FOMC Minutes

May 4, 2004

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 4, 2004, at 9:00 a.m.

Present:

Mr. Greenspan, Chairman

Mr. Geithner, Vice Chairman

Mr. Bernanke

Ms. Bies

Mr. Ferguson

Mr. Gramlich

Mr. Hoenig

Mr. Kohn

Ms. Minehan

Mr. Olson

Ms. Pianalto

Mr. Poole

Messrs. McTeer, Moskow, Santomero, and Stern, Alternate Members of the Federal

Open Market Committee

Messrs. Broaddus and Guynn, Presidents of the Federal Reserve Banks of Richmond

and Atlanta respectively

Mr. Reinhart, Secretary and Economist

Mr. Bernard, Deputy Secretary

Ms. Smith, Assistant Secretary

Mr. Mattingly, General Counsel

Mr. Baxter, Deputy General Counsel

Ms. Johnson, Economist

Mr. Stockton, Economist

Messrs. Connors, Fuhrer, Hakkio, Howard, Madigan, Rasche, Struckmeyer, Tracy,

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 and Whitesell, Deputy Associate Directors, Division of Monetary

Affairs, Board of Governors

Messrs. English and Sheets, Assistant Directors, Divisions of Monetary Affairs and

International Finance respectively, 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

Mr. Bassett, Economist, Division of Monetary Affairs, 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. Connolly and Moore, First Vice Presidents, Federal Reserve Banks of Boston

and San Francisco respectively

Messrs. Eisenbeis, Evans, Goodfriend, Judd, Ms. Mester, and Mr. Rolnick, Senior

Vice Presidents, Federal Reserve Banks of Atlanta, Chicago, Richmond, San

Francisco, Philadelphia, and Minneapolis respectively

Mr. Altig, Ms. Hargraves, and Mr. Koenig, Vice Presidents, Federal Reserve Banks

of Cleveland, New York, and Dallas respectively

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

on March 16, 2004, were approved.

By unanimous vote, Joseph S. Tracy was elected to serve as associate economist until the

first regularly scheduled meeting of the Committee after December 31, 2004, with the

understanding that in the event of the discontinuance of his official connection with a Federal

Reserve Bank or with the Board of Governors, he would cease to have any official

connection with the Committee.

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.

By unanimous vote, the Committee voted to extend for one year beginning in mid-December

2004 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.

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 16, 2004, through May 3, 2004. By unanimous

vote, the Committee ratified these transactions.

The information reviewed at this meeting suggested that the economy expanded at a rapid

pace in the first quarter. Consumer spending and the housing market continued to exhibit

strength. Business fixed investment grew smartly, reflecting increased outlays for equipment

and software that more than offset a significant fall in investment in nonresidential structures.

The labor market displayed further signs of improvement during the quarter, capped by a

significant increase in private payrolls in March. Recent increases in the prices of imports

and commodities showed through to a pickup in core consumer price inflation during the first

quarter, although some of the categories that registered large gains had posted unusually

small increases earlier.

The labor market showed renewed vigor during the first quarter. The growth in payroll

employment during March pushed the average monthly gain for the first quarter as a whole

well above that of the fourth quarter of last year. Hiring during the quarter was widespread

across industries, with large increases in construction, retail trade, and business and

nonbusiness services. Net job losses in manufacturing, which had waned during the winter,

reportedly came to an end by March. Some surveys of business hiring intentions also

suggested renewed strength. However, a small decline in the average workweek during

March held down the increase in aggregate hours, which rose at a slightly slower pace in the

first quarter than in the fourth quarter. Moreover, the unemployment rate ticked up to 5.7

percent in March, and the labor force participation rate remained low.

Despite a weather-related decline in output at utilities during March, the pace of industrial

production quickened during the first quarter, and the gains were widespread across industry

and market groups. The high-tech sector accounted for a significant part of the increase, as

output of computers and semiconductors rose rapidly. Production of other business

equipment also increased markedly, and indexes for business and construction supplies were

up notably. Motor vehicle assemblies were slightly higher for the first quarter as a whole,

although they slowed in March. Manufacturing capacity utilization rose for the second

consecutive quarter, but to a rate well below its long-run average. Available weekly physical

product data for April were up slightly.

