FOMC Minutes

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Minutes of the Federal Open Market Committee

September 16, 2008

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, September 16, 2008 at 8:30 a.m.

PRESENT:

Mr. Bernanke, Chairman

Ms. Duke

Mr. Fisher

Mr. Kohn

Mr. Kroszner

Ms. Pianalto

Mr. Plosser

Mr. Stern

Mr. Warsh

Ms. Cumming, Messrs. Evans, Lacker, and Lockhart, and Ms. Yellen, Alternate Members of the

Federal Open Market Committee

Messrs. Bullard, Hoenig, and Rosengren, Presidents of the Federal Reserve Banks of St.

Louis, Kansas City, and Boston, respectively

Mr. Madigan, Secretary and Economist

Ms. Danker, Deputy Secretary

Mr. Skidmore, Assistant Secretary

Ms. Smith, Assistant Secretary

Mr. Alvarez, General Counsel

Mr. Sheets, Economist

Mr. Stockton, Economist

Messrs. Connors, English, Kamin, Rolnick, Rosenblum, Slifman, Tracy, and Wilcox, Associate

Economists

Mr. Dudley, Manager, System Open Market Account

Mr. Cole, Director, Division of Banking Supervision and Regulation, Board of Governors

Mr. Blanchard, Assistant to the Board, Office of

Board Members, Board of Governors

Mr. Clouse, Deputy Director, Division of Monetary Affairs, Board of Governors

Mr. Parkinson, Deputy Director, Division of Research and Statistics, Board of Governors

Mr. Struckmeyer, Deputy Staff Director, Office of

Staff Director for Management, Board of

Governors

Mr. Gagnon, Visiting Associate Director, Division

of Monetary Affairs, Board of Governors

Messrs. Reifschneider and Wascher, Associate Directors, Division of Research and Statistics,

Board of Governors

Mr. Oliner, Senior Adviser, Division of Research

and Statistics, Board of Governors

Mr. Small, Project Manager, Division of Monetary

Affairs, Board of Governors

Mr. Luecke, Section Chief, Division of Monetary

Affairs, Board of Governors

Mr. Carlson, Economist, Division of Monetary Affairs, Board of Governors

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

Mr. Moore, First Vice President, Federal Reserve

Bank of San Francisco

Mr. Judd, Executive Vice President, Federal Reserve Bank of San Francisco

Mr. Altig, Ms. Baum, Messrs. Rasche, Schweitzer,

Sellon, and Tootell, Senior Vice Presidents,

Federal Reserve Banks of Atlanta, New York,

St. Louis, Cleveland, Kansas City, and Boston,

respectively

Mr. Krane, Vice President, Federal Reserve Bank

of Chicago

Mr. Chatterjee, Senior Economic Adviser, Federal

Reserve Bank of Philadelphia

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Federal Open Market Committee

Mr. Wolman, 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 operations in government securities and federal agency obligations during the period since the previous meeting. By unanimous vote, the Committee ratified these transactions.

In light of severe stresses in dollar funding markets, the

Committee considered a proposal intended to provide

the flexibility necessary to respond promptly to requests from foreign central banks to engage in temporary reciprocal currency (“swap”) arrangements to be

used in supporting dollar liquidity in their jurisdictions.

After the discussion, the Committee voted unanimously to authorize its Foreign Currency Subcommittee to direct the Federal Reserve Bank of New York as

needed to expand existing swap arrangements and to

enter into new arrangements with foreign central banks

to address strains in money markets. This authority

extends through January 30, 2009.

The information reviewed at the September meeting

indicated that economic activity decelerated considerably in recent months. The labor market deteriorated

further in August as private payrolls declined and the

unemployment rate moved markedly higher. Industrial

output was little changed in July, but fell sharply in August. Consumer spending weakened noticeably in recent months. Meanwhile, residential investment continued to decline steeply through midyear. In contrast,

business investment in equipment and structures generally held up through July. On the inflation front,

overall consumer prices rose rapidly for a third straight

month in July but then edged down in August, because

of a sharp drop in energy prices. Core consumer price

inflation remained elevated in July and eased somewhat

in August.

