By unanimous vote, the minutes of
the meeting of the Federal Open Market Committee held on February 1-2,
2000, were approved.
The Manager of the System Open
Market Account reported on recent developments in foreign exchange
markets. There were no open market operations in foreign currencies
for the System's account in the period since the previous meeting, and
thus no vote was required of the Committee.
The Manager also reported on
developments in domestic financial markets and on System open market
transactions in government securities and federal agency obligations
during the period February 2, 2000, through March 20, 2000. By
unanimous vote, the Committee ratified these transactions.
At its meeting in August 1999, the
Committee had voted to expand the collateral that could be accepted in
System repurchase transactions and had authorized the use of reverse
repurchase agreements. These authorizations were scheduled to expire
at the end of April 2000. At this meeting the Manager proposed that
the authority to use the broader range of collateral be extended until
the first meeting in 2001 and that the authority to engage in reverse
repurchase agreements be made permanent.
The principal effect of the expanded
collateral authorized last August, together with the use of tri-party
repurchase agreements, was to allow passthrough mortgage securities of
GNMA, FNMA, and FHLMC and "stripped" securities of the U.S.
Treasury and federal government agencies to be taken as collateral for
repurchase transactions. Direct Treasury obligations remained the
preferred means for meeting the System's needs, but anticipated
paydowns of marketable federal debt associated with projected budget
surpluses were likely to limit the System's ability in the future to
continue to add substantially to holdings, even on a temporary basis,
without generating undesirable market repercussions.
In this setting, the Manager
recommended that a broad-gauge study be undertaken to consider
alternative asset classes and selection criteria that could be
appropriate for the System Open Market Account (SOMA), with particular
attention to alternatives to the current reliance on net additions to
outright holdings of Treasury securities as the sole means of
effectuating the upward trend in the asset side of the System's
balance sheet.
Pending the completion of that study
and the Committee's consideration of alternative asset allocations,
the Manager suggested that the Desk could rely on temporary operations
with relatively long maturities to meet the growth in underlying
reserve needs that could not comfortably be met by further outright
purchases of Treasury securities. In implementing these temporary
operations, the Manager expressed a preference to distribute the
System's demand for collateral as broadly as possible in order to
minimize the impact on spread relationships in the financing market.
This preference motivated his recommendation to extend temporarily the
authority to operate in the broader range of collateral.
The required size of the longer-term
temporary operations would depend on how much of the permanent reserve
need could be met by outright purchases of Treasury securities. The
Manager noted that the desirability of maintaining a liquid bill
portfolio suggested that System holdings of any bill issue should be
limited to 35-40 percent of the outstanding amount. With issue sizes
declining, such limits might mean that from time to time some portion
of the System's maturing bill holdings would be redeemed rather than
rolled over in Treasury auctions. The Manager also intended to roll
over maturing holdings of Treasury coupon issues in auctions and to
add to the System's portfolio to meet permanent reserve needs by
purchasing coupon securities in the secondary market. However, the
amount that could be added through outright purchases without
disturbing the Treasury market would have to be gauged over time
relative to conditions in the market as Treasury issuance patterns
evolved in response to System purchases and Treasury buybacks of
coupon securities.
All the members endorsed the
proposal for a study of the issues associated with the System's asset
allocation in light of declining Treasury debt. They noted that the
requested temporary expansion of authority, pending the Committee's
consideration of the completed study, should not be read as indicating
in any way how the Committee might ultimately choose to allocate the
portfolio, and any interim operations in the broader range of
collateral should be capable of being unwound without adverse market
consequences.
At the conclusion of this
discussion, the Committee voted unanimously to extend the suspension
of several provisions of the "Guidelines for the Conduct of
System Operations in Federal Agency Issues" until the first
regularly scheduled meeting in 2001.
