Monetary Policy Report

1988 MONETARY POLICY OBJECTIVES Summary Report of the Federal Reserve Board February 23, 1988 1988 MONETARY POLICY OBJECTIVES Summary Report to the Congress on Monetary Policy pursuant to the Full Employment and Balanced Growth Act of 1978. February 23, 1988. Contents Section Page Monetary Policy and the Economic Outlook for 1988 2 Monetary Policy Plans for 1988 2 Economic Projections 4 The Performance of the Economy during the Past Year 6 The External Sector 7 The Household Sector 7 The Business Sector 8 The Government Sector 9 Labor Markets 9 Price Developments 10 Monetary Policy and Financial Markets 1n 1987 11 Behavior of Money and Credit 11 Implementation of Monetary Policy 13 Monetary Policy and the Economic Outlook for 1988 The national economy has scored major gains in the the System eased the pressures a bit further on past year. Growth of real gross national product at reserve positions of depository institutions in the 3 ¾ percent over the four quarters of 1987 out past several weeks. stripped most expectations, and the unemployment But while the Federal Reserve has had to be rate dropped below 6 percent for the first time in responsive to the risks of an economic downturn, it this decade. With such sectors as agriculture, min has not lost sight of the potential influence of policy ing, and manufacturing benefiting considerably from actions on longer-term trends in the economy. The an improved competitive position internationally, the United States is in the process of an important read expansion of the economy was better balanced than justment in the balance of economic activity, after a in 1985-86. Wage increases remained moderate and period of several years in which growth of domestic contributed to favorable cost trends in many sectors. spending outstripped the pace of domestic produc However, a rebound in oil prices, coupled with the tion. Over that span, the trade balance moved into effects of the dollar's decline on the prices of deep deficit, and the nation began to amass a huge imported goods generally, pushed the rate of price net external debt. It is important to allow room for inflation back up to the 4 percent range by most a significant improvement in our trade balance, measures. especially given that high rates of capacity utilization At times last year, soaring commodity prices, and low unemployment, evident in many segments sharp declines in the dollar, and bond prices sig of industry, suggest the need for added care in naled the possibility of greater inflationary dangers. maintaining progress toward price stability. With the economy moving toward higher levels of These considerations underlay the decisions of the resource utilization, the Federal Reserve had to be Federal Open Market Committee when it met especially alert to these and other indications of earlier this month to chart its monetary policy pressures that might have led to a significant depar strategy for 1988. Such considerations also must be ture from the longer-run trend toward price stabil kept in the forefront as decisionmakers elsewhere in ity. In these circumstances, monetary policy was the government set policy. In particular, continuing characterized by a tendency toward greater restraint fiscal restraint is crucial if we are to free up through last October. This was reflected in a moder resources to finance productivity-enhancing private ate rise in money market interest rates, which in investment while bringing about an improved pat turn damped growth of the monetary aggregates. tern of international transactions. Moreover, addi While M3 grew at a pace equal to the lower bound tional efforts at bringing greater coherence to poli of the range set for the year by the Federal Open cies, domestically and internationally, will promote Market Committee (FOMC), M2 fell short of its greater stability in financial markets and greater range. After the plunge in the stock market in internal and external balance to the economy. October, the System focused its efforts primarily on • ensuring adequate liquidity in the economy, and Monetary Policy Plans for 1988 since that time interest rates have reversed a good part of the rise that occurred earlier in 198 7. For 1988, the Committee set ranges of 4 to 8 per However, conditions in financial markets have yet cent for growth of M2 and M3. Expansion of to return fully to "normal," and the edginess of money within these ranges,· whose midpoints are one participants continues to be reflected in volatility percentage point lower than those of the ranges for and fairly sizable risk premia. Moreover, there have last year, would be expected to support economic been some signs of weakness in the economy growth at a pace that is consistent with continued recently. In particular, the fourth quarter of 198 7 external adjustment and progress over time toward