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Weekly Economic Commentary


Will the Fed Deliver a Chock Full of New Insights?

October 31, 2011

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The policy statement, economic forecast, and Bernanke’s press conference on November 2, after a two-day FOMC meeting, are likely to contain both conventional nuggets of information about changes in the Fed’s view about the economy and a few new nuances. The Fed indicated in August that it would hold the federal funds rate at the current level (0-0.25%) until mid-2013. The minutes of the September FOMC meeting noted that they were looking into enhancing transparency of monetary policy and improving the Fed’s communications strategy. Vice Chair Yellen heads a committee examining the ways to improve the Fed’s communication strategy. Yellen’s speech on October 2, 2011 included the following:

“We have been discussing potential approaches for providing more information--perhaps through the SEP-- regarding our longer-run objectives, the factors that influence our policy decisions, and our views on the likely evolution of monetary policy.”

The Fed will be publishing the Summary of Economic Projections (SEP) on November 2. If Yellen’s remarks are prescient, it is entirely possible the new SEP will offer guidance about the conditions under which the FOMC would no longer hold the federal funds rate at the current rate.

The overall monetary policy approach of the Fed is unlikely to show radical changes following the November 1-2 meeting despite suggestions from within the Fed and from academia for the Fed to examine other options. Chicago Fed President Evans holds the opinion that the FOMC should announce it would hold the funds rate unchanged until the unemployment declined to 7.0% or medium-term inflation expectations advance to 3.0%. The unemployment rate in October was 9.1% and inflation expectations in the 5-year space are holding at 1.94% as of October 28, 2011.

Another proposal that has received attention is to target nominal GDP. Nominal GDP is the current value of all goods and services produced in an economy at a given point time. Nominal GDP of the U.S. economy in the third quarter stood at $15199 billion and is short by roughly 10% from the fourth quarter of 2007, if a growth rate of 4.5% is assumed as the desired growth rate of the economy. The 4.5% growth rate assumes a 2.5% real potential growth of the economy and 2.0% inflation as the Fed’s preferred rate of inflation. The economy fell into a recession and caused this shortfall. Under a nominal GDP target approach, the Fed would announce that it would put in place suitable monetary policies such that the economy reaches this target path of GDP growth. There are advantages and disadvantages to this approach, which is the subject of another commentary. Given the recent visibility of this discussion, there are expectations that it would be considered.

In this context, an excerpt from Bernanke’s speech of October 18, 2011 comes to mind and suggests that the Fed is unlikely to adopt any of these proposals at the present time.

“My guess is that the current framework for monetary policy--with innovations, no doubt, to further improve the ability of central banks to communicate with the public--will remain the standard approach, as its benefits in terms of macroeconomic stabilization have been demonstrated.”

Stay tuned for Bernanke’s press conference on November 2 following the two-day meeting. Bernanke’s comments pertaining to the success/failure of “Operation Twist” will be interesting, given that the 10-year Treasury note yield as of this writing is 2.18% after closing at 1.72% on September 22, 2011 (one market day after Operation Twist was announced) and mortgage rates do not show any benefits after the implementation of Operation Twist (see Chart 1).

Chart 1 - 10 31 2011









The opinions expressed herein are those of the author and do not necessarily represent the views of The Northern Trust Company. The Northern Trust Company does not warrant the accuracy or completeness of information contained herein, such information is subject to change and is not intended to influence your investment decisions.