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

16, 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, 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. Beebe, Cecchetti, Eisenbeis, Goodfriend, Lindsey, Promisel, Siegman,

Slifman, and Stockton, Associate Economists

Mr. Fisher, Manager, System Open Market Account

Mr. Winn, Assistant to the Board, Office of Board Members, Board of Governors

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

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

Messrs. Connolly and Rives, First Vice Presidents, Federal Reserve Banks of Boston

and St. Louis respectively

Mses. Browne, Krieger, Messrs. Dewald, Hakkio, Lang, and Rosenblum, Senior Vice

Presidents, Federal Reserve Banks of Boston, New York, St. Louis, Kansas City,

Philadelphia, and Dallas respectively

Mr. Miller, Vice President, Federal Reserve Bank of Minneapolis

Messrs. Bryan and Evans, Assistant Vice Presidents, Federal Reserve Banks of

Cleveland and Chicago respectively

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

on November 12, 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

November 12, 1997. There were no open market transactions in foreign currencies for

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

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

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

period November 12, 1997, through December 15, 1997. By unanimous vote, the Committee

ratified these transactions.

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 this meeting suggested that economic activity had continued to

grow at a rapid pace in recent months. The further advance reflected moderating but still

sizable increases in business fixed investment and consumer spending and an upturn in

business inventory accumulation. Housing demand remained at a high level, and deepening

trade deficits provided only a partial offset to the strength in domestic spending. Against this

background, employment and production posted further large gains. Price inflation remained

subdued despite tight labor markets and some pickup in the rate of wage increases.

Nonfarm payroll employment rose sharply further in October and November. The increases

in payrolls were widespread across sectors, and in November they included notably large

gains in the service- producing industries. Manufacturing employment also rose considerably

further in November, and aggregate weekly hours of production or nonsupervisory workers

registered a particularly large advance in that month. The civilian unemployment rate fell to

4.6 percent in November, its low for the current expansion.

Industrial production continued to advance at a brisk pace in October and November. The

November increase was widespread across market groups. It featured particularly strong

growth in the production of durable goods, including a surge in the output of motor vehicles

and parts. Partly offsetting the strength in the manufacturing sector in November was a

decline in mining activity and in utilities output after two months of robust expansion. The

large rise in production boosted the rate of utilization of manufacturing capacity to its highest

level in more than two years.

Growth in consumer spending had moderated in recent months from a very brisk pace during

the summer. Retail sales were unchanged on balance over October and November after

having increased rapidly in the third quarter. The flat sales for the two months reflected some

softening in the durable goods category, notably at automotive dealers, and relatively slow

growth in the nondurable goods sector. Consumer spending on services appeared to have

remained relatively robust in October. According to recent surveys, consumer sentiment

remained at an extraordinarily ebullient level in the context of continuing strong gains in jobs

and incomes, the cumulative effect of large increases in household net worth, and the ready

availability of financing for most consumers.

Available information suggested that business capital expenditures had moderated in recent

months from the exceptionally strong increases of the second and third quarters. Shipments

of office and computing equipment fell in nominal terms in October, while shipments of

communications equipment were about unchanged after having posted strong gains earlier in

the year. Shipments of nondefense capital goods other than aircraft and high-tech equipment

also declined in October. Spending on nonresidential structures had softened a bit in recent

months.

In the housing sector, demand had continued to display appreciable strength in recent months

in association with relatively moderate mortgage rates and very positive consumer

assessments of homebuying conditions. In October, the latest month for which data were

available, sales of new homes were well maintained, and sales of existing homes rose.

Housing starts increased somewhat in October and November from the already high level

reached earlier in the year.

After picking up considerably in September, the pace of business inventory investment in

October remained above that recorded earlier in the summer. The rise in stocks at the

manufacturing level was at a somewhat faster pace in October than in September, but the

buildup in inventories at the wholesale level, and especially at the retail level, moderated in

October. On balance, inventories remained at quite low levels in relation to shipments and

sales.

The nominal deficit on U.S. trade in goods and services was significantly larger in the third

quarter than in the second. Exports of goods and services rose only marginally in the third

quarter, as increases in machinery, industrial supplies, and service receipts were nearly offset

by sharp declines in exports of aircraft and gold. Imports of goods and services rose

appreciably in the third quarter; the increases were in most major trade categories and

included strong further advances in the quantity of oil imports. Economic growth in most

major foreign industrial countries was relatively vigorous in the third quarter, and

preliminary indicators for the fourth quarter suggested continued above-trend expansion.

