FOMC Statement Not Dull

June 22, 2011

After recent meetings, the FOMC had been releasing statements that hardly changed language and bordered on being boring.  This time was different.

The elements of surprise did not involve the actions taken.

  • The federal funds target was left at 0 to 1/4%.
  • The full $600 billion of longer-term Treasury buying is being completed this month and will not be followed by a third round of quantitative easing.
  • Funds from maturing securities acquired in QE1 and QE2 will be reinvested so that the Fed’s balance sheet does not contract passively.

The assessment of growth was downgraded.  Today’s FOMC statement asserts that the moderate pace of recovery has been somewhat slower than expected of late because of temporary factors such as the squeeze on discretionary household purchasing power from elevated food and energy prices and supply chain disruptions in the wake of the Sendai earthquake that have hit the auto sector among others.  Improvement in the U.S. labor market, like GDP growth, has been weaker than anticipated.

In several ways, more concern is voiced about inflation.  A previous assertion that core inflation remains subdued was deleted from the text, and note is made that inflation “has picked up in recent months.”  For now, officials are hopeful that “inflation will subside to levels at or below those consistent with the Committee’s mandate” of price stability, but they are adopting a trust-but-verify-approach, paying “close attention to the evolution of inflation and inflation expectations.”

The statement no longer asserts that stimulus is needed to better promote its goals of fostering maximum jobs and price stability.  A resumed gradual downtrend in unemployment toward desired levels is predicted, and the backdrop of pricing pressure no longer supports undertaking additional stimulus.

The most intriguing changes were made in the paragraph that offers some guidance regarding future interest rate policy.  While the vote taken today was unanimous, the text modifications suggest a diversity of opinions and a struggle to find language that could satisfy all committee members.  The previous language gave a conditional forecast that the federal funds rate would stay exceptional low for an extended period so long as “low rates of resource utilization, subdued inflation trends, and stable inflation expectations” continue.  Tom Hoenig of the K.C. Fed, who was a voting member in 2010 but not this year, consistently had cast a dissenting vote at each meeting last year because he felt the repeated language might promote future economic imbalances.  The new paragraph on rate guidance is more convoluted than the old one.  The announcement that there will not be a third round of quantitative easing appears in this paragraph, and the three conditions for exceptionally low rates are reduced to two.  The need for subdued inflation trends and stable inflation expectations has been replaced by the single requirement of “a subdued outlook for inflation.” 

Tellingly, the Fed chose to alter the conditional part of the paragraph, not its bottom line that “exceptionally low levels for the federal reserve rate for an extended period” are likely.  In making such a change, the Fed reveals a dovish predisposition.  The case for ultra-low rates had become less defensible because inflation is more problematic than it was when QE1 or QE2 were launched.  To avoid appearing to ignore its own conditions upon which a case seems to be building for removing stimulus, officials changed the wording of those conditions.  In the press conference that starts in less than one hour, Chairman Bernanke no doubt will be quizzed for additional clarification of the reasons behind the statement’s changes.

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



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