Tuesday, December 11, 2012

FOMC Report 
December 12-13, 2012
Martin B. McGuire

Consistent with the changes to policy and communication adopted simultaneously at the September FOMC meeting we should expect the Fed to continue to combine announced changes in LSAP measures with adjustments to guidance.  Diminished returns have accompanied successive additional LSAP so that at this juncture standalone supportive capabilities from additional LSAP are found wanting.  

It is difficult to know that the Fed will find consensus at this meeting to move forward with a threshold approach to policy prescription guidance.  There is clearly a growing block of support for these measures, thus driving consent toward an affirmative vote for the enactment of numeric threshold values for unemployment and inflation. 

The September FOMC statement took pains to reference the new $85 billion size for monthly increases to longer-term securities holdings through the end of the year.  By sparing us the difficulty from having to compute the sum of $45 billion existing MEP longer-end purchases with the new $40 billion of agency mortgage-backed securities the Fed gave lasting importance to the $85 billion figure.  Putting as strong a light on this dollar figure they have created a perception for many that this level of monthly longer-term securities purchases was the new status quo.  While a one-for-one replacement of MEP with outright purchases would be considered a greater level of accommodation, the Fed risks disappointing the market if it does less. 

It is hard to imagine a benefit to be derived from keeping any new outright Treasury purchase plan as a separate entity from the existing program for purchasing agency mortgage-backed securities.  The Fed has already given itself the mandate to ‘undertake additional asset purchases’ in the event ‘the outlook for the labor market does not improve substantially’.  There has been no substantial improvement in the labor market and we should therefore expect no delay in additional measures taken rather than a maintenance level of support. 

The transition from MEP to outright Treasury purchases would then carry with it the existing ‘open-ended’ directive agency mortgage-backed securities purchases enjoy.  Going forward the Fed would have the capacity to throttle back or increase purchase size for either Treasury or agency mortgage-backed securities without initiating a new directive. This should clearly be a favored status for operations.    

It is extremely important the Fed correctly articulates the nature of numeric thresholds for economic variables in the guidance of policy prescription.  We should expect the Fed to acknowledge the value for a large number of economic variables which influence adjustments to monetary policy.  The December post-meeting statement may adopt language similar to; ‘Under current conditions, and consistent with the outlook for only gradual improvement in employment in the context of price stability, the Fed expects to provide strong accommodative measures until such time where general labor market conditions consistent with a 6.5% level of unemployment are reached so long as inflation does not exceed 2.5% over the intermediate term.
If the Fed decide to move forward with ‘threshold guidance’ at the December 2012 meeting as I expect, they may decide at this juncture to remove the date-specific reference to mid-2015 and instead simply note ‘the Committee expects that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the economic recovery strengthens.       


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