National Bureau of Economic Research
NBER: Latest column on reasons why the Fed didn't Tape

Latest column on reasons why the Fed didn't Tape

From: Martin Feldstein <mfeldstein39_at_gmail.com>
Date: Mon, 30 Sep 2013 21:07:38 -0400

I have copied below my piece from the Project_Syndicate and possible
explanations of why the Fed did not start to tape and the implication of
those explanations for the future of QE

MF

  Project Syndicate The Taper Chase

September 2013

By MARTIN FELDSTEIN

Global financial markets were stunned when the US Federal Reserve announced
on September 18 that it was not ready to begin the widely anticipated
reduction in the pace of its “quantitative easing” (QE) program. Fed
Chairman Ben Bernanke said that the Fed would continue its monthly
purchases of $85 billion of long-term securities. Understanding the reasons
for the Fed’s unexpected change of plans may help to anticipate what is
coming next.

After Bernanke announced in May that the Fed intended to “taper” QE,
investors began to expect that some reduction in the pace of asset
purchases might begin in the early fall. As a result, the interest rate on
ten-year Treasury bonds increased by nearly 50 basis points, from 1.66% on
May 1 to 2.13% on at the beginning of June. Bernanke’s press conference
after the next meeting of the Federal Open Market Committee (FOMC) on June
19 caused a further rise in the ten-year rate, to 2.5% on July 1 and then
to 2.92% just before the Fed’s September meeting.

In short, the market was clearly expecting that the tapering would begin in
September and that the asset- buying would end in mid-2014. There are at
least three possible reasons why the Fed shifted its actions and policy
guidance so dramatically.

One possibility is that Bernanke and the other FOMC leaders – especially
Vice Chair Janet Yellen and New York Fed President Bill Dudley – never
intended to start tapering. Their earlier statements sought merely to
reassure FOMC members who wanted to end QE that the leadership was
listening to their arguments and taking them seriously. Doing that
prevented QE’s opponents from voting against the majority FOMC position,
something that would suggest policy disarray at the Fed and a lack of
respect for Bernanke. If this explanation is correct, Fed leaders can be
expected to continue with an undiminished program of buying long-term
securities into next year.

A second possible explanation is that Bernanke and other Fed leaders were
indeed anticipating that they would begin tapering QE in September but were
startled at how rapidly long-term rates had risen in response to their
earlier statements. Bernanke spoke about his surprise in this regard at his
June press conference, when rates were up only about 50 basis points. By
September, they were up 125 basis points, to nearly 3%. The markets
obviously were not convinced by Bernanke’s statements that a slower pace of
asset purchases would still represent an easy-money policy. In this way,
the Fed had already achieved a significant rise in rates without having to
taper QE. Even if the economy were robust, this increase would dampen
housing and other activities that are sensitive to long-term rates.

The third scenario is that economic activity was clearly slowing, with the
future pace of activity therefore vulnerable to even higher interest rates.
The annualized GDP growth rate in the first half of 2013 was just 1.8%, and
final sales were up by only 1.2%. Although there are no official GDP
estimates for the third quarter, private-sector assessments anticipate no
acceleration in growth, putting the economy on a path that will keep this
year’s output gain at well under 2%. In addition, the Fed’s preferred
measure of inflation was much lower than its 2% target. The annual price
index for personal consumer expenditure, excluding food and energy, has
been rising for several months at a rate of just 1.2%, increasing the
possibility of a slide into deflation.

Putting all of this together suggests that the Fed is likely to continue
the current pace of QE through the end of this year and into 2014. Although
Bernanke pointed in his September press conference to the possibility that
the tapering might begin before the end of 2013, he conditioned this on the
economy performing up to the FOMC’s expectations. If that is interpreted to
mean that the FOMC’s members must be satisfied with the rate of real GDP
growth, the Fed is highly unlikely to start tapering QE this year, because
growth would have to accelerate to about 3% in the final quarter.

And yet, while all of this points to continued asset purchases at the
current pace into 2014 (and perhaps beyond), there is one reason why some
small tapering might occur in December: Bernanke is scheduled to retire in
January. Since he introduced the “unconventional monetary policies” of QE
and forward guidance, he might want to show before he steps down that he
has put the Fed back on a path to conventional policies. But a single step
in that direction would not have a significant impact on the level of
interest rates and the pace of economic growth.

I continue to believe that the benefits of QE are no longer significant and
that the low level of interest rates is driving investors and banks to take
undesirable risks. In these circumstances, the Fed should move swiftly to
end its long-term asset-purchase program.

Martin Feldstein, Professor of Economics at Harvard, was Chairman of
President Ronald Reagan's Council of Economic Advisers and is former
President of the National Bureau for Economic Research.

Copyright: Project Syndicate, 2013.

www.project-syndicate.org

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9/30/2013
Received on Mon Sep 30 2013 - 21:07:38 EDT