As a senior economist and central bank strategist, I have performed a comparative analysis of the FOMC statements from June 30, 2004, and August 10, 2004.
The Federal Open Market Committee decided today to raise its target for the federal funds rate by 25 basis points to 1-1/2 percent ~~1-1/4 percent~~.
The Committee believes that, even after this action, the stance of monetary policy remains accommodative and, coupled with robust underlying growth in productivity, is providing ongoing support to economic activity. ~~The evidence accumulated over the intermeeting period indicates that output is continuing to expand at a solid pace and labor market conditions have improved.~~ In recent months, output growth has moderated and the pace of improvement in labor market conditions has slowed. This softness likely owes importantly to the substantial rise in energy prices. The economy nevertheless appears poised to resume a stronger pace of expansion going forward. ~~Although incoming inflation data are somewhat elevated, a portion of the increase in recent months appears to have been due to transitory factors.~~ Inflation has been somewhat elevated this year, though a portion of the rise in prices seems to reflect transitory factors.
The Committee perceives the upside and downside risks to the attainment of both sustainable growth and price stability for the next few quarters are roughly equal. With underlying inflation still expected to be relatively low, the Committee believes that policy accommodation can be removed at a pace that is likely to be measured. Nonetheless, the Committee will respond to changes in economic prospects as needed to fulfill its obligation to maintain price stability.
Voting for the FOMC monetary policy action were: Alan Greenspan, Chairman; Timothy F. Geithner, Vice Chairman; Ben S. Bernanke; Susan S. Bies; Roger W. Ferguson, Jr.; Edward M. Gramlich; Thomas M. Hoenig; Donald L. Kohn; Cathy E. Minehan; Mark W. Olson; Sandra Pianalto; and William Poole.
In a related action, the Board of Governors unanimously approved a 25 basis point increase in the discount rate to 2-1/2 percent ~~2-1/4 percent~~. In taking this action, the Board approved the requests submitted by the Boards of Directors of the Federal Reserve Banks of Boston, New York, Philadelphia, Cleveland, Richmond, Atlanta, Chicago, St. Louis, Minneapolis, Kansas City, Dallas, and San Francisco.
| Removed | Added | Significance |
|---|---|---|
| "output is continuing to expand at a solid pace and labor market conditions have improved" | "output growth has moderated and the pace of improvement in labor market conditions has slowed" | Significant. A direct pivot from describing growth as "solid" to "moderated." Acknowledges a cooling economy. |
| (N/A) | "This softness likely owes importantly to the substantial rise in energy prices." | High. The Fed is attributing the slowdown to an external supply shock (energy) rather than a systemic failure of demand. |
| "incoming inflation data are somewhat elevated" | "Inflation has been somewhat elevated this year" | Minor. Shifts from "incoming data" (short-term) to a broader "this year" (trend) perspective. |
| (N/A) | "The economy nevertheless appears poised to resume a stronger pace of expansion" | Moderate. A "confidence" hedge to justify continuing the rate hike cycle despite the moderation. |
Inflation
The characterization of inflation remains largely consistent. The Committee continues to view the current elevation as partially "transitory." By shifting the language from "incoming data" to "this year," the Fed is acknowledging a more persistent trend of elevated prices, but they are not yet signaling a shift toward a more aggressive inflation-fighting posture.
Labor Markets & Growth
This is the most critical shift in the statement. In June, the Fed viewed growth as "solid" and labor markets as "improving." By August, they admit growth has "moderated" and labor improvement has "slowed." However, the strategic inclusion of "energy prices" as the culprit is a crucial nuance; it suggests the Fed views this as a temporary headwind rather than a structural downturn, allowing them to maintain their tightening bias.
Forward Guidance
The forward guidance remains identical. The phrases "roughly equal" risks and "pace that is likely to be measured" are carried over verbatim. This indicates that while the current data has softened, the strategy for the rate path (gradualism) has not changed.
The Committee has shifted Slightly Dovish in observation, but remained Hawkish in action.
While the Fed raised rates by 25bps (a hawkish action), the accompanying text is notably more cautious than the previous statement. The admission that growth has "moderated" and labor markets have "slowed" is a clear dovish pivot in the assessment of the economic backdrop. However, by attributing this softness to energy prices and asserting that the economy is "poised to resume" expansion, the Fed is effectively "talking down" the weakness to justify the rate hike. They are signaling that they see through the temporary noise of energy prices to a core economy that still requires the removal of accommodation.