Since September we have seen considerable strength in the interest-sensitive sectors of the economy, including housing, autos and durable goods, in spite of the uncertainty and drag from fiscal policy. Improvement in these sectors suggests that monetary policy may be gaining additional traction. This is important because it suggests that the benefit from a given amount of asset purchases has increased. On the cost side, I conclude that costs specific to balance sheet expansion have turned out to be no greater than I had anticipated and, because we have less uncertainty about those costs, they are lower than I would have expected in a risk-adjusted sense. Let me start with three commonly cited potential costs – impairment of market functioning, the unanchoring of inflation expectations, and threats to financial stability. We carefully monitor financial markets for signs that market functioning has been impaired, looking at metrics such as trading volumes, bid-offer spreads, failures to deliver securities and our own ability to execute transactions. On some of these metrics, market functioning has actually improved in recent months. Of course, we will need to continue to monitor this, particularly if a rise in interest rates leads to less MBS issuance. But so far, so good. In terms of inflation expectations, a wide range of measures remain well anchored. For example, the 5-year, 5-year forward measure of inflation expectations calculated from Treasury TIPs versus nominal yields is well within the historical range of recent years (Exhibit 12).
First, consistent with the September statement, the FOMC began a new purchase program of $ billion long-dated Treasuries per month. Second, the FOMC shifted to economic thresholds from calendar-based rate guidance. The FOMC committed to keep the federal funds rate at its current level of zero to 25 basis points at least as long as unemployment remains above 6.5 percent, projected inflation on a one to two year horizon is below 2.5 percent and inflation expectations stay well anchored. Both elements of the policy stance were reaffirmed at last week’s FOMC meeting. So why did we make these changes? The additional asset purchases provide further monetary stimulus. This is appropriate given that we were falling short of our objectives.6 Moving to an outcome-based purchase program also has other advantages. In particular, expectations of the ultimate amount of purchases should change as the economic outlook evolves. This acts as an automatic stabilizing mechanism. In particular, the FOMC’s statement that purchases will continue until the labor market outlook improves substantially provides additional support for the recovery by reducing downside tail risk. The shift to rate guidance based on economic thresholds was not intended to provide additional accommodation at the time it was implemented.7 But, the adoption of thresholds does support the recovery by changing the risk profile in a different way. The thresholds  4  In addition to reinvestment of maturing MBS.