Today’s big economic news is the coming announcement from the Federal Open Market Committee (FOMC) of the Federal Reserve on whether it will take further action to stimulate economic growth. Low trends in recent jobs numbers combined with signalling from Fed Chairman Ben Bernanke in his address last month at the Economic Policy Symposium in Jackson Hole, Wyoming, have led many to believe that the Fed will announce a third round of quantitative easing today, referred to as QE3. The Fed has already completed two separate rounds of easing, which entails purchasing long-term assets by printing money, in an effort to lower longer-term interest rates and encourage investment.
While some economists are skeptical of the Fed’s ability to stimulate further growth, others believe that there are a number of actions the Fed can take. In his symposium address, Bernanke made it clear that he believes that the Fed has a number of instruments at its disposal, should a situation arise that required further action. While many believe that such statements hint at another round of easing, Bernanke has shown reluctance toward overly aggressive monetary policy. Joseph Gagnon provides a good review of the many possible reasons why the Fed hasn’t taken stronger action on the economy.
Even though pressure for the Fed to act decisively is mounting in many corners, the cautious history of Fed action under Bernanke explains why some, including The Economist’s Free Exchange blog, argue that we shouldn’t expect much from the Fed: “While Mr Bernanke’s Fed acts with alacrity when the economy seems to be slowing down or shrinking, there has been no evidence that it will do anything aggressive for the sole purpose of reducing unemployment.”
The author suggests that slow, but steady economic growth, as well as the rise of inflation toward the Fed’s target, means that it is unlikely that Bernanke will opt for further action.
Ryan Avent offers a different take on possible Fed action. Ryan thinks (and I agree) that the most likely scenario is “that the Fed will recognise that some of the recent increase in expectations is a result of markets pricing in new Fed action, that it must therefore follow through to keep expectations at the current level, but it will also include tempering language designed to discourage the view that it is now open to temporary moderate inflation.”
Ryan concludes that such a policy, while fulfilling expectations with its announcement, while likely have negligible effects on the economy and fail to aid in the recovery.
It is precisely this sentiment that is provoking some to call for the Fed to do something audacious, rather than merely another round of QE. Indeed, the Fed’s own research suggests that QE has been getting less effective. One of the more potent options available to the Fed is announcing an open-ended round of QE. Such a process would be linked to specific measures of the economy, such as the unemployment rate, nominal GDP (economic output), or a higher inflation target, instead of a dollar value or timed-based commitment.
Some economists believe an open-ended commitment would have a more substantial impact on the economy and would signal a more aggressive commitment by the Fed to pursue both facets of its dual mandate. Tim Duy, on his Fed Watch blog, offers his bottom-line on the Fed announcement: “To be most effective, the Fed needs to link open-ended policy explicitly to the economy, thereby removing the uncertainty associated with the previous arbitrary programs. I think anything less should be viewed as a disappointment.”
This suggests that, while the plan itself is important, there are many who feel the Fed must make clear signals about where it wants to go and what it expects from the market.
While many of the concepts and concerns of economic policy can be difficult to wrap the mind around, Mike Konczal provides a great GIF-aided explanation of the circumstances surrounding the Fed’s decision today.
For a brief dialectic explaining several aspects of QE, inflation, fiscal stimulus, and debt, check out this post from Simon Wren-Lewis. And for the policy wonks out there, one of the more significant but underreported features of the FOMC announcement today will be the release of the committee’s economic projections. It will be interesting and telling to see how these projections align with the previous projections made by the committee.