Monetary Policy Report

February 24, 1998 : _J 9.9.§M9NEIMYP0LICYOBJECTNES A Summary Report of the Federal Reserve Board Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 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 The U.S. Economy in 1997 1 Monetary Policy in 1997 4 The Outlook for 1998 5 The Forecasts of the Governors of the Federal Reserve Board and the Presidents of the Federal Reserve Banks 7 The Ranges for the Debt and Monetary Aggregates 8 Uncertainty about the Outlook 8 Monetary Policy and the Economic Outlook 11 Economic Projections for 1998 15 Money and Debt Ranges for 1998 19 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Testimony of Alan Greenspan Chairman, Federal Reserve Board Mr. Chairman and members Measured consumer price inflation came in at 1¾ percent over the twelve of the Committee, I welcome months of 1997, down about 1½ per this opportunity to present the centage points from the pace of the prior year. While swings in the prices Federal Reserve' s semiannual of food and fuel contributed to this report on economic conditions decline, both narrower price indexes excluding those items and broader and the conduct of monetary ones including all goods and services policy. produced in the United States also paint a portrait of continued progress toward price stability. Businesses, for the most part, were able to pay these higher real wages while still increasing The U.S. Economy in 1997 their earnings. Although aggregate The U.S. economy delivered another data on profits for all of 1997 are not exemplary performance in 1997. Over yet available, corporate profit margins the four quarters of last year, real GDP most likely remained in an elevated expanded close to 4 percent, its fastest range not seen consistently since the annual increase in ten years. To 1960s. These healthy gains in earnings produce that higher output, about and the expectations of more to come 3 million Americans joined the provided important support to the nation's payrolls, in the process equity market, with most major stock contributing to a reduction in the price indexes gaining more than unemployment rate to 4¾ percent, 20 percent over the year. its lowest sustained level since the The strong growth of the real late 1960s. And our factories were income of workers and corporations working more intensively too: is not unrelated to the economy's Industrial production increased continued good performance on 5¾ percent last year, exceeding inflation. Taken together, recent robust additions to capacity. evidence supports the view that such Those gains were shared widely. low inflation, as closely approaching The hourly wage and salary structure price stability as we have known rose about 4 percent, fueling impres in the United States in three decades, sive increases in personal incomes. engenders many benefits. When Unlike some prior episodes when changes in the general price level are faster wage rate increases mainly small and predictable, households and reflected attempts to make up for firms can plan more securely for the more rapidly rising prices of goods future. The perception of reduced risk and services, the fatter paychecks that encourages investment. Low inflation workers brought home represented also exerts a discipline on costs, real increments to purchasing power. Digitized for FRASER https://fraser.stlouisfed.org 1 Federal Reserve Bank of St. Louis fostering efforts to enhance productiv and communication and information ity. Productivity is the ultimate source technology appear to have been a of rising standards of living, artd we major force behind this beneficial witnessed a notable pickup in this trend. Those innovations, together measure in the past two years. with fierce competitive pressures in The robust economy has facilitated our high-tech industries to make them the efforts of the Congress and the available to as many homes, offices, Administration to restore balance in stores, and shop floors as possible, the unified federal budget. As I have have produced double-digit annual indicated to the Congress on numer reductions in prices of capital goods ous occasions, moving beyond this embodying new technologies. Indeed, point and putting the budget in many products considered to be at the significant surplus would be the surest cutting edge of technology as recently and most direct way of increasing as two to three years ago have become national saving. In turn, higher so standardized and inexpensive that national saving, by promoting lower they have achieved near ''commodity'' real long-term interest rates, helps status, a development that has allowed spur spending to outfit American businesses to accelerate their accumu firms and their workers with the lation of more and better capital. modern equipment they need to Critical to this process has been the compete successfully on world rapidly increasing efficiency of our markets. We have seen a partial financial markets-:-itself a product of down payment of the benefits the new technologies and of significant of better budget balance already: market deregulation over the years. It seems reasonable to assume that Capital now flows with relatively little the decline in longer-term Treasury friction to projects embodying new yields last year owed, in part, to ideas. Silicon Valley is a tribute both reduced competition-current and to American ingenuity and to the prospective-from the federal gov financial system's ever-increasing ernment for scarce private saving. ability to supply venture capital to the However, additional effort remains entrepreneurs who are such a dynamic to be exerted to address the effects force in our economy. on federal entitlement spending With new high-tech tools, American of the looming shift within the next businesses have shaved transportation decade in the nation's retirement costs, managed their production and demographics. use of inventories more efficiently, As I noted earlier, our nation has and broadened market opportunities. been experiencing a higher growth rate of productivity-output per hour worked-in recent years. The dramatic improvements in computing power Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 2 The threat of rising costs in tight labor The acceleration in productivity, markets has imparted a substantial however, has been exceeded by the impetus to efforts to take advantage strengthening of demand for goods of possible efficiencies. In my and services. As a consequence, Humphrey-Hawkins testimony last employers had to expand payrolls July, I discussed the likelihood that at a pace well in excess of the