A BALANCING ACT: THE FOMC’S DECISION TO REDUCE THE TARGET FEDERAL FUNDS RATE

Last week, the Federal Open Market Committee (FOMC) announced a decrease in the federal funds rate target.  What reasoning may have led to that decision?

Many of the recent economic data releases have been good.  For example, my understanding is that data for overall U.S. retail sales from August 2019 exceeded forecasts.  Further, U.S. U3 unemployment rates calculated by the U.S. Bureau of Labor Statistics are either at or near fifty-year lows.  Moreover, the U.S. Treasury yield curve calculated from the two-year rate and the ten-year rate has “de-inverted” based on data from CNBC, possibly signaling forecasts of stronger economic growth.

However, I seem to recall hearing that August 2019 retail sales in the U.S. excluding automobile sales were essentially unchanged and that the announcement for total retail sales cited strong growth in automobile sales and online sales.  Does this imply that U.S. retail sales for August 2019 excluding automobile sales and online sales actually decreased?  A chart near the top of the release from the Census Bureau available at the web address below (at least as of 9/28/19) shows that a category labeled “Gen Mer,” probably meaning general merchandise, had decreases in sales in two of the three most recent months, June and August of 2019.

https://www.census.gov/retail/marts/www/marts_current.pdf

I also seem to recall reading that in a recent month, the number of new job openings decreased compared with the previous month.  More information about July job openings from the U.S. Bureau of Labor Statistics can be found at the following web addresses (at least as of 9/28/19):  https://www.bls.gov/news.release/jolts.nr0.htm

and https://www.bls.gov/news.release/jolts.a.htm.

Additionally, as the reader may have inferred from above, the U.S. Treasury yield curve calculated from the two-year interest rate and the ten-year interest rate was inverted recently, if possibly only temporarily.  Further, the two-to-five-year U.S. Treasury yield curve has been inverted most of the time for more than nine months.  Moreover, based on data from economagic.com, after increasing every quarter for a year, the velocity of the M1 money supply in the U.S. has decreased for two nonconsecutive quarters recently, including a decrease in the second quarter of 2019.

Some questions may remain.  Did problems in the repurchase market (repo market) as discussed on CNBC and elsewhere play a role in the FOMC decision, and if so, to what extent did those problems influence the decision?  Did the FOMC react at least in part to the perception of weak economic conditions in other countries?  Is the FOMC trying to "de-invert" the portions of the U.S. Treasury yield curve that are still inverted and to prevent the re-inversion of the U.S. Treasury two-to-ten year yield curve to stave off a recession?

Some may question the decision to reduce the target federal funds rate due to perceived inflation pressures.  In textbook-type analysis, monetary policies that are likely to increase employment would also likely create pressure for inflation to rise.  Critics of the recent FOMC decision to lower rates may worry about the credibility of the Federal Reserve in its commitment to control inflation if it reduces interest rates when domestic unemployment rates are either at or near fifty-year lows.  Supporters of the decision may point to any of the recent data releases that seem disappointing to justify the rate reduction.

According to Burton and Lombra’s (2006, fourth edition, pp. 589-590) The Financial System and the Economy:  Principles of Money and Banking and perhaps many other sources, both 1978’s Humphrey-Hawkins Full Employment and Balanced Growth Act and the earlier Employment Act from 1946 charge monetary policy in the United States with implementing policy to reach full employment in a way that will not spark inflation.  Does the job creation component of this legislation implicitly mean that the FOMC must attempt to stimulate growth in real GDP when economic growth rates fail to reach goals or targets?  Among its responsibilities, the Federal Reserve helps to ensure that the payments system and the financial system operate smoothly according to Burton and Lombra (2006, fourth edition, pp. 69-72).  Do the reductions in the targets for the federal funds rate and the discount rate help to alleviate pressure for funds in the repo market, and thus help the financial system?

The FOMC may be trying an ‘in between’ approach in balancing its commitments to job creation and inflation control, with some preference toward growth.  This week, the pattern of mixed data continued.  For example, an article written by Christopher Rugaber of the Associated Press on page A8 of today’s (Saturday, September 28) Atlanta Journal-Constitution (with the headline “Consumer spending barely up in August”) notes that personal incomes rose in August of 2019, but consumption spending and one price index barely increased, while another price index remained unchanged.  In my view and likely in the view of others, either slow growth or no growth in the price indexes could suggest that much higher inflation rates are not much of a concern in the immediate future.

The Rugaber article further indicates that consumer confidence is elevated, but the Conference Board reported a decrease in its consumer confidence measure this week.  Further, the Rugaber article points out that orders for durable goods increased by a relatively small amount, according to the Commerce Department.  The article also discusses a drop in business investment.

The FOMC may decide to continue the ‘in between’ approach in its balancing act until data more decisively suggest that the overwhelming problem or threat for the U.S. economy is either unemployment and perhaps also real GDP growth or inflation.  Could fiscal policy help to create growth in U.S. real GDP?