FOMC Minutes

October 28, 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, October 28, 2003, at 9:00 a.m.

Present:

Mr. Greenspan, 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

Ms. Smith, Assistant Secretary

Mr. Mattingly, General Counsel

Ms. Johnson, Economist

Mr. Stockton, Economist

Mr. Connors, Ms. Cumming, Messrs. Goodfriend, Howard, Madigan, Struckmeyer,

and Wilcox, Associate Economists

Mr. Kos, Manager, System Open Market Account

Mr. Ettin, Deputy Director, Division of Research and Statistics, Board of Governors

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

Board of Governors

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

Monetary Affairs, International Finance, and Monetary Affairs respectively, Board of

Governors

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

Mr. Hambley, Assistant to the Board and Director for Congressional Liaison, Office

of Board Members, 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, Ms. Mester, Messrs. Rasche, Rolnick, Rosenblum, and

Sniderman, Senior Vice Presidents, Federal Reserve Banks of Boston, Kansas City,

Philadelphia, St. Louis, Minneapolis, Dallas, and Cleveland respectively

Mr. Dwyer, Ms. Hargraves, Messrs. Krane and Rudebusch, Vice Presidents, Federal

Reserve Banks of Atlanta, New York, Chicago, and San Francisco respectively

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

on September 16, 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 September 16, 2003, through October 27, 2003. By

unanimous vote, the Committee ratified these transactions.

The pace of the economic expansion appeared to have picked up substantially. Consumer

spending and the demand for housing were quite strong in the third quarter and business

outlays for capital evidently accelerated. At the same time, labor markets seemed to be

leveling out, and industrial production had firmed in recent months. While core consumer

prices had risen faster in recent months than earlier in the year, the twelve-month increase

through September was notably lower than during the preceding year.

Labor markets appeared to be stabilizing as private nonfarm payrolls grew in September for

the first time since January, and employment losses in July and August turned out to be

smaller than data initially had indicated. The largest employment gain in September was in

the business services sector, which includes temporary help supply firms. Employment also

increased in most other major industries in September, with the exceptions of manufacturing

and wholesale trade. Even in these sectors, the pace of job loss was somewhat slower than

the declines of previous months. Aggregate hours of private production workers and the

average workweek were both unchanged in September. The unemployment rate in September

remained at 6.1 percent.

Conditions in the industrial sector had improved somewhat in the previous months. Industrial

output displayed solid growth in the third quarter after declining earlier in the year. A

downturn in motor vehicle assemblies depressed overall manufacturing somewhat in August,

but a step-up in auto production boosted it significantly in September. The strength in

manufacturing in September was somewhat offset, however, by a decrease in energy

production as temperatures returned to more normal ranges after being unusually high in July

and August. In line with these patterns in output, capacity utilization in manufacturing, which

had been at historically low levels, decreased slightly in August, then firmed in September.

Real personal consumption expenditures surged in July and August, but available data

suggested that consumer spending had fallen back in September, largely reflecting a swing in

consumer purchases of motor vehicles. Even apart from motor vehicles, outlays rose at a

solid pace in August, and they seemed to have declined only slightly in September. Spending

was supported in recent months by the sizable boost to disposable personal income from tax

cuts as well as by levels of wealth and confidence that were considerably above their values

earlier in the year.

Housing construction and sales remained very strong in August and September despite some

rise in mortgage rates from the very low levels reached in the early summer. The rapid pace

of new single-family home construction eased slightly in August but advanced again in

September. Multifamily home construction remained around its pace of the past several

years. Sales of existing homes reached a record high in August and then climbed further in

September. New home sales rose in August and September at a rate just a bit below the

record set in June.

Real outlays for equipment and software in the third quarter appeared to have advanced at a

faster rate than in the second quarter. Shipments of nondefense capital goods excluding

aircraft moved up in September, more than reversing a decline in August. Orders for these

goods rose moderately in September after being flat in August. Nominal outlays for

construction of privately owned buildings were about unchanged, on net, during the twelve

months ending in August. Continued strength in the construction of private institutional

structures such as schools, churches, and hospitals was about offset by weakness in other

areas of nonresidential construction.

