Full text of Federal Open Market Committee Meeting Minutes, Transcripts, and Other Documents : Meeting, December 16, 1997 : Transcript

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Meeting of the Federal Open Market Committee
December 16, 1997

A meeting of the Federal Open Market Committee was held in the offices of the Board
of Governors of the Federal Reserve System in Washington, D.C., on Tuesday, December 16,
1997, at 9:00 a.m.

PRESENT:

Mr. Greenspan, Chairman
Mr. McDonough, Vice Chairman
Mr. Broaddus
Mr. Ferguson
Mr. Gramlich
Mr. Guynn
Mr. Kelley
Mr. Moskow
Mr. Meyer
Mr. Parry
Ms. Phillips
Ms. Rivlin
Messrs. Hoenig, Jordan, and Ms. Minehan, Alternate Members of
the Federal Open Market Committee
Messrs. Boehne, McTeer, and Stern, Presidents of the Federal
Reserve Banks of Philadelphia, Dallas, and Minneapolis
respectively
Mr. Kohn, Secretary and Economist
Mr. Bernard, Deputy Secretary
Mr. Coyne, Assistant Secretary
Mr. Gillum, Assistant Secretary
Mr. Mattingly, General Counsel
Mr. Baxter, Deputy General Counsel
Mr. Prell, Economist
Mr. Truman, Economist
Messrs. Beebe, Cecchetti, Eisenbeis, Goodfriend, Lindsey,
Promisel, Siegman, Slifman, and Stockton, Associate
Economists
Mr. Fisher, Manager, System Open Market Account

12/16/97
Mr. Winn, Assistant to the Board, Office of Board Members,
Board of Governors
Mr. Ettin, Deputy Director, Division of Research and Statistics,
Board of Governors
Messrs. Madigan and Simpson, Associate Directors, Divisions of
Monetary Affairs and Research and Statistics respectively,
Board of Governors
Messrs. Alexander, Hooper, and Ms. Johnson, Associate Directors,
Division of International Finance, Board of Governors
Ms. Low, Open Market Secretariat Assistant, Division of
Monetary Affairs, Board of Governors
Messrs. Connolly and Rives, First Vice Presidents, Federal
Reserve Banks of Boston and St. Louis respectively
Mses. Browne, Krieger, Messrs. Dewald, Hakkio, Lang, and
Rosenblum, Senior Vice Presidents, Federal Reserve Banks
of Boston, New York, St. Louis, Kansas City, Philadelphia,
and Dallas respectively
Mr. Miller, Vice President, Federal Reserve Bank of Minneapolis
Messrs. Bryan and Evans, Assistant Vice Presidents, Federal
Reserve Banks of Cleveland and Chicago respectively

Transcript of Federal Open Market Committee Meeting
December 16, 1997

CHAIRMAN GREENSPAN. I would first like to welcome our temporary new
Bank representative, LeGrande Rives.
MR. RIVES. Thank you, Mr. Chairman.
CHAIRMAN GREENSPAN. Also, sadly, this is Charlie Siegman's last meeting after
several generations of watching the ups and downs of these proceedings. We are going to miss
you, Charlie.
MR. SIEGMAN. Thank you very much. On my list of things from the Federal
Reserve that I will look back to, this is one of the activities that I will miss very much.
CHAIRMAN GREENSPAN. When all of a sudden we begin to see a hole in the staff
analysis, we will infer its cause. [Laughter] Would somebody like to move approval of the
minutes of the November 12 meeting?
VICE CHAIRMAN MCDONOUGH. So move.
CHAIRMAN GREENSPAN. Without objection, they are approved. Mr. Fisher, you
have the floor.
MR. FISHER. Thank you, Mr. Chairman. I will be referring to the
package of colored charts, which you should find in front of you.
On the first page are charts covering the same information we have
shown in the past, but we have changed the source of the data for the current
3-month deposit rates. Traders have persuaded me that the LIBOR fixing
provides a better comparison than the Eurodollar series we have been using,
so that is a slight change.
Focusing first on U.S. forward rates, there are two points to which I
would draw your attention. One is that there has been relatively little net
change in these rates since the November meeting, as shown by the red
lines, but clearly some compression has occurred as the money market yield
curve has become increasingly flatter in the period since October. I think
1 Copies of the charts used by Mr. Fisher are appended to this transcript.

12/16/97

the updrift in the solid line, the current dollar LIBOR, reflects a fairly
typical year-end phenomenon. I would not attach any significance to that.
Looking at the German forward rates, Mr. Tietmeyer said rather
publicly on November 14 what other Bundesbank officials have been saying
for some time, namely, that the market should not expect German rates to go
up by 120 basis points between now and next May to meet Italian rates
halfway, as the market had come to believe was going to happen. In effect,
Tietmeyer was saying that the German economy is stronger but not really all
that strong. You can see the gentle drift downward in German forward
rates. If you look at the solid blue line, the current mark LIBOR, it is quite
interesting that the spike in early December parallels the spike in the yen
LIBOR, shown in the chart below, at the time of heightened concerns about
the Japanese premium. Now, this is interesting for those of us in the money
market business, as it were, because the calculations really are quite
different. In the British Bankers Association panel for the yen LIBOR
fixing, there are eight Japanese banks, whereas in the panels for the dollar
and the mark, there are only three and the calculation is done by throwing
out the highs and the lows. So, I think the spike in the German money
market rates reflects the demand for funds from the Japanese banks. It is not
a reflection of the credit premium, as it were, from the demand side but a
pushing through of the demand coming from the Japanese banks.
Turning to the Japanese market, we need a little magnification of the
bottom panel to see what is going on in Japan. So, if you turn to the second
page, I will work through some of the events in the Japanese markets.
Three rates are traced in the top panel: the current yen LIBOR 3-month
deposit fixing in dark purple, the 9-month forward 3-month yen deposit rate
in orange-yellow, and the Japanese overnight call rate in green. In the
middle panel, we have plotted the excess reserves in the Japanese banking
system. I talked to Bank of Japan officials at some length about their

calculation of this measure. It is not quite how we would calculate it, but it
is the way they do it. The chart illustrates the heightened generosity that the
Bank of Japan was practicing by leaving their market in considerable
surplus following the closure of Yamaichi and subsequently in the last few
days. The bottom panel has two measures of the Japanese premium in
dollar interest rates: the solid line is the difference between the 1-month
LIBOR rates at the Bank of Tokyo-Mitsubishi and at Chase, and the dotted
line is the Fuji rate minus the Bank of Tokyo-Mitsubishi rate. There was
some modest differentiation among Japanese names at the height of the
crisis, but clearly the dominant difference may be seen in the comparison
between the best Japanese name and Chase as shown in this example.

12/16/97
Going back to the top panel, I would like to draw out two points. One
is that in the last few days the Bank of Japan has pushed the overnight call
rate down into the 20 basis point range. A Bank of Japan official has told
me that "you may call this a temporary easing." I took that to mean that the
emphasis was on "you" because they were not going to call it that out loud
quite yet. But clearly, they have pushed the overnight call rate down. The
gap between the purple line showing the current LIBOR and the orange line
does tend to indicate that the current premium is expected to wash out on the
other side of the fiscal year. That is, the high premium, high demand for
funds coming out of the Japanese banks is thought by the market to be
something that will wash out 9-months forward when we get happily to the
other side of the Japanese fiscal year-end in March.
Turning to the third page, I thought I would give a little background on
events in East Asia. I know Ted Truman will be speaking more about that.
The main purpose of these panels is to remind us that this is not just a bad
thunderstorm but something more like the 100-year flood. The top panel
shows the exchange rate movements since July 1; the middle panel has
percent changes in equity indices; and the bottom panel depicts 1-month
interest rates. Focusing on the currency panel, I think it's easy to say that
the currencies have overshot their fundamental values. But I think it's
important to recognize that there is still a very large position overhang
weighing on these exchange markets. In effect, a leveraged convergence
trade as we would have called it in Europe a few years ago, short dollar or
yen external currencies and long internal currencies, was embedded on the
balance sheets of businesses throughout the region, and they have not yet
completed hedging those exposures. In these thin markets, both bankers and
traders have a very hard time thinking of these currencies as having overshot
because they are aware of how much more there is yet to hedge that is
weighing on the exchange rate.
A second inference I would draw from this page is to note that the
downward slope of the foreign exchange and equity values is somewhat
steeper than the upward slope in the 1-month interest rates at the bottom.
Another point I would note is that so far Taiwan, the red line, has managed
to distinguish itself. In the top panel you can see that its currency has
declined against the dollar only slightly more than the yen; and in the middle
panel, you can see that their equity market has really broken out of the pack.
While looking at this chart overall, I think it is possible that we will look
back and see that the end-of-year effect for some of these currencies and
values provided something of a nadir for them, given the risk aversion that
is generally typical at this time of year. But I think it would be risky to
count on a bounceback after the New Year for all of them.

12/16/97

Turning to the fourth page, I have depicted in the top panel both the
March Eurodollar contract and the March fed funds futures contract as they
have traded throughout the fall. There is relatively little net change in both
those series from just prior to the November meeting to today. The middle
panel shows the U.S. Treasury constant maturity yields for 30, 10 and 2
years. You can see that we have had a continued decline in bond yields in
the 30- and 10-year areas, while the yield on the 2-year note has been more
or less flat over that time horizon. Clearly, this is something that is quite
difficult to interpret. I think that with the worsening of the Asian crisis,
market participants have inferred that there will be no action at this meeting,
and more of them have come to adopt the deflationist outlook or at least are
taking it more seriously than they did some time ago. While point estimates
for inflation have moved down a bit, I think the better explanation is that
market participants have shaved off the upside risk in the inflation
probability distribution, that is, the risk that inflation will rise over the next
six months. That is what is tending to bring down the yield curve in
combination with the flight-to-quality, end-of-year effect, making market
participants more comfortable about moving their duration out the yield
curve in this end-of-year environment.
The last page of charts relates to our open market operations in this
period. The top panel covers daily fed funds trading: the blue lines show the
daily ranges, the vertical red lines show the standard deviations, and the
horizontal red lines indicate the effective rates. The panel at the bottom has
the level of free reserves and indicates our daily misses from the projections.
I should point out that at the start of the middle period, which included
Thanksgiving, we raised the allowance for excess reserves from $1 billion to
$1.4 billion. The demand for excess reserves clearly has been inching up. I
do not want to suggest that this is a precise science, but we are trying to get
a handle on how much it has drifted up. I think it will be some while before
we are confident that we know where it has settled. We had some volatility
around the Thanksgiving holiday and the start of December. As you can
see, excess reserves averaged around $2 billion in that period, and we still
had a slightly firm funds rate. We may have slightly overcompensated at
the beginning of the current maintenance period, but the market was quite
tight. Yesterday was a corporate tax payment date, and we tried to prepare
the market for that.
We purchased a total of $15.6 billion on an outright basis since the last
FOMC meeting and a total of $17.2 billion since early November. The
total included a small amount of bills, $1.5 billion, and those purchases
seemed to go quite well. I was trying to leave something of a marker with
the market and the Treasury--a notice that we were not forgetting about the
bill sector, that we plan to come back to it. In making these permanent

12/16/97
reserve injections, we did change our pattern of operations from last year. A
year ago, we left a larger need in the market, but we reverted to our
traditional pattern this year by adding a large amount of permanent reserves.
That may put us in a position of having to drain reserves to a modest extent
toward the end of January when the Christmas demand comes out of the
market. At that point, we also will be reaching rather low levels of
operating balances, but I think we are ready to handle the effects of being on
the drain side at what are likely to be new lows in operating balances.
We had no foreign operations in this period. Mr. Chairman, I will need
the Committee's ratification of our domestic operations, and I would be
happy to answer any questions.
CHAIRMAN GREENSPAN. The Southeast Asian exchange rate patterns imply, as
you say, that a lot of market participants are overshooting the fundamentals in a certain sense. It
is difficult to avoid that sort of conclusion. We cannot get a 40 or 50 percent decline in an
exchange rate in a short period of time under any realistic assumptions concerning what has
changed. Stock prices can do that. They reflect net long positions, and if everyone decides to
pull out, stock prices will go to zero. But exchange rates are zero-sum games; one person's rise
is another person's decline. So, this exchange rate decrease looks extraordinarily large. You
raised a question when you stated that the balance of foreign currency positions is still
effectively long in local currencies and short in dollars or perhaps yen. One would assume that
forward positions in the currency, if they exist, would be able to pick this up. I have never seen
9-month or 1-year forwards on baht/dollars. Do they exist?
MR. FISHER. They exist. They are quite thinly traded, and I'm not sure how much
confidence people put in them, but they are there. They are not the kind of market instruments
that one can click on a Reuters page and see.
CHAIRMAN GREENSPAN. But the question is whether they give us at least a
partial answer. If we are getting extreme disequilibrium, the deep forward positions ought to be

6

12/16/97

closer to minus 10 or minus 15 as distinct from minus 40. And if we cannot infer it from these
other positions, we could in principle handle the credit risk in this situation--I haven't thought
this through--by focusing on the spot rate adjusted for covered interest rate differentials to give
us an idea of the forward position. I wonder whether we know anything about the more distant
horizon in order to answer the question about overshooting, so to speak, in the adjustment of
balances. If indeed those balances are precisely what you say, namely, that they are comprised
of long positions in the local currency and short positions in dollars, that imbalance would give
us a very significant premium on the forward position vis-a-vis the spot. It would be very
interesting to test that if the information is at all available.
MR. TRUMAN. Are you not just as likely to see higher short-term interest rates, so in
fact it would go the other way? The forward foreign exchange rates would be more depressed.
You use the word position, which is quite different-CHAIRMAN GREENSPAN. I'm thinking of 2-year forwards, for example.
MR. TRUMAN. I don't think you can find 2-year forwards in these markets. If they
existed, they would tend to have higher interest rates and would be more depressed than the
current spot rates.
MR. FISHER. I think the problem is that we do not have a time horizon where one
ought to find fundamental value. There is not enough confidence in markets that one would
want to have a contract with a maturity of that length. That is a long duration exposure to take
on a currency that is declining so rapidly now.
CHAIRMAN GREENSPAN. Before the Southeast Asian markets collapsed, we used
to talk about the ability of the Koreans to fund long-term debt more readily than short-term,

7

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which goes against everyone's view of the way the world works. Was that true then or was it
just an illusion?
MR. FISHER. I don't know. I have not heard that story.
CHAIRMAN GREENSPAN. If it was true, it would be an indication that there is a
premium in a longer forward exchange rate. This is a crucial question because the adjustment is
either going to implode down to minus 80 percent or it is going to run into downside resistance.
MR. TRUMAN. Peter Fisher may want to comment, but I think it is reasonable to say
that many people want to cover their positions. There are a lot of different ways of covering
them. Some covering can be done in the spot market; some in the forward market; some
through borrowing; and some through lending. How it manifests itself in individual cases may
be quite different. If you have thin markets, this continuing activity may be depressing spot
exchange rates and you may get some bounceback even though the whole process has not played
itself out because basically no one is in a position to provide forward cover.
MR. FISHER. I think what we are seeing is the implosion of the intermediation
process in these exchange markets. The exchange markets for the won and the baht have
disappeared. There are not a lot of people who are excited about participating in those markets.
CHAIRMAN GREENSPAN. It will be fascinating to watch what happens. It's like
the tide coming in for the first time in 20 years, and we find all the junk on the shore that we
didn't know existed. This is partly what is going on in the financial system.
VICE CHAIRMAN MCDONOUGH. Also, if and when confidence is restored or
when greed overcomes fear, people may suddenly find that they are much better off to keep a lot
of those positions that they now want to get out of.

