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Quantitative Easing: the Fed’S Tough Decision Around the World, Financial Markets Have Been Talking of Little Else for Weeks

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Quantitative Easing: the Fed’S Tough Decision Around the World, Financial Markets Have Been Talking of Little Else for Weeks FOMC PREVIEW QUANTITATIVE EASING: THE FED’s tOUGH DECISION Around the world, financial markets have been talking of little else for weeks. On Wednesday, the waiting game finally comes to an end. REUTERS/ KEVIN LAMARQUE BY PEDRO NICOLACI DA COstA Treasury bond buying from the Federal that, like its promise to keeping interest WASHINGTON, OCT 21 Reserve could ultimately rival the hefty first rates low, the second round of so-called round of asset purchases. quantitative easing will be around for an NE HUNDRED BILLION here, one With expectations of at least $500 billion “extended period” if needed. hundred billion there. Pretty soon already built into financial markets, the Fed The rationale for further monetary we’reO talking real money. may try to counter possible disappointment accommodation has been laid out by It may not be “shock and awe” at first by making its commitment open ended. Chairman Ben Bernanke, whose views on blush, but the ultimate sums involved in It will likely do so by setting parameters policy carry the day at the Federal Open a second, widely anticipated program of vague enough to convince the markets Market Committee. OCTOBER 2010 FOMC PREVIEW OCTOBER 2010 ”DepenDING ON EVOLVING ECONOMIC AND FINANCIAL CONDITIONS, QE2 HAS THE POTENTIAL TO GROW QUITE LARGE.” He has made clear that, with the 9.6 percent unemployment rate far above what might be seen as normal even in a post- recession context and inflation dangling at uncomfortably low levels, policymakers deem the risk of an outright deflationary rut significant enough to justify action. An incremental, flexible approach serves two purposes. First, it seems commensurate with an economy that, while sluggish, is still growing, giving the Fed room to dial the pace of buying up or down depending on economic conditions. An earlier round of unorthodox Fed easing, which totaled $1.7 trillion and centered primarily on mortgage-linked debt, was meant to quell a free fall rather than shake economic activity out of a slumber. ”Depending on evolving economic and financial conditions, QE2 has the potential to grow quite large,” said Dana Saporta, economist at Credit Suisse in New York. “The FOMC may choose to introduce forward guidance that would achieve the same effect of a ‘shock and awe’ strategy while not committing policymakers to any specific purchase total.” The second benefit of a more cautious initial announcement would be to engender unanimity where it may be lacking. Given DECISION TIME: U.S. Federal Reserve Chairman Ben Bernanke attends the G20 Finance Ministers and Central Bank Governors the untested nature of the new policy, some meeting in Gyeongju October 22, 2010. REUTERS/AHN YOUNG-JOON/POOL inflation hawks at the Fed have vocally opposed further easing in recent weeks. in which the FOMC has an incentive to go a and businesses to spend, but also set a CHASING SHADOWS bit farther than markets anticipate while the tangible upward boundary for the extent of AS foR THE paCE of buying, two regional markets -- knowing this -- periodically raise quantitative easing. Fed presidents indicated this week the the bar,” said Andrew Tilton, economist at This is a boundary that could win over Fed would parcel out its buying in monthly Goldman Sachs. hawks like Charles Plosser of the Philadelphia installments of $100 billion, cementing While median forecasts in a Reuters poll Fed, who are skeptical about central bankers’ market expectations for such a sequence. of 27 analysts released last week pointed to ability to influence any key indicators other Ever cognizant of expectations, the Fed $500 billion in easing, the average was closer than inflation. could overshoot the market’s $500 billion to $650 billion. Forecasts in a separate poll Still, the Fed’s November meeting may base case in order to get the ball rolling and of U.S. primary dealers earlier this month be a bit too early to expect anything in the achieve the desired market effects. topped out at $1.5 trillion. [FED/R] way of a concrete inflation goal. Discussion For many of the Fed’s most influential by some FOMC members of a bolder, price- members, bond purchases stimulate growth SHOOTING FOR TARGETS level target that would allow the Fed to by forcing investors to buy higher yielding, AnothER way to DEFLECT concerns that temporarily overshoot its goal suggests the riskier assets like equities and corporate the Fed is laying the groundwork of future issue remains very much in flux. bonds, driving down the cost of capital for inflation by further expanding credit to the While Bernanke singled out 2 percent “or U.S. firms. banking system, already three times pre- a bit below” as the appropriate inflation rate This view might call for larger initial crisis levels, is to make explicit the Fed’s to shoot for, the more hawkish Jeffrey Lacker purchases than the market has already taken presumed anchor for inflation of around 2 argued 1.5 percent would be better, adding for granted, even if the game of chasing percent. that a policy statement is too fleeting a place market expectations has its dangers. A numerical goal would at once boost for a benchmark meant to offer a sense of ”There is a potentially unstable ... dynamic inflation expectations, pushing consumers permanence and stability. 