Manufacturing and trade inventories excluding motor vehicles fell further in August after

edging down in July. Manufacturers ran off stocks at a fairly rapid pace in both months,

while wholesalers and retailers excluding motor vehicle and parts dealers recorded small

declines in stocks in August after accumulations in July. Generally small changes in

shipments and sales in the July-August period kept book-value inventory-sales ratios about

flat at very low levels.

The U.S. international trade deficit declined in August to its lowest level since February as

imports fell more than exports. Available data for the third quarter generally suggested

moderate growth in the major foreign industrial countries. Evidence pointed to a likely

resumption of real GDP growth in the third quarter in Canada and the euro area and

continued expansion in Japan and the United Kingdom.

Core consumer prices rose slightly in August and September, but headline consumer inflation

was up a bit more, largely reflecting a run-up in gasoline prices. Energy prices also boosted

overall consumer inflation over the past twelve months, while core consumer inflation moved

lower over the same period. At the producer level, core prices were about unchanged during

August and September, but rising energy and food prices led to somewhat larger increases in

the prices of total finished goods. With regard to labor costs, average hourly earnings of

production or nonsupervisory workers on private nonfarm payrolls edged down in

September. The increase in earnings during the previous twelve months was a bit below that

during the previous year.

At its meeting on September 16, 2003, the Federal Open Market Committee adopted a

directive that called for maintaining conditions in reserve markets consistent with keeping the

federal funds rate at around 1 percent. In reaching this decision, the Committee members

generally perceived the upside and downside risks to the attainment of sustainable growth for

the next few quarters to be roughly equal; however, they viewed the probability, though

minor, of an unwelcome fall in inflation as exceeding that of a rise in inflation from its

already low level. The Committee judged that, on balance, the risk of inflation becoming

undesirably low would remain the predominant concern for the foreseeable future. In those

circumstances, the Committee believed that policy accommodation could be maintained for a

considerable period.

The Committee's decision to leave its target for the federal funds rate and assessment of risks

unchanged at the September meeting was widely anticipated. Although there was relatively

little shift in market expectations for the federal funds rate following the policy decision,

longer-dated federal funds futures rates rose significantly in the weeks before the October

meeting in the context of better-than-expected economic data, positive announcements of

corporate earnings, and a pronounced weakening of the dollar. Short- and intermediate-term

Treasury yields also increased somewhat over the intermeeting period, but yields on

longer-term Treasuries were about unchanged. While rates on investment-grade securities

moved about in line with those on Treasuries, yields and spreads on lower-tier obligations

registered further significant and broad-based declines. Major equity indexes rose roughly 2

percent over the intermeeting period.

The exchange value of the dollar, as measured by the major currencies index, fell

significantly over the intermeeting period. Negative market sentiment toward the dollar,

apparently reinforced by market participants' interpretation of the G-7 communiqué from

Dubai on September 20, was not overcome by several better-than-expected U.S. economic

reports, though there were some short-lived gains related to the data releases during the

period.

M2 contracted moderately in September after growing rapidly in July and August. The

reversal appears to have stemmed mainly from a contraction in deposits resulting from

reduced mortgage refinancing activity. In addition, the temporary effects of a major power

blackout in August had boosted M2 growth in that month, and the subsequent runoff of those

deposits likely depressed M2 in September.

The staff forecast prepared for this meeting continued to point to a substantial strengthening

in the economic expansion during the second half of the year. Accommodative financial

conditions, recent additional fiscal stimulus, and robust gains in structural productivity were

evidently providing significant impetus to business and consumer spending. Inventory levels

had been substantially reduced, and the size of business capital stocks apparently had

continued to move closer to acceptable levels. As a consequence, improving sales and profits,

low financing costs, and the temporary federal tax incentive for investment in new equipment

and software were projected to boost business investment spending over time. Given the

substantial ongoing slack in resource utilization, the staff forecast anticipated some slight

downward pressure on core consumer price inflation.

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

referred to widespread indications of a marked strengthening in the growth of economic

activity. While views regarding the probable vigor of the expansion differed to some extent,

the members generally anticipated growth at a pace near or somewhat above the economy's

potential over the forecast horizon, assuming no major shocks to the economy. Factors cited

as likely to encourage robust and sustained economic growth included substantial fiscal and

monetary policy stimulus, accommodative financial conditions, indications of strengthening

foreign economies, much improved business earnings and cash flows, and the favorable

implications of strongly rising productivity for business investment and worker earnings.

