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 Wednesday, November

12, 1997, at 9:00 a.m.

Present:

Mr. Greenspan, Chairman

Mr. McDonough, Vice Chairman

Mr. Broaddus

Mr. Ferguson

Mr. Gramlich

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. Baxter, Deputy General Counsel

Mr. Prell, Economist

Mr. Truman, Economist

Messrs. Cecchetti, Goodfriend, Eisenbeis, Lindsey, Promisel, Slifman, and Stockton,

Associate Economists

Mr. Fisher, Manager, System Open Market Account

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

and Research and Statistics respectively, Board of Governors

Messrs. Alexander, Hooper, and Ms. Johnson, Associate Directors, Division of

International Finance, Board of Governors

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

Governors

Ms. Pianalto and Mr. Rives, First Vice Presidents, Federal Reserve Banks of

Cleveland and St. Louis respectively

Messrs. Dewald, Hakkio, Rolnick, and Sniderman, Senior Vice Presidents, Federal

Reserve Banks of St. Louis, Kansas City, Minneapolis, and Cleveland respectively

Messrs. Bentley, Meyer, and Rosengren, Vice Presidents, Federal Reserve Banks of

New York, Philadelphia, and Boston respectively

Ms. Gonczy and Mr. Koenig, Assistant Vice Presidents, Federal Reserve Banks of

Chicago and Dallas respectively

Mr. Trehan, Research Officer, Federal Reserve Bank of San Francisco

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

on September 30, 1997, were approved.

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

exchange and international financial markets in the period since the previous meeting on

September 30, 1997. 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 September 30, 1997, through November 11, 1997. By unanimous vote, the Committee

ratified these transactions.

By unanimous vote, paragraph 1.A of the Authorization for Domestic Open Market

Operations was amended to raise from $8 billion to $12 billion the dollar limit on

intermeeting changes in System Account holdings of U.S. government and federal agency

securities for the intermeeting period through December 16, 1997. The Manager advised the

Committee that, as was usually the case at this time of year, the anticipated pattern of reserve

needs was such that he might want to add considerably to the System's outright holdings of

U.S. government securities over the coming intermeeting period. By unanimous notation

vote, the Committee subsequently approved a further increase in the intermeeting leeway to

$17 billion. The increase, effective December 8, was made on the recommendation of the

Manager who saw the need for substantially more outright purchases of Treasury obligations

than anticipated earlier, largely in light of much greater than projected growth in currency.

With Mr. Broaddus dissenting, the Committee authorized the renewal for an additional

one-year period of the System's reciprocal currency ("swap") arrangements with foreign

central banks and the Bank for International Settlements. The amounts and current maturity

dates of the arrangements approved for renewal are shown in the table that follows:

Foreign

Bank

Amount of

Term

Arrangement (months)

Maturity

Date

(millions of $

equivalent)

Austrian National Bank

250.0 12 mos.

12/04/97

Bank of England

3,000.0 "

12/04/97

Bank of Japan

5,000.0 "

12/04/97

Bank of Norway

250.0 "

12/04/97

Bank of Sweden

300.0 "

12/04/97

4,000.0 "

12/04/97

600.0 "

12/04/97

1,250.0 "

12/04/97

Bank of Mexico

3,000.0 "

12/12/97

Bank of Canada

2,000.0 "

12/15/97

National Bank of Belgium

1,000.0 "

12/18/97

National Bank of Denmark

250.0 "

12/28/97

Bank of France

2,000.0 "

12/28/97

German Federal Bank

6,000.0 "

12/28/97

Bank of Italy

3,000.0 "

12/28/97

500.0 "

12/28/97

Swiss National Bank

Bank for International Settlements-Swiss francs

Other authorized European currencies

Netherlands Bank

Mr. Broaddus dissented because he believed that the Federal Reserve's participation in

foreign exchange market intervention compromises its ability to conduct monetary policy

effectively. Because sterilized intervention cannot have sustained effects in the absence of

conforming monetary policy actions, Federal Reserve participation in foreign exchange

operations risks one of two undesirable outcomes. First, the independence of monetary policy

is jeopardized if the System adjusts its policy actions to support short- term foreign exchange

objectives set by the Treasury. Alternatively, the credibility of monetary policy is damaged if

the System does not follow interventions with compatible policy actions, the interventions

consequently fail to achieve their objectives, and the System is associated in the mind of the

public with the failed operations. In these circumstances, he did not view renewal of the

existing swap lines as desirable because they are used primarily to facilitate market

intervention.

