Fed day

Fed Decision Day: What to Watch For by Binyamin Appelbaum

President Obama gave a long speech Tuesday night about the things government can do to help the economy without ever mentioning the Federal Reserve. Presidents rarely do. But it’s also the case that folks at the White House, like most Fed officials, think the central bank already has done as much as it should.

The Fed ended 2013 by announcing that it would begin to reduce its extraordinary efforts to stimulate the economy. At the end of its first policy-making meeting of 2014 on Wednesday, it is likely to announce that the retreat will continue.

This is also the last meeting for the Fed chairman, Ben S. Bernanke, who will step down on Friday after leading the central bank for eight years. After failing to foresee the financial crisis, he led the Fed’s aggressive efforts to contain the damage, and then its more tentative campaign to help restore the flow of economic activity.

He said at the beginning of his second term that he hoped to see that effort through to completion, but with the retreat barely begun, a significant part of Mr. Bernanke’s legacy will be shaped by the performance of his successor, Janet L. Yellen.

Here are three things to watch on Wednesday:  

1. Twice is a pattern

Fed officials have given every indication that they plan to reduce their monthly accumulation of Treasury and mortgage-backed securities by $10 billion at the January meeting, just as they did at their last meeting in December. That, in turn, would reinforce the expectation that the Federal Open Market Committee will do the same thing when it next meets in March.

Investors will be watching the language of Wednesday’s statement for any sign that the Fed has doubts about the wisdom of maintaining that pace, like a weakening in the Fed’s description of the economic outlook.  

2. What happens after the unemployment rate hits 6.5 percent?

The unemployment rate used to be a pretty decent proxy for the health of the labor market. But its rapid fall to 6.7 percent in December, from a peak of 10 percent in 2009, probably overstates the actual improvement in the labor market. The rate is based on the number of people who are looking for work, and a lot of people have given up. Some have settled into retirement or qualified for disability benefits, but others may simply be waiting for economic conditions to improve.

The Fed has said since December 2012 that it plans to keep short-term interest rates near zero at least as long as the unemployment rate is above 6.5 percent. With the unemployment rate about to drop below that threshold, a number of Fed officials have said that the central bank needs to clarify its plans.

The Fed took a stab at the problem in December, saying that it intended to keep interest rates near zero “well past the time that the unemployment rate declines below 6.5 percent, especially if projected inflation” remains modest.

That’s a thin reed, particularly for a central bank that has described forward guidance as its most powerful means of stimulating the economy. But in deciding whether to say more, the Fed is wrestling with the balance between precision and accuracy. Precision increases the power of forward guidance, but only if investors believe the Fed will hew to its plans. And the decision to taper bond purchases has already shown that officials are nervous about doing too much.  

3. Hey, aren’t you guys in charge of inflation?

The pace of price increases remains sluggish and, with each passing month, the confidence of Fed officials that inflation will rebound gets a little harder to justify.

The Fed says that it wants annual inflation of about 2 percent, but last year the Consumer Price Index rose by just 1.5 percent. (A second measure, which the Fed regards as more reliable, will be published Friday.)

The Fed’s official statements have reflected growing concern about low inflation. In its December statement, the Fed said that “inflation persistently below its 2 percent objective could pose risks to economic performance.”

Strikingly, a number of Fed officials also have expressed puzzlement, saying that they do not understand why prices are rising so slowly.