FOMC Minutes

May 6, 2003

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, May 6, 2003, at 9:00 a.m.

Present:

Mr. Greenspan, Chairman

Mr. McDonough, Vice Chairman

Mr. Bernanke

Ms. Bies

Mr. Broaddus

Mr. Ferguson

Mr. Gramlich

Mr. Guynn

Mr. Kohn

Mr. Moskow

Mr. Olson

Mr. Parry

Mr. Hoenig, Mses. Minehan and Pianalto, Messrs. Poole and Stewart, Alternate

Members of the Federal Open Market Committee

Messrs. McTeer, Santomero, and Stern, Presidents of the Federal Reserve Banks of

Dallas, Philadelphia, and Minneapolis 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

Mr. Connors, Ms. Cumming, Messrs. Eisenbeis, Goodfriend, Howard, Hunter, Judd,

Lindsey, Struckmeyer, 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 Oliner, 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. Skidmore, Special Assistant to the Board, Office of Board Members, Board of

Governors

Mr. Luecke, Senior Financial Analyst, Division of Monetary Affairs, Board of

Governors

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

Governors

Messrs. Fuhrer and Hakkio, Mses. Mester and Perelmuter, Messrs. Rasche,

Rosenblum, Rolnick, and Sniderman, Senior Vice Presidents, Federal Reserve Banks

of Boston, Kansas City, Philadelphia, New York, St. Louis, Dallas, Minneapolis, and

Cleveland respectively

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

on March 18, 2003, 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 March 18, 2003, through May 5, 2003. By unanimous

vote, the Committee ratified these transactions.

With Mr. Broaddus dissenting, the Committee voted to extend for one year beginning in

mid-December 2003 the reciprocal currency ("swap") arrangements with the Bank of Canada

and the Bank of Mexico. The arrangement with the Bank of Canada is in the amount of $2

billion equivalent and that with the Bank of Mexico in the amount of $3 billion equivalent.

Both arrangements are associated with the Federal Reserve's participation in the North

American Framework Agreement. The vote to renew the System's participation in the swap

arrangements maturing in December was taken at this meeting because of the provision that

each party must provide six months prior notice of an intention to terminate its participation.

Mr. Broaddus dissented because he believed that the swap lines exist primarily to facilitate

foreign exchange market intervention, and he was opposed to such intervention for the

reasons he had expressed at the January meeting.

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

conduct of monetary policy over the intermeeting period.

The information reviewed at this meeting suggested that economic activity continued to grow

at a subpar pace in recent months. Consumer spending advanced slightly in the first quarter

and housing activity remained at a high level, but business investment slowed. Industrial

production was sluggish, and additional slack accumulated in the labor market. Core

consumer inflation had moved lower, but overall consumer prices had been pushed up

recently by sharp rises in energy prices.

Private nonfarm payroll employment continued to fall in April. Manufacturing employment

registered widespread losses, and the retail trade, transportation, and utilities industries

extended their declines of prior months. The unemployment rate rose to 6 percent in April,

with increases spread widely across most demographic groups. Initial claims for

unemployment insurance remained at an elevated level, suggesting further labor market

weakness in May.

Industrial production fell in March, and weekly physical product data and other indicators

pointed to another drop in April. Lower output at utilities accounted for some of the decline

in overall production in March but manufacturing output, especially motor vehicle

assemblies, fell again. Total industrial capacity utilization declined in March, with capacity

utilization in manufacturing reaching a twenty-year low.

Real personal consumer expenditures rose in March and for the first quarter as a whole.

Spending on durable goods increased in March but was down a bit for the full quarter. By

contrast, spending on services and nondurable goods fell in March but was up on balance in

the first quarter. Disposable income was unchanged in March. Measures of consumer

confidence rebounded sharply in April after sizable declines in February and March.

Residential housing activity remained solid, though some signs of potential moderation

emerged. Supported by continued low mortgage rates, first-quarter housing starts in the

single-family sector stayed at the high level of the fourth quarter. Multifamily starts also

changed little in the first three months of the year and vacancy rates in the sector remained

high. Sales of existing homes were off a bit in March, but sales for the first quarter as a

whole edged up from the fourth-quarter rate. New home sales, however, were down from

their fourth-quarter pace.

Real outlays on equipment and software declined in the first quarter after rising moderately

over the three preceding quarters. A sharp drop in purchases of transportation equipment

more than accounted for the first-quarter decline. The weakness in the transportation

category reflected sluggish expenditures for aircraft, medium and heavy trucks, and light

vehicles. By contrast, the high-tech category recorded strong growth owing to a surge in

spending for computer and peripheral equipment and an upturn in purchases of

communications equipment. Although investment fundamentals, such as corporate cash

flows and reduced costs of capital, remained favorable, reports from businesses were

downbeat. The extended decline in real investment spending on nonresidential structures

moderated further in the first quarter, with the smallest decline since the first quarter of 2001.

