The Fed is out with their statement and the words “considerable time” live to see another day!
Since then, the Fed has tried to explain that less bond-buying doesn't mean rates will rise faster. The opposite, actually. The Fed will try to counteract its reduced bond-buying by raising rates even slower than it planned before. So it's taking monetary stimulus out with the right hand, and putting it back with the left. And there's still plenty more it can put back. After all, the Fed hasn't explicitly lowered its unemployment threshold, nor added an inflation floor. It's just suggested it will do both—and that was enough for now. That the taper didn't make stocks fall or expected rates rise shows that it was.
But there's still work to do. Unemployment is still above target, and inflation is still below. In fact, the Fed expects inflation to stay below target all the way through 2016. As Robin Harding of the Financial Times points out, that's the Fed admitting that it plans to fall short of what it says the best policy is right now. That best policy—what Janet Yellen calls "optimal control"—calls for above-target inflation the next few years to bring down unemployment faster. You can see what that looks like in the chart below from a speech she gave last year.
In other words, the Fed doesn't need to figure out how to keep monetary stimulus constant even as it tapers. It needs to figure out how to increase monetary stimulus even as it tapers. Or stop tapering.
But what will have most pleased Bernanke is the reaction in the bond markets, where the yield on ten-year Treasuries barely moved at all. Most mortgage rates are tied to these yields. If they had jumped sharply—as they did earlier this year when Bernanke first raised the prospect of a taper—the recovery in the housing market, a key element of the broader recovery, could have been threatened. As things turned out, the bond market had already anticipated the taper, and, at least for now, the housing market is safe.
In fact, things are going pretty much as the Fed chairman had hoped. The markets are calm, and growth and hiring are finally picking up, a development for which the Fed deserves some credit. As Bernanke pointed out, fiscal policy—set by Congress and the White House—has been working in the opposite direction to monetary policy, knocking perhaps one and a half percentage points off G.D.P. growth this year. But we’ve still managed to struggle through with growth of about two per cent. That’s far from great. But without the Fed’s offsetting policy moves, the economy would have been much weaker.
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.That certainly seems like the right interpretation. Indeed, I wrote that the Fed was unlikely to taper because inflation is so low; the choice to go ahead and taper anyway certainly looks like evidence that they're not that worried about prices.
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.Yesterday this became:
The Committee recognizes that inflation persistently below its 2 percent objective could pose risks to economic performance, and it is monitoring inflation developments carefully for evidence that inflation will move back toward its objective over the medium term.The newer version (to my eyes, at least) implies that policy may change in the future specifically in order to raise inflation. The Fed has acted before to halt disinflation, but it has been reluctant to take positive steps to raise inflation that is low but stable. This suggests a slight change in tone in that direction.
The Committee now anticipates, based on its assessment of these factors, that it likely will be appropriate to maintain the current target range for the federal funds rate well past the time that the unemployment rate declines below 6-1/2 percent, especially if projected inflation continues to run below the Committee's 2 percent longer-run goal.This is very close to adoption of an interest-rate threshold for an inflation minimum, something this newspaper has supported as a means to strengthen forward guidance. The taper provides one signal, yes, and had the Fed opted not to taper and explicitly linked that decision to these changes in guidance, that would have been a more powerful policy combination. But it is much harder to argue today that the Fed is not concerned about inflation below target and willing to work to raise it than it was on Tuesday. Unsurprisingly, expectations for future inflation, as measured by breakevens, jumped on the statement.
The Committee now anticipates, based on its assessment of these factors, that it likely will be appropriate to maintain the current target range for the federal funds rate well past the time that the unemployment rate declines below 6-1/2 percent, especially if projected inflation continues to run below the Committee’s 2 percent longer-run goal.So from the perspective of monetary stimulus, the Fed giveth in terms of forward guidance and