Monetary Policy Report

February 26, 1997 Federal Reserve Board Summary Report NiONETARY POLICY OBJECTIVES 9 9 7 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis This Executive Summary provides highlights of the Board's Report to Congress on the Full Employment and Balanced Growth Act of 1978. MO~ETARY POLICY OBJECTIVES Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Contents Section Page Testimony of Alan Greenspan Chairman, Federal Reserve Board 1 Monetary Policy and the Economic Outlook 11 Monetary Policy, Financial Markets, and the Economy in 1996 12 Economic Projections for 1997 15 Money and Debt Ranges for 1997 18 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Testimony of Alan Greenspan Chairman, Federal Reserve Board I appreciate the opportunity continued low levels of inflation and inflation expectations have been a key to appear before this support for healthy economic perfor Committee to present the mance. They have helped to create a financial and economic environment Federal Reserve's semiannual conducive to strong capital spending report on monetary policy. and longer-range planning generally, and so to sustained economic expan sion. Consequently, the Federal Open Market Committee (FOMC) believes it is crucial to keep inflation contained The performance of the U.S. economy in the near term and ultimately to over the past year has been quite move toward price stability. favorable. Real GDP growth picked up Looking ahead, the members of the to more than three percent over the FOMC expect inflation to remain low four quarters of 1996, as the economy and the economy to grow appreciably progressed through its sixth year of further. However, as I shall be dis expansion. Employers added more cussing, the unusually good inflation than two-and-a-half million workers performance of recent years seems to to their payrolls in 1996, and the owe in large part to some temporary unemployment rate fell further. factors, of uncertain longevity. Thus, Nominal wages and salaries have the FOMC continues to see the distri increased faster than prices, meaning bution of inflation risks skewed to the workers have gained ground in real upside and must remain especially terms, reflecting the benefits of rising alert to the possible emergence productivity. Outside the food and of imbalances in financial and prod energy sectors, increases in consumer uct markets that ultimately could prices actually have continued to edge endanger the maintenance of the lower, with core CPI inflation only low-inflation environment. Sustain 2½ percent over the past twelve able economic expansion for 1997 and months. beyond depends on it. Low inflation last year was both a For some, the benign inflation symptom and a cause of the good outcome of 1996 might be considered economy. It was symptomatic of the surprising, as resource utilization balance and solidity of the expansion rates-particularly of labor-were and the evident absence of major in the neighborhood of those that strains on resources. At the same time, historically have been associated with building inflation pressures. Digitized for FRASER https://fraser.stlouisfed.org 1 Federal Reserve Bank of St. Louis To be sure, an acceleration in nominal Thus, the willingness of workers labor compensation, especially its in recent years to trade off smaller wage component, became evident increases in wages for greater job over the past year. But the rate of pay security seems to be reasonably increase still was markedly less than well documented. The unanswered historical relationships with labor question is why this insecurity market conditions would have persisted even as the labor market, predicted. Atypical restraint on by all objective measures, tightened compensation increases has been considerably. One possibility may lie evident for a few years now and in the rapid evolution of technologies appears to be mainly the consequence in use in the work place. Technological of greater worker insecurity. In 1991, change almost surely has been an at the bottom of the recession, a survey important impetus behind corporate of workers at large firms by Interna restructuring and downsizing. Also, tional Survey Research Corporation it contributes to the concern of indicated that 25 percent feared being workers that their job skills may laid off. In 1996, despite the sharply become inadequate. No longer can lower unemployment rate and the one expect to obtain all of one's tighter labor market, the same survey lifetime job skills with a high-school organization found that 46 percent or college diploma. Indeed, continuing were fearful of a job layoff. education is perceived to be increas The reluctance of workers to leave ingly necessary to retain a job. The their jobs to seek other employment more pressing need to update job as the labor market tightened has skills is doubtless also a factor in the provided further evidence of such marked expansion of on-the-job concern, as has the tendency toward training programs, especially in tech longer labor union contracts. For many nical areas, in many of the nation's decades, contracts rarely exceeded corporations. three years. Today, one can point to Certainly, other factors have five- and six-year contracts-contracts contributed to the softness in compen that are commonly characterized by sation growth in the past few years. an emphasis on job security and that The sharp deceleration in health care involve only modest wage increases. costs, of course, is cited frequently. The low level of work stoppages of Another is the heightened pressure recent years also attests to concern on firms and their workers in indus about job security. tries that compete internationally. Domestic deregulation has had similar effects on the intensity of competitive forces in some