APPENDIX

- 2

seemed

to arrive volume

at the picnic and price

a little

late,

contributing

to

increased

movements

during

overnight

trading

As a result divergence sentiment between

of the sharp the current

movement, pricing

there

is a bit

of a

in the market analysts.

and market

as expressed

by dealers

and market

Yields

and prices

now appear

to reflect will

a tension

between

the expectation posture through that

that monetary

policy

remain

in the current and the

the end of the year, the Committee might

on the one hand, move to lower hand.

expectation rate

the Fed Funds the spread basis suggests of an

as early

as the summer,

on the other note

Thus, at only

between points that ease

Fed Funds and the

and the two-year

stands

structure is skewed over

of Fed Funds slightly

futures

contracts

the market in policy

toward

the probability

the coming

months.

Opinions wider spectrum.

and market

sentiment, there rates

however, are those lower

are divided who think soon

along

a

At one end, need to move

the

Committee turn

might

either

or by the are many

of the year. that

But at the other the Committee will

end of the spectrum be raising they rates

who believe fourth rebound

by the may be a

quarter,

as a result activity

of what

anticipate half

in economic

in the second

of the year.

- 3

This

latter

view

has been priced in their

out of the market: found

Those

who expressed to maintain adjustments.

this in the

view

positions data

it too expensive of position

face of current

and the rush

Turning been made

to the dollar,

in American spurt upward vote.

press

accounts, after

much the

has

of the dollar's House fiscal Budget policy

on May 11th The

late-night American factors focusing

Committee

improving one

tone of of the But by rates, on we

deliberations crawl

was certainly up, off

which just

helped

the dollar

its back. exchange

on our own

side of the dollar's significance

may be obscuring the other side.

the potential

of developments

When 50 basis

the Bundesbank points on March

surprised 3Oth, many

the market market

by lowering

rates expressed and

participants

skepticism,. the dollar The quick to reflect

viewing

the move

as a sop for the French to Bundesbank immediate rise

franc

and potentially reversal and

damaging

credibility. appeared both

of the dollar's

to vindicate

this view.

Since German lower. rising

then,

however, policy the

expectations shifted

for the German

economy

and

monetary Gone are

have

modestly,

but perceptibly growth in 1996 and of

forecasts

of 3 percent

interest weak

rates. headline

Indications M3 data,

of weaker and lower

current

activity, forecasts

continuing

activity

- 4

have and

contributed

to declining focus rates

short-term

German

interest

rates

to an increasing lower official

on whether again.

and when

the Bundesbank

might

While a gnawing plausible economy interest Japanese

a change concern remedies

has been

less evident participants

in dollar-yen, about

there

is of

among

market

the absence

for the persistent financial and fiscal

weakness

of the Japanese of

and

the Japanese reductions

sector. stimulus as

The package offered

rate

up by the

authorities

was viewed

mostly

While few who will entering concern condition yen's traded state conclusively spiral, that there the Japanese are many economy

there is the

are

a deflationary that this could

who express they

occur--particul~arly banks. Thus, market

when

contemplate with have the

the

of the Japanese burst

it appears participants, economy recently

that who

recent

of strength, that a weak

in the belief lead

Japanese yen, have

would begun to

continuously ponder

to a stronger

the limits

of this hypothesis.

So while dollar's notice views

trying

to avoid

the risk of over-interpreting lows, I urge you to

the

modest not only

correction the markets' North

fr-om all-time correction

from overly

negative signs

about

matters

American,

but also

the tentative

of the markets' appetite

reconsideration and yen.

of its previously

unrestrained

for marks

- 5 -

In foreign intervened total

operations, markets dollars

on Monday

April

3rd the Desk trading, and yen, evenly selling evenly a

in Asian

and in New York worth of marks and also

of 1.5 billion between

divided between were

the two currencies Account

divided operations we

the System

and the ESF.

In these

joined

by the Bank

of Japan.

