Charles Plosser, the President of the Federal Reserve Bank of Philadelphia, gave a speech today at the Cato Institute Conference examining the question: “Was the Fed a Good Idea?” The Fed has been around for 100 years now. Plosser’s speech is titled, “A Limited Central Bank.” He started out by observing that central banks have expanded their role in managing the economy and financial markets:

Yet, in recent years, we have seen many of the explicit and implicit limits stretched. The Fed and many other central banks have taken extraordinary steps to address a global financial crisis and the ensuing recession. These steps have challenged the accepted boundaries of central banking and have been both applauded and denounced.

Plosser will be a voting member of the FOMC in 2015. He thinks that the Fed has taken on too much power and would like to limit it as follows:

• First, limit the Fed’s monetary policy goals to a narrow mandate in which price stability is the sole, or at least the primary, objective;
• Second, limit the types of assets that the Fed can hold on its balance sheet to Treasury securities;
• Third, limit the Fed’s discretion in monetary policymaking by requiring a systematic, rule-like approach;
• And fourth, limit the boundaries of its lender-of-last-resort credit extension and ensure that it is conducted in a systematic fashion.

Fed Vice Chair Janet Yellen has become the fairy godmother of the bull market. When she speaks, stock prices tend to rise, especially since late 2011. She took office for a four-year term on October 4, 2010. Odds are she will be the next Fed Chair. Yellen and I both received our PhDs from Yale and studied under Professor James Tobin. She graduated in 1971. I graduated in 1976. She’s a liberal. I’m a conservative. She is powerful and can move markets. I write about her power to move the stock market higher.

Rich Miller posted a very interesting article today about Yellen and Yale on Bloomberg. He noted, “As a teaching assistant, Yellen was so meticulous in taking notes during Tobin’s macroeconomic class that they ended up as the unofficial textbook for future graduate students.” I studied from those notes. He also refers to a very interesting speech she presented to a reunion of the economics department in April 1999. It was titled, “Yale Economics in Washington,” and is worth reading.

In the speech, she declared that the liberal Keynesian orthodoxy preached by Tobin had conquered Washington. At the time, she was chair of the President’s Council of Economic Advisers, the post held by Tobin during the Kennedy administration. Here, in brief, is the gospel according to Yellen:

(1) “I will try to make the case that the lessons that we learned here at Yale remain the right and relevant ones for improving economic performance, that Yale-trained economists in Washington are succeeding in making their voices heard, and, where Yale economics has been applied, it is working. … I have noticed that Yalies often have a sharper eye for identifying market failures and greater concern for policies to remedy them than economists from institutions I will leave nameless.”

(2) "The Yale macroeconomic paradigm provides clear answers to key questions dividing macroeconomists along with policy prescriptions. Will capitalist economies operate at full employment in the absence of routine intervention? Certainly not. … On the question of whether monetary and fiscal policy can succeed in moving the economy toward full-employment Yale answers yes in both cases except in exceptional circumstances such as a liquidity trap. … Do policymakers have the knowledge and ability to improve macroeconomic outcomes rather than make matters worse? Yes, although there are lags and additive and multiplier uncertainty with which to contend.”

(3) “Although most Americans apparently loathe inflation, Yale economists have argued that a little inflation may be necessary to grease the wheels of the labor market and enable efficiency enhancing changes in relative pay to occur without requiring nominal wage cuts by workers. The attempt to push inflation too low could permanently raise unemployment and reduce the scope for monetary policy.”

(4) “Having described the key elements of the Yale approach to macroeconomics let me go on to claim that the Yale paradigm is alive, well and succeeding in Washington.”

Yellen and Yale will soon be running the Fed.

Fed Governor Jerome Powell presented a short speech defending the FOMC today titled, “Communications Challenges and Quantitative Easing.” He noted that the labor market has improved significantly since QE3 was launched in September 2012. He admitted that it is “unclear” how much the program contributed to the progress in the labor market. However, he claimed that “there is evidence that it played a role, lowering long-term interest rates and raising equity prices and home prices, effects that have supported household and business spending.”

In other words, the Fed has succeeded in inflating asset prices, which somehow created more jobs. The market capitalization of the Wilshire 5000 is up $11.3 trillion, or 165%, to a record $18.4 trillion since March 9, 2009. The median existing single-family home price is up 37.3% through August since it bottomed during January 2012. It is just 8.1% below its record high during July 2006.

Housing starts are up from a low of 478,000 units during April 2009 to 891,000 units through August of this year. Yet residential construction jobs are up only 162,000 since they bottomed during January 2011, to 2.1 million in August. They are still 38% below the record high during the spring of 2006. So far, the so-called "wealth effect" hasn't created too many construction jobs.

Powell acknowledged that there has been a failure in communicating Fed policy recently, but mostly blamed it on trigger-happy fixed-income traders, who “began to lose touch with Committee intentions” since Bernanke first hinted at tapering in his May 22 congressional testimony. He said that his decision at the last meeting was a “close call” and that he would have been comfortable with a tiny taper, though he voted against it. He dismissed the notion that the meeting “damaged the Committee's communications strategy.” In his opinion, “market expectations are now better aligned with Committee assessments and intentions.”

The Fed’s monetary policy has always depended on incoming economic data. It became even more data dependent when the FOMC first formally tied the federal funds rate to the unemployment rate at the December 2012 meeting of the Fed’s policymaking committee. Today, San Francisco FRB President John Williams said, "[C]learly data that's generated by federal government agencies--obviously labor, but also inflation--are key inputs into our thinking about the economy, about our forecast. Obviously, not having that information makes it a little harder to know what's going on." He said so in a Q&A with reporters after presenting a speech titled, “Will Unconventional Monetary Policy Be the New Normal?”

Williams is a nonvoting member of the FOMC, and won’t get to vote until 2015. In his speech, he acknowledged that the Fed’s so-called “unconventional” monetary policies, particularly QE and forward guidance, have become the convention over the past five years. Interestingly, Williams stated that in theory, QE “would have essentially no effect, positive or negative” in a textbook world of perfectly functioning markets.

In reality, he claimed that it can have a positive effect on the economy. More specifically, he noted that numerous studies suggest that “each $100 billion of asset purchases lowers the yield on 10-year Treasury notes by around 3 to 4 basis points.” As for the impact on the economy, he said that the Fed’s $600 billion QE2 purchases might have lowered the unemployment rate by about ¼ percentage point. Wow, that’s a lot of dough for so little bread!

As for forward guidance, Williams admitted, “[C]learly communicating monetary policy and the associated data dependence is simply hard to do well. …Just as good communication can reduce confusion and enhance the effectiveness of monetary policy, poor communication can do the opposite.” He also acknowledged that tying policy to specific data thresholds is “difficult to get right and comes with the risk of oversimplifying and confusing rather than adding clarity.” Finally, he concluded with the following less-than-reassuring thoughts on QE:

Despite all that we’ve learned, the effects of asset purchases are much less well understood and are much more uncertain and harder to predict than for conventional monetary policy. Indeed, the recent outsize movements in bond rates in response to Fed communications about our current asset purchase program illustrate the difficulty in gauging the effects of asset purchases. Moreover, given our limited experience, we can’t be sure of all their consequences, which may play out over many years.

