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, March 19,

2002, at 9:00 a.m.

Present:

Mr. Greenspan, Chairman

Mr. McDonough, Vice Chairman

Ms. Bies

Mr. Ferguson

Mr. Gramlich

Mr. Jordan

Mr. McTeer

Mr. Olson

Mr. Santomero

Mr. Stern

Messrs. Broaddus, Guynn, Moskow, and Parry, Alternate Members of the Federal

Open Market Committee

Mr. Hoenig, Ms. Minehan, and Mr. Poole, Presidents of the Federal Reserve Banks of

Kansas City, Boston, and St. Louis respectively

Mr. Kohn, Secretary and Economist

Mr. Bernard, Deputy Secretary

Mr. Gillum, Assistant Secretary

Ms. Smith, Assistant Secretary

Mr. Mattingly, General Counsel

Ms. Johnson, Economist

Mr. Reinhart, Economist

Mr. Stockton, Economist

Mr. Connors, Ms. Cumming, Messrs. Howard and Lindsey, Ms. Mester, Messrs.

Oliner, Rolnick, Rosenblum, Sniderman, 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. Whitesell, Deputy Associate Director, Division of Monetary Affairs, Board of

Governors

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

Governors

Mr. English, 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

Ms. Pianalto and Mr. Stewart, First Vice Presidents, Federal Reserve Banks of

Cleveland and New York respectively

Messrs. Beebe, Eisenbeis, Fuhrer, Goodfriend, Hakkio, Hunter, and Rasche, Senior

Vice Presidents, Federal Reserve Banks of San Francisco, Atlanta, Boston,

Richmond, Kansas City, Chicago, and St. Louis respectively

Ms. Hargraves, Vice President, Federal Reserve Bank of New York

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

on January 29-30, 2002, were approved.

By notation vote completed on March 19, 2002, the members of the Federal Open Market

Committee voted unanimously to accept the Report of Examination of the System Open

Market Account conducted as of the close of business on November 14, 2001, by the

Division of Reserve Bank Operations and Payment Systems of the Board of Governors.

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 January 30, 2002, through March 18, 2002. By

unanimous vote, the Committee ratified these transactions.

At this meeting the staff requested Committee guidance on the priorities, given limited staff

resources, it should attach to further studies of the feasibility of outright purchases for the

System Open Market Account (SOMA) of mortgage-backed securities guaranteed by the

Government National Mortgage Association (GNMA-MBS) and the addition of foreign

sovereign debt securities to the list of collateral eligible for U.S. dollar repurchase

agreements by the System. Such alternatives could prove useful if outstanding Treasury debt

obligations were to become increasingly scarce relative to the necessary growth in the

System's portfolio, and the Committee had previously requested initial staff exploration of

these options. Noting that many of the staff engaged in these studies were also involved in

contingency planning, which had been intensified after the September 11 attacks, the

consensus of the members was to give the highest priority to such planning. All the members

preferred continued reliance to the extent feasible on direct Treasury debt for outright System

transactions, and they were persuaded that budget developments over the last year meant that

constraints on Treasury debt supplies would not become as pressing an issue as soon as they

had previously thought. Still, given the inherent uncertainty of budget forecasts, the likely

significant needs for large SOMA operations in coming years and the lead times needed to

implement new procedures, the Committee decided that the study of alternative market

instruments should go forward once it was possible to do so without impeding the

contingency planning effort. With regard to the two proposed alternatives for broadening the

System's options for open market operations, the members instructed the staff to give a

higher priority to further examination of outright purchases of GNMA-MBS. Although these

securities have a number of shortcomings as an outright investment vehicle from the

System's perspective, the market for GNMA-MBS was well developed and the securities

were guaranteed by the full faith and credit of the U.S. government.

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

conduct of monetary policy over the intermeeting period ahead.

The information reviewed at this meeting indicated that economic activity had turned up in

the final quarter of last year and strengthened further since then. Consumer spending on

goods other than motor vehicles was brisk in the early part of this year, business purchases of

equipment and software appeared to be beginning to recover from their marked decline of

last year, and housing starts turned back up. Amid signs that most firms had worked down

their inventories to more comfortable levels, industrial production increased slightly after

having declined for nearly a year and a half, and payroll employment appeared to be

bottoming out. Inflation remained low despite some firming of energy prices.

