By David Andolfatto, Vice President and Economist
In response to the recent financial crisis, the Federal Reserve dropped its key policy rate (the federal funds rate) essentially to zero, where it has remained for more than six years. But with real gross domestic product growing at an annual rate of 5 percent in the third quarter of 2014, the U.S. economic recovery finally appears to be accelerating. Fed watchers are now parsing through each Federal Open Market Committee (FOMC) statement looking for hints of the imminent “liftoff” date, or the date the Fed will announce an increase in its policy rate.
The FOMC has been promising for years to keep rates low for a “considerable time.” In the days leading up to the Dec. 16-17, 2014, FOMC meeting, there was much talk of the Fed finally dropping the “considerable time” language and announcing some move toward policy normalization (that is, raising its policy rate). But the Dec. 17 FOMC statement surprised many not by removing “considerable time,” but by inserting another buzzword: “patient.” While many in the market breathed a sigh of relief knowing that the Fed was in no hurry to raise rates, others debated the exact meaning of the new language.
As seasoned Fed watchers will know, none of this language is new. Consider, for example, the Dec. 9, 2003, FOMC statement: “However, with inflation quite low and resource use slack, the Committee believes that policy accommodation can be maintained for a considerable period.” This “considerable period” language was also used in the three previous FOMC statements. As seen below, the policy rate at the time was 1 percent, headline inflation measured by the personal consumption expenditures price index was around 2 percent, and the unemployment rate was around 6 percent.
At the next FOMC meeting, the Fed switched from “considerable period” to “patient.” From the Jan. 28, 2004, statement: “With inflation quite low and resource use slack, the Committee believes that it can be patient in removing its policy accommodation.” The FOMC repeated this phrase in its March 16, 2004, statement, then replaced “patient” with “measured” in its May 4, 2004, statement. In particular, the FOMC stated: “At this juncture, with inflation low and resource use slack, the Committee believes that policy accommodation can be removed at a pace that is likely to be measured.”
With the labor market still considered weak by some members of the FOMC and with inflation running well below the Fed’s 2 percent inflation target (a temporary phenomenon according to most members of the FOMC), it seems reasonable to suppose that the FOMC will replace “patient” with “measured pace”—or something similar—to describe the expected path of its policy rate when the liftoff date is announced. Of course, the statement will also contain language to make clear that the future is not perfectly forecastable and that policy actions will be contingent on incoming data.