QE3 and beyond: $85 billion per month and counting

There's not much question that the asymmetric treatment of the inflation threshold biases policy toward using monetary stimulus to reduce unemployment.

And that's not all. Bernanke stressed that "reaching one of those thresholds will not automatically trigger immediate reduction in policy accommodation. If unemployment was to decline at a time inflation expectations were subdued and (expected) to remain so, the Committee might judge an immediate increase in the target for the federal funds rate to be inappropriate."

Bernanke said the FOMC "will follow a balanced approach in seeking to mitigate deviations of inflation from the longer run 2% goal and deviations of employment from the estimated maximum level."

Even more bluntly, he said unemployment "could be well less than 6.5% after the (funds rate) take off point." And he said, "Whenever that occurs it would be relatively gradual. I don't think we're looking at rapid increase."

The FOMC  is assuming "an increase in the funds rate first occurring sometime after unemployment goes below 6.5% but doesn't necessarily assume rapid increase after that....," he said.

  "We'll look at the situation. But, assuming inflation remains well controlled, which I fully expect, the increase in rates would be moderate...."

Bernanke called the 6.5% unemployment threshold merely "a guidepost in terms of when it is that the beginning of a reduction of accommodation could begin. It could be later than that, but ... no earlier than that time."

Essentially, the FOMC is willing to tolerate inflation up to 2.5% in an effort to lower unemployment, but is willing to keep policy easy even if the unemployment rate falls below 6.5% if inflation is deemed not to be a threat. If that's not an easing bias, what is it?

Chicago Fed President Charles Evans, an early proponent of numerical thresholds who will be an FOMC voter in 2013, has called the inflation threshold a "safeguard." But for others, it provides very little protection against inflation.

Richmond Fed President Jeffrey Lacker warns the unemployment and inflation thresholds "could well conflict" and could "tie our hands." If they had been in place in 1994, he says the FOMC could not have preemptively raised rates when it saw incipient signs of inflation pressures.

The so-called "safeguard" is really "an inadequate defense because it essentially requires that we lose a measure of credibility before it can be invoked," says Lacker.

And in fact, by using an inflation forecast, the FOMC has given itself an enormous out if it chooses to use it. If actual inflation rises to 2.5% or higher, while unemployment is still above 6.5%, the FOMC can rationalize maintaining an easy policy or even making it easier by projecting that inflation will come back below 2.5%.

 You might say that, from the Fed's standpoint, the inflation "safeguard" has a safety valve.

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About the Author
Steven K. Beckner

Steve Beckner is senior correspondent for Market News International. He is heard regularly on National Public Radio and is the author of "Back From The Brink: The Greenspan Years" (Wiley).

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