Noisia Records

I agree with David Beckworth that Richard Koo is wrong to insist that monetary policy cant do anything in a balance sheet recession. But I think Beckworth introduces unnecessary complications; also, Koo isnt entirely wrong.

Koos argument is that interest rates and monetary policy dont matter because everyone is debt-constrained. That cant be right; if there are debtors, there must also be creditors, and the creditors must be influenced at the margin by interest rates, expected inflation, and all that.

That said, widespread credit constraints presumably reduce the number of players who can take advantage of lower rates. So the IS curve, while still downward-sloping, is probably steeper than normal, a point Mark Thoma has made.

So Im not clear why Beckworth needs to invoke some other story about coordination and all that. There is still a sufficiently low real interest rate that would produce recovery, but its a rate thats hard to achieve.

Interest rates may have peaked in the country, though the full impact of monetary tightening by the Reserve Bank of India (RBI) is not felt yet, former governor YV Reddy said.

“The interest rate already has increased and, therefore, we have to see how much more monetary action is required or is it required at all. I will put this as a question mark,” Reddy said in an interview in the Banker’s Trust programme on Bloomberg UTV to be telecast this week.

“RBI has acted pretty well. The monetary policy transmission will take time and, hence, one has to be careful whether any further tightening is required at this stage,” he said.

Since its monetary tightening process started in January 2010, the Indian central bank has hiked banks’ cash reserve ratio, or the portion of deposits that banks need to keep with RBI, by 100 basis points (bps) and the policy rate by 425 bps through 10 incremental hikes. After the latest hike on 16 June, the policy rate is now 7.5%. One basis point is one-hundredth of a percentage point.

Policymakers and analysts may have overestimated the capacity of the economy to grow and it is inherently a wrong approach to think that economy is slowing because it is now growing at 8-8.5%, Reddy said.

On the contrary, it could be the sustainable growth rate for the economy as 9% growth is beyond its absorptive capacity and something that has led to overheating, the offshoot of which is now evident in the prevailing high inflation.

“We should be growing only at 8.5%, and since we allowed us to grow at 9%, we are suffering from inflation now,” Reddy said. “When growth hit 9%, I used the word overheating. Everybody was unhappy with it and I stopped using the word, but I took whatever action was required.”

Reddy was RBI governor for five years between 2003 and 2008. He stepped down in September 2008, a week before the collapse of US investment bank Lehman Brothers Holdings Inc.

India’s economy grew at around 9.5% for three successive years between 2006 and 2008 and Reddy raised policy rates by 300 bps to 9% to fight inflation that hit a 13-year high of 12.5% in early August of 2008.

Reddy, widely credited to keep the Indian banking system safe from the global credit crisis, said notions such as inflation targeting may not be the right approach for a country like India where fiscal prudence is questionable.

“When there is a fiscal dominance, what will just inflation targeting do?” he asked. “Post-crisis, the supporters for inflation targeting are becoming less. The wisdom is not in favour of inflation targeting and the Indian conditions haven’t been changed.”

A proponent of an independent debt office, Reddy was candid enough to admit that he was “immature” in doing so. Referring to the sovereign debt crisis in Greece, he is of the view that any such debt offices can be easily influenced by outsiders and, hence, debt management should be a mandate of the central bank, which is in charge of financial stability and inflation management.

“At one stage I myself was a proponent of this (independent debt management office), but at that time I was immature. I went by the textbook. I went on the assumption that fiscal consolidation will take place,” he said. “Afterwards I realized…that if we have independent debt office, it’s a recipe for problems, especially if you have high debt.”

The Indian banking system is shirking its core responsibility, according to Reddy. A “hollow” banking is emerging, he warned, that is taking away banks from their core work of providing credit to agriculture, small and medium enterprises and other productive sectors of the economy.

“Everybody encourages banks to do everything other than the core function. There is a hollowing of banking in India,” he said, “and that’s not good for the economy.”

However, Reddy is not worried about the “vulnerability” of the banking system, as banks’ balance sheets are “fairly strong”.

They have grown some bad assets “but there is enough capital,” he said.

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By John Kell

NEW YORK (MarketWatch) — The International Monetary Fund has said it would aim to select a new leader by the end of the month, with French Finance Minister Christine Lagarde seen as the clear favorite for the post.

