FOMC Cuts 25 But Says Inflation Risk Has Increased; Policy Stance Back To “Neutral”

I think this was a little more hawkish than the market was expecting. 

Bernanke and Co. did cut rates 25 basis points but they said that inflation risks had increased and that “upside risks to inflation roughly balance the downside risks to growth” (FOMC Statement, October 31).

This seems to constitute a move back to “neutral” in contrast towards the greater concern with economic growth and the concomitant bias toward cutting the last two statements have implied.

Consider the August 17th weighing of risks: “…. the FOMC judges that the downside risks to growth have increased appreciably” (FOMC Statement August 17).

And September 18th: “Developments in financial markets since the Committee’s last regular meeting have increased the uncertainty surrounding the economic outlook” (FOMC Statement September 18).

Now, all of a sudden, inflation is back in the picture and that will play a factor in Fed decisions going forward.

It is not, however, the “predominant policy concern” that it was prior to August 17th.  Consider, for instance, the August 7th statement: “Although the downside risks to growth have increased somewhat, the Committee’s predominant policy concern remains the risk that inflation will fail to moderate as expected” (FOMC Statement August 7).

So I think this gives you a good idea of how the Fed goes about, and continually adjusts, its views about the risks for economic growth and inflation (For a comprehensive treatment of how the Fed sets policy see my “The Significance of the Fed Pause: Interest Rates, the Economy and Inflation”, August 10, 2006).