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, December

17, 1996, at 9:00 a.m.

Present:

Mr. Greenspan, Chairman

Mr. McDonough, Vice Chairman

Mr. Boehne

Mr. Jordan

Mr. Kelley

Mr. Lindsey

Mr. McTeer

Mr. Meyer

Ms. Phillips

Ms. Rivlin

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,

Sniderman, 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. Reinhart, Assistant Director, Division of Monetary Affairs, Board of Governors

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

Governors

Mr. Barron, First Vice President, Federal Reserve Bank of Atlanta

Messrs. Beebe, Davis, Eisenbeis, and Goodfriend, Senior Vice Presidents, Federal

Reserve Banks of San Francisco, Kansas City, Atlanta, and Richmond respectively

Messrs. Gavin, Kos, and Rosengren, Vice Presidents, Federal Reserve Banks of St.

Louis, New York, and Boston respectively

Mr. Evans, Assistant Vice President, Federal Reserve Bank of Chicago

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

on November 13, 1996, were approved.

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

exchange markets since the meeting on November 13, 1996. There were no 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 from November 13, 1996, through December 16, 1996. By unanimous vote, the

Committee ratified these transactions.

The Committee members discussed certain changes in the procedures for conducting

domestic open market operations that the Manager of the System Open Market Account had

proposed for implementation at the beginning of 1997. The changes included advancing the

normal time for initiating daily operations by one hour to between 10:30 a.m. and 10:45 a.m.

Moving to the earlier time would place Desk operations closer to the period during the day

when the financing market was most active and thus in a position to accommodate a larger

volume of System transactions when necessary. As at present, the Manager might choose to

undertake Desk operations at other times during the day when special circumstances dictate.

The Manager also indicated that the normal time for domestic operations might be moved to

an even earlier hour after expedited procedures were developed for assembling the necessary

statistical information on a timely basis for such operations. In the interest of making

information about System operations available more promptly to market participants and the

broader public, the Desk also would begin at the start of 1997 to announce the par amount of

its market transactions shortly after the completion of the operations. With respect to

purchases of Treasury coupon securities for System account, the Desk had adopted about one

year ago the practice of making such purchases in separate maturity tranches but might at its

option in the future spread such purchases over a number of weeks rather than over the

course of several days. This more flexible timing would allow the Desk to inject reserves into

the banking system through outright operations as the need arose without waiting for that

need to accumulate to particularly high levels.

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All the members who commented endorsed the changes, with several noting that they were

appropriate responses to evolving market circumstances. Because the new procedures did not

involve any alterations in the Committee's current directives, authorizations, or rules, a

formal vote was not required.

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 continued to

expand at a moderate pace in recent months. Consumer spending had rebounded from its

summer lull, but housing demand was somewhat weaker on balance and the growth of

business spending on durable equipment had slowed from a very rapid pace. Although

inventory investment had picked up, stocks in most sectors had remained well aligned with

sales. Both industrial production and employment had recorded sizable advances. Increases

in labor compensation had trended up this year, and consumer price inflation also had picked

up, but the faster rise in overall consumer prices owed entirely to larger increases in food and

energy prices.

Private-sector demand for labor remained solid in November. Private nonfarm payroll

employment increased appreciably further in November after an October surge, and the

average workweek of private production or nonsupervisory workers retraced more than half

of its October decline. Service industries recorded another large gain in employment despite

a sharp drop in payrolls at help-supply firms, and the number of jobs in retail trade expanded

further in November after a steep rise in October. In the goods-producing sector, employment

in construction and manufacturing rose moderately. The civilian unemployment rate

increased slightly, to 5.4 percent, in November.

Industrial production rose sharply in November after a small October decline. A rebound in

motor vehicle assemblies from the disruptive effects of work stoppages accounted for much

of the increase in production in November, but output from utilities also surged in response to

unusually cool weather. The production of nondurable consumer goods and business

equipment other than motor vehicles also was up significantly in November while the

manufacture of consumer durables and defense and space equipment decreased further.

