Last week, the WSJ’s ace Federal Reserve reporter Jon Hilsenrath wrote a piece on Fed strategy that got a lot of attention in markets.
The gist was: Just because the Fed may signal a reduction in asset purchases doesn’t mean that an interest rate hike is getting closer.
Specifically Hilsenrath wrote:
Federal Reserve officials have been trying to convince investors for weeks not to overreact when the central bank starts pulling back on its $85 billion-per-month bond-buying program. An adjustment in the program won’t mean that it will end all at once, officials say, and even more importantly it won’t mean that the Fed is anywhere near raising short-term interest rates.
But in a note put out yesterday, Morgan Stanley Chief Economist Vincent Reinhart argues there’s a flaw in this logic.
Fed officials have been trying to convince everyone that their asset purchase decision
• is data-dependent,
• could be made soon, but,
• once taken, does not put the balance sheet on a fixed course.
The logical conclusion they hope everyone draws from this is that, as it is a flexible instrument subject to an ongoing calibration of the costs and benefits, the onset of tapering does not convey information about the date of the first fed funds rate hike.
Such an inference, however, is flawed. As long as the Fed is using the two instruments to influence the economy, policy decisions on their setting depend on the Fed’s outlook for the economy. A change in one reveals something about a change in the Fed’s outlook, which therefore has implications for the other policy instrument. Asset purchases can be a data-dependent, flexible instrument, but they will also be informative. Logically then, the Fed’s tapering talk reveals some combination of their being more confident about the economic outlook and less convinced that additional QE is providing net benefits.
Basically, if both QE and rate decisions are data dependent, then you can’t separate the two.
Probably the best defence of the Fed on this is that for a rate hike, the parameters are incredibly clear. Evan’s Rule sets the levels at which the Fed would consider raising rates, and it won’t raise rates before then. On the other hand, the pace of QE is clearly more subjective (and possibly also takes into account a desire to prevent excess speculation).
Anyway, between this confusion, and the latest comments from Obama hinting that Bernanke’s time at the Fed is over, we should be in for one hell of a press conference today.
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