was marked by a sharp rise in inventories in a few price stability. sectors, and there were indications of a slackening in labor demand early this year. Against this backdrop, 2 Ranges of Growth for Monetary and In light of the experience of recent years, which Debt Aggregates1 have been marked by large swings in velocity, the ranges for 1988 were widened somewhat. There is Percent change, fourth quarter to fourth quarter continuing "noise" in the relationship of money growth to economic activity; in addition, velocity of 1988 1987 money is sensitive to changes in market rates of interest. This sensitivity means that even small M2 4 to 8 5½ to 8½ changes in rates, caused by variations in spending or M3 4 to 8 5½ to 8½ prices, can have sizable effects on the quantity of money the public wishes to hold. Combined with an Debt 7 to 11 8 to 11 uncertain outlook for the economy and inflation, this implies that wider ranges are needed to encompass possible outcomes for monetary growth consistent Decisions regarding the ranges for money and with satisfactory economic performance in 1988. credit growth in 1988 were shaped in part by the Thus, while the Committee at this time expects that experience of 1987. Last February, the FOMC growth of M2 and M3 will be around the middle of established annual target ranges of 5 ½ to 8 ½ per their ranges, the outcome could differ if significant cent for both M2 and M3; both aggregates had changes in interest rates are required to counter increased more than 9 percent in 1986, but slower unanticipated weakness in aggregate demand or an growth was expected to be consistent with the Com intensification of inflation. In carrying out policy, mittee's goal of sustaining business expansion while the Committee will continue to assess the behavior maintaining long-run progress toward price stability. of the aggregates in light of information about the The deceleration proved sharper than anticipated, pace of business expansion and the source and and in July, the Committee stated that growth for strength of price pressures, with attention to the per the year around the lower ends of these ranges, or formance of the dollar on foreign exchange markets even below them, might be acceptable in certain cir and other indicators of the impact of monetary cumstances. Velocity had increased in the first half policy. of the year partly under the influence of rising The FOMC will continue to monitor the growth interest rates, and the Committee agreed that if of debt in 1988. The expansion of the debt of inflation forces were to exhibit renewed strength and domestic nonfinancial sectors is expected to slow interest rates were to increase further in the second somewhat from the 9 ½ percent pace of 1987, to half of the year, continued slow money expansion around the middle portion of a 7 to 11 percent might be appropriate. Rates did move upward again range. Growth of debt however, appears likely to in the late summer, including an increase of 1/ 2 per outpace that of income, as it has for the past several centage point in the discount rate to counter poten years. Although the debt of governmental units may tial inflation. M2 growth did in fact fall substantially not grow as rapidly as it did last year, continued short of the Committee's range, at 4 percent for the rapid expansion of private debt is probable, unless year, while M3 growth, at 5 ½ percent, was at the the current tide of corporate restructurings ebbs. lower end of its range. The Committee decided not to establish a range for Ml in 1988. It is especially difficult to anticipate the relationship between growth in this aggregate and the performance of the economy. The character of this aggregate had been affected more than the broader monetary aggregates by deregulation, because it now contains a large volume of interest earning accounts that serve as savings as well as transactions vehicles. 3 Economic Projections candy. By and large, U.S. manufacturers have let the foreign currency prices of their products decline The uncertainties attending the present economic sit with the depreciation of the dollar, achieving uation are reflected in a considerable range of fore enhanced profitability through greater volume and casts among Committee members and other Reserve aggressive efforts to increase efficiency and control Bank presidents. However, the central tendency costs. This enhanced competitiveness is expected to ranges encompass the vast majority of forecasts and point to growth in real GNP of 2 to 2 ½ percent in provide a further boost to export growth this year, while the increases in the relative prices of foreign 1988. goods apparently now in train should curb import This pace of activity would be expected to gener growth. As a result, some improvement in the ate appreciable gains in employment over the nation's current account balance is