On Wednesday, selling a total

April

5th, we intervened dollars worth

in New York of marks

trading,

of 1.1 billion of marks

and yen, again joined by

850 million evenly both

worth

and 250 million

worth

of yen, we were

divided

with

the ESF.

On this occasion,

the Bank banks

of Japan refrained

and the Bundesbank. from participating attention the effort

At our request, on April 5th,

other

central sought exercise

as we of the

to focus

the market's

on the G-3 nature from previous,

and to distinguish

concerted

interventions.

On neither as heavy leading 19th. demand

occasion for yen

did we have much continued

impact

on dollar-yen, year --

into the new

fiscal

dollar-yen However,

to the new,

historic

low of 79.75. on April to weaken following against the

even

as the dollar did stabilize

continued

the yen, April 5th

dollar-mark intervention

in the days

with

the Bundesbank.

-

6

-

In other the first

foreign three

operations, possible swap with

for value rollovers the Bank

May

3rd we transacted 1

of the

of the outstanding of Mexico

billion same

dollar

go-day

and we did the swap.

on the ESF's

short-term

1 billion

dollar

outstanding

As a result 3 billion authorities the U.S. facility

of drawings

on the ESF's

medium

term

facility

of

on April

19th and 2 billion a total

on May

19th,

the Mexican outstanding term on

now have

of 10 billion

dollars

facilities: and 1 billion

8 billion on each

on the Treasury's of two short-term

medium

facilities.

In domestic build coupon upon

operations,

temporary

transactions

were

used

to of

an outright

purchase 4th.

of 4 and

a half billion

dollars

securities

on April

The above the

Funds

rate

traded

generally

close with

to or just upward

slightly coming and

expected of the

rate of 6 percent, first quarter, with

pressure

at the end with

the April

tax date,

Treasury

coupon

settlements.

Looking add reserves billion

forward,

according

to current steadily next

estimates, reaching and

the need about 10

to

is projected

to grow

dollars

at the time of your period arise immediately principally as well

meeting

12 billion meeting. increases in

in the maintenance These reserve needs

after from

the next seasonal

domestic

demand

for currency

as continued

expected

- 7 -

currency

outflows

to foreign like

countries.

Under

these to increase the

circumstances, normal leeway from

I would permitted 8 billion with

to ask the Committee changes dollars, to conduct

for permanent to 10 billion

in the System in order to

portfolio provide

the Desk

the flexibility prove

two outright

purchases,

if that

should

necessary.

Mr. report.

Chairman,
I

I would

be pleased votes

to answer

questions

on my

will

need

separate

of the Committee

to ratify to

the Desk's increase

foreign

and domestic leeway

operations from

and for approval

the inter-meeting

8 to 10 billion.

Michael J. PrelL May 23. 1995

FOMC

BRIEFING

We've meeting: failed

received starts

a number fell

of impressive percent Sales

data

since

the

last and

Housing to rebound

6-l/2

further

in March vehicles

at all in April. Payroll jumped And over

of light

plummeted and

11 percent

last month. rate

growth

ground

to a halt

in April,

the unemployment high

three-tenths

of a point,

to a seven-month than a 4

of 6.8 percent. annual All rate

core the

CPI inflation two months.

ran at more

percent

past

of this would decisions greeted

seem to smack

of serious But

stagflation the stock rallies. might

and

some

difficult have

for monetary developments

policy. with

and bond

markets

these

powerful

To the and disorienting.

layman, But.

such

a confluence expert

of events staff,

be confusing of cake we But. still fed albeit pace. did

for your

it was

a piece that

to .sort all of this could assure

out--and

indeed

to persuade

ourselves

you that

everything

is going of risks

according

to plan! we're a stable

seriously, reasonably funds

while

we see plenty with

in the

outlook, that

comfortable yield

our prior soft

projection landing

rate would a slight

a fairly

for the economy,

one with

increase on the than

in inflation real side.

relative it appears More

to last year's that

To be sure. weaken homes sharply, more quickly

the economy sales of

we predicted. other

to the

point,

and of autos

and some

consumer had

goods

all fell

off more and their

than producers
backed up.

and distributors Producers is whether have

anticipated,

inventories output.

moved

now to gear down through this

The question

we can come

adjustment

FOMC

Briefing--May

23. 1995

Michael

J. Prell

with yes.

the momentum for three First.

of expansion reasons:

still

intact.

