Wed, 18 Dec 2013
Given current fiscal tightness and low inflation rates, tapering monetary stimulus too severely is riskier than continuing the program, says Morningstar's Bob Johnson.
Jason Stipp: The Federal Reserve announced on Wednesday that it would reduce its monthly bond purchases to $75 billion from $85 billion.
I'm Jason Stipp for Morningstar. The market did like that news when it heard it--at least at first. We're here with Morningstar's Bob Johnson, our director of economic analysis, to get his take on the news.
Thanks for joining me, Bob.
Bob Johnson: It is great to be here today.
Stipp: We did hear from Bernanke that they're going to reduce the monthly purchases. There are a lot of different impacts from this. First, you think it's just good policy right now for the Fed [given the] fact that it's in a transition period?
Johnson: I think now is a great time to do it. This is perhaps Bernanke's last meeting, so I think it's really useful that he started [tapering] under his watch, because there is kind of an unwritten rule that [when] you come in as a new chairman, you really don't rock the boat or change things in your first couple of meetings. So, I'm glad he got the ball rolling here and got the tapering program [going]. Now we don't have to [wonder], what month and what date does it start? All that betting is over, and people can focus on what's happening in the real economy.
Stipp: The Fed is still planning to spend quite a bit of money, even after this reduction: $75 billion still in monthly bond purchases. Do you think we still need that much stimulus?
Johnson: Fiscal policy is unbelievably tight, with the sequestration and the budget deals. Policy is still very tight. We've never dropped the deficit as much in one year as we did in 2013.
Now, in  we've got an array of very odd items out of the government that will also weigh on data. So I'm glad [the Fed] is staying loose [with monetary policy]. We've got things like the FHA home mortgage program. The limits are going to be reduced on that, first in the high-price cities and then in all of the cities. That limit is coming way in, which will certainly affect the housing market.
We saw the food stamps program get cut back starting in November. That's certainly a government action that's weighing on the data.
The sequestration process continues on the mandatory-spending side of the House, even though we have changed on the discretionary side a little bit. So, some government spending will again be reduced next year. And the Social Security increases will be smaller than they'll usually be in January as well.
Those things all add up to a very tight fiscal policy. And therefore, I think you need the bond-buying to help offset some of that.
Stipp: Would you say that there is still more risk today in tapering too fast than in continuing for a little bit longer with the stimulus?
Johnson: Absolutely, and the reason I say that is because, number one, the inflation rate. The inflation rate right now is, year-over-year, running at about 1.2% on my moving-average basis, and [the Fed's] target is something that's closer to 2%. So, we're way below it. Maybe it's a little bit unnatural because of some of the things that are happening with gas right now, but with 1.2% being so far below target, they are definitely worried about deflation, and that gives them a little bit more room to operate. If we had a high inflationary environment, then I'd say you'd better stop some of that bond buying now and cool thing down a little bit. But right now it's almost the opposite problem, and deflation could be an issue.
Stipp: Like you say, fiscal policy is still very tight, so the fact that we're still seeing that means that they have a little more room to be stimulative on the monetary side?
Johnson: They need to be stimulative, would be [Bernanke's] take on it.
Stipp: Let's talk about the Fed's forecast. They are forecasting now 2.8% to 3.2% GDP growth next year. How does that align with what you are thinking?
Johnson: I'm just a little bit lower than consensus and that number. I am at 2% to 2.5%, which has been my forecast for probably the last three years.
I think there are some positives in the year ahead. I think the government fiscal policy will be a little bit less of a drag, but on the other hand you are probably going to have interest rates a little bit higher next year. Autos and housing will not grow as fast or be as a big a contributor as they were this year. That will hold things back a little bit.
And like I said, some of the fiscal drag will still be there. I think people are saying, I'll just take the 1.5% that went off [GDP] this year [due to fiscal tightening] and put it in next year. It's not that way. Some of the authorization bills last year will affect this year or the year after and the year after that even. So we're in for some government pain along the way.
Stipp: If we see lower growth than what the Fed expects, do you think they may consider extending their stimulus program even past next year?
Johnson: They've got a very data-driven program, and they'll watch the data as it comes in. If we had a couple of months of good data, then we taper a little bit more, [maybe] $65 billion worth of purchases. And if the numbers make a turn for the worse, I think they pause. I don't think we'll see them going back to $85 billion [in bond purchases]. I don't think we'll ever reverse that curve. That's an opinion, but I don't think they'll reverse it back up the other way, unless things get really bad.
Stipp: And the Fed didn't mention anything about raising those short-term rates, so those are going to stick at zero for quite a while most likely.
Johnson: They actually clarified their thinking. Until we're well under 6.5% in terms of an unemployment rate, they really won't consider moving those short rates. It has to be "well under" 6.5%--their words--and when it actually does hit 6.5%, they're going to start teasing it all apart. Did this go down because of the participation rate? Did this go down for a bad reason?
Stipp: Bob, great insights on the Fed's big announcement today. Thanks for joining me.
Johnson: Thank you.
Stipp: For Morningstar, I'm Jason Stipp. Thanks for watching.