Monetary Policy Report

1990 MONETARY POLICY OBJECTIVES Summary Report of the Federal Reserve Board February 20, 1990 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 1990 MONETARY POLICY OBJECTIVES Testimony of Alan Greenspan, Chairman Board of Governors of the Federal Reserve System February 20, 1990 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Testimony of Alan Greenspan Chairman, Federal Reserve Board Mr. Chairman and Members of the About a year ago, Federal Reserve policy was in the final phase of a period of gradual tightening, Committee) I appreciate the designed to inhibit a buildup of inflation pressures. Interest rates moved higher through the winter, but opportunity to testify today on the started down when signs of more restrained Federal Reserve)s semiannual aggregate demand and of reduced potential for higher inflation began to appear. As midyear Monetary Policy Report to the approached, a marked strengthening of the dollar on foreign exchange markets further diminished the Congress. My prepared remarks threat of accelerating inflation. New economic data discuss our monetary policy actions suggested that the balance of risks had shifted toward the possibility of an undue weakening in and plans in the context not only of economic activity. With M2 and M3 below the lower bounds of their annual ranges in the spring, the the current and projected state of the Federal Reserve in June embarked on a series of economy) but also against the measured easing steps that continued through late last year. Across the maturity spectrum, interest background of our longer-term rates declined further, to levels about 1 ½ percentage points below March peaks. Reductions in inflation objectives and strategy for achieving expectations and reports of a softer economy them. The final section of the evidently contributed to the drop in rates in longer-term markets. testimony addresses some issues for The decrease in short-term rates lifted M2 to around the middle of its annual range in the latter monetary policy raised by the part of the year. Efforts under the Financial increasingly international character Institutions Reform, Recovery, and Enforcement Act of 1989 (FIRREA) to close insolvent thrift off inancial markets. institutions and strengthen undercapitalized thrifts led to a cutback of the industry's assets and funding needs. This behavior held down M3 growth in the second half of the year, and that aggregate ended the year around the lower end of its annual range. The Economic and Monetary Policy restructuring of the thrift industry did not, however, Developments in 1989 seem to appreciably affect the overall cost and Last year marked the seventh year of the longest availability of residential mortgage credit, as other peacetime expansion of the U.S. economy on suppliers of this credit stepped into the breach. In record. Some 2 ½ million jobs were created, and the aggregate, the debt of nonfinancial sectors the civilian unemployment rate held steady at slowed somewhat, along with spending, to a rate just 5 ¼ percent. Inflation was held to a rate no faster below the midpoint of its annual range. than that in recent years, but unfortunately no progress was made in 1989 toward price stability. Thus, while we can look back with satisfaction at the economic progress made last year, there is still important work to be done. 1 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis So far this year, the federal funds rate has inflation and inflation expectations, while avoiding a remained around 8 ¼ percent, but rates on Treasury recession. Approaching price stability may involve a securities and longer-term private instruments have period of expansion in activity at a rate below the reversed some of their earlier declines. Investors growth in the economy's potential, thereby relieving have reacted to stronger-than-expected economic pressures on resources. Once some slack develops, data, a runup in energy prices, and increasingly real output growth can pick up to around its attractive investment opportunities abroad, potential growth rate, even as inflation continues to especially in Europe. trend down. Later, as price stability is approached, real output growth can move still higher, until full resource utilization is restored. The Ultimate Objectives and Medium-Term While these are the general principles, no one can Strategy of Monetary Policy be certain what path for the economy would, in Monetary policy was conducted again last year with practice, accompany the gradual approach to price an eye on long-run policy goals, and economic stability. One key element that would minimize the developments in 1989 were consistent with the costs associated with the transition would be a Federal Reserve's medium-term strategy for conviction of participants in the economy that the reaching them. The ultimate objective of economic anti-inflation policy is credible, that is, likely to be policy is to foster the maximum sustainable rate of effective and unlikely to be reversed. economic growth. This outcome depends on market Stability of the general price level will yield mechanisms that provide incentives for economic important long-run benefits. Nominal interest rates progress by encouraging creativity, innovation, will be reduced with the disappearance of expecta saving, and investment. Markets perform these tions of inflation, and real interest rates likely will be tasks most effectively when individuals can reason lower as well, as less uncertainty about the future ably believe that by forgoing consumption or leisure behavior of overall prices induces a greater willing in the present they can reap adequate rewards in the ness to save. Higher saving and capital accumula future. Inflation insidiously undermines such tion will enhance productivity, and the trend growth confidence. It raises doubts in people's minds about in real GNP will be greater than would be possible if the future real value of their nominal savings and the recent inflation rate continued. earnings, and it distorts decision-making. Faced If past patterns of monetary behavior persist, with inflation, investors are more likely to divert maintaining price stability will require an average their attention to protecting the near-term purchas rate of M2 growth over time approximately equal to ing power of their wealth. Modern-day examples of the trend growth in output. During the transition, economies stunted by rapid inflation are instructive. the decline of market interest rates in response to the In countries with high rates of inflation, people tend moderation in inflation would boost the public's to put their savings in foreign currencies and demand for M2 relative to nominal spending, commodities rather than in the financial investments lowering M2 velocity. M2 growth over several