Economic Update


Fed is balancing dual objectives deftly

July 30, 2014

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The Federal Open Market Committee (FOMC) on Wednesday continued, as expected, the tapering program. Asset purchases were reduced to $25 billion per month from $35 billion. President Charles Plosser of the Philadelphia Federal Reserve Bank dissented because, in his opinion, the intention to maintain the low interest-rate environment after the completion of the asset purchase program is inconsistent with the “considerable economic progress that has been made towards the Committee’s goals.”

Speaking about progress toward its dual goals of full employment and price stability, the Fed modified the policy statement to reflect recent developments. In June, the FOMC described the labor market as improved but still facing an “elevated” jobless rate. The Fed continues to see an improved labor market but one beset with “significant underutilization of labor resources,” which mostly refers to the large pool of part-time workers, a huge percentage of long-term unemployment and significantly modest wage gains.

These changes are consistent with Fed Chair Janet Yellen’s stance that the official unemployment rate overstates improvement in the labor market and that other labor market indicators are important to evaluate underlying conditions.

Today’s second quarter gross domestic product report showed an increase in the Fed’s preferred inflation gauges – the personal consumption expenditure price index rose 50 basis points to 1.6% and the core personal consumption expenditure price index, which excludes food and energy, advanced 20 basis points to 1.5%. Essentially, inflation measures are moving closer to the 2.0% target.

These firmer readings of inflation prompted a change in the FOMC’s view about inflation. The statement notes that “inflation has moved somewhat closer to the Committee’s long-run objective,” which replaces the depiction in June that “inflation has been running below the Committee’s long-run objective.” The likelihood of inflation running persistently below 2.0% is also seen to be “diminished somewhat.”

Taken together, the Fed’s dovish view about employment conditions counterbalances its hawkish opinion about inflation.

The Fed also noted that economic activity “rebounded,” household spending rose, business spending advanced, fiscal policy is a drag and the housing sector remains sluggish. It left unchanged the forward guidance language that the Committee will continue to maintain the current range for the federal funds rate unchanged for a considerable period of time after the asset program ends.

The minutes of this meeting, scheduled for publication in three weeks, and upcoming remarks from Fed officials should offer more color on where the Fed stands with respect to inflation, slack in the labor market, wage growth, and how it views the convergence toward the dual mandate of price stability and full employment.

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