However, growth since midyear appeared to have recovered only modestly in Japan from a

sharp second-quarter decline. The ongoing financial turmoil affecting a number of Asian

economies had led to a significant slowdown in economic activity in the region. Available

data also suggested a favorable economic performance in major Latin American countries in

the third quarter.

Consumer price inflation had remained at a low level in recent months, reflecting a variety of

influences including a favorable labor cost environment, falling import prices, small

increases in energy prices, and declining inflation expectations. For the twelve months ended

in November, overall consumer prices and consumer prices excluding food and energy items

increased appreciably less than in the year-earlier period. At the producer level, prices for

finished goods edged lower in November and the index was down somewhat on balance over

the past year, reflecting declines in the food and energy components. The rate of increase in

average hourly earnings had picked up in recent months, apparently reflecting the effects of

an increase in the federal minimum wage and some bidding up of wages in a tight labor

market.

At its meeting on November 12, 1997, the Committee had 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. In the directive the Committee had retained a tilt

toward a possible firming of reserve conditions during the intermeeting period. Such a bias

had been seen as consistent with the members' views that the risks continued to be skewed

toward rising inflation and that the next policy move was more likely to be in the direction of

some firming than toward easing. Reserve market conditions associated with this directive

had been expected to be consistent with some moderation in the growth of M2 and M3 over

coming months.

Open market operations throughout the intermeeting period were directed toward

maintaining reserve conditions consistent with the intended average of around 5-1/2 percent

for the federal funds rate, and the average effective rate over the period was close to that rate

level. In other domestic financial markets, short-term interest rates registered small mixed

changes since the day before the Committee meeting on November 12, 1997, while bond

yields fell somewhat. Share prices in U.S. equity markets recorded mixed changes over the

period. Domestic financial markets became somewhat less volatile over the period, though

further turmoil in a number of foreign markets fostered a sense of unease that was reflected

in relatively wide yield spreads and, on occasion, in trading activity and price movements.

Equity markets in other countries, notably in Asia, remained volatile.

In foreign exchange markets, the value of the dollar rose over the intermeeting period in

terms of both the trade-weighted index of the other G-10 currencies and the currencies of a

number of Asian countries. The dollar's appreciation against the German mark and other

Western European currencies appeared to reflect market perceptions that the prospects for

monetary tightening had ebbed in those countries in light of the persistence of subdued

inflation and indications that the continuing financial turmoil in Asian and other emerging

economies was likely to have a retarding effect on the economies of the industrial countries.

The dollar's appreciation relative to the yen appeared to reflect rising concerns about the

Japanese economy in the wake of continuing financial difficulties in Japan and spillover

effects from events elsewhere in Asia. The dollar strengthened further in this period against

most of the other East Asian currencies, notably against the Korean won.

Growth in the broad monetary aggregates picked up to relatively rapid rates in November.

Strength in currency and a surge in liquid deposits boosted the expansion of M2, while that

of M3 was amplified by a step-up in RP borrowing to help finance more rapid growth in

bank credit. For the year through November, M2 expanded at a rate that was slightly above

the upper bound of the Committee's annual range, and M3 at a rate substantially above the

upper bound of its range. The increase in total domestic nonfinancial debt for the year to date

was at a pace somewhat below the middle of the Committee's range.

The staff forecast prepared for this meeting suggested somewhat greater moderation in

economic expansion than had been projected earlier and slightly less pressure on wages and

prices. A number of factors were expected to contribute to the slowing of aggregate demand

and reduced pressure on resources. These included: a slackening in world economic

expansion that, in conjunction with the appreciation of the dollar, would substantially restrain

U.S. exports; some moderation of the growth in household and business investment; and a

diminution in the desired rate of inventory accumulation.

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

commented on indications that growth in economic activity had remained solid and that

inflation had continued to be surprisingly low. While wages appeared to be increasingly

subject to upward pressure, productivity had picked up in recent quarters, and the persisting

strength in profits suggested that unit labor costs were not accelerating noticeably. The

evidently higher pace of productivity growth was very encouraging, though it was still

difficult to assess how long this favorable performance might last and the extent to which it

might ease the price pressures that could emerge if the economic expansion did not moderate

as members anticipated. Domestic demand for goods and services had been quite strong and

was likely to remain reasonably robust. However, the effects of the persisting turmoil in

Asian financial markets were likely to moderate the pace of expansion, though the extent of

this effect was difficult to judge. The ongoing turbulence since the last Committee meeting,

which included further noticeable increases in the dollar against the currencies of affected

countries, likely would have a somewhat greater damping effect on output and prices in the

United States than previously had been anticipated. Exports to many Asian countries, and

possibly to other U.S. trading partners whose economies might be adversely affected by the

spillover effects of developments in Asia, would be reduced, and declines in import prices

would ease inflation pressures. However, the ultimate extent of the adjustment in Asian

economies remained unknown, and more substantial downward pressure on the economies of

the United States and its trading partners could not be ruled out.

