Tapering To Continue, But Fed Policy May Get Murkier

Posted by Patrick Barnard on March 19, 2014 No Comments
Categories : Required Reading

The Federal Reserve will continue to taper its bond-buying program, reducing its monthly purchase of assets by another $10 billion, as revealed by minutes of the Federal Open Market Committee (FOMC) released Wednesday.

Beginning in April, the Fed will scale back its purchase of agency mortgage-backed securities to a pace of $25 billion per month rather than $30 billion per month, and will scale back its purchase of longer-term Treasury securities at a pace of $30 billion per month rather than $35 billion per month. The reductions bring the bond-buying, or qualified easing (QE) program from its original $85 billion per month to $55 billion per month.

The FOMC voted 8-1 to continue tapering. It was the first such vote with new Federal Reserve Chair Janet Yellen at the helm. Federal Reserve Bank of Minneapolis President Narayana Kocherlakota was the lone dissenter.

‘The FOMC currently judges that there is sufficient underlying strength in the broader economy to support ongoing improvement in labor market conditions,’ the FOMC says in a statement. ‘In light of the cumulative progress toward maximum employment and the improvement in the outlook for labor market conditions since the inception of the current asset purchase program, the committee decided to make a further measured reduction in the pace of its asset purchases.’

The FOMC has also decided to provide a greater level of detail in explaining how it arrives at its forward guidance on interest rates and QE. While the Fed has traditionally used the national unemployment rate as a primary factor in formulating economic policy, it also uses a wide range of other economic data. Still, in recent months, the Fed has emphasized that the rate of unemployment and inflation has been the main criteria used in deciding whether to taper its bond buying. In June of last year, then-Fed Chair Ben Bernanke said he wanted to see the rate of unemployment fall below 7% before any decision was made to taper.

But with the rate of unemployment now relatively stagnant at around 6.7% – and with no sign that the labor market will improve anytime soon – the Fed has decided to change its policy and will now start using a broader range of criteria – and further will give the public greater insight into the various criteria being used to drive its decision-making – particularly with regard to short-term rates.

During a press conference, Yellen said the reason the committee revised forward guidance is not because the previous guidance was ineffective, but rather, that providing more detail on the criteria used in formulating policy would help markets better understand the Fed's decision-making.

Yellen said if and when the rate of unemployment rate dips below 6.5%, the Fed would decide how long it would hold interest rates at the current 0% to 0.25%. However, when asked during the press conference how quickly the Fed will move to adjust interest rates after unemployment drops below the prescribed threshold, Yellen was not specific, saying a rate hike could come as soon as six months from that date.

Otherwise, the fed is sticking to its benchmark of 2% inflation and once again reiterated that it could reverse course and increase bond buying should the economy worsen.

‘The committee currently anticipates that, even after employment and inflation are near mandate-consistent levels, economic conditions may, for some time, warrant keeping the target federal funds rate below levels the committee views as normal in the longer run,’ the FOMC statement says.

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