anticipated this year-about in line with labor force growth-and year. the civilian unemployment rate is projected to In contrast, domestic demand is expected to change little on balance between now and the end of remain relatively subdued in 1988, as the economy 1988. Prices, as measured by the implicit price moves toward a better balance between domestic deflator for GNP, are expected to rise 3 ¼ to 3 ¾ spending and domestic production. Consumer percent, not appreciably different from the pace last demand probably will be damped to a degree by the year; consumer prices likely will increase a little loss of household wealth associated with the decline faster than the deflator. The central tendency fore in stock prices last fall. Some increase in personal casts encompass the Administration's projections for saving would be beneficial to the economy, as it real GNP, but are a bit more optimistic on prospects would aid investment and help reduce our depen for price inflation. dence on foreign capital. However, a severe Higher real net exports of goods and services are retrenchment by consumers could have a significant expected to provide a major impetus to U.S. eco deflationary effect; fortunately, the indications from nomic activity in 1988. As reflected by the rapid surveys of household attitudes are that the sharp growth of real exports of goods and services of more drop in confidence that occurred immediately after than 15 percent last year, the international competi the October shock has been substantially reversed. tiveness of U.S. producers has improved signifi- Housing activity should pick up some in coming Economic Projections for 1988 (percent) FOMC Members and other FRB Presidents Administration Range Central Tendency Nominal GNP 4 to 6½ 5¼ to 6 6.4 Change, fourth quarter to fourth Real GNP 1/2 to 3 2 to 2½ 2.4 quarter: Implicit deflater for GNP 2½ to 4 3¼ to 3¾ 3.9 Average level in the fourth quarter: Civilian unemployment rate 5 ½ to 6 ¾ 5¾ to 6 5.8* *Overall unemployment rate. 4 months as a result of the recent decline in mortgage depreciation is an unavoidable component of the rates. In addition, business spending on plant and process of correcting external imbalance, as an equipment should be buttressed by the desire to increase in the relative price of foreign goods build upon the progress made in regaining interna encourages exports and discourages imports. How tional competitiveness and by already high levels of ever, if we are to maintain and extend the progress capacity utilization in a number of major industries. made in the 1980s toward price stability, it is crucial Although real GNP sh0u]d rise moderately for the that business and labor continue to exercise restraint year as a whole, the pattern of growth may be in price and wage behavior. The forecasts of the uneven over time. An adjustment to the runup in FOMC members and other Reserve Bank presidents inventories that occurred in the fourth quarter of anticipate that such a pattern will persist through 1987 could produce relatively slow output growth this year. It is important, too, that the Congress during the first part of the year. Such an adjustment remain mindful of the effects of legislation on the appears in process in the auto sector, in light of cost structure of American industry. domestic automakers' current assembly schedules. The forecasts of the Federal Reserve policymakers There may also be similar patterns in a few other also assume further progress in reducing the federal sectors, but at this time there are no signs that deep budget deficit. Continuing evidence of fiscal restraint cutbacks in production will be necessary. is viewed as crucial in maintaining financial condi Although no significant change is anticipated in tions that are conducive to balanced growth and to the overall pace of inflation this year, the primary an improved pattern of international transactions. It source of the rise in prices is likely to change. is critical that the package of deficit-reduction meas Assuming relative stability in world oil prices, ures for 1988 and 1989-agreed to in December-be domestic energy prices should increase only a bit fully implemented. this year after their sharp rebound in 198 7. How ever, prices of non-oil imports likely will continue to rise substantially further in the wake of the decline in the foreign exchange value of the dollar in 198 7, providing continuing impetus to domestic inflation. This impulse to prices associated with the dollar's 5 The Performance of the Economy during the Past Year The economy completed a fifth consecutive year of A number of sectors that had been depressed in expansion in 1987, with real gross national product recent years began to show signs of improvement in increasing about 3 ¾ percent over the four quarters 1987. The turnaround was most pronounced in of the year.