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, December

11, 2001, at 9:00 a.m.

Present:

Mr. Greenspan, Chairman

Mr. McDonough, Vice Chairman

Ms. Bies

Mr. Ferguson

Mr. Gramlich

Mr. Hoenig

Mr. Meyer

Ms. Minehan

Mr. Moskow

Mr. Olson

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. Smith, Assistant Secretary

Mr. Mattingly, General Counsel

Mr. Baxter, Deputy General Counsel

Ms. Johnson, Economist

Mr. Reinhart, Economist

Mr. Stockton, Economist

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

Wilcox, Associate Economists

Mr. Kos, Manager, System Open Market Account

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

Messrs. Ettin and Madigan, Deputy Directors, Divisions of Research and Statistics

and Monetary Affairs respectively, Board of Governors

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

Governors

Mr. Connors, Associate Director, Division of International Finance, Board of

Governors

Messrs. Oliner and Struckmeyer, Associate Directors, Division of 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

Ms. Low, Open Market Secretariat Assistant, Office of Board Members, Board of

Governors

Mr. Rasdall, First Vice President, Federal Reserve Bank of Kansas City

Messrs. Eisenbeis and Goodfriend, Mses. Krieger and Mester, and Mr. Rosenblum,

Senior Vice Presidents, Federal Reserve Banks of Atlanta, Richmond, New York,

Philadelphia, and Dallas respectively

Messrs. Bryan, Judd, and Krane, Vice Presidents, Federal Reserve Banks of

Cleveland, San Francisco, and Chicago respectively

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

Prior to this meeting, Ms. Susan Schmidt Bies and Mr. Mark W. Olson had executed their

oaths of office as members of the Board of Governors and the Federal Open Market

Committee.

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

held on November 6, 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 securities issued or fully guaranteed

by federal agencies during the period November 6, 2001, through December 10, 2001. By

unanimous vote, the Committee ratified these transactions.

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

conduct 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 indicated that economic activity had continued to

decline into the fourth quarter, although some very recent data suggested that the rate of

decline might be moderating. Labor market conditions had worsened further, especially in

manufacturing and related industries, and industrial production had fallen in October and

probably also in November. However, purchases of motor vehicles were very strong in

both months, and other household and business spending seemed to have recovered

somewhat from the sharp September decline. Energy prices were moderating noticeably in

response to lower worldwide demand, and core price inflation remained subdued.

The labor market deteriorated substantially in October and November. Nonfarm payroll

employment fell significantly in both months, with the largest job losses occurring in

manufacturing, help supply services, and retail trade. Steep cuts in employment also

occurred in industries directly affected by the September attacks, notably transportation,

lodging, and tourism. Among the few industries that had not been adversely affected were

health services, which continued to add workers, and finance, insurance, and real estate,

which maintained stable employment on balance. The heavy job losses boosted the

unemployment rate to 5.7 percent in November.

Industrial production fell sharply further in October, and the cuts continued to be spread

widely across groups and industries, reflecting weak demand for business equipment,

efforts by firms to pare inventories, and foreign competition. Motor vehicle assemblies

slowed for a third straight month from the relatively high levels attained in the spring and

early summer, and the output of high-technology goods remained on a steep downward

trajectory, though a few positive signs had begun to emerge in the semiconductor and

computer industries. The rate of utilization of total manufacturing capacity contracted

further in October and was at a level substantially below the trough reached in the 1990-91

recession.

Personal consumption expenditures are estimated to have rebounded in October, following

the large September decline, and were slightly above the third-quarter average. Purchases

of motor vehicles surged in response to aggressive zero-rate financing packages offered by

automakers, while spending on other goods made a partial recovery from the September

drop. Outlays on consumer services strengthened in October, but they remained below their

third-quarter average.

Residential building activity softened somewhat further in October, but in an environment

of very low mortgage rates, homebuilding remained at a relatively high level despite the

weak labor market and sluggish growth in personal income. Demand for single-family

housing had held up relatively well. Sales of new single-family homes changed little in

October and had been relatively steady since May, while sales of existing homes partially

retraced the sharp drop-off that occurred in September.

