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Meeting of the Federal Open Market Committee
December 19, 2000

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 19, 2000 at
9:00 a.m.
PRESENT: Mr. Greenspan, Chairman
Mr. McDonough, Vice Chairman
Mr. Broaddus
Mr. Ferguson
Mr. Gramlich
Mr. Guynn
Mr. Jordan
Mr. Kelley
Mr. Meyer
Mr. Parry
Mr. Hoenig, Ms. Minehan, Messrs. Moskow and Poole, Alternate
Members of the Federal Open Market Committee
Messrs. McTeer, Stern, and Santomero, Presidents of the Federal Reserve Banks
of Dallas, Minneapolis, and Philadelphia respectively
Mr. Kohn, Secretary and Economist
Mr. Bernard, Deputy Secretary
Mr. Gillum, Assistant Secretary
Ms. Fox, Assistant Secretary
Mr. Mattingly, General Counsel
Mr. Baxter, Deputy General Counsel
Ms. Johnson, Economist
Mr. Stockton, Economist
Mr. Beebe, Ms. Cumming, Messrs. Goodfriend, Howard, Lindsey,
Reinhart, Simpson, and Sniderman, Associate Economists
Mr. Fisher, Manager, System Open Market Account
Messrs. Madigan and Slifman, Associate Directors, Divisions of
Monetary Affairs and Research and Statistics respectively,
Board of Governors

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. Oliner, and Struckmeyer, Associate Directors, Division
of Research and Statistics, Board of Governors
Mr. Whitesell, Assistant Director, Division of Monetary Affairs,
Board of Governors
Ms. Low, Open Market Secretariat Assistant, Division of Monetary
Affairs, Board of Governors
Mr. Lyon, First Vice President, Federal Reserve Bank of
Minneapolis
Ms. Browne, Messrs. Hakkio, Hunter, Kos, Ms. Mester, Messrs. Rolnick
and Rosenblum, Senior Vice Presidents, Federal Reserve Banks
of Boston, Kansas City, Chicago, New York, Philadelphia, Minneapolis,
and Dallas respectively
Messrs. Cunningham and Gavin, Vice Presidents, Federal Reserve Banks of
Atlanta and St. Louis respectively

Transcript of Federal Open Market Committee Meeting of
December 19, 2000

CHAIRMAN GREENSPAN. Would somebody like to move approval of the minutes for
the November 15th meeting?
VICE CHAIRMAN MCDONOUGH. So move.
SPEAKER(?). Second.
CHAIRMAN GREENSPAN. Peter Fisher.
MR. FISHER. Thank you, Mr. Chairman. I’ll be referring to a package of charts with a
peach or salmon cover that should be in front of you.1
The first page depicts deposit rates on forward contracts. U.S.
current and forward rates have moved lower since the last FOMC
meeting, most noticeably in a series of steps. The first such step was on
November 28th, following the release of the durable goods data; the next
was on December 5th, following Chairman Greenspan's speech to the
Community Bankers group; and rates moved down again at the end of
last week following the release of the PPI and CPI.
The current 3-month rate is now less than 5 basis points over the
Committee's target fed funds rate, and the 9-month forward 3-month rate
is now 85 basis points under the current 3-month rate. Euro deposit
rates have also moved lower since your last meeting, following roughly
the same pattern and timing as the declines in dollar rates. In addition to
moving down after the release of the durable goods orders data and after
the Chairman's speech on Friday, December 5th, they also fell last week.
The latter move was in conjunction not only with the release of the CPI
but also the report of the sixth consecutive monthly decline in the
German IFO survey of business confidence.
While the differentials have narrowed somewhat because of the
larger declines in the dollar, they remain rather considerably in the
dollar's favor. The differential in the current 3-month rate is still 160
basis points. In the 3-month and 9-month forward rates the differentials
are 125 basis points and more than 100 basis points, respectively.
As for Japan, deteriorating sentiment about the Japanese economy
is not obviously reflected in the forward rates shown in the bottom
1

A copy of the charts used by Mr. Fisher is appended to this transcript (Appendix 1)

panel, which at first glance appear to be treading water. However, I
think the convergence of the 3-month forward and the 9-month forward
rates in the last few weeks does reflect an unwinding of the modest
hopes for an accelerating economy over the next year. The current 3month yen deposit rate has ticked up on funding pressures, reflecting the
combination of the Bank of Japan's new payments system--launched at
the beginning of the year--and the normal fiscal year-end financing
requirements associated with the first calendar quarter, which is their last
fiscal quarter.
In the top panel of the next page you can see movements in the U.S.
Treasury yield curve, with the 2-year note in red, the 10-year note in
blue, and the 30-year bond in green. These yields have moved down in
roughly the same pattern as the forward rates, with the rate on 2- and 10year notes having come down by just less than 60 basis points each since
your last meeting.
In the bottom panel I've depicted the differential between dollar and
euro swap rates--the 2-year differential in red and the 10-year in blue.
The dramatic narrowing of the latter since the Chairman's speech to the
Community Bankers has been explained as reflecting expectations of a
more pronounced slowing in the U.S. economy as compared with
Europe. While that perception is around, focusing on the 10-year sector
seems to me to overstate the change in the relative outlooks. If there had
been a sharp divergence in growth expectations, one might have
expected to see a bit more of it reflected in the 2-year rates. While the 2year differential has narrowed by about 20 basis points since your last
meeting, that is considerably less than the narrowing of 46 basis point in
the 10-year differential. The explanation I have been offered by market
participants is that the pronounced fall in 10-year swap rates reflects the
needs of those who manage mortgage portfolios and have to extend their
portfolio's duration as interest rates decline in order to hedge prepayment
risks. And with thinning Treasury markets, these portfolio managers
increasingly look to agency securities and the swap market as additional
sources of liquidity to complete their hedging.
In effect, the more pronounced narrowing of the 10-year swap
differential reflects the greater extent to which the agency financing of
the housing stock is marked to market on a daily basis here in North
America as compared with Europe. Two-year rates may yet prove to be
a lagging indicator, or the short end of our yield curve may yet decline
by more than the market now expects. But as long as the 2-year
differential remains over 100 basis points in the dollar's favor, it is hard
for me to think that market participants are expecting markedly
diverging growth paths for Europe and North America.

On page 3 I've provided a set of charts on yield curves similar to the
charts I showed you at the last meeting, this time with addition of the
BB1 industrial corporate index. At the upper left is the yield curve as of
May 16th, the day the Committee last raised rates. The upper right panel
shows yields just after your November 15th meeting. The lower left
panel is for November 28th, after the release of the durable goods orders
data, and the lower right one is for December 15th, after the CPI release.
Looking from the upper right to the lower right--comparing rates at
the end of the day of your last meeting to today--you can see that the
U.S. Treasury yield curve has moved noticeably lower. One might say
that the 2- to 30-year curve now hovers around the central tendency of 51/2 percent, 100 basis points under the funds rate. The swap curve over
that maturity range has been pulled completely below the funds rate.
And 2-year A2 industrial corporate paper yields the same as the
overnight rate. The BB1 yields have moved appreciably lower, by 50
basis points in the 2-, 5-, and 10-year maturities since the time of your
last meeting.
Now, with the short ends outperforming the long ends and the better
credits outperforming the lesser credits at the long end, what seems to
me to be happening is that very different sets of concerns in the markets
at the moment are converging in terms of investor behavior. From
whatever their different starting points, investors are tending to shorten
duration and move into the higher quality credits. Those who expect a
pronounced and enduring slowdown of activity expect a considerable
easing of monetary policy and thus are positioning themselves to enjoy a
rally in the short end of the yield curve. Those who think the current
slowdown may only be a pause are concerned about the potential
volatility of GDP and thus are tending to reduce their duration in order
to minimize their exposure to the long end. Those who are concerned
about corporate earnings strains and deteriorating credit quality are
fearful of corporate event risks and are reducing the maturity of their
credit exposures while shifting into better credits. Those who have
finished their risk-taking for the year because they have a sufficiency of
either gains or losses, have positioned themselves into the short end
while they await next year’s opportunities. As the short end of the curve
and the better credits across the curve have rallied, the hedging by
mortgage portfolio managers has accelerated the movement down.
On the other side are those who think that interest rates, or at least
some portion of the 2- to 30-year curve, are at or near their bottom
because the soft landing will be achieved. In their view any pause in
activity will be quite brief or may even be over. These accounts have
been content to sell Treasury securities and swap contracts to the eager
buyers. Implicit in this view is the intriguing idea that the market has

not only led the Fed but that the market has lapped the Fed. Even as
they expect the Committee to lower short-term rates, they expect longerterm rates to be steady or rising. All of these views are usually reduced
to the simple dichotomy between those who expect a hard landing and
those who expect a soft one. On the one hand are those who anticipate a
pronounced weakness in demand and a deterioration of credit, and on
the other are those who think activity will stabilize or pick up and that
credit spreads will normalize once we pass through the typical year-end
seasonal risk aversion.
Turning to page 4, you can see some extraordinary movements in
the commercial paper market. In the top chart are spreads of A2/P2 30day commercial paper over the A1/P1 paper for all borrowers, financial
and nonfinancial, from September through February of each year since
1996. In the bottom chart are comparable data for 90-day commercial
paper. In both cases the heavy red line represents those spreads over the
period since September of this year.
Clearly, the pattern in 2000 is outside the range of recent
experience, reflecting something more than normal risk aversion
associated with the window-dressing of year-end balance sheets. In
talking to those in the commercial paper market, one does not get a
sense of crisis in the A2/P2 market. But there is a rather strong sense of
saturation of higher risk assets. Portfolios that might have carried A2/P2
paper through the year-end have more than their fill of telecom paper
and other paper, whether long-term or short-term, of questionable credit
quality. And there is this wonderful notion in the markets that event risk
is somehow different from credit risk. It seems to me that event risk is
credit risk that they didn’t anticipate or didn’t price, but they'd rather not
admit that to their superiors. Clearly, the sharpness of the jump in the
30-day spread is a function of the term rolling through the turn of the
year. However, the extent of the spike can’t be attributed to the calendar
nor can the ratcheting up of the 90-day spread.
On page 5 are the underlying data for the charts on the previous
page. Please don't try to read the fine print or take out your microscope!
Just view it from a few inches away and look at the shapes of the lines.
On the left side are the 30-day yields and on the right side the 90-day
yields; the A1/P1 rates are the red lines and the A2/P2 rates the black
lines. You can see the year-end for each year, marked by the heavy
dashed vertical line. Compare the bottom panel, which depicts the 30and 90-day yields for this year, with those above from the preceding
years. While the spike in the 30-day A2/P2 yield is quite abrupt, what is
even more extraordinary about this year compared to the previous four
years is the relative stability of the A1/P1 yields, with the 30-day yield
rising only modestly and the 90-day yield actually declining. This

seems to me to depict something of a noticeable flight into A1/P1 paper,
with that paper perhaps playing something of a safe haven role as a
substitute for Treasury bills. One can note that the A1/P1 yield for 90day paper is right around 6-1/2 percent, which is about what the market
is being rewarded for holding 2-year A2 industrial paper. That's not
much of a reward for being that much farther out in duration. Market
participants are expecting some liquidity to come back to the market in
January and for some of this extraordinary spread to unwind. The
question that we won’t know the answer to until then is by how much.
Turning briefly to domestic operations, Mr. Chairman, on the last
page are two panels on reserve needs that are similar to the ones I
included last time. The top panel depicts actual and projected
cumulative changes in reserve needs as we forecast them. The solid
orange line is our current forecast for autonomous factors. The dashed
red lines show our projections at the time of your last meeting; we've
had very modest changes in our forecast. In the bottom panel is the path
of open market operations we’re contemplating for year-end. As you
can see, we’re on course for having about $23 billion in long-term, onemonth RPs outstanding, and we expect to top off the year-end with just a
little more than $5 billion in overnight repos. This contrasts with the
more than $140 billion in repos we had outstanding on December 31st of
last year.
Mr. Chairman, we had no foreign exchange operations to report. I
will need the Committee’s ratification of our domestic operations. I’d
be happy to answer any questions.
CHAIRMAN GREENSPAN. Refresh my memory, what’s the difference between A
and P?
MR. FISHER. One is the S&P terminology and the other is Moody’s.
CHAIRMAN GREENSPAN. Which is which?
MR. FISHER. A is S&P, am I right?
MR. KOS. A is S&P, P is Moody’s.
CHAIRMAN GREENSPAN. Let me ask about the sharp drop in the 10-year swap
differentials associated with the December 5th speech. This is an arbitrage operation. What is it that
makes rates move or can induce that sort of response on an arbitrage operation?

MR. FISHER. Well, the whole yield curve began to move. I think the mortgage portfolio
managers looked at your speech and saw in it a mix of a soft landing forecast and an easing forecast
without date specificity. And they came to feel a need to rush and anticipate the hedging needs for
their portfolios this late in the year. And that, I think, drove them to grab whatever assets were
available--whether they were agency debt securities, U.S. Treasuries, or swaps--to move into to
hedge their duration risk. There was an arbitrage opportunity to wash some of this back out as our
10-year swap rate came down in a very pronounced manner, more than in Europe. But in the yearend environment-CHAIRMAN GREENSPAN. If they had those expectations, wouldn’t you expect to see
it more pronounced in the 2-year swap? It depends on whether it’s solely a mortgage hedging
operation, and it's obviously not. But the way you described it there was a sort of broader soft
landing, monetary ease notion. If that were the fundamental concept from which they were dealing,
wouldn’t one have expected the 2-year swap rate to go down more?
MR. FISHER. The explanation offered to me relates to the availability of futures market
substitutes. That is, the overall hedging market at the short end of the yield curve is so much deeper
than at the current longer end of the yield curve, the 10-year, that the result is this exaggerated
swing. And were this not happening at a year-end, the expectation is that it would have sorted itself
out more quickly.
CHAIRMAN GREENSPAN. Finally, on the commercial paper spread issue, I assume on
the supply side that there’s really no shift from A1s to A2s that would alter the supply position here.
That's a very rare event as I recall. So it’s truly the result of all of the telecom paper that they held;
they thought it was a good investment but became disenchanted. I would assume if that is true, that
the 30-day spread--in fact both spreads--would look like the NASDAQ. Does it?

MR. FISHER. I don’t know.
CHAIRMAN GREENSPAN. In other words, if you became disenchanted with telecom
A2/P2 paper, the presumption, I would assume, is that you became disenchanted with the companies.
The amount of paper issued in the timeframe it took for, say, the 30-day rate to surge couldn’t be
very much. So it had to be what they were previously holding. I have no way of knowing, but one
would assume the telecom segment of the NASDAQ would look like this, in reverse obviously. You
don’t know that?
MR. FISHER. I guess I would share that sentiment. I’m trying to rack my mind on this; I
have a sense here that the commercial paper market lagged slightly what happened to the firms’
equity values in this case, and it's playing catch-up.
CHAIRMAN GREENSPAN. What happened to efficient market theory? [Laughter]
MR. FISHER. No comment.
VICE CHAIRMAN MCDONOUGH. Different people handling the portfolio who don’t
talk to each other.
CHAIRMAN GREENSPAN. Thank you, sir, that's very helpful! Further questions for
Peter? Yes, Governor Gramlich.
MR. GRAMLICH. Peter, on your page 5, there is a very visible spike in the lower left
panel. Was there some particular event that caused that?
MR. FISHER. This is the roll into December, the point at which the 30-day paper carries
over into the new year.
CHAIRMAN GREENSPAN. President Jordan.
MR. JORDAN. On the same page, Peter, my puzzle was just a little different from the
Chairman’s puzzle on the bottom part because I was looking at the red line going up last year and

this year, and I was thinking that the A2/P2 didn’t go up as much this year. But what’s going on
with the A1/P1 that the yield is just flat across there? There's no year-end movement in it, whereas
in all the rest of the years shown on the page there was some movement even in the A1/P1 rate. And
this year it was zip.
MR. FISHER. To elaborate on what I’d hoped to convey in my remarks, I think it’s a
flight to quality issue of the substitution for Treasury bills being much more pronounced. In the
prior years, there’s a sense that the total sum of balance sheet credit to be offered is being
constrained as the intermediaries want to slim down for year-end, affecting both the A1 and the A2
market, though not quite equally. But you can see the impact in the prior years. What is quite
different this year is that there doesn’t seem to be any constraint on the A1/P1 market. So it doesn’t
look like a quantity constraint. It looks like a flight to quality. They’re substituting for Treasury
bills and maybe the A1 market is being pulled down a little by the rally in Treasury bills.
CHAIRMAN GREENSPAN. Any further questions for Peter? Vice Chair, do you want
to use your usual-VICE CHAIRMAN MCDONOUGH. Move approval of domestic operations.
CHAIRMAN GREENSPAN. I usually don’t get the request for a motion out in time!
You move approval before I get the words out.
VICE CHAIRMAN MCDONOUGH. Well, I’ll tell you what I was thinking about. In
further answer to Jerry Jordan’s question, if you look back at 1996-97, the A1/P1 line was very flat
then. In 1997-98 we had the Asian crisis, in 1998-99 we had the Russian crisis, and in 1999-2000
we had Y2K. So one can argue that this year is the closest thing we’ve had to a normal year since
this time in 1996. I don’t know if that’s valid, but that’s what I was thinking of when I forgot to
move approval of the domestic operations.