* The overall growth in output not only manufacturing, where production and employment, was greater than in 1986, but was better balanced especially in capital goods and industrial materials across industries and regions of the country. In industries, picked up sharply, both in response to addition, the rise in activity supported a net gain of stronger orders from abroad and to higher levels of more than three million jobs last year, and the civil capital spending by domestic producers. However, ian unemployment rate stood at 5.8 percent in Janu improvement also was apparent in the domestic ary of this year, nearly a percentage point below its energy sector, where, in response to the partial level a year-ago. recovery in oil prices, oil drilling retraced a small part of its earlier precipitous decline. Higher exports Percent change from end of and continued federal support in agriculture boosted Real GNP previous period, annual rate farm income and helped bring about some firming in land prices. The improvement in economic conditions last year could be traced to the effects of increased competi tiveness on the volume of imports and exports. Nevertheless, the combination of a substantial in crease in the value of oil imports and rising prices of non-oil imports more than offset an improvement in real net exports, and the nominal trade deficit wid ened to almost $160 billion in 1987. In addition, a further erosion of net income on investments and other service transactions pushed the current account 1982 1983 1984 1985 1986 1987 deficit above $160 billion. Although economic activity rose at a brisk pace for 1987 as a whole, the October stock market crash Virtually all broad measures of inflation-after added substantial uncertainty to the prospects for dropping sharply in 1986-rebounded in 1987 to continued economic growth at year-end. The sharp about the pace seen in 1984 and 1985. In large part, drop in stock prices reduced household wealth con the pattern of price movements over the past two siderably, raising the possibility of a further slowing years reflected developments in oil markets, where in consumer spending, domestic business invest prices rebounded last year after a sharp drop in ment, and housing construction. 1986. However, prices also rose sharply for some imported consumer goods and, at the producer level, for a number of industrial commodities. In contrast, wage trends remained restrained last year, although tightening labor markets and the faster pace of infla tion stemmed the pattern of wage deceleration evi dent in previous years. •Except where noted, all percent changes are from the fourth quarter of the previous year to the fourth quarter of the year indicated. 6 Foreign Exchange Value of the The U.S. merchandise trade deficit widened for U.S. Dollar* 1987 as a whole, but leveled off on balance in the Index, March 1973 =100 latter part of the year. The volume of imports increased, reflecting a moderate expansion in both oil and non-oil imports. Moreover, non-oil import prices moved up further in response to the continu ing decline in the dollar through 1987, and, with oil prices also up sharply, imports rose substantially in value terms. Higher imports were matched, to a large extent, by merchandise exports, which also grew briskly in 1987. Economic expansion abroad strengthened slightly in 1987, providing only limited support for the improvement in the U.S. trade position. In the 1982 1983 1984 1985 1986 1987 other industrial countries, economic activity picked *Index of weighted average exchange value of U.S. dollar in terms of currencies up somewhat by the middle of the year after a slow of other G-10 countries plus Switzerland. Weights are 1972-76 global trade of start, but on average real GNP grew less than 3 per each of the 10 countries. cent over the year. The External Sector The Household Sector The dollar depreciated by 14 percent in nominal terms over the course of 1987 relative to a trade-weighted Spending by households, which had been a major average of the currencies of the other G-10 countries, contributor to growth in past years, slowed consider leaving the dollar by the end of the year at a level ably in 198 7. Real consumer spending rose less than almost 45 percent below its February 1985 peak and 1 percent last year, after a 4 percent gain in 1986. close to its 1980 low. The decline in the exchange value of the dollar was resisted by substantial official Percent of Personal Saving Rate disposable income intervention purchases of dollars and an apparent movement of differentials in long-term real interest rates between the United States and major foreign 6 countries. Nonetheless, some depreciation in the dol lar evidently was seen by participants in foreign \J v exchange markets as a necessary element in the C7 adjustment of the huge U.S. current account deficit. 