FOMC Statement Embodies Some Changes… Cautious and Accommodative Stance Retained

September 23, 2009

No change was made in the 0-25% target for the fed funds rate or the prediction of “exceptionally low levels for an extended period of time.”  No changes were announced in the size of the quantitative easing programs.  The plan to buy $300 billion of Treasury securities, as previously announced, will be completed by end-October and not reloaded beyond that point.  The planned total purchases of mortgage-backed securities and agency bonds remain the same in size but are now being tapered off more slowly to be finished at end-March 2010 instead of end-2009.  The last two sentences in the paragraph on policy intentions were not edited through deletions or additions.  There is no further clarification of the exit strategy other than a promise to monitor the size and composition of the balance sheet and adjust liquidity programs as warranted.

Today’s statement had no dissenting votes.

Modifications in the assessment of economic conditions and prospects are all predictable and non-controversial.  Activity is now said to be “picking up,” an upgrade from “leveling off” in the August 12th statement and “contracting more slowly” in the June 24th statement.  Special new mention is made to note an increase in housing sector activity.  Greater confidence is expressed about the stabilizing process observed in household spending.  Job and business spending cuts are occurring more slowly than before.  The statement postulates that economic growth will strengthen, a more upbeat verb than the prior characterization of “a gradual resumption of sustainable growth” ahead.  Perhaps most important, the statement anticipates “a gradual return to higher levels of resource utilization,” something not mentioned explicitly before.

Nevertheless, future inflation is not depicted as more worrisome.  Considerable resource slack currently exists.  In the Fed’s thinking, the level of slack is more important than its rate of change, and the pace at which slack disappears is going to be “gradual.”  So the force on cost pressures for now is down, not up.  Plus, the observation of rising commodity prices from the August statement was deleted in the new communique, and instead a fresh allusion to “stable longer-term inflation expectations” was added to a text that as before concludes “that inflation will remain subdued for some time.”

Six to seven weeks, the typical interval between FOMC meetings, can see huge changes in an economic landscape as uncertain as the current one.  All along, Fed policy has retained a large amount of flexibility to handle the unexpected.  But greater care is being directed against the possibility of an economic relapse than against accelerating inflation.  This is quite different from what one hears Norwegian monetary authorities saying (see my earlier post today).  “Extended period of time” sounds similar to “considerable period,” which was used during the second half of 2003, some 6-12 months before the first rate hike of the last cycle, and growth in the four quarters to mid-2004 of roughly 4% was much stronger than what is likely to occur over the coming year.  It’s not difficult to imagine the first increase of the funds rate being delayed to 4Q10 and more probably sometime in 2011.  At the current level of rates, any ratcheting up of accommodation can be accomplished only by quantitative easing (QE).  While the direction of QE will be toward less stimulus next year, it would be easy to reverse such of necessary should the recovery hit an air pocket.  The only promise in the statement is not to lift rates soon.  No attempt is made to quantify how much of the exit strategy is likely to have been administered by end-2010 or mid-2011.  Meanwhile, the dollar falls, gold climbs, and long-term rates hold comparatively steady at very low levels in spite of recovering equity wealth.  

All in all, the message remains highly accommodating.  Indeed, monetary conditions are still easing, and G-20 leaders attending tomorrow’s summit in Pittsburgh are likely to be pleased about that.

Copyright Larry Greenberg 2009.  All rights reserved.  No secondary distribution without express permission.



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