U.S. Federal Reserve policy-makers last month discussed whether they should increase asset buying if the economic outlook worsened, and some argued that more aggressive purchases would aid the recovery.
Some members thought that an increase in the maximum amount of the Committee's purchases of agency MBS (mortgage-backed securities) could help to reduce economic slack more quickly than in the baseline outlook, according to minutes of the Fed's September 22-23 meeting out on Wednesday.
The U.S. central bank held interest rates near zero as expected after the meeting of its policy-setting Federal Open Market Committee (FOMC), and voiced guarded optimism about the sustainability of the country's economic recovery.
It also opted to extend its mortgage debt buying campaign until the end of March 2010 from a previously announced close of December 31, 2009, while keeping the total size of the purchases the same at $1.45 trillion.
The minutes repeated that Fed policy-makers felt that economic conditions were likely to warrant exceptionally low rates for an extended period.
There also appeared to have been no discussion at the September meeting about changing this language, or to more broadly define an exit strategy, beyond emphasizing that the Fed had the tools that it needed to accomplish this withdrawal of monetary policy stimulus when the time was right.
The main insight from the minutes came from what was not discussed, said Millan Mulraine, economics strategist TD Securities in Toronto.
With rates already as low as they can go, the Fed is buying agency mortgage debt together with longer-dated U.S. government bonds as part of its efforts to stimulate activity.
This action has already doubled the size of its balance sheet to above $2 trillion since last year, and although the current asset purchase campaign is winding down, the Fed made plain that this strategy could be reexamined if necessary.
Members discussed the importance of maintaining flexibility to expand the asset purchase programs should the economic outlook deteriorate or to scale back the programs should economic and financial conditions improve more than anticipated, the Fed said.
However, policy-makers were divided over the likely benefits of further increasing the size of its balance sheet.
The asset purchase campaign has made Fed critics nervous that it is effectively monetizing U.S. debt by purchasing government bonds at a time when the country faces a record budget deficit, which they say could spark future inflation.
One Fed policy-maker, possibly reflecting this concern, believed that an improved economic outlook could justify scaling back the size of the asset purchase program that had already been announced, although this view did not prevail.
Fed policy-makers also raised predictions for growth over the next 18 months and said the risks to their forecasts were balanced, but remained wary that the economy still remained quite fragile as it exited the worst recession in 70 years.
Under these circumstances, the Committee judged that the costs of growth turning out to be weaker than anticipated could be relatively high, the Fed said.
A separate economic prediction prepared for the meeting by Fed staff also raised forecasts for growth in the second half of this year and 2010, but only expected a slow recovery in the labor market. U.S. unemployment hit 9.8 percent last month.
The U.S. dollar weakened somewhat and U.S. government bonds trimmed price losses on the news, which analysts said had a dovish tilt that showed hawks on the committee were so far not making a big impact despite better recent economic data.
It cements the view that the Fed will hold interest rates for a long time, said Richard Franulovich, senior currency strategist at Westpac in New York.
Policy-makers stressed inflation was likely to remain subdued given the persistence of substantial slack in the economy and with future price expectations stable.
The initial reading on the minutes could be read bullishly (for bonds) because of the discussion about increasing asset purchases. This means the Fed is still focusing on the slack of the labor market, said Ian Lyngen, senior government bond strategist at CRT Capital Group in Stamford, Connecticut.
(Additional reporting by Richard Leong and Gertrude Chavez-Dreyfuss in New York, Editing by James Dalgleish)