growth the sharp acceleration in capital of the working age population that investment in advanced technologies profess a desire for a job, including beginning in 1993 reflected synergies new immigrants. As I pointed out last of new ideas, embodied in increasingly year in testimony before the Congress, inexpensive new equipment, that have that gap has been accommodated by elevated expected returns and have declines in both the officially unem broadened investment opportunities. ployed and those not actively seeking More recent evidence remains work but desirous of working. The consistent with the view that this number of people in those two cate capital spending has contributed to gories decreased at a rate of about a noticeable pickup in productivity one million per year on average over and probably by more than can be the last four years. By December 1997, explained by usual business cycle the sum had declined to a seasonally forces. For one, the combination of adjusted 10½ million, or 6 percent continued low inflation and stable of the working age population, the to rising domestic profit margins lowest ratio since detailed information implies quite subdued growth in on this series first became available total consolidated unit business costs. in 1970. Anecdotal information from With labor costs constituting more surveys of our twelve Reserve Banks than two-thirds of those costs and attests to our ever tightening labor labor compensation per hour accelerat markets. ing, productivity most be growing Rapidly rising demand for labor faster, and that stepup must be has had enormous beneficial effects roughly in line with the increase in on our work force. Previously low- compensation growth. For another, or unskilled workers have been drawn our more direct observations on into the job market and have obtained output per hour roughly tend to training and experience that will help confirm that productivity has picked them even if they later change jobs. up significantly in recent years, Large numbers of underemployed although how much the ongoing have been moved up the career ladder trend of productivity has risen to match their underlying skills, and remains an open question. many welfare recipients have been added to payrolls as well, to the bene fit of their long-term job prospects. Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 3 . The recent acceleration of wages Monetary Policy in 1997 likely has owed in part to the ever His~ory teaches us that monetary tig~t~ning labor market and in part policy has been its most effective to nsmg productivity growth, which, when it has been preemptive. The through competition, induces firms lagging relationship between the to grant higher wages. It is difficult at Federal Reserve's policy instrument this time, however, to disentangle the and spending, and, even further relative contributions of these factors. removed, inflation, implies that What is clear is that, unless demand if policy actions are delayed until growth softens or productivity growth prices begin to pick up, they will accelerates even more, we will grad be too late to fend off at least some ually run out of new workers who persistent price acceleration and can be profitably employed. It is attendant economic instabilities. not possible to tell how many more Pr~em~tive policymaking is keyed of the 6 percent of the working-age to Judgmg how widespread are population who want to work but emerging inflationary forces, and do not have jobs can be added to when, and to what degree, those payrolls. A significant number are forces will be reflected in actual so-called frictionally unemployed, inflation. For most of last year, the as they have left one job but not yet evident strains on resources were chosen to accept another. Still others sufficiently severe to steer the Federal have chosen to work in only a limited Open Market Committee (FOMC) geographic area where their skills toward being more inclined to tighten may not be needed. ~an to ease monetary policy. Indeed, Should demand for new workers m March, when it became apparent continue to exceed new supply, that strains on resources seemed we would expect wage gains increas to be intensifying, the FOMC ingly to exceed productivity growth, imposed modest incremental restraint squeezing profit margins and eventu raising its intended federal funds rate' ally leading to a pickup in inflation. ¼ percentage point, to 5½ percent. Were a substantial pickup in inflation We did not increase the federal to occur, it could, by stunting eco funds rate again during the summer nomic growth, reverse much of the and fall, despite further tightening remarkable labor market progress of the labor market. Even though of recent years. I will be discussing the labor market heated up and our assessment of these and other labor compensation rose, measured possibilities and their bearing inflation fell, owing to the appre on the outlook for 1998 shortly. ciation of the dollar, weakness in international commodity prices, and faster productivity growth. Digitized for FRASER https://fraser.stlouisfed.org 4 Federal Reserve Bank of St. Louis Those restraining forces were more While the tightening may have been evident in goods-price inflation, which passive in that sense, it was by no in the CPI slowed substantially to only means inadvertent. Members of the about½ percent in 1997, than on FOMC took some comfort in the service-price inflation, which moder upward trend of the real federal funds ated much less-to around 3 percent. rate over the year and the rise in the Providers of services appeared to be foreign exchange value of the dollar more pressed by mounting strains in because such additional restraint was labor markets. Hourly wages and viewed as appropriate given the salaries in service-producing sectors strength of spending and building rose 4½ percent last year, up consider strains on labor resources. They also ably from the prior year and almost recognized that in virtually all other 1½ percentage points faster than in respects financial markets remained goods-producing sectors. However, a quite accommodative and, indeed, significant portion of that differential, judging by the rise in equity prices, but by no means all, traced to commis were providing additional impetus · sions in the financial and real estate to domestic spending. services sector related to one-off increases in transactions prices and in The Outlook for 1998 volumes of activity, rather than to There can be no doubt that domestic increases in the underlying wage demand retained considerable structure. momentum at the outset