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, August 21,

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

Mr. Mattingly, General Counsel

Mr. Baxter, Deputy General Counsel

Ms. Johnson, Economist

Mr. Reinhart, Economist

Mr. Stockton, Economist

Ms. Cumming, Messrs. Hakkio, Howard, Hunter, Lindsey, Rasche, Slifman, and

Wilcox, Associate Economists

Mr. Kos, Manager, System Open Market Account

Ms. Smith, Assistant to the Board, Office of Board Members, Board of Governors

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

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

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

Governors

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

Statistics, Board of Governors

Mr. Helkie, Assistant Director, Division of International Finance, 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, Office of Board Members, Board of

Governors

Ms. Browne, Executive Vice President, Federal Reserve Bank of Boston

Messrs. Eisenbeis, Lacker, Ms. Mester, Messrs. Rosenblum and Sniderman, Senior

Vice Presidents, Federal Reserve Banks of Atlanta, Richmond, Philadelphia, Dallas,

and Cleveland respectively

Ms. Hargraves and Mr. Judd, Vice Presidents, Federal Reserve Banks of New York

and San Francisco

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

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

on June 26-27, 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 U.S. government securities and securities issued or fully

guaranteed by federal agencies during the period June 27, 2001, through August 20, 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.

The information reviewed at this meeting suggested that economic activity exhibited little, if

any, upward movement in midsummer. Increases in household expenditures on consumer

items and housing appeared to have been relatively well maintained, but business capital

expenditures had weakened substantially since early in the year. Efforts to reduce inventories

were continuing, and manufacturing activity had decreased further. Employment had

declined over recent months. With energy prices having turned down, overall consumer price

inflation had eased slightly in recent months, while core measures of consumer prices

showed mixed changes on a twelve-month basis. Measures of labor costs had decelerated on

balance.

Private nonfarm payroll employment, after declining appreciably during the second quarter,

fell further in July, led by additional job losses in manufacturing and help-supply services.

Labor demand remained weak in other sectors, with employment in most industries flat to

down. The unemployment rate edged up to 4.5 percent in June and remained at that level in

July. Although initial claims for unemployment insurance had declined in recent weeks, on

balance data suggested persisting softening in the labor market.

Industrial production edged lower in July after larger drops in each of the previous three

months. Motor vehicle assemblies rose markedly, but production of high-tech equipment

continued to plummet, registering its largest one-month decline in more than a decade.

Outside those two industries, manufacturing production either moved sideways or fell

slightly. The rate of utilization of manufacturing capacity was little changed in July and

remained well below its long-run average.

Growth in consumer spending slowed somewhat in the second quarter, but except for

automotive dealers, retailers reported sizable gains in July. Consumer confidence appeared to

have stabilized at moderately favorable levels in recent months. Supported by low mortgage

rates, residential building activity had held up well this year. In July, single-family starts

increased slightly from a strong pace in the first and second quarters, though permits fell

marginally. Sales of new homes rose in June (latest data), and sales of existing homes edged

down but remained only slightly below their historical peak.

Business spending on equipment and software declined substantially in the second quarter

after falling somewhat in the preceding two quarters. The weakness stemmed from sluggish

growth in business sales, significantly reduced corporate cash flows, and continued

uncertainty about prospects for future sales and earnings. Shipments of nondefense capital

goods declined in June after a modest increase in May, but for the second quarter as a whole

they contracted at more than twice the first-quarter pace. Moreover, orders data for June were

extraordinarily weak, led by a steep decline in communications equipment. Those data, as

well as numerous anecdotal reports, suggested further weakness in spending for equipment

and software going forward. Nonresidential construction, which had held up well in the first

quarter, was down substantially in the second quarter, as spending for office, industrial, and

lodging facilities contracted sharply. Vacancy rates, particularly in high-tech centers, had

increased significantly in recent months, as demand for office space and data centers

plunged. In contrast, expenditures for drilling and mining equipment soared further in the

second quarter.