2 Annual rate, U.S. Real Merchandise Trade billions of 1982 dollars 1982 1983 1984 1985 1986 1987 Imp=400 In large part, the cutback in spending reflected ~ smaller increases in real disposable income. Substan -- tial employment growth and increases in farm and / Exports ---✓ interest income fueled continued gains in nominal ~ --- -------------- 200 incomes. However, a pickup in consumer price inflation eroded much of that rise and reduced real income growth to about 2 percent last year, versus 3 ½ percent in 1986. 1982 1983 1984 1985 1986 1987 7 In general, consumers cut back their expenditures high vacancy rates on rental units and tax-law for both durable and nondurable goods, while changes reduced the profitability of rental housing spending on services continued to increase at about and continued to deter building in that sector. the pace of recent years. Within the durables cate gory, sales of new cars fell from 11 ½ million units The Business Sector in 1986 to about 10 ¼ million units last year. Some of that dropoff can be traced to an especially slow Business spending on plant and equipment rose pace of sales in early 198 7, as consumers shifted about 3 ¾ percent in real terms in 1987. In large automobile purchases into 1986 to take advantage part, investment spending was associated with the first of major sales incentives and then of the sales overall pickup in economic activity. However, finan tax deduction available only under the old tax law. cial conditions also were conducive to spending, with Associated with the more cautious spending pat cash flows strong and the costs of external capital terns of consumers in 1987 was a slowing in house fairly attractive through much of the year. hold debt accumulation. Consumer installment debt decelerated sharply because of high debt burdens of Changes in Real Business households and a shift toward home equity loans in Annual rate, Inventories billions of 1982 dollars response to the new tax law. Housing starts totaled 1. 62 million for the year as D Nonfarm Less Autos a whole, about 10 percent below the 1986 total and !illl Autos the lowest in five years. Single-family homebuilding 60 began the year at a brisk pace, but weakened con siderably as conventional mortgage interest rates 30 rose beginning in April, reaching about 11 ½ per cent for fixed-rate loans by mid-October. Although interest rates on mortgages have dropped substan + tially since then, the stimulative impact of that change on housing demand may have been offset thus far by stock market losses and reduced con sumer confidence. In the multifamily market, activity 1982 1983 1984 1985 1986 1987 also weakened over the past year, as near record- For equipment, the year began on the weak side, with first-quarter spending down sharply after firms Annual rate, millions of Private Housing Starts shifted expenditures into late 1986 to take advantage units, quarterly average of the favorable treatment of investment under the depreciation provisions of the old tax law. However, 2.0 investment in equipment rebounded sharply in the second and third quarters of last year. s:;:;::; 1.5 Outlays for nonresidential structures also turned / up last year after a sharp drop in 1986. Much of the turnaround in spending reflected an improvement in - 1.0 the energy sector in response to higher oil prices. .5 ( Multifamily 1982 1983 1984 1985 1986 1987 8 Business inventory investment generally moved in Quarterly Civilian Unemployment Rate line with sales over most of 1987, but a: sharp · average, percent accumulation of stocks in the fourth quarter sug gested the possibility of excess inventory levels at some retailers. In manufacturing, inventories 10 changed little on balance over the first half of the year, but rose considerably in the second half as 8 activity picked up. Stockbuilding was most evident in capital goods industries, where orders and ship ments strengthened substantially, as producers added 6 supplies in anticipation of higher production levels. In the retail trade sector, inventories of goods other than automobiles also rose over the year, pushing the inventory-sales ratio to a relatively high level by 1982 1983 1984 1985 1986 1987 December. The accumulation was most pronounced for home goods such as furniture and appliances and for apparel. At auto dealers, stocks generally rose in tially in the second half in response to the sharp gains 1987, and, at year-end, supplies appeared to be well in industrial production. Moreover, the expansion of above desired levels despite the prevalence of special jobs in the trade, service, and finance industries remained sizable during most of 1987. Hiring in incentive programs and production cutbacks late in trade and finance apparently slowed in the latter the year. part of the year in the wake of sluggish consumer spending and the stock market crash. The Government Sector