The labor market continued to weaken. According to

the August employment report, private payroll employment fell by a bit more than the average seen earlier this year. Most major industry groups shed jobs;

manufacturing posted a particularly noticeable loss.

Job losses in the construction industry diminished over

July and August despite the ongoing contraction in

_

residential investment. Hiring in nonbusiness services,

which include the education and health industries, and

in natural resources and mining increased in line with

recent trends. The average workweek held steady and

aggregate hours edged lower. The unemployment rate

jumped 0.4 percentage point, to 6.1 percent, in August,

while the labor force participation rate held steady.

Industrial production fell sharply in August after edging

up in July. Motor vehicle assemblies dropped in August as automakers scaled back production following a

sharp decline in vehicle sales in July. The output of

high-tech equipment rose at a moderate rate in the first

half of the year, but indicators of production gains in

the high-tech sector pointed toward relatively subdued

growth in the third quarter. The output of other manufacturing sectors declined for a third consecutive

month in August, and indicators of near-term production suggested that the industrial sector was likely to

remain soft over the next few months. For most major

industry groups, factory utilization rates in August remained below their long-run averages.

Real personal consumption expenditures (PCE) turned

down in June and declined more noticeably in July;

over the two months, outlays for motor vehicles

dropped markedly and spending on other goods weakened substantially. The recent weakness in consumer

spending on goods excluding motor vehicles contrasted

sharply with solid growth in the spring. Outlays for

services were reported to have increased modestly in

June and July. Total nominal retail sales decreased in

August. Real disposable income was boosted significantly by the tax rebates in the second quarter; excluding the temporary rebates, real disposable income fell in

that quarter and continued to move lower in July.

Early September readings on consumer sentiment rose

from the low levels recorded over the past several

months.

Residential construction activity continued to decline

steeply through midyear. In July, both single-family

housing starts and permit issuance fell further. In the

multifamily sector, starts dropped back in July to a rate

more in line with its historical range. June’s spike in

multifamily starts was related to more-stringent building codes that took effect in New York City on July 1,

which apparently led developers to pull forward the

start date of some planned apartment projects. Recent

cutbacks in new residential construction reduced the

level of new home inventories, and the relative stability

in sales of new homes allowed those inventory reductions to begin to bring down the months’ supply of

Minutes of the Meeting of September 16, 2008

new homes for sale. Even so, the months’ supply of

new homes for sale remained extremely elevated relative to the level that prevailed before the downturn in

the housing market. Sales of existing single-family

homes were relatively flat since the end of last year.

Tight conditions in mortgage markets over the summer

continued to restrain housing demand, especially for

borrowers seeking nonconforming mortgages. Several

indexes indicated that house prices had declined substantially over the past 12 months, and these prices appeared to remain on a downward trajectory.

In the business sector, investment in equipment and

software fell in the second quarter, largely reflecting a

sharp drop in spending on motor vehicles. In contrast,

growth of real outlays for nontransportation equipment

posted a moderate gain. The data on nominal orders

and shipments of nondefense capital goods excluding

aircraft rose substantially in July, although some of the

gain in nominal shipments may have reflected unusually

large price increases. Moreover, as in previous months,

orders and shipments were likely supported in July by

increased foreign demand. Real nonresidential investment increased at a robust rate in the second quarter;

however, nominal expenditures declined in July, and

forward-looking indicators remained downbeat. Vacancy rates for commercial properties moved higher in

the first half of the year and the architectural billings

index continued to register weak readings.

Real nonfarm inventories excluding motor vehicles fell

in the second quarter. The book value of manufacturing and trade inventories (excluding motor vehicles)

stepped up modestly in July from the second-quarter

level, but the ratio of these inventories to sales held

steady.

The U.S. international trade deficit widened in July, as a

surge in the value of imports of goods and services

more than offset strong growth in exports. Imports in

July were led by a rapid increase in imports of oil, reflecting both higher volumes and higher prices, and

were supported by a rise in imports of industrial supplies, capital goods, and services. The strength in exports was broadly based but benefited in particular

from robust exports of automotive products.