years and claims on productive assets that can best foster accordingly may show little deceleration, and it domestic growth. By ensuring stable prices, could actually speed up from time to time, as monetary policy can play its most important role in interest rates decline in fits and starts. Hence, the promoting economic progress. FOMC would not expect to lower its M2 range The strategy of the Federal Open Market mechanically each and every year in the transition to Committee (FOMC) for moving toward this goal price stability. remains the same-to restrain growth in money and aggregate demand in coming years enough to establish a clear downward tilt to the trend of 2 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis This qualitative description of our medium-term money and debt. With the economic situation not strategy is easy to state, but actually implementing it materially different from what was anticipated will be difficult. Unexpected developments no doubt at that time, the FOMC reaffirmed the tentative will require flexible policy responses. Any such 3 to 7 percent growth range for M2 in 1990 that it set adjustments will not imply a retreat from the last July. This range, which is the same as that used medium-term strategy or from ultimate policy goals. in 1989, is expected by most FOMC members to Rather, they will be mid-course corrections that produce somewhat slower growth in nominal GNP attempt to keep the economy and prices on track. this year. The declines in short-term interest rates The easing of reserve pressures starting last June is a through late last year can be expected to continue to case in point. Successive FOMC decisions to ease boost the public's demands for liquid balances in operating policy were intended to forestall an M2, at least for a while longer. M2 growth over 1990 economic downturn, the chances of which seemed to thus may be faster than in recent years, and M2 be increasing as the balance of risks shifted away velocity could well decline over the four quarters of from greater inflation. The FOMC was in no way the year, absent a pronounced firming in short-term abandoning its long-run goal of price stability. market interest rates. Instead, it sought financial conditions that would In contrast with M2, the range for M3 has been support the moderate economic expansion judged to reduced from its tentative range set last July. The be consistent with progress toward stable prices. In new M3 range of 2 ½ to 6 ½ percent is intended to the event, output growth was sustained last year, embody the same degree of restraint as the M2 although in the fourth quarter a major strike at range, but it was lowered to reflect the continued Boeing combined with the first round of production decline in thrift assets and funding needs now cuts in the auto industry accentuated the underlying anticipated to accompany the ongoing restructuring slowdown. On the inflation side, price increases in of the thrift industry. This asset runoff began in the second half were appreciably lower than those in earnest in the second half oflast year, so its magni the first. Although the CPI for January, as expected, tude was not incorporated into the tentative M3 showed a sizable jump in energy and food prices in range for 1990 set lastjuly. The bulk of the mort the wake of December's cold snap, a reversal is gage and real estate assets that thrifts will shed are apparently underway. expected to be acquired by the Resolution Trust Corporation and diversified investors other than depository institutions. Such assets thus will no Monetary Policy and the Economic longer be financed by monetary instruments Outlook for 1990 included in M3. In addition, commercial banks are Against this background, the Federal Reserve likely to be more cautious in their lending activities, Governors and the Presidents of Reserve Banks reducing their need to issue wholesale managed foresee continued moderate economic expansion liabilities included in M3. These influences should over 1990, consistent with conditions that will foster retard the growth of M3 relative to M2 again this progress toward price stability over time. At its year. meeting earlier this month, the FOMC selected The debt of domestic nonfinancial sectors is ranges for growth in money and debt it believes will expected to decelerate along with nominal GNP for promote this outcome. a fourth straight year, and the Committee chose to My testimony last July indicated the very lower the monitoring range for this aggregate to preliminary nature of the tentative ranges chosen for 5 to 9 percent for 1990. Merger and acquisition 1990, given the uncertain outlook for the economy, activity has retreated from the feverish pace of financial conditions, and appropriate growth of recent years, reflecting some well-publicized 3 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis difficulties of restructured firms and more caution Risks to the Economic Outlook on the part of creditors. All other things equal, less Experience has shown such macroeco~omic . restructuring activity and greater use of equity forecasts to be subject to a variety of risks. Assessing finance imply reduced corporate borrowing. An the balance of risks between production shortfalls ebbing of growth in household debt also seems and inflation pressures in the current outlook is probable. complicated by several cross-currents in the Over the last decade, money and debt aggregates domestic and international economic and financial have become less reliable guides for the Federal situation. Reserve in conducting policy. The velocities of the One risk is that the weakness in economic activity aggregates have ranged widely from one quarter or evident around year-end may tend to cumulate, one year to the next, in response to interest rate causing members' forecasts about production and movements and special factors. In the coming year, employment this year to be overly optimistic. the effects of the contraction of the thrift industry on However, available indicators of near-term eco the velocity of M3, and to a lesser extent on that of nomic performance suggest that the weakest point M2, are especially difficult to predict. While may have passed. The inventory correction in the recognizing that the growth rates of the broader auto industry-a rapid one involving a sharp monetary aggregates over long periods are still good reduction in motor vehicle assemblies injanuary indicators of trends in inflation, the FOMC will coupled with better motor vehicle sales-seems to be continue to take an array of factors into account in largely behind us. Industrial activity outside of guiding operating policy. Information about . motor vehicles appears to be holding up. Production emerging patterns of inflationary pressure, business of business equipment, where