FOMC Minutes: Some Inferences to Draw

October 12, 2010

On the key question about whether to launch QE2, the majority of U.S. monetary policy makers were predisposed to doing such, but a wait-and-see camp was larger than just Tom Hoenig, who continued to dissent in favor of a 25-basis point rate increase.  In the key passage below, “several” constitutes more people than “some,” the term “some” means more than one, and those itching to launch QE2 did not appear averse to taking action at the following meeting scheduled for November 3.  In the key sentences below, bolding was added by this blogger.  In Fed-speak, the use of “soon” has in the past meant at the soonest scheduled opportunity.

In light of the considerable uncertainty about the current trajectory for the economy, some members saw merit in accumulating further information before reaching a decision about providing additional monetary stimulus. In addition, members wanted to consider further the most effective framework for calibrating and communicating any additional steps to provide such stimulus. Several members noted that unless the pace of economic recovery strengthened or underlying inflation moved back toward a level consistent with the Committee’s mandate, they would consider it appropriate to take action soon.

One consideration that seems to separate hawks from doves regarding QE2 is whether conditions must improve to prevent taking action (doves) or worsen in order to justify new stimulus (hawks).

QE2 would be a major step and a controversial one.  Ideally, policymakers would want to have a good consensus before acting.  The wish for a show of near unanimity may delay action beyond November.  It’s a matter of group dynamics that will dictate the choice, rather than strictly economic trends.

True to form, the minutes avoid comment on the weak dollar and only allude to currency wars with observations that the Bank of Japan had intervened in mid-September and that the yen had fallen in immediate response.  The yen of course bounced back, and the trade weighted dollar has lost nearly 4% since the September 21 meeting, which if sustained would deliver about as much stimulus as a 40 basis point decline in short-term interest rates.  With the U.S. Fed funds rate at 0.25% or less since December 2008, even thinking of a reduction in short-term rates is a non-starter.  Monetary stimulus can be delivered either by stimulating the monetary base through quantitative easing or by depreciating the dollar.  The second channel is in fact happening and may persuade Fed officials to stay in wait-and-see mode.  Alternatively, the market has been expecting QE2 in November.  The juxtaposition of a right turn in government on November 2, a Fed surprise the next day in which QE2 is not undertaken, and the onset of the critical end-of-year shopping season might scare Fed officials enough for them not to risk how markets and the economy would react to a decision not to change monetary policy.

Fed officials have a very difficult decision to make.  They will need to not only get the economics correct but also the game theory element of the process.

Copyright Larry Greenberg 2010.  All rights reserved.  No redistribution without express permission.



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