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Monetary Policy Report to the Congress
          Report submitted to the Congress on February 17, 2000, pursuant
          to the Full Employment and Balanced Growth Act of 1978 


          Monetary Policy and the Economic Outlook
          The U.S. economy posted another exceptional performance in
          1999. The ongoing expansion appears to have maintained
          strength into early 2000 as it set a record for longevity,
          and--aside from the direct effects of higher crude oil
          prices--inflation has remained subdued, in marked contrast to the
          typical experience during previous expansions. The past year
          brought additional evidence that productivity growth has
          improved substantially since the mid-1990s, boosting living
          standards while helping to hold down increases in costs and
          prices despite very tight labor markets. 
          The Federal Open Market Committee's pursuit of financial
          conditions consistent with sustained expansion and low inflation
          has required some adjustments to the settings of monetary policy
          instruments over the past two years. In late 1998, to cushion the
          U.S. economy from the effects of disruptions in world financial
          markets and to ameliorate some of the resulting strains, money
          market conditions were eased. By the middle of last year,
          however, with financial markets resuming normal functioning,
          foreign economies recovering, and domestic demand continuing
          to outpace increases in productive potential, the Committee
          began to reverse that easing. 
          As the year progressed, foreign economies, in general, recovered
          more quickly and displayed greater vigor than had seemed likely
          at the start of the year. Domestically, the rapid productivity
          growth raised expectations of future incomes and profits and
          thereby helped keep spending moving up at a faster clip than
          current productive capacity. Meanwhile, prices of most
          internationally traded materials rebounded from their earlier
          declines; this turnaround, together with a flattening of the
          exchange value of the dollar after its earlier appreciation,
          translated into an easing of downward pressure on the prices of
          imports in general. Core inflation measures generally remained
          low, but with the labor market at its tightest in three decades and
          becoming tighter, the risk that pressures on costs and prices
          would eventually emerge mounted over the course of the year.
          To maintain the low-inflation environment that has been so
          important to the sustained health of the current expansion, the
          FOMC ultimately implemented four quarter-point increases in the
          intended federal funds rate, the most recent of which came at the
          beginning of this month. In total, the federal funds rate has been
          raised 1 percentage point, although, at 5-3/4 percent, it stands
          only 1/4 point above its level just before the autumn-1998
          financial market turmoil. At its most recent meeting, the FOMC
          indicated that risks appear to remain on the side of heightened
          inflation pressures, so it will need to remain especially attentive
          to developments in this regard. 
          Monetary Policy, Financial Markets, and the Economy over 1999
          and Early 2000 
          The first quarter of 1999 saw a further unwinding of the
          heightened levels of perceived risk and risk aversion that had
          afflicted financial markets in the autumn of 1998; investors
          became much more willing to advance funds, securities issuance
          picked up, and risk spreads fell further--though not back to the
          unusually low levels of the first half of 1998. At the same time,
          domestic demand remained quite strong, and foreign economies
          showed signs of rebounding. The FOMC concluded at its
          February and March meetings that, if these trends were to
          persist, the risks of the eventual emergence of somewhat greater
          inflation pressures would increase, and it noted that a case could
          be made for unwinding part of the easing actions of the
          preceding fall. However, the Committee hesitated to adjust policy
          before having greater assurance that the recoveries in domestic
          financial markets and foreign economies were on firm footing. 
          By the May meeting, these recoveries were solidifying, and the
          pace of domestic spending appeared to be outstripping the
          growth of the economy's potential, even allowing for an
          appreciable acceleration in productivity. The Committee still
          expected some slowing in the expansion of aggregate demand,
          but the timing and extent of any moderation remained uncertain.
          Against this backdrop, the FOMC maintained an unchanged
          policy stance but announced immediately after the meeting that it
          had chosen a directive tilted toward the possibility of a firming
          of rates. This announcement implemented the disclosure policy
          adopted in December 1998, whereby major shifts in the
          Committee's views about the balance of risks or the likely
          direction of future policy would be made public immediately.
          Members expected that, by making the FOMC's concerns public
          earlier, such announcements would encourage financial market
          reactions to subsequent information that would help stabilize the
          economy. In practice, however, those reactions seemed to be
          exaggerated and to focus even more than usual on possible
          near-term Committee action. 
          Over subsequent weeks, economic activity continued to expand
          vigorously, labor markets remained very tight, and oil and other
          commodity prices rose further. In this environment, the FOMC
          saw an updrift in inflation as a significant risk in the absence of
          some policy firming, and at the June meeting it raised the
          intended level of the federal funds rate 1/4 percentage point. The
          Committee also announced a symmetric directive, noting that the
          marked degree of uncertainty about the extent and timing of
          prospective inflationary pressures meant that further firming of
          policy might not be undertaken in the near term, but that the
          Committee would need to be especially alert to emerging
          inflation pressures. Markets rallied on the symmetric-directive
          announcement, and the strength of this response together with
          market commentary suggested uncertainty about the
          interpretation of the language used to characterize possible future
          developments and about the time period to which the directive
          In the period between the June and August meetings, the
          ongoing strength of domestic demand and further expansion
          abroad suggested that at least part of the remaining easing put in
          place the previous fall to deal with financial market stresses was
          no longer needed. Consequently, at the August meeting the
          FOMC raised the intended level of the federal funds rate a
          further 1/4 percentage point, to 5-1/4 percent. The Committee
          agreed that this action, along with that taken in June, would
          substantially reduce inflation risks and again announced a
          symmetric directive. In a related action, the Board of Governors
          approved an increase in the discount rate to 4-3/4 percent. At
          this meeting the Committee also established a working group to
          assess the FOMC's approach to disclosing its view about
          prospective developments and to propose procedural
          At its August meeting, the FOMC took a number of actions that
          were aimed at enhancing the ability of the Manager of the
          System Open Market Account to counter potential liquidity
          strains in the period around the century date change and that
          would also help ensure the effective implementation of the
          Committee's monetary policy objectives. Although members
          believed that efforts to prepare computer systems for the century
          date change had made the probability of significant disruptions
          quite small, some aversion to Y2K risk exposure was already
          evident in the markets, and the costs that might stem from a
          dysfunctional financing market at year-end were deemed to be
          unacceptably high. The FOMC agreed to authorize, temporarily,
          (1) a widening of the pool of collateral that could be accepted in
          System open market transactions, (2) the use of reverse
          repurchase agreement accounting in addition to the currently
          available matched sale-purchase transactions to absorb reserves
          temporarily, and (3) the auction of options on repurchase
          agreements, reverse repurchase agreements, and matched
          sale-purchase transactions that could be exercised in the period
          around year-end. The Committee also authorized a permanent
          extension of the maximum maturity on regular repurchase and
          matched sale-purchase transactions from sixty to ninety days. 
          The broader range of collateral approved for repurchase
          transactions--mainly pass-through mortgage securities of
          government-sponsored enterprises and STRIP securities of the
          U.S. Treasury--would facilitate the Manager's task of addressing
          what could be very large needs to supply reserves in the
          succeeding months, primarily in response to rapid increases in
          the demand for currency, at a time of potentially heightened
          demand in various markets for U.S. government securities. The
          standby financing facility, authorizing the Federal Reserve Bank
          of New York to auction the above-mentioned options to the
          government securities dealers that are regular counterparties in
          the System's open market operations, would encourage
          marketmaking and the maintenance of liquid financing markets
          essential to effective open market operations. The standby
          facility was also viewed as a useful complement to the special
          liquidity facility, which was to provide sound depository
          institutions with unrestricted access to the discount window, at a
          penalty rate, between October 1999 and April 2000. Finally, the
          decision to extend the maximum maturity on repurchase and
          matched sale-purchase transactions was intended to bring the
          terms of such transactions into conformance with market practice
          and to enhance the Manager's ability over the following months
          to implement the unusually large reserve operations expected to
          be required around the turn of the year. 
          Incoming information during the period leading up to the
          FOMC's October meeting suggested that the growth of domestic
          economic activity had picked up from the second quarter's pace,
          and foreign economies appeared to be strengthening more than
          had been anticipated, potentially adding pressure to already-taut
          labor markets and possibly creating inflationary imbalances that
          would undermine economic performance. But the FOMC viewed
          the risk of a significant increase in inflation in the near term as
          small and decided to await more evidence on how the economy
          was responding to its previous tightenings before changing its
          policy stance. However, the Committee anticipated that the
          evidence might well signal the need for additional tightening,
          and it again announced a directive that was biased toward
          Information available through mid-November pointed toward
          robust growth in overall economic activity and a further
          depletion of the pool of unemployed workers willing to take a
          job. Although higher real interest rates appeared to have induced
          some softening in interest-sensitive sectors of the economy, the
          anticipated moderation in the growth of aggregate demand did
          not appear sufficient to avoid added pressures on resources,
          predominantly labor. These conditions, along with further
          increases in oil and other commodity prices, suggested a
          significant risk that inflation would pick up over time, given
          prevailing financial conditions. Against this backdrop, the FOMC
          raised the target for the federal funds rate an additional 1/4
          percentage point in November. At that time, a symmetric
          directive was adopted, consistent with the Committee's
          expectation that no further policy move was likely to be
          considered before the February meeting. In a related action, the
          Board of Governors approved an increase in the discount rate of
          1/4 percentage point, to 5 percent. 
          At the December meeting, FOMC members held the stance of
          policy unchanged and, to avoid any misinterpretation of policy
          intentions that might unsettle financial markets around the
          century date change, announced a symmetric directive. But the
          statement issued after the meeting also highlighted members'
          continuing concern about inflation risks going forward and
          indicated the Committee's intention to evaluate, as soon as its
          next meeting, whether those risks suggested that further
          tightening was appropriate. 
