FOMC Minutes

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Minutes of the Federal Open Market Committee

August 11-12, 2009

A joint meeting of the Federal Open Market Committee and the Board of Governors of the Federal Reserve

System was held in the offices of the Board of Governors in Washington, D.C., on Tuesday, August 11,

2009, at 2:00 p.m. and continued on Wednesday, August 12, 2009, at 9:00 a.m.

Mr. Frierson,¹ Deputy Secretary, Office of the Secretary, Board of Governors

PRESENT:

Mr. Bernanke, Chairman

Mr. Dudley, Vice Chairman

Ms. Duke

Mr. Evans

Mr. Kohn

Mr. Lacker

Mr. Lockhart

Mr. Tarullo

Mr. Warsh

Ms. Yellen

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

Mr. Bullard, Ms. Cumming, Mr. Hoenig, Ms. Pianalto, and Mr. Rosengren, Alternate Members

of the Federal Open Market Committee

Messrs. Fisher, Plosser, and Stern, Presidents of

the Federal Reserve Banks of Dallas, Philadelphia, and Minneapolis, respectively

Mr. Madigan, Secretary and Economist

Ms. Danker, Deputy Secretary

Mr. Luecke, Assistant Secretary

Mr. Skidmore, Assistant Secretary

Ms. Smith, Assistant Secretary

Mr. Alvarez, General Counsel

Mr. Baxter,¹ Deputy General Counsel

Mr. Sheets, Economist

Mr. Stockton, Economist

Messrs. Altig, Clouse, Connors, Slifman, Sullivan,

and Wilcox, Associate Economists

Mr. Struckmeyer, Deputy Staff Director, Office of

the Staff Director for Management, Board of

Governors

Ms. Robertson, Assistant to the Board, Office of

Board Members, Board of Governors

Ms. Liang, Messrs. Reifschneider and Wascher, Senior Associate Directors, Division of Research

and Statistics, Board of Governors

Mr. Meyer, Senior Adviser, Division of Monetary

Affairs, Board of Governors

Messrs. Leahy and Nelson,¹ Associate Directors,

Divisions of International Finance and Monetary Affairs, respectively, Board of Governors

Mr. Carpenter, Deputy Associate Director, Division of Monetary Affairs, Board of Governors

Mr. Small, Project Manager, Division of Monetary

Affairs, Board of Governors

Ms. Wei, Economist, Division of Monetary Affairs,

Board of Governors

Ms. Beattie,¹ 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. Sack, Manager, System Open Market Account

Mr. Lyon, First Vice President, Federal Reserve

Bank of Minneapolis

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

Secretary, Board of Governors

Mr. Sniderman, Executive Vice President, Federal

Reserve Bank of Cleveland

Ms. George, Acting Director, Division of Banking

Supervision and Regulation, Board of Governors

¹ Attended Tuesday’s session only.

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Federal Open Market Committee

Mr. McAndrews,¹ Ms. McLaughlin, Messrs. Rudebusch, Sellon, Tootell, and Waller, Senior Vice

Presidents, Federal Reserve Banks of New

York, New York, San Francisco, Kansas City,

Boston, and St. Louis, respectively

Messrs. Burke, Dotsey, Koenig, and Pesenti, Vice

Presidents, Federal Reserve Banks of New

York, Philadelphia, Dallas, and New York, respectively

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

Mr. Hetzel, Senior Economist, Federal Reserve

Bank of Richmond

¹ Attended Tuesday’s session only.

Developments in Financial Markets and the Federal Reserve’s Balance Sheet

The Manager of the System Open Market Account

reported on recent developments in domestic and foreign financial markets. The Manager also reported on

System open market operations in Treasury securities,

agency debt, and agency mortgage-backed securities

(MBS) since the Committee’s June 23-24 meeting. By

unanimous vote, the Committee ratified those transactions. There were no open market operations in foreign currencies for the System’s account during the

intermeeting period. The Federal Reserve’s total assets

were about unchanged, on balance, since the Committee met in June, remaining at approximately $2 trillion

as the System’s purchases of securities were essentially

matched by a further decline in usage of the System’s

credit and liquidity facilities.

Meeting participants again discussed the merits of including agency MBS backed by adjustable-rate mortgages (ARMs) in the Committee’s MBS purchase program: Some thought it would be useful to include

agency ARM MBS, noting that doing so could reduce

the unusually large spreads between ARM rates and

yields on similar-duration Treasury securities—spreads

that were far larger than the comparable spreads on

fixed-rate mortgages; others saw little potential benefit,

given the small stock and limited issuance of ARM

MBS, and were hesitant to involve the Federal Reserve

in another market segment. The Committee made no

decision on purchasing ARM MBS at this meeting.

