December 2012 FOMC Meeting Minutes: Discussing Quantitative Easing

Econintersect: This is the meeting which culminated in QE4. The 11 December 2012 meeting statement presented the actions taken. This post covers the discussion during this FOMC meeting between the members.  It should be noted that despite all the quantitative easing, the Fed’s Balance Sheet (which we report on weekly) – still has not exceeded the peak value achieved in mid-February 2012.  Since 11 December, the balance sheet has contracted $10 billion.

It appears that the FOMC members believed the economy is expanding moderately, and were worried that the Fiscal Cliff debate was muting demand.  The most interesting discussion was on the potential effects of the QE programs:

With regard to the possible costs and risks of purchases, a number of participants expressed the concern that additional purchases could complicate the Committee’s efforts to eventually withdraw monetary policy accommodation, for example, by potentially causing inflation expectations to rise or by impairing the future implementation of monetary policy. Participants also discussed the implications of continued asset purchases for the size of the Federal Reserve’s balance sheet. Depending on the path for the balance sheet and interest rates, the Federal Reserve’s net income and its remittances to the Treasury could be significantly affected during the period of policy normalization.

Specific participant discussions follows.

Econintersect publishes below the views of the FOMC members, and does not go over the reports 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, participants regarded the information received during the intermeeting period as indicating that economic activity and employment continued to expand at a moderate pace, apart from weather-related disruptions. The unemployment rate had declined somewhat since the summer but remained elevated. Although household spending had continued to advance, growth in business fixed investment had slowed. The housing sector had shown further signs of improvement. Consumer price inflation had been running somewhat below the Committee’s longer-run objective of 2 percent, apart from temporary variations that largely reflected fluctuations in energy prices, and longer-term inflation expectations had remained stable.

In their assessments of the economic outlook, many participants thought that the pace of economic expansion would remain moderate in 2013 before picking up gradually in 2014 and 2015. This outlook was little changed from their projections at recent meetings. Hurricane Sandy was expected to weigh on economic growth in the current quarter, but rebuilding could provide some temporary impetus early in 2013. Participants’ forecasts, which generally were conditioned on the view that it would be appropriate to maintain a highly accommodative monetary policy for a considerable time, included an outlook for a continued gradual decline in the unemployment rate toward levels judged to be consistent with the Committee’s mandate over the longer run, with inflation running near the Committee’s 2 percent longer-run goal.

Participants observed that growth in economic activity continued to be restrained by several persistent headwinds, including ongoing deleveraging on the part of households and still-tight credit conditions for some borrowers, and that a major headwind facing the economy at present appeared to be uncertainty about U.S. fiscal policy and the outcome of the ongoing negotiations on federal spending and taxes. While participants generally saw it as likely that the Congress and the Administration would avert the full force of the tax increases and spending cuts scheduled to occur in 2013, almost all indicated that heightened uncertainty about fiscal policy probably was affecting economic activity adversely. For example, it likely had reduced household and business confidence and led firms to defer hiring and investment spending. Some participants noted that an early and constructive resolution to fiscal policy negotiations had the potential to release pent-up demand and therefore be followed by a boost to spending, investment, and employment; however, a few pointed out that an extended breakdown of negotiations could have significant adverse effects on economic growth. Other factors weighing on the economic outlook included the slowdown in global economic growth and continued uncertainty regarding the European fiscal and banking situation.

In their discussion of the household sector, many participants noted a recent drop in consumer sentiment and a softening in consumer spending. Some participants thought this reflected uncertainty about fiscal policy, including the prospect of higher taxes, and several noted that growth of households’ real disposable income remained weak despite recent gains in employment. While indicators of spending were mixed, purchases of autos and other durables remained relatively strong. A couple of participants observed that businesses in a few areas had reported strong holiday-related activity. Many pointed out that reductions in households’ debt, together with rising home prices, had led to an improvement in household balance sheets; it was noted that household net worth was approaching levels seen before the financial crisis.

Meeting participants generally agreed that the recovery in the housing sector had continued. Many commented that the headwinds facing the housing market appeared to have dissipated somewhat. The capacity constraints on the processing of new home-mortgage applications appeared to be easing, and gradually rising home prices had reduced the proportion of households with underwater mortgages. It was noted that the mix of new home sales seemed to have shifted from homes already completed to homes not yet built.

In discussing labor market developments, participants generally viewed the recent data as having been somewhat better than expected, with moderate gains in payroll employment and a decline in the unemployment rate. However, the unemployment rate remained elevated, and part of the decline in unemployment in November was attributable to a drop in labor force participation. A few participants noted that some exits from the labor force may have been related to the loss or prospective loss of eligibility for emergency unemployment insurance benefits. Several pointed to indicators suggesting that rates of hiring remained depressed relative to those observed before the financial crisis. A couple of participants noted that vacancies remained at a high level in terms of their historical relationship to the rate of unemployment, suggesting that at least some firms were having a hard time finding suitable workers; indeed, business contacts in a couple of regions had reported difficulty in locating and retaining workers with requisite skills. However, one participant suggested that employer-worker mismatch likely reflected longer-term problems and had probably not worsened materially as a result of the recent deep recession and slow recovery.