In a speech presented 10/2, Boston FRB President Eric S. Rosengren, who is a voting member of the committee this year and among its super-doves, said there were three concerns that argued against tapering. First, the incoming data were “disappointing.” Second, Washington’s fiscal deadlock “might provide a further potential slowdown in economic activity.” Third, bond yields and mortgage rates had jumped to levels that threatened the ability of interest-sensitive sectors to support the economy’s recovery. None of this is new, but his speech confirms and neatly sums up what we knew already.

He also said, “Unfortunately, this [fiscal policy] remains an area of significant uncertainty, given debates in Congress on continuing resolutions and potentially allowing the country to default on its debt. The uncertainties, not to mention the outcomes themselves, threaten to have a collateral impact on the rest of the economy.”

Minneapolis FRB President Narayana Kocherlakota, who is a non-voting member of the FOMC this year and a voter next year, said in a 9/26 speech that the committee must “do whatever we can to facilitate a faster rate of improvement in labor market conditions.” He implied that more rather than less QE might be needed. If employment weakens over the next few months, then instead of tapering QE, the FOMC might vote to buy securities at a faster monthly pace, as suggested by Kocherlakota.

New York FRB President Bill Dudley would certainly vote to do so in this scenario. In a 9/23 speech, he said: “To begin to taper, I have two tests that must be passed: (1) evidence that the labor market has shown improvement, and (2) information about the economy’s forward momentum that makes me confident that labor market improvement will continue in the future. So far, I think we have made progress with respect to these metrics, but have not yet achieved success.”

Kansas City FRB President Esther George has been the lone voting dissenter at every meeting of the FOMC this year for exactly the same reason, i.e., her concern “that the continued high level of monetary accommodation increased the risks of future economic and financial imbalances and, over time, could cause an increase in long-term inflation expectations.” In a 9/26 speech titled, “US Monetary Policy: Risks of Delayed Action,” she strongly criticized the FOMC’s no-taper decision:

I view the data has being sufficiently positive to continue with the plan the Chairman presented in June, which called for the pace of purchases to moderate this year and gradually decline for several months until they come to an end around mid-2014. Consistent with this roadmap, our previous guidance and market expectations, my preferred course of action would have been to begin tapering asset purchases at last week’s meeting.

She then summarized the risks of not tapering:

Delaying action not only allows potential costs to grow, it also has the potential to threaten the credibility and the predictability of future monetary policy actions. Policy moves that surprise the market often result in additional volatility. And by deciding that it needs to await further data, the Committee is suggesting its desire to be ‘data dependent’ involves putting more emphasis on the most recent data points, which can be volatile and subject to revision, rather than on its own medium-term view of the economy. Another risk is that markets might misconstrue the postponement of action as reflecting a Committee assessment that the broader economic outlook is substantially weaker, when that is not the case.

In his highly technical speech today, Fed Governor Jeremy Stein summarized the findings from recent research he has conducted on the impact of monetary policy on forward real rates. He obviously has too much free time. In the speech, he said a few words about the previous week’s FOMC meeting. He voted not to taper QE. However, he said, “It was a close call for me….” He explained his wavering as follows:

The Chairman laid out a framework for winding down purchases in his June press conference. Within that framework, I would have been comfortable with the FOMC's beginning to taper its asset purchases at the September meeting. But whether we start in September or a bit later is not in itself the key issue--the difference in the overall amount of securities we buy will be modest. What is much more important is doing everything we can to ensure that this difficult transition is implemented in as transparent and predictable a manner as possible. On this front, I think it is safe to say that there may be room for improvement.

He concluded that he would like to see tapering tied automatically to the unemployment rate:

Achieving the desired transparency and predictability doesn't require that the wind-down happen in a way that is independent of incoming data. But I do think that, at this stage of the asset purchase program, there would be a great deal of merit in trying to find a way to make the link to observable data as mechanical as possible. For this reason, my personal preference would be to make future step-downs a completely deterministic function of a labor market indicator, such as the unemployment rate or cumulative payroll growth over some period. For example, one could cut monthly purchases by a set amount for each further 10 basis point decline in the unemployment rate. Obviously the unemployment rate is not a perfect summary statistic for our labor market objectives, but I believe that this approach would help to reduce uncertainty about our reaction function and the attendant market volatility. Moreover, we would still retain the flexibility to respond to other contingencies (such as declines in labor force participation) via our other more conventional policy tool--namely, the path of short-term rates.

The Fed’s transparency policy has made it transparently clear that Fed officials are confused about what to do next. That confusion is abundantly clear when we compare what Fed Chairman Bernanke said at his press conference today and the previous press conference on June 19. Even his latest one was full of internal contradictions. Let’s review:

(1) Do markets matter? As noted above, at last week’s press conference, Bernanke said in his prepared remarks that the FOMC’s decision not to taper was heavily influenced by the backup in bond yields and mortgage rates. Yet when he was asked whether the Fed might be confusing investors and sending mixed signals, he snapped, “We try our best to communicate to markets--we'll continue to do that--but we can't let market expectations dictate our policy actions. Our policy actions have to be determined by our best assessment of what's needed for the economy.” However, the bond market's tightening of financial conditions was one of the major reasons that the Fed voted not to taper, according to Bernanke!

(2) What happened to the “stock theory” of easy money? During his press conference on June 19, Bernanke indicated that he still believed in “the stock theory of the portfolio,” which posits that if the Fed buys bonds at a slower pace that should still put downward pressure on interest rates. Indeed, he even said that just holding onto the securities that have already been purchased and reinvesting funds from maturing issues is stimulative. He did acknowledge that he was puzzled by why bond yields were rising on tapering talk. The stock theory was not mentioned by Bernanke at last week’s press conference.

(3) Is forward guidance on QE still tied to the unemployment rate? At his press conference on June 19, Bernanke specified, for the first time, that 7% is the jobless rate threshold that would mark a substantial improvement in the labor market. He said that the Fed would start reducing its bond purchases later this year if this rate continued to fall toward 7% by the middle of next year, as anticipated by most of the members of the FOMC, according to Bernanke. He expected that QE would be terminated once the jobless rate fell to 7%. Back then, the FOMC knew that May’s rate was 7.6%. Last week, they knew that it had fallen to 7.3% in August.

At last week’s press conference, Bernanke backed away from the 7% threshold: “Last time, I gave 7% as an indicative number to give you some sense of, you know, where that might be. But as my first answer suggested, the unemployment rate is not necessarily a great measure in all circumstances of the--of the state of the labor market overall.”

(4) Is forward guidance on the federal funds rate still tied to the unemployment rate? Bernanke was asked why the unemployment rate threshold for discussing raising the federal funds rate at the FOMC wasn’t lowered at the latest meeting. He chose not to answer the question, simply stating: “There are a number of options that we have talked about. But today, we--as of today, we didn't choose to make any changes to the guidance.” Meanwhile, he effectively did lower the threshold in his prepared remarks as follows:

As I have noted frequently, the economic conditions we have set out as preceding any future rate increase are thresholds, not triggers. For example, a decline in the unemployment rate to 6-1/2 percent would not lead automatically to an increase in the federal funds rate target, but would instead indicate only that it had become appropriate for the Committee to consider whether the broader economic outlook justified such an increase. The Committee would be unlikely to increase rates if inflation were projected to remain below our 2 percent objective for some time, for example; and, in making its assessment, the Committee would also take into account additional measures of labor market conditions, such as job gains. Thus, the first increases in short-term rates might not occur until the unemployment rate is considerably below 6-1/2 percent.

