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 15,

2001, starting at 9:00 a.m.

Present:

Mr. Greenspan, Chairman

Mr. McDonough, Vice Chairman

Mr. Ferguson

Mr. Gramlich

Mr. Hoenig

Mr. Kelley

Mr. Meyer

Ms. Minehan

Mr. Moskow

Mr. Poole

Messrs. Jordan, McTeer, Santomero, 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

Ms. Fox, Assistant Secretary

Mr. Mattingly, General Counsel

Ms. Johnson, Economist

Mr. Stockton, Economist

Ms. Cumming, Messrs. Fuhrer, Hakkio, Howard, Lindsey, Rasche, Reinhart, Slifman,

and Wilcox, Associate Economists

Mr. Kos, Manager, System Open Market Account

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

Mr. Simpson, Senior Adviser, Division of Research and Statistics, Board of

Governors

Messrs. Connors, 1 Madigan, Oliner, and Struckmeyer, Associate Directors,

Divisions of International Finance, Monetary Affairs, Research and Statistics, and

Research and Statistics, Board of Governors

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

Mr. Skidmore, Special Assistant to the Board, Office of Board Members, Board of

Governors

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

Governors

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

Governors

Mr. Connolly, First Vice President, Federal Reserve Bank of Boston

Messrs. Beebe, Eisenbeis, and Goodfriend, Mses. Mester and Perelmuter, Messrs.

Rosenblum and Sniderman, Senior Vice Presidents, Federal Reserve Banks of San

Francisco, Atlanta, Richmond, Philadelphia, New York, Dallas, and Cleveland

respectively

Mr. Sullivan, Vice President, Federal Reserve Bank of Chicago

Mr. Weber, Senior Research Officer, Federal Reserve Bank of Minneapolis

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

on March 20, 2001, 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.

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 20, 2001, through May 14, 2001. By unanimous vote, the Committee ratified

these transactions.

By unanimous vote, the Committee approved the extension for one year beginning in

December 2001 of the System's 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. The early vote to renew the System's participation

in the swap arrangements maturing in December relates to the provision that each party must

provide six months prior notice of an intention to terminate its participation.

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 economic expansion remained

very sluggish. Household spending, especially for housing and motor vehicles, had held up

relatively well, but business investment was quite weak and appeared to be decreasing

further. Persistent inventory overhangs in a number of sectors had led to additional

substantial cuts in manufacturing production. Reflecting in part the downtrend in

manufacturing output, labor demand had weakened considerably and unemployment had

risen. Price inflation had picked up a little but, abstracting from energy, had remained

relatively subdued.

Private nonfarm payroll employment fell sharply in April after a small drop in March.

Manufacturing, construction, and the service sector recorded large payroll declines in April,

and gains elsewhere were small. The unemployment rate increased further, to 4.5 percent in

April, and initial claims for unemployment insurance averaged over the four weeks ended

April 28 were at their highest level since 1993.

Industrial production declined appreciably further in April. Manufacturing output registered a

seventh consecutive monthly drop, while a robust boost to mining activity associated with

strong gains in crude oil and gas production was offset by a decrease in utilities output in a

period of unusually warm weather. In manufacturing, the production of motor vehicles and

parts was unchanged in April after having surged in February and March, but the output of

high-tech equipment continued to trend steeply downward, and there was widespread

weakness in the manufacture of other industrial products. Reflecting the production cutbacks,

the rate of utilization of manufacturing capacity fell even further below its long-run average.

Consumer spending had held up relatively well thus far this year despite the deceleration in

personal incomes, reduced household net worth, and deterioration in consumer sentiment

since last autumn. After a solid first-quarter gain, nominal retail sales rose briskly in April,

reflecting strong outlays at general merchandise and apparel stores, building and material

outlets, and automotive dealers. Growth of spending on services slowed in the first quarter

(latest data), partly because of a weather-related drop in consumption of energy services.

Low mortgage rates continued to provide support to residential building activity. The firstquarter average for total housing starts was the strongest quarterly reading in a year despite a

March decline in starts that might have been exaggerated by unusual weather patterns. In

addition, sales of new and existing homes remained brisk through March. New home sales

reached a new high in March, and sales of existing homes were only a little below their

record high in June 1999.

