Monetary Policy Report

/ ~ t ' \_ ' \ - I I I I / \ . ~ I \.v - ,.. '-' I I I .(; r ( I I ( 4 I ,,, '- 7 L ~ .J. \ I I I\/ ./ / /; '1 \ I \ ) 1993 J ~ ) ,.. ,MONET/ ARY{,; , ~ ( \ I 1 POLICY ' '\): ) OBJECTIVES I ( \ Midyear Review of the Federal Reserve Board ,,_ .A I \ I / \ I ( ,.- J.. '( / ./ I-.-. \ l " -'i J V i ( ,,.. ..,, ;r '1 J I ; I Digitized for FRASER \_ https://fraser.stlouisfed.org / Federal Reserve Bank of St. Louis 1993 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. Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Contents Section Page Testimony of Alan Greenspan Chairman, Federal Reserve Board 3 Monetary Policy and the Economic Outlook for 1993 and 1994 15 Monetary Objectives for 1993 and 1994 15 Economic Projections for 1993 and 1994 16 Developments in 1993 20 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Testimony of Alan Greenspan Chairman, Federal Reserve Board Thank you for this opportu As the economic expansion has progressed somewhat fitfully, our nity to discuss the Federal earlier characterization of the economy Reserve' s semiannual as facing stiff head winds has appeared increasingly appropriate. monetary policy report to the Doubtless the major head wind in this Congress. My remarks this regard has been the combined efforts of households, businesses, and morning will cover the financial institutions to repair and to current monetary policy and rebuild their balance sheets following the damage inflicted in recent years as economic settings, as well as weakening asset values exposed the Federal Reserve' s excessive debt burdens. But there have been other head longer-term strategy for winds as well. The build-down of contributing, to the best of our national defense has cast a shadow over particular industries and regions abilities, to the nation's of the country. Spending on nonresi economic well-being. dential real estate dropped dramati cally in the face of overbuilding and high vacancy rates and has remained in the doldrums. At the same time, corporations across a wide range of industries have been making efforts to pare employment and expenses in order to improve productivity and their competitive positions. These efforts have been prompted in part by innovative technologies, which have been applied to almost every area of economic endeavor, and have boosted investment. However, their effect on jobs and wages through much of the expansion also has made households more cautious spenders. Digitized for FRASER https://fraser.stlouisfed.org 3 Federal Reserve Bank of St. Louis In the past several years, as these As a result, monetary policy in recent influences have restrained the econ years has had to remain alert to the omy, they have been balanced in part possibility that an ill-timed easing by the accommodative stance of could be undone by a flare-up of monetary policy and, more recently, inflation expectations, pushing by declines in longer-term interest long-term interest rates higher, and rates as the prospects for credible short-circuiting essential balance sheet federal deficit cuts improved. From the repair. time monetary policy began to move The cumulative monetary easing toward ease in 1989 to now, short-term over the last four years has been very interest rates have dropped by more substantial. Since last September, than two-thirds and long-term rates however, no further steps have been have declined substantially, too. All taken, as the stance of policy has along the maturity spectrum, interest appeared broadly appropriate to the rates have come down to their lowest evolving economic circumstances. levels in twenty or thirty years, aiding That stance has been quite accom the repair of balance sheets, bolstering modative, especially judging by the the cash flow of borrowers, and level of real short-term interest rates in providing support for interest the context of, on average, moderate sensitive spending. economic growth. Short-term real The process of easing monetary interest rates have been in the neigh policy, however, had to be closely borhood of zero over the last three controlled and generally gradual, quarters. In maintaining this accom because of the constraint imposed by modative stance, we have been the marketplace's acute sensitivity to persuaded by the evidence of persis inflation. As I pointed out in my tent slack in labor and product February testimony to the Congress, markets, increasing international this is a constraint that did not exist in competitiveness, and the decided an earlier time. Before the late 1970s, absence of excessive credit and money financial market participants and expansion. The forces that engendered others apparently believed that, while past inflationary episodes appear to inflationary pressures might surface have been lacking to date. from time to time, the institutional Yet some of the readings on inflation structure of the U.S. economy simply earlier this year were disturbing. It would not permit sustained inflation. appeared that prices might be acceler But as inflation and, consequently, ating despite product market slack and long-term interest rates soared into an unemployment rate noticeably the double digits at the end of the above estimates of the so-called 1970s, investors became painfully "natural" rate of unemployment aware that they had underestimated that is, the rate at which price pres the economy's potential for inflation. sures remain roughly constant. Digitized for FRASER https://fraser.stlouisfed.org 4 Federal Reserve Bank of St. Louis In the past, the existing degree of slack but the sample from which those data in the economy had been consistent are derived is too small to be persua with continuing disinflation. sive. Moreover, the price of gold, However, the inflation outcome, which can be broadly reflective of history tells us, depends not only on inflationary expectations, has risen the amount of slack remaining in labor sharply in recent months. And at times and product markets, but on other this spring, bond yields spiked higher factors as well, including the rate at when incoming news about inflation which that slack is changing. If the was most discouraging. economy is growing rapidly, inflation The role of expectations in the pressures can arise, even in the face of inflation process is crucial. Even excess capacity, as temporary bottle expectations