The Federal Reserve, as expected, left the Fed funds rate unchanged at a range between 0.0% and 0.25%. More importantly it also kept the key line in its policy statement: “are likely to warrant exceptionally low levels of the federal funds rate for an extended period.”
Below are the current Fed Statement, and the previous Fed statement from April 28th, paragraph by paragraph, with my interpretation and translations interspersed.
Information received since the Federal Open Market Committee met in April suggests that the economic recovery is proceeding and that the labor market is improving gradually. Household spending is increasing but remains constrained by high unemployment, modest income growth, lower housing wealth, and tight credit. Business spending on equipment and software has risen significantly; however, investment in nonresidential structures continues to be weak and employers remain reluctant to add to payrolls. Housing starts remain at a depressed level. Financial conditions have become less supportive of economic growth on balance, largely reflecting developments abroad. Bank lending has continued to contract in recent months. Nonetheless, the Committee anticipates a gradual return to higher levels of resource utilization in a context of price stability, although the pace of economic recovery is likely to be moderate for a time.
Information received since the Federal Open Market Committee met in March suggests that economic activity has continued to strengthen and that the labor market is beginning to improve. Growth in household spending has picked up recently but remains constrained by high unemployment, modest income growth, lower housing wealth, and tight credit. Business spending on equipment and software has risen significantly; however, investment in nonresidential structures is declining and employers remain reluctant to add to payrolls. Housing starts have edged up but remain at a depressed level. While bank lending continues to contract, financial market conditions remain supportive of economic growth. Although the pace of economic recovery is likely to be moderate for a time, the Committee anticipates a gradual return to higher levels of resource utilization in a context of price stability.
The opening line is a decided downgrade of the Fed’s assessment of the strength of the recovery. The last statement implied that the recovery was accelerating, while the current one has no such implication. They added the word “gradually” to the improvement of the labor market.
Not a lot of difference in the second line between “has picked up” and “is increasing”. The data, though, seems to suggest that the rate of increase of household spending has decelerated.
The third line on business investment is unchanged from last time. Construction, both non-residential and residential, remains a major thorn in the side of the current recovery. This was dramatically reemphasized this morning by an extremely weak report on New Home Sales (see New Home Sales Collapse), which fell to an all time record low (since the numbers have been tracked starting in 1963). This is sort of acknowledged in the point about housing starts, which is unchanged from the last statement. There is a major downgrade in its language on financial conditions, from “remain supportive of economic growth” to being “less supportive of economic growth”. This is the first Fed meeting since the Greek Drama moved to center stage and the Fed is saying that there will be at least some impact on this side of the pond. They noted in both statements that bank lending continues to contract. The still express optimism about the recovery continuing. That is what returning to higher levels of resource utilization means. Note that in the April statement they made no mention of the pace of economic recovery being moderate. Both statements imply that inflation is not a threat right now.
Prices of energy and other commodities have declined somewhat in recent months, and underlying inflation has trended lower. With substantial resource slack continuing to restrain cost pressures and longer-term inflation expectations stable, inflation is likely to be subdued for some time.
With substantial resource slack continuing to restrain cost pressures and longer-term inflation expectations stable, inflation is likely to be subdued for some time.
The language on inflation is, if anything, more emphatic this time than last time, noting the decline in commodity prices and how that is likely to filter into the rest of the economy. I would have liked to see them go further and recognize that outright deflation is a real and present danger. Deflation raises the real interest rate and makes it harder for borrowers to repay their loans, and increases the likelihood that they will take the less desirable way out of too much debt, default. Deflation can be much more destructive to the economy than inflation can be. While 3% inflation might not be ideal, the economy can easily deal with it. If deflation is 3%, we are likely to see a wholesale collapse of the economic system.
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 of 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 of the federal funds rate for an extended period. The Committee will continue to monitor the economic outlook and financial developments and will employ its policy tools as necessary to promote economic recovery and price stability.
No change to the key term “likely to warrant exceptionally low levels of the fed funds rate for an extended period.”
The Committee will continue to monitor the economic outlook and financial developments and will employ its policy tools as necessary to promote economic recovery and price stability.
I’m not sure why they decided to make the continuing to monitor the economy boilerplate into a separate paragraph. But no change other than that.
In light of improved functioning of financial markets, the Federal Reserve has closed all but one of the special liquidity facilities that it created to support markets during the crisis. The only remaining such program, the Term Asset-Backed Securities Loan Facility, is scheduled to close on June 30 for loans backed by new-issue commercial mortgage-backed securities; it closed on March 31 for loans backed by all other types of collateral.
All the exceptional facilities put in place at the height of the meltdown have or are about to be retired. Since most have been closed down for several months now, the Fed apparently decided that it was ancient history and dropped the reference in the statement. I would not read too much into that.
Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; James Bullard; Elizabeth A. Duke; Donald L. Kohn; Sandra Pianalto; Eric S. Rosengren; Daniel K. Tarullo; and Kevin M. Warsh. Voting against the policy action was Thomas M. Hoenig, who believed that continuing to express the expectation of exceptionally low levels of the federal funds rate for an extended period was no longer warranted because it could lead to a build-up of future imbalances and increase risks to longer-run macroeconomic and financial stability, while limiting the Committee’s flexibility to begin raising rates modestly.
Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; James Bullard; Elizabeth A. Duke; Donald L. Kohn; Sandra Pianalto; Eric S. Rosengren; Daniel K. Tarullo; and Kevin M. Warsh. Voting against the policy action was Thomas M. Hoenig, who believed that continuing to express the expectation of exceptionally low levels of the federal funds rate for an extended period was no longer warranted because it could lead to a build-up of future imbalances and increase risks to longer run macroeconomic and financial stability, while limiting the Committee’s flexibility to begin raising rates modestly.
Tom Hoenig, head of the Kansas City Fed, again was the lone dissenter. He is the head of the hawk faction at the Fed that wants to raise rates sooner rather than later. In my opinion, Mr. Hoenig is not only wrong, but dangerously wrong. If his advice were followed, the risk of a double dip recession, which is already fairly significant, would increase exponentially. It is good that the rest of the Fed has the common sense to ignore him. Tom, for goodness sake, there is no inflation around and the unemployment rate is still near 10%. Almost half of the unemployed have been without work for more than six months. If keeping rates low under those circumstances is not warranted, when would it be? The bond market has not been signaling any worries about inflation being about to break out. Indeed just about the only potential bubble right now is in T-notes.
The risk is deflation, not inflation. Raising rates would be exactly what would raise the risks to longer term macroeconomic and financial stability. Potentially, it could cause a renewed downturn that would throw millions more out of work, which would endanger not just macro economic stability but social, and even, potentially, political stability.
Overall the only real change is a downgrade to the economic outlook relative to last time, in part due to the situation is Europe. The Fed will probably wait until at least the start of 2011 before it raises rates, if not much longer than that. I would have liked to see some reference to the possibility of the Fed going the other way, and easing monetary policy further, perhaps by buying longer dated T-notes. Also some discussion of cutting the interest rate the Fed pays to banks on their excess reserves would have been welcome. If we want banks like Bank of America (BAC) and J.P. Morgan (JPM) to start lending more aggressively again, it might make sense to stop rewarding them for sitting on the money and not lending it out.
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