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QE3 – Will They or Won’t They?

Calculated Risk reads this passage in a recent speech by San Francisco Federal Reserve President John Williams:

This is a situation in which there’s no conflict between maximum employment and price stability. With regard to both of the Fed’s mandates, it’s vital that we keep the monetary policy throttle wide open.

and concludes:

QE3 is coming.

Dallas Federal Reserve President Richard Fisher states:

“In my view, it’s not going to happen,” he said. “It’s a fantasy. Wall Street keeps dangling QE3 out there [but] I just don’t see it happening.”

I guess we are going to see who knows more about monetary policy – CR or Fisher.  My instinct tells me CR, but Fisher seems just a little too certain to dismiss entirely.  Reviewing the most recent minutes, one find to the now oft-repeated line:

A few members observed that, in their judgment, current and prospective economic conditions–including elevated unemployment and inflation at or below the Committee’s objective–could warrant the initiation of additional securities purchases before long.

Presumably, Williams is among the few.  I would like the Fed to publish their definition of a “few.”  In my book that is three or less, which is well short of the the majority necessary to shift policy.  That said, the next line of the minutes is:

Other members indicated that such policy action could become necessary if the economy lost momentum or if inflation seemed likely to remain below its mandate-consistent rate of 2 percent over the medium run.

Now you have a solid majority willing to move forward with QE3 if the economy sags or inflation remains below 2%.  The recent US data flow, however, has been generally positive, and it is hard to ignore the steady drop in initial unemployment claims.  To be sure, we have been fooled by seemingly upbeat data in the past.  But  I suspect the median FOMC member will be wary about dismissing the generally positive data – sooner or later, some parts of the US economy, such as home building, are going to come back on line.  Which leaves us pondering inflation data.  With gasoline prices marching higher, headline inflation will head in that direction as well.  Typically, however, the Fed will look toward core inflation as a gauge of where headline will eventually settle, and recently core has been soft:

Corepce

Still, notice the recent uptick.  And if FOMC members want to focus on the year-over-year numbers, it looks like core and headline are set to converge at the 2% mark:

Headline
All in all, I tend to view the Fed as generally in wait and see mode.  I doubt very much the case is as clear cut as Fisher or CR believes.  However, I tend to think the general mood of the FOMC favors CR’s position, as long as core inflation stays on the weak side of 2%.  But if inflation ticks up and general economic data remains solid, hope of QE3 may quickly be dashed.

This post originally appeared at Tim Duy’s Fed Watch and is posted with permission.

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