FOMC minutes reveal members discussed the ‘how to’ but not when for an exit strategy

The June 21-22, 2011 meeting of the FOMC – Federal Open Market Committee – met against the backdrop of slowing economic activity, a pick up in core inflation, which it still believes is temporary, and growing fears that one or more countries in Europe might default on their debt.

The FOMC minutes noted that growth in consumer spending has declined, the labor market has softened, and activity in the housing market remains depressed.

Exit stage left
At the conclusion of the meeting, the FOMC decided that when the time comes to begin normalizing policy, it plans to:

1. Stop reinvesting some or all principal repayments
2. Modify its forward guidance on the path of the fed funds rate and initiate temporary reserve-draining operations aimed at supporting the implementation of increases in the fed funds rate when appropriate
3. When conditions warrant, begin raising the target for the fed funds rate
4. Sale of agency securities likely to begin sometime after the first hike in the fed funds rate, with timing and pace communicated to the public in advance
5. Once sales begin, the pace of sales is expected to be aimed at eliminating the holdings of agency securities over a period of three to five years
6. And finally the FOMC stands ready to adjust its exit strategy depending on economic and financial conditions.

The template provides the investing public with guidelines, but there was not indication as to when such an undertaking might begin.

Currently, the Fed is battling a slowdown in economic activity and an acceleration in core inflation.

Further increases in inflation would greatly complicate the Fed’s job of promoting its statutory mandate of maximum employment and price stability.

Commodity prices have jumped, which is fueling the rise in inflation, but wage gains have been stagnant, and excess capacity and subdued demand suggest any further and unwanted gains in inflation are probably not on the horizon.

Additionally, the Committee pointed out that longer-run inflation expectations remain stable.

Most participants expected that much of the rise in headline inflation this year would prove transitory, and inflation over the medium term would be subdued as long as commodity prices did not continue to rise rapidly and longer-term inflation expectations remained stable.

Nevertheless, a number of participants judged the risks to the outlook for inflation as tilted to the upside. Moreover, a few participants saw a continuation of the current stance of monetary policy as posing some upside risk to inflation expectations and actual inflation over time.

But Committee members were divided on what to do.

On the one hand, a few members noted that, depending on how economic conditions evolve, the Committee might have to consider providing additional monetary policy stimulus, especially if economic growth remained too slow to meaningfully reduce the unemployment rate in the medium run. QE3?

But a few members viewed the increase in inflation risks as suggesting that economic conditions might well evolve in a way that would warrant the Committee taking steps to begin removing policy accommodation sooner than currently anticipated.

Consequently, the Fed stayed on its expected path, signaling it will hold the fed funds rate at the current level for an extended period and concluded the meeting by stating it will end its planned purchases of $600 billion in Treasuries by the end of June.