Auto makers are forecast to report on Friday an 11% increase in U.S. new-vehicle sales in June from a year ago, according to car-shopping website Edmunds.com, as gains from Detroit’s Big Three and Nissan Motor Co. (NSANY, 7201.TO) should offset declines from Japan’s other top manufacturers.

Concerns about Greece’s weak economic recovery and increased uncertainty about the sustainability of debt have spooked markets ahead of a key parliament vote on the country’s latest austerity package.

The IMF is aiming to select a new leader by Thursday, as the group seeks a successor after former chief Dominique Strauss-Kahn resigned following his arrest last month on sexual-assault charges in New York. Lagarde is expected to secure the managing director's job, as she has the backing of most European countries, as well as some others in the developing world. Her only rival is Mexican central banker Agustin Carstens.

Japanese auto makers Toyota Motor Corp. (TM, 7203.TO) and Honda Motor Co. (HMC, 7267.TO) are each expected to post a double-digit decline in U.S. new-vehicle sales in June, as the auto makers continue to be stung by inventory shortages in the wake of an earthquake that struck Japan in March. Nissan, which has suffered less than its peers, is seen posting a 25% jump in sales, while strong growth is also projected for the Big Three.

Despite the choppy results in recent months, the auto industry has benefited from a broad economic recovery, although higher gasoline prices have resulted in a higher mix of smaller-vehicle sales.

Greek members of parliament must pass stringent measures worth some 28 billion euros ($39.68 billion) before the struggling nation can get EUR12 billion from an existing aid package. Approval must come by June 30 so that Greece is ready for the Eurogroup meeting scheduled for July 3, although Greek opposition parties have said they will vote against the package. Prime Minister George Papandreou said earlier Friday that Greece has also secured a second bailout from the European Union and IMF that would total EUR110 billion.

Nortel Networks Corp. (NRTLQ, NT.T) will auction off its portfolio of patents Monday, with Internet giant Google Inc.

/quotes/zigman/93888/quotes/nls/goog GOOG
+0.50%

expected to open bidding with a $900 million lead offer. Nortel, which filed for Chapter 11 production in early 2009, has said it has about 6,000 patents and patent applications. Both Google and Apple Inc.

/quotes/zigman/68270/quotes/nls/aapl AAPL
-0.92%

have received antitrust clearance to place bids at the auction, which is also expected to draw interest from Microsoft, BlackBerry maker Research in Motion Ltd. (RIMM, RIM.T) and several other firms.

Microsoft Corp.

/quotes/zigman/20493/quotes/nls/msft MSFT
-0.72%

will introduce a cloud-based version of its popular Office productivity suite next week as the software giant seeks to carve out a niche next to early entrants, like competitor Google.

On June 28, Microsoft Chief Executive Steve Ballmer is scheduled to appear at a New York launch event for Office 365, a combination of communication, collaboration and productivity software delivered via the Internet. Microsoft calls the package of services the "next generation cloud service."

Office 365 blends many existing Microsoft utilities, which are currently offered online a la carte, into a single cloud offering. In a major break with the packaged software era, customers will be able to buy only what they need.

Microsoft is debuting Office 365 in a crowded field. Google's eponymous Google Docs and VMware Inc.'s

/quotes/zigman/464645/quotes/nls/vmw VMW
-0.79%

Zimbra email, for example, are attracting hundreds of corporate users seeking tools that work from either desktop computers or mobile devices.

The U.S. will tackle trade barriers to investment in India during high-level talks in the District of Columbia next week, seeking to tap opportunities in one of the world's hottest economies. The meeting among Treasury Secretary Timothy Geithner, India Finance Minister Pranab Mukherjee and others is part of an ongoing dialogue between the two nations to deepen their economic relationship.

Earnings are due from a handful of consumer-focused companies, including dollar-store chain Family Dollar Stores Inc.

/quotes/zigman/226252/quotes/nls/fdo FDO
+0.90%

, packaged-food company General Mills Inc.

/quotes/zigman/227548/quotes/nls/gis GIS
+0.78%

, sporting-goods maker Nike Inc.

/quotes/zigman/235840/quotes/nls/nke NKE
-0.08%

and mattress maker Sealy Corp.