Reflecting the strong advance in production, the utilization of total industrial capacity picked

up considerably in November.

Consumer spending increased appreciably on balance in recent months after a lackluster

performance in the summer. Total retail sales fell in November but nonetheless were

considerably above their average in the third quarter. The November decline reflected

weakness in auto sales; retail spending on other items, notably durable goods, rose

significantly further. Spending on services picked up in October (latest data) following a

relatively weak third quarter. Housing starts rebounded in November after declining in

September and October. Single-family starts in November were a little below the average

pace of previous months in the year while multifamily starts surged to a level not seen since

late 1990. By contrast, sales of both new and existing homes dropped again in October (latest

data).

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Growth of business fixed investment appeared to have slowed to a moderate pace in the

fourth quarter after a sharp rise in the previous quarter. Shipments of nondefense capital

goods fell in October, reversing a sizable September gain; however, recent data on orders

pointed to further increases in business spending for equipment, especially for

communications equipment where shipments already were at a high level. Business

investment in transportation equipment evidently weakened, as sales of heavy trucks

remained sluggish and production shortfalls held back fleet sales of light vehicles. By

contrast, nonresidential construction continued to expand at a solid rate in October, with

building activity particularly strong in the office, other commercial, institutional, and

industrial categories.

Business inventory investment picked up sharply in October from the slow September pace,

but total stocks remained at a low level in relation to sales. Most of the October increase

occurred at the wholesale level; inventories of farm products turned up sharply after months

of sizable drawdowns, and petroleum stocks were built up from unseasonably low levels.

Despite the October rise, the ratio of wholesale inventories to shipments remained at the

lower end of its range over recent years. In manufacturing, stocks increased at a pace in line

with shipments, and the aggregate inventory-shipments ratio stayed at a very low level.

Retail inventories were up moderately in October. The inventory-sales ratio for the sector

was unchanged and remained in the middle of its range over recent years.

The nominal deficit on U.S. trade in goods and services was somewhat larger in September

than in August; exports decreased slightly in September while imports were little changed.

For the third quarter, the deficit widened substantially from its rate in the second quarter as

exports fell and imports rose moderately. Nearly all of the decline in exports reflected lower

sales of aircraft and gold. Increases in imports were widespread but they were largely offset

by declines in imports of gold and semiconductors. Economic growth picked up in most of

the major foreign industrial countries in the third quarter, but available indicators generally

suggested some slowing of growth in the fourth quarter. In Japan, by contrast, economic

activity had been sluggish in the third quarter but appeared to have picked up more recently.

Consumer price inflation in October and November was lifted slightly by sizable advances in

energy prices and, to a lesser degree, increases in food prices; however, consumer prices for

items other than food and energy rose modestly during the two months. The rise in core

consumer prices over the twelve months ended in November was somewhat smaller than it

had been over the previous twelve months, although the total index registered a bigger

advance as a result of larger increases in food and energy prices. At the producer level, prices

of finished energy goods rose sharply in October and November while prices of finished

foods advanced less rapidly. Excluding food and energy, prices of finished goods edged

lower on balance over October and November, and in the twelve months ended in November,

these prices rose substantially less than in the previous twelve months. Average hourly

earnings of production and nonsupervisory workers were up considerably in November after

edging down in October. The twelve-month rise in this index was somewhat larger than the

advance over the previous twelve months.

At its meeting on November 13, 1996, the Committee adopted a directive that called for

maintaining the existing degree of pressure on reserve positions but that included a bias

toward the possible firming of reserve conditions 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, somewhat greater reserve restraint would be acceptable and

slightly lesser reserve restraint might be acceptable during the intermeeting period. The

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

moderate growth of M2 and relatively strong expansion of M3 over coming months.

