The ‘taper tantrum’ of May and June, as the mid-year spike in interest rates became known, appears to have humbled Federal Reserve officials into having a second look at their convictions about the power of forward guidance on interest rate policy.
Take James Bullard, president of the St. Louis Fed. He acknowledged on Friday that the Fed’s view of the separation between rates guidance and asset purchases had not been fully accepted by financial markets. “This presents challenges for the Committee,” he noted.
A decision to modestly reduce the pace of asset purchases can still leave a very accommodative policy in place to the extent forward guidance remains intact.
The Committee needs to either convince markets that the two tools are separate, or learn to live with the joint effects of tapering on both the pace of asset purchases and the perception of future policy rates.
San Francisco Fed President John Williams also recently outlined some of the drawbacks on relying too greatly on promises of future behavior.