Fed Splitting into Deeply Divided Factions

We gained a lot of insight into Fed policy this week, and not all of it was pretty.  Some thoughts as Friday comes to a close:

1.) The Fed is deeply divided.  The minutes of the last FOMC meeting clearly revealed that the FOMC is splitting into deeply divided factions.  Those factions were on display today with the comments of St. Louis Federal Reserve President James Bullard and Philadelphia Federal Reserve President Charles Plosser.  Bullard pushed hard on the policy implications of the inflation data.  From the Wall Street Journal:

“If [inflation] drops any further from here, we are going to have to take it very seriously,” Federal Reserve Bank of St. Louis President James Bullard said in an interview with the Wall Street Journal. Price pressures are at the “lower bound” of where they should be, and “I’m a little nervous” about this situation, the official said.

…Mr. Bullard said the “simplest” way the Fed could counter under-target inflation is by extending its current bond buying stimulus program for longer than currently planned, and take off the table for now any move toward shrinking the monthly size of the effort.

As his dissent made clear, Bullard clearly feels that talk of tapering is clearly premature.  On the other side is Plosser, who not only wants to end asset purchases this year, but also change the Evan’s rule from thresholds to triggers:

The second step is for the FOMC to commit to its forward guidance on the fed funds rate path, that is, to begin treating the 6.5 percent unemployment rate and the 2.5 percent inflation rate in the guidance as triggers rather than thresholds.

The growing division makes it increasingly difficult to think of “the Fed” as a single entity with regards to policy intentions.

2.) Bernanke is pulling the strings.  Someone brokered a truce at the FOMC meeting that allowed Federal Reserve Chairman Ben Bernanke to lay out the path to ending asset purchases.  That someone must have been Bernanke, indicating that he wanted to introduce the idea that asset purchases would most likely soon be curtailed.  This suggests that Bernanke is pro-tapering.

3.) Bernanke tipped his hand big time.  Bernanke claimed in his press conference that his comments represented the views of the FOMC.  But as I noted earlier this week, the minutes make no reference to his 7% unemployment trigger for ending asset purchases.  So where did that number come from?  Must have been Bernanke revealing his own preference.  This was confirmed today by Bullard:

In the interview, Mr. Bullard said that when Mr. Bernanke said the bond buying program will likely end when a 7% jobless rate is achieved, he was not stating official FOMC policy.

“The committee itself has not voted on or approved any threshold for the [bond buying] program. It’s not clear we would,” Mr. Bullard said, adding that central bankers will discuss this matter further at future gatherings.

Ouch – so how much of what Bernanke says in a press conference is consensus policy, and how much is his own position?  Not clear any more.  But the plot thickens.  From Plosser’s speech:

In the June press conference, Chairman Bernanke added some clarification and more specifics regarding the forward guidance for the latest round of asset purchases, which are adding $85 billion a month to our balance sheet…He indicated that if the incoming data are broadly aligned with this central tendency outlook, the Committee anticipates it would moderate the pace of monthly purchases later this year, perhaps ending them around mid-2014. The Chairman indicated that at that point, the unemployment rate is likely to be near 7 percent. If this plan unfolds as described, this latest round of large-scale asset purchases would exceed $1 trillion and the Fed’s balance sheet would grow to more than $4 trillion.

So what are the economic conditions that would lead the Committee to slow the pace at which we are expanding the balance sheet? ..The Chairman noted that the asset purchase program is expected to end before the Committee begins raising the fed funds rate. So, ending the program by mid-2014, when the unemployment rate is anticipated to be around 7 percent, would be consistent with this.

Notice how carefully Plosser differentiates between the Committee and the Chairman.  It sounds as if Plosser also attributes the 7% number to the Chairman, not the Committee.  Not that Plosser is unhappy with the number:

My forecast has the unemployment rate approaching 7 percent by the end of this year and 6.5 percent before the end of 2014…consistent with my forecast and with the Committee’s forward guidance, I favor starting to reduce the pace of purchases and ending the asset purchase program by year-end.

Plosser is happy to take the 7% number because it justifies his desire to end asset purchases by the end of this year.  If Bernanke unilaterally set policy, the policy he set was one that favored the hawks.

Now for a big question:  Did Bernanke set the 7% unemployment trigger as FOMC policy because he is pulled toward the more hawkish of the FOMC factions?   If the 7% was not consensus FOMC policy, I think he tipped his hand.

4.) Is there a fight brewing?  Let’s go back to Bullard’s comment:

“The committee itself has not voted on or approved any threshold for the [bond buying] program. It’s not clear we would,” Mr. Bullard said, adding that central bankers will discuss this matter further at future gatherings.

What exactly will be discussed?  The 7% trigger, or the unilateral policy action on the part of Bernanke?  Bullard sounds like a very unhappy camper – how hard is he going to push on Bernanke in the Chairman’s final days?

Bottom Line:  It is increasingly important that we get some real clarity on the Chairman’s 7% unemployment trigger.  I think it might help more clearly define where he sits on the policy spectrum. That might be on a more hawkish side that we tend to believe.  And with the FOMC increasingly divided, should we be expecting a real power struggle within the Fed in the waning days of the Bernanke era?

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