FOMC Minutes

December 13, 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, December 13, 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

Ms. Cumming, 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

Mr. Baxter, Deputy General Counsel

Ms. Johnson, Economist

Mr. Stockton, Economist

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

Tracy, 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

Messrs. English and Sheets, Assistant Directors, Divisions of Monetary Affairs and

International Finance, respectively, Board of Governors

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

Governors

Mr. Skidmore, Special Assistant to the Board, Office of Board Members, Board of

Governors

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

Mr. Zakrajsek, Section Chief, Division of Monetary Affairs, Board of Governors

Mr. Kumasaka, Senior Financial Analyst, Division of Monetary Affairs, Board of

Governors

Ms. Low, Open Market Secretariat Specialist, Division of Monetary Affairs,

Board of Governors

Mr. Barron, First Vice President, Federal Reserve Bank of Atlanta

Messrs. Fuhrer, Hakkio, Rasche, Sniderman, Weinberg, and Williams, Senior Vice

Presidents, Federal Reserve Banks of Boston, Kansas City, St. Louis, Cleveland,

Richmond, and San Francisco, respectively

Mr. Cunningham, Ms. Mosser, and Mr. Sullivan, Vice Presidents, Federal Reserve

Banks of Atlanta, New York, and Chicago, respectively

Mr. Weber, Senior Research Officer, Federal Reserve Bank of Minneapolis

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 continued to expand at

a solid rate in the fourth quarter. Industrial production rebounded, and employment growth

appeared to have recovered smartly from the depressing effects of recent hurricanes.

Although some scattered signs of cooling of the housing sector had emerged, the pace of

construction activity and sales remained brisk. More broadly, spending by consumers and

businesses was well maintained. Core consumer price inflation remained subdued, even

though some of the increase in energy costs had apparently passed through to prices of final

goods and services.

Private nonfarm payrolls grew rapidly in November after a small gain in October.

Construction employment posted another large increase, probably owing in part to hurricanerelated activity. Broad-based gains in durable goods industries augmented manufacturing

employment, and employment in the related industries of temporary help services and

wholesale trade increased as well. With employment rising but the average workweek of

production or nonsupervisory workers falling slightly, aggregate hours slipped in November--

albeit to a level above that of their third-quarter average. The unemployment rate held steady

at 5 percent, and the labor force participation rate was also unchanged. Survey measures of

individuals' expectations of future labor market conditions improved in November, largely

reversing post-Katrina declines.

Industrial production rebounded in October after having been held down in September by

hurricanes and by a strike at Boeing. The resumption of commercial aircraft production

boosted manufacturing output and more than offset a fall in the production of motor vehicles

and parts. Large output gains in hurricane-affected industries--such as segments of the food,

rubber and plastics, and paper industries--also contributed to the increase in manufacturing

output. The growth of high-tech output slowed slightly in October, mainly as a result of

smaller increases in the production of semiconductors. In contrast, production of

communication equipment--particularly data networking equipment--accelerated. With many

energy facilities in the Gulf region still closed, output at mines, which is defined to include

oil and gas extraction, slipped further in October. Manufacturing capacity utilization moved

up again in October and was only a touch below its long-run average.

Real personal consumption expenditures appeared to be increasing solidly over the course of

the fourth quarter, led by improvements in the fundamental determinants of consumer

spending. Real disposable personal income was bolstered by gains in employment and falling

retail energy prices, while continued brisk advances in house prices and the recent

strengthening of equity prices contributed importantly to increases in household wealth.

Consumer sentiment picked up in November and early December; some survey measures of

confidence returned to the range seen during the first half of the year. The personal saving

rate--while still slightly negative--moved up in October.

