The recovery remains subpar, but has improved enough to moderate Federal Reserve rhetoric about injecting more monetary stimulus. A third round of large-scale asset purchases, or “quantitative easing,” remains possible.
With or without “QE3,” there is little prospect of the Fed’s rate-setting Federal Open Market Committee (FOMC) bringing forward hikes in the federal funds rate from the late-2014 conditional time frame. That implies no asset sales to shrink the Fed’s bloated securities portfolio until 2015 — unless the economy proves much stronger and unemployment lower than expected.
QE3 was very much on the table early in the year. Minutes of the Jan. 24-25 FOMC meeting show “a few members feeling current and prospective economic conditions — including elevated unemployment and inflation at or below the committee’s objective — could warrant the initiation of additional securities purchases before long.” Others thought such policy action could become necessary if the economy lost momentum or if inflation seemed likely to remain below its 2% mandate.
In his post-FOMC press conference, Bernanke said the FOMC “is prepared to provide further monetary accommodation.”
Even while acknowledging housing and mortgage credit problems were rendering low interest rates less effective, he said, “If inflation is going to remain below target for an extended period and unemployment progress is very slow, then ...there is a case for additional policy action....”
The Fed chief even suggested a situation could arise where the Fed would maintain an easy money policy in spite of inflation running above the 2% target. After saying the FOMC treats price stability and maximum employment goals symmetrically, he said, “If inflation did go above target by modest amount, we would certainly try to get it back down to target. But if unemployment were very high, that would lead us to be more cautious and slower in returning to target....”
By the time Bernanke delivered his semi-annual Monetary Policy Report to Congress on Feb. 29, he was toning down such talk. The unemployment rate had fallen to 8.3%; fourth quarter GDP growth had been estimated at 3%; the European debt bomb had been somewhat defused and the Fed was confronting an oil price spike.
Conspicuously absent from his testimony was any reference to QE3. He upheld the need for “a highly accommodative stance for monetary policy,” but refrained from talking about new reserve injections.
But nothing Bernanke said rules out that option. Notably, he was skeptical about labor market improvements. “The decline in the unemployment rate over the past year has been somewhat more rapid than might have been expected, given that the economy appears to have been growing during that time frame at or below its longer-term trend,” he said, adding, “continued improvement in the job market is likely to require stronger growth in final demand and production.”
Bernanke acknowledged that the gasoline price spike could push up inflation temporarily but was more concerned about its impact on consumer spending, the fundamentals of which he called “weak.”
The message is that, while the odds may have lessened, QE3 still may be needed if growth disappoints and inflation runs below 2%. Bernanke’s fellow FOMC voters were of different minds. San Francisco Federal Reserve Bank President John Williams said “we may need to do more if the recovery falters or if inflation stays well below 2%,” and added, “if the economy does need more stimulus, restarting our program of purchasing mortgage-backed securities would probably be the best course of action.”
Others agree, though some FOMC members are less enthused. Middle-of-the-road Atlanta Fed President Dennis Lockhart said he’s cautious about expanding the Fed’s balance sheet. Asked what it would take for him to back QE3, Lockhart said, “the onset of recessionary conditions and movement in the direction of deflation would certainly be a set of conditions in which we would have to consider further balance sheet kinds of stimulus.” Another criterion would be “more receptive (credit market) conditions combined with a clear need of some kind.”
The only clear “no” vote is Richmond Fed President Jeffrey Lacker, who opposed extending the expected period of zero rates by 18 months.
But Bernanke won’t pursue QE3 without a careful cost-benefit analysis by his staff concluding that QE3 is not only needed but would help. Mortgage rates are already very low to little effect, so further asset purchases to slash them further might not accomplish much — certainly in contrast to November 2010 when the FOMC launched QE2 amid higher unemployment and a whiff of deflation.
And the FOMC would have to consider potential negatives, such as complicating the Fed’s eventual exit strategy and jeopardizing its credibility, inflation expectations and the dollar.
QE3’s perceived benefits would rise to the extent growth slows; inflation declines and/or financial conditions deteriorate.
Steve Beckner is senior correspondent for Market News International. He is heard regularly on National Public Radio and is the author of “Back From The Brink: The Greenspan Years” (Wiley).