Here's A Great One-Paragraph Explanation Of What Goldman Says Is The Fed's Next Play

janet yellen

Bloomberg

Earlier this week, top Goldman economist Jan Hatzius made a splash when he said that the Fed would soon lower its unemployment rate threshold for considering a rate hike.

Basically right now the Fed operates under what's called "Evan's Rule" whereby it's told the market that it won't consider hiking rates until the unemployment rate hits 6.5% or inflation hits 2.5%.

Hatzius believes that next year, the Fed will drop the unemployment rate side of the rule down to 6%, with the idea being that this will operate as further stimulus because it will imply lower rates for longer.

Economist Tim Duy (via Calculated Risk) has a great blog post explaining what this is all about, and why the Fed might take this step. This paragraph is really key:

Policymakers would like to normalize policy by moving away from asset purchases to interest rates. Emphasizing forward guidance is part of that process. Incoming research suggests not only that threshold based forward guidance is effective, but has room to be even more effective. That should be a comfort to policymakers who worry that ending asset purchases will excessively tighten financial conditions; they have a tool to change the mix of policy while leaving the level of accommodation unchanged. Whether they use it or not is another question. There has clearly been some discomfort among policymakers regarding changing the unemployment threshold. This suggests it would not necessarily be an immediate replacement for ending asset purchases. That said, it is difficult to see how the current threshold is meaningful at all if the Fed is still purchasing assets when the threshold is breached. Indeed, the current low level of unemployment relative to the threshold, combined with clear indications that the Fed has no intention of raising rates anytime soon, argues by itself that a change in the thresholds is a likely scenario in the months ahead.

Basically, QE is of limited effectiveness, and there are fears about the size of the Fed's balance sheet, and how much of the market in certain fixed income assets the Fed has become.

Thus the goal is to move away from asset purchases, and use more robust forward guidance as the primary Fed tool.

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