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

monetary policy over the intermeeting period ahead.

The information reviewed at the meeting suggested that economic activity continued to grow

rapidly in recent months. The further advance reflected a surge in business fixed investment

and consumer spending, while housing demand remained at a high level. Significant slowing

in exports and inventory investment provided only a partial offset to the strength.

Accordingly, production and employment recorded further large gains. Price inflation

remained subdued despite tight labor markets and a pickup in the pace of labor

compensation.

Nonfarm payroll employment rose substantially further in October. Manufacturing payrolls

recorded their largest rise in the current economic expansion, and aggregate weekly hours

worked increased significantly; most of the gain in payrolls occurred at durable goods

establishments. Hiring remained robust in the service- producing sector, led by sizable

increases at computer services and engineering and management services firms. The civilian

unemployment rate fell to 4.7 percent in October, its low for the current expansion.

Industrial production registered a large advance in the third quarter and apparently remained

strong in October. A third-quarter surge in the manufacture of durable goods, notably of

motor vehicles, aircraft, and information-processing equipment, more than offset weak

expansion in the output of nondurable goods and a decline in mining activity. Although the

step-up in manufacturing production boosted further the rate of utilization of manufacturing

capacity, the latter was somewhat below its most recent peak in January 1995.

Retail sales posted a sharp rise in the third quarter, though growth in sales of both durable

and nondurable goods moderated during the quarter. Consumer spending on services also

continued to increase at a relatively brisk pace. Growth in such spending was underpinned by

continuing substantial gains in incomes, the cumulative increase in household net worth over

the past several years, and the ready availability of credit to most consumers. Housing

demand remained strong in the third quarter in association with moderate interest rates and

very positive consumer assessments of homebuying conditions. Sales of both new and

existing homes increased a bit, and housing starts were little changed in the third quarter

from the high level recorded during the first half of the year.

Business fixed investment increased at an unusually rapid rate in the third quarter. The rise in

outlays was spread across all categories of producers' durable equipment, but the largest

gains were in office, computing, and communications equipment. Available data on new

orders pointed to further broad-based and robust expansion in equipment spending in coming

months. Nonresidential construction grew at a moderate pace in the latest quarter despite a

decline in September. Available information suggested that construction would trend upward

at a modest rate in coming months.

Business inventory investment appeared to have moderated substantially in the third quarter

from the rapid rate of the previous quarter, and on balance stocks were at relatively low

levels in relation to sales. In manufacturing, stocks rose somewhat further in September, but

the inventory-to-shipments ratio for the sector declined to the low end of its range for the past

twelve months. Wholesale inventories posted another sizable advance in September; the

inventory-sales ratio for this sector was just above the high end of its range for the past year.

Retail stocks fell in August (latest available data), more than reversing their July increase.

The inventory-sales ratio for the sector also was at the low end of its range for the past year.

The nominal deficit on U.S. trade in goods and services widened substantially on balance

over July and August from its rate in the second quarter. Exports of goods and services

changed little on net in the July-August period but imports rose considerably; the largest

increases in imports were for aircraft and automotive products, but sizable gains also were

recorded for computers, semiconductors, and industrial supplies. Available indicators of

economic activity in the third quarter pointed to robust expansion in all the major foreign

industrial countries except Japan, where activity rebounded only moderately from a sharp

second-quarter decline. Although timely data were sparse, the economies of many Asian

countries probably were weakening as their exchange rates came under pressure, problems in

their financial sectors were revealed, and their monetary and fiscal policies moved toward

restraint.

Consumer price inflation remained subdued in September. The increase in both overall

consumer prices and the prices of consumer items other than food and energy was modest.