(5) Why is the Fed so intent on seeing inflation rise? The Fed’s inflation target (using the core personal consumption deflator) has been 2% for quite some time. It’s been below that rate since May 2012. At last week’s press conference, Bernanke said that the FOMC is considering setting an inflation floor. If inflation falls to or below this lower bound, then the federal funds rate won’t be raised even if the unemployment rate continues to decline. He added, “I mean, that we should be very reluctant to raise rates if inflation remains persistently below target and that's one of the reasons that I think we can be very patient in raising the federal funds rates since we have not seen any inflation pressure.”

It’s not obvious to me why Fed officials want to boost inflation. The recent decline in inflation has been led by such goods as airfares, used cars, and furniture and bedding. The biggest plunge has been in medical care commodities inflation. Medical services inflation has also been falling. On the other hand, tenant rent inflation rose during August to 3.0% y/y, the highest since May 2009.

Why would it be good for the economy to have rents rise faster? Do Fed officials really want medical care inflation to rebound? These are questions that the Fed chairman did not address in his press conference.

(6) Is there no exit strategy from the Fed’s QE? Bernanke did not address the implications of the Fed’s decision not to taper since just talking about doing so drove yields higher, and raised concerns about the negative impact on the economy among the members of the FOMC. Why won’t that happen again next time the Fed talks about tapering? Why didn’t the Fed proceed with the tiny taper that was widely anticipated and lower the unemployment threshold from 6.5% to 5.5%?

In his prepared remarks at today’s ECB press conference, ECB President Mario Draghi reiterated the ultra-easy forward guidance first provided in July:

Looking ahead, our monetary policy stance will remain accommodative for as long as necessary, in line with the forward guidance provided in July. The Governing Council confirms that it expects the key ECB interest rates to remain at present or lower levels for an extended period of time. This expectation continues to be based on an unchanged overall subdued outlook for inflation extending into the medium term, given the broad-based weakness in the economy and subdued monetary dynamics.

During the Q&A session, Draghi was asked about the geopolitical risks posed by the crisis in Syria. He responded as follows:

We certainly are alert to the geopolitical risk that may come out of the Syrian situation and to the economic risk that may derive from the emerging market situation, which are two different things, really. At this point, I should say something I should have said before. As you can observe, when we look at the nature or the composition of the beginning of a recovery, I am very, very cautious about the recovery. I cannot share any enthusiasm. It is just the beginning. Let us see – these shoots are still very, very green. One thing I should have said is that, for the first time in about two years, it is domestic demand that is at the root of this recovery. It is still coupled with exports, but it is domestic demand. That is very important because if it continues, it gives a sense that the dependence of the recovery on the rest of the world is somewhat balanced by domestic demand. Secondly, we certainly stand ready to act. I did say this when I was asked about what we would do if interest rate or money market developments were unwarranted in view of our assessment of medium-term price stability. We certainly stand ready to act, whichever source these developments may derive from. I have commented on that before. We have not yet discussed any coordinated action, but we have periodic exchanges anyway. One of them will be this weekend in Basel. There will be an opportunity for a meeting with the central banks of major countries.

When asked about the ECB forward guidance policy, he said:

There are two types of forward guidance: one is qualitative and the other one is quantitative, with precise state conditions. Ours is the first type. So, all in all, the Governing Council is fairly united – unanimous, actually – on the wish to maintain this type of forward guidance. I have previously mentioned the BIS paper which actually compares the results and levels of success of different types of forward guidance. As I have said before, the ECB does not score too badly. It scores very well on having controlled volatility and reduced the uncertainty within the corridor and it scores ok in controlling the levels of rates.

Finally, Draghi was asked to explain why his OMT policy has been so successful even though it has yet to be actually implemented. Here is his response in full:

Well, it’s very hard to answer this question without flattering oneself! But I suspect that the design of this measure has made it both powerful and credible. It’s powerful because it addresses a realistic objective, namely redenomination risk spreads – the spreads that are derived from redenomination risks. It’s credible because it is accompanied by conditionality. In our present situation (and in many others, I suspect), a commitment to buy an infinite amount of bonds in order to keep interest rates at a certain level is often not credible – besides being illegal in our present situation. So, I think this combination of a realistic target, accompanied by what are in principle unlimited means (but are, in fact, limited by the market’s size) and by conditionality, has made this measure very effective without it needing to be activated. But conditionality is an important ingredient, because it says that once this measure is activated, the country that is on the receiving end will actually be undertaking a series of actions – budgetary consolidation or structural reforms, or both – that will have the effect of increasing the value of the bonds issued by that country, the value of the very bonds that the ECB is buying into it. So, the conditionality, if properly activated, produces an increase in the value – if you want to use that word – of the collateral that the country posts in exchange for ECB action. I think that’s one way to look at this. Thanks for asking!

In a speech today titled, “The Economic Outlook, Unemployment, and Monetary Policy,” FRB-SF President John Williams spent a fair amount of time discussing factors influencing the unemployment rate. Before doing so, he claimed that the Fed’s policies “have given a shot in the arm to the economy by significantly reducing longer-term interest rates.” He acknowledged that they’ve been rising lately, but said that they are “still quite low.” He then reminded his audience that monetary policy is now closely tied to the unemployment rate. If it continues to fall toward 7% by the middle of next year, then QE will be phased out and terminated by then. If it continues to fall to 6.5%, that will be the threshold for the FOMC to start discussing raising short-term rates. He observed: “Clearly, the unemployment rate plays an important role in our thinking and communication about future policy. Therefore, an important issue is whether it is giving an accurate read on where things stand relative to our maximum employment mandate.” He then went on to address this important issue as follows:

(1) Overall, he believes it is a useful measure that “closely tracks other indicators of how much slack there is in the labor market, such as data from surveys on the share of households that finds jobs hard to get and the share of businesses that say it’s hard to fill openings. This adds to our confidence in its reliability.”

(2) He is not a fan of the employment-to-population ratio, which has been much more downbeat about the labor market than the jobless rate: “Although the unemployment rate is by no means a perfect measure of labor market conditions, the employment-to-population ratio blurs structural and cyclical influences. That makes it a problematic gauge of the state of the labor market for monetary policy purposes.”

(3) He also discussed structural reasons behind why the labor force participation rate has been falling and may also exaggerate the weakness of the labor market: “The overall ranks of the unemployed have been declining because many people are leaving the labor force, rather than finding jobs. But, it’s important to remember that much of this decline in labor force participation reflects long-running demographic trends, such as retiring baby boomers leaving the workforce. In addition, in recent years there has been a big exodus of young people and so-called prime-age adults. Again, some of this is related to ongoing trends, such as an increasing share of young adults enrolling in school, and workers moving onto disability rolls.”

