United States: Fed continues with tapering plans, leaves policy rate unchanged again
January 29, 2014
At its policy meeting on 28-29 January, the Federal Open Market Committee (FOMC) announced that it would continue winding down its asset purchase program as it had announced at the previous meeting that took place in December. The decision to continue tapering was reached unanimously, marking the first policy meeting without a dissent since June 2011. The Fed explained that there has been, "cumulative progress towards maximum employment and improvement in the outlook for labor conditions," and therefore it has decided to, "make a further measured reduction in the pace of its asset purchases."
Starting in February, the Fed will conduct purchases of USD 35 billion of long-term Treasury securities and USD 30 billion of mortgage-backed securities per month, down from USD 40 billion and USD 35 billion respectively. This cumulative USD 10 billion reduction equals that which was carried out early in January. The Fed expects that maintaining a still sizeable portion of the original purchase program will continue to promote economic recovery.
According to the Fed, growth in economic activity has picked up in recent quarters. The Fed pointed out that household spending and business fixed investment have been advancing quickly in recent months, although recovery in the housing sector continues to slow. Tightened fiscal policy is "restraining" economic growth, but to a lesser extent than in previous months. In its official statement, the Fed also emphasized that labor market indicators are mixed, but that they are on balance and have shown further improvement. Moreover, it noted that, while the unemployment rate has declined, it still remains elevated. Overall, the Fed sees the downside risks for the economy and labor market as, "having become more nearly balanced." The Fed is encouraged by the, "growing underlying strength in the broader economy," and will continue to monitor economic developments. If there are further improvements in the labor market and if inflation continues to move towards it 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 on sustained economic improvements.
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 its forward guidance regarding this low target range. Specifically, it stated that it would be appropriate to maintain the current low target range for the federal funds, "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 2.0% longer-run goal, and longer-term inflation expectations continue to be well anchored." This leaves the possibility open for the funds rate to remain low even if the unemployment rate falls to 6.5%.
In terms of price developments, monetary authorities explained that inflation is still, "running below the Committee's longer-run objective," while adding that long-term inflation expectations have remained stable. The Fed recognized that inflation that is persistently below its 2% target could pose risks to economic growth, and it is waiting for evidence that inflation will move back toward this objective over the medium term.
FocusEconomics Consensus Forecast panelists expect the Fed to keep interest rates unchanged in 2014, with the federal funds rate averaging 0.74% in 2015.
Author: Carl Kelly, Economist