Monetary Policy Report

MONETARY y p 0 L I C OBJECTIVES A Summary Report of the Federal Reserve Board February 23, 1999 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis MONETARY p y 0 L I C OBJECTIVES This Executive Summary provides highlights of the Board's Report to Congress on the Full Employment and Balanced Growth Act of 1978 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Contents Section Page Testimony of Alan Greenspan Chairman, Federal Reserve Board 1 Recent Developments 2 The Economic Outlook 5 Ranges for Money and Credit 9 The FOMC' s Disclosure Policy 11 Year 2000 Issues 11 Concluding Comment 12 Monetary Policy and the Economic Outlook 13 Monetary Policy, Financial Markets, and the Economy over 1998 and Early 1999 17 Economic Projections for 1999 21 Money and Debt Ranges for 1999 24 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 Can this favorable performance be sustained? In many respects the of the Committee, I appreciate fundamental underpinnings of the the opportunity to present the recent U.S. economic performance are strong. Flexible markets and the shift Federal Reserve' s semiannual to surplus on the books of the federal report on monetary policy. government are facilitating the build-up in cutting-edge capital stock. That build-up in turn is spawning rapid advances in productivity that are The U.S. economy over the past year helping to keep inflation well behaved. again performed admirably. Despite The new technologies and the opti the challenges presented by severe mism of consumers and investors are economic downturns in a number of supporting asset prices and sustaining foreign countries and episodic spending. financial turmoil abroad and at home, But, after eight years of economic our real GDP grew about 4 percent for expansion, the economy appears a third straight year. In 1998, 2¾ mil stretched in a number of dimensions, lion jobs were created on net, bringing implying considerable upside and the total increase in payrolls to more downside risks to the economic than 18 million during the current outlook. The robust increase of economic expansion, which late last production has been using up our year became the longest in U.S. nation's spare labor resources, peacetime history. Unemployment suggesting that recent strong growth edged down further to a 4¼ percent in spending cannot continue without a rate, the lowest since 1970. pickup in inflation unless labor And despite taut labor markets, productivity growth increases signifi inflation also fell to its lowest rate in cantly further. Equity prices are high many decades by some broad mea enough to raise questions about sures, although a portion of this whether shares are overvalued. The decline owed to decreases in oil, debt of the household and business commodity, and other import prices sectors has mounted, as has the that are unlikely to be repeated. external debt of the country as a Hourly labor compensation adjusted whole, reflecting the deepening for inflation posted further impressive current account deficit. We remain gains. Real compensation gains have vulnerable to rapidly changing condi been supported by robust advances in tions overseas, which, as we saw last labor productivity, which in turn have summer, can be transmitted to U.S. partly reflected heavy investment in markets quickly and traumatically. I plant and equipment, often embody will be commenting on many of these ing innovative technologies. issues as I review the developments of Digitized for FRASER 1 https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis the past year and the prospects going budget. Burgeoning receipts, along forward. In light of all these risks, with continuing restraint on federal monetary policy must be ready to spending, produced the first unified move quickly in either direction budget surplus in thirty years, should we perceive imbalances and allowing the Treasury to begin to pay distortions developing that could down the federal debt held by the undermine the econqmic expansion. public. This shift in the federal government's fiscal position has fostered an increase in overall national saving as a share of GDP to 17¼ per Recent Developments cent from the 14½ percent low reached A hallmark of our economic perfor in 1993. This rise in national saving has mance over the past year was the helped to hold down real interest rates continuing sharp expansion of and to facilitate the financing of the business investment spending. boom in private investment spending. Competitive global markets and Foreign savers have provided an persisting technological advances both additional source of funds for vigorous spurred the business drive to become domestic investment. The counterpart more efficient and induced the price of our high and rising current account declines for many types of new deficit has been ever-faster increases in equipment that made capital spending the net indebtedness of U.S. residents more attractive. to foreigners. The rapid widening of Business success in enhancing the current account deficit has some productivity and the expectation of disquieting aspects, especially when still further, perhaps accelerated, viewed in a longer-term context. advances buoyed public optimism Foreigners presumably will not want about profit prospects, which contrib to raise indefinitely the share of their uted to another sizable boost in equity portfolios in claims on the United prices. Rising household wealth along States. Should the sustainability of the with strong growth in real income, buildup of our foreign indebtedness related to better pay, slower inflation, come into question, the exchange and expanding job opportunities, value of the dollar may well decline, boosted consumption at the fastest clip imparting pressures on prices in the in a decade and a half. The gains in United States. income and wealth last year, along In the recent economic environment, with a further decrease in mortgage however, the widening of the trade rates, also prompted considerable and current account deficits had some activity in the housing sector. beneficial aspects. It provided a safety The impressive performance of the valve for strong U.S. domestic private sector was reflected in a demand, thereby helping to restrain continued improvement in the federal pressures on U.S. resources. It also Digitized for FRASER 2 https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis cushiorted, to some extent, economic tions. In August, the FOMC returned weakness in our trading partners. to an unbiased policy predilection in Moreover, decreasing import prices, response to the adverse implications which partly came from the apprecia for the U.S. outlook of worsening tion of the dollar through midsummer, conditions in foreign economies and in corttributed to low overall U.S. global financial markets, including our inflation, as did ample manufacturing own. capacity in the Urtited States and Shortly thereafter, a further deterio lower prices for oil and other com ration in financial market conditions modities stemming from the weak began to pose a more serious threat to activity abroad. The marked drop in economic stability. In the wake of the energy prices significantly contributed Russian crisis artd subsequent difficul to the subdued, less than 1 percertt, ties in other emerging-market econo increase in the price index for total mies, investors perceived that the personal consumption expenditures uncertainties in financial markets had during 1998. In addition, supported by broadened appreciably and as a rapid accumulation of more efficient consequence they became decidedly capital, the growth of labor productiv more risk averse. Safe-haven demands ity picked up last year, allowing for U.S. Treasury securities intensified nomirtal labor compensation to post at the expense of private debt securi another sizable gain without putting ties. As a result, quality spreads added upward pressure on costs and escalated dramatically, especially for prices. I shall return to art analysis of lower-rated issuers. Many financial the extraordinary performartce of markets turned illiquid, with wider inflation later in my remarks. bid-asked spreads and heightened The Federal Open Market Commit price volatility, and issuance was tee conducted monetary policy last disrupted in some private securities year with the aim of sustaining the markets. Even the liquidity in the remarkable combination of economic market for seasoned issues of U.S. expansion and low inflation. At its Treasury