As a senior economist and central bank strategist, I have performed a comparative analysis of the FOMC statements from June 23, 2010, and August 10, 2010. This period is critical as it reflects the Fed's reaction to a slowing post-crisis recovery and the transition toward more explicit balance sheet management.
Information received since the Federal Open Market Committee met in ~~April~~ June ~~suggests that the economic recovery is proceeding and that the labor market is improving gradually~~ indicates that the pace of recovery in output and employment has slowed in recent months. Household spending is increasing ~~but~~ gradually, but remains constrained by high unemployment, modest income growth, lower housing wealth, and tight credit. Business spending on equipment and software ~~has risen significantly~~ is rising; however, investment in nonresidential structures continues to be weak and employers remain reluctant to add to payrolls. Housing starts remain at a depressed level. ~~Financial conditions have become less supportive of economic growth on balance, largely reflecting developments abroad.~~ Bank lending has continued to contract ~~in recent months~~. Nonetheless, the Committee anticipates a gradual return to higher levels of resource utilization in a context of price stability, although the pace of economic recovery is likely to be ~~moderate for a time~~ more modest in the near term than had been anticipated.
~~Prices of energy and other commodities have declined somewhat in recent months, and underlying inflation has trended lower.~~ Measures of underlying inflation have trended lower in recent quarters and, with substantial resource slack continuing to restrain cost pressures and longer-term inflation expectations stable, inflation is likely to be subdued for some time.
The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels of the federal funds rate for an extended period.
To help support the economic recovery in a context of price stability, the Committee will keep constant the Federal Reserve's holdings of securities at their current level by reinvesting principal payments from agency debt and agency mortgage-backed securities in longer-term Treasury securities. The Committee will continue to roll over the Federal Reserve's holdings of Treasury securities as they mature.
The Committee will continue to monitor the economic outlook and financial developments and will employ its policy tools as necessary to promote economic recovery and price stability.
Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; James Bullard; Elizabeth A. Duke; Donald L. Kohn; Sandra Pianalto; Eric S. Rosengren; Daniel K. Tarullo; and Kevin M. Warsh.
Voting against the policy ~~action~~ was Thomas M. Hoenig, who ~~believed that continuing to express the expectation of exceptionally low levels of the federal funds rate for an extended period was no longer warranted because it could lead to a build-up of future imbalances and increase risks to longer-run macroeconomic and financial stability, while limiting the Committee’s flexibility to begin raising rates modestly~~ judges that the economy is recovering modestly, as projected. Accordingly, he believed that continuing to express the expectation of exceptionally low levels of the federal funds rate for an extended period was no longer warranted and limits the Committee's ability to adjust policy when needed. In addition, given economic and financial conditions, Mr. Hoenig did not believe that keeping constant the size of the Federal Reserve's holdings of longer-term securities at their current level was required to support a return to the Committee's policy objectives.
| Removed | Added | Significance |
|---|---|---|
| "recovery is proceeding... improving gradually" | "pace of recovery... has slowed in recent months" | Major Downgrade: Shift from optimism to an admission of economic deceleration. |
| "moderate for a time" | "more modest in the near term than had been anticipated" | Lowered Expectations: Explicit admission that previous forecasts were too optimistic. |
| "Financial conditions have become less supportive... developments abroad" | (Removed) | De-emphasis: Removal of external/global headwinds as the primary narrative. |
| (None) | New paragraph on reinvesting agency debt/MBS into Treasuries | Policy Expansion: Formalization of balance sheet maintenance to support the recovery. |
| Hoenig's focus on "future imbalances" | Hoenig's objection to the new securities reinvestment policy | Dissent Evolution: The lone dissenter now opposes both the rate guidance and the balance sheet strategy. |
The shift here is subtle but technical. The Committee removed the mention of "energy and other commodities" declining. By focusing specifically on "measures of underlying inflation" (core inflation), the Fed is signaling that it is looking past volatile headlines to the deeper trend of disinflation. The conclusion remains the same: inflation is "subdued," which provides the Committee with the "policy space" to remain accommodative.
This is the most aggressive shift in the statement. The narrative has moved from a recovery that is "proceeding" to one that has "slowed." The change from "moderate" to "more modest... than had been anticipated" is a significant admission of a growth miss. The description of business spending also shifted from "risen significantly" to simply "rising," indicating a loss of momentum in private investment.
While the language regarding the federal funds rate ("exceptionally low levels... for an extended period") remains identical, the Forward Guidance has expanded to the Balance Sheet. The addition of the reinvestment strategy (converting agency debt/MBS into Treasuries) is a proactive move to ensure the Fed's balance sheet does not shrink, effectively extending the duration of their quantitative easing efforts.
The Committee has shifted decisively Dovish.
While the target interest rate remained unchanged, the surrounding narrative shifted from "gradual improvement" to "slowing recovery." The admission that growth is "more modest... than had been anticipated" creates a justification for the new, more accommodative balance sheet policy (the reinvestment of agency securities). By acknowledging a weaker-than-expected economic trajectory and formalizing a plan to maintain its massive holdings of securities, the Fed is signaling that it believes the economy requires more support than previously thought.