As a senior economist and central bank strategist, I have performed a comparative analysis of the FOMC statements from September 20 and November 1, 2005.
The Federal Open Market Committee decided today to raise its target for the federal funds rate by 25 basis points to 4 percent.
~~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.~~ Elevated energy prices and hurricane-related disruptions in economic activity have temporarily depressed output and employment. However, monetary policy accommodation, coupled with robust underlying growth in productivity, is providing ongoing support to economic activity that will likely be augmented by planned rebuilding in the hurricane-affected areas. ~~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,~~ The cumulative rise in energy and other costs has the potential to add to inflation pressures; however, core inflation has been relatively low in recent months and longer-term inflation expectations remain 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; Mark W. Olson; 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 5 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 |
|---|---|---|
| Detailed description of Katrina's "tragic toll" and "widespread devastation." | "Temporarily depressed output and employment." | Shift from an emergency/crisis tone to a normalized economic assessment. |
| "Uncertainty about near-term economic performance." | "Augmented by planned rebuilding." | Transition from fearing a setback to anticipating a reconstruction-led stimulus. |
| "Higher energy and other costs..." | "The cumulative rise in energy and other costs..." | Acknowledges the compounding effect of price increases over time. |
| Mark W. Olson's dissent. | Mark W. Olson's vote in favor. | Indicates a move toward full Committee consensus on the tightening path. |
Inflation
The Committee remains cautious but stable. The shift from "Higher energy costs" to "The cumulative rise" suggests the Fed is monitoring the aggregate impact of energy prices on the broader price level. However, the anchor remains the same: core inflation is low and long-term expectations are contained, justifying the continued removal of accommodation.
Labor Markets & Growth
There is a notable shift in the narrative regarding Hurricane Katrina. In September, the tone was one of alarm ("tragic toll," "set back in the near term"). By November, the language is clinical and optimistic. The use of the word "temporarily" to describe the depression of output and the mention of "planned rebuilding" indicates the Committee now views the disaster as a short-term shock that may actually provide a fiscal stimulus via reconstruction.
Forward Guidance
The forward guidance remains virtually identical. The Committee continues to signal a "measured" pace of rate hikes. The commitment to balance upside and downside risks remains the primary framework, suggesting that while they are hiking, they are not in a "panic" mode to curb overheating.
The Committee has shifted Hawkish.
While the "measured pace" language remains neutral, the overall tone is more aggressive for two reasons: first, the Committee successfully executed another 25bps hike despite a previous dissent from Mark W. Olson (who has now joined the majority). Second, the Committee has effectively "downgraded" the severity of the Hurricane Katrina shock—moving from a narrative of "devastation" and "uncertainty" to one of "temporary" depression and "planned rebuilding." By minimizing the negative impact of the hurricane, the Committee has cleared the intellectual path to continue raising rates without appearing insensitive to economic headwinds.