Two initiatives were introduced over the intermeeting period to help manage the expansion of the balance sheet and promote control of the federal funds rate. First, on September 17, the Treasury announced a temporary Supplementary Financing Program at the request of the Federal Reserve. Under this program, the Treasury issued short-term bills over and above its regular borrowing program, with the proceeds deposited at the Federal Reserve. This facility helped offset the provision of reserves to the banking system through the various liquidity facilities. Second, employing authority granted under the Emergency Economic Stabilization Act, the Federal Reserve Board announced on October 6 that it would pay interest on required and excess reserve balances beginning on October 9. The payment of interest on excess reserve balances was intended to assist in maintaining the federal funds rate close to the target set by the Committee. Initially, the interest rate on required reserves was set at the average target federal funds rate over each reserve maintenance period less 10 basis points, while the rate on excess reserves was set at the lowest target federal funds rate over each reserve maintenance period less 75 basis points. On October 22, the rate on excess reserves was adjusted to be the lowest target federal funds rate during the maintenance period less 35 basis points.
In the forecast prepared for the meeting, the staff lowered its projection for economic activity in the second half of 2008 as well as in 2009 and 2010. Real GDP appeared to have declined in the third quarter, and the few available indicators that reflected conditions following the intensification of the financial market turmoil in mid-September pointed to another decline in the fourth quarter. The declines in stock-market wealth, low levels of consumer sentiment, weakened household balance sheets, and restrictive credit conditions were likely to hinder household spending over the near term. Business expenditures also probably would be held back by a weaker sales outlook and tighter credit conditions. The staff expected that real GDP would continue to contract somewhat in the first half of 2009 and then rise in the second half, with the result that real GDP would be about unchanged for the year. Although futures markets pointed to a lower trajectory for oil prices than at the time of the September meeting, real activity was expected to be restrained by further contraction in residential investment, reduced household wealth, continued tight credit conditions, and a deterioration of foreign economic performance. In 2010, real GDP growth was expected to pick up to near the rate of potential growth, as the restraints on household and business spending from the financial market tensions were anticipated to begin to ease and the contraction in the housing market to come to an end. With growth below its potential rate for an extended period, the unemployment rate was expected to rise significantly through early 2010. The staff reduced its forecast for both core and overall PCE inflation, as the disinflationary effects of the receding cost pressures of energy, materials, and import prices and of resource slack were expected to be greater than at the time of the September FOMC meeting. Core inflation was projected to slow considerably in 2009 and then to edge down further in 2010.
In conjunction with this FOMC meeting, all participants--that is, Federal Reserve Board members and Reserve Bank presidents--provided annual projections for economic growth, the unemployment rate, and inflation for the period 2008 through 2011. The projections are described in the Summary of Economic Projections, which is attached as an addendum to these minutes.
In their discussion of the economic situation and outlook, FOMC meeting participants indicated that the worsening financial situation, the slowdown in growth abroad, and incoming information on economic activity had led them to mark down significantly their outlook for growth. While economic activity had evidently already been slowing over the summer, the turmoil in recent weeks had apparently resulted in tighter financial conditions and greater uncertainty among businesses and households about economic prospects, further limiting their ability and willingness to make significant spending commitments. Recent measures of business and consumer sentiment had fallen to historical lows. Participants generally expected the economy to contract moderately in the second half of 2008 and the first half of 2009, and agreed that the downside risks to growth had increased. While some expected an improving financial situation to contribute to a recovery in growth by mid-2009, others judged that the period of economic weakness could persist for some time. Several participants indicated that they expected some fiscal stimulus in coming quarters, but they were uncertain about the extent and duration of the resulting support to economic activity. Participants agreed that in coming quarters inflation was likely to move down to levels consistent with price stability, reflecting the recent declines in the prices of energy and other commodities, the appreciation of the dollar, and the expected widening of margins of resource slack. Indeed, some saw a risk that over time inflation could fall below levels consistent with the Federal Reserve's dual objectives of price stability and maximum employment.
