Damaging taper idea should never have been floated
The Federal Reserve did the right thing in the wrong way and very likely for the wrong reasons.
The Fed said on Wednesday it would continue buying bonds at an US$85 billion monthly pace for now, citing concerns about a sharp rise in borrowing costs in recent months and the upcoming budget battle in Washington.
This came as a huge surprise to most people, well anyone who listened to and believed what Fed chairman Ben Bernanke has been saying for the past three months or so, when he did a masterful job of setting the market up for a tapering of bond purchases.
"The tightening of financial conditions observed in recent months, if sustained, could slow the pace of improvement in the economy and labour market," the US central bank said in a statement explaining its decision.
Seriously, the Fed, having led us to believe it would taper, just told us it wasn't tapering because we believed them. What, exactly, are we now to think?
I've been among those who criticised the Fed for artificially suppressing volatility in financial markets, but I didn't intend for them to increase it by acting unpredictably; I was hoping more that they'd let assets find their own values.
To be sure, this was the right thing to do. Neither of the Fed's mandates - controlled inflation or full employment - was anywhere near target.
Inflation is too low, as the Fed acknowledged, and though energy prices rise and fall there seems little demand push in the economy which will bring it back towards the Fed's 2 per cent target. The risks are the other way.
And employment too is nothing like in shape to justify a tightening of financial conditions, which is exactly what a taper is.
It was good to hear Bernanke say that the unemployment rate, which is hugely flattered by frustrated and ageing workers falling out of the count, is not always the best indicator.
Good too to hear him nod towards the participation rate, though we may be waiting quite some time for a taper if a normalising of labour force participation becomes a precondition.
So yes, there was no good economic reason, other than doubts that the risks of QE are greater than the benefits, to taper. And yes, the data over the summer wasn't fantastic, and yes, people believing the Fed's communications meant that mortgage rates went higher, which slows the housing recovery.
I get all that, but can't help but feel that things would be better if the Fed hadn't floated the taper idea in the first place.
If we've learned anything in the past 10 years it is that the Fed has only a few tools, and they are suited to only a few purposes.