securities dried up, as meetings from March to July, the investors shifted toward the more inflation risks accompanying the actively traded, recently issued continued strength of domestic securities and dealers pared inven demand and the tightening of labor tories, fearing that heightened price markets necessitated that the FOMC volatility posed an unacceptable risk place itself on heightened inflation to their capital. alert. Although the FOMC kept the Responding to losses in foreign nominal federal funds rate unchanged, financial markets and to pressures it allowed the real funds rate to rise from counterparties, highly leveraged with continuing declines in inflation investors began to unwind their and, presumably, inflation expecta- positions, which further weighed on Digitized for FRASER 3 https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis market conditions. As e:redit became • markets :remain ,exceptionally-tight • less available to business borrowers in and the economy evidently retains a capital markets, their:demandswere· great deal of underlying momentum redirected to commercial banks, which despite the global economic problems reacted to the enlarged borrowing,: and and the-still-visible remnants of the more uncertain business prospects; by earlier financial turmoil' in :the United r tightening their standards and terms · • States.; At the same time, no evidence, ' on such lending'. : , of any upturn in inflatiowhas, as yet, To cushion the -domestic economy1 surfaced. •. from the impact of the 'increasing Abroad, the situation is mixed. In weakness in foreign. economies and · • some East Asian countries that, in the less·a ccommodative conditions· in recent, years, experienced a loss of : U.S . .financial markets, the.•FOMC, investor confidertce; a severe currency beginning in-late-September, under- •• depreciation, artd a deep recession, took three policy easin.gs. By mid early signs of stabilization and eco November; the FOMChad reduced-the nomic recovery have·appeared. This federal funds rate from 5½ perc:ent-to is particularly the-case for Korea and 43/4percen.t. These actions were taken Thailand: Authorities in those coun to rebalance the risks· tOit he outlook, tries, in the context of IMF stabilization and, in the event the .markets have programs, early-on established 1 recovered appreciably: Our economy appropriate macroeconomic policies has weathered the disturbances with· and undertook significant-structural· remarkable resilience, though some reforms to buttress the banking system yield and bid-asked spreads still • • • and repair the firiances of the corpo- • reflect a hesitancy ion the-part' of- • rate sector.-As-investor confidence marker participants:to-take :On risk, has rerumed, :exchange rates have • : The Federal~Reserve mu-st eontinue • risen-and interest rates:have fallen. to evaluate, among other issues, •• ., d: With persistence and follow-through. whether the fl!l1ll·extent of thepolicy .-'. on reforms, the fotute ofl,those. easings undertaken last faU to addtes-s economies has p'tomise; : ·; ,·, ,,.- :· the seizing-up of ;fin.a:ncraf niarkets The· sifua tidrts: itl some other · , •• •; • .- r· remains appropda:te.-as tltcdse di$fur .. • .: emerging market ~fconomies are riot as: bances-abate. • encouragirt:g.;The Russian :govern-· -•:·, • To date, domestic ctefoartd-and•- , ,· 1• ment:.s.decision in,.mid:..August:to hence employment and-0utpµt have· susp~nd payment1- 0n its domestic ·:.; ·: remained vigorous. Real:GDP-'is•·•.,•· .. • ' debt'and devalue th'e:ruble took • ,. 1 estimated ,to h~ve risen at art ann,uaF mark{its:by-sutprise:-Irivestor Jlight -· ... ,:, rate exceeding 5½ percenfiiJ.Ythe'~,, •• · •• exaterbated the'.coUapse.of •}!'rides· in·· ·' • ' fourth 0 quarter'oflastyt!'at."Although J• ~ Russian-finandai'.markets and led.-t-o-a, some sloWlhgafrom this' to.trid,p ace.,isr:: sharp; tl-epreciation of. th~,rubH~5T he'·· .. , most likely in,the 'first quarter:, labo~<,. ~ earlie-t .d~cline inobtput,.gathered: :; 1:. Digitized for FRASER 4 https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis momentum, and by late in the year those positions or allow them to run inflation had moved up to a triple off. With the net exposure smaller, and digit annual rate. Russia's stabilization increasingly held by those who both program with the IMF has been on recognized the heightened risk and hold since the financial crisis hit, and were willing to bear it, some of the the economic outlook there remains elements that might have contributed troubling. to further contagion may have been The Russian financial crisis immedi significantly reduced. ately spilled over to some other countries, hitting Latin America The Economic Outlook especially hard: Countering down ward pressure on the exchange values These recent domestic and interna of the affected currencies, interest rates tional developments provide the moved sharply higher, especially in backdrop for U.S. economic prospects. Brazil. As a consequence of the high Our economy's performance should interest rates and growing economic remain solid this year, though likely uncertainty, Brazil's economic activity with a slower pace of economic took a turn for the worse. Higher expansion and a slightly higher rate interest rates also had negative of overall inflation than last year. The consequences for the fiscal outlook, as stocks of business equipment, housing, much of Brazil's substantial domestic and household durable goods have debt effectively carries floating interest been growing rapidly to quite high rates. With budget reform legislation levels relative to business sales or encountering various setbacks, market household incomes during the past confidence waned further and capital few years, and some slowing in the outflows from Brazil continued, draw growth of spending on these items ing down foreign currency reserves. seems a reasonable prospect. More Ultimately, the decision was taken to over, part of the rapid increase in allow the real to float, and it subse spending, especially in the household quently depreciated sharply. sector, has resulted from the surge in Brazilian authorities must walk a wealth associated with a run-up in very narrow, difficult path of restoring equity prices that is unlikely to be confidence and keeping inflation repeated. And the purchasing power contained with monetary policy while of income and wealth has been dealing with serious fiscal imbalances. enhanced by declines in oil and other Although the situation in Brazil import prices, which also are unlikely remains uncertain, there has been to recur this year. Assuming that limited contagion to other countries aggregate demand decelerates, thus far. Apparently, the slow onset of underlying inflation pressures, as the crisis has enabled many parties captured by core price measures, in with Brazilian exposures to hedge all likelihood will not intensify Digitized for FRASER 5 https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis significantly in the year ahead, among manufacturers, could weaken though the Federal Reserve will need appreciably if pressures on domestic to monitor developments carefully. profit margins mount and capacity We perceive stable prices as optimum utilization drops further. And it for economic growth. Both inflation remains to be seen whether corporate and deflation raise volatility and risks earnings will disappoint investors, that thwart maximum economic even if the slowing of economic growth. growth is only moderate. Investors Most Governors and Reserve Bank appear to have incorporated into Presidents foresee that economic current equity price levels both robust growth this year will slow to a 2½ to profit expectations and low compensa 3 percent rate. Such growth would tion for risk. As the economy slows to keep the unemployment rate about a more sustainable pace as expected, unchanged. The central tendency of profit forecasts could be pared back, the Governors' and Presidents' which together with a greater sense predictions of CPI inflation is 2 to of vulnerability in business prospects 2½ percent. This level represents a could damp appetites for equities. A pickup from last year, when energy downward correction to stock prices, prices were falling, but it is in the and an associated increase in the cost vicinity of core CPI inflation over the of equity capital, could compound a last couple of years. slowdown in the growth of capital This outlook involves several spending. In addition, a stock market risks. The