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Wednesday, September 18, 2013

Why Didn't the Fed Begin Tapering?

[Update: There is a revised version of this at CBS MoneyWatch.]

I was supposed to be on Reuters right now discussing the Fed decision, but had technical problems (no sound). Grrr.

I was going to give four reasons for the delay.

But let me say first that I agree with the decision -- as I said yesterday, I didn't think it was time to begin backing off of QE just yet. But I thought that all of the talk about tapering and the predictions of $5-$20 billion change, and the fact that financial markets were expecting something would tip the scales toward beginning the taper.

Here's why I think they delayed:

1. Fiscal policy. The uncertainty over a government shutdown, how much additional austerity there might be, and so on made the Fed nervous about doing anything that might add to the negative shock from fiscal policy. Fiscal policymakers have performed terribly over the course of the crisis, and the Fed is the only game in town. It can't take the risk of adding to the potential problems that fiscal policy might cause.

2. Inflation and unemployment. As I said already, inflation is too low and unemployment is too high. There are no signs of an acceleration in the recovery of unemployment, and no signs that inflation expectations are moving above the Fed's long-run target. Since all signs point to easing, why do anything that might be construed as a negative shock?

3. The Fed is gun shy. The negative shock -- i.e. the rise in long-term interest rates and the corresponding slowdown in housing and investment -- when it first began talking about tapering surprised the Fed. Just talking about tapering led to an unexpected spike in interest rates and although it appears that tapering was priced into financial markets, why risk another surprise? I don't think additional bond purchases are going to do much good for the economy, all that can be done has pretty much been done already, but there is the potential for a negative reaction from markets and with all the less than robust recovery, fiscal policy worries and the like, why take a chance?

4. Capital flight from developing markets. A investors have anticipated rising yields do to the Fed potentially beginning to unwind policy, capital has flowed from developing markets to the US causing problems for these countries. Those problems could feed back into US markets and make a slow recovery even slower, so why take that chance?

Overall, then, while there probably isn't a lot to be gained from continuing QE, there is potentially a lot to lose from miscalculating the markets reaction to the onset of tapering, and the Fed wants to be more sure than it is right now about the strength of the economy before it takes that chance.

I had more to say, e.g. there's an argument to be made that this represents further easing (the rise in long-term rates has slowed mortgage markets, so the Fed is now buying a larger share of the assets issued in these markets, and the same is true for Treasuries -- due to the fall in the deficit and corresponding fall in new debt issues) but I'll leave it that for the moment. Here's the press release:

Press Release, Release Date: September 18, 2013, For immediate release: Information received since the Federal Open Market Committee met in July suggests that economic activity has been expanding at a moderate pace. Some indicators of labor market conditions have shown further improvement in recent months, but the unemployment rate remains elevated. Household spending and business fixed investment advanced, and the housing sector has been strengthening, but mortgage rates have risen further and fiscal policy is restraining economic growth. Apart from fluctuations due to changes in energy prices, inflation has been running below the Committee's longer-run objective, but longer-term inflation expectations have remained stable.
Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. The Committee expects that, with appropriate policy accommodation, economic growth will pick up from its recent pace and the unemployment rate will gradually decline toward levels the Committee judges consistent with its dual mandate. The Committee sees the downside risks to the outlook for the economy and the labor market as having diminished, on net, since last fall, but the tightening of financial conditions observed in recent months, if sustained, could slow the pace of improvement in the economy and labor market. The Committee recognizes that inflation persistently below its 2 percent objective could pose risks to economic performance, but it anticipates that inflation will move back toward its objective over the medium term.
Taking into account the extent of federal fiscal retrenchment, the Committee sees the improvement in economic activity and labor market conditions since it began its asset purchase program a year ago as consistent with growing underlying strength in the broader economy. However, the Committee decided to await more evidence that progress will be sustained before adjusting the pace of its purchases. Accordingly, the Committee decided to continue purchasing additional agency mortgage-backed securities at a pace of $40 billion per month and longer-term Treasury securities at a pace of $45 billion per month. The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction. Taken together, these actions should maintain downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative, which in turn should promote a stronger economic recovery and help to ensure that inflation, over time, is at the rate most consistent with the Committee's dual mandate.
The Committee will closely monitor incoming information on economic and financial developments in coming months and will continue its purchases of Treasury and agency mortgage-backed securities, and employ its other policy tools as appropriate, until the outlook for the labor market has improved substantially in a context of price stability. In judging when to moderate the pace of asset purchases, the Committee will, at its coming meetings, assess whether incoming information continues to support the Committee's expectation of ongoing improvement in labor market conditions and inflation moving back toward its longer-run objective. Asset purchases are not on a preset course, and the Committee's decisions about their pace will remain contingent on the Committee's economic outlook as well as its assessment of the likely efficacy and costs of such purchases.
To support continued progress toward maximum employment and price stability, the Committee today reaffirmed its view that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the asset purchase program ends and the economic recovery strengthens. In particular, the Committee decided to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that this exceptionally low range for the federal funds rate will be appropriate at least as long as the unemployment rate remains above 6-1/2 percent, inflation between one and two years ahead is projected to be no more than a half percentage point above the Committee's 2 percent longer-run goal, and longer-term inflation expectations continue to be well anchored. In determining how long to maintain a highly accommodative stance of monetary policy, the Committee will also consider other information, including additional measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments. When the Committee decides to begin to remove policy accommodation, it will take a balanced approach consistent with its longer-run goals of maximum employment and inflation of 2 percent.
Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; James Bullard; Charles L. Evans; Jerome H. Powell; Eric S. Rosengren; Jeremy C. Stein; Daniel K. Tarullo; and Janet L. Yellen. Voting against the action was Esther L. George, who was concerned that the continued high level of monetary accommodation increased the risks of future economic and financial imbalances and, over time, could cause an increase in long-term inflation expectations.

    Posted by on Wednesday, September 18, 2013 at 12:33 PM in Economics, Monetary Policy | Permalink  Comments (20)


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