          The FOMC also decided on some modifications to its disclosure
          procedures at the December meeting, at which the working group
          mentioned above transmitted its final report and proposals. These
          modifications, announced in January 2000, consisted primarily of
          a plan to issue a statement after every FOMC meeting that not
          only would convey the current stance of policy but also would
          categorize risks to the outlook as either weighted mainly toward
          conditions that may generate heightened inflation pressures,
          weighted mainly toward conditions that may generate economic
          weakness, or balanced with respect to the goals of maximum
          employment and stable prices over the foreseeable future. The
          changes eliminated uncertainty about the circumstances under
          which an announcement would be made; they clarified that the
          Committee's statement about future prospects extended beyond
          the intermeeting period; and they characterized the Committee's
          views about future developments in a way that reflected policy
          discussions and that members hoped would be more helpful to
          the public and to financial markets. 
          Financial markets and the economy came through the century
          date change smoothly. By the February 2000 meeting, there was
          little evidence that demand was coming into line with potential
          supply, and the risks of inflationary imbalances appeared to have
          risen. At the meeting, the FOMC raised its target for the federal
          funds rate 1/4 percentage point to 5-3/4 percent, and
          characterized the risks as remaining on the side of higher
          inflation pressures. In a related action, the Board of Governors
          approved a 1/4 percentage point increase in the discount rate, to
          5-1/4 percent. 
          Economic Projections for 2000 
          The members of the Board of Governors and the Federal
          Reserve Bank presidents, all of whom participate in the
          deliberations of the FOMC, expect to see another year of
          favorable economic performance in 2000, although the risk of
          higher inflation will need to be watched especially carefully. The
          central tendency of the FOMC participants' forecasts of real GDP
          growth from the fourth quarter of 1999 to the fourth quarter of
          2000 is 3-1/2 percent to 3-3/4 percent. A substantial part of the
          gain in output will likely come from further increases in
          productivity. Nonetheless, economic expansion at the pace that is
          anticipated should create enough new jobs to keep the
          unemployment rate in a range of 4 percent to 4-1/4 percent,
          close to its recent average. The central tendency of the FOMC
          participants' inflation forecasts for 2000--as measured by the
          chain-type price index for personal consumption expenditures--is
          1-3/4 percent to 2 percent, a range that runs a little to the low
          side of the energy-led 2 percent rise posted in 1999.\1 Even
          though futures markets suggest that energy prices may turn down
          later this year, prices elsewhere in the economy could be pushed
          upward by a combination of factors, including reduced restraint
          from non-oil import prices, wage and price pressures associated
          with lagged effects of the past year's oil price rise, and larger
          increases in costs that might be forthcoming in another year of
          tight labor markets. 
          The performance of the economy--both the rate of real growth
          and the rate of inflation--will depend importantly on the course
          of productivity. Typically, in past business expansions, gains in
          labor productivity eventually slowed as rising demand placed
          increased pressure on plant capacity and on the workforce, and a
          similar slowdown from the recent rapid pace of productivity gain
          cannot be ruled out. But with many firms still in the process of
          implementing technologies that have proved effective in
          reorganizing internal operations or in gaining speedier access to
          outside resources and markets, and with the technologies
          themselves still advancing rapidly, a further rise in productivity
          growth from the average pace of recent years also is possible. To
          the extent that rapid productivity growth can be maintained,
          aggregate supply can grow faster than would otherwise be
          However, the economic processes that are giving rise to faster
          productivity growth not only are lifting aggregate supply but also
          are influencing the growth of aggregate spending. With firms
          perceiving abundant profit opportunities in
          productivity-enhancing high-tech applications, investment in new
          equipment has been surging and could well continue to rise
          rapidly for some time. Moreover, expectations that the
          investment in new technologies will generate high returns have
          been lifting the stock market and, in turn, helping to maintain
          consumer spending at a pace in excess of the current growth of
          real disposable income. Impetus to demand from this source also
          could persist for a while longer, given the current high levels of
          consumer confidence and the likely lagged effects of the large
          increments to household wealth registered to date. The boost to
          aggregate demand from the marked pickup in productivity
          growth implies that the level of interest rates needed to align
          demand with potential supply may have increased substantially.
          Although the recent rise in interest rates may lead to some
          slowing of spending, aggregate demand may well continue to
          outpace gains in potential output over the near term, an
          imbalance that contains the seeds of rising inflationary and
          financial pressures that could undermine the expansion. 
          In recent years, domestic spending has been able to grow faster
          than production without engendering inflation partly because the
          external sector has provided a safety valve, helping to relieve the
          pressures on domestic resources. In particular, the rapid growth
          of demand has been met in part by huge increases in imports of
          goods and services, and sluggishness in foreign economies has
          restrained the growth of exports. However, foreign economies
          have been firming, and if recovery of these economies stays on
          course, U.S. exports should increase faster than they have in the
          past couple of years. Moreover, the rapid rise of the real
          exchange value of the dollar through mid-1998 has since given
          way to greater stability, on average, and the tendency of the
          earlier appreciation to limit export growth and boost import
          growth is now diminishing. From one perspective, these external
          adjustments are welcome because they will help slow the recent
          rapid rates of decline in net exports and the current account.
          They also should give a boost to industries that have been hurt
          by the export slump, such as agriculture and some parts of
          manufacturing. At the same time, however, the adjustments are
          likely to add to the risk of an upturn in the inflation trend,
          because a strengthening of exports will add to the pressures on
          U.S. resources and a firming of the prices of non-oil imports will
          raise costs directly and also reduce to some degree the
          competitive restraints on the prices of U.S. producers. 
          Domestically, substantial plant capacity is still available in some
          manufacturing industries and could continue to exert restraint on
          firms' pricing decisions, even with a diminution of competitive
          pressures from abroad. However, an already tight domestic labor
          market has tightened still further in recent months, and bidding
          for workers, together with further increases in health insurance
          costs that appear to be coming, seems likely to keep nominal
          hourly compensation costs moving up at a relatively brisk pace.
          To date, the increases in compensation have not had serious
          inflationary consequences because they have been offset by the
          advances in labor productivity, which have held unit labor costs
          in check. But the pool of available workers cannot continue to
          shrink without at some point touching off cost pressures that
          even a favorable productivity trend might not be able to counter.
          Although the governors and Reserve Bank presidents expect
          productivity gains to be substantial again this year, incoming
          data on costs, prices, and price expectations will be examined
          carefully to make sure a pickup of inflation does not start to
          become embedded in the economy. 
          The FOMC forecasts are more optimistic than the economic
          predictions that the Administration recently released, but the
          Administration has noted that it is being conservative in regard
          to its assumptions about productivity growth and the potential
          expansion of the economy. Relative to the Administration's
          forecast, the FOMC is predicting a somewhat larger rise in real
          GDP in 2000 and a slightly lower unemployment rate. The
          inflation forecasts are fairly similar, once account is taken of the
          tendency for the consumer price index to rise more rapidly than
          the chain-type price index for personal consumption
          Money and Debt Ranges for 2000 
          At its most recent meeting, the FOMC reaffirmed the monetary
          growth ranges for 2000 that were chosen on a provisional basis
          last July: 1 percent to 5 percent for M2, and 2 percent to 6
          percent for M3. As has been the case for some time, these
          ranges were chosen to encompass money growth under
          conditions of price stability and historical velocity relationships,
          rather than to center on the expected growth of money over the
          coming year or serve as guides to policy. 
          Given continued uncertainty about movements in the velocities
          of M2 and M3 (the ratios of nominal GDP to the aggregates),
          the Committee still has little confidence that money growth
          within any particular range selected for the year would be
          associated with the economic performance it expected or desired.
          Nonetheless, the Committee believes that money growth has
          some value as an economic indicator, and it will continue to
          monitor the monetary aggregates among a wide variety of
          economic and financial data to inform its policy deliberations. 
          M2 increased 6-1/4 percent last year. With nominal GDP rising 6
          percent, M2 velocity fell a bit overall, although it rose in the
          final two quarters of the year as market interest rates climbed
          relative to yields on M2 assets. Further increases in market
          interest rates early this year could continue to elevate M2
          velocity. Nevertheless, given the Committee's expectations for
          nominal GDP growth, M2 could still be above the upper end of
          its range in 2000. 
          M3 expanded 7-1/2 percent last year, and its velocity fell about
          1-3/4 percent, a much smaller drop than in the previous year.
          Non-M2 components again exhibited double-digit growth, with
          some of the strength attributable to long-term trends and some to
          precautionary buildups of liquidity in advance of the century date
          change. One important trend is the shift by nonfinancial
          businesses from direct holdings of money market instruments to
          indirect holdings through institution-only money funds; such
          shifts boost M3 at the same time they enhance liquidity for
          businesses. Money market funds and large certificates of deposit
          also ballooned late in the year as a result of a substantial demand
          for liquidity around the century date change. Adjustments from
          the temporarily elevated level of M3 at the end of 1999 are
          likely to trim that aggregate's fourth-quarter-to-fourth-quarter
          growth this year, but not sufficiently to offset the downward
          trend in velocity. That trend, together with the Committee's
          expectation for nominal GDP growth, will probably keep M3
          above the top end of its range again this year. 
          Domestic nonfinancial debt grew 6-1/2 percent in 1999, near the
          upper end of the 3 percent to 7 percent growth range the
          Committee established last February. This robust growth
          reflected large increases in the debt of businesses and households
          that were due to substantial advances in spending as well as to
          debt-financed mergers and acquisitions. However, the increase in
          private-sector debt was partly offset by a substantial decline in
          federal debt. The Committee left the range for debt growth in
          2000 unchanged at 3 percent to 7 percent. After an aberrant
          period in the 1980s during which debt expanded much more
          rapidly than nominal GDP, the growth of debt has returned to its
          historical pattern of about matching the growth of nominal GDP
          over the past decade, and the Committee members expect debt to
          remain within its range again this year. 
