LITTLE ROCK, Ark. – Federal Reserve Bank of St. Louis President James Bullard discussed “A Tame Taper” at the Arkansas Day with the Commissioner event hosted by the Arkansas Bankers Association on Friday.
During his presentation, Bullard addressed several recent themes in U.S. monetary policy. First, he noted that the impact of the Federal Open Market Committee’s (FOMC’s) taper this year has been tame compared with the “taper tantrum” last summer. “The FOMC’s reductions in the pace of asset purchases have proceeded smoothly so far,” Bullard said. He also discussed the weak U.S. GDP growth at the beginning of this year. “First-quarter real GDP growth was weak, but forecasts for the remainder of the year are strong,” he said. Regarding inflation and unemployment, Bullard noted, “The FOMC is much closer to its policy goals than it has been in the past five years.” He added that inflation has stabilized at a low level.
The Fed’s Taper
Bullard noted that the FOMC took no explicit policy action at the June 2013 meeting, yet triggered a significant movement in global financial markets. During last summer’s taper tantrum, longer-term U.S. interest rates increased, emerging-market currencies depreciated against the U.S. dollar, capital flowed to the U.S. and emerging-market stock indexes declined.
“The taper tantrum during the summer of 2013 was based on perceptions of Fed actions,” Bullard said, adding that the actual decision to begin tapering did not occur until December 2013. Since then, the FOMC has reduced its pace of asset purchases four times by $10 billion each time. “Yet the effects on global financial markets have been much less striking,” he noted.
He discussed how to interpret the two different responses. “One interpretation is that as of June 2013, it was premature to argue that the U.S. economy was strong enough to pull back on asset purchases,” Bullard said. “As of December 2013, better growth and employment data justified the taper decision.”
First-Quarter GDP Growth
Turning to first-quarter data for 2014, the reported annualized growth rate of U.S. real GDP was close to zero. Bullard noted that some tracking estimates are calling for an even lower reading once revised data are taken into account. “The weak first-quarter performance has been widely attributed to particularly cold and snowy winter weather,” he said.
“While first-quarter GDP growth was weak, growth in coming quarters is still predicted to be robust,” Bullard said. “The average quarterly pace of growth in 2014 may still be an improvement relative to 2013,” he added. The average quarterly pace of growth in 2013 was 2.6 percent.
Monetary Policy Goals
Bullard noted that over the past five years U.S. unemployment has been high and inflation has remained relatively low, and that this situation has led to an extraordinary monetary policy response. “But today, Fed goals are within sight. This helps to justify the FOMC’s tapering of asset purchases,” he said.
To measure the distance of the economy from the FOMC’s goals, Bullard used a simple objective function, which depends on the distance of inflation from the FOMC’s long-run target and on the distance of the unemployment rate from its long-run average. This version puts equal weight on inflation and unemployment and is sometimes used to evaluate various policy options, Bullard noted.
In his calculations, the target rate of inflation was set at 2 percent, the FOMC’s inflation target. The long-run average rate of unemployment was set at 5.4 percent, the midpoint of the central tendency of the FOMC’s Summary of Economic Projections. “The objective function value is closer to the FOMC’s goals than it has been about 60 percent of the time since 1960,” Bullard said.
He then addressed the question of why monetary policy is so far from normal if the Fed is relatively close to its objectives. “Labor markets do not seem to be fully recovered,” Bullard said. In addition, “Inflation remains low.”