Monetary Policy Report

. /s~.v}· 1 ~ s-t. ~ 'r 1 }ur- tria 1 l 9 [Jr 9 od 6 uc tio,; ~ /Ii ll/~t/ In OCT 2 9 1997 Tax Pnifl' ~JwrcofGross Domc~th Pr Jducl • 1 MONETARY I l xpend1 ll. i, l. POLICY ds a1ul ~err,ices . c,urrent 4cc'llLtnf 'f\1ct OBJECTIVES rcha Val of the S. Do/la Change in Consumption Change in mploymen l Cost i Fnergy ,~ >1!Sllmer Prices• Federal Unified Summary Report of the Federal Reserve Board ,. anLt F'orc(«n Interest ]~ates• lntcrc~t l~\11c11~c February 20, 1996 jed Dollm· Exchange Rates • GrmPt h R:?tcs ~ Income and Consumption • Private Housing ?stment • Industrial Production • Change in 1996 Tax Profit Share of Gross Domestic Product • MONETARY eal State and Local Expenditures• Real GDP POLICY ds and Services • U.S. Current Account• Neb OBJECTIVES ;change Value of the U.S. Dollar • Change i 2onsumption Change in Employment Cos ♦ Energy• Consumer Prices• Federal Unifie r This Executive Summary provides highlights of the Board's Report to Congress on the Full Employment and Balanced Growth Act of 1978. :. and Foreign Interest Rates• Interest Expens February 20, 1996 '.ted Dollar Exchange Rates • Growth Rates Contents Section Page Testimony of Alan Greenspan Chairman, Federal Reserve Board 1 Monetary Policy and the Economic Outlook 13 Economic Projections for 1996 17 Money and Debt Ranges for 1996 20 Testimony of Alan Greenspan Chairman, Federal Reserve Board I appreciate the opportunity to Our intent was to be preemptive- to head off an incipient increase in appear before this Committee inflationary pressures and to forestall to present the Federal the emergence of imbalances that so often in the past have undermined Reserve' s semiannual report economic expansions. on monetary policy. As we entered the spring of 1995, it became increasingly evident that our policy was likely to succeed. Although various price indexes were rising a bit more rapidly, there were indications The United States economy performed that pressures would not continue to reasonably well in 1995. One-and intensify, and might.even reverse to a three-quarter million new jobs were degree. Moderating overall demand added to payrolls over the year, and growth left businesses with excess the unemployment rate was at the inventories. In response, firms initiated lowest sustained level in five years. production cutbacks to prevent serious Despite the relatively high level of inventory imbalances, and the growth resource utilization, inflation remained of economic activity slowed substan well contained, with the consumer tially. With inflation pressures price index rising less than 3 percent apparently receding, the previous the fifth year running at 3 percent or degree of restraint in monetary policy below. A reduction in inflation was no longer deemed necessary, and expectations, together with anticipa the Federal Open Market Committee tion of significant progress toward consequently implemented a small eliminating federal budget deficits, reduction in reserve market pressures was reflected in financial markets, last July. where long-term interest rates During the summer and early fall, dropped sharply and stock prices aggregate demand growth strength rose dramatically over the year. ened. As a result, business stocks of This outcome was influenced in part raw materials and finished goods by monetary policy actions taken by appeared somewhat better aligned the Federal Reserve in recent years. with sales. In sum, the economy, as Responding to evidence that inflation hoped, appeared to have moved onto ary pressures were building, we a trajectory that could be maintained progressively raised short-term one less steep than in 1994, when the interest rates over 1994 and early 1995. rate of growth was clearly unsustain Rates had been purposely held at able, but one that nevertheless would quite low, stimulatjve levels in 1993. imply continued significant growth in We moved in 1994 tol evels more employment and incomes. consistent with sustainable growth. l Importantly, the performance of the The situation was difficult to judge, economy seemed to be consistent with partly because economic statistics were maintaining low inflation. Despite the more sparse than usual, owing mainly step-up in growth and the relatively to the government shutdowns. In high levels of resource utilization, addition, harsh weather in January measured inflation abated a little, disrupted both data flows and patterns and many of the signs that had been of economic activity. But several pointing toward greater price pres indicators-including initial claims for sures gradually disappeared. Expecta unemployment insurance, purchasing tions of both near-and longer-term managers' surveys, and consumer inflation fell substantially over the confidence measures-appeared to second half of the year, as gauged signal some softening in the economy. by survey results as well as by the Consonant with this•pattern, some downward movements in longer-term Reserve Bank Presidents reported that interest rates. The fall in bond rates they seemed to be detecting anecdotal was also encouraged by improving indications of weakness in the expan prospects for significant progress in sion within their districts with reducing the federal budget deficit. somewhat greater frequency than The declines in actual and expected previously. Moreover, growth in inflation meant that maintaining the several of our major trading partners existing nominal federal funds rate seemed to be lagging, which could would raise real short-term interest tend to moderate demand for exports. rates, implying a slight effective A number of factors have prompted firming in the stance of monetary the recent tendency toward renewed policy. Such a shift would have been weakness. Some are clearly quite particularly inappropriate because transitory-related, for example, to economic growth near the end of the bad weather or the federal government year seemed to be slowing, and some shutdown. Others may be somewhat FOMC members were concerned more significant, but still temporary. about the risks of prolonged sluggish The constraint on government spend ness. Consequently, the Committee ing while permanent budget authori decided in December that a further zations are being negotiated is one. reduction in the funds rate was Another may be a temporary reduc warranted. tion in output in some industries as Information becoming available businesses have further adjusted in late December and January inventories to disappointing sales. raised additional questions about the prospective pace of expansion. 