APPENDIX

.

FCMC Notes -- Peter Fisher SEPTEMBER 27, 1994

Mr.

Chairman, I will handed be briefly referring out this morning. to the two pages of color charts

There

are three market

main

points

I would since

like your

to make

about

international

developments

last meeting:

are attempting to discern more First, market participants refined differences in the business cycles of the major industrial countries; Second, the dollar has traded against the mark and the yen in ranges which reflect the clearing prices between quite divergent views about its prospects; and Third, Mexican financial markets were stable through the Presidential election and the peso has responded positively to the news that the new "Pacto" includes no change in the speed of the peso's crawling peg to the dollar.

As the summer ask themselves economic only more

came

to an end, market questions

participants

began

to

focused

about

the different Instead of asking its

conditions

of the major was

countries.

whether

a country were

in or out of recession, down or up, they have

whether begun

interest intensive among

rates

headed

the more

process

of drawing

increasingly

refined

distinctions

national

cyclical

conditions

and prospects.

I have total-return August. quarter, markets

updated indices

the chart

of the quarterly markets, latter

percent

change you

in in

for G-7 bond

which half

I showed of the

Looking you that

particularly

at the greater

third

can see the much occurred

differentiation of the rest

among of the

in contrast

to most

-2-

year.

I mention

this

because

I think

that,

if this process

of

differentiation in the major several

continues, exchange rates

we could

begin

to see greater had over

movement

than we have

the past

months.

Dollar-mark your last meeting. views

is little

changed

from

its level range

at the time has reflected will bond

of

Its relatively whether

limited

divergent

over favor

short-term how U.S.

differentials and European

move market

in the dollar's developments

and over

will

affect

the dollar.

With who will are think

respect that

to the short

end,

there

are some

in the market and

the Committee put

will

raise points

rates before

at this meeting year-end. the

ultimately also

in 100 basis

There

a number

of market official

participants rates

who expect

Bundesbank after

to lower

by as much

as 50 basis Thus,

points

the October rates

16th German

federal

elections. there

with

overnight view that

now virtually dollar over

identical, interest

is a plausible have a 150-

short-term advantage

rates

could

basis-point

the mark

by Christmas.

However, Committee

there

are other

market

participants November

who expect or December possible even

the and

to wait once

to raise

rates

until

to do so only the Bundesbank them.

this year. not lower

It is also rates again

thought

that raise

will

and could

In this view,

the short-end,

U.S.-German

differential

- 3 -

might

only

be 50 basis

points

in the dollar's

favor

by year-end

or could

be unchanged.

As interest about rates first

indicated rate

on the second contracts

page

of the charts, imply

the December of

futures points

currently

a differential

60 basis

in the dollar's given who

favor

in three-month sustained

euro-

at year-end. half

However,

the losses traded

in the on

of the year

by those

dollar-mark

expected

shifts

in short-term to be having participants

differentials, less look

the current on dollar-mark at bond market

expectations as exchange developments.

seem market

of an impact increasingly

With which U.S.

respect

to the long

end,

there

is one school

of thought pushing and

asserts lo-year

that without yields

prompt

rate hikes above

by the Fed, German

significantly will

comparable to move deficit. will

European of our

ones, large

the dollar

continue account

lower

in the face there is

and growing

current that

While

an obvious long-term, favor, year, rising.

logic

to the view rate school

the dollar

strengthen in its

WHEN

interest

differentials of thought m U.S.

are decisively notes that,

a different the dollar Indeed,

so far this HAVE ~BEEN has

has weakened particularly

interest weeks,

rates

in recent

the dollar

-4-

responded negatively

quite

positively

to price ~rall:ies in the bond were backing up.

market

and

to signs

that yields

If all this precisely how

feels

like

a bit of a muddle, -- the exchange decreasing

I think market

that

is and

-- collectively has traded

feels and

why dollar-mark direction.

with

conviction

Dollar-yen's divergent might think again views,

recent in this

range case

has also between

reflected

contending thought who

and it

those

who have

be able that drop

to move

up to 105 yen and beyond continue to grind

and those

it will sharply

either

lower talks.

or might

yet

as a result

of the trade

Early 100 yen.

in the period This appeared

the dollar to reflect rhetoric

briefly

strengthened perception

to above of for the Since last of and of the

the market's

improvements strengthening then,

in trade-talk Japanese traded off

and in the prospects imports.

economy back

to absorlb; more forth around

the dollar when

and

99 yen until

Tuesday

it came

sharply increase data

following

the announcement U.S. goods

the worse-than-expected services deficit. This

in the overall served

release

as a reminder the view that,

sluggishness regardless meaningful U.S.

