By Steven K. Beckner

Overhanging the outlook, of course, are dark clouds from Europe,
which remains on the brink despite the ballyhooed efforts of EU leaders
to salvage the situation. Looming not far behind are concerns about the
United States’ own unresolved fiscal mess. And there are fears that
China may experience something less than a soft landing, in which case
U.S. exports could take a serious hit.

But none of these negatives necessitate making an already easy U.S.
monetary policy even easier at this particular juncture.

The FOMC majority, including the reconstituted voting ranks of
2012, will probably want to see some shortfall from the November
economic projections, including some further disinflation. Bernanke will
want to be able to point to a demonstrable need for more Fed action.

Should those conditions fall into place, QE3 becomes not just
possible but probable, and there is no reason why the FOMC has to wait
until the scheduled conclusion of Operation Twist at the end of June. It
could easily authorize the New York Fed open market trading desk to
layer QE3 purchases on top of the Twist purchases. Alternatively, QE3
could substitute for Twist.

But the first step, possibly as early as Tuesday, is some tweaking
of the FOMC’s “forward guidance” on the path of the federal funds rate.

There is general dissatisfaction with the current practice of
naming a specific date, however conditional, for the end of zero rates.
There is a desire to make rate changes more “state contingent,” i.e.
responsive to changes in key economic indicators.

That’s not automatic either, however. Some, including Bernanke,
have spoken of using communication as an easing “tool.” But that is
anathema to others.

Plosser, for instance, told MNI not long ago that if clearer
communication with a “reaction function” were adopted and “if that
ultimately implies that rates will be lower longer then so be it,” but
“that’s an outcome, not an objective.”

“If someone were to say that ‘I already believe that I want to keep
rates lower longer, and I just have to figure out a way to convince
people that’s what I want to do … that’s the wrong way to conduct
policy,” said Plosser, who serves on Yellen’s communications task force
with Evans. “It’s a means rather than an end.”

Those “who want a different set off communication strategies and
frameworks so we can rationalize keeping rates lower longer” have it
“backwards,” he continued, “because that way you’ve already assumed what
the answer is; you just want a rationale for how to deliver it. That’s
not the way to think about it.”

“Now, if we can get an understanding of a rule that constitutes
good policy that may be an outcome of that,” Plosser went on. “But you
don’t make rules out of convenience that you’re free to violate whenever
you want to because it doesn’t suit you. That’s not the way to think
about systematic policy.”

Those who see communication as an easing tool are almost certainly
in the majority. But the question then becomes whether now, when
unemployment has just fallen four ticks to 8.6%, is the appropriate time
to use that tool or whether the FOMC is better off waiting awhile longer
before expending that particular form of easing accommodation
ammunition.

If communication really an easing tool, it might be asked, wouldn’t
it be better to save it for a time when it is more clearly needed?

And there are other issues to hash out as the subpar recovery
continues to stumble along amid great uncertainty.

For one thing, there is a big difference of opinion among
policymakers about what is keeping growth so sluggish and unemployment
so stubbornly high.

For Evans, for Yellen, for her successor at the San Francisco Fed
John Williams and others, it’s purely a matter of inadequate aggregate
demand. And they are convinced that a “dearth of demand,” as Yellen
calls it, is responsive to traditional Keynesian demand stimulus, of
both the monetary and fiscal variety.

For others, notably Dallas Fed President Richard Fisher, the
economy’s woes are more “structural.” They see it as struggling under
the weight of uncertainty about government regulations, tax burdens and
other forces. That faction believes that further monetary stimulus would
do little or no good or could even be counterproductive.

It may seem like an unbridgeable chasm. But saying that the economy
is suffering from weak demand rather than from “structural” issues
merely pushes back the question: what is causing this dearth of demand?

If people and firms are too uncertain about future tax rates,
regulatory burdens and other governmental caprice, as indeed the Fed has
been hearing from its contacts for many months, then that will certainly
affect hiring and investment and in turn spending on a broad array of
goods and services, will it not? At least that’s what the Fed is hearing
from many of its contacts.

There is so much for the FOMC to contemplate.

As if the European debt crisis wasn’t enough, the Fed has to
contemplate America’s own looming fiscal mess. Aside from uncertainty
about continuation of payroll tax relief and the Bush tax cuts, the
larger issue is whether Congress and the administration are going to get
serious about slowing the rate of growth of deficit spending and the
national debt.

As things now stand, with the Super Committee having flubbed its
responsibility to “cut” $1.2 trillion over 10 years, a sequestration of
that amount is due to take effect. That’s not necessarily a bad thing,
contend people like former Texas Senator Phil Gramm, but even with
sequestraton, the debt is still on track to rise by $8-9 trillion over
the next 10 years and reach the kind of debt to GDP ratios that have
dragged Europe down.

Then there’s the ongoing housing morass. The Fed is painfully
cognizant of the fact that any efforts it makes to stimulate the economy
by easing monetary policy are sure to run up against housing market
constraints. After all, historically low mortgage rates have so far made
barely a dint.

Despite various government efforts to help homeowners facing
foreclosure and to expedite refinancings, millions of Americans are
unable to take advantage of lower interest rates. With home prices
having fallen nationwide, roughly a quarter of Americans have “negative
equity” in their homes, which is to say they owe more than their home is
worth, making it hard for them to qualify for refinancing.

As Fisher and others have remarked, there is no point in pumping
more liquidity into the financial system and the economy if the
“transmission mechanism” is clogged up.

So there is much for weary Fed officials to discuss ahead of the
holidays.

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** Market News International **

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