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posted on 16 August 2017

26 July 2017 FOMC Meeting Minutes: The Main Topic Continues To Be Inflation

Fed-sealSMALL-- this post authored by Steven Hansen

The 26 July 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:

... Participants discussed possible reasons for the coexistence of low inflation and low unemployment. These included a diminished responsiveness of prices to resource pressures, a lower natural rate of unemployment, the possibility that slack may be better measured by labor market indicators other than unemployment, lags in the reaction of nominal wage growth and inflation to labor market tightening, and restraints on pricing power from global developments and from innovations to business models spurred by advances in technology. .....

Analyst Opinion of these minutes

These meeting minutes again seem to contain an inordinate discussion on inflation. The FOMC seems to underestimate the reasons that inflation is moderating and below their targets. Wonder why they do not twig that they have been saying inflation will meet their targets in the "medium term" for years now. The unwinding of their balance sheet remains in the short term cards.

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 their discussion of the economic situation and the outlook, meeting participants agreed that information received over the intermeeting period indicated that the labor market had continued to strengthen and that economic activity had been rising moderately so far this year. Job gains had been solid, on average, since the beginning of the year, and the unemployment rate had declined, on net, over the same period. Household spending and business fixed investment had continued to expand. On a 12‑month basis, both overall inflation and the measure excluding food and energy prices had declined and were running 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 were little changed, on balance, since the June FOMC meeting. Participants continued to expect that, with 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 continued 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, most participants judged that inflation would stabilize around the Committee's 2 percent objective over the medium term.

Data received over the intermeeting period reinforced earlier indications that real GDP growth had turned up after having been slow in the first quarter of this year. As anticipated, growth in household spending appeared to have been stronger in the second quarter after its first-quarter weakness. Reports from District contacts on consumer spending were generally positive. However, sales of motor vehicles had softened, and automakers were reportedly adjusting production and assessing whether the underlying demand for automobiles had declined. Participants noted that the fundamentals underpinning consumption growth, including increases in payrolls, remained solid. However, the weakness in retail sales in June offered a note of caution.

Reports from District contacts on both manufacturing and services were also generally consistent with moderate growth in economic activity overall. Construction-sector contacts were generally upbeat. Reports on the energy sector indicated that activity was continuing to expand, albeit more slowly than previously; survey evidence suggested that oil drilling remained profitable in some locations at current oil prices. The agricultural sector remained weak, and some regions were experiencing drought conditions. A couple of participants had received indications from contacts that business investment spending in their Districts might strengthen.

Nevertheless, several participants noted that uncertainty about the course of federal government policy, including in the areas of fiscal policy, trade, and health care, was tending to weigh down firms' spending and hiring plans. In addition, a few participants suggested that the likelihood of near-term enactment of a fiscal stimulus program had declined further or that the fiscal stimulus likely would be smaller than they previously expected. It was also observed that the budgets of some state and local governments were under strain, limiting growth in their expenditures. In contrast, the prospects for U.S. exports had been boosted by a brighter international economic outlook.

Participants noted that labor market conditions had strengthened further over the intermeeting period. The unemployment rate rose slightly to 4.4 percent in June but remained low by historical standards. Payroll gains picked up substantially in June. In addition, the employment-to-population ratio increased. Participants observed that the unemployment rate was likely close to or below its longer-run normal rate and could decline further if, as expected, growth in output remained somewhat in excess of the potential growth rate. A few participants expressed concerns about the possibility of substantially overshooting full employment, with one citing past difficulties in achieving a soft landing. District contacts confirmed tightness in the labor market but relayed little evidence of wage pressures, although some firms were reportedly attempting to attract workers with a variety of nonwage benefits. The absence of sizable wage pressures also seemed to be confirmed by most aggregate wage measures. However, a few participants suggested that, in a tight labor market, measured aggregate wage growth was being held down by compositional changes in employment associated with the hiring of less experienced workers at lower wages than those of established workers. In addition, a number of participants suggested that the rate of increase in nominal wages was not low in relation to the rate of productivity growth and the modest rate of inflation.

