17 September 2014 FOMC Meeting Minutes: Discussion of Global Downside Risks to USA Economy

Econintersect: The 17 September 2014 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 (albeit now at a slower and slower pace).

One of the more interesting meeting minute statements:

… Some participants expressed concern that the persistent shortfall of economic growth and inflation in the euro area could lead to a further appreciation of the dollar and have adverse effects on the U.S. external sector. Several participants added that slower economic growth in China or Japan or unanticipated events in the Middle East or Ukraine might pose a similar risk. At the same time, a couple of participants pointed out that the appreciation of the dollar might also tend to slow the gradual increase in inflation toward the FOMC’s 2 percent goal.

The meeting minutes have a slightly different feel with more convergence of views and events. 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 the Federal Reserve Bank presidents submitted their projections of real output growth, the unemployment rate, inflation, and the federal funds rate for each year from 2014 through 2017 and over the longer run, conditional on each participant’s assessment of appropriate monetary policy. The longer-run projections represent each participant’s assessment of the value 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 SEP, which is attached as an addendum to these minutes.

In their discussion of the economic situation and the outlook, meeting participants viewed the information received over the intermeeting period as suggesting that economic activity was expanding at a moderate rate. On balance, labor market conditions improved somewhat further; however, the unemployment rate was little changed, and most participants judged that there remained significant underutilization of labor resources. Participants generally expected that, over the medium term, real economic activity would increase at a pace sufficient to lead to a further gradual decline in the unemployment rate toward levels consistent with the Committee’s objective of maximum employment. Inflation was running below the Committee’s longer-run objective, but longer-term inflation expectations were stable. Participants anticipated that inflation would move toward the Committee’s 2 percent goal in coming years, with several expressing concern that inflation might persist below the Committee’s objective for quite some time. Most viewed the risks to the outlook for economic activity and the labor market as broadly balanced. However, a number of participants noted that economic growth over the medium term might be slower than they expected if foreign economic growth came in weaker than anticipated, structural productivity continued to increase only slowly, or the recovery in residential construction continued to lag.

Household spending appeared to be rising moderately, with several participants noting that the recent positive reports on retail sales, motor vehicle purchases, and health-care spending had reduced their concern about weakness in the underlying pace of household spending. Among the favorable factors attending the outlook for consumer spending, participants cited continued gains in household wealth, improved household balance sheets, low delinquency rates, a high saving rate, or rising confidence in employment and income prospects. However, other participants said they heard mixed reports from business contacts regarding consumer spending or were uncertain about the prospects for stronger gains in real income necessary to sustain moderate growth in household spending.

The recovery in housing activity remained slow in all but a few areas of the country despite relatively low mortgage rates, rising house prices, and improvements in household wealth. Contacts in a couple of Districts reported that new construction was being held back by shortages of materials, of lots available for development, and of skilled workers or by the overhang of vacant homes not on the market. Households with relatively low credit scores continued to have difficulty obtaining mortgage loans. It was noted that this difficulty could be a factor restraining the demand for housing, particularly among younger households who have high levels of student loan debt or weak job prospects. A few participants pointed out the relative strength in construction of and demand for multifamily units, which possibly was due to a shift in demand among younger homebuyers away from single-family homes.

Information from business contacts in most parts of the country indicated improvements in business conditions, rising confidence about the economic outlook, and increasing willingness to undertake new investment projects. According to national and regional surveys, manufacturing activity was strong, and several participants had received reports of hiring and increased capital spending in that sector. Among the other industries cited as relatively strong in recent months were transportation, energy, and services. Several participants noted positive signs of further increases in investment spending going forward, including elevated levels of new orders and shipments of capital goods, strong interest in the technology sector, and the need to replace aging capital. A couple of participants added that nonresidential construction activity was rising in their Districts.

The improvement in business conditions was reflected in reports of increased demand for loans at banks in several Districts. Demand rose for loans to both households and businesses, and a couple of participants indicated that borrowers were expanding their use of existing credit lines as well as obtaining new commitments. Bankers in one District stated that, while they had eased the terms and conditions on loans in response to competition from other lenders, they had not taken on riskier loans. Some financial developments that could undermine financial stability over time were noted, including a deterioration in leveraged lending standards, stretched stock market valuations, and compressed risk spreads. However, one participant suggested that the leveraged loan market seemed to be moving into better balance, and that market participants appeared to be taking appropriate account of the changes in interest rates that might be associated with the eventual normalization of the stance of monetary policy. Moreover, a couple of participants, while stressing the importance of remaining vigilant about potential risks to financial stability, observed that conditions in financial markets at present did not suggest the types of financial stability considerations that would impede the achievement of the Committee’s macroeconomic objectives.

