Fed Statement Decoded

The Federal Reserve just finished its meeting, and as was universally expected, it kept the Fed Funds rate at the 0 to 0.25% range where it has been since December 2008. The real action since then has been in the policy statement and the changes in the language of it.

Below, I present the current policy statement, and the policy statement released after its March 15th meeting on a paragraph-by-paragraph basis, and then interpret and translate the statements from “Central Bankerese” to plain English and assess the significance of the changes. Chairman Ben Bernanke will be holding the first-ever post meeting press conference later this afternoon.

“Information received since the Federal Open Market Committee met in March indicates that the economic recovery is proceeding at a moderate pace and overall conditions in the labor market are improving gradually. Household spending and business investment in equipment and software continue to expand.

“However, investment in nonresidential structures is still weak, and the housing sector continues to be depressed. Commodity prices have risen significantly since last summer, and concerns about global supplies of crude oil have contributed to a further increase in oil prices since the Committee met in March. Inflation has picked up in recent months, but longer-term inflation expectations have remained stable and measures of underlying inflation are still subdued.”

“Information received since the Federal Open Market Committee met in January suggests that the economic recovery is on a firmer footing, and overall conditions in the labor market appear to be improving gradually. Household spending and business investment in equipment and software continue to expand.

“However, investment in nonresidential structures is still weak, and the housing sector continues to be depressed. Commodity prices have risen significantly since the summer, and concerns about global supplies of crude oil have contributed to a sharp run-up in oil prices in recent weeks. Nonetheless, longer-term inflation expectations have remained stable, and measures of underlying inflation have been subdued.”

Not a huge change between “preceding at a moderate pace” and “on a firmer footing” but might be considered a minor upgrade. They note the continued rise in commodity prices, particularly oil prices. Those prices have put upward pressure on headline inflation, but not on core inflation.

The Fed tends to watch core inflation measures more closely than headline inflation numbers. Because inflation expectations are still low and not rising, the Fed is thinking that the rise in headline inflation is not likely to persist.

“Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. The unemployment rate remains elevated, and measures of underlying inflation continue to be somewhat low, relative to levels that the Committee judges to be consistent, over the longer run, with its dual mandate.

“Increases in the prices of energy and other commodities have pushed up inflation in recent months. The Committee expects these effects to be transitory, but it will pay close attention to the evolution of inflation and inflation expectations. The Committee continues to anticipate a gradual return to higher levels of resource utilization in a context of price stability.”

“Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. Currently, the unemployment rate remains elevated, and measures of underlying inflation continue to be somewhat low, relative to levels that the Committee judges to be consistent, over the longer run, with its dual mandate.

“The recent increases in the prices of energy and other commodities are currently putting upward pressure on inflation. The Committee expects these effects to be transitory, but it will pay close attention to the evolution of inflation and inflation expectations. The Committee continues to anticipate a gradual return to higher levels of resource utilization in a context of price stability.”

The key problem with the economy is that the unemployment rate is too high, not that inflation Is too high, particularly after one backs out food and energy prices. At least in the short run, there is a trade-off between fighting inflation and bringing unemployment down. Over the long run, higher inflation hurts growth, but in the short-run there is a trade-off between the two.

Food and Energy prices tend to be volatile and influenced by factors out of the control of the Central Bank. If the Fed tightened every time there was instability in the Middle East — or a poor harvest due to bad weather — it would whipsaw the economy. Similarly, they should not be lowing interest rates or increasing the money supply simply due to a good harvest.

I fully agree that the core problem is unemployment, not inflation. The Fed really should be doing more, not less, in terms of providing monetary stimulus. However, it has already had to resort to very unconventional means to do so; its conventional ammunition was used up long ago.

Overwhelmingly, though, the criticism of the Fed has been that it has been too loose with monetary policy. I think that criticism is entirely off-base.

“To promote a stronger pace of economic recovery and to help ensure that inflation, over time, is at levels consistent with its mandate, the Committee decided today to continue expanding its holdings of securities as announced in November.

“In particular, the Committee is maintaining its existing policy of reinvesting principal payments from its securities holdings and will complete purchases of $600 billion of longer-term Treasury securities by the end of the current quarter. The Committee will regularly review the size and composition of its securities holdings in light of incoming information and is prepared to adjust those holdings as needed to best foster maximum employment and price stability.”

“To promote a stronger pace of economic recovery and to help ensure that inflation, over time, is at levels consistent with its mandate, the Committee decided today to continue expanding its holdings of securities as announced in November.

“In particular, the Committee is maintaining its existing policy of reinvesting principal payments from its securities holdings and intends to purchase $600 billion of longer-term Treasury securities by the end of the second quarter of 2011. The Committee will regularly review the pace of its securities purchases and the overall size of the asset-purchase program in light of incoming information and will adjust the program as needed to best foster maximum employment and price stability.”

No real change here. QE2, its unconventional step to increase monetary stimulus, will be completed as scheduled at the end of June. No indication of a QE3. The “review of the size and composition of its securities holdings” is mostly about its exit strategy. Do they eventually start to sell off the bonds that they have been buying up, or do they just sit and let them mature?

If inflation starts to heat up — particularly if inflation starts to spread to the core — they will probably start to sell some of their holdings and reduce the size of the balance sheet; if not they will just sit tight and let things roll off over time.

“The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels for the federal funds rate for an extended period.”

“The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels for the federal funds rate for an extended period.”

No change, but here the lack of change is noteworthy. The Fed is not only saying that the fed funds rate is not going up today, but it is not going up for a long time to come. This should help hold down intermediate-term interest rates.

The Fed will probably drop the “extended period” language at least six months before they actually raise the Fed Funds rate. I seriously doubt that the rate will be increased before the start of next year.

Unemployment, while off its peaks and showing some nice progress, is still extremely high by just about any historical standard. Fiscal policy is turning very concretionary, and that will put a drag on the economy. The Fed is not going to compound that mistake by turning monetary policy concretionary as well.

Again, the Fed does not see inflation as being a serious problem — now or in the near future. It is not going to undermine progress on bringing down unemployment by fighting a phantom.

“The Committee will continue to monitor the economic outlook and financial developments and will employ its policy tools as necessary to support the economic recovery and to help ensure that inflation, over time, is at levels consistent with its mandate.”

“The Committee will continue to monitor the economic outlook and financial developments and will employ its policy tools as necessary to support the economic recovery and to help ensure that inflation, over time, is at levels consistent with its mandate.”

This is standard boilerplate that has been in just about every policy statement they have ever issued. It would be really big news if they were not going to monitor the economic outlook and financial developments. They have a dual mandate to promote full employment and low inflation, and they have to monitor the economy to try to fulfill their mandate.

“Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; Elizabeth A. Duke; Charles L. Evans; Richard W. Fisher; Narayana Kocherlakota; Charles I. Plosser; Sarah Bloom Raskin; Daniel K. Tarullo; and Janet L. Yellen.”

“Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; Elizabeth A. Duke; Charles L. Evans; Richard W. Fisher; Narayana Kocherlakota; Charles I. Plosser; Sarah Bloom Raskin; Daniel K. Tarullo; and Janet L. Yellen.”

Despite somewhat hawkish rhetoric from some of the regional fed presidents, all of them that have votes this year — including notable hawks like Kocherlakota and Plosser — decided to vote in favor of this “stay the course” path for monetary policy.

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