The 2008 transcripts confirm: The Fed´s obsession with inflation “crashed” the economy

David Andolfato wrote a post: “2008”:

Like many people out there, I am eagerly awaiting the release of the full transcripts of the Fed’s monetary policy meetings for 2008. When they come out (and it should be very soon), you will be able to find them here. (Note: it´s out)

I expect that the media will have a field day with these. No doubt a number of Fed officials will have said things that, with the benefit of hindsight, they wish they had not said, or said somewhat differently.

Jim Bullard, president of the St. Louis Fed, recently gave a speech on the subject titled: The Notorious Summer of 2008. The slides associated with that speech are available here.

Bullard makes some very good observations:

First, many people think of the financial crisis as beginning in the fall of 2008, with the collapse of Lehman and AIG. In fact, the crisis had been underway for more than a year at that point (August 2007). The fact that the crisis had gone on for over a year without major turmoil suggested to many that the financial system was in fact relatively stable–it seemed to be absorbing various shocks reasonably well. Throughout this period of time, the Fed reacted with conventional monetary policy tools–lowering the Fed Funds target rate from over 5% to 2% over the course of a year.

So what happened? Essentially, an oil price shock. By June 2008, oil prices had more than doubled over the previous year. The real-time data available to decision-makers turned out to greatly underestimate the negative impact of this shock (and other factors as well). The rapidly slowing economy served to greatly exacerbate financial market conditions.

Is that it? Are we to understand that all the misery that has followed was the result of a frigging oil shock?

I don´t think so, and here´s why.

In the last stretch of his tenure Greenspan also faced a quite similar oil price shock. My charts consider two 20 month periods: December 2004 to July 2006 and December 2006 to July 2008.

Before putting them up, let´s check the peculiarities as gleaned from the post FOMC meeting statements.

August 08 (a “copy-paste” of the June statement): The Federal Open Market Committee decided today to keep its target for the federal funds rate at 2 percent.

Inflation has been high, spurred by the earlier increases in the prices of energy and some other commodities, and some indicators of inflation expectations have been elevated. The Committee expects inflation to moderate later this year and next year, but the inflation outlook remains highly uncertain.

Although downside risks to growth remain, the upside risks to inflation are also of significant concern to the Committee. The Committee will continue to monitor economic and financial developments and will act as needed to promote sustainable economic growth and price stability.

Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; Timothy F. Geithner, Vice Chairman; Elizabeth A. Duke; Donald L. Kohn; Randall S. Kroszner; Frederic S. Mishkin; Sandra Pianalto; Charles I. Plosser; Gary H. Stern; and Kevin M. Warsh. Voting against was Richard W. Fisher, who preferred an increase in the target for the federal funds rate at this meeting.

And next a very quick glimpse into the transcripts (just released) for the June 08 FOMC meeting. Note that “inflation” permeates the meeting:

The tightening expected over the next year is not anticipated to begin soon. As shown in exhibits 23 and 24, options on federal funds rate futures contracts currently imply that market participants expect that the FOMC will stand pat at both this and the August FOMC meetings. Although considerable tightening is priced in over the next year, this is not unusual at this stage of the monetary policy cycle.

Exhibit 11 presents the near-term inflation outlook. As you can see in the top left panel, the recent data on consumer prices have come in a little lower than we had expected at the time of the April Greenbook. As shown on line 3, core PCE prices rose only 0.1 percent in April, and based on the latest CPI and PPI readings, we expect an increase of 0.2 percent in May. As a result, we have marked down our estimate of core PCE inflation in the second quarter by 0.3 percentage point, to an annual rate of 2 percent. Total PCE prices (line 1) have risen at a substantially faster pace than core prices; but here, too, the current-quarter forecast is a little lower than in our previous projection, both because of the lower core inflation and because the sharp increases in oil prices have been slow to feed through to finished energy prices.

