FOMC Statement Highlights and Some Reflections

September 21, 2011

The FOMC released its new monetary policy statement 10-15 minutes later than usual.  Dissenting votes from three regional presidents — Plosser, Fisher and Kocherlakota — for the second meeting in a row suggest that the discussion was contentious.

Fed officials downgraded their assessment of present economic conditions and, more importantly, escalated the downside growth risks associated with a baseline forecast that still calls for continuing recovery and in fact “some pickup in its pace over coming quarters.”  For what it’s worth, I can not recall the Fed projecting a recession before one has been declared by the NBER to have started. 

The FOMC did not unveil QE3, nor was the interest rate paid on bank reserves held at the Fed reduced.  These options were considered less likely than Operation Twist, the move that was in fact selected.  Operation Twist will run for nine months until mid-2012, amount to $400 billion, and involve simultaneous buying of Treasury Securities with maturities of 6-30 years and sales of maturities no longer than three years.  $400 billion represents about 75% of the latter.  The intent is to cut long-term interest rates without actually increasing the central bank’s balance sheet.  The main surprise was a decision to reinvest principal payments from holdings of agency debt in agency mortgage-backed securities.  The maturing principal of agency mortgage-backed securities also will be reinvested.  It is hoped that both types of operations will “help support conditions in mortgage markets and “make broader financial conditions more accommodative.”

The paragraph that provides future rate guidance, whose time horizon was widened in August from six months to almost two years, was not modified additionally.

The Fed’s new stimulus will not produce at-trend U.S. economic growth.  The stimulus is not nearly as forceful as the many steps the Fed applied between the autumn of 2008 and March 2010, nor is it as meaningful as the QE2 operations in late 2010 and 1H11.  At best, the Fed is trying to mitigate the severity of the slowdown and avoid a recession, which still looks like a better than even bet.  It doesn’t build confidence either that the troika of dissenters continue to object to any stimulus.  The dissenters believe that any further monetary stimulus will not boost growth and will increase inflation.  The internal flaw in that logic is that the channel of causation from a monetary stimulus to higher inflation has to run through strengthening economic growth first.  Since fiscal policy will be contractionary, the strategy of the dissenters is wait-and-see, in other words many more years of sluggishness.

Copyright 2011, Larry Greenberg.  All rights reserved.  No secondary distribution without express permission.

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