Highlights from the FOMC minutes:
We came this close to QE3:
- Some participants noted that additional asset purchases could be used to provide more accommodation by lowering longer-term interest rates.
- Others suggested that increasing the average maturity of the System’s portfolio—perhaps by selling securities with relatively short remaining maturities and purchasing securities with relatively long remaining maturities—could have a similar effect onlonger-term interest rates.
- A few participants noted that a reduction in the interest rate paid on excess reserve balances could also be helpful in easingfinancial conditions.
- A few members felt that recent economic developments justified a more substantial move at this meeting, but they were willing to accept the stronger forward guidance as a step in the direction of additional accommodation. Three members dissented because they preferred to retain the forward guidance language employed in the June statement.
Yet this stopped them:
- In contrast, some participants judged that none of the tools available to the Committee would likely do much to promote a faster economic recovery, either because the headwinds that the economy faced would unwind only gradually and that process could not be accelerated with monetary policy or because recent events had significantly lowered the path of potential output. Consequently, these participants thought that providing additional stimulus at this time would risk boosting inflation without providing a significant gain in output or employment.
On "transitory" commodity prices:
- Transitory factors, including supply chain disruptions from the earthquake in Japan and a surge in energy and other commodity prices, had pushed up both headline and core measures of inflation for a time.
- More recently, however, as prices of energy and some commodities have declined from their earlier peaks, headline inflation has moderated.
- Participants generally noted that, with apparently significant slack in labor and product markets, slow wage growth, and little evidence of pricing power among firms, inflation was likely to decline somewhat over time.
On September 21:
- Participants noted that devoting additional time to discussion of the possible costs and benefits of various potential tools would be useful, and they agreed that the September meeting should be extended to two days in order to provide more time.
And why the conclusion at this point is foregone:
- Many participants pointed to the recent downward revision to estimates of economic activity over the past three years, and some to the financial market strains seen during the intermeeting period, as contributing to a downgrade of the outlook for the economy. Moreover, many participants saw increased downside risks to the outlook for economic growth.
- Meeting participants generally noted that overall labor market conditions had deteriorated in recent months.
And on why the dissenters (now minus 1), are about to be trampled:
Messrs. Fisher, Kocherlakota, and Plosser dissented because they would have preferred to continue to describe economic conditions as likely to warrant exceptionally low levels for the federal funds rate for an “extended period,” rather than characterizing that period as “at least through mid-2013.” Mr. Fisher discussed the fragility of the U.S. economy but felt that it was chiefly nonmonetary factors, such as uncertainty about fiscal and regulatory initiatives, that were restraining domestic capital expenditures, job creation, and economic growth. He was concerned both that the Committee did not have enough information to be specific on the time interval over which it expected low rates to be maintained, and that, were it to do so, the Committee risked appearing overly responsive to the recent financial market volatility. Mr. Kocherlakota’s perspective on the policy decision was shaped by his view that in November 2010, the Committee had chosen a level of accommodation that was well calibrated for the condition of the economy. Since November, inflation had risen and unemployment had fallen, and he did not believe that providing more monetary accommodation was the appropriate response to those changes in the economy. Mr. Plosser felt that the reference to 2013 might well be misinterpreted as suggesting that monetary policy was no longer contingent on how the economic outlook evolved. Although financial markets had been volatile and incoming information on growth and employment had been weaker than anticipated, he believed the statement conveyed an excessively negative assessment of the economy and that it was premature to undertake, or be perceived to signal, further policy accommodation. He also judged that the policy step would do little to improve near-term growth prospects, given the ongoing structural adjustments and external challenges faced by the U.S. economy.
The latest Philly Fed update should have put Philly Plosser's doubt to rest.
Bottom line: the Fed knows the economy is contracting, but it needs that final deflationary confirmation to launch QE3. That confirmation will have to come in either the ISM, the NFP, or a 15-20% drop in the S&P.