Comerica Economic Weekly

A lot happened this week. Most significantly, on Wednesday the Federal Reserve took several major steps. As expected, it announced that Operation Twist ends this month. The Fed will now add T-bonds to its program of outright bond purchases known as QE3. QE3 was launched in October as a program of purchases of $40 billion per month of agency mortgage-backed securities. In addition to the agency MBS purchases, the Fed will now add $45 billion of longer-term Treasury bond purchases. This may increase inflation expectations and the Fed does allow for at least a little of that. The Fed has announced a tolerance for higher near-term inflation expectations, up to 2.5 percent. QE3 will remain in place until the Fed thinks that economic conditions have improved enough. There is no specific unemployment rate target for QE3. However, the Fed has announced an unemployment rate target for the fed funds rate. Previously, the Fed had pledged to keep the fed funds rate near zero through mid-2015. Now that deadline has been replaced by an economic target, namely, an unemployment rate of 6.5 percent. This action ties monetary policy more directly to the outcome of the fiscal policy debate about the Fiscal Cliff. In the absence of an agreement to roll back the Fiscal Cliff, the unemployment rate can be expected to stall or even increase through 2013, thus pushing back the timeline for the eventual increase in the fed funds rate. The U.S. international trade gap widened slightly in October, about as expected to -$42.2 billion. Trade is not expected to be a major factor in fourth quarter GDP growth. The National Federation of Independent Businesses’ Small Business Optimism Index fell sharply in November, down 5.6 points, described as “one of the largest declines in survey history.” Two events pushed the index down: one was Hurricane Sandy, and the other was the election. Retail sales for November increased by 0.3 percent with help from a rebound in auto sales as storm-damaged vehicles were replaced. The producer price index for finished goods fell by 0.8 percent in November, largely reflecting a drop in energy prices. The consumer price index for November declined by 0.3 percent. Initial claims for unemployment insurance fell by 29,000 for the week ending December 8 to hit 343,000, nearly matching the pre-Sandy low of 342,000 for early October. U.S. industrial production increased by 1.1 percent in November, as industries washed out by Hurricane Sandy in late October got back to work.

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