He summed it all up as follows:

All this gets quite complex. On the one hand, we have structural trends, like the aging of the workforce and young people spending more time in school. On the other hand, we have the effects of a weak economy, which discourages people from looking for work. From the standpoint of gauging the state of the labor market for monetary policy, it is crucial that we distinguish between structural developments in the labor market and the effects of a weak economy. Recent estimates by the U.S. Bureau of Labor Statistics and others suggest that structural factors account for most of the decline in participation over the past several years.8 According to this research, structural factors reducing labor supply are the main reason that the employment-to-population ratio has stayed so low while unemployment has declined. Therefore, the employment-to-population ratio is sending a much too pessimistic signal regarding the amount of slack in the labor market. On the other hand, this evidence also suggests that the unemployment rate probably is overstating somewhat the extent of improvement in the labor market. However, over time, as discouraged workers rejoin the labor force, this problem should go away.

The talk of the town at this past weekend’s Jackson Hole monetary policy conference was a paper presented by Arvind Krishnamurthy and Annette Vissing-Jorgensen on Friday. At the annual FRB-KC symposium, the two academics argued that the Fed should taper its purchases of US Treasuries while increasing its purchases of mortgage-backed securities. That certainly is a novel variation on the QE tapering theme that has been unsettling financial markets since May 22, when Fed Chairman Ben Bernanke first raised the subject.

Adding to the influence of the two economists is that Bernanke mentioned another one of their papers in a footnote of his presentation at last year's conference. In his speech back then, the Fed Chairman focused mostly on QE, also known as "Large-Scale Asset Purchases (LSAP)" in Fed jargon. He admitted that it’s unconventional and has been mostly a “process of learning by doing.” It’s worth rereading his comments in light of recent developments. Most noteworthy is the following quote:

How effective are balance sheet policies? After nearly four years of experience with LSAPs, a substantial body of empirical work on their effects has emerged. Generally, this research finds that the Federal Reserve’s large-scale purchases have significantly lowered long-term Treasury yields. … Three studies considering the cumulative influence of all the Federal Reserve’s asset purchases, including those made under the MEP ["Operation Twist"], found total effects between 80 and 120 basis points on the 10-year Treasury yield. These effects are economically meaningful.

Here’s the rub: The 10-year Treasury bond yield has spiked by 116 basis points from this year’s low of 1.66% on May 2 to 2.82% on Friday. That happened mostly as a result of all the Fed’s chatter about tapering QE. Oh well: Easy come, easy go. I presume that Bernanke must view the backup in yields as economically meaningful! QE was an experiment from the beginning, as Bernanke admitted. If the Fed does phase out QE, it will most likely have to provide more monetary stimulus through forward guidance, as discussed below.

The sharp increase in yields caused by the QE tapering talk suggests that the Fed's bond purchases inflated a big bubble in the bond market. As I’ve noted previously, the 10-year yield normally tends to trade around the y/y growth rate in nominal GDP. The jump in yields is normalizing this relationship. The Fed’s tapering talk has caused investors around the world to taper their holdings of bonds. That’s starting to poke holes in other bubbles as well, particularly emerging market bonds, currencies, and stocks.

(Based on an excerpt from YRI Morning Briefing)

In her speech at Jackson Hole today, IMF Chief Christine Lagarde sounded the alarm on the recent turmoil in emerging markets. Their currency and bond markets have been roiled by QE tapering talk in the US as capital flows back to the developed world. Her basic message was that the Fed and other central banks should consider the impact on other countries when exiting their unconventional monetary policies. In the speech titled, “The Global Calculus of Unconventional Monetary Policies,” she said:

So this is my main message today: We need to work better together to understand more fully the impact of these unconventional policies--local and global--and how that affects the path of exit. And, above all, we must use the time wisely and not waste the space provided by unconventional policies. Global policymakers--all policymakers, within countries and across countries--have a responsibility to take the full range of actions needed to restore stability and growth, and to reduce imbalances.

(Based on an excerpt from YRI Morning Briefing)

Today’s minutes of the July 30-31 FOMC meeting suggest that QE tapering is likely to begin following the next meeting on September 17-18. Here are some of the clues:

1) On the economy. Economic growth was slower during the first half of the year than many participants expected. They mostly blamed tighter fiscal policy for the slowdown. Slower growth overseas also slowed exports. Looking ahead, they “generally continued to anticipate that the growth of real GDP would pick up somewhat in the second half of 2013 and strengthen further thereafter.” They cited several reasons why this might happen, including “highly accommodative monetary policy, improving credit availability, receding effects of fiscal restraint, continued strength in housing and auto sales, and improvements in household and business balance sheets.” On the other hand (since many of them are economists), the participants are worried about “recent increases in mortgage rates, higher oil prices, slow growth in key U.S. export markets, and the possibility that fiscal restraint might not lessen.”

2) On the wealth effect. Participants expect that recent high readings of consumer confidence and rising household wealth will boost consumer spending. However, a few of them cautioned that the wealth effect might be weaker than in the past if consumers might not view rising equity prices as lasting and if extracting home equity is harder to do now. The participants mostly expect that housing activity will continue to improve and that home prices will continue to rise despite the rise in mortgage rates. They are counting on strong pent-up demand to keep housing going. However, they are concerned that mortgage refinancing has dropped sharply.

3) On employment. The committee is impressed with recent payroll employment gains through June. However, the minutes noted that the unemployment rate remains high and that the participation rate and the employment-to-population ratio are low. Furthermore, there are still too many people working part-time for economic reasons. In addition, “It was noted that employment growth had been stronger than would have been expected given the recent pace of output growth, reflecting weak gains in productivity.” Not mentioned was the possibility that the slow pace of GDP growth during the first half was consistent with the trend to hire more part-time workers.

4) On inflation. There was a wide range of opinions on when inflation might rise back to the FOMC’s 2% target. However, more participants expected inflation to remain below 2% for some time than expected a fast pickup:

A few participants, who felt that the recent low inflation rates were unlikely to persist or that the low PCE inflation readings might be marked up in future data revisions, suggested that, as transitory factors receded and the pace of recovery improved, inflation could be expected to return to 2 percent reasonably quickly. A number of others, however, viewed the low inflation readings as largely reflecting persistently deficient aggregate demand, implying that inflation could remain below 2 percent for a protracted period and further supporting the case for highly accommodative monetary policy.

5) On bond yields. The minutes acknowledged that the financial markets were confused by the message in the FOMC’s statement following the June meeting and Fed Chairman Ben Bernanke’s subsequent press conference. Both might have “heightened financial market uncertainty about the path of monetary policy and a shift of market expectations toward less policy accommodation.” However, the participants were mostly satisfied that they had succeeded in clearing up the confusion, as various Fed officials stressed that “a highly accommodative stance of monetary policy would remain appropriate for a considerable period after purchases are completed.” In other words, the federal funds rate will remain near zero long after QE is terminated.

As a result, many participants felt that the markets now understand the game plan (whatever it is): “A number of participants mentioned that, by the end of the intermeeting period, market expectations of the future course of monetary policy, both with regard to asset purchases and with regard to the path of the federal funds rate, appeared well aligned with their own expectations.” Of course, since the end of July, bond yields have continued to rise, suggesting that the markets aren’t as aligned with their views as they thought back then.

At the July meeting, “some participants” were concerned that the rise in bond yields could slam the brakes on the economy. However, “[s]everal others” were much less worried about the backup in yields. Maybe more of them are now that yields have continued to spike higher.