          Economic and Financial Developments in 1999 and Early 2000 
          The U.S. economy retained considerable strength in 1999.
          According to the Commerce Department's advance estimate, the
          rise in real gross domestic product over the four quarters of the
          year exceeded 4 percent for the fourth consecutive year. The
          growth of household expenditures was bolstered by further
          substantial gains in real income, favorable borrowing terms, and
          a soaring stock market. Businesses seeking to maintain their
          competitiveness and profitability continued to invest heavily in
          high-tech equipment; external financing conditions in both debt
          and equity markets were quite supportive. In the public sector,
          further strong growth of revenues was accompanied by a step-up
          in the growth of government consumption and investment
          expenditures, the part of government spending that enters directly
          into real GDP. The rapid growth of domestic demand gave rise
          to a further huge increase in real imports of goods and services
          in 1999. Exports picked up as foreign economies strengthened,
          but the gain fell short of that for imports by a large margin.
          Available economic indicators for January of this year show the
          U.S. economy continuing to expand, with labor demand robust
          and the unemployment rate edging down to its lowest level in
          thirty years. 
          The combination of a strong U.S. economy and improving
          economic conditions abroad led to firmer prices in some markets
          this past year. Industrial commodity prices turned up--sharply in
          some cases--after having dropped appreciably in 1998. Oil
          prices, responding both to OPEC production restraint and to the
          growth of world demand, more than doubled over the course of
          the year, and the prices of non-oil imports declined less rapidly
          than in previous years, when a rising dollar, as well as sluggish
          conditions abroad, had pulled them lower. The higher oil prices
          of 1999 translated into sharp increases in retail energy prices and
          gave a noticeable boost to consumer prices overall; the
          chain-type price index for personal consumption expenditures
          rose 2 percent, double the increase of 1998. Outside the energy
          sector, however, consumer prices increased at about the same
          low rate as in the previous year, even as the unemployment rate
          continued to edge down. Rapid gains in productivity enabled
          businesses to offset a substantial portion of the increases in
          nominal compensation, thereby holding the rise of unit labor
          costs in check, and business pricing policies continued to be
          driven to a large extent by the desire to maintain or increase
          market share at the expense of some slippage in unit profits,
          albeit from a high level. 
          The Household Sector 
          Personal consumption expenditures increased about 5-1/2 percent
          in real terms in 1999, a second year of exceptionally rapid
          advance. As in other recent years, the strength of consumption in
          1999 reflected sustained increases in employment and real hourly
          pay, which bolstered the growth of real disposable personal
          income. Added impetus came from another year of rapid growth
          in net worth, which, coming on top of the big gains of previous
          years, led households in the aggregate to spend a larger portion
          of their current income than they would have otherwise. The
          personal saving rate, as measured in the national income and
          product accounts, dropped further, to an average of about 2
          percent in the final quarter of 1999; it has fallen about 4-1/2
          percentage points over the past five years, a period during which
          yearly gains in household net worth have averaged more than 10
          percent in nominal terms and the ratio of household wealth to
          disposable personal income has moved up sharply. 
          The strength of consumer spending this past year extended
          across a broad front. Appreciable gains were reported for most
          types of durable goods. Spending on motor vehicles, which had
          surged about 13-1/2 percent in 1998, moved up another 5-1/2
          percent in 1999. The inflation-adjusted increases for furniture,
          appliances, electronic equipment, and other household durables
          also were quite large, supported in part by a strong housing
          market. Spending on services advanced about 4-1/2 percent in
          real terms, led by sizable increases for recreation and personal
          business services. Outlays for nondurables, such as food and
          clothing, also rose rapidly. Exceptional strength in the purchases
          of some nondurables toward the end  of the year may have
          reflected precautionary buying by consumers in anticipation of
          the century date change; it is notable in this regard that grocery
          store sales were up sharply in December and then fell back in
          January, according to the latest report on retail sales. 
          Households also continued to boost their expenditures on
          residential structures. After having surged 11 percent in 1998,
          residential investment rose about 3-1/4 percent over the four
          quarters of 1999, according to the advance estimate from the
          Commerce Department. Moderate declines in investment in the
          second half of the year offset only part of the increases recorded
          in the first half. As with consumption expenditures, investment in
          housing was supported by the sizable advances in real income
          and household net worth, but this spending category was also
          tempered a little by a rise in mortgage interest rates, which likely
          was an important factor in the second-half downturn.
          Nearly all the indicators of housing activity showed upbeat
          results for the year. Annual sales of new and existing homes
          reached new peaks in 1999, surpassing the previous highs set in
          1998. Although sales dropped back a touch in the second half of
          the year, their level through year-end remained quite high by
          historical standards. Builders' backlogs also were at high levels
          and helped support new construction activity even as sales eased.
          Late in the year, reports that shortages of skilled workers were
          delaying construction became less frequent as building activity
          wound down seasonally, but builders also continued to express
          concern about potential worker shortages in 2000. For 1999 in
          total, construction began on more than 1.3 million single-family
          dwellings, the most since the late 1970s; approximately 330,000
          multifamily units also were started, about the same number as in
          each of the two previous years. House prices rose appreciably
          and, together with the new investment, further boosted household
          net worth in residential real estate. 
          The increases in consumption and residential investment in 1999
          were, in part, financed by an expansion of household debt
          estimated at 9-1/2 percent, the largest increase in more than a
          decade. Mortgage debt, which includes the borrowing against
          owner equity that may be used for purposes other than
          residential investment, grew a whopping 10-1/4 percent. Higher
          interest rates led to a sharp drop in refinancing activity and
          prompted a shift toward the use of adjustable-rate mortgages,
          which over the year rose from 10 percent to 30 percent of
          originations. Consumer credit advanced 7-1/4 percent, boosted by
          heavy demand for consumer durables and other big-ticket
          purchases. Credit supply conditions were also favorable;
          commercial banks reported in Federal Reserve surveys that they
          were more willing than in the previous year or two to make
          consumer installment loans and that they remained quite willing
          to make mortgage loans. 
          The household sector's debt-service burden edged up to its
          highest level since the late 1980s; however, with employment
          rising rapidly and asset values escalating, measures of credit
          quality for household debt generally improved in 1999.
          Delinquency rates on home mortgages and credit cards declined
          a bit, and those on auto loans fell more noticeably. Personal
          bankruptcy filings fell sharply after having risen for several years
          to 1997 and remaining elevated in 1998.
          The Business Sector 
          Private nonresidential fixed investment increased 7 percent
          during 1999, extending by another year a long run of rapid
          growth in real investment outlays. Strength in capital investment
          has been underpinned in recent years by the vigor of the
          business expansion, by the advance and spread of computer
          technologies, and by the ability of most businesses to readily
          obtain funding through the credit and equity markets. 
          Investment in high-tech equipment continued to soar in 1999.
          Outlays for communications equipment rose about 25 percent
          over the course of the year, boosted by a number of factors,
          including the expansion of wireless communications, competition
          in telephone markets, the continued spread of the Internet, and
          the demand of Internet users for faster access to it. Computer
          outlays rose nearly 40 percent in real terms, and the purchases of
          computer software, which in the national accounts are now
          counted as part of private fixed investment, rose about 13
          percent; for both computers and software the increases were
          roughly in line with the annual average gains during previous
          years of the expansion. 
          The timing of investment in high-tech equipment over the past
          couple of years was likely affected to some degree by business
          preparations for the century date change. Many large businesses
          reportedly invested most heavily in new computer equipment
          before the start of 1999 to leave sufficient time for their systems
          to be tested well before the start of 2000; a very steep rise in
          computer investment in 1998--roughly 60 percent in real
          terms--is consistent with those reports. Some of the purchases in
          preparation for Y2K most likely spilled over into 1999, but the
          past year also brought numerous reports of businesses wanting to
          stand pat with existing systems until after the turn of the year.
          Growth in computer investment in the final quarter of 1999, just
          before the century rollover, was the smallest in several quarters. 
          Spending on other types of equipment rose moderately, on
          balance, in 1999. Outlays for transportation equipment increased
          substantially, led by advances in business purchases of motor
          vehicles and aircraft. By contrast, a sharp decline in spending on
          industrial machinery early in the year held the yearly gain for
          that category to about 2 percent; over the final three quarters of
          the year, however, outlays picked up sharply as industrial
          production strengthened. 
          Private investment in nonresidential structures fell 5 percent in
          1999 according to the advance estimate from the Commerce
          Department. Spending on structures had increased in each of the
          previous seven years, rather briskly at times, and the level of
          investment, though down this past year, remained relatively high
          and likely raised the real stock of capital invested in structures
          appreciably further. Real expenditures on office buildings, which
          have been climbing rapidly for several years, moved up further
          in 1999, to the highest level since the peak of the building boom
          of the 1980s. In contrast, investment in other types of
          commercial structures, which had already regained its earlier
          peak, slipped back a little, on net, this past year. Spending on
          industrial structures, which accounts for roughly 10 percent of
          total real outlays on structures, fell for a third consecutive year.
          Outlays for the main types of institutional structures also were
          down, according to the initial estimates. Revisions to the data on
          nonresidential structures often are sizable, and the estimates for
          each of the three years preceding 1999 have eventually shown a
          good bit more strength than was initially reported. 
          After increasing for two years at a rate of about 6 percent,
          nonfarm business inventories expanded more slowly this past
          year--about 3-1/4 percent according to the advance GDP report.
          During the year, some businesses indicated that they planned to
          carry heavier stocks toward year-end to protect themselves
          against possible Y2K disruptions, and the rate of accumulation
          did in fact pick up appreciably in the fall. But business final
          sales remained strong, and the ratio of nonfarm stocks to final
          sales changed little, holding toward the lower end of the range of
          the past decade. With the ratio so low, businesses likely did not
          enter the new year with excess stocks. 
