STRICTLY CONFIDENTIAL (FR) CLASS 11-FOMC

Materialfor

Staff Presentation to the
Federal Open Market Committee

February 7,1989

Chart 1

Basic Assumptions 0 Federal Reserve will seek to bring about a gradual reduction of inflation.
0

Fiscal policy will be restrictive. Crop yields will be normal. Energy prices will rise only moderately.

0

0

Financial Implications
0

Interest rates will rise into early 1990 and then ease a bit.

M2 will grow roughly 3.5 percent in 1989 and 5 percent in 1990.
0

The dollar will fall moderately over the forecast period.

Chart 2

FISCAL POLICY ASSUMPTIONS

I
I

-

For fiscal year 1990, sequester is avoided through a $27 billion deficit reduction package: $20 billion in spending cuts $7 billion in user fees and other revenue enhancements.

BUDGET SURPLUS/DEFICIT (-)

r
Billions of dollars

FY86

FY87
-1 69

FY88

FY89 -209 49 -1 59

FY90 -1 92 65

On Budget
Off Budget

-238

-1 94
39 -1 55

17 -22 1

20 -1 50

Total

-1 27

Caleqdm Years

- 18 - 12
- 6

Stimulus
'\\

' Restraint
"

I I

' '' .
I

0 -

+

6

I

I

I

I

I

I

* 12

Chart 3

Forecast Summary
REAL GNP

Percent change, SAAR

Percent change 0 4 to 0 4

-

Drought Actual Adjusted

Drought AdJusled(Second bar)

4

1987 1988

5.0 2.7
3.0

5.0
3.4
2.2

2

1989 1990

1.1

1.1

1987

1988

1989

1990

0

CIVILIAN UNEMPLOYMENT RATE

Percent

0 4 level

1987 1988 1989 1990

5.9 5.3 5.5 6.1

INFLATION

Percent change, a4 l a o 4

Consumer Price Index Rxedd-welghlQNP Prloo Index (Second bar)

Percent change Q4 to 0 4 Fixed-welght CPI GNP Index
4

2

1990
0

1987

1988

1989

1990

Chart 4

ECONOMIC PROJECTIONS FOR 1989
FOMC
Range
Percent change, Q4 to Q4

Central Tendency

Admlnlstratlon 7.4

Staff
7.1

Nominal GNP Real GNP CPI
Average level, Q4, percent

5 112 to a 112 1 112 to 3 114

6 112 to 7 1l2
2 112 to 3

35 . 3.6

30 .
4.9

3 112 to 5 114

4 112 to 5

Unemployment Rate

5 to 6

5 114 to 5 1l2

5.2

5.5

Chart 5

Household Spending
REAL PERSONAL CONSUMPTION EXPENDITURES Parwnl change tmm four quartam eatller

7 15

Percent change a 4 to a 4 PCE
1987 1.8 3.6 2.6 .7

Durables

10

DPI

3.0
3.8 2.2 .9

5

1988
and Services

,
1987 1988 1989

'.
1990

0 -

+

1989 1990

1985

5

1986

HOUSEHOLD NET WORTH

RaUo to DPI

CONSUMER SENTIMENT

r

Index

1

130

110

90

I
1985 1986 1987 1988 1985 1986

Michigan Survey

I
70

1987

1988

HOUSING STARTS

Milllons of u n b . annual rate 1.5

Real Residential
Fixed Investment Percent change a 4 to a 4
1987

-

1

-3.5
2.4 -.9 -1.6

0.5

1988 1989

I
1985 1886

I
1987

I
1988

I
1989

I
1990

1990
0

ChaR 6

Business Spending
REAL BUSINESS FIXED INVESTMENT

Percenlc h a m . SAAR

Toti BFI
15

Percent change 0 4 to Q4
1987 8.8

0 -

+

1988 1989 1990

5.5
3.8 1.1

I
1988 1969

I
1990

15

NONDEFENSE CAPITAL GOODS ORDERS Bmom of dollan Bllllons of dollars

CONTRACTS
- 8 Nonreslddal Construction &month movlng average

- 7

Am
I
1987

- 6

I

I

4

1988

REAL INVENTORY-SALES RATIOS

1.6

r

Aatb .