not validated by eco necks emerge and as workers and nomic fundamentals can themselves producers raise wages and prices in add appreciably to wage and price anticipation of continued strengthen pressures for a considerable period, ing in demand. Near the end of last potentially derailing the economy year, about the time many firms from its growth track. probably were finalizing their plans Why, for example, despite an for 1993, sales and capacity utilization above-normal rate of unemployment were moving up markedly and there and permanent layoffs, have uncer was a surge of optimism about future tainties about job security not led to economic activity. This may well have further moderation in wage increases? set in motion a wave of price increases, The answer appears to lie at least in which showed through to broad part in the deep-seated anticipations measures of prices earlier this year. understandably harbored by workers Moreover, inflation expectations, at that inflation is likely to reaccelerate in least by some measures, appear to the near term and undercut their real have tilted upward this year, possibly wages. contributing to price pressures. The The Federal Open Market Commit University of Michigan survey of tee (FOMC) became concerned that consumer attitudes, for example, inflation expectations and price reported an increase in the inflation pressures, unless contained, could rate expected to prevail over the next raise long-term interest rates and stall 12 months from about 3¾ percent in economic expansion. Consequently, at the fourth quarter of last year to nearly its meeting in May, while affirming the 4½ percent in the second quarter. Pre more accommodative policy stance in liminary data imply some easing of place since last September, the FOMC such expectations earlier this month, also deemed it appropriate to initiate a so-called asymmetric directive. Such Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 5 a directive, with its bias in the direc drop in defense spending, a sharp tion of a possible firming of policy deterioration in net exports, a major over the intermeeting period, does not blizzard, and some inevitable retrench prejudge that action will be taken ment by consumers converged to yield and indeed none occurred. But it did only meager gains in output in the first indicate that further signs of a poten quarter. But growth apparently picked tial deterioration of the inflation up in the second quarter, and nearly outlook would merit serious consider one million net new jobs were created ation of whether short-term rates over the first half. Smoothing through needed to be raised slightly from their the quarterly pattern, the economy relatively low levels to ensure that appears to have accelerated gradually financial conditions remained condu over the past two years, to maintain a cive to sustained growth. pace of growth that should yield Certainly the May and June price further reductions in the unemploy figures have helped assuage concerns ment rate. Consequently, the evidence that new inflationary pressures had remains consistent with our diagnosis taken hold. Nonetheless, on balance, that the underlying forces at work are the news on inflation this year must be keeping the economy generally on a characterized as disappointing. moderate upward track. However, as I Despite disinflationary forces and have often emphasized, not all the old continued slack, the rate of inflation economic and financial verities have has at best stabilized, rather than held in the current expansion, and easing further as past relationships changes in fiscal policy will have would have suggested. uncertain effects going forward. Thus, In assessing the stance of monetary caution in assessing the path for the policy and the likelihood of persistent economy remains appropriate. inflationary pressures, the FOMC took Financial conditions have improved account of the downshift in the pace of considerably, lessening the need for economic expansion earlier this year. balance sheet restructuring that has This downshift left considerable been damping economic activity for remaining slack in the economy and several years now. By no means is the promised that the adverse price , process over, but good progress has movements prompted by the accelera been made. Debt service burdens, tion in growth late last year likely eased by lower interest rates and would diminish. lower debt-equity ratios, have fallen While a slowdown from the unsus substantially in both the business and tainably rapid growth in the latter household sectors. On the other hand, part of last year had been anticipated, the economies of a number of our the deceleration was greater than major trading partners have been quite expected. A surprisingly precipitous weak, constraining the growth of demand for our exports. Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 6 Although expectations of a signifi Assuming, however, we construc cant, credible decline in the budget tively resolve over time the major deficit have induced lower long-term questions about federal budget and interest rates and favorably affected health care policies, with the further the economy, the positive influence waning of earlier restraints on growth, thus far is apparently being at least the U.S. economy should eventually partly offset by some business spend emerge healthier and more vibrant ing reductions as a consequence of than in decades. The balance sheet concerns about the effects of pending restructuring of both financial and tax increases. nonfinancial establishments in recent It seems that the prospective cuts in years should leave the various sectors the deficit are having a variety of of the economy in much better shape substantial economic effects, well in and better able to weather untoward advance of any actual change in taxes developments. Similarly, the ongoing or in projected outlays. Moreover, efforts by corporations to pare uncertainty about the final shape of expenses are putting our firms and our the package may itself be injecting a industries in a better position to note of caution into private spending compete both within the U.S. market plans. In addition, uncertainty about and globally. And after a period of the outlook for health care reform may some dislocation, the contraction in the be affecting spending at least by