To: FOMC Policy Committee / Board of Governors
From: Senior Economist & Central Bank Strategist
Date: June 29, 2006
Subject: Comparative Analysis of Monetary Policy Statements (May 10 vs. June 29)
The Federal Open Market Committee decided today to raise its target for the federal funds rate by 25 basis points to 5-1/4 ~~5~~ percent.
~~Economic growth has been quite strong so far this year. The Committee sees growth as likely to moderate to a more sustainable pace,~~ Recent indicators suggest that economic growth is moderating from its quite strong pace earlier this year, 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,~~ Readings on core inflation have been elevated in recent months. ~~ongoing~~ Ongoing productivity gains have ~~helped to hold the growth of~~ held down the rise in unit labor costs, 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.~~ However, the high levels of resource utilization and of the prices of energy and other commodities have the potential to sustain inflation pressures.
~~The Committee judges that some further policy firming may yet be needed 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.~~ Although the moderation in the growth of aggregate demand should help to limit inflation pressures over time, the Committee judges that some inflation risks remain. The extent and timing of any additional firming that may be needed to address these risks will depend on the evolution of the outlook for both inflation and economic growth, 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 6-1/4 ~~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 |
|---|---|---|
| "Growth as likely to moderate" | "Growth is moderating" | Shift from a forecast to an observation; confirms the slowdown is happening. |
| "Modest effect on core inflation" | "Core inflation have been elevated" | Significant hawkish shift; core inflation is now a primary concern. |
| "Potential to add to inflation" | "Potential to sustain inflation" | Shift from "increasing" risk to "persistent" risk. |
| "Depend... on the economic outlook" | "Depend on the outlook for both inflation and economic growth" | Explicit "dual-mandate" balancing; signals the Fed is watching growth risks as closely as inflation. |
| "Some further policy firming" | "Any additional firming" | Subtle shift from "likely" to "conditional" future hikes. |
There is a marked escalation in the Committee's concern regarding inflation. In May, the Fed viewed energy prices as having a "modest effect" on core inflation. By June, they explicitly state that core inflation readings have been "elevated." Furthermore, the shift from the phrase "add to inflation pressures" to "sustain inflation pressures" suggests the Committee is now worried about inflation becoming entrenched rather than just reacting to a temporary shock.
The Committee has moved from a predictive stance to a confirmatory stance. In May, they viewed moderation as "likely"; in June, they state that "indicators suggest" growth "is moderating." The introduction of the term "aggregate demand" indicates a more technical analysis of the economic slowdown, acknowledging that the cooling economy is now actively working to "limit inflation pressures."
The guidance has become more nuanced and balanced. While the May statement focused primarily on the "economic outlook" (a broad term), the June statement explicitly bifurcates the decision-making process between "inflation and economic growth." This signals that the Committee is now weighing the risk of over-tightening (which could stifle growth) against the risk of under-tightening (which could allow inflation to persist).
Overall Tone: Balanced / Cautiously Hawkish
The Committee remains Hawkish in action (continuing the rate hike cycle) and in its diagnosis of inflation (moving from "modest" to "elevated"). However, the accompanying text is notably more Dovish than the previous statement. By admitting that growth "is moderating" and that this moderation "should help to limit inflation," the Fed is signaling that the "heavy lifting" of the tightening cycle may be nearing its end. They are no longer just fighting inflation; they are now actively monitoring the cooling economy to ensure they do not over-correct.