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posted on 11 October 2017

20 September 2017 FOMC Meeting Minutes: Again Much Talk About Inflation

Fed-sealSMALL-- this post authored by Steven Hansen

The 20 September 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 the hurricanes, and an interesting quote:

... participants judged that the recent storms were unlikely to materially alter the course of the national economy over the medium term.....

Analyst Opinion of these minutes

These meeting minutes continue 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 was formalized during this meeting.

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 2020 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, which is an addendum to these minutes.

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 remained solid in recent months, and the unemployment rate had stayed low. Household spending had been expanding at a moderate rate, and growth in business fixed investment had picked up in recent quarters. On a 12-month basis, overall inflation and the measure excluding food and energy prices had declined this year 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 acknowledged that Hurricanes Harvey, Irma, and Maria would affect economic activity in the near term. They expected growth of real GDP in the third quarter to be held down by the severe disruptions caused by the storms but to rebound beginning in the fourth quarter as rebuilding got under way and economic activity in the affected areas resumed. Similarly, employment would be temporarily depressed by the hurricanes, but, abstracting from those effects, employment gains were anticipated to remain solid, and the unemployment rate was expected to decline a bit further by year-end.

Based on the estimated effects of past major hurricanes that made landfall in the United States, participants judged that the recent storms were unlikely to materially alter the course of the national economy over the medium term. Moreover, they generally viewed the information on spending, production, and labor market activity that became available over the intermeeting period, which was mostly not affected by the hurricanes, as suggesting little change in the outlook for economic growth and the labor market over the medium term. Consequently, they 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 the aftermath of the hurricanes, higher prices for gasoline and some other items were likely to boost inflation temporarily. Apart from that effect, inflation on a 12-month basis was expected to remain somewhat below 2 percent in the near term but to stabilize around the Committee's 2 percent objective over the medium term. Near-term risks to the economic outlook appeared roughly balanced, but participants agreed to continue to monitor inflation developments closely.

Consumer spending had been expanding at a moderate rate through the summer, and reports on retail activity from participants' contacts were generally positive. Participants expected some fluctuations in consumer spending to result from the hurricanes, but they generally judged that consumption growth would continue to be supported by still-solid fundamental determinants of household spending, including the income generated by the ongoing strength in the labor market, improved household balance sheets, and high levels of consumer confidence. Sales of autos and light trucks had softened over the summer, leading producers to slow production to address a buildup of inventories, but a couple of participants noted that automakers expected to see a temporary increase in demand as households and businesses replaced vehicles damaged during the storms.

Incoming data on business spending showed that equipment investment had picked up during 2017 after having been weak during much of 2016. Shipments and orders of nondefense capital goods had been on a steady uptrend over the first eight months of 2017. A number of participants reported that their business contacts appeared to have become more confident about the economic outlook, and it was noted that the National Federation of Independent Business reported that greater optimism among small businesses had contributed to a sharp increase in the proportion of small firms planning increases in their capital expenditures. A couple of participants commented that competitive pressures and tight labor markets were increasing the incentives for businesses to substitute capital for labor or to invest in information technology. In contrast, reports on the strength of nonresidential construction were mixed. And in energy-producing regions, the count of drilling rigs in operation had begun to level off before the onset of Hurricane Harvey.

Participants generally indicated that, before the recent hurricanes, business activity in their Districts was expanding at a moderate pace. Although industrial production in areas affected by the storms was estimated to have declined in August, a number of participants from other areas reported further solid gains in manufacturing activity in their Districts. Participants from the regions affected by the hurricanes reported that businesses in their Districts anticipated that the disruptions to business and sales would be relatively short lived. In the energy sector, Hurricane Harvey had shut down drilling and refining activity, but by the time of the meeting, these operations had substantially resumed. And many business contacts in the affected areas reported that they expected their operations to return to normal before the end of the year. Farming in some parts of the country had been affected by drought, and income in the agricultural sector was under downward pressure because of low crop prices.