12/16/97
CHAIRMAN GREENSPAN. If this thing turns, it can turn on a dime. The trouble is,
it cannot turn on a baht. [Laughter] President Parry, bail me out!
SPEAKER(?). Neither won!
MR. PARRY. A question about Yamaichi: It was closed on the 23rd of November,
and I guess they ceased being a primary dealer on December 4th. Could you talk a little about
what our financial relationships with them were just before the 23rd and then between the 23rd
and the 4th?
MR. FISHER. We had been monitoring their trading exposure to us rather carefully
for many, many months. We had an arrangement where if they needed to elevate their demand
for financing in our RP operations from the agreed routine amount, they would call Sandy
Krieger and give us some advance notice and information to enable us to understand their need.
The process of getting a resignation letter from them was really a formality. The lag can be
attributed to all the things they had to do other than type out a letter and send it to us, but I think
their management understood that was something they would have to do in the course of winding
up their affairs. Was that helpful?
MR. PARRY. Yes.
CHAIRMAN GREENSPAN. Anyone else? Would somebody like to move to ratify
the Domestic Desk operations?
VICE CHAIRMAN MCDONOUGH. Move approval.
CHAIRMAN GREENSPAN. Thank you. Without objection, they are approved.
This is a very short agenda. Messrs. Prell and Truman please.
MR. PRELL. Thank you. Anticipating that, as last month, the focus of
your interest this morning is on the international side, I will try again to be

12/16/97
brief. I thought, however, that I would offer a few remarks on some of the
tougher calls we had to make on the domestic side of our forecast--namely
those relating to the outlook for wages, the stock market, and capital
spending.
Before that, however, just a few words on this morning's statistics:
The CPI--total and core--increased just 0.1 percent in November. The
twelve-month changes were 1.8 percent for the total CPI and 2.2 percent for
the core--the total a tenth below our Q4/Q4 forecast and the core right on it.
Housing starts rose slightly further last month. We had expected a
dropback. Most of the upside surprise was in the lower value multifamily
segment, which held at a high level. For what it's worth, I am told that this
may be the result of a new seasonal pattern related to efforts to qualify for
tax breaks on low-income housing projects. We'll have to look into that
further. Single-family starts were up a little, but permits were down, so this
more important segment looks broadly in line with our prediction of
flatness.
Now back to my main theme, some of the tougher issues in the
projection. The first I noted was the outlook for wages. As you know, we
have forecast that wages and total compensation will decelerate slightly in
the next year, in the face of continued low unemployment. We certainly are
not arguing that the labor market is not tight. We have heard the anecdotes
and read the surveys, as you have, and we are persuaded that finding and
retaining qualified workers is a major problem for employers. While many
firms continue to report that they will do just about anything they can to
avoid raising their wage bills--including even forgoing expansion
opportunities--wage increases have been creeping up for a while now.
My gut tells me that the pressure is building in this labor market pot to
where the lid could blow off. But, for better or worse, our forecast has not
been shaped by this visceral sensation. In particular, we have given major
weight to the observations that wages are rather inertial and that they can be
significantly affected by perceived trends in prices. And, at this point,
workers and employers are looking at very low inflation over the past year,
and they should be seeing more of the same for a while longer, given
conditions in goods markets. The net result in our forecast is still a hefty
further rise in real wages and a marked increase in the labor share of the
income pie--but not an upward wage-price spiral.
Another tough call relates to the stock market outlook. As you know,
in light of our reassessment of the prospects for inflation, we have
eliminated our prior assumption of an increase in the federal funds rate. We

12/16/97

had viewed that tightening as an important trigger for a marked downturn in
the market in the first half of next year. The question before us, then, was
whether disappointing corporate earnings alone could be expected to
produce a significant correction before long. Our answer was yes, but that
the decline will likely be more gradual and smaller overall--about 15 percent
from yesterday's close by early 1999. Question marks remain, however.
To date, individual companies or industries have been punished for bad
earnings announcements, but this seemingly has occasioned merely a
rotation to other sectors by determined equity investors. So, could the
market shrug off the negative news we are forecasting? Perhaps, at least for
a while. Certainly, on our numbers, aggregate year-on-year profit
comparisons will not begin to look really poor until next summer or fall.
That said, though, I think there is the distinct possibility that, once the
deterioration of profits comes clearly into view, the market could develop
even more downward momentum than we have anticipated. I would note
that we are currently projecting a low for the Wilshire 5000 in 1999 that
would only take it back to where it was this spring and leave price-earnings
multiples at historically high levels. A combination of revised earnings
expectations and any further increase in the equity premium from what
probably has occurred recently would point to a much more sizable decline,
unless interest rates were to fall appreciably at the same time.
Finally, a few thoughts on the outlook for business investment. This is
a sizable sector and one that has provided a lot of propulsion for the
expansion to date. We have forecast a significant deceleration in capital
spending, and while this gets a little circular, it fits well with our predictions
of rising equity capital costs and decelerating output. However, most of the
indications at this point are that investment plans are very strong going into
1998. For example, the semi-annual survey of the National Association of
Purchasing Managers indicated that manufacturers are expecting to
increase their capital expenditures next year by 15 percent--an even greater
increment than they reported for this year. The NFIB's November survey of
small firms also showed extremely upbeat investment plans.
These surveys underscore the risk that investment will, yet again, prove
stronger than we have gauged. But, there is some reason to doubt their
predictive power in the present case. For one thing, even if the surveys are
merely a few weeks old, they may still be providing pretty stale readings.
Just looking at how our own changing perception of the international
outlook has altered our GDP projection over the past few weeks, it seems
reasonable to think that businesses are also reassessing their plans and that
many of them will be trimming their investment budgets. If we are wrong,

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that does raise the question of whether this capital spending boom won't
come to a more jarring end sometime down the road, with firms finding
themselves with excess capacity and experiencing a deeper hit to profits.
So, to sum up, we think we have provided a realistic baseline forecast,
but there is still plenty to puzzle over--and perhaps to worry about from a
policy standpoint. On that comforting note, let me now turn the floor over
to Ted, who has been doing a lot of worrying lately.
MR. TRUMAN. Our message about the international economy and the
external sector of the U.S. economy is straightforward and easily
summarized: We have a weaker outlook for net exports, primarily as a
consequence of the further deterioration of economic and financial
conditions in Asia. While I am tempted to stop at this point and turn to
questions, there may be a bit more that I usefully can add. It is true that we
are again projecting slower global growth, in particular in Asia. We also are
projecting a stronger dollar and lower oil prices; the first is associated to a
considerable degree, though not entirely, with Asian developments, but
those developments have only marginally affected our view of oil prices.
Finally, we have updated our worse-case scenario, and I will say a few
words about our current thinking on that subject.
With respect to the current quarter, we have very little hard data on
U.S. international transactions; trade data for October will not be released
until Thursday. However, we have written down a small negative
contribution of net exports to GDP growth this quarter, in contrast with a
small positive contribution in the November Greenbook. This estimate is
based primarily upon three considerations: first, our assessment of the
third-quarter data that revealed somewhat weaker exports than we had
anticipated; second, a judgment that the unexpected strength in our exports
during the first half of this year was coming largely from an accelerator
effect on exports of capital goods that has waned with the Asian crisis; and
third, anecdotal information, for example, from the Beige Book and the
supplementary reports received from Reserve Banks about the apparent
negative effects of the Asian crisis on trade flows this quarter. The
anecdotal information, in turn, is consistent with our prior assessment that
the first-round effects of the Asian crisis on our trade will be felt sooner
rather than later.
Turning to our forecasts for 1998 and 1999, our aggregate projection of
growth in the rest of the world, weighted by U.S. nonagricultural exports, is
now 2-1/2 percent next year and 3-1/4 percent the following year, compared
with a trend rate of around 4 percent. Most of the downward adjustment is
for the developing economies in Asia, where we anticipate greater near-term

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weakness and a more protracted return to trend. We have also marked down
slightly further our growth forecast for Japan, while that for the other
industrial economies is essentially unchanged.
Our outlook for Japan and the other industrial countries has been
affected by our revised view of dollar exchange rates. As Peter Fisher has
reported, the dollar strengthened against both the yen and the continental
European currencies during the intermeeting period. We attribute the yen's
weakness to continuing question marks hanging over the Japanese economy
and financial system--questions marks that we do not expect will be
removed by the announcement, now postponed until tomorrow, of yet
another package of policy measures. Because we do not expect underlying
conditions in Japan to improve immediately or dramatically and because we
anticipate that the effects of Asian developments will prevent a further
substantial expansion of the Japanese external surpluses in the aggregate, we
have incorporated into our projection only a slight appreciation of the yen/
dollar rate from its recent level. Compared with our September projection,
we now have the yen more than 15 percent weaker at the end of 1999.
With respect to continental Europe, we are no longer expecting a
further increase in German official interest rates prior to the start of
monetary union, and the market appears to be gradually coming around to
the same conclusion. This has contributed to the weakness of the DM and
its associated currencies, and we expect that recent lower exchange rates
against the dollar will persist, on balance, over the forecast period. We also
anticipate in our forecast that sterling will depreciate somewhat against the
dollar as U.K. economic growth and interest rates ease but that the Canadian
dollar will strengthen somewhat as interest rates continue to rise in Canada.
With respect to the currencies of non-G-10 countries, in particular in
the Asian region, our crystal ball is murkier. The Asian currencies, except
for those of China and Hong Kong, have declined substantially further over
the intermeeting period. We are not expecting further depreciation, on
balance, from the current highly depressed levels, nor are we expecting a
recovery. To borrow a term from the politics of 1884, I would characterize
this as a mugwump position with regard to the nominal exchange rates of
these economies--our mug is on one side of the fence and our wump is on
the other. However, real dollar exchange rates of these countries should
appreciate somewhat due to inflation rates that in many cases will approach
or exceed double digits.
The net result of these assumptions is that the dollar is stronger in both
real and nominal terms throughout the forecast period against both G-10 and

12/16/97
non-G-10 currencies, with an associated negative impact on our outlook for
net exports.
Turning to oil prices, we have reduced our assumption about the price
of imported oil by about $2 per barrel in 1998 and 1999. Our revised
assumption is based on the substantial increase in official OPEC quotas
(which has led us to boost our projection of OPEC production by 900,000
barrels per day in 1998), the easing--at least for the moment--of tensions
with Iraq and Iran, and the slowing of global growth, especially in Asia.
The market appears to have adopted a more cautious interpretation of these
developments. Although futures prices have declined, the implied
downward adjustment in import prices over the forecast period is about half
the size embodied in our assumption. We believe that the difference reflects
primarily continuing concerns about the availability of supply from Iraq and,
perhaps, a different assumption about the increase in actual OPEC
production--in particular by Kuwait, Saudi Arabia, and the United Arab
Emirates--under the new quotas.
In terms of our overall forecast, lower oil prices, of course, imply lower
U.S. inflation. The principal impact on our external forecast is with respect
to the nominal balances: Our assumption of lower oil import prices
translates into a projected reduction in the value of U.S. oil imports in 1998
and 1999 of about $7 billion a year compared with the November
Greenbook. Lower oil prices have only marginal effects on net exports in
real terms, boosting real imports slightly.
In total, the estimated drag from the external sector in the December
Greenbook is about 0.9 percentage point over the four quarters of 1998 and
0.4 percentage point during 1999. As a rough approximation, the drag
from net exports would be a bit less than half this amount in the absence of
the effects of the Asian crisis and the weaker outlook for Japan and the yen,
using the September Greenbook as the basis for comparison. I would
caution, however, that it becomes increasingly difficult to disentangle causes
and effects in successive forecasts. For example, in the case of effects that
are transmitted through third countries, establishing the counterfactual
assumption is problematic. As an illustration, in the November and
December Greenbooks, we've assumed progressively more moderate
trajectories for monetary policies in the major foreign industrial countries as
well as in the United States, and these assumptions have affected our
thinking about the path for the dollar. No doubt some, but probably not all,
of these adjustments can and should be attributed to the generally weaker
global outlook and in particular to the effects of the Asian crisis, but it is
increasingly tenuous to try to separate out how much is due to developments
in Asia and how much is due to other underlying factors.

12/16/97

Some of the same qualifications apply to the interpretation of
alternative scenarios. For this meeting, we have updated and circulated to
the Committee a "worse case" scenario for the global economy in which the
already seriously affected Asian economies experience deeper and more
prolonged recessions and less recovery in their real exchange rates. In this
scenario, the crisis also spreads in a major way to China and Hong Kong,
and it impacts with greater ferocity on Latin America, Eastern Europe, and
the countries in the area of the former Soviet Union. On our assumptions,
such a worse case would further reduce the growth rate of U.S. real GDP by
about a half percentage point next year and about a quarter point in 1999,
compared with the Greenbook forecast, with comparable effects on other
industrial economies. An important qualification to this analysis is that it
assumes that the authorities, in particular those in the major industrial
countries, would respond under the hypothesized circumstances by taking
appropriate countercylical actions, primarily in the area of monetary
policy--that is, they would lower interest rates. As I noted earlier, in
preparing our Greenbook forecasts, we have already incorporated
assumptions that go in this direction; we are no longer assuming much
monetary tightening. It is another matter, some might argue, to assume that
policymakers will act aggressively and on a timely basis to damp a global
slowdown in growth that is having differential effects on their economies.
Policymakers in Europe, preoccupied with the transition to monetary union,
might be less than poised to take prompt, decisive action. On the other
hand, this alternative scenario is one that combines both lower inflation and
lower growth, which would facilitate easing action, at least in the area of
monetary policy.
Although our revised worse case scenario is possible, and you might
even see it in February as our base case, I do not believe at this point that
this scenario is the most likely outcome. No doubt, Asian financial markets
and economies will continue to experience substantial downs and ups for
some months, but my view of the situation is one of optimism combined
with realism. I am optimistic that the political leaders in Asia, on balance,
are acting and will continue to act constructively to stabilize their economies
and financial systems and that the support they receive from the
international financial community will help to bridge the gap until
confidence in their policies and underlying economies returns. On the other
hand, it is clear that the crisis is not over, and there is plenty of scope for
additional errors or negative surprises.
Mr. Chairman, I will conclude our presentation on that note.
CHAIRMAN GREENSPAN. Thank you. Questions for either gentleman?

12/16/97
MR. BROADDUS. Ted, on the worse case scenario, do you have any sense of what
probability you would put on that given what you know now?
MR. TRUMAN. I am never quite sure how to answer those questions about
probabilities, but I would guess a fifth or something like that. How seriously should we take that
scenario? I would say moderately seriously. This is not a meltdown scenario because it assumes
that action will be taken by others to prevent a meltdown.
CHAIRMAN GREENSPAN. President Moskow.
MR. MOSKOW. I was going to ask Al's question, but I will ask a follow-up. Is there
a better case?
MR. TRUMAN. Yes, I think there is. That's partly because we are in December and
this crisis has been going on for some time. As Peter said, we have the sense of a flood rather
than a severe rainstorm. The psychology is pretty gloomy, though one might say it has been
slightly less gloomy in the last couple of days. It is slightly less so only with respect to Korea,
not with respect to any of the other countries. But there is a scenario in which we could have a
rebound in that situation. For example, their exchange rates could move back up in nominal
terms--we are assuming essentially that they will not--and the global economies could pick up
faster than we anticipate. I think this scenario is equally likely, though I would argue that it is
not completely symmetrical. I think a better case would be associated with a series of the right
policy steps in the right order, rather than two steps forward and one step back as is often the
case in these situations.
MR. MOSKOW. When you say it is not symmetrical, do you mean the better case has
a lower probability?

12/16/97

MR. TRUMAN. No, I would say the better case has the same probability, but it
probably is not as good as the worse case is bad. We have a somewhat skewed distribution in
that regard.
CHAIRMAN GREENSPAN. President Parry.
MR. PARRY. Ted, I have a question about China and Hong Kong. In early 1994,
China abolished its official foreign exchange rate, and I guess that produced a depreciation of
about 40 percent in their currency. That obviously had an adverse impact on the relative
competitive position of Southeast Asian countries. The real appreciation of the Southeast Asian
and Chinese currencies since early 1994 and the problems in their banking systems led last
summer to depreciation of their currencies and related capital outflows. We now have China's
relative position very adversely affected by foreign exchange developments. What adjustment is
likely to occur in China and Hong Kong? China's currency is not convertible but I guess there
could be capital flight out of Hong Kong. In fact, we could get a depreciation of both currencies.
It seems to me there is the possibility of a rather significant adjustment in these areas, and we do
not seem to be focusing on that.
MR. TRUMAN. That possibility certainly is incorporated in the worse case scenario
we have laid out, though the effect may not be as big as some would argue it could be. Let me
go back to one of your premises. Although there was a 40 percent adjustment in China's official
exchange rate in 1994, most of China's trade--some 80 percent of it--was already being
conducted at the unofficial exchange rate. So, although the sign certainly was right, we, unlike
some commentators, do not think the depreciation was a major cause of all these developments.
Moreover it came in early 1994, not in 1997. The Chinese financial system is very weak and has

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many of the same problems, if not worse, as the financial systems in these other economies. The
important difference is that the Chinese financial system is not as integrated into the world
financial system so it is not a major source of external weakness. It may be a source of internal
weakness, but one can debate that point. Clearly, it is not the same source of external weakness
that we find in some of these other countries.
That having been said, there certainly is scope for continuing capital flight from
China. I know some analysts, including colleagues on my staff, who estimate that capital flight
on the order of $10 billion a year probably is occurring today from Mainland China. It is
disguised in the trade account and so forth and there are errors and omissions in the data. There
certainly is plenty of money in that economy and there always are ways of getting it out, though
that may require some patience. In my view, the Chinese authorities have taken a fairly
responsible and nuanced position to date with regard to the yuan. In fact, at the meetings this
week in Kuala Lumpur they basically said that they were not going to devalue their exchange
rate, but they also indicated that they were not going to go out of their way to help neighboring
nations financially any more than they already were. As you know, they have a fairly
comfortable international reserve position of well over $130 billion--the latest number that I
remember seeing. So, there is a risk there. Setting aside the Chairman's view about the
possibility of a downward limit to declines in other Asian exchange rates, which seems to be
right to me, there is a point at which the competitive pressures on China and the different
competitive pressures on Hong Kong would be felt. Therefore, I think we cannot rule out the
possibility that that pair of dominoes, to use an old metaphor, could affect other Asian economies
and likely have a secondary ripple effect on the United States and other parts of the world. That

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is a risk, though if I were to assess the risks, I think there is a higher probability of a problem in
Brazil associated in the short run with a spread of the Asian disease and a lower probability of a
problem in Mainland China and Hong Kong.
MR. PARRY. It seems to me that, without getting into specific probabilities, if one
were constructing another worse case, Brazil would be an interesting dimension to add to it.
MR. TRUMAN. It is in this scenario; it just may not be in the outline that we sent to
you. We assumed that the Hong Kong peg goes and, as I remember, that economic growth in
China drops from essentially 4 or 5 percent to zero or close to it next year and similarly in Hong
Kong. That aspect of the scenario could be worse, if you want to put it that way, and in some
sense it is just illustrative of what would be happening. Any of these developments could be
augmented by 25 or even 50 percent without much argument from me.
MR. PARRY. Okay, thank you.
CHAIRMAN GREENSPAN. Any further questions for these two gentlemen? If not,
do you want to start the go-around?
VICE CHAIRMAN MCDONOUGH. Thank you, Mr. Chairman. I will not comment
to any degree on the economy of the Second District, which actually is a little better than it was
at the time of our last meeting, nor on the national economy because we agree essentially with
the viewpoint of the Greenbook. Since I have spent a little more than four decades on the
international side of things, I thought I would devote some comments to my feel for the political
and economic situation in the world. My views are not significantly dissimilar from those that
have just been shared.