evidence has accumu activity, and conditions in domestic and interna lated of some stability-if not an increase-in orders tional financial markets again will need to supple for capital goods, is likely to support manufacturing ment monetary data in providing the background output in coming months. Housing starts were . for decisions about the appropriate operating stance. depressed in December by severely cold weather in The Committee's best judgment is that money much of the country. But starts bounced back and debt growth within these annual ranges will be strongly in January, in line with the large gain in compatible with a moderation in the expansion of construction employment last month. From these nominal GNP. Most FOMC members and other and similar data, one can infer the beginnings of a Reserve Bank presidents foresee real GNP growing modest firming in economic activity. While we 1 ¾ to 2 percent over the year as a whole. Such a cannot be certain that we are as yet out of the rate would be around last year's moderate pace, recessionary woods, such evidence warrants at least excluding the rebound in agricultural output from guarded optimism. the 1988 drought. A slight easing of pressures on There are, however, other undercurrents that resources probably is in store. Inflation pressures continue to signal caution. One that could disturb should remain contained, even though the decline in the sustainability of the current economic expansion the dollar's value over the past half-year likely will has been the recent substantial deterioration in reverse some of the beneficial effects on domestic profit margins. A continuation of this trend could inflation stemming from the dollar's earlier appreci seriously undercut the still expanding capital goods ation. The CPI this year is projected to increase market. However, if current signs of an upturn in 4 to 4 ½ percent, as compared with last year's economic activity broaden, profit margins can be 4½ percent. expected to stabilize. 4 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis A more deep-seated concern with respect to the International Financial Markets and longer-run viability of the expansion is the increase Monetary Policy in debt leverage. Although the trends of income and Among other concerns, recent events have high cash flow may have turned the corner, the structure lighted the complex interactions between develop of the economy's financial balance sheet weighs ments in the U.S. economy and financial markets increasingly heavily on the dynamics of economic and those in the other major industrial countries. expansion. In recent years, business debt burdens Specifically, the parallel movements in long-term have been enlarged through corporate restructur interest rates here and abroad over the early weeks ings, and as a consequence interest costs as a percent of 1990 have raised questions: To what extent is the of cash flow have risen markedly. Responding to U.S. economy subject to influences from abroad? To certain well-publicized debt-servicing problems, what extent, as a consequence, have we lost control creditors have become more selective in committing over our economic destiny? The simple answer to funds for these purposes. Within the banking these questions is that the U.S. economy is influ industry, credit standards have been tightened for enced from abroad to a substantially greater degree merger and LBO loans, as well as for some other than, say, two or three decades ago, but U.S. business customers. Credit for construction projects monetary policy is, nonetheless, able to carry out its reportedly has become less available because of responsibilities effectively. FIRREA-imposed limits and heightened concerns The post-war period has seen markedly closer ties about overbuilding in a number of real estate among the world's economies. Markets for goods markets. have become increasingly, and irreversibly, Among households, too, debt-servicing burdens integrated as a result of the downsizing of economic have risen to historic highs relative to income, and output and the consequent expansion of interna delinquency rates have moved up oflate. Suppliers tional trade. The past decade, in particular, also has of consumer and mortgage credit appear to have witnessed the growing integration of financial tightened lending terms a little. Real estate values markets around the world. Advancing technology have softened in some locales, although prices have has fostered the unbundling and transfer of risk and maintained an uptrend in terms of the national engendered a proliferation of new financial prod averages, especially for single-family residences. ucts. Cross border financial flows have accordingly These and other financial forces merit careful accelerated at a pace in excess of global trade gains. This globalization of financial markets has meant monitoring. While welcome from a supervisory that events in one market or in one country can perspective, more cautious lending does have the affect within minutes developments in markets potential for damping aggregate demand. throughout the world. It is difficult to assess how serious a threat More integrated and open financial markets have increased leverage is to the current levels of eco enabled all countries to reap the benefits of nomic activity. Clearly, should the economy fall into enhanced competition and improved allocation of a recession, excess debt service costs would intensify capital. Our businesses can raise funds almost the problems of adjustment. But it is unlikely that in anywhere in the world. Our savers can choose from current circumstances strains coming from the a lengthening menu of investments as they seek the economy's financial balance sheet can themselves highest possible return on their funds. Our financial precipitate a downturn. As I indicated earlier, we institutions enjoy wider opportunities to compete. expect nonfinancial debt growth to continue to slow from its frenetic pace of the mid-1980s. This should lessen the strain and hopefully the threat to the economy. 