Ratlo
1.75

NONFARM INVENTORY INVESTMENT Average annual rates, 1982 dollars

-

60
Aulo Dealer So t&

Omer (Second bar)
1.85

40

1.55

20

.._
1987 1988

1.45
1888 1 W

0
1990

Chart 7

Government Sector
REAL FEDERAL PURCHASES

Defense

Percentchange, Q4 lo Q4

Nondefense less CCC (Second bar)

1
+ 0 1990

-

Total Pun ises less CCC Percent change 0 4 to Q4
1987 1988 1989 1990

-

2o 10

7.0

-2.1
-2.7 -1.4

1987

1988

1989

10

r
I-

REAL STATE AND LOCAL PURCHASES
Construction
Other (Second bar)

Percent change, 04 to 0 4
6

-

Total Purchases Percent change Q4 to Q4
1987 1988 1989 1990 2.5 2.9 2.1 2.1

-

4

1987

1988

1969

1990

STATE AND LOCAL SURPLUS
Operating and Capltal Account

Bllllons of dollars, annual rate

Total Billions of dollars
1987 1988 1989 1990 -9.2 -14.1 -8.4

-7.5

I
1980

I
1982

I

I
1984

I

I
1986

I

I
1988

I

I
1990

40

Chart 8

Labor Market
“OKUNSLAW“
Change in unemployment rate, percentagepoints

LABOR PRODUCTIVITY
3

-

1982 dollars Der hour 20

0

Nonfarm Business Sector
2

18

+

Annual Obsetvations
1980 - 1990, Q4 to Q4
2

16

4

2

6

1 1 1 1 1 1 1 1 114 11111111
2
4

6

8

1975

1980

1985

19

Growth in Real GNP, percent

Nonfarm Business Sector

- 8

Compensation

, -

-- -

- 6
/----/---

-- 4 - 2

I

0

Chart 9

Prices
CAPACITY UTILIZATION PRODUCER PRICE INDEXES Percent change from four quarters earlier
Food and Energy

Percent

CPI FOOD

1 7 8

75

IntermediateGoods
- 6

FinishedGoods

--- 2

4

1987

1988

1 989

1990

0

1987

1988

1989

1990

Percentchange, 04 to a4

CPI ENERGY

10

8

r

Percent change, 04 (0 a4

1

lo

8

4

2

0

1987

1988

1989

1990

Percent change Q4 to Q4

-

1987 1988

4.3

4.5 5.2

5.7

1989
1990

10 97

1989

1990

Chsrt 10

EXTERNAL BALANCES
Billions d l 9 8 2 dollars
100

Bllllons of dollars
100

50

59

: 50

0 -

+

.

\\

Real GNP Net Exports

, 50 100

100

150

Current Account'

150

2M)

I
1982

I

I
1984

I

I
1986

I

I
1988

I

I
1990

200

r

CURRENT ACCOUNT' AS A PERCENT OF GNP
Percent

-

,

FOREIGN EXCHANGE VALUE OF THE US. DOLLAR

Ratio scale, March 1973 100
170

-

Selected Dollar Exchange Rates
Percent Change 1247 to 2/3/89

150

130

Deutschemark Yen

15. 1. -4.1 -9.’

110

Poundsterling Canadian dollar

90

S. Koreanwon -14. Taiwan dollar
-4.

70
1981 1983 1985 1997 1999

REAL LONG-TERM INTEREST RATES”’

Percent

1

Percent

-

Feb. Feb.3 1988 1989

Selected Interest Rates

l2

Overnight: Japan Germany U.S. Long-term:
3.82 3.29 6.60 3.94 5.75 9.04

I
I
1991

-

Japan Germany U.S.

