Call it Fed fatigue.
After three years of aggressive monetary easing and unprecedented action to prop up the financial system, the U.S. economy is beginning to show some scattered signs of improvement, and the Federal Reserve decided to take it easy, at least for this meeting.
"Monetary policy has its limits, and the Fed may be close to what they can do at this point," says Andrew Busch, global currency and public policy strategist at BMO Capital.
With its key federal funds rate firmly planted near zero and billions of its dollars tied up in Operation Twist, an effort to decrease long-term interest rates by selling short-term securities and buying longer-term ones, it's not surprising the Federal Reserve's Open Market Committee passed on undertaking any big new initiatives today, Busch says.
"They probably need to sit back for a while and assess, be prepared to engage in more quantitative easing, because it's one of the last things that they can do, given the situation in Europe," he says.
The relatively positive economic data coming out lately probably played a role in the FOMC's decision to keep things quiet, Busch says.
"I think they have to be relatively happy on what's going on in the economy," Busch says. "The numbers that have been coming out have been much better than expected."
The unemployment rate and new unemployment claims are dropping, retail sales are holding up well and manufacturing is picking up, hinting at broader growth in the U.S. economy.
"We could see a GDP (gross domestic product) number above 3 percent or maybe even 3.5 percent for the fourth quarter," he says.
The FOMC statement seems to reflect some of this good news: "Information received since the Federal Open Market Committee met in November suggests that the economy has been expanding moderately, notwithstanding some apparent slowing in global growth."
You can be sure the FOMC members are keeping a close eye on the debt crisis in Europe and are ready to act if need be, says Karen Dynan, vice president and co-director of economic studies at The Brookings Institution.
"The situation in Europe represents perhaps the most major risk to the U.S. economy right now," Dynan says. "If there were a major meltdown, there is a good deal of potential for it to spill over into our financial markets and cause lending conditions to seize up."
The FOMC's statement acknowledges this: "Strains in global financial markets continue to pose significant downside risks to the economic outlook."
The Fed has already taken some action to address the eurozone's problems, including cutting the rate at which it lends dollars to central banks in foreign countries, Busch says.
There's also risk stemming from the gridlock in Washington, D.C. The Fed has to be particularly concerned about the looming expiration date of the payroll tax credit, Dynan says. If lawmakers can't agree on a deal to extend the credit, it will take billions of dollars out of the pockets of consumers and undercut some of the last months' progress on consumer confidence and spending, she says.
Fed works its communication skills
But just because the Fed didn't make any big policy splash doesn't mean the FOMC spent the day twiddling its thumbs, Dynan says. Lately the committee has been concentrating on one of Ben Bernanke's signature initiatives: improving the way the Fed communicates with global markets.
"They're definitely working on their communications strategy," Dynan says. "The whole goal here is to make sure they are being as transparent as possible and when they make a move, they don't surprise markets."
One example of the new transparency has been the Fed's unprecedented pledge to keep the key federal funds rate near zero through mid-2013, says Ricardo Reis, professor of economics at Columbia University.
"The Fed has committed to keep interest rates at zero for a long period of time so as to provide an assurance to investors that interest rates are not just low in the next few months but are going to be low a year ahead of us," Reis says.
Of the additional transparency initiatives under consideration, perhaps the most significant is the idea of setting an explicit target rate for inflation, Reis says. While the FOMC has hinted at wanting to keep inflation at 2 percent, it's considering making that pledge explicit and committing to hitting that target by either monetary easing or tightening, he says.
"It would be an extra weapon in that the Fed, beyond doing programs, beyond announcing a path for interest rates, would now be announcing a path for the inflation rate and would be able to transmit, in an increasingly credible way, its commitment to monetary stimulus," Reis says.
While the Fed didn't take that step today, it's likely the minutes from the FOMC meeting will show continued discussion of inflation targets and other communication methods to encourage growth and smooth out market volatility.