In her prepared remarks for her Senate confirmation hearing, Janet Yellen gave no specific recommendations for monetary policy changes. She is widely expected to be confirmed as the next chair of the Federal Open Market Committee later this year. She will assume her duties as chair at the March 18/19 meeting of the FOMC. With four months to go until she officially heads the FOMC, we are already seeing her more visible imprint on monetary policy. Within the past few weeks, speculation has increased about the possibility of a change in forward guidance regarding the near-zero fed funds rate. The near-zero fed funds rate is now linked to an unemployment rate threshold of 6.5 percent. This threshold implies that the fed funds rate will likely remain near zero until at least late 2014, and probably longer, well into 2015. The Fed now appears to be contemplating the possibility of lowering the unemployment rate threshold, to a range between 5.5 and 6.0 percent. Lowering the threshold to 5.5 percent could effectively delay the first increase in the fed funds rate for about another year, pushing the first increase into 2016.
The Fed’s other monetary policy lever, its asset purchase program, is also in play. The Federal Reserve currently purchases $85 billion worth of Treasury bonds and mortgage-backed securities per month. It was broadly assumed, consistent with guidance from key Federal Reserve officials, that the Fed would begin to taper QE3 before the end of 2013. With the last policy statement from the FOMC on October 30, that assumption no longer holds. The policy statement says that “…asset purchase purchases are not on a preset course…”.
The next meeting of the FOMC is scheduled for December 17/18. For that meeting the Fed may have its own “grand bargain” in the works. One possible outcome of the meeting would be for the Fed to begin the taper process for its asset purchase program, perhaps “taper-lite”, at the same time that it lowers the unemployment rate threshold for the fed funds rate. Such a maneuver would allow the Fed to take a step towards unwinding its extraordinary measures while providing more monetary stimulus through guidance on the fed funds rate. Ideally, the opposing forces would offset. However, there may be an asymmetrical outcome to that maneuver, as it would extend, for another year, the unintended and distortive consequences of a near-zero fed funds rate. Moreover, it is reasonable to assume that the returns to the U.S. economy from ultra-cheap money are diminishing. We will get less bang for the cheap bucks in 2016 than we did in 2008.
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