Real nonfarm inventories excluding motor vehicles appeared to have declined a little in the

first quarter after accumulating in recent quarters. The buildup of manufacturing and trade

inventories, however, continued in January and February at an average pace similar to that of

the second half of 2002. Relative to sales, non-auto inventory stocks in most sectors were

low by recent standards. According to industry reports, inventories in the motor vehicle

industry apparently had risen above desired levels.

The U.S. trade deficit in goods and services narrowed slightly in February and brought the

average deficit for January and February to an annual rate near that of the fourth quarter. The

narrowing in February was accounted for by a small decline in imports and a marginal rise in

exports. Recent indicators suggested continued sluggish economic growth in most foreign

industrial nations. The Japanese economy was about flat in the early months of the year,

activity in the euro area remained subdued, and first-quarter growth in the United Kingdom

was lackluster. Canadian domestic demand remained relatively robust but appeared to be

slowing. Economic conditions in other countries were mixed. In Latin America, Mexican

data releases pointed toward increases in economic activity, and the Argentine economy

continued to show signs of recovery. In contrast, Venezuela remained in crisis, and economic

activity in Brazil appeared to have moderated despite improved financial market conditions.

In developing Asia, indicators suggested that economic growth had slowed in much of the

region. China, however, registered robust growth in the first quarter.

Core consumer price inflation moved down further in the first quarter from its already low

level. A sharp run-up in energy prices, however, pushed up overall consumer prices in the

first quarter and in the year ended in March (measured by both the consumer price index and

the chain-type personal consumption expenditure index). Producer prices also were boosted

significantly by the jump in energy prices in recent months. Core producer prices were up

appreciably in the first quarter but at a slower pace than overall producer prices. With regard

to labor costs, the employment cost index for hourly compensation of private industry

workers rose at a faster rate during the three months ended in March, reflecting increases in

wages and salaries and in benefit costs. The expansion of compensation costs over the twelve

months ended in March was virtually the same as in the previous twelve-month period.

When the Committee met on March 18, 2003, the nation appeared to be on the brink of war.

At the end of that meeting, the Committee adopted a directive that called for maintaining

conditions in reserve markets consistent with keeping the federal funds rate around 1-1/4

percent. The Committee agreed to indicate in its announcement that in light of the unusually

large uncertainties clouding the geopolitical situation in the short run and their apparent

effects on economic decisionmaking, it could not at that time usefully characterize the

current balance of risks with respect to the prospects for its long-run goals of price stability

and sustainable economic growth. The Committee also agreed that heightened surveillance

would be particularly informative. It was noted that while the recent economic data were

mixed, the hesitancy of the economic expansion appeared to owe significantly to oil price

premiums and other aspects of geopolitical uncertainties. The Committee believed that as

those uncertainties lifted, the accommodative stance of monetary policy, coupled with the

ongoing growth in productivity, would provide vital support toward fostering improving

economic performance over time.

The decision to leave policy on hold had been largely anticipated by market participants, but

the inclusion in the policy announcement of a reference to "heightened surveillance" led

initially to downward revisions to expectations for the future path of the federal funds rate.

The abatement of war-related risks was reflected in sizable declines in forward-looking

measures of uncertainty in short- and long-term interest rates, exchange rates, and oil and

equity prices. Nearer-term Treasury yields had fallen, but longer-term Treasury yields had

changed little since the March meeting. Risk spreads on corporate debt securities narrowed

across the credit quality spectrum. Broad equity indexes registered notable gains related to

better-than-expected corporate earnings reports.

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

foreign currencies declined over the intermeeting period. The dollar depreciated somewhat

more against the euro and the Canadian dollar and only slightly against the Japanese yen. The

dollar also declined against an index of currencies of other important trading partners. Equity

markets in the major industrial economies, except Japan, had risen significantly since the

March FOMC meeting.

Growth in M2 slowed over March and April, but most of the deceleration appeared to be

attributable to temporary tax-related flows of funds. A movement toward earlier electronic

filing apparently weakened M2 in March by shifting refund distributions into February.

Reduced M2 growth in April reflected, in part, slower-than-average buildups of deposits

associated with final tax payments by individuals. Substantial net inflows to equity mutual

funds occurred during the same period.

