Monetary Policy Report

1991 MONETARY POLICY OBJECTIVES Midyear Review of the Federal Reserve Board July 16, 1991 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 1991 MONETARY POLICY OBJECTIVES Testimony of Alan Greenspan, Chairman Board of Governors of the Federal Reserve System July 16, 1991 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 Economic and Financial Developments in the First Half of 1991 Committee) I am pleased to be here At the time of our last Report in February, the today to present the midyear economy had been declining for several months. The considerable uncertainty and higher oil prices Monetary Policy Report to the that followed the invasion of Kuwait had depressed confidence and real incomes, discouraging spending Congress. My prepared remarks this by consumers and businesses and pulling down morning will take their cue from that output and employment. However, even by February, the first seeds of an economic recovery Report by focusing on current appeared to have been sown: The initial coalition successes in the Gulf War, the reversal of much of economic and financial conditions) as the runup in oil prices, and the significant easing of well as on the outlook for the economy monetary policy all pointed in the direction of a resumption of growth. and monetary policy over the coming Today, there are compelling signs that the recession is behind us. Although the turning point year and a half These topics merit has not yet been given a precise date, a variety of particularly close attention at the cyclical indicators bottomed out by early spring, and some have moved noticeably higher in recent current time) when the economy months. Such data strongly suggest that the economy is moving into the expansion phase of the appears to be poised at a cyclical cycle. Nevertheless, convincing evidence of a turning point-moving from dynamic expansion is still rather limited, and we must remain alert to the chance that the recovery recession to expansion. In addition) I. could be muted or could even falter. In recent months, there also have been promising plan to devote some time to discussing signs of a slowing in inflation. The price figures themselves have bounced around from month to the importance of the changes that we month, partly in response to the gyrations in oil have been seeing in patterns of credit prices and the partial embedding of those swings in the underlying cost structure of the economy. A usage and in the flows of money and bunching of price increases and excise tax hikes at the beginning of the year also boosted "core" credit through the financial system. inflation measures for a time. But in their wake, an There are signs of what could be underlying softening trend has become evident, with consumer prices outside of the food and energy significant departures from the trends sectors rising quite modestly. In an environment of slack demand, businesses have worked especially prevalent in the 1980s) with hard to control costs by keeping their operations as potential implications for the lean and productive as possible. interpretation off inancial data and economic developments. 2 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis With the threat of an oil-related inflation surge guard against the risk of adding excessive monetary largely behind us and output evidently declining, stimulus to an economy that might already be solidly the Federal Reserve took a series of easing steps in into recovery. Monetary policy during the first half quick succession over the latter part of last year and of the year has had two jobs: first, to help bring the into the spring. These actions, aimed at ensuring a economy out of recession and, second, to avoid satisfactory upturn in the economy, brought the setting the stage for the next recession, which would federal funds rate more than 2 percentage points follow if we allowed inflationary imbalances to below its pre-recession level and 4 percentage points develop in the economy. below its peak of about two years ago. Other The progress against inflation that has been set in short-term interest rates dropped more or less motion must not be lost. Moreover, by consolidating commensurately. Despite the progressive easing of and building upon the gains against inflation, we monetary policy, the foreign exchange value of the come that much closer to our longer-run goal of dollar is up substantially since the beginning of the price stability. Inflation and uncertainty about year, in part owing to the brightening outlook in the inflation keep interest rates higher than they need United States for economic recovery without added be, distort saving and investment, and impede the inflation. Anticipations of economic expansion also ability of our economy to operate at its peak were reflected in rising stock prices and in long-term efficiency and to generate higher standards ofliving. interest rates, which have changed relatively little on balance so far this year even as short-term rates have The Economic Outlook declined. With the cumulative drop in short-term interest It is this strategy that has been guiding monetary rates making monetary assets more attractive to the policy recently, and the effects of the strategy are public, M2 growth picked up noticeably in the first reflected in the economic projections of the Federal half of 1991. Its growth probably was restrained to a Open Market Committee members and other degree, however, by the firmness in returns on Reserve Bank presidents. On the whole, their capital market instruments. And, as had been outlook is for underlying inflation to continue to anticipated at the beginning of the year, growth of slacken as the economy first recovers and then M2 remained below what would have been pre expands at a moderate rate through the end of next dicted solely on the basis of historical relationships year. with interest rates and income. Money growth also For this year, while there remain-without continued to be held down by the ongoing restruc question-frailties in the economy, economic turing of credit flows away from depository institu activity appears on balance to be picking up in a tions. As the thrift industry has contracted and fairly broad-based manner. The expectation that the banks have remained quite cautious about expand turnaround in output is occurring, and that it will ing their balance sheets, there has been less need for persist, is evident in the economic projections of the depositories to issue liabilities-which constitute the FOMC members and other Reserve Bank presi vast bulk of the monetary aggregates. Currently, dents. Their forecasts for real GNP growth over the M2 and M3 are somewhat below the midpoints of four quarters of 1991 center on 1 percent or a shade their respective target ranges. below, implying growth over the remainder of this In the last several months, monetary policy has year that not only offsets the first-quarter decline in adopted a posture of watchful waiting as economic GNP, but also lifts output above its pre-recession indicators have pointed increasingly toward peak by year-end. recovery. With an eye to the usual lags in policy effects, this stance has been viewed as prudent to 3 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Two fundamental questions may be posed with And this recession, assuming it came to an end in regard to this outlook for the rest of the year. The the spring, seems to have been mild. Not only does it first is an inquiry into the potential sources of appear to have been marked by a considerably strength in the recovery-those forces that will be at smaller contraction in real GNP and industrial work to pull the economy out of recession in a lasting production than the average postwar recession, fashion. We see a number of factors as having set the it also was a bit shorter. In at least one respect, stage for the recovery: in particular, the reversal of however, this recession was close to average, and the spike in world oil prices and the favorable effects that was in job losses, as firms cut payrolls fairly of that reversal on real incomes; the conclusion of aggressively. Nevertheless, the unemployment rate the Gulf War and the consequent rebound in did not rise as much or as high as was typical in the consumer and business confidence; and, finally, the past. decline in short-term interest rates following our Arguing against a rapid rebound in the economy policy easings and the narrowing of risk premiums are several other factors as well, including the lack of in financial markets. Against this backdrop, impetus from some sectors that contributed in consumer expenditure growth seems to have turned earlier cycles. First, it has not been unusual to see positive again, along with real