FOMC Minutes

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., on Tuesday, May 21,

1996, at 9:00 a.m.

Present:

Mr. Greenspan, Chairman

Mr. McDonough, Vice Chairman

Mr. Boehne

Mr. Jordan

Mr. Kelley

Mr. Lindsey

Mr. McTeer

Ms. Phillips

Mr. Stern

Ms. Yellen

Messrs. Broaddus, Guynn, Moskow, and Parry, Alternate Members of the Federal

Open Market Committee

Messrs. Hoenig, Melzer, and Ms. Minehan, Presidents of the Federal Reserve Banks

of Kansas City, St. Louis, and Boston respectively

Mr. Kohn, Secretary and Economist

Mr. Bernard, Deputy Secretary

Mr. Coyne, Assistant Secretary

Mr. Gillum, Assistant Secretary

Mr. Mattingly, General Counsel

Mr. Baxter, Deputy General Counsel

Mr. Prell, Economist

Mr. Truman, Economist

Messrs. Lang, Lindsey, Mishkin, Promisel, Rolnick, Rosenblum, Siegman, Simpson,

and Stockton, Associate Economists

Mr. Fisher, Manager, System Open Market Account

Mr. Ettin, Deputy Director, Division of Research and Statistics, Board of Governors

Mr. Slifman, Associate Director, Division of Research and Statistics, Board of

Governors

Mr. Madigan, Associate Director, Division of Monetary Affairs

Ms. Low, Open Market Secretariat Assistant, Division of Monetary Affairs, Board of

Governors

Mr. Rives, First Vice President, Federal Reserve Bank of St. Louis

Mr. Beebe, Ms. Browne, Messrs. Davis, Dewald, Eisenbeis, Goodfriend, and Hunter,

Senior Vice Presidents, Federal Reserve Banks of San Francisco, Boston, Kansas

City, St. Louis, Atlanta, Richmond, and Chicago respectively

Mr. Altig, Mses. Chen and Rosenbaum, Vice Presidents, Federal Reserve Banks of

Cleveland, New York, and Atlanta respectively

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

on March 26, 1996, were approved.

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

exchange markets during the period March 26 through May 20, 1996. There were no open

market transactions in foreign currencies 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 March 26 through May 20, 1996. 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 that economic activity had expanded

moderately on balance in recent months. Final demand, which had been quite robust early in

the year, was showing some signs of slowing in recent data. Consumer spending appeared to

be growing at a moderate pace; business expenditures on durable equipment had registered

further large gains, though new orders had flattened out; and housing demand seemed to be

holding up well despite the increase in mortgage interest rates this year. Business inventories,

most notably in the automotive industry, had been brought into better alignment with sales,

and industrial production and employment had risen appreciably. Upward pressures on food

and energy prices accounted for somewhat larger increases in consumer prices.

Nonfarm payroll employment was essentially unchanged in April after rising substantially in

the first quarter; part of the slowdown resulted from an unwinding of special factors that had

boosted job growth in the first quarter. Payrolls continued to expand in April in retail trade;

finance, insurance, and real estate; and the services industries. In contrast, cmployment in

construction fell sharply, reversing much of the large first-quarter gain. In manufacturing,

employment declined further in April despite the settlement of a major strike in the

automotive sector and the return of affected workers to their jobs. The civilian

unemployment rate fell to 5.4 percent.

Industrial production rebounded in April from an appreciable decline in March. The changes

in industrial output over the two-month period largely reflected fluctuations in motor vehicle

assemblies associated with a strike and its subsequent settlement. Manufacturing of products

other than motor vehicles rose moderately in April on the strength of further large advances

in the output of office and computing equipment and of construction supplies. Utilization of

total industrial capacity, which had varied in recent months in concert with movements in

production, climbed in April to a rate slightly above that of the fourth quarter of 1995.

Retail sales declined somewhat in April after posting a strong gain in the first quarter. Sales

of durable goods, which had increased substantially in the first quarter, retraced part of that

advance in April; the drop more than offset a further rise in sales of nondurable goods.

Housing activity was well sustained in April, with the run-up in mortgage rates that began in

February having had little perceptible effect to date. Single-family housing starts were up

considerably in April, and sales of new and existing homes remained brisk in March (latest

data available).