5 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis In such an environment, a change in the expected Moreover, despite globalization, financial rate of return on financial assets abroad naturally markets do not necessarily move together-they also can affect the actions of borrowers or lenders in the respond to more localized influences. Over 1989, for United States. In response, exchange rates, asset example, bond yields in West Germany and Japan prices, and rates of return all may adjust to new rose about a pe_rcentage point, while those in the values. United States fell by a similar amount. The contrast Strengthened linkages among world financial between 1989 and 1990 illustrates the complexity of markets affect all markets and all investors. Just as relationships among financial markets. Interactions U.S. markets are influenced by developments in can show through in movements in exchange rates markets abroad, foreign markets are influenced by as well as interest rates, and changes in the relative events here. These channels of influence do not prices of assets depend on a variety of factors, depend on whether a country is experiencing a including economic developments and inflation deficit or a surplus in its current account. In today's expectations in various countries as well as mone financial markets, the net flows associated with tary and fiscal policies here and abroad. current account surpluses and deficits are only the The importance of foreign economic policies for tip of the iceberg. What are more important are domestic economic conditions has given rise in the huge stocks of financial claims-more than recent years to a formalized process of policy $1.5 trillion held in the United States by foreigners coordination among the major industrial countries. and more than $26 trillion of dollar-denominated The purpose of such coordination is to help policy claims on U.S. borrowers held by U.S. residents. makers achieve better performance in their national This is in addition to the vast quantities of assets economies. It begins with improved communication held in foreign currencies abroad. It is these among authorities about economic developments holdings that can respond to changes in actual and within each country. It includes systematic analysis expected rates of return. of the likely impact of these developments on the In recent years we have seen several instances in economies of the partner countries and on variables which rates of return have changed essentially such as exchange rates that are inherently jointly simultaneously around the world. For example, determined in international markets. Within such a stock prices moved together in October 1987 and framework, it is possible to consider alternative 1989, and in 1990 bond yields have risen markedly choices for economic policies and to account in many industrial countries. explicitly for the impacts of likely policy measures in However, we must be cautious in interpreting one country on the other economies. such events, and in drawing implications for the The influence of economic policies abroad and United States. Frequently, such movements occur in other foreign developments on the U.S. economy is response to a common worldwide influence. profound, and the Federal Reserve must carefully Currently, the world economy is adjusting to the take them into account when considering its implications of changes in Eastern Europe, where monetary policy. But these influences do not there are tremendous new opportunities to invest fundamentally constrain our ability to meet our and promote reconstruction and growth. Those most important monetary policy objectives. opportunities, while contributing to the increase in interest rates in the United States, also open up new markets for our exports. 6 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Developments within U.S. financial markets remain Monetary policy is only one tool, however, and it the strongest influence on the asset prices and cannot be used successfully to meet multiple interest rates determined by those markets and, objectives. The Federal Reserve, for example, can through them, on the U.S. economy. Exchange address itself to either domestic prices or exchange rates absorb much of the impact of developments in rates but cannot be expected to achieve objectives foreign asset markets, permitting U.S. interest rates for both simultaneously. Monetary policy alone is to reflect primarily domestic economic conditions. not readily capable of addressing today's large Exchange rates influence the prices of products that current account deficit, which is symptomatic of do, or can, enter into international trade. Such underlying imbalances among saving, spending, factors can bring about changes in the composition and production within the U.S. economy. Contin of production between purely domestic goods and ued progress in reducing the federal deficit is a more services and those entering international trade, and appropriate instrument to raise domestic saving and they can affect aggregate price movements for a free additional resources for productive investment. time. The long-term health of our economy requires the However, the overall pace of spending and output balanced use of monetary and fiscal policy in order in the United States depends on the demands upon to reach all of the nation's policy objectives. all sectors of the U.S. economy taken together. And our inflation rate, over time, depends on the strength of those demands relative to our ability to supply them out of domestic production. Because the Federal Reserve is able to affect short-term interest rates in U.S. financial markets, it is able to influence the pace of economic activity in the short-run and inflationary pressures longer-term. To be sure, monetary policy must currently balance more factors than in previous decades. But our goals are still achievable. 7 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 1990 MONETARY POLICY OBJECTIVES This Executive Summary provides highlights of the Board's Review to the Congress on the Full Employment and Balanced Growth Act of 1978. February 20, 1990 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Contents Section Page Monetary Policy and the Economic Outlook for 1990 3 Monetary Policy for 1990 4 Economic Projections for 1990 5 The Performance of the Economy 1n 1989 6 The Household Sector 6 The Business Sector 7 The Government Sector 7 The External Sector 7 Labor Markets 8 Price Developments 9 Monetary Policy and Financial Developments during 1989 10 Implementation of Monetary Policy 10 Behavior of Money and Credit 11 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Monetary Policy and the Economic Outlook for 1990 The U.S. economy recorded its seventh consecutive M3 Billions of Dollars year of expansion in 1989. Although growth was slower than in the preceding two years, it was suffi cient to support the creation of 2 ½ million jobs and 4150 to hold the unemployment rate steady at 5 ¼ per cent, the lowest reading since the early 1970s. On 4050 the external front, the trade and current account deficits shrank further in 1989. And while inflation 3950 remained undesirably high, the pace was less than many analysts-and, indeed, most members of the 3850 Federal Open Market Committee (FOMC)-had predicted, owing in part to the continuing diminu 3750 tion in longer-range inflation expectations. In 1989, monetary policy was tailored to the changing contours of the economic expansion and 0 N D J F M A M J J A S O N D the potential for inflation. Early