FOMC Minutes

A meeting of the Federal Open Market Committee was held in the offices of the Board of

Governors of the Federal Reserve System in Washington, D.C., on Tuesday, May 19,

1998, at 9:00 a.m.

Present:

Mr. Greenspan, Chairman

Mr. McDonough, Vice Chairman

Mr. Ferguson

Mr. Gramlich

Mr. Hoenig

Mr. Jordan

Mr. Kelley

Mr. Meyer

Ms. Minehan

Ms. Phillips

Mr. Poole

Ms. Rivlin

Messrs. Boehne, McTeer, Moskow, and Stern, Alternate Members of the Federal

Open Market Committee

Messrs. Broaddus, Guynn, and Parry, Presidents of the Federal Reserve Banks of

Richmond, Atlanta, and San Francisco respectively

Mr. Kohn, Secretary and Economist

Mr. Gillum, Assistant Secretary

Mr. Mattingly, General Counsel

Mr. Prell, Economist

Mr. Truman, Economist

Ms. Browne, Messrs. Cecchetti, Dewald, Hakkio, Lindsey, Simpson, and Stockton,

Associate Economists

Mr. Fisher, Manager, System Open Market Account

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

Ms. Fox, Deputy Congressional Liaison, Office of Board Members, Board of

Governors

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

Messrs. Madigan and Slifman, 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

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

Ms. Garrett, Economist, Division of Monetary Affairs, Board of Governors

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

Governors

Mr. Kumasaka, Research Assistant, Division of Monetary Affairs, Board of

Governors

Messrs. Eisenbeis, Goodfriend, Hunter, Lang, Rolnick, and Rosenblum, Senior Vice

Presidents, Federal Reserve Banks of Atlanta, Richmond, Chicago, Philadelphia,

Minneapolis, and Dallas respectively

Messrs. Altig, Bentley, and Judd, Vice Presidents, Federal Reserve Banks of

Cleveland, New York, and San Francisco respectively

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

on March 31, 1998, were approved.

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

exchange markets during the period March 31, 1998, through May 18, 1998. 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 March 31, 1998, through May 18, 1998. By unanimous vote, the Committee ratified

these transactions.

The Manager informed the Committee of his intention to discuss with market participants

proposed changes in the procedures for lending securities from the System Open Market

Account. The changes would be intended to adapt the lending program to the evolving

structure of the U.S. Treasury securities market. They are designed to make System securities

lending more effective at helping to relieve occasional significant shortages of particular

securities, which could cause disruptions to the market. In a brief discussion, Committee

members sought clarification of some of the proposed details of the new program and how it

would fit with the Federal Reserve's broader responsibilities. Action to amend paragraph 2 of

the Authorization for Domestic Open Market Operations would be required at a later date

when the details of the new program had been decided upon after discussions with market

participants.

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 the economy continued to expand

rapidly in 1998. Strength in consumption, business outlays for durable equipment, and

homebuilding boosted growth in domestic final demand to a very rapid pace in the first

quarter, and there had been indications of slower expansion since then. However, weakening

net exports were exerting a considerable drag on economic growth. Moreover, the

extraordinary pace of inventory investment thus far this year might foreshadow less robust

expansion ahead. Payroll employment remained on a brisk uptrend, but industrial production

decelerated sharply after surging in the second half of last year. Despite indications of

persisting pressures on employment costs associated with tight labor markets, consumer price

inflation remained subdued, importantly reflecting large declines in energy prices.

Nonfarm payroll employment registered another large increase in April after a small decline

in March; these data, along with the still-low level of initial claims for unemployment

insurance in recent weeks, suggested that labor demand had remained robust thus far in 1998.

Hiring in the trade, finance and real estate, and services industries was brisk in April;

employment in construction retraced part of an apparently weather-related drop in March.

The number of manufacturing jobs declined in April for a second consecutive month. The

civilian unemployment rate fell sharply, to 4.3 percent in April, after having averaged around

4-3/4 percent since last November.

