FOMC Minutes

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Minutes of the Federal Open Market Committee

December 15-16, 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 Monday, December 15, 2008 at 2:00 p.m. and continued on

Tuesday, December 16, 2008 at 9:00 a.m.

Mr. Struckmeyer, Deputy Staff Director, Office of

Staff Director for Management, Board of

Governors

Mr. Blanchard, Assistant to the Board, Office of

Board Members, Board of Governors

PRESENT:

Mr. Bernanke, Chairman

Ms. Duke

Mr. Fisher

Mr. Kohn

Mr. Kroszner

Ms. Pianalto

Mr. Plosser

Mr. Stern

Mr. Warsh

Messrs. Clouse and Parkinson,1 Deputy Directors,

Divisions of Monetary Affairs and Research

and Statistics, respectively, Board of Governors

Mr. Frierson,² Deputy Secretary, Office of the Secretary, Board of Governors

Messrs. Leahy,² Nelson,³ Reifschneider, and

Wascher, Associate Directors, Divisions of International Finance, Monetary Affairs, Research and Statistics, and Research and Statistics, respectively, Board of Governors

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

Federal Open Market Committee

Mr. Gagnon,² Visiting Associate Director, Division

of Monetary Affairs, Board of Governors

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

Louis, Kansas City, and Boston, respectively

Ms. Shanks,² Associate Secretary, Office of the

Secretary, Board of Governors

Mr. Madigan, Secretary and Economist

Ms. Danker, Deputy Secretary

Mr. Skidmore, Assistant Secretary

Ms. Smith, Assistant Secretary

Mr. Alvarez, General Counsel

Mr. Ashton,1 Assistant General Counsel

Mr. Sheets, Economist

Mr. Stockton, Economist

Messrs. Perli and Reeve, Deputy Associate Directors, Divisions of Monetary Affair and International Finance, respectively, Board of Governors

Mr. Covitz, Assistant Director, Division of Research and Statistics, Board of Governors

Messrs. Connors, English, and Kamin, Ms. Mester,

Messrs. Rolnick, Rosenblum, Slifman, and

Wilcox, Associate Economists

Ms. Goldberg,² Visiting Reserve Bank Officer, Division of International Finance, Board of Governors

Mr. Dudley, Manager, System Open Market Account

Mr. Zakrajsek,² Assistant Director, Division of

Monetary Affairs, Board of Governors

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

Ms. Johnson,2 Secretary, Office of the Secretary,

Board of Governors

________________

Attended Tuesday’s session.

² Attended the portion of the meeting relating to the zero

lower bound on nominal interest rates.

3 Attended the meeting through the discussion of the zero

lower bound on nominal interest rates.

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Federal Open Market Committee

Messrs. Meyer² and Oliner, Senior Advisers, Divisions of Monetary Affairs and Research and

Statistics, respectively, Board of Governors

Mr. Small, Project Manager, Division of Monetary

Affairs, Board of Governors

Messrs. Ahmed and Luecke, Section Chiefs, Divisions of International Finance and Monetary

Affairs, respectively, Board of Governors

Ms. Aaronson, Senior Economist, Division of Research and Statistics, Board of Governors

Messrs. Gapen and McCabe,² Economists, Divisions of Monetary Affairs and Research and

Statistics, respectively, Board of Governors

Ms. Beattie,² Assistant to the Secretary, Office of

the Secretary, 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. Fuhrer, Executive Vice President, Federal Reserve Bank of Boston

Messrs. Altig, Hilton, Potter, Rasche, Rudebusch,

Schweitzer, Sellon, Sullivan, and Weinberg, Senior Vice Presidents, Federal Reserve Banks of

Atlanta, New York, New York, St. Louis, San

Francisco, Cleveland, Kansas City, Chicago,

and Richmond, respectively

Mr. Burke,² Assistant Vice President, Federal Reserve Bank of New York

Mr. Eggertsson,² Senior Economist, Federal Reserve Bank of New York

________________

² Attended the portion of the meeting relating to the zero

lower bound on nominal interest rates.

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 mar-

_

kets 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.

The information reviewed at the December meeting

pointed to a significant contraction in economic activity

in the fourth quarter. Conditions in the labor market

deteriorated considerably in recent months as most

major industry groups shed jobs. Private payrolls continued to fall at a faster pace than earlier in the year,

and the unemployment rate rose to 6.7 percent. Industrial production, excluding special hurricane- and strikerelated effects, fell further in November, and consumer

spending declined across a broad range of spending

categories over recent months. The housing market

weakened again as construction activity, new home

sales, and home prices declined further. In the business sector, investment in equipment and software appeared to continue to contract. Financial markets saw

a further pullback in risk-taking, spurred in part by the

more pessimistic outlook for economic activity; this

situation led to lower equity prices, higher risk spreads,

and tighter constraints in credit markets, all of which

intensified the decline in real activity. On the inflation

front, headline consumer prices declined in recent

months, as energy prices continued to fall and consumer food price increases moderated.

