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, August 19,

1997, at 9:00 a.m.

Present:

Mr. Greenspan, Chairman

Mr. McDonough, Vice Chairman

Mr. Broaddus

Mr. Guynn

Mr. Kelley

Mr. Moskow

Mr. Meyer

Mr. Parry

Ms. Phillips

Ms. Rivlin

Messrs. Hoenig, Jordan, Melzer, and Ms. Minehan, Alternate Members of the Federal

Open Market Committee

Messrs. Boehne, McTeer, and Stern, Presidents of the Federal Reserve Banks of

Philadelphia, Dallas, and Minneapolis respectively

Mr. Kohn, Secretary and Economist

Mr. Bernard, Deputy Secretary

Mr. Coyne, Assistant Secretary

Mr. Gillum, Assistant Secretary

Mr. Mattingly, General Counsel

Mr. Prell, Economist

Mr. Truman, Economist

Messrs. Beebe, Cecchetti, Goodfriend, Eisenbeis, Lindsey, 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

Messrs. Madigan and Simpson, Associate Directors, Divisions of Monetary Affairs

and Research and Statistics respectively, Board of Governors

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

Governors

Ms. Strand, First Vice President, Federal Reserve Bank of Minneapolis

Messrs. Lang, Rolnick, Rosenblum, and Sniderman, Senior Vice Presidents, Federal

Reserve Banks of Philadelphia, Minneapolis, Dallas, and Cleveland respectively

Messrs. Gavin, Kahn, and Ms. Perelmuter, Vice Presidents, Federal Reserve Banks of

St. Louis, Kansas City, and New York respectively

Ms. Little and Mr. Sullivan, Assistant Vice Presidents, Federal Reserve Banks of

Boston and Chicago respectively

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

on July 1-2, 1997, were approved.

By unanimous vote, the Committee elected Mr. Stephen G. Cecchetti of the Federal Reserve

Bank of New York as Associate Economist to serve until the election of his successor at the

first meeting of the Committee after December 31, 1997. It was understood that in the event

of the discontinuance of his official connection with the Federal Reserve Bank of New York,

he would cease to have any official connection with the Federal Open Market Committee.

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

exchange markets since the meeting in early July. There were no System open market

transactions in foreign currencies 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 July 2, 1997, through August 18, 1997. By unanimous vote, the Committee ratified

these transactions.

The Committee then turned to a discussion of the economic 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 was expanding

moderately. Growth in consumer spending had picked up after having slowed sharply in early

spring, business purchases of durable equipment were still on a strong upward trend, and

housing demand seemed to have been well maintained. The overall rise in production had

been held down recently by supply disruptions in the motor vehicles industry, but

employment had continued to expand at a strong pace and the unemployment rate was at a

low level. Increases in labor compensation had remained moderate even though labor

markets were tight, and price inflation was still subdued.

Private nonfarm payroll employment rose sharply in July after a June increase that was below

the average for earlier months of the year. The step-up in job growth in July reflected

substantially larger job gains in business services, retail trade, and the finance, insurance, and

real estate industries. A small decline in manufacturing jobs roughly offset slightly higher

employment in construction. The civilian unemployment rate, at 4.8 percent in July, matched

its low for the current economic expansion.

Industrial production increased relatively slowly in July after having advanced at a fairly

brisk pace over the first half of the year. The July slowdown reflected a temporary drop in

motor vehicle assemblies partly associated with work stoppages at a major automotive

manufacturer. Outside the motor vehicles sector, the output of business equipment and

consumer durable goods rose strongly while the production of consumer nondurables

weakened further. Factory capacity increased a little more than production in July, and the

utilization of total manufacturing capacity slipped to its lowest level since last autumn.

Retail sales rose briskly in June and July after having changed little over the preceding three

months. Sales at automotive dealers rebounded in June and July following substantial

weakness in earlier months, and expenditures at nondurable goods stores also strengthened.

By contrast, sales at non-automotive durable goods outlets were unchanged over June and

July. The pickup in consumer spending occurred against a backdrop of further strong gains in

incomes and household net worth. In addition, credit was readily available to most

consumers, although lenders continued to tighten terms for marginal borrowers. Total private

housing starts were unchanged in July after having rebounded in June from a May decline.