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

appreciation of the dollar against a wide range of currencies, along with the prospective

slackening in world economic expansion associated with the Asian turmoil, could be

expected to exert a considerable damping effect on U.S. exports over the next several

quarters. In addition, increased uncertainty about financial asset values, possibly related in

part to further difficulties in Asia, could lead to greater caution in spending, while a

substantial decline in equity values, should it occur, would have a more pronounced effect by

reducing household wealth and raising the cost of equity capital. However, a number of

members suggested that consumer spending might hold up relatively well if the effects of the

Asian crisis on the U.S. economy were not markedly deeper or more prolonged than

currently expected. To date, anecdotal reports indicated only scattered signs of weaker export

demand, primarily some slackening in orders for and shipments of selected commodities

such as agricultural goods and lumber and wood products, and there were few indications of

reduced demand for manufactured goods. At the same time, business contacts were

optimistic about holiday sales, tourism was booming in some parts of the country, and

spending for services had been brisk. In the circumstances, continuing gains in wages and

employment, the prevailing high levels of confidence, the cumulative effects of very large

increases in household wealth in recent years, and the intense competition among retailers for

the consumer's attention could promote substantial further growth in consumer expenditures.

The same factors, along with the favorable cash-flow affordability of home ownership, were

maintaining housing demand at a relatively high level.

The outlook for business fixed investment remained favorable. In the near term, the low cost

of capital, the ready availability of finance on attractive terms, and the potential for reducing

production costs in highly competitive markets were providing strong support for capital

spending. Moreover, shrinking vacancy rates and rising lease rates were fostering a rapid

increase in the number of large commercial building projects, notably office buildings, that

were planned or under way in many areas of the country. Even so, the growth of business

capital spending was expected to slow from the unusually rapid pace of recent quarters in

response to the projected smaller increases in sales and profits arising from moderating

economic growth. In addition, business firms were expected to trim the pace of their

inventory accumulation to keep stocks at desired levels relative to sales.

In their comments on recent developments in labor markets, the members emphasized the

very limited supply of new workers and the extraordinary tightness prevailing in markets

throughout the nation. Several reported that the scarcity of available workers was limiting the

growth of economic activity in some parts of the country and that some employers were

trying out novel approaches aimed at enticing people not currently seeking a job to enter the

work force. While wage increases remained moderate on balance, larger increases were

gradually becoming more pervasive as labor markets tightened. Moreover, employers were

continuing their efforts to attract or retain workers that were in particularly scarce supply by

means of a variety of bonus payments and other incentives that were not included in standard

measures of labor compensation. There also were reports of offers of expanded benefits and,

in some instances, the granting of very large wage increases to highly skilled technical

personnel.

In the course of their discussion, many members remarked on the absence of inflationary

price pressures during a period when economic activity had risen briskly and labor markets

had grown steadily tighter. The muted effect of higher labor compensation on unit labor costs

and prices reflected sharp advances in productivity partly associated with the rapid expansion

of the stock of capital; the latter had been stimulated, most probably, by the desire to enhance

efficiency and thus hold down costs. In addition, the earlier appreciation of the dollar and the

unusually damped increases in the cost of health benefits in recent years had helped to limit

the rise in compensation.

As members had noted at previous meetings, these favorable influences were likely to erode

over time. Anecdotal reports indicated that health insurance premiums were beginning to

trend higher, and the dollar would not rise indefinitely. More fundamentally, persistent

tightness in labor markets risked a continuing uptrend in labor compensation increases that,

at some point, could not be fully offset by productivity gains. Under those circumstances,

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

in their costs. However, for some period ahead, developments associated with the turmoil in

Asia along with the partly related appreciation of the dollar would tend to intensify import

competition and damp the prices of goods.

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

members favored a proposal to maintain an unchanged policy stance. In their discussion,

members emphasized that price inflation had remained subdued, indeed with some key price

measures indicating declining inflation, despite the persistence of robust economic growth

and high levels of resource use, notably in labor markets. They expressed concern, however,

that multiplying indications of faster wage increases might presage rising price inflation at

some point. Weighing against the risks of higher inflation was the financial turmoil that had

intensified in Southeast Asia during October and more recently in Korea. The effects of those

developments on the U.S. economy were quite limited thus far, but the members expected

some damping of economic expansion and price increases in the quarters ahead and they did

not rule out a potentially strong impact in the event of an even deeper crisis in Asia, or one

that spread to other countries. Nonetheless, many members commented that, with domestic

demand still quite strong and the economy possibly producing beyond its potential, they

viewed the risks on balance as pointing to rising price inflation and the next policy move as

likely to be in the direction of some tightening. However, most members agreed that the need

for such a policy adjustment did not appear to be imminent, and that prevailing near-term

uncertainties warranted a cautious wait-and-see policy posture. One member, while

acknowledging the downside risks to the expansion associated with potential developments

in Asia, still was persuaded that the economy probably would continue to expand at an

unsustainable pace and that monetary policy should be tightened promptly to avert a further

buildup of pressures in already strained labor markets, associated increases in labor costs,

and at some point an inevitable rise in price inflation.

