The FOMC announced today that they were not going to make any policy changes, but they stand ready to act. This is a line we have heard a lot in the last couple years, so it came as no surprise to most analysts. A few may have deluded themselves into thinking QE3 was on the horizon, but it was pretty clear that the Fed was not going in that direction. If anything, members of the Committee have been indicating that they are looking at alternative policy options aside from asset purchases. So, what is next in the world of monetary policy?
Tomorrow we will see if ECB President Mario Draghi can make good on his proclamation to do "whatever it takes" to preserve the euro. Given that we have not seen any signals of a meeting of the minds between the ECB and the German Bundesbank, any tricks up Draghi's sleeve might have to be despite German opposition, not with their aid. This will definitely weaken the policy move and likely set us up for a short term bounce in the euro and the equity markets, but it will probably look like the ECB is once again kicking the can down the road rather than providing a long term solution.
Back stateside some commentators have already begun speculating that Bernanke and the Fed will do nothing until after the election in an effort to seem apolitical and prompt Congress to act on fiscal policy. In Congressional testimony, Bernanke adamantly denied doing this when he said that his role is "not to hold threats over Congress' head." Moreover, Chairman Bernanke is still as responsible as anyone for the economic health of the nation, so it seems highly unlikely that he would fail to act when needed in hopes that he can coax a gridlocked Congress into action.
The next step for the Fed will likely be to float a new policy idea at the late-August Jackson Hole Economic Symposium. Historically, this has been where new ideas in monetary policy have been discussed before implementation. This year we should expect the Fed and other central banking personnel to be discussing the risks and benefits of lowering the rate the Fed pays on excess reserves. Either that, or a more complex joint policy with Treasury that looks something like the British "Funding for Lending" program. The goal of either policy would be to prompt banks to lend more freely and ultimately increase the velocity of money. This would help theoretically keep inflation near the 2% target and hopefully aid the employment situation while bolstering the real estate market without adding more liquidity to a system that is sitting on a lot of cash.
Ultimately, it is unlikely that Draghi will announce a dramatic new policy direction tomorrow, but equity markets and the euro will respond favorably to whatever meager action he does take. After this initial bump, investors will realize that the eurozone and the global economy continue to sit in a tenuous position and equity markets will turn downward by the end of trading Friday (barring surprisingly strong U.S. employment numbers) and likely continue into next week. Eventually, the persistent near-crisis conditions will prompt central bankers convening in Jackson Hole to evaluate their policy options once again. In evaluating their options, central bankers will likely put the ball back in the Fed's court as Mario Draghi is forced to admit that without German support, it is tough for him to do anything super.