Against the background of a sluggish economy and deteriorating earnings, business capital

spending on equipment and software declined somewhat further in the first quarter. Increased

purchases of cars and trucks were among the few areas of strength in business equipment

expenditures; elsewhere, outlays for high-tech equipment decreased on a quarterly basis for

the first time since the 1990 recession, and spending for equipment such as industrial

machinery changed little. Moreover, recent data on orders for nondefense capital goods

suggested that some further slippage in future spending for equipment was likely. By

contrast, nonresidential construction continued to expand briskly; expenditures for oil and

gas exploration surged in the first quarter, and nonresidential building activity continued at a

rapid pace, with sizable gains recorded for most major categories of buildings.

Business inventories on a book-value basis fell steeply further in March, with roughly half of

the decline reflecting a runoff of motor vehicle stocks at the wholesale and retail levels.

Despite the sharp liquidation of inventories in the manufacturing sector in February and

March, the aggregate inventory-shipments ratio for that sector edged higher in March to a

level well above that of a year ago. In the wholesale trade sector, aggregate stocks dropped

somewhat on balance in the first quarter and the sector's stock-sales ratio edged lower;

nonetheless, the sector's ratio in March also was above its level of a year earlier. Retail

inventories ran off in February and March after a small January rise, and the sector's

inventory-sales ratio decreased somewhat on balance to around the middle of its range for the

past twelve months.

The U.S. trade deficit in goods and services narrowed considerably in February, reflecting a

further rise in the value of exports and a sharp drop in the value of imports. The average

deficit for the first two months of the year was smaller than that for the fourth quarter.

Nonetheless, exports for the January-February period were below the fourth-quarter average,

with notable declines occurring in automotive products, industrial supplies, and

semiconductors. The slowdown in imports in January-February was broadly spread across

trade categories, with the largest decreases occurring in automotive products, high-tech

goods, and oil. Recent information indicated that economic activity in the foreign industrial

countries had decelerated since the fourth quarter. Expansion in the euro area, the United

Kingdom, and Canada appeared to have slowed significantly, while the Japanese economy

seemed to have faltered after a brief rebound late last year. In addition, economic growth in

the major developing countries had softened markedly, with the slowdown in most of those

countries reflecting weaker external demand.

Overall inflation had been held down thus far this year by a deceleration in energy prices, but

by some measures core price inflation had picked up a bit. The total consumer price index

(CPI) increased moderately in February and March (latest data), and the increase in that

index during the past twelve months was smaller than that during the previous twelve-month

period, reflecting reduced increases in energy prices. By contrast, core CPI inflation picked

up slightly in the February-March period and on a year-over-year basis. However, inflation as

measured by the core personal consumption expenditure (PCE) chain-type price index,

though also running a little higher in February-March, recorded a small decline on a

year-over-year basis. At the producer level, core finished goods inflation was subdued in

March and April but moved up somewhat on a year-over-year basis. With regard to labor

costs, growth in the employment cost index (ECI) for hourly compensation picked up

noticeably in the first quarter of this year; however, the gain in compensation for the four

quarters ended in March was a little below the large increase for the four-quarter period

ended in March 2000. By contrast, average hourly earnings of production or nonsupervisory

workers rose more briskly in April and on a year-over-year basis.

At its meeting on March 20, 2001, the Committee adopted a directive that called for

maintaining conditions in reserve markets consistent with a decrease of 50 basis points in the

intended level of the federal funds rate, to about 5 percent. This action, in conjunction with a

further easing of ½ percentage point on April 18, was intended to help promote a more

satisfactory economic expansion going forward. Under then-current conditions, the members

agreed that the balance of risks remained weighted toward conditions that could generate

economic weakness in the foreseeable future.

Federal funds traded at rates near the Committee's target levels over the intermeeting period.

Other short-term interest rates generally fell somewhat less than the reduction in the federal

funds rate because the markets had anticipated the easing in policy, though only in part. In

contrast to the declines in short-term rates, longer-term yields rose on balance as investors

apparently became more confident of a pickup in output growth, supported in part by

improved prospects for substantial federal tax reductions. The more optimistic assessment of

the economic outlook and the unexpected intermeeting easing action apparently contributed

to a narrowing of risk premiums on lower-grade private debt obligations and to a rise in

equity prices. Better-than-expected first-quarter earnings also boosted stock prices, and broad

indexes of U.S. stock market prices moved substantially higher.

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

major foreign currencies changed little on balance over the intermeeting interval. A number

of major foreign central banks cut their policy rates during the period, but by less than the

two easing steps in the United States. The dollar's appreciation against the euro was offset by

its decline in terms of the yen and the Canadian dollar. The dollar also was essentially

unchanged in terms of an index of the currencies of other important trading partners. The

value of the Mexican peso rose appreciably against the dollar as monetary authorities

maintained their tight policy stance and as spreads on Mexican debt narrowed. In contrast,

concerns about potential spillovers from Argentina's worsening financial difficulties

depressed the value of the Brazilian real relative to the dollar.