Participants discussed the softness in inflation in recent months. Many participants noted that much of the recent decline in inflation had probably reflected idiosyncratic factors. Nonetheless, PCE price inflation on a 12‑month basis would likely continue to be held down over the second half of the year by the effects of those factors, and the monthly readings might be depressed by possible residual seasonality in measured PCE inflation. Still, most participants indicated that they expected inflation to pick up over the next couple of years from its current low level and to stabilize around the Committee's 2 percent objective over the medium term. Many participants, however, saw some likelihood that inflation might remain below 2 percent for longer than they currently expected, and several indicated that the risks to the inflation outlook could be tilted to the downside. Participants agreed that a fall in longer-term inflation expectations would be undesirable, but they differed in their assessments of whether inflation expectations were well anchored. One participant pointed to the stability of a number of measures of inflation expectations in recent months, but a few others suggested that continuing low inflation expectations may have been a factor putting downward pressure on inflation or that inflation expectations might need to be bolstered in order to ensure their consistency with the Committee's longer-term inflation objective.

A number of participants noted that much of the analysis of inflation used in policymaking rested on a framework in which, for a given rate of expected inflation, the degree of upward pressures on prices and wages rose as aggregate demand for goods and services and employment of resources increased above long-run sustainable levels. A few participants cited evidence suggesting that this framework was not particularly useful in forecasting inflation. However, most participants thought that the framework remained valid, notwithstanding the recent absence of a pickup in inflation in the face of a tightening labor market and real GDP growth in excess of their estimates of its potential rate. Participants discussed possible reasons for the coexistence of low inflation and low unemployment. These included a diminished responsiveness of prices to resource pressures, a lower natural rate of unemployment, the possibility that slack may be better measured by labor market indicators other than unemployment, lags in the reaction of nominal wage growth and inflation to labor market tightening, and restraints on pricing power from global developments and from innovations to business models spurred by advances in technology. A couple of participants argued that the response of inflation to resource utilization could become stronger if output and employment appreciably overshot their full employment levels, although other participants pointed out that this hypothesized nonlinear response had little empirical support.

In assessing recent developments in financial market conditions, participants referred to the continued low level of longer-term interest rates, in particular those on U.S Treasury securities. The level of such yields appeared to reflect both low expected future short-term interest rates and depressed term premiums. Asset purchases by foreign central banks and the Federal Reserve's securities holdings were also likely contributing to currently low term premiums, although the exact size of these contributions was uncertain. A number of participants pointed to potential concerns about low longer-term interest rates, including the possibility that inflation expectations were too low, that yields could rise abruptly, or that low yields were inducing investors to take on excessive risk in a search for higher returns.

Several participants noted that the further increases in equity prices, together with continued low longer-term interest rates, had led to an easing of financial conditions. However, different assessments were expressed about the implications of this development for the outlook for aggregate demand and, consequently, appropriate monetary policy. According to one view, the easing of financial conditions meant that the economic effects of the Committee's actions in gradually removing policy accommodation had been largely offset by other factors influencing financial markets, and that a tighter monetary policy than otherwise was warranted. According to another view, recent rises in equity prices might be part of a broad-based adjustment of asset prices to changes in longer-term financial conditions, importantly including a lower neutral real interest rate, and, therefore, the recent equity price increases might not provide much additional impetus to aggregate spending on goods and services.

