It was more than a year ago that the U.S. central bank first
promised not to raise interest rates until joblessness fell to at
least 6.5 percent, a pledge that policymakers thought would hold
until at least mid-2015.
The Fed still wants to assure investors that rates will stay low for
at least another year, but there is growing debate among
policymakers over how to get this message across now that the
jobless rate stands at 6.6 percent but the pace of job creation
remains erratic at best.
Fed officials are likely to drop any reference to a specific rate of
unemployment, according to several who have addressed the topic in
recent days. They could also renew a pledge not to tighten policy
until inflation starts to rise back to more normal levels, and they
may reinforce the notion that financial conditions will factor into
"We will have to reformulate it and provide some qualitative way of
providing an assessment of what time horizon we think is most
likely," Jeffrey Lacker, president of the Richmond Fed, told
reporters in Virginia on Tuesday.
This reformulation could come as soon as a Fed policy-setting
meeting on March 18-19.
On the surface, the shift to a more qualitative, succinct message
may seem modest.
But the stakes are high: policymakers are in the midst of phasing
out their massive bond-buying program, but worry that the U.S.
economic recovery could stall if financial conditions tighten too
soon. To ensure that stimulus still flows, they plan to lean ever
more heavily on their promise to investors that a rate hike is far
in the future.
Lacker pointed to one option available to the Fed: relying more on
charts the Fed publishes four times a year showing when each
individual policymaker expects rates to finally rise, and how high
they will be up to four years into the future.
The so-called summary of economic projections, or SEP, last
published in December, has 12 of the Fed's 17 policymakers expecting
to begin to tighten policy some time next year — an expectation that
aligns with traders in rate-futures markets.
"I'd point out that the SEP provides a rich portrayal of the array
of views within the committee, and even if we said nothing the SEP
would be pretty informative," Lacker said.
At its March policy meeting, the Fed could simply erase an extensive
reference to its rate-rise thresholds — including a nod to
6.5-percent unemployment and 2.5 percent inflation — and restate
that easy policy will be needed "for a considerable time after the
asset purchase program ends and the economic recovery strengthens."
Yellen, at her first press conference as chair after the meeting,
could then direct investors' attention to the SEP, which also shows
Fed officials' forecasts for unemployment, inflation and economic
growth over the next few years.
As it stands, the central bank's policy is to keep rates near zero
until "well past the time" joblessness falls to below 6.5 percent
"especially" if inflation expectations remain weak.
The trick for Yellen is rewriting this so-called forward guidance
without suggesting the Fed is poised to drop its support for the
economy, which could spark a spike in borrowing costs that stalls
the slow recovery from the Great Recession.
"What you don't want is for markets to suddenly say, 'the economy is
doing better,'" said Paul Ashworth, chief North American economist
at Capital Economics, a research firm.
LIFE BEFORE AND AFTER THRESHOLDS
The idea of using inflation and unemployment thresholds to telegraph
rate expectations initially came from Chicago Fed President Charles
Evans. He spent more than a year urging colleagues it was more
effective than so-called calendar-based guidance, which the Fed had
adopted in 2011 with a pledge to keep rates low until mid-2013.
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By late 2012, the Fed had twice revised its low-rate pledge,
extending it out to mid-2015. It was then that Evans won a key
Yellen, who was vice chair at the time, worried that each shift
to a later date would deliver a jolt of pessimism about the economic
outlook, prompting renewed caution on hiring and spending — exactly
the opposite reaction from what the Fed hoped its low-rate promise
would elicit. A month after she publicly endorsed Evans' thresholds
approach, citing its market-stabilizing effects, the Fed adopted it.
Now, though, even Evans acknowledges that Yellen will need to
consider a rewrite.
"You start writing the statement without reference to 6.5 percent,
but you find a way to mention that it will still be 'well past the
time,' some language that captures that, and also the important
guidance that as long as inflation is below our 2-percent objective,
we can continue to have very accommodative monetary policy," Evans
told reporters in Detroit this week.
In a surprise to some, unemployment has swiftly fallen from 7.9
percent a year ago, and from a post-recession high of 10 percent in
2009. On Friday, the Labor Department reported the jobless rate had
fallen to a five-year low of 6.6 percent, but the fewer than 200,000
new jobs created over the past two months is insufficient to sustain
the current pace of economic growth.
The quick drop in joblessness has soured Fed officials to the idea
of simply lowering the unemployment threshold.
Instead, as Boston Fed President Eric Rosengren suggested on
Thursday, they could stress that broader measures of the labor
market — such as the number of part-time or discouraged workers, or
the rate of wage growth — will play a bigger role as they mull a
Any change to the approach could have global ramifications, given
that former Chairman Ben Bernanke was a trailblazer in telegraphing
policy intentions since the 2008 financial crisis.
The Bank of England followed the Fed's lead in tying a rate rise to
an unemployment threshold — a policy that seems to have run its
course on both sides of the Atlantic.
As they move away from that approach, though, Fed policymakers will
need to take care not to roil markets.
That happened last May when Bernanke first let it be known the Fed's
bond-buying program would soon be pared; while investors have become
accustomed to the idea, emerging markets sold off in the last few
weeks as the U.S. central bank made its first reductions in the
"The Fed has taken the first two tentative steps in a very long
journey of bringing its balance sheet down to normal," said Carl
Tannenbaum, chief economist at Chicago-based Northern Trust.
"I believe that the success of that effort is going to hinge
critically on the Fed's communication with markets," he said. "The
Fed would like to engineer the return to normalcy in a smooth and
(Reporting by Ann Saphir and Jonathan
Spicer; Additional reporting by Krista Hughes; editing by Paul Simao)
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