Real consumer spending grew at a somewhat faster pace in the first quarter than it had in the

fourth quarter. Retail sales rose briskly, with strength widespread across spending categories,

while expenditures on services also posted a substantial increase. Light vehicle sales were

down slightly for the first quarter as a whole, but they firmed in March. Solid growth in

wages and salaries and an increase in tax refunds generated a large increase in real disposable

personal income in the first quarter. Measures of consumer confidence were roughly stable in

March and April.

Residential housing activity remained high in the first quarter despite a marked rise in

mortgage interest rates. Smoothing through weather-related swings in the volatile monthly

data, the underlying pace of single-family housing starts continued to display appreciable

strength. Sales of new homes jumped to a record level in March, and sales of existing homes

increased to their highest level since last September. In the multifamily sector, construction

activity also remained robust through March, even though the vacancy rate for multifamily

units reached a record high in the first quarter.

Business fixed investment continued to be supported by favorable underlying fundamentals,

including increased corporate cash flow, a low user cost of capital, and, at least as judged by

survey data, increased business confidence in the sustainability of the economic expansion.

Outlays for equipment and software expanded at a vigorous pace in the first quarter, with the

exception of spending on transportation equipment. Shipments of nondefense capital goods

excluding aircraft were strong, especially outside the high-tech industries. Within the

high-tech sectors, rapid growth of shipments of communications equipment offset declines in

the computers and peripherals category. By contrast, investment in nonresidential structures

fell considerably in the first quarter, and vacancy rates for industrial buildings and office

properties remained high.

Real nonfarm inventories increased a bit more in the first quarter than they had in the fourth

quarter. Motor vehicle inventories at the retail and wholesale levels accounted for the entire

increase, while non-auto inventories ran off slightly. In particular, manufacturers continued to

reduce their stocks, though at a slower pace than last year. Inventory accumulation lagged

growth in sales and shipments, and the inventory-sales ratio edged down further.

The U.S. international trade deficit shrank in February from January's record high, with

exports increasing across a range of major categories of goods. Economic growth in the

major industrialized countries in the first quarter was uneven. The economies of Japan and

the United Kingdom likely continued to expand, though at paces below those of late last year.

In the euro area, economic indicators were mixed. A moderation of growth in Canada led the

Bank of Canada to ease monetary policy for the third time this year, citing a need to support

aggregate demand. Inflation was little changed in Canada and the euro area, but it slipped

further in the United Kingdom. In Japan, consumer prices were about unchanged, while

wholesale prices edged up in March relative to their level of a year earlier and posted the first

increase on a twelve-month basis since July 2000.

In the United States, the core consumer price index advanced at a faster rate in the first

quarter than it had in the fourth quarter, reflecting the pass-through of higher energy prices

and a leveling off of goods prices after sizable declines last year. The higher goods price

inflation owed, in part, to the recent run-up in the prices of non-oil imports, energy, and other

commodities. The price index for core personal consumption expenditures also rose at a

faster rate in the first quarter than it had late last year. Despite the rise in inflation this year,

however, the cumulative increase in the overall consumer price index for the year ending in

March was somewhat less than the advance for the twelve months ending in March 2003. In

the year ending in March, the increase in the price index for total personal consumption

expenditures was similar to that of a year earlier. Survey measures of near-term inflation

expectations edged up somewhat in March and April, but measures of longer-term

expectations decreased. With regard to labor costs, average hourly earnings of production or

nonsupervisory workers on private nonfarm payrolls rose notably less for the twelve months

ending in March than they had in the year-earlier period. The overall increase in the

employment cost index for private industry for the twelve months ending in March was about

the same as that for the twelve-month period ending a year earlier, as wages and salaries

decelerated and benefits accelerated.

At its meeting on March 16, 2004, the Federal Open Market Committee decided to keep its

target for the federal funds rate unchanged at 1 percent. In its announcement of this decision,

the Committee indicated that the upside and downside risks to sustainable growth were

roughly equal and that the probability of an unwelcome fall in inflation had declined further

so that it was almost equal to that of a rise. The Committee also noted in March that although

output had continued to expand at a solid pace, new hiring had lagged, and increases in core

consumer prices were muted and expected to remain low. As a result, the Committee

determined that it could remain patient in removing its policy accommodation.