industries. Digitized for FRASER https://fraser.stlouisfed.org 2 Federal Reserve Bank of St. Louis In any event, although I do not doubt The possibility that this reflects greater that all these factors are relevant, I confidence by workers accords with would be surprised if they were nearly a recent further rise in the percent of as important as job insecurity. households responding to a Confer If heightened job insecurity is the ence Board survey who perceive that most significant explanation of the job availability is plentiful. Of course, break with the past in recent years, the job market has continued to be then it is important to recognize that, quite good recently; employment as I indicated in last February's in January registered robust growth Humphrey-Hawkins testimony, and initial claims for unemployment suppressed wage cost growth as a insurance have been at a relatively consequence of job insecurity can be low level of late. Wages rose faster in carried only so far. At some point, 1996 than in 1995 by most measures, the tradeoff of subdued wage growth perhaps also raising questions about for job security has to come to an end. whether the transitional period of In other words, the relatively modest unusually slow wage gains may be wage gains we have experienced are drawing to a close. a temporary rather than a lasting To be sure, the pickup in wage gains phenomenon because there is a limit has not shown through to underlying to the value of additional job security price inflation. Increases in the core people are willing to acquire in CPI, as well as in several broader exchange for lesser increases in living measures of prices, have stayed standards. Even if real wages were subdued or even edged off further in to remain permanently on a lower recent months. As best we can judge, upward track than otherwise as a faster productivity growth last year result of the greater sense of insecu meant that rising compensation gains rity, the rate of change of wages did not cause labor costs per unit of would revert at some point to a output to increase any more rapidly. normal relationship with inflation. Non-labor costs, which are roughly The unknown is when this transition a quarter of total consolidated costs period will end. of the nonfinancial corporate sector, Indeed, some recent evidence were little changed in 1996. suggests that the labor markets bear Owing in part to this subdued especially careful watching for signs behavior of unit costs, profits and that the return to more normal rates of return on capital have risen patterns may be in process. The to high levels. As a consequence, Bureau of Labor Statistics reports that businesses believe that, were they people were somewhat more willing to raise prices to boost profits further, to quit their jobs to seek other employ competitors with already ample ment in January than previously. profit margins would not follow suit; Digitized for FRASER https://fraser.stlouisfed.org 3 Federal Reserve Bank of St. Louis instead, they would use the occasion and in any case was unlikely to pick to capture a greater market share. up very rapidly, in part because the This interplay is doubtless a significant economic expansion appeared likely factor in the evident loss of pricing to slow to a more sustainable pace. power in American business. In the event, inflation has remained Intensifying global competition also quiescent since then. may be further restraining domestic Given the lags with which monetary firms' ability to hike prices as well as policy affects the economy, however, wages. Clearly, the appreciation of the we cannot rule out a situation in which dollar on balance over the past a preemptive policy tightening may eighteen months or so, together with become appropriate before any sign low inflation in many of our trading of actual higher inflation becomes partners, has resulted in a marked evident. If the FOMC were to imple decline in non-oil import prices that ment such an action, it would be has helped to damp domestic inflation judging that the risks to the economic pressures. Yet it is important to expansion of waiting longer had emphasize that these influences, too, increased unduly and had begun to would be holding down inflation only outweigh the advantages of waiting temporarily; they represent a transi for uncertainties to be reduced by the tion to a lower price level than would accumulation of more information otherwise prevail, not to a perma about economic trends. Indeed, the nently lower rate of inflation. hallmark of a successful policy to Against the background of all these foster sustainable economic growth considerations, the FOMC has recog is that inflation does not rise. I find it nized the need to remain vigilant for ironic that our actions in 1994-95 were signs of potentially inflationary criticized by some because inflation imbalances that might, if not corrected did not tum upward. That outcome, promptly, undermine our economic of course, was the intent of the expansion. The FOMC in fact has tightening, and I am satisfied that ·s ignaled a state of heightened alert for our actions then were both necessary possible policy tightening since last and effective, and helped to foster July in its policy directives. But, we the continued economic expansion. have also taken care not to act prema To be sure, 1997 is not 1994. The real turely. The FOMC refrained from federal funds rate today is significantly changing policy last summer, despite higher than it was three years ago. expectations of a near-term policy Then we had just completed an firming by many financial market extended period of monetary ease participants. In light of the develop which addressed the credit stringen ments I've just discussed affecting cies of the early 1990s, and with the wages and