of trade of outcome, impact

flows the

and invigorated trade talks

are unlikely between

to have and

a the

on the bilateral future.

flows

Japan

for the

foreseeable

- 5 -

Over

the period,

the Bank dollars

of Japan against as their

intervened the yen. agent.

purchasing Of this total,

the Desk

purchased

Looking is that some

forward

to September will

30th,

the dominant in modest

expectation progress While of in

the trade

talks

result over

either

sectors

or in a papering have begun being

of disagreements.

market some

participants

to consider

the possibility that HOW the

limited

sanctions

applied, is made

I think is likely

September as WHAT

30th

announcement

to be as. important an announcement by

is announced. progress

For example,

I can imagine but which

of modest extreme, an impact

and no sanctions,

is accompanied @

national-competitiveness on dollar-yen of limited trade as would sanctions

rhetoric, a calm,

as having

negative

business-like as intended to reduce

announcement the bilateral

described

deficit.

Mexican election

markets

fared

quite

well

through

the Presidential weekend's of

and the peso that

has gained

following contains

this past no change

announcement the peso's last week,

the new PACT0

in the rate Late of no

devaluation

in its crawling came to expect

peg to the dollar. the announcement one-year market

as the market

change

in the peg,

the peso points

strengthened, and the stock the stock

interest gained.

rates

fell by over Yesterday being

50 basis

was a bit

choppier: levels--

market

sold off a bit

-- it further,

at rather

lofty

and the peso

firmed

-

6

-

then peso

sold faced

off, but

still

closed

higher

than

Friday's

close.

The of

some difficult

circumstances

this week

as a result of a large

the combination amount

of this meeting, Mexican

the maturity government However,

today debt

of dollar-indexed demand

and regular close

quarter-end

for dollars. the peso

from Thursday's

to yesterday's

close,

was up 0.8 percent.

The much

Canadian

dollar

has also victory

strengthened, of the Quebec reduced With September

following separatist

the bloc

narrower-than-feared

in the provincial success over

elections,which referendum. since

prospects

fo.r the dollar of up

of a separatist

the Canadian I2th,

one and a half acted

percent

the Bank mix

Canada monetary

last Wednesday through

to maintain money market

its existing operations

of a

conditions

indicating money

25-basis-point rates.

reduction

in its target

range

for call

Mr. period. changes reserves. my report

Chairman However, that

we had no intervention we have distributed

operations

during

the

a memorandum

on certain mark first on

are planned

for the investment to answer

of Deutsche perhaps

I would

be happy

questions

and second

on the memorandum.

CHART

1

Quarterly

Percent Changes of G-7 Total Return Bond Indices

4.0

2.0

0.0

-2.0

-4.0

-4.0

-6.0

-6.0 j~~~I~~i~~!!~~~!/~/ /~j/l!j~~~~~~~~!l/~f ~~~~i~:~~~~~~~~~~j~~i~ ~~~~~~~~/~~j~~‘ ~~ ~l~~j~~/f~~;~~ Iii1lll!Ilji1 ~~~‘~~z~‘
. . . . . . . . . . . . . . . . . .

Jan

Feb US

Mar Germany

Apr Japan

May

Jun

Jul

Jw UK

Sep
Italy

France Canada

Foreign Exchange Function: FRBNY Updated September 23,1994

Source: JP Morgan

CHART 2

Interest Rates Implied by Prices of December 1994 3-Month Eurodeposit Futures Contracts
6.2 1 I 6.2 6.0 5.8
5.6 -___________________..............~~~~...~........._...._._

5.6 5.4 5.2 5.0 4.8

Jul

Aug

Sw

Interest Rates Implied by Prices of Series of 3-Month Eurodeposit Futures Contracts
August 16, 1994 8.0 -................._......... 7.5 -...~....................... September 23, 1994 8.0 -..........................

Foreign Exchange Function: FRBNY Updated September 23,1994

Source: Bloomberg

Information

Service

Notes for FOMC Meeting September 27, 1994 Joan E. Lovett

During the firmer degree meeting, cent. because approved reserves

the intermeeting of reserve

period,

we sought to

maintain

pressure

adopted

at your August

16

with Federal

funds expected allowance

to trade around

4 3/4 per-

The borrowing

was left unchanged

at that time rate, also

the full 50 basis point hike in the discount that day, was allowed market. The allowance to show through

fully to the in two in

was lifted by $50 million

steps early in the interval each case to accommodate stands at $475 million.

