Focus on Economic Data: The Federal Reserve and Monetary Policy, April 28, 2010
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The Federal Open Market Committee (FOMC) of the Federal Reserve System (Fed) meets approximately every six weeks to determine the nation's monetary policy goals and, specifically, to set the target for the federal funds rate (fed funds rate). The fed funds rate is the interest rate at which banks lend their balances at the Federal Reserve to other banks, usually overnight.
The FOMC has maintained the target federal funds rate at a range of 0 to 1/4 percent since its December 16, 2008 meeting. The fed funds rate has been kept at this historically low level due to over a year of low and often negative real GDP growth, significant numbers of non-farm employment losses and very high unemployment.
This lesson focuses on the April 28, 2010, press release by the Federal Open Market Committee on the current Federal Reserve monetary policy actions and goals.
- Explain the meaning of the April 28, 2010, Federal Open Market Committee decision concerning the target for the federal funds rate.
- Identify the current monetary policy goals of the Federal Reserve and the factors that have recently influenced monetary policy goals.
- Explain the structure and functions of the Federal Reserve System, Federal Reserve Banks, and the Federal Open Market Committee.
- Identify the monetary policy options and other tools available to the Federal Reserve to stimulate or contract the economy.
- Demonstrate how successive deposits and loans by depository institutions cause the money supply to expand.
- Calculate the simple money multiplier when a required reserve ratio is provided.
- Explain that money is created when banks make loans and destroyed when loans are repaid.
Federal Open Market Committee “Monetary Policy” Statement
Released: April 28, 2010
The FOMC policy statement began with a quick summary of recent economic conditions, "Information received since the Federal Open Market Committee met in March suggests that..."
- "Economic activity has continued to strengthen and that the labor market is beginning to improve."
- "Growth in household spending has picked up recently but remains constrained by high unemployment, modest income growth, lower housing wealth, and tight credit."
- "Business spending on equipment and software has risen significantly; however, investment in nonresidential structures is declining and employers remain reluctant to add to payrolls."
- "Housing starts have edged up but remain at a depressed level."
- "While bank lending continues to contract, financial market conditions remain supportive of economic growth."
- "Although the pace of economic recovery is likely to be moderate for a time, the Committee anticipates a gradual return to higher levels of resource utilization in a context of price stability."
This statement is a great example of a "good news" and "bad news" assessment. The bottom line - conditions are getting better, but still not very good.
The FOMC then reaffirmed its assessment of the prospects for inflation. "With substantial resource slack continuing to restrain cost pressures and longer-term inflation expectations stable, inflation is likely to be subdued for some time." This is essentially the same statement about inflation as for the past year.
The FOMC Policy Decision
"The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels of the federal funds rate for an extended period. The Committee will continue to monitor the economic outlook and financial developments and will employ its policy tools as necessary to promote economic recovery and price stability."
Again, the FOMC opted for no change in the target federal funds rate, essentially repeating the March policy statement. 'The fed funds rate can't be used effectively to help the member banks, who borrow reserves at the fed funds rate from other member banks. With the target so low, monetary policy, especially open market operations, is not an effective stimulatory tool.
The FOMC also indicated that the extraordinary series of special programs designed to prop up the banking system and provide greater liquidity in financial markets was no longer necessary. "In light of improved functioning of financial markets, the Federal Reserve has closed all but one of the special liquidity facilities that it created to support markets during the crisis. The only remaining such program, the Term Asset-Backed Securities Loan Facility, is scheduled to close on June 30 for loans backed by new-issue commercial mortgage-backed securities; it closed on March 31 for loans backed by all other types of collateral."
Also repeating the pattern from the March policy statement, the vote on the statement had one dissenter. "Voting against the policy action was Thomas M. Hoenig (president of the Federal Reserve Bank of Kansas City), who believed that continuing to express the expectation of exceptionally low levels of the federal funds rate for an extended period was no longer warranted because it could lead to a build-up of future imbalances and increase risks to longer run macroeconomic and financial stability, while limiting the Committee’s flexibility to begin raising rates modestly." Mr. Hoenig's dissent was in support of a less strong statement that would give the committee more flexibility in the future.
Take a look at the past few monetary policy statements to see the consistency of reasoning throughout the recession. The statement that "subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels of the federal funds rate for an extended period" has been very consistent in recent statements. See the 2010 Monetary Policy Releases .