Members nonetheless saw some factors that could restrain the degree of vigor in household

and business spending and present downside risks to their forecasts. Among the negatives

mentioned were the still-cautious business attitudes that continued to inhibit hiring and

investment decisions, the potentially adverse effect on household confidence if appreciable

further gains in employment should fail to materialize, and the waning impetus over time of

the tax reductions that had taken effect this year. On balance, while the factors pointing to a

vigorous expansion seemed to predominate, members acknowledged that the economy was

emerging from an atypical period that limited the guidance that historical experience

provided for evaluating the economic outlook. Developments in the next few months, notably

including the strength of holiday sales, should provide an improved basis for judging the

underlying momentum of the expansion.

In contrast to the usual experience in economic recoveries during recent decades, the

expansion appeared to be gathering momentum at a time when key measures of inflation

suggested that price stability had essentially been achieved. Looking ahead, members

generally anticipated that an economic performance in line with their expectations would not

entirely eliminate currently large margins of unemployed labor and other resources until

perhaps the latter part of 2005 or even later. Accordingly and given the presumed persistence

of strong worldwide competition, significant inflationary pressures were not seen as likely.

Members commented that the strengthening in final sales had fostered some firming in

industrial production and had led purchasing managers to report an improvement in current

and anticipated business conditions. Moreover, labor demand had begun to show signs of

stabilizing after an extended period of weakness. Anecdotal reports of plans to increase

hiring and of actual increases had multiplied. However, the extent to which recently positive

labor market developments might be harbingers of substantial further employment gains was

unclear at this point, given evidently continuing business efforts to respond to growing

demand by improving productivity rather than hiring new workers. Members nonetheless

expressed optimism regarding the prospects for substantial employment gains once business

firms were persuaded that a major uptrend in final sales was firmly established.

In their comments about the outlook for demand in key sectors of the economy, members

continued to view business capital spending as a critical factor in the prospects for the

performance of the overall economy. Business expenditures for new equipment and software

clearly had turned up since earlier in the year, but anecdotal reports from around the nation

continued to suggest that much of this spending was for replacement and upgrading purposes

rather than expansion. Such reports also indicated that business contacts, while more

confident, remained very cautious, with most firms hesitant to expand their facilities or hire

permanent workers until they saw firmer indications that the recent upturn in business

activity would be sustained. Some firms reportedly were directing capital investments to

foreign markets rather than domestically, apparently largely to take advantage of lower labor

costs abroad. Members nonetheless expressed the view that in the context of further

anticipated increases in profits and sales, business confidence would continue to improve and

induce greater investment and workforce expansions. On the negative side, there were few

indications of a possible upturn in commercial construction activity.

The recent strength in final sales was associated with sizable inventory liquidation by

business firms, and recent surveys and anecdotal commentary suggested that inventories

were at unusually low levels in relation to sales, notably in manufacturing. In the

circumstances, a continuation of robust final demand could be expected to foster efforts to

rebuild inventories, with potentially substantial short-run stimulus to the economy. However,

the timing and extent of such restocking were subject to uncertainty, and for now available

reports indicated that business firms were continuing to follow a highly cautious approach to

inventory investment.

As had been true for an extended period, household spending had continued to be the

mainstay of what until recent months had been a sluggish economic recovery. Personal

consumption expenditures had posted quarterly increases throughout the recent period of

limited economic growth. During the summer months, consumer spending evidently was

boosted by a surge of disposable income generated by the federal tax cuts, but how long that

income effect would stimulate increases in consumer spending remained uncertain. On the

encouraging side, according to a number of reports retailers were optimistic about the

outlook for sales during the holiday period and about the economy more generally. However,

some members expressed concern that unless the recent improvement in labor market

conditions was sustained, there could be adverse repercussions on consumer attitudes and

spending.

Propelled by still low mortgage interest rates, housing demand had remained at a very high

level in recent months. Indeed, record sales were being reported in some regions. There were,

however, indications of concern about the longer-term outlook for housing on the part of

some real estate contacts.

Fiscal policy was expected to be somewhat less expansionary next year, though still an

important contributor to economic growth. Members again mentioned concerns on the part of

business contacts regarding the adverse economic implications of very large deficits for the

economy over the longer term.