Despite this recent news, we expect inflation to rise sharply over the next few months. In part, this reflects our judgment that core prices were held down in the first half by some factors that will not persist into the second half. In addition, as shown to the right, we expect increases in food and energy prices to push up the twelve-month change in the total PCE price index more than 1 percentage point over the next several months, to about 4½ percent.

Regarding inflation, every single participant with the possible exception of Mishkin, showed grave concern. This is reflected in Bernanke´s summary:

My bottom line is that I think the tail risks on the growth and financial side have moderated. I do think, however, that they remain significant. We cannot ignore them. I’m also becoming concerned about the inflation side, and I think our rhetoric, our statement, and our body language at this point need to reflect that concern. We need to begin to prepare ourselves to respond through policy to the inflation risk; but we need to pick our moment, and we cannot be halfhearted. When the time comes, we need to make that decision and move that way because a halfhearted approach is going to give us the worst of both worlds. It’s going to give us financial stress without any benefits on inflation. So we have a very difficult problem here, and we are going to have to work together cooperatively to achieve what we want to achieve.

The last thing I’d like to say is on communications. Just talking about communications following this meeting, I’d like to advise everyone, including myself, to lean, not to lurch. That is, we are moving toward more concern about inflation, but we still have concerns about economic growth and financial markets. We should show that shift in emphasis as we talk to the public, but we should not give the impression that inflation is the entire story or that we have somehow decided that growth and financial problems are behind us, because they are not. So if we can convey that in a sufficiently subtle way, I think we will prepare the markets for the ultimate movements that we’re going to have to make.

Unfortunately, and that was to be expected, the “public” gathered that inflation, if not the entire story, was the major part. In the Minutes of that meeting we read that “likely the next move in interest rates will be up”!

Now, contrast the statement from that meeting with the one from September 2005, chaired by Greenspan:

Sep 05: The Federal Open Market Committee decided today to raise its target for the federal funds rate by 25 basis points to 3-3/4 percent.

Output appeared poised to continue growing at a good pace before the tragic toll of Hurricane Katrina. The widespread devastation in the Gulf region, the associated dislocation of economic activity, and the boost to energy prices imply that spending, production, and employment will be set back in the near term. In addition to elevating premiums for some energy products, the disruption to the production and refining infrastructure may add to energy price volatility.

While these unfortunate developments have increased uncertainty about near-term economic performance, it is the Committee’s view that they do not pose a more persistent threat. Rather, monetary policy accommodation, coupled with robust underlying growth in productivity, is providing ongoing support to economic activity. Higher energy and other costs have the potential to add to inflation pressures. However, core inflation has been relatively low in recent months and longer-term inflation expectations remain contained.

The Committee perceives that, with appropriate monetary policy action, the upside and downside risks to the attainment of both sustainable growth and price stability should be kept roughly equal. With underlying inflation expected to be contained, the Committee believes that policy accommodation can be removed at a pace that is likely to be measured.

Voting for the FOMC monetary policy action were: Alan Greenspan, Chairman; Timothy F. Geithner, Vice Chairman; Susan S. Bies; Roger W. Ferguson, Jr.; Richard W. Fisher; Donald L. Kohn; Michael H. Moskow; Anthony M. Santomero; and Gary H. Stern. Voting against was Mark W. Olson, who preferred no change in the federal funds rate target at this meeting.

Note that while in the August 08 statement Richard (Inspector Clouseau) Fisher wanted an immediate increase in rates, in September 05 Mark W. Olson wanted to keep rates pat.

The 2005 statement explicitly and emphatically mentions the stability of core inflation. In 2008 the statement eschews any mention of core inflation and is very concerned with rising headline inflation pulled up by oil prices.

A big difference in the two statements, to my mind, is Greenspan´s emphasis on “appropriate monetary policy action”. That´s certainly an elusive concept, but maybe a much better form of “communication” than the “lean not lurch” style proposed by Bernanke.

