More Monetary Stimulus Needed, but Not Now: FOMC Briefing

There are two, seemingly conflicting, themes in the FOMC’s current narrative about policy today and going

  • First: More monetary policy action will be needed.
  • Second: But it’s not warranted now.
  • Another theme, not directly related to monetary policy, is that more fiscal stimulus is also needed, though it may not be forthcoming. That could affect the degree of stimulus that the FOMC sees as appropriate.

There are several reasons why there is no urgency to provide more stimulus now.

  • First, the substantial scale of the ongoing asset purchases across the curve has already been providing support to the recovery, contributing to lower yields across the curve.
  • Second, the momentum in the economy is quite good now, at least relative to expectations, and participants may want to wait until the spring to get a better read on the next phase of the recovery.
  • Third, with longer-term yields already so low, there might be little incremental value in moving to more-aggressive asset purchases.

There are two, seemingly conflicting, themes in the FOMC’s current narrative about policy today and going

First: More monetary policy action will be needed.

Second: But it’s not warranted now.

Another theme, not directly related to monetary policy, is that more fiscal stimulus is also needed, though it may not be forthcoming. That could affect the degree of stimulus that the FOMC sees as appropriate.

There are several reasons why there is no urgency to provide more stimulus now.

  • First, the substantial scale of the ongoing asset purchases across the curve has already been providing support to the recovery, contributing to lower yields across the curve.
  • Second, the momentum in the economy is quite good now, at least relative to expectations, and participants may want to wait until the spring to get a better read on the next phase of the recovery.
  • Third, with longer-term yields already so low, there might be little incremental value in moving to more-
    aggressive asset purchases.

There are additional steps the FOMC could take, even employing only the tools used during the last period at the ELB.

  • It could lengthen the horizon over which asset purchases will continue at the current pace or increase the scale of those asset purchases.
  • It could move from asset purchases across the curve to asset purchases concentrated at the longer end—LSAPs.

At this meeting, however, we don’t expect any change in either policy or forward guidance.

  • No announcement of a longer horizon for the current asset purchases or an increase in the pace.
  • No announcement of LSAPs.
  • No change in the forward guidance for the funds rate.
  • We do expect there to be a discussion of the structure of the SEP, keeping open the option of implementing revisions in December. But we probably won’t know about that until the minutes are released.

There are several topics we expect to be raised at the press briefing.

  • If the FOMC were to move toward further stimulus, what tools would be employed?
  • If more stimulus will be needed, why not do more now?
  • What are the conditions under which the FOMC would implement more stimulus?
  • What does “moderate” mean in terms of the desired overshoot? What would be too high? Participants have suggested thresholds over a pretty wide range. When will you provide such details?
  • What have participants generally assumed about fiscal stimulus? Will the amount of additional fiscal stimulus affect how much monetary stimulus the FOMC believes is appropriate?
  • How do the results of the election affect what you see as appropriate monetary policy? Do you worry about attempts by Congress or the White House to influence monetary policy and undermine Fed independence?

Outlook Context 

The economy appears to be at an important inflection point. The sharp declines in economic activity,  employment, and prices following the initial impact of the pandemic are behind us. So is the very sharp rebound in activity as the economy began to open up. Where do things go from here? The outlook remains highly uncertain, several of the main sources of uncertainty of course being fiscal policy, the U.S. election,  and the course of the pandemic. 

Uncertainty Dominates the Outlook 

There are, of course, always uncertainties in the outlook. Still, they are often treated as outside the baseline  forecast. Today, it’s hard to even designate a particular scenario as a baseline that’s significantly more likely  than other outcomes. 

Fiscal Stimulus 

The data have generally been better than expected despite the lack of additional fiscal support, which FOMC  participants have said is critical to the outlook. In particular, the lapse in elevated unemployment insurance  payments showed up strongly in the income data, but not on the spending side. But the assumption about  fiscal stimulus remains important to the near-term outlook. 

