FOMC Minutes

December 10, 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 Tuesday, December 10,

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

Ms. Johnson, 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

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

Mr. Whitesell, Deputy Associate Director, Division of Monetary Affairs, 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. Skidmore, Special Assistant to the Board, Office of Board Members, Board of

Governors

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

Governors

Ms. Holcomb, First Vice President, Federal Reserve Bank of Dallas

Messrs. Eisenbeis, Fuhrer, Goodfriend, Green, Hakkio, and Rasche, Senior Vice Presidents,

Federal Reserve Banks of Atlanta, Boston, Richmond, Chicago, Kansas City, and St. Louis

respectively

Messrs. Elsasser and Furlong, Vice Presidents, Federal Reserve Banks of New York and San

Francisco respectively

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

on November 6, 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 November 6, 2002, through December 9, 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 been

sluggish on balance since midsummer. Housing demand remained strong, but business fixed

investment was still in the doldrums and consumer spending had flagged in late summer

before apparently picking up somewhat in the autumn. Payroll employment had changed

little since midyear, and industrial production still seemed to be on a downward trend. Most

price indexes continued to indicate that inflation had declined over the past year.

Private nonfarm payroll employment remained stagnant in the third quarter and edged down

in October and November. Job losses in manufacturing were again large in the two months,

and employment declined in construction and in the wholesale and retail trade industries. By

contrast, services (except help-supply) and the finance, insurance, and real estate grouping

recorded further solid gains. The unemployment rate rose to 6 percent in November, a level

more consonant with other recent labor market indicators. Labor productivity in the nonfarm

business sector continued to climb briskly, with the advance over the last four quarters being

the largest since 1973.

Industrial production dropped sharply further in October, with roughly half of the decline

related to a slowdown in motor vehicle assemblies and the manufacture of related parts. The

rest of the manufacturing sector also was weak on balance, with output down in almost all

market groups. The high-tech sector was an exception, although the rise in output of

computers and semiconductors in October was smaller than earlier in the year and the

production of communications equipment continued to fall. Consistent with the poor

performance of industrial production, capacity utilization in manufacturing fell again in

October and remained substantially below its long-run average.

Against the backdrop of smaller gains in disposable personal income and low readings on

consumer confidence, growth of consumer spending had been quite sluggish in the last

several months. Much of the weakness reflected a falloff in spending on new motor vehicles

in September and October, largely because of reduced manufacturer discounts. Apart from

motor vehicles, personal consumption expenditures picked up in October following two

months of softness. Increases in outlays for services in September and October remained

modest and about equal to the average rate of rise earlier in the year.

Housing starts dropped moderately in October, which was an unusually wet month across

much of the country. However, residential housing activity had been very strong on balance

this year despite an environment of sluggish employment and declining household wealth.

Mortgage rates near historical lows had provided important support for single-family

housing demand, and sales of new and existing homes had remained buoyant. In the

multifamily sector, starts plunged in October to the slowest pace in almost six years. While

some of the decline likely was attributable to inclement weather, apartment vacancy rates

had risen significantly over the past year, perhaps partly in response to the single-family

housing boom.

Business spending on equipment and software increased moderately in the third quarter, but

the recent monthly pattern of data on shipments and orders for nondefense capital goods,

along with anecdotal reports from businesses, signaled renewed weakness. Shipments of

nondefense capital goods rebounded in October, led by a rise in computing equipment. In

contrast, shipments of communications equipment plunged. Construction in the

nonresidential sector slowed sharply further in the third quarter, but a few signs, including a

rise in activity in October, suggested some moderation in the rate of decline.

The aggregate book value of manufacturing inventories changed little in October: declines

in stocks of many types of durable goods were offset by modest stockbuilding of

nondurables, and the ratio of stocks to shipments remained very low. Anecdotal information

suggested that disruptions of West Coast dock operations stemming from a labor dispute had

been quite small.

The U.S. trade deficit in goods and services changed little in September and the third

quarter. The available information on economic activity abroad in the third quarter indicated

that economic expansion remained moderate in the United Kingdom and sluggish in the

euro area. Economic growth subsided somewhat from elevated second-quarter rates in

Canada, Japan, and emerging Asia. Economic conditions in South America were generally

still fragile.