The charts.

1 The oil shocks


The 2004-06 shock is initially stronger than the 2006-08 one. Over the 20 month period the big difference between the two shocks shows up in the last three months.

2 Inflation: Headline and Core PCE


There´s no quantitative or qualitative difference in the behavior of core inflation in the two periods. Why did Bernanke ignore the signals from core inflation?

The headline inflation is qualitatively similar. In 2004-06 headline inflation is stronger early on given the timing of the rise in oil prices. Greenspan kept his cool, Bernanke didn´t!

3 10-year inflation expectations (Cleveland Fed)


Interestingly, to Greenspan longer term inflation expectations were contained. To Bernanke they appeared to be elevated. The drop in long term inflation expectations halfway through the 2006-08 period is quite consistent with the Fed´s demonstrated concern with inflation and is also indicative that, contrary to the Fed´s (and conventional) wisdom, monetary policy was “tightening”! Note that the Fed stopped reducing rates in the April meeting and they remained at 2% all the way to October 6 (that´s 3 weeks after Lehmann)!

4 Unemployment


As Bullard notes, “The fact that the crisis had gone on for over a year without major turmoil suggested to many that the financial system was in fact relatively stable–it seemed to be absorbing various shocks reasonably well.”

But as soon as the Fed “tightens”, unemployment starts going up. The next chart shows this clearly.

5 NGDP Gap


In December 07, by lowering the Fed Funds rate by only 25 basis points, less than the market expected (and showing concerns with inflation), monetary policy goes into tightening mode. The spending (NGDP) gap reacts almost instantly and soon unemployment picks up.

Bottom line: The oil shock of 07-08 was a trigger for the Fed´s actions. And these actions were inimical to the health of the economy, already weakened by the fall-out of the house price bust. It is clear from the statements, minutes and now transcripts for 2008 that the Fed´s focus was on headline inflation, and since that was being significantly impacted by oil prices, the “public” anticipated monetary policy tightening (a rise in rates). No wonder NGDP dropped significantly (plunging after July 08).

Contrast the Fed´s actions and reactions in 2008 to those that took place in 2005, also during a significant rise in oil prices.

The behavior of NGDP (here represented by the gap relative to the great moderation trend) is consistent with my view that the Bernanke Fed grossly mismanaged the monetary policy process and should take major responsibility for the macroeconomic consequences that followed.

Update: The verdict on “inflation obsession” is in:

We plugged all 1,865 pages of central-bankery into a computer programme and came up with a few extremely informative nuggets.

First, there is only one winner in the dual mandate. The word “inflation” (or variants thereof, such as “inflationary”) was mentioned a cool 2,664 times in 2008; “unemployment” pops up just 275 times. (After saying “inflation” a few thousand times it begins to sound funny.Inflation.)

20 thoughts on “The 2008 transcripts confirm: The Fed´s obsession with inflation “crashed” the economy

  1. “The behavior of NGDP (here represented by the gap relative to the great moderation trend) is consistent with my view that the Bernanke Fed grossly mismanaged the monetary policy process and should take major responsibility for the macroeconomic consequences that followed.”





    Either the financial system is going to implode in a major way, which will lead to a significant further easing, or it is not.

    But I should follow the philosophy of Charlie Brown, who I think said, “Never do today what you can put off until tomorrow.” [Laughter]

    Deleveraging is likely to occur with a vengeance as firms seek to survive this period of significant upheaval… I support alternative A to reduce the fed funds rate 25 basis points. Thank you.

    Mr HOENIG.
    I also encourage us to look beyond the immediate crisis, which I recognize is serious. But as pointed out here, we also have an inflation issue. Our core inflation is still above where it should be.

