17 December 2014 FOMC Meeting Minutes: Some Concern over Slower Foreign Growth, Labor Slack, and Not Enough Inflation
Econintersect: The 17 December 2014 meeting statement presented the actions taken. This post covers the economic discussion during this FOMC meeting between the members. The Fed's Balance Sheet (which we report on weekly) should begin to slightly contract shortly.
One of the more interesting meeting minute statements:
... Some participants suggested that the recent domestic economic data had increased their confidence in the outlook for growth going forward. Participants generally regarded the net effect of the recent decline in energy prices as likely to be positive for economic activity and employment. However, many of them thought that a further deterioration in the foreign economic situation could result in slower domestic economic growth than they currently expected.
The meeting minutes have a slightly different feel with more convergence and divergence of views and events. The interesting points are highlighted in bold below. Econintersect publishes below the views of the FOMC members, and ignores the reports given to the members. We are looking for a glimpse of insight into the minds of the FOMC members.
Participants' Views on Current Conditions and the Economic Outlook
In conjunction with this FOMC meeting, members of the Board of Governors and the Federal Reserve Bank presidents submitted their projections of the most likely outcomes for real GDP growth, the unemployment rate, inflation, and the federal funds rate for each year from 2014 through 2017 and over the longer run, conditional on each participant's judgment of appropriate monetary policy. The longer-run projections represent each participant's assessment of the rate to which each variable would be expected to converge, over time, under appropriate monetary policy and in the absence of further shocks to the economy. These economic projections and policy assessments are described in the Summary of Economic Projections (SEP), which is attached as an addendum to these minutes.
In their discussion of the economic situation and the outlook, meeting participants regarded the information received over the intermeeting period as supporting their view that economic activity was expanding at a moderate pace. Labor market conditions improved further, with solid job gains and a lower unemployment rate; participants judged that the underutilization of labor resources was continuing to diminish. Participants expected that, over the medium term, real economic activity would increase at a pace sufficient to lead to further improvements in labor market indicators toward levels consistent with the Committee's objective of maximum employment. Inflation was continuing to run below the Committee's longer-run objective, reflecting in part continued reductions in oil prices and falling import prices. Market-based measures of inflation compensation declined further, while survey-based measures of longer-term inflation expectations remained stable. Participants generally anticipated that inflation would rise gradually toward the Committee's 2 percent objective as the labor market improved further and the transitory effects of lower energy prices and other factors dissipated. The risks to the outlook for economic activity and the labor market were seen as nearly balanced. Some participants suggested that the recent domestic economic data had increased their confidence in the outlook for growth going forward. Participants generally regarded the net effect of the recent decline in energy prices as likely to be positive for economic activity and employment. However, many of them thought that a further deterioration in the foreign economic situation could result in slower domestic economic growth than they currently expected.
Household spending continued to advance over the intermeeting period, and reports from contacts in several parts of the country indicated that recent retail or auto sales had been robust. Many participants pointed to relatively high levels of consumer confidence as signaling near-term strength in discretionary consumer spending, and most participants judged that the recent significant decline in energy prices would provide a boost to consumer spending. Participants also cited solid gains in payroll employment, low interest rates, and the decline in levels of household debt relative to income as factors that were expected to support continued growth in consumer spending. In contrast, residential construction continued to be slow, and recent readings on single- family building permits suggested that this sluggishness was likely to continue in the short run.
Industry contacts pointed to generally solid business conditions, with businesses in many parts of the country expressing some optimism about prospects for further improvement in 2015. Manufacturing activity was strong, as indicated by the index of industrial production and a variety of regional reports. Information from some regions pointed to a pickup in capital investment, although the continued decline in oil prices led business contacts to expect a slowdown in drilling activity and, if prices remain low, reduced capital investment in the oil and gas industries. In the agricultural sector, the robust fall harvest reportedly lowered crop prices; operating margins for food processing and farm equipment businesses have been narrowing, putting stress on some producers.
In their discussion of the foreign economic outlook, participants noted that the implications of the drop in crude oil prices would differ across regions, especially if the price declines affected inflation expectations and financial markets; a few participants said that the effect on overseas employment and output as a whole was likely to be positive. While some participants had lowered their assessments of the prospects for global economic growth, several noted that the likelihood of further responses by policymakers abroad had increased. Several participants indicated that they expected slower economic growth abroad to negatively affect the U.S. economy, principally through lower net exports, but the net effect of lower oil prices on U.S. economic activity was anticipated to be positive.
Participants saw broad-based improvement in labor market conditions over the intermeeting period, including solid gains in payroll employment, a slight reduction in the unemployment rate, and increases in the rates of hiring and quits. Positive signals were also seen in the decline in the share of workers employed part time for economic reasons and in the increase in the labor force participation rate. These favorable trends notwithstanding, the levels of these measures suggested to some participants that there remained more labor market slack than was indicated by the unemployment rate alone. However, a few others continued to view the unemployment rate as a reliable indicator of overall labor market conditions and saw a narrower degree of labor underutilization remaining. Although a few participants suggested that the recent uptick in the employment cost index or average hourly earnings could be a tentative sign of an upturn in wage growth, most participants saw no clear evidence of a broad-based acceleration in wages. A couple of participants, however, pointing to the weak statistical relationship between wage inflation and labor market conditions, suggested that the pace of wage inflation was providing relatively little information about the degree of labor underutilization.