Some participants noted that expectations for the path of the federal funds rate implied by market quotes appeared to remain below most of the projections of the federal funds rate provided by Committee participants in the SEP, which represent each individual participant’s assessment of the appropriate path for the federal funds rate consistent with his or her economic outlook. However, it was pointed out that measures of financial market participants’ expectations incorporate their judgments regarding not only the most likely outcomes, but also the possible downside tail risks that might be associated with especially low paths for the federal funds rate. For example, respondents to the recent Survey of Primary Dealers placed considerable odds on the federal funds rate returning to the zero lower bound during the two years following the initial increase in that rate. The probability that investors attach to such low interest rate scenarios could pull the expected path of the federal funds rate computed from market quotes below most Committee participants’ assessments of appropriate policy as reported in the SEP.

The restraint on economic activity from fiscal policy was seen as diminishing, and a couple of participants pointed out that, over the second half of the year, the remaining drag was likely to be small. Nonetheless, the cutbacks in both defense and nondefense federal outlays, as well as state governments’ budget restraint, continued to weigh on jobs and income in some parts of the country. Fiscal policy overall was anticipated to be a neutral factor for economic growth over the next several years.

During participants’ discussion of prospects for economic activity abroad, they commented on a number of uncertainties and risks attending the outlook. Over the intermeeting period, the foreign exchange value of the dollar had appreciated, particularly against the euro, the yen, and the pound sterling. Some participants expressed concern that the persistent shortfall of economic growth and inflation in the euro area could lead to a further appreciation of the dollar and have adverse effects on the U.S. external sector. Several participants added that slower economic growth in China or Japan or unanticipated events in the Middle East or Ukraine might pose a similar risk. At the same time, a couple of participants pointed out that the appreciation of the dollar might also tend to slow the gradual increase in inflation toward the FOMC’s 2 percent goal.

Labor market conditions continued to improve over the intermeeting period. Although the unemployment rate was little changed, participants variously cited positive readings from other indicators, including a decline in longer-term unemployment, the low level of new claims for unemployment insurance, the rise in job openings, and survey reports of increased hiring plans and job availability. While the most recent estimate of nonfarm payroll employment showed a smaller monthly gain than earlier in the year, it followed six months in which increases had averaged more than 200,000. Some participants were reluctant to place much weight on one monthly report or noted that the first estimate for August has frequently been revised up in recent years. Participants generally agreed that the accumulated progress in labor market conditions since the Committee’s current asset purchase program began in September 2012 had been substantial and expected that progress would be sustained. Nonetheless, they continued to express differing views on the extent of remaining slack in labor markets. Most agreed that underutilization of labor resources remained significant; these participants noted variously that the level of nonfarm payroll jobs had only recently returned to its pre-recession level, that the number of individuals working part time for economic reasons was still elevated relative to the level of unemployment, and that the labor force participation rate was still below assessments of its structural trend. In this regard, a couple of participants pointed out that the stability of the participation rate, on balance, over the past year suggested that some of the cyclical shortfall had diminished. Most agreed that the Committee’s assessment of labor market slack should be grounded in its review of a range of labor market indicators, although a few saw the gap between the unemployment rate and their estimate of its longer-run normal level as a reliable indicator of slack.

Most measures of labor compensation showed no broad-based increase in wage inflation. However, businesses in several Districts continued to report upward pressure on wages in specific industries and occupations associated with labor shortages or difficult-to-fill jobs, while a couple of participants noted a more general rise in current or planned wage increases in their regions. Several participants commented that the relatively subdued rise in nominal labor compensation was still below longer-run trend rates of productivity growth and inflation and was a signal of slack remaining in the labor market. However, a couple of others suggested some caution in reading subdued wage inflation as an indicator of labor market underutilization. They pointed out that if nominal wages did not adjust downward when unemployment was high, pent-up wage deflation could help explain the modest increases in wages so far during the recovery, and wages could rise more rapidly going forward as the unemployment rate continues to decline.

