The Fed’s Indecisiveness On The Taper

By Chandrashekar (Chandra) Tamirisa, (On Twitter) @c_tamirisa

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The Federal Reserve did not start the taper.

The markets priced-in the Fed to begin, in September, the process of reducing its monthly purchases of long-dated Treasury Securities and Mortgage-Backed Securities (MBS). Instead the Fed delivered an expansionary monetary shock to market expectations as can be seen from the positive reaction of Dow Jones Industrial Average and the S&P 500.

The Fed’s risk averseness in not beginning to withdraw monetary accommodation to support economic growth can be rationalized by the political-economic context: political battles over the budget and debt-ceiling, turnover on the Federal Open Market Committee (FOMC) including Fed Chair and governor appointments, and the sequester. Still, continued quantitative easing (QE) is unjustified.

Fed’s complaint about fiscal policy restraining growth is misplaced because private, not government, spending must rise to grow the economy to reduce deficit with the higher tax revenue from economic growth. QE has adequately fulfilled its role of providing the US economy the necessary support in the face of restrictive or ineffective fiscal policy and fiscal uncertainty.

Moreover, if the markets are given a choice between QE and growth and employment they would pick QE to inflate financial asset prices and real asset prices such as housing. Markets would neither want to lower unemployment nor increase inflation to Fed’s targets for the two variables sooner than later because either or both would increase interest rates. Hence, the sluggish pace of job creation. The markets are creating fewer jobs and of modest wages with moderate levels of investment to contain inflation so as not to trigger interest rate increases sooner than later. Hence, the moderate pace of growth. An unemployment target would not work unless more hands-on approaches to raise investment to create jobs accompany monetary policy.

The US economy, nevertheless, is growing at a steady state of comfortably more than 2 per cent real gross domestic product (GDP) annual growth rate with inflation well within target, albeit a recovery with slow job growth and of low job quality, with the markets expecting QE to begin to end. The global economy is also slowly on the mend including in Europe and the major emerging markets. US economic growth can be weaned off the central bank support of QE.

The low quality of the job market, defined as the combination of slow job growth rate and low job quality, is a structural matter which takes time to change. The low quality of the job market should not restrain the Fed from beginning the end of QE. The Fed, otherwise, may step into the zone of risking inflation, stoking asset price bubbles, and may find itself in a bind on the pace of withdrawing QE if it plays hide-and-seek with market expectations, overriding its own forward guidance.

It appears Ben Bernanke does not want the taper to be his legacy.


About Chandrashekar (Chandra) Tamirisa
This entry was posted in Economics, Monetary Policy, North America and Caribbean and tagged , . Bookmark the permalink.

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