STRICTLY CONmDENTzAL (FR) CLASS I-FOMC

Material for

Staff Presentation to the
Federal OpenMarket Committee

July 2,1996

Chart 1

Recent Indicators
Payroll EmploymentGrowth Average monthly rate in thousands ProductionWorker Hours

F t
r

%monthmoving average

1

-

Q

Index Quarterly average

6oo

1
May

4

138

136

300
200
100

:
1995 1996

I I I I I
I , ,

100

1

,

,

,

1

.

,

.

,

,

130

1995

1996

Personal Consumption Expenditures Billions of chained (1992) dollars
Q

Single-familyStarts and New Home Sales Millions of units
1.5

Quarterlyaverage

May
7 5 0
14

1

0.5

1995

1996

0

Nondefense Capital Goods

r

Billions of dollars

Manufacturingand Trade Inventories Change, billions of dollars, annual rate

Excluding aircraft

1

40

Apr.

-

60

35

-30

1995

1996

30

I

0

Chart 2

Forecast Summary
Real GDP Growth Percentchange, annual rate
5

Four-quarter percent change
4

r
I

-

Q4Q4 Percent Change

1993
3

22 3.5 1.3

1994 1995

2 1996
1

2.5
22

1997

1995

1996

1997

0

Unemployment Rate

I
Total CPI
-5

Q4 Average

1993 1994 1995 1996 1997

6.6 5.6
5.5 5.5 5.5

04/04 Percent Change
CPI 1993
3
2.7

CPI excluding food and energy

- 4

CPlX 3.1 2.0 3.0

1994 1995

2.6
2.7 3.1 3.2

- 2
- 1
I I I
I

1996 1997

2.9
3.0

1995 1996 1997

n

-

Chart 3

Interest Rates

0

-

Federal funds rate remains near 5 114 percent through 1997. Long-term interest rates decline just a little from current levels.

0

Real Interest Rates'
Percent 10

5

0
-

+

1977

1980

1983

1986

1989

1992

1995

5

*Nominal rate minus rate of increase fn core CPI Over prior year for hlnds rate and over prbr 5 years for 10-year Treasury.

Yield Curve and GDP Growth

r

Percent

1

lo

5

0
-

+

1977

1980

1983

1986

1989

1992

1995

5

Chart 4

Fiscal Policy
Unified Budget Deficit Billions of dollars Deficit
Percent of GDP

500
Deficit/GDP

1

5

1993 255 203 163

Fiscal years

-

400 300 200

100

Billions Percent of dollars of GDP

4.0 3.1

1994 1995 1996

2.4 1.9 2.3

128
163

/
0
1 1 1 1 1 1 1 1

Deficn
1 1 1 1 1 1 1 1 1 1

7 9

1982

1985

1988

1991

1994

dn 1997

1’ I
-

1997

0

Why does the deficit bounce back in PI 1997?

We are assuming some cuts from baseline in discretionary programs, but not targe enough to reduce the absolute lev�. Jf spending. We are not anticipating a continuation of the slow P I1996 growth in entitlement (especially health) outlays.
No more OBRA retroactive tax installment payments.

0

0

0

Individual withholding apparently is up in P I1996, implies less of a final-payments bulge next year.

Chart 5

Exchange Rates and Interest Rates
The Dollar and Real Interest Differential Percentagepoints Index, December 1994 = 100
0 Real long-term interest
110

Price-Adjusted Dollar

ratedrfferentiaP

r
I II

-

0.5

-

105

Percent Change 12/94 to 6/96G-10 -0.2 8 Non-G-10’ -1.1 G-18 -0.5 12/95 to 6/96 4.6 8 Non-G-10’ -2.3 G-18 3.0

1

G-10 Weighted-Average

G-10 Price-Adjusted

DollaP

1W

G-10

1.5

95

2
1994 1995 1996 *Real U.S. interest rate less weighted average f o G-10rml interest rate. Yvpihted m e against f m q n G 0 couhes, adjusted by relalive I m ,36m s rnoymg average CP!. ‘+eightad average aga~nrt foragn G 0 commes. I