12/16/97
It seems to me that the world economy is walking along a rather narrow ridge. To the
right, we have a pleasantly upward sloping meadow and to the left, a rather large precipice. The
forecast essentially has the world economy continuing to walk successfully along that ridge. It is
not very likely to begin to enter the meadow and experience better conditions nor is it likely to
fall into the precipice. What are the dangers? If we look at the three economies in Asia that
already are in the hands of the International Monetary Fund--Korea, Thailand, and Indonesia--we
see that even though they are very different in many ways, they all have command economies in
which resources are allocated by politicians and bureaucrats and not by the marketplace. The
tool that the politicians and bureaucrats have used to allocate resources has been the financial
system, and the financial systems in all these countries are extremely weak. The process of
allocating resources by politicians and bureaucrats through the banking system means that a
country does not produce good bankers and it does not produce good bank supervisors.
However, the leaders of these countries have had very long records of success. Accordingly, it is
very difficult for them to believe that the leadership they have provided, which has taken
advantage of some very real virtues--such as very high saving rates and tremendous investment
in education that have created a dedicated, hardworking, and well-educated labor force--has
suddenly become wrong. They really were not wrong during that long period of success. What
they miss is that the world has changed, just as a number of years ago the leaders of the Soviet
Union missed that the world had changed.
The command economy simply does not work today in a more integrated world with
very rapid technological developments. That means that the leaders in those countries do not
understand, either emotionally or intellectually, how the new economy in which they must

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operate now functions. This is where there is a great deal of confusion that leads to equating
these Southeast Asian situations with that of Mexico in 1994 and 1995. The differences are that
Mexico has had political leadership that very deeply understands how a market economy
behaves; it has had the good luck of having a president who is an outstanding economist and
understands markets very well and, after a short adjustment period, it has had an outstanding
finance minister who also understands very well how markets work; it has a much better, more
market-oriented entrepreneurial sector and a population that sadly has had many centuries of
experience with hardship and thus has the ability to adjust to this new hardship with patience.
Therefore, the Mexican economy, with some very creative help from the United States and the
International Monetary Fund, improved rather quickly. It began to turn upward in March and
April of 1995, within months after the rescue package was put into effect. I do not think that we
can have great confidence that the same favorable outcomes will prevail in Korea, Thailand, and
Indonesia.
Among the other countries in Southeast Asia, Malaysia certainly has a very similar
economy, but I think it is involved in an advanced exercise in denial. Even countries that have
managed themselves particularly well, Hong Kong and Singapore, are being battered, as the
Singapore dollar was today, by people who view them as command economies. They have been
much better managed, certainly in the case of Singapore with a very high degree of integrity at
the official level, but they are still regarded as command economies that may have the same
problem in adjusting to the real world.
The Chinese leadership, as Ted Truman suggested, has thus far behaved extremely
well. Overnight, the spokesman for Jiang Zemin, the chairman and president, said that they

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would not devalue their currency. Their vice premier for economic management, Zhu Rongji,
who is generally deemed to be the premier-to-be, provides very effective leadership especially
considering that he has lived all of his life in a command economy that is still under Communist
Party leadership. He understands rather well how the world economy works. One can hope that
China will not add to the problems by making some unfortunate policy mistakes. As President
Parry suggested in his questions, the temptations certainly are there.
The major command economy in Asia is that of Japan. It is after all the Japanese
model that Korea followed. Japan basically has the same structural problem: Resources are
allocated by bureaucrats and politicians.

one has to hope that certain steps will be taken that recognize that the way they have been
managing their economy may have been grand for a while, but it no longer works.
If we were to have a continuing contagion from Asia, I think it is very likely, again as
suggested by President Parry in his question and Ted Truman in his answer, that the next country
about which one would have to worry is Brazil. The Brazilian real is overvalued in the exchange
markets; the banking sector is extremely weak; and the political system is not functioning well
except when there is a feeling among the politicians that they are about to be infected by Asia.
After some improvement in facing reality a couple of weeks ago when the Asian flu seemed
particularly virulent, there appears to have been a return to politics as usual. Fortunately, Brazil
has a very good government team at the levels of the president, the finance minister, and the
central bank governor. Argentina continues to do well, but because of its Mercosur involvement,
it would not be able to withstand a shock from Brazil.

12/16/97
If we look at Europe, there were dire warnings at the recent BIS meeting of the
dangers from Russia. Every central bank governor took us aside--Alice Rivlin, Ted Truman,
Peter Fisher, and me--and said they hoped we were not concentrating so much on Asia and on
our own hemisphere that we were unaware of how precarious the Russian economic situation
was. That situation is exacerbated somewhat by the most recent illness of President Yeltsen.
The leadership that we normally share with Europe is adversely affected, though one should
not overstate this, by the fact that they are heading into the most crucial six-month period for the
creation of the euro. The concentration of European political and economic leaders is very much
focused on their own affairs and that of the United Kingdom. Even though the United Kingdom
is going to be an "out" initially, though an "in" later, it also is going to concentrate on European
economic affairs by the historical accident that its prime minister is the president of the European
Union for the first six months of next year.
Therefore, it would appear that we have a world that is not likely to slide into the
precipice, but that risk is very considerable. In my view, what would bring about such a slide
would be the implosion of the financial systems in some of the Asian countries, as happened in a
number of well-developed economies in the 1930s. That is not likely to happen but it remains a
possibility.
There is a positive side. As we have been suggesting, markets probably have
overreacted in relation to fundamentals. I think it is less likely but not at all impossible that, if
the Asian financial systems do not implode, the markets would decide that the risk is behind us.
Markets participants might decide that there are some very good buying opportunities and that
there could be a recovery. The latter probably would be accompanied by a certain amount of

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euphoria, which could have us entering the meadow that I described. There might be a very big
question, if that happened, about the degree of realism that would accompany the euphoria and
whether we would be preparing ourselves for an even more difficult situation a year or two down
the path.
In the middle of all this, the United States should continue to do rather well, as Mike
Prell and Ted Truman have suggested and certainly the New York Bank agrees. Therefore, I
think we, the central bank of the United States, are in the very fortunate position of being able to
pursue our primary long-term goals of sustained economic growth and price stability. However,
I believe there is a tactical aspect relating to what I have described as the precipice on the left.
Tactically, I think we should maintain an extremely flexible view of what we need to do, and that
approach should characterize at least our operating view of our responsibilities in the coming
months. Thank you.
CHAIRMAN GREENSPAN. President Parry.
MR. PARRY. Mr. Chairman, the pace of economic growth in the Twelfth Federal
Reserve District remained solid in recent months, although down slightly from its trend during
the first half of the year. Despite the slowdown, economic activity is expanding more rapidly in
most District states than in the nation as a whole. Employment growth in the District continues
to outpace growth in the labor force, pushing unemployment rates down and creating very tight
labor markets, particularly in urban areas. The District-wide unemployment rate fell nearly 1
percentage point over the last twelve months.
The generally positive outlook in the District is tempered by reports of tight labor
markets, shipping bottlenecks, and recent problems in East Asia. In several areas in the District,

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competition for employees has become so fierce that employers reportedly are converting
temporary part-time jobs to permanent full-time jobs in an effort to attract workers. Shipping
bottlenecks associated with the Union Pacific rail scheduling problems reportedly have caused
delays in deliveries of both final and intermediate goods, with the most affected sector
apparently being agriculture.
Initial reports from District states indicate that recent developments in East Asia have
reduced the demand for exports of some commodities, primarily raw and processed agricultural
goods and lumber and wood products. At this early stage, other vulnerable industries such as
high-tech equipment reportedly have not been greatly affected, although we recently heard that
Microsoft is talking about some weakness as a result of problems in Asia. Data on merchandise
exports indicate that in percentage terms the Twelfth District exports about twice as much of its
estimated gross product to East Asia as does the United States as a whole. Thus, the effects of
recent developments in East Asia on economic growth likely will be larger in the Twelfth
District than in the nation.
Turning to the national economy, the data certainly indicate that real GDP growth
remains robust in the current quarter and that inflation continues subdued. But traditional macro
models strongly suggest that growth will slow next year. We expect real GDP growth of just
above 2 percent in 1998. Our pure model forecast actually showed a more pronounced
slowdown than this, but we boosted it a bit to reflect the effect of a possible favorable
productivity shock. Just to mention very briefly a couple of the factors behind the projected
slowdown: First, the dollar's appreciation over the last year and the projected slowing in foreign
demand in 1998 certainly should reduce demand for U.S. products. Of course, both of these

12/16/97

25

factors are being reinforced by recent developments in Asia. In addition, real short-term interest
rates appear to have been nudged up by recent declines in expected inflation. I must add,
however, that there is plenty of room for skepticism about whether a slowdown this big will
actually occur next year. Traditional models have been incorrectly predicting slower growth for
the past year and a half. As I mentioned, it is quite possible that economic activity is being
boosted to some extent by a positive productivity shock, but it is certainly too soon to tell how
much of an effect this factor may be having or how long it may last.
With regard to inflation, we have reduced our forecast since the November meeting.
Certainly, the continued appreciation of the dollar will help to hold down prices. Secondly, the
results of the last Philadelphia Fed survey of inflation expectations were impressive. The sizable
drop in long-term expectations provides an important confirmation of the evidence that we have
seen from the inflation-indexed Treasury bond market. And third, recent productivity data have
been encouraging, and it may be reasonable to build in a modest reduction in future inflation
from faster productivity gains. There is, of course, one major factor that goes in the opposite
direction. The unemployment rate has continued to fall and is now well below the natural rate.
Given all these considerations, we expect that price inflation will hold steady in 1998
and 1999 at about this year's rate. At our last meeting, it seemed more likely that there would
be some upward tilt to inflation. I must add, however, that the risk to this forecast may be
skewed to the upside. If economic activity does not slow as much as we expect, labor markets
could tighten further and add upward pressure on inflation. Thank you.
CHAIRMAN GREENSPAN. President Moskow.

12/16/97
MR. MOSKOW. Mr. Chairman, economic conditions in the Seventh District are quite
similar for the most part to what I reported at our last meeting, but the Asian situation has left a
sense of greater uncertainty about the outlook. In terms of consumer spending, retailers have
used the terms "sluggish" and "soft" to describe recent sales trends. That may be partly due to
what has become a bimodal holiday sales season, with sales relatively stronger around Thanksgiving and the week before Christmas but weaker in-between. While it is possible that we will
see the same pattern this year, at least one large retailer in our District has trimmed expectations
for industry sales from a rise of 4 to 7 percent to one of 2 to 3 percent.
Light vehicle sales this month seem to be tracking around the 15 million unit rate
according to our contact at the Big Three who also noted that incentives are a very important
factor in maintaining sales at this level. Overall manufacturing output in the District has been
expanding at about the same pace as in the nation, but trends are mixed across industries.
Demand for heavy trucks has been very strong, with order books filled through the middle of
next year. One truck manufacturer believes that there has been some double ordering, although
cancellation rates have been low thus far. A number of District industries including steel,
cement, gypsum board, container board, and housing have not experienced as much strength as
seen nationally.
In terms of any impact from the Southeast Asian situation, it is still too soon to know
all the direct effects on the region, let alone the indirect effects. On the export side, the Seventh
District is likely to be directly affected less than the nation as a whole because the Southeast
Asian countries account for a smaller share of our export markets, a flip side of the situation in
the Twelfth District that Bob Parry was describing. Contacts in the food equipment, paper, and

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plastic laminate industries already have seen some reduction in export orders to Asia, but they
also note that business has been good in Europe. Depreciating foreign currencies and slow
economic growth in several Asian markets may account for part of the sluggishness in our corn
exports, but an increased supply from China, Eastern Europe, and the former Soviet Union may
be a more critical factor there.
On the other side of the trade equation, auto and steel imports could rise as Asian
producers attempt to find replacement markets in the United States for their products, and that
would affect our region relatively more than the United States as a whole. One of our directors
in the steel industry believes that steel imports will surge and that the quality of selected
categories of imports will be quite high relative to the more common imports from Eastern
Europe. Steel and auto industry contacts said that they were moving ahead with plans to
accelerate their cost-cutting measures substantially over the next year, perhaps spurred in part by
prospects of more intense import competition. As I have been reporting for some time now,
labor markets are very tight in our District, with the unemployment rate at or below 4 percent
since May, and we continue to hear many anecdotes of various ways that firms are dealing with
worker shortages.
Turning to the national outlook, my view at the last several meetings has been similar
to that expressed in past Greenbooks. GDP growth and inflation could only be contained by
policy tightening in 1998. The question now is whether the deteriorating international situation
will have the major consequences for the U.S. economy that the current Greenbook envisions.
Of course it could, but I don't see the balance of risks pointing in that direction. Considering the
strength of the underlying domestic economy, we tend to think that real GDP growth in 1998

12/16/97

28

will be closer to 2-1/2 percent than to the 1.7 percent rate in the Greenbook. Our figure factors
in a substantial degree of pessimism based on the Asian crisis. Net exports subtract about 0.7
percentage point from 1998 GDP growth in our projection. Combined with some further
collateral effects on U.S. financial markets, this takes us to the 2-1/2 percent forecast. This is not
a worse case scenario; it is our best guess given the information to date. Regarding prices, I, too,
am concerned that the favorable inflation shocks that we anticipate from the international
situation in 1998 will be transitory and their reversal will have to be addressed later at a time
when action will be more difficult. In summary, I see the upside risks for 1998 to be
substantially greater than the Greenbook portrays.
CHAIRMAN GREENSPAN. President Broaddus.
MR. BROADDUS. Thank you, Mr. Chairman. Overall, it appears that aggregate
demand remains relatively strong in our region, although reports are a little more mixed than
they were a month ago. Regarding a couple of the details, general retail and service-sector
activity picked up sharply in November according to our latest monthly survey. However, we
also heard a number of reports of weaker auto sales over the course of the last several weeks, and
recent anecdotal reports indicate that housing may be softening a little from a very high level.
Commercial real estate activity, in contrast, appears to remain very strong, especially in the
Washington area but generally around the District as a whole. Elsewhere, manufacturing activity
moderated in November according to our survey, but there is some evidence of a firming in this
sector so far in December. Labor markets--what can I say? They are at least as tight as they
have been in our region, perhaps even a little tighter than they were if that's possible. We have
reports of record-breaking job vacancy backlogs at a number of temp agencies. Labor shortages

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apparently are resulting in some buildup in wage pressures in at least some sectors of the
regional economy, especially construction and retail. Typically, seasonal workers earn the
minimum wage on average during the holiday season. They are now making $6.00 an hour or
even more in some cases.
Turning to the national picture, I have to say that I found the abrupt revisions in the
Greenbook projections surprising, at least their extent. Actually, this month's real growth and
inflation forecasts are not all that different from last month's. But in this Greenbook, the
moderation in the rate of real GDP growth and the containment of inflation take place without
any tightening of monetary policy. In the November Greenbook, a significant tightening was
assumed to occur over the course of 1998. I understand, of course, that this change reflects the
potential negative fallout of Asian problems on the U.S. economy, but it is not at all clear to me
from the discussion in the Greenbook that in terms of the most likely outcome recent
developments have changed the outlook as substantially as the projections indicate.
Let me make four observations about this very quickly. First, at our November
meeting I expressed concern that the widespread view in financial markets that Fed policy was
on hold, at least for the time being, was preventing long-term interest rates from playing their
usual automatic stabilizer role. In my view, the market reaction to the November employment
reports was very strong evidence for this point of view and this concern. That report was much
stronger than expected. The strength was across the board, and the report included an hourly
increase in wages that was well above any reasonable projection of productivity gains. The
markets hardly reacted at all. It appears now that the markets think the only thing that will make
us react is a fairly substantial jump in CPI inflation. With labor markets as tight as they are, I

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think this absence of the usual stabilizer mechanism coming from long-term interest rates is a
significant upside risk in the outlook, and I believe that needs to be given considerable weight
along with whatever weight we give to the Asian problem.
Second, a key element in the Greenbook's new projections is the estimate that the
Asian crisis will double the decline in U.S. net exports in 1998 from what was projected in the
November Greenbook and that net exports will reduce real GDP growth by about one percentage
point next year. I don't know exactly how that estimate was arrived at. More importantly, I do
not have a clear sense of what the staff would say about the confidence interval around that
estimate. I think it would be helpful to know that, given the extent of the changes in the
projections, although Ted's answer to my question helps to put a little more of a quantitative
dimension on it. The basic point is that net exports clearly present downside risks, but we need
to be careful not to overstate them when weighing them against other risks that we face in the
outlook. For all of the talk about globalization, the U.S. economy is still self-contained to a very
considerable extent.
Third, the flip side of the prospective widening of the U.S. current account deficit is a
widening capital account surplus. The Asian crisis, as I think we all know, has redirected capital
flows away from emerging economies back toward industrial economies, especially the U.S.
economy. This is certainly part of the reason for the recent declines in bond rates in U.S.
markets, and I think it has helped to increase loanable funds at banks. In short, the capital
reflow that is occurring has some of the effects of an easing of monetary policy. I don't think the
Greenbook mentions this, and I wonder whether the projections take account of it.