Economic indicators pointed to a marked deceleration

of economic activity in the advanced foreign economies. In the second quarter, gross domestic product

(GDP) was flat in Canada and the United Kingdom

and fell in both Japan and the euro area. In July, employment continued to weaken in Japan, and retail sales

fell in the euro area. Headline inflation in the major

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advanced foreign economies stayed elevated. Data received over the intermeeting period showed a further

slowing of growth in emerging market economies. For

Mexico, anemic growth in the second quarter followed

a slight contraction in the first. In Asia, output decelerated significantly in the second quarter, as growth

moderated in China and weakened more sharply in

several other economies. Headline inflation rose in

some developing countries but fell in others.

Headline consumer prices in the United States declined

slightly in August after having risen rapidly during the

preceding three months. Energy prices dropped

steeply, and the rate of increase in food prices moderated somewhat. Core consumer prices rose a bit more

slowly in August than they had in June and July. Excluding food and energy, producer prices rose modestly

in August, although prices for capital goods other than

motor vehicles and high-tech equipment posted a large

increase. During recent months, some cost pressures

eased as the prices of crude oil and other commodities

declined and non-oil import prices decelerated. Some

measures of inflation expectations were down notably

over the intermeeting period. Measures of hourly labor

compensation continued to increase moderately with

no sign of acceleration.

At its August meeting, the Federal Open Market

Committee (FOMC) kept the target federal funds rate

unchanged at 2 percent. The Committee’s statement

noted that economic activity expanded in the second

quarter, partly reflecting growth in consumer spending

and exports. However, labor markets had softened

further and financial markets remained under considerable stress. Tight credit conditions, the ongoing housing contraction, and elevated energy prices were likely

to weigh on economic growth over the next few quarters. The Committee stated that, over time, the substantial easing of monetary policy, combined with ongoing measures to foster market liquidity, should help

to promote moderate economic growth. Inflation had

been high, spurred by the earlier increases in the prices

of energy and some other commodities, and some indicators of inflation expectations had been elevated. The

Committee expected inflation to moderate later this

year and next year, but the inflation outlook remained

highly uncertain. Although downside risks to growth

remained, the upside risks to inflation were also of significant concern to the Committee. The Committee

indicated that it would continue to monitor economic

and financial developments and would act as needed to

promote sustainable economic growth and price stability.

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Federal Open Market Committee

Over the intermeeting period, investors marked down

considerably their expectations for the path of monetary policy. Policy expectations were largely unaffected

by the outcome of the August FOMC meeting, as the

Committee’s decision to leave the target federal funds

rate unchanged was broadly anticipated and the accompanying statement was reportedly in line with investor expectations. Subsequently, the expected future

path of monetary policy dropped amid increasing concerns about the health of financial institutions. The

market’s expectation for the onset of policy tightening

was also pushed back as labor market conditions weakened and oil prices declined further, developments that

were seen as tempering inflation pressures. Yields on

nominal Treasury coupon securities declined over the

intermeeting period while yields on inflation-indexed

Treasury securities were roughly unchanged, which left

inflation compensation noticeably lower. The decrease

in inflation compensation was most pronounced at

shorter horizons, likely reflecting the drop in oil prices.

Conditions in short-term funding markets remained

strained for most of the intermeeting period and deteriorated considerably just before the FOMC meeting.

The spreads of London interbank offered rates, or Libor, over comparable-maturity overnight index swap

rates, especially those beyond the one-month horizon,

moved up from already-high levels. In the commercial

paper market, spreads on lower-rated nonfinancial and

asset-backed commercial paper fluctuated in an elevated range, as did spreads on financial paper. Depository institutions continued to bid aggressively for 28day funds at the Term Auction Facility (TAF) during

the intermeeting period, and demand for funds was

strong at both of the 84-day TAF auctions. The

amount of overnight primary credit outstanding was

about unchanged at a high level, while term primary

credit continued to rise. No credit was extended

through the Primary Dealer Credit Facility until the

final week of the intermeeting period. Conditions in

markets for repurchase agreements, or repos, against

some types of collateral deteriorated over the intermeeting period, and liquidity in non-Treasury, nonagency term repo markets remained poor.