The Resurgence in Infections 

The U.S. is currently experiencing another surge in infections, the third so far. One of the main themes of the  September FOMC minutes was a reassessment following the summer surge by both the Board staff and  policymakers of the economic effects of a resurgence of infections. Still, we don’t know how this surge will  proceed, and it’s already bigger than the summer surge. It does look like a dark winter, in any case. How long  will it continue and how severe will it become? Will severe restrictions be reimposed? Even if they’re not, will  it matter if the public is more cautious regardless? 

Timing of an Effective Vaccine 

There is optimism that a vaccine will be approved by early 2021, but even in that case uncertainty would  remain. How quickly would a vaccine become available to the public at large? One shot or two? How effective  would it be? How many would take the vaccine? How long would immunity last? On balance, a vaccine is  not an instantaneous cure-all. But the public could react as if it is, perhaps even offsetting the positive effect  of a vaccine. 

The Election 

The upcoming election bears on the outlook in myriad ways. The outcome likely to be the worst for the  prospects of much-needed fiscal relief is a Biden presidency and a Republican-controlled Senate, as Senate  Republicans, already uneasy with significant further relief, will have much less incentive to go along with it  when their party isn’t in the White House. 

Growth at an Inflection Point 

After a dramatic but very brief decline in real GDP through mid-year, there’s been a rebound that has been  nearly as dramatic. The pace of the rebound has been marked up progressively as incoming data proved  stronger than expected. Real GDP declined at a 5% annualized pace in Q1 and a 31% annualized pace in Q2,  bringing its level in Q2 down to just over 10% below its level in 2019:Q4, the last full quarter before the  pandemic reached the U.S. In Q3, real GDP expanded at a 33% annualized pace. That’s rapid and better than expected, to be sure. But the level of real GDP in Q3 was still 3.5% lower than in 2019:Q4. Moreover, the  recent pace of growth says much less than it normally would about what to expect for the pace of growth in  quarters to come. 

Many expect real GDP to reach its pre-pandemic level by the end of 2021. But that’s not the same as returning  to potential, and hence to full employment, much less maximum employment. FOMC participants’ projections  suggest that won’t be achieved until 2023 at the earliest. 

But the more immediate question is whether the economy is slowing sharply in Q4 to growth rates less  shocking and so far outside historical experience. Activity—notably consumer spending—seems to have  maintained momentum through the end of Q3, and growth is still likely to be well above trend in Q4. But  many forecasters expect something like 3% growth in Q4. The data have yet to provide much confirmation. 

Labor Market Also at An Inflection Point 

As in the case of real GDP, the recovery in the labor market has been quicker and stronger than expected. A  little more than half the employment lost has been recovered. While the pace of job gains has slowed through  September, with the recent pace much lower than several months ago, it remains highly elevated relative to  historical experience. But even if the September pace were sustained going forward, it would take sixteen  months to recover to the pre-pandemic level of employment. And the pace of course is expected to slow  quite dramatically into 2021 and 2022. 

From the perspective of the FOMC, what matters for the timing of exit is when the economy gets to maximum  employment. While the level of the NAIRU is quite uncertain, the level of employment consistent with  maximum employment is much more uncertain. That will be judged based on how inflation responds to  declines in the unemployment rate. Given how flat the Phillips curve is, it could take an unemployment rate  quite a bit below the estimated NAIRU to make that judgement. Let’s say, preliminarily, 3½%, the level before  the pandemic and the level that Powell celebrated for its social benefits. 

Multiple Inflection Points Ahead for Inflation 

The 12-month core PCE inflation rate was 1.5% in September, down a bit from 1.6% in August. That’s lower than the pre-pandemic rate of 1.9% in February but still represents a recovery from the 0.9% rate in April. 

There have been two effects on inflation recently: (1) a price-level effect that only temporarily affects inflation  and (2) an effect on underlying inflation that is more persistent and tied to economic slack. 

The price-level effects account for both the sharpness of the initial decline in inflation, to 0.9% in April, and  the sharpness of the rise through early next year. 12-month inflation rates are likely to spike in May of next  year, perhaps to meaningfully above 2%, when the price declines in March and April of this year fall out of  the 12-month window. After that point, we expect the price level effects to dissipate and for inflation to be 

driven by the degree of tightness in the labor market. Given the flatness of the Phillips curve, we expect the  underlying rate to rise very slowly, not reaching 2% until 2023.