The demand for labor considerably outpaced Last year, there was significant progress toward increases in labor supply, and the civilian unemploy,.. reducing federal budget deficits. The FY 1987 defi ment rate dropped nearly 1 percentage point over cit, at $150 billion, was about a third lower than the the year to 5 ¾ percent at year-end-the lowest level record level of the previous year. The Administra since 1979. The jobless rate for adult men moved tion and Congress reached agreement on deficit down to about 4 ½ percent by the end of last year, reduction actions totaling more than $30 billion in reflecting strong growth in the industrial sector. The FY 1988 and about $46 billion in FY 1989. How rate for adult women fell to around 4 ¾ percent early ever, a number of factors that raised receipts and in the year, but changed little in the second half. lowered outlays in FY 1987 are not likely to be repeated, and-absent further legislative action Nonfarm Payroll deficits could expand again unless there are particu Net change, millions Employment of dollars, annual rate larly favorable economic circumstances. □ Total l!!!I Manufacturin 4 Labor Markets Employment increased three million over the 12 2 months of 1987, as the pickup in economic activity + led employers to add workers at a brisk pace. In contrast to prior years when the labor market was 2 characterized by sharp disparities across sectors, the strengthening in hiring in 1987 was widespread by industry. In manufacturing, employment edged up 1982 1983 1984 1985 1986 1987 over the first half of the year and then rose substan- 9 Unit labor costs in the nonfarm business sector Percent change from end of Consumer Prices• rose only 1 ¼ percent last year, after a 2 percent previous period, annual rate increase in 1986. The continued restraint in labor costs primarily reflected moderate compensation growth, as productivity gains for the sector as a whole have improved little from the sluggish pace of the 1970s. In contrast, manufacturers apparently have made significant progress in increasing effi ciency and streamlining operations, and output per hour in this sector rose nearly 3 ½ percent in 1987. Price Developments Inflation rebounded in 1987, largely reflecting higher energy prices and continued price hikes for imported goods. The fixed-weighted price index for GNP increased about 4 percent for the year as a 1982 1983 1984 1985 1986 1987 Percent change from end of •Consumer Price Index for all urban consumers. GNP Prices previous period, annual rate Fixed-weighted Price Index whole, after a 2 ¼ percent rise in 1986. The consumer price and producer price indices suggested an even sharper acceleration in prices over 198 7, owing to the greater importance of energy in those indices. The con sumer price index was up 4 ½ percent in the 12 months ended December, after a 1 percent rise in 1986. The pro ducer price index, which only includes prices of domes tically produced goods, rose 2 ¼ percent over the year, after dropping 2 ¼ percent in 1986. Prices for many industrial commodities also rose con siderably in 1987. In addition to the increase in crude oil prices, copper prices more than doubled last year, and steel scrap prices were up 36 percent. To some ex tent, the sharp rise in commodity prices reflects the influ 1982 1983 1984 1985 1986 1987 ence of dollar depreciation on markets for internally traded goods. 10 Monetary Policy and Financial Markets in 1987 While the Federal Open Market Committee set tar M2 Billions of Dollars gets for some of the monetary aggregates, it was deemed necessary to maintain a flexible approach in 3050 conducting its operations. The Committee looked at 3000 a broad range of information in judging when or if to adjust its basic instruments-reserve availability 2950 and the discount rate-in response to deviations in 2900 monetary growth from expected rates. Such factors as the pace of business expansion, the strength of 2850 inflation and inflation expectations, as well as developments in exchange markets, played a major 2800 role in governing the System's actions. In light of 2750 the behavior of these other factors, growth in the targeted aggregates, M2 and M3, was permitted to 2700 run at or below the established ranges. 