Private nonfarm payroll employment moved up in February, retracing part of January's drop.

Layoffs in manufacturing slowed further, the construction industry added back some workers

in February, and the retail trade and services sectors continued to hire in both months. The

unemployment rate edged down again in February to 5.5 percent, and initial claims for

unemployment insurance continued to drop.

Industrial production increased somewhat in January and February after a steep decline from

its June 2000 peak. Manufacturing output rose in both months, and the factory operating rate

moved up slightly from its low level at year-end. The pickup in manufacturing this year was

spread across several major industries, including chemicals, computers and semiconductors,

paper, and tobacco. In addition, output of communications equipment steadied after having

plunged for more than a year. In contrast, production of motor vehicles and parts changed

little over January and February after a surge late in 2001.

Consumer spending remained strong in the early part of the year, despite a sizable drop in

purchases of light vehicles in January that was followed by a rebound in February as

manufacturers switched from attractive financing terms to cash rebates. Outlays for retail

items other than motor vehicles expanded further in February after the large increases

recorded in the two prior months. Outlays for services continued to rise moderately in

January (latest data). Consumer purchases were supported by a sizable gain in disposable

personal income in January, and readings on consumer sentiment were close to their

historical averages.

Residential construction had been very strong in the past several months, with new starts

reaching their highest level in almost two years. The strength in homebuilding was associated

in part with unusually warm and dry weather, but very low mortgage rates also continued to

play an important role.

Business spending on durable equipment and software appeared to be turning upward after a

marked moderation in the fourth quarter of the steep decline recorded in the two previous

quarters. Shipments and orders of nondefense capital goods were unexpectedly strong in

January. There were signs of recovery in the high-tech sector, with shipments of computers

and peripherals increasing for a fifth straight month, but shipments of communications

equipment turned down in January after a December bounce. Shipments in most other sectors

recorded increases and were particularly robust for machinery, engines, and turbines.

Business demand for motor vehicles remained mixed, with fleet sales of light vehicles higher

and purchases of medium and heavy trucks somewhat weaker. Nonresidential construction

remained in a slump, with spending on new office buildings and industrial structures down

sharply in an environment of elevated vacancy rates.

The pace of liquidation of manufacturing and trade inventories, excluding motor vehicles,

slowed in January after a very rapid rundown in the fourth quarter, and with sales higher the

aggregate inventory-sales ratio declined to its lowest level since midyear 2000.

Manufacturers' stocks were drawn down sharply further in January, and the sector's stockto-shipments ratio fell appreciably. At the wholesale level, the rate of inventory runoff

slowed somewhat, but the sector's inventory-sales ratio declined further. The level of

inventories at the retail level increased somewhat despite a rise in sales, and the sector's

aggregate inventory-sales ratio was at an historically low level.

The U.S. trade deficit in goods and services widened somewhat in January. The value of

exports changed little but the value of imports rose appreciably, to about the November level.

The available information indicated that economic activity in the foreign industrial countries

showed little net change in the fourth quarter. The Canadian economy rebounded from a

weak third quarter, but economic expansion in the United Kingdom nearly came to a halt in

the fourth quarter, economic activity in the euro area slipped a little, and the Japanese

economy recorded a steep drop. There were indications, however, of a gradually improving

economic outlook in several of these economies in the first quarter as a consequence of

previous monetary policy easing actions that their respective central banks had taken and

from the effects of an improved economic performance in the United States. Among the

major emerging-market countries, the exports of a number of Asian economies were

benefiting from the nascent recovery in high-tech industries around the world. In Latin

America, although Argentina remained in a steep downward trend, the Mexican and

Brazilian economies seemed to be recovering from weakness in the fourth quarter.

Consumer price inflation picked up a bit in January as energy prices posted their first

increase since September. However, on a year-over-year basis, core price inflation as

measured by the consumer price index leveled out at a moderate rate, while core PCE

(personal consumption expenditure) price inflation declined appreciably. Labor costs also

appeared to have decelerated recently. The employment cost index for hourly compensation

in private industry rose moderately in the fourth quarter of last year and for the year as a

whole. Both the salary and benefits components recorded slightly smaller increases last year.

Average hourly earnings of production and nonsupervisory workers advanced only slightly in

January and February of this year, and the average wage increase during the twelve months

through February was slightly lower than that for the twelve-month period ending in

February 2001.