Other considerations cited by some members in favor of an unchanged policy included the

possibility that, because a policy tightening move was not expected at this juncture, even a

modest firming action might well have outsized effects in financial markets, especially the

foreign exchange markets. Current conditions in domestic financial markets clearly remained

supportive of spending, but it also was noted that the real federal funds rate was relatively

high and that growth in the broad measures of money was expected to moderate over coming

months after a period of robust expansion. The members agreed that the crosscurrents that

were generating the present uncertainties in the outlook for economic activity and inflation

made a flexible approach to monetary policy particularly desirable at this juncture.

Views were somewhat more divided with regard to the instruction in the directive relating to

the possible adjustment of policy during the intermeeting period. A majority of the members

indicated a preference for a shift to a symmetrical directive even though many continued to

anticipate that the next policy move was likely to be in a tightening direction. They noted that

while the probability of any policy change in the near term was very low, uncertainties in the

outlook had increased, and they could not rule out the possibility that the next change might

be in the direction of some easing if, contrary to current expectations, the turmoil in Asia

were to intensify to the extent that it seemed likely to exert very substantial effects on the

U.S. economy. A symmetric directive would position the Committee to respond flexibly in

either direction to unanticipated developments in the period ahead. Other members expressed

a slight preference for retaining a directive that was tilted toward tightening. In their view,

such a directive would continue to underscore their concern that at current and prospective

levels of resource utilization, rising inflation was the most serious risk to the economy and

the Committee remained committed to fostering progress toward a stable price environment

that in turn would heighten the prospects for sustained economic expansion and full

employment.

At the conclusion of the Committee's discussion, all but one member endorsed 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 did not include a presumption

about the likely direction of any adjustment to policy during the intermeeting period.

Accordingly, in the context of the Committee's long-run objectives for price stability and

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

monetary developments, the Committee decided that a slightly higher 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 some moderation in the

growth of 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. Nonfarm payroll employment

increased sharply in October and November; the civilian unemployment rate fell

to 4.6 percent in November, its low for the current economic expansion.

Industrial production continued to advance at a brisk pace in October and

November. Retail sales were unchanged on balance over the two months after

rising sharply in the third quarter. Housing starts increased slightly further in

October and November. Available information suggests on balance that business

fixed investment will slow from the exceptionally strong increases of the second

and third quarters. The nominal deficit on U.S. trade in goods and services

widened significantly in the third quarter from its rate in the second quarter.

Price inflation has remained subdued, despite some increase in the pace of

advance in wages.

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

before the Committee meeting on November 12, 1997, while bond yields have

fallen somewhat. Share prices in U.S. equity markets recorded mixed changes

over the period; equity markets in other countries, notably in Asia, have

remained volatile. In foreign exchange markets, the value of the dollar has risen

over the intermeeting period in terms of both the trade-weighted index of the

other G-10 countries and the currencies of a number of Asian countries.

M2 and M3 grew rapidly in November. For the year through November, M2

expanded at a rate slightly above 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 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

slightly higher federal funds rate or a slightly lower federal funds rate might be

acceptable in the intermeeting period. The contemplated reserve conditions are

expected to be consistent with some moderation in the 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 continued to believe that a modest tightening

of policy would be prudent in light of the apparent persisting strength in

aggregate demand for goods and services. He recognized the case for holding

policy steady given recent developments in East Asian economies and financial

markets; he believed, however, that a slight firming at this meeting would

provide valuable insurance against the risk that demand growth might remain

above a sustainable trend and require a sharper policy response later. He thought

further that the potential benefits of this insurance outweighed the risk that such

an action would have a significant negative impact on U.S. economic activity.

He also believed that signaling a greater willingness to tolerate modest policy

adjustments in response to emerging developments would foster more flexible

movements in longer-term financial markets, and specifically enable longer-term

interest rates to play their traditional role as automatic stabilizers for the

economy more effectively.

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

February 3-4, 1998.

The meeting adjourned at 12:45 p.m.

Donald L. Kohn

Secretary

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