FOMC Minutes

November 6, 2002

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 Wednesday, November 6,

2002, at 9:00 a.m.

Present:

Mr. Greenspan, Chairman

Mr. McDonough, Vice Chairman

Mr. Bernanke

Ms. Bies

Mr. Ferguson

Mr. Gramlich

Mr. Jordan

Mr. Kohn

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. Reinhart, 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. Stockton, Economist

Messrs. Howard, Lindsey, Ms. Mester, Messrs. Oliner, Rosenblum, Sniderman, and Wilcox,

Associate Economists

Mr. Kos, Manager, System Open Market Account

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

Monetary Affairs respectively, Board of Governors

Messrs. Slifman and Struckmeyer, Associate Directors, Division of Research and Statistics,

Board of Governors

Messrs. Kamin and Whitesell, Deputy Associate Directors, Divisions of International

Finance and Monetary Affairs respectively, Board of Governors

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

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

Mr. Nelson, 1 Senior Economist, Division of Monetary Affairs, Board of Governors

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

Governors

Mr. Forte, 1 Senior Technical Editor, Division of Research and Statistics, Board of

Governors

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

Governors

Mr. Varvel, First Vice President, Federal Reserve Bank of Richmond

Mr. Lang, Executive Vice President, Federal Reserve Bank of Philadelphia

Messrs. Eisenbeis, Fuhrer, Goodfriend, Hakkio, Hunter, Judd, Ms. Perelmuter, and Mr.

Rasche, Senior Vice Presidents, Federal Reserve Banks of Atlanta, Boston, Richmond,

Kansas City, Chicago, San Francisco, New York, and St. Louis respectively

Mr. Peach, Vice President, Federal Reserve Bank of New York

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

1. Attended portion of meeting relating to the discussion of alternatives to holding Treasury

securities in the System Open Market Account. Return to text

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

on September 24, 2002, 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 September 24, 2002, through November 5, 2002. 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.

The information reviewed at this meeting suggested that economic growth had slowed from

the moderate pace of the third quarter. Residential construction activity remained high, but

consumer spending had softened and business investment was still sluggish. Industrial

production had slipped in recent months and private payroll employment had changed little,

while labor productivity remained on a strong upward trend. Overall price inflation had

fallen over the past year, reflecting both favorable developments in the food and energy

sectors and a continuing decline in core inflation.

Aggregate labor market conditions weakened further in October. Private nonfarm payroll

employment declined in September and October after four previous months of modest gains

in hiring. The number of jobs in manufacturing and related industries continued to fall, with

losses widely spread. The construction, transportation, and utilities industries also registered

further job losses. By contrast, the services sector continued to expand despite job

reductions in the help-supply industry, and the strong housing market and mortgage

refinancing activity led to brisk hiring in the finance, insurance, and real estate industries.

Total hours worked by private production workers moved down in October, and initial

claims for unemployment insurance were at a relatively elevated rate. The civilian

unemployment rate rose to 5.7 percent in October.

Industrial production decreased slightly further in September, and available weekly

information pointed to another reduction in output in October. Softness in the manufacturing

sector was widespread. In the high-tech sector, output continued to rise, but much less

rapidly than earlier in the year. Motor vehicle assemblies ebbed a little from the robust thirdquarter pace. Elsewhere in manufacturing, production weakened in many categories,

including commercial aircraft, non-auto consumer goods, and various types of business

equipment. Capacity utilization in manufacturing edged lower in September and was

substantially below its long-run average.

In the context of limited gains in personal income and declining consumer confidence, retail

sales weakened in September after two months of robust increases. The earlier gains were

fueled mainly by very large manufacturer discounts on 2002 models of motor vehicles.

Incentives on 2003 models were smaller in September, and consumer response was tepid.

Retail sales of non-auto goods also decreased in September after having registered only

modest growth in July and August. Outlays for services edged up in September.

Residential housing activity, supported by mortgage rates near historical lows, remained

very strong in September despite an environment of sluggish employment and declining

household wealth. Starts of single-family units reached a twenty-three year high in

September, and starts in the multifamily sector were a little above their average since

January of this year. Sales of new homes edged up to a record level in September, and sales

of existing homes continued to be brisk, though a little below the exceptional pace of the

first half of the year. The strength of housing demand was also reflected in further rapid

gains in home prices.