CHAIRMAN GREENSPAN. If you say it fast enough, it has a certain tenor! Shall we
move on to the economic report? Dave Stockton and Karen Johnson.
MR. STOCKTON. Thank you, Mr. Chairman. I thought that
perhaps I could make a useful contribution to the meeting this morning
by dispensing with my usual briefing and moving straight to the question
and answer period. And, as a holiday offering to you, I propose to pose
the questions, as well as answer them.
In my view, there would appear to be three principal questions
surrounding the changes that we have made to the Greenbook forecast.
First, has the staff overreacted to the accumulating signs of a slowing
economy, many anecdotal, by marking down substantially our near-term
forecast? In that regard, we revised down our outlook significantly in
1995 and 1998 when signs of slowing emerged, only to discover a few
months later that the expansion had lost little or no momentum. Second-and conversely--is the staff ignoring some powerful signals that the
economy is moving through a cyclical turning point and that a cumulative
contraction in activity may already be under way? After all, as I noted in
the July chart show, the staff--and for that matter virtually all economic
forecasters--fail to reliably predict recessions. And finally, is it possible
that the staff’s projection of slowing growth and an attendant easing of
resource pressures--without recession--could be correct?
Let me begin by answering the final question, both because it is the
simplest to answer and because it provides my implicit response to the
first two questions. I think I can safely say, with probability
approaching one, that the staff forecast will not be correct. Exactly how
we will be wrong, of course, is not clear. But I do think a reasonable
case can be made that what we are currently experiencing is a sharp
slowing of aggregate production, rather than either a temporary dip in
growth or an outright broad-based decline in activity.
There can be little doubt that the signs of a significant and
widespread slowing in real output have continued to multiply since the
last meeting. As a consequence, we have knocked about 1 to 1-1/2
percentage points off of our projection of real GDP growth this quarter
and next, and we have made somewhat smaller downward adjustments
to our forecast beyond the near term.
The most dramatic developments have occurred in the motor
vehicle sector, which accounts for roughly half of the near-term
downward revision that we have made to the forecast. Sales of light
vehicles have declined in recent months, and we are expecting a further
noticeable drop-off in the pace of sales into the first quarter. Faced with

clear evidence of a more persistent slowdown in sales, it now looks as if
the automakers are poised to move more aggressively to rein in
burgeoning inventories. Rather than prop up sales through a further
sweetening of incentives, the manufacturers are cutting production
schedules. Moreover, we are expecting that these already-reduced plans
will be marked down further and that some currently scheduled holiday
shutdowns will be extended into January. Even with the prompt and
sizable production cuts we have envisioned, the inventory situation is
not likely to be cleared up until the spring.
Neither sales nor production of light vehicles as yet have exhibited
a fall of cyclical dimensions. The same cannot be said of heavy trucks-a sector where the term “recession” can be applied fairly. By the first
quarter of next year, we expect production of medium and heavy trucks
to be only about one half the level of a year ago. Moreover, with order
backlogs severely depressed, we are not expecting a perceptible
recovery any time soon.
The weakness we are seeing in factory activity, however, extends
beyond the motor vehicle manufacturers. To be sure, some of the
apparent softness reflects the indirect effects on upstream suppliers to
the motor vehicle industry--for example, fabricated metals, textiles, and
semiconductors. But evidence of inventory overhangs and of
accompanying production adjustments has become apparent over the
past couple of months in a broad range of industries. The production of
appliances, machinery, steel, paper, and lumber has declined over the
past month or so. Heightened competition from imports also has
weighed heavily on some of these industries, especially steel and
lumber. Adding to these difficulties, there has been a marked slowing in
the production of computers and microprocessors.
All told, we are now projecting manufacturing output to decline in
the first quarter before turning up in the spring. We are anticipating that,
going forward, manufacturers will move reasonably promptly to work
off undesired inventories and to adjust to a slower pace of final sales
growth.
In that regard, we think that the growth of private demands has
slowed over the course of this year and that the slowdown will intensify
in coming months. In addition to the falloff in sales of motor vehicles,
other consumer spending has slowed--though by just a bit more than we
had been anticipating. But given the recent deterioration of consumer
sentiment and our projection of a further slowing in job gains, we have
lowered our forecast for the growth of real PCE noticeably in the near
term to about 3 percent. That’s still not shabby, but it’s a far cry from
the 5 percent plus pace of the past few years.

The downward adjustment that we have made to our forecast for
equipment and software spending over the next few quarters, I’d have to
admit, is a bit more speculative. Indeed, the data on orders and
shipments of capital goods actually came in a bit stronger than we had
projected in the November Greenbook; so our revisions here are more
forecast than fact. That said, the tightening of financial conditions this
fall and the apparent slowdown in the growth of output and final sales
seems very likely to take a toll on capital spending in coming months.
In addition, we have marked down further our projection for hightech equipment spending. There has been a gradual evolution in the
stories that have been told about this sector over the past four or five
months. The initial signs of weakness were attributed to firm-specific
problems of market share. Then, the difficulties were ascribed to the
weakness of the euro and the associated softness in profits earned
abroad. Now, with most firms and nearly every market segment
experiencing sales and earnings disappointments, there is more troubling
talk of a global slowdown in demand.
Accordingly, we have reduced our forecast of business spending on
computers, software, and communications equipment, with the largest
revisions occurring over the first three quarters of next year. Our
projection of spending on high-tech equipment has more of a cycle now,
with the coming year being one of comparative weakness followed by
some recovery in 2002. We continue to believe that a rapid pace of
technical progress will create profitable opportunities for investment in
this equipment over the longer haul. Moreover, to the extent that there
has been over-investment in these goods, the situation should prove
relatively short-lived. In contrast to the situation with respect to office
buildings in the late 1980s, the pace of technical progress is rapid
enough in the tech sector that a firm can probably carry a quarter of its
IT equipment out to the dumpster every year--an action that is a bit more
difficult to take with an office building.
Taken together, we see a confluence of factors combining to
produce a period of very subdued growth and rising unemployment over
the next several quarters. But we are not yet forecasting recession.
There certainly have been several developments in recent weeks that could
be read as signaling the onset of a cyclical downturn. These include, most
notably, the steep rise in initial claims for unemployment insurance, the plunge
in consumer sentiment in December, the declines in industrial production in
October and November, and the widening scope of downward revisions in
expectations of corporate earnings. This is a configuration that could be
consistent with a cyclical turning point.

The problem is that these same developments are also consistent
with a sharp slowing in activity, not just outright declines. We would
expect further increases in initial claims, if payroll employment growth
slows to the 30,000 to 40,000 monthly pace that we are expecting this
winter. Consumer sentiment also should be expected to deteriorate
further if our macro outlook comes to pass. Industrial production has
declined outside of recession periods in the past. And, a flattening out of
corporate earnings should be expected to accompany a cyclical slowing
of productivity and an updrift in labor compensation in an economy
where there are some restraints on pricing power.
We are acutely aware that this interpretation of recent events could
be analogous to that of the proverbial man who jumps off the roof of the
building and reports as he passes the third-floor window, “So far, so
good.” And we cannot rule out that the economy, like the man, will
experience a hard and painful landing. But, we think the odds favor a
continuation of positive growth, and we still do not yet see enough
evidence to persuade us that we have entered, or are about to enter,
recession.
If the economy manages a downshift in growth while escaping an
abrupt contraction in activity, there are forces that should be working to
support aggregate demand next year and into 2002. Oil prices already
have retraced some of the spike observed this fall, and futures markets
and our forecast anticipate further declines in the quarters ahead, giving
a boost to domestic incomes. The dollar has come off its recent peaks,
and a further projected decline should support faster growth of exports
later next year. While considerable uncertainty surrounds the fiscal
outlook, it is difficult to imagine any greater restraint going forward and
not far-fetched to imagine much greater ease. And, finally, despite some
minor downward adjustments of late, we remain optimistic about
underlying productivity developments, and we expect longer-term
income trends to be favorable.
Because we are projecting a more substantial slowdown in activity
next year than in the last Greenbook, labor market pressures abate more
quickly in this forecast. Indeed, those pressures are now about fully
offset by the indirect effects of declining oil prices on business costs and
on nominal compensation. As a consequence, we are essentially
projecting no further acceleration in price inflation, with core PCE and
core CPI inflation leveling off at a 2 and 2-1/2 percent pace,
respectively, over the forecast period.

All in all, I guess I’m not bringing you tidings of great joy. On the
other hand, it's not yet a big sack of coal. With that, I’ll turn the floor
over to Karen.
MS. JOHNSON. Let me first update you on the implications for
our outlook of the data we have received since the Greenbook forecast
was finalized. Last week the balance of payments data for the third
quarter were released, and this morning trade data for October became
available. The nominal trade balance narrowed slightly in October to
$33.2 billion, with exports and imports both decreasing from their
September figures. On balance, these data released since last
Wednesday imply small changes to our outlook for the external sector
that net to essentially no change from the net export projection we
presented in the Greenbook.
In putting together this forecast, we revised down our projection for
growth in our trading partners, with the downward adjustment averaging
about 3/4 percentage point at an annual rate in the near term but
diminishing over the forecast period. The extent of revision varies
across countries and regions. Still, real output growth abroad should
remain moderately strong and rebound a bit from the 3-1/4 percent pace
that we project for the near term to around 3-3/4 percent by the second
half of 2001 and during 2002.
Three different sets of factors have become more visible over the
intermeeting period, leading us, as well as others, to become less
optimistic about the global economy. First are the direct effects of
slower growth of the U.S. economy on the rest of the world. These
effects are strongest on our closest trading partners such as Canada and
Mexico but are significant elsewhere as well. In this set of factors I
include the projected impact on exports and imports that the improved
competitiveness of U.S. products in all markets that results from the
change in the value of the dollar is projected to have.
A second set of factors relates to the indirect effects of recent
developments in the U.S. economy that are transmitted through global
financial markets. These include widespread equity price declines,
higher spreads for emerging market debt, and generally reduced
willingness to bear risk. To some degree, these shifts are happening in
global markets as investors react to changed perceptions about the U.S.
economy and earnings prospects and rebalance their portfolios in order
to reduce overall risk or respond to major valuation changes. Less
optimistic expectations for the high-tech sector in the United States and
the pace of “new economy” investment translate into reduced profit
projections for industries in that sector globally, and the equity prices of
those firms have been depressed in most markets. These financial

market channels in turn have an impact on business and consumer
confidence and wealth abroad that lessens the outlook for domestic
demand in those countries.
Finally, a third set of factors relates to developments in the global
economy not associated with recent U.S. developments that imply a less
robust pace for foreign output growth. In principle, there are similar
factors that would boost foreign growth, but the last five weeks do not
seem to have yielded many of these. In this category belong financial
pressures in Argentina and in Turkey, which have become urgent.
Although right now it appears that with the support of the IMF these
countries will avoid financial collapse and a forced change in exchange
rate regime, their prospects are darker than in November. In the case of
Argentina, the effects of this crisis on other emerging market countries
in the region have led us to reduce our forecast for output growth in
Latin America a bit more than we would otherwise have done. Political
stresses in some Asian economies, including the Philippines and
Indonesia, are an additional negative factor. In Japan, consumption
remains weak and the recovery has not succeeded in becoming
established. These developments are largely in line with our prior
expectations, which have been more pessimistic than consensus
forecasts. However, the prolonged failure of the Japanese economy to
rebound makes adjustment in the Asian emerging economies all the
more difficult.
We have no precise way to separate and measure these three sets of
influences on foreign activity. The indicators that we rely upon to guide
our near-term forecast, such as orders data, confidence surveys, and the
elements of production, reflect all of these channels at work. The staff’s
global econometric model tells us that a shock to U.S. investment
demand spills over to reduce average foreign GDP growth after four
quarters by about one third of the total impact on U.S. GDP growth
when U.S. monetary policy responds according to a Taylor rule. The
effects are strongest on Canadian and Mexican GDP growth, as would
be expected. This corresponds to what I have termed above the direct
effects of weaker U.S. growth.
In revising down our outlook for foreign growth by more than this
one-third rule of thumb would suggest, we have given some weight to
indirect effects not captured in the model. In particular, we think several
developing Asian economies rely heavily on the electronics industries
and will be hit hard, including through indirect financial channels. In
addition, a combination of wealth effects and blows to consumer and
business confidence are expected to reduce the growth of domestic
demand somewhat in several other industrial countries. We have no
illusion that we have gotten this just right. Clearly, we can imagine

“worse case” outcomes in which a global cycle of reduced demand,
diminished prospects for profits, asset price declines, and some further
reductions in demand spiral sharply down. But we think there are
macroeconomic safeguards out there, particularly in Europe and Canada,
that will moderate the deceleration in economic activity abroad and spur
an acceleration later in 2001 and 2002. Important among them are
planned fiscal stimulus and reasonably favorable credit expansion
conditions.
While I cannot point to significant positive developments that
would have worked to offset those pointing to downward revision, there
are some steadying influences that at least kept our pessimism in check.
Real output growth in China remains solid and should help to support
activity in Asia. Global oil prices still seem poised to decline
significantly going into next year. And growth in Europe, while
moderating, should remain sound.
We would be happy to answer any questions.
MR. BROADDUS. Mr. Chairman, I don’t really have a question but I have an issue I
want to raise if no one is going to ask a question. I’m not sure this is the right time to do it, but I
don’t know when else on the agenda to do it. The issue relates to the new legislation that reinstitutes
our semi-annual monetary policy reports. I believe that legislation requires you to testify, among
other things, on the objectives and plans of the Board and the Committee with respect to the conduct
of monetary policy, as well as on economic developments and prospects for the future. I think it’s
interesting because before, under the Humphrey-Hawkins legislation, our statements in the report on
our objectives and plans had to be tied to the growth of the monetary aggregates. Under this new
legislation, as I understand it, the ball is really in our court in terms of how we present that report;
the legislation hasn’t instructed us to do it in a particular way or tied our hands in any respect. It
seems to me that this might give us an opportunity to consider some approaches like inflation
targeting that we have been reluctant to consider before because we might be seen as preempting the
Congress. I was just wondering: Are we perhaps going to be able to look at some options on this?

CHAIRMAN GREENSPAN. President Broaddus, I think not. In my view that legislation
was merely a compromise to get the reporting requirement through and reinstate it. If the issue of
how the statistics are presented or evaluated is disputable, it is on a very minor level. The notion of
whether we go to a specifically different type of policy structure has greater content in it, and if we
did that I believe we would find that all of a sudden blatant concerns would emerge in the Congress.
So I would not misread what the passage of that legislation was. It was one of those last minute,
patching together types of compromise, and if anybody thought something was being substantively
changed in the process, they would have objected. The presumption on the part of everybody is that
although it involved a language change, everything remains the same. If we indicated that we were
shifting our approach to this--I guess it’s no longer called Humphrey-Hawkins--one side or the other
would have developed a fairly strident position against us. It is conceivable that at some later date
that we might be able to do what you suggest, but to do it before enabling legislation would be ill
advised. We should in no way misread the changes in the legislation as substantive.
MR. BROADDUS. If I may say so, I would hope that we would look for opportunities to
consider alternative approaches. It worries me that we no longer have anything like the ranges for
the aggregates, which for all of their weaknesses in recent years were a fairly objective anchor, at
least at the beginning, for our longer-run policy actions.
CHAIRMAN GREENSPAN. I think it certainly has been the general view of the
Committee, as evidenced by the nature of our discussions, that long-term price stability is our
objective. It’s unambiguous, unequivocal, and I would say held pretty much by everyone around
this table. The only operative question is whether it is statutory or not. And were we to try to make
it statutory, I suspect we’d run into some very significant resistance.
MR. BROADDUS. Okay.