in the year, as for 1988 1989 most of 1988, the Federal Reserve tightened money market conditions in order to prevent pressures on Around midyear, risks of an acceleration in infla wages and prices from building. Market rates of tion were perceived to have diminished as pressures interest rose relative to those on deposit accounts, on industrial capacity had moderated, commmodity and unexpectedly large tax payments in April and prices had leveled out, and the dollar had strength May drained liquid balances, restraining the growth ened on exchange markets, reinforcing the signals of the monetary aggregates in the first half of the conveyed by the weakness in the monetary year. By May, M2 and M3 lay below the lower aggregates. In June, the FOMC began a series of bounds of the annual target ranges established by steps, undertaken with care to avoid excessive infla the FOMC. tionary stimulus, that trimmed 1 ½ percentage points from short-term interest rates by year-end. M2 Billions of Dollars Longer-term interest rates moved down by a like amount, influenced by both the System's easing and a reduction in inflation expectations. 3250 Growth of M2 rebounded to end the year at about the midpoint of the 1989 target range. Growth of M3, however, remained around the lower end of 3150 its range, as a contraction of the thrift industry, encouraged by the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (FIRREA), 3050 reduced needs to tap M3 sources of funds. The pri mary effect of the shrinkage of the thrift industry's 2950 assets was a rechanneling of funds in mortgage mar kets, rather than a reduction in overall credit avail ability; growth of the nonfinancial ,sector debt 0 N D J F M A M J J A S O N D aggregate monitored by the FOMC was just a bit 1988 1989 slower in the second half than in the first, and this measure ended the year only a little below the mid point of its range. 3 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Thus far this year, the overnight rate on federal The Committee reduced the M3 range to 2 ½ to funds has held at 8 ¼ percent, but other market 6 ½ percent to take account of the effects of the rates have risen. Increases of as much as 1/2 per restructuring of the thrift industry, which is expected centage point have been recorded at the longer end to continue in 1990. A smaller proportion of mort of the maturity spectrum. The bond markets gages is likely to be held at depository institutions responded to indicators suggesting a somewhat and financed by elements in M3; thrift institution greater-than-anticipated buoyancy in economic assets should continue to decline, as some solvent activity-which may have both raised expected real thrifts will be under pressure to meet capital stan returns on investment and renewed some apprehen dards and insolvent thrifts will continue to be sions about the outlook for inflation. The rise in shrunk and closed, with a portion of their assets yields occurred in the context of a general ~imup in carried, temporarily, by the government. An international capital market yields, which appears to increase in lender-and borrower-caution more have been in part a response to emerging opportuni generally points to some slowing in the pace at ties associated with the opening of Eastern Europe; which nonfinancial sectors take on debt relative to this development had particularly notable effects on their income in 1990. In particular, recent develop the exchange value of the West German mark, ments suggest that leveraged buyouts and other which rose considerably relative to the dollar, the transactions that substitute debt for equity in cor yen, and other non-EMS currencies. porate capital structures will be noticeably less important in 1990 than in recent years. Moreover, Monetary Policy for 1990 a further decline in the federal sector's deficit is expected to reduce credit growth this year. In light The Federal Open Market Committee is committed of these considerations, the Committee reduced the to the achievement, over time, of price stability. The monitoring range for debt of the nonfinancial sectors importance of this objective derives from the fact to 5 to 9 percent. that the prospects for long-run growth in the econ The setting of targets for money growth in 1990 is omy are brightest when inflation need no longer be made more difficult by uncertainty about develop a material consideration in the decisions of house ments affecting thrift institutions. The behavior of holds and firms. The members recognize that certain M3 and, to a more limited extent, M2 is likely to short-term factors-notably a sharp increase in food be affected by such developments, but there is only and energy prices-are likely to boost inflation early limited basis in experience to gauge the impact. this year, but anticipate that these factors will not persist. Under these circumstances, policy can sup port further economic expansion without abandoning Ranges of Growth for Monetary and the goal of price stability. Credit Aggregates 1 To foster the achievement of those objectives, the (Percent Change, Fourth Quarter to Fourth Quarter) Committee has selected a target range of 3 to 7 per cent for M2 growth in 1990. Growth in M2 may be 1988 1989 1990 more rapid in 1990 than in recent years, and yet be consistent with some moderation in the rate of M2 4 to 8 3 to 7 3 to 7 increase in nominal income and restraint on prices; M3 4 to 8 3 ½ to 7 ½ 2 ½ to 6½ in particular, M2 may grow more rapidly than nominal GNP in the first part of this year in lagged Debt 7 to 11 6½ to 10½ 5 to 9 response to last year's interest rate movements. Eventually, however, slower M2 growth will be required to achieve and maintain price stability. 4 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Economic Projections for 1990 The recent depreciation of the dollar likely will constitute another impetus to near-term price The Committee members, and other Reserve Bank increases reversing the restraining influence exerted presidents, expect that growth in the rea! economy by a stro~g dollar throug~ mos~ o~ last year: Prices will be moderate during 1990. Most project real of imported goods, excluding 011, increased in the GNP growth over the four quarters of the year to be fourth quarter after declining through the first three between 1 ¾ and 2 percent-essentially the same quarters of 1989. The full eff~ct o~ this upturn_ likely increase as in 1989, excluding the bounceb ack in will not be felt on the domestic pnce level until farm output after the 1988 drought. It is expected some additional time has passed. that this pace of expansion will be reflected in some Despite these adverse elements in the near-term easing of pressures on domestic resources; the cen picture, the Committee believes that _progr~ss toward tral tendency of forecasts is for an unemployment price stability can be achieved over time, given the rate of 5 ½ to 5 ¾ percent in the fourth quarter. apparently moderate pace of activity. In terms of the Given their importance in determining the trend consumer price index, most_ members expect an of overall costs, a deceleration in the cost of labor increase of between 4 and 4 ½ percent, compared inputs is an integral part of any solid progress with the 4. 