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, November 1, 2011, at 10:30 a.m. and continued on Wednesday, November 2, 2011, at 8:30 a.m.
PRESENT:
Ben Bernanke, Chairman
William C. Dudley, Vice Chairman
Elizabeth Duke
Charles L. Evans
Richard W. Fisher
Narayana Kocherlakota
Charles I. Plosser
Sarah Bloom Raskin
Daniel K. Tarullo
Janet L. Yellen
Christine Cumming, Jeffrey M. Lacker, Dennis P. Lockhart, Sandra Pianalto, and John C. Williams, Alternate Members of the Federal Open Market Committee
James Bullard, Esther L. George, and Eric Rosengren, Presidents of the Federal Reserve Banks of St. Louis, Kansas City, and Boston, respectively
William B. English, Secretary and Economist
Deborah J. Danker, Deputy Secretary
Matthew M. Luecke, Assistant Secretary
David W. Skidmore, Assistant Secretary
Michelle A. Smith, Assistant Secretary
Scott G. Alvarez, General Counsel
David W. Wilcox, Economist
James A. Clouse, Thomas A. Connors, Steven B. Kamin, Loretta J. Mester, Simon Potter, David Reifschneider, Harvey Rosenblum, Lawrence Slifman, Daniel G. Sullivan, and Kei-Mu Yi, Associate Economists
Brian Sack, Manager, System Open Market Account
Jennifer J. Johnson, Secretary of the Board, Office of the Secretary, Board of Governors
Patrick M. Parkinson, Director, Division of Banking Supervision and Regulation, Board of Governors
Nellie Liang, Director, Office of Financial Stability Policy and Research, Board of Governors
Robert deV. Frierson, Deputy Secretary, Office of the Secretary, Board of Governors
William Nelson, Deputy Director, Division of Monetary Affairs, Board of Governors
Andrew T. Levin, Special Adviser to the Board, Office of Board Members, Board of Governors
Linda Robertson, Assistant to the Board, Office of Board Members, Board of Governors
Charles S. Struckmeyer, Deputy Staff Director, Office of the Staff Director, Board of Governors
Michael P. Leahy, Senior Associate Director, Division of International Finance, Board of Governors; William Wascher, Senior Associate Director, Division of Research and Statistics, Board of Governors
Ellen E. Meade, Senior Adviser, Division of Monetary Affairs, Board of Governors
Daniel M. Covitz and Michael T. Kiley,1 Associate Directors, Division of Research and Statistics, Board of Governors
Christopher J. Erceg,1 Deputy Associate Director, Division of International Finance, Board of Governors; Fabio M. Natalucci, Deputy Associate Director, Division of Monetary Affairs, Board of Governors
Brian J. Gross,1 Special Assistant to the Board, Office of Board Members, Board of Governors
David Lopez-Salido,1 Assistant Director, Division of Monetary Affairs, Board of Governors
David H. Small, Project Manager, Division of Monetary Affairs, Board of Governors
Mark A. Carlson, Senior Economist, Division of Monetary Affairs, Board of Governors
Penelope A. Beattie, Assistant to the Secretary, Office of the Secretary, Board of Governors
Sarah G. Green, First Vice President, Federal Reserve Bank of Richmond
Glenn D. Rudebusch, Executive Vice President, Federal Reserve Bank of San Francisco
David Altig, Geoffrey Tootell, and Christopher J. Waller, Senior Vice Presidents, Federal Reserve Banks of Atlanta, Boston, and St. Louis, respectively
Todd E. Clark, Edward S. Knotek II, and Nathaniel Wuerffel, Vice Presidents, Federal Reserve Banks of Cleveland, Kansas City, and New York, respectively
Deborah L. Leonard, Assistant Vice President, Federal Reserve Bank of New York
Robert L. Hetzel, Senior Economist, Federal Reserve Bank of Richmond
By unanimous vote, the Committee selected David W. Wilcox to serve as Economist, and Lawrence Slifman to serve as Associate Economist, effective November 1, 2011, until the selection of their successors at the first regularly scheduled meeting of the Committee in 2012.
Developments in Financial Markets and the Federal Reserve’s Balance Sheet
The Manager of the System Open Market Account (SOMA) reported on developments in domestic and foreign markets during the period since the Federal Open Market Committee (FOMC) met on September 20-21, 2011. He also discussed the developments in connection with the bankruptcy filing of MF Global Holdings Ltd. and its finance subsidiary, MF Global Finance USA Inc., and with the termination of MF Global Inc. as a primary dealer. The Manager reported on System open market operations, including the ongoing reinvestment into agency-guaranteed mortgage-backed securities (MBS) of principal payments received on SOMA holdings of agency debt and agency-guaranteed MBS as well as the operations related to the maturity extension program authorized at the September 20-21 FOMC meeting. By unanimous vote, the Committee ratified the Desk’s domestic transactions over the intermeeting period. There were no intervention operations in foreign currencies for the System’s account over the intermeeting period.
Monetary Policy Strategies and Communication
The staff gave a presentation on alternative monetary policy strategies, and meeting participants discussed those alternatives as well as potential approaches for enhancing the clarity of their public communications. No decision was made at this meeting to change the Committee’s policy strategy or communications. It was noted that many central banks around the world pursue an explicit inflation objective, maintain flexibility to stabilize economic activity, and seek to communicate their forecasts and policy plans as clearly as possible. Many participants pointed to the merits of specifying an explicit longer-run inflation goal, but it was noted that such a step could be misperceived as placing greater weight on price stability than on maximum employment; consequently, some suggested that a numerical inflation goal would need to be set forth within a context that clearly underscored the Committee’s commitment to fostering both parts of its dual mandate. More broadly, a majority of participants agreed that it could be beneficial to formulate and publish a statement that would elucidate the Committee’s policy approach, and participants generally expressed interest in providing additional information to the public about the likely future path of the target federal funds rate. The Chairman asked the subcommittee on communications to give consideration to a possible statement of the Committee’s longer-run goals and policy strategy, and he also encouraged the subcommittee to explore potential approaches for incorporating information about participants’ assessments of appropriate monetary policy into the Summary of Economic Projections.
Committee participants shared their views regarding the potential merits and pitfalls of making conditional commitments regarding the future course of monetary policy. As noted in the staff briefing, economic theory and model simulations suggested that a policy strategy involving such commitments could foster better macroeconomic outcomes than a discretionary approach of reoptimizing policy at every meeting, so long as the public understood the central bank’s strategy and believed that policymakers would follow through on those commitments. Some participants noted that conditional commitments might be particularly helpful in providing additional accommodation and mitigating downside risks when the policy rate is close to its effective lower bound, because a central bank can commit to a shallower interest rate trajectory than investors would expect if policymakers followed a purely discretionary approach. However, many pointed out that the implementation of such a strategy could pose substantial communication challenges and that the benefits would be diminished if the strategy was not fully credible. Indeed, one participant suggested that additional purchases of longer-term securities would be a clearer and more effective way to provide additional monetary accommodation when the federal funds rate was near its lower bound.
Given the potential pitfalls of pursuing commitment strategies extending far out into the future, many participants thought that the Committee should consider policies intended to accrue some of the gains from conditional commitments and to perform well in a wide range of alternative scenarios. In this vein, a number of participants expressed support for the possibility of clarifying the conditionality of the Committee’s forward guidance about the trajectory of the federal funds rate through setting numerical thresholds for unemployment and inflation that would warrant exceptionally low levels for the policy rate. However, several participants noted that such thresholds could be confusing in the absence of a clear expression of the Committee’s longer-term goals. Moreover, others suggested that such an approach could be problematic in light of significant uncertainties about the longer-run normal rate of unemployment. One participant pointed to those uncertainties as instead supporting the use of thresholds as a way of managing potential inflation risks associated with additional accommodation.
The Committee also considered policy strategies that would involve the use of an intermediate target such as nominal gross domestic product (GDP) or the price level. The staff presented model simulations that suggested that nominal GDP targeting could, in principle, be helpful in promoting a stronger economic recovery in a context of longer-run price stability. Other simulations suggested that the single-minded pursuit of a price-level target would not be very effective in fostering maximum sustainable employment; it was noted, however, that price-level targeting where the central bank maintained flexibility to stabilize economic activity over the short term could generate economic outcomes that would be more consistent with the dual mandate. More broadly, a number of participants expressed concern that switching to a new policy framework could heighten uncertainty about future monetary policy, risk unmooring longer-term inflation expectations, or fail to address risks to financial stability. Several participants observed that the efficacy of nominal GDP targeting depended crucially on some strong assumptions, including the premise that the Committee could make a credible commitment to maintaining such a strategy over a long time horizon and that policymakers would continue adhering to that strategy even in the face of a significant increase in inflation. In addition, some participants noted that such an approach would involve substantial operational hurdles, including the difficulty of specifying an appropriate target level. In light of the significant challenges associated with the adoption of such frameworks, participants agreed that it would not be advisable to make such a change under present circumstances.
Staff Review of the Economic Situation
The information reviewed at the November 1-2 meeting indicated that the pace of economic activity strengthened somewhat in the third quarter, reflecting in part a reversal of the temporary factors that weighed on economic growth in the first half of the year. However, labor market conditions continued to be weak. Overall consumer price inflation was more moderate than earlier in the year, as prices of energy and some commodities declined from their recent peaks. Inflation for other goods and services also appeared to have moderated, and measures of longer-run inflation expectations remained stable.
Private nonfarm employment rose modestly in September, boosted in part by the return of communications workers who were on strike in August. Nonetheless, the pace of private-sector job gains in the third quarter as a whole was less than it was in the first half of the year. Meanwhile, employment in the state and local government sector continued to trend lower. The unemployment rate held at 9.1 percent in September, and both long-duration unemployment and the share of workers employed part time for economic reasons were still high. Initial claims for unemployment insurance have edged down since the middle of September but have remained at a level consistent with only modest employment growth, and most indicators of businesses’ hiring plans have showed no improvement.
Industrial production rose modestly in September, and the manufacturing capacity utilization rate edged up. Output in the motor vehicle–related sectors continued to step up following the disruptions associated with the earthquake in Japan earlier in the year, but the pace of factory production outside of those sectors was sluggish. Motor vehicle assemblies were scheduled to rise further in the fourth quarter, but broader indicators of near-term manufacturing activity, such as the diffusion indexes of new orders from the national and regional manufacturing surveys, remained at levels consistent with only modest increases in production in the coming months.
Real personal consumption expenditures (PCE) rose briskly in September but posted a more moderate gain for the third quarter as a whole. Motor vehicle purchases increased significantly in September to a level well above that in the spring (when availability of some models was limited by supply chain disruptions), and sales of new light motor vehicles stepped up further in October. However, real disposable income declined in the third quarter, as increases in consumer prices more than offset small gains in nominal income. Moreover, consumer sentiment continued to be downbeat in October.
Housing market activity remained very weak, held down by the large overhang of foreclosed and distressed properties along with limited demand in an environment of uncertainty about future home prices and tight underwriting standards for mortgage loans. Although starts and permits for new single-family homes edged up in September, they stayed near the depressed levels seen since the middle of last year. Sales of new and existing homes continued to be soft in recent months, and home prices trended lower.
Real business purchases of equipment and software expanded appreciably in the third quarter. Moreover, new orders for nondefense capital goods continued to run ahead of shipments in August and September; the buildup of unfilled orders pointed toward further increases in spending for business equipment in subsequent months. Nevertheless, survey measures of business conditions and sentiment in October suggested that firms remained cautious. Real business expenditures for nonresidential construction also rose appreciably in the third quarter, but spending was still at a relatively low level and continued to be held back by elevated vacancy rates and tight credit conditions for construction loans. In the third quarter, businesses increased their inventories at a much slower pace than in the second quarter, and inventory-to-sales ratios in most industries appeared to be in a comfortable range.
Real federal purchases increased in the third quarter, as defense expenditures continued to rise from unusually low levels early in the year, more than offsetting a decrease in nondefense spending. At the state and local level, real purchases declined in the third quarter at a noticeably slower rate than in the first half of the year as the pace of reductions in payrolls eased and construction spending rose slightly.
The U.S. international trade deficit was virtually the same in August as it was in July, as both exports and imports moved down only by small amounts. The decrease in exports reflected lower sales of automotive products and capital goods, which more than offset increases in exports of industrial supplies and consumer goods. The dip in imports was the result of lower purchases of capital goods, automotive products, and consumer goods, which outweighed an increase in petroleum imports. The advance release of the third-quarter data for the national income and product accounts showed real exports of goods and services expanding faster than real imports. As a result, net exports were estimated to have made a small positive contribution to real GDP growth in the third quarter, a contribution of about the same size as in the second quarter.
Overall U.S. consumer price inflation, as measured by the PCE price index, was more moderate in the third quarter than in the first half of the year. Consumer prices for food and energy increased last quarter at a slower pace than earlier in the year, and consumer prices excluding food and energy rose a bit less than in the preceding quarter. Near-term inflation expectations from the Thomson Reuters/University of Michigan Surveys of Consumers in October continued to be well below the elevated level seen in the spring, and longer-term inflation expectations in the survey remained stable.
Measures of labor compensation showed that wage increases continued to be subdued. The employment cost index increased at a modest rate over the year ending in the third quarter, and compensation per hour in the nonfarm business sector appeared to have decalerated somewhat last quarter. Similarly, the 12-month change in average hourly earnings for all employees remained subdued in September.
Foreign economic activity appeared to have largely recovered from the effects of the Japanese disaster in March, as production in Japan rebounded and supply disruptions waned. However, recent data pointed to considerable weakness in the euro-area economy. Elsewhere, indicators were somewhat more upbeat, with employment in Canada continuing to rise through September, while GDP growth in China over the year ending in the third quarter was a little less than in the first half of the year but still quite robust. Foreign inflation remained contained, although the reversal of earlier increases in energy prices appeared to be passing through to consumer price inflation relatively slowly in some countries.
Staff Review of the Financial Situation
Financial markets were quite volatile over the period since the September FOMC meeting. Investor sentiment was strongly influenced by prospects for Europe, as market participants remained highly attuned to developments regarding possible steps to contain the fiscal and banking problems there. Economic data releases that were, on balance, somewhat better than market participants expected provided some support to financial markets.
Longer-term Treasury yields declined appreciably following the release of the September FOMC statement. Investors reportedly viewed the Committee’s assessment of the economic outlook as more downbeat than anticipated. In addition, the announcement that the Federal Reserve would lengthen the average maturity of its portfolio by purchasing longer-term Treasury securities and selling an equivalent amount of shorter-term Treasury securities reportedly contributed to the decline in longer-term yields on the day. Yields on current-coupon agency MBS also moved lower on the announcement that the Federal Reserve would begin to reinvest principal payments on agency securities in agency MBS. Over the following weeks, movements in yields were driven by shifts in investors’ assessments of the ongoing efforts to address the European fiscal and banking situation and by somewhat stronger-than-expected U.S. economic data. On balance since the September FOMC meeting, Treasury yields on shorter-dated securities and the expected path of the federal funds rate implied by money market futures quotes were not much changed. Yields on Treasury securities with maturities beyond 10 years moved down. Measures of near-term inflation compensation derived from nominal and inflation-protected Treasury securities rose slightly over the intermeeting period, while similar measures of longer-term inflation compensation were about unchanged.
Credit default swap (CDS) spreads and equity prices of large U.S. banking organizations were again volatile over the period. Investor sentiment toward these financial institutions was strongly influenced by changes in investors’ assessments of the risks associated with the European fiscal and banking problems and the exposure of various financial institutions to Europe. Third-quarter U.S. bank earnings reports generally met investors’ expectations. On net, equity prices for U.S. banking firms were not much changed over the period since the last FOMC meeting, while their CDS spreads were a bit higher. European bank CDS spreads remained elevated, and these institutions continued to face somewhat strained conditions in short-term bank funding markets.
Although equity markets were volatile, broad U.S. equity price indexes ended the intermeeting period little changed. Earnings reports for nonfinancial firms generally came in somewhat better than investors expected and about in line with second-quarter levels. Gross public equity issuance by nonfinancial firms continued to be very weak in September and October, with a large number of firms shelving planned initial public offerings amid the volatility in equity markets.
Yields on investment- and speculative-grade corporate bonds edged lower, on net, over the period, leaving their spreads to Treasury securities slightly narrower. Credit flows for nonfinancial firms were mixed in September and October. The pace of bond financing by investment-grade nonfinancial corporations slowed some in October from its robust September pace, while bond issuance by speculative-grade firms was limited. Nonfinancial commercial paper outstanding posted solid growth in October. In the leveraged loan market, issuance financed by institutional investors slowed significantly in the third quarter.
Financing conditions for commercial real estate (CRE) markets appeared to have deteriorated in some respects. Issuance of commercial mortgage-backed securities (CMBS) slowed further in the third quarter amid widening CMBS spreads, and only a small number of deals were in the pipeline for the rest of the year. Prices of most types of commercial properties remained depressed, and aggregate vacancy and delinquency rates for commercial properties were close to their recent highs.
Interest rates on residential mortgages changed little, on net, over the intermeeting period but remained at historically low levels. The recent low rates appeared to have only a modest effect on the pace of mortgage refinancing, as tight underwriting standards and low home equity continued to limit the access of many households to the mortgage market. However, in October, the Federal Housing Finance Agency announced changes to the Home Affordable Refinance Program to expand eligibility and take-up among borrowers with mortgages backed by Fannie Mae and Freddie Mac. Indicators of home prices remained weak, reflecting a large inventory of unsold properties and modest demand for homes. The pace at which performing prime mortgages became newly delinquent rose over the summer but remained below last year’s levels.
Consumer credit decreased in August. Growth in nonrevolving credit, which had been volatile due to a shift in the timing of student loan originations, stepped down from the pace seen earlier in the year but remained solid in recent months. Issuance of consumer credit asset-backed securities continued at a moderate pace through mid-October. Delinquency rates for several categories of consumer loans remained low, a reflection in part of tighter underwriting standards that shifted the composition of borrowers toward those with stronger credit histories.
Core commercial bank loans expanded slightly in the third quarter. Commercial and industrial (C&I) loans accelerated following the already strong increases seen over the first half of the year. That growth was concentrated among large domestic banks and non-European foreign institutions. Consumer loans on banks’ books advanced modestly in the third quarter, ending a two-year string of quarterly declines. Closed-end residential mortgage loans held by banks also increased amid the modest pickup in refinancing activity, while CRE loans contracted. The October Senior Loan Officer Opinion Survey on Bank Lending Practices showed less net easing of lending standards by domestic banks than in the past few surveys. In particular, domestic banks reported little change in their standards on C&I loans over the third quarter, on net, compared with more widespread reports of easing in the previous several quarters. Demand for loans reportedly was little changed, on balance, over the third quarter.
M2 grew at a modest pace in September and October, well below the rapid rate seen in July and August. Some of the factors that contributed to M2 growth over the summer, such as concerns about European financial developments and equity market volatility, persisted and supported elevated levels of M2 deposits but did not trigger additional sizable inflows. The monetary base also grew moderately as its major components–reserve balances and currency–increased over the period.
Foreign financial markets remained volatile over the intermeeting period, and funding pressures for many European financial institutions continued. After falling sharply in August and early September, foreign equity prices rose, with stocks in the euro area outperforming those in most other economies. For most of the period, market participants seemed heartened by European leaders’ efforts to address the fiscal and financial challenges present in the euro area, although the news late in the period on a possible Greek referendum sent stock prices down sharply. Benchmark sovereign yields increased over the period, but spreads of yields on 10-year sovereign bonds of the most vulnerable euro-area countries over yields on German bunds were little changed on net. Some reversal of safe-haven flows in October reportedly led the dollar to give back most of the gains it registered in late September, leaving the broad nominal foreign exchange value of the dollar little changed, on balance, relative to its level at the time of the September FOMC meeting. At the end of October, Japanese officials intervened in foreign exchange markets through sales of yen.
The first round of the three-month U.S. dollar auctions that major foreign central banks announced on September 15 was held in October; demand was quite limited, and only the European Central Bank (ECB) drew on its swap line with the Federal Reserve. Korea and Japan announced that they would increase the size and scope of their bilateral currency swap arrangements, expanding the size of their existing won–yen swap arrangement and establishing a $30 billion facility in which dollars could be swapped for either won or yen.
A number of central banks announced additional measures to stimulate economic activity. The Bank of England and Bank of Japan each announced expansions of their respective asset purchase programs, and the ECB announced that it would conduct two refinancing operations with maturities of slightly more than a year and launched a new covered bond purchase program. The central banks of Brazil, Indonesia, and Israel lowered their policy rates, citing a potential slowdown in global growth.
Staff Economic Outlook
With the recent data on spending, particularly for consumer expenditures and business outlays for capital goods and nonresidential construction, stronger than the staff anticipated at the time of the September FOMC meeting, the staff’s near-term projection for the rate of increase in real GDP was revised up. However, other important near-term indicators of economic activity remained downbeat: Measures of consumer sentiment were still very low, business surveys pointed to continued caution by firms, conditions in the labor market remained weak, and gains in manufacturing production outside of the motor vehicle–related sectors were sluggish. Moreover, many of the factors that have been restraining the recovery, such as the large overhang of vacant houses, tight credit conditions, and elevated risk premiums, remained in place. Consequently, the staff’s outlook for economic activity over the medium term was similar to the projection prepared for the September FOMC meeting. The staff continued to project that real GDP would accelerate gradually in 2012 and 2013, supported by accommodative monetary policy, further improvements in credit conditions, and a pickup in consumer and business sentiment from their current low levels. Over the forecast period, the increase in real GDP was projected to be sufficient to reduce the slack in product and labor markets only slowly, and the unemployment rate was expected to remain elevated at the end of 2013.
The staff’s forecast for inflation was essentially unchanged from the projection prepared for the September FOMC meeting. The upward pressure on consumer prices from the rise in commodity and import prices early in the year was anticipated to ease further in the current quarter. With longer-run inflation expectations stable and significant slack anticipated to persist in labor and product markets, the staff continued to expect prices to rise at a subdued pace in 2012 and 2013.
Participants’ Views on Current Conditions and the Economic Outlook
In conjunction with this FOMC meeting, all participants–the five members of the Board of Governors and the presidents of the 12 Federal Reserve Banks–provided projections of output growth, the unemployment rate, and inflation for each year from 2011 through 2014 and over the longer run. Longer-run projections represent each participant’s assessment of the rate to which each variable would be expected to converge, over time, under appropriate monetary policy and in the absence of further shocks to the economy. Although participants had revised downward their projections for growth since their previous forecasts in June, they continued to anticipate that economic growth would pick up and the unemployment rate would decline gradually through 2014. They also continued to project that inflation would settle at or below levels consistent with the Committee’s dual mandate. Participants’ forecasts are described in more detail in the Summary of Economic Projections, which is attached as an addendum to these minutes.
In their discussion of the economic situation and outlook, meeting participants regarded the information received during the intermeeting period as indicating that economic growth had strengthened somewhat in the third quarter, reflecting in part a reversal of temporary factors that had weighed on the economic recovery in the first half of the year. Participants noted that global supply chain disruptions associated with the natural disaster in Japan had diminished, and that the prices of energy and some commodities had come down from their recent peaks, easing strains on household budgets and likely contributing to a somewhat stronger pace of consumer spending in recent months. More broadly, final demand from consumers and businesses was stronger than had been expected at the time of the September FOMC meeting. Nonetheless, most participants anticipated that the pace of economic growth would remain moderate over coming quarters. While they believed that the economic recovery would continue to be supported by accommodative monetary policy, ongoing improvements in households’ and businesses’ financial positions, and pent-up demand for goods and services, a number of factors were seen as likely to continue to restrain the pace of economic growth. Those included persistent weakness in the labor and housing markets, still-tight credit conditions for many households and small businesses, low consumer and business confidence, fiscal consolidation at all levels of government, and elevated volatility in financial markets. Moreover, the recovery was still subject to significant downside risks, including strains in global financial markets. With longer-term inflation expectations remaining stable, the effects of earlier increases in the prices of energy and other commodities continuing to wane, and low levels of resource utilization restraining increases in prices and wages, most participants anticipated that inflation would settle, over coming quarters, at or below levels they judged to be most consistent with their dual mandate.
In the household sector, incoming data on retail sales were somewhat stronger than expected, and participants reported scattered optimism among their contacts regarding the prospects for holiday spending. Some participants thought that the effects of balance sheet deleveraging might be running their course or that such effects could be less powerful than had been thought. Others noted that the recent pickup in consumer spending outpaced growth in after-tax incomes and was accompanied by a decline in the saving rate, raising doubts about its sustainability unless income growth picked up. In addition, households appeared to remain pessimistic about the prospects for their future income, the job market was still weak, consumer confidence was historically very low, and credit conditions for many households were still tight. The housing sector continued to be depressed, and some meeting participants indicated that the elevated supply of available homes and the overhang of foreclosures, together with limited access to mortgage credit, were continuing to put downward pressure on house prices and housing construction. A few participants noted that recent government initiatives aimed at helping high-loan-to-value borrowers refinance could be useful steps toward stabilizing the housing market.
Business contacts in many parts of the country were reported to be cautious and uncertain about the economic and political outlook and so remained reluctant to hire or expand capacity. However, production in the manufacturing, agriculture, and energy sectors continued to increase, and the auto sector was rebounding from earlier supply chain disruptions. In addition, businesses in a number of regions reported ongoing capital investment to increase productivity. Input cost pressures were said to have abated somewhat, while labor costs remained subdued. Overall, credit costs were low, and profits and balance sheets at nonfinancial corporations were healthy, with many firms continuing to hold very high levels of cash.
Despite some signs of improvement of late, the available indicators pointed to continued weakness in overall labor market conditions, and the unemployment rate remained elevated. Some participants suggested that the persistently high level of unemployment reflected the impact of structural factors, including mismatches between the skills of the unemployed and the skills demanded in sectors in which jobs were currently available. Consistent with this view, some business contacts reportedly were concerned about the low quality of many job applicants, while other contacts noted that workers with some specialized skills continued to be in short supply. However, other participants indicated that such concerns were not new and that much of the current elevated level of unemployment reflected cyclical factors, with one pointing to the lack of wage pressures as evidence. As a result, they expected that unemployment would fall back as the economy recovered. Some participants again warned that the exceptionally high level of long-term unemployment could ultimately lead to permanent negative effects on the skills and employment prospects of the unemployed.
Meeting participants observed that financial markets continued to be particularly volatile during the intermeeting period as investors responded to incoming economic data and to news regarding fiscal and financial developments in Europe. Liquidity in many markets worsened, in part because financial institutions more reliant on short-term funding markets reportedly pulled back from risk-taking and became somewhat less willing to make markets. Participants noted the announcement by European policymakers of a new package of measures to address Greece’s fiscal situation as well as the vulnerabilities of European banks and sovereigns. However, participants indicated that many details of the new plan had not yet been worked out and that a number of important issues remained unresolved. Participants took note of the possible adverse effects on U.S. financial markets and the broader U.S. economy if European sovereign debt and banking problems intensified. Participants observed, however, that the capital and liquidity positions of U.S. banks had strengthened in recent quarters and that the credit quality of loans to businesses and households had improved further. Contacts in the banking sector reported that U.S. banks continued to be willing to extend loans to creditworthy borrowers, but loan demand remained weak and competition for such borrowers was putting pressure on net interest margins. It was noted that very low interest rates were negatively affecting pension funds and the profitability of the life insurance industry. Participants also discussed the events surrounding the bankruptcy filing of MF Global Holdings Ltd. and saw the financial stability implications of this development as limited to date.
Participants generally agreed that measures of total inflation appeared to have moderated since earlier in the year as prices of energy and some commodities declined from their peaks. Measures of core inflation also seemed to have declined in recent months, and longer-term inflation expectations remained well anchored. Nonetheless, some participants noted that core inflation had not come down as quickly or by as much as they had expected in light of the reduction in commodity prices, perhaps suggesting that the level of potential output was lower than had been thought. However, other participants pointed to the subdued pace of gains in labor costs as a factor damping inflation, and reports from contacts suggested that upward pressure on wages remained limited.
Regarding their overall outlook for economic activity, participants generally agreed that, even with the positive news received over the intermeeting period, the most probable outcome was a moderate pace of economic growth over the medium run with only a gradual decline in the unemployment rate. While some factors were seen as likely to support growth going forward–such as pent-up demand, improvements in household and business balance sheets, and accommodative monetary policy–participants observed that the pace of economic recovery would likely continue to be held down for some time by persistent headwinds. In particular, they pointed to very low levels of consumer and business confidence, further efforts by households to deleverage, cutbacks at all levels of government, elevated financial market volatility, still-tight credit conditions for some households and small businesses, and the ongoing weakness in the labor and housing markets. While recent incoming data suggested reduced odds that the economy would slide back into recession, participants still saw significant downside risks to the outlook for economic growth. Risks included potential spillovers to U.S. financial markets and institutions, and so to the broader U.S. economy, if the European debt and banking crisis were to worsen significantly. In addition, participants noted the risk of a larger-than-expected fiscal tightening and the possibility that structural problems in the housing market had attenuated the transmission of monetary policy actions to the real economy. It was also noted that the extended period of highly accommodative monetary policy could eventually lead to a buildup of financial imbalances. A few participants, however, mentioned the possibility that economic growth could be more rapid than currently expected, particularly if gains in output and employment led to a virtuous cycle of improvements in household balance sheets, increased confidence, and easier credit conditions.
With respect to the outlook for inflation, participants generally anticipated that inflation would recede further over coming quarters and would settle over the medium run at levels at or below those judged to be most consistent with the Committee’s dual mandate. They pointed to the further dissipation of the effects of earlier increases in the prices of energy and some commodities, the significant slack in resource utilization, the continued subdued growth in labor compensation, and well-anchored inflation expectations as factors likely to contribute to the moderation in inflation over time. A number of participants saw the risks to the outlook for inflation as roughly balanced. A few participants felt that the continuation of the current stance of monetary policy, coupled with the possibility of a rebound in energy and commodity prices, posed some upside risks to inflation. Other participants instead saw inflation risks as tilted to the downside, in light of their expectations for persistent resource slack. It was noted that U.S. inflation had been influenced relatively more by commodity price fluctuations in recent years; because commodity prices reflect global economic conditions, U.S. inflation might be less affected by domestic factors and more linked to the global outlook than in the past.
Committee Policy Action
Members noted that information received over the intermeeting period pointed to somewhat stronger economic growth in the third quarter, partly reflecting a reversal of temporary factors that had depressed economic growth in the first half of the year. However, overall labor market conditions remained weak. Members generally anticipated that unemployment would decline only gradually from levels significantly above those that the Committee would expect to prevail in the longer run, with inflation likely to settle at levels at or below those consistent with the Committee’s dual mandate. Accordingly, in the discussion of monetary policy for the period ahead, all Committee members agreed to continue the program of extending the average maturity of the Federal Reserve’s holdings of securities as announced in September. The Committee decided to maintain its existing policy of reinvesting principal payments from its holdings of agency debt and agency MBS in agency MBS and of rolling over maturing Treasury securities at auction. In addition, the Committee agreed to keep the target range for the federal funds rate at 0 to 1/4 percent and to reiterate its expectation that economic conditions–including low rates of resource utilization and a subdued outlook for inflation over the medium run–are likely to warrant exceptionally low levels for the federal funds rate at least through mid-2013. A few members expressed interest in using language specifying a period of time during which the federal funds rate was expected to remain exceptionally low, rather than a calendar date, arguing that such language might be better to indicate a constant stance of monetary policy over time. However, members generally preferred to retain the existing forward guidance, at least for now. A few members indicated that they believed the economic outlook might warrant additional policy accommodation. However, it was noted that any such accommodation would likely be more effective if it were provided in the context of a future communications initiative, and most of these members agreed that they could support retention of the current policy stance at this meeting. One member dissented from the policy decision on the grounds that additional monetary policy accommodation was warranted at this time. With the Committee in the process of reviewing its monetary policy strategies and communication, and no additional accommodation being provided at this meeting, a few members indicated that they could support the Committee’s decision even though they had not favored recent policy actions. The Committee reiterated that it will regularly review the size and composition of its securities holdings and that it is prepared to adjust those holdings as appropriate to promote a stronger economic recovery in the context of price stability. With respect to the statement to be released following the meeting, members agreed that only relatively small changes were needed to reflect the modest improvement in the economic outlook and to note that the Committee would continue to implement its policy steps from recent meetings.
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 1/4 percent. The Committee directs the Desk to continue the maturity extension program it began in September to purchase, by the end of June 2012, Treasury securities with remaining maturities of approximately 6 years to 30 years with a total face value of $400 billion, and to sell Treasury securities with remaining maturities of 3 years or less with a total face value of $400 billion. The Committee also directs the Desk to maintain its existing policies of rolling over maturing Treasury securities into new issues and of reinvesting principal payments on all agency debt and agency mortgage-backed securities in the System Open Market Account in agency mortgage-backed securities in order to maintain the total face value of domestic securities at approximately $2.6 trillion. The Committee directs the Desk to engage in dollar roll transactions as necessary to facilitate settlement of the Federal Reserve’s agency MBS transactions. 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 12:30 p.m.:

“Information received since the Federal Open Market Committee met in September indicates that economic growth strengthened somewhat in the third quarter, reflecting in part a reversal of the temporary factors that had weighed on growth earlier in the year. Nonetheless, recent indicators point to continuing weakness in overall labor market conditions, and the unemployment rate remains elevated. Household spending has increased at a somewhat faster pace in recent months. Business investment in equipment and software has continued to expand, but investment in nonresidential structures is still weak, and the housing sector remains depressed. Inflation appears to have moderated since earlier in the year as prices of energy and some commodities have declined from their peaks. Longer-term inflation expectations have remained stable.
Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. The Committee continues to expect a moderate pace of economic growth over coming quarters and consequently anticipates that the unemployment rate will decline only gradually toward levels that the Committee judges to be consistent with its dual mandate. Moreover, there are significant downside risks to the economic outlook, including strains in global financial markets. The Committee also anticipates that inflation will settle, over coming quarters, at levels at or below those consistent with the Committee’s dual mandate as the effects of past energy and other commodity price increases dissipate further. However, the Committee will continue to pay close attention to the evolution of inflation and inflation expectations.
To support a stronger economic recovery and to help ensure that inflation, over time, is at levels consistent with the dual mandate, the Committee decided today to continue its program to extend the average maturity of its holdings of securities as announced in September. The Committee is maintaining its existing policies of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction. The Committee will regularly review the size and composition of its securities holdings and is prepared to adjust those holdings as appropriate.
The Committee also decided to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that economic conditions–including low rates of resource utilization and a subdued outlook for inflation over the medium run–are likely to warrant exceptionally low levels for the federal funds rate at least through mid-2013.
The Committee will continue to assess the economic outlook in light of incoming information and is prepared to employ its tools to promote a stronger economic recovery in a context of price stability.”
Voting for this action: Ben Bernanke, William C. Dudley, Elizabeth Duke, Richard W. Fisher, Narayana Kocherlakota, Charles I. Plosser, Sarah Bloom Raskin, Daniel K. Tarullo, and Janet L. Yellen.
Voting against this action: Charles L. Evans.
Mr. Evans dissented because he saw the high unemployment rate and the outlook for only weak economic growth as calling for additional policy accommodation at this meeting. Moreover, the longer the current situation of low resource utilization lasted, the more the economy’s longer-term growth potential could be impaired. Furthermore, given current policy, his outlook was for inflation to come in below levels consistent with the Committee’s dual mandate, bolstering the case for additional monetary easing at this time. He also believed policies with more-explicit forward guidance about the economic conditions under which exceptionally low levels of the funds rate could be maintained would improve the prospects for growth and employment and, while possibly admitting somewhat higher inflation for a time, would still safeguard price stability.
It was agreed that the next meeting of the Committee would be held on Tuesday, December 13, 2011. The meeting adjourned at 10:30 a.m. on November 2, 2011.
Notation Vote
By notation vote completed on October 11, 2011, the Committee unanimously approved the minutes of the FOMC meeting held on September 20-21, 2011.
 
