James Bullard, president of the Federal Reserve Bank of St. Louis, has been an outspoken supporter of quantitative easing. A voting member of the Federal Open Market Committee, Bullard has articulated and advocated for an accommodative monetary strategy and a data-driven, dynamic approach to forward guidance — and in his public commentary he has worked to clarify these aspects of Fed policy.
On December 9, he gave a presentation to the CFA society in St. Louis in which he did just that. Bullard opened with the critical, but sometimes overlooked, distinction between the two major components of current U.S. monetary policy. The first is “A short-term policy rate, which has been near zero since December 2008, and associated forward guidance for that policy rate,” and the second is “An asset purchase program, with current purchases at a pace of $85 billion per month, divided between mortgage-backed securities and Treasuries.” It is this second component of the Fed’s monetary strategy, called quantitative easing, that has been in the spotlight.
The Fed began the current round of asset purchases in September 2012. These purchases increase the price of those financial assets, which lowers their yield, putting additional downward pressure on long-term interest rates. The intended consequence is to spur spending in interest rate sensitive sectors, which, as Fed Vice Chair Janet Yellen articulated in her recent testimony before the Senate Banking Committee, should “stimulate a favorable dynamic in which jobs are created, incomes rise, more spending takes place.”
Along with its impact on interest rates, quantitative easing drives down currency valuations (which impacts imports and exports), increases inflation expectations (although inflation, as Bullard put it in, “continues to surprise to the downside”), and increases equity valuations. Quantitative easing impacts pretty much every corner of the vast financial market, which means that any changes to the program will impact pretty much every corner of the vast financial market.
Beginning with the third round of quantitative easing, the Fed has made it clear that its decision on when to taper will depend on economic conditions. Chiefly, the decision will depend on the status of inflation and the health of the labor market. The first, as mentioned, is barely existent — but the second has shown better-than-expected performance over the past 12 months.
“To the extent that key labor market indicators continue to show cumulative improvement, the likelihood of tapering asset purchases will continue to rise,” Bullard said. “The Committee’s 2012 criterion of substantial improvement in labor markets gets easier and easier to satisfy on a cumulative basis as labor markets continue to heal.”
Bullard suggested back in November that a December taper wasn’t out of the question, and with strong labor market data coming in recently, he isn’t the only regional Fed president to lean in that direction. Fed President Charles Plosser told CNBC Friday that while he doesn’t like to get too excited over a single month’s numbers, November’s job report was a good indicator of the U.S.’s economic improvement.
“It’s pretty positive clearly. We continue to make solid progress,” said Plosser to CNBC, referring to the decline of unemployment, from 7.3 percent unemployment in October to 7.0 percent in November. As such, he notes that it may be a good point in time to “gracefully exit” quantitative easing.
“It is in a good direction,” said Plosser in the interview, “You’ve got a pretty stable positive rate of growth in jobs right now.” Plosser told CNBC that he’s believes leaving the bond purchasing program behind would be a smart move. “I don’t think it’s doing very much good for us. It has a lot of unintended consequences and risk for the economy down the road.”