Bernanke Seeing the Difference Between Tapering and Tightening
Based on the December 2013 Market Overview report.
On November 19th at National Economists Club Annual Dinner Bernanke gave a speech which could be seen as a sort of testimony or farewell (probably one of many coming soon). The message he has sent was in perfect compliance with what was being communicating to the public. Firstly he offered a "forward guidance", which was to reassure us that low short term interest rates are here to stay for the longer term. The possible boundary line, as we repeatedly heard, is lower unemployment and/or significantly higher inflation rate. Until then we are still in the ZIRP - zero interest rate policy - scenario.
Years ago it was supposed by many that unusually low interest rate levels were introduced as a temporary measure to combat recession. At first it was supposed to be for "some time", then an "extended period". It did not take a long to hear it's going be 2013, then late 2014, and finally mid-2015. Since the public eventually got tired of this temporary (6-year!) low interest rate policy, we switched to qualitative signals. The interest stays low until things get better for labor markets and/or for inflation.
Yet even if we reach such levels, in Bernanke's own words: we are in the realm of "thresholds, not triggers. Crossing one of the thresholds will not automatically give rise to an increase in the federal funds rate target; instead, it will signal only that it is appropriate for the Committee to begin considering whether an increase in the target is warranted." Therefore even though recent official numbers of employed look very optimistic, it does not lead us to tighter monetary policy. At least not yet.
Bernanke is trying to reaffirm us that interest rate hikes are far, far away on the horizon. No tightening is to be seen anywhere soon. And just like Dennis Lockhart he is dehomogenizing interest rates policies and asset purchases. Therefore the "tapering" could happen even with a very expansionary monetary policy. Both of those tools are to achieve the same end: boosting the banking system and supplying more cheap money for it. Low long-term interest rates allow (in theory) for money debt issuance and more returns for those supplying the debt. Lower long interest rates are to be created by the Fed's short-term rates, mostly through expectations. If people constantly expect low short-term future rates, this should be discounted, or in some way included, in the longer rates.
This we did not see. Therefore the Fed triggers another, now very famous, channel of QE: asset purchasing. This also is supposed to lower longer rates, but differently. If the Fed buys some of the assets from the market, less is available for the rest of the investors. Therefore scarcity of those assets is about to bid up their prices, ergo decrease the expected returns on them (higher expected returns are of course the same as longer term interest rates).
Even though those two tools have similar effects on the market interest rates, they are not viewed as equivalent. It is possible that one of those policy tools may be tapered. Yet it does not mean that easy monetary policy is over. Even with currently rising employment levels. Stay tuned.