As a senior economist and central bank strategist, I have analyzed the transition between the emergency action of January 21, 2008, and the scheduled meeting of January 30, 2008. This period represents a critical escalation in the Federal Reserve's response to the burgeoning Global Financial Crisis.
The Federal Open Market Committee ~~has~~ decided today to lower its target for the federal funds rate ~~75~~ 50 basis points to ~~3-1/2~~ 3 percent.
~~The Committee took this action in view of a weakening of the economic outlook and increasing downside risks to growth. While strains in short-term funding markets have eased somewhat, broader~~ Financial market conditions ~~have continued to deteriorate~~ remain under considerable stress, and credit has tightened further for some businesses and households. Moreover, ~~incoming~~ recent information indicates a deepening of the housing contraction as well as some softening in labor markets.
The Committee expects inflation to moderate in coming quarters, but it will be necessary to continue to monitor inflation developments carefully.
Today’s policy action, combined with those taken earlier, should help to promote moderate growth over time and to mitigate the risks to economic activity. However, ~~Appreciable~~ downside risks to growth remain. The Committee will continue to assess the effects of financial and other developments on economic prospects and will act in a timely manner as needed to address those risks.
Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; Timothy F. Geithner, Vice Chairman; ~~Charles L. Evans; Thomas M. Hoenig;~~ Donald L. Kohn; Randall S. Kroszner; ~~Eric S. Rosengren;~~ Frederic S. Mishkin; Sandra Pianalto; Charles I. Plosser; Gary H. Stern; and Kevin M. Warsh. Voting against was ~~William Poole, who did not believe that current conditions justified policy action before the regularly scheduled meeting next week~~ Richard W. Fisher, who preferred no change in the target for the federal funds rate at this meeting. ~~Absent and not voting was Frederic S. Mishkin.~~
In a related action, the Board of Governors unanimously approved a ~~75~~ 50-basis-point decrease in the discount rate to ~~4~~ 3-1/2 percent. In taking this action, the Board approved the requests submitted by the Boards of Directors of the Federal Reserve Banks of ~~Chicago and Minneapolis~~ Boston, New York, Philadelphia, Cleveland, Atlanta, Chicago, St. Louis, Kansas City, and San Francisco.
| Removed | Added | Significance |
|---|---|---|
| "strains... have eased somewhat" | "remain under considerable stress" | Critical. A reversal in narrative; the Fed is admitting that the previous "easing" of funding markets was temporary or illusory. |
| "weakening of the economic outlook" | "promote moderate growth... mitigate risks" | Shift from describing the problem to explicitly stating the intent of the policy intervention. |
| "Appreciable downside risks" | "However, downside risks... remain" | Softening of the adjective "appreciable," but maintaining the warning. |
| 75 bps cut | 50 bps cut | A reduction in the velocity of cuts, though the cumulative effect is a deeper easing. |
| 2 Fed Bank requests | 9 Fed Bank requests | Indicates a systemic collapse in liquidity across almost all districts, not just a few. |
Inflation
There is zero shift in the inflation narrative. The language is identical: "expects inflation to moderate... monitor inflation developments carefully." This suggests that while the Fed is terrified of a growth collapse, they are still maintaining a vestigial caution regarding price stability, likely to avoid a complete surrender of their inflation mandate.
Labor Markets & Growth
The characterization of the economy has shifted from "weakening" to a state of "considerable stress." While the phrase "softening in labor markets" remains, the context has darkened. The most significant shift is the admission that financial market stress is persistent rather than easing. The Fed is moving from a "reactive" posture (responding to a weakening outlook) to a "preventative" posture (trying to "mitigate risks to economic activity").
Forward Guidance
The guidance remains highly data-dependent and open-ended. The phrase "will act in a timely manner as needed" is preserved, which serves as a "blank check" for future emergency cuts. However, the addition of the phrase "combined with those taken earlier" signals that the Committee is now viewing its actions as a cumulative campaign rather than isolated events.
The Committee has shifted decidedly Dovish.
While the nominal size of the cut decreased (from 75bps to 50bps), the underlying tone is significantly more alarmed. The removal of the claim that funding markets had "eased somewhat" and its replacement with "considerable stress" is a major admission of deteriorating conditions. Furthermore, the expansion of the discount window requests from two Federal Reserve Banks to nine indicates a systemic liquidity crisis. By explicitly stating that these actions are intended to "mitigate risks to economic activity," the Fed has signaled that it is now in "crisis management" mode, prioritizing growth and financial stability over all other concerns.