Federal Reserve officials came to the conclusion that they must “soon” change their “forward guidance” on the path of the federal funds rate at the the Jan. 18-19 meeting of the Federal Open Market Committee, minutes released Wednesday show.
How soon a change might be accomplished is unclear, however, as the minutes show considerable divergence as to how best to change the FOMC policy statement’s phraseology on what will determine the timing of eventual hikes in the funds rate.
While some wanted to continue with a “quantitative” approach, others preferred a “qualitative” approach, and others wanted to add financial risk considerations to the “forward guidance.”
For the time being, the FOMC stayed with the numerical thresholds it first adopted in December 2012, reiterating that it expects to keep the funds rate between zero and 25 basis points “at least as long as the unemployment rate remains above 6-1/2 percent, inflation between one and two years ahead is projected to be no more than a half percentage point above the Committee’s 2 percent longer-run goal, and longer-term inflation expectations continue to be well anchored.”
In recognition of the fact that the unemployment rate was already near the 6.5% “threshold,” the FOMC also repeated an addendum first adopted at its December meeting – that “it likely will be appropriate to maintain the current target range for the federal funds rate well past the time that the unemployment rate declines below 6-1/2 percent, especially if projected inflation continues to run below the Committee’s 2 percent longer-run goal.”
The minutes suggest, much as MNI recently reported, that there was general dissatisfaction with the existing forward guidance, even as amended, and make clear that a new approach is coming at some point.
“Participants agreed that, with the unemployment rate approaching 6 1/2 percent, it would soon be appropriate for the Committee to change its forward guidance in order to provide information about its decisions regarding the federal funds rate after that threshold was crossed,” the minutes disclose.
However, the minutes also suggest considerable disagreement among FOMC participants about how best to fix forward guidance.
“A range of views was expressed about the form that such forward guidance might take,” they say.
“Some participants favored quantitative guidance along the lines of the existing thresholds, while others preferred a qualitative approach that would provide additional information regarding the factors that would guide the Committee’s policy decisions,” the minutes reveal.
“Several participants suggested that risks to financial stability should appear more explicitly in the list of factors that would guide decisions about the federal funds rate once the unemployment rate threshold is crossed, and several participants argued that the forward guidance should give greater emphasis to the Committee’s willingness to keep rates low if inflation were to remain persistently below the Committee’s 2 percent longer-run objective,” they continue.
The minutes also report that “additional proposals included relying to a greater extent on the Summary of Economic Projections as a communications device and including in the guidance an indication of the Committee’s willingness to adjust policy to lean against undesired changes in financial conditions.”
Financial conditions, particularly as they related to troubles in emerging market countries, were considered by the FOMC in deciding to continue to scale back large-scale asset purchases.
But, at least for the time being, the minutes say “recent volatility in emerging markets appeared to have had only a limited effect to date on U.S. financial markets.”
FOMC participants did agree that “a number of developments in financial markets needed to be watched carefully, including the financing situation of the Puerto Rican government and particularly the unfolding events in emerging markets.”
However, the determining factor in the FOMC’s decision to make a second $10 billion reduction in monthly purchases of longer term Treasury and mortgage backed securities to $65 billion was the officials’ sense that the economy and labor markets were improving.
Following a second half in which real GDP growth averaged 3.7%, the minutes say “participants generally did not expect the recent pace of economic growth to be sustained, but they nonetheless anticipated that the economy would expand at a moderate pace in coming quarters.”
They believed growth would be assured by a still “highly accommodative monetary policy, a further easing of fiscal restraint and a modest additional pickup in global economic growth, as well as continued improvement in credit conditions and the ongoing strengthening in household balance sheets.”
The minutes say “a number of participants noted that recent economic news had reinforced their confidence in their projection of moderate economic growth over the medium run.”
“It was also noted that recent developments in several emerging market economies, if they continued, could pose downside risks to the outlook,” the minutes go on. But “overall, most participants still viewed the risks to the outlook for the economy and the labor market as having become more nearly balanced in recent months.”
Although December non-farm payrolls had been reported up just 74,000 at the time of the January FOMC meeting, the minutes say “a number” of participants considered the weaker-than-expected job gain a weather-related “anomaly.” And others pointed to anecdotal reports of plans for increased hiring.
The FOMC debated the “reliability” of the unemployment rate, which had fallen to 6.7% in December. There was also disagreement about the labor force participation rate and the extent to which its decline was cyclical or structural.
Although the vote to “taper” asset purchases was unanimous, the minutes reflect an array of views among participants, which include voters and non-voters.
“A couple of participants observed that continued low readings on inflation and considerable slack in the labor market raised questions about the desirability of reducing the pace of purchases,” the minutes say. “(T)hese participants judged, however, that a pause in the reduction of purchases was not justified at this stage, especially in light of the strength of the economy in the second half of 2013.”
“Several participants argued that, in the absence of an appreciable change in the economic outlook, there should be a clear presumption in favor of continuing to reduce the pace of purchases by a total of $10 billion at each FOMC meeting,” they continue.
“That said, a number of participants noted that if the economy deviated substantially from its expected path, the Committee should be prepared to respond with an appropriate adjustment to the trajectory of its purchases,” the minutes add.
Although the FOMC unanimously kept the funds rate target near zero, the minutes say “a few participants raised the possibility that it might be appropriate to increase the federal funds rate relatively soon.”
“One participant cited evidence that the equilibrium real interest rate had moved higher, and a couple of them noted that some standard policy rules tended to suggest that the federal funds rate should be raised above its effective lower bound before the middle of this year,” the minutes say.
“Other participants, however, suggested that prescriptions from standard policy rules were not appropriate in current circumstances, either because the target federal funds rate had been constrained by the lower bound for some time or because the equilibrium real rate of interest was likely still being held down by various factors, including the lingering effects of the financial crisis, and was significantly below the value of the longer-run rate built into standard policy rules.”