Fed signals: The Federal Reserve just gave the markets something more to worry about. Minutes from the latest meeting of its Federal Open Market Committee reveal a growing schism over whether to ease monetary policy to cope with persistent unemployment or to start tightening sooner to attack inflation. Already spooked investors can now fret over the possible incompatibility of the Fed’s dual mandate.
The trouble signs are already burning out investor spreadsheets. The European crisis has spread from the modest fringe economies of Greece, Ireland and Portugal to Italy, an original EU member and home to the world’s eighth-largest GDP. The United States faces technical default in three weeks and budget talks aren't improving. Chinese inflation and the end of quantitative easing are becoming greater factors. On that basis, the market could use some clear signals from the US central bank.
But it’s not getting any. Besides the FOMC’s admission that the outlook for employment and inflation were “unusually uncertain,” the minutes from its June 21-22 gathering indicate a deepening divide between the hawks and the doves. Some participants believe the rise in prices is a sign that policy tightening might be needed “sooner than currently anticipated”. Yet others noted that another round of monetary stimulus could be justified, especially if economic growth doesn’t pick up the pace to create more jobs.
This is where the dual mandate problem is writ large. If the Fed were tasked simply with price stability, committee members might differ on the urgency of the problem, but once deflation stopped being a realistic possibility, they could agree on the general direction of policy. But with the extra responsibility of combating unemployment, FOMC members stand to clash not only about the intensity of policy but its direction. If stubbornly high unemployment and creeping inflation persist, this dilemma will only become sharper, with the Fed agonizing between advocates of a third round of bond buying, or QE3, and those who would push up the federal funds rate. Instead of the calm and measured leadership the markets tend to expect from central bankers, they're getting signs of an epic struggle — just exactly what they don't need.