FOMC Minutes

March 20-21, 2007

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, March 20, 2007 at 2:30 p.m., and

continued on Wednesday, March 21, 2007 at 9:00 a.m.

Present:

Mr. Bernanke, Chairman

Mr. Geithner, Vice Chairman

Mr. Hoenig

Mr. Kohn

Mr. Kroszner

Ms. Minehan

Mr. Mishkin

Mr. Moskow

Mr. Poole

Mr. Warsh

Ms. Cumming, Mr. Fisher, Ms. Pianalto, and Messrs. Plosser and Stern, Alternate

Members of the Federal Open Market Committee

Messrs. Lacker and Lockhart, and Ms. Yellen, Presidents of the Federal Reserve

Banks of Richmond, Atlanta, and San Francisco, respectively

Mr. Reinhart, Secretary and Economist

Ms. Danker, Deputy Secretary

Ms. Smith, Assistant Secretary

Mr. Skidmore, Assistant Secretary

Mr. Alvarez, General Counsel

Ms. Johnson, Economist

Mr. Stockton, Economist

Messrs. Connors, Evans, Fuhrer, Kamin, Madigan, Rasche, Slifman, and Wilcox,

Associate Economists

Mr. Dudley, Manager, System Open Market Account

Messrs. Clouse and English,1 Associate Directors, Division of Monetary Affairs,

Board of Governors

Mr. Struckmeyer, Associate Director, Division of Research and Statistics, Board of

Governors

Mr. Reifschneider, Deputy Associate Director, Division of Research and Statistics,

Board of Governors

Messrs. Dale2 and Oliner, Senior Advisers, Divisions of Monetary Affairs and

Research and Statistics, respectively, Board of Governors

Mr. Hambley,2 Assistant to the Board, Office of Board Members, Board of

Governors

Mr. Meyer, Visiting Reserve Bank Officer, Division of Monetary Affairs, Board of

Governors

Mr. Small,1 Project Manager, Division of Monetary Affairs, Board of Governors

Mr. Kiley2 and Ms. Kole,2 Section Chiefs, Divisions of International Finance and

Research and Statistics, respectively, Board of Governors

Mr. Doyle,2 Ms. Mauskopf,2 and Mr. Wood,2 Senior Economists, Divisions of

International Finance, Research and Statistics, and International Finance,

respectively, Board of Governors

Ms. Roush, Economist, Division of Monetary Affairs, Board of Governors

Mr. Gross, Special Assistant to the Board, Office of Board Members, 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. Rosenblum, Executive Vice President, Federal Reserve Bank of Dallas

Mr. Hakkio, Ms. Mester, Messrs. Rolnick, Rudebusch, and Sniderman, Senior Vice

Presidents, Federal Reserve Banks of Kansas City, Philadelphia, Minneapolis, San

Francisco, and Cleveland, respectively

Messrs. Cunningham and Hilton, Vice Presidents, Federal Reserve Banks of Atlanta

and New York, respectively

Ms. Sbordone, Research Officer, Federal Reserve Bank of New York

Mr. Hetzel, Senior Economist, Federal Reserve Bank of Richmond

1. Attended Wednesday’s session. Return to text

2. Attended portion of the meeting relating to the discussion of communications

issues. Return to text

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 the March meeting indicated that the economy appeared to be

expanding at a modest pace in the first quarter. Declines in residential construction activity

continued to weigh on overall activity, and business investment had softened considerably

over the preceding several months, especially in equipment used in the construction and

motor vehicle industries. However, consumer spending had increased appreciably in the early

part of the year, and labor demand continued to expand, albeit at a somewhat slower pace

than last year. Meanwhile, the twelve-month increase in core consumer prices remained

elevated relative to its pace one year earlier.

Employment gains moderated in early 2007. In February, employment in the construction

industry contracted considerably, in part because of severe winter storms; manufacturing

employment also declined, but hiring in service-producing sectors remained solid. A decline

in the average workweek led to a contraction in aggregate hours. At the same time, the

unemployment rate edged down from 4.6 percent in January to 4.5 percent in February.

