Takeaways from the October FOMC minutes

Part 3

Why did the Fed adjust its economic outlook at the October FOMC?

The staff made some adjustments to the economic forecast from September

The staff economists took down their near-term estimate of GDP growth based on the government shutdown and retail sales coming in lower than expected (which makes the previous comments about consumer strength in the earlier parts of this series seem even more strange). It took up its forecasts for future growth based on expectations of further growth in asset prices, particularly equities and real estate and also currency-related moves. It still anticipates that the economy will accelerate in 2014 and 2015. Inflation is expected to remain about where it is.

Labor Force Particiption RateEnlarge Graph

The participants based some of their future growth expectations in the abatement of some of the big economic headwinds that have been with us since the beginning of the recession, particularly household de-leveraging and tight credit. It mentioned that fiscal drag is dropping as well, which is true on a relative basis, but the government’s fiscal stance is still highly, highly accommodative.

As has been the case for this entire recession, capital expenditures and hiring remain sticking points, and business seems loath to do it until absolutely forced to. At this stage of the game, the fear for management still seems to be the dread of having too high a cost structure—not the fear of missing out on sales. That psychology has been firmly in place since 2008.

Participants viewed the effects of the shutdown as “temporary and limited,” a view that has been borne out by some stronger-than-expected data, particularly the October jobs report and the retail sales report released this morning. They mention that fiscal policy has been exerting significant restraint on economic growth, which fails to take into account that government spending as a percentage of GDP is well above post-WWII levels by a few percentage points and that five of the seven biggest postwar deficits as a percentage of GDP have been over the past five years. In other words, while fiscal accommodation is lower than a year or two ago, it’s still highly loose. It’s ironic that the Fed frets about market participants interpreting a decrease in asset purchases as “tightening” when it’s doing the same thing about fiscal policy.

On the labor market, it notes that the unemployment rate is dropping in the context of a lower labor force participation rate and discusses what that drop ultimately means. If workers are exiting the workforce due to retirement, that’s a different situation than workers leaving the workforce because they can’t find jobs. It notes a secular (long-term) decline in labor market dynamism or turnover, which is limiting wage gains (most people have to find a new job to get a raise—getting one from your current boss is difficult).

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