Econintersect: The 18 September 2013 meeting statement presented the actions taken. This post covers the economic discussion during this FOMC meeting between the members. The Fed’s Balance Sheet (which we report on weekly) continues to grow at record levels.
Overall, the meeting participants generally seem confused about the current economic conditions:
… economic activity had continued to expand at a moderate pace, albeit somewhat more slowly than earlier anticipated, and they generally indicated that the broad contours of the outlook further out had not changed materially since their July meeting.
… downside risks to the outlook for the economy and the labor market were generally viewed as having diminished;
… the effects of the federal sequestration appeared to be less pronounced than previously anticipated.
Overall, the tapering timeline appears unchanged as indicated below.
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 conjunction with this FOMC meeting, meeting participants–5 members of the Board of Governors and the presidents of the 12 Federal Reserve Banks, all of whom participated in the deliberations–submitted their assessments of real output growth, the unemployment rate, inflation, and the target federal funds rate for each year from 2013 through 2016 and over the longer run, under each participant’s judgment of appropriate monetary policy. The longer-run projections represent 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 economic projections and policy assessments are described in the Summary of Economic Projections (SEP), which is attached as an addendum to these minutes.
In their discussion of the economic situation and outlook, meeting participants regarded the information received during the intermeeting period as indicating that economic activity had continued to expand at a moderate pace, albeit somewhat more slowly than earlier anticipated, and they generally indicated that the broad contours of the outlook further out had not changed materially since their July meeting. Participants continued to project the rate of growth of economic activity to strengthen over coming years, supported by highly accommodative monetary policy and the gradual abatement of the headwinds that have been slowing the pace of economic recovery, such as household-sector deleveraging, tight credit conditions for some households and businesses, and fiscal restraint. Accordingly, the unemployment rate was projected to continue to decline over time toward levels judged to be consistent with the Committee’s dual mandate. While downside risks to the outlook for the economy and the labor market were generally viewed as having diminished, on balance, since last fall, a number of significant risks remained, including those related to the potential economic effects of the sizable increases in interest rates since the spring, ongoing fiscal drag, and the possible fallout from near-term fiscal debates. Inflation continued to run below the Committee’s longer-run objective, apart from fluctuations that largely reflected changes in energy prices, and participants generally saw it as moving back gradually to 2 percent in the medium term.
In the household sector, consumer spending continued to advance, but incoming data on retail sales were somewhat weaker than expected. Auto sales, however, remained strong, supported in part by steady interest rates on auto loans, which, unlike mortgage rates, did not rise substantially in recent months. Despite the continued improvement in household balance sheets, a number of factors were mentioned as possible restraints on spending, including declines in consumer confidence, concerns about job security and availability, and the lingering effects of this year’s payroll tax increase. While the housing sector continued to strengthen, supported by improving fundamentals and gains in house prices, the increases in mortgage rates since the spring were seen as a potential risk. The extent to which the higher mortgage rates had materially affected that sector remained unclear, with the exception of the sharp decline in refinancing activity. But it was noted that recent softness in housing starts and home sales might well reflect some restraint from those higher rates.
Business contacts in selected parts of the country were reported to be cautiously optimistic, consistent with encouraging responses to a number of business surveys. Nonetheless, uncertainties regarding the outlook for the economy and fiscal and regulatory policies were reportedly continuing to weigh on business decisionmaking, with firms focused on improving their balance sheets and enhancing productivity and still quite cautious about expanding their workforces. Reports on manufacturing activity pointed to some rebound, with production related to autos the most notable area of strength, and activity in the energy sector continued to expand at a steady pace. In the agricultural sector, farmland values increased further, even though farm income was reported to be declining. Some business contacts indicated that wage and price pressures were subdued; however, in one District, contacts pointed to rising wage pressures and labor shortages.
Participants discussed the extent to which the ongoing tightening in fiscal policy was likely to further restrain economic activity in the second half of this year, with one participant noting that the effects of the federal sequestration appeared to be less pronounced than previously anticipated. However, a number of others pointed to heightened uncertainty about the course of federal fiscal policy over coming months, including the potential for a government shutdown or strains related to the debt ceiling debate, which posed downside risks to the economic outlook.
