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., beginning on Tuesday,

June 26, 2001, at 2:00 p.m. and continuing on Wednesday, June 27, 2001, 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. Bernard, Deputy Secretary

Mr. Gillum, Assistant Secretary

Ms. Fox, Assistant Secretary

Mr. Mattingly, General Counsel

Mr. Baxter, Deputy General Counsel

Ms. Johnson, Economist

Mr. Stockton, Economist

Messrs. Fuhrer, Hakkio, Howard, Hunter, Lindsey, Rasche, Reinhart, Slifman, and

Wilcox, Associate Economists

Mr. Kos, Manager, System Open Market Account

Ms. Smith and Mr. Winn, Assistants to the Board, Office of Board Members, Board

of Governors

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

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

Governors

Mr. Madigan, Associate Director, Division of Monetary Affairs, Board of Governors

Messrs. Oliner and Struckmeyer, Associate Directors, Division of Research and

Statistics, Board of Governors

Messrs. Freeman1 and Whitesell, Assistant Directors, Divisions of International

Finance and Monetary Affairs, Board of Governors

Ms. Kusko1 and Mr. Sichel2, Senior Economists, Division of Research and Statistics,

Board of Governors

Mr. Nelson, Senior Economist1, and Ms. Garrett, Economist, Division Monetary

Affairs, Board of Governors

Mr. Fleischman2, Economist, Division of Research and Statistics, Board of

Governors

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

Governors

Ms. Pianalto, First Vice President, Federal Reserve Bank of Cleveland

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

Rolnick, Rosenblum, and Steindel, Senior Vice Presidents, Federal Reserve Banks of

San Francisco, Atlanta, Richmond, New York, Philadelphia, Minneapolis, Dallas, and

New York respectively

Mr. Altig, Vice President, Federal Reserve Bank of Cleveland

Mr. Fernald3, Economist, Federal Reserve Bank of Chicago

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

on May 15, 2001, were approved.

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

to 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 May 15, 2001, through June 26, 2001. By unanimous vote, the Committee ratified

these transactions.

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 economic activity continued to grow

little, if at all, in the second quarter. Employment fell somewhat over the first two months of

the quarter, industrial output dropped sharply, and the limited available information

suggested that both probably continued to decline in June. Expansion in consumer spending

appeared to have slowed and business purchases of equipment and software had fallen

appreciably, though homebuilding had been well maintained. Energy prices had been

relatively flat recently, at a high level, and core price inflation had moderated a little.

Private nonfarm payroll employment fell slightly further in May after a sharp drop in April

and lackluster growth in the first quarter. Manufacturing recorded additional widespread job

losses in May, and there were signs that weakness in employment was spreading to related

sectors, notably wholesale trade and help-supply services. By contrast, construction

employment rebounded in May, retracing part of its large April loss, and hiring in finance,

insurance, and real estate remained brisk. The unemployment rate edged lower in May, to 4.4

percent, but initial unemployment insurance claims and other data suggested persisting

softening in the labor market in that month.

The rapid contraction in industrial production continued unabated in May, with

manufacturing output registering an eighth consecutive monthly drop. Moreover, output from

electric utility plants fell, and mining activity slowed further in May following a strong firstquarter gain. Within manufacturing, decreases in output were widely spread across sectors,

and the production of high-tech equipment continued to plummet. The motor vehicle industry

was one of the few sectors to record a rise in production. The further contraction in

production in May brought the rate of utilization of manufacturing capacity to its lowest level

since 1983.

Growth of consumer spending seemed to have slowed in the second quarter, reflecting the

deceleration in personal income, the rise in unemployment, and the earlier decline in

household net worth. Nominal retail sales were up only slightly in May after a brisk rise in

April, and the average rate of increase over the two months was somewhat slower than that

of the first quarter.

Low mortgage rates continued to provide support to residential building activity in April and

May despite a weakening labor market and sluggish growth in personal income. Total

housing starts in April-May remained at the high first-quarter level, as stronger single-family

starts offset a slower pace of multifamily starts. Sales of new and existing homes slipped in

April (latest data) after both reached near-record levels in March.