The Committee also accepted a
proposal by the Manager to make permanent the authority to use reverse
repurchase agreements in the conduct of open market operations. Such
agreements are equivalent to matched sale-purchase transactions, which
the Manager has long been authorized to use, but reverse RPs have the
advantage of much greater flexibility because they are the common
practice in financial markets. The Manager indicated that he did not
expect to use reverse RPs on a regular basis until the System's new
trading system became operational, but in conjunction with existing
tri-party arrangements there might be occasions in the interim when
the timing of open market operations would make it desirable to use
them instead of matched sale-purchase transactions. The members voted
unanimously to adopt on a permanent basis, subject to the annual
review required for all the Committee's instruments, paragraph 1 (c)
of the Authorization for Domestic Open Market Operations in the form
reproduced below.
- The Federal Open Market Committee
authorizes and directs the Federal Reserve Bank of New York, to
the extent necessary to carry out the most recent domestic policy
directive adopted at a meeting of the Committee:
(c) To sell U.S. Government
securities and securities that are direct obligations of, or fully
guaranteed as to principal and interest by, any agency of the
United States to dealers for System Open Market Account under
agreements for the resale by dealers of such securities or
obligations in 90 calendar days or less, at rates that, unless
otherwise expressly authorized by the Committee, shall be
determined by competitive bidding, after applying reasonable
limitations on the volume of agreements with individual dealers.
The Committee then turned to a
discussion of the economic and financial outlook and the
implementation of monetary policy over the intermeeting period ahead.
The information reviewed at this
meeting suggested that the expansion of economic activity remained
rapid. Consumer spending and business fixed investment were still
trending upward strongly, and housing demand was holding at a high
level. Although the growth in domestic demand was being met partly
through rising imports, industrial production and nonfarm payrolls
were expanding briskly. Labor markets continued to be very tight, but
there were few signs of any acceleration in labor costs. Price
inflation was still moderate, except for the upturn in energy prices
in recent months.
Labor demand remained robust in
January and February, with the average increase in private nonfarm
payroll employment over the two months only a little below the strong
pace of 1999. Job growth in manufacturing and construction was solid,
while hiring in the services sector slowed appreciably. The civilian
unemployment rate, at 4.1 percent in February, was just above its 1999
low, and initial claims for unemployment insurance were at an
extremely low level in early March.
Industrial production was up sharply
in the early months of the year, reflecting large gains in the
manufacturing and utilities sectors. Within manufacturing, output of
high-tech equipment was notably strong, but production of motor
vehicles and parts also recorded a sizable advance on balance over the
January-February period. By contrast, output of aircraft and parts
weakened again. The continuing strength in manufacturing lifted the
factory operating rate further, but capacity utilization stayed a
little below its long-term average.
Retail sales continued to increase
rapidly in January and February against the backdrop of strong growth
in disposable income and household wealth and elevated consumer
confidence. Sales of light vehicles surged over the January-February
period. Purchases of goods other than motor vehicles picked up
substantially further, with gains widespread across most major
categories. Outlays for services rose briskly in January (latest
data); part of the gain resulted from higher spending for heating as
temperatures in many parts of the country dropped to more seasonable
levels.
Residential housing activity
remained strong in the first two months of the year. Total private
housing starts in January and February held at the high December
level, as a surge in starts of multifamily units offset a downturn in
starts of single-family homes. The demand for housing, associated with
continuing gains in jobs and incomes, had remained ebullient despite
an appreciable increase in mortgage rates. Although sales of new
single-family homes fell in January (latest data), the decline
followed a December pace that was the highest monthly rate in more
than twenty years. Sales of existing homes also declined in January,
continuing a trend that had begun last July, but inventories of
existing homes for sale evidently were at very low levels.
Business spending on durable
equipment and software and on nonresidential structures increased
sharply in January. Shipments of computing and communications
equipment surged after the century rollover, and shipments of other
non-aircraft goods rose moderately. Deliveries of aircraft continued
to be held down by the labor strike at Boeing. The recent strength in
orders for many types of equipment pointed to further advances in
spending in coming months. Expenditures for nonresidential structures
turned up last autumn and rose rapidly in January. Office and other
commercial construction activity was robust, while industrial building
was little changed.
The pace of accumulation of
manufacturing and trade inventories slowed somewhat in January from
the elevated rate in the fourth quarter; however, sales grew briskly
and the aggregate inventory-sales ratio edged down from an already
very low level. In manufacturing, stocks increased moderately further
in January; however, shipments grew by more, and the aggregate
stock-shipments ratio for the sector declined to a new low. Both
wholesale and retail inventories increased in line with sales, and
inventory-sales ratios for these sectors stayed at the bottom of their
respective ranges over the past twelve months.
