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Fed: Of inflation targets and QE3

By Sheyna Steiner · Bankrate.com
Thursday, November 15, 2012
Posted: 5 pm ET

At its October meeting, the Federal Open Market Committee discussed options for communicating its intentions, regarding the federal funds rate and the possibility of expanding its third round of quantitative easing, or QE3, into additional asset purchases at the conclusion of Operation Twist at the end of this year.

As the interest rate setting group at the Federal Reserve, the FOMC has searched for ways to effectively transmit its goals in setting the federal funds rate. That's the very short-term benchmark interest rate which dictates interest rates across a broad spectrum of loans and investment products. It's currently set as close to zero percent as it can get and the plan so far is that it will stay there until 2015.

As the time-based forward guidance seems vague and arbitrary, at the most recent meeting three weeks ago, the committee discussed how it could communicate inflation and unemployment targets or thresholds that might precede a rate increase.

From the minutes:

Participants generally agreed that the committee would need to resolve a number of practical issues before deciding whether to adopt quantitative thresholds to communicate its thinking about the timing of the initial increase in the federal funds rate. These issues included whether to specify such thresholds in terms of realized or projected values of inflation and the unemployment rate and, in either case, what values for those thresholds would best balance the committee’s objectives of promoting maximum employment and price stability. Another open question was whether to supplement thresholds expressed in terms of the unemployment rate and inflation with additional indicators of economic and financial conditions that might signal a need either to raise the federal funds rate before a threshold is crossed or to delay until well afterward.

Nothing was resolved, but there should be more discussions forthcoming.

Another interesting discussion took place, this one involving the likely evolution of QE3 following the end of Operation Twist at the end of the year. In addition to monthly mortgage-backed securities purchases, the FOMC could add more Treasuries to the central bank's portfolio.

Looking ahead, a number of participants indicated that additional asset purchases would likely be appropriate next year after the conclusion of the maturity extension program to achieve a substantial improvement in the labor market. In that regard, a couple of participants noted the likely usefulness of clarifying the range of indicators that would be evaluated in assessing the outlook for the labor market. Participants generally agreed that in determining the appropriate size, pace and composition of further purchases, they would need to carefully assess the efficacy of asset purchases in fostering stronger economic activity and consider the potential risks and costs of such purchases.

The next meeting of the FOMC will be Dec. 11 and 12 and will feature a press conference. Do you think the Fed is going in the right direction on interest rates? Is it enough to help the economy?

Follow me on Twitter: @SheynaSteiner

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