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Prefatory Note The attached document represents the most complete and accurate version available based on original copies culled from the files of the FOMC Secretariat at the Board of Governors of the Federal Reserve System. This electronic document was created through a comprehensive digitization process which included identifying the bestpreserved paper copies, scanning those copies, 1 and then making the scanned versions text-searchable. 2 Though a stringent quality assurance process was employed, some imperfections may remain. Please note that this document may contain occasional gaps in the text. These gaps are the result of a redaction process that removed information obtained on a confidential basis. All redacted passages are exempt from disclosure under applicable provisions of the Freedom of Information Act. 1 In some cases, original copies needed to be photocopied before being scanned into electronic format. All scanned images were deskewed (to remove the effects of printer- and scanner-introduced tilting) and lightly cleaned (to remove dark spots caused by staple holes, hole punches, and other blemishes caused after initial printing). 2 A two-step process was used. An advanced optimal character recognition computer program (OCR) first created electronic text from the document image. Where the OCR results were inconclusive, staff checked and corrected the text as necessary. Please note that the numbers and text in charts and tables were not reliably recognized by the OCR process and were not checked or corrected by staff. Strictly C onfide ntial (F.R.) Class II – FOMC August 16, 2001 M ONETARY P OLICY A LTERNATIVES Recent D evelopm ents (1) Market exp ectations for the p ath of the federal fu nds rate mo ved up in late June as investors apparently read the Committee’s choice of a 25 basis point easing at the June meeting and the May minutes released the next day as evidence that the Com mittee migh t ease in the future b y less than previo usly though t.1 This step-up was short-lived , though, as m arket participants began to m ark down the expected p ath for policy in light of predominantly disappointing news on economic activity and corporate earnings and generally benign inflation reports. Policy expectations declined considerably following the Chairman’s monetary policy testimony in midJuly–which was seen as emphasizing downside risks for the economy in general and capital spending in particular–and the anecdo tal reports in the August Beigebook–wh ich were viewed as signs that econom ic weakness was becoming more widespread. Concerns about the deteriorating economic outlook in Europe and Japan, along with the continuing w oes of Argentina and som e other emerging market countries, ad ded to the sen se of un certain ty and pessim ism in globa l financial markets. Futures market quotes sugg est that investors are confident that the FOM C will ease by at least ¼ p ercentage poin t at this meeting (c hart 1). Futures p rices imply a pa th for the funds ra te that trough s at about 3¼ percent early nex t year–abou t ¼ percentage point lower and a few months later than expected at the time of the June 1. The federal funds rate averaged close to 3¾ percent over the intermeeting period. The Desk redeemed $4.7 billion of Treasury securities to maintain SOMA holdings of individual securities within the internal per-issue guidelines. Over the period, the Desk purchased $9.5 billion of Treasury securities in outright operations, including $2.1 billion in Treasury bills and $7.4 billion in coupon securities. The outstanding volume of long-term RPs increased $4 billion, to $16 billion. Chart 1 Financial Market Indicators Expected Federal Funds Rates Estimated from Percent Financial Futures* Selected Treasury Yields* Percent 5.0 Daily 4.5 7.0 Two-year 6.5 6.0 Ten-year 5.5 4.0 5.0 4.5 June 26, 2001 3.5 4.0 TIPS 3.5 August 16, 2001 3.0 Aug Oct 2001 Dec Feb Apr Jun 2002 Aug Oct 3.0 May *Estimates from federal funds and eurodollar futures rates with an allowance for term premia and other adjustments. 