income; homebuild some fiscal stimulus in the early stages of expansion ing has bottomed out and is providing some lift to in the past; this time, however, the Congress and the overall growth; and orders for capital goods are Administration have worked long and hard to make pointing to a firming in demand that should be sure that genuine progress will be made in righting reflected in production and shipments in coming the structural imbalance in the budget, putting months. federal spending in real terms on a downward path. The strongest force behind output growth in the Nor is fiscal stimulus likely to emerge from the state near term, though, probably will be the behavior of and local sector, where deepening budget problems inventories. Business inventories have been drawn are constraining spending. A portion of the financial down aggressively in recent quarters, and, with distress of localities can be traced to the softness in inventories now quite lean, sales increasingly will real estate markets feeding through to property tax have to be satisfied out of new production. The receipts. The condition of the real estate market also inherent dynamics of an inventory cycle, as the is certain to restrain the pickup in construction that . drawdown ceases and eventually turns to rebuild usually accompanies a recovery, with overbuilding ing, likely will engender the bulk of the initial in commercial real estate likely to damp activity in step-up in output. But there may be additional areas this area for some time to come. Finally, in the of demand that will impel the recovery; it is quite consumer area, expenditures are unlikely to grow common at this point in the cycle for forecasts both more rapidly than personal income, as households to underestimate the strength of the recovery and to avoid reducing their saving rate further from its miss the forces that end up driving the expansion. already low level. In fact, recessions typically have been followed by The expansion is seen as becoming more securely periods of appreciably stronger growth than that established next year, with real GNP growth strong foreseen here. This raises the second question about enough to bring the unemployment rate dow the near-term forecasts, that is, whether they are ½ percentage point or more from its current level. optimistic enough. A number of considerations Should the recovery unfold about as we expect, price come to mind on that side of the issue. First, and in pressures will remain muted and progress on some sense most appealing, is the simple notion, inflation is likely. The expectations of FOMC which is lent some support by history, that relatively members and other Reserve Bank presidents for mild recessions beget relatively mild recoveries. inflation this year are centered in the neighborhood of 3 ½ percent, well down from the 6 ¼ percent rate of inflation experienced last year. Although the 4 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis slowdown this year is exaggerated by the retreat in On a provisional basis, the FOMC extended the oil prices, a clear deceleration should be evident 1991 ranges for money and debt growth to 1992, even abstracting from energy prices. That decelera with the understanding that there will be opportuni tion in the underlying trend is expected to continue ties to reevaluate the appropriateness of these ranges next year, as well. However, the unwinding of the oil before they come fully into play next year. The shock this year masks the improvement, so that the ranges were viewed as consistent with additional projection for the increase in overall consumer progress against inflation and with sustained prices is about the same for 1992 as for 1991. economic expansion. Moreover, the path of no change appeared most sensible to the Committee at the current time of some uncertainty about the vigor Ranges for Money and Debt Growth and even the durability of the economic recovery, as for 1991 and 1992 well as about developments affecting the future of The FOMC viewed the near-term outlook for the thrift and banking industries. output and prices as generally favorable and This uncertainty about the credit intermediation consistent with growth of money and debt within the process is one of the factors that could possibly make ranges that had been specified earlier in the year. movements in M2 somewhat difficult to interpret in Consequently, at its meeting earlier this month, the the short run, but I would emphasize that we expect FOMC reaffirmed the 1991 ranges for money and the aggregate to remain a stable guide for policy debt growth. In addition, it was felt that the money over the longer term. The relationship between M2 ranges retained enough scope for policy to be and nominal income has been one of the more responsive, should the economy stray substantially enduring in our fina~cial system. Since the founding from its expected path over the remainder of the of the Federal Reserve, nominal GNP and M2 have year. With M2 and M3 now well within their grown, on average, at almost precisely the same ranges, there remains ample room for money rate. Presumably, this parity reflects an underlying growth to change in the event policy needs either to demand for liquidity on the part of businesses and ease in support of a faltering recovery or to tighten consumers that is associated with a given level of in reaction to an unexpected resurgence of inflation spending and wealth. This demand is likely to pressures. persist, though the financial structures that supply Unlike the monetary aggregates, our latest the liquidity may change. reading on debt of the domestic nonfinancial sectors places it right at the bottom edge of its 1991 range. Changing Patterns of Financial Its growth has been unusually low, and its position Intermediation and Debt Accumulation within the range is indicative both of the reduced demands for credit associated with the weak Recently, patterns of financial intermediation have economy and of the restraint, on the part of been changing, and there are signs that patterns of borrowers and lenders, that has been evident in credit usage in general have been changing as well. recent quarters. In these circumstances, the FOMC It is difficult to know which of these developments felt that lowering the monitoring range would be will show some permanence and which will prove inappropriate and might falsely suggest a compla ephemeral. But some of the recent changes have cency on the part of policymakers about weakness in been striking and have affected a number of the credit gro 111th. Instead, maintaining the debt range financial variables that the Federal Reserve rou unchanged underlines the implication that a further tinely monitors in an effort to glean information slowdown in this aggregate would warrant close scrutiny. 5 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis about the health of the economy, the soundness of financed more purchases both of physical assets and the financial system, and the appropriateness of of financial assets. As far as physical assets are current monetary policy. I would like to address concerned, the 1980s saw some strong spending on several aspects of these recent developments in the consumer durables and nonresidential structures; remainder of my remarks today. spending on physical assets, such as these, appears First, at the most aggregate level, the ratio of more often to be financed with debt than is spending domestic nonfinancial sector debt to nominal GNP, on most other types of goods and services. Now, which soared in the 1980s, is beginning to show with stocks of those assets already built up and with signs of flattening out. With the federal govern tax law changes that have made it less attractive in ment's borrowing lifted by the effects of the many cases to borrow to finance their purchase, recession and payments related to deposit insurance, credit demands are likely to remain relatively these signs have been evident so far only in the other damped. sectors. While the changes in behavior may, in part, The high interest rates of the late 1970s and early reflect cyclical factors at work, a longer-term trend 1980s spurred increased financial innovation and also may be emerging. And this trend, if it develops extensive deregulation, helping to bring businesses fully, would represent a return to the pattern evident and consumers increasingly into more complex in earlier postwar decades. In that case, it would be financial dealings. The state and local sector built up the 1980s, with their burgeoning federal deficits and a large stock of financial assets, and the household massive corporate restructurings, that would appear sector acquired assets from the wider array of the aberration. The