The Fed Keeps Slouching Toward Oblivion

But don't worry. If things get worse, it will try to do its job. Kind of. Maybe.

(Reuters)

It's a summer sequel so bad even Michael Bay couldn't dream it up. For the third straight year, a strong winter has given way to, well, bleh. Job growth stalled to just 69,000 in May. That's not a recovery worthy of the name.

It's time for the Fed to do more, right? Yes. The Fed projects inflation to stay too low and unemployment too high for years. It's a situation that screams for Fed easing. But the Fed isn't easing. It's playing a game of wait-and-see.

Even the big news at the Fed's latest meeting wasn't really new. The big news was that the Fed

will extend "Operation Twist" -- which was set to expire -- through the end of the year. In plain English, the Fed will keep selling short-term bonds, and using that money to buy long-term bonds. It's a way to push down long-term interest rates without printing money. But that was it. There wasn't any more bond-buying. Nor did the Fed say that it expects to keep rates low for longer. It was a status quo meeting when the status quo is not good.

Markets noticed. The chart below from Bloomberg shows how Bernanke's favored metric, 5-year breakevens, reacted today. Breakevens give us a decent idea of how much inflation expect -- in this case, five years from now. When easing works, breakevens rise. When it doesn't, they don't. Let's look at what happened today -- keeping in mind that breakevens can act funky because the inflation-protected bonds they're derived from are terribly illiquid.

Breakevens shot up right before the Fed's announcement on hopes that Bernanke & Co. would unleash a new round of bond-buying -- so-called QE3. Breakevens subsequently collapsed when that didn't happen. Then they shot up again, thanks to the silliest story in at least a day. Angela Merkel said she might be open to something that is a matter of public record, which wouldn't do anything to solve the euro crisis. Markets rejoiced. Then they realized it was meaningless. Breakevens subsequently collapsed, again. They finished down on the day.

That's not a passing grade for today. Next month might be better. Bernanke said several times that the Fed wants to see more data before it decides whether or not to do more. It's a question of whether the economy is weak because it's weak or because a warm winter drew economic activity forward. In what counts as forceful language for Fedspeak, the committee did say that they were prepared to take further action -- which was new this month -- if weakness persists. As Justin Wolfers put it, QE3 might be one bad jobs report away.

That will be one bad jobs report too late. We've already had a string of bad ones. More than enough to justify further Fed accommodation. Just ask the Fed. The table below show the central bank's projections for key economic variables through 2014. Notice that the Fed thinks everything is worse than it did in April.

If the economy is worse and the Fed does nothing new, that's a "passive tightening" of monetary policy. Doing nothing is doing something. Something sad, as Tim Duy puts it.

But that's not even the most depressing part about these projections. No, that would be what the Fed thinks will happen with inflation. Remember, the Fed has a dual mandate of low inflation and low unemployment. It's supposed to care about each equally. What does this mean exactly? The "low inflation" half of the dual mandate is defined is long-term 2 percent inflation -- and it's that "long-term" bit that gives the Fed some wiggle room. Greg Ip of The Economist has laid out a very sensible way this would work. If unemployment is high, like it is now, the Fed could briefly stray above its 2 percent target. In other words, the Fed's inflation target must be symmetrical: It has to be just as willing to overshoot as undershoot it.

The Fed is not telling us it has a symmetrical inflation target. The Fed is telling us it has an inflation ceiling. Look at the inflation projections again. None of them go above 2.0 percent. That's a catastrophe. It puts a speed limit on the recovery. If the economy does pick up, and inflation creeps above 2 percent, the Fed is signaling that they may very well raise rates -- even if unemployment is still high. Now, Bernanke has explicitly said that they wouldn't do this ... but the table above tells a different story.

Even if the Fed does more soon, this kind of policymaking will hold the economy back. With millions still unemployed three years on from the end of the Great Recession, it's simply not good enough. This isn't the recovery, or the Fed, we need.