U.S. Fed holds rate, will be patient in normalizing policy

December 17, 2014

By CentralBankNews.info
    The U.S. Federal Reserve maintained its benchmark federal funds rate at zero to 0.25 percent, as widely expected, and said it “can be patient in beginning to normalize the stance of monetary policy,” a new guidance that is consistent with its previous statement that its policy rate would be maintained for “a considerable time” following the conclusion of quantitative easing in October.
    The Federal Reserve, the central bank of the United States, has held its fed funds rate at the current level since December 2008 but is slowly taking steps toward its first rate rise – expected around the middle of 2015 – in light of the continuing strengthening of the U.S. economy.
     Along with cutting its rate to essentially zero, the Fed has undertaken three major installments of asset purchases to hold down long term interest rates. The third installment, which included purchases of U.S. Treasuries and housing-related debt and known as QE 3, started in September 2012 and concluded in October with the final asset purchases of $15 billion.
    The next step for the Fed in normalizing its policy is to prepare financial markets for its first rate hike by adjusting the language in its guidance. Since September the Fed has been considering replacing the phrase “considerable time” – which it began to use in September 2012 – with another description that conveys the message that the Fed will not jeopardize the economic recovery and yet respond appropriately to the improving economy.
    Financial markets have recently turned volatile in response to the near 50 percent fall in crude oil prices since June and economists have questioned whether the Fed would be worried over whether this would have a lasting impact on its inflation projections.

    But the Fed said it still expects inflation to rise gradually toward its 2 percent target “as the labor market improves further and the transitory effects of lower energy factors and other factors dissipate.”
    In its latest economic forecast, the Fed cut its 2014 forecast for its preferred inflation gauge – personal consumption expenditures – to 1.2-1.3 percent from September’s forecast of 1.5-1.7 percent.
    For 2015 the inflation forecast was cut to 1.0-1.6 percent from 1.6-1.9 percent while the 2016 forecast was maintained at 1.7-2.0 percent and the 2017 forecast was trimmed to 1.8-2.0 percent from 1.9-2.0 percent.
    Economic growth has been stronger than the Fed forecast in September, with the forecast for 2014 Gross Domestic Product revised up to 2.3-2.4 percent from 2.0-2.2 percent. The 2015 forecast was maintained at 2.6-3.0 percent and the 2016 forecast revised to 2.5-3.0 percent from 2.6-2.9 percent. For 2017 the forecast was maintained at 2.3-2.5 percent.
    As part of its economic forecast, the Fed also shows when the 12 members of its policy-setting body, the Federal Open Market Committee (FOMC), expect the first rate rise to take place.
    Fifteeen FOMC members expect the first rate rise to take place at some point next year while only two expect the first policy tightening to occur in 2016.
    In September one FOMC member had expected the first rate rise to take place this year, 14 that it would happen in 2015 and two in 2016.
    In contrast with the FOMC’s meeting in September when only Narayana Kocherlakota voted against the committee’s statement, two further members voted against today’s statement. Richard Fisher and Charles Plosser joined Kocherlakota in opposing today’s statement.

    The Federal Reserve issued the following statement:

“Information received since the Federal Open Market Committee met in October suggests that economic activity is expanding at a moderate pace. Labor market conditions improved further, with solid job gains and a lower unemployment rate. On balance, a range of labor market indicators suggests that underutilization of labor resources continues to diminish. Household spending is rising moderately and business fixed investment is advancing, while the recovery in the housing sector remains slow. Inflation has continued to run below the Committee’s longer-run objective, partly reflecting declines in energy prices. Market-based measures of inflation compensation have declined somewhat further; survey-based measures of longer-term inflation expectations have remained stable.
Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. The Committee expects that, with appropriate policy accommodation, economic activity will expand at a moderate pace, with labor market indicators moving toward levels the Committee judges consistent with its dual mandate. The Committee sees the risks to the outlook for economic activity and the labor market as nearly balanced. The Committee expects inflation to rise gradually toward 2 percent as the labor market improves further and the transitory effects of lower energy prices and other factors dissipate. The Committee continues to monitor inflation developments closely.
To support continued progress toward maximum employment and price stability, the Committee today reaffirmed its view that the current 0 to 1/4 percent target range for the federal funds rate remains appropriate. In determining how long to maintain this target range, the Committee will assess progress–both realized and expected–toward its objectives of maximum employment and 2 percent inflation. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments. Based on its current assessment, the Committee judges that it can be patient in beginning to normalize the stance of monetary policy. The Committee sees this guidance as consistent with its previous statement that it likely will be appropriate to maintain the 0 to 1/4 percent target range for the federal funds rate for a considerable time following the end of its asset purchase program in October, especially if projected inflation continues to run below the Committee’s 2 percent longer-run goal, and provided that longer-term inflation expectations remain well anchored. However, if incoming information indicates faster progress toward the Committee’s employment and inflation objectives than the Committee now expects, then increases in the target range for the federal funds rate are likely to occur sooner than currently anticipated. Conversely, if progress proves slower than expected, then increases in the target range are likely to occur later than currently anticipated.
The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction. This policy, by keeping the Committee’s holdings of longer-term securities at sizable levels, should help maintain accommodative financial conditions.
When the Committee decides to begin to remove policy accommodation, it will take a balanced approach consistent with its longer-run goals of maximum employment and inflation of 2 percent. The Committee currently anticipates that, even after employment and inflation are near mandate-consistent levels, economic conditions may, for some time, warrant keeping the target federal funds rate below levels the Committee views as normal in the longer run.
Voting for the FOMC monetary policy action were: Janet L. Yellen, Chair; William C. Dudley, Vice Chairman; Lael Brainard; Stanley Fischer; Loretta J. Mester; Jerome H. Powell; and Daniel K. Tarullo.

Voting against the action were Richard W. Fisher, who believed that, while the Committee should be patient in beginning to normalize monetary policy, improvement in the U.S. economic performance since October has moved forward, further than the majority of the Committee envisions, the date when it will likely be appropriate to increase the federal funds rate; Narayana Kocherlakota, who believed that the Committee’s decision, in the context of ongoing low inflation and falling market-based measures of longer-term inflation expectations, created undue downside risk to the credibility of the 2 percent inflation target; and Charles I. Plosser, who believed that the statement should not stress the importance of the passage of time as a key element of its forward guidance and, given the improvement in economic conditions, should not emphasize the consistency of the current forward guidance with previous statements.”

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