We think

the answer. is

major aside

from motor

vehicles.

we don't more into clear

think

that

the

inventory production subdued excess profits. firms here

overhang

is so large in order

as to require to get stocks will help

than

small more of the to as

adjustments trends.

line with out some hits

sales stocks. And

Discounting

admittedly foreign their

at the cost will

of sc~me short-run share in the output

producers imports.

adjustment

trim

The it likely and income indicators remained added

second

reason

for our sanguine will pick

outlook

is that

we think

that

household

demand

up some

even

if employment

are less have

robust mixed

in coming changes

months. of late.

Though they

sentiment have has in

shown

generally

at healthy

levels.

and the rise wealth.

in securities Despite the

prices run-up

substantially debt. remain

to household still

consumer lenders don't years

households enthusiastic financial

seem to be paying extending credit

their

bills,and we three

about

to them--so After

see a major of hefty demand

impediment sales.

on that there

front. may

gains left:

in durables but we think

not be a lot of for some neardive and for

pent-up term

it reasonable after

to look the

bounceback rise

in purchases in both

of vehicles

recent

a moderate Meanwhile. drop

durables market,

and other there

outlays

thereafter. signs that the big

in the housing rates

are already

in mortgage homes:

is leading should

to a firming follow before

of demand long,

for singleinventory

family

construction is reduced. we believe

as the

of unsold

units Finally.

that

there

will

continue capital

to be goods and export in

substantiql sectors.

impetus There

to growth here

coming

from the

are hints

and there

of some

deceleration

FOMC

Briefing--May

23, 1995

Michael

J. Prell

equipment dimensions Overall, equipment
on

demand. of the

but this surge

is scarcely

surprising over the

in light past that

of the

we've

experienced and backlogs
at a good

few years. production term. over ok And. the are

the trends will

of orders

suggest clip

continue side.

to rise many which

in the near develqped

the

structures

of the building operating good rates gains

plans

past jusr

year

or so, during

and profits

soared,

beginning

to be implemented: seem reasonably is true

in nonresidential a few quarters. after Indeed,

construction

assured

for at least where appear that

The same allowance judging

of exports, adjustment,

the trends, quite look

for the Mexican

favorable. for a greater that this

by scme of the outside of GDP later this

forecasts year.

acceleration sector more

you would upside

think

is a The

containing

one of the view is that

bigger

risks

in our forecast. will improve exchange into

optimistic

the U.S. trade

balance

spectacularly. rates.

given

our competitive have taken the than

position

at recent exchange

We of course

the dollar's that

value less

consideration--including trade-weighted also perceive basis that

fact

it has declined the mark

on a broad We

it has

against

and the yen. hesitant

growth economies last

in activity and likely

is now

rather

in some

important basis than

foreign it was

to be less line,

rapid

on a worldwide is that exports in

year.

The bottom

though.

can be expected this country.

to provide

a solid

contribution

to output

growth

Now that might
to

I hopefully

have

eliminated

any doubts forecast. after

that

you

have

had about

the accuracy

of our output that.

let me turn threeor

the

inflation

side.