14 Nov Jan Mar May 2001 Jul Selected Risk Spreads* Percent 12 Daily 13 Sep 2000 *Nominal Treasury yields are estimated from a smoothed yield curve based on off-the-run securities. Selected Private Long-Term Yields Percent Jul 11 High Yield (left scale) 12 Basis Points 800 300 Daily 700 High Yield (left scale) 10 600 Ten-year BBB (right scale) 11 200 9 500 10 8 400 9 7 Ten-year Swap (right scale) 8 6 May Jul Sep 2000 Nov Jan Mar May 2001 200 May Jul 100 Ten-year BBB (right scale) 300 Jul Sep 2000 Nov Jan Mar May 2001 Jul *Computed as the spread of the yield on the Merrill Lynch 175 index and an estimated ten-year BBB yield over ten-year swap rates. Selected Equity Indexes Index(5/31/00) = 100 140 Daily Nominal Trade-Weighted Dollar Exchange Rates Index(5/31/00) = 100 110 Daily 108 120 Major Currencies Index 106 Wilshire 5000 Broad Index 100 104 DJIA 102 80 Nasdaq 100 Other Important Trading Partners 60 98 May Jul Sep 2000 Nov Jan Mar May 2001 Jul Note: Solid vertical line indicates last FOMC meeting. May Jul Sep 2000 Nov Jan Mar May 2001 Jul 2 FOM C meeting–before rebo unding to about 4 percen t or so by late next year.2 (2) The souring mood regarding the economic outlook and the attendant change in expectations for monetary p olicy were associated with widespread declines in longer-term yields over the period and a selloff in equity markets. Off-the-run nominal Treasury coup on yields fell 20 to 30 basis points, with shorter maturities registering the steepest declines.3 By contrast, yields on longer-term Treasury inflation-indexed securities were little changed, implying that the inflation compensation in nom inal securities fell about 25 basis points.4 Despite the more pessimistic economic outlook, investment- and most speculative-grade private yields declined about in line with com parable off-the-run Treasury yields, leaving risk spreads little changed on balance. As an exception to this general pattern, yields on junk b onds in the telecom sector rose fu rther to widen already he fty spre ads. Through early August, stock prices largely proved resilient to a spate of negative earnings announcements and resulting cuts in analysts’ earnings projections for the remainder of this year. But equity prices have slumped since then in response to the 2. The box on page 6 highlights investors’ uncertainty surrounding that mean expected path for the fun ds rate. 3. The yield on the on-the-run ten-year note fell considerably more than that on the compara ble off-the-run security over the period as the n ewly auction ed note, as usu al, garnered a sizable premium; other on-the-run Treasury coupon yields declined about in line with comparable off-the-run yields. Treasury bill yields fell over the period, but by less than other money market yields, in part as the ramping up of weekly bill auction sizes and the additional supply from the introduction of the weekly four-week bill put pressure on the financing market at times and evidently strained investors’ willingness to accumulate more of those securities. Inde ed, the overn ight RP rate m oved abo ve the fund s rate on a few days, and bill rates were unusually elevated relative to other money market instruments. Spreads of three-mo nth comm ercial paper an d eurodo llar rates over the thre e-month b ill yield touched historic lows of only a few basis points in late July. 4. The drop in imp lied inflation compensation may have been am plified by upward pressures on indexed yields surrounding the auction of new ten-year indexed notes in midJuly, as investors m ay have req uired larger prem iums to abso rb these securities into their portfolios. 3 accumulation of adverse news on the economy and earnings; broad indexes have fallen 2¾ to 6½ percent over the period, with especially disappointing reports on profits for high-tech firms weighing on the Nasdaq. (3) The index of the dollar’s trade-weighted exchang e value against other major currencies declined 2½ percent over the period, with much of this change occurring in recent days. While investors marked down their expectations of economic growth around the world an d interest rates and equity prices fell in most industrial countries, the downward revision to th e expected path of policy rates seemed greatest in the United States. In addition, public debate about the merits of the “strong-dollar” policy intensified over the intermeeting period, and m arket concerns