Reflections on FOMC Minutes

May 21, 2008

I take away three main thoughts, none of which is surprising.

First, the outlook for growth is dim and worse than such seemed in January. Projected 2008 growth was revised down to 0.3-1.2% from 1.2-2.0%, strongly suggesting some negative quarters given on-year growth of 2.5% in 1Q08. But inflation prospects have worsened. Officials project PCE inflation of 3.1-3.4% in 2008, revised up from a forecast of 2.1-2.4% released in January. In light of a 17% jump in oil prices since April 30th when the FOMC met, the new inflation forecast looks dead on arrival. If officials were to forecast knowing what oil costs now, they would have released a higher projection than they did. But even at 3.1-3.4% and in light of cited evidence of rising expected inflation, they were comfortable asserting that downside growth risks were almost matched by upside inflation risks. That means the deterioration of inflation risk outflanked the deterioration since the prior meeting in the risk to growth.

The second major revelation is that only a significant further weakening of the economic outlook would justify any further decline in interest rates. Low or even negative growth in coming quarters will not satisfy that condition. Still, officials imagine circumstances that might warrant further easing in the future. There was no parallel discussion of what it would take to raise rates. Risks on April 30th were deemed “more closely balanced” and the decision to cut rates then, although supported by all voting members except hawks Plosser and Fisher, was called a “close one.” Since April 30th, growth data have been on balance better than expected, and inflation circumstances took a worisome turn for the worse. So while the minutes highlight a shifting balance in the Fed’s priorities of things to worry about, that swing in rate bias may have already evolved considerably further away from cutting rates again and toward anticipating eventual rate hikes.

Finally, the minutes do not talk about the dollar, other than to note that its depreciation is one factor supporting exports. The FOMC very seldom talks about the dollar, except for those few occasions like in the late 1970’s when the light bulbs go on and reality sets in that the exchange rate is critical to price stability and well-functioning financial markets. The dollar’s lowest cyclical levels coincide with the March 17th rescue of Bear Stearns. However, even if the Fed stops easing, U.S. monetary policy remains much looser than the credit stances in Europe, Canada, or Australia. Institutionally, currency policy lies in the Treasury’s jurisdiction. That is a mistake in my opinion. The Fed manages the supply of U.S. money and so exerts more functional influence over the external and internal value of that money than anything the executive or legislative branches of the government might do. Just because the Fed chairman is muzzled from speaking about the dollar, the currency should be fair game for FOMC discussions. It would be reassuring to know that the central bankers are watching the dollar and sensitive to its movements.

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