The U.S. trade deficit in goods and
services climbed to a new high in January, with the value of exports
retreating from the peak reached in December and the value of imports
rising sharply. The drop in exports was concentrated in computers,
semiconductors, aircraft, chemicals, and consumer goods, while the
increase in imports was primarily in oil and automotive products. The
available information suggested that economic expansion continued to
be robust in most foreign industrial economies. The Japanese economy
was still the notable exception, though some favorable signs were
evident. Economic activity in the developing countries also picked up
further, with Asian countries registering the largest gains.
Price inflation had remained
moderate in recent months, with the exception of higher energy prices.
Consumer prices jumped in February as energy prices surged.
Abstracting from energy prices, however, consumer price inflation was
moderate in January and February. Moreover, the increase in consumer
prices of items other than food and energy during the twelve months
ended in February was the same as the change during the previous
twelve-month period. At the producer level, prices of finished goods
other than food and energy changed little in January and February, and
their rise during the twelve months ended in February was somewhat
smaller than the advance during the previous twelve-month period. At
earlier stages of processing, however, producer prices registered
somewhat larger increases than those for finished goods in both the
January-February period and the twelve months ended in February. With
regard to labor costs, average hourly earnings grew at a slightly
faster rate in January and February than they had in the fourth
quarter of last year. However, the advance in this earnings measure in
the twelve months ended in February was about the same as that in the
previous twelve-month period.
At its meeting on February 1-2,
2000, the Committee adopted a directive that called for a slight
tightening of conditions in reserve markets consistent with an
increase of � percentage point in the federal funds rate to an
average of about 5-3/4 percent. The members agreed that this action
was needed to help bring the growth of aggregate demand into better
alignment with the expansion of potential aggregate supply and thereby
help avert rising inflationary pressures. The members also agreed that
the risks remained weighted mainly in the direction of greater
inflation pressures and that further tightening actions might be
necessary to bring about financial conditions that were sufficiently
firm to contain upward pressures on labor costs and prices.
Open market operations during the
intermeeting period were directed toward implementing the desired
slightly greater pressure on reserve positions, and the federal funds
rate averaged very close to the Committee's 5-3/4 percent target. The
Committee's action and its announcement that the risks were weighted
in the direction of rising inflation were widely anticipated and had
little immediate effect on market yields. Subsequently, market rates
moved up in response to the receipt of data that signaled persisting
strength of the economy, but they turned back down in response to new
information indicating continued low inflation and to greater
volatility in equity prices. On balance over the intermeeting period,
interest rates on private instruments registered small mixed changes
while yields on longer-term Treasury securities declined
significantly. Most major indexes of equity prices moved up
appreciably on net over the intermeeting period.
In foreign exchange markets, the
trade-weighted value of the dollar changed little over the
intermeeting period against a basket of major currencies. The dollar
rose against the Australian dollar, British pound, Canadian dollar,
and the euro as investors apparently revised down their expectations
of the extent of monetary tightening in those countries. By contrast,
the dollar declined against the Japanese yen and the currencies of a
number of other important trading partners, notably the Mexican peso
and the Brazilian real.
The growth of M2 and M3 slowed in
February, partly reflecting an unwinding of Y2K effects and rising
opportunity costs of holding liquid balances. In addition, the surging
prices of technology-related equities might have spurred depositors to
shift some of their M2 balances into equity mutual funds. The growth
of total domestic nonfinancial debt slowed early in the year as large
federal debt paydowns resumed following the sharp buildup of Treasury
balances prior to year-end.