The labor market continued to worsen. According to

the November employment report, payroll employment fell at a rapid pace over the preceding three

months, with substantial losses across a wide range of

industry groups, including manufacturing, construction,

retail, financial activities, and business services. Indicators of hiring plans also dropped steeply in November,

and other labor market indicators suggested that jobs

remained in short supply. The unemployment rate

climbed to 6.7 percent in November, while the labor

force participation rate fell after remaining steady for

much of the year. New claims for unemployment insurance rose sharply through early December.

Industrial production, excluding special hurricane- and

strike-related effects, fell markedly in November after

sizable declines in the preceding two months. The recent contraction in industrial output was broadly based.

The steep pace of decline in the production of consumer goods reflected not only cutbacks in motor vehicle assemblies but also drops in the output of other

goods, such as appliances, furniture, and products related to home improvement. The production of business equipment was held down by declines in the output of both industrial and high-tech equipment. The

Minutes of the Meeting of December 15-16, 2008

output of construction supplies extended its decline

after a brief pause in the middle of the year, and the

contraction in the production of materials intensified.

In particular, steel production plummeted, and the output of organic chemicals contracted noticeably. For

most major industry groups, factory utilization rates

declined relative to their levels in July and remained

below their long-run averages. Available forwardlooking indicators pointed to a significant downturn in

manufacturing output in coming months.

Real personal consumption expenditures (PCE) fell for

the fifth straight month in October, with the slowdown

evident in nearly all broad spending categories. Sales of

light motor vehicles, which slumped in October, fell

further in November, but the available information on

retail sales suggested a small increase in real outlays for

other consumer goods. The annualized three-month

change in spending on services in October was just

one-third of the rate registered in the first half of 2008.

Preliminary data for October and November suggested

that overall fourth-quarter real spending would receive

a modest boost from recent price declines for gasoline.

Real incomes were also boosted by the reversal in energy prices, though the negative wealth effects of continued declines in equity and house prices likely offset

this somewhat. Measures of consumer sentiment released in November and December remained low, and

available evidence suggested further tightening in consumer credit conditions in recent months.

Real construction activity continued to decline in November. Single-family housing starts and permit issuance fell further. In the multifamily sector, starts

dropped sharply in November while permit issuance

remained on a downtrend. Housing demand remained

weak, and although the number of unsold new singlefamily homes continued to move lower, inventories

remained elevated relative to the current pace of sales.

Sales of existing single-family homes changed little,

although a drop in pending home sales in October

pointed to further declines in the near term. The comparative strength of existing home sales appeared to be

attributable partly to increases in foreclosure-related

and other distressed sales. Financing conditions for

prime borrowers appeared to ease slightly after the

Federal Reserve’s announcement that it would purchase agency debt and agency mortgage-backed securities (MBS) to support mortgage financing, while the

market for nonconforming loans remained impaired.

Several indexes indicated that house prices continued

to decline substantially.

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In the business sector, investment in equipment and

software appeared to be contracting at a faster rate in

the fourth quarter than during the third quarter. While

the decline in the previous quarter was concentrated in

computers and transportation equipment, declines in

spending in the fourth quarter were more widespread.

Shipments of nondefense capital goods excluding aircraft fell in October, and orders continued to decline

sharply. Investment demand seemed to be weighed

down by weak fundamentals and increased uncertainty

about the state of the economy, while prospects for

future investment activity reflected in surveys of business conditions and sentiment worsened in recent

months. In addition, credit conditions remained tight.

Real nonresidential investment declined in the third

quarter after nearly three years of robust expansion,

and nominal expenditures edged down further in October. Vacancy rates rose and property values fell in

the first three quarters of the year.

Real nonfarm inventories (excluding motor vehicles),

which had dropped noticeably in the second quarter,

fell again in the third quarter. The book value of

manufacturing and wholesale trade inventories (excluding motor vehicles) showed a further drawdown in October. However, the ratio of these inventories to sales

increased noticeably in September and October. The

purchasing managers survey for November indicated

that many purchasing agents saw their customers’ inventories as too high.

The U.S. international trade deficit widened in October,

as a fall in imports was more than offset by a significant

decline in exports. Much of the decline in exports was

the result of drops in agricultural goods and industrial

supplies, which largely reflected a decrease in the prices

of these goods. The decline in imports was led by

lower imports of non-oil industrial supplies, capital

goods, and automotive products, although these declines were partly offset by an increase in the value of

oil imports.

Economic activity in most advanced foreign economies

contracted in the third quarter, driven by sharp declines

in investment and by significant negative contributions

of net exports, as the global recession took hold more

strongly. Incoming data pointed to an even weaker

pace of activity in the fourth quarter. In Canada, however, real gross domestic product (GDP) increased at a

faster-than-expected pace in the third quarter, though

consumption and investment continued to soften. In

the euro area and the United Kingdom, purchasing

managers indexes fell in November to levels associated

with severe contractions in economic activity. Labor

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Federal Open Market Committee

market conditions in the advanced economies deteriorated further, with most countries experiencing rising

unemployment rates. In Japan, real GDP fell in the

third quarter as domestic demand declined and private

investment fell for the second consecutive quarter.