Core consumer price inflation, as measured by the consumer price index (CPI) and the

chain-weighted personal consumption expenditure (PCE) index, continued to trend lower in

October. Inflation, in terms of both indexes, was down over the last twelve months when

compared with the previous twelve-month period. At the producer level, core price inflation

for finished goods over the twelve months ended in October was at a very low rate. With

regard to labor costs, average hourly earnings of production or nonsupervisory workers

increased moderately in November, and the growth in those earnings over the last twelve

months fell considerably, evidently reflecting the slack in labor markets.

At its meeting on November 6, 2002, the Committee adopted a directive that called for

lowering the target for the intended federal funds rate by 50 basis points, to 1-1/4 percent.

The Committee also agreed that, in light of the decision to ease, it would be appropriate to

indicate in the press release that the risks were balanced for the foreseeable future. Market

participants had expected a 25 basis point cut and retention of a statement of risks toward

weakness. The unexpectedly large reduction in the federal funds rate target led to an initial

decline in Treasury coupon yields. That drop was reversed when market participants

apparently focused on the shift to balanced risks and concluded that the odds of pronounced

economic weakness had fallen. The subsequent release of better-than-expected economic

data and earnings news provided reassurance to investors, though more mixed economic

reports became available late in the intermeeting period. Over the period as a whole, major

equity indexes registered mixed changes, and yields on longer-term Treasury bonds

increased somewhat. In private debt markets, rates on investment-grade debt issues eased a

little, and those on speculative-grade bonds fell considerably more.

The dollar appreciated slightly in terms of an index of major foreign currencies, principally

against the yen, and changed little against the currencies of other important trading partners.

The dollar edged lower against most major currencies in the aftermath of the policy easing

on November 6, but those losses were subsequently retraced after the release of U.S.

economic data that were seen as suggesting relatively better economic conditions in the

United States.

M2 growth slowed a little in November from October's elevated pace. The further advance

again was concentrated in liquid deposits. The low level of opportunity costs and heavy

mortgage financing continued to support the demand for liquid assets.

The staff forecast prepared for this meeting suggested that the expansion of economic

activity would be relatively muted over the near term. Faced with heightened geopolitical

tensions as well as persisting concerns about the near-term course of economic activity and

corporate earnings, businesses and households were likely to hold down their spending, and

the outlook for continued sluggish economic growth among most major trading partners

would damp U.S. exports. However, those restraining influences were expected to abate

over time, and the considerable monetary ease and fiscal stimulus already in place,

continuing strong gains in structural productivity, and anticipated improvement in business

confidence would provide significant impetus to spending. Inventory overhangs 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 provide a gradual boost to business investment spending. 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

noted that the recent information had continued on the whole to suggest quite sluggish

economic growth. Uncertainties about the outlook remained substantial, and downside risks

stemming from potential shocks, notably those associated with a high level of geopolitical

risks, could not be dismissed. Nonetheless, the behavior of financial markets in recent weeks

suggested that investor concerns about an actual downturn in the economy had diminished,

as data on economic developments took on a more mixed tone after having been somewhat

negative for some time. The improvement in financial markets reinforced the members'

expectations that a gradual strengthening of the economic expansion was likely over coming

quarters, with the growth in economic activity gaining momentum over time in the absence

of major adverse shocks to business and consumer confidence. Their assessment took

account of the currently very accommodative stance of monetary policy, likely further fiscal

policy stimulus, and the positive effects on business and consumer spending of a strong

uptrend in labor productivity. With regard to the outlook for inflation, the gap between

actual and potential output was anticipated to diminish only slowly unless aggregate demand

expanded much more rapidly than the members currently foresaw. Given the persistence of

limited pressures on resources, cost and price increases were expected to remain subdued

and possibly to edge lower.

The improvement of overall conditions in financial markets had provided an additional

positive element to the economic outlook. The improvement began before the November

meeting and had been given added impetus by the Committee's sizable easing at that

meeting. The general calming of financial markets was reflected in some decline in risk

spreads from very high levels and sizable new issuance in private bond markets; in equity

markets, issuance had edged up and stock prices, though recently declining somewhat, were

still well above the lows of early October. Some of this improvement in financial markets

seemed to be related to apparently lessening concerns about new revelations of corporate

governance issues as a result of the passage of time without further significant incidents. In

addition, many business firms had continued to enhance their prospects for rising profits

through productivity improvements and debt restructurings that were strengthening their

balance sheets and liquidity. Concurrently, indicators of credit quality in the household

sector appeared to have remained essentially stable. Reference also was made to the

continued robust growth in reserve and money measures.

The better tone in financial markets might also have been signaling a modest reduction in

uncertainty and risk aversion among business executives from the extraordinarily elevated

levels that had been constraining investment spending. Lingering excess capacity in a

number of industries undoubtedly was continuing to inhibit new investment outlays as well.

