Monetary Policy Report

MONETARY POLICY OBJECTIVES A Summary Report of the Federal Reserve Board February 13, 2001 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis MONETARY POLICY OBJECTIVES A Summary Report of the Federal Reserve Board This brochure provides the testimony by the Chairman of the Federal Reserve Board on the Board's semiannual Monetary Policy Report Digitized for FRASER and excerpts from that report, as submitted to the Congress pursuant https://fraser.stlouisfed.org to section 2B of the Federal Reserve Act. Federal Reserve Bank of St. Louis Contents Testimony of Alan Greenspan Chairman, Federal Reserve Board 1 Economic Projections 6 Government Debt Repayment and the Implementation of Monetary Policy 6 Monetary Policy and the Economic Outlook 8 Monetary Policy, Financial Markets, and the Economy over the Second Half of 2000 and Early 2001 10 Economic Projections for 2001 14 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Testimony of Alan Greenspan Chairman, Federal Reserve Board I appreciate the opportunity annually, in many cases new supply was coming on even faster. Overall, this morning to present the capacity in high-tech manufacturing Federal Reserve's semiannual industries rose nearly 50 percent last year, well in excess of its rapid rate of report on monetary policy. increase over the previous three years. Hence, a temporary glut in these indus tries and falling prospective rates of The past decade has been extraordinary return were inevitable at some point. for the American economy and mon Clearly, some slowing in the pace of etary policy. The synergies of key tech spending was necessary and expected nologies markedly elevated prospective if the economy was to progress along a rates of return on high-tech balanced and sustainable growth path. investments, led to a surge in business But the adjustment has occurred capital spending, and significantly much faster than most businesses increased the underlying growth rate of anticipated, with the process likely productivity. The capitalization of those intensified by the rise in the cost of higher expected returns boosted equity energy that has drained business and prices, contributing to a substantial household purchasing power. Pur pickup in household spending on new chases of durable goods and invest homes, durable goods, and other types ment in capital equipment declined in of consumption generally, beyond even the fourth quarter. Because the extent that implied by the enhanced rise in of the slowdown was not anticipated real incomes. by businesses, it induced some backup When I last reported to you in July, in inventories, despite the more economic growth was just exhibiting advanced just-in-time technologies initial signs of slowing from what had that have in recent years enabled firms been an exceptionally rapid and unsus to adjust production levels more rap tainable rate of increase that began a idly to changes in demand. Inventory year earlier. sales ratios rose only moderately; but The surge in spending had lifted the relative to the levels of these ratios growth of the stocks of many types of implied by their downtrend over the consumer durable goods and business past decade, the emerging imbalances capital equipment to rates that could appeared considerably larger. Reflect not be continued. The elevated level ing these growing imbalances, manu of light vehicle sales, for example, facturing purchasing managers implied a rate of increase in the number reported last month that inventories of vehicles on the road hardly sustain in the hands of their customers had able for a mature industry. And even risen to excessively high levels. though demand for a number of high As a result, a round of inventory tech products was doubling or tripling rebalancing appears to be in progress. Digitized for FRASER https://fraser.stlouisfed.org 1 Federal Reserve Bank of St. Louis Accordingly, the slowdown in the still patently in evidence at the time economy that began in the middle of of its January meeting, the FOMC 2000 intensified, perhaps even to the retained its sense that the risks are point of growth stalling out around weighted toward conditions that may the turn of the year. As the economy generate economic weakness in the slowed, equity prices fell, especially in foreseeable future. the high-tech sector, where previous Crucial to the assessment of the out high valuations and optimistic forecasts look and the understanding of recent were being reevaluated, resulting in policy actions is the role of technologi significant losses for some investors. cal change and productivity in shaping In addition, lenders turned more cau near-term cyclical forces as well as tious. This tightening of financial condi long-term sustainable growth. tions, itself, contributed to restraint on The prospects for sustaining strong spending. advances in productivity in the years Against this background, the Fed ahead remain favorable. As one would eral Open Market Committee (FOMC) expect, productivity growth has slowed undertook a series of aggressive mon along with the economy. But what is etary policy steps. At its December notable is that, during the second half meeting, the FOMC shifted its of 2000, output per hour advanced at a announced assessment of the balance pace sufficiently impressive to provide of risks to express concern about eco strong support for the view that the nomic weakness, which encouraged rate of growth of structural productiv declines in market interest rates. Then ity remains well above its pace of a de on January 3, and again on January 31, cade ago. the FOMC reduced its targeted federal Moreover, although recent