Business fixed investment accelerated sharply in the first quarter of 1996 following three

quarters of relatively moderate expansion; however, recent data on orders and contracts

pointed, on balance, to some deceleration in business spending on both durable equipment

and nonresidential structures. Much of the first-quarter pickup reflected stronger spending for

durable equipment; purchases of computing equipment remained robust and spending on

other durable equipment increased. Nonresidential construction activity also advanced further

in the first quarter; however, construction of office buildings continued to lag, and

construction of other commercial buildings slowed after recording strong gains for several

years.

Business inventories declined in March after rising appreciably on average over January and

February; inventory accumulation over the quarter as a whole was of modest proportions, as

firms sought to bring stocks into better balance with sales. In manufacturing, inventories

changed little in March and the ratio of stocks to sales was not far above historical lows. In

the wholesale sector, inventories declined a little further in March, reflecting a reduction in

stocks of motor vehicles, and the inventory-sales ratio remained near the middle of its range

in recent years. Retail inventories also declined in March, with cuts in stocks of motor

vehicles more than accounting for the drop. The inventory-sales ratio for the retail sector was

near the low end of its range in recent years.

The nominal deficit on U.S. trade in goods and services in the first quarter was substantially

larger than in the fourth quarter of last year. The value of imports increased sharply in the

first quarter after declining in the two previous quarters. Moreover, growth in the value of

exports slowed considerably in the first quarter from the pace of other recent quarters.

Available data indicated that the performance of the economies of the major foreign

industrial countries was mixed in the first quarter. The recovery in Japan was still under way

while economic activity in continental Europe remained generally weak, with the German

economy apparently having contracted further and the French economy exhibiting signs of

only a modest upturn after a fourth-quarter decline. Moderate further expansion in economic

activity evidently was occurring in Canada and the United Kingdom.

Rising crude oil and, to a lesser extent, food prices led to somewhat larger increases in

consumer and producer price indexes in March and April. For nonfood, non-energy items,

however, consumer prices rose only slightly in April after three months of somewhat faster

advances; over the twelve months ended in April, this measure of consumer inflation

increased a little less than the rise over the comparable year-earlier period. At the producer

level, prices of finished goods other than food and energy items recorded a third straight

small increase in April. Over the twelve months ended in April, this measure of producer

prices rose slightly less than over the comparable year-earlier period. Hourly compensation

of private industry workers expanded in the first quarter at the average rate for all of 1995;

the growth was associated with a decline in benefit costs and a sharp rise in wages and

salaries.

At its meeting on March 21, 1996, the Committee adopted a directive that called for

maintaining the existing degree of pressure on reserve positions and that did not include a

presumption about the likely direction of any adjustments to policy during the intermeeting

period. 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, slightly greater reserve restraint or slightly

lesser reserve restraint would be acceptable during the intermeeting period. The reserve

conditions associated with this directive were expected to be consistent with moderate

growth in M2 and M3 over coming months.

Open market operations were directed toward maintaining the existing degree of pressure on

reserve positions throughout the intermeeting period, and the federal funds rate averaged near

5-1/4 percent, the level expected to be associated with that unchanged policy stance. Other

short-term market interest rates changed little over the period, and because the Committee's

decision had been largely anticipated in financial markets, longer-term rates also were little

changed initially. Over the remainder of the period, however, intermediate- and long-term

rates came under upward pressure when incoming economic data were seen by market

participants as pointing to stronger growth in output and employment and therefore to a

somewhat tighter monetary policy stance than previously had been expected. Despite the

increase in bond yields, most indexes of stock prices rose on balance over the intermeeting

period, apparently reflecting generally favorable first-quarter earnings reports and the

improved economic outlook.

In foreign exchange markets, the rise of U.S. interest rates contributed to a considerable

appreciation of the trade-weighted value of the dollar in terms of the other G-10 currencies.

The dollar was particularly strong against the German mark, reflecting incoming data that

suggested continued weakness in economic activity in Germany and, accordingly, a greater

likelihood of further monetary policy easing by the Bundesbank. The dollar rose less against

the yen, partly owing to information indicating a strengthening of the economic recovery in

Japan and heightened market expectations of a near-term tightening of monetary policy by

the Bank of Japan.

Growth of M2 and M3 slowed substantially in April after having recorded sizable increases

earlier in the year. Weakness in demand deposits after unusually rapid first-quarter expansion

and sluggishness in currency demand were factors in the slowdown. In addition, the rise in

market interest rates in recent months, which had increased the opportunity costs of holding

retail deposits, likely had a restraining effect on these deposits. For the year through April,

both aggregates grew at rates somewhat above the upper bounds of their respective ranges for

the year. Expansion in total domestic nonfinancial debt remained moderate on balance over

recent months, and this aggregate stayed near the middle of its monitoring range for the year.