After peaking in the third quarter, consumer price inflation moderated in all advanced foreign economies,

primarily as a result of falling energy and food prices.

Economic activity in most emerging market economies

decelerated sharply in the third quarter, though a surge

in agricultural output helped to support activity in Mexico, and the Brazilian economy continued to expand

rapidly. In Asia, output decelerated significantly, as the

pace of real activity moderated in China and several

other economies saw declines in real GDP. Recent

readings on production, sales, and exports suggest that

emerging market economies weakened further in the

current quarter. Headline inflation generally declined

across emerging market economies, primarily because

of lower food and energy prices and, in some cases,

weaker economic activity.

In the United States, headline consumer prices declined

in recent months while core consumer price inflation

slowed further. With energy prices falling sharply and

the rate of increase in food prices moderating, headline

PCE prices fell in October, and data from the consumer price index (CPI) indicated that the decline extended into November. Core PCE prices were unchanged in October, and based on the CPI, appeared

to have been unchanged again in November. The recent slowing in core consumer price inflation was widespread and likely reflected not only the weak pace of

economic activity but also the easing of some earlier

cost pressures as the prices of crude oil, gasoline, and

other commodities declined. Excluding food and energy, producer prices rose modestly again in November, as prices at earlier stages of processing continued

to retreat for the third consecutive month. Measures of

inflation expectations continued to fall or hold steady

during the intermeeting period. Measures of nominal

hourly labor compensation continued to increase moderately in the third quarter.

At its October 28-29 meeting, the Federal Open Market Committee (FOMC) lowered its target for the federal funds rate 50 basis points to 1 percent. The

Committee’s statement noted that economic activity

appeared to have slowed markedly, due importantly to

a decline in consumer expenditures. Business equipment spending and industrial production had weakened

in recent months, and slowing economic activity in

many foreign economies was damping the prospects

for U.S. exports. Moreover, the intensification of fi-

_

nancial market turmoil was likely to exert additional

restraint on spending, partly by further reducing the

ability of households and businesses to obtain credit.

The Committee noted that, in light of the declines in

the prices of energy and other commodities and the

weaker prospects for economic activity, it expected

inflation to moderate in coming quarters to levels consistent with price stability. The Committee also noted

that recent policy actions, including the rate reduction

that was approved at the October 28-29 meeting, coordinated interest rate cuts by central banks, extraordinary liquidity measures, and official steps to strengthen

financial systems, should help over time to improve

credit conditions and promote a return to moderate

economic growth. Nevertheless, downside risks to

economic activity remained and the Committee indicated that it would monitor economic and financial

developments carefully and act as needed to promote

sustainable economic growth and price stability.

Over the intermeeting period, investors marked down

their expectations for the path of monetary policy.

Policy expectations were largely unaffected by the outcome of the October 28-29 FOMC meeting, as the

Committee’s decision to reduce the target federal funds

rate was broadly anticipated and the accompanying

statement was reportedly in line with investor expectations. Subsequently, however, the expected future path

of monetary policy dropped amid data releases that

suggested a weaker outlook for economic activity and

lower inflation than had been anticipated, along with

continued strains in financial markets that weighed on

investor sentiment. Yields on nominal Treasury coupon

securities declined significantly over the intermeeting

period in response to safe-haven demands as well as

the downward revisions in the economic outlook and

the expected policy path. Meanwhile, yields on inflation-indexed Treasury securities declined by smaller

amounts, leaving inflation compensation lower. Although the decline in inflation compensation occurred

amid sharp decreases in inflation measures and energy

prices, it was likely amplified by increased investor preference for the greater liquidity of nominal Treasury

securities relative to that of inflation-protected Treasury

securities.

Conditions in short-term funding markets remained

strained for most of the intermeeting period, though

some signs of improvement were evident. The spreads

of London interbank offered rates, or Libor, over

comparable-maturity overnight index swap rates declined noticeably across most maturities early in the

intermeeting period; however, some of this decline was

reversed once maturities began to lengthen past year-

Minutes of the Meeting of December 15-16, 2008

end. Trading in longer-term interbank funding markets

reportedly remained thin. Credit outstanding under the

Federal Reserve’s Term Auction Facility (TAF) increased to about $448 billion because of expanded auction sizes. Recent auctions for both 28-day and 84-day

credit from the TAF were undersubscribed, and bidding for the two forward TAF auctions during the intermeeting period was very light. Meanwhile, primary

credit outstanding remained high, although it had declined somewhat in recent weeks. Use of the Primary

Dealer Credit Facility dropped significantly. A number

of the Term Securities Lending Facility (TSLF) auctions were oversubscribed, as was the auction of options for 13-day Schedule 2 TSLF loans straddling the

end of the year.

