Officials worried at the Sept. 16-17 policy meeting that disappointing growth in Europe, Japan and China could crimp U.S. exports. Meantime, the stronger currency, by reducing the cost of imported goods and services, could hold U.S. inflation below the Fed’s 2% objective. Fed staff also reduced its projection for medium-run growth in part because of these concerns.
The collective worry is added reason for the Fed to hold short-term interest rates near zero, even as the economy improves.
“Some participants expressed concern that the persistent shortfall of economic growth and inflation in the euro area could lead to a further appreciation of the dollar and have adverse effects on the U.S. external sector,” according to the minutes, which were released by the Fed with the traditional three-week lag. “Several participants added that slower economic growth in China or Japan or unanticipated events in the Middle East or Ukraine might pose a similar risk.”
These worries about global growth and the economic impacts of a strong dollar represent a new twist in the Fed’s running debate about when to raise short-term interest rates. Officials spent much of the summer discussing the timing and mechanics of rate increases. Many officials expect the first rate increase by mid-2015. An improving U.S. job market led some officials to press for earlier increases.
The minutes showed more clearly than before that concerns about global growth and the disinflationary impact of a strong currency are giving officials additional pause about moving quickly on rates.
The euro is down nearly 8% against the dollar so far this year, with much of the move happening since June. The Wall Street Journal’s broad dollar index is up more than 5%.
There are plenty of benefits from a strong currency. It goes hand-in-hand with capital inflows which could spur domestic investment. But it also tamps down inflation and takes pressure off the central bank to push up interest rates.
But officials have been trying to push inflation up, not down, of late because it has run below their 2% goal for more than two years.
Fed officials have started speaking out more about their concerns about the global landscape.
“The appreciation of the dollar and weakening of foreign-growth prospects,” in addition to low energy prices, will collectively “damp inflation pressures,” William Dudley, president of the Federal Reserve Bank of New York, said in a speech Tuesday at Rensselaer Polytechnic Institute.
Mr. Dudley added that “the appreciation of the dollar is likely due in part to increasing confidence that growth prospects in the U.S. have improved,” and as such, is a positive vote in favor of the American economy.
While officials debated the impacts of a weakening global environment on the U.S. economy, they pressed ahead with several other issues that have been on the Fed’s agenda for weeks. Among them, when and how to change their guidance to the public about short-term interest rates.
The Fed has been saying since last March that it would keep interest rates near zero for a “considerable time” after its bond-buying program ends. With the program on track to end in October, a debate has heated up about changing the guidance.
“Several participants thought that the current forward guidance regarding the federal funds rate suggested a longer period before liftoff, and perhaps also a more gradual increase in the federal funds rate thereafter, than they believed was likely to be appropriate given economic and financial conditions,” the minutes said. “In addition, the concern was raised that the reference to ‘considerable time’ in the current forward guidance could be misunderstood as a commitment rather than as data dependent.”
The minutes emphasized that the Fed’s decision on rates was in fact dependent on how the economy performed and suggested a shift in the guidance was taking shape.
“Most participants indicated a preference for clarifying the dependence of the current forward guidance on economic data and the Committee’s assessment of progress toward its objectives of maximum employment and 2% inflation,” the minutes said. “A clarification along these lines was seen as likely to improve the public’s understanding of the (Fed’s) reaction function while allowing the Committee to retain flexibility to respond appropriately to changes in the economic outlook.”