Thanks goodness it’s over. Financial market behavior ahead of last night’s announcement by Ben Bernanke on a gradual reduction in U.S. monetary stimulus has been tedious and irritating, rather like listening to whining children in the back of the car on a long journey: “Daddy, are we there yet?” In fact, impatient whining about when the Fed might start to “taper” has spoiled for many investors what should have been one of the most enjoyable financial journeys of all time, scaling previously unexplored market peaks and passing through unprecedented monetary vistas.
Imagine if everyone had simply taken Ben Bernanke at his word when he said in May that the Fed would continue buying bonds at the rate of $85 billion every month until it was absolutely confident that unemployment was on the way to 6.5 percent and that the scale of these purchases would only be increased or diminished if and when a change was clearly warranted by economic statistics. Investors would then have concluded, as I suggested at the time, that no significant changes in U.S. monetary policy were likely until the end of 2013.
Stock markets around the would have enjoyed their strongest year for a decade without the trauma of the spring and summer “taper tantrum.” Nobody would have been shocked or embarrassed by the “September surprise,” when the Fed very sensibly decided to keep up the pace of monetary stimulus in the face of lackluster economic figures, despite the howls of indignation from analysts who were wrong-footed by their own unsubstantiated predictions of early tapering. Finally, investors would have been fully prepared for the Fed’s decision to go ahead with tapering this week. After all, the recent strong run of U.S. employment, housing and production data provided exactly the sort of strong economic background that Bernanke had posited all along as the necessary condition for tapering, especially in conjunction with the Congressional budget deal that was ratified by the Senate at the same moment Bernanke as spoke across town.
Which brings us to the implications of this week’s momentous events in Washington for economic and financial prospects. For the U.S. economy, the combination of Fed tapering and overwhelming support in both houses of Congress for the budget deal is unambiguously good news. The uncertainties over monetary and fiscal policy that have dominated business, consumer and financial sentiment since the 2008 financial crisis are now essentially resolved. The budget deal virtually guarantees stability in both taxes and public spending until at least 2015 and probably until the next president is inaugurated in January 2017. Meanwhile, the addendum to the Fed’s tapering announcement, which promised to maintain interest rates at their present level until “well past the time that unemployment declines below 6.5 percent,” virtually excludes any possibility of monetary tightening until well into 2015 and represents a much stronger and clearer commitment to near-zero interest rates than anything previously heard from the Fed.
Most importantly, the Fed has now made absolutely clear and unambiguous the two key messages that Bernanke spent this year trying to explain to the markets. First, that a gradual slowdown in the Fed’s asset purchases does not imply any chance in the outlook for interest rates and the Fed will ensure that short-term rates remain firmly anchored near zero. Second, that U.S. interest rates will only start to rise after the U.S. economy has been restored to something approaching full employment — and given the millions of discouraged workers who have recently dropped out of the labor force, the restoration of full employment is likely to require several years of rapid growth, at well above the U.S. economy’s long-term trend growth rate.