Recent information suggested that the downward trend in business spending on durable

equipment and software might be moderating somewhat. After plunging during the spring

and summer, orders and shipments of nondefense capital goods turned up in October. Of

particular note, both orders and shipments of office and computing equipment increased in

October after having declined sharply for most of the year. For durable equipment in

general, shipments had exceeded new orders since the first of the year, and as a result the

backlog of unfilled orders was now below its level of a year ago. Nonresidential

construction also had been weak during the spring and summer, reflecting an upward trend

in vacancy rates and uncertainties regarding rents and property values. Although spending

on industrial structures dropped further in October, outlays for office buildings and other

commercial structures picked up noticeably.

The book value of business inventories fell steeply in the third quarter. The bulk of the

reduction occurred in the manufacturing sector, but the sharp drop in stocks was matched

by a contraction in shipments and the aggregate stock-shipments ratio for the sector

remained at a very high level. In October, an additional sizable decline in manufacturing

stocks resulted in a decrease in the sector's aggregate stock-shipments ratio, though it

remained elevated. Wholesalers also experienced a sizable drop in inventories in the third

quarter that produced a slight reduction in their aggregate inventory-sales ratio, but the

latter was still in the upper portion of its range for the past two years. Retail inventories

and the sector's inventory-sales ratio both edged up in the third quarter. Nonetheless, the

sector's ratio remained in the lower end of its range for the past year.

The U.S. trade deficit in goods and services narrowed significantly in September and the

third quarter, though most of those declines reflected estimated payments by foreign

insurers related to the events of September 11. Abstracting from those payments, the trade

deficit fell only a little in the third quarter as the value of exports fell by less than the value

of imports. The softness in exports was widespread, with steep declines occurring in

consumer goods, capital goods, and industrial supplies. Reductions in imports also were

widespread, and as with exports, capital goods and industrial supplies were down sharply.

The limited available information suggested a further weakening of economic activity in

the foreign industrial countries in the current quarter, but there were some indications of a

possible brightening of the economic outlook in the period ahead despite a sharp decline in

business confidence in the aftermath of the September terrorist attacks. Additional

monetary easing actions by the European Central Bank, the Bank of England, and the Bank

of Canada contributed to that brighter outlook. Japan remained the weakest of the major

foreign industrial economies, and the available information suggested further contraction

in economic activity and worsened labor market conditions this quarter. Economic

conditions in the major emerging-market countries remained weak, but there were signs

that the worst might be over in some of the Asian economies most affected by the global

downdraft in the high-tech sector. Economic growth in China seemed to have slowed a

little. In Latin America, Argentina remained mired in recession, and the global slowdown

continued to depress the economies of other nations in that region.

Core consumer price inflation remained at a relatively subdued pace in September and

October, and a renewed decline in energy prices in October contributed to a sizable drop in

total consumer price inflation during the twelve months ended in October when compared

with the previous twelve-month period. The core personal consumption expenditure (PCE)

chain-type price index also indicated that consumer inflation was significantly lower

during the year ended in October, while the core consumer price index (CPI), with its

narrower range of spending categories, had changed little over the past year. Core producer

prices for finished goods edged up on balance during September and October, but inflation

as measured by this index moderated slightly on a year-over-year basis. With regard to

labor costs, growth of average hourly earnings of production or nonsupervisory workers

slowed in September and October from the relatively moderate rate that had prevailed in

earlier months.

At its meeting on November 6, 2001, the Committee adopted a directive that called for

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

the intended level of the federal funds rate, to about 2 percent. The members referred to the

heightened degree of uncertainty and risk aversion following the terrorist attacks that was

having a significant effect on business and household spending, and they noted that the

substantial easing of monetary policy that had been put in place this year had not shown

through fully to long-term interest rates, equity prices, bank lending rates, and the foreign

exchange value of the dollar. In these circumstances, with price inflation relatively low and

pressures on prices and resources likely to ebb further, the members concluded that further

monetary stimulus would provide some added insurance against a more extended

contraction of the economy at little risk of a pickup in inflation. The members also

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

economic weakness in the foreseeable future.