We are projecting from January through

rising

four-tenths

per month just

April,

the core over the

CPI will rest of

generally,rise the year.

two-

or three-tenths

per month

3

FOMC

Briefing--May

23, 1995

Michael

J. Prell

It is not hard that the outcome prices could being

to come

up with

a list

of reasons costs

to worry

be worse--rising among those

materials

and increases But.

in import given the

coming

immediately

to mind. and

projected

decline

in factory those

utilization should run, should

rates

stabilization second efforts restraint away with the rise half

of the dollar. of the year. away

pressures

ease.over

the the

And,

in the short inventories while

as I've noted, impose some

to clear

unwanted MOreOVer,

extra

on pricing. the slicing

we don't

want

to get carried noted that

and dicing rates added

of the indexes, to measured

we have

in interest auto

inflation CPI;

over the past on our interest problem. the tightening seems labor to be

year because

loan this

rates should

are included no longer

in the

rate assumption. Finally, of the rising
COSTS.

be a significant is that--despite

a more

general that

consideration has

labor

market

occurred--compensation to a subdued trend

still of unit

moderately,

contributing

All the risks small

things

considered,

we believe

our

price

forecast

balances of only to a

in the

outlook. of full

By our reckoning, employment

the

combination downshifting pickup

overshooting growth trend

and a quick in which

moderate underlying in our several

implies

an environment is likely

the

in the it is

of inflation if one looks

to be very CPI

gradual--as

forecast, tenths

at the core 1996.

acceleration

of just

between

1994 and

To be sure. not overlook fronts running the food

in evaluating and energy for some

the inflation sectors. concern. Recent Oil

outlook, news

one should these

on both have been

suggests higher

a basis than

prices price we've

we expected. in coming effects

and our energy months. And

forecast largely ignored

anticipates the potential

a drop-back adverse

on crops--and

thence

on food prices--of

4

FOMC Briefing--May

23. 1995

Michael

J. Prell

the recent fronts

rains

in the Midwest. through

Shocks the

arising and

on either create that

of these

could

reverberate

system

broader it is too early

inflation to build forecast.

problems. more But

At this

juncture,

we believe into

pessimistic a cautionary

supply note note

assumptions probably briefly

our baseline be sounded. potentially

should

In closing, important forecast, on this issue namely subject with the

I would respect path

one other

to the assumptions policy.

of our baseline expound at length have pxt

of fiscal

I won't

today.

What

the Republicans a much more

in the Congress aggressive almost attack

on the table budget several known.

clearly than

represents we have the

on the be

deficit months

assumed.

but

it will

surely

before

outcome

of the political the budgetary it seemed

conflict effects

will be become to adhere

and several Under being

more the

months

before

significant. for the time include magnitude We may we meet

circumstances.

reasonable

to our more

conservative

assumptions reading

and simply orders of

in the Greenbook we might

a model-generated with.

on what

be dealing clues

in terms will

of macroeconomic be confronting promises

effects. us when score.

have

some better but

as to what

next. Mr.

I'm certainly that

not making

any

on that

Chairman.

concludes

my prepared

remarks. the

Ted and I might

will have.

be happy

to attempt

to an.swer any questions

Committee

May 23, 1995 FOMC Briefing Donald L. Kohn The Committee would seem to have ample reasons for keeping policy on hold at this meeting. Inflation has picked up this year. resource

but the expansion has slowed--by more than expected--and

utilization levels have declined, promising to limit any uptick in inflation. While most observers see inflation as higher in 1995 and

1996 than in 1994, there is little evidence of any ongoing deterioration in inflation expectations. In the staff forecast, steady federal

funds rates bring the economy in around its potential, with inflation running just a little above 1994. of the deceleration In particular, with the dimensions

in final demand still uncertain, the Committee

might want to await additional information before deciding its next step. Obviously, there are significant risks on both sides of the outlook--risks that, as Peter noted, seem to be reflected in a certain

diversity among market observers on the question of the direction of your next move. In brief, markets appear to see the current federal

funds rate as a bit more restrictive than does the staff, and have priced in an easing action in the second half of the year. On the

other hand, many of the economists advising market makers believe that you will need to tighten again to keep inflation from accelerating appreciably. I thought it might be instructive to take a closer look

at these two views to help gauge sources of risk to the outlook. Markets evidently have taken incoming information on the

economy as suggesting a considerably weaker underlying path for aggregate demand than previously anticipated. They may also be reacting

to perceptions ing years. for interest impetus

of higher

odds this

on substantial year of revising

fiscal

restraint

in com-

The process rates

the expected additional

trajectory

has provided through value

considerable its effects

financial capital markets real

for spending,

on domestic Still,

and the foreign rates that remain given

exchange

of the dollar.

