Tapering: Always on the Table, But It’s Never Quite Time

Money Cut in Half

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On October 30, at the conclusion of a two-day policy meeting, the Federal Open Market Committee announced that it would make no change to its strategy of monetary easing. In order to suppress longer-term interest rates and stimulate business activity, the FOMC, through the Federal Reserve, is purchasing $40 billion worth of agency mortgage-backed securities and $45 billion worth of longer-term securities every month, a program called quantitative easing (or, QE).

QE has four primary effects on the economy. First, it increases inflation expectations. By buying government bonds (and MBS) in the open market, the Fed is effectively increasing the monetary base in the United States. If the Fed overestimates how much easing is required (how much the monetary base should be increased), it could add inflationary pressure into the economy.

So far, inflation has been low. As measured by the core personal consumption expenditures price index, consumer prices increased just 0.1 percent on the month in September and 1.2 percent on the year. The Fed has prescribed a 2.0 percent inflation target. So far, so good — but many observers have expressed concern that the Fed’s strategy of open-ended QE is snowballing toward an unhappy ending. Too much stimulus is absolutely a bad thing.

The other primary effects that QE has on the economy are currency deprecation, higher equity valuations, and lower real interest rates. Similar to conventional monetary policy, in which the Fed edits the target federal funds rate, QE’s most significant effect is arguably its impact on nominal and real interest rates. Currency depreciation and increased equity valuations are sometimes given second-order consideration, but each plays a significant role in the economy.

A depreciated currency, for one, directly benefits exporters and dollar-denominated debtors. Conversely, though, a depreciated currency has a negative impact on creditors for the same reason in benefits debtors: as a currency depreciates, so does the value of the debt, which is a liability for borrowers but an asset for lenders.

But the Fed’s balance sheet has grown to enormous size under the various QE programs that were enacted in the wake of the financial crisis. The Fed’s balance sheet currently sits $3.85 trillion, and it’s growing larger every month QE continues. Many economists have expressed concern about this fact, and the pressure is mounting for the Fed to being tapering asset purchases. When asked if the FOMC would consider this at its next policy meeting in December, Federal Reserve Bank of Atlanta President Dennis Lockhart said that a change in policy would, at least, be on the table.

But “on the table” has been the status of the program since its inception. QE3 is ongoing by design, and the flow rate of purchases has always been described as a function of incoming economic data. To date, that data has not been up to snuff. The Fed is specifically looking at labor market data, which of all economic metrics has been particularly underwhelming.

Total nonfarm payroll employment increased by 204,000 in October, according to the most recent Employment Situation report, which was released by the Bureau of Labor Statistics on Friday. This was significantly greater than the 120,000 payroll increase expected by economists, and the headline unemployment rate actually increased from 7.2 percent to 7.3 percent on the month. September’s payroll growth was revised up, from 148,000 to 163,000. Total private payrolls increased by 212,000.

Average hourly earnings increased 0.1 percent, coming in below expectations for 0.2 percent growth. The average work week shrank from 34.5 hours to 34.4 hours. At 11.3 million, the total number of unemployed people was effectively unchanged. The civilian labor force continued to shrink, falling by 720,000, or 0.4 percentage points, to 62.8 percent. The BLS employment-to-population ratio declined by 0.3 percentage points to 58.3 percent. The number of long-term unemployed was relatively unchanged, at 4.1 million, or 36.1 percent of the total unemployed. “It is an encouraging number,” Lockhart told reporters on Friday about the jobs report, but added, “I would be reticent to draw very profound conclusions to one month’s positive jobs number.”

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