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Charles T. Carlstrom |

Senior Economic Advisor

Charles T. Carlstrom

Charles Carlstrom is an economic advisor in the Research Department of the Federal Reserve Bank of Cleveland. In this role, he conducts research and authors articles on monetary economics and public finance.

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Samuel B. Chapman |

Author

Samuel B. Chapman

Samuel Chapman is a former research analyst in the Research Department of the Federal Reserve Bank of Cleveland.

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12.28.12

Economic Trends

How Long Will QE3 Last?

Charles T. Carlstrom and Samuel Chapman

In September, the Federal Open Market Committee (FOMC), the Federal Reserve’s monetary policymaking body, announced what has widely been referred to as QE3 (quantitative easing 3). QE3 will consist of purchasing additional mortgage-backed securities (MBS) at the rate of $40 billion per month. Unlike previous QEs, this one was described in open-ended terms, such that “if the outlook for the labor market does not improve substantially, the Committee will continue its purchases of agency mortgage-backed securities.”  The Committee did not specify, however, what “substantial improvement” would be.

To get an idea of whether labor market conditions going forward might be getting close to triggering this threshold, we look at how labor market conditions have been evolving, especially since September.

In August the unemployment rate was 8.1 percent. One month later it dropped to 7.8 percent. It now stands at 7.7 percent. While the improvement since August could be interpreted as a sign that the unemployment-rate decline is picking up steam (that is, declining more rapidly), professional forecasters don’t seem to view it that way. Judging by their expectations for the unemployment rate in the next couple of years, they see it as largely a one-time decrease in their forecasted path for unemployment. In September, the median Blue Chip expectation for the unemployment rate at the end of 2013 was 7.8 percent, and in November it was 7.6 percent. This improvement is roughly the same as the decline in the current unemployment rate from September to November. Macroeconomic Advisors’ forecast for the end of 2013 showed a 0.5 percent improvement in the unemployment rate from September to November. But by the end of 2014 the improvement in the forecast was only 0.2 percent.

Blue Chip Unemployment Rate Forecasts

 

April

May

June

July

August

September

October

November

December

2012:Q1

8.3

8.3

8.3

8.3

8.3

8.3

8.3

8.3

8.3

2012:Q2

8.2

8.2

8.2

8.2

8.2

8.2

8.2

8.2

8.2

2012:Q3

8.1

8.1

8.1

8.1

8.2

8.2

8.1

8.1

8.1

2012:Q4

8.0

8.0

8.0

8.1

8.1

8.2

8.1

7.9

7.9

2013:Q1

7.9

7.9

8.0

8.0

8.0

8.1

8.1

7.9

7.9

2013:Q2

7.8

7.8

7.8

7.9

8.0

8.0

8.0

7.8

7.8

2013:Q3

7.7

7.7

7.7

7.8

7.9

7.9

7.9

7.7

7.7

2013:Q4

7.5

7.6

7.6

7.7

7.7

7.8

7.8

7.6

7.6

Source: Blue Chip Consensus.

Unemployment rates are not a complete indicator of labor market conditions. For example, the slight uptick in the unemployment rate from 7.8 percent in September to 7.9 percent in October was largely because the labor force increased. An increase in the labor force can be good news, if (as often is the case in recoveries) the number of discouraged workers decreases as they once again enter the labor force. Discouraged workers are those that drop out of the labor force because they think their job prospects are grim. Since September, the Macroeconomic Advisors’ forecast of labor force participation rates in 2013 has shown moderate improvement. Thus the improvement in labor market conditions as indicated by the unemployment rate is likely understated.

So far, we have focused on changes in the outlook for labor markets since that is what the Committee referred to in its statement. But since current labor market conditions will probably play a role, we also look at changes in nonfarm payroll (employment). The employment figures for 2012 suggest that the labor market has improved substantially since its midyear slump. From May to July employment growth was a very anemic 63,000, but since August it has averaged 152,000. While this growth is certainly encouraging, it should be noted that this pace is consistent with only a very slow decline in the unemployment rate. To put this number in context, if we look at past recoveries, employment growth has averaged around 200,000 per month.

To get a sense of how widespread changes in labor market condition are, the BLS publishes an employment diffusion index. A higher score on the index means the gains or losses are more widely dispersed across industries, and a lower score means they are concentrated in a few growing or shrinking industries. The diffusion indexes for both manufacturing and total private employment have improved in recent months. In August the manufacturing employment diffusion index stood at 43.2, which showed that manufacturing employment was declining (greater than 50 roughly indicates employment growth). In October, it had increased to 56.8, but then it fell to 47.5 in November. The diffusion index for total private employment showed an increase from 52.4 in August to 59.0 in November.

Inflation will also enter into the FOMC’s calculus when it deliberates on the ending of QE3. Since there has been little change in the Blue Chip inflation forecast, changes in labor market conditions will likely dominate discussions of QE3’s continuation.

The outlook for the labor market has certainly improved since September, but it only roughly gets us back to where we were earlier in the year. For example, the Blue Chip unemployment forecast in March was largely the same as it is today. While conditions at that time did not warrant a QE program, that does not mean that QE3 is close to an end. Arguably the improvement in labor market conditions might be because of QE3 and the market’s anticipation that it is probably not going to end imminently. It remains to be seen how much more improvement is necessary before the Committee ends QE3.