17

Michelle H. Garfinkel

Michelle R. Garfinkel is an economist at the Federal ReserveBank of St. Louis. Scott Leitz provided research assistance.

The FOMC in 1989: Walking aTightrope

IL HE FEDERAL Open Market Committee(FOMC) sought to balance the risk of infla-tionary pressures against that of a weakeningeconomy in 1989, the seventh year of the cur-rent economic expansion.’ The changing relativeintensity of these risks, as perceived by theFOMC (hereafter, the Committee), influencedthe course of monetary policy throughout theyear.

Because the Committee believed that long-runprice stability is necessary to promote maximumsustainable economic growth over time, theperceived risks of inflationary pressures greatlyinfluenced its decisions early in the year. As theyear progressed, however, it became increasing-ly apparent to the Committee that the economicexpansion was weakening. At the same time,the Committee’s perception of the trend in infla-tion became slightly more optimistic. According-ly, the weight that the Committee attached toreducing the risks of a slowdown in economicactivity increased somewhat throughout the se-cond half of 1989. Nevertheless, the Committee’sconcern about future price pressures and theimportance of maintaining its own credibility as

an inflation-fighter remained in the forefront ofits deliberations.

This article reviews the formulation of mone-tary policy by the Committee in 1989. The dis-cussion focuses on how changing economic con-ditions influenced the Committee’s decisions asit balanced the risk of future inflation againstthat of a future slowdown in economic activity.

L()N5411.JN ()FJFCTIVF:S

The Board of Governors of the FederalReserve System reports to Congress twice ayear on its annual growth rate targets for themonetary and debt aggregates. The one-yeartarget periods run from the fourth quarter ofthe previous year to the fourth quarter of thecurrent year. These reports are mandated bythe Full Employment and Balanced Growth Actof 1978 (or the Humphrey-Hawkins Act). Afterits first meeting of the year in February, theCommittee submits a report on its monetaryand debt growth objectives for the currentyear. In July, upon reviewing the progress ithas made toward achieving its objectives for the

NOTE: Citations to the Record refer to the “Record ofPolicy Actions of the Federal Open Market Committee” aspublished in various issues of the Federal Reserve Bulletin.Citations to “Report” refer to the “Monetary Policy Reportto the Congress,” which is also published in the FederalReserve Bulletin.

‘See the shaded insert on pages 18 and 19 for a descrip-tion of the Committee’s membership during 1989.

19

anclther llesei e Ba iik and staFf at the Boa ccl - (2) a sun)FiIa I V 0! rc’n’ nt in tr’rna tioltalC )t lic’i- niernlwrs of the C oiririu’t lee may pa i- Financial clct elopnic nts and the I - SicipaIc a mid are informed of he cia iiy jilaii In’ Foreign I rack’ ha Ian Le;

iii teJ nail niemno or wire.(3) a sun ni,i i-v ol open market ojwrat loris.

- . growth of t he 1110!ie tar~ag’’re ‘ales andI he direct i i sstied bv the ( ornnul tee and . r, n- - - . batik m-c~,ert’es and rncnie~n iCLr Let con di-

a summa rv of the ci iscussion anti rca suns for . . -Lions stine t lie previous meetings,(.0111 intL Ice actions ai C’ published iii the

Hecoi d oF Polk~’,-ct ions of the I edera I Open (4 t a soinma r\ of the Corn mtlee’s disc us-I ai ket Cornnil ttec’.’’ 1 he ‘‘Hec ord’’ for catch 5w n of tim current and prosperti ‘. e

met’ ti ng is relc’a sod a fet~da~s aftc r the nn t en mom ic ,mcl Ii nancia I c’om idi I ioi is;sc heduleri Coi limit tee meting It subsequent- — - -

(.) a suiii ma rv ol t lie n ione I ais po1icy

lv appears in the l-eth~ra!Reserve I3ullelzn. In . - . - . -

- - - ciisnissiol i of the ( . irn init tee,addition, Records for the entire year arepu hI ished in tIn’ ann0.31 Pc poit of the Board (6) a pol u ~. cii rect iye iss uecl I w the (om niii-oF C m ernors. -l he rc‘cord for each meetirig iii LIE’ to the I c’der al liesnyc Bank of \ en’1989 included: Vork;

- . ~ a list of the members’ votes a ,id a n~(1) a staff summna i~ c if Ic.~ent eccjncnnic -

- dissei~t ing comments; a riddevelopnien I s—slit Ii as c-ha rigt’s niprices empIo~mci it, ii idus trial ptocliic- (81 a description of an v .ic’l (ni s rega cclii igtic)! i at id coini Jonen t s oF I he nat iona I the (ow tint Leo’s ot lie! a~it ho ration~dcc-cm ifls—and projectic)! s of genera I ai u! di ret t i yes, and r eports on any ac-price ciii t 1)1.11 anc I eni~Io~iiii’tit t 101k, that might hat c’ OcT11 rred lie t n eendc’s c’!ojmien Is f Lw the year a hi ad ; the it ‘gula rl~’s 1 n’chi It’d meti t iii,,s.

first half of the year, the Committee decideswhether to adjust or retain its target for thecurrent year and establishes tentative targetsfor the following year. Shortly after the Julymeeting, a report of the Committee’s decisionsis submitted to Congress. Table 1 summarizesthe Committee’s long-run monetary growth ob-jectives for 1989 as reported to Congress.

As was the case in the previous two years,the Committee did not establish a target rangefor Ml in 1989. The Committee believed thatthe unpredictable relation of Ml to economicactivity and prices did not warrant reliance onthis aggregate as a guide to the implementationof monetary policy.2

To underscore its commitment to resist futureinflationary pressures and to make progresstoward reasonable price stability, the Committeereaffirmed the 1989 targets for M2 and M3, 3to 7 percent and 3½to 7½percent, respective-

ly, that had been set tentatively in July 1988.’These target ranges for M2 and M3 ss’ere 1 and½percentage points, respectively, lower thanthose established for 1988.

The Committee also decided to maintain the 4percentage-point spreads between the upperand lower bounds of the target ranges for thetwo broad monetary aggregates. Until two yearsago, this spread had been 3 percentage points.The wider ranges were adopted in 1988 whenthe Committee concluded that the relations ofM2 and M3 growth to economic growth and in-flation had become considerably more variableand, therefore, that estimates of growth ratesfor these aggregates that would be consistentwith the Committee’s objectives for the economywere subject to greater uncertainty. Forecastingthe appropriate growth rates was made moredifficult by the Committee’s uncertainty aboutthe impact of future developments on thrift in-stitutions and the subsequent effect on the

2Recorrj (May 1989), pp. 357-58. See Hafer and Hastag(1988), who discuss the Committee’s decision to omit atarget range for Ml.

‘Report (March 1989), p. 108.