deregulation, technological instruments available. Moreover, household advances, and financial innovations that came at an borrowing behavior was shaped importantly by the accelerated pace in the 1980s lowered the cost of rising capital gains available on residential real borrowing for many and probably raised the estate over this period. As house prices escalated, equilibrium ratio of debt to net worth for a wide mortgage debt on existing homes increased, both as range of economic entities. A temporary surge capital gains were realized in home sales and as in borrowing was implied in the course of this unrealized gains were tapped through the use of transition from one equilibrium to another. second mortgages and, more recently, home equity A tapering-off of that surge would then be lines. In this process, home owners were able to expected as the new equilibrium was approached, redirect a portion of these capital gains toward other and this may be what we currently are witnessing. assets or current consumption. The new equilibrium debt-to-income ratio may even Over the decade, the financial services industry be below the current level, implying the possibility grew at an extraordinary rate, in part by creating of sluggish debt growth for some time. If these sorts debt instruments seemingly tailored to every need of adjustments were in train, the slow debt growth and financial assets for any portfolio. While associated with them should not be read as implying households took advantage of a number of these that credit was insufficient to support satisfactory new instruments, the bulk of them were directed economic performance. toward business. Mergers and acquisitions took off, A number of considerations point in the direction financed essentially by debt, resulting in net of restructuring of balance sheets. The forces that retirements of equity that averaged nearly appear to be restraining the demand for credit can $100 billion annually between 1984 and 1989. be generally categorized as less "grossing up" of balance sheets and less substitution of debt for equity. During the 1980s, there was a great deal of this "grossing up" of balance sheets, as credit 6 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis More recently, with debt levels relatively high and In certain areas, however, the credit retrenchment lenders less eager to extend credit, markets have appears to have gone beyond a point of sensible changed. One aspect of this change shows up balance. In some cases, lender attitudes and actions dramatically in data for the second quarter, where have been characterized by excessive caution. As a equity issuance by nonfinancial corporations is result, there doubtless are creditworthy borrowers estimated to have exceeded equity retirements for that are unable to access credit on reasonable terms. the first time in eight years, removing this element Even in the obviously troubled real estate area, new behind the buildup of debt. While much of the loans are arguably too scarce, in some cases weakness in credit demand at present reflects intensifying the illiquidity of the market for existing cyclical influences, borrowers likely will continue to properties. To an extent, the scarcity of some types shy away from the heavy expansion of debt seen in ofloans may reflect the efforts of individual financial the 1980s. institutions to reduce the share of their assets in a On the supply side of the credit market, perhaps particular category, such as commercial mortgages. the major factor at work in creating a break with the While a single bank may be able to do this without behavior of the 1980s has been the adverse conse too much trouble, when the entire industry is trying quences of that behavior. It is now clear that a to make the same balance sheet adjustment, it significant fraction of the credit extended during simply cannot be done without massive untoward those years should not have been extended. We need effects. Instead, it may be in the banks' self-interest merely look at the recent string of defaults and to make the adjustment in an orderly manner over bankruptcies, and the condition of many of our time. Regulatory efforts to address credit availabil financial intermediaries to confirm this impression. ity concerns continue. In a sense, this process may have been very nearly Credit conditions remain tight in some sectors, inevitable. With the financial system groping toward but in others the situation appears to have improved a new equilibrium, the likelihood of mistakes was considerably since our last Report in February. To high. Laxity by lenders abetted the spiral of debt, chronicle briefly what we know about credit supply and we regulators were too often slow to intervene. conditions at present: In financial markets generally, Now, financial institutions, regulators, and risk premiums and spreads between yields on taxpayers are facing the wrenching unwinding of different types of debt have declined substantially those lending decisions. A key lesson to be learned is this year as investor attitudes have improved. In how important it is to avoid these costly adjustments part reflecting this narrowing, corporate bond in the future and that this can only be done by offerings surged over the first half of the year. avoiding a return to such financial laxity. Banking firms, too, gained increased access to Going forward, we likely will see a continuation of capital markets, leaving them in a better position to the "credit correction" now under way. One aspect lend as credit demands begin to pick up in the of this correction is the increased attention paid by recovery. Indexes of bank stock prices rose much regulators and the financial markets to the capital more rapidly than the stock market as a whole, positions of financial intermediaries. The more bringing the average market value of shares in the prudent approach to capitalization and lending top fifty bank holding companies back up to around decisions is overwhelmingly a healthy development their book value. Yield spreads on bank-related that ultimately will result in strengthened balance debt obligations narrowed sharply over the first half sheets for the nation's financial institutions and of the year, prompting considerable issuance. more assurance of stability of the financial system. 7 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Thus far, however, lending by commercial banks has about the financing of those purchases are usually remained quite weak. To the extent we canjudge, being made. Increasingly, it appears that those this appears primarily to reflect weak credit decisions are not being reflected in credit on the demand, as is typical at this point in the business books of depository institutions. Banks still may be cycle. Nonetheless, supply restrictions remain a involved, however. They may, for example, provide problem. This so-called "credit crunch" owes letters of credit or arrange financing through a importantly to financial institutions' efforts to build special-purpose corporation. Mortgage and capital to meet the demands of both the market and consumer debt may pass through the balance sheets the regulators. Information on lending terms, of these intermediaries only briefly, as it is increas however, suggested little further tightening over the ingly being securitized and sold into capital markets. sprmg. As banks make further strides in bolstering their Not only the behavior of the debt aggregate itself, capital positions, however, they will become better but also the avenues through which the debt flows, able to take advantage of opportunities to add represent something of a break with the past. The profitable loans to their balance sheets. While the recent decline in the importance of depository role of the banking industry has been changing, its institutions as intermediaries, when measured by importance in the financial system and the economy the credit they book, is quite striking. While this remains assured. predominantly reflects the contraction of the thrift In sum, the financial system in this country is industry, banks, too, have contributed by growing changing, and it is changing rapidly. Technology, only slowly. Over time, other financial institutions regulatory initiatives, and market innovations are have provided more close substitutes for banking changing many dimensions of the financial system. services, and the profitability of the banking The relationships between borrowers and lenders, industry suffered over the last decade or so from a between risk and balance-sheet exposure, and decline in loan quality. Moreover, recent emphasis between credit and money are being altered in on higher capital ratios and higher deposit insurance profound ways. In response, we must understand