FOMC Minutes

November 1, 2005

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 Tuesday, November 1, 2005 at 9:00 a.m.

Present:

Mr. Greenspan, Chairman

Mr. Geithner, Vice Chairman

Ms. Bies

Mr. Ferguson

Mr. Fisher

Mr. Kohn

Mr. Moskow

Mr. Olson

Mr. Santomero

Mr. Stern

Messrs. Guynn and Lacker, Mses. Pianalto and Yellen, Alternate Members of the

Federal Open Market Committee

Mr. Hoenig, Ms. Minehan, and Mr. Poole, Presidents of the Federal Reserve Banks of

Kansas City, Boston, and St. Louis, respectively

Mr. Reinhart, Secretary and Economist

Ms. Danker, Deputy Secretary

Ms. Smith, Assistant Secretary

Mr. Alvarez, General Counsel

Ms. Johnson, Economist

Mr. Stockton, Economist

Messrs. Connors, Freeman, and Madigan, Ms. Mester, Messrs. Oliner, Rosenblum,

Tracy, Rolnick, and Wilcox, Associate Economists

Mr. Kos, Manager, System Open Market Account

Messrs. Slifman and Struckmeyer, Associate Directors, Division of Research and

Statistics, Board of Governors

Mr. Whitesell, Deputy Associate Director, Division of Monetary Affairs, Board of

Governors

Mr. English, Assistant Director, Division of Monetary Affairs, Board of Governors

Mr. Simpson, Senior Adviser, Division of Research and Statistics, Board of

Governors

Mr. Small, Project Manager, Division of Monetary Affairs, Board of Governors

Mr. Nelson, 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

Mr. Eisenbeis, Executive Vice President, Federal Reserve Bank of Atlanta

Messrs. Fuhrer, Hakkio, Rasche, Rudebusch, and Sniderman, Senior Vice Presidents,

Federal Reserve Banks of Boston, Kansas City, St. Louis, San Francisco, and

Cleveland, respectively

Mr. Krane and Ms. Mucciolo, Vice Presidents, Federal Reserve Banks of Chicago

and New York, respectively

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.

The information reviewed at this meeting suggested that the economy had a good deal of

forward momentum in the third quarter. Although recent hurricanes caused considerable

damage and disruption, particularly in the energy sector, economic activity outside the Gulf

region appeared to have been well maintained. In September, hiring in other regions

remained in line with its pace over the preceding twelve months, and excluding the estimated

effects of the hurricanes and a strike by Boeing machinists, industrial production increased

briskly. In addition, residential construction remained buoyant. Consumer spending,

however, showed some signs of weakening. Although consumer spending was strong for the

third quarter as a whole, it softened in September, and survey measures of consumer

confidence slumped noticeably. Despite the large increase in consumer energy prices since

midyear, core price inflation was restrained through September.

Hurricane Rita caused further disruption to energy production in the Gulf area, which had not

yet fully recovered from Hurricane Katrina. Energy production in October was still below

pre-hurricane levels, although progress had been made in reopening shut-down energy

facilities. Rising imports, along with more-subdued consumption of gasoline and other

petroleum products, helped to offset the effect on energy prices of some of the output losses

in refined products. In addition, to address the low level of gasoline inventories and

more-immediate retail demands, domestic refiners sharply increased the share of gasoline in

their output of total refined product. Wholesale and retail gasoline prices spiked soon after

Rita's landfall but had since declined to pre-hurricane levels. Spot prices for natural gas

soared with the hurricanes and remained at elevated levels.

Payroll employment fell in September, held down by substantial job losses associated with

Hurricane Katrina. Employment in the areas unaffected by the hurricane increased at a rate in

line with the average pace over the previous twelve months. The largest employment loss

occurred in the leisure and hospitality category, an industry particularly hard hit by the storm.

The average workweek was unchanged in September, so with employment lower, aggregate

hours declined slightly. The unemployment rate rose 0.2 percentage points to 5.1 percent.

The labor force participation rate held steady, but the number of individuals reporting that

they had a job but were not at work because of bad weather surged. More recently, weekly

data on initial claims for unemployment insurance suggested that the job losses associated

with the hurricane were subsiding.

