UPDATE: Stocks soared late in the session, and 10-year Treasuries continued to go down. So the two-day total for the “effect” of S&P’s downgrade is: less than 1% loss in the Dow, and US debt yields crashing. They’re geniuses! Meanwhile, the economy still sucks and the Fed refuses to do anything about it.

Why did the Dow swing 400 points (it’s since bounced back and even gained; you cannot read the market as in any way rational) after the Federal Reserve Board released its formal statement from today’s 1-day meeting? I had not fully understood that the markets were begging the Fed to announce more monetary easing today. In fact, stocks in Europe rose on the expectation. But the Fed disappointed again.

Let’s take a look at their statement. They start by saying that “economic growth so far this year has been considerably slower than the Committee had expected.” They cite a “deterioration in overall labor market conditions in recent months,” add that “household spending has flattened out, investment in nonresidential structures is still weak, and the housing sector remains depressed.” They agree that some temporary factors caused this slowdown, such as the supply chain disruptions from the Japan earthquake, and rising food and fuel prices, which have since declined. But they say that the temporary factors cannot account for everything. What’s more, they acknowledge that inflation, which would be their constraint against monetary easing, has “moderated as prices of energy and some commodities have declined.”

They conclude that recovery will be slow, that the unemployment rate will not decline significantly, that “downside risks to the economic outlook have increased,” and that inflation will “settle … at levels at or below those consistent with the Committee’s dual mandate.”

And then… nothing. The policy prescription for this horrific outlook, with slow growth, inflation below target, and unacceptably high unemployment, is to keep the federal funds rate at the same price, “at least through mid-2013,” and reinvesting principal payments on its securities. In other words, nothing new from what it’s doing today. They “discussed the range of policy tools available to promote a stronger economic recovery in a context of price stability,” and will look in the future to perhaps employ those tools. But they’re doing nothing right now. And this got a 7-3 vote on the committee, with the three dissenters not wanting to name mid-2013 as a target for the federal funds rate.

As Matt Yglesias writes, this is a misfire.

Ask yourself what would happen on opposite planet. Suppose that growth were stronger than expected, and that inflation, after looking low, popped back up. What would the Fed do? Obviously, they would change the stance of policy to head inflation off at the pass. But with growth weakening and inflation moderating, they stand pat. Why?

Just as you go to war on fiscal policy and executive action with the Administration you have, you go to monetary policy war with this Fed. I don’t think all the monetary tools would do much good, but there are some creative solutions out there. But Ben Bernanke and his crew seems unwilling to employ them.

Mind you, there are still two empty slots on the Fed board of governors, and the Obama Administration could, you know, actually try and fill them, Peter Diamond’s failure notwithstanding. But it’s not totally clear how much that would help.

David Dayen

David Dayen

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