of this year. Although the nominal federal funds Production and employment have rate was maintained after March, been on a strong uptrend in recent the apparent drop in inflation expecta months. Confident households, tions over the balance of 1997 induced enjoying gains in income and wealth some firming in the stance of monetary and benefitting from the reductions policy by one important measure-the in intermediate-and longer-term real federal funds rate, or the nominal interest rates to date, should con federal funds rate less a proxy for tinue to increase their spending. inflation expectations. Some analysts Firms should fjnd financing avail have dubbed the contribution of the able on relatively attractive terms reduction in inflation expectations to fund profitable opportunities to raising the real federal funds rate to enhance_e fficiency by investing a "passive" tightening, in that it in new capital equipment. By itself, increased the amount of monetary this strength in spending would policy restraint in place without seem to presage intensifying pres an explicit vote by the FOMC. sures in labor markets and on prices. Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 5 Yet, the outlook for total spending The forces of Asian restraint could on goods and services produced well be providing another, more in the United States is less assured direct offset to inflationary impulses of late because of storm clouds arising domestically in the United massing over the Western Pacific States. In the wake of weakness and heading our way. in Asian economies and of lagged This is not the place to examine effects of the appreciation of the dollar in detail what triggered the initial more generally, the dollar prices problems in Asian financial markets of our non-oil imports are likely and why the subsequent deterioration to decline further in the months ahead. has been so extreme. I covered that These lower import prices are appar subject recently before several commit ently already making domestic tees of the Congress. Rather, I shall producers hesitant to raise their own confine my discussion this morning prices for fear of losing market share, to the likely consequences of the Asian further contributing to the restraint crisis for demand and inflation in the on overall prices. Lesser demands United States. for raw materials on the part of Asian With the crisis curtailing the economies as their activity slows financing available in foreign curren should help to keep world commod cies, many Asian economies have had ity prices denominated in dollars in no choice but to cut back their imports check. Import and commodity prices, sharply. Disruptions to their financial however, will restrain U.S. inflation systems and economies more generally only as long as they continue to fall, will further damp demands for our or to rise at a slower rate than the pace exports of goods and services. Ameri of overall domestic product prices. can exports should be held down as The key question going forward well by the appreciation of the dollar, is whether the restraint building which will make the prices of compet from the turmoil in Asia will be ing goods produced abroad more sufficient to check inflationary tenden attractive, just as foreign-produced cies that might otherwise result from goods will be relatively more the strength of domestic spending attractive to buyers here at home. and tightening labor markets. As a result, we can expect a worsening The depth of the adjustment abroad net export position to exert a discern will depend on the extent of weakness ible drag on total output in the United in the financial sectors of Asian ·S tates. For a time, such restraint might economies and the speed with be reinforced by a reduced willingness which structural inefficiencies in the of U.S. firms to accumulate inventories financial and nonfinancial sectors as they foresee weaker demand ahead. of those economies are corrected. Digitized for FRASER https://fraser.stlouisfed.org 6 Federal Reserve Bank of St. Louis If, as we suspect, the restraint coming The Forecasts of the Governors from Asia is sufficient to bring the of the Federal Reserve Board demand for American labor back into and the Presidents of the Federal line with the growth of the working Reserve Banks age population desirous of working, In these circumstances, the forecasts labor markets will remain unusually of the governors of the Federal tight, but any intensification of Reserve Board and presidents of the inflation should be delayed, very Federal Reserve Banks for the perfor gradual, and readily reversible. mance of the U.S economy over this However, we cannot rule out two year are more tentative than usual. other, more worrisome possibilities. Based on information available On the one hand, should the momen through the first week of February, tum to domestic spending not be monetary policymakers were gene~ally offset significantly by Asian or other of the view that moderate econormc developments, the U.S. economy growth is likely in store. The growth would be on a track along which rate of real GDP is most commonly spending could press too strongly seen as between 2 and 2¾ percent against available resources to be over the four quarters of 1998. consistent with contained inflation. Given the strong performance On the other, we also need to be alert of real GDP, these projections envis to the possibility that the forces from age the unemployment rate remaining Asia might damp activity and pri~es in the low range of the past half year. by more than is desirable by exerting Inflation, as measured by the four a particularly forceful drag on the quarter percent change in the con volume of net exports and the prices sumer price index, is expected to be of imports. 