Inside story: Fed leaning toward reducing stimulus in 2013

Agence France-Presse

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Federal Reserve policymakers were deeply divided over whether to reduce monetary stimulus in September, according to the minutes of the meeting

MONETARY STRATEGY. US Federal Reserve, chaired by Ben Bernanke, decides to keep interest rates?

WASHINGTON, USA – Federal Reserve policymakers were still leaning toward reducing US monetary stimulus this year, despite a decision to hold fire in September, the minutes of their last meeting showed Wednesday, October 9.

Markets were surprised when the Fed announced, after the September 17-18 meeting, that it would leave unchanged its $85 billion a month in asset purchases, or quantitative easing, after signaling since May that it could begin to taper the stimulus later in 2013.

Investors had expected the Federal Open Market Committee (FOMC) would launch the QE taper at the September meeting, sending interest rates higher in anticipation of tighter credit.

The minutes revealed that the decision to not begin trimming QE, given a recent batch of mixed economic data, was “a relatively close call.”

“Most participants viewed their economic projections as broadly consistent with a slowing in the pace of the Committee’s purchases of longer term securities this year and the completion of the program in mid-2014.”

In the debate about whether to reduce asset purchases at the meeting, “a number of members emphasized the contingent and data-dependent nature of the Committee’s purchase program,” the minutes said.

“In light of the mixed data recently, including inflation readings that remained below the Committee’s longer-run objective, and the concerns over near-term fiscal uncertainties, some members indicated that they preferred to await more evidence that their expectation of continuing improvement would be realized.”

Since the September meeting, economic indicators have continued to point to sluggish growth. But the government data flow has been cut off since October 1, a victim of the partial federal government shutdown as Democrats and Republicans battle over the budget and debt ceiling with no end in sight.

The shutdown has sent home hundreds of thousands of workers without pay and has cast a cloud over the economy’s outlook.

The uncertainty caused by Washington gridlock has meanwhile weighed on equity markets.

“If fiscal policy issues are resolved satisfactorily and with no lasting impact on the labor market, the Fed will stay on its current taper path,” said Paul Edelstein, director of financial economics at IHS Global Insight.

But, he warned, the Fed probably would not have enough information to decide this by its October 29-30 meeting, particularly if the labor market data is further delayed, he said.

“Our expectation remains for a December taper contingent on the outcome of fiscal policy debates and labor market data. Given the current backdrop, though, it could be a close call,” Edelstein said.

The minutes revealed Fed officials fretted that their communications strategy with the public may be damaged by the decision to stay the course with QE.

“Some participants emphasized a need to clearly communicate the rationale behind any decision not to do so, in order to avoid conveying a message of pessimism regarding the economic outlook or to reinforce the distinction between decisions concerning the pace of purchases and those concerning the federal funds rate,” the minutes said.

“It was noted that the postponement of such an announcement to later in the year or beyond could have significant implications for the effectiveness of Committee communications.”

FOMC members also expressed concern about the potential for a September tightening to push up interest rates, pressuring the broad economy and the housing recovery, one of its few bright spots.

“The announcement of a reduction in asset purchases at this meeting might trigger an additional, unwarranted tightening of financial conditions, perhaps because markets would read such an announcement as signaling the Committee’s willingness, notwithstanding mixed recent data, to take an initial step toward exit from its highly accommodative policy.” – Rappler.com

Dollar bill with Tape measure Image from Shutterstock

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