MR. KOHN. In support of your perceptions, Mr. Chairman, there actually was an attempt
by some senators to embody an explicit price stability goal in the legislation. And others who were
involved at the committee level objected to that and did not want to go to that point.
MR. MEYER. Just one point to follow up on that: One possible way to operate is to note
that while we’re no longer required to report targets for the monetary aggregate it doesn’t mean that
we shouldn’t be monitoring and looking at them. They still play the role of anchoring a sense of
inflation targeting.
CHAIRMAN GREENSPAN. Vice Chair.
VICE CHAIRMAN MCDONOUGH. Mr. Chairman, two points: One, I associate myself
with your comments 1000 percent, which is 10 times more than the usual enthusiasm with which I
support your views.
CHAIRMAN GREENSPAN. Last time I recall 1000 percent being used that way was in
a Presidential campaign [laughter] and it didn’t work out very well!
VICE CHAIRMAN MCDONOUGH. This will work out better! My second point is on
the staff presentations. I think the reason there seem to be no questions or comments is that the
presentations were remarkably good and extremely well balanced. I'd like to note that I thought
Karen’s presentation of the balance of risks internationally was right on the mark. I wouldn’t
disagree with a single thing she said.
CHAIRMAN GREENSPAN. President Poole.
MR. POOLE. I agree that the presentations gave a very nice sense of the uncertainties
that we face. I have a question about the inventory situation, given that inventories are so often a
major part of cyclical processes. My impression from looking at the data and the charts is that
inventories are not far out of line. We have nothing like the kind of inventory situation that we’ve

seen at cyclical peaks, where inventories clearly have blown up, leading to a substantial cut in
production. Yet there are areas where there are inventory concerns. Could you elaborate a bit on
the inventory situation? What is the right sense of that?
MR. STOCKTON. I think your description is pretty close to the one that I would give as
well. There has been some backing up in inventory levels. If we went back four or five months, we
would have been hard pressed, outside of maybe some hints in automobiles, to see much in the way
of inventory problems developing. But in recent months we have seen some heaviness of
inventories in a variety of areas. Obviously, the automotive sector is one where they have built up
quite a bit. Steel is another. I gave a list of areas where we’re seeing a buildup. But it doesn’t yet
look like a recession-type scenario in terms of the magnitude of the rise in inventory/sales ratios.
And in our forecast we are assuming a quite prompt adjustment in production--we think we’re
already seeing it--that is going to prevent such a situation from developing and then lead to the kind
of normal cyclical turn that one might expect. Obviously, that’s predicated on our underlying view
about final sales not falling out of bed either. If there really were a significant contraction of sales
over the next months, what doesn’t now appear to be a terribly troubling inventory problem could
become one relatively quickly. So we see us getting through this with a production adjustment and a
period of some decline in industrial production, but not one that spills over to a business cycle
adjustment. Nevertheless, we’re nervous about that situation.
CHAIRMAN GREENSPAN. May I just raise a caveat with respect to that? Historically
during recessions we basically were looking at an essentially trendless inventory/sales ratio. And the
types of cyclical patterns President Poole was referring to involved bulges that looked obviously far
greater than the one that we now have. But in the last decade we’ve had declining inventory/sales
ratios. The point really is that inventory excess is essentially in the eyes of the beholder--or more

importantly, in the eyes of the beholder who has his hands on the production lever. And I think we
have to use a different measure to make a judgment as to whether in fact the true underlying trend is
still heading down. In this case, if you tilt the trend, the bulge looks big. The only statistic we have
to help make that judgment is the answer to a question in the National Association of Purchasing
Managers monthly survey of manufacturers, "How do you evaluate the inventories of your
customers?" And since by definition all inventories are produced either by a manufacturing or
mining or some other goods operation, presumably we have all of the customers represented
implicitly in that sample. That number has started to move up and is now at a somewhat elevated
level relative to the past. But the series is not long enough, as I understand it, to give us a reliable
analytical basis. We actually recommended that the question be put in the survey. Was it a couple
of years ago now?
MR. STOCKTON. Several years ago.
CHAIRMAN GREENSPAN. Okay, several years ago. But that number has moved up,
which does tend to square with what Dave Stockton is saying. It's not an abnormal concern, but
clearly it is edging up. Were final sales to slow, my suspicion is that that particular number would
go up quite noticeably. But reading inventories is not as easy as it used to be. In the past, people
didn’t know precisely what their inventories were, and as a consequence they rose very rapidly at
times and were unambiguously out of line and recessions happened--usually before people had the
inventory numbers that told them inventories were too high. So this is a different type of situation,
but one that still can be a potential problem.
MR. KELLEY. One more comment on inventories? As one who in an earlier incarnation
had responsibility for managing inventories, the technology that’s available to managers today is
light years better than we used to have some time ago--not only information technology but many

other things as well. As a consequence, there's a micro control capability, absent an absolute decline
in final demand of course. That ability to micro control is going to lead, I think, to more little saw
tooth type variations in inventories rather than the large waves that we saw earlier. And I would
submit that the likelihood is that the inventory recessions that we remember historically are a thing
of the past.
CHAIRMAN GREENSPAN. One would almost assume that, on the grounds that in fully
automated retail establishments the bar codes check out what is being sold and items are
automatically reordered. So the long lag in bookkeeping, where inventories could build up before
one knew it, no longer exists. Adjustments occur very quickly. If sales go down, boom! Suddenly
there’s a big shift in the purchasing pattern. The question, however, is how prevalent is this totally
automated system. I think the answer to that is only partly-MR. KELLEY. But perhaps increasingly.
CHAIRMAN GREENSPAN. Yes, no question about it. In fact the "only partly" issue is
the answer to how far out on the S curve we are in a technological sense. President Parry.
MR. PARRY. Dave, in the forecast, your estimate of potential growth for the next two
years is in the low 4 percent area or something like that. We have forecast GDP growth of 2-1/2
percent, roughly, and have discussed the risk that it could be even slower than that--perhaps by a
percent or two. Should our response and thoughts about policy be different now, given that potential
is quite a bit higher than in the past? In other words, should the prospect of 0 to 2 percent GDP
growth generate the same level of concern that we would have had maybe five years ago with a 0 to
-2 percent forecast?
MR. STOCKTON. I think that's a very interesting question. It's one that we’ve been
kicking around, but I'm not sure we have a complete answer to it. It's obvious in some sense that

with higher underlying potential output growth, a 2 percent shortfall would still give us growth of
around 2 to 2-1/4 percent whereas when potential output was 2-1/4 percent growth could be near 0.
However, as to whether or not you should be thinking about it entirely differently, the one caution I
would provide is that I think there are still likely to be cyclical events. Those could be sharp,
nonlinear type events that would drive a growth rate from 4 percent to 2 percent simply because
there is a rather abrupt change in expectations--a significant shift that would produce a situation that
would look like a recession. It wouldn't just be a slowing in growth from 4 percent to 1 or 2 percent.
It would have the look and feel of a recession even if the numbers were a little higher than in the
recessions we have experienced in the past, with very rapidly increasing unemployment and
cutbacks in consumer spending that would be related to shifts in consumer sentiment. So in that
regard I think the way you approach some of the risks to the economy still ought to involve thinking
that there is the potential for highly nonlinear events to occur. And your response in that sense ought
to be the same as you thought about it in the past.
MR. PARRY. But the consequences of the growth rate declining to, say, 0 to 2 percent
could be even more significant. One could get greater employment effects et cetera., and the impact
on inflation eventually could be even stronger.
MR. STOCKTON. Yes, I agree. That is absolutely correct.
CHAIRMAN GREENSPAN. Further questions for our colleagues? If not, would
somebody like to start the Committee discussion? Go ahead, President McTeer.
MR. MCTEER. In the Eleventh District the slowing economic growth that I've reported
at the last two FOMC meetings has continued and has become more widespread. Weaker growth is
apparent nearly everywhere. At last Thursday's board of directors meeting there was considerable
discussion of anemic retail sales and the enormous discounting of merchandise--to a degree not seen

in many years. Construction activity has been declining throughout much of this year and the
softening in that sector has spread to construction-related manufacturers.
New capacity coming on line in a number of industries is exacerbating the effects of
slowing demand. Manufacturers of petrochemicals, metals, and cement indicate that they have
stopped hiring and have laid off workers. These industries also report rising inventories and falling
prices. The widely reported softening of sales and profits in computers, semiconductors, and
telecommunications equipment has muted the growth outlook in Texas due to the concentrated
presence of these industries. Even in the services sector, employment growth is half what it was
earlier this year. Law firms seem to be unaffected. They just shift their specialty from new
incorporations and IPOs to bankruptcies! Parenthetically, there's an ad on the radio that I hear every
morning when I’m driving to work. A law firm advertises itself as a small boutique for taking care
of your intellectual property and class action needs. [Laughter] They're straddling the old economy
and the new economy.
At last month's FOMC meeting, I noted the deteriorating mood of the Dallas Fed's
directors at recent meetings. Their negative view of the current economic environment and the
outlook showed further deterioration at last Thursday's meeting.
Turning to the national economy, let me raise this question: What do we know now that
we didn't know at the time of our November meeting? For one we know that the political
uncertainties we faced then were not a short-term phenomenon. The uncertainties go well beyond
vote counting and constitutional interpretations and will be of longer duration. Second, we know
that the economy is much weaker now than anticipated a month ago. The "R" word is now used
openly just about everywhere, and even the Greenbook authors felt obliged to include a hard landing
scenario. Third, inflation risks are somewhat lower than contemplated a month ago. Virtually every

projected measure of inflation on page I-11 of the Greenbook is lower this time than last. And
fourth, the psychological mood of the country has deteriorated in some cases and nose-dived in
others. We see it in consumer confidence measures and we hear it in the media and in our own
boardrooms.
When I put all this together, I see a cumulative, compounding, downside risk to the
economic outlook. Adding to our difficulty is the reality that the Fed is the only economic policy
game in town for at least the next several months and maybe longer. Discretionary fiscal policy is
likely to be on hold for months to come. Still worse, the debates that we will be hearing about
dozens of tax and spending plans will lead businesses and households to postpone important
investment and spending decisions until a clearer picture emerges on what will actually pass the
political process. Adding to the psychologically based economic pulling back that we've already
seen, the international risks to our economy have also shifted. Estimates of growth abroad have been
scaled back. Several important countries are facing a downshifting in their rate of growth, adding to
their already serious financial strains. Evidence of new financial strains in the United States has
been appearing daily. Tighter credit conditions for all but the most exemplary credit risks are adding
to expectations of inventory price reductions.
As the Bluebook points out on page 8, there is considerable cost in policy inaction. We
could wait and see what new information we get between now and our meeting at the end of
January, but I sense that the deterioration in the economic situation will likely accelerate in the
weeks ahead. If we wait, I think we will find ourselves at our January meeting wishing that we had
adopted the Bluebook's alternative A. While a 4 to 4-1/2 percent real funds rate may have been
appropriate earlier this year when the economy and productivity growth were much stronger and
credit conditions were much easier, a lower rate is called for currently. Easing today would be

awkward if not embarrassing because of our current bias. However, making an awkward right
decision for the economy is preferable to making a face-saving wrong one.
CHAIRMAN GREENSPAN. President Minehan.
MS. MINEHAN. Thank you, Mr. Chairman. Current data suggest that the New England
economy continues to grow at a solid pace, with very low unemployment and higher inflation than
the rest of the nation. But recent Beigebook and other contacts suggest an increasing sense of
caution about the future. In addition, a survey we conducted related to the use of stock options as a
form of compensation raises concerns about increasing wage pressures.
New England's rate of unemployment declined again in October to 2-1/2 percent, a new
series low. Connecticut, at 2 percent, recorded the lowest state jobless rate in the nation but
Massachusetts wasn't far behind. And even the two New England states with the highest rates of
unemployment, Rhode Island and Maine, are below the national rate by 1/2 percentage point or
better.
We've been watching a new Web-based electronic job monitoring service called “Flip
Dog” that began last spring. According to that index, Massachusetts ranks number one in electronic
job vacancies relative to the size of its labor force and in absolute size is second only to California.
In addition, according to this service’s job opportunity index, which ranks highly competitive labor
markets with insufficient pools of qualified labor and the need for new workers from out-of-state, all
New England states ranked in the top 10, with Vermont and Massachusetts numbers one and two.
Obviously, this is a new source of data and it's hard to know its accuracy. However, it is completely
in tune with the region's reported unemployment rates and the anecdotes we continue to hear about
labor being extremely hard to find and increasingly expensive. In fact, recent Commerce
Department data on personal income for all workers, not just production workers--including hours,

tips, and bonuses, as well as wages--indicate that per employee income rose by 6-1/2 percent in the
region from Q2 1999 to Q2 2000. That is 2 percentage points higher than in the nation as a whole.
Looking forward, Beigebook and other contacts were more cautious than they have been,
particularly in the manufacturing and retail areas. Software and temporary agency firms still see
very tight labor markets and view the demise of some dot-coms as an opportunity to get skilled
workers that have been in very short supply. Manufacturers have been doing fairly well, especially
in export markets, but sounded concerns about future prospects. In particular, retailers such as WalMart have cut back orders, and companies in the high-tech arena mentioned concerns about
softening demand on both the consumer and the business sides. One

CEO

of a very large bank, recently held a two-day planning session aimed specifically at reducing costs
by 10 percent or better, given the expectation that revenue growth would be slower than expected in
2001. An investment manager of a local large insurance company reported bond losses in 2000 that
were more sizable than expected and a real sense of caution looking forward. Thus, even in the face
of continued regional job strength, export growth, and rising wages and house prices, it is also
increasingly clear that the future is more in doubt and that expectations are gloomier now than they
have been.
This sense of increasing uncertainty has characterized the incoming national data since
our last meeting. We, like the Greenbook, have revised our forecast for consumption over the near
term. Given relatively weak personal income and real consumption, a weaker stock market, and a
serious drop in motor vehicle spending, we've revised that forecast to the mid-2s along with the
Greenbook, with GDP growth at about 3 percent or a bit below. This slower pace of growth
continues through the first half of 2001 as it does in the Greenbook, with some pickup in the second

half. We're a bit agnostic about the Greenbook's assessment of potential, so we see less of an uptick
in unemployment and a bit more price pressure, but overall not enough to quibble about.
The interesting question that Dave Stockton and Bob Parry talked about, regarding what is
the definition of "weak" in a high potential economy with growing structural productivity, is
something we've debated a bit, too. And I think some of the numbers in the Greenbook baseline
projection stand out simply because of the way the two factors--the higher productivity and the
slower growth--play out. In particular, I really focused on the degree to which unemployment rises
in a very short period of time; I've never seen that before outside of a recession. So this sense that
we are in different waters and different times, and that it’s harder to use the past as a prologue to the
future, certainly has affected our thinking as well.
That takes me to the issue of the risks to this forecast. The economy needed to slow
and seemingly it has. Interestingly, however, reflecting that earlier conversation, most levels of
activity--whether we look at car sales, residential investment, employment, sentiment, or changes in
business investment--would at most other times seem pretty solid. But now, after the truly stunning
growth of 1999 into 2000, formerly respectable levels of activity seem meager. The general tenor of
things has soured. That is clear. Witness the stock market, the credit markets, and the general
feelings of doom and gloom. Downside risks certainly have emerged, as the Greenbook makes
clear. But the biggest risk, I think, is overreacting. Labor markets remain strong and consumer and
business spending could as easily be in a lull as a downturn. And inflationary pressures, while
quiescent, have not disappeared. Holding steady seems to me, anyway, a wiser course than moving
now as we wait to see what the New Year brings. Thank you.
CHAIRMAN GREENSPAN. President Jordan.