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Figure 1Money Stock (M2)

1988

The July Report also stated that the 1989target ranges for M2 and M3 would be extendedtentatively to 1990. While the Committee recog-nized that a further reduction in the growth ofthe monetary aggregates would be more consis-tent with attaining price stability over time,many members believed that more rapid M2growth might be necessary to promotereasonable growth in economic activity in 1990.Reductions in the ranges would increase the like-lihood of making policy appear unpredictable byincreasing the possibility of a reversal later or of

having to tolerate growth rates exceeding thelower target ranges. The targets for 1990 couldbe adjusted in February, if appropriate.°

Table 2 indicates that the actual rate of growthin Ma during 1989, 4.8 percent, was close tothe middle of its target range. The actual rateof growth in M3, 3.3 percent, however, wasslightly below the lower bound of its targetrange. The growth rates varied considerably

during the year as illustrated in figures 1 and 2,which show the monthly averages of (revised)daily figures, respectively, for M2 and M3. As dis-cussed below, these variations had some in-fluence on the Committee’s short-run policydecisions.

SHORT-RUN POLICY OBJECTIVES

Each year, the Committee holds eight regular-ly scheduled meetings to review incoming dataand assesses the current economic environmentand the prospects for the future course of theeconomy. Based on this information, the mem-bers determine what changes, if any, should bemade in short-run monetary policy to achievethe Committee’s long-term goals. At the close ofeach meeting, the Committee issues a domesticpolicy directive to the Federal Reserve Bank ofNew York. This directive serves as the basis forday-to-day implementation of policy in the inter-

1989

Nov Dec Jan Feb Mar Apr May Jun Jut Aug Sep Oct Nov Dec

°Record(October 1989), pp. 693-94.

Figure 2Money Stock (M3)Billions of dollars4250

3950

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Seasonally AdjustedMonthly Averages of Daily Figures

1989

meeting period by the Manager for DomesticOperations, who is responsible for executing thedirectives. As usual, the directives issued during1989 primarily emphasized the degree of re-straint on reserve positions (maintain, increase ordecrease) that was considered by the membersto be consistent with the Committee’s moneygrowth targets and goals for the economy.

Maintaining the approach used since October1982, the Federal Reserve System followed aborrowed-reserves operating procedure. Thisprocedure translates the degree of reserve re-straint specified in the directive into a target forborrowed reserves (reserves borrowed from theFederal Reserve Banks). For example, under this

procedure, an instruction to increase the degreeof pressure on reserve positions would imply ahigher target for borrowed reserves (adjustmentplus seasonal borrowings) and a higher federalfunds rate for a given discount rate.7

Toward the end of 1988 and continuing into1989, however, this operating procedure wascomplicated by the unstable relation between thedemand for borrowed reserves and the federalfunds rate. Specifically, the willingness of deposi-tory institutions to borrow reserves, for givenfederal funds and discount rates, was decliningunexpectedly. At the December 1988 meeting,the Committee considered the possibility of ad-justing the operating procedure to shift the focus

‘The positive relation between borrowed reserves and thefederal funds rate follows from economic theory.Specifically, the demand for borrowed reserves (the bor-rowings function”) is negatively related to the opportunitycost of borrowing from the discount window. This costequals the spread between the discount rate (the interestrate paid by depository institutions for borrowed reserves

from Federal Reserve Banks) and the federal funds rate(the interest rate paid for reserves borrowed from otherdepository institutions). For a discussion of the implemen-tation of monetary policy under the borrowed-reservesoperating procedure, see Gilbert (1985) and Thornton(1988).

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23

of policy implementation to the federal fundsrate, but the members generally agreed that ad-hering to the current procedure would be ap-propriate given its advantages.~Nevertheless, theCommittee believed that the uncertainty aboutthe relation of borrowings to the federal fundsrate warranted flexibility in implementing mone-tary policy. Hence, some of the directives issuedin 1989 were written with the understandingthat flexibility would be permitted in conductingday-to-day policy so as to achieve the Commit-tee’s objectives, given the changing conditions inthe market for borrowed reserves.

Furthermore, the Committee maintained theflexibility in short-run policy adopted in previousyears because of uncertainty about the relationsof monetary aggregate growth to output growthand inflation. The Committee believed that short-run policy should be decided not only on thebasis of the behavior of the monetary aggre-gates, but on the basis of indicators of infla-tionary pressures, economic growth and thechanging conditions in domestic financial andforeign exchange markets.°

In addition to the desired degree of reservepressure, the directives indicated potentialmodifications in the intermeeting period, andthe expected growth rates of M2 and M3 condi-tional on the desired reserve restraint. Eachdirective also established a monitoring range forthe federal funds rate. The Chairman could in-itiate a Committee consultation if, during the in-termeeting period, the federal funds rate wereto move out of that range. Over the past severalyears, however, such consultations have beeninitiated because of unexpected economic andfinancial developments.

The following discussion reviews each FOMCmeeting chronologically. It focuses on the im-portant economic developments of 1989, show-

ing how they influenced the Committee’s formu-lation of short-run policy objectives. Table 3summarizes the directives issued in 1989. Table4 shows the actual (revised) intra-year growthrates in Ma and M3, as well as those rates ex-pected by the Committee.

.Februariv •7-8 .MeetjrL~

Economic data reviewed at this meeting sug-gested that, abstracting from the direct impactof the previous year’s drought, economicgrowth continued at a fast pace. The markedincrease in total nonfarm payroll employment inJanuary was widespread and the civilian unem-ployment rate of 5.4 percent was only marginal-ly above December’s rate of 5.3 percent. Indus-trial production rose sharply in December andJanuary and the industrial capacity utilizationrate in January exceeded its average rate overthe fourth quarter of the previous year.1°

Indicators of inflation at the beginning of1989 showed hardly any change from 1988. Al-though the producer price index rose sharply inDecember, the behavior of the consumer priceindex, excluding food and energy, was perceivedto be in line with its pattern in 1988.” Laborcosts, particularly wages and salaries, rose appre-ciably faster than one year earlier, however.

As instructed by the Committee’s last directivein 1988, the degree of pressure on reserve posi-tions was increased at the beginning of the pre-vious intermeeting period. During this period,the average level of adjustment plus seasonalborrowings was slightly above $500 million andthe federal funds rate rose to about 9 percentfrom about 8½percent. As other market inter-est rates rose, the growth of the broadermonetary aggregates, particularly Ma, weakenedin January.12

8Record (April 1989), pp. 295-96. Also see, for example,Record (May 1989), p. 359. The particular advantage ofthe current operating procedure mentioned in the Commit-tee’s discussion was that it permits ‘greater scope formarket forces to determine short-term interest rates.”(Record (April 1989), p. 296.] Such a procedure, however,can be less effective in maintaining short-term control overthe money stock if the borrowings function is subject tounexpected shifts that are not quickly identified andreflected in changes to the borrowings assumption. SeeThornton (1988) for a discussion on the advantages anddisadvantages of this procedure.

9Report (March 1989), p. 108.‘°Record (May 1989), p. 353. Industrial production rose at

annual rates of 4.4 percent and 3.5 percent, respectively,

in December and January. The Board’s measure of thetotal industry capacity utilization rate in January was 84.3percent, up from the previous quarter’s average of 84.1percent.

lilbid., pp. 353-54. The annual growth rate of the seasonallyadjusted producer price index for finished goods was 3.3percent in December, while the seasonally adjusted con-sumer price index for all urban consumers rose at an an-nual rate of 4.1 percent. Excluding food and energy, thelatter index rose at an annual rate of 4.9 percent.

i2lbid., p. 354. In January, M2 rose sluggishly at an annualrate of 0.5 percent and M3 rose at an annual rate of 2.4percent.

