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May 10, 2006
A meeting of the Federal Open Market Committee was held in the offices of the Board of Governors
of the Federal Reserve System in Washington, D.C., on Wednesday, May 10, 2006 at 8:30 a.m.
Present:
Mr. Bernanke, Chairman
Mr. Geithner, Vice Chairman
Ms. Bies
Mr. Guynn
Mr. Kohn
Mr. Kroszner
Mr. Lacker
Mr. Olson
Ms. Pianalto
Mr. Warsh
Ms. Yellen
Mr. Hoenig, Ms. Minehan, and Messrs. Moskow and Poole, Alternate Members of
the Federal Open Market Committee
Messrs. Fisher and Stern, Presidents of the Federal Reserve Banks of Dallas and
Minneapolis, respectively
Mr. Stone, First Vice President, Federal Reserve Bank of Philadelphia
Mr. Reinhart, Secretary and Economist
Ms. Danker, Deputy Secretary
Ms. Smith, Assistant Secretary
Mr. Skidmore, Assistant Secretary
Mr. Alvarez, General Counsel
Ms. Johnson, Economist
Mr. Stockton, Economist
Messrs. Connors, Eisenbeis, Judd, Kamin, Madigan, Sniderman, Struckmeyer, and
Wilcox, Associate Economists
Mr. Kos, Manager, System Open Market Account
Messrs. Oliner and Slifman, Associate Directors, Division of Research and Statistics,
Board of Governors
Mr. Simpson, Senior Adviser, Division of Research and Statistics, Board of
Governors
Mr. Orphanides, Adviser, Division of Monetary Affairs, Board of Governors
Mr. Small, Project Manager, Division of Monetary Affairs, Board of Governors
Mr. Wright, Section Chief, Division of Monetary Affairs, Board of Governors
Mr. Luecke, Senior Financial Analyst, Division of Monetary Affairs, Board of
Governors
Ms. Low, Open Market Secretariat Specialist, Division of Monetary Affairs, Board of
Governors
Mr. Werkema, First Vice President, Federal Reserve Bank of Chicago
Messrs. Fuhrer and Rosenblum, Executive Vice Presidents, Federal Reserve Banks of
Boston and Dallas, respectively
Messrs. Evans and Hakkio, Ms. Mester, and Mr. Rasche, Senior Vice Presidents,
Federal Reserve Banks of Chicago, Kansas City, Philadelphia, and St. Louis,
respectively
Mr. Hilton, Vice President, Federal Reserve Bank of New York
Mr. Potter, Assistant Vice President, Federal Reserve Bank of New York
Mr. Weber, Senior Research Officer, Federal Reserve Bank of Minneapolis
Mr. Hetzel, Senior Economist, Federal Reserve Bank of Richmond
The Manager of the System Open Market Account reported on recent developments in
foreign exchange markets. There were no open market operations in foreign currencies for
the System's account in the period since the previous meeting. The Manager also reported on
developments in domestic financial markets and on System open market transactions in
government securities and federal agency obligations during the period since the previous
meeting. By unanimous vote, the Committee ratified these transactions.
With Mr. Lacker dissenting, the Committee voted to extend for one year beginning in
mid-December 2006 the reciprocal currency ("swap") arrangements with the Bank of Canada
and the Banco de Mexico. The arrangement with the Bank of Canada is in the amount of $2
billion equivalent, and that with the Banco de Mexico is in the amount of $3 billion
equivalent. Both arrangements are associated with the Federal Reserve's participation in the
North American Framework Agreement of 1994. The vote to renew the System's
participation in the swap arrangements maturing in December was taken at this meeting
because of the provision that each party must provide six months prior notice of an intention
to terminate its participation. Mr. Lacker dissented because of his opposition, as indicated at
the January meeting, to foreign exchange market intervention by the Federal Reserve, which
such swap arrangements facilitate, and because of his opposition to direct lending to foreign
central banks.
By unanimous vote, the Committee delegated the authority to review and determine appeals
of a denial of access to Committee records under FOIA and other rules to the Board members
designated as the primary and alternate Administrative Governors for Freedom of
Information and Privacy Act Matters. Also by unanimous vote, the Committee established a
FOIA Requester Service Center and designated Carol R. Low to fulfill the associated
responsibilities.