12/16/97
Finally, while the appreciation of the dollar obviously will reduce export demand, that
effect will be partially offset by the restraining effects of the dollar's appreciation on prices. The
better inflation performance will bolster real wage gains in the U.S. economy and probably
increase household confidence that those wage gains will continue. That could well keep
consumption expenditures on an above-trend path and add further to the tightness in labor
markets.
In short, while events in Asia obviously are serious and present significant downside
risks, the upside risks that were in the outlook before the Asian crisis emerged have not
disappeared. We should not discount them in our assessment of the outlook. Thank you.
CHAIRMAN GREENSPAN. President Boehne.
MR. BOEHNE. Thank you, Mr. Chairman. The economy in the Philadelphia District
is operating at a high level, with most sectors doing well. Labor markets, as elsewhere, are very
tight, but inflation remains subdued despite some upward pressures on compensation. We talk
about the tight labor markets, but business people are doing a lot more than talking about it.
They are being rather creative in terms of attracting people who ordinarily would not be
available to work. For example, along some of the main arteries in the Philadelphia region, we
see large signs advertising job opportunities at ABC company or XYZ company. Local theaters
advertise jobs in their film clips. Instead of just getting previews of the next film, the moviegoer
gets a film clip about working for specific companies. Flyers about available jobs are being
distributed at senior citizens' meetings and in grocery stores. I am told that serious consideration
has been given in some schools to sending flyers home with school children to invite their
parents or other caretakers to call a number or come to a particular place to discuss available

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jobs. The subways, buses, and taxis also are getting advertising from employers. So, business is
responding to this labor scarcity and is exercising some flexibility in terms of enticing
unemployed people to accept jobs. Clearly, there are limits to this process, but I think those
limits are being pushed back.
In the consumer spending area, holiday retail sales seem to be doing reasonably well
overall. However, one can get quite a mixed message depending on whom one talks to.
Competition is fierce, and the patterns of retail sales are changing. Sales through the TV
medium and catalogue sales are taking away some business from traditional retailers. The large
malls with the more established stores seem to be doing well, whereas the big box retail stores
and strip malls tend to be having a tougher time. We can get any story we want depending on
whom we talk to on any given day, but if we put it all together, I think we come away with a
sense that holiday sales are doing reasonably well.
The commercial real estate market continues to tighten and office vacancy rates are
dropping. Home builders and real estate agents report that demand for both new and existing
homes is quite healthy. At this point, manufacturers report some moderation in demand and
output, but they do not point in particular to the Asian situation, although they may well do so
over the next several weeks.
We in the Fed and other central banks focus on inflation and the goal of price stability.
Being a good central banker, I always warn people of the risks of inflation and the virtues of
price stability. When I finish that talk, the first question I get now concerns what I think about
deflation. In my view, this deflation talk is not something one can just dismiss. That's mainly
because it is coming from fairly sensible people, the same people who told us not to worry a

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whole lot about inflation in 1996 and 1997 when we insisted that there was a big problem. In
part, I believe these comments are reflecting the fierce competition that businesses face, and they
also reflect the fact that most businesses find deflation harmful. I think they would rather have a
little inflation than a little deflation. Nonetheless, while we do not have to buy into it and we
want to be sure to keep it in perspective, this is something that we ought not to dismiss out of
hand as coming from people who are ill-informed.
On the international side I want to compliment President McDonough on his analysis.
It was a very insightful analysis of what is happening and I appreciate very much having it.
As far as the national economy goes, we are in an enviable position in terms of
underlying demand in the economy, in terms of job creation, and in terms of benign inflation.
There clearly are risks and we have talked about those risks for months. I think we need to be
flexible both in our assessment of where the risks lie and what monetary policy might or might
not have to do over the next 12 months or so.
CHAIRMAN GREENSPAN. President Guynn.
MR. GUYNN. Thank you, Mr. Chairman. The Sixth District economy continues to
expand at a moderate rate. Tourism remains a real strength for us, with flights to Florida already
booked up earlier and faster than last year and with above-average attendance at tourist
attractions for the holiday period. In particular, the influx of tourists from Latin America is
reportedly boosting retail sales in south Florida. Hotels, car rental companies, cruise lines--all
indicate that current and advanced bookings are strong. Similar patterns prevail along the
Mississippi and the Gulf Coast. Production and new manufacturing orders have declined
somewhat recently in our area, according to both anecdotal evidence as well as our December

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regional manufacturing survey. However, expectations are for a pickup in both production and
new orders looking six months out. Not unexpectedly, orders for textiles and apparel are
reported to be declining. Also, the rig count in the Gulf slipped back a tad in the last month.
The picture for housing has changed very little since the last FOMC meeting. Home
sales remain mixed, and housing inventories are reported to be in good shape. Single-family
home construction has been essentially flat and multifamily construction has begun to slacken.
Occupancy rates are expected to stabilize by the first of the year. As was the case at the time of
our last meeting, commercial real estate markets remain healthy, as evidenced by increases in
both occupancy and rental rates. However, the industrial real estate sector has shown some signs
of a slowdown. Overall, both developers and real estate agents remain optimistic about the
period immediately ahead.
With regard to the now familiar story that everybody is talking about, labor markets in
our area remain tight. Reports of wage increases have been occurring with some greater
frequency recently. In certain hot areas like Atlanta, finders fees are being offered to employees
who recruit family and friends. Overall, however, prices generally are remaining steady. There
are scattered reports, some coming from our District manufacturing survey, of a slight rise in
materials prices.
The impact of Asian problems on our region does not appear to have been great to
date. Like President Parry, we have reports of citrus shipments, mainly grapefruit, that are either
being cancelled or are down considerably, especially to Japan. Port contacts in both Miami and
New Orleans report some decline in the overall volume of shipments to Asia, while the port of
Savannah indicates a slight reduction in shipments of wood pulp. The big Georgia Pacific

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Company states that it has seen some slowing in shipments of pulp and paper to the Pacific rim,
but the company had expected a seasonal slowdown in any case.
As for the national economy, the consumer sector is a little stronger than we expected
at the time of the last FOMC meeting. Because of the deepening difficulties in Asia, the foreign
sector has been a bit weaker than we anticipated. Business investment spending has been
maintained at strong levels longer than we had forecast. I continue to be heartened by the good
balance we continue to see in the economy and the fact that inflation remains moderate and is
showing a slight downward trend.
Four developments have led us to modify our projections: the stronger-than-expected
November employment report, the decline in energy prices, the surprising upward revisions to
rates of growth in industrial capacity, and the view that the weakness in Asian economies may be
greater than initially was thought. As a result, we project the consumer sector to be somewhat
stronger, the international trade sector somewhat weaker, and capacity utilization somewhat
lower, with inflation marginally more subdued in the near term. Both our judgmental forecast
and our VAR policy model suggest that real GDP growth will be a bit smoother than that
reflected in the Greenbook, with near-term growth being somewhat lower and longer-term
growth somewhat stronger but with an inflation path closer to the Greenbook alternative with no
stock market decline. Indeed, our VAR model, which does not consider the effects of the Asian
flu, implies that if one wanted to hold the rate of inflation at about current levels, a small
temporary increase in the federal funds rate would be necessary sometime next year.
Considering that to be a warning signal and in light of my desire not to lose the gains we have
had in bringing inflation to its current level, I regard the likely drag that the Asian problems

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36

imply for the economy as equivalent to a slight policy tightening, but with a more immediate
short-run impact on the real economy, an outcome that seems desirable at this time. Projected
results should take some of the heat off both production and labor markets and may even have
the desirable effect of taking inflation down another notch. Thank you, Mr. Chairman.
CHAIRMAN GREENSPAN. President McTeer.
MR. MCTEER. The economy in the Dallas District continues to grow considerably
faster than the nation's. Growth has remained broad-based through all segments of the private
sector. The strongest employment growth has been in oil and gas extraction, followed by the
finance, insurance, and real estate sectors. The only industry running at or beyond full capacity
is oil and gas drilling, where supplies of all key inputs have constrained activity. A few meetings
ago, I mentioned that some oil companies were going as far as Great Britain to find machinists.
More recently, we have heard reports of a company recruiting welders from India. In spite of the
somewhat bearish outlook for oil prices over the next year or two, most companies expect to
remain profitable and are trying to expand exploration and production.
All sectors of the real estate market remain quite strong, especially the industrial and
office markets. Both the Dallas and Houston office markets have had falling vacancy rates and
steeply rising rents throughout 1997. In Dallas, it is expected that over 11 million square feet of
office space will become available next year. That is the equivalent of about 15 Dallas Fed
buildings. In Houston, plans for the construction of the first downtown office tower since 1986
have just been announced. Class A space in Houston's central business district is now about 90
percent occupied. Prices of existing homes in Texas are up 3 percent year over year, with some
metropolitan markets such as Dallas showing gains of more than double that. The president of

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the largest single-family real estate agency in Dallas told us that October and November were the
two best months in the firm's history, and she expects December to be the same. Normally, they
would be practically shut down at the end of the year for the holidays, but demand has been
making that impossible this year.
Not all sectors are this robust. Employment has been weak in the apparel industry,
and the announcement by Levi Strauss that it will close three El Paso plants has increased the
level of concern in that community. More recently, Hasbro also announced a plant closing in El
Paso that, together with the big decline in wages in Southeast Asia, has begun to undermine
some of the confidence that had been returning to the border economy. The last year has not
been such a good one for our manufacturers of semiconductors, electronic equipment, and
instruments. While they are anticipating a better year in 1998, recent financial turmoil in Asia
has damped near-term prospects.
At our board meeting last week, our director from the retailing industry reported that
Christmas sales were about on track so far this season and that retailers were expecting a "ho-ho"
year rather than a "ho-hum" or a "bah-humbug" year. Labor markets remain extremely tight.
Sizable wage increases are reported for highly skilled technical workers. Salaries have soared as
much as $20,000 in the last year for workers such as software engineers, though the more typical
increases have been in the $7,000 to $10,000 range. The greater the shortage, the more
extraordinary are the measures taken to find workers. For example, Intel is building a chip
factory in Fort Worth and is reported to have mailed letters to 14,000 engineers working at
competing companies with offers of a week-long trip to Hawaii for two if they joined Intel. One
telecommunications company has been helping Asian students to get visas after graduate school.

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Consequently, 11 percent of their workforce of 2,500 is Asian. The company also has begun
recruiting in Canada. Another large Dallas-based firm offers telecommuting to engineers who
wish to live in Austin and work in Dallas. To increase the future supply of engineers, a number
of leading telecommunications companies including Motorola, Southwestern Bell, AT&T, and
Texas Instruments have joined forces with several leading Texas universities to form the Texas
Telecommunications Consortium, which will fund research and educational programs.
Turning to the national economic outlook, it is clear that the risks have shifted
considerably since the November meeting. The Greenbook does a good job of reflecting this
increased uncertainty, both on the downside and the upside. The so-called "worse case" scenario
is a highly plausible and unnerving one. We must be concerned that a serious slowing of world
economic growth would imperil the ability and willingness of countries in Latin America,
Eastern Europe, and Asia to continue their transition to more democratic, market-based
economies.
This seems to be a time that calls for economic diplomacy on our part and an excellent
time not to "rock the boat." Against the backdrop of continued disinflation stemming from lower
energy prices, a stronger dollar, and plenty of domestic and worldwide industrial capacity, the
inflation risks seem small indeed and may be shifting rapidly toward the other end of the
spectrum.
CHAIRMAN GREENSPAN. President Minehan.
MS. MINEHAN. Mr. Chairman, the New England region continues its recent trend of
solid growth, low unemployment relative to that for the nation, tight labor markets, but only
moderate price and wage pressures. There are exceptions in specific job categories where

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39

workers are in extremely short supply, especially in information technology and engineering.
Like Atlanta, the First District is experiencing a boom in tourism. We, too, have some large
manufacturers who are concerned about deflation as in the Philadelphia region. But my sense is
that their concern reflects a long period of very strong competition within their industries rather
than any real expectation that the economy will experience broad-based reductions in prices and
wages.
While it has been a short period since our last meeting, we have seen a change in
attitudes regarding the sustainability of this favorable economic situation. On the one hand, there
is the Asian crisis, which will both limit the exports of some of New England's fastest growing
companies and increase domestic competition because of lower import prices. However, we also
are told that some New England companies outsource production to Southeast Asia and may now
be getting cheaper components, thereby keeping costs lower than would otherwise be the case.
The other area that has called into question the sustainability of the regional expansion
is speculative commercial real estate construction. I have been reporting for some time that
while the Boston commercial real estate market was very tight, with only small amounts of
contiguous Class A space available, there also were no reports of plans for major building
projects or much new building under way except for that related to the Artery Project going
through the center of the city. That has now changed. Senior city officials told me recently that
plans have been submitted for 40 new hotels in Boston proper. We also have reports of 11.3
million square feet of speculative office space being proposed for construction in the greater
Boston area within the next 12 to 18 months. At current absorption rates, this additional office
space will take about four years to fill. Commercial loan data support stories of an increase in

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40

construction plans. First District loans are growing at better than twice the national rate, with
real estate lending at our two largest banks leading the way at over three times the national pace.
Commercial real estate lending is seen as a growth opportunity for the first time since the late
1980s, raising regulatory as well as economic concerns. We understand that a Systemwide effort
is under way to investigate lower lending standards of banks. We would suggest that some
follow-up be done on commercial real estate lending as well, as we are doing in the First District.
Finally, one of our directors, the chairman of State Street, sounded a warning of a
different nature at our last meeting. As you know, State Street has extensive and highly
mission-critical information technology systems. As a result, it has been a leader in century date
change planning. Recently, State Street was asked to speak to eight very large European banks
to discuss Year 2000 problems and ways to work together to solve them.

