–Retransmitting Updated Story Originatlly Published 15:22 ET Oct. 25

By Steven K. Beckner

(MNI) – There is every reason to believe that the Federal Reserve
will inject more monetary stimulus into the economy if it deteriorates,
and quite possibly even if it fails to improve, but it is doubtful
whether Fed policymakers are prepared to take significant additional
steps as soon as next week’s Federal Open Market Committee meeting.

The next most likely action appears to be some refinement of the
FOMC’s communication strategy, but that contentious issue may not be
amenable to resolution next week either.

The FOMC will be undergoing its quarterly exercise of making
three-year and longer-term economic projections. How the economy
performs relative to that revised outlook will go far toward determining
whether and when the Fed’s policymaking body decides to launch a third
round of quantitative easing.

The Fed has already done quite a lot, although some think it could
have done more and others believe it should have done less.

After completing $600 billion of long-term Treasury securities
purchases at the end of June, the FOMC took only a brief hiatus from
easing. Meanwhile, it avoided any passive tightening by reinvesting
principal payments on agency and agency-guaranteed mortgage backed
securities in its portfolio into Treasury securities to prevent
shrinkage of the Fed balance sheet and of bank reserves .

As the recovery proved disappointingly slow after the FOMC
downgraded its forecast in July, the easing process resumed — first via
a communications strategem, then via large-scale asset purchases.

On Aug. 9, the FOMC reaffirmed its zero to 25 basis point target
for the federal funds rate and, instead of saying it expected the rate
to stay “exceptionally low….for an extended period,” it gave new, more
precise “forward guidance.”

The FOMC now said it “currently anticipates that economic
conditions–including low rates of resource utilization and a subdued
outlook for inflation over the medium run–are likely to warrant
exceptionally low levels for the federal funds rate at least through
mid-2013.”

Then, at the end of its Sept. 20-21 meeting, at which it warned of
“significant downside risks,” the FOMC adopted a pair of measures.

First, in lieu of outright “quantitative easing,” in which the Fed
creates new money (or reserves) to buy long-term assets, the FOMC
announced a “maturity extension program,” better known as “operation
twist,” in which the Fed will buy $400 billion of longer term Treasury
securities by the end of June 2012, financed by sales of short-term
Treasuries.

Second, in an effort to boost the moribund housing market, the FOMC
altered its reinvestment policy to use proceeds of maturing securities
to buy MBS instead of Treasuries.

And the FOMC signaled it was prepared to do more at some point,
saying “it will continue to assess the economic outlook in light of
incoming information and is prepared to employ its tools as
appropriate.”

As next week’s meeting approaches, the FOMC confronts a dizzying
economic and financial picture, complicated by the still-unresolved
European debt crisis.

The beige book survey of economic conditions around the nation
prepared for review at the meeting conveyed a dreary picture.

Although “overall economic activity continued to expand,” the
report said “many Districts described the pace of growth as ‘modest’ or
‘slight.” And contacts “generally noted weaker or less certain outlooks
for business conditions.”

The report validated Federal Reserve Chairman Ben Bernanke’s
comment, in Oct. 4 Congressional testimony, that “the recovery is close
to faltering.”

Although the economic data since then have not been uniformly weak,
and although the stock market has rallied considerably since September,
the gloomy mood has persisted. Tuesday, the Conference Board reported an
unexpectedly steep drop in its index of consumer confidence to a
preliminary 39.8 in October — more than 10 points below a year earlier
and the lowest level in two and a half years.

The Richmond Federal Reserve Bank’s manufacturing index registered
its fourth straight month of contraction in October. And the S&P Case
Schiller home price index showed further weakness in wake of last week’s
report that existing home sales fell a greater than expected 3% in
September.

The GDP is widely expected to grow faster in the second half than
in the first half, and to sustain that faster pace in 2012, but few
expect it to much exceed the economy’s estimated “potential” growth pace
of around 2.5%. And so the fear is that non-farm payrolls will not grow
rapidly enough to absorb new entrants into the labor force and bring
unemployment down from 9.1%.

And so the FOMC remains under pressure to do more to spur growth
and job creation. Some of that pressure is self-imposed as policymakers
feel duty bound to fulfill their statutory dual mandate.

Bernanke and others have said monetary policy is not a “panacea,”
and some FOMC voters believe further Fed easing would be ineffective and
could do more harm than good.

Dallas Fed President Richard Fisher, for instance, said last week
that the Fed is “exhausting the limits of prudent monetary policy. The
programs popularly known as QE2 and Operation Twist are, to my way of
thinking, of doubtful efficacy … . Even if you believe … that the
benefits of QE2 and Operation Twist outweigh their costs, you would be
hard-pressed to now say that still more liquidity, or more fuel, is
called for given the $1.5 trillion in excess bank reserves and the
substantial liquid holdings businesses are hoarding above their normal
working-capital needs.”

Fisher said the economy would perform better if “the people we
elect to tax us and spend our money and create the rules and regulations
that govern our economic behavior can get their act together, confront
their own denial of most rudimentary budgetary discipline, learn to
shoot straight and remove the Damocles Sword of uncertainty that they
have for too long wielded over our job-creating private sector.”

Minneapolis Fed President Narayana Kocherlakota said last Friday
that, if anything, the Fed should be tightening, not easing, albeit at a
slower pace than if the economy were growing at a better pace.

However, most policymakers reject the argument that further Fed
easing would not help and believe the Fed is obligated to try to improve
growth and reduce joblessness by its statutory dual mandate to pursue
price stability and maximum employment.

Typifying that view, Fed Governor Daniel Tarullo said last Thursday
that “the absence of such (non-monetary pro-growth) policies cannot be
an excuse for the Federal Reserve to ignore its own statutory mandate.”

“The Federal Reserve Act requires that the FOMC promote the goals
of maximum employment and stable prices,” Tarullo said. “The statute
does not qualify that mandate by saying that we should promote these
goals only if all parts of the government — or, for that matter, the
private sector — are acting just the way we think they should. In other
words, we have to take the world as we find it and adjust our actions
accordingly.”

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