A new US Fed: Central bank aims to reform functioning as Marsh takes charge

Aside from the shifts, one of the biggest takeaways from the Fed statement and Mr Warsh's first press conference as its chairman was the firm commitment to price stability and the 2% inflation target

The first Federal Open Market Committee (FOMC) meeting under Kevin Warsh this week set the stage for significant changes in the functioning of the world’s most important central bank, the United States (US) Federal Reserve. Although the FOMC left the target range for the rate for federal funds unchanged at 3.5-3.75 per cent, the statement in just about 130 words was significantly shorter than the usual, and refrained from giving any kind of forward guidance. However, it categorically noted that the inflation rate remained elevated compared to the Fed’s 2 per cent target, and that the committee would deliver price stability. Given the circumstances and elevated inflation rate, financial markets expected some hawkish talk, but the statement seemed to have exceeded expectations. Both the stock and bond markets fell after the announcement. 

The Fed also released its economic projections, or the so-called dot plot, which includes projections by Federal Reserve Board members and Federal Reserve Bank presidents. It showed that nine of the 18 members expected the policy rate to go up by at least 25 basis points this year. Notably, Mr Warsh did not submit his projections. He has strong views on the practice as it is currently structured. In the post-policy press conference, Mr Warsh also announced the formation of five task forces to study the Fed’s communication, the composition of its balance sheet, the data sources it uses, productivity and jobs, and the inflation framework. It is now well known that Mr Warsh is of the opinion that Fed officials should communicate less. The level of communication from the Fed and other central banks increased over time, particularly since the global financial crisis, which has arguably helped reduce information asymmetry between policymakers and other stakeholders, including financial markets. However, in Mr Warsh’s view, policymakers can become prisoners of their own words. At a broader level, it is possible that the recommendations of the task forces and the manner in which they are implemented by the Fed could influence other central banks, with wider consequences. 

Aside from the shifts, one of the biggest takeaways from the Fed statement and Mr Warsh’s first press conference as its chairman was the firm commitment to price stability and the 2 per cent inflation target. Mr Warsh has maintained that inflation is a choice, which he also repeated in the press conference on Wednesday. There were concerns among stakeholders that he might adopt a softer tone on this front in line with American President Donald Trump’s views. However, his remarks should allay such fears, at least for now. How Mr Trump reacts to the Fed’s positions in the coming months will be worth watching. In terms of outcome, a potential rate increase later this year could tighten global financial conditions. Some economists believe that inflationary pressures in the US are more deeply entrenched than can be explained by the rise in energy prices owing to the war in Iran. The European Central Bank and Bank of Japan have raised rates in recent days. Although global risk aversion might decline in the near term owing to the agreement between the US and Iran, potentially tighter financial conditions could adversely affect economies like India. Recent efforts, such as attracting foreign currency deposits, might help in the near term, but India needs to do more to attract both stable equity and debt flows.