prices, we thought infla abatement of the credit crunch, tion might well remain damped, Digitized for FRASER https://fraser.stlouisfed.org 4 Federal Reserve Bank of St. Louis the low real funds rate of early 1994 As always, with resource utilization was clearly incompatible with contain rates high, we would need to watch ing inflation and sustaining growth closely a situation in which demand going forward. In February 1997, in was clearly unsustainable because it contrast, our concern is a matter of was producing escalating pressures on relative risks rather than of expected resources, which could destabilize the outcomes. The real funds rate, judging economy. And we would need to be by core inflation, is only slightly below watchful that the progress we have its early 1995 peak for this cycle and made in keeping inflation expectations might be at a level that will promote damped was not eroding. In general, continued non-inflationary growth, though, our analysis will need to especially considering the recent rise encompass all potentially relevant in the exchange value of the dollar. information, from financial markets as Nonetheless, we cannot be sure. well as the economy, especially when And the risks of being wrong are some signals, like those in the labor clearly tilted to the upside. market, have not been following their I wish it were possible to lay out established patterns. in advance exactly what conditions The ongoing economic expansion have to prevail to portend a buildup to date has reinforced our conviction of inflation pressures or inflationary about the importance of low psychology. However, the circum inflation-and the public's confidence stances that have been associated in continued low inflation. The with increasing inflation in the past economic expansion almost surely have not followed a single pattern. would not have lasted nearly so long The processes have differed from had monetary policy supported an cycle to cycle, and what may have unsustainable acceleration of spending been a useful leading indicator that induced a buildup of inflationary in one instance has given off mis imbalances. The Federal Reserve must leading signals in another. not acquiesce in an upcreep in I have already discussed the inflation, for acceding to higher key role of labor market develop inflation would countenance an ments in restraining inflation insidious weakening of our chances in the current cycle and our for sustaining long-run economic careful monitoring of signs that growth. Inflation interferes with the the transition phase of trading off efficient allocation of resources by lower real wages for greater job confusing price signals, undercutting security might be coming to a close. a focus on the longer run, and distort ing incentives. Digitized for FRASER https://fraser.stlouisfed.org 5 Federal Reserve Bank of St. Louis This year overall inflation is antici The unemployment rate, according pated to stay restrained. The central to Board members and Bank presi tendency of the forecasts made by the dents, should stay around 5¼ to Board members and Reserve Bank 5½ percent through the fourth quarter, presidents has the increase in the total consistent with their projections of CPI slipping back into a range of 2¾ to measured real GDP growth of 2 to 3 percent over the four quarters of the 2¼ percent over the four quarters of year. This slight falloff from last year's the year. Such a growth rate would pace is expected to owe in part to a represent some downshifting in output slower rise in food prices as some expansion from that of last year. The of last year's supply limitations ease. projected moderation of growth likely More importantly, world oil supplies would reflect several influences: are projected by most analysts to (1) declines in real federal government increase relative to world oil demand, purchases should be exerting a modest and futures markets project a further degree of restraint on overall demand; decline in prices, at least in the near (2) the lagged effects of the increase in term. The recent and prospective the exchange value of the dollar in declines in crude oil prices not only recent months likely will damp U.S. should affect retail gasoline and home net exports somewhat this year; and heating oil prices but also should (3) residential construction is unlikely relieve inflation pressures through to repeat the gains of 1996. On the lower prices for other petroleum other hand, we do not see evidence products, which are imbedded in the of widespread imbalances either in economy's underlying cost structure. business inventories or in stocks of Nonetheless, the trend in inflation equipment and consumer durables rates in the core CPI and in broader that would lead to a substantial price measures may be somewhat cutback in spending. And financial less favorable than in recent years. conditions overall remain supportive; A continued tight labor market, whose real interest rates are not high by influence on costs would be aug historical standards and credit is mented by the scheduled increase in readily available from intermediaries the minimum wage later in the year _and in the market. and perhaps by higher growth of The usual uncertainties in the benefits now that considerable overall outlook are especially focused health-care savings already have been on the behavior of consumers. Con realized, could put upward pressure sumption should rise roughly in line on core inflation. Moreover, the effects with the projected moderate expansion of the sharp rise in the dollar over the of disposable income, but both upside last eighteen months in pushing down and downside risks are present. - import prices are likely to ebb over coming quarters. Digitized for FRASER https://fraser.stlouisfed.org 6 Federal Reserve Bank of St. Louis