Boston Fed president, Eric Rosengren has been dovish (and right) for the past few years. Reading the FOMC minutes, my guess has been that he is the one that wants more stimulus now due to low inflation.
The fact that he was packing the following chart tends to support this hunch … But
His speech overnight suggests he has changed his mind (or that i was wrong, in which case arch dove is likely to be Kocherlakota).
In terms of monetary policy, it would in my view be premature to stop the Fed’s large-scale asset purchase program at this time. I believe the Fed should continue the purchase program until we see more sustained improvement in labor markets and have greater confidence that the economic recovery is sufficiently self-sustaining to yield continued progress in reducing the still very high unemployment rate.
However, I would also say that it may be undesirable to abruptly stop purchases, so it may make sense to consider a modest reduction in the pace of asset purchases if we see a few months more of gradual improvement in labor markets and improvement in the overall growth rate in the economy – consistent, by the way, with my forecast, which is somewhat more optimistic than that of many private forecasters.
What’s going on here? The FOMC are missing badly on employment and inflation, but might taper soon? I think it is the old stock-flow debate. The FOMC thinks it is the stock that does the work – so they will not have tightened until their balance sheet shrinks. The market, however, thinks it is the flow!
I would reiterate that with an open-ended asset purchase program, changing the flow of purchases does not necessarily yield, in the end, a smaller central bank balance sheet. That would depend on having a fixed point for cessation of purchases, combined with a lower flow of purchases. So, even if we were to adjust the rate of monthly purchases, the ultimate size of the Fed’s balance sheet would depend on the point of cessation. If economic growth proves sufficient and the purchase program was not extended over a longer time period, the size of the balance sheet could be smaller than otherwise.
We will see if the Fed holds their nerve when they actually taper … The exits from QE1 and QE2 suggest the equity market won’t like it, and that may undo the economic argument for monetary tightening from higher inflation, and ultimately cause the FOMC to reverse track.
In any case, with Rosengren talking tapering it seems like the FOMC is headed toward the exit, probably at their September or December meetings (which are followed by press conferences).