Participants noted that financial conditions had worsened significantly over the intermeeting period. The failure or near failure of a number of major financial institutions had deepened market concerns about counterparty credit risk and liquidity risk. As a result, financial intermediaries had cut back on lending to some counterparties, particularly for terms beyond overnight, and in general were conserving liquidity and capital. Moreover, risk aversion of investors increased, driving credit spreads sharply higher. Survey results and anecdotal information also suggested that credit conditions had tightened significantly further for businesses and households. Equity prices had varied widely and were substantially lower, on net. Participants saw the potential for financial strains to intensify if some investors, such as hedge funds, found it necessary to sell assets and as lending institutions built reserves against losses. Participants were concerned that the negative spiral in which financial strains lead to weaker spending, which in turn leads to higher loan losses and a further deterioration in financial conditions, could persist for a while longer. While the global efforts to recapitalize banks and guarantee deposits had helped stabilize the situation, risk spreads remained higher, asset prices lower, and credit conditions tighter than prior to the recent disruptions. Moreover, some participants noted that the specifics and effectiveness of some government programs to support financial markets and institutions remained unclear.
Participants indicated that the increase in financial turmoil had already had an impact on business decisions. Reports from contacts in many parts of the country suggested that the weaker and less certain economic outlook was leading businesses to cancel capital and other discretionary expenditures and lay off workers. Several participants noted that even businesses that had previously been largely unaffected by the financial turbulence were now experiencing difficulties obtaining new credit, and some businesses were said to be drawing down lines of credit preemptively rather than risk the lines becoming unavailable. Contacts indicated that fewer commercial real estate construction projects were being undertaken. Residential construction activity remained extremely subdued, with the stock of unsold homes still very elevated.
Meeting participants noted that real consumer spending had been weakening through the summer, responding to lower employment and tighter credit. Moreover, households, like businesses, were reportedly reacting to the shifting economic circumstances in recent weeks by cutting expenditures further. Spending on consumer durables, such as automobiles, and discretionary items had been particularly hard hit, and retailers anticipated very weak holiday spending.
Participants noted that the financial turmoil had increasingly become an international phenomenon, leading to a marked deterioration in global growth prospects. While advanced foreign economies had already shown signs of slowing, they had been significantly affected by the worsening of financial strains over the intermeeting period. Moreover, a number of emerging market economies, which had heretofore been less influenced by the financial developments in industrial countries, had in recent weeks been significantly affected, as the increasing strains in financial markets led global investors to pull back from exposures to such economies. As a result, interest rates on emerging market debt had shot up and prices of emerging market equity had dropped sharply. Participants saw the stronger dollar and weaker growth abroad as likely to restrain future growth in U.S. exports.
Participants agreed that inflation was likely to diminish materially in coming quarters. Commodity prices had fallen sharply, the dollar had strengthened notably, and considerable economic slack was anticipated. Moreover, some survey measures of inflation expectations had declined as had those derived from inflation-linked Treasury securities, although recent movements in the latter measures were likely influenced in part by increases in the premiums required to hold the relatively illiquid inflation-indexed securities. Some participants indicated that their business contacts had reported reduced pricing power and lower markups. Against this backdrop, participants generally expected inflation to decline to levels consistent with price stability. A few participants noted that disruptions to the credit intermediation process and the inefficiencies associated with shifts of resources among economic sectors could be expected to reduce aggregate supply as well as restrain aggregate demand; as a consequence, such factors could limit the effect of slower output growth on rates of resource slack and inflation. Others, though, saw a risk that if resource utilization remained weak for some time, inflation could fall below levels consistent with the Federal Reserve's dual mandate for promoting price stability and maximum employment, a development that would pose important policy challenges in light of the already-low level of the Committee's federal funds rate target.
