Brexit: The Press Release the Fed should have put out
The Federal Reserve just released the following statement:
The Federal Reserve is carefully monitoring developments in global financial markets, in cooperation with other central banks, following the results of the U.K. referendum on membership in the European Union. The Federal Reserve is prepared to provide dollar liquidity through its existing swap lines with central banks, as necessary, to address pressures in global funding markets, which could have adverse implications for the U.S. economy.That is all fine, but this is the statement the Fed really should have released instead:
“The members of the Federal Open Market Committee notes that the British people has voted to leave the European Union. The decision today has caused an increase in volatility in global financial markets and increased demand for safe assets including increased demand for the US dollar. This effectively is an unwarranted tightening of US monetary conditions. While the Federal Reserve is not in the business of fine tuning neither the US economy nor the financial markets the Federal Open Market Committee nonetheless would like to remind market participants that the Federal Reserve has an 2% inflation. Expectations for Fed Fund rates should reflect this target and so should expectations for potential asset purchases. Presently market inflation expectations on all relevant time horizons are below this target and the Federal Reserve therefore stand ready to take the appropriate action to ensure inflation expectations match the 2% inflation target. In this regard it should be noted that the Federal Reserve has the ability to increase the money base as much as necessary to hit this this target. This means that the Federal Reserve remains committed to offsetting any internal and external shocks to nominal demand in the US economy that might jeopardize the inflation target. The Federal Open Market Committee will not allow inflation expectations to drift significantly away from the 2% inflation target.”…Ideally it should of course say “4% Nominal GDP target” instead of “2% inflation target”, but for now lets just hope the Fed will take the 2% inflation target serious. I will try to write more on Brexit in the coming days, which I essentially think is a "Remain Uncertainty"-shock (a supply shock) to the European economy that causes the "natural interest rates" to drop further below the the Zero Lower Bound. This in turns causes an tightening of monetary condition as the markets do not fully trust the ECB (and the Fed) to use to its ability to control the money base to offset this shock. PS I think Scott Sumner is overestimating the scale of the “monetary shock” as a result of Brexit. Scott would realize this by looking at the change in the dollar, stock markets and inflation expectations over the past week instead of looking only at the market action today. The shocks related to a more hawkish Fed and toubles in China in August last year and in January-February this year were larger.