0 N D J F M A M J J A S O N D During episodes beginning in the spring and then 1986 1987 again in late summer, the dollar came under sus tained downward pressure and inflationary expecta tions appeared to be on the rise, partially in finance purchases. The latter preference occurred in response to the dollar's weak performance. With the the wake of tax reform measures which reduced the economy expanding at rates sufficient to produce ris deductibility of nonmortgage interest payments. ing rates of resource utilization, the FOMC sought However, much of the pickup in velocity appears some firming of pressures on reserve positions and attributable to increases in the competing returns on increased the discount rate in September. When other assets, which raised the opportunity costs stock prices collapsed in mid-October, the resulting associated with holding M2 balances. turmoil required that the focus of policy be on M3 was stronger than M2 over the year, expand ensuring the liquidity of the financial system. Over ing 5 ½ percent and ending the year at the bottom the remainder of the year, emphasis in the conduct of its 5 ½ to 8 ½ percent annual growth range. Its of open market operations shifted toward main - faster growth reflected heavy reliance by depository tenance of steady and somewhat easier money mar institutions on large time deposits and on certain ket conditions to promote a return of stability to other instruments included in M3 but not in M2. financial markets generally and to cushion the effects of the stock market decline on the economy. M3 Billions of Dollars Behavior of Money and Credit 3750 M2 increased only 4 percent in 1987, well below both the lower bound of its 5 ½ to 8 ½ percent annual growth range and its more than 9 percent 3650 rate of expansion over the preceding two years. The velocity of this aggregate picked up substantially, reversing a portion of the sharp decline that 3550 occurred in 1985-86. The rise in velocity may have reflected in part a number of special factors affecting the public's demand for M2 balances in 1987, 3450 including a much-reduced rate of saving out of income and a preference for drawing upon liquid 0 N D J F M A M J J A S O N D assets-rather than using consumer credit-to 1986 1987 11 Both commercial banks and thrift institutions a record postwar decline a year earlier. The sharp stepped up their issuance of wholesale managed lia slowing of growth and the abrupt turnabout in its bilities to fund more asset growth than could be velocity are indicative of the increased sensitivity to accommodated by greatly reduced inflows of core movements in market interest rates that has emerged deposits. Even so, M3 growth was subdued relative for Ml in recent years. As suggested by its com to prior years, reflecting in part reduced overall paratively larger deceleration in 1987, Ml now needs for funds as asset expansion at bariks and appears to have a greater sensitivity to changes in thrifts slowed. In addition, banks relied heavily on interest rates than the broader aggregates. managed liabilities obtained from non-M3 sources, The debt of domestic nonfinancial sectors grew especially funds borrowed from their foreign 9 ½ percent last year, ending the year at the middle branches. of the Committee's monitoring range of 8 to 11 per Growth of M 1 slowed to 6 ¼ percent from the cent. Debt expansion moderated considerably from very rapid 15 ½ percent increase posted the previous the 13 ¼ pace of the two previous years, but still year, owing to a small decline in demand deposits rose faster than income. and a sharply lower expansion of other checkable deposits. The velocity of M 1 increased slightly, after Growth of Money and Debt (Percentage changes)2 Domestic Period M1 M2 M3 N onfinancial Debt Fourth quarter to 1979 7.7 8.2 10.4 12.3 fourth quarter 1980 7.5 8.9 9.5 9.6 1981 5.2 (2.5)3 9.3 12.3 10.0 1982 8.7 9.1 9.9 8.9 1983 10.2 12.1 9.8 11.3 1984 5.3 7.6 10.4 14.2 1985 12.0 (12.9)4 8.9 7.7 13.3 1986 15.6 9.4 9.1 13.2 1987 6.2 4.0 5.4 9.6 Quarterly Ql 13.2 6.5 6.5 10.5 growth rates 1987 Q2 6.6 2.6 4.7 8.7 Q3 0.8 2.8 4.5 8.1 Q4 3.9 4.0 5.6 9.7 12 Implementation of Monetary Policy target range for M 1, given the unpredictability of the behavior of this aggregate relative to economic During the first half of 198 7, monetary policy was activity. carried out in an atmosphere of increasing concerns For a short time after the July meeting, the dollar about the course of inflation, arising in part from rose further, but with the release of trade data in heavy downward pressure on the dollar. Growth of mid-August that disappointed market participants, the economy was bringing about noticeable increases the dollar again came under substantial downward in resource utilization. Inflation was picking up, pressure. Long-term bond yields moved up sharply reflecting the effect of a weaker dollar on import as the dollar's weakness against a backdrop of prices as well as a rebound of oil prices from low strength in the economy spurred concerns about 1986 levels. When the dollar came under heavy inflation and possible firming of monetary policy. pressure in late March, previously tranquil credit Interest rates in short-term markets also increased markets began to exhibit concern about the effect but by lesser amounts. In light of the potential fo; that declines of the dollar would have on prices. greater inflationary pressures, in part related to Long-term interest rates, in particular, moved