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FOMC: More of the Same on QE, But New Language to Guide It
Northern Trust
December 13, 2012

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The Fed’s decision to increase the scope and size of the quantitative easing program following the two-day FOMC meeting was largely expected. Its choice of new wording to express its posture came sooner than expected.

The Fed’s quantitative easing program now includes purchases of $45 billion of Treasury securities each month, in addition to purchases of $40 billion in mortgage backed securities.  It is an aggressive plan that will increase the size of the Fed’s balance sheet to nearly $4 trillion by the end of 2013 from $2.84 trillion as of December 5, 2012.  Fed President Jeffrey Lacker of the Richmond cast the only dissenting vote and he has done so at each meeting in 2012. 

Economic Update - chart 1 - 121212

Recent economic data justify the Fed’s actions today.  Employment conditions remain tepid, consumer and business confidence are falling, exports are limited by slow growth in Europe, and capital spending remains weak.

Clearly, most on the FOMC see the benefits from quantitative easing outweighing the costs.  Addressing critics who wonder about this tradeoff, Chairman Ben Bernanke noted during his press conference that the Fed’s asset purchase plan is flexible and will be calibrated in a manner that is consistent with economic developments.  He added that the efficacy of the asset purchase plan will be borne in mind as the Fed moves along with its program. 

New Monetary Policy Thresholds

With its December statement, the Fed moved away from a calendar-based approach for forward guidance about monetary policy to an economic-indicator based method.  The Fed reiterated that it will continue to purchase Treasury and mortgage-backed securities until there is "substantial improvement" in the labor market, but quantified this view by noting that the "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." 

Respecting the dual mandate of full employment and price stability, the Fed indicated its stimulus would continue only if "inflation between two and three years ahead is projected to be no more than a half percentage point above the Committee’s 2.0% longer-run goal.”

For context, the November unemployment rate stands at 7.7% and overall inflation, as measured by the year-to-year change of the core personal consumption expenditure price has risen 1.6% from a year ago in October.

Economic Update - chart 2 - 121212

Several thoughts on the new turns of phrase:

  • We think the new passage is a major improvement over the date-based guidance.  It allows for the possibility that much better economic performance could bring an earlier end to accommodation, and offers a framework to assess when this might occur.
  • The passage on a tolerable range for inflation was clearly addressed at those concerned that a focus on employment might diminish our central bank’s attention to inflation.  Nonetheless, long-term Treasury bonds sold off in the hours after the statement was issued.
  • The statement leaves considerable room for discretion, which we think is essential to policy making.  The two target variables are not hard limits, and allow for a broad range of price and employment indicators to enter the discussion.
  • Given the updated forecasts from the participants, the unemployment rate is not expected to drop below the 6.5% level until 2015.  So, functionally, the expected timing of a change in policy should not have changed materially as a result of the change in wording.

The possibility of dual targets was first promoted by Fed President Charles Evans of Chicago (a voting member in 2013) in 2010, and has gained adherents ever since.  This should represent the last of the tinkering with FOMC communications for some time.


(c) Northern Trust


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