Our director believes it would be helpful and in the national interest if the Federal
Reserve were to raise this issue more forcefully.
Turning to the national scene, we had prepared our own forecast prior to receiving the
Greenbook. Our assessment for GDP growth in 1998 was in the area of 2.8 percent, following
growth of about 4 percent in the fourth quarter of 1997. We had unemployment trending down
by year-end 1998 and the core CPI trending up, even after adjustments were made for
measurement changes. Obviously, in terms of broad trends this is quite different from the
Greenbook scenario though it is in line with several private forecasts. In preparing this forecast,

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we incorporated between .50 and .75 percentage point of negative impact on GDP as a result of
the Asian crisis and a few tenths more reflecting our expectations of a general slowdown in the
domestic economy. The result is that we had projected a bit less of a slowdown in GDP growth
than the Greenbook.
When I looked at the Greenbook forecast this weekend to assess the progressively
gloomier Asian prospects, I could accept the Greenbook estimates of the effects of the external
situation. However, I am more agnostic about the impact of smaller additions to inventories and
the gradual decline in stock market prices, both of which contribute to a Greenbook GDP outlook
that is well below our forecast in Boston. Inventory and stock market levels are difficult to
project, and I worry that they are expected to play such an important role in reining in the
domestic economy. I believe there is a good probability of growth being stronger,
unemployment levels more stable, and pressure on prices greater than is evident in the
Greenbook, though I do agree that the Asian situation is a wild card.
CHAIRMAN GREENSPAN. President Stem.
MR. STERN. Thank you, Mr. Chairman. The District economy continues to grow at
a healthy pace as usual. I will not dwell on much of that in detail; it is not an unfamiliar story.
We recently had a couple of meetings with business leaders, and I would say the general
information gleaned at those meetings indicated no major surprises. Business people are
uniformly positive about the 1998 outlook. Construction is a particularly bright sector. They
clearly expect economic growth to continue. All in all, I would say the forecast is generally
favorable. It is also clear now, at least in our region, that wage pressures have become pervasive
both geographically and by job and skill categories. It is very, very hard to find workers, and

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there are more reports of larger wage increases. Some business people believe that they can
offset the higher wages with productivity improvements or other actions. Some say that they
expect profit margins to be squeezed in 1998 and presumably beyond. That was the general
thrust of the commentary at those meetings. All in all, the District economy continues to
perform very nicely.
As far as the national economy is concerned, my view is that the risks are on the
downside at this stage. But in making that statement, I would not start with the current
Greenbook forecast. If we compare that forecast with, say, that in the September Greenbook, we
do not have any tightening of policy in the current Greenbook in contrast to the staff assumption
in September. While I certainly recognize that Asia and its repercussions represent a significant
shock that was not anticipated in September, we also have had more sustained aggregate demand
than was anticipated. We now have tighter labor markets. We have an economy that displays a
good deal of momentum. So, if I were going to write down a baseline forecast based on all of
this, I would put in more real growth and more inflation than is in the Greenbook.
Against that background, I think the risks are on the downside. I say that because if
the Greenbook is right that there will be no appreciable acceleration in inflation, and if I am right
that wage pressures are now pervasive, which is pretty well baked in the cake, then it seems to
me that the implications or at least the risks for profit margins, stock prices, and ultimately real
activity are on the downside.
CHAIRMAN GREENSPAN. President Hoenig.
MR. HOENIG. Thank you, Mr. Chairman. The economy in the Kansas City District
continues to do well. Reports from our directors and other contacts suggest a healthy business

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environment throughout the region. Manufacturing activity remains strong, especially in our
durable goods sector. Our manufacturing employment has grown about 1.6 percent over the past
year, and that is quite a bit higher than the national average. Our most recent survey of
manufacturers found that production, shipments, and new orders are all increasing at least
moderately. District exports of manufactured goods to Asia represented less than 3 percent of
our total shipments in 1996, so we don't think there will be a strong direct effect on District
manufacturing from developments in that part of the world. Retailers reported higher sales last
month and expect a very robust holiday season across the District. Our regional farm economy
continues to do well.
As strong as this District report is, there are some signs of slowing. Construction
activity has been flat, as are indicators of future construction activity. Housing permits grew at a
rate of only 2 percent in October, down from a 13 percent rate the month before. The value of
total construction contracts fell 6 percent in October, resuming a downward trend from earlier in
the year. District energy activity has edged down somewhat for three consecutive months.
Actually, the rig count in our District is now only about 1 percent higher than it was a year ago.
Business loan activity is only modest throughout the District.
Labor markets, though, remain tight in most of the District, and reports of wage
pressures have become more common in the last couple of months. However, there is still no
evidence that these pressures are showing through to prices. The District's unemployment rate
remains a full percentage point below the national average. Almost all the firms we have
contacted are reporting labor shortages, and a substantial majority say they are raising wages and
benefits in an effort to attract and retain workers. The labor shortages are especially severe for

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44

some skilled positions. As one rather frustrated Kansas City employer said, he now feels very
much like the owner of a sports team in his efforts to set salaries for data processing workers. He
is being told to negotiate with the workers' agents, and he is only half joking about that. But, as
I said, the higher wages are not enabling firms to raise prices.
On the national front, like others, I expect to see strong economic growth for this
quarter followed by a slowing toward trend over the next year. This slowing is caused in part by
the restraint on some economic activities in the United States stemming from the Asian financial
crisis. However, domestic economic fundamentals remain quite healthy, and I think they will
keep the economy growing at a pace around trend through next year. At this point, I expect
inflation to remain modest over the next year or two despite the tight labor markets, partly
because the appreciation of the dollar will keep import prices down for a while. I think the
downward revisions in the utilization rate of manufacturing capacity also suggest less price
pressure than we might have thought previously. Inflation continues to be low and stable, and
inflation expectations remain subdued and are declining at the moment. Low inflation and
inflation expectations in fact may help damp future wage demands as we face these tight labor
markets.
Finally, although I recognize the upside risks and I believe they are real for both the
growth forecast and the price environment, I do not see any evidence, at least not any
overwhelming evidence, that action is required at this time. Thank you.
CHAIRMAN GREENSPAN. Governor Rivlin.
MS. RIVLIN. I think it was brave of the staff to produce a Greenbook forecast at all.
The increased uncertainty about world events in the short interval between meetings certainly

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has widened our confidence intervals quite a lot, even though we don't know exactly what our
confidence intervals are!
My own hunches are that the domestic economy may prove stronger and more
resilient than the Greenbook suggests, and others around the table have voiced that feeling. I
sense that we now have some momentum in wage increases, especially at the low end of the
wage spectrum, and I'm not sure that declining inflation matters that much for wage increases.
We may have achieved the Chairman's definition of price stability: It occurs when inflation does
not play into business and consumer calculations. I also am more skeptical than the staff that the
minimum wage has had a lot to do with the wage increases that we have seen. I'm more inclined
to attribute the increases to tight labor markets. If that is true, the absence of another minimum
wage increase going forward will not have as much of a restraining effect as the staff seems to
anticipate. I also think we could see health cost increases adding more to labor costs than the
Greenbook predicts, though we have not seen that happen yet. Especially with somewhat higher
wages, consumer spending may prove stronger than is projected in the Greenbook. I am a little
skeptical of a significant negative wealth effect if the stock market does what we all hope it will
do, namely, reflect real earnings prospects company by company and drift down at a moderate
rate. That kind of outcome may not have a major negative wealth effect. There also may be a
little more momentum in business investment than the staff is estimating. I would not expect,
however, that a slightly stronger economy would give us significantly higher inflation. Cheaper
imports, including the flood of goods we will be getting from Asia, are certainly going to hold
down price increases, and productivity growth may hold up a little better than the Greenbook
suggests.

12/16/97

I, too, am mystified by the deflation question that we get every time we make a
speech. I have concluded, unlike Ed Boehne, that the question should not be taken too seriously.
That's because when I ask those who pose the question what they really mean by it, I often do
not get a very good answer. They may have in mind something they read on the front page of
the Wall Street Journal that sounds like a good question to ask a speaker from the Federal
Reserve. The prospect that prices actually will go down in the face of what we normally see as
continuing strength in the economy strikes me as bizarre.
On the foreign front I, too, thought Bill McDonough's analysis was extremely cogent.
I spent a week
in Europe listening to the remarks of Japanese finance ministry and central bank officials
concerning what they are going to do about their economy. The explanations were not
reassuring. One of our European colleagues asked me if I thought they didn't understand the
problem or if they just didn't have the political will to do what was needed. I said that I did not
know. But, there is still a great deal of uncertainty about whether they can come to grips with
their problem. There are, of course, possibilities that we could fall off the precipice
internationally or even conceivably domestically if an international rout had a sudden effect on
the U.S. stock market and consumer confidence, the kind of Gulf War phenomenon that nobody
expected but that did happen. I think that is unlikely. On balance, I am not that far from the
Greenbook forecast, although my confidence interval on anything that might be said about the
next few weeks is very wide.
CHAIRMAN GREENSPAN. Governor Phillips.

12/16/97
MS. PHILLIPS. Thank you, Mr. Chairman. What a difference a month makes! The
stock market has recovered from its 500 point decline. The economy seems to be marching
ahead. We have an incredible labor market and generally benign aggregate inflation, although
there is quite a split between inflation rates in the goods and the services sectors. Services
inflation, largely affected by wages, more than offsets price stability or deflation in the
commodity and goods sectors. I think that managing in this dichotomous situation is going to be
a challenge for monetary policy. So far, demand and growth are holding up quite well this
quarter. We even hear debates about how to spend the federal surplus.
Under normal conditions, we would expect the current momentum to carry the
economy forward at a rather high level of activity well into 1998. However, the depth of the
Asian problems is still unknown. What is certain is that no one can say that the Asian turmoil
has bottomed out or that the situation in that part of the world is under control. I expect that the
upcoming debates about funding the IMF and the use of the Exchange Stabilization Fund will
not shore up confidence in contemplated solutions. In the near term, the apparent inability or
unwillingness to make changes, particularly in Korea and Japan, makes the prognosis somewhere
between uncertain and grim. The terms "denial," "haven't got a clue," and "no political will"
seem to crop up continually in assessments of the Asian economies. The high Asian saving
rates, the culture or Asian way of doing business, and their economic growth history appear to be
dulling corrective response actions.
In the United States, we see only the beginnings of an awareness of the potential
problem and its effects on U.S. economic activity. Firms are now starting to assess sales
forecasts, profit outlooks, and related investment plans. In any case, a widening of the U.S. trade

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and current account deficits is certain. More generally, we have been expecting slower growth to
occur in the United States. We may be seeing some very tentative signs of developments that
could lead eventually to a slowdown. As mentioned, net exports clearly will be diminished by
the Asian flu and by the strength of the dollar. Labor shortages may directly curtail expansion
plans in some cases. In other cases, firms that are unable to raise prices to pass on higher labor
costs may find that expansion or investment plans simply will not pencil out. Profits seem to be
coming under pressure. Classic bottlenecks also are showing up, for example, in transportation.
In short, the staff forecast of a reduced rate of business fixed investment makes sense. Although
the fundamentals remain reasonably strong in terms of current cash flows and sales as well as the
cost of capital, the risk to investment has risen considerably. The flattening of the yield curve is
another indicator that some slowdown is likely. Inflationary expectations appear to have abated.
Looking at the stock market volatility, I am hoping that it is reflecting a fundamental
reassessment of prospects by investors.
Turning to inflation and productivity, despite press debate on the subject, the
productivity picture appears to be getting a bit clearer. We have seen some improved statistics
recently. There is some recognition of improvement by economists. More attention is now
being directed to trying to understand what is going on in different sectors of the economy.
Capacity increases help to explain the performance of inflation to some extent. We may now be
witnessing some of the benefits of a low inflation or stable price environment: persisting
economic growth, strong balance sheets, and sufficient confidence in forecasts to carry low
inventories and make capital investments.

12/16/97

In sum, international uncertainty has heightened, but the U.S. economy is doing quite
well for the moment. It is better to be facing this higher-risk international situation with a U.S.
economy that is not fragile.
CHAIRMAN GREENSPAN. Governor Ferguson.
MR. FERGUSON. Thank you, Mr. Chairman. As we meet today, both international
and domestic developments give us obvious food for thought. I believe, as others do, that our
watchwords at this point should perhaps be a "cautious" and maybe even a "nervous"
wait-and-see stance. The trend of the domestic economy, as others have said, is clearly quite
strong. The latest figures indicate continued tightness in some sectors of the labor market,
particularly in the area of information technology. I also am impressed by indications of
declining labor underutilization, which suggest that there are fewer people, at least domestically,
who can be pulled into the labor markets by the creative solutions that others have mentioned. I
am not an expert on how an employer can pull in workers internationally, but the need to attract
such workers may increase. There is also some obvious strength in industrial production. The
recent numbers indicate quite clearly a widespread increase in production activity. There is a
large backlog of unfilled orders suggesting some continued strength in manufacturing output.
I also see evidence pointing to some moderation. If we look at the real adjusted orders
measures, we see an indication of possible slowing in growth, admittedly at still very high levels
of activity. While we are observing tightness in the labor market, I continue to believe that the
evidence indicates an increase in productivity above the anemic 1 percent trend that we have
seen thus far. It is quite clear that some capital deepening has occurred. We should continue to
watch that. Obviously, there have been changes in capacity utilization measurements that

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50

indicate some room for continued output growth without taxing productive resources. Others
have already talked about recent indications of some slowing in inflationary pressures stemming
from lower oil prices, which I think will continue to be important.
With respect to financial markets, it is clear that credit conditions are not overly tight.
In addition, some of the evidence that President Minehan referred to with respect to investments
in Boston, discussions with other bankers, and even this morning's American Banker continue to
indicate some loosening of lending standards. We should be mindful of that as we go forward.
Finally, with respect to the international situation I, too, commend the analysis that we
heard earlier with respect to international markets. The major issue we are dealing with there is
that the recovery periods of these countries and the potential impact on U.S. prices and export
demand are still very unclear. At the time of the previous Greenbook forecast, I believed that the
actual outcome might end up being closer to the so-called "worse case" scenario than to the
Greenbook forecast. This time, I am more convinced of that. The anecdotal evidence, at least,
suggests that the Greenbook forecast as it stands now is about right. Secondly, we should also
consider our own financial markets. A number of different forces evidently are driving them, but
it is clear that we have declining inflation expectations, which we should continue to keep in
mind. The financial markets apparently do not perceive that monetary policy is behind the
curve in terms of fostering our price stability goal. I do think the dichotomy between goods
inflation and services inflation will start to come more into play going forward, but at this point
neither of them is pressing us to do anything dramatically different.
In summary, there are some clear stresses, particularly in parts of the labor market.
There are signs of a pickup in wage-induced inflation, but there also is room to believe that

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productivity gains will preclude significant wage pressures. I will admit that there are few clear
signs of moderation in economic growth or price pressures. And, finally, I think the staff has the
likely impact of Asia on our economy about right in the Greenbook, and I commend them for
that. I conclude that this is a period to wait and see. In my view, any other posture risks
upsetting a fairly complex economic and financial system that is looking for a new equilibrium.
Thank you.
CHAIRMAN GREENSPAN. Governor Meyer.
MR. MEYER. Thank you, Mr. Chairman. The forecast to which policy must respond
is now being shaped by three powerful forces. The first is the strong cyclical upturn over the last
two years. The second is the diverse set of factors--some combination of temporary influences
and longer-lasting structural changes--that have restrained inflation and resulted in a virtual
disconnect between the real sector and the wage/price sector. The new ingredient, also
threatening to be a powerful player in its own right, is the Asian turmoil. In terms of monetary
policy, we mainly have watched as the first two forces have battled to a near draw. We have
remained alert and asymmetric to be sure, but mostly unmoved. Our inaction has been rewarded
with exceptional macroeconomic performance. However, the further decline in the
unemployment rate over the past two months and the evidence of growth at a pace still well
above trend in this quarter have begun, in my judgment, to tilt the balance toward policy action
to lean against the cyclical winds, notwithstanding the continued excellent inflation performance.
Simply put, an economy growing at a pace near 4 percent and operating at a 4.6
percent unemployment rate deserves to have a little sand thrown into its wheels. The Asian
crisis will throw a heap of sand into the wheels of the economy. This should, in my judgment

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substitute for at least part of any monetary policy tightening that otherwise might have been
appropriate. This suggests the use of a comparison. How much monetary tightening would be
required to yield the same slowing in growth over the next two years as the staff now expects
from the Asian turmoil? Between the September and the December Greenbooks, the forecast for
growth over 1998 was revised downward by almost a full percentage point and over 1999 by 1/2
percentage point. The September forecast in this comparison is adjusted to reflect the same
monetary policy assumptions as in December. The effect of the Asian turmoil with allowance
for a multiplier effect accounts for most of this revision. We can compare this effect with that of
a 100 basis point tightening over 1998 as shown in the December Greenbook. This tightening is
estimated to slow growth 0.3 percentage point over 1998 and 0.7 percentage point over 1999.
The dynamics of the two shocks are quite different. Nevertheless, this comparison suggests that
the effects of the Asian turmoil might easily match or exceed the outer end of any monetary
policy tightening we might have contemplated over the next year. That is a lot of sand to throw
into the wheels of the economy. The dynamics of the response to the Asian crisis are more front
loaded, and that may be even better suited to policy objectives at the moment than a policy
tightening.
The next questions are whether the staff may have overestimated the spillover from
the Asian crisis or underestimated the momentum in the economy in the absence of an Asian
shock. The reality is that there is a great deal of uncertainty about the dimension of the Asian
turmoil. First, the situation has not stabilized in the region. Second, it is very difficult to predict
the effect of the crisis on growth in that region. And third, the degree of spillover to other
developing economies remains in question.