The information reviewed at this meeting suggested that economic activity expanded
strongly in the first quarter and that gains were widespread across most categories of final
sales. Consumer spending posted a sizable increase, driven by January's bounceback in motor
vehicle purchases and an acceleration in spending on other goods at the turn of the year. In
addition, favorable weather boosted housing construction early in the quarter. Later in the
quarter, however, the pace of consumer spending moderated, and housing starts retraced their
earlier run-up. Business investment spending strengthened in the first quarter, in part because
of a surge in the purchases of transportation and high-tech equipment and a step-up in
nonresidential construction. Manufacturing production also posted solid gains in the first
quarter and payroll growth moderated a bit in April after robust gains in employment in the
first quarter. Overall consumer prices jumped in March because of higher energy prices,
while core prices rose a bit more rapidly than in earlier months.
Nonfarm payrolls increased by 138,000 jobs in April following robust growth in March. The
gains in April were widespread: Manufacturing and related industries registered significant
increases, mining activity and employment were boosted by rising energy prices,
construction hiring posted a moderate gain, and a range of services-producing industries
strengthened, with the important exception of retail trade, which more than reversed its
March gains. Average hours of production or nonsupervisory workers on private nonfarm
payrolls edged up in April. The increases in the workweek and employment in April led to
notable growth in aggregate hours of production or nonsupervisory workers. The
unemployment rate edged down to 4.7 percent in March and remained at that level in April.
Industrial production in March expanded at about the same strong pace as it did in February,
with gains posted across all major components of the index. Manufacturing activity picked
up in March after a lull in February. While manufacturing growth for the first quarter as a
whole slowed from the rapid pace of the fourth quarter, it exceeded that of the previous year.
Manufacturing capacity utilization during the quarter was a bit above its long-run average.
Mining output--which includes oil and natural gas extraction--strengthened in the first
quarter as a whole. Within the quarter, however, the boost from hurricane-related recovery
seemed to ebb. While utility output surged in February and moved up a bit more in March,
these increases only partly reversed the weather-related plunge in January.
Growth of consumer spending appeared to moderate after posting sizable gains around the
turn of the year. Excluding motor vehicles, real outlays rose temperately in March, boosted
by the continued rise in spending on services. Spending on goods excluding motor vehicles
posted a second-straight monthly decline after robust gains over the previous four months.
Sales of light vehicles held steady in March and picked up a bit in April, bringing the average
pace for the year well above that of the fourth quarter but about even with the rate of last
year. Although continued improvements in the labor market had been generating
considerable gains in nominal wage and salary income, rising gasoline prices held down the
increase in real disposable personal income in March and were expected to damp it in April
as well. Ongoing increases in home prices and additional gains in the stock market, however,
further boosted household wealth during the first quarter. Measures of consumer confidence
remained consistent with moderate increases in consumer spending.
The underlying pace of residential activity seemed to moderate in the first quarter. After
unseasonably warm weather allowed a high level of single-family housing starts in January
and February, starts fell in March to their lowest level in a year. New permit issuance for
single-family homes also fell in March, continuing its downward trend. Multifamily starts
recovered a bit in March from their low rate in February but remained well within their
historical range. Home sales also declined, on net, in recent months. Although sales of
existing single-family homes edged up in February and March, the level of sales for the first
quarter as a whole was notably below the record high in the second quarter of last year. Sales
of new homes also moved up in March, but their average in the first quarter was down
substantially from the peak in the third quarter of last year. House price appreciation
appeared to have slowed from the elevated rates seen over the past summer. Growth in the
average sales price of existing homes in March, versus a year earlier, decelerated sharply, and
the average price for new homes in March fell compared to a year earlier. In addition, other
indicators, such as months' supply of both new and existing homes for sale and the index of
pending home sales, supported the view that housing markets had cooled in recent months.
Real outlays for equipment and software surged in the first quarter after a relatively subdued
performance in the fourth quarter of last year. Much of the growth reflected a sharp jump in
business purchases of transportation equipment, such as airplanes and motor vehicles.
Spending on high-tech equipment and software also improved as exceptionally strong growth
in expenditures for communications equipment more than compensated for fairly soft
spending on computers and peripherals and on software. Conditions in the nonresidential
construction sector improved noticeably. Although spending on nonresidential building
construction remained well short of the robust levels seen in late 2000, growth of
expenditures in this sector was at its fastest pace in the first quarter in nearly six years.
Outlays on drilling and mining structures continued to climb in the first quarter, and available
data pointed to ongoing growth.