          After slowing to a 1 percent rise in 1998, the economic profits of
          U.S. corporations--that is, book profits with inventory valuation
          and capital consumption adjustments--picked up in 1999.
          Economic profits over the first three quarters of the year
          averaged about 3-1/2 percent above the level of a year earlier.
          The earnings of corporations from their operations outside the
          United States rebounded in 1999 from a brief but steep decline
          in the second half of 1998, when financial market disruptions
          were affecting the world economy. The profits earned by
          financial corporations on their domestic operations also picked
          up after having been slowed in 1998 by the financial turmoil;
          growth of these profits in 1999 would have been greater but for
          a large payout by insurance companies to cover damage from
          Hurricane Floyd. The profits that nonfinancial corporations
          earned on their domestic operations in the first three quarters of
          1999 were about 2-1/2 percent above the level of a year earlier;
          growth of these earnings, which account for about two-thirds of
          all economic profits, had slowed to just over 2 percent in 1998
          after averaging 13 percent at a compound annual rate in the
          previous six years. Nonfinancial corporations have boosted
          volume substantially further over the past two years, but profits
          per unit of output have dropped back somewhat from their 1997
          peak. As of the third quarter of last year, economic profits of
          nonfinancial corporations amounted to slightly less than 11-1/2
          percent of the nominal output of these companies, compared with
          a quarterly peak of about 12-3/4 percent two years earlier. 
          The borrowing needs of nonfinancial corporations remained
          sizable in 1999. Capital spending outstripped internal cash flow,
          and equity retirements that resulted from stock repurchases and a
          blockbuster pace of merger activity more than offset record
          volumes of both seasoned and initial public equity offerings.
          Overall, the debt of nonfinancial businesses grew 10-1/2 percent,
          down only a touch from its decade-high 1998 pace.
          The strength in business borrowing was widespread across
          funding sources. Corporate bond issuance was robust,
          particularly in the first half of the year, though the markets'
          increased preference for liquidity and quality, amid an
          appreciable rise in defaults on junk bonds, left issuance of
          below-investment-grade securities down more than a quarter
          from their record pace in 1998. The receptiveness of the capital
          markets helped firms to pay down loans at banks--which had
          been boosted to an 11-3/4 percent gain in 1998 by the financial
          market turmoil that year--and growth in these loans slowed to a
          more moderate 5-1/4 percent pace in 1999. The commercial
          paper market continued to expand rapidly, with domestic
          nonfinancial outstandings rising 18 percent on top of the 14
          percent gain in 1998. 
          Commercial mortgage borrowing was strong again as well, as
          real estate prices generally continued to rise, albeit at a slower
          pace than in 1998, and vacancy rates generally remained near
          historical lows. The mix of lending shifted back to banks and life
          insurance companies from commercial mortgage-backed
          securities, as conditions in the CMBS market, especially investor
          appetites for lower-rated tranches, remained less favorable than
          they had been before the credit market disruptions in the fall of
          Risk spreads on corporate bonds seesawed during 1999. Over the
          early part of the year, spreads reversed part of the 1998 run-up
          as markets recovered. During the summer, they rose again in
          response to concerns about market liquidity, expectations of a
          surge in financing before the century date change, and
          anticipated firming of monetary policy. Swap spreads, in
          particular, exhibited upward pressure at this time. The likelihood
          of year-end difficulties seemed to diminish in the fall, and
          spreads again retreated, ending the year down on balance but
          generally above the levels that had prevailed over the several
          years up to mid-1998. 
          Federal Reserve surveys indicated that banks firmed terms and
          standards for commercial and industrial loans a bit further, on
          balance, in 1999. In the syndicated loan market, spreads for
          lower-rated borrowers also ended the year higher, on balance,
          after rising substantially in 1998. Spreads for higher-rated
          borrowers were fairly steady through 1998 and early 1999,
          widened a bit around midyear, and then fell back to end the year
          about where they had started. 
          The ratio of net interest payments to cash flow for nonfinancial
          firms remained in the low range it has occupied for the past few
          years, but many measures of credit quality nonetheless
          deteriorated in 1999. Moody's Investors Service downgraded
          more nonfinancial debt issuers than it upgraded over the year,
          affecting a net $78 billion of debt. The problems that emerged in
          the bond market were concentrated mostly among borrowers in
          the junk sector, and partly reflected a fallout from the large
          volume of issuance and the generous terms available in 1997 and
          early 1998; default rates on junk bonds rose to levels not seen
          since the recession of 1990-91. Delinquency rates on C&I loans
          at commercial banks ticked up in 1999, albeit from very low
          levels, while the charge-off rate for those loans continued on its
          upward trend of the past several years. Business failures edged
          up last year but remained in a historically low range.
          The Government Sector 
          Buoyed by rapid increases in receipts and favorable budget
          balances, the combined real expenditures of federal, state, and
          local governments on consumption and investment rose about
          4-3/4 percent from the fourth quarter of 1998 to the fourth
          quarter of 1999. Annual data, which smooth through some of the
          quarterly noise that is often evident in government outlays,
          showed a gain in real spending of more than 3-1/2 percent this
          past year, the largest increase of the expansion. Federal
          expenditures on consumption and investment were up nearly 3
          percent in annual terms; real defense expenditures, which had
          trended lower through most of the 1990s, rose moderately, and
          outlays for nondefense consumption and investment increased
          sharply. Meanwhile, the consumption and investment
          expenditures of state and local governments rose more than 4
          percent in annual terms; growth of these outlays has picked up
          appreciably as the expansion has lengthened. 
          At the federal level, expenditures in the unified budget rose 3
          percent in fiscal 1999, just a touch less than the 3-1/4 percent
          rise of the preceding fiscal year. Faster growth of nominal
          spending on items that are included in consumption and
          investment was offset in the most recent fiscal year by a
          deceleration in other categories. Net interest outlays fell more
          than 5 percent--enough to trim total spending growth about 3/4
          percentage point--and only small increases were recorded in
          expenditures for social insurance and income security, categories
          that together account for nearly half of total federal outlays. In
          contrast, federal expenditures on Medicaid, after having slowed
          in 1996 and 1997, picked up again in the past two fiscal years.
          Spending on agriculture doubled in fiscal 1999; the increase
          resulted both from a step-up in payments under farm safety net
          programs that were retained in the "freedom to farm" legislation
          of 1996 and from more recent emergency farm legislation. 
          Federal receipts grew 6 percent in fiscal 1999 after increases that
          averaged close to 9 percent in the two previous fiscal years. Net
          receipts from taxes on individuals continued to outpace the
          growth of personal income, but by less than in other recent
          years, and receipts from corporate income taxes fell moderately.
          Nonetheless, with total receipts growing faster than spending, the
          surplus in the unified budget continued to rise, moving from $69
          billion in fiscal 1998 to $124 billion this past fiscal year.
          Excluding net interest payments--a charge resulting from past
          deficits--the federal government recorded a surplus of more than
          $350 billion in fiscal 1999. 
          Federal saving, a measure that results from a translation of the
          federal budget surplus into terms consistent with the national
          income and product accounts, amounted to 2-1/4 percent of
          nominal GDP in the first three quarters of 1999, up from 1-1/2
          percent in 1998 and 1/2 percent in 1997. Before 1997, federal
          saving had been negative for seventeen consecutive years, by
          amounts exceeding 3 percent of nominal GDP in several
          years--most recently in 1992. The change in the federal
          government's saving position from 1992 to 1999 more than offset
          the sharp drop in the personal saving rate and helped lift national
          saving from less than 16 percent of nominal GDP in 1992 and
          1993 to a range of about 18-1/2 percent to 19 percent over the
          past several quarters. 
          Federal debt growth has mirrored the turnabout in the
          government's saving position. In the 1980s and early 1990s,
          borrowing resulted in large additions to the volume of
          outstanding government debt. In contrast, with the budget in
          surplus the past two years, the Treasury has been paying down
          debt. Without the rise in federal saving and the reversal in
          borrowing, interest rates in recent years likely would have been
          higher than they have been, and private capital formation, a key
          element in the vigorous economic expansion, would have been
          lower, perhaps appreciably. 
          The Treasury responded to its lower borrowing requirements in
          1999 primarily by reducing the number of auctions of thirty-year
          bonds from three to two and by trimming auction sizes for notes
          and Treasury inflation-indexed securities (TIIS). Weekly bill
          volumes were increased from 1998 levels, however, to help build
          up cash holdings as a Y2K precaution. For 2000, the Treasury
          plans major changes in debt management in an attempt to keep
          down the average maturity of the debt and maintain sufficient
          auction sizes to support the liquidity and benchmark status of its
          most recently issued securities, while still retiring large volumes
          of debt. Alternate quarterly refunding auctions of five- and
          ten-year notes and semiannual auctions of thirty-year bonds will
          now be smaller reopenings of existing issues rather than new
          issues. Thirty-year TIIS will now be auctioned once a year rather
          than twice, and the two auctions of ten-year TIIS will be
          modestly reduced. Auctions of one-year Treasury bills will drop
          from thirteen a year to four, while weekly bill volumes will rise
          somewhat. Finally, the Treasury plans to enter the market to buy
          back in "reverse auctions" as much as $30 billion of outstanding
          securities this year, beginning in March or April. 
          State and local government debt expanded 4-1/4 percent in 1999,
          well off last year's elevated pace. Borrowing for new capital
          investment edged up, but the roughly full-percentage-point rise in
          municipal bond yields over the year led to a sharp drop in
          advance refundings, which in turn pulled gross issuance below
          last year's level. Tax revenues continued to grow at a robust rate,
          improving the financial condition of states and localities, as
          reflected in a ratio of debt rating upgrades to downgrades of
          more than three to one over the year. The surplus in the current
          account of state and local governments in the first three quarters
          of 1999 amounted to about 1/2 percent of nominal GDP, about
          the same as in 1998 but otherwise the largest of the past several
          The External Sector 
          Trade and the Current Account 
          U.S. external balances deteriorated in 1999 largely because of
          continued declines in net exports of goods and services and some
          further weakening of net investment income. The nominal trade
          deficit for goods and services widened more than $100 billion in
          1999, to an estimated $270 billion, as imports expanded faster
          than exports. For the first three quarters of the year, the current
          account deficit increased more than one-third, reaching $320
          billion at an annual rate, or 3-1/2 percent of GDP. In 1998, the
          current account deficit was 2-1/2 percent of GDP. 
