Monetary Policy Report

1990 MONETARY POLICY OBJECTIVES Midyear Review of the Federal Reserve Board July 18, 1990 1990 MONETARY POLICY OBJECTIVES This Executive Summary provides highlights of the Board's Midyear Review to the Congress on Monetary Policy pursuant to the Full Employment and Balanced Growth Act of 1978. July 18, 1990 Contents Section Page Monetary Policy and the Economic Outlook for 1990 and 1991 3 Development Thus Far in 1990 3 Monetary Objectives for 1990 and 1991 4 Economic Projections for 1990 and 1991 5 The Performance of the Economy During the First Half of 1990 7 Price Developments 7 The Household Sector 8 The Business Sector 8 The Government Sector 9 The External Sector 10 Labor Markets 10 Monetary and Financial Developments During the First Half of 1990 11 The Implementation of Monetary Policy 12 Monetary and Credit Flows 13 Monetary Policy and the Economic Outlook for 1990 and 1991 The Federal Reserve delivered its initial Humphrey fluctuated narrowly around 8 ¼ percent throughout Hawkins report of 1990 to the Congress in Febru the first half of the year, has declined to about ary, and the period since then has been an especially 8 percent, and other market rates of interest also challenging one for monetary policy decisionmaking. have eased a bit in recent days. The already difficult task of moving a quite fully employed economy toward price stability without Developments Thus Far in 1990 mishap has been further complicated by a variety of In the early part of 1990, economic activity disturbances to business activity and financial appeared to be regaining momentum, a development markets. that reduced previous concerns about recessionary Inflation has been somewhat greater on average risks. At the same time, even discounting weather than expected in February; however, this mainly related spurts in food and energy prices and an reflected the influence of transitory factors early in unusual bunching of price increases for some other the year. Price increases recently have been more items, there appeared to be no abatement in under moderate. Meanwhile, the economy has continued lying inflationary pressures. Through the first quar to expand, but apparently rather sluggishly overall ter, M2 remained near the top of the annual range since the winter. set by the Committee. Although M3 was near the lower bound of its range, this weakness appeared Consumer Prices 12-Month Percent Change consistent with the anticipated effects of the restructuring of the thrift industry. The Federal Reserve maintained a steady pressure on reserve positions during the first quarter, rather 6 than extending the sequence of easing steps that had fostered a drop in the federal funds rate of 1 ½ per centage points between June and December of 1989. However, in keeping with the tenor of most of the w 3 economic data released during the quarter, other interest rates generally moved higher, particularly at the long end of the yield curve. This shift suggested that market participants had re-evaluated the pros pects for moderating inflation and a further easing 1984 1985 1986 1987 1988 1989 1990 of monetary policy. Early in the year, bond yields in the United States rose along with rates in Japan and While these aspects of the economic situation were Western Europe, as developments in Eastern Europe important elements in the Federal Open Market suggested a further spur to worldwide economic Committee's (FOMC) review of its policy plans activity, carrying the potential for greater inflation earlier this month, the Committee also gave careful and heightened pressures on a limited international attention to developments in financial markets. pool of savings. Although market interest rates had changed little on In the second quarter, some of the weather-related net since February, slow growth of the monetary increases in food and energy prices that had caused stock and other evidence in hand pointed to a small inflation to pick up earlier in the year were but significant tightening of credit supplies. This reversed, and price increases for many other goods implied greater effective restraint on aggregate and services moderated. Inflation trends remained in demand in the months ahead than was thought the range prevailing over the prior three years, desirable, and in the past week the System shifted to though price pressures in the industrial sector gave a slightly more accommodative stance in the pro signs of some easing. The incoming information vision of reserves to depository institutions. As a pointed to a sluggish pace of economic expansion. result, the overnight federal funds rate, which had 3 In foreign exchange markets, the dollar has With depository credit damped, not only were depreciated somewhat on balance thus far this year, managed liabilities weak, but banks and thrifts did under the influence of a diverse set of economic, not bid aggressively for retail funds-thereby con financial and political developments around the tributing to reduced growth of M2. In addition, world. The dollar has appreciated slightly in terms increases in expected returns on stocks and bonds of the yen, while depreciating somewhat in terms of may have restrained expansion