The Committee's decision at its March meeting to leave the intended level of the federal

funds rate unchanged had been fully anticipated in financial markets. However, market

participants reportedly viewed the accompanying statement as suggesting that the Committee

had a slightly weaker outlook for the economy than had been expected, and longer-dated

futures rates and Treasury yields declined a few basis points after the announcement. In

response to the generally positive tone of economic data-especially the release of the much

stronger-than-expected employment report for March-and congressional testimony by

Chairman Greenspan, investors pushed market interest rates substantially higher over the

intermeeting period. By the time of the FOMC meeting in early May, quotes on federal funds

futures contracts suggested that market participants expected policy tightening to begin

sooner than previously anticipated and to proceed at a faster pace once it began. The revision

to policy expectations showed through to interest rates on nominal Treasury securities, which

climbed significantly. Yields on inflation-indexed Treasury securities rose almost as much,

implying that inflation compensation only edged a little higher. Yields on investment-grade

corporate bonds rose a bit less than those on comparable-maturity Treasuries, but risk spreads

on below-investment-grade bonds narrowed significantly as their yields increased by a more

modest amount. Major equity price indexes were about unchanged, as the downward pressure

exerted by higher interest rates was offset by the effects of strong earnings reports, upward

revisions to expected future earnings, and other positive economic news.

In foreign exchange markets, the dollar appreciated against most major currencies over the

intermeeting period, and it also gained against an index of the currencies of other major U.S.

trading partners. The dollar fell sharply against the yen early in the intermeeting period, but

subsequently about reversed the decline. Market participants attributed the dollar's overall

gains particularly to the stronger-than-expected U.S. economic data and the weakerthan-expected performance of the Canadian economy and economies in the euro area.

M2 grew briskly during March and April as continued low opportunity costs and the

temporary effects of mortgage refinancing boosted liquid deposits. The strength was likely

offset somewhat by the effects of individual non-withheld tax payments in April, which were

lower than last year and therefore probably led to a smaller buildup in liquid deposits than

incorporated in the seasonal adjustment factors. Although currency growth continued to be

held down in the first quarter by weak demand from abroad, it moved closer to its long-term

trend in April.

The staff forecast prepared for this meeting suggested that the economy would continue to

expand briskly for the rest of 2004 before decelerating somewhat in 2005 as fiscal policy

shifted to a slightly restrictive stance. The considerable monetary and fiscal stimulus this year

and still-strong advances in structural productivity were expected to cause businesses to shed

still more of the caution they had been exhibiting in investing and hiring. The labor market

was projected to show steady improvement through the end of 2004, but the forecasted pace

of hiring was expected to slow a little next year as economic growth moderated. The staff

anticipated that inventories would increase at a modest rate during the forecast horizon as

businesses responded to continued strength in demand. Business spending on equipment and

software was expected to remain strong, with the expiration of the partial-expensing tax

provision at the end of 2004 adding impetus this year. The rise in mortgage rates was not

likely to show through to demand for housing until the second half of 2004 and was expected

to be partially offset in the longer term by rising employment and personal income. The

increases in employment and income were also projected to continue to boost consumer

spending. In light of recent increases in some price measures, the staff anticipated a transitory

rise in the pace of core inflation in the near term. However, it was expected that the

remaining slack in resource utilization and strong productivity growth would keep core

inflation at a low level over the forecast period.

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

of members noted that the outlook for production and employment had improved distinctly in

the period since the March FOMC meeting. Newly available data as well as commentary

from business contacts almost uniformly suggested that the expansion had continued to

broaden and had become more firmly established. Statistical releases confirmed that

consumer spending was rising at a brisk rate, housing activity remained at a high level, and

business fixed investment was growing vigorously. Significantly, the most recent data also

provided evidence that the pace of hiring had begun to pick up, a development that was

expected to provide further support to the expansion going forward. Anecdotal information

gathered from business contacts across the nation-particularly commentary suggesting rising

orders, improving confidence, and a growing willingness to increase payrolls-tended to

confirm the data that pointed to increasingly solid expansion. Prospects for growth continued

to be supported by fiscal policy, which was expected to remain stimulative through 2004, and

by the effects of monetary policy accommodation. Overall, Committee members were now

more convinced that robust growth would be sustained, and most likely at a pace that would

be adequate to make appreciable headway in narrowing margins of unutilized resources.

Regarding the outlook for inflation, members took particular note of recent data pointing to

jumps in consumer and producer prices. Many members indicated that the surprisingly large

advances had substantially reduced the odds of further disinflation and also had increased

their uncertainty about prospective price trends. Still, most members saw low inflation as the

most likely outcome.

In their comments about key economic sectors, a number of members pointed to

developments that were likely to support increased investment spending going forward.