In longer-term credit markets, yields on investmentgrade corporate bonds were not much changed, but

yields on speculative-grade bonds rose somewhat. Risk

spreads on corporate bonds jumped, as comparablematurity Treasury yields dropped; most of the increase

in risk spreads occurred late in the intermeeting period.

Corporate bond issuance moderated a bit further in

August, while growth of bank lending to businesses

_

was tepid. Broad equity indexes declined over the intermeeting period. Financial sector equity indexes were

volatile and ended the period down sharply.

Liquidity conditions in the money markets of major

foreign economies deteriorated over the intermeeting

period. Sovereign bond yields moved down, mainly

reflecting declines in inflation compensation. On a

trade-weighted basis, the dollar rose against the currencies of our major trading partners.

M2 contracted slightly in August following a generally

weak performance over the previous few months. The

August data showed a considerable reallocation among

the components of M2. Liquid deposits and retail

money funds fell while small time deposits surged as

some banks and thrifts bid aggressively for these deposits.

On September 7, the Treasury Department and the

Federal Housing Finance Agency announced that Fannie Mae and Freddie Mac had been placed into conservatorship and that Treasury would establish a backstop

lending facility for the government-sponsored enterprises (GSEs), purchase preferred stock in the GSEs as

necessary to ensure that they maintain a positive net

worth, and initiate a program to purchase mortgagebacked securities (MBS). Following the announcement,

spreads on Fannie Mae and Freddie Mac debt and on

agency MBS narrowed, while share prices for their

common and preferred stock fell. Auctions of GSE

debt following the conservatorship announcement reportedly attracted heavy demand, but market participants indicated that liquidity in the secondary market

for GSE debt remained somewhat lower than normal.

Before the conservatorship announcement, interest

rates on 30-year fixed-rate mortgages had declined less

than those on comparable-maturity Treasury securities,

leaving mortgage spreads at the top of their range of

the past two decades. Following the Treasury announcement, rates and spreads on new conforming

fixed-rate mortgages dropped sharply.

In the days immediately before the FOMC meeting,

Lehman Brothers Holdings filed for bankruptcy, Bank

of America announced that it would acquire Merrill

Lynch, and market concerns about the health of other

financial institutions increased. To address potential

liquidity pressures in financial markets associated with

these developments, the Federal Reserve announced

several additional initiatives, including an expansion of

collateral eligible for the Primary Dealer Credit Facility

and the Term Securities Lending Facility (TSLF), increases in the size and frequency of TSLF auctions, and

Minutes of the Meeting of September 16, 2008

a temporary relaxation of the limitations on brokerdealers’ access to funding from affiliated depository

institutions. In addition, a consortium of 10 major

banks announced the creation of a liquidity pool from

which participants could draw collateralized loans. Despite these enhanced liquidity measures, short-term

funding markets remained severely strained, reflecting

investors’ heightened concerns about the financial condition of other large financial firms, including American

International Group, a prominent insurance and financial services company. To further support market liquidity and to help keep the federal funds rate near its

target, the Federal Reserve conducted very large reserve-adding open market operations the day before

and the morning of the FOMC meeting. Market expectations for the path of monetary policy moved

down sharply. Yields on nominal Treasury securities

dropped steeply, and credit spreads on corporate bonds

widened significantly. Equity markets were volatile and

equity prices dropped considerably.