_____________________________
William B. English
Secretary
 

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A meeting of the Federal Open Market Committee was held in the offices of the Board of Governors in Washington, D.C., on Tuesday, December 14, 2010, at 8:30 a.m.

PRESENT:
Ben Bernanke, Chairman
William C. Dudley, Vice Chairman
James Bullard
Elizabeth Duke
Thomas M. Hoenig
Sandra Pianalto
Sarah Bloom Raskin
Eric Rosengren
Daniel K. Tarullo
Kevin Warsh
Janet L. Yellen

Christine Cumming, Charles L. Evans, Richard W. Fisher, Narayana Kocherlakota, and Charles I. Plosser, Alternate Members of the Federal Open Market Committee

Jeffrey M. Lacker and Dennis P. Lockhart, Presidents of the Federal Reserve Banks of Richmond and Atlanta, respectively

John F. Moore, First Vice President, Federal Reserve Bank of San Francisco

William B. English, Secretary and Economist
Deborah J. Danker, Deputy Secretary
Matthew M. Luecke, Assistant Secretary
David W. Skidmore, Assistant Secretary
Michelle A. Smith, Assistant Secretary
Scott G. Alvarez, General Counsel
Nathan Sheets, Economist
David J. Stockton, Economist

Alan D. Barkema, James A. Clouse, Thomas A. Connors, Jeff Fuhrer, Steven B. Kamin, Lawrence Slifman, Christopher J. Waller, and David W. Wilcox, Associate Economists

Brian Sack, Manager, System Open Market Account

Patrick M. Parkinson, Director, Division of Bank Supervision and Regulation, Board of Governors

Nellie Liang, Director, Office of Financial Stability Policy and Research, Board of Governors

William Nelson, Deputy Director, Division of Monetary Affairs, Board of Governors

Linda Robertson, Assistant to the Board, Office of Board Members, Board of Governors

Charles S. Struckmeyer, Deputy Staff Director, Office of the Staff Director, Board of Governors

David Reifschneider and William Wascher, Senior Associate Directors, Division of Research and Statistics, Board of Governors

Andrew T. Levin, Senior Adviser, Office of Board Members, Board of Governors

Michael G. Palumbo and Joyce K. Zickler, Deputy Associate Directors, Division of Research and Statistics, Board of Governors; Gretchen C. Weinbach, Deputy Associate Director, Division of Monetary Affairs, Board of Governors

Fabio M. Natalucci, Assistant Director, Division of Monetary Affairs, Board of Governors

Randall A. Williams, Records Management Analyst, Division of Monetary Affairs, Board of Governors

Dale Roskom, First Vice President, Federal Reserve Bank of Cleveland

Harvey Rosenblum, Daniel G. Sullivan, and John C. Williams, Executive Vice Presidents, Federal Reserve Banks of Dallas, Chicago, and San Francisco, respectively

David Altig, Richard P. Dzina, Mark E. Schweitzer, and Kei-Mu Yi, Senior Vice Presidents, Federal Reserve Banks of Atlanta, New York, Cleveland, and Minneapolis, respectively

Tobias Adrian, Vice President, Federal Reserve Bank of New York

Satyajit Chatterjee, Senior Economic Adviser, Federal Reserve Bank of Philadelphia

Alexander L. Wolman, Senior Economist, Federal Reserve Bank of Richmond

Developments in Financial Markets and the Federal Reserve’s Balance Sheet
The manager of the System Open Market Account (SOMA) reported on developments in domestic and foreign financial markets since the Federal Open Market Committee (FOMC) met on November 2-3, 2010. He also reported on System open market operations, including the continuing reinvestment into longer-term Treasury securities of principal payments received on the SOMA’s holdings of agency debt and agency-guaranteed mortgage-backed securities (MBS) as well as the ongoing purchases of additional Treasury securities authorized at the November 2-3 FOMC meeting. Since the last meeting, the Open Market Desk at the Federal Reserve Bank of New York purchased a total of about $105 billion of Treasury securities, reflecting about $30 billion of purchases with the proceeds of principal payments and about $75 billion as part of the authorized expansion of the Federal Reserve’s securities holdings. Purchases were concentrated in nominal Treasury securities with maturities of 2 to 10 years, though some longer-term securities were purchased along with some Treasury inflation-protected securities (TIPS). The Manager also discussed the Desk’s intention to place additional limits on its purchases of individual securities, as the Federal Reserve’s holdings of such securities increased beyond 35 percent of the total outstanding; these limits were intended to help ensure that Federal Reserve purchases do not impair the liquidity in Treasury markets. In addition, the Manager updated the Committee on the SOMA’s holdings of foreign-currency instruments. There were no open market operations in foreign currencies for the System’s account over the intermeeting period. By unanimous vote, the Committee ratified the Desk’s transactions over the intermeeting period.

In light of ongoing strains in some foreign financial markets, the Committee considered a proposal to extend its dollar liquidity swap arrangements with foreign central banks past January 31, 2011. After discussing possible alternative periods for such an extension, the Committee unanimously approved the following resolution:

The Federal Open Market Committee directs the Federal Reserve Bank of New York to extend the existing temporary reciprocal currency arrangements (“swap arrangements”) for the System Open Market Account with the Bank of Canada, the Bank of England, the Bank of Japan, the European Central Bank, and the Swiss National Bank. The swap arrangements shall now terminate on August 1, 2011, unless further extended by the Committee.

Staff Review of the Economic Situation
The information reviewed at the December 14 meeting indicated that economic activity was increasing at a moderate rate, but that the unemployment rate remained elevated. The pace of consumer spending picked up in October and November, exports rose rapidly in October, and the recovery in business spending on equipment and software (E&S) appeared to be continuing. In contrast, residential and nonresidential construction activity was still depressed. Manufacturing production registered a solid gain in October. Nonfarm businesses continued to add workers in October and November, and the average workweek moved up. Longer-run inflation expectations were stable, but core inflation continued to trend lower.

Labor demand rose further in recent months, but unemployment stayed at a high level. The average increase in private nonfarm payroll employment in October and November was close to the pace over the preceding six months, while the average workweek for all employees edged higher. The bulk of the private-sector job gains continued to be in the services industries; employment in manufacturing, construction, and retail trade declined, on average, in October and November. Employment at state and local governments rose slightly over the two-month period. A number of indicators of job openings and hiring plans improved in October and November, and initial claims for unemployment insurance trended steadily lower through November and early December. However, the unemployment rate, which remained at 9.6 percent during the preceding three months, increased to 9.8 percent in November, while the labor force participation rate and the employment-population ratio remained depressed.

Industrial production in the manufacturing sector increased at a solid pace in October, with advances widespread across industries; total industrial production was unchanged due to an offsetting weather-related drop in the output of utilities. The manufacturing capacity utilization rate continued to move up in October, although it remained significantly below its 1972-2009 average. Most indicators of near-term industrial activity, such as the new orders diffusion indexes in the national and regional manufacturing surveys, were at levels consistent with moderate gains in industrial production in the near term. Motor vehicle assemblies, which rose in October, fell back in November but were scheduled to move up again in coming months.

The pace of consumer spending picked up in recent months from the modest rate that prevailed earlier in the year. Nominal retail sales, excluding purchases at motor vehicles and parts outlets, posted a strong gain in November, and revised estimates showed larger increases in September and October than previously reported. In addition, sales of new light motor vehicles stepped up in October and remained at that higher level in November. A number of factors supporting consumer spending also improved. Revised data on personal income indicated that it was stronger last spring and summer than previously reported. Household net worth rose further in the third quarter, as an increase in equity values more than offset the effect of a drop in house prices. Consumer sentiment turned more positive in November and early December, retracing most of the decline that occurred during the summer. However, while consumer credit outstanding showed signs of stabilizing after two years of runoffs, credit terms were still noticeably less favorable than in the past, and demand for credit appeared to remain weak.

Activity in the housing market was still quite depressed. In October, starts of new single-family homes remained at the very low level that had prevailed since August. Moreover, the level of permit issuance, which is typically a near-term indicator of new homebuilding, continued to run below starts. The persistence of a large excess supply of existing homes on the market and tight credit conditions for construction appeared to constitute a significant restraint on new homebuilding. Demand for housing also remained very weak: Sales of new homes in October were at the lowest level in the 48-year history of the series. Purchases of existing homes edged lower in October; in part, the still-low level of sales likely reflected the payback from the earlier surge in sales associated with the homebuyer tax credit and also the moratoriums on sales of bank-owned properties. Measures of house prices declined recently, and households’ concerns that home values might continue to fall, their pessimism about the outlook for employment and income, and the tight standards faced by many mortgage borrowers appeared to be weighing on demand.

Real business investment in equipment and software appeared to be increasing, although the pace of spending seemed to have moderated from the rapid rate of the first half of the year. The rise in E&S spending during the third quarter, while somewhat slower than earlier in the year, remained solid and broad based, but the available data for the fourth quarter were mixed. Nominal orders and shipments of nondefense capital goods excluding aircraft declined in October, and business purchases of new vehicles in October and November were down a bit from their third-quarter level. In contrast, sales of software still appeared to be on a solid uptrend, and deliveries of completed aircraft picked up in November. Surveys of purchasing managers reported plans to step up capital spending in 2011; however, reports from small businesses on their planned expenditures remained downbeat. Business outlays on nonresidential structures appeared to be declining further, with a drop in spending on building construction offset only slightly by increased investment in drilling and mining structures. Overall borrowing by nonfinancial corporations was robust again in November, indicators of credit quality continued to improve, and small businesses noted some easing in credit availability. However, financing conditions for commercial real estate remained tight.

Real inventory investment rose sharply in the third quarter, but book-value data for October suggested that the pace of accumulation was slowing. Although inventory-sales ratios rose during the third quarter, survey data implied that few businesses perceived inventory stocks as being too high.

Consumer price inflation trended lower in October. The 12-month change in the total personal consumption expenditures (PCE) price index reached its lowest level of the past year; the 12-month change in the PCE price index for core goods and services also moved down. In October, core PCE prices were unchanged for a second month, as goods prices declined and prices of non-energy services posted a small increase. The broad-based deceleration in underlying inflation was also apparent in other measures, such as the trimmed-mean PCE price index and a diffusion index of PCE price changes. Despite the rise in agricultural commodity prices, the increase in retail food prices was modest. In contrast, consumer energy prices continued to rise rapidly in October, and spot prices of imported crude oil moved higher, on net, during November and early December. The rise in prices of nonfuel industrial commodities moderated over the intermeeting period as spot prices of metals declined, but the producer price index for domestically manufactured intermediate goods accelerated in October and November. In November and early December, survey measures of households’ short- and long-term inflation expectations remained in the ranges that have prevailed since the spring of 2009.

Available measures of labor compensation showed that labor cost pressures were still restrained. The 12-month change in average hourly earnings for all employees remained low in November. In the third quarter, the modest rise in hourly compensation in the nonfarm business sector was matched by a similar increase in productivity.

The U.S. international trade deficit narrowed considerably in October, shrinking to its lowest level since the beginning of the year, as exports surged and imports edged down. The strength in exports was relatively broad based. Exports of industrial supplies and agricultural goods registered the largest increases, although rising prices accounted for some of those gains. Exports of machinery and automotive products also rose strongly. The decrease in imports was concentrated in petroleum products, reflecting lower volumes, and in computers. In contrast, imports of consumer goods posted a noticeable increase.

Recent data releases confirmed that, in the aggregate, the rise in foreign real gross domestic product (GDP) slowed sharply in the third quarter from the very rapid pace earlier in the year. The slowdown was most pronounced in the emerging market economies (EMEs), where economic activity was restrained by the abatement of inventory rebuilding and the associated waning of the rebound in global trade, the unwinding of fiscal stimulus measures, and a continued tightening of monetary policies in several countries. More recent indicators for the EMEs, including purchasing managers indexes (PMIs), pointed to a rebound in economic activity in the fourth quarter. The advanced foreign economies (AFEs) also saw a slower rise in real economic activity in the third quarter than occurred earlier in the year. In the euro area, economic performance continued to diverge across countries. The increase in German economic activity in the third quarter was nearly twice the euro-area average rate, and recent indicators, including PMIs and consumer and business sentiment, showed further solid performance. In contrast, Spanish economic activity stagnated in the third quarter, Greek GDP extended its decline, and more-recent indicators point to continued weakness in peripheral European economies. Headline inflation rates generally picked up in the foreign economies, driven largely by food and energy prices; measures of inflation excluding food and energy prices were relatively steady.

Staff Review of the Financial Situation
The decision by the FOMC at its November meeting to maintain the 0 to 1/4 percent target range for the federal funds rate was widely anticipated. The decision to expand its holdings of longer-term securities by $600 billion by the end of the second quarter of 2011 was also roughly in line with market expectations, although market participants appeared to expect the purchase program would be increased over time. In the weeks following the November meeting, yields on nominal Treasury securities increased significantly, as investors reportedly revised down their estimates of the ultimate size of the FOMC’s new asset-purchase program. Incoming economic data that were viewed, on balance, as favorable to the outlook and news of a tentative agreement between the Administration and some members of the Congress regarding a package of fiscal measures also reportedly contributed to the backup in yields. Market participants pointed to abrupt changes in investor positions, the effects of the approaching year-end on market liquidity, and hedging flows associated with investors’ holdings of MBS as factors that may have amplified the rise in yields. Futures quotes suggested that the path for the federal funds rate expected by market participants rose over the intermeeting period.

