How Should The Fed React To Tax Reform?


  • How Should The Fed React To Tax Reform?
  • The Inflation Puzzle Persists
  • Financial Conditions Are A Growing Concern

The U.S. Federal Reserve will conduct its final monetary policy meeting of the year next Tuesday and Wednesday. It is practically a foregone conclusion that short term rates will be lifted for a third time this year; the U.S. economy has been strong, and Fed officials have been dropping hints of an impending tightening for a couple of months. It looks very much like the Federal Open Market Committee (FOMC) will end up following the path of short-term rates that appeared in its forecasts a year ago.

The Fed also delivered on its promise to begin reducing its balance sheet, with billions of dollars in bonds returning to private hands each quarter. Communication with markets has been handled virtually flawlessly; there have been fewer false starts and surprises for investors than there were in 2016. A smooth leadership transition is underway. And while the Fed is still operating short-handed, recent nominations to the Board of Governors suggest that help is on the way.

But the task of normalizing monetary policy will not be easy from here. Recent events suggest the Fed may not be able to continue moving at the slow, measured pace it might prefer. Here is a matrix analysis of the factors that are likely to tell the tale in 2018.

Economic Growth

The U.S. expansion may be mature, but it is not acting its age. Even prior to the enactment of tax reform, business investment had resumed a powerful upward trajectory, providing an ingredient that had been absent from the growth picture for three years. The list of potential 2018 tailwinds is a long one, suggesting this cycle could get stronger even as it approaches a record length. (The current benchmark is the 10-year expansion that lasted from 1991 until 2001.)