I was travelling back on 9/16, which marks the fifth anniversary of the Fed´s fateful decision to ‘stand pat’, despite the Lehmann affair of the previous day. Scott Sumner has a post in which he says that´s the day he became a market monetarist.
I went to the minutes of the meeting. It is a “what not to do” guide for future chairmen. At the meeting´s conclusion we read:
Members agreed that keeping the federal funds rate unchanged at this meeting was appropriate. The current low real federal funds rate appeared necessary to provide adequate counterweight to the restraining effects of tight credit conditions and of continued declines in the housing market on spending and output.
Committee members generally saw the current stance of monetary policy as consistent with a gradual strengthening of economic growth beginning next year, although they recognized that recent financial developments had boosted the downside risks to the economic outlook. Inflation risks appeared to have diminished in response to the declines in the prices of energy and other commodities, the recent strengthening of the dollar, and the outlook for somewhat greater economic slack, and Committee members were a bit more optimistic that inflation would moderate in coming quarters. However, the possibility that core inflation would not moderate as anticipated was still a significant concern. With substantial downside risks to growth and persisting upside risks to inflation, members judged that leaving the federal funds rate unchanged at this time suitably balanced the risks to the outlook. Some members emphasized that if intensifying financial strains led to a significant worsening of the growth outlook, a policy response could be required; however, such a response was not called for at this meeting. Indeed, it was noted that, with elevated inflation still a concern and growth expected to pick up next year if financial strains diminish, the Committee should also remain prepared to reverse the policy easing put in place over the past year in a timely fashion.
And they were ‘finger itchy’ to pull the interest rate trigger!
This had been going on for a while. In the August meeting, for example, in addition to Richard Fisher´s dissent, wanting an immediate rise in the FF rate, the minutes from that meeting concluded:
Although members generally anticipated that the next policy move would likely be a tightening, the timing and extent of any change in policy stance would depend on evolving economic and financial developments and the implications for the outlook for economic growth and inflation.
Some pictures help us see how misguided they were. The red dots mark the information available to the committee at the time of the meeting.
Apparently the information they received during the meeting that industrial production had fallen 1% in August or that the unemployment rate had jumped more than 1 percentage point in just a few months or that inflation expectations were coming down fast, as were oil prices, did not matter at all. All that counted was the fact that headline inflation was elevated! (I find it interesting that always when inflation is below target it is believed to be something “temporary”, but that it will quickly ‘contaminate’ expectations when it is above target).