I said in a note on Tuesdaythat the best way for the Federal Reserve to smoothly exit from its current stance on monetary policy is to make it more a process than an event, in particular by conditioning any change in the commitment on rates to economic and financial conditions. The Federal Reserve today conditioned its commitmenton rates, by adding in three conditions that will determine the future course of monetary policy:
“The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels of the federal funds rate for an extended period.”
In citing these three conditions, the Federal Reserve has provided a roadmap by which market participants can gauge with greater precision the evolution of monetary policy, in particular the exit strategy for the Fed’s current stance.
The roadmap will guide market participants to react incrementally and in process-like fashion to incoming data and financial conditions rather than react suddenly to either the Fed’s policy statements or speeches and comments by Federal Reserve officials delivered during the inter-meeting period. This will make the implementation of the Fed’s exit strategy more a process than event. It will also give the Fed an “out” because incoming data related to the three conditions mentioned will take on greater weight than the Fed’s own words, allowing the Fed to simply rubberstamp the conclusions drawn by market participants regarding the incoming data.
By making conditional any changes to its policy commitment, the timeline for future Fed policy changes is left unchanged, which should also smooth the market response.