The FOMC’s Decision in a Parallel Universe

The FOMC continues to disappoint. Other than acknowledging the economy is getting worse, the FOMC decided to sit on its hands and hope the aggregate demand slump disappears on its own. As I have noted before, this failure to act by the Fed when money demand is elevated and growing amounts to a passive tightening of monetary policy. Caroline Baum in her latest Bloomberg column agrees. Can anyone say Lords of Finance 2.0?

I have been disappointed for so long that sometimes I feel the need to believe in parallel universes where somewhere out there a FOMC actually does its job. In that universe, the FOMC responds forcefully to the aggregate demand slump and does so using a nominal GDP level target. Below is what the FOMC statement in that parallel universe would look like. (It is an update on a similar post I did for the April FOMC. I plan to update and post it every FOMC meeting the Fed fails to do its job.)

Release Date: August 1, 2012

For immediate release

Information received since the Federal Open Market Committee met in June suggests that economic growth remains anemic. Labor market conditions are weakening and the unemployment rate continues to remain elevated. Household spending and business fixed investment appears to be slowing down. Inflation has moderated in recent months. Long-term inflation expectations remain well anchored.

Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. The Committee continues to expect a sluggish pace of economic growth over coming quarters as the crisis in Europe, the slowdown in Asia, and the uncertainty over year-end fiscal austerity plans are creating significant headwinds for the economy. These developments along with the economy operating below its full-employment level indicates that further action is warranted by the Committee.

To support a stronger economic recovery and to help ensure that inflation, over time, is at levels consistent with the dual mandate, the Committee decided today to begin a new conditional asset purchasing program tied to an explicit growth path for nominal GDP. The Committee believes that nominal GDP should expand to $16 trillion dollars and grow at a 5% annual pace thereafter. To this end, the Committee intends to purchase Treasury and Agency securities every week until this target is hit.

This program should raise expectations of future nominal GDP growth and cause a rebalancing of portfolios that will facilitate a rise in current aggregate nominal spending. The Committee will regularly review the size and composition of its securities holdings and is prepared to adjust those holdings as appropriate.

The Committee also decided to continue through the end of the year its program to extend the average maturity of its holdings of securities as announced in June, and it is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities. The Committee will closely monitor incoming information on economic and financial developments and will provide additional accommodation as needed to promote a stronger economic recovery and sustained improvement in labor market conditions in a context of price stability.

Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; Elizabeth A. Duke; Dennis P. Lockhart; Sandra Pianalto; Sarah Bloom Raskin; Daniel K. Tarullo; John C. Williams; and Janet L. Yellen. Voting against the action was Jeffrey M. Lacker, who does not anticipate that economic conditions are likely to warrant a new conditional asset purchase program.

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