Industrial production rose strongly in February and was revised up for both December and

January. In February, production was boosted by a rebound in motor vehicle assemblies and

by a temporary surge in output at utilities that reflected a swing from unseasonably warm

temperatures in January to colder weather in February. Production rose at a solid pace in all

major high-tech categories. Output of materials and defense and space equipment expanded

as well. In contrast, production of consumer goods and business equipment changed little,

while output of construction supplies declined.

Real consumer spending appeared on track to rise at a robust pace in the first quarter, buoyed

in part by a weather-related surge in spending on energy services and by a jump in sales of

light motor vehicles. Outside of these areas, however, real consumer spending moderated.

The determinants of household spending were mixed. Disposable personal income was

estimated to have risen sharply in January, but the increase was partly the result of special

factors, such as pay raises for federal and military personnel and cost-of-living adjustments to

Social Security payments. Meanwhile, readings on consumer sentiment, which had been

favorable in recent months, edged down in early March. The boost to consumer spending

from earlier gains in wealth was likely being muted by the lagged effects of the upward trend

in borrowing costs. In addition, recent declines in equity prices and slowing house price

appreciation pointed to a modest reduction in households’ wealth-to-income ratio in the first

quarter.

Housing starts declined in January, extending the downward trend that had been in place

since early 2006, but bounced back in February. However, adjusted permit issuance in the

single-family sector continued to step down, suggesting that builders were still slowing the

pace of new construction to work off elevated inventories. The inventory of new homes for

sale remained high, although cuts in residential construction in the last few months had

reduced the number of unsold homes. As at the time of the January meeting, available data

suggested that housing demand was stabilizing. Sales of both new and existing single-family

homes in recent months were, on balance, in line with the pace seen since mid-2006.

However, a tightening of standards for subprime borrowers in recent weeks seemed likely to

restrain home sales. House price appreciation had slowed further, with some measures

showing outright declines in home values.

Business fixed investment had been sluggish in recent months. Real spending on equipment

and software fell in the fourth quarter, and nominal orders for and shipments of nondefense

capital goods excluding aircraft posted widespread declines in January, with transportation

equipment showing a very large drop. Business purchases of light vehicles remained low, and

new orders for and deliveries of medium and heavy trucks plunged in the last few months

after a surge in 2006. Investment in goods and services other than transportation and

high-tech equipment softened more than fundamentals had suggested. Declines in spending

for capital equipment that is used heavily in the construction and motor vehicle industries

accounted for an outsized share of the drop in orders and shipments at manufacturers outside

high-tech and transportation in January. Investment in categories such as industrial

equipment; electromedical, measuring, and controlling devices; and other electrical

equipment also softened. In contrast, computer imports surged in January, suggesting rising

domestic purchases, and computer sales appeared to have picked up in February. The ample

cash reserves held by firms and ongoing reductions in the user cost of high-tech capital goods

remained supportive of investment going forward.

Businesses accumulated inventories of items other than motor vehicles at a slower pace in

January than in the previous two quarters. Even so, the ratio of inventories to sales for

manufacturing and trade excluding motor vehicles remained elevated. In addition, purchasing

managers at manufacturing firms, on net, continued to view their customers’ inventory levels

as too high.

The U.S. international trade deficit narrowed considerably in the fourth quarter. Exports rose,

partly reflecting a robust increase in deliveries of civilian aircraft to foreign buyers, while

imports were pushed down by a fall in the volume and price of imported oil. In January, the

trade deficit was little changed.

Economic activity in the advanced foreign economies accelerated in the fourth quarter. In

Japan, private consumption rebounded strongly, and private investment and net exports

continued to boost growth. The pace of economic expansion in the euro area picked up as

investment and exports rose. Growth in the United Kingdom firmed because of brisk

investment spending and a rebound in consumption growth. In contrast, output in Canada

decelerated in the fourth quarter as inventory accumulation turned down sharply. Recent data

for the emerging-market economies pointed to continued strength in activity, although there

were signs that growth was moderating in some countries. Growth remained solid in China

but decelerated in several other Asian economies and Mexico.

