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posted on 06 July 2017

14 June 2017 FOMC Meeting Minutes: The Main Topic Was Inflation

Fed-sealSMALL-- this post authored by Steven Hansen

The 14 June 2017 meeting statement presented the actions taken. This post covers the economic discussion during this FOMC meeting between the members (minutes were released today). There was considerable discussion on inflation, and an interesting quote:

... Several participants expressed concern that a substantial and sustained unemployment undershooting might make the economy more likely to experience financial instability or could lead to a sharp rise in inflation that would require a rapid policy tightening that, in turn, could raise the risk of an economic downturn. .....

Analyst Opinion of these minutes

There meeting minutes seem to contain an inordinate discussion on inflation. The FOMC seems surprised that inflation is moderating and below their targets. It seems that they now little more about inflation than you or me.

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 Federal Reserve Bank presidents submitted their projections of the most likely outcomes for real output growth, the unemployment rate, and inflation for each year from 2017 through 2019 and over the longer run, based on their individual assessments of the appropriate path for the federal funds rate. The longer-run projections represented 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 projections and policy assessments are described in the Summary of Economic Projections (SEP), which is an addendum to these minutes.

In their discussion of the economic situation and the outlook, meeting participants agreed that the information received over the intermeeting period indicated that the labor market had continued to strengthen and that economic activity had been rising moderately, on average, so far this year. Job gains had moderated since the beginning of the year but had remained solid, on average, and the unemployment rate had declined. Household spending had picked up in recent months, and business fixed investment had continued to expand. Inflation measured on a 12-month basis had declined recently and, like the measure excluding food and energy prices, had been running somewhat below 2 percent. Market-based measures of inflation compensation remained low; survey-based measures of longer-term inflation expectations were little changed on balance.

Participants generally saw the incoming information on spending and labor market indicators as consistent, overall, with their expectations and indicated that their views of the outlook for economic growth and the labor market had changed only slightly since the May FOMC meeting. As anticipated, growth in consumer spending seemed to have bounced back from a weak first quarter, and participants continued to expect that, with further gradual adjustments in the stance of monetary policy, economic activity would expand at a moderate pace and labor market conditions would strengthen somewhat further. In light of surprisingly low recent readings on inflation, participants expected that inflation on a 12-month basis would remain somewhat below 2 percent in the near term. However, participants judged that inflation would stabilize around the Committee's 2 percent objective over the medium term.

Growth in consumer spending appeared to be rebounding after slowing in the first quarter of this year. Participants generally continued to expect that ongoing job gains, rising household income and wealth, and improved household balance sheets would support moderate growth in household spending over the medium term. However, District contacts reported that automobile sales had slowed recently; some contacts expected sales to slow further, while others believed that sales were leveling out.

Participants generally agreed that business fixed investment had continued to expand in recent months, supported in particular by a rebound in the energy sector. District contacts suggested that an expansion in oil production capacity was likely to continue in the near term, though the longer-term outlook was more uncertain. Conditions in the manufacturing sector in several Districts were reportedly strong, but activity in a couple of them had slowed in recent months from a high level, and some contacts in the automobile industry reported declines in production that they expected to continue in the near term. District reports regarding the service sector were generally positive. In contrast, contacts in a couple of Districts indicated that conditions in the agricultural sector remained weak. Contacts in many Districts remained optimistic about business prospects, which were supported in part by improving global conditions. However, this optimism appeared to have recently abated somewhat, partly because contacts viewed the likelihood of significant fiscal stimulus as having diminished. Contacts at some large firms indicated that they had curtailed their capital spending, in part because of uncertainty about changes in fiscal and other government policies; some contacts at smaller firms, however, indicated that their capital spending plans had not been appreciably affected by news about government policy. Reports regarding housing construction from District contacts were mixed.