Participants also discussed the merits of progressively

reducing the pace at which the Federal Reserve buys

_

Treasury securities, agency debt, and agency MBS prior

to the end of the asset purchase programs. They generally were of the view that gradually slowing the pace

of the Committee’s purchases of $300 billion of Treasury securities and extending their completion to the

end of October could help promote a smooth transition in markets. A number of participants noted that a

similar tapering of agency debt and MBS purchases

could be helpful in the future as those programs approach completion. The Committee made no decisions

on tapering those purchases at this meeting.

The staff presented an update on the continuing development of several tools that could help support a

smooth withdrawal of policy accommodation at the

appropriate time. These measures include executing

reverse repurchase agreements on a large scale, potentially with counterparties other than the primary dealers; implementing a term deposit facility that would be

available to depository institutions in order to reduce

the supply of excess reserves; and taking steps to tighten the link between the interest rate paid on reserve

balances held at the Federal Reserve Banks and the

federal funds rate. Several participants noted the need

to continue refining the Committee’s strategy for an

eventual withdrawal of policy accommodation. The

staff also updated the Committee on developments in

the Term Asset-Backed Securities Loan Facility

(TALF), summarized the pros and cons of expanding

the range of collateral eligible for TALF loans, and recommended extending the final date for making new

TALF loans into 2010. Participants generally supported the extension of TALF into 2010 but were

skeptical about expanding the range of assets at this

time.

Secretary’s note: As announced on August

17, 2009, the Board of Governors subsequently approved an extension of the TALF

while holding in abeyance any further expansion in the types of collateral eligible for the

TALF.

Staff Review of the Economic Situation

The information reviewed at the August 11-12 meeting

suggested that overall economic activity was stabilizing

after a contraction in real gross domestic product

(GDP) during 2008 and early 2009 that the Bureau of

Economic Analysis recently reported to have been

greater than it had previously estimated. Employment

continued to move lower through July, but the pace of

job losses had slowed noticeably in recent months. A

sizable pickup in motor vehicle production appeared to

be under way. Housing activity apparently was begin-

Minutes of the Meeting of August 11-12, 2009

ning to turn up. Consumer spending dropped only a

little further in the first half of this year, on balance,

after falling sharply in the second half of last year. The

decline in equipment and software (E&S) investment

seemed to be moderating, although the incoming data

did not point to an imminent recovery. The sharp cuts

in production this year reduced inventory stocks significantly, though they remained high relative to the level

of sales. A jump in gasoline prices pushed up overall

consumer price inflation in June, but core consumer

price inflation remained relatively stable in recent

months.

Job losses continued to abate in July, and aggregate

hours of production and nonsupervisory workers were

unchanged. The step-up in motor vehicle assemblies

boosted employment in that industry; job losses decreased in a number of other manufacturing industries,

and factory workweeks generally rose. Employment

declines in business and financial services in July were

also smaller than those in recent months. Payrolls in

nonbusiness services posted their third monthly gain,

supported by the continued uptrend in health and education and a small gain in the leisure and hospitality

industry. However, job losses in the construction industry continued at about the recent rate. In the

household survey, the unemployment rate edged down

in July to 9.4 percent, while the labor force participation rate fell back to its March level. Other indicators

also suggested a reduced pace of deterioration in labor

demand. Both initial claims for unemployment insurance and insured unemployment moved down since

June. However, with labor markets still quite slack,

year-over-year growth in average hourly earnings of

production and nonsupervisory workers slowed further

in July.

The contraction in industrial production slowed markedly in the second quarter, although the rate of decline

remained rapid and the factory utilization rate recorded

a new low in June. The moderation in the pace of decline in industrial production in the second quarter was

widespread across industries and major market groups.

Available indicators suggested that industrial production increased noticeably in July, led by motor vehicle

assemblies; manufacturing output excluding motor vehicles likely also rose in July.

Real personal consumption expenditures (PCE) edged

down in June after holding steady in May and declining

in April. Apart from a jump in motor vehicle purchases, which were boosted appreciably by the government’s “cash-for-clunkers” program, indicators of consumer spending in July were mixed. Most determinants

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of spending remained weak on balance. In particular,

the weak labor market continued to place significant

strains on household income, and earlier declines in net

worth were still holding back spending. However,

household net worth received a boost from the rise in

equity prices since their low in March. In addition, the

July Senior Loan Officer Opinion Survey on Bank

Lending Practices indicated that the fraction of banks

tightening standards and terms for consumer credit had

diminished further. Moreover, measures of consumer

sentiment, though they recently retraced a portion of

their earlier gains, remained well above levels seen at

the turn of the year.

