The FOMC statement was released this morning. Key points are that Operation Twist will be converted one-for-one to an outright purchase program and the long-debated issue of thresholds became a reality. First thoughts:
On the current situation:
Information received since the Federal Open Market Committee met in October suggests that economic activity and employment have continued to expand at a moderate pace in recent months, apart from weather-related disruptions. Although the unemployment rate has declined somewhat since the summer, it remains elevated. Household spending has continued to advance, and the housing sector has shown further signs of improvement, but growth in business fixed investment has slowed. Inflation has been running somewhat below the Committee’s longer-run objective, apart from temporary variations that largely reflect fluctuations in energy prices. Longer-term inflation expectations have remained stable.
Slow and steady, taking into account Hurricane Sandy, with a special nod to weak investment numbers. Inflation both low in near-term and longer-term inflation expectations remain anchored. Nothing too surprising here as it seems broadly consistent with the tenor of recent speeches by Fed speakers.
Next, the outlook:
Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. The Committee remains concerned that, without sufficient policy accommodation, economic growth might not be strong enough to generate sustained improvement in labor market conditions. Furthermore, strains in global financial markets continue to pose significant downside risks to the economic outlook. The Committee also anticipates that inflation over the medium term likely will run at or below its 2 percent objective.
Slow and steady is not enough to generate the improvement in labor market the Fed believes is necessary within the context of the dual mandate. They continue to see strains in global financial markets…although this seems odd, as it seems that financial markets have calmed considerably in recent months. The FOMC reaffirms its commitment to long-term price stability.
Bond buying, key addition:
The Committee also will purchase longer-term Treasury securities after its program to extend the average maturity of its holdings of Treasury securities is completed at the end of the year, initially at a pace of $45 billion per month.
I am not surprised, but I was cautious that the Fed would choose to pull the trigger on a complete conversion of Operation Twist to an outright purchase program. I think the St. Louis Federal Reserve President James Bullard is right when he notes that this is a more dovish policy. The Fed has more than doubled the pace of the balance sheet expansion, a much more stimulative stance – unless, of course, we are deep into the territory of diminishing marginal returns.
We all knew thresholds were coming, but in general did not expect it this meeting:
To support continued progress toward maximum employment and price stability, the Committee expects 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. The Committee views these thresholds as consistent with its earlier date-based guidance. 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.
The expiration date of low-interest rate policy is replaced with economic thresholds, which I believe is a more appropriate communications strategy. The baseline expectation is that as long as unemployment remains above 6.5%, the Fed will tolerate an inflation forecast as high as 2.5% in the near term, assuming that long-term expectations remain anchored, before considering to raise rates. In other words, all bets are off if the Fed judges that long-term expectations are accelerating even if unemployment and near-term inflation forecasts remain within their respective bounds. The Fed is also taking pains to explain that policy depends on more than just two variables, and may act on the basis of that additional information. Also, the Fed does not believe the move to thresholds changes policy relative to the date-based guidance; it only changes the communications strategy.
Finally, a dissent:
Voting against the action was Jeffrey M. Lacker, who opposed the asset purchase program and the characterization of the conditions under which an exceptionally low range for the federal funds rate will be appropriate.
Not surprising in the least.
Bottom Line: The Fed delivered an early Christmas present to the economy by acting above expectations with not only a one-for-one conversion of Operation Twist to outright asset purchases, more than doubling the pace of balance sheet expansion, but also shifting the communications strategy to thresholds. The latter ties policy explicitly to outcomes rather than dates, which I think is the appropriate direction for policy.