Federal funds traded at rates close to the Committee's target level of 2 percent during the

intermeeting period. Against the background of better-than-expected incoming economic

data and of favorable news on military operations in Afghanistan, short-term interest rates

declined a little over the intermeeting interval while intermediate- and long-term Treasury

rates rose substantially. With market concerns about the economic outlook diminishing,

yields on investment-grade corporate debt securities increased considerably less than those

on comparable-maturity Treasuries, rates on speculative-grade bonds fell sharply, and

major indexes of equity prices moved significantly higher.

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

foreign currencies increased slightly on balance over the intermeeting period; the release of

better-than-expected U.S. economic data lifted the dollar early in the intermeeting period,

but subsequent data releases led to some erosion of that gain. Abroad, central bank policy

rates were lowered in the euro area, England, and Canada in response to indications of

flagging economic activity. In Japan, disappointing economic news and comments by

Japanese officials about possible intervention to weaken the yen contributed to a decline in

that currency. Meanwhile, the dollar was about unchanged on balance in terms of an index

of the currencies of other important trading partners. The Mexican peso changed little on

balance, the Brazilian real firmed despite the deepening problems of Argentina, and the

Korean won rose against the background of incoming data that suggested the persistence of

resilient domestic demand.

M2 growth in November was robust though well below the average pace of the two

previous months. Liquid deposits continued to increase rapidly, reflecting the sharp drop in

market interest rates this year, but inflows to retail money funds slowed as the economic

outlook improved and the equity markets rallied. M3 expansion remained at a very high

rate in November, bolstered by the growth of M2 and heavy bank acquisitions of

nondeposit liabilities. The debt of domestic nonfinancial sectors grew at a moderate pace

on balance through October.

The staff forecast prepared for this meeting suggested that economic activity would extend

its decline for a time in 2002 but then would begin to turn upward. The recovery would be

supported in part by the cumulative easing that had occurred in the stance of monetary

policy, along with the fiscal stimulus already in place and some assumed additional

measures not yet enacted. The turnaround in the economy and the gradual strengthening of

the recovery would also be fostered by the completion of downward adjustments to

inventories, a marked slowing in the contraction of business capital investments, and the

added purchasing power arising from the recent declines in oil prices. Economic expansion

was projected to strengthen appreciably by the second half of 2002 as the climate for

business fixed investment improved and a strengthening of foreign economies led to

somewhat greater demand for U.S. exports. Subpar expansion in the next few quarters was

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

moderation in core price inflation.

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

members commented that the economy clearly was continuing to contract, led by further

inventory liquidation and ongoing reductions in capital spending. The decline in

inventories was likely to abate before long, boosting production, but the course of a

recovery would depend on the behavior of final demand. The recent statistical and

anecdotal information was more mixed than had been the case earlier and pointed on

balance toward some moderation in the decline of overall final demand; for the first time in

a long while the incoming data did not call for a downward revision to current forecasts.

The members agreed, however, that the evidence of emerging stabilization in the economy

remained quite tentative and the timing and strength of the eventual recovery continued to

be surrounded by a high degree of uncertainty, with the risks to the economy still clearly

tilted toward economic weakness. Among those risks, members cited the apparently

reduced prospects for additional fiscal stimulus legislation, the vulnerability of current

stock market valuations should forecasts of a robust rebound in earnings fail to materialize,

the possibility of further terrorist incidents, and especially the potentially adverse effect on

consumer confidence and spending of additional deterioration in labor market conditions.

Nonetheless, with the critical consumer sector holding up relatively well thus far, members

continued to anticipate an upturn in the economy during the year ahead in light of the

progress already made by business firms in reducing excess inventories and unwinding

capital overhangs, and the beneficial effects of the decline of energy prices. The lagged

effects of the substantial easing in monetary policy this year and the fiscal stimulus

measures already enacted into law were expected to buttress demand and economic

recovery over the next year. The outlook for inflation was viewed as favorable, given the

slack in labor and product markets, subdued inflationary expectations, and the prospect that

aggregate demand would remain well below the economy's potential output over the next

several quarters.