Business contacts in many parts of the country were also said to be highly uncertain about the outlook for U.S. fiscal policy, and participants noted that this uncertainty appeared to have weighed on investment and hiring decisions. Although firms’ balance sheets were generally strong and liquidity was ample, some business contacts reported that they had shifted toward a higher proportion of part-time employees and postponed plans to expand capacity. A number of participants suggested that the business sector was well positioned to expand spending and hiring quickly upon a positive resolution of the fiscal cliff negotiations. In a few regions, contacts reported concerns about the expense associated with new regulations, including those related to health care, and in some cases indicated a shift to the hiring of part-time workers in order to avoid these costs. There were reports of weaker manufacturing, particularly in the Northeast in the aftermath of Hurricane Sandy, and a slackening in economic activity in the Southwest related in part to cutbacks in defense spending. Export orders had softened, reflecting the slowdown in global growth. The energy sector continued to expand. In the agricultural sector, farm incomes were high, notwithstanding the drought, although elevated grain prices were cutting into profits on livestock.

Incoming information pointed to stable, low inflation that was running a little below the Committee’s longer-run goal of 2 percent. Crude oil prices had moved down since the October meeting amid accumulating inventories and market concerns about a weaker global outlook. Despite some reports of labor shortages in certain industries, compensation pressures had remained subdued, and unit labor costs were little changed over the previous four quarters. Most participants saw the risks to the inflation outlook as broadly balanced, and many noted that longer-term inflation expectations were well anchored. One participant, however, expressed concern that considerable uncertainty surrounded the relationship between unemployment and inflation, raising questions about the extent to which resource slack would keep inflation restrained over the medium term.

In their discussion of financial developments, a few participants commented that recent steps taken by European authorities had reduced volatility in sovereign debt markets over the intermeeting period; however, concerns remained about the fiscal and economic outlook in Europe. Many noted the ongoing deleveraging in the private nonfinancial sector of the U.S. economy and indicated that it was difficult to judge when that process would be complete. A few participants, observing that low interest rates had increased the demand for riskier financial products, pointed to the possibility that holding interest rates low for a prolonged period could lead to financial imbalances and imprudent risk-taking. One participant suggested that there were several historical episodes in the United States and other countries that might be used to build a better understanding of the financial strains that could develop from a long period of very low long-term interest rates. Pointing to a recent decision of the Financial Stability Oversight Council, one participant commented that further money market mutual fund reform would help reduce risk in the financial system.

Participants exchanged views on the likely benefits and costs of additional asset purchases in the context of an assessment of the ongoing purchases of MBS and possible additional purchases of longer-term Treasury securities to follow the conclusion of the maturity extension program. Regarding the benefits, it was noted that asset purchases provide support to the economic recovery by putting downward pressure on longer-term interest rates and promoting more-accommodative financial conditions. Participants discussed the effectiveness of purchasing different types of assets and the potential for the effects on yields from purchases in the market for one class of securities to spill over to other markets. If these spillovers are significant, then purchases of longer-term Treasury securities might be preferred, in light of the depth and liquidity of that market. However, if markets are more segmented, purchases of MBS might be preferred because they would provide more support to real activity through the housing sector. One participant commented that the best approach would be to continue purchases in both the Treasury and MBS markets, given the uncertainty about the precise channels through which asset purchases operated. Others emphasized the advantages of MBS purchases, including by noting the apparent effectiveness of recent MBS purchases on the housing market, while another participant objected and thought that Federal Reserve purchases should not direct credit to a specific sector. With regard to the possible costs and risks of purchases, a number of participants expressed the concern that additional purchases could complicate the Committee’s efforts to eventually withdraw monetary policy accommodation, for example, by potentially causing inflation expectations to rise or by impairing the future implementation of monetary policy. Participants also discussed the implications of continued asset purchases for the size of the Federal Reserve’s balance sheet. Depending on the path for the balance sheet and interest rates, the Federal Reserve’s net income and its remittances to the Treasury could be significantly affected during the period of policy normalization. Participants noted that the Committee would need to continue to assess whether large purchases were having adverse effects on market functioning and financial stability. They expressed a range of views on the appropriate pace of purchases, both now and as the outlook evolved. It was agreed that both the efficacy and the costs would need to be carefully monitored and taken into account in determining the size, pace, and composition of asset purchases.