Data from the housing sector indicated that construction activity appeared to be emerging from its extended

decline. Single-family housing starts registered a sizable

increase in June, and the number of starts stood well

above the record low recorded in the first quarter of

this year. However, in the much smaller multifamily

sector, starts continued to decline, on net, in 2009 after

falling significantly in the second half of 2008 amid

tight credit conditions and rapidly deteriorating demand

fundamentals for apartment buildings. The latest sales

data suggested that demand for new houses may be

strengthening after stabilizing in the early portion of

this year. Although sales remained quite modest, they

were enough, given the very slow pace of production,

to pare the overhang of unsold new single-family houses: In June, these inventories stood at about one-half

of their peak in the summer of 2006, and the months’

supply of new homes was down considerably from its

record high in January. Sales of existing single-family

houses, which were fairly flat early in the year, posted

their third consecutive monthly increase in June, and

pending home sales agreements through June suggested

that resale activity would rise further in the months

ahead. Sales of existing homes had been supported for

much of the year by heightened volumes of transactions involving bank-owned and other distressed properties; the uptick in May and June, however, appeared

to have been driven by an increase in transactions of

non-distressed properties. The apparent stabilization in

housing demand seen in recent months was likely due,

in part, to improvements in housing affordability

stemming from low interest rates for conforming

mortgages and lower house prices.

Real investment in E&S continued to contract in the

second quarter; however, the estimated rate of decline

was substantially smaller than in the previous two quarters. Business outlays on motor vehicles leveled off in

the second quarter after an extended period of steep

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Federal Open Market Committee

declines. Real spending in the high-tech sector declined, although real outlays for computing equipment

posted their first gain in a year. Outside of high-tech

and transportation, real spending on equipment

dropped again in the second quarter but at a slower

pace than in the previous quarter. Although the fundamental determinants of investment in E&S remained

weak, conditions appeared less unfavorable, on balance,

than earlier in the year. In particular, the decline in

business output was less pronounced in the second

quarter than in prior quarters, and estimates of the user

cost of capital fell back somewhat in the second quarter

after spiking last year. Other forward-looking indicators generally improved, but they remained at levels

consistent with a weak outlook for E&S investment.

Corporate bond spreads over Treasury securities continued to ease, and monthly surveys of business conditions and sentiment generally were less downbeat than

earlier in the year. In addition, the July Senior Loan

Officer Opinion Survey reported that the net percentage of banks that had tightened standards and

terms on commercial and industrial (C&I) loans receded somewhat, although the July National Federation

of Independent Business survey showed that the share

of small businesses reporting increased difficulty in

obtaining credit remained high. Conditions in the nonresidential construction sector generally remained quite

poor, with spending in most major categories staying

on a downward trajectory through June. Vacancy rates

continued to rise, property prices fell further, and, as

indicated by the July Senior Loan Officer Opinion Survey, financing for nonresidential construction projects

became even tighter.

In May, the U.S. international trade deficit narrowed to

its lowest level since 1999, as exports increased moderately and imports declined. The increase in exports

of goods and services was led by a climb in exports of

industrial supplies, particularly of petroleum products,

and reflected both higher prices and greater volumes.

The value of imports of goods and services fell at a

slower pace than in April. Imports of petroleum products exhibited the largest decline, with the fall wholly

reflecting lower volumes, as petroleum prices rose.

Imports of services and automotive products moved

down somewhat, while non-oil industrial supplies were

largely unchanged. Overall imports of consumer goods

were also about unchanged, as a large decline in pharmaceuticals offset increases in a number of other

goods. In contrast, imports of computers moved up

strongly in May.

_

Recent indicators of economic activity in the advanced

foreign economies suggested that the pace of contraction in those countries moderated further. Purchasing

managers indexes continued to rebound but did not yet

point to expansion for all countries. Industrial production, while remaining well below pre-crisis levels,

moved up strongly in Japan and edged up in the euro

area and in the United Kingdom. Indicators of economic sentiment also improved. However, labor market conditions continued to deteriorate, and credit

standards remained generally tight. In emerging market

economies, recent data showed that economic activity

surged across emerging Asia in the second quarter.

