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Yellen defends Fed’s decision to forgo unemployment threshold

The Fed’s policy-making body, the Open Market Committee, announced Wednesday they will again draw down purchases of bonds by $10 billion. Monthly bond purchases will now decreases from $65 billion to $55 billion.

The more noteworthy news, albeit technical in nature, is about the FOMC’s conditions for increasing the federal funds rate — the rate at which banks trade funds being held at the Federal Reserve. With unemployment at 6.7 percent — what the committee calls “elevated” — they’ve dropped the 6.5 percent unemployment threshold for raising the federal funds rate in favor of a more qualitative assessment of the labor market and inflation.

The current target rate is between zero and one-quarter percent. The committee predicts that economic conditions may require the committee to keep rates low even after terminating the asset purchase program, known as quantitative easing.

The reason for dropping that threshold, Fed Chair Janet Yellen explained in her first press conference, is not because it hasn’t been effective. Rather, adopting a more qualitative measure for forward guidance, she said, is about remaining transparent to the public. As the unemployment rate nears the threshold, she said, “the question is, markets want to know, and the public wants to understand, how will we decide what to do?” So removing the threshold “reflects changes in conditions we face,” she said, not any policy changes. The Fed’s goals remain full employment and inflation of 2 percent.

Unusual weather patterns, Yellen said, have made it more difficult to assess the true health of the economy this winter.

But labor market conditions, she said, have continued to improve. Yellen noted that broader measures of unemployment, which include what’s called marginally attached workers, have fallen, while labor force participation has increased. For much of 2013, the unemployment rate decreased in large part because people dropped out of the labor force, not because more people were working. For this reason, at previous FOMC press conferences, former Fed chair Ben Bernanke had acknowledged that a broader view of unemployment was necessary to gauge the health of the labor market.

Beginning next month, the Fed will add to its coffers $25 billion of mortgage-backed securities and $30 billion of longer-term Treasury securities, which represents a $5 billion reduction from each category.