1¾ to 2¼ percent in 1998-near the When confronted at the beginning low rate recorded in 1997. This outlook of this month with these, for the embodies the expectation that the moment, finely balanced, though effects of continuing tightness in labor powerful force~, the members of the markets will be largely offset by Federal Open Market Committee technical adjustments shaving a couple decided that monetary policy should tenths from the published CPI, healthy most appropriately be kept on hold. productivity growth, flat or dec~g With the continuation of a remarkable import prices, and little pressure_ m seven-year expansion at stake and commodity markets. But the policy so little precedent to go by, the range makers' forecasts also reflect their of our intelligence gathering in the determination to hold the line on weeks ahead must be wide and inflation. especially inclusive of international developments. Digitized for FRASER https://fraser.stlouisfed.org 7 Federal Reserve Bank of St. Louis The Ranges for the Debt and This anomalous behavior of velocity Monetary Aggregates severely set back most analysts' confidence in the usefulness of M2 The FOMC affirmed the provisional as an indicator of economic develop ranges for the monetary aggregates ments. In recent years, there have been in 1998 that it had selected last July, tentative signs that the historical which, once again, encompass the relationship linking the velocity of growth rates associated with condi M2-measured as the ratio of nominal tions of approximate price stability, GDP to the money stock-to the cost provided that these aggregates act of holding M2 assets was reasserting in accord with their pre-1990s histori itself. However, a persistent residual cal relationships with nominal income upward drift in velocity over the past and interest rates. These ranges are few years and its apparent cessation identical to those that had prevailed very recently underscores our ongoing for 1997-1 to 5 percent for M2 and uncertainty about the stability of this 2 to 6 percent for M3. The FOMC also relationship. The FOMC will continue reaffirmed its range of 3 to 7 percent to observe the evolution of the for the debt of the domestic nonfinan monetary and credit aggregates cial sectors for this year. I should carefully, integrating information caution, though, that the expectations about these variables with a wide of the governors and Reserve Bank variety of other information in presidents for the expansion of determining its policy stance. nominal GDP in 1998 suggest that growth of M2 in the upper half of its Uncertainty about the Outlook benchmark range is a distinct possibil ity this year. Given the continuing With the current situation reflecting strength of bank credit, M3 might even a balance of strong countervailing be above its range as depositories use forces, events in the months ahead liabilities in this aggregate to fund loan are not likely to unfold smoothly. growth and securities acquisitions. In that regard, I would like Nonfinancial debt should come in to flag a few areas of concern around the middle portion of its range. about the economy beyond those In the first part of the 1990s, money mentioned already regarding Asian growth diverged from historical developments. relationships with income and interest Without doubt, lenders have rates, in part as savers diversified into provided important support to spend bond and stock mutual funds, which ing in the past few years by their had become more readily available willingness to transact at historically and whose returns were considerably small margins and in large volumes. more attractive than those on deposits. Digitized for FRASER https://fraser.stlouisfed.org 8 Federal Reserve Bank of St. Louis Equity investors have contributed A second area of concern involves as well by apparently pricing in the our nation's continuing role in the expectation of substantial earnings new high-tech international financial gains and requiring modest compensa system. By joining with our major tion for the risk that those expectations trading partners and international could be mistaken. Approaching the financial institutions in helping to eighth year of the economic expansion, stabilize the economies of Asia and this is understandable in an economic promoting needed structural changes, environment that, contrary to histori we are also encouraging the contin cal experience, has become increas ued expansion of world trade and ingly benign. Businesses have been global economic and financial stability meeting obligations readily and on which the ongoing increase of our generating high profits, putting own standards of living depends. them in outstanding financial health. If we were to cede our role as a world But we must be concerned about leader, or backslide into protectionist becoming too complacent about policies, we would threaten the evaluating repayment risks. All too source of much of our own sustained often at this stage of the business cycle, economic growth. the loans that banks extend later make A third risk is complacency about up a disproportionate share of total inflation prospects. The combination nonperforming loans. In addition, and interaction of significant increases quite possibly, twelve or eighteen in productivity-improving technolo months hence, some of the securities gies, sharp declines in budget deficits, purchased on the market could and disciplined monetary policy has be looked upon with some regret damped product price changes, by investors. As one of the nation's bringing them to near stability. While bank supervisors, the Federal Reserve part of this result owes to good policy, will make every effort to encourage part is the product of the fortuitous banks to apply sound under- emergence of new technologies and writing standards in their lending. of some favorable price developments Prudent lenders should consider in imported goods. However, as his a wide range of economic situations tory counsels, it is unwise to count in evaluating credit; to do otherwise on any string of good fortune to would risk contributing to potentially continue indefinitely. At the same disruptive financial problems down time, though, it is also instructive the road. to remember the words of an old sage that "luck is the residue of design." Digitized for FRASER https://fraser.stlouisfed.org 9 Federal Reserve Bank of St. Louis He meant that to some degree we can Simply put, while the pursuit deliberately put ourselves in position of price stability does not rule out to experience good fortune and be misfortune, it lowers its probability. better prepared when misfortune If firms are convinced that the general strikes. For example, the 1970s were price level will remain stable, they will marked by two major oil-price shocks reserve increases in their sales prices and a significant depreciation in the of goods and services as a last resort, exchange value of the dollar. But those for fear that such increases could mean misfortunes were, in part, the result of loss of market share. Similarly, if allowing imbalances to build over the households are convinced of price decade as policymakers lost hold of · stability, they will not see variations the anchor provided by price stability. in relative prices as reasons to change Some of what we now see helping their long-run inflation expectations. rein in inflation pressures is more Thus, continuing to make progress