continuing downside risk decline would tend to restrain con posed by possible economic and sumption spending through its effect financial instability around the on household net worth. world was highlighted earlier But on the upside, our economy has this year by the events in Brazil. proved surprisingly robust in recent Although financial contagion else years. More rapid increases in capital where has been limited to date, more spending, productivity, real wag€s, significant knock-on effects in financial and asset prices have combined to markets and in the economies of boost economic growth far more and Brazil's important trading partners, far longer than many of us would have including the United States, are still anticipated. possible. Moreover, the economies of This "virtuous cycle" has been able several of our key industrial trading to persist because the behavior of partners have shown evidence of inflation also has been surprisingly weakness, which if it deepens could favorable, remaining well contained at further depress demands for our levels of utilization of labor that in the exports. past would have produced accelerat Another downside risk is that ing prices. That it has not done so in growth in capital spending, especially recent years has been the result of a 6 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis combination of special one-time through 1996, it does not appear that a factors holding down prices and further heightening of worker insecu more lasting changes in the processes rity about employment prospects can determining inflation. explain the more recent improved Among the temporary factors, the behavior of inflation. sizable declines in the prices of oil, Instead, a variety of evidence, other internationally traded commodi anecdotal and otherwise, suggests that ties, and other imports contributed the source of recent restrained inflation directly to holding down inflation last may be emanating more from employ year, and also indirectly by reducing ers than from employees. In the inflation expectations. But these prices current economic setting, businesses are not likely to fall further, and they sense that they have lost pricing power could begin to rise as some Asian and generally have been unwilling economies revive and the effects of to raise wages any faster than they the net depreciation of the dollar since can support at current price levels. midsummer are felt more strongly. Firms have evidently concluded At the same time, however, recent that if they try to increase their experience does seem to suggest that prices, their competitors will not the economy has become less inflation follow, and they will lose market prone than in the past, so that the share and profits. chances of an inflationary breakout Given the loss of pricing power, arguably are, at least for now, less it is not surprising that individual than they would have been under employers resist pay increases. But similar conditions in earlier cycles. why has pricing power of late been so Several years ago I suggested that delimited? Monetary policy certainly worker insecurity might be an impor has played a role in constraining the tant reason for unusually damped rise in the general level of prices and inflation. From the early 1990s through damping inflation expectations over 1996, survey results indicated that the 1980s and 1990s. But our current workers were becoming much more discretionary monetary policy has concerned about being laid off. difficulty anchoring the price level Workers' underlying fear of over time in the same way that the technology-driven job obsolescence, gold standard did in the last century. and hence willingness to stress job Enhanced opportunities for produc security over wage increases, appeared tive capital investment to hold down to have suppressed labor cost pres costs also may have helped to damp sures despite a reduced unemploy inflation. Through the 1970s and 1980s, ment rate. More recently, that effect firms apparently found it easier and seems to have diminished in part. So more profitable to seek relief from while job loss fears probably contrib rising nominal labor costs through uted to wage and price suppression price increases than through cost- Digitized for FRASER 7 https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis reducing capital investments. Price industrial capacity faster than factl5'ty relief evidently has not been available output has risen. The resulting slack in in recent years. But relief from cost product markets has put greater pressures has. The newer technologies competitive pressure on businesses to have made capital investment dis hold down prices, despite taut labor tinctly more profitable, enabling firms markets. to substitute capital for labor far more The role of technology in damping productively than they would have a inflation is manifest not only in its decade or two ago. effects on U.S. productivity and Starting in 1993, capital investment, costs, but also through international especially in high-tech equipment, rose trade, where technological develop sharply beyond normal cyclical ments have progressively broken experience, apparently the result of down barriers to cross-border expected increases in rates of return on trade. The enhanced competition the new investment. Had the profit in tradable goods has enabled expectations not been realized, one excess capacity previously bottled would have anticipated outlays to fall up in one country to augment back. Instead, their growth accelerated worldwide supply and exert restraint through the remainder of the decade. on prices in all countries' markets. The More direct evidence confirms resulting price discipline also has improved underlying profitability. constrained nominal wage gains in According to rough estimates, labor internationally tradable goods indus and capital productivity has risen tries. As workers have attempted to significantly during the past five years. shift to other sectors, gains in nominal It seems likely that the synergies of wages and increases in prices in advances in laser, fiber optic, satellite, nontradeable goods industries have and computer technologies with older been held down as well. technologies have enlarged the pool of The process of price containment opportunities to achieve a rate of has potentially become, to some return above the cost of capital. extent, self-reinforcing. Lower inflation Moreover, the newer technologies in recent years has altered expecta have facilitated a dramatic foreshort tions. Workers no longer believe that ening of the lead times on the delivery escalating gains in nominal wages are of capital equipment over the past needed to reap respectable increases in decade, presumably allowing busi real wages, and their remaining sense nesses to react more expeditiously to of job insecurity is reinforcing this. an actual or expected rise in nominal Since neither firms nor their competi compensation costs than, say, they tors can count any longer on a general could have in the 1980s. In addition, inflationary tendency to validate the surge in investment not only has decisions to raise their own prices, restrained costs, it has also increased each company feels compelled to Digitized for FRASER 8 https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis concentrate on efforts to hold down ing pressure on labor markets and on costs. The availability of new technol costs. ogy to each company and its rivals The number of people willing to affords both the opportunity and the work can be usefully defined as the competitive necessity of taking steps unemployed component of the labor to boost productivity. force plus those not actively seeking It is difficult to judge whether these work, and thus not counted in the significant shifts in the market labor force, but who nonetheless say environment in which firms function they would like a job if they could get are sufficient to account for our benign one. This pool of potential workers overall price behavior during the past aged 16 to 64 currently numbers about half decade. Undoubtedly, other 10 million, or just 5¾ percent of that factors have been at work as well, group's population-the lowest such including those temporary factors I percentage on record, which begins in mentioned earlier and some more 1970, and 2½ percentage points below lasting I have not discussed, such as its average over that period. The rapid worldwide deregulation and privatiza increase in aggregate demand has tion, and the freeing-up