Table 3The FOMC’s Short-Run Operating Ranges for 1989

Expected Degree lntermeetinggrowth of federal

Date of Target rates reserve fundsMeeting period M2 M3 pressure1 range

February 7-8. December 1988- 2% 31/2% maintain 7-11%1989’ March 1989 (+)

March 28. 1989~ March-June 3 5 maintain 8-12(+)

May 16, j9994 March-June 1½ 4 maintain 8-12

July 5-6, 1989~ June-September 7 7 slightly reduce 7-11

August 22, 19896 June-September 9 7 maintain 7-11(.—)

October 3, 1989’ September- 61/2 4½ maintain 7-11December 1—)

November 14, September- 7’/2 41/2 maintain 7-1119896 December

December 18-19. November 1989- 81/2 51/2 slightly reduce 6-101989° March 1990

IA - +‘ indicates an expectation that during the intermeeting period developments were morelikely to warrant an adjustment toward restraint than toward ease. The opposite is true for a

2Messrs. Hoskins and Parry dissented. Mr. Hoskins thought that an immediate move towardgreater monetary restraint would be appropriate to put policy on a course toward price stabilityin the longer run. Mr Parry stressed that, since economic growth had exceeded its long-run.noninflationary rate, inflationary pressures were already increasing. In their view, without animmediate increase in restraint on reserve positions, inflationary pressures would intensify andthereby make the task of achieving the Committee’s anti-inflationary goal more difficult.

~Ms.Seger dissented. Although maintaining the existing degree of reserve pressure was ap-propriate in her view, she believed that the bias toward monetary restraint was undesirable inlight of the lagged effects of appreciable tightening that had been undertaken earlier alongwith current indications of slower economic growth.

4Mr. Melzer dissented, advocating prompt action to ease the degree of reserve pressure slight-ly. Pointing to the past two years of slow money growth, he stressed that the current high in-flation would be reduced eventually and that, in the absence of an easing action, the risks ofa recession would be augmented. Reaching the System’s non-inflationary goal would behampered if, in response to a recession, monetary policy were to aim at a quick recovery.

°Ms.Seger dissented. She favored a greater degree of easing that. in her view, would benecessary to promote reasonable economic growth in the following years.

°Mr.Guffey dissented. He could accept an unchanged policy. But he believed that a directivethat was biased toward ease was not appropriate given that the chances of a weakening ofthe economic expansion appeared to be essentially the same as the chances of a strengthen-ing of the expansion while, in his view, the current and expected future inflation rates werenot acceptable. Furthermore, such a bias toward ease could lessen confidence in the Commit-tee’s commitment to achieve long-run price stability

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Some members advocated an immediate tight-ening of reserve conditions to contain any futureinflationary pressures. In their view, without im-mediate action, the task of achieving pricestability could become more difficult. Othermembers expressed concern that additionalpressure on reserve positions could aggravatethe financial conditions of many thrift institutionsand highly indebted firms. In addition, further re-straint might add to the recent unusual strengthof the dollar.” Although the recent slow growthof the monetary aggregates was thought to indi-cate future restraint on price pressures, somemembers cautioned that a shortfall fromtargeted ranges would be a matter of concern.’0

At the end of the meeting, the Committeeadopted a directive that called for an unchangeddegree of pressure on reserve positions, with apossible increase or decrease depending on forth-coming information about inflationary pressures,the strength of business expansion, growth inthe monetary aggregates and developments inforeign exchange and domestic financial markets.As table 3 indicates, however, there was a“bias” toward restraint, and the members calledfor “remaining alert to potential developmentsthat might require some firming during the in-termeeting period.”~In light of the continuinguncertainty about the relation of the demandfor borrowed reserves to the federal funds rate,the directive was issued with the explicit under-standing that flexibility would be needed in im-plementating monetary policy. Given the con-templated reserve conditions, the Committee ex-pected the annual growth rates for M2 and M3to be around 2 percent and 3½percent, respec-tively, from December to March, The directiveleft the range for the federal funds rate un-changed at 7 to 11 percent.18

March 28 Meeting

During the intermeeting period, additionalpressure was placed on reserve positions, in

light of incoming data indicating greater infla-tionary pressures. Also, on February 24, theBoard of Governors approved a 50 basis-pointincrease in the discount rate to 7 percent. Fromthe time of the increase in the discount rate tothis meeting, the federal funds rate rose nearly75 basis points to slightly above 9¾percent.Other market interest rates, especially those onshorter-term securities, also rose. As the de-mand for borrowed reserves appeared to fall,the borrowings assumption was lowered as atechnical adjustment. The average of adjustmentplus seasonal borrowings during the six-weekperiod just before this meeting fell to about$450 million. Although the monetary aggregatesappeared to gain some strength in February andMarch, their growth was viewed as sluggish re-lative to that in the previous year.’9

The information available for review at thismeeting suggested that economic activity ex-panded considerably in the first quarter. Totalnonfarm employment advanced sharply inFebruary and the civilian unemployment ratefell to 5.1 percent. Only part of the employmentgain was attributed to the unusually mild weath-er during the first two months of the year.2°

There were, however, indications of a slightweakening of the economic expansion. For ex-ample, preliminary data suggested that industrialproduction remained flat and capacity utilizationrates fell slightly in February.” Furthermore,growth in consumer spending slowed in thefirst two months of the year from its vigorouspace during the last quarter of 1988. Althoughthe data indicated that the nominal U.S. mer-chandise trade deficit improved in January, thevalue of exports fell. But the observed net riseof the trade-weighted value of the dollar overthe intermeeting period was attributed largelyto the rise in market interest rates stemming, inpart, from restrictive actions taken during thatperiod.”

“Ibid., pp. 358-59. As a measure of the relative strength ofthe dollar in foreign exchange markets, the FederalReserve Board constructs a trade-weighted index usingthe currencies of Belgium, Canada, France, Germany, Ita-ly, Japan, the Netherlands, Sweden, Switzerland and theUnited Kingdom. The trade-weighted index rose about 6percent over the intermeeting period.

‘~lbid

“‘Ibid., p. 359.18lbid,, pp. 359-60.

March. M3 rose at annual rates of 3.3 percent and 6.2percent, respectively, during those same two months.

20Ibid., p. 502. The civilian unemployment rate in Februaryhas been revised upward to 5.2 percent.

2llbid. Revised data indicate that industrial production ac-tually fell in February at an annual rate of 2.5 percent.

22lbid., pp. 502-03. The trade-weighted index of the value ofthe dollar in foreign exchange markets rose approximately1.5 percent over the intermeeting period.

“Record (July 1989), p. 503. M2 rose at annual rates of 1.8percent and 3.5 percent, respectively, in February and

‘1

Price pressures appeared to gain somestrength in the first two months of 1989. Theobserved increases in price indexes werethought to be due chiefly to energy and foodprices. Even excluding these components, how-ever, the producer and consumer price indexesrose sharply in January and February.”

The Board’s staff predicted that the pace ofeconomic expansion would slow considerablyfrom the pace in 1988. The forecast assumedthat monetary policy would restrain the infla-tionary tendencies in the economy. Such a policycould put additional pressure on financial mar-kets and involve slower growth in consumerspending and business fixed investment.”

