Careful reading of the FOMC minutes provides interesting insights as to the dilemma and the uncertainties policy makers face as they struggle with both interpreting the path that the economy has been on, especially with respect to labor market conditions and inflation, and crafting an exit strategy. While there seemed to be general agreement that the growth of the economy has been on a steady and positive track, Committee members’ interpretations differed widely regarding labor market conditions, whether there was or was not slack in labor markets, and whether further improvements were still possible. It was difficult to distill a consensus from their discussion, other than the fact that there was none.
Similar difficulties plagued the Committee’s interpretation of the inflation situation. For example, there seemed to be some puzzlement that many measures of inflation expectations had actually declined further. But whether this trend was the result of a reduction in term premiums or in expected inflation was not clear. Obviously, the decline in oil prices was a factor, but the consensus was that the decline was a net positive, both for the US and for other countries. There was, however, no discussion of the impact the decline was having on countries dependent on oil production or the risks that persistently low oil prices might have on both the internal and external politics of those countries.
The minutes also devoted significant attention to both the Committee’s communications and the experimental term and overnight reverse repo facilities. The overnight reverse repo facilities were seen in previous minutes and discussions as secondary tools that might be employed as policy returned to normalcy, but the minutes of this latest meeting did not offer the impression that there was as yet confidence in how reverse repos might work – thinking regarding this policy tool appears to still be a work in progress. Since experimentation with these facilities will extend through March, we can be skeptical that they would be ready for prime time if a policy move were to begin in June.
The sense that an exit strategy was not yet firmed up came through clearly in the discussion of the Committee’s policy planning and the wording of its statement. Clearly, the minutes reveal that a wider range of options for the path of policy are being considered, but the minutes were devoid of any specifics. This contrasts starkly with the discussion of the reverse repo facilities. One wonders whether the lack of details was intentional or simply reflected a lack of consensus on which track to take?
In the discussion of policy options members were also concerned about the risks of departing either too early or too late from the existing 0-25 basis-point target for the federal funds rate. Attention was also given to the problem of how to communicate to the markets that a possible move in policy might be forthcoming when inflation was still far below its target. There was also discussion of the calibration of rate moves and the risk that too abrupt a move might then be disruptive, trigger a market overreaction, and compel the Committee to backtrack. The upshot of the minutes and the characterization of the policy discussion was that there is still no consensus on how to proceed, and without a consensus it is hard to see that the Committee could have settled on a communications strategy. The most telling sentence was the following:
Many participants indicated that their assessment of the balance of risks associated with the timing of the beginning of policy normalization had inclined them toward keeping the federal funds rate at its effective lower bound for a longer time.
This sentiment and the fact that it was expressed by “many” and not “some” or a “few” suggests that the recent statements by several reserve bank presidents that they want to keep June on the table as an option to move policy simply reflect their desire to maintain maximum discretion to move policy when the data suggest that such action is appropriate, and should not be taken to mean that a policy move is likely in June. Also note that no Federal Reserve Governor has commented publicly on this point that we are aware of. Having an option doesn’t mean it will necessarily be exercised.
We continue to believe that the Committee will be studiously cautious about moving policy, and the January minutes are consistent with that view. That caution has many dimensions including the desire to avoid disrupting markets; to have a well-formed policy strategy (which apparently does not yet exist); to be sensitive to international considerations and what easy policies elsewhere might mean for the conduct of a policy tightening here; and, finally, to be cognizant that never before has the Fed exited from such a policy regime, so there is no history to guide them. In light of the Committee’s well-advised caution, we continue to believe that there will not be a policy move until well into the third quarter or sometime after.