/quotes/zigman/413020/quotes/nls/zz ZZ
-1.33%

.

Analysts polled by Thomson Reuters predict Nike, Family Dollar and General Mills will each post a double-digit increase in earnings from a year ago, as each company should report higher sales. Results from Sealy, which has swung to a loss the past three consecutive quarters, are expected to be weaker.

The Conference Board, a private research group, will release its index of U.S. consumer confidence for the month of June on Tuesday. The group's index declined to 60.8 in May from a revised 66 in April, far worse than the 66.4 expected by economists surveyed by Dow Jones Newswires. After reaching a three-year high of 72 in February, the index is now at its lowest point since November.

Among the significant conferences next week are the Biotechnology Industry Organization International Convention Monday through Thursday in the District of Columbia and the Oppenheimer & Co. Consumer Conference on Tuesday and Wednesday in Boston.

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Microsoft Corp.

$
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VMware Inc.

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* Bahrain to underperform after political turmoil

* Foreign investors waiting to see a return to normality
there

* US debt unappealing to Gulf central banks

BASEL, Switzerland, June 26 (Reuters) – Gulf economies will
grow on average 4 percent this year thanks to elevated oil
prices but Bahrain will underperform the others because of
political turbulence, the head of the Arab Monetary Fund said on
Sunday.

Prices of oil at around $100 a barrel are very lucrative
for oil producers. Based on this the economic situation will
continue to improve. On average 4 percent is achievable as a
whole, Jassim Al-Mannai, director general of the Abu
Dhabi-based AMF, told Reuters in an interview

In Bahrain because of the turmoil, growth could be revised
down a little bit, he said on the sidelines of the Bank for
International Settlements.

Bahrain, a regional financial centre, has suffered after a
month of unrest in which the government cracked down on mainly
Shiite-led protests. Around 24 people died, banks and shops
were closed and investors took flight. Economic losses reached
$1 billion or about 20 percent of quarterly gross domestic
product, according to NCB Capital estimates.

A Reuters poll showed that economists slashed estimates for
Bahrains gross domestic product growth this year to 2.7
percent, on average, from 3.4 percent seen in March. For 2012 it
was cut to 3.3 percent from 3.6 percent.

A national dialogue involving the government and opposition
will start on July 1 but a top Bahraini Shiite cleric said on
Friday that it looked set to fail .

Because of the turbulence people are relatively concerned,
especially investors, and they would like to make sure Bahrain
is back to the normal situation for sure so that they can go
back to business. They are watching the dialogue process,
Al-Mannai said.

Foreign investors will never throw into money into the
uncertain situation. It will take some time.

US TREASURIES

The oil-rich Gulf region is home to large US Treasury
holdings, but low rates are making it unattractive for central
banks to buy additional US government debt, Al-Mannai said.

Negotiations aimed at raising the US debt limit and
avoiding default fell apart on Thursday as Republicans walked
out over Democrats demand for tax increases as part of a
deficit reduction plan.

A deal must be reached by Aug. 2 to avoid a potential
default on the countrys $14.3 trillion debt.

Ratings agencies…are a bit concerned about the financial
situation but it does not mean necessary that the US will go
into default. If there is a default, the problem is not only
limited to countries associated with the dollar. It will be a
catastrophe, he said.

I dont think they will add more given the rate but doesnt
mean their portfolio is empty of US Treasuries. From the
investment point of view are they going to add more? I dont
think so.

Earlier, UAE central bank governor Sultan Nasser Al-Suwaidi
told Reuters that US Treasuries were unattractive and the
central bank preferred other dollar-based instruments to manage
reserves .

(Editing by Sophie Walker)

On Friday the forecast of the economic growth of the US was slashed by the IMF as it cautioned Washington and other debt-ridden European countries that unless immediate steps were taken by them for reduction in budget deficits, they would be considered as playing with fire. Since its earlier report in April, larger menaces to growth had surfaced, said the IMF, in its regular review of global economic panoramas, alluding to debt crisis in the euro zone and indications of sweltering in budding market economies.

The global lender headquartered at Washington, forecast that US GDP (gross domestic product) would grow a moderate 2.5% this year and 2.7% next year. The forecast it made 2 months back spoke of 2.8% and 2.9% growth expectations respectively.   The Fund said in an unhurried tone that the retarded growth of the past few months should be short-term considering the overall global economy.