    MS YELLEN. I agree with the Greenbook’s assessment that the strength we saw in the upwardly revised real GDP growth in the second quarter will not hold up. Despite the tax rebates, real personal consumption expenditures declined in both June
    and July, and retail sales were down in August. My contacts report that cutbacks in spending are widespread, especially for discretionary items. For example, East Bay plastic surgeons and dentists note that patients are deferring elective procedures. [Laughter]

    Meanwhile, an inflation problem is brewing. The headline CPI inflation rate, the one consumers actually face, is about 6¼ percent year-to-date…My policy preference is to maintain the federal funds rate target at the current level and to wait for some time to assess the impact of the Lehman bankruptcy filing, if any, on the national economy.

    As I said, it is my view that the current stance of policy is inconsistent with price stability in the intermediate term and so rates ultimately will have to rise.

    Given the lags in policy, it doesn’t seem that there is a heck of a lot we can do about current circumstances, and we have already tried to address the financial turmoil. So I would favor alternative B as a policy matter. As far as language is concerned with regard to B, I would be inclined to give more prominence to financial issues. I think you could do that maybe by reversing the first two sentences in paragraph 2. You would have to change the transitions, of

    But I think we should be seen as making well-calculated moves with the funds rate, and the current uncertainty is so large that I don’t feel as though we have enough information to make such calculations today.

    Given the events of the weekend, I still think it is appropriate for us to keep our policy rate unchanged. I would like more time to assess how the recent events are going to affect the real economy. I have a small preference for the assessment-of-risk language under alternative A.

    In fact, it’s heartening that compensation growth is coming in a little below expected in response to the energy price shock this year. This has allowed us to accomplish the inevitable decline in real wages without setting off an inflationary acceleration in wage rates.

    I think what we did with Lehman was the right thing because we did have a market beginning to play the Treasury and us, and that has some pretty negative consequences as well, which we are now coming to grips with.

    I think it’s too soon to know whether what we did with Lehman is right. Given that the Treasury didn’t want to put money in, what happened was that we had no choice…I hope we get through this week. But I think it’s far from clear, and we were taking a bet, and I hope in the future we don’t have to be in situations where we’re taking bets.

    Mr. FISHER. All of that reminds me—forgive me for quoting Bob Dylan—but money doesn’t talk; it swears. When you swear, you get emotional. If you blaspheme, you lose control. I think the main thing we must do in this policy decision today is not to lose control, to show a steady hand. I would
    recommend, Mr. Chairman, that we embrace unanimously—and I think it’s important for us to be unanimous at this moment—alternative B

    Those would be my suggestions to try to strike that balance—that we are keenly focused on what’s going on, but until we have a better view of its implications, we are not
    going to act.

  3. Some things that really stand out to me so far in these transcripts:

    Worst prediction:

    Charles Plosser

    September 16:
    “As I said, it is my view that the current stance of policy is inconsistent with price stability in the intermediate term and so rates ultimately will have to rise.”

    Worst metaphors:

    Richard Fisher

    March 18:
    “The fact of the matter is that we have undertaken significant liquidity enhancement initiatives, and I think we’re going to have to do more, and I’ve been fully supportive of them, but I think 75 basis points, Mr. Chairman, is way too much. My thought is that it encourages the financial markets. They’re not going to be satisfied. I said this last time. It’s Jabba the Hutt. They will keep asking for more and more. We have to quit feeding them.”

    June 24:
    “So, Mr. Chairman, I would say that currently our patient—the economy—is indeed a sick puppy. … I think we have, like loyal practitioners and with the equivalent of the Hippocratic oath, done the job that we are expected to do in terms of resuscitating the victim. That is the good news. The real bad news is that our patient appears to be acquiring a staph infection in this hospital that we have created, and that staph infection is inflation.”

    September 16:
    “Money doesn’t talk; it swears. When you swear, you get emotional. If you blaspheme, you lose control. I think the main thing we must do in this policy decision today is not to lose control, to show a steady hand.”