about the sustainability of the U.S. current accoun t deficit were heightened by the publication this week of the IM F Article IV review of the U .S. econ omy. O n balance since the June meeting, the dollar has fallen 6 percent against the euro and 3 percent against the yen despite further discouraging news about the economies of Europe and Japan . On Augu st 14, the Bank of Japan surprised man y market participants by announcing an increase in its provision of liquidity to the financial system. The dollar gained 1 percent on balance against the Canadian dollar; the Bank of Canada cut its policy rate 25 basis points in mid-July, citing spillover effects from slower growth in the U.S. economy. Over the intermeeting period, U.S. monetary authorities did not intervene. (4) The dollar was little changed against a basket of currencies of our o ther important tr ading partn ers. Concern s about the A rgentine gov ernment’s ab ility to resolve its budg et problem s were not allaye d by the ann ouncem ent of a fiscal austerity plan requiring budgetary balance o n a month-to-mo nth basis. The runoff of privatesector deposits from the banking system was very steep, and spreads of Argentine debt over comparable Treasuries remained high and volatile. Spillovers from the turmoil in Argentina add ed to problems in Brazil, which reso rted to monetary policy 4 tightening and foreign exchange intervention to blunt pressure on the real. Despite the announcement in early August that Brazil would obtain a new $15 billion IMF program, the real has depreciated 7½ percent against the dollar on net over the intermeeting period. Me xican financial m arkets were large ly unaffected by th e turmoil elsewhere in Latin America, and the p eso held steady even as the central bank eased policy. In emerging Asia, the ongoing worsening of global high-tech markets put downward p ressure on exchange rates and equity prices in several coun tries. (5) In the United States, overall private borrowing ap pears to have slowed from the brisk pace registered in the spring (chart 2). In recent months, issuance of corporate bonds has drop ped well below its earlier torrid rate, while commercial pap er and busines s loans at bank s have continu ed to contract. A ccording to r espondents to the August Senior Loan Officer Survey, almost all of whom represent large banks, the recent decline in business loans owed importantly to a weakening in demand that has stemmed, in part, from firms scaling back their capital spend ing. These banks also reported a further tightening of terms and standards on business loans, although the fraction doing so was down from prior surveys. In the household sector, mortgage debt growth has slowed only a little, but the expansion of consumer credit has fallen off appreciably. By contrast, federal debt growth has turned up in the last couple of months–albeit probably only temporarily–reflecting both weaker-than-expected tax receipts and borrowing to finance the tax reb ates. (6) M2 growth remained strong in July, at about 8½ percent, but was below the average pace over the first half of this year. The expansion over the first half was supported by declining opportunity costs associated with policy easing, but M2 grow th was faster than w ould h ave been exp ected b ased on histo rical relationships. Indeed, M2 velocity fell at a 6¾ percent rate, the most rapid half-year decline since the early 1980s. A portion of this unusual strength likely owes to a surge in mortgage refinancing spurred by declining long-term interest rates late last year and also to the increase in stock market volatility and steep declines in equity prices earlier this year, Chart 2 Growth of M2 and Selected Debt Aggregates Growth of M2 Percent Annualized 12 10 p f 8 6 4 2 0 Q1 p - Preliminary. f - Forecast. 1999 A 2000 Growth of Federal Debt M 2001 J J A Growth of Nonfederal Debt Percent p Annualized 6 Percent Annualized 4 16 2 14 0 12 -2 10 -4 8 -6 6 p -8 4 f -10 Q1 1999 p - Preliminary. 2000 A M J 2001 J 0 -14 -2 -16 -4 -18 Q1 1999 p - Preliminary. f - Forecast. 2000 A M J 2001 -6 J Growth of Consumer Credit Percent Annualized 18 16 Percent Annualized 16 14 12 12 10 10 8 8 6 6 4 p 2 f A M J 2001 18 14 4 p 1999 2000 p - Preliminary. f - Forecast. *Bonds, commercial paper, and C&I loans. 