WASHINGTON – Some Federal Reserve officials think the U.S. economy is improving fast enough that the Fed will need to act sooner than previously thought to slow the extraordinary support it’s been providing through ultra-low interest rates.
Minutes of the Fed’s discussion at its July 29-30 meeting released Wednesday show that some officials thought the Fed would need “to call for a relatively prompt move” to reduce the stimulus it has supplied since the financial crisis erupted in 2008. Otherwise, these officials felt the Fed risked overshooting its targets for unemployment and inflation.
In the end, the Fed made no changes at the July meeting. It approved, 9-1, keeping its current stance on interest rates.
Still, the minutes revealed a sharp and perhaps intensifying debate within the Fed about how and when to scale back its help for a steadily improving economy.
Those who think the Fed should withdraw its support only slowly cited persistent drags on the job market despite solid hiring and a steady drop in the unemployment rate: High levels of people who have been unemployed for more than six months; many people who are working part time even though they want full-time jobs; and chronically weak pay growth.
In addition, the minutes showed that the Fed debated how to unwind the bond purchases it’s made over the past six years to keep long-term rates low. Decisions such as how and when to start reducing its enormous investment portfolio — amounting to nearly $4.5 trillion — remain unsettled. The minutes showed that Fed officials expect to have more details on the process to announce before year’s end.
There was also disagreement over what mix of tools the Fed should use to eventually raise rates. But “almost all” officials thought the Fed should keep its target for the federal funds rate, the rate which banks charge each other, as the key policy rate.
The Fed’s target range for the funds rate has remained at a record low between zero and 0.25 per cent since December 2008. The minutes stated that officials think the Fed should keep using a quarter-point range when it begins raising this rate, rather than specifying a specific rate.
Officials felt the size of the bond holdings should be reduced “gradually and predictably” over time to the smallest level possible that would be consistent with the Fed’s policy. Before the crisis hit with force in the fall of 2008, the Fed’s balance sheet was only around $900 billion.
The minutes stated that most officials favoured ending or at least reducing the re-investment of the Fed’s bond holdings sometime after the first increase in the funds rate. By stopping the re-investment of bond holdings as they mature, the Fed would begin reducing its overall holdings.
Paul Dales, senior U.S. economist at Capital Economics, said the minutes showed the Fed was moving closer to raising rates.
Many economists still think the central bank will wait until next summer to start raising rates. But Dales said he foresees the first increase much sooner — in March — because he expects the job market to maintain better-than-expected improvement.
Dales said the information revealed in the minutes will heighten the attention paid to the speech that Fed Chair Janet Yellen will give Friday to open the annual economic conference in Jackson Hole, Wyoming. Investors will be watching to see whether Yellen moderates her view that the economy still needs significant support from the Fed.
The minutes of the July meeting were released after the customary three weeks after the Fed’s policy meeting. In its policy statement released after that meeting, the Fed acknowledged that growth was strengthening. But it indicated that it needed to see further improvement in the job market before it starts raising its key short-term rate.
It retained language in the statement that it planned to keep that rate low “for a considerable time” after it ends its monthly bond purchases.
At the meeting, the Fed reduced the bond purchases by another $10 billion to $25 billion. It was the sixth $10 billion reduction in the purchases. Before the reductions began in December, the Fed was buying $85 billion in bonds each month as a way to keep long-term interest rates low.
Charles Plosser, president of the Federal Reserve Bank of Philadelphia, dissented from the Fed move. He objected to repeating language in the statement that the first rate hike won’t occur until a “considerable time” after the bond purchases end. Plosser argued that retaining this language failed to take account of the considerable improvements in the economy.
Though many economists think the Fed will begin raising rates next summer, the discussion revealed in the minutes could alter such a timetable.