short funds rate½ percentage point, to its term business profits have softened current level of 5 ½ percent. An essen considerably, most corporate managers tial precondition for this type of appear not to have altered to any response was that underlying cost and appreciable extent their long-standing price pressures remained subdued, so optimism about the future returns from that our front-loaded actions were using new technology. A recent survey unlikely to jeopardize the stable, low of purchasing managers suggests that inflation environment necessary to the wave of new on-line business-to foster investment and advances in business activities is far from cresting. productivity. Corporate managers more generally, The exceptional weakness so evident rightly or wrongly, appear to remain in a number of economic indicators remarkably sanguine about the poten toward the end of last year (perhaps in tial for innovations to continue to part the consequence of adverse enhance productivity and profits. At weather) apparently did not continue least this is what is gleaned from the in January. But with signs of softness projections of equity analysts, who, one Digitized for FRASER https://fraser.stlouisfed.org 2 Federal Reserve Bank of St. Louis must presume, obtain most of their times on delivery of capital equipment, insights from corporate managers. a result of information and other newer According to one prominent survey, the technologies, has engendered a more three-to five-year average earnings rapid adjustment of capital goods pro projections of more than a thousand duction to shifts in demand that result analysts, though exhibiting some signs from changes in firms' expectations of of diminishing in recent months, have sales and profitability. A decade ago, generally held firm at a very high level. extended backlogs on capital equip Such expectations, should they persist, ment meant a more stretched-out pro bode well for continued strength in cess of production adjustments. capital accumulation and sustained Even consumer spending decisions elevated growth of structural produc have become increasingly responsive tivity over the longer term. to changes in the perceived profitability The same forces that have been of firms through their effects on the boosting growth in structural produc value of households' holdings of equi tivity seem also to have accelerated the ties. Stock market wealth has risen sub process of cyclical adjustment. Extraor stantially relative to income in recent dinary improvements in business-to years-itself a reflection of the extraor business communication have held unit dinary surge of innovation. As a conse costs in check, in part by greatly speed quence, changes in stock market wealth ing up the flow of information. New have become a more important deter technologies for supply-chain manage minant of shifts in consumer spending ment and flexible manufacturing imply relative to changes in current house that businesses can perceive imbalances hold income than was the case just five in inventories at a very early stage to seven years ago. virtually in real time-and can cut pro The hastening of the adjustment to duction promptly in response to the emerging imbalances is generally ben developing signs of unintended inven eficial. It means that those imbalances tory building. are not allowed to build until they Our most recent experience with require very large corrections. But some inventory backup, of course, sug the faster adjustment process does raise gests that surprises can still occur and some warning flags. Although the that this process is still evolving. None newer technologies have clearly theless, compared with the past, much allowed firms to make more informed progress is evident. A couple of decisions, business managers through decades ago, inventory data would out the economy also are likely not have been available to most firms responding to much of the same until weeks had elapsed, delaying a enhanced body of information. As response and, hence, eventually requir a consequence, firms appear to be act ing even deeper cuts in production. In ing in far closer alignment with one addition, the foreshortening of lead another than in decades past. The result Digitized for FRASER https://fraser.stlouisfed.org 3 Federal Reserve Bank of St. Louis is not only a faster adjustment, but one some time to run its course. It is not that is potentially more synchronized, that underlying demand for Internet, compressing changes into an even networking, and communications ser shorter time frame. vices has become less keen. Instead, as This very rapidity with which the I noted earlier, some suppliers seem current adjustment is proceeding raises to have reacted late to accelerating another concern, of a different nature. demand, have overcompensated in While technology has quickened pro response, and then have been forced to duction adjustments, human nature retrench-a not-unusual occurrence in remains unaltered. We respond to a business decisionmaking. heightened pace of change and its asso A pace of change outstripping the ciated uncertainty in the same way we ability of people to adjust is just as evi always have. We withdraw from action, dent among consumers as among busi postpone decisions, and generally ness decisionmakers. When consumers hunker down until a renewed, more become less secure in their jobs and comprehensible basis for acting finances, they retrench as well. emerges. In its extreme manifestation, It is difficult for economic policy to many economic decisionmakers not deal with the abruptness of a break in only become risk averse but attempt to confidence. There may not be a seam disengage from all risk. This precludes less transition from high to moderate taking any initiative, because risk is to low confidence on the part of busi inherent in every action. In the fall of nesses, investors, and consumers. 