The Fed Remains in "Wait and See" Mode

Last Updated Sep 21, 2010 3:16 PM EDT

Here is the press release from today's FOMC meeting followed by a few comments on the Fed's decision to wait and see if conditions deteriorate before taking any further action:
Press Release, Federal Reserve Press Release, Release Date: September 21, 2010, For immediate release: Information received since the Federal Open Market Committee met in August indicates that the pace of recovery in output and employment has slowed in recent months. Household spending is increasing gradually, but remains constrained by high unemployment, modest income growth, lower housing wealth, and tight credit. Business spending on equipment and software is rising, though less rapidly than earlier in the year, while investment in nonresidential structures continues to be weak. Employers remain reluctant to add to payrolls. Housing starts are at a depressed level. Bank lending has continued to contract, but at a reduced rate in recent months. The Committee anticipates a gradual return to higher levels of resource utilization in a context of price stability, although the pace of economic recovery is likely to be modest in the near term.
Measures of underlying inflation are currently at levels somewhat below those the Committee judges most consistent, over the longer run, with its mandate to promote maximum employment and price stability. With substantial resource slack continuing to restrain cost pressures and longer-term inflation expectations stable, inflation is likely to remain subdued for some time before rising to levels the Committee considers consistent with its mandate.
The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels for the federal funds rate for an extended period. The Committee also will maintain its existing policy of reinvesting principal payments from its securities holdings.
The Committee will continue to monitor the economic outlook and financial developments and 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.
Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; James Bullard; Elizabeth A. Duke; Sandra Pianalto; Eric S. Rosengren; Daniel K. Tarullo; and Kevin M. Warsh.
Voting against the policy was Thomas M. Hoenig, who judged that the economy continues to recover at a moderate pace. Accordingly, he believed that continuing to express the expectation of exceptionally low levels of the federal funds rate for an extended period was no longer warranted and will lead to future imbalances that undermine stable long-run growth. In addition, given economic and financial conditions, Mr. Hoenig did not believe that continuing to reinvest principal payments from its securities holdings was required to support the Committee's policy objectives.
The Fed is "prepared to provide additional accommodation," to support its mandate for high employment and low inflation and, as Calculated Risk points out, this is paving the way for more quantitative easing.

Awhile back, Bernanke said the Fed wasn't sure what it should do, so at least now it is prepared, but for me that doesn't go far enough. The Fed appears to be waiting for significant bad news on either inflation or employment before it will consider further easing, but (1) we have a big employment problem now that needs to be addressed, so why wait? And (2) once the bad news arrives, it will be too late for the Fed to do much about it. The Fed should have learned that it needs to act preemptively from its mistake in dealing with the housing bubble. The Fed believed that it didn't have to act preemptively to pop the housing bubble, it thought that if the bubble popped, it could clean up afterward without much trouble. But that turned out to be very wrong. Cleaning up after the fact, which is what "wait and see" amounts to, is inferior to preventing problems before they appear, and the Fed needs to act preemptively and try to prevent a worse outcome from occurring.

So there are two reasons to act now, to help employment markets that are still in shambles, and to ensure against another downturn in the future, or what I think is more likely, to ensure against extended stagnation. Instead, the Fed seems to be resigned to a wait and see approach that accepts a slow, plodding, agonizing recovery for the unemployed.

As I've said before on these pages about the Fed's wait and see approach:
...presently the Fed does not feel the benefits [of further action]outweigh the costs, and it remains in "wait and see" mode.
My first question for the Fed would be this. To date, you have overestimated the strength of the recovery at every step. Presently, you believe that the economy is still recovering, albeit slowly, but do you see the risks around that forecast as symmetric? Given the forecasts to this point, all of which have been too rosy, I would place more weight on the downside, quite a bit more, but it's not clear the Fed is doing this.
The Fed apparently does not weight the downside risk as highly as I do (which includes extended stagnation), and they have different weights than I do on the benefit of reducing unemployment versus the potential costs of more action such as inflation and market collapse. So the Fed sees no need to act now.
I don't think the inflation fear is very large, and the Fed has new tools to battle it in any case. In fact, the inflation risk is just the opposite of what the Fed is telling us. ... Disinflation/deflation is the risk right now...
I also view the unemployment risk, risks such as long-term unemployment turning into a permanent structural problem, as being much higher that the Fed seems to. The benefits of reducing unemployment are larger than the Fed apparently realizes.
So, in my view, the Fed should drop its relatively rosy forecast for the recovery and take more account of the downside risks, the Fed should place more weight on the unemployment problem, and have less fear of inflation -- the risk right now is in the other direction. Making these adjustments that would compel the Fed to action instead of "waiting and seeing," a policy that, to date, has kept the Fed from getting out in front of the economy's problem.
It's time for the Fed to stop playing catch-up as it waits and sees that its forecasts were wrong, and and take the steps needed to boost the economy.
That was a month ago, and nothing much has changed in the interim. The Fed appears to be more worried than before, and prepared -- and that's progress -- but those worries need to translate into action. As I noted recently:

People need jobs, or more social support until jobs appear, and both the Congress and the Fed are failing to do all that they can do to help. Apparently, imagined fears of deficits and inflation are more important than the real struggles of the unemployed.

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    Mark Thoma is a macroeconomist and time-series econometrician at the University of Oregon. His research focuses on how monetary policy affects the economy, and he has also worked on political business cycle models. Mark is currently a fellow at The Century Foundation.

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