The staff forecast prepared for this
meeting suggested that the economic expansion would moderate gradually
from its currently elevated pace to a rate around, or perhaps a little
below, the growth of the economy's estimated potential. The expansion
of domestic final demand increasingly would be held back by the
anticipated waning of positive wealth effects associated with large
earlier gains in equity prices and by higher interest rates. As a
result, the growth of spending on consumer durables and houses was
expected to slow; in addition, business investment in equipment and
software was projected to decelerate following a first-quarter surge
that partly reflected information technology expenditures that had
been postponed until after the century rollover. In addition, solid
economic expansion abroad was expected to boost the growth of U.S.
exports for some period ahead. Core price inflation was projected to
increase somewhat over the forecast horizon, partly as a result of
rising import prices and some firming of gains in nominal labor
compensation in persistently tight labor markets that would not be
fully offset by productivity growth.
In the Committee's discussion of
current and prospective economic developments, members commented, as
they had at earlier meetings, that they saw little evidence of any
slowing in the rapid expansion of domestic economic activity, but they
also saw few signs to date of significant acceleration in inflation.
The growth in aggregate demand continued to display remarkable vigor,
evidently driven by high levels of consumer and business confidence
and accommodative financial markets. Large increases in imports were
helping to satisfy the impressive growth in demand. At the same time,
aggregate supply also continued to record strong gains amid
indications of further acceleration in productivity. Looking ahead,
however, members reiterated earlier concerns that aggregate demand
could continue to grow faster than potential aggregate supply, even
under optimistic assumptions regarding future productivity gains.
Contributing to that continuing imbalance, the strengthening of most
foreign industrial economies and the diminishing effects of the
earlier appreciation of the dollar were likely to boost further
foreign demand for U.S. output. The experience of recent years amply
demonstrated, however, that the extent to which prospective growth in
demand might exceed further expansion in the economy's potential and
the implications for inflation were subject to a wide range of
uncertainty as to both degree and timing. Nonetheless, given the
persistence of rapid growth in aggregate demand beyond growth in
aggregate supply and very tight conditions in labor markets, the
members continued to be concerned about the risks of rising inflation.
In their comments about economic
conditions across the nation, members referred to anecdotal and other
evidence of widespread strength in business activity, which in many
areas appeared to be rising appreciably further from already high
levels. Agriculture continued to be a notable exception, though
members also reported signs of softening in housing and other
construction activity in some areas. With regard to developments in
key sectors of the economy, consumer spending had remained
particularly robust thus far this year according to reports from most
parts of the nation. Some moderation in such spending to a pace more
in line with the growth in household incomes was cited as a reasonable
expectation, given underlying factors such as the large buildup of
durable goods in consumer hands, the rise in consumer debt loads, and
the effects of higher oil prices. Of key importance was the
prospective performance of the stock market, whose robust gains in
recent years had undoubtedly boosted consumer confidence and spending.
The members noted that equity prices generally had posted further
gains during the intermeeting period, but in their view the large
increases of recent years were not likely to be repeated, and an
absence of such gains would have a restraining effect on consumer
expenditures over time. Even so, further increases in household
incomes along with the lagged wealth effects of the sharp earlier
advances in stock market prices seemed likely to sustain relatively
strong consumer spending for some period of time.
After moderating toward the end of
1999, in part because of caution ahead of the century date change,
business fixed investment again appeared to be expanding at a vigorous
pace. The advance included not only notable strength in the high-tech
sector but brisk spending in a number of other areas as well. Factors
underlying business optimism included robust growth in revenues and
profits and the ready availability of both debt and equity financing.
The divergence, at least until recently, in the stock market between
the valuations of high-tech firms and those of more traditional,
established firms was inducing a redirection of investment funds to
business activities that were perceived to be more productive. While
the associated capital investments undoubtedly had contributed to the
acceleration in productivity, some members expressed concern that the
historically elevated valuations of many high-tech stocks were subject
to a sizable market adjustment at some point. That risk was
underscored by the increased volatility of the stock market.
In the housing sector, building
activity generally remained at a high level, though slipping a bit in
some parts of the country, and there were only limited indications
that the rise in mortgage interest rates was holding down residential
construction. On the other hand, housing and other construction
activity reportedly was being retarded by shortages of labor and, in
some areas, of materials as well. On balance, recent developments did
not augur any significant changes in homebuilding.