that defense sector ultimately will mean a industry. freeing up of resources for more To be sure, the conventional wisdom productive uses. Finally, a credible is that budget deficit reduction and effective fiscal package would restrains economic growth for a time, promise an improved outlook for and I suspect that probably is correct. sustained lower long-term interest However, over the long run, such rates and a better environment for wisdom points in the opposite private sector investment. All told, the direction. In fact, one can infer that productive capacity of the economy recent declines in long-term interest will doubtless be higher, and its rates are bringing forward some of resilience greater. these anticipated long-term gains. As a Over the last two years, the forces of consequence, the timing and magni restraint on the economy have tude of any net restraint from deficit changed, but real growth has contin reduction is uncertain. Patently, the ued, with one sector of the economy overall economic effect of fiscal policy, after another taking the lead. Against especially when combined with the this background, Federal Reserve uncertainties of the forthcoming health Board governors and Reserve Bank reform package, has imparted a presidents project that the U.S. number of unconventional unknowns economy will remain on the moderate to the economic outlook. growth path it has been following as Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 7 the expansion has progressed. Their and commercial banks have pulled forecasts for real GDP average around back as well, largely reflecting the 2½ percent from the fourth quarter of burgeoning loan losses that followed 1992 to the fourth quarter of 1993, and the lax lending of earlier years. With cluster around 2½ to 3¼ percent over depository credit weak, there has been the four quarters of 1994. Reflecting little bidding for deposits, and this moderate rise and the outlook for depositors in any case have been labor productivity, unemployment is drawn to the higher returns on capital generally expected to edge lower, to market instruments. Inflows to bond around 6¾ percent by the end of this and stock mutual funds have reached year, and to perhaps a shade lower by record levels, and, to the extent that the end of next year. For this year as a these inflows have come at the whole, FOMC participants see expense of growth in deposits or inflation at or just above 3 percent, and money market mutual funds, the most of them have about the same broad monetary aggregates have been forecast for next year. depressed. In addition to focusing on the In this context, the FOMC lowered outlook for the economy at its July the 1993 ranges for M2 and M3- meeting, the FOMC, as required by the to 1 to 5 percent and O to 4 percent, Humphrey-Hawkins Act, set ranges respectively. This represents a reduc for the growth of money and debt for tion of 1 percentage point in the M2 this year and, on a preliminary basis, range and ½ percentage point for M3. for 1994. One premise of the discus Even with these reductions, we would sion of the ranges was that the unchar not be surprised to see the monetary acteristically slow growth of the broad aggregates finish the year near the monetary aggregates in the last couple lower ends of their ranges. of years-and the atypical increases in As I emphasized in a similar context their velocities-would persist for a in February, the lowering of the while longer. M2 has been far weaker ranges is purely a technical matter; it than income and interest rates would does not indicate, nor should it be predict. Indeed, if the historical perceived as, a shift of monetary relationships between M2 and policy in the direction of restraint. nominal income had remained intact, It is indicative merely of the state of the behavior of M2 in recent years our knowledge about the factors would have been consistent with an depressing the growth of the aggre economy in severe contraction. To an gates relative to spending, of the important degree, the behavior of course of the aggregates to date, M2 has reflected structural changes and of the likelihood of various out in the financial sector: The thrift comes through the end of the year. industry has downsized by necessity, Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 8 While the lowering of the range The FOMC never single-mindedly reflects our judgment that shifts out of adhered to a narrow path for M2, but M2 will persist, the upper end of the persistent and sizable deviations of revised range allows for a resumption that aggregate from expectations were of more normal behavior or even some a warning sign that policy and the unwinding of M2 shortfalls. The economy might not be interacting in a FOMC also lowered the 1993 range for way that would produce the desired debt of the domestic nonfinancial results. The so-called "P-star" model, sectors, by ½ percentage point, to 4 to developed in the late 1980s, embodied 8 percent. The debt aggregate is likely a long-run relationship between M2 to come in comfortably within its new and prices that could anchor policy range, as it continues growing about in over extended periods of time. But that line with nominal GDP. The new long-run relationship also seems to ranges for growth of money and debt have broken down with the persistent in 1993 were carried over on a prelimi rise in M2 velocity. nary basis into 1994. M2 and P-star may reemerge as In reading the longer-run intentions reliable indicators of income and of the FOMC, the specific ranges need prices once the yield curve has to be interpreted cautiously. The returned to a more normal configura historical relationships between money tion, borrowers' balance sheets have and income, and between money and been restored and traditional credit the price level have largely broken demands resume, savers have adjusted down, depriving the aggregates of to the enhanced availability of alterna much of their usefulness as guides to tive investments, and depositories policy. At least for the time being, finally reach a comfortable size relative M2 has been downgraded as a reliable to their capital and earnings. In the indicator of financial conditions in the meantime, the process of probing a economy, and no single variable has variety of data to ascertain underlying yet been identified to take its place. economic and financial conditions has At one time, M2 was useful both become even more essential to to guide Federal Reserve policy and formulating sound monetary policy. to communicate the thrust of mone This general approach obviously has tary policy to others. Even then, its weaknesses. When examining many however, a wide range of data was indicators, some can always be found routinely evaluated to assure our that counsel against actions that later selves that M2 was capturing the appear to have been necessary. important elements in the financial system that would affect the economy. Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 9 In these circumstances, it is espe Moreover, the equilibrium rate cially prudent to focus on longer-term structure responds to the ebb and flow policy guides. One important guide of underlying forces affecting spend post is real interest rates, which have a ing. So, for example, in recent years key bearing on longer-run spending the appropriate real rate structure decisions and inflation prospects. doubtless has been depressed by the In assessing real rates, the central head winds of balance sheet restruc issue is their relationship to an turing and fiscal retrenchment. Despite equilibrium interest rate, specifically the uncertainties about the levels of the real rate level that, if maintained, equilibrium and actual real interest would keep the economy at its rates, rough judgments about these production potential over time. Rates variables can be made and used in persisting above that level, history tells conjunction with other indicators in us, tend to be associated with slack, the monetary policy process. Cur disinflation, and economic rently, short-term real rates, most stagnation-below that level with directly affected by the Federal eventual resource bottlenecks and Reserve, are not far from zero; rising inflation, which ultimately long-term rates, set primarily by the engenders economic contraction. market, are appreciably higher, Maintaining the real rate around its judging from the steep slope of the equilibrium level should have a yield curve and reasonable supposi stabilizing effect on the economy, tions about inflation expectations. This directing production toward its configuration indicates that market long-term potential. participants anticipate that short-term The level of the equilibrium real real rates will have to rise as the head rate-or more appropriately the winds diminish, if substantial infla equilibrium term structure of real tionary imbalances are to be avoided. rate~annot be estimated with a While the guides we have for policy great deal of confidence, though with may have changed recently, our goals enough to be useful for monetary have not. As I have indicated many policy. Real rates, of course, are not times to this Committee, the Federal directly observable, but must be Reserve seeks to foster maximum inferred from nominal interest rates sustainable economic growth and and estimates of inflation expectations. rising standards of living. And in The most important real rates for that endeavor, the most productive private spending decisions almost function the central bank can perform surely are the longer maturities. is to achieve and maintain price stability. Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 10 Inflation is counterproductive in This is a net change, however, which many ways. Of particular importance, masks the many millions who found, increased inflation has been found to lost, and changed jobs over the same be associated with reduced growth of period. Currently, people are being productivity, apparently in part hired at a pace of approximately because it confounds relative price 400,000 per week, with job losses movements and obscures price signals. running modestly below that figure. Compounding this negative effect, Such vast churning in the nation's under the current tax code, inflation labor markets is a normal and ulti raises the effective taxation of savings mately a productive process. -and investment, discouraging the Central planning of the type that process of capital formation. Since prevailed in post-war Eastern Europe productivity growth is the only source and the Soviet Union represented one of lasting increases in real incomes and attempt to fashion an economic system because even small changes in growth that eliminated this competitive rates of productivity can accumulate churning and its presumed wasteful. . over time to large differences in living ness. But when that system eliminated standards, its association with inflation the risk of failure, it also stifled the is of key importance to policymakers. incentive to innovate and to prosper. The link between the control of Central planning fostered stasis: inflation and the growth of productiv In many respects, the eastern-bloc ity underscores the importance of economies marched in place for more providing a stable backdrop for the than four decades. economy. Such an environment is Risk-taking is crucial in the process especially important for an increas that leads to a vital and progressive ingly dynamic market economy, such economy. Indeed, it is a necessary as ours, where technology and condition for wealth creation. In a telecommunications are making rapid market economy, competition and advances. New firms, new products, innovation interact; those firms that new jobs, new industries, and new are slow to innovate or to anticipate markets are continually being created, the demands of the consumer are soon and they are unceremoniously displac left behind. The pace of churning ing the old ones. The U.S. economy is a differs by industry, but it is present in dynamic system, always renewing all. At one extreme, firms in the most itself. It is extraordinary that the sys high-tech areas must remain con tem overall is as stable as it is, consid stantly on the cutting edge, as prod ering the persistent process of change ucts and knowledge become rapidly in the structure of our economy. For obsolete. Many products that were at example, a frequently cited figure is technology's leading edge, say five the two million new jobs that have years ago, are virtually unsalable in been created since the end of 1991. today's markets. In high-tech fields, Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 11 leadership can shift rapidly. In