This morning’s alarming jobs report is the latest in a long line of worrying indicators about the economy. The Federal Reserve reacted to last month’s negative indicators by announcing that they would keep short-term interest rates near zero through 2013. The unemployment report, which is probably the most important indicator, could spur the Federal Open Markets Committee to take even more drastic action when it meets for an unprecedented two-day session on the 20th and 21st of this month. In his Jackson Hole speech, Ben Bernanke said that the point of the two-day meeting was to “to allow a fuller discussion,” but it could also be to convince the unwilling members of the committee to embrace new measures for stimulating the economy.
Before looking at what those actions may be, it’s worth noting that the term “quantitative easing” has lost some of its usefulness. Before people became aware of what would ultimately be known as QE2, “quantitative easing” had a specific, technical meaning: usually the Fed targets the Federal Funds Rate as its policy instrument, meaning that it announces what the rate should be, and then purchases or sells as many short-term bonds as it needs in order for the market to settle on that rate (usually those purchases/sales are relatively small). Quantitative easing, on the other hands, means that the Fed targets a dollar number of securities as its policy instrument — hence quantitative — instead of a rate, and allows the market to determine the rate. With QE2, for example, the Fed announced that it would purchase $600 billion of longer-term securities, without specifying what the interest rates on long-term bonds should be.
Nowadays, however, quantiative easing is taken to mean “accommodative actions by the Fed.” While it’s been reported that the Fed may try a QE3, the reality is that quantative easing is only one of the options the members of the FOMC are considering. We can see what options they’re weighing from the minutes of their last meeting, when they discussed what they might do if the economy takes a turn for the worse:
Some participants noted that additional asset purchases could be used to provide more accommodation by lowering longer-term interest rates. Others suggested that increasing the average maturity of the System’s portfolio–perhaps by selling securities with relatively short remaining maturities and purchasing securities with relatively long remaining maturities–could have a similar effect on longer-term interest rates. Such an approach would not boost the size of the Federal Reserve’s balance sheet and the quantity of reserve balances. A few participants noted that a reduction in the interest rate paid on excess reserve balances could also be helpful in easing financial conditions.
In other words, it’s very possibly that we’ll see one of three things on the 21st: more bond-buying, a shift from short-term to long-term bond purchases, or a decrease on the rate paid on excess reserves held at the Fed. Either way, it’ll be called QE3.