The improved economic outlook for
most of the nation's important trading partners, in association with
the fading effects of the dollar's earlier appreciation, pointed to
faster expansion in exports and recent anecdotal reports were broadly
consistent with such a development. Growth in imports was expected to
moderate over time, though imports currently were still rising
rapidly. Even so, prospective developments in the foreign trade sector
were not likely to provide much relief to demand pressures on the U.S.
economy.
With regard to the outlook for
inflation, members saw little evidence to date of any acceleration in
core inflation, and unit costs for nonfinancial corporations were
unchanged in the fourth quarter. Despite such welcome developments,
members expressed concern about indications of a less benign inflation
climate. The direct and indirect effects of higher fuel prices, the
rise in other import prices, increasing medical costs, and some
deterioration in surveys of inflation expectations could begin to show
through to higher underlying inflation. More fundamentally, however,
the members believed that current growth in aggregate demand, should
it persist, would continue to exceed the expansion of potential output
and, by putting added pressure on already tight labor markets, would
at some point foster inflationary imbalances that would undermine the
economic expansion.
In the Committee's discussion of
policy for the intermeeting period ahead, all the members endorsed a
proposal to tighten reserve conditions by a slight amount consistent
with an increase in the federal funds rate to a level of 6 percent.
Persisting strength in aggregate domestic demand had been accommodated
thus far without a pickup in underlying inflation because of the
remarkable acceleration in productivity and because of two safety
valves--the economy's ability to draw on the pool of available workers
and to finance the rapid growth in imports relative to exports.
However, a further acceleration in productivity was unlikely to boost
the economy's growth potential sufficiently to satisfy the expansion
in aggregate demand without some slowing in the latter. In addition,
the two safety valves could not be counted on to work indefinitely. In
these circumstances, the members saw substantial risks of rising
pressures on labor and other resources and of higher inflation that
called for some further firming of monetary policy at this meeting.
They agreed, though, that because a significant acceleration in
inflation did not appear to be imminent and because uncertainties
continued to surround the economic outlook, a gradual approach to
policy adjustments was warranted. Some members commented that,
although a more forceful policy move of 50 basis points might be
needed at some point, measured and predictable policy tightening
moves, such as the one contemplated today, still were desirable in
current circumstances, which included somewhat unsettled financial
markets.
Looking ahead, the Committee would
continue to assess the need for further tightening to contain
inflation. Even after taking account of the lagged effects of the
considerable tightening that already had been implemented since
mid-1999, additional tightening might well be needed to ensure that
financial conditions would adjust sufficiently to bring aggregate
demand into better balance with potential supply and thereby counter a
possible escalation of pressures on labor costs and prices. The
members agreed that the press statement to be issued shortly after
this meeting should continue to highlight their view that even after
today's tightening move the risks would remain tilted toward
heightened inflation pressures.
At the conclusion of this
discussion, the Committee voted to authorize and direct the Federal
Reserve Bank of New York, until it was instructed otherwise, to
execute transactions in the System account in accordance with the
following policy directive:
The Federal Open Market Committee
seeks monetary and financial conditions that will foster price
stability and promote sustainable growth in output. To further its
long-run objectives, the Committee in the immediate future seeks
conditions in reserve markets consistent with increasing the federal
funds rate to an average of around 6 percent.
The vote also encompassed approval
of the sentence below for inclusion in the press statement to be
released shortly after the meeting:
Against the background of its
long-run goals of price stability and sustainable economic growth
and of the information currently available, the Committee believes
the risks are weighted mainly toward conditions that may generate
heightened inflation pressures in the foreseeable future.
Votes for this action:
Messrs. Greenspan, McDonough, Broaddus, Ferguson, Gramlich, Guynn,
Jordan, Kelley, Meyer, and Parry.
Votes against this action:
None.
The meeting was recessed briefly
after this vote and the members of the Board of Governors left the
room to vote on increases in the discount rate that were pending at
several Federal Reserve Banks. On the Board members' return, Chairman
Greenspan announced that the Board had approved a � percentage point
increase in the discount rate to a level of 5-1/2 percent. The
Committee concluded its meeting with a review of the press release
announcing the joint policy action.
It was agreed that the next meeting
of the Committee would be held on Tuesday, May 16, 2000.
The meeting adjourned at 12:50 p.m.