Dollar Exchange Rates
Percent change 12/95 to 7/1/96 Yen
Swiss franc
Deutschemark
Korean won
G-10 AVemg
Mexican peso
Italian lira
7.6 7.4 5.8

-

-

r

Inter& Rates

Level Change 7/1/96 12/95t0 7/1/96 3.30 0.61 5.45 -0.52 0.09 -0.1 7

50
. 33 .
-1.o

Three-month Germany Japan United States Ten-year Germany Japan United States

-3.8

6.52 3.17 6.75

0.44
0.31 1.04

Ten-Year Interest Rates

Percent

1994
$

1995

1996

I

9 8
7

Three-Month Interest Differenti&*

-

-

u.s.-

u.s.-

Genanva
2.30 4.89

Actual 7/1/96

6

-

kltilaterd tradbweightad average f forsign G-10mu&. w

‘Euro-Market Ratss

Chart 6

Foreign IndustrialCountries
Industrial Production
1995Q1 = 100 105 3-month moving average

100

95

90

1994 1995 1996
*Gemany, Italy, France and me United Kingdom,weighted by US.exports.

Consumer Prices

U.S.-EU' Inflation Differential

Percentage points
1.2

0.9

I

--1995 1996 19:
1. W. Germany 2. France 3. Italy 4. United Kingdom" 5. Canada 6. Japan 1.6 1.9 5.9 2.9 2.1 -0.8 1.5 1.8 4.1 2.7 1.8 1 1 3

0.6

03
. 0
03
.
0.6

+

2
1 1

04 .

7. G-10 Average" 8. United States

0.9

Interim EU-comparable basis

'Excluding mortgage interespayments. "Weightedby US. non-oliimports.

chan7

Foreign Growth and U.S. Exports

1”

:i
4 2

a

1

00

0

aO *
0

8

Real GDP

-

6

F

5

- - 1. G= =Y

4 3

2kancs

PelmdrayWQvai 19% ISM lggl 1.0 1.4 23 0.5 24 27

a4.uriLedl(ingdom

2
1 0

5. carmda

23 1.9 0.7

KJaPa
7 Induslnalcuun~e9

25
14

20 21 24 4.0 25

22 25 28 28

26
52 38

a. w
9 Total foregn.

*.a
17

38 .
35

I

I

I
1SBs

1985

im7

I -1

1o.ur*sdsla*ls

1.3

25

22

Chart 0

World Oil Markets

I

I

I

I

I

I

I

I

I

I

1988

1990

1992

1994

1996

Growth in World Consumptionand Production o Oil f Year-to-year change, mb/d

-

ExcessCapacity at End of 1995

Consumption 1. llyndd Production
2. ! ! c A u Q 3. Iraq

rn

l.2

-

Mb/d

­

lw
OPEC* ROW

!L5 3.0
35 .
0.0

ea
0.0

M
0.0 0.5 0.4 0.4 0.1 -0.1 0.3

U
0.3 0.3 0.4 0.7 0.1

Itz
0.5 0.4 0.3 0.6

4. 5 . 6. 7. 8. 9.

OPEC' NorthSea Non-OPECLDCs
FormerUSSR

03 .
0.7 0.5 -1 .o -0.1 0.4

Longer-termSources of Additional Oil Production
1. Middle East 2. FormerUSSR '3.Latin America 4. Africa
exuuaing Iraq.

00 .
-0.2 0.1

UnitedStates Other

-. 02
0.1

Stockbuilding"

J"W
8--,

- 19
8 ,

1

' -' *,

,
Import Price torecast

- 10

-

-
-

'.
I

* .

, , ,
.
.

, , , , ,
I

'. S.