likely to occur in an environment toward this legislated objective will of stable prices and price expectations make future supply shocks less likely that thwarts producers from indis and our nation's economy less criminately passing on higher costs, vulnerable to those that occur. puts a premium on productivity enhancement, and rewards more effectively investment in physical and human capital. Digitized for FRASER 10 https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Monetary Policy and the Economic Outlook The U.S. economy turned in another Household Net Worth excellent performance in 1997. Growth Percent of disposable personal income was strong, the unemployment rate declined to its lowest level in nearly a Four-quarter moving average Q3 quarter-century, and inflation slowed 540 further. Impressive gains were also 520 made in other important respects: The federal budget moved toward 500 balance much more quickly than almost anyone had anticipated; 480 capital investment, a critical ingredi ent for long-run growth, rose sharply 460 further; and labor productivity, the 440 ultimate key to rising living standards, displayed notable vigor. 1965 1973 1981 1989 1997 Change in Real GDP Percent, annual rate Budgetary restraint at the federal level has raised national saving, easing the competition for funds in our capital markets and thereby encouraging ----------------- 4 greater private investment. Monetary policy, for its part, has sought to foster an environment of subdued inflation ---~t--~----f~---f/il\1~+4-P-t-- 2 and sustainable growth. The experi ence of recent years has provided + additional evidence that the less _ .......... ..__. ......... __. ....... __.-......____........__........._.....__......__ o households and businesses need to cope with a rising price level, or worry about the sharp fluctuations in employment and production that 1991 1992 1993 1994 1995 1996 1997 usually accompany inflationary Note. In this chart and in subsequent charts that instability, the more long-term show the components of real GDP, changes are measured to the final quarter of the period indi investment, innovation, and enter cated, from the final quarter of the previous period. prise are enhanced. Among the influences that have brought about this favorable per formance are the sound fiscal and monetary policies that have been pursued in recent years. Digitized for FRASER https://fraser.stlouisfed.org 11 Federal Reserve Bank of St. Louis The circumstances that prevailed Robust growth of spending early in through most of 1997 required that the year heightened concerns among the Federal Reserve remain especially members of the Federal Open Market attentive to the risk of a pickup in Committee (FOMC) that growing inflation. Labor markets were already strains on productive resources might tight when the year began, and touch off a faster rate of cost and price nominal wages had started to rise rise that could eventually undermine faster than previously. Persistent the expansion. Financial market strength in demand over the year led participants seemed to share these to economic growth in excess of the concerns: Intermediate-and long-term expansion of the economy's potential, interest rates began moving up in intensifying the pressures on labor December 1996, effectively antici supplies. In earlier business expan pating Federal Reserve action. When sions, such developments had usually the FOMC firmed policy slightly at its produced an adverse turn in the March meeting by raising the intended inflation trend that, more often than federal funds rate from 5¼ percent to not, was accompanied by a worsening 5½ percent, the market response was of economic performance on a variety small. of fronts, culminating in recession. Selected Interest Rates Percent Daily: Three-year Treasury 1/31 3/26 5/21 7/3 8/20 9/24 11/13 12/17 2/5 3/25 5/20 7/2 8/19 9/30 ll/12U/16 2/4 1996 1997 1998 Note. Dotted vertical lines indicate days on The dates on the horizontal axis are those on which which the Federal Open Market Committee the FOMC held scheduled meetings. Last observa (FOMC) announced a monetary policy action. tions are for February 20, 1998. Digitized for FRASER 12 https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis The economy slowed a bit during In the latter part of the year, the second and third quarters, and developments in other parts of the inflation moderated further. In world began to alter the perceived addition, the progress being made risks attending the U.S. economic by the federal government in reducing outlook. Foreign economies generally the size of the deficit was becoming had seemed to be on a strengthening more apparent. As a consequence, growth path when the Federal Reserve by the end of September, longer-term presented its midyear monetary policy interest rates fell¾ percentage point report to the Congress last July. But from their peaks in mid-April, leaving over the remainder of the summer them about ¼ percentage point below and during the autumn, severe their levels at the end of 1996. The financial strains surfaced in a num decline in interest rates along with ber of advanced developing countries continued reports of brisk growth in Asia, weakening somewhat the in corporate profits sparked increases outlook for growth abroad and thus in broad indexes of equity prices the prospects for U.S. exports. of 20 percent to 35 percent between Although the circumstances in April and September. individual countries varied, the Even with a more moderate pace problems they encountered generally of growth, labor markets continued resulted in severe downward pres to tighten, generating concern among sures on the foreign exchange values the FOMC members over this period of their currencies; in many cases, that rising costs might trigger a rise steep depreciations occurred despite in inflation. Consequently, at its substantial upward movement of meetings from May through Novem interest rates. Asset values in Asia, ber, the Committee adopted directives notably equity and real estate prices, for the conduct of policy that assigned also declined appreciably in some greater likelihood to the possibility of instances, leading to losses by finan a tightening of policy than to the cial institutions that had either possibility of an easing of policy. invested in those assets or lent Even though the Committee kept the against them; nonfinancial firms nominal federal funds rate unchanged, began to encounter problems ser it saw the rise in the real funds rate vicing their obligations. In many resulting from declining inflation instances the debts