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Wednesday, May 18, 2011

FOMC Minutes: Exit Strategy Discussion

by Calculated Risk on 5/18/2011 02:00:00 PM

The Bernanke press conference after the FOMC meeting covered some of discussion in the statement.

From the April 27, 2011 FOMC meeting. There is a lengthy discussion on the eventual exit strategy, although it clearly will not happen soon.

Meeting participants agreed on several principles that would guide the Committee's strategy for normalizing monetary policy. First, with regard to the normalization of the stance of monetary policy, the pace and sequencing of the policy steps would be driven by the Committee's monetary policy objectives for maximum employment and price stability. Participants noted that the Committee's decision to discuss the appropriate strategy for normalizing the stance of policy at the current meeting did not mean that the move toward such normalization would necessarily begin soon. Second, to normalize the conduct of monetary policy, it was agreed that the size of the SOMA's securities portfolio would be reduced over the intermediate term to a level consistent with the implementation of monetary policy through the management of the federal funds rate rather than through variation in the size or composition of the Federal Reserve's balance sheet. Third, over the intermediate term, the exit strategy would involve returning the SOMA to holding essentially only Treasury securities in order to minimize the extent to which the Federal Reserve portfolio might affect the allocation of credit across sectors of the economy. Such a shift was seen as requiring sales of agency securities at some point. And fourth, asset sales would be implemented within a framework that had been communicated to the public in advance, and at a pace that potentially could be adjusted in response to changes in economic or financial conditions.

In addition, nearly all participants indicated that the first step toward normalization should be ceasing to reinvest payments of principal on agency securities and, simultaneously or soon after, ceasing to reinvest principal payments on Treasury securities. Most participants viewed halting reinvestments as a way to begin to gradually reduce the size of the balance sheet. It was noted, however, that ending reinvestments would constitute a modest step toward policy tightening, implying that that decision should be made in the context of the economic outlook and the Committee's policy objectives. In addition, changes in the statement language regarding forward policy guidance would need to accompany the normalization process.
The sequence will probably be: 1) End of QE2 at the end of June, 2) stop reinvestment some time later this year, 3) remove the "exceptionally low levels for the federal funds rate for an extended period" late this year or in 2012, 4) and then start raising rates / selling assets in 2012 or even 2013. Anyone expecting the Fed to raise rates this year is probably overlooking some of these steps.

And here were the forecasts as of April 27th (GDP was revised down, inflation up, unemployment rate down - Bernanke released this earlier):

April 2011 Economic projections of Federal Reserve Governors and Reserve Bank presidents
201120122013
Change in Real GDP3.1 to 3.33.5 to 4.23.5 to 4.3
Previous Projection (Jan 2011)3.4 to 3.93.5 to 4.43.7 to 4.6
Unemployment Rate 8.4 to 8.77.6 to 7.96.8 to 7.2
Previous Projection (Jan 2011)8.8 to 9.07.6 to 8.16.8 to 7.2
PCE Inflaton2.1 to 2.81.2 to 2.01.4 to 2.0
Previous Projection (Jan 2011)1.3 to 1.71.0 to 1.91.2 to 2.0
Core PCE Inflation1.3 to 1.61.3 to 1.81.4 to 2.0
Previous Projection (Jan 2011)1.0 to 1.31.0 to 1.51.2 to 2.0

FOMC definitions:
1 Projections of change in real GDP and in inflation are from the fourth quarter of the previous year to the fourth quarter of the year indicated.
2 Projections for the unemployment rate are for the average civilian unemployment rate in the fourth quarter of the year indicated.