Business fixed investment edged up in the third quarter, as a pickup in expenditures for

equipment and software nearly offset a further sharp decline in spending on nonresidential

structures. The return to positive growth of spending for equipment and software was led by

robust business outlays for computers and peripheral equipment and for motor vehicles. By

contrast, investment in telecommunications equipment and aircraft remained on a steep

downward trend. Nonresidential construction activity also continued to decline rapidly, with

considerable further reductions in all major categories.

The book value of manufacturing and trade inventories excluding motor vehicles registered

consecutive gains in July and August after months of heavy liquidation. Despite the recent

accumulation, inventory-sales ratios in most industries were at, or near, historic lows.

The U.S. trade deficit in goods and services widened in August, and the average deficit for

July and August was virtually unchanged from that for the second quarter. The value of both

imports and exports changed little in the July-August period. The available information on

economic activity abroad in the third quarter suggested mixed results. Canada apparently

grew briskly, and the United Kingdom recorded further moderate economic expansion. In

the euro area and Japan, growth appeared to be weakening. The pace of recovery in most of

emerging Asia also appeared to have slowed, though China evidently remained on a path of

robust expansion. In South America, economic conditions generally remained fragile.

Economic activity was still very weak in Argentina and Venezuela, and the Brazilian

economy continued to be adversely affected by uncertainties concerning the economic

policies of the incoming government. Mexico has been largely unaffected by the financial

and political problems of major South American countries, but it nonetheless experienced

slower economic growth in the third quarter.

Consumer price inflation continued to trend downward in September. The rise in consumer

prices for the year ending in September was considerably smaller than that for the previous

twelve-month period. While much of that drop reflected developments in the food and

energy sectors, core inflation also declined noticeably. Judged by consumer surveys, slower

price increases over the past year apparently led consumers to lower their expectations of

near-term inflation. At the producer level, prices for core finished goods likewise

decelerated over the twelve months ended in September. With regard to labor costs, growth

in average hourly earnings of production or nonsupervisory workers declined significantly

over the twelve months ended in September, evidently reflecting the effects of both the rise

in unemployment and the drop in consumer price inflation.

At its meeting on September 24, 2002, the Committee adopted a directive that called for

maintaining conditions in reserve markets consistent with keeping the federal funds rate

around 1-3/4 percent, and it also retained a balance of risks statement that was tilted toward

economic weakness in the foreseeable future. Market participants had anticipated the

unchanged policy stance and risk assessment, but the inclusion in the policy announcement

of a reference to heightened geopolitical risks led to downward revisions to expectations for

the future path of the federal funds rate. The subsequent release of better-than-expected

news on profits for several major corporations buoyed equity prices and lifted market

interest rates and predicted policy rates. Later in the intermeeting period, weakerthan-anticipated economic data along with press reports suggesting that the FOMC was

inclined to ease by year-end led again to downward revisions of the expected path of the

federal funds rate target. Over the intermeeting period as a whole, broad equity indexes

registered sizable gains and intermediate- and longer-term bond yields increased somewhat.

The dollar traded in a narrow range in foreign exchange markets during the intermeeting

period. It depreciated slightly in terms of an index of major foreign currencies and was little

changed on balance against the currencies of other important trading partners.

M2 grew more moderately on average in September and October, with aggregate spending

apparently softening, the effects of past monetary easing actions wearing off, and

significantly weaker foreign demand for currency emerging. By contrast, the high level of

mortgage refinancing activity provided a continuing boost to deposit growth.

