Monday, 10 September 2012

QE3 Expectations

Bill McBride from Calculated Risk blog (and Sven Stehn of Goldman Sachs) weighs in on his expectation of a Sept 13th announcement of QE3 and why he thinks it'll be effective.

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.
• 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.

• 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.

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