The broad monetary aggregates continued to grow rapidly in March and April. In addition to

the effects of lower market interest rates, extensive mortgage financing activity and a flight

to safety from volatile equity markets likely added to M2's strong upward trend. The

expansion of M3 was bolstered by robust growth of institution-only money funds and by

greater issuance of managed liabilities included in this aggregate to help finance faster

growth of bank credit and a shift in bank funding from foreign to U.S. sources. The debt of

domestic nonfinancial sectors had grown at a moderate pace on balance through April.

The staff forecast prepared for this meeting suggested that, after a period of slow growth

associated in part with an inventory correction, the economic expansion would gradually

regain strength over the next two years and move back toward a rate near the staff's current

estimate of the growth of the economy's potential output. The period of subpar expansion

was expected to foster an easing of pressures on resources and some moderation in core price

inflation. Despite the substantial easing in the stance of monetary policy, the forecast

anticipated that the expansion of domestic final demand would be held back to an extent by

some of the developments in financial markets-in particular, the decline in household net

worth associated with the earlier downturn in equity prices, the continuation of relatively

stringent terms and conditions on some types of loans by financial institutions, and the

appreciation of the dollar. Partly as a result of the decline in household wealth, growth of

consumer spending was expected to remain relatively low for some time, and housing

demand would increase only a little from its recent level. However, business fixed

investment, notably outlays for equipment and software, would resume relatively good

growth after a period of adjustment of capital stocks to more desirable levels; a projected

recovery in the growth of foreign economies was seen as providing increased support for

U.S. exports; and fiscal policy was assumed to become more expansionary.

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

commented that the slowdown in the expansion to a now quite sluggish pace was likely to be

more prolonged than they had anticipated earlier and indeed, with the economy displaying

some signs of fragility and inventories still appearing excessive in some sectors, it was not

entirely clear that the slowing in the growth of the economy had bottomed out. Despite the

crosscurrents and uncertainties that were involved, members saw an upturn in the economic

expansion by later in the year as the most likely outlook. This view was premised in large

measure on the lagged effects of the Committee's relatively aggressive easing actions this

year, including any further easing that might be adopted at this meeting, growing prospects of

some fiscal policy stimulus later in the year, and more generally the favorable effects of still

substantial productivity gains on profit opportunities and income growth and hence on

business and household demands for goods and services. As business profits stabilized and

final demand firmed, inventory liquidation would come to an end, adding to the upward

momentum of economic activity. The members were uncertain as to the degree and timing of

the strengthening in final demand, and although a relatively prompt and strong rebound could

not be ruled out, many saw a variety of factors that pointed to the possibility that the upturn

could be weaker or more delayed than the central tendencies of their expectations. With

regard to the outlook for inflation, a number of members expressed concern about a tendency

for some measures of inflation to edge higher this year, but many members expected that the

easing of pressures in labor and product markets that already had occurred and were likely to

continue in the months ahead would damp inflation going forward.

In their review of developments across the nation, members referred to quite sluggish

economic conditions in many parts of the country. Weakness remained especially pronounced

in manufacturing, but as reflected in the employment data for April and in widespread

anecdotal reports, softening had spread to other sectors of the economy as well. At the same

time, pockets of strength could be found in a number of industries, notably in energy and

construction, and overall business activity continued to display considerable vigor in a

number of regions. Members noted that business confidence had deteriorated, but some also

observed that the pessimism tended to be limited to the nearer term and was accompanied by

favorable expectations regarding the outlook later in the year and in 2002.

With regard to the outlook for key sectors of the economy, a number of members commented

that consumer spending had held up reasonably well in recent months despite a variety of

adverse developments including the negative wealth effects of stock market declines, widely

publicized job cutbacks, heavy consumer debt loads, and previous overspending by many

consumers. A recent survey had indicated that consumer sentiment had firmed a little, but the

survey results had yet to be confirmed by additional surveys and the level of consumer

confidence was still well below earlier highs. As in the past, consumer spending attitudes

likely would depend importantly on trends in employment and income, and further increases

in unemployment in the period just ahead along with the negative wealth effects of earlier

stock market price declines and the persistence of high energy costs were likely to constrain

the growth in consumer expenditures over coming quarters.

