FOMC composition and future monetary policy | FT Alphaville

FOMC composition and future monetary policy

Just a few things to note, somewhat belatedly, about the latest reservations expressed by three FOMC members — Kevin Warsh, Richard Fisher, and Thomas Hoenig — towards further QE measures.

But first, remember this chart from RBS?

We bring it to your attention because of the changes that will take place in the composition of the FOMC’s voting membership next year. According to this categorisation, among those who vote there are five doves, four neutrals, one soft hawk, and one outright hawk (and a partridge in a pear tree).

Because of the annual rotation of Fed presidents who vote, next year’s voting membership will look like this:

Doves — Bernanke, Dudley, Evans, Yellen
Neutral — Duke, Bloom Raskin, Tarullo
Soft Hawks — Kocherlakota, Warsh
Hawks — Fisher, Plosser

This is a somewhat wider distribution of stances than exists now, with the losses coming from the doves and neutral members. In other words, if these stances are the same for newly contemplated easing measures in the future, there will be more voting members who are at least a bit skeptical of big new moves.

That said, for the purposes of this post we’re not so interested in Hoenig’s comments — his criticisms are well known by now and his time as a voting member ends this year. Same with Fisher’s speech, though as you can see above, he will soon have a vote.

But the speech by Warsh, who as a member of the board of governors gets to keep his vote, is worth considering a bit more.

First, Warsh seems to agree with Bernanke that monetary policy needs help. But whereas Bernanke keeps private his views on fiscal policy and lets them leak to the New York Times, Warsh’s views are obviously now quite public.

But the two seem to disagree on the specifics. Bernanke, according to the NYT piece, believes more fiscal stimulus would be helpful, whereas Warsh instead calls for a simplified tax code, rules-based regulation, and anti-protectionism.

But more interesting to us is that not only are Fed members (other than Bernanke) publicly commenting on fiscal policy, but you now have the US president openly defending the central bank’s maneuvers.

Unless we’re reading this wrong, which is quite possible, it seems the previously implicit boundaries governing who talks about what (and about whom) are starting to blur. This is a development we’ll be watching more closely.

Second, we wonder to what the extent the other soft hawks and neutral members agree with Warsh’s reservations. Here’s why: if you look again at the last two FOMC statements, you’ll notice that each focused on a different half of the Fed’s dual mandate.

The September 21 statement, which signaled that the Fed would pursue further QE, was the first in which the Fed stated that inflation levels were “below those the Committee judges most consistent, over the longer run, with its mandate to promote maximum employment and price stability.” The statement made references to unemployment, but it mostly emphasized that the Fed had room to do more because inflation had declined sufficiently.

But as some analysts noted, the recent November 3 statement gave unemployment equal prominence (emphasis ours):

Information received since the Federal Open Market Committee met in September confirms that the pace of recovery in output and employment continues to be slow. Household spending is increasing gradually, but remains constrained by high unemployment

Employers remain reluctant to add to payrolls.

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

Yet Warsh, in his speech Monday, seems to put the focus firmly back on worrying about inflation and other possible distortions in financial markets caused by more purchases of treasuries:

But when non-traditional tools are needed to loosen policy and markets are functioning more or less normally–even with output and employment below trend–the risk-reward ratio for policy action is decidedly less favorable. In my view, these risks increase with the size of the Federal Reserve’s balance sheet. As a result, we cannot and should not be as aggressive as conventional policy rules–cultivated in more benign environments–might judge appropriate. …

There are significant risks that bear careful monitoring by the FOMC. If the recent weakness in the dollar, run-up in commodity prices, and other forward-looking indicators are sustained and passed along into final prices, the Fed’s price stability objective might no longer be a compelling policy rationale. In such a case–even with the unemployment rate still high–the FOMC would have cause to consider the path of policy. This is truer still if inflation expectations increase materially. And if the Fed’s holdings work predominantly through the so-called portfolio balance channel, the cessation of purchases should not reverse any benefits attained.

Hey, that bit on prices passing through and complicating Bernanke’s life sounds awfully familiar.

But, again, the real question we have is to what extent the rest of the FOMC non-dove-ish voting members (in 2011) share Warsh’s concerns. Given the shifting composition of the voting members next year, it seems Bernanke will really have his work cut out for him if we wishes to pursue anything bold in 2011. Not that he’ll have trouble getting votes for whatever he ultimately decides to do, but it will be a lot more difficult to get consensus on the committee, and he might have to do less than he would prefer.

We’ll probably learn more about this in the minutes to the last FOMC meeting, which will be available later in November. And although a lot can happen in the interim, we expect these meetings in the future to be even more contentious.

Related links:
The QE2 sails right over the 35 per cent rule – FT Alphaville
QE2: analyst reactions – FT Alphaville