6) On QE. The minutes confirmed that “almost all participants” felt “broadly comfortable” with the plan for tapering QE presented in Bernanke’s June post meeting press conference and in his July monetary policy testimony. If the economy continued to improve, with the unemployment rate heading down to 7% and the inflation rate rising back to 2% by mid-2014, then QE would be terminated by then.

7) On forward guidance. The committee also discussed what to do about its forward guidance, and decided to reaffirm that 6.5% remains the threshold for the unemployment rate. The FOMC won’t even start talking about raising the federal funds rate until the jobless rate falls to that level. However, “several participants” were willing to consider lowering this threshold “if additional accommodation were to become necessary or if the committee wanted to adjust the mix of policy tools used to provide the appropriate level of accommodation.”

(Based on an excerpt from YRI Morning Briefing)

Today’s minutes of the July 30-31 FOMC meeting note that the Fed’s staff is working on a new monetary policy tool. It’s actually a variation of the Fed’s traditional overnight reverse repurchase agreement facility. However, instead of the rate being determined by the market, it will be fixed by the Fed. This will allow the Fed to drain reserves from the banking system at a fixed rate:

In support of the Committee’s longer-run planning for improvements in the implementation of monetary policy, the Desk report also included a briefing on the potential for establishing a fixed-rate, full-allotment overnight reverse repurchase agreement facility as an additional tool for managing money market interest rates. The presentation suggested that such a facility would allow the Committee to offer an overnight, risk-free instrument directly to a relatively wide range of market participants, perhaps complementing the payment of interest on excess reserves held by banks and thereby improving the Committee’s ability to keep short-term market rates at levels that it deems appropriate to achieve its macroeconomic objectives.

This is another indication that the Fed is setting the stage for the eventual tightening of monetary policy.

In a letter today to Chancellor of the Exchequer George Osborne, BOE Governor Mark Carney ties the central bank’s forward guidance to the unemployment rate, which is currently at 7.8% in the UK. The BOE’s Monetary Policy Committee (MPC) will keep interest rates near zero until the jobless rate falls to 7%:

In its assessment the MPC has concluded that explicit forward guidance can enhance the effectiveness of the exceptionally stimulative monetary stance in three ways. First, it provides greater clarity regarding the MPC's view of the appropriate trade-off between the horizon over which inflation is returned to target and the speed with which growth and employment recover. Second, it reduces uncertainty about the future path of monetary policy, in particular helping to avoid the risk that market interest rates rise prematurely as the recovery gains traction. Third, it gives monetary policy greater scope to explore the potential sustainable level of employment and output without putting price and financial stability at risk. In these ways, forward guidance can help to secure the recovery that is now in train.

In light of that assessment, the MPC agreed at its meeting on 1st August--and is announcing today--forward guidance about the future path for monetary policy. In essence, the MPC intends at a minimum to maintain the current exceptionally accommodative stance of monetary policy until economic slack has been substantially reduced, provided that this does not put at risk either price stability or financial stability. In practice, that means the MPC intends not to raise Bank Rate above its current level of 0.5%, at least until the Labour Force Survey headline measure of unemployment has fallen to a threshold of 7%. While the unemployment rate remains above 7%, the MPC stands ready to undertake further asset purchases if additional stimulus is warranted. But until the unemployment threshold is reached, and subject to maintaining price and financial stability, the MPC intends not to reduce the stock of asset purchases financed by the issuance of central bank reserves. Consistent with that, the MPC intends to reinvest the cashflows associated with all maturing gilts held in the Asset Purchase Facility.

The MPC doesn’t expect the unemployment rate to fall below 7% for at least the next three years, i.e., after the third quarter of 2016. If the risks to price stability or financial stability increase over this period, then the unemployment threshold will be “knocked out.” This doesn’t mean that the central bank will start raising rates, but it will “reconsider the appropriate stance of policy.”

FRB-Chicago President Charles Evans (a voting member of the FOMC this year) told reporters today, “We are quite likely to reduce the flow of [QE bond] purchases rate starting later this year--I couldn't tell you exactly which month that will be--and it's likely to wind down over time in a couple or few stages.” Asked if he would rule out voting to start tapering QE at the September 18 meeting of the FOMC, Evans said he "clearly" would not. That makes him the third Fed official in two days to suggest that a September pullback on QE bond purchases is possible. He also said that the federal funds rate would remain near zero until the unemployment rate falls below 6.5%, which he doesn’t expect to happen until mid-2015.

Two other Fed officials this week signaled the possibility of a QE pullback starting in September. FRB-Dallas President Richard Fisher on Monday said he would prefer to start cutting back on bond-buying next month, while FRB-Atlanta President Dennis Lockhart said on Tuesday that the Fed might make reductions starting in September or wait longer if economic growth fails to pick up.

A few weeks ago, FRB-Minneapolis President Narayana Kocherlakota called for the Fed to lower its threshold for considering a hike in rates to 5.5% unemployment. Evans said the Fed is already open to keeping rates low well beyond the current 6.5% threshold, but if Fed officials thought it would be useful to lower the threshold, he would not have a problem with doing so.

In a speech today, FRB-Dallas President Richard Fisher reviews the costs of QE. He acknowledges that the Fed’s bond-buying program has been stimulative:

[D]riving down mortgage rates has certainly assisted a robust recovery in housing, and with it, construction jobs and manufacturing and transportation of materials that go into homes. This was clear from reading the components of the Institute for Supply Management’s manufacturing index released last Thursday, which showed the biggest one-month jump since 1996. Very liberal financing terms for automobiles that we have induced have coincided with an aging of the nation’s auto fleet to regenerate domestic auto sales to the 15.7 million units level.

Then he goes on to outline the major costs of QE:

Counteracting whatever benefits one can trace to the Fed’s unorthodox policies are some obvious costs. First, savers and others who rely on retirement monies invested in short-maturity fixed-income investments, such as bank CDs and Treasury bills, have seen their income evaporate while the rich and the quick, the big money players of Wall Street have become richer still.

Second, the standard return assumptions of 7.5 to 8 percent for retirement pools, as you well know, have been dashed (though I have always felt they were already calculated on an imaginary and politically convenient basis rather than a realistic one).

Third, accompanying the Fed’s growing balance sheet we have seen a dramatic expansion in the monetary base—the sum of reserves and currency. Currently, much of the monetary base has piled up in the form of excess reserves of banks who have not found willing or able borrowers. Other forms of surplus cash are lying fallow on the balance sheets of businesses or being deployed in buying back shares and increasing dividend payouts so as to buttress company stock prices. A basic understanding of demand-pull inflation is “too much money chasing too few goods.” Thus, the excess, currently nondeployed money could prove the kindling of an inflationary conflagration unless the Fed is nimble in managing its effect as it works its way into the economy’s production and consumption of goods and services.

A corollary of reining in this massive monetary stimulus in a timely manner is that financial markets may have become too accustomed to what some have depicted as a Fed “put.” Some have come to expect the Fed to keep the markets levitating indefinitely. This distorts the pricing of financial assets, encourages lazy analysis and can set the groundwork for serious misallocation of capital.

