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FOMC Minutes

January 08, 2009 | "Barron’s Econoday"

The Fed minutes for the historic December 15-16, 2008 FOMC meeting show members engaged in sharp debate over how the Fed should communicate and implement its new policy of fed funds rates near zero. Additionally, the Fed staff sharply lowered its forecast for economic growth in 2009. The minutes confirm that the Fed is going to hold rates low for some time and that the Fed’s attention will now focus on other measures of policy instead of mainly interest rates.

The release of the FOMC minutes had to compete with announcements by President-elect Obama that he believes trillion dollar federal deficits are likely to continue for years. Obama’s comments bumped up interest rates and lowered the day’s stock gains.

At the December FOMC meeting, the Fed made the historic policy move of cutting the fed funds target from 1 percent to a range of zero to 0.25 percent. The Fed is now easing further by buying various financial instruments, including mortgage backed securities (MBS). FOMC members agreed to not specify the timing of purchases MBS and to leave that to the discretion of the New York Fed which implements open market operations for the Fed. The purchase of MBS would depend on market conditions.

Not only did the Fed’s staff lower its economic growth forecast, but FOMC participants also anticipate negative growth in the near term.

"Participants expected economic activity to contract sharply in the fourth quarter of 2008 and in early 2009. Most projected that the economy would begin to recover slowly in the second half of 2009, aided by substantial monetary policy easing and by anticipated fiscal stimulus. Meeting participants generally agreed that the uncertainty surrounding the outlook was considerable and that downside risks to even this weak trajectory for economic activity were a serious concern. Indeed, the severe ongoing financial market strains, the large reductions in household wealth, and the global nature of the economic slowdown were seen by some participants as suggesting the distinct possibility of a prolonged contraction, although that was not judged to be the most likely outcome. Inflation pressures had diminished appreciably as energy and other commodity prices dropped and economic activity slumped."

This expected economic weakness led the Fed to cut its target rate and to move focus away from interest rates to other measures of monetary policy.

"Most participants judged that the benefits in terms of support for the overall economy of federal funds rates close to, but slightly above, zero probably outweighed the adverse effects. With the federal funds rate already trading at very low levels as a result of the large volume of excess reserves associated with the Federal Reserve's liquidity operations, participants agreed that the Committee would need to focus on other tools to impart additional monetary stimulus to the economy in the near term."

Along with this shift, the FOMC also decided to be more explicit about communicating policy – notably the fact that low rates are likely to continue for some time. Some members indicated that it also would be helpful to be more explicit about the Fed’s inflation expectations.

"Another possible form of communication that participants discussed was a more explicit indication of their views on what longer-run rate of inflation would best promote their goals of maximum employment and price stability. The added clarity in that regard might help forestall the development of expectations that inflation would decline below desired levels, and hence keep real interest rates low and support aggregate demand."

The practical news from the latest minutes is signs of what Fed watchers should give more attention. The minutes cited a number of measures that have not gotten much attention in recent years or even decades, compared to changes in fed funds targets. The minutes gave more attention to M2 growth, agency debt spreads (Fannie Mae, Freddie Mac, and Ginnie Mae) which reflect availability of residential mortgage credit, mortgage rates, and items in the Fed’s balance sheets including excess reserves.

FOMC participants indicated that a number of the Fed’s new lending facilities will continue for some time and that others might be created.

But the new emphasis on quantitative easing has caused a significant shift in the technical balance of power within the Fed that appears to be addressed in a new manner. Open market operations are determined by the combined oversight of the Board of Governors and the regional presidents in the FOMC. However, supervision of the new credit facilities officially falls under only the Board of Governors, technically leaving regional presidents out in the cold. But informally, there appears to be an agreement between the Board and regional presidents to regularly consult on operating the facilities. The latest minutes reflect the implementation of such non-official consultation between the Board and the presidents on policy with the credit facilities.

The bottom line is that the economy still is in deep recession, the Fed is aggressively easing and beyond just what zero rates allow, and that the new Fed policy of quantitative easing is going to be a challenge to track.

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