Fed Tapering and Bullard’s Dissent

Michael Stephens | June 20, 2013

(Updated)

Here’s what’s new from yesterday’s FOMC statement and Bernanke’s press conference:  the Fed has indicated that asset purchases (QE) will end when unemployment hits 7 percent.  (Note that that’s different from the point at which the Fed will begin considering raising short-term interest rates — previously linked to a threshold of 6.5 percent unemployment.)

Commentators have pointed out that the Fed seems to be basing its expectations — that asset purchases will begin “tapering” this year and end by next year — on some fairly optimistic economic forecasts (this is a recurring issue).  There are also a lot of questions as to what’s motivating these signals of a less expansionary stance, given that inflation is too low by the Fed’s own measure.  “Frankly,” Yves Smith writes, “the real issue seems to be that the Fed has gotten itchy about ending QE.  Who knows why. It may be 1937 redux, that they’ve gotten impatient with the length of time they’ve been engaged in extraordinary measures.”

Somewhat related to this post on the Fed’s historic “reaction function,” here’s Tim Duy’s analysis:

Bernanke continued to deflect attention from the low inflation numbers, describing them as largely transitory, identifying the impact of the sequester on medical payments as a factor.  Here is what I think is going on:  Overall, the Fed has basically a Phillips Curve view of inflation.  Low inflation now is attributable to high unemployment.  Given that unemployment is forecast to fall, and the forecasts are improving such that it is falling faster than anticipated, they anticipate that disinflation will soon be halted.  In other words, right now policy is being driven by the unemployment rate.  The more quickly unemployment is moving to the Fed’s long run target, the more they will reduce accommodation despite low inflation.  At least, that is what it appears.

One interesting wrinkle is that James Bullard dissented from the near-unanimous decision.  According to the official FOMC statement, he “believed that the Committee should signal more strongly its willingness to defend its inflation goal in light of recent low inflation readings.”

Normally, you would think of Bullard as a “hawk” (this dove–hawk framework seems to have become less useful in the era of unconventional monetary policy).  In his April speech at the Minsky conference, Bullard warned against unemployment targeting and suggested the Fed ought to focus primarily on price stability (price-level targeting).  The cynic might dismiss this as just a convenient technical excuse for ignoring high unemployment, but Bullard’s dissent suggests that he takes the model quite seriously — which is to say, not just when inflation is above or near the target.  If you want more insight into what might be motivating his vote, here’s the full speech:

Update (6/21):  Bullard explains his dissent (copied below from St. Louis Fed).  Key line:  “to maintain credibility, the Committee must defend its inflation target when inflation is below target as well as when it is above target.”

ST. LOUIS – Federal Reserve Bank of St. Louis President James Bullard dissented with the Federal Open Market Committee decision announced on June 19, 2013.  In his view, the Committee should have more strongly signaled its willingness to defend its inflation target of 2 percent in light of recent low inflation readings.  Inflation in the U.S. has surprised on the downside during 2013.  Measured as the percent change from one year earlier, the personal consumption expenditures (PCE) headline inflation rate is running below 1 percent, and the PCE core inflation rate is close to 1 percent.  President Bullard believes that to maintain credibility, the Committee must defend its inflation target when inflation is below target as well as when it is above target.

President Bullard also felt that the Committee’s decision to authorize the Chairman to lay out a more elaborate plan for reducing the pace of asset purchases was inappropriately timed.  The Committee was, through the Summary of Economic Projections process, marking down its assessment of both real GDP growth and inflation for 2013, and yet simultaneously announcing that less accommodative policy may be in store.  President Bullard felt that a more prudent approach would be to wait for more tangible signs that the economy was strengthening and that inflation was on a path to return toward target before making such an announcement.

In addition, President Bullard felt that the Committee’s decision to authorize the Chairman to make an announcement of an approximate timeline for reducing the pace of asset purchases to zero was a step away from state-contingent monetary policy.  President Bullard feels strongly that state-contingent monetary policy is best central bank practice, with clear support both from academic theory and from central bank experience over the last several decades.  Policy actions should be undertaken to meet policy objectives, not calendar objectives.

While President Bullard found much to disagree with in this decision, he does feel that the Committee can conduct an appropriate and effective monetary policy going forward, and he looks forward to working with his colleagues to achieve this outcome.

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