The members generally agreed that, in light ofmixed evidence about the strength of economicexpansion and the uncertain prospects for thefuture, an unchanged policy would be accept-able. Some members, who preferred an immedi-ate tightening of reserve conditions, believedthat inflationary pressures could intensify giventhe apparent momentum in economic activity.These members, however, were willing to waitfor additional information that tended to confirmtheir fears. Most members believed that theunusual strength of the dollar in foreign ex-change markets would dampen price pressures.Furthermore, as suggested by earlier ex-perience, the sluggish growth in the monetaryaggregates lessened the likelihood that inflationcould gain much strength in the future.’~

As table 3 shows, the Committee adopted adirective that did not call for a change in policybut that permitted a policy adjustment duringthe intermeeting period more readily towardrestraint than ease. Open market operationswere to be conducted with some degree of flex-ibility because of the continuing uncertaintyabout the relation of the demand of borrowedreserves to the federal funds rate. Growth inM2 and M3 were expected to be around 3 per-cent and 5 percent, respectively, from March to

June. The intermeeting range for the federalfunds rate was increased 1 percentage point to8 to 12 percent, “in light of the tightening ofreserves since the February meeting and therelated increase in the federal funds rate.”2°

11:1ev ..i B Alerting

Aside from the slightly firmer reserve condi-tions due to the greater-than-expected reserveflows related to April tax payments, reserveconditions hardly changed in the intermeetingperiod. During this period, the average of adjust-ment plus seasonal borrowing rose to about$565 million, while the rate at which federalfunds traded rose slightly to around 9-7/8 per-cent. Other market interest rates, especiallyshort-term rates, fell over the intermeetingperiod, however. Estimated growth of the mone-tary aggregates was sluggish, with the cumula-tive growth of M2 since the fourth quarter of1988 well below the lower bound of the Com-mittee’s target range and that of M3 just abovethe lower limit of its target range.27

Economic data reviewed at this meeting sug-gested that the expansion of economic activityhad moderated in recent months. Growth intotal nonfarm employment edged downward inMarch and April, while the civilian unemploy-ment rate climbed from 5.0 percent in March to5.3 percent in April. In addition, growth in con-sumer spending maintained the much slowerpace established in the first part of the yearrelative to that in 1988, Industrial productiongrew in April, but, from December to April, itgrew more slowly than it had in 1988. Much ofthe April growth was attributed to an increasein automobile assemblies after a weak firstquarter and a rebound in the output of otherconsumer goods. Although the total capacityutilization rate rose slightly in April, it remainedbelow its January rate.28

There were indications, however, that themomentum in economic activity had not been en-

23lbid. The seasonally adjusted producer price index forfinished goods rose at annual rates of 13.9 percent and7.8 percent, respectively, in January and February; ex-cluding food and energy prices, it rose at annual rates of6.2 percent and 7.2 percent, respectively, in January andFebruary. Similarly, the seasonally adjusted consumerprice index for all urban consumers rose at annual rates of7.2 percent and 5.1 percent, respectively, during the firsttwo months of the year; excluding food and energy, thisindex rose at annual rates of 5.9 percent and 4.8 percent.

l4lbid., p. 504.

25lbid., p. 505.26lbid., p. 506.27Record (September 1989), pp. 626-27. In April, M2 and M3grow at annual rates of 1.0 percent and 2.6 percent,respectivoly.

28lbid., p. 625. The annual growth rate in the industrial pro-duction index rose from 1.7 percent in March to 8.9 per-cent in April. During that month, the total capacity utiliza-tion rate rose 0.4 percentage points from the previousmonth to 84.2 percent.

28

tirely lost. Capital business spending reboundedafter falling in the last quarter of 1988. Further-more, although the nominal U.S. merchandisetrade deficit widened in February, the averagedeficit for the first two months of 1989 remain-ed below that for the fourth quarter of 1988,with the value of exports growing more rapidlythan that of imports - Despite the slight deteriora-tion in the external trade balance in Februaryand the general downward movement in interestrates more recently, the dollar gained furtherstrength in the intermeeting period.”

The recent behavior of the price indexes didnot ease the members’ fear of future inflation.Rather, price level movements were interpretedby the members as an indication that inflation-ary pressures were rooted deeply in the econo-my. Although the producer price index grewmore slowly in March and April than in theearlier two months of the year, the consumerprice index grew at a slightly faster pace in thefirst quarter of 1989 than in the previousquarter. Increases in food and energy pricescontributed to the observed increases in mea-sured inflation, but were not the sole drivingforce of the perceived upward trend in infla-tion.3°

The staff’s projection changed little from thatprepared for the previous meeting. Growth ineconomic activity was expected to be slowerthan in 1988. The forecast indicated that pricesat both the consumer and producer levelswould increase at somewhat faster rates in 1989.In the staff’s view, monetary policy that at-tempted to contain such inflationary pressures,should they materialize, would imply greaterpressure on financial markets. In addition to acontinuation of sluggish growth in consumerspending, the staff expected that growth in busi-ness capital spending would retreat from its fastpace in the first quarter.3’

Uncertainty about the impact of previous re-strictive policy actions on inflation and the paceof economic growth dominated the discussion atthis meeting. Whether monetary conditions

were sufficiently restrictive to contain future in-flationary pressures without precipitating an ex-cessive slowing of economic growth remainedunclear. Although one member believed that animmediate easing of reserve pressure would beboth necessary and desirable to improve theprospects for adequate monetary growth to sus-tain the economic expansion, others feared therisks associated with such a policy—that is, ofhaving to reverse the easing if the monetary ag-gregates were to accelerate unduly and pricepressures were to intensify later.”

In the discussion about possible adjustments tomonetary policy in the intermeeting period, mostmembers agreed that no bias—either towardrestraint or ease—would be appropriate. Whileone member believed that policy should be par-ticularly alert to behavior of the monetary aggre-gates that could warrant some easing, othersbelieved that the deeply rooted inflationarypressures called for a bias toward restraint. Anumber of members expressed concern that theabsence of a bias toward restraint might give anincorrect signal that the Committee was movingaway from its anti-inflationary commitment.’~

At the end of this meeting, the Committeeissued a directive that called for an unchangeddegree of pressure on reserve positions. Depen-ding on forthcoming information, a move tosome restraint or ease would be acceptable dur-ing the intermeeting period. The Committeebelieved that continuing uncertainty about therelation of the demand for borrowed reservesto the federal funds rate warranted continuingflexibility in the implementation of monetarypolicy. The Committee expected that the contem-plated reserve conditions would be consistentwith M2 and M3 growing at 1½and 4 percentannual growth rates, respectively, from Marchto June. The intermeeting range for the federalfunds rate was kept at 8 to 12 percent.34

July 5-6 Meeting

Late in the intermeeting period, incoming in-formation tended to confirm earlier indications

“Ibid., pp. 625-26. The value of the dollar relative to theother 0-10 currencies appreciated about 4 percent overthe intermeeting period.

“Ibid., p. 626. The seasonally adjusted consumer price in-dex for all urban consumers rose at annual rates of 6.1percent and 8.1 percent, respectively, in March and April.Excluding food and energy prices, this price index rose4.8 percent and 2.9 percent. The producer price index for

finished goods, excluding food and energy, rose at annualrates of 2 percent and 1 percent.

