Out of Control Policy Blog

The Fight at the Fed

On Tuesday the Federal Open Market Committee (FOMC) released minutes from its August 9 meeting, and it revealed quite the internal fight—for a Fed meeting at least. I've added some of the pertinent text below, which speaks for itself, but I'll annotate a bit of it. This comes towards the end of the meeting after hearing reports on the state of the economy and discussing what is causing economic weakness. 

"Participants discussed the range of policy tools available to promote a stronger economic recovery should the Committee judge that providing additional monetary accommodation was warranted. Reinforcing the Committee's forward guidance about the likely path of monetary policy was seen as a possible way to reduce interest rates and provide greater support to the economic expansion; a few participants emphasized that guidance focusing solely on the state of the economy would be preferable to guidance that named specific spans of time or calendar dates."

A number of the voting members of the FOMC began arguing for naming a specific time to keep interest rates low, but others preferred linking low interest rates to trends in the economy. We know now that the majority won out, voting for a policy that keeps the federal funds rate at zero until mid-2013. We also know the names of "the few"—Fed Presidents Richard Fisher, Narayana Kocherlakota, and Charles I. Plosser. Later on in the meeting, it was suggested that the FOMC pick a specific target for the unemployment rate, but "the few" pushed back. For the time being the FOMC has decided it does not have an appropriate way to determine what that target rate would be. 

"Some participants noted that additional asset purchases could be used to provide more accommodation by lowering longer-term interest rates."

This would be QE3, little was outlined in the minutes beyond this sentence, but it suggests that the option really is on the table, as more than one person is advocating it. According to the Wall Street Journal, after this news broke investors cheered the prospect of more bond buying. And why wouldn't they, given how quantitative easing has been so kind to stocks—though hurtful to main street.

"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 on longer-term interest rates. Such an approach would not boost the size of the Federal Reserve's balance sheet and the quantity of reserve balances."

While some may argue this would be better than more original asset purchases, and as noted it would not expand the already bloated Fed balance sheet, it would still be an expansion of what QE2 was trying to do. At the very least it would be QE2.5 and not what the economy needs to work through the great contraction and massive debt cycle. 

"A few participants noted that a reduction in the interest rate paid on excess reserve balances could also be helpful in easing financial conditions."

This is confirmation of another frequently discussed option on the table for the Fed. Lowering payments to banks for keeping reserves of cash at the Fed would in theory encourage them to lend that money. But they could just as easily park that money in Treasuries or something else. 

"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."

This is a good sign. More than a few FOMC members looked at the possibility of QE3, QE2.5, or lowering interest rates on reserves and determined that none of it would move the recovery on any faster (they are right). It also means that there is at least a discussion of inflation concerns. 

It will be interesting to see what comes of the September meeting and where allegiances shift on what action the FOMC should take. 

Anthony Randazzo is Director of Economic Research


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