Labor market conditions continued to strengthen in recent months. The unemployment rate fell from 4.5 percent in March to 4.3 percent in May and was below levels that participants judged likely to be normal over the longer run. Monthly increases in nonfarm payrolls averaged 160,000 since the beginning of the year, down from 187,000 per month in 2016 but still well above estimates of the pace necessary to absorb new entrants in the labor force. A few participants interpreted this slowing in payroll growth as an expected development that reflected a tight labor market. Other labor market indicators, such as the number of job openings and broader measures of unemployment, were also seen as consistent with labor market conditions having strengthened in recent months. Moreover, contacts in several Districts reported shortages of workers in selected occupations and in some cases indicated that firms were significantly increasing salaries and benefits in order to attract or keep workers. However, other contacts reported only modest wage gains, and participants observed that measures of labor compensation for the overall economy continued to rise only moderately despite strengthening labor market conditions. A couple of participants saw the restrained increases in labor compensation as consistent with the low productivity growth and moderate inflation experienced in recent years. In light of the recent behavior of labor compensation and consumer prices as well as demographic trends, a number of participants lowered their estimate of the longer-run normal level of the unemployment rate.

Recent readings on headline and core PCE price inflation had come in lower than participants had expected. On a 12-month basis, headline PCE price inflation was running somewhat below the Committee's 2 percent objective in April, partly because of factors that appeared to be transitory. Core PCE price inflation--which historically has been a more useful predictor of future inflation, al­though it, too, can be affected by transitory factors--moved down from 1.8 percent in March to 1.5 percent in April. In addition, CPI inflation in May came in lower than expected. Most participants viewed the recent softness in these price data as largely reflecting idiosyncratic factors, including sharp declines in prices of wireless telephone services and prescription drugs, and expected these developments to have little bearing on inflation over the medium run. Participants continued to expect that, as the effects of transitory factors waned and labor market conditions strengthened further, inflation would stabilize around the Committee's 2 percent objective over the medium term. Several participants suggested that recent increases in import prices were consistent with this expectation. However, several participants expressed concern that progress toward the Committee's 2 percent longer-run inflation objective might have slowed and that the recent softness in inflation might persist. Such persistence might occur in part because upward pressure on inflation from resource utilization may be limited, as the relationship between these two variables appeared to be weaker than in previous decades. However, a couple of other participants raised the concern that a tighter relationship between inflation and resource utilization could reemerge if the unemployment rate ran significantly below its longer-run normal level, which could result in inflation running persistently above the Committee's 2 percent objective.

Overall, participants continued to see the near-term risks to the economic outlook as roughly balanced. Participants again noted the uncertainty regarding the possible enactment, timing, and nature of changes to fiscal and other government policies and saw both upside and downside risks to the economic outlook associated with such changes. A number of participants, pointing to improved prospects for foreign economic growth, viewed the downside risks to the U.S. economic outlook stemming from international developments as having receded further over the intermeeting period. With regard to the outlook for inflation, some participants emphasized downside risks, particularly in light of the recent low readings on inflation along with measures of inflation compensation and some survey measures of inflation expectations that were still low. However, a couple of participants expressed concern that a substantial undershooting of the longer-run normal rate of unemployment could pose an appreciable upside risk to inflation or give rise to macroeconomic or financial imbalances that eventually could lead to a significant economic downturn. Participants agreed that the Committee should continue to monitor inflation developments closely.

In their discussion of recent developments in financial markets, participants observed that, over the intermeeting period, equity prices rose, longer-term interest rates declined, and volatility in financial markets was generally low. They also noted that, according to some measures, financial conditions had eased even as the Committee reduced policy accommodation and market participants continued to expect further steps to tighten monetary policy. Participants discussed possible reasons why financial conditions had not tightened. Corporate earnings growth had been robust; nevertheless, in the assessment of a few participants, equity prices were high when judged against standard valuation measures. Longer-term Treasury yields had declined since earlier in the year and remained low. Participants offered various explanations for low bond yields, including the prospect of sluggish longer-term economic growth as well as the elevated level of the Federal Reserve's longer-term asset holdings. Some participants suggested that increased risk tolerance among investors might be contributing to elevated asset prices more broadly; a few participants expressed concern that subdued market volatility, coupled with a low equity premium, could lead to a buildup of risks to financial stability.