MR. JORDAN. Thank you, Mr. Chairman. Speaking from the old economy region of the
country in contrast to the new economy region, the view really is quite different. At a joint board of
directors meeting of our three boards last Thursday, one of the directors cited an index that I had
never looked at before. She said that in the three weeks since Thanksgiving to that date, the
Salvation Army's collections were down 18 percent from a year earlier. Now, I don't know what to
make of that because I always thought that a little prayer went along with the coins in the kettle. So
I don't know if it means there's less to pray about or less money to spend!
MS. MINEHAN. It's too cold to go out!
MR. JORDAN. Exactly. First, on construction, public sector construction spending in the
region remains strong, but residential, commercial, and industrial are all down, and most
expectations are that activity in 2001 will be below that experienced in 2000. Inventories of
construction materials are said to be high, and the earlier reported shortages and long lead times,
especially for items such as brick and drywall, have disappeared. Prices of construction materials
are reported to be below levels prevailing at the beginning of the year.
Turning to motor vehicles, truck production is off sharply and parts suppliers have begun
layoffs and plant shutdowns. In the region people would say the trucking industry is in a depression
not a recession. One large truck dealer that sells in seven states of the region said that almost 50
percent of his sales have gone delinquent in the last 60 days. Several auto assembly and parts plants
have closed for the final weeks of the year.
Steel executives expect the auto companies to cut production schedules further, which
reinforces what you were suggesting, Dave. In the steel industry, the situation was described as dire.
One company reentered bankruptcy--it's the second time for them--and others are expected to
declare bankruptcy soon. Three CEOs in the District were fired in the past month. Timken has

closed all of its steel plants and three bearings plants for the balance of the year.

with a

long career in steel said the bloodletting has only just begun.
Retailers, not only those in the region but chains that operate nationally, report sharply
lower year-over-year sales. Even with the additional selling days and the extra Saturday between
Thanksgiving and Christmas, sales through the middle of last week were so far below year-earlier
levels that the difference cannot be made up in the remaining selling days. Sales at one company,
Bath and Body, are down 10 percent, and this is the first year-over-year decline in the company's
history.
On the subject of inventories I've heard one report that I don't know what to make of, nor
do I know enough about the issue to be well informed. Nevertheless, we were told that Wal-Mart
has notified its suppliers that starting next year they won't get paid until the goods are sold. And if
the goods are not sold Wal-Mart will return them, which means they are the property of the supplier.
I don't know how Wal-Mart will set prices in that kind of environment. So, that type of practice is
going to muddle the inventory data further, among other things.
A food processing and distribution company reports that while sales have been soft, the
prices of food processing equipment have dropped and labor turnover has declined, so profit margins
are good even in the face of the larger discounts they are now offering.
Labor markets are reported to have eased considerably with the major exception of the
health-care sector, where the shortage of hospital workers and pharmacists is still described as
severe. Among our contacts two areas were cited as showing some strength: safety equipment is
described as strong, with an orders backlog, both domestic and foreign; and orders for spring
delivery of sporting apparel from one manufacturer are said to be high. Bankers report a noticeable
slowing in loan demand, especially for mortgage and auto financing. But on the other side, large and

small banks reported a significant drawing down of home equity loans, which may not be a sign of
strength. Members of our commercial bank advisory council all reported increases in what they
described as "voluntary repossessions," especially of SUV-type vehicles, trucks, and boats. Most
expect loan growth to be much slower in 2001 and have budgeted for higher charge-offs. The head
of one large banking company headquartered in our District said that a year ago they were getting
hammered by institutional investors because they were only promising 10 to 12 percent earnings
growth, and this year they are getting rewarded for promising 8 percent. So, expectations may be
adjusting. Software companies are said to be cutting prices, especially for development of Internet
sites. Otherwise, I guess they move to Boston! Some dot-com companies have ceased operations
because venture capital funds have dried up and these firms never reached the bankable stage.
Let me turn to the national economy and economic policies. At recent meetings of
directors and advisory councils I suggested that perhaps what we had been observing in recent weeks
was what I called the “Gulf War Syndrome." My idea was that uncertainty--in this case uncertainty
associated with the election outcome--was causing only a temporary postponement of commitments
by households and businesses alike, as we saw in the weeks before Desert Storm. I found almost no
support for the idea. It certainly cannot explain what we see in the trucking and steel industries. It is
likely that we will see a succession of downward revisions in private sector forecasts for major
industries, as well as for the national economy in 2001.
I want to make a few observations about what I consider to be appropriate and
inappropriate uses of contemporaneous or high frequency data for policy purposes. I do not believe
that reports of economic weakness should call for monetary or fiscal pump-priming stimulus to head
off a cumulative process of contraction. I don't think that's the way our economy works. I do
believe that a market economy has an inherent tendency to expand, as adverse effects of various

shocks such as sharp increases in energy prices tend to wear off. However, we do have to be alert to
the mirror image of the sharp acceleration of productivity growth that we've observed, with a lag, in
recent years. By that I mean that our observations were with a lag. We came to recognize that if we
held the overnight interbank rate unchanged as the natural or equilibrium market rates of interest
rose in the face of strong wealth creation, we could inadvertently accommodate an inflationary
process. An unchanged federal funds rate with rising market rates is a de facto easing of the stance
of policy, and that's true whether it comes from an increasing inflation premium or what we call the
real rate.
Conversely, if forces are at work that are putting downward pressure on the natural rate,
an unchanged overnight bank rate is a de facto tightening of the stance of policy. In this context, the
natural or the equilibrium structure of market rates is not the same thing as what we usually mean
when we talk about real rates, which can never be observed ex ante. This year, for example, it might
be tempting to cite the lower Treasury yields in the face of faster inflation as evidence of lower real
interest rates and consequently an easier stance of policy. I believe that conclusion would be wrong.
In a nutshell, lowering the fed funds rate in the present environment would not and should not be
viewed as an act of stepping on the monetary accelerator. It would be and should be viewed as an
act of reducing the pressure currently being applied to the brake pedal. Thank you, Mr. Chairman.
CHAIRMAN GREENSPAN. President Guynn.
MR. GUYNN. Thank you, Mr. Chairman. The evidence is now clearer that the pace of
growth has slowed in our Southeast region, although some sectors continue to perform quite well.
Single and multi-family housing permits, units under construction, and home sales are flat to down
slightly from year-ago levels, although still at respectable levels. Builders tell us that traffic is down,
inventories of unsold houses are up somewhat, and price concessions are now more common. And

that softness is spilling over to many of our region’s related industries like lumber and appliances.
Autos are showing the same pattern and that, too, is affecting the many local suppliers that feed that
industry. Commercial real estate markets have remained relatively strong across much of our
District. Neither office nor industrial markets have shown much evidence of excessive speculation
and vacancy rates are little changed. Reports indicate that fewer projects are in the pipeline, and
caution has put some plans on hold, including an in-town residential project that is planned for part
of the leftover property we recently sold that was adjacent to our new Fed building.
In manufacturing, overall activity continues to moderate, with cutbacks in hours as well as
some temporary and permanent plant closings. Lumber and steel production declines are clearly due
to lower demand and to foreign competition, while cutbacks in the paper industry we've seen
recently are the consequence of consolidations and restructuring. However, all is not bad.
Shipbuilding continues to expand and the Louisiana oil and gas industry is back to pre-1999 levels,
which is benefiting rig fabricators and pipeline makers. And despite the current inventory problems,
there are labor production adjustments. The auto industry continues to make long-term investments
in new and more modern plant and equipment in our region.
Retail sales were reported to be moderately strong over the Thanksgiving weekend, but
colder weather may have provided a bit of a boost. Inventories are reported to be reasonably in
balance. Retailers tell us that their expectations for the holiday period are more modest than a year
ago. Tourism is a bit more mixed this time, with recent reports of continuing strength in some areas
and new weakness in others. The cruise ship business is feeling the effects of substantial new
capacity brought on-line in recent years and Florida is suffering a bit of a hangover from the pullout
of the Bush and Gore lawyers. [Laughter] Somewhat slower growth appears to be moderating
pressures on labor markets just a bit, but scarcities in nursing and other technical skills remain.

Finally, price pressures remain in check for the most part, despite the headline news about winter
natural gas bills that are up to triple year-ago levels.
Our bankers are telling us that loan growth has slowed considerably across all business
lines. Some borrowers are reportedly complaining about the shrinking syndicated loan markets and
having to pay higher prices to generate interest in their debt issues. There has been considerable
public discussion about deteriorating credit quality, especially at large banks. While nonperforming
assets have grown at our banks this year, they are still at modest and manageable levels.
Turning to the national economy, I share the Greenbook’s broad view that the slower pace
is now more obvious and evident across almost all sectors. But I continue to remind myself and
others that the degree of slowing we are seeing has to be viewed with the realization that the skyhigh levels at which we were operating simply weren't sustainable. Of course, our policy actions of
a year ago were intended to help create conditions that would discourage excesses and bring the
economy back to more rational and more sustainable levels of activity. Now that those adjustments
are taking place in autos, in equities, in credit markets, and in other areas, we should be neither
surprised nor discouraged. In fact, many of the developments we are seeing--the better control over
inventories, the better and quicker rationing of money to the construction industry, the more prudent
adjustments to credit availability generally based on borrower risk--are all positive in my view and
hopefully will help damp cyclical swings. Markets really do work.
Our job now is to judge whether the path we are on is measurably below potential and is
likely to remain so. Looking forward, if investment spending slows further and inventory
investment continues to subtract from growth, if credit availability actually begins to bite, and if
companies continue to report undershoots of their earnings forecasts, then we really will have
something to worry about from a policy perspective--especially if unemployment picks up

measurably and spending declines further. However, our Bank's latest simulations are consistent
with a slowing of real GDP growth to only about recent estimates of trend, and our projections are
not as pessimistic as the Greenbook's. At the same time, I can easily imagine a combination of
developments that would leave us at subpar levels of growth and quite vulnerable to any negative
shock that might come along. The most recent inflation data have been generally good, although I
think the inflation risks we've pointed out before are still there, even if somewhat diminished.
My overall sense is that our next move will likely be to relax policy sometime soon, at
least marginally. I'd be most comfortable at the moment, however, letting things play out a bit more
in terms of the important adjustments that are taking place and that we want to see continue. At the
same time, it would seem to me prudent and responsible to adjust our press statement coming out of
this meeting to reflect the fact that while inflation risks remain and we have not let down our guard
on that front, there are now significant risks that the rate of growth may be below what we consider
optimal. Thank you, Mr. Chairman.
CHAIRMAN GREENSPAN. President Hoening.
MR. HOENIG. Thank you, Mr. Chairman. Since our last meeting, the District has
continued to expand, but quite modestly, and there are additional pockets of weakness and some new
areas of concern within the regional economy. There have been some highly publicized layoffs,
although the actual level of employment has remained relatively high. And private employment
growth continues to follow a modest slowing trend for the District, just as it does for the nation.
Retail sales got off to an okay start this holiday season, but few expect the kind of yearover-year growth seen last year. Also, some concern has been expressed that holiday sales levels
have been dependent on some heavy discounting. By far the weakest component of consumer
spending in our region has been for automobiles and light trucks. Both GM and Ford have reduced

activity at their Kansas City plants. One has eliminated all overtime and the other has actually shut
down its line for some weeks during the holidays.
manufactures prefabricated metal buildings and serves on the
national trade association says he sees softening not only in his business but in many other segments
of manufacturing as well. And businesses appear to be taking a very clear wait-and-see attitude
toward investment decisions going into next year.
Construction activity is down from a year ago but remains relatively solid overall in the
region, particularly in the Denver area. Homebuilders report that starts turned downward in
November, following a modest rebound the month before. Nevertheless, housing starts and home
sales remained high by historical standards, and the fact that housing prices in most cities continue to
rise faster than the general price level suggests that demand for housing is still relatively strong.
Nonresidential construction starts have also stabilized recently, after trending down much
of the year. Energy activity in our District has leveled off recently but is still the highest in years
and is being held back mainly by a lack of rigs and skilled workers. So far, District energy firms
have benefited from both higher gas prices and oil prices.
Inflationary pressures in the region do not seem to have changed significantly since our
last meeting. A somewhat higher proportion of business contacts reported above-normal wage
increases in November than in previous months. However, businesses did not appear to have any
more success than before in passing such costs on to the customers. Finally, the farm economy
remains in a slump and dependent on Government subsidies, although there has been some reduction
in inventories that may help to sustain prices in the future.
In terms of the national economy, my outlook has not changed a lot over the past month. I
remain cautious about the economy. Economic activity clearly has slowed. So far the slowing has

been orderly and I expect it to continue to be so. The incoming price data continue to be consistent
with a moderate underlying inflation rate as well.
Let me talk briefly about inflation. Obviously, we’ve received little new information
about inflation over the last month, but what we have received has been generally favorable. Despite
higher energy prices and rising import prices, core inflation remains modest. And we agree with the
Board's staff that it should continue that way. I realize, of course, that headline inflation will be far
from stable over the next few months. The spike in natural gas prices is just one example of the
factors that will complicate our reading of prospective inflation. However, as the winter passes
energy prices should retreat to more normal levels, a prospect reflected in the futures market. Thus,
while we may see some volatility in inflation, I expect it to remain modest for the foreseeable future.
Turning to the economy more generally, growth appears to be moderating as expected in
the fourth quarter. Consumers are reining in their spending because of slower employment growth
and lower stock prices this year. Manufacturing activity has also moderated and businesses more
generally are retrenching. Tighter financial conditions, softer earnings, and softer balance sheets
appear to be causing firms to scale back their spending plans. One key question is whether the
economy is decelerating too quickly, as David mentioned. To be sure, recent reports on consumer
confidence and retail activity are noteworthy. While the jury is still out, the evidence is mounting
that the slowdown is real and may last a while. The stock market is down significantly and
anecdotal evidence suggests that labor markets are softening. And as I noted earlier, in our District-and I think it is true more generally--holiday sales have gotten off to only an okay start and no one
expects strong sales suddenly to emerge.
In essence, I agree with the Greenbook that growth will be below trend for some period.
Also, as I mentioned at the last meeting, I remain somewhat concerned that tighter financial

conditions pose an additional and important downside risk. These include higher interest rate
spreads, lower equity prices, tighter lending terms and standards, increased risk aversion toward
more speculative ventures, and a rise in junk bond default rates. We see higher though still modest
C&I loan delinquencies as well. And finally, after-tax corporate earnings growth is down. As a
result, we're seeing debt as a share of net worth rise in 2000 after leveling off in prior years. Debt
service costs are rising and downward adjustments of capital spending plans are taking place. None
of these factors taken in isolation means growth would decelerate beyond expectations. But the
combination of tighter financial conditions and large financial imbalances increases the risks to the
outlook, and I think significantly.
In summary, what the data suggest to me is that the economy can grow at a more modest
but healthy pace in the future and that inflation will remain modest. However, we might wish to
rebalance the risks to the economy by considering an adjustment in policy that goes beyond just the
words in our press statement. Thank you.
CHAIRMAN GREENSPAN. President Broaddus.
MR. BROADDUS. Mr. Chairman, the signs of slower growth in the national economy
are now more clearly reflected in our District economy than they were at the time of our last
meeting. Consumer spending in particular has throttled down and home sales and housing
construction have continued to moderate. We are hearing more reports now about layoffs at
manufacturing plants in the Carolinas. More generally we have a sense that labor markets are
loosening a bit; they are a little less tight. Trucking companies in particular have reported fewer
difficulties finding and retaining drivers. Looking forward, I think it's fair to say that most of our
business contacts are still reasonably optimistic about the prospects for the year ahead, despite the
slowing in activity, but an increasingly vocal minority is worried that the national economy is going

to decline sharply going forward. And we now hear the “R” word fairly frequently in our region for
the first time in several years, especially in the southern parts where there is a lot of old economy
manufacturing activity. At the same time, I would point out that our latest monthly survey of retail
and service firms indicated that their prices have drifted upward in recent weeks.
The data released since our November FOMC meeting have provided further confirmation
of the softening in the national economy. The Greenbook has reduced its projections of real GDP
growth for the current quarter and for the first quarter of next year to about 2-1/2 percent.
Obviously, that would be a quite pronounced deceleration from the 6 percent rate of growth we saw
in the four quarters ending in the second quarter of the year. To keep it in perspective, though, that 6
percent growth rate was not sustainable, especially in labor markets. That's why we tightened
monetary policy in that period. So, we are getting the slowing we needed.
The question, of course, is whether we're going to get more slowing than we need or
wanted. My sense of the Greenbook baseline forecast is that the staff is relatively optimistic on this
score. Private domestic final purchases, a key component of the underlying longer-term growth in
aggregate demand, are projected to grow between 3 and 3-1/2 percent for the year ahead, which
would be moderately below the estimated 4-1/2 percent potential GDP growth going forward. That
does push the projected unemployment rate up to 4.7 percent in the fourth quarter. Rising
unemployment, obviously, is never a good thing, but it seems to me that an increase of that
magnitude would probably be manageable, especially if inflation remains contained and growth
reaccelerates in the second half of the year and in 2002, as in the baseline forecast.
In short, as I see it, the baseline Greenbook forecast projects what I would call a classic
soft landing with no change in the funds rate. I have no reason to quarrel with the projection and I
think the upside and downside risks are reasonably well balanced around it, given the tone of the

