Goldman’s Jan Hatzius has some more in-depth thoughts relating to yesterday’s Fed decision to extend Operation Twist, but not (yet) do full-blown QE3.
Further easing is likely to be needed. Our forecast implies that the US economy will continue to struggle with slow growth and high unemployment of more than 8% going into 2013. Specifically, we forecast a slowdown in real GDP growth to just 1.5% (quarter-on-quarter, annualized) in the first quarter of 2013. Moreover, the economy now faces a “monetary cliff” in addition to the “fiscal cliff” in early 2013. Although we have generally subscribed to the “stock view” of the Fed’s asset purchase programs, we do believe that unconventional easing is subject to “decay” and that there are some modest “flow” effects at the very long end of the yield curve. Taken together, these factors make a convincing case for additional easing in early 2013. As neither a further extension of the twist nor an extension of the rate guidance would constitute a significant easing step, our baseline expectation is that the FOMC will return to an expansion of the balance sheet by early 2013. The most natural avenue would be a return to large-scale asset purchases, but Chairman Bernanke’s reaction to a question on the Bank of England’s recently announced credit easing program–he simply said “we are interested”–might suggests that a Fed program explicitly designed to improve credit availability is also a possibility.
So basically, the Fed will have no choice but to do QE3 at some point around the beginning of next year because otherwise policy would start to get contractionary, and we’d be seeing monetary tightening at around the same time as the fiscal cliff.
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