The increase in yields on nominal Treasury coupon securities was accompanied by increases in yields on TIPS. TIPS-based inflation compensation moved up at the 5-year horizon amid rising energy prices, but forward inflation compensation 5 to 10 years ahead was about unchanged. Yields on investment-grade corporate bonds rose about in line with those on comparable-maturity Treasury securities, leaving risk spreads about unchanged; spreads on speculative-grade corporate bonds moved down somewhat. Secondary-market prices for leveraged loans rose slightly over the intermeeting period, while bid-asked spreads in that market continued to drift down.

Some signs of modest stress emerged in certain short-term funding markets over the intermeeting period as investors focused increasingly on the evolving situation in Europe. The spread of the three-month London interbank offered rate (or Libor) forward rate agreement over the three-month forward overnight index swap (OIS) rate moved a bit higher, on balance, perhaps pointing to heightened concerns about future funding conditions. In the commercial paper market, spreads increased on paper issued by financial institutions with parents in peripheral European countries, and the amount outstanding of such paper declined. Spreads on asset-backed commercial paper were somewhat volatile over the intermeeting period. Nonetheless, spreads on nonfinancial commercial paper remained at low levels, as did the spreads of dollar Libor over OIS rates at one- and three-month maturities.

Broad U.S. equity price indexes increased moderately, on net, over the intermeeting period, in part reflecting incoming economic data that were read by investors as suggesting that the recovery could be gaining traction, at least outside the housing sector. Stock prices for domestic commercial banks were volatile but outperformed broad indexes on balance. Option-implied volatility on the S&P 500 index fell modestly, and the spread between the staff’s estimate of the expected real return on equity for S&P 500 firms and the real 10-year Treasury yield–a rough measure of the equity risk premium–narrowed a bit, although it remained elevated relative to longer-run norms.

In the December 2010 Senior Credit Officer Opinion Survey on Dealer Financing Terms, dealers reported an easing of credit terms over the preceding three months with respect to securities financing transactions and across a range of counterparties. Dealers also noted that demand for funding of all types of securities increased over the same reference period.

Net debt financing by U.S. nonfinancial corporations continued to be robust in November. Gross issuance of corporate bonds was very heavy, particularly for speculative-grade firms. Investor demand for syndicated leveraged loans also appeared to have remained high. Nonfinancial commercial paper outstanding declined noticeably during October and November, in part because some firms reportedly shifted to bond financing. Gross public equity issuance by nonfinancial firms through seasoned and initial public offerings was particularly strong in November. Measures of the credit quality of nonfinancial corporations continued to improve.

Conditions in the commercial real estate market remained tight. Commercial mortgage debt was estimated to have declined in the third quarter, and the delinquency rates for securitized commercial mortgages and those for existing properties at commercial banks increased further. However, some modest signs of improvement continued to surface. Prices of commercial real estate changed little, on balance, over September and October, holding in the relatively narrow range that had prevailed since the spring when the steep decline in these prices ended. Issuance of commercial mortgage-backed securities increased in November but was still far below pre-crisis levels.

Residential mortgage rates rose considerably over the intermeeting period, though not by as much as rates on longer-term Treasury securities. The spread between mortgage rates and MBS yields dropped back, reversing the widening of the spread that occurred over the preceding several months. Refinancing activity declined in response to the higher mortgage rates. Outstanding residential mortgage debt was estimated to have contracted in the third quarter at about the average rate of decline seen over the preceding year. Delinquency rates on prime and subprime mortgages ticked down but remained extremely elevated.

In contrast, the consumer credit market exhibited continued signs of stabilization. Although consumer credit contracted in the third quarter, the decline was the smallest since late 2008, and consumer credit edged higher in October. The pace of issuance of consumer asset-backed securities in November was slightly above the average for the year to date, and the delinquency rate on consumer loans at banks declined further in the third quarter.

Commercial bank credit was about flat, on average, during October and November. Banks continued to increase their holdings of securities, while core loans–the sum of commercial and industrial (C&I), real estate, and consumer loans–decreased moderately. The declines were attributable to a drop in consumer loans as well as to continued runoffs in commercial real estate and home equity loans. In contrast, C&I loans edged up, ending a nearly two-year string of monthly declines. In addition, the Survey of Terms of Business Lending conducted in the first week of November showed that interest rates on C&I loans were generally little changed while spreads remained extremely wide.

According to the latest Call Report data, bank profitability was little changed in the third quarter, remaining positive but well below pre-crisis levels. As in the second quarter, banks’ net incomes were supported by declines in loan loss provisioning, while revenues declined. Banks continued to boost regulatory capital ratios, likely, at least in part, in anticipation of the need to eventually meet stricter Basel III standards.

M2 expanded at a moderate rate in November. Interest rates available on all M2 assets remained very low, and households continued to shift their holdings of M2 assets toward liquid deposits, which continued to rise rapidly, and away from small time deposits and retail money market mutual funds. Currency increased strongly, with indicators suggesting robust demand from abroad.

The foreign exchange value of the dollar, which depreciated immediately following the FOMC’s November announcement of further asset purchases, subsequently appreciated amid intensifying concerns about stresses in the euro area and some apparent reassessment by investors of the monetary policy outlook in the United States. On net, the dollar ended the intermeeting period up against most currencies, with particularly large gains against the euro. The announcement of the European Union (EU)-International Monetary Fund (IMF) financial aid package for Ireland on November 28 did little to reverse the depreciation of the euro, as investors reportedly became increasingly concerned about other euro-area economies and the adequacy of resources available to support them should they come under stress. Spreads of sovereign yields in some peripheral euro-area countries over those on German bunds rose to new highs, although they fell back near the end of the intermeeting period amid reports that the European Central Bank (ECB) had increased its purchases of Irish and Portuguese sovereign debt. Banks in the euro-area periphery continued to rely heavily on funding from the ECB, and some signs of increased dollar funding pressures emerged. Implied short-term interest rates for the coming year shifted down in the euro area, as market participants apparently scaled back the pace at which they expected the ECB to normalize policy, but rose in some other AFEs. Ten-year sovereign yields increased significantly throughout the AFEs, although by less than yields in the United States. Headline stock price indexes in the AFEs generally ended the period higher, whereas bank stocks in Europe declined.

The People’s Bank of China raised the required reserve ratio for banks a cumulative 150 basis points over the intermeeting period, and other central banks in emerging Asia increased policy rates. China’s Shanghai Composite Index fell in the wake of Chinese policy actions, while other emerging market stock indexes were mixed over the period. In Latin America, Brazil’s central bank also raised reserve requirements late in the period. The dollar appreciated slightly, on average, against the emerging market currencies, although it edged down against the Chinese renminbi.

Staff Economic Outlook
With the recent data on production and spending stronger, on balance, than the staff anticipated at the time of the November FOMC meeting, the staff revised up its projected increase in real GDP in the near term. However, the staff’s outlook for real economic activity over the medium term was little changed, on net, relative to the projection prepared for the November meeting. The staff forecast incorporated the assumption that new fiscal actions, some of which had not been anticipated in its previous forecast, were likely to boost the level of real GDP in 2011 and 2012. But, compared with the November forecast, a number of other conditioning assumptions were less favorable: House prices and housing activity were likely to be lower, while interest rates, oil prices, and the foreign exchange value of the dollar were projected to be higher, on average, than previously assumed. As a result, although the staff projection showed a higher level of real GDP, the average pace of growth over 2011 and 2012 was little changed from the November forecast, and the unemployment rate was still projected to decline slowly.

The underlying rate of consumer price inflation in recent months was lower than the staff expected at the time of the November meeting, and the staff forecast anticipated that core PCE prices would rise a bit more slowly in 2011 and 2012 than previously projected. As in earlier forecasts, the persistent wide margin of economic slack in the projection was expected to sustain downward pressure on inflation, but the ongoing stability in inflation expectations was anticipated to stem further disinflation. The staff anticipated that relatively rapid increases in energy prices would raise total consumer price inflation above the core rate in the near term, but that this upward pressure would dissipate by 2012.

Participants’ Views on Current Conditions and the Economic Outlook
In their discussion of the economic situation and outlook, meeting participants saw the information received during the intermeeting period as pointing to some improvement in the near-term outlook, and they expected that economic growth, which had been moderate, would pick up somewhat going forward. Indicators of production and household spending had strengthened, and the tone of the labor market was a little better on balance. The new fiscal package was generally expected to support the pace of recovery next year. However, a number of factors were seen as likely to continue restraining growth, including the depressed housing market, employers’ continued reluctance to add to payrolls, and ongoing efforts by some households and businesses to delever. Moreover, the recovery remained subject to some downside risks, such as the possibility of a more extended period of weak activity and lower prices in the housing sector and potential financial and economic spillovers if the banking and sovereign debt problems in Europe were to worsen. In light of recent readings on consumer inflation, participants noted that underlying inflation had continued trending downward, but several saw the risk of deflation as having receded somewhat.

In the household sector, incoming data on retail sales were somewhat stronger than expected, and there were some reasonably upbeat reports from business contacts regarding holiday spending. Consumer confidence appeared to be improving. Financial obligations and debt service costs had been declining as a share of household income, and that process was seen as providing greater latitude for a pickup in discretionary purchases. Nonetheless, there were indications that retail spending by middle- and lower-income households had risen less than spending by high-income households, suggestive of ongoing financial pressures on those of more modest means. Furthermore, the housing sector, including residential construction and home sales, continued to be depressed. Some participants noted that the elevated supply of available homes and the overhang of foreclosed homes were contributing to a further decline in house prices. The lower house prices, in turn, were seen as reducing household wealth and thus restraining growth in consumer spending.

A number of participants noted that their business contacts had become more optimistic about the outlook for sales and production. Nonetheless, many contacts remained cautious about hiring and investment, with some reportedly concerned about the potential effects of government policies. The manufacturing, agriculture, and energy sectors showed particular signs of strength, and the high-tech sector appeared to be improving. However, nonresidential construction remained very weak, apart from drilling and mining. It was noted that credit conditions had eased further, although nonfinancial corporations continued to hold very high levels of cash.

Conditions in the labor market appeared to be improving on balance. That improvement was reflected in a range of recent indicators, including a declining number of new jobless claims, an increase in job openings, and an uptick in the average workweek. Nonetheless, participants noted that the pace of hiring was still sluggish; indeed, the unemployment rate had edged higher in November, and the employment-population ratio remained very low.

Interest rates at intermediate and longer maturities rose substantially over the intermeeting period, while credit spreads were roughly unchanged and equity prices rose moderately. Participants pointed to a number of factors that appeared to have contributed to the significant backup in yields, including an apparent downward reassessment by investors of the likely ultimate size of the Federal Reserve’s asset-purchase program, economic data that were seen as suggesting an improved economic outlook, and the announcement of a package of fiscal measures that was expected to bolster economic growth and increase the deficit over coming quarters. It was noted that the backup in rates may have been amplified by year-end positioning, as well as by some reported mortgage-related hedging flows. A number of participants indicated that, because the backup in rates appeared to importantly reflect changes in investors’ expectations about the size of Federal Reserve asset purchases, the backup was consistent with purchases helping to keep longer-term yields lower than would otherwise be the case. Several meeting participants mentioned the communications challenges faced in conducting effective policy, including the need to clearly convey the Committee’s views while appropriately airing individual perspectives.  

Measures of underlying inflation continued to trend downward over the intermeeting period, with the slowdown in price increases evident across categories of goods and services and across different inflation measures. Although the prices of some commodities and imported goods had risen appreciably, several participants noted that businesses seemed to have little ability to pass these increases on to their customers, given the significant slack in the economy. Also, the high level of unemployment was limiting gains in wages and thereby contributing to the low level of inflation. TIPS-based measures of inflation compensation had risen modestly over the intermeeting period, while surveys of households and professional forecasters continued to suggest that longer-term inflation expectations remained stable.

Regarding their overall outlook for economic activity, participants generally agreed that, even with the positive news received over the intermeeting period, the most likely outcome was a gradual pickup in growth with slow progress toward maximum employment. However, they held a range of views about the risks to that outlook. A few mentioned the possibility that growth could pick up more rapidly than expected, particularly in light of the very accommodative stance of monetary policy currently in place. It was noted that such an acceleration would likely be accompanied by significantly more rapid growth in bank lending and in the monetary aggregates, suggesting that such indicators might prove to be useful sources of information. Others pointed to downside risks to growth. One common concern was that the housing sector could weaken further in light of the considerable supply of houses either on the market or likely to come to market. Another concern was the ongoing deterioration in the fiscal position of U.S. states and localities, which could lead to sharp cuts in spending and increases in taxes. In addition, participants expressed concerns about a possible worsening of the banking and financial strains in Europe, which could spill over to U.S. financial markets and institutions, and so to the broader U.S. economy. They observed that market stresses in Europe intensified during the intermeeting period, requiring an assistance package for Ireland from the EU and the IMF, and that after that package was announced, market attention appeared to shift to other European countries. Participants noted, however, that the European authorities were taking steps to stabilize conditions in the euro area.

Regarding the outlook for inflation, participants generally anticipated that inflation would remain for some time below levels judged to be most consistent, over the longer run, with maximum employment and price stability. In particular, most participants expected that underlying measures of inflation would bottom out around current levels and then move gradually higher as the recovery progresses. A few participants pointed to the risk that the ongoing expansion of the Federal Reserve’s balance sheet and the sustained low level of short-term interest rates could trigger undesirable increases in inflation expectations and so in actual inflation. To minimize such risks, it was noted that the Committee should continue its planning for the eventual exit from the current exceptionally accommodative stance of policy. Other participants noted that, with substantial resource slack persisting, underlying inflation might fall further below the levels that the Committee sees as consistent with its mandate. Nonetheless, several participants saw the risk of deflation as having receded somewhat over recent months.

Committee Policy Action 
Members noted that, while incoming information over the intermeeting period had increased their confidence in the economic recovery, progress toward the Committee’s dual objectives of maximum employment and price stability was disappointingly slow. In addition, members generally expected that progress was likely to remain modest, with unemployment and inflation deviating from the Committee’s objectives for some time. Accordingly, in their discussion of monetary policy for the period immediately ahead, nearly all Committee members agreed to continue expanding the Federal Reserve’s holdings of longer-term securities as announced in November in order to promote a stronger pace of economic recovery and to help ensure that inflation, over time, is at levels consistent with the Committee’s mandate. The Committee decided to maintain its existing policy of reinvesting principal payments from its securities holdings into longer-term Treasury securities. In addition, the Committee agreed to continue buying longer-term Treasury securities with the intention of purchasing $600 billion of such securities by the end of the second quarter of 2011, a pace of about $75 billion per month. While the economic outlook was seen as improving, members generally felt that the change in the outlook was not sufficient to warrant any adjustments to the asset-purchase program, and some noted that more time was needed to accumulate information on the economy before considering any adjustment. Members emphasized that the pace and overall size of the purchase program would be contingent on economic and financial developments; however, some indicated that they had a fairly high threshold for making changes to the program. The Committee also decided to maintain the target range for the federal funds rate at 0 to 1/4 percent and to reiterate its expectation that economic conditions are likely to warrant exceptionally low levels for the federal funds rate for an extended period. One member dissented from the Committee’s policy decision, judging that, in light of the improving economy, a continued high level of monetary accommodation would increase the risks of future economic and financial imbalances. Members agreed that the Committee should continue to regularly review the pace of its securities purchases and the overall size of the program in light of incoming information–including information on the economic outlook, the efficacy of the program, and any unintended consequences that might arise–and make adjustments as needed to best foster maximum employment and price stability. With respect to the statement to be released following the meeting, members agreed that only small changes were necessary to reflect the modest improvement in the near-term economic outlook.

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 1/4 percent. The Committee directs the Desk to execute purchases of longer-term Treasury securities in order to increase the total face value of domestic securities held in the System Open Market Account to approximately $2.6 trillion by the end of June 2011. The Committee also directs the Desk to reinvest principal payments from agency debt and agency mortgage-backed securities in longer-term Treasury securities. 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 November confirms that the economic recovery is continuing, though at a rate that has been insufficient to bring down unemployment. Household spending is increasing at a moderate pace, but remains constrained by high unemployment, modest income growth, lower housing wealth, and tight credit. Business spending on equipment and software is rising, though less rapidly than earlier in the year, while investment in nonresidential structures continues to be weak. Employers remain reluctant to add to payrolls. The housing sector continues to be depressed. Longer-term inflation expectations have remained stable, but measures of underlying inflation have continued to trend downward.

Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. Currently, the unemployment rate is elevated, and measures of underlying inflation are somewhat low, relative to levels that the Committee judges to be consistent, over the longer run, with its dual mandate. Although the Committee anticipates a gradual return to higher levels of resource utilization in a context of price stability, progress toward its objectives has been disappointingly slow.

To promote a stronger pace of economic recovery and to help ensure that inflation, over time, is at levels consistent with its mandate, the Committee decided today to continue expanding its holdings of securities as announced in November. The Committee will maintain its existing policy of reinvesting principal payments from its securities holdings. In addition, the Committee intends to purchase $600 billion of longer-term Treasury securities by the end of the second quarter of 2011, a pace of about $75 billion per month. The Committee will regularly review the pace of its securities purchases and the overall size of the asset-purchase program in light of incoming information and will adjust the program as needed to best foster maximum employment and price stability.

The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels for the federal funds rate for an extended period.

The Committee will continue to monitor the economic outlook and financial developments and will employ its policy tools as necessary to support the economic recovery and to help ensure that inflation, over time, is at levels consistent with its mandate.”

Voting for this action: Ben Bernanke, William C. Dudley, James Bullard, Elizabeth Duke, Sandra Pianalto, Sarah Bloom Raskin, Eric Rosengren, Daniel K. Tarullo, Kevin Warsh, and Janet L. Yellen.

Voting against this action: Thomas M. Hoenig.

Mr. Hoenig dissented because he judged that economic conditions were improving, and that the current highly accommodative stance of monetary policy was inconsistent with the Committee’s long-run mandate. Mr. Hoenig noted that the economic recovery was shifting from transitory to more sustainable sources of growth and was picking up momentum. In his assessment, maintaining highly accommodative monetary policy in the current economic environment would increase the risk of future imbalances and, over time, cause an increase in longer-term inflation expectations. Mr. Hoenig also was concerned that the eventual orderly reduction of policy accommodation would become more difficult the longer the first step in that process was delayed. In Mr. Hoenig’s view, the Committee should begin preparing markets for a reduction in policy accommodation. Accordingly, he thought the press statement should indicate that sufficient monetary stimulus was in place to support the recovery.

It was agreed that the next meeting of the Committee would be held on Tuesday-Wednesday, January 25-26, 2011. The meeting adjourned at 12:55 p.m. on December 14, 2010.

Notation Vote
By notation vote completed on November 22, 2010, the Committee unanimously approved the minutes of the FOMC meeting held on November 2-3, 2010.

_____________________________
William B. English
Secretary

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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 10, 2010, at 8:00 a.m.

PRESENT:

Ben Bernanke, Chairman
William C. Dudley, Vice Chairman
James Bullard
Elizabeth Duke
Thomas M. Hoenig
Donald L. Kohn
Sandra Pianalto
Eric Rosengren
Daniel K. Tarullo
Kevin Warsh

Christine Cumming, Charles L. Evans, Richard W. Fisher, Narayana Kocherlakota, and Charles I. Plosser, Alternate Members of the Federal Open Market Committee

Jeffrey M. Lacker, Dennis P. Lockhart, and Janet L. Yellen, Presidents of the Federal Reserve Banks of Richmond, Atlanta, and San Francisco, respectively

William B. English, Secretary and Economist
Matthew M. Luecke, Assistant Secretary
David W. Skidmore, Assistant Secretary
Michelle A. Smith, Assistant Secretary
Thomas C. Baxter, Deputy General Counsel
Richard M. Ashton, Assistant General Counsel
Nathan Sheets, Economist

James A. Clouse, Thomas A. Connors, Steven B. Kamin, Lawrence Slifman, Mark S. Sniderman, and David W. Wilcox, Associate Economists

Brian Sack, Manager, System Open Market Account

Jennifer J. Johnson, Secretary of the Board, Office of the Secretary, Board of Governors

Patrick M. Parkinson, Director, Division of Bank Supervision and Regulation, Board of Governors

Robert deV. Frierson, Deputy Secretary, Office of the Secretary, Board of Governors

Charles S. Struckmeyer, Deputy Staff Director, Office of the Staff Director for Management, Board of Governors

William Nelson, Deputy Director, Division of Monetary Affairs, Board of Governors

Linda Robertson, Assistant to the Board, Office of Board Members, Board of Governors

Seth B. Carpenter, Senior Associate Director, Division of Monetary Affairs, Board of Governors; David Reifschneider and William Wascher, Senior Associate Directors, Division of Research and Statistics, Board of Governors

Stephen A. Meyer, Senior Adviser, Division of Monetary Affairs, Board of Governors; Stephen D. Oliner, Senior Adviser, Division of Research and Statistics, Board of Governors

Brian J. Gross, Special Assistant to the Board, Office of Board Members, Board of Governors

Eric M. Engen, Assistant Director, Division of Research and Statistics, Board of Governors

David H. Small, Project Manager, Division of Monetary Affairs, Board of Governors

John C. Driscoll and Jennifer E. Roush, Senior Economists, Division of Monetary Affairs, Board of Governors

Penelope A. Beattie, Assistant to the Secretary, Office of the Secretary, Board of Governors

Kimberley E. Braun, Records Project Manager, Division of Monetary Affairs, Board of Governors

Randall A. Williams, Records Management Analyst, Division of Monetary Affairs, Board of Governors

David Sapenero, First Vice President, Federal Reserve Bank of St. Louis

Loretta J. Mester and Robert H. Rasche, Executive Vice Presidents, Federal Reserve Banks of Philadelphia and St. Louis, respectively

David Altig, Ron Feldman, Craig S. Hakkio, Glenn D. Rudebusch, Daniel G. Sullivan, and Geoff Tootell, Senior Vice Presidents, Federal Reserve Banks of Atlanta, Minneapolis, Kansas City, San Francisco, Chicago, and Boston, respectively

Linda Goldberg, Vice President, Federal Reserve Bank of New York

Annmarie S. Rowe-Straker, Assistant Vice President, Federal Reserve Bank of New York

Pia Orrenius, Research Officer, Federal Reserve Bank of Dallas

Robert L. Hetzel, Senior Economist, Federal Reserve Bank of Richmond

Developments in Financial Markets and the Federal Reserve’s Balance Sheet
The Manager of the System Open Market Account (SOMA) reported on developments in domestic and foreign financial markets during the period since the Committee met on June 22-23, 2010. He also reported on System open market operations during the intermeeting period, noting that the Desk at the Federal Reserve Bank of New York had engaged in coupon swap transactions in agency mortgage-backed securities (MBS) to substantially reduce the number of the Committee’s earlier agency MBS purchases that remained to be settled. In addition, the Manager briefed the Committee on the System’s progress in developing tools for possible future reserve draining operations. The Federal Reserve successfully conducted two more small-value auctions of term deposits to confirm operational readiness for such auctions at the Federal Reserve and at the depository institutions that chose to participate. The Manager noted that the staff was developing plans for additional small-value tests of the Term Deposit Facility. In early August, the Federal Reserve successfully executed a few small-value term reverse repurchase operations, including the first the Federal Reserve conducted using agency MBS as collateral, to ensure operational readiness for such transactions at the Federal Reserve, the clearing banks, and the primary dealers. There were no open market operations in foreign currencies for the System’s account over the intermeeting period. By unanimous vote, the Committee ratified the Desk’s transactions over the intermeeting period.

The Manager also noted the staff’s projection that, if mortgage rates were to remain near their levels at the time of the meeting, repayments of principal on the agency MBS held in the SOMA likely would reduce the face value of those holdings by roughly $340 billion from August 2010 through the end of 2011. The level of repayments would be expected to increase further if mortgage rates were to decline from those levels. In addition, about $55 billion of agency debt held in the SOMA portfolio would mature over the same time frame.

Staff Review of the Economic Situation
The information reviewed at the August 10 meeting indicated that the pace of the economic recovery slowed in recent months and that inflation remained subdued. In addition, revised data for 2007 through 2009 from the Bureau of Economic Analysis showed that the recent recession was deeper than previously thought, and, as a result, the level of real gross domestic product (GDP) at the end of 2009 was noticeably lower than estimated earlier. Private employment increased slowly in June and July, and industrial production was little changed in June after a large increase in May. Consumer spending continued to rise at a modest rate in June, and business outlays for equipment and software moved up further. However, housing activity dropped back, and nonresidential construction remained weak. Additionally, the trade deficit widened sharply in May. A further decline in energy prices and unchanged prices for core goods and services led to a fall in headline consumer prices in June.

Private nonfarm employment expanded slowly in recent months. The average monthly gain in private payroll employment during the three months ending in July was small, considerably less than the average increase over the preceding three months. However, average weekly hours of all employees continued to recover. The net addition of jobs in manufacturing and related industries, and in nonbusiness services such as health and education, continued to contribute importantly to the net increase in private employment. Employment in construction and financial activities fell further. The unemployment rate moved down in June from its level earlier in the year, and was unchanged in July, as declining civilian employment was accompanied by decreases in labor force participation. Initial claims for unemployment insurance remained at an elevated level over the intermeeting period.

Industrial production was little changed in June after three months of strong increases. The output of utilities was boosted by unseasonably hot weather while manufacturing production declined. The drop in manufacturing output included a reduction in motor vehicle assemblies, but they were scheduled to increase noticeably in July. The June decrease in factory output also reflected weaker production in industries producing non-automotive consumer goods and construction and business supplies. The output of high-technology items and other business equipment continued to rise. Capacity utilization in manufacturing in June stood well above its mid-2009 low, but it was still substantially short of its longer-run average.

Revised data indicated that consumer spending fell more sharply in 2008 and in the first half of 2009, and subsequently recovered more slowly, than previously estimated. Real personal consumption expenditures (PCE) rose gradually during the second quarter. Sales of light motor vehicles continued to move up, on balance, with the level of sales in July slightly higher than the second-quarter average. Real disposable personal income increased at a noticeably stronger pace than spending in recent months, and the personal saving rate moved up further from the upwardly revised level reported in the revisions to the national income and product accounts. Indicators of household net worth–such as stock prices and house prices–were little changed, on net, over the intermeeting period. Consumer confidence fell back in July, with households expressing greater concern about their personal finances and the outlook for the recovery.

The housing market, which had been supported earlier in the year by activity associated with the homebuyer tax credits, was quite soft for a second consecutive month in June. Sales of new single-family homes rebounded some in June after their sharp drop in May, but they remained at a depressed level. Sales of existing homes fell for a second month in June, and the index of pending home sales suggested another decline in July. Starts of new single-family houses, which had dropped steeply in May, edged down in June to the lowest level since the spring of 2009. The low number of new permits issued in June appeared to signal that little improvement in new homebuilding was likely in July. House prices were largely stable, on balance, in recent months. The interest rate on 30-year fixed-rate conforming mortgages fell further during July, reaching a record low for the 39-year history of the series.

Real business spending on equipment and software rose strongly again in the second quarter, with increases widespread across the categories of spending. New orders for nondefense capital goods excluding aircraft remained on a solid uptrend, although their three-month change for the period ending in June was less rapid than earlier in the year. Survey indicators of business conditions and sentiment softened in July but remained consistent with further gains in production and capital spending in the near term. Business investment in nonresidential structures turned up in the second quarter, with spending boosted by the rise in outlays for drilling and mining structures. The decline in spending for other types of nonresidential buildings appeared to be slowing, and there were a few signs that financial conditions in commercial real estate markets, though still difficult, were stabilizing. In the second quarter, businesses appeared to add to inventories at a faster rate. However, ratios of inventories to sales for most industries did not point to any sizable overhangs.

Inflation remained subdued in recent months. Headline consumer prices declined in May and June because of sizable drops in consumer energy prices. At the same time, the core PCE price index moved up only slightly, and the year-over-year increase in the index in June was lower than earlier in the year. In recent months, prices of core consumer goods continued to decline while prices of non-energy services rose moderately. At earlier stages of production, producer prices of core intermediate materials fell back in June; in contrast, most indexes of spot commodity prices moved up during July. Inflation compensation based on Treasury inflation-protected securities moved down further over the intermeeting period, partly in response to softer-than-expected data on economic activity, but survey measures of short- and long-term inflation expectations were largely stable.

Nominal hourly labor compensation–as measured by compensation per hour in the nonfarm business sector and the employment cost index–rose modestly during the year ending in the second quarter. Average hourly earnings of all employees rose slowly over the 12 months ending in July. Output per hour in the nonfarm business sector declined in the second quarter after rising rapidly in the preceding three quarters. On net, unit labor costs remained well below their level one year earlier.

The U.S. international trade deficit widened sharply in May, as a significant increase in exports was more than offset by a surge in imports. The corresponding decline in real net exports made a significant negative contribution to U.S. GDP growth in the second quarter. The increase in exports was broadly based, with particular strength in exports of capital equipment. Imports of capital goods also were strong, as were imports of consumer goods and automotive products. In contrast, imports of petroleum products fell in May, held back by both lower prices and reduced volumes.

Available data suggested that aggregate GDP growth in foreign economies remained strong in the second quarter. Recent indicators of economic activity for the euro area showed little imprint of the fiscal stresses that emerged in the spring. Industrial production continued to grow in May, with particularly solid gains in Germany and France, and purchasing managers indexes and economic sentiment turned up in July. In Japan, exports continued to support economic growth, even as indicators of household spending remained weak. Machinery orders declined in May, however, and industrial production moved down in June, suggesting some deceleration in economic activity. In the emerging market economies (EMEs), incoming data generally pointed to a moderation of economic growth, albeit to a still-solid pace, with a notable slowing in China in the second quarter. In other EMEs, purchasing managers indexes generally still pointed to expansions in manufacturing activity, though industrial production in many countries began to decelerate. In contrast, Mexican indicators suggested that economic activity rebounded in the second quarter after contracting in the first quarter. Headline inflation rates generally declined abroad, reflecting prior declines in oil and other commodity prices.

Staff Review of the Financial Situation
The decision taken by the Federal Open Market Committee (FOMC) at its June meeting to maintain the 0 to 1/4 percent target range for the federal funds rate was about in line with investor expectations and elicited little market reaction; the same was true of the wording of the accompanying statement. Over the intermeeting period, investors appeared to mark down the path for monetary policy in response to weaker-than-expected economic data releases and Federal Reserve communications that were read as suggesting that policymakers’ concerns about the economic outlook had increased.

Reflecting the same factors, yields on nominal Treasury coupon securities fell noticeably on net. Treasury auctions were generally well received, with bid-to-cover ratios mostly exceeding historical averages. Yields on investment- and speculative-grade corporate bonds decreased, and their spreads relative to yields on comparable-maturity Treasury securities declined moderately. Secondary-market bid prices on syndicated leveraged loans rose a bit, while bid-asked spreads in that market edged down.

Conditions in short-term funding markets improved somewhat over the intermeeting period. Spreads of term London interbank offered rates (Libor) over rates on overnight index swaps moved down at most horizons, and liquidity in term funding markets reportedly increased. Spreads on unsecured commercial paper were little changed. In secured funding markets, spreads on asset-backed commercial paper moved down, while rates and haircuts on collateral for repurchase agreements involving Treasury and agency collateral held steady.

Broad U.S. equity price indexes increased slightly, on net, as generally positive corporate earnings news and an easing of investors’ worries about the potential effects of fiscal strains in Europe were partly offset by concerns about the strength of the economic recovery. Most firms in the S&P 500 reported second-quarter earnings that exceeded analysts’ forecasts. Option-implied volatility on the S&P 500 index declined but remained somewhat elevated by historical standards. The spread between the staff’s estimate of the expected real return on equities over the next 10 years and an estimate of the expected real return on a 10-year Treasury note–a rough measure of the equity risk premium–was little changed at an elevated level. Financial stock prices moved about in line with broader indexes, and credit default swap spreads for large financial institutions narrowed moderately.

Gross bond issuance by U.S. investment-grade nonfinancial corporations rebounded in July from relatively subdued levels in May and June. Nonfinancial commercial paper outstanding also increased. Issuance of syndicated leveraged loans rose in the second quarter, but terms on such deals reportedly tightened somewhat. Measures of the credit quality of nonfinancial firms remained solid. Gross equity issuance was moderate in June and July.

Prices of commercial real estate appeared to have increased in the second quarter, though the number of transactions was small. Nonetheless, commercial real estate markets remained under pressure. Delinquency rates for securitized commercial mortgages continued to rise in June, and commercial mortgage debt was estimated to have contracted by a sizable amount again in the second quarter. However, investor demand for high-quality commercial mortgage-backed securities (CMBS) reportedly was robust, although issuance of CMBS remained muted.

