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Federal Reserve is torn on tipping point for action

Federal Reserve officials agreed at a meeting in June that unemployment would remain elevated for another five to six years, but most did not regard that as reason enough to expand the Fed?s efforts to stimulate growth, according to an official account published on Wednesday.

Federal Reserve officials agreed at a meeting in June that unemployment would remain elevated for another five to six years, but most did not regard that as reason enough to expand the Fed?s efforts to stimulate growth, according to an official account published on Wednesday.

The American economy is stuck in a new kind of normal, somewhere between crisis and prosperity, and economic policymakers are struggling to define their role. The Fed, which has responded forcefully each time the economy tips back toward recession, remains divided over whether it should try with similar urgency to return the economy to prosperity.

The account of the June meeting suggested that Fed officials now viewed the risk of standing still, so clear in a crisis, as smaller and harder to measure, while the uncertain consequences of action are weighing heavily on their willingness to expand the central bank?s aid campaign. ?A few? of the 12 officials who vote on Fed policy thought further measures, like bond purchases, ?likely would be necessary to promote satisfactory growth,? the account said. But several others were willing to consider such steps only if economic conditions deteriorated. This was more than the Fed said after its last meeting in April, but less than many investors were hoping to hear.

The Fed expected slow growth this year, but the account ? released after a standard three-week lag ? said officials were still disappointed that ?a variety of indicators showed smaller gains than had been anticipated? in recent months.

Among the drags on the economy cited in the document were ?slow growth or even contraction in some major foreign economies, ongoing and prospective fiscal tightening in the United States, modest growth in household income, and ? despite some recent signs of improvement ? continued weakness in the housing sector.? The Fed announced after the meeting on June 19-20 that it would continue until year?s end with an effort to reduce borrowing costs for businesses and consumers by rearranging its portfolio. The expected impact is modest, however. The account said it would put ?some downward pressure on longer-term interest rates and help make broader financial conditions more accommodative.?

The document, a summary rather than a transcript, offered little clarity about the Fed?s next steps, a point underscored by the diversity of conclusions that analysts who follow the central bank quickly drew from the text. Some saw clear evidence that action was imminent; others drew the opposite lesson.

Paul Ashworth, chief United States economist at Capital Economics, was among the analysts who chose a position in the middle, writing to clients that ?officials are edging closer to launching a third round of large-scale asset purchases, but it won?t become a reality unless the recovery loses even more momentum.?

The Fed began the year on the sidelines, its officials united in the view that they had done enough. The central bank has already said that it plans to hold short-term interest rates near zero until late 2014, at least. It has amassed a vast portfolio of Treasury securities and mortgage bonds to further reduce long-term rates.

But growth has once again fallen short of the Fed?s expectations, and the lack of public clarity is a consequence of the internal debate among the 19 officials who participate in the discussions of the Federal Open Market Committee.

The case for additional action is easy to explain. The economy is not growing fast enough to reduce unemployment, a point underscored last week by a government report that employers added only 80,000 jobs in June. Moreover, inflation has fallen below the 2 percent pace the Fed regards as healthy. ?We are falling short on both our employment and price stability mandates and I expect that we will make only very limited progress toward these goals over the next year,? John C Williams, president of the San Francisco Fed, said Monday. Williams, who favored asset purchases last year before backing off earlier this year, said that it was again time to consider additional action, and that any new round of purchases should include mortgage securities.

But proponents of additional action have not yet won the support of the Fed?s chairman, Ben S Bernanke, who controls the decision-making process. Bernanke has not offered a clear account of his hesitations, beyond the premise that additional action should not be taken lightly. He may clarify his views when he testifies before the Senate and House next week.

The account released Wednesday did offer some explanations, however, for the Fed officials? reluctance to take additional action. Some officials see evidence that unemployment cannot quickly return to normal levels because many people looking for jobs lack the skills sought by companies looking for workers. And they are concerned that policies aimed at reducing unemployment would instead accelerate the pace of inflation.

There is also skepticism about the power of additional asset purchases to improve economic conditions. While previous rounds of purchases have clearly lowered interest rates, tight credit standards have prevented many borrowers from taking advantage.

And the account said some officials sought information about how far the Fed could expand its purchases without soaking up so much of the supply of Treasuries or mortgage bonds that shortages might cause ?a meaningful deterioration in securities market functioning.?

A result of these concerns, according to the account, is that the Fed is searching for other ways to foster growth. ?Several participants,? it said, ?commented that it would be desirable to explore the possibility of developing new tools to promote more accommodative financial conditions and thereby support a stronger economic recovery.?

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First published on: 13-07-2012 at 20:54 IST
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