Real nonfarm inventories stepped down in the first quarter, largely reflecting a decline in
investment in motor vehicle inventories. Excluding motor vehicles, inventories increased at a
pace well above that in the fourth quarter. Over the past twelve months, inventories relative
to shipments and sales had moved down moderately on balance, extending the long-run
downward trend.
The U.S. international trade deficit narrowed in February as a sharp decrease in imports more
than offset a modest fall in exports. The declines in both categories were generally
widespread across sectors with the exception of oil imports, which were flat, and imported
services, which rose. Incoming data for foreign industrial economies were generally
favorable and pointed to continued expansion. Available data showed continued growth in
GDP in the United Kingdom in the first quarter, continuing strong domestic demand in
Canada through February, ongoing recovery in Japan, and a first-quarter rebound in euro-area
economic performance.
Headline inflation turned up in March. Although the price of natural gas had fallen because
of continued plentiful inventories, retail gasoline prices surged, leading to a jump in overall
energy prices for the month. Prices of core goods and services also rose more quickly in
March, largely because of a spike in the apparel component that unwound a decline in
February and a one-time step-up in medical prices related to changes in Medicare
reimbursement rules. During the twelve months ending in March, overall inflation rose at a
slightly faster pace than that in the preceding twelve-month period, while core prices for the
same period increased a bit more slowly than in the previous year. Producer price inflation
also moved up in March, driven largely by higher food and energy prices. Readings on the
growth in the cost of labor were mixed. Over the three months ending in March, the
employment cost index for hourly compensation of private industry workers rose at its
slowest pace in several years. Data on compensation per hour in the nonfarm business sector,
however, pointed toward notably faster growth in the first quarter. Some financial-market and
survey indicators suggested that inflation expectations, both for the upcoming year and for
the longer term, had moved up since the March meeting.
At its March meeting, the Federal Open Market Committee decided to raise its target for the
federal funds rate 25 basis points, to 4¾ percent. In its accompanying statement, the
Committee indicated that the slowing of the growth of real GDP in the fourth quarter of 2005
seemed largely to have reflected temporary or special factors. Economic growth had
rebounded strongly in the first quarter but seemed likely to moderate to a more sustainable
pace. As yet, the run-up in the prices of energy and other commodities appeared to have had
only a modest effect on core inflation, ongoing productivity gains had helped to hold the
growth of unit labor costs in check, and inflation expectations had remained contained. Still,
the Committee noted that possible increases in resource utilization, in combination with the
elevated prices of energy and other commodities, had the potential to add to inflation
pressures. In these circumstances, the Committee judged that 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, but reiterated that in any event the Committee would
respond to changes in economic prospects as needed to foster these objectives.
Investors anticipated the FOMC's decision at its March meeting to raise the target federal
funds rate 25 basis points, but the Committee's post-meeting statement evidently led them to
mark up somewhat their expected path for the federal funds rate. Subsequently, the path was
pushed up further by data releases that were, on balance, stronger than market participants
had expected. Speeches by Federal Reserve officials, the minutes of the March meeting, and
Congressional testimony by the Chairman combined to restrain policy expectations some. On
net, the anticipated path of the federal funds rate over the next two years nonetheless rotated
upward. Yields on inflation-indexed Treasury securities moved up over the intermeeting
period, but yields on nominal Treasury issues rose more. Spreads of yields on
investment-grade bonds over those on comparable-maturity Treasury securities were about
unchanged, while those on speculative-grade bonds declined. Major stock price indexes were
up a bit over the intermeeting period, as positive first-quarter earnings reports more than
offset the negative effects of higher energy prices and rising interest rates.
The trade-weighted exchange value of the dollar against major foreign currencies fell since
the March meeting. Increased focus in public debate on the risks posed by the large U.S.
external imbalance appeared to erode investor support for the dollar.
Domestic nonfinancial sector debt was estimated to have grown at a robust pace in the first
quarter, down only slightly from the brisk pace of 2005. Business sector debt appeared to
have expanded strongly, supported by significant net issuance of U.S. corporate bonds and
double-digit growth of business loans at commercial banks. In the household sector,
consumer credit continued to rise slowly, and the growth of household mortgage debt was
thought, based on limited data, to have moderated somewhat in the first quarter against a
backdrop of higher mortgage interest rates and some signs of a deceleration in house prices.
M2 advanced at a pace somewhat below that of nominal GDP in the first quarter and was
estimated to have expanded moderately in April.