2 -12 Growth of Business Debt Sum of Selected Components* Q1 18 J f 2 0 0 -2 -2 -4 -4 -6 Q1 1999 p - Preliminary. f - Forecast. 2000 A M J 2001 J -6 MARA:SF 5 which may have pro mpted portfolio substitutions toward liquid deposits and money funds. The rec ent slowing in M2 reflects in p art the ebbing of portfolio ad justments to opp ortun ity costs and p erhap s the effects of somew hat less volatile equ ity markets. Tending to offset this underlying slowing in the near term, M2 has been boosted of late by tax rebates a nd continu ed strong de mand for U .S. currency abro ad, particularly in Argentin a. 6 The Expected Path of the Federal Funds Rate and Investor Uncertainty The staff often presents measures of the expected path of the federal funds rate derived from federal funds and eurodollar futures, as in the panel below. This path is constructed by subtracting estimates of term premiums from futures quotes and, in the case of eurodollar futures, the premium of the spot three-month LIBOR rate (the settlement rate for the eurodollar futures contract) over the target federal funds rate. Estimates of term premiums are based on historical differences between futures rates and subsequent spot rates. The reliance on such estimates necessarily implies some imprecision in the calculated expected funds rate path. But the estimated expected funds rate path has nonetheless seemed to provide a reasonable measure of market participants’ mean expectation of possible future federal funds rates. In addition to a mean expectation of future federal funds rates, investors also have views about the variance of possible future federal funds rates. A measure of this type of uncertainty–investors’ perceptions of the likely range of potential outcomes for the federal funds rate–can be obtained from the prices of options on eurodollar futures using a standard option-pricing formula. Such estimates indicate that investors believe there is a 90 percent probability that realized funds rates over the next twelve months will fall in the shaded area. Thus, although the expected funds rate path indicates that investors are forecasting some modest further easing into early next year followed by substantial tightening, the 2¼ percentage point width of the shaded area twelve months from now suggests that they believe it quite possible that the actual funds rate a year from now could turn out to be considerably higher or lower than their current mean expectation of almost 4 percent. 7 MONEY AND CREDIT AGGREGATES (Seasonally adjusted annual percentage rates of growth) Apr 2001 May 2001 Jun 2001 Jul 2001 (p) M2 10.4 5.2 9.6 8.5 M3 18.2 14.0 13.1 6.8 Domestic nonfinancial debt Federal Nonfederal 3.9 -10.0 7.0 4.1 -15.8 8.4 4.1 2.7 4.4 n.a. n.a. n.a. 5.5 5.9 1.4 1.8 -1.4 -2.7 -0.8 1.7 7.1 7.6 6.3 6.2 5.6 5.7 11.6 11.3 Money and Credit Aggregates Bank credit Adjusted1 Memo: Monetary base2 Adjusted for sweeps 1. Adjusted to remove the effects of mark-to-market accounting rules (FIN 39 and FASB 115). 2. Adjusted for discontinuities associated with changes in reserve requirements. p -- preliminary 8 Policy Alternatives (7) Benchm ark revisions to th e National In come and Product A ccount data and reports of a bleaker outlook for fixed investm ent in the near term have prom pted the staff to red uce further its estim ate of p rospective growth in potential o utput. Given the associated scaling down of future returns to labor and capital, as well as weaker-than-expected spending data here and abroad, the Greenbook projection of the growth of aggregate d emand h as been lowe red about as m uch as that of ag gregate supply. As a result, the forecasts of the output gap and inflation do n ot differ much from those p repared for the June meetin g. As before, the sta ff believes that a variety of forces–including the expected com pletion of the inventory correction, further declines in energy prices, the fiscal stimulus provided by the tax cut, and the cumulative monetary policy easing–will support a revival of economic growth at around p revailing financial m arket condition s. In the baseline projection, the staff assumes that the federal funds rate will be maintained at 3¾ percent over the forecast