up weakness in the dollar, the Federal Reserve sought strongly. In conjunction with some easing moves to reduce marginally the availability of reserves abroad, the Federal Reserve sought somewhat through open market operations; it also raised its greater restraint in the provision of reserves to the . discount rate by 1/2 percentage point in early Sep banking system. Initially, this action produced tember to 6 percent. After the discount-rate action further increases in interest rates, but subsequently, . ' mterest rates rose further, especially in short-term financial pressures eased somewhat. In response to markets. reductions in interest rates abroad, to some flatten Stock prices, which had reached very high levels ing in commodity prices, and to better news on the relative to earnings and had been falling since mid U.S. trade deficit, the dollar firmed and there was a August, plunged on October 19 in chaotic trading. broad decline in interest rates, with long-term rates The stock market drop prompted a marked decline falling somewhat more than short-term rates. in interest rates as investors sought refuge in the When the FOMC met in July to review its perceived safety of fixed-income assets, especially growth ranges for money and credit, all of the Treasury securities. Although most stock indexes monetary aggregates had decelerated considerably. recovered somewhat in the wake of the crash, finan The weakness in monetary growth did not reflect cial markets remained turbulent, with bond and any evident weakness in the economy. Rather, the equity prices fluctuating widely. slower money growth, and accompanying strength In a financial environment of extraordinary tur ening in velocity, appeared largely attributable to moil and apparent fragility, the Federal Reserve the rise in market rates of interest fostered in part shifted the emphasis in the conduct of open market by the Federal Reserve' s response to adverse transactions to providing reserves generously to developments with respect to the dollar and infla ensure that adequate liquidity would be available to tion. The Committee decided to reaffirm its 1987 meet any unusual needs. This action helped to calm growth ranges for M2 and M3; in doing so, it antic the financial markets, although conditions remained ipated some pickup in the growth of M2 over the somewhat unsettled over the rest of the year. remainder of the year. It indicated that growth for Early in 1988, as incoming data suggested that all of 1987, near or even below the bottom of the economic expansion over the first part of the year target ranges, might be acceptable for both aggre might be weak, bond rates dropped substantially and gates, depending on the behavior of their velocities the Federal Reserve sought some slight additional and other financial and economic developments, easing in desired pressures on reserve positions. Bet notably the evolving strength of inflationary pres ter trade news bolstered confidence in the dollar sures. The Committee also decided not to set a and the monetary aggregates showed signs of ' renewed strength. 13 Footnotes 1. Mt is currency held by the public, plus travelers' checks, plus demand deposits, plus other checkable deposits [including negotiable order of withdrawal (NOW and Super NOW) accounts, automatic transfer service (ATS) accounts, and credit union share draft accounts]. M2 is M 1 plus savings and small denomination time deposits, plus Money Market Deposit Accounts, plus shares in money market mutual funds ( other than those restricted to institutional investors), plus overnight repur chase agreements and certain overnight Eurodollar deposits. M3 is M2 plus large time deposits, plus large denomi nation term repurchase agreements, plus shares in money market mutual funds restricted to institutional investors and certain term Eurodollar deposits. 2. M 1, M2, and M3 incorporate effects of benchmark and seasonal adjustment revisions made in February 1988. Certain technical redefinitions affecting only Ml were made at the same time. 3. Ml figure in parentheses is adjusted for shifts to NOW accounts in 1981. 4. M 1 figure in parentheses is the annualized growth rate from the second to the fourth quarter of 1985. A copy of the full report to Congress is available from Publication Services, Federal Reserve Board, Washington, D.C. 20551 FRBl.3-48000-0288 14

Federal Reserve (1988, February 22). Monetary Policy Report. Monetary Policy Reports, Federal Reserve. https://whenthefedspeaks.com/doc/monetary_policy_report_19880223

@misc{wtfs_monetary_policy_report_19880223,
  author = {Federal Reserve},
  title = {Monetary Policy Report},
  year = {1988},
  month = {Feb},
  howpublished = {Monetary Policy Reports, Federal Reserve},
  url = {https://whenthefedspeaks.com/doc/monetary_policy_report_19880223},
  note = {Retrieved via When the Fed Speaks corpus}
}