Transcripts of the monetary policymaking body of the Federal Reserve from 2002–2008.

Thank you, Mr. Chairman. At our last meeting, my inclination was to favor an additional 25 basis point increase in the fed funds rate. In my view, there has been very little change in the economic case for some additional policy firming. The incoming data have not persuaded me to think that growth would be considerably below trend in ’07, although I do think that there will be moderation over the next couple of quarters. I do not think that a 25 basis point change in interest rates one way or the other will have much effect on the housing market at this point, and I do not believe that we should stand in the way of the adjustment to the housing sector to move to a more sustainable level of activity.

Thus far the Committee has maintained its credibility, and long-run inflation expectations have been stable. That is very good. My concern, however, is that the longer we tolerate inflation above our comfort zone, the more risk we have that those expectations will become unhinged. Their becoming unhinged, as I noted in my earlier comments, could lead to some very unpleasant outcomes, and we would find regaining our credibility very difficult. Because of the weakness in residential investment, a rise in the fed funds rate could be viewed as potentially costly; but that potential cost increases the value of the actions as a signal of the Fed’s commitment and its effectiveness in keeping inflation expectations firmly in check.

As the discussions around this table in August and today show, reasonable people doing sound economic analysis can have different views about whether further policy firming will be needed. I understand and respect both sides of that argument. My goal at this point is to stress, as many people have stressed, that we shouldn’t lose sight of the importance of our credibility and to state that I am unhappy with the level of core inflation and with the pace at which it seems to be declining, at least in the staff’s forecast. Credibility is difficult to acquire and easy to lose. If we convince ourselves at each juncture of the decisionmaking process that at the margin we can risk sacrificing a little credibility to achieve some other loosely defined and perhaps illusive objective, we may find our capital significantly depleted. Once that is obvious in the data, it is too late.

The decision to pause in August was a close call, but the pause cannot be ignored, I think, in deciding the appropriate action for today. While I believe the language we used in our August statement gives us the flexibility to raise rates, I think doing so today would pose a very different and difficult communication challenge. I argued last time that, if the data for August and September continued to evolve as they had in June and July, it would be hard to change our policy stance if we paused in August. That seems to be exactly where we are. I might argue that another six weeks of inflation above our comfort zone has increased the risk to our credibility, but I think that initiating a rate increase so soon after pausing, given the data we have received, could be misinterpreted and pose its own risk to our credibility for sound monetary policymaking.

Thus, I come down on the side that it would be better to remain on hold for this meeting but to have strong enough language in today’s statement to enable us to initiate rate increases in the near future unless the incoming data are significantly different from what we’ve expected. The language in alternative B+ comes close to doing that. It is important that we continue to say, as in section 4, that inflation risks remain. I would not like to cite factors restraining aggregate demand in the list of things that would potentially help moderate inflation. I do not think we can measure the tradeoffs between growth and inflation precisely enough to depend on a moderate deceleration to bring inflation down over the forecast period. Moreover, and even more important to me, such language fosters a belief among the public and others that we have a desire and an ability to engage in fairly precise fine-tuning.

I am opposed to alternative A language. First, I do not think that we can say with any great confidence that inflation risks appear to have diminished. Second, I do not think that saying “downside risks to growth have become more significant” is helpful at this point. Saying that is likely to lower the expected path of future interest rates, as has been pointed out, and to reinforce the idea that interest rates are likely to come down sooner than is built into our forecast. To the extent that the assessment-of-risk language is supposed to help with the public’s understanding of the monetary policy process over the coming months, I think the language in alternative A would be counterproductive.

Finally, I would like to reiterate a point that has been made around the table several times. When we look at the longer-term survey data and at what the markets are saying, they seem to be reading the fact that we do not actually have a target zone of 1 to 2 percent. The target zone is really maybe 1 to 3 percent or 2 to 3 percent. If in fact our comfort zone is 2 to 3 percent, then we should communicate that fairly directly rather than speaking one way and acting another way. Of course, as Governor Kohn and several others mentioned, that point brings us right back to the communication issue, which I think will be a very important agenda item in the coming meeting. Thank you, Mr. Chairman.

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