August 30, 2011

FOMC Minutes Show Some Dissension at Fed After S&P’s U.S. Debt Downgrade

Several unnamed Federal Reserve policy makers objected to specifying mid-2013 for keeping rates low

Minutes released Tuesday from the controversial Aug. 9 meeting of Federal Reserve policy makers show that they were fully aware of the volatile global markets and issues surrounding the Standard & Poor’s downgrade of U.S. debt when they announced that they will keep interest rates low through mid-2013.

Federal Reserve Chairman Ben BernankeA few unnamed Fed policy makers were opposed to being so specific in naming a date for keeping rates low, but Fed Chairman Ben Bernanke (left) was not among the dissenters.

The Federal Open Market Committee minutes show the Fed policy makers believed their decisions at the June FOMC meeting “were about in line with market expectations and elicited little market reaction.” In June, the Fed announced it would complete on June 30 its second round of “quantitative easing,” or Treasury asset purchases, and keep the target range for the federal funds rate at 0% to 0.25%.

However, according to the Aug. 9 meeting minutes, between June and August, “investors marked down the expected path for the federal funds rate substantially, reflecting incoming economic data that were weaker than expected and concomitant concerns about the prospects for global growth.”

Yields on nominal Treasury securities fell “notably” during the summer period, the FOMC minutes acknowledge, adding that later, “investor focus appeared to turn to the U.S. debt ceiling and the potential for delayed debt service payments by the Treasury Department, the possibility of a downgrade of U.S. sovereign debt, and the prospects for significant long-term fiscal consolidation.”

Further, the minutes acknowledge that although market turmoil eased after legislation to raise the debt ceiling and cut the budget was signed into law on Aug. 2, U.S. equity prices in the last week of July and the first week of August fell considerably, reflecting weaker-than-expected economic data releases and the Aug. 5 announcement by Standard & Poor’s of its downgrade of long-term U.S. sovereign debt.

All this turmoil led the Fed to depart from its standard language of recent months, a vague affirmation that economic conditions “are likely to warrant exceptionally low levels for the federal funds rate for an extended period.” Instead, on Aug. 9, the Fed for the first time allayed market fears by giving a specific date to their policy of monetary easing, saying that conditions “are likely to warrant exceptionally low levels for the federal funds rate at least through mid-2013.”

The minimal word change in the Aug. 9 announcement came only after much debate within the FOMC—a fact that the minutes make clear.

“Those viewing a shift toward more accommodative policy as appropriate generally agreed that a strengthening of the Committee’s forward guidance regarding the federal funds rate, by being more explicit about the period over which the Committee expected the federal funds rate to remain exceptionally low, would be a measured response to the deterioration in the outlook over the intermeeting period,” according to the minutes.

A few unnamed members felt that recent economic developments justified a more substantial move at this meeting, “but they were willing to accept the stronger forward guidance as a step in the direction of additional accommodation.”

Three members dissented against the mid-2013 language—Richard W. Fisher, Narayana Kocherlakota and Charles I. Plosser—“because they preferred to retain the forward guidance language employed in the June statement.”

One unnamed FOMC member expressed concern that the use of a specific date in the forward guidance “would be seen by the public as an unconditional commitment,” according to the minutes, “and it could undermine committee credibility if a change in timing subsequently became appropriate. Most members, however, agreed that stating a conditional expectation for the level of the federal funds rate through mid-2013 provided useful guidance to the public.”

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