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posted on 22 November 2017

01 November 2017 FOMC Meeting Minutes: Again Much Talk About Inflation

Fed-sealSMALL-- this post authored by Steven Hansen

The 01 November 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 the persistently weak inflation data could lead to a decline in longer-term inflation expectations or may have done so already; they pointed to low market-based measures of inflation compensation, declines in some survey measures of inflation expectations, or evidence from statistical models suggesting that the underlying trend in inflation had fallen in recent years ...

Analyst Opinion of these minutes

These meeting minutes continue to contain an inordinate discussion on inflation. The FOMC seems to underestimate (or misunderstand) the reasons that inflation is moderating and below their targets.

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 since the FOMC met in September indicated that the labor market had continued to strengthen and that economic activity had been rising at a solid rate despite hurricane-related disruptions. Al­though the hurricanes depressed payroll employment in September, the unemployment rate, which was less affected by the storms, declined further. Household spending had been expanding at a moderate rate, and growth in business fixed investment had picked up in recent quarters. Gasoline prices rose in the aftermath of the hurricanes, boosting overall inflation in September; however, inflation for items other than food and energy remained soft. On a 12-month basis, both inflation measures 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 hurricane-related disruptions and rebuilding would continue to affect economic activity in the near term, and they noted that, in October, wildfires in California had displaced many households. Past experience, however, suggested that the economic effects of the hurricanes and other natural disasters would be mostly temporary and unlikely to materially alter the course of the national economy over the medium term. Participants saw the incoming information on spending and the labor market as consistent with continued above-trend economic growth and a further strengthening in labor market conditions, al­though the hurricanes, in particular, made it more difficult than usual to interpret some of this information. 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. 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 to be roughly balanced, but participants agreed that it would be important to continue to monitor inflation developments closely.

Participants expected solid growth in consumer spending in the near term, supported by ongoing strength in the labor market, improved household balance sheets, and a high level of consumer sentiment. Robust gains in consumer spending in September were viewed as consistent with that outlook. Light motor vehicle sales had rebounded in September, and District contacts generally expected sales to remain strong in the near term, boosted in part by demand to replace vehicles destroyed by the hurricanes.

Reports on business spending from District contacts were generally upbeat. Participants anticipated appreciable increases in business fixed investment. Improved demand from abroad, rising business profits, and the substitution of capital for labor in response to tightening labor markets were viewed as factors supporting growth in investment. Several participants reported that business contacts appeared to be more confident about the economic outlook and thus more inclined to undertake capital expansion plans. In that context, it was noted that the expansion in business fixed investment could be given additional impetus if legislation involving tax reductions was enacted; a few participants judged that the prospects for significant tax cuts had risen recently. Some firms, especially those operating in industries in which technological advances were spurring competition, were reportedly planning to expand capacity through mergers and acquisitions rather than through investment in new plant and equipment.

Reports from District contacts about both manufacturing and services were generally positive. District contacts in regions affected by the hurricanes reported that the disruptions to production and sales were mostly short lived, including in the energy sector where drilling and refining outages were temporary. However, some homebuilders were reporting shortages of certain building materials in the aftermath of the hurricanes. Farm incomes in some regions were said to remain under downward pressure because of declining crop and livestock prices.

Participants judged that increases in nonfarm payroll employment, apart from the temporary effects of the hurricanes, remained well above the pace likely to be sustainable in the longer run and that labor market conditions had strengthened further in recent months. Changes in payrolls, as measured by the establishment survey, had been temporarily depressed by the storms in September but were expected to bounce back in later months. Data from the household survey, which generally were viewed as not materially affected by the hurricanes, indicated that the unemployment rate ticked down to 4.2 percent in September, falling further below participants' estimates of its longer-run normal level. Participants also cited other indicators suggesting that labor market conditions continued to strengthen, including increases in the labor force participation rates of both prime-age and all individuals. Reports from some Districts pointed to difficulty attracting and retaining labor, but anecdotal information from other Districts suggested that workers with the requisite skills remained reasonably available. Many participants judged that the economy was operating at or above full employment and anticipated that the labor market would tighten somewhat further in the near term, as GDP was expected to grow at a pace exceeding that of potential output.

Participants discussed wage developments in light of the continued strengthening in labor market conditions. A few participants interpreted recent data on aggregate wage and labor compensation as indicating some firming in wage growth; a few others, however, judged wage growth to have been little changed over the past year. Overall, wage increases were generally seen as modest. A couple of participants expressed the view that, when the rate of labor productivity growth was taken into account, the pace of recent wage gains was consistent with an economy operating near full employment. Reports from District contacts indicated that some businesses facing tight labor markets found it more effective to expand their workforces by using a variety of nonpecuniary means, including offering greater job flexibility and training, rather than by increasing wages. Other District contacts, however, reported some increased wage pressure as a result of tightening labor market conditions.

Gasoline prices rose in the aftermath of the hurricanes, boosting overall inflation in September. Still, on a 12‑month basis, PCE price inflation in September, at 1.6 percent, remained below the Committee's longer-run objective; core PCE price inflation, which excludes consumer food and energy prices, was only 1.3 percent. Many participants judged that much of the recent softness in core inflation reflected temporary or idiosyncratic factors and that inflation would begin to rise once the influence of these factors began to wane. Most participants continued to think that the cyclical pressures associated with a tightening labor market were likely to show through to higher inflation over the medium term.