2 As I noted last July, the change in the if any, of the age of the business pace of inventory investment when the expansion. Some analysts, viewing economy shifts gears can be substan recent weakness, have observed that tial. Inventory investment surged in the expansion is approaching the start 1994 and into the early months of 1995, of its sixth year and is now one of the but proceeded to fall markedly longer peacetime spans of growth in throughout the rest of the year. This the past half century. Economic has placed significant downward expansions, however, do not necessar pressure on output, which should lift ily die of old age. Although the factors as inventory adjustments subside. But governing each individual business for the moment, the pressures remain, cycle are not always clear, expansions in the motor vehicle industry and usually end because serious imbal elsewhere. ances eventually develop. Ultimately, of course, it is the path When aggregate demand exceeds of final demand after the temporary the economy's potential, for example, influences work themselves out that inflationary pressures pick up. The determines the trajectory of the inevitable increase in market interest economy. There are some factors, rates, as inflation expectations rise and such as high consumer debt levels, price pressures intensify, depresses that may be working to restrain final demand. Lagging demand in turn spending. But as I shall be detailing sets off an inventory correction that shortly, a number of fundamentals frequently triggers a downturn in the point to an economy basically on track economy. As I noted, we acted in 1994 for sustained growth, so any weakness to forestall such a process. Monetary is likely to be temporary. Nonetheless, policy began to tighten in advance of the Committee decided in late January the buildup of inflationary pressures that the evidence suggested sufficient and, at least to date, these pressures risk of subpar performance going appear to have been held in check. forward to warrant another slight Capital expenditures by households easing of the stance of monetary and firms can also contribute signifi policy. Given the subdued trends in cantly to the development of cycle costs and wages, the odds that such a ending imbalances. The level of stocks move would boost inflation pressures of such real assets have effects on seemed low. output very similar to those of In assessing the likely course of the business inventories. In typical economy and the appropriate stance of cycles, capital expenditures tend to policy, one question is the significance, grow rapidly in the early stages of recovery: Pent-up demands coming out of a recession by consumers and businesses are satisfied by rapid growth of spending on capital assets. 3 There is a limit, however, on, say, how The decline in interest rates also has many cars people choose to own, or contributed to a pronounced rise in how many square feet of floor space stock prices. The spread of mutual retailers need to service customers. fund investments has meant that the Spending on such assets generally gain in wealth as financial asset prices an tends to grow more slowly after the have risen has been shared by pent-up demand is met As with ever-wider segment of households. business inventories, the downshifting These developments should tend to of spending on consumer durable counter, in part, the depressing effects goods or business plant and equip on spending of rising debt burdens. ment may not occur smoothly. The In addition, with the condition of most dynamics of expanding output and financial institutions strong, lenders rising profit expectations often create are likely to remain willing to extend a degree of exuberance which, as in credit to firms and households on much of human nature, tends on favorable terms. We have seen some occasion to excess-in this case, move by lenders toward tighter in the form of a temporary over standards, but these actions are a accumulation of assets. The ensuing modest correction after a marked correction in demand for such assets swing toward ease and should not triggers production adjustments that constrain the availability of funds can significantly mute growth for a to creditworthy borrowers. time or even cause a downturn if the Against this backdrop, Federal imbalances are large enough. Reserve policymakers expect the most The current extent of any asset likely outcome for 1996 as a whole is overhang is difficult to determine. further moderate growth. On the new The growth of demand for durables chain-weighted basis, the central and some categories of capital goods tendency of the forecasts of Board evidently has slowed, but the available members and Reserve Bank Presidents evidence does not suggest a degree of is for real gross domestic product to saturation in capital assets that would expand 2 to 2¼ percent on a fourth tip the economy into a downturn. quarter to fourth-quarter basis, similar Moreover, financial conditions are to the Administration's outlook. With likely to be generally supportive of output expanding roughly in line with spending. The low level of long-term standard estimates of the increase in interest rates should have an especially the productive capacity of the econ favorable effect. Low rates increase the omy, the unemployment rate is affordability of housing for consumers expected to remain around recent and foster investment in productive levels, as is also forecast by the plant and equipment by businesses. Administration. 