For investors trying to estimate when the Fed will raise interest rates, today’s statement was a non-event. The Fed upgraded its assessment of economic conditions, but did not radically revise its view of the trajectory of growth going forward and left its discussion of inflation unchanged.
It underscored its intention to complete its exit from unconventional liquidity policy soon – but drew a bright ECB-style distinction between liquidity policy and monetary policy. It left for 2010 the question of whether the unusually narrow discount rate spread falls into the first category or the second.
Not much to get excited about.
But for analysts trying to understand the arc of Fed policy from crisis to a new normal it was a bit more interesting.
The statement highlighted something that has been in train for some time but is nonetheless a critical development: the narrowing down of the tools the Fed uses to support the economy.
At the peak of the crisis the Fed deployed pretty much every tool any serious economist had thought off to battle a giant shock and ward off deflation: zero rates, forward guidance on rates, asset purchases, a QE-style commitment to a large balance sheet and unorthodox liquidity provision.
Now it is gradually phasing out unorthodox liquidity provision, tapering off asset purchases and dropping its commitment to monitor the size and composition of its balance sheet and make adjustments as warranted.
When this narrowing down is more or less complete (around the end of Q1 2010) the Fed will rely more or less exclusively on two tools: zero rates and forward guidance on rates.
Then, at some point – I assume when the committee sees a reasonable probability that it will raise rates within a six month horizon – the forward guidance will be cut back and eventually dropped altogether.
