fomc minutes · January 31, 1995

FOMC Minutes

Meeting of January 31-February 1, 1995

A meeting of the Federal Open Market Committee was held in the offices of the Board of Governors

of the Federal Reserve System in Washington, D.C., starting on Tuesday, January 31, 1995 at 1:30

p.m. and continuing on Wednesday, February 1, 1995 at 9:00 a.m.

PRESENT:

Mr. Greenspan, Chairman

Mr. McDonough, Vice Chairman

Mr. Blinder

Mr. Hoenig

Mr. Kelley

Mr. LaWare

Mr. Lindsey

Mr. Melzer

Ms. Minehan

Mr. Moskow

Ms. Phillips

Ms. Yellen

Messrs. Boehne, Jordan, McTeer, and Stern,

Alternate Members of the Federal Open Market

Committee

Messrs. Broaddus, Forrestal, and Parry, Presidents

of the Federal Reserve Banks of Richmond,

Atlanta, and San Francisco, respectively

Mr. Kohn, Secretary and Economist

Mr. Bernard, Deputy Secretary

Mr. Coyne, Assistant Secretary

Mr. Gillum, Assistant Secretary

Mr. Mattingly, General Counsel

Mr. Patrikis, Deputy General Counsel

Mr. Prell, Economist

Mr. Truman, Economist

Messrs. Davis, Dewald, Lindsey, Mishkin, Promisel,

Siegman, Slifman, and Stockton, Associate

Economists

Mr. Fisher, Manager, System Open Market Account

Mr. Ettin, Deputy Director, Division of Research

and Statistics, Board of Governors

Mr. Madigan, Associate Director, Division of

Monetary Affairs, Board of Governors

Mr. Simpson, Associate Director, Division of

Research and Statistics, Board of Governors

Mr. Winn,1 Assistant to the Board, Office of

Board Members, Board of Governors

Messrs. Hooper and Reinhart, Assistant Directors,

Divisions of International Finance and Monetary

Affairs, respectively, Board of Governors

Mr. Rosine,1 Senior Economist, Division of

Research and Statistics, Board of Governors

Mr. English,1 Economist, Division of Monetary

Affairs, Board of Governors

Mr. Freeman,1 Section Chief, Division of

International Finance, Board of Governors

Ms. O'Day,1 Associate General Counsel, Legal

Division, Board of Governors

Mr. Baer,1 and Ms. Misback,1 Managing Senior

Counsels, Legal Division, Board of Governors

Mr. Ely,1 Senior Attorney, Legal Division, Board

of Governors

Ms. Low, Open Market Secretariat Assistant,

Division of Monetary Affairs, Board of

Governors

Messrs. Barron and Rasdall, First Vice Presidents,

Federal Reserve Banks of San Francisco and

Kansas City, respectively

Messrs. Beebe, Goodfriend, Lang, Rosenblum,

Sniderman, and Ms. Tschinkel, Senior Vice

Presidents, Federal Reserve Banks of San

Francisco, Richmond, Philadelphia, Dallas,

Cleveland, and Atlanta, respectively

Messrs. McNees and Miller, Vice Presidents, Federal

Reserve Banks of Boston and Minneapolis,

respectively

Mr. Evans and Ms. Krieger, Assistant Vice

Presidents, Federal Reserve Banks of Chicago

and New York, respectively

1. Attended portions of the meeting.

In the agenda for this meeting, it was reported that advices of the election of the following members

and alternate members of the Federal Open Market Committee for the period commencing January 1,

1995, and ending December 31, 1995, had been received and that the named individuals had

executed their oaths of office.

The elected members and alternate members were as follows:

William J. McDonough, President of the Federal Reserve Bank of New York, with James H. Oltman,

First Vice President of the Federal Reserve Bank of New York, as alternate;

Cathy E. Minehan, President of the Federal Reserve Bank of Boston, with Edward G. Boehne,

President of the Federal Reserve Bank of Philadelphia, as alternate;

Michael H. Moskow, President of the Federal Reserve Bank of Chicago, with Jerry L. Jordan,

President of the Federal Reserve Bank of Cleveland, as alternate;

Thomas C. Melzer, President of the Federal Reserve Bank of St. Louis, with Robert D. McTeer,

President of the Federal Reserve Bank of Dallas, as alternate;

Thomas M. Hoenig, President of the Federal Reserve Bank of Kansas City, with Gary H. Stern,

President of the Federal Reserve Bank of Minneapolis, as alternate.

