New Minutes Show a More Fractured Fed
Nonvoting Members May Have Been Less Patient on Inflation, Against Pause in Interest Rate Increases

By Nell Henderson
Washington Post Staff Writer
Wednesday, August 30, 2006

The Federal Reserve, it became plain yesterday, is a house divided.

This month, the central bank's top policymaking committee decided to halt its long campaign of interest rate increases, betting that the economy will slow enough to cool down a worrisome level of inflation. That decision appeared to be nearly unanimous, supported by a 9 to 1 vote of the panel, known as the Federal Open Market Committee.

But the committee was more split than the lopsided vote indicated, according to minutes of the Aug. 8 meeting released yesterday.

Under the complicated logistics by which the Federal Reserve is governed, 17 committee members took part in the rate-setting meeting, but only 10 got to vote. The minutes show that many participants thought more interest rate increases might be needed to tame inflation -- suggesting that some of the seven people who did not vote might have opted for another rate bump if given a chance.

The dissenting voter, Jeffrey M. Lacker, president of the Federal Reserve Bank of Richmond, wanted to raise interest rates higher, the minutes said.

And Lacker "obviously was not alone," said Mickey Levy, chief economist for Bank of America Corp. "These minutes suggest that the call to remain on hold was significantly closer than one dissent suggested."

All 17 committee members remained worried about inflation, noting that it has been higher than they prefer for more than two years and has accelerated this year, the minutes said.

But the policymakers were uncertain about whether the recent surge in inflation is a transitory, oil-related bulge that they can wait out or the beginning of a more stubborn rise in prices that might be stopped by only more aggressive credit tightening, according to the minutes, which summarize the discussions without identifying participants by name.

The minutes also underscore a debate within the group over the wisdom of allowing inflation to run for four years above many members' preferred range of 1 to 2 percent, as measured by a Commerce Department price index that excludes volatile food and energy items.

That measure shows that "core" inflation was 2.4 percent in the 12 months ended in June, and the Fed forecasts it to stay above 2 percent through next year. And revisions to data released just before the meeting surprised the Fed by showing that core prices rose faster than 2 percent a year in 2004 and 2005.

Some Fed policymakers, such as Chairman Ben S. Bernanke, believe it's all right to let inflation hover above that level for a while because it will probably drift lower over the next 18 months as the economy slows and energy prices flatten. They also worry that the Fed would have to raise interest rates much higher, choking the economy and throwing many people out of work, to force inflation down any sooner.

But other Fed policymakers are less patient, believing it's dangerous to let inflation linger so high for so long. For example, Michael H. Moskow, president of the Federal Reserve Bank of Chicago, has argued that inflation tends to get stuck at a certain rate and becomes harder to bring down because businesses and consumers get into the habit of expecting price and wage increases to continue.

"The risk of inflation remaining too high is greater than the risk of growth being too low," Moskow said in a speech two weeks after the meeting, suggesting more rate increases "may yet be necessary to bring inflation back into the comfort zone within a reasonable period of time."

Richard W. Fisher, president of the Federal Reserve Bank of Dallas, said in speech shortly after the meeting that it is too soon to know whether the central bank will raise rates again. But he echoed Moskow's concern, saying: "Once the perception of having pricing power becomes entrenched, it is difficult to alter. This is a psychological as well as an economic phenomenon. Behaviors become habits, and habits are hard to change."

Moskow and Fisher were not voters at the last meeting, and the minutes give no indication how they might have voted.

Lacker "dissented because he believed that further [credit] tightening was needed to bring inflation down more rapidly," the minutes said.

And he disagreed with Fed staff and policymakers who contend that the current flare-up in inflation is a temporary result of higher energy and import prices. He said "the recent surge in core inflation had persisted and appeared to be broad-based."

He also did not think the economy would slow enough to lower core inflation.

The committee comprises the 12 regional Fed bank presidents and the seven members of the Board of Governors based in Washington -- usually 19 people.

The group's voting members are the board members and a rotating group of five bank presidents. Because there are two vacancies on the board, there were 17 members present, 10 of whom voted at the last meeting.

The decision to pause "was a much closer call than I thought," said Richard Yamarone, director of research at Argus Research Corp. The "hawks," the members who are more worried than others about inflation, "had their wings clipped because they're not all voting this year."

The minutes show that most committee members shared the chairman's optimism that "inflation pressures quite possibly would ease gradually over coming quarters" as the economy slows. They were content to leave their benchmark rate unchanged at 5.25 percent and even thought they might be done raising rates.

Stocks and bonds rallied after the minutes were released, in part because they also revealed that the Fed staff has lowered its forecast for economic growth over the next 18 months to below a 3 percent annual rate -- potentially bolstering the case for not raising rates any higher.

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