Business inventory liquidation was sizable in the second quarter, at a pace estimated to be a

bit more rapid than in the first quarter. Manufacturing stocks, particularly of computers and

electronic products, were reduced substantially; however, shipments of those products also

plunged and the inventory-sales ratio in the computer and electronics sector rose further from

an already high level. Elsewhere in manufacturing, the ratio of stocks to sales held steady,

with stocks remaining high in a number of manufacturing industries despite aggressive

production cutbacks. Inventories rose in the wholesale sector and, given sluggish sales of

late, the ratio of inventories to sales moved sharply higher in the second quarter. Stocks in the

automobile sector declined over the quarter and moved lower in July. Retail inventories,

excluding motor vehicles, fell moderately and the sector's inventory-sales ratio edged lower.

The U.S. trade deficit in goods and services narrowed over the May-June period and was

about $20 billion smaller at an annual rate in the second quarter than in the first. The value of

imports dropped sharply in the second quarter. The value of exports also decreased

significantly, with most of the decline in capital goods, primarily computers and

semiconductors. Recent information on foreign industrial economies suggested that growth

weakened further in the second quarter. The Japanese economy contracted in the quarter, and

growth in the euro area appeared to have weakened substantially. Among the developing

countries, economic and financial conditions had deteriorated further in Argentina. In most

other developing countries, the pace of economic growth continued to decline.

Consumer price inflation had eased in recent months, as energy prices turned down and

increases in core consumer prices subsided after a pickup early in the year. The core

consumer price index (CPI) rose in July at about the same pace as in the second quarter, but

the twelve-month change in that index had increased slightly. However, revised data

indicated that the core personal consumption expenditure (PCE) chain index had decelerated

on a year-over-year basis. At the producer level, prices fell in July, leaving the twelve-month

change in the producer price index for finished goods somewhat below the twelve-month

change of a year earlier. With regard to labor costs, the employment cost index (ECI)

increased at a somewhat slower pace in the twelve months ended in June than over the

preceding twelve months.

At its meeting on June 26-27, 2001, the Committee adopted a directive that called for

maintaining conditions in reserve markets consistent with a decrease of 25 basis points in the

intended level of the federal funds rate, to about 3¾ percent. This action was deemed

appropriate in light of incoming information indicating somewhat weaker economic

performance than most members had anticipated and the absence of firm evidence that the

deceleration in the economic expansion had run its course or that output growth was about to

rebound. With greater slack in labor and product markets and with inflation expectations

contained, the members agreed that the balance of risks continued to be weighted toward

conditions that could generate economic weakness in the foreseeable future.

Federal funds traded at rates near the Committee's reduced target level over the intermeeting

period, and other short-term rates also fell. Market participants became less optimistic

regarding the economic outlook over the intermeeting period, inducing widespread declines

in longer-term Treasury yields over the period that were most pronounced at the shorter end

of the coupon maturity spectrum. Except for the obligations of the most troubled sectors,

declines in investment-grade corporate bond yields were about in line with those on Treasury

issues of comparable maturity, leaving most risk spreads little changed on balance. A spate of

weak second-quarter earnings reports and sizable reductions in analysts' earnings projections

for the remainder of the year took a toll on equity markets, however, and broad stock market

indexes moved down appreciably over the intermeeting interval.

The trade-weighted value of the dollar, after an extended period of strength, fell against most

major foreign currencies, with much of the decline occurring in the days just before this

meeting. The decline was particularly marked against the yen, the euro, and the Swiss franc.

In contrast, the dollar was little changed against the currencies of some major trading

partners, including Canada and Mexico.

Growth in the broad monetary aggregates remained strong in July but was below the average

pace over the first half of the year. Despite some recent slowing, deposit growth was held up

by a flight to liquidity and safety in light of the poor performance and substantial volatility in

equity markets. Foreign demands for U.S. currency also boosted money growth in July.

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

associated in large part with very weak business fixed investment and to some extent with an

inventory correction, 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.

Although substantial monetary easing had already been implemented and fiscal stimulus was

in train, the forecast anticipated that the expansion of domestic final demand would continue

to be held back by the effects on household net worth of recent and possible future declines

in stock market prices and by damped consumer and business sentiment in a weaker job

market. With long-term trends in innovation holding up reasonably well, business fixed

investment, notably outlays for equipment and software, likely would return to relatively

robust growth after a period of adjustment of capital stocks to more desirable levels, and a

projected pickup in foreign economies was seen as providing some support for U.S. exports.