In his prepared remarks today at the press conference following the latest meeting of the ECB’s Governing Council, ECB President Mario Draghi said, “Looking ahead, our monetary policy stance will remain accommodative for as long as necessary.” This statement confirmed July’s forward guidance. He said that the six-quarter recession in the euro area may be coming to an end based on the latest surveys of economic activity. He attributed this improvement in the real economy to the stabilization in financial markets since last summer. Nevertheless, the risks remain on the downside, as lending conditions remain tight.

According to the FOMC’s statement yesterday, the economy “expanded at a modest pace during the first half of the year.” The pace had been characterized as “moderate” in the previous seven statements since the one dated September 13, 2012. The downgrade is understandable given that yesterday morning the Bureau of Economic Analysis (BEA) once again revised Q1’s real GDP downward to only 1.1% (saar). That contributed to a better-than-expected gain of 1.7% during Q2.

The FOMC statement also tweaked the message about inflation to reflect the latest numbers: “The Committee recognizes that inflation persistently below its 2 percent objective could pose risks to economic performance, but it anticipates that inflation will move back toward its objective over the medium term.” The previous seven statements simply noted: “The Committee also anticipates that inflation over the medium term likely will run at or below its 2 percent objective.” (A searchable archive of these FOMC statements is available at The Fed Center.)

Yesterday’s GDP report showed that the core personal consumption deflator rose at an annual rate of just 0.8% during Q2, down from 1.4% during Q1. On a y/y basis, it is up 1.2%.

All in all, the FOMC didn’t change the message much at all from the previous one dated June 19. Despite widespread expectations that QE will be tapered at the next FOMC meeting in September, the latest statement simply indicated that the Fed will continue to buy $85 billion in Treasuries and Agencies but will either increase or decrease this pace “as the outlook for the labor market or inflation changes.”

There was no change in the forward guidance on how long the federal funds rate will remain near zero. The unemployment threshold for starting to discuss the possibility of tightening monetary policy remains at 6.5%. There was no hint that a lower jobless rate, such as 5.5%, was even discussed. Nor was there any hint that the FOMC is considering a threshold for the inflation rate.

On balance, the statement was more dovish than the previous one. That simply reflects the fact that monetary policy is data dependent. The data that were released yesterday showed weak GDP growth and near-zero inflation. Indeed, nominal GDP was up only 2.9% y/y during Q2, the lowest since Q1-2010.

I suppose that all this lowers the odds of QE tapering starting at the September meeting. However, I hope that there was some discussion at the latest meeting about why the economy is so weak given so much QE. Since the latest program was started on September 13, 2012, the Fed’s balance sheet has increased by $751 billion to a record $3.5 trillion.

(Based on an excerpt from YRI Morning Briefing)

Today’s FRB-SF Economic Letter features an article titled, “Uncertainty and the Slow Labor Market Recovery,” written by two of the bank’s economists. In their study, they use a measure of fiscal and monetary policy uncertainty constructed using the volume of newspaper articles discussing economic policy uncertainty, the number of tax code provisions scheduled to expire, and the extent of disagreements among economic forecasters about such variables as future levels of inflation and government spending. The sharp increase in this measure since 2007 coincides with the rightward shift in the Beveridge Curve, which shows the inverse relationship between the job openings rate and the unemployment rate. Since 2007, the unemployment rate has been higher than in the past at the same job openings rates.

The authors dismiss the notion that a mismatch between the skills unemployed workers have and what employers are looking for can explain the shift in the Beveridge Curve. They also don’t buy the idea that the expansion of unemployment insurance benefits can account for the shift, noting that “unemployment insurance benefits have been reduced substantially over the past two years.” Here is their startling finding:

As the figure shows, policy uncertainty did not contribute to the shift in the Beveridge curve from December 2007 to August 2009. However, beginning in autumn 2009, policy uncertainty became an increasingly important factor behind the shift in the Beveridge curve. By the end of 2012, heightened policy uncertainty accounted for about two-thirds of the shift. Our results suggests that, in late 2012, if there had been no policy uncertainty shocks, the unemployment rate would have been close to 6.5% instead of the reported 7.8%.

The policy uncertainty measure includes uncertainty about monetary policy. Could it be that the Fed’s constant tweaking of its ultra-easy monetary policy, including all the discordant chatter from members of the FOMC, has contributed to the stubbornly high unemployment rate? That certainly is the implication of this study coming out of one of the most respected research departments in the Fed’s system! The unemployment rate would be down to 6.5% by now if not for all the policy uncertainty.

The Fed seems to have four mandates now. The official two are to lower the unemployment rate as much as possible, while keeping inflation low but avoiding deflation. The two “shadow” mandates are to boost stock and bond prices, while avoiding asset bubbles:

During the Q&A session following Fed Chairman Ben Bernanke’s prepared congressional testimony on monetary policy last Wednesday, he said, “I think the market is beginning to understand our message, and the volatility has obviously moderated.” Since the June 24 closing low of 1573, the S&P 500 is up 7.6% to yet another record high of 1692. Over this same period, the S&P 400 and S&P 600 are up 9.7% and 10.1%, also to record highs. Friday’s WSJ reported: “Yields on noninvestment-grade corporate debt fell below 6% at Thursday's close for the first time since June 4, hitting 5.89%.... While that is well above the 5% threshold the debt briefly pierced in a frantic early-spring rally, the milestone comes only weeks after yields on so-called junk debt neared 7%."

Apparently, the message is that Bernanke & Co. wants stock prices to rise and bond yields to fall. That seems to be one of the two shadow mandates. This is the one lurking behind the Fed’s official dual mandate, which according to the FOMC statements since December 12 of last year is to lower the unemployment rate to 6.5% and to boost inflation back to 2%.

Of course, another shadow mandate is to maintain financial stability and to avoid asset bubbles. Fed Governor Sarah Bloom Raskin weighed in on this subject in a 7/17 speech titled, “Beyond Capital: The Case for a Harmonized Response to Asset Bubbles.” She stated, “Even within the regulated sector, crafting appropriate financial regulation to address asset bubbles is challenging. In reality, it is hard to know in real time when asset prices have deviated sharply from fundamentals.”

This seems to be the house view at the Fed. In his Q&A last Wednesday, Bernanke said: “We have some tools. The Federal Reserve has recently issued some guidance to banks on leverage lending and other kinds of practices that could contribute to asset bubbles. All that being said, we want to make the financial system as transparent as possible, I don't think we can guarantee that we can prevent any bubble." Currently, the Fed's priority for the two shadow mandates seems to be to boost stock and bond prices rather than to avert asset bubbles.

(Based on an excerpt from YRI Morning Briefing)

When Fed Chairman Ben Bernanke outlined the FOMC’s plan for phasing out QE at his press conference on June 19, the S&P 500 dropped 1.4% that day and 2.5% the following day. When he repeated the plan yesterday during his congressional testimony, the market rose slightly, remaining near its recent record high.

Bernanke said that the FOMC will start tapering QE “later this year” if the economy continues to improve and inflation moves back toward 2%: “And if the subsequent data continued to confirm this pattern of ongoing economic improvement and normalizing inflation, we expected to continue to reduce the pace of purchases in measured steps through the first half of next year, ending them around midyear. At that point, if the economy had evolved along the lines we anticipated, the recovery would have gained further momentum, unemployment would be in the vicinity of 7 percent, and inflation would be moving toward our 2 percent objective. Such outcomes would be fully consistent with the goals of the asset purchase program that we established in September.”