According to various surveys, senti In fact, we may be seeing both ment is decidedly upbeat. Consumers wealth and debt effects already at have enjoyed healthy gains in their work for different segments of the real incomes along with the extraor population, to an approximately dinary stock-market driven rise in offsetting extent. Saving out of current their financial wealth over the last income by households in the upper couple of years. Indeed, econometric income quintile, who own nearly models suggest that the more than three-fourths of all non-pension $4 trillion rise in equity values since equities held by households, evidently late 1994 should have had a larger has declined in recent years. At the positive influence on consumer same time, the use of credit for pur spending than seems to have actually chases appears to have leveled off occurred. after a sharp runup from 1993 to 1996, It is possible, however, that house perhaps because some households are holds have been reluctant to spend becoming debt constrained and, as a much of their added wealth because result, are curtailing their spending. they see a greater need to keep it to The Federal Reserve will be weigh support spending in retirement. Many ing these influences as it endeavors households have expressed heightened to help extend the current period concern about their financial security of sustained growth. Participants in old age, which reportedly has led in financial markets seem to believe to increased provision for retirement. that in the current benign environment The results of a survey conducted the FOMC will succeed indefinitely. annually by the Roper Organization, There is no evidence, however, that which asks individuals about their the business cycle has been repealed. confidence in the Social Security Another recession will doubtless occur system, shows that between 1992 some day owing to circumstances that and 1996 the percent of respondents could not be, or at least were not, expressing little or no confidence perceived by policymakers and finan in the system jumped from about cial market participants alike. History 45 percent to more than 60 percent. demonstrates that participants in Moreover, consumer debt burdens financial markets are susceptible to are near historical highs, while credit waves of optimism, which can in tum card delinquencies and personal foster a general process of asset-price bankruptcies have risen sharply over inflation that can feed through into the past year. These circumstances markets for goods and services. Exces may make both borrowers and lenders sive optimism sows the seeds of its a bit more cautious, damping spending. own reversal in the form of imbalances that tend to grow over time. Digitized for FRASER https://fraser.stlouisfed.org 7 Federal Reserve Bank of St. Louis When unwarranted expectations Markets may have become more ultimately are not realized, the efficient, competition is more global, unwinding of these financial excesses and information technology has can act to amplify a downturn in doubtless enhanced the stability of economic activity, much as they can business operations. But, regrettably, amplify the upswing. As you know, history is strewn with visions of such last December I put the question this "new eras" that, in the end, have way: " ... how do we know when proven to be a mirage. In short, irrational exuberance has unduly history counsels caution. escalated asset values, which then Such caution seems especially become subject to unexpected and warranted with regard to the sharp prolonged contractions ...? " rise in equity prices during the past We have not been able, as yet, two years. These gains have obviously to provide a satisfying answer to this raised questions of sustainability. question, but there are reasons in the Analytically, current stock-price current environment to keep this valuations at prevailing long-term question on the table. Clearly, when interest rates could be justified by very people are exposed to long periods strong earnings growth expectations. of relative economic tranquility, they In fact, the long-term earnings projec seem inevitably prone to complacency tions of financial analysts have been about the future. This is understand marked up noticeably over the last able. We have had fifteen years year and seem to imply very high of economic expansion interrupted earnings growth and continued rising by only one recession-and that was profit margins, at a time when such six years ago. As the memory of such margins are already up appreciably past events fades, it naturally seems from their depressed levels of five ever less sensible to keep up one's years ago. It could be argued that, guard against an adverse event in the although margins are the highest in a future. Thus, it should come as no generation, they are still below those surprise that, after such a long period that prevailed in the 1960s. Nonethe of balanced expansion, risk premiums less, further increases in these margins for advancing funds to businesses would evidently require continued in virtually all financial markets have restraint on costs: labor compensation declined to near-record lows. continuing to grow at its current pace Is it possible that there is something and productivity growth picking up. fundamentally new about this current Neither, of course, can be ruled out. period that would warrant such But we should keep in mind that, complacency? Yes, it is possible. at these relatively low long-term interest rates, small changes in long-term earnings expectations could have outsized impacts on equity prices. Digitized for FRASER https://fraser.stlouisfed.org 8 Federal Reserve Bank of St. Louis Caution also seems warranted by Rather, the FOMC has to be sensitive the narrow yield spreads that suggest