Bond buying is one of two prongs in the Fed’s strategy to boost the economy. The other is low interest rates, and Fed officials are once again debating how best to describe their plans for when they eventually begin raising short-term rates.
In December, the Fed said rates would remain near zero “well past” the time when the unemployment rate falls to 6.5%. The Fed is in no hurry to raise interest rates. But because officials have tied their plans to movements in the jobless rate, they see a need to better explain their plans as the jobless rate drops.
The Labor Department reported employers added just 74,000 jobs in December, a slowdown from average gains of 214,000 during the four previous months. Many Fed officials doubt the economy is as weak as the December report suggested. The data may have been distorted by bad weather or normal statistical variation. Many other indicators suggest the recovery picked up strength during the second half of 2013, driven in part by stronger consumer spending and improved trade.
After struggling for months last year to produce an exit strategy from the bond buying in the face of pronounced investor anxiety, Fed officials say they are reluctant to shift plans abruptly or without convincing evidence.
Fed officials are especially heartened by developments in interest-rate futures markets, where investors are betting rate increases won’t begin until 2015, in line with what policy makers are currently expecting. The Fed spent months last year trying to convince investors the end of the bond-buying program didn’t presage an imminent Fed campaign to raise short-term interest rates.
Still, challenges loom for the Fed, and they could dominate discussions at coming policy meetings.
The jobless rate is declining much faster than the Fed expected—hitting 6.7% in December. It is falling in part because people are leaving the labor force, reducing the ranks of those counted as unemployed. Yet this could be interpreted in different ways. The decline in the share of adults participating in the labor force might reflect weakness in the economy—a reason for Fed officials not to rush into raising interest rates. It could also signal that slack in the economy—in this case, people searching for jobs—is diminishing, which could cause inflationary pressure that would merit higher rates.
With inflation and wage pressures low, many officials doubt the drop in the jobless rate is a sign of sharply reduced economic slack or inflationary pressures.
They first declared in December 2012 that they would need to see a 6.5% unemployment rate before they would consider interest rate hikes. But they have taken steps since then to distance themselves from that unemployment marker because they have doubts about it as a reliable indicator of economic health.
The Fed’s debate about again revising its rate guidance will be one of the first challenges faced by incoming Fed Chairwoman Janet Yellen, who takes over Feb. 1.
Different options are on the table. Under one scenario, the Fed could lower the 6.5% threshold to some lower number, such as 6%. But that idea hasn’t garnered much support among officials to date. Another would create an interest-rate buffer zone of sorts, in which rates would go no higher than, say, 0.5% as long as the jobless rate is above 5.5%.
ed officials have been leaning toward a different, less specific approach of giving general guidance about what other measures they will be looking at when considering rate increases.
Mr. Bernanke, for instance, noted in a recent speech that “after the unemployment threshold is crossed, many other indicators become relevant to a comprehensive judgment of the health of the labor market, including such measures as payroll employment, labor force participation, and the rates of hiring and separation.”
…officials risk making a policy error if they misread the perplexing trend behind the jobless rate drop. If officials raise interest rates too soon, they risk choking off the recovery—but raising them too late could send inflation too high or fuel financial market bubbles. — (WSJ)