The Federal Open Market Committee today announced a slight reduction in the pace of its quantitative easing programs. In the future it will buy $75 billion per month worth of assets rather than $85 billion. But in keeping with my view that the statement is more important than the policy, I think this is the key action (emphasis added):
The Committee also reaffirmed its expectation that the current exceptionally low target range for the federal funds rate of 0 to 1/4 percent will be appropriate 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 percent longer-run goal, and longer-term inflation expectations continue to be well anchored. In determining how long to maintain a highly accommodative stance of monetary policy, the Committee will also consider other information, including additional measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments. The Committee now anticipates, based on its assessment of these factors, that it likely will be appropriate to maintain the current target range for the federal funds rate well past the time that the unemployment rate declines below 6-1/2 percent, especially if projected inflation continues to run below the Committee's 2 percent longer-run goal. When the Committee decides to begin to remove policy accommodation, it will take a balanced approach consistent with its longer-run goals of maximum employment and inflation of 2 percent.
The old forward guidance ("Evans Rule") said no rate hikes until unemployment reached 6.5 percent unless inflation rises up to 2.5 percent. From where we stand today, it looks overwhelmingly likely that we'll hit 6.5 percent unemployment sometime next year with inflation still running below 2 percent. What the Fed is saying here is that the 6.5 percent mark is not a trigger for rate hikes.
If inflation and inflation expectations remain low (which they probably will) as unemployment ticks down to 6.5 percent, then the Fed will consider "additional measures of labor market conditions" (i.e., the still-low employment-population ratio) and keep interest rates low. That's the right call, and it means Ben Bernanke will be wrapping up his term as Fed chairman with a move in the right direction.
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