The world will be watching the latest announcement from the Federal Reserve a little more closely this time around. The added interest is due in part to the internal struggle going on behind the scenes at the Fed between doves like Chair Janet Yellen and her more hawkish colleagues, including Philadelphia Fed president Charles Plosser, who dissented at the last meeting.
If noted economist James Galbraith, professor at The University of Texas at Austin, is correct, there is good reason for the heightened interest and drama surrounding Wednesday’s announcement and press conference. In Professor Galbraith’s view, the Fed may have painted itself into a corner.
“The Fed has a dilemma. It, of course, would like to come off of its present policy stance, but people are accustomed to it and if interest rates go up, you get an inverted yield curve with bad consequences.”
Galbraith points to the global market reaction to comments from Yellen’s predecessor at the Fed, Ben Bernanke, when he signaled in June 2013 that the Fed would begin to wind down its asset-purchase program eventually.
Stocks plunged, sending the The Dow Jones Industrial Average (^DJI) down more than 200 points. Bond prices (^TNX) also fell, sending yields higher on the news. Just the notion of tightening at some point in the future was enough to send a ripple effect through global markets.
“Even when they talked about it a year ago that happened, and so the consequences of changing at this point are serious and every time they start yielding to the pressure to change, they come up against the constraints.” Galbraith adds, ominously, “There may not be a good way out of that box.”
No news, good news for stocks
Wall Street is pulling for the status quo. Stocks rallied Tuesday, apparently in response to reassurances from one well-known Fed-watcher that two key words, "considerable time," would remain in the Fed's language in Wednesday's statement.
Wall Street Journal Economics Correspondent Jon Hilsenrath said in a WSJ.com webcast that he expects the Fed to continue to use the same langauge to describe how long interest rates will remain at current low levels.
“Given the economic backdrop, they don’t want to send a signal right now that rate increases are imminent,” Hilsenrath said. “I think what they do, at the end of the day, is they qualify it.”
So what is the Fed to do?
The question that has created two distinct camps inside the Fed is: When to raise interest rates? The key factors under consideration are, as always, the job market and the pace of economic recovery.
The August jobs report from the Labor Department did nothing but complicate the answer to that question. The 142,000 jobs created last month came in well short of expectations and off the pace so far in 2014, which averaged 225,000 new jobs per month through July.
The weak number bolstered Yellen’s argument for patience when it comes to raising interest rates, even as pressure from her dissenters mounts.
“I think that’s where they’re still wrestling with the consequences of trying to raise interest rates in a world climate where the world has a lot of very low-interest, long-term assets and a lot of expectation that it’s going to continue," said Professor Galbraith.
More from Yahoo Finance