Some astute commentators have recently noted that while the Fed's highly stimulative monetary policy is in keeping with their dual mandate to maintain low and stable inflation and pursue maximum employment, their policy choices might be risking broader financial stability. Although this assertion does an excellent job highlighting the fragility of our current financial system, it largely neglects the fragility of the ongoing economic recovery.

Over the last few weeks near economic euphoria has faded to the reality of a slow and unsteady economic recovery in the U.S. During this time, Fed officials have pivoted from talking about "tapering" asset purchases to the possibility of increasing asset purchases. Aside from cuts to government spending, the main drag on the U.S. economy continues to be weak global growth. In fact, central banks around the world are once again discussing increased stimulus, as dropping inflation has

Like the second quarter of 2012, the second quarter of 2013 is looking like a big economic disappointment after a very optimistic start to the year. The Philadelphia Fed's Manufacturing Index suggests slowing growth and the Fed's Industrial Production and Capacity Utilization Data suggests that this slowdown fits the pattern of an annual cycle. Independent analysis by Macroeconomic Advisers suggests that some of the slowdown in growth in the second quarter of 2013 is due to a slowdown in government spending revising first quarter economic data downward. So, how will the Fed respond?

Last year at this time the Fed's ongoing stimulus measures were limited to Operation Twist; weak economic growth last spring prompted the FOMC to extend Twist beyond its June expiration. Indications are that the Fed will follow suit this year as well. In the past week, regional Fed Presidents Bullard, Lacker and Kocherlakota have

The release of the March FOMC Minutes has brought renewed discussion of when the Fed will slow and eventually halt their asset purchases. The minutes suggest that given improving economic conditions, several members were in favor of curtailing asset purchases immediately or by midyear with purchases ending by the close of 2013:

In light of the current review of benefits and costs, one member judged that the pace of purchases should ideally be slowed immediately. A few members felt that the risks and costs of purchases, along with the improved outlook since last fall, would likely make a reduction in the pace of purchases appropriate around midyear, with purchases ending later this year. Several others thought that if the outlook for labor market conditions improved as anticipated, it would probably be appropriate to slow purchases later in the year and to stop them by year-end.

It is important

Over the last couple months a number of news stories and editorials have pondered the decline of central bank independence. These stories have primarily focused on how various central banks, especially the Fed, will adjust their inflation targeting policy as political pressure becomes increasingly tied to monetary policy. The most astute of these commentaries have suggested that central banks might target nominal GDP as a more technical mechanism to target higher inflation. As a growing body of academic research has noted, new monetary policy mechanisms and increased technocracy have a long history of coaxing the Fed into increased transparency as a means of combating political pressure. So, while some commentators have suggested that the Fed might follow the tack of the Bank of Japan and the Bank of England by opening discussing the possibility of targeting nominal GDP, I don't see such a bold step coming from

For those of you who don't know, the VIX is The Chicago Board Options Exchange Volatility Index. It measures the cost of using options as insurance against declines. As equity markets have been rising over the last few weeks/months analysts have been increasingly talking about the VIX as a hedge. In theory this makes sense, but in practice this strategy is flawed.

The trouble is that the VIX is supposed to be a prospective look account of upcoming volatility, but it is based solely on retrospective data. So every time a macro decision (monetary or fiscal) is made and the market reacts, the VIX drops before those decisions are even implemented and markets are substantively impacted. A prime example of this phenomenon is the VIX response to FOMC meetings. When the Fed is contemplating a policy change, the VIX rises ahead of the meeting only to drop rapidly once a

Over the last few weeks markets have been presented with myriad new data about the state of the economy. The Dow is at an all-time high, the unemployment rate is at its lowest level since 2008, and despite monetary stimulus the dollar remains strong in comparison to other currencies. All the while, fiscal policy coming from Washington has presented one failure after another. With the Fed's next meeting just over a week away, it is time to evaluate where Fed policy is headed.

Fed Policy Risks

Before evaluating the Fed policy timeline it is crucial to examine the risks facing Fed policy. While much has been written about the inflationary risk of asset purchases and the Fed eventually unwinding their balance sheet, a series of other risks have garnered far less attention. In particular, several of the Fed's communication strategies are risky in and of themselves. Should any

With the "sequester" upon us, it is time to examine the economic impact of austerity. The argument generally states that governments must undergo austerity to credibly bring down their long term debt loads so that the economy can flourish in the future. Unfortunately, IMF research has already come to the conclusion that austerity severely damages economic growth in the near term, and has long term growth consequences. Other countries that have undergone austerity have already demonstrated this.