Overall, the available information suggested that, although the storms would likely affect the quarterly pattern of changes in real GDP at least through the second half of the year, economic activity would continue to expand at a moderate rate over the medium term, supported by further gains in consumer spending and the pickup in business investment. In addition, improving global economic conditions and the depreciation of the dollar in recent months were anticipated to result in a modest positive contribution to domestic economic activity from net exports. In contrast, most participants had not assumed enactment of a fiscal stimulus package in their economic projections or had marked down the expected magnitude of any stimulus.

Labor market conditions strengthened further in recent months. The increases in nonfarm payroll employment in July and August remained well above the pace likely to be sustainable in the longer run. Although the unemployment rate was little changed from March to August, it remained below participants' estimates of its longer-run normal level. Other indicators suggested that labor market conditions had continued to tighten over recent quarters. The labor force participation rate had been moving sideways despite factors, such as demographic changes, that were contributing to a declining longer-run trend. In addition, the number of individuals working part time for economic reasons, as a share of household employment, had moved lower. The job openings rate, the quits rate, households' assessments of job availability, and the labor market conditions index prepared by the Federal Reserve Bank of Kansas City had returned to pre-recession levels. However, some participants still saw room for further increases in labor utilization, with a couple of them noting that the employment-to-population ratio and the participation rate for prime-age workers had not fully recovered to pre-recession levels.

Against the backdrop of the continued strengthening in labor market conditions, participants discussed recent wage developments. Increases in most aggregate measures of hourly wages and labor compensation remained subdued, and several participants commented that the absence of broad-based upward wage pressures suggested that the sustainable rate of unemployment might be lower than they currently estimated. Other factors that may have been contributing to the subdued pace of wage increases reported in the national data included low productivity growth, changes in the composition of the workforce, and competitive pressure on employers to hold down their costs. However, reports from business contacts in several Districts indicated that employers in labor markets in which demand was high or in which workers in some occupations were in short supply were raising wages noticeably to compete for workers and limit turnover. It was noted that the expected increase in demand for skilled construction workers for reconstruction in hurricane-affected areas would likely exacerbate existing shortages. Most participants expected wage increases to pick up over time as the labor market strengthened further; a couple of participants cautioned that a broader acceleration in wages may already have begun, consistent with already-tight labor market conditions.

Based on the available data, PCE price inflation over the 12 months ending in August was estimated to be about 1-1/2 percent, remaining below the Committee's longer-run objective. In their review of the recent data and the outlook for inflation, participants discussed a number of factors that could be contributing to the low readings on consumer prices this year and weighed the extent to which those factors might be transitory or could prove more persistent. Many participants continued to believe that the cyclical pressures associated with a tightening labor market or an economy operating above its potential were likely to show through to higher inflation over the medium term. In addition, many judged that at least part of the softening in inflation this year was the result of idiosyncratic or one-time factors, and, thus, their effects were likely to fade over time. However, other developments, such as the effects of earlier changes to government health-care programs that had been holding down health-care costs, might continue to do so for some time. Some participants discussed the possibility that secular trends, such as the influence of technological innovations on competition and business pricing, also might have been muting inflationary pressures and could be intensifying. It was noted that other advanced economies were also experiencing low inflation, which might suggest that common global factors could be contributing to persistence of below-target inflation in the United States and abroad. Several participants commented on the importance of longer-run inflation expectations to the outlook for a return of inflation to 2 percent. A number of indicators of inflation expectations, including survey statistics and estimates derived from financial market data, were generally viewed as indicating that longer-run inflation expectations remained reasonably stable, although a few participants saw some of these measures as low or slipping.

Participants raised a number of important considerations about the implications of persistently low inflation for the path of the federal funds rate over the medium run. Several expressed concern that the persistence of low rates of inflation might imply that the underlying trend was running below 2 percent, risking a decline in inflation expectations. If so, the appropriate policy path should take into account the need to bolster inflation expectations in order to ensure that inflation returned to 2 percent and to prevent erosion in the credibility of the Committee's objective. It was also noted that the persistence of low inflation might result in the federal funds rate staying uncomfortably close to its effective lower bound. However, a few others pointed out the need to consider the lags in the response of inflation to tightening resource utilization and, thus, increasing upside risks to inflation as the labor market tightened further.

