Are We There Yet? Plus Other Questions to Ask the Fed
“Modest to moderate”. These are the adjectives that have been favored by economists at the U.S. Federal Reserve to describe the recovery to date. In the latest Beige Book — a summary of economic commentary gathered from the 12 Federal Reserve districts — eight districts characterized growth as moderate, four characterized growth as modest, and all of them suggested that while indicators are still somewhat mixed, the trend is clear: conditions are improving.
Back in May, Federal Reserve Bank of San Francisco President John Williams offered a conceit that has proven to be a convenient way to think about the recovery. “Overall,” he said, “if we were in a car, you might say we’re motoring along, but well under the speed limit. The fact that we’re cruising at a moderate speed instead of still stuck in the ditch is due in part to the Federal Reserve’s unprecedented efforts to keep interest rates low. We may not be getting there as fast as we’d like, but we’re definitely moving in the right direction.”
On Friday morning, with America’s economic engine stuck in second gear and the destination (true, sustainable economic growth) still lost in the haze of the horizon, Federal Reserve Bank of Chicago President Charles Evans asked the question that has been occupying the space between everyone’s eyes for months now. It’s the same question that kids ask when buckled in to the back seat of a car on a long, tedious trip. Speaking at the AgFirst Summit in South Carolina, Evans asked an audience thick with financial and economic experts, “Are we there yet?”
The question was more hypothetical than anything. With 7.3 percent headline unemployment, declining labor force participation, unprecedented monetary easing, and tremendous policy uncertainty, the answer is an obvious ‘not yet’, and Evans offered the inevitable follow up, “If not now, when?”
In this scenario, it may be accurate to paint Main Street as the kid in the back seat. Government and the Fed can play the part of the parents, and right now it looks like the Fed is is behind the wheel. Main Street, then, may be appropriately kicking the back of the driver’s seat, as dad slams the gas, tries to shift up, and the transmission sticks. (We’ll admit, the metaphor isn’t perfect.)
On Friday morning, Evans outlined a few questions in his speech that he imagined were on the mind of his audience, both of those present and across the nation. How much longer will the Fed continue with QE3 purchases? How large will the Fed’s balance sheet become by the time these asset purchases end? And will the balance sheet ever shrink? ”Some days,” Evans mused, “I wish that questions like these could be answered with a firm date, a single number and a confident ‘yes,’ accompanied by a fist pump.”
Unfortunately, the answers can’t be that simple. How much longer will the Fed continue with QE3 asset purchases? Not until incoming data indicate that economy has sufficiently improved. Attempting to define ‘sufficient’ is a bit nebulous, but it can be taken to mean that the longer conditions improve, the more likely tapering is to begin. Current Fed projections suggest that tapering could be announced as early as its next policy meeting this September, and purchases could end totally by the middle of 2014.
How large will the Fed’s balance sheet be by that time? Evans and others have speculated that QE3 will add about $1.2 trillion in total to the balance sheet, pushing it to about $4 trillion total. This is up from just $800 billion before the crisis.
Will the balance sheet ever shrink? One day, probably. Fed policymakers — including Chairman Ben Bernanke — have indicated that they could be holding on to treasuries through maturity. This creates a timeline that is decades long, and there’s no telling what crises the Fed will have to respond to in the intervening period.