In their discussion of monetary policy, participants generally saw the outlook for economic activity and the medium-term outlook for inflation as little changed and viewed a continued gradual removal of monetary policy accommodation as being appropriate. Based on this assessment, almost all participants expressed the view that it would be appropriate for the Committee to raise the target range for the federal funds rate 25 basis points at this meeting. These participants agreed that, even after an increase in the target range for the federal funds rate at this meeting, the stance of monetary policy would remain accommodative, supporting additional strengthening in labor market conditions and a sustained return to 2 percent inflation. A few participants also judged that the case for a policy rate increase at this meeting was strengthened by the easing, by some measures, in overall financial conditions over the previous six months. One participant did not believe it was appropriate to raise the federal funds rate target range at this meeting; this participant suggested that the Committee should maintain the target range for the federal funds rate at 3/4 to 1 percent until the inflation rate was actually moving toward the Committee's 2 percent longer-run objective.

Participants noted that, with the process of normalization of the level of the federal funds rate continuing, it would likely become appropriate this year for the Committee to announce and implement a specific timetable for its program of reducing reinvestment of the Federal Reserve's securities holdings. It was observed that the ensuing reduction in securities holdings would be gradual and would follow an extended period of Committee communications on balance sheet normalization policy, including the information that would be released at the conclusion of this meeting. Consequently, the effect on financial market conditions of the eventual announcement of the beginning of the Federal Reserve's balance sheet normalization was expected to be limited.

Participants expressed a range of views about the appropriate timing of a change in reinvestment policy. Several preferred to announce a start to the process within a couple of months; in support of this approach, it was noted that the Committee's communications had helped prepare the public for such a step. However, some others emphasized that deferring the decision until later in the year would permit additional time to assess the outlook for economic activity and inflation. A few of these participants also suggested that a near-term change to reinvestment policy could be misinterpreted as signifying that the Committee had shifted toward a less gradual approach to overall policy normalization.

Several participants indicated that the reduction in policy accommodation arising from the commencement of balance sheet normalization was one basis for believing that, if economic conditions evolved broadly as anticipated, the target range for the federal funds rate would follow a less steep path than it otherwise would. However, some other participants suggested that they did not see the balance sheet normalization program as a factor likely to figure heavily in decisions about the target range for the federal funds rate. A few of these participants judged that the degree of additional policy firming that would result from the balance sheet normalization program was modest.

Participants generally reiterated their support for continuing a gradual approach to raising the federal funds rate. Several participants expressed confidence that a series of further increases in the federal funds rate in coming years, along the lines implied by the medians of the projections for the federal funds rate in the June SEP, would contribute to a stabilization, over the medium term, of the inflation rate around the Committee's 2 percent objective, especially as this tightening of monetary policy would affect the economy only with a lag and would start from a point at which policy was still accommodative. However, a few participants who supported an increase in the target range at the present meeting indicated that they were less comfortable with the degree of additional policy tightening through the end of 2018 implied by the June SEP median federal funds rate projections. These participants expressed concern that such a path of increases in the policy rate, while gradual, might prove inconsistent with a sustained return of inflation to 2 percent.

Several participants endorsed a policy approach, such as that embedded in many participants' projections, in which the unemployment rate would undershoot their current estimates of the longer-term normal rate for a sustained period. They noted that the longer-run normal rate of unemployment is difficult to measure and that recent evidence suggested resource pressures generated only modest responses of nominal wage growth and inflation. Against this backdrop, possible benefits cited by policymakers of a period of tight labor markets included a further rise in nominal wage growth that would bolster inflation expectations and help push the inflation rate closer to the Committee's 2 percent longer-run goal, as well as a stimulus to labor market participation and business fixed investment. It was also suggested that the symmetry of the Committee's inflation goal might be underscored if inflation modestly exceeded 2 percent for a time, as such an outcome would follow a long period in which inflation had undershot the 2 percent longer-term objective. Several participants expressed concern that a substantial and sustained unemployment undershooting might make the economy more likely to experience financial instability or could lead to a sharp rise in inflation that would require a rapid policy tightening that, in turn, could raise the risk of an economic downturn. However, other participants noted that if a sharp rise in inflation or inflation expectations did occur, the Committee could readily respond using conventional monetary policy tools. With regard to financial stability, one participant emphasized the importance of remaining vigilant about financial developments but observed that previous episodes of elevated financial imbalances and low unemployment had limited relevance for the present situation, as the current system of financial regulation was likely more robust than that prevailing before the financial crisis.


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