8

,

___-------------- 17 ,

0.5

--- -- --- ----__ - 16
Futures quotes (adjusted)'
I

0

t

--,
8

a

- 15
14 0.5

I

Chart 9

Exports and Imports
Orders and Exports
N e difference, SA
12-month percent change, SA

Inventories and lmoorts

r

Percent change, SAAR

-20

"

v

I

I

*

Inu-

1992

t .

Nonagrioulhlral e

b s decrsaa in export orders. s m ex. aruaR

1994

1996

h u limports ex.gold.

1994

1995

1996

Export Prices, Chain-weighted
Quarter percent change

Import Prices, Chain-weighted

r
-

Muarter Dercent change

1995

1996

1997

* Nonagriwlhlralgoods ex.cunprtsrs and smimndudws. Exports o Goods and services f

1996 1997 Nonul g c d s ex.mmputersand semiconductors.

1995

1 lXx)

Imports of Goods and Services
Flatii scale, billions of chained (1992)$, SAAR

-

Ratio scale, billions of chained (1992)$, SAAR

1 I 1990

I

I

I

I

I

I

1994 1996 h - o i l goar ex. mmputers and semmnductaa

1992

Chart 10

Summary
External Balances Billions of dollars, SAAR Contributionof Net Exports to Real GDP Growth'

-I
Real Net ~ x p o c s of Goods and Seriices"

a

+

-

Percentage Points
0.6 0.4 -0.4 -0.7 -0.3 4.6 0.9 -0.9 -0.2 0.0

m

9995-HI
140
'

210

19 90

1994

Alternative Scenarios

Baseline:
Alternatives:

Greenbook forecast extended. (a) Growth spurt in industrial countries equal to 1-1/2 percent of real GDP. (b) Growth spurt in developing countries equal to 2-1/2 percent of real GDP.

P o l i i asumptim:

U.S. and foreign monetary authorities target baseline nominal GDP.

Percent change, Q4 to Q4

I9 s6
US. Real GDP Baseline (a) Industrialspurt (b) Developingspurt US. Consumer Prices Baseline (a) Industrialspurt (b) Developingspurt 2.5 2.7 2.6

199z
2.2 2.5 2.4

19 98
1.7 1.7 1.?

1999
1.7 1.6 1.7

3.1 3.2 3.1

3.2 3.4 3.3

3.2 3.4 3.3

3.2 3.4 3.3

Billions of Dollars, Q4

U.S.

c re t Accwnt urn
Baseline (a) Industrialspurt (b) Developing spurt

-164 -146 -159

-175 -136 -163

-169 -125 -151

-190 -144 -166

Chart 1 1

Consumer Spending
Personal Consumption Expenditures

r
I I I I I I

Four-quarterpercent change Durables

1
l6

1993 2 5 . 1994 3 0 . 1995 2 0 . 1996 2 9 . 1997 2 5 . 73 . 70 . 1.8 6.2 52 .

-

Q4/Q4 percent change

-..-._. -Nondurables and

- 8

PCE Dur. Nondui 8 Sew

------_.+
- 8

19
.

0
-

25
.
21
. 25
. 21
.

I

I

I

I

16 1997

1989

19 91

1993

1995

Net Worth and Personal Saving Percent of DPI, four-quarter moving average

-

Debt Service Burdens Percent of DPI Consumer and mortgage loans

12

1976

Loan Delinquencies

Household net worth
45
.

Personalsaving rate

4

35 .

1980

1984

1988

1992

1996

1

I I I I I I I I I I I I I I I I I I I I I

I,,

1976

1980

1984

1988

1992

1996

Percent

32

Consumer.
2.4

r
1

Bank Willingness to Make Consumer Loans Percent Senior Loan Officer Survey
50

0
1

16
.

Mortgage"
1 ~ ~ ~ ~ ~ ~ ~ ~ ~ ~

08 .

