Many economists and investors think there's a good chance that at the end of their two-day meeting that begins Tuesday, Fed policymakers will announce they'll begin reducing their $85 billion dollar monthly stimulus, their third round of quantitative easing or QE3.
The analysts think recent economic data, like a drop in the unemployment rate to 7 percent and a budget deal in Washington, have brightened the outlook for the economy enough that the Fed can pull back.
But there's another troubling number that could make Fed policymakers stand pat, says University of Chicago professor and former Fed governor Randy Kroszner. That number is the inflation rate.
"The inflation being far below where the Fed wants it to be is a major reason why they may hesitate," Kroszner says.
Princeton economist Alan Blinder points out that, strangely, during a period when the Fed has pumped trillions into the financial system, inflation has drifted lower.
"Inflation has in fact fallen on average over the last five years," Blinder says.
The most recent measurement shows that core inflation in a basket of consumer goods through the twelve months ending in October was running at just 1.7 percent. That's below the Fed's target of 2.0 percent, and it's been drifting downward this year.
Blinder, a former vice-chairman of the Fed, says this falling inflation is an extraordinary development given the trillions the Fed has pumped into the financial system. Economics textbooks say that's a recipe for inflation.
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So what happened to that $85 billion a month — a trillion dollars total — that the Fed has pumped into the financial system over the past year?
"It all of it got bottled up in the banks and essentially none of it ... got lent out," Blinder says.
Blinder says that the banks are the key to making quantitative easing work. It would work by the Fed announcing it wants to buy $85 billion each month in government bonds and mortgage-backed securities. Blinder says banks would then line up to sell them, and the Fed pays the banks by putting money in their reserve accounts at the Federal Reserve.
"You can think of these as the deposits that banks hold at the Federal Reserve, which is a bank for them," he says.
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