period, with eq uity prices and th e foreign excha nge value of th e dollar projecte d to edge off only a little and longer-term yields moving up a tad. Against this financial backdrop, real GDP is anticipated to advance at a rate of 1¼ percent in the second half of this year and of 2¾ percent over the four quarters of next year. Output growth over 2002 about matches the downward-revised estimate of growth of the economy’s potential output and keeps the unemploym ent rate around the level consistent with no change in inflation pressures. The resulting slack in resource utilization help s to hold core PCE in flation to 1¾ percent next year, a touch below the rate projected for 2001. Given the projected drop in energy prices, overall PCE inflation is expected to decline from 2 percent this year to 1¾ percent in 2002.5 (8) Should the Com mittee find the staff’s explication of the forces 5. The Greenbook portrays a significantly weaker economy and somewhat less inflation than implicit in the central tendencies of the forecasts of the Board members and Reserve Bank pre sidents reported in July. 9 promoting a rebound in economic growth and shaping the inflation outlook to be convincing, it may opt to keep the fund s rate unchanged. After all, cumulative policy easing this year has put the real funds rate well below estimates of its equilibrium value (see box on page 13), and this policy stance presum ably will, after some further delay, foster a reasonable revival in the growth of spending over time. In that regard, the rapid growth of M2 and other measures of household liquidity so far this year might be taken as a ten tative indication th at financial cond itions are well po sitioned to support such a rebound. In these circumstances, the Committee may believe that further policy stim ulus wou ld carry too gre at a risk of an over shooting of ag gregate demand that would lead to added pressures on in flation and a de terioration in inflation expectations that may prove stubborn to unwind. Indeed, the Co mmittee may be of the view that the slow recovery of aggregate demand in the Greenbook forecast, and the associated easing of pressures in labor markets, is both necessary and desirable so as to provide better assurance that core inflation will be capped going forward, as it is in the staff forecast. (9) The choice of an unchanged federal funds rate target would come as a surprise to financial markets that would be little tempered by an announcement of continued d ownside risks. S hort-term inte rest rates would back up by a considerable amount and eq uity prices likely would decline, as the tighter-than-expected monetary policy stance more than offsets the perception that the Federal R eserve sees a stronger econom y than previou sly thought b y market par ticipants. The po licy surprise wo uld tend to raise bo nd yields by pu shing expected funds rates high er. The likely decline in equity prices, however, would lead investors to anticipate more restraint on consumption via the w ealth effect, perhaps limiting the extent to which the expected path of the funds rates is ratcheted up and, accordingly, the pickup in lon ger-term yields. (10) The Com mittee may c onsider the G reenbook fo recast to be both 10 plausible and acceptable, even with the projected delay in the resumption of satisfactory output growth, but still choose to reduce the federal funds rate 25 basis points. In particular, the string of bad news on the econom y may heighten the sense that there are sizable odds on especially adverse outcomes for aggregate demand, particularly for capital spending. The Com mittee may be of the view that such downside risks to the real side could be countered by a slight further easing in the present situation with little ill effect, as inflation rece ntly has been b enign and is like ly to remain contained. Given the scop e for downside developm ents, the Committee may be especially averse to surprising markets, in that an unchan ged policy stance could risk tighte ning financial co nditions app reciably should market particip ants begin to question Federal Reserve intentions. Alternatively, the Com mittee may consider the staff’s outlook, especially the speed and the extent of the projected rise in the