The January FOMC Meeting: All Done Tightening (Maybe)

January 31, 2006 – The FOMC voted today to raise its Fed funds target by 25 basis points to 4.5%. This was the fourteenth 25 basis-point increase (Chart 1). It also may be the last.

Chart 1. The nominal and real target Fed funds rate. January 1987 through January 2006.

According to the FOMC’s post-meeting policy statement, “Although recent economic data have been uneven, the expansion in economic activity appears solid.” Thus, the FOMC seems to have been largely unmoved by Friday’s weak Q4 GDP report.

The recent inflation data remain acceptable. Nevertheless, FOMC members continue to worry that “possible increases in resource utilization as well as elevated energy prices have the potential to add to inflation pressures”.

The biggest change in today’s FOMC statement took the form of a few small words. In the boilerplate language describing the outlook for U.S. monetary policy, the FOMC said, “…some further policy firming may be needed to keep the risks to the attainment of both sustainable economic growth and price stability roughly in balance.” In the last FOMC statement (in December), this phrase began with the words, “…some further measured policy firming is likely to be needed…” (Differences are highlighted in red.)

Thus, we “may” see further monetary policy tightening, but it is no longer “likely”. In addition, if the FOMC should decide that further tightening is needed, they are no longer promising to restrain themselves to small (“measured”) 25 basis point increases in their Fed funds target. These changes open the door to a wide array of future policy choices.

In particular, it looks like today’s tightening action effectively completed the FOMC’s policy “program” of gradually unwinding its past easing actions. While this doesn’t rule out future tightening, it does mean (as noted in the FOMC’s December minutes) that future monetary policy will depend more on economic developments than it has in the recent past.

At the same time, given its continuing emphasis on inflation risks, the FOMC seems to have retained an implicit tightening bias. Easing doesn’t seem to be on the table, at present.

Convincing evidence of rising inflation or rising inflation risks would probably provoke further tightening. The size of any future tightening moves would vary in part with the strength of this evidence.

At this point, however, the presumption for the FOMC’s next policy meeting on March 28 seems to be a steady course for U.S. monetary policy. Contingent on the economic data for the next two months, that’s the current best guess here.

Suzanne Rizzo

Note: Fed Chairman Greenspan will retire from the Federal Reserve Board effective tomorrow (Wednesday, February 1). The Senate confirmed Ben Bernanke as Greenspan’s replacement today. Bernanke will be sworn in tomorrow morning in a private ceremony at the Federal Reserve Board.