However, that’s not a “preset course.” In any event, he reiterated that the Fed’s forward guidance pledges to keep the federal funds rate near zero “at least as long as” the unemployment rate remains above 6.5%. If inflation remains persistently below 2%, then the federal funds rate will remain near zero even if the jobless rate is down to 6.5%.

The market’s reaction to Bernanke’s “Can you hear me now?” testimony suggests that the answer is “Yes, now we can!” The Fed may or may not taper QE depending on the performance of the economy. In any event, highly accommodative monetary policy will persist for the foreseeable future.

For now, the Fed will continue to buy $40 billion per month in agency MBS and $45 billion per month in Treasuries.

(Based on an excerpt from YRI Morning Briefing)

The minutes of the BOJ’s monetary policy meeting on June 10-11 were released today. The members seem to be satisfied with the initial success of the QE policy they implemented in April. So they will stay on course:

With respect to the future conduct of monetary policy, most members shared the view that the Bank would continue with quantitative and qualitative monetary easing, aiming to achieve the price stability target of 2 percent, as long as it was necessary for maintaining this target in a stable manner.

They had been concerned about the volatility of bond yields lately. However, they noted “that fluctuations in long-term interest rates had recently been subdued, reflecting market participants' positive response to the Bank's revision to the operational outline for outright purchases of JGBs following the meetings with market participants.” There was some discussion of providing additional forward guidance on short-term interest rates:

In this regard, a few members expressed the view that, in order to reduce such differences and stabilize interest rates, it was vital for the Bank to firmly anchor short-term interest rates at low levels by reiterating its commitment to continuing with quantitative and qualitative monetary easing as long as it was necessary for maintaining the price stability target of 2 percent in a stable manner.

India’s rupee fell to a record low on July 8, weakened by the slowest economic growth in a decade and a record current-account deficit. The Reserve Bank of India (RBI) responded today by increasing the marginal standing facility and the bank rate from 8.25% to 10.25%, and said it will conduct open-market sales of government bonds of $2 billion on July 18.

Charles I. Plosser (FRB-Phil.), a nonvoting participant on the FOMC, gave a speech today titled, “Assessing Monetary Policy.” He flies with the FOMC’s hawks. He is more optimistic than most of his colleagues about the US economy. He sees the unemployment rate approaching 7% by the end of this year and 6.5% before the end of 2014. He wants to start tapering QE now and stop purchasing assets by the end of the year. He wants to change the forward guidance on the fed funds rate path by treating the 6.5% unemployment rate and the 2.5% inflation rate as triggers rather than thresholds. In his own words:

In my view, it is important that we end purchases before we reach the 6.5 percent threshold for considering an increase in the funds rate target. If we don't, I believe the 6.5 percent threshold will lose meaning. Would anyone believe we would raise the fed funds rate at the same time that we are increasing the size of the balance sheet through asset purchases? Thus, consistent with my forecast and with the Committee's forward guidance, I favor starting to reduce the pace of purchases and ending the asset purchase program by year-end.

Here is why he prefers targets to thresholds:

In August 2011, the Committee began using dates to signal when the policy rate might increase, but it changed those dates at subsequent meetings. The FOMC then opted to formulate its forward guidance in terms of thresholds for unemployment and inflation. This is preferable to calendar dates because it is state contingent. Yet, the FOMC has specifically said that the thresholds are not triggers — they are not firm commitments and they may change. The Committee has repeatedly opted for language that allows a great deal of discretion to behave as it chooses, depending on the circumstances. But effective forward guidance demands commitment. When the Committee stresses the general flexibility of its policy decisions or makes vague references to data dependency, it does little to clarify the FOMC's intentions about future policy, even though clarity is what the FOMC wants to provide to the markets through its forward guidance. Thus, there is a fundamental tension between wanting to provide clarity as to the forward course of policy and wanting to maintain complete discretion. The Committee has failed to address this tension, which undermines the effectiveness of its policy.

James Bullard (FRB-SL), a voting member of the FOMC, spoke at a forum on monetary policy today at Jackson Hole. His remarks are summarized on the FRB-SL website. The key point: “Bullard noted that the FOMC recently authorized Fed Chairman Ben Bernanke to discuss possible plans for the ‘tapering of QE,’ which refers to reducing the pace of asset purchases. ‘The financial market reaction has been substantial, even though the Committee has not actually changed any policy settings at this point,’ Bullard said.” Here’s more from the post:

Current U.S. monetary policy has three components: the policy rate, forward guidance and asset purchases, he said. The policy rate has been near zero since December 2008. Forward guidance is a promise to keep that rate near zero at least until unemployment falls below 6.5 percent or inflation rises above 2.5 percent. Asset purchases of Treasury securities and mortgage-backed securities are continuing at $85 billion per month until there is substantial improvement in the labor market, as stated by the FOMC.

In a speech today in Singapore, Vítor Constâncio, ECB Vice-President, said that Europe is responding to its crisis by implementing structural reforms:

Europe is addressing its structural problems which have been holding back growth and at the same time it is ensuring that its banking sector contributes to global stability and growth. Europe is undertaking a process of wide and deep reforms, of which the Banking Union project is a major example, that will ensure a future healthier path of economic progress.

He claims that euro zone members are making good progress in becoming more competitive through product and labor market measures and also deeper reforms to tax systems, public administration, and the judicial system:

They are achieving greater sustainability by moving towards an economic model based less on external borrowing and more on internal competitiveness. Indeed, according to harmonised competitiveness indicators based on unit labour costs have all registered significant improvements since 1999, Ireland (-19% since 1999), Spain (-9.5%), Greece (-9%), and Portugal (-6.6%). The loss of competitiveness accumulated until 2007 has been totally offset since the beginning of the crisis. As a consequence, the EU Commission forecast for this year is that all stressed countries will show a surplus on current account with the exception of Greece with a deficit of just 1.1 % of GDP.

He also notes that European banks are in much better shape than widely recognized:

First, there have been steady improvements in solvency positions of many euro area banks. For large and complex banking groups in the euro area, covering about two thirds of total assets, the median core Tier 1 capital ratio reached 11.1% in the first quarter of this year – up from 9.6% at the end of 2011 and 8.3% at end-2009.

Second, euro area large banks have become less leveraged, from a level of 3.3% of tier 1 equity to 5% now. This was achieved mainly through capital increases....

Third, the restructuring efforts in the stressed countries to strengthen their banks with the help of the European Stability Mechanism (ESM) funds have led to improved funding conditions for euro area banks. With the financing provided by the ESM, banks in Spain, Portugal, Greece and Ireland have been recapitalized. Bank deposits in these countries have risen by around 200 bn since September last year, and the cost of both deposit and bond funding for banks has fallen significantly. Euro area banks’ issuance of medium and long-term debt has increased and we have also seen a noticeable pick-up in repo market activity.

