In the quiet, polite world of Federal Reserve policymaking meetings, no one ever shouts or pounds the table, but during the last two days of June there was a palpable sense of strain and disagreement as 17 officials struggled to reach their usual consensus, according to Fed sources.
The sticking point wasn't so much over what to do about interest rates -- the group decided to raise the Fed's target for overnight rates to 5 percent from 4.75 percent -- but what to tell the world about what the policymakers had in mind for the future.
Some officials wanted to indicate the group might well raise rates again at the next meeting on Aug. 24. Others wanted to signal a more open-minded stance, as they waited for more information about how the economy is performing.
At the contentious meeting, the officials disagreed on whether the economic outlook was clear enough to justify additional rate increases to preempt an outbreak of inflation that might never occur. The debate was sharpened by the fact that the policymakers had committed themselves to announcing their intentions.
One key concern for them was how financial markets would react to any signal, the sources said. The policymakers knew that the markets were straining for clues as to whether the Fed had embarked on a series of rate increases, which would affect investments and decisions worth billions of dollars.
"To act preemptively, you have got to have some level of confidence in your ability to forecast," said Edward Boehne, president of the Philadelphia Federal Reserve Bank in an interview. Noting that the Fed forecasts have been off repeatedly in recent years, he said, "It shouldn't be surprising that at times when you have such a level of uncertainty, that bright people who are not shrinking violets should bring different views to the table."
In the end, the policymaking group, called the Federal Open Market Committee, adopted a so-called neutral directive, which implies it is not leaning toward cutting or raising rates any time soon. The markets rallied strongly on the news, apparently concluding that the FOMC was unlikely to raise rates at the next meeting.
However, the policymakers themselves have different views on what the directive, whether neutral or otherwise, indicates about future changes in interest rates and over what period of time it applies.
As J. Alfred Broaddus, Boehne's counterpart at the Richmond Fed, said, having a "neutral" or a "biased" FOMC directive "means different things to different people."
Tomorrow, Fed Chairman Alan Greenspan is scheduled to give his semiannual monetary policy report to the House Banking Committee, in which he will seek to explain what the Fed has been doing and why.
The debate at the meeting reflected, in part, the officials' differing views on the nation's economic outlook. As usual, none of the Fed officials interviewed would discuss the specifics of what occurred at the meeting.
The U.S. economy has rarely grown so rapidly for so long with such low inflation. Fed officials remain unsure why that has been possible, and some are distinctively nervous about how long this can last.
Many Fed economists now say that productivity gains have accelerated enough that the U.S. economy can grow at a sustainable rate of at least 3 percent, perhaps more, without triggering more inflation. The San Francisco Federal Reserve Bank has publicly estimated that rate is now up to 3.25 percent annually, not all that much below the high 4 percent pace at which the economy has grown over the past three years. And Greenspan has stressed that he believes productivity growth, and hence the sustainable growth rate, is still accelerating.
Furthermore, some of the Fed officials expect economic growth to slow to the neighborhood of 3 percent even without further rate increases.
Until recently, the Fed did not immediately announce its shifts in thinking when rates weren't changed. But in December, in an effort to communicate more openly with the public, the FOMC decided it would make such announcements.
The first time it did so was following its May meeting, at which it left rates unchanged but adopted a "biased directive," which the markets interpreted as a virtual promise to raise rates at the June meeting.
But Broaddus cautioned that the policymakers are not making any such promises.
"At the May meeting, I was certainly strongly in favor of going to a bias toward tightening. But that was not a commitment to raise rates at the next meeting or any other time.
"It was just telling the world that the committee would be particularly sensitive to the upside risk" -- that is, that economic growth would not slow and inflation pressures rise.
"I know there has been some market confusion over this," he continued. "But markets are smart. Over a period of time, markets will get accustomed to [the announcements of changes in the bias] and the confusion will diminish."
However, some confusion may persist as long as the policymakers disagree about what their directives mean.
Some interpret the bias as applying only until the next FOMC meeting, which is in fact what the directive actually says, Broaddus said. "But I have a somewhat longer period in mind."
The president of the Kansas City Fed, Thomas M. Hoenig, said that while the goal of openness is important for the Fed, "there is always the issue, are you really going to help clarify or confuse."
Hoenig acknowledged that there "can be different time horizons in people's view" about the length of the period to which a biased directive applies. "If I were to describe myself, I would be more a strict constructionist," he said, implying that for him it applies only until the subsequent meeting.
Boehne said, "Some have seen it as a way to achieve consensus" at one meeting without it having any implications for the future at all.
Robert McTeer, the Dallas Fed president, raised a separate point about the practice of announcing the directive.
"If you watch something, its meaning changes," McTeer said. "If the [directive's] tilt's private, it's one thing. If the public is watching, you have to take that into account and something changes" in the way the FOMC uses the tool.
Looking ahead, Greenspan, Hoenig, Boehne, Broaddus, McTeer and a number of other officials believe the U.S. economy is now capable of expanding at a 3 percent rate without making inflation worse.
Some of them, including the chairman, think the number may well be higher.
Broaddus, for example, said, "It may be that 3.25 percent rate is on the low side."
He nevertheless remains concerned about the potential for overheating and more inflation because spending by consumers, businesses and governments has been rising even faster than that.
However, since the June decision to raise rates and shift to a neutral directive, most of the economic data have pointed to at least slightly slower growth and low inflation.
Federal Open Market Committee
What it is: The most important monetary policymaking body of the Federal Reserve System.
What it does: Is responsible for formulating a U.S. policy that promotes economic growth, full employment, stable prices and a sustainable pattern of international trade and payments. The FOMC makes key decisions on the conduct of open market operations -- purchases and sales of U.S. government and federal agency securities. These decisions affect the level of reserves in depository institutions.
Who's in it: Seven members of the Board of Governors and five Reserve Bank presidents. They are Alan Greenspan, William J. McDonough, Edward G. Boehne, Roger W. Ferguson Jr., Edward M. Gramlich, Edward W. Kelley Jr., Robert D. McTeer Jr., Laurence H. Meyer, Michael H. Moskow, Gary H. Stern.
Meetings: The FOMC must meet at least four times each year.
For more information: See the Federal Reserve Web site at www.federal reserve.gov
SOURCE: Federal Reserve
CAPTION: Alan Greenspan will talk about monetary policy tomorrow.
CAPTION: The Federal Reserve Building downtown.