Its forecast of global growth saw slight pruning only this year, from 4.4 % to 4.3%, maintaining strong 9.6% growth rate for China in spite of indications of deceleration there lately. If politicians in Europe and the US do not begin showing more control in addressing the debt problems of their country, the fund may soon do away with its compassionate behavior.

Jose Vinals, under whose leadership the capital markets and monetary department of the fund work, cautioned that decisions which are of such first magnitude cannot be postponed in a world economy as it would indicate their flippancy and playing with fire. He also added during an interview in Sao Paulo that they had now entered into the political phase of the global crisis, which was its newest part.

Clashes over lifting the officially authorized ceiling on the debt of the nation is a part of the political problems in the US. The AAA rating given to the country would be jeopardized by the slightest technical default, according to Fitch Ratings and even the markets would be shaken by the first-ever US non-payment. Revenues which have been higher-than-expected have resulted in an improvement in the attitude towards budget deficit in the US this year. Though the deficit forecast by it (in a different report) was 9.9% of GDP , indicating recovery in comparison to the deficit of 10.8% of GDP, estimated in April, the level is still close to historic highs.

MARKETS INCREASINGLY ON EDGE

The retarded growth of the global economy was not thought to be reassuring by the fund which has suffered a political crisis because its’ chief, Dominique Strauss-Kahn had to resign as he was charged with the sexual assault of a maid. The main reasons responsible for the faults were transitory disruptions like higher energy prices, food crops being pressurized by bad weather conditions and the Japan earthquake.

Second half of the year should see a reacceleration of the global growth, as per the report. Its forecast for the next year remained unaltered at 4.5% global growth; however, the growth view of the euro area saw a raise from 1.6 % to 2.0 % in the year 2011. Forecasts for the year 2012 see growth at 1.7%, a slight change from its earlier 1.8 percent. Still Europe has been considered as a risky affair for the global economy by Vinals.

Drawing attention to 4 countries, Vinals said that the United States, Japan, Ireland and Greece would have to restore their public finances to a bearable condition with relation to debt levels.  Greece, an indebted country, is on the verge of non-payment as the officials in the euro zone have disagreed to plan another aid package for it. The country is suffering from protests and strikes while uncertainty has been doubled by the political turmoil. Chances are that the government would be unable to tighten its belt enough for the reduction of paralyzing deficits. In The past sessions, the global markets have been driven lower by the fears of corruption within the Euro Zone. Germany, which is considered as the euro zone’s powerhouse saw the forecast of 3.2 %growth up from 2.5% in the last year along with a mere 2% growth for the year 2012. The GDP view of China remained unaltered while that of Brazil was reduced from 4.5% to 4.1%

BRICS comprises of South Africa, India and Russia and its quick expansion has surpassed the growth of developed markets lately. While the developed nations with a view to enhance anemic growth, keep the monetary policy liberal, unlike them the budding economies prefer keeping it tight along with reserve requirements and high interest because of increasing inflation amp; tough economic growth.

Still the IMF has been warning the emerging markets to tighten their policies more. Eg in China, if the inflation rate is higher, then it would imply that the real interest rates are negative. There are a few emerging markets which have been unwilling to tighten the policies, fearing the growth getting ruined or a push to their currencies by more speculative investment flows.

By Li Hong

At a time of global economic uncertainty which is also spreading to China, it is normal to see a host of nay-sayers and skeptics rise to diminish this countrys economic prospect. Lately, we have read headlines and pundits opinion like cracks emerging in the worlds second largest economy, the biggest bank debt crisis in 17 years incurred by Chinas local governments, and a hard landing to serve the country better than a soft-landing.

Just dont weigh them too much, or lock them in the drawer. Whenever a tumult of voices erupts, one just needs to keep calm, refusing to be drawn to the verbal fray.

After a long spell of double-digit growth from 2003-2008, and a silky recovery in 2009 and 2010 following a hiccup brought by the giant US financial system meltdown, Chinas policy-makers could be well assured of their ability to tackle any economic problems. The country has bountiful options stored to remove barricades and stones in its road to prosperity. Those who aspire to short China will prove to be wrong.

