With the outcome of the June FOMC meeting settled, we can set our sights on the August meeting. And at this point, the outcome of that meeting is just as hazy as the last. There is once again a wide range of reasonable views, spanning from QE3 at the next meeting until early 2013, or not at all. Calculated Risk reviews the various opinions here. Interestingly, Goldman Sachs, who expected QE3 to be announced last week, has completely changed gears and is no longer expecting QE until next year. This after offering up the possibility of open-ended QE on the eve of the last FOMC meeting!
Goldman's view is that the extension of Operation Twist was substantive enough to keep the FOMC on the sidelines. CR takes the opposite bet, expecting QE at the August meeting, anticipating a low-bar for additional action. Still, CR makes an important point:
Perhaps an argument against a QE3 announcement on August 1st is there will not be much data released between now and the next FOMC meeting. For employment, the only major report will be the June employment report to be released on July 6th. Also the advance estimate for Q2 GDP will be released on July 27th.
I have tended to argue that the calendar is very important, especially when policymakers are genuinely uncertain of the next most. Absent major financial crisis, they need sufficient data to justify moving, and they just don't have it yet. That story fits with last week's Jon Hilsenrath analysis of Federal Reserve Chairman Ben Bernanke:
When he has lacked conviction, though, his moves have tended to be very deliberate and have unfolded in step-by-step fashion over months, not days. One reason is that he has had to build consensus on a policy-making committee with sharply divergent views. Another is that he appears to be trying to gather information and calibrate his response.
Presumably one FOMC member Bernanke would like to turn is Richmond Federal Reserve President Jeffrey Lacker, who explained his dissent:
“I dissented on this decision because I do not believe that further monetary stimulus would make a substantial difference for economic growth and employment without increasing inflation by more than would be desirable. While the outlook for economic growth has clearly weakened in recent weeks, the impediments to stronger growth appear to be beyond the capacity of monetary policy to offset. Inflation is currently close to 2 percent, which the Committee has identified as its inflation goal. A significant increase in inflation could threaten the Fed’s credibility and make it more difficult to achieve the Committee’s longer-run goals, including maximum employment. Should a substantial and persistent fall in inflation emerge, monetary stimulus may be appropriate to ensure the return of inflation toward the Committee’s 2 percent goal
No surprises here. In his view, monetary policy is out of bullets, leaving no benefits and only costs to additional action. I don't think Bernanke is going to change Lacker's mind very easily. Not that he has to - I still believe this "Bernake needs to build consensus" argument is fundamentally flawed. At best there are three or four true hawks in the room. Bernanke could achieve sufficient consensus if he really wanted it.
Speaking of hawks, St. Louis Federal Reserve President James Bullard was back on the speaking circuit with a Bloomberg interview:
Federal Reserve Bank of St. Louis President James Bullard said today a possible third round of quantitative easing would face a “pretty high hurdle.”
“We can do that and I think it would be effective,” Bullard said in a television interview on Bloomberg Surveillance with Tom Keene. “But we’d be taking a lot more risk on our balance sheet. We’d be going further into uncharted territory.”
I find this to be disturbing, because here Bullard explains the Fed still has firepower, but instead has chosen the certainty of high unemployment to some uncertain risk. I just don't understand how he sees this as an acceptable trade off.
Interestingly, Bullard starts to hit on a fundamental flaw with policy making with his remarks on the Operation Twist extension:
“It’s a continuation of the existing policy,” said Bullard, who doesn’t vote on the Fed’s monetary policy this year. “The committee felt that it was maybe a bit imprudent to end the twist program right at this particular juncture. The committee has kind of been haunted by having end dates on programs and it seems like the end dates never occur at the right moment.” Operation Twist was to have ended this month.
One would hope that Bullard follows this line of thought through to its logical conclusion: The end dates are arbitrary, have no economic relevance, and only create unnecessary uncertainty in the policy making process. Open-ended QE tied to macroeconomic objectives would eliminate this problem.
Bullard divulges that the FOMC still doesn't understand its job:
Bullard said that “Treasury yields have gone to extraordinarily low levels. That took some of the pressure off the FOMC since a lot of our policy actions would be trying to get exactly that result.”
The FOMC just cannot see that low interest rates are a sign of tight money, an expectation that the economy is facing headwinds and the Fed is not going to sufficiently offset the subsequent drag on growth. They need policy such that interest rates start to rise on the back of economic gains. That falling yields are a bad, not good sign, completely eludes them.
Bottom Line: The fundamental problem is that the Fed has failed to communicate the trigger point for additional policy. CR reads the tea leaves and concludes the bar is reasonably low; Bullard leaves the meeting thinking the bar is high. The reality is likely somewhere in between. I tend to think QE in August requires some pretty clear evidence that the labor market is moving in the wrong direction, and I am hesitant to think we will get enough such evident before then. The next employment report and the weekly initial claims reports will be critical.