4 The Federal Open Market Commit The Committee also reaffirmed the tee expects a continuation of reason 3 to 7 percent range for debt. Patterns ably good inflation performance in of money growth and velocity have 1996. The success during 1995 in been erratic in recent years, but should keeping the increase in the consumer the monetary aggregates at some point price index below 3 percent in the fifth re-establish their previous trend year of an expansion illustrates that an relationships with nominal income, extended period of growth with low average growth near the center of inflation is possible. And most on the these ranges should be consistent Committee anticipate consumer price with the eventual achievement of price inflation at or somewhat below stability. 3 percent in 1996. Although well Determining whether further known biases in the CPI, as well changes to the stance of monetary as the more favorable price perfor policy will be necessary in the months mance of business equipment, which ahead to foster progress toward our is not included in that index, indicate goals will be a continuing challenge. that the true rate of inflation for the In formulating monetary policy, while whole economy would be significantly we have in mind a forecast of the most lower than 3 percent, the Committee likely outcome, we must also evaluate recognized that its expectations for the consequences of other possible inflation do not imply that price developments. Thus, it is sometimes stability has as yet been reached. the case that we take out monetary Nonetheless, keeping inflation from policy "insurance" when we perceive rising significantly during economic an imbalance in the net costs or expansions will permit a gradual benefits of coming out on one side ratcheting down of inflation over the or the other of the most probable course of successive business cycles scenario. For example, in our most that will eventually result in the recent actions, we saw a decline in achievement of price stability. the federal funds rate as not increasing To emphasize its continued commit inflationary risks unacceptably, while ment to price stability, the Committee addressing the downside risks to the chose to reaffirm the relatively low most likely forecast. In assessing the ranges for money growth in 1996 that costs and benefits of adjustments to it had selected on a provisional basis the stance of policy, members of the last July. These ranges are identical to Committee recognize that policy those employed in 1995-1 to 5 per affects the economy and inflation cent for M2 and 2 to 6 percent for M3. with a lag and thus needs to be formulated with a focus on the future. 5 Over the past year, we have kept In some cases, the job skills that were firmly in mind our goals of containing adequate only five years ago are no inflation in the near term and moving longer as relevant. Partly for that over time toward price stability, and reason, most corporate restructurings they will continue to guide us in the have involved a significant number of period ahead. permanent dismissals. Structural forces may be assisting us The phenomenon of restructuring in this regard. Increases in producers' can be especially unfortunate for those costs and in output prices proved to be workers directly caught up in the a little lower last year than many had process. Many dedicated, long-term anticipated. While it is too soon to workers in all types of American draw any definitive conclusions, this businesses-including long experience provides some tentative established, stable, and profitable evidence that basic, ongoing changes firms-have been let go. in the structure of the economy may be An important consequence of the helping to hold down price pressures. layoffs and dismissals associated with These changes stem from the introduc restructuring activity is a significant tion of new technologies into a wide and widely reported increase in the variety of production processes sense of job insecurity. Concern about throughout the economy. Successive employment has been manifested generations of these new technologies in unusually low levels of indicators are being quickly embodied in the of labor unrest. Work stoppages, for nation's capital stock and older example, were at a fifty-year low last technologies are, at a somewhat slower year. And contract negotiators for pace, being phased out. As a conse labor unions have sought to obtain quence, the nation's capital stock is greater job security for their members turning over at an increasingly rapid through very long-term labor con pace, not primarily because of physical tracts, including some with virtually deterioration but reflecting technologi unprecedented lengths of five or six cal and economic obsolescence. years. The more rapid advance of infor Of particular relevance to the mation and communications technol inflation outlook, the sense of job ogy and the associated acceleration insecurity is having a pronounced in the turnover of the capital stock effect in damping labor costs. For are being mirrored in a brisk restruc example, the increase in the employ turing of firms. In line with their ment cost index for compensation in adoption of new organizational the private sector, which includes structures and technologies, many both wage and salary payments and enterprises are finding that their benefit costs, slowed further in 1995, needs for various forms of labor are evolving just as quickly. 