Conditions in markets for repurchase agreements, or

repos, arranged using certain types of collateral deteriorated over the intermeeting period, and liquidity for

repos backed by non-Treasury, non-agency collateral

remained poor. Amid high demand for safe investments, the overnight Treasury general collateral (GC)

repo rate remained very low and fell to around zero late

in the intermeeting period. Still, failures to deliver in

the Treasury market declined substantially from the

levels reached in October and overnight securities lending from the System Open Market Account portfolio

fell sharply. Heavy demand for safe instruments was

also apparent in the Treasury bill market, where yields

turned negative at times. During the intermeeting period, the Treasury announced that it would not roll

over bills related to the Supplementary Financing Program in order to preserve flexibility in the conduct of

debt management policy, and uncertainty about supply

reportedly exacerbated poor liquidity conditions in the

bill market. Despite the decline in spreads of agency

and mortgage-backed repo rates over Treasury GC

rates later in the period, strains in these markets remained evident, with bid-asked spreads and haircuts

very elevated.

In contrast, conditions in the commercial paper (CP)

market improved over the intermeeting period, likely as

a reflection of recent measures taken in support of this

market. Spreads on 30-day A1/P1 and asset-backed

commercial paper (ABCP) continued to narrow after

the Commercial Paper Funding Facility (CPFF) became

operational on October 27, although spreads subsequently reversed a portion of the declines as maturities

crossed over year-end. In contrast, spreads on commercial paper not eligible for purchase under the CPFF

remained elevated. The dollar amounts of unsecured

financial CP and ABCP outstanding rebounded from

their October lows, though issuance into the CPFF

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more than accounted for this increase. Credit outstanding under the Asset-Backed Commercial Paper

Money Market Mutual Fund Liquidity Facility fell by

more than half over the intermeeting period. The

Money Market Investor Funding Facility program registered no activity.

As financial market conditions worsened over the intermeeting period, investors seemed to become more

concerned about the likelihood of a deep and prolonged recession. In addition, the Treasury Department’s announcement that funds from the Troubled

Asset Relief Program would not be used to purchase

securities backed by mortgage-related and other assets

appeared to prompt negative price reactions in several

financial markets. Stock prices of financial corporations fell considerably, while broad equity indexes declined, on net, amid high volatility. Yields on investment-grade bonds moved lower, but risk spreads on

these instruments over comparable-maturity Treasury

securities widened substantially as yields on Treasury

securities fell more. Yields and risk spreads on speculative-grade bonds soared, and credit default swap

spreads on speculative-grade, as well as investmentgrade, corporate bonds widened further. Gross issuance of bonds by nonfinancial investment-grade companies continued at a solid pace, but issuance of speculative-grade bonds remained at zero. Issuance of leveraged syndicated loans was also extremely weak. Strains

were evident in a number of other financial markets as

well. The functioning of Treasury markets remained

impaired, and premiums for the on-the-run ten-year

nominal Treasury security rose from levels that were

already elevated. The market for commercial mortgage-backed securities experienced a particularly pronounced selloff.

Reflecting investor concerns about the conditions of

financial institutions, spreads on credit default swaps

for U.S. banks widened sharply, and those for insurance companies remained elevated. To support market

stability, the U.S. government on November 23 entered

into an agreement with Citigroup to provide a package

of capital, guarantees, and liquidity access. In other

developments, banking organizations began to take

advantage of the Federal Deposit Insurance Corporation’s (FDIC) Temporary Liquidity Guarantee Program; eleven institutions issued bonds under the program.

In view of the tightening of credit conditions for consumers and small businesses, the Federal Reserve announced on November 25 the creation of the Term

Asset-Backed Securities Loan Facility to support the

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markets for asset-backed securities collateralized by

student loans, auto loans, credit card loans, and loans

guaranteed by the Small Business Administration. The

facility, developed jointly with the Treasury, was expected to be operational by February 2009, and discussions with market participants about operational details

of this facility were ongoing.

The Federal Reserve also announced on November 25

that, to help reduce the cost and increase the availability

of residential mortgage credit, it would initiate a program to purchase up to $100 billion in direct obligations of housing-related government-sponsored enterprises (GSEs) and up to $500 billion in MBS backed by

Fannie Mae, Freddie Mac, and Ginnie Mae. Agency

debt spreads, which had widened early in the period,

narrowed somewhat after the announcement. Subsequent purchases of agency debt by the Open Market

Desk at the Federal Reserve Bank of New York led to

a further reduction in agency spreads. Likely reflecting

in part these developments, conditions in the primary

residential mortgage market improved. The interest

rate on 30-year fixed-rate conforming mortgages declined, which prompted a noticeable increase in mortgage refinancing.