    October 28-29:
    “Mr. Chairman, I think it is clear that inflation has been rolled over by the steamroller of the credit crisis. I am not going to belabor what I have heard from the CEOs I have spoken to. Basically, the best summary is that things have gone from interesting to unbelievable. We have had an implosion of economic activity. Business women and men, not having any pricing power, are doing what you would expect them to do: They are cutting their costs of goods sold, which means they are shedding head count dramatically.”

    And as Matthew Yglesias observed in a tweet:
    “…[there’s] a strong inverse correlation between being Richard Fisher and knowing what’s happening.”

    Best damage control ahead of the release of the 2008 transcripts:

    James Bullard

    The St Louis Fed tweeted a speech from last year with him arguing that the real-time economic data in 2008 was badly trailing events:

    David Andolfatto of the St. Louis Fed also has a new post (“2008”) linking to the same speech.

    The FOMC transcripts show that St. Louis Fed President Bullard, as late as September 2008, was far more worried about high inflation than the possibility of a recession.

    September 16:
    “Meanwhile, an inflation problem is brewing. The headline CPI inflation rate, the one consumers actually face, is about 6¼ percent year-to-date…”

    Inflation expectations as measured by 5-year TIPS closed at 1.23% the day before the September 16 meeting.

    Too bad he didn’t have as good foresight in 2008 as he evidently does now.

      • As well as the excellent Benjamin Cole guest posts, can’t you get Mark Sadowski doing a few too? With Scott blogging less, this would become the go-to site for monetarists.

        You can now see, in the absence of rules, the “reaction function” of central bank governors is key. Greenspan good, Bernanke poor. Mervyn King poor, Carney good (hopefully), as Britmouse likes to point out.

  4. Here’s Janet Yellen on October 7, 2008 (in regard to Bernanke’s proposal to cut the FF rate 50 basis points)

    MS. YELLEN: Thank you, Mr. Chairman.
    I strongly support your proposal to cut the federal funds rate by 50 basis points today and the wording of the statement. I’m pleased that the FOMC will take this step as part of a coordinated program with other central banks. In my opinion, a larger action could easily be justified and is ultimately likely to prove necessary. We’re
    witnessing a complete breakdown in the functioning of credit markets, and it is affecting every class of borrowers. The financial developments are dangerous and are having a pronounced impact on the economic outlook. The outlook has deteriorated very sharply, and even so, I still see the risks to the downside. Moreover, recent data on consumer and capital spending and on housing confirm that a sharp contraction in domestic demand is under way. As far as I’m concerned, for the reasons you gave, inflation risks have diminished markedly. Indeed, in a contraction as severe as that which is now on the horizon, I anticipate that inflation will decline noticeably below my own estimate of price stability.

    • After the “horse has bolted” some (only some) see the “real” problem (which is nominal).
      Pity they were so ‘conservative’ 10 months earlier (Dec 07). 50 bp then would have made a significant difference.

  5. Pingback: The 2008 transcripts confirm: The Fed´s obsession with inflation “crashed” the economy « Economics Info

  6. Some more selected quotes from the 2008 FOMC transcripts:

    1) The “are we there yet?” award

    Charles Plosser

    October 28-29:
    “We have been lowering the funds rate since January, largely in anticipation of a recession or to mitigate the chances of one occurring. Now, it may finally have arrived. Does that mean we have to lower more?”

    2) The “we blew up the economy, but at least we retained our credibility” award.

    Jeffrey M. Lacker

    September 16:
    “I don’t want to be sanguine about it, but the silver lining to all the disruption that’s ahead of us is that it will enhance the credibility of any commitment that we make in the future to be willing to let an institution fail and to risk such disruption again.”

    3) Richard Fisher on December 16 lecturing the rest of the FOMC on effective monetary policy communications (you can’t make this stuff up).