Industrial production fell substantially in September, but excluding the effects of hurricanerelated disturbances and the Boeing strike, industrial production was estimated to have risen

at a brisk pace. The hurricanes caused the index for oil and natural gas extraction and

refining to plummet in September, and they also significantly affected petrochemical

production. Manufacturing output fell noticeably in the shipbuilding, food manufacturing,

paper, and plywood industries. In the transportation equipment category, motor vehicle

production climbed notably, but the machinists' strike at Boeing caused the company to cease

nearly all commercial aircraft production during the month. High-tech output--led by strong

gains in the production of semiconductors and communications equipment--surged in

September. Manufacturing capacity utilization dropped substantially in September, but was

still noticeably above its year-earlier level.

Real consumer spending increased at a moderate rate in the third quarter as a whole, although

it declined in August and September after having risen substantially earlier in the summer.

The softening in spending of late reflected in part the diminishing boost to light vehicle sales

from manufacturers' programs offering employee discounts to nonemployees. Spending on

other goods and services was also sluggish, likely because of the direct effects of the

dislocation of households by the hurricanes, high energy prices, and falling consumer

confidence. Consumer sentiment in October, as measured by both the Michigan Survey and

the Conference Board's indicator, dropped a little further after plunging in September. The

personal saving rate remained slightly negative in September.

Residential construction continued at a robust pace. In September, new single-family homes

were started at a rate a bit above their elevated average rate in the first half of the year, and

permit issuance jumped to a new high. New home sales remained substantial in August, but

they were below July's elevated level. Although they remained low by historical standards,

both the thirty-year fixed mortgage rate and the one-year adjustable rate had moved up a bit

in recent months and were notably above the levels seen at the beginning of the year. The

average selling price of existing homes rose in the twelve months ending in September at

about the same rapid clip as a year earlier, but the average selling price of new homes rose

more slowly over the past few months.

Real outlays for equipment and software were sluggish in the summer, but a broad-based

pickup in orders for and shipments of nondefense capital goods excluding aircraft in August

suggested some firming. Investment fundamentals remained relatively solid, including

continued expansion in business sales, a declining cost of capital, and corporate balance

sheets that were flush with cash. Surveys of executive sentiment squared well with the

fundamentals: Although business leaders expressed some misgivings about the overall

macroeconomic environment, their stated capital spending intentions pointed to increasing

investment. Vacancy rates for nonresidential properties continued to edge lower, but they

remained elevated for office and industrial properties, and real spending on new construction

had yet to improve materially.

Business investment in real nonfarm inventories was subdued over the summer. Although

inventory-to-sales ratios moved down some in July and August, businesses did not appear

dissatisfied with their level of stocks. For example, September results from the Institute for

Supply Management survey indicated that respondents viewed their customers' current

inventory situation as reasonably well aligned with demand.

The U.S. international trade deficit widened somewhat in August, as a surge in imports of

goods and services was partially offset by a sizable gain in exports. The growth in imports

reflected both a marked increase in oil imports and a rise in nonoil goods; imports of services

were little changed. The increase in exports was driven by higher merchandise exports,

although exports of services also advanced a bit. GDP growth in foreign industrial economies

appeared to have continued at a moderate pace in the third quarter.

Soaring energy prices have boosted overall measures of consumer price inflation in recent

months. However, measures of core consumer price inflation were much more restrained.

The twelve-month change in core consumer prices through September was about unchanged

from its year-earlier level. One survey of households in October found that expectations for

inflation over the coming year rose to a level well above the readings that had prevailed over

the spring and summer, presumably in response to rising energy prices. However, median

expectations for inflation over the next five to ten years were only a little above the average

range reported in recent years. With regard to labor costs, the employment cost index for

private industry workers rose at a moderate pace in the third quarter, up somewhat from its

second-quarter pace, but the twelve-month change in the index declined from that of a year

earlier. Hourly compensation in the nonfarm business sector was estimated to have also risen

at a moderate rate in the third quarter.

At its September meeting, the Federal Open Market Committee decided to increase the target

level of the federal funds rate 25 basis points, to 3¾ percent. In its accompanying statement,

the Committee indicated that, with appropriate monetary policy action, the upside and

downside risks to the attainment of sustainable growth and price stability should be kept

roughly equal. The Committee noted that the widespread devastation in the Gulf region from

Hurricane Katrina, the associated dislocation of economic activity, and the boost to energy

prices would set back spending, production, and employment in the near term. However, the

Committee judged that these unfortunate developments did not pose a more persistent threat

to the overall economy. Rather, monetary policy accommodation, coupled with robust

underlying growth in productivity, was providing ongoing support to economic activity.

Although higher energy and other costs had the potential to add to inflation pressure, core

inflation had been relatively low in the preceding few months and longer-term inflation

expectations remained contained. In these circumstances, the Committee believed that policy

accommodation could be removed at a pace that would likely be measured but noted that it

would respond to changes in economic prospects as needed to fulfill its obligation to

maintain price stability.