The members agreed that a pickup in capital spending remained the essential factor in the

outlook for substantial strengthening of economic activity. On the positive side, spending for

business equipment had turned up since early this year, and with efforts to reduce excess

capacity seemingly well under way or completed in many industries, further firming in such

capital expenditures was anticipated as the year 2003 progressed. However, nonresidential

building was expected to continue to lag, especially given high vacancy rates in industrial

and office structures in many major markets.

The household sector of the economy had continued to provide major support to the

recovery in economic activity. The increase in consumer spending evidently had moderated

in the current quarter, largely as a result of a decline in sales of motor vehicles from an

extraordinary pace during the summer. However, the latest information on retail sales,

including anecdotal reports, pointed to some improvement in recent weeks, and key

measures of consumer confidence had turned up from their recent lows. While some

uncertainty surrounded the prospects for consumer spending, members cited continued

sizable increases in income, more stable wealth-to-income ratios, and the ongoing stimulus

of equity extractions from housing as favorable factors in the outlook for consumer

expenditures.

Housing activity had continued to display solid overall strength, though members mentioned

weakness in multifamily construction and the high-end sector of the single-family market.

Historically low mortgage interest rates along with rising incomes evidently were

continuing to sustain the robust demand for housing. In addition, large extractions of equity

from appreciated housing values continued to foster not only added consumer spending but

also improvement in the financial condition of many households through debt consolidation

and repayments and reduced interest charges. However, there were anecdotal indications of

decreasing refinancing activity in the housing sector.

The outcome of the recent Congressional elections had fostered expectations that fiscal

policy might be more expansive than previously anticipated, although the size, timing, and

composition of federal budget initiatives were subject to substantial uncertainty. Members

commented that added fiscal stimulus might prove to be a useful complement to an

accommodative monetary policy in the period immediately ahead when economic activity

was likely to remain below the economy's potential. In this regard, some observed that

additional stimulus on the federal level would be an offset to measures that were being taken

by numerous state and local governments to address severe budget deficits. At the same

time, a number of members expressed the hope that new fiscal legislation would not

endanger the prospects for federal budget discipline over the longer run, given the

desirability of supporting national saving and capital accumulation.

With regard to the external sector, members commented that the growth of the nation's

important trading partners had remained sluggish, and there seemed to be little basis for

anticipating any appreciable impetus to the U.S. economy from significant strengthening in

demand for U.S. exports. Indeed, economic growth abroad was widely viewed as dependent

to a significant extent on the performance of the U.S. economy. Conditions in some major

Latin American countries were especially problematic, and adverse developments there

could have negative repercussions on international financial markets and trade.

Members believed that the economy probably would continue to operate with significant

margins of slack in both labor and product markets. Moreover, in an environment

characterized by highly competitive markets and the absence of pricing power, business

firms would persist in their efforts to hold down or reduce costs, with favorable implications

for productivity. In these circumstances, inflation pressures could be expected to remain

subdued and some further disinflation might well occur. In this regard, members commented

that appreciable disinflation seemed unlikely, but if that were to occur it could present

difficult problems for monetary policy. One member noted, however, that declining inflation

or even some deflation in the context of rapid growth in productivity could turn out to be

relatively benign.

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

endorsed a proposal to retain the current stance of policy. The members agreed that, given

what was now a quite accommodative policy following the relatively aggressive easing

move in November, monetary policy was well positioned to support a strengthening

economic expansion in line with their expectations for coming quarters. Although it was

uncertain how long the current period of below-par growth would persist, the economic

outlook remained subject to upside as well as downside risks. Indeed, all the members also

supported the retention of the current balanced-risks statement in the post-meeting press

release, with some commenting that recent developments had established a firmer basis for

such a risk assessment than at the November meeting when it was adopted. The November

easing had contributed to some improvement in financial markets that, in conjunction with

prospects for further stimulus from fiscal policy, should bolster the anticipated acceleration

of economic activity. At the same time, the members saw little risk of any significant

increase in inflationary pressures over the foreseeable future. Against this background, the

members concluded that there was no need to change the stance of monetary policy; they

would continue to assess emerging economic and financial developments, retaining the

flexibility to adjust monetary policy as emerging conditions might warrant.

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 maintaining the federal funds rate at 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.

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

January 28-29, 2003.

The meeting adjourned at 12:05 p.m.

Vincent R. Reinhart

Secretary

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