Real GDP rebounded sharply in China and South Korea, and the preliminary estimate in Singapore indicated

a substantial increase. In China, policy stimulus lifted

activity and thus helped boost China’s imports, primarily from other countries in Asia. Indicators for these

other countries also pointed to a strong rebound in the

second quarter. Activity remained depressed in Mexico, partly reflecting the adverse effect of a swine flu

outbreak. In contrast, activity in Brazil appeared to

have begun to recover.

In the United States, overall PCE prices rose in June

following little change in each of the previous three

months. The increase largely reflected a sizable increase in gasoline prices, which appeared to have

caught up with earlier increases in crude oil prices. The

latest available survey data showed that gasoline prices

flattened out, on net, in July. Excluding food and

energy, PCE prices moved up moderately in June. For

the second quarter as a whole, core inflation picked up

from the pace in the first quarter, which had been revised down because of smaller increases in the imputed

prices of nonmarket services. Median year-ahead inflation expectations in the Reuters/University of Michigan Survey of Consumers held relatively steady in July,

as in recent months. Longer-term inflation expectations were about the same as the average over 2008.

The producer price index for core intermediate materials turned up in June following a string of monthly

declines that likely reflected the pass-through of the

large declines in spot prices of commodities in the

second half of last year. All measures of hourly compensation and wages suggested that labor costs decelerated markedly this year in response to the considerable deterioration in labor market conditions.

Staff Review of the Financial Situation

The decisions by the Federal Open Market Committee

(FOMC) at the June meeting to leave the target range

for the federal funds rate unchanged and to maintain

Minutes of the Meeting of August 11-12, 2009

the sizes of its large-scale asset purchase programs,

along with the accompanying statement, were broadly

in line with market expectations. However, investors

initially marked up their expected path for the federal

funds rate following the release of the statement, as

they apparently interpreted it as suggesting a more favorable assessment of prospects for economic growth

than had been anticipated. Subsequently, investors

revised down the expected policy path after the June

employment report and the Chairman’s semiannual

monetary policy testimony. These declines were more

than offset by the favorable economic information received toward the end of the intermeeting period, including the stronger-than-expected July employment

report. On net, the market-implied path of the federal

funds rate ended the period about the same as at the

time of the June FOMC meeting. Yields on nominal

Treasury securities were also little changed, on balance,

over the intermeeting period, though there were sizable

intraday movements in response to macroeconomic

data releases and Federal Reserve communications.

Inflation compensation based on five-year Treasury

inflation-protected securities (TIPS) declined, on net,

over the intermeeting period, while five-year inflation

compensation five years ahead rose somewhat. Liquidity in the TIPS market reportedly continued to be poor,

making unclear the extent to which movements in

TIPS inflation compensation reflected changes in investors’ expectations of future inflation.

Functioning in short-term funding markets generally

showed further improvement over the intermeeting

period. Consistent with reduced concerns about the

financial condition of large banking institutions, London interbank offered rates (Libor) continued to edge

down. Three- and six-month Libor-OIS (overnight

index swap) spreads—while still somewhat elevated by

historical standards—declined a bit further and stood at

levels last recorded in early 2008. Bid-asked spreads

for most types of repurchase agreements edged down.

Since June, spreads on A2/P2-rated commercial paper

and AA-rated asset-backed commercial paper were little changed, on net, remaining at the low ends of their

ranges over the past two years. Indicators of Treasury

market functioning were little changed over the intermeeting period, and functioning continued to be

somewhat impaired. Bid-asked spreads held roughly

steady, and trading volumes remained low. The onthe-run liquidity premium for the 10-year Treasury note

was little changed at elevated levels, although it was

well below its peak last fall.

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Broad stock price indexes rose, on net, over the intermeeting period, as investors responded to strong

second-quarter earnings reports and indications that

the economy may be stabilizing. The spread between

an estimate of the expected real equity return over the

next 10 years for S&P 500 firms and an estimate of the

real 10-year Treasury yield—a rough gauge of the equity risk premium—narrowed a bit more but remained

high by recent historical standards. Option-implied

volatility on the S&P 500 index also dropped a bit further. Yields on BBB-rated and speculative-grade corporate bonds declined over the intermeeting period.

As a result, corporate bond spreads narrowed further

and dropped below the previous peak levels reached in

2002 following the 2001 recession. Conditions in the

leveraged loan market continued to improve as secondary-market prices rose further and bid-asked spreads

narrowed.