unemploym ent rate, to be unacceptable and to warrant ano ther slight further policy easing as a countervailing move. (11) The selection o f a 25 basis point r eduction in th e funds rate, presu mably accompan ied by an assessm ent that the risks are still weighted tow ard econom ic weakness, wo uld be alm ost as accom modative a s the average exp ectation built into financial markets. Accordingly, bond yields likely would ed ge higher, while stock prices may come under some downward pressure. The recent downdraft of the dollar on foreign currency markets makes it more difficult to predict the probable course of exchange rates. While textbooks teach that po licy ease that falls short of market expectations should lead to an appreciation of the currency, the recent market focus on relative spending prospects suggests that the dollar might come under some downward pressure. (12) Choice of a 50 basis point easing action might follow from the concern that m ore eco nomic weakness c ould w ell be in train th an pro jected in the G reenbook. Althoug h consum ption has held up remark ably well so far, an a brupt softenin g in 11 consumer spending is not implausible given the prospect of a sharp rise in the unemployment rate and already relatively high debt burdens. Moreover, foreign economic activity could well disappoint for a variety of reasons, including deepening crises in certain emerging market economies or additional slowing in the pace of activity in some major industrial economies. Such eventualities would tend to prolong both the inve ntory liquidatio n and the d ecline in capital spen ding, which w ould translate into a decline in the equilibrium real funds rate. Although the level of the real funds rate implied by the 3¼ percent nominal funds rate of this alternative and prevailing inflation expectations w ould be app reciably below that which is su stainable in the long ru n, a rapid policy r eversal along th e lines of that curre ntly embed ded in futures market prices could be undertaken once information finally starts to signal convincingly that more solid economic growth has taken hold. (13) The choice of a 50 basis point easing, combined with a statement continuing to point to downside risks, would be more forceful than markets have priced in for this m eeting, though futures mark et participants seem to expect that a cumulative easing of this magnitude w ill be put in place by early next year. If investors com e to believe that th e Comm ittee is more con cerned abou t econom ic softening than previously thought as a result of the surprise component of the action, they would both mo ve the anticipated easing forwar d in time and augmen t its cumulative e xtent. As an im mediate con sequence, shor t-term interest rates w ould move down. The unexpected size of the policy ease would probably prompt a decline in bond yield s and the foreign exchange va lue of the dollar a nd some in crease in equity values, although the magnitud e of these changes would imp ortantly be shaped by the word ing of the statemen t anno uncin g the action. (14) Under the Greenbook assumption of no change in the federal funds rate, the staff projects that the growth of M2 from July to December would slow to a 5¼ percent rate, mainly reflecting the widening of the opportunity cost of holding M2 12 as deposit rates adjust further to prior easing actions. Other contributors to the slowing in M2 growth include the likely waning of mortgage refinancing activity and a leveling out of stock prices. M2 would still be grow ing faster than nominal GD P over the second and third quarters, b ut the contraction in velo city wo uld be slowing. Howev er, the staff considers th is money pr ojection to be su bject to conside rable uncertainty because several unusual influences will be boo sting observed money growth to an extent that is difficult to assess. These special factors include households’ placement of tax rebate checks in liquid deposits and elevated demands for U.S. currency in Argentina ow ing to that country’s financial crisis and in the euro area ahead of the conversion to euro cash at the start of next year. (15) The staff anticipate s that growth of domestic n onfinancial deb t will move lower to a 3½ percent rate over