In the forecast prepared for the meeting, the staff left

its projection for real GDP growth in the second half

of 2008 little changed from the previous meeting, but it

marked down its forecast for 2009 slightly. Real GDP

was estimated to have increased at a solid pace in the

second quarter; however, the available indicators

pointed to a sharp deceleration in economic activity in

the third quarter. Consumer spending softened appreciably in recent months, and housing construction remained on a steep downtrend. Some of the weakness

in the household sector appeared to reflect the ongoing

deterioration in the labor market, but the effects of the

earlier run-up in oil prices, weakened balance sheets,

and restrictive financial conditions also likely put the

finances of many households and businesses under

pressure. The staff continued to expect that real GDP

would advance slowly in the fourth quarter of 2008 and

at a faster rate in 2009, but still less than that of its potential. Real GDP growth was expected to pick up to

slightly above the rate of potential growth in 2010, as

the restraint on household and business spending associated with financial market turmoil gradually eases and

the contraction in the housing sector comes to an end.

The staff’s outlook for both core and overall PCE inflation over the next two years also changed little. The

staff continued to project that core inflation would

edge lower in 2009 and 2010 as the prices of imports,

energy, and other commodities decelerate and the margin of resource slack remains relatively wide.

In their discussion of the economic situation and outlook, FOMC participants noted that financial market

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strains had intensified in the days before the meeting

and that these strains could potentially weigh further on

economic activity. Participants agreed that economic

growth was likely to be sluggish in the second half of

2008. Several participants had marked down their

near-term outlook for economic activity and some

judged that downside risks had increased, but most

continued to expect a gradual recovery in 2009. Despite concern that recent high inflation readings suggested that price pressures could persist, participants

generally thought that the outlook for inflation had

improved, mainly reflecting the recent declines in the

prices of oil and other commodities, the stronger foreign exchange value of the dollar, and the weakening of

the labor market.

Participants noted that stresses on financial markets

and institutions had increased. The announcement of

government support for Fannie Mae and Freddie Mac

appeared to have had a positive impact on financial

markets, most importantly on the primary and secondary markets for residential mortgages. However, the

bankruptcy of Lehman Brothers and market concerns

about other financial institutions were causing a wide

variety of financial firms to experience increasing difficulty in obtaining funding and raising capital, a development that was likely to lead to a further tightening of

credit availability to households and firms. Meeting

participants were highly uncertain about future financial

developments and their implications for the broader

economy. There was agreement that the liquidity facilities established by the Federal Reserve over the past

year had been helpful in ameliorating strains in financial

markets, but it was also noted that the capital of banks

and other financial institutions would need to be bolstered in order to strengthen the functioning of the

financial system and ease constraints on credit.

Strains on the financial system, and their interactions

with housing developments and the real economy more

broadly, continued to restrain aggregate demand and

pose substantial downside risks to the expected path

for economic activity. The fall in employment in August highlighted concerns that an adverse dynamic was

taking hold, in which economic weakness increased

financial firms’ losses, leading to tighter credit conditions and thus causing a further softening in economic

activity. However, some participants cited indications

that the pace of decline in house prices might begin to

slow in coming months, which would serve to limit the

strains on lenders. Mortgage rates had fallen after action on the GSEs, inventories of houses for sale had

fallen, and reports from contacts in some parts of the

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Federal Open Market Committee

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nation suggested a possible bottoming of the housing

sector might not be far off, although the differences in

the prospects for housing across states and regions

seemed to be large. All in all, the contraction in the

housing sector and the adverse implications for the

performance of mortgage-related financial assets continued to represent a drag on economic performance.

increases in the costs of energy and other raw materials

and would resist reversing previous price increases.

Participants noted that recent readings on core and

headline inflation had been elevated, and they expressed concern that high inflation might become embedded in expectations and retain considerable momentum.

Recent readings on consumer spending had been weak

despite the tax rebates, which were mostly paid out by

mid-July; these indicators suggested that consumption

may remain soft as the effects of the stimulus fade over

the near term. Falling real estate prices were likely to

continue to reduce household wealth, and the eroding

quality of consumer loans had the potential to lead to a

further tightening of credit conditions. Many participants worried that the deterioration in labor market

conditions over the summer would damp the growth of

income and depress consumer confidence, further

holding back consumption.

Members agreed that keeping the federal funds rate

unchanged at this meeting was appropriate. The current low real federal funds rate appeared necessary to

provide adequate counterweight to the restraining effects of tight credit conditions and of continued declines in the housing market on spending and output.