1998, for example, the desire for liquid Looking back at recent cyclical epi ity became so intense that financial sodes, we see that the change in atti markets seized up. Indeed, investors tudes has often been sudden. In earlier even tended to shun risk-free, previ testimony, I likened this process to ously issued Treasury securities in water backing up against a dam that favor of highly liquid, recently issued is finally breached. The torrent carries Treasury securities. with it most remnants of certainty and But even when decisionmakers are euphoria that built up in earlier only somewhat more risk averse, a pro periods. cess of retrenchment can occur. Thus, This unpredictable rending of confi although prospective long-term returns dence is one reason that recessions are on new high-tech investment may so difficult to forecast. They may not be change little, increased uncertainty can just changes in degree from a period of induce a higher discount of those economic expansion, but a different returns and, hence, a reduced willing process engendered by fear. Our eco ness to commit liquid resources to illiq nomic models have never been particu uid fixed investments. larly successful in capturing a process Such a process presumably is now driven in large part by nonrational under way and arguably may take behavior. Digitized for FRASER https://fraser.stlouisfed.org 4 Federal Reserve Bank of St. Louis Although consumer confidence has face of major changes in the speed of fallen, at least for now it remains at a economic processes. Fortunately, the level that in the past was consistent very advances in technology that have with economic growth. And as I quickened economic adjustments have pointed out earlier, expected earnings also enhanced our capacity for real-time growth over the longer-run continues surveillance. to be elevated. If the forces contributing As I pointed out earlier, demand has to long-term productivity growth been depressed by the rise in energy remain intact, the degree of retrench prices as well as by the needed slowing ment will presumably be limited. Pros in the pace of accumulation of business pects for high productivity growth capital and consumer durable assets. should, with time, bolster both con The sharp rise in energy costs pressed sumption and investment demand. down on profit margins still further in Before long in this scenario, excess the fourth quarter. About a quarter of inventories would be run off to desired the rise in total unit costs of nonfinan levels. cial, nonenergy corporations reflected a Still, as the FOMC noted in its last rise in energy costs. The 12 percent rise announcement, for the period ahead, in natural gas prices last quarter con downside risks predominate. In addi tributed directly, and indirectly through tion to the possibility of a break in con its effects on the cost of electrical power fidence, we don't know how far the generation, about one-fourth of the rise adjustment of the stocks of consumer in overall energy costs for nonfinancial, durables and business capital equip non-energy corporations; increases in ment has come. Also, foreign econo oil prices accounted for the remainder. mies appear to be slowing, which In addition, a significant part of the could damp demands for exports; and, margin squeeze not directly attributable although some sectors of the financial to higher energy costs probably has markets have improved in recent reflected the effects of the moderation weeks, continued lender nervousness in consumer outlays that, in turn, has still is in evidence in other sectors. been due in part to higher costs of Because the advanced supply-chain energy, especially for natural gas. management and flexible manufactur Hence, it is likely that energy cost ing technologies may have quickened increases contributed significantly more the pace of adjustment in production to the deteriorating profitability of non and incomes and correspondingly financial, non-energy corporations in increased the stress on confidence, the the fourth quarter than is suggested by Federal Reserve has seen the need to the energy-related rise in total unit respond more aggressively than had costs alone. been our wont in earlier decades. Eco To be sure, the higher energy nomic policymaking could not, and expenses of households and most busi should not, remain unaltered in the nesses represent a transfer of income to Digitized for FRASER https://fraser.stlouisfed.org 5 Federal Reserve Bank of St. Louis producers of energy. But the capital balance, for the year as a whole. The investment of domestic energy produc central tendency for real GDP growth ers, and, very likely, consumption by over the four quarters of this year is 2 their owners, have provided only a to 2½ percent. Because this average small offset to the constraining effects pace is below the rise in the economy's of higher energy costs on spending by potential, they see the unemployment most Americans. Moreover, a signifi rate increasing to about 4½ percent by cant part of the extra expense is sent the fourth quarter of this year. The cen overseas to foreign energy producers, tral tendency of their forecasts for infla whose demand for exports from the tion, as measured by the prices for per United States is unlikely to rise enough sonal consumption expenditures, to compensate for the reduction in suggests an abatement to 1¾ to 2 ¼ per domestic spending, especially