some given the inherently uncertain out markets where American firms were comes of all business and household losing share just a few years ago, we decisions. But many uncertainties and have regained considerable domi risks do not foster economic progress, nance. In one case, U.S. firms have and where feasible should be sup seized a commanding lead in just two pressed. A crucial risk in this category years in the new laptop computer is that induced by inflation. To allow a market, and now account for more market economy to attain its potential, than 60 percent of U.S. sales last year, the unnecessary instability engendered triple the figure for Japanese firms. by inflation must be quieted. More generally, it appears that the A monetary policy that aims at price pace of dynamism has been accelerat stability permits low long-term interest ing. As one indication, the average rates and helps provide a stable setting economic life expectancy of new to foster the investment and innova capital equipment has been falling. tion by the private sector that are key The average life of equipment pur to long-run economic growth. In chased in 1982, for example, was pursuing our objectives, we must 16½ years. By 1992 that figure had remain acutely aware that the struc declined to 14½ years, a drop more ture of the economy has been changing than twice as large as that over the and growing ever more complex. The preceding decade. In addition, relationships between the key vari telecommunications technology is ables in the economy are always obviously quickening the decision shifting to a degree, and this evolution making process in both financial and presents an ongoing challenge to the product markets. business leader, to the econometric In such a rapidly changing market modeler, and to those responsible for place, the agile survive by being the conduct of economic policy. flexible. One aspect of this flexibility Clearly, the behavior of many of the has been the spread of "just-in-time" forces acting on the economy over the inventory controls at manufacturing course of the last business cycle have firms. Partly as a result of innovations been different from what had gone in inventory control techniques, the before. The sensitivity of inflation · variability of inventories relative to expectations has been heightened, and, total output appears to be on a as recent evidence suggests, businesses downtrend. and households may be becoming The possibility of failure has more forward-looking with respect to productive side effects, encouraging fiscal policies as well. economic agents to do their best to succeed. But there are nonproductive and unnecessary risks as well. There is no way to avoid risk altogether, Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 12 I believe we are on our way toward found receptive markets in recent reestablishing the trust in the purchas months for fifty-year bonds. This had ing power of the dollar that is crucial not happened in decades. The reopen to maximizing and fulfilling the ing of that market may be read as one productive capacity of this nation. The indication that some investors once public, however, clearly remains to be again believe that inflationary pres convinced: Survey responses and sures will remain subdued. financial market prices embody It is my firm belief that, with fiscal expectations that the current lower consolidation and with the monetary level of inflation not only will not be policy path that we have charted, the bettered, it will not even persist. But United States is well-positioned to there are glimmers of hope that trust is remain at the forefront of the world reemerging. For example, issuers have economy well into the next century. Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 13 Monetary Policy and the Economic Outlook for 1993 and 1994 Monetary Objectives in July 1992. In fact, velocities of the for 1993 and 1994 broad monetary aggregates have been especially strong; in the first quarter of In reviewing the annual ranges for the 1993, the velocities of M2 and M3 monetary aggregates in 1993, the posted substantial increases of FOMC noted that the relationship of 6¼ percent and 8 percent, respectively, broadly defined money to income has and appear to have recorded addi continued to depart from historical tional, but smaller, gains in the second patterns. The annual velocities of these quarter. As a consequence, at its aggregates last fell in 1986, and their meeting this month, the Committee prolonged upward movements since red~~ed the 1993 range for M2 by an then strongly suggest breaks from additional percentage point and the previous long-run trends of flat range for M3 by another one-half veloc~ty for M2 and slowly decreasing percentage point, leaving them at 1 to velocity for M3. The rise in the velocity 5 percent for M2 and O to 4 percent for measures has been particularly M3. surprising in the last four years, a The reductions of these growth period of declining interest rates, ranges represented further technical normally associated with a reduction adjustments in response to actual and in velocity. anticipated increases in velocity and In February, anticipating that not a shift in monetary policy, which further balance sheet restructuring and remains focused on fostering sustain portfolio shifts from deposits to able economic expansion while mutual funds would result in further making continued progress toward increases in velocity, the FOMC price stability. With further substantial lowered the 1993 growth ranges for increases in velocities, continued ~ and M3 by one-half percentage sluggish expansion of M2 and M3, pomt from the provisional ranges set Ranges for Growth of Monetary and Credit Aggregates 1 (Percentage change, fourth quarter to fourth quarter) 1993 1993 (As of (As of 1992 February) July) 1994 M2 2½to6½ 2 to 6 lto5 lto5 M3 lto5 ½to4½ 0 to4 0 to 4 Debt 4½to8½ 4½to8½ 4to8 4 to 8 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 15 which are now at the lower ends of Economic Projections their revised ranges, would be for 1993 and 1994 consistent with an acceptable track for The members of the Board of Gover the economy. Also at the July meeting, nors and the Reserve Bank presidents, the annual monitoring range for the all of whom participate in the delibera domestic nonfinancial debt aggregate tions