to indications of even slowly building perceptions of low risk, possibly imbalances, whatever their source, unrealistically low risk. Considerable that, by fostering the emergence of optimism about the ability of busi inflation pressures, would ultimately nesses to sustain this current healthy threaten healthy economic expansion. financial condition seems, as I indi Unfortunately, because the mone cated earlier, to be influencing the tary aggregates were subject to an setting of risk premiums, not just episode of aberrant behavioral in the stock market but throughout patterns in the early 1990s, they are the financial system. This optimistic likely to be of only limited help attitude has become especially evi in making this judgment. For three dent in quality spreads on high-yield decades starting in the early 1960s, corporate bonds-what we used to call the public's demand for the broader "junk bonds." In addition, banks have monetary aggregates, especially M2, continued to ease terms and standards was reasonably predictable. In the on business loans, and margins on intermediate term, M2 velocity many of these loans are now quite nominal income divided by the stock thin. Many banks are pulling back of M2-tended to vary directly with a little from consumer credit card the difference between money market lending as losses exceed expectations. yields and the return on M2 assets Nonetheless, some bank and nonbank that is, with its short-term opportunity lenders have been expanding aggres cost. In the long run, as adjustments in sively into the home equity loan deposit rates caused the opportunity market and so-called "subprime" cost to revert to an equilibrium, M2 auto lending, although recent prob velocity also tended to return to an lems in the latter may already be associated stable equilibrium level. introducing a sense of caution. For several years in the early 1990s, Why should the central bank be however, the velocities of M2 and M3 concerned about the possibility that exhibited persisting upward shifts that financial markets may be overestimat departed markedly from these ing returns or mispricing risk? It is not historical patterns. that we have a firm view that equity In the last two to three years, prices are necessarily excessive right velocity patterns seem to have now or risk spreads patently too low. returned to those historical Our goal is to contribute as best we relationships, after allowing can to the highest possible growth for a presumed permanent upward of income and wealth over time, and shift in the levels of velocity. we would be pleased if the favorable Even so, given the abnormal velocity economic environment projected behavior during the early 1990s, in markets actually comes to pass. Digitized for FRASER https://fraser.stlouisfed.org 9 Federal Reserve Bank of St. Louis FOMC members continue to see But, even with such velocity behavior considerable uncertainty in the this year, when inflation is expected relationship of broad money to oppor to still be higher than is consistent tunity costs and nominal income. with our long-run objective of reason Concern about the possibility of able price stability, the broader aberrant behavior has made the FOMC aggregates could well grow around hesitant to upgrade the role of these the upper bounds of these ranges. The measures in monetary policy. debt aggregate probably will expand Against this background, at its around the middle of its range this February meeting, the FOMC year. reaffirmed the provisional ranges set I will conclude on the same upbeat last July for money and debt growth note about the U.S. economy with this year: 1 to 5 percent for M2, which I began. Although a central 2 to 6 percent for M3, and 3 to banker's occupational responsibility 7 percent for the debt of domestic is to stay on the lookout for trouble, nonfinancial sectors. The M2 and even I must admit that our economic M3 ranges again are designed prospects in general are quite favor to be consistent with the FOMC's able. The flexibility of our market long-run goal of price stability: system and the vibrancy of our private For, if the velocities of the broader sector remain examples for the whole monetary aggregates were to continue world to emulate. The Federal Reserve behaving as they did before 1990, will endeavor to do its part by then money growth around the continuing to foster a monetary middle portions of the ranges would framework under which our citizens be consistent with noninflationary, can prosper to the fullest possible sustainable economic expansion. extent. Digitized for FRASER https://fraser.stlouisfed.org 10 Federal Reserve Bank of St. Louis Monetary Policy and the Economic Outlook The economy performed impressively Several factors helped to restrain this past year, and members of the price increases this past year in the Board of Governors and Reserve Bank face of high levels of resource utiliza presidents anticipate that 1997 will tion. With workers still concerned bring further appreciable economic to some degree about job security, expansion with relatively low infla acceleration in hourly compensation tion. In 1996, solid advances in the was not so pronounced as in compa real expenditures of households and rable periods in the past; wage businesses led to sizable gains in increases picked up relatively moder output. Employment rose briskly, and ately, and further success in control the unemployment rate edged down ling health care costs helped to temper to its lowest level of the current the rise in benefits. Moreover, signifi expansion. Consumer price inflation cant declines in the prices of U.S. increased owing to the likely tempo imports, owing to low inflation abroad rary effects of firmness in food and and appreciation of the dollar on energy markets, but some broader