~

1

0 -

+

50

1

1

1

1

1

1

1

1

100

Chart 12

Housing
Housing Starts Millionsof units

1 1
2.4 1.8

1993 1994 1995 1996

Millions of units

-

Total

Singlefamily

1.29 1.46 1.35 1.42
1.36

1.13 1.20 1.08 1.13 1.07

V
I I I
I

Single-family

I
I I

^ ^

1997

I

I

I

I

I

1987

1989

1991

1993

1995

1997

230

r

MortgageApplications and Housing Starts Index Millions of units Mortgageappliitions homepurchase (MBA)

-

1

1.8

r

Perceived HomebuyingConditions and Housing Starts Millionsof units Diffusion Index

-

100

1.5

1992

Homebuyingconditions SRC SUNSY

75

130

1.2

50

80

Singie-family starts

0.9

Single-familystarts

25

30

I

I

I

I

I

06 .
1996 1993 1994 1995 * Good time to buy minus bad time to buy. 1996

1992

1993

1994

1995

0

1.2

-

PerceivedAttractiveness of Mortaaae Rates Ratio 3-mOnthmoving averages Ratesanractiie ** Relative FRM rate *

__

Percentageof all respondents

- loo
-80

1.1 1

0.9
08
.
0.7

V
I

V
I

I

06 .

I

I

I

I

I

I

I

I

I

I

20

1986 1988 1990 1992 1994 * Ratio of cumnt FRM rate to average of past four years. ** Good time to buy because rates low minus bad time to buy because rates hlgh SRC sutvey.
~

1996

Chart 13

Business Investment
Business Fixed Investment Four-quarter percentchange, annual rate

60

PDE

NRS 1.5

Q4/Q4 Percent Change
30

1993 1994

11.5

12.6

3.7

0 Other producers' durables Nonresidentialstructures
I

+

1995 '7.3 1996 1997

5.0
4.3

8.2

5.4

0.5

I

I

I

I

I

I

I

I

I

1987

1989

1991

1993

1995

1997

30

36
24

r -

Real PDE and the Acceleration of Business Output Four-quarterpercent change Percentage points

Ratio of Capital Spending to Cash Flow rNonfinanciaicorporations

Ratio

1
-

2o
10

1.4

12

+
12

0 --

-+; , - 10

1.2

-

1

2 4 1 1 1 1 1 1 1 1 1 1 1 " 1 1 1 1 1 1 1 1 1 1 1 1 201
1 1 1 1 1

1970 1975 1980 1985 1990 1995 'The amelerator 1 U eeightquarter percent chan Inbuslness s output less the yearearlier elghtquarter percent gnge. Nonfarm Inventory Investment Percent chanae in stock. saar 9

0.8

Inventory-SalesRatio * Ratio 4.3

6

42

3

4.1

0 I

+

4

~

1991 1992 1993 1994 1995 19%

1997

3

I

I

I

I

I

I

1991 1992 1993 1994 1995 1996 1997 'Nonfarminventoriesrelative to final sales of goods and slruchlres.

3.9

Chart 14

Labor Markets
Labor Productivity Labor Force Particbation Rate Chained (1992) dollars Percent

Nonfarmbusiness

1

68

. .

1973

1981

1989

1597

1973

1981

1989

1997

* Pre-1994 data adjusted for change i CPS. n

Okun’s Law

Four-quarter change in unemployment rate

EmDlOVment Cost Index

l2

- 2
- 1

Quarterly, 1990:Q1-19!36:Q1 I 2
-0+

:
I
2 1

J
I
I I

I

I

I

I

1

0

4

6

Four-quarter percent change in real GDP

chart 15

Prices
Unemployment and Price Acceleration Change in Mto Q4 growth of GDP chained prices

