It's 'tightrope walking day' for the Fed

Vincent Reinhart, BNY Mellon Chief Economist, joins Yahoo Finance Live to break down what we can expect from the Fed’s latest FOMC meeting and outlook for inflation.

Video transcript

JULIE HYMAN: But we do of course start with the Federal Reserve press conference and announcement this afternoon and what we should make of it. Vincent Reinhart is joining us. He's the BNY Mellon Chief Economist, and of course also the former Director of the Federal Reserve Board's Division of Monetary Affairs. Vince, it's great to see you here this morning.

You know, it's so fascinating to watch the Fed decision making process unfold. It has been a very transparent process. And I wonder should we be focused not just on what they were actually doing or thinking about doing, but sort of the framework itself and the theory behind monetary policy itself. Do we need to be rethinking that at this point?

VINCENT REINHART: The Fed spent a tortured year and a half working through their monetary policy framework, and arrived at this conclusion that they should conduct monetary policy the way they were doing it 40 years ago. Go figure. I think that a couple FOMC participants identified exactly the question you're raising. Right now, the Fed's framework is outcome based monetary policy.

You don't do anything until you see inflation move. You don't do anything until the output gap's closed. For 40 years, it has been outlook based policy. You base your policy setting in anticipation of what you think will happen to inflation. And why? Because monetary policy works with a lag.

If you wait until you're actually there, you've waited too long. And that's the risk the Fed's running. It's not a bug in there. It's the feature of their framework. They're just tired of expecting inflation to rise. They went a decade in which it didn't happen. They're going to have to see the whites of inflation's eyes.

- And Vincent, in conversations with your clients, on this topic-- because I think the way you just outlined it probably doesn't get said enough on how the Fed has changed policy. I mean, you're dealing with clients who have either worked their whole careers under the kind of anticipatory regime or learned that that was how the Fed would conduct policy through their schooling and so on and so forth. How receptive or confused are clients maybe by this outline of this new regime that I think you said so well for us?

VINCENT REINHART: So in some sense they get the joke. Fed officials are going to tolerate an inflation overshoot. It's built into the outcome based monetary policy. And what's everybody talking about? The reflation trade. There were lots of concerns about inflation, not just in the US-- around the world-- because central bankers mostly move in a pack.

And they mostly fight the last war. In 2008, 2009, you can make the case that Fed officials remove policy accommodation too soon after the recession. And that was because they remembered the '70s and the '80s. This time around, thy are just sensitized to the 0 lower bound and interest rates. They're thinking about that episode, and they've forgotten about the inflation experience.

That's the risk about outcome based monetary policy. They might just be a little slow on the uptake. Do our clients understand this? I think, deep down, yes. The Fed's telling them to worry about inflation. They're telling them to expect inflation. They're expecting inflation.

- Can the Fed pull off a tapering of bond purchases, Vincent, without spooking the stock market?

VINCENT REINHART: Jay Powell is in the building during the taper tantrum. He is very much aware of all the risks associated with it. That's why he keeps emphasizing not thinking about thinking, and that they'll give us a very, very long runway. The problem is if a passenger is so afraid of the liftoff, length of the runway doesn't help. It just actually, you know, extends the period of panic.

It'll be very hard. I think he's-- you know, it's no decision day at the Fed today. Julie's right about that. But it's tightrope walking day. Jay Powell is going to have to balance a lot of risks. He's going to be asked, when will they start slow on asset purchases?

He'll also be asked about the composition of those asset purchases-- will they slow mortgage backed security purchases before Treasury? Those things will matter for relative prices. And so therefore, the chair does not have an enviable job this afternoon.

JULIE HYMAN: And Vincent, just quick in 30 seconds-- sorry. Where do you come out in the debate of transitory versus non versus how they're going to be able to manage this exit in this tapper-- not from the market's perspective but from the inflation perspective?

VINCENT REINHART: A repeated mistake is to confuse a permanent change for temporary one. It's really tough to separate transitory from more long lasting. I think this is more long lasting. Inflation has gone up and hit households' pocketbooks-- the things that really matter, what's salient in what you consume. I think inflation expectations are rising. And part of it is the Fed told us to expect higher inflation. It's going to be tough to pull back down. And that's the risk you're taking.

JULIE HYMAN: We'll see if they can pull it off, but we'll have to wait. Vincent Reinhart, thanks so much. It's great to see you on this Fed day. BNY Mellon Chief Economist, Vince Reinhart.