In William Greider's long book on the Federal Reserve, Secrets of the Temple (a fascinating book but, in retrospect, a remarkably ill-considered indictment of inflation-fighting), there's not much mention of the conversion of the Federal Reserve into a bully pulpit. But as today's quarter-point hike in the discount rate--in addition to the expected quarter-point hike in the federal funds rate--demonstrates, the Fed has, at some point in the last five years or so, come to see inflation-fighting as not merely a matter of raising or lowering rates. It's also a matter of sending the right messages to the bond (and, to a lesser extent, the stock) markets.
I've touched on this point once before, when the Fed announced at its last meeting that it was keeping interest rates steady but changing its bias. Where once the Fed kept its deliberations secret and acted as sphinxlike as possible about its intentions, it now tries to indicate what it's concerned about and the direction in which it's leaning. In one sense, this has made the exercise of trying to game the Fed easier, since there's more material to go on. In another sense, it's made everything trickier, since there are a host of signals to interpret, and sometimes they're not in harmony.
Today, for instance, the Fed didn't make what would have been the surprising move, namely hiking interest rates by 50 basis points instead of 25. (One basis point is equal to one-hundredth of a point.) Had it pushed through the larger hike, the sell-off in the stock market would probably have been frightening, at least at first. But the increase would certainly have slammed the brakes on an economy that's still running very hot.
You might assume that the quarter-point hike means the Fed isn't that worried about inflation, even though there are signs that continued strong demand and tight labor markets are beginning to make themselves felt. But then there's the discount-rate hike to consider. This is the first time since the spring of 1995 that the Fed has increased the discount rate (which is the interest rate the Fed charges banks who want to borrow money from it). And while the discount rate itself is not that important, which is to say that an increase in it will have no material effect on the economy, the message the increase sends is important, and that message is that the Fed is more concerned about inflation than the small hike in the federal funds rate would indicate. I think.
In addition to the rate increases, the Fed also shifted its bias back toward neutral, which suggests that the economy is still growing faster than Greenspan believed it would be. But the fact that the Fed isn't biased toward further tightening suggests that the economy isn't necessarily growing faster than Greenspan would like it to be.
Got all that? Good, because I'm not sure that I do.
In the long run, worrying about all this stuff probably doesn't matter very much. The Fed and the bond market will determine how fast the economy goes by determining interest rates, and the concrete impact of the federal funds rate and of the Fed's printing or not-printing money will far outweigh any psychological effect of the Fed's symbolic gestures. But it also seems true that Greenspan has come to recognize the beneficial effect of using those gestures to push interest rates in a certain direction without the Fed's having to take concrete action. It's as if he can speed things up or slow them down without doing much of anything real.
Of course, mixed messages are a persistent danger here, as evidenced by today's herky-jerky market, where bond prices rose sharply, while the Dow meandered and the Nasdaq actually went up. But the truth is that in the end the market will do a good job of sorting through the messages and finding the ones that matter. It's trying to interpret the messages on your own--like I just tried to do--that's a recipe for utter confusion.