In discussing labor market developments, a number of participants indicated that gains in payrolls in the July and August employment reports were disappointing, but one participant also noted that seasonal adjustment tended to be challenging during the summer months. Taking a range of data into account, participants generally agreed that labor market conditions had improved meaningfully since the start of the asset purchase program in September 2012. Participants discussed how to reconcile the notable decline in the unemployment rate over the past year with the only moderate pace of expansion in real GDP. One possible explanation was that, to the extent the decline in the unemployment rate was primarily driven by a fall in the labor force participation rate and low productivity growth, such a decline might overstate the degree of improvement in broader labor market conditions. Indeed, the continued low readings on the employment-to-population ratio were supportive of this explanation, suggesting that overall labor market conditions had not improved as much as the unemployment rate would indicate. An alternative explanation for the significant improvement in the labor market performance despite the moderate growth in real GDP over the past year was that growth had been understated somewhat; notably, some research suggested that real gross domestic income, which expanded at a somewhat faster pace than real GDP, may provide better information about overall economic activity. Despite recent declines in the unemployment rate, one participant noted the risk that the longer the duration of elevated unemployment, the more likely it was that the labor market and economy would experience some lasting structural damage. While judging the extent of structural damage continued to be quite difficult, one piece of evidence consistent with this view was the apparent decline in the job-finding rate of the long-term unemployed.
Despite the reversal of some transitory factors that had contributed to the earlier softness in inflation, recent readings continued to be below the Committee’s longer-run objective of 2 percent. However, participants generally expected inflation to pick up over the coming year as the pace of economic growth accelerated and slack in resource utilization diminished further, although to a rate still below the Committee’s longer-run objective.
Participants discussed financial market developments, including their views on the extent to which the rise in longer-term interest rates since May reflected growing confidence about the economic outlook or a perception by financial markets that monetary policy would be less accommodative going forward than had been previously anticipated. Several participants judged that overall financial conditions had tightened notably over the past few months, as seen most importantly in the rise in mortgage rates. While acknowledging that it was too early to assess the effects of such an increase, they expressed concerns that tighter financial conditions might weigh on the recovery in the housing sector. A few others observed that the increase in longer-term yields in recent months had not seemed to leave a meaningful imprint on other asset prices, suggesting that the effects on the economy were likely to be relatively muted. While recognizing the potentially significant impact of higher mortgage rates on the housing market, these same participants pointed to higher equity prices, the further gradual loosening of terms in bank lending, and the continued availability of credit at inexpensive terms in corporate debt markets as signs that financial conditions more generally had not tightened materially. In any case, however, the assessment of the adverse effects of the increase in longer-term rates on financial conditions and ultimately on economic activity would depend importantly upon the extent to which rates stabilized at current levels or instead continued to rise.
Participants also touched on the implications for financial stability resulting from the increase in interest rates, focusing on the effects on securities held by banking and other nonbank institutions, the unwinding of leveraged trades, and the liquidity and functioning of a number of fixed-income markets. One participant noted that, notwithstanding the recent rise in interest rates, net interest margins remained under pressure at community and regional banks, and as a result many of these banks continued to add to risk exposures. Another participant raised the possibility that financial stability risks might arise from recent adverse developments in municipal bond markets. It was also noted that financial conditions in a number of EMEs had tightened as a result of some depreciation of their currencies, an increase in yields and borrowing costs, and some capital outflows as measured by withdrawals from bond funds. More broadly, a couple of participants noted the complexities related to the interaction between the stance of monetary policy and the vulnerabilities in the financial system.
In their discussion of the path for monetary policy, participants debated the advantages and disadvantages of reducing the pace of the Committee’s asset purchases at this meeting, focusing importantly on whether the conditions presented to the public in June for reducing the pace of asset purchases had yet been met. In general, those who preferred to maintain for now the pace of purchases viewed incoming data as having been on the disappointing side and, despite clear improvements in labor market conditions since the purchase program’s inception in September 2012, were not yet adequately confident of continued progress. Many of these participants had revised down their forecasts for economic activity or pointed to near-term risks and uncertainties. For example, questions were raised about the effects on the housing sector and on the broader economy of the tightening in financial conditions in recent months, as well as about the considerable risks surrounding fiscal policy. Moreover, the announcement of a reduction in asset purchases at this meeting might trigger an additional, unwarranted tightening of financial conditions, perhaps because markets would read such an announcement as signaling the Committee’s willingness, notwithstanding mixed recent data, to take an initial step toward exit from its highly accommodative policy. As a result of such concerns, a number of participants thought that risk-management considerations called for a cautious approach and that, in light of the ambiguous cast of recent readings on the economy, it would be prudent to await further evidence of progress before reducing the pace of asset purchases. Consistent with the framework discussed by the Chairman during the June press conference, asset purchases were contingent on the Committee’s ongoing assessment of the economic outlook and were not on a preset course; this approach implied a need to adapt and to adjust asset purchases in response to changes in economic conditions in order to preserve the Committee’s credibility. With many outside observers expecting a decision to reduce purchases at this meeting, some participants emphasized a need to clearly communicate the rationale behind any decision not to do so, in order to avoid conveying a message of pessimism regarding the economic outlook or to reinforce the distinction between decisions concerning the pace of purchases and those concerning the federal funds rate. One participant suggested that postponing the reduction in the pace of asset purchases would also allow time for the Committee to further discuss and to implement a clarification or strengthening of its forward guidance for the federal funds rate, which could temper the risk that a future downward adjustment in asset purchases would cause an undesirable tightening of financial conditions.