premiums should affect this trend as well. the nature of these changes, their permanence, their Even as the economy has firmed, financial flows limitations, and their possible implications for the through depository institutions have remained economy and monetary policy. And we must ensure weak. Some lag is typical. Indeed, iri the case of that the stability of the financial system is protected business loans, there is enough of a regularity that as changes occur, for a sound financial system is an they are included in the Department of Commerce's essential ingredient of an effective monetary policy Index of Lagging Economic Indicators. But lending and a vital economy. to businesses has been unusually weak for some time now and the outlook is for a rather modest upturn when it comes. At the same time that decisions to purchase goods and services are made, decisions 8 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 1991 MONETARY POLICY OBJECTIVES This Executive Summary provides highlights of the Board's Midyear Review to the Congress on the Full Employment and Balanced Growth Act of 1978. July 16, 1991 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Contents Section Page Monetary Policy and the Economic Outlook for 1991 and 1992 3 Monetary Objectives for 1991 and 1992 4 Economic Projections for 1991 and 1992 5 The Performance of the Economy during the First Half of 1991 7 The Household Sector 8 The Business Sector 9 The Government Sector 10 The External Sector 11 Labor Markets 12 Price Developments 12 Monetary and Financial Developments during the First Half of 1991 14 The Implementation of Monetary Policy 14 Monetary and Credit Flows 16 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Monetary Policy and the Economic Outlook for 1991 and 1992 When the Federal Reserve presented its last mone- Industrial Production Index, 1987 = 100 tary policy report to the Congress, in February of ----------------------• this year, the economy was still in a downswing that had been precipitated by Iraq's invasion of Kuwait in August 1990 and the associated spike in oil prices. To be sure, several developments early in the 110 year had created conditions that promised to help foster a turnaround in the economy: Not only had June oil prices reversed most of their earlier runup, but monetary policy had been eased substantially in the final months of 1990 and the early part of this year. 105 However, the economy continued to weaken for a time, and policy was eased further into the spring, with the objective of ensuring a satisfactory recovery. Recent evidence suggests that a pickup in activity probably is now under way. Much of the uncer 1989 1990 1991 tainty that had depressed business and consumer sentiment was removed by the successful end of The Federal Reserve' s easing moves over the first hostilities in the Persian Gulf. The resulting improve part of the year were taken not only in light of th~ ment in confidence, combined with the boost to real contraction of economic activity and the progress m purchasing power provided by the retreat in oil reducing inflationary pressures, but also were prices, raised consumer spending on balance over prompted by the continued slow growth of the the late winter and spring. These same factors, as monetary aggregates early in the year and continu well as lower mortgage rates, also have spurred a ing credit restraint by banks and other intermedi gradual recovery in the housing sector. Reflecting aries. Reserve market conditions were held steady the stimulus from housing and consumer demand, after April, however, as evidence began to accumu along with the continued growth in U.S. exports, late that the economy was on track toward recovery. industrial production turned up in April and has Reflecting the Federal Reserve' s policy actions and advanced appreciably since then; in addition, labor generally weak credit demands, short-term interest demand showed signs of stabilizing during the rates declined appreciably during the first half. spring. Longer-term rates, which had moved down markedly As anticipated earlier this year, inflation has in the final months of 1990, were mixed over the slowed from its pace in 1990. Retail energy prices first half; with bond market participants focusing on came down substantially during the first half of the signs of an emerging recovery, Treasury bond yields year, and the rise in consumer food prices moder rose a bit, while rates on bonds issued by businesses ated after several years of relatively large increases. fell as risk premiums narrowed sharply. In the stock More generally, the softness of labor and product market, share prices have registered sizable increases markets has attenuated price pressures for a range of since January, and broad indexes remain within a goods and services. This downdrift in· "core" infla few percent of the all-time highs set in the spring. tion was difficult to discern earlier in the year Meanwhile, the value of the dollar has climbed sub because of a bunching of price increases in January stantially on foreign exchange markets, supported by and February; however, most of the significant the successful conclusion of military operations in increases in those months either did not continue or the Gulf, expectations of a recovery in the U.S. were reversed. economy, and by economic developments in Ger many and political difficulties in the Soviet Union. 3 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Consumer Prices* Percent-change, Dec. to Dec. rate of GNP increase. If, on the other hand, institu-: ? '. .: tions were to ·l)ecom:e'(more .aggressive in bidding for loanable fonds in the, retail deposit ~arket, and thus the public· began to snift its portfolio baik · in favor· of M2 ·asset_s,- the!]- velocity could,~eakin·-~nd faster 6 M2 growth might be required. The· Committee . expects· that the· curreri·t annua_l growth range will . · permit it to _4eal .'with such velocity-alterin"g distur- . bances in money _supply .and de:rp.arid ·wnile it fosters 4 financial conditions conducive to ·moderate economic growth and further progress toward pric~. stability. The 1 to·5 perc~nt range for M3 adopted in •• February took account of the expected continued 1!111 2 contraction in the thrift industry and associated redirection of credit flows away from d~pository . institutions. The assets of thrift institutions are expected to shrink. further in the second half, owing + in large part to closures by the Resolution Trust Corporation (RT C). Issuance of large time deposi_ts by branches and agencies of foreign banks has moderated; but domestic banks may have a gre~ter appetite for funds in the s·econd half as sound lend 1986 1987 1988 1989 1990 1991 ing opportunities increase with the projected I improvement in the economy. . . . . •Cor1:sumer Price Index fo'r .all urban consumers. ••Per,cent c4ange from Dec. 1990 to May 1991, annual rate. Even though growth' of the aggregate debt of domestic nonfinancial ·sectors at midyear was at the . Monetary Objectives for 1991 and 1992 lower end of its current 4 ½ 'to 8 ½ percent mon'itor At its meeting earlier this month; the Federal Open ing range, the Committee anticipates that the debt Market Committee· (FOMC) reaffirmed its previ measur.e will end the year well within that r,ange. ously established ranges for money and credit for Stronger priv~te credit·d emands are expected to 1991. The target range for M2 had been lowered in arise as the economy grows, and federal borrowing February to 2 ½ to 6 ½ percent from the ·3 to 7 per will increase to finance stepped-up RTC activity". cent range that had been in place for 1990. To date However, debt growth is likely to continue to be this year,; M2 has grown at an annual rate of a little damped ·by' th~ s~ift in attitudes about lev:eraging. less than 4 percent, placing it well within the target range for 1991 as a whole. This, in effect, leaves the Ranges for Growth of Monetary and Committee some room to maneuver as events unfold Credit Aggregatesl . · in the coming months, while remaining within the annual -range. The potential need for such room (Percent Change, Fo-urth Quarter to ·Fourth Quarter) arises in part in connection with the significant Provisional uncertainties attending the prospects for the velocity ,for of M2. If, for ·example, the public's demand for M2 1990 1991 1992 i"j balances should be damped. by moves among deposi- 1 \ ' ., tory institutions to lower deposit rates (in response M2 3 to 7 2½ to 6½ 2½ , to 6½ to earlier declines in market yields and to higher M3 1 to 5 1 to 5 1 to, 5 insurance premiums), then velocity might tend· to be stronger than otherwise would be the case and less Debt 5 to 9 4½ to 8½ 4½ to 8½ M2 growth would be required to support a given 4 