and later cuc back by $25 million, in seasonal borrowing demands. It now

movements Adjustment

was generally

very

light and averaged

just $35 million. reserve shortages we faced at the start of further in and

The sizable the intermeeting September, required inflows

period

were expected

to deepen

first as a result of high levels around

of currency

reserves around

the Labor Day holiday, 15 corporate

and later when

the September

and individual Fed balance. reserve accounts, shortages, acquiring

nonwithheld

tax date would To help address

lift the Treasury's the largest expected from foreign

we resumed purchasing about $900 million

securities

of Treasury

bills from this source

in the

early days of the period. of Treasury coupon issues

We then purchased in the market

about $4 I/2 billion 30.

on August

2 Temporary reserve needs. operations met the balance of remaining System

we arranged

a total of seven muitiday

operations ..xelated. maintenance

and five overnight The larger multiday period

RPs, moat of which were customeroperations came in the first full Much smaller-sized

ahead of the coupon pass. arranged in subsequent

R?s were generally

periods. period--

our market entries which ends tomorrow--have outright purchases,

in the current maintenance light.

been particularly downward

The earlier to currency, levels

cumulative

revisions

and a Treasury
that were

balance

that never quite reached for mid-September

the higher

first anticipated

left the reserve a modest

estimates surplus. occasions customer

in this period close Consequently,

to path or even showing the market

we have entered arranging to currency

on just two of

during this period,

a modest volume growth

RPs.

The revisions

were a surprise: was an below the

the growth estimated

rate for the two months 6 l/2 percent, about

ending

in September points

1 l/2 percentage and about

New York staff's mid-August points below the average year. Data areavailable

forecast

5 percentage

rate for the first seven months only for August and suggest

of the

that the demand.

slower growth

then was IJ& due to a weakening

of foreign

The effective

funds rate often traded with a slightly partly reflecting a general absence

soft cast over the interval, of large reserve deficiencies meeting, the effective

on most days.

Since your last

rate has averaged

4.11 percent.

3 In the securities markets, interest rates were buffeted by shifting perceptions about the economic outlook, the pace of inflation, and the immediacy of Fed policy actions. Investor

--participationin the market was sometimes very light, but was interspersed with bouts of intense activity on some days. policy moves announced in August were viewed favorably. The

Very

short-term rates immediately backed up to reflect the tighter reserve conditions, but yields on Treasury coupons dropped 5 to 10 basis points that day. Since then, however, these yields have

worked their way higher in erratic fashion, rising a net 20 to 40 basis points, accompanied by some steepening in the yield curve. Over the first several weeks after the August meeting, movementa in yields generally established trading ranges. backed and filled within The data released during this time

provided a somewhat mixed picture of the economy, which contributed to some volatility in rates, best illustrated by the gyrations that followed the release of the August payroll data in early September when the market both gained and lost ground on the same day. Yields broke out decisively on the upside in midSeptember as the evidence seemed to tilt toward a visible quickening of price pressures. steep losses on two consecutive
To

Fridays brought yields to new highs for the year.

many

analysts, the August PPI report was a first glimpse of higher inflation rates In a broad-based measure which some of the more

4

leading price indicators had been hinting ac previously.

Then,

the industrial production and capacity utilization reports released a week later were taken as a sign that some strains were .._slready being placed on operating capacity in the manufacturing sector, and yields surged higher across the yield curve with the
current
bond

yield moving above 7 3/4 percent.

Most analysts now

seem confident that, after a pause in the current quarter, economic activity will resume at a pace into next year that will
maintain some

upward pressure on infiation, although views

diverge on where these forces will peak in the current cycle. The financial markets did not have to absorb a significant amount of new supply this intermeeting period, either from the Treasury or in other sectors. The Treasury paid down a

substantial amount of bills, about $19 billion, mostly when
several

cash management bills came due last Thursday.

The

expected reinvestment demand associated with these maturing bills and a desire to stay defensive in the current market climate helped keep short-term rates in check until last week, when the market actively began to revise its near-term rate outlook. issuance of coupon securities was also fairly moderate, about $15 billion altogether, which does not include the twos-year notes that will be sold early this afternoon or tomorrow's five-year offering. Net

5 A reassessmenL changing perceptions believe of policy prospects has accompanied the

about the economy over the past that Fed tightening

few weeks.

Many analysts

to date will not pace, and that than

.,.,sufficeto bring growth policy will eventually

to a non-inflaticnary reach a greater There degree

of restraint

they previously consensus

thought.

is also a fairly general step, whenever it comes, will take the

that the next policy

the form of a 50 basis point hike in rates, possibility of a smaller move the perception

although

is not entirely remains

ruled out.