Industrial production rose somewhat over March and April after weakening earlier in the

year. Part of the slowdown this year, following rapid growth in the second half of last year,

was attributable to weakness in utility output associated with unusually warm winter weather

across much of the country. More importantly, though, manufacturing output had changed

little on balance in recent months. In April, a pickup in the production of business equipment,

particularly of information processing equipment, was largely offset by further declines in the

output of construction supplies, basic metals, and nondurable materials. The production of

consumer goods was unchanged. The factory operating rate eased further in April, reflecting

the continuing brisk expansion in manufacturing facilities and slow growth in output.

Consumer spending had remained strong this year in the context of robust gains in income

and household net worth and of very favorable consumer sentiment. Total retail sales rose

appreciably in April, boosted by increases in purchases of automobiles and nondurable

goods. Housing demand and residential construction activity also continued to increase at a

rapid pace this year. Home sales were at very high levels, reflecting the continuing

improvement in housing affordability as a result of declining mortgage rates. Although

housing starts slipped in April, they remained at an elevated level.

Business fixed investment rebounded sharply in the first quarter from a small decline in the

fourth quarter of 1997. A surge in expenditures on producers' durable equipment, notably on

computers, communications equipment, and heavy trucks, more than offset continued

weakness in outlays for nonresidential structures. While available indicators pointed to

further substantial gains in equipment purchases over coming months, data on construction

contracts offered little evidence of a pickup in nonresidential construction activity in the near

term, even though vacancy rates were declining and office rents were rising.

Business inventories increased at a very rapid pace in the first quarter, but with sales strong,

inventory-sales ratios remained within their ranges over the past year. In manufacturing,

stock accumulation slowed in March after increasing fairly rapidly in January and February.

At the wholesale level, inventories rose about in line with sales during the quarter, and in the

retail sector inventories built up at a greatly accelerated pace in the first quarter.

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

February from its average monthly rate in the fourth quarter. The value of exports declined

considerably in the January-February period, with most of the drop attributable to reduced

sales to Asian countries. The decrease in exports was concentrated in agricultural products,

industrial supplies, and machinery. The value of imports rose slightly, largely reflecting

higher amounts of imported automotive products and higher service payments. The available

information suggested that economic growth in continental Europe strengthened in the first

quarter, with strong domestic demand apparently offsetting the effects of Asian turmoil on

foreign trade. Robust domestic demand also continued to buoy the Canadian economy. By

contrast, economic activity in Japan contracted in the first quarter and decelerated sharply

further in Asian countries that had experienced financial turmoil.

Consumer prices were unchanged in March and rose moderately in April. Energy prices were

down slightly further in April after declining markedly in previous months, and food prices

increased a little; excluding food and energy, consumer price inflation picked up in April as

prices of services accelerated and prices of tobacco surged higher. Over the course of recent

months, core consumer inflation had accelerated to rates that were somewhat above those

registered earlier. Even so, on a year-over-year basis, the increases in total and core consumer

prices were substantially smaller over the twelve months ended in April than they were in the

year-earlier period; falling import prices apparently helped damp the goods component of the

index. At the producer level, price inflation of finished goods other than food and energy

picked up a bit in April, but it was considerably lower over the twelve months ended in April

than over the year-earlier interval. Inflation at earlier stages of production also remained

subdued. The rate of increase in hourly compensation of private industry workers slowed in

the first quarter, reflecting smaller advances in both the wage and benefit components of the

index; however, compensation costs accelerated appreciably on a year-over-year basis,

primarily as a result of faster growth in wages and salaries.

At its meeting on March 31, 1998, 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. However, in light of increased concerns that

growth in aggregate demand might outpace the expansion of the economy's potential for

some time, possibly generating inflationary imbalances in labor markets, the Committee

decided that the directive should include a bias toward the possible firming of reserve

conditions and a higher federal funds rate. The reserve conditions associated with this

directive were expected to be consistent with considerable moderation in the growth in M2

and M3 over the months ahead.