5 percent advance recorded in 1989. toward price stability. Unfortunately, the near-term Relative to the Committee, the Administration prospects for a moderation in labor cost pressures currently is forecasting more rapid growth in real are not favorable. Compensation growth is being and nominal GNP. At the same time, the Adminis boosted in the first half of 1990 by an increase in tration's projection for consumer price inflation is at social security taxes and a hike in the minimum the low end of the Committee's central tendency wage. The anticipated easing of pressures in the range. labor market should help produce some moderation Most Committee members believe that growth in in the pace of wage increases in the second hal_f of nominal GNP will be between 5 ½ and 6 ½ percent, 1990 but the Committee will continue to momtor but a more rapid expansion in nominal income . closeiy the growth of labor costs for signs of progress would be welcome if it promised to be accompamed in this area. by a declining path for inflation in 1990 and beyond. Economic Projections for 1990 1989 Actual FOMC Members and other FRB Presidents Administration Range Central Tendency Nominal GNP 6.4 4 to 7 5 ½ to 6½ 7.0 Percent change, fourth quarter to Real GNP 2.4 1 to 2¼ 1 ¾ to 2 2.6 fourth quarter: Consumer price index 4.5 3½ to 5 4 to 4½ 4.11 Average level in the fourth quarter, Unemployment rate 5.3 5 ½ to 6½ 5 ½ to 5¾ 5.42 percent: 1. CPI-W. FOMC forecasts are for CPI-U. 2. Percent of total labor force, including armed forces residing in the United States. 5 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis The Performance of the Economy • 1989 Ill Real GNP grew 2 ½ percent over the four quarters The Household Sector of 1989, 2 percent after adjustment for the recovery Household spending softened significantly in 1989, in farm output from the drought losses of the prior with a marked weakening in the demand for motor year. This constituted a significant downshifting in vehicles and housing. Real consumer spending on the pace of expansion from the unsustainably rapid goods and services increased 2 ¼ percent over the rates of 198 7 and 1988, which had carried activity to four quarters of 1989, 1 ½ percentage points less the point that inflationary strains were beginning to than in 1988. Growth in real disposable income become visible in the economy. As the year slowed last year, but continued to outstrip growth in progressed, clear signs emerged that pressures on spending, and, as a result, the personal saving rate resource utilization were easing, particularly in the increased to 5 ¾ percent in the fourth quarter of industrial sector. Nonetheless, the overall unemploy 1989. ment rate remained at 5.3 percent, the lowest read ing since 19 7 3, and inflation remained at 4 ½ per Percent of cent despite the restraining influence of a dollar that Personal Saving disposable income was strong for most of the year. Real GNP Percent change, Q4 to Q4 6 Drought-Adjusted 6 3 4 1984 1985 1986 1987 1988 1989 2 The slackening in consumer demand was concen trated in spending on goods. Real spending on + durable goods was about unchanged from the fourth quarter of 1988 to the fourth quarter of 1989-after jumping 8 percent in the prior year-chiefly reflect ing a slump in purchases of motor vehicles. Residential investment fell in real terms through 1984 1985 1986 1987 1988 1989 the first three quarters of 1989, and with only a slight upturn in the fourth quarter, expenditures decreased 6 percent on net over the year. Construc tion was weighed down throughout 1989 by the overbuilding that occurred in some locales earlier in the decade. Vacancy rates were especially high for multifamily rental and condominium units. In the single-family sector, affordability problems con stained demand, dramatically so in those areas in which home prices had soared relative to household income. 6 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis The Business Sector The External Sector Business fixed investment, adjusted for inflation, The U.S. external deficits improved somewhat in increased only 1 percent at an annual rate during 1989, but not by as much as in 1988. On a balance the second half of 1989 after surging 7 ¾ percent of-payments basis, the deficit on merchandise trade during the first half. Although competitive pressures fell from an annual rate of $128 billion in the fourth forced many firms to continue seeking efficiency quarter of 1988 ( and $12 7 billion for the year as a gains through capital investment, the deceleration in whole) to $114 billion in the first quarter of 1989. overall economic growth made the need for capacity Thereafter, there was no further net improvement. expansion less urgent, and shrinking profits reduced The appreciation in the foreign exchange value of the availability of internal finance. the dollar between early 1988 and mid-1989 appears Nonfarm business inventory investment averaged to have played an important role in inhibiting fur $21 billion in 1989. Although the average pace of ther progress on the trade front. During the first accumulation last year was slower than in 1988, the three quarters of 1989, the current account, exclud pattern across sectors was somewhat uneven. ing the influence of capital gains and losses that are Nonetheless, most sectors of the economy have largely caused by currency fluctuations, showed a adjusted fairly promptly to the deceleration in sales, deficit of $106 billion at an annual rate-somewhat and appear to have succeeded in preventing serious below the $124 billion deficit in the comparable overhangs from developing. period of 1988. The Government Sector Foreign Exchange Value of the Budgetary pressures continued to restrain the growth U.S. Dollar* Index, March 1973 =100 of purchases at all levels of government. At the fed eral level, purchases fell 3 percent in real terms over the four quarters of 1989, lower defense purchases 150 accounting for the bulk of the decline. Nondefense purchases also declined in real terms from the fourth 130 quarter of 1988 to the fourth quarter of 1989; increases in such areas as the space program and 110 drug interdiction were more than offset by general budgetary restraint that imposed real declines on most other discretionary programs. 