Participants also considered equity valuations in their discussion of financial stability. A couple of participants noted that favorable macroeconomic factors provided backing for current equity valuations; in addition, as recent equity price increases did not seem to stem importantly from greater use of leverage by investors, these increases might not pose appreciable risks to financial stability. Several participants observed that the banking system was well capitalized and had ample liquidity, reducing the risk of financial instability. It was noted that financial stability assessments were based on current capital levels within the banking sector, and that such assessments would likely be adjusted should these measures of loss-absorbing capacity change. Participants underscored the need to monitor financial institutions for shifts in behavior--such as an erosion of lending standards or increased reliance on unstable sources of funding--that could lead to subsequent problems. In addition, participants judged that it was important to look for signs that either declining market volatility or heavy concentration by investors in particular assets might create financial imbalances. A couple of participants expressed concern that smaller banks could be assuming significant risks in efforts to expand their CRE lending. Furthermore, a couple of participants saw, as possible sources of financial instability, the pace of increase in real estate prices in the multifamily segment and the pattern of the lending and borrowing activities of certain government-sponsored enterprises.

Participants agreed that the regulatory and supervisory tools developed since the financial crisis had played an important role in fostering financial stability. Changes in regulation had likely helped in making the banking system more resilient to major shocks, in promoting more prudent balance sheet management strategies on the part of nonbank financial institutions, and in reducing the degree to which variations in lending to the private sector intensify cycles in output and in asset prices. Participants agreed that it would not be desirable for the current regulatory framework to be changed in ways that allowed a reemergence of the types of risky practices that contributed to the crisis.

In their discussion of monetary policy, participants reaffirmed their view that a gradual approach to removing policy accommodation was likely to remain appropriate to promote the Committee's objectives of maximum employment and 2 percent inflation. Participants commented on a number of factors that would influence their ongoing assessments of the appropriate path for the federal funds rate. Most saw the outlook for economic activity and the labor market as little changed from their earlier projections and continued to anticipate that inflation would stabilize around the Committee's 2 percent objective over the medium term. However, some participants expressed concern about the recent decline in inflation, which had occurred even as resource utilization had tightened, and noted their increased uncertainty about the outlook for inflation. They observed that the Committee could afford to be patient under current circumstances in deciding when to increase the federal funds rate further and argued against additional adjustments until incoming information confirmed that the recent low readings on inflation were not likely to persist and that inflation was more clearly on a path toward the Committee's symmetric 2 percent objective over the medium term. In contrast, some other participants were more worried about risks arising from a labor market that had already reached full employment and was projected to tighten further or from the easing in financial conditions that had developed since the Committee's policy normalization process was initiated in December 2015. They cautioned that a delay in gradually removing policy accommodation could result in an overshooting of the Committee's inflation objective that would likely be costly to reverse, or that a delay could lead to an intensification of financial stability risks or to other imbalances that might prove difficult to unwind. One participant stressed that the risks both to the Committee's inflation objective and to financial stability would require careful monitoring. This participant expressed the view that a gradual approach to removing policy accommodation would likely strike the appropriate balance between promoting the Committee's inflation and full employment objectives and mitigating financial stability concerns.

A number of participants also commented that the appropriate pace of normalization of the federal funds rate would depend on how financial conditions evolved and on the implications of those developments for the pace of economic activity. Among the considerations mentioned were the extent of current downward pressure on longer-term yields arising from the Federal Reserve's asset holdings and how this pressure would diminish over time as balance sheet normalization proceeded, the strength and degree of persistence of other domestic and global factors that had contributed to the easing of financial conditions and elevated asset prices, and whether and how much the neutral rate of interest would rise as the economy continued to expand.

Participants also discussed the appropriate time to implement the plan for reducing the Federal Reserve's securities holdings that was announced in June in the Committee's postmeeting statement and its Addendum to the Policy Normalization Principles and Plans. Participants generally agreed that, in light of their current assessment of economic conditions and the outlook, it was appropriate to signal that implementation of the program likely would begin relatively soon, absent significant adverse developments in the economy or in financial markets. Many noted that the program was expected to contribute only modestly to the reduction in policy accommodation. Several reiterated that, once the program was under way, further adjustments to the stance of monetary policy in response to economic developments would be centered on changes in the target range for the federal funds rate. Al­though several participants were prepared to announce a starting date for the program at the current meeting, most preferred to defer that decision until an upcoming meeting while accumulating additional information on the economic outlook and developments potentially affecting financial markets.


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