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. Though tax flows were heavy at times and reserves were drained

from depository institutions as tax payments spilled into Treasury deposits at the Federal

Reserve Banks, the federal funds rate averaged a little below its intended level over the

period. Most other market interest rates declined slightly on balance over the intermeeting

period; incoming data suggested that labor markets remained tight and that the economy

retained considerable upward momentum, but market participants evidently gave greater

weight to information indicating that wage and price inflation was well contained in the first

quarter. Share prices in U.S. equity markets rose further despite some reports of soft

corporate earnings, and equity prices in most other industrial countries also reached new

highs.

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

currencies changed little on balance over the period. The dollar declined considerably against

the German mark and other continental European countries amid signs of strong growth in

the German economy and further progress in resolving the outstanding issues associated with

next year's launch of the euro; French and German interest rates also rose slightly over the

period. The dollar appreciated somewhat against the yen; the announcement of a large fiscal

stimulus package and Japan's intervention in support of the yen did not offset indications of

further weakening in the Japanese economy and related declines in Japanese interest rates.

Other Asian financial markets came under renewed pressure after a brief period of relative

calm. The currencies of several key Asian emerging market economies depreciated

considerably against the dollar; and in sharp contrast to the performance of equity markets in

most industrial countries, prices in Asian equity markets declined substantially on balance

over the period to near their lows of late 1997 or early 1998.

M2 and M3 expanded briskly further in April, but data for late April and early May showed

M2 declining and M3 leveling out; much of the fluctuation in M2 during the April-May

period appeared to be related to movements of funds associated with unusually heavy

nonwithheld tax payments and a surge in mortgage refinancings to take advantage of lower

long-term rates. On balance, the underlying growth of these aggregates seemed to be slowing

from the pace of the first quarter. The moderation in M3 partly reflected a reduced need for

non-M2 sources of funds at a time when bank credit expansion seemed to be slowing.

Growth of total domestic nonfinancial debt apparently had slipped somewhat after picking up

earlier in the year.

The staff forecast prepared for this meeting indicated that the expansion of economic activity

would slow considerably during the next few quarters and remain moderate in 1999. Reduced

growth of foreign economic activity and the lagged effects of the sizable rise that had

occurred in the foreign exchange value of the dollar were expected to place substantial

restraint on the demand for U.S. exports and to add to the pressures on domestic producers to

hold down prices to meet import competition. An anticipated sharp slowdown in the pace of

inventory accumulation also would damp domestic production as the growth of stocks was

brought into balance with the expected more moderate trajectory of final sales. The staff

analysis suggested that further strong gains in income, along with the surge in household net

worth over the past several years, would support brisk, though gradually diminishing, gains

in consumer spending. Housing demand, fostered by the favorable cash flow affordability of

home ownership, was expected to remain at a generally high level, though the anticipated

slowing in income growth over the projection period would damp residential construction

activity somewhat. Substantial increases in capital spending would continue, but slower

growth in business sales and profits would produce a gradual deceleration. While pressures

on production resources were likely to abate to a degree as output growth slowed, inflation

was expected to increase somewhat from its recent pace in response to rising compensation

costs associated with persisting tightness in labor markets, a limited rebound in energy

prices, and a diminishing drag on non-oil import prices.

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

noted the exceptional strength in domestic final demand and viewed robust further expansion

in such demand as highly likely. Final purchases were being supported by accommodative

financial conditions, especially a rising equity market, by ebullient consumer sentiment, and

by business spending on productivity-enhancing equipment. While there were limited

indications of weakness in some sectors of the economy--such as manufacturing, energy, and

agriculture in some areas--the members did not see conclusive evidence of appreciable

moderation in the pace of the overall economic expansion. Nonetheless, they generally

believed that substantial moderation in the expansion was a likely prospect in coming

quarters, largely as a consequence of a marked slowing in inventory investment from the

clearly unsustainable pace of the first quarter and, to a lesser extent, from some further

weakness in net exports. The outlook for the latter was especially uncertain, and the

weakness could be greater than previously anticipated owing to renewed turmoil in emerging

Asian economies and pronounced weakness in Japan. Whether the moderation in U.S.

economic growth would be sufficient to forestall cost increases arising from tight labor

markets that in turn would add to pressures on prices was open to question. To date,

developments in business costs had been relatively benign, owing to an important extent to

somewhat faster productivity growth. This circumstance and a number of one-time influences

holding down costs and prices had contained inflation at rates that were lower than those

seen in several decades, and probably would continue to do so for a while. But the members

generally were concerned that inflation might begin to rise over the intermediate term,

especially if labor markets tightened further.

