It may be the mother of all FOMC statements.
The political firestorm over the fate of Fed Chairman Ben Bernanke will bring extraordinary scrutiny to the central bank’s policy meeting decision Wednesday and is bound to spark heated debate over whether Congressional pressure had any influence over it.
The additional attention and pressure also come at a critical time when the FOMC may need to make subtle, but important changes to the language of the statement because of recent developments in the economic environment.
"We’ve never seen anything like this," says Bank of America economist Mickey Levy. "The threat to the Fed’s independence is extraordinarily untimely."
You can say that again. The Senate is locked in a battle to schedule a vote on a second term for Bernanke by the end of the week, right at the time the Fed’s policy committee happens to have a regularly scheduled two-day meeting Tuesday and Wednesday.
"Given the political pressures on the Fed, bending the rules they put in place could subject them to some criticism," says Robert Brusca, chief economist at FAO Economics. "On the other hand, the economy may not be what they thought it should be, so there's a dilemma about changing the language.”
“The largest issue facing the Fed is maintaining its independence over monetary policy, particularly its exit strategy,” adds Levy.
Congress happens to be questioning the effectiveness of Bernanke’s policies both in containing the financial crisis and jumpstarting the economic recovery at the same time a Democratic Congress and President have approved massive fiscal stimulus programs for the same purposes. They are even proposing more.
The apparent lack of effectiveness of all those monetary and fiscal measures has compounded voter and Congressional impatience about the speed of the economic recovery in a mid-term election year.
“If you were in PR, you would certainly be advising the Fed members to keep their heads down,“ says Chris Rupkey, chief financial economist at Bank of Tokyo-Mitsubishi. "Rubber stamp last month’s December’s statement with very few changes.”
That is certainly one option, say Rupkey and other economists, which could arguably be justified by economic conditions, but there are a number of other options that are just as likely, including the idea of introducing a new interest-rate oriented tool that would essentially replace the federal funds rate or an increase in the discount rate.
“Nothing would shock me at this point,” adds Rupkey, after going through most of the scenarios.
In sum, the FOMC’s December statement (see complete text) was notable because it contained important policy information beyond the ever-present language describing economic conditions and monetary policy.
It specifically referred to the end of some (but not all) of the Fed's special liquidity programs, such as one for the commercial paper market, implemented during the crisis in late 2008 and early 2009, because of “improvements in the functioning of financial markets.”
Equally important was the Fed’s stated intention to wind down its purchase of some $1.2 trillion of mortgage backed securities and other debt—meant to help the mortgage and housing markets—by the end of the first quarter to “promote a smooth transition."
What, if anything, the Fed does in these two area, is both very important and highly debatable, partly because the measures are so unusual yet critical to the central bank's so-called exit policy, which is not expected to involve any change in the fed funds rate for at least several months.
Some say policymakers need to be clearer about the FOMC's future intentions for these programs. Others say the committee may need to back track a bit or provide some wiggle room because recent jobs and housing data have been disappointing to some.
“The jobs data gives them pause; the backtracking in jobless claims gives them pause,” says Brusca, explaining why it could be difficult for the Fed to keep its December language virtually intact. “That’s the problem for them. The thing that the Fed hates to do is to reverse itself.”
Other economists say the Fed can and should avoid that by making has to subtle changes, either in its general stance or in particular areas, to move the ball forward.
“At this stage you want to tell people the policy accommodation is a temporary thing,” says Rupkey. “You want to start conditioning people that all this liquidity is not as necessary as it was in the crisis. I think they are learning in the direction of stimulus ending.”
If there’s one area under great scrutiny and subject to great debate, it is the program to purchase GSE and MBS debt, and how the Fed handles the language on that.
“I think they will maintain the statement that mortgage [support] will end on schedule," says Levy.
“I think the Fed will look at the housing market and be convinced we have found bottom,” says Zach Pandl of Normura Securities.
Nevertheless, Pandl thinks the central bank would prefer to take a “wait and see” approach to housing and should therefore be “more clear about contingency plans for the program,” giving it the option of bringing back purchases after the March 31 expiration.
Pandl says that would make evident what is already known from FOMC minutes and public speeches.
Bernanke’s Fed has had to say more in its FOMC statements than many every imagined after the somewhat haiku-style of the Greenspan era, especially during the last recovery period when the repeated use of certain phrases was used to manage--some would even say spoon feed—market expectations.
Now all those words—there were 500 in the December 2009 statement versus about 200 in the 2003-2004 era—have another audience, with a different set of expectations and priorities.
As difficult as that may be, some economists say the Fed has no choice but to do the right thing—whatever that may be.
“The stakes are too high; the Fed can't put the economy above its credibility, “ says Brusca. “In the end it (the credibility) will prove itself.”