Words ought to be a little wild, for they are the assault of thoughts on the unthinking
- J.M. Keynes

Wednesday, 20 February 2013

Fed Minutes Still Signalling Many Months of QE


Headlines such as ‘Fed backsaway from asset buying’ in the FT raised hope about the end of central bank lunacy at least in the USHowever hope soon diminished on reading the statement. The relevant bits are as follows:

However, a few participants expressed concerns that the current highly accommodative stance of monetary policy posed upside risks to inflation in the medium or longer term.

This is fairly dovish as inflation is not a concern.

A number of participants thought that the growth of potential output had been reduced in recent years, possibly in part because restrictive financial conditions and weak economic activity in the aftermath of the financial crisis had reduced investment, business formation, and the pace of adoption of new technologies.

At least this is a tilt towards lowering the ceiling for accommodative monetary policy. Even for fans of NGDP targeting, it shows a downward assessment of potential GDP and hence output gap.

…several others expressed concern about the potential for excessive risk-taking and adverse consequences for financial stability. Some participants mentioned the potential for a sharp increase in longer-term interest rates to adversely affect financial stability and indicated their interest in further work on this topic.

Good, it shows that Jeremy Stein is not batting alone and several others are growing uneasy with the accommodating stance and the perverse incentives it is creating. Wonder if anyone mentioned Greenspan?

Most participants commented that the Committee’s asset purchases had been effective in easing financial conditions and helping stimulate economic activity, and many pointed, in particular, to the support that low longer-term interest rates had provided to housing or consumer durable purchases.

Ah, a break for a self-administered pat on the back. Post hoc ergo prompter hoc. Everyone wants to believe that they saved the world.

Fortunately the sensible stuff continues.

…many participants also expressed some concerns about potential costs and risks arising from further asset purchases. Several participants discussed the possible complications that additional purchases could cause for the eventual withdrawal of policy accommodation, a few mentioned the prospect of inflationary risks, and some noted that further asset purchases could foster market behavior that could undermine financial stability. Several participants noted that a very large portfolio of long-duration assets would, under certain circumstances, expose the Federal Reserve to significant capital losses when these holdings were unwound…

Unfortunately not for long.

…but others pointed to offsetting factors and one noted that losses would not impede the effective operation of monetary policy. A few also raised concerns about the potential effects of further asset purchases on the functioning of particular financial markets, although a couple of other participants noted that there had been little evidence to date of such effects. In light of this discussion, the staff was asked for additional analysis ahead of future meetings to support the Committee’s ongoing assessment of the asset purchase program.

Now we need to watch the results of those analyses. But meanwhile take courage from the fact that this ship is unsinkable and the fact it hasn’t sunk yet proves it.

The last paragraph is the focus in the press with its description of the debate on varying the pace of asset purchases.

Several participants emphasized that the Committee should be prepared to vary the pace of asset purchases, either in response to changes in the economic outlook or as its evaluation of the efficacy and costs of such purchases evolved. For example, one participant argued that purchases should vary incrementally from meeting to meeting in response to incoming information about the economy. A number of participants stated that an ongoing evaluation of the efficacy, costs, and risks of asset purchases might well lead the Committee to taper or end its purchases before it judged that a substantial improvement in the outlook for the labor market had occurred. Several others argued that the potential costs of reducing or ending asset purchases too soon were also significant, or that asset purchases should continue until a substantial improvement in the labor market outlook had occurred. A few participants noted examples of past instances in which policymakers had prematurely removed accommodation, with adverse effects on economic growth, employment, and price stability; they also stressed the importance of communicating the Committee’s commitment to maintaining a highly accommodative stance of policy as long as warranted by economic conditions. In this regard, a number of participants discussed the possibility of providing monetary accommodation by holding securities for a longer period than envisioned in the Committee’s exit principles, either as a supplement to, or a replacement for, asset purchases.

This is not as hawkish as the headlines are making it to be. True opinion seems to be divided more evenly but it states that a number of participants stated that evaluation “might well lead” to “taper or end” purchases. First, it is not as strong as “will lead” and entirely dependent on data and analysis put forward by Fed researchers. Second, how this analysis is interpreted is also important since no concrete criteria to evaluate “efficacy, costs and risks” have been put forth. In the end, the overall dovish bias is clear from the discussion on holding securities for a longer period.

At best there is some equivocation but this is far from being a rejection of the Bernanke-Greenspan doctrine. No need to worry about the end of cheap money yet.

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