Federal Reserve officials are prepared to begin reversing the central bank's major crisis-era stimulus measures next month, notes from their July meeting published Wednesday suggest.
At the July 25-26 meeting, several Fed members were prepared to begin shrinking the central bank's balance sheet, the new minutes from the meeting revealed. Most preferred to defer the decision until a later meeting.
While the group was mostly on the same page regarding the Fed's bond holdings, it was split on the timing of future interest rate hikes.
Robust job growth this year has emboldened Chairwoman Janet Yellen and others at the Fed to begin shrinking the large balance sheet they built up through successive rounds of bond purchases, commonly referred to as quantitative easing.
The Fed has just under $4.5 trillion in bonds, mostly Treasury and mortgage-backed securities guaranteed by Fannie Mae and Freddie Mac. Before the crisis, the central bank had just less than $900 billion in assets, but it went on several bond-buying spreesto increase the amount of money in private hands and boost economy-wide spending.
In theory, shrinking the balance sheet would have the opposite effect and would slow spending. From the Fed's perspective, such an anti-stimulus would be desirable because the greater danger to the economy now is too-high inflation, rather than high unemployment. With the nation's unemployment rate at 4.3 percent, officials believe that wages and prices must rise soon, forcing the Fed to tighten monetary policy to stave off higher inflation.
At the same time, though, the Fed is moving tentatively. Yellen and company have said that they will start by shrinking the balance sheet by just $10 billion a month, eventually ramping up to $50 billion. And they don't plan to sell bonds, but rather allow existing bonds to mature without reinvesting the proceeds in new securities.
Several Fed members have played down the impact of slowly shrinking the balance sheet. As a group, they had not spelled out before Wednesday just how much they might reduce the central bank's holdings. Federal Reserve Bank of New York President William Dudley suggested in an interview with the Associated Press this week that he might favor a balance sheet of $2.5 trillion to $3.5 trillion.
The bigger issue, in the eyes of Fed members, is what the central bank does with its short-term interest rate target. Currently set at 1 percent to 1.25 percent, the target influences rates on financial products throughout the economy, such as business loans, mortgages and credit cards. Higher rates should translate to lower spending and inflation.
Before Wednesday's meeting, investors saw a roughly fifty-fifty chance that the Fed might raise rates again this year.
Some members of the Fed, however, questioned the premise that falling unemployment will inevitable yield higher inflation. A few suggested that the relationship between unemployment and inflation, known to economists as the Phillips Curve, "was not particularly useful in forecasting inflation."
Yet "most" participants still believe in the Phillips Curve, the minutes revealed. In their assessment of the economy today, inflation is only running below the Fed's 2 percent target because of one-time factors, such as the steep drop in the price of cell phone service thanks to competition among carriers to offer unlimited data plans. In time, they think, inflation is bound to rise.
The Fed is "having a tough time rationalizing the tension between low unemployment and inflation, hoping that it will be resolved sometime beyond the 'near-term,'" remarked Mark Hamrick, the senior economic analyst for Bankrate.com.
At July's meeting, Fed members also discussed the new post-crisis banking rules, and the efforts by the Trump administration and the congressional GOP to roll some of them back. They unanimously agreed that the new regulations on banks have made the financial system safer, and "that it would not be desirable for the current regulatory framework to be changed in ways that allowed a reemergence of the types of risky practices that contributed to the crisis."