In their assessment of the factors underlying the persisting strength of aggregate final

demand, members took particular note of the effect of accommodative financial conditions.

The rapid growth in consumer spending was being bolstered by large gains in stock market

wealth; and the strength in housing and other interest-sensitive consumer expenditures also

reflected declines in nominal, and perhaps in real, intermediate- and long-term interest rates

and the ample availability of loans. Likewise, the ready availability of equity and debt

financing on favorable terms was a key factor in the continuing robust growth of business

investment. Indeed, some members expressed concern that the widespread perceptions of

reduced risk or complacency that had bolstered equity prices beyond levels that seemed

justified by fundamentals were beginning to be felt in a variety of other markets as well,

including commercial and residential properties, business ventures, and land. In the view of a

number of members, rapid growth of the monetary aggregates, though it had slowed very

recently, was a further indication that financial conditions were not restraining economic

activity.

Despite the failure of domestic demand to moderate in line with their earlier expectations, the

members were persuaded that appreciable slowing in the growth of economic activity was a

likely prospect over the course of coming quarters even though its exact timing and extent

were unknown. Key elements in this assessment were the outlook for inventories and net

exports. The surge in inventory accumulation in the first quarter did not appear to have

resulted in overall stock imbalances as evidenced by stock-sales ratios or anecdotal reports.

Even so, growth in inventory investment at a pace sharply exceeding the sustainable growth

of final sales was unlikely to continue for an extended period. Given the ample availability of

industrial capacity and the related absence of pressures on lead or delivery times, business

firms did not need to build precautionary stocks. Thus, inventory investment was likely to

respond to the expected deceleration in final sales over coming quarters. Some members

expressed reservations about the probable extent of the deceleration in the period ahead,

especially in the context of their expectations of a still relatively robust uptrend in final sales.

Developments in Asia clearly were having adverse effects on a number of U.S. industries,

but the overall effects on the U.S. economy appeared to have been limited thus far. Indeed,

the direct effects of the Asian financial and economic problems on U.S. trade over time

needed to be weighed against their indirect but positive effects in the near term in helping to

hold down U.S. interest rates and in reducing the prices of oil and other imported

commodities. However, members were concerned that, as evidenced by the most recent

developments, conditions in Asian financial markets and economies were deteriorating

further, with potentially adverse consequences for net U.S. exports. Of particular concern in

this regard was the possibility of worsening economic conditions in Japan and the negative

implications not only for U.S. trade with Japan but for worldwide trade and financial

markets. Some members also commented that unsettled financial and economic conditions in

East Asia could tend to exacerbate the economic problems of several important emerging

economies in other parts of the world, including major Latin American trading partners of the

United States. On balance, forecasts of a limited further drag on U.S. net exports from

developments in Asia were subject to substantial uncertainty, with the risks tilted toward a

greater effect on the U.S. economy than had been anticipated earlier. Moreover, the lingering

effects of the dollar's appreciation last year against a broad array of currencies would

continue to depress the nation's foreign trade position for some time.

The decline in the unemployment rate to its lowest level in nearly three decades underscored

anecdotal reports of further tightening in labor markets in recent months and added to

concerns about the outlook for inflation. Though the first-quarter data had not suggested as

steep an increase as a number of observers had anticipated, labor compensation clearly was

trending higher. But as suggested by the rise until recently in profit margins, businesses had

been able to realize productivity gains that tended to offset the faster increases in

compensation costs. Indeed, while the most recent data were difficult to read, once likely

revisions were taken into account productivity improvements could well be on a steeper

uptrend than had been estimated earlier. Even so, the members remained concerned that if

pressures on labor resources continued to intensify, the associated increases in labor

compensation would at some point significantly exceed the gains in productivity. The

resulting pressures on prices might be muted, but probably only for a time, by the inability of

many business firms in highly competitive markets to raise their prices or to raise them

sufficiently to offset rising costs. Some members emphasized that a number of developments

that had held down prices, including the dollar's sizable appreciation last year, the drop in

world oil prices, and the downtrend in employee benefit cost increases were unlikely to be

repeated over the coming year and could even be reversed to a degree. Members

acknowledged, however, that the nexus between labor market tightness, accelerating labor

costs, and the effects on price inflation was very difficult to ascertain and analyses based on

earlier patterns that pointed to rising inflation had proved consistently wrong in recent years.

