There is no time like the present. That’s what my mother and father always told me, and that’s something the Federal Reserve should keep in mind when policy makers gather next week to consider tapering asset purchases.
That doesn’t sound like a good reason to start tapering? It’s not. So bear with me.
Let’s start with the premise that the Fed is anxious to get out of the unconventional-policy business and get back to basics. Of course, that’s hard to do when the basics involve adjusting the benchmark overnight interest rate, something the Fed has no intention of doing anytime soon. Various studies and official comments seem to acknowledge the diminishing returns from the third round of quantitative easing, which consisted of the purchase of $85 billion in Treasury and mortgage-backed securities a month, compared with the first two rounds.
Given the Fed’s predilection for tapering, the time frame outlined by Fed Chairman Ben Bernanke in June (“later this year”), and the expectation that the end of asset purchases would coincide with a 7 percent unemployment rate, next week seems like the best time to start.
What’s the urgency? The U.S. economy has been growing at the subpar pace of 2.1 percent since the recession ended in June 2009. The unemployment rate has fallen largely because Americans have dropped out of the labor force. So why now?
First off, consider the Fed’s view of how QE works.
“Quantitative easing typically refers to policies that seek to have effects by changing the quantity of bank reserves, a channel which seems relatively weak, at least in the U.S. context,” Bernanke said in a November 2010 speech at a banking conference in Frankfurt. “In contrast, securities purchases work by affecting the yields on the acquired securities and, via substitution effects in investors’ portfolios, on a wider range of assets.”
If there is no longer a positive effect on the yields of acquired securities and other assets, then there is little point in continuing the current pace of purchases. A delay in tapering is not going to reduce long-term interest rates because everyone knows it’s coming -- and soon.
Besides, the difference between the predicted effect, derived from an econometric model, of $85 billion in monthly purchases and $70 billion, a likely first step, is infinitesimal and overwhelmed by other market forces.
Absent a monetarist framework, QE becomes more of a constraint than a solution.
A second not-very-good reason for tapering now is that a better opportunity may not present itself in the next couple of months. August’s disappointing employment report injected some caution into calls for tapering. Nonfarm payrolls rose by 169,000, below the 12-month average. Of greater concern was the downward revision, for the second consecutive month, of job growth in previous months. Data revisions tend to reflect the trend. So when additional information -- in this case, a more complete survey sample of businesses -- reduces the head count, it’s a worrisome sign.
The labor force participation rate fell to a 35-year low of 63.2 percent in August. The unemployment rate declined to 7.3 percent for the wrong reason. As in almost every month for the last five years, the number of unemployed workers leaving the labor force exceeded the number who found a job.
In the fourth quarter of 2012 and the first quarter of this year, employment growth was running ahead of what was implied by real gross domestic product growth. Now GDP and employment seem to be in better alignment. A monthly increase of 169,000 jobs may be as good as it gets until economic growth accelerates.
The packed fall calendar is a third reason to consider tapering now. The Fed’s subsequent meeting on Oct. 29-30 could very well coincide with negotiations over an increase in the debt ceiling and the announcement of the next Fed chairman.
“This would not be an ideal moment for the central bank to experiment with a potentially disruptive operational change,” Credit Suisse Group AG economists Neal Soss and Dana Saporta wrote in the bank’s Sept. 6 U.S. Economic Digest.
In addition to calendar constraints, Soss and Saporta argue that a desire to avoid market disruptions in the face of reduced mortgage and Treasury issuances is “the best and least-tortured reason for tapering.” That makes four.
Throw in an indefinite delay in a U.S. response to Syria’s use of chemical weapons, and you have the five least bad reasons for the Fed to take its first baby tapering steps next week. That’s not to say it isn’t a close call. The economic justification -- a substantial improvement in the outlook for the labor market -- is still lacking, even though the unemployment rate is close to where the Fed expected it to be in mid-2014.
Soss and Saporta expect the Fed to “sugarcoat” the message that tapering is not tightening -- is there anyone who missed it? -- and perhaps spell out plans to let assets mature rather than sell them when the time comes.
At this point, I have to believe that tapering is fully priced into the market. Isn’t that what forward guidance is all about?
(Caroline Baum, author of “Just What I Said,” is a Bloomberg View columnist.)
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