The staff forecast prepared for this meeting showed real GDP growth moderating somewhat
from the average pace of the previous several quarters. The projected deceleration of real
GDP reflected the lagged effects of the tightening of monetary policy, the waning impetus
from increases in household wealth, and reduced stimulus from fiscal policy. While higher
energy prices were expected to boost inflation in the near term, structural productivity was
strong, and the influence of higher energy and material costs was thought likely to moderate.
Thus, consumer prices, after increasing at a faster rate in the first half of the year, were
expected to decelerate later this year and next year.
In their discussion of the economic situation and outlook, meeting participants saw the
economy as having rebounded strongly so far this year after the slowing of growth in the
fourth quarter. The advance in output had been vigorous in the first quarter of this year, with
real GDP increasing at around a 5 percent annual rate. Although the expansion appeared
likely to moderate, it evidently remained solid. Inflation pressures appeared to be somewhat
greater than the Committee had anticipated at the time of its March meeting. Consumer
prices recently had risen at a pace noticeably above the average rise over the previous twelve
months. Also, prices of energy and many other commodities had climbed sharply of late, and
inflation expectations appeared to have risen slightly. If economic growth continued to
moderate over coming quarters, as anticipated, pressures on productive resources would most
likely continue to be limited. Most participants expected that, after allowing for some
possible near-term volatility related to the recent jump in energy and other commodity prices,
core inflation would probably remain around the levels experienced on average over the past
year. However, recent developments suggested that upside risks to inflation had risen
somewhat since the time of the March meeting.
In their discussion of major sectors of the economy, some participants noted that growth of
household spending was likely to slow over the remainder of the year. Anecdotal information
pointed to some cooling of housing markets. That cooling was especially noticeable for
high-end homes and for houses in markets that previously had experienced the steepest
appreciation. Data on home sales, permits, and starts on the whole likewise suggested that
activity was gradually diminishing. Some reports indicated that speculative building of
homes had dropped off considerably, but inventories of unsold homes still seemed to be
expanding. Although fresh comprehensive data were not available, home prices on average
appeared still to be rising, but at a slower pace than over the past few years. Going forward,
growth in consumption spending was likely to be supported by gains in employment and
personal income. But slower appreciation of home prices and the effects of the increases in
energy prices and interest rates that had already occurred would likely act to restrain
consumption spending somewhat. Certain features of recently popular nontraditional
mortgage products had the potential to cause financial difficulties for some households and
erode mortgage loan performance for some lenders. Nonetheless, the household sector
seemed likely to remain in sound financial condition overall. On balance, consumption
spending was viewed as most likely to expand at a moderate pace in coming quarters.
Several participants remarked that business investment spending was robust. Nonresidential
construction was accelerating notably, in the process absorbing some of the resources that
were being diverted from housing. Office vacancy rates were declining, spurring construction
of new office buildings. Drilling and mining activity was said to be particularly strong,
propelled by the high levels of energy prices. Investment in equipment and software appeared
to be expanding at a solid rate. Capital formation was likely to continue to be supported by
rising output, strong balance sheets in the business sector, and ready availability of financing
on attractive terms.
Some participants commented on the recent surge in federal tax revenues, a development that
was being mirrored at the state level. While the precise reasons for the increase in federal
receipts were not entirely clear, robust income growth was probably an important factor. In
any case, the effect was to trim the current federal budget deficit noticeably. Nonetheless, the
longer-run federal fiscal imbalance remained a serious concern.
Data on economic growth outside the United States indicated that the global expansion was
firming, a sense amplified by reports from international contacts. The apparent strengthening
of global growth was likely to support U.S. exports and economic activity and would also
tend to maintain upward pressures on energy and commodity prices.
Meeting participants expressed some concern about recent price developments and their
implications for inflation prospects. Core consumer inflation lately had been a little higher
than expected. Moreover, energy prices had risen steeply in the period since the March
meeting, and, although pass-through apparently had been limited to date, the most recent
increases might be reflected to a greater degree in core inflation in coming months.
Participants noted that prices of non-energy commodities, such as industrial metals and
building supplies, also had been climbing. The recent decline in the dollar was another factor
that could add to inflation pressures, although the effect of prior changes in the foreign
exchange value of the dollar on core consumer prices had apparently been limited. Business
contacts had reported continued shortages of certain types of skilled labor and related wage
pressures in some occupations, which would tend to boost costs.