At its meeting on January 29-30, 2002, the Committee adopted a directive that called for

implementing conditions in reserve markets consistent with keeping the intended level of the

federal funds rate at 1-3/4 percent. The members noted that policy had been eased

substantially over the past year and that the inflation-adjusted federal funds rate was at an

unusually low level. As a result, policy was positioned to support an economic recovery as

forces restraining aggregate demand abated. Nonetheless, the members agreed that there

were factors that might keep the pace of expansion below the rate of growth of potential for a

while, and thus the balance of risks continued to be tilted toward economic weakness in the

foreseeable future.

The federal funds rate remained close to the Committee's target level of 1-3/4 percent during

the intermeeting period. However, short-term market rates increased slightly over the

intermeeting interval, and yields on longer-term Treasury instruments and high-grade

corporate bonds rose by more. The rise in rates was sparked initially by market participants'

reading of the Committee's press statement as suggesting greater-than-expected optimism

about the economy going forward. That assessment was subsequently strengthened by data

on spending and output released during the intermeeting interval that came in well above

market expectations. Speculative-grade bond yields fell somewhat in reaction to the

improved economic outlook and the perceived reduction of credit risk. Most major indexes of

equity prices moved up sharply on the bullish economic reports.

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

foreign currencies eased slightly on balance over the intermeeting period. The dollar fell

more against the yen than the euro despite negative economic news from Japan and the

disappointing reaction to the Japanese government's announcement of an "anti-deflation"

package. The exchange value of the dollar changed little in terms of an index of the

currencies of other important trading partners, in part because of the further depreciation of

the Argentine peso.

Expansion of M2 rebounded somewhat in February from January's lackluster rate, but growth

in the early part of the year was down sharply from the robust pace of late last year. The

slowdown apparently was related to the ebbing effect of earlier declines in opportunity costs

of holding M2 assets and to the shift of large amounts of money from retail money market

funds into bond and equity mutual funds as concerns about volatility in financial markets

eased. Reduced demand for mortgage refinancing also seemed to have contributed to the

deceleration of M2. The debt of the domestic nonfinancial sectors was estimated to have

increased at a relatively slow rate in January, reflecting weak demand for business debt

financing and little net borrowing by the federal government.

The staff forecast prepared for this meeting suggested that economic activity was expanding

briskly in the early months of the year after having turned up and increased modestly in the

fourth quarter. Elevated household spending and a shift from inventory liquidation to

accumulation would provide significant impetus for the recovery in the context of the

substantial monetary ease and fiscal stimulus already in place. Moreover, the recently

enacted federal incentive for new business equipment investment along with the outlook for

continued robust gains in productivity were expected to help boost business capital spending.

At the same time, still-depressed equity prices, limited growth abroad, and the dollar's

strength would tend to hold down the pace of recovery. On balance, recent developments

suggested that the course of final sales now had a more positive contour over the forecast

horizon and that resource utilization would rise somewhat more than anticipated earlier

despite higher projected growth in structural productivity. Even so, overall activity would

remain below estimates of the economy's potential output for some time, and the persistence

of underutilized resources was expected to keep downward pressure on core price inflation.

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

commented that the decidedly positive information received over the intermeeting period

provided strong evidence that an economic recovery was now under way, though its

prospective strength remained subject to substantial uncertainty. In this regard it was noted

that the economy was undergoing significant structural changes and those changes were

adding to the usual difficulty of projecting the trajectory of economic activity after a turning

point. Unexpected strength in household expenditures, much reduced weakness in business

capital spending, and substantial slowing in inventory liquidation had produced an earlier

upturn in economic activity than many had anticipated. A further strengthening of inventory

investment would probably generate appreciable further growth in business activity over the

quarters just ahead. Once the ongoing inventory correction was completed, however, it was

not clear to what extent final demand in key sectors of the economy, notably business capital

investment, would provide support for further economic growth. While the members agreed

that the stimulative fiscal and monetary policies currently in place would undergird further

economic expansion, most continued to anticipate a relatively subdued rate of expansion that

would only gradually erode current margins of underutilized productive resources. The

members viewed the outlook for core price inflation as still quite benign, largely reflecting

the ample availability of labor and other producer resources to accommodate rising economic

activity and the favorable prospects for further robust growth in productivity.

