To: FOMC Policy Committee / Board of Governors
From: Senior Economist & Central Bank Strategist
Date: May 10, 2006
Subject: Comparative Analysis of Monetary Policy Statements (March 28 vs. May 10)
The Federal Open Market Committee decided today to raise its target for the federal funds rate by 25 basis points to 5 percent.
~~The slowing of the growth of real GDP in the fourth quarter of 2005 seems largely to have reflected temporary or special factors. Economic growth has rebounded strongly in the current quarter but appears likely to moderate to a more sustainable pace.~~ Economic growth has been quite strong so far this year. The Committee sees growth as likely to moderate to a more sustainable pace, partly reflecting a gradual cooling of the housing market and the lagged effects of increases in interest rates and energy prices.
As yet, the run-up in the prices of energy and other commodities appears to have had only a modest effect on core inflation, ongoing productivity gains have helped to hold the growth of unit labor costs in check, and inflation expectations remain contained. Still, possible increases in resource utilization, in combination with the elevated prices of energy and other commodities, have the potential to add to inflation pressures.
The Committee judges that some further policy firming may yet be needed ~~to keep the risks to the attainment of both sustainable economic growth and price stability roughly in balance~~ to address inflation risks but emphasizes that the extent and timing of any such firming will depend importantly on the evolution of the economic outlook as implied by incoming information. In any event, the Committee will respond to changes in economic prospects as needed to support the attainment of its objectives.
Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; Timothy F. Geithner, Vice Chairman; Susan S. Bies; Jack Guynn; Donald L. Kohn; Randall S. Kroszner; Jeffrey M. Lacker; Mark W. Olson; Sandra Pianalto; Kevin M. Warsh; and Janet L. Yellen.
In a related action, the Board of Governors unanimously approved a 25-basis-point increase in the discount rate to 6 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, Dallas, and San Francisco.
| Removed | Added | Significance |
|---|---|---|
| Reference to Q4 2005 GDP slowing/temporary factors. | "Gradual cooling of the housing market" and "lagged effects of increases in interest rates." | High. The Fed is now explicitly acknowledging the housing slowdown and the transmission of its own previous hikes. |
| "Keep risks... roughly in balance" (Growth vs. Price Stability). | "Depend importantly on the evolution of the economic outlook as implied by incoming information." | High. Shift from a general "balancing act" to explicit "data-dependency," signaling a potential pause or slower pace. |
| "Foster these objectives." | "Support the attainment of its objectives." | Low. Minor stylistic change in phrasing. |
| 4-3/4% (FFR) / 5-3/4% (Discount). | 5% (FFR) / 6% (Discount). | Moderate. Continuation of the tightening cycle (25bps hike). |
The Committee’s assessment of inflation remains static. The entire second paragraph is identical to the previous statement. The Fed continues to view core inflation as stable, supported by productivity gains, while remaining vigilant about "resource utilization" and commodity prices. However, the guidance section now specifically links further firming to "address inflation risks" rather than the broader "balance" of growth and stability.
There is a notable shift from backward-looking analysis to forward-looking caution. The March statement focused on dismissing the Q4 2005 slowdown as "temporary." The May statement pivots to the current year's strength but introduces two critical headwinds: the cooling housing market and the lagged effects of monetary policy. This indicates the Committee is now monitoring the "braking distance" of the economy more closely.
The guidance has shifted from presumptive to conditional. In March, the Committee suggested further firming was needed to maintain a balance. In May, while they leave the door open ("may yet be needed"), they have added a strong caveat regarding "extent and timing" based on "incoming information." This is a classic central bank signal that the pace of hikes may slow or that the Committee is preparing the markets for a potential plateau.
Verdict: Dovish Tilt (within a Hawkish Action)
While the Committee took a Hawkish action (raising rates by 25 basis points), the tonal shift in the text is Dovish. The Fed has moved from a stance of steady tightening to one of cautious observation. By explicitly mentioning the "cooling of the housing market" and emphasizing "incoming information" for future timing, the Committee is signaling that it is no longer on "autopilot" with its rate hikes. They are acknowledging that the lagged effects of their previous actions are beginning to manifest, suggesting a transition from a phase of aggressive tightening to a phase of data-dependent calibration.