In January, the overall PCE price index rose moderately as a decline in energy prices helped

to offset a jump in food prices. Meanwhile, the PCE price index excluding food and energy

rose at a faster pace than in the previous two months. Increases in consumer energy prices

and higher prices for fruits and vegetables in February reflected a period of unusually cold

weather and contributed to an acceleration in that month’s CPI. Excluding food and energy,

core CPI inflation slowed slightly in February but remained elevated. In recent months,

prices had risen across a broad range of core goods. On a twelve-month-change basis, core

CPI inflation in February was considerably above its pace a year earlier, largely because of a

sharp acceleration in shelter rents over the past year. Average hourly earnings also rose at a

noticeably faster pace during the year ending in February than during the preceding

twelve-month period. Surveys indicated that households’ expectations of inflation over the

next year were little changed in February while households’ and professional forecasters’

longer-term inflation expectations edged lower.

At its January meeting, the Federal Open Market Committee maintained its target for the

federal funds rate at 5-1/4 percent. The Committee’s accompanying statement noted that

recent indicators had suggested somewhat firmer economic growth and that some tentative

signs of stabilization had appeared in the housing market. Overall, the economy seemed

likely to expand at a moderate pace over coming quarters. Readings on core inflation had

improved in recent months, and inflation pressures seemed likely to moderate over time, but

the high level of resource utilization had the potential to sustain inflation pressures. The

Committee judged that some inflation risks remained. The extent and timing of any

additional firming that might be needed to address these risks would depend on the evolution

of the outlook for both inflation and economic growth, as implied by incoming information.

The FOMC’s decision at its January meeting was in accord with market expectations, but the

accompanying statement reportedly was read as a sign that the Committee was more

sanguine about inflation prospects than in December, and the expected path for monetary

policy beyond 2007 edged lower. Policy expectations declined a bit more in the wake of the

Chairman’s semiannual monetary policy testimony, which apparently reinforced investors’

beliefs that the FOMC anticipated gradually diminishing inflation pressures. Economic data

releases were somewhat weaker than expected on balance over the first few weeks of the

intermeeting period, and policy expectations moved appreciably lower on net by

mid-February. Financial market volatility increased sharply in the second half of the

intermeeting period amid an apparent pullback from risk-taking that was reportedly spurred

by mixed news on domestic economic activity, mounting concerns about the subprime

mortgage sector, and significant declines in foreign equity prices. On net over the

intermeeting period, investors tilted their anticipated path for monetary policy beyond

mid-2007 down substantially, and yields on two- and ten-year nominal Treasury securities

fell 30 to 40 basis points. Yields on inflation-indexed Treasury securities generally declined

somewhat less than their nominal counterparts, leaving inflation compensation slightly lower

across the term structure. Broad stock price indexes dropped several percent on net over the

period. Yields on investment-grade corporate bonds fell about in line with those on Treasury

securities of comparable maturity. In contrast, yields on speculative-grade bonds declined

only modestly, leaving risk spreads noticeably wider, albeit still narrow by historical

standards.

Domestic nonfinancial sector debt appeared to be continuing to rise at a relatively brisk rate

in the first quarter. Despite the recent volatility in financial markets, funding in the bond and

syndicated loan markets appeared to remain readily available. However, borrowing by

nonfinancial corporations was estimated to be moderating somewhat in the first quarter, with

a step-down in bond issuance associated with merger and acquisition activity. Indicators

pointed to a continuing deceleration in house prices this quarter, and home mortgage

borrowing probably continued to slow. M2 increased more moderately in February than at

the end of 2006 as the expansion of liquid deposits slowed from its outsized fourth-quarter

rate.

In its forecast prepared for this meeting, the staff marked down the projected increase in real

GDP in the first quarter in response to weaker-than-expected incoming data on business

equipment spending and federal defense purchases. The recent increase in oil prices and

decline in equity prices, along with increased strains in the subprime mortgage sector, were

expected to exert some drag on real activity over the remainder of the year. Even so, real

GDP growth was expected to pick up to a rate a little below that of the economy’s long-run

potential for the remainder of 2007, as declines in residential construction activity lessened,

and to remain at a similar rate in 2008. The increase in energy prices over the intermeeting

period led the staff to revise up its forecast for headline PCE inflation during the first half of

this year, but the staff continued to expect that core PCE inflation would edge down over the

remainder of this year and next.