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

the members commented that the anticipated strengthening in economic expansion had not

yet occurred and, indeed, that the economy and near-term economic prospects appeared to

have deteriorated marginally further in the period since the previous meeting. Several

members referred to a number of recently available economic indicators that in their view

suggested the possibility that the string of disappointing readings on the economy might be

about to end, but those indicators were insufficiently robust and too recent to provide

conclusive evidence of emerging stabilization, much less that some overall strengthening

might be under way. Among other things, the economy was still adjusting to downward

revisions to expected earnings and to perceptions of greater risk and associated declines in

wealth. In sum, the timing of the pickup in the growth of the economy had again been pushed

back. Even so, the prospects for an upswing over coming quarters remained favorable against

the backdrop of the lagged effects of substantial monetary policy easing already implemented

this year, the recent passage and initial implementation of stimulative fiscal policy measures,

the progress businesses had already achieved toward completing inventory adjustments, and

the underlying support for business investments from continued technological innovations.

Nonetheless, the members recognized that the recovery in business fixed investment, the

major source of weakness in the economy, was likely to follow a more extended period of

adjustment than had been anticipated in their earlier forecasts. With regard to the outlook for

inflation, members reported on widespread indications of some slackening in what were still

generally tight labor markets and also noted that capacity utilization rates had declined

substantially in many industries. The reduced pressures on resources along with expectations

of some further declines in energy prices were seen by many members as likely to foster a

modest deceleration in many measures of wages and prices.

Statistical evidence of an ongoing, though gradual, worsening in overall business conditions

was supported by anecdotal reports from around the nation. Weakness continued to be

concentrated in manufacturing, notably in the high-tech sector and in high-tech service

industries. Indications that the softening was spreading more generally were still fairly

limited as suggested by employment data and anecdotal reports. At the same time, members

cited some still quite tentative signs that declines in manufacturing had slowed or that

activity had steadied in some depressed industries.

In their review of developments in key sectors of the economy, members again emphasized

the ongoing strength in household spending and its vital role in moderating the weakness in

overall economic activity. Tax rebates, declining energy prices, and widespread discounting

of retail prices were cited as positive factors in support of consumer spending on a wide

range of goods and services. In addition, increasingly persuasive evidence indicated that

realized capital gains from the sale of homes were a source of fairly significant amounts of

consumer purchasing power in the economy. Looking ahead, members expressed some

concern about how long the household sector would continue to prop up the economy in the

absence of an upturn in business expenditures. While accommodative financial conditions

and reduced income tax rates should continue to undergird consumer spending and the data

on retail sales for July displayed relatively impressive gains, negative wealth effects from

falling stock market prices, declining payrolls, and sluggish income gains--should they

persist--might well depress consumer expenditures over coming months. In this regard, some

recent anecdotal reports pointed to weaker retail sales, importantly including motor vehicles.

There also were some recent indications of declining consumer confidence, and many

retailers had become less optimistic about the outlook for sales over the balance of the year.

Homebuilding generally had remained robust in recent months, as relatively low mortgage

interest rates continued to offset weakness in employment and incomes and the negative

effects of declining stock market wealth. Most regions continued to report strong housing

markets, albeit with evidence of some weakening in sales of high-priced homes in a number

of areas. For now, however, there were few signs that overall housing activity might be

softening, though members noted that potentially bearish factors relating to the outlook for

consumer spending might at some point also affect housing.

With household spending already elevated relative to income and its rate of increase unlikely

to strengthen materially, if at all, under foreseeable near-term economic conditions, the

anticipated upturn in overall economic expansion would depend critically on business

investment spending and in turn on improved prospects for business profits and cash flows.

Business capital expenditures appeared to be slowing sharply further after posting large

declines earlier in the year in conjunction with the marking down of the expected growth of

demand for and profitability of capital equipment, weak sales, the emergence of substantial

excess capacity in many industries, notably in high-tech facilities, and the resulting decline in

earnings. Market forecasts of business profits were progressively being reduced, and as a

consequence members saw little likelihood of a marked turnaround in business capital

investment over the months ahead despite some elements of strength such as sizable

construction projects involving public utilities, energy, and, in some areas, public works.