Data on home sales in recent months continued to suggest that demand for single-family

housing was still relatively buoyant.

Real business fixed investment increased substantially further in the second quarter,

reflecting a broad-based surge in spending on producers' durable equipment. Real outlays for

office and computing equipment continued to grow rapidly as prices of personal computers

and networking equipment remained on a steep downtrend. Spending for communications

equipment grew at a slower pace in the second quarter, but recent orders for such equipment

pointed to larger increases in the current quarter. Nonresidential construction activity was

sluggish in the second quarter. While available information on construction contracts

suggested little improvement in building activity in coming months, prices for commercial

real estate had risen slightly and vacancy rates had declined.

Nonfarm business inventories increased rapidly in the second quarter, but there were few

signs of inventory imbalances. In June, the pace of inventory investment in manufacturing

slowed from the rapid average rate for April and May, and the inventory-shipments ratio for

the sector was at a very low level. In wholesale trade, stocks rose sharply in June after little

net change over the two previous months. Despite the June increase, the stock-sales ratio was

at the middle of its relatively narrow range of the past year. At the retail level, the rise in

inventories in June retraced only part of the May decline; the inventory-sales ratio for the

sector also was near the middle of its range for the last year.

The nominal deficit on U.S. trade in goods and services was slightly smaller on balance over

April and May than the downward-revised average rate in the first quarter. Measured against

their first-quarter levels, the value of exported goods and services grew more than the value

of imports over the April-May period. The largest increases in exports were in machinery and

aircraft and parts, while the biggest gains in imports were in consumer goods, computers, and

capital goods other than computers. The available information suggested that in recent

months economic activity had expanded further in all the major foreign industrial countries

except Japan. Growth continued to be robust in Canada and the United Kingdom and

apparently remained moderate in France and Germany. Economic activity in Japan had

slowed after a rise in that country's consumption tax in April.

Consumer price inflation picked up slightly in July from the slow pace in each of the

previous four months; a small decline in energy prices offset a further increase in food prices.

The index for items other than food and energy rose in July at the same low rate recorded for

both the first six months of 1997 and the twelve months ended in July. At the producer level,

prices of finished goods edged down for a seventh consecutive month, reflecting a further

drop in food prices. Prices of finished goods other than food and energy were unchanged

over the twelve months ended in July. At earlier stages of production, producer prices for

core intermediate materials rose slightly over the year ended in July and prices of core crude

materials increased by a larger amount over the same period. Growth in hourly compensation

of private industry workers picked up somewhat in the second quarter, but the rise in

compensation over the year ended in June matched the advance over the comparable

year-earlier period. Average hourly earnings of production and nonsupervisory workers were

unchanged in July, and the rise in such earnings over the twelve months ended in July also

was the same as in the year-earlier period.

At its meeting on July 1-2, 1997, the Committee adopted a directive that called for

maintaining the existing degree of pressure on reserve positions. Because the Committee

continued to see a potential need for some tightening of monetary policy to counter rising

inflationary pressures, the directive included a bias toward a possible firming of reserve

conditions during the intermeeting period. The reserve market conditions associated with this

directive were expected to be consistent with moderate growth of M2 and M3 over coming

months.

Open market operations were directed throughout the intermeeting period toward

maintaining the existing degree of pressure on reserve positions, and the average federal

funds rate for the period was at the Committee's intended level of 5-1/2 percent. Most other

market interest rates declined further on balance over the period in an atmosphere of greater

volatility in financial markets. The net decline in market rates seemed to have reflected a

judgment by market participants that the outlook for inflation had improved slightly on

balance and that the likelihood of any tightening of monetary policy in coming months had

receded a little further. Share prices in equity markets increased on balance over the period.

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

G-10 currencies rose significantly on balance over the intermeeting period. The appreciation

of the dollar was uneven against the currencies of the major foreign industrial countries. The

dollar's substantial increase against the German mark and other continental European

countries reflected both the continuing favorable developments in the U.S. economy and

persisting market concerns that difficulties faced by the major European countries would lead

to policies that might detract from strength in the euro. The dollar rose only slightly against

the yen. That currency came under downward pressure in reaction to incoming data

suggesting a somewhat- greater-than-expected falloff in demand following the recent

increase in the consumption tax, but the release of the June current account surplus late in the

intermeeting period rekindled market concerns about Japanese external balances and led to

some appreciation of the yen.