With core inflation readings continuing to surprise on the downside, however, many participants observed that there was some likelihood that inflation might remain below 2 percent for longer than they currently expected, and they discussed possible reasons for the recent shortfall. Several participants pointed to a diminished responsiveness of inflation to resource utilization, to the possibility that the degree of labor market tightness was less than currently estimated, or to lags in the response of inflation to greater resource utilization as plausible explanations for the continued soft readings on inflation. A few noted that secular influences, such as the effect of technological innovation in disrupting existing business models, were likely offsetting cyclical upward pressure on inflation and contributing to below-target inflation.

In discussing the implications of these developments, several participants expressed concern that the persistently weak inflation data could lead to a decline in longer-term inflation expectations or may have done so already; they pointed to low market-based measures of inflation compensation, declines in some survey measures of inflation expectations, or evidence from statistical models suggesting that the underlying trend in inflation had fallen in recent years. In addition, the possibility was raised that monetary policy actions or communications over the past couple of years, while inflation was below the Committee's 2 percent objective, may have contributed to a decline in longer-run inflation expectations below a level consistent with that objective. Some other participants, however, noted that measures of inflation expectations had remained stable this year despite the low readings on inflation and judged that this stability should support the return of inflation to the Committee's objective.

In their comments regarding financial markets, participants generally judged that financial conditions remained accommodative despite the recent increases in the exchange value of the dollar and Treasury yields. In light of elevated asset valuations and low financial market volatility, several participants expressed concerns about a potential buildup of financial imbalances. They worried that a sharp reversal in asset prices could have damaging effects on the economy. It was noted, however, that elevated asset prices could be partly explained by a low neutral rate of interest. It was also observed that regulatory changes had contributed to an appreciable strengthening of capital and liquidity positions in the financial sector over recent years, increasing the resilience of the financial system to potential reversals in valuations.

A few participants mentioned the limited reaction in financial markets to the announcement and initial implementation of the Committee's plan for gradually reducing the Federal Reserve's securities holdings. It was noted that, consistent with that limited response, market participants had characterized the Committee's communications regarding the balance sheet normalization program as clear and effective.

In their discussion of monetary policy, all participants thought that it would be appropriate to maintain the current target range for the federal funds rate at this meeting. Nearly all participants reaffirmed the view that a gradual approach to increasing the target range was likely to promote the Committee's objectives of maximum employment and price stability. Participants commented on several factors that informed their assessments of the appropriate path of the federal funds rate. Several participants noted that the neutral level of the federal funds rate appeared to be quite low by historical standards. Most saw the outlook for economic activity and the labor market as little changed since the September meeting, and participants expected increasing tightness in the labor market to put only gradual upward pressure on inflation. Still, with an accommodative stance of policy, most participants continued to anticipate that inflation would stabilize around the Committee's 2 percent objective over the medium term.

Many participants observed, however, that continued low readings on inflation, which had occurred even as the labor market tightened, might reflect not only transitory factors, but also the influence of developments that could prove more persistent. A number of these participants were worried that a decline in longer-term inflation expectations would make it more challenging for the Committee to promote a return of inflation to 2 percent over the medium term. These participants' concerns were sharpened by the apparently weak responsiveness of inflation to resource utilization and the low level of the neutral interest rate, and such considerations suggested that the removal of policy accommodation should be quite gradual. In contrast, some other participants were concerned about upside risks to inflation in an environment in which the economy had reached full employment and the labor market was projected to tighten further, or about still very accommodative financial conditions. They cautioned that waiting too long to remove accommodation, or removing accommodation too slowly, could result in a substantial overshoot of the maximum sustainable level of employment that would likely be costly to reverse or could lead to increased risks to financial stability. A few of these participants emphasized that the lags in the response of inflation to tightening resource utilization implied that there could be increasing upside risks to inflation as the labor market tightened further.

Participants agreed that they would continue to monitor closely and assess incoming data before making any further adjustment to the target range for the federal funds rate. Consistent with their expectation that a gradual removal of monetary policy accommodation would be appropriate, many participants thought that another increase in the target range for the federal funds rate was likely to be warranted in the near term if incoming information left the medium-term outlook broadly unchanged. Several participants indicated that their decision about whether to increase the target range in the near term would depend importantly on whether the upcoming economic data boosted their confidence that inflation was headed toward the Committee's objective. A few other participants thought that additional policy firming should be deferred until incoming information confirmed that inflation was clearly on a path toward the Committee's symmetric 2 percent objective. A few participants cautioned that further increases in the target range for the federal funds rate while inflation remained persistently below 2 percent could unduly depress inflation expectations or lead the public to question the Committee's commitment to its longer-run inflation objective.

In view of the persistent shortfall of inflation from the Committee's 2 percent objective and questions about whether longer-term inflation expectations were consistent with achievement of that objective, a couple of participants discussed the possibility that potential alternative frameworks for the conduct of monetary policy could be helpful in fulfilling the Committee's statutory mandate. One question, for example, was whether a framework that generally sought to keep the price level close to a gradually rising path--rather than the current approach in which the Committee does not seek to make up for past deviations of inflation from the 2 percent goal--might be more effective in fostering the Committee's objectives if the neutral level of the federal funds rate remains low.


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