After hearing about QE2 in the news, I decided to read the latest Federal Open Market Committee (FOMC) minutes. For anyone who (like me) has not read the minutes before, they are about 9 pages long, and start with a litany of economic statistics concerning the past few months (sadly none of which is very numerically specific or contextual). The FOMC minutes then discuss the committee members economic forecast. In reading the minutes I noticed 3 overarching issues that appeared contradictory in the minutes. I have tried to bring them to light below.

Doubt is Not a Pleasant Condition, but Certainty is Absurd

One cannot miss the odd vacillation between negative current conditions and positive future estimates that are difficult to reconcile.

For example, on page 5 of the FOMC minutes (highlights mine):

"...the staff lowered its projection for the increase in real economic activity over the second half of 2010. The staff also reduced slightly its forecast of growth next year but continued to anticipate a moderate strengthening of the expansion in 2011 as well as a further pickup in economic growth in 2012. The softer tone of incoming economic data suggested that the underlying level of demand was weaker than projected at the time of the August meeting. "Moreover, the outlook for foreign economic activity also appeared a bit weaker. In the medium term, the recovery in economic activity was expected to receive support from accommodative monetary policy."

So despite using aggressive monetary policy in prior quarters, the effect of the monetary operations has been less than what was anticipated. But despite being previously overly optimistic, the committee is still anticipating growth and "strengthening" next year, and a "further pickup" in 2012, based on....well Im not exactly sure to be honest, because they dont expand on reasoning. But assuming the reader trusts in the Feds confidence that improvement will continue and gain traction within about 12 months, there is this conflicting analysis on pg. 7 (highlights mine):

"Many participants noted that if economic growth remained too slow to make satisfactory progress toward reducing the unemployment rate or if inflation continued to come in below levels consistent with the FOMCs dual mandate, it would be appropriate to provide additional monetary policy accommodation."

Therefore many of the group believes that if the current growth propelling us toward economic "strengthening" and a "pickup" in 2012 remains in place, it will be "too slow to make satisfactory progress" without massive government intervention...

If the U.S. economy is indeed as the Globe & Mail says, "a patient recovering from a major operation," then I am not sure these are the doctors I would want at my bedside. Their advice is akin to telling someone they were sick, but are getting better, and that in a few months they will be walking again; unless, that is, they are not, and in which case they will soon be critically ill.

It is Error Alone Which Needs the Support of Government. Truth Can Stand by Itself

A key area not discussed in the minutes is the actual effect of past FOMC actions. Their assumption and proclamations that interest rate management has resulted in the moderation in the economy are not substantiated in the least. On the contrary, the minutes suggest quite the opposite. Page 7 of the FOMC minutes state that

"With short-term nominal interest rates constrained by the zero bound, a decline in short-term inflation expectations increases short term real interest rates (that is, the difference between nominal interest rates and expected inflation), thereby damping aggregate demand. Conversely, in such circumstances, an increase in inflation expectations lowers short-term real interest rates, stimulating the economy."

The Fed in essence says that by lowering interest rates and increasing credit, and therefore creating inflation, this will have the desired effect of increasing economic activity and employment. This was attempted during the first phase of quantitative easing started around November 2008. The minutes go on to state therefore that "credit [has] remained readily available for larger corporations with access to financial markets."

However despite this credit availability "bank loans continued to contract..." and "both home equity loans and commercial real estate loans contracted further.... while consumer loans fell sharply." It turns out that far from using available credit to spur production and job growth, "many businesses had built up large reserves of cash, in part by issuing long-term debt, but were refraining from adding workers or expanding plants and equipment."

One would think with such conflicting evidence in their own discussion, the committee would ask the critical question. Namely, can the Feds open market operations to date be correlated with commensurate increased credit expansion and employment increases. The answer appears to be no, based on their stated evidence above. Clearly many banks and businesses are concerned with liquidity over expansion at present. If this is the case, providing government loans to large financial institutions can at least be argued to have no effect currently on the Feds first mandate of full employment.

As an aside, in October 1978, the Full Employment and Balanced Growth Act required the Fed to "promote full employment...and reasonable price stability (Thorbeke, p. 1)." However, if one looks at the U.S. unemployment rate from the month the act was passed (5.8%), the unemployment rate did not fall for 9 years, and in fact increased substantially. In fact over a 15 year period beginning in 1978, the unemployment rate improved over 5.8% in only 3.5 of those years. If there is a causal relationship between Fed management and lower unemployment in a historical sense, it is hard to find.

We Thought, Because We had Power, We had Wisdom

Given that the Fed does not seem to be able to effect improvement in the unemployment rate, there remains its other current mandate: price stability. Surprisingly, there is no discussion in the FOMC minutes of the obvious diametric opposition between attempting to reach full employment and price stability concurrently. The Fed states that cash is being hoarded by financial and industrial firms and therefore prices of real goods remain acceptably low; low enough that further credit creation will have no effect on nominal prices. As described on page 8 of the FOMC minutes:

"With respect to the statement to be released following the meeting, members agreed that it was appropriate to adjust the statement to make it clear that underlying inflation had been running below levels that the Committee judged to be consistent with its mandate for maximum employment and price stability, in part to help anchor inflation expectations."

Implicitly contained in the policy above is a very unwise assumption, namely that current widespread price levels accurately describe real inflation in the money supply and, by extension, future price stability.

At best, if their estimate is correct and people "anchor" their inflation expectations, they are still having no effect on employment, their first mandate. Potentially they are creating pockets of limited inflation in the economy, punishing savers of dollars, increasing dollar volatility and working against their second mandate.

At worst those committee members will not accurately predict the date that marks the end of debt destruction in the larger economy, will be unable to reign in their dormant liquidity during future expansion, and will create a high inflation environment for society. This again would not assist the Fed in meeting its mandates as prices would be unstable, and employers and employees would be less willing to enter into contractual relations due to future uncertainty in prices.

To this novice observer of the Fed, the benefit of future Fed action appears limited to non-existent, while the potential cost appears quite devastating. Perhaps before the Fed attempts to further cure U.S. economic ills, they should review the guidance in the Hippocratic Corpus to first "...do no harm."

References
Thorbecke, W. The Pursuit of Price Stability and Full Employment, EasternEconomic Journal, Vol. 28, No. 2, Spring 2002.
Quotations attributed to Voltaire, Thomas Jefferson, and Stephen Vincent Benet