M2 expanded at a considerably slower rate in November than October. Retail money funds contracted after

a surge in October that reflected safe-haven inflows to

Treasury-only funds. Small time deposits increased

somewhat more slowly than in October, although the

rate of expansion remained quite rapid as banks continued to bid aggressively for these deposits. Flows

into demand deposits covered by the FDIC’s new temporary guarantee program were significant and apparently reflected shifts out of savings accounts as well as

redirection of funds by banks’ customers away from

other money market instruments. Currency continued

its strong increase, apparently boosted by solid foreign

demand for U.S. banknotes.

Liquidity conditions in the money markets of major

foreign economies improved but remained strained

over the intermeeting period. Movements in stock

prices were mixed in the advanced foreign economies,

although equity prices generally rose in emerging market economies. In response to evidence of a slowdown

in economic activity and a rapid waning of inflationary

pressures, central banks around the world eased policy

sharply. Sovereign bond yields fell, reflecting prospects

for lower inflation and lower policy rates for an extended period. The dollar declined on balance against

the currencies of major U.S. trading partners.

_

In the forecast prepared for the meeting, the staff revised down sharply its outlook for economic activity in

2009 but continued to project a moderate recovery in

2010. Real GDP appeared likely to decline substantially in the fourth quarter of 2008 as conditions in the

labor market deteriorated more steeply than previously

anticipated; the decline in industrial production intensified; consumer and business spending appeared to

weaken; and financial conditions, on balance, continued

to tighten. Rising unemployment, the declines in stock

market wealth, low levels of consumer sentiment, weakened household balance sheets, and restrictive credit

conditions were likely to continue to hinder household

spending over the near term. Homebuilding was expected to contract further. Business expenditures were

also likely to be held back by a weaker sales outlook

and tighter credit conditions. Oil prices, which

dropped significantly during the intermeeting period,

were assumed to rise over the next two years in line

with the path indicated by futures market prices, but to

remain below the levels of October 2008. All told, real

GDP was expected to fall much more sharply in the

first half of 2009 than previously anticipated, before

slowly recovering over the remainder of the year as the

stimulus from monetary and assumed fiscal policy actions gained traction and the turmoil in the financial

system began to recede. Real GDP was projected to

decline for 2009 as a whole and to rise at a pace slightly

above the rate of potential growth in 2010. Amid the

weaker outlook for economic activity over the next

year, the unemployment rate was likely to rise significantly into 2010, to a level higher than projected at the

time of the October 28-29 FOMC meeting. The disinflationary effects of increased slack in resource utilization, diminished pressures from energy and materials

prices, declines in import prices, and further moderate

reductions in inflation expectations caused the staff to

reduce its forecast for both core and overall PCE inflation. Core inflation was projected to slow considerably

in 2009 and then to edge down further in 2010.

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

downturn had intensified over the fall. Although some

financial markets exhibited signs of improved functioning, financial conditions generally remained very

strained. Credit conditions continued to tighten for

both households and businesses, and ongoing declines

in equity prices further reduced household wealth.

Conditions in the housing market weakened again and

house prices declined further. Against this backdrop,

measures of business and consumer confidence fell to

new lows, and private spending continued to contract.

Minutes of the Meeting of December 15-16, 2008

Employment and production indicators weakened further as businesses responded very rapidly to the fall-off

in demand. Participants expected economic activity to

contract sharply in the fourth quarter of 2008 and in

early 2009. Most projected that the economy would

begin to recover slowly in the second half of 2009,

aided by substantial monetary policy easing and by anticipated fiscal stimulus. Meeting participants generally

agreed that the uncertainty surrounding the outlook

was considerable and that downside risks to even this

weak trajectory for economic activity were a serious

concern. Indeed, the severe ongoing financial market

strains, the large reductions in household wealth, and

the global nature of the economic slowdown were seen

by some participants as suggesting the distinct possibility of a prolonged contraction, although that was not

judged to be the most likely outcome. Inflation pressures had diminished appreciably as energy and other

commodity prices dropped and economic activity

slumped. Looking forward, participants agreed that

inflationary pressures looked set to moderate further in

coming quarters, reflecting recent declines in commodity prices and rising slack in resource markets, and several saw risks that inflation could drop for a time below

rates they viewed as most consistent over time with the

Federal Reserve’s dual mandate for maximum employment and price stability.

Meeting participants observed that financial strains

continued to exert a powerful drag on economic activity and that the adverse feedback loop between financial conditions and economic performance had intensified. Although improvements were evident in some

markets, particularly those for highly rated commercial

paper and for interbank funds, financial markets generally remained under severe stress. Equity prices continued to drop amid high volatility, further reducing

household wealth. Rising risk spreads kept the cost of

issuing corporate bonds at a high level—especially for

lower-rated firms—even though Treasury yields had

declined sharply since the October 28-29 meeting. Securitization markets, which over recent years had been

an important channel in credit intermediation, remained largely dysfunctional, with the exception of

those for mortgages guaranteed by the GSEs. The

sharp drops and unusual volatility in the prices of many

financial assets since the beginning of the fourth quarter were likely to cause more losses for financial institutions, and a number of participants noted that loan delinquencies were increasing significantly in the consumer sector, adding to pressures on banks’ balance

sheets and reinforcing banks’ cautious lending stance.

