By Steven K. Beckner
(MNI) – Despite a deluge of discouraging data, it’s probably too
soon to expect Federal Reserve policymakers to charge forward with more
monetary stimulus at their Federal Open Market Committee meeting next
Tuesday.
The groundwork may be laid for future action if the economic
picture does not improve. But with limited arrows left in its quiver,
the FOMC no longer has the luxury of acting aggressively. A divided
committee will have to act more judiciously in a very uncertain economic
and financial climate.
To be sure, monetary policy thinking and market expectations of
policy have evolved considerably in recent months.
Until relatively recently, many were speculating, prematurely,
about when the FOMC would implement an “exit strategy.” And, in fact, at
its April 26-27 meeting, Fed governors and presidents agreed on a set of
principles that the minutes said “would guide the Committee’s strategy
for normalizing monetary policy.”
It was generally agreed, for example, that “the first step toward
normalization should be ceasing to reinvest payments of principal on
agency securities and, simultaneously or soon after, ceasing to reinvest
principal payments on Treasury securities.”
But that exit strategy session, which updated a similar discussion
that had taken place a year earlier, was not intended to signal
near-term implementation. Rather, it was primarily an effort to reassure
financial markets about the Fed’s long-term committment to price
stability.
Neither at the April nor at the late June FOMC meeting was there
any inclination to begin “normalizing,” i.e. tightening, monetary policy
anytime soon.
Indeed, at the June 21-22 meeting, minutes disclosed that “some
participants noted that if economic growth remained too slow to make
satisfactory progress toward reducing the unemployment rate and if
inflation returned to relatively low levels after the effects of recent
transitory shocks dissipated, it would be appropriate to provide
additional monetary policy accommodation.”
The FOMC was not united, though. “Several” participants thought
that “the withdrawal of monetary accommodation may need to begin sooner
than currently anticipated in financial markets.” And “a few
participants expressed uncertainty about the efficacy of monetary policy
in current circumstances but disagreed on the implications for future
policy.”
But it was unanimous that, given an “unusually uncertain” outlook,
the federal funds rate target should be left in the zero to 25 basis
point range, that it would stay “exceptionally low…for an extended
period” and that, while the $600 billion “QE2″ program would be allowed
to expire at the end of June, the Fed would continue to prevent any
shrinkage in its bloated balance sheet by continuing to reinvest
principal payments from its securities holdings.
And in his post-FOMC press conference, Fed Chairman Ben Bernanke
acknowledged for the first time that the first half slowdown might be
more than just “temporary,” that some of it may prove “longer lived.”
Bernanke, in effect, verbally extended the “extended period” by
saying, “I think the thrust of extended period is that we believe we’re
at least two or three meetings away from taking any further action, and
I emphasize ‘at least.’ But depending on how the economy evolves and
inflation and unemployment run, it could be significantly longer.”
What’s more, he opened the door to additional stimulative measures,
including possibly a third round of quantitative easing.
“We do have a number of ways of acting, none of them without risk
or costs,” Bernanke said. “We could, for example, do more securities
purchases and structure them in different ways; we could cut the
interest on excess reserve that we pay to banks and … (we could give)
guidance on the balance sheet or by perhaps even giving a fixed date to
define extended period.”
Following the June FOMC meeting, as it became more and more clear
that the recovery might be stalling, views solidified among both Fed
officials and Fed watchers that, at the very least, monetary policy was
going to be kept highly accommodative for an indefinite period.
And speculation began to mount that, not only would the Fed not
allow a passive shrinkage of the balance sheet by discontinuing the
reinvestment policy, but that a “QE3″ program of additional long-term
bond purchases might be necessary.
Bernanke did nothing to discourage such talk. On the contrary, in
his July 13 Monetary Policy Report to Congress, he was widely seen as
opening the door a bit wider to some form of additional monetary
stimulus.
“The possibility remains that the recent economic weakness may
prove more persistent than expected and that deflationary risks might
reemerge, implying a need for additional policy support,” he said. “Even
with the federal funds rate close to zero, we have a number of ways in
which we could act to ease financial conditions further.”
“One option would be to provide more explicit guidance about the
period over which the federal funds rate and the balance sheet would
remain at their current levels,” Bernanke elaborated in testimony before
the House Financial Services Committee.
“Another approach would be to initiate more securities purchases or
to increase the average maturity of our holdings,” he continued. “The
Federal Reserve could also reduce the 25 basis point rate of interest it
pays to banks on their reserves, thereby putting downward pressure on
short-term rates more generally.”
The Fed chief conceded that such policies “would entail potential
risks and costs,” but said, “prudent planning requires that we evaluate
the efficacy of these and other potential alternatives for deploying
additional stimulus if conditions warrant.”
The rhetorical shift has been data driven. Between Bernanke’s June
22 press conference and his July 13 Congressional testimony, the Labor
Department’s June employment report had shown a meager 18,000 rise in
non-farm payrolls, a 44,000 downward revision to prior months’ payrolls
and a further uptick in the unemployment rate to 9.2% that occurred
despite substantial shrinkage in the labor force.
Since the Monetary Policy Report, there have been more discouraging
economic signs. The Commerce Department’s advance estimate of second
quarter GDP growth came in at a worse-than-expected 1.3% and first
quarter growth was revised down to a scant 0.4%.
And the slump seems to be continuing into the third quarter,
notwithstanding hopes of a second half rebound.
The Fed’s beige book survey, based on a survey of business and
banking contacts by the 12 Federal Reserve Banks through July 15, found
that the pace of growth “has moderated in many Districts.”
Both the manufacturing and non-manufacturing purchasing managers
surveys confirmed a July slowdown. The Institute for Supply Management’s
manufacturing index dropped 4.4 points to 50.9, still expansionary but
the lowest in two years. And the new orders component showed outright
contraction. The non-manufacturing index slipped six tenths to 52.7, the
slowest pace of expansion in 17 months. There too, orders weakened.
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