Indeed, history strongly suggested that capital spending might well fall below sustainable

levels for a time as business firms over adjusted on the downside to previously excessive or

misdirected buildups of capital resources. While the near-term outlook for business

investment was not promising and considerable uncertainty surrounded the timing of the

eventual upturn, members remained optimistic about the longer-term prospects for capital

expenditures. In the context of a still favorable outlook for continued elevated rates of

technological progress, business firms reportedly had not yet exploited many potentially

profitable investment opportunities.

The persistence of substantial inventory liquidation was another negative factor in the current

performance of the economy. While considerable progress reportedly had been made by

numerous business firms in reducing their inventories to bring them into better alignment

with sales, a rebound to inventory accumulation did not appear imminent for the economy as

a whole. Unexpected weakness in final demands would, of course, lead to additional efforts

to pare inventories, which would tend to damp and delay the rebound. Even so, leaner

inventories had favorable implications for production going forward.

Fiscal policy developments were a supportive factor in the economy. The tax rebates

currently being distributed undoubtedly were having a limited but positive effect on

consumers, which likely would continue over coming months. The impetus could not be

measured precisely, but it was reflected in available anecdotal reports. Moreover, the

reductions in income tax rates would have an ongoing effect in boosting disposable

household incomes. On the negative side, financial difficulties in a number of states were

being met in part through higher taxes that implied at least some offset to the federal tax

relief.

Many of the members expressed concern about what appeared to be cumulating weakness in

numerous foreign economies that would feed back to the U.S. economy through reduced

demand for U.S. exports and potentially through perceptions of greater risks in financial

markets. A number of major industrial economies were growing more slowly than had been

expected earlier in the summer. Moreover, severe economic and financial problems in a few

developing nations could spill over to their trading partners and other similarly situated

countries that could in turn have adverse repercussions more generally on the world

economy.

The members generally viewed a modest decline in inflation as a reasonable prospect, at least

for a while. Reports from around the nation indicated that labor market conditions had eased,

though they remained generally tight and workers available to fill a variety of skilled job

openings continued to be in short supply. On balance, however, upward pressures on labor

compensation appeared to be easing somewhat despite large increases in the costs of medical

care. Competitive pressures continued to make it very difficult for business firms to raise

their prices and there were no signs that widespread discounting might be coming to an end.

An apparent downtrend in the costs of energy was another favorable factor in the outlook for

inflation. Some members expressed a degree of concern, however, about the longer-term

outlook for inflation. Pressures on resources would rise as the anticipated upturn and possible

above-trend growth brought the economy closer to full capacity utilization. An important

uncertainty in this regard was the outlook for productivity, whose growth might have

moderated from the unusually high growth rates of 1999 and 2000, with possibly adverse

implications for labor costs at very low levels of unemployment.

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

endorsed a proposal calling for a slight further easing in reserve conditions consistent with a

25 basis point reduction in the federal funds rate to a level of 3-1/2 percent. No member

expressed a preference for leaving policy unchanged or easing by more than 25 basis points.

The economy had continued to be weak--indeed, weaker than many had expected--and data

and anecdotal reports from around the country had yet to point to persuasive signs of a

turnaround. The monetary and fiscal policy stimulus already in train seemed adequate to

promote and support an eventual appreciable rise in the growth of business activity to a pace

near that of the economy's potential, but the strength and timing of the pickup remained

uncertain and further weakness was a distinct threat in the nearer term. In particular, possible

faltering in household expenditures at a time when business firms were still adjusting to

inventory imbalances and to capital overinvestments would exacerbate the slowdown in the

economy and delay its anticipated recovery. Growing concerns about foreign economies

added to the current unease about potential near-term developments.

Against the considerable forces of restraint on aggregate demand, the federal funds rate had

been lowered substantially and the monetary aggregates were growing rapidly, but some

members noted that in a number of respects financial conditions did not indicate as much

oncoming stimulus. Since the start of the year, long-term interest rates generally had not

extended earlier declines, prices in equity markets had fallen substantially further, and the

dollar had appreciated in foreign exchange markets. Accordingly, the inflation risks of some

further monetary stimulus seemed limited and were outweighed by the need to lean against

actual and potential shortfalls in demand and business activity.