M2 expanded at a moderate pace over June and July after having fluctuated sharply in April

and May as a result of tax-related flows. Data for early August suggested a somewhat faster

rate of M2 growth in association with heavier inflows to retail money funds; the latter might

have been related to heightened demand for liquidity as a result of recently higher volatility

in bond and equity markets. For the year through July, M2 expanded at a rate near the upper

bound of its range. M3 also fluctuated sharply over April and May and grew at a relatively

moderate rate in June. M3 surged in July, however, as heavy volumes of large time deposits

were issued by U.S. branches of foreign banks to pay down borrowings from their overseas

offices and by domestic banks to counter the runoff of government deposit accounts; the

latter two sources of funds are not included in M3. For the year through July, M3 expanded at

a rate appreciably above the upper bound of its range. Total domestic nonfinancial debt had

continued to expand in recent months at a rate near the middle of its range.

The staff forecast prepared for this meeting suggested that the expansion of the economy

would be damped in the second half of the year by a slowing of inventory accumulation from

the unsustainably brisk pace in the first half of the year. In 1998, the economy would expand

at a pace in line with the growth of its estimated potential. Growth of consumer spending,

supported by high levels of household wealth and projected further gains in employment and

income, was expected to be relatively brisk over the forecast horizon. Business spending on

equipment and structures was anticipated to continue to outpace the overall expansion of the

economy, though the differential would tend to narrow over time in association with the

gradual diminution of increases in sales and profits that was expected in conjunction with

moderating economic growth. Housing construction was projected to drift lower over the

forecast horizon. The staff anticipated that the external sector would exert some mild restraint

on the expansion of economic activity. With labor compensation gradually accelerating in the

context of higher resource utilization, core consumer price inflation was forecast to drift

slightly higher.

The Committee's discussion of current and prospective economic developments highlighted

statistical and anecdotal evidence of a solid economic performance, including indications of a

rebound in final demand after a lull during the spring and the persistence of relatively

subdued, and by some measures declining, inflation. Growth in consumer spending had

slowed sharply and a surge in inventory accumulation had accounted for much of the

expansion of economic activity in the second quarter. Looking ahead, the members did not

believe that recent developments had altered the prospect that the economy would settle into

a pattern of moderate growth approximating its potential. Such a forecast was subject to

considerable uncertainty, and several members observed that the risks appeared to be mostly

in the direction of stronger growth in demand. With regard to the outlook for inflation,

widespread evidence of very tight labor markets was associated with scattered indications

that the rise in labor compensation might be accelerating, but overall labor costs had

remained relatively damped and price inflation restrained. Gains in productivity and muted

increases in nonlabor costs probably also were contributing to holding producer costs under

good control. Nonetheless, the members remained concerned about the risks of rising

inflation, especially if somewhat-faster-than-projected growth in economic activity were to

occur and add to pressures on resources in an economy that already seemed to be operating

close to, or perhaps even above, its sustainable potential.

The uncertain prospects for inventory investment were a dominant factor in the outlook for

economic activity over the nearer term. The accumulation of inventories had been unusually

high in the second quarter according to the available evidence. There was no broad sense of

an undesired buildup, but the rate of inventory investment would have to be reined in if an

overhang were to be averted. A concern in this regard was that the apparent upturn in final

demand, particularly if it proved to be somewhat stronger than currently expected, and

related business optimism about sales prospects might well result in a further buildup of

inventories at a relatively rapid rate. While such a development was not viewed as the most

likely outcome and, indeed, less-than-projected strength in the inventory sector could not be

ruled out, relatively rapid inventory accumulation in the context of persisting above-trend

growth in final demand would generate additional pressure on resources and heighten the

risks of accelerating inflation.

