A split at the FOMC

Low inflation in the face of low unemployment (low resource slack) and easing of financial conditions is fostering disagreement at the FOMC.

FOMC Minutes:

Participants commented on a number of factors that would influence their ongoing assessments of the appropriate path for the federal funds rate. Most saw the outlook for economic activity and the labor market as little changed from their earlier projections and continued to anticipate that inflation would stabilize around the Committee’s 2 percent objective over the medium term.

However, some participants expressed concern about the recent decline in inflation, which had occurred even as resource utilization had tightened, and noted their increased uncertainty about the outlook for inflation. They observed that the Committee could afford to be patient under current circumstances in deciding when to increase the federal funds rate further and argued against additional adjustments until incoming information confirmed that the recent low readings on inflation were not likely to persist and that inflation was more clearly on a path toward the Committee’s symmetric 2 percent objective over the medium term.

In contrast, some other participants were more worried about risks arising from a labor market that had already reached full employment and was projected to tighten further or from the easing in financial conditions that had developed since the Committee’s policy normalization process was initiated in December 2015. They cautioned that a delay in gradually removing policy accommodation could result in an overshooting of the Committee’s inflation objective that would likely be costly to reverse, or that a delay could lead to an intensification of financial stability risks or to other imbalances that might prove difficult to unwind.

“Most participants” plus “some other participants” still constitutes the majority, and those are in favor of keeping to the timetable.

Before an end of year rate decision has to be made, however, there will be another four readings on inflation. If, as we expect, inflation remains subdued, the majority could flip.

The “financial conditions” people, like Dudley, will likely see that the more the Fed veers to “tightening”, the more financial conditions will “ease”. The lesson here is that “financial conditions”, being a classic case of “reasoning from a price change”, should not inform monetary policy decisions.

The release of the Minutes “eased” financial conditions. Long rates and the dollar fell significantly!


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