regular monthly economic reports since our last meeting. Clearly, there are significant downside
risks and I recognize them. A further decline in equity markets or additional tightening in credit
markets would increase the downside risks, especially if equity prices were to weaken sharply.
To my mind, another point that is important here is exactly how households react to rising
unemployment if in fact the unemployment rate does begin to rise. If we think back, when we
tightened in 1994 the unemployment rate was higher than it is now, but it was on a downward trend.
Today it looks to have bottomed out and, of course, the staff is projecting an increase and that
increase could be even greater than projected. We have not had rising unemployment in this country
in about 10 years. It's hard at this point to gauge how much consumer confidence would decline if
unemployment did begin to rise, even to the moderate degree projected in the Greenbook, but
especially if it were to increase by more than is projected.
Now, I want to be clear: I'm aware of the downside risks out there and I take them
seriously. I think it's essential that we do all we can to avoid unnecessarily weakening the current
expansion. At the same time, I also believe there's a considerable risk in a precipitous reaction by
this Committee to what at this point is still an incipient slowdown, and in particular I think a marked
shift to ease could cost us over time.
I have just a couple of additional comments. In thinking back on our easing in the fall of
1998, it was clearly appropriate in retrospect, but it probably contributed over time to the moderate
increase we have seen in various measures of inflation over the last several quarters. Going back
even further, our easing in 1987--while again clearly necessary in the circumstances--in my view
helped produce the sharp increase in inflation in 1988 and 1989 that set the stage for the recession in
1990. So against that background, I think any significant easing in policy now risks creating the

perception that we're willing to accept a further increase in inflation today to prevent even a
moderate increase in the unemployment rate from what is historically a quite low level.
Let me close by saying that we need to remind ourselves that we have worked very hard
over the last couple of decades to build what I believe is now the considerable credibility of our
commitment to low inflation. That credibility enhances our flexibility to respond to downside risks.
Unquestionably, if circumstances warrant, we may need to spend some of that credibility. But in
confronting the immediate situation, I think we should recognize that there is a risk in easing policy
more than expected at a time when labor markets, while perhaps a bit looser, are still quite tight and
inflation is drifting upward. Absent a very sharp deterioration in financial markets--a real market
break as in 1987 and 1998--I think we still have time to proceed in a measured manner, and I would
hope that we’d do that. Thank you.
CHAIRMAN GREENSPAN. President Parry.
MR. PARRY. Mr. Chairman, employment growth in the Twelfth District has continued
to moderate in recent months. District payrolls have expanded at a 2-1/4 percent pace in recent
months, somewhat below the 3 percent pace of the first half of the year. More moderate
employment growth and declines in the market values of high-tech stocks have begun to show
through to personal income and spending. Data through the third quarter indicate slower growth in
District payroll withholding and other personal income and sales tax revenues. In retail sales, data
for the holiday shopping season point to a slower pace of consumer spending in the District. During
the first 2-1/2 weeks of the shopping season, year-over-year same-store sales increased 3 percent in
the West, down from the 3.8 percent pace a year earlier.
The dot-com shakeup continues but at a slower pace. However, the outlook for District
high-tech manufacturers also has softened recently. In the past couple of months, several high-tech

manufacturers in the District have announced downward revisions to earnings forecasts, sending
their stock prices lower. These revisions were based on a number of important fundamentals,
including slower growth in sales of semiconductors and computers, declines in new orders for
electronics and other electrical equipment, a pickup in order cancellations, and increased inventory
accumulation.
Rising energy costs have become a major concern for many Twelfth District states. On
the producer side, record-setting prices for natural gas and electricity have pushed a number of
agricultural producers into the red and induced some manufacturers to shut down, with some opting
to sell their forward contracts on energy in the spot market. On the consumer side, as you have read
in the press, major utilities nationally have warned customers that natural gas bills could increase by
50 percent over last year's level. Pacific Gas and Electric estimates that the increase in California
will be 75 percent, due to an especially tight gas market in the West.
The most pressing problem in energy markets in the past week occurred in California and
concerned the financial health of major utilities. Due to the gaping divide between wholesale and
retail electricity prices, Pacific Gas and Electric and Southern California Edison have accumulated
billions of dollars of undercharges financed largely by borrowing. Given the increasingly uncertain
outlook, the debt of both PG&E and Edison was downgraded last week. Ultimate solutions to the
problem will be political, a process that is currently evolving. Until recently, the bulk of electricity
contracts have been confined to the day ahead in spot markets. The Federal Energy Regulatory
Commission's ruling on Friday is a small positive step in that it will improve forward contracting in
the California electricity markets. The California Public Utilities Commission also has indicated that
it will at least consider some increase in retail electricity prices. However, the increase being
discussed is unlikely to provide much of a solution to the problem.

Turning to the national economy, recent developments suggest a more pronounced nearterm slowdown than seemed likely when we met last. At the same time, the downside risk to the
outlook certainly has intensified. The recent weakness in consumer spending is especially
noteworthy and the large drop in the preliminary December Michigan index of consumer sentiment
demonstrates a risk that consumers could cut back even more sharply in the near future.
We have revised down our forecast of real GDP in both the current quarter and the next
one by about one percentage point to around 2-1/2 percent. Under the assumption that the federal
funds rate, the stock market, and the dollar are all unchanged, our best guess is that growth will pick
up in the second half of next year and that real GDP would rise by just under 3 percent for the year
as a whole. This slowdown in growth from the 4 percent rate expected for this year is readily
explained by tightening financial conditions on a broad range of fronts. And this may be the
slowdown we need to contain inflationary pressures. However, even with a slowdown of this
magnitude, our forecast shows a modest increase in core PCE inflation next year to around 2 percent
from the 1-3/4 percent rate expected this year. While this prospect concerns me, I’m also concerned
that adverse expectations are posing a risk that the economy will weaken more than seems warranted
by the tightenings we've seen in the financial conditions themselves. Thank you, Mr. Chairman.
CHAIRMAN GREENSPAN. President Moskow.
MR. MOSKOW. Thank you, Mr. Chairman. Economic activity in the Seventh District
has definitely slowed further over the past month or so, and many contacts indicate that additional
slowing is likely. Labor markets are still tight, but an increasing number of layoffs and plant
shutdowns have been reported. Construction is one of the few areas of continued strength, with one
of our Detroit branch directors noting that workers are still being recruited from out-of-state to work
on projects in Michigan. But our winter storms over the past week or so have probably put many

construction projects on hold, even more than seasonally expected, at least temporarily. Signs of
moderating consumer demand are increasingly apparent. While reports from retailers have been
mixed, they generally indicate that holiday sales have been soft since the Thanksgiving weekend
spurt. Despite a fairly high level of promotional activity thus far in December, as in past years
consumers seem to be holding out for even better prices on the days just before and after Christmas,
and reports indicate that retailers will be stepping up their promotional activity further. A former
director told us that there has been a sudden large drop in Asian import shipments trucked from the
West Coast in recent weeks, another sign of softening demand.
The auto industry had been boosting growth in our region earlier this year but is now
pulling it down. Light vehicle sales declined considerably in October and November, and the latest
estimates from the Big Three suggest further declines in December, with sales running at an annual
rate in the mid-15 million unit range--still historically high but down significantly nevertheless. As
David Stockton mentioned, production schedules continue to be trimmed to bring inventories into
better alignment with lower sales levels, and most analysts are reducing their forecasts for light
vehicle sales in 2001.
Other contacts in our manufacturing sector also report considerable slowing. The Chicago
purchasing managers’ composite index for December, to be publicly released on December 29th,
shows activity contracting again, though not quite as sharply as in November. The index was 44.7 in
December, up from 41.7 in November. And related to our discussion earlier, inventories contracted
significantly in December.
In terms of specific industries, our steel and heavy-duty truck businesses are still in the
doldrums, similar to Jerry Jordan's comments about his District earlier. Contacts in the printing and
publishing industry report that almost all of their customers are pulling back, and in some cases are

pulling back fast--with advertising in magazines off sharply, a dramatic change from six months ago.
In addition to automakers and their suppliers, consumer durables manufacturers, including Amana,
Maytag, Electrolux, Motorola, and other firms, are laying off workers, and temporary help firms
report declining demand for industrial workers. But with continued tightness in our labor markets,
other employers are often right there to offer laid off workers new jobs, and temporary positions are
still rising for workers outside of the industrial sector.
Needless to say, the competitive environment is fierce and firms have little pricing power.
Energy prices, of course, are the exception and particularly high heating bills are now arriving in
consumers’ mailboxes. Businesses, too, face higher energy costs along with softening demand for
their products and services, and they are becoming more pessimistic about the outlook for 2001.
What is perhaps of concern is that contacts have used words like "sharp," "dramatic," and
"tremendous" to describe the slowdown they’ve experienced in the past few weeks.
In early December we hosted our 14th Annual Economic Outlook Symposium for which
over 30 regional economists provided forecasts for 2001. The median of these forecasts, which were
prepared in late November, had real GDP rising 3-1/2 percent next year. If those same forecasters
were polled today, my guess is that the median forecast would be lower. Growth is coming down
from rates that were unsustainable, and that slowing was needed to restore balance between
aggregate demand and potential supply. But as my directors cautioned me last week, we need to
remain alert so that the slowing does not persist to the point of threatening the current expansion.
The national economy has clearly entered a period of below-trend growth. As we all
know, in such periods it is more difficult than usual to gauge whether the slowing will be excessive.
Although our current assessment for real GDP growth this quarter and next is a bit stronger than the

Greenbook's, we are still predicting growth below trend. Thus, we expect that the unemployment
rate will be rising next year as labor markets begin to ease noticeably.
Mr. Chairman, I agree with your comments earlier this month that this is a time when the
effects of any negative shocks would likely be amplified. With the sharp drop in consumer
confidence recently, the consumer seems wary and perhaps weary after a long run of strong
consumption growth. Tighter credit standards for businesses and slower growth in investment
spending all signal smaller additions to productive capacity in the short term. I'm still concerned
about future inflationary pressures, although they seem less urgent today. If the economy slows as
much as we project, it seems plausible that inflation will level off.
In my view the balance of risks has changed since November and I'm sure that we will
want to explain that in our press release.
CHAIRMAN GREENSPAN. President Stern.
MR. STERN. Thank you, Mr. Chairman. I would describe economic conditions in the
District as steady, but sentiment has changed recently and significantly so, as best I can judge.
Clearly, people are becoming more cautious and more concerned about the outlook. I think financial
market developments have something to do with that, with the flight to quality in the debt markets
and the decline in equity values.
As far as evidence on activity in the District is concerned, it's a mixed bag. Labor markets
remain tight and employment does continue to increase. Commercial construction is a distinct bright
spot--it's very strong--and home building has held up well. And, as I’ve commented before,
agricultural conditions turned out to be better this year than earlier anticipated, and farm incomes
and credit conditions were better as a consequence.

On the less positive side, I would say that consumer spending has to be described as no
better than mediocre. Traffic in the malls and other places seems to be high, but spending doesn't
seem to be commensurate with the traffic. As for the auto industry, of course, auto dealers are
having a tough time. It's not hard to prompt them to use the word "fear." Clearly, inventories of
new cars are high; we are also hearing that inventories of used cars are quite high as well.
Higher energy prices have adversely affected some manufacturers, forcing them either to
curtail activity or in some cases to shut down because of profitability concerns. In general, I would
say that profit margins are being squeezed in a variety of businesses. Price pressures in the District
seem to be confined mostly to the services sector.
As far as the national economy is concerned, I think Dave Stockton did a good job of
summarizing the current economic situation. Specifically, it seems to me that a slowing in real
growth has occurred more rapidly and with more severity than I had earlier anticipated. This may
turn out to be temporary, as both the Greenbook and our forecasting models suggest, especially if
one interprets the slowing as simply a reduction from the 5 to 6 percent range we experienced part of
last year and this year to something more like 2 or 3 percent. But I must admit I am not entirely
comfortable with that interpretation, partly because of what I perceive to be the breadth of the
slowing and partly because I remember painfully from my forecasting days that one doesn't
recognize excessive inventories and high inventory/sales ratios until after the fact. The imbalances
become evident after sales turn out to be more disappointing than expected. However that may be, it
seems to me that going forward inflation is likely to level off and perhaps even abate a bit over time.
Thank you.
CHAIRMAN GREENSPAN. President Santomero.

MR. SANTOMERO. Thank you, Mr. Chairman. Incoming data suggest that the
slowdown in economic growth continues in our region and in the nation. The real question is
whether growth is slowing too much so that the economy will enter a recession. My own reading is
that this is still a growth slowdown and that the economy is not heading toward a recession.
Conditions in the Third District are similar to those that I reported at the last meeting.
Growth is down appreciably from earlier in the year, with economic activity in the region expected
to grow at a slow pace over the next six months. Manufacturing activity in particular has slowed
considerably since last spring and manufacturing employment has declined this year. Our business
outlook survey of area manufacturers, which will be released this Thursday, shows declines in the
level of economic activity in December, and new orders remain weak. Increased energy costs and
increased import competition stemming from the strong dollar were cited by steel and metal
producers as drags on their businesses. And manufacturers' near-term outlook has weakened
appreciably in recent months.
In contrast, indicators in the construction industry are mixed, with the residential housing
sector weakening but the nonresidential sector remaining robust. Housing permits continue on a
downward track in our three states, similar to the pattern in the nation. And home sales are relatively
weak in Pennsylvania and New Jersey. On the other hand, the value of nonresidential construction
in our region rebounded in the third quarter and for the year to date has risen about 6 percent, in
contrast to the 2 percent decline for the nation as a whole. The demand for office and commercial
space remains strong in our region, and rents have moved up as a result.
The Third District retail picture continues to be similar to that of the nation. Retail sales
are increasing modestly and area retailers remain somewhat optimistic about holiday sales, expecting
an increase of about 4 percent in nominal sales compared to last year. Motor vehicle sales, by

contrast, remain quite weak. Bank lending has improved in recent weeks, mainly in the consumer
area. Bankers report a slowing in demand for business loans and indicate that they have begun to
tighten credit standards because of concern about slower economic growth and declining corporate
profits. Nonetheless, bankers expect overall loan demand to continue at a slow pace for the
remainder of this year and into next.
I would characterize our labor markets in the District as still tight. A decline in
employment in the third quarter, which I reported earlier, appears to have been reversed this quarter.
The unemployment rate in our region has remained at 4 percent or less all year. Price pressures in
our region appear to be lower than in the nation, with the CPI inflation in Philadelphia running at a
lower pace than the national average this year. And employment costs in the Northeast are also
increasing somewhat more slowly than in the nation. According to our business outlook survey,
there's less upward pressure in industrial prices than reported earlier in the year. And the prices paid
diffusion index is at its lowest level since September 1999. But this good news is tempered by the
fact that businesses in Philadelphia and elsewhere in the nation have suffered sharp increases in the
cost of health benefits. In Philadelphia the cost has gone up 8-1/2 percent this year, the largest rise
since 1992, and many employers are reporting increases in health benefit costs in the 10 to 20
percent range for next year. So inflation concerns remain.
Turning to the national condition, the data received since the last FOMC meeting
confirmed that the economy is growing at a slower and indeed a below-trend pace. But a period of
below-trend growth is needed to bring the economy back to potential growth. Compared to a few
months ago, the risks of economic weakness are now higher. The question is whether growth will
slow too quickly and turn negative, given the current stance of policy. In my view, we are about
where we want to be. Consumption and investment spending have been the driving forces in this