With investors putting only small odds on a pause in the tightening cycle following

Hurricane Katrina, there was little market reaction to the Committee's decision at the

September meeting. However, the expected path for monetary policy shifted up in

subsequent weeks, as incoming data indicated that output had been expanding briskly prior to

the hurricanes and that the disruptions to economic activity from the hurricanes were likely to

be less severe than initially feared. This upward pressure on interest rates may have been

amplified by comments from a number of Federal Reserve officials that were read as

stressing inflation concerns. Nominal Treasury yields rose in line with the shift in the outlook

for monetary policy. Despite a large increase in the overall consumer price index for

September, measures of inflation compensation calculated using yields on nominal and

inflation-protected Treasury securities were about unchanged over the intermeeting period,

although they remained a bit above the levels seen before Hurricane Katrina. As broad

indexes of investment- and speculative-grade corporate bond yields moved largely in line

with Treasury yields over the period, spreads were little changed. Major stock price indexes

fell moderately and the trade-weighted foreign exchange value of the dollar appreciated

slightly over the intermeeting period.

Domestic nonfinancial debt appeared to have advanced briskly in the third quarter. Growth in

household debt was estimated to have edged down in the third quarter because of a slowing

in mortgage debt growth but remained elevated. Household bankruptcies surged in the weeks

immediately before bankruptcy reforms went into effect on October 17. The debt of

nonfinancial businesses rose in the third quarter at a rate comparable to the increases seen in

the first half of the year. Bank loans to businesses continued to advance briskly, and the

results of the October Senior Loan Officer Opinion Survey showed some further easing of

lending terms and standards for such loans. M2 expanded at a fairly solid rate in September.

The increase in September was in part attributable to a boost to currency and liquid deposits

resulting from Hurricane Katrina. Growth in nominal output in the third quarter exceeded

that of M2, implying a further rise in velocity.

In the forecast prepared for this meeting, the staff continued to project moderate economic

growth for the second half of 2005. Output growth was expected to pick up in 2006, as the

boost from hurricane-related rebuilding activity more than offset the effects of somewhat

tighter financial conditions, and then slow in 2007, as the impetus from rebuilding waned.

The near-term forecast again entailed a marked downshift in headline inflation as energy

prices fall back consistent with readings from futures markets. Favorable incoming data led

the staff to reduce its forecast for near-term core inflation a bit. The outlook continued to be

for core inflation to pick up modestly over coming quarters owing to the lagged effects of

higher energy prices but then to return to near current levels in 2007 primarily as the result of

the restraining influence of falling energy prices.

In their discussion of the economic situation and outlook, meeting participants saw the

economy as continuing to grow at a solid pace, notwithstanding the disruptive effects to

economic activity and employment from the hurricanes. However, the near-term outlook

continued to be subject to considerable uncertainty given the difficulties in assessing the net

effects of the downturn in consumer confidence and the rise in energy prices through the

summer, on the one hand, and the rebuilding from hurricane damage, on the other. Although

oil and gasoline prices had fallen in recent weeks and core inflation had remained benign,

some businesses had reported increased ability to pass through cost increases in the

environment of higher headline inflation. On balance, meeting participants remained

concerned about heightened inflation pressures.

Meeting participants generally saw accumulating evidence as supporting the view that the

disruptions to aggregate economic activity and employment from the hurricanes were likely

to be limited and temporary. In areas that had been devastated by the hurricanes, recovery of

energy production and the rebuilding of homes and businesses might take longer than had

been expected, in part because of a slow return of evacuees. However, in regions just outside

those that were most severely damaged, recovery was already well underway, and the pace of

economic activity had strengthened, in some cases owing to spending by relocated

households. Reconstruction along the Gulf Coast would likely pick up substantially in the

next couple of quarters.

In the household sector, spending seemed to have held up fairly well, aside from a drop in

purchases of autos. Some participants noted, however, that the erosion of consumer

confidence, still-elevated gasoline prices, and the prospect of higher heating bills might augur

weakness ahead. The housing market had remained robust, although a slowing in house price

gains in some areas and recent declines in home equity lending at banks could be indicating

that the long-expected cooling in the housing market was near. Motor vehicle purchases had

slowed substantially in October, but that seemed to owe primarily to the end of discount

programs that had generated a surge in auto spending over the summer. Over the longer-term,

with house price gains moderating and perhaps greater perceived needs to invest for

retirement purposes, the household saving rate was likely to rise gradually.