of the Federal Open Market was reduced by one-half percentage Committee, generally anticipate that point to 4 to 8 percent; growth in this economic activity will strengthen in aggregate is likely to continue t~ be the second half of 1993 and continue to roughly in line with that of nommal expand moderately in 1994. The GDP. t? growth of output is likely b~ While the future behavior of the accompanied by further gams m velocities of broad money aggregates productivity, but increases in employ was recognized to be difficult to ment are projected to be large enough predict with precision at a ~e of to keep the unemployment rate ongoing structural changes m the moving down. Inflation is not financial sector, it appears likely that expected to change materially over the forces contributing to the unusual this period. strength in velocities will continue for some time, and the FOMC carried forward the revised 1993 ranges for the monetary and debt aggregates to Civilian Unemployment Rate 1994 as well. With considerable Percent uncertainty persisting about the relationship of the monetary aggre gates to spending, the behavior of the --------------8 aggregates relative to th~ir_annual . ranges will likely be of limited use m guiding policy over the next eighte~n months, and the Federal Reserve will continue to utilize a broad range of financial and economic indicators in --------------4 assessing its policy stance. 1987 1989 1991 1993 Digitized for FRASER https://fraser.stlouisfed.org 16 Federal Reserve Bank of St. Louis Economic Projections for 1993 and 1994 FOMC Members and Other FRB Presidents 1993 Range Central Tendency Percentage Nominal GDP 4¾to6¼ StoS¾ change, ------------------------------- fourth quarter Real GDP 2to3½ 2¼to2¾ to fourth quarter: Consumer price index 3to3½ 3to3¼ Average level in the fourth Civilian unemployment rate 6½ to7 6¼ quarter, percent: 1994 Range Central Tendency Percentage Nominal GDP 4½ to6¾ 5to6½ change, fourth quarter Real GDP 2to3¼ 2½ to3¼ to fourth quarter: Consumer price index 2to4¼ 3to3½ Average level in the fourth Civilian unemployment rate 6¼to7 6½ to6¾ quarter, percent: Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 17 The forecasts of the Board members Moreover, with at least a moderate and Reserve Bank presidents for pickup in average growth in foreign economic growth in 1993 are some industrial countries, the external sector what weaker than in February, mainly should be exerting a less negative because of the shortfall in real growth influence on economic activity in the in the first quarter. Most expect output United States. gains over the balance of the year to be Despite the improvement in large enough to result in a four-quarter financial conditions, there are reasons change in real gross domestic product to be cautious about the near-term in the range of 2¼ to 2¾ percent; for outlook. Efforts this year to bring the 1994, the central tendency of the federal budget deficit under control forecasts spans a range of 2½ to already have helped to ease pressures 3¼ percent. The civilian unemploy on long-term interest rates, and a ment rate, which averaged 7 percent in successful agreement to reduce deficits the second quarter of 1993, is projected significantly will produce substantial to fall to the area of 6¾ percent by the benefits over the longer run. But such fourth quarter of this year and to drop actions also are expected to exert some slightly further over the course of restraint on aggregate demand this 1994. year and next. Government outlays for Recent developments in the financial defense will continue to contract, sphere should be conducive to the extending the dislocations and sustained increases in spending disruptions that have been evident for projected for the quarters ahead. The some time in industries and regions financial positions of many households that depend heavily on military and businesses have continued to spending. Prospects for higher taxes improve, and banks are showing signs may already be influencing the of greater willingness to make loans. behavior of some households and Short-term interest rates are relatively businesses, and the constraint is likely low, and the appreciable declines in to intensify in 1994. In addition, long-term interest rates over the past uncertainties about prospective federal several months should further the policies reportedly are weighing on process of balance sheet adjustment businesses and consumers; although and are anticipated to provide the outcome of the Congressional considerable impetus to business budget deliberations will be known investment and residential construc shortly, uncertainties about health care tion. It is likely that business invest reform are not anticipated to be ment also will continue to be bolstered resolved fully for some time. by the ongoing push to improve products and boost efficiency through the use of state-of-the-art equipment. Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 18 Consumer Prices* The fundamentals remain consistent Percent change, Dec. to Dec. with additional disinflation; businesses continue to focus on controlling costs, and slack in labor and product ----------tl&-------- markets is anticipated to decrease only 6 gradually in the period ahead. However, the disappointing price --Ii~------- performance in the first half of the 4 year suggests that further progress will not come easily-in part perhaps because inflation expectations remain high. Lowering inflation and inflation expectations over time, and achieving sustained reductions in long-term 1987 1989 1991 1993 interest rates, will depend importantly "Consumer price index for all urban consumers. on a monetary policy that remains ••Percent change, June 1992 to June 1993. committed to fostering further progress toward price stability. The performance of prices and the econ Most Board members and Bank omy also will depend on government presidents expect the rise in the policies in other areas. Namely, a consumer price index over the four sound fiscal policy, a judicious quarters of 1993 to be in the range of 3 approach to foreign trade issues, and to 3¼ percent, about the same as the regulatory policies that preserve increase over the four quarters of 1992. flexibility and minimize the costs they At this stage, the food and energy impose are crucial to reestablishing the sectors are riot expected to have much disinflation trend of the past couple of effect, on balance, on the broad price years and allowing the economy to measures in 1993, but the flooding in perform at its full potential. the Midwest raises the risk of higher The Administration has not yet food prices in the quarters ahead. For released the mid-year update to its 1994, the central tendency forecast is economic and budgetary projections. for CPI inflation in the range of 3 to However, statements by Administra 3½ percent, not much different than in tion officials suggest that the revised 1992 and 1993. forecasts for real growth and inflation in 1993 and 1994 are not likely to differ significantly from those of the Federal Reserve. Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 19 Developments in 1993 Like most private forecasters, the Board members and Bank presidents In February, when the Federal Reserve generally have trimmed their projec~ prepared its monetary policy plans for tions of growth in real gross domestic 1993, the broad trends in the economy product (GDP) for the year as a whole, appeared favorable. A~er a hesi~ant although they continue to foresee beginning, the econormc expansion increases in output large enough to had picked up steam in the latter _part extend the reduction in the unemploy of 1992, while inflation seemed still to ment rate that began last summer. be headed downward. Most members Events on the price side also have been of the Federal Open Market Commit disappointing. The inflation rate in the tee (FOMC) and nonvoting presidents first part of this year was higher than anticipated that 1993 would be a good in late 1992. There is evidence that year for growth and would also see some of the pickup in the consumer further progress toward price stability. price index (CPI) may have reflected As the year has unfolded, however, difficulties in seasonal adjustment, and the economy's performance has fallen price data for the past couple of short of these expectations. Economic months have been much more growth has slowed ap~reciably ~om favorable. Nonetheless, a broad array the pace late last year; m part, this has of indicators points to a leveling out of reflected a retreat in business and the underlying inflation trend. consumer confidence and the effects In this circumstance, and with on our trade balance of weakness in a short-term interest rates unusually number of other industrial countries. low, especially when compared with inflation, the Federal Reserve recog nized a need to be alert to the possibil Real GDP ity that the balanc~ of ris~ in th~ Percent change, annual rate economy could shift soon m a drr~- tion dictating some firming of policy; failure to act in a timely manner could lead to a buildup of inflationary ------------tt-w---- 3 pressures, to adverse reactions in financial markets, and ultimately to + the disruption of the growth process. _ _fillL....E!l.....JtJ....,--"ffl'!J".....i.u_,l;;;;;;lLU..flL.liO'----- 0 To this point, however, the moderate thrust of aggregate demand and con siderable slack in the economy, taken -----~-------- 3 together with the more subdued price data of late, do not suggest that a sus tained upswing in inflation is at hand. 1989 1990 1991 1992 1993 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 20 Accordingly, the Federal Reserve has Private Housing Starts not adjusted its monetary policy Annual rate, millions of units instruments. Quarterly average The pace of economic growth in the final quarter of 1992 was not expected to be sustained, but the slowing in the first quarter of 1993 was surprisingly sharp. With the exception of business fixed investment, the slowdown cut across the major categories of final demand. After stepping up their spending in late 1992, consumers became more pessimistic about their economic prospects and more cautious in their spending decisions; the 1987 1989 1991 1993 uncertainty surrounding the efforts to *April-May average. reduce the federal deficit may have been a factor in the weakening of household sentiment. Housing The more recent statistical indica activity, which also had been excep tors, taken together, point to a resump tionally strong late last year, hit a tion of moderate growth in real GDP lull-even before the March blizzard in the second quarter. Most notably, on the East Coast-and real defense on the positive side, the increase in purchases plunged. Moreover, net aggregate hours worked for the exports deteriorated sharply, as quarter as a whole-a useful indicator exports declined and imports surged; of movements in overall output-was the drop in exports was attributable the largest of the current expansion. in part to continued weak growth in Sales of motor vehicles also exhibited some other industrial countries and in considerable vigor. But other key part was an adjustment to the big indicators were less robust. In particu increase in late 1992. lar, after allowing for the effects of the blizzard, consumer spending on items other than motor vehicles was lacklus ter, and housing activity improved only modestly. In the manufacturing sector, orders generally remained soft, and factory output, after having posted solid gains over the preceding seven months, is estimated to have declined somewhat over May and June. Digitized for FRASER https://fraser.stlouisfed.org 21 Federal Reserve Bank of St. Louis Broad measures of inflation picked In financial markets, short-term up in early 1993, with monthly interest rates have changed little so far increases through April in the upper in 1993, while intermediate-and part of the range of the past couple of long-term interest rates have fallen years. Although readings on consumer three-quarters to one percentage point and producer prices were much more to their lowest levels in over twenty favorable in May and June, the years. The decline in longer-term rates cumulative price and wage data for seems largely to have been a response the year to date suggest that under to the enhanced prospects for credible lying inflation has flattened out, after fiscal restraint, though the slower pace trending down over the preceding two of economic expansion may also have years. Excluding the especially volatile played a role. Falling interest rates food and energy components, the have helped stock market indexes set twelve-month change