          Real imports of goods and services expanded strongly in
          1999--about 13 percent according to preliminary estimates--as
          the rapid import growth during the first half of the year was
          extended through the second half. The expansion of real imports
          was fueled by the continued strong growth of U.S. domestic
          expenditures. Declines in non-oil import prices through most of
          the year, partly reflecting previous dollar appreciation,
          contributed as well. All major import categories other than
          aircraft and oil recorded strong increases. While U.S.
          consumption of oil rose about 4 percent in 1999, the quantity of
          oil imported was about unchanged, and inventories were drawn
          Real exports of goods and services rose an estimated 4 percent
          in 1999, a somewhat faster pace than in 1998. Economic activity
          abroad picked up, particularly in Canada, Mexico, and Asian
          developing economies. However, the lagged effects of relative
          prices owing to past dollar appreciation held down exports. An
          upturn in U.S. exports to Canada, Mexico, and key Asian
          emerging markets contrasted with a much flatter pace of exports
          to Europe, Japan, and South America. Capital equipment
          composed about 45 percent of U.S. goods exports, industrial
          supplies were 20 percent, and agricultural, automotive, and
          consumer goods were each roughly 10 percent. 
          Capital Account 
          U.S. capital flows in 1999 reflected the relatively strong cyclical
          position of the U.S. economy and the global wave of corporate
          mergers. Foreign purchases of U.S. securities remained
          brisk--near the level of the previous two years, in which they had
          been elevated by the global financial unrest. The composition of
          foreign securities purchases in 1999 showed a continued shift
          away from Treasuries, in part because of the U.S. budget surplus
          and the decline in the supply of Treasuries relative to other
          securities and, perhaps, to a general increased tolerance of
          foreign investors for risk as markets calmed after their turmoil of
          late 1998. Available data indicate that private foreigners sold on
          net about $20 billion in Treasuries, compared with net purchases
          of $50 billion in 1998 and $150 billion in 1997. These sales of
          Treasuries were more than offset by a pickup in foreign
          purchases of their nearest substitute--government agency
          bonds--as well as corporate bonds and equities. 
          Foreign direct investment flows into the United States were also
          robust in 1999, with the pace of inflows in the first three
          quarters only slightly below the record inflow set in 1998. As in
          1998, direct investment inflows last year were elevated by
          several large mergers, which left their imprint on other parts of
          the capital account as well. In the past two years, many of the
          largest mergers have been financed by a swap of equity in the
          foreign acquiring firm for equity in the U.S. firm being acquired.
          The Bureau of Economic Analysis estimates that U.S. residents
          acquired more than $100 billion of foreign equity through this
          mechanism in the first three quarters of 1999. Separate data on
          market transactions indicate that U.S. residents made net
          purchases of Japanese equities. They also sold European equities,
          probably in an attempt to rebalance portfolios in light of the
          equity acquired through stock swaps. U.S. residents on net
          purchased a small volume of foreign bonds in 1999. U.S. direct
          investment in foreign economies also reflected the global wave
          of merger activity in 1999 and will likely total something near its
          record level of 1998. 
          Available data indicate a return to sizable capital inflows from
          foreign official sources in 1999, following a modest outflow in
          1998. The decline in foreign official assets in the United States
          in 1998 was fairly widespread, as many countries found their
          currencies under unwanted downward pressure during the
          turmoil. By contrast, the increase in foreign official reserves in
          the United States in 1999 was fairly concentrated in a relatively
          few countries that experienced unwanted upward pressure on
          their currencies vis-a-vis the U.S. dollar. 
          The Labor Market 
          As in other recent years, the rapid growth of aggregate output in
          1999 was associated with both strong growth of productivity and
          brisk gains in employment. According to the initial estimate for
          1999, output per hour in the nonfarm business sector rose 3-1/4
          percent over the four quarters of the year, and historical data
          were revised this past year to show stronger gains than
          previously reported in the years preceding 1999. As the data
          stand currently, the average rate of rise in output per hour over
          the past four years is about 2-3/4 percent--up from an average of
          1-1/2 percent from the mid-1970s to the end of 1995. Some of
          the step-up in productivity growth since 1995 can be traced to
          high levels of capital spending and an accompanying faster rate
          of increase in the amount of capital per worker. Beyond that, the
          causes are more difficult to pin down quantitatively but are
          apparently related to increased technological and organizational
          efficiencies. Firms are not only expanding the stock of capital
          but are also discovering many new uses for the technologies
          embodied in that capital, and workers are becoming more skilled
          at employing the new technologies. 
          The number of jobs on nonfarm payrolls rose slightly more than
          2 percent from the end of 1998 to the end of 1999, a net
          increase of 2.7 million. Annual job gains had ranged between
          2-1/4 percent and 2-3/4 percent over the 1996-98 period. Once
          again in 1999, the private service-producing sector accounted for
          most of the total rise in payroll employment, led by many of the
          same categories that had been strong in previous
          years--transportation and communications, computer services,
          engineering and management, recreation, and personnel supply.
          In the construction sector, employment growth remained quite
          brisk--more than 4 percent from the final quarter of 1998 to the
          final quarter of 1999. Manufacturing employment, influenced by
          spillover from the disruptions in foreign economies, continued to
          decline sharply in the first half of the year, but losses thereafter
          were small as factory production strengthened. Since the start of
          the expansion in 1991, the job count in manufacturing has
          changed little, on net, but with factory productivity rising
          rapidly, manufacturing output has trended up at a brisk pace.
          In 1999, employers continued to face a tight labor market. Some
          increase in the workforce came from the pool of the
          unemployed, and the jobless rate declined to an average of 4.1
          percent in the fourth quarter. In January 2000, the rate edged
          down to 4.0 percent, the lowest monthly reading since the start
          of the 1970s. Because the unemployment rate is a reflection only
          of the number of persons who are available for work and
          actively looking, it does not capture potential labor supply that is
          one step removed--namely those individuals who are interested
          in working but are not actively seeking work at the current time.
          However, like the unemployment rate itself, an augmented rate
          that includes these interested nonparticipants also has declined to
          a low level, as more individuals have taken advantage of
          expanding opportunities to work. 
          Although the supply-demand balance in the labor market
          tightened further in 1999, the added pressure did not translate
          into bigger increases in nominal hourly compensation. The
          employment cost index for hourly compensation of workers in
          private nonfarm industries rose 3.4 percent in nominal terms
          during 1999, little changed from the increase of the previous
          year, and an alternative measure of hourly compensation from
          the nonfarm productivity and cost data slowed from a 5-1/4
          percent increase in 1998 to a 4-1/2 percent rise this past year.
          Compensation gains in 1999 probably were influenced, in part,
          by the very low inflation rate of 1998, which resulted in
          unexpectedly large increases in inflation-adjusted pay in that year
          and probably damped wage increments last year. According to
          the employment cost index, the hourly wages of workers in
          private industry rose 3-1/2 percent in nominal terms after having
          increased about 4 percent in each of the two previous years. The
          hourly cost to employers of the nonwage benefits provided to
          employees also rose 3-1/2 percent in 1999, but this increase was
          considerably larger than those of the past few years. Much of the
          pickup in benefit costs came from a faster rate of rise in the
          costs of health insurance, which were reportedly driven up by
          several factors: a moderate acceleration in the price of medical
          care, the efforts of some insurers to rebuild profit margins, and
          the recognition by employers that an attractive health benefits
          package was helpful in hiring and retaining workers in a tight
          labor market. 
          Because the employment cost index does not capture some forms
          of compensation that employers have been using more
          extensively--for example, stock options, signing bonuses, and
          employee price discounts on in-store purchases--it has likely
          been understating the true size of workers' gains. The
          productivity and cost measure of hourly compensation captures
          at least some of the labor costs that the employment cost index
          omits, and this broader coverage may explain why the
          productivity and cost measure has been rising faster. However, it,
          too, is affected by problems of measurement, some of which
          would lead to overstatement of the rate of rise in hourly
          With the rise in output per hour in the nonfarm business sector
          in 1999 offsetting about three-fourths of the rise in the
          productivity and cost measure of nominal hourly compensation,
          nonfarm unit labor costs were up just a shade more than 1
          percent. Unit labor costs had increased slightly more than 2
          percent in both 1997 and 1998 and less than 1 percent in 1996.
          Because labor costs are by far the most important item in total
          unit costs, these small increases have been crucial to keeping
          inflation low.
          Rates of increase in the broader measures of aggregate prices in
          1999 were somewhat larger than those of 1998. The chain-type
          price index for GDP--which measures inflation for goods and
          services produced domestically--moved up about 1-1/2 percent, a
          pickup of 1/2 percentage point from the increase of 1998. In
          comparison, acceleration in various price measures for goods and
          services purchased amounted to 1 percentage point or more: The
          chain-type price index for personal consumption expenditures
          increased 2 percent, twice as much as in the previous year, and
          the chain-type price index for gross domestic purchases, which
          measures prices of the aggregate purchases of consumers,
          businesses, and governments, moved up close to 2 percent after
          an increase of just 3/4 percent in 1998. The consumer price
          index rose more than 2-1/2 percent over the four quarters of the
          year after having increased 1-1/2 percent in 1998. 