Business spending on equipment and software declined further early in the second quarter in

response to sluggish sales, an erosion of earnings and corporate cash flows, and an uncertain

outlook for future sales and earnings. Shipments of nondefense capital goods slumped in

April, and the weakness in incoming orders suggested that shipments would fall further in

coming months. Fleet sales of cars and trucks, which had been among the few areas of

strength in business equipment expenditures in the first quarter, also slowed. By contrast,

nonresidential construction remained robust, though the level of activity slipped a little in

April and slightly higher vacancy rates and smaller increases in rents suggested that the

profitability of new nonresidential investment might be lessening. Strength was particularly

evident in outlays for industrial structures, partly reflecting construction of electric power

plants and facilities for cogeneration of power by industrial companies, and in continuing

strong oil and gas exploration activity.

Business inventories on a book-value basis edged higher in April after a sizable runoff in the

first quarter. Excluding motor vehicles, manufacturing stocks were little changed in April,

but shipments were down sharply and the aggregate inventory-shipments ratio for the sector

remained on a steep upward trend, with many industries facing sizable inventory overhangs.

In the wholesale sector, inventories rose in step with sales; the sector's inventory-sales ratio

was unchanged in April and remained at the top of its range for the past twelve months.

Retail inventories continued to decline in April, and the sector's inventory-sales ratio

decreased further and was near the middle of its range for the past twelve months.

The U.S. trade deficit in goods and services continued to shrink in April. The value of

exports fell, with most of the drop occurring in capital goods, notably computers and

semiconductors. The value of imports also decreased but by slightly more than exports,

reflecting sizable declines in capital and consumer goods that were partly offset by increases

in oil and automotive products. Recent information indicated that economic growth in the

euro area and the United Kingdom in the first quarter was at about the reduced pace seen in

the fourth quarter, and growth likely stayed relatively slow more recently. Expansion in

Canada appeared to have weakened recently after a slight pickup in the first quarter. In Japan,

the contraction in economic activity that began early in the year appeared to have continued

into the second quarter. Most of the developing countries, with the notable exception of

China, also were experiencing an economic slowdown that was related at least in part to

weaker external demand.

Core price inflation had moderated a little recently after a pickup earlier in the year. The core

consumer price index (CPI) rose relatively slowly in April and May, and the increase in that

index during the past twelve months was about the same as that during the previous

twelve-month period. The core personal consumption expenditure (PCE) chain-type price

index presented a similar picture, with inflation in April and May a little lower than earlier in

the year and no change in inflation on a year-over-year basis. Core producer price inflation

for finished goods also was subdued in the April-May period but edged higher on a

year-over-year basis. There also were indications that upward pressures on energy prices had

abated somewhat. In particular, the return of some domestic refineries to operation after

maintenance or breakdowns and a surge in imports had replenished gasoline stocks, and as a

result wholesale and retail gasoline prices had retreated recently. With regard to labor costs,

average hourly earnings of production or nonsupervisory workers continued to rise in April

and May at the relatively brisk rate that had prevailed over the past year.

At its meeting on May 15, 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 4 percent. The members generally agreed

that this action was necessary in light of the continuing weakness of the economic expansion

and the lack of evidence that output growth had stabilized or was about to rebound, coupled

with a climate of fragile business and consumer confidence. In addition, the members

believed 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 level over the intermeeting period.

Other short-term market rates declined somewhat following the Committee's announcement

of the easing action and subsequently moved down noticeably further in response to weakerthan-expected news on economic activity and corporate earnings. Yields on long-term

Treasury and investment-grade corporate securities fell appreciably during the intermeeting

interval, but rates on speculative-grade bonds rose sharply in response to the adverse earnings

news. The pessimistic earnings reports also weighed on equity prices, which edged lower on

balance.

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

major foreign currencies increased slightly over the intermeeting interval, as the dollar's

appreciation against euro and other European currencies more than offset the U.S. dollar's

further decline against the Canadian dollar. European currencies weakened in response to

disappointing data on economic activity, with inflation concerns seen as constraining

countervailing monetary easing actions. The dollar also was up slightly on net in terms of an

index of the currencies of other important trading partners. The real was adversely affected

by Brazil's internal problems and spillovers from Argentina's financial difficulties, while the

Mexican peso benefited from continued foreign interest in Mexican investments and from

high oil prices.

The broad monetary aggregates continued to grow rapidly in the second quarter, reflecting

the effects of lower opportunity costs of holding liquid deposits and money market mutual

funds, a buildup in deposits associated with extensive mortgage financing activity, and a

flight to liquidity and safety from volatile equity markets. The debt of domestic nonfinancial

sectors expanded at a moderate pace on balance through May.

