In September, the Federal Open Market Committee kicked off the third round of quantitative easing by announcing that it would purchase $40 billion worth of agency mortgage-backed securities each month. In December, with unemployment at 7.8 percent and about to edge up, the FOMC announced the fourth round, which added purchases of longer-term securities at a rate of $45 billion per month to the purchases of mortgage-backed securities.
Combined, these two programs define the current state of Fed open-market operations. Broadly speaking, these purchases have four effects on the economy: higher inflation expectations, currency depreciation, higher equity valuations, and lower real interest rates.
Since the inception of the program, it was understood that at some point — when economic conditions improved sufficiently — purchases would end. But the Fed had already been pumping money into the economy for four years by the time the fourth round rolled around, and the markets have grown accustomed to the policy.
Economic conditions have finally improved enough for the Fed to begin talking about tapering purchases. If current FOMC projections hold true, the Fed could begin tapering purchases as early as this year. If conditions improve more quickly than expected, purchases could be tapered more quickly; if conditions improve more slowly than expected, tapering won’t begin until later. The federal funds rate is expected to remain at the zero bound until purchases end.
“The Committee has reiterated that the purchase program will continue until the outlook for the labor market has improved substantially in a context of price stability,” the July Monetary Policy Report says. “In addition, the FOMC has indicated that the size, pace, and composition of purchases will be adjusted in light of the Committee’s assessment of the likely efficacy and costs of such purchases as well as the extent of progress toward its economic objectives.”
As far as its projections about economics conditions are concerned, the Fed has been very clear.
Half of the 54 economists recently surveyed by Bloomberg anticipate that the Fed will reduce total asset purchases by $20 billion per month come September. From here, purchases are expected to be tapered slowly until the program ends sometime in 2014, probably in the second or third quarter.
This projections are roughly in line with what the Fed itself has forecast if its economic projections hold true. Labor market conditions are expected to improve through 2015 and inflation is expected to gravitate toward the long-run target of 2 percent. In this context, GDP growth is expected to pick up in 2013 and 2014, eventually reaching a pace between 2.9 and 3.6 percent in 2015.
The minutes from the June 18-19 policy meeting state: “While recognizing the improvement in a number of indicators of economic activity and labor market conditions since the fall, many members indicated that further improvement in the outlook for the labor market would be required before it would be appropriate to slow the pace of asset purchases. Some added that they would, as well, need to see more evidence that the projected acceleration in economic activity would occur, before reducing the pace of asset purchases.”