While higher,

that rates are headed sooner than expected only

and that a Fed move

is possible

a few weeks ago, views are split on the need action. prevent

for immediate delay to

One camp holds that the Fed must move without price pressures from building further,

and that not psychology.

acting now would Others

court the emergence

of an inflation

feel that the case for an immediate

move is not conclusive off, awaiting reports would

and that there is an acceptable some confirmation

risk to holding momentum

of the economy's meeting.

in upcoming surveys

or until the November probably place

Current market camp.

the majority

in the second

I would be happy

to answer any questions

you may have.

Michael J. Prell September 27. 1994

FOMC

BRIEFING

It is with having to report

more

than once

a little again.

chagrin

that

I find

myself

to you.

that

we have the

raised

our forecast momentum be weil of

of near-term activity short

economic

growth.

Moreover. money market

surprising may

suggests level

to us that needed

rates

still

of the

to hold

inflation

in check. that our previous was wrong. incoming forecast Indeed.

AdmirTedly. of a sharper in the seemed early

it is not yet certain
deceleration intermeeting Notably.

second-half part of the

in activity period. the

indicators dropped in

to support

our thesis. and

durable hours

goods

orders

appreciably August. even fall

in July,

production like

worker

slipped's GDP

bit

It looked short But the

for a while last

third-quarter forecast. back in the

growth

might

of the scales

Greenbook tipped

quickly surged

other

direction. up the Nexf. advance All the in

Sales

of light this slump

vehicles pattern in sales

in August validation

as production for the to supply not only story

picked that

smartly: earlier report spending seemed surveys. analysts

provided owed

importantly revealed revisions buoyant

problems. a healthy months.

on m-auto in August. to fit with in the had The

retail but the

sales

upward fairly

to prior

of this

sentiment rise

evidenced

in household that many

face

of a continuing would damage

in interest

rates

thought

confidence. data for August clearly the argued summer 0.7 poinr.

industrial slackening only

production in the pace

against months. -percent,

much Not

of expansion rise

over

did overall

production soared

an estimated percentage

but manufacturing

output

a full

FOMC

Briefing--September

27,

1994

Michael

J. Prell

With now

upward looks

revisions factory

to each output

of the will

prior

three

months

as well,

it

like

rise

almost

7 percent,

ar an annual

rate,

in the

third

quarter. initial levels claims for jobless benefits have that strong remained the pace of

Meanwhile. near their lowest labor growth. If these notion demand housing report the that were the

of this

expansion. reveal

suggesting a sustained

September payroll

market

report

will

data

were

not

enough to call into question
of higher interest rates the

our

negative

effects

on aggregate figures The on

about

to manifest

themselves last

more week

clearly. certainly was

permits showed level

and starts

released

did.

that

single-family

building since the

in August spring.

at virtually see some starts of

same

as had prevailed in this

We still

signs data

of softening did seem

secror

in other

indicators, of our

but the forecast

to require

some

upward

adjustment

residential

investment. these developments--and than we had also the prospect earlier GDP of a steeper (barring forecast the proven risk a

Given rise in auto

assemblies decided

anticipated

strike)--we point. could always monetary perceive at least

to elevate

our fourth-quarter so, we just

a half that we

to 2-3/4 be giving a hazard policy the

percent.

In doing idea

recognized it's

up on a good

before

correct-of we to be

in forecasting. effects is hard

especially

because But.

the timing that said,

to pin down. our revised short.

risk

of overshooting as that

near-term

forecast

as great

of falling

In arriving there rates One were might any

at that

conclusion. identify muted

we asked for why effect

ourselves the rise

whether in interest demand.

reasons

we could

be having to that

a relatively may

on aggregate financial

answer

question

be that

the normal

2

FOMC

Briefing--September

27,

1994

Michael

J. Prell

transmission The dollar has

mechanisms has

have

not

been the

working beginning

as one might of the year:

anticipate. the stock

depreciated up rather this

since little year:

market rich been the

given

of what and bank

appeared credit

to be an awfully availability has that

valuation improving, rise

earlier possibly yields

substantially. has been at least

MOreOVer, in part the

it is.arguable a reflection in the of

in bond

heightened of capital.

inflation

expectations--limiting

rise

real

COST

It's forces

also

possible demand be that

that

we've

underestimated rate for

some

of the For homes

buttressing it could than

at given the

interest

levels.