foreign exchange markets, tended price measures showed inflation to hold down domestic prices. holding steady or even declining. Damped inflation expectations With the economy strengthening, probably contributed as well to intermediate-and long-term interest the favorable price performance: A rates rose on net, but credit continued lengthening run of years during which to be amply available to businesses inflation has been in a more moderate and most households, and equity range, together with an understanding prices soared. of the Federal Reserve' s commitment to maintaining progress toward price Change in Real GDP stability, may have discouraged Percent, annual rate aggressive pricing behavior. Business firms continued to rely on cost control and gains in productivity, rather than on price increases, as the primary 4 channels for achieving profit growth. Still, the Federal Open Market Committee (FOMC) recognized the 2 danger that pressures emanating from the tight labor market might + trigger an acceleration of prices, o which could eventually undermine the ongoing economic expansion. 1991 1992 1993 1994 1995 1996 Digitized for FRASER https://fraser.stlouisfed.org 11 Federal Reserve Bank of St. Louis Household Debt Service Burden Monetary Policy, Financial Percent of disposable personal income Markets, and the Economy in 1996 The FOMC eased the stance of Quarterly monetary policy twice around the beginning of last year-in December 17 1995 and in January-lowering the federal funds rate½ percentage point in total, to 5¼ percent. These actions 16 were taken to offset the effect on the level of the real federal funds rate of declines in inflation and inflation 15 expectations in the second half of 1995 and thereby to help ensure the resumption of moderate eco nomic growth after the marked 1984 1986 1988 1990 1992 1994 1996 slowdown and inventory correc Note. Debt service is the sum of required interest and principal payments on consumer and household-sector tion in late 1995. By the spring, mortgage debt. economic growth had become more Consequently, although conditions last vigorous than either the Committee year were not deemed to warrant or financial markets had foreseen. immediate policy action, the Commit Three-month Interest Rates tee's policy directives starting in mid-1996 reflected a perception that Percent the most likely direction of any policy Monthly action would be toward greater restraint in the provision of reserves Average foreign to the banking system. Forestalling a disruptive buildup of inflationary pressures in the near term and moving toward price stability over time remain central to the System's mission of promoting maximum sustainable growth of employment and production. 1984 1986 1988 1990 1992 1994 1996 Note. Average foreign rates are the global trade weighted average, for the other G-10 countries, of yields on instruments comparable to U.S. instruments shown. Digitized for FRASER https://fraser.stlouisfed.org 12 Federal Reserve Bank of St. Louis Ten-year Interest Rates By early summer, however, the continued momentum in demand Percent and pressures on labor resources Monthly that were being reflected in faster growth in wages were seen as pos- ing a threat of increased inflation. Core --+--+-------------- 12 inflation remained moderate, but in light of the heightened risk that it would tum upward, the Committee in its early July directive to the Manager of the Open Market Account indicated its view that near-term economic developments were more likely to lead to a tightening of policy than to an easing. Labor markets continued to be 1984 1986 1988 1990 1992 1994 1996 taut over the balance of the year, and Note. Average foreign rates are the global trade this bias toward restraint was included weighted average, for the other G-10 countries, of yields on instruments comparable to U.S. instruments in directives adopted at all of the shown. Committee's remaining meetings In response, intermediate-and in 1996. longer-term interest rates as of mid-May were up around a full Civilian Unemployment Rate percentage point from the two-year Percent lows reached early in the year .In combination with some softening of economic activity abroad and declines in interest rates in major --------------- 8 foreign industrial countries, these developments contributed to a further ~\.. appreciation of the dollar, building on -✓----~--6 the rise that had started in mid-1995. Jan. The Committee anticipated that the increase in the cost of credit, along --------------- 4 with the higher exchange value of the dollar, would be sufficient to foster a downshift in economic expansion 1990 1992 1994 1996 to a more sustainable pace and contain Note. The break in data at January 1994 marks price pressures; thus, it left its policy the introduction of a redesigned survey; data from stance unchanged at its spring that point on are not directly comparable with the data of earlier periods. meetings. Digitized for FRASER https://fraser.stlouisfed.org 13 Federal Reserve Bank of St. Louis After peaking during mid-summer, The foreign exchange value of the interest rates moved down on balance dollar has posted further gains, in part through the fall, as expansion of reflecting greater-than-expected consumer spending and economic weakness in Europe and renewed activity in general appeared to be pessimism about economic and moderating and markets saw less financial prospects in Japan. Equity likelihood of a need for Federal prices have registered new highs since Reserve firming action. Equity prices the start of the year. As of mid fell back for a time during the sum February, intermediate-and long-term mer, reversing some of the substantial interest rates were up about ½ to increase registered over the first half ¾ percentage point, on balance, since