As a consequence, credit conditions for both busi-

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nesses and households had tightened further, with

banks generally adopting stricter lending standards and

declining to renew or paring back existing credit lines.

Participants observed that the effects of the financial

turmoil, increased uncertainty, and drops in confidence

and demand were becoming increasingly evident in the

business sector. Business contacts across the country

expected considerable near-term weakness in sales and

declining pricing power. Some meeting participants

reported especially sharp drops in new orders in their

Districts. Even sectors that had performed relatively

well until recently, such as mining and drilling, were

experiencing reduced activity, mostly due to the decline

in commodity prices. Agricultural activity was also

showing signs of weakness. Business sentiment had

deteriorated sharply since September, likely contributing to steep drops in employment and production.

Participants anticipated that, with the deteriorating

economic outlook and tightening of credit conditions,

capital expenditures were likely to be soft in coming

quarters.

Many participants noted that the decline in household

wealth resulting from large drops in equity and house

prices, together with tighter credit conditions, rapidly

increasing unemployment, and deteriorating consumer

sentiment, was contributing to a sharp contraction in

consumer spending. Some participants pointed out

that reduced consumer wealth and concerns about employment could lead to a further increase in saving,

which, although desirable in the longer term, could put

additional downward pressure on consumer spending

in coming quarters. The latest housing data suggested a

continued substantial contraction in that sector. The

recent decline in mortgage rates had sparked some refinancing and purchase activity, but the extent of the

longer-term impact of lower rates on housing demand

remained uncertain.

Meeting participants noted that economic conditions

had deteriorated substantially in recent months in both

advanced and emerging market economies. As a consequence, demand for U.S. exports had weakened, held

back also by the strengthening of the dollar since the

summer. Going forward, global demand was expected

to remain weak, and thus growth in exports was

unlikely to provide much support for U.S. activity.

However, the weakness in the global economy was

contributing to lower prices of energy and other commodities, which should boost real incomes and provide

modest support to household spending.

Participants agreed that falling prices for energy and

other commodities and diminished economic activity

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Federal Open Market Committee

had resulted in an appreciable reduction in inflationary

pressures. Those pressures were seen as likely to continue to abate because of the emergence of substantial

slack in resource utilization and diminishing pricing

power. Participants were uncertain about the extent to

which inflation would fall. Some saw inflation leveling

out near desired levels, while others expressed concern

that inflation might decline below levels consistent with

price stability in the medium term. Participants generally agreed that inflation expectations were an important determinant of future price dynamics. Some noted

that those expectations, especially at longer horizons,

appeared well anchored. However, some survey evidence suggested that firms expected prices to continue

to decline as they had over the previous few months.

Several participants observed that monitoring measures

of inflation expectations for signs of disinflationary

dynamics would be especially important going forward.

In a joint session of the Federal Open Market Committee and the Board of Governors, meeting participants

discussed extensively how in current circumstances the

Committee could best support the resumption of sustainable economic growth and promote the maintenance of price stability over the medium term. Participants noted that very low levels of the federal funds

rate had the potential to help buoy aggregate demand

and economic activity, but they also had potential costs

in terms of the functioning of certain financial markets

and some financial institutions. Most participants

judged that the benefits in terms of support for the

overall economy of federal funds rates close to, but

slightly above, zero probably outweighed the adverse

effects. With the federal funds rate already trading at

very low levels as a result of the large volume of excess

reserves associated with the Federal Reserve’s liquidity

operations, participants agreed that the Committee

would need to focus on other tools to impart additional

monetary stimulus to the economy in the near term.

One broad class of such tools was the use of FOMC

communication with the public to provide more information regarding future policy intentions. In particular,

participants judged that communicating the Committee’s expectation that short-term interest rates were

likely to stay exceptionally low for some time could be

useful because it could lead to pricing of longer-term

interest rates consistent with the path of monetary policy that policymakers saw as most likely. Participants

emphasized the importance of explicitly conditioning

communication regarding future policy on the evolution of the economic outlook. Another possible form

of communication that participants discussed was a

more explicit indication of their views on what longer-

_

run rate of inflation would best promote their goals of

maximum employment and price stability. The added

clarity in that regard might help forestall the development of expectations that inflation would decline below

desired levels, and hence keep real interest rates low

and support aggregate demand.

