Why the Fed may do more stimulus, in one chart

June 19, 2012

On Tuesday and Wednesday, Federal Reserve officials meet to discuss the state of the U.S. economy. The crucial question is whether the recovery has crumbled to the point that it needs more monetary stimulus. And the answer to that may depend on whether Fed officials expect more halfway-decent jobs reports like March’s — or more dismal job reports like May’s.


Credit: Alex Brandon, AP

The chart below, created bythe Council on Foreign Relations, shows this nicely. Back in April, at its last meeting, the Fed Open Market Committee said it expected employment to “decline gradually towards levels that it judges to be consistent with its dual mandate” — down to 7.8 percent by November. But those projections came shortly after a March jobs report in which the U.S. economy added 159,000 jobs.

The jobs report in May was much, much worse, showing just 69,000 new jobs. If the labor market keeps adding jobs at that rate, then unemployment will remain much higher than even the Fed’s worst-case unemployment projections for years to come. That will put pressure on the central bank for more stimulus.

Of course, there's more than the unemployment rate to consider. Jobless claims have been ticking upward of late. Retail and manufacturing is weakening. The housing market is still flailing along. Plus, Fed officials will have to consider whether Europe still poses a threat to the U.S. recovery. But the above graph lays the choice out starkly. If the rough patch in May wasn't just a blip, then the Fed will be failing to achieve its own stated goals for unemployment.

So what could the Federal Reserve do to bolster the economy? Fed Watch's Tim Duy lays out some of the most likely options here. The central bank could continue Operation Twist, in which it sells short-term securities and buys long-term bonds in order to lower interest rates and try to boost borrowing and spending. (Though Duy thinks there's only so much room to maneuver here.) Or the Fed could take more drastic steps, like buying up new assets--like mortgage securities--in order to try to bolster the housing market.

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