          The acceleration in the prices of goods and services purchased
          was driven in part by a reversal in import prices. In 1998, the
          chain-type price index for imports of goods and services had
          fallen 5 percent, but it rose 3 percent in 1999. A big swing in oil
          prices--down in 1998 but up sharply in 1999--accounted for a
          large part of this turnaround. Excluding oil, the prices of
          imported goods continued to fall in 1999 but, according to the
          initial estimate, less rapidly than over the three previous years,
          when downward pressure from appreciation of the dollar had
          been considerable. The prices of imported materials and supplies
          rebounded, but the prices of imported capital goods fell sharply
          further. Meanwhile, the chain-type price index for exports
          increased 1 percent in the latest year, reversing a portion of the
          2-1/2 percent drop of 1998, when the sluggishness of foreign
          economies and the strength of the dollar had pressured U.S.
          producers to mark down the prices charged to foreign buyers. 
          Prices of domestically produced primary materials, which tend to
          be especially sensitive to developments in world markets,
          rebounded sharply in 1999. The producer price index for crude
          materials excluding food and energy advanced about 10 percent
          after having fallen about 15 percent in 1998, and the PPI for
          intermediate materials excluding food and energy increased about
          1-1/2 percent, reversing a 1998 decline of about that same size.
          But further along in the chain of processing and distribution, the
          effects of these increases were not very visible. The producer
          price index for finished goods excluding food and energy rose
          slightly less rapidly in 1999 than in 1998, and the consumer
          price index for goods excluding food and energy rose at about
          the same low rate that it had in 1998. Large gains in productivity
          and a margin of excess capacity in the industrial sector helped
          keep prices of goods in check, even as growth of domestic
          demand remained exceptionally strong. 
          "Core" inflation at the consumer level--which takes account of
          the prices of services as well as the prices of goods and excludes
          food and energy prices--changed little in 1999. The increase in
          the core index for personal consumption expenditures, 1-1/2
          percent over the four quarters of the year, was about the same as
          the increase in 1998. As measured by the CPI, core inflation was
          2 percent this past year, about 1/4 percentage point lower than in
          1998, but the deceleration was a reflection of a change in CPI
          methodology that had taken place at the start of last year; on a
          methodologically consistent basis, the rise in the core CPI was
          about the same in both years. 
          In the national accounts, the chain-type price index for private
          fixed investment edged up 1/4 percent in 1999 after having
          fallen about 3/4 percent in 1998. With construction costs rising,
          the index for residential investment increased 3-3/4 percent, its
          largest advance in several years. By contrast, the price index for
          nonresidential investment declined moderately, as a result of
          another drop in the index for equipment and software. Falling
          equipment prices are one channel through which faster
          productivity gains have been reshaping the economy in recent
          years; the drop in prices has contributed to high levels of
          investment, rapid expansion of the capital stock, and a step-up in
          the growth of potential output. 
          U.S. Financial Markets 
          Financial markets were somewhat unsettled as 1999 began, with
          the disruptions of the previous autumn still unwinding and the
          devaluation of the Brazilian real causing some jitters around
          mid-January. However, market conditions improved into the
          spring, evidenced in part by increased trading volumes and
          narrowed bid-asked and credit spreads, as it became increasingly
          evident that strong growth was continuing in the United States,
          and that economies abroad were rebounding. In this environment,
          market participants began to anticipate that the Federal Reserve
          would reverse the policy easings of the preceding fall, and
          interest rates rose. Nevertheless, improved profit expectations
          apparently more than offset the interest rate increases, and equity
          prices continued to climb until late spring. From May into the
          fall, both equity prices and longer-term interest rates moved in a
          choppy fashion, while short-term interest rates moved up with
          monetary policy tightenings in June, August, and November.
          Worries about Y2K became pronounced after midyear, and
          expectations of an acceleration of borrowing ahead of the fourth
          quarter prompted a resurgence in liquidity and credit premiums.
          In the closing months of the year, however, the likelihood of
          outsized demands for credit and liquidity over the year-end
          subsided, causing spreads to narrow, and stock prices surged
          once again. After the century date change passed without
          disruptions, liquidity improved and trading volumes grew,
          although both bond and equity prices have remained quite
          volatile so far this year. 
          Interest Rates 
          Over the first few months of 1999, short-term Treasury rates
          moved in a narrow range, anchored by an unchanged stance of
          monetary policy. Yields on intermediate- and long-term Treasury
          securities rose, however, as the flight to quality and liquidity of
          the preceding fall unwound, and incoming data pointed to
          continued robust economic growth and likely Federal Reserve
          tightening. Over most of the rest of the year, short-term Treasury
          rates moved broadly in line with the three quarter-point increases
          in the target federal funds rate; longer-term yields rose less, as
          markets had already anticipated some of those policy actions. 
          Bond and note yields moved sharply higher from early
          November 1999 to mid-January 2000, as Y2K fears diminished,
          incoming data indicated surprising economic vitality, and the
          century date change was negotiated without significant technical
          problems. In recent weeks, long-term Treasury yields have
          retraced a good portion of that rise on expectations of reduced
          supply stemming from the Treasury's new buyback program and
          reductions in the amount of bonds to be auctioned. This rally has
          been mostly confined to the long end of the Treasury market;
          long-term corporate bond yields have fallen only slightly, and
          yields are largely unchanged or have risen a little further at
          maturities of ten years or less, where most private borrowing is
          Concerns about liquidity and credit risk around the century date
          change led to large premiums in private money market rates in
          the second half of 1999. During the summer, this "safe haven"
          demand held down rates on Treasury bills maturing early in the
          new year, until the announcement in August that the Treasury
          was targeting an unusually large year-end cash balance, implying
          that it would issue a substantial volume of January-dated cash
          management bills. Year-end premiums in eurodollar, commercial
          paper, term federal funds, and other money markets--measured as
          the implied forward rate for a monthlong period spanning the
          turn relative to the rate for a neighboring period--rose earlier and
          reached much higher levels than in recent years. 
          Those year-end premiums peaked in late October and then
          declined substantially, as markets reflected increased confidence
          in technical readiness and special assurances from central banks
          that sufficient liquidity would be available around the century
          date change. Important among these assurances were several of
          the Federal Reserve initiatives described in the first section of
          this report. Securities dealers took particular advantage of the
          widened pools of acceptable collateral for open market
          operations and used large volumes of federal agency debt and
          mortgage-backed securities in repurchase agreements with the
          Open Market Desk in the closing weeks of the year, which
          helped to relieve a potential scarcity of Treasury collateral over
          the turn. Market participants also purchased options on nearly
          $500 billion worth of repurchase agreements under the standby
          financing facility and pledged more than $650 billion of
          collateral for borrowing at the discount window. With the
          smooth rollover, however, none of the RP options were
          exercised, and borrowing at the discount window turned out to
          be fairly light. 
          Equity Prices 
          Nearly all major stock indexes ended 1999 in record territory.
          The Nasdaq composite index paced the advance by soaring 86
          percent over the year, and the S&P 500 and Dow Jones
          Industrial Average posted still-impressive gains of 20 percent
          and 25 percent. Last year was the fifth consecutive year that all
          three indexes posted double-digit returns. Most stock indexes
          moved up sharply over the first few months of the year and were
          about flat on net from May through August; they then declined
          into October before surging in the final months of the year. The
          Nasdaq index, in particular, achieved most of its annual gains in
          November and December. Stock price advances in 1999 were
          not very broad-based, however: More than half of the S&P 500
          issues lost value over the year. So far in 2000, stock prices have
          been volatile and mixed; major indexes currently span a range
          from the Dow's nearly 10 percent drop to the Nasdaq's 8 percent
          Almost all key industry groups performed well. One exception
          was shares of financial firms, which were flat, on balance.
          Investor perceptions that rising interest rates would hurt earnings
          and, possibly, concern over loan quality apparently offset the
          boost resulting from passage in the fall of legislation reforming
          the depression-era Glass-Steagall constraints on combining
          commercial banking with insurance and investment banking.
          Small-cap stocks, which had lagged in 1998, also performed
          well; the Russell 2000 index climbed 20 percent over the year
          and finally surpassed its April 1998 peak in late December. 
          At large firms, stock price gains about kept pace with expected
          earnings growth in 1999, and the S&P 500 one-year-ahead
          earnings-price ratio fluctuated around the historically low level of
          4 percent even as real interest rates rose. Meanwhile, the Nasdaq
          composite index's earnings-price ratio (using actual twelve-month
          trailing earnings) plummeted from an already-slim 1-1/4 percent
          to 1/2 percent, suggesting that investors are pricing in
          expectations of tremendous earnings growth at technology firms
          relative to historical norms. 
          Debt and the Monetary Aggregates 
          Debt and Depository Intermediation 
          The debt of domestic nonfinancial sectors is estimated to have
          grown 6-1/2 percent in 1999 on a fourth-quarter-to-fourth-quarter
          basis, near the upper end of the FOMC's 3 percent to 7 percent
          range and about a percentage point faster than nominal GDP. As
          was the case in 1998, robust outlays on consumer durable goods,
          housing, and business investment, as well as substantial net
          equity retirements, helped sustain nonfederal sector debt growth
          at rates above 9 percent. Meanwhile, the dramatically increased
          federal budget surplus allowed the Treasury to reduce its
          outstanding debt about 2 percent. These movements follow the
          pattern of recent years whereby increases in the debt of
          households, businesses, and state and local governments relative
          to GDP have come close to matching declines in the federal
          government share, consistent with reduced pressure on available
          savings from the federal sector facilitating private borrowing. 
          After increasing for several years, the share of total credit
          accounted for by depository institutions leveled out in 1999.