of this aggregate, the German mark and other currencies of the Euro although some portion of the slowdown in M2 pean Monetary System (EMS) exchange rate mecha remains unexplained by changes in relative yields or nism and somewhat more in terms of the Swiss income. The weakness in depository credit and the franc and pound sterling. monetary aggregates likely has had, to date, only limited effects on spending. The bulk of the credit formerly supplied by depositories has been provided Foreign Exchange Value of the by other lenders, in part through the securities mar .s. U Dollar* Index, March 1973 -100 kets, with little change in the terms to most borrowers. Monetary Objectives for 1990 and 1991 150 In re-evaluating its ranges for money and credit for 1990 and in establishing tentative ranges for 1991, 125 the FOMC had to take account of the redirection of credit flows away from depository institutions and the resulting effect on the growth of the financial 100 aggregates relative to spending and prices. In Febru ary, the Committee expected that the continued shrinkage of the thrift industry would damp growth in M3. To take account of this, it lowered the M3 1984 1985 1986 1987 1988 1989 1990 range for 1990 to 2 ½ to 6 ½ percent, one percent *Index of weighted average foreign exchange value of U.S. dollar in terms of cur age point below the range set tentatively in July 1989. rencies of other G-10 countries plus Switzerland. Weights are 1972-76 global trade of each of the 10 countries. However, the contraction of thrift assets has been faster than anticipated, in part because of the step-up in Resolution Trust Corporation (RT C) activity, The monetary aggregates flattened out during the and bank credit has expanded less rapidly. As a con second quarter, and by midyear M2 was in the lower half of its annual range and M3 had fallen sequence, through June, M3 grew at an annual rate of only 1 ¼ percent from its fourth-quarter 1989 base. below the lower bound of its annual range. The weakness in the monetary aggregates mainly, though not wholly, reflected a rechannelling of credit flows Ranges for Growth of Monetary and away from depository institutions. Total borrowing Credit Aggregates 1 by domestic nonfinancial sectors moderated only a (Percent Change, Fourth Quarter to Fourth Quarter) little in the first half of 1990 from the pace of 1989. Growth in the aggregate debt of these sectors was in Adopted in Adopted in Provisional the middle of the FOMC's monitoring range. How February July for ever, the proportion of lending accounted for by 1989 1990 1990 1991 depositories was down substantially, much of the decrease related to the shrinkage of savings and loan M2 3 to 7 3 to 7 3 to 7 2½ to 6½ associations. Meanwhile, concerns about credit qual M3 3 ½ to 7 ½ 2 ½ to 6½ 1 to 5 1 to 5 ity and pressures on capital positions led banks to adopt more cautious lending postures and to hold Debt 6½ to 10½ 5 to 9 5 to 9 4½ to 8½ down asset growth. 4 The weakness in M3 growth is expected to continue The range for growth of M3 was tentatively set at into the second half of the year and to be associated 1 to 5 percent, the same as that now in effect for with a further substantial increase in velocity-the 1990. The growth of this aggregate is especially sen ratio of nominal GNP to money. Recognizing this sitive to the pattern of credit flows. Thus, the con unusual behavior of M3 velocity, the FOMC voted tinuing downsizing of the thrift industry is likely to in early July to reduce the M3 range for 1990 to result in slower growth of M3 than of M2 again 1 to 5 percent. At the same time, the Committee next year, as managed liabilities in the broader reaffirmed its range of 5 to 9 percent for total aggregate run off. growth in the debt of domestic nonfinancial sectors. For debt, the FOMC adopted a tentative monitor The Committee seeks to ensure that credit continues ing range of 4 ½ to 8 ½ percent, a half percentage to be available in amounts and at terms compatible point below the range for 1990. The Committee with further moderate expansion of the economy. It viewed slower growth of debt, more in line with the will continue to assess the implications of develop expansion of nominal income, as a healthy develop ments at depositories for credit conditions more ment for the economy. generally. The contraction of the thrift industry and the Economic Projections for 1990 and 1991 moderate growth in bank credit also have affected The members of the FOMC and the Reserve Bank the growth of M2, as potential inflows of retail presidents not currently serving as members believe deposits have outpaced the needs of depository insti that the monetary ranges for 1990 and 1991 are con tutions for such funds. The velocity of this aggregate sistent with achievement of sustainable economic has risen, unexpectedly, but less than that of M3. growth and a reduction of inflation over time. Most Growth of M2 from its fourth-quarter base through of them expect that the pace of expansion will be June was at a 3 ¾ percent annual rate, within its moderate over the remainder of 1990 and through annual range, though in the lower half. M2 velocity the next year. The central tendency of their forecasts