instance. is greater degree further further

pent-up

demand

single-family the

we judged. restraint

Consequently, through the

to achieve

anticipated take a a

of demand

housing

sector,

it may

deterioration rise in short the

in affordability rates that makes cost

measures--perhaps it less attractive

including

to use ARMS

to circumvent

higher the

initial

of fixed-rate lesser

loans. financial do not yet under anticipate should the see

Whatever restraint the or the

case--whether underlying slowing

it is the demand--we in this

greater

simply

evidence

of a decisive we concluded effects monetary

expansion.

circumstances, meaningful assume

that--while of the policy earlier

we do still rate

lagged

increases--we

a greater

tightening points

than to the

in our previous SO basis last points of

projection. additional Expecting supply suffice -believe

So, we added funds that rate

50 basis

increase will

already

assumed

in our further

forecast. credit

the

dollar will the

not depreciate to ease. of aggregate

and that that

conditions to produce essential

not continue slackening

we think demand in check.

this may that we

growth

if inflation

is to be held

FOMC Briefing--September

27. 1994

Michael J. Prell outlook. We've

Let me turn now to the issue of the inflation raised our forecast reasons. projection

for price increases through next year for two

The first is that the level of output is higher in this than in the last, until the latter part of 1998. This. in and thus

itself, would imply a higher level of resource utilization greater potential manufacturing inflationary pressure.

But. in the case of the

sector, the tensions are compounded by the upward At 84.3 percent

revisions to prior levels of factory utilization. now, the rate is within

a point of the 1989 peak and considerably

above levels that in the past have been associated with accelerating prices. In fact. we could be said to be discounting this observation in our forecast: a Phillips-curve rather than unemployment the importance of

type model using

capacity utilization

as the slack variable than we have written any such econometric

would point to a greater pickup in inflation down.

Given the wide standard error attending this normally wouldn't

prediction,

cause much anxiety: but in a period rate has been obscured by the

when the meaning

of the unemployment

revision to the household

survey, this gives one a little pause. is one of the

As it is, the run-up in capacity utilization

factors behind our forecast of roughly 3-l/2 percent core CPI inflation through utilization materials the first part of 1995. We believe that the rise in

is a key factor explaining

the ongoing surge in industrial

prices. which is likely to be passed through to finished least to some degree--in utilization the near term. As activity

goods prices--at

slows and capacity

ebbs a tad next year, we expect that

the rise in materials

prices will taper off. the pass-through of higher

As you know, we've also identified

crude oil prices and firmer non-oil import prices as giving some

4

FOMC Briefing--September

27, 1994

Michael

J. Prell

impetus to inflation in the near term. taut. there likely will be some tendency

And. with labor markets fairly for the acceleration of

prices to feed through to wages, thus raising unit labor costs and giving some momentum to higher core inflation 1995. This is why we've presented in the latter part of subpar

a forecast that produces

growth for a time and a slight increase in unemployment:

We wanted to

present the Committee with a baseline forecast that did not involve a reversal of the disinflationary trend of the past decade. a question. our quarterly the difference

If I may attempt to anticipate model says that, starting between

from the Greenbook

forecast.

our funds rate path and holding the rate at 4-3/4 is. by 1996. between a minimal downward tilt to inflation versus a

the difference

slight upward tilt.

But this really is putting far too fine a point And this exercise doesn't answer forecast is broadly correct and

on what such models can tell one. the question of whether a substantial aggregate

our Greenbook

further policy tightening

truly is needed to moderate

demand. I would say that such a view is implicit in the market yield

curve as well as in the analyses

of most private forecasters. and it is possible

Of course, they, and we, have been wrong before.

that we are all being misled by a tendency to look at the much greater size of past funds rate upswings in a cyclical expansion. misleading restrictive bond yields. culminated in gauging what it might take to rein that could be a

As I've noted previously,

standard. given that fiscal policy is relatively this time, and that we've had a disproportionate Moreover, past major upswings rise in

in rates typically HOWeVer. is the

in recessions--which

is not our current design.

on the other side of this ledger. as I've noted this morning, observation that we have not had in the current episode much

5

FOMC

Briefing--September

27.

1994

Michael

J. Prell

reinforcement financial

of the money

market least

tightening

in other

aspects

of the

environment--at On that point.
let

not yet. the floor over to Ted for .some sector fit

me turn

comments into

on how the dollar

and other

aspects

of the external

the picture.

-

6

E.M.Truman September 27, 1994 FOMC Presentation like -- International three comments Develooments about the external

I would sector Lo amplify First, improved added

to add

Mike's

presentation. for economic growth abroad has we have

the outlook

substantially.