of resources generated growth of employment in previously employed to produce excess of growth in population, military products that was brought causing the number of potential about by the end of the cold war. workers to fall since the mid-1990s There also may be other contributory at a rate of a bit under 1 million forces lurking unseen in the wings that annually. We cannot judge with will only become clear in time. Over precision how much further this level the longer run, of course, the actions of can decline without sparking ever the central bank determine the degree greater upward pressures on wages of overall liquidity and hence rate of and prices. But, should labor market inflation. It is up to us to validate the conditions continue to tighten, there favorable inflation developments of has to be some point at which the rise recent years. in nominal wages will start increas Although the pace of productivity ingly outpacing the gains in labor increase has picked up in recent years, productivity, and prices inevitably the extraordinary strength of demand will begin to accelerate. has meant that the substitution of capital for labor has not prevented Ranges for Money and Credit us from rapidly depleting the pool of available workers. This worker At its February meeting, the Commit depletion constitutes a critical upside tee elected to ratify the provisional risk to the inflation outlook because it ranges for all three aggregates that it presumably cannot continue for very had established last July. Specifically, much longer without putting increas- the Committee again has set growth Digitized for FRASER 9 https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis rate ranges over the four quarters of growth late in the year partly reflected 1999 of 1 to 5 percent for M2, 2 to a reaction to this turmoil by the public, 6 percent for M3, and 3 to 7 percent who began scrambling for safer and for domestic nonfinancial debt. As more liquid financial assets. Monetary in previous years, the Committee expansion has moderated so far this interpreted the ranges for the broader year, evidently in lagged response to monetary aggregates as benchmarks the calming of financial markets in the for what money growth would be autumn. Layered on top of these under conditions of price stability and influences, though, the public also may sustainable economic growth, assum have been reapportioning their savings ing historically typical velocity flows into money balances because the behavior. huge run-up in stock prices in recent Last year, these monetary aggre years has resulted in an uncomfortable gates far overshot the upper bounds portion of their net worth in equity. of their annual ranges. While nominal For the coming year, the broad GDP growth did exceed the rate monetary aggregates could again likely consistent with sustained price run high relative to these ranges. To be stability, the rapid growth of M2 sure, the decline in the velocities of the and M3 also reflected outsized declines broader aggregates this year should in their velocities, that is, the ratio of abate to some extent, as money nominal GDP to money. M2 velocity demand behavior returns more to dropped by about 3 percent, while M3 normal, and growth in nominal GDP velocity plunged by 5¼ percent. should slow a? well, as suggested by Part of these velocity declines the Governors' and Presidents' central reflected some reduction in the tendency. Both factors would restrain opportunity cost of holding money; broad money expansion relative to interest rates on Treasury securities, last year. Still, the growth of M2 and which represent an alternative return M3 could well remain outside their on non-monetary assets, dropped price-stability ranges this year. more than did the average of interest Obviously, considerable uncertainty rates on deposits and money market continues to surround the prospective mutual funds in M2, drawing funds behavior of monetary velocities and into the aggregate. Even so, much of growth rates. last year's aberrant behavior of broad Domestic nonfinancial debt seems money velocity cannot readily be more likely than the monetary explained by conventional determi aggregates to grow within its range nants. Although growth of the broad for this year. Indeed, domestic aggregates was strong earlier in the nonfinancial debt also could grow year, it accelerated in the fourth more slowly this year than last year's quarter after credit markets became 6¼ percent pace, which was in the turbulent. Perhaps robust money upper part of its 3 to 7 percent annual Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis range. With the federal budget surplus after every change in the tilt of the poised to widen further this year, directive. Instead, this option would federal debt should contract even be reserved for situations in which more quickly than last year. And debt the consensus of the Committee clearly in each of the major nonfederal sectors had shifted significantly, though not in all likelihood will decelerate as well by enough to change current policy, from last year's relatively elevated and in which the absence of an rates, along with the projected slowing explanation risked misleading markets of nominal GDP growth. about the prospects for monetary policy. The FOMC's Disclosure Policy Year 2000 Issues The FOMC at recent meetings has discussed not only the stance of Before closing, I'd like to address an policy, but also when and how it issue that has been receiving increas communicates its views of the evolv ing attention-the century date ing economic situation to the pub- change. While no one can say that the lic. The FOMC's objective is to release rollover to the year 2000 will be as much information about monetary trouble free, I am impressed policy decisionmaking, and as by the efforts to date to address the promptly, as is consistent with problem in the banking and financial maintaining an effective deliberative system. For our part, the Federal process and avoiding roiling markets Reserve System has now completed unnecessarily. Since early 1994, each remediation and testing of 101 of its change in the target nominal federal 103 mission-critical applications, with funds rate has been announced the remaining two to be replaced by immediately with a brief rationale for the end of March. We opened a test the action. The FOMC resolved at its facility in June at which more than December meeting to take advantage 6,000 depository institutions to date of an available, but unused policy, have conducted tests of their Y2K originally stated in early 1995, of compliant systems, and we are well releasing, on an infrequent basis, a along in our risk mitigation and statement immediately after some contingency planning activities. As FOMC meetings at which the stance of a precautionary measure, the Federal monetary policy has not been changed. Reserve has acted to increase the The Federal Reserve will release such a currency in inventory by about statement when it wishes to communi one-third to approximately $200 bil cate to the public a major shift in its lion in late 1999 and has other contin views about the balance of risks or the gency arrangements available if likely direction of future policy. Such needed. While we do not expect an announcement need not be made currency demand to increase dramati- Digitized for FRASER 11 https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis cally, the Federal Reserve believes it Concluding Comment is important for the public to have A~ericans can justifiably feel proud of confidence in the availability of cash their recent economic achievements. in advance of the rollover. As a result Competitive markets, with open trade of these kinds of activities, I can say both domestically and internationally, with assurance that the Federal have kept our production efficient and Reserve will be ready in both its on the expanding frontier of techno operations and planning activities logical innovation. The determination for the millennium rollover. of Americans to improve their skills The banking ind us try is also and knowledge has allowed workers working hard, and with evident suc to ~e even more productive, elevating cess, to prepare for the event. By the their real earnings. Macroeconomic end of the first quarter, every institu policies have provided a favorable tion in the industry will have been setting for the public to take greatest subject to two rounds of on-site Y2K advantage of opportunities to improve examinations. The Federal Reserve its economic well being. The restrained like the other regulators, has found fiscal policy of the Administration and that only a small minority of institu the Congress has engendered the tions has fallen behind in their welcome advent of a unified budget preparations, and those institutions ~urplus, freeing up funds for capital have been targeted for additional mvestment. A continuation of respon follow-up and, as necessary, formal sibl_e _fiscal and, we trust, monetary enforcement actions. The overwhelm policies should afford Americans the ing majority of the industry has made opportunity to make considerable impressive progress in their remedia further economic progress over time. tion, testing, and contingency planning efforts. 