Consumer credit contracted again in the second quarter, as revolving credit continued to decline and nonrevolving credit edged down. Issuance of consumer asset-backed securities slowed a bit in July, reflecting, in part, typical seasonal patterns. Consumer credit quality continued to show improvement. Delinquency and charge-off rates for most types of consumer loans moved down in recent months, although these rates remained elevated. Spreads of credit card interest rates over those on Treasury securities stayed elevated in May, while interest rate spreads on auto loans remained near their average level over the past decade.

Commercial banks’ core loans–the sum of commercial and industrial (C&I), real estate, and consumer loans–continued to contract in June and July. However, the recent runoff in core loans was appreciably smaller than the declines posted earlier in the year, reflecting a more modest contraction in C&I loans. The July Senior Loan Officer Opinion Survey on Bank Lending Practices showed, for the second straight quarter, that a small net fraction of respondents had eased standards for C&I loans over the previous three months. Commercial real estate loans continued to decline steeply in June and July, and residential real estate loans also decreased. Consumer loans at commercial banks were about flat, on balance, as reductions in credit card loans about offset an increase in nonrevolving consumer loans. Securities holdings by banks increased substantially in recent weeks.

M2 was little changed in July after expanding slightly in the second quarter. Its subdued growth in recent months likely reflected a continued unwinding of earlier safe-haven flows as well as the very low rates of return on some components of M2, particularly small time deposits and retail money market mutual funds.

In foreign exchange markets, the value of the dollar declined on balance over the intermeeting period, likely reflecting some reversal of flight-to-safety flows, better-than-expected European economic data, and the softer economic outlook for the United States. The release of the results of the European Union stress-test exercise, including data on European banks’ exposures to sovereign debt, appeared to ease concerns about the potential for severe financial dislocations in Europe. Investors also seemed to take comfort from several oversubscribed auctions of government debt by Spain, Portugal, Ireland, and Greece. Accordingly, risk spreads on these governments’ bonds, though elevated, generally declined, and European banks’ access to dollar funding improved somewhat. The lack of any disruption to market functioning following the expiration, on July 1, of the European Central Bank’s first one-year refinancing operation also supported investor sentiment. Market indicators of expectations for future overnight rates in the euro area shifted up during the period. No changes were made to policy interest rates in the euro area, the United Kingdom, or Japan. The Bank of Canada tightened policy a step further during the period, raising its target for the overnight rate 25 basis points to 3/4 percent.

Notwithstanding the improved investor sentiment toward Europe, data releases pointing to lower-than-expected growth in economic activity in the United States and China may have weighed on global sovereign bond yields, which declined on net in Canada, Germany, the United Kingdom, and Japan. Equity prices, while up in Europe over the intermeeting period, were little changed in Canada and down in Japan. By contrast, share prices rose in emerging markets and flows into emerging market equity funds continued to be strong. The central banks of a number of EMEs, including Brazil, Chile, India, Malaysia, South Korea, Taiwan, and Thailand, increased policy interest rates.

Staff Economic Outlook
In the economic forecast prepared for the August FOMC meeting, the staff lowered its projection for the increase in real economic activity during the second half of 2010 but continued to anticipate a moderate strengthening of the expansion in 2011. The softer tone of incoming economic data suggested that the pace of the expansion would be slower over the near term than previously projected. Financial conditions, however, became somewhat more supportive of economic growth. Interest rates on Treasury securities, corporate bonds, and mortgages moved down further over the intermeeting period; the dollar reversed its April to June appreciation; and equity prices edged higher. Over the medium term, the recovery in economic activity was expected to receive support from accommodative monetary policy, further improvement in financial conditions, and greater household and business confidence. Over the forecast period, the increase in real GDP was projected to be sufficient to slowly reduce economic slack, although resource slack was still anticipated to remain quite elevated at the end of 2011.

Overall inflation was projected to remain subdued over the next year and a half. The staff’s forecasts for headline and core inflation in 2010 were revised up slightly in response to the higher prices of oil and other commodities and the depreciation of the dollar. Even so, the wide margin of economic slack was projected to contribute to some slowing in core inflation in 2011, though the extent of that slowing would be tempered by stable inflation expectations.

Participants’ Views on Current Conditions and the Economic Outlook
In their discussion of the economic situation and outlook, meeting participants generally characterized the economic information received during the intermeeting period as indicating a slowing in the pace of recovery in output and employment in recent months. Real GDP growth was noticeably weaker in the second quarter of 2010 than most had anticipated, and monthly data suggested that the pace of recovery remained sluggish going into the third quarter. Private payrolls and consumer spending had risen less than expected. Business spending on equipment and software had increased strongly but reportedly was concentrated in replacements and upgrades that had been postponed during the economic downturn. Investment in nonresidential structures continued to be weak. Housing starts and sales remained at depressed levels, falling back after the expiration of the temporary homebuyer tax credits. The incoming data suggested that economic growth abroad had been somewhat stronger than anticipated and remained solid, boosting U.S. exports and supporting a pickup in U.S. manufacturing output and employment, though a surprising surge in imports in the second quarter widened the U.S. trade deficit. Conditions in financial markets had become somewhat more supportive of growth over the intermeeting period, in part reflecting perceptions of diminished risk of financial dislocations in Europe: Medium- and longer-term interest rates had fallen, some risk spreads had narrowed, and the decline in equity prices that had occurred in the months before the Committee’s June meeting had been partly reversed. Moreover, participants saw some indications that credit conditions for households and smaller businesses were beginning to improve, albeit gradually. Thus, while they saw growth as likely to be more modest in the near term, participants continued to anticipate that growth would pick up in 2011.

Revised national income and product account data showed that the contraction in aggregate output during the recent recession had been larger than previously reported. In particular, consumer spending had contracted more over the course of 2008 and the first half of 2009, and recovered less rapidly, than previously estimated, even as households’ after-tax incomes had increased more than shown by the earlier data. In combination, these revisions indicated that the personal saving rate had been higher and had risen somewhat more during the past three years than previously thought. Participants recognized that the implications of these new data for the outlook were unclear. On the one hand, the revised data might indicate that households have made greater progress in repairing their balance sheets than had been realized, potentially allowing stronger growth in consumer spending as the recovery proceeds. On the other hand, the revised data might signify that households are seeking to raise their net worth more substantially than previously understood, or to build greater precautionary balances in what they perceive to be a more uncertain economic environment, with the result that growth in consumer spending could remain restrained for some time.

Many participants noted that the protracted downturn in house prices and in residential investment seemed to have ended, although ups and downs in housing starts and home sales associated with the temporary tax credit for homebuyers made it difficult to be certain. A few commented that home sales and prices appeared to be edging up in their Districts. While recognizing that the housing sector likely had bottomed out, participants observed that large inventories of vacant and unsold homes, along with continuing foreclosures that would increase the number of houses for sale, likely would continue to damp residential construction, indicating that a sustained upturn from very low levels was not imminent.

Business investment in equipment and software had grown at a robust pace, but growth in new orders for nondefense capital goods, though volatile from month to month, appeared to have stepped down. Many participants noted that capital investment was heavily concentrated in replacement investment and upgrades that firms had postponed during the economic downturn. A number of participants reported that business contacts again indicated that their uncertainty about the fiscal and regulatory environment made them reluctant to expand capacity. Other participants cited business surveys and reports from business contacts indicating that slow growth in sales and uncertainty about the strength and durability of the recovery likely were more important factors. Except in the extractive industries (drilling and mining), investment in nonresidential structures had continued to decline. The near-term outlook for commercial real estate investment remained weak despite a decline in vacancy rates in some markets.

Participants agreed that credit conditions did not appear to be an important restraint on investment spending by larger firms that have access to the capital markets. Such firms were able to borrow readily and at relatively low rates; moreover, many businesses held substantial cash balances. In addition, survey results suggested that a sizable fraction of banks had eased loan terms, and a few had eased lending standards, on C&I loans. Some participants observed that small businesses continued to find credit hard to obtain. However, several participants noted recent survey evidence indicating that most small firms that requested credit were able to borrow, and that relatively few small firms thought that access to credit was their most important problem. Standards for commercial real estate loans and residential mortgages remained very tight, and banks did not appear to be easing standards on such loans. Some limited easing of lending standards was noted for consumer loans, but credit availability remained a constraint and consumer credit continued to contract. However, several participants noted that with credit quality improving, some bankers were more actively seeking loan growth, though the same bankers also indicated that the demand for loans remained weak.

Many participants noted that European countries’ efforts to address their fiscal imbalances, and the release of the results of the stress test of European banks along with information about their exposures to sovereign debt, had reduced investor concern about downside risks in Europe. These factors appeared to have supported improvements in financial markets both here and abroad. Moreover, growth in Europe and Asia apparently remained solid, boosting U.S. exports. Nonetheless, a continuation of strong foreign growth would require a pickup in private demand abroad to offset a decline in policy stimulus and a smaller boost from inventory investment. Several participants noted that the same shift in the sources of demand would need to take place in the United States: Waning fiscal stimulus on the part of the federal government and continuing retrenchment in spending by state and local governments would weigh on the economic recovery, and recent data raised questions as to whether private demand would strengthen enough to increase resource utilization.

The incoming data on the labor market were weaker than meeting participants had anticipated. Private-sector payrolls grew sluggishly in recent months. The unemployment rate declined a bit, but that reflected a decrease in labor force participation rather than an increase in employment. Policymakers discussed a variety of factors that appeared to be contributing to the slow pace of job growth. A number of participants reported that business contacts again indicated that uncertainty about future taxes, regulations, and health-care costs made them reluctant to expand their workforces. Instead, businesses had continued to meet growth in demand for their products largely through productivity gains and by increasing existing employees’ hours. Several participants suggested that structural factors such as mismatches between unemployed workers’ skills and the needs of employers with job openings, or unemployed workers’ inability to move to a new locale, were contributing to the elevated level and long average duration of unemployment. Other participants, while agreeing that such factors could restrain job growth and contribute to high rates of unemployment, noted that employment was lower than a year earlier and that job openings were only slightly above their lowest level in 10 years, indicating that few firms saw a need to add employees. Most participants viewed weak demand for firms’ outputs as the primary problem; they saw substantial scope for stronger aggregate demand for goods and services to spur employment in a wide range of industries.

Weighing the available information, participants again expected the recovery to continue and to gather strength in 2011. Nonetheless, most saw the incoming data as indicating that the economy was operating farther below its potential than they had thought, that the pace of recovery had slowed in recent months, and that growth would be more modest during the second half of 2010 than they had anticipated at the time of the Committee’s June meeting. Some policymakers whose forecasts for growth had been in the low end of the range of participants’ earlier projections viewed the recent data as consistent with their earlier forecasts for a weak recovery. A few participants, observing that month-to-month data releases are noisy and subject to revision, did not see the recent data as clearly indicating a change in the outlook. Many policymakers judged that downside risks to the U.S. recovery had become somewhat larger; a few saw the incoming data as suggesting a greater risk that private demand for goods and services might not grow enough to offset waning fiscal stimulus and a smaller impetus from inventory restocking. In contrast, most saw a reduced risk of financial turmoil in Europe and attendant spillovers to U.S. financial markets.

Policymakers generally saw the inflation outlook as little changed. They observed that a range of measures continued to indicate subdued underlying inflation and that growth in wages and compensation remained quite moderate. Many said they expected underlying inflation to stay, for some time, below levels they judged most consistent with the dual mandate to promote maximum employment and price stability. Participants viewed the risk of deflation as quite small, but a number judged that the risk of further disinflation had increased somewhat despite the stability of longer-run inflation expectations. One noted that survey measures of longer-run inflation expectations had remained positive in Japan throughout that country’s bout of deflation. A few saw the continuation of exceptionally accommodative monetary policy in the United States as posing some upside risk to inflation expectations and actual inflation in the medium run.

Committee Policy Action
In their discussion of monetary policy for the period ahead, Committee members agreed that it would be appropriate to maintain the target range of 0 to 1/4 percent for the federal funds rate. Members still saw the economic expansion continuing, and most believed that inflation was likely to stabilize near recent low readings in coming quarters and then gradually rise toward levels they consider more consistent with the Committee’s dual mandate for maximum employment and price stability. Nonetheless, members generally judged that the economic outlook had softened somewhat more than they had anticipated, particularly for the near term, and some saw increased downside risks to the outlook for both growth and inflation. Some members expressed a concern that in this context any further adverse shocks could have disproportionate effects, resulting in a significant slowing in growth going forward. While no member saw an appreciable risk of deflation, some judged that the risk of further near-term disinflation had increased somewhat. More broadly, members generally saw both employment and inflation as likely to fall short of levels consistent with the dual mandate for longer than had been anticipated.

Against this backdrop, the Committee discussed the implications for financial conditions and the economic outlook of continuing its policy of not reinvesting principal repayments received on MBS or maturing agency debt. The decline in mortgage rates since spring was generating increased mortgage refinancing activity that would accelerate repayments of principal on MBS held in the SOMA. Private investors would have to hold more longer-term securities as the Federal Reserve’s holdings ran off, making longer-term interest rates somewhat higher than they would be otherwise. Most members thought that the resulting tightening of financial conditions would be inappropriate, given the economic outlook. However, members noted that the magnitude of the tightening was uncertain, and a few thought that the economic effects of reinvesting principal from agency debt and MBS likely would be quite small. Most members judged, in light of current conditions in the MBS market and the Committee’s desire to normalize the composition of the Federal Reserve’s portfolio, that it would be better to reinvest in longer-term Treasury securities than in MBS. While reinvesting in Treasury securities was seen as preferable given current market conditions, reinvesting in MBS might become desirable if conditions were to change. A few members worried that reinvesting principal from agency debt and MBS in Treasury securities could send an inappropriate signal to investors about the Committee’s readiness to resume large-scale asset purchases. Another member argued that reinvesting repayments of principal from agency debt and MBS, thereby postponing a reduction in the size of the Federal Reserve’s balance sheet, was likely to complicate the eventual exit from the period of exceptionally accommodative monetary policy and could have adverse macroeconomic consequences in future years.

All but one member concluded that it would be appropriate to begin reinvesting principal received from agency debt and MBS held in the SOMA by purchasing longer-term Treasury securities in order to keep constant the face value of securities held in the SOMA and thus avoid the upward pressure on longer-term interest rates that might result if those holdings were allowed to decline. Several members emphasized that in addition to continuing to develop and test instruments to facilitate an eventual exit from the period of unusually accommodative monetary policy, the Committee would need to consider steps it could take to provide additional policy stimulus if the outlook were to weaken appreciably further. Given the softer tone of recent data and the more modest near-term outlook, members agreed that some changes to the statement’s characterization of the economic and financial situation were necessary. All members but one judged that it was appropriate to reiterate the expectation that economic conditions–including low levels of resource utilization, subdued inflation trends, and stable inflation expectations–were likely to warrant exceptionally low levels of the federal funds rate for an extended period. One member argued that the recovery was proceeding about as outlined earlier this year and that starting a gradual process of removing policy accommodation fairly soon would better foster the Committee’s long-run objectives of maximum employment and price stability.

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 1/4 percent. The Committee directs the Desk to maintain the total face value of domestic securities held in the System Open Market Account at approximately $2 trillion by reinvesting principal payments from agency debt and agency mortgage-backed securities in longer-term Treasury securities. The Committee directs the Desk to engage in dollar roll and coupon swap transactions as necessary to facilitate settlement of the Federal Reserve’s agency MBS transactions. 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 indicates that the pace of recovery in output and employment has slowed in recent months. Household spending is increasing gradually, but remains constrained by high unemployment, modest income growth, lower housing wealth, and tight credit. Business spending on equipment and software is rising; however, investment in nonresidential structures continues to be weak and employers remain reluctant to add to payrolls. Housing starts remain at a depressed level. Bank lending has continued to contract. Nonetheless, the Committee anticipates a gradual return to higher levels of resource utilization in a context of price stability, although the pace of economic recovery is likely to be more modest in the near term than had been anticipated.

Measures of underlying inflation have trended lower in recent quarters and, with substantial resource slack continuing to restrain cost pressures and longer-term inflation expectations stable, inflation is likely to be subdued for some time.

The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels of the federal funds rate for an extended period.

To help support the economic recovery in a context of price stability, the Committee will keep constant the Federal Reserve’s holdings of securities at their current level by reinvesting principal payments from agency debt and agency mortgage-backed securities in longer-term Treasury securities.¹ The Committee will continue to roll over the Federal Reserve’s holdings of Treasury securities as they mature.

The Committee will continue to monitor the economic outlook and financial developments and will employ its policy tools as necessary to promote economic recovery and price stability.