Since

the beginning

of the year,

more

than a percentage abroad as well

point

to our projection

of 1994 G-7

average

growth

as to growth since

in the foreign

countries. about growth and

Information in foreign initial

received industrial

the August

FOMC meeting the second have of

countries

during

quarter

indications to mark

about up our

the third forecasts.

quarter

reinforced Japan, dropped

our tendency

In the case expectation, it is in financial

second-quarter 1.6 percent

GDP,

contrary

to the general However, no reaction data.

at an annual was

rate.

instructive markets that

that there

essentially

or in public

commentary

to these

The reason orders, that the

may be and

information demand economy

received during most the

on business third

sentiment, suggest

consumer Japanese

quarter

likely

has turned

the corner. growth Given averages the large such an outlook upside a

In our forecast, shade output hardly risk under gaps four percent in most

aggregate in 1994 and

foreign 1995.

foreign

industrial

countries, abroad

amounts

to a boom,

but growth

is a definite

to our overall Second,

outlook. our forecast for the

let me try to explain toward the dollar

dollar.

Sentiment

continued

to be somewhat

- 2 -

bearish influence

during

the intermeeting concern

period about

primarily U.S.

under

the

of continuing

inflation. of the dollar, we expect points from the its of we

Notwithstanding have not changed

the further

slight

depreciation

our projection by a couple

for the dollar: of percentage that level

dollar current

to appreciate level and

to remain Our

around

for the balance several

the forecast

period.

reasoning

involves

considerations. First, short-term market monetary Germany, our assumption interest about the near-term fairly course closely of to

dollar

rates

coincides less

expectations, policies

but we see much the market the futures rates will

tightening,

in foreign

than

expects. market

In the case of is projecting that by June it

for example, interest while

three-month of next year

rise

by 100 basis be unchanged. have

points

we think

they will markets As

We think the of

is likely strength growth

that

the financial

over-estimated projections should look

of the recovery are revised

abroad. down,

implicit assets

abroad

dollar

relatively along been with

more Fred

attractive. Bergsten an exchange that

In addition, for the past

for those seven

who believe we have zones, its

years

operating note value

rate regime is about since

of de facto five percent

target below

I would average 1987:

that

the dollar

for the period implies

the Louvre

meeting

in early

our forecast

some regression

toward

the mean. has been of rates a

The dollar's surprise. restraint

depreciation

so far this

year

It has vitiated on the U.S.

one of the normal exerted

channeis

economy

by higher

interest

- 3

Moreover, Thus, growth

further

weakness

in the dollar upside

cannot risk

be ruled

out. of

the dollar and

is an additional

to our forecast

inflation. point concerns ceased our forecast that the external factor for GDP this and

My third sector growth of the U.S.

economy quarter.

to be a negative

in the third with

You might

ask how we square on trade

projection services

~uly's

near-record

deficit

in goods

that was

announced

last week.

Part

of the explanation in July such as

can be traced a temporary

to the

influence

of special deliveries.

factors Our

drop

in aircraft in August

implicit

projection

for the deficit lower. involves The

and September

is about

$l-,l/2 billion quarter terms and

remainder

of the explanation between

for the third in nominal factors

the difference in real during

the balance of such

the balance

terms.

Because and

as the spike of nonterms we

in oil prices oil imports

the summer

the boost

to prices

from

the dollar's

depreciation, deterioration we estimate

in nominal

are projecting deficit while

a $5 billion in real terms

of the third-quarter a $5 billion period, improvement.

For the remainder for the U.S. basic factors: and external faster

of the forecast relies

our projection of three in this

sector growth

on the influence a slowing

abroad,

of growth on

country, balance goods

the influence year.

of the decline

in the dollar

so far this services

As a consequence, to be about the next less real

real net exports neutral in their this

of

and

are projected

contribution would fourth amount quarter

to U.S. to &out

real GDP over $30 billion

six quarters; restraint

by the in January --

of next year

than we were

projecting

4

equal

to a bit more real GDP

than

half

a percentage

point

on the

level

of

projected

in that

quarter. reached the end of my written

Mr. Chairman, comments.

I have

September

27,

1994

FOMC Briefing Donald L. Kohn As Mike seen as suggesting of a more has discussed, the incoming data may be the that

that

the Committee

may not have

luxury

or less automatic after

"no-change"

decision The

it perhaps ent strength source yet make

anticipated

the last meeting. and higher about

persist-

of aggregate raise

demand questions

level

of repolicy is

utilization

whether

positioned progress

to head toward

off increasing

inflation--much goal was of price no--that

less

the longer-run in the Greenbook

stability. a conto this

The answer siderable accomplish outlook ening with the further

tightening

is likely objectives. to keep few

to be necessary In evaluating that

the Committee's

it may be important over the next

in mind

the tightin line

assumed market

quarters period.