Many business firms appeared to be experiencing a significant pickup in demand. Anecdotal

information suggested that some manufacturers had seen a notable rebound in orders, with

several members citing, in particular, stronger demand for high-tech products as well as for

machine tools, various types of heavy machinery, and aircraft. Also, optimism regarding

economic prospects among business executives seemed to be mounting, no doubt prompted

in part by the increased demand they were experiencing and robust growth in profits.

Business contacts in several districts had indicated that, as a result of the improved outlook,

they were taking steps to expand their capacity to produce, both by starting to augment work

forces and by boosting fixed investment. Committee members generally perceived overall

business fixed investment as accelerating considerably, especially for equipment and

software. In contrast, investment in nonresidential structures remained sluggish, as vacancy

rates in many markets were elevated and considerable excess capacity persisted in many

production plants. Drilling, however, was said to be strengthening in response to high oil and

gas prices.

While Committee members saw an overall brightening in the outlook for business fixed

investment, a number of policymakers commented that some of the considerable caution that

had earlier marked business attitudes apparently lingered. The pace of hiring seemed to be

picking up only gradually, fixed investment was still moderate in comparison with the strong

cash flow being generated by robust profits, and anecdotal information indicated that firms in

most industries were continuing to exercise tight control over inventories. Indeed, several

members remarked that the rate of inventory investment was surprisingly modest in the first

quarter, although motor vehicle inventories were on the high side. On the whole, the evidence

of continued caution and disciplined spending in the business sector was seen as boding well

for the durability of the expansion.

Members viewed the household sector as continuing to play a key role in the expansion, with

recent data as well as anecdotal information indicating that consumer spending was rising at

a solid pace. After dropping back in January, auto sales had accelerated over the remainder of

the first quarter and appeared to be well maintained in April. Expenditures for consumer

services seemed to be expanding steadily. Several members noted that tourism in their

regions was picking up. In addition, housing activity had stayed strong across the nation and

was still climbing in some regions, with reports of growing backlogs in deliveries and

substantial price increases in some markets. The overall vigor in household spending was

being supported by substantial gains in disposable income, partly reflecting tax cuts,

generally sound balance sheets, accommodative financial conditions, and increases in

consumer sentiment over the past year or so. To date, the backup in fixed mortgage interest

rates in recent months seemed to have had little adverse effect on homebuying, although it

was noted that an appreciable further rise in longer-term market rates would represent a

potential source of restraint on future household spending.

Fiscal policy was viewed as likely to buoy the expansion of economic activity through 2004.

Real federal expenditures had jumped in the first quarter and were expected to rise further

over the balance of the year. Next year, fiscal impetus was likely to diminish, largely owing

to the expiration of the tax provision permitting partial expensing of certain capital outlays.

Assessing the prospects for fiscal policy, however, was complicated by a lack of legislative

progress to date in passing federal appropriations bills. Regarding the longer-term federal

budgetary outlook, an apparent breakdown in fiscal discipline was seen as an ongoing

concern. However, some progress was noted in reducing budgetary imbalances at the state

and local levels.

The external sector was expected to provide limited support for U.S. economic growth over

the next two years. Expansion of foreign economies was likely to fuel increases in U.S.

exports, with strength expected particularly in computers and semiconductors. Real imports,

however, also appeared likely to continue rising strongly as domestic demand climbed

further, leading to a widening of already substantial trade and current account deficits. Some

members saw a risk that growth in certain rapidly expanding regions abroad could slow,

perhaps sharply, with potentially significant effects on the demand for U.S. exports as well as

on global commodity prices.

After a protracted period of meager gains in employment, conditions in the U.S. labor market

evidently were improving in recent weeks. In addition to noting the substantial jump in

payrolls in March, several members relayed anecdotal information from business contacts

around the nation that hiring was continuing to pick up and that firms were planning further

increases in workforces. Some temporary help firms reported rising demand, a possible

precursor of a pickup in permanent hiring. A number of members cited reports of difficulties

in hiring within certain job families in which specialized skills were in short supply together

with indications that wage increases in those occupations tended to be larger than average.

Even so, considerable slack seemed to remain in the labor market overall, and wage gains on

the whole were moderate.