The staff forecast prepared for this meeting suggested that the economy would remain

generally around its estimated potential. Consumer spending was expected to grow in line

with disposable income; the favorable effect of higher equity prices on household wealth and

the still-ample availability of credit were expected to outweigh persisting consumer concerns

about job security and the influence of already-high household debt burdens. Homebuilding

was projected to decline a little in response to the recent backup in residential mortgage rates

but to remain at a relatively high level because of generally supportive employment and

income conditions and the still- favorable cash-flow affordability of homeownership.

Business spending on equipment and structures was expected to grow less rapidly in light of

the projected moderate growth of sales and profits and the lower rate of utilization of

production capacity now prevailing. The external sector was projected to exert a small

restraining influence on economic activity over the projection period, even though an

anticipated firming of economic activity abroad would bolster demand for U.S. exports.

Little additional fiscal contraction was anticipated over the projection period. Inflation

recently had been lifted by adverse developments in the energy market and was projected to

remain above the levels of recent years, given the high level of resource utilization and the

effects of tight grain supplies on food prices. Further risks of inflationary pressure were

associated with a possible elevation of the federal minimum wage.

In their discussion of current and prospective economic conditions, members commented that

the economy had been stronger this year than they had anticipated and appeared to be

growing at a quite robust pace. However, they generally expected the expansion to slow,

keeping the economy close to its potential. Views differed to some extent with regard to the

risks surrounding such an outlook. Some saw those risks as fairly evenly balanced, given

prospective restraint from the rise in bond yields and the foreign exchange value of the dollar

since early this year. Others expressed concern that economic growth might continue at a

pace that could increase pressures on resources, with adverse implications for inflation in an

economy already operating in the neighborhood of its estimated long-term potential.

Moreover, faster increases in energy and food prices could contribute to higher overall

inflation, both directly and by boosting inflationary expectations, and the proposed increase

in the minimum wage would add to cost pressures if it were enacted into law. Nonetheless,

while the chances of a pickup in inflation later had risen to some extent, a number of

members emphasized that no firm evidence had surfaced thus far to signal that labor

compensation was increasing at a faster rate or that core inflation was worsening, and even

the early signs of increased pressures on costs and prices were mixed. The last few years had

witnessed significantly lower cost pressures and more subdued inflation than typically would

have been experienced in earlier years with similar rates of resource utilization, but whether

this favorable outcome would persist was an open question.

Members observed that the stronger-than-expected performance of the economy thus far this

year reflected relatively rapid growth in final demand. Favorable financial conditions,

notably the relatively low interest rates of the latter part of 1995 and early 1996 and increases

in wealth stemming from sizable advances in stock market prices, evidently were

undergirding the expansion. Indications of improving or continuing high levels of economic

activity were widespread across the nation according to recent anecdotal reports and regional

data, though agricultural conditions in many areas were cited as a significant exception.

While the economy appeared to have solid and balanced momentum that pointed to sustained

growth, a number of factors were seen as likely to foster more moderate expansion beginning

in the second half of the year. These included the effects of higher intermediate- and

long-term interest rates on interest- sensitive sectors of the economy such as housing,

consumer durables, and business fixed investment. The appreciation of the dollar over the

past year and near-term moderation in federal government spending also were expected to

exert some restraint on economic activity over the forecast horizon. Some members also

questioned the sustainability of the performance of the stock market; a correction in this

market would help to restrain aggregate demand. Nonetheless, the continued strength in

economic activity raised questions about whether these developments would damp demand

sufficiently to keep resource utilization at sustainable levels.

In their review of recent developments and the outlook for key sectors of the economy,

members noted that consumer spending had strengthened considerably this year after a

period of sluggish growth in late 1995. The recent data on consumer spending were

reinforced by anecdotal reports from various parts of the country. The wealth effects from the

further gains that had occurred in stock market prices, along with sustained increases in

employment and a ready availability of consumer financing, were seen as playing a positive

role in boosting consumer expenditures. Barring changes in these underlying factors,

continued growth in consumer spending seemed likely, although members referred to

developments that could begin to slow such growth over the months ahead. The latter

included the satisfaction of much of the earlier pent-up demand for consumer durables and

fairly elevated levels of consumer debt. On balance, moderate expansion in consumer

expenditures, perhaps in line with the growth in incomes, seemed likely over the projection

period.