90 Purchases of goods and services at the state and local level increased 2 ½ percent in real terms over the four quarters of 1989, down more than a per 1984 1985 1986 1987 1988 1989 centage point from the average pace of the preced *Index of weighted average foreign exchange value of U.S. dollar in terms of cur ing five years. Nonetheless, there were some areas rencies of other G-10 countries plus Switzerland. Weights are 1972-76 global trade of each of the 10 countries. of growth. Spending for educational buildings increased, and employment in the state and local sector rose 350,000 over the year, largely driven by On a GNP basis, merchandise exports increased a pickup in hiring by schools. Despite the overall about 11 percent in real terms over the four quarters slowdown in the growth of purchases, the budgetary of 1989-roughly 4 percentage points less than in 1988. position of the state and local sector deteriorated further over the year. 7 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Labor Markets Annual rate, U.S. Real Merchandise Trade billions of 1982 dollars Employment growth slowed in the second half of 1989; nonetheless, nonfarm payrolls increased nearly 500 2 ½ million during the year. The bulk of this expan Imports sion occurred in the service-producing sector. By 400 contrast, the manufacturing sector shed 100,000 jobs. These job losses were more than accounted for by declines in the durable goods industries, and 300 ---~ ,,,, ,,,, appeared to reflect the slump in auto sales, the Exports -- weakening in capital spending, and the effects of a -- 200 stronger dollar on exports and imports. Despite the slowdown in new job creation, the overall balance of supply and demand in the labor market remained steady over the year. The civilian 1984 1985 1986 1987 1988 1989 unemployment rate, which had declined about 1/2 percentage point over the twelve months of Merchandise imports excluding oil expanded 1988, finished 1989 at 5.3 percent-unchanged from about 7 percent in real terms during 1989, with twelve months earlier. much of the rise accounted for by imports of com puters. Imports of oil increased 6 percent from the Quarterly Civilian Unemployment Rate fourth quarter of 1988 to the fourth quarter of 1989, average, percent to a rate of 8.3 million barrels per day. At the same time, the average price per barrel increased almost 40 percent, and the nation's bill for foreign oil 9 jumped 45 percent. The counterpart of the current account deficit of '---- $106 billion at an annual rate over the first three ..........., 7 quarters of 1989 was a recorded net capital inflow of about $60 billion at an annual rate and an unusually large statistical discrepancy, especially in the second 5 quarter. Nonfarm Payroll Employment Net change, millions 1984 1985 1986 1987 1988 1989 of persons, Q4 to Q4 lilll Total D Manufacturing A slowdown in the growth of productivity often 6 accompanies a softening in the general economy, and productivity gains were lackluster in 1989. Out put per hour in the private nonfarm business sector 3 increased only 1/2 percent over the four quarters of the year-1 percentage point below the rate of increase in 1988. In the manufacturing sector, + productivity gains during the first half of 1989 kept pace with the 1988 average of 3 percent; in the sec ond half, however, productivity growth slowed to an 1984 1985 1986 1987 1988 1989 annual rate of 2 ¼ percent. 8 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Price Developments Consumer Food Prices* Percent change, Q4 to Q4 Inflation in consumer prices remained in the neigh borhood of 4 ½ percent for the third year in a row, as the level of economic activity was strong and con 6 tinued to exert pressures on available resources. During the first half of the year, overall inflation was boosted by a sharp runup in energy prices and a carry-over from 1988 of drought-related increases in food prices. However, inflation in food prices slowed during the second half, and energy prices retraced about a third of the earlier run-up. Food prices increased 5 ½ percent at the retail level, slightly more than in 1988 when a number of crops were severely damaged by drought. Continued supply problems in some agricultural markets in 1989-notably a poor wheat crop and a shortfall in 1984 1985 1986 1978 1988 1989 dairy production-likely prevented a deceleration •Consumer Price Index for all urban consumers. from the drought-_induced rate of increase in 1988. Consumer energy prices surged 17 percent at an Consumer Prices* Percent change, Q4 to Q4 annual rate during the first six months of 1989, before dropping back 6 percent in the second half. Consumer price increases for items other than food and energy remained at about 4 ½ percent in 1989. 6 In contrast to goods prices, the prices of nonenergy services-which make up half of the overall con sumer price index-increased 5 ¼ percent in 1989, 1/4 percentage point more than in 1988. The pickup in this category was led by rents, medical services, and entertainment services. 1984 1985 1986 1987 1988 1989 •Consumer Price Index for all urban consumers. 9 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Monetary and Financial Developments during 1989 In 1989 the Federal Reserve continued to pursue a Implementation of Monetary Policy policy aimed at containing and ultimately eli~inat In the opening months of the year, the Federal ing inflation while providing suppo:t for contu~ued Open Market Committee extended the mo:e toward economic expansion. In implementmg that policy, restraint that had begun almost a year earlier, seek the Federal Open Market Committee mai~tained_ a ing to counter a disquieting intensification of infla flexible approach to monetary targeting, with policy tionary pressures. Policy actions in January and responding to emerging conditions in the economy February, restraining reserve availability and raising and financial markets. This flexibility has been the discount rate,· prompted a further 3/4 percentage necessitated by the substantial variability in the point increase in short-term market i~te:est r_ates. short-run relationship between the monetary As evidence on prospective trends m mflat10n and aggregates and economic performan:e; however, spending became more mixed in the se~ond quarter, when viewed over a longer perspective, those the Committee refrained from further t1ghtenmg and aggregates are still useful in conveying information in June began to ease pressures on reserve marke.ts. about price developments. . As the information on the real economy, along with As the year began, monetary policy was followmg the continued rise in the dollar, suggested that the through on a set of measured steps begun a year outlook for inflation was improving, most long-term earlier to check inflationary pressures. By then, how nominal interest rates fell as much as a percentage ever, evidence of a slackening in aggregate demand, point from