Tuesday, September 28, 2010

Trial baloons...

...like a hot-air baloon convention in Fed Land...

First, the set up and "intellectual justification" from the San Francisco branch of the Fed:
"Conventional wisdom holds that severe recessions are typically followed by rapid recoveries. But more than a year after the end of the most severe recession since 1947, the recovery is proceeding at a tepid pace. This is happening despite massive federal fiscal stimulus and extremely low interest rates. Forecasts derived from the Chicago and Philadelphia Fed business cycle indicators predict that real GDP growth through the first half of 2011 will remain at or below potential. When translated into a forecast for the labor market, our analysis suggests that the unemployment rate could rise anywhere from 0 to 0.5 percentage point during this period.

A sluggish recovery should perhaps be expected. The recent recession was preceded by a decade-long consumption and housing boom financed by an unsustainable run-up in household debt relative to income (see Lansing 2005). Current efforts to stimulate consumer spending with low interest rates may be less effective than in the past because households remain overleveraged (see Glick and Lansing 2009). In a comprehensive historical review of periods leading up to financial crises and their aftermath, Reinhart and Reinhart (2010) find that episodes of prosperity that are fueled by easy credit and rising debt are typically followed by lengthy periods of deleveraging characterized by subdued growth in GDP and employment.

David Lang is a research associate at the Federal Reserve Bank of San Francisco."

...then pinging the community about the execution of QE:

INSTEAD OF SHOCK AND AWE, is the Federal Reserve preparing surgical strikes to spur the economy?

An article on the Wall Street Journal's Web site late Monday afternoon said the Fed was considering a smaller, open-ended plan to buy Treasury securities, in contrast to the massive, $1.7 trillion securities purchase the central bank undertook beginning in March 2009.

But instead of the Fed setting an amount of securities it would buy, the WSJ.com story by Jon Hilsenrath said the central bank was studying announcing purchases in smaller increments and conditioned on the state of the economy.

It should be recalled that Hilsenrath broke the story during the summer that the Fed would consider replacing maturing mortgage-backed securities rather than letting them run off. As it happened, that approach was approved at the Aug. 10 meeting of the Federal Open Market Committee in order to prevent a passive tightening of monetary policy.

At last week's meeting, the FOMC pointedly said that inflation is currently "somewhat below those the Committee judges most consistent, over the longer run, with its mandate to promote maximum employment and price stability." As a result, the panel added "it is prepared to provide additional accommodation if needed to support the economic recovery and to return inflation, over time, to levels consistent with its mandate."

That statement was widely inferred by market participants that the Fed could take further steps toward "quantitative easing"—the academic term for central bank securities purchases—at the next FOMC meeting on Nov. 2-3 (conveniently concluding the day after Election Day.)

A small-scale approach to purchasing, say, $100 billion or less per month, might bridge disagreements on the FOMC, some of whose members are reluctant to commit to a large-scale QE2 (as a second phase of quantitative easing is being dubbed) at this time.

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