By unanimous vote, the following officers of the Federal Open Market Committee were elected to

serve until the election of their successors at the first regularly scheduled meeting of the Committee

after December 31, 1995, with the understanding that should they discontinue their official

connection with the Board of Governors or with a Federal Reserve Bank, they would cease to have

any official connection with the Federal Open Market Committee:

Alan Greenspan

William J. McDonough

Donald L. Kohn

Normand R. V. Bernard

Joseph R. Coyne

Gary P. Gillum

J. Virgil Mattingly, Jr.

Ernest T. Patrikis

Michael J. Prell

Edwin M. Truman

Lynn E. Browne, Thomas E. Davis, William G.

Dewald, David E. Lindsey, Frederic S. Mishkin,

Larry J. Promisel, Charles J. Siegman, Lawrence

Slifman, David J. Stockton, and Carl E. Vander

Wilt

Chairman

Vice Chairman

Secretary and Economist

Deputy Secretary

Assistant Secretary

General Counsel

Deputy General Counsel

Economist

Associate Economists

By unanimous vote, the Federal Reserve Bank of New York was selected to execute transactions for

the System Open Market Account until the adjournment of the first meeting of the Committee after

December 31, 1995.

By unanimous vote, Peter R. Fisher was selected to serve at the pleasure of the Committee as

Manager, System Open Market Account, on the understanding that his selection was subject to being

satisfactory to the Federal Reserve Bank of New York.

Secretary's note: Advice subsequently was received that the selection of Mr. Fisher was

satisfactory to the board of directors of the Federal Reserve Bank of New York.

By unanimous vote, the minutes of the meeting of the Federal Open Market Committee held on

December 20, 1994, were approved.

The Manager of the System Open Market Account reported on developments in foreign exchange

markets since the December meeting. There were no market transactions for System Account during

this period, and thus no vote was required of the Committee.

The Manager also reported on developments in domestic financial markets and on System open

market transactions in government securities and federal agency obligations during the period

December 20, 1994, through January 31, 1995. By unanimous vote, the Committee ratified these

transactions.

The Committee then turned to a discussion of the economic and financial outlook and the

implementation of monetary policy over the intermeeting period ahead. A summary of the economic

and financial information available at the time of the meeting and of the Committee's discussion is

provided below, followed by the domestic policy directive that was approved by the Committee and

issued to the Federal Reserve Bank of New York.

The information reviewed at this meeting suggested a strong further rise in economic activity during

the closing months of 1994. Although consumer spending appeared to be less buoyant and housing

demand had softened somewhat, growth in business investment, exports, and inventories remained

brisk. Industrial production and payroll employment continued to record substantial gains. Broad

indexes of prices for consumer goods and services had risen moderately on average over recent

months despite shrinking margins of unemployed resources and further sizable increases in the prices

of many materials.

Nonfarm payroll employment advanced considerably further in December after a sharp rise in

November. Substantial job gains were recorded in December in service industries and in the retail

trade sector. Hiring in manufacturing was brisk for a third straight month, with labor demand

especially strong in motor vehicles, capital goods, and electronic equipment. Construction payrolls

slipped after a large increase in November. The average workweek was unchanged in December, but

factory overtime edged back up, matching the highest level reached in the history of this series. The

civilian unemployment rate declined to 5.4 percent.

Industrial production registered another large advance in December. Manufacturing accounted for all

of the gain; an upturn in mining production offset a decline in the output of utilities associated with

unseasonably warm weather. In manufacturing, the output of motor vehicles and parts surged again

and further solid gains were recorded in the production of other goods. The large advance in

industrial output in December boosted rates of capacity utilization above already high levels.

Retail sales were reported to have changed little over November and December after substantial

advances in September and October; the flattening of sales reflected sharply reduced increases in

outlays for non-auto consumer goods. Consumer spending on services rose moderately on balance

over November and December, with outlays for energy services held down by unusually mild

weather. Although some indicators of housing demand had weakened, housing starts posted sizable

gains on balance over November and December; single-family construction remained at a relatively

high level despite the rise in mortgage rates in 1994, and multifamily construction continued its

gradual recovery from the depressed levels of early 1993. The regional pattern of starts activity

suggested that favorable weather accounted for little of the strength in December.