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis In setting provisional ranges for 1992, the Com In appraising the near-term outlook, the FOMC mittee chose to carry forward the 1991 ranges for participants have placed considerable weight on the the monetary aggregates and for debt. Recognizing apparent absence of inventory overhangs in most that the ranges had been reduced significantly over sectors. Accordingly, the recent firming of aggregate the past few years, the Committee at this time final demand is expected to bring a halt soon to .the believes that expansion of money and debt in 1992 inventory drawdowns that persisted into the second within the current ranges probably would be consis quarter. The resulting swing in the pace of inven tent with consolidating and extending the gains that tory investment is expected to boost domestic have been made to date toward lower inflation, production considerably over the rest of 1991. As while providing sufficient liquidity to support a sus typically occurs in the initial stage of a recovery, tainable expansion of economic activity. The ranges much of this rise in output is expected to reflect will, of course, be reevaluated next February in light gains in the productivity of existing workers, rather of intervening economic and financial events. The than a marked pickup in employment. Thus, the Committee will want to update its assessment of the Board members and the Bank presidents project underlying tendencies in the economy as well as in only modest progress in reducing unemployment the relations between money and debt expansion over the second half of the year; the central tendency and economic performance. Although the initial for the civilian jobless rate in the fourth quarter is indications of money and credit ranges that are 6 ¾ to 7 percent. given in July always are tentative, flexibility seems The pace of expansion may moderate somewhat all the more warranted in the current circumstances, in 1992, as the initial impetus from the inventory with the economy apparently at a cyclical turning swing subsides and gains in production track the point and the financial system being buffeted by growth in final demand more closely. The advance fundamental change. in real GNP expected for 1992, though subdued relative to that in the early part of most previous Economic Projections for 1991 and 1992 expansions, is anticipated to reduce the margin of slack in the economy over the year. The central ten The target ranges for the monetary aggregates and dency of the civilian unemployment rate projected debt have been selected with the objective of sup for the fourth quarter of 1992 is 6 ¼ to 6 ½ percent, porting a sound economic expansion accompanied roughly 1/2 percentage point below the level expected by declining inflation-a pattern the Board members in the fourth quarter of this year. and Reserve Bank presidents generally expect to Several factors lie behind the expectation of a prevail over the coming year and a half. Most fore relatively mild upswing in economic activity. In real cast that real GNP will grow 3/4 to 1 percent over estate markets, the persistent overhang of vacant the four quarters of 1991; given the decline during space for many types of buildings, along with con the first quarter, this central tendency range for tinued caution on the part of lenders, likely will 1991 as a whole implies an appreciable pickup in limit the amount of new construction. In addition, activity over the remainder of the year. The projec fiscal policy will remain moderately restrictive owing tions of growth in real GNP over the four quarters to the federal budget agreement reached last fall and of 1992 have a central tendency of 2 ¼ to 3 percent. efforts by state and local units to correct serious imbalances in their budgets; although this fiscal restraint ultimately will strengthen the U.S. econ omy by boosting domestic saving and investment, its near-term effect will be to hold down aggregate demand. Further, with the personal saving rate already at a low level and some households saddled with heavy debt burdens, consumer spending is projected to grow at a relatively slow pace. Finally, 5 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis the appreciation of the dollar this year has offs et the downtrend in core inflation anticipated over the some of the previous declines in relative prices of next year and a half. In particular, most of the slow U.S. goods in international markets, thus limiting ing of inflation observed thus far this year has the contribution that can be expected from the exter reflected the sharp drop in energy prices and a move nal sector. toward smaller increases in food prices; excluding By adopting policies intended to put the economy food and energy, the deceleration in the CPI so far on a path of moderate, sustainable growth, the has been relatively small. However, with the temper Board members and Reserve Bank presidents believe ing of labor-cost increases now under way and the that it will be possible to achieve meaningful pro reduced pressure on plant utilization, core inflation gress in reducing inflation over the remainder of this is expected to recede significantly in coming quarters. year and into 1992. The central tendency of the As these declines become widely perceived, expecta forecasted rise in the total consumer price index tions of inflation should moderate, reinforcing the (CPI) is 3 ¼ to 3 ¾ percent over the four quarters of tendencies toward deceleration. By reducing and 1991 and 3 to 4 percent over 1992, well below the ultimately eliminating the distortion to resource allo 6 ¼ percent rise over the four quarters of 1990. In cation stemming from ongoing, generalized price each of the prior three years, 1987-89, the CPI rose increases, a monetary policy aimed at achieving about 4 ½ percent. price stability over time will enhance the economy's The common midpoint of the forecast ranges for potential to grow and thereby raise standards of CPI increases in 1991 and 1992, 3 ½ percent, masks living. Economic Projections for 1991 and 1992 FOMC Members and other FRB Presidents Administration 1991 Range Central Tendency Nominal GNP 3¾ to 5¾ 4½ to 5 ¼ 5.0 Percent change, fourth quarter to Real GNP ½ to 1 ½ ¾ to 1 0.8 fourth quarter: Consumer price index 3 to 4½ 3 ¼ to 3¾ 3.41 Average level in the fourth quarter, Civilian unemployment rate 6 ½ to 7 6¾ to 7 6.72 percent: 1992 Range Central Tendency Nominal GNP 4 to 6¾ 5 ½ to 6½ 7.5 Percent change, fourth quarter t.o Real GNP 2 to 3½ 2¼ to 3 3.6 fourth quarter: Consumer price index 2 ½ to 4¼ 3 to 4 3.91 Average level in the fourth quarter, Civilian unemployment rate 6 to 6 ¾ 6¼ to 6½ 6.32 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 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis The Performance of the Economy during the First Half of 1991 The magnitude and length of the recent recession Percent change, still are not known with certainty, but the decline in ConSumer Energy Prices* Dec. to Dec. real GNP appears to have been considerably smaller than the average decline during the previous post- World War II recessions; for the industrial sector alone, production dropped 5 percent between the 15 peak in September of last year and the low point in March, compared with an average fall-off of nearly 10 percent during previous recessions. The recent contraction also seems to have been relatively short + by historical standards. Aggregate job losses, how ever, were close to the average in previous reces sions, suggesting that firms cut payrolls vigorously given the fairly shallow drop in real activity. 15 •• Real GNP Percent change, annual rate 1986 1987 1988 1989 1990 1991 •Consumer Price Index for all urban consumers. 2 .. Percent change from December 1990 to May 1991, annual rate. Apart from food and energy, price increases were large early in the year, but have been more moder + ate in recent months. On balance, over the first five jP months of 1991, this portion of the CPI increased a ill !1!1I1 bit more than 5 percent at an annual rate, about Iillll 1/2 percentage point below the trend rate of increase Ill I ,l ! 1 ! 2 as of last summer. In part, the recent headway ij made on inflation reflects the reduction in labor-cost iii "I pressures that accompanied the rise in unemploy ment. As measured by the employment cost index, compensation per hour increased at an average annual rate of 4 ¼ percent over the second half of 1989 1990 1991 1990 and the first quarter of this year, compared with the 5 ¼ percent (annual rate) rise over the first Consumer price inflation, which exceeded 6 per half of 1990. cent last year, slowed to a 2 ¾ percent annual rate over the first five months of 1991. Consumer energy prices fell sharply early this year, after soaring dur ing the second half of 1990. In addition, the rate of increase in food prices has retreated this year from the pace registered during the preceding three years. 