Be
3

-
Annual, 1961-97

3

B

I

I

I

I

I

CPI Food and Energy inflation
Semiannual percent change.annual rate
18 40

r

Intermediate Gwds inflation
Index 3month change,annual rate

1
PPI intermediate

l6

9 20

8

+ + 0 0 - -

0

+

9 20

I

I

I

I

I

I

18

1993

1994

1995

1996

1997

1993

1994

1995

1996

Chart 16

ECONOMIC PROJECTIONS FOR 1996
FOMC Range Central Tendency Staff

Percent change, Q4 to Q L Nominal GDP
previousestimate

4314 to 6
4 to 5

4314 to 5l/2
4*/4 to 4314

4.7
4.5

Real GDP
previous estimate

PI4to 3
1112 to2112

2lI2 to 23/4
2 to 2’14

2.5
1.8

CPI
previous estimate

2314 to S1/2
2l12 t o3

3 to 3’14
2314 to 3

3.1
3.0

Average level, Q4, percent Unemployment rate
previous estimate

5lI4 to 5314
5’12 to 6

About S1/2 5l/2 to 5=/4

5.5
5.6

ECONOMIC PROJECTIONS FOR 1997 FOMC Ranae Central Tendencv Staff

L Percent change, Q4 to Q

Jominal GDP 3eal GDP :PI

3314to 5
1114 to 2112

4 to 5 1 1 to PI4 34 2112 to 3

4.5 2.2 3.2

2l12 t0 3’14

Average level, Q4, percent Jnemployment rate
S1/2 to 6 5’12 to 5314 5.5

NOTE Centraltendencies constructed by droppingtop and bottom three fromdistribution,and rounding to nearest quarter percent.

J u l y 2 , 1996 Long-Run Ranges David E . L i n d s e y

M2 and M 3 s o f a r t h i s y e a r h a v e b e e n g r o w i n g a r o u n d t h e u p p e r
bounds o f t h e i r a n n u a l r a n g e s . W expect t h e s e broader aggregates t o e This

c o n t i n u e e x p a n d i n g a t s u c h r a t e s o v e r t h e n e x t y e a r and a h a l f .

p r o s p e c t a g a i n r a i s e s f a m i l i a r i s s u e s f o r t h e Committee’s d e c i s i o n a t t h i s m e e t i n g a b o u t t h e r a n g e s f o r t h i s y e a r and n e x t y e a r . Chart 1 i n your package c a p t u r e s t h e e s s e n t i a l s u n d e r l y i n g t h e s t a f f ’ s v i e w o f t h e o u t l o o k f o r M2. I t shows a s c a t t e r p l o t w i t h q u a r ­ t e r l y d a t a of t h e r e l a t i o n s h i p b e t w e e n M 2 ’ s v e l o c i t y . on t h e v e r t i c a l a x i s , and i t s o p p o r t u n i t y c o s t . on t h e h o r i z o n t a l a x i s , s i n c e e a r l y

1959.

The d o t s a n d l i n e i n b l a c k r e p r e s e n t what we once had c o n f i d e n c e

i n - - t h e co-movement o f M 2 ’ s v e l o c i t y and i t s o p p o r t u n i t y c o s t p r i o r t o t h e 1990s. T h a t i s . M 2 t e n d e d t o move t o g e t h e r w i t h n o m i n a l GDP, The s o l i d

e x c e p t a s i n f l u e n c e d by c h a n g e s i n i t s o p p o r t u n i t y c o s t .

b l a c k l i n e r e p r e s e n t s a r e g r e s s i o n f i t o v e r t h i s p e r i o d , which i s a s i m p l i f i e d v e r s i o n o f t h e s t a f f ’ s s t a n d a r d M 2 demand e q u a t i o n . b r o k e n l i n e s show t h e 95 p e r c e n t c o n f i d e n c e i n t e r v a l a r o u n d i t . The r e d d o t s , which b e g i n i n 199O:Ql. i n d i c a t e t h e p r o g r e s s i v e upward s t r u c t u r a l d r i f t i n M2 v e l o c i t y t h r o u g h t h e e a r l y 1990s a s t h e h i s t o r i c a l r e l a t i o n s h i p b e t w e e n v e l o c i t y and o p p o r t u n i t y c o s t i n c r e a s i n g l y b r o k e down.
A number o f r e a s o n s f o r t h i s u p d r i f t i n M2