Business fixed investment was estimated to have grown at a very rapid pace in the fourth quarter,

with a pickup indicated for business spending on both equipment and nonresidential structures. New

orders for nondefense capital goods declined on balance over November and December, but the large

backlog of unfilled orders, especially for computers, pointed to a continued strong expansion in

spending on business equipment in coming months. Nonresidential construction activity was up

considerably in November for a third straight month, with increases in construction widespread by

type of structure. Recent data indicated that permits for nonresidential construction were continuing

to trend higher and perhaps were running ahead of construction activity.

Business inventory investment remained brisk in November; in the aggregate, the buildup was in line

with shipments and sales. In manufacturing, stocks increased more rapidly in November, but the ratio

of stocks to shipments declined further and was at a historically low level. In wholesale trade,

inventories rose less rapidly in November, but the inventory-to-sales ratio increased further, although

it remained within its range of recent years. Inventory accumulation slowed a little at the retail level,

and the inventory-to-sales ratio for this sector remained near the middle of its range of recent years.

The nominal deficit on U.S. trade in goods and services widened somewhat further in November, and

for October and November combined the deficit was well above its average rate in the third quarter.

The value of exports of goods and services increased more slowly in the October-November period

than in the third quarter, largely reflecting reduced growth of exported industrial supplies. The rise in

the value of imports of goods and services for the October-November period was led by increased

imports of non-oil industrial supplies and automotive, capital, and consumer goods. Available data

for the fourth quarter of 1994 indicated continued growth in economic activity, though perhaps at a

somewhat slower pace, in the major foreign industrial countries.

Consumer price inflation slowed a little in December despite a jump in food prices that was only

partly offset by a decline in energy prices. Excluding food and energy items, consumer prices edged

up in December and rose significantly less in 1994 than in 1993. At the producer level, prices of

finished goods also advanced more slowly in December, with a drop in energy prices balancing a

surge in food prices. Prices of finished goods other than food and energy increased modestly in 1994

after being held down in 1993 by a sharp drop in the prices of tobacco products. In contrast to prices

of finished goods, price inflation at earlier stages of production picked up in 1994. For intermediate

goods other than food and energy items, prices rose at a faster rate in the second half of 1994, with

the pickup most clearly evident in materials used in manufacturing. Prices of crude materials rose

rapidly in the second half of 1994 and for the year as a whole. Increases in labor costs remained

moderate. Average hourly earnings were little changed on balance over November and December,

and for the year as a whole they advanced only slightly more than in 1993. More broadly, hourly

compensation of private industry workers increased more slowly in the fourth quarter than in any of

the previous three quarters of 1994, and the rise for the year was significantly less than in 1993.

At its meeting on December 20, 1994, the Committee adopted a directive that called for maintaining

the existing degree of pressure on reserve positions and that included a bias toward the possible

firming of reserve conditions during the intermeeting period. Accordingly, the directive stated that in

the context of the Committee's long-run objectives for price stability and sustainable economic

growth, and giving careful consideration to economic, financial, and monetary developments,

somewhat greater reserve restraint would be acceptable or slightly lesser reserve restraint might be

acceptable during the intermeeting period. The reserve conditions associated with this directive were

expected to be consistent with modest growth in the broader monetary aggregates over coming

months.

Open market operations during the intermeeting period were directed toward maintaining the

existing degree of pressure on reserve positions. With the need for seasonal credit diminishing over

the period, adjustment plus seasonal borrowing trended lower but averaged a little above anticipated

levels. Near year-end, the Trading Desk accommodated heavy demands for reserves through System

RPs. The federal funds rate averaged close to 5-1/2 percent during the intermeeting period.

Most other market interest rates declined slightly on balance over the period after the December 20

meeting. Very short term interest rates fell after the first of the year, reflecting the disappearance of

year-end premiums. More broadly, favorable news on inflation and indications of some unexpected

slowing in the growth of final demands apparently led market participants to conclude that further

tightening of monetary policy, though still expected to be substantial, would be less than previously

thought and would be spread over a longer period. Yields on tax-exempt instruments declined

considerably as concerns about the implications of Orange County's problems for the financial

condition of other municipal governments abated. Strong earning reports for the fourth quarter

boosted major indexes of equity prices.