However, participants also cited some factors that could be expected to restrain inflation.
Although alternative measures of labor compensation provided divergent readings, growth of
total compensation on balance appeared to remain moderate. And, even if nominal wages
should accelerate somewhat, relatively wide profit margins could buffer the effect on prices
of final goods and services. While firms would seek to maintain those margins, recent
experience suggested that this might be accomplished in part through further productivity
gains, which had remained fairly strong on balance in recent quarters, rather than through
more rapid price hikes.
Participants discussed in some detail inflation expectations--a potentially important factor
influencing future inflation trends. Some surveys suggested that inflation expectations had
risen in recent weeks, but others implied that expectations were little changed. Measures of
inflation compensation based on the difference between yields on nominal Treasury
securities and inflation-indexed issues had edged higher. It was possible, though, that
investors' uncertainty regarding inflation prospects, not just inflation expectations
themselves, had risen. On balance, participants judged that inflation expectations had risen
somewhat--a development that would have to be taken into account in policymaking and
warranted close monitoring--but remained contained.
Although the Committee discussed policy approaches ranging from leaving the stance of
policy unchanged at this meeting to increasing the federal funds rate 50 basis points, all
members believed that an additional 25 basis point firming of policy was appropriate today to
keep inflation from rising and promote sustainable economic expansion. Recent price
developments argued for another firming step at today's meeting. Core inflation recently had
been a bit higher than had been expected, and several members remarked that core inflation
was now around the upper end of what they viewed as an acceptable range. Moreover, a
number of factors were augmenting the upside risks to inflation: the surge in energy and
commodity prices, some recent weakness in the foreign exchange value of the dollar, and the
possibility that the apparent increase in inflation expectations could, if it persisted, impart
momentum to inflation. In addition, the economy appeared to be operating at a relatively
high level of resource utilization and had been growing quite strongly, and whether economic
growth would moderate to a sustainable pace was not yet clear. At the same time, members
also saw downside risks to economic activity. For example, the cumulative effect of past
monetary policy actions and the recent rise in longer-term interest rates on housing activity
and prices could turn out to be larger than expected. Still, it seemed most likely that, with
modest further policy action, including a 25 basis point firming today, growth in activity
would moderate gradually over coming quarters, pressures on resources would remain
limited, and core inflation would stay close to levels experienced over the past year.
Given the risks to growth and inflation, Committee members were uncertain about how
much, if any, further tightening would be needed after today's action. In view of the risk that
the outlook for inflation could worsen, the Committee decided to repeat the indication in the
policy statement released after the March meeting that some further policy firming could be
required. However, the Committee agreed to emphasize that "the extent and timing of any
such firming will depend importantly on the evolution of the economic outlook as implied by
incoming information." Members debated the appropriate characterization of inflation
expectations in the statement. Low and stable inflation expectations were key to the
attainment of the Committee's dual objectives of price stability and maximum sustainable
economic growth. However, the apparent pickup in longer-term expectations, while
worrisome, was relatively small. They remained within the range seen over the past couple of
years, and the increase could well reverse before long. Accordingly, it appeared appropriate
to characterize inflation expectations again as "contained."
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 increasing the federal funds rate to
an average of around 5 percent."
The vote encompassed approval of the paragraph below for inclusion in the statement to be
released shortly after the meeting:
"The Committee judges that some further policy firming may yet be needed to
address inflation risks but emphasizes that the extent and timing of any such
firming will depend importantly on the evolution of the economic outlook as
implied by incoming information. In any event, the Committee will respond to
changes in economic prospects as needed to support the attainment of its
objectives."
Votes for this action: Messrs. Bernanke and Geithner, Ms. Bies, Messrs. Guynn, Kohn,
Kroszner, Lacker, and Olson, Ms. Pianalto, Mr. Warsh, and Ms.Yellen.
Votes against this action: None.
During the interval between the March and May meetings, Chairman Bernanke had
appointed a subcommittee on communications issues to be chaired by Governor Kohn and
including Presidents Stern and Yellen. At today's meeting, Governor Kohn indicated that the
objective of the subcommittee was to help the Committee frame and organize discussion of a
broad range of such issues over coming meetings.
The meeting adjourned at 1:10 p.m.
Notation Vote
By notation vote completed on April 17, 2006, the Committee unanimously approved the
minutes of the Federal Open Market Committee meeting held on March 27-28, 2006.
Vincent R. Reinhart
Secretary
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