is likely to increase further over the second half of of real GNP growth is 1 ½ to 2 percent over the the year; however, a substantial slowing of M2 could four quarters of 1990 and 1 ¾ to 2 ½ percent over suggest more restraint than would be consistent with the course of 1991 . sustained upward momentum of the economy, and Demand from abroad is likely to provide support thus the Committee reaffirmed the established range for continued growth in U.S. production and for M2 growth for 1990. employment. At current exchange rates, U.S. In setting ranges for 1991, the Committee faced producers appear to be in a position to compete more than the usual uncertainty about the growth of effectively in most international markets, and eco money that would foster its objectives of sustained nomic activity is growing relatively rapidly on aver expansion and a gradual abatement of inflation. For age in other major industrial countries. In time, M2, the Committee tentatively adopted a range of export demand should be bolstered by the shift 2 ½ to 6 ½ percent-one-half percentage point below toward more open, market-based economic systems the 1990 range. The adjustment is consistent with in Eastern Europe. Although the continental Euro the Committee's intention to move over time toward pean nations may be most immediately affected by the low trend rates of monetary expansion that these developments, given the high rates of capacity would be consistent with price stability. At the same utilization in those economies, the United States is time, the range is expected to allow for sufficient likely to benefit both directly and indirectly from the expansion of money to sustain moderate growth in increased demand for consumer and capital goods. the economy. 5 The growth of total output projected for 1990 and Inflation at the retail level also should be damped 1991 probably will involve rather slow gains for the over the remainder of this year by favorable goods-producing sectors of the economy. The service developments in the energy sector. Despite the very producing industries are likely to continue to be the recent upturn in crude oil prices, gasoline prices are locus of important increases in output and, espe widely expected to decline in coming months, as the cially, employment. Demands for a wide range of return of refinery output to normal levels alleviates services have remained robust thus far this year, and the tightness that has characterized the product mar demographic trends suggest that such sectors as ket. With inflation for other goods and services medical care and education will continue to expected to remain below the first-quarter pace, the experience appreciable growth. central tendency of the policymakers' forecasts of the The overall growth in economic activity forecast overall Consumer Price Index (CPI) is for an for the period ahead is expected to be consistent increase of between 4 ½ and 5 percent over the four with a slight easing of pressures on resources and a quarters of 1990-compa:red with the 5 ¾ percent diminution of inflation. With respect to the labor annual rate of increase recorded during the first five market, the central tendency of the forecasts for the months of the year. The lower trajectory of the CPI civilian unemployment rate is 5 ½ to 5 ¾ percent in is projected to be sustained in 1991, with forecasts the fourth quarter of this year and 5 ½ to 6 percent for the year centering on the 3 ¾ to 4 ½ percent in the final quarter of 1991. The jobless rate has range. fluctuated narrowly at a little below 5 ½ percent since late 1988. Economic Projections for 1990 and 1991 FOMC Members and other FRB Presidents Administration 1990 Range Central Tendency Nominal GNP 5 to 6½ 5½ to 6½ 6.8 Percent change, fourth quarter to Real GNP 1 to 2 1 ½ to 2 2.2 fourth quarter: Consumer price index 4 to 5 4½ to 5 4.81 Average level in the fourth quarter, Civilian unemployment rate 5 ½ to 6 ½ 5 ½ to 5¾ 5.62 percent: 1991 Range Central Tendency Nominal GNP 3½ to 7 5¼ to 6½ 7.2 Percent change, fourth quarter to Real GNP 0 to 3 1 ¾ to 2 ½ 2.9 fourth quarter: Consumer price index 3½ to 5 3¾ to 4½ 4.21 Average level in the fourth quarter, Civilian unemployment rate 5 ¼ to 7 5½ to 6 5.62 percent: 1. CPI-W. FOMC forecasts are for CPI-U. 2. Percent of total labor force, including armed forces residing in the United States. 6 The Performance of the Economy During the First Half of 1990 Production expanded further during the first half of Consumer Prices Excluding 1990, but evidently no faster than the reduced pace Food and Energy 12-Month Percent Change of 1989. The comparatively slow rate of growth largely reflected weaker spending by domestic busi nesses and households, while merchandise exports Services Less Energy apparently remained on a fairly strong growth path. 6 Although job creation in the private sector of the economy has slowed this year, the civilian unem ployment rate has remained near 5 ¼ percent, the 3 lowest level in nearly 20 years. \ J • •. ..,~ \ I"" I " \ t"'-1 Commodities Less Food and Energy \./ Quarterly Civilian Unemployment Rate average, percent 1984 1985 1986 1987 1988 1989 1990 8 In the service sector, inflation rose markedly in the