With regard to the prospects for final demand in key sectors of the economy, members noted

that the appreciable rebound in consumer spending followed a weak second quarter, and

some moderation in the growth of such spending was likely later this year and in 1998. Even

so, favorable prospects for employment and incomes and the large gains that had occurred in

financial wealth suggested that consumer expenditures were likely to be well maintained over

the projection horizon. The high level of consumer confidence reported by consumer surveys

was another supporting factor in this favorable outlook.

In the area of business fixed investment, a strong upward trend in outlays for new equipment

was thought likely to persist, notably in the computer-related and the telecommunications

industries. Anecdotal reports also pointed to appreciable strength in commercial construction

activity, including office structures, hotels, and warehouses in various parts of the country.

Indeed, in some areas construction activity was said to be limited only by shortages of

qualified labor. Positive factors in the outlook for business investment included the

persistence of a high level of profits, an accommodative financial climate, and the rapid

obsolescence of high-tech equipment. There were, nonetheless, indications of some

moderation in commercial construction activity in a number of areas, including reports of

developing overcapacity of retail space in shopping centers. Spending for basic industrial

equipment also was likely to soften, given moderating growth in overall final demand in line

with current forecasts.

Housing activity continued to display considerable vigor in many parts of the nation as

evidenced by available statistics and anecdotal reports. The affordability of housing and the

very large increases that had occurred in stock market wealth clearly were supportive factors.

Concurrently, however, there were indications of slowing in residential building activity in

several areas. On balance, some moderation in housing construction appeared likely over the

projection horizon in keeping with longer-term population and other trends affecting such

construction.

In the Committee's discussion of the prospects for inflation, members commented that a

number of factors could be cited to explain the persistence of relatively subdued inflation this

year despite high levels of resource use. Among those factors were the appreciation of the

dollar and its effects on prices of imports and competing domestic products, a significant

decline in world oil prices, the relatively sluggish performance of many foreign economies

that had tended to moderate prices of products traded in world markets, and relatively large

grain harvests in the United States that had curbed pressures on food prices. However, the

underlying reasons for the favorable price trends were not entirely clear. Labor costs were

still rising appreciably less than would have been expected on the basis of past experience

under similarly tight labor market conditions. Explanations tended to focus on the concerns

about job security felt by many workers, the muted rise in the costs of worker benefits,

notably for health care, and the increased use of innovative and highly targeted methods of

compensation. With regard to the market pricing of goods, businesses tended to cite highly

competitive conditions across the nation that made it very difficult to raise prices and gave

impetus to efforts to improve productivity. Indeed, the available evidence suggested that the

profits of business concerns generally had continued to increase in the second quarter,

implying that productivity had been rising at a pace that exceeded published estimates by a

significant margin.

Even though inflation had not accelerated, some signs were beginning to emerge that wages

and other labor costs might be experiencing increasing pressure. These included some limited

evidence that job security concerns might be diminishing and multiplying anecdotal reports

of a less benign outlook for health care costs. Some members commented that the outcome of

the recent labor negotiations involving a very large package delivery firm might well be a

harbinger of more militant labor negotiating attitudes. Against this background, members

expressed concern that a further increase in labor utilization rates could put substantial

upward pressures on wages that eventually would work their way through to prices.

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

endorsed a proposal to maintain an unchanged policy stance. Underlying economic

conditions and the outlook for economic activity and inflation had changed little in recent

months. The most likely outcome of the current policy stance was growth near potential and

some pickup in inflation as the effects of special factors holding it down abated. For the

present, monetary policy appeared to be appropriately positioned to foster the Committee's

objectives of resisting an intensification of inflationary pressures while supporting a fully

employed economy. The level of real short-term interest rates was relatively high by

historical standards and provided some assurance that the current stance of policy would not

accommodate a significant increase in underlying inflationary pressures. Nonetheless, the

members remained concerned about the outlook for inflation. Although some decline in

inflation could not be ruled out, persistence of the current degree of tightness in labor

markets, consistent with the economy growing at a pace near its potential, could at some

point begin to put more pressure on costs and prices, and growth somewhat above potential,

which some members saw as a distinct possibility, would be even more likely to produce that

result. While there were no current indications that inflation might be accelerating and no

policy move was called for at this time, the members saw a need for continuing vigilance. As

at earlier meetings, a number of them expressed the view that an anticipatory policy move to

counter intensifying inflationary pressures likely would be needed at some point.