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

existing degree of pressure on reserve positions. However, the federal funds rate tended to

average a little above the level expected with an unchanged policy stance in apparent

response to scattered operating problems and occasional unexpectedly large clearing needs at

banks. Other short-term interest rates registered small mixed changes since the November 13

meeting; Treasury bill rates drifted lower, partly because of heightened demands for safety

and liquidity as asset markets became more volatile during the period, while year-end

pressures boosted rates on private instruments with maturities in early 1997. At longer

maturities, yields drifted lower over most of the intermeeting period in response to incoming

data that suggested economic growth would remain moderate and inflation subdued, but they

rebounded late in the period in response to the release of firmer economic data and growing

concerns regarding the sustainability of current domestic asset prices. Despite these concerns,

most major indexes of equity prices advanced further on balance.

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

G-10 currencies rose slightly over the intermeeting period. The dollar rose even more against

the German mark and the French franc amid increased market apprehension that the

European Monetary Union's common currency, the euro, will not be as strong a currency as

the mark. The dollar also might have been boosted by statements by French and German

officials that suggested the dollar was undervalued against their currencies.

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Expansion of the broad monetary aggregates was relatively strong in November. Growth of

M2 picked up, reflecting a sharp increase in demand deposits and smaller runoffs in other

checkable deposits. Inflows to retail money market funds remained substantial. Expansion of

M3 moderated somewhat from its brisk pace in October as growth in business demands for

credit slowed and banks reduced their reliance on large time deposits and other managed

liability components. For the year through November, M2 was estimated to have grown at a

rate in the upper half of the Committee's annual range, and M3 at a rate a little above the top

of its range. Total domestic nonfinancial debt expanded moderately on balance over recent

months and remained in the middle portion of its range.

The staff forecast prepared for this meeting suggested that the expansion would be sustained

at a pace close to the economy's estimated growth potential. Consumer spending was

projected to increase at a rate generally in line with the anticipated rise in disposable income;

the favorable effects on household wealth of the advance that had occurred in stock prices

and the ample availability of credit for most borrowers were expected to balance the damping

effects of continuing consumer concerns about the adequacy of their savings, the security of

their jobs, and the extent of their debt burdens. Homebuilding was forecast to decline

somewhat but to stabilize at a relatively high level in the context of continued income growth

and the generally favorable cash-flow affordability of home ownership. Business spending on

equipment and structures was projected to expand less rapidly in light of some anticipated

slowing in the growth of sales and profits. Fiscal policy and the external sector were expected

to continue to exert small restraining influences on economic activity over the projection

period. Consumer price inflation, excluding the relatively volatile food and energy

components of the price index, was forecast to rise slightly over 1997 and 1998 in the context

of anticipated high resource use and an accompanying appreciable pickup in the growth of

labor compensation that would be augmented by the legislated rise in the federal minimum

wage. Somewhat larger increases would have been projected in consumer price inflation in

the absence of anticipated technical measurement changes to the index.

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

commented that the information received during the relatively short interval since the

previous meeting had not materially altered either their assessment that the economy was

performing quite favorably or their forecasts of further growth at a pace averaging near the

economy's potential. The economy currently displayed fairly solid underpinnings, with few

imbalances of the kind that historically had tended to create problems. Against the

background of generally supportive financial conditions and a high degree of consumer and

business confidence, further economic growth was thought likely to be sustained by

appreciable increases in consumer spending and business investment. The overall pace of the

expansion was expected to be restrained to an extent, however, by declining federal

government outlays for goods and services and ongoing weakness in net exports.

Despite the prospects for moderate economic growth, members observed that the risks on

inflation still seemed to be tilted toward some rise over time. Measures of core inflation had

displayed little trend and even some decline over the past year. However, wage increases had

moved higher over that period, a development suggesting the possibility that labor markets

might be tighter than could be sustained over the long term. At some point accelerating labor

compensation costs, were they to continue, likely would spill over into higher inflation. Such

an outcome remained subject to a great deal of uncertainty, however, in light of the relatively

benign behavior in recent years of both wages and prices in comparison with historical

experience at prevailing levels of resource utilization.

