St. Louis Fed's Bullard Discusses Tapering, Forward Guidance and Fed Communications

ST. LOUIS – Federal Reserve Bank of St. Louis President James Bullard discussed “Some Issues in Current U.S. Monetary Policy” at a meeting of the CFA Society of St. Louis on Monday.

During his presentation, Bullard reiterated that current U.S. monetary policy has two components: 1) a short-term policy rate, which has been near zero since December 2008, and its associated forward guidance, and 2) an “open-ended” asset purchase program that began in September 2012, with purchases currently at a pace of $85 billion per month.

In regard to the asset purchase program, he emphasized that any Federal Open Market Committee (FOMC) decision on tapering is data dependent, where tapering refers to reducing the pace of purchases.  “Data dependence encompasses both cumulative progress in labor markets since September 2012 and a judgment concerning the sustainability of that progress,” Bullard explained.  He also noted that “inflation continues to surprise to the downside.”

Bullard discussed other current U.S. monetary policy issues, including possible changes to forward guidance and the idea of holding a press conference after all FOMC meetings.

Cumulative Progress in Labor Markets

When the FOMC began the current asset purchase program, the stated goal was substantial improvement in labor market outcomes.  Bullard noted that two key labor market indicators—unemployment and nonfarm payroll employment—have shown clear improvement over the past year.  “Cumulative progress in labor market outcomes since September 2012 provides the most powerful part of the case for tapering,” he said.

“To the extent that key labor market indicators continue to show cumulative improvement, the likelihood of tapering asset purchases will continue to rise,” Bullard said.  “The Committee’s 2012 criterion of substantial improvement in labor markets gets easier and easier to satisfy on a cumulative basis as labor markets continue to heal.”

He noted that it is possible that the pace of labor market improvement will slow down in coming months or quarters.  “For this reason the Committee also needs to assess whether progress made in labor markets will continue into the future,” he said.  However, he added that recent labor market results seem to suggest that coming months will show continued labor market improvement.

“Based on labor market data alone, the probability of a reduction in the pace of asset purchases has increased,” Bullard said.

Low Inflation

While labor market outcomes have been considerably better than those predicted at the time of the September 2012 decision, Bullard noted that inflation has surprised to the downside.  “There is no widely accepted reason why inflation is running as low as it is in the face of extraordinarily accommodative policy from the Fed,” he said.

“A small taper might recognize labor market improvement while still providing the Committee the opportunity to carefully monitor inflation during the first half of 2014,” Bullard said.  “Should inflation not return toward target, the Committee could pause tapering at subsequent meetings,” he added.

Changes to Forward Guidance

Bullard also addressed the “taper talk” this past June and September and the spillovers to forward guidance.  He noted that in June and September, changes in perceived tapering scenarios led to large movements in key financial market variables.  “Perhaps surprisingly, the perception of the expected path of the policy rate also changed sharply in response to these events—that is, tapering was clearly linked to forward guidance,” he added.

“The Committee needs to either convince markets that the two tools are separate, or learn to live with the joint effects of tapering on both the pace of asset purchases and the perception of future policy rates,” Bullard said.

“To clarify the independence of the asset purchase program from forward guidance, the Committee may consider changes to forward guidance,” he said, noting that the current guidance states that the FOMC will not raise rates as long as unemployment is above 6.5 percent and inflation remains below 2.5 percent.

He discussed three possible options for altering forward guidance, including lowering the unemployment threshold.  However, Bullard cautioned, this “puts the credibility of the thresholds approach at risk.”  He said another option would be to establish an inflation floor at 1.5 percent, which would be symmetric with the current forward guidance on inflation and which could be helpful if inflation continues to behave in an unusual manner.  The third option would be to state verbally that the FOMC is unlikely to raise rates even after the 6.5 percent unemployment threshold is crossed, which Chairman Ben Bernanke has already done.  This option is “less complicated and possibly just as effective,” Bullard said.

Press Conferences

Regarding Fed communications, Bullard repeated his call for press conferences to be held after every FOMC meeting instead of only some meetings.  “Markets have suggested that meetings without press conferences are unlikely to be situations where the Committee can take important action,” Bullard noted.

“The FOMC needs to keep its options open,” he said, adding that one way to do so is to include a press conference after every meeting.  “A press conference at every meeting would likely improve Fed communications,” Bullard concluded.