Since the last Federal Open Market Committee (FOMC) meeting at the end of September, there have been further clear indications that the U.S. economy has gradually begun to recover from its worst postwar economic recession. There have also been encouraging signs that the U.S. financial system is continuing to heal. At its forthcoming meeting on November 3 and 4, the FOMC will take note of these developments. However, the FOMC can be expected to maintain the view that the economic recovery is likely to be weak in the quarters immediately ahead. The FOMC can also be expected to underscore the particularly weak state of the U.S. labor market, as reflected in an overall unemployment rate close to 10 percent. The FOMC will consider this weakness highly likely to restrain wage income growth and household consumption in the period ahead.

The FOMC will likely to reiterate its view that the large gaps presently characterizing the U.S. labor and product markets will keep inflation well-contained. However, the FOMC can be expected to express concern about the potential inflationary impact of the ongoing weakening in the U.S. dollar as well as the recent sharp increases in international oil and commodity prices.

The FOMC will likely see little reason to change its monetary policy stance since economic developments have stood  very much in line with the Fed’s expectations. Accordingly, the FOMC can be expected to repeat the view that weak economic conditions will likely warrant the maintenance of exceptionally low levels of the federal funds rate for an extended period. The Fed will also likely see little reason to change its announced program of Treasury and agency mortgage-backed securities purchases.

The one policy area where one might expect a change in nuance relates to the Fed’s exit strategy from this period of unprecedented monetary policy accommodation. In the context of the ongoing weakening in the U.S. dollar, the FOMC might be expected to connote its preparedness to start its exit strategy at the first sign of the economic recovery gaining traction.

Among the economic policy indicators on which the FOMC will focus are the following:

(a)    Clear signs that the U.S. recession has finally ended as suggested by the 3.5 percent GDP expansion in the third quarter of 2009.

(b)    Troubling signs that companies are still shedding workers and that unemployment is now heading for double digits.

(c)    Disturbing indications that involuntary part-time work has increased at the fastest pace in the postwar period and has now boosted unemployment including involuntary part-time workers to 16.5 percent of the labor force.

(d)    Tentative signs that consumer confidence is stabilizing, albeit at low levels.

(e)    Indications from retail sales numbers that household consumption remains weak.

(f)    Signs that the U.S. housing market has at last started to stabilize.

(g)    Troubling signs that the commercial property market bust continues apace.

(h)    Further indications that financial markets are healing as reflected in lower credit-market spreads.

(i)    Troubling signs that the U.S. dollar is under significant pressure.

(j)    Disturbing signs that international commodity prices including oil are again on the rise.

Desmond Lachman is a resident fellow at the American Enterprise Institute. Lachman joined AEI after serving as a managing director and chief emerging market economic strategist at Salomon Smith Barney.

FURTHER READING: Lachman also wrote “The Next Economic Shoes to Drop” on what further strains on the financial system to expect in 2009, and “Don’t Repeat Japan’s Mistakes” on the Japanese authorities’ mishandling of their own financial crisis during the early 1990s. Go here to see Lachman’s presentation on the housing market bottom.

Image by Darren Wamboldt/Bergman Group.