In the consumer sector, a major downside concern was the possibility that substantial

further deterioration in labor market conditions, which was widely anticipated, could have

a significant inhibiting effect on consumer confidence, incomes, and spending. Other

potentially adverse economic factors cited by members included rising consumer debt

burdens, the risk of a downturn in the stock market, and the recent rise in mortgage interest

rates. That increase, among other things, would impinge on the extraction of capital gains

from the turnover or refinancing of existing homes, which had provided important support

for consumer spending. However, consumer expenditures appeared to have been relatively

well sustained thus far, evidently in part the result of widespread price discounting and low

interest rates, including zero rates on many motor vehicle loans, that were helping to

overcome a currently high degree of caution and price consciousness among consumers.

Moreover, recent survey evidence suggested that consumer confidence might be stabilizing

after earlier declines. The significant decreases that had occurred in the prices of fuel oil

and gasoline were a positive factor that would continue to bolster household spending for a

while. Looking ahead, it was unclear how the various factors affecting consumers would

interact, though apart from a likely downward adjustment in sales of motor vehicles to a

more sustainable level following their recent surge, members generally anticipated that

solid gains in consumer spending would underpin the economic recovery.

Like consumer spending, new home construction and sales had displayed considerable

resilience in recent months, apparently in large part as a result of relatively attractive

mortgage interest rates and perhaps to some extent as a consequence of favorable weather

conditions in many parts of the country. Though overall housing activity remained at a

high level, members reported softening activity in a few areas of the nation, notably in

apartment units in some major cities. Sales of high-end houses also continued to be

relatively depressed. With regard to the outlook, the recent rise in mortgage interest rates

could be expected to have a retarding effect on housing activity. Even so, in the absence of

seriously adverse shocks to confidence, housing activity seemed likely to hold near current

levels over the quarters immediately ahead.

Business capital spending appeared to be continuing to decline at a rapid pace as business

firms persisted in their efforts to bring production capacity into better alignment with

forecasts for the growth of sales. With the near-term outlook for sales and profits

remaining relatively depressed, the prospects for a significant pickup in spending for

equipment and software did not seem favorable for the period immediately ahead.

Businesses were reported to be very cautious, with many business executives awaiting

concrete indications of improving markets before proceeding with planned investment

expenditures. Even so, members referred to some tentative indications, such as an uptick in

orders for durable goods and expectations of improving sales of some high-tech products,

that might be signaling a turnaround in overall capital spending over coming quarters.

Further progress in adjusting capacity and strengthening profit expectations would at some

point lead to an upturn in spending for new equipment and software, but business contacts

indicated that the timing for individual firms would vary considerably, with delays

extending in some cases into 2003. New construction of nonresidential structures had

declined sharply over the past several quarters, and with vacancy rates still rising in many

key markets a further sizable decline was anticipated over the year ahead. Some members

reported that higher insurance costs since the September 11 terrorist attacks were exerting

an inhibiting effect on some nonresidential construction activity in their regions.

The liquidation of business inventories appeared to have accelerated in the current quarter,

fostered to an important extent by very large declines in stocks of motor vehicles.

Inventories now seemed to be approaching levels where firms would start to reduce their

rate of liquidation early next year and perhaps turn to inventory accumulation as the year

ahead progressed, giving a boost to production and incomes. Anecdotal reports provided

some support for such an outlook, including widespread indications that retail inventories

were already at quite lean levels, even outside the motor vehicle sector. At the same time,

recent survey results pointed to less discomfort with current inventory levels though some

further inventory correction was anticipated in manufacturing.

Further fiscal stimulus remained under active debate in the Congress, but with the rapid

approach of the date for adjourning the current session, it was now questionable whether

the legislation would be enacted this year. Although an expansionary fiscal policy was

already in place as a result of earlier legislation and more stimulus might be legislated next

year, especially if the economy continued to deteriorate, members saw an additional boost

to near-term economic activity from new fiscal initiatives as increasingly unlikely. Some

members also commented on mounting state and local government deficits, largely the

result of diminishing income and sales tax receipts, and the adverse implications for

governmental budgets and spending in various parts of the country.

