Policymakers Expect Slower Growth in Second Half of Year

According to the minutes from the August 10 policy meeting of the Federal Open Market Committee (FOMC), second quarter gross domestic product (GDP) growth was "noticeably weaker" than most meeting participants had expected. The recovery in the labor market was also sluggish, said the meeting minutes released August 31. Although the unemployment rate saw a slight decline, it reflected lower labor force participation rather than employment growth.

However, participants more optimistically feel that financial market conditions have become more supportive of growth, perhaps due to lessening concern among investors over the European debt crisis. Participants further believe that credit conditions for households and small businesses are gradually improving, which should help support the economic recovery. Indeed, FOMC members expect the recovery to continue in the second half of the year—albeit at a more modest pace—and to gather strength in 2011.

Risk of deflation "quite small"
Most Fed policymakers view the inflation outlook as little changed since the last FOMC meeting in June. The majority see the risk of deflation as quite small, but, according to some, the risk of further disinflation has increased somewhat. Overall, FOMC members "generally saw both employment and inflation as likely to fall short of levels consistent with the dual mandate for longer than had been anticipated," according to the minutes.

Against this backdrop, most participants agreed that a faster-than-expected drawdown in the Fed's balance sheet is inappropriate given the sluggish economy. All but one committee member agreed that the principal repayments received on the Fed's holdings of mortgage-backed securities (MBS) and maturing agency debt should be reinvested in longer-term Treasuries. Participants also noted that reinvesting in MBS could be an option if conditions were to change. The meeting minutes show disagreement over whether the Committee's decision could send the wrong signal to investors.

For more detailed information from the FOMC's August 10 meeting, including participants' views on current conditions and the economic outlook, please see the full release of the minutes.