    Mr. Fisher: “Finally, on the issue of communications, one of my colleagues often says that, if you’re Elton John, you are expected to sing “Bennie and the Jets” every single time and at every single concert. It seems to me that, once we get and hone our message, we must repeat it incessantly and stay on message in order to have it penetrate. In Austin, you gave what I consider to be a hallmark and—not trying to flatter you—for monetary policy a historic speech. What was Bloomberg’s first reaction? The Fed may cut rates further. The message was lost. We all need to stay on message. But I think it’s very important, whether we have press conferences or whether you give speeches, that we need to hammer the theme of the new regime that we are about to embrace over and over and over again. So I didn’t pick “Bennie and the Jets” just because of your name, Mr. Chairman. [Laughter] But I do hope you remember that we must have that constant refrain. If we’re going to sell something, we have to sell it by repeating it, not asking the press to interpret it for us but to get the message out in—excuse me, Governor Kohn—full frontal view. Thank you, Mr. Chairman.”

    Chairman Bernanke: “I’m in awe of a presentation that has Rube Goldberg, the Black Death, “Bennie and the Jets,” and full frontal view all in it.” [Laughter]

    4) The “phew, I’m glad that’s all over” award

    James Bullard

    August 5:
    “My sense is that the level of systemic risk associated with financial turmoil has fallen dramatically…As one of my contacts at a large bank described it, the discovery process is clearly over. I say that the level of systemic risk has dropped dramatically and possibly to zero.”

    • Agree, Sadowski, but would like to add the “Hamlet award”

      William “Hamlet” Dudley
      September 16, 2008:
      “Either the financial system is going to implode in a major way…or it is not.”

  7. Two Large Issues Not Discussed:
    1…China had begun Selling GSEs and Buying Treasuries with real money. This is called a Flight to Safety and leads to lower yields.
    2…There was a Special Trading Session held on the Sunday before the Monday of Lehman’s Bankruptcy to allow some buying and selling of Lehman Investments, I suppose, during which the Traders, also people with real money, spent their time discussing what to do when Merrill-Lynch filed for Bankruptcy during the coming week, unless they were saved. They were already discussing a financial disaster.

      • I understand. I meant that the Fed had not been paying enough attention to China’s Actions and what Traders were saying going into that fateful Monday in Sept. 08. Obviously, they had been seeing something different from what the Fed was seeing in the previous months, especially after Bear Stearns. I was focusing upon the Myopia and Obsession with Certain Indicators that could lead them to make such a major mistake in assessing what would likely occur if Lehman Declared Bankruptcy. I’m saying that they would have been better off focusing on my two examples, as well as ones others, I’m sure, could come up with. It’s not just about Charts in the Real World.

  8. In 2008 Fisher told the Council of Foreign Relations that the economy would skirt a recession…in 2009 he told the Japanese that “I consider inflation an evil spirit that rots the core of economic prosperity and must never, ever be countenanced.” That was in Japan, btw.

    You have to wonder about Fisher. If he had been Fed Chairman, we would be in the Great Depression…but he is unabashed.

    Fisher missed his real career, which was as a boxer. No matter how hard he gets hit, no matter how many times he goes down, he just bounces right back off the canvas.

  9. BTW, in going through the transcripts, I find rare, almost no references to unit labor costs. They talk incessantly about oil, commodities, real estate—but the big basic is never talked about.

    And sadly, when the FOMC board is advised on unit labor costs, they get it wrong.

    A Fed staffer told the FOMC board in June 2008 that, “Accordingly, we expect the rise in trend unit labor costs, shown in the table to the right, to hold steady at about 2 percent per year over the projection period.” So several years of 2 percent hikes in unit labor costs.

    The real story is that unit labor costs have increased 1.7 percent since the first quarter…2007.

    Perhaps 0.3 percent a year increases in unit labor costs.

    I again call for Fed staffers to have salaries tied to real growth in GDP, with a high beta. Staffers now have an incentive—since they have a sinecure and do not work in construction, manufacturing, or retailing etc—to fret about inflation, not growth.

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