Committee members generally saw the current stance

of monetary policy as consistent with a gradual

strengthening of economic growth beginning next year,

although they recognized that recent financial developments had boosted the downside risks to the economic outlook. Inflation risks appeared to have diminished in response to the declines in the prices of energy

and other commodities, the recent strengthening of the

dollar, and the outlook for somewhat greater economic

slack, and Committee members were a bit more optimistic that inflation would moderate in coming quarters. However, the possibility that core inflation would

not moderate as anticipated was still a significant concern. With substantial downside risks to growth and

persisting upside risks to inflation, members judged

that leaving the federal funds rate unchanged at this

time suitably balanced the risks to the outlook. Some

members emphasized that if intensifying financial

strains led to a significant worsening of the growth outlook, a policy response could be required; however,

such a response was not called for at this meeting. Indeed, it was noted that, with elevated inflation still a

concern and growth expected to pick up next year if

financial strains diminish, the Committee should also

remain prepared to reverse the policy easing put in

place over the past year in a timely fashion.

Business spending had held up well over the summer,

and inventories appeared to be well managed. However, reports from business contacts suggested that new

commercial real estate projects were difficult to finance.

With credit conditions generally tight and economic

prospects relatively uncertain, investment spending was

likely to be on the soft side going forward.

Foreign economic growth had slowed in recent months

and the dollar had risen broadly; both of these developments suggested that the contributions to U.S. GDP

growth from net exports would likely be less strong

than it had been of late. Some participants noted that

financial strains were increasing in many foreign countries. However, a beneficial side effect of the global

slowdown was the falling prices of oil and other commodities, which would help to bolster real incomes of

U.S. households.

Participants generally were somewhat more confident

about the outlook for some moderation in inflation

over the forecast horizon. Recent substantial declines

in the prices of oil and other commodities should help

to contain broader price pressures in coming quarters.

In addition, the effects of the stronger dollar on import

prices along with increased economic slack would tend

to damp inflation. Various measures of inflation expectations had declined since the last meeting, and

nominal wage increases had continued to be moderate.

Indeed, with solid growth in productivity, unit labor

costs had been well contained. Still, reports from business contacts suggested that firms were continuing to

attempt to pass through to their customers previous

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

Minutes of the Meeting of September 16, 2008

with maintaining the federal funds rate at an average of around 2 percent.”

The vote encompassed approval of the statement below to be released at 2:15 p.m.:

“The Federal Open Market Committee decided

today to keep its target for the federal funds rate

at 2 percent.

Strains in financial markets have increased significantly and labor markets have weakened further. Economic growth appears to have slowed

recently, partly reflecting a softening of household spending. Tight credit conditions, the ongoing housing contraction, and some slowing in

export growth are likely to weigh on economic

growth over the next few quarters. Over time,

the substantial easing of monetary policy, combined with ongoing measures to foster market

liquidity, should help to promote moderate economic growth.

Inflation has been high, spurred by the earlier

increases in the prices of energy and some other

commodities. The Committee expects inflation

to moderate later this year and next year, but the

inflation outlook remains highly uncertain.

The downside risks to growth and the upside

risks to inflation are both of significant concern

to the Committee. The Committee will monitor

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economic and financial developments carefully

and will act as needed to promote sustainable

economic growth and price stability.”

Votes for this action: Mr. Bernanke, Mses. Cumming

and Duke, Messrs. Fisher, Kohn, and Kroszner, Ms.

Pianalto, Messrs. Plosser, Stern, and Warsh.

Votes against this action: None.

Ms. Cumming voted as the alternate for Mr. Geithner.

It was agreed that the next meeting of the Committee

would be held on Tuesday-Wednesday, October 28-29,

2008.

The meeting adjourned at 12:30 p.m.

Notation Vote

By notation vote completed on August 25, 2008, the

Committee unanimously approved the minutes of the

FOMC meeting held on August 5, 2008.

_____________________________

Brian F. Madigan

Secretary