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 16,

2000, at 9:00 a.m.

Present:

Mr. Greenspan, Chairman

Mr. McDonough, Vice Chairman

Mr. Broaddus

Mr. Ferguson

Mr. Gramlich

Mr. Guynn

Mr. Jordan

Mr. Kelley

Mr. Meyer

Mr. Parry

Mr. Hoenig, Ms. Minehan, Messrs. Moskow and Poole, Alternate Members of the

Federal Open Market Committee

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

Minneapolis respectively

Mr. Kohn, Secretary and Economist

Mr. Bernard, Deputy Secretary

Ms. Fox, Assistant Secretary

Mr. Gillum, Assistant Secretary

Mr. Mattingly, General Counsel

Mr. Baxter, Deputy General Counsel

Ms. Johnson, Economist

Mr. Prell, Economist

Mr. Beebe, Ms. Cumming, Messrs. Eisenbeis, Howard, Lindsey, Reinhart, Simpson,

Sniderman, 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 Slifman, Associate Directors, Divisions of Monetary Affairs

and Research and Statistics respectively, Board of Governors

Messrs. Oliner and Whitesell, Assistant Directors, Divisions of Research and

Statistics and Monetary Affairs respectively, Board of Governors

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

Governors

Messrs. Rives and Stone, First Vice Presidents, Federal Reserve Banks of St. Louis

and Philadelphia respectively

Messrs. Hakkio, Hunter, Lacker, Lang, Rasche, Rolnick, and Rosenblum, Senior Vice

Presidents, Federal Reserve Banks of Kansas City, Chicago, Richmond, Philadelphia,

St. Louis, Minneapolis, and Dallas respectively

Messrs. Bentley and Kopcke, Vice Presidents, Federal Reserve Banks of New York

and Boston respectively

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

on March 21, 2000, were approved.

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

foreign exchange markets. There were no open market operations in foreign currencies for

the System's account in the period since the previous meeting, 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 21, 2000, through May 15, 2000. The Committee ratified these transactions by

unanimous vote.

With Mr. Broaddus dissenting, the Committee voted to extend for one year beginning in

mid-December 2000 the reciprocal currency ("swap") arrangements with the Bank of Canada

and the Bank of Mexico. The arrangement with the Bank of Canada is in the amount of $2

billion equivalent and that with the Bank of Mexico in the amount of $3 billion equivalent.

Both arrangements are associated with the Federal Reserve's participation in the North

American Framework Agreement, which was established in 1994. Mr. Broaddus dissented

because he believed that the swap lines existed primarily to facilitate foreign exchange

market intervention, and he was opposed to such intervention for the reasons he had

expressed at the February meeting.

The Manager discussed some aspects of a suggested approach to the management of the

System's portfolio over coming quarters prior to the Committee's review of an ongoing study

relating to the conduct of open market operations in a period of substantial declines in

outstanding Treasury debt. During that interim, the management of the System portfolio

should try to satisfy a number of objectives: keeping the maturity of the portfolio from

lengthening materially; meeting long-run reserve needs to the extent possible through

outright purchases of Treasury securities without distorting the yield curve or impairing the

liquidity of the market; and concentrating expansion of the System portfolio in "off-the-run"

securities in the secondary market to help to maintain liquid markets in benchmark securities.

It was important to announce a strategy to allow market participants to take the System's

operations into account as they adapted to the declining Treasury debt levels. While no

specific blueprint could be given at this point regarding future Desk operations, the members

encouraged the Manager to discuss his plans with Treasury officials.

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

implementation of monetary policy over the intermeeting period ahead.

The information reviewed at this meeting suggested that economic growth had remained

rapid through early spring. Consumer spending and business fixed investment were still

trending upward strongly, and housing demand was holding at a high level. Industrial

production and nonfarm payrolls were expanding briskly in response to burgeoning domestic

demand, but the strength of demand was also showing through in the form of rising imports.

