Why the Doves Rule At Bernanke’s Fed

For the first time, the Fed links rates to inflation and job targets | “The economy just seems to languish”

Peter Coy and Matthew Philips

Mild-mannered Federal Reserve Chairman Ben Bernanke has pulled off a feat any pol would envy: winning more than 90 percent support for an extreme and untested new policy. On Dec. 12, the Fed’s rate-setting committee voted 11-1 for a monetary policy that for the first time links interest rates explicitly to numerical targets for unemployment and inflation. The Fed also voted to expand its bond purchases to bring down long-term interest rates.

Hawks are concerned that inflationary psychology could become embedded in the economy if the Fed stays dovish for too long. But the only member of the Federal Open Market Committee to vote against the new policy was Jeffrey Lacker, president of the Federal Reserve Bank of Richmond, who has dissented all year. He’ll rotate off the roster of voting members in 2013. The FOMC probably won’t have a strongly hawkish presence until 2014, when Philadelphia Fed President Charles Plosser and Dallas Fed President Richard Fisher gain votes.

Is the Fed prey to groupthink, in which the dovish members pull the hawks over to their side? Unlikely, says John Silvia, chief economist at Wells Fargo. Relatively hawkish FOMC voters such as St. Louis Fed President James Bullard are sticking with Bernanke not out of blind loyalty but because they see that the economy remains weak and inflation low. “They just haven’t seen the improvement that they would have expected. The economy just seems to languish,” says Silvia.

The Fed adopted a three-part test for interest rates. Rates will stay low “at least as long” as the jobless rate remains above 6.5 percent; inflation between one and two years ahead is projected to be no more than 2.5 percent; and long-term inflation expectations remain “well anchored” — a code phrase meaning investors and consumers continue to trust that any big jump in prices is a blip, not a trend.

The Fed’s vote is a victory for the bank’s leading dove, Chicago Fed President Charles Evans, who has been pushing for numerical targets since last year. In a landmark speech in September 2011 he said inflation hawks “would be acting as if their hair was on fire” if inflation got too high. “We should be similarly energized about improving conditions in the labor market,” he said. Bernanke, for one, seems to have his hair on fire. He told reporters that high unemployment is “an enormous waste of human and economic potential.”

The bottom line The Federal Reserve adopted a three-part test for how long rates should stay low: the jobless rate, inflation, and inflationary expectations.


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