Wednesday, October 08, 2014

FOMC Minutes: "Costs of downside shocks to the economy would be larger than those of upside shocks"

by Calculated Risk on 10/08/2014 02:00:00 PM

Note: Not every member of the FOMC agrees, but I think this is the key sentence: "the costs of downside shocks to the economy would be larger than those of upside shocks because, in current circumstances, it would be less problematic to remove accommodation quickly, if doing so becomes necessary, than to add accommodation".

There was also some discussion about the impact of a strong dollar (weaker exports, lower inflation).

From the Fed: Minutes of the Federal Open Market Committee, September 16-17, 2014. Excerpts:

Inflation had been running below the Committee's longer-run objective, and the readings on consumer prices over the intermeeting period were somewhat softer than during the preceding four months, in part because of declining energy prices. Most participants anticipated that inflation would move gradually back toward its objective over the medium term. However, participants differed somewhat in their assessments of how quickly inflation would move up. Some cited the stability of longer-run inflation expectations at a level consistent with the Committee's objective as an important factor in their forecasts that inflation would reach 2 percent in coming years. Participants' views on the responsiveness of inflation to the level and change in resource utilization varied, with a few seeing labor markets as sufficiently tight that wages and prices would soon begin to move up noticeably but with some others indicating that inflation was unlikely to approach 2 percent until the unemployment rate falls below its longer-run normal level. While most viewed the risk that inflation would run persistently below 2 percent as having diminished somewhat since earlier in the year, a couple noted the possibility that longer-term inflation expectations might be slightly lower than the Committee's 2 percent objective or that domestic inflation might be held down by persistent disinflation among U.S. trading partners and further appreciation of the dollar.

In their discussion of the appropriate path for monetary policy over the medium term, meeting participants agreed that the timing of the first increase in the federal funds rate and the appropriate path of the policy rate thereafter would depend on incoming economic data and their implications for the outlook. That said, several participants thought that the current forward guidance regarding the federal funds rate suggested a longer period before liftoff, and perhaps also a more gradual increase in the federal funds rate thereafter, than they believed was likely to be appropriate given economic and financial conditions. In addition, the concern was raised that the reference to "considerable time" in the current forward guidance could be misunderstood as a commitment rather than as data dependent. However, it was noted that the current formulation of the Committee's forward guidance clearly indicated that the Committee's policy decisions were conditional on its ongoing assessment of realized and expected progress toward its objectives of maximum employment and 2 percent inflation, and that its assessment reflected its review of a broad array of economic indicators. It was emphasized that the current forward guidance for the federal funds rate was data dependent and did not indicate that the first increase in the target range for the federal funds rate would occur mechanically after some fixed calendar interval following the completion of the current asset purchase program. If employment and inflation converged more rapidly toward the Committee's goals than currently expected, the date of liftoff could be earlier, and subsequent increases in the federal funds rate target more rapid, than participants currently anticipated. Conversely, if employment and inflation returned toward the Committee's objectives more slowly than currently anticipated, the date of liftoff for the federal funds rate could be later, and future federal funds rate target increases could be more gradual. In addition, some participants saw the current forward guidance as appropriate in light of risk-management considerations, which suggested that it would be prudent to err on the side of patience while awaiting further evidence of sustained progress toward the Committee's goals. In their view, the costs of downside shocks to the economy would be larger than those of upside shocks because, in current circumstances, it would be less problematic to remove accommodation quickly, if doing so becomes necessary, than to add accommodation. A number of participants also noted that changes to the forward guidance might be misinterpreted as a signal of a fundamental shift in the stance of policy that could result in an unintended tightening of financial conditions.

Participants also discussed how the forward-guidance language might evolve once the Committee decides that the current formulation no longer appropriately conveys its intentions about the future stance of policy. Most participants indicated a preference for clarifying the dependence of the current forward guidance on economic data and the Committee's assessment of progress toward its objectives of maximum employment and 2 percent inflation. A clarification along these lines was seen as likely to improve the public's understanding of the Committee's reaction function while allowing the Committee to retain flexibility to respond appropriately to changes in the economic outlook. One participant favored using a numerical threshold based on the inflation outlook as a form of forward guidance. A few participants, however, noted the difficulties associated with expressing forward guidance in terms of numerical thresholds for some set of economic variables. Another participant indicated a preference for reducing reliance on explicit forward guidance in the statement and conveying instead guidance regarding the future stance of monetary policy through other mechanisms, including the SEP. It was noted that providing explicit forward guidance regarding the future path of the federal funds rate might become less important once a highly accommodative stance of policy is no longer appropriate and the process of policy normalization is well under way.

It was generally agreed that when changes to the forward guidance become appropriate, they will likely present communication challenges, and that caution will be needed to avoid sending unintended signals about the Committee's policy outlook.
emphasis added