April 2012 FOMC Minutes: Big Question Mark on Employment Outlook

Econintersect: Looking into the minds of the members of the Federal Open Market Committee (FOMC) gives insights on how they view the economy. The April 25, 2012 meeting statement provided the actions taken, but the meeting minutes released today provides the detailed discussion.

It appears that the FOMC members believe the economy is improving but are uncertain that the improvements are sustainable.

There seemed to be an unusual amount of uncertainty on employment – see meeting minute extract below.  In addition, it seems that a division in the FOMC is developing on establishing set monetary policy benchmarks for reacting economic conditions.

Econintersect publishes below the comments of the FOMC members, not reports to the members – as it is an insight into the minds of the FOMC members.

The short version of where the economy is:

Participants’ assessments of the economic outlook were little changed, with the intermeeting information generally seen as suggesting that economic growth would remain moderate over coming quarters and then pick up gradually. Reflecting the moderate pace of economic growth, most anticipated a gradual decline in the unemployment rate. The incoming information led some participants to become more confident about the durability of the recovery. However, others thought it was premature to infer a stronger underlying trend from the recent positive indicators, since those readings may partially reflect the effects of the mild winter weather or other temporary influences. A number of factors continued to be seen as likely limiting the economic expansion to a moderate pace in the near term; these included slow growth in some foreign economies, prospective fiscal tightening in the United States, slow household income growth, and–notwithstanding some recent signs of improvement–ongoing weakness in the housing market. Participants continued to expect most of the factors restraining economic expansion to ease over time and so anticipated that the recovery would gradually gain strength.

The strains in global financial markets, though generally less pronounced than last fall, continued to pose a significant risk to the outlook, and the possibility of a sharp fiscal tightening in the United States was also considered a sizable risk. Most participants anticipated that inflation would fall back from recent elevated levels as the effects of higher energy prices waned, and still expected that inflation subsequently would run at or below the 2 percent rate that the Committee judges to be most consistent with its statutory mandate. However, other participants saw upside risks to the inflation outlook given the recent pickup in inflation and the highly accommodative stance of monetary policy.

On the household sector:

…… consumer spending continued to expand moderately, notwithstanding high gasoline prices. The recent strengthening in the pace of light motor vehicle sales was attributed to both pent-up demand and the desire for increased fuel efficiency in the wake of higher gasoline prices. Looking forward, increases in household wealth from the rise in equity prices, improving consumer sentiment, and a diminishing drag from household deleveraging were seen as helping to support continued increases in household expenditures, notwithstanding sluggish growth in real disposable income and restrictive fiscal policies.

Recent housing-sector indicators, including sales and starts, suggested some upward movement, but some participants saw the improvement as likely related to unusually warm winter weather in much of the country. Overall, the level of activity in the sector remained depressed. House prices appeared to be stabilizing but had not yet begun to rise in most markets. Most participants anticipated that the housing sector was likely to recover only slowly over time, but a few were more optimistic about the potential for a more rapid housing recovery given reports of stronger demand in some regions and of improved sentiment among builders, as well as signs that recent changes to the Home Affordable Refinance Program were contributing to the refinancing of performing high loan-to-value mortgages.

On business:

Reports from business contacts indicated that activity in the manufacturing, energy, and agriculture sectors continued to advance in recent months. Auto production had picked up in light of strengthening demand. Business contacts suggested that sentiment was improving, but many firms remained somewhat cautious in their hiring and investment decisions, with most capital investment being undertaken to improve productivity or gain market share rather than to expand capacity. Reportedly, this caution reflected in part continued uncertainty about the strength and durability of the economic recovery, as well as about government policies.

….. Exports have supported U.S. growth so far this year; however, some participants noted risks to the export picture from economic weakness in Europe or from a more significant slowdown in the pace of expansion in China and emerging Asia.

On fiscal policy:

Participants expected that the government sector would be a drag on economic growth over coming quarters. They generally saw the U.S. fiscal situation also as a risk to the economic outlook; if agreement is not reached on a plan for the federal budget, a sharp fiscal tightening could occur at the start of 2013. Several participants indicated that uncertainty about the trajectory of future fiscal policy could lead businesses to defer hiring and investment. It was noted that agreement on a longer-term plan to address the country’s fiscal challenges would help to alleviate uncertainty and consequent negative effects on consumer and business sentiment.

