As was universally expected, the Federal Reserve Board decided to keep the Fed Funds Rate at the 0 to 0.25% range it has been at since December 2008. At the last meeting (quotes in italics below) they more or less promised to keep it there until the middle of 2013, so this is perhaps the least shocking news anyone has heard all day.
The key issue today (quotes in bold face below) was if the Fed would take additional measures to ease monetary policy and thus stimulate the economy. There were three steps in particular that were widely speculated they might take (in declining order of probability). Below I present the current Fed Statement, and the one From August and in between I intersperse my commentary/translation on a paragraph by paragraph basis.
1) Operation Twist: Keeping the size of the Fed’s (very large) balance sheet the same, but extending the duration of the portfolio. The idea behind doing that is that it would act to lower longer-term interest rates.
2) Stop Paying Interest on Excess Reserves: Frankly, I am at a loss to explain why they still have not done this. The steps that the Fed has taken to ease monetary policy have been relatively ineffective because the money has not made its way out onto Main Street. Instead it has piled up in bank excess reserves at the Fed. The Fed has been paying them 0.25% not to lend. In normal times that in not a very high rate, but now it is almost as much as they can earn on three-year T-notes.
3) QE3: Further expanding its balance sheet by buying more (and longer-dated) bonds in the open market. Since the Fed buys those bonds with money it creates, in effect this is the “printing press option.”
The Fed decided to do step one to the tune of $400 billion. It will be selling securities with maturities of less than 3 years, and buying an equal amount of securities with maturities between six and thirty years. It will do this by June 2012. I suspect the bulk of the buying will be in the six to 10 year area, but that is just a guess.
I have to say that I am disappointed that they did not take step two, as I think it would prove to be much more effective, would save money and would remove, rather than add a distortion to the economy.
"Information received since the Federal Open Market Committee met in August indicates that economic growth remains slow. Recent indicators point to continuing weakness in overall labor market conditions, and the unemployment rate remains elevated. Household spending has been increasing at only a modest pace in recent months despite some recovery in sales of motor vehicles as supply-chain disruptions eased. Investment in nonresidential structures is still weak, and the housing sector remains depressed.
"However, business investment in equipment and software continues to expand. Inflation appears to have moderated since earlier in the year as prices of energy and some commodities have declined from their peaks. Longer-term inflation expectations have remained stable."
"Information received since the Federal Open Market Committee met in June indicates that economic growth so far this year has been considerably slower than the Committee had expected. Indicators suggest a deterioration in overall labor market conditions in recent months, and the unemployment rate has moved up. Household spending has flattened out, investment in nonresidential structures is still weak, and the housing sector remains depressed.
"However, business investment in equipment and software continues to expand. Temporary factors, including the damping effect of higher food and energy prices on consumer purchasing power and spending as well as supply chain disruptions associated with the tragic events in Japan, appear to account for only some of the recent weakness in economic activity. Inflation picked up earlier in the year, mainly reflecting higher prices for some commodities and imported goods, as well as the supply chain disruptions.
"More recently, inflation has moderated as prices of energy and some commodities have declined from their earlier peaks. Longer-term inflation expectations have remained stable."
Its assessment of economic conditions did not change that much. It referred to growth as "slow," rather than put it in the context of being lower than they expected. That just sort of means they had lowered their expectations, not any real change in the economy.
On unemployment there was a subtle change, as they appear to be talking more about the level this time, rather than the direction as they did last time. They give a shout-out to the recovery in the auto sector from the Japan disaster as actually happening, rather than as something that will happen in the near future. Despite that recovery, consumers continue to sit on their wallets.
Construction — both residential and non-residential — remains very weak, but businesses continue to spend on equipment and software. They do not see inflation as being a big problem, now or in the near future.
"Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. The Committee continues to expect some pickup in the pace of recovery over coming quarters but anticipates that the unemployment rate will decline only gradually toward levels that the Committee judges to be consistent with its dual mandate.
"Moreover, there are significant downside risks to the economic outlook, including strains in global financial markets. The Committee also anticipates that inflation will settle, over coming quarters, at levels at or below those consistent with the Committee’s dual mandate as the effects of past energy and other commodity price increases dissipate further. However, the Committee will continue to pay close attention to the evolution of inflation and inflation expectations."
"Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. The Committee now expects a somewhat slower pace of recovery over coming quarters than it did at the time of the previous meeting and anticipates that the unemployment rate will decline only gradually toward levels that the Committee judges to be consistent with its dual mandate.
"Moreover, downside risks to the economic outlook have increased. The Committee also anticipates that inflation will settle, over coming quarters, at levels at or below those consistent with the Committee’s dual mandate as the effects of past energy and other commodity price increases dissipate further. However, the Committee will continue to pay close attention to the evolution of inflation and inflation expectations."
The first sentence is the same. My assessment of how well they are achieving those two goals also remains the same. They get an A for the price stability side, and an F on the maximum employment side. (Well, perhaps a D to account for the fact that they are trying hard — harder than the rest of the policy makers.)
Keep in mind that “some pick up in the pace of recovery” is coming from a point where the economy is near a full stop to begin with. If the economy were to grow at 0.8% in the second half, it would represent “some pick up" from the 0.7% pace in the first half, but it would not represent the economy getting back to anything close to its potential output.