FOMC Call 

The FOMC has been very busy since it began to lower the funds rate towards zero in March. There is some  dissonance in the FOMC guidance about further monetary stimulus. FOMC participants generally say, on the  one hand, that the FOMC is not done and that further monetary stimulus will be needed. On the other hand,  they also say, “not now.” That is, there is no urgency to do so and no guidance about what would trigger  further action or what that action would be. The only additional policy option under discussion is asset  purchases. They could say that they will continue to buy across the curve for longer than the markets now  expect, they could increase the pace, or they could move to LSAPs, meaning purchases concentrated at the  longer end with the intention of lowering long-term yields relative to short-term yields. In any case, under the  new framework, the catalysts for exit are so far away that plausible changes in the outlook are unlikely to  have any implications for near-term policy, other than speeding the implementation of LSAPs. So no policy  changes on Thursday, no guidance about near-term policy, no change in expectations of policy over the  medium term. As a result, we don’t expect the statement or the press briefing to make much news. 

Relax (a Bit) 

The FOMC has been very busy. A quick move to the effective lower bound (ELB); massive asset purchases  aimed at supporting market functioning; speedy implementation of a large number of 13(3) lending facilities  to facilitate the flow of credit; and deliberations on the Framework Review, culminating in a new policy  framework and forward guidance for the funds rate. So relax next week. You deserve it. In any case, there’s  not as much on the near-term agenda now. LSAPs at some point. With or without a shift in the structure of  purchases, policymakers would prefer to have proper forward guidance for the Fed’s asset purchases, but  that’s not urgent. Plus, they need to discuss and agree on a roadmap for asset purchases before they can  develop any guidance. The next task may be considering changes to the SEP, which Clarida previously  indicated the FOMC would do at upcoming meetings, with the goal of implementing any changes by the end  of this year. For those to be implemented in the December SEP, participants will likely devote discussion to  this topic at next week’s meeting. 

More Monetary Stimulus Will Be Needed 

We are told that “additional support from monetary…policy will be needed” (Clarida, 10/14). But at the same  time we are told that the time for it is not now. We are left to ask: What is the FOMC waiting for? What  additional monetary stimulus are they contemplating? What are the developments that would move the  Committee in that direction? Have participants incorporated their respective views about the timing of  additional monetary stimulus into their individual macro and rate projections? 

Brainard noted that, “we will, no doubt, have the opportunity in the months ahead to deliberate, and to further  clarify how the asset purchase program could best work in combination with that new forward guidance”  (italics our emphasis). In the meantime: “over the time when we will have that opportunity, our existing  commitment to continue asset purchases at least at the current pace is providing support to the economy.”  And Evans, for example, has said: “We do have plenty of tools available. We’ve used them in the past, and  we could use them again.” 

The FOMC is already doing asset purchases, buying across the curve, and they say they will continue doing  so in coming months at least at the current pace. What more could they do? The FOMC could extend the  horizon (currently “over coming months”), increase the pace (“at least at the current pace”), or shift the  maturity distribution toward the longer end of the curve. 

LSAPs? Not Now

Doing asset purchases across the curve for longer would at least maintain the current accommodative  conditions. But one option likely to be considered is to provide additional support by moving from buying  across the curve to concentrating purchases at the longer end. That would be a transition from asset  purchases as implemented today to LSAPs, which focus on lowering longer-term yields relative to shorter 

term yields, the latter being anchored by the near-zero funds rate. It is the decline in longer-term yields that  activates the transmission mechanism, making financial conditions more accommodative. However, longer term yields remain low—notwithstanding the recent run-up in yields. 

But not now. Evans summarized, in our view, the general consensus that it is still too early: 

There will come a time when we probably will want to be much more explicit about our asset  purchases and that, but it’s still kind of early…I’m personally kind of waiting, thinking that by the  spring I’m going to have a better idea of where the state of the labor market is and what the recovery  path is going to be…At the moment I’m pretty comfortable with our asset-purchase plan. 

