Yes, the FOMC is behind the curve. A dangerous place to be, especially if the FOMC is very far behind the curve, as I believe is the case today. When that happens, the probability of recession is higher. On Friday, following the jobs report, we indicated that the risks to our call were more firmly weighted to more tightening this year (four hikes). Now we’re making four hikes this year our baseline call. In addition to calling for four hikes this year (hikes at meeting with SEPs, the first being in March), we also now think that the FOMC is likely to continue hiking at a pace of one hike per quarter until the funds rate reaches neutral.
It’s not at all surprising that the FOMC is behind the curve today. I have argued that this is virtually inevitable under the new framework when policy has fallen to the effective lower bound (ELB). Of course, that’s built into its design, and has a purpose. Additionally, the rate guidance for liftoff that the FOMC crafted to implement the goal of the new framework (overshoot after undershooting at the ELB) set clear and explicit rules: Maximum employment must have been achieved and inflation must have reached 2% on a sustained basis and be on track to overshoot. While the intention of this guidance was to preclude a pre-emptive rise in the policy rate—as the Committee sees 2015 as a mistake—they also risk an unwelcome rise in inflation beyond the moderate overshoot for some time that is called for in the new framework. This is the inflation bias that I have emphasized is a feature of the new framework, and we are seeing that today.
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