In the Committee's discussion of monetary policy for the intermeeting period ahead, a

majority of the members indicated that they preferred or could accept an unchanged policy.

These members also expressed a preference for retaining the asymmetric instruction in the

directive that the Committee had adopted at the previous meeting. In this view, the

uncertainties in the outlook for economic expansion and inflation remained sufficiently great

to warrant a continued wait-and-see policy stance. Considerations underlying this view

included the possibility that financial and economic conditions in Asia might worsen further

and exert a stronger retarding effect on the performance of the U.S. economy than presently

seemed to be in train. A good deal of uncertainty also surrounded the potential extent to

which developments in the domestic economy, notably the pace of inventory accumulation

over coming months, might foster slower economic expansion and the related degree to

which pressures in labor markets would be affected. Moreover, considerable questions

remained about the relationship of labor market pressures to inflation. In these circumstances,

it was possible that inflation would continue to be contained, though the risks clearly seemed

to be tilted in the direction that action would become necessary at some point to keep

inflation low.

While a delay in implementing a tighter policy that ultimately proved to be needed to curb

rising inflation involved some risks, many of the members concurred in the view that the

potential costs of postponing action for a limited time were small. By some measures,

inflation had continued to drop in the first quarter, and the appreciation of the dollar, reduced

commodity prices, and low--if not declining--inflation expectations would help to hold down

nominal wage increases and price pressures for some time, even if, as a number of members

suspected, the economy was now producing beyond its long- run potential. Forecasts of

rising inflation had proved unreliable and needed to be viewed in light of the considerable

uncertainties surrounding them. The members recognized, however, that the longer any

needed action was delayed, the more important it would be to take prompt and perhaps

vigorous action once the danger of rising inflation became clearer.

Another reason for not taking action at this meeting was the possibility that even a modest

tightening action could have outsized effects on the already very sensitive financial markets

in Asia. The resulting unsettlement could have substantial adverse repercussions on U.S.

financial markets and, over time, on the U.S. economy. Many of the members emphasized,

however, that market considerations could not be allowed to jeopardize the effective conduct

of a U.S. monetary policy aimed at an optimal performance of the U.S. economy. Indeed,

such a performance would best serve the interests of troubled financial markets and

economies abroad.

A number of members indicated that the decision was a close call for them. In this regard,

some emphasized that financial conditions were very accommodative in terms of the ample

availability of financing to most borrowers on very attractive terms and increases in equity

prices. Several expressed concern that the persistence of quite rapid monetary growth this

year was symptomatic of a monetary policy that was not positioned to restrain ebullient

domestic demand sufficiently, even if short-term real interest rates were quite high. Although

some of these members could accept postponing action for the present to await further

information on the balance of risks, two members, while acknowledging the uncertainties

that surrounded the economic outlook, indicated a strong preference for tightening the stance

of policy at this meeting. They believed that current policy was accommodating excessive

strength in aggregate demand that very likely would be felt in higher inflation before long.

Prompt tightening was needed to avert the necessity of stronger and potentially disruptive

policy actions later to contain inflation.

All the members who intended to vote for an unchanged policy at this meeting supported the

retention of a directive that was biased toward restraint. In their view, current developments

did not call for any policy action, at least at this meeting, but because they felt the risks were

tilted in the direction of rising inflation, a policy tightening move, possibly in the near future,

was a likely though not an inevitable prospect.

At the conclusion of the Committee's discussion, all but two of the members 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 contained a bias toward the

possible firming of reserve conditions and a higher federal funds rate. 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

considerable moderation in the growth of M2 and M3 over the months ahead.