Inflation had been running below the Committee’s longer-run objective, and the readings on consumer prices over the intermeeting period were somewhat softer than during the preceding four months, in part because of declining energy prices. Most participants anticipated that inflation would move gradually back toward its objective over the medium term. However, participants differed somewhat in their assessments of how quickly inflation would move up. Some cited the stability of longer-run inflation expectations at a level consistent with the Committee’s objective as an important factor in their forecasts that inflation would reach 2 percent in coming years. Participants’ views on the responsiveness of inflation to the level and change in resource utilization varied, with a few seeing labor markets as sufficiently tight that wages and prices would soon begin to move up noticeably but with some others indicating that inflation was unlikely to approach 2 percent until the unemployment rate falls below its longer-run normal level. While most viewed the risk that inflation would run persistently below 2 percent as having diminished somewhat since earlier in the year, a couple noted the possibility that longer-term inflation expectations might be slightly lower than the Committee’s 2 percent objective or that domestic inflation might be held down by persistent disinflation among U.S. trading partners and further appreciation of the dollar.

In their discussion of the appropriate path for monetary policy over the medium term, meeting participants agreed that the timing of the first increase in the federal funds rate and the appropriate path of the policy rate thereafter would depend on incoming economic data and their implications for the outlook. That said, several participants thought that the current forward guidance regarding the federal funds rate suggested a longer period before liftoff, and perhaps also a more gradual increase in the federal funds rate thereafter, than they believed was likely to be appropriate given economic and financial conditions. In addition, the concern was raised that the reference to “considerable time” in the current forward guidance could be misunderstood as a commitment rather than as data dependent. However, it was noted that the current formulation of the Committee’s forward guidance clearly indicated that the Committee’s policy decisions were conditional on its ongoing assessment of realized and expected progress toward its objectives of maximum employment and 2 percent inflation, and that its assessment reflected its review of a broad array of economic indicators. It was emphasized that the current forward guidance for the federal funds rate was data dependent and did not indicate that the first increase in the target range for the federal funds rate would occur mechanically after some fixed calendar interval following the completion of the current asset purchase program. If employment and inflation converged more rapidly toward the Committee’s goals than currently expected, the date of liftoff could be earlier, and subsequent increases in the federal funds rate target more rapid, than participants currently anticipated. Conversely, if employment and inflation returned toward the Committee’s objectives more slowly than currently anticipated, the date of liftoff for the federal funds rate could be later, and future federal funds rate target increases could be more gradual. In addition, some participants saw the current forward guidance as appropriate in light of risk-management considerations, which suggested that it would be prudent to err on the side of patience while awaiting further evidence of sustained progress toward the Committee’s goals. In their view, the costs of downside shocks to the economy would be larger than those of upside shocks because, in current circumstances, it would be less problematic to remove accommodation quickly, if doing so becomes necessary, than to add accommodation. A number of participants also noted that changes to the forward guidance might be misinterpreted as a signal of a fundamental shift in the stance of policy that could result in an unintended tightening of financial conditions.

Participants also discussed how the forward-guidance language might evolve once the Committee decides that the current formulation no longer appropriately conveys its intentions about the future stance of policy. Most participants indicated a preference for clarifying the dependence of the current forward guidance on economic data and the Committee’s assessment of progress toward its objectives of maximum employment and 2 percent inflation. A clarification along these lines was seen as likely to improve the public’s understanding of the Committee’s reaction function while allowing the Committee to retain flexibility to respond appropriately to changes in the economic outlook. One participant favored using a numerical threshold based on the inflation outlook as a form of forward guidance. A few participants, however, noted the difficulties associated with expressing forward guidance in terms of numerical thresholds for some set of economic variables. Another participant indicated a preference for reducing reliance on explicit forward guidance in the statement and conveying instead guidance regarding the future stance of monetary policy through other mechanisms, including the SEP. It was noted that providing explicit forward guidance regarding the future path of the federal funds rate might become less important once a highly accommodative stance of policy is no longer appropriate and the process of policy normalization is well under way. It was generally agreed that when changes to the forward guidance become appropriate, they will likely present communication challenges, and that caution will be needed to avoid sending unintended signals about the Committee’s policy outlook.

 

Steven Hansen

Source: Federal Reserve