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, April 27, 2010, at 2:00 p.m. and continued on Wednesday, April 28, 2010, at 9:00 a.m.

PRESENT:
Ben Bernanke, Chairman
William C. Dudley, Vice Chairman
James Bullard
Elizabeth Duke
Thomas M. Hoenig
Donald L. Kohn
Sandra Pianalto
Eric Rosengren
Daniel K. Tarullo
Kevin Warsh

Christine Cumming, Charles L. Evans, Narayana Kocherlakota, and Charles I. Plosser, Alternate Members of the Federal Open Market Committee

Jeffrey M. Lacker, Dennis P. Lockhart, and Janet L. Yellen, Presidents of the Federal Reserve Banks of Richmond, Atlanta, and San Francisco, respectively

Helen E. Holcomb, First Vice President, Federal Reserve Bank of Dallas

Brian F. Madigan, Secretary and Economist
Matthew M. Luecke, Assistant Secretary
David W. Skidmore, Assistant Secretary
Michelle A. Smith, Assistant Secretary
Scott G. Alvarez, General Counsel
Thomas C. Baxter, Deputy General Counsel
Nathan Sheets, Economist
David J. Stockton, Economist

Alan D. Barkema, Thomas A. Connors, William B. English, Jeff Fuhrer, Steven B. Kamin, Simon Potter, Lawrence Slifman, Mark S. Sniderman, Christopher J. Waller, and David W. Wilcox, Associate Economists

Brian Sack, Manager, System Open Market Account

Jennifer J. Johnson, Secretary of the Board, Office of the Secretary, Board of Governors

Patrick M. Parkinson, Director, Division of Bank Supervision and Regulation, Board of Governors

Robert deV. Frierson,¹ Deputy Secretary, Office of the Secretary, Board of Governors

Charles S. Struckmeyer, Deputy Staff Director, Office of the Staff Director for Management, Board of Governors

James A. Clouse, Deputy Director, Division of Monetary Affairs, Board of Governors

Linda Robertson, Assistant to the Board, Office of Board Members, Board of Governors

William Nelson, Senior Associate Director, Division of Monetary Affairs, Board of Governors; Nellie Liang, David Reifschneider, and William Wascher, Senior Associate Directors, Division of Research and Statistics, Board of Governors

Seth B. Carpenter, Associate Director, Division of Monetary Affairs, Board of Governors

Christopher J. Erceg, Deputy Associate Director, Division of International Finance, Board of Governors; Egon Zakrajsek, Deputy Associate Director, Division of Monetary Affairs, Board of Governors

Brian J. Gross, Special Assistant to the Board, Office of Board Members, Board of Governors

David H. Small, Project Manager, Division of Monetary Affairs, Board of Governors

Jennifer E. Roush, Senior Economist, Division of Monetary Affairs, Board of Governors

Kurt F. Lewis, Economist, Division of Monetary Affairs, Board of Governors

Penelope A. Beattie, Assistant to the Secretary, Office of the Secretary, Board of Governors

Kimberley E. Braun, Records Project Manager, Division of Monetary Affairs, Board of Governors

Randall A. Williams, Records Management Analyst, Division of Monetary Affairs, Board of Governors

Esther L. George, First Vice President, Federal Reserve Bank of Kansas City

Loretta J. Mester, Harvey Rosenblum, and John C. Williams, Executive Vice Presidents, Federal Reserve Banks of Philadelphia, Dallas, and San Francisco, respectively

David Altig, Richard P. Dzina, Daniel G. Sullivan, and John A. Weinberg, Senior Vice Presidents, Federal Reserve Banks of Atlanta, New York, Chicago, and Richmond, respectively

Warren Weber, Senior Research Officer, Federal Reserve Bank of Minneapolis

Developments in Financial Markets and the Federal Reserve’s Balance Sheet
The Manager of the System Open Market Account (SOMA) reported on developments in domestic and foreign financial markets during the period since the Committee met on March 16, 2010. The Manager also reported on System open market operations in Treasury securities and in agency debt and agency mortgage-backed securities (MBS) during the intermeeting period. By unanimous vote, the Committee ratified those transactions. There were no open market operations in foreign currencies for the System’s account over the intermeeting period.

By unanimous vote, the Committee decided to extend the reciprocal currency (“swap”) arrangements with the Bank of Canada and the Banco de Mexico for an additional year, beginning in mid-December 2010; these arrangements are associated with the Federal Reserve’s participation in the North American Framework Agreement of 1994. The arrangement with the Bank of Canada is in the amount of $2 billion equivalent, and the arrangement with the Banco de Mexico is in the amount of $3 billion equivalent. The vote to renew the System’s participation in these swap arrangements was taken at this meeting because of a provision in the arrangements that requires each party to provide six months’ prior notice of an intention to terminate its participation.

The staff also briefed the Committee on recent progress in the development of reserve draining tools. The Desk was preparing to conduct small-scale reverse repurchase operations to ensure its ability to use agency MBS collateral. It also continued to work toward expansion of the set of counterparties for reverse repurchase operations. The staff noted that the Board had recently approved changes to Regulation D that would be necessary for the establishment of a term deposit facility.

The staff next gave a presentation on potential longer-run strategies for managing the SOMA. At previous meetings, Committee participants had expressed support for steps to reduce the size of the Federal Reserve’s balance sheet over time and return the composition of the SOMA to only Treasury securities. The staff discussed the potential portfolio paths and macroeconomic consequences of a number of different strategies for accomplishing these objectives. To date, the Desk had been reinvesting the proceeds of all maturing Treasury securities in newly issued Treasury securities, but it had not been reinvesting principal and interest payments on maturing agency debt and agency MBS, nor had it been selling securities. One strategy considered in the staff presentation was a continuation of the current practice, which would normalize the balance sheet very gradually. In addition, the staff presented information on a number of other strategies that included sales of SOMA holdings of agency debt and MBS and under which the proceeds of maturing Treasury securities would not be reinvested; these strategies differed by the date and circumstances under which sales would be initiated, by the average pace of sales, and by the degree to which the timing and pace of such sales would be adjusted in response to financial and economic developments.

Meeting participants agreed broadly on key objectives of a longer-run strategy for asset sales and redemptions. The strategy should be consistent with the achievement of the Committee’s objectives of maximum employment and price stability. In addition, the strategy should normalize the size and composition of the balance sheet over time. Reducing the size of the balance sheet would decrease the associated reserve balances to amounts consistent with more normal operations of money markets and monetary policy. Returning the portfolio to its historical composition of essentially all Treasury securities would minimize the extent to which the Federal Reserve portfolio might be affecting the allocation of credit among private borrowers and sectors of the economy.

Most participants expressed a preference for strategies that would eventually entail sales of agency debt and MBS in order to return the size and composition of the Federal Reserve’s balance sheet to a more normal configuration more quickly than would be accomplished by simply letting MBS and agency securities run off. They agreed that sales of agency debt and MBS should be implemented in accordance with a framework communicated in advance and be conducted at a gradual pace that potentially could be adjusted in response to changes in economic and financial conditions.

Participants expressed a range of views on some of the details of a strategy for asset sales. Most participants favored deferring asset sales for some time. A majority preferred beginning asset sales some time after the first increase in the Federal Open Market Committee’s (FOMC) target for short-term interest rates. Such an approach would postpone any asset sales until the economic recovery was well established and would maintain short-term interest rates as the Committee’s key monetary policy tool. Other participants favored a strategy in which the Committee would soon announce a general schedule for future asset sales, with a date for the initiation of sales that would not necessarily be linked to the increase in the Committee’s interest rate target. A few preferred to begin sales relatively soon. Earlier sales would normalize the size and composition of the balance sheet sooner and would unwind at least part of the unconventional policy stimulus put in place during the crisis before conventional policy firming got under way. Some participants saw advantages to varying the FOMC’s holdings of longer-term assets system-atically in response to economic and financial developments. However, others thought that a pre-announced pace of sales that was unlikely to vary much would provide a high degree of certainty about sales, helping to limit disruptions in financial markets.

The views of participants also differed to some extent regarding the appropriate pace of asset sales. Most preferred that the agency debt and MBS held in the portfolio be sold at a gradual pace that would complete the sales about five years after they began. One possibility would be for the pace to be relatively slow initially but to increase over time, allowing markets to adjust gradually. A couple of participants thought faster sales, conducted over about three years, would be appropriate and felt that such a pace would not put undue strain on financial markets. In their view, a relatively brisk pace of sales would reduce the chance that the elevated size of the Federal Reserve’s balance sheet and the associated high level of reserve balances could raise inflation expectations and inflation beyond levels consistent with price stability or could generate excessive growth of credit when the economy and banking system recover more fully.

Participants saw both advantages and disadvantages to not rolling over Treasury securities as they mature. On the one hand, redeeming Treasury securities would contribute to a more expeditious normalization of the size of the balance sheet and the quantity of reserves. On the other hand, such redemptions could put upward pressure on interest rates and would tend to work against the objective of returning the SOMA to an all-Treasuries composition.

No decisions about the Committee’s longer-run strategy for asset sales and redemptions were made at this meeting. For the time being, participants agreed that the Desk should continue the interim approach of allowing all maturing agency debt and all prepayments of agency MBS to be redeemed without replacement while rolling over all maturing Treasury securities. Participants agreed to give further consideration to their longer-run strategy at a later date.

Staff Review of the Economic Situation
The information reviewed at the April 27-28 meeting suggested that, on balance, the economic recovery was proceeding at a moderate pace and that the deterioration in the labor market was likely coming to an end. Consumer spending continued to post solid gains in the first three months of the year, and business investment in equipment and software appeared to have increased significantly further in the first quarter. In addition, growth of manufacturing output remained brisk, and gains became more broadly based across industries. However, residential construction, while having edged up, was still depressed, construction of nonresidential buildings remained on a steep downward trajectory, and state and local governments continued to retrench. Consumer price inflation remained low.

The labor market showed signs of a nascent recovery in recent months. Private nonfarm payroll employment increased over the first quarter of 2010–the first quarterly increase since the onset of the recession. The average workweek also rose last quarter and data from the household survey pointed to a firming in labor market conditions. The unemployment rate held steady at 9.7 percent throughout the first quarter, and the labor force participation rate increased over the past few months following sharp declines over the second half of last year. The number of new job losers as a percentage of household employment continued to drop, and the fraction of workers on part-time schedules for economic reasons moved down since the end of last year. Nonetheless, finding a job remained very difficult, and the average duration of unemployment spells increased further.

Industrial production continued to expand at a brisk pace during the first quarter. Recent production gains remained broadly based across industries, as both foreign demand and a mild restocking of inventories contributed positively to output growth. Capacity utilization stood significantly above the trough recorded last June but was still well below its long-run average. Light motor vehicle production stepped up in March, and assemblies in the first quarter were above their fourth-quarter average as automakers cautiously began to rebuild dealers’ inventories. Production in high-tech industries increased solidly, and available indicators pointed toward further expansion in this sector in the near term. On balance, indicators of near-term manufacturing activity remained quite positive.

Consumer spending continued to rise at a solid pace through March, with recent gains pronounced for most non-auto goods and food services. Despite signs of improvement recently, the determinants of spending remained subdued. While wages and salaries picked up early this year, real disposable income was flat in February after a slight decline in January; housing wealth was still well below its level prior to the crisis. Furthermore, although banks indicated a somewhat greater willingness to lend to consumers in recent months, terms and standards on consumer loans remained restrictive. Additionally, consumer sentiment dropped back in early April and was little changed, on net, since the beginning of the year.

Starts of new single-family homes edged up, on net, over February and March, but much of this increase likely reflected delayed projects getting under way as weather conditions returned to normal. Home sales strengthened noticeably, as sales of new single-family homes jumped and sales of existing single-family homes rose as well. However, both new home sales and existing home sales were likely boosted, at least in part, by the anticipated expiration of the homebuyer tax credit. Interest rates for conforming 30-year fixed-rate mortgages changed little in recent months and remained at levels that were very low by historical standards.

Real spending on equipment and software continued to rebound in the first quarter. Investment in high-tech equipment and transportation advanced further, and real spending for equipment other than high-tech and transportation appeared to turn up sharply after falling for more than a year, suggesting that the recovery in equipment and software investment became more broadly based. The recovery in equipment and software spending was consistent with the strengthening in many indicators of business activity. In contrast, the nonresidential construction sector continued to contract. Real outlays on structures outside drilling and mining fell steeply last year, and recent data on nominal expenditures through February suggested a further decline in the first quarter. The weakness was widespread across categories and likely reflected elevated vacancy rates, low levels of property prices, and difficulties in obtaining financing for new projects. Real spending on drilling and mining structures picked up strongly over the second half of last year in response to the rebound in oil and natural gas prices.

Available data suggested that the pace of inventory liquidation moderated further in the first quarter after slowing sharply in the fourth quarter of last year. Inventories appeared to approach comfortable levels relative to sales in the aggregate, although inventory positions across industries varied. Months’ supply remained elevated for equipment, materials, and, to a lesser degree, construction supplies. By contrast, inventories of consumer goods, business supplies, and high-tech goods appeared low relative to demand.

Consumer price inflation was low in recent months; both headline and core personal consumption expenditures (PCE) prices were estimated to have risen slightly in March after remaining unchanged in February. On a 12-month change basis, core PCE prices slowed over the year ending in March, with deceleration widespread across categories of expenditures. In contrast, the corresponding change in the headline index moved up noticeably, as energy prices rebounded. Survey measures of long-term inflation expectations were fairly stable in recent months at levels slightly lower than those posted a year ago. Meanwhile, measures of inflation compensation based on Treasury inflation-protected securities (TIPS) edged up slightly. Cost pressures from rising commodity prices showed through to prices at early stages of processing, and the producer price index for core intermediate materials continued to rise rapidly through March. However, measures of labor costs decelerated sharply last year, as compensation per hour in the nonfarm business sector increased only slightly over the four quarters of 2009.

The U.S. international trade deficit widened in February, as a rise in nominal imports outpaced a small increase in exports. Increased exports of industrial supplies, capital goods, and automotive products were partly offset by declines in agricultural goods and consumer goods. The February rise in imports reversed a similarly sized decrease in January. Imports of oil accounted for more than one-third of the January decline, reflecting lower volumes, but they accounted for only about one-tenth of the February increase, as volumes rebounded but prices fell. Imports of capital goods rose as strong computer imports more than offset falling aircraft purchases, and imports of industrial supplies and consumer goods also moved up.

Recent indicators in the advanced foreign economies suggested a continued divergence in the pace of recovery, with a strong performance in Canada, a moderate expansion in Japan, and a more subdued rebound in Europe. Fiscal strains in Greece intensified during the intermeeting period, and in mid-April, euro-area member states announced a plan to provide financing aid to Greece in coordination with the International Monetary Fund. However, at the time of the April FOMC meeting, no official agreement had been reached concerning the scale, composition, and implementation of such an aid package. Economic activity in emerging markets continued to expand robustly in the first quarter. Despite the strength of exports, merchandise trade balances declined for some countries where strong domestic demand caused imports to outpace exports. In China, real gross domestic product (GDP) increased at a higher-than-expected annual rate in the first quarter as the economic recovery remained broad based, with industrial production, investment, and domestic demand continuing to grow briskly. In Latin America, indicators suggested that economic activity in Mexico and Brazil expanded further in the first quarter. Foreign inflation was boosted by increases in the prices of oil and other commodities, but core inflation generally remained subdued.

Staff Review of the Financial Situation
The decision by the FOMC at the March meeting to keep the target range for the federal funds rate unchanged and to retain the “extended period” language in the statement was largely anticipated by market participants. However, some market participants reportedly interpreted the retention of the “extended period” language as pointing to a longer period of low rates than previously expected, and Eurodollar futures rates temporarily declined a bit in response.

On balance over the intermeeting period, the expected path of policy edged down slightly. Yields on 2-year and 10-year nominal Treasury securities posted small mixed changes amid some volatility that reportedly reflected evolving views about the U.S. fiscal outlook, prospects for U.S. economic growth, and the fiscal situation in peripheral European countries. Inflation compensation–the difference between nominal Treasury yields and yields on TIPS–rose some over the period, but survey measures of longer-term inflation expectations were about unchanged.