Meeting participants discussed the possibility of replacing the calendar date in the forward guidance for the federal funds rate with specific quantitative thresholds of 6-1/2 percent for the unemployment rate and 2-1/2 percent for projected inflation between one and two years ahead. Most participants favored replacing the calendar-date forward guidance with economic thresholds, and several noted that the consistency between the “mid-2015” reference in the Committee’s October statement and the specific quantitative thresholds being considered at the current meeting provided an opportunity for a smooth transition. However, possible advantages of waiting a while to introduce the change to the Committee’s forward guidance were also mentioned, including that a delay might simplify communications by keeping the introduction of thresholds separate from the announcement of additional asset purchases. Among the benefits of quantitative thresholds that were cited was that they could help the public more readily understand how the likely timing of an eventual increase in the federal funds rate would shift in response to unanticipated changes in economic conditions and the outlook. Accordingly, thresholds could increase the probability that market reactions to economic developments would move longer-term interest rates in a manner consistent with the Committee’s view regarding the likely future path of short-term interest rates. A few participants expressed a preference for using a qualitative description of the economic indicators influencing the Committee’s thinking about current and future monetary policy rather than quantitative guidance because they felt that qualitative guidance would be at least as effective as numerical thresholds while avoiding some potential disadvantages, including the possibility that the numerical thresholds would be mistakenly interpreted as the Committee’s longer-run objectives. A few participants commented that the quantitative thresholds might be interpreted as triggers that, when reached, would prompt an immediate increase in short-term rates. However, a number of participants indicated that the Chairman’s press conference and other avenues of communication could be used to emphasize, for example, the distinction between thresholds and the longer-run objectives as well as between thresholds and triggers. Participants also discussed the importance of clarifying that the thresholds would not be followed mechanically and that a variety of indicators of labor market conditions and inflation pressures, as well as financial developments, would be taken into account in setting policy.

Committee Policy Action

Committee members viewed the information received over the intermeeting period as suggesting that economic activity and employment continued to expand at a moderate pace in recent months, abstracting from weather-related disruptions. Household spending had continued to advance and the housing sector had shown further signs of improvement, but growth in the business sector had slowed. Anecdotal evidence indicated that uncertainty about U.S. fiscal policy weighed heavily on sentiment in the household and business sectors. Although the unemployment rate had declined somewhat since the summer, it was still elevated relative to levels that members viewed as normal in the longer run. Members generally agreed that the economic outlook was little changed since the previous meeting and judged that, without sufficient policy accommodation, economic growth might not be strong enough to generate sustained improvement in labor market conditions. Furthermore, strains in global financial markets continued to pose significant downside risks to the economic outlook. Inflation had been subdued, apart from some temporary variations that largely reflected fluctuations in energy prices. With longer-term inflation expectations stable, inflation over the medium term was anticipated to run at or below the Committee’s longer-run objective of 2 percent.

In their discussion of monetary policy for the period ahead, all members but one judged that continued provision of monetary accommodation was warranted in order to support further progress toward the Committee’s goals of maximum employment and price stability. The Committee judged that such accommodation should be provided in part by continuing to purchase MBS at a pace of $40 billion per month and by purchasing longer-term Treasury securities, initially at a pace of $45 billion per month, following the completion of the maturity extension program at the end of the year. The Committee also maintained its existing policy of reinvesting principal payments from its holdings of agency debt and agency MBS into agency MBS and decided that, starting in January, it will resume rolling over maturing Treasury securities at auction. While almost all members thought that the asset purchase program begun in September had been effective and supportive of growth, they also generally saw that the benefits of ongoing purchases were uncertain and that the potential costs could rise as the size of the balance sheet increased. Various members stressed the importance of a continuing assessment of labor market developments and reviews of the program’s efficacy and costs at upcoming FOMC meetings. In considering the outlook for the labor market and the broader economy, a few members expressed the view that ongoing asset purchases would likely be warranted until about the end of 2013, while a few others emphasized the need for considerable policy accommodation but did not state a specific time frame or total for purchases. Several others thought that it would probably be appropriate to slow or to stop purchases well before the end of 2013, citing concerns about financial stability or the size of the balance sheet. One member viewed any additional purchases as unwarranted.

With regard to its forward guidance about the federal funds rate, the Committee decided to indicate in the statement language that it expects the highly accommodative stance of monetary policy to remain appropriate for a considerable time after the asset purchase program ends and the economic recovery strengthens. In addition, all but one member agreed to replace the date-based guidance with economic thresholds indicating that the exceptionally low range for the federal funds rate would remain appropriate at least as long as the unemployment rate remains above 6½ percent, inflation between one and two years ahead is projected to be no more than a half percentage point above the Committee’s longer-run goal, and longer-term inflation expectations continue to be well anchored. The Committee thought it would be helpful to indicate in the statement that it viewed the economic thresholds as consistent with its earlier, date-based guidance. The new language noted that the Committee would also consider other information when determining how long to maintain the highly accommodative stance of monetary policy, including additional measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments. One member dissented from the policy decision, opposing the new economic threshold language in the forward guidance, as well as the additional asset purchases and continued intervention in the MBS market.

Steven Hansen

Source: Federal Reserve