4.29 5.73 8.21

4.90 6.71 9.01

I

I
1993

I

I
1985

I

I
1997

I

I
1989

3

‘Weghted a v e w agalnsl w ol foregn G-10 countdm uslng total 1072.76 average mde.
** Adjwted by relatlve consumer +m.
“’Mullllateral tnde-welghledaverage of long-termgovernment w plbnc amhorltybond rat88 ad@stedlor eqected lnllallon mtlmated by a SEmmIh centered moving average of actual lnflatlon (stall fwecasls where needed).

Chart 12

r

INDUSTRIAL PRODUCTION ABROAD ' Percent chanae from lwelve months earlier

1

lo

1986

1987

1988

COMMODITY PRICES **

-

Index, 1980 100

-

Foreign Currency

1
1980 1981 1982 1983 1984 1985 1986 1987 1988

120

ECONOMIC POLICY ABROAD Increased concern about inflation and capacity pressures. Monetary policy expected to tighten further in 1989. Fiscal policy generally neutral (tighter in Germany).

' WeigMed average lor the six major loreign lndustllal muntrles u81ng 1982 GNP ** IMF index d 30 pdce aerles lor 34 non-fuel prlmary conmdties.

Chvll3

REALGNP

Percent change, SAAR

F
-

United States *

Slx Forelgn Indu$trial Countfles ** (Secondbar)

i
6

8

Foreign **

Domestic QNP Spending

Percent change, Q4 to Q4

- 6

- 5

- 4

1 I
CONSUMER PRICES

I
I

\//\,
-----/

//-=
- 2

3

I

I

1

r

Percent change from four qusr(en earlier

1987

Percent change
Q4 to Q4

-

Foreign *** U.S.
2.5 3.1 3.6 3.0 4.4 4.3 4.9 5.1

1988
1989 1990

I

M l h s ot 1982 dollars
130

COMPUTERS = h

-

Chmll4

Exports
Ratlo scale, bllllons of dollars

100
70

r
Value Price
10

Percent Change 0 4 to Q4 1988 14 1989
5

199( 2 -12 16

40

-6
21

-12 18

10

I
1986

I

I
1988

I

I
1990

1982$

400-

-400

350

00-

350-

Percent Change 0 4 to Q4 1988 Value
22

1990 14 4 9

300-

Value
00

0 ' 0

- m

1989 14

- 250
Quant3y'

Mo

-

200

150

I

Price 1982$

5
16

5
9

150

AGRICULTURAL EXPORTS
l h 8 of 1882 d l dm
la(k scale,

Ratio scale, bllllons of dollars

-

Percent Change Q4 to Q4 1988 1989 1990

Quantity

I
1 3 0

1982$

-1

14

m

1986

21988

1990

0

Chart 15

Non-oil Imports PRICES QUANTITIES
Percent change, Q4 to Q4 1987

-

Percent change, Q4 to Q4 1987

-

1988

1988

1. Food
2. IndustrialSupplies 3. Computers
4. Other Capital Goods

0

5
13 -6

1. Food
2. IndusMal Supplies

2 2 73 10 5
0

-5
-3 15 6 -2 1

11
-20 9
4

5
5 6 7
7

5. Automolve
6. Consumer Goods

7. Other 8. Total Non-011
NlPA fixed-webht indexes

9 7

7

3. Computers 4. Other Capital Goods 5. Automotive 6. Consumer Goods 7. Other 8. Total NOROII
NiPA amounts.

9 9

-1 2

90-

70

-

Quantity

_---_--- -90

70
50

Percent Change Q4 to Q4 1988 Value Price 1982$ 9 1989

-

Value

- 30

199C

-------__
10

1
-12
14

-1
-12
13

- 10
I

-6
15

I

I

I

I
Ratio scale, billions of dollars

Ratio scale, billlons of 1982 dollars

480
420

-

1480

Percent Change 0 4 to Q4 1988 1989
8

1990
4

360

Value
300

7

7

5 3

7 -3

240

1988

1988

1990

--_

1982$

0

ChM 1 6

Petroleum and Products

40-

-40

30

- 30
West Texas Intermediate U S . Import Price
Feb. 3 = $17.76
/--------

20-

- 20 - lo

10

I

0

I

I

I

I

I

I

I

0

-

Mllllon barrels p'

