QE3: Forward guidance, debt purchases, unemployment target

As expected, the US Federal Reserve announced QE3 early this morning NZ time.

In the statement, they commit the the purchase of mortgage debt people expected (carrying on for an undefined period of time), they state they will keep the cash rate exceptionally low until at least mid-2015 (which was anticipated) – but they also say they will do more unless they get traction on the labour market.

This is reasonably significant.  They are fully testing their view that there is no structural problem in the labour market (which is empirically supported) and are banking on the idea that easier monetary conditions, combined with a credible commitment on the labour market will lead to households and firms finally bringing forward consumption and investment.

This makes more sense than prior policy.  The constant forecasting of “failure” in monetary policy in the US led to policy that can be seen as insufficient – the Fed was treating the risks of inflation (and thereby the outlook for the domestic economy) asymmetrically – obviously Woodford’s speech had an impact (although the projections still have a pretty slow improvement in the unemployment rate – would need to see employment rate forecast to really get a feeling for what they mean).

It may also be seen as reinforcing the view of market monetarists (eg Sumner) that the Fed’s expectations have a significant impact on expectations of real economic and labour market activity within the cycle (at least in response to large shocks – possibility of multiple equilibrium.  Note:  They wouldn’t see it the same way.).  This is a view I would like to see in more detail (eg what sort of expectations does this rely on, and what sort of conception of the real rate – are they are artifact of current monetary policy settings).

Although this is encouraging – when looking over here in NZ it is the European debt crisis that is impeding growth.  Yes, a stronger US economy will support growth in Asia and NZ helping remove large scale risks – but the European debt crisis continues to have a separate impact on NZ that is binding.

Update:  Having a read around on the piles of good sites discussing the issue, I ran into this post via Money Illusion.  Now, doesn’t this scream multiple equilibrium to you?  To criticise the Fed for rates being low and indicating a weak recovery, we need to blame the Fed for the drop in the natural interest rate – this has to imply that the Fed either created uncertainty, or is so far away from their mandate we’ve fallen into a “suboptimal” eqm.  You cannot blame the Fed for exogenous shocks (which you’d normally pin this on), so there MUST be an implicit multiple eqm argument behind NGDP level targeting – I find it conceivable, although potentially hard to test empirically … can someone send it to me please 🙂

Update II:  Good point from Scott Sumner:

In addition, they did move closer to level targeting, something I didn’t think was politically possible:

(Fed statement) To support continued progress toward maximum employment and price stability, the Committee expects that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the economic recovery strengthens.

What’s changed since June?  That’s pretty easy to answer; Woodford’s paper was obviously very influential, and that changed the politics on level targeting.

This is still consistent with flexible inflation targeting at the ZLB.  Of course, NGDP level targeting and inflation targeting share a lot of similarities – and to be fair, NGDP level targeting would be more transparent when faced with the ZLB problem.  In net terms I’m still a flexible inflation targeter – as the benefits of a predictable price level ex-ante from a point in time seem significant, and best served by doing that directly (through inflation targeting).  Of course, if the facts at my disposal change I’m happy to move around 🙂

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