Why not now? First, the current asset purchases across the curve are at the pace under QE3. Given that  scale, they are already removing a significant amount of duration from the market. That limits the incremental  value of LSAPs, and reduces the urgency to do so. 

Second, given how low longer-term yields are today, FOMC members recognize that LSAPs might not be very  effective in meaningfully lowering them further. Again that lowers the incremental value of transitioning to  LSAPs. Of course, we should note that, under the Fed’s stock-based notion of how asset purchases work,  what matters is what assets (and thus duration) have been removed from the market and put on the Fed’s  balance sheet, not when the purchases occurred. So even if the impact of purchases is less right now, it’s  still something, and they’d continue to impact financial conditions going forward. 

Third, while growth must moderate significantly following its outsized post-lockdown rebound, the economy  has demonstrated that it has momentum, and some of the more pessimistic scenarios have been averted or  down-weighted. Better-than-anticipated economic outcomes lessen the urgency of transitioning to LSAPs.  That is why Committee members say that they want to wait for additional data before doing so, in this case,  waiting until spring. 

Fourth, the market is already pricing in continued asset purchases for quite some time, again limiting the  incremental value of confirming that they will continue. 

So we do expect LSAPs, but not on Thursday and likely not in December. 

The Message in the Statement 

The principal question about the statement is whether there will be additional forward guidance.

Forward Guidance 

Of course, we like the FOMC to provide forward guidance. They did so in the last statement when they  explained the implications of the new framework for future policy, mainly funds rate policy. We don’t expect  any changes to that guidance. 

They could, of course, go further and identify the next move as LSAPs and give a sense of the conditions  that would trigger LSAPs. Personally, I think it is more likely that they would forgo preemptively providing  guidance about the conditions for LSAPs and simply announce, when ready, that LSAPs will be implemented  shortly after that meeting.

In any case, such guidance is very unlikely to come in the post meeting statement on Thursday. It’s possible  that at the press briefing Powell might in response to a question give more context and color about what  would trigger such a move, but there seems to be little reason for him to depart from how he’s answered  such questions in the past. 

What the Committee Learned Since the Last Meeting 

As covered above, we see changes to the later paragraphs of the postmeeting statement as very unlikely.  Any changes are likely to come in the first part of the statement, which describes the incoming data and what  the Committee has learned since the last meeting. What the Committee learned is that the Q3 rebound was  stronger than had been anticipated; that the decline in the unemployment rate was also faster than  anticipated; and that inflation is already rebounding from its trough below 1%, immediately after the initial  impact of the pandemic. 

Well, that’s what they learned, but not necessarily what they will say. At the September FOMC meeting, they  had also learned a lot, but they opted to do little with that part of the statement. Especially now that the Q3  GDP data are out, the language needs to be updated, at least a bit. How exactly the FOMC will do that is  uncertain, but in any case it’s unlikely to be very market moving. 

Previous statements have said that economic activity and employment “have picked up in recent months but  remain well below their levels at the beginning of the year.” Real GDP in Q2 was 10% below its level in  2019:Q4, and in Q3 it had recovered to “only” 3.5% below that level. Is that still “well below”? We’d say it  qualifies. Nonfarm payroll employment has recovered about half of its initial losses but is still about 11 million  jobs below its pre-pandemic level. That would seem to qualify as well. 

If they wanted to add some nuance, there are many ways to do it. They could say something about how  employment has recovered but the pace has decelerated. On the “economic activity” side of things, they  could say something about the uneven recovery across sectors (e.g., consumer spending on services still  sharply lower, while goods spending has increased, notably on durables). They haven’t shown an inclination  for such nuance to this point, so we don’t include it in our guess of the statement. We also don’t see a  pressing need to change the simple description of inflation, especially since 12-month core PCE inflation  edged down a bit in September, to 1.5%: “Weaker demand and significantly lower oil prices are holding down  consumer price inflation.” 

