by Asha Ban­ga­lore, vice pres­i­dent and econ­o­mist of The North­ern Trust  Company.

The min­utes of the Sep­tem­ber 20–21 FOMC meet­ing indi­cate that sev­eral mem­bers see sig­nif­i­cant down­side risks to eco­nomic growth. They do not project a decline in GDP, but noted that the econ­omy was “vul­ner­a­ble to adverse shocks.” In this con­text, the sources of adverse shocks included “pro­nounced or more pro­tracted delever­ag­ing by house­holds, the chance of a large-than-expected near-term fis­cal tight­en­ing, and poten­tial spillovers to the United States if the finan­cial sit­u­a­tion in Europe were to worsen appreciably.”

The FOMC views that risks are bal­anced with regard to infla­tion. Sta­ble infla­tion expec­ta­tions and a con­tin­ued dis­si­pa­tion of the impact of the past increases in energy and com­mod­ity prices are fac­tors that sup­port mem­bers cited to sup­port pro­jec­tions of both head­line and core infla­tion set­tling close to lev­els con­sis­tent with the Fed’s dual man­date. The min­utes indi­cate that despite these expec­ta­tions, the “out­look for growth and infla­tion as more uncer­tain than usual.”

The Sep­tem­ber meet­ing included an exten­sive dis­cus­sion of tools avail­able to sup­port the econ­omy if eco­nomic con­di­tions weaken. The delib­er­a­tions were focused on three options. First, rein­vest prin­ci­pal pay­ments it receives on hold­ings of agency bonds in long-term Trea­sury secu­ri­ties. Sec­ond, pur­chases long-term Trea­sury secu­ri­ties and sell a match­ing amount of shorter-term Trea­sury secu­ri­ties in such a man­ner that reserves and the Fed’s bal­ance sheet would not be affected. Third, the FOMC would pur­chase longer-term Trea­sury secu­ri­ties and increase the bal­ance sheet size of the Fed. The min­utes note that a “large num­ber of par­tic­i­pants saw large-scale asset pur­chases as a more potent tool that should be retained as an option in the event fur­ther pol­icy action to sup­port a stronger eco­nomic recov­ery was warranted.”

The FOMC chose the sec­ond option of the three, which is known as Oper­a­tion Twist. The vote was 7–3 in favor of Oper­a­tion Twist. The min­utes reveal that two mem­bers would have pre­ferred to take more aggres­sive steps com­pared with Oper­a­tion Twist. They were will­ing to con­sider Oper­a­tion Twist because addi­tional future sup­port was not ruled out. The impli­ca­tions of reduc­ing inter­est on reserve bal­ances (IOR) were also part of the dis­cus­sion. A range of opin­ions were pre­sented and it was noted that addi­tional infor­ma­tion would be nec­es­sary to assess the use­ful­ness of this tool in the cur­rent eco­nomic environment.

The min­utes also show that the Com­mit­tee is exam­in­ing mod­i­fi­ca­tions of its com­mu­ni­ca­tions pol­icy: “Most par­tic­i­pants indi­cated that they favored tak­ing steps to increase fur­ther the trans­parency of mon­e­tary pol­icy, includ­ing pro­vid­ing more infor­ma­tion about the committee’s longer-run pol­icy objec­tives and about the fac­tors that influ­ence the committee’s pol­icy deci­sions.” The Com­mit­tee also looked into “ways to elu­ci­date the eco­nomic con­di­tions that could war­rant rais­ing the level of short-term inter­est rates.” Over­all, it appears that the Fed is work­ing on improv­ing its com­mu­ni­ca­tion about mon­e­tary pol­icy changes with the public.

Source: Asha Ban­ga­lore, North­ern Trust – Daily Eco­nomic Com­men­tary, Octo­ber 12, 2011.

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