On balance, participants continued to forecast that PCE price inflation would stabilize around the Committee's 2 percent objective over the medium term. However, several noted that in preparing their projections for this meeting, they had taken on board the likelihood that convergence to the Committee's symmetric 2 percent inflation objective might take somewhat longer than they anticipated earlier. Participants generally agreed it would be important to monitor inflation developments closely. Several of them noted that interpreting the next few inflation reports would likely be complicated by the temporary run-up in energy costs and in the prices of other items affected by storm-related disruptions and rebuilding.

In financial markets, longer-term interest rates and the foreign exchange value of the dollar declined over the intermeeting period, and equity prices increased. It was noted that U.S. financial conditions recently appeared to be responding as much or more to economic and financial news from abroad as to domestic developments. Many participants viewed accommodative financial conditions, which had prevailed even as the Committee raised the federal funds rate, as likely to provide support for the economic expansion. However, a couple of those participants expressed concern that the persistence of highly accommodative financial conditions could, over time, pose risks to financial stability. In contrast, a few participants cautioned that these financial market conditions might not deliver much impetus to aggregate demand if they instead reflected a more pessimistic assessment of prospects for longer-run economic growth and, accordingly, a view that the longer-run neutral rate of interest in the United States would remain low.

In their discussion of monetary policy, all participants agreed that the economy had evolved broadly as they had anticipated at the time of the June meeting and that the incoming data had not materially altered the medium-term economic outlook. Consistent with those assessments, participants saw it as appropriate, at this meeting, to announce implementation of the plan for reducing the Federal Reserve's securities holdings that the Committee released in June. Many underscored that the reduction in securities holdings would be gradual and that financial market participants appeared to have a clear understanding of the Committee's planned approach for a gradual normalization of the size of the Federal Reserve's balance sheet. Consequently, participants generally expected that any reaction in financial markets to the start of balance sheet normalization would likely be limited.

With the medium-term outlook little changed, inflation below 2 percent, and the neutral rate of interest estimated to be quite low, all participants thought it would be appropriate for the Committee to maintain the current target range for the federal funds rate at this meeting, and nearly all supported again indicating in the postmeeting statement that a gradual approach to increasing the federal funds rate will likely be warranted. Nevertheless, many participants expressed concern that the low inflation readings this year might reflect not only transitory factors, but also the influence of developments that could prove more persistent, and it was noted that some patience in removing policy accommodation while assessing trends in inflation was warranted. A few of these participants thought that no further increases in the federal funds rate were called for in the near term or that the upward trajectory of the federal funds rate might appropriately be quite shallow. Some other participants, however, were more worried about upside risks to inflation arising from a labor market that had already reached full employment and was projected to tighten further. Their concerns were heightened by the apparent easing in financial conditions that had developed since the Committee's policy normalization process was initiated in December 2015. These participants cautioned that an unduly slow pace in removing policy accommodation could result in an overshoot of the Committee's inflation objective in the medium term that would likely be costly to reverse or could lead to an intensification of financial stability risks or to other imbalances that might prove difficult to unwind.

Consistent with the expectation that a gradual rise in the federal funds rate would be appropriate, many participants thought that another increase in the target range later this year was likely to be warranted if the medium-term outlook remained broadly unchanged. Several others noted that, in light of the uncertainty around their outlook for inflation, their decision on whether to take such a policy action would depend importantly on whether the economic data in coming months increased their confidence that inflation was moving up toward the Committee's objective. A few participants thought that additional increases in the federal funds rate should be deferred until incoming information confirmed that the low readings on inflation this year were not likely to persist and that inflation was clearly on a path toward the Committee's symmetric 2 percent objective over the medium term. All agreed that they would closely monitor and assess incoming data before making any further adjustment to the federal funds rate.


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