Highlights
The FOMC minutes of the June 24-25, 2008 meeting showed a sharp internal debate over the risks of inflation. The "hawks" on the FOMC are worried that a negative real fed funds rate will lead to higher inflation and possibly a wage-price spiral. Those on the committee who are worried about growth risks point to an economy held back by weak housing and other factors. Despite continuing downside risks to growth, the overall view was that a rise in inflation was the greater. Some members indicated that not only should the next rate change be up, but that it should be eminent. But a key point is that financial markets have changed substantially since the June 24-25 meeting, with the moves by the Fed and Treasury to support Fannie Mae and Freddie Mac and with the FDIC closing Indymac Bank. At this week's Congressional testimony, Chairman Bernanke essentially downgraded the forecasts for economic growth that had been included in today's minutes but had been prepared more than three weeks earlier.

The Fed is in a difficult position. Many FOMC members rightfully are worried about a rise in inflation and that the Fed - because of lags in the impact of monetary policy - should move now to preclude a locking in of higher inflation rates. But financial markets are fragile and Bernanke has indicated that restoring financial stability is the top priority. Fighting inflation is now on pause but perhaps not for too long.

Indeed, the debate over inflation risks has heated up, with a low real fed funds rate a key concern.

"Some participants noted that certain measures of the real federal funds rate, especially those using actual or forecasted headline inflation, were now negative, and very low by historical standards. In the view of these participants, the current stance of monetary policy was providing considerable support to aggregate demand and, if the negative real federal funds rate was maintained, it could well lead to higher trend inflation. In this view, a significant portion of the easing in monetary policy since last fall was aimed at providing insurance against the risk of an especially severe weakening in economic activity and, with downside risks having diminished somewhat, some firming in policy would be appropriate very soon, if not at this meeting."

The debate also heated up over whether a wage-price spiral is developing and whether inflation expectations were being locked in at a higher pace.

"Some participants noted that wage growth had been quite moderate, reinforcing a view that longer-term inflation expectations and labor cost pressures had remained fairly well contained. However, others commented that wages might accelerate with a lag only after inflation expectations had moved higher, and that it would be very costly to subsequently bring those expectations back down. Participants' views of the recent evidence on inflation expectations varied. Some noted that the increase was greatest for short-term survey measures of households' inflation expectations, which may be influenced disproportionately by consumers' perceptions of changes in the prices of food and gasoline; those participants judged that underlying inflation trends had not risen nearly as much and anticipated that such survey measures would reverse their recent increases as headline inflation moderated. However, others saw the signs of a rise in inflation expectations as more broad-based and were concerned that this development could signal an erosion of confidence in the Committee's commitment to price stability and, absent effective action by the Committee, could impart greater momentum to the inflation process."

But those worried about too weak growth had plenty of ammunition for their view.

"Nonetheless, the risks to growth remained tilted to the downside. Conditions in some financial markets had improved, but many financial institutions continued to experience significant credit losses and balance sheet pressures, and in these circumstances credit availability was likely to remain constrained for some time."

Housing was still seen as a serious drag on the economy.

"Participants judged that the outlook for the housing market remained bleak, with falling prices, slow sales, high inventories of unsold homes, and further declines in construction activity over coming months."

The overall posture of the economy was seen as very uncertain and with stagflation as a likely near-term outcome. But at the time, inflation was still seen as the bigger problem.

"Members commented that the continued strong increases in energy and other commodity prices would prompt a difficult adjustment process involving both lower growth and higher rates of inflation in the near term. Members were also concerned about the heightened potential in current circumstances for an upward drift in long-run inflation expectations. With increased upside risks to inflation and inflation expectations, members believed that the next change in the stance of policy could well be an increase in the funds rate; indeed, one member thought that policy should be firmed at this meeting."

The bottom line is that with the significant uncertainty for both growth and inflation risks, the FOMC chose an unchanged fed funds target as the best policy for now. With recent increased fragility of financial markets, inflation fighting clearly is on hold. But also, we can expect this debate again very soon.

2008 Release Schedule

Released On: 1/2 2/20 4/8 5/21 7/16 8/26 10/7 11/19 Released For: Dec Jan Mar Apr Jun Aug Sep Oct