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In the Committee's discussion of developments in major sectors of the economy bearing on

the outlook for business activity, members noted that consumer spending had picked up as

expected after a lull during the summer months. Survey data and anecdotal reports suggested

that consumer confidence was currently high, and there were widespread indications of

robust retail sales during the early weeks of the holiday season, though holiday sales were

always difficult to read at this stage. Thus far, however, sales of motor vehicles had not

strengthened to the extent that was anticipated after full production was restored following a

work stoppage at a major manufacturer. Members cited a number of factors--the rise in

consumer debt burdens, tightening consumer credit standards, continued worker concerns

about job security, and the satisfaction of earlier pent-up demands--that were tending to

inhibit the growth in consumer spending and perhaps helped to explain why the sharp

increases in stock market wealth had not been accompanied by stronger growth in such

spending. The behavior of the stock market injected an additional note of uncertainty into the

forecast for consumer spending and the economy more generally. The rise over recent years

had been extraordinary and had brought market valuations to fairly high levels relative to

earnings and dividends. In these circumstances, the members recognized the need to monitor

with special care price movements in the stock market and asset markets more generally for

their implications for consumer and other spending. On balance, favorable employment and

income conditions seemed likely to foster a level of consumer spending that would provide

key support for sustained economic expansion.

The members anticipated smaller though still sizable gains in business fixed investment over

the year ahead. Slowing growth in profit levels and cash flows was likely to retard spending

for many types of business equipment, but favorable prices, advancing technology, and

readily available financing probably would continue to foster rapid expansion in office,

computing, and communications equipment. The outlook for nonresidential construction

remained uneven across the country, but such construction seemed likely to edge higher on

balance over the next several quarters. Members noted in this regard that the construction of

office buildings had strengthened in a number of urban areas. Business inventories currently

seemed on the whole to be at desired and sustainable levels in relation to sales. In the

circumstances, inventory accumulation was projected to remain moderate and, barring

unexpected surges or declines in final sales, was not likely to be a significant factor affecting

the course of the economy.

The recent information on residential construction was mixed. Weakness in late summer and

early fall evidently reflected the effects of earlier increases in mortgage interest rates, but

some measures of housing activity in November indicated unexpected strength. In addition,

reports from around the country pointed to uneven conditions ranging from further strength

to some emerging weakness in regional housing markets. On balance, the statistical and

anecdotal information was interpreted, by some members at least, as consistent with a

tendency for housing activity to stabilize. In this view, a level of housing construction

somewhat below the peak reached earlier in 1996 was likely to be sustained, buoyed in part

by the recent decline in mortgage interest rates and the continuing rise in consumer incomes

and favorable consumer sentiment.

A modest degree of fiscal restraint seemed likely over the next two fiscal years. Some

members expressed optimism with regard to the prospects for an agreement between the

President and the Congress that would provide a basis for reaching a balanced budget by the

year 2002. Such an agreement would need to include controversial constraints on the growth

of entitlements, but its achievement would have favorable effects on financial markets and on

business and consumer sentiment more generally, thereby tending to offset at least in part any

direct effects of reduced federal spending on aggregate demand.

Members anticipated that the external sector of the economy would continue to exert some

restraint on domestic economic activity, though perhaps to a lesser extent than over the past

year. In particular, the growth of U.S. exports was expected to accelerate somewhat in

association with some strengthening on average in the economies of the nation's key trading

partners. The economic recovery in Mexico from its earlier financial crisis was already

providing a considerable boost to exports from some parts of the United States.

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Inflation had remained subdued, but the members continued to view the risks as tilted toward

increases in the future. Labor compensation costs clearly were rising at a faster pace in the

context of persistently tight labor markets, and an upturn in core price inflation seemed quite

possible at some point in the absence of some easing of pressures in labor markets. However,

the members recognized that the increase in wage inflation had been significantly less than

would have been anticipated on the basis of historical relationships with labor market

conditions, and price performance also had been more favorable than those relationships

would have suggested. In the circumstances, there was a good deal of uncertainty regarding

the outlook for inflation, including the potential degree of utilization in labor markets, the

associated pressures on labor costs, and the ability of firms to pass higher labor costs into

prices in markets that generally continued to be described as highly competitive. With the

economy operating in the neighborhood of its sustainable potential, relatively minor

differences in overall economic growth could have a significant effect over time on whether

inflation would tend to trend up or down.