Anecdotal commentary from around the country was somewhat less positive on the whole

than the recent macroeconomic data for the nation. Business conditions were reported to be

improving in most areas and industries, but the pickup was uneven, with continued weakness

still characterizing numerous industries. Many business contacts, although somewhat less

pessimistic about the economic outlook, still did not appear to be anticipating a strong upturn

this year. Gradual recovery was reported in the depressed tourism and travel industries. The

manufacturing sector, where much of the economy's weakness had been concentrated, was

displaying increased signs of stabilizing, with activity actually picking up in a number of

industries and some firms anticipating increases in their payrolls over the next several

months after experiencing large declines. However, employers in manufacturing and other

sectors of the economy generally remained cautious in their hiring policies and in their plans

for capital spending.

In their discussion of developments in key expenditure sectors of the economy, members

commented that inventory investment was likely to remain a pivotal factor in the nearer-term

performance of the economy. Firms had moved rapidly to correct earlier inventory

imbalances. Data indicating a very large drawdown of inventories in the fourth quarter and

further, albeit much diminished, liquidation in January along with anecdotal commentary

suggested that inventories were now close to desired levels in many industries, notably in the

retail sector, and the swing toward smaller drawdowns was giving a boost to industrial

production. Looking ahead, inventory investment likely would turn toward accumulation as

business firms facing brisk demand and depleted stocks stepped up their new orders,

providing a source of significant strength in fostering economic recovery over the near term.

A major uncertainty in the economic outlook was the extent to which growth in final demand

by households and business firms would provide ongoing support for the expansion as the

impetus from inventory investment dissipated. The prospects for consumer spending

remained favorable against the backdrop of a solid uptrend in disposable incomes associated

to an important extent with an improving employment picture, robust underlying growth in

labor productivity, and the further phase-in of personal income tax cuts enacted in 2001.

Consumer confidence had improved considerably in recent months and consumer

expenditures had displayed surprising strength. Members nonetheless cited some negatives in

the outlook for consumer spending including the possibilities that a negative stock market

wealth effect stemming from large earlier declines and the somewhat elevated rate of

unemployment would weigh on consumer confidence. Importantly, because consumer

spending for automobiles and other consumer durables had been well maintained through the

extended period of economic weakness, further gains in such expenditures were likely to be

limited over coming quarters in contrast to the typical surge in past economic recoveries.

Moreover, energy price increases, especially if they were to become more pronounced, would

tend to hold back household spending. On balance, members saw moderate further growth in

consumer spending as a reasonable prospect for coming quarters.

After a lull during the fall of 2001, housing activity had displayed renewed vigor in recent

months, in part as a consequence of widely favorable weather conditions. Indeed, singlefamily construction was described as a particularly bright sector in a number of local

economies. Looking ahead, the favorable factors affecting consumer spending more

generally along with relatively low mortgage interest rates were expected to sustain a high

level of housing expenditures this year. In keeping with the outlook for consumer durables,

however, a long period of active housing construction suggested that significant additional

strength in housing was unlikely in coming quarters.

The members generally viewed business fixed investment spending as the key to the strength

of economic activity once the thrust from inventory restocking had run its course. The

outlook for business capital expenditures would be governed to an important extent by

business expectations regarding sales and profits. After the steep declines in business

investment over the past year, anecdotal reports from around the country provided scattered

indications of an upturn but no evidence at this point of any broad-based improvement.

According to such reports and despite the strength of recent economic statistics, which had

boosted the economic forecasts of many observers, business confidence remained at a low

level, evidently reflecting a weak outlook for profits in the business community in the

context of strong competitive pressures. Negative factors bearing on the outlook for

investment in capital equipment included the persistence of large margins of excess capacity

in many industries. The outlook for commercial and other nonresidential construction seemed

even less promising, at least for the next several quarters, given high vacancy rates in

commercial structures in many parts of the nation. Members nonetheless cited some positives

in this outlook that included the favorable effects on incentives to purchase capital equipment

stemming from the outlook for relatively rapid growth in productivity and the recent passage

of legislation providing a temporary tax incentive for investments in equipment and software.

On balance, a substantial pickup in overall capital spending seemed likely to be delayed in

the absence of surprising strength in final demand, but a wide range of possible outcomes

could not be ruled out for this key sector of the economy.