The language on financial conditions could use some tweaking. The old language was that “Overall financial  conditions have improved in recent months, in part reflecting policy measures to support the economy and  the flow of credit to U.S. households and businesses.” Most recently, overall financial conditions have seemed  to move sideways rather than improve, especially since the trade-weighted dollar is about where it was at  the time of the September FOMC meeting. Before that, it had been declining. However, it might be awkward  for them to say that financial conditions are accommodative: For example, in her most recent speech, Brainard  said, “In contrast to the favorable financing conditions for large businesses with access to capital markets,  financing conditions for small businesses remain tight, with lower lending activity and signs of deteriorating  loan performance.” The basis for Kashkari and Kaplan’s September dissents—the new guidance—will still be  in effect, but we don’t expect any dissents. They made their points on the guidance, and dissenting at every  meeting on the same basis would limit their ability to attract attention to any issues they have in the future. 

Revisions to the Structure of the SEP 

Revisions to the SEP are perhaps the remaining task most deserving of discussion at next week’s meeting because reaching an agreement would give them the option to implement any revisions in the next SEP, which will be in December. (See my previous note for my views on changes to the SEP.) Very little chance of change. The most likely change would be to connect individuals’ funds rate projections with their respective macro projections. Please don’t. TMI!

More valuable, but even less likely, is the one change in communications practice that would increase  transparency the most and allow a wider audience to understand monetary policy: A matrix showing what  the FOMC’s instruments are, what its objectives are, and how, given the outlook, that translates into a policy approach. 

Of course, no consensus forecast by the Committee. Impossible and unnecessary. Perhaps the closest to that  they might come would be to give the pen to Powell and trust him to reflect the broad consensus on the  Committee in a coherent narrative: where monetary policy is, why the Committee believes it is appropriate,  and how prospective changes in the outlook would affect its setting. I think Powell would gladly take the  pen. The narrative would appear only quarterly, when there are updated macro and rate projections. 

Our Guess of the Postmeeting Statement 

The Federal Reserve is committed to using its full range of tools to support the U.S. economy in this  challenging time, thereby promoting its maximum employment and price stability goals. 

The COVID-19 pandemic is causing tremendous human and economic hardship across the United States and  around the world. Economic activity and employment have continued to recover in recent months  but remain well below their levels at the beginning of the year. Weaker demand and significantly lower oil  prices are holding down consumer price inflation. Overall financial conditions improved following a period  of heightened stress earlier in the year, in part reflecting policy measures to support the  economy and the flow of credit to U.S. households and businesses, and that improvement has been sustained  in recent months. 

The path of the economy will depend significantly on the course of the virus. The ongoing public health crisis  will continue to weigh on economic activity, employment, and inflation in the near term, and poses  considerable risks to the economic outlook over the medium term. 

The Committee seeks to achieve maximum employment and inflation at the rate of 2 percent over the longer  run. With inflation running persistently below this longer-run goal, the Committee will aim to achieve inflation  moderately above 2 percent for some time so that inflation averages 2 percent over time and longer-term  inflation expectations remain well anchored at 2 percent. The Committee expects to maintain an  accommodative stance of monetary policy until these outcomes are achieved. The Committee decided to  keep the target range for the federal funds rate at 0 to 1/4 percent and expects it will be appropriate to  maintain this target range until labor market conditions have reached levels consistent with the Committee’s  assessments of maximum employment and inflation has risen to 2 percent and is on track to moderately  exceed 2 percent for some time. In addition, over coming months the Federal Reserve will increase its holdings  of Treasury securities and agency mortgage-backed securities at least at the current pace to sustain smooth  market functioning and help foster accommodative financial conditions, thereby supporting the flow of credit  to households and businesses. 

In assessing the appropriate stance of monetary policy, the Committee will continue to monitor the  implications of incoming information for the economic outlook. The Committee would be prepared to adjust  the stance of monetary policy as appropriate if risks emerge that could impede the attainment of the  Committee’s goals. The Committee’s assessments will take into account a wide range of information,  including readings on public health, labor market conditions, inflation pressures and inflation expectations,  and financial and international developments. 

Voting for the monetary policy action were Jerome H. Powell, Chair; John C. Williams, Vice Chair; Michelle  W. Bowman; Lael Brainard; Richard H. Clarida; Patrick Harker; Robert S. Kaplan; Neel Kashkari; Loretta J.  Mester; and Randal K. Quarles.

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