Fed Begins to Taper

The Fed announced that they will reduce their bond purchases by $10 billion (will now purchase $75 billion per month).  It emphasized that future tapering depends on economic data; further tapering will take place if the labor market continues to improve and/or inflation rises from its current low rate.  At the same time, it stated that the "Committee now anticipates, based on its assessment of these factors (labor market, inflation, financial developments), that it likely will be appropriate to maintain the current target range for the federal funds rate well past the time that the unemployment rate declines below 6-1/2 percent, especially if projected inflation continues to run below the Committee's 2 percent longer-run goal" (words in italics added for clarification).   This represents a change from previous statements in which it stated that 6.5% unemployment was its threshold (though not a trigger, as emphasized by Ben Bernanke).  In other words, previous statements said that the federal funds rate wouldn't be raised until unemployment declined to at least 6.5%.  However, the unemployment rate has fallen more quickly than expected, not because of a very strong job market, but due in part to a declining labor force participation rate.  Thus, the unemployment rate by itself is not the best gauge of the labor market.  In the statement released today, the Fed stated that it will consider various measures of the labor market, not just the unemployment rate.  Prior to today, most economists expected the Fed to begin to raise the federal funds rate in 2015.  What about now?  According to projections released by the Fed today, most members of the Fed still anticipate that the federal funds rate will begin to increase in 2015.

What's the key takeaway?  The Fed thinks that the economy is strong enough to begin to reduce the amount of stimulus, though it still needs significant stimulus.  It thinks that the recent decline in inflation is temporary and that inflation will increase somewhat in the next year or two (so deflation is not a serious threat).  Though it changed the wording of the unemployment threshold leading to an increase in the federal funds rate, this is expected to have little impact on the timing of the increase.