For the twelve months ended in September, prices of consumer items other than food and

energy increased by a considerably smaller amount than in the year- earlier period. At the

producer level, the September rise in prices was the largest monthly increment since January

1991; nonetheless, the overall index was unchanged over the past twelve months after a

sizable rise over the previous twelve-month period. The core index also decelerated on a

year-over-year basis. The rate of increase in the hourly compensation of private industry

workers was unchanged in the third quarter, but the advance over the past four quarters was

somewhat larger than that for the previous four. Growth in average hourly earnings picked up

in September and October, perhaps partly reflecting the effects of an increase in the federal

minimum wage.

At its meeting on September 30, 1997, the Committee adopted a directive that called for

maintaining conditions in reserve markets that were consistent with an unchanged federal

funds rate averaging around 5-1/2 percent. The Committee retained a tilt in the directive

toward a possible firming of reserve conditions during the inter- meeting period, reflecting its

view that the risks continued to be skewed toward rising inflation. Reserve market conditions

associated with this directive were expected to be consistent with some moderation in the

growth of M2 and M3 over coming months.

Open market operations were directed throughout the inter- meeting period toward

maintaining reserve conditions consistent with the Committee's intended level of around

5-1/2 percent for the federal funds rate, and the rate averaged close to that level over the

period. Other financial markets became quite volatile from time to time. Share prices in

equity markets fluctuated widely in occasionally turbulent trading activity and were down

somewhat on balance over the period; equity markets in other countries, notably in Asia, also

were volatile, and very large declines were recorded in some of those markets. Against this

background, U.S. short-term interest rates registered small mixed changes over the period

since the September 30 meeting, while Treasury bond yields declined somewhat on balance.

Unexpectedly strong incoming data on U.S. producer prices, employment, and wages tended

to exert upward pressures on bond yields on some days, but these were more than offset by

investor desires for safety and quality, the continuing moderation in consumer inflation, and

the perception engendered by international financial developments that inflation pressures

were likely to remain subdued.

The dollar also was affected by the spreading financial turmoil in developing countries,

appreciating significantly over the intermeeting period against the currencies of a number of

Asian and Latin American countries. Much of the increase was counterbalanced, however, by

a sizable decline in the dollar's trade-weighted value in terms of the currencies of the other

G-10 countries. The dollar's decline against the German mark and other European currencies

partly reflected diminished market expectations of potential tightening in the United States

and a snugging of monetary conditions by the Bundesbank and other continental European

central banks. Further progress in resolving uncertainties surrounding the European

Monetary Union also may have contributed to the rise in European currencies. The dollar

appreciated slightly on balance against the Japanese yen.

Growth of M2 and M3 apparently moderated further in October, though the expansion of

these aggregates remained brisk. A sharp slowing of inflows to money market mutual funds

accounted for much of the deceleration of M2, and an easing in the pace of issuance of large

time deposits, evidently reflecting a smaller rise in bank credit, also contributed to a modest

reduction in M3 growth. For the year through October, M2 expanded at a rate that was at the

upper bound of the Committee's range for the year and M3 at a rate substantially above the

upper bound of its range. Total domestic nonfinancial debt increased in recent months at a

rate somewhat below the middle of its range.

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

expand for a time at a pace considerably above its potential, but growth was expected to

moderate to a more sustainable rate later. Further rapid increases in business investment

would provide strong impetus to income growth in the near term, and the rise in household

wealth so far in 1997 would stimulate robust consumer demand going forward. The projected

strength of domestic demand would be offset to some extent by a considerable weakening in

the growth of exports in response to the lagged effects of the earlier appreciation of the dollar

and sharp anticipated reductions in the economic growth of Asian and other developing

countries.

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

focused on widespread indications of a continued solid advance in economic activity, spurred

by strength in all major sectors of the domestic economy, and the persistence of subdued

increases in prices. The current momentum of the expansion, together with broadly

supportive financial conditions and favorable business and consumer sentiment, suggested

that economic growth was likely to be well maintained, especially over the nearer term. As a

consequence, the members agreed that there remained a clear risk of additional pressures on

already tight resources and ultimately on prices that could well need to be curbed by tighter

monetary policy. But the members also focused on two important influences that were

injecting new uncertainties into this outlook. Turmoil in Asian financial markets and

economies would tend to damp output and prices in the United States. To date, it appeared

that the effects on the U.S. economy would be quite limited, but the ultimate extent of the

adjustment in Asia was unknown, as was its spillover to global financial markets and to the

economies of nations that were important U.S. trading partners. The second influence was the

apparently sharp increase in productivity in the second and third quarters. This was an

encouraging development, although it was too early to judge the persistence of the uptrend in

productivity growth and the extent to which it might reduce the additional price pressures

that would be generated in the event of an extended period of further robust economic

expansion.

