By Steven K. Beckner

(MNI) – Federal Reserve policymakers wanted to take a “flexible”
approach in their latest effort to stimulate the economy through
large-scale asset purchases (“quantitative easing”), minutes of the
Sept. 12-13 Federal Open Market Committee, released Thursday, show.

Although the FOMC launched an open-ended $40 billion-per-month
program of mortgage backed securities purchases, the minutes say members
wanted to be able to “tailor” the amount and type of asset purchases to
the needs of the economy.

While some FOMC participants warned about the costs of continuing
to increase bank reserves and swell the Fed’s balance sheet, the minutes
say the majority concluded that any costs or risks “could be managed”
because asset purchases can be adjusted “as needed.”

There was concern about further delaying the anticipated date of
eventual hikes in the federal funds rate from near zero, with some
warning it might send a counterproductive, “pessimistic” signal. But the
FOMC majority believed the Fed could improve public psychology and help
the economy by extending the date, while also declaring that the Fed
would keep rates low even after the recovery strengthened.

The minutes also reflect growing dissatisfaction with using a
calendar date to communicate how long the Fed expects to keep rates near
zero and a growing acceptance of the notion that the Fed should
substitute some kind of economic thresholds, perhaps numerical ones.

It was agreed, however, that more work would be needed to agree on
thresholds.

To lower long-term interest rates, the FOMC announced on Sept. 13
that the Fed would buy $40 billion per month of MBS, financed by the
creation of new bank reserves, until the labor market improves
“substantially.” This was to be on top of the $45 billion per month of
longer term Treasury bonds being bought through the Maturity Extension
Program (“Operation Twist”), financed by sales of shorter term
Treasuries.

The FOMC also extended its “forward guidance” on the path of the
federal funds rate, delaying the anticipated date of initial hikes from
the zero to 25 basis point target range until at least “mid-2015,”
instead of the previously announced “late 2014.” The FOMC said it
“expects that a highly accommodative stance of monetary policy will
remain appropriate for a considerable time after the economic recovery
strengthens.”

The FOMC discussed whether or not to buy MBS or Treasuries, but the
minutes suggest an overwhelming majority favored the former “because
they would more directly support the housing sector, which remains weak
but has shown some signs of improvement of late.”

The minutes say “one participant” — presumably dissenting Richmond
Federal Reserve Bank President Jeffrey Lacker — “objected that
purchases of MBS, when compared to purchases of longer-term Treasury
securities, would likely result in higher interest rates for many
borrowers in other sectors.”

In addition to Lacker, there were others who “highlighted the
uncertainty about the overall effects of additional purchases on
financial markets and the real economy.”

“Some participants thought past purchases were useful because they
were conducted during periods of market stress or heightened deflation
risk and were less confident of the efficacy of additional purchases
under present circumstances,” the minutes say.

In addition to questioning the efficacy of QE3, Lacker and other
opponents warned of potential inflationary consequences and said it
“could lead to excessive risktaking on the part of some investors and so
undermine financial stability over time.” They also cited “the possible
adverse effects of large purchases on market functioning.”

But “most participants thought these risks could be managed since
the Committee could make adjustments to its purchases, as needed, in
response to economic developments or to changes in its assessment of
their efficacy and costs.”

Indeed, adjustability was seen as a central virtue of making the
third round of quantitative easing open-ended, instead of pre-announcing
a set amount of asset purchases of a certain type over a pre-determined
timeframe.

Referencing the FOMC’s announcement that it would continue to buy
MBS and “employ its other policy tools as appropriate” until there is
“substantial” labor market improvement, the minutes say “this flexible
approach was seen as allowing the Committee to tailor its policy
response over time to incoming information while incorporating
conditional features that clarified the Committee’s intention to improve
labor market conditions, thereby enhancing the effectiveness of the
action by helping to bolster business and consumer confidence.”

QE3 proponents got an assist from a Federal Reserve Board staff
report, which compared “flow-based purchase programs” to programs of
fixed size.

Contrary to minority contentions that the costs of additional asset
purchases were likely to exceed the benefits, the staff report projected
otherwise.

In estimating the financial and macroeconomic effects of asset
purchases, the staff acknowledged that “significant uncertainty
surrounds such estimates,” but contended that “asset purchases could be
effective in fostering more rapid progress toward the Committee’s
objectives.”

“The staff noted that, for a flow-based program, the public’s
understanding of the conditions under which the Committee would end
purchases would shape expectations of the magnitude of the Federal
Reserve’s holdings of longer-term securities, and thus also influence
the financial and economic effects of such a program,” the minutes say.

The staff also maintained that “significant additional asset
purchases should not adversely affect the ability of the Committee to
tighten the stance of policy when doing so becomes appropriate.”

Communication about the level of short-term interest rates was the
other aspect of the Fed’s latest monetary stimulus effort, and the
minutes disclose that there was a far-ranging discussion of how best to
do that.

Two weeks ahead of the FOMC meeting, at the Kansas City Fed’s
annual Jackson Hole symposium, prominent world renowned monetary
economist Michael Woodford of Columbia University warned that
continually announcing later dates for rate hikes the Fed might be
sending exactly the wrong signal — that the economy is in for even more
problems than previously thought. He said this might well lead people to
increase savings, rather than increase spending as the Fed wants.

That critique was rejected by most FOMC participants. But the
minutes take pains to emphasize that the Fed does not necessarily expect
a longer period of economic weakness — as did Fed Chairman Ben Bernanke
in a speech this past Monday.

“That new (forward guidance) language was meant to clarify that the
maintenance of a very low federal funds rate over that period did not
reflect an expectation that the economy would remain weak, but rather
reflected the Committee’s intention to support a stronger economic
recovery,” the minutes say.

The consensus was that “clear communication and credibility allow
the central bank to help shape the public’s expectations about policy,
which is crucial to managing monetary policy when the federal funds rate
is at its effective lower bound.”

But the minutes say “a number of participants questioned the
effectiveness of continuing to use a calendar date to provide forward
guidance, noting that a change in the calendar date might be interpreted
pessimistically as a downgrade of the Committee’s economic outlook
rather than as conveying the Committee’s determination to support the
economic recovery.”

“If the public interpreted the statement pessimistically, consumer
and business confidence could fall rather than rise,” the committee was
warned.

-more- (1 of 2)

** MNI **

[TOPICS: M$U$$$,MMUFE$,MGU$$$,MFU$$$,M$$BR$]