The Fed just finished its meeting, and here is its current policy statement, along with its previous statement (from June 22, 2011). I present the two statements on a paragraph by paragraph basis, and then intersperse my translation/commentary.
As was universally expected, there was no change in the 0 to 0.25% Fed Funds rate. QE2 is over, and despite the bad economic data and receding inflation threats, Fed Chair Ben Bernanke gave no indication that they would move on to a third round of large scale asset purchases, or QE3. However, proceeds from maturing securities will be reinvested, keeping the size of the Fed’s balance sheet unchanged.
The one significant change is that they defined “an extended period of time" as through the middle of 2013. That helps at the margin, but only very slightly. An even easier monetary policy would help at this point, but not as much as an easier fiscal policy. But it looks like we are getting no help from either side.
"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."
"Information received since the Federal Open Market Committee met in April indicates that the economic recovery is continuing at a moderate pace, though somewhat more slowly than the Committee had expected. Also, recent labor market indicators have been weaker than anticipated.
"The slower pace of the recovery reflects in part factors that are likely to be temporary, 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.
"Household spending and business investment in equipment and software continue to expand. However, investment in nonresidential structures is still weak, and the housing sector continues to be depressed. Inflation has picked up in recent months, mainly reflecting higher prices for some commodities and imported goods, as well as the recent supply chain disruptions. However, longer-term inflation expectations have remained stable."
The Fed realizes that its previous growth estimates were way too optimistic. The economy is clearly slowing, and the momentum we had has been lost. Construction, both residential and non-residential, is very weak. Consumers are sitting on their wallets. The hope is that it is just temporary, due to the high oil (and to a lesser extent, food) prices we saw in the spring.
With oil prices moving back down, it will act as a tax cut to consumers. But on the other hand, gasoline prices collapsed in late 2008-early 2009 along with everything else, so it is not a panacea. Yes, businesses have been investing in new plants and equipment, but mostly where that investment will pay off in having fewer workers produce the same amount of stuff.
The supply chain disruptions will pass, and that should help a bit as well, particularly for the Auto sector. However, with low wage growth and high unemployment, people may well decide to try to keep the old clunker running rather than get a new car, regardless of what is happening in the supply chain.
Inflation was a minor problem earlier in the year, particularly at the headline level. Excluding food and energy, inflation is still very low by any historical standard. The market expects it to remain low for the foreseeable future. That is what the bond market, at virtually every point on the yield curve, has been screaming at the top of its lungs.
"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."
"Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. The unemployment rate remains elevated; however, the Committee expects the pace of recovery to pick up over coming quarters and the unemployment rate to resume its gradual decline toward levels that the Committee judges to be consistent with its dual mandate.
"Inflation has moved up recently, but the Committee anticipates that inflation will subside to levels at or below those consistent with the Committee’s dual mandate as the effects of past energy and other commodity price increases dissipate. However, the Committee will continue to pay close attention to the evolution of inflation and inflation expectations."
By law, the Fed is supposed to do two things: keep inflation low, and growth (and hence employment) strong. With inflation expected to be at or below target levels, and unemployment WAY over what it should be, any first year student in Macroeconomics would tell you that monetary policy is still too tight. This is despite the Fed having used up all of its conventional ammo way back in December 2008, when it cut the Fed Funds rate to its current 0% ot 0.25% range.
Since then it has tried to loosen up things with unconventional measures. To do so it did two rounds of large-scale asset purchases, the first one buying mortgages and the second with intermediate-term T-notes. I think that a third round is called for, but even if it were to happen, it would only help a little bit. At this point they are pushing on a string. Fiscal stimulus would be much more useful, but Congress and the administration are moving the wrong direction there.
It is not so much that the debt ceiling agreement makes massive short-term spending cuts, it really doesn’t — most of the cuts come out in 2018 and 2019. It does take any fiscal stimulus measures off the table.
There is some fiscal contraction that is baked into the cake under current law. If not renewed, the payroll tax on individuals will jump from 4% to 6% in January, and millions of people will see their extended unemployment benefits end. That will be a significant loss of purchasing power, and will cause growth to slow significantly. The debt ceiling agreement, and the theatrics that led up to it, make it likely that those things will not be renewed.
"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."
"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 continues to anticipate 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 for an extended period.
"The Committee will complete its purchases of $600 billion of longer-term Treasury securities by the end of this month and 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."
They finally defined what they mean by “an extended period;” in this case it is through the middle of 2013. This is by far the most significant policy change at the meeting. I had suspected that somewhere into 2013 was what they had meant previously, but had thought it would be dependent on how the data came in, and was reluctant to make a call beyond until mid-2012.
This is a small but useful move. It should keep rates out to two years near zero, not just rates out to six months or so near zero. No change in the language about the size and composition of its securities holding. In other words, no QE3 at this time.
"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."
"The Committee will monitor the economic outlook and financial developments and will act as needed to best foster maximum employment and price stability."
One of the tools at its disposal that was probably under discussion was doing away with paying banks interest on their excess reserves. Why they didn’t do this a long time ago, and why they still have not done so is a mystery to me. In effect, they are paying banks not to lend.
While 0.25% is not very much, it still adds up when you are talking about over $1 trillion in excess reserves just sitting there and doing nothing for the economy. But hey, technically the Fed is owned by the banks, not the U.S. Government, and thus they like to funnel money to the banks. The line about monitoring developments is pure boilerplate. It would be big news if they were not going to do so.
"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."
"Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; Elizabeth A. Duke; Charles L. Evans; Richard W. Fisher; Narayana Kocherlakota; Charles I. Plosser; Sarah Bloom Raskin; Daniel K. Tarullo; and Janet L. Yellen."
Three dissents! That is the most divided a Fed Policy statement vote that I can remember. These things are unanimous about 95% of the time, and occasionally there will be one person disagreeing. Three is almost unheard of. The dissenters mostly wanted to keep the timing of when the Fed might change course ambiguous. They want a freer hand to raise rates sooner, and by putting a date on things it ties their hands.
I think the clarity helps. It was not a big change, but at the margin it was a good thing to do. Raising rates any time soon would be a very bad thing to do, and it is about the last thing the economy needs right now, or at any time in the reasonably near future. Thus I don’t mind their hands being tied that way.
I found this statement to be depressing but not unexpected. The Fed is not about to move off the sidelines, despite the lousy economic data we have been seeing. Even though QE3 was not really expected by the markets to be announced today, I would have liked to see some sign that it might possibly come along soon.
The markets and the economy are on their own, and the cavalry is not about to ride to the rescue with help from either the fiscal and monetary side. That is not good for confidence. The market is not going to like that at all. With unemployment at crisis levels, and inflation at very low levels and likely to remain that way, the Fed should be doing everything it can to get the economy moving again.
Granted, at this point the tools they have are not the best ones possible, but with fiscal policy moving in the wrong direction, sitting on the sidelines wringing their hands and not doing anything is not going to help the situation.
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