FOMC Minutes: Fed Beginning To See The Limits Of Its Power

The release of the Fed’sFOMC minutes for their September meetingrevealed a divided Fed, forcing Chairman Ben Bernanke to work hard in order to keep its active stance.

  While QE3, along with extension of the zero-rate guidance and Operation Twist, was approved by all but one FOMC members, a number of them expressed skepticism as to how much asset purchases and communication can do to spur economic growth and ultimately push down the unemployment rate.

The Fed is beginning to see the limits of its power.  Despiteunveiling a bold open-ended $40 billion-a-month asset purchase program, an extension of Operation Twist, and a lengthening of its forward-guidance for its zero-bound interest rate policy, regional Fed presidents are increasingly doubting how much they can do to spur growth. This was most explicitly uttered by Ben Bernanke in his post-FOMC press conference, where he said “I don’t think our tools are that strong.”  And the Minutes hammered this point down.  “A number of participants highlighted the uncertainty about the overall effects of additional purchases on financial markets and the real economy,” read one line, indicating their concern over their capacity to affect the path of the economy via quantitative easing.

At another juncture, the minutes read: “A few expressed skepticism that additional policy accommodation could help spur an economy that they saw as held back by uncertainties and a range of structural issues.”

Bernanke has been clear on this before, repeating “monetary policy is not a panacea” while he urged Congress to man up and solve issues like the looming fiscal cliff.

But there was more.  Over the last few months, in which not only Bernanke, but the ECB’s Draghi, the People’s Bank of China, and the central banks of the UK and Japan have announced easing, financial markets rallied on the more concrete mentions of the coming policy, rather than on policy action itself.

While “verbal intervention” and communication have worked to spark short-bursts of risk asset buying, there is concern within the FOMC that their use of a specific date in their forward rate-guidance pledge could have nefarious effects:

A number of participants questioned the effectiveness of continuing to use a calendar date to provide forward guidance, noting that a change in the calendar date might be interpreted pessimistically as a downgrade of the Committee’s economic outlook rather than as conveying the Committee’s determination to support the economic recovery.

If the public interpreted the statement pessimistically, consumer and business confidence could fall rather than rise. Many participants indicated a preference for replacing the calendar date with language describing the economic factors that the Committee would consider in deciding to raise its target for the federal funds rate.

There were even suggestions that the Fed use specific “numerical thresholds for labor market and inflation indicators” that would be consistent with its zero-rate policy.  At the end of the day, all FOMC members, with the exception of outspoken critic Jeffrey Lacker of the Richmond Fed, agreed to go along with the Chairman.

Bernanke has been working hard to secure support for his policies.  As a great report in the WSJ showed, the Chairman has reached out to hawks and moderates in his committee in order to convince them to go along with him.  Bernanke understands that he needs to court their support in order to continue easing, which is what he considers to be the right move given the dire economic situation, Europe’s sovereign debt crisis, and political impasse (which could lead to falling off the dangerous fiscal cliff).

The Fed’s minutes did little to lift markets.  U.S. equity indexes remained relatively unchanged after their release, as did major financials like Bank of America and Citigroup.  Gold, as measured by the GLD ETF, actually fell marginally on the news, as did silver, while yields on 10-year Treasuries moved higher, hitting 1.66%. Bernanke & Co. haven’t given market participants enough clarity as to what they believe are the right conditions for increasing or decreasing their easing stance.  While the Minutes revealed a divided Fed, Bernanke remains firmly in charge, as he has for a while.  He’s built his strength on courting and working on his fellow FOMC members.  Now he hopes policymakers in Washington can do the same.  It seems unlikely.

source: forbes.com

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