Fed Officials Divided on Further Stimulus
Federal Reserve policy makers disagreed on whether additional monetary stimulus will be needed even if the outlook for economic growth remains weak, minutes of their meeting last month showed.
“A few members noted that, depending on how economic conditions evolve, the committee might have to consider providing additional monetary stimulus, especially if economic growth remained too slow to meaningfully reduce the unemployment rate in the medium run,” the Federal Open Market Committee said in the minutes of its June 21-22 meeting, released today in Washington.
“On the other hand, a few members viewed the increase in inflation risks as suggesting that economic conditions might well evolve in a way that would warrant” the FOMC “taking steps to begin removing policy accommodation sooner than currently anticipated.”
Policy makers cut their forecasts for growth this year before a July 8 government report showed employers added jobs at the slowest pace in nine months in June. Chairman Ben S. Bernanke at a June 22 news conference said growth will pick up as energy prices subside and disruptions of parts from Japanese factories ease, while also leaving the door open to additional stimulus. In their meeting, policy makers also agreed on a strategy for withdrawing record monetary stimulus and adopted a new set of communications guidelines.
Stocks rallied after the report before giving up gains as Moody’s Investors Service cut Ireland’s debt rating to junk. The Standard & Poor’s 500 Index fell 0.4 percent to 1,313.64 at the 4 p.m. close of trading in New York after rising as much as 0.6 percent. The yield on the 10-year Treasury note fell to 2.88 percent from 2.92 percent late yesterday.
A divided FOMC means officials are likely to prolong their low interest-rate policy, said Chris Low, chief economist at FTN Financial in New York.
“The majority view is that they can’t ease because inflation is rising but at the same time they can’t tighten because the unemployment rate is too high, so they’re on hold,” Low said.
The minutes show some officials have doubts about whether their policy toolkit has anything more to offer. “A few participants expressed uncertainty about the efficacy of monetary policy in current circumstances but disagreed on the implications for future policy,” the minutes said.
Some members of the FOMC “saw the recent configuration of slower growth and higher inflation as suggesting that there might be less slack in labor and product markets than had been thought,” the minutes said. In that case, “the withdrawal of monetary accommodation may need to begin sooner than currently anticipated in financial markets.”
The Fed’s Washington-based governors and regional presidents agreed to complete their $600 billion bond buying program, known as QE2 for the second round of quantitative easing, as scheduled at the end of June.
“The Fed will be watching and waiting to learn more about the economy,” said Michael Feroli, chief U.S. economist at JPMorgan Chase & Co. (JPM) in New York. “One camp is worried about what happens if growth slows more than expected. The other camp is worried about what happens if the rise in inflation isn’t transitory.”
Policy makers also renewed their pledge to hold interest rates “exceptionally low” for an “extended period.” The Fed has kept its target rate in a range of zero to 0.25 percent since December 2008. Bernanke at the June press conference said the Fed would be “prepared to take additional action, obviously, if conditions warranted,” including the purchase of more Treasury securities.
“Most” FOMC members said the rise in inflation would “prove transitory” and that over the medium term inflation would “be subdued as long as commodity prices did not continue to rise rapidly and longer-term inflation expectations remained stable.”
“A few participants saw a continuation of the current stance of monetary policy as posing upside risk to inflation expectations and actual inflation over time,” the minutes said.
Policy makers discussed adopting an explicit target for the rate of inflation, with “a few” saying it “could help keep longer-term inflation expectations well anchored.” One participant said an inflation target could “alter the relative importance of the two components of the committee’s dual mandate.” The Fed has a mandate from Congress to achieve both stable prices and maximum employment.
Economists predict the central bank’s target rate will remain near zero until the second quarter of 2012, according to the median estimates of a Bloomberg News survey from June 28 to July 7. Investors who trade Fed funds futures, or bets on the central bank’s target rate, see an 86 percent chance that interest rates will remain unchanged until at least the second quarter of 2012, according to Bloomberg data.
The committee said that “the recovery remained subject to some downside risks” such as a further decline in housing prices, a larger-than-expected tightening of fiscal policy in the near future, and “potential financial and economic spillovers” from the European debt crisis.
Policy makers also said that “even a short delay in the payment of principal or interest on the Treasury Department’s debt obligations would likely cause severe market disruptions” and have a “lasting effect on U.S. borrowing costs.”
Steps to Exit
The minutes showed that all but one of the FOMC members agreed on the sequence for an exit from record monetary stimulus. The minutes said the discussion was part of “prudent planning” and didn’t imply that an exit would take place soon.
The minutes said the committee will determine “the timing and pace of policy normalization.” The first step will be to “cease reinvesting some or all payments of principal” on securities holdings in the Fed’s portfolio.
“At the same time or sometime thereafter, the committee will modify its forward guidance on the path of the federal funds rate and will initiate temporary reserve-draining operations aimed at supporting the implementation of increases in the federal funds rate when appropriate,” the minutes said.
When economic conditions warrant, the committee would raise the federal funds rate, which would become the “primary means of adjusting the stance of monetary policy.” Sales of agency securities from the Fed’s portfolio would likely begin after the first federal funds rate increase, with the timing and pace of sales communicated to the public in advance. The pace of sales will be aimed at eliminating agency securities from the Fed’s portfolio over a period of three to five years.
Policy makers said they expected the Fed’s portfolio to return to a more normal size “over a period of two to three years” once the sales begin.
When officials met in April, crude oil was trading close to its highest since 2008. Inflation expectations, as measured by the breakeven rate for five-year Treasury Inflation Protected Securities, had climbed to 2.41 percentage points from 1.73 points at the end of 2010. Some inflation pressures have declined in recent months, with the five-year breakeven rate falling to 2 percent.
The national average price of a gallon of gasoline has fallen to $3.63 from a three-year high of $3.99 on May 4, according to the American Automobile Association. After the slide, gasoline prices remain 34 percent higher than they were a year ago, as high prices continue to dent consumer spending and confidence.
The Bloomberg Consumer Comfort Index decreased to minus 45.5 for the period ended July 3 from minus 43.9 the prior week, as consumers’ views of the economy slipped to a three-month low.
In the public statement after its meeting, the FOMC said “the economic recovery is continuing at a moderate pace, though somewhat more slowly than the Committee had expected.”
Since that meeting, the Labor Department reported that the economy added 18,000 jobs in June, less than the most pessimistic forecast in a Bloomberg News survey of economists, and the jobless rate unexpectedly rose to 9.2 percent.
“We don’t have a precise read on why this slower pace of growth is persisting,” Bernanke said in his news conference after the Fed’s meeting. Referring to “frustratingly” slow job growth and weakness in the financial and housing industries, Bernanke said “some of these headwinds may be stronger and more persistent than we thought.”
In the minutes of the meeting, “several” policy makers said that reallocating workers into new industries and workers losing skills after long bouts of unemployment may have “temporarily reduced the economy’s level of potential output.”
Jeannine Aversa in Washington at firstname.lastname@example.org
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