Data on consumer and producer prices over the intermeeting period had generally come in on

the high side of expectations, following considerable increases in commodity prices. A

significant number of Committee members reported information from their contacts that

businesses were increasingly able to pass on cost increases to their customers and to boost

prices more generally. Some members cited instances in which earlier price discounts had

been canceled and noted that surcharges for higher energy and steel prices were being added

to base prices for certain goods. Nonetheless, the extent to which these developments

signaled an upturn in underlying inflation was unclear. To some degree, the recent uptick in

various price measures partly reflected factors, such as jumps in the prices of energy and

non-oil imports, that were unlikely to be repeated. Also, the recent evidence could be

interpreted as indicating that the surprisingly sharp decline in measured inflation in 2003

exaggerated the drop in the underlying rate of inflation. Indeed, some members saw

underlying inflation as relatively stable and put low odds on the possibility that prices now

were accelerating. In their view, a range of factors was continuing to restrain inflation,

including slack in resource utilization, strong productivity gains and corresponding

downward pressures on unit labor costs, currently high price markups, and longer-term

inflation expectations that apparently remained contained. Others, however, were less

confident about the degree of restraint on prices, noting that inflation predictions based on

estimated output or employment gaps were subject to considerable error.

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

favored maintenance of the existing target of 1 percent for the federal funds rate. It was

recognized that the Committee would need to initiate a process of removing monetary policy

accommodation at some point, and the recent experience suggested that the time at which

policy firming appropriately would commence might be closer than previously had seemed

most probable. However, the appreciable rise in real long-term interest rates over the

intermeeting period implied that financial market conditions had already tightened on

balance. Moreover, the evidence of a significant acceleration in hiring was still limited, and

some members referred to the possibility that growth could falter, particularly if market

yields were to rise sharply further. With inflation low and resource use slack, the Committee

saw a continuation of its existing policy stance as providing a degree of support to the

economic expansion that was still appropriate.

With regard to the Committee's announcement to be released after the meeting, it was

understood that the recent evidence that hiring had picked up, as well as the continued solid

growth in output, would be highlighted. Policymakers also concurred that, with the

expansion apparently well established, the statement should again indicate that the upside

and downside risks to sustainable growth for the next few quarters seemed to be roughly

equal. Members saw both downside and upside risks to prospects for inflation. The probable

persistence of slack in the economy for at least several more quarters, together with the

likelihood that recent substantial gains in productivity would be extended, should continue to

exert slight downward pressures on inflation. At the same time, though, the recent strongerthan-expected increases in a number of price measures, anecdotal information suggesting a

greater ability of businesses to implement and sustain price hikes, and multiplying signs of

solid economic growth suggested that the upside risks to inflation had increased. The

members agreed that, all things considered, the risks to the goal of price stability had moved

into balance in the period since the last meeting.

The Committee also discussed at length the advantages and disadvantages of modifying or

dropping its statement in the announcement following the March meeting that "With inflation

quite low and resource use slack, the Committee believes that it can be patient in removing

its policy accommodation." All of the members agreed that, with policy tightening likely to

begin sooner than previously expected, the reference to patience was no longer warranted.

The Committee focused instead on a formulation that would emphasize that policy

tightening, once it began, probably could proceed at a pace that would be "measured." A

number of policymakers were concerned that such an assertion could unduly constrain future

adjustments to the stance of policy should the evidence emerging in coming months suggest

that an appreciable firming would be appropriate. Others, however, saw substantial benefits

to inclusion of the proposed language. These members noted that current economic

circumstances made it likely that the process of returning policy to a more neutral setting

would be more gradual, once under way, than in past episodes when inflation was well above

levels consistent with price stability. In addition, some policymakers observed that the timing

and magnitude of future policy adjustments would ultimately be determined by the

Committee's interpretation of the incoming data on the economy and prices rather than by its

current expectation of those developments. On balance, all the members agreed that they

could accept an indication in the statement that ". . . policy accommodation can be removed

at a pace that is likely to be measured."

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 Open Market 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."

The vote encompassed approval of the paragraph below for inclusion in the press statement

to be released shortly after the meeting:

"The Committee perceives that the upside and downside risks to the attainment

of sustainable growth for the next few quarters are roughly equal. Similarly, the

risks to the goal of price stability have moved into balance. At this juncture, with

inflation quite low and resource use slack, the Committee believes that policy

accommodation can be removed at a pace that is likely to be measured."

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

Ferguson, Gramlich, Hoenig, Kohn, Minehan, Mr. Olson, Ms. Pianalto, and Mr.

Poole.

Vote against this action: None.

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

June 29-30, 2004.

The meeting adjourned at 1:15 p.m.

Vincent R. Reinhart

Secretary

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