The subtle sport of Fed-watching
Anticipating the March FOMC minutes
The FOMC, the Fed's policymaking committee, meets eight times a year. At the end of each meeting, the US central bank publishes a statement on monetary policy, and three weeks later it releases the minutes of the meeting. I read these minutes when they come out, but I don't always read them in the same way. Sometimes there are technical details that others gloss over; other times the minutes give important context only in a compressed form, a form that can usefully be expanded.
The FOMC met on January 25–26, and at that point the plan was this: raise interest rates in March, then start contracting the balance sheet. One month later, Russia invaded Ukraine, destabilizing interpretations of political-economic conditions: suddenly the arrangement of the global monetary system is up for discussion in a way it had not been. At the next meeting, March 15–16, the FOMC went ahead with the interest rate increase. Tomorrow, the minutes of that meeting will be released.
This time around, I thought I would have a go at writing about the minutes before they come out. Not a prediction, but a small contribution to discourse on Fed-watching, the art and sport of interpreting central bank pronouncements.
The Fed has the discretion to act
"Don't fight the Fed" says ancient Wall Street wisdom, but why not, exactly? There are two special characteristics of central banks that make them worth watching, the Fed most of all.
The first is their central position in the payments system. Central banks issue the money that other big financial institutions use to settle their debts to one another—bank reserves. So, within the domestic payment system that each one operates, central banks are always in a position to affect patterns of settlement. They can do this by affecting the price and availability of the settlement medium. The Fed targets the federal funds rate, for example, as a way of moving an entire overnight interest-rate complex.
To an extent, central banks share this characteristic with other institutions that issue money-like liabilities—banks, money market funds, and stablecoin issuers all have some power to issue circulating liabilities, and discretion as to how and when. But these other issuers can lose the ability, as they tend to do during liquidity crises. Even in such moments, central banks can still issue, and this is just what received central banking wisdom has them do.
So, despite the big changes in context from January, the March minutes will tell us what the Fed was planning to do in the money markets—raise interest rates, and in all likelihood start contracting the balance sheet sooner rather than later. This matters because the Fed's discretion to implement these policies is not dependent on anything else that might happen, short of the dissolution of the dollar system. Unlike other actors, who have objectives, goals, and platforms, the Fed has levers that it controls. It might decide not to use them, and it might use them poorly, but it is very unlikely to be unable to use them.
The Fed cannot just say whatever it wants
The structural centrality of the Fed and its peers would already be a good reason to pay attention. But today's technocratic central banks have another characteristic that makes watching them good sport: their behavior is constrained by their intellectual paradigm.
Much of what the FOMC does can be read in terms of academic economic theory. Policy discussions' emphasis on expectations, for example, reflects specific currents of thought in academic monetary economics. The Fed's so-called dot plots are a fine example. These depict policymakers' expectations of the future course of policy: the FOMC literally sits down, reflects on what its own future course of action will be, and publishes the results. Only a room full of economists could have come up with this, which is likely why the job of Fed chair has in recent decades been reserved for someone who holds a Ph.D in the field.
This is not to say that the Fed's macro- and monetary economic theories are good descriptions of the world, nor that their theories are scientifically sound. (Indeed, I am skeptical.) But whether good or bad, the Fed is constrained to act and communicate in conformity with them. Understanding this relationship between communication and policy makes the minutes more informative.
For example, a discussion from the January minutes talks about the relationship between interest-rate liftoff and balance-sheet runoff. Monetary policy works in part through expectations, the theory says, so the public needs to know how to interpret whether the Fed is tightening or easing. But if there are two policy instruments, which one gives the answer? "In their discussion, participants reaffirmed that changes in the target range for the federal funds rate are the Committee's primary means for adjusting the stance of monetary policy." Interest rates communicate the stance of policy, that is, and thereafter the FOMC is constrained to act accordingly, or to clearly communicate a change.
Another example from the January meeting: in discussing the pace of balance-sheet contraction, the committee agreed 1) to publish its principles, 2) that its decisions would remain data-dependent, 3) that the principles would guide future discussions, and 4) not to finalize any decisions yet. Such tortuous transparency tries to trim away all ambiguity from the interpretation of the Fed's actions.
It is an awkward dance: the Fed constantly insists on a very precise coherence to its actions. That insistence rings hollow in the face of the increasingly incoherent political-economic context. Still, the central bank can act, it will act, and its actions will be consequential. That's the case whether its theories are right or wrong, and whether its decisions are good or bad. So I will read the March minutes when they come out this week, and I think others should too.