12 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Monetary Policy and the Economic Outlook In 1998, the U.S. economy again Change in Payroll Employment performed impressively. Output Thousands of jobs, monthly average expanded rapidly, the unemployment rate fell to the lowest level since 1970, Total nonfarm and inflation remained subdued. Transitory factors, most recently -------------- 400 falling prices for imports and com modities, especially oil, have helped to produce the favorable outcomes of recent years, but technological advances and increased efficiency, + likely reflecting in part heightened _......._~.....---,........_. ....... ____._....__. .......- --"""...___......_.........,.~ 0 global competition and changes in business practices, suggest that some of the improvement will be more lasting. 1990 1992 1994 1996 1998 Change in Real GDP restraint at the federal level has Percent, annual rate bolstered national saving and permit ---------------- ted the Federal Reserve to maintain lower interest rates than would otherwise have been possible. This -----------==----ii!+- 4 policy mix and sustained progress toward price stability have fostered clearer price signals, more efficient 2 resource use, robust business invest ment, and sizable advances in the + productivity of labor and in the real Q wages of workers. The more rapid expansion of productive potential has, in turn, helped to keep inflation low even as aggregate demand has been 1992 1994 1996 1998 surging and as labor markets have Note. In this chart and in subsequent charts that show the components of real GDP, changes are tightened. measured to the final quarter of the period indi This past year, economic troubles cated, from the final quarter of the previous period. Last data point is from the advance GDP report for abroad posed a significant threat 1998:Q4. to the performance of the economy. Foreign economic growth slowed Sound fiscal and monetary policies markedly, on average, as conditions in have contributed importantly to the many countries deteriorated. The good economic results: Budgetary recession in Japan deepened, and Digitized for FRASER 13 https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis several emerging market economies in industrial countries and international Asia, which had started to weaken in efforts to provide support to troubled the wake of the financial crises of 1997, emerging market economies. Although contracted sharply. A worsening some U.S. financial flows were economic situation in Russia last disrupted for a time, most firms summer led to a devaluation of the and households remained able to ruble and a moratorium by that obtain sufficient credit, and the country on a substantial portion of its turbulence did not appear to con debt payments. As the year pro strain spending to a significant degree. gressed, conditions in Latin America More recently, some markets were also weakened. Although some of the unsettled by the devaluation and troubled foreign economies are subsequent floating of the Brazilian showing signs of improvement, others real in mid-January, and the problems either are not yet in recovery or are in Brazil continue to pose risks to still contracting. global markets. Thus far, however, The Russian crisis in mid-August market reaction outside Brazil to that precipitated a period of unusual country's difficulties has been rela volatility in world financial markets. tively muted. The losses incurred in Russia and in The foreign exchange value of the other emerging market economies dollar rose substantially against the heightened investors' and lenders' currencies of the major foreign concerns about other potential industrial countries over the first eight problems and led them to become months of 1998, but subsequently it substantially more cautious about fell sharply, ending the year down a taking on risk. The resulting effects little on net. The appreciation of the on U.S. financial markets included a dollar in the first half of the year substantial widening of risk spreads carried it to an eight-year high against on debt instruments, a jump in the Japanese yen. In June, this strength measures of market uncertainty against the yen prompted the first U.S. and volatility, a drop in equity prices, foreign exchange intervention opera and a reduction in the liquidity of tion in nearly three years, an action many markets. To cushion the U.S. that appeared to slow the dollar's rise economy from the effects of these against the yen over the following financial strains, and potentially to days and weeks. Later in the summer, help reduce the strains as well, the concerns about the possible impact on Federal Reserve eased monetary policy the U.S. economy of increasing on three occasions in the fall. Global difficulties in Latin America began to financial market stresses lessened weigh on the dollar's exchange value somewhat after mid-autumn, reflect against major foreign currencies. After ing, in part, these policy steps peaking in mid-August, it fell sharply as well as interest rate cuts in other over the course of several weeks, Digitized for FRASER 14 https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Nominal Dollar Exchange Rate gested continued strength of economic Indexes activity in the United States. Since the Index, Marcl} 1973 = 100 end of 1998, the dollar has appreciated about 7 percent against the yen, partly reflecting further monetary easing in Japan. At the turn of the year, the launch of the third stage of European Economic and Monetary Union fixed the eleven participating countries' conversion rates and created a new common currency, the euro. The dollar has appreciated more than 5 percent against the euro, in part because of signs that growth has slowed recently in some euro-area economies. With the U.S. economy expanding 1994 1995 1996 1997 1998 1999 rapidly, the economies of many U.S. Note. The data are monthly. Indexes are trade trading partners struggling, and the weighted averages of the exchange value of the dollar against major currencies and against the foreign exchange value of the dollar currencies of a broad group of important U.S. having risen over 1997 and the first trading partners. Last observations are for the first three weeks of February 1999. part of 1998, the U.S. trade deficit widened considerably last year. Some domestic industries were especially reversing by mid-October the appreci ation that had occurred earlier in the Change in Real Imports and Exports year. The depreciation during this of Goods and Services period was particularly sharp against Percent, Q4 to Q4 the yen. The reasons for this decline against the yen are not clear, but D Imports - repayment of yen-denominated loans □ Exports - by international investors and - 12 - - decisions by Japanese investors to repatriate their assets in light of - 8 " increased volatility in global markets - seem to have contributed. The ~ 4 exchange value of the dollar fluctuated ,- f moderately against the major curren ~ + cies over the rest of the year, and after ' ' :% y ~ 0 declining somewhat early in 1999, it has rebounded strongly in recent weeks, as incoming data have sug- 1992 1994 1996 1998 Digitized for FRASER 15 https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis affected by reductions in foreign Deteriorating economic conditions demand or by increased competition abroad, coupled with the strength of from imports. For example, a wide the dollar over the first eight months range of commodity producers, of the year, helped to hold down notably those in agriculture, oil, and inflation in the United States by metals, experienced sharp price trimming the prices of oil and other declines. Parts of the manufacturing imports. These declines reduced both sector also suffered