Clarida’s Very Hawkish Speech Confirms Abandonment of FAIT

The Federal Reserve normalising policy into a supply shock means they have effectively given up on FAIT. Vice Chair Clarida’s very hawkish speech yesterday confirmed such.  Fiscal easing has been so large that we need not worry about tightening monetary policy, Clarida essentially said. That is, my take of the very long (150 words!) and convoluted last two sentences of the speech: 

‘In the context of our new framework, as I have noted before, while the effective lower bound (ELB) can be a constraint on monetary policy, the ELB is not a constraint on fiscal policy, and appropriate monetary policy under our new framework, to me, must—and certainly can—incorporate this reality.’ 

Simply, he is saying ‘we need to keep in mind fiscal policy is not as constrained as monetary policy.’ And: 

‘Indeed, under present circumstances, I judge that the support to aggregate demand from fiscal policy—including the nearly $2 trillion in accumulated excess savings accruing from (as yet) unspent transfer payments—in tandem with appropriate monetary policy, can fully offset the constraint, highlighted in our Statement on Longer-Run Goals and Monetary Policy Strategy, that the ELB imposes on the ability of an inflation-targeting monetary policy, acting on its own and in the absence of sufficient fiscal support, to restore, following a recession, maximum employment and price stability while keeping inflation expectations well anchored at the 2 percent longer-run goal.’ 

Here, he is saying ‘with all the fiscal stimulus already enacted by the administration, that still has to be fully spent, we will reach our 2% target even if we tighten monetary policy.’ 

This contradicts, or gives a hawkish meaning to, the other message of the speech, namely that taper timing has no implications for lift-off timing. Also, it ignores the swing to a very tight fiscal policy highlighted by The Brookings Institution, the premier US macro think-tank where Bernanke and Yellen are/were Senior Fellows. The Brookings Institution use a Fed-developed methodology, making it even more striking. This is also a marked difference with Chair Powell who, in recent Q&As and testimonies, had carefully avoided discussing any possible inflation impact of fiscal policy (that in my view is the main driver of the ongoing inflation spike). 

Clarida’s speech is also a reminder of the mandate asymmetry between monetary policy, that has an explicit mandate to stabilise the economy, and fiscal, that does not. Simply, the Federal Reserve must clear up after Congress. Based on this logic, it could be argued that monetary policy must be tighter to make up for the unprecedented fiscal easing of the Biden administration. 

‘Risks to inflation are to the upside’ is the other important message of the Clarida speech. This is also different from Chair Powell who has not explicitly discussed the balance of risks on inflation.  Instead, Chair Powell has been the proverbial double handed economist, for instance saying in the last presser ‘As the reopening continues, bottlenecks, hiring difficulties, and other constraints could again prove to be greater and longer-lasting than anticipated, posing upside risks to inflation.’ Followed by ‘The path of the economy continues to depend on the course of the virus, and risks to the economic outlook remain.’ 

Clarida’s view that risks to inflation are tilted to the upside conflicts somewhat with his view that inflation is transitory.  Or perhaps it implies that Clarida thinks that inflation will be transitory provided policy is tightened. 

The unusually strong views conveyed by the speech suggest that Clarida could be talking to the FOMC doves, and possibly showing some frustration.  Clarida could also be in legacy preservation mode as he seems unlikely to have his Vice Chair mandate renewed next year.  Central bankers have long prided themselves in having vanquished inflation.  The recent inflation surge is therefore a major cognitive dissonance that could be driving what is in my view an over-reaction to various supply shocks and suggests more curve flattening. 

Dominique Dwor-Frecaut is a macro strategist based in Southern California. She has worked on EM and DMs at hedge funds, on the sell side, the NY Fed , the IMF and the World Bank. She publishes the blog Macro Sis that discusses the drivers of macro returns.

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