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

associated in large part with an inventory correction, a sizable decline in capital spending,

and a related sharp contraction in manufacturing output, the economic expansion would

gradually regain strength over the forecast horizon and move back to a rate around the staff's

current estimate of the growth of the economy's potential output. The period of sub-par

expansion was expected to foster an appreciable easing of pressures on resources and some

moderation in core price inflation. Despite the substantial monetary easing that had been

implemented already and the fiscal stimulus, including federal tax rebates, that was in train,

the forecast anticipated that sluggish hiring and the decline in household wealth would

restrain the growth of both consumer spending and housing demand. Business fixed

investment, notably outlays for equipment and software, would be weaker for a while but

would return to relatively robust growth after a period of adjustment of capital stocks to more

desirable levels. The gradual strengthening of investment, together with a projected

improvement in foreign economies that was seen as providing some support for U.S. exports,

would foster the pickup in growth of demand and output.

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

noted that by some measures overall economic activity remained at a reasonably high level.

However, recent data indicated that growth of spending and output was quite sluggish and

below the pace many members had anticipated at the time of the previous meeting. Weakness

in business spending for equipment and software, efforts to reduce excess inventories, and

the ongoing adaptation to lower equity prices in the United States and around the world were

likely to hold back economic activity in the short run. Nonetheless, the members continued to

anticipate a strengthening as the year progressed and during 2002, fostered to a large extent

by the lagged effects on spending of the substantial easing in monetary policy since early this

year, the stimulus from recently enacted tax cuts, and the positive effects on household and

business purchasing power of some recent reductions in energy prices. In addition, the

abatement and eventual turnaround of the downward adjustments to capital spending and

inventories would add impetus to economic growth going forward. It was noted, however,

that the unique characteristics of the current cyclical experience, including the heavy

concentration of weakness in business expenditures and manufacturing output, increased the

uncertainty that surrounded any forecast. Most of the members believed that the risks to the

expansion, notably for the nearer term, remained to the downside of current forecasts.

Potential sources of shortfalls included the effects of possible further increases in

unemployment on consumer and business confidence; the risks of disappointing business

earnings that could damp investment and, through lower equity prices, consumption; and the

growing indications of weakness in foreign economies that could limit demand for exports.

In an environment of diminished pressures in product and labor markets and of lower energy

costs, members commented that price pressures were likely to remain contained, at least over

the near to intermediate term.

In preparation for the mid-year monetary policy report to Congress, the members of the

Board of Governors and the presidents of the Federal Reserve Banks provided individual

projections of the growth of GDP, the rate of unemployment, and the rate of inflation for the

years 2001 and 2002. The forecasts of the rate of expansion in real GDP had central

tendencies of 1-1/4 to 2 percent for 2001, suggesting at least a little acceleration in the

second half of the year, and 3 to 3-1/4 percent for 2002. The civilian rates of unemployment

associated with these forecasts had central tendencies of 4-3/4 to 5 percent in the fourth

quarter of 2001 and 4-3/4 to 5-1/4 percent in the fourth quarter of 2002. Forecasts of the rate

of inflation, as measured by the chain price index for personal consumption expenditures,

were centered on a range of 2 to 2-1/2 percent for this year and 1-3/4 to 2-1/2 percent in

2002.

Continuing softness in the expansion of economic activity was mirrored in anecdotal reports

of business conditions in much of the nation. Typical regional reports referred to slowing

increases in economic activity from an already reduced pace or to the persistence of sluggish

business activity and generally downbeat business sentiment. Manufacturing continued to

display particular weakness. However, actions to reduce excess inventories or to address

problems relating to overcapacity in some sectors of the economy, including

telecommunications and other high-tech industries, were under way and were likely to exert a

decreasing drag on economic activity over coming quarters as corrective adjustments were

completed. Financial conditions, while generally supportive of greater spending, presented a

mixed picture in some respects. Short- and intermediate-term interest rates had fallen

substantially this year, and long-term yields had moved down late last year. But equity prices

were only holding their own after a substantial decline earlier and the dollar had appreciated.

Though lenders were cautious about marginally creditworthy firms, most businesses were

finding ample credit available at attractive terms.

