Reading through the December meeting minutes of the Federal Open Market Committee (the group that decided to start reducing the Federal Reserve’s monthly purchases of Treasury and mortgage bonds), I was very surprised. Considering the Fed has, historically, gone out of its way to be obscure, the minutes’ clarity was unusual. In the words of former chair Alan Greenspan, “I know you think you understand what you thought I said, but I’m not sure you realize that what you heard is not what I meant.”
The Fed under Chairman Bernanke has made an effort to be more straightforward, but it still tends to focus on “one hand, other hand” discussions. Harry Truman’s search for a one-armed economist goes on.
In the current minutes, though, a strong positive trend about the real economy keeps surfacing. To wit:
- “The economy was expanding at a moderate pace . . . most expressed greater confidence in the outlook, and saw the risks associated with . . . real GDP growth and the unemployment rate as more nearly balanced.”
- “Almost all participants continued to project that the rate of growth of economic activity would strengthen in coming years.”
- “Consumer spending appeared to be strengthening, with solid gains in retail sales in recent months.”
- “Participants discussed a number of factors that should support a continued recovery in housing going forward.”
- “A number of the fundamental determinants of business investment were positive.”
- “ Participants generally viewed the increases in nonfarm payroll employment . . . as encouraging signs of ongoing improvement in labor market conditions.”
- “Participants generally anticipated that the improvement in labor market conditions would continue, and most had become more confident in that outlook.”
I’ve cherry-picked the minutes, of course, and there’s certainly enough back-and-forth and hedging to cover everyone. But still, when you look at the overall take on the economy, the Fed seems to feel that it’s not only on the mend but poised to improve at an accelerating rate over the next year or two.
This is, of course, confirmed by the decision to start tapering the bond purchase program. But my reading of the minutes suggested that one of the factors that may have prevented a faster taper was, in fact, that inflation continued to run below the Fed’s target range.
The Fed has a dual mandate, with stable prices and employment having equal weight. Historically, stable prices have been the major factor, but, more recently, employment has taken the fore. Reading the minutes, the focus may be shifting back to prices—although this time with an emphasis on increasing rather than decreasing inflation. The downside risks for inflation were a major topic, to wit:
- “Inflation continued to run noticeably below the Committee’s longer-run objective of 2 percent.”
- “Many participants expressed concern about the deceleration in consumer prices over the past year.”
- “Some participants also questioned whether slowing the pace of purchases at a time when inflation was running well below the Committee’s longer-run objective was appropriate.”
The message on inflation isn’t nearly as clear, in my opinion, as that regarding higher growth, but the concern is clearly there, and it may well be a factor in keeping the stimulus program longer and larger than some FOMC members would prefer. (More about this in a minute.)
Overall, the conclusion to start tapering opens the door for continued reduction in stimulus. With all but one member voting in favor, there’s clearly consensus, supported by the overall optimistic read of the economy. If that is correct, it should also solve the low-inflation problem. In fact, if growth really does accelerate, inflation may increase faster than anyone now expects.
I read an interesting analysis the other day, which noted that the Fed always starts stimulus reduction in a measured, stately way (as we see here). Then, surprised by how much more quickly recovery, and inflation, kicks in, it pulls back in a much more hurried way than it had planned—with resulting turbulence in the markets. Looking at the current minutes, I can see how this could come about.
Ultimately, this story may end up being more about unexpectedly strong growth and inflation, which could require a much more aggressive cut in stimulus than expected.