is about

expectations

for this rates

As a consequence, likely rates to pro-

rise

in short-term changes

is not thought interest

duce major weighted variables

in longer-term value

or the key In these

average

exchange

of the dollar--two policy.

in the transmission however,

of monetary

circumstances, market lower

a failure well

to tighten

in line with dollar and

expectations long-term real

could rates moving

lead

to a lower perhaps

(though these

not nominal influences on

rates),

effectively

two important

-2. aggregate their demand in a stimulative as well direction relative forecast. have overto

current

values

as to the staff

That would shot--if building long-term in more

not be a concern real rates have

if markets

moved

up excessively, prove to be that

policy

tightening it would

than will

appropriate; capital extending does tion

certainly

not be the first

time

markets

over-reacted

and miscalculated. the Greenbook will

In fact, projection and infla-

the forecast that

horizon,

assume less

aggregate into

demand

be softer producing

than built rates

the markets, in 1995.

a decline

in long-term But not yet unusually through Moreover,

later

evidence Real

of actual rates

or expected risen,

overshooting are not not

is

obvious. high

have

but they and have

by historical

standards,

shown

substantially other

in interest-sensitive or related or private

spending. as those

financial equities that market

markets--such debt

for commodities, not real And, show signs

instruments--do increases activity. the inafto in

participants

see the

interest

rates

as significantly other

inhibiting

in contrast has some

to some These

tightening responses through have

episodes, themselves which tended

dollar hibit fects

fallen.

market

of the usual

channels markets

policy

the economy. data

Credit

to react

incoming tial

suggesting

strength

in spending

or the potenFederal reading Reserve of

for inflation That

by building may

in additional their

-tightening.

in part be simply

-3your reaction to over function, tighten, and but if markets sensed that that you were a hump in the emerge,

likely term

one might

expect

structure

its imbedded

forward

rates would

and none

is evident. As to the near-term, the staff forecast does not

necessarily views

assume might

tightening happen

at this meeting, are mixed.

and market The key task if the evidence strongly that a

on what

today

for the Committee that has

would

seem to be assessing the last meeting action. find than

accumulated

since for

points In making

enough

to the need

immediate may

determination, heavier ings full that allow burden year.

the Committee from For that one, just

reason

to demand

evidence

for previous

tightena of

this

the funds six weeks

rate was ago.

increased

50 basis action

points

The magnitude pre-emptive--to the results was conveyed of to

was

intended of policy Moreover,

to be somewhat rest this to evaluate intention

a period moves.

earlier markets bility

in a statement of at least

that

held hiatus

out the distinct in policy The

possicreatof the

a short

changes,

ing market future reasons

expectations

to that sort

effect. could

credibility unless

statements

of that

be impaired

for overriding Second,

its implied with

commitment

are perceived

as compelling. one of 50 basis

another

tightening--especially policy this could year, be seen even

points--Federal Previous action,

Reserve

as in a new place. -including the August

tightenings

can be interpreted

as moving

-4. interest rates broadly into line with rates. historical experience point the

for periods action upper policy would end,

of stable push real

inflation short-term what

A 50 basis rates

interest have want

toward as clear a sus-

if not above

many

characterized especially onto

neutrality. that

The FOMC might the economy were

indications tainable before posture

not moving

growth

track

or that into what

prices might

had already be perceived

accelerated as a

moving

policy

of restraint. But restraint to higher may rates in fact be needed is damped, And, if the response factors

of spending are pushing risks from

or exogenous there from

on aggregate demanding

demand.

are potential the evidence, In

too clear

a signal

especially particular, plicate affect reduce

in an economy if price

operating

around

its potential. delay

pressures

are building,

can comadversely can

the future

conduct

of policy

and possibly Prompt real

the performance the levels have that

of the economy. nominal and even

action

rates

will objecshould

eventually tive

to reach time

to achieve frame.

a given

inflation

in a specific with

Smoother

rate paths

be associated strains

smoother

paths

for the economy financial

and fewer inter-

on the private The cost

sector,

including could

mediaries. severe, adjust -current

of waiting that than which

be particularly expectations lower from end of might

if it were higher more

feared readily levels,

inflation they

adjust

inflation

are at the lower

-5. experience financial over markets the past does 30 years. The recent behavior of for

suggest and

a certain

predilection

expectations

to rise, those

if inflation

itself

accelerated more general

for any period. in labor

expectations markets.