3’ Ibid., p. 627.32lbid., pp. 628-29.

“Ibid., p. 629.“Ibid.

29

that the economic expansion had slowed so thatthe prospect of weakening inflationary pressuresseemed more promising. Furthermore, the mon-etary aggregates continued to exhibit slowgrowth and the dollar had gained considerablestrength earlier in the intermeeting period. Ac-cordingly, a slight lowering of the pressure onreserve positions was sought. Before this easing,however, a technical upward revision had beenmade to accommodate unusual strength in sea-sonal borrowing. Over the six-week period end-ing June 27, the average of adjustment plusseasonal borrowings was around $550 million,and the federal funds rate edged down to 9½percent. Other market interest rates, especiallythose on long-term securities, also fell. The ob-served decline in the level of the broader mone-tary aggregates during May was interpreted asa reversal of the temporary rise in transactionaccounts related to April tax payments.”

Confirming earlier evidence, the informationavailable for review at this meeting suggestedthat the economic expansion had slowed consid-erably from its pace in 1988. While the civilianunemployment rate fell to 5.2 percent in May,growth in total nonfarm employment was rela-tively weak. Preliminary data indicated that, inMay, growth in industrial production was modestand the total capacity utilization rate had fallenback to its March Ievel.30 While business capitalspending appeared to make further gains in thesecond quarter, growth in consumer spendingremained sluggish. Further, the significant im-provement in the nominal U.S. merchandisetrade balance during April stemmed chieflyfrom a considerable drop in imports with only aslight increase in exports.’7

Price pressures persisted despite the indica-tions of slowing economic expansion. Increasesin food and energy prices, however, made largecontributions to the increases in the producerprice index and, to a lesser extent, in the con-

sumer price index.” Nevertheless, the growth inlabor costs appeared to have maintained itsmomentum from the middle of 1988.

The Board’s staff revised its forecast foreconomic growth in the second half of the yeardownward from that made earlier in the year.The staff’s forecast now suggested less inflationthan was previously expected, though more in-flation than had been experienced in 1988, andcontinued growth in labor costs in 1989. Thisinflation outlook took account of the persistentstrengthening of the dollar that was expected todampen inflationary pressures. The forecast,however, also pointed to slightly more favorableinflationary conditions in 1990 than werepreviously expected.”

In the context of a weaker outlook foreconomic growth, the members generally believ-ed that a further reduction in the degree ofpressure on reserve positions would be ap-propriate. Although there was some disagree-ment about the timing and the extent of sucheasing, most members agreed that they couldaccept an immediate slight reduction in reservepressure. In the view of many members, agreater move toward ease could have an unde-sirable effect on inflationary expectations, there-by putting upward pressure on long-term inter-est rates. A substantial move toward ease mighthave to be reversed if inflationary pressuressubsequently intensified.

Nearly all believed, however, that the easingshould be implemented immediately given theslowing pace of economic expansion and thesluggish growth of the broader monetary aggre-gates. Although some members preferred a direc-tive that was biased toward restraint to main-tain the credibility of the Committee’s anti-infla-tionary commitment despite the easing of policy,others advocated a bias toward ease to com-municate the Committee’s belief that the risks

“Record (October 1989), p. 691. Revised data indicate thatin May, M2 declined at an annual rate of 1.6 percent andM3 rose sluggishly at an annual rate of 0.2 percent. InJune, the annual growth rates in M2 and M3 rebounded to6.5 percent and 6.0 percent, respectively.

“Ibid., p. 689. Revised data indicate that the industrial pro-duction index fell at an annual rate of 0.8 percent in May,while the total capacity utilization rate in May, which fell to84.0 percent from 84.2 percent in April, was above therate of 83.8 percent in March.

‘ibid., pp. 689-90. Despite the improvement in the externalbalance, the value of the dollar relative to the other 0-10currencies fell on net about 3 percent over the in-

termeeting period. After having risen sharply in the firsthalf of the period, the trade-weighted index of the value ofthe dollar declined appreciably over the second half.

“Ibid., p. 690. But, even excluding food and energy prices,the seasonally adjusted producer price index advancedsharply, rising at annual rates of 7.2 percent and 8.2 per-cent, respectiv&y, in May and June. Similarly, theseasonally adjusted consumer price index, excluding foodand energy components, rose 5.8 percent and 2.8 percent,respectively, in May and June.

“Ibid., p. 691.

30

of an undesirable shortfall in economic growthwere substantial. Most members agreed that,given the prevailing uncertainty, they could ac-cept an unbiased directive.~°

As table 3 shows, the directive issued by theCommittee at the close of this meeting calledfor an immediate and slight reduction in thedegree of reserve pressure. Further easing orsome tightening was considered to be ap-propriate depending on future developments.Conditional on the contemplated reserve condi-tions, the Committee expected that both M2 andM3 would grow at an annual rate of 7 percentfrom June to September. Given the easing ofreserve pressure in early June and thatspecified in this directive, the monitoring rangefor the federal funds rate was lowered 1percentage point to 7 to 11 percent.4’

./lu.gust 2.2 Meeting

As instructed by the Committee at the close ofthe previous meeting, the degree of pressure onreserve positions was reduced at the beginningof the intermeeting period. Toward the end ofJuly, the degree of reserve restraint was easedfurther, in light of incoming data that indicateda continued weaker economic expansion and aslight reduction in inflationary pressures. At thebeginning of the intermeeting period, however,the assumed level of adjustment plus seasonalborrowing was increased as a technical revisionprompted by a projected rise in seasonal bor-rowing during the summer months. Hence, theaverage of adjustment plus seasonal borrowingsover the six-week period ending August 22 roseto approximately $600 million despite the easingactions taken during this period. Nevertheless,the federal funds rate fell 50 basis points toaround 9 percent. Preliminary data indicatedthat, in July, growth in the monetary aggregatesgained considerable strength, which appeared tocontinue into August.4’

The data reviewed at this meeting reinforcedthe earlier evidence of a moderate economic ex-pansion. The data, however, suggested less weak-ness in the expansion than they had toward theend of July. Nonfarm payroll employment madeconsiderable advances in June and July. The ci-vilian unemployment rates for these months, 5.3percent and 5.2 percent, respectively, wereclose to the average unemployment rate duringthe first five months of the year. In addition,preliminary data indicated that industrial produc-tion rebounded in July after having fallen inMay and June.4’ Industrial capacity utilizationmaintained its high rate, although the rate formanufacturing in July was well below that inJanuary. Moreover, growth in consumer spend-ing in the second quarter was stronger than ori-ginally estimated, and the observed narrowingof the nominal U.S. merchandise trade deficitreflected not only a notable decline in the valueof imports, but a marked jump in the value ofexports.44

The recent behavior of price indexes sug-gested somewhat less inflation primarilybecause of appreciable declines in food andenergy prices. Preliminary data indicated that,while the consumer price index rose in bothJune and July, the increases were modest, andthe producer price index for finished goodsfell.~’Wage growth over the past severalmonths did not appear to deviate from previous-ly established trends.