adverse conse the prices paid by consumers and quences from the shocks from abroad. the costs of production in many lines Overall, real net exports deteriorated of business, and the competition from sharply, as exports stagnated and abroad kept businesses from raising imports continued to surge. The prices as much as they might have deterioration was particularly marked otherwise. As the result of a reduced in the first half of the year; the second rate of price inflation, workers enjoyed half brought a further, more modest, a larger rise in real purchasing power net widening of the external deficit. even as increases in nominal hourly Meanwhile, domestic spending compensation picked up only slightly continued to advance rapidly. House on average. Because of increased gains hold expenditures were bolstered by in productivity, corporations in the gains in real income and a further rise aggregate were able to absorb the in wealth, while a low cost of capital larger real pay increases without and optimism about future profitabil suffering a serious diminution of ity spurred businesses to invest profitability. heavily in new capital equipment. Although securities markets were Change in Consumer Prices disrupted in late summer and early Percent, Q4 to Q4 fall, credit generally remained available from alternative sources. Once the strains on securities markets had eased, businesses and households generally had ready access to credit and other sources of finance on relatively favorable terms, although spreads in some markets remained quite elevated, especially for lower rated borrowers. All told, household and business outlays rose even more rapidly than in 1997, and that accelera tion kept the growth of real GDP 1990 1992 1994 1996 1998 strong even as net exports were Note. Consumer price index for all urban slumping. consumers. Digitized for FRASER 16 https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Monetary Policy, Financial of an excessive weakening of aggre Markets, and the Economy over gate demand. 1998 and Early 1999 Over the first seven months of the year, neither of these potential Monetary policy in 1998 needed to tendencies was sufficiently dominant balance two major risks to the eco to prompt a policy action by the nomic expansion. On the one hand, FOMC. Although the incoming data with the domestic economy displaying gave no evidence of a sustained considerable momentum and labor slowing of output growth, the Com markets tight, the Federal Open mittee members believed that the Market Committee (FOMC) was pace of expansion likely would concerned about the possible emer moderate as businesses began to slow gence of imbalances that would lead to the rapid rates at which they had been higher inflation and thereby, eventu adding to their stocks of inventories ally, put the sustainability of the and other investment goods, and as expansion at risk. On the other households trimmed the large hand, troubles in many foreign advances in their spending on con economies and resulting financial sumer durables and homes. Relatively turmoil both abroad and at home firm real interest rates, buoyed by a seemed, at times, to raise the risk high real federal funds rate resulting Selected Interest Rates Percent Five-year Treasury 7 6 - 5 \ Discount rate Intended federal funds rate 4 2/5 3/25 5/20 7/ 2 8/19 9/30 11/12 12/16 2/4 3/31 5/19 7/ 1 8/18 9/ 29 11 /17 12/22 2/3 10/15 1997 1998 1999 Note. The data are daily. Vertical lines indicate scheduled meeting or a policy action was the days on which the Federal Reserve announced a announced. Last observations are for February 19, monetary policy action. The dates on the horizontal 1999. axis are those on which either the FOMC held a Digitized for FRASER https://fraser.stlouisfed.org 17 Federal Reserve Bank of St. Louis Civilian Unemployment Rate producers. Nonetheless, with labor Percent markets already quite taut and aggre gate demand growing rapidly- a combination that often has signaled the impending buildup of inflationary --------------- 8 pressures-the Committee, at its meetings from March through July, judged conditions to be such that, if a -------::j,-.-----~------- 6 policy action were to be taken in the period immediately ahead, it more likely would be a tightening than an --------------- 4 easing; its directives to the Account Manager of the Domestic Trading Desk at the Federal Reserve Bank of New York noted that asymmetry. 1990 1992 1994 1996 1998 By the time of the August FOMC Note. The break in data at January 1994 marks meeting, however, the situation was the introduction of a redesigned survey; data from that point on are not directly comparable with those changing. Although tight labor of earlier periods. markets and rapid output growth from the decline in the level of continued to pose a risk of higher expected inflation, were thought likely inflation, the damping influence of to help restrain the growth of spend foreign economic developments on the ing by businesses and households. U.S. economy seemed likely to Another check on growth was increase. The contraction in the emerg expected to come from the effects on ing market economies in Asia imports and exports of the economic appeared to be deeper than had been difficulties in emerging market anticipated, and the economic situa economies in Asia and elsewhere. tion in Japan had deteriorated. Indeed, production in the manufactur Financial markets in some foreign ing sector slowed substantially in the economies also had experienced first half of the year, and capacity greater turmoil, and, the day before utilization dropped noticeably. the Committee met, Russia was forced Moreover, inflation remained sub to devalue the ruble. These difficulties dued, and a pickup was not expected had been weighing on U.S. asset in the near-to-intermediate term markets: Stock prices had fallen because of declining oil prices, and sharply in late July and into August as because of economic.weakness abroad investors became concerned about the and the appreciation of the dollar, outlook for profits, and risk spreads in which were expected to trim the prices debt markets had widened, albeit from of imported goods and to increase very low levels. Taking-account of price competition for many U.S. these circumstances, the Committee Digitized for FRASER 18 https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis again left monetary policy unchanged over those on comparable Treasury at the August meeting, but it shifted to instruments widened considerably a symmetric directive, reflecting its further, and issuance slowed sharply. perception that the risks to the Measures of market volatility economic outlook, at prevailing increased, and liquidity in many short-term rates, had become roughly financial markets was curtailed. Equity balanced. prices continued to slide lower, with most broad indexes falling back by Major Stock Price Indexes early September to near their levels at Index (January 2, 1998 = 100) the start of the year. Reflecting the weaker and more uncertain economic outlook, some banks boosted interest rate spreads and fees on new loans to businesses and tightened their underwriting standards. Against this backdrop, at its September meeting the FOMC looked Spreads of Corporate Bond Yields Over Treasury Security Yields Percentage points JFMAMJ JASONDJFMAMJJASONDJF 1997 1998 1999 Note. The data are daily. Last observations are for February 19, 1999. Over subsequent weeks, conditions in financial markets and the economic outlook in many foreign countries BBB deteriorated further, increasing the :r - dangers to the U.S. expansion. With - -------------.,C-.~=-___-_:i-ii=M~!•"' -~ 2 investors around the world apparently J reevaluating the risks associated with AA various credits and seemingly becom J F M A M J J A S O N D J F ing less willing or able to bear such 1998 1999 risks, asset demands shifted toward Note. The data are daily. The spread of high yield bonds compares the yield on the Merrill safer and more liquid instruments. Lynch Master II index with that on a seven-year These shifts ca used a sharp fall in Treasury; the other two spreads compare yields on the appropriate Merrill Lynch indexes with that on yields on Treasury securities. Spreads a ten-year Treasury. Last observations are for of yields on private debt securities February 19, 1999. 