On employment:

Labor market conditions continued to improve, although unusually warm weather may have inflated payroll job figures somewhat earlier this year. Contacts in some parts of the country said that highly qualified workers were in short supply; overall, however, wage pressures had been limited so far. The decline in labor force participation, which has been sharpest for younger workers, has been a factor in the nearly 1 percentage point decline in the unemployment rate since last August, a drop that was larger than would have been predicted from the historical relationship between real GDP growth and changes in the unemployment rate. Assessing the extent to which the changes in labor force participation reflect cyclical factors that will be reversed once the recovery picks up, as opposed to changes in the trend rate of participation, was seen as important for understanding unemployment dynamics going forward. One participant cited research suggesting that about half of the decline in labor force participation had reflected cyclical factors, and thus, as participation picks up, unemployment may decline more slowly in coming quarters compared with the recent pace. Another posited that the strength in payroll job growth in recent months may be a one-time reaction to the sharp layoffs in 2008 and 2009 and that future job gains may be somewhat weaker unless the pace of economic growth increases. Participants expressed a range of views on the extent to which the unemployment rate was being boosted by structural factors such as mismatches between the skills of unemployed workers and those being demanded by hiring firms. A few participants acknowledged there could be structural factors at work, but said that in their view, slack remained high and weak aggregate demand was the major reason that unemployment was still elevated. Two noted the possibility that sustained high levels of long-term unemployment could result in higher structural unemployment, an outcome that might be forestalled by increased aggregate demand. A few participants noted that current measures of labor market slack would be overstated if structural factors accounted for a large portion of the current high levels of unemployment. As a result, such measures might be an unreliable guide as to how close the economy was to maximum employment. These participants pointed out that, over time, estimates of the potential level of output have declined, reducing, as a consequence, estimates of the level of economic slack. Some participants cited the recent rise in inflation, abstracting from the direct effect of the rise in energy prices, as supportive of the view that the level of slack was lower than some believe.

On monetary policy rules:

In their discussion of the economic outlook and policy, some participants noted the potential usefulness of simple monetary policy rules, of the type the Committee regularly reviews, as guides for monetary policy decisionmaking and for external communications about policy. These participants suggested that because such rules give an indication of how policy should systematically respond to changes in economic conditions they might help clarify the relationship between appropriate monetary policy and the evolution of the economic outlook. While acknowledging that there could be differences across participants in the type of rules they might favor–for example, one participant expressed a preference for rules based on growth rates rather than output gaps because of measurement issues–a few participants indicated that the likely degree of commonality across participants was suggestive that this might be a promising approach to explore. However, a few other participants were more skeptical. One thought that, while prescriptions from rules might provide useful benchmarks, applying the rules mechanically and with little thought about the embedded assumptions would be counterproductive. Another participant questioned the value of interest rate rules when the policy rate is constrained by the zero lower bound on nominal interest rates and unconventional policy options are being used, but others indicated they believed the rules could be appropriately adjusted to account for these factors. Interest was expressed in examining the usefulness of simple policy rules in a more normal environment, as well as in the current environment in which the policy rate is at the zero lower bound and large-scale asset purchases and the maturity extension program have been implemented. Participants planned to discuss further, at a future meeting, the potential merits and drawbacks of using simple rules as guides to monetary policy decisionmaking and for communications.

On Inflation:

Readings on consumer price inflation had picked up somewhat mainly because of increases in oil and gasoline prices earlier in the year. In recent weeks, oil prices had begun to fall and readings from the oil futures market suggested this may continue; non-energy commodity prices had remained relatively stable. Several participants noted that increases in labor costs continued to be subdued. With longer-run inflation expectations well anchored and the unemployment rate elevated, most participants anticipated that after the temporary effect of the rise in oil and gasoline prices had run its course, inflation would be at or below the 2 percent rate that the Committee judges to be most consistent with its mandate. Overall, most participants viewed the risks to their inflation outlook as being roughly balanced. However, some participants saw a risk that inflation pressures could increase as the expansion continued; they pointed to the fact that inflation was currently above target and were skeptical of models that rely on economic slack to forecast inflation partly because of the difficulty in measuring slack, especially in real time. These participants were concerned that maintaining the current highly accommodative stance of monetary policy over the medium run could erode the stability of inflation expectations and risk higher inflation. In this regard, one participant noted the potential risks and costs associated with additional balance sheet actions.

There were several procedural votes on extending or slightly modifying existing Fed policy. These can be read by clicking on the hyperlink below.

Steven Hansen

source: Federal Reserve