QE tapering / forward guidance

QE, finitely by Greg Ip

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But then the tide, almost miraculously, began to turn. The pace of job growth increased, the unemployment rate declined (albeit in part due to a shrinking labour force), retail sales and manufacturing activity picked up. Congress declared a truce and passed a budget agreement that for the first time loosens the fiscal vise, albeit modestly, and foreign economies showed signs of momentum. Even housing, which wavered as mortgage rates shot up in anticipation of tapering, did not crumble, and indeed housing starts in November hit a post-recession high.
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More important, tapered QE was coupled with a stronger commitment to keep the short-term interest rate target at zero. The Federal Open Market Committee (FOMC) had previously said it would stay at zero at least until unemployment had fallen below 6.5%. On Wednesday it said it would stay there “well past the time” that unemployment drops below 6.5%, “especially if projected inflation continues to run below” its 2% target. That, according to FOMC members’ projections, means until 2015 or later.
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Mr. Bernanke indicated he thought the drop in inflation was due to transitory factors, such as a slowing rise in health costs, and that it would drift back to 2%. Whether a failure to do so would cause QE to be ramped up again is unclear, but it would certainly result in a much longer period of zero interest rates. The bottom line is that an improving path for growth figured more prominently in the Fed’s thinking than the declining path of inflation.
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