first quarter, in part reflecting some bunching of ~ increases for items whose prices tend to change in 6 irregular jumps, such as public transportation fares ~----Q2 and auto registration fees. Although inflation in ser 4 vice prices moderated in the spring, there was little retracing of the earlier increases. Indeed, in May, the CPI for nonenergy services was 5 ½ percent above its level twelve months earlier, the upper end 1984 1985 1986 1987 1988 1989 1990 of the range of increases seen over the past three and a half years. Increases in prices of rents, medi cal services, and a variety of labor-intensive services Price Developments have contributed significantly to the rise in overall After surging in the first quarter of 1990, price service prices so far this year. increases moderated this spring. Food and energy The signs of moderating inflation for goods at prices were boosted early in the year by weather earlier stages of processing, which had surfaced as related developments, and prices for a wide range of capacity utilization rates moved down during 1989, other goods and services also picked up sharply. appear to have continued into 1990. After rising However, by May, the transitory effects of the 4 ¼ percent in 1989, the Producer Price Index (PPI) weather on inflation largely had been reversed, and for finished goods excluding food and energy has price increases for many other items slowed increased at an annual rate of about 3 ¾ percent significantly. during the first six months of 1990. Producer prices The CPI excluding food and energy rose about for intermediate materials excluding food and energy 4 ¾ percent over the twelve months ending in May, increased at an annual rate of just 3/4 percent near the upper end of the range experienced during between December and June, roughly the same rate the current expansion. Price increases for consumer of increase as recorded over 1989 as a whole. The goods, particularly apparel, rose sharply early in the moderation of inflation for goods at the producer year. However, the burst in prices did not carry level is perhaps one indication that earlier moves through to the second quarter, as prices for com toward monetary restraint and the slower pace of modities excluding food and energy were little changed in April and May. 7 economic activity have worked to ease the resource Growth of consumption has slowed this year constraints that had pushed up materials prices against a backdrop of somewhat smaller g~ins in real between 1987 and early 1989. disposable personal income. But consumption has slowed even more than income, and the personal The Household Sector saving rate rose above 6 percent in the spring. Con sumers may be spending more cautiously as they Total personal consumption expenditures were reassess their income and wealth prospects in light of buffeted this winter by large swings in outlays for the slower growth of the economy and a softening of energy items and motor vehicles. Expenditures for residential property values in many parts of the home heating declined sharply in the first quarter as country. unseasonably warm temperatures in January and Both demand and supply factors have contributed February followed a December that had been colder to the recent weakness in housing construction. Sales than usual. This influence was largely offset by a of new and existing homes generally have been mov rise in motor vehicle sales. To date this year, sales ing lower for more than a year; in part, de~a.nd of cars and light trucks have averaged 14 million may have been restrained by slower growth m mcome units ( annual rate )-a pace not far below the total and reduced investment motivation for home pur for 1989-and seem largely to reflect replacement chase because of softening house prices. Demand demand and growth in the driving age population. also may have been tempered this spring by some Abstracting from the swings in outlays on home edging up in mortgage rates. Since early May, heating and motor vehicles, consumption spending however, mortgage rates have moved down about appears to have stagnated this spring after posting a 1/2 percentage point, and there is no evidence that moderate gain 'in the first quarter of 1990. The access to home loans has been curtailed. recent sluggishness in spending reflects declines in On the supply side, building is being deterred in outlays for a wide variety of consumer goods, some parts of the country by an overhang of unsold including furniture and other household durables. In or unrented housing units. In addition, it appears contrast, spending for services other than energy, that a reduction in credit availability for construc especially medical services, continues to outpace real tion may be playing some role in damping b~ilding income growth. activity. To a degree, this less favora~le credit_ climate is attributable to the cutback m financmg Real Income and supplied by thrift institutions owing to the ~losure Percent change from end Consumption of previous period, annual rate of savings and loans as well as the more strmgent capital requirements and lending limits mandated by 0 Real Disposable Personal Income the Financial Institutions