in the CPI has new records. Despite a decline in the held in the range of 3¼ to 3½ percent dollar versus the yen, the average since the summer of 1992. value of the dollar on a trade-weighted basis relative to G-10 currencies has risen, on balance, since the end of 1992. Although foreign intermediate Foreign Exchange Value term interest rates have been down, on of the U.S. Dollar* average, about as much as U.S. interest Index, March 1973 = 100 rates, short-term rates abroad have decreased substantially relative to U.S. rates, as foreign monetary authorities have taken steps to bolster weak economies. Declining U.S. market interest rates contributed to robust growth in narrow measures of money and in reserves over the first half of the year, -------------- 75 but broad monetary aggregates were very weak and their velocities contin ued to show exceptional increases. Credit demands on depositories 1987 1989 1991 1993 remained quite subdued relative to •Index of weighted average foreign exchange value of U.S. dollar m terms of currencies of other spending, considerable depository G-10 countries. Weights are based on 1972-76 global credit was funded from nonmonetary trade of each of the fo countries. sources, and savers continued to demonstrate a marked preference for capital market instruments over money stock assets. Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 22 In part owing to the drop in bond In turning to equity and other and stock yields, as well as to the nondeposit funds, banks have reduced desire to strengthen balance sheets, the share of depository credit that is corporate borrowers have continued to financed by monetary liabilities. concentrate credit demands on Depositors, for their part, have long-term securities markets, using the continued to shift funds into capital proceeds in part to repay bank loans; markets, attracted by still-high returns business loans at banks have not in these markets relative to earnings grown this year, although there were on deposits. Inflows into bond and tentative signs of a pickup over May equity mutual funds have run at and June. Total lending and credit record levels this year, and banks have growth at banks has risen only slightly facilitated investing in mutual fund from the depressed pace of 1992, and products by increasingly offering them these institutions have therefore not in their lobbies. As a consequence of needed to pursue deposits. Thrifts these various forces, M2 increased at have continued to contract, but at a only a ¾ percent annual rate from its much slower pace than in recent years. fourth-quarter 1992 average through Banks have eased lending standards June, while M3 fell slightly. The sum for smaller firms for several quarters of M2 and estimated household and recently relaxed standards for holdings of long-term mutual funds medium-and large-sized firms as well. grew at about a 4¾ percent rate from An increased willingness to lend on the fourth quarter through June, little the part of banks has been associated changed from the pace of recent years. with considerably more comfortable Debt growth has edged up this year, capital positions. Banks have contin despite a deceleration in nominal ued to strengthen their balance sheets spending, perhaps buoyed by by issuing large volumes of equity and improvements in financial positions subordinated debt, while retaining a achieved over the past few years by substantial amount of earnings. As a both borrowers and lenders. Invest result, the portion of the industry that ment outlays are estimated to have is well-capitalized (taking account of exceeded the internal funds of supervisory ratings as well as capital corporations for the first time in two ratios) increased from about one-third years, while household borrowing has at the end of 1991 to more than picked up relative to spending. In two-thirds by March 1993. addition, Treasury financing needs have remained heavy. Nevertheless, nonfinancial debt growth has been running at only a 5 percent rate this year. Digitized for FRASER https://fraser.stlouisfed.org 23 Federal Reserve Bank of St. Louis Growth of Money and Debt Total Nonfederal domestic domestic nonfinancial nonfinancial Mt M2 M3 debt debt (Percentage changes) Annually, 1980 7.4 8.9 9.5 9.5 9.0 Fourth quarter to fourth quarter 1981 5.4 (2.5)1 9.3 12.3 10.0 9.7 1982 8.8 9.1 9.9 9.3 7.4 1983 10.4 12.2 9.9 11.4 8.8 1984 5.5 8.1 10.8 14.3 13.9 1985 12.0 8.7 7.6 13.8 13.3 1986 15.5 9.3 8.9 14.0 13.7 1987 6.3 4.3 5.8 10.1 10.4 1988 4.3 5.3 6.4 9.2 9.6 1989 0.6 4.7 3.7 8.2 8.5 1990 4.3 4.0 1.8 6.8 5.9 1991 8.0 2.8 1.1 4.4 2.5 1992 14.3 1.8 0.3 4.8 2.9 Semiannually 1993 Hl 8.7 0.1 --0.7 5.1 3.3 (annual rate) 2 Quarterly 1993 Ql 6.6 -2.0 3.8 4.4 3.0 (annual rate)2 Q2 10.6 2.2 2.4 5.7 3.6 Fourth quarter 1992 9.5 0.8 --0.3 5.13 3.33 to June 1993 (annual rate) 1. Adjusted for shift to NOW accounts in 1981. 2. From average for preceding quarter to average for quarter indicated. Second quarter debt aggregates estimated on data through May. 3. 1992: Q4-1993: May for debt aggregates. Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Footnotes 1. Mt is currency held by the public, plus travelers' checks, plus demand deposits, plus other checkable deposits [including negotiable order of with drawal (NOW and Super NOW) accounts, automatic transfer service (ATS) accounts, and credit union share draft accounts]. M2 is Ml plus savings and small denomination time deposits, plus Money Market Deposit Accounts, plus shares in money market mutual funds (o ther than those restricted to institu tional investors), plus overnight repurchase agreements and certain overnight Eurodollar deposits. M3 is M2 plus large time deposits, plus large denomination term repur chase 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 FRBl-49000--0793 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 25

Federal Reserve (1993, July 19). Monetary Policy Report. Monetary Policy Reports, Federal Reserve. https://whenthefedspeaks.com/doc/monetary_policy_report_19930720

@misc{wtfs_monetary_policy_report_19930720,
  author = {Federal Reserve},
  title = {Monetary Policy Report},
  year = {1993},
  month = {Jul},
  howpublished = {Monetary Policy Reports, Federal Reserve},
  url = {https://whenthefedspeaks.com/doc/monetary_policy_report_19930720},
  note = {Retrieved via When the Fed Speaks corpus}
}