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The good news is that we may not have to wait long to grade this forecast. The staff
expects the effect of the Asian turmoil on the United States to occur very quickly. It may be
hinted at in a downward revision to the forecast for net exports and the less favorable mix
between inventory investment and final sales now projected for the fourth quarter. It will be
clear for all to see, according to the staff, in the halving of growth in the first quarter relative to
the fourth quarter. Nevertheless, most of the data we are likely to see between now and the next
meeting will be dominated by the monthly data for November and December and the NIPA data
for the fourth quarter. These data will more likely, in my judgment, signal momentum rather
than slowdown. So, we are likely to have to be patient and wait for the data that will come out
after our next meeting to see more clearly the effects of the Asian turmoil.
The degree of the slowdown will, of course, dictate the nature of the challenge
monetary policy will face going forward. The staff forecast, now close to where private sector
consensus forecasts have been for some time, presents one vision, a remarkably graceful
version of what I would call a reverse soft landing. We begin from an economy already
operating beyond its point of sustainable capacity, with the prospect of a slow progressive updrift
in inflation. Growth slows immediately to below trend where it remains over the next two years,
ending 1999 close to NAIRU. Inflation is restrained over the interval by a variety of factors; it
rises only modestly, and the cumulative increase is limited by the return toward NAIRU by the
end of the period. This scenario allows monetary policy to remain on hold and permits the
economy to move into the year 2000 near full employment and with inflation still low. Maybe!
But given the more balanced risks going forward, I certainly cannot rule out that the next move
might be toward ease if the Asian shock turns out to be even greater than is now projected.

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Let me offer an alternative that I believe is at least as likely as the staff forecast. This
is a forecast that already has been presented today by Presidents Moskow, Broaddus, and
Minehan. The economy slows only to trend. The unemployment rate stabilizes near its current
level, having declined by 1/2 percentage point recently without any response from us, and
inflation begins to edge upward over time. This would be a challenge for monetary policy--to
tighten into an economy that already has slowed to trend when the updrift of inflation is still only
a forecast. It is a challenge I believe we may still face. Certainly, as Presidents McDonough and
Boehne have noted, flexibility should be our key word, both in respect to the outlook and to
demands on monetary policy going forward.
CHAIRMAN GREENSPAN. Governor Kelley.
MR. KELLEY. Thank you, Mr. Chairman. At our November meeting, at least some
of us were thinking hard about tightening policy in the face of very strong economic growth, but
we were deterred from doing so by the problems of Asia. The Asian turbulence, the severity of
which was and still is difficult to judge, introduced major uncertainties, and we felt it unwise to
stir that bubbling pot further with a shift in policy. Basically, I believe that constraint still holds.
The domestic economy still looks quite strong, with what has come to be a rather standard array
of driving factors. Those factors still seem to shift about but not to weaken on balance.
Inflation, of course, remains dormant at this time. However, we do face some important
changes. The Asian concerns have intensified substantially, and their likely impact on our GDP
appears to be growing. I, for one, would bet that the news is likely to get worse before the crisis
is over. For the domestic economy, the Greenbook and many analysts see a slowing in prospect
that goes well beyond the Asia impact. It is driven by reductions in rates of growth in

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55

investments by businesses and households and a slowing in inventory accumulation. To make
this bet, I would ask for somewhat better odds, but there is a good probability of such an
outcome.
So, I find myself once again favoring a "steady as she goes policy" but with these
added thoughts. Number one, upside risks seem to me to have moderated a bit while, number
two, significant downside concerns have now emerged. Taken together, while quite substantial
in both directions, those risks seem roughly in balance. This is indeed a remarkable time. Thank
you.
CHAIRMAN GREENSPAN. President Jordan.
MR. JORDAN. Thank you. Last week we held a joint meeting of our three boards of
directors. I had asked our directors to come to the meeting to convey their own views and those
of other companies or organizations with which they confer. I asked them in particular to
compare how 1997 was now finishing in relation to their expectations a year ago and then to
characterize their outlook for 1998. The word I wrote down afterwards in summarizing all of
this was one that Governors Phillips and Ferguson already have used this morning,
"dichotomy." It was quite obvious that the economic evaluations were similar to the story of the
blind man and the elephant in that the economy looks and feels differently to different people.
Clearly, for firms in some sectors, such as metals and energy and those that compete with
imports or are engaged in exports, the year 1997 was disappointing and the prospects for 1998
are not as good as previously anticipated. In other areas, retailers and especially importers say
that business conditions are terrific and can only get better. One director reported that a real

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estate developer who operates in Ohio and Kentucky said that his industry was starting to
experience the super boom of the century.
My concerns are more along the lines of what Cathy Minehan and Gary Stern
indicated earlier about where some of the risks lie. A realtor said that activity cannot increase in
1998 because his firm barely could handle all the work that was available in 1997 and it has no
capacity to handle more transactions. Construction, at least in our region, cannot grow very
much simply because there are no additional workers to be found. A union director said that
employment in every segment of construction could increase if workers were available, but he
does not expect to be able to find them and he anticipates that employment will be close to the
current level a year from now. He said that even though union contracts are going to increase
worker compensation only about 4 percent in 1998, nonunion compensation is rising much more
rapidly. He indicated that the unions are trying to recruit and retain members by offering them
more training and a focus on lifetime considerations because they cannot keep up with the
competition for workers on the basis of compensation alone. A new problem for the unions is
how to stop subcontractors on a site from pirating employees from other subcontractors. The
unions could provide some discipline if the subcontractors were both union employers, but
otherwise there really was no discipline left on projects. Most directors said that they and other
people they talk to were concerned about the cost of attracting additional workers. One director
commented that to keep employees under current conditions, an employer did not give them a
raise within the current pay grade but jumped them two grade levels. Another argued that it was
impossible to discipline workers because of the hot job market. If an employer tried to tell a
worker that there were policies about showing up on time or the length of the lunch hour, the

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57

worker simply left and went someplace else. There is no accountability. The paradox for our
region of the country is that employment growth is so slow. We probably will report
employment growth of about 0.6 percent this year in Ohio. The increase is so low because
people are going elsewhere or there is not enough labor force growth.
On the national and international situation, I remember a meeting with my directors
about six months ago and hearing them talk about how great the U.S. economy was. I said, yes,
but the paradox is that the rest of the world is a mess. We spent quite a bit of time talking about
the rest of the world. Oddly enough, the foreign economies have gotten worse and are likely to
get worse yet. So, again the word "dichotomy" seems to fit the international context. The U.S.
economy is doing very well while much of the rest of the world is very troubled. This is not the
first time that that has happened; we have been in that situation before.
While we all recognize the problems that exporting and some import-competing firms
are having, people generally are optimistic about the next year or two. Americans are getting
richer. This is a period of prosperity. Last week in preparing for the directors' meeting, I looked
at the Blue Chip forecast that had just come out for December. It had some special questions
because of the Far East. Consistently, every participant in the forecast revised down their
forecast of real growth and inflation because of what was happening in Southeast Asia. How is it
possible that we are worse off in the sense of anticipating slower growth and simultaneously
better off with low inflation, higher real incomes, and wealth rising at a faster rate? Everybody
agrees that net capital inflows are going to be even larger than they were before. That word
"dichotomy" has to be applied to asset prices as well as to goods prices. Some Board members
referred earlier to the dichotomy between the prices of services and the prices of goods. That

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clearly is the case, but the notion of dichotomy also has to be applied in the case of asset prices
because we would not say that we have had deflation if we think in terms of what has happened
in the stock market in the last three years.
When I get that question about deflation, I usually remind the audience that in the
early 1990s we had a lot of people, including some reputable economists, writing about asset
deflation because of what they saw happening in commercial real estate. They were not
referring to deflation at all; they were simply talking about the prices of certain types of
manufactured goods that were falling, as was the case in the 1920s. I was reading some material
about the operations of the FOMC in the early 1930s. This involved a discussion of the concern
about the international situation in Britain, Germany, and Japan. As we know, some countries
turned to militarism because they experienced a depression while we enjoyed a boom in the
1920s. I decided to go back and look at A Monetary History of the United States, written by
Friedman and Schwartz. They say at one point that U.S. monetary policy was too restrictive for
goods prices and too expansionary for asset prices. That observation may strike some as
somewhat curious. I think that it's a useful reminder of what can go wrong if we are too narrow
in thinking about words like "inflation" or "deflation." When people use the term "deflation"
today to refer to the price changes of certain types of manufactured goods caused by foreign
competition, innovations, product enhancements, productivity gains, or some combination of
those factors, that does raise some questions. What do they mean by the word "inflation?"
Clearly, it cannot refer simply to the current prices of goods, whether domestically produced or
imported. We have to think in terms of the present price of future consumption.

12/16/97
Three years ago, Mexican officials said that their monetary policies were not
inflationary as conventionally measured in terms of peso goods prices or peso wages in 1994.
That was too narrow a way to think about it. One would not have found warning signs of the
problems in Southeast Asia by looking at prices of goods available in the marketplace in these
Southeast Asian economies or wages paid in domestic currencies. That is not where the problem
was manifested any more than it was where one would have found the problem in the 1920s in
the United States, when the wholesale price index fell and the CPI rose at a 1 percent rate, or in
Japan in the 1980s, when wholesale prices fell and the CPI did not increase at all. But that did
not mean that they did not have a problem.
CHAIRMAN GREENSPAN. Governor Gramlich.
MR. GRAMLICH. Thank you, Mr. Chairman. At the last meeting, I felt that from the
standpoint of domestic considerations alone, it was time to raise the funds rate. I was dissuaded
from actually voting to do so by the worrisome situation in Southeast Asia. While I still favor no
change this month, my reasoning has changed. On the one hand, events in Southeast Asia have
become much more worrisome. Last month's worse case scenario has now become the best
guess scenario, and this month's worse case scenario has gotten quite bad indeed. The impact of
the Southeast Asian crisis on the U.S. economy already generates all the demand restraint that
anybody should want. More tightening, I think, would not be called for. Moreover, there is still
the question of what I will call international leadership. The United States does not want to be
taking monetary actions that will drive up the dollar and drive down Asian currencies any more
than at present or actions that reduce the growth in overall world demand any more than at
present.

12/16/97
Domestically, too, conditions have changed. While the economy may still be on the
inflationary side of the NAIRU, that is not quite as clear to me. Recently, the Board revised its
capacity utilization figures showing much more productive capacity than was apparent earlier.
Evidently, the respondents to the survey do not feel that much capacity tightness, and the overall
utilization rate is now close to its historical average. It is not clear whether the state of demand is
best measured by labor market statistics or by the capacity statistics. Indeed, the capacity
statistics seem to be explaining price and wage changes better at present. Moreover, other
leading indicators of price increases, such as commodity prices, gold prices, and term-structure
spreads, are remarkably quiescent. All that refers to where the economy is now. If the staff is
right and we are looking at a weakening economy as we peer ahead, it may be even less wise to
be tightening now. Hence, I would favor no change in current policy.
Several speakers around the table used the word "flexibility" and I think that is a very
good word for the present time. It is frankly quite hard for me to know where the predominant
risks are, whether they are up or down. Thank you.
CHAIRMAN GREENSPAN. President McTeer, you wanted to add a few points.
MR. MCTEER. I will not insist on doing it before the break unless you want to do
that. I want to follow up on the Vice Chairman's parable of the meadow and the precipice.
CHAIRMAN GREENSPAN. Better to do it now.
MR. MCTEER. Okay. He did not mention the role of the IMF, and I thought I would
ask him about that and you, Mr. Chairman, as well. I know that the IMF does a lot to promote
movement toward market mechanisms in command economies, and they do a lot to bring
government policymakers out of an attitude of denial. But it also seems that IMF officials

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promote a lot of austerity wherever they go. They have a root canal theory of the way to get out
of difficult situations by canceling projects and so forth. If one watches CNN frequently, one
sees a lot of Asian people on the street talking about how they are going to do their patriotic duty
and stop spending money. It seems to me that there is a psychology that presupposes that the
way out of this problem situation is to stop spending. It is hard to save your way to prosperity in
an environment of collapsing aggregate demand. I wonder what we really think about the role of
the IMF in all of this.
CHAIRMAN GREENSPAN. I think the IMF has pulled back a good deal from some
of its previous statements. In addition, there has been a lot of talk suggesting that implicit in the
IMF agreement with Korea is a 3 percent growth limit. Such a limit does not exist. There is a
series of recommendations with respect to policy, which essentially rest on the issue of
disbanding the dirigiste-type of activities, the command economies that the Vice Chair was
talking about, and a series of other types of deregulatory, market-opening type initiatives from
which the IMF forecasts that the growth would be 3 percent. But there is no directive on the
issue of growth.
The interest rate issue is also noteworthy. I think there is a recognition that when we
have a degree of instability in exchange rates, which suggests very rapid changes in expectations,
small increases in the annual rate of interest are going to be overwhelmed by changes in
exchange rates. You will recall that in 1992 the Swedes tried to curb a run on their exchange rate
by raising their overnight interest rate to 500 percent. They discovered that when they divided
that rate by 365, the daily interest rate was small relative to the fluctuations they were
experiencing in their exchange rates. I believe that lesson is understood by the IMF at this stage.

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The issue really is not about raising interest rates for the purpose of affecting the exchange rate.
It is essentially a balancing of market forces and an effort to keep the money supply from
growing too fast and potentially engendering undermining inflationary pressures.
So, I do question the IMF and their tendency to use language relating to this Southeast
Asian set of actions that sounds very similar to that used to describe actions taken to counter the
inflationary, government-debt type of problems in Latin America to which that language was
applicable. Fortunately, when we look at the details of what the IMF is doing in Southeast Asia,
it turns out to be significantly less that kind of issue. The IMF is dealing with a different regime
from that associated with the problems in Latin America.
MR. MCTEER. Thank you.
CHAIRMAN GREENSPAN. First Vice President Rives, do you want to add anything
to our discussions?
MR. RIVES. Nothing that has not already been said, Mr. Chairman. Thank you.
CHAIRMAN GREENSPAN. Then, let us break for coffee.
[Coffee break]
CHAIRMAN GREENSPAN. Mr. Kohn.
MR. KOHN. Thank you, Mr. Chairman. The Committee's decisions
at this meeting, with respect both to its immediate posture in reserve markets
and to the symmetry or asymmetry in its directive, entail weighing actual
evidence of strong domestic economic activity against the prospective
effects on the U.S. economy of financial and economic developments
abroad and the possible interaction of any Federal Reserve action with
conditions in foreign markets.
Incoming data have indicated on balance that the U.S. economy has
continued to grow at an unsustainable pace. Labor markets have tightened
further and give more suggestions of mounting pressure on wages. While
there are hints on the spending side of some slackening in demand, this

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could well be another brief pause in inherently noisy statistics; judging from
continuing low levels of initial claims, employers have not yet trimmed
their hiring in response to actual or prospective softening of growth in sales.
Moreover, with the important exception of the dollar, financial market
conditions remain at least as accommodative as those that have been
associated with persistent rapid expansion this year. In fact, bond yields are
noticeably lower than they have been for some time--including rates on
corporate bonds despite a slight rise in risk premia. Although much of the
decline in longer-term interest rates since earlier this year is probably
accounted for by lower inflation expectations, real bond rates likely are no
higher than they were over recent quarters, and they could be lower. Equity
prices remain near the much higher levels reached over the spring and
summer, holding down the cost of capital and boosting wealth. And we see
no signs of additional caution by banks and other lenders in advancing
credit. The ample availability of credit and liquidity is reflected in robust
growth of late in broad measures of money. In the staff forecast, although
the economy slows substantially, the level of output remains beyond its
estimated long-run potential, and the resulting updrift in underlying inflation
begins to emerge in the second half of next year. Taken by themselves,
these circumstances might suggest serious consideration be given to firming
policy.
But developments overseas provide the important counterweight to
those at home. The dollar is higher against a broad array of currencies, as
Ted discussed. Appreciation against the Asian currencies transmits a
portion of the negative spending shocks those economies are experiencing to
the United States. Demands from Asia for our exports are further damped
by lower incomes there and possibly by financing problems that will also
constrain their ability to import until confidence in their financial systems
returns. And the dollar has risen against the currencies of industrial
economies of Europe, putting even more downward pressure on demand
and prices in the United States. Lower oil prices will reduce near-term
inflation, though they will also boost aggregate demand. Changes in the
level of the dollar and oil prices can leave a more lasting imprint on inflation
by reducing inflation expectations a little. Altogether, these influences will
override any increases in underlying inflation pressures in the next few
quarters and could well help to keep inflation relatively subdued over a
longer period without policy tightening, as now embodied in the staff
forecast.
By the way the financial markets have shaken off incoming data, it
appears that investors have placed much more weight on the potential
effects of weakness abroad than on current pressures on resources at home.
Not only have long-term rates fallen half a percentage point since the