Labor markets continued to be very tight, and some measures of labor costs and price

inflation showed signs that they might be picking up.

Employment surged in March and April. Part of the pickup resulted from a step-up in

government hiring of census workers, but gains in private employment were very large over

the two months. Job growth in retail trade and services was robust, and employment in

manufacturing and construction trended higher. The civilian unemployment rate dropped in

April to 3.9 percent, a thirty-year low.

Industrial production accelerated in April after a strong gain in the first quarter.

Manufacturing, notably in high-tech industries, led the way, but growth in mining and

utilities also was sizable. The pickup in manufacturing lifted the factory operating rate

further, and capacity utilization in April was about equal to its long-term average.

Consumer spending increased very rapidly in the first quarter but apparently decelerated

early in the second quarter. Nominal retail sales were down slightly in April after brisk gains

in February and March. Sales slumped at durable goods stores and changed little at

nondurable goods outlets. However, the underlying trend in spending remained strong as a

result of robust expansion of disposable incomes, the large accumulated gains in household

wealth, and very positive consumer sentiment.

Residential housing activity stayed at an elevated level in April; total private housing starts

edged higher while starts of multifamily units partially reversed a sharp drop in March. Sales

of both new and existing single-family homes rose in March (latest data). The persisting

strong demand for housing during a period of rising mortgage rates apparently was being

underpinned by the rapid growth of jobs and the accumulated gains in stock market wealth.

Business fixed investment was up sharply in the first quarter after a sluggish performance

late last year. The pickup encompassed both durable equipment and software and

nonresidential structures. Shipments of computing and communications equipment surged

following the century rollover, and shipments of other non-aircraft capital goods recorded an

unusually large rise as well. Moreover, the recent strength in orders for many types of

equipment pointed to further advances in capital spending in coming months. Expenditures

for nonresidential structures, which had turned up last autumn, rose rapidly in the first

quarter; unusually favorable weather over the two quarters likely was a contributing factor.

The upturn in nonresidential building activity was spread broadly across the major types of

structures.

The pace of accumulation of manufacturing and trade inventories slowed somewhat in the

first quarter following a sizable buildup in late 1999, and the aggregate inventory-sales ratio

edged down from an already very low level. Stockbuilding by manufacturers and merchant

wholesalers picked up slightly in the first quarter, but stocks remained at low levels in

relation to sales. By contrast, inventory investment slowed among retailers. Part of this

slowdown might have involved a liquidation of precautionary stocks built up in anticipation

of the century date change. The inventory-sales ratio in this sector was at a historically lean

level.

The U.S. trade deficit in goods and services reached another new high in February as the

value of imports rose sharply further and the value of exports changed little. For the JanuaryFebruary period, the moderate rise in exports and the sharp increase in imports from fourthquarter levels were spread across most major trade categories. The available information

suggested that economic expansion remained robust in most foreign industrial economies.

The recent decline in the exchange value of the euro was spurring economic activity in the

euro area, and Canada was benefiting from spillovers from the U.S. economy. For the

Japanese economy, which had been the notable exception among the foreign industrial

economies, there were indications of some strengthening of aggregate demand during the

first five months of the year. Economic activity in the developing countries also continued to

pick up. Key South American countries were recovering from recent recessions, while

several Asian emerging-market countries were settling into growth at more sustainable rates.

Recent information suggested that price inflation might be picking up slightly and only partly

as a direct result of increases in energy prices. Although consumer prices were unchanged in

April, they recorded sizable step-ups in February and March; moreover, while the rise in core

consumer prices over the twelve months ended in April was the same as the change in the

year-earlier twelve-month period, core consumer price inflation was up slightly in the

March-April period compared with other recent months. At the producer level, prices of

finished goods other than food and energy edged higher in March and April, but the increase

over the twelve months ended in February was a little smaller than the rise over the preceding

twelve months. With regard to labor costs, the employment cost index for hourly

compensation of private industry workers registered a larger advance in the first quarter than

in previous quarters, and the rate of increase in compensation over the year ended in March

was substantially larger than the rise over the year-earlier period. Faster growth in benefits

accounted for more than half of the acceleration. Average hourly earnings of production or

nonsupervisory workers grew at a slightly faster rate in April than in March, and the increase

for the twelve months ended in April was larger than for the previous twelve-month period.