Household expenditures on home construction had been maintained at a relatively robust

level in recent months, evidently reflecting the cushioning effects of very attractive mortgage

interest rates. Housing activity was described as a source of strength in many regions.

Housing prices had tended to edge higher across the nation, though there were signs that the

price appreciation had eased in some parts of the country, notably on the West Coast. While

the prevailing negative influences on household spending might spill over a bit more to

housing activity over the year ahead, there were few current developments in housing

markets that might be read as signaling any marked weakening in this sector of the economy.

A softening in business demand for capital equipment had accounted for much of the

slowdown in the growth of final demand in late 2000 and early 2001. The latest available

data on new orders pointed to further, and possibly larger, declines in business spending on

equipment and software over the months ahead. Members cited anecdotal and survey reports

that indicated many business firms were canceling, cutting back, or stretching out planned

capital expenditures. It was difficult to see any signs of a significant near-term turnaround in

business spending for equipment and software, and the timing and strength of a subsequent

rebound would depend importantly on the outlook for sales and profits. With regard to profit

expectations, the most recent data showed continued markdowns, but the pace of downward

revisions was diminishing. It was too early to conclude that the outlook for profits might be

approaching a degree of stability or be near the point of turning up, and in any event it was

clear that business sentiment currently was quite gloomy. Looking to the future, however,

members anticipated that continuing gains in efficiency engendered by new technologies

would provide substantial profit opportunities and likely strengthen investment spending

during the course of the year ahead. In the meantime, nonresidential construction and energyrelated investments were a source of some support to investment spending, but they provided

only a very partial offset to widespread weakness in other business spending.

Ongoing efforts to reduce excess inventories were continuing to curb output in

manufacturing industries and to restrain growth in overall economic activity. A number of

members commented that anecdotal and other evidence suggested that considerable progress

already had been made in scaling down unwanted inventories, notably of motor vehicles, but

substantial further progress probably would be needed in high-tech industries where sales

were still falling. How long inventory cutbacks would continue to exert a significant drag on

the economic expansion remained a key uncertainty in the economic outlook. In the view of

many members, the adjustment process might not be substantially completed until much later

in the year and could take even longer for high-tech firms. This evaluation assumed

continued sluggish growth in final demand during the period immediately ahead. Stronger

growth, which could not be ruled out, would of course bring inventory-sales ratios to desired

levels more quickly.

Members also expressed concern about the potential implications for U.S. expansion from

developments abroad. To some extent, economic difficulties in foreign nations had occurred

in concert with softening activity in the United States, and notable weakness in world

high-tech markets along with the downward adjustment in equity prices globally represented

a downside risk factor worldwide. The anticipated recovery in this country would help to

strengthen many foreign economies and in turn improve prospects for U.S. exports. Members

noted, however, that in some nations persisting structural problems presented threats to

national economic prosperity and international trade. On balance, while the external risks to

the U.S. economy clearly were to the downside, at least over the nearer term, the prospective

rebound in U.S. economic activity and stimulative macroeconomic policies abroad were

expected to contribute to strengthening growth worldwide and to improving prospects for

exports during the year ahead.

The nation's fiscal outlook was seen as supportive of aggregate demand. While the exact

structure of tax cuts was still being negotiated, passage of new fiscal measures seemed

imminent and likely would help bolster consumption spending beginning later in the year.

Whatever its precise timing, the expansionary fiscal package would undoubtedly join at some

point in coming quarters with the lagged effects of the System's policy easing actions to

foster strengthening economic expansion.

A number of members commented that the persisting updrift in some key measures of core

inflation had become increasingly worrisome. In this regard, they noted that some of the

recent increases in bond yields could represent a rise in long-term inflation expectations.

Such a rise would not be entirely unexpected in the context of improving sentiment about the

strength of the expansion, the potentially adverse implications for costs of the cyclical

weakness in productivity, and the possibility that high energy prices and their passthrough

effects might persist longer than had been anticipated earlier. To a considerable extent,

however, any uptick in inflation expectations likely represented a reversal of anticipated

declines in inflation earlier this year when economic prospects had seemed weaker and

survey data did not confirm any increase in long-term inflation expectations. Moreover, not

all measures of core inflation had accelerated; in particular, core PCE price inflation had been

quite stable on a twelve-month basis for some time.

