The Federal Reserve doesn’t usually drop hints and then fail to follow through with them. Fed officials spent much of July hinting that a new batch of monetary stimulus is in the works, both in public speeches and bugs carefully placed in influential reporters’ ears.
So the big question surrounding the two-day meeting of top Fed policymakers ending Wednesday isn’t whether a third round of quantitative easing is on the way; it certainly appears to be. The question is whether the Federal Open Market Committee will announce QE3 this week, or whether it will wait to do it in September.
“QE” is the shorthand for unconventional monetary policy employed when growth is slow but interest rates are essentially down to zero. It involves central bank purchases of securities to try to push real interest rates down even further. If QE3 comes to pass, most economists expect it would include the Fed buying mortgage-backed securities, Treasury bonds, or a mix of both.
Buying Treasuries or mortgage-backed securities would reduce long-term interest rates, by increasing demand for the securities and thus lowering their yields. Researchers at the San Francisco Fed explained in a paper last year that those lower rates should “produce higher stock market valuations and a modestly lower foreign exchange value of the dollar. These changes in financial conditions provide considerable stimulus to real economic activity over time.” Large-scale mortgage-security purchases could also push home lending rates down, if banks pass on the lower rates to consumers.
The late pre-meeting consensus shifted toward the idea that Fed officials will hold off launching QE3 for another month. Dow Jones Newswires surveyed Fed-watching economists and reported on Monday that “analysts tended to argue that the central bank needs to see two more jobs-data releases before reaching a consensus on the need for more stimulus."
Dow Jones also said that the wait-till-next-month crowd was buoyed by the Commerce Department’s estimate on Friday that gross domestic product grew by 1.5 percent in the second quarter, beating forecasters expectations — albeit only by a tenth of a percentage point. As economists from IHS Global Insight put it in a research note, “There was nothing in the GDP report to give the Fed an itchy trigger finger” for QE3.
Very rarely is Fed Chairman Ben Bernanke accused of having an itchy trigger finger. What he has been accused of lately, by a chorus of economists and bloggers, is giving short-shrift to the half of the Fed’s dual mandate that calls for pursuing full employment in the economy.
With unemployment still above 8 percent and inflation not threatening to break free of the Fed’s 2 percent target — in line with its other mandate, pursuing price stability — the critics ask why Bernanke and the FOMC have been so slow to act forcefully to boost growth.
Framed differently, many of those critics are asking why the Fed wouldn't ease again as soon as possible.
As the economics blogger Bill McBride wrote over the weekend at Calculated Risk: “The data supports QE3 this week, but the data also supported QE3 in June.”
McBride added that he didn’t think the FOMC would launch more easing in June because no one had foreshadowed the move. Since then, he wrote, “there have been plenty of hints” — but not enough to make an August move a sure-fire bet.