Let’s start by stipulating the following: a) the Fed was going to begin tapering at some point soon, b) whatever it is that QE is doing, a little less of it would make an imperceptible difference (and, ftr, the evidence shows it’s helping a little with longer-term rates, as Bernanke asserted yesterday, though more from MBS than Treasuries), c) evidence suggests forward guidance is more effective stimulus than QE, d) raising rates too soon would be more damaging than a too-early-slight-unwinding of QE.
If you mostly accept those points, then you might agree with me that Bernanke and the Fed may be doing more with less, i.e., introducing more effective monetary stimulus with slightly lower asset buys.
Re “a,” the key was to ignite the taper without a meaningful market disruption. I’m not talking about equity markets here—who knows what drives them up or down on a given day. I’m talking about interest rates, and remember how the unfortunate “taper tantrum,” (h/t: JH) from May helped to move the 30-year mortgage rate up a full percentage point.
Back then, by merely suggesting the obvious—“um…markets…at some point we’re going to start tapering”—Bernanke sent bond yields soaring. Yesterday, when the actual taper was announced, yields barely budged. I still don’t understand the tantrum, i.e., why it wasn’t obvious to traders that this was coming. But it appears to have taken a “surprise” for the Fed to convince markets that they really were going to unwind based on the data flow. The reaction to yesterday’s move suggests they ultimately conveyed that message.
Point “c” is the most important. My calculus here is simply this: a little less QE will have little impact on the real economy, outside of the impact of its kickoff (which, as per “a,” was fine). But highly accommodative forward guidance is a different story. According to a few papers that have looked at this, the impact on key variables, like mortgage rates and financial conditions, are significantly larger from guidance than QE (this link shows some useful analysis by GS researchers on this point).
So I’d say the benefit/cost outcome from yesterday’s Fed announcement is likely to be positive, meaning they could be giving the economy a bit more of a boost from monetary policy while spending (OK, printing) a bit less.
Two other important points/caveats. Though, as you can see, I’m impressed by the way they played this, there’s only so much the Fed can do, especially with fiscal policy pushing the wrong way (and while the new budget deal helps a bit here, it’s just a bit). Bernanke was very strong on that in the press conference yesterday, calling out Congress in pointed terms for offsetting his tailwinds with their headwinds. “People don’t appreciate how tight fiscal policy has been,” he said. Lemme tell ya, bro—some people do.
Second, one area where one didn’t hear enough from Ben was around the idea of a higher inflation target. That would be a useful complement to their guidance right now, but even while he worried aloud about disinflation, he remains too committed to “well-anchored inflationary expectations” to mess with the 2% target. Part of this reluctance may also relate to interesting comments by Bernanke in the Q&A about how it’s harder than you think for the Fed to move the rate of inflation around (BB: “inflation cannot be picked up and moved where you want it”). That too should be filed under “limits of the Fed not appreciated by those who think they can set key variables where they want them at will.”