At its meeting on March 21, 2000, the Committee adopted a directive that called for a slight

tightening of conditions in reserve markets consistent with an increase of ¼ percentage point

in the federal funds rate to an average of about 6 percent. The members saw substantial risks

of rising pressures on labor and other resources and of higher inflation, and they agreed that

the tightening action would help bring the growth of aggregate demand into better alignment

with the sustainable expansion of aggregate supply. They also noted that even with this

additional firming the risks were still weighted mainly in the direction of rising inflation

pressures and that more tightening might be needed.

Open market operations during the intermeeting period were directed toward implementing

the desired slightly tighter pressure on reserve positions, and the federal funds rate averaged

very close to the Committee's 6 percent target. The Committee's action and its announcement

were widely anticipated and had little initial effect on financial markets. Later in the week,

however, market interest rates moved up in response to the release of the minutes of the

February meeting and the mention therein of some sentiment for a larger policy tightening

than had been undertaken. Subsequently, interest rates fell as stock prices tumbled over the

first half of April, when investors seemed to revise downward their assessments of equity

valuations, especially those of more speculative technology shares that previously had risen

considerably. Interest rates more than reversed those declines, however, when stock prices

began to level out and incoming data suggested that aggregate demand continued to expand

faster than potential supply and that wage and price developments were becoming more

worrisome. On balance over the intermeeting period, private interest rates moved up

appreciably while Treasury yields increased somewhat less. Most major indexes of equity

prices declined significantly over the intermeeting period.

In foreign exchange markets, the trade-weighted value of the dollar appreciated considerably

over the intermeeting period against a basket of major currencies, reflecting in part the larger

intermeeting increase in U.S. long-term yields relative to rates in most foreign industrial

countries. The dollar's rise against the euro was sizable, but the dollar also made moderate

gains against the British pound, the Japanese yen, and the Canadian dollar. The dollar also

appreciated somewhat against the currencies of a group of other important trading partners,

notably the Mexican peso and the Brazilian real.

Growth of M2 picked up further in April from its already strong pace in March, as

households boosted their liquid balances to meet higher-than-usual levels of final payments

on 1999 taxes. In contrast, M3 growth slowed considerably in April after a robust March

advance. From the fourth quarter of 1999 through April, M2 and M3 expanded at rates well

above the upper ends of their annual ranges for 2000. Total domestic nonfinancial debt

continued to expand at a pace in the upper portion of its range.

The staff forecast prepared for this meeting continued to suggest that the expansion would

gradually moderate from its currently elevated pace to a rate around, or perhaps a little

below, the growth of the economy's estimated potential. The expansion of domestic final

demand increasingly would be held back by the anticipated waning of positive wealth effects

associated with earlier large gains in equity prices and by higher interest rates. As a result,

the growth of spending on consumer durables and houses was expected to slow; in contrast,

however, overall business investment in equipment and software was projected to remain

robust, partly because of the upward trend in replacement demand, especially for computers

and software. In addition, continued solid economic growth abroad was expected to boost the

growth of U.S. exports for some period ahead. Core price inflation was projected to rise

noticeably over the forecast horizon, partly as a result of higher import prices and some

firming of gains in nominal labor compensation in persistently tight labor markets that would

not be fully offset by productivity growth.