Unemployment is going to remain a big problem for a long time. While on one level that is no change, for those out of work, it will mean they are out of work for longer and longer and thus they get poorer and poorer and they become less and less employable. For them, no change means that things continue to get worse — much worse.
"To support a stronger economic recovery and to help ensure that inflation, over time, is at levels consistent with the dual mandate, the Committee decided today to extend the average maturity of its holdings of securities. The Committee intends to purchase, by the end of June 2012, $400 billion of Treasury securities with remaining maturities of 6 years to 30 years and to sell an equal amount of Treasury securities with remaining maturities of 3 years or less.
"This program should put downward pressure on longer-term interest rates and help make broader financial conditions more accommodative. The Committee will regularly review the size and composition of its securities holdings and is prepared to adjust those holdings as appropriate."
This is the big news of the day — Operation Twist is underway. This is the first time that the Fed has done something like this since the early 1960’s, back when people were still listening to Chubby Checker and doing the Twist. I don’t think it will be as successful as Operation Overlord (D-Day), but neither will it be a disaster like Operation Marketgarden (the Battle of Arnhem/Nijmegen — read or watch “A Bridge Too Far” sometime).
At most, it is likely to have a small positive effect in bringing down long-term interest rates, but they are already at rock-bottom levels. Even if they are wildly successful in bringing down long-term interest rates, I don’t think it would really translate into a lot more economic activity.
It is not the price of credit that is the problem in this economy. Availability — particularly for individuals and small businesses — is a bigger issue, but even there it is not the central problem. We simply don’t have enough aggregate demand in the economy. Fiscal stimulus would be much more effective in addressing that problem than monetary stimulus.
"To help support conditions in mortgage markets, the Committee will now reinvest principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities. In addition, the Committee will maintain its existing policy of rolling over maturing Treasury securities at auction."
This will keep the composition of the balance sheet the same, previously it was gradually shifting out of agency paper and into treasuries. The agency (Fannie/Freddie) paper was acquired in the first round of quantitative easing. Previously, as it rolled off or was paid off, they reinvested the proceeds in treasuries.
Given the amounts involved, the shift was going to be gradual in any case, but now that process has stopped for the time being. I don’t think this is going to have a major effect on the mortgage market, which like the treasury market currently has extremely low interest rates as it is.
"The Committee also decided to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that economic conditions–including low rates of resource utilization and a subdued outlook for inflation over the medium run–are likely to warrant exceptionally low levels for the federal funds rate at least through mid-2013."
"To promote the ongoing economic recovery and to help ensure that inflation, over time, is at levels consistent with its mandate, the Committee decided today to keep the target range for the federal funds rate at 0 to 1/4 percent. The Committee currently anticipates that economic conditions — including low rates of resource utilization and a subdued outlook for inflation over the medium run — are likely to warrant exceptionally low levels for the federal funds rate at least through mid-2013.
"The Committee also will maintain its existing policy of reinvesting principal payments from its securities holdings. The Committee will regularly review the size and composition of its securities holdings and is prepared to adjust those holdings as appropriate."
Last time they promised to keep the fed funds rate at its current rock-bottom level through the middle of 2013. So far they are keeping their promise, to nobody’s surprise.
"The Committee discussed the range of policy tools available to promote a stronger economic recovery in a context of price stability. It will continue to assess the economic outlook in light of incoming information and is prepared to employ its tools as appropriate."
"The Committee discussed the range of policy tools available to promote a stronger economic recovery in a context of price stability. It will continue to assess the economic outlook in light of incoming information and is prepared to employ these tools as appropriate."
Given the minutes of the last meeting, this “discussion” was probably somewhere between the “discussion” a Yankee fan would have with a Red Sox fan about the relative ball-playing abilities of Derek Jeter and David Ortiz.
"Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; Elizabeth A. Duke; Charles L. Evans; Sarah Bloom Raskin; Daniel K. Tarullo; and Janet L. Yellen. Voting against the action were Richard W. Fisher, Narayana Kocherlakota, and Charles I. Plosser, who did not support additional policy accommodation at this time."
"Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; Elizabeth A. Duke; Charles L. Evans; Sarah Bloom Raskin; Daniel K. Tarullo; and Janet L. Yellen. Voting against the action were: Richard W. Fisher, Narayana Kocherlakota, and Charles I. Plosser, who would have preferred to continue to describe economic conditions as likely to warrant exceptionally low levels for the federal funds rate for an extended period."
Three dissents is extremely unusual, and we see them for the second meeting in a row. Proof that the discussion resolved about as much as the discussion between those Yankee and Red Sox fans.
The Fed is deeply divided. I come down strongly in favor of those who supported this move, but I would have been inclined to do more (as Charles Evans has indicated he wants to do). Operation Twist is fine with me, but I think it will have relatively little impact on the economy (though it will be good for those who are holding longer-term T-notes).
Step two above — stopping paying banks not to lend — would have been at the top of my list. I would have seriously considered QE3, and I hope that is has only been postponed, not ruled out. Inflation is not a big problem now, and it is not likely to be one any time soon, so stop worrying about that boogeyman.
Unemployment is a real and present crisis. The Fed should do its job, and do everything in its power to bring it down. I will grant you its powers are limited, and fiscal policy is a much better tool. Passage of the AJA would do much more to bring down unemployment and spur economic growth than would an additional $750 billion or so of Quantitative easing. However, that is still no excuse for not doing anything, which seems to be the position of the dissenters.
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