6 to 2¾ percent, despite labor market Once fiber-optic anc:,l satellite technolo conditions that, by historical stan gies are in place, the added resource dards, were fairly tight. With pro cost of another 200 or 2,000 miles is ductivity also expanding, the increase often quite trivial. As a consequence, in unit labor costs was even lower. the movement of inputs and outputs In manufacturing, such costs have across geographic distance is progres actually been falling in recent years. sively becoming a smaller component While the link between labor costs, of overall business expenses, particu which account for two-thirds of larly as intellectual-and therefore consolidated business sector costs, immaterial-products become and prices is not rigid, these very proportionately more important in limited increases in labor expenses the economy. This enables an average nonetheless constitute a significant business firm to broaden markets and restraint on inflation. sales far beyond its original domicile. In addition to its effect on labor Accordingly, fixed costs are spread costs, the more rapid pace of techno more widely. For the world market as logical change is reducing business a whole, the specialization of labor is costs through other channels. Initially enhanced to the benefit of standards most important, the downsizing of of living of all market participants. products resulting from semiconduc To be sure, advancing technology, tor technologies, together with the with its profound implications for the increasing proportion of national nature of the economy, is nothing output accounted for by high-tech new, and the pace of improvement has products, has reduced costs of never been even. But it is possible that transporting the average unit of GDP. we may be in the midst of a quicken Quite simply, small products can be ing of the process. It is possible that moved more quickly and at lower cost. the rate at which earlier computer More recently, dramatic advances technologies are being applied to in telecommunications technologies new production processes is still have lowered the costs of production increasing. This would explain the for a variety of products by slashing recent decline in the growth of unit further the information component of costs. Nonetheless, we have to be those costs. Increasingly, the physical careful in projecting a further accelera distance between communications tion in the application of technology endpoints is becoming less relevant indefinitely into the future, as would in determining the difficulty and be required for technological change cost of transporting information. to depress the rate of increase in unit business costs even more. 7 Similarly, suppressed wage cost Should the nation's true growth growth as a consequence of job potential exceed actual growth, for insecurity can be carried only so far. example, the disparity and lessened At some point in the future, strain would be signaled in shorter the tradeoff of subdued wage growth lead times on the delivery of materials, for job security has to come to an end. declining overtime, and ebbing While it is difficult to judge the time inflationary pressures. Conversely, frame on such adjustments, the risks actual growth in excess of the econo to cost and price inflation going my's true potential would soon result forward are not entirely skewed to in tightened markets and other the downside, especially with the distortions which, as history amply economy so recently operating at demonstrates, would propel the high levels of resource utilization. economy into recession. Consequently, In light of the quickened pace of we must be cautious in reaching technological change, the question conclusions that growth in productiv arises whether the U.S. economy can ity and hence of potential output has expand more rapidly on an ongoing as yet risen to match the evident basis than the 2 to 2¼ percent range step-up in technological advance. for measured GDP forecasted for 1996 The hypothesis that advancing by government agencies and most technology has enhanced productivity private forecasters without adding growth would be more persuasive if to inflationary pressures, which in national data on productivity increases turn would undermine growth. The showed a distinct improvement. To a Federal Reserve would certainly degree, the lack of any marked pickup welcome faster growth-provided may be a shortcoming of the statistics that it is sustainable. rather than a refutation of the hypoth The particular rate of maximum esis. Faulty data could be arising in sustainable growth in an economy part because business purchases are as complex and ever-changing as increasingly concentrated in items that ours is difficult to pin down. Fortu are expensed but which market prices nately, the Federal Reserve does not suggest should be capitalized. Grow need to have a firm judgment on such ing disparities between book capital an estimate, for persistent deviations and its valuation in equity markets of actual growth from that of capacity may in part reflect widening effects potential will soon send signals that of this misclassification. If this problem a policy adjustment is needed. is indeed growing, we may be under estimating the growth of our GDP and roductivi o· i 8 This classification proplem com In an intriguing parallel, electric pounds other difficulties with measur motors in the late nineteenth century ing output in the increasingly impor were well-known as a technology, but tant service sector. The output of were initially integrated into produc services-and the productivity of labor tion systems that were designed for in that sector-is particularly hard to steam-driven power plants. It wasn't measure. In part, the statisticians have until the gradual conversion of simply thrown up their hands, previously vertical factories into gauging output in some service horizontal facilities, mainly in the industries just in terms of labor input. 