of the year, but by autumn they early 1996, and the value of the dollar had reached new highs. Interest was up around 9 percent against an rates and dollar exchange rates average of other G-10 currencies. turned back up late in the year when For the nonfinancial business sector, signs of rapid growth and more the effect of the higher intermediate intense use of the economy's resources and long-term interest rates on the reemerged. Since year-end, interest overall cost of funds last year was rates have changed little, on net. offset to some degree by an easing of lending terms at banks and a narrow Weighted Average Exchange Value ing of yield spreads on corporate of the U.S. Dollar bonds over Treasuries, as well as by Index, March 1973 = 100 declines in the cost of capital in the equity market. Encouraged, perhaps, Nominal by the prospects of sustained economic expansion and low inflation, banks, market lenders, and equity investors displayed a strong appetite for business obligations and seemed willing to require less compensation for the possible risks entailed. Some households, by contrast, faced a tightening of standards and terms with respect to credit card debt and some other types of consumer debt last year, as banks reacted to a 1991 1992 1993 1994 1995 1996 rising volume of delinquencies and Note. In terms of the currencies of the other G-10 charge-offs on these instruments. countries. Weights are based on 1972-76 global trade of each of the ten countries. Digitized for FRASER https://fraser.stlouisfed.org 14 Federal Reserve Bank of St. Louis Delinquency Rates Economic Projections for 1997 on Household Loans With the economy free of serious Percent imbalances, prospects appear favor able for further growth of activity and Quarterly Credit card expansion of job opportunities in the accounts at banks coming year, although resource ______________ __,_ constraints seem likely to keep the 4 pace of growth below that of 1996. The central tendency of the GDP growth forecasts put forth by mem bers of the Board of Governors and -....._...--~...,.....~------- 2 the Reserve Bank presidents is from 2 percent to 2¼ percent, measured as Mortgages Q3 (over 60 days) the change in real output between the final quarter of 1996 and the final quarter of 1997. Output growth of this 1980 1984 1988 1992 1996 magnitude is expected to result in little However, credit availability under change in the civilian unemployment home equity lines increased, particu rate, which is projected to be between larly from finance companies but also 5¼ percent and 5½ percent in the from banks. Overall debt growth fourth quarter of this year. These slowed slightly but remained forecasts of GDP growth and unem near the midpoint of its 3 percent ployment are similar to those of the to 7 percent monitoring range.The Administration. The central tendency growth rates of M2 and M3 edged up of the policymakers' CPI forecasts for last year and, as was anticipated in the 1997 spans the relatively narrow monetary policy reports to the interval of 2¾ percent to 3 percent, Congress last February and July, both with the lower bound near the infla aggregates ended 1996 near or above tion forecast of the Administration. ·the upper end of their growth ranges. Consumer spending, which accounts Again last year, the growth of M2 for about two-thirds of total GDP, relative to nominal income and should be supported in coming interest rates was generally in line quarters by further gains in income with historical relationships, in and the substantial increase in contrast to its behavior during the household net worth that has early years of the decade. occurred over the past two years; Digitized for FRASER https://fraser.stlouisfed.org 15 Federal Reserve Bank of St. Louis Economic Projections for 1997 Percent Federal Reserve governors and Reserve Bank presidents Administration Central Indicator Range tendency Change, Nominal GDP 4¼-5¼ 41/2-4¾ 4.6 fourth quarter to fourth RealGDP2 2-2½ 2-2¼ 2.0 quarter:1 Consumer price index 3 2¾-3½ 2¾-3 2.6 Average level, Civilian unemployment rate 5¼-5½ 5¼-5½ 5.4 fourth quarter: 1. Change from average for fourth quarter of 2. Chain-weighted. 1996 to average for fourth quarter of 1997. 3. All urban consumers. debt problems, although rising of late, Foreign demand for U.S. products do not seem to be so widespread as to should continue to rise with growth threaten the ongoing expansion of the world economy, even in the of household expenditures in the wake of the significant appreciation aggregate. In the business sector, of the dollar since the first half balance sheets are strong, profits have of 1995; however, imports also seem been rising, and efforts to bolster likely to remain on a clear upward efficiency through the use of techno trend, given the prospects for contin logically advanced equipment are ued expansion of the U.S. economy. continuing at an intense pace. In the Government expenditures for con commercial real estate market, the sumption and investment probably supply-demand balance has shifted will follow recent trends, with further in many locales to a point at which cutbacks in real outlays at the federal interest in office building projects level and moderate increases in the has picked up noticeably. These combined purchases of state and local conditions, together with the ready governments. access to a wide variety of sources Although the risk of increased of finance that businesses currently inflation pressures is significant, are enjoying, should keep investment especially in view of the tightness of spending on an upward trajectory. the labor market and the strength in activity that has been evident recently, Digitized for FRASER https://fraser.stlouisfed.org 16 Federal Reserve Bank of St. Louis Change in Consumer Prices By contrast