In a perfect world, the Federal Reserve Committee would prefer to sit in the background and not wield any influence, but after the 2008 global financial collapse, they needed to intervene.
That action created a dilemma: Do they go deep with an aggressive policy or wait and see how things would shake out? The latter mistake was made in the 1930’s, which helped extend the Great Depression. When they started on their plan to heal the financial markets from a very steep decline and potential depression, the Fed was committed to doing whatever was necessary to steer clear of a disastrous outcome. The world was watching and waiting.
At first, the idea was to be decisive with a time line. However, the depth of the crisis required an extended time period, and their language in statements and minutes eventually became “Accommodation will end at some point.” Of course, their eyes have always been on the data (and the Fed has TOLD us this), and the data was pretty good throughout 2014.
The Fed’s dual mandate of price stability and achieving full employment took quite a bit longer to accomplish after the dismantling of both during the 2008 financial crisis. Chairman Ben Bernanke, a student of history (and an expert of the 1930s Depression Era), was the architect behind current policy: Keep rates low for as long as needed, buy bonds to achieve the goal, and allow the job market time to repair itself by shoring up confidence in financial markets and thus confidence around the world.
Who really knew how much stimulus was needed or for how long. The Fed embarked on QE not once, not twice, but THREE times – and they didn’t put a time limit on the last effort. Many have argued that the policy was unusual, excessive, and unnecessary – but I would prefer to be where we are at today (with recent 5% GDP growth) than where we might have been without some divine Fed intervention.
As we ended 2014, the sun set on QE, and that part of Fed Policy is history. However, we still have extraordinarily low rates, and the big talk for 2015 is not if but when those rates will start to rise.
Normally, the Fed gets hawkish when inflation expectations have risen higher than they would like. Today, that is not the case (inflation is low, perhaps even too low). Admittedly, extreme policy accommodation is probably not needed and could be quite harmful if in place for too long. The Fed is aware of the dangers here and continues to calibrate as necessary without setting off alarm bells. The entire World is STILL watching and will pivot off Fed Policy.
So, in 2015 we have some ideal conditions that MAY allow the Fed to start retreating from excessive policy accommodation to a more normalized environment, but that will likely be a longer process than usual (maybe 2-3 years). Given the damage inflicted, the Fed will use extreme caution and care and all the time necessary to be sure they are not hurting the recovery as they start raising rates.
But with good growth in GDP, lower commodity prices, solid improvement in the jobs market (with more needed) and other key areas healing, the table is set for the economy and markets to decouple from the Fed – at last. And that will be a great moment for Ben Bernanke – mission accomplished.