As a senior economist and central bank strategist, I have performed a comparative analysis of the FOMC statements from August 9 and September 20, 2005. This period is particularly notable as it captures the Committee's immediate reaction to the macroeconomic shock of Hurricane Katrina.
The Federal Open Market Committee decided today to raise its target for the federal funds rate by 25 basis points to 3-3/4 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. 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.~~
Output appeared poised to continue growing at a good pace before the tragic toll of Hurricane Katrina. The widespread devastation in the Gulf region, the associated dislocation of economic activity, and the boost to energy prices imply that spending, production, and employment will be set back in the near term. In addition to elevating premiums for some energy products, the disruption to the production and refining infrastructure may add to energy price volatility.
While these unfortunate developments have increased uncertainty about near-term economic performance, it is the Committee's view that they do not pose a more persistent threat. Rather, monetary policy accommodation, coupled with robust underlying growth in productivity, is providing ongoing support to economic activity. Higher energy and other costs have the potential to add to inflation pressures. However, core inflation has been relatively low in recent months and 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; Donald L. Kohn; Michael H. Moskow; Anthony M. Santomero; and Gary H. Stern. Voting against was Mark W. Olson, who preferred no change in the federal funds rate target at this meeting.
In a related action, the Board of Governors unanimously approved a 25-basis-point increase in the discount rate to 4-3/4 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, Richmond, Chicago, Minneapolis, and Kansas City. ~~Cleveland, Richmond, Atlanta, Chicago, St. Louis, Minneapolis, Kansas City, Dallas, and San Francisco.~~
| Removed | Added | Significance |
|---|---|---|
| "Aggregate spending... strengthened since late winter" | Detailed analysis of Hurricane Katrina's impact on spending, production, and employment. | Shift from a general growth narrative to a specific "shock" narrative; acknowledges a near-term setback. |
| "Pressures on inflation have stayed elevated" | "Higher energy and other costs have the potential to add to inflation pressures." | Shifts inflation risk from a current state ("stayed elevated") to a potential future risk ("potential to add"). |
| Unanimous voting block | Dissent by Mark W. Olson (preferred no change). | Indicates a growing internal divide regarding the pace of tightening amidst economic uncertainty. |
| General "accommodative" stance | "Do not pose a more persistent threat" (regarding Katrina). | Explicitly attempts to "look through" the disaster, signaling that the shock is transitory. |
Inflation
The Committee has shifted its language from describing inflation pressures as currently "elevated" to describing them as a "potential" risk stemming from energy price volatility. By emphasizing that core inflation remains low and expectations are contained, the Fed is signaling that it views the post-Katrina energy spike as a supply-side shock rather than a systemic inflationary trend.
Labor Markets & Growth
There is a stark shift here. The August statement noted that labor markets "continue to improve gradually." The September statement replaces this optimism with a warning that employment and production "will be set back in the near term." However, the Committee balances this by stating these developments "do not pose a more persistent threat," effectively categorizing the downturn as a temporary dip rather than a trend reversal.
Forward Guidance
The "boilerplate" language regarding the "measured" pace of removal of accommodation remains identical. However, the guidance is implicitly weakened by the introduction of a dissenting vote. The fact that one member preferred no change suggests that the "measured pace" is now a subject of active debate within the Committee.
The Committee remained Hawkish, but with a notable Dovish tilt in its reasoning.
The action itself was Hawkish: the Fed continued its tightening cycle by raising rates another 25 basis points despite a major natural disaster. However, the text is significantly more cautious. By acknowledging the "set back" in employment and production and recording a dissenting vote for the first time in this sequence, the Fed is signaling that it is no longer blindly confident in the growth trajectory. They are "looking through" the disaster to justify the rate hike, but the emergence of a dissenter suggests the Committee's consensus on the "measured pace" is fracturing.