1920s, that firms were able to take By construction, such a procedure will full advantage of the synergies implicit miss improvements in productivity in the electric dynamo, thus achieving caused by other inputs. In manufactur dramatic productivity increases. ing, where output is more tangible and Analogously, existing production therefore easier to assess, measured systems today to some degree cannot productivity has been rising briskly, be integrated easily with new informa suggesting that technological advances tion and communication technologies. are indeed having some effect. Some existing equipment is not Nonetheless, there is still a nagging capable of control by computer, for inconsistency: The evidence of signifi example. Thus, it may be that the full cant restructurings and improvements advantage of even the current genera in technology and real costs within tion of information and communica business establishments does not tion equipment will be exploited over seem to be fully reflected in our a span of quite a few years and only national productivity measurements. after a considerably updated stock of It is possible that some of the frenetic physical capital has been put in place. pace of business restructuring is mere While the Federal Reserve does wheel spinning-changing production not need to establish targets-and inputs without increasing output definitely not limits-for long-term rather than real increases in productiv growth, it is helpful in coming to ity. One cause of the wheel spinning, shorter-run policy insights to have if that is what it is, may be that it takes some judgments about the growth some time for firms to adapt in such a in potential GDP in the past and way that major new te~hnology is what it is likely to be in the future. translated into increased output. Judgments of potential, quite naturally, are based on experience. 9 Through the four quarters of 1994, for To be fully effective in achieving example, real GDP, pressed by strong potential productivity improvements, demand, rose 3½ percent. If that were technological innovations also require the true rate of increase in the econo a considerable amount of human my's long-run potential, then we investment on the part of workers would have expected no change in who have to deal with these devices rates of resource utilization. Instead, on a day-to-day basis. On this score, industrial capacity utilization rose we still may not have progressed very nearly 3 percentage points and the far. Many workers still possess only unemployment rate dropped a rudimentary skills in manipulating percentage point. Moreover, we began advanced information technology. to see signs of strains on facilities; In these circumstances, firms and deliveries of materials slowed appre employees alike need to recognize that ciably and factory overtime rose obtaining the potential rewards of the sharply. These signs of developing new technologies in the years ahead pressures on capacity suggest that the will require a renewed commitment growth rate in economic potential in to effective education and training, 1994 was below 3½ percent. In especially on-the-job training. This is general, as we get close to presumed especially the case if we are to prevent potential, we are required to step up the disruptions to lives and the our surveillance for inflationary nation's capacity to produce that arise pressures. from mismatches between jobs and Estimates of potential growth workers. We need to improve the necessarily recognize that expansion preparation for the job market our in the economy over time comes schools do, but even better schools are essentially from three factors-growth unlikely to be able to provide adequate in population, increases in labor force skills to support a lifetime of work. participation, and gains in average Indeed, the need to ensure that our labor productivity. Of these factors, labor force has the ongoing education the first two are determined basically and training necessary to compete in by demographic and social factors and an increasingly sophisticated world seem unlikely to change dramatically economy is a critical task for the years over the next few years. Thus, the ahead. source of any significant pickup of output growth would need to be a more rapid pace of productivity growth. Here, the uncertainty of the pace of conversion of rapid technologi cal advance into productivity gains is crucial to the determination. 10 Our nation faces many important But more remains to be done. As I and difficult challenges in economic have emphasized many times, lower policy. Nonetheless, we have made budget deficits are the surest and most significant and fundamental gains direct way to increase national saving. in macroeconomic performance in Higher national saving would help to recent years that enhance the prospects reduce real interest rates further, for maximum sustainable economic promoting more rapid accumulation growth.Inflation, as measured by the of productive capital embodying consumer price index, has been recent technological advances. gradually reduced from a peak Agreement is widely shared that of more than 13 percent in 1979 to attaining a higher national saving rate 2½ percent last year. Lower rates of quite soon is crucial, particularly in inflation have brought a variety of view of the anticipated shift in the benefits to the economy, including nation's demographics in the first few lower long-term interest rates, a sense decades of the next century. of greater economic stability, an Lower inflation and reduced budget improved environment for household deficits will by no means solve all of and business planning, and more the economic problems we face. But robust investment in capital expendi the achievement of price stability and tures, The years ahead should see federal budget balance or surplus will further progress against inflation and provide the best possible macroeco the eventual achievement of price nomic climate in which the nation can stability. address other economic challenges. We have also made considerable progress on the fiscal front. Over the past ten years and especially since 1993, our elected political leaders, through sometimes pro longed and even painful negotiations, have been successful in reaching several agreements that have signifi cantly narrowed the budget deficit. 