to the favorable outlook Percent, Q4 to Q4 for food and energy prices, some risk exists that core inflation could turn up during the coming year. The minimum wage will be moving up further in ------------- 6 1997, compounding whatever cost pressures might be in train as a result of labor market tightness, and the -~?I------------- 4 degree to which businesses can con tinue to absorb stepped-up increases in labor costs without raising prices --+--+-........,+--.......,~i--t---+-+-----h--t----+--+-- 2 more rapidly is not certain. Change in Consumer Prices Excluding Food and Energy 1990 1992 1994 1996 Percent, Q4 to Q4 Note. Consumer price index for all urban consumers. Federal Reserve policymakers expect this year's rise in the consumer price ---------------6 index to be somewhat smaller than that of 1996. The major reason for expecting a smaller CPI increase ----------- 4 this year is a more favorable outlook for food and energy prices. Prices of farm products have dropped back 2 from the highs of last summer, and, barring further weather problems, this year's rise in food prices at retail should be considerably smaller than 1990 1992 1994 1996 that of 1996. Oil prices have recently Note. Consumer price index for all urban consumers. declined and seem likely to ease As noted in the July 1996 mone further in coming months as world tary policy report, the CPI forecasts production and consumption come of the governors and Reserve Bank back into better balance; this price presidents incorporate allowances relief is important not only because for the technical improvements of the direct effects on the price of to this index that have been made gasoline and other consumer energy by the Bureau of Labor Statistics. items but also because petroleum is a major element in the cost of producing and distributing many other goods. Digitized for FRASER https://fraser.stlouisfed.org 17 Federal Reserve Bank of St. Louis These technical changes are estimated A long-run pattern of reasonably to have trimmed the reported rate of stable velocity behavior broke down CPI inflation slightly in each of the in the early 1990s when the public's past two years, and additional changes holdings of monetary assets were will be affecting the rise in the index depressed by several factors: the in 1997. In view of the remaining contraction of the thrift industry; difficulties of accurately measuring a tightening of credit supplies and price change in a highly complex and deleveraging by businesses and rapidly changing economy, alternative households; an extremely wide spread price indexes will continue to be given between short-and intermediate-term substantial weight, along with the CPI, interest rates that heightened the in monitoring progress toward the attractiveness of capital market long-run goal of price stability. Some instruments relative to bank deposits; of the broad measures of inflation and the expanding availability and derived from the GDP accounts growing acceptance of stock and slowed in 1996; the Committee is bond mutual funds as household concerned that, even if the CPI investments. decelerates as expected in 1997, other indexes-with different Ranges for Growth of Monetary and scope and weights-may pick up Debt Aggregates in reflection of the pressures on Percent productive resources. Aggregate 1995 1996 1997 Money and Debt Ranges for 1997 M2 1-5 1-5 1-5 Again in 1997, the Committee has set ranges for M2 and M3 that would M3 2-6 2-6 2-6 encompass monetary growth expected to be consistent with approximate Debt price stability and a sustainable rate of real economic growth, assuming Note. Change from average for fourth quarter that the behavior of velocity is in line of preceding year to average for fourth quarter of year indicated. with historical norms. These ranges are unchanged from those for 1996: With the waning of all but the last 1 to 5 percent for M2 and 2 to 6 per of these influences, movements in cent for M3. velocity have become more predictable As has been the case for several over the past couple of years. This years, the 1997 ranges for M2 and M3 recent evidence of stability, however, were set against a backdrop of covers only a relatively brief period, uncertainty about the stability and and its durability remains uncertain. predictability of their velocities. Digitized for FRASER https://fraser.stlouisfed.org 18 Federal Reserve Bank of St. Louis In these circumstances, the Committee has opted to continue treating the ranges as benchmarks for the trends of money growth consistent with price stability rather than as short-run targets for policy. Meanwhile, the actual behavior of the monetary measures will be monitored for such information as it may convey about underlying economic developments. The central tendency of the Commit tee's expectations for nominal GDP growth in 1997 is slightly below that registered in 1996. Thus, if velocity behaves as it did last year, M2 and M3 might decelerate a bit but even so would again expand around the upper ends of their growth ranges. Debt of the nonfinancial sectors is anticipated to increase this year at around the pace of last year, remaining near the midpoint of its unchanged 3 to 7 percent range. FRBl-30000-0297 Digitized for FRASER https://fraser.stlouisfed.org 19 Federal Reserve Bank of St. Louis

Federal Reserve (1997, February 25). Monetary Policy Report. Monetary Policy Reports, Federal Reserve. https://whenthefedspeaks.com/doc/monetary_policy_report_19970226

@misc{wtfs_monetary_policy_report_19970226,
  author = {Federal Reserve},
  title = {Monetary Policy Report},
  year = {1997},
  month = {Feb},
  howpublished = {Monetary Policy Reports, Federal Reserve},
  url = {https://whenthefedspeaks.com/doc/monetary_policy_report_19970226},
  note = {Retrieved via When the Fed Speaks corpus}
}