An unsteady hand at the Fed

Francis Rivera

Chair Janet Yellen's Federal Reserve hardly inspires confidence by the way its views oscillate on the health of the global economy. In September 2015, the Fed chose not to start raising interest rates on the grounds that there were considerable risks to the global economic outlook. Yet in December 2015, not only did the Fed hike interest rates, it also signaled that it might do so again on another four occasions in 2016. Now in her most recent testimony to Congress, Yellen is reversing herself yet again to suggest that there are considerable risks to the global economy. She is also intimating that the Federal Reserve might now be on hold for a considerable period of time as far as the interest rate hiking cycle is concerned.

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These gyrations in view in such a short space of time have to raise the basic question as to whether over the past few months the global economic outlook has really moved around in a way remotely paralleling the way that the Fed's views have changed. Or might we ask whether the Fed's views have simply been moved around by market perceptions of global events. Sadly, a look at the facts would suggest that the Fed's views have not been based on a well-grounded view of the global economic outlook, but have rather simply followed the market's mood.

Recent Chinese economic developments, which are among the main reasons for concern about the global economy, would provide a case in point. For more than a year now, the Chinese economy has been causing consternation by showing very clear signs of slowing. Yet there has been no real evidence to suggest that slowing terminated between September 2015 and December 2015, during which time the Fed moved from a position of concern about the state of the global economy to one of unconcern.

Similarly, over the past year, the Chinese economy has been plagued by very large capital outflows that have raised questions about China's economic stability and its exchange rate policy. If anything, these capital outflows picked up in the time that the Federal Reserve shifted its view about the state of the world economic outlook. Indeed, China lost a staggering $110 billion in international reserves in the single month of January 2016.

The same might be said about commodity prices and the precarious state of a number of major emerging market economies like Brazil, Russia, South Africa and Turkey, which have been another cause for concern about the state of the global economy. For long, it has been clear that the "super boom" in international commodity prices, which the Fed's own policies of aggressive quantitative easing had spawned, have now turned into a major commodity price bust. It has also long been clear that the commodity bust has tended to destabilize the world's oil-exporting economies as well as those commodity-dependent emerging market economies across Latin America and Africa. All of this matters, of course, since the emerging markets now account for around 40 percent of the global gross domestic product.

It is difficult, then, to explain why between September 2015 and December 2015, the Fed should have suddenly become more sanguine about those countries' troubled economic outlooks. After all, nothing had changed to suggest that the world economy now would not have to struggle for a long period of time with unusually low international commodity prices.

The Federal Reserve often complains about the vagaries of the market. Indeed, as recently as January 2016, senior Fed officials were chastising the financial markets for pricing in only two additional Fed interest rate hikes for the year, rather that the four rate hikes that the Fed governors were expecting. This seems to be very much a case of the pot calling the kettle back, given how all over the place the Fed has been on the state of the global economy.

Hopefully, in the period ahead, we will have a steadier hand at the Fed, since a steadier hand would seem to be a necessary condition for restoring the Fed's credibility after its premature and misguided interest rate hike in December 2015. It would also appear to be a necessary condition for enhancing the Fed's ability to communicate better with the markets.

Lachman is a resident fellow at the American Enterprise Institute. He was formerly a deputy director in the International Monetary Fund's Policy Development and Review Department and the chief emerging market economic strategist at Salomon Smith Barney.

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