ECB and FOMC Minutes

February 19, 2015

The ECB meeting of January 22 authorized quantitative easing totaling 60 billion euros per month over the twenty months to September 2016.  This substantial loosening of monetary policy was taken in response to a weaker-than-hoped quantitative response by banks to initiatives launched last September, to newly arisen expectations of sub-zero CPI inflation “for some time,” and to a perceived growing risk of deflation.  This justification is summarized in the following passage from minutes of the January 22 meeting that were released today.

Coinciding with this shortfall in quantitative stimulus, a continuous deterioration in the outlook for price stability over the medium term had been observed. The sharp decline in oil prices was, in itself, a positive factor for the economic outlook, but only if inflation expectations remained well anchored. In the current environment of very weak price developments, further falls in commodity prices had accelerated a downward trend that had been evident since the start of the sovereign debt crisis and had increased the risk that inflation might stay “too low for too long”. First , a range of available inflation indicators currently stood at, or close to, their historical lows. Second, exclusion-based measures of inflation currently also displayed significantly lower resilience to negative headline inflation shocks. Third, the sharp drop in oil prices had contributed to the further fall in medium to longer-term market-based inflation expectations, thereby signaling increased risks of an unanchoring of those expectations.  Against this background, the risk of second-round effects had increased further and, with it, the risk of too prolonged a period of too low inflation. This, in turn, raised the possibility of deflationary forces setting in, which would not permit an attitude of “benign neglect”.

Minutes from the January 28 meeting of the FOMC proved to be somewhat more dovish that the immediate statement had seemed.  Not only did officials again proclaim the appropriateness of being “patient” regarding the timing of the first hike in the federal funds rate.  The minutes show a deepening inclination to be cautious rather than hasty in this lead-up period.  Risks originating from outside the U.S. economy were noted:

The increase in the foreign exchange value of the dollar was expected to be a persistent source of restraint on U.S. net exports, and a few participants pointed to the risk that the dollar could appreciate further. In addition, the slowdown of growth in China was noted as a factor restraining economic expansion in a number of countries, and several continuing risks to the international economic outlook were cited, including global disinflationary pressure, tensions in the Middle East and Ukraine, and financial uncertainty in Greece.

Other concern was expressed about the perceived message of tightening policy while inflation sinks further below the central bank’s 2% target.

Several participants remarked that inflation measures that excluded energy items had also moved down in recent months, but these declines partly reflected transitory factors, including downward pressure on import prices and the pass-through of lower energy costs to the prices of non- energy items. Nonetheless, several participants saw the continuing weakness of core inflation measures as a concern. In addition, a few participants suggested that the weakness of nominal wage growth indicated that core and headline inflation could take longer to return to 2 percent than the Committee anticipated.

Participants further argued that the stability of survey-based measures of inflation expectations should not be taken as providing much reassurance; in particular, it was noted that in Japan in the late 1990s and early 2000s, survey-based measures of longer-term inflation expectations had not recorded major declines even as a disinflationary process had become entrenched. In addition, a few participants argued that even if the shift down in inflation compensation reflected lower inflation risk premiums rather than reductions in expected inflation, policymakers might still want to take that decline into account because it could reflect increased concern on the part of investors about adverse outcomes in which low inflation was accompanied by weak economic activity. Participants generally agreed that the behavior of market-based measures of inflation compensation needed to be monitored closely.

Much discussion was devoted to the risks of a rate cut being done somewhat too soon versus somewhat too late.  A lot of ideas were thrown out to the group without a clear preference emerging.  Likewise, reservations were expressed that forward guidance might prove less effective once rate normalization begins.  The main message for that next stage of policymaking seems to be that decisions will be guided by the data and that the best the Fed can offer is to enumerate what kinds of data and what kinds of conditions in such data they may wish to watch.

A number of participants noted that while forward guidance had been a very useful tool under the extraordinary conditions of recent years, as the start of normalization approaches, there would be limits to the specificity that the Committee could provide about its timing. Looking ahead, some participants highlighted the potential benefits of streamlining the Committee’s postmeeting statement once normalization has begun. More broadly, it was suggested that the Committee should communicate clearly that policy decisions will be data dependent, and that unanticipated economic developments could therefore warrant a path of the federal funds rate different from that currently expected by investors or policymakers.

Copyright 2015, Larry Greenberg.  All rights reserved.  No secondary distribution without express permission.

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