The staff forecast prepared for this meeting suggested that, in light of further weakerthan-expected incoming economic data, the expansion of economic activity would be

relatively muted for some time. Moreover, current and prospective sluggish economic

growth among major trading partners would damp U.S. exports, and businesses and

households were likely to hold their spending down while faced with the possibility of a

military conflict as well as persisting concerns about the near-term course of economic

activity and corporate earnings. Nonetheless, those restraining influences were expected to

abate over time and economic activity strengthen gradually. The considerable monetary ease

and fiscal stimulus already in place, continuing gains in structural productivity, and

anticipated improvement in business confidence would provide significant impetus for

spending. Inventory overhangs already had been largely eliminated, and business capital

stocks had moved closer to desired levels. As a consequence, a slowly improving outlook

for sales and profits, low financing costs, and the temporary federal tax incentive for

investment in new equipment and software were expected to boost business investment

spending. Even so, a less robust pickup in final sales was now expected over the forecast

period, which would put somewhat less pressure on resource margins than had been

anticipated previously, and the level of activity would remain below the economy's potential

for a longer time. The persistence of underutilized resources was expected to foster a slight

moderation in core price inflation.

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

commented that the recent data on the performance of the economy had been disappointing

and had tended to confirm widespread anecdotal indications that economic growth had

slowed to a pace well below that experienced earlier in the year. Even so, the members

acknowledged that the economy had displayed remarkable resiliency over the past year

despite being subjected to severe adverse shocks. While the latter clearly had taken their toll

on confidence, notably in the business sector, consumer spending had held up relatively

well. Business investment expenditures continued to be constrained by a high degree of

uncertainty and related caution. Looking beyond the near term, the members anticipated that

as the prevailing uncertainties began to diminish, the economy's resiliency abetted by

broadly accommodative monetary and fiscal polices and the continuation of a strong uptrend

in productivity would underpin a gradual economic recovery. Indeed, some members

commented that an even more robust recovery could not be ruled out in the absence of

further major shocks to confidence. With pressures on labor and other resources expected to

be limited over coming quarters, inflation was likely to remain subdued and perhaps even to

edge a little lower.

In their review of developments and prospects in key expenditure sectors of the economy,

members noted that consumer spending appeared to have decelerated since midsummer,

while an anticipated and hopefully compensating strengthening in business investment had

not yet materialized. Factors cited by the members that appeared to help account for the

recent softness in consumer demand included substantial decreases in equity wealth,

declining consumer confidence in the context of geopolitical and other uncertainties, the

waning effects of earlier income tax cuts, and the failure of the most recent round of motor

vehicle sales incentives to maintain the extraordinary level of sales seen during the summer.

Looking ahead, some members referred to subdued expectations among their retailer

contacts regarding the upcoming holiday season, with sales prospects likely to be held back

at least marginally by the lingering effects of the recent West Coast dock strike on the

availability of merchandise. There also was some question as to whether funds extracted

from rising home equity values would continue to provide as important a source of

financing for purchases of consumer durables as they had for some time unless mortgage

interest rates declined from their already low levels. Members also mentioned a number of

favorable factors bearing on the longer-term outlook for consumer spending. These included

the prospect of strengthening consumer confidence if geopolitical uncertainties began to

dissipate, the gradual diminution of the negative wealth effects from earlier stock market

declines, and importantly the outlook for continued robust growth in structural labor

productivity and its favorable effects over time on wages and salaries.

High and persisting uncertainty and concomitant aversion to risk among business executives

apparently continued to hold down business investment spending. While such expenditures

remained at a high level, members saw few signs of a significant pickup in the nearer term.

Apart from notably adverse business sentiment and disappointing growth in sales and

profits, factors that were curbing capital expenditures cited by members included persisting

capital overhangs stemming from what were now seen as excessive earlier buildups in

equipment and software and substantial idle capacity in many industrial and commercial

structures. Some divergence of opinion was expressed regarding the overall extent of capital

overhangs, though it was clearly evident in some industries and in high vacancy rates in

nonresidential buildings in many areas of the country. Looking to the future, the timing and

strength of a decisive upturn in capital expenditures, a key factor in the outlook for some

improvement in the performance of the overall economy, would depend critically on the

dissipation of prevailing uncertainties, including those associated with geopolitical risks,

and increasing prospects for profits. In the latter regard, it was suggested that in the context

of rising productivity, profits could prove to be stronger than many now expected, with

favorable implications for cash flows and in turn investment activity.

