Monetary policy U. S.

Tapering is not tightening

The minutes of FOMC July meeting was published on Wednesday. The market indexes dropped for the most part of the week in anticipation and in response to the discussion of asset purchases in the minutes. Thanks to the sizeable recovery in equity market on Friday, the major indexes lost only less than one percent for the week.

I think that makes the Fed happy.

In 2013, when the Fed announced future tapering of its policy of assets purchases, there was a collective reactionary panic that triggered a spike in U. S. Treasury yields, and fears that the market would crumble. The Fed has learned a lesson and I think it has been mindful to avoid a repeat of taper tantrum that occurred in 2013. First, the chair Powell since this year has told the market that the Fed would communicate well before taper begins for the purpose of smoothing market responses. Second, under the new framework of monetary policy, the Fed adopted “outcome-based” guidance that the paths of federal funds rates and the asset purchases would depend on actual progress in maximum-employment and inflation goals. Clear communication and outcome-based guidance make policy path more transparent and less uncertain.

The FOMC meetings this year reflected a gradual and careful path toward tapering. At the very early meeting the Fed did not even “talk about talking about tapering”. At June meeting, they touched the topic and at July meeting, the Fed has spent time to talk about the timeline (year end) and possible detail method to reduce the purchases of Treasury securities and agency MBS. I think the Fed will very likely announce the pace and the timeline of tapering at the October or November meeting.

I think the market responses would be mild this time. After all tapering is not tightening.

We have to see when the federal funds rate can be lifted from near zero. If asset purchases are to reduce the value of our money, high interests are to restore the time value of our money. If the asset purchase is in horizon, the interest rise is too far to be certain (though in my view could be 2023).

Unemployment in the US was down to 5.4% in July. However as of June the US economy has a shortfall of approximate seven millions jobs compared with early 2020 and nine millions relative to the pre-pandemic. Joblessness continues to fall disproportionately on African Americans, Hispanics and lower-wage workers in service sectors. Under the new monetary framework where inclusiveness becomes a goal and instituted, the Fed can hardly declare mission completed without seeing substantial improve in employment for lower-wage workers.

On inflation, it is 4-5% and it is high, but it is transitory. Based on its dynamic, I think inflation will drop below 2% again around middle next year, assuming the COVID cases peak in a month or two in the US, and then drop in a manageable path.

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