11 Monetary Policy and the Economic Outlook The economy performed well in 1995. Indeed, it is by fostering price stability Moderate economic growth kept the that a central bank can make its unemployment rate at a relatively low greatest contribution to the efficient level, and inflation, as measured by operation and overall ability of the the change in the consumer price nation's economy to create jobs and index, was in a range of 3 percent advance living standards over time. or less for the fifth straight year, the first such occurrence in thirty years. Change in Real GDP This desirable combination of low inflation and low unemployment Percent, annual rate provided further substantiation of a fundamental point that the Board has made in past reports-namely, that there is no trade-off in the long run 4 -----------1.._,I+------ between the monetary policy goals Q3 of maximum employment and stable prices set in the Federal Reserve Act. + 0 ----.....,,,,..---.,,,,,y-W.1--""'l~L.........la...u..J"'-"'-l"'-"'l.J. ........ .ua.._ _ Change in Consumer Prices Percent, Q4 to Q4 1990 1991 1992 1993 1994 1995 ,-..---------6 As economic prospects changed in 1995 and early 1996, the Federal ~-------- 4 Reserve found that promoting full employment and price stability required several adjustments in its 2 policy settings. Last February, the economy still seemed to be pressing against its potential, and prices were tending to accelerate. To reduce the 1989 1991 1993 1995 risk that inflation might mount, with Note. Consumer price index for all urban the attendant threat to continued consumers. economic expansion, the Federal Open Market Committee raised the federal funds rate an additional ½ percentage point, to 6 percent. Inflation did, in fact, pick up in the first part of 1995, 13 but data released during the spring Long-Term Interest Rates indicated that price pressures were Percent receding, and the Committee reduced the federal funds rate ¼ percentage Monthly point at its July meeting. Through the Home Mortgage remainder of the year, inflation was Primary Conventional even more favorable than had been anticipated in July, and inflation expectations decreased. In addition, an apparent slowing of economic activity late in the year further reduced the potential for inflationary pressures going forward. To forestall an undue increase in real interest rates as inflation slowed, and to guard against the possibility of unnecessary 1983 1985 1987 1989 1991 1993 1995 slack developing in the economy, the Committee eased reserve conditions These financial developments reduced in December and again at the end of the cost to businesses of financing January 1996, reducing the federal investment and to households of funds rate by a total of½ percentage buying homes and consumer durables; point. households were also aided by Monetary policy easings since substantial additions to financial mid-1995 contributed to declines in wealth from rising bond and equity short-term market interest rates, which prices. by mid-February were down 1 to The foreign exchange value of the 2 percentage points from the highs U.S. dollar, measured in terms of the reached early last year. Intermediate currencies of the other G-10 countries, and long-term rates also moved fell about 5 percent, on net, during sharply lower last year as the risks 1995. The dollar appreciated sub of rising inflation receded and as stantially from the summer on prospects for substantial progress in and has advanced further on balance reducing the federal budget deficit in 1996 but not enough to offset a seemed to improve. As of mid sharp decline that took place in the February, these rates were 1¾ to first four months of 1995. Interest 2¾ percentage points below their rates fell in most other foreign levels at the beginning of 1995. Helped industrial countries, which also by lower interest rates and favorable were experiencing slower economic earnings, major equity price indexes growth, but by less than the rose 30 to 40 percent last year and decline in rates in the United States. have moved still higher in early 1996. 14 Early in 1995, the dollar also was Before-Tax Profit Share of GDP pulled down by the reactions to the Percent crisis in Mexico, but the negative influence on the dollar from this Nonfinancial corporations source appeared to lessen as Mexican Q3 financial markets stabilized over the balance of the year. Inflation rates in major industrial countries held fairly steady in 1995 at levels somewhat lower than those prevailing in this country; thus, depreciation of the dollar in real terms against other G-10 currencies was less than the deprecia tion in nominal terms. Against the currencies of a broader group of U.S. trading partners, the dollar's real 1989 1991 1993 1995 depreciation in 1995 was even smaller. Note. Profits from domestic operations with inventory valuation and capital consumption adjustments, divided by gross domestic product of nonfinancial corporate sector. Weighted Average Foreign Exchange Value of the U.S. Dollar Borrowing and spending in the December 1993 = 100 United States was facilitated not only by lower interest rates but also by Daily favorable supply conditions in credit markets. Spreads between interest rates on securities issued by private firms and those issued by the Treasury generally remained narrow, and banks continued to ease terms and qualifying standards on loans to businesses and households through most of the year. Total debt of domestic nonfinancial sectors grew slightly more than 5 percent last year, just above the midpoint of the Committee's 3 percent 1993 1994 1995 1996 to 7 percent monitoring range. Rapid Note. Index of weighted foreign exchange value of U.S. dollar in terms of currencies of the other growth of business spending on inven G-10 countries. Weights are based on 1972-76 tories and fixed capital early in the global trade of each of the foreign countries. year boosted the credit demands of firms, despite strong corporate profits. 