expansion. A drop in equity prices has had an impact on consumer spending via the wealth effect.
However, holiday sales are expected to be fairly good, though not as strong as last year. Sales of
motor vehicles have shown a drop in November but that, too, is not surprising given their recent
extraordinary pace. Investment spending has also slowed over the first three quarters, but monthly
data on orders and shipments of capital goods show continued strong growth. Employment
indicators point to an easing in the labor market; although the unemployment rate edged up to 4
percent in November and initial claims have risen, conditions remain tight.
On the inflation front, there are hints that price pressures are easing and that acceleration
in core inflation may be ending. In my view, we would be wise not to reach this conclusion too
soon, however. The core PCE and the core CPI ticked downward in October, but core CPI ticked
back up in November, and the Cleveland Fed’s median price index continues to accelerate. Inflation
expectations have remained in check so far, but recent developments have added to price pressures
and inflation remains a concern to me. Thank you.
CHAIRMAN GREENSPAN. Governor Gramlich.
MR. GRAMLICH. Thank you, Mr. Chairman. At the last meeting I said that the
situation was sufficiently unclear that I was glad there were others to participate in our decisions.
This time around conditions have changed enough that the picture is coming into clearer focus for
me. To get right to the bottom line, I think monetary policy has become too tight.
A simple argument for arriving at this judgment is based on a standard I've used before.
The real interest rate from the TIPS market is about 3.8 percent now, and if we build in an
anticipated inflation rate of about 2 percent, the equilibrium funds rate should be slightly less than 6
percent. The actual funds rate is more than that, indicating that monetary policy is on the tight side.
It made perfect sense to tighten monetary policy to this level last May when we were leaning against

the inflation rates, but things have changed now and I no longer believe it makes sense to keep the
funds rate this high.
The second standard is just to examine the Greenbook baseline forecast from a normative
standpoint. I’ll raise a few questions about that forecast in a second, but for now let's assume it is
perfectly accurate. It shows a period of below-trend growth, with the unemployment rate eventually
rising to 5 percent. I am not one who believes this outcome is desirable or necessary to control
inflation. If we can avert some of that rise in unemployment by cutting rates--and I believe we can-I think we should.
As for risks, on one side I think the inflation risk has become relatively quiescent. The
core PCE bounces around and we make a lot of the fact that it has risen recently, but it’s still below
its levels of 1996 and 1997. Long-term inflation expectations have been very stable in this whole
period and indeed have dropped to historical lows in both the Michigan and Philadelphia surveys.
The nominal/real spread has dropped sharply recently to about 1.5 percent with or without the staff's
adjustments for the timing of interest payments. It is possible that special factors could be
influencing very recent movements in this spread, but it still has declined noticeably this year. Trend
unit labor cost increases have come back up a bit but are still low. All wholesale price measures are
very stable and commodity prices have stabilized. There may always be some chronic risks that
inflation will accelerate, but these risks seem relatively low right now.
Indeed, given these numbers, I doubt we’d be worried very much at all about inflation if it
weren't for what I'll call NAIRU guilt pangs. Estimates of the NAIRU have always been weak
econometrically in the sense of having high standard errors. Moreover, point estimates of NAIRU
are bound to be reduced the longer the economy goes without accelerating inflation. We are now
nearing the end of the fourth year where the unemployment rate is less than the conventional

estimates of NAIRU, with very little evidence of accelerating inflation. Sure, there have been
special factors, such as the rise in the dollar and the productivity shock. But as time goes on, I still
become less and less convinced that unemployment is below the imperfectly estimated NAIRU
level.
On the down side, as I’ve said above, I see a case for lowering rates even in the baseline
Greenbook forecast. Given the slowdown, that forecast has the economy settling in for a period of
below-trend growth, eventually taking the unemployment rate to 5 percent. Unemployment will
probably rise some from its present level. That seems almost inevitable given the circumstances.
But I do think we should try to avert some of that rise. I think we'll get very little added inflation
credibility by letting unemployment increase more than is necessary to control inflation.
But that slow growth scenario is not the only downside risk. As the Greenbook freely
acknowledges, there is a downside risk in the Greenbook forecast itself. I talked recently to a noted
economist who has been studying recessions since the first postwar recession of 1949. [Laughter]
He reports that they seem to develop in three steps--an inventory buildup, followed by a crumbling
of the pillars of the expansion, followed by some unforeseen break in confidence. We already have
at least a mini inventory buildup. As for the pillars of the expansion, the stock market has been level
to declining for 18 months. Foreign real growth is tapering off and has already been downgraded a
few times in our forecasts. The critical Japanese economy is a continuing source of forecasting
malaise. Auto sales are weak and future production levels are being cut back. Manufacturing output
beyond auto sales is turning down. Consumer confidence has just taken its first hit, and it is known
to be related to unemployment. Even high-tech investment is beginning to weaken.
Some of these types of spending are bound to slow from their rapid earlier growth rates,
and some of these other signals may prove to be false positives. But the list I cited still represents a

lot of crumbling pillars. While the odds, I think, are still against an out-and-out recession, a broader
break in confidence is certainly becoming more possible. Given the suddenness with which these
forces can accumulate, we definitely don’t want to get behind this particular curve. We don't want to
be in a position of waiting too long, seeing the economy deteriorate, and then having to respond too
vigorously.
Adding all this up, I see very few costs in cutting rates soon and very many benefits.
Thank you.
CHAIRMAN GREENSPAN. Governor Ferguson.
MR. FERGUSON. Thank you, Mr. Chairman. I think the staff is to be commended for
accurately representing in its baseline forecast what I believe is a preponderance of the quantitative
evidence. The only problem I have is that the baseline forecast in the Greenbook strikes me as a
triumph of hope over reality; I certainly believe that the risks are almost all to the down side. The
relatively sudden reversal in the outlook that has emerged recently from more qualitative data
suggests that the trajectory of the economy may be further downward instead of stabilizing at an
annual growth rate of 2-1/2 to 3 percent. The rise in initial claims and the drop in consumer
sentiment both suggest to me the possibility that consumers are likely to retrench more aggressively
than is assumed in the baseline. Similarly, earnings revisions have been coming in at a pace I would
describe as fast and furious. Since our last meeting, for example, we have seen a significant
reduction in the expectations of analysts for fourth-quarter earnings for the S&P 500. The year-overyear growth rate of earnings per share is now estimated at about 0.9 percent. At the last meeting that
same number was about 4.4 percent, which suggests a fourth-quarter annual growth rate of minus 8
percent. That is quite a major change. Similarly, if we look at analysts' earnings forecasts for the
year 2001 and adjust them for the usual optimism they tend to have, a number close to 2 percent is

what they are expecting for growth in the year 2001. That clearly suggests some greater risk of
retrenchment with respect to capital investment and capital deepening, which have been, as you
know, a major part of the story thus far in our economy.
Similarly, we've seen in other areas an ongoing tightening of financial conditions and
what I think someone described as a "tenderness" in balance sheets. When I looked at Moody’s
results to get a sense of all of this, their expectation is that between 385 and 400 companies will
default on bank loans, bonds, or other borrowings in the next 12 months. That is more than triple the
number of defaults we've had since December of 1999. These defaults, as I said, are driven by debt
burdens, higher costs of credit, energy, etc.
So it seems to me that the risks are primarily to the down side and that the challenge today
is to figure out how best to respond to that. We obviously have two choices. One is to use language,
an option that I think is certainly heavily on the table. The other is to actually make a move with
respect to policy.
So why am I not supporting a move in policy as my friend and colleague Governor
Gramlich is suggesting? For a couple of reasons. One is that I believe some of the first-round
effects of our tightening moves are probably already behind us. Oil prices are likely to fall and the
futures market suggests that. Second, there is a slightly weaker dollar in the forecast, which I think
is probably going to materialize, and that will give us a bit of assistance. And third, frankly, I think
financial markets are ready to react quite abruptly to almost any change, and in my view our role
should be to make sure that their reactions don't end up being overreactions that then force us to take
another action.

So, at this stage I think language is probably better than action, but I also believe we
should be quite flexible and ready to move if the incoming data suggest that my outlook here is
inaccurate. Thank you, Mr. Chairman.
CHAIRMAN GREENSPAN. Governor Meyer.
MR. MEYER. Thank you, Mr. Chairman. There are two key questions that highlight, at
least for me, the challenges in making the forecast and setting the course of policy today. First, is
the growth rate in the Greenbook forecast over the next few quarters or the rate of revision in that
forecast over the two most recent intermeeting periods a better guide to what the forecast will be the
next time we meet? If the current Greenbook forecast turns out to be on the mark, we have in my
view a relatively benign outcome. We would see some of the excesses arising from a long period of
above-trend growth unwind and would return to near-trend growth by 2002. That outcome would
contain the risk of higher inflation and likely extend the life of this expansion.
I think there are two ways of describing this outcome. The first is as a reverse soft landing
emphasizing the therapeutic value of a slowdown. The second is a growth recession. We have had
around the table a bit of discussion of that concept. This emphasizes the pain associated with rising
unemployment, production cutbacks in areas where demand has weakened the most, profit
disappointments, declines in equity values, and the associated swing in consumer and business
confidence. But I'll remind you that these are just two different ways of describing the same
outcome.
However, once the economy has slowed to below trend, the downside risks to the forecast
that earlier might actually have been welcomed, quickly become a source of serious concern. And as
President Moskow noted, when there is a rapid swing from above-trend growth to below-trend
growth it becomes, as it does at turning points, especially difficult to forecast. The internal

dynamics of the economy become very hard to anticipate. There are dangers of inventory cycles just
as there are at turning points and, therefore, of overshooting.
While available monthly data seem consistent with the Greenbook forecast for the current
quarter, measures of confidence in some real-time anecdotal reports point to downside risks. In this
regard I really expect that the December data may be very helpful in getting a better handle on
whether the slowdown is stabilizing or deepening. I think an important key will be whether or not
production cutbacks in the fourth quarter make a significant contribution to slowing inventory
investment, as in the Greenbook forecast. Another important contingency is whether we face a
further significant decline in equity prices in response to additional profit disappointments.
The second key issue we face today relates to the possibility--and in my mind strong
probability--that the economy was operating beyond sustainable capacity before this loss of
momentum. If so, the question is whether that requires a more cautious and measured policy
response to the slowdown to below-trend growth than would be the case if the economy were
operating close to capacity when growth moved to below trend. The answer here seems obvious, but
perhaps the real issue is the level of output relative to potential and our confidence in such a reading.
Those who, like myself, believe we are operating beyond sustainable capacity welcome a slowdown
to below-trend growth while appreciating the importance of not allowing a slowdown to escalate to
one that is either excessive or to an outright recession. But certainly if I, like Governor Gramlich,
believed that 4 percent was a sustainable unemployment rate, I'd be right where he is in terms of the
need to ease quickly.
CHAIRMAN GREENSPAN. Governor Kelley.
MR. KELLEY. Thank you, Mr. Chairman. Things have been moving fast recently. Two
meetings ago we thought we might have a real slowdown at hand but could not yet be sure. At the

last meeting it was clear that a slowdown was under way but its characteristics were not yet
ascertainable. Today we are confronted with several recent weeks of strong and concerning
downside data. While a softening was expected, I have been surprised at the often seriously
weakening news about autos, consumer confidence, corporate earnings, retail sales, high-tech
expenditures, and foreign economic growth, among other things. Clearly, the balance of risks has
shifted substantially downward.
However, considerable strength remains, albeit less robust in almost every sector. While
credit extension has slowed and asset quality concerns have appeared, banks remain very healthy.
Indeed, many interest rates have fallen, which will bolster activity. And while productivity increases
may slow with economic activity, the basic momentum in productivity growth remains strong.
Business investment spending is slowing but continuing, with capital deepening remaining a
corporate imperative. Oil prices are easing, but remain shock-prone and it must be noted--and has
already been noted--that natural gas prices are on a tear. New jobs are still being created, although at
a slower rate. I would argue that the composition of the decline in the stock market from the
intergalactic levels of a few months ago is more a sign of the market's strength than of its weakness.
My main worry there is that market prices are still very high by historical standards.
I would make two key observations, and each leads to a key question. Observation
number one: It is clear that the economy is transitioning to a lower growth level, and within limits
this is welcomed. Question: Will this decline bottom out spontaneously at an acceptable growth
rate, perhaps not too far below trend growth, or will its momentum carry it dangerously lower?
Observation number two: By most measures inflation is off its lows and is slowly rising. Question:
How will inflation behave in this slowdown, characterized as it is by an intensely competitive and

high productivity growth environment? Will inflation stall out quickly in this environment or will
momentum carry it on up, driven perhaps by rising unit labor costs?
On balance, it would seem wise to begin to move to counter the new weakness, given all
the uncertainties and the lagged response of the economy to policy shifts. But how and by how
much? Making a policy decision today in this situation reminds me a bit of how I feel upon
checking into a hotel room and finding it too chilly. I'm confronted with how to reset a strange
thermostat of unknown properties. Several clicks in the warming direction are available, but how
many clicks will most likely result in a comfortable temperature when I return in a few hours after a
dinner meeting? My usual response is a firm but cautious reset to start with, knowing that additional
warming clicks are available if it stays too cool, but minimizing the likelihood of inducing
overheating and having to spend the night in an unpleasant and unnecessary sweat! [Laughter]
CHAIRMAN GREENSPAN. Vice Chair, top that if you can!
VICE CHAIRMAN MCDONOUGH. There is no way I can top that! Mr. Chairman, the
Second District’s economy continues to expand, though at a more subdued pace than in some time.
Cost and wage pressures persist, but there are few signs that these increases are being passed along
to consumers. Private sector employment grew at a brisk 1-1/2 percent annual rate in October, a bit
below the third-quarter pace, despite declines in manufacturing. Unemployment rates continue to
hold steady near cyclical lows. New York State retailers report that same-store sales slowed
somewhat in early December and were running 2 to 4 percent ahead of a year ago, led by book,
record, and specialty apparel stores.
Available official and private sector data make it clear that the expansion is slowing to a
pace below trend growth. Inflation seems quiescent, but it is not decreasing. Anecdotal evidence,
however, is overwhelming that the economy is slowing considerably faster than the available data

indicate, and the anecdotal information is more forward-looking. The economy in my view is highly
likely to grow at a slower pace than we had hoped to achieve through our policy tightening.
It is clear in my view that the balance of risks has shifted and now points to concern about
economic weakness. For this Committee not to note the realities of the world in which we live
would itself be a source of instability. Our choice today, it seems to me, is between one of two
options. One is a reduction in the fed funds rate, probably by 25 basis points, with a statement that
the risks are balanced between concern about inflation and about economic weakness. Alternatively,
we could leave the rate where it is and go to language expressing the view that the risks are weighted
mainly toward concern about economic weakness. I prefer the latter option for two reasons.
First of all, it’s closer to my own view. Secondly, it gives us maximum flexibility to
respond to incoming data by reducing rates early next year either at our next meeting or beforehand
if the data are sufficiently weak to make the more dramatic response of a move between meetings
appropriate. On the other hand, if the data are not clearly in that direction, it also leaves us the
option of not having to move the rate at all. Although a shift in the balance of risks language from
our current stance of risks toward inflation to one of risks toward weakness in economic growth is
rather strong, it really more clearly reflects what is going on in markets. I think the markets are
assuming that, as a minimum, we will go to a balanced risks statement. And in the last few days, the
view has probably become that we will move to language that the risks are weighted toward
economic weakness. On the other hand, I don't think the banging of the gong of a rate change at this
meeting is anticipated. Now, the markets are extraordinarily thin and very risk averse. And
therefore, if we were to do something that might be deemed a bit too dramatic, I am not sure what
the market reaction would be--especially what the second or third tier reactions would be after the
first one. It seems to me that that is a bit more risk than we need to take when there is an option for

us to show that we see what's going on--that we are concerned about economic weakness--without
taking the market risk that I think a rate move would involve. Thank you.
CHAIRMAN GREENSPAN. Finally, President Poole.
MR. POOLE. Thank you, Mr. Chairman. In recent weeks at the St. Louis Fed we've had
luncheons with investment professionals from the St. Louis area and with senior officials from
biotech firms. The message from them is very similar to the one we've heard around the table, one
of a great deal of caution. The people I've talked with, however, do not believe that the economy is
sinking--just that growth is weaker, not currently negative.
A somewhat different view emerged when I talked to my FedEx and UPS contacts. The
first comment my FedEx contact made was that since early November there has been a real
slowdown on the domestic side. Their domestic package business is now up only 1 to 1-1/2 percent
year over year, and given the rapid growth they had experienced before, that would mean--if a
seasonally adjusted series existed--that it is actually down. Both of my contacts said that
international business remains good, but both had the same view of the domestic business. UPS
volume is running 3 to 5 percent below what had been projected.
My FedEx contact said that his firm has a lot of the package business in the auto,
computer, and retail industries. They have checked with their customers such as