In the Committee's review of current and prospective economic and financial developments,

members focused on persisting indications that aggregate demand was expanding more

rapidly than potential supply and that pressures on labor and other producer resources were

continuing to increase. While there were tentative signs that the growth in demand might be

moderating in some key sectors of the economy, such as retail sales and housing, clear-cut

evidence of any significant deceleration in the rapid growth of aggregate demand was

lacking. Bond yields and other financial conditions had firmed to some extent recently, but

those adjustments had been influenced by the buildup in market expectations of more

monetary policy tightening. In the absence of further monetary restraint, any slowing over

coming quarters was not viewed as likely to be sufficient to avert increasing pressures on the

economy's already strained resources and rising inflation rates that would undermine the

economy's remarkable performance. Adding to concerns about heightened inflation pressures

was statistical and anecdotal evidence that could be read as suggesting that underlying

inflation already was beginning to pick up. Unit costs, however, were still remarkably

subdued and members saw no developments at this stage that might augur a sharp near-term

deterioration in price inflation.

In their assessment of business conditions across the country, members commented on

continuing indications of robust economic activity in all regions and widely increasing

pressures on labor and other resources. Indeed, economic activity appeared to have grown

appreciably further from already elevated levels in numerous parts of the country, although

the latest regional data and anecdotal reports provided scattered indications that business

conditions might be starting to soften in some areas. In this regard, members referred to the

emergence of slightly more cautious attitudes on the part of some business executives

concerning the prospects for their industries.

With respect to developments in key expenditure sectors of the economy, growth in

consumer spending was expected to slow from the exceptional pace of the first quarter,

though still likely to be relatively robust. Retail sales had edged lower in April, but members

commented that it was too early to gauge whether this softening was a harbinger of a more

moderate trend. Consumer sentiment had remained upbeat in the context of an extended

period of sizable expansion in employment and incomes and the sharp rise in stock market

prices over the course of recent years. Some members observed that the slightly less ebullient

consumer behavior recently might have been influenced to some extent by the volatility and

downward movement in the stock market over the course of the past several weeks. Higher

financing costs probably also were beginning to play a role. Looking ahead, the experience of

recent years amply demonstrated the difficulty of forecasting the performance of the stock

market. The failure of further large increases to materialize, should that occur, would over

time imply a more neutral or even a negative net impact from wealth once the positive effects

of the earlier advance had played themselves out, but the latter would take some time.

The same background factors were likely to govern the prospective behavior of housing

activity. The evidence of a downturn in homebuilding was still quite marginal, but some

anecdotal reports suggested that higher mortgage rates were starting to exert a retarding

influence on housing demand. Even so, members continued to identify areas of remarkable

strength across the nation, and overall housing construction remained at an elevated level. On

the assumption of further growth in jobs and incomes in line with current forecasts and

absent markedly higher mortgage financing costs, housing activity might reasonably be

expected to settle at a level a bit below recent highs.

Business investment spending retained strong upward momentum, though it had exhibited an

uneven growth pattern in recent quarters that importantly reflected Y2K effects. Looking

ahead, further rapid growth was expected in spending for business equipment and software in

light of likely ongoing efforts to hold down costs by substituting capital embodying advanced

technology for scarce labor resources. Recent order trends and rising capacity utilization

rates were consistent with this expectation. Expenditures on nonresidential structures and

other construction generally had strengthened in recent months, and members expected them

to be well maintained in part because of heavy spending on roads and other public projects

by state and local governments.

The foreign trade sector of the economy was projected to provide less of a safety valve for

the accommodation of domestic demand going forward. Although a number of foreign

nations continued to face political and economic problems, the strengthening economies of

many U.S. trading partners would tend to limit the availability of excess foreign production

capacity to help meet the growth in U. S. demand. At the same time, foreign demand for U.S.

goods and services would be expanding, thereby adding to demand pressures on U.S.

producer resources, other things equal. In the latter regard, several members mentioned

anecdotal evidence of growing export demand for a variety of domestic products.

