Recent Improvements Aren't Enough to Slow Monetary Easing
By Said IsrailovPublished May 1, 2013By Said Israilov, Published 5/1/13
According to recently released data, the U.S. economy is showing persistent signs of recovery despite across-the-board spending cuts. Partly driven by improvements in the housing market, the US economy added an estimated 200,000 jobs a month since last November – nearly enough to shrug off defense and infrastructure spending cuts. After the third revision, US economic growth, for the fourth quarter of 2012, was revised to 0.4 percent from previous the estimate of 0.1 percent. Driven by labor market improvements, US consumer spending rose 0.7 percent as personal incomes rose 1.1 percent in February, noted the Commerce Department last week. Meanwhile, the Michigan consumer sentiment index increased to 78.6, a point higher from 77.6 in February.
If the private sector can demonstrate that it’s capable of creating enough jobs to fully offset short-term restrictive fiscal policies, would it be enough for Federal Reserve (Fed) to gradually wind up its Quantitative Easing (QE) policies? The answer is not as simple as it seems. In his latest press conference on March 20th, Fed Chairman Ben Bernanke addressed ongoing economic challenges and the importance of the Fed’s forward guidance on its future monetary policies. Chairman argued that current monetary policies are fine tuned to support the recovering economy in the face of federal budget cuts. In particular, he outlined two key elements that will shape monetary policies going forward. First, Federal Open Market Committee (FOMC) preserved a long running asset purchase program that was first announced back in September. This program is designed to purchase up to $40 billion in mortgage backed securities per month in addition to $45 billion in long-term Treasury securities. Bernanke noted that the committee can vary the pace of purchases as the economy progresses to stability. Second, FOMC kept the federal funds rate between 0 and .25 percent. The federal funds rate is the borrowing rate charged by the Fed to financial intermediaries for inter-bank lending between depository institutions; this helps these institutions maintain a minimum reserve balance at their local reserve banks during periods of capital shortages. Lowering the Fed funds rate helps influence interbank lending by reducing the rate in shaky economic times. Bernanke pointed out that such an accommodative stance on monetary policy will remain appropriate as long as the unemployment rate remains above 6.5 percent, and will likely outlast the asset purchase program. However, Bernanke didn’t provide specific criteria that will help determine the exit plan from QE. He argued that despite the recent improvements in the jobs market and business and consumer spending, the Fed will retain its current policies until reaching sustained and long lasting improvements across a range of labor market indicators, including unemployment rate, payroll, hiring rate, quit rate and claims for unemployment insurance.