Sunday, January 27, 2013

Thresholds for QE

by Bill McBride on 1/27/2013 02:42:00 PM

In the schedule for this coming week, I mentioned there is a two day Federal Open Market Committee (FOMC) meeting ending on Wednesday, January 30th with the FOMC announcement expected at 2:15 PM ET on Wednesday. No significant changes are expected at this meeting.

At the last meeting, the FOMC set "thresholds" for raising the Fed Funds rate. From the December FOMC statement:

"[The FOMC] 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."
emphasis added
An interesting question is if the FOMC will set thresholds for reducing or ending the current $85 billion per month in asset purchases (aka Quantitative Easing or QE). Goldman Sachs chief economist Jan Hatzius discussed this possibility last week:
"The rationale for QE thresholds is similar to that for funds rate thresholds, namely that they would help the financial markets understand the Fed's reaction function with respect to changes in the economic outlook. If the committee adopted such an approach, the most likely thresholds would be 7.25% for the unemployment rate, 2.5% for the 1-2 year PCE inflation outlook, and "well anchored" inflation expectations. We would also expect an additional "out," namely that QE must not impair market functioning or create financial imbalances.

Any move to QE thresholds would probably not occur until the spring or summer of 2013. But the future of QE, the criteria for slowing or ending it, and perhaps even the question of whether QE thresholds are desirable in principle are likely to be on the FOMC's agenda as soon as next week."
Boston Fed President Eric Rosengren discussed this in a speech last year:
"My own personal assessment is that as long as inflation and inflation expectations are expected to remain well-behaved in the medium term, we should continue to forcefully pursue asset purchases at least until the national unemployment rate falls below 7.25 percent and then assess the situation.

I think of this number as a threshold, not as a trigger – and the distinction is important. I think of a trigger as a set of conditions that necessarily imply a change in policy. A threshold, unlike a trigger, does not necessarily precipitate a change in policy."
Based on the current FOMC projections of the unemployment rate, this threshold would not be reached until some time in 2014. I don't expect QE thresholds to be announced this week, but this might happen later this year.

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