Strength in consumer spending had provided an important underpinning for robust economic

expansion, and substantial growth was likely to persist, sustained by increases in

employment and incomes, high levels of confidence, and the cumulative effects of very large

gains in stock market wealth over the past several years. The outlook for capital spending

also remained quite favorable because the factors that were contributing to the ongoing surge

in such spending--its potential for lowering production costs in highly competitive markets

and the ready availability of finance on attractive terms--were likely to persist. While private

domestic demand most likely would continue to display considerable strength, both

consumption and investment were somewhat vulnerable to developments in financial

markets, perhaps arising from further difficulties in Asia. Increased uncertainty about asset

values could engender greater caution on spending, and of course a substantial decline in

equity values would reduce household wealth and raise the cost of equity capital. Some

members also commented that additional appreciation of the dollar, perhaps in association

with possible further turbulence in Asia and weakness in foreign economies, would have

adverse implications for net exports, which already were seen as a somewhat negative factor

in the economic outlook. At the same time, of course, a stronger dollar would have a positive

effect on domestic inflation over the projection horizon.

In the course of their discussion, the members gave consider- able emphasis to recent

developments in labor markets. Statistical indicators of rising levels of employment, low and

falling rates of unemployment, and a diminishing supply of new workers were reinforced by

anecdotal evidence of tight labor markets throughout the nation. The demand for many types

of workers exceeded the supply in many regions, and a number of members reported that

growth of economic activity in various parts of the country was being held back by the

scarcity of labor. While labor compensation had accelerated, the pickup was moderate in

light of the taut conditions in labor markets and some of it reflected the legislated rise in the

minimum wage. Nonetheless, members cited numerous examples of efforts to attract or

retain workers in especially scarce supply through a variety of bonus payments and other

incentives that were not included in standard measures of labor compensation.

The effects on costs and prices of somewhat faster increases in compensation evidently were

being muted by what appeared to have been a sharp advance in productivity growth in the

last two quarters. The acceleration in productivity seemed to be related in part to the surge in

capital spending, which had been stimulated by the ability of new equipment to enhance

efficiency and hold down costs, suggesting that productivity might be on a higher trend for a

time. But it also could be attributed to some extent to the strengthening in economic output;

such strengthening often is associated with a pickup in productivity as producers react

initially to the upturn in demand by stretching available labor further. If the pace of the

economic expansion were to moderate in line with current expectations, the growth in

productivity could also be expected to slow, but to an uncertain extent.

The trend in productivity gains was a key factor in the outlook for unit costs and ultimately

for price inflation. As had been true for an extended period, inflation had remained relatively

subdued in comparison with past experience under broadly similar economic conditions. The

reasons for the relative quiescence of inflation were not fully understood, but they

undoubtedly included a number of special factors beyond higher productivity such as a

lagged response to earlier appreciation of the dollar and unusually damped increases in the

cost of health benefits. As they had at previous meetings, members suggested that these

favorable influences were likely to erode over the year ahead. A number of members again

cited reports of increases in health insurance premiums next year and subsequently. More

fundamentally, it was difficult to predict whether anticipated increases in labor compensation

would be fully offset by productivity gains in coming quarters and whether, in turn,

competitive market conditions would allow firms to raise prices to compensate for any

increases in their costs. On balance, the members felt that the risks remained in the direction

of rising price inflation though the extent and timing of that outcome were subject to

considerable debate.