the last six months of the year. A renew ed paydown of federal debt in the fourth qu arter is expected to offset the rise this quarter, leaving fed eral debt outstan ding abou t unchange d on net ov er the second h alf of the year. The growth of the debt of nonfederal sectors is foreseen to decline to a 4¼ percen t rate from Jun e to Decem ber. For hou seholds, mor tgage borro wing is expected to be maintained at around its second-quarter pace, based on the continuation of low mo rtgage interest rates, a p redilection for extr acting equity in refinancings, and still-solid housing activity. Consumer credit growth, though, seems poised to downshift further from th e second quarter pace, in line with projected weakness in nominal ou tlays on consume r dura bles ov er the second half of the yea r. Businesses hav e already mad e considerable s trides in restructu ring their balance sheets in response to lower longer-term yields and the favorable issuance climate of the first half of this year. With capital spending remaining weak and share repurchases and merger activity u nlikely to revive for a time, overall bu siness borrow ing should r emain light. That borrowing should still be concentrated in bond markets, though the paydown of C& I loans and comm ercial paper should be drawing to a close. 13 Estima tes of the Eq uilibrium Real Fed eral Fund s Rate One way to assess the stance of monetary policy is by comparing the actual real federal funds rate to estimates of its equilibrium level. The equilibrium real federal funds rate can be thought of as the rate consistent with output being at its potential level once the effects o f transitory shock s–those with dynamics th at play out w ithin a few years–h ave dis sipated. Board staff con structs various estim ates of the equilib rium real fede ral funds rate using three different frameworks: the FRB/US model, a statistical filter based on the relationship between the real federal funds rate and the output gap, and yields on indexed Treasury debt (which are available only since 1998). The FRB/US model and the statistical filter are each used to derive two estimates, the first based on historical data only and the second on h istorical data Sources of the Change in the augmen ted by the staff Equilibr ium F ederal Fu nds Ra te projection. from 2000Q3 to 2001Q3 (Percentage points) The chart that follows shows the range of these estim ates, as well 1. Total change in FRB/ US measure* -1.1 as the actual real federal funds rate and the real funds rates Sources: implied by the policy alternatives discussed in the text. (The real 2. Lower struc tural GD P growth -0.4 funds rates are measured as the nominal federal funds rate less 3. Higher average equity premium -0.4 the lagged fou r-quarter chan ge in core PCE prices as a proxy for 4. Higher aver age real exchan ge rate -0.1 expected inflation.) Over the past year or so, the range of the 5. Other -0.2 estimates of the equilibrium funds rate has fallen by ab out half a * Calculated using historical data augm ented by the staff percentage point. For the projection. equilibrium rates based on the FRB/U S mode l, we can identify the sources of the decline. The table at the right p arses the chang e in the FRB /US estim ate using the histo rical data augmented by the staff forecast. A reduction in the structural growth rate of GDP and a h igher a verage equity prem ium accoun t for the bulk of the d ecline. 14 Estimates of the Equilibrium Real Federal Funds Rate (continued) Benchmark revisions to the NIPA data published over the intermeeting period, as well as other incoming data, caused the staff to revise down its assessments of aggregate demand and potential output, both in the past and going forward. These changes had mostly offsetting effects on the estimates of the equilibrium real federal funds rate. In the case of the FRB /US measures, a r eduction in the staff’s estimates of structural growth in GDP in recent years and in the forecast caused a decrease in estimates of the equilibrium funds rate. However, this effect was countered by lower estimates of the equity premium–which reconcile the level of equity prices in recent years with more modest gains in earnings. As shown in the bottom-left panel of the