In their comments about the external sector of the economy, members referred to indications

of strengthening economic activity abroad that in conjunction with a weaker dollar was

fostering some improvement in exports. At the same time, imports continued to expand

rapidly, reflecting not only growth in U.S. domestic demand but also the increased

availability of foreign products at attractive prices stemming from the rapid expansion of

output capacity in a number of foreign countries. In this regard, many business contacts

continued to note pressures on their domestic operations from foreign competition.

In their review of the outlook for inflation, members emphasized that the prospects for

persisting slack in labor and other resources in combination with substantial further increases

in productivity were likely to hold inflation to very low levels over the next year or two.

Indeed, many saw modest further disinflation as likely, at least over the year ahead, though

they also agreed that the probability of substantial and worrisome disinflation had become

increasingly remote in light of the recent strengthening in economic activity. Members also

cited the weakness in the dollar as a factor that would tend to reduce the degree of any

domestic disinflation. Some members emphasized that the outlook for inflation was clouded

by a high degree of uncertainty about the underlying trend in productivity. The growth in

productivity could remain higher than had earlier been anticipated, damping employment,

labor costs, and price pressures. On balance, the members did not view changes in inflation

in either direction as likely to generate significant policy concerns over the forecast horizon.

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

agreed that an unchanged target of 1 percent remained appropriate for the federal funds rate.

The current degree of policy ease evidently was contributing to an upturn in the expansion of

economic activity. The strengthening economy had reduced concerns of significant further

disinflation, but those concerns had not been eliminated. The pickup in demand had yet to

materially narrow currently wide margins of idle labor and other resources, and these

margins along with the uncertainties that still surrounded current forecasts of robust

economic growth suggested that an accommodative monetary policy might remain desirable

for a considerable period of time. Members referred to the contrast between their current

policy expectations and the typical experience during earlier cyclical upturns when it was felt

that policy adjustments needed to be made quite promptly to gain greater assurance that

inflation would not rise from what were already relatively elevated levels. In present

circumstances, the degree of slack in resources and a rate of inflation that was essentially

consistent with price stability suggested that the Committee could wait for more definitive

signs that economic expansion would otherwise generate inflationary pressures before

making a significant adjustment to its current policy stance.

In their discussion of the press statement to be issued shortly after this meeting, the members

indicated that the Committee's risk assessments relating to economic activity and inflation to

be referenced in that statement should remain the same as those in use since the May

meeting. Some members, while expressing support for this view, also commented that the

time for some changes in the current risk assessments might be approaching if the economy

continued to strengthen in line with recent experience. At this meeting, the members agreed

that the risks to the goal of sustainable economic growth were roughly balanced for the next

few quarters and the probability of an unwelcome fall in inflation, though minor, exceeded

that of a rise in inflation from its currently low level. On balance, the risk of undesirably low

inflation was likely to remain the Committee's predominant concern for the foreseeable

future. At the conclusion of this discussion, the Committee agreed to the release of a press

statement after this meeting that was virtually identical to the one used after the September

meeting apart from some updating to reflect ongoing economic developments.

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 percent.

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

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

Stewart. (Mr. Stewart voted as an alternate member.)

Votes against this action: None.

The vote encompassed the substance of the following statements concerning risks that would

be conveyed in the Committee's press release to be made available shortly after the meeting:

The risks to the Committee's outlook for sustainable economic growth over the

next several quarters are balanced; the risks to its outlook for inflation over the

next several quarters are weighted toward the downside; and, taken together, the

balance of risks to its objectives is weighted toward the downside in the

foreseeable future.

At this meeting the members continued their earlier discussion of how best to communicate

the Committee's general assessment of the outlook for economic activity and inflation. The

members recognized that changing circumstances required adaptations in the Committee's

communications with the ultimate objective of fostering the best possible public

understanding of monetary policy decisions. A number of alternative approaches and specific

suggestions were discussed, and in the absence of a consensus at this meeting the members

agreed that further study under the guidance of a working group comprised of Committee

members was desirable. The working group would develop a limited number of specific

proposals for consideration at a later meeting.

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

9, 2003.

The meeting adjourned at 2:00 p.m.

Vincent R. Reinhart

Secretary

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