Monetary Policy and Macroeconomic Data
How consistent have the FOMC’s assessments of the health of the economy been when compared to macroeconomic data? Take a look at the two charts of the unemployment rates and rates of real GDP growth
Figure 1, below, shows the target range for the federal funds rate from 1990 to the present. The target range has not changed since it was set at 0 – ¼ percent on December 18, 2008.
These are the highlights of the Federal Open Market Committee Monetary Policy statements for the last 18 months – since the onset of the current recession. The FOMC now typically begins a statement with a “big picture” statement about the health and direction of economic activity. Note the language beginning in October 2008 recognizing that the economy had “slowed markedly.”
October 29, 2008: “The pace of economic activity appears to have slowed markedly, owing importantly to a decline in consumer expenditures.”
[NOTE: The NBER declared that the current recession began December 1, 2008.]
- December 16, 2008: “labor market conditions have deteriorated, and the available data indicate that consumer spending, business investment, and industrial production have declined.”
- January 28, 2009: “the economy has weakened further.”
- March 18, 2009: “the economy continues to contract”
- April 29, 2009: “the economy has continued to contract, though the pace of contraction appears to be somewhat slower.”
- June 24, 2009: “the pace of economic contraction is slowing”
- August 12, 2009 “economic activity is leveling out”
- September 23, 2009: “economic activity has picked up following its severe downturn”
- November 4, 2009: “economic activity has continued to pick up”
- December 16, 2009: “economic activity has continued to pick up and that the deterioration in the labor market is abating.”
- January 27, 2010: “economic activity has continued to strengthen and that the deterioration in the labor market is abating.”
- March 16, 2010: “economic activity has continued to strengthen and that the labor market is stabilizing.”
- April 28, 2010: “economic activity has continued to strengthen and that the labor market is beginning to improve.”
After the beginning of the recession (remember the beginning of the recession was not declared until December 2009), the Fed’s tone about slowing became more intense, using the term “deteriorated.”
When was the first good news? In August, 2009, the Fed characterized activity in the economy as “leveling out.” Later in the year, it “picked up” and “strengthened.”
Did the recession actually end in August 2009? Labor markets (the unemployment rate and job creation) were “deteriorating,” but at a “slower rate” by the end of 2009, “stabilized” in March 2010, and “beginning to improve” in April 2010.
Is the recession over? That’s not the Fed’s decision, but maybe a combination of the employment data and what some call “Fed speak” gives us a clue.
Figure 2, below, shows the U.S. monthly unemployment rates from 1990 through March 2010. Compare the dates in the FOMC statements to the level of the unemployment rate. Do you see any correlation?
Figure 3, below, shows the quarterly U.S. real GDP growth rates from 1990 through 2009, Note the reversal from real GDP declines to growth beginning in mid-2009, somewhat consistent with the FOMC’s view of leveling off in August 2009.
On April 12, 2010, the National Bureau of Economic Research (NBER) issued an unusual “mid-recession” statement in response to those who have argued that the recession is over and that the NBER declare that the business cycle has hit the trough and that expansion has begun. A New York Times article about the NBER statement pointed out that, ”gross domestic product, the broadest measure of economic activity, officially began rising in the second half of 2009, suggesting that a recovery might have quietly started. But the committee takes other factors into consideration, like employment trends and consumer confidence.” The NBER seems to want more conclusive evidence of growth and, possibly, to avoid an early declaration of a trough in the case of a “double dip” recession. (Sewell Chan and Louise Story, “Recession Arbiters, Wary of Certifying an Upturn,” New York Times, April 11, 2010.)
NBER COMMITTEE CONFERS: NO TROUGH ANNOUNCED
CAMBRIDGE, April 12 -- The Business Cycle Dating Committee of the National Bureau of Economic Research met at the organization’s headquarters in Cambridge, Massachusetts, on April 8, 2010. The committee reviewed the most recent data for all indicators relevant to the determination of a possible date of the trough in economic activity marking the end of the recession that began in December 2007. The trough date would identify the end of contraction and the beginning of expansion.
Although most indicators have turned up, the committee decided that the determination of the trough date on the basis of current data would be premature. Many indicators are quite preliminary at this time and will be revised in coming months. The committee acts only on the basis of actual indicators and does not rely on forecasts in making its determination of the dates of peaks and troughs in economic activity. The committee did review data relating to the date of the peak, previously determined to have occurred in December 2007, marking the onset of the recent recession. The committee reaffirmed that peak date.
