Notes On Fed Minutes

Below we present both the most recent Federal Reserve statement and the previous one from its mid-March meeting along with my translation and interpretation interspersed between the paragraphs.

“Information received since the Federal Open Market Committee met in March indicates that the economy has continued to contract, though the pace of contraction appears to be somewhat slower.

“Household spending has shown signs of stabilizing but remains constrained by ongoing job losses, lower housing wealth, and tight credit. Weak sales prospects and difficulties in obtaining credit have led businesses to cut back on inventories, fixed investment, and staffing.

“Although the economic outlook has improved modestly since the March meeting, partly reflecting some easing of financial market conditions, economic activity is likely to remain weak for a time. Nonetheless, the Committee continues to anticipate that policy actions to stabilize financial markets and institutions, fiscal and monetary stimulus, and market forces will contribute to a gradual resumption of sustainable economic growth in a context of price stability.”

“Information received since the Federal Open Market Committee met in January indicates that the economy continues to contract. Job losses, declining equity and housing wealth, and tight credit conditions have weighed on consumer sentiment and spending.

“Weaker sales prospects and difficulties in obtaining credit have led businesses to cut back on inventories and fixed investment. U.S. exports have slumped as a number of major trading partners have also fallen into recession.

“Although the near-term economic outlook is weak, the Committee anticipates that policy actions to stabilize financial markets and institutions, together with fiscal and monetary stimulus, will contribute to a gradual resumption of sustainable economic growth.”

Very little change from what they were saying in March — just a little bit more upbeat tone. The economy is still very weak, but the Fed thinks that the actions taken so far, both by it and by the Treasury, will eventually turn the economy around.

Credit market indicators have more or less returned to normal from the off-the-charts awful levels of last fall, and eventually that should filter through to the real economy.

“In light of increasing economic slack here and abroad, the Committee expects that inflation will remain subdued. Moreover, the Committee sees some risk that inflation could persist for a time below rates that best foster economic growth and price stability in the longer term.”

“In light of increasing economic slack here and abroad, the Committee expects that inflation will remain subdued. Moreover, the Committee sees some risk that inflation could persist for a time below rates that best foster economic growth and price stability in the longer term.”

Word for word the same as last time. The big threat is deflation (i.e. inflation below rates that foster economic growth). The Fed will fight that by keeping the printing press running at full speed. This is no surprise; Bernanke told us that he would do this long before he ever became Fed Chairman (hence the nickname Helicopter Ben).

While inflation is not a problem for the short term, over the longer term, this level of expansion of the Fed balance sheet and the money supply raises the possibility of very high rates of inflation once the economy picks up.

“In these circumstances, the Federal Reserve will employ all available tools to promote economic recovery and to preserve price stability. The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and anticipates that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period.

“As previously announced, to provide support to mortgage lending and housing markets and to improve overall conditions in private credit markets, the Federal Reserve will purchase a total of up to $1.25 trillion of agency mortgage-backed securities and up to $200 billion of agency debt by the end of the year.

“In addition, the Federal Reserve will buy up to $300 billion of Treasury securities by autumn. The Committee will continue to evaluate the timing and overall amounts of its purchases of securities in light of the evolving economic outlook and conditions in financial markets.

“The Federal Reserve is facilitating the extension of credit to households and businesses and supporting the functioning of financial markets through a range of liquidity programs. The Committee will continue to carefully monitor the size and composition of the Federal Reserve’s balance sheet in light of financial and economic developments.”

“In these circumstances, the Federal Reserve will employ all available tools to promote economic recovery and to preserve price stability. The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and anticipates that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period.

“To provide greater support to mortgage lending and housing markets, the Committee decided today to increase the size of the Federal Reserve’s balance sheet further by purchasing up to an additional $750 billion of agency mortgage-backed securities, bringing its total purchases of these securities to up to $1.25 trillion this year, and to increase its purchases of agency debt this year by up to $100 billion to a total of up to $200 billion.

“Moreover, to help improve conditions in private credit markets, the Committee decided to purchase up to $300 billion of longer-term Treasury securities over the next six months. The Federal Reserve has launched the Term Asset-Backed Securities Loan Facility to facilitate the extension of credit to households and small businesses and anticipates that the range of eligible collateral for this facility is likely to be expanded to include other financial assets.

“The Committee will continue to carefully monitor the size and composition of the Federal Reserve’s balance sheet in light of evolving financial and economic developments.”

No significant change here. Quantitative easing continues, but was not expanded. They dropped mention of the TALF, but that is already underway (off to a very slow start, but underway). The Fed is effectively now the only buyer of mortgaged-backed securities, and by the end of the year will be holding about 20% of all Fannie Mae (FNM) and Freddie Mac (FRE) backed securities outstanding.

This is a lot of credit risk for a Central Bank to be taking on, but if it were not doing so, mortgage rates would skyrocket, rather than falling to historically low levels. Those low levels are allowing people to refinance and thus have more money to spend on other things. This may be why consumption spending was so unexpectedly strong in the first quarter.

Still, this is a violation of one of the central tenants of central banking, namely that Central Banks do not take on significant credit risk. Given that both Fannie and Freddie are on government life-support, the fact that these securities are insured by them does not provide much comfort about the level of credit risk being undertaken. Unprecedented conditions call for unprecedented actions.

“Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; Elizabeth A. Duke; Charles L. Evans; Donald L. Kohn; Jeffrey M. Lacker; Dennis P. Lockhart; Daniel K. Tarullo; Kevin M. Warsh; and Janet L. Yellen.”

“Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; Elizabeth A. Duke; Charles L. Evans; Donald L. Kohn; Jeffrey M. Lacker; Dennis P. Lockhart; Daniel K. Tarullo; Kevin M. Warsh; and Janet L. Yellen.”

Well, not much action taken this time around, but everyone agreed.

Overall, the Fed is taking a wait-and-see approach. In previous meetings, it has taken extremely aggressive measures (indeed, it could turn out to be recklessly aggressive). Monetary policy always works with very long time lags. They want to see if what they have done so far works, rather than further increasing the odds that they have already overshot the target.

If not for the easing moves that the Fed started to take well over a year ago, the economy would be in far worse shape than it is today. Those actions are not, however, without cost. Just how big a price we will end up paying will not be known for some time yet.

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