 | Fed Shows Its Dovish Side |
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| Posted Under: Government • Research Reports • Fed Reserve • Interest Rates |
The Federal Reserve made several small changes to the text of its statement, which, combined, suggest a slightly more dovish posture at this meeting than at the last one in June.
First, the Fed said the expansion of economic activity was "modest," rather than "moderate." Second, it added a reference to rising mortgage rates in a way that suggested some concern it could slow the housing recovery. Third, the Fed added language saying "inflation persistently below its 2%" target could hurt the economy. And last, the Fed highlighted its intention to maintain near zero interest rates for a "considerable time" after the end of quantitative easing. The one change that was more hawkish was an assertion that growth would "pick up from its recent pace" rather than "proceed at a moderate pace."
Like the last statement in June, today's lacked any hints of when a tapering of quantitative easing would begin. Meanwhile, Kansas City Fed Bank President Esther George continued to dissent against a policy she believes is overly accommodative. St. Louis Fed bank President James Bullard, who dissented in June because he wanted a more dovish statement voted for the statement this month. Bullard likely ended his dissent because of the new language on sub-2% inflation hurting the economy.
Notably absent from the statement was any change to the unemployment thresholds the Fed has used to guide the markets, such as 6.5% for starting to consider interest rate hikes or 7% for ending quantitative easing.
We project a 7% unemployment rate for early next year, so an end to quantitative easing announced at the meeting in March 2014. Meanwhile, we are projecting a 6.5% unemployment rate in the third or fourth quarter of 2014.
As we have written many times before, QE3 is simply adding to the already enormous excess reserves in the banking system, not dealing with the underlying causes of economic weakness, including growth in government, excessive regulation, and expectations of higher future tax rates. QE3 does not add anything to economic growth and, as long as banks are reluctant to lend aggressively, does not cause hyper-inflation either. Notably, former Treasury Secretary Lawrence Summers, now being considered for the Fed chairmanship, appears to share our view on the ineffectiveness of quantitative easing.
Nominal GDP – real GDP plus inflation – is up at a 3.7% annual rate in the past two years. At that pace, the economy can already sustain a much higher federal funds rate than now prevails. Maintaining rates near zero percent will eventually lead to inflation running consistently above the Fed's 2% target, which means once it starts raising rates the peak for fed funds will be higher than the 4% the Fed now projects, perhaps much higher.
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