in the cent over this year from 2½ percent short-run. Thus, given the evident over 2000. inability of energy users, constrained by intense competition for their own Government Debt Repayment products, to pass on much of their cost and the Implementation of increases, the effects of the rise in Monetary Policy energy costs does not appear to have had broad inflationary effects, in con Federal budget surpluses have bol trast to some previous episodes when stered national saving, providing addi inflation expectations were not as well tional resources for investment and, anchored. Rather, the most prominent hence, contributing to the rise in the effects have been to depress aggregate capital stock and our standards of liv demand. The recent decline in energy ing. However, the prospective decline prices and further declines anticipated in Treasury debt outstanding implied by futures markets, should they occur, by projected federal budget surpluses would tend to boost purchasing power does pose a challenge to the implemen and be an important factor supporting tation of monetary policy. The Federal a recovery in demand growth over Reserve has relied almost exclusively coming quarters. on increments to its outright holdings of Treasury securities as the "perma nent" asset counterpart to the uptrend Economic Projections in currency in circulation, our primary The members of the Board of Gover liability. Because the market for Trea nors and the Reserve Bank presidents sury securities is going to become foresee an implicit strengthening of much less deep and liquid if outstand activity after the current rebalancing is ing supplies shrink as projected, we over, although the central tendency of will have to turn to acceptable substi their individual forecasts for real GDP tutes. Last year the Federal Reserve still shows a substantial slowdown, on System initiated a study of alternative Digitized for FRASER https://fraser.stlouisfed.org 6 Federal Reserve Bank of St. Louis approaches to managing our portfolio. ing with the Congress on these possible At its late January meeting, the steps before the FOMC further consid FOMC discussed this issue at length, ers such transactions. Taking such and it is taking several steps to help assets in repurchase operations would better position the Federal Reserve significantly expand and diversify the to address the alternatives. First, as assets our counterparties could post in announced on January 31, the Commit temporary open market operations, tee extended the temporary authority, reducing the potential for any impact in effect since late August 1999, for the on the pricing of private sector Trading Desk at the Federal Reserve instruments. Bank of New York to conduct repur Finally, the FOMC decided to study chase agreements in mortgage-backed further the even longer-term issue of securities guaranteed by the agencies whether it will ultimately be necessary as well as in Treasuries and direct to expand the use of the discount win agency debt. Thus, for the time being, dow or to request the Congress for a the Desk will continue to rely on the broadening of its statutory authority same types of temporary open market for acquiring assets via open market operations in use for the past year and operations. How quickly the FOMC a half to offset transitory factors affect will need to address these longer-run ing reserve availability. portfolio choices will depend on how Second, the FOMC is examining the quickly the supply of Treasury securi possibility of beginning to acquire ties declines as well as the usefulness under repurchase agreements some of the alternative assets already autho additional assets that the Federal rized by law. Reserve Act already authorizes the In summary, although a reduced Federal Reserve to purchase. In par availability of Treasury securities will ticular, the FOMC asked the staff to require adjustments in the particular explore the possible mechanisms for form of our open market operations, backing our usual repurchase opera there is no reason to believe that we tions with the collateral of certain debt will be unable to implement policy as obligations of U.S. states and foreign required. governments. We will also be consult- Digitized for FRASER https://fraser.stlouisfed.org 7 Federal Reserve Bank of St. Louis Monetary Policy and the Economic Outlook When the Federal Reserve submitted gradually accumulated during the its previous Monetary Policy Report to summer and into the autumn. For a the Congress, in July of 2000, tentative time, this downshifting of growth signs of a moderation in the growth of seemed likely to leave the economy economic activity were emerging fol expanding at a pace roughly in line lowing several quarters of extraordi with that of its potential. Over the last narily rapid expansion. After having few months of the year, however, ele increased the interest rate on federal ments of economic restraint emerged funds through the spring to bring the from several directions to slow growth growth of aggregate demand and even more. Energy prices, rather than potential supply into better alignment turning down as had been anticipated, and thus contain inflationary pressures, kept climbing, raising costs throughout the Federal Reserve had stopped tight the economy, squeezing business prof ening as evidence of an easing of eco its, and eroding the income available nomic growth began to appear. for discretionary expenditures. Equity Indications that the expansion had prices, after coming off their highs ear moderated from its earlier rapid pace lier in the year, slumped sharply start ing in September, slicing away a por- tion of household