Reform, Recovery, and II!!I Real Personal Consumption Expenditures Enforcement Act. 6 The Business Sector 4 The financial position of the business sector deteri orated further during the early part of 1990. Before tax profits from current operations of nonfinancial 2 corporations edged down in the first quarter after falling nearly 18 percent over the four quarters of 1989. + 1984 1985 1986 1987 1988 1989 1990 8 Real Business they appear to be in good alignment with sales Percent change from end of Fixed Investment trends. Among the possible exceptions are wholesale previous period, annual rate distributors of machinery and nonauto retailers, 0 Structures where some mild overhangs appear to have devel l!!ll Producers' Durable Equipment oped this spring; these could precipitate further adjustments, probably affecting both domestic and 40 foreign producers. The Government Sector 20 The federal budget deficit over the first eight months of the fiscal year was $152 billion, up from $113 bil lion. About $15 billion of this increase resulted from spending by the Resolution Trust Corporation and + further R TC outlays during June imply that the year-to-year deficit increase is likely. to widen. ~ost of the R TC spending reflects financial transactions in which existing federal insurance obligations to 1984 1985 1986 1987 1988 1989 1990 thrift depositors are being recognized in the govern ment's budget outlay and public debt accounts. The R TC' s borrowing and spending thus should have lit Shrinking profits, which have reduced the avail tle effect on real economic activity or interest rates. ability of internal funds, along with a slower growth However, several other budget components also of final sales and easing of capacity pressures over have contributed to the higher deficit. While defense the past year, have muted the demand for new plant outlays have continued to be restrained, spending on and equipment. Excluding transitory developments Medicare and other health care programs and some in the transportation sector, real equipment spending discretionary programs has surged. During the same slowed further in the first quarter of 1990; while period, revenue growth has lagged as weak cor shipments of most types of capital goods-especially porate profits have cut into receipts and last year's industrial machinery-remained soft in April and surprisingly large personal income tax collections May. have not been sustained. Nonresidential construction was boosted by Real state and local government purchases favorable weather early in the year, but most of the increased at an annual rate of 4 ¼ percent in the gain has since been reversed. The weakness is most first quarter, compared with the 3 to 3 ½ percent evident in office and commercial real estate, for pace recorded over the past three years. Revenue which vacancy rates are high and data on contracts growth generally has not kept up with gains in and permits suggest the outlook for building remains spending, however, and an increasing number of decidedly negative. state and local governments face significant budget The emergence of uncomfortably high inventories ary difficulties; indeed, the overall deficit of the in some sectors in late 1989 led to corrective actions sector ( excluding social insurance funds) was about in the first part of this year. Most prominently, $45 billion ( annual rate) in the first quarter of 1990, manufacturers of motor vehicles cut production almost $11 billion greater than the deficit recorded sharply and reinstated widespread sales incentives to in the 1989 calendar year. eliminate an overhang of stocks on dealer lots. In most other sectors, stocks have been trimmed or have been increased only modestly this year, and 9 The External Sector Labor Markets While the value of the dollar has not changed dra Job growth was strong early in the year, but has matically on a trade-weighted average basis against softened recently. In January and February, the other G-10 currencies this year, there have been increases in nonfarm payroll employment averaged some divergences in bilateral exchange rates. On more than 350,000, fueled by large increases in balance, the dollar has depreciated significantly service-producing industries as well as by robust hir against sterling and the Swiss franc, and somewhat ing in construction during the warmer than normal less against the German mark and related curren winter weather. Since March, however, job growth cies. In contrast, the dollar has appreciated against has slowed, averaging about 125,000 jobs per the yen, despite exchange market intervention by month. Manufacturing employment has continued to the Bank of Japan and other central banks to sup shrink this year at about the same rate as in the sec port the value of the yen early in the year. ond half of 1989, and construction payrolls also have Prices of non-oil imports, which fell at about a declined since the winter. Meanwhile, job growth in 3 percent annual rate between the first and third the service-producing industries has slowed in recent quarters of last year, rose at a similar pace between months. Although hiring gains have continued the third quarter of 1989 and first quarter of 1990. strong