The NBER, in its declaration of the current recession, summarized the general criteria used to identify the peak and decline. “Because a recession is a broad contraction of the economy, not confined to one sector, the committee emphasizes economy-wide measures of economic activity. The committee believes that domestic production and employment are the primary conceptual measures of economic activity. The committee views the payroll employment measure, which is based on a large survey of employers, as the most reliable comprehensive estimate of employment. This series reached a peak in December 2007 and has declined every month since then.” Note: The decline in employment during the recession, as reported by the Bureau of Labor Statistics, has reversed to small increases over the past two months, but the employment figures are still subject to revision.
The Rest of the Fed Story
Since interest rates have been extraordinarily low and reducing the federal funds rate has not really been possible for over a year, how has the Fed reacted to the recession? The Fed designed a series of special programs to provide liquidity and stabilize the financial markets. The Fed web page explains these programs.
Link: Credit and Liquidity Programs and the Balance Sheet (February 5, 2010).
“The Federal Reserve responded aggressively to the financial crisis that emerged in the summer of 2007. The reduction in the target federal funds rate from 5-1/4 percent to effectively zero was an extraordinarily rapid easing in the stance of monetary policy. In addition, the Federal Reserve implemented a number of programs designed to support the liquidity of financial institutions and foster improved conditions in financial markets. These new programs led to significant changes to the Federal Reserve's balance sheet.”
“In light of improved functioning of financial markets, many of the new programs have expired or been closed. These include the Money Market Investor Funding Facility (MMIFF), the Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility (AMLF), the Commercial Paper Funding Facility (CPFF), the Primary Dealer Credit Facility (PDCF), the Term Securities Lending Facility (TSLF), and the temporary liquidity swap arrangements between the Federal Reserve and other central banks.”
The Fed’s New Tools
“The tools described in this section can be divided into three groups. The first set of tools, which are closely tied to the central bank's traditional role as the lender of last resort, involve the provision of short-term liquidity to banks and other depository institutions and other financial institutions. The traditional discount window, Term Auction Facility, PDCF, and TSLF fall into this category. Because bank funding markets are global in scope, the Federal Reserve also approved bilateral currency swap agreements with 14 foreign central banks. These swap arrangements assisted these central banks in their provision of dollar liquidity to banks in their jurisdictions.”
“A second set of tools involve the provision of liquidity directly to borrowers and investors in key credit markets. The CPFF, AMLF, MMIFF, and the Term Asset-Backed Securities Loan Facility (TALF) fall into this category. All of the programs are described in detail elsewhere on this website.”
“As a third set of instruments, the Federal Reserve has expanded its traditional tool of open market operations to support the functioning of credit markets through the purchase of longer-term securities for the Federal Reserve's portfolio. For example, in November 2008, the Federal Reserve announced plans to purchase up to $100 billion in government-sponsored enterprise (GSE) debt and up to $500 billion in mortgage-backed securities. In March 2009, the Federal Reserve announced plans to purchase up to $300 billion of longer-term Treasury securities in addition to increasing its total purchases of GSE debt and mortgage-backed securities to up to $200 billion and $1.25 trillion, respectively.”
In August 2009, when the FOMC’s view was that the economy was “leveling out,” the FOMC announced that, to “promote a smooth transition in markets, it would gradually slow the pace of its purchases of Treasury securities. In September 2009, the FOMC made a similar statement about its purchases of agency and agency mortgage-backed securities. The full amount of announced Treasury security purchases were completed in October 2009. In November 2009, the Federal Reserve announced that the total purchases for agency debt would be $175 billion, somewhat less than previously announced, reflecting the limited availability of agency debt.”
“As the performance of financial markets has improved, the Federal Reserve has wound down some of the programs. The MMIFF expired October 30, 2009. The AMLF, CPFF, PDCF, and TSLF were closed on February 1, 2010. Also on February 1, 2010, the bilateral currency swap agreements with other central banks expired. The Federal Reserve Board has authorized extensions of credit through the TALF until June 30, 2010, for loans collateralized by newly issued CMBS and through March 31, 2010, for loans collateralized by all other TALF-eligible securities.”
See these Federal Reserve web pages for details about the stimulus and stabilization programs.