Meeting participants also discussed how best to employ

the Federal Reserve’s balance sheet to promote monetary policy goals. The Federal Reserve had already

adopted a series of programs that were providing liquidity support to a range of institutions and markets,

and participants generally agreed that a continued focus

on the quantity and the composition of Federal Reserve

assets would be necessary and desirable. Specifically,

participants discussed the merits of purchasing large

quantities of longer-term securities such as agency debt,

agency mortgage-backed securities, and Treasury securities. The available evidence indicated that such purchases would reduce yields on those instruments, and

lower yields on those securities would tend to reduce

borrowing costs for a range of private borrowers, although participants were uncertain as to the likely size

of such effects. Participants also generally believed that

the special liquidity and lending facilities implemented

or announced recently would support the availability of

credit to businesses and households and thus help sustain economic activity. Many participants thought that

the Federal Reserve should continue to consider

whether expanding some of the existing facilities and

creating new facilities could be helpful. Participants

emphasized that the ultimate objective of special lending facilities and asset purchases was to support overall

market functioning, financial intermediation, and economic growth. Participants acknowledged that the effective federal funds rate probably would need to remain very low for some time. However, they also recognized that, as economic activity recovered and financial conditions normalized, the use of certain policy

tools would need to be scaled back, the size of the balance sheet and level of excess reserves would need to

be reduced, and the Committee’s policy framework

would return to focus on the level of the federal funds

rate.

A number of participants observed that, under the approach of conducting monetary policy by acquiring a

variety of assets as needed to address financial and macroeconomic strains, the quantity of excess reserves

and the size of the Federal Reserve’s balance sheet

would be determined by the Federal Reserve’s asset

purchases and the usage of its lending facilities. It was

likely that, during the period of financial turmoil, the

size of the Federal Reserve’s balance sheet would need

Minutes of the Meeting of December 15-16, 2008

to be maintained at a high level. Participants discussed

the potential advantages and disadvantages of setting

quantitative targets for bank reserves or the monetary

base. Some were of the view that quantitative targets

for an increasing reserve base could be effective in preventing deflationary dynamics and useful in communicating to the public the Committee’s determination to

take the steps needed to avoid such an outcome. Several other participants, however, noted that increases in

excess reserves or the monetary base, by themselves,

might not have a significant stimulative effect on the

economy or prices because the normal bank intermediation mechanism appeared to be impaired, and banks

may not be willing to lend their excess reserves. Conversely, a decline in excess reserves or the monetary

base would not necessarily be contractionary if it occurred in the context of improving financial market

conditions. A few of those who supported quantitative

base or reserve targets did so because they saw them as

helping to coordinate the actions of the Board of Governors, which is responsible for authorizing most special liquidity and lending facilities, and the Committee,

which is responsible for open market operations. Most

participants, however, were of the view that such coordination would best be achieved by continued close

cooperation and consultation between the Committee

and the Board. Going forward, consideration will be

given to whether various quantitative measures would

be useful in calibrating and communicating the stance

of monetary policy.

In the discussion of monetary policy for the intermeeting period, Committee members recognized that the

large volume of excess reserves had already resulted in

federal funds rates significantly below the target federal

funds rate and the interest rate on excess reserves.

They agreed that maintaining a low level of short-term

interest rates and relying on the use of balance sheet

policies and communications about monetary policy

would be effective and appropriate in light of the sharp

deterioration of the economic outlook and the appreciable easing of inflationary pressures. Maintaining that

level of the federal funds rate implied a substantial further reduction in the target federal funds rate. Even

with the additional use of nontraditional policies, the

economic outlook would remain weak for a time and

the downside risks to economic activity would be substantial. Moreover, inflation would continue to fall,

reflecting both the drop in commodity prices that had

already occurred and the buildup of economic slack;

indeed some members saw significant risks that inflation could decline and persist for a time at uncomfortably low levels.

Page 9

Members debated how best to communicate their decisions regarding monetary policy actions. Since the

large amount of excess reserves in the system would

limit the Federal Reserve’s control over the federal

funds rate, several members thought that it might be

preferable not to set a specific target for the federal

funds rate. Indeed, those members felt that lack of an

explicit target could be helpful, in that it would focus

attention on the shift in the policy framework from

targeting the federal funds rate to the use of balance

sheet policies and communications about monetary

policy as a way of providing further monetary stimulus.

A few members stressed that the absence of an explicit

federal funds rate target would give banks added flexibility in pricing loans and deposits in the current environment of unusually low interest rates. However,

other members noted that not announcing a target

might confuse market participants and lead investors to

believe that the Federal Reserve was unable to control

the federal funds rate when it could, in fact, still influence the effective federal funds rate through adjustments of the interest rate on excess reserves and the

primary credit rate. The members decided that it

would be preferable for the Committee to communicate explicitly that it wanted federal funds to trade at

very low rates; accordingly, the Committee decided to

announce a target range for the federal funds rate of 0

to ¼ percent. Members also agreed that the statement

should indicate that weak economic conditions were

likely to warrant exceptionally low levels of the federal

funds rate for some time. The members emphasized

that their expectation about the path of the federal

funds rate was conditioned on their view of the likely

path of economic activity.

Members also discussed how best to communicate the

focus of the Federal Reserve’s policy going forward.

