Three cheers for Ben Bernanke!
The chairman of the US Federal Reserve has made it clear that monetary policy settings in the US will remain super stimulatory until either the unemployment rate drops to 6.5 per cent or inflation lifts to 2.5 per cent. That is the crux of the monetary policy announcement this morning.
US stocks jumped on the news, and why wouldn’t they with such a favourable outlook and the promise of easy policy settings for the next year or two? Bond yields also ticked higher, although they remain low, aided no doubt by the unrelenting buying from the Fed.
The steady yet increasingly sustained improvement in the US economy continues to unfold. The Federal Open Markets Committee of the Fed remains confident that GDP growth is on track to expand around 2.5 per cent in 2013, before accelerating to over 3 per cent in each of 2014 and 2015.
It is rosy outlook and it shows all too clearly how monetary policy is working to underpin economic growth and employment.
The end point is that the Fed decided to keep interest rates near zero and will maintain its strategy of quantitative easing as it reiterated its policy of buying $US85 billion of bonds each month. Bernanke even said in his press conference after the FOMC decision had been announced, that he “needed to see a sustained improvement in the economy, more than a few months, before slowing down quantitative easing”.
US interest rates have been near zero since December 2008.
In a slight change of tone, the Fed statement noted that “fiscal policy has become somewhat more restrictive", implying that the federal government’s deficit reduction plans may weigh on the economy, at least in the short term. In his press conference, Bernanke estimated that fiscal restraint was cutting 1-1.5 percentage points off the GDP growth estimates. This fiscal contraction was a likely reasons for the Fed to suggest that, despite the favourable outlook, it “continues to see downside risks to the economic outlook”.
That said, the Fed was upbeat on other matters, noting that “labour market conditions have shown signs of improvement in recent months” and that “the housing sector has strengthened further”.
One FOMC member dissented against the majority decision to keep monetary policy so easy. Kansas City Fed President Esther George maintained her position that she was “concerned that the continued high level of monetary accommodation increased the risks of future economic and financial imbalances and, over time, could cause an increase in long-term inflation expectations.”
For the moment George’s concerns look overblown and she is well away from the consensus view on policy and inflation risks.
Last week, I wrote about some of the issues associated with the possible exit strategy for the Fed from zero interest rates and the accumulated US$3 trillion or so of QE on its balance sheet (Tight spot to manoeuvre the Fed's reversal, March 14).
While it won't be easy, it is manageable, especially as the news of economic recovery continues to flow in.
The more hawkish members of the Fed (most are not voting members on the FOMC) are clearly starting to fret about the strength of the US recovery and the magnitude of the task of reversing what is the easiest monetary policy in US history. It is a concern based on the risk, which is so far invisible, that inflation will kick higher due to the easy money.
What the hawks seem to be missing is the fact that core inflation has been below 2 per cent for the last six years and has been at or below 2.5 per cent for 15 years. Inflation is nowhere to be seen. It isn’t a problem and while the labour remains well below capacity and the output gap remains very wide, inflation will not be a problem.
The bottom line of all of this is that the Fed will be keeping monetary policy extremely easy until there is ongoing momentum in the economic recovery. A further pick-up in housing, GDP growth at or above 3 per cent for the next few years and of course the unemployment rate on its way to 6.5 per cent or less will require tighter monetary policy at some stage. The best estimates are that this should be a year away at the earliest, but more likely it will happen sometime in 2015.