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

while recent economic data had been mixed, the economy was likely to expand at a moderate

pace in coming quarters. Although the housing sector adjustment continued, accumulating

data suggested that the demand for homes was leveling out. Business fixed investment had

been soft in recent months, but financing conditions and other fundamentals remained

favorable for a pickup in capital spending. Moreover, continuing gains in personal income

could be expected to support growth in consumer spending. Thus economic growth likely

would increase in coming quarters to a pace close to or modestly below the economy’s trend

growth rate. However, additional evidence of sluggish business investment and recent

developments in the subprime mortgage market suggested that the downside risks relative to

the expectation of moderate growth had increased in the weeks since the January FOMC

meeting. At the same time, the prevailing level of inflation remained uncomfortably high,

and the latest information cast some doubt on whether core inflation was on the expected

downward path. Most participants continued to expect that core inflation would slow

gradually, but the recent readings on inflation and productivity growth, along with higher

energy prices, had increased the odds that inflation would fail to moderate as expected; that

risk remained the Committee’s predominant concern.

Participants reported signs of stabilization in housing demand in most regions of the country.

At the national level, sales of new and existing homes, while fluctuating in recent months,

did not display declining trends. The inventory of new homes for sale reportedly had fallen

further from its recently elevated level. Participants noted, however, that such inventories

likely would need to be worked down appreciably more before growth in housing

construction would resume. The increase in delinquencies on subprime adjustable-rate

mortgage loans and the ensuing increase in interest rates and tightening of credit standards in

the subprime mortgage market likely would constrain home purchases by some borrowers,

perhaps retarding the recovery in the housing sector. However, there was no sign of

spillovers from the subprime market to the overall mortgage market; indeed, interest rates on

prime mortgage loans had declined somewhat in recent weeks, along with yields on U.S.

Treasury securities. Moreover, home-buying attitudes had improved and continuing job

growth could be expected to support home sales.

Business fixed investment spending had been surprisingly weak of late, given strong

corporate balance sheets, high profitability, anticipated growth in sales, and favorable

financial conditions. Participants continued to expect these fundamentals to support a firming

of investment spending going forward, and they saw no indication that recent market

volatility had prompted a reduction in the availability of financing for business investment.

Also, declining office vacancy rates in some areas were spurring gains in nonresidential

construction activity, and further advances in commercial construction were seen as likely.

Energy prices were high enough to encourage continued investment in alternative fuels.

However, the relatively slow pace of investment in recent months might be signaling that

business executives had become less certain about the outlook, and perhaps that they

expected quite modest gains in sales. Participants agreed that the possibility of persistently

sluggish investment spending was an important downside risk to the outlook for economic

growth.

Growth in consumer spending would likely continue to be supported by gains in employment

and incomes. Meeting participants noted that weakness in the housing market had not spilled

over to aggregate consumption--though the flattening out in house prices likely would

contribute to an increase in the personal saving rate--and turmoil in the subprime mortgage

market did not appear to be generating any diminution in the availability of other types of

household credit. The recent increase in oil prices and the reduction in household net worth

resulting from the small net declines in equity prices during the intermeeting period

warranted a modest downward adjustment in projected growth of consumer spending. Even

so, the possibility that the personal saving rate would fail to rise as projected in the staff

forecast remained an upside risk to the outlook.

Growth in federal as well as state and local government spending probably would remain a

source of stimulus to the economy. Moreover, continued expansion in domestic demand in

our major trading partners could be expected to sustain solid growth in U.S. exports.

Many participants again reported softness in manufacturing, primarily but not exclusively in

industries related to housing or automobiles. However, a number of firms outside of the

housing sector--including auto companies--appeared to have made progress in reducing

inventories to more comfortable levels, and contacts in the industrial sector were generally

optimistic about future growth. Such attitudes were consistent with national and regional

surveys that pointed to a rebound in manufacturing activity later this year.

Anecdotal and statistical evidence suggested that labor markets remained relatively tight.

Business contacts continued to report shortages of skilled workers in technical and

professional fields, with significant wage pressures in some occupations, as well as a scarcity

of less skilled and unskilled workers in some areas of the country. So far, aggregate measures

of labor compensation were showing only moderate increases, but, looking ahead, the

possibility that labor costs might rise more rapidly was seen as an upside risk to inflation. It

was noted, however, that increases in compensation that exceeded productivity gains might

be absorbed to some extent by a narrowing of firms’ high profit margins. Participants

expected that productivity growth would pick up as firms slowed hiring to a pace more in

line with output growth but acknowledged that the improvement might be limited,

particularly if business investment spending were to remain soft.