The staff expected that, during the rest of theyear, growth in the nonfarm economy wouldmaintain its pace from the first half of the yearand then grow more slowly in 1990. With inter-est rates falling since the spring and the recent-ly observed substantial job gains, consumerspending was expected to exhibit greaterstrength in the coming months. The forecast in-dicated that business capital spending wouldcontinue to make a large contribution to econom-ic growth. Partly because of the earlier strength-

40Ibid., p. 695.41lbid., p. 696. In this instance, there was no mention of theuncertainty revolving around the relationship between bor-rowings and the federal funds rate and, therefore, noreference to flexibility in monetary policy implementation.

42Record (December 1989), p. 813. Growth in M2 ac-celerated from 6.5 percent in June to 10.3 percent in July.The annual growth rate in M3 rose less dramatically from6.0 percent in June to 6.9 percent in July.

4’Ibid., p. 812. Revised data, however, indicate that in-dustrial production rose at an annual rate of 3.4 percent in

June and fell at an annual rate of 0.8 percent in July. TheJuly civilian unemployment rate has been revised upwardto 5.3 percent.

“Ibid., pp. 812-13.~‘lbid.,p. 813. The seasonally adjusted producer price index

for finished goods rose at an annual rate of 1.1 percent inJune and fell at an annual rate of 4.1 percent in July. But,excluding the food and energy prices, this index rose atan annual rate of 8.2 percent in June and fell at an annualrate of 1.9 percent in July.

31

ening of the dollar in foreign exchange markets,however, foreign trade was not expected to bea significant source of economic growth. In ad-dition, although expected further declines infood and energy prices suggested that pricepressures could weaken in the coming quarter,the staff expected no substantial improvementin the inflationary trend through 1990.48

With evidence that the economic expansionhad stabilized at a “provisionally acceptable pace”and that inflationary pressures were not gainingstrength, the members generally believed thatthe current degree of reserve pressure shouldbe maintained, at least in the early part of theintermeeting period. An unchanged course forpolicy was also justified by the observation thatgrowth in M2 and M3 recently had gained suffi-cient strength to place these aggregates in theirtarget ranges.47

Discussing possible adjustments in policy dur-ing the intermeeting period, many members ex-pressed the belief that, if future developmentswere to warrant a change in policy, the directionof change would most likely be toward someease. Some members, however, preferred not toincorporate such a presumption in the directive.In their view, the “risks to the economy weremore evenly balanced.” That is, the direction ofchange in policy justified by developments inthe intermeeting period was just as likely to betoward restraint as it was toward ease. Further,these members believed that a bias toward easecould “lead to a misreading of System policy inthe context of an unacceptably high rate of in-flation.”~’

The directive issued at the end of this meetingspecified no immediate change in policy, as table

3 indicates. Despite some members’ reserva-tions, the directive included a bias toward ease.The Committee expected M2 and M3 to grow atannual rates of about 9 percent and 7 percent,respectively, from June to September. The inter-meeting range for the federal funds rate waskept at 7 to 11 percent.4°

Oct:~ehe.r3 Itteeting

Over the intermeeting period, reserve condi-tions displayed no noticeable change. The aver-age of adjustment plus seasonal borrowing dur-ing the four weeks ending September 20 fellslightly to about $550 million, and the federalfunds rate fluctuated within a narrow rangecentered around 9 percent. Although M2growth was strong, M3 growth had unexpected-ly lost some of its strength in August and prelim-inary data suggested that this slower growthhad continued into September30

The data available for review at this meetingreaffirmed earlier projections, that the economicexpansion had continued at a moderate pace inthe third quarter. Nonfarm payroll employmentgenerally made considerable advances after al-lowing for the effects of strike activity. Neverthe-less, there were hardly any job gains in manu-facturing industries, and the civilian unemploy-ment rate in August and September was close to5¼percent. Further, after increasing moderate-ly in August, industrial production fell slightlyin September.” The industrial capacity utiliza-tion rate, however, remained relatively high.While growth in business capital spendingseemed to have slowed in the third quarter, con-sumer spending continued to exhibit consider-able strength. With the value of imports declin-

4~lbid.,p. 814. Over the intermeeting period, the value ofthe dollar relative to the other 0-10 currencies rose ap-proximately 2.7 percent, almost offsetting the previous netdecline. Even so, the trade-weighted value of the dollarwas below the highs reached in June.

4~Ibid.,pp. 815-16. Although the staff predicted that M2 andM3 growth would slow considerably from the current pace,the growth in the aggregates was expected to remain com-fortably within their target ranges. These forecasts formoney growth as well as those made subsequently in1989, however, were subject to great uncertainty as aresult of the uncertainty revolving around the resolution ofthrift institution insolvencies and the responses of thrift in-stitutions to recently enacted legislation. These factorswere expected to dampen growth in the broader monetaryaggregates, particularly that in M3. Thus, any observedweakness in the growth of these aggregates would not beinterpreted as evidence of a slowing economy. Ibid., p.

“Ibid., p. 816.

“Ibid., pp. 816-17.

‘°Record(January 1990), pp. 18-19. The slowing of thegrowth of the monetary aggregates was especially evidentin M3. M2 grew at annual rates of about 7.8 percent and6.5 percent, respectively, in August and September; M3grew at an annual rate of 1.4 percent in August and wasflat in September.

~‘Ibid., p. 17. The annual rate of growth of the industrial pro-duction index fell from 5.2 percent in August to -1.7 per-cent in September. Revised data indicate that the civilianunemployment rate in August and September was 5.3percent.

816.

-32

ing by more than the value of exports, the U.S.merchandise trade deficit improved further inJuly52

The price indexes continued to indicate alower rate of inflation. In August, producerprices fell and the consumer price index wasunchanged.” The upward trend in labor costs,however, did not appear to change on a year-to-year basis.

The staff’s forecast for economic growth inthe remaining part of 1989 and 1990 were es-sentially unchanged from those made for theprevious meeting. Growth in business capitalspending was expected to slow from its pace inthe first half of the year, however,’~Most mem-bers believed that, although economic activitywould continue to expand in the coming quar-ters, the pace of the expansion would more like-ly slow than build momentum. While the mem-bers generally expected some weakening in in-flationary pressures, only a few thought thisweakening might be appreciable. A number ofmembers expressed concern that progresswould be constrained considerably if economicactivity were to build momentum. Furthermore,the members believed that the recent fall of thevalue of the dollar in foreign exchange marketswould add to future upward pressure onprices.”

Most members thought that an unchangedpolicy would be appropriate in the near term.The focus of policy continued to be that ofgradually reducing inflation over time and asteady policy course seemed consistent withthat objective, at least for the time being.’°

Growth in the monetary aggregates was ex-pected to moderate from the rapid pace sincethe middle of the year, given an unchangedpolicy. Most members believed, however, thatfuture developments would more likely requireease than restraint in the intermeeting period.Nevertheless, the recent depreciation of theforeign value of the dollar warranted caution inundertaking any easing adjustments.”

The directive issued at the end of this meetingwas written with the understanding that adownward technical adjustment to the borrow-ings objective might be appropriate, if, as ex-pected, seasonal borrowings were to drop inthe intermeeting period. The reserve conditionscontemplated by the members were thought tobe consistent with M2 and M3 growing at an-nual rates of 6½percent and 4½percent,respectively, between September and December.The monitoring range for the federal funds ratewas unchanged at 7 to 11 percent.”