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turmoil intensified in October, but commodity prices have dropped
substantially in reaction to the stronger dollar and prospects for weaker
global demand. However, markets do not seem to be anticipating that
problems abroad will on balance weaken U.S. economic performance
substantially. The resilience of equity markets indicates that, aside from
companies with high Asian exposures, investors do not see the foreign
difficulties as exerting enough restraint on demand and prices in the United
States to impair earnings prospects materially. Some of the decline in
long-term interest rates, probably impossible to quantify, is associated
with a flight to quality. Even allowing for such distortions, however, the
flatness of the yield curve suggests that market participants expect
short-term rates to remain near current levels well into the future, implying
that they do not anticipate inflation pressures--or economic weakness--that
would require much action on your part.
Notwithstanding the assessment of the markets and the staff, the
Committee still may view policy as somewhat more accommodative than
desirable at this level of labor utilization. It could be concerned that the
staff and the markets have overestimated the impact of foreign difficulties
on the United States. Or the Committee could view as inconsistent with its
own long-run goals the uptilt of inflation in the staff forecast or level of
inflation expectations still embodied in long-term market interest rates.
Nonetheless, there would seem to be reasons to consider postponing a
corresponding tightening action. One reason would be the effect any
tightening might have on global markets. To be sure, several countries
have tightened policy since the problems intensified in October, including
the United Kingdom, Canada, and Sweden. But their combined GDPs do
not approach that of the United States and, more importantly, their
currencies do not play the lynch-pin role of the dollar, which is, among other
things, the currency of denomination for many of the debts of troubled
Asian countries. By itself, a 25 basis point increase in short-term dollar
rates would not add appreciably to the burdens of these borrowers, whose
principal problems center around doubts they can roll over their debts. But
higher rates and the associated strengthening of the dollar would not make
their task any easier. And, unexpected tightening in tender markets does
risk an outsized response, here and abroad, especially if markets extrapolate
further policy action.
In addition, the cost of waiting for economic and market conditions to
become clearer could be viewed as rather small, even if foreign and U.S.
economies turn out to be stronger than the staff expects. With inflation
already low and declining and with inflation expectations, by some
measures, still above actual inflation, these expectations are unlikely to turn
around very quickly. Moreover, some of the influences that will be

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restraining prices in the near term should persist in any event. The dollar is
unlikely to roll back soon all of its recent increases, even if foreign markets
begin to recover, because the level of demand overseas will remain
depressed. And oil prices should be held down for some time by greater
OPEC production and smaller world demand, even if not by as much as the
staff is forecasting. It might be important to firm policy promptly if growth
in the United States appeared to be continuing at a rapid enough pace to
tighten labor markets further, but in the current circumstances it seems
unlikely that the Committee would find itself seriously "behind the curve,"
in the sense of chasing rising inflation expectations, if it waited until it had
additional information on foreign markets and the domestic outlook.
There is always a temptation to await more evidence on the state of the
economy, and the inertia this can impart to policymaking can lead to policy
errors that end up creating or accentuating business cycles. However, the
range of possible outcomes for the economy would appear especially large
at this time, given conflicting signals from data and projections and the fluid
state of foreign markets and economies. Among those outcomes is the
possibility that problems abroad could exert sufficient restraint on the U.S.
economy to warrant monetary policy easing. This possibility is what led us
to reintroduce an easing alternative in the Bluebook after a prolonged
absence. In that regard, some outside economists have marked down their
forecasts for the United States by more than Board staff owing to these
events. And, even if the staff's baseline is the best modal forecast, the
Committee might perceive some odds--albeit small--of an even worse
market disruption that could spread further and feed back more forcefully on
the U.S. economy and financial markets. In something like the "worse case"
scenario presented by Ted, it would be important for you to ease to cushion
the effects on the United States and other economies, as was assumed in that
exercise. And the worse case did not encompass a freeze up of markets and
credit availability in affected countries, which could constrain their imports
even more for a time.
If the Committee, like the market and the staff, now sees a more
balanced set of risks going forward, including the possibility of needing to
ease, it might want to reconsider the asymmetry in its directive. Retaining
the current asymmetry could be justified on the grounds that in a
fundamental sense the balance of risks remains tilted toward higher
inflation. Persistent strength in domestic demand is likely to keep the
economy producing beyond most estimates of its potential for some time.
At some point, escalating labor costs should begin to pressure prices, and
the sooner this situation is addressed, the less disruptive will be the
correction. Moreover, of course, the Committee could ease its policy stance
from an asymmetric directive toward tightening if circumstances changed

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enough. But the Committee may view the odds on tightening over the
intermediate term as having receded considerably, especially with price
increases likely to be damped for a while. And it might want to put some
weight on the original purpose of the sentences in question--that is, possible
policy actions over the intermeeting period--if it considers there to be some
potential that a worsening situation would call for a prompt response. If the
Committee shares these perspectives, symmetry might better represent the
contingencies it sees confronting policy.
CHAIRMAN GREENSPAN. Thank you. Questions for Don? If not, let me warn of
our talking about the "worst" case or "worst" around-the-world scenario because everyone here
can contemplate a case, which is far more negative than the so-called "worst" case.
MS. RIVLIN. Ted Truman, to his credit, did not say "worst" case. He referred to a
"worse" case.
MR. TRUMAN. This time we did it right; we did not call it "worst!" [Laughter]
CHAIRMAN GREENSPAN. Oh, "worse" case. Sorry about that. There is a "worst"
case, but I don't even want to contemplate it.
There is not terribly much I can add with the exception of one area that I think has not
been fully addressed in our deliberations today. We are looking at a November CPI increase of
0.1 percent. In prior months, the changes in the CPI and the PPI clearly exhibited a receding
trend in the rate of inflation, no matter how these measures are affected by technical adjustments.
In fact, we have been observing that trend for quite a long period of time in the context of still
rising profit margins, as best we can judge the latter from the most recent data.
A distinctive feature of the Greenbook forecasts in the last two or three years, which it
has shared with other forecasts, has been the projection that profit margins would begin to fall
immediately from the base period of the forecasts. This is important because arithmetically, as
we all know, if prices are not changing and profit margins are rising, unit costs are going

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nowhere. As we saw in the third-quarter profit data for nonfinancial corporations, that was
indeed the case. We do not have such data for the fourth quarter as yet, but the presumption that
unit cost increases are low and productivity is accelerating seems rather difficult to support
considering the size of the increase in the hours input, adjusted or otherwise for hours of
self-employed workers, in the available data for the fourth quarter. It will be difficult to get a
significant increase in productivity in the fourth quarter with the data we already have seen for
October and November unless the December hours numbers truly collapse. Indeed, some
softening is implicit in the Greenbook because there appears to be a very substantial aberration in
the 400,000 plus increase in the payroll employment number for November. In particular, the
seasonal adjustments are dubious, not to mention the hours figures, as was explained in Part II of
the Greenbook.
Leaving aside the measurement problems, there is no way of getting around the fact
that, on average, productivity has been accelerating over the past several quarters. We can argue
at great length about how businesses are managing their operations. Obviously, if the
technological capabilities are not there, the potential real rates of return on facilities are not
achievable. I don't care how assiduously businesses try to contain costs. If they don't have the
necessary underlying infrastructure, they will not be able to do so. But they have succeeded in
doing so, and the reason, as we have discussed on numerous occasions in the past, is that the
opportunities to improve profits clearly have been expanding. I don't know what the real gains
in underlying productivity will turn out to be in the fourth quarter. I don't know what they will
be in the first, second, third, and fourth quarters of next year. I do know that the current
Greenbook does the same thing it did last time, namely, it takes the growth of so-called total

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factor productivity--the residual in the decomposition of labor productivity growth--and turns it
significantly negative. The staff forecast of a pickup in capital deepening implies a full
percentage point slowing in output per hour between 1997 and 1998 from what it would be if
total factor productivity growth were held at its 1997 pace and another quarter percentage point
slowing for 1999. I don't think any of us knows what that number can or should be. All I can
tell you is that we keep getting reams of ever lower CPI readings that seem outrageous in the
context of clearly accelerating wages and an ever-tighter labor market in which employers are
running out of people they can hire. Yet, prices are just locked in. Indeed, as Don Kohn pointed
out, if we look at the underlying price structure, we see falling prices. The Journal of Commerce
industrial price index, which every deflationist and every bear uses to make this case, does
indeed show prices going down significantly. That is noteworthy because this is not a
particularly biased commodity price index. It may well be the best among comparable indexes.
Something very different is happening. I think the only way we can explain it is from
the output per hour side. Unfortunately, that is where our data are weakest. The behavior of
inflation suggests to me that potential output is a lot higher than we tend to assume. Leaving
aside the mismeasurement of prices, the notion that we are on the brink of a major acceleration
of inflationary pressures is correct arithmetically if we assume a stable rate of growth in
productivity. It is not correct if we leave open the potential for an acceleration in productivity.
The price data are telling us that the hypothesis that productivity is accelerating cannot be
dismissed unless the profit figures we are looking at are all wrong. I am merely indicating that
there is something quite unusual going on here, and we have been aware of this for a
considerable period of time. As I have argued many times in the past and despite the latest set of

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employment data, employment cannot increase indefinitely at the rate it has been increasing.
Leaving the Phillips curve aside, leaving NAIRUs aside, leaving everything aside, I do not know
how one can put negative people in an equation and then run it out. At some point, something
has to give. We cannot increase productivity merely by an act of will. There are upside limits,
so that if effective demand continues to grow as it has, there is no question that inflationary
pressures have to emerge. To paraphrase St. Augustine, yes, but not yet.
VICE CHAIRMAN MCDONOUGH. He said, "God, make me pure, but not yet."
CHAIRMAN GREENSPAN. I didn't want to say the first part of that! [Laughter]
There is something going on here that we have not observed in decades, and maybe decades is
too short an interval. I was startled by this morning's CPI report. We cannot keep getting such
numbers and continue to say that inflation is about to rise. As we keep projecting a higher rate of
inflation, it keeps going down, and there has to be an admission at some point that something
different is affecting prices. The growing recognition of that is the reason why markets are
reacting as they are to incoming economic information. That is why the big November surge of
400,000 in payroll employment had only a very slight market impact. I don't think the surge
affected policy expectations and economic forecasts. The markets are responding to something
that they perceive as important. We don't know fully what it is; we do not have any data; and
we probably will not for a while.
As I said last time, I do not deny that the Asian problem is a crucial issue with respect
to policy. But I think it is a mistake to say that we should be moving at this stage, absent the
Asian difficulties. That is at least a debatable issue. I probably would come out in favor of
moving if for no other reason than that this economy has been undergoing a powerful surge and

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we could not do much to harm it by moving rates up 25 basis points. It is very hard to make the
case that we have tight money when the housing market is behaving as well as it is, including the
starts figures, granted the seasonal factors, that came out this morning. So, we have experienced
unusual developments, which get compounded by the Asian situation. The Asian problem is a
fascinating one for macroeconomic evaluation because, as those of you who have been involved
in building models know, there is virtually no way that we can infer a very large impact on the
American economy from the Asian developments in light of our fairly limited trade connections.
We cannot get a very large number using the existing model structure because the latter in effect
has coefficients that essentially reflect the level of confidence that has existed over the period for
which we are fitting the model. We have to bring in a confidence-deterioration factor as an
exogenous variable to get a different result. It is very difficult to infer it in any material sense.
In theory, we can get virtually any impact we want if we remember that what we mean
by psychology is the degree to which people withdraw or reach out. In effect, it is a time
preference type of issue. When people get frightened, they disengage or pull back from
whatever they are doing. If they are involved in markets and are net long, then disengaging
means that prices go down. If they are net short, prices go up. In most markets, participants are
net long. There are very few historical periods like the Northern Pacific panic early in this
century when everyone decided that there were more shorts than there were stocks outstanding.
That led to a panic and everybody ran for cover; they disengaged. If people disengage enough,
the payments system begins to freeze up, intermediation is curtailed, and all forms of lending
contract. There is no downside in any model that is structured to pick this up, but a huge

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implosion can nonetheless occur. I don't think any econometric model would have picked up the
1929-1932 debacle without a major exogenous evaluation of how human beings behave.
There is something going on out there, and I ask myself where its impact is being felt.
Can it be on consumer confidence in the United States? I would say, hardly. There is no
evidence of it; that would require a far greater disturbance. We are just beginning to see reports
on the Asian crisis on the front pages of our newspapers. It is still not in our mindset; it is not
significantly affecting attitudes. Is bank lending pulling back here? I do not see any evidence of
that whatever. A significant pullback cannot be based on the notion that there are a lot of losses
on loans to Southeast Asia, because our financial institutions have not lent that much to
borrowers in that part of the world. Even if they lost 90 percent of those loans, it would not be a
big deal.
The only place a material effect can occur is in the combination of asset prices and
capital investments. For example, one can envisage a significant change in the equity premium
in the American stock market. The calculations that people are currently making have the equity
premium at the low end of normal ranges with very significant further increases in earnings
embodied in the relationship. At any realistic earnings forecast, stock prices will be substantially
overvalued. It is conceivable that we could get a significant implosion here. I believe the odds
are small but not zero. What that essentially does is to create a high level of uncertainty, as the
Vice Chair was mentioning. It gives us the much wider ranges of uncertainty that Governor
Rivlin referred to. A lot of us were gradually becoming concerned about the range of
possibilities, not the probabilities but the tails of the various types of distributions, which very
clearly seem to be getting more extended.

12/16/97
It is useful to think in terms of the Vice Chair's analogy about the meadow on the right
and the ditch on the left. Some of the market changes in Asia have been overdone. If financial
conditions there stabilize, the economies in that region could very easily recover, putting us back
in much the same place that we were in the sense that our economy would still be experiencing
quite strong demand. There would be some lessening of export demand because it is very
unlikely, given the trauma they have experienced, that the Asian economies will suddenly return
to 8, 9, or 10 percent rates of economic growth. If they achieve 2, 3, or 4 percent rates for a
while, that is not going to be a bad outcome. They have been subjected to a tremendous shock,
and economies do not recover from that sort of shock readily. It is going to take a while for them
to recover. But that is not the critical issue. The issue is whether their economic performance
will be severely negative or whether these countries just will not be the Asian tigers that they
once were.
As I indicated before, the IMF is facing a different type of model in its efforts to
address the Asian situation. It is not clear that the problems are going to be resolved readily. I
do not think the issue here is one of propping up a number of institutions. I believe there is a
fundamental flaw in the Asian economic model that is only becoming apparent now as their
technologies move closer to the cutting edge of technologies in the world and they begin to run
into problems because government-directed investment cannot work in highly sophisticated
economies. I do not think they believe that. They have had an extraordinary run for three
decades. You cannot tell a Korean cabinet minister that what they have been doing is wrong.
you can do a lot of things to get them to say things that sound more

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forthcoming; but you do not change a people's view of how the world works in a matter of two
or three weeks.
If there is a big flood of IMF money into Asia, I think we will find that they are going
to continue doing whatever they did before. They are going to behave the way they think they
ought to, which is what got them into trouble. Injecting a lot of IMF money would just prolong
the problem situation, but I don't believe that is going to happen. I think that there has been a
considerable increase of realism in the IMF. I do not anticipate a crisis, but I do not expect a
quick recovery. The problem is going to be with us for a good while, and I think it is going to
have generally negative effects, the extent of which I do not have any way to evaluate.
I have gone on longer than I expected. Where I come out on policy is that I continue
to believe that we will have to move rates up at some point. I see that as the most probable next
move. This assumes that the Asian problem will diminish and that the tremendous underlying
thrust that we have in our economy eventually will run into limits stemming from productivity
constraints. But if we focus on the very short run, it strikes me that the probability of our having
to move in the next month or two is exceptionally low, given the price numbers we have been
looking at. The only move that we might make in this period, if we move at all, might be to
lower rates as a consequence of some substantial asset deflation, a prospect that has a low
probability.
Accordingly, I would be marginally in favor of alternative B symmetric this time. On
the basis of the price indexes for the last couple of months, that probably is the right policy until
we see some evidence, not necessarily of consumer prices, but at least of commodity prices or
the prices of intermediate goods starting to move or some evidence of declines in profit margins.

