To QEfinity and Beyond? Nope

Waiting for QE3? You'd have better luck with Godot.

If past performance is any guide to future policy, the Fed won't expand its balance sheet any further unless inflation falls significantly. The below chart compares changes in the size of the Fed's balance sheet (blue) versus core inflation (red) since the start of the Great Recession.


FedBalanceSheet.pngThe basic story is that the Fed has only acted when inflation falls below its comfort level. The first instance came in early 2009 -- back when the idea that the world as we knew it was ending didn't seem like such crazy talk. Core inflation was faling sharply, and markets expected outright deflation as a very real possibility.* The Fed responded with QE1. It wasn't until core inflation subsequently fell to around a half of a percent in late 2010 that the Fed embarked on QE2. 

With core inflation currently hovering above 2 percent, QE3 is off the agenda -- for now. Actually, we don't even need to extrapolate from the past to know that. The Fed has told us this. Here's the relevant passage from its most recent minutes.

A couple of members indicated that the initiation of additional stimulus could become necessary if the economy lost momentum or if inflation seemed likely to remain below its mandate-consistent rate of 2 percent over the medium run.

There it is. If you want to know if and when QE3 is coming, just look at core inflation. If it settles below 1 percent, the Fed will consider additional asset purchases. If it doesn't, the Fed won't. At most, the Fed will continue to try to talk down long-term rates by promising to keep short-term rates low for an extended period. That matters, but it's not what markets are looking for now. But they should stop looking. Godot isn't coming.

___________________________

*So-called break-evens can be a less than reliable guide to inflation expectations because Treasury Inflation-Protected Securities (TIPS) are much less liquid than their nominal cousins.

    >

    Presented by

    Matthew O'Brien

    Matthew O'Brien is a former senior associate editor at The Atlantic.

    Google Street View, Transformed Into a Tiny Planet

    A 360-degree tour of our world, made entirely from Google's panoramas

    Join the Discussion

    After you comment, click Post. If you’re not already logged in you will be asked to log in or register.

    blog comments powered by Disqus

    Video

    Google Street View, Transformed Into a Tiny Planet

    A 360-degree tour of our world, made entirely from Google's panoramas

    Video

    The 86-Year-Old Farmer Who Won't Quit

    A filmmaker returns to his hometown to profile the patriarch of a family farm

    Video

    Riding Unicycles in a Cave

    "If you fall down and break your leg, there's no way out."

    Video

    Carrot: A Pitch-Perfect Satire of Tech

    "It's not just a vegetable. It's what a vegetable should be."

    Video

    The Benefits of Living Alone on a Mountain

    "You really have to love solitary time by yourself."

    More in Business

    Just In