Minutes from the October meeting hint at an FOMC that is aiming at a dovish hike in December.

Dovish because: (a) it seems likely that they will emphasize the low equilibrium real rates as a reason for "keeping the target federal funds rate below the levels the Committee views as normal in the longer run" even after full employment and 2% inflation, and (b) it appears likely that a message will be sent that the Fed will not run out of ammunition and it would be ready to reverse course if economy unexpectedly weakens (perhaps "unconventional" policies will become "conventional"?).

The point (b) above is important because it might be what is needed for the 'doves' to be on board for voting for a hike next month.

Main takeaways from the Committee:
  • Decision to be on hold explained:
    • Almost all members agreed it was appropriate to wait for additional information to clarify whether the recent deceleration in the pace of progress in the labor market was transitory or reflected more persistent factors (note: the October report, released after the meeting, was probably enough to conclude deceleration was transitory).
    • Also, in the absence of greater confidence about the inflation outlook, it would be prudent to wait for additional information.
  • How much further progress in labor market is needed?
    • Members expressed a range of views regarding the extent of further progress in labor market indicators they would need to see to judge it appropriate to raise the target range for the fed funds in December.
  • How much progress toward 2 percent inflation?
    • The same bla bla that members anticipate inflation would gradually return to 2% over the medium term.
    • But minutes mentioned that most of the members were not yet sufficiently confident of that to begin increasing rates.
    • A couple of members expressed concern about the continued decline in market-based measures of inflation compensation. "Moreover, the risk was noted that downward pressures on inflation from the appreciation of the dollar could persist".
    • The October CPI report, however, has shown all the measures of core inflation rising (see http://bit.ly/USOctCPI).
  • Changes to postmeeting statement:
    • FOMC changed its near-term policy path from the assessment that would be needed to determine "how long to maintain the current target range" to what would be needed to determine "whether it would be appropriate to raise the target range at its next meeting".
    • The idea was to convey the information that rates would be increased IF: (a) unanticipated shocks do not adversely affect economic outlook, and (b) incoming data support expectation labor market will continue to improve and inflation will return to 2%.
    • So the goal was to leave policy options open for December; but a couple of members worried this could be signaling too strongly that rates would be increased in December.

Discussion on equilibrium real rates (r*)
  • The staff briefed the participants regarding the concept of an equilibrium real interest rate (r*).
  • Conclusions leaned towards:
    • r* was negative in the aftermath of the 2008-09 financial crisis and is currently close to zero.
    • Equilibrium level of r* would likely remain low relative to estimates before the financial crisis (due to productivity and demographic factors).
  • Policymakers made a number of observations:
    • actual levels of short-term real rate has been below r* (but not substantially below), consistently with estimates that r* is currently close to zero.
    • a number of participants expect r* to rise as the expansion continues (but probably only gradually).
    • r* will not go back to pre-crisis levels (this is why the dot for long run nominal fed funds has been falling in Fed's forecasts).
    • Lower r* imply rates will be closer to the ZLB --- and this "might increase the frequency of episodes in which policymakers would not be able to reduce the federal funds rate enough".
    • Therefore "some participants noted that it would be prudent to have additional policy tools that could be used in such situations".

According to the Taylor rule mentioned by Yellen on her remarks earlier this year, even considering r*=0 (the green line in the chart below) the Fed would already be behind the schedule. An r*=0 (and current readings on PCE inflation and unemployment rate) would imply fed funds at 0.75% in Sept/15 and 1% by December (based on Fed's forecasts).

This might be what Fischer had in mind when he mentioned last week that monetary policy has already responded to the dollar appreciation and foreign weakness "through deferring liftoff relative to what was expected".


Participants' Views:
  • There was a lot of talk about the labor market in the aftermath of a slowdown in job gains in August and September, and the discussion centered on whether it was temporary or more persistent. Hawks and doves made the usual arguments.
  • There was somewhat widespread concern with downside risks to inflation (mentioning market-based measures of inflation compensation).
  • Arguments against delaying increasing rates were presented: delay could increase uncertainty in financial markets, unduly magnify the importance of the beginning of policy normalization, increasing risk of a buildup of financial imbalances, decision to delay could be interpreted as signaling lack of confidence in the US economy, could erode FOMC credibility, progress should be measured in light of the cumulative gains without placing excessive weight on month-to-month changes in incoming data.
  • Arguments for delaying were also presented: downside risks to the outlook remained, concerns about loss of momentum in the economy, that inflation might fail to increase, uncertainty about whether growth was robust enough to withstand potential adverse shocks given limited ability of monetary policy to offset such shocks, concern that beginning of normalization might be associated with unwarranted tightening of financial conditions -- risk management considerations would call for caution, premature tightening might damage FOMC credibility to reach 2% inflation.
  • From the size of the previous two bullets, one may infer the arguments are balanced.
  • But the more important, perhaps, was that "several participants" think it would be prudent to consider options for providing additional policy accommodation if the economic outlook were to weaken and undermine progress in labor market conditions and reaching 2% inflation.