Think about the last raise you expected and didn't get. You'd already spent some of it in your head. Maybe in real life too. Two American economists just won the Nobel Prize for taking that habit seriously. Robert E. Hall of Stanford and Michael Woodford of Columbia share 12 million Swedish kronor, about $1.3 million, for work on how expectations hold an economy together.
Here's the idea in kitchen terms. You don't budget off this month's paycheck. You budget off what you expect to earn for years. A one-time check gets saved or spent on a repair. A real raise changes the grocery list. Hall made the case in a 1978 paper. In 1982, with Frederic Mishkin, he found about 20% of households live hand to mouth, and the other 80% act on what they expect. That's from David R. Henderson's op-ed in Tuesday's Journal. Henderson, a Hoover fellow, draws his own conclusion from it, that Keynesian fiscal policy such as a temporary tax cut wouldn't work. That part is his argument.
Telling people the plan
Woodford took the idea to the central bank. If households act on expectations, then what the Fed says is a tool by itself. His 2003 book Interest and Prices has been called a bible for central bankers, Henderson notes. After the financial crisis, with rates at zero, the Fed promised to keep them there a long while. That promise was meant to get people borrowing and spending right away. It's called forward guidance, and central banks used it from 2009 on.
Then comes the twist, and it's Greg Ip's in Wednesday's paper. Kevin Warsh, Fed chairman since May, ended forward guidance. He argues it makes the Fed stick with a plan after the facts change, and gets markets watching the Fed's mouth instead of the data. The Nobel committee, the same week, called clear and credible central-bank communication vital. Ip's point is that the two camps aren't that far apart. Many central bankers have dialed guidance back since rates left zero. And Warsh's own deputies have lately been "discouraging expectations of an interest-rate increase this month." That's talk. The decision comes when the Fed meets later this month.
Our read
Two planning domains here. Behavioral, because the 20/80 split is the whole game. The households that plan on expected income are the ones that end up with choices. And Fixed Income, IN02, because the Fed just took away a crutch. For years investors could read the Fed's own map. Now the map is gone, and rate bets swing on each data release. That's one reason the desk keeps safe money in Treasury bills and floating-rate paper, SGOV in 49 books and USFR in 14. Long bonds sit in only a few older books. You don't have to guess the path when your money resets every few months.
Here's the connection to your own plan. Your plan runs on expectations too, and the big one is the rate your safe money earns. Find the next maturity in your T-bill or CD ladder, or the rate line on your savings account, and write two things next to it. What you'd do if it rolls over a full point lower, and what you'd do a point higher. That's your own forward guidance, and nobody can cancel it. The Fed meets later this month. If you'd rather walk through it with someone, that's what a review is for. An answer written before the meeting beats working it out the day the rate changes.