The participants who spoke in favor of moderating the pace of securities purchases at this meeting also cited the incoming data, but viewed those data as broadly consistent with the Committee’s outlook for the labor market at the time of the June FOMC meeting when the contingent expectation that the pace of asset purchases would be reduced later in the year was first presented to the public. Moreover, they highlighted what they saw as meaningful cumulative progress in labor market conditions since the purchase program began. Those participants generally were satisfied that investors had come to understand the data-dependent nature of the Committee’s thinking about asset purchases, and, because they judged that the conditions laid out in June had been met, they believed that the credibility of the Committee would best be served by announcing a downward adjustment in asset purchases at this meeting. With the markets apparently viewing a cut in purchases as the most likely outcome, it was noted that the postponement of such an announcement to later in the year or beyond could have significant implications for the effectiveness of Committee communications. In particular, concerns were expressed that a delay could potentially undermine the credibility or predictability of monetary policy by, for example, increasing uncertainty about the Committee’s reaction function and about its commitment to the forward guidance for the federal funds rate, with the result of an increase in volatility in financial markets. Moreover, maintaining the pace of purchases could be perceived as a sign that the FOMC had turned more pessimistic about the economic outlook. Finally, it was noted that if the Committee did not pare back its purchases in these circumstances, it might be difficult to explain a cut in coming months, absent clearly stronger data on the economy and a swift resolution of federal fiscal uncertainties. Most of the participants leaning toward a downward adjustment in the pace of asset purchases also indicated that they favored a relatively small reduction to signal the Committee’s intention to proceed cautiously.
With regard to adjustments in the pace of asset purchases, whether at this or a future meeting, a few participants expressed a preference for not cutting MBS purchases but reducing purchases only of Treasury securities initially, with the intent of continuing to support the recovery in the housing sector. However, the appeal of including both types of securities in any reduction was also mentioned. In addition, in an effort to reduce uncertainty about how the Committee might adjust its purchases in response to economic developments and to alleviate some of the related communications issues, one participant suggested an approach that would mechanically link the reduction in asset purchases to numerical values for the unemployment rate, with the goal of ending the program when the unemployment rate reached a stated level.
Participants also discussed the potential for clarifying or strengthening the Committee’s forward guidance for the federal funds rate. To the extent that financial markets have at times interpreted the Committee’s communications regarding the asset purchase program as also signaling information about the federal funds rate target, participants thought it might be important to reiterate the distinction between the two, and a clarification or strengthening of the forward guidance might help to reinforce this message. In part toward this end, participants mentioned several possible steps that might be considered, including stating that the Committee would not raise its target for the federal funds rate if the inflation rate was expected to run below a given level or providing additional information on the Committee’s intentions regarding the federal funds rate after the 6-1/2 percent unemployment threshold was reached. One participant stressed that the Committee could use the full range of its tools, including forward guidance, to further improve the alignment of the medium-term outlook for employment and inflation with its longer-term goals. In light of the importance of credibility for the effectiveness of the forward guidance for the federal funds rate, participants noted the possible implications of uncertainties related to the Federal Reserve leadership transition in considering the appropriate timing of any enhancements to the guidance.
In discussing the projections for the target federal funds rate at the end of 2016 as reported in the SEP, some participants highlighted the importance of communicating to the public the reasons why the policy rates that were projected by most, but not all, participants appeared to remain at low levels even as the unemployment rate and inflation by then were expected to be close to their longer-run values. In particular, if economic headwinds died away only slowly, as a number of participants expected, the achievement of the Committee’s employment and price stability objectives would likely require keeping the federal funds rate below its longer-run equilibrium value for some time even as economic conditions improved. In light of the potential difficulties in succinctly conveying this information in the Committee’s policy statement, the Chairman’s postmeeting press conference and the minutes were mentioned as more appropriate vehicles for providing this information. A couple of participants also remarked that they viewed their projections of a low federal funds rate in 2016 as reflecting a commitment to support the economy by maintaining a more accommodative policy for longer.
After reading this, one wonders whether there will not always be something which works against tapering of Fed purchases.
Source: Federal Reserve