UNDERSTANDING THE FEDERAL RESERVE STATEMENTS


today, the federal reserve open market committee met to discuss the state of the economy and to decide if they needed to adjust their stance with regards to monetary policy. interest rates are the key to the whole thing yet what they say, in their all important statement, is much more important than what they do. in fact, the interpretation of what they say or do is even more important than what they actually say or do. FED 101 would be a great course on college campuses. i'm not sure if it would be a business course or an english course, but nontheless a great pre-requisite for anyone who needs to understand the economy or the english language.

with that as the intro to this blog, i'll do my best to decipher exactly what they said and did.

the easy part is that they did not change the FED funds rate of interest charged to banks for overnight lending. easy enough to understand and no interpretation necessary. except for the fact that the FED funds rate is at 45 year lows and has been steadily lowered over the past few years in order to 'prop' up the economy and prevent a deeper economic slowdown or crisis. please note that as many as two of the rate reductions were self proclaimed 'emergency' inter-meeting moves &/or 'insurance' moves to make sure that the economy wouldn't fall back into recession. thus, by leaving rates unchanged, they must feel that the economy continues to need its current accomodative policy stance in order to sustain its recent activity level.

interpretations would vary but its clear that the FED felt that the interest rates needed to be held at the current low level in order to allow the recovery to proceed. other interpretations might be that the FED is continuing to see uncertainties and has concerns about the recovery, so they need to keep money easy. a final interpretation could be that they still don't feel that the economy could handle higher rates and would jeopardize the recovery if rates got rose to normalized levels.

then theres the verbatim statement issued by the FED. this is where it gets complicated. what i will try to do is unravel each sentence in order to break it down into bits of information that a non-fed pro can understand.

it starts with one sentence stating that the FOMC decided to keep its target for the federal funds rate at 1%. simple enough.

the next paragraph states that the committee believes that their "accomodative stance and still robust underlying growth in productivity, is providing important ongoing support to economic activity". it continues by stating that "the evidence accumulated over the intermeeting period shows that spending is firming". that sentence is modified by an evaluation of the labor market, stating that "labor market indicators are mixed". i'm not sure why they modify the spending evaluation with the labor issues, but its probably got something to do with the fact that if people don't have jobs, they spend less. the paragraph ends with the FED pointing out that "business pricing power and increases in core consumer prices remain muted". not knowing exactly what a muted price is i looked up what muted means. encarta had the following definition...understated: subdued and understated rather than forceful or enthusiastic. my take is that businesses cannot raise prices due to fierce competition, which normally is not a good thing.

ready for the 2nd paragraph? "the committe perceives that the upside and downside risks to the attainment of sustainable growth for the next few quarters are roughly equal". interpretation...no call, it could go either way, we just don't know. so these geniuses, with much more information than the other geniuses out there, just don't know if the economy is recovering or not. thats what they said. not me, them!

they continue by stating that "in contrast, the probability, though minor, of an unwelcome fall in inflation exceeds that of a rise in inflation from its already low level". wow. thats some sentence. lets analyze together. 1st paragraph they state that the upside and downside risks to sustainable growth are roughly equal". then they state that in contrast, there is a minor probability for an unwelcome fall in inflation. aside from the fact that it seems like a double negative of sorts, how can there be a fall in an indicator that measures something that goes up? not to get bogged down in semantics, the whole sentence is uninterpretable. but please be advised that they state very clearly, as unusual as it may be, that inflation is already at a low level. and by the way, thats something that the FED has strived to achieve for many years! now they are worried that its a bad thing!!!! are they serious?

the last part of the paragraph states that "the committee judges that, on balance, the risk of inflation becoming undesirably low is likely to be the predominant concern for the forseeable future. in these circumstances, the committee believes that policy accommodation can be maintained for a considerablew period". enough said. they won't raise rates till they can be sure that inflation isn't too "muted" and that the recovery has taken hold...firmly. feel better now?

i know that seems like alot, and i'm sure that is exactly what their intention is, but it does little to explain what is really going on in the most vibrant and resiliant economy in the world. which by the way, is vital to the world economic recovery that is forecast for the second half of this year. by the way, the FED statement is subject to your own interpretation.

have a great day!

larry