Investor sentiment toward the financial sector improved further over the intermeeting period, boosted,

in part, by better-than-expected second-quarter earnings results at larger banking institutions. Over the

period, bank equity prices rose, and credit default swap

spreads on financial firms declined. Nonetheless, some

investors commented that the positive upside surprises

at large financial institutions were mostly related to investment banking and trading activities, which may not

provide a stable source of earnings, and to mortgage

refinancing activity, which may recede if longer-term

rates rise. Market participants also focused on the large

consumer loan losses reported by many banks. The

financial condition of CIT Group, Inc., one of the largest lenders to middle-market firms, worsened sharply

over the period, but broader financial market conditions appeared to be largely unaffected by this development.

The level of private domestic nonfinancial sector debt

apparently declined again in the second quarter, as

household debt was estimated to have dropped and

nonfinancial business debt appeared to have been essentially unchanged. Gross issuance of speculativeand investment-grade bonds by nonfinancial corporations slowed in July from its outsized second-quarter

pace. Issuance of institutional loans in the syndicated

leveraged loan market reportedly remained extremely

weak in July, while bank loans and commercial paper

continued to run off, leaving net debt financing by

nonfinancial corporations at around zero. In contrast,

the federal government issued debt at a rapid clip, and

state and local government debt was estimated to have

expanded moderately.

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Federal Open Market Committee

Commercial bank credit contracted further in June and

July. All major loan categories declined, apparently

reflecting the combined effects of weaker demand for

most types of loans, some substitution from bank loans

to other funding sources, and an ongoing tightening of

lending standards and terms. Commercial and industrial lending dropped steeply amid subdued origination

activity and broad-based paydowns of outstanding

loans. In the July Senior Loan Officer Opinion Survey,

respondents indicated that the most important reasons

for the decline in C&I loans in 2009 were weaker demand from creditworthy borrowers and the deterioration in credit quality that had reduced the number of

firms that respondents viewed as creditworthy. The

contraction in commercial real estate (CRE) lending

accelerated. Large fractions of respondents to the July

survey again noted that they had tightened standards

and that the demand for CRE loans had weakened further.

M2 was little changed, on net, in June and July. Retail

money market mutual funds and small time deposits

dropped significantly in June and were estimated to

have contracted again in July, likely reflecting the very

low rates of interest on these assets and a continued

reallocation of wealth toward riskier assets. These declines were partly offset by a net increase in liquid deposits, also suggesting some portfolio reallocation within M2 assets. Currency expanded weakly, apparently

because of soft foreign demand.

The tone of financial markets abroad improved further

during the intermeeting period. Stock markets rose

globally, as positive U.S. earnings reports and news of

strong economic rebounds in emerging Asian economies reportedly lifted investor sentiment. European

bank stocks rose especially rapidly, spurred by reports

of better-than-expected earnings among some European banks as well as some U.S. financial institutions.

The dollar depreciated mildly on a trade-weighted basis

since late June.

The European Central Bank (ECB), the Bank of England, the Bank of Canada, and the Bank of Japan kept

their respective policy rates constant over the intermeeting period. However, overnight interest rates in

the euro area declined in the wake of the June 24 injection by the ECB of one-year funds at a fixed rate of

1 percent. The ECB also began its purchases of covered bonds, and yields on intermediate-term European

covered bonds declined since the purchases began in

early July. After leaving the size of its Asset Purchase

Facility (APF) unchanged at its July meeting, the Bank

of England, at its August meeting, raised the size of the

_

APF to £175 billion and widened the set of gilts it

would purchase. Benchmark gilt yields fell noticeably

on the announcement after moving higher in July.

Staff Economic Outlook

In the forecast prepared for the August FOMC meeting, the staff’s outlook for the change in real activity

over the next year and a half was essentially the same as

at the time of the June meeting. Consumer spending

had been on the soft side lately. The new estimates of

real disposable income that were reported in the comprehensive revision to the national income and product

accounts showed a noticeably slower increase in 2008

and the first half of 2009 than previously thought. By

themselves, the revised income estimates would imply a

lower forecast of consumer spending in coming quarters. But this negative influence on aggregate demand

was roughly offset by other factors, including higher

household net worth as a result of the rise in equity

prices since March, lower corporate bond rates and

spreads, a lower dollar, and a stronger forecast for foreign economic activity. All told, the staff continued to

project that real GDP would start to increase in the

second half of 2009 and that output growth would pick

up to a pace somewhat above its potential rate in 2010.

The projected increase in production in the second half

of 2009 was expected to be the result of a slowing in

the pace of inventory liquidation; final sales were not

projected to increase until 2010. The step-up in economic activity in 2010 was expected to be supported by

an ongoing improvement in financial conditions,

which, along with accommodative monetary policy, was

projected to set the stage for further improvements in

household and business sentiment and an acceleration

in aggregate demand.