.IV4ye:nhe.r 14 A::leen.ng

Reserve conditions were eased in mid-October.For a short period after the sharp drop in stockprices on October 13, an accommodative provi-sion of reserves was undertaken while financialmarkets remained highly sensitive and volatile.Around the same time, in keeping with theprevious meeting’s directive, a decision wasmade to implement some easing on a more per-manent basis. Incoming data, indicating an in-creased risk of a weakening in the business ex-pansion, also prompted additional easing earlyin November. Furthermore, in light of a per-ceived decline in adjustment plus seasonal bor-

“Ibid., pp. 17-18.

“Ibid., p. 18. The decline in producer prices, however, wasdriven largely by a continued decline in energy prices. InAugust, the seasonally adjusted producer price index forfinished goods fell at an annual rate of about 3.1 percent,but, excluding energy and food, this index rose at an an-nual rate of 6.1 percent. The seasonally adjusted con-sumer price index excluding energy and food, however,rose only 1.9 percent in August. In their discussion aboutthe outlook for inflation, the members commented that therecent declines in food and energy prices that haddampened price inflation might be temporary. Ibid., p. 20.

‘~lbid., p. 19.

“Ibid., pp. 19-20. The trade-weighted value of the dollarrelative to the other 0-10 currencies fell 2.7 percent overthe intermeeting period. A fall in the value of the dollar,holding all else constant, increases the attractiveness ofU.S-produced goods to foreign importers and U.S. in-dividuals. The resulting shift in demand can createdomestic price pressures. A fall in the value of the dollar

can also increase the costs of production for those U.S.firms relying heavily on imported intermediate goods,thereby creating additional price pressures. See Hafer(1989) for a detailed discussion of the link between infla-tion and a dollar depreciation.

“Ibid., p. 20. There was also a concern that, given the re-cent 0-7 meeting, an easing of policy would be mistakenlyinterpreted as an action to lower the value of the dollar.The Committee believed that monetary policy should notbe used as an instrument for achieving a given objectivefor the dollar in foreign exchange markets if that objectivewere not compatible with domestic policy objectives. In theview of some members, if recent intervention by 0-7 andother nations were to result in a lower value of the dollar,the inflationary consequences would hamper the Commit-tee’s ability to achieve its long-run goal of price stability.bid,, pp. 20-21.

“Ibid., p.21.

‘8lbid., pp. 21-22.

rowings, several technical adjustments in theborrowing assumption were made during the in-termeeting period. From early October to thismeeting, actual borrowings fell from about $635million to about $200 million. With most marketinterest rates falling, the federal funds rate de-clined from about 9 percent to 8½percent inthe intermeeting period and growth in the mon-etary aggregates gained strength in October.”

The data reviewed at this meeting indicatedthat the economic expansion had continued at amoderate pace. Nonfarm employment gainswere considerable in October and the civilianunemployment rate did not budge at 5.3 per-cent. The data also suggested, however, that thestrength of expansion was not evenly distributedthroughout the economy. For example, mostemployment gains occurred in the service sec-tor, while manufacturing employment declined.In addition, industrial production dropped appre-ciably in October, though much of the declinewas attributed to several incidents that tendedto disrupt production temporarily (the Boeingstrike, the earthquake and the hurricane).~°Thedata also showed that retail sales had fallen andthe growth of business capital spending hadweakened. Furthermore, with the value of im-ports rising and the value of exports falling inAugust, the U.S. merchandise trade deficit hadrisen to its highest level thus far in 1989.61

The recent behavior of price indexes wereconsistent with a slight reduction in inflationarypressures. The percentage rise in producerprices fell in October and, excluding energy andfood, had hardly changed.~’But the data did notsuggest any slowing in the growth of laborcosts.

In light of the temporary disruptions to pro-duction, the staff’s forecast pointed to a furtherslowing in growth in the fourth quarter and arebound in the first quarter of 1990. On net,

the staff predicted that economic growth wouldcontinue at a sluggish pace in the coming quar-ters. Although continuing growth in consumerdemand was expected to contribute to economicactivity in the near term, consumer demandwas expected to weaken subsequently. Further,the forecast indicated that the sluggish pace inthe growth of business capital spending wouldcontinue and that net exports would not make asignificant contribution to the economic expan-sion. The staff’s forecast did not suggest, how-ever, any substantial improvement in the under-lying trend in inflation,°’

Most members agreed that the data pointed,on balance, to a sustained economic expansion,although growth had weakened recently. Butthere was no strong consensus among the mem-bers about the future outlook. While some mem-bers expected that the risks of a stronger-than-desirable expansion and a weaker expansionwere evenly balanced, others expected a greaterlikelihood of either a stronger or considerablyweaker economic expansion activity, and stillothers believed that the chances of an economicexpansion close to the economy’s potential inthe future were not remote.’4 Similarly, somemembers believed that progress on improvingthe underlying inflation trend might be achievedgiven the recent behavior of the price level in-dexes and other factors, though others saw thatsuch progress, if any, would be small over thenext several quarters.”

Although the economic expansion appeared tobe slowing, most members advocated a steadypolicy with no immediate change in the degreeof pressure on reserve positions. Such a policywas considered to be consistent with the Com-mittee’s goals of promoting a sustained economicexpansion while making progress toward reduc-ing inflation in the long run. Moreover, membersbelieved that the recent and expected growth inthe monetary aggregates did not warrant any

“Report (February 1990), p. 56. The annual rates of growthof M2 and M3 rose to 7.1 and 1.4 percent, respectively, inOctober. This acceleration was not as pronounced as thatin Ml whose annual growth rate rose from 3.9 percent inSeptember to 8.3 percent in October.

“Ibid., p. 55. The industrial production index fell at an an-nual rate of about 4.1 percent in October.

“Ibid., pp. 55-56.‘2lbid., p. 56. Revised data indicate that the seasonally ad-

justed producer price index for finished goods rose at anannual rate of 6.5 percent in October. Excluding food andenergy components, it rose at a 2.0 percent annual rate.

“Ibid., p. 57.‘4lbid., p. 57. The recent depreciation of the dollar in foreign

exchange markets was expected by some members toprovide a source of improvement in the nation’s tradedeficit, especially in light of the observed strength ineconomic activity experienced recently by other industrialnations. Such an improvement would provide additionalstrength to the U.S. economic expansion.

“Ibid., pp. 57-58.

adjustment in policy. Hence, as table 3 shows,the directive issued at the close of this meetingdid not call for any change in policy.”

Most members, however, believed that thepossibility of weakening in the economic expan-sion exceeded the possibility of excessivegrowth and, accordingly, that future economicdevelopments would more likely warrant subse-quent easing actions than tightening actions inthe intermeeting period. Those members whobelieved that the likelihood of excessive growthwas evenly balanced against the likelihood ofweakening in the expansion indicated that theycould accept a directive containing a bias towardease in the intermeeting period. But some em-phasized the need for approaching possible eas-ing adjustments with caution so as not todetract from any progress that could be madein eventually approaching the Committee’s goalof reasonable price stability.”

