FOMC Minutes: Fed Opted to Keep Powder Dry on Using Large-Scale Asset Purchase Effort

October 12, 2011 09:25 AM
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via a special arrangement with Informa Economics, Inc.

Decision made to keep this ‘potent’ tool available should conditions warrant

NOTE: This column is copyrighted material, therefore reproduction or retransmission is prohibited under U.S. copyright laws.

Making large-scale asset purchases was viewed as a “potent” policy tool at the Federal Open Market Committee (FOMC) Sep. 20-21 meeting, but FOMC members opted to not pursue that option yet so as keep that as a policy tool if “further policy action to support a stronger economic recovery” are required. That’s one conclusion from the minutes released from the Sep. FOMC session. Link.

FOMC members were briefed on three options for policy actions, including actions utilizing the System Open Market Account (SOMA):

-- a reinvestment maturity extension program;

-- a SOMA portfolio maturity extension program; and

-- a large-scale asset purchase program.

“Under the first of these options, the Federal Reserve would reinvest the principal payments it receives on its holdings of agency securities exclusively in long-term Treasury securities,” the minutes noted. “Under the second option, the Committee would purchase long-term Treasury securities and sell the same amount of shorter-term Treasury securities; these transactions would significantly increase the average maturity of the SOMA portfolio, but the size of the Federal Reserve's balance sheet and the level of reserve balances would be largely unaffected in the near term. Under the third option, the Committee would purchase longer-term Treasury securities, increasing the size of its balance sheet and the supply of reserve balances.”

Operation Twist. While eventually deciding to go the route of the second option (now dubbed Operation Twist), the minutes noted the following of the large-scale asset purchase option: “A number of participants saw large-scale asset purchases as potentially a more potent tool that should be retained as an option in the event that further policy action to support a stronger economic recovery was warranted. Some judged that large-scale asset purchases and the resulting expansion of the Federal Reserve's balance sheet would be more likely to raise inflation and inflation expectations than to stimulate economic activity and argued that such tools should be reserved for circumstances in which the risk of deflation was elevated.”

Further, the FOMC minutes signaled “Two members said that current conditions and the outlook could justify stronger policy action, but they supported undertaking the maturity extension program at this meeting as it did not rule out additional steps at future meetings.” But the minutes do not say who the two FOMC members were.

Officials also discussed other steps such as lowering a 0.25 percent rate the Fed pays banks on their cash deposits at the central bank, but that option was not pursued out of concern it could temper lending activity.

As we learned via the FOMC statement following the meeting, Dallas Fed President Richard Fisher, Minneapolis Fed President Narayana Kocherlakota and Philadelphia Fed President Charles Plosser all voted against Operation Twist.

Their detailed reasons spelled out in the minutes:

“Messrs. Fisher, Kocherlakota, and Plosser dissented because they did not support additional policy accommodation at this time. Mr. Fisher saw a maturity extension program as providing few, if any, benefits in support of job creation or economic growth, while it could potentially constrain or complicate the timely removal of policy accommodation. In his view, any reduction in long-term Treasury rates resulting from this policy action would likely lead to further hoarding by savers, with counterproductive results on business and consumer confidence and spending behaviors. He felt that policymakers should instead focus their attention on improving the monetary policy transmission mechanism, particularly with regard to the activity of community banks, which are vital to small business lending and job creation. Mr. Kocherlakota's perspective on the policy decision was again shaped by his view that in November 2010, the Committee had chosen a level of accommodation that was well calibrated for the condition of the economy. Since November, inflation, and the one-year-ahead forecast for inflation, had risen, while unemployment, and the one-year-ahead forecast for unemployment, had fallen. He did not believe that providing more monetary accommodation was the appropriate response to those changes in the economy, given the current policy framework. Mr. Plosser felt that a maturity extension program would do little to improve near-term growth or employment, in light of the ongoing structural adjustments and fiscal challenges both in the United States and abroad. Moreover, in his view, with inflation continuing to run above earlier forecasts, such a program could risk adding unwanted inflationary pressures and complicate the eventual exit from the period of extraordinarily accommodative monetary policy.”

As for a more-explicit statement explaining FOMC policy objectives, “Participants generally saw the Committee's post-meeting statements as not well suited to communicate fully the Committee's thinking about its objectives and its policy framework, and agreed that the Committee would need to use other means to communicate that information or to supplement information in the statement.”

Comments: FOMC members still have tools they feel could be very powerful in terms of their potential impact on the economic situation, but they weren’t unanimous that current economic conditions were enough to warrant deploying this “potent” policy option. Now markets will be reading each economic indicator released with an eye on whether it increases or decreases the odds the Fed to embark on large-scale asset purchases.

But if markets view economic data as signaling further deterioration in the U.S. economic situation, markets will expect the large-scale asset purchase effort to be deployed by the Fed. If the Fed doesn’t share the view that economic data warrant a large-scale asset purchase program, markets will react accordingly which could force the Fed’s hand. For now, however, the powder is still dry.

NOTE: This column is copyrighted material, therefore reproduction or retransmission is prohibited under U.S. copyright laws.






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