19 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis beyond incoming data suggesting that Greenspan and followed a conference the economy was continuing to call with Committee members. At the expand at a robust pace, and it same time, the Board of Governors lowered the intended level of the approved a ¼ percentage point federal funds rate ¼ percentage point. reduction in the discount rate. These The Committee noted that the rate cut actions were taken to buffer the would cushion the effects on prospec domestic economy from the impact of tive U.S. economic growth of increas the less accommodative conditions in ing weakness in foreign economies domestic financial markets, in part by and of less accommodative conditions contributing to some stabilization of in domestic financial markets. The the global financial situation. directive adopted at the meeting suggested a bias toward further Implied Volatilities easing over fhe intermeeting period. In Percent Percent the days following the policy move, disturbances in financial markets - worsened. Movements in the prices of 13 S&P 500 40 securities were exacerbated by a 12 35 deterioration in market liquidity, as some securities dealers cut back on 11 30 their market-making activities, and by the expected unwinding of positions 10 25 by hedge funds and other leveraged investors. In early October, Treasury 9 20 yields briefly tumbled to their lowest 8 15 levels in many years, reflecting efforts m - l;)ond by investors to exchange other instru ments for riskless and liquid Treasury J F 1999 securities. ote. The data are daily. Implied volatilities are Although some measures of market calculated from options prices. Last observations turbulence had begun to ease a bit by are for February 19, 1999. mid-October, financial markets remained extremely volatile and risk Following the October policy move, spreads were. very wide. On October strains in domestic financial markets 15, consistent with the directive from diminished considerably. As safe the September meeting, the intended haven demands for Treasury securities federal funds rate was trimmed ebbed, Treasury yields generally another ¼ percentage point, to trended higher, and measures of 5 percent. This policy move, which financial market volatility and illiquid occurred between FOMC meetings, ity eased. Nonetheless, risk spreads came at the initiative of Chairman remained very wide, and liquidity in 20 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis many markets continued to be limited. Yields on Treasury securities were Mo.reover, although pressures on some about flat, on balance, in January, as emerging market economies had the effect of stronger-than-expected receded a bit, partly reflecting con- economic growth appeared to be about certed international efforts.to provide offset by data suggesting-that inflation assistance to Brazil~ the foreign remained quiescent and perhaps also economic outlook remained uncertain. by the effects of some safe-haven flows With downside risks still substantial, prompted by. the -deteriorating and in light of the cumulative effect situation in Brazil. Over the same since August of the tightening in many period, stock prices surged higher, led sectors of the credit markets and the by computer and other technology weakening of economic activity shares, and most-stockprice indexes abroad, the FOMC reduced the posted new highs. By the time of the intended federal funds rate a further February 2-3 meeting, financial ¼ percentage point at its November markets were easily accommodating,· meeting, bringing the total reduction robust demands for credit, and · during-the autumn to ¾ percentage economic activity seemed to have- point The Board of Governors also more momentum than many had approved a second ¼ percentage point anticipated-. However, the foreign cut in the discount rate. The Commit-- sector continued to pose a threatto tee believed that, with this policy U.S. growth going forward, inflation action, financial conditions could showed nq_signs of picking up despite, reasonably be expected to be consis- the rapid pace' of growth 'anti the very' tent with fostering sustained economic tight labor market, and some slowing expansion whil_e keeping inflatiopary, _ of economic growth remained a likely pre_ssure~ subdued. The _$.ctjon , -~--. prospect. In these circumstances, the proyi4.~~--~Q!Ile i.J.tsµr.~r:i~e_c, 1-g9-i!}AUlIJ. . . ,f _QN,Ir ~PIJ.dud~d t}:l_aJ i.t,wa.s,..pru~_~µ_t ,~ 0.,_'_ unexpectedly severe weakening of the to wait for further information, and it expansion, and the Committee left policy unchanged. ~eref~• •e s- ta bl~ed a. S¥JllrnetriraL... •• ,.,.. •E coriomk'Prctectiori's fof1999' .. ,.. - d1rechv~. By the hme of .the December · J . , meeting, -the situation in financial By and large, the members of the markets had changed little, on balance, Board of Governors and the Federal' , . and the Committee decided that no Reserve Bank presidents,,all of whom· i.uuher....-eha.nge,Jn,,ra tes. .w .as.desir.abJe.~~.. . ., ..p..ar,ticiµ.a.te in..the"..deliberatiQ.GS .of...the,>le< and that the directive should remain FOMC, expect the economy to expand symmetrical. moderately, on average, in 1999. The · Some measures of financial volatility central tendency of the FOMC partici-• _$?a~~2-J1rrJb.~r.. ..m Jl}~,11e~ ~Y~~r,_,_,_,7,.W.,_.- ·= ~ an~~'.fpr_~..e,~~-Qf r~aL~P~ grp~ tlL .,., although risk spreads on corporate from the foµrth quarter of 1998 to bonds remained at quite high-levels. the fourth quarter of 1999 is 2½ percent Digitized for FRASER 21 https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis to 3 percent. The anticipated expah the Administration is projecting. sidn is expected to create enough new Present circumstances suggest that jobs to keep the civilian unemploy domestic demand could continue to ment rate near its recent average, in a ris~ briskly for a while longer. Con range of 4¼ percent to 4½ perteht, sumer spending continues td be driveh With tightness of the labor market by strong gains in employment, expeded to persist and oil and import increases in real incdrtles, and rising prices unlikely to be as weak in 1999 levels of wealth. Those same factors, as they were in 1998, inflation is together with low mortgage interest expected to move up somewhat from rates, are keeping hbusing activity the rate of this past year but to remairt robust. Businesses are still investing low by the standards of the past three heavily in new (apital, especially decades: The central tendency of the computers and other high. . tech FOMC participants' CPI infiatioh equipment. Households and busi fon;casts for 1999 is 2 percent to nesses appear willing to take ort more 2½ percent. The Federal Reserve debt in support of spending; although bfficials' inflation forecasts are closely spreads on corporate_ debt remain aligned with that of the Administra- elevated, rate levels are perceived to tion, and their forecasts of real GDP be attractive for most borrowers, and and unemployment depict a some. .. restraint on access to finance is not what strcmger real economy than much in evidence. Econmriic Projections for 1999 Percent Federal Reserve governors Jnd Reserve Bank presidents AdrtHnisttation Central Indicator Range tendency Change, Nominal GDP 3¾-5 4--4½ 4.0 fourth quarter to fourth Real GDP2 2-3½ 2½-3 2.0 quarter: 1 Consutner price index 3 1½-2½ 2-2½ 2.3 Average level, Civilian unemployment rate 4¼--4¾ 4¼--4½ 4.9 fourth quarter: 1. Change from average for fourth quarter of 2. Chain-weighted. 1998 to a-{.rerage for fourth quarter t>f 1999. 