The staff forecast prepared for this meeting continued to suggest that economic expansion

would be sluggish in the near term. Faced with persisting weakness in product and labor

markets, businesses and consumers were likely to hold down their spending. In addition,

continued slow economic growth in most of the nation's major trading partners would tend to

restrain U.S. exports, though those restraints were expected to abate over time. The

cumulative effects of an accommodative monetary policy, likely further reduction in taxes,

and robust gains in structural productivity would provide significant impetus to spending.

Inventory overhangs had been substantially reduced, 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 gradually boost business investment spending. Given the

ongoing slack in resource utilization, downward restraint on core price inflation was

expected to persist over the forecast period.

In the Committee's discussion, members commented that the recent information bearing on

the economic outlook was mixed. The latest reports on economic activity generally were

disappointing, notably those relating to employment and production, but members noted that

most of these reports covered developments occurring before the end of hostilities in Iraq.

The successful prosecution of the war had served to reduce geopolitical uncertainties and in

turn had helped to foster a marked strengthening of domestic financial markets, a sizable

decline in oil prices, and an apparent upturn in consumer confidence. In this improved

environment, members anticipated that near-term sluggishness in economic growth would

give way to more vigorous expansion as the year progressed. In support of this expectation, it

was noted that if the substantial gains in financial markets experienced recently persisted,

experience indicated that a stronger economic performance generally would follow.

Favorable factors in the outlook mentioned by members included an accommodative

monetary policy, prospective legislation that would increase an already stimulative fiscal

policy, and evidence of a persisting uptrend in productivity that provided enhanced

investment opportunities and ongoing support for household incomes. Continued progress in

lifting various constraints on economic growth, including the unwinding of excessive or

misdirected capital expenditures undertaken in earlier years and the steps taken to address

corporate governance and credit problems were also working to strengthen the expansion.

Against that backdrop, it was noteworthy that many private-sector forecasters predicted a

pronounced upturn in economic growth in the third quarter. Despite underlying factors that

seemed increasingly conducive to an accelerating expansion, members noted that the timing

and vigor of a pickup in economic activity remained uncertain, especially in the context of a

persistently high degree of caution in the business community with regard to investment and

hiring decisions. With the removal of key uncertainties associated with the Iraqi war, the

information that would become available in the weeks ahead was expected to provide a

clearer basis for assessing future trends in business spending and, more generally, the

underlying strength of the economy. Members anticipated that inflation would remain at a

low level for an extended period and indeed that the probability of further disinflation was

higher than that of a pickup in inflation, given the current high levels of excess capacity in

labor and product markets, which seemed likely to diminish only gradually.

Business fixed investment remained a key factor in the prospects for overall economic

activity, and persisting weakness in such spending in association with gloomy sentiment and

a high degree of risk aversion among business decisionmakers did not bode well for the

capital investment outlook, at least for the near term. Anecdotal reports by business contacts

tended to emphasize widespread excess capacity as a reason for holding down business

capital spending, including high vacancy rates in office and other business structures. In this

atmosphere, most business decisionmakers evidently preferred to rely on the increasingly

efficient or fuller utilization of existing producer facilities rather than expanding the latter to

meet growth in demand. Indeed, according to business contacts, investment expenditures

generally were limited to replacement and to some extent to upgrading of existing facilities

rather than for expansion. In some cases, businesses reportedly were acquiring used capital

equipment and unoccupied building space at greatly reduced costs, thereby holding down the

current production of new capital but also relieving selling firms of some excess capacity.

Members nonetheless saw a number of favorable elements in the outlook for business

investment expenditures. These included a decline in the cost of business capital, a recent rise

in orders and backlogs of nondefense capital goods, persisting gains in productivity that

undoubtedly pointed to growing profit opportunities, progress in strengthening business

balance sheets, and reduced capital overhangs. With regard to business attitudes, members

reported very recent but also widespread indications from their contacts that business

confidence might be in the process of improving, though the upturn in confidence was not

likely to show through to investment outlays for some time.

In the household sector, an appreciable decline in sales of motor vehicles and slower growth

in other consumer spending in the first quarter appeared to reflect concerns relating to the

Iraqi war and adverse weather conditions in some parts of the country. More recently,

attractive sales incentives had boosted consumer purchases of motor vehicles, albeit not as

much as some industry contacts had hoped, and members referred to tentative signs of a

pickup in retail sales. On balance, however, the members did not see any firm indications of

significant acceleration in consumer spending. More positively, they cited recent survey and

anecdotal evidence of improving consumer confidence and referred to the gains in the stock

market as a source of potential impetus going forward. In the housing markets, activity

currently was somewhat uneven across the nation but had remained at a high overall level.