The prime example of the failure of austerity is Britain. In particular, the Cameron/Osborne government has made austerity a continuing priority even in the face of riots by furloughed or laid off government workers and sustained economic stagnation and even contraction. To combat this economic contraction the Bank of England has had to pursue several aggressive rounds of quantitative easing that dwarf the Fed's efforts per capita. In the face

In both September and October of 2012, I wrote articles examining whether the Federal Reserve was engaged in a global currency war or whether it was merely coordinated monetary stimulus. My conclusion was simple: we are not engaged in a currency war.

Immediately after those articles, we saw a brief lull in talk of a currency war, and a recent resurgence of the topic in the financial media. Some commentators have taken this resurgence to signify that the existing currency war is escalating, but I do not believe that to be the case. To claim that it is a war and that it is escalating is to suggest that central banks and governments around the world are actively attempting to devalue their currencies to undercut the labor costs of competitor nations. At present, the evidence suggests that central banks and governments around the world are simply

Last week I wrote a post about timing the end of QE3. Since that time several Fed officials have spoken publicly about how (not when) that might occur. In particular, Dallas Fed President Richard Fisher and St. Louis Fed President James Bullard have both recently used the phrase "tapering off" in reference to how QE3 will come to a close. In his justification of this tapering off strategy, Richard Fisher said "you can't go from Wild Turkey to cold turkey." So, despite his initial opposition to QE3, he (and presumably his colleagues) understands that QE must be slowly brought to an end so as not to shock the market.

Although the conversation about bringing QE to an end has become increasingly open and we have seen some encouraging signs about the U.S. economy, foreign economic pressures could still alter the trajectory of U.S. monetary policy. In particular,

Despite the fact that over the past week news networks have almost exclusively covered cabinet post confirmation hearings and blizzard forecasts, another round of negotiations are beginning to heat up in Washington. Specifically, although lawmakers compromised on the American Tax Relief Act, three significant downside risks still remain:

1. The spending sequester.
2. The possibility of government shutdown.
3. The debt ceiling.

As it stands right now, the self-imposed spending sequester will go into effect on March 1. According to forecasts by Macroeconomic Advisers, this massive across the board cut in government spending will reduce GDP growth "by 0.7 percentage points over the four quarters of 2013 (from 2.6 to 1.9) and by nearly a full percentage point over the second half of the year as the cuts build cumulatively." In other words, Congress is once again heading toward a down-to-the-wire agreement to resolve potentially disastrous self-imposed fiscal constraints.

Compounding the complex

The January 30 FOMC meeting press release provided little tangible insight into when QE will come to an end, but it did provide a couple of hints.

Hint #1: Esther George

Esther George, President of the Kansas City Fed, cast a dissenting vote. This means that she is continuing the hawkish Kansas City tradition. This is relevant because the makeup of the FOMC in 2013 is particularly dovish, so a dissenting voice could pull some of the more moderate voting members (namely Jerome Powell and James Bullard, but possibly also Elizabeth Duke, Jeremy Stein, and Sarah Bloom Raskin) away from continued stimulus over the next few months.

Hint #2: Even Split

Previous FOMC minutes and murmurings from within the Fed indicate that the Committee is roughly evenly split on whether QE3 will come to a close in mid-2013 or later. This indicates that if the numbers look like

As the Fed's balance sheet recently reached the $3 trillion benchmark, I found myself reflecting on the Fed's actions by reading old FOMC transcripts. Looking back to the 2007 transcripts is a reminder of a simpler world and a much different Federal Reserve. At that time, the Fed's balance sheet was less than one-third its current size, interest rates could be easily lowered to stimulate economic activity, and the biggest debate among Fed policymakers was about the necessity of orchestrating currency swaps to maintain consistent levels of dollar liquidity in the international markets. Today, Fed discussions are undoubtedly about ways to further stimulate employment growth and increase the velocity of money without losing control of inflationary pressures.

In some sense, current debates bring the Fed's policy discussions much closer to their statutory dual mandate to maintain price stability and full employment, but only because current economic conditions fail

I have spent the last few days examining the fiscal cliff deal and pondering just how I should feel about Congress averting a disaster they caused. The only conclusion I can come to is that the 112th Congress declaring victory from the fiscal cliff brings to mind a favorite line from an Adam Sandler movie. At one point in "Big Daddy" the child Sandler has been caring for proudly proclaims "I wipe my own @**;" Congress declaring victory by averting a cliff they designed is much like members running through the halls proud that they are capable of wiping their own butt. Unfortunately, they didn't do a very good job because the 113th Congress is going to have to clean up their mess in the next two months, and they have plenty of other work to be doing.

Unresolved Issues

I could go on to examine what exactly

Upon release of the December 2012 FOMC minutes the stock market reversed course and closed down on Thursday, after initial gains. The rapid drop was a reaction, or overreaction, to a consensus among FOMC members that QE3 will end in 2013. Aside from the fact that the market could have read this sentiment as optimism about a growing economy, rather than an end to free cash, the reality is that the FOMC that made these statements in December is not the same group of people making decisions in 2013.

