Much has been written about how the U.S. Federal Reserve has pivoted to a more “hawkish” stance, leaning toward fighting rather than tolerating inflation. But has it? On the contrary, I would argue that it has done the opposite over the past year – a move that likely has more to do with markets or politics than with what’s best for the economy.

True, the Fed is now expecting to cut back on asset purchases and raise interest rates faster than it was earlier this year. The median forecast among officials is for three 0.25-percentage-point interest-rate increases in 2022. As of their September policymaking meeting, they were projecting just one such hike. But this is merely the natural, almost automatic, response that any policy maker, hawk or dove, would have to surprisingly high inflation and surprisingly low unemployment (as embedded, for example, in the famous Taylor rule).

Thus, one must look elsewhere to understand whether and how the Fed’s stance has changed. Consider, for example, the central bank’s projections for unemployment and inflation. They offer a good indicator of what officials want to achieve, because they assume appropriate monetary policy. As of December 2020, the median two-year forecast was for inflation to remain below 2 percent and for unemployment to decline from 6.7 percent to 4.2 percent. Now, the Fed is aiming for inflation to fall from 4 percent to 2.3 percent over the next two years, while the unemployment rate remains mostly below 4 percent.

In other words, the Fed is aiming for considerably higher inflation and lower unemployment than it was a year ago. This is a strongly dovish pivot, not a hawkish one.

What might explain the Fed’s behavior? It can’t be the central bank’s new monetary policy framework, which entails allowing inflation to overshoot the Fed’s 2 percent target to make up for previous downside misses. That was announced in August 2020, so would already have been in effect last December.

The remaining explanations are markets and politics. The Fed might be keeping interest rates low to avoid shocking investors, who have become accustomed to monetary accommodation – a modern version of the “Greenspan put,” the widespread belief that the Fed would always step in to prevent asset prices from falling too rapidly. Also, Jerome Powell might have become more dovish to curry favor with the Biden administration during the long process of reappointing him for a second term as Fed chair. This political influence will only get stronger as Biden makes more Democratic appointments to the central bank’s board of governors.

Unfortunately, these motivations have little to do with achieving the optimal longer-term outcome for the economy – and increase the risk that inflation, already running well above the central bank’s target, will eventually get out of its control.


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