Judging by the heavily hedged, qualified, rear-end-covering tone of its post-meeting statement, yesterday’s FOMC session must have been a lively one. Signs are that growth is “moderating toward a pace closer to the rate of growth of the economy’s potential to produce,” according to the announcement. Notably, these indications are no longer “tentative and preliminary,” as was the case at the previous meeting in late June, at which time the panel also refrained from raising the 6.5% funds rate. That’s because “the data also have indicated that more rapid advances in productivity have been raising that potential growth rate as well as containing costs and holding down underlying price pressures.” At the same time, though, the committee “remains concerned” about excessive demand growth with “utilization of the pool of available workers” at such a high level, and “believes the risks continue to be weighted mainly toward conditions that may generate heightened inflation pressures in the foreseeable future….”

This is the confused public face of an institution in the throes of intellectual upheaval.  The Phillips Curve/NAIRU forces personified by Governor Laurence Meyer have lost standing and credibility. Their dire warnings failed to account for the surge in productivity-enhancing investment spurred in no small measure by the tight labor market conditions that their models tell them create inflation. A new vanguard led by Cleveland’s Jerry Jordan and several other regional bank presidents, with at least the tacit acceptance of Alan Greenspan, has sent the Phillips Curvers into retreat. Nevertheless, having spent so much of its capital on the “growth is inflationary” mantra of the past year, institutional imperatives restrain the central bank from publicly acknowledging the obvious – that there is not the slightest trace of incipient inflation risk evident anywhere.

That resistance, though, is likely to break before long. Word from inside the system is that the zero-inflation environment outlined here Monday (“The Zero Inflation Reality,” August 21, 2000) is acknowledged by key policymakers, and is factoring into their approach. As it becomes more and more clear that a 6.5% funds rate is totally out of whack with non-existent inflation expectations, speculation should turn from lingering and diminishing threats of rate hikes to the growing possibility of rate cuts. For the first time, in fact, the Wall Street Journal today allowed that the deep inversion of the entire Treasury yield curve relative to the funds rate could represent an early bet that the Fed’s next move will be toward ease. Today’s 5/8 point long-bond rally, pushing the yield to near 16-month lows below 5.7%, likely reflects nascent additional support for such thinking.