While favorable financing would help to sustain the housing sector, members anticipated that

any further impetus to growth from that sector was likely to be limited.

The members expected economic activity to be supported by substantial fiscal stimulus in

coming quarters, with that already built into existing federal legislation likely to be

augmented by further initiatives under active consideration in the Congress. However,

budgets of numerous state and local governments remained under severe pressure, and efforts

to contain spending and raise taxes by those governments would offset some of the federal

stimulus this year and next. It was not clear at this point how some state and local

governments would resolve their current budgetary crises and what the effects would be on

many local economies.

A weakening dollar and sluggish economic conditions abroad were key factors impinging on

the prospective contribution of the foreign sector to U.S. economic activity. While foreign

demand for U.S. products and services would be supported by the dollar's depreciation,

relatively weak foreign economic activity would tend to hold down such demand. On

balance, the nation's trade deficit was likely to remain at an elevated level, with moderate

gains in exports more than offset by larger increases in imports if forecasts of relatively

robust U.S. growth in fact materialized.

Even assuming a pickup in the expansion of economic activity in line with current forecasts

for this year and next, excess capacity in labor and product markets would remain elevated

and might well foster further disinflation over coming quarters. The decline in inflation might

be limited to some extent by the depreciated value of the dollar in foreign exchange markets

and by the anticipated effects of further large increases in worker benefit costs. Given the

pressure of a considerable amount of unused resources, any adverse developments that held

down economic expansion would increase the probability of further disinflation. Members

commented that substantial additional disinflation would be unwelcome because of the likely

negative effects on economic activity and the functioning of financial institutions and

markets, and the increased difficulty of conducting an effective monetary policy, at least

potentially in the event the economy was subjected to adverse shocks. Members also agreed

that there was only a remote possibility that the process of disinflation would cumulate to the

point of a decline for an extended period in the general price level.

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

indicated that they could support a proposal to maintain an unchanged policy stance. The

members acknowledged that a case could be made for easing policy immediately in light of

the generally disappointing reports on the recent performance of the economy, the ongoing

disinflation trend in a period of already low inflation, and forecasts of persisting excess

capacity. Nonetheless, they concluded that, on balance, an easing action was not desirable at

this time. They noted that not enough time had elapsed since the end of the Iraqi war to sort

out the underlying forces at work in the economy. In particular, the lifting of key

uncertainties relating to the war would provide an improved opportunity to assess whether

the favorable factors in the outlook would in fact lead to the anticipated strengthening in

economic activity and, at the same time, diminish the risk of appreciable further disinflation.

Some members cautioned that persisting uncertainty regarding economic trends should not

provide a basis for prolonged inaction in light of the risks of further disinflation and subpar

economic growth. In the absence of convincing indications of an appreciable pickup in

economic growth, an easing move might be desirable in the near term, perhaps at the June

meeting.

With regard to the press announcement to be released shortly after this meeting, the members

supported new language that provided separate assessments of the risks to the goal for

acceptable economic growth and the risks to the goal of price stability. They recognized that

the usual summary statement did not allow for the circumstances in which the Committee

saw some probability, albeit minor, of a significant further decline in inflation to an

unwelcome level. After discussion, the members generally agreed on separate sentences

indicating that the risks to its goal of sustainable economic growth were about balanced but

that the probability of some disinflation from an already low level exceeded that of a pickup

in inflation. The members also accepted a summary statement stating that, taken together, the

balance of risks to the Committee's dual goals was tilted toward the downside over the

foreseeable future. There was some concern that including such a summary sentence in the

press release might be mistakenly interpreted as an indication of Committee concern about

the outlook for economic activity rather than a judgment about the relative odds on further

inflation. Two members saw merit in adopting a balanced risks assessment at this meeting

despite the evident shortcomings in present circumstances of the form of such statements in

use in recent years.

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. Consistent with

the decision made at the March meeting, the vote did not formally encompass the wording of

the press statement to be released shortly after this meeting.

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.

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

Messrs. Broaddus, Ferguson, Gramlich, Guynn, Kohn, Moskow, Olson, and

Parry.

Votes against this action: None.

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

June 24-25, 2003.

The meeting adjourned at 1:25 p.m.

Notation Vote

By notation vote completed on May 20, 2003, the Committee authorized Vice Chairman

McDonough to accept the "Order of the Aztec Eagle" honor to be awarded by the

government of Mexico.

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

Broaddus, Ferguson, Gramlich, Guynn, Kohn, Moskow, Olson, and Parry.

Votes against this action: None.

Abstention: Mr. McDonough.

Vincent R. Reinhart

Secretary

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