The staff forecast for inflation was also about unchanged from that at the June meeting. Interpretation

of the incoming data on core PCE inflation was complicated by changes in the definition of the core measure recently implemented by the Bureau of Economic

Analysis, as well as by unusually low readings for some

nonmarket components of the price index.2 After accounting for these factors, the underlying pace of core

inflation seemed to be running a little higher than the

staff had anticipated. Survey measures of inflation expectations showed no significant change. Nonetheless,

As part of the July 2009 comprehensive revision of the

national income and product accounts, the Bureau of Economic Analysis reclassified restaurant meals from the food

category to the services category. As a result, the price index

for PCE excluding food and energy (the core PCE price

index) now includes prices of restaurant meals.

2

Minutes of the Meeting of August 11-12, 2009

with the unemployment rate anticipated to increase

somewhat during the remainder of 2009 and to decline

only gradually in 2010, the staff still expected core PCE

inflation to slow substantially over the forecast period;

the very low readings on hourly compensation lately

suggested that such a process might already be in train.

Participants’ Views on Current Conditions and the

Economic Outlook

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

data and anecdotal evidence had strengthened their

confidence that the downturn in economic activity was

ending and that growth was likely to resume in the

second half of the year. Many noted that their baseline

projections for the second half of 2009 and for subsequent years had not changed appreciably since the

Committee met in June but that they now saw smaller

downside risks. Consumer spending appeared to be in

the process of leveling out, and activity in a number of

local housing markets had stabilized or even increased

somewhat. Reports from business contacts supported

the view that firms were making progress in bringing

inventories into better alignment with their reduced

sales and that production was stabilizing in many sectors—albeit at low levels—and beginning to rise in

some. Nonetheless, most participants saw the economy as likely to recover only slowly during the second

half of this year, and all saw it as still vulnerable to adverse shocks. Conditions in the labor market remained

poor, and business contacts generally indicated that

firms would be quite cautious in hiring when demand

for their products picks up. Moreover, declines in employment and weakness in growth of labor compensation meant that income growth was sluggish. Also,

households likely would continue to face unusually

tight credit conditions. These factors, along with past

declines in wealth that had been only partly offset by

recent increases in equity prices, would weigh on consumer spending. The data and business contacts indicated very substantial excess capacity in many sectors;

this excess capacity, along with the tight credit conditions facing many firms, likely would mean further

weakness in business fixed investment for a time.

Even so, less-aggressive inventory cutting and continuing monetary and fiscal policy stimulus could be expected to support growth in production during the

second half of 2009 and into 2010. In addition, the

outlook for foreign economies had improved somewhat, auguring well for U.S. exports. Participants expected the pace of recovery to pick up in 2010, but

they expressed a range of views, and considerable uncertainty, about the likely strength of the upturn—

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particularly about the pace of projected gains in consumer spending and the extent to which credit conditions would normalize.

Most participants anticipated that substantial slack in

resource utilization would lead to subdued and potentially declining wage and price inflation over the next

few years; a few saw a risk of substantial disinflation.

However, some pointed to the problems in measuring

economic slack in real time, and several were skeptical

that temporarily low levels of resource utilization would

reduce inflation appreciably, given the loose empirical

relationship of economic slack to inflation and the fact

that the public did not appear to have reduced its expectations of inflation. Participants noted concerns

among some analysts and business contacts that the

sizable expansion of the Federal Reserve’s balance

sheet and large continuing federal budget deficits ultimately could lead to higher inflation if policies were not

adjusted in a timely manner. To address these concerns, it would be important to continue communicating that the Federal Reserve has the tools and willingness to begin withdrawing monetary policy accommodation at the appropriate time to prevent any persistent

increase in inflation.

Developments in financial markets during the intermeeting period were again seen as broadly positive; the

cumulative improvement in market functioning since

the spring was viewed as quite significant. Markets for

corporate debt continued to improve, and private credit

spreads narrowed further. With the TALF continuing

to provide important support, markets for asset-backed

securities also showed improvement, and recent issuance had neared levels observed prior to the second

half of 2008. Higher equity prices appeared to result

not only from generally better-than-expected corporate

earnings, which seemed largely to reflect aggressive cost

cutting, but also from a reduction in the perceived risk

of extremely adverse outcomes and a consequent increase in investors’ appetite for riskier assets. However, participants noted that many markets were still

strained and that financial risks remain. The improvement in financial markets was due, in part, to support

from various government programs, and market functioning might deteriorate as those programs wind

down. While financial markets had improved, credit

remained tight, with many banks—though fewer than

in recent quarters—having reported that they again

tightened loan standards and terms. Increases in interest rates and reductions in lines on credit cards were

affecting small businesses as well as consumers. All

categories of bank lending had continued to decline.

