The Fed has become a ‘prisoner’ of its own making

The Federal Reserve is caught between a rock and a hard place due to a “destructive” mistake made a decade ago, says an economist.

In an interview with Bloomberg, Macquarie strategist Viktor Shvets said the Fed has become “a prisoner of policies” established as far back as 2012.

Key among them is the now infamous “dot plot” forecast introduced by then-Chairman Ben Bernanke.

Released every quarter, the dot plot is a peculiar chart that tracks the FOMC’s interest rate expectations over the coming years.

“Whenever you have a high degree of volatility that is externally or internally driven, dots really don’t tell you anything because it’s really a personal opinion of several governors,” Shvets said.

But as long as the Fed uses the dots, policymakers are trapped into making decisions that reflect their expected path of interest rates.

The other problem facing the Fed is a more recent decision to be more “data dependent rather than forward-looking.”

It’s “basically a dependency on the backward-looking [...] numbers that you have,” Shvets said. The problem is the Fed is dealing with “a lot of faulty numbers, whether it is how you determine shelter expenses [...] secondhand car prices [...] or measure insurance policy.”

According to Shvets, “If you become data dependent, you start to create exceptional volatility because you’re basically like a deer in the light, you are stuck, you cannot move to the left, you cannot move to the right.”

It’s “different this time”

The ironic thing about the Fed’s rigid framework is that Chairman Jerome Powell has admitted that the economy “is different this time” because inflation isn't responding to rates like it has in the past.

Nevertheless, Fed officials keep parroting the same data-dependent mantra.

Regional Fed Bank presidents Loretta Mester, John Williams, and Thomas Barkin all said separately that interest rates need to remain higher for longer to bring inflation back down to its 2% target.

Meanwhile, Powell told investors in Amsterdam, “We’re just going to have to see where the inflation data fall out.”

Economists are becoming more skeptical about the Fed’s ability to balance economic growth and inflation. Others are questioning whether the Fed’s inflation target still makes sense in today’s economy.

According to Nobel Prize-winning economist Joseph Stiglitz, the Fed’s 2% target was “pulled out of thin air.”

“There’s no economic science behind that. No economic science says how fast you should go back to whatever goal, arbitrary as it is,” Stiglitz said.