Last month the Fed decided to start tapering its monthly bond purchases. According to the FOMC minutes, most officials supported the gradual reduction in QE as they saw waning benefits from it. Although some officials expressed concern that additional asset purchases increase the likelihood that the Fed might at some point suffer capital losses, most still believe that the program is a positive factor on net and are in no hurry to end purchases now or relatively soon. With respect to the decision to taper, most members agreed that the cumulative improvement in labor market conditions and the likelihood that the improvement would be sustained indicated that the Committee could appropriately begin to slow the pace of its asset purchases at this meeting. As such, the decision was not such a close call after all.
Further reductions will be undertaken in measured steps, as indicated in the statement, but the pace of asset purchases is not on a preset course and will remain contingent on the Committee’s outlook for the labor market and inflation as well as the efficacy and costs of purchases. With respect to the latter, Fed officials are not so much concerned about inflation risks as financial stability risks since easy money could provide an incentive for excessive risk-taking in the financial sector, according to a survey among Federal Open Market Committee members. In any event, our current forecasts for real GDP, inflation and unemployment are broadly consistent with the view that bond buying will slow at its current pace.
According to the survey cited above, bond-purchases may be riskier than holding the fed funds rate close to zero for an extended period because QE works through lowering term premiums which policymakers also have less experience in.
With respect to the forward guidance on the fed funds rate, a few members suggested that lowering the unemployment threshold to 6 percent could effectively convey the Committee’s intension to keep the fed funds rate low for an extended period. However, most members wanted to make no change to the threshold and instead preferred to provide qualitative guidance to clarify that a range of labor market indicators would be used when assessing the appropriate stance of policy once the threshold is crossed. Moreover, a number of members thought that the forward guidance should emphasize the importance of inflation as a factor in their decisions.
As such, almost all members agreed to add language indicating the Committee’s anticipation, based on current assessment of additional measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments, that it would be appropriate to maintain the current target range for the federal funds rate well past the time that the unemployment rate declines below 6.5 percent, especially if projected inflation continues to run below the Committee’s longer-run objective.
While we find it interesting that officials actually talked about a specific number as an alternative to the current 6.5 percent unemployment threshold, lowering the threshold is off the table at least for the next few meetings. Its current qualitative guidance seems to work fine anyway.
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