The Federal Reserve has become more in interested in what it says about policy than policy itself...

Is this a sign the Federal Reserve has run out of ammo?

The latest Federal Open Market Committee minutes contain a whole section on 'Monetary Policy Strategies and Communication' (the FOMC had a presentation on the subject - to have been a fly on the wall...)

Here are a few extracts, followed by a brief interpretation of what it all might mean.

First, notice how the merits of an inflation target are judged with reference to how such a target's existence might be perceived:

"Many participants pointed to the merits of specifying an explicit longer-run inflation goal, but it was noted that such a step could be misperceived as placing greater weight on price stability than on maximum employment."

Next, the FOMC grapples with the thorny issue of what might happen if the Fed made a commitment now to step in were the economy to get any worse:

"Some participants noted that conditional commitments might be particularly helpful in providing additional accommodation and mitigating downside risks when the policy rate is close to its effective lower bound, because a central bank can commit to a shallower interest rate trajectory than investors would expect if policymakers followed a purely discretionary approach. However, many pointed out that the implementation of such a strategy could pose substantial communication challenges and that the benefits would be diminished if the strategy was not fully credible."

Ah, the old credible threat problem. Let's just hope no one starts losing faith in what Bernanke and co have to say, eh?

Our next extract is positively Wittgensteinian:

"A few members expressed interest in using language specifying a period of time during which the federal funds rate was expected to remain exceptionally low, rather than a calendar date, arguing that such language might be better to indicate a constant stance of monetary policy over time."

Finally we have the FOMC's eagerly-awaited take on additional "policy accommodation" - widely taken to mean third round of quantitative easing:

"A few members indicated that they believed the economic outlook might warrant additional policy accommodation. However, it was noted that any such accommodation would likely be more effective if it were provided in the context of a future communications initiative, and most of these members agreed that they could support retention of the current policy stance at this meeting. One member dissented from the policy decision on the grounds that additional monetary policy accommodation was warranted at this time."

What are we to make of this obsession with 'Communication'?

At one level, it is perfectly reasonable for a central bank to consider - as all routinely do - how its pronouncements could have an impact on outcomes. Central bank communications - through their effect on economic expectations - have long been recognized as one of the channels through which policy is transmitted.

It seems that now, though, the Fed has gone a step further, and made 'Communication' the star of the show. Is this because it is now the only policy tool it has left? Have US monetary policy decisions been reduced to decisions about 'language', tone of voice, and whether or not to raise an eyebrow at a particular point in a press conference?

This is a bit facetious, granted - but there is some merit to the idea that the Fed may be tapped out. Interest rates are as low as they can go. And the issue now is not whether or not they should be raised again, but how best to convince everyone that they are never ever going higher.

As for more "accommodation", the perceived failure of the first two rounds has made QE3 politically very hot. One gets the sense that the Fed now hopes to raise inflationary expectations - and thus stimulate economic activity (a contentious assumption in itself, but we'll leave that for another day) - by merely hinting that QE3 will happen, in the hope of never having to actually do it.

A word of caution therefore to those expecting QE3 is a sure thing. Central banks have a clear incentive to say one thing and do another. Influencing expectations is, as we have seen, a core part of their business. Just because these minutes may sound accommodative in tone does not, ipso facto, mean QE3 is round the corner.

Nonetheless, sooner or later the Fed - as it acknowledges - risks running into a credibility problem. If they 'threaten' QE3 but then don't do it, could that entrench the very deflationary expectations the Fed hopes to expunge?

One FOMC member (Charles Evans) seems very keen to avoid this scenario, voting for more accommodation right now. The longer he is outvoted, the more the impression will grow that the Fed has indeed run out of feasible policy options. One can only imagine how the markets will feel about that.