United States: Fed acknowledges economic improvements, but refrains from signaling earlier rate hike
July 30, 2014
At its policy meeting that took place on 29–30 July, the Federal Open Market Committee (FOMC) announced that it would continue winding down its asset purchase program at the pace it first announced in December of last year. The Fed explained that given the, “cumulative progress towards maximum employment and the improvement in the outlook for labor conditions,” it has decided to, “make a further measured reduction in the pace of its asset purchases.” Starting in August, the Fed will conduct purchases of USD 15 billion in long-term Treasury securities and USD 10 billion in mortgage-backed securities per month, which is down from USD 20 billion and USD 15 billion respectively. This cumulative USD 10 billion reduction equals that which was implemented at each of the previous five meetings. The Fed expects that maintaining a portion of the original purchase program will continue promoting economic recovery. If the winding down of asset purchases continues at the current pace, the program will end in December of this year.
According to the Fed, economic growth rebounded in the second quarter. In terms of the labor market, the Fed pointed out that, while conditions have improved and the unemployment rate has declined further, “there remains significant underutilization of labor resources.” Moreover, while household spending is rising moderately and business fixed investment has advanced, recovery in the housing market continues to be slow. The Fed considers there to be, “sufficient underlying strength in the broader economy to support ongoing improvement in labor market conditions,” and will continue to monitor economic developments. As in previous meetings, the Fed stated that, if there are further improvements in the labor market and if inflation continues to move towards its long-run objective, it, “will likely reduce the pace of asset purchase in measured steps at future meetings.” However, the Fed reiterated that asset purchases are not on a “preset course” and its decisions remain contingent upon sustained economic improvements.
In terms of price developments, monetary authorities explained that inflation, “has moved somewhat closer to the Committee’s longer-run objective,” while adding that long-term inflation expectations have remained stable. The Fed also recognized that the risk of inflation running persistently below the 2.0% target has diminished.
Meanwhile, in order to support continued progress in the economy, the FOMC announced that the federal funds target rate would remain within the current range of between 0.00% and 0.25%. The Fed maintained the forward guidance regarding this low target range, which was introduced three meetings ago. Decisions to hike the rate will depend on the assessment of a, “wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments.” Moreover, the Fed indicated that it would likely be appropriate to maintain the current low target range for the federal funds rate for, “a considerable time after the purchase program ends.” The Fed currently anticipates that economic conditions will warrant keeping the rate at low levels, “even after employment and inflation are near mandate-consistent levels.”
Philadelphia Federal Reserve President Charles Plosser was the only member of the FOMC to show dissent with the decision to keep rates low for an extended period of time, but his view reflects the intense debate that is taking place both within and outside the Fed over when and how interest rates should be raised. Plosser’s argument against the Fed’s guidance is that, “such language is time dependent and does not reflect the considerable economic progress that has been made toward the Committee's goals.” The median projection made by committee members in a supplementary document released at the last meeting is for rates to rise to 1.25% by the end of 2015. However, with unemployment falling steadily and inflation creeping up, many economists agree with Plosser and believe that a rate hike should happen sooner.
Author: Carl Kelly, Economist