The two

v e l o c i t y and a s s o c i a t e d weakness i n M2 demand w e r e adduced a t t h e t i m e . They i n v o l v e d t h e u n u s u a l l y s t e e p l y s l o p e d y i e l d c u r v e and v e r y l o w l e v e l of s h o r t - t e r m i n t e r e s t r a t e s . w h i c h h e l p e d t o a t t r a c t t h e p u b l i c

t o more r e a d i l y a v a i l a b l e l o n g - t e r m m u t u a l f u n d s o u t of l i q u i d
b a l a n c e s : t h e c r e d i t c r u n c h a t b a n k s and t h e r e s o l u t i o n o f t r o u b l e d

-2

t h r i f t s , w h i c h r e d u c e d t h e a g g r e s s i v e n e s s w i t h which t h e s e i n s t i t u t i o n s s o u g h t r e t a i l d e p o s i t s : and t h e h o u s e h o l d b a l a n c e - s h e e t r e s t r u c t u r i n g , w h i c h e n t a i l e d repayment o f l o a n s o u t of l i q u i d money b a l a n c e s . I’ve plotted t h e data s t a r t i n g i n l a t e 1994 i n green. These

s i x q u a r t e r s a l l l i e close t o t h e green regression l i n e f i t over j u s t t h i s r e c e n t t i m e frame. The c l o s e c o n f o r m i t y w i t h t h e l o w e r b l a c k

r e g r e s s i o n l i n e might s u g g e s t t h a t t h e upward s t r u c t u r a l d r i f t i n v e l o c i t y h a s ended and t h a t t h e b e h a v i o r a l p a t t e r n s t y p i f y i n g M2 demand i n t h e 1 9 6 0 s . 1 9 7 0 s . and 1 9 8 0 s have r e e m e r g e d . T h i s i s what w e ’ v e

a d o p t e d a s o u r working a s s u m p t i o n i n o u r f o r e c a s t s , shown by t h e b l u e

Xs, of M2 v e l o c i t y f o r t h e f o u r t h q u a r t e r s of t h i s y e a r and n e x t y e a r .
A s t h e b l u e b o o k d i s c u s s i o n i n d i c a t e d , we e x p e c t t h e o p p o r t u n i t y c o s t o f

M2 t o b e e d g i n g down a s c o m p e t i t i v e f o r c e s p u s h up r a t e s on s m a l l t i m e
deposits.
S o , M2’s v e l o c i t y s h o u l d c o n t i n u e t o d i m i n i s h m a r g i n a l l y

through next year.

With n o m i n a l GDP p r o j e c t e d t o grow a t a 4-1/2

p e r c e n t r a t e . t h i s v e l o c i t y b e h a v i o r y i e l d s o u r M2 f o r e c a s t o f 5 p e r c e n t growth t h i s y e a r and n e x t . Your s e c o n d c h a r t g i v e s a d i f f e r e n t p e r s p e c t i v e on t h e r e l a ­ t i o n s h i p o f M2 and G D P - - i t shows t h e b e h a v i o r o f r e a l M2 i n a b u s i n e s s c y c l e c o n t e x t , a s w e l l a s t h e r e c o r d of r e a l G D P . This c h a r t i n d i c a t e s

t h a t . a l t h o u g h r e a l M2 was a n i m p e r f e c t l e a d i n g i n d i c a t o r o f r e a l GDP p r i o r t o t h e 1 9 9 O s , i t s p r o p e r t i e s i n t h i s r e g a r d b r o k e down c o m p l e t e l y during t h e f i r s t half of t h e 1990s. t h e e x p a n s i o n i n r e a l GDP p e r s i s t e d . resume i t s e a r l i e r u p t r e n d . R e a l M2 c o n t i n u e d t o d e c l i n e w h i l e Only a b o u t a y e a r a g o d i d r e a l M2

W h a v e f o r e c a s t c o n t i n u e d growth i n r e a l e

M2 t h r o u g h t h e end of n e x t y e a r g i v e n t h e G r e e n b o o k ’ s p r o j e c t i o n o f
s u s t a i n e d expansion i n r e a l GDP.