The members expected M2 and M3 to grow atannual rates of 7½and 4½percent, respective-ly, between September and December. The mon-itoring range for the federal funds rate wasmaintained at 7 to 11 percent.”

ilece,nb.er I ~J II Meeling

During the intermeeting period, policy aimedto maintain a steady (or unchanged) degree ofreserve restraint. Technical adjustments in theborrowings assumption were made twice in theperiod in light of ongoing declines in seasonalborrowing. During the first two weeks of De-cember, adjustment plus seasonal borrowingsaveraged about $130 million, down from theaverage of about $400 million during the twoprevious weeks. Meanwhile, the federal fundsrate remained at about 8½percent and othermarket interest rates changed little during mostof this period. Preliminary data indicated thatthe growth in the broader monetary aggregatespicked up during November and remained ro-bust in the first part of December.”

The information available for review at thismeeting suggested that the economic expansionin the fourth quarter had slowed from its paceearlier in the year. Although total nonfarm pay-roll employment made considerable gains inNovember, these gains were concentrated in theservice, trade and financial sectors, with conti-nuing losses in manufacturing. The Novembercivilian unemployment rate, 5.4 percent, was atits highest level since January. Industrial pro-duction in November rebounded from its pre-vious decline driven by earlier strike activityamong other factors.’° Upon adjusting for thesefactors, industrial production appeared to havefallen, on average, in recent months. In ad-dition, although nominal retail sales reboundedin November, sales had hardly changed fromtheir average in the third quarter, and data in-dicated a weakening in business capital spend-ing. With imports up sharply and exports virtual-ly unchanged, the nominal U.S. merchandisetrade deficit rose considerably in October afterhaving fallen slightly in September.”

Estimated movements in price indexes contin-ued to suggest a slight weakening in inflationarypressures. For example, the producer price in-dex, based on preliminary data, fell in November.This decline, however, was partly attributableto sharp reductions in energy prices.72 Althoughaverage hourly earnings had fallen in November,the underlying trend in labor cost growth wasnot expected to change given the results of therecent collective bargaining activities.”

The staff’s forecast had not changed substan-tially from the previous meeting. It pointed to aslowing in the economic expansion in the fourthquarter with a rebound in the first quarter of1990. The magnitude of the rebound was ex-pected to be limited by anticipated declines inmotor vehicle production. Economic growth forthe rest of 1990 was expected to be driven pri-marily by moderate growth in consumer spend-ing. Net exports were expected to make a small

“Ibid., p. 58.Ollbid., pp. 58-59.

“Ibid., pp. 59-60.“Record (Federal Reserve Press Release, February 9,1990), pp. 4-5. The annual rate of growth in M2 increasedslightly to 7.5 percent in November, while the annualgrowth rate in M3 nearly tripled to 4.0 percent.

“Ibid., p. 1. The annual growth rate of the industrial produc-tion index rose to 3.4 percent in November. It should benoted that the November civilian unemployment rate hasbeen revised to 5.3 percent.

“Ibid., p. 2-3. Total industry capacity utilization having notchanged in November from October at 83.1 percent was 1percentage point below its level a year earlier.

‘2lbid., pp. 3-4. Revised data indicate that the seasonally ad-justed producer price index actually rose at an annual rateof 1.1 percent in November. Excluding food and energy,this index rose at an annual rate of 3.0 percent.

“Ibid., p. 4.

35

contribution to the economic expansion in 1990.Further, while the staff anticipated that pres-sures on labor and other resources for produc-tion would lessen slightly, no large changes inthe underlying trend of inflation were cx-pected.’~

The members generally agreed that there wasconsiderable evidence that the economy’sgrowth had weakened and would likely remainat a sluggish pace in the near term. Although anumber of members thought that some strength-ening in the economic expansion in 1990 was areasonable expectation, most believed that thechances of a weakening were “sufficiently highto justify an immediate move to slightly easierreserve conditions.” Those advocating this poli-cy change believed that such a move would notjeopardize the System’s credibility of adheringto its long-run goal of price stability, as pricepressures and business conditions appeared tohave weakened.

Others less optimistic about the potential pro-gress toward reducing inflation favored an un-changed policy. Skepticism about this progresswas partly driven by the recent decline of thedollar and the possibility that, if economic activi-ty were to rebound in the next year, inflationarypressures could gain considerable strength.”Those advocating an unchanged policy empha-sized that maintaining current reserve condi-tions would be sufficient to ensure a continua-tion of the expansion with an easing of pressureon productive resources, and that “further eas-ing might overcompensate for current weaknessin the economy at the cost of delaying progresstoward price stability.” Nevertheless, most ofthese members, recognizing the risks of an ad-ditional weakening in the economy, could ac-cept a policy that sought an immediate butslight easing of the degree of pressure on re-serve positions. In their view, given such a poli-cy, it was highly unlikely that further easingwould be warranted during the intermeetingperiod.”

As indicated in table 3, at the close of thismeeting, the Committee issued a directive call-ing for a slight easing of reserve conditions.

This directive did not reflect a presumptionabout the direction of possible adjustments inthe intermeeting period. The Committee ex-pected that the annual rates of growth of M2and M3 would be 8½percent and 5½percent,respectively, from November 1989 to March1990. In addition, given the easing of reserveconditions in recent months and the furthereasing stipulated in this directive, the Committeelowered the monitoring range for the federalfunds rate 1 percentage point to 6 to 10 per-cent.”

During 1989, the economic data available forreview at FOMC meetings prompted Committeemembers to shift their primary concern fromthe risks of inflation to the risks of a slowdownin economic activity. At the beginning of theyear, the threat of a worsening in the underly-ing inflationary trend drove the formulation ofpolicy. As the evidence of a weakening economicexpansion accumulated and the outlook for in-flation appeared to become less threatening, theCommittee became more sensitive to the risksof a future slowdown in economic activity.Because the Committee understood that its in-terpretation of the data was unavoidably subjectto great uncertainty, however, it took what itperceived to be a conservative approach to re-acting to this information in an effort to balancethese risks. This approach was also motivatedby the Committee’s ultimate goal of eventuallyachieving reasonable price stability and its desireto maintain its own credibility as an inflation-fighter.

REFEIIENCE-S

Garfinkel, Michelle R. “The FOMC in 1988: Uncertainty’s Ef-fects on Monetary Policy,” this Review (March/April 1989),pp.16-33.

Gilbert, R. Alton. “Operating Procedures for ConductingMonetary Policy[ this Review (February 1985), pp. 13-21.

Hafer, R.W. “Does Dollar Depreciation Cause Inflation?”this Review (July/August 1989), pp. 16-28.

Hafer, R.W., and Joseph H. Haslag. “The FOMC in 1987:The Effects of a Falling Dollar and the Stock Market Col-lapse,” this Review (March/April 1988), pp. 3-16.

Thornton, Daniel L. “The Borrowed-Reserves Operating Pro-cedure: Theory and Evidence:’ this Review (January/February 1988), pp. 30-54.

‘-‘Ibid., p. 5-6.

“Ibid., p. 10.“Ibid., pp. 9-10. Over the intermeeting period, the trade-

weighted value of the dollar relative to the other 0-10 cur-rencies fell about 2.8 percent.

“Ibid., p. 10.‘8lbid., pp. 11-12.“Ibid., pp. 13-15.