Activity in the housing market remained brisk despite a rise in mortgage interest rates. Starts

of new single-family homes dropped back somewhat in October from September's very

strong pace, but permit issuance remained elevated. New home sales reached a new high in

October, and existing home sales eased off only a little from the high levels recorded during

the summer. Other available indicators of housing activity were on the soft side: An index of

mortgage applications for purchases of homes declined in November, and builders' ratings of

new home sales had fallen off in recent months. In addition, survey measures of homebuying

attitudes had declined to levels last observed in the early 1990s.

Real outlays for equipment and software posted a solid gain in the third quarter. Although

business purchases of motor vehicles declined in October and November, growth in

investment in nontransportation equipment appeared to have been well maintained in the

fourth quarter. Rising business sales, a declining cost of capital, and ample financial

resources in the corporate sector continued to foster a favorable environment for capital

spending, a sentiment echoed in executive surveys, which generally pointed to widespread

increases in planned capital outlays. Real spending on nonresidential construction improved

materially in the third quarter, boosted by substantial gains in drilling and mining

expenditures.

Real nonfarm inventories ran off in the third quarter as automakers pared their motor vehicle

stocks. But even outside the motor vehicle sector, inventory investment was relatively

restrained, and partial data for October suggested that real stockbuilding continued to be

subdued. The level of stocks appeared reasonably well aligned with sales.

The U.S. international trade deficit reached a new record in September. A surge in imports

was accompanied by a fairly sizable drop in exports, part of which was due to a steep falloff

in aircraft exports as a result of the strike at Boeing. The jump in the value of imports was

driven by strong growth in most categories of goods and, to a lesser extent, growth in

services; increases in the dollar value of imports of oil and of industrial supplies--especially

natural gas--were particularly strong, a reflection of higher prices. Foreign industrialized

economies expanded robustly in the third quarter, and available indicators for the fourth

quarter appeared promising, on balance.

Core consumer price inflation was moderate in recent months, although some signs of

pass-through of higher energy costs were evident, especially in transportation services.

Consumer energy prices had retreated notably from their elevated post-hurricane levels.

Wholesale and retail gasoline prices dropped as gasoline inventories rebounded. And spot

prices for natural gas fell sharply through mid-November amidst unusually temperate

weather, plentiful inventories, and declining prices of competing fuels; unusually cold

weather in early December, however, caused spot prices to move back up to their October

levels. Presumably in response to falling retail energy prices, one survey of households in

November and early December showed a marked retreat in expectations for inflation over the

coming year. Longer-term inflation expectations also edged down, but stayed a touch above

the narrow range observed in recent years. Although recent increases in energy costs had

pushed up producer prices in some sectors, overall producer price inflation remained

subdued. With regard to labor costs, the twelve-month change in the employment cost index

for private industry workers in September was well below its year-ago increase. Hourly

compensation in the nonfarm business sector also appeared to have slowed a bit recently.

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

level of the federal funds rate 25 basis points, to 4 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 also noted that elevated energy prices and hurricane-related

disruptions in economic activity had temporarily depressed output and employment.

However, monetary policy accommodation, coupled with robust underlying growth in

productivity, was providing ongoing support to economic activity. And although the

cumulative rise in energy and other costs had the potential to add to inflation pressures, core

inflation had been relatively low in recent months, and longer-term inflation expectations

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

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

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

maintain price stability.

Market participants widely anticipated the Committee's decision at its November meeting,

and the policy announcement evoked little reaction in financial markets. Over the

intermeeting period, investors marked up slightly their expectations for the path of monetary

policy in light of stronger-than-expected data on spending and production. Nominal Treasury

yields changed little, on net, but measures of inflation compensation at longer

horizons--which are calculated using yields on nominal and inflation-protected securities-declined somewhat. Credit spreads on both investment- and speculative-grade corporate

bonds were about unchanged over the intermeeting period. Major equity price indexes posted

substantial gains, spurred by the perception that the economy had retained considerable

momentum with limited inflation pressures. In foreign exchange markets, the trade-weighted

value of the dollar was about unchanged over the intermeeting period.

