Tinker, Taper

Emily G. Murphy

Econ 122

June 23, 2013

Since December 2008 when the Federal Reserve’s main policy interest rate fell near zero they have enacted a wide spectrum of what The Economist refers to as “unconventional policies” meant to advance the economy.  The Economist informs us that very recently the Federal Open Market Committee has “ostensibly” left “its foot on the gas.”  An example of this is the FOMC’s pledge to continue adding $85 billion in bonds per month which has almost quadrupled to $3.4 trillion since the beginning of the recession.  We can identify from class that this latest round of bond buying is a strategy to help inch the federal funds rate towards the Fed’s desired target. 

The Economist also informs us that the stocks of risker assets have fallen steeply, which results in an “effective tightening” in the monetary climate.  This tightening is said to be a direct effect of Ben Bernanke’s assertion that a “tapering” of the pace of the purchase of assets may possibly begin later this year.  This has significance to us as we have learned this semester that a tightening in the monetary climate has numerous negative effects but most importantly it decreases the available credit in the market as banks are less willing to lend and take high risks.  The Fed’s opinion of this however is not as panicked of a response as the market’s is.  They believe a more comfortable buying pace doesn’t equal tightening.  It is also believed that it is really the overall size of the Fed’s balance sheet that is most important and as long as assets grow policy will loosen. 

An important piece of the conversation to remember is that Bernanke has informed us, “tapering will be closely linked to economic conditions” says The Economist.    However the Fed’s plan, all going well, would end asset purchases by the middle of 2014.  There are of course many complications when dealing with a central bank.  These issues are only intensified when the Fed’s main interest rate tool cannot be further reduced.  In this situation the economic forecast and the Fed’s response to the forecast are ever crucial. 

The Economist continues on addressing the fact that if the Federal Reserve desires to gain more stern control in quantitative easing (QE) without harming the economy their main job must be convincing markets it won’t allow inflation to drop or employment to fall behind.  The idea that the Fed must convince markets it won’t allow inflation to drop or employment to fall behind is of course related to the idea of uncertainty in money demanded.  We learned that as uncertainty rises the demand for money shifts outward meaning we are less likely to see high levels of investment, especially in risker assets.  As uncertainty falls the demand for money shifts inward meaning we will be more likely to invest and convert our hard currency into other risker assets.  Another goal of Bernanke’s latest press conference was to attempt to make crystal clear the Fed’s policy strategy, among other things.  Bernanke’s main message was that the outlook for the labor market will be considered substantially improved only after unemployment has dropped to around seven percent.  Bernanke reiterated that until that time comes QE will continue. The Economist proceeds to state that a “hawkish minority” of the Fed’s nineteen policymakers desire bond buying to end as soon as possible, claiming dangerous risk taking and “asset misallocation.”  Whereas recently Bernanke stated his most looming concern about QE isn’t inflation but instead is financial stability.  It is extremely clear that the internal division of the Fed is complicating goal clarity and communication.

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Citation - Tinker, taper: the federal reserve tries to clarify it's goals. (2013, June 22). The Economist. Retrieved from http://www.economist.com/