net worth and Change in Real GDP discouraging the initial offering of Percent, annual rate new shares by firms. Many businesses encountered tightening credit condi tions, including a widening of risk _________________ 6 spreads on corporate debt issuance and bank loans. Foreign economic activity decelerated noticeably in the latter part --------- 4 of the year, contributing to a weakening of the demand for U.S. exports, which also was being restrained by an earlier i---.. ... . --1--- 2 appreciation in the exchange value of the U.S. dollar. The dimensions of the economic slowdown were obscured for a time by the usual lags in the receipt of eco- nomic data, but the situation began to come into sharper focus late in the year 1994 1996 1998 2000 as the deceleration steepened. Spend Note. Here and in subsequent charts, except as ing on business capital, which had been noted, annual changes are measured from Q4 to rising rapidly for several years, elevat Q4, and change for a half-year is measured ing stocks of these assets, flattened between its final quarter and the final quarter of abruptly in the fourth quarter. Con- the preceding period. Digitized for FRASER https://fraser.stlouisfed.org 8 Federal Reserve Bank of St. Louis sumers clamped down on their outlays economy that still appear to be present for motor vehicles and other durables, despite the sluggishness encountered the stocks of which also had climbed to of late. The most notable of these high levels. As the demand for goods strengths is the remarkable step-up in softened, manufacturers adjusted pro structural productivity growth since duction quickly to counter a buildup in the mid-1990s, which seems to be inventories. Rising concern about closely related to the spread of new slower growth and worker layoffs con technologies. Even as the economy tributed to a sharp deterioration of con slowed in 2000, evidence of ongoing sumer confidence. In response to the efficiency gains were apparent in the accumulating weakness, the Federal form of another year of rapid advance Open Market Committee (FOMC) in output per worker hour in the non lowered the intended interest rate on farm business sector. With households federal funds ½ percentage point on and businesses still in the process of January 3 of this year. Another rate putting recent innovations in place and reduction of that same size was imple with technological breakthroughs still mented at the close of the most recent occurring, an end to profitable invest meeting of the FOMC at the end of last ment opportunities in the technology month. area does not yet seem to be in sight. As weak economic data induced Should investors continue to seek out investors to revise down their expecta emerging opportunities, the ongoing tions of future short-term interest rates transformation and expansion of the in recent months and as the Federal capital stock will be maintained, Reserve eased policy, financial market conditions became more accommoda Change in Output per Hour tive. Since the November FOMC meet ing, yields on many long-term corpo Percent rate bonds have dropped on the order of a full percentage point, with the larg est declines taking place on riskier bonds as the yield spreads on those securities narrowed considerably from their elevated levels. In response, bor rowing in long-term credit markets has strengthened appreciably so far in 2001. The less restrictive conditions in ____......._ _ _..............,,....... _____. ........ __. ....____ +0 financial markets should help lay the groundwork for a rebound in economic growth. That rebound should also be encour 1990 1992 1994 1996 1998 2000 aged by underlying strengths of the Note. Nonfarm business sector. Digitized for FRASER https://fraser.stlouisfed.org 9 Federal Reserve Bank of St. Louis thereby laying the groundwork for fur ing to place additional strains on the ther gains in productivity and ongoing economy's resources, which already advances in real income and spending. appeared to be stretched thin. Private The impressive performance of produc long-term interest rates had risen con tivity and the accompanying environ siderably in response to the strong ment of low and stable underlying economy, and, in an effort to slow the inflation suggest that the longer-run growth of aggregate demand and outlook for the economy is still quite thereby prevent a buildup of inflation favorable, even though downside risks ary pressures, the Federal Reserve had may remain prominent in the period tightened its policy settings substan immediately ahead. tially through its meeting in May 2000. Over subsequent weeks, preliminary signs began to emerge suggesting that Monetary Policy, Financial growth in aggregate demand might Markets, and the Economy over be slowing, and at its June meeting the Second Half of 2000 and the FOMC left the federal funds rate Early 2001 unchanged. As described in the preceding Mon Further evidence accumulated over etary Policy Report to the Congress, the the summer to indicate that demand very rapid pace of economic growth growth was moderating. The rise in over the first half of 2000 was threaten- mortgage interest rates over the previ- Selected Interest Rates Percent - 7 Three-month Treasury - 4 2/3 3/30 5/18 6/30 8/24 10/5 11/16 12/21 2/2 3/21 5/16 6/28 8/22 10/3 11/15 12/19 1/31 1/3 1999 2000 2001 Note. The data are daily and extend through are those of scheduled FOMC meetings and of any February 8, 2001. The dates on the horizontal axis intermeeting policy actions. Digitized for FRASER https://fraser.stlouisfed.org 10 Federal Reserve Bank of St. Louis Major Stock Price Indexes to grow faster than potential supply January 4, 