and

others to see if the slowdown had something to do with FedEx or was an economy-wide issue, and
their customers all said that the overall economy was slow. My UPS contact expressed the same
view.
On the labor front, both companies have found considerably easier conditions with only
isolated pockets of staffing problems. They don't have any general problems with staffing their
operations anymore. My FedEx contact in particular pointed out that they no longer have difficulty

recruiting and retaining people in the professional ranks. Essentially, I think what has happened is
that the slowdown in the dot-com industry has released a lot of workers into the marketplace and
they are being absorbed. It is taking a lot of the pressure off the labor market.
I think it's correct to say that economic activity in recent weeks has been surprisingly
slow. And most people view the outlook for coming months, the first quarter or so, as also likely to
be slow. However, there is a general sense of optimism about, let's say, the second quarter and
beyond among the business people we talked with. But as we look further out into the future, I think
perhaps we need to apply more economic analysis because my gut feeling is that cyclical processes
are under way. I see these reflected in areas like durable goods orders and much wider credit
spreads that are reducing credit availability to more marginal borrowers. In my view we are
observing a fairly standard set of cyclical processes. But they need not, of course, end up creating
recession if we have a policy response that is appropriate to the changing circumstances.
I'm reminded that a couple of weeks ago I had the very pleasant experience of touring the
Boeing F-18 assembly plant and had about thirty minutes in the simulator for an F-18. I must say
I'm a lot happier sitting around this table than I am in an F-18! But in the process of trying to land
that plane in the simulator of the aircraft carrier, I ended up producing what the instructor called
"pilot-induced oscillation." [Laughter] That means finding oneself wobbling first one way and then
the other way. And I think we have some of the same concerns about monetary policy. We don't
want to overreact-CHAIRMAN GREENSPAN. Let me ask--did you land or didn't you land?
MR. POOLE. Well, I did not end up in the drink! I had some helping hands, although on
one occasion the instructor forgot to put the hook down, so there was no catch on the deck, and we

pushed the throttle forward and took off again. What it amounts to is a $20 million video game and
it's a lot of fun!
Anyway, we don't want to produce a Fed-induced policy oscillation. I think that is part of
our concern. In my view we don't have that situation in front of us for the following reason: Policy
is really positioned very much on one side at the present time. Adjusted for risk, the federal funds
rate is the highest rate in the market. Back in May when we raised it to 6-1/2 percent, some rates
were above and some rates were below. The funds rate was pretty much in the middle and there was
room for rates to move substantially in either direction. Right now, if we have a resurgence in the
economy, there is room for longer-term rates to rise by 150 to 200 basis points without our doing
anything. We're not forecasting a resurgence but if that happens, there's lots of room for rates to rise.
I don't think there's much room for the market to take rates lower. Outside of a recession situation, I
don't think one could find in the data a term structure more inverted than the one we have now. So it
seems to me that positioning ourselves in the middle requires that we ease a bit. There would still be
a lot of room then for rates to rise without a move by us, if it turns out that the economy is about to
rebound.
That is where I come out and why I think this is an appropriate time to ease. I'd also point
out that as of yesterday the federal funds market had priced in a 40 percent probability of an easing
at today's meeting. I don't know what the fed funds market is doing at this moment, obviously, but a
probability of about 40 percent is not quite half way there but almost. And the probability looking to
the February fed funds futures contract is that by the end of January we will be more than 25 basis
points along an easing path. An easing of 25 basis points plus is priced into the February contract.
So my bottom line is that we need to reposition ourselves to get back in the middle of the playing
field again. Thank you.

CHAIRMAN GREENSPAN. Thank you very much. Is the coffee out there?
MR. BERNARD. Yes, it is.
CHAIRMAN GREENSPAN. Let's recess.
[Coffee break]
CHAIRMAN GREENSPAN. Don Kohn.
MR. KOHN. The information becoming available in the few weeks
since your last meeting has reinforced the perception that the economy
has entered a period of adjustment of uncertain dynamics and
dimensions. The Committee tightened policy from mid-1999 to mid2000 in order to slow economic expansion to a more sustainable pace.
This downshifting probably could never have been as smooth a process
as some had hoped for, as the inventory cycle now taking place in autos
and elsewhere attests. But, in addition, the macroeconomic downshift
has interacted with and has been amplified by other developments that
appear to be sapping aggregate demand by considerably more than was
anticipated a few months ago. One of these developments is the
persistence of high energy prices, restraining household spending and
business profits. Another is the emergence of credit problems for
marginal business borrowers even before economic growth moderated,
leading banks and other lenders to have become more cautious already.
A final factor has been an apparent reassessment of the returns, at least
in the near term, from producing, owning, and operating high-tech
equipment. This reassessment is not only damping business and
household spending on such equipment, but, through its effects on
equity prices, it is curbing demand more broadly. Significantly, as
Karen noted, many of the factors damping demand in the United States
also appear to be at work in other countries; this has kept the dollar from
depreciating much and will constrain the lift to net exports that might
ordinarily accompany a weakening in domestic demand.
In many respects, as Dave noted, there would seem to be some
countervailing positive pressures that provide natural limits on the extent
to which many of these factors will tend to reduce the growth of
aggregate demand. Continuing underlying strength in structural
productivity growth should support capital investment, income, and
consumption; a number of the credit problems are the residue of lax
lending standards in effect before the fall of 1998 that have since been
firmed; and energy prices probably will move lower. Moreover, fiscal
policy seems highly likely to move in a stimulative direction over
coming years. However, these supportive elements are working against
the interactions of slower growth, increasing risk aversion, declining

equity prices, and eroding consumer and business confidence that could
well weaken demand more than called for by an orderly adjustment to a
more sustainable supply and demand balance.
The strength of the forces restraining demand clearly has increased
since your last meeting. As a consequence, the Committee’s assessment
of the balance of risks would seem likely to have shifted since that
meeting, when you still saw inflation as the more important threat to
achieving your long-term objectives, albeit by a smaller margin than at
your previous meetings this year. The issues the Committee faces are by
how much these risks have changed and what is the appropriate
response.
Announcing that the risks were balanced would suggest a relatively
modest change in the Committee’s perceptions of economic
developments--slightly greater prospects for slower economic growth,
and partly as a consequence, a little less inflation risk. This is what most
market commentators expected you to do before the unfortunate Wall
Street Journal article on Monday, and balanced risks are roughly
consistent with the staff forecast. In that forecast a steady federal funds
rate produces a gradual approach to the staff’s estimate of a sustainable
level of labor utilization, with core inflation holding at about current
rates, helped by declining energy prices. Ordinarily, one might expect
the real federal funds rate to decline as the unemployment rate rises
toward its NAIRU in order to minimize overshooting. But in the staff
forecast, the real funds rate implicitly is seen as not particularly high
relative to its neutral level, and some continuing policy restraint is
needed to damp the effects on demand of falling energy prices, a
declining dollar, and more stimulative fiscal policy.
Still, the Committee may see downside risks to the staff outlook for
both inflation and output that it may want to take account of in its
announcement or its action. Two key factors adding to pressures on
prices and producing the rough balance in the staff forecast are the level
of the NAIRU and the decline in the foreign exchange value of the
dollar. If you judge the NAIRU as likely to be lower than does the staff,
inflation would tend to diminish, despite the expected fall in the dollar,
if economic activity does indeed expand more slowly than the growth of
potential as projected by the staff. And, while you may believe that the
dollar is more likely to fall than to rise over time given the current
account deficit, the timing of any decline is unknowable. A steady
dollar, as shown in the Greenbook simulation with the staff’s NAIRU,
produces noticeably less inflation and slower growth in 2002 than in the
staff forecast.

Moreover, in a situation apparently characterized by large and rapid
shifts in business and consumer sentiment, in lender perceptions of risk,
in financial asset prices, and in the interactions of financial markets and
the real economy, judging the relationship of policy interest rates to
economic outcomes is even more difficult than usual. In such an
environment, the weak tone to some of the very recent evidence on
economic developments, including the appreciable downward revisions
to businesses’ sales and earnings expectations, together with the
decreases in equity prices and the rise in risk premiums that have
characterized financial market responses to this information, may
suggest that the current stance of policy entails a significant risk that the
economy will be weaker than you will find acceptable. This seems to be
the view implicit in financial market prices, which have built in
expectations of more than a full percentage point of policy easing next
year, beginning at the January meeting.
If you were reasonably confident that policy would need to be eased
before long, you might want to get started at this meeting. The
tightening through last May was necessary in part to counter the effects
of optimistic earnings expectations on investment and equity prices. The
fading of this optimism and the projected edging lower of productivity
growth may suggest that rates can now be reduced. The market value of
equity prices has fallen nearly 10 percent since your May meeting.
Though interest rates on mortgages and investment-grade debt have
decreased since May, those on high-yield debt have risen and the dollar
has appreciated a bit. With long-term inflation expectations perhaps
dropping significantly, judging from the Treasury bond market, even
those households and businesses facing lower nominal rates may be
seeing little decline in real borrowing costs, if they have declined at all.
Evidence on shorter-term inflation expectations is harder to extract from
the markets. If such expectations also fall--a not unreasonable response
to a weakening economy--the federal funds rate would need to be
reduced at some point just to forestall a firming in policy in real terms.
And, the spread of credit concerns increasingly into the investmentgrade area may suggest a risk that credit restraint could become less
selective and more pervasive. Lastly, if you believe the economy can, in
fact, operate on a sustained basis at a lower rate of unemployment than
in the staff forecast--even if that rate is a bit above the current level--a
prompt easing could help to forestall an unnecessarily large rise in the
unemployment rate.
At the same time, flat or declining inflation expectations and
softening labor markets should alleviate concerns about inflation.
Against this background, the Committee may see little to be gained by
waiting if it saw high odds that the growth of aggregate demand was still
weakening.

Circumstances that had become serious enough in a short time to
require immediate action might also be serious enough to warrant an
assessment that the risks going forward were weighted toward economic
weakness even after policy was eased. The market reaction to a cut in
rates coupled with unbalanced risks would be substantial, as market
participants built in more and more rapid easing than they have to date.
Previously, they may have been held back in their forecasts of the path
of short-term rates by perceptions that the Federal Reserve would be
constrained by its concerns about inflation and its assessment that the
economic slowdown was not excessive.
A more measured approach, even if the Committee were worried
about the possibility of slower growth than in the staff forecast, would
be to keep rates unchanged but announce that you now saw the risks as
weighted toward economic weakness. One reason for adopting this
approach is the starting point for the economy. It still is operating with
very tight labor markets, near the lower end of plausible estimates of
sustainable values, if not below. And by many measures, core inflation
has edged higher, perhaps close to the upper end of the range of some
Committee members’ objective for inflation over time. In addition, if
productivity growth is leveling out, cost pressures could mount in tight
labor markets. In these circumstances, the Committee might want to
proceed more deliberately in easing policy in order to gain greater
assurance that labor market pressures would abate and inflation would
be contained, even if it suspected that the NAIRU might not be far above
the current level of the unemployment rate. The nature of the recent
information might also counsel caution. A number of the more negative
readings are from volatile, high frequency series; are qualitative, in the
sense of being anecdotal or about confidence; or concern earnings and
sales shortfalls that may be measured against expectations that may well
have been unreachable in an economy growing at a sustainable pace.
Indeed, many of the spending and employment data are consistent with
continued reasonable economic expansion, albeit at a much slower rate
than in the first half of the year and below potential. In the transition to
a slower-growth economy, which the Committee had sought, it is likely
to be especially difficult to sort out whether the new information
represents excessive weakness or is mostly a by-product of the desired
downshift. Lastly, financial markets continue to function reasonably
well: they are by no means “seized up.” Better investment-grade firms
have been able to access large volumes of credit at lower interest rates
and have issued new equity. And, in contrast to the circumstances in
1990, financial intermediaries themselves remain sound, limiting the
potential for concerns about their health to lead to general restrictions on
credit availability.

In these circumstances, you might want greater confirmation that
the economy is slowing by more than you would find acceptable before
lowering interest rates. Announcing a balance of risks toward economic
weakness would itself help to buoy values in financial markets and thus,
spending. Equity and bond prices should hold yesterday’s gains and
might rally further with the confirmation that the Committee recognized
the greater potential for weak growth and, implicitly, was prepared to
take action to deal with it. In this regard, if the Committee were
concerned about downside risks to the economy, through this
announcement it would realize a portion of the effects from an easing,
without making the immediate commitment. Thank you, Mr. Chairman.
CHAIRMAN GREENSPAN. Questions for Don?
MR. JORDAN. Two questions, Don, that may lead into one. At this time last year, we
had a funds rate of 5-1/2 percent. We were really constrained then from doing anything because of
Y2K, but we were learning at that time of upward revisions to growth, reinforced by the anecdotal
information that things were coming in much stronger. We now know that we were halfway through
a period of over 8 percent nominal spending growth on average for the four-quarter period. And,
clearly, a 5-1/2 percent fed funds rate was not consistent with that. We agree about that. At the next
three meetings we moved rather promptly and got the funds rate up to 6-1/2 percent. Once we got
the rate to 6-1/2 percent, the differences among us were about whether it needed to go higher or not,
and that had to do with the forecast. Now, certainly, if I had thought that the economy was going to
continue at 8 plus percent nominal growth, I would have been in the camp, too, that felt our work
was not done and that we should keep going. But in fact growth did decelerate. When I look at the
current Greenbook, I see that we are now, including the forecast for next year, in a six-quarter period
of 5 percent or a little less in nominal spending growth. And yet the Greenbook assumes that a 6-1/2
percent funds rate is consistent with nominal spending of 5 percent or less. How do I get to that
assessment? How do I close that circle?

MR. KOHN. Dave might want to speak to this as well, but in the Greenbook forecast the
6-1/2 percent funds rate is slightly restrictive. It is consistent with the economy growing below the
rate of potential, so the unemployment rate is rising. It is not greatly restrictive, but I think it's
slightly restrictive. And as I noted in my remarks, the relatively high level of the nominal funds rate
and the real funds rate is made necessary by the judgment that underlying structural productivity
growth will remain relatively strong so that the equilibrium interest rate is relatively high. And there
are forces, like more expansive fiscal policy--and in particular the assumption of a depreciating
dollar, which puts upward pressure on prices and helps to cushion weakness in the United States-that require a slightly restrictive stance of monetary policy.
MR. JORDAN. That leads into my second question because I read the Bluebook as
saying that the reason for holding the funds rate at 6-1/2 percent is the desire to have the
unemployment rate rise to 5 percent and to hold growth below potential. So, if you don't want to
raise the unemployment rate and hold growth below potential, then you’d be in favor of reducing the
rate. The only reason I saw in the Bluebook for holding the funds rate at 6-1/2 percent was to try to
drive up the unemployment rate.
MR. KOHN. If you were absolutely certain about the course the economy was going to
take and there was no uncertainty about the NAIRU or about the strength of demand--if you keyed in
on these point forecasts as what you expected to happen--then I think that rationale would carry
through. In other words, it would carry through if you just accepted everything in the Greenbook
forecast. But there are a lot of uncertainties here. A major issue that was raised in the Bluebook was
the degree of uncertainty and the extent to which it's very hard to interpret the incoming information.
So in this circumstance, and with labor markets a little to the tight side--even if you didn't think the
unemployment rate needed to go to 5 percent but you wanted a little daylight there to ease inflation

pressures a bit--you might want to proceed with any easing a little cautiously. Even if you didn't
intend to get the unemployment rate to 5 percent, waiting six weeks to reduce the federal funds rate
until you had more confirmation about the evolving situation wouldn't make very much difference.
MR. JORDAN. One more brief follow-up question: Am I right that given the Greenbook
forecast for inflation, nominal spending, trucks, and houses, and everything else, if the current
unemployment rate were 5 percent, then you would say "cut"?
MR. KOHN. And if the NAIRU were perceived to be 5 percent. Then that assessment
probably would be more likely.
CHAIRMAN GREENSPAN. Further questions for Don? Let me start then.
There continues to be some divergence of views among Committee members, and those
views have changed fairly significantly from where they were two meetings ago. Not only have the
average and the median of those views moved, but I think the tails of the distribution have moved as
well. Everybody has moved, and the changes are fairly uniform and predictable among the various
members of this Committee. [Laughter] The rate of economic expansion has very clearly and
unambiguously moved down dramatically from its pace of earlier this year, which was
unsustainable, to a point where the general view among the members is that if it stabilized at its
current level it would be sustainable. I emphasize the words “if it stabilized,” obviously, because the
syllogism isn't that we had a high degree of unsustainable growth at the beginning of the year, that
growth has moved down to a more sustainable pace, and therefore everything is fine. The key
question, and one we really cannot answer, is whether the growth rate has stabilized. At this point
we cannot know because growth has not been at its current rate long enough to exhibit evidence of
what we would normally call stabilization.

