Dissent Won’t Stop QE2 From Being Completed

By Michael S. Derby

Meeting minutes from the Federal Reserve’s late January policy meeting indicate the central bank’s bond-buying program will almost certainly run its full course.

To be sure, the minutes show the central bank’s policy making arm riven by more dissent over the $600 billion program than is typical for the Federal Open Market Committee. The document showed “a few” officials questioning both the prudence and economic impact of continuing forward with the effort to buy longer-dated Treasurys. Meanwhile, there was also a constituency who would like to stop or reduce the buying should a “sufficiently strong” recovery take shape.

The generalized language typical of meeting minutes assigns view points to “all,” “some,” “few” and “others,” preventing Fed watchers from getting a firm handle how many policymakers cotton to any given position. But in the current episode the battle lines were already well drawn, allowing observers to have a pretty strong idea just who these prospective dissidents are. (See a breakdown of the 2011 voters here, courtesy of DJ FX Trader)

Over recent weeks Dallas Fed President Richard Fisher and Philadelphia Fed leader Charles Plosser have expressed discomfort with the program popularly referred to as QE2. But they’ve also suggested they’ll refrain from formal opposition as long at the effort ends in June, as planned.

Whether the two men have stealth fellow travelers is unclear. A number of governors are more focused on regulatory issues and haven’t made their economic views widely known. That said, these type of governors–Daniel Tarullo, Elizabeth Duke, Sarah Bloom Raskin–have been historically the least likely to rock the monetary policy boat.

The discord portrayed by the minutes points obscures the fact there’s almost no chance the economy could suddenly gin up enough growth to get the program stopped by mid-year. Indeed, the “few” members arguing for a potential early stop were countered by “others,” who in the minutes “pointed out that it was unlikely that the outlook would change by enough to substantiate any adjustments to the program before its completion.”

The Fed’s central worry is that unemployment rates are too high, and inflation is too low. Most agree that for the unemployment rate to fall the economy will have to grow well above its trend rate of around 2.5% to 3% to make that happen.

FOMC voter and Chicago Fed President Charles Evans has noted a 4% growth rate would not bring the jobless rate down much this year. Fed chief Ben Bernanke told Congress last week that an “ambitious” 4.5% growth rate, if sustained, would bring what is currently a 9% unemployment rate back down to around 6% in three to four years, a painfully long time.

The Fed itself expects the economy to grow by 3.4% to 3.9% this year, by 3.5% to 4.4% next year and by 3.7% to 4.6% in 2013. They see the unemployment rate moving to between 7.6% to 8.1% next year, which would still represent historically high levels of joblessness. Put another way, the economy would have to see a huge surge in growth to make big headway in clearing the ranks of the jobless.

“QE2 will be completed,” said Pierpont Securities Chief Economist Stephen Stanley, even as he personally doesn’t see much value in the effort. “The doves in charge are quite unlikely to relent before June.”

Some see dissidents influencing the pace of the program. Dana Saporta of Credit Suisse expects the program to be tapered off. She says “there is precedent for such a strategy, as this is how the FOMC eventually concluded its original $1.725 billion purchase program of Treasuries, agency debt and [mortgage securities].”

The primary uncertainty in the outlook is inflation. The Fed expects it to stay very low for years to come. But surging commodity prices may be a threat to this outlook, and if they were to start infecting the core price measures most closely watched by the Fed, it could be a game changer. That said, the time frame it would take for that to happen would not have much bearing on QE2–it would instead be an issue for longer-run monetary policy conduct.