In foreign exchange markets, the trade-weighted value of the dollar in terms of the other G-10

currencies declined somewhat over the intermeeting period. The dollar fell substantially against the

mark, which was buoyed by safe-haven inflows from weaker European currencies, but dropped less

against the yen. One factor that weighed against the dollar was uncertainty about the consequences

for the U.S. economy of the sharp depreciation of the Mexican peso and the related economic and

financial problems in Mexico and other developing economies; market participants expressed some

concern that the crisis might constrain U.S. monetary policy in the event of further domestic inflation

pressures and that the counterpart to the large prospective reduction in the Mexican current account

deficit would lie importantly in the already substantial U.S. deficit.

Growth of M2 and M3 strengthened in December, and data for the first half of January suggested a

further acceleration in that month. Much of the pickup in M2 in December was due to rapid

expansion in overnight repurchase agreements and overnight Eurodollars, which outweighed a

further contraction of liquid accounts associated in part with depositor efforts to obtain higher returns

by shifting funds into market instruments. The faster growth of M3 reflected, in addition to the

acceleration of its M2 component, bank use of large CDs and nondeposit sources of funds to finance

relatively robust demands for credit. From the fourth quarter of 1993 to the fourth quarter of 1994,

M2 grew at the lower end of the Committee's range for 1994 and M3 in the lower half of its range.

Total domestic nonfinancial debt had continued to expand at a moderate rate in recent months, and

for 1994 it was in the lower half of its monitoring range.

The staff forecast prepared for this meeting suggested that growth of economic activity would slow

substantially over the next several quarters and for some period thereafter would average less than

the rate of increase in the economy's potential output. Consumer spending was projected to be well

sustained for a time but to be restrained later by smaller gains in real incomes, the satisfaction of

pent-up demands, and the lagged effects of higher interest rates on the demand for durable goods.

Business outlays for new equipment were expected to decelerate substantially in response to higher

financing costs and slower growth of sales and profits. Homebuilding was anticipated to soften a

little in response to slower growth in jobs and income as well as to the increase that had occurred in

mortgage rates. Recent developments in Mexico were expected to cut into exports in the near term,

but the sustained economic growth elsewhere would keep export demand on an uptrend. Although

there was considerable uncertainty regarding the fiscal outlook, in light of the Congressional intent to

cut the federal deficit the forecast incorporated a somewhat greater degree of fiscal restraint than had

been built into recent forecasts. In the staff's judgment, the economy currently was operating beyond

its long-run, noninflationary capacity, and there remained a substantial risk that inflation could

ratchet higher absent further monetary policy actions.

In the Committee's discussion of current and prospective economic developments, the members

agreed that growth in economic activity could be expected to moderate considerably over the course

of 1995, although inflation was likely to be higher than in 1994. They acknowledged that their

current projections were subject to substantial risks. The expansion continued to display appreciable

momentum and signs of slower growth were still quite limited and tentative. Even so, the members

remained persuaded that the lagged effects of the policy tightening implemented over the course of

1994 would become increasingly evident in interest-sensitive sectors of the economy as the year

progressed. The projected moderation in the growth of final demands, which probably would be

concentrated at least initially in the housing and consumer durables sectors, would undoubtedly

reinforce an expected cutback in inventory investment from its unsustainable pace in recent quarters.

A key uncertainty in the outlook was whether the slowing in overall economic growth would be

sufficient to relieve the current pressures on labor and other producer resources, which many

members saw as portending higher inflation, or, indeed, whether such pressures would intensify

further. Opinions differed to some degree with regard to both the likely extent of the prospective

slowing in economic growth and the outlook for inflation. However, most of the members concluded

that some rise in inflation appeared probable over coming quarters, and they were concerned that this

upturn would not be reversed and could be extended in the absence of further monetary restraint.

In keeping with the practice at meetings when the Committee establishes its long-run ranges for

growth of the money and debt aggregates, the members of the Committee and the Federal Reserve

Bank presidents not currently serving as members had prepared individual projections of economic

activity, the rate of unemployment, and inflation for the year 1995. Measured from the fourth quarter

of 1994 to the fourth quarter of 1995, their forecasts of the growth in real GDP had a central

tendency of 2 to 3 percent, compared with a growth rate of 4 percent estimated for 1994. Most of the

members also anticipated that economic expansion in line with their forecasts would be associated

with little change in the unemployment rate and their projections of the rate in the fourth quarter of

1995 were centered in a narrow range around 5-1/2 percent. The high levels of resource utilization

implied by these projections were viewed by most members as likely to foster somewhat greater

pressure on wages and prices. Accordingly, projections of the rate of inflation, as indexed by the

consumer price index, had a central tendency of 3 to 3-1/2 percent for the period from the fourth

quarter of 1994 to the fourth quarter of 1995, compared with rates of about 2-3/4 percent in both

1993 and 1994.