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

member endorsed a proposal to maintain an unchanged policy stance, and all agreed that the

risks remained tilted toward rising inflation. While developments in Southeast Asia were not

expected to have much effect on the U.S. economy, global financial markets had not yet

settled down and further adverse developments could have greater-than-anticipated spillover

effects on the ongoing expansion. In this environment, with markets still skittish, a tightening

of U.S. monetary policy risked an oversized reaction. Some members also emphasized that

the relatively favorable trends in productivity, costs, and prices continued to raise questions

about the strength and timing of any pickup in inflation. Other members stressed that the

unsustainable pace of domestic demand and rising resource utilization seemed to call for a

near-term tightening of policy. Some of these members noted that overall financial conditions

remained quite supportive despite the recent market turmoil and high real short-term interest

rates. Credit from a wide variety of lenders appeared to be amply available on favorable

terms, perhaps overly so in present circumstances. Nonetheless, all but one of the members

believed that in light of the uncertainties about the economic outlook, an immediate policy

tightening was not needed in the absence of firmer indications that inflationary pressures

might be emerging. In the view of one member, however, aggregate final demand was so

strong that, with economic activity and the associated demand for labor having expanded at

an unsustainable pace for some time, one could be reasonably confident that inflation would

most likely pick up in the absence of policy action.

In their discussion of possible adjustments to policy during the intermeeting period, the

members indicated that they wanted to retain in the operating paragraph of the directive the

existing asymmetry toward restraint that was initially adopted at the May meeting. Such a

directive was consistent with their view that the risks continued to be biased toward rising

inflation. Accordingly, the members continued to view the next policy move as more likely to

be in the direction of some firming than toward easing.

At the conclusion of the Committee's discussion, all but one member supported 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 and that retained a bias 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 growth 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

continued to grow rapidly in recent months. In labor markets, hiring has

remained robust and the civilian unemployment rate fell to 4.7 percent in

October, its low for the current economic expansion. Industrial production

increased very rapidly in the third quarter, and appears to have remained strong

in October. Retail sales also rose sharply in the third quarter, though at a

moderating pace as the summer progressed. Housing starts, while fluctuating

from month to month, were little changed on balance in the third quarter.

Business fixed investment posted unusually strong increases in the latest quarter,

and available indicators point to further sizable gains in coming months. The

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

average in July and August from its rate in the second quarter. Price inflation has

remained subdued despite some increase in the pace of advance in labor

compensation.

Short-term interest rates have registered small mixed changes since the day

before the Committee meeting on September 30, 1997, while bond yields have

fallen somewhat. Share prices in U.S. equity markets have fluctuated widely in

turbulent trading activity and are down on balance over the period; equity

markets in other countries, notably in Asia, have been volatile as well and some

have registered very large declines. In foreign exchange markets, the tradeweighted value of the dollar in terms of the other G-10 currencies declined

somewhat on balance over the intermeeting period. The dollar appreciated

significantly, however, in terms of the currencies of a number of Asian and Latin

American countries.

Growth of M2 and M3 appears to have moderated further in October from the

unusually brisk rates of August. For the year through October, M2 expanded at

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

upper bound of its range. Total domestic nonfinancial debt has expanded in

recent months at a pace somewhat below 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 develop- ments 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 consider- ation 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, Ferguson, Gramlich,

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

Vote against this action: Mr. Broaddus.

Mr. Broaddus dissented because he believed that a modest tightening of policy

would be prudent in view of the recent strength in aggregate demand for goods

and services; such demand appeared to be growing considerably more rapidly

than the sustainable rate at which it could be supplied without an increase in

inflation. While he recognized that a tightening at this meeting presented risks in

view of recent financial and economic developments in East Asia, he believed

these risks were outweighed by the risk that policy would have to be tightened

more aggressively if action were delayed, demand remained robust, and the

recent apparent reduction in inflationary expectations were reversed. The

negative impact on economic activity in such circumstances would be markedly

greater than if a more modest action were taken at this meeting.

Rules Regarding Availability of Information

By notation vote the Committee unanimously approved in final form certain revisions to its

Rules Regarding the Availability of Information. The final rules take account of comments

received from the public on the Committee's proposed revisions to the rules that were

published earlier in the Federal Register. The purpose of the revisions is to bring the rules

into conformity with the Electronic Freedom of Information Act of 1996 (EFOIA), which

amends the Freedom of Information Act (FOIA). The new rules take effect on December 17,

1997.

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

16, 1997.

The meeting adjourned at 1:10 p.m.

Donald L. Kohn

Secretary

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