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Federal Open Market Committee

Worsening credit quality was still cited by banks as an

important reason for the tightening of credit conditions, though anecdotal evidence suggested that the

deterioration in the credit quality of consumer loans

might be slowing. Nonetheless, several participants

noted that banks still faced a sizable risk of additional

credit losses and that many small and medium-sized

banks were vulnerable to deteriorating performance of

commercial real estate loans. Participants again observed that obtaining or renewing financing for commercial real estate properties and projects was extremely difficult amid worsening fundamentals in that sector,

though some noted anecdotal evidence that the addition of highly rated commercial MBS to the list of securities that can be pledged as collateral for TALF

loans had contributed to an improvement in liquidity in

that market.

Labor market conditions remained of particular concern to meeting participants. Though recent data indicated that the pace at which employment was declining

had slowed appreciably, job losses remained sizable.

Moreover, long-term unemployment and permanent

separations continued to rise, suggesting possible problems of skill loss and a need for labor reallocation that

could slow recovery in employment as the economy

begins to expand. The unusually large fraction of those

who were working part time for economic reasons and

the unusually low level of the average workweek, combined with indications from business contacts that

firms would resist hiring as sales and production turn

up, also pointed to a period of modest job gains and

thus a slow decline in the unemployment rate. Wages

and benefits continued to decelerate, reflecting—in the

judgment of many participants—substantial slack in

labor markets. Several participants noted that the deceleration in labor costs should eventually support a

pickup in hiring. Recently, however, it contributed to

weakness in household incomes.

Consumer spending remained weak, but participants

saw evidence that it was stabilizing, even before the

boost to auto purchases provided by the cash-forclunkers program. Real PCE declined little, on balance,

during the first half of 2009 after dropping sharply during the second half of 2008 and was essentially constant

during May and June. Several participants noted the

recent rebound in equity prices and thus household

wealth as a factor that was likely to support consumer

spending. Many noted, however, that households still

faced considerable headwinds, including reduced

wealth, tight credit, high levels of debt, and uncertain

job prospects. With these forces restraining spending,

_

and with labor income likely to remain soft, participants generally expected no more than moderate

growth in consumer spending going forward. An important source of uncertainty in the outlook for consumer spending was whether households’ propensity to

save, which had risen in recent quarters, would increase

further: Analysis based on responses to past changes in

wealth relative to income suggested that the personal

saving rate could level out near its current value; however, there was some chance that the increased income

volatility and reduced access to credit that had characterized recent experience could lead households to save

a still-larger fraction of their incomes.

Regional surveys and anecdotal reports continued to

indicate low levels of activity across many goodsproducing industries and in the service sector, but they

also pointed to some optimism about the outlook.

Firms appeared to be making substantial progress in

reducing inventories toward desired levels; indeed, inventories of motor vehicles appeared quite lean following earlier production shutdowns and the recent boost

to sales from the cash-for-clunkers program. Accordingly, participants expected firms to slow the pace of

inventory reduction by raising production; this adjustment was likely to make an important contribution to

economic recovery in the second half of this year. In

contrast, business contacts generally reported setting a

high bar for increasing capital investment once sales

pick up, because their firms now have unusually high

levels of excess capacity.

In the residential real estate sector, home sales, prices,

and construction had shown signs of stabilization in

many areas and were increasing modestly in others, but

a still-sizable inventory of unsold existing homes continued to restrain homebuilding. Commercial real estate activity, in contrast, was being weighed down by

deteriorating fundamentals, including declining occupancy and rental rates; by falling prices; and by difficulty in refinancing loans on existing properties.

Manufacturing firms appeared to have benefitted recently from an earlier- and stronger-than-expected

pickup in foreign economic activity, especially in Asia,

and the resulting increase in demand for U.S. exports.

Several participants noted that improving growth

abroad would likely contribute to greater growth in

U.S. exports going forward.

A number of participants noted that fiscal policy

helped support the stabilization in economic activity, in

part by buoying household incomes and by preventing

even larger cuts in state and local government spend-

Minutes of the Meeting of August 11-12, 2009

ing. Participants generally anticipated that fiscal stimulus already in train would contribute to growth in economic activity during the second half of 2009 and into

2010, but the stimulative effects of policy would fade as

2010 went on and would need to be replaced by private

demand and income growth.

