In a speech to the Council on Foreign Relations on Friday, Federal Reserve Gov. Jeremy Stein echoed statements made last week by Chairman Ben Bernanke that the Fed would start tapering its bond-buying starting in the fourth quarter.
However, Stein emphasized – as did Bernanke – that tapering would proceed only if the unemployment rate was forecast to drop to 7% by next year. He said the Fed would not rely entirely on fresh payroll numbers to arrive at a decision. Rather, it would consider economic data accumulated since last fall, which could offer greater insight into the overall trend.
Stein indicated that, if the data is favorable, tapering could begin as early as September – thus presenting a more definitive timeline for when the wind-down would begin.
His speech sent stocks lower on Friday morning.
‘The best approach is for the [Fed] to be clear that in making a decision in, say, September, it will give primary weight to the large stock of news that has accumulated since the inception of the program and will not be unduly influenced by whatever data releases arrive in the few weeks before the meeting – as salient as these releases may appear to be to market participants,’ Stein said.
‘If the news is bad, and it is confirmed by further bad news in October and November, this would suggest that the 7% unemployment goal is likely to be further away, and the remainder of the program would be extended accordingly,’ he added.
The markets took a nosedive last Wednesday after Bernanke announced that the central bank would likely scale back its $85 billion-per-month bond-buying program later this year, phasing it out completely by mid-2014.
His speech roiled the markets, which in turn caused mortgage rates for 30-year loans to spike to 4.46% from 3.93% the week prior – the highest level since July 2011 and the biggest single-week increase since 1987.
While many investors were critical of the timing of the announcement, three top Fed officials, including Jerome Powell and William Dudley, defended it, saying the markets overreacted.
Stein said the stimulus program was instrumental in revitalizing the economy.
‘With respect to the economic fundamentals, both the current state of the labor market, as well as the outlook, have improved since September 2012,’ he said. ‘Back then, the unemployment rate was 8.1 percent, and non-farm payrolls were reported to have increased at a monthly rate of 97,000 over the prior six months. Today, those figures are 7.6 percent and 194,000, respectively.’
Stein pointed out that as of last fall the Federal Open Market Committee had forecast an unemployment rate of around 7.75% for 2013 and 7% for 2014. Recently these forecasts were revised down roughly half a percentage point each.
‘While it is difficult to determine precisely, I believe that our asset purchases since September have supported this improvement,’ he said. ‘For example, some of the brightest spots in recent months have been sectors that traditionally respond to monetary accommodation, such as housing and autos. Although asset purchases also bring with them various costs and risks – and I have been particularly concerned about risks relating to financial stability – thus far I would judge that they have passed the cost-benefit test.’
For full text of Stein's speech, click here.