Fed didn't see it coming


Labor Markets

On a more somber note, Yellen said that labor markets “are weakening across the board” and “the interaction of higher unemployment with the housing and financial markets raises the potential for even worse news -- namely, an intensification of the adverse feedback loop we have long worried about and are now experiencing.”

Still, when it came time to vote, Yellen joined the majority in favor of holding rates at 2 percent.

Officials had earlier taken quick action as the economic outlook deteriorated, cutting the federal funds rate from 4.25 percent at the start of the year, when Yellen had warned that the nation was on the “brink of recession.”

By September, the monetary policy response, along with the emergency liquidity facilities for financial markets, were seen as adequate for handling the strains in the economy.

“I think our aggressive approach earlier in the year is looking pretty good,” Bernanke said. Even so, he said it was likely that the country was already in a recession, and “I think we are in for a period of quite slow growth.”

Fannie Mae

In addition to the collapse of Lehman Brothers, the U.S. government had seized control of Fannie Mae and Freddie Mac, the largest U.S. mortgage-finance companies, on Sept. 7.

Some policy makers in September continued to see inflation as the primary risk to the economy.

“I also encourage us to look beyond the immediate crisis, which I recognize is serious,” said Thomas Hoenig, then president of the Kansas City Fed. “But as pointed out here, we also have an inflation issue.”

James Bullard of St. Louis said that he took comfort from the Fed’s experience in March, when the investment bank Bear Stearns Cos. collapsed.

“Financial-market turmoil is certainly a key concern, but the U.S. economy still outperformed expectations in the first half of 2008, despite the demise of Bear Stearns,” said Bullard, who described it as “an event not too different in some respects from the current episode.”

The decision to hold the federal funds rate at 2 percent was unanimous among the committee’s voters. Fed presidents have rotating votes on monetary policy, and Boston Fed President Eric Rosengren, who didn’t vote that year, favored easing.

“This is already a historic week, and the week has just begun,” he said. “I am not convinced that the unemployment rate will level off” as the Fed board had forecast.

“The failure of a major investment bank, the forced merger of another, the largest thrift and insurer teetering, and the failure of Freddie and Fannie are likely to have a significant impact on the real economy.”

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