Committee Policy Action

In their discussion of monetary policy for the period

ahead, Committee members agreed that the stance of

monetary policy should not be changed at this meeting.

Given the prospects for an initially modest economic

recovery, substantial resource slack, and subdued inflation, the Committee agreed that it should maintain its

target range for the federal funds rate at 0 to ¼ percent.

The future path of the federal funds rate would continue to depend on the Committee’s evolving outlook,

but, for now, given their forecasts for only a gradual

upturn in economic activity and subdued inflation,

members thought it most likely that the federal funds

rate would need to be maintained at an exceptionally

low level for an extended period. With the downside

risks to the economic outlook now considerably reduced but the economic recovery likely to be damped,

the Committee also agreed that neither expansion nor

contraction of its program of asset purchases was warranted at this time. The Committee did, however, decide to gradually slow the pace of the remainder of its

purchases of $300 billion of Treasury securities and

extend their completion to the end of October to help

promote a smooth transition in markets. Members

noted that, with the programs for purchases of agency

debt and MBS not due to expire until the end of the

year, it was not necessary to make decisions at this

meeting about any potential modifications to those

programs. The Committee agreed that it would continue to evaluate the timing and overall amounts of its

purchases of securities in light of the evolving economic outlook and conditions in financial markets.

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 from 0 to ¼ percent.

The Committee directs the Desk to purchase

Page 9

agency debt, agency MBS, and longer-term

Treasury securities during the intermeeting

period with the aim of providing support to

private credit markets and economic activity.

The timing and pace of these purchases

should depend on conditions in the markets

for such securities and on a broader assessment of private credit market conditions.

The Desk is expected to purchase up to $200

billion in housing-related agency debt and up

to $1.25 trillion of agency MBS by the end of

the year. The Desk is expected to purchase

about $300 billion of longer-term Treasury

securities by the end of October, gradually

slowing the pace of these purchases until

they are completed. The Committee anticipates that outright purchases of securities

will cause the size of the Federal Reserve’s

balance sheet to expand significantly in coming months. 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.:

“Information received since the Federal

Open Market Committee met in June suggests that economic activity is leveling out.

Conditions in financial markets have improved further in recent weeks. Household

spending has continued to show signs of stabilizing but remains constrained by ongoing

job losses, sluggish income growth, lower

housing wealth, and tight credit. Businesses

are still cutting back on fixed investment and

staffing but are making progress in bringing

inventory stocks into better alignment with

sales. Although economic activity is likely to

remain weak for a time, the Committee continues to anticipate that policy actions to stabilize financial markets and institutions, fiscal

and monetary stimulus, and market forces

will contribute to a gradual resumption of

sustainable economic growth in a context of

price stability.

The prices of energy and other commodities

have risen of late. However, substantial resource slack is likely to dampen cost pres-

Page 10

Federal Open Market Committee

sures, and the Committee expects that inflation will remain subdued for some time.

In these circumstances, the Federal Reserve

will employ all available tools to promote

economic recovery and to preserve price stability. The Committee will maintain the target range for the federal funds rate at 0 to

¼ percent and continues to anticipate that

economic conditions are likely to warrant exceptionally low levels of the federal funds

rate for an extended period. As previously

announced, to provide support to mortgage

lending and housing markets and to improve

overall conditions in private credit markets,

the Federal Reserve will purchase a total of

up to $1.25 trillion of agency mortgagebacked securities and up to $200 billion of

agency debt by the end of the year. In addition, the Federal Reserve is in the process of

buying $300 billion of Treasury securities.

To promote a smooth transition in markets

as these purchases of Treasury securities are

completed, the Committee has decided to

gradually slow the pace of these transactions

and anticipates that the full amount will be

purchased by the end of October. The

Committee will continue to evaluate the tim-

_

ing and overall amounts of its purchases of

securities in light of the evolving economic

outlook and conditions in financial markets.

The Federal Reserve is monitoring the size

and composition of its balance sheet and will

make adjustments to its credit and liquidity

programs as warranted.”

Voting for this action: Messrs. Bernanke and Dudley,

Ms. Duke, Messrs. Evans, Kohn, Lacker, Lockhart,

Tarullo, and Warsh, and Ms. Yellen.

Voting against this action: None.

It was agreed that the next meeting of the Committee

would be held on Tuesday-Wednesday, September 2223, 2009. The meeting adjourned at 11:40 a.m. on August 12, 2009.

Notation Vote

By notation vote completed on July 14, 2009, the

Committee unanimously approved the minutes of the

FOMC meeting held on June 23-24, 2009.

_____________________________

Brian F. Madigan

Secretary