15 Borrowing was also lifted by the M2: Actual Range and Actual Level financing of heavy net retirements Billions of dollars of equity shares in connection with mergers and share repurchase pro 5% grams. Growth of household debt slowed a bit but remained brisk; consumer credit continued to grow quite rapidly. Federal debt growth was relatively modest for a second year, influenced by a lower deficit and constraints on normal seasonal bor rowing at year-end owing to the federal debt ceiling. Outstanding state and local government debt ran off more rapidly than in 1994. 0 N D J F M A M J J A S O N D 1994 1995 Household Financial Condition boosting the expansion of the broad Ratio monetary aggregates. M3 grew Net Worth as a Share 6 percent, at the upper end of its of Disposable Income 2 percent to 6 percent annual range established by the Committee at midyear. Depositories relied heavily on large-denomination time deposits for funding, but retail deposits also showed gains as declining market interest rates made these deposits more attractive to retail customers. M2 advanced 4¼ percent, putting it in the upper portion of its 1 percent to 5 percent annual range. The expansion 1980 1985 1990 1995 of M2 was the largest in six years, and its velocity was unchanged after Commercial banks and thrift insti increasing during the previous tutions again financed a large portion three years. Nonetheless, growth of the borrowing last year; their share of the aggregate was erratic through of total outstanding debt of nonfederal the year, and the stability of its sectors edged up in 1994 and 1995 relationship to nominal spending after declining for more than fifteen remains in doubt. Ml declined last years. The growth in depository credit year for the first time since the begin was funded primarily with deposits, ning of the official series in 1959. 16 An increasing number of banks In the household sector, the accumu introduced retail sweep accounts, lation of financial wealth brought on which shift money from interest by the rise in the stock market has bearing checkable accounts to savings provided the wherewithal for accounts in order to reduce banks' increases in consumption greater reserve requirements. Without these than would otherwise have been shifts, Ml would have risen in 1995, expected-countering the potential although slowly. negative influences of more burden some levels of consumer debt. At the Economic Projections for 1996 same time, reductions in mortgage interest rates have put the cost of The relatively small amount of financing a house within reach information that is available for 1996 of a greater number of families and indicates that the economy has started made it possible for a significant off slowly early this year, but funda number of households to ease their mental conditions appear to be more debt-service burdens by refinancing encouraging than recent data might their homes at lower rates. In the seem to suggest. Bad weather in a business sector, reductions in the cost number of regions and the partial of financing investment in new capital shutdown of the federal government are providing some offset to the have been disruptive to the economy slowing tendencies that normally this winter. These influences seem accompany a cyclical moderation likely to leave only temporary in the growth of aggregate output. imprints on spending and production, creating volatility in incoming data over the near term while having little Change in Real Business Fixed effect on underlying trends. Investment The economy also has been slowed Percent, annual rate by production adjustments in some industries in which efforts are being □ Structures made to bring stocks into better ml Producers' durable equipment --------------- 20 alignment with sales. Inventory accumulation apparently slowed in the fourth quarter, and with finan cial conditions remaining broadly conducive to growth of private _..........,...,.............,....,..... ___. ........ ........................... __ o+ ~ final sales, inventory problems of a degree that might prompt a sustained period of widespread production adjustments do not seem likely. 1990 1991 1992 1993 1994 1995 17 In addition, business investment in Against the backdrop of these high-tech equipment likely will developments, members of the Board continue to be boosted not only by of Governors and the Reserve Bank the ready availability of finance but Presidents, all of whom participate in also by technological upgrades and the deliberations of the Federal Open ongoing steep declines in the effective Market Committee, anticipate that the price of real computing power. U.S. economy will grow moderately, with little change in underlying inflation trends. The central tendency Change in Real Imports and Exports of the participants' forecasts of real of Goods and Services GDP growth ranges from 2 percent to Percent, Q4 to Q4 2¼ percent, measured as the cumula tive change in output from the final D Imports quarter of 1995 to the final quarter of Iii Exports 1996. The rise in activity is expected to --------------- 15 be accompanied by further expansion of job opportunities and little change, on net, in the civilian unemployment rate over the four quarters of 1996. Civilian Unemployement Rate Percent 1989 1991 1993 1995 Note. Values for 1995 are measured from ---------------8 1994: Q4 to 1995: Q3 at an annual rate. ~ In the U.S. external sector, growth of exports strengthened after some 6 ~ sluggishness early in 1995. Expansion ~an. of income abroad seems likely to pick up this year, although the prospects ---------------4 still are subject to some downside risk. Imports, meanwhile, have slowed from the very rapid pace seen earlier 1989 1991 1993 1995 in the expansion. On net, the under Note. The break in data at January 1994 marks lying trends in exports and imports the introduction of a redesigned survey; data from of goods and services appear to be that point on are not directly comparable with the data of earlier periods. essentially canceling out in terms of their combined contribution to growth of U.S. real GDP. 18 Economic Projections for 1996 Percent Federal Reserve Governors and Reserve Bank Presidents Administration Central Indicator Range Tendency Change, Nominal GDP 4-5 4¼-4¾ 5.1 fourth quarter ------------------ to fourth Real GDP2 1½-2½ 2-2¼ 2.2 quarter:1 Consumer price index 3 2½-3 21/4-3 3.1 Average level in Civilian unemployment rate 5½-6 5½-5¾ 5.74 the fourth quarter: 1. Change from average for fourth quarter of 3. All urban consumers. 