- Term Auction Facility (TAF)
- Primary Dealer Credit Facility (PCDF)
- Term Securities Lending Facility (TSLF)
- Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility (ABCP MMMF)
- Commercial Paper Funding Facility (CPFF)
- Money Market Investor Funding Facility (MMIFF)
- Term Asset-Backed Securities Loan Facility (TALF)
These new tools were a new direction for the Fed – given little opportunity to use lower interest rates to stimulate the economy. On April 14, 2010 in his “Economics Outlook” testimony before the Joint Economic Committee of the U.S. Congress, Fed Chairman Ben S. Bernanke assessed the Fed’s recent performance.
The Economic Outlook
Bernanke said, “Supported by stimulative monetary and fiscal policies and the concerted efforts of policymakers to stabilize the financial system, a recovery in economic activity appears to have begun in the second half of last year. An important impetus to the expansion was firms' success in working down the excess inventories that had built up during the contraction, which left companies more willing to expand production. Indeed, the boost from the slower drawdown in inventories accounted for the majority of the sharp rise in real gross domestic product (GDP) in the fourth quarter of last year, during which real GDP increased at an annual rate of 5.6 percent. With inventories now much better aligned with final sales, however, and with the support from fiscal policy set to diminish in the coming year, further economic expansion will depend on continued growth in private final demand.”
“On balance, the incoming data suggest that growth in private final demand will be sufficient to promote a moderate economic recovery in coming quarters. Consumer spending continued to increase in the first two months of this year and has now risen at an annual rate of about 2-1/2 percent in real terms since the middle of 2009. In particular, after slowing in January and February, sales of new light motor vehicles bounced back in March as manufacturers offered a new round of incentives. Going forward, consumer spending should be aided by a gradual pickup in jobs and earnings, the recovery in household wealth from recent lows, and some improvement in credit availability.”
Financial Market Developments
The Fed Chairman added, “Financial markets have improved considerably since I last testified before this Committee in May of last year. Conditions in short-term credit markets have continued to normalize; spreads in bank funding markets and the commercial paper market have returned to near pre-crisis levels. In light of these improvements, the Federal Reserve has largely wound down the extraordinary liquidity programs that it created to support financial markets during the crisis. The only remaining program, apart from the discount window, is the Term Asset-Backed Securities Loan Facility for loans backed by new-issue commercial mortgage-backed securities, and that facility is scheduled to close at the end of June. Overall, the Federal Reserve's liquidity programs appear to have made a significant contribution to the stabilization of the financial system, and they did so at no cost to taxpayers and with no credit losses.”
On the Fed’s role as a banking regulator, Bernanke commented, “The Federal Reserve has been working to ensure that our bank supervision does not inadvertently impede sound lending and thus slow the recovery. Achieving the appropriate balance between necessary prudence and the need to continue making sound loans to creditworthy borrowers is in the interest of banks, borrowers, and the economy as a whole. Toward this end, in cooperation with the other banking regulators, we have issued policy statements to bankers and examiners emphasizing the importance of lending to creditworthy customers, working with troubled borrowers to restructure loans, managing commercial real estate exposures appropriately, and taking a careful but balanced approach to small business lending.”
How important has the Fed been in the recovery?
Banks, in general, are more stable and financial markets are “open for business,” but there still remains a lot of uncertainty and perceived risk in financial markets. Uncertainty more often results in inaction – waiting to see more clear signs that things will be better in the future.
What more can the Federal Reserve, Congress, the President, or other government agencies do to get the economy going?
The Fed has kept the fed funds rate target historically low, influencing other rates to remain low - mortgage rates, consumer loans, auto loans, etc. Interest rates are not the issue. Uncertainty about the future and, perhaps, caution not to make the same mistakes may be keeping banks from lending, businesses from hiring and, consumers from purchasing.
The Fed's current policy statement provides a few rays of hope - some good news about positive growth of output and employment. Still, the Fed's assessment is cautious, as is the NBER's, refusing to declare that the recession is over and cautioning that problems still exist. In recent days, totally unrelated events - a major oil spill in the Gulf of Mexico and investigations into the operations of a major investment firm, Goldman Sachs, have rattled stock markets and may have created more uncertainty.
Is the recession over?
Next, complete the essay question below on the interactive notepad.
- What is the purpose of the FOMC's target for the federal funds rate?
The Federal Reserve Bank of Philadelphia has published a new online activity called The Case of the Gigantic $100,000 Bill.” In this lesson, students participate in a demonstration of the money creation process using a large $100,000 bill. Expansions of the money supply caused by successive deposits and loans are traced on the board so that students can observe the process. Students learn to calculate the upper bound of the money creation process using the simple money multiplier.