-3-

J u d g i n g b y e i t h e r c h a r t , t h e e v i d e n t r e t u r n o f M2’s b e h a v i o r t o h i s t o r i c a l norms h a s l a s t e d o n l y f o r a b r i e f recent p e r i o d .
This

o b s e r v a t i o n i m p l i e s a wide range o f u n c e r t a i n t y around t h e s t a f f M2 p r o j e c t i o n and makes a s i g n i f i c a n t u p g r a d i n g M2’s p o l i c y r o l e seem premature. The f i r s t column o f y o u r n e x t e x h i b i t . t a k e n from page 11 o f t h e b l u e b o o k . shows o u r M 2 g r o w t h f o r e c a s t o f 5 p e r c e n t o v e r t h i s y e a r and n e x t . a l o n g w i t h o u r M3 g r o w t h p r o j e c t i o n o f 6 p e r c e n t f o r t h e two years. A l s o . we s e e d e b t e x p a n d i n g a t a 4 - 1 / 2 p e r c e n t r a t e o v e r b o t h The c e n t r a l t e n ­

y e a r s . m a t c h i n g t h e a n t i c i p a t e d p a c e of n o m i n a l GDP.

dency o f y o u r own f o r e c a s t s o f n o m i n a l GDP i s a b i t h i g h e r t h a n t h e s t a f f ’ s t h i s y e a r b u t a b o u t t h e same n e x t y e a r . Two a l t e r n a t i v e s e t s of r a n g e s a r e p r e s e n t e d f o r Committee consideration. A l t e r n a t i v e I r e p l i c a t e s t h e c u r r e n t y e a r ’ s ranges
T h e M 2 r a n g e of

p r e v i o u s l y s e l e c t e d by t h e Committee.

1 t o 5 percent
At

was o r i g i n a l l y r e d u c e d t o i t s c u r r e n t s p e c i f i c a t i o n i n J u l y 1993.

t h a t t i m e . f o r e c a s t s f o r t h a t y e a r s u g g e s t e d . c o r r e c t l y a s it t u r n e d o u t , t h a t M 2 g r o w t h would u n d e r s h o o t t h e l o w e r bound o f t h e 2 t o 6 p e r c e n t r a n g e p r e v i o u s l y s e t i n F e b r u a r y of t h a t y e a r . By J u l y 1995

t h e r e s t r a i n i n g e f f e c t s on M 2 of s p e c i a l f a c t o r s a n d of h i k e s i n s h o r t t e r m i n t e r e s t r a t e s h a d a b a t e d and f a s t e r growth o f M 2 a p p a r e n t l y had resumed. Even s o , t h e Committee was r e l u c t a n t t o r e a d j u s t t h e M2 r a n g e

upward f o r 1995 o r t o u s e a h i g h e r r a n g e f o r 1996 t o a l i g n t h e s e r a n g e s b e t t e r with l i k e l y M2 growth. The Committee was c o n c e r n e d t h a t t h e

market c o u l d m i s p e r c e i v e a d e c i s i o n t o r a i s e t h e r a n g e a s s i g n a l l i n g e i t h e r lessened a n t i - i n f l a t i o n a r y r e s o l v e o r heightened confidence a b o u t v e l o c i t y p a t t e r n s t h a t would l e a d t h e FOMC t o u p g r a d e t h e mone­ t a r y a g g r e g a t e s as p o l i c y v a r i a b l e s .

