As a senior economist and central bank strategist, I have performed a comparative analysis of the FOMC statements from November 1, 2005, and December 13, 2005. This period represents a critical phase of the "measured pace" tightening cycle under Chairman Alan Greenspan.
The Federal Open Market Committee decided today to raise its target for the federal funds rate by 25 basis points to 4-1/4 ~~4~~ percent.
Despite ~~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~~, the expansion in economic activity appears solid. ~~The cumulative rise in energy and other costs has the potential to add to inflation pressures; however,~~ Core inflation has stayed ~~been~~ relatively low in recent months and longer-term inflation expectations remain contained. Nevertheless, possible increases in resource utilization as well as elevated energy prices have the potential to add to inflation pressures.
The Committee judges ~~perceives~~ that ~~with appropriate monetary policy action,~~ some further measured policy firming is likely to be needed to keep the ~~upside and downside~~ risks to the attainment of both sustainable economic growth and price stability roughly in balance ~~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.~~ In any event, the Committee will respond to changes in economic prospects as needed to ~~fulfill its obligation to maintain price stability~~ foster these objectives.
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.
In a related action, the Board of Governors unanimously approved a 25-basis point increase in the discount rate to 5-1/4 ~~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 |
|---|---|---|
| "temporarily depressed output and employment" | "expansion... appears solid" | Shift from concern over hurricane shocks to confidence in growth. |
| "policy accommodation can be removed at a pace... measured" | "further measured policy firming is likely to be needed" | Transition from describing the pace to predicting more hikes. |
| "cumulative rise in energy... potential to add to inflation" | "increases in resource utilization... potential to add to inflation" | Shift from supply-side (energy) to demand-side (resource utilization) inflation risks. |
| "upside and downside risks... kept roughly equal" | "risks... roughly in balance" | Subtle linguistic tightening; implies a more active role in balancing. |
The Committee has shifted its focus from exogenous inflation risks to endogenous ones. In November, the risk was the "cumulative rise in energy and other costs" (supply shock). By December, while energy is still mentioned, the Committee explicitly introduces "increases in resource utilization" (demand-pull inflation). This indicates the Fed believes the economy is heating up internally, making inflation more persistent and less "temporary."
There is a marked increase in confidence regarding the real economy. The November statement was cautious, noting that hurricanes had "depressed output and employment." The December statement completely removes this language, replacing it with the assertive claim that the "expansion in economic activity appears solid." The "support" previously provided by policy accommodation is no longer the focus; the focus is now the strength of the expansion itself.
The guidance has moved from passive/conditional to active/predictive. In November, the Fed stated that accommodation can be removed at a measured pace. In December, they state that further firming is likely to be needed. This is a significant signal to the markets that the tightening cycle is not yet complete and that the "measured pace" is continuing upward.
Verdict: Hawkish
The Committee has shifted decisively in a Hawkish direction. While the rate hike itself was a consistent 25bps, the supporting text has evolved from a defensive posture (worrying about hurricane disruptions) to an offensive posture (addressing resource utilization). By explicitly stating that "further measured policy firming is likely to be needed," the Fed has signaled that the neutral rate is still below the current trajectory and that the risk of overheating now outweighs the risk of stagnation.