With the U.S. economy showing signs of life, the Federal Reserve is inclined to inch carefully toward further stimulus, rather than court further controversy with aggressive policies.
The Fed’s policy committee struggled at its latest meeting to form a consensus on what to do next, the minutes of the Nov. 1-2 gathering show. Members agreed the economy was gathering pace in the third quarter, but not nearly fast enough to dent unemployment.
A few members argued for “additional policy accommodation,” but were persuaded that the time wasn’t right. At the same time, the few policy makers who previously opposed the Fed’s latest stimulus measures opted to get on board, suggesting the central bank is tilted toward doing more if the economic outlook worsens. And at the moment, the outlook is looking up.
Economic indicators have been broadly positive in recent weeks, and analysts used a new forecast for third-quarter U.S. gross domestic product Tuesday to predict a strong finish to 2012. That makes it difficult to justify another multi-billion-dollar purchase of financial assets, a policy commonly referred to as quantitative easing.
“For me, the conditions that would make another round of quantitative easing would be entering clear recessionary conditions, the worsening of the unemployment rate and the conceivable prospect of deflation,” Dennis Lockhart, the president of the Federal Reserve Bank of Atlanta, told reporters after a speech in Sao Paulo on Monday, according to Reuters.
Mr. Lockhart’s comments came as the Commerce Department in Washington reported that the U.S. economy advanced at an annual rate of 2 per cent in the third quarter, buoyed by household consumption and exports. Commerce’s second of three estimates was weaker than its initial forecast, which put third-quarter growth at 2.5 per cent.
The revision was the result of a revaluation of inventories after stockpiles were overestimated, which suggested that demand was higher than companies anticipated. That heralds increased economic activity as businesses replenish their stores in anticipation of the holiday season
Faster growth of late stands out because the economy barely grew at all in the first half of the year.
Most economists say the U.S. economy could grow at an annualized rate of about 3 per cent in the fourth quarter, lifted by consumer demand and restocking by companies to ready for the holiday shopping season.
That’s a decent pace in normal times, but the U.S. needs a sustained growth at rate closer to 4 per cent to restore the millions of jobs lost during the recession. The unemployment rate sits at 9 per cent, well in excess of what Fed officials consider to be in line with their mandate to achieve “maximum” employment. That unofficial target is in the range of 6 per cent, probably a bit less.
So feeling the need to do more, yet worried about the longer-term effects of flushing the financial system with more cheap money, the Fed is considering the cheapest form of stimulus in any central bank’s arsenal: talk. The Fed’s policy committee spent a considerable amount of time at its November discussing how it could better explain its intentions.
While less obvious than cutting the benchmark interest rate, and less dramatic than creating hundreds of billions of dollars to buy bonds and mortgage securities, communication can actually be an effective form of stimulus through its effect on confidence. If households, executives and investors are fairly certain they won’t be jolted by a sudden increase in borrowing costs, then they are more likely to borrow and invest over a longer term.
The Fed started down this road earlier this year by indicating that it intended to keep its benchmark borrowing rate near zero until the middle of 2013. But many on the policy committee believe that they could be even more explicit. Chairman Ben Bernanke is among them, and the minutes say that he asked the subcommittee that is studying the issue to “give consideration to a possible statement of the committee’s longer-run goals and policy strategy.”
Officials ruled out one communications strategy that has been discussed a lot in academic circles lately. Unlike the Bank of Canada, which targets the inflation rate, the Fed has an abstract mandate to achieve price stability and maximum employment. Some feel the Fed could clarify its policy goals by targeting a certain increase in nominal GDP. While Fed economists produced models that suggest the strategy could work, officials decided it would be too difficult to choose the right target. “Participants agreed that it would not be advisable to make such a change under present circumstances,” the minutes said.