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Why the Federal Reserve is vague about interest rates

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Federal Reserve Chair Janet Yellen can expect questions about interest rates and unemployment when the Fed wraps up its two-day meeting later today.

The Fed had promised to keep interest rates near zero, at least until unemployment hit 6.5 percent. Unemployment is currently at 6.7 percent and dropping (and the Fed has said it will likely look at other factors, too). Yellen is known as a proponent of transparency – but she’s expected to say as little as possible  about what those other factors might be.  Here’s why:

1. Players in the stock and bond markets always want to know exactly what the Fed will do next.  Even when the Fed can’t say for sure.  

“They’re trying to figure out ‘What is the Fed telling me about, what are interest rates going to do?’” says Ann Owens, a Hamilton College economics professor and former Fed economist. “There’s a real incentive to figure that out before everybody else does. Because if you can do that, then you can make a profit.”  

2. The Fed wants to give some guidance about what it’s thinking, without boxing itself in. Williams College economics professor Kenneth  Kuttner, who also worked for the Fed, says the Fed is like a college professor—with market players as grade-grubbing students.

“You hand out the grading rubric, and some kid says, ‘Oh, look, I did X that’s on your grading rubric. Why didn’t I get an A?'” he says.  “You need to be specific enough that they know what to do in the paper, but vague enough that you can say, ‘There are these other things I’m taking into account as well.'”

Because if those students get too unruly, it can cause trouble for the whole class.


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