Fed's September Statement Hints at Deflation Concern

The Federal Reserve's Open Market Committee met Tuesday to determine whether or not alter U.S. monetary policy. Rather than concede to critics who call for a more aggressive approach, the FOMC decided to stay the course, for now. Although it still anticipates the recovery has weakened, it does not appear to think additional intervention is necessary to prevent a double dip at this time. But subtleties in its language indicate that it is becoming a bit concerned with prices rising more slowly than its inflation target.

To be sure, this statement was far less interesting than the one from August when it announced it would reinvest proceeds from its maturing assets in longer-term Treasuries. But if you dig deep, you find a bit more concern expressed about the price level than we've seen in prior statements. Here's what the committee said about inflation this month:

Measures of underlying inflation are currently at levels somewhat below those the Committee judges most consistent, over the longer run, with its mandate to promote maximum employment and price stability. With substantial resource slack continuing to restrain cost pressures and longer-term inflation expectations stable, inflation is likely to remain subdued for some time before rising to levels the Committee considers consistent with its mandate.

Compare that to what the Committee said in August:

Measures of underlying inflation have trended lower in recent quarters and, with substantial resource slack continuing to restrain cost pressures and longer-term inflation expectations stable, inflation is likely to be subdued for some time.

While the FOMC clearly isn't taking any action on slowing inflation at this time, it does note the concern. In its September language, it appears that the economists believe that this period of very low inflation will end on its own, and its inflation target will eventually be met again without any additional steps taken. The statement goes on to say that that the FOMC will monitor the price level and take action if necessary.

This new expression of concern about low inflation is interesting, because the price level has actually risen over the past few months, after declining the months before that. So it's a little strange that the Fed appears more worried about inflation now. Here's the consumer price index (CPI) and the core CPI, which excludes energy and food:

cpi 2010-08.png

As you can see CPI has risen recently, while core CPI has remained quite stable over the trailing 12 months.

We'll have to wait until the minutes come out in a few weeks to know what else was discussed during this month's meeting. It's likely that the committee members revised their June economic estimates downward and discussed various techniques to expand the money supply if the economy worsens or if deflation becomes more of a concern.

Finally, the maverick committee member Kansas City Fed President Thomas Hoenig continued to dissent. He maintains his argument for greater flexibility by weakening the Fed's pledge to keep interest rates low for an extended period. He also doesn't like the reinvestment policy announced last month. But he remains the lone dissenter, while the broader committee appears to be more concerned about deflation than inflation.