The Federal Reserve adopting the “Evans Rule” policy to govern the duration of quantitative easing in the U.S. threw markets for a loop, coming as it did on the heels of a surprise drop in the unemployment rate. Suddenly, the Fed’s new target of 6.5% unemployment looked a lot closer than the previously promised “at least through mid-2015.” Markets will now wonder if the bond buying will suddenly stop one month.
However, little attention is being paid to the other half of the benchmark, that states that QE will continue until the unemployment rate hits 6.5% “…as long as forecast inflation levels remain below 2.5%.” What if unemployment stays above 6.5% while inflation comes back? Since the drop in unemployment was from people giving up, not people finding jobs, we could see unemployment stay at 7% or above as those who find jobs are replaced by those re-entering the job market. All the while, the Fed will be pumping $85 billion a month into the economy, using freshly-printed money. There’s a very real possibility of inflation rising above 2.5% long before unemployment drops to 6.5%, which would mandate an end to quantitative easing by the Fed under their own criteria.
The Fed itself sets the forecast inflation numbers looking forward.
Tim Iacono covers this subject in an excellent article on FinancialSense.com, titled “The Fed’s New, Squishy Inflation Target”. Recommended reading, indeed.