Why Does The FOMC Have To Move In 0.250% Increments?

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This morning, Chicago Federal Reserve Board President  Michael Moskow gave a spirited talk to members of Jobs For Youth, a Chicago-based community organization that helps young adults train to enter the workforce with the necessary skills.

I was among the 100 people or so crammed into a breakfast/conference room, but as you can tell from the photo, I had a pretty good seat.  It's too bad my Treo 650 can't take higher mega-pixel photos -- I swear that Dr. Moskow is less grainy in real life.

The speech was an enjoyable one.  Dr. Moskow talked about:

• The basement of the Chicago Federal Reserve Bank ("that holds $8-9 billion dollars")
• The number of bills that circulate through the Chicago Fed that are unfit to re-enter people's wallets ("about one-third")
• How rising oil prices slow down the economy ("by taking away money to be spent elsewhere -- a little like a tax").

Then there was a Q & A session.

Now, if you know me well, you know that I have loads of questions I would have loved to hear the 12-year FOMC veteran answer. 

• Do the voting members make up their minds before showing up at the meeting? 
• Does everyone just vote with the Chairman so that markets don't freak out about dissension? 
• Do you really think that the FOMC statements clear to average Americans?

Instead, the question that came out of my mouth was this: 

"Why does the Fed only raise or lower rates in 25 basis point increments?  Why not 10 basis points?  Or six?"

There was brief silence in the room and some muffled laughter (probably at me being an idiot).  Crickets.

I think I stumped Dr. Michael Moskow.

After the pause (and without answering the question), Dr. Moskow told a funny story about the "measured pace" verbiage that became so closely watched the past two years. 

When the Fed started raising rates from the 1.00% level June 30, 2004, it raised the Fed Funds Rate by 0.25% and said that it would continue to raise rates at a "measured pace" as it deemed necessary.

At the next meeting, the Fed raised rates by 0.25% and again included the "measured pace" verbiage.

Then, at the next meeting, the Fed raised rates by 0.25% and so the markets interpreted "measured pace" to actually mean "a 25 basis point increase".  This is a case of the markets dictating to the Fed how to communicate to them. 

It's funny in an ironic way.

At this point, I think Moskow realized that he not only didn't answer my question, he didn't even allude to it.  So, he said, "Never say never."

So the FOMC meets again August 8, 2006 and the voting FOMC members will sit in a room, discussing what do to about the Fed Funds Rate.  Raising it by 25 basis points is too high some will argue.  Not raising it at all will be too little, others will say.

Not Moskow.  He's going to vote for a 16 basis point increase now that the idea's been planted in his brain -- never say never, after all.