          Growth in credit extended by those institutions edged down to
          6-1/2 percent from 6-3/4 percent in 1998. Adjusted for
          mark-to-market accounting rules, bank credit growth retreated
          from 10-1/4 percent in 1998 to 5-1/2 percent last year, with a
          considerable portion of the slowdown attributable to an
          unwinding of the surge in holdings of non-U.S. government
          securities, business loans, and security loans that had been built
          up during the market disruptions in the fall of 1998. Real estate
          loans constituted one of the few categories of bank credit that
          accelerated in 1999. By contrast, thrift credit swelled 9 percent,
          up from a 4-1/2 percent gain in 1998, as rising mortgage interest
          rates led borrowers to opt more frequently for adjustable-rate
          mortgages, which thrifts tend to keep on their books. The trend
          toward securitization of consumer loans continued in 1999: Bank
          originations of consumer loans were up about 5 percent, while
          holdings ran off at a 1-3/4 percent pace. 
          The Monetary Aggregates 
          Growth of the broad monetary aggregates moderated
          significantly last year. Nevertheless, as was expected by the
          FOMC last February and July, both M2 and M3 finished the
          year above their annual price-stability ranges. M3 rose 7-1/2
          percent in 1999, somewhat outside the Committee's range of 2
          percent to 6 percent but far below the nearly 11 percent pace of
          1998. M3 growth retreated early in 1999, as the surge in
          depository credit in the final quarter of 1998 unwound and
          depository institutions curbed their issuance of the managed
          liabilities included in that aggregate. At that time, the expansion
          of institution-only money funds also slowed with the ebbing of
          heightened preferences for liquid assets. However, M3 bulged
          again in the fourth quarter of 1999, as loan growth picked up
          and banks funded the increase mainly with large time deposits
          and other managed liabilities in M3. U.S. branches and agencies
          of foreign banks stepped up issuance of large certificates of
          deposit, in part to augment the liquidity of their head offices
          over the century date change, apparently because it was cheaper
          to fund in U.S. markets. Domestic banks needed the additional
          funding because of strong loan growth and a buildup in vault
          cash for Y2K contingencies. Corporations apparently built up
          year-end precautionary liquidity in institution-only money funds,
          which provided a further boost to M3 late in the year. Early in
          2000, these effects began to unwind. 
          M2 increased 6-1/4 percent in 1999, somewhat above the
          FOMC's range of 1 percent to 5 percent. Both the easing of
          elevated demands for liquid assets that had boosted M2 in the
          fourth quarter of 1998 and a rise in its opportunity cost (the
          difference between interest rates on short-term market
          instruments and the rates available on M2 assets) tended to bring
          down M2 growth in 1999. That rise in opportunity cost also
          helped to halt the decline in M2 velocity that had begun in
          mid-1997, although the 1-3/4 percent (annual rate) rise in
          velocity over the second half of 1999 was not enough to offset
          the drop in the first half of the year. Within M2, currency
          demand grew briskly over the year as a whole, reflecting
          booming retail sales and, late in the year, some precautionary
          buildup for Y2K. Money stock currency grew at an annualized
          rate of 28 percent in December and then ran off in the weeks
          after the turn of the year. In anticipation of a surge in the
          public's demand for currency, depository institutions vastly
          expanded their holdings of vault cash, beginning in the fall to
          avoid potential constraints in the ability of the armored car
          industry to accommodate large currency shipments late in the
          year. Depositories' cash drawings reduced their Federal Reserve
          balances and drained substantial volumes of reserves, and, in
          mid-December, large precautionary increases in the Treasury's
          cash balance and in foreign central banks' liquid investments at
          the Federal Reserve did as well. The magnitude of these flows
          was largely anticipated by the System, and, to replace the lost
          reserves, during the fourth quarter the Desk entered into a
          number of longer-maturity repurchase agreements timed to
          mature early in 2000. The Desk also executed a large number of
          short-term repurchase transactions for over the turn of the year,
          including some in the forward market, to provide sufficient
          reserves and support market liquidity. 
          The public's demand for currency through year-end, though
          appreciable, remained well below the level for which the banking
          system was prepared, and vault cash at the beginning of January
          stood about $38 billion above its year-ago level. This excess
          vault cash, and other century date change effects in money and
          reserve markets, unwound quickly after the smooth transition
          into the new year. 
          International Developments 
          Global economic conditions improved in 1999 after a year of
          depressed growth and heightened financial market instability.
          Financial markets in developing countries, which had been hit
          hard by crises in Asia and Russia in recent years, recovered last
          year. The pace of activity in developing countries increased, with
          Asian emerging-market economies in particular bouncing back
          strongly from the output declines of the preceding year. Real
          growth improved in almost all the major industrial economies as
          well. This strengthening of activity contributed to a general rise
          in equity prices and a widespread increase in interest rates.
          Despite stronger activity and higher prices for oil and other
          commodities, average foreign inflation was lower in 1999 than in
          1998, as output remained below potential in most countries. 
          Although the general theme in emerging financial markets in
          1999 was a return to stability, the year began with heightened
          tension as a result of a financial crisis in Brazil. With the effects
          of the August 1998 collapse of the ruble and the default on
          Russian government debt still reverberating, Brazil was forced to
          abandon its exchange-rate-based stabilization program in January
          1999. The real, allowed to float, soon fell nearly 50 percent
          against the dollar, generating fears of a depreciation-inflation
          spiral that could return Brazil to its high-inflation past. In
          addition, there were concerns that the government might default
          on its domestic-currency and dollar-indexed debt, the latter
          totaling more than $50 billion. In the event, these fears proved
          unfounded. The turning point appears to have come in March
          when a new central bank governor announced that fighting
          inflation was a top priority and interest rates were substantially
          raised to support the real. Over the remainder of the year,
          Brazilian financial markets stabilized on balance, despite
          continuing concerns about the government's ability to reduce the
          fiscal deficit. Inflation, although accelerating from the previous
          year, remained under 10 percent. Brazilian economic activity
          also recovered somewhat in 1999, after declining in 1998, as the
          return of confidence allowed officials to lower short-term interest
          rates substantially from their crisis-related peak levels of early in
          the year. 
          The Brazilian crisis triggered some renewed financial stress in
          other Latin American economies, and domestic interest rates and
          Brady bond yield spreads increased sharply from levels already
          elevated by the Russian crisis. However, as the situation in
          Brazil improved, financial conditions in the rest of the region
          stabilized relatively rapidly. Even so, the combination of elevated
          risk premiums and diminished access to international credit
          markets tended to depress activity in much of the region in the
          first half of 1999. Probably the most strongly affected was
          Argentina, where the exchange rate peg to the dollar was
          maintained only at the cost of continued high real interest rates
          that contributed to the decline in real GDP in 1999. In contrast,
          real GDP in Mexico rose an estimated 6 percent in 1999, aided
          by higher oil prices and strong export growth to the United
          States. The peso appreciated against the dollar for the year as a
          whole, despite a Mexican inflation rate about 10 percentage
          points higher than in the United States. 
          The recovery of activity last year in Asian developing countries
          was earlier, more widespread, and sharper than in Latin America,
          just as the downturn had been the previous year. After a steep
          drop in activity in the immediate wake of the financial crises that
          hit several Asian emerging-market economies in late 1997, the
          preconditions for a revival in activity were set by measures
          initiated to stabilize shaky financial markets and banking sectors,
          often in conjunction with International Monetary Fund programs
          that provided financial support. Once financial conditions had
          been stabilized, monetary policies turned accommodative in
          1998, and this stimulus, along with the shift toward fiscal deficits
          and an ongoing boost to net exports provided by the sharp
          depreciations of their currencies, laid the foundation for last
          year's strong revival in activity. Korea's recovery was the most
          robust, with real GDP estimated to have increased more than 10
          percent in 1999 after falling 5 percent the previous year. The
          government continued to make progress toward needed financial
          and corporate sector reform. However, significant weaknesses
          remained, as evidenced by the near collapse of Daewoo, Korea's
          second largest conglomerate. Other Asian developing countries
          that experienced financial difficulties in late 1997 (Thailand,
          Malaysia, Indonesia, and the Philippines) also recorded increases
          in real GDP in 1999 after declines the previous year. Indonesian
          financial markets were buffeted severely at times during 1999 by
          concerns about political instability, but the rupiah ended the year
          with a modest net appreciation against the dollar. The other
          former crisis countries also saw their currencies stabilize or
          slightly appreciate against the dollar. Inflation rates in these
          countries generally declined, despite the pickup in activity and
          higher prices for oil and other commodities. Inflation was held
          down by the elevated, if diminishing, levels of excess capacity
          and unemployment and by a waning of the inflationary impact of
          previous exchange rate depreciations. 
          In China, real growth slowed moderately in 1999. Given China's
          exchange rate peg to the dollar, the sizable depreciations
          elsewhere in Asia in 1997 and 1998 led to a sharp appreciation
          of China's real effective exchange rate, and there was speculation
          last year that the renminbi might be devalued. However, with
          China's trade balance continuing in substantial, though reduced,
          surplus, Chinese officials maintained the exchange rate peg to
          the dollar last year and stated their intention of extending it
          through at least this year. After the onset of the Asian financial
          crisis, continuance of Hong Kong's currency-board-maintained
          peg to the U.S. dollar was also questioned. In the event, the tie
          to the dollar was sustained, but only at the cost of high real
          interest rates, which contributed to a decrease in output in Hong
          Kong in 1998 and early 1999 and a decline of consumer prices
          over this period. However, real GDP started to move up again
          later in the year, reflecting in part the strong revival of activity
          in the rest of Asia. 
          In Russia, economic activity increased last year despite persistent
          and severe structural problems. Real GDP, which had dropped
          nearly 10 percent in 1998 as a result of the domestic financial
          crisis, recovered about half the loss last year. Net exports rose
          strongly, boosted by the lagged effect of the substantial real
          depreciation of the ruble in late 1998 and by higher oil prices.
