Mark November 23 in your calendars — it’s the day the FOMC will be releasing the minutes of the latest meeting in which the committee approved QE2.
In a speech Sunday night, cautioning against using monetary policy over-aggressively to pursue a specific unemployment target, Richmond Fed president Jeffrey Lacker telegraphed a little of what to expect in the minutes:
It’s interesting to note that in the Committee’s projections released after its June meeting — the most recent projections available — the range of members’ opinions about long run unemployment is quite wide — wider than the range of their near term projections. By contrast, for inflation, the range of variation is notably smaller for the long term projections.
Given current economic conditions — with inflation running below levels viewed by most policymakers as mandate consistent, and with unemployment stubbornly high as the economic recovery proceeds slowly — the FOMC voted November 3 to further expand its balance sheet through the purchase of long-term U.S. Treasury securities. In its statement, the Committee noted that progress toward lower employment has been “disappointingly slow.” That observation makes the important distinction that it is not the high level of unemployment alone that motivated the action, but rather the slow pace of improvement and the belief that further monetary stimulus could help.
The minutes of the November meeting — which also will include a new round of participants’ economic projections — will provide a fuller account of the analysis that went into the decision, as well as elements of the debate within the Committee.
Most of Lacker’s speech was about what you would expect from someone who is firmly in the hawkish camp of the FOMC. He appeals to the lessons of the inflationary period of the late 1960s and 1970s, and argues that unlike the inflation rate target — which most members agree should be somewhere between 1.5-2 per cent — the natural unemployment rate is less certain at any given point in time. He also believes the Fed has much less influence over unemployment, and monetary policy shouldn’t be the only mechanism trying to fight it.
But what is most interesting to us is his interpretation, bolded above, of the actual FOMC statement that announced QE2.
We had previously noted that the statement elevated the unemployment level to nearly the same position of prominence that preventing deflation had taken in previous statements.
But Lacker puts a different spin on this: obviously the Fed wants to see the unemployment rate improve, but it is the disappointing pace of this improvement that led the FOMC to believe that additional monetary policy could help — not the actual unemployment rate itself. He emphasises that FOMC members are in much closer agreement on what constitutes an appropriate inflation rate than on what constitutes full employment. Translation: inflation still rules.
Lacker’s analysis would suggest that at some point, either if quantitative easing doesn’t lead to a noticeable improvement in the unemployment rate — or if inflation approaches the Fed’s target regardless of what’s happening in unemployment — there will be further significant pressure on Bernanke to scale back.
Is Lacker right? Hey, we don’t know. There are big risks involved with QE2 — distortions in asset markets, problems for pension schemes and other entities that manage long-term liabilities, keeping zombie companies alive, and yes, unhinging inflation. But there are also risks in having monetary policy do nothing, and we can’t claim to know how to adjudicate between the two.
(We will say that whatever his views on what the Fed should do in the future, Lacker’s recent track record on reading inflation itself is debatable. He gave a speech in October saying that inflation was already at a level he was comfortable with because the PCE index, the Fed’s preferred measure, was actually higher than the core CPI, which has been well below the Fed’s implicit 2 per cent target. But there were problems with this analysis, as we pointed out, and since then the September PCE reading came in flat and the indicator is clearly converging with the lower CPI.)
Since announcing QE2, the inevitable tension between the Fed’s doing what it can to combat unemployment on the one hand, and the risk of unhinging inflation expectations on the other, has been clearly present in the public statements of other FOMC members. The issue has also become even more of a hot button in both domestic and, to a surprising degree, international politics. Bernanke himself, without actually coming out and saying it publicly, has let it be known that he’d love some help from the fiscal side.
Again, we’re really looking forward to finding out more of the Fed’s internal deliberations come November 23.