The Fiscal Cliff and the FOMC

Well, it looks like our leaders have chosen not to put a fence at the top of the fiscal cliff, but to count on an ambulance at the bottom to clean up the mess. We only have three weeks to go before we find out how messy it will be. I don’t have an informed opinion on that, but I do have a strong opinion that the Federal Reserve should lay low until it is resolved one way or another. More specifically, at the FOMC meeting on December 11 and 12, the members should do nothing new. Positive measures would only help enable further inaction.

Doing something will be tempting since the FOMC’s so-called operation twist is scheduled to expire at year-end. The most likely measure would be to add some Treasuries, probably long-term, to the monthly MBS purchases of $40 billion per month, and cease offsetting the Treasury purchases with sales of shorter-term paper. This would end the sterilization of those Treasury purchases and cause the Fed’s assets to grow faster and presumably create money at a faster rate. To date, since QE3 was announced on September 13, a graph of the Fed’s total assets shows very little growth. Likewise, the M2 money supply has grown at an 8.4 percent rate in the three months ending November 28, not much more that the 7.3 percent growth over the past year. Actual inflation and potential inflation remain tame, as evidenced by recent prices of gold, the dollar, and TIPS. So, the temptation to do more will be great.

To ease now, however, would be to take pressure off the politicians to adopt a more responsible fiscal policy. If it becomes necessary, it can be done after the 2013 recession begins.

 

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  1. Kyle says:

    If the FOMC were to start easing again, which side of the aisle would it benefit more in terms of bargaining about the fiscal cliff?