for health services, growth in jobs in business Prices of imported oil surged around the turn of the services has moderated, and there have been only year, moving above $20 per barrel in January, but small gains in employment at retail establishments. since then they have more than retraced this runup. Although the rate of increase in straight-time wages has changed little over the past year and a U.S. Real Merchandise Trade Annual rate, half, benefit costs have picked up markedly. In addi billions of 1982 dollars tion, unit labor costs have been boosted by a poor performance in labor productivity. As a conse Ql quence, unit labor costs in the first quarter of 1990 475 were 5 percent above their level a year earlier, about the same increase as recorded over 1989 as a whole, 350 but well above the rates that prevailed earlier in the 7 Exports .,,, ' - expansion. ---- ,,,, ,,,,,. -- __ .,,,,. 225 Nonfarm Payroll Net change, millions Employment of persons, annual rate D Total l!!!I Manufacturing 1984 1985 1986 1987 1988 1989 1990 6 Merchandise exports continue to provide an important impetus to growth in the domestic econ omy, although the increases in exports have slowed H1 3 [ [ n somewhat from the very rapid advances recorded in Et□ n the latter part of the 1980s. Two factors have con D tributed to further large gains in the quantity of ... + lilllllll ,w U.S. exports: many of our major trading partners abroad have continued to register strong economic growth, and the average dollar prices of U.S. exports have declined somewhat relative to average prices 1984 1985 1986 1987 1988 1989 1990 abroad. Meanwhile, slower import growth has accompanied the slackening pace of activity in the United States. 10 Monetary and Financial Developments During the First Half of 1990 Shifts in financial intermediation and credit flows, reduced range. Not only has the thrift industry con stemming from the continued restructuring of the tracted more rapidly than expected, but commercial thrift industry and a more cautious attitude of banks banks have picked up little of the lending forgone by toward certain credit extensions, exerted a major thrifts and, in fact, have curtailed their own lending influence on the monetary aggregates and their rela in some sectors, thus further depressing depository tion to economic activity during the first half of credit. With little need to fund asset growth, banks 1990. In anticipation of further contraction in the and thrifts have pursued retail deposits less aggres thrift industry, and its associated effects on deposi sively, leading to the opening of a sizable gap tory intermediation, the Committee reduced the between yields available in the open market and annual growth range for M3 by a full percentage those on such deposits. Partly as a result, M2 also point in February. In the event, M3 has slowed has slowed, moving down into the lower portion of even more dramatically than had been anticipated, its annual growth range. leaving this aggregate below the lower bound of its Growth of Money and Debt (Percentage change) Debt of Domestic Ml 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 11.2 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 9.1 1989 0.6 4.5 3.3 8.1 Quarterly 1990 Q1 4.8 6.0 2.7 6.9 (annual rate) Q2 3.6 2.3 0.4 7.oe Semiannually 1990 H1 4.2 4.2 1.6 7.0 (annual rate) *Figure in parentheses is adjusted for shifts to NOW accounts in 1981. e-estimated 11 The deceleration of the monetary aggregates In the opening months of the year, incoming mainly reflects a reduction in the share of credit information on spending and prices caused markets provided by depositories, rather than a sharp slow to re-evaluate the prospects for a near-term reduc ing of income or total credit flows. The velocities of tion of inflationary pressures and further easing of both M2 and M3 posted sizable increases, particu monetary policy. As a result, market interest rates larly in the second quarter. Total debt of nonfinan rose, particularly at the longer end of the maturity cial sectors grew at an annual rate of 7 percent over spectrum, despite a steady federal funds rate. the first half of the year-down only slightly from its In early May, the pendulum of market opinion pace in the latter half of 1989 and in the middle of began to swing away from the view that a tightening its monitoring range. of U.S. monetary policy was in the offing as incom The somewhat more cautious lending posture that ing data pointed to a somewhat slower pace of commercial banks have recently adopted is mainly a activity and reduced price pressures. Evidence also response to heightened credit risks caused by the suggested that restricted credit availability, in part more moderate pace of economic expansion overall the result of tightened credit standards, may have and a downturn in several sectors. The resulting spread beyond commercial real estate, construction, loan write-offs and pressures on capital positions and merger related lending. In response to this firm may also have induced some tightening of standards. ing of credit conditions, the Federal Reserve began Growing markets for securitized loans largely have providing reserves slightly more generously