Participants generally anticipated that inflation was likely to decline further in the near term, reflecting the reduction in oil prices and the effects of the rise in the foreign exchange value of the dollar on import prices. Most participants saw these influences as temporary and thus continued to expect inflation to move back gradually to the Committee's 2 percent longer-run objective as the labor market improved further in an environment of well-anchored inflation expectations. Survey-based measures of longer-term inflation expectations remained stable, although market-based measures of inflation compensation over the next five years, as well as over the five-year period beginning five years ahead, moved down further over the intermeeting period. Participants discussed various explanations for the decline in market-based measures, including a fall in expected future inflation, reductions in inflation risk premiums, and higher liquidity and other premiums that might be influencing the prices of Treasury Inflation-Protected Securities and inflation derivatives. Model-based decompositions of inflation compensation seemed to support the message from surveys that longer-term inflation expectations had remained stable, although it was observed that these results were sensitive to the assumptions underlying the particular models used. It was noted that even if the declines in inflation compensation reflected lower inflation risk premiums rather than a reduction in expected inflation, policymakers might still want to take them into account because such changes could reflect increased concerns on the part of investors about adverse outcomes in which low inflation was accompanied by weak economic activity. In the end, participants generally agreed that it would take more time and analysis to draw definitive conclusions regarding the recent behavior of inflation compensation.
In their discussion of financial market developments, participants observed that movements in asset prices over the intermeeting period appeared to have been importantly influenced by concerns about prospects for foreign economic growth and by associated expectations of monetary policy actions in Europe and Japan. A couple of participants remarked on the apparent disparity between market-based measures of expected future U.S. short-term interest rates and projections for short-term rates based on surveys or based on the median of federal funds rate projections in the SEP. One participant noted that very low term premiums in market-based measures might explain at least some portion of this gap. Another possibility was that market-based measures might be assigning considerable weight to less favorable outcomes for the U.S. economy in which the federal funds rate would remain low for quite some time or fall back to very low levels in the future, whereas the projections in the SEP report the paths for the federal funds rate that participants see as appropriate given their views of the most likely evolution of inflation and real activity.
Participants discussed a number of risks to the economic outlook. Many participants regarded the international situation as an important source of downside risks to domestic real activity and employment, particularly if declines in oil prices and the persistence of weak economic growth abroad had a substantial negative effect on global financial markets or if foreign policy responses were insufficient. However, the downside risks were seen as nearly balanced by risks to the upside. Several participants, pointing to indicators of consumer and business confidence as well as to the solid record of payroll employment gains in 2014, suggested that the real economy may end up showing more momentum than anticipated, while a few others thought that the boost to domestic spending coming from lower energy prices could turn out to be quite large. With regard to inflation, a number of participants saw a risk that it could run persistently below their 2 percent objective, with some expressing concern that such an outcome could undermine the credibility of the Committee's commitment to that objective. Some participants were worried that the recent substantial fall in energy prices could lead to a reduction in longer-term inflation expectations, while others were concerned that the decline in market-based measures of inflation compensation might reflect, in part, that such a decline had already begun. However, a couple of others noted that if the unemployment rate continued to decline quickly, wage and price inflation could rise more than generally anticipated.
In their discussion of communications regarding the path of the federal funds rate over the medium term, most participants concluded that updating the Committee's forward guidance would be appropriate in light of the conclusion of the asset purchase program in October and the further progress that the economy had made toward the Committee's objectives. Most participants agreed that it would be useful to state that the Committee judges that it can be patient in beginning to normalize the stance of monetary policy; they noted that such language would provide more flexibility to adjust policy in response to incoming information than the previous language, which had tied the beginning of normalization to the end of the asset purchase program. This approach was seen as consistent, given the Committee's assessment of the economic outlook at the current meeting, with the Committee's previous statement. Most participants thought the reference to patience indicated that the Committee was unlikely to begin the normalization process for at least the next couple of meetings. Some participants regarded the revised language as risking an unwarranted concentration of market expectations for the timing of the initial increase in the federal funds rate target on a narrow range of dates around mid-2015, and as not adequately allowing for the possibility that economic conditions might evolve in a way that could call for either an earlier or a later liftoff date. A few participants suggested that the statement should focus on the economic conditions that would likely accompany the decision to raise rates. Participants generally stressed the need to communicate that the timing of the first increase in the federal funds rate would depend on the incoming data and their implications for the Committee's assessment of progress toward its objectives of maximum employment and inflation of 2 percent. With lower energy prices and the stronger dollar likely to keep inflation below target for some time, it was noted that the Committee might begin normalization at a time when core inflation was near current levels, although in that circumstance participants would want to be reasonably confident that inflation will move back toward 2 percent over time.
A few participants spoke of the importance of explaining to the public how economic and financial conditions would influence the Committee's decisions regarding the appropriate path for the federal funds rate after normalization begins. It was noted that to the extent that such guidance can be effectively communicated, the precise date of liftoff becomes less important for economic outcomes. In this regard, some participants emphasized that policy will still be highly accommodative for a time after the first increase in the federal funds rate target, given the difference between the current setting of the federal funds rate target range and the Committee's view of the longer-run normal rate as well as the Federal Reserve's elevated holdings of longer-term securities.
Source: Federal Reserve