In their discussion of the outlook for inflation, the members focused on statistical and

anecdotal indications of further tightening of labor resources, acceleration in some measures

of labor compensation, and early signs of a possible upturn in underlying price inflation. Data

on employment, reinforced by anecdotal commentary from around the country, continued to

provide evidence of extremely tight labor markets, which at least in some parts of the country

appeared to have tightened further since early in the year. Business contacts spoke of

spending a great deal of time and expense to attract and retain workers while concomitantly

persisting in efforts to improve the productivity of their operations to accommodate

burgeoning growth in demand in the face of labor force constraints. There were more reports

that rising wages and benefits and increasing costs of nonlabor inputs could no longer be

fully offset by improvements in productivity, and more business firms appeared to be

attempting or considering increases in their selling prices to maintain or improve their profit

margins. However, their ability to set higher prices, or at least to raise them significantly,

continued to be severely constrained by the persistence of strong competition across much of

the economy. Indeed, examples of successful efforts to mark up prices, which tended to be

concentrated in products using oil-related inputs, were still the exception. Even so, the

members believed that the risks of acceleration in core prices were now appreciably higher

given current trends in aggregate demand, pressures on resources, and developments in

foreign economies.

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

endorsed a proposal to tighten reserve conditions sufficiently to raise the federal funds rate

by ½ percentage point to a level of 6-1/2 percent. A more forceful policy move than the 25

basis point increases that had been implemented since mid-1999 was desirable in light of the

extraordinary and persisting strength of overall demand, exceeding even the increasingly

rapid growth of potential supply, and the attendant indications of growing pressures in

already tight markets for labor and other resources. The strength in demand might itself be, at

least in part, the result of the ongoing acceleration of productivity, with the latter feeding

back on demand through higher equity prices and profitable investment opportunities.

Financial markets seemed to have recognized the need for real interest rates to rise further

under these circumstances, and while market assessments were not always correct, the

evidence suggested that a more substantial tightening at this meeting was needed to limit

inflation pressures. The members saw little risk in a relatively aggressive policy move, given

the strong momentum of the expansion and widespread market expectations of such a move.

The greater risk to the economic expansion at this point was for policy to be too sluggish in

adjusting, thereby allowing inflationary disturbances and dislocations to build. A 50 basis

point adjustment was more likely to help forestall a rise in inflationary expectations that, at

least in the opinion of some members, already showed signs of worsening. A widespread

view that the Federal Reserve would take whatever steps were needed to hold down inflation

over time probably had contributed to the persistence of subdued long-run inflation

expectations during an extended period when rapidly rising demand was pressing on limited

supply resources. Today's policy move would undergird such relatively benign expectations

and help assure the success of the Committee's policy.

The members agreed that the balance of risks sentence that would be included in the press

statement to be released shortly after this meeting should indicate, as it had for other recent

meetings, that even after today's tightening action the members believed the risks would

remain tilted toward rising inflation. This view of the risks was based primarily on the

persisting momentum of aggregate demand growth and the unusually high level of labor

resource utilization. At the same time, a number of the members commented that they did not

want to prejudge the potential extent or pace of future policy tightening and that the

Committee should continue to assess the need for further policy moves in the light of

evolving economic conditions to be reviewed on a meeting-by-meeting basis.

At the conclusion of this discussion, the Committee voted to authorize and direct the Federal

Reserve Bank of New York, until it was instructed otherwise, to execute transactions in the

System Account in accordance with the following domestic policy directive:

The Federal Open Market Committee seeks monetary and financial conditions

that will foster price stability and promote sustainable growth in output. To

further its long-run objectives, the Committee in the immediate future seeks

conditions in reserve markets consistent with increasing the federal funds rate to

an average of around 6-1/2 percent.

The vote also encompassed approval of the sentence below for inclusion in the press

statement to be released shortly after the meeting:

Against the background of its long-run goals of price stability and sustainable

economic growth and of the information currently available, the Committee

believes the risks are weighted mainly toward conditions that may generate

heightened inflation pressure in the foreseeable future.

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

Gramlich, Guynn, Jordan, Kelley, Meyer, and Parry.

Votes against this action: None.

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

June 27-28, 2000.

The meeting adjourned at 1:05 p.m.

Donald L. Kohn

Secretary

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