Several members referred to the currently high degree of fiscal policy stimulus, which had

been augmented by recent legislation. Much of the added stimulus from the investment

incentive component of that legislation was not likely to be felt for some period and might

occur at a time when the economy would already be expanding at a solid pace. Federal

spending was increasing rapidly and its growth could taper off more slowly than current

budget estimates implied. An at least partially offsetting factor was the prospect that state and

local government expenditures would increase at a reduced pace this year amid widespread

budget pressures that had emerged as tax receipts weakened along with the economy.

However, some reports indicated that spending on local infrastructure projects was

continuing at a solid pace in some parts of the nation.

Members saw a number of downside risks from potential developments abroad. In particular,

concern was expressed about heightened tensions in the Middle East and their possible

impact on oil markets and the cost of energy. For a variety of reasons, oil prices already had

risen appreciably since the start of the year. With regard to the outlook for foreign trade,

members reported some indications of an improving volume of trade with some Asian

nations. However, the nation's net export position could deteriorate further when much of the

impetus to world economic growth was coming from the U.S. economy.

The members expected price pressures to remain relatively contained over the next several

quarters in the context of what they anticipated would be only a gradual reduction of the

excess capacity in labor and product markets as the recovery progressed. Moreover, the

prospects of relatively robust growth in productivity in a highly flexible and competitive

economy likely would moderate the extent of any potential buildup in inflationary pressures

in the future. Members nonetheless mentioned some potential negatives in this outlook,

notably the possibility of rising wage pressures as labor markets became more fully

employed and upward price pressures stemming from increasing steel, energy, and insurance

costs.

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

supported a proposal to maintain an unchanged policy stance, with the target for the federal

funds rate staying at 1-3/4 percent. While the economy currently appeared to be expanding at

a fairly vigorous pace, the advance importantly reflected a temporary swing in inventory

investment and considerable uncertainty surrounded the outlook for final demand over the

quarters ahead. Against this background, the members judged the currently accommodative

stance of monetary policy to be appropriate for now, especially in light of the relatively high

unemployment rate, low capacity utilization rates in numerous industries, and quiescent

inflation pressures.

Looking ahead, however, the stance of policy would need to be adjusted at some point to

provide less stimulus as the members gained more confidence that the recovery was

becoming better entrenched and the risks had shifted toward rising inflationary pressures.

The need to adjust monetary policy during the early stages of a recovery presented a special

challenge with regard to its timing and extent in that raising rates prematurely or too

precipitately could weaken or abort the recovery, while waiting too long could risk a pickup

in inflationary pressures later. Members concluded that the Committee would be in a better

position to assess the appropriate timing of a policy change at the May meeting when it

would have more information to gauge the economy's performance in two critical areas,

namely developments relating to inventory investment and the implications of trends in sales

and profits for capital investment. A reference to the Committee's currently accommodative

policy stance in the press announcement to be issued shortly after this meeting would alert

the public to the need to firm policy at some point in the future.

All the members indicated that they could accept a proposal to move the balance of risks

statement from potential weakness to a neutral position. It was clear that significant downside

risks remained in the economy even apart from any major unanticipated shocks to business

and consumer confidence, but in light of the strength of the recent economic information

nearly all the members agreed that a balanced risks statement now best represented their

consensus regarding the economic outlook over the foreseeable future. Members noted that a

neutral statement did not preclude a tightening policy move should the latter seem warranted

by rapidly evolving economic conditions.

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 maintaining the federal funds rate

at 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 are balanced with respect to prospects for both goals in the

foreseeable future.

Votes for this action: Messrs. Greenspan, McDonough, Ms. Bies, Messrs.

Ferguson, Gramlich, Jordan, McTeer, Olson, Santomero, and Stern.

Votes against this action: None.

Disclosure Policy

By unanimous vote, the Committee approved a proposal to include the vote on monetary

policy in the press statement released after every meeting, beginning with this meeting. In

addition to identifying the voters, the press release would indicate the policy preferences of

dissenters, if any. Such information could prove useful to market participants, who on

occasion had employed indirect and frequently misleading information to gauge the

Committee's vote before it was released as part of the minutes after the next meeting.

It was agreed that the next meeting of the Committee would be held on Tuesday, May 7,

2002.

The meeting adjourned at 1:30 p.m.

Donald L. Kohn

Secretary

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