The Fed's fat-tailed dilemma
Add Axios as your preferred source to
see more of our stories on Google.
Fed chair Jerome Powell. Illustration: Aïda Amer/Axios
Earlier this month, Federal Reserve chair Jerome Powell made a sneakily profound comment, important for understanding how the central bank will approach policy in its meeting this week and beyond.
The big picture: "However fat you think the tails are, they're fatter than you think," Powell said, referring to the outer edges of a probability distribution.
- Translation: The odds of some seemingly unlikely, extreme scenario occurring are higher than most people comprehend.
- Powell made the comment in discussing the pandemic-era economy, but it could apply just as well in thinking about the Trump 2.0 economy, where an onslaught of policy change is creating a wider range of possibilities than usual for how the economy will evolve.
State of play: Projecting the future is never easy. With trade, fiscal, immigration and regulatory policies all in extreme flux, charting how the economy will fare over the next couple of years is a fool's errand.
- Fed officials have to do it anyway. They have the unlucky task of penciling in their projections for growth, inflation, unemployment and interest rates at this meeting, to be released Wednesday afternoon.
- Look for an even wider dispersion than usual in these projections.
Zoom in: Fed officials are reluctant to react to the kinds of financial market moves and soft, survey data that have been the main developments of the last two months.
- To the extent the data does matter, it's sending signals with conflicting policy implications.
- The latest University of Michigan sentiment survey for March, for example, pointed to higher long-term inflation expectations — which tilts toward keeping rates high — but also worsening expectations for the job market, which points toward rate cuts being needed.
Between the lines: The Fed's quarterly projections are always of dubious value, but right now, they're worth additional grains of salt.
- Powell will face a balancing act in his news conference Wednesday, looking to present the Fed as a source of stability in a turbulent time while also signaling it will be nimble in adapting policy to a changing economy.
What they're saying: "Most likely the FOMC will stress the uncertainty of policy and outcomes and their potential impact on activity and inflation," wrote Steve Englander of Standard Chartered Bank in a note.
- "The view will likely be that the economy is firm enough and there is no need for the FOMC to do anything until outcomes are clear," he added.
The bottom line: The tails are fat, with possibilities for extreme results on either growth or inflation. But they're fat on both sides of the Fed's mandate, which will make the case for caution.