Reflecting unusually synchronous global economic developments, foreign nations also

were experiencing sluggish economic activity and in many instances actual recessions. The

weakness was reflected in declining U.S. exports. Members saw little prospect that foreign

economies would strengthen sufficiently on their own to provide significant independent

impetus to U.S. exports, at least over the near term. Instead, an upturn in foreign economic

activity would depend more on recovery in the United States.

Expectations that output would remain below the economy's potential for some time led

many members to believe that underlying inflation might well edge lower from its

currently modest levels. Reinforcing this outlook was recent evidence of somewhat faster

than anticipated productivity growth, the prospect that world economic conditions would

hold down energy prices, and a sharp drop in near-term inflation expectations of

households as reported in recent surveys. Moreover, labor compensation appeared to be on

a decelerating trend despite rapid increases in the cost of healthcare and other worker

benefits. In these circumstances and given the persistence of highly competitive conditions

in domestic and international markets, the ability of most businesses to raise prices was

likely to remain quite limited or even nonexistent. While a number of members referred to

the possibility of further disinflation, some also noted that the risks of a deflationary spiral

seemed very limited, given the economy's self-correcting resilience and the ongoing effects

of stimulative fiscal and monetary policies.

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

member indicated their support of a proposal to ease reserve conditions slightly further,

consistent with a 25 basis point reduction in the federal funds rate to a level of 1-3/4

percent. While there were signs that the weakness in aggregate demand might be abating,

those signs were still quite limited and tentative. For now, contractionary forces continued

to depress overall economic activity, and subpar economic performance seemed likely to

persist, at least for a time. Moreover, a number of members saw substantial risks that

economic activity could even fall short of a projection of stabilization in the near term and

moderate recovery later next year. In these circumstances, the consequences of inactivity at

this meeting could turn out to be considerable, and several members viewed an easing

action as a measure of insurance against the potential for greater or more prolonged

economic weakness than they currently anticipated. If a modest easing action taken today

turned out to be unneeded, the Committee would have ample opportunity to reverse its

action without incurring any real risk of allowing inflationary pressures to gather

momentum, given the projected degree of slack in resource use and the current absence of

significant inflationary pressures. The risk that a policy reversal, should it prove to be

needed in the near term, would foster significant market unsettlement seemed limited in

light of widespread expectations of some further easing at this meeting to be followed by a

policy turnaround next year.

At the same time, members emphasized that the stance of policy was already quite

accommodative, that much of the effects of recent easings had yet to be felt, and that

tentative signs suggested the economy and the economic outlook were beginning to

stabilize. In these circumstances several saw a decision to ease as a close call, but they

favored it on balance given their weighting of the possible consequences should restraining

forces in the economy persist to a greater extent than they currently expected. In the view

of one member, policy was already sufficiently stimulative and the outlook improved

enough to warrant a pause to assess further developments. In any event, members

commented that the Committee's easing cycle was likely to be approaching its completion,

and several suggested the desirability of signaling that view to the public.

Given their views about the risks to the economy, the members supported the retention of

the sentence in the press statement to be released shortly after this meeting indicating that

the risks continued to be weighted mainly toward conditions that could foster economic

weakness in the foreseeable future. Such a statement was not intended to convey the

impression that the Committee necessarily contemplated further easing actions. Members

felt that the reduced size of today's action along with a reference in the statement to the

emergence of signs that weakness in the economy could be moderating would tend to

mitigate such an interpretation.

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 1-3/4 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, Ms. Bies, Messrs.

Ferguson, Gramlich, Meyer, Ms. Minehan, Messrs. Moskow, Olson, and

Poole.

Votes against this action: Mr. Hoenig.

Absent and not voting: Mr. Kelley.

Mr. Hoenig dissented because he preferred to leave the federal funds rate unchanged. He

judged that a 2 percent federal funds rate was already quite stimulative and that a more

stimulative policy was not needed. Following the rapid and aggressive policy actions

already taken, it would be prudent to give the current policy more time to work through the

economy. It was also his position that reducing the federal funds rate at this meeting could

increase interest rate volatility by creating an expectation of a faster or a more aggressive

reversal of policy.

It was agreed that the next meeting of the Committee would be held on TuesdayWednesday, January 29-30, 2002.

The meeting adjourned at 1:20 p.m.

Donald L. Kohn

Secretary

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