In their comments about developments in key sectors of the economy, members noted that

overall business activity had been supported, at least to this point, by the relative strength of

household demand. Growth in consumer spending for goods and services, while moderating

appreciably since earlier in the year, had nonetheless held up unexpectedly well given the

adverse wealth effects associated with the declines in stock market prices, relatively high

levels of consumer indebtedness, and job losses in a growing number of industries. Members

referred in particular to the persisting strength in demand for light motor vehicles, which

evidently was boosted by continuing sales incentives and attractive financing terms. Looking

ahead, the outlook for consumer spending was subject to a number of downside risks that

included the possibility of rising unemployment and further weakness in the stock market,

which could damp consumer confidence as well as income and wealth. However, some

further growth in consumer spending remained the most likely prospect for the balance of the

year in light of the impetus provided by monetary and fiscal policy and the apparent

stabilization in consumer sentiment in recent months after its earlier decline.

Housing activity remained at a high level as attractive mortgage interest rates evidently

continued to counterbalance the negative effects on consumer attitudes of somewhat weaker

labor markets and reduced stock market wealth. While housing activity in a number of areas

continued to be described as fairly robust, members noted that residential sales and

construction had slipped in some parts of the nation. Even so, given existing backlogs and the

continued availability of attractive mortgage rates, nationwide housing construction was

expected to remain near its currently elevated level.

The near-term outlook for business fixed investment seemed less promising. The weakness in

spending for new equipment and software had played a key role in the softening of the

overall expansion of economic activity in recent quarters, and a material pickup in such

expenditures did not appear likely until the latter part of this year or early next year. Indeed,

anecdotal reports from many business firms indicated that they were delaying at least some

equipment and software outlays until evidence of an upturn in their sales and earnings began

to accumulate. Caution was especially pronounced among high-tech firms, many of which

had experienced major cutbacks in the demand for their products and services. An analysis

prepared for this meeting suggested that in the aggregate the apparent overhang of excess

capital might not be large, but the dimensions and duration of the adjustment in spending on

capital goods were a major source of uncertainty in the outlook, and there was some risk of

substantially greater weakness in investment spending than was forecast for coming months.

Beyond the nearer term, however, the prospects for an upturn in investment outlays seemed

favorable in the context of profit opportunities associated with expectations of continued

elevated rates of technological progress and rapid declines in the prices of new equipment. In

this regard the members reviewed several staff reports that generally concluded that the

growth of productivity in the years ahead was highly likely to remain appreciably stronger

than it had been from the mid-1970s to the mid-1990s, though how much stronger was an

open question. With regard to the outlook for nonresidential construction activity, members

referred to signs of developing weakness in some commercial real estate markets, but there

were few reports of overbuilding and the construction of commercial facilities was being

well maintained in other parts of the country. On balance, further modest growth in

nonresidential construction, though well below the average pace in recent quarters, was seen

as a likely prospect.

Business efforts to bring their inventories into better alignment with sales were a key factor

in the deceleration of overall economic activity in recent quarters and in forecasts that the

upturn in economic activity would be relatively limited over the balance of the year. Net

inventory liquidation appeared to have diminished in the current quarter from its pace earlier

in the year, but inventory-sales ratios had risen further in recent months, especially for

high-tech equipment. Accordingly, liquidation was not likely to abate substantially further for

some time.

With regard to the foreign sector of the economy, members commented that economic

activity had softened more than anticipated in many nations that were important trading

partners, with clearly negative implications for U.S. exports. Major Latin American countries

were experiencing particularly severe economic difficulties, but growth was slowing or

economic activity declining in many industrial countries as well. At the same time, a number

of important U.S. industries were subject to increased domestic competition from foreign

imports. While growth abroad could be expected to rebound next year, responding in part to

faster expansion in the U. S. economy, the nearer-term outlook for U.S. and indeed world

trade was less favorable.

In their review of the outlook for inflation, members generally anticipated that increases in

consumer prices would remain relatively subdued over the next several quarters. Factors

underlying that assessment included the emergence of less taut conditions in labor markets,

relatively low capacity utilization rates in manufacturing, and the persistence of highly

competitive conditions in most product markets that made it very difficult for business firms

to preserve or increase their profit margins by raising prices. Moreover, energy prices

recently had declined appreciably, and the earlier inflationary effects of energy price

increases on a broad range of costs and prices appeared to have begun to subside as a result.

Inflation expectations that currently appeared by various measures and survey results to be

essentially flat or even to have declined a bit were reinforcing the factors holding down price

increases. Some negatives in the inflation outlook also were noted, such as some increase in

labor compensation including rapid advances in health care costs, and a consequent squeeze

on profit margins that was exacerbated by a cyclical decline in productivity gains. Labor

pressures on business costs might persist for a time in lagged response to earlier advances in

headline consumer price inflation and labor productivity, but their effects would tend to

diminish or to be offset over time if, in line with the members' forecasts, pressures on labor

resources continued to ease. Some members expressed concern about the longer-run

prospects for wages and prices if the stimulative stance of monetary policy was maintained

too long and allowed demand pressures to outrun the economy's potential.