The FOMC has 19 participants with 12 of them designated as voting members. The even dozen includes the seven Fed governors and five of the 12 regional Fed presidents, who rotate as members once a year. The minutes of the latest June 18-19 FOMC meeting suggest that the members are more dovish than the broader group of participants:

(1) Members. “While recognizing the improvement in a number of indicators of economic activity and labor market conditions since the fall, many members indicated that further improvement in the outlook for the labor market would be required before it would be appropriate to slow the pace of asset purchases.” This assessment appeared in the usual “Committee Policy Action” section near the end of the minutes.

(2) Participants. “About half of these participants indicated that it likely would be appropriate to end asset purchases late this year. Many other participants anticipated that it likely would be appropriate to continue purchases into 2014.” This assessment appeared in the appendix “Summary of Economic Projections.”

These two quotes from the minutes suggest that six or more of the voting members (i.e., “many” of the 12) are not inclined to taper QE at all unless they see that the labor market continues to improve. Apparently, nine participants (i.e., “about half” of 19) are pushing to terminate QE by the end of the year. If so, then at least two of those nine must be voting members since 19 (participants) minus 12 (voting members) is only seven (non-voters).

The participants authorized the Fed chairman to explain during his press conference what they meant to say in their usual post-meeting statement:

At the conclusion of the discussion, most participants thought that the Chairman, during his post-meeting press conference, should describe a likely path for asset purchases in coming quarters that was conditional on economic outcomes broadly in line with the Committee’s expectations. In addition, he would make clear that decisions about asset purchases and other policy tools would continue to be dependent on the Committee’s ongoing assessment of the economic outlook. He would also draw the distinction between the asset purchase program and the forward guidance regarding the target for the federal funds rate, noting that the Committee anticipates that there will be considerable time between the end of asset purchases and the time when it becomes appropriate to increase the target for the federal funds rate.

At his press conference on June 19, Fed Chairman Bernanke strongly suggested that QE would be tapered within the next few months and probably terminated by mid-2014 as long as the labor market continued to improve. Yet many of the voters on the FOMC weren’t ready to taper, let alone terminate it, according to the minutes of the FOMC meeting that concluded that same day.

At his press conference on July 19, Fed Chairman Bernanke strongly suggested that QE would be tapered within the next few months and probably terminated by mid-2014 as long as the labor market continued to improve. Late this afternoon, he simplified the message in response to a question after a speech in Cambridge, Mass. He said, “Highly accommodative monetary policy for the foreseeable future is what’s needed in the US economy.” Actually, he answered numerous questions from the audience. The transcript of the Q&A shows that this statement appeared in the context of the following response to a question on whether the Fed is turning hawkish:

The [Fed’s] dual mandate is to pursue maximum employment and price stability. Currently, we have an unemployment rate of 7.6%, which I think, if anything, overstates the health of our labor markets given participation rates and many other indicators of underemployment and long-term unemployment. So we’re not there, obviously, on the maximum employment part of the mandate. On price stability, inflation is now about 1%, which is below our 2% objective. So both sides of our mandate--both the employment side and the inflation side, are saying that we need to be more accommodating. Moreover, the other portion of macroeconomic policy--fiscal policy is now actually quite restrictive. The CBO estimates that current federal fiscal policy is subtracting 1 1/2 percentage points or so of growth from the U.S. economy this year. So you put that all together, and I think you can only conclude that highly accommodative monetary policy for the foreseeable future is what’s needed in the U.S. economy.

Mr. Bernanke didn’t talk much about QE. Instead, he focused on NZIRP, saying that the federal funds rate would stay near zero:

And in particular, we said that we will not raise interest rates until--at least until unemployment hits 6.5%, as long as inflation is well-behaved--again, I think as I’ve said before, that that 6.5% is a threshold, not a trigger. There will not be an automatic increase in interest rates when unemployment hits 6.5%. Instead, that will be a time to think about the situation anew. And given, as I said, the weakness of the labor market, the fact that the unemployment rate probably understates the weakness of the labor market, given where inflation is, I would suspect that it may be well sometime after we hit 6.5% before rates reach any significant level.

He concluded this response by implying that even if QE is tapered, overall monetary policy will remain very easy because the federal funds rate will remain near zero for a long while:

So again, the overall message is accommodation. There is some prospective gradual and possible change in the mix of instruments. But that shouldn’t be confused with the overall thrust of policy, which is highly accommodative.

In a press release today, the IMF’s latest mission to Greece reported that the country’s macroeconomic outlook remains the same as previously projected, with some slow growth expected to resume in 2014. The government promises to take some corrective measures to achieve its fiscal targets for this year. The government is still aiming for primary balance in its budget this year. It is still working on controls over excessive health care spending. Here are some of the other steps the government is taking towards reforming its finances:

The income tax, property tax, and tax procedure codes are being reformed, and the autonomy and efficiency of revenue administration is being strengthened. The authorities have also committed to take steps to bring public administration reforms back on track, such as by completing staffing plans by end-year, placing staff in the mobility and reallocation scheme, and meeting the agreed targets for mandatory exits. With the recapitalisation of the banking sector nearly complete, the authorities have committed to further steps to safeguard financial stability, including through the sale of two bridge banks and completion of their strategy for a four-pillar banking system. These reforms are a further important step towards facilitating adjustment and enabling growth. The mission also discussed with the authorities progress in strengthening the social safety net, including through targeted employment and training programmes supported by the EU and a programme to provide access to primary health care for the uninsured.

The IMF conducts regular (usually annual) missions to member countries “under Article IV of the IMF's Articles of Agreement, in the context of a request to use IMF resources (borrow from the IMF), as part of discussions of staff monitored programs, and as part of other staff reviews of economic developments.” Today, the IMF posted the concluding statement of the mission to Italy. Basically, progress is being made toward fixing the country’s economy, but more needs to be done at a faster pace:

The euro zone crisis hit Italy hard, but the seeds of Italy’s low growth pre-date the crisis and follow from its stagnant productivity, difficult business environment, and over-leveraged public sector. Accelerating reforms to address these structural weaknesses will be crucial to limit the risks of long-term unemployment, especially for the youth, and raise Italy’s trend growth.

The IMF mission concluded that Italy must boost business competition by lowering barriers to entry and reducing regulations. The high cost of electricity (up to 40% greater than in France and Germany) has also been a drag on Italy’s competitiveness. The justice system is woefully inefficient with a significant backlog of cases, which increases the cost of doing business. There are too many small firms. As for fiscal policy, the IMF wants to see stepped-up efforts to combat tax evasion, “including through better use of anti-money laundering tools, and increasing the inheritance tax would also raise revenue and more fairly distribute the tax burden.” Italy’s banking system is in woeful shape as the “ratio of nonperforming loans has almost tripled since 2007, while provisioning coverage has declined.” The mission statement recommends that Italian banks sell, dispose, or write down impaired loans. The ECB and the EU could help as follows:

Direct asset purchases by the ECB, such as for SME credits, another LTRO of considerable tenor, and lower haircuts on eligible collateral would help lower bank funding costs and lending rates. Greater progress in the banking union, especially the single resolution mechanism and ESM backstop, would help sever the sovereign banking link. Moves to strengthen the common market, such as the Services Directive, would enhance the cross-border benefits of reforms. Progress in European policies combined with vigorous reforms in Italy would go far in producing a more vibrant and dynamic currency union.