As the US economy slowly drags itself from the mire of the deepest economic downturn since the 1930s Great Depression, the US Federal Reserve will do all in its power to sustain the recovery to the point where it sees the unemployment rate falling to 6.5 per cent.
That is message from the Federal Open Markets Committee of the Fed as it maintained its quantitative easing program at $US85 billion of bond purchases per month and reiterated its objective of keeping "exceptionally low” or near zero interest rates in place until 2015 or at least until the unemployment rate falls. The Fed is confident inflation will remain low which is an outlook that allows it to turn its policy focus on the jobs market.
This is a further nuanced change in objective for the Fed, with Chairman Ben Bernanke bringing the policy focus ever closer to conditions in the labour market. In the statement issued after the FOMC meeting, Bernanke said, "Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. The Committee remains concerned that, without sufficient policy accommodation, economic growth might not be strong enough to generate sustained improvement in labour market conditions. Furthermore, strains in global financial markets continue to pose significant downside risks to the economic outlook.”
To meet these objectives, the Fed reiterated its plan to purchase around $US40 billion of mortgage backed securities per month and it effectively extended its "operation twist” into 2013 by saying that it will buy longer dated bonds at a rate of around $US45 billion a month. Bernanke was at pains to suggest that this did not add to the monetary stimulus, it merely maintained the stimulatory policy setting announced in September.
The Fed’s objective is clear and explicit: "these actions should maintain downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative”.
Monetary policy remains super-stimulatory and it is because the economic and banking crisis in the US of recent years was the most acute threat to the economy since the 1930s Great Depression and the hangover being experienced at the moment reflects that.
It has been more than six years since through the year growth in GDP was above 3 per cent, a sign of the uninspiring economic recovery. At the moment, the output gap as measured by industrial capacity utilisation and the labour market is huge. It is so huge that the US economy could grow by 4 per cent for three straight years and only then just close the output gap and be close to full employment. Don’t get excited, no one thinks 4 per cent GDP growth is on the cards any time soon.
The fact that Bernanke and the Fed have been able to engineer an economic scenario in this current slice of economic history where the peak unemployment rate was 10 per cent and deflation was avoided is remarkable. Bold policy settings have yielded fantastic returns for an economy that in 2008 was on the brink of collapse.
In terms of some other specifics, the Fed forecasts for the US economy contain no surprises. GDP growth in 2013 is expected to be in a 2.3 to 3 per cent range, the unemployment rate in a 7.4 to 7.7 per cent range while inflation is forecast to remain entrenched below 2 per cent, possible as low as 1.3 per cent. If these forecasts come to fruition, it would be a good rather than a great result and there is no doubt the Fed itself and those in the market would be delighted if the economy out-performed these cautious forecasts.
The markets reacted reasonably positively to the Fed action with US stocks up a little although off their highs for the day and bond yields also rose on the outlook for respectable economic growth. The US dollar was again pushed lower dropping to around 1.31 against the euro while the Australian dollar jumped to 1.0570.
While it is clearly premature to spend too much time looking at how the Fed will exit its QE program without derailing the economy, our own RBA Governor Glenn Stevens was speaking in Thailand yesterday on the blurring of monetary and fiscal policy.
Stevens noted that central bank purchases of government securities not only gave support to the economy, but also lowered the debt servicing costs for governments and as a result, helped reduce fiscal deficits. In a Jerry Seinfeld moment, Stevens emphasised that "there is nothing necessarily wrong with that… but the problem will be the exit from these policies.”
Implicitly Stevens was unsure how high government bond yields would rise not only when there were no central bank purchases but especially when the central banks sold their massive bond holding into the market. Obviously yields would rise, which by definition would restrict economic growth and would boost the debt servicing costs and undermine the fiscal policy objectives of governments.
He has a fair point, but in the US, it is an issue that is not in focus as Bernanke and the Fed are more worried about economic and jobs growth in the next couple of years.
They are doing whatever it takes to grow the economy. The exit strategy from QE is a problem I am sure they would love to confront. It would mean the economy is growing at near full capacity and the unemployment rate would be low. It doesn’t mean that exit will be easy, but it is something that can be looked at another day.
Until then, the Fed is going for growth.