The expansion of domestic nonfinancial debt appeared to have moderated a little from its

brisk third-quarter pace. Consumer credit dipped in October, and nonfinancial firms' net

borrowing in the form of bank loans, commercial paper, and bonds was a bit below the thirdquarter pace. Household bankruptcies hovered at very low levels in recent weeks after

soaring to unprecedented heights just before the implementation of more-stringent

bankruptcy rules in mid-October. Hurricane relief payments apparently boosted M2 in

October, but that aggregate decelerated in November, partly reflecting the continued rise in

the opportunity cost of holding liquid deposits.

The staff forecast prepared for this meeting suggested that growth of economic activity

would slow from this year's pace, but remain solid, with output staying near the economy's

potential over the next two years. Although hurricane-related rebuilding would boost activity,

especially in the near term, this stimulus increasingly would be countered by higher interest

rates, the anticipated waning of the positive wealth effect associated with large earlier gains

in equity and house prices, and reduced impetus from fiscal policy. Both overall and core

consumer price inflation were projected to move higher in the first half of next year,

reflecting the effects of higher energy prices, but then to trend lower as those effects ebb.

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

incoming data over the intermeeting period had been encouraging with regard to both

economic growth and inflation. The economic expansion had shown considerable resilience

in the face of higher energy prices and hurricane-related disruptions, suggesting greater

underlying strength than had been apparent at the time of the November meeting. At the

same time, incoming inflation data had been benign, indicating relatively modest

pass-through of higher energy prices to core inflation to date; subdued gains in compensation

and strong growth in productivity were holding down business costs; and inflation

expectations, which had jumped after the hurricanes, had fallen back. Nonetheless, with

growth solid and prices of energy products still well above levels earlier in the year, possible

increases in resource utilization had the potential to add to pressures on prices, especially in

the absence of some further firming of policy.

In their discussion of major sectors of the economy, meeting participants noted that, while

light vehicle sales had slowed in the fall, consumer spending outside the auto sector appeared

to have remained vigorous. Holiday sales were said to be off to a good start in many parts of

the country. The substantial recovery in measures of consumer confidence after their sharp

declines in the aftermath of the hurricanes had reduced meeting participants' concerns about a

significant pull-back in spending. Going forward, consumer outlays were expected to be

supported by further advances in employment and income.

Meeting participants discussed tentative signs that activity was beginning to slow in the

housing sector. Reports from contacts in many parts of the country suggested somewhat less

ebullient market conditions, and measures of confidence of homebuyers and builders had

fallen back noticeably. A downshift in attitudes regarding the outlook for the housing sector

could have significant market effects, in part by damping the demand for houses by investors

and speculators. A slowing of house price increases, by restraining the expansion of

consumption, and a moderation in the pace of new building were expected to reduce the

growth of aggregate demand somewhat in coming quarters. To date, however, the national

data on home prices, sales, and construction activity did not suggest a significant weakening

in the sector.

Business investment spending had accelerated some since midyear. In part, the pickup may

have reflected an increase in business confidence as the economy proved resilient in the face

of this year's substantial adverse shocks. Participants noted that the improved performance of

investment suggested that the expansion was becoming more balanced, with strengthening

business spending potentially offsetting some moderation in the growth of household

spending from the elevated rates of recent years.

Economic activity also could be buoyed by developments in other sectors of the economy.

Increased federal government outlays were expected to boost output a little next year.

Supportive financial conditions and an apparent increase in confidence had contributed to a

pickup in growth abroad. Despite possible firming of monetary policy by some foreign

central banks and the rise in the foreign exchange value of the dollar owing to global

demands for dollar assets, a good portion of the recent strength in foreign economic growth

was expected to persist and provide support for U.S. exports.

In their discussion of prices, participants indicated that their concerns about near-term

inflation pressures had eased somewhat over the intermeeting period. Recent data suggested

that, thus far, indirect effects of elevated energy prices on core inflation had been muted.