First, the economy has maintained ample momentum and is on track for another solid growth this year. There wont be a crash landing — a scene we have witnessed in US in 2008 and 2009 with the equity assets bleeding, labor market devastated and its economy grounded to a chilly standstill. The so-called macro-control policy put into place by Beijing since middle 2010 has worked, and the Chinese economy is geared for a “soft landing” of 9 percent expansion in 2011 — an ideal growth rate that fits Chinas conditions and is largely sustainable.

Chinas GDP rose 9.7 percent in the first quarter, and is expected to grow by 9.5 percent in the second quarter. A precipitous slowdown to lower than 8 percent in the third and fourth quarters is fear-mongering.

Therefore, Beijing should be consistent in implementing the prudent monetary policy, steadfast in unwinding previous stimulus plan, and be resolute in tightening credit supply in order to put elevated inflation under check. Premier Wen Jiabao and his cabinet, including the central bankers, should bear in mind that peoples anger with inflation has proved to be more incendiary– endangering stability – than decelerated GDP growth, because it erodes their buying power and lowers their livelihood.

The widespread online demand for the central bank to raise interest rates, in addition to raising banks required reserve ratios, should not be neglected.

And, to thwart the cascading inflows of overseas hot money to the country, which has exacerbated credit supply and inflation in China, the decision makers should consider drastically hiking the value of the yuan against major global currencies — a quantitative one-off appreciation is a better policy option. Only after inflation is put under stern control – with core CPI rise retreating to 3 percent, Beijing could, gradually, lessen its monetary tightening to nourish healthy and solid growth.

Some seem seriously worried about the chilling effect of monetary tightening on Chinas equity prices. However, lowered home prices and a property sector that is devoid of Japan and America-style bubbles are healthier, and a boon for Chinese economy. And, the policys impact on the stock market is genuinely negligible. (Last year, I wrote that even if the stocks went down by several hundred points because of tightening, the economy wont be harmed.)

Actually, Beijing is not clueless, facing the rising recovery uncertainty abroad. It has begun to give tax relief to tens of millions of Chinese lower and middle class families by reducing their personal income tax. Beijing should consider giving them fatter tax refunds to inspire domestic consumption, amid decreasing export demands from the Western countries.

And, Beijing needs to be prepared to reach deeper to its coffers, and spend more on roads, ports, bridges, tunnels, subways and high-speed railways – to spur economic growth. It has just allowed local governments to sell bonds to raise money for affordable housing projects, or public homes for rental. The move will rein in prices on commodity home market while meet the demand of the low-tier urban residents and migrant workers.

By allowing local municipalities to sell securities, the long-festering problem of local government debts – which I explained in my previous column – could also be addressed, removing a much-feared default crisis. Meanwhile, the local governments will be forced to be choosy in investing in future projects, as they have to be accountable for all the bondholders.

MONETARY Policy Committee member Paul Fisher yesterday warned of how difficult it would be for the UK to get back from a deflationary situation and highlighted his belief that the danger of such a scenario of falling prices remains.

His comments on the risk of deflation, in a speech to the Global Borrowers and Investors Forum in London, will almost certainly reinforce the view that UK base rates are likely to stay at 0.5% for a while longer as the economy struggles.

Mr Fisher, one of nine members of the Bank of England rate-setting committee, defended the MPCs decision to hold base rates at the record low at which they have stood since March 2009 in spite of above-target inflation. Following the example of Bank of England Governor Mervyn King in a speech last week, Mr Fisher highlighted the damage which could have been done to the economy by hiking interest rates to combat inflation.

Mr Fisher said: In our current projections, there are very major risks to either side of the central case. On one side, higher inflation expectations could become entrenched, making it very costly for the MPC to subsequently bring inflation back to target.

On the other side, the economy could be much weaker than we expect, pushing down on inflation and risking deflation. Recovering to the target from that could be even harder, at least in my personal view. MPC members place different weight on these possibilities and reach different judgments accordingly. But it is clear to all of us that both risks exist.

Mr Fisher highlighted the part which the hike in value-added tax from 17.5% to 20%, higher import prices resulting from a weaker pound, and increased energy costs had played in pushing inflation above target.

He said: Yes, we could have tightened policy to keep inflation at target when the shocks first hit but it would have needed to be a very material tightening. I believe that would have engendered a worse outcome on all counts.

