The Fed Says: Tell Me About Your Mother

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In one of my favorite posts ever, I wrote about the time Chicago Fed President Michael Moskow addressed the topic of inflation with a room of Chicago businesspeople.

Paraphrasing, Moskow made the following points:

1. There is a direct link between the expectation of inflation and actual inflation
2. Because they prepare for inflation, businesses actually make inflation happen
3. One function of the FOMC is to manage business' expectation of inflation

Summarized: Inflation is a self-fulfilling prophecy and the FOMC uses its words and the Fed Funds Rate to fight predictions. 

Stated differently: The FOMC responds to market psychology as well as data. 

That's a strange and frightening thought.  Economists are not psychiatrists.  We alluded to this game last September in a post titled "Did the Fed fake out the markets in an attempt to slow down the economy?" and the concept has not warmed on us one bit.

Today, the FOMC begins their two-day affair and you can be sure that managing business' prevailing inflation anxiety is high on the meeting agenda. 

In their last post-meeting press releases, the FOMC stated that housing weakness should drag down growth by about a full percent.  Yet, housing has shown resiliency and has some pundits even calling for a <gasp!> rebound. 

If housing bounces back, businesses know that the "1% drag" on growth will never happen and that puts inflation back in play.  Back to the self-fulfilling prophecy bit: this is a major contributor to the huge run-up in mortgage rates lately; markets are preparing for inflation.

Tomorrow afternoon, the FOMC will issue a press release summarizing its meeting.  The questions remains, though: Will the press release be issued from behind the desk, or from the fluffy couch?