FOMC | More Choices–Rip van Winkle Awakes

Oct. 29, 2014–What's the FOMC going to do today? A quick sampling of forecasts is that it will move away from QE3, its makeshift easy-money policy during the period of zero-bound interest rates.

I've been following the Fed since I worked there and at the FDIC five decades ago as a financial economist.

The latest week's Initial Unemployment Claims, which FRED (the wonderful database of the St. Louis Fed–thank you, James Bullard) graphs for us, has fallen to 283,000.

That's about to where it was briefly in 2000 before the dot-com bubble burst. Not since the early 1970s have initial claims been lower. This suggests inflation should be waiting to ambush us.

It's certainly taken a long time to get to this point. In January 2009, former Fed Governor and inflation hawk Laurence Meyer of Macroeconomic Advisers told a packed luncheon group sponsored by the New York Association for Business Economics that recovery was "at least 18 months away". He wasn't kidding.

Now, nearly six years later, we seem there. Unemployment is below the 6 percent threshold where the Fed historically (using the NAIRU) has started to worry about inflation.

However, wages have not kept pace, which shows slack in the labor market. And, as Paul Krugman reminds us, there are still no signs of overall inflation. (See graph - the Personal Consumption Expenditures chart shows the same pattern.)

So the Fed doves - Chair Janet Yellen, Gov. Daniel Tarullo, and Fed Bank Presidents William Dudley (NY), Charles Evans (Chicago) and Eric Rosengren (Boston) don't want to raise interest rates yet.

They point to the big mistake of FDR's economic policymaking in 1937, when interest rates were raised too soon. Wall Street has an adage: "When the Fed starts to crunch, it's time to go to lunch."

Fed hawks, however - Bank Presidents Richard Fisher (Dallas), Jeffrey Lacker (Richmond) and Charles Plosser (Philadelphia) - are concerned to stay ahead of the curve. They have their eyes on the 1970s when it seemed the Fed had lost control over prices because of the oil crisis... although former Fed Chair Paul Volcker proved in the early 1980s that if you closed your eyes to the temporary pain, the Fed can always dampen inflationary expectations.

At least in the coming months the FOMC will start getting back to the job it is familiar with, controlling T-bill interest rates through open market operations. A zero-bound interest context doesn't leave much latitude for policy options. Larry Meyer in 2009 even suggested, tongue in cheek, that  the FOMC take a long vacation. If they had followed his advice, they would just now be getting back to work. Like Washington Irving's Rip van Winkle, they may find it hard to settle back in to their traditional role after all these years.