Declaring that the impact of the VAT increase and rise in commodity prices was likely to be temporary, he added that such policy tightening would have meant a greater fall in output and a bigger rise in unemployment.

He added: By the time the price shocks wore off, we would have been facing a severe undershoot of the inflation target and deflation would have been a distinct possibility.

Council Bluffs, Ia. Limiting government control over the countrys financial system and cutting publicly funded benefit programs would revitalize the US economy, Republican presidential candidate Ron Paul said Tuesday during a campaign stop here.

Paul, who also ran for president in 2008, released a statement outlining his fiscal policy shortly before talking money matters with a crowd of more than 100 at a local hotel.

If we can deliver to our children a sound monetary system, free markets (and) property rights, we wont have to worry about them they will take care of themselves, Paul said. Its the dependency thats so bad.

The Texas congressman said he would call for a stop to deficit spending if elected and put an end to the Federal Reserve.

The departments power to raise and lower interest rates has contributed to the countrys deficit, Paul said. And the elimination of the agency also would make it easier for the United States to return to the gold standard, a system where paper money is backed by units of precious metals, he noted.

In the last campaign I dont know if anybody noticed there was some laughing and some giggling when Id bring up some of those ideas, said Paul, who finished first in a straw poll held Saturday at the Republican Leadership Conference in New Orleans. That has stopped.

Rod Schmidt is glad Paul is running for president. The Garden Grove man plans to vote for him because of his stance on money policy.

In addition to revamping the countrys monetary system, Paul said he would eliminate the Internal Revenue Service to reduce the role government plays in the marketplace.

Ron Paul is not part of the bailout brotherhood he voted against them all, said the 61-year-old Vietnam veteran.

Tuesdays statement also said Paul would veto any spending bills that provide funding for abortion facilities, cease the implementation of the recently passed health care legislation and shrink the size of the federal government.

Many of the attendees at the Council Bluffs gathering said they were longtime Paul supporters. But undecided voters and some new fans including several college students and young adults also showed up to hear the congressman.

The increased interest shows that people want leaders who will follow the Constitutions vision of limited government, Paul said.

It symbolizes that change is coming, he told the crowd. It has to be a generational change, and that is where we are making great progress.

Paul also made a noon appearance at a Sergeant Bluff community center.

- Register correspondent Alyssa Hoogendoorn contributed to this report.

Recommended Photos

WASHINGTON (Reuters) – Mexicos central bank chief Agustin Carstens on Tuesday portrayed himself as a consensus builder with diverse experience in dealing with economic crises during an interview with the IMFs board on Tuesday.

Carstens was the first candidate to be interviewed by the 24-member IMF board, which will decide by June 30 on who the next head of the International Monetary Fund will be.

French Finance Minister Christine Lagarde goes before the IMF board on Wednesday and is widely regarded as the front-runner in the bid to lead the global leader.

Carstens has acknowledged he is a long-shot candidate. However, he has cautioned that having a European run the IMF while trying to resolve the European debt crisis could amount to a conflict of interest.

He is no newcomer to debt crises, having experienced those that hit Latin America since the 1980s. He was at the central bank during the Mexican peso crisis in 1994.

The IMF top spot came open last month following the sudden resignation of Dominique Strauss-Kahn on sexual assault charges. He has denied all of the charges.

Carstens said he saw four challenges for the next IMF managing director: increasing the influence of developing countries in the fund, strengthening IMF surveillance of the global economy, building the IMFs ability to prevent crises, and overseeing global policy coordination.

Failure to address these issues risks diminishing the IMFs relevance and alienating its membership, Carstens said in a statement to the board released by the IMF.

He said the IMF had to increase the influence of emerging and developing countries to better reflect their global economic clout. That included boosting their representation in staff and management positions.

Continued…

The Feds Federal Open Market Committee is meeting today to decide the course of monetary policy. The meeting, which concludes on Wednesday, comes amid signs the recovery is slowing. Will the Fed alter policy in response to the emerging weakness in the economy?