In their review of regional economic developments, members referred to widespread evidence of

further growth in business activity, but a number also mentioned scattered signs of some softening in

a few areas or industries. Several emphasized, however, that the anecdotal evidence did not currently

point to any significant moderation in the overall growth of the economy. With regard to financial

conditions, members commented that they saw little indication that policy tightening actions over the

past year were constraining the availability of credit to any observable degree. Despite higher interest

rates, financial conditions remained broadly supportive of further economic expansion. The

performance of stock market prices and the relatively narrow quality spreads in debt markets attested

to a considerable degree of confidence among investors. Members also took note of the

accommodative lending policies of banking institutions. Those policies had encouraged rapid growth

in consumer and business loans and evidently were contributing to the ongoing strength of the

economic expansion. Some members expressed concern that a number of banks might have eased

their lending standards unduly and thus assumed unwarranted risks in their loan portfolios.

In their assessment of developments in key sectors of the economy, members referred to the sluggish

behavior of non-auto retail sales in November and December, but they also noted that the available

information on consumer spending during the first few weeks of this year was inconclusive with

regard to the possible emergence of a slowing trend. Anecdotal commentary on retail sales was

mixed, and evidence of some decline in January sales of motor vehicles needed to be evaluated with

caution because of the introduction of a new reporting method. Consumer confidence was at a high

level, but some members observed that consumer indebtedness had grown rapidly and was likely to

exert a retarding effect on consumer spending at some point. In this regard, however, it was pointed

out that rising consumer incomes had kept debt service burdens from increasing significantly thus

far. On balance, the members believed that the growth in consumer spending probably would slow

over the forecast horizon though such spending might be relatively well maintained for some period,

given the ongoing expansion in jobs and incomes and the ready availability of financing to many

consumers. In any event, the outlook for this sector of the economy, which was critical to any

significant moderation in overall economic growth, was uncertain with regard to both the timing and

the extent of possible slowing.

Housing construction was cited as potentially the most important demand sector of the economy that

was likely to contribute to more moderate economic growth over the year ahead. As evidenced by

nationwide data through the end of 1994, single-family housing starts had held up unexpectedly well

despite sizable increases in home mortgage rates, but anecdotal reports from around the country had

pointed to weakening demand for new homes for several months and continued to do so. Against the

background of current mortgage rate levels and the rise that had occurred in home mortgage

indebtedness, the members continued to anticipate softening demand for housing, at least in the

single-family sector. The mild uptrend in the much smaller multifamily sector was likely to continue

for some period, given low rental vacancy rates in a number of areas, and further improvement in

nonresidential construction was likely to offset to some extent the overall slowing in housing

construction.

In the capital goods sector, real business-fixed investment had strengthened further in the fourth

quarter, and the members believed, on the basis of rising order backlogs and the strength of permits

for new business construction, that considerable momentum had carried into this year. While the

growth in spending for business equipment undoubtedly would moderate from its extraordinary pace

over an extended period, large business profits and the still relatively low user cost of capital would

tend to support appreciable further growth in such investment in the context of elevated levels of

capacity utilization and ongoing efforts, induced by strong market competition, to increase

productivity. Moreover, nonresidential construction was now trending higher, with particular strength

evident in industrial and commercial construction.

