As a senior economist and central bank strategist, I have performed a comparative analysis of the FOMC statements from June 30, 2005, and August 9, 2005.
The Federal Open Market Committee decided today to raise its target for the federal funds rate by 25 basis points to 3-1/2 percent ~~3-1/4 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. ~~Although energy prices have risen further, the expansion remains firm~~ Aggregate spending, despite high energy prices, appears to have strengthened since late winter, and labor market conditions continue to improve gradually. Core inflation has been relatively low in recent months and longer-term inflation expectations remain well contained, but pressures on inflation have stayed elevated. ~~Pressures on inflation have stayed elevated, but longer-term inflation expectations remain well contained.~~
The Committee perceives that, with appropriate monetary policy action, the upside and downside risks to the attainment of both sustainable growth and price stability should be kept roughly equal. With underlying inflation expected to be contained, 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; Susan S. Bies; Roger W. Ferguson, Jr.; Richard W. Fisher; ~~Edward M. Gramlich;~~ Donald L. Kohn; Michael H. Moskow; Mark W. Olson; Anthony M. Santomero; and Gary H. Stern.
In a related action, the Board of Governors unanimously approved a 25-basis-point increase in the discount rate to 4-1/2 percent ~~4-1/4 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 |
|---|---|---|
| "Although energy prices have risen further, the expansion remains firm" | "Aggregate spending... appears to have strengthened since late winter" | Bullish Growth: Shifts from a defensive posture (energy prices vs. firmness) to an active observation of strengthening demand. |
| "Pressures on inflation have stayed elevated, but longer-term inflation expectations remain well contained." | "Core inflation has been relatively low... but pressures on inflation have stayed elevated." | Nuanced Inflation: Introduces "Core inflation" as a stabilizing factor, though maintains the warning on overall pressures. |
| 3-1/4% (FFR) / 4-1/4% (Discount) | 3-1/2% (FFR) / 4-1/2% (Discount) | Tightening: Continuation of the hiking cycle to normalize policy. |
| Edward M. Gramlich | (Removed from voting list) | Administrative: Change in Committee membership/composition. |
Inflation
The Committee has introduced a more granular distinction between "Core inflation" and general "pressures." By explicitly noting that core inflation has been "relatively low," the Fed is signaling that while headline volatility (likely driven by the energy prices mentioned) remains a concern, the underlying inflationary trend is not yet spiraling. However, by moving the phrase "pressures on inflation have stayed elevated" to the end of the sentence, they maintain a cautionary tone.
Labor Markets & Growth
There is a notable upgrade in the assessment of economic activity. The previous statement focused on the expansion remaining "firm" despite energy costs. The current statement is more assertive, noting that aggregate spending has "strengthened." This suggests the Committee sees the economy as having more "room to run," which justifies the continued removal of policy accommodation.
Forward Guidance
The forward guidance remains remarkably static. The phrases "pace that is likely to be measured" and "risks... kept roughly equal" are carried over verbatim. This indicates that while the Committee is raising rates, they are not yet signaling an acceleration of the hiking pace; they remain in a "measured" tightening phase.
Verdict: Slightly Hawkish
The shift is subtly hawkish. While the forward guidance language remains neutral ("measured"), the underlying economic assessment has improved. By upgrading the description of aggregate spending from "firm" to "strengthened," the Committee is effectively removing the "economic weakness" justification for keeping rates low. The introduction of "relatively low" core inflation provides the Committee with the confidence to continue raising rates without fearing an immediate inflation spike, while the continued mention of "elevated pressures" provides the mandate to keep hiking. In short: the economy is stronger than previously thought, providing more headroom for further rate increases.