The members recognized that in light of the lags in the effects of policy, the easing process

probably would have to be terminated before available measures of economic activity

provided clear evidence of a substantial strengthening trend. In the view of some members,

this point might come relatively soon. Beyond the nearer term members also envisaged the

desirability of moving preemptively to offset some of the extra monetary stimulus now in the

economy in advance of inflation pressures beginning to build. The members were fully

prepared to act on a timely basis, but several emphasized the recognition lags that would be

involved in stopping and subsequently beginning to reverse the policy easing.

Given their views about the risks to the economy, notably over the nearer term, all the

members supported the retention of the sentence in the press statement indicating that the

risks continued to be weighted toward further weakness in the foreseeable future.

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 3-1/2 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, Messrs. Moskow and Poole.

Votes against this action: None.

It was agreed that the next meeting of the Committee would be held on Tuesday, October 2,

2001.

The meeting adjourned at 12:40 p.m.

Reciprocal Currency Arrangements

Following the terrorist attacks on September 11, 2001, the Committee established or enlarged

reciprocal currency (swap) arrangements with the European Central Bank, the Bank of

Canada, and the Bank of England. The purpose of these arrangements was to facilitate the

functioning of U.S. financial markets by providing as necessary through the foreign central

banks the liquidity in dollars needed by European, Canadian, and British banks whose U.S.

operations had been disrupted by the disturbances in the United States. These central bank

arrangements would mature in thirty days unless extended by the Committee. Except for an

initial drawing of up to $12 billion by the European Central Bank on September 12,

individual drawings were subject to approval by the Foreign Currency Subcommittee of the

Federal Open Market Committee. Under the agreements, dollars would be made available in

the form of deposits at the Federal Reserve Bank of New York in exchange for deposits in the

counterparty central banks of an equivalent amount of their currencies. The individual

actions and votes were as follows:

On September 12, 2001, available members of the Committee voted unanimously to establish

a $50 billion swap line with the European Central Bank with a maturity of thirty days unless

renewed.

Votes for this action: Messrs. Greenspan, Ferguson, Gramlich, Hoenig, Ms.

Minehan, Messrs. Moskow, Poole, and Stewart.

Absent and not voting: Messrs. Kelley and Meyer. Mr. Stewart voted as

alternate for Mr. McDonough.

On September 13, 2001, available members of the Committee voted unanimously to increase

the System's swap line with the Bank of Canada from $2 billion to $10 billion, with the

added facility to mature in thirty days unless renewed.

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

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

Absent and not voting: Mr. Meyer.

On September 14, 2001, available members of the Committee voted unanimously to establish

a $30 billion swap line with the Bank of England, with a maturity of thirty days unless

renewed.

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

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

Absent and not voting: Messrs. Gramlich and Meyer.

Intermeeting Policy Action

On September 13, 2001, the Committee met by telephone conference to assess economic and

financial developments stemming from the terrorist attacks on September 11 and the possible

need for a monetary policy response. Banking and other financial market conditions, notably

in New York City but also around the nation, were discussed in some detail as well as the

outlook for reopening the stock exchanges. While the ongoing reactions to the recent tragedy

were undoubtedly a negative factor in the economic outlook, the members agreed that

financial markets were still too disrupted and the economic outlook too uncertain to provide

an adequate basis for a policy move at this time. However, the members contemplated the

need for some policy easing in the very near future. In the interim, the System would

continue to stand ready to provide whatever liquidity might be needed to counter unusual

strains and help assure the effective functioning of the banking system and restore more

normal conditions in financial markets.

Subsequently, on September 17, 2001, the Committee members voted unanimously to ease

reserve conditions appreciably further, consistent with a reduction in the federal funds rate of

50 basis points to a level of 3 percent. This policy action was associated with the approval by

the Board of Governors of a reduction of equal size in the discount rate to a level of 2-1/2

percent. These actions were taken against the backdrop of heightened concerns and

uncertainty created by the recent terrorist attacks and their potentially adverse effects on asset

prices and the performance of the economy. In conjunction with these policy moves, the

Federal Reserve would continue to supply, as needed, an atypically large volume of liquidity

to the financial system. As a consequence, the Committee recognized that the federal funds

rate might fall below its target on occasion until more normal conditions were restored in the

functioning of the financial system. The Committee's vote encompassed the retention of a

statement in its press release indicating that the balance of risks remained weighted toward

weakness for the foreseeable future.

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

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

Votes against this action: None.

Donald L. Kohn

Secretary

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