United States

12

---_
9

U.S. IMPORTS
ia
9

-----1986

Other Industrial Countries

6

1987

1988

1989

3

lailo scale. illlion barrels per day

Ratlo scale, bllllons of dollars

1

Q4 Level

-

7o

8

7

1987 1988

17.46 12.70 15.00 15.00

7.1

7.8
7.9
8.1

6

5

1989 1990

4
1985

I
1986

I
1987

I
1988

I
1989

I
1990

20

Chad 17

U.S. CURRENT ACCOUNT

Bllllons of dollars

Billims of dollars
MerchTrade

-

cumn(
Account

1985 1986 1987 1988 1989 1990

-1 22 -1 45 -1 60
-1 25

-1 22 -151 -170 -131 -1 32 -112

-1 22 -98

.. .

1968

1988

1990
* Exdudng OSpHal g n and lwra. d

U.S. CAPITAL TRANSACTIONS
1986
1. Pllvate Capital, net 2. US. Banking Offices 3. Bonds and Stocks 1 2 4. D M investment2 3 5. Other Flows 6. StalMlcal Dlscrepancy U.S. and Fonlgn official Assets 7. United sae tts 8. Other G-10 Countries 9. Other Countries

Binions of ~oiiars, et I~ROWS N 1987 1988

-+

1989
66 28 25 14 -1 20

101

20
65 23 -7 16

96 47 28 16 5 19
55 10 39 6

80
28 39 16 -3 16
35

34
-2 31 5 18 -151

4 6
4 25 17 na -1 32

-6 17 24 2 -131

Memo: 10. U.S. and Other Q 1 0 11. Current Account

Purchases of Dollars

95 -170

Alternative Forecast
Baseline: Greenbook forecast extended into 1991 with assumption of no new deficitreductionaction in 1991 and a slight easing of short-term interest rates.

Unchanged Dollar: Dollar remains at current level; monetary policy adjusts to hold real GNP on baseline path.
1989 1990 1991

Percent change, Q4 t Q4 o

Real GNP, US.
Baseline Unchanged Dollar

3.0
3.0

1.1 1.1

1.7 1.7

M2
Baseline Unchanged Dollar

3.5 3.8 4.4 4.4

5.0 5.3

6.0 6.5

GNP Prices
Baseline Unchanged Dollar

4.7 4.5

4.3 3.9

Real GNP Abroad*
Baseline Unchanged Dollar 2.5 2.6 2.6 3.3 2.5 3.3

0 4 level

Current Account
easeline Unchanged Dollar
-1 29 -130 -1 02 -119 -80 -112

Other (3-10 countries.

Chart 19

Alternative Forecasts

Baseline:

Greenbook forecast extended into 1991 with assumption of no new deficit reduction action in FYI991 and a slight easing of short-term interest rates.

More Money: Money stock is expanded rapidly enough to hold short-term rates at present levels. Tighter Fiscal: $27 billion deficit reduction packagefor FY1990is expanded to $50 billion by raising income tax rates.
1989 Percent change, Q4 to Q4 1990 1991

Real GNP
Baseline More Money Tighter Fiscal 3.0 3.5 2.8 1.1 3.1 1.1 1.7 4.0 2.0

GNP Prices
Baseline More Money Tighter Fiscal 4.4 4.5 4.4 4.7 5.3 4.6 4.3 6.0 4.3

M2
Baseline More Money Tighter Fiscal Q4 level, percent 3.5 4.2 3.5

5.0 75 . 50 .

6.0 9.4 6.0

Unemployment Rate
Baseline More Money Tighter Fiscal Billions of dollars 5.5 5.4 5.5 6.1 5.2 6.2 6.5 4.6 6.4

Budget Deficit
Baseline More Money Tighter Fiscal 159 157 159 127 100 104 138 68 105