short-term

above

long-run

averages,

and markets demand,

seem to be saying the current take structure to be the

their

assessment a little

of aggregate

of rates

is perhaps

too high to meet

what

they

Committee's

objectives. sort of result rule, can also be found as you may funds in the results tracks well from the since

This John Taylor's FOMC's policy

policy

which

remember,

decisions the

on the federal federal funds

rate fairly

1987 by relating ployment rate that cent,

real

rate to deviations objectives.

of unemfunds

and inflation falls

from

longer-term formula

The federal below

out of this that

is now significantly a tighter this

6 perto

suggesting

the FOMC

is running

policy

relative

its behavior importantly flation.

over the last on using

eight

years--though rather than

conclusion

depends in-

the deflator

the CPI to measure

In judging ket's assessment, don't

the possible there

implications

for policy

of the marFor don't

however.

are a few caveats much Most ease

to consider. and therefore

one. markets see policy iate-

seem to be expecting restrictive. since late

now as highly rates

of the drop represents

in intermeda recision expecBlue CPI

and long-term

last year Second,

of previously tations Chip

expected

tightening. inflation than

implicit find

in market acceptable. 3-l/2

may be higher

you would

forecasters, both

for example,

have been

predicting although

percent are in

inflation

this year

and next.

Third,

markets

effect changes activity tions

guessing in those

at the

strength

of future

aggregate data have

demand, about

whether

guesses

are based fiscal

on incoming policy might

current implicafi-

or on anticipated path

different

for the time markets

of monetary to catch

policy.

In the former they perceive

case,

nancial

are trying in the

up to what

already short-term With

to be occurring rates regard actions should

real economy,

and if they their

are right, judgment.

adjust

on schedule markets

to validate

to fiscal and the

policy. response may

are projecting demand

future

government Reserve. markets rates occur,

of private contain

and the Federal on financial with

The latter getting

situation

greater

odds

ahead

of themselves--that decreases

is compensating demand

lower

for substantial may be well mediateeffects

in aggregate In this could

which,

if they

into the

future. rates

situation, have

declines net

in interstimulative on

and longer-term over an interim

significant

period,

arguing

for holding account

off for a time of the different

any adjustment lags for fiscal

in short-term and monetary many

rates, policy.

taking

Apparently, having pects. unneeded especially credit Many over-reacted They

market

economists economic

do view data

the markets

as

to the incoming

and fiscal rates

pros-

see the drop

in interest later with

and exchange this year

as providing in 1996, easing of

impetus when

to the economy taken together

and early continued

the atypical

supply

conditions economists

and the have

substantial

rise in equity of expected data, the

prices. Federal

of these

postponed

the date

Reserve still

tightening

as a consequence to raise short-term

of the incoming rates to keep

but they from

see a need

economy from

operating

substantially an upward

beyond trend.

its potential

and inflation

establishing

-4

Adding ation--and

to the difficulty to concerns the tendency to tumble

in interpreting an economic

the current resurgence around

situin

perhaps been world

about

later the inthis which

the year--has dustrialized understandable

for interest

rates

at the same time. shock

To a degree in the U.S..

is an has

response

to the spending countries

been transmitted and which d egree downward other rates foreign

to other monetary

through

the decline

in the dollar. given the

authorities own economies.

are trying

to offset,

of slack move

in their

But for the scale negative spending

of the surprises of in

in rates

to be warranted, there have

countries--of that

which

been

some--or

the correction

had been too high that

would

seem to be required. and exchange out--there price rates have fallen

The possibility below equilibrium studies larger levels

interest

cannot

be ruled

are several frequently some caution may be reactand

academic have been

indicating than

that market

movements Still

justified

by fundamentals. Market

in this

regard

is warranted

as well. failed

economists

ing to the fact that they exchange
some

to call the drop see them

in interest

rates--and

therefore

can't

as justified. Federal Reserve

MOrC20"62r. tighten-

of the previous

expectations

of further

ing seemed in prior

to be based

on comparisons

with the size

of rate movements rates in advance rather rates

business

cycles.