Participants discussed a number of issues relating to broader monetary policy strategy. Over the past year, the Federal Reserve's response to the financial turbulence had encompassed substantial monetary policy easing, the provision of large volumes of liquidity through standard and extraordinary means, and facilitating the resolution of troubled, systemically important financial institutions. Participants judged that the policy actions had been helpful and well calibrated to their assessment of the developing situation. Several participants observed that it would be crucial for such policy actions to be unwound appropriately as the financial situation normalized. However, participants also observed that unfolding economic developments could require the FOMC to further lower its target for the federal funds rate in the future and to review the adequacy of its liquidity facilities.
In the discussion of monetary policy for the intermeeting period, Committee members agreed that significant easing in policy was warranted at this meeting in view of the marked deterioration in the economic outlook and anticipated reduction in inflation pressures. The recent substantial tightening in financial conditions, the sharp downshift in spending here and abroad, and the rapid abatement of upside inflation risks all suggested that a forceful policy response would be appropriate. Some members were concerned that the effectiveness of cuts in the target federal funds rate may have been diminished by the financial dislocations, suggesting that further policy action might have limited efficacy in promoting a recovery in economic growth. And some also noted that the Committee had limited room to lower its federal funds rate target further and should therefore consider moving slowly. However, others maintained that the possibility of reduced policy effectiveness and the limited scope for reducing the target further were reasons for a more aggressive policy adjustment; an easing of policy should contribute to a beneficial reduction in some borrowing costs, even if a given rate reduction currently would elicit a smaller effect than in more typical circumstances, and more aggressive easing should reduce the odds of a deflationary outcome. Members also saw the substantial downside risks to growth as supporting a relatively large policy move at this meeting, though even after today's 50 basis point action, the Committee judged that downside risks to growth would remain. Members anticipated that economic data over the upcoming intermeeting period would show significant weakness in economic activity, and some suggested that additional policy easing could well be appropriate at future meetings. In any event, the Committee agreed that it would take whatever steps were necessary to support the recovery of the economy.
At the conclusion of the discussion, the Committee voted to authorize and direct the Federal Reserve Bank of New York, until it was instructed otherwise, to execute transactions in the System Account in accordance with the following domestic policy directive:
"The Federal Open Market Committee seeks monetary and financial conditions that will foster price stability and promote sustainable growth in output. To further its long-run objectives, the Committee in the immediate future seeks conditions in reserve markets consistent with reducing the federal funds rate to an average of around 1 percent."
The vote encompassed approval of the statement below to be released at 2:15 p.m.:
"The Federal Open Market Committee decided today to lower its target for the federal funds rate 50 basis points to 1 percent.
The pace of economic activity appears to have slowed markedly, owing importantly to a decline in consumer expenditures. Business equipment spending and industrial production have weakened in recent months, and slowing economic activity in many foreign economies is damping the prospects for U.S. exports. Moreover, the intensification of financial market turmoil is likely to exert additional restraint on spending, partly by further reducing the ability of households and businesses to obtain credit.
In light of the declines in the prices of energy and other commodities and the weaker prospects for economic activity, the Committee expects inflation to moderate in coming quarters to levels consistent with price stability.
Recent policy actions, including today's rate reduction, coordinated interest rate cuts by central banks, extraordinary liquidity measures, and official steps to strengthen financial systems, should help over time to improve credit conditions and promote a return to moderate economic growth. Nevertheless, downside risks to growth remain. The Committee will monitor economic and financial developments carefully and will act as needed to promote sustainable economic growth and price stability."
Votes for this action: Messrs. Bernanke and Geithner, Ms. Duke, Messrs. Fisher, Kohn, and Kroszner, Ms. Pianalto, Messrs. Plosser, Stern, and Warsh.
Votes against this action: None.
It was agreed that the next meeting of the Committee would be held on Tuesday, December 16, 2008.
The meeting adjourned at 11:45 a.m.