United States: Fed pushes ahead with tapering despite lower 2014 economic growth forecast
June 19, 2014
At its policy meeting on 17–18 June, 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. 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 July, the Fed will conduct purchases of USD 20 billion in long-term Treasury securities and USD 15 billion in mortgage-backed securities per month, which is down from USD 25 billion and USD 20 billion respectively. This cumulative USD 10 billion reduction equals that which was implemented at the previous four 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 has rebounded in recent months after a dismal first quarter. In fact, the contraction registered in Q1 prompted the Fed to cut its 2014 GDP forecast from a range of 2.8%–3.0% to 2.1%–3.0%. In terms of the labor market, the Fed pointed out that indicators have generally shown an improvement although the unemployment rate remains elevated. 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.
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 two meetings ago. Specifically, future decisions to hike the rate do not depend on a 6.5% unemployment threshold, but rather 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.” The median projection made by committee members in a supplementary document is for rates to rise to 1.25% by the end of 2015, which is up from the 1.00% median estimate made in March.
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 if inflation is persistently below the 2.0% target, this could pose risks to economic growth and it is waiting for evidence that inflation will move back toward this objective over the medium term.
Author: Carl Kelly, Economist