So, the Fed got it right. The so-called taper is off. That is, the Federal Open Market Committee decided to follow its stated policy of continuing to increase monetary stimulus while the labor market remains sick. The decision has surprised markets. It shouldn’t have.
Think about it. We’re at a moment when inflation is well below the Fed’s inflation target, unemployment remains unconscionably high, Congress is threatening to either shut down the government or default, and the recovery is faltering. There is simply no sensible approach to monetary policy that would suggest that this was the moment to take your foot off the gas.
Moreover, Chairman Ben Bernanke promised that future quantitative easing would depend on the incoming economic data. Those data clearly have been weaker than most analysts, including the Fed, had hoped. The only way for the Fed to convince markets that its policies are data-dependent is to make data-dependent decisions. Let's hope this episode has helped rebuild some of the Fed's credibility.
This whole taper debate is one that should never have happened. It’s the result of a failed communication strategy.
Think back to the June press conference, and you’ll recall Chairman Bernanke signaled that the Fed was thinking about tapering quantitative easing. Taper-talk came to dominate the financial headlines, and a monetary meme was quickly born. The result -- as I pointed out at the time--was that markets over-reacted, interpreting the Fed as being less committed to easy monetary policy in the longer run. Long-term interest rates rose, mortgage rates rose, financial conditions tightened. All of this was the result of a needless miscommunication.
Over the ensuing few weeks, a parade of Fed officials gave speeches attempting to persuade investors to abandon the judgment that a monetary tightening was looming. This unnecessary tightening probably did harm the recovery. Indeed, today’s Fed statement notes that “the tightening of financial conditions observed in recent months, if sustained, could slow the pace of improvement in the economy and labor market.”
The point is that “taper off” doesn't really represent an interesting new policy easing, but rather its main function is to undo the damaging tightening in financial conditions that occurred following the initial taper talk.
Where are we? We’re not really back to where we were the day before the markets got spooked by Bernanke’s last press conference. This isn't just a do-over. Even though financial conditions have eased based on this news, they remain much tighter, and the last three months of tighter financial conditions have left us with a more fragile recovery.
(Justin Wolfers is a Bloomberg View columnist. Follow him on Twitter.)