7 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis The Household Sector Among the major components of consumer spend ing, outlays were cut back sharply for motor vehicles Consumer spending was an area of notable weakness and other durable goods as the recession unfolded. last fall and early this year, largely in response to a Substantial cuts also were made in purchases of non substantial decline in real income. Real consumer durable goods. In contrast, consumer outlays for spending fell at a 1 ½ percent annual rate in the first services trended up at a pace only slightly below that quarter, after a 3 ½ percent ( annual rate) decline in registered during the first three quarters of 1990. the fourth quarter of 1990. However, in February, Since the January trough in total consumer outlays, real income turned up and consumer confidence purchases of both durable and nondurable goods rebounded late in the month with the end of the have turned up. In particular, as of May, real con Gulf war; both developments bolstered consumer sumer purchases of motor vehicles had risen about spending. As a result of the spending gains that 8 percent from the depressed January level. began in February, the average level of outlays in Although consumers cut back spending, they April and May stood considerably above the first cushioned some of the effect of weak income by quarter average. reducing their savings. After averaging about 5 per cent over the first half of 1990, the personal saving Percent change rate dropped to 4. 2 percent in the third quarter and Income and Consumption annual rate remained at that level through the first quarter of this year. The decline in the saving rate occurred D Real Disposable Personal Income Ifill Real Personal Consumption Expenditures despite some deterioration, on net, in wealth posi tions during the second half of 1990, which reflected the softening of house prices and losses in the stock market. The average level of the saving rate dropped 4 another notch in the spring, to about 3 ¾ percent. The saving rate is now at the lowest level since late 1987, and it would not be surprising if gains in con sumption lagged behind those for income in the near Iii!!!! term as households worked to rebuild net worth jjHlil through increased saving. + 1111111 Residential construction activity, which had been trending lower since 1986, slumped further in the second half of last year. However, the market for single-family homes bottomed out in January and has staged a mild recovery since then, spurred by a firming of demand. Several factors account for the 1989 1990 1991 pickup in demand, including the decline in home prices to more affordable levels in a number of mar •Percent change from 1991 Ql to average of April and May 1991, at an annual rate. kets, improv~d prospects for employment and income, and some reduction in mortgage rates from those prevailing in the middle of last year. Despite continued caution on the part of lenders in granting land acquisition and construction loans, the quantity of financing available appears sufficient, on balance, to support a further recovery in this sector. In con trast, the market for multifamily housing has con tinued to weaken this year. Starts in May were at the lowest monthly level since the 1950s. 8 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Annual rate, millions of units, Business spending for fixed investment was flat in Private Housing Starts quarterly average real terms during the fourth quarter of last year and dropped sharply during the first quarter of this year. Spending for new equipment typically does not turn up until several months after the end of a recession, and the lag is often substantially longer for construc 1.6 tion outlays. As yet, there is little sign of a rebound in spending for either equipment or nonresidential structures. Nonetheless, shipments of industrial equipment and other nondefense capital goods-a coincident indicator of equipment spending-have .8 stabilized in recent months. Real Business Percent change Fixed Investment annual rate 1986 1987 1988 1989 1990 1991 lill1 Producers' Durable Equipment D Structures The Business Sector 10 During the latter part of 1990 and the first quarter of this year, the business sector experienced considerable stress. Demand for + business output was depressed both by the loss of domestic purchasing power and by the enor mous uncertainties created by the situation in the Persian Gulf. In response to the slump in 10 demand, industrial production turned down ward last October; it continued to fall through March. The combination of plummeting sales and rising energy prices caused profit margins, which were already slim, to shrink further in 1989 1990 1991 most industries during the second half of 1990. In the first quarter, before-tax profits from cur rent operations for U.S. corporations edged down from the low fourth-quarter level. 9 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis An unusual feature of the recent recession was the The Government Sector speed with which producers cut output in order to The federal budget deficit over the first eight months avoid a buildup of inventories. The promptness of of fiscal year 1991 was $17 5 billion, compared with this adjustment likely reflected a combinati~n of fac the $151 billion deficit recorded during the same tors. The downturn in final demand was widely part of fiscal year 1990. The deficit during the cur anticipated, and some producers cut output pre rent fiscal year has been boosted considerably by the emptively, rather than risk being saddled with exces slowdown in economic activity, and this cyclical sive stocks. In addition, improved systems for increase has masked the fiscal restraint imposed by monitoring and controlling inventories have been last autumn's budget agreement. On the revenue installed in recent years, which enabled firms to side, federal tax receipts have been held down by react quickly to signs of slowing demand. Further, the anemic growth of nominal income since last f ~l. the relatively heavy debt burdens in the corporate The slowdown in activity also has raised the deficit sector created substantial financial pressures for by increasing outlays for income-support programs many firms and focused attention on the need to cut such as unemployment insurance, food stamps, and costs. Medicaid. These effects of the contraction have been Accordingly, inventories were run off at a rapid offset, to some degree, by the easing of short-term clip beginning late last summer. Automakers sI::ished interest rates, which has restrained the growth of production and inventories particularly aggressively. interest payments on the federal debt. Despite production cutbacks by the auto~akers and Federal purchases of goods and services, the part other producers, the inventory-to-sales rat10 for total of federal spending that is included directly in GNP, manufacturing and trade moved up through Janu rose 5 ¼ percent in real terms over the four quarters ary. However, by May, the ratio had retraced most of 1990. This increase reflected the fourth-quarter of the runup that began with the onset of the reces rise in defense purchases to support operations in sion reflecting the continued liquidation of stocks the Persian Gulf, as well as increases over the year and 'an upturn in sales. Inventories in m~st indu~ in such nondefense programs as law enforcement, tries appear now to be reasonably well aligned with space exploration, and health research. In the first sales, and output has begun to rise with the expan quarter of 1991, real defense purchases ~oved above sion of final demand. Orders for a range of manufac the already high fourth-quarter level, while non tured goods firmed in April and May, pointing to a defense purchases fell somewhat on net, pushed further pickup in production during the summer. down by sales of oil from the Strategic Petroleum Reserve. Over the rest of 1991, fiscal policy like! y will be a restraining influence on the economy, owing to the spending limits and tax increases man dated by last fall's budget agreement. The fiscal position of state and local governm~nts has remained extremely weak in recent quarters. The deficit in operating and capital accounts ( that is the deficit excluding social insurance funds) stood above $40 billion at an annual rate in both the fourth quarter of 1990 and the first quarter of 1991, after holding at a $30 billion rate for a year. 10 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis The External Sector Annual rate, U.S. Real Merchandise