Quantitative Easing

In my view, the most important aspect of today’s Fed meeting is the statement rather than the bond purchases as such. The statement drives expectations, and driving expectations is the name of the game. They state that currently “measures of underlying inflation are somewhat low, relative to levels that the Committee judges to be consistent, over the longer run, with its dual mandate.” That is to say that the FOMC is targeting a level of inflation that’s higher than the current level, though the precise target remains a secret.

They further say that the FOMC “will employ its policy tools as necessary to support the economic recovery and to help ensure that inflation, over time, is at levels consistent with its mandate.” I take that to mean that they’re not engaging in level targeting where they try to have the price level “catch up” with its pre-recession trajectory.

The upshot should be a modest increase in inflation expectations, and thus a modest uptick in economic activity. The reality of modestly elevated inflation should somewhat speed the debt-payback cycle and modestly reduce the real interest rate, both of which can spur economic activity. Consequently, the immediate market response looks to be positive but modest. I think we’re seeing here that the Fed understands the basic shape of the problem just fine, but they don’t feel urgent about it. FOMC members and federal reserve staff don’t spend a lot of time socializing with people in the worst-afflicted demographic groups and thus find themselves uninspired to do anything too bold or risky to help them out.