Welcome to the world of the do-nothing Fed.
After three years of frantic activity by Ben Bernanke & Co., the Federal Reserve has entered a period in which its hands are likely to be tied by a limping economy and the toxic politics of inflation. That is, unless there is another crisis. If you feel the walls closing in a bit, you’re not alone.
The Federal Open Market Committee’s statement Wednesday admits the recovery is going “more slowly” than the central bank expected. But putting on a brave face, the central bank insists the economy will start rolling again in the second half of 2011.
If the economy does bounce, it would enable the Fed to start considering moves in 2012 to sop up some of the funds it has pumped into the financial system. Bernanke was talking wishfully early last year about his exit strategy, and no doubt he’d like to get on with it sooner rather than later.
But the reality is that the economy is going nowhere in a hurry. Banks, for instance, haven't started lending (see chart, right) in spite of the Fed's largess.
This means growth numbers are unlikely any time soon to improve enough to permit Fed tightening. Meanwhile, we have fallen so far that the economy is unlikely to deteriorate quite as much as might justify more easing.
Economists at Goldman Sachs estimated in a note to clients this month that unemployment forecasts would have to rise by a point and a quarter to give the Fed cover for another round of the bond purchases known as quantitative easing or a similar stimulus.
Unemployment, recently 9.1%, would have to clear 10% this year, 9% next year or 8% in 2013 in order to justify a new Fed easing push, the Goldman research suggests. Alternatively, core inflation estimates would have to drop by a percentage point, suggesting an economy struggling through another brush with deflation.
The bar is set high on the optimistic scenario too. If job creation suddenly caught fire and the unemployment forecast dropped by three quarters of a percentage point (or inflation expectations rose by half a point), the Fed might be forced into tightening policy unexpectedly.
But neither scenario looks terribly likely right now, says Goldman’s Sven Jari Stehn.
“The ‘zone of inaction’ looks wide,” he writes. Bernanke’s message, starting with this afternoon’s press conference, “is unlikely to be pleasant for either the chairman or his audience.” Add the frozen Fed to a long list of unpleasant economic realities.