1999=100 at a time when the labor market was already taut, and it saw the balance of risks still tilted toward heightened inflation pressures. The FOMC faced fairly similar cir cumstances at its October meeting. By then, it had become more apparent that the growth in demand had fallen to a pace around that of potential sup ply. Although consumer spending had picked up again for a time, it did not regain the vigor it had displayed earlier in the year, and capital spending, while still growing briskly, had decelerated JFMAMJJASONDJFMAMJJASONDJF from its first-half pace. With increases 1999 2000 2001 in demand moderating, private Note. The data are daily and extend though February 8, 2001. employment gains slowed from the rates seen earlier in the year. However, labor markets remained exceptionally ous year seemed to be damping activity tight, and the hourly compensation of in the housing sector. Moreover, the workers had accelerated to a point at growth of consumer spending had which unit labor costs were edging up slowed from the exceptional pace of despite strong gains in productivity. In earlier in the year; the impetus to addition, sizable increases in energy spending from outsized equity price prices were pushing broad inflation gains in 1999 and early 2000 appeared measures above the levels of recent to be partly wearing off, and rising years. Although core inflation mea energy prices were continuing to erode sures were at most only creeping up, the purchasing power of households. the Committee felt that there was some By contrast, business fixed investment risk that the increase in energy prices, still was increasing very rapidly, and which was lasting longer than had strong growth of foreign economies seemed likely earlier in the year, would was fostering greater demand for U.S. start to leave an imprint on business exports. Weighing this evidence and costs and longer-run inflation expecta recognizing that the effects of previous tions, posing the risk that core inflation tightenings had not yet been fully felt, rates could rise more substantially. the FOMC decided at its meeting in Weighing these considerations, the August to hold the federal funds rate FOMC decided to hold the federal unchanged. The Committee remained funds rate unchanged at its October concerned that demand could continue meeting. While recognizing that the Digitized for FRASER https://fraser.stlouisfed.org 11 Federal Reserve Bank of St. Louis Change in PCE Chain-Type Price ward. Those price declines, along with Index the elevated volatility of equity prices, Percent also hampered the ability of firms to raise funds in equity markets and were □Total likely discouraging business invest ■ Excluding food and energy ment. Some firms faced more restrictive --------------- 3 conditions in credit markets as well, as risk spreads in the corporate bond mar ket widened significantly for firms -2 with lower credit ratings and as banks tightened the standards and terms on their business loans. Meanwhile, -1 incoming data indicated that the pace of economic activity had softened a bit further. Still, the growth of aggregate demand apparently had moved only modestly below that of potential sup- 1994 1996 1998 2000 Measures of Labor Utilization Note. Data are for personal consumption Percent expenditures (PCE). risks in the outlook were shifting, the FOMC believed that the tautness of 12 labor markets and the rise in energy prices meant that the balance of those risks still was weighted towards heightened inflation pressures, and this 6 assessment was noted in the balance of-risks statement. By the time of the November FOMC meeting, conditions in the financial markets were becoming less accommo 1970 1981 1991 2001 dative in some ways, even as the Fed Note. The augmented unemployment rate is eral Reserve held the federal funds rate the number of unemployed plus those who are not in the labor force and want a job, divided by steady. Equity prices had declined con the civilian labor force plus those who are not in siderably over the previous several the labor force and want a job. The break in data months, resulting in an erosion of at January 1994 marks the introduction of a redesigned survey; data after that point are not household wealth that seemed likely to directly comparable with those of earlier periods. restrain consumer spending going for- The data extend through January 2001. Digitized for FRASER https://fraser.stlouisfed.org 12 Federal Reserve Bank of St. Louis ply. Moreover, while crude oil prices weakened. Moreover, growth in foreign appeared to be topping out, additional economies seemed to be slowing, on inflationary pressures were arising in balance, and U.S. export performance the energy sector in the form of surging began to deteriorate. Market interest prices for natural gas, and there had rates had declined sharply in response been no easing of the tightness in the to these developments. Against this labor market. In assessing the evidence, backdrop, the FOMC at its December the members of the Committee felt that meeting decided that the risks to the the risks to the outlook were coming outlook had swung considerably and into closer balance but had not yet now were weighted toward economic shifted decisively. At the close of the weakness, although it decided to wait meeting, the FOMC left the funds rate for additional evidence on the extent unchanged once again, and it stated and persistence of the slowdown that the balance of risks continued to before moving to an easier policy point toward increased inflation. How stance. Recognizing that the current po ever, in the statement released after the sition of the economy