In a nod to the holiday-giving season, all monetary policy forecasters received the gift of “being right” with today’s announcement. Defying expectations of “Will they or won’t they?” the Federal Reserve pre-announced a change to its policy for the new year, and will now purchase $35 billion a month in agency mortgage-backed securities beginning in January 2014 (down from a current pace of $40 billion a month) and $40 billion a month in U.S. Treasuries (down from a current pace of $45 billion a month). Today’s announcement specifically mentioned the Committee’s “modest reduc[tion]” and “sizable and still-increasing holdings of longer-term securities,” emphasizing that the move should not be viewed as a tightening of policy, but rather, a reduction in what is still a substantial degree of accommodation.
The Committee forecast a greater decline in the unemployment rate than it had in September (Table 1), which is consistent with a statement referencing “more nearly balanced” risks to the outlook for the economy and the labor market. (The statement from six weeks ago, in contrast, described “downside” risks as merely “having diminished.”) However, what was surprising was the statement that it is “likely [to] be appropriate to maintain the current target range for the Federal Funds rate well past the time that the unemployment rate declines below 6-1/2 percent, especially if projected inflation continues to run below the Committee's 2 percent longer-run goal.”
With November’s unemployment rate already having fallen to 7%, the Federal Reserve risked damaging its credibility by not tightening policy via an increase in the Federal Funds rate should the labor market have continued to improve going forward. Instead, the Committee has now shifted attention away from one number (the unemployment rate) to another (Personal Consumption Expenditure inflation) and bought itself some flexibility in holding the Federal Funds rate at its historic low. With today’s release, 15 out of 17 participants forecast that Federal Funds rate would still be at current levels at the end of 2014, virtually unchanged from the 14 participants who held this view in September, despite today’s more optimistic prognosis for employment.