chart, the net changes over the intermeeting period in the FRB/US estimates of the equilibrium funds rate (based on the historical data and the staff projection) are relatively small. Adjustments to the statistical-filter-based estimates of the equ ilibriu m fun ds rate were a lso modest (the bo ttom-right panel). While the sta ff trimmed its estim ates of potential o utput, it marke d down a ggregate demand by a similar amount, with only a modest impact on the estimates of the output gap that underlie these estimates of the equ ilibriu m rate . The revisions to the various equilibrium funds rate measures over the intermeeting period are quite small compared to the substantial uncertainty associated with the estimates. In the case of the statistical filter method, for example, formal standard errors of the estimates can be calculated for each observation. These standard errors indicate that a 90 percent confidence interval around the estimates of the equilibrium funds rate ranges from 1½ to 2½ percentage points on each side of the point estimates. Chart 3 Actual Real Federal Funds Rate and Range of Estimated Equilibrium Real Rates Percent 5 Quarterly Actual Real Funds Rate 4 Historical Average: 2.80 (1966Q1-2001Q3) 3 ● ● ● Current Rate 25 b.p. Easing 50 b.p. Easing 2 1 0 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 Note: The shaded range represents the maximum and the minimum values each quarter of the five estimates of the equilibrium real federal funds rate described in the box. Real federal funds rates employ four-quarter lagged core PCE inflation as a proxy for inflation expectations, with the staff projection used for the third quarter of 2001. Equilibrium Funds Rate Estimates FRB/US Measure* Statistical Filter Measure* 5 Quarterly 1990 Percent August 16 June 22 1992 1994 1996 1998 2000 Percent 5 Quarterly August 16 June 22 4 4 3 3 2 2 1 1 0 0 1990 * Calculated using the historical data augmented by the staff projection. 1992 1994 1996 1998 2000 15 Directive and Balance-of-Risks Language (16) Presented below for the members' consideration is draft wording for (1) the directive and (2) the “balance-of-risks” sentence to be included in the press release issued after the meeting (no t part of the directiv e). (1) Directive Wording The Federal Open Market Comm ittee seeks monetary and financial conditions th at will foster price stab ility and prom ote sustainable g rowth in output. To fu rther its long-run objectives, the Co mmittee in th e immed iate future seeks conditions in reserve markets consistent with MAINTAINING/ INCREASING /reducing the federal funds rate AT/to an average of around ___3¾ percent. (2) “Balance-of-Risks” Sentence 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 BO TH GOALS] [ARE WEIGHTE D MAINLY TOWARD CONDITIONS THAT MAY GENERATE HEIGHTENED INFLAT ION PR ESSUR ES] [continue to be weighted m ainly toward conditions that may generate econo mic weakness] in the foreseeable future. Alternative Growth Rates for Key Monetary and Credit Aggregates M2 ---------------------------Ease Ease No Move 50 b.p. 25 b.p. ---------------------------- M2 M3 Debt --------------------------Greenbook Forecast* --------------------------- Monthly Growth Rates Mar-2001 Apr-2001 May-2001 Jun-2001 Jul-2001 Aug-2001 Sep-2001 Oct-2001 Nov-2001 Dec-2001 14.4 10.4 5.2 9.6 8.5 8.0 8.8 5.7 4.6 4.6 14.4 10.4 5.2 9.6 8.5 7.8 8.2 4.9 3.9 4.0 14.4 10.4 5.2 9.6 8.5 7.6 7.6 4.1 3.1 3.4 14.4 10.4 5.2 9.6 8.5 7.6 7.6 4.1 3.1 3.4 9.8 18.2 13.9 13.1 6.8 2.5 5.9 5.4 5.4 5.6 6.2 3.9 4.1 4.1 2.3 5.0 6.1 2.6 2.6 2.5 Quarterly Averages 2000 Q4 2001 Q1 2001 Q2 2001 Q3 2001 Q4 6.3 10.7 10.2 8.4 6.3 6.3 10.7 10.2 8.2 5.6 6.3 10.7 10.2 8.1 5.0 6.3 10.7 10.2 8.1 5.0 7.3 12.6 14.1 8.0 5.2 4.6 4.8 4.6 3.9 3.7 Growth Rate From Dec-2000 Dec-2000 Jun-2001 Jul-2001 To Jun-2001 Jul-2001 Dec-2001 Dec-2001 10.7 10.4 6.8 6.4 10.7 10.4 6.3 5.8 10.7 10.4 5.8 5.2 10.7 10.4 5.8 5.2 13.9 13.0 5.3 5.0 4.4 4.1 3.5 3.8 2000 Q4 2000 Q4 2000 Q4 Jun-2001 Jul-2001 Dec-2001 10.3 10.1 8.9 10.3 10.1 8.6 10.3 10.1 8.4 10.3 10.1 8.4 13.6 12.9 10.0 4.6 4.4 4.2 1999 Q4 2000 Q4 2000 Q4 2001 Q4 6.2 9.2 6.2 9.0 6.2 8.8 6.2 8.8 9.3 10.3 5.3 4.3 * This forecast is consistent with nominal GDP and interest rates in the Greenbook forecast.
@FedFRASER