The decision of the Fed to define a time line for tapering given the low inflation numbers has been something of a puzzle. Cleveland Federal Reserve President Sandra Pianalto provides a concise explanation of that puzzle in her speech today:
Last fall, the FOMC initiated a third round of asset purchases. In this program, which is often referred to as “QE3,” we are purchasing $85 billion of Treasury securities and mortgage-backed securities per month. This policy was designed to drive some near-term momentum in the economy with the specific goal of achieving a substantial improvement in the outlook for the labor market.
Labor market data comes in every month and is subject to different interpretations. In my view, there has been meaningful improvement in both current labor market conditions and in the outlook for the labor market since the FOMC launched the current asset purchase program. Employment growth has been stronger than I was expecting, and the unemployment rate today is more than half a percent lower than I projected it to be last September.
In light of this progress, and if the labor market remains on the stronger path that it has followed since last fall, then I would be prepared to scale back the monthly pace of asset purchases.
Thus, according to Pianalto, QE3 was never about inflation, but instead was always about the labor market. And, by her assessment, they can roll out the "Mission Accomplished" banner. In short, the improvement in the labor market - or, more specifically, the stability of the labor market in light of fiscal contraction - is a driving force in the tapering decision. Hence why officials are not willing to end speculation on a September taper despite no evidence that inflation is trending back toward the Fed's target in a timely fashion. Inflation management, it would seem, is a problem that many policymakers simply think is a task best left for interest rate policy.