was difficult meeting, the FOMC noted the possibil to discern because of lags in the data ity of subpar growth in the economy in and that prospects for the near term the period ahead. were particularly uncertain, the Com Toward the end of the year, the mod mittee agreed at the meeting that it eration of economic growth gave way, would be especially attentive over com fairly abruptly, to more sluggish condi ing weeks to signs that an intermeeting tions. By the time of the December policy action was called for. FOMC meeting, manufacturing activity had softened considerably, especially in motor vehicles and related industries, Change in Real Imports and Exports of Goods and Services and a number of industries had accu mulated excessive stocks of invento Percent, annual rate ries. Across a broader set of firms, fore □Imports casts for corporate sales and profits in ■Exports the fourth quarter and in 2001 were 15 being slashed, contributing to a contin ued decline in equity prices and a fur ther widening of risk spreads on lower-rated corporate bonds. In this environment, growth in business fixed investment appeared to be slowing appreciably. Consumer spending showed signs of decelerating further, as falling stock prices eroded house hold wealth and consumer confidence 1994 1996 1998 2000 Digitized for FRASER https://fraser.stlouisfed.org 13 Federal Reserve Bank of St. Louis Additional evidence that economic remained cautious, as evidenced by activity was slowing significantly widening spreads in commercial paper emerged not long after the December markets. Incoming data pointed to fur meeting. New data indicated a marked ther weakness in the manufacturing weakening in business investment, and sector and a sharp decline in consumer retail sales over the holiday season confidence. Moreover, slower U.S. were appreciably lower than busines growth appeared to be spilling over ses had expected. To contain the result to several important trading partners. ing buildup in inventories, activity in In late January, the FOMC cut the the manufacturing sector continued to intended federal funds rate ½ percent drop. In addition, forecasts of near age point while the Board of Gover term corporate profits were being nors approved a decrease in the dis marked down further, resulting in count rate of an equal amount. Because additional declines in equity prices and of the significant erosion of consumer in business confidence. Market interest and business confidence and the need rates continued to fall, as investors for additional adjustments to produc became more pessimistic about the tion to work off elevated inventory lev economic outlook. Based on these de els, the FOMC indicated that the risks velopments, the Committee held a tele to the outlook continued to be phone conference call on January 3, weighted toward economic weakness. 2001, and decided to cut the intended federal funds rate ½ percentage point. Economic Projections for 2001 Equity prices surged on the announce ment, and the Treasury yield curve Although the economy appears likely steepened considerably, apparently to be sluggish over the near term, the because market participants became members of the Board of Governors more confident that a prolonged and the Reserve Bank presidents ex downturn in economic growth would pect stronger conditions to emerge as likely be forestalled. Following the the year progresses. For 2001 overall, policy easing, the Board of Governors the central tendency of their forecasts approved a decrease in the discount of real GDP growth is 2 percent to 2½ rate of a total of ½ percentage point. percent, measured as the change from The Committee's action improved the fourth quarter of 2000 to the fourth financial conditions to a degree. Over quarter of 2001. With growth falling the next few weeks, equity prices rose, short of its potential rate, especially in on net. Investors seemed to become the first half of this year, unemploy less wary of credit risk, and yield ment is expected to move up a little spreads narrowed across most corpo further. Most of the governors and rate bonds even as the issuance of Reserve Bank presidents are forecast these securities picked up sharply. ing that the average unemployment But in some other respects, investors rate in the fourth quarter of this year Digitized for FRASER https://fraser.stlouisfed.org 14 Federal Reserve Bank of St. Louis Economic Projections for 2001 Percent Federal Reserve governors and Reserve Bank presidents Memo: Central Indicator 2000 actual Range tendency Change, Nominal GDP 5.9 3¾-5¼ 4-5 fourth quarter ---------------------- to fourth Real GDP2 3.5 2-2¾ 2-2½ quarter1 PCE chain-type price index 2.4 1¾-2½ 1¾-2¼ Average level, Civilian unemployment rate 4.0 41/z-5 About4½ fourth quarter l. Change from average for fourth quarter of 2. Chain-weighted. 