Cautious business attitudes and expectations of sluggish sales over coming months were

inducing business firms to continue to hold down what were already generally lean

inventories. Nonetheless, some members commented that inventory accumulation was likely

to provide some limited impetus to the economy over the next several quarters to the extent

that an acceleration in economic activity occurred and businesses sought to maintain an

acceptable balance between their inventories and sales. Indeed, with inventories at unusually

low levels in many industries, efforts to rebuild such inventories appeared inevitable.

Housing activity had remained at a generally elevated level in recent months and in the

context of low mortgage interest rates likely would continue to provide important support to

the economy over the forecast period. Most regional reports indicated persisting strength in

the housing sector, though there was evidence of modestly flagging activity in some areas.

In this regard, it was noted that the declining trend in mortgage interest rates probably would

not continue once forecasts of a strengthening economic expansion began to materialize.

Indeed, the rise in bond yields since the September meeting associated with the

improvement in the stock market had induced a small increase in mortgage rates from their

very low levels. At some point the extraordinary levels of cash-outs from mortgage

refinancings and home sales would undoubtedly moderate, with adverse implications for

spending on home improvements and consumer durables more generally. Still, household

spending probably would continue to be supported by the increases in income and wealth

associated with strengthening economic expansion and rising productivity.

Members commented that fiscal policy remained accommodative, but an analysis cited at

this meeting suggested that the stimulus embodied in current legislation had diminished

considerably since earlier in the year. Reference also was made to the partial expensing

provision of the tax legislation enacted in March of this year, which was seen as a positive

but not in itself a compelling factor in inducing expenditures on business equipment and

software. Some members observed that further federal tax cuts, should they be enacted,

would likely take effect too late to foster much added spending over the year ahead. At the

state and local government levels, efforts to control very large deficits likely would lead to

tax and spending legislation that would offset at least part of the remaining stimulus inherent

in the federal budget.

Members commented that little if any stimulus could be expected from the export sector of

the economy in light of current and prospective shortfalls in the economic performance of

important U.S. trading partners. Indeed, recent forecasts incorporated downward revisions to

the growth of overall foreign economic activity.

With the economy evidently on a lower-than-anticipated growth path and with slack in labor

and product markets at elevated levels, members anticipated that inflation would remain

quite subdued over the year ahead even in the context of some anticipated acceleration in

economic activity. Indeed, the prospect of some persisting slack in resource use over coming

quarters pointed to further disinflation. In this regard, some members referred to the

possibility, which they viewed as remote, of a period of deflation in the event of a strongly

negative demand shock.

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

favored a proposal to reduce the target for the intended federal funds rate by 50 basis points

to 1-1/4 percent. While the current stance of monetary policy was still accommodative and

was providing important support to economic activity, the members were concerned that the

generally disappointing data since the previous meeting, reinforcing the general thrust of the

anecdotal evidence in recent months, pointed to a longer-lasting spell of subpar economic

performance than they had anticipated earlier. In the circumstances, a relatively aggressive

easing action could help to ensure that the current soft spot in the economy would prove to

be temporary and enhance the odds of a robust rebound in economic activity next year. A

further reason cited by some members for a sizable easing move related to their perceptions

of a diminishing stimulus from earlier policy easing actions and indications that overall

financial conditions, including bank lending terms, had become more restrictive this year

even though the nominal federal funds rate target had not been changed since late 2001. The

members agreed that monetary policy could do little to improve the performance of the

economy in the near term, but some emphasized that a 50 basis point easing likely would

feed through to some degree to market interest rates, with favorable implications for

spending next year.

Members commented that the potential costs of a policy easing action that later proved not

to have been needed were quite limited in that there was little risk that such a move would

foster inflationary pressures under likely economic conditions over the next several quarters.

Moreover, the policy easing could readily be unwound without significant effects on

financial markets if the reversal appeared to be warranted by growing pressures on resources

in a strengthening economy. In contrast, a failure to take an action that was needed because

of a faltering economic performance would increase the odds of a cumulatively weakening

economy and possibly even attendant deflation. An effort to offset such a development,

should it appear to be materializing, would present difficult policy implementation

problems.

