Here’s the Latest Chapter in the Fed Policy Debate

Federal Reserve

“Committee members viewed the information received over the intermeeting period as suggesting that economic activity had expanded at a moderate pace.”

If you’re a regular reader of minutes from Federal Open Market Committee meetings, then this language from the June 18-19 meeting is probably familiar to you. Minus a reference to the end-of-year slowdown in 2012, the statement is effectively the same language that appears in the minutes from the previous meeting in March under the discussion of committee policy action.

In fact, as if on a budget — but more likely recycling language because economic change has been slow during the past few months — much of the description of current conditions was unchanged from the previous minutes. The most recent minutes repeated the same economic mantra as the last: “Labor market conditions showed further improvement in recent months, on balance, but the unemployment rate remained elevated. Household spending and business-fixed investment advanced, and the housing sector strengthened further, but fiscal policy was restraining economic growth.”

More to the point, “The Committee expected that, with appropriate policy accommodation, economic growth would proceed at a moderate pace and result in a gradual decline in the unemployment rate toward levels consistent with its dual mandate.” That is, quantitative easing will continue and rates will remain unchanged for the time being.

The markets knew immediately after the June 18-19 meeting that the Fed was keeping policy unchanged for the time being. The development — and the reason markets went nuts during a post-meeting press conference — had to do with Fed thinking. If purchases aren’t being tapered now, then when? If policy won’t tighten until the economy improves, what’s the benchmark? More than anything, the markets want to know what the Fed is thinking and when it will act.

Answers to these questions exist, but they are more nebulous than most market participants are comfortable with. From the minutes: “Key factors informing participants’ views of the appropriate path for monetary policy included their judgments regarding the values of the unemployment rate and other labor market indicators that would be consistent with maximum employment; the extent to which the economy fell short of maximum employment and the extent to which inflation was running below the Committee’s longer-term objective of 2 percent; and the implications of alternative policy paths for the likely extent of progress, over the medium-term, in returning employment and inflation to mandate-consistent levels.”

So what do Fed policymakers have to say about those metrics? On unemployment, the committee was largely more optimistic in June than in March.

The minutes said: “All of the participants who judged that raising the federal funds rate target would become appropriate in 2015 also projected that the unemployment rate would decline below 6.5 percent during that year and that inflation would remain near or below 2 percent…Three of the four participants who judged that policy firming should begin in 2013 or 2014 indicated that, in their judgment, the Committee would need to act relatively soon in order to keep inflation near the FOMC’s longer-run objective of 2 percent and to keep longer-run inflation expectations well anchored.”

FOMC Unemployment

Source: U.S. Federal Reserve

Inflation expectations have trended slightly lower but remain on track to meet long-term expectations. In his most recent testimony before Congress, Fed Chairman Ben Bernanke warned about incipient deflationary pressures that were driving inflation measures lower. These pressures seem to be apparent in the recent revisions to expectations, but the minutes show that policymakers believe these pressures to be transient.

Core PCE inflation expectations were slightly lower in the short term and slightly higher in the long term. This is likely due to expectations for lower energy prices in the short term.

FOMC Inflation

Source: U.S. Federal Reserve

As far as the timing of policy tightening is concerned, Fed policymakers are mostly all on the same page, and broadly have the same vision for the pace of tightening. It’s also important to point out that purchases will be tapered before rates are changed.

“While recognizing the improvement in a number of indicators of economic activity and labor market conditions since the fall, many members indicated that further improvement in the outlook for the labor market would be required before it would be appropriate to slow the pace of asset purchases,” the minutes read. “Some added that they would, as well, need to see more evidence that the projected acceleration in economic activity would occur, before reducing the pace of asset purchases.”

FOMC Policy

Source: U.S. Federal Reserve

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