Growth in business investment spending seemed to remain moderate overall, but anecdotal

reports suggested that a number of firms had boosted their plans for capital spending.

Moreover, construction spending and commercial real estate investment seemed to be

picking up in some areas. Significant problems persisted amongst U.S. nameplates in the

auto sector, however. The rise in longer-term real interest rates and some widening of private

credit spreads in recent months were seen as perhaps having a little restraining effect on the

investment outlook.

Economic growth in the near term was likely to be boosted by additional fiscal stimulus, in

part to support recovery and rebuilding from the hurricanes. Strong demand from overseas

was evidently boosting exports this year by more than the increase in imports, with the

nation's external accounts thereby providing a small net positive contribution to growth in

domestic production. Next year, however, the arithmetic contribution to growth from net

exports was seen as likely to return to negative territory.

While participants noted some recent favorable data on core inflation and labor costs, upside

risks to the outlook for underlying inflation remained a key concern. Wage gains had

remained modest relative to continued strong productivity growth, suggesting that labor costs

were not putting much upward pressure on prices. Indeed, core inflation continued to be

subdued, and in recent weeks gasoline prices had unwound a significant portion of their steep

increases. Nevertheless, there was a risk that the large cumulative rise in energy and

petroleum product prices through the summer would be transmitted to core consumer prices.

A number of firms had been reporting a greater ability to pass through increases in energy

and other costs to customers, though evidently more so to other businesses than to

consumers. A survey measure of the near-term inflation expectations of households had risen

notably, but intermediate- and longer-term inflation expectations implied by Treasury

security yields had remained fairly stable. It was noted, however, that longer-term

expectations of inflation remained contained in the context of an increase in the extent of

additional monetary policy tightening expected in financial markets.

In the Committee's discussion of monetary policy for the intermeeting period, all members

favored raising the target federal funds rate 25 basis points to 4 percent at this meeting. The

economy seemed to be growing at a fairly strong pace, despite the temporary disruptions

associated with the hurricanes, and underlying economic slack was likely quite limited. In

that context, all members believed it important to continue removing monetary policy

accommodation in order to check upside risks to inflation and keep inflation expectations

contained, but noted that policy setting would need to be increasingly sensitive to incoming

economic data. Some members cautioned that risks of going too far with the tightening

process could also eventually emerge. Nonetheless, all members agreed to indicate at the

conclusion of this meeting that a continued measured pace of policy firming remained likely.

In their ongoing discussion of the Committee's communication strategy, participants

expressed a variety of perspectives about how the policy statement issued at the end of

FOMC meetings might evolve over time. Several aspects of the statement language would

have to be changed before long, particularly those related to the characterization of and

outlook for policy. Possible future changes in the sentence on the balance of risks to the

Committee's objectives were also discussed. Participants noted that any forward-looking

elements of the statement should clearly be conditioned on the outlook for inflation and

economic growth. For this meeting, members concurred that the current statement structure

could be retained, as it accurately conveyed their near-term economic and policy outlook.

In view of the continued rapid pace of observed productivity gains, members agreed that the

statement to be released after the meeting should again indicate that robust underlying

productivity growth and monetary policy accommodation were supporting the economic

expansion. Those influences were expected to be augmented by planned rebuilding and

recovery activity in hurricane-affected areas. While gasoline prices had recently moved

lower, the cumulative rise in energy prices and other costs was seen as having the potential to

add to inflation pressures. However, core inflation had been subdued in recent months and

longer-run inflation expectations remained contained. Against that backdrop, the risks to the

objective of price stability, as well as that for sustainable growth, remained in balance, given

appropriate monetary policy actions.

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 4 percent."

The vote encompassed approval of the paragraph below for inclusion in the statement to be

released shortly after the meeting:

"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. Nonetheless, the Committee will respond

to changes in economic prospects as needed to fulfill its obligation to maintain

price stability."

Votes for this action: Messrs. Greenspan and Geithner, Ms. Bies, Messrs. Ferguson, Fisher,

Kohn, Olson, Moskow, Santomero, and Stern.

Votes against this action: None

It was agreed that the next meeting of the Committee would be held on Tuesday, December

13, 2005.

The meeting adjourned at 1:15 p.m.

Notation Vote

By notation vote completed on October 7, 2005, the Committee unanimously approved the

minutes of the meeting of the Federal Open Market Committee held on September 20, 2005.

Vincent R. Reinhart

Secretary

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Last update: November 22, 2005, 2:00 PM