Most participants continued to expect a gradual decline in core inflation over the next year or

two, fostered by stable inflation expectations, a likely deceleration in shelter costs, and a

slight easing of pressures on resources. Nonetheless, all meeting participants expressed

concern about the risks to this outlook. The latest readings on core inflation were higher than

expected, and it was difficult to discern whether the apparent downward trend in core

inflation during the past few quarters was continuing. Also, the recent increases in prices for

energy and some non-energy imports likely would boost overall inflation in the near term and

might put upward pressure on prices of some core goods and services. Moreover, rates of

resource utilization that were near the high end of historical experience suggested a

possibility that inflation pressures could build. Participants agreed that risks around the

expected and desired path of a gradual decline in core inflation remained mainly to the

upside; some noted that upside risks to inflation appeared to have increased slightly in recent

months.

In the Committee’s discussion of monetary policy for the period between its March and May

meetings, all members favored keeping the target federal funds rate at 5-1/4 percent. Recent

developments were seen as supporting the Committee’s view that maintaining the current

target was likely to foster moderate economic growth and to further the gradual reduction of

core inflation from its elevated level. Nonetheless, the combination of generally weakerthan-expected economic indicators and uncomfortably high readings on inflation suggested

increased downside risks to economic growth and greater uncertainty that the expected

gradual decline in core inflation would materialize.

In light of the recent economic data and anecdotal information, the Committee agreed that

the statement to be released after the meeting should note that economic indicators had been

mixed, that the adjustment in the housing market was ongoing, and that the economy seemed

likely to expand at a moderate pace over coming quarters. Members agreed the statement

also should indicate that inflation pressures seemed likely to moderate over time, but that

recent readings on core inflation had been somewhat elevated and the high level of resource

utilization had the potential to sustain inflation pressures. A persistence of inflation at recent

rates could eventually have adverse consequences for economic performance. All members

agreed the statement should indicate that the Committee’s predominant policy concern

remains the risk that inflation will fail to moderate as expected. The Committee agreed that

further policy firming might prove necessary to foster lower inflation, but in light of the

increased uncertainty about the outlook for both growth and inflation, the Committee also

agreed that the statement should no longer cite only the possibility of further firming.

Instead, the statement should indicate that future policy adjustments will depend on the

evolution of the outlook for both inflation and economic growth, as implied by incoming

information.

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 maintaining the federal funds rate

at an average of around 5-1/4 percent.”

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

released at 2:15 p.m.:

“In these circumstances, the Committee’s predominant policy concern remains

the risk that inflation will fail to moderate as expected. Future policy

adjustments will depend on the evolution of the outlook for both inflation and

economic growth, as implied by incoming information.”

Votes for this action: Messrs. Bernanke, Geithner, Hoenig, Kohn, and Kroszner, Ms.

Minehan, Messrs. Mishkin, Moskow, Poole, and Warsh.

Votes against this action: None.

The Committee then returned to the topic of improving policy communications. Participants

expressed a range of views on the possible advantages and disadvantages of specifying a

numerical price objective for monetary policy and on technical aspects of a quantification.

Participants emphasized that any such move would need to be consistent with the

Committee’s statutory objectives for promoting maximum employment as well as price

stability. The Committee made no decisions on this issue. Participants also discussed the

communications role of the economic projections that are made periodically by the members

of the Board of Governors and the Reserve Bank presidents. A number of substantive and

practical issues would still need to be evaluated before the Committee could make decisions

about an enhanced role for projections in explaining policy. The Committee planned to

continue its review of communication issues at the FOMC meeting in June 2007.

It was agreed that the next meeting of the Committee would be held on Wednesday, May 9,

2007.

The meeting adjourned at 1:30 p.m.

Notation Vote

By notation vote completed on February 20, 2007, the Committee unanimously approved the

minutes of the FOMC meeting held on January 30-31, 2007.

Vincent R. Reinhart

Secretary

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Last update: April 11, 2007, 2:00 PM