1995 to average for fourth quarter of 1996. 4. Annual average. 2. Chain-weighted. The central tendency of the unemploy remain subpar again this year; and, ment rate forecasts for the fourth even though recent upward pressures quarter of 1996 is a range of 5½ per on energy prices should diminish with cent to 5¾ percent, compared with an the return of normal weather, another average of 5.6 percent in the final year of declining prices cannot be quarter of 1995. The Committee's taken as a given. Nonetheless, the forecasts of economic growth and experience with inflation at high levels unemployment are quite similar to of resource utilization was favorable in those of the Administration. 1995, and with businesses still tightly The central tendency of the Gover focused on cost control and efficiency nors' and Bank Presidents' forecasts gain, broad tendencies toward of the rise in the consumer price index increased rates of price increase are over the four quarters of 1996 is a not anticipated. The Administration range of 2¾ percent to 3 percent, a forecast of inflation is higher than the shade to the high side of the actual forecasts of the Federal Reserve outcome of 1995. At this early point officials, but the difference is not in 1996, with grain stocks exception significant, given the uncertainties of ally tight, there is some risk that forecasting. food price increases at retail could be larger than those of recent years, especially if crop production should 19 Price increases like those being Ranges for Growth of Monetary and forecast for the coming year would Debt Aggregates leave inflation no higher than it was Percent in the first year or so of the current economic expansion, with the rate of Aggregate 1994 1995 1996 increase holding appreciably below the average rate seen during the M2 1-5 1-5 1-5 expansion of the 1980s. Although the Federal Reserve's long-run goal of M3 0-4 2-61 2-6 restoring price stability has not yet been achieved, the capping of inflation Debt2 4-8 3--7 3--7 and its diminution over recent busi ness cycles is a clear indication of the Note. Change from average for fourth quarter of preceding year to average for fourth quarter substantial progress that has been of year indicated. made to date. 1. Revised at July 1995 FOMC meeting. 2. Monitoring range for debt of domestic nonfinancial sectors. Money and Debt Ranges for 1996 The Committee's intention to make If velocities of the aggregates were to further progress over time toward exhibit roughly normal behavior this price stability formed the basis for year and nominal income were to the selection of the growth ranges expand as anticipated by the Commit for the monetary aggregates in 1996. tee, M2 and M3 might grow near the In reaffirming the ranges that were upper ends of their ranges. In assess adopted on a provisional basis in July, ing the possible outcomes, the Com the Committee noted that it viewed mittee noted that considerable them as benchmarks for what would uncertainty remains about the useful be expected under conditions of ness of the monetary aggregates in reasonable price stability and historical guiding the pursuit of its macro velocity behavior. The Committee set economic objectives.Although the the range for M2 at 1 percent-to monetary aggregates have been 5 percent and the range for M3 at behaving more in line with historical 2 percent to 6 percent. patterns than was the case earlier in Given its expectations for inflation the decade, the effects of financial in 1996, the Committee anticipates innovation and deregulation over the that nominal GDP will grow years have raised questions about the somewhat faster this year than stability of the relationships between would be the case if the economy the aggregates and nominal GDP that already were at price stability. have yet to be resolved. 20 The Committee also reaffirmed the 3 percent to 7 percent growth range for debt. Although there are indications that lenders may no longer be easing terms and conditions for granting credit to businesses and households, the Committee anticipated that credit supplies would remain ample and that debt would grow at about the same pace as nominal GDP. Such increases would be consistent with containing inflation and promoting sustainable growth. 21 Growth of Money and Debt Percent Domestic Period Ml M2 M3 Nonfinancial Debt Year1 1980 7.5 8.7 9.6 9.5 1981 5.4 (2.5)2 9.0 12.4 10.2 1982 8.8 8.8 9.7 9.8 1983 10.3 11.8 9.5 11.9 1984 5.4 8.1 10.8 14.6 1985 12.0 8.6 7.7 14.3 1986 15.5 9.2 9.0 13.3 1987 6.3 4.2 5.9 9.9 1988 4.3 5.7 6.3 9.0 1989 .5 5.2 4.0 7.8 1990 4.2 4.1 1.8 6.8 1991 7.9 3.1 1.2 4.6 1992 14.3 1.8 .6 4.7 1993 10.5 1.4 1.0 5.2 1994 2.4 .6 1.6 5.2 1995 -1.8 4.2 6.1 5.3 1994 Ql -.1 1.4 4.8 5.3 Quarter (annual rate)3 Q2 -.5 4.3 6.7 7.0 Q3 -1.5 7.0 8.0 4.6 Q4 -5.1 4.0 4.4 3.9 1. From average for fourth quarter of preced- 3. From average for preceding quarter to ing year to average for fourth quarter of year average for quarter indicated. indicated. 2. Adjusted for shifts to NOW accounts in 1981. FRBl-43000-0296 22

Federal Reserve (1996, February 19). Monetary Policy Report. Monetary Policy Reports, Federal Reserve. https://whenthefedspeaks.com/doc/monetary_policy_report_19960220

@misc{wtfs_monetary_policy_report_19960220,
  author = {Federal Reserve},
  title = {Monetary Policy Report},
  year = {1996},
  month = {Feb},
  howpublished = {Monetary Policy Reports, Federal Reserve},
  url = {https://whenthefedspeaks.com/doc/monetary_policy_report_19960220},
  note = {Retrieved via When the Fed Speaks corpus}
}