of nonfinancial expectations, together with the and financial firms were denom increase in the exchange value inated in dollars and unhedged. of the dollar, as providing some Concerted international efforts measure of additional restraint to bring economic and financial against the possible emergence stability to the region are under way, of greater inflation pressures. and some progress has been made, Digitized for FRASER https://fraser.stlouisfed.org 13 Federal Reserve Bank of St. Louis but it is evident that in several of the The dollar has also appreciated, on affected economies the process of balance, against an index of currencies adjustment will be painful. Mean of the G-10 (Group of Ten) industrial while, economic activity in Japan stag countries; this G-10 trade-weighted nated, in part because of the develop index of dollar exchange rates is up ments elsewhere in East Asia, and the about 13 percent in nominal terms weaknesses in the Japanese financial since the end of 1996. system became more apparent. The difficulties in Asia contributed to additional declines of¼ to½ per Weighted Average G-10 Exchange centage point in the yields on Value of the U.S. Dollar intermediate-and long-term Treasury Index, March 1973 = 100 securities in the United States between mid-autumn and the end of the year. Nominal These decreases were due in part Jan. to an international flight to the safe haven of dollar assets, but they also reflected expectations that these difficulties would exert a mod- erating influence on the growth of aggregate demand and inflation in the United States. Equity prices were quite volatile but showed little trend in the fourth quarter. Major Stock Price Indexes 1992 1993 1994 1995 1996 1997 1998 Index (December 31, 1996 = 100) Note. In terms of the currencies of the other G-10 countries. Weights are based on 1972-76 global trade Daily of each of the ten countries. The steep depreciations of many Asian currencies contributed to a substantial further appreciation of the U.S. dollar. Measured against a broad set of currencies that includes those of the advanced developing countries of Asia, the exchange value of the dollar, adjusted for relative consumer prices, has moved up about 8 percent since October and JFMAMJJASONDJFMAMJJASONDJFM has increased about 16 percent 1996 1997 1998 from its level at the end of 1996. Note. Last observations are for February 20, 1998. Digitized for FRASER https://fraser.stlouisfed.org 14 Federal Reserve Bank of St. Louis In light of the ongoing difficulties in Nonetheless, the available statistics Asia and the possible effects on the suggest on balance that overall growth United States, the FOMC not only left of output and employment has interest rates unchanged in December, remained brisk in the early part of but shifted its instructions to the 1998. Manager of the System Open Market Confronted with the marked Account to symmetry between ease cross-currents described above and tightening in the near term. involving both upside and downside risks to the growth of output and Change in Real Imports and Exports prospects for inflation-the FOMC of Goods and Services earlier this month once again chose Percent, Q4 to Q4 to hold its federal funds rate objective unchanged. In credit markets, interest D Imports - rates have fallen further this year as II Exports - - the effects of the Asian turmoil seemed even more likely to restrain any - 10 tendencies toward unsustainable growth and greater inflation in the - United States. With interest rates lower and the negative effects of the Asian - 5 problems seen by market participants ~ as mostly limited to particular sectors, broad indexes of equity prices have risen appreciably, many to new highs. 1991 1993· 1995 1997 Economic Projections for 1998 Some spillover from the problems The outlook for 1998 is clouded with in Asia has recently begun to appear a greater-than-usual degree of uncer in reports on business activity in the tainty. Part of that uncertainty is a United States. Customers in the reflection of the financial and eco advanced developing countries nomic stresses that have developed reportedly have canceled some of the in Asia, the full consequences of which orders they had previously placed are difficult to judge. But there are with U.S. firms, and companies more some other significant question marks generally are expressing concerns as well, many of them growing out of about the possibilities of both reduced the surprising performance of the U.S. sales to Asia and more intense price economy in 1997: Growth was competition here as the result of the considerably stronger and inflation sharp changes in exchange rates. considerably lower than Federal Reserve officials and most private analysts had anticipated. Digitized for FRASER https://fraser.stlouisfed.org 15 Federal Reserve Bank of St. Louis Change in Employment Cost Index Circumstances as favorable as those of Percent, Dec. to Dec. 1997 are not likely to persist, although several elements in the recent mix Hourly compensation could help maintain, for some time, a more favorable economic performance than historical relationships would 4 suggest. In assessing the situation, the members of the Board of Governors and the Reserve Bank presidents, all 2 of whom participate in the delibera tions of the FOMC, think that the most likely outcome for 1998 will be one of moderate growth, low unemployment, and low inflation. Most of them have 1990 1992 1994 1996 placed their point estimates of the rise Note. Private industry excluding farm and in real GDP from the fourth quarter household workers. of 1997 to the fourth quarter of 1998 Some of the key forces that gave rise in the range of 2 percent to 2¾ per cent. The civilian unemployment to this favorable performance can be rate in the fourth quarter of 1998 is readily identified. An ongoing capital expected to be at about its recent level. spending boom, encouraged in part by declining prices of high-technology equipment, provided stimulus to Civilian Unemployment Rate aggregate demand and at the same Percent time created the additional capacity to help meet that demand. A further jump in labor productivity that was fueled partly by the buildup of capital --------------8 0"\. helped firms overcome the production and pricing challenges posed by tight labor markets. A surprisingly robust stock market bolstered the finances of households and enabled them to spend more freely. Falling world oil --------------4 prices reduced the prices of petroleum products and helped hold down the prices of other energy-intensive goods. Finally, a rising dollar imposed addi 1990 1992 1994 1996 Note. The break in data at January 1994 marks tional restraint on inflation, as prices the introduction of a redesigned survey; data from of imported goods fell appreciably. that point on are not directly comparable with the data of earlier periods. Digitized for FRASER https://fraser.stlouisfed.org 16 Federal Reserve Bank of St. Louis Change in Consumer Prices But the timing and magnitude of these Percent, Q4 to Q4 developments are hard to predict. In contrast to the slower growth that seems to be in prospect for exports, domestic spending seems "!'