Trade billions of 1982 dollars Over the first half of 1991, the foreign exchange value of the dollar appreciated about 15 percent, on balance, in terms of the currencies of the other QI 500 Group of Ten (G-10) countries. The net appreciation over this period reversed about two-thirds of the QI decline in the dollar that had occurred between the 400 middle of 1989 and the end of 1990. On a bilateral basis, the dollar has appreciated about 20 percent 300 this year against the German mark and by similar amounts against the European currencies associated with the mark. The weakness of these currencies partly reflects economic difficulties in Germany and 1986 1987 1988 1989 1990 1991 the spillover effects of the turmoil in the Soviet Union and Yugoslavia. Real merchandise imports declined in the first quarter to a level about 5 percent below that in the Foreign Exchange Value of the third quarter of 1990, with the drop largely reflect U.S. Dollar* Index, March 1973 =100 ing the weakness in domestic demand. Preliminary data for April show some increase in non-oil imports, a pattern that is likely to continue with the apparent firming of domestic activity. The quantity of oil 125 imports-which plunged after the spurt in oil prices last summer and remained relatively low early this year-has moved back up in recent months, reflect 100 ing efforts to rebuild U.S. petroleum inventories. Merchandise exports continued to move higher through the spring, a factor that clearly tempered the output loss in manufacturing after the oil shock 1986 1987 1988 1989 1990 1991 last year. The competitive position of U.S. compa nies has benefitted, at least until quite recently, from •Index of weighted average foreign exchange value of U.S. dollar in terms of cur rencies of other G-10 countries. Weights are 1972-76 global trade of each of the the substantial drop in the dollar over 1990 and the 10 countries. latter part of 1989. However, recessions in the econ omies of some of our major trading partners, espe The overall strengthening of the dollar this year cially Canada and the United Kingdom, have offset has acted to restrain prices for non-oil imports. Over part of the stimulus to U.S. exports provided by the the first quarter of 1991, these prices rose at a rapid growth in such countries as Germany, Japan, 2 ½ percent annual rate, less than half the rate of and Mexico. increase recorded between June and December of 1990; non-oil import prices then fell during April and May, more than reversing the entire first-quarter rise. The price of imported oil, which surged between August and October of last year, has since retraced most of the rise induced by the Iraqi invasion of Kuwait. Taken together, these two developments contributed significantly to the restraint on domestic inflation. 11 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Labor Markets Price Developments Labor demand appears to have stabilized after con Inflation pressures have eased somewhat this year. tracting sharply during the latter part of 1990 and The bulk of last year's spike in energy prices has the early part of this year. Employment on private been retraced, and the rate of increase in food prices nonfarm payrolls peaked last June, edged lower has slowed. In addition, the margin of slack in labor through September, and then fell substantially in and product markets that emerged during the reces each month from October through April. However, sion is placing downward pressure on price increases employment on private nonfarm payrolls rose in for other goods and services; this trend toward May, the first increase since the middle of 1990. slower "core" inflation, however, was obscured Although part of this gain was reversed in June, early in the year by a number of price increases that firms continued to lengthen the average workweek of either were one-time events or have since been their employees. This pattern of C!3-utious hiring reversed. combined with an extension of the workweek is com Energy prices for consumers have followed the mon in the early stage of a recovery. The civilian movements in world oil prices since last summer. unemployment rate continued to inch up over the The CPI for energy peaked in November 1990 at a second quarter, but increases in the jobless rate level 15 percent above that in July, pushed up by often occur during the first several months of a the sharp rise in oil prices that occurred between recovery. August and October. Consumer energy prices then fell sharply through the first quarter of this year. By April, the decline in crude oil prices had been fully Net change, millions of persons, Payroll Employment passed through to energy prices at the retail level. annual rate Increases in consumer food prices this year have Total Private onfarm slowed from the 5 ¼ to 5 ½ percent range that prevailed over the preceding three years. During the first five months of 1991, the CPI for food rose at 2 only a 3 ¼ percent annual rate, held down in large part by price declines for dairy products and by roughly stable prices on balance for meat, poultry, and eggs. !!!!111!!!!!11! + The consumer price index for items other than food and energy rose sharply during January and February, but the jumps in those months reflected a number of one-time or transitory increases. Higher 2 federal excise taxes went into effect on cigarettes and alcoholic beverages, raising consumer prices for both items; these tax hikes supplemented the increases in sales and excise taxes that a number of states have imposed over the past year. More generally, the 1989 1990 1991 spurt in oil prices last fall spilled over ·t hrough early 12 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis \ -'~f. f ,. -.... Consumer Food Prices* Percent c?ange, Dec. to Dec. 1991 to prices for _a wide range of non-energy good.s and sei:vices: How-ever/ 'th~se factors. btfosHrif infla. . tion prnve<;l ~o be shorHivec;L After the la~ge .incre~es in J9-.nuai;y. and. Feb 1 ~ary,_t p.~ (:;Pl .~xcluding .food . and .energy rose at jµst a 2.¼ percent annual rate t i . 6 between ;Febr,\la[>y-'<i;nd May.. , . ,. , , The . uneve:n pace 9f inflatipn this y,ear has tended to obscure tr:~nds in the general leyel. of retail prices. Nonetheless, t.qere .i,s little doubt thatthe unde1lying --l!!llli!!!tffittt----- 4 - · pace of inflation has moderated since. last year.i The twelve-month change in the CPI excluding food and energy-which held around 4 ½ percent throughout 1988, 1989, and the early' part of 1990.Lmoved up· 2 to about 5 ½ percent in August 1990. By May of this year, the twelve-month change in this index had fallen back to 5.1 p~rcent. ; i ,· i + 1986 1987 1988 1989 1990 1991 *Consumer Price Index for all urban consumers. **Percent change from Dec. 1990 to May 1991, annual rate. r, 13 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Monetary and Financial Developments during the First Half of 1991 The Implementation of Monetary Policy funds rate of a quarter point each time, and reduced the discount rate one-half percentage point on The Federal Reserve adjusted policy in three sepa February 1, resulting in a similar-sized decline in rate steps in the first quarter of the year, extending the federal funds rate. The monetary aggregates the series of moves initiated in the final months of were very weak in January, and while strengthening 1990. Amid signs of continuing steep declines in considerably in February and early March, remained economic activity and abating inflation pressures, on a moderate growth track, especially taking into the Federal Reserve eased reserve provision through consideration the lack of expansion late in 1990. open market operations in January and again in early March, leading to a decline in the federal Growth of Money and Debt (Percent change) Debt of Domestic Mt M2 M3 N onfinancial Sectors Annually, 1980 7.4 8.9 9.5 9.4 fourth quarter to fourth quarter 1981 5.4 (2.5)* 9.3 12.3 10.1 1982 8.8 9.1 9.9 9.1 1983 10.4 12.2 9.8 11.1 1984 5.4 8.0 10. 7 14.2 1985 12.0 8.7 7.6 13.1 1986 15.5 9.2 9.0 13.2 1987 6.3 4.3 5.8 9.7 1988 4.2 5.2 6.3 9.2 1989 0.6 4.7 3.6 7.7 1990 4.2 3.8 1. 7 6.7 Quarterly 1991 Ql 5.9 3.4 4.0 4.8 (annual rate) Q2 7.4 4.6 1.8 4.2 Semiannually 1991, Hl 6.7 4.0 2.9 4.5 fourth quarter to second quarter (annual rate) *Figure in parentheses is adjusted for shifts to NOW accounts in 1981. 