While many Fed-watchers will note that the 2012 FOMC was rather dovish (save for Richmond Fed President Jeffrey Lacker), the 2013 FOMC is even more dovish. With Boston Fed President Eric Rosengren and Chicago Fed President Charles Evans as voting members, the committee has the two most dovish members of the 19 member body voting this year. Historically,

Listening to Japanese economic policy experts might lead one to the conclusion that the apt parallel to current Japanese economic policy is Japan in 1995. They draw this conclusion based on the weakening of the yen that took place between 1995 and 1998, and the fact that current policy is focused on a similar weakening of the currency, not simply lower interest rates. To me, the more interesting parallel is to the United States in 1979.

To be precise, in 1979 the U.S. economy was facing significant inflationary pressure partly caused by a politicized central bank throughout the 1970s. Modern Japan faces an eerily opposite problem -- they have deflation and a central bank that has avoided political pressure at all costs. This avoidance of political pressure by Japanese central bankers is largely a reaction to years of undue political pressure causing unsustainable monetary policy. Regardless of the reason, the

As 2012 comes to a close, it is obvious that this has been a year of coordinated monetary stimulus, but what will be the hallmark of monetary policy in 2013? Undoubtedly we will see continued stimulus from many central banks throughout 2013, but it is crucial to point out that the world's five most important central banks are all undergoing changes and challenges to their transparency policies. Surely these changes to transparency policies at the Federal Reserve, Bank of England, Bank of Japan, European Central Bank and the People's Bank of China are largely a result of having no place to go with rate policies, but that does not diminish the potential impact of these transparency measures. If anything, investors should be preparing for the effect of these new transparency strategies as we move into the New Year.

The most prominent change in central bank transparency for American

President Obama and Speaker Boehner are Thelma and Louise, getting ready to drive the car off the cliff with the U.S. public locked in the trunk. While the Fed may not have the power to hit the breaks for them, they could simply refuse to fill the car with gas. Instead, the FOMC decided today to top off the tank and soup-up the engine in hopes that the President can floor it to clear the ravine. The trouble is, just a couple hours after the FOMC announced this topping off, Ben Bernanke gave a press conference in which he pointed out that the laws of physics (or in this case, economics) make it simply impossible to clear the ravine, even with the Fed's help.

QE3+

The FOMC announced today that it would be expanding asset purchases by $45 billion per month to offset the conclusion of Operation Twist.

On December 6 the Bank of England voted not to extend asset purchases as a form of monetary stimulus. This is despite prevailing weakness in the British economy and sentiment expressed in the BOE November minutes indicating that members of the policy committee still believe that asset purchases fundamentally are an effective policy tool. Nevertheless, the BOE voted not to extend stimulus and effectively halted a policy of counteracting fiscal austerity with monetary stimulus. The lingering question for the global economy is whether the Fed will follow a similar course of inaction.

British Policy

Despite the fact that the American financial news media was quick to latch onto the fiscal austerity measures put in place by the British government, the BOE's quantitative easing policies have maintained a lower profile. By the end of summer 2012, the Bank of England had engaged in quantitative easing to the tune of £375

The FOMC's final meeting of 2012 is just a week away (December 11-12), and the economic recovery is still not as strong as it ought to be. This continued economic weakness has caused financial journalists to speculate about the Fed increasing the size of monthly asset purchases (QE3) in 2013. This speculation was bolstered by comments from New York Fed President William Dudley, indicating that an increase in the size of QE might be necessary to offset the drag from the expiration of Twist. However, while this speculation has begun, economic growth has remained stable, and stronger than expected in the face of the looming fiscal cliff. So, what is the Fed's next police move?

Possible Stimulus Options

Aside from the obvious possibility that Fed policymakers choose to make no change to policy next week, they have several stimulative actions at their disposal.

The first and most

As it has been reported ad nauseum, in the absence of a legislative deal between the White House and Congress, on January 1, the U.S. government will go over the "fiscal cliff." Despite all of this reporting, the details about what the fiscal cliff entails have been glossed over by everyone from John Boehner to Warren Buffett. So, here is a simplified breakdown.

If the fiscal cliff remains unresolved, the U.S. economy can expect a net contraction of GDP in the first half of 2013 and growth averaging around 1% for the whole year. The labor market would suffer a similar setback with the unemployment rate rising back above 8%, toward the 8.5% mark, rather than continuing its current downward trend.

The essential components of the fiscal cliff that have the largest impact to both GDP and tax payers are the expiration of the "Bush Tax Cuts," the defense