Since the Jackson Hole Symposium, I’ve been thinking it is very likely that so-called “QE3” would be announced at the next FOMC meeting (Sept 12th and 13th). And after thinking about Columbia University professor Michael Woodford’s paper presented at Jackson Hole, I think this round of asset purchases might be more effective than most people expect.
Notes: QE3 is shorthand for another Large Scale Asset Purchases (LSAP) program. “QE” is monetary policy, not fiscal policy (not spending).
Yesterday, Goldman Sach economist Sven Jari Stehn beat me to the punch. He wrote:
[W]e expect the Federal Open Market Committee (FOMC) to announce a return to asset purchases as well as a lengthening of the FOMC’s forward guidance for the first hike in the funds rate to mid-2015 or beyond at the September 12-13 FOMC meeting. Our baseline forecast is an open-ended purchase program, focused on agency mortgage-backed securities.
[O]ur “double punch” Fed call relates to the much-discussed study presented by Columbia University professor Michael Woodford at Jackson Hole last Friday. Woodford argues that forward guidance is a powerful tool both in theory and practice. But in his view the effect of asset purchases is largely confined to their role in conveying guidance about future monetary policy actions. …
We fully agree with Woodford’s view that such aggressive guidance measures could be a powerful tool. However, we also believe that Fed officials are unlikely to adopt them anytime soon.
Fortunately, we are somewhat more optimistic than Woodford with regard to the impact of Fed asset purchases. … we believe that a more moderate strengthening of the forward guidance coupled with renewed asset purchases could provide a decent amount of monetary easing next week.
I’d like to add a few points:
• Nothing in recent data suggests a “substantial and sustainable strengthening” in economic activity. This was the key sentence from the last FOMC minutes:
“Many members judged that additional monetary accommodation would likely be warranted fairly soon unless incoming information pointed to a substantial and sustainable strengthening in the pace of the economic recovery”
• Note that Goldman Sachs expects BOTH “a lengthening of the forward guidance to mid-2015” AND “an open-ended purchase program”. Atlanta Fed President Dennis Lockhart alluded to this in his interview in the WSJ last week:
If the Fed were to act, Mr. Lockhart said half-measures would not get the job done. While he didn’t state what the steps could be, he said stimulus, if chosen, should be “a package. When I say package that means two or three things done at the same time to create maximum possible gains.”
• As far as additional forward guidance, imagine if Fed Chairman Ben Bernanke made it very clear that the 2% inflation target is symmetrical – not a ceiling, and that the FOMC would not move quickly to slow inflation if the unemployment rate was still high.
This isn’t as strong a forward guidance as nominal GDP targeting (NGDP), but it would still provide guidance that the Fed will show patience before raising rates.
In fact, back in April, Fed Chairman Ben Bernanke said:
“[The 2 per cent target is] not a ceiling, it’s a symmetric objective, and we attempt to bring inflation close to 2 per cent. And in particular, if inflation were to jump for whatever reason—and we don’t have, obviously don’t have perfect control of inflation—we’ll try to return inflation to 2 per cent at a pace which takes into account the situation with respect to unemployment.”
I expect Bernanke to reiterate this again in the press conference this week.
• And on effectiveness, one of the key transmission channels for monetary policy is through residential investment and mortgages. The previous rounds of QE (and “twist”) have lowered mortgage rates and allowed homeowners with excellent credit and income to refinance. However this channel has been limited as Bernanke noted in his Jackson Hole speech:
It is likely that the crisis and the recession have attenuated some of the normal transmission channels of monetary policy relative to what is assumed in the models; for example, restrictive mortgage underwriting standards have reduced the effects of lower mortgage rates.
As residential investment recovers, and house prices increase (or at least stabilise), this channel will probably become more effective.
Last month I summarized some of The economic impact of a slight increase in house prices. This includes mortgage lenders and appraisers becoming more confident in the mortgage and housing markets. I think that is starting to happen, and I think QE might have more traction now through the housing channel.
Conclusion: I expect both QE, and an extended forward guidance, to be announced this week at the FOMC meeting.
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