The pace of inventory accumulation in recent quarters was viewed as unsustainable and a decline in

inventory investment was seen as likely over the forecast horizon, though the precise timing and

extent were impossible to predict. While slower growth in final demand might in most circumstances

stimulate a relatively sharp adjustment in inventory investment, members cited factors that could

mute the size of that adjustment and its effects on overall GDP. These included relatively low

inventory/sales ratios across much of the economy and little anecdotal or other evidence of

unintended inventory accumulation. Moreover, because an unusually large share of the inventory

buildup in recent quarters appeared to involve imports, a cutback in such investment should tend to

have a smaller-than-usual impact on domestic production. There was no current evidence that

inventory investment was slowing, and indeed recent data on business loans at banks might suggest

some acceleration in inventory accumulation since the beginning of the year. Nonetheless, as more

moderate growth in final demand began to emerge, concerns about the availability of materials used

in the production process or stocks needed to meet market demand should diminish, and business

firms could be expected to trim their demand for inventories, perhaps aggressively for a time. Indeed,

this sector of the economy might well account for much of the slowing in the expansion for some

period of time during the year ahead.

Fiscal policy was under active debate in the Congress, and the members viewed the outcome of that

debate as very uncertain. The emergence of a moderately restrictive fiscal policy might be a

reasonable assumption to incorporate in current forecasts, albeit an assumption that clearly was

subject to a wide range of error. In any event, any progress toward cutting future budget deficits was

likely to have a favorable effect on domestic financial markets and perhaps also on the dollar in

foreign exchange markets.

Developments in Mexico and their possible repercussions in other developing nations had negative

implications for U.S. exports, at least over the short run. Indeed, some members cited anecdotal

evidence that reduced trade with Mexico had already emerged since late 1994. Moreover, the effects

of the earthquake in Kobe, Japan, seemed to be disrupting trade with that nation in agricultural and

other bulk goods and was likely to continue doing so over the near term. Looking beyond the months

immediately ahead, the relatively robust growth projected for many industrial countries together with

the lower value of the dollar should boost the nation's overall external trade balance, though probably

not to the extent of providing substantial stimulus to the economy. One member observed that a

number of countries throughout the world faced the potential for important changes in political

conditions that could have adverse effects on their growth and trading relationships, with possible

repercussions on U.S. exports.

Members commented that the strong growth in economic activity and high levels of resource

utilization had fostered relatively rapid increases in the prices of many raw materials and

semi-finished goods used in the production process, but contrary to numerous forecasts these

developments had not led thus far to a broad pickup in inflation as measured by the prices of final

goods and services. This favorable development might be explained in part by lags in the inflation

transmission process and perhaps to some degree by various structural changes and productivity

improvements in recent years that may have raised both the level and the rate of increase of the

economy's potential for sustained activity. Many members observed, however, that it would not be

prudent from a monetary policy standpoint to assume that continued rapid economic growth and

further pressures on producer resources would not lead to rising inflation over the quarters ahead.

While competitive pressures still generally limited the extent to which business firms could pass

through rising costs of raw materials and other producer inputs to the prices of final goods, the

members referred to increasingly numerous examples of successful efforts to raise such prices and to

apparently growing business expectations that it would be possible to implement such increases over

the months ahead. On balance, the members generally were persuaded that the economy had attained

levels of labor and capital utilization that implied a strong risk of rising inflation over coming

quarters.

In keeping with the requirements of the Full Employment and Balanced Growth Act of 1978 (the

Humphrey-Hawkins Act), the Committee at this meeting reviewed the ranges for growth of the

monetary and debt aggregates in 1995 that it had established on a tentative basis at its meeting in

July 1994. The tentative ranges included expansion of 1 to 5 percent for M2 and 0 to 4 percent for

M3, measured from the fourth quarter of 1994 to the fourth quarter of 1995. The monitoring range

for growth of total domestic nonfinancial debt had been set provisionally at 3 to 7 percent for 1995.

The ranges for M2 and M3 were unchanged from those that the Committee had used in 1994, while

the range for debt was one percentage point lower.

All the members endorsed a proposal to adopt the ranges that the Committee had set on a tentative

basis in July 1994. While some acceleration in the growth of the broad monetary aggregates from the

pace in 1994 could be anticipated over the year ahead according to a staff analysis, monetary

expansion within the ranges in question appeared to be consistent with the moderation in the

expansion of nominal GDP that the members were projecting for 1995 and that they viewed as

desirable to head off increasing inflation. Moreover, the ranges for the broad monetary aggregates

had been reduced over the past decade to levels that, notably in the case of M2, should now be

consistent over long periods with the Committee's objectives for stable prices and maximum

sustainable economic growth. This outcome would depend on the restoration over time of the

historical velocity patterns linking the monetary aggregates to broad measures of economic

performance, including a level velocity trend for M2. It was noted in this regard that until recent

years the growth of M3 had tended to exceed that of M2--a pattern that seemed to be

re-emerging--and therefore a somewhat higher range might be set for M3 than for M2. However, the

members did not believe that a persuasive argument could be made at this juncture for raising the M3

range, though they did not want to rule out the option of doing so later, possibly when the ranges

were reviewed at midyear. Indeed, to make the change at this point might convey a misleading

message regarding the Committee's policy intentions or its confidence in prospective monetary

growth relationships.

