I just don’t believe that the Federal Reserve will step out this week with another round of quantitative easing. The Fed meets tomorrow and Chairman Bernanke holds another press conference on Wednesday so we should hear about this soon.
There are several reasons why I believe that monetary policy will continue along recent lines.
First, the economy is growing. It is not growing as fast as some would like, but it is growing. It is not growing faster than it is because of structural problems in the labor market, in capital utilization, in housing markets, and in state and local government finance. Due to these structural problems economic growth will not be robust over the next year or so, but will be in the 2.0% to 3.0% range. The Fed can do little to speed up this growth.
Second, loan growth has started up again in the commercial banking sector. Whereas this pick-up will not contribute much to the economic growth mentioned above, I believe that it will produce some “down-side” protection against weaker economic growth. The reason for this is that the loan growth will go into helping resolve some of the structural problems in the economy; it will not be going into producing more output and much higher employment.
Third, whereas the Fed has done about all it can to create more rapid economic growth at this time, it has also done as much as it can to protect the financial system against further shocks. There are still a lot of (smaller) commercial banks that have weak balance sheet positions, but bank closures are only averaging about one per week this year, down from about three every two weeks last year and three every week in 2010.
This, of course, does not include the assisted acquisitions and other mergers that are taking place. We will have to wait until the FDIC releases first quarter results on the banking system to see how much smaller the banking system has gotten. In 2011, 240 banks dropped out of the banking system, approaching five commercial banks leaving the system every week.
The crucial thing is that the banking system is handling these adjustments smoothly and there seems to be no apparent reason that there should be any surprises in this area. Excess reserves in the banking system averaged above $1.5 trillion for the two banking weeks ending April 18. There is still plenty of liquidity in the banking system.
Fourth, although there is much to worry about internationally, most of the “unknowns” are “known”. Again, the thought is that even though Europe is facing a recession and there are some political changes that seem to be taking place in France (Sarkozy might not be re-elected) and the Netherlands (the prime minister has now resigned and new elections will be announced soon) that the continent will “muddle through” this mess and will continue to work toward some kind of fiscal union that will provide some more stability. The fear, again, is of those “unknowns” that are “unknown.” Surprise shocks are not wanted.
Fifth, this is an election year in the United States. As I have stated before, I believe that the Fed will try to avoid anything that makes it look like it is taking sides in the upcoming presidential election. I believe that unless there is some kind of negative shock to the economic or financial system that is not on the radar, any effort to conduct another round of quantitative easing will be jumped on by the Republican presidential candidate and the Republicans in Congress. To engage in QE3 at this time would bring down tremendous political criticism ... on the campaign trail as well as in the Senate and House of Representatives.
And, I believe that another round of quantitative easing would have little or no impact on the economy between now and the election in November. As far as the Fed goes, the cost/benefit ratio does not favor more quantitative easing at this time. Barring any unforeseen shocks, I believe that the trajectory of the economy is pretty well in place for the rest of the year.
Therefore, in terms of the new directive coming out of the Fed’s Open Market Committee meeting tomorrow and Wednesday, I believe we will just hear what we have been hearing over the past quarter or so. At the end of the meeting, Chairman Bernanke will gather with the press and “make clear to us” that things have not changed. For more on this see “Fed, Aiming for Clarity, Falls Short in Some Eyes.”