At its May meeting, the Fed prepared markets for a rate hike that it never intended to result in an inevitable move when it announced the bias toward tightening. But the FOMC did end up raising the FFR in June, despite the fact that April’s jump in the core CPI appeared to be a one-off event rather than an indication that inflation had begun to accelerate. So why did the Fed act?
As the transcripts reveal, the Fed’s new instrument failed to affect markets in the way the Fed anticipated:
I was startled by the extraordinary market talk after we announced an asymmetrical directive following the May meeting. . . We might as well have raised rates at that point as far as I am concerned. . . . Indeed, what we are looking at is a long-term interest rate that is moving up because market participants think the Fed is going to move (Greenspan, Transcript, June, p. 88).
Thus, because markets were anticipating a rate hike, some saw the increase as preordained, arguing that raising the federal funds rate was “largely a foregone conclusion” (Boehne, Transcript, June, p. 44). Others, such as President McTeeter and Vice Chairman McDonough believed that conditions did not merit an increase and that the Fed should show restraint until such time as inflation appeared to resurface:
[T]he public and markets everywhere are waiting for us to pounce on growth and job creation and stifle them. Since I do not believe we should do that, I believe that our challenge is to clarify out strategy – first to ourselves, then to the public and the markets. . . . we should not be in a tactical position of being constantly poised to attack an enemy that does not appear visible to me. We need to find a way to tactical symmetry – to a position where we, the public, and the markets think we are watchfully waiting but not looking for windmills to knock down (McDonough, Transcript, June, p. 48).
Thus, while some felt compelled to validate the market’s expectations in order to maintain credibility, others believed that a rate hike was unwarranted in the absence of troublesome news on the inflation front. After much deliberation, the FOMC felt compelled to move, voting to raise the FFR 25 basis points at the close of its June meeting.
To justify the June increase, members argued that despite a drop in the core CPI, there were reasons to believe that inflationary pressures were mounting. Some truly strange anecdotes were offered as “evidence” of these pressures. For example, President Broaddus relayed the following story:
One of our economists [from the First District] has a close friend who has a house in the Boston area. The friend got an estimate last year for an addition to his house but didn’t have the work done. He got an estimate again just recently, a year later, and it’s up about 30 percent. That’s really extraordinary!” (Transcript, June 1999, p. 40).
And President Minehan shared the following:
The job market for summer teenage employment is strikingly good if my 17-year old and his friends are any indication of that market” (Transcript, June 1999, p. 37).
No one offered any tangible evidence of pipeline inflation. Yet the majority – many of whom felt ‘boxed in’ by the May directive – clearly wanted to raise the FFR. Ultimately, they justified their move for the record by offering anecdotal evidence and impassioned commentary about the importance of credibility and the need to fulfill market expectations.
- Bell-Kelton, Stephanie. “Behind Closed Doors. The Political Economy of Central Banking in the United States.” International Journal of Political Economy 35.1 (2006): 5-23.