through filled the vacuum created by the retrenchment of open market operations in mid-July. thrifts in the area of mortgage lending, with little Market interest rates, which already had receded attendant effect on the cost or availability of residen somewhat from their early spring highs, declined tial mortgage credit to households. Both banks and further with the Federal Reserve's recent easing, thrifts have cut back on other types of lending that though intermediate and long-term rates remained can less easily be rechannelled, however, including above the levels seen last December. construction and nonresidential real estate loans, loans to highly leveraged borrowers, and loans to Long-term Interest Rates small and medium-sized businesses. To offset tighter Percent credit market conditions, which could exert undue Monthly restraint on aggregate demand, the Federal Reserve 18 has recently adopted a slightly more accommodative 16 stance with regard to reserve provision, fostering a Home Mortgage small decline in market interest rates. Primary Conventional 14 The Implementation of Monetary Policy 12 The FOMC maintained a steady degree of pressure 10 in reserve markets during the first six months of the year. Policy had been eased in the second half of 8 1989 amid concerns that the economic slowdown might cumulate and thereby threaten the expansion. 1982 1983 1984 1985 1986 1987 1988 1989 1990 In the first half of 1990, however, the Committee viewed the balance of evidence as suggesting that Observations are monthly averages of daily data; last observation for June, 1990. underlying trends were generally consistent with its objectives of sustaining economic growth while containing and eventually reducing inflationary pressures. 12 Monetary and Credit Flows M3 Billions of Dollars Growth of the monetary aggregates was sluggish over the first half of 1990, with M2 and M3 4350 expanding at annual rates of only 3 ½ percent and 6.5% 1 ¼ percent, respectively, from the fourth quarter of 4250 1989 through June. The weakness in money growth primarily reflected a redirection of credit extensions 4150 away from depository institutions owing to the con tinued downsizing of the thrift industry and a more 4050 cautious lending posture of commercial banks. . ... •················ 3950 M2 Billions of Dollars 0 N D J F M A M J J A S O N D 7% 3400 1989 1990 3300 5 percent annual rate of contraction. Much of this deflection of deposits towards commercial banks was 3200 the direct result of R TC resolutions. In the first half of the year, the R TC resolved 170 thrifts holding 3100 $32 billion of nonbrokered retail deposits, with much of these deposits immediately assumed by commer 0 N D J F M A M J J A S O N D cial banks. Bank lending to businesses also has been 1989 1990 depressed this year. Surveys of commercial bank lending officers through early May suggest that the The deceleration of M2 growth did not begin slowdown in bank credit largely reflects diminished until the second quarter of 1990, when growth demand for credit and deteriorating conditions in slowed to a 2 ¼ percent annual rate from the 6 to the real estate market, although tighter lending 7 percent range seen in the previous three quarters. terms and more stringent credit standards were fre Retail deposits (which include NOW accounts as quently cited for borrowers below investment grade, well as savings, small time deposits, and similar including many small businesses. Banks seem to instruments) had begun to decelerate in the first have raised lending rates somewhat to small firms, quarter, slowing to a pace of less than 4 percent judging from the slight increase in the spread from the 5 ¾ percent rate seen in the fourth quarter between rates on small business loans and on federal of 1989. funds. Separate surveys in which small businesses The unwillingness of banks to price their deposits were queried about general credit availability have as aggressively as in the past is partly an indirect pointed to some recent increases in the difficulty result of the contraction of the thrift industry. Dur these firms face in obtaining credit, though on bal ing the first six months of 1990, commercial banks ance they found credit availability little changed enjoyed $62 billion in retail deposit inflows-about a from mid-1989. The slowdown in bank business 10 percent increase at an annual rate-while thrifts lending this year has mainly reflected reduced were shedding $28 billion in retail deposits-about a merger activity. 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. A copy of the full report to Congress is available from Publication Services, Federal Reserve Board, Washington, D.C. 20551 FRB18-48000-0790 14

Federal Reserve (1990, July 17). Monetary Policy Report. Monetary Policy Reports, Federal Reserve. https://whenthefedspeaks.com/doc/monetary_policy_report_19900718

@misc{wtfs_monetary_policy_report_19900718,
  author = {Federal Reserve},
  title = {Monetary Policy Report},
  year = {1990},
  month = {Jul},
  howpublished = {Monetary Policy Reports, Federal Reserve},
  url = {https://whenthefedspeaks.com/doc/monetary_policy_report_19900718},
  note = {Retrieved via When the Fed Speaks corpus}
}