FOMC Minutes Released -- Delphic Discussions on the Future Direction of QE

Earlier this afternoon, The Federal Reserve Board released minutes from a Committee meeting held on September 21, 2010. Summary and excerpts follow:

Economic Situation

Overall economic picture: economic expansion slowed, inflation stayed low.

"The information reviewed at the September 21 meeting indicated that the pace of the economic expansion slowed in recent months and that inflation remained low. Private bus

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inesses increased employment modestly in August, but the length of the workweek was unchanged and the unemployment rate remained elevated. Industrial production advanced at a solid pace in July and rose further in August. Consumer spending continued to increase at a moderate rate in July and appeared to move up again in August. The rise in business outlays for equipment and software looked to have moderated recently following outsized gains in the first half of the year. Housing activity weakened further, and nonresidential construction remained depressed. After falling in the previous three months, headline consumer prices rose in July and August as energy prices retraced some of their earlier decline while prices for core goods and services edged up slightly."

Economic Situation

Overall economic picture: economic expansion slowed, inflation stayed low.

"The information reviewed at the September 21 meeting indicated that the pace of the economic expansion slowed in recent months and that inflation remained low. Private bus

Labor market improved only slightly.

"The labor market situation continued to improve only slowly. The average monthly increase in private payroll employment over the three months ending in August was small and was less than the average gain earlier in the year. Moreover, average weekly hours of all employees were little changed, on net, in recent months after rising during the first half of the year. The unemployment rate ticked up in August and remained close to the level that has prevailed since the beginning of this year. The labor force participation rate moved up a little in August but was still low. Initial claims for unemployment insurance remained at an elevated level over the intermeeting period. In addition, other indicators of labor demand, such as measures of hiring and job vacancies, did not improve."

Personal consumption showed moderate improvement, on par with previous two months. Consumer confidence still low.

"Real personal consumption expenditures rose modestly in July, similar to the average increase over the preceding two months. Data for retail sales and the sales of light motor vehicles pointed to a moderate gain in real consumer spending in August.

Real disposable personal income declined a bit in July after increasing at a solid pace in the second quarter. The personal saving rate edged down in July but remained near the high level registered in the second quarter. Indicators of household net worth were mixed; home prices moved down in July, while equity prices inched up, on balance, over the intermeeting period. After falling back in July, consumer confidence remained downbeat in August and early September, with households more pessimistic about the outlook for their personal financial situations and general economic conditions. "

Housing softened further in July; mortgage rates stayed unchanged at historical lows:

"Housing activity, which had been supported earlier in the year by the availability of homebuyer tax credits, softened further in July. Sales of new single-family homes remained at a depressed level.

Sales of existing homes fell substantially in July, and the index of pending home sales suggested that sales were muted in August. Starts of new single-family houses in July and August were below the low level seen in June, and the number of new permits issued in August appeared to signal that little improvement in new homebuilding was likely in September.

House prices declined modestly in July after changing little, on net, in recent months. The interest rate for 30-year fixed-rate conforming mortgages remained essentially unchanged over the intermeeting period at a historically low level."

Business expenditures slowed further. Credit remains tight and vacancy rates stay high.

"Real business spending on equipment and software appeared to have slowed in July after expanding rapidly over the preceding three quarters. Both new orders and shipments of nondefense capital goods excluding aircraft dipped in July.

Moreover, survey indicators of business conditions softened further in August. Incoming construction data indicated that business investment in nonresidential structures decreased in the second quarter but at a slower pace than over the preceding year. Increases in spending for drilling and mining structures were more than offset by continued declines in outlays for other types of nonresidential buildings.

Despite some indications that the difficult financial conditions in commercial real estate markets might be stabilizing, credit was still tight and vacancy rates for office and commercial space remained high. In the second quarter, businesses appeared to build their inventories at a faster pace than earlier in the year, but ratios of inventories to sales for most industries did not point to any sizable overhangs. "

Inflation not a significant threat. Headline inflation up on energy price rebound; slight increase in core prices.

Inflation remained subdued in recent months. Headline consumer prices rose in July and August as energy prices rebounded after their decline over the previous three months. At the same time, prices for core goods and services moved up slightly. At earlier stages of production, producer prices of core intermediate materials moved down, on net, during July and August while most indexes of spot commodity prices increased. Survey measures of short- and long-term inflation expectations were essentially unchanged.

Economic Outlook

Delphic commentary on the future discussions of QE:

Participants discussed the medium-term outlook for monetary policy and issues related to monetary policy implementation. Many participants noted that if economic growth remained too slow to make satisfactory progress toward reducing the unemployment rate or if inflation continued to come in below levels consistent with the FOMC's dual mandate, it would be appropriate to provide additional monetary policy accommodation. However, others thought that additional accommodation would be warranted only if the outlook worsened and the odds of deflation increased materially. Meeting participants discussed several possible approaches to providing additional accommodation but focused primarily on further purchases of longer-term Treasury securities and on possible steps to affect inflation expectations.

Participants reviewed the likely benefits and costs associated with a program of purchasing additional longer-term assets--with some noting that the economic benefits could be small in current circumstances--as well as the best means to calibrate and implement such purchases. A number of participants commented on the important role of inflation expectations for monetary policy: With short-term nominal interest rates constrained by the zero bound, a decline in short-term inflation expectations increases short-term real interest rates (that is, the difference between nominal interest rates and expected inflation), thereby damping aggregate demand. Conversely, in such circumstances, an increase in inflation expectations lowers short-term real interest rates, stimulating the economy.

Participants noted a number of possible strategies for affecting short-term inflation expectations, including providing more detailed information about the rates of inflation the Committee considered consistent with its dual mandate, targeting a path for the price level rather than the rate of inflation, and targeting a path for the level of nominal GDP. As a general matter, participants felt that any needed policy accommodation would be most effective if enacted within a framework that was clearly communicated to the public.

Policy Actions

Nearly all committee members agree to keep fed funds rate unchanged.

"In their discussion of monetary policy for the period immediately ahead, nearly all of the Committee members agreed that it would be appropriate to maintain the target range for the federal funds rate of 0 to 1/4 percent and to leave unchanged the level of the combined holdings of Treasury, agency debt, and agency mortgage-backed securities in the SOMA"

Almost all agree inflation running below optimal levels:

"With respect to the statement to be released following the meeting, members agreed that it was appropriate to adjust the statement to make it clear that underlying inflation had been running below levels that the Committee judged to be consistent with its mandate for maximum employment and price stability, in part to help anchor inflation expectations. Nearly all members agreed that the statement should reiterate the expectation that economic conditions were likely to warrant exceptionally low levels of the federal funds rate for an extended period. One member, however, believed that continuing to communicate that expectation in the Committee's statement would create conditions that could lead to macroeconomic and financial imbalances."

K.C.'s Hoening votes against:

"Mr. Hoenig dissented, emphasizing that the economy was entering the second year of moderate recovery and that, while the zero interest rate policy and "extended period" language were appropriate during the crisis and its immediate aftermath, they were no longer appropriate with the recovery under way. Mr. Hoenig also emphasized that, in his view, the current high levels of unemployment were not caused by high interest rates but by an extended period of exceptionally low rates earlier in the decade that contributed to the housing bubble and subsequent collapse and recession."

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