My first take on the Fed minutes is that they are pretty dovish – maybe not quite as dovish as Don Kohn’s speech yesterday, but not far off. I do not see much concern about inflation here. The staff have core inflation falling from its current rate – which is below the Fed’s de facto target – over the next two years, with headline converging with core in 2011. And it looks as if the staff upgraded their growth forecasts more than the policymakers did. The mainstream view among policymakers is that the risks to inflation are “roughly balanced.”
Meanwhile both the staff and the policymakers see a very protracted period of high unemployment. The staff has unemployment at 8 per cent at the end of 2011 – way above even a pessimist’s view of where NAIRU is these days. Given this forecast, assuming inflation expectations remain stable, I cannot see why the Fed would raise rates in the first half of 2010. Indeed, there must be a significant chance that it does not tighten at all next year.
The caveat is of course to do with inflation expectations. Fed hawks and doves alike agreed to monitor expectations carefully. There is some hard-to-measure risk that the Fed’s bloated balance sheet will fuel inflationary concerns as the recovery gets underway. A handful of Fed hawks would like to act preemptively to lock down inflation expectations by raising interest rates before this happens.
But this is not the mainstream view on the committee. Rather, most policymakers want to target balance-sheet related concerns directly by talking about how they have both the means and the will to tighten policy when they need to. If this strategy works, it would substitute for early rate increases and allow the Fed to remain on hold for a long time.