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If central bank governors speak in generalities, it is not necessarily because they want to be evasive, it’s just that they don’t know all the answers either. If a Raghuram Rajan, or a Duvvuri Subbarao before him, knew precisely at what point inflation would turn, or even what made it turn, they would have no hesitation in telling the market just when they would stop hiking rates. Which is why, new Fed chairperson Janet Yellen has probably learnt the virtues of being vague—recall the famous Alan Greenspan quote “if I seem unduly clear to you, you must have misunderstood what I said”.
The Fed’s written statement on March 18 was along expected lines, and spoke of continuing with the policy of reducing monthly bond purchases by another $10 billion, of keeping monetary policy accommodative—that is, keeping the Fed funds rate at the current 0-0.25% range—as long as the objectives of maximum employment and a 2% inflation were not achieved. Given the current US unemployment rate is pretty near the 6.5% target the Fed used to speak of—the unemployment number is artificial since a large number of people are simply not re-entering the workforce—not surprisingly, Yellen’s first FOMC statement dropped the 6.5% number in favour of a more vague ‘maximum employment’. Yet, in the Q&A session, Yellen goofed up by being very specific and said the Fed would start hiking interest rates six months after it wound down its bond-purchase programme—that means by April 2015. While markets panicked immediately, it was always known the Fed was going to raise rates, but this is to be done gradually—the markets, however, focussed on just the 6-month number. While the median FOMC vote was for a 1% Fed funds rate in 2015 in the March meeting, it was 0.75% in the previous meeting. But hiking beyond that was something the Fed clearly said would take more time—in the March meeting, the median FOMC vote for raising rates to 4%, the long-run average, is not for at least till the end of 2016.
While markets will settle down soon, and Yellen will take lessons in being Greenspanesque, the point is that US rates are only going up, the timing will remain a matter of conjecture. The Fed, after all, needs to bring its balance sheet back to earlier levels—it rose from $1 trillion before the crisis to $4 trillion right now. In which case, if the