WASHINGTON — Policy makers at the Federal Reserve appeared almost stunned by an economy that was sinking faster than they had expected on almost every front in December, so much so that they even toyed with the idea of not announcing an official target for overnight interest rates, according to minutes of the meeting released on Tuesday.
At the meeting on Dec. 15 and 16, Fed policy makers jumped through the looking glass and slashed the benchmark federal funds rate on overnight loans between banks virtually to zero. Vowing to use “all available tools” for stimulating the economy, the Fed then outlined a radical new approach of pumping money into the economy through its own lending programs and through heavy purchases of mortgage-backed securities and possibly longer-term Treasury bonds.
Despite having already created a raft of new lending programs to financial institutions and even corporate borrowers, Fed policy makers as well as the Fed’s staff forecasters began the meeting with sharply reduced forecasts. They all expected a severe economic contraction that was likely to last through at least the first half of 2009.
“All meeting participants agreed that the economic downturn had intensified over all,” according to the minutes. The housing market was still weakening, credit conditions were tighter than ever, consumer spending had fallen for five months in a row. Even exports, which had been the one bright spot, were being hurt by a global economic slowdown.
“Many participants noted that the decline in household wealth resulting from large drops in equity and house prices, together with tighter credit conditions, rapidly increasing unemployment and deteriorating consumer sentiment, was contributing to a sharp contraction in consumer spending,” according to the meeting minutes.
Fed officials had scheduled a second day for the meeting to hash out their approach to policy once they reduced the federal funds rate to zero.
All of the policy makers agreed that they had to use “other tools” to stimulate the economy. But there was considerable debate about which tools would be most effective, and about how the Fed should communicate to the public about what it was doing.
In one of the most startling discussions, some policy makers argued that the central bank should simply drop its official target for the federal funds rate altogether. They noted that bank lending had become so paralyzed that the actual Fed funds rate was already well below the official target of 1 percent for the last month. Some advocates of not setting a Fed funds rate argued that it might actually help focus investor attention on the Fed’s new arsenal of policy measures.
Other policy makers feared that such a change would lead to confusion, and might prompt investors to think the Fed had lost control over short-term interest rates. In the end, the central bank lowered the target rate from 1 percent to a range from zero to one-quarter of a percent.
The minutes also conveyed a striking shift in worries about inflation. The minutes showed no hint that any of the Fed policy makers were worried that their actions might rekindle inflation. The only concerns about price levels were in connection with deflation, or an across-the-board decline in consumer prices.
Not only did policy makers agree that inflation would continue to fall, according to the minutes, but “some members saw significant risks that inflation could decline and persist for a time at uncomfortably low levels.” Officials also debated how they should communicate their actions once they stopped moving the Fed funds rate. Some wanted the Fed to announce quantitative targets for the amount of additional bank reserves they wanted to create, saying it might help ward off deflationary pressures.
The notes hinted at a possible power struggle between presidents of the Federal Reserve district banks, who serve on the Federal Open Market Committee that sets monetary policy, and the Federal Reserve Board in Washington, which consists of the Fed chairman and up to six Fed governors. The open market committee sets interest rates, but the Fed governors in Washington have the power on their own to enact new lending programs, bail out financial institutions or buy up particular kinds of securities.
“A few” of those who supported quantitative targets, according to the minutes, argued that it would help “coordinate” actions between Fed governors in Washington and the Federal Open Market Committee, which included regional Fed presidents. In the end, policy makers decided against setting any quantitative targets and to continue “close consultation between the committee and the board.”
Policy makers acknowledged that a Fed funds rate of zero could cause headaches in certain parts of the financials markets, like money-market mutual funds, which might have difficulty earning fees to cover their operating costs. But “most participants” agreed that the benefits of a lower rate outweighed the headaches.
