The
US economy has seen steady growth since the recession. Now, the Fed is ready to
begin to remove some of its highly accommodative monetary policy. The Fed has
started to taper Quantitative Easing and should continue with the trend until
the purchases are ended altogether. However, the Fed shouldn’t touch the Fed Funds
rate until the labor market and inflation have reached an adequate level.
In
the December FOMC meeting, the Fed started the process of scaling back the $85
billion-a-month bond-buying program by $10 billion, $5 billion in
mortgage-backed securities and $5 billion in long-term Treasury securities. In
the January meeting, the Fed continued the process of tapering by cutting
another $10 billion. However, there have been some recent weaknesses in economic
data, such as a .8% decrease in January manufacturing and the addition of only
113,000 jobs last month and 75,000 jobs in December, but that data is mostly
attributable to severe weather, instead of a faltering economic recovery[1].
Now, since the Fed has already set a trend of tapering, the public is expecting
further tapering, as the Treasury yield has recently risen based on speculation
that the Fed won’t stop tapering. Also, Quantitative Easing is meant to target
long-term interest rates, and long term projections for inflation, economic
growth, and unemployment remain stable. Given the current and projected
economic conditions, the Fed should continue the trend of tapering by $10
billion a month until they end the purchases in December, unless there is a
notable change in the outlook of the economy such as the continuation of weak
job growth.
Even though the Fed has started
tapering and has projected a stable price level and economic growth in the long
run, the persistently low inflation and distorted unemployment rate should keep
the target Fed Funds rate at near zero way past the time when QE has ended. The
last time inflation has risen to or above the target rate of 2% was back in
April of 2012. The current year-to-year core PCE inflation is only at 1.2%.[2]
The unemployment rate of 6.6% is getting closer to the 6.5% threshold; however,
the current low unemployment rate is partly caused by discouraged workers: the
labor force participation rate is at 63%, a level similar to the recession in
the late 1970s.[3] In
the short run, the Fed should continue with its forward guidance of keeping the
Fed Funds rate at near zero. As the unemployment rate gets closer to the
threshold, the Fed should take a look at other indicators such as the labor
force participation rate and U-6. The pre-recession levels for labor force
participation rate and U-6 are 66% and 8-9% respectively.[4]
Once the labor force participation rate has reached 64.5% and U-6 has reached
10%, the Fed should start raising the Fed Funds rate by a quarter percent each
meeting. Even though inflation has been persistently low, there are signs of
increasing levels of inflation and the long-run projection still remains stable
and inflation is expected to be at 1.5% in 2014 and rises up to 1.6 to 2.0%
next year. Therefore, the Fed should begin raising the Fed Funds rate around mid-to-late
2015.
With the improvements in the
economy, the Fed has begun reducing its expansionary policy by scaling back the
bond-buying program. However, the economy is not yet ready for a rise in the Fed
Funds rate. So, the Fed should continue with its forward guidance and
No comments:
Post a Comment