could

become of these

and product

1n light reasonably of slowing

potential that the

difficulties, economy path give

if the FOMC were

confident

is not in the process inflation

to a sustainable it might from

and that serious

pressures

are building,

consideration

to overcoming

any inertia policy

the August under

announcement

and tightening

promptly--as cirany

alternatives

C or D in the bluebook. of prompt action

In such might

cumstances, costs

the benefits

outweigh

in the form

of reduced

credibility

for future very

attempts

the Committeeto However, sufficient

pre-commit

its policy

stance

far ahead. as not yet

if the Committee the need conditions

sees

the data

to indicate market

for further unchanged, The

tightening, as under size alterof the of

kee~ping reserve native moves their clear B, would earlier effects sustained might

be appropriate.

substantial about with

this year

and uncertainty together in broad

the timing

on the economy, acceleration be seen

an absence of costs

of a and

measures

prices,

as arguing

for waiting step.

for additional Indeed, if or

information there more were scope

before

taking

an additional still

considerable for more

restraint

in the pipeline, without additional

vigorous

expansion

-6. inflation stantial lags pressures additional than the staff might had foreseen, then Given subthe

action

not be needed. to tighten result

in policy weakness

effects, will

continuing

until

data

suggest ing.

ultimately

in policy

overshoot-

Certainly suggest July, a building

the behavior inflation

of money

and credit

do not in for

problem.

After

the spurt and data

all money half

measures

weakened

in August, little

the first

of September this month. growth paths

suggest

growth

in any of

the aggregates on the anemic decelerated reserves

For the year, of 1992 and resulting moderation the

M2 and M3 continue while Ml has in bank of

1993,

substantially,

in a decline

and an appreciable base. well

in the expansion weakness

the monetary growth--as natural

We believe

recent

of money a

as sluggish

growth

for the year--reflects opportunity in nominal

reaction

by depositors any signal banks

to widening of a slowing have since been

costs--rather ing. The

than

spend-

puzzle

is why

so laggard

in raisof

ing deposit credit ently

rates,

especially

it is not a symptom opportunities. and sales expensive from than

restraint they believe

or lack

of lending funds be less retail

Appar bloated raising

wholesale will

securities the funding

portfolios cost

of their

deposit

base. remains moderate, signal Borrowing a

Moreover, with no sign

the expansion

of credit

of any overall of a "borrow

acceleration and spend"

that might

-strengthening

psychology.

-7. by nonfederal shown few sectors picked up early since last year, then, but has more debt more

signs

of accelerating by banks.

despite

aggressive growth

lending

To be sure,

household while

has been

rapid,

but business end,

borrowing, moderate. has these

concentrated by state indicating constraining recent months, and

at the short local

remains

Borrowing decelerated, sectors, and in

and federal of demand debt

governments from

a lack

impetus

overall

growth

to 5 percent earlier

or less

down marginally were

from

this year. on hold to con to at

If the Committee this meeting incoming sidered react strong might it would If the need

to keep

policy how

to consider of higher

to react

data.

risks

inflation

were

sufficiently

worsening, meetings, were

the Committee to signs

might

want

promptly, or price consider

between pressures

that

growth case, toward

was it

mounting. directive,

In this tilted

an asymmetrical

tightening. There an asymmetrical Boehne was considerable discussion of the meaning of

directive Kelley

at the July meeting. noted at that time,

As President the asymmetry to pin down a directive shiftto Ml

and Governor may

provisions their was

be necessarily could

vague,

and efforts Such

meaning used

be counterproductive. 198Os, when

first

in the early changes

the Committee keyed

ed from to more _metry

automatic

in reserve

conditions regime,

discretionary

changes.

In this

the asymfor

afforded

an element

of flexibility

and direction

-8.

between-meeting out the meaning members markets have when

moves.

The Committee

has

resisted

spelling

of asymmetry the

in any formula. signals but it sends

Sometimes to financial has had to

emphasized

it is published, significance:

the directive its value

operational markets

indeed,

as a signal

would

soon deteriorate directive

if it did not. that

In general, sees

the asymmetrical an imbalance forward, side. quickly available particular tive. spell
or

signalled to meeting from missing it had wanted forcefully suggesting it would the policy

the Committee

in the risks in the costs

its objectives

going

to one particular to respond more

As a consequence, and perhaps between more

to evidence the need

becoming to move in one direc-

meetings than

direction

under

a symmetrical

Members

have used

discussion they tied

to try to thought was

out the nature but

of the information have rarely been

critical, ticular evitable likely. directives 60 percent

responses

to one parin-

statistic. under From

Intermeeting

changes directive,

are far from but they

an asymmetrical 1987 on, about been followed

are more

30 percent

of symmetrical changes, and

have

by intermeeting

of asymmetrical

directives.