Fed Signals Next Move May Link Stimulus to Economic ‘Mileposts’

U.S. Federal Reserve Chairman Ben S. Bernanke
U.S. Federal Reserve chairman Ben S. Bernanke. Photographer: Andrew Harrer/Bloomberg

Federal Reserve officials moved closer to setting targets for economic performance such as inflation to decide how long to keep interest rates at a record low, an action analysts said may come as soon as next month.

Most of the central bank’s 17 governors and regional bank presidents “saw advantages” in the approach and judged it would make policy more effective, the Fed said yesterday in minutes of its Sept. 20-21 meeting in Washington. Some officials wanted to keep more bond purchases as an option, the minutes said.

Chairman Ben S. Bernanke is trying to find new ways to spur growth and reduce joblessness stuck around 9 percent, while cushioning the economy from risks including the housing slump and Europe’s debt crisis. He may set the new policy benchmarks as early as his planned press conference following a two-day gathering of policy makers on Nov. 2, said Michael Feroli, chief U.S. economist at JPMorgan Chase & Co. in New York.

“That seems like a logical next step” by officials should they decide the economy needs another jolt, said Feroli, a former Fed researcher. “There’s pushback in terms of properly implementing it, but the idea itself didn’t seem to generate a lot of intrinsic opposition” at the meeting last month.

The policy would aim to discourage investors from expecting higher interest rates until economic measures such as inflation or employment reach specified levels, thereby keeping borrowing costs low.

Philadelphia Fed President Charles Plosser told reporters yesterday that policy makers are struggling over how to improve public understanding of their actions, and he doesn’t predict they’ll resolve the issue at November’s meeting.

Hinge on Inflation

The Fed could make it clearer how its policies hinge on inflation, inflation expectations and employment, he said after a speech in Philadelphia. Some Fed officials support incorporating the so-called Taylor Rule, which measures where the policy interest rate should be set based on inflation and growth, said Plosser, one of three officials to dissent from the easing in August and September.

A portion of officials suggested at the meeting that the Summary of Economic Projections, which explains policy makers’ forecasts and will next be released Nov. 22, could be a vehicle for providing more information about the Fed’s long-run goals and the “likely evolution of monetary policy,” the minutes said.

The Fed’s challenge is deciding which “economic mileposts,” or variables, to use, said Dana Saporta, a U.S. economist at Credit Suisse in New York. The Fed would have to choose between measures of employment, including the jobless rate and changes in payrolls, and between inflation gauges that the Fed prefers or are better known to the public, she said.

‘Very Tricky’

“The unemployment rate is a very tricky statistic these days because it’s being moved around by forces other than job creation,” Saporta said. A drop in labor-force participation accounts for much of the decline in the unemployment rate to its most recent level of 9.1 percent in September from 10.1 percent in October 2009, Saporta said.

Fed officials also discussed ways to better specify the central bank’s long-run objectives for inflation and jobs, the minutes said. U.S. central bankers currently stop short of formal targets for prices or unemployment, instead stating levels that represent where data would “converge over time under appropriate monetary policy and in the absence of further shocks.”

Several policy makers last month were reluctant to identify an unemployment goal, because it’s influenced “importantly by nonmonetary factors,” in contrast to a central bank’s control over inflation, according to the minutes.

Cut Unemployment

Only Chicago Fed President Charles Evans has publicly supported the idea of allowing consumer-price increases faster than 2 percent annually as a way to lower unemployment. The interest-rate commitment should be contingent on joblessness falling to around 7 percent or 7.5 percent as long as inflation stays below 3 percent in the medium term, Evans said Sept. 7. Fed policy makers aim for long-run inflation of about 1.7 percent to 2 percent.

Fed officials debated the changes as part of a wide-ranging discussion of policy tools last month, the minutes showed. The meeting culminated in the Federal Open Market Committee’s decision to replace $400 billion of Treasuries in the central bank’s portfolio with longer-term debt to reduce borrowing costs. Three officials dissented.

Bernanke said last week the so-called Operation Twist program is a “significant step but not a game changer” for reviving growth and reducing unemployment stuck near 9 percent.

Boost the Economy

The minutes said an unspecified “number” of officials wanted to keep further asset purchases as an option to boost the economy as policy makers saw “considerable uncertainty” that U.S. growth will pick up.

Additional asset purchases would constitute a third round of so-called quantitative easing after the Fed bought $2.3 trillion in housing and government debt in two rounds from December 2008 to June 2011.

“The clear message here is that we are heading toward quantitative easing three,” which may come in the first quarter, said Harm Bandholz, chief U.S. economist at Unicredit Group in New York.

Bandholz forecasts the economy to slow from an annual pace of 1.5 percent to 2 percent in the third quarter to 1.3 percent in the current period and 1 percent in the first quarter of next year. Such slow growth rates will keep unemployment high and force the Fed to expand its balance sheet further from $2.86 trillion today, he said.

Too Large

Policy makers also decided on Sept. 21 to reinvest maturing housing debt into mortgage-backed securities in part to keep the Fed’s Treasury holdings from getting too large and possibly causing a “deterioration in Treasury market functioning,” the minutes said.

The FOMC left its benchmark interest rate in a range of zero to 0.25 percent, where it’s been since December 2008 and reiterated language from its August meeting that the rate is likely to stay very low through at least mid-2013. The rate is now contingent on “low rates of resource utilization and a subdued outlook for inflation over the medium run,” the statement said.

The Standard & Poor’s 500 Index of stocks pared gains after the report, rising 1 percent to 1,207.25 at the close in New York. Yields on 10-year Treasuries rose 6 basis points, or 0.06 percentage point, to 2.21 percent.

‘Risk of Deflation’

Some officials said expanding the Fed’s balance sheet further “would be more likely to raise inflation and inflation expectations than to stimulate economic activity and argued that such tools should be reserved for circumstances in which the risk of deflation was elevated,” the minutes said.

The Fed is considering further easing and disclosure as it faces pressure and criticism from politicians, especially Republicans. Former House Speaker Newt Gingrich called Bernanke a “disaster” in an Oct. 11 Republican presidential candidate debate in New Hampshire sponsored by Bloomberg News and the Washington Post. Republican lawmakers, including House Speaker John Boehner of Ohio, sent letter to Fed officials last month urging them to forgo additional easing.

Bernanke may need to use the press conference, potentially next month, to provide more clarity to the public on the Fed’s use of unconventional monetary policies, said Dan Greenhaus, chief global strategist at BTIG LLC, a New York market maker whose clients include the largest institutional investors in the U.S.

“There is an enormous amount of confusion among the politicians and citizens at large about what the Fed is doing, and it may get to the point where Bernanke may just have to speak English,” Greenhaus said. “I don’t see any other way than to use the press conferences as a clear megaphone.”

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