The minutes from the FOMC’s January 29-30 meeting provided additional detail on the committee’s pivot to “patience” as well as balance sheet “flexibility.” With respect to the balance sheet, the consensus among the committee is that it can continue to conduct monetary policy “in an environment of ample reserves” and sees little need to stick to a program of balance sheet runoff.
Further to that point, “almost all participants thought that it would be desirable to announce before too long a plan to stop reducing the Federal Reserve’s asset holdings later this year.” The FOMC will likely announce more details of its balance sheet plans in upcoming meetings.
The minutes offered several justifications for the move to a “patient approach to monetary policy” including waiting on additional data on consumer and business sentiment, understanding the persistence of lower inflation compensation (market-based expectations), evaluating the impact of the federal government shutdown, and international developments including trade policy and the apparent slowdown in European and Chinese growth.
Key Implications
The dramatic change in the Fed’s monetary policy stance boils down to an assessment that uncertainty and downside risks to economic growth had increased (including from abroad), while upside risks to inflation had diminished.
The Federal Reserve has always intended for movements in its balance sheet to operate in the background with the federal funds rate its main policy tool. Still, while the Fed sees little evidence of its balance sheet impacting on its core policy instrument, it is cognizant of the fact that, even if misplaced, investor concern about balance sheet runoff can in itself tighten financial conditions. The move to flexibility and away from reserve scarcity is an attempt to take the focus off the balance sheet and put it back on the federal funds rate.
On that note, the case for any further increases in the federal funds rate lies in an expectation that the economy will continue to deliver above-trend growth and event risks will not throw it off its trajectory. In this kind of world, the FOMC will feel justified in nudging up the federal funds rate above the bottom of its “neutral range.” Still, the onus is on inflation to prove that the current rate of policy is not the right one.