The Committee also considered the potential advantages and disadvantages of setting specific targets

for bringing inflation down and achieving price stability over time. Such targets might provide an

alternative or supplemental approach to the monetary growth ranges, which had been found to be

unreliable guides for monetary policy over the past several years. The members discussed a number

of aspects of inflation targeting. On the one hand, such targeting would help to anchor the conduct of

monetary policy and progress in meeting these objectives could enhance the credibility of the Federal

Reserve and perhaps reduce the overall cost of attaining price stability. On the other hand, close

adherence to preset inflation targets could unduly constrain the Federal Reserve in its efforts to

counteract the effects of cyclical shortfalls in the performance of the economy. The members agreed

that the discussion had been helpful in outlining the issues and that the subject should be revisited. It

was noted in this connection that the Committee might be asked to comment during the months

ahead on specific Congressional proposals for inflation targeting.

At the conclusion of its discussion, all the members voted to approve without change the tentative

ranges for 1995 that the Committee had established in July of last year. In keeping with its usual

procedures under the Humphrey-Hawkins Act, the Committee would review its ranges at midyear, or

sooner if interim conditions warranted, in light of the growth and velocity behavior of the aggregates

and ongoing economic and financial developments. Accordingly, the following longer-run policy

statement for 1995 was approved for inclusion in the domestic policy directive.

The Federal Open Market Committee seeks monetary and financial conditions that will

foster price stability and promote sustainable growth in output. In furtherance of these

objectives, the Committee at this meeting established ranges for growth of M2 and M3

of 1 to 5 percent and 0 to 4 percent respectively, measured from the fourth quarter of

1994 to the fourth quarter of 1995. The Committee anticipated that money growth within

these ranges would be consistent with its broad policy objectives. The monitoring range

for growth of total domestic nonfinancial debt was lowered to 3 to 7 percent for the year.

The behavior of the monetary aggregates will continue to be evaluated in the light of

progress toward price level stability, movements in their velocities, and developments in

the economy and financial markets.

Votes for this action: Messrs. Greenspan, McDonough, Blinder, Hoenig, Kelley,

LaWare, Lindsey, Melzer, Ms. Minehan, Mr. Moskow, Mses. Phillips and Yellen.

Votes against this action: None.

In the Committee's discussion of policy for the intermeeting period ahead, all the members indicated

that they could support some firming in reserve conditions, though a few preferred to delay such an

action pending the receipt within the next few weeks of significant new information that could help

the Committee to evaluate whether and to what extent the economic expansion might be slowing.

Most of the members were convinced, however, that current monetary policy should be adjusted

promptly to a more clearly restrictive stance. In their view, prompt action was needed to counter

inflationary pressures and inflationary expectations in an economy that already seemed to be

operating at, and perhaps beyond, sustainable capacity levels and to be continuing to expand at a

pace above its long-run potential. In these circumstances, a delay in tightening policy would incur an

unacceptable risk of allowing further inflationary momentum to develop in the economy and would

require more tightening over time than might otherwise be needed to achieve the Committee's

objectives. Part of the risk involved a potential further decline in the dollar at a time when there

already was considerable concern about rising pressures on prices. Some tightening of policy at this

meeting was generally anticipated in markets, and a failure to take action now was likely in the view

of a number of members to raise questions about the credibility of the System's anti-inflation resolve

and to generate some unsettlement in financial markets, notably in the foreign exchange market

where the dollar already appeared to be vulnerable to further weakness. In terms of balancing the

policy risks that were involved, a prompt move would provide some insurance against what these

members viewed as the principal risk in current circumstances--that of rising inflation. The risks of

excessive tightening, while not completely absent, were believed to be limited in light of the

apparent strength and momentum of the expansion, which many forecasters had underestimated over

the past year. One member expressed the view that while monetary growth had been damped,

continuing restraint on the growth of the narrow monetary aggregates was desirable to offset a

previous build-up in liquidity and help assure that inflationary pressures would be contained.

