4. Inflation is quiescent; the vast amounts of liquidity pumped into the financial system have not stirred inflation or inflationary expectations. The core PCE rate y/y was 1.2% in July. The CPI core rate y/y was 1.7% in July and 1.8% in August. It has turned up from 1.6% in June, ending 13 months of disinflation that began in June of last year. The PCE rate is forecast to remain at 1.2% when it is released on Sept. 27; perhaps Chairman Bernanke can take some deflation comfort from the reversal in CPI.
5. The Fed can always pull back from any taper. Chairman Bernanke has said more than once that future quantitative easing policy could go either way depending on the state of the economy. After the policies of the past five years, markets would expect a return to easing should the economy falter or be threatened by economic or political developments elsewhere in the world. The biggest risk from a change in quantitative easing is in managing the reactions of the credit, equity and currency markets.
6. The Fed already has decided to begin the end of quantitative easing. That is the only possible explanation for Mr. Bernanke’s policy statements on May 22, June 19 and July 10. The economic window for this change is open, barely.
On the FOMC, the chairman has a consensus for the end of quantitative easing. But this bureaucratic permission could soon vanish. The current dispensation could and probably will change under a new chairman. Mr. Bernanke’s term ends Jan. 31, four and a half months from now. Soon, likely very soon, will begin public comment and pressure to leave the quantitative easing decision to the next chairman who, after all, will have to oversee and implement this policy for the next four years.
There has been little or no political pressure for the Fed to keep open the money spigot. But that could change as well. Congressional elections are in a little over a year, a rounding error in most economic trends. The pressure on the Fed and especially the new chairman to provide as much support as possible to the economy going into the election may be hard for a new chairman to resist. If the change in policy is not effected before these pressures surface and particularly before a new chairman takes over, the consensus for termination could dissipate. Its revival could be a long time coming.
Ben Bernanke’s chairmanship of the Fed always will be associated with quantitative easing, an extraordinary policy for extraordinary times. After eight tumultuous years, the Chairman knows the economic and political possibilities better than anyone else. If he thinks it is time to end this experiment in monetary policy, he will be very hard pressed not to begin before his term is over. In practical terms that means a policy change at this FOMC or the next.
If the Fed does not end quantitative easing soon, it may be too late.