Liveblogging World War II: June 17, 1942
Matthew Yglesias: Labor Unions and Public Opinion

The Fed: Once Again Behind the Curve and Scrambling to Catch Up...

Bernanke's Fed has spent his entire term skating toward where the puck is, rather than toward where the puck is going to be.

Gavyn Davies:

Fed doves ready to act: A further large bout of unconventional easing is now on the agenda. As usual, the Federal Reserve will be the critical player in leading a co-ordinated easing in global monetary policy. Until recently, the Fed was not generally expected to ease policy at all after the FOMC meeting on Tuesday/Wednesday of next week, but economic conditions inside the US, not all of which are directly related to the eurozone crisis, have now changed markedly…. Why will the Fed have changed its thinking, compared to the neutral tone it was adopting only a few weeks ago? There are three key reasons for this:

  1. The US economy has slowed down markedly since the early spring. At the April meeting of the FOMC, the central tendency of the committee’s forecast for GDP growth in 2012 was 2.7 per cent, which is a little above the Fed’s 2.5 per cent estimate of long term trend. This forecast for GDP growth in 2012 is no longer tenable, and it is likely to be downgraded to around 2.0-2.2 per cent this week…. Hence, the growth rate has fallen well below the level which would normally be required to bring unemployment down…. The inadequacy of GDP growth is not a short run phenomenon. As the graph above shows, GDP growth has only been above trend in one of the last 8 quarters, which must be alarming the doves.

  2. Core inflation is now hovering around the Fed’s 2 per cent target. Probably the main reason why the doves fell silent earlier this year was the fact that core price inflation was running at higher levels than had been generally expected. This never seemed likely to prove to be a permanent problem, given the absence of any acceleration in unit labour costs. But the rise in commodity prices was taking time to pass through the rest of the economy, and the Fed had only recently introduced a formal 2 per cent inflation target…. [T]he doves thought it was worth waiting for core inflation to subside before easing again…. Overall, the inflation picture might normally induce the Fed to wait another month or two before easing, but the luxury of delay may not be open to them this time. This is because:

  3. Financial conditions have been tightening as the economy has slowed. Fed policy has always been highly sensitive to an undesired tightening in monetary conditions, caused by declines in equity prices, rises in credit spreads or appreciation in the dollar. This is exactly what has happened since the April meeting of the FOMC….

Goldman Sachs and Morgan Stanley both think that that this tightening in monetary conditions will induce the Fed to act more aggressively than is generally expected this week. According to a recent survey undertaken by the Wall Street Journal, 63 per cent of market economists do not expect the Fed to announce a QE3-style increase in its balance sheet, and only 43 per cent expect a lessor action, such as a renewal of Operation Twist…. But Goldman Sachs says its quantitative model assigns a probability of 75 per cent to easing this week. Vincent Reinhart of Morgan Stanley, who in a previous role attended many meetings of the FOMC, judges that there is an 80 per cent chance of easing, and if it occurs, he says there is a 70-30 chance that it will come in the aggressive form of QE3…