14 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Other short-term rates generally fell about a per In the wake of the successful Gulf war and in centage point over this period. The commercial bank view of initial signs that the System's earlier easing prime loan rate was reduced one-half percentage actions had begun to take hold, the FOMC con point in early January in lagged response to earlier cluded at its meeting in late March that the risks to declines in short-term rates. The drop apparently the economy had become more evenly balanced. had been delayed as banks attempted to hold down Accordingly, the Committee decided to end the formal loan growth as last year drew to a close, bolstering tilt toward ease that it had adopted in mid-1990, their capital positions in response to market concerns when slowing money growth and tightening credit and the initial phase-in of risk-based capital require availability aroused concerns that financial condi ments. The prime rate was reduced again after the tions might be placing greater-than-anticipated cut in the discount rate in early February. restraint on economic acivity. Under the previous Longer-term rates also fell on balance over the instructions, the FOMC's directive to the domestic first two months of the year, under the influence of trading desk at the Federal Reserve Bank of New monetary easings and prospects for lower inflation, York had stipulated that possible adjustments to especially when it became clear that the Gulf war reserve pressures between Committee meetings would not interrupt oil supplies. Initial success in would be more responsive to unanticipated signs of the Persian Gulf also led briefly to weakness in the economic weakness and abating price pressures than dollar in foreign exchange markets, as safe-haven to unexpected evidence of strength. The directive demands that had been boosting its value since late issued at the March meeting restored symmetry to in 1990, in the face of a substantial easing of U.S. these instructions concerning intermeeting monetary policy, evaporated. adjustments. In March, however, long-term market rates began Interest rates generally declined during April, to firm on the rebound in consumer confidence and mainly at the short end, reflecting market par initial indications of a turnaround in the housing ticipants' disappointment that the response they had market, which were seen as pointing to a somewhat expected to earlier monetary easings and to the shorter and milder recession than many had previ rebound in consumer confidence had yet to show ously feared. Rate increases were muted on private through in measures of economic activity. At the instruments, though, as risk premiums began to same time, with evidence also continuing to point to shrink in response to brightening prospects for a a further abatement of inflation, particularly as recovery. These gains extended even to below reflected in wage behavior, the Federal Reserve at investment-grade bonds, and growing optimism was the end of April reduced the discount rate another reflected as well in a strong stock market in Febru one-half percentage point, allowing about half that ary and into March. The debt and equity instru amount to show through to money market rates. As ments of banks generally outperformed broader was the case in February, this action was followed indexes over this period, as the market apparently by a one-half percentage point decline in the bank expected their earnings to be bolstered by lower prime rate. Despite further monetary ease, the dollar short-term interest rates and the deterioration in the continued to rally on foreign exchange markets, in quality of their loan portfolios to be limited as the part boosted by political developments abroad, par anticipated economic recovery materialized. Better ticularly in the Soviet Union, and potential eco prospects for a U.S. economic recovery about coin nomic difficulties in Germany. cided with a turn toward more pessimism regarding the economic outlook abroad. As a result, the exchange value of the dollar reversed and began to appreciate sharply. 15 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Short-term Interest Rates Monetary and Credit Flows Percent Despite the continuing w.eakness in economic Monthly activity, expansion of t~e monetary aggregates in the 14 first half of 1991 picked up from the lackluster pace of late 1990, and M2 and M3 grew at annual rates of 3 ¾ and 2 ¼ percent, respectively, from the fourth quarter of last, year through June .. M2 growt~ 12 increased as policy actions reduced short-term mar ket interest rates relative to returns that could .be earned on assets in this aggregate ( a decline in the 10 "opportunity cost" of holding M2). As a conse quence, expansion of M2 exceeded the growth 9f nominal GNP. However, the growth in M2 (and 8 decli_ne in its velocity) was smaller than would have been expected on the basis of past ~elationships with income, interest rates, and opportunity c9sts. This Coupon equivalent 6 shortfall of M2 growth from historical_p atterns fol lowed an even greater discrepancy in 1990. M2: Target Range and 1982 1983 1984 1985 1986 1987 1-988 1989. 1990 1991 Actual Growth Last observation for June 1991. Billions of Dollars Market interest rates were little changed until 6.5% early June, when they rose in response to the release of data on employment and retail sales for May that 3500 strongly suggested the trough of the recession had been reached or at least was close at hand. The ensuing rise in interest rates was particularly sharp at the long end of the Treasury market. As signs of the recovery grew more distinct and interest rates 3400 firmed, the dollar strengthened further, and by June had retraced all of its declines of late 1990 and early 1991 . On balance, Treasury bond yields rose almost one-quarter percentage point over the first" half, 3300 while yields on investment-grade corporates were down close to one-half percentage point. 0 N D J F M A M J J A S O N D 1990 1991 16 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Growth of M3 over the first half was concentrated M3: Target Range and in the early months of the year, when it received a Actual Growth Billions of Dollars considerable boost from heavy issuance of large time deposits by U.S. branches and agencies of foreign banks. The strength of M3 in the first quarter also reflected strong growth of money market mutual funds. M3 was about flat between March and June. 4300 Shifts of foreign bank liabilities toward large time deposits slowed, large time deposits at domestic depositories ran off more rapidly with a contraction of their credit, and money funds decelerated as their 4200 yields came into line with market rates. Bank credit expanded very slowly in the first half of 1991, and was concentrated in acquisitions of securities, particularly those of the Treasury and agencies. As in 1990, the recent strength in acquisi 4100 tions of these securities owes in part to their favora _.,,,. _.,,,.7 _.,,,. ble treatment under risk-based capital requirements. _.,,,. _.,,,._.,,,. _.,,,. Mainly, however, it reflects the impact on loan _.,,,. growth of weaker spending by potential borrowers 0 N D J F M A M J J A S O N D and continued lending restraint by banks. Overall, the debt of domestic nonfinancial sectors 1990 1991 increased at about a 4 ½ annual percent rate over the first half. This was likely a bit above the rate of expansion of nominal GNP, though by considerably less than on average over the previous decade, as both borrowers and lenders apparently have been adopting more cautious attitudes toward additional debt. 17 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Footnotes 1. Ml is d.1.r·rency h'eld by the 1public, 1plus travelers': checks, i)lus demand deposits, plus other checkable deposits [indudin1g negotiable m:det 'of withdrawal (NOW and Super NO'W9 accounts, automatic transfer service r. (ATS) accounts,· and. credit union share draft accounts M2 is M.1 plu~ savings and small denomination time deposits; plus Money Market Depo_sit. Accounts, plus shares jn. mon~y market mutual. funds ( other than those restricted to instituti9nal investors)... plus o_vernight repur chase agreements and ce'rtain overnight Eurodollar deposit·s. . . . . . M3 is M2 plus large time deposits, plus large denomi nation term repurchase agreements; plus shares in money market mutual fonds restritted to institutional investors and Gertain term ·Eurodollar deposits. A copy of the full report to Congress is available from Publication Services, Federal Reserve Board, Washington, D.C. 20551 FRB29-50000-0791 18 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis

Federal Reserve (1991, July 15). Monetary Policy Report. Monetary Policy Reports, Federal Reserve. https://whenthefedspeaks.com/doc/monetary_policy_report_19910716

@misc{wtfs_monetary_policy_report_19910716,
  author = {Federal Reserve},
  title = {Monetary Policy Report},
  year = {1991},
  month = {Jul},
  howpublished = {Monetary Policy Reports, Federal Reserve},
  url = {https://whenthefedspeaks.com/doc/monetary_policy_report_19910716},
  note = {Retrieved via When the Fed Speaks corpus}
}