Members who saw an advantage in postponing a decision to tighten policy commented that, in light

of some scattered signs of a moderating expansion, it would be helpful to wait for certain key

statistics that would become available within the next few weeks to judge the extent of any

moderation. Data on retail sales in January might provide particular insights as to whether the

softening in such sales in November and December was persisting. The favorable news on inflation

in the fourth quarter had lessened concerns about an immediate inflation threat, and if the incoming

information confirmed the need for further tightening, the short delay in implementing it would have

only a minimal cost. In addition, an increase in monetary restraint would be likely to exacerbate the

problems of Mexico and perhaps to some extent those of Canada and would have potentially adverse

implications for U.S. trade with both of these key trading partners. Because the probability that

incoming information would counsel against any further policy tightening was certainly less than 50

percent so that only a matter of timing was likely to be involved, these members indicated that they

would join with the other members in voting to tighten policy at this meeting.

Concerning the possible need to adjust policy during the intermeeting period, the members were

unanimously in favor of adopting a symmetric directive. Given a decision to implement some

tightening in monetary policy at this meeting, they did not believe that there should be a presumption

toward possible further tightening in this period. A number of members observed that further

monetary restraint might not be needed if, in line with their expectations, the incoming evidence on

the performance of the economy suggested that the expansion was moderating sufficiently for the

economy to return to a growth path consistent with containing inflation pressures. In any event, the

Committee's most difficult decision over the next several quarters was likely to be that of

determining when further tightening was no longer desirable.

Prior to the end of the meeting, the members were apprised of a disposition on the part of the Board

of Governors to approve an increase of 1/2 percentage point in the discount rate that was pending at

several Federal Reserve Banks. In the event that such an increase was approved by the Board, the

members agreed that open market operations should be conducted so as to allow that increase to be

reflected fully in reserve markets.

At the conclusion of the Committee's discussion, all the members indicated that they could support a

directive that called for increasing somewhat the degree of pressure on reserve positions. In the

implementation of this policy, account would be taken of a possible increase of 1/2 percentage in the

discount rate that was under consideration by the Board of Governors. The members also agreed that

the directive should not include any presumption about possible adjustments to policy during the

intermeeting period. Accordingly, in the context of the Committee's long-run objectives for price

stability and sustainable economic growth, and giving careful consideration to economic, financial,

and monetary developments, the Committee decided that somewhat greater or somewhat lesser

reserve restraint would be acceptable during the intermeeting period. According to a staff analysis,

the reserve conditions contemplated at this meeting would be consistent with moderate growth in M2

and M3 over coming months.

At the conclusion of the meeting, the Federal Reserve Bank of New York was authorized and

directed, until instructed otherwise by the Committee, to execute transactions in the System Account

in accordance with the following domestic policy directive:

The information reviewed at this meeting suggests a strong further rise in economic

activity during the closing months of 1994. Nonfarm payroll employment was up

considerably further in December after a sharp increase in November, and the civilian

unemployment rate declined to 5.4 percent. Industrial production registered another

large advance in December and capacity utilization continued to move up from already

high levels. Current estimates indicate little change in retail sales over November and

December, while housing starts posted sizable gains on balance over the two months.

Orders for nondefense capital goods point to a continued strong expansion in spending

on business equipment; permits for nonresidential construction have been trending

appreciably higher. The nominal deficit on U.S. trade in goods and services widened

somewhat in October-November from its average rate in the third quarter. Prices of

many materials have continued to move up rapidly, but broad indexes of prices for

consumer goods and services have increased moderately on average over recent months.

Most market interest rates have declined slightly on balance since the Committee

meeting on December 20, 1994. In foreign exchange markets, the trade-weighted value

of the dollar in terms of the other G-10 currencies has declined somewhat over the

intermeeting period. The Mexican peso has depreciated sharply against the dollar.

Growth of M2 and M3 strengthened in December and January. From the fourth quarter

of 1993 to the fourth quarter of 1994, M2 grew at a rate at the bottom of the Committee's

range for 1994 and M3 at a rate in the lower half of its range for the year. Total domestic

nonfinancial debt has continued to expand at a moderate rate in recent months, and for

the year 1994 it grew at a rate in the lower half of its monitoring range.