As was universally expected, the Federal Reserve left the Fed Funds rate at a range of between 0.00% and 0.25%. The main focus is on the changes to the language of the policy statement. Below, I present the current and previous (1/26/11) policy statements on a paragraph-by-paragraph basis, and then comment/translate them after each paragraph.
“Information received since the Federal Open Market Committee met in January suggests that the economic recovery is on a firmer footing, and overall conditions in the labor market appear to be improving gradually. Household spending and business investment in equipment and software continue to expand.
“However, investment in nonresidential structures is still weak, and the housing sector continues to be depressed. Commodity prices have risen significantly since the summer, and concerns about global supplies of crude oil have contributed to a sharp run-up in oil prices in recent weeks. Nonetheless, longer-term inflation expectations have remained stable, and measures of underlying inflation have been subdued.”
“Information received since the Federal Open Market Committee met in December confirms that the economic recovery is continuing, though at a rate that has been insufficient to bring about a significant improvement in labor market conditions. Growth in household spending picked up late last year, but remains constrained by high unemployment, modest income growth, lower housing wealth, and tight credit.
“Business spending on equipment and software is rising, while investment in nonresidential structures is still weak. Employers remain reluctant to add to payrolls. The housing sector continues to be depressed. Although commodity prices have risen, longer-term inflation expectations have remained stable, and measures of underlying inflation have been trending downward.”
A nice improvement in the tone of its statement about the state of the economy. The Fed sees the recovery as for real, and now self-sustaining. Finally we are starting to see significant job growth, but at the current rate it will still be a very long time before we return to anything approaching full employment.
The tone of the statement about consumer spending was also more upbeat as the Fed dropped the mention of the factors constraining consumers. They note that construction — both residential and non-residential — is still very depressed. Normally residential investment is the sector of the economy that leads us out of recessions, but it has been a persistent drag this time.
The members of the Fed Reserve note the rise in oil prices, but think that it will not flow through to cause generalized inflation. Given the huge amount of slack in the economy, I agree with them. Increasing relative prices for energy and other commodities are a good reason to overweight producers of them in your portfolio, but as long as they are not flowing through to core measures of inflation, they are not a good reason to tighten monetary policy.
The bond market is in full agreement with the Fed (and me). The ten-year T-note is yielding only 3.3%, which in any historical context is still extremely low. If the bond market expected inflation to become a serious issue, then it would sell of dramatically to raise rates that reflected the higher expected inflation.
If you do think inflation is a real problem, then you should borrow every nickel you can and buy the Double Short Treasury ETF (TBT). If you are not willing to buy the TBT, stop worrying about inflation.
“Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. Currently, the unemployment rate remains elevated, and measures of underlying inflation continue to be somewhat low, relative to levels that the Committee judges to be consistent, over the longer run, with its dual mandate.
“The recent increases in the prices of energy and other commodities are currently putting upward pressure on inflation. The Committee expects these effects to be transitory, but it will pay close attention to the evolution of inflation and inflation expectations. The Committee continues to anticipate a gradual return to higher levels of resource utilization in a context of price stability.”
“Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. Currently, the unemployment rate is elevated, and measures of underlying inflation are somewhat low, relative to levels that the Committee judges to be consistent, over the longer run, with its dual mandate.
“Although the Committee anticipates a gradual return to higher levels of resource utilization in a context of price stability, progress toward its objectives has been disappointingly slow.”
The Fed has two jobs: keep prices stable, which in practical terms has meant keep core inflation around 2% per year, and keep unemployment low. It has done a “great job” on inflation, but a “lousy job” on jobs. It is not all the Fed’s fault, which is why I put the quotation marks in. Still, the policy response should be straightforward given those conditions.
Monetary policy needs to be looser. However, short-term rates are already at zero, and have been since December 2008. The Fed long ago shot all of its conventional ammo, and now has to load the cannons with scrap metal and silverware. At the zero boundary, the desired level of savings (including the paying down of debt) far exceeds the desired level of investment by companies, even with super low interest rates. That slows the economy.
The Fed has to respond with unconventional policies, like buying longer-term assets — the monetary policy equivalent of loading the cannons with forks and knives. The Fed expects the oil price increase to fade once the situation in Libya is resolved. I suspect they are right about that, but frankly I have no idea when the Libya situation will be settled, and it is looking more and more like a civil war, not just a rebellion.
“To promote a stronger pace of economic recovery and to help ensure that inflation, over time, is at levels consistent with its mandate, the Committee decided today to continue expanding its holdings of securities as announced in November.
“In particular, the Committee is maintaining its existing policy of reinvesting principal payments from its securities holdings and intends to purchase $600 billion of longer-term Treasury securities by the end of the second quarter of 2011. The Committee will regularly review the pace of its securities purchases and the overall size of the asset-purchase program in light of incoming information and will adjust the program as needed to best foster maximum employment and price stability.”
“To promote a stronger pace of economic recovery and to help ensure that inflation, over time, is at levels consistent with its mandate, the Committee decided today to continue expanding its holdings of securities as announced in November.
“In particular, the Committee is maintaining its existing policy of reinvesting principal payments from its securities holdings and intends to purchase $600 billion of longer-term Treasury securities by the end of the second quarter of 2011. The Committee will regularly review the pace of its securities purchases and the overall size of the asset-purchase program in light of incoming information and will adjust the program as needed to best foster maximum employment and price stability.”
No change in either the magnitude or the timing of QE2. I am not surprised that the full amount will be purchased, but I had suspected that they might stretch it out and taper off the purchase activity, perhaps ending in September. Recent events in Japan make the program more needed than it was last week.
The Bank of Japan announced a quantitative easing program in response to the quake that is roughly as big as our QE2 program, relative to the size of the Japanese economy. That comes on top of previous zero interest rate and quantitative easing steps that Japan has taken (seemingly for decades now).
“The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels for the federal funds rate for an extended period.”
“The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels for the federal funds rate for an extended period.”
The key “to warrant exceptionally low levels for the federal funds rate for and extended period” language was retained. That suggests that the very earliest that the Fed will consider raising the Fed Funds rate is the start of 2012. The fact that the rate stayed where it is at this meeting should be meet with no more surprise than the fact that the sun rose in the east this morning.
“The Committee will continue to monitor the economic outlook and financial developments and will employ its policy tools as necessary to support the economic recovery and to help ensure that inflation, over time, is at levels consistent with its mandate.”
“The Committee will continue to monitor the economic outlook and financial developments and will employ its policy tools as necessary to support the economic recovery and to help ensure that inflation, over time, is at levels consistent with its mandate.”
A standard boilerplate statement that never changes. Really, would you expect them to say, “We plan to completely ignore economic data so that the economic recovery fails and inflation or deflation gets totally out of control”?
“Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; Elizabeth A. Duke; Charles L. Evans; Richard W. Fisher; Narayana Kocherlakota; Charles I. Plosser; Sarah Bloom Raskin; Daniel K. Tarullo; 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; Richard W. Fisher; Narayana Kocherlakota; Charles I. Plosser; Sarah Bloom Raskin; Daniel K. Tarullo; Kevin M. Warsh; and Janet L. Yellen.”
Everyone agreed, but this time the Fed was even more short handed than last time since Kevin Warsh has resigned. One of Obama’s replacement nominees, Peter Diamond — the Nobel prize-winning expert on the employment market — is being held up by Senator Richard Shelby, supposedly because he is not qualified. Diamond is by any measure far more qualified than Warsh was when he was appointed. At the very least Professor Diamond deserves an up or down vote in the full Senate.
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