US Federal Reserve
The Federal Reserve lowered its expectations for U.S. economic growth this year, according to minutes from the latest meeting of the U.S. central bank's interest rate-setting panel, but the bank stood by its forecast on 2012 unemployment. Reuters

When Federal Reserve Chairman Ben Bernanke walked to the podium for his semi-monthly press conference on Sept. 13, just hours after the central bank announced its latest venture deeper into the land of loose monetary policy, the first thing longtime Fed watchers noted was just how exhausted the man looked.

On Thursday, with the release of the minutes from the September Federal Reserve meeting, the reasons behind the chairman’s tired appearance that day became more than clear.

As much as can be gleaned from the highly technocratic language of Fed meeting minutes, the latest minutes suggest that the two-day assembly in mid-September was about as close as central bankers get to a drag-down, hair-pulling brawl. According to the minutes, members of the Fed who otherwise agreed that something needed to be done to spur the economy spent hours wrangling over how to execute the Fed’s mandate, portray the institution’s thought process and announce the decisions they had just taken.

One reason for the varied and conflicting views: the mixed data Federal Reserve officials had in front of them on the state of the American economy. At the meeting, for example, Fed economists noted that there were data suggesting a slow but steady improvement in the housing and employment markets. The developments in consumer spending were marginally positive. At the same time, central bankers concluded that business investment “appeared to be decelerating.”

The employment situation was the big sticking point, with members of the monetary policy committee deciding they needed to look beyond the nominal month-to-month changes to consider more complicated dynamics in the labor market that favored further stimulus. Beyond the number of jobs added and labor participation rates, the Fed minutes note, central bankers discussed how “an ongoing process of polarization in the labor market” was a dangerous trend to leave undisturbed, as well as the fact that “high levels of unemployment, even if initially cyclical, might ultimately induce adverse structural changes.”

In layman’s terms, the Fed economists, even when seeing a slowly improving jobs picture, went with their gut that the rate of employment recovery was just unacceptably slow. As Bernanke would put it during the press conference after the meeting, the Fed governors were unable to determine exactly which exact rate of growth was healthy, but they nearly unanimously agreed that “what we've seen the past six months, isn't it.”

Economists don’t like making policy decisions based on their gut, however, and it appears that being backed into that corner by the data made the central bankers that much more obsessive about making sure their decision to stimulate the economy was presented just so.

In particular, it seemed once the decision was made that the Fed should go ahead with a new round of stimulative bond-buying, members of the rate-setting committee bickered about how the decision should be presented, as well as how to answer the first question that would be on everyone’s mind: Now that the Fed was deciding to step on the throttle, when would it decide to tap the brakes?

“Reaching agreement”

According to the Fed minutes, the central bankers spent some time discussing how “clear communication and credibility allow the central bank to help shape the public’s expectations about policy, which is crucial to managing monetary policy when the federal funds rate is at its effective lower bound.” Everyone agreed the Fed needed to be clear about its intentions and then … pretty much then went on to disagree as to the appropriate way to define “clear” and “intention.”

“A number of participants questioned the effectiveness of continuing to use a calendar date to provide forward guidance, noting that a change in the calendar date might be interpreted pessimistically as a downgrade of the committee’s economic outlook rather than as conveying the committee’s determination to support the economic recovery,” the Fed minutes note, adding that “if the public interpreted the statement pessimistically, consumer and business confidence could fall rather than rise."

In a related tangent, “many participants indicated a preference for replacing the calendar date with language describing the economic factors that the committee would consider when deciding to raise its target for the federal funds rate,” and “many participants thought that more-effective forward guidance could be provided by specifying numerical thresholds for labor market and inflation indicators that would be consistent with maintaining the federal funds rate at exceptionally low levels.”

However, “reaching agreement on specific thresholds could be challenging given the diversity of participants’ views, and some were reluctant to specify explicit numerical thresholds out of concern that such thresholds would necessarily be too simple to fully capture the complexities of the economy and the policy process or could be incorrectly interpreted as triggers prompting an automatic policy response.”

In other words, the Fed heads agreed there was a need to stimulate the economy, and to be clear they would be continuing their path until the economy got better, but then could not agree on any kind of benchmark they could point to publicly as a validation on whether the economy was getting better or not.

Noisy hawks

Adding to the stressful nature of the two-day deliberations was that a marginalized minority of members who felt the Fed should not pursue further stimulative action kept raising their hands to talk during the meeting, even when it was clear the consensus could not be swayed.

While the minutes do not call out those monetary policy hecklers by name, voting records and public statements since the Fed meeting suggest they included Richard Fisher, president of the Federal Reserve Bank of Dallas, and Jeffrey Lacker, head of the Richmond Fed, well-known “hawks” who have long argued the U.S. central bank is not taking inflation seriously enough when undertaking unorthodox monetary actions.

The hawks beat the inflation drum at the meeting, but they also took the tack that the Fed should back away from further stimulus because it was wading into uncharted waters, with the minutes explaining how “one participant noted that, while there were few current signs of excessive risk-taking, low interest rates could ultimately lead to financial imbalances that would be challenging to detect before they became serious problems.”

Similarly, “one participant noted that an extended period of accommodation resulting from additional asset purchases could lead to excessive risk-taking on the part of some investors and so undermine financial stability over time.”

When the decision was taken to buy mortgage bonds as a way to deliver the stimulus, “one participant,” possibly Lacker, “objected that purchases of MBS, when compared to purchases of longer-term Treasury securities, would likely result in higher interest rates for many borrowers in other sectors.”

“A cure to all these ills”

In the end, as was always going to be the case anyway, the “doves” won. QE3 happened, and further stimulus sent financial markets soaring.

But due to the fact, as evidenced in the meeting minutes, that there was so much dissent in how to present the motives for the Fed action as clearly as possible, the members of the bank board put Bernanke in a situation where, at the press conference afterward, he had to be substantially vague.

"We're not promising a cure to all these ills, but what we can do is provide some support," Bernanke said at that conference, in a typical generality about the Fed’s responsibility for the economy. And then there was the disingenuous answer Bernanke gave to a question from The Economist’s Greg Ip, who asked why the Fed was now pegging the future view on policy decisions to conditional -- albeit somewhat vacuous -- goals.

“Our policies have always had a significant element of conditionality, but the idea here is to make it more explicit. More transparent to the public,” Bernanke said, fooling no one.

In hindsight, there was one moment in the press conference that revealed a lot about what had happened in the meeting.

Asking about members of the Federal Reserve board who oppose further stimulus, MarketWatch’s Greg Robb asked Bernanke if he didn’t sometimes “wish that some of the Fed officials … would keep their mou -- keep their fears to themselves?”

Bernanke took a second before answering the question and just smiled.