Moreover, energy prices generally had fallen back on balance since earlier in the fall, and

much of the increases in inflation expectations posted in the aftermath of the hurricanes had

reversed. Participants noted that robust competition--including that from foreign

producers--and further substantial gains in productivity were helping to contain cost and

price pressures. Moreover, measures of labor compensation showed only moderate gains

while relatively wide profit margins could allow firms to absorb somewhat larger increases in

labor and other costs without boosting prices. Nonetheless, surveys and anecdotal reports

suggested that some firms were successfully passing at least a portion of their increased costs

on to customers, and many participants remained concerned that elevated energy prices could

put pressure on core inflation. Also, in the view of a number of participants, the economy

was possibly producing in the neighborhood of its potential, and the persistent strength in

spending of late suggested that resource markets could tighten further and inflation pressures

build. Under these circumstances, and with policy having been accommodative for some

time, inflation expectations could rise if monetary policy were not seen as responding to

contain such risks.

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 4-1/4 percent. With spending

apparently retaining considerable momentum, and with the indirect effects of increased

energy prices still threatening to raise core inflation at least for a time, the Committee

thought that additional policy firming at this meeting was appropriate to keep inflation and

inflation expectations in check. Committee members generally anticipated that policy would

likely need to be firmed further going forward. In that process, the Committee would need to

be mindful of the lags in the effect of policy firming on the economy. However, it would also

have to take account of the effects of the sustained period of favorable financial conditions

on asset prices and aggregate demand as well as the resulting possibility of further increases

in resource utilization and pressures on prices. Views differed on how much further

tightening might be required. Because the Committee's actions over the past eighteen months

had significantly reduced the degree of monetary policy accommodation, members thought

that the policy outlook was becoming considerably less certain and that policy decisions

going forward would depend to an increased extent on the implications of incoming

economic data for future growth and inflation.

The Committee agreed that several changes in the wording of the announcement to be

released after today's meeting would be appropriate. The federal funds rate had been boosted

substantially, and, in the view of some members, it was now likely within a broad range of

values that might turn out to be consistent with output remaining close to potential. In these

circumstances, the Committee thought that policy should no longer be characterized as

accommodative. Members concurred that the statement should note that the expansion

remained solid despite elevated energy prices and hurricane-related disruptions. While

inflation and long-term inflation expectations remained contained, the Committee agreed that

the announcement should indicate that possible increases in resource utilization, as well as

elevated energy prices, had the potential to add to inflation pressures and that "some further

measured policy firming is likely to be needed to keep the risks to the attainment of both

sustainable economic growth and price stability roughly in balance." Although future action

would depend on the incoming data, this characterization of the outlook for policy was seen

by most members as indicating that, given the information now in hand, the number of

additional firming steps required probably would not be large. Some members thought that

the word "measured" was no longer necessary, but its retention for this meeting was seen as

potentially useful to preclude a possible misinterpretation that the Committee now saw a

significant possibility of adjusting policy in larger increments in the near future. Wording of

the announcement along these lines was not expected to have a substantial effect on market

expectations for policy, though such effects were especially difficult to judge given the

extensive changes being made to the statement. The members agreed that the announcement

should end by noting that policy will respond to changes in economic prospects as needed to

foster the Committee's objectives.

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 4-1/4 percent."

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

released shortly after the meeting:

"The Committee judges that some further measured policy firming is likely to be

needed to keep the risks to the attainment of both sustainable economic growth

and price stability roughly in balance. In any event, the Committee will respond

to changes in economic prospects as needed to foster these objectives."

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, January 31,

2006.

The meeting adjourned at 1:00 p.m.

Notation Vote

By notation vote completed on November 21, 2005, the Committee unanimously approved

the minutes of the meeting of the Federal Open Market Committee held on November 1,

2005.

Vincent R. Reinhart

Secretary

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