Tomorrow should bring QE3 from the Federal Reserve. I am reminded on the length of this debate from a piece I wrote in February:
Calculated Risk reads this passage in a recent speech by San Francisco Federal Reserve President John Williams:
This is a situation in which there’s no conflict between maximum employment and price stability. With regard to both of the Fed’s mandates, it’s vital that we keep the monetary policy throttle wide open.
and concludes:
QE3 is coming.
Dallas Federal Reserve President Richard Fisher states:
“In my view, it’s not going to happen,” he said. “It’s a fantasy. Wall Street keeps dangling QE3 out there [but] I just don’t see it happening.”
I guess we are going to see who knows more about monetary policy - CR or Fisher. My instinct tells me CR, but Fisher seems just a little too certain to dismiss entirely.
Not dismissing Fisher entirely meant expecting QE later than sooner. But, ultimately, barring a massive surprise, I think we will learn tomorrow that CR does in fact know more about monetary policy than Fisher. Then again, who doesn't?
I have been a bit busy this week, so I have been a little under the radar. With respect to the meeting tomorrow, I agree with Robin Harding at the FT on this point:
For me, the question of what the Fed will do is far less interesting – and far less in doubt – than how the Fed will do it. This will not be a pro forma repeat of previous actions. As Mr Bernanke’s speech shows, the Fed is trying to address grave concerns about the labour market. The crucial issue is whether and how they tie any action to the state of the economy.
I don't anticipate a lump sum QE announcement. I anticipate an open-ended commitment to regular purchases of securities, Treasuries and/or MBS, that can be scaled up or down in response to the economy. Wall Street may be initially disappointed by the lack of a big number, but over time I think markets will come to appreciate the greater impact offered by a regular commitment based upon economic outcomes rather than the arbitrary amounts and time lines of previous QE efforts.
As Harding says, how they tie the policy to the economy is key. It is probably too much to expect an explicit nominal GDP target. Nor do I think we will get Chicago Federal Reserve President Paul Evan's suggestion of an explicit unemployment target coupled with higher inflation tolerance. Harding suggests:
“The committee intends to purchase a further $xbn of Treasury and agency mortgage-backed securities per quarter until incoming information points to a substantial and sustainable strengthening in the pace of the economic recovery.”
Sounds good, although as I have trouble expecting the Fed to undertake open ended QE in the absence of direct reference to both parts of the dual mandate, a possible variant :
“The committee intends to purchase a further $xbn of Treasury and agency mortgage-backed securities per quarter until incoming information points to a substantial improvement in labor utilization rates in the context of price stability.”
You get the idea.
Bottom Line: QE3 is expected, but more important is the message that comes with it. 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 dissappointment.
