Fed didn't see it coming


The day after Lehman Brothers Holdings Inc. declared the largest bankruptcy in U.S. history in 2008, Federal Reserve officials remained unsure whether the financial crisis would do lasting damage to the U.S. economy.

“I don’t think we’ve seen a significant change in the basic outlook,” Dave Stockton, the Fed’s top forecaster, said on Sept. 16, 2008 according to transcripts released today in Washington. “We’re still expecting a very gradual pickup in GDP growth over the next year.”

The records show Fed officials struggling to understand the magnitude of the financial crisis that was underway, and the potential fallout for the economy. The unemployment rate jumped to 6.1 percent in August from 5 percent at the start of the year, even as inflation was also rising.

The financial crisis would lead to a credit freeze that helped push the unemployment rate up as high as 10 percent. By 2009, more than 15 million Americans would be out of work.

At the September meeting, officials discussed the collapse of Lehman, yet left their main interest rate at 2 percent, rebuffing calls by some investors for an immediate cut.

“I don’t really have anything useful to say about the economic consequences of the financial developments of the past few days,” Stockton said. “I must say I’m not feeling very well about it at the present, but I’m not sure whether that reflects rational economic analysis or the fact that I’ve had too many meals out of the vending machines downstairs in the last few days.”

Growing Strains

The Fed signaled it would consider a rate cut in the future by acknowledging, in its statement, growing strains in financial markets. Policy makers also said employment was weakening and export growth slowing, and they dropped a reference to elevated inflation expectations.

“Tight credit conditions, the ongoing housing contraction, and some slowing in export growth are likely to weigh on economic growth over the next few quarters,” the FOMC said in its statement.

Janet Yellen, then president of the San Francisco Fed, amused her colleagues by relaying anecdotal reports of cutbacks in discretionary spending.

“East Bay plastic surgeons and dentists note that patients are deferring elective procedures,” Yellen said to laughter, according to the transcripts. Yellen became Fed vice chair in 2010 and succeeded Ben S. Bernanke as chair earlier this month.

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