This article is a guest contribution by Asha Bangalore, Northern Trust.
The Fed's unscheduled announcement on August 10, 2007 indicating liquidity provisions due to "dislocations in money and credit markets" marked the beginning of the Fed's extraordinary actions to provide support to the global financial system and the U.S. economy as the crisis has unfolded. The policy statement on this 3rd anniversary will also be important for it may contain new directions of Fed policy.
First, the Fed's depiction of the status of the economy will be of interest. The June statement noted that "the economic recovery is proceeding and the labor market is improving gradually." The economy advanced at a 2.4% pace in the second quarter and the pace of economic growth is projected to be noticeably slower in the second half. Labor market conditions have not improved since June. In fact, initial jobless claims have shown sideways movement for the first seven months of the year (see chart 1). Unemployment claims under special programs are currently distorted because of the delay in Congress funding these programs.
The employment report of July cast another big shadow on the labor market. Private sector payrolls posted a paltry gain of 71,000 in July after a downwardly revised gain of 31,000 in the prior month. The jobless rate held steady at 9.5% because of a reduction of the labor force and was not the result of increased hiring. Comparative measures indicate that the current hiring pace is the slowest on record in the early stages of economic recovery.
Second, housing markets conditions have not improved since the June meeting. Sales of existing home declined in June, while that of new homes rose, following large revisions to sales of earlier months. The Mortgage Purchase Index and the Pending Home Sales Index both point to a further weakness in the housing market. Third, bank credit continues to present a challenge, with only a marginal improvement visible in weekly data of bank loans. Monthly estimates for July will be published later in the month. The challenges in the labor, housing, and credit markets still preoccupy the Fed, with the latest reports offering no meaningful progress since the June meeting.
Interest rates have dropped since the June meeting (see chart 4) in anticipation of further support from the Fed given the soft nature of economic reports. 
The Fed is expected to announce an explicit plan to address the probability of further lackluster growth in the economy and growing concern about a deflationary situation developing in the months ahead. One option the Fed could consider is to reinvest prepaid and expired mortgage back securities in Treasury securities. In other words, if the Fed engages in this action, its balance sheet will not shrink.
Alternatively, the Fed could lower the interest rate paid on excess reserves (0.25%) to induce banks to lend and reduce the quantity of excess reserves of $1 trillion (see chart 6).