Members agreed that the statement should indicate that

all available tools would be employed to promote the

resumption of sustainable economic growth and to

preserve price stability. They also agreed that the

statement should note that it was the Committee’s intention to sustain the size of the Federal Reserve’s balance sheet at a high level through open market operations and other measures to support financial markets

and stimulate the economy. In addition to the alreadyannounced asset purchases and liquidity programs,

members concurred that the statement should indicate

that the Committee stands ready to expand purchases

of agency debt and agency mortgage-backed securities,

and that it is evaluating the potential benefits of purchasing longer-term Treasury securities.

Page 10

Federal Open Market Committee

In light of the use of additional tools for implementing

monetary policy, the Committee revised the form of

the directive to the Open Market Desk of the Federal

Reserve Bank of New York. In addition to specifying

that it now seeks conditions in reserve markets consistent with federal funds trading in a range of 0 to ¼ percent, the Committee instructed the Desk to purchase

up to $100 billion in housing-related GSE debt and up

to $500 billion in agency-guaranteed MBS by the end of

the second quarter of 2009. Members agreed that they

should not specify the precise timing of these purchases, but that they should leave discretion to the

Desk to intervene depending on market and broader

economic conditions. The directive also noted that the

Manager of the System Open Market Account and the

Secretary of the FOMC would keep the Committee

informed of developments regarding the System’s balance sheet that could affect the attainment of the

Committee’s statutory 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 seeks conditions in reserve

markets consistent with federal funds trading in

a range of 0 to ¼ percent. The Committee directs the Desk to purchase GSE debt and agency-guaranteed MBS during the intermeeting period with the aim of providing support to the

mortgage and housing markets. The timing and

pace of these purchases should depend on conditions in the markets for such securities and on

a broader assessment of conditions in primary

mortgage markets and the housing sector. By

the end of the second quarter of next year, the

Desk is expected to purchase up to $100 billion

in housing-related GSE debt and up to $500 billion in agency-guaranteed MBS. The System

Open Market Account Manager and the Secretary will keep the Committee informed of ongoing developments regarding the System’s balance sheet that could affect the attainment over

time of the Committee’s objectives of maximum

employment and price stability.”

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

“The Federal Open Market Committee decided

today to establish a target range for the federal

funds rate of 0 to ¼ percent.

Since the Committee's last meeting, labor market conditions have deteriorated, and the available data indicate that consumer spending, business investment, and industrial production have

declined.

Financial markets remain quite

strained and credit conditions tight. Overall, the

outlook for economic activity has weakened further.

Meanwhile, inflationary pressures have diminished appreciably. In light of the declines in the

prices of energy and other commodities and the

weaker prospects for economic activity, the

Committee expects inflation to moderate further in coming quarters.

The Federal Reserve will employ all available

tools to promote the resumption of sustainable

economic growth and to preserve price stability.

In particular, the Committee anticipates that

weak economic conditions are likely to warrant

exceptionally low levels of the federal funds rate

for some time.

The focus of the Committee's policy going forward will be to support the functioning of financial markets and stimulate the economy

through open market operations and other

measures that sustain the size of the Federal Reserve's balance sheet at a high level. As previously announced, over the next few quarters the

Federal Reserve will purchase large quantities of

agency debt and mortgage-backed securities to

provide support to the mortgage and housing

markets, and it stands ready to expand its purchases of agency debt and mortgage-backed securities as conditions warrant. The Committee

is also evaluating the potential benefits of purchasing longer-term Treasury securities. Early

next year, the Federal Reserve will also implement the Term Asset-Backed Securities Loan

Facility to facilitate the extension of credit to

households and small businesses. The Federal

Reserve will continue to consider ways of using

its balance sheet to further support credit markets and economic activity.”

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.

_

Minutes of the Meeting of December 15-16, 2008

Page 11

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

Notation Votes

The Committee also continued its discussion of possible refinements to the Committee’s approach to projections that could provide additional information about

participants’ views of longer-run sustainable rates of

economic growth and unemployment and the measured rates of inflation that would be consistent with

price stability, but it made no decisions regarding these

issues. Finally, staff briefed the Committee on the progress of plans for implementing the Federal Reserve’s

Term Asset-Backed Securities Loan Facility, which had

initially been announced on November 25, 2008.

By notation vote completed on November 18, 2008,

the Committee unanimously approved the minutes of

the FOMC meeting held on October 28-29, 2008.

By notation vote completed on November 26, 2008,

the Committee unanimously approved the extension

until April 30, 2009, of its authorization for the Federal

Reserve Bank of New York to engage in transactions

with primary dealers through the Term Securities Lending Facility, subject to the same collateral, interest rate,

and other conditions previously established by the

Committee.

It was agreed that the next meeting of the Committee

would be held on Tuesday-Wednesday, January 27-28,

2009.

_____________________________

The meeting adjourned at 3:00 p.m. on December 16,

2008.

Brian F. Madigan

Secretary