Looking ahead, most members did not foresee a significant rise in inflation as a likely

prospect. They cited the prevalence of highly competitive conditions in most markets, which

continued to make it very difficult for business firms to raise prices despite pressures to do so

in a period of rising labor, energy, and other costs. Widespread evidence of some lessening of

pressures in most labor markets across the nation had not yet resulted in lower wage

inflation, but the members expected that recent and anticipated ebbing of pressures on labor

and other resources and associated slack in product markets in a period of continuing subpar

economic growth, along with projected declines in energy prices, would hold down inflation

over the forecast horizon. Nonetheless, there were some risks of rising inflation. An

unexpectedly strong rebound in economic growth could begin to put added upward pressure

on prices at a time when labor markets were still tight by historical standards and

accelerating productivity no longer held down increases in unit labor costs. Given the lags in

the effectiveness of monetary policy, such pressure might materialize before the effects of

countervailing actions by the Committee had a chance to take hold.

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

of the members indicated that they could support a proposal calling for further easing of

reserve conditions consistent with a 50 basis point reduction in the federal funds rate to a

level of 4 percent. One member expressed a strong preference for a 25 basis point reduction

and two others indicated that they could have accepted that more limited easing move.

Despite their somewhat differing preferences, all the members agreed that further easing was

desirable in light of what they viewed as the continuing weakness in the economy, the

absence of evidence that growth had stabilized or was about to rebound, and still decidedly

downside risks to the economic expansion. Some members noted that, although policy had

been eased substantially, it might still be considered to be only marginally accommodative in

relation to the forces that were damping aggregate demand. Accordingly, the action

contemplated for today was needed to provide adequate stimulus to an economy whose

outlook for significant strengthening remained tenuous in a climate of fragile business and

consumer confidence. Members noted that the lagged effects of the monetary policy easing

implemented earlier this year were still very hard to discern, though they should be felt

increasingly over the year ahead. In this regard the risks of rising inflation could not be

dismissed, and while those risks appeared to be quite limited for the nearer term, excessive

monetary stimulus had to be avoided to avert rising inflation expectations and added inflation

pressures over time. Members who preferred or could support a 25 basis point easing action

gave particular emphasis to the desirability at this point of taking and signaling a more

cautious approach to policy, relative to the 50 basis point federal funds rate reductions the

Committee had been implementing, given the lagged effects of the substantial reduction in

the federal funds rate to date, the accompanying buildup in liquidity, and the related risk that

a further aggressive easing action would increase the odds of an overly accommodative

policy stance and rising inflationary pressures in the future.

All the members accepted a proposal to include in the press statement to be released after this

meeting a sentence indicating that the Committee continued to regard the risks to the

economic outlook as being tilted toward weakness even after today's easing action. Forecasts

of growth in business earnings and spending continued to be revised down, and until that

process ended, weakness in demand seemed to be the main threat to satisfactory economic

performance. At the same time the members anticipated that a neutral balance of risks

statement could be appropriate before long, probably well before substantial evidence had

emerged that economic growth had strengthened appreciably, once the Committee could see

that policy had eased enough to promote a future return to maximum sustainable economic

growth. Indeed, it was not clear how much more the federal funds rate might have to be

reduced after today in the absence of further significantly adverse shocks, and some members

noted that the end of the easing process might be near. Even so, with the economy perhaps

still in the midst of a process of weakening growth in aggregate demand of unknown

persistence and dimension, the members generally agreed that, given prevailing uncertainties,

it would be premature for the Committee to shift its balance of risks statement at this time.

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 reducing the federal funds rate to

an average of around 4 percent.

The vote 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 that the risks continue to be weighted mainly toward conditions that

may generate economic weakness in the foreseeable future.

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

Kelley, Meyer, Ms. Minehan, Messrs. Moskow and Poole.

Votes against this action: Mr. Hoenig.

Mr. Hoenig dissented because he preferred a less aggressive easing action involving a

reduction of 25 basis points in the federal funds rate. While the risks of weaker economic

growth still tended to dominate those of rising inflation and called for some further easing,

the Committee had added significant liquidity to the economy this year through its

cumulatively large easing actions. The lagged effects of those actions should be felt

increasingly over time. Moreover, following the rapid and aggressive policy actions already

taken, a more cautious policy move at this point would in his view appropriately limit the

risks of producing an overly accommodative policy stance and rising inflation over time.

The Chairman called for a recess after this vote and convened a meeting of the Board of

Governors to consider one-half percentage point reductions in the discount rate that had been

proposed by a number of Federal Reserve Banks. After the recess, the Chairman informed

the Committee that the pending reductions had been approved.

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

June 26-27, 2001.

The meeting adjourned at 1:15 p.m.

Donald L. Kohn

Secretary

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Footnotes

1. Attended portion of meeting relating to staff briefings. Return to text

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