3. All urbJn cortsumets. Digitized for FRASER 22 https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis As the year progresses, however, the expected slowing of income gains in domestic spending should growth in the United States, and the begin to moderate. Spending increases possibility of a slight pickup in for housing, consumer durables, and economic growth abroad-provide a business equipment have been basis for thinking that this year's drop exceptionally large for a while now, in net exports might not be as large as substantially raising the rate of growth that of 1998. in the amounts of these goods owned The future course of inflation will by businesses and households; some depend in part on what happens to the moderation in outlays seems likely, prices of oil and other imports, and lest these holdings become dispropor restraint from those sources seems tionate to underlying trends in income unlikely to be as great as it was in and output. The outlook for spending 1998. The drop in the price of oil this continues to be obscured to some past year left it toward the lower end degree by uncertainties about the of its range of the past couple of course of equity prices; a failure of decades and has thereby reduced the these prices to match the outsized incentives for exploration, drilling, and gains posted in recent years would production. Futures markets have contribute to some moderation in been showing a gradual rise in the spending growth, especially by price of oil going forward. Prices of households. Government spending, nonoil imports changed little in the which accounts for about one-sixth of fourth quarter of last year after having domestic demand, seems likely to fallen sharply in previous quarters. expand at a moderate pace overall. Indicators of the pressures on domes Along with the numerous other tic resources provided mixed signals uncertainties that attend the outlook, over the past year. In manufacturing, an additional uncertainty is present capacity utilization declined consider this year because of the approach of ably, to a level below its long run the year 2000 and the associated Y2K average, reflecting slower production problem. growth and sizable additions to the Growth abroad is expected to stock of capital. However, labor remain sluggish, on balance, in 1999, markets remained very taut, and with limiting the prospects for exports. At the economy apparently carrying the same time, growth of the U.S. substantial momentum into this year, economy probably will continue to data on costs and prices will need to generate fairly brisk increases in be monitored carefully for signs that a imports. In total, real net exports of rising inflation pattern might start to goods and services seem likely to fall take hold. In that regard, the FOMC further in the coming year, although will continue to rely not only on the several factors-the decline in the CPI but also on a variety of other price dollar from its peak of last summer, measures to gauge the economy's Digitized for FRASER 23 https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis inflation performance in the period growth within any particular range ahead. selected for the year would be associ ated with the economic performance it Money and Debt Ranges for 1999 expected or desired. Nonetheless, the Committee believes that, despite the At its most recent meeting, the FOMC apparent large shift in velocity reaffirmed the 1999 monetary growth behavior in the early 1990s, money ranges that were chosen on a provi growth has some value as an economic sional basis last July: 1 percent to indicator. Indeed, some FOMC 5 percent for M2, and 2 percent to members have expressed the concern 6 percent for M3. As has been the case that the unusually rapid growth in the for some time, the FOMC intends these money and debt aggregates in 1998 money growth ranges to be bench might have reflected monetary marks for growth under conditions of conditions that were too accommoda price stability, sustainable real tive and would ultimately lead to an economic growth, and historical increase in inflation pressures. The velocity relationships rather than Committee will continue to monitor ranges that encompass the expected the monetary aggregates as well as a growth of money over the coming year wide variety of other economic and or that serve as guides to policy. financial data to inform its policy deliberations. Ranges for Growth of Monetary and Last year, M2 increased 8½ percent, Debt Aggregates and with nominal GDP rising 5 per Percent cent, M2 velocity decreased 3 percent. This drop in velocity was considerably Aggregate 1997 1998 1999 larger than would have been expected on the basis of historical relationships M2 1-5 1-5 1-5 and the modest decline in the opportu nity cost of M2 (measured as the M3 2-6 2-6 2-6 difference between the interest rate on Treasury bills and the weighted Debt 3-7 3-7 3-7 average rate available on M2 assets). The fall in velocity in part reflected an Note. Change from average for fourth quarter of preceding year to average for fourth quarter increased demand for the safe and of year indicated. liquid assets in M2 as investors responded to the heightened volatility Given continued uncertainty about in financial markets in the second half movements in the velocities of M2 and of the year. Other factors that may M3 (the ratios of nominal GDP to the have contributed include lower aggregates), the Committee would long-term interest rates and a very flat have little confidence that money yield curve, which might have Digitized for FRASER 24 https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis suggested to households that they last year by a large advance in the would be giving up very little in managed liabilities banks used to fund earnings by parking savings in rapid growth in bank credit. In part, short-term assets in M2. In addition, the growth in bank credit reflected M2 may have been boosted by a desire demand by borrowers shifting from on the part of some investors to the securities markets, and with these redirect savings flows away from markets again receptive to new issues, equities after several years of outsized bank credit growth this year is gains in stock market wealth. With expected to slow to a pace more in line equity wealth still elevated and the with broader debt aggregates. How yield curve likely to remain flat, M2 ever, institutional money funds are velocity could continue to fall this likely to continue their robust gains, year. However, the pace of decline contributing to a further diminution in should slow as some households M3 velocity and, possibly, to growth respond to the easing of concerns of this aggregate above its price about financial market volatility by stability range. reversing a portion of the shift toward Domestic nonfinancial debt grew M2 assets that occurred last fall. 6¼ percent in 1998, somewhat above Indeed, this effect may already be the middle of the 3 percent to 7 per visible, as M2 growth, while still cent growth range the Committee robust, has slowed considerably early established last February. This robust this year. If velocity does fall, given growth reflected large rises in the debt the Committee's expectations for of businesses and households owing nominal income growth, M2 could to substantial advances in spending as again exceed its price-stability bench well as debt-financed mergers and mark range. acquisitions. However, the increase in M3 expanded 11 percent last year, private-sector debt was partly offset by and its velocity fell 5¼ percent, the the first annual decline in federal debt largest drop in many years. The rapid in almost thirty years. As with the growth in this aggregate owed in large monetary aggregates, the Committee part to a substantial rise in institu left the range for debt growth tional money funds. These funds have unchanged for 1999. After an aberrant been expanding rapidly in recent years period in the 1980s during which debt as nonfinancial firms increasing! y growth greatly exceeded growth of employ them to provide cash manage:. nominal GDP, debt growth over the ment services. Investments in these past decade has returned to its funds provide businesses with greater historical pattern of about matching liquidity than direct holdings of growth of nominal GDP, and the money market instruments, and by Committee members expect debt to substituting for such direct holdings, fall within its range this year. they boost M3. M3 was also buoyed Digitized for FRASER 25 https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Growth of Money and Debt Percent Domestic Period Ml M2 M3 nonfinancial debt Annual1 1988 4.2 5.6 6.4 9.1 1989 .6 5.2 4.1 7.5 1990 4.2 4.2 1.9 6.7 1991 8.0 3.1 1.2 4.5 1992 14.3 1.8 .6 4.5 1993 10.6 1.3 1.0 4.9 1994 2.5 .6 1.7 4.9 1995 -1.6 3.9 6.1 5.4 1996 -4.5 4.6 6.8 5.3 1997 -1.2 5.8 8.8 5.0 1998 1.8 8.5 11.0 6.3 1998 Ql 3.2 7.6 10.3 6.2 Quarterly (annual rate)2 Q2 1.0 7.5 10.1 6.1 Q3 -2.0 6.9 8.6 6.0 Q4 5.0 11.0 13.2 6.4 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-16700-0299 Digitized for FRASER 26 https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis

Federal Reserve (1999, February 22). Monetary Policy Report. Monetary Policy Reports, Federal Reserve. https://whenthefedspeaks.com/doc/monetary_policy_report_19990223

@misc{wtfs_monetary_policy_report_19990223,
  author = {Federal Reserve},
  title = {Monetary Policy Report},
  year = {1999},
  month = {Feb},
  howpublished = {Monetary Policy Reports, Federal Reserve},
  url = {https://whenthefedspeaks.com/doc/monetary_policy_report_19990223},
  note = {Retrieved via When the Fed Speaks corpus}
}