-4-

T h e s e c o n c e r n s d i d n o t d e t e r t h e Committee a y e a r a g o , howe v e r , f r o m making a l a r g e t e c h n i c a l upward a d j u s t m e n t t o t h e M3 r a n g e for 1995.
I t r a i s e d t h a t r a n g e from 0 t o 4 p e r c e n t , which had b e e n i n

e f f e c t s i n c e J u l y 1993, t o 2 t o 6 p e r c e n t . higher range f o r 1 9 9 6 a s w e l l .

The Committee u s e d t h i s

T h i s a d j u s t m e n t r e c o g n i z e d t h a t M3 Histori­

s e e m i n g l y had resumed i t s h i s t o r i c a l t e n d e n c y t o o u t p a c e M2.

c a l l y , t h e v e l o c i t y o f M3 had t r e n d e d down, w h i l e t r e n d v e l o c i t y o f N2 had b e e n f l a t . I n r e p o r t s t o t h e C o n g r e s s . b o t h a y e a r ago and l a s t

F e b r u a r y a f t e r t h e r a n g e s were r e a f f i r m e d , t h e Committee c h a r a c t e r i z e d t h e a l t e r n a t i v e I s p e c i f i c a t i o n s f o r b o t h M2 and M3 a s benchmarks f o r l o n g e r - r u n g r o w t h o f t h e m o n e t a r y a g g r e g a t e s t h a t . on t h e a s s u m p t i o n of h i s t o r i c a l l y t y p i c a l v e l o c i t y t r e n d s . would b e c o n s i s t e n t w i t h e f f e c ­ t i v e price s t a b i l i t y . To b e s u r e , o v e r t h i s y e a r and n e x t , n o m i n a l GDP growth i s l i k e l y t o r u n n o t i c e a b l y a b o v e t h e p a c e t h a t would be a s s o c i a t e d w i t h effective price stability.

Also, t h e v e l o c i t i e s o f M2 and M3 a r e

l i k e l y t o b e m a r g i n a l l y d e p r e s s e d by t h e e d g i n g l o w e r o f t h e a v e r a g e opportunity c o s t s of holding r e t a i l d e p o s i t s . Thus, t h e s t a f f ’ s

b a s e l i n e p r o j e c t i o n s f o r M2 and M3 t h i s y e a r and n e x t a r e a r o u n d t h e upper ends of t h e i r a l t e r n a t i v e I r a n g e s . staff projection. I n t h e framework of t h e

it would t a k e a s u b s t a n t i a l i n c r e a s e i n s h o r t - t e r m

i n t e r e s t r a t e s , a s i n t h e t i g h t e r p o l i c y s c e n a r i o i n t h e s e c o n d column. t o move M2 and M3 c o m f o r t a b l y w i t h i n t h e a l t e r n a t i v e I r a n g e s . The a l t e r n a t i v e I1 r a n g e s f o r t h e b r o a d m o n e t a r y a g g r e g a t e s a r e 1 p e r c e n t a g e p o i n t h i g h e r t h a n t h e a l t e r n a t i v e I r a n g e s , enough t o c l e a r l y encompass t h e s t a f f ’ s M2 and M3 p r o j e c t i o n s . The Committee may

j u d g e t h a t an a d d i t i o n a l h a l f y e a r of monetary d a t a has l e n t c r e d e n c e t o t h e s t a f f ’ s v i e w t h a t growth i n b r o a d money r o u g h l y i n l i n e w i t h

5

n o m i n a l GDP w i l l c o n t i n u e o v e r t h e r e s t o f t h i s y e a r and t h r o u g h n e x t year as well. Even i f t h e Committee h a s no i n t e n t i o n o f u p g r a d i n g t h e

broad monetary a g g r e g a t e s a s g u i d e s f o r monetary p o l i c y a d j u s t m e n t s , i t may s t i l l w i s h f o r t h e r a n g e s t o l i n e up b e t t e r w i t h t h e p r o b a b l e outcomes f o r M2 a n d M 3 .