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 a rise in inflation.

Accordingly, while they did not attach a high probability to the prospect that the incoming

information would warrant a tightening move during the intermeeting period, they continued

to view the next policy move as more likely to be in the direction of some firming than

toward easing.

The members reviewed proposals for rewording the operational paragraph of the directive for

the purpose of updating and clarifying the description of the Committee's instructions to the

Manager of the System Open Market Account and to conform the directive wording with

current public announcement practices regarding the Committee's policy decisions. In

particular, the directive would in the future include specific reference to the federal funds rate

that the Committee judged to be consistent with the stance of monetary policy. The

Committee also modified the present sentence relating to the intermeeting bias in the

directive to recognize that changes in the stance of policy are now expressed in terms of the

federal funds rate. These changes were not intended to alter the substance of the directive or

the Committee's operating procedures.

At the conclusion of the Committee's discussion, all the members expressed their support of a

directive that called for maintaining conditions in reserve markets that were consistent with

an unchanged federal funds rate of about 5-1/2 percent. All the members also agreed on the

desirability of retaining a bias in the directive toward the possible firming of reserve

conditions and a higher federal funds rate 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 a somewhat higher federal funds rate would be acceptable or a

slightly lower federal funds rate might be acceptable during the intermeeting period. The

reserve conditions contemplated at this meeting were expected to be consistent with

moderate 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 is

expanding at a moderate pace. In labor markets, hiring remained robust at

midyear, and the civilian unemployment rate, at 4.8 percent in July, matched its

low for the current economic expansion. Industrial production increased

relatively slowly in July, owing in part to a temporary drop in motor vehicle

assemblies. Retail sales rose briskly in June and July after having changed little

over the preceding three months. Housing starts rebounded in June and July after

having weakened in May. Business fixed investment increased substantially

further in the second quarter and available indicators point to further sizable

gains in the current quarter. The nominal deficit on U.S. trade in goods and

services narrowed slightly on balance over April and May from its downwardrevised average rate in the first quarter. Price inflation has remained subdued and

increases in labor compensation have been moderate.

Market interest rates generally have declined somewhat further since the start of

the Committee meeting on July 1-2, 1997. Share prices in equity markets have

increased on balance. In foreign exchange markets, the trade-weighted value of

the dollar in terms of the other G-10 currencies rose significantly on balance

over the intermeeting period.

After fluctuating sharply from April to May, growth of M2 was at a moderate

pace over June and July and that of M3 picked up to a relatively rapid rate. For

the year through July, M2 expanded at a rate near the upper bound of its range

for the year and M3 at a rate appreciably above the upper bound of its range.

Total domestic nonfinancial debt has continued to expand in recent months at a

rate near the middle 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 February for growth of M2 and M3 of 1 to 5

percent and 2 to 6 percent respectively, measured from the fourth quarter of 1996

to the fourth quarter of 1997. The range for growth of total domestic

nonfinancial debt was maintained at 3 to 7 percent for the year. For 1998, the

Committee agreed on a tentative basis to set the same ranges as in 1997 for

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

1997 to the fourth quarter of 1998. 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

conditions in reserve markets consistent with maintaining the federal funds rate

at an average of around 5-1/2 percent. 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, a

somewhat higher federal funds rate would or a slightly lower federal funds rate

might 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, Broaddus, Guynn,

Kelley, Meyer, Moskow, Parry, Mses. Phillips and Rivlin.

Votes against this action: None.

Rules Regarding Availability of Information

By notation vote completed on August 20, 1997, the Committee approved for public

comment a revision of its Rules Regarding the Availability of Information. The purpose of

the revision is to bring the rules into conformance with the Electronic Freedom of

Information Act of 1996 (EFOIA), which amends the Freedom of Information Act (FOIA).

The revision does not incorporate any substantive changes in the rules other than to conform

them to the requirements of EFOIA and to update and clarify the Committee's procedures for

processing FOIA requests. After review of the comments that are received from the public,

the Committee will issue the rules in final form on or before October 2, 1997.

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

30, 1997.

The meeting adjourned at 12:40 p.m.

Donald L. Kohn

Secretary

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