Markets aren’t taking kindly to Wednesday’s release of the minutes of January’s Fed meeting, specifically to indications in the report that FOMC members see new “upside risks” in the economy, and that faster growth and lower unemployment may create the need for even more than three interest rate increases this year.
But perhaps the most interesting part of these minutes was a vigorous debate over the correlation between the unemployment rate and inflation. Once upon a time, there was a pretty clear relationship between the two: A low unemployment rate meant the economy was using up most available resources, thus causing inflation to rise. The cure? Higher interest rates to prevent runaway price increases.
But in today’s global economy, there appears to be no end to the ability of businesses and consumers to keep a lid on prices— whether the result of an increasingly global labor market, or easy online price comparison—and the Fed hasn’t a clue how to respond. The minutes from the most recent meeting show some hawkish board members blaming its decade-long inability to coax inflation to its 2% annual goal on “transitory” factors that will soon clear up, and that higher price growth is just around the corner. On the other side of the spectrum, there were members arguing for abandoning an inflation target altogether, in favor of targeting nominal GDP growth instead (i.e. a combination of real GDP and inflation). This would, theoretically, signal to markets that the Fed would be willing to accept significantly higher-than-2% during periods of slow real growth, like we’re experiencing today.
Specifics of the debate aside, that it is being had at all, and that the poles of the discussion are so far apart, should give investors pause. After all, it’s the Fed’s job to keep inflation and unemployment low and stable, but there is very little agreement on how to achieve this, or why it hasn’t been able to hit its inflation goals thus far.
What this means for markets is difficult to say, because those who are supposed to understand the macroeconomy better than anybody are so divided and dumbfounded as to how it works. By selling off in the immediate wake of the Fed’s minutes released Wednesday, and new FOMC member Randy Quarles hawkish speech in Tokyo Thursday, investors seem to be taking the side of FOMC member Charles Evans, who dissented against the last hike on the logic that the global economy has evolved to constrain the ability of firms to raise prices, and whatever wage gains result from tighter labor markets will simply have to be eaten by firms rather than passed on to customers, trimming margins and hurting equities. Worse still for believers in this framework, that this is the minority view at the FOMC means that the Fed could persist in hiking rates when the economy really needs more patience, risking a central bank instigated recession.
But the other side of the argument, articulated by Quarles Thursday, is that the global economy will soon be cured of its epidemic lack of inflation, and that the American consumer is finally healthy enough to absorb those price increases. Corporate profits, in this scenario, continue to grow with the aid of recent tax cuts, and the stock market continues to head higher.
The bottom line is that the Fed is all but throwing up its hands, and admitting that an increasingly globalized financial system—and market for labor and consumer goods—means that the old rules of monetary policy no longer apply. FOMC members are increasingly relying on their intuition rather than old models like the relationship between unemployment and inflation. Given that there are three empty seats on the FOMC, and an administration in the White House which has contradicted itself time and again on monetary policy, it’s near impossible to know which of these philosophies will win out in the end, and whether the argument that wins the day in the Eccles Building will be what Wall Street really needs.
Christopher Matthews is a writer who splits his time between New York City and Accra, Ghana, with an interest in the intersection of markets, the economy, and public policy. He previously held staff positions at Axios, Fortune Magazine, and Time Magazine, and has been published in Forbes and Debtwire.