The Fed Faces a Faltering Recovery

In May, the economy created 54,000 payroll jobs, too few to even keep up with population growth, auto sales fell substantially, retail sales slowed, manufacturing output growth fell off significantly, house prices reached new post-bubble lows (as of March), and home sales were sluggish. In addition, claims for unemployment insurance have been elevated, consumer sentiment has weakened, and corporate bond issuance “fell to its slowest pace of the year.” And if thats not enough, ARRA spending and QE2 are coming to an end, and state and local budgets are still a problem.

Thus, there are substantial headwinds pushing against the recovery, but there is uncertainty over how long they will persist (good discussions of this can be found at the SF Fed and Calculated Risk). My own view is that the weakness is likely to be with us for awhile, and that it would be a mistake for policymakers to dismiss the recent data as a temporary blip in the recovery.

Decisions the Fed Must Make

As noted above, QE2 which expanded the Feds balance sheet in an attempt to stimulate the economy is coming to an end. In response, the Fed can make three choices. It can expand the balance sheet further by moving on to QE3, maintain the balance sheet at its present size, or begin reducing the size of its balance sheet immediately (ie sell the assets it purchased during QE1 and QE2).

The other decision is must make is whether to increase the target interest rate, and if so by how much, or leave it at its present level.

What Will the Fed Will Do?

I think the chances of QE3 at this point are non-existent. If the economy continues to weaken, then perhaps the Fed will consider it, but conditions are not yet bad enough for the Fed to take this step.

If anything, the Fed is inclined to move in the other direction. The Fed has reached new ground with its swelled balance sheet and, as Bernanke made clear in the press conference after the last meeting, the Fed is not entirely sure what to expect. The desire to reduce this uncertainty makes the Fed anxious to return the balance sheet to a more familiar size.

When will the balance sheet reduction begin? The first thing that will happen is that the Fed will stop reinvesting maturing securities, and after a time it will also begin selling the financial assets it accumulated during QE1 ad QE2. Several months back I expected the first step to happen in late summer. But now I expect it to be much later than that, near or past the first of the year. And once it does begin, I expect the Fed will move at a measured pace to avoid upsetting financial markets.

As for interest rates, the Fed wont begin increasing rates until after balance sheet reduction is well underway. Thus, I dont expect to see an increase in the target interest rate before the year has ended, and it will likely be several months after that perhaps even longer. And, like balance sheet reductions, I expect the increases to proceed at a relatively slow rate.

Key Things to Look For

The results of the meeting will be communicated in the press release that is posted on the Feds website when the meeting is concluded, and in the Press Conference Ben Bernanke will hold shortly thereafter his second since the Fed began this practice. Heres what to look for:

Press Release: In the press release, look for any changes in language related to the Feds outlook for the economy. This will help to determine when the Fed is likely to begin reversing policy (again, I dont think QE3 is likely unless there is a substantial deterioration in the outlook). In particular, look for indications of whether the Fed sees the current weakness as a bump in the road, or something more persistent. The more persistent the weakness appears, the longer policy is likely to remain on hold.

I will also be looking for any change in the language about inflation. Is the Fed more worried about inflation than before? If inflation worries intensify, the Fed is likely to reverse course sooner.

Press Conference: In the press conference Bernanke will hold after the meeting ends, look for signals about the same things how the Fed views the present slowdown and how worried it is about inflation. In addition, as Jill Schlesinger says, Of particular interest will be whether Ben Bernanke gives any hint of a potential QE3. Will there be any signs of willingness to move on to QE3 should conditions worsen? If so, how bad do things have to get? I expect the bar for further action is high, but what can we learn about how high the bar actually is?

Finally, how does the Fed see the unemployment problem? Is it largely cyclical or structural? If its cyclical, the Fed is more likely to act if the economy worsens, but if its structural theres little the Fed can do. I think the problem is mostly cyclical, but what is the Feds view on this?

Summarizing, look for:

• Whether the Fed sees the recent weakness in the economy as long-term or short-term
• If its long-term and severe, whether the Fed is willing to try QE3
• Whether the Fed views the unemployment problem as mostly cyclical or mostly structural
• How worried the Fed is about inflation
• Signals about when the will Fed will begin reducing the size of its balance sheet
• Signals about when the Fed will begin raising its target interest rate

For now, policy is unlikely to change from its current course. But there may be subtle signals about when policy is likely to change, particularly in the press conference where the message is largely unscripted.