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All of these developments will precede an acceleration of the CPI, but we are seeing none of
that, and it is going to take several months for anything like that to emerge. I think the market, in
looking at central bank policy, probably is saying that the Fed will not move until we see some
pressure on prices. It is not sufficient evidence to argue that the economy is running hot, that the
labor markets are very tight, and that there is evidence that wages are accelerating. That is
necessary evidence, but it certainly is not sufficient for a policy move unless one argues that
productivity is not accelerating, that profit margins are not expanding, and that the total unit
costs structure is beginning to exert greater pressure on prices that we are able to observe. As far
as I can see, none of that is occurring. So, I would argue for "B" symmetric. Other members
may feel that we should remain asymmetric. I could live with that without any difficulty. Vice
Chair.
VICE CHAIRMAN MCDONOUGH. Mr. Chairman, I think that "B" is the right call
and that it is a clearer choice than the intermeeting adjustment decision. I agree with you that,
absent the international events, this might be a rather good opportunity for a 25 basis point
move that could do very little harm in present circumstances and probably some good toward
achieving our goal of price stability. But given the international considerations, I believe such a
move would be very ill-advised at this time. The financial markets are thin, both because the
markets in Asia are very thin and our normally much more liquid markets are becoming thinner
as we get closer to the end of the year. So, this is not a good time for a policy move, which
clearly would be a great surprise in the financial markets.
I believe I have become something of a resident theologian on the meaning of
symmetry and asymmetry. We have been using asymmetry since the May meeting essentially to

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indicate that the central bank of the United States remembers that its primary responsibility is to
foster sustained economic growth through price stability and that the balance of risks has been in
the direction of rising inflation even though there has been no evidence in the inflation numbers
to that effect. However, I think the international situation currently demands that we be flexible
enough to respond as appropriate to unanticipated developments, so that signaling our general
anti-inflation intent with a bias in the intermeeting adjustment instruction is not desirable at this
point. We may wish to return to asymmetry at some later date. I certainly do not think we have
reached a point where we would want an asymmetric directive toward easing. That would have
to be based on the assumption of an international crisis that we are not in fact assuming. On the
other hand, I also think a tightening move would not be appropriate at this time. In my view,
there is almost a zero possibility that we would tighten between now and the next meeting.
Therefore, the best choice is to move to symmetry, largely to avoid an emotional or intellectual
bias that might make us feel that we could not respond appropriately to any critical development.
With that interpretation of what symmetry means, I believe that "B" symmetric is the right
judgment.
CHAIRMAN GREENSPAN. President Minehan.
MS. MINEHAN. In thinking about the current situation, I ask myself, where are the
risks to the forecast? Last month, I was more negative than the staff on the Asian situation, but
my sense now is that the Greenbook has it about right, although there certainly is a lot of
uncertainty about potential developments in Asia. It is possible, of course, that a "worse case"
situation could materialize. The Asian situation could get worse, spread to Latin America, affect
Hong Kong and in turn China more significantly, and the contagion could develop into a

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worldwide downturn. On the other hand, it is also possible that, given the strength of the current
data, domestic growth could fail to slow sufficiently despite retarding external effects, feeding
into a cycle of more intense wage and price pressures and ultimately into higher inflation. To
me, these risks seem fairly balanced right now, but I think the costs of being wrong are not
balanced.
If, in fact, international developments occur along the lines of the Greenbook forecast
or even get worse, we will not be in such a bad situation if we do nothing now. Monetary policy
is not overly tight. We have inflows of capital to the United States that are reducing interest
rates. We have low inflationary expectations. There is not a lot to be lost in waiting in that case.
On the other hand, if resource use is tighter than we think and economic growth is stronger than
projected in the Greenbook, we could be waiting too long. Wage inflation could get embedded.
It would then cost more to root it out, and it could cost more at a time when the strength of the
U.S. economy is more rather than less important to the worldwide situation. In thinking about
these alternative costs, I conclude that the right decision is probably not to do anything now. The
underlying situation is too uncertain in Asia. I also believe that it would be desirable to see the
price data stabilize, if not tick up, before we move on the inflationary front. But because I think
the costs of being wrong in the direction of greater inflation are more significant than if we are
wrong in the other direction, I would have a slight preference for staying with the asymmetric
directive. I would interpret symmetry and asymmetry a little more broadly than simply looking
at what is likely to happen over the next several weeks.
CHAIRMAN GREENSPAN. President Parry.

12/16/97
MR. PARRY. Mr. Chairman, in view of the situation in Asia, I certainly would
recommend against a change in rates at the present time. So, I would support alternative B. I
have a slight preference at this point for asymmetry because I do not think the distribution of
likely outcomes with regard to inflation is unbiased. In my view, it is biased toward higher
inflation, but in the short run--at least in the very short run--it may be less biased than it was in
the past. Therefore, I would not object to symmetry.
CHAIRMAN GREENSPAN. President Broaddus.
MR. BROADDUS. My policy preference today, Mr. Chairman, takes account of the
new Greenbook projection, which assumes no action on our part and has the growth of
employment barely getting down to a sustainable trend over the projection horizon. Given that
forecast and for the reasons I outlined earlier today, I still think there is a significant upside risk
in the projection, even taking account of Asia. I mentioned a number of things earlier, and one
of them was my concern about the impact of rising real wages on consumption. Some of the
comments around the table have reinforced that point for me.
I recognize, of course, that there are arguments for not moving at this point. There are
clear reasons for lying low. Don Kohn laid them out well, and you summarized them also, Mr.
Chairman. But I continue to believe that there are considerable risks to delaying action further.
Cathy Minehan mentioned some of those. Weighing the reasonably hard information we have
about current U.S. economic conditions against the softer projections, I still think, stubbornly no
doubt, that a modest 1/4 point increase in the funds rate today would be a prudent step for us to
take. It is a form of cheap insurance. In my view, not only would a small rate increase today
better position policy for unanticipated strength in the economy if domestic demand should fail

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to slow, but it would signal that we are prepared to take whatever actions we need going forward
to contain inflation. That in itself would help longer-term interest rates resume their role as
automatic stabilizers.
Let me make one final comment about flexibility. A lot of people have used the word
flexibility today. I know I am shifting the context a little here, but flexibility certainly does not
apply to our management of the funds rate. Over much of the last year, that rate has been parked
at 5-1/2 percent. That is not the way one would expect short-term interest rates to behave in an
adjusting, fluid economy. I worry that we may be introducing inflexibility by the way we are
dealing with this policy instrument.
CHAIRMAN GREENSPAN. President Hoenig.
MR. HOENIG. Thank you, Mr. Chairman. I would support your recommendation on
the "B" alternative, and I certainly would not disagree with you on symmetry. I will tell you that
I, like others, remain concerned about the tight labor markets and the possible effects they may
have on inflation, but I do not conclude that monetary policy has necessarily been overly
accommodative. I say that partly because, as has been noted, the real fed funds rate has been
above its long-run average. I know that average should not be equated to the real long-term
equilibrium rate, but still it has been relatively high. I would also mention that while M2 growth
has been above the upper bound of the Committee's range, it has not been substantially above
that range and it is projected to moderate. As I mentioned earlier, the utilization of
manufacturing capacity is near its long-term average after the latest revisions. Perhaps most
importantly, as you also noted, inflation has been quite stable. Core inflation has been stable or
declining, pipeline inflation is basically nonexistent, and various measures of short-term and

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long-term inflation expectations are stable or declining. Long-term rates have fallen in this
environment. So, I do not think that right now we are in a position to change monetary policy.
Thank you.
CHAIRMAN GREENSPAN. Governor Phillips.
MS. PHILLIPS. I support your recommendation of "B" symmetric. There is no
pressure to act now. It seems to me that there is time to see how things play out. Given the
shape of the yield curve, the recent inflation experience, and the inflation outlook, I have to
question the direction and timing of the next move. This seems to me to be an argument for
removing the asymmetry from the directive.
CHAIRMAN GREENSPAN. President Boehne.
MR. BOEHNE. I support your recommendation for "B." I think the case for staying
where we are is overwhelming today. The issue of symmetry is a more marginal decision, and I
don't have strong feelings about it one way or the other. In my view, the major case for
removing the asymmetry is that symmetry is probably a more accurate description of where
policy is. Now and then, I think we ought to be accurate. [Laughter]
MS. MINEHAN. Not to mention transparent.
CHAIRMAN GREENSPAN. President Moskow.
MR. MOSKOW. Mr. Chairman, the economy is quite strong currently, but I believe
the situation in Asia is likely to be a key restraining factor going forward. I agree that no one
knows for sure exactly how severe the Asian problems will be and how they will play out. In his
comments, Ted Truman did not rule out the possibility of a better case. It was not the best
possible case, but it was a better case. So, there is another side to this in that adverse

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developments in Asia may not be as severe as we now tend to anticipate. I agree that we should
be cautious until more of the uncertainty is resolved. While I do not favor changing policy at
this time, I do think that the risks are tilted to the upside. So, I would personally favor retaining
the asymmetric directive, Mr. Chairman, although I could live with your recommendation for
going back to a balanced directive.
CHAIRMAN GREENSPAN. President Guynn.
MR. GUYNN. Mr. Chairman, I support the recommendation for no change this
morning. After trying to sort out the crosscurrents we have discussed in the last three and a half
hours, I still have the sense that the Asian shock represents something of a substitute for a
modest policy move. I, too, could support a symmetric directive, but on balance I would be a
little more comfortable with an asymmetric directive for a while longer to make sure that the
strength in the domestic economy is not overwhelming the drag we are getting from
international developments. But, again, I can support a "B" symmetric directive.
CHAIRMAN GREENSPAN. President Stern.
MR. STERN. Thank you, Mr. Chairman. I support your recommendation both in
terms of alternative B and a symmetric directive. I do so principally because I believe there is
more than enough uncertainty to go around. We do not know how severe the Asian problem is
going to be. We do not know how far it is going to spread. We really do not know what it
means for the United States in terms of quantifying it. In light of all that, it seems to me that no
change in policy and a fair amount of flexibility are appropriate at this point.
CHAIRMAN GREENSPAN. Governor Rivlin.

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81
MS. RIVLIN. I, too, support the "B" symmetric. I don't think there is any case for

moving rates down. Were it not for the Asian problem, one could make a case for moving rates
up, but I'm not sure I would be totally persuaded by that case, given the CPI and the
productivity information. But we do have the Asian problem and we do not know how severe its
effects will be. So, it seems to me that "B" symmetric is the right thing to do.
CHAIRMAN GREENSPAN. Governor Ferguson.
MR. FERGUSON. I, too, concur with your "B" symmetric proposal. I agree
particularly with what President Stern has said. We are in an era of significant uncertainty, and I
think it is important to signal to the markets that as a responsible central bank we are prepared to
be flexible in our effort to address whatever challenges may emerge. I also recognize that this is
an intermeeting approach, and we will have a chance to rethink this in the near future.
CHAIRMAN GREENSPAN. President Jordan.
MR. JORDAN. After our action to increase the funds rate last March, we had a debate
at the May meeting concerning the desirability of a further increase--whether we should drop the
other shoe. In an environment of decelerating real growth as evidenced by an assortment of
measures, related expectations of a fairly soft second quarter, and slowing money growth, we
decided against raising the funds rate another notch. That decision was partly conditioned on an
expectation that growth in employment, real output, and other measures was going to be a lot
slower in the second half of the year in the context of fairly benign money growth. That did not
happen in the third quarter, but at the September meeting we were still looking for much
slower money and economic growth in the fourth quarter. So, we decided not to tighten policy
then either. My guess is that if we had been focusing on nominal spending growth last May or

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any of the other measures of demand people want to focus on, such as real output growth,
employment growth, the unemployment rate, or various measures indicating capacity pressures
in the economy, we probably would have raised rates at that time and we probably would be glad
today that we did. We would not have financed so much demand over the past six months that
induced a lot more imports and enabled the Asians to get themselves into a deeper hole.
However, of the various reasons for not acting now, I think the Far East crisis is among the better
reasons.
CHAIRMAN GREENSPAN. Governor Kelley.
MR. KELLEY. Mr. Chairman, as I said earlier, I think this is a remarkable time in the
sense that we face very substantial risks, both up and down. This leads me to support strongly
your proposal for a "B" symmetric directive. But there is another interesting reason for
symmetry this time. It relates to some asymmetries that I see in terms of the time frames within
which these different sets of risks might present themselves. The downside risks primarily
revolve around the Asian situation, and if that situation blows up and forces some kind of policy
easing move, that is liable to happen reasonably soon and probably fairly dramatically. On the
other hand, the upside risks that have been with us for a long time are liable to emerge over the
longer term and more slowly. As a consequence, we would have a better opportunity to respond
if that is the way to go. So, the short-term risks seem to me to be more on the downside, and we
presently have an asymmetric directive toward tightening. I would prefer not to face the
prospect, should it emerge, of going all the way from an asymmetric directive toward tightening
to an easing move in an intermeeting period. If we were to adopt a symmetric directive now, I

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believe we would then be very well positioned to respond to whatever might emerge as time goes
on, whenever it might emerge. Thank you.
CHAIRMAN GREENSPAN. Governor Meyer.
MR. MEYER. Thank you, Mr. Chairman. Given the expected effects and uncertainty
related to the Asian turmoil, I agree that we should hold policy unchanged today. Because the
risks are better balanced, I also support a move to a symmetric directive. It is, as President
Boehne suggested, likely to be a much better description of our intermeeting posture. I believe a
symmetric directive has the advantage of signaling our flexibility to respond quickly to a worse
case scenario, should it materialize, without changing our view that the next move is still likely
to be in a policy tightening direction. Thank you.
CHAIRMAN GREENSPAN. President McTeer.
MR. MCTEER. I supported a symmetric directive before Governor Kelley talked
about the relative timing of the various risks, and I support such a directive even more after
hearing his comments. It is doubtful that we will have to ease in the near future, but it certainly
would be embarrassing to ease with an asymmetric directive toward tightening. So, I support
your recommendation.
CHAIRMAN GREENSPAN. Governor Gramlich.
MR. GRAMLICH. I am for "B" with symmetry. I say that both from an international
standpoint and a domestic standpoint. The one thing that gives me pause is that if we wait to see
evidence of inflation, given that there are lags in monetary policy, it could be too late. I think
that is a cost that we need to keep in mind, but I still conclude, given the current data on the

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economy and the international situation, that "B" with symmetry is the most logical course of
action.
CHAIRMAN GREENSPAN. First Vice President Rives, do you want to add anything
to this discussion?
MR. RIVES. Thank you, Mr. Chairman. Real GDP growth through the first three
quarters is above most estimates of potential growth. Fourth-quarter estimates and forecasts are
sharply higher than they were earlier in the year. Personal spending and credit growth are
expected to end the year on a high note. The broad monetary aggregates, M2 and M3, are
growing at or above the announced target ranges. On balance, it appears that the surprisingly
low rate of inflation in 1997 may give way to higher inflation in 1998 and beyond.
Nevertheless, continued turmoil in the Asian markets argues for a steady policy prescription at
this meeting. In my view, the FOMC continues to face the challenge of when and how to lock in
recent gains on inflation. We would support "B" asymmetric.
CHAIRMAN GREENSPAN. There seems to be a very substantial majority for "B"
and a modest majority for symmetry. Would you read the directive in that context?
MR. BERNARD. The directive is on page 14 of the Bluebook: "In the
implementation of policy for the immediate future, the Committee seeks conditions in reserve
markets consistent with maintaining the federal funds rate at an average of around 5-1/2 percent.
In the context of the Committee's long-run objectives for price stability and sustainable
economic growth, and giving careful consideration to economic, financial, and monetary
developments, a slightly higher federal funds rate or a slightly lower federal funds rate might be

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acceptable in the intermeeting period. The contemplated reserve conditions are expected to be
consistent with some moderation in the growth of M2 and M3 over coming months."
CHAIRMAN GREENSPAN. Would you call the roll on that directive?
MR. BERNARD.
Chairman Greenspan
Vice Chairman McDonough
President Broaddus
Governor Ferguson
Governor Gramlich
President Guynn
Governor Kelley
Governor Meyer
President Moskow
President Parry
Governor Phillips
Governor Rivlin

Yes
Yes
No
Yes
Yes
Yes
Yes
Yes
Yes
Yes
Yes
Yes

CHAIRMAN GREENSPAN. Thank you. Our next meeting is-MR. BERNARD. February 3rd and 4th.
CHAIRMAN GREENSPAN. February 3rd and 4th. The lunch to bid farewell to our
colleague from St. Louis is scheduled to begin in about three minutes.
END OF MEETING