The Federal Reserve’s Open Market Committee (FOMC) has left the outlook for additional quantitative easing ambiguous. The summary from the most recent meeting of Fed policy makers expresses confidence that inflation will remain contained and concern over sluggish economic growth, unemployment and the threat of “global financial strains.” The FOMC promises, in response, to keep short-term interest rates low, with the target federal funds rate between 0 and 25 basis points into late 2014. It also promises to continue through year-end “Operation Twist,” in which it buys longer-term Treasury bonds, to sell nothing from its now-extensive portfolio of mortgage-backed securities and even to reinvest any interest and principal payments it receives. But on the crucial issue, the one that weighs on Wall Street’s collective mind, of a third quantitative easing—QE3 in the Street’s jargon—the Fed remains coy and promises only to respond to the flow of economic and financial information as needed.
It is apparent from this lack of commitment that the Fed remains unsure whether the economy needs another quantitative easing now, or, for that matter, ever. The reasons for this ambiguity, frustrating as it may be for Wall Street’s traders, are nonetheless plain in the policy criteria outlined some time ago by Fed Chairman Ben Bernanke. Because inflation seems well contained for the time being, Bernanke identified two areas as policy cues: one is the jobs market, as a test of whether the economy is making acceptable progress, and the other is bank lending, to judge whether past monetary easing is reaching the economy. The inconclusive mix of evidence on these fronts explains the Fed’s coy attitude. How events in these areas unfold will determine when and, contrary to the common belief on Wall Street, even if the FOMC will go forward with a QE3.
At the same time, the jobs picture which the Fed chairman cited as one arbiter of policy leaves questions about the need for more Fed action. The labor market is far from strong, but according to Bernanke, the Fed looks not for a fully healed market, which policy makers know may be years away, but for substantive progress. On that score, the crucial matter is jobs growth and, to a lesser extent, any increase in hours worked. The hours would tell the Fed to wait on further stimulus. Average hours have risen from 33 a week in 2009 to more than 34.5 most recently. The data on jobs growth are less clear. The July report that payrolls expanded by more than 160,000 cuts two ways. As an acceleration from the extremely disappointing growth over the previous three months, it militates against a rush to ease further. The still historically slow pace of expansion—inadequate, in fact, even to keep up with the growth of the labor force—puts the Fed on notice that the battle to secure an economic recovery is far from won.
The pattern of bank lending argues more strongly against the need for more easing. To be sure, banks are going cautiously. They still resist lending in real estate, where credit for commercial and residential ventures, including home mortgages, has dropped all year, a decline that even accelerated in June, though spotty data for July suggest stability. But then even the optimists at the Fed had little expectation of a near-term pickup in this kind of lending.