2000 to average for fourth quarter of 2001. will be about 4½ percent, still quite output into better alignment with low by historical standards. sales. Nevertheless, stocks at year-end The rate of economic expansion were above desired levels in a number over the near term will depend impor of industries. tantly on the speed at which inventory Once inventory imbalances are overhangs that developed over the lat worked off, production should become ter part of 2000 are worked off. Gains more closely linked to the prospects for in information technology have no sales. Household and business expen doubt enabled businesses to respond ditures have decelerated markedly in more quickly to a softening of sales, recent months, and uncertainties about which has steepened the recent pro how events might unfold are consider duction cuts but should also damp the able. But, responding in part to the eas buildup in inventories and facilitate a ing of monetary policy, financial mar turnaround. The motor vehicle indus kets are shifting away from restraint, try made some progress toward reduc and this shift should create a more ing excess stocks in January owing to a favorable underpinning to the ex combination of stronger sales and a pected pickup in the economy as the further sharp cutback in assemblies. year progresses. The sharp drop in In other parts of manufacturing, the mortgage interest rates since May of sizable reductions in production late last year appears to have stemmed the last year suggest that producers in decline in housing activity; it also has general were moving quickly to get enabled many households to refinance Digitized for FRASER https://fraser.stlouisfed.org 15 Federal Reserve Bank of St. Louis existing mortgages at lower rates, an How quickly investment spending action that should free up cash for starts to pick up again will depend not added spending. Conditions of busi only on the cost of finance but also on ness finance also have eased to some the prospective rates of return to capi degree. Interest rates on investment tal. This past year, expectations regard grade corporate bonds have recently ing the prospects of some high-tech fallen to their lowest levels in about 1½ companies clearly declined, and capital years. Moreover, the premiums re spending seems unlikely to soon quired of bond issuers that are per regain the exceptional strength that ceived to be at greater risk have was evident in the latter part of the dropped back in recent weeks from the 1990s and for a portion of last year. elevated levels of late 2000. As credit From all indications, however, techno conditions have eased, firms have logical advance still is going forward issued large amounts of corporate at a rapid pace, and investment will bonds so far in 2001. However, consid likely pick up again if, as expected, the erable caution is evident in the com expansion of the economy gets back on mercial paper market and among more solid footing. Private analysts are banks, whose loan officers have still anticipating high rates of growth reported a further tightening of lend in corporate earnings over the long ing conditions since last fall. In equity run, suggesting that the current slug markets, prices have recently dropped gishness of the economy has not in response to negative reports on cor undermined perceptions of favorable porate earnings, reversing the gains long-run fundamentals. that took place in January. The degree to which increases in The restraint on domestic demand exports might help to support the U.S. from high energy prices is expected to economy through a stretch of sluggish ease in coming quarters. Natural gas ness has become subject to greater prices have dropped back somewhat in uncertainty recently because foreign recent weeks as the weather has turned economies also seem to have deceler milder, and crude oil prices also are ated toward the end of last year. How down from their peaks. Although these ever, the expansion of imports has prices could run up again in conjunc slowed sharply, responding in part to tion with either a renewed surge in the softening of domestic demand demand or disruptions in supply, par growth. In effect, some of the slow ticipants in futures markets are antici down in demand in this country is pating that prices will be trending being shifted to foreign suppliers, gradually lower over time. A fall in implying that the adjustments required energy prices would relieve cost pres of domestic producers are not as great sures on businesses to some degree as they otherwise would have been. and would leave more discretionary In adjusting labor input to the slow income in the hands of households. ing of the economy, businesses are Digitized for FRASER https://fraser.stlouisfed.org 16 Federal Reserve Bank of St. Louis facing conflicting pressures. Speedy Most of the governors and Reserve adjustment of production and ongoing Bank presidents are forecasting that gains in efficiency argue for cutbacks the rise in the chain-type price index in labor input, but companies are also for personal consumption expendi reluctant to lay off workers that have tures will be smaller than the price rise been difficult to attract and retain in in 2000. The central tendency of the the tight labor market conditions of the range of forecasts is 1¾ percent to 2¼ past few years. In the aggregate, the percent. Inflation should be restrained balance that has been struck in recent this coming year by an expected down months has led, on net, to slower turn in energy prices. In addition, the growth of employment, cutbacks in the reduced pressure on resources that is length of the average workweek, and, associated with the slowing of the in January of this year, a small increase economy should help damp increases in the unemployment rate. in labor costs and prices. Inflation is not expected to be a pressing concern over the coming year. FRBl-18000-0201-C Digitized for FRASER https://fraser.stlouisfed.org 17 Federal Reserve Bank of St. Louis

Federal Reserve (2001, February 12). Monetary Policy Report. Monetary Policy Reports, Federal Reserve. https://whenthefedspeaks.com/doc/monetary_policy_report_20010213

@misc{wtfs_monetary_policy_report_20010213,
  author = {Federal Reserve},
  title = {Monetary Policy Report},
  year = {2001},
  month = {Feb},
  howpublished = {Monetary Policy Reports, Federal Reserve},
  url = {https://whenthefedspeaks.com/doc/monetary_policy_report_20010213},
  note = {Retrieved via When the Fed Speaks corpus}
}