If stock market’s initial mega-bullish reaction is any gauge, then the Bernanke Fed’s decision to, effectively, refrain from reducing monetary stimulus is good for US economic growth. And it probably is. Although the Federal Open Market Committee did announce it was reducing its monthly bond buys to $75 billion from $85 billion, at the same time policymakers also strengthened their commitment to keeping interest rates low for a long time.
The FOMC will now likely “maintain the current target range for the federal funds rate well past the time that the unemployment rate declines below 6-1/2 percent” if inflation remains quiescent. And a variety of labor market metrics will be used to determine when it is time to raise rates. In particular, Bernanke highlighted the high levels of long-term unemployment and underemployment.
As IHS Global Insight puts it, “In essence, [the Fed] maintained the existing threshold for higher rates, but suggested it will likely ignore it.” And Barclays:
Consequently, although the Fed did not reduce its unemployment rate threshold below 6.5% or provide an outright inflation floor, it came as close as it could by saying it “anticipates” that it will not seek to raise rates until it forecasts unemployment of around 6.0% and headline PCE inflation is in the range of 1.6-2.0% y/y.
Economist Scott Sumner, who would prefer the Fed target the level of nominal GDP, previously recommended the central bank drop the unemployment trigger as a way of making policy more expansionary. As such, he was heartened by today’s move:
Today’s decision did not drop the unemployment threshold, but it weakened it. It should simply be removed. If they promised to wait until expected inflation rose to 2.5% before raising rates, it would mean roughly 2% inflation over the next few years, as the inflation rate is now running below 2%. That’s still too tight, but much better than the old policy, and even better than today’s revision. Unemployment should never have been made a part of the forward guidance.
Bernanke is certainly correct that a “highly accommodative monetary policy remains appropriate.” Inflation is still very low, unemployment high. While critics will argue that the 2013 economy isn’t much better than the 2012 version, Bernanke is also correct to point out that the Fed offset a “good bit” of fiscal austerity. We still have a pro-growth monetary policy, now it’s time for some pro-growth fiscal policy from the White House and Congress.