Wednesday, November 06, 2013

Will the Fed "Taper" QE and Change "Thresholds" at the same time?

by Bill McBride on 11/06/2013 08:39:00 AM

From Jeff Cox at CNBC yesterday: Fed could be about to make a major policy change

Separate papers that will be presented formally this week at an International Monetary Fund meeting suggest that the U.S. central bank should lower its target for the jobless rate before it hikes rates.
Note: The Fed has made it clear that these are "thresholds", not "targets". More from Cox:
Under current Fed thinking, the unemployment rate would have to drop to just 6.5 percent—with the inflation rate rising to 2.5 percent—before making changes in the present structure, which has the policy target rate near zero.

But the research from a half-dozen Fed economists maintains the unemployment objective actually should be lowered to 6.0 percent or even 5.5 percent before it makes any moves.
...
According to an analysis from Jan Hatzius, chief economist at Goldman Sachs, the two Fed papers actually would imply an earlier reduction of QE than planned—perhaps as soon as December—while the zero-bound interest rates could remain in place until 2017 and kept below normal into "the early 2020s."

"The studies suggest that some of the most senior Fed staffers see strong arguments for a significantly greater amount of monetary stimulus than implied by either a Taylor rule or the current 6.5 percent/2.5 percent threshold guidance," Hatzius wrote. "Given the structure of the Federal Reserve Board, we believe it is likely that the most senior officials—in particular, Ben Bernanke and (Chair-elect) Janet Yellen—agree with the basic thrust of the analysis."
Here is more from Goldman's Hatzius:
It is hard to overstate the importance of two new Fed staff studies that will be presented at the IMF's annual research conference on November 7-8. The lead author for the first study is William English, who is the director of the Monetary Affairs division and the Secretary and Economist of the FOMC. The lead author for the second study is David Wilcox, who is the director of the Research and Statistics division and the Economist of the FOMC. The fact that the two most senior Board staffers in the areas of monetary policy analysis and domestic macroeconomics have simultaneously published detailed research papers on central issues of the economic and monetary policy outlook is highly unusual and noteworthy in its own right. But the content and implications of these papers are even more striking.

...[O]ur initial assessment is that they considerably increase the probability that the FOMC will reduce its 6.5% unemployment threshold for the first hike in the federal funds rate, either coincident with the first tapering of its QE program or before.
...
[O]ur central case is now that the FOMC will reduce the threshold from 6.5% to 6% at the March 2014 FOMC meeting, alongside the first tapering of QE; however, a move as early as the December 2013 meeting is possible, and if so, this might also increase the probability of an earlier tapering of QE.
CR Note: Changing the thresholds (basically saying the FOMC will keep the Fed Funds rate exceptionally low for a longer period) could offset any negative impact from starting to taper QE3. I wouldn't be surprised if tapering - and lowering the unemployment rate threshold - happen at the same meeting.  This could happen as soon as the December meeting (depending on incoming data as I noted this weekend) or sometime in 2014.

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