% even tougher.

The Fed has initiated its quinquennial review of monetary policy strategy, tools and communications. Central bankers should set a hard goal for inflation to be at or below 2%, publish FOMC forecasts for inflation and other economic indicators after each meeting, detail decisions to change or leave unchanged interest rates - and do a lot less public speaking.

Peter Morici is an economist and emeritus business professor at the University of Maryland, and a national columnist.

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Plus: Trump's tariffs and tax plans are inflationary. Voters won't tolerate it.

-Peter Morici

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February 18, 2025 07:05 ET (12:05 GMT)

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