Overall, conditions in short-term funding markets remained generally stable during the intermeeting period. Spreads between London interbank offered rates (Libor) and overnight index swap (OIS) rates were about unchanged at levels near those that prevailed in late 2007, although they began to edge up in the final days of the intermeeting period. Spreads in the commercial paper market were little changed. Equity indexes rose, on balance, over the intermeeting period, with bank shares outperforming the broader market. Stock prices were supported by somewhat better-than-expected macroeconomic data and a favorable response by investors to the initial batch of first-quarter earnings reports, especially those of banking institutions. Option-implied volatility on the S&P 500 index generally declined over the period but jumped at end of April on renewed concerns regarding the fiscal situation in Greece. The gap between the staff’s estimate of the expected real equity return over the next 10 years for S&P 500 firms and the real 10-year Treasury yield–a rough measure of the equity risk premium–remained well above its average over the past decade. Yields on investment-grade corporate bonds edged down, leaving their spreads to comparable-maturity Treasury securities a bit lower, at levels around those that prevailed in late 2007. Consistent with more-favorable investor sentiment toward risky assets, yields and spreads on speculative-grade corporate bonds declined, and secondary market prices of syndicated leveraged loans rose further.

Overall, net debt financing by nonfinancial firms was positive in March. Issuance of nonfinancial bonds surged, and net issuance of commercial paper rebounded appreciably. Net equity issuance by nonfinancial firms was negative again in the first quarter as the solid pace of gross public issuance was more than offset by equity retirements from both cash-financed mergers and share repurchases. Financial firms issued a significant volume of debt securities in the first quarter and also raised a moderate amount of gross funds in the equity market, a pattern that appeared to continue in the first half of April. Credit quality in the commercial real estate sector continued to deteriorate as the delinquency rate for securitized commercial mortgages increased again in March. The decline in outstanding commercial mortgage debt in the fourth quarter of last year was the largest on record. Nonetheless, indexes of prices for credit default swaps on commercial mortgage-backed securities ticked up noticeably over the period, in line with the overall reduction in financial market risk premiums.

The conclusion of purchases under the Federal Reserve’s agency MBS program had only a modest market effect. Over the intermeeting period, spreads on agency MBS retraced much of the increase seen around the time of the program’s conclusion, ending the period roughly unchanged. The factors contributing to the recent narrowing of MBS and mortgage spreads included the low level of mortgage originations, which damped the supply of new MBS, and Fannie Mae’s and Freddie Mac’s increased purchases of mortgages through their buyouts of delinquent loans. Consumer credit continued to trend lower in recent months, pushed down by a steep decline in revolving credit. Spreads on high-quality credit card and auto loan asset-backed securities (ABS) edged down over the period, with little upward pressure evident from the end of the portion of the Term Asset-Backed Securities Loan Facility supporting ABS. Nonetheless, fewer ABS were issued in the first quarter than in the fourth quarter, reflecting continued weakness in loan originations. Delinquency rates on consumer loans edged down further in February but remained very elevated. Spreads of interest rates on credit cards over yields on two-year Treasury securities continued to drift upward, while interest rates on new auto loans at dealerships and their spreads over yields on five-year Treasury securities extended their previous decline.

After adjusting to remove the effects of banks’ adoption of Financial Accounting Standards 166 and 167, bank credit contracted again in March, as both loans and securities holdings declined.² The contraction in commercial and industrial loans remained pronounced. The drop in commercial real estate loans persisted, reflecting weak fundamentals that limited originations as well as charge-offs of existing loans. Residential real estate loans also decreased further in March, as did credit card loans and other consumer loans.

M2 fell in March, reflecting a slowing in the expansion of liquid deposits along with a further contraction in small time deposits and a steep runoff in retail money market mutual funds. Currency grew at a moderate pace, likely as a result of continued demand for U.S. banknotes from abroad coupled with solid domestic demand. The monetary base contracted as the effect on reserves of purchases under the Federal Reserve’s large-scale asset purchase programs was more than offset by a further contraction in credit outstanding under liquidity and credit facilities and an increase in the Treasury’s balances at the Federal Reserve.

Until the intensification of the Greek crisis near the end of the intermeeting period, equity indexes were higher in nearly all countries, and emerging-market risk spreads had generally declined. These moves appeared to reflect growing confidence that the global recovery was gaining momentum, particularly in emerging market economies. However, sovereign debt spreads in Greece, Portugal, and other peripheral European countries widened in the days leading up to the April FOMC meeting, as investor anxiety about the fiscal situation in those countries increased. Downgrades to the credit ratings of Greece and Portugal weighed on investor sentiment, and global markets retraced some of their earlier gains.

Over the intermeeting period, the Bank of Japan doubled the size of its three-month fixed-rate funds facility, the Bank of Canada dropped its conditional commitment to keeping rates steady through the first half of the year, and the Reserve Bank of Australia raised its policy rate. The trade-weighted value of the dollar changed little, on net; gains against the euro and yen were offset by declines against many emerging market currencies.

Staff Economic Outlook
The economic forecast prepared by the staff for the April FOMC meeting was similar to that developed for the March meeting. The staff continued to project that the accommodative stance of monetary policy, together with a further attenuation of financial stress, the waning of adverse effects of earlier declines in wealth, and improving household and business confidence, would support a moderate recovery in economic activity and a gradual decline in the unemployment rate over the next two years. The staff forecast for both real GDP growth and the unemployment rate through the end of 2011 was roughly in line with previous projections.

Recent data on core consumer prices led the staff to mark down slightly its forecast for core PCE inflation. The staff continued to anticipate that downward pressure on inflation from the substantial amount of projected resource slack would be tempered by stable inflation expectations. With energy price increases expected to slow next year, total PCE inflation was seen as likely to fall back in line with core inflation by the end of 2011, as in previous projections.

Participants’ Views on Current Conditions and the Economic Outlook
In conjunction with this FOMC meeting, all meeting participants–the five members of the Board of Governors and the presidents of the 12 Federal Reserve Banks–provided projections of economic growth, the unemployment rate, and consumer price inflation for each year from 2010 through 2012 and over a longer horizon. Longer-run projections represent each participant’s assessment of the rate to which each variable would be expected to converge over time under appropriate monetary policy and in the absence of further shocks. Participants’ forecasts through 2012 and over the longer run are described in the Summary of Economic Projections, which is attached as an addendum to these minutes.

In their discussion of the economic situation and outlook, meeting participants agreed that the incoming data and information received from business contacts indicated that economic activity continued to strengthen and the labor market was beginning to improve. Although some of the recent data on economic activity had been better than anticipated, most participants saw the incoming information as broadly in line with their earlier projections for moderate growth; accordingly, their views on the economic outlook had not changed appreciably. Participants expected the economic recovery to continue, but, consistent with experience following previous financial crises, most anticipated that the pickup in output would be rather slow relative to past recoveries from deep recessions. A moderate pace of expansion, in turn, would imply only a modest improvement in the labor market this year, with the unemployment rate declining gradually. Most participants again projected that the economy would grow somewhat faster in 2011 and 2012, generating a more pronounced decline in the unemployment rate. In light of stable longer-term inflation expectations and the likely continuation of substantial resource slack, policymakers anticipated that both overall and core inflation would remain subdued through 2012, with measured inflation somewhat below rates that policymakers considered to be consistent over the longer run with the Federal Reserve’s dual mandate.

Participants expected that economic growth would continue: Recent data pointed to significant gains in retail sales, business spending on equipment and software had picked up substantially, and reports from business contacts and regional surveys indicated that production was increasing briskly in many sectors. Participants agreed that the growth in real GDP appeared to reflect a strengthening of private final demand and not just fiscal stimulus and a slower pace of inventory decumulation; this welcome development lessened policymakers’ concerns about the economy’s ability to maintain a self-sustaining recovery without government support. Businesses appeared to be gaining confidence in the economic recovery, and narrowing credit spreads in private debt markets were allowing low policy rates to be reflected more fully in the cost of capital. At the same time, rising stock prices and the apparent stabilization of house prices were helping to repair household balance sheets. As a result, consumers and firms were beginning to satisfy demands for durable goods and capital equipment that had been postponed during the economic downturn. Many participants noted that employment had increased in recent months, and that they expected a further firming of labor market conditions going forward. A stronger labor market could continue to boost consumer and business confidence and so contribute to further gains in spending.

Although these developments were positive, participants noted several factors that likely would continue to restrain expansion in economic activity and posed some downside risks. The recent increase in consumer spending appeared to be supported importantly by pent-up demands and possibly by other temporary factors, such as unusually large income tax refunds. With the personal saving rate having dropped back to a relatively low level, it seemed unlikely that consumer spending would be the major factor driving growth as the recovery progressed. Moreover, the recovery in the housing market appeared to have stalled in recent months despite various forms of government support. Although residential real estate values seemed to be stabilizing and in some areas had reportedly moved higher, housing sales and starts had leveled off in recent months at depressed levels. Some participants saw the possibility of elevated foreclosures adding to the already very large inventory of vacant homes as posing a downside risk to home prices, thereby limiting the extent of the pickup in residential investment for a while.

In the business sector, prospects for nonresidential construction outside the energy sector remained weak. Commercial real estate activity continued to fall in most parts of the country as a result of deteriorating fundamentals, including declining occupancy and rental rates and tight credit conditions. However, a number of participants noted that investment in equipment and software had been strengthening, and they relayed anecdotal information from their business contacts that suggested continued growth in orders for capital equipment.

Business investment was expected to be supported by improved conditions in financial markets. Large firms with access to capital markets appeared to be having little difficulty in obtaining credit, and in many cases they also had ample retained earnings with which to fund their operations and investment. However, many participants noted that while financial markets had improved, bank lending was still contracting and credit remained tight for many borrowers. Smaller firms in particular reportedly continued to face substantial difficulty in obtaining bank loans. Because such firms tend to be more dependent on commercial banks for financing, participants saw limited credit availability as a potential constraint on future investment and hiring by small businesses, which normally are a significant source of employment growth in recoveries. Some participants noted that many small and regional banks were vulnerable to deteriorating performance of commercial real estate loans.

Economic conditions abroad, especially in several emerging Asian economies, continued to strengthen in recent months, contributing to gains in U.S. exports. However, participants saw the escalation of fiscal strains in Greece and spreading concerns about other peripheral European countries as weighing on financial conditions and confidence in the euro area. If other European countries responded by intensifying their fiscal consolidation efforts, the result would likely be slower growth in Europe and potentially a weaker global economic recovery. Some participants expressed concern that a crisis in Greece or in some other peripheral European countries could have an adverse effect on U.S. financial markets, which could also slow the recovery in this country.

Developments in labor markets were positive over the intermeeting period. Nonfarm payrolls posted a modest gain in March, and the upturn in private employment was widespread across industries. Nevertheless, participants remained concerned about elevated unemployment, including high levels of long-term unemployment and permanent separations, which were seen as potentially leading to the loss of worker skills and greater needs for labor reallocation that could slow employment growth going forward. Moreover, information from business contacts generally underscored the degree to which firms’ reluctance to add to payrolls or start large capital projects reflected uncertainty about the economic outlook and future government policies. A number of participants pointed out that the economic recovery could eventually lose traction without a substantial pickup in job creation.

Participants cited a wide array of evidence as indications that underlying inflation remained subdued. The latest readings on core inflation–which exclude the relatively volatile prices of food and energy–were generally lower than they had anticipated. One participant noted that core inflation had been held down in recent quarters by unusually slow increases in the price index for shelter, and that the recent behavior of core inflation might be a misleading signal of the underlying inflation trend. However, a number of participants pointed out that the recent moderation in price changes was widespread across many categories of spending and was evident in measures that exclude the most extreme price movements in each period. In addition, survey measures of longer-term inflation expectations remained fairly stable, wage growth continued to be restrained, and unit labor costs were still falling; reports from business contacts also suggested that pricing power remained limited. Against this backdrop, most participants anticipated that substantial resource slack and stable longer-term inflation expectations would likely keep inflation subdued for some time.

Participants’ assessments of the risks to the inflation outlook were mixed. Some participants saw the risks to inflation as tilted to the downside in the near term, reflecting the quite elevated level of economic slack and the possibility that inflation expectations could begin to decline in response to the low level of actual inflation. Others, however, saw the balance of risks as pointing to potentially higher inflation and cited pressures on commodity and energy prices associated with expanding global economic activity as an upside inflation risk; some also noted the possibility that inflation expectations could rise as a result of the public’s concerns about the extraordinary size of the Federal Reserve’s balance sheet in a period of very large federal budget deficits. While survey measures of longer-term inflation expectations had been fairly stable, some market-based measures of inflation expectations and inflation risk suggested increased concern among market partici-pants about higher inflation. To keep inflation expectations well anchored, all participants agreed that it was important for policy to be responsive to changes in the economic outlook and for the Federal Reserve to continue to communicate clearly its ability and intent to begin withdrawing monetary policy accommodation at the appropriate time and pace.

Committee Policy Action
In the members’ discussion of monetary policy for the period ahead, they agreed that no changes to the Committee’s federal funds rate target range were warranted at this meeting. On balance, the economic outlook had changed little since the March meeting. Even though the recovery appeared to be continuing and was expected to strengthen gradually over time, most members projected that economic slack would continue to be quite elevated for some time, with inflation remaining below rates that would be consistent in the longer run with the Federal Reserve’s dual objectives. Based on this outlook, members agreed that it would be appropriate to maintain the target range of 0 to ¼ percent for the federal funds rate. In addition, nearly all members judged that it was appropriate to reiterate the expectation that economic conditions–including low levels of resource utilization, subdued inflation trends, and stable inflation expectations–were likely to warrant exceptionally low levels of the federal funds rate for an extended period. As at previous meetings, a few members noted that at the current juncture, the risks of an early start to policy tightening exceeded those associated with a later start, because the scope for more accommodative policy was limited by the effective lower bound on the federal funds rate, while the Committee could be flexible in adjusting the magnitude and pace of tightening in response to evolving economic circumstances. In light of the improved functioning of financial markets, Committee members agreed that it would be appropriate for the statement to be released following the meeting to indicate that the previously announced schedule for closing the Term Asset-Backed Securities Loan Facility was being maintained.

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 engage in dollar roll transactions as necessary to facilitate settlement of the Federal Reserve’s agency MBS transactions. 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 March suggests that economic activity has continued to strengthen and that the labor market is beginning to improve. Growth in household spending has picked up recently but remains constrained by high unemployment, modest income growth, lower housing wealth, and tight credit. Business spending on equipment and software has risen significantly; however, investment in nonresidential structures is declining and employers remain reluctant to add to payrolls. Housing starts have edged up but remain at a depressed level. While bank lending continues to contract, financial market conditions remain supportive of economic growth. Although the pace of economic recovery is likely to be moderate for a time, the Committee anticipates a gradual return to higher levels of resource utilization in a context of price stability.

With substantial resource slack continuing to restrain cost pressures and longer-term inflation expectations stable, inflation is likely to be subdued for some time.

The Committee will maintain the target range for the federal funds rate at 0 to ¼ percent and continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels of the federal funds rate for an extended period. The Committee will continue to monitor the economic outlook and financial developments and will employ its policy tools as necessary to promote economic recovery and price stability.

In light of improved functioning of financial markets, the Federal Reserve has closed all but one of the special liquidity facilities that it created to support markets during the crisis. The only remaining such program, the Term Asset-Backed Securities Loan Facility, is scheduled to close on June 30 for loans backed by new-issue commercial mortgage-backed securities; it closed on March 31 for loans backed by all other types of collateral.”

Voting for this action: Ben Bernanke, William C. Dudley, James Bullard, Elizabeth Duke, Donald L. Kohn, Sandra Pianalto, Eric Rosengren, Daniel K. Tarullo, and Kevin Warsh.

Voting against this action: Thomas M. Hoenig.

Mr. Hoenig dissented because he believed it was no longer advisable to indicate that economic and financial conditions were likely to warrant “exceptionally low levels of the federal funds rate for an extended period.” Mr. Hoenig was concerned that communicating such an expectation could lead to the buildup of future financial imbalances and increase the risks to longer-run macroeconomic and financial stability, while limiting the Committee’s flexibility to begin raising rates modestly in the near term. Mr. Hoenig believed that the target for the federal funds rate should be increased toward 1 percent this summer, and that the Committee could then pause to further assess the economic outlook. He believed this approach would leave considerable policy accommodation in place to foster an expected gradual decline in unemployment in the quarters ahead and would reduce the risk of an increase in financial imbalances and inflation pressures in coming years. It would also mitigate the need to push the policy rate to higher levels later in the expansionary phase of the economic cycle.

It was agreed that the next meeting of the Committee would be held on Tuesday-Wednesday, June 22-23, 2010. The meeting adjourned at 12:50 p.m. on April 28, 2010.

Notation Vote
By notation vote completed on April 5, 2010, the Committee unanimously approved the minutes of the FOMC meeting held on March 16, 2010.

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Brian F. Madigan
Secretary