All the members indicated that, in light of the contemplated 50 basis point easing action,

they could support a shift in the Committee's assessment of the risks to the economy from

tilted toward economic weakness to balanced for the foreseeable future, although some

voiced reservations about the need for such a shift. The economy probably would continue

to underperform in the period immediately ahead, but in the absence of unpredictable

adverse shocks this sluggish performance was more likely to be balanced by subsequent

economic strength in light of the policy action. A 50 basis point move would tend to have a

more pronounced effect than usual in financial markets, at least initially, because it would be

largely unexpected and would come after an extended hiatus in implementing policy

changes. In the view of many members, retaining the assessment that the risks were tilted

toward weakness would raise the odds of an overreaction in financial markets, which might

well misread the Committee's decision as a sign that the members were more concerned

about the potential for greater economic weakness than was in fact the case and that

therefore the Committee currently saw a likely need for further easing later. Some members

saw a lesser risk of such a development, partly because of widespread market expectations

that even with a sizable reduction in the intended federal funds rate the Committee would

not change its assessment of unbalanced risks to the economy in present circumstances.

Although they had at least a marginal preference for retaining the current tilt toward

weakness, these members were willing to accept a balanced statement in light of the

uncertainties that surrounded prospective market reactions. While the possible market

response was not a primary factor determining the desirability of a policy action, the

Committee needed to take it into account in gauging the potential effects of particular policy

moves.

At the conclusion of the 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 1-1/4 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, Bernanke, Ms. Bies,

Messrs. Ferguson, Gramlich, Jordan, Kohn, McTeer, Olson, Santomero, and

Stern.

Votes against this action: None.

Use of Alternative Assets in Open Market Operations

At this meeting the Committee provided further guidance to the staff on priorities for the

continuing study of alternatives to Treasury securities in the conduct of System open market

operations. At its meeting in March of this year, the Committee had reaffirmed its

preference for the use of Treasury securities to implement the System's monetary policy,

contingent upon the continued availability of a sufficient outstanding volume of such

obligations to accommodate the System's very large operations. As was already apparent at

the time of the March meeting, fiscal policy developments made it clear that earlier

concerns about a contracting supply of securities in the U.S. government securities market

would not likely impose constraints on the System's open market operations in the near

term.

Even so, the members expressed a consensus in favor of continuing to study alternatives to

Treasury obligations for potential future use. Pursuant to the Committee's instructions in

March, the staff had activated its study of the possible employment of mortgage-backed

securities guaranteed by the Government National Mortgage Association (Ginnie Maes) in

outright System open market operations. Such obligations were already being utilized for

temporary additions to the System's portfolio through repurchase agreements. During their

discussion at this meeting, the members recognized that outright purchases of Ginnie Maes

for permanent additions to the System's portfolio would present a number of difficulties and

would require extensive preparations for their effective integration, if deemed desirable at a

later date, into the conduct of outright System open market operations. Still, in view of their

possible advantages in helping to meet SOMA portfolio objectives at some point in the

future, the Committee instructed the staff to continue to focus available resources on the

possible use of Ginnie Maes for such operations. The Committee also decided to discontinue

further consideration of the possible use of foreign sovereign debt obligations as collateral

for repurchase agreements in light of the problems that were envisaged in the employment

of such securities.

At this meeting the Committee also reviewed work that had been done on the potential use

of an auction credit facility (ACF) that could serve as a partial substitute for Treasury or

other securities. In addition, the Committee reviewed a study that considered whether an

ACF might be adapted for use in a contingency (CACF) as a full substitute for open market

operations. Many of the members commended the staff for its careful assessment of the

potential for such operations. The members concluded, however, that significant resources

should not be assigned at this time to the further study of these alternatives to open market

operations given the prospects for an enlarged supply of Treasury obligations, the decision

to focus on Ginnie Maes, and the introduction of a new discount window program, the

System's primary credit facility, scheduled for implementation in early 2003. In addition, the

CACF had been made unnecessary by the implementation of contingency plans and backup

facilities since September 2001. The members concurred with the staff's recommendation

that the staff studies prepared for the Committee in January 2001, when it discussed in detail

various alternatives to holding U.S. government securities, should be released to the public

after light editing was completed.

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

10, 2002.

The meeting adjourned at 1:55 p.m.

Vincent R. Reinhart

Secretary

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