Clean air but murky policy

If US Federal Reserve chief Janet Yellen chooses to use her closely watched address on Friday to clear the air, she will have plenty of clearing to do.

Yellen, who will address a ballyhooed annual gathering of central bankers in the crisp climate of Jackson Hole, Wyoming, presides over US monetary policy now derided by market watchers as "schizophrenic." 

On the health of the economy and the dangers of inflation, her colleagues on the committee that sets key interest rates are at odds with each other -- with one member perhaps unfairly chided in the business press for appearing to contradict himself more than once in the space of a single week.

All members of the Federal Open Markets Committee agree that interest rates will have to rise. The only question is how soon. 

But the central bank this year has retreated from its announced course of rate hikes, fearing for the resilience of the US economy in the face of Brexit, slowing Chinese growth and domestic signs of weakness.

The question for Yellen, and for global markets affected by her decisions, is whether the American economy is strong enough again.

- 'Completely befuddled' -

"I think the problem is we're all completely befuddled as to their next move," said Jared Bernstein, former economic adviser to Vice President Joe Biden. 

William Dudley, the influential president of the New York Fed, suggested this month that a rate hike was possible in 2016. Dennis Lockhart of the Atlanta Fed said there could even be two.

John Williams, president of the San Francisco Fed, appeared to agree, telling The Washington Post on August 11 that rates could rise this year but then publishing an essay just four days later saying the time had come "to critically reassess" prevailing interest rate policy and speaking of "limits to what monetary policy can and indeed should do."

For good measure, three days later, Williams, who does not currently have a vote on the FOMC, said publicly that a rate hike would be a good idea "sooner rather than later."

Futures traders currently put the likelihood of at least one rate hike by December at 51 percent.

Bernstein told AFP the Fed was experiencing a moment of policy ferment.

"I think they themselves are legitimately questioning some of their most basic guideposts," he said. "That's definitely confusing to a lot of market participants."

The "new normal" that policy makers are contending with is an era of predominantly low interest rates and productivity growth, when rising employment fails to produce the expected gains in inflation and GDP growth is sluggish.

Donald Kohn, who was Fed vice chair until 2010, said that on leaving office he had expected to see a quicker recovery from the Great Recession of 2008 - 2009 but had been surprised by longer-term trends in productivity, demand and interest rates.

"As a consequence, even highly accommodative monetary policy hasn't been as stimulative as I anticipated," he told AFP. "It has taken longer than I expected to get the US economy back to the region of full employment and inflation climbing back to the two percent target."

All of this has left key players like Williams and Stanley Fischer, the current vice chair of the Fed, calling for non-traditional measures including new fiscal and regulatory policies, such as investments in infrastructure and education or responsive tax rates that vary with unemployment.

Last month, the phrase "fiscal stimulus" appeared in news stories more frequently than at any point since 2009, the height of the global financial crisis, according to research produced by Bank of America Merril Lynch.

Yellen's Friday address is billed as a discourse on the Fed's "monetary policy toolkit" and observers say she is unlikely to give clear signals on the timing of the next rate hike. But markets have little choice but to watch and listen anyway, looking for hints about her views on the health of the world's largest economy. 

Without a doubt, though, investors are not watching the game they are used to.

"Rules that made sense ten years ago don't make sense right now," said Bernstein, reiterating that Fed members were themselves searching for answers. 

"I think their understanding of key economic parameters is in flux."