But. by beginning and by starting the extent

to raise from a base nominal

of an uptick than negative

in inflation, real rates. was

of zero and real

to which

need to rise likely book and bluebook. comes

reduced

considerably. expects

As noted

in the greenas in.

the staff

itself

some back up in rates seems small, to have built

the economy But the

in less weak correction

than the market is relatively funds rate.

size of that a change

and not associ-

ated with

in the federal

In days--or behavior outlook recent of money

years--of

yore,

we might about

have

looked

to the fo the over

and credit

for clues

how the risks

are resolving quarters have

themselves. resumed growth

In fact. money roughly

and credit

in line with

historical for moder-

experience

and are broadly of nominal growth supply

supportive

of the staff increases

outlook

ate expansion Private ingly that credit

GDP with

limited

in inflation.

has been

strong,

driven

in part by the increasagain this month extent

favorable they

conditions.

Banks

reported

continue

to ease bank

lending

terms.

and to a lesser in securities on credit borrowing

standards. markets ability primarily overall to the

especially very

for business narrow.

loans.

Spreads

remain

indicating But increases

few restraints in private from

avail-

from this

source.

have and close

substituted credit growth

for diminished remains

demands

government,

in the neighborhood

of 5 percent, GDP.

actual

and expected

rate of growth borrowing

of nominal from banks above

The strength broad this with have small measures range M2.

of private

has boosted range, but

of money.

M3 is a little

its annual

is rather The latter

low by historical aggregate

standards

and by comparison costs on

also has picked slightly with

up as opportunity the rise The level in rates

leveled time

out or even declined and drop

deposits relative

in market

rates.

of M2 remains has been

depressed

to its usual in income

determinants. and opportunity

but its growth costs. base--have

in line with narrow this

changes

Meanwhile. decelerated seem

measures

of money--Ml

and the monetary measures

year.

In sum, the broadest with ample demands

of credit

and money

consistent

for and supplies

of credit

to support

continued flecting limits to

growth the the This

of

spending: of past in

narrower interest and

measures rate

are

constrained. suggestive inflation. the market

reof

effects strength

increases. in in

spending of the staff

increases views

discussion sides of

disparate forecast. shifting last

suggests shares

risks this

to

both

the

If the to

Committee

judgment.

it might is

consider higher than with the

a symmetr-ical the odds on

directive. further to the was damped inits

Although creases estimated surprises adopted labor in

inflation might appear

year.

lower than at

the last since

economy meeting. the

operating

closer

potential in the have been

In addition.

incoming more also on

data the

asymmetrical final of

directive demand and

side

of

weaker

costs--both than cycle

suggesring last pushing the

reduced

risk

further greater below to

acceleration chance of

prices

perceived dynamics

t~iime and ourpur

perhaps

some

business In these pr-omptly tion or

signifi~cantly might 1101~want

potential. more inflathis

circumstances. 01. strongly slower to

Committee data

react higherconvey

incoming

suggesting

either would

growth--and

a symmerrical

dir-ecrive

instruction. Of to remain saw course, inflation above as its has risen. and many year. forecasts If the a~-e for Committee or was its stated it

noticeably the risks

level toward

oft last even the

still

tilted

highermovement retain the

inflation. away the from current hand. if the

concerned long-run metrical metrical saw

about goal of

eventuall~y price

revetuing it

stability.

could On be

asymasym-

directive directive

toward toward

tightening. ease would that to

other

an

appropriate in final

Committee would to any

a substantial or deepen. this

probability and wanted

weakness

demands

persist

~~eact especially

promptly

sign:; rhar

was

occurring.