Business fixed investment was believed likely to remain a source of considerable strength in

the expansion, though growth in this sector of the economy also was expected to moderate

from the elevated pace thus far this year. The desire of many business firms and other users

of capital equipment to take advantage of new, more effective, and less expensive computer

and other technologies and more generally to add further to capital in an effort to reduce

costs in highly competitive markets would continue to underpin investment spending. In

addition, equity and other financing remained available on relatively attractive terms. On the

other hand, the rise in business investment in recent years had brought capital stocks into

more acceptable alignment with expected sales, damping the need for further sizable

additions.

Business firms appeared to have completed, or nearly completed, their efforts to bring

inventories into better balance with sales, including the rebuilding of motor vehicle stocks

after the strike at a major manufacturer was settled in March. On the basis of recent

experience, subdued growth in inventories could be anticipated in the context of the projected

expansion of overall economic activity at a pace near the economy's long-run potential. It

was suggested, however, that such an expectation implied relatively restrained inventory

investment in comparison with past cyclical patterns. Accordingly, much stronger growth in

such investment could occur, with concomitant effects on incomes and the growth of overall

spending.

With regard to the outlook for housing, the rise in mortgage rates in the past few months

could be expected to retard residential construction activity to some extent. Thus far.

however, increased interest costs did not appear to have had any perceptible effects on

housing sales or construction. Indeed, the housing sector was continuing to display a good

deal of strength in many parts of the country. Some members observed that the appreciable

momentum in housing activity reflected strength in the underlying fundamentals, including

continued affordability, that seemed likely to sustain a high level of housing construction for

a considerable period of time despite somewhat higher mortgage rates.

In the area of fiscal policy, legislative agreement had not yet been reached on how to

implement the objective of a balanced federal budget over time, but decisions covering the

nearer term implied continued budget restraint. On the foreign trade side of the economy, an

anticipated firming of economic conditions abroad would provide impetus to real net exports,

At the same time, however, imports were expected to rise appreciably in response to the

expansion of domestic economic activity and the appreciation of the dollar, and on balance

the external sector probably would not be boosting real GDP.

The outlook for inflation was of key importance to the formulation of monetary policy at this

time, but it was clouded by substantial uncertainty. One source of uncertainty was the

behavior of food and energy prices. Increases in these prices largely accounted for the more

rapid rise in consumer prices thus far this year, and they likely would continue to add to

inflation in the months ahead. Retail energy prices had risen appreciably, but at least some of

that increase was expected to be reversed over the near term. Retail food prices did not yet

display any significant effects from the sizable rise in grain prices in recent months, and

while some effects on retail prices were likely, their extent and duration were difficult to

gauge at this point. Moreover, it was difficult to anticipate how much the higher food and

energy prices might affect inflation expectations and wage demands and thereby potentially

become embedded more generally in the price structure.

Also of concern to the members were the possible effects on inflation of continued pressures

on resources, especially if the current pace of the expansion should fail to moderate as much

as projected. In recent years, the relationship between resource use and inflation had not

followed earlier patterns. In particular, increases in labor compensation had been

comparatively subdued over an extended period of what seemed to be relatively full

employment highlighted by anecdotal reports of scarcities of various types of labor in

numerous parts of the country. In part, worker willingness to accept compara- tively limited

increases in compensation could be attributed to the apparent rise in insecurity about the

permanence of jobs or the availability of alternative jobs, but the reasons were not fully

understood. From the standpoint of the inflation outlook, it therefore was uncertain how long

the period of relatively restrained increases in labor compensation would last. Against this

background, a number of members indicated that they perceived an appreciable risk of rising

labor costs and related inflation, even though there was little evidence to date of such

developments; others noted that they could not rule out the possibility that the favorable

experience would be extended.