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 grow rapidly in 1998. Nonfarm payroll employment registered

another substantial increase in April after a slight decline in March, and the

civilian unemployment rate fell to 4.3 percent in April. However, factory output

has changed little on balance in recent months. Retail sales grew appreciably in

April, and consumer spending as a whole has been very strong this year.

Residential sales and construction also have strengthened this year. Business

fixed investment rebounded sharply in the first quarter after having declined

slightly in the fourth quarter, and available indicators point to continuing

strength over coming months. Business inventories appear to have increased

very rapidly in the first quarter. The nominal deficit on U.S. trade in goods and

services widened substantially in January and February from its average monthly

rate in the fourth quarter. Despite indications of persisting pressures on

employment costs associated with tight labor markets, price inflation has

remained subdued this year, primarily as a consequence of large declines in

energy prices.

Most market interest rates have declined slightly on balance over the

intermeeting period. Share prices in U.S. equity markets have moved up a little

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

terms of major currencies has changed little on net over the period. However, the

dollar has risen on balance against the currencies of key emerging market

economies, particularly those in Asia. Equity markets in Asia have fallen

substantially over the period to near their lows of late 1997, while those in

Europe have risen to new highs.

M2 and M3 expanded briskly further in April, but data for late April and early

May show M2 declining and M3 leveling out. The swing in these measures

seemed to be related largely to movements of funds associated with tax

payments. Expansion of total domestic nonfinancial debt appears to have

moderated somewhat after a pickup earlier in the year.

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 February

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

respectively, measured from the fourth quarter of 1997 to the fourth quarter of

1998. The range for growth of total domestic non- financial debt was set at 3 to 7

percent for the year. The behavior of the monetary aggregates will continue to be

evaluated in the light of progress toward price level stability, movements in their

velocities, and developments in the economy and financial markets.

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

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 considerable moderation in the

growth in M2 and M3 over coming months.

Votes for this action: Messrs. Greenspan, McDonough, Ferguson, Gramlich,

Hoenig, Kelley, Meyer, Mses. Minehan, Phillips, and Rivlin.

Votes against this action: Messrs. Jordan and Poole.

Mr. Poole dissented because he believed that the sustained increase in money growth in

recent quarters and associated accommodative conditions in the credit markets pointed to

rising inflation. Although faster productivity growth suggested that trend output growth

might be modestly higher than previously thought, the growth rate of aggregate demand over

the past two years clearly had exceeded the economy's long-run growth potential. Without a

reduction of aggregate demand growth, inflation would rise. In his view, the Federal Reserve

should therefore take prompt action to reduce money growth to limit the rise in inflation and

to avoid an increase in longer-term inflation expectations, which would tend to destabilize

aggregate employment and financial markets.

Mr. Jordan also noted that the monetary and credit aggregates had accelerated further from

already rapid growth rates in 1997. In his view, these high growth rates were fueling

unsustainably rapid increases of real estate and other asset prices, and reports of "too much

cash chasing too few deals" were becoming more frequent. Anticipated gains on both real

and financial investments had risen relative to the cost of borrowed funds. In these

circumstances, it was increasingly likely that the Committee would face a choice between

smaller increases in interest rates sooner versus larger increases later. He added that

maximum sustainable economic growth occurs when businesses and households act on the

assumption that the dollar will maintain its value over time, and nothing he had heard from

consumer groups, bankers, or other business people in his District led him to believe that

decisions were being made in the expectation that the purchasing power of the dollar would

be stable. Furthermore, expectations that market values of income-producing investments

would continuously rise relative to underlying earning streams were not consistent with a

stable purchasing power of money. He also believed that the view that real interest rates

currently were high was not confirmed by observed behavior. Bankers told him that both

consumers and businesses believed that credit was cheap and plentiful. These potentially

inflationary conditions and imbalances in the economy were not conducive to sustained

maximum growth.

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

June 30-July 1, 1998.

The meeting adjourned at 1:35 p.m.

Donald L. Kohn

Secretary

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