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

members supported both some further easing of reserve conditions consistent with a 25 basis

point reduction in the target federal funds rate and the retention of the Committee's public

statement that the risks were weighted toward excessively soft economic performance. The

information received since the May meeting suggested a somewhat weaker economic

performance than most had anticipated, and the members were persuaded that in the absence

of firm evidence that the deceleration in the economic expansion had run its course a further

easing action was needed at this point to help stabilize the economy. With greater slack in

labor and product markets, and with inflation expectations contained, an added easing ran

very little risk of exacerbating price pressures, provided the Committee was prepared to firm

the stance of policy promptly if and when demand pressures threatened to intensify. One

member was persuaded that policy had already become so expansionary that further easing

ran an unacceptable risk of exacerbating inflation over time.

A smaller easing move than those the Committee had been making earlier this year was

deemed desirable by the members in light of the substantial easing that already had been

implemented since the start of this year. By a number of measures--including the level of real

federal funds rates, the robust growth of the monetary aggregates, and the ready availability

of finance to most borrowers--policy had become stimulative. Such a policy stance was

appropriate for a time to counter the various forces holding back economic expansion. But

much of the lagged effects of the Committee's earlier easing actions had not yet been felt in

the economy, and they would be supplemented in coming quarters by the implementation of

the recently legislated tax cut stimulus. In these circumstances, a smaller move than those

undertaken earlier this year would have the advantage of reducing the odds on adding to

inflation pressures later and of underlining the Committee's assessment of its policy stance.

In the view of a number of members, the Committee might well be near the end of its easing

cycle. At the same time, several emphasized that they did not want to rule out further easing

later if warranted by the tenor of incoming economic information.

All except one of the members accepted a proposal to retain the Committee's press statement

that the risks would continue to be weighted toward economic weakness after today's easing

move. The member who opposed additional policy easing expressed strong reservations

about such a statement because in his view it likely would be interpreted as an intention to

ease policy further, which was contrary to his own assessment that a more neutral outlook

regarding the future course of policy was desirable. In the view of most members, however,

the weakness of the recent information relating to the performance of the economy was

consistent with unbalanced risks at least insofar as it pertained to the outlook for the rest of

this year, and their primary policy concern at this point remained the strength of economic

activity rather than potentially worsening inflation over the longer term.

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 3-3/4 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,

Hoenig, Kelley, Meyer, Ms. Minehan, and Mr. Moskow.

Votes against this action: Mr. Poole.

Mr. Poole dissented because he believed that FOMC actions this year had already established

a highly stimulative monetary policy stance. The M2 and MZM measures of money had risen

at annual rates in excess of 10 percent and 20 percent respectively over the past six months,

and the real federal funds rate was very likely below its equilibrium level. Other more

qualitative information on financial conditions pointed in the same direction. Economic

forecasts were that the economy's growth would resume later this year and the fact that

long-term interest rates had not declined since December also indicated that the market

anticipated a revival of faster economic growth before long. Given the lags in monetary

processes, he believed that adding further monetary policy stimulus raised an undue risk of

fostering higher inflation in the future. Moreover, against this background, he was especially

concerned that a statement that the Committee continued to view the balance of risks as

weighted toward weakness would be read in the market as a sign that the Committee was

likely to ease further in the near term. He thought future developments were equally likely to

warrant an action in either direction, and he did not think the Committee should take a step

that probably would cause expectations of further easing to become embedded in market

interest rates.

It was agreed that the next meeting of the Committee would be held on Tuesday, August 21,

2001.

The meeting adjourned at 12:25 p.m.

NOTATION VOTE

By notation vote completed on August 16, 2001, the Committee members voted unanimously

to elect Vincent R. Reinhart to the position of economist for the period until the first

regularly scheduled meeting in 2002, with the understanding that in the event of the

discontinuance of his official connection with the Board of Governors he would cease to

have any official connection with the Federal Open Market Committee

Donald L. Kohn

Secretary

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Footnotes

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

2. Attended portion of meeting relating to productivity developments. Return to text

3. Attended Tuesday's session only. Return to text

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Last update: August 23, 2001, 2:00 PM