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TheStreet Open House

Yellen's Fed Pivots Emphasis Back to Inflation, but Is That a Good Thing?

NEW YORK (TheStreet) -- While the market tanked on Federal Reserve Chairwoman's apparent error in specifying when the central bank will begin to raise rates, the key shift the policy-making arm delivered on Wednesday was to focus its efforts mainly on inflation.

Fed watchers know that the key function of the Federal Open Market Committee is to set short-term policy for the central bank, and its decision to drop a 6.5% unemployment rate as a threshold to consider raising the nation's federal funds rate shows that the committee is perplexed by inflation running below the target of 2%.

"Because the unemployment rate fell much fast than expected, they dropped that 6.5% target; however, inflation is staying much lower than they expected, so really she wants to shift focus back to this inflation undershoot," Ben Garber, economist at Moody's Analytics, said in an interview. "And even as the labor market continues to improve, they may keep rates especially low if inflation continues to underperform."

Yellen, who held her first press conference as chair of the Fed on Wednesday, uttered the word "inflation" 53 times, and repeatedly said inflation continues to run below the central bank's objective. While many wondered if dropping the unemployment threshold nullified the action of implementing it in the first place, Yellen pushed back. She said it had been effective, but that new circumstances triggered new market expectations. Thusly, they dropped the unemployment rate threshold.

Some economists don't think the shift to put more emphasis on lagging inflation is such a good idea.

"If you had grown up studying economics and central banks in those days you would've thought that the only job, the only thought, the only duty, of the central bank was to control inflation," Bob Brusca, chief economist of FAO Economics, wrote in a note to clients. "It may not be the central bank's duty to spur growth; on the other hand, if there is no growth, no one is particularly interested in controlling inflation."

Brusca, who is a former Fed economist, essentially is saying that a clear lack of inflation, and a lack of evidence that deflation is overtaking the economy, gives the central bank the room to address other problems in the real economy, because inflation is taking care of itself.

Other problems include targeting a prolonged high unemployment rate and maintaining growth in gross domestic product by not taking actions that could spook markets. As Brusca put it: "[T]here will be no inflation unless the central bank had done something outrageously bad previously."

Which begs the question: could talk about raising the federal funds rate some six months after the Fed concludes its economic stimulus program -- which Yellen suggested in her comments -- become something outrageously bad?

"If you start raising rates in an economy where you have very little slack or very little give, I'm not sure the economy bears that well," Lance Roberts, chief strategist at STA Wealth Management, said in a phone interview.

Roberts said he believes that if the U.S. economy isn't growing at a 3% to 4% annual clip, then we wouldn't benefit from raising the federal funds rate. Roberts argued that raising rates could push costs higher for companies, which right now are posting record profits but underwhelming revenue. If rates rise, Roberts says, costs for companies will rise, which will affect profitability, which will in turn slow economic growth.

It could be harmful for the economy if the Fed pivots to more focus on inflation, and as markets worry about the fed funds rate rising sooner than anticipated. But Yellen reiterated that the central bank will continue to focus on a range of economic indicators. Additionally, the rebound in stocks late Wednesday afternoon to offset the sudden plunge on Yellen's six-month comment, suggests that investors know economic conditions could change, making the Fed head's prediction obsolete.

Fed watchers are far too familiar since the 2008 financial crisis with how often Fed forecasts can swing.

-- Written by Joe Deaux in New York.

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