2 FOMC PREVIEW OCTOBER 2010 TREASURY PURCHASES MAY START AT $500 BILLION St. Louis Fed prefers incremental purchases to maintain flexibility BY MARK FELSENTHAL AND know. So that makes the policy decision KRIstINA COOKE extremely difficult,” Plosser told reporters in ST. LOUIS, OCT 22 Philadelphia. Plosser has a reputation for being among EDERAL RESERVE OFFICIALS are those most concerned about holding inflation Fconsidering easing that could start with at bay at all costs. $500 billion, and progress in increments as St. Louis Fed President James Bullard, high as $250 billion, but worry how such a viewed as a centrist between inflation- move would be perceived, according to a top focused hawks and full employment- adviser for the St. Louis Federal Reserve. prioritizing doves, said that if the Fed decides “There’s a lot of momentum and support to to ease monetary conditions, he would favor do something,” Christopher Waller, director incremental purchases of about $100 billion of research at the St. Louis Fed, told Reuters of Treasury securities, without setting an in an interview. outer limit on the total amount of purchases. Waller said the St. Louis Fed vastly prefers “IT DEPENDS WHAT incremental purchases to maintain flexibility YOUR OBJECTIVE as the economy evolves and that an approach under discussion is to buy as much as $250 FUNCTION IS AND WHAT billion from one meeting to the next, roughly YOUR ESTIMATES FOR the equivalent of a quarter-point move in short-term interest rates. THE EFFECTS ARE. I Policy-makers take as a rough estimate THINK IT’S A LOT OF that $100 billion in Treasury purchases would reduce the yield on the benchmark 10- GUESSWORK. WE Don’T NO NEED: President of the Federal Reserve Bank of year Treasury note by about one-tenth of a REALLY KNOW. “ Philadelphia Charles I. Plosser gives a speech during the percentage point, Waller said. European Banking & Financial Forum 2010 in Prague March “There’s a lot of credibility to it that if we 23, 2010. REUTERS/DAVID W CERNY “It’s just how huge, and is it going to be were going to (move) the fed funds rate 25 time-dependent or state-dependent. ... basis points meeting to meeting ... that’s kind The likelihood we do something is probably was monetizing the national debt. of like a $250 billion purchase intermeeting,” pretty high,” he said. Many market participants had been Waller said. “The only thing that’s tempering The Fed, which cut rates to near zero and expecting an easing program of about $500 that number back for us is we’re worried about bought $1.7 trillion in securities, is widely billion. the optics of that in terms of monetizing the expected to renew an easing program at An important principal in the debate, deficit.” its Nov. 2-3 meeting. Fed Chairman Ben Philadelphia Fed President Charles Plosser, One possibility would be to launch the Bernanke has said that high unemployment said there are different views within the Fed Fed’s first move with a larger purchase and and low inflation appear to meet about whether a small step or a big-bang scale back the increments after that, he said. requirements for further Fed action. approach would be more effective. “You could make the argument for the first Waller’s comments, in a rare on-the- Plosser, who has said repeatedly he does meeting you may want to go bigger than that, record interview with an aide who is not see the need for the Fed currently to which would be the equivalent of a 50-basis present at discussions of the U.S. central buy more assets, said the views depend point cut, that would be $500 billion,” Waller bank’s policy-setting Federal Open Market on how policymakers see the purchases said. “And then after that, you do smaller Committee, suggest a lively debate in the working and what they are trying to achieve increments.” Fed on the scope of easing, with discussion -- be it nudging up inflation or lowering the Fed officials worry, however, that purchases encompassing options as extensive as $1.5 unemployment rate. in the neighborhood of $1.5 trillion over the trillion over a year -- tempered by worry a “It depends what your objective function is next year would look like the central bank too-aggressive strategy could backfire if and what your estimates for the effects are.
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