." 6 likely to maintain considerable (.: fl'; strength in coming quarters. House holds as a group are quite upbeat v 4 in their assessments of their personal " finances-as might be expected in "" conjunction with expanding job - ...._ - ...._ - - ...._ 2 opportunities, rising incomes, ~ and huge gains in wealth. Recently, ,< - - many households have taken advan tage of lower long-term interest rates 1990 1992 1994 1996 by refinancing their home mortgages, Note. Consumer price index for all urban and this will provide a little additional consumers. wherewithal for spending. Moreover, the decline in mortgage rates is also For the most part, the forecasts have bolstering housing construction. the total CPI for all urban consumers rising between 1¾ percent and Household Debt-Service Burden 2¼ percent this year. These predic tions do not differ appreciably Percent of disposable personal income from those recently put forth Quarterly by the Administration. Although developments in Asia over the past few months have not yet affected aggregate U.S. economic performance in a measurable way, these influences will likely become more visible in coming months. Growth of U.S. exports is expected to be restrained by weaknesses in Asian economies and by the lagged effects of the appreciation of the dollar since 1995. Moreover, with the rise in the 1982 1987 1992 1997 dollar's value making imports less Note. Debt service is the sum of required interest and expensive, some U.S. businesses principal payments on consumer and household-sector and consumers will likely switch mortgage debt. from domestic to foreign sources for some of their purchases. Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 17 Business outlays for fixed invest and those firms turning to the debt ment seem likely to advance at a and equity markets are most often relatively brisk pace in the coming finding financing generously available year, although gains as large as those on good terms. Inventory growth will of the past couple of years may be likely put less pressure on business difficult to match. Outlays for com cash flow this year; after adding to puters, which have dominated the stocks at a substantial clip in 1997, investment surge of the past few years, businesses seem likely to scale back should climb substantially further as such investment somewhat, especially businesses press ahead with new as they perceive a moderation in sales investment in the latest technologies, increases. encouraged in part by ongoing price The Federal Reserve policymakers' declines. With labor markets tight, forecasts of the average unemploy firms continue to see capital invest ment rate in the fourth quarter of 1998 ment as the key in efforts to increase are mostly around 4¾ percent. The efficiency and maintain competitive persistence for another year of this ness. Internally generated funds degree of tightness in the labor market remain adequate to cover the bulk means that firms will likely continue of businesses' investment outlays, to face difficulties in finding workers Economic Projections for 1998 Percent Federal Reserve Governors and Reserve Bank Presidents Administration Central Indicator Range tendency Change, Nominal GDP 31/2-5 3¾-4½ 4.0 fourth quarter to fourth RealGDP2 1¾-3 2-2¾ 2.0 quarter:1 Consumer price index 3 11/2-2½ 1¾-2¼ 2.2 Average level, Civilian unemployment rate 41/2-5 about4¾ 5.0 fourth quarter: 1. Change from average for fourth quarter of 2. Chain-weighted. 1997 to average for fourth quarter of 1998. 3. All urban consumers. Digitized for FRASER https://fraser.stlouisfed.org 18 Federal Reserve Bank of St. Louis and that hiring and retaining workers Ample supplies and the prospect of could become more costly. Indeed, softer global demand have been there are indications that wage depressing the prices of many other inflation picked up further at the end commodities, both in agriculture and of last year. Improvements in labor in industry. Perhaps most important, productivity have become more as the low level of inflation that has sizable in the past couple of years, prevailed in recent years gets built into and if such gains can be extended, wage agreements, other contracts, and wage increases of the magnitude of individuals' inflation expectations, it those of 1997 need not translate into will provide an inertial force helping greater price inflation. The more rapid sustain the favorable price perfor growth in productivity is consistent mance for a time. with the high level of capital invest Although many of the factors ment in recent years, but the extent currently placing restraint on inflation to which the trend in productivity has are not necessarily long lasting, the picked up is still uncertain. Further Committee judged that their effect more, if momentum in nominal wages in 1998 would about offset the continues to build, the pay increases pressures from tight labor markets. will eventually squeeze profit margins Consequently, the Board members and place upward pressures on prices, and Reserve Bank presidents antici even with exceptional productivity pate that the rate of price inflation will gains. The strains in labor markets change little this year. Again in 1998, therefore constitute an ongoing the FOMC will be monitoring a variety inflationary risk that will have to be of price measures in addition to the monitored closely. CPI for indications of changes in In the near term, however, there are inflation and will be assessing move several factors that should lessen the ments in the CPI in the context of risk of a step-up in inflation. Manufac ongoing technical improvements turing capacity remains ample, and by the Bureau of Labor Statistics that bottlenecks are not hampering are likely to damp the reported 1998 production. The recent appreciation rise in that index. of the dollar should damp inflation both because of falling import prices Money and Debt Ranges for 1998 and because the added competition In establishing the ranges for growth from imports may induce domestic of broad measures of money over producers to hold down prices. Oil 1998, the Committee recognized prices have weakened considerably the considerable uncertainty that since the latter part of 1997 in response still exists about the behavior to abundant supplies, the softening of the velocities of these aggregates. of demand in Asia, and a mild winter. Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 19 The velocity of M3 (the ratio of The relationship of M2 to spending nominal GDP to the monetary aggre in recent years has come back more gate) in particular has proved difficult into line with historical patterns in to predict. Last year, the growth which the velocity of M2 tended to be of this aggregate relative to spending fairly constant, except for the effects of was affected by the rapid increase the changing opportunity cost of in depository credit and by the way M2-the spread between yields that in which that increase was funded, savers could earn holding short-term as well as by the changing cash market instruments and those that management practices of corporations, they could earn holding M2. In the which have been using the services early 1990s, M2 velocity departed from of institution-only money funds in M3. this pattern, rising substantially and These factors boosted M3 growth last atypically. Even after the unusual shift year to 8¾ percent, 3 percentage of the early 1990s died out, M2 points faster than nominal GDP-an velocity continued to drift somewhat unusually large decline in M3 velocity. higher from 1994 into 1997. That drift Going forward, it seems likely that M3 probably reflected some continued, growth will continue to be buoyed by albeit more moderate, redirection of robust credit growth at depositories savings into bond and equity markets, and continuing shifts in cash manage especially through the purchase of ment. Thus, its velocity is likely to mutual funds. However, last year decline further, though the amount the drift abated. There was little of decline is difficult to predict. change, on balance, in the opportunity cost of holding M2, and M2 velocity Ranges for Growth of Monetary and also was about unchanged, as M2 Debt Aggregates grew 5½ percent, nearly the same as Percent nominal GDP. Nevertheless, the upward drift could resume in the Aggregate 1996 1997 1998 years ahead as financial innovations or perceptions of attractive returns lead M2 1-5 1-5 1-5 households to further shift their savings away from M2 balances. M3 2--6 2--6 2--6 Or velocity might be pushed down ward if volatility or setbacks in bond Debt 3--7 3--7 3--7 and stock markets were to lead investors to seek the safety of M2 Note. Change from average for fourth quarter assets, which have stable principal. of preceding year to average for fourth quarter of year indicated. Digitized for FRASER https://fraser.stlouisfed.org 20 Federal Reserve Bank of St. Louis In light of the uncertainties about Debt of the nonfinancial sectors the behavior of velocities, the Commit grew 4¾ percent in 1997, near the tee followed its practice of recent years middle of the range of 3 percent to and established the ranges for 1998 not 7 percent established by the Commit as expectations for actual money tee last February. As with the mone growth, but rather as benchmarks for tary aggregates, the Committee has left M2 and M3 behavior that would be the range for debt unchanged for 1998. consistent with sustained price The range it has chosen encompasses stability, assuming velocity change the likely growth of debt given in line with pre-1990 historical Committee members' forecasts of experience. Thus, the ranges for nominal GDP. Except for the 1980s, fourth-quarter to fourth-quarter the growth of debt has tended growth are unchanged from those to be reasonably in line with the in 1997: 1 percent to 5 percent for M2, growth of nominal GDP. and 2 percent to 6 percent for M3. Although the ranges for money and Given the central tendency of the debt are not set as targets for monetary Committee's forecast for growth policy in 1998, the behavior of these of nominal GDP of 3¾ percent to variables, interpreted care.fully, can 4½ percent, M2 is likely to be in the at times provide useful information range, perhaps in the upper half, if about the economy and the workings short-term interest rates do not change of the financial markets. The Commit much and velocity continues recent tee will continue to monitor the patterns. For M3, however, a continua movements of money and debt tion ofrecent velocity behavior could along with a wide variety of other imply growth around the upper end financial and economic indicators- of, if not above, the price-stability to inform its policy deliberations. range. Digitized for FRASER https://fraser.stlouisfed.org 21 Federal Reserve Bank of St. Louis Growth of Money and Debt Percent Domestic Period Ml M2 M3 nonfinancial debt Annual1 1987 6.3 4.2 5.8 9.9 1988 4.3 5.7 6.3 8.9 1989 .5 5.2 4.0 7.8 1990 4.2 4.1 1.8 6.8 1991 7.9 3.1 1.2 4.5 1992 14.4 1.8 .6 4.7 1993 10.6 1.3 1.1 5.1 1994 2.5 .6 1.7 5.1 1995 -1.6 3.9 6.1 5.4 1996 -4.5 4.6 6.9 5.2 1997 -1.2 5.6 8.7 4.7 1997 Ql -1.4 5.1 8.0 4.3 Quarterly (annual rate)2 Q2 -4.5 4.4 7.7 4.7 Q3 .3 5.4 8.1 4.1 Q4 .8 6.8 9.8 5.2 Note. Ml consists of currency, travelers of the outstanding credit market debt of the U.S. checks, demand deposits, and other checkable government, state and local governments, deposits. M2 consists of Ml plus savings households and nonprofit organizations, deposits (including money market deposit nonfinancial businesses, and farms. accounts), small-denomination time deposits, 1. From average for fourth quarter of preced- and balances in retail money market funds. ing year to average for fourth quarter of year M3 consists of M2 plus large-denomination time indicated. deposits, balances in institutional money market 2. From average for preceding quarter to funds, RP liabilities (overnight and term), and average for quarter indicated. Eurodollars (overnight and term). Debt consists FRBl-46000--0298 Digitized for FRASER https://fraser.stlouisfed.org 22 Federal Reserve Bank of St. Louis

Federal Reserve (1998, February 23). Monetary Policy Report. Monetary Policy Reports, Federal Reserve. https://whenthefedspeaks.com/doc/monetary_policy_report_19980224

@misc{wtfs_monetary_policy_report_19980224,
  author = {Federal Reserve},
  title = {Monetary Policy Report},
  year = {1998},
  month = {Feb},
  howpublished = {Monetary Policy Reports, Federal Reserve},
  url = {https://whenthefedspeaks.com/doc/monetary_policy_report_19980224},
  note = {Retrieved via When the Fed Speaks corpus}
}