their March peaks; the yield on the bell along with sluggish growth of the moneta:y . wether thirty-year Treasury bond moved down to aggregates, suggested that the year-long nse 1~ . about 8 percent by the end of June. short-term interest rates was noticeably restrammg In July, when the FOMC met for its semiann~al the potential for more inflation. But, after a 1/2 per review of the growth ranges for money and credit, centage point increase in the discount rate at the M2 and M3 lay at or a bit below the lower bounds end of February, the Federal Reserve took no fur of their target cones. This weakness, reinforcing the ther policy action until June. Over the balance ~f signals from prices and activity, c??tribute~ to the 1989 the Federal Reserve moved toward an easmg Committee's decision to take add1t10nal easmg of m~ney market conditions, as indications mounted action in reserve markets. of a slack in demand and lessened inflation pres Late in the summer, longer-term interest rates sures. The easing in reserve availability induced turned higher, as several economic data releas~s sug declines in short-term interest rates of 1 ½ percent gested reinvigorated inflationary pressures. ~1th age points; money growth strengthened appreciably, growth in the monetary aggregates reboundmg, the and M2 was near the middle of its target range by Committee kept reserve conditions about unchanged the end of 1989. The level of M3, on the other until the direction of the economy and prices ; hand remained around the lower bound of its clarified. rang~, with its weakness mostly reflecting the shi.ft Beginning in October, amid indi~ations of. added ing pattern of financial intermediation as the :hnft risks of a weakening in the economic expans10n, the industry retrenched. The growth of nonfinanc1~l FOMC reduced pressures on reserve markets in debt was trimmed to 8 percent in 1989, about m three separate steps, which nudged the federal funds line with the slowing in the growth of nominal GNP, rate down to around 8 ¼ percent by year-end, about and ended the year at the midpoint of its monitoring 1 ½ percentage points below its level when incre range. mental tightening ceased in February. 10 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Behavior of Money and Credit The Ml component of M2 was especially affected by the swings in interest rates and opportunity costs Growth in M2 was uneven over 1989, with marked last year, and in addition was buffeted by the effects weakness in the first part of the year giving way to of outsized tax payments in April. After its 4 ¼ per robust growth thereafter. On balance over the year, Y: cent rise in 1988, Ml grew only 1/2 percent in M2 expanded 4 ½ percent, down from 5 pe~cent 1989 with much of the weakness in this transactions growth in 1988, placing it about at the m1dpomt of aggr;gate occurring early in the. ye~r. . . its 1989 target range of 3 to 7 percent. The sl?we~ The shift of deposits from thrift mst1tut10ns to rate of increase in M2 reflected some moderat10n m commercial banks and money fund shares owed, in nominal income growth as well as the pattern of part, to regulatory pressures that broug_ht down rates interest rates and associated opportunity costs of paid by some excessively aggressive thrifts. On bal holding money, with the effects of increases in_ 1988 ance the weak growth of retail deposits at thrifts and 1989 outweighing the later, smaller, drop m appe~rs to have been about offset by the shift into rates. Growth of Money and Debt (Percent change) Debt of Domestic M1 M2 M3 N onfinancial Sectors Fourth quarter to 1980 7.4 8.9 9.5 9.5 fourth quarter 1981 5.4 (2.5)* 9.3 12.3 10.2 1982 8.8 9.1 9.9 9.1 1983 10.4 12.2 9.8 11.1 1984 5.4 7.9 10.6 14.2 1985 12.0 8.9 7.8 13.1 1986 15.5 9.3 9.1 13.2 1987 6.3 4.3 5.8 9.9 1988 4.3 5.2 6.3 9.2 1989 0.6 4.6 3.3 8.1 Quarterly growth Ql -0.1 2.3 3.9 8.4 rates 1989 (annual rates) Q2 -4.4 1.6 3.3 7.9 Q3 1.8 6.9 3.9 7.2 Q4 5.1 7 .1 2.0 8.0 * Figure in parentheses is adjusted for shifts to NOW accounts in 1981. 11 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis commercial banks and money market mutual funds, Footnotes leaving M2 little affected overall by the realignment 1. M1 is currency held by the public, plus travelers' of the thrift industry. checks, plus demand deposits, plus other checkable M3 was largely driven, as usual, by the funding deposits [including negotiable order of withdrawal (NOW needs of banks and thrifts; under the special circum - and Super NOW) accounts, automatic transfer service stances of the restructuring of the thrift industry, it (ATS) accounts, and credit union share draft accounts]. was a less reliable barometer of monetary policy M2 is M 1 plus savings and small denomination time pressures than is normally the case. After expanding deposits, plus Mon~y Market Deposit Accounts, plus 6 ¼ percent in 1988, M3 hugged the lower bound of shares in money market mutual funds ( other than those its 3 ½ to 7 ½ percent target cone in 1989, closing restricted to institutional investors), plus overnight repur chase agreements and certain overnight Eurodollar the year about 3 ¼ percent above its fourth deposits. quarter-1988 base. In 1989, bank credit growth M3 is M2 plus large time deposits, plus large denomi about matched the previous year's 7 ½ percent nation term repurchase agreements, plus shares in money increase, but credit at thrift institutions is estimated market mutual funds restricted to institutional investors to have contracted a bit on balance over the year, in and certain term Eurodollar deposits. contrast to its 6 ¼ percent growth in 1988. Aggregate debt of the domestic nonfinancial sec tors grew at a fairly steady pace over 1989, averag ing 8 percent, which placed it near the midpoint of its monitoring range of 6 ½ to 10 ½ percent. Although the annual growth of debt slowed in 1989, as it had during the preceding two years, it still exceeded the 6 ½ percent growth of nominal GNP. Federal sector debt grew 7 ½ percent, about 1/2 per centage point below the 1988 increase-and the lowest rate of expansion in a decade-as the deficit leveled off. A copy of the full report to Congress is available from Publication Services, Federal Reserve Board, Washington, D.C. 20551 FRB 17-48000-0290 12 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis

Federal Reserve (1990, February 19). Monetary Policy Report. Monetary Policy Reports, Federal Reserve. https://whenthefedspeaks.com/doc/monetary_policy_report_19900220

@misc{wtfs_monetary_policy_report_19900220,
  author = {Federal Reserve},
  title = {Monetary Policy Report},
  year = {1990},
  month = {Feb},
  howpublished = {Monetary Policy Reports, Federal Reserve},
  url = {https://whenthefedspeaks.com/doc/monetary_policy_report_19900220},
  note = {Retrieved via When the Fed Speaks corpus}
}