          The inflation rate moderated to about 50 percent, somewhat
          greater than the depreciation of the ruble over the course of the
          The dollar's average foreign exchange value, measured on a
          trade-weighted basis against the currencies of a broad group of
          important U.S. trading partners, ended 1999 little changed from
          its level at the beginning of the year. There appeared to be two
          main, roughly offsetting, pressures on the dollar last year. On the
          one hand, the continued very strong growth of the U.S. economy
          relative to foreign economies tended to support the dollar. On the
          other hand, the further rise in U.S. external deficits--with the
          U.S. current account deficit moving up toward 4 percent of GDP
          by the end of the year--may have tended to hold down the dollar
          because of investor concerns that the associated strong net
          demand for dollar assets might prove unsustainable. So far this
          year, the dollar's average exchange value has increased slightly,
          boosted by new evidence of strong U.S. growth. Against the
          currencies of the major foreign industrial countries, the dollar's
          most notable movements in 1999 were a substantial depreciation
          against the Japanese yen and a significant appreciation relative to
          the euro. 
          The dollar depreciated 10 percent on balance against the yen
          over the course of 1999. In the first half of the year, the dollar
          strengthened slightly relative to the yen, as growth in Japan
          appeared to remain sluggish and Japanese monetary authorities
          reduced short-term interest rates to near zero in an effort to
          jumpstart the economy. However, around mid-year, several signs
          of a revival of activity--particularly the announcement of
          unanticipated strong growth in real GDP in the first
          quarter--triggered a depreciation of the dollar relative to the yen
          amid reports of large inflows of foreign capital into the Japanese
          stock market. Data releases showing that the U.S. current
          account deficit had reached record levels in both the second and
          third quarters of the year also appeared to be associated with
          depreciations of the dollar against the yen. Concerned that a
          stronger yen could harm the fledgling recovery, Japanese
          monetary authorities intervened heavily to weaken the yen on
          numerous occasions. So far this year, the dollar has firmed about
          7 percent against the yen. Japanese real GDP increased
          somewhat in 1999, following two consecutive years of decline.
          Growth was concentrated in the first half of the year, when
          domestic demand surged, led by fiscal stimulus. Later in the
          year, domestic demand slumped, as the pace of fiscal expansion
          flagged. Net exports made virtually no contribution to growth for
          the year as a whole. Japanese consumer prices declined slightly
          on balance over the course of the year. 
          The new European currency, the euro, came into operation at the
          start of 1999, marking the beginning of stage three of European
          economic and monetary union. The rates of exchange between
          the euro and the currencies of the eleven countries adopting the
          new currency were set at the end of 1998; based on these rates,
          the value of the euro at its creation was just under $1.17. From a
          technical perspective, the introduction of the euro went smoothly,
          and on its first day of trading its value moved higher. However,
          the euro soon started to weaken against the dollar, influenced by
          indications that euro-area growth would remain very slow. After
          approaching parity with the dollar in early July, the euro
          rebounded, partly on gathering signs of European recovery.
          However, the currency weakened again in the fall, and in early
          December it reached parity with the dollar, about where it closed
          the year. The euro's weakness late in the year was attributed in
          part to concerns about the pace of market-oriented structural
          reforms in continental Europe and to a political wrangle over the
          proposed imposition of a withholding tax on investment income.
          On balance, the dollar appreciated 16 percent relative to the euro
          over 1999. So far this year, the dollar has strengthened 2 percent
          further against the euro. Although the euro's foreign exchange
          value weakened in its first year  of operation, the volume of
          euro-denominated transactions--particularly the issuance of debt
          securities--expanded rapidly. 
          In the eleven European countries that now fix their currencies to
          the euro, real GDP growth remained weak early in 1999 but
          strengthened subsequently and averaged an estimated 3 percent
          rate for the year as a whole. Net exports made a significant
          positive contribution to growth, supported by a revival of
          demand in Asia and Eastern Europe and by the effects of the
          euro's depreciation. The areawide unemployment rate declined,
          albeit to a still-high rate of nearly 10 percent. In the spring, the
          European central bank lowered its policy rate 50 basis points, to
          2-1/2 percent. This decline was reversed later in the year in
          reaction to accumulating evidence of a pickup in activity, and the
          rate was raised an additional 25 basis points earlier this month.
          The euro-area inflation rate edged up in 1999, boosted by higher
          oil prices, but still remained below the 2 percent target ceiling. 
          Growth in the United Kingdom also moved higher on balance in
          1999, with growth picking up over the course of the year. Along
          with the strengthening of global demand, the recovery was
          stimulated by a series of official interest rate reductions, totaling
          250 basis points, undertaken by the Bank of England over the
          last half of 1998 and the first half of 1999. Later in 1999 and
          early this year, the policy rate was raised four times for a total of
          100 basis points, with officials citing the need to keep inflation
          below its 2-1/2 percent target level in light of the strength of
          consumption and the housing market and continuing tight
          conditions in the labor market. On balance, the dollar appreciated
          slightly against the pound over the course of 1999. 
          In Canada, real growth recovered in 1999 after slumping the
          previous year in response to the global slowdown and the related
          drop in the prices of Canadian commodity exports. Last year,
          strong demand from the United States spurred Canadian exports
          while rising consumer and business confidence supported
          domestic demand. In the spring, the Bank of Canada lowered its
          official interest rate twice for a total of 50 basis points in an
          effort to stimulate activity in the context of a rising Canadian
          dollar. This decline was reversed by 25-basis-point increases near
          the end of the year and earlier this month, as Canadian inflation
          moved above the midpoint of its target range, the pace of output
          growth increased, and U.S. interest rates moved higher. Over the
          course of 1999, the U.S. dollar depreciated 6 percent on balance
          against the Canadian dollar. 
          Concerns about liquidity and credit risk related to the century
          date change generated a temporary bulge in year-end premiums
          in money market rates in the second half of the year in some
          countries. For the euro, borrowing costs for short-term interbank
          funding over the year changeover--as measured by the interest
          rate implied by the forward market for a one-month loan
          spanning the year-end relative to the rates for neighboring
          months--started to rise in late summer but then reversed nearly
          all of this increase in late October and early November before
          moving up more moderately in December. The sharp
          October-November decline in the year-changeover funding
          premium came in response to a series of announcements by
          major central banks that outlined and clarified the measures these
          institutions were prepared to undertake to alleviate potential
          liquidity problems related to the century date change. For yen
          funding, the century date change premium moved in a different
          pattern, fluctuating around a relatively low level before spiking
          sharply for several days just before the year-end. The
          late-December jump in the yen funding premium was partly in
          response to date change-related illiquidity in the Japanese
          government bond repo market that emerged in early December
          and persisted into early January. To counter these conditions,
          toward the end of the year the Bank of Japan infused huge
          amounts of liquidity into its domestic banking system, which
          soon brought short-term yen funding costs back down to near
          Bond yields in the major foreign industrial countries generally
          moved higher on balance in 1999. Long-term interest rates were
          boosted by mounting evidence that economic recovery was
          taking hold abroad and by rising expectations of monetary
          tightening in the United States and, later, in other industrial
          countries. Over the course of the year, long-term interest rates
          increased on balance by more than 100 basis points in nearly all
          the major industrial countries. The notable exception was Japan,
          where long-term rates were little changed. 
          Equity prices showed strong and widespread increases in 1999,
          as the pace of global activity quickened and the threat from
          emerging-market financial crises appeared to recede. In the
          industrial countries equity prices on average rose sharply,
          extending the general upward trend of recent years. The average
          percentage increase of equity prices in developing countries was
          even larger, as prices recovered from their crisis-related declines
          of the previous year. The fact that emerging Latin American and
          Asian equity markets outperformed those in industrial countries
          lends some support to the view that global investors increased
          their risk tolerance, especially during the last months of the year.
          Oil prices increased dramatically during 1999, fully reversing the
          declines in the previous two years. The average spot price for
          West Texas intermediate, the U.S. benchmark crude, more than
          doubled, from around $12 per barrel at the beginning of the year
          to more than $26 per barrel in December. This rebound in oil
          prices was driven by a combination of strengthening world
          demand and constrained world supply. The strong U.S. economy,
          combined with a recovery of economic activity abroad and a
          somewhat more normal weather pattern, led to a 2 percent
          increase in world oil consumption. Oil production, on the other
          hand, declined 2 percent, primarily because of reduced supplies
          from OPEC and other key producers. Starting last spring, OPEC
          consistently held production near targeted levels, in marked
          contrast to the widespread lack of compliance that characterized
          earlier agreements. So far this year, oil prices have risen further
          on speculation over a possible extension of current OPEC
          production targets and the onset of unexpectedly cold weather in
          key consuming regions.
          The price of gold fluctuated substantially in 1999. The price
          declined to near a twenty-year low of about $250 per ounce at
          mid-year as several central banks, including the Bank of England
          and the Swiss National Bank, announced plans to sell a sizable
          portion of their reserves. The September announcement that
          fifteen European central banks, including the two just mentioned,
          would limit their aggregate sales of bullion and curtail leasing
          activities, saw the price of gold briefly rise above $320 per
          ounce before turning down later in the year. Recently, the price
          has moved back up, to above $300 per ounce.    
            1. In past Monetary Policy Reports to the Congress, the FOMC
          has framed its inflation forecasts in terms of the consumer price
          index. The chain-type price index for PCE draws extensively on
          data from the consumer price index but, while not entirely free
          of measurement problems, has several advantages relative to the
          CPI. The PCE chain-type index is constructed from a formula
          that reflects the changing composition of spending and thereby
          avoids some of the upward bias associated with the fixed-weight
          nature of the CPI. In addition, the weights are based on a more
          comprehensive measure of expenditures. Finally, historical data
          used in the PCE price index can be revised to account for newly
          available information and for improvements in measurement
          techniques, including those that affect source data from the CPI;
          the result is a more consistent series over time. This switch in
          presentation notwithstanding, the FOMC will continue to rely on
          a variety of aggregate price measures, as well as other
          information on prices and costs, in assessing the path of



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