Monetary Policy Important but No Panacea

With the federal funds rate as low as it could effectively go, the Federal Open Market Committee (FOMC) used two unconventional policy tools in 2013: forward guidance about the expected path of the federal funds rate and large-scale asset purchases (often called quantitative easing, or QE), at a pace of $85 billion per month. Both tools aimed to push down longer-term interest rates to spur households and businesses to borrow, spend, and invest—in turn, triggering a virtuous cycle that would include increased production, hiring, and more spending.

The FOMC conditioned the duration of the QE program on achieving substantial improvement in the outlook for labor markets. By the end of 2013, the unemployment situation had improved enough that the Committee voted to reduce its purchases by $10 billion per month, thus beginning the much-anticipated “tapering” process.

With that transition under way, the key monetary policy question for the Fed is how long to keep the fed funds rate at zero. Throughout 2013, FOMC members continued to anticipate that the fed funds rate would stay put at least until the unemployment rate falls below 6.5 percent. In the statement following its December meeting, the Committee also noted that the near-zero rate would likely be appropriate “well past” the 6.5 percent threshold, especially if annual inflation continues to look like it will fall short of the Committee’s longer-run objective of 2 percent.

Is it working?

It’s difficult to isolate precisely the effects of the Fed’s monetary stimulus, in part because the linkages between policy and employment are indirect. However, recent research suggests that monetary policy has helped push down interest rates and boost asset prices. And as Atlanta Fed President Dennis Lockhart noted in a February 2013 speech, the Fed’s monetary stimulus has “without question helped achieve the economic progress we’ve made since the end of the recession.”

The economy has recovered considerably, but the job is not done. The jobless rate, at 6.7 percent in December, remained well above FOMC members’ projections for the longer-run rate of unemployment, which ranged from 5.2 to 5.8 percent. Obviously, there’s still work to do. But with the appropriate monetary policy, the FOMC in December expected that the jobless rate would gradually decline toward levels the Committee judges consistent with its dual mandate.