The Federal Reserve is finally allowing data to guide policy. With US unemployment down to seven per cent, a level once floated by Chairman Ben Bernanke as a trigger, the central bank knocked $10 billion off its monthly bond purchases. This limits the expansion of the central bank's balance sheet and sets it on a course for normality.
Bernanke said at his subsequent press conference that he did not consider the move a tightening of monetary policy because it was accompanied by an offsetting softening of the rhetoric on interest rates. The Fed's rate-setting committee now thinks near-zero short-term rates will stay in place well beyond the time when the unemployment rate reaches 6.5 per cent, a threshold previously seen by many as potentially triggering a rate increase.
Nevertheless, in terms of trajectory it's a big change. After all, the Fed decided against a so-called tapering of its $85 billion monthly purchases in September and October despite already firmer data on the economy, jobs and housing. Assuming steady reductions through 2014's eight policy meetings, incoming Fed boss Janet Yellen will be able to declare the bond-buying program over this time next year. The Fed's balance sheet would top out at around $4.5 trillion.
Importantly for Fed policymakers, they can now be more confident in the sustainability of the US recovery. The modest fiscal accord in Washington this month provides extra comfort. Even the market reaction - a pop in stocks - supports that thinking, with investors seemingly persuaded, unlike six months ago, that tapering by the Fed is a positive sign, not a negative one. The Fed's shallow glide-path towards tighter monetary conditions would normally leave lots of space for inflation to build, and that's still a danger - if not an immediate one. And, Bernanke comes over as almost eager to see inflation running even above his two per cent target.
His sanguine attitude on prices may yet test his successor in the coming years. For now, while inflation hawks and proponents of tight money will hardly be cheering, the Fed has at last shifted policy back their way. They'll be hoping Yellen and her colleagues are as hard to budge from the new direction as Bernanke was from the old.
