We know that the Federal Reserve kept the status quo on its monetary policies yesterday, extending Operation Twist (selling short-term maturities and buying long-term ones to try and reduce longer-term interest rates) through to the end of the year, but going no further. But the Fed released another set of data yesterday, its updated forecasts for the economy. And it was really bad:
In contract to the tone of the statement, this is a significant downward revision to the forecast for not just this year, but next year as well. Moreover, they expect no meaningful progress on the unemployment rate and the PCE inflation forecast remains centered well below 2%.
So, the basic analysis done by those expecting QE3 was correct. The forecast was revised significnatly downward, with no change in inflation, and downside risks have increased. But the Fed did not follow through on the logical conclusion to pursue QE3.
QE3 stands for quantitative easing, of which there have been two attempts previously.
Bernanke clearly knows both that the economy has slowed, and that several factors contribute to that: fiscal consolidation at the state and local level, a poor housing market, and headwinds from Europe (Bernanke could aid the first thing, by the way, by having the Fed go into the muni market, saving state and local government’s $85 billion annually). So this was the big question from everyone at Ben Bernanke’s news conference yesterday: because the economic forecasts have been revised downward, what is the rationale for not doing more monetary accommodation at this time? Bernanke attempted to blame Congress, coming close to saying that the bullets are out of the gun on the monetary side and that what we really need is fiscal stimulus. We also need a pony, but that’s not happening either. However, Bernanke did give a sense that he could reach for that ammo if he chose.
From today’s presser, my feeling is that Bernanke maybe doesn’t feel as strongly any more that he would be reckless to act more aggressively. But he does still feel that the upside from doing so is “doubtful”. If he’s forced by crisis to pull out the ammo, he’ll do so. But Bernanke clearly doesn’t consider the unemployment crisis to be a crisis in that sense. If something happens suddenly, then policymakers can act strongly and decisively. Years of high unemployment are in many ways more damaging than the sudden drop in government spending that risks arriving with the fiscal cliff. But because the damange is slow-acting and invidious, it seems that unemployment, on its own, is incapable of persuading Bernanke to do more.
There’s an opinion out there that Bernanke paved the way for QE3 in August, after another look at the data. But the forecast alone gives you most of what you need to make that determination. The recent history of the Fed includes a lot of waiting for more data to confirm economic slowdowns. Anticipatory action simply doesn’t happen.