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

supported a proposal to maintain an unchanged policy stance while also retaining a bias

toward restraint in the directive. An unchanged policy was warranted by the quite satisfactory

performance of the economy and inflation and the uncertainties surrounding the outlook.

Thus, while the longer-term risks might point toward rising inflation, there were reasonable

prospects that inflation would remain contained, and any pickup in inflation, should it occur,

was likely to be limited at least for a time. In the circumstances, the members concluded that

watchful waiting remained the prudent course for policy as they continued to assess ongoing

developments. Because the risks of waiting did not appear to be substantial at this juncture,

anticipatory tightening was not yet called for.

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

period, members agreed that the retention of an asymmetric directive toward tightening was

consistent with their view that the risks remained biased toward higher inflation.

Accordingly, while they were not suggesting that policy should be especially quick to react to

incoming information over the intermeeting period, they did view the next policy move as

more likely to be in the direction of some firming than toward easing. In this connection,

some members emphasized that it would be especially important for the Committee to act

promptly to counter any tendency for price inflation to rise and for higher inflation

expectations to become embedded in financial markets and economic decision-making more

generally.

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

supported a directive that called for maintaining the existing degree of pressure on reserve

positions and that retained a bias toward the possible firming of reserve conditions 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 reserve restraint would be acceptable and slightly lesser reserve restraint might be

acceptable during the intermeeting period. The reserve conditions contemplated at this

meeting were expected to be consistent with relatively strong expansion in M2 and M3 over

coming months.

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 economic activity has

continued to expand at a moderate pace. Private nonfarm payroll employment

increased appreciably further in November, although the civilian unemployment

rate edged up to 5.4 percent. Industrial production rose sharply in November, in

part because of a rebound in motor vehicle assemblies that had been depressed

earlier by work stoppages. Consumer spending has posted appreciable gains over

recent months after a summer lull. Housing starts rebounded in November after

declining in September and October. Business fixed investment appears to be

growing moderately after a sharp rise in the third quarter. The nominal deficit on

U.S. trade in goods and services widened substantially in the third quarter from

its rate in the second quarter. Increases in labor compensation have trended up

this year, and consumer price inflation also has picked up owing to larger

increases in food and energy prices.

Short-term market interest rates have registered mixed changes since the

Committee meeting on November 13, 1996, while long-term yields have risen

slightly. In foreign exchange markets, the trade-weighted value of the dollar in

terms of the other G-10 currencies has risen slightly over the intermeeting

period.

Growth of M2 picked up in November, while expansion of M3 moderated

somewhat from its brisk pace in October. For the year through November, M2 is

estimated to have grown at a rate in the upper half of the Committee's annual

range, and M3 at a rate a little above the top of its range. Total domestic

nonfinancial debt has expanded moderately on balance over recent months and

has remained in the middle portion of its range.

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 July reaffirmed

the ranges it had established in January 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 maintained at 3 to 7 percent for the year. For 1997, the

Committee agreed on a tentative basis to set the same ranges as in 1996 for

growth of the monetary aggregates and debt, measured from the fourth quarter of

1996 to the fourth quarter of 1997. 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, somewhat greater reserve restraint would or slightly lesser

reserve restraint might be acceptable in the intermeeting period. The

contemplated reserve conditions are expected to be consistent with relatively

strong expansion in M2 and M3 over coming months.

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

Lindsey, McTeer, Meyer, Mses. Phillips, Rivlin, 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,

February 4-5, 1997.

The meeting adjourned at 12:40 p.m.

Donald L. Kohn

Secretary

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