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

supported a proposal to maintain an unchanged degree of pressure in reserve markets. The

members agreed that the balance of risks on inflation had shifted substantially since early in

the year. At that time, the economy had seemed sluggish and inflation was seen as possibly

easing, but more recent developments indicated that the economy was stronger and rising

inflation down the road could not be ruled out. Nonetheless, while policy might need to be

firmed at some point to head off emerging inflation pressures, financial conditions were not

so obviously stimulative as to counsel a need for any immediate tightening of policy. The real

federal funds rate probably was not greatly out of line with its appropriate level, and the rise

in longer-term interest rates and the exchange rate meant that financial conditions were now

exerting more restraint than earlier this year. More information might provide a better sense

of how the higher interest rates were affecting aggregate demand and perhaps also help--to a

small degree--to shed light on the considerable uncertainties surrounding the relationship of

output to inflation. In any event, actual inflation data--apart from food and energy prices--and

many of the usual early warning signs of mounting price pressures did not yet indicate a

pickup in the underlying trend of prices. Accordingly, the members viewed policy as

appropriately positioned under current circumstances, though ongoing developments would

need to be reassessed at the upcoming meeting in early July. Some members noted that the

Committee would need to anticipate, and act to preclude, a rise in the core rate of inflation

that, if it were to materialize, would be difficult and costly to reverse. In this regard. the view

was expressed that a firming in policy sooner rather than later was likely to end up promoting

stability in output and prices.

In the Committee's discussion of possible intermeeting adjustments to policy, all the

members indicated at least some preference for retaining a symmetric directive. Members

commented that the probability of developments during this period that would warrant a

change in policy before the next meeting was quite low, Moreover, symmetry did not rule out

an intermeeting adjustment, and the Chairman could call for a Committee consultation

should the incoming information raise questions about the stance of monetary policy. Some

members felt that it was especially appropriate that a policy action that represented a reversal

of the previous move be made with a full discussion at a regular meeting. Some members

also commented that an asymmetric directive toward restraint would imply a predisposition

on the part of the Committee to tighten policy at some point, possibly at the next meeting.

While they would be prepared to take such a step if the evidence warranted, their preference

was to come into the July meeting without such a presumption.

At the conclusion of the Committee's discussion, all the members indicated a preference for a

directive that called for maintaining the existing degree of pressure on reserve positions and

that did not include a presumption about the likely direction of any 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 slightly greater or slightly lesser reserve restraint would be acceptable during the

intermeeting period. The reserve conditions contemplated at this meeting were expected to 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 that, on balance, economic

activity has grown moderately in recent months. Nonfarm payroll employment

changed little in April after rising substantially in the first quarter; the civilian

unemployment rate fell to 5.4 percent. Industrial production increased sharply in

April, largely reflecting a rebound in motor vehicle assemblies after a strike in

March. Retail sales declined somewhat in April after posting a strong gain in the

first quarter. Single-family housing starts rose considerably in April. Orders and

contracts point to some deceleration in spending on business equipment and

nonresidential structures after a very rapid expansion in the first quarter. The

nominal deficit on U.S. trade in goods and services widened significantly in the

first quarter from its rate in the fourth quarter of last year. Upward pressures on

food and energy prices have led to somewhat larger increases in the consumer

price index over recent months.

Short-term market interest rates have changed little while long-term rates have

risen somewhat further since the Committee meeting on March 26. In foreign

exchange markets, the trade-weighted value of the dollar in terms of the other

G-10 currencies has appreciated considerably over the intermeeting period.

Growth of M2 and M3 slowed substantially in April after recording sizable

increases earlier in the year. For the year through April, both aggregates grew at

rates somewhat above the upper bounds of their respective ranges for the year.

Expansion in total domestic nonfinancial debt remained moderate on balance

over recent months.

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 its meeting in January

established ranges for growth of M2 and M3 of 1 to 5 percent and 2 to 6 percent

respectively, measured from the fourth quarter of 1995 to the fourth quarter of

1996. The monitoring range for growth of total domestic nonfinancial debt was

set at 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.

In the implementation of policy for the immediate future, the Committee seeks

to maintain the existing degree of pressure on reserve positions. 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, slightly greater reserve restraint or slightly lesser reserve restraint

would be acceptable in the intermeeting period. The contemplated reserve

conditions are expected to be consistent with moderate growth in M2 and M3

over coming months.

Votes for this action: Messrs. Greenspan, McDonough, Boehne, Jordan, Kelley,

Lindsey, McTeer, Ms. Phillips, Mr. Stern, and Ms. Yellen.

Votes against this action: None.

It was agreed that the next meeting of the Committee would be held on

Tuesday-Wednesday, July 2-3, 1996.

The meeting adjourned at 1:15 p.m.

Donald L. Kohn

Secretary

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