Policy experimentation continues unabated in the US with the Federal Reserve launching on Wednesday a new initiative to influence market valuations and, through this, the outlook for the country’s economy. The Fed hopes to use greater transparency to mould expectations in a manner that promotes economic growth and price stability. But this new approach could also create confusion and even greater hesitancy on the part of healthy balance sheets to engage in productive investments.
I suspect the Fed recognises that the policies at its disposal are a long way from ideal. Interest rates are already floored at zero and, according to the latest statement, will likely stay there at least through the end of 2014. Meanwhile, its balance sheet has ballooned to a previously-unthinkable 20 per cent of gross domestic product through direct purchases of securities in the market place.
Few expect this new initiative to have an immediate or durable impact. Beyond 2012, individual FOMC members’ forecasts are quite dispersed, including a 0.25 per cent to 2.75 per cent range for the target Federal Funds rate for end 2014. It will also take time for households, companies and investors to digest yet another set of signals. Moreover, they are much more interested in the likelihood of a new round of Fed purchases, QE3, than forecasts that deal with an unusually uncertain future and are likely to change frequently. Continue reading »