The FOMC released its latest statement on March 19, 2014.  The tapering has continued, with another reduction in monthly purchases of $10 billion.  Since the end of 2013, the FOMC has announced tapering 3 times in a row, going from asset purchases of $85 billion per month, now down to $55 billion per month.

Surprisingly, this is not what got the most news.  The media is instead focusing on the change in the FOMC statement regarding the federal funds rate.  Before, the FOMC had guidelines of likely keeping the federal funds rate where it is (targeted between 0% and .25%) as long as unemployment stayed above 6.5% and inflation expectations stayed at or below 2%.

The latest statement removed the 6.5% unemployment guideline.  When Janet Yellen was asked about this in her press conference, she indicated (unconvincingly) that the federal funds rate could go up as soon as 6 months after the end of the taper.  This sent markets down.

Peter Schiff is speculating that this 6.5% trigger was removed because the Fed is going to find excuses to delay raising rates.  Schiff says (correctly) that the unemployment rate has been drifting down in large part because people have stopped looking for jobs.

In this instance, I am taking an opposite view, speculating that the Fed may be concerned that the unemployment rate won’t fall below 6.5% and does not want to be bound by this guideline.  The Fed never said that it had to raise rates if unemployment fell below 6.5%, but only that it would not anticipate raising rates as long as it was above this mark.

Either way, I think everyone is focused on the wrong thing.  The federal funds rate doesn’t matter right now.  The thing that matters is the so-called quantitative easing and the tapering of it.

The Fed has inflated a lot since 2008, but there have also been periods of relative monetary stability.  It hasn’t made any difference in the federal funds rate, which is the overnight borrowing rate.  This is because the banks have piled up massive excess reserves and have little need for borrowing overnight funds to meet reserve requirements.  They are already way in excess of the reserve requirements and they have been since the end of 2008.

What is the Fed going to do to raise the federal funds rate?  It can’t control this with monetary policy right now, therefore it doesn’t have that great of an effect on us.  It can change the federal funds rate by dramatically increasing reserve requirements.  It can also change it by increasing the interest rate it pays for excess reserves, which is the reverse of what most people think.  But monetary policy is not going to change the federal funds rate as long as there are massive excess reserves in the banking system.

Let’s not lose focus.  The big news is the taper and whether the Yellen Fed will continue with it, even if the economy starts to show more signs of weakness.  Yellen is a Keynesian, but she is also a political figure.  Will she be able to continue tapering even if the stock market starts falling dramatically?  It hasn’t happened yet, but it will be entertaining to watch if and when it does.