The problem, as I’ve indicated on numerous occasions and as a number of you have
commented, is that we do not have the capability of reliably forecasting a recession. The reason may
be expressed in the terminology that Dave Stockton used--in terms of “nonlinear events”--or in terms
of the analogy that I have often employed in the last two or three years, namely that pressure may
build up on a dam and nothing seems to be a problem. But at some point the dam starts to crumble
and may do so fairly rapidly as the water rushes out of the system, as indeed confidence rushes out
of the economic system. Our models do not forecast a recession because we build them and fit them
in a linear manner so that the coefficients imply multiplier effects that are not sufficiently rapid to
offset the other specifications of the models, namely the adjustment process. If we have an economy
whose growth rate is declining, our models will have interest rates and costs of capital falling at
speeds sufficiently rapid to engender a rebalancing of the economy--often before it falls into
recession. We never actually see the nonlinear events in the model because they are defined out of
the model.
As we have observed on numerous occasions, such as the oil crises, we have never been
able to use our model structures to forecast a recession out of an oil shock. We've had three oil
shocks in recent decades that were followed by recessions. There are two possible explanations.
Either strictly unrelated chance events occurred, which is possible, or our models cannot capture the
changes that were going on. My own impression is that an oil shock does not necessarily mean we
are going to get a recession, but I do think such a shock definitely weakens the structure of the
economy. And when we add to the latest shock the natural gas/electric power generation problems
that have emerged, we’re clearly observing significant pressure on the economy.
The negative effects of the energy shock have occurred essentially as a result of a
withdrawal of demand through either the "import tax" that we’re all familiar with, or as a

consequence of increased domestic natural gas costs. Clearly, no matter what one thinks about the
impact of rising energy prices on demand, the increased cost of energy is having an adverse effect on
corporate profits. That’s basically because the decline in the profit margins of nonfinancial, nonenergy corporations appears to be greater than the improved margins of the energy corporations.
Moreover, the apparent impact of these developments on the capital expenditures of the non-energy
corporations does not seem to be fully offset by the obvious increases that we're seeing in capital
outlays in the energy area. Part of the problem is the current restraint on the limited resources
available to the energy sector, such as drilling rigs. But it is also a result of a very subdued response
that we are seeing largely because the exploration and development budgets of the major energy
corporations are to a very large extent related to the West Texas Intermediate oil price, depending on
whether it is above or below the area of, say, $15 to $17 a barrel. In previous years when the price
went up over $30, as it did in this particular run, those budgets were expanded very rapidly and were
subsequently cut all the way back. The energy firms have stopped doing that. As a result, we are
getting an asymmetrical macroeconomic response to the natural gas and electricity components of
the cost increases, which have been quite substantial, needless to say.
It strikes me that we will not know for a good number of weeks whether the underlying
structure of confidence has been breached. We are at a point where we are going to learn whether
that is indeed the case, because if confidence has not been breached, the normal recuperative
processes, the normal rebalancing processes, will gradually eliminate the risk. Part of the problem is
very obviously stock market price declines, and clearly the NASDAQ declines have a major impact
on the investments of high-tech industries. I have gotten calls from a number of senior high-tech
executives who are telling me that the market is dissolving rapidly before their eyes. But I suspect
that a not inconceivable possibility is that what is dissolving in front of their eyes is their own

personal net worth! [Laughter] That does bias one's view of what is happening in the world. So, we
have to be a little careful about being seduced by those types of evaluations. I've been hearing the
same sort of adjectives that all of you have heard used to describe everything that is going wrong.
And indeed we ought to be very careful to recognize that if one could put hard numbers on the
anecdotal data we now have, we would not be looking at a 2 percent plus growth rate in GDP. It
would be closer to zero. How one reads that evidence is a question, which we have to consider.
At this point I would say that the outlook is for a very significantly subdued rate of
inflation and, if anything, pricing power in the corporate sector has been falling quite appreciably in
the last six to eight weeks. There are some slightly disturbing price patterns in the consumer area.
As you know, I don't like the CPI, so let’s stay with the PCE implicit deflator. For the first time we
are beginning to see some movement in the underlying rental components. Now, owner equivalent
rent is not exactly a market price; it is based on a sample of market rentals. The ratio of rent to value
of properties, which has been going down progressively quarter after quarter, now finally seems to
be showing that the expansion in asset prices may be beginning to spill over into consumer prices.
I think the medical cost increases we are seeing are real. They are dollar figures. But the
division of medical costs between price and volume, I'm almost certain, is terribly biased toward an
inflation that does not exist. In my view, the inflation rate for the noncorporate sector, which is well
above that for the corporate sector, is not a reflection of real inflation in medical prices because
there's very little evidence that the underlying structure of such prices is accelerating. Indeed, every
analyst who does a microanalysis of a specific price category in the medical services area concludes
that the data we see on medical price inflation are grossly overvalued. And with medical technology
changing the way it is, we are having very little in the way of medical price inflation, if such
inflation is measured properly. Even so, there is no question that we are seeing very significant

inflation in medical costs, and to the extent that those costs feed into labor compensation they have
an impact on prices. But, if anything, that process is not accelerating at this particular stage. And
indeed what we're seeing in the implications for inflation expectations in the TIPS spreads is that
irrespective of the price level from which we start, inflation expectations have clearly come down
about 0.3 percentage point. How much of that truly represents an underlying decline in inflation
expectations is an arguable issue because the TIPS implicit price deflator is fundamentally an
arguable issue to begin with.
In any event, when we look at what's going on in the economy and recognize that we have
almost a “go/no go” possibility over the next number of weeks with respect to how this economic
deterioration is going to play out, it seems pretty evident that what we want to be sure of, whatever
we decide, is that we not end up with a symmetric or balanced risks statement. That is not the way it
looks out there. If we were to decide to reduce the funds rate by 25 basis points today, which I don't
think is a good idea, we still should adopt, in my judgment, a balance of risks statement weighted
toward the down side. That’s because with whatever move we make, whether it’s 25 basis points or
something else, a symmetric risks statement would imply that we have finished our adjustment
process, and that conclusion in my judgment would be mistaken.
So I think the real choices here are 25 basis points plus asymmetry toward the down side
or zero change now with downside asymmetry and the understanding that it is quite conceivable that
we may have to have a telephone conference and move the rate before the next meeting. That's
because we may find in this interval the answer concerning whether or not the decline in the rate of
economic growth has stabilized.
What I conclude at the end of the day is that we need to recognize that we really do not
know the answer for the intermediate period. I would encapsulate that into no change in the funds

rate, but with a bias toward the down side and the recognition that, if the erosion continues, we very
likely will have to move before the next meeting. And that move would be triggered, I would
presume, by a telephone conference sometime in the early days of January--the first week or maybe
the second week at the latest. Given the uncertainties that we face and the general tenor of what I've
heard around the table this morning, that strikes me as the best thing that we should do for the
moment. Vice Chair.
VICE CHAIRMAN MCDONOUGH. Mr. Chairman, I agree fully with both the
conclusions you’ve reached and the reasoning for them. I believe that the most important thing in
public life is to know what you don’t know. And we don't in fact know enough at this point to move
the rate downward. Doing so would be unwise, in my view, especially for the reasons I cited earlier.
The markets are just too thin. But I think we have to have the balance of risks toward concern for
economic weakness, and we have to be very flexible during the month of January as you have
suggested.
CHAIRMAN GREENSPAN. President Poole.
MR. POOLE. Mr. Chairman, as you know from my earlier comments, I would have
preferred to reduce the federal funds rate at this meeting by 25 basis points. Let me try to put my
position this way. On the issue of when to ease we can ask the question in two ways. Obviously, the
market fully expects an easing at the beginning of next year, and one question to ask is what
difference does it make if we ease now rather than wait. But we can put the question the other way
around, what difference does it make if we wait six weeks? It's hard to imagine that six weeks
makes any real difference. The extent to which it may make a difference has to have something to
do with expectations and public attitudes. In my view, in terms of public attitudes and expectations
about our policy moves, there are ample data in hand now to justify easing. That is, I don't think

anyone would say that we are making a mistake by acting at this point. On the other hand, probably
the single most prominent piece of information we’re going to get that bears on this policy issue is
the December employment report that will come out at the beginning of January. If that shows
weakness--very low employment growth or a decline in employment--I think there will be a great
deal of pressure, probably within the Committee and in the public at large, for us to respond. Quite
frankly, I believe it would be better for us to anticipate that development rather than wait until we
have such a piece of negative news. As I said before, I think there's ample space for rates to move
up and not much space for them to move down. So, I would prefer to see us position ourselves in
the middle, as I indicated earlier.
CHAIRMAN GREENSPAN. President Hoenig.
MR. HOENIG. Mr. Chairman, I too would prefer moving now. I think the funds rate is
high and the effect has been to slow the economy as intended. In my view a quarter point reduction
in the rate now would still leave us with a tight policy, one that continues to slow the economy, and
yet it would recognize the risks that we've talked about around the table. I believe it is likely that we
will have a conference call and that we will lower rates at that point. And certainly we can wait until
then.
CHAIRMAN GREENSPAN. President Parry.
MR. PARRY. Mr. Chairman, I can certainly accept your recommendation. When I was
thinking about that possibility at the end of last week, I was concerned that the markets might find it
a bit confusing in terms of what we are trying to communicate. Ironically, as it turns out, the article
that appeared in the Wall Street Journal may make that less of a problem. In addition, it seems to me
that our press statement should be very carefully worded because my concern is that the markets
might be a little confused about how weak we think the economy is and might raise the issue of why

we didn't change the funds rate today. So, how our decision is written up could be an important
element in terms of the success of your recommendation.
CHAIRMAN GREENSPAN. President Moskow.
MR. MOSKOW. Thank you, Mr. Chairman. I have a slight difference of opinion with
my colleague, Mr. Parry, on the Wall Street Journal article. I consider that article very unfortunate
because when leaks like that occur I think it makes us look bad as a central bank. We’ve had this
discussion before. So, I don't see any good side to it.
Getting back to the subject at hand, clearly we are in a situation where we're all concerned
that the slowing that we wanted to see and are now seeing is going to be excessive. As you and
others have pointed out, no one knows with certainty whether further weakening will occur because
of the complexity of our economy and the interaction of the financial markets, consumer confidence,
and all the other factors that we discussed. I agree that the anecdotes point to a much lower rate of
growth than do our models at this time. But they are anecdotes, and I think we’d all like to see some
more evidence in the data and other information we receive that would help clarify the situation. In
a period of uncertainty like this, the incremental approach seems appropriate and I agree with your
recommendation for no change in rates but an asymmetric statement that the risks are weighted
toward economic weakness at this time.
MR. PARRY. Mr. Chairman, I thought the article was abominable.
CHAIRMAN GREENSPAN. Now you agree! So do I.
MR. PARRY. Okay.
CHAIRMAN GREENSPAN. President Guynn.
MR. GUYNN. Mr. Chairman, I would prefer not to ease today. I don't know how you
scored me on your note pad, but in the go-around I was trying to convey that I came with a view that

a balanced risk statement would be the proper first move. My staff would tell you that we were
debating until I left for the airport whether the slowdown was as broad as we were beginning to
sense and whether the uneasiness was as great as we sensed and, therefore, whether the
recommendation you made would be the appropriate move.
Vice Chairman McDonough captured my view that an easing today--although I suspect
that's where we are headed--is too much too soon. To the extent that part of what is going on is that
people are recalibrating from expectations of 5, 6, and 7 percent GDP as related to housing and autos
and cruise ships or whatever, I think that's something we ought to let play out. So I think your
recommendation is the right one. Thank you, Mr. Chairman.
CHAIRMAN GREENSPAN. President Santomero.
MR. SANTOMERO. I support your proposal for the reasons you stated, Mr. Chairman.
As President McDonough indicated, it’s also important that we recognize what we don't know and
not communicate to the marketplace something that we didn't intend to convey by moving at this
point.
CHAIRMAN GREENSPAN. Governor Gramlich.
MR. GRAMLICH. Thank you, Mr. Chairman. As you know, the policy you suggested is
not my first choice. Obviously, there is a lot of uncertainty out there, but I share the view of a few
others around the table who think that we've seen enough to ease fairly soon. On the other hand, if
we all agree to stand by our telephones, [Laughter] the policy you suggested "morphs" into what I
would prefer, so I will support it on that basis. But I think we ought to be alert and stand by our
telephones.
CHAIRMAN GREENSPAN. President Minehan.

MS. MINEHAN. Thank you, Mr. Chairman. I certainly don't want to be predictable but I
suppose I am in this regard.
CHAIRMAN GREENSPAN. Sorry about that! I was just reporting as a statistician.
MS. MINEHAN. What do they say about consistency being the hobgoblin of something?
I'm also not in favor of retaining any particular policy solely to move the unemployment rate up. I
don't know where the NAIRU is; I don't know whether anyone really knows where it is right now.
But I do continue to see resource constraints in labor markets, and they have been a constraint on
growth for some industries. I think the current slowing could potentially lead to a resolution of this
whole problem.
Another issue that people have focused on relates to financial conditions--widening credit
spreads and the level of real interest rates. I'm in harmony with Jack Guynn on the idea that credit
markets right now are reflective of the last loans made when spreads were really narrow in 1997 and
early 1998. And in an environment of generally healthy banking conditions, I don't view them as a
problem. I think that bankable credits are getting banked. Where should real interest rates be?
That's a tricky question when we’re moving from a period of very rapid growth to one of slower
growth in an environment of strong underlying productivity. So it's hard for me to look at the level
of the fed funds rate right now and see it as a problem all by itself.
I agree that we have to wait and see. I would have been able to vote for a balanced risk
statement, but I can also go with a statement of the growing sense of uncertainty on the down side. I
just think we ought not to let all the strength that's still in the economy be forgotten in the face of
what are largely anecdotal and expectations-related data. They could turn if the market receives
what we do today very favorably. So I think the wait-and-see attitude is the right one. Hopefully we
won't have to stand by our telephones!

CHAIRMAN GREENSPAN. Well, you have to stand by, you just don't have to answer!
[Laughter]
MS. MINEHAN. No, I intend on answering.
CHAIRMAN GREENSPAN. Governor Kelley.
MR. KELLEY. I support your recommendation, Mr. Chairman.
CHAIRMAN GREENSPAN. President Stern.
MR. STERN. I generally support your recommendation. Let me briefly make two other
comments. First, I do share some of Bob Parry’s concerns that a statement about risks weighted
toward economic weakness is going to raise the question of why didn't we act now. Hopefully, we
will have some language in the announcement that will at least give a sense of our reasons.
Secondly, and this is a point I’ve made before, I think we soon ought to consider putting at
least one nail in the NAIRU coffin. Not only has the economy failed to perform according to that
framework in the last five or six years but, so far as I'm aware, going back 15 or 16 years there just is
no evidence of an empirical relation between labor market conditions and inflation.
CHAIRMAN GREENSPAN. President Broaddus.
MR. BROADDUS. Mr. Chairman, let me say first that I can accept your proposal. I
definitely recognize the downside risks and I am getting the same kinds of messages as everyone
else. My preference would have been to have a balanced risk statement. My concern with this move
is that it is not yet fully priced in the markets. And I think it will be seen by some as a fairly
aggressive move toward ease in the context of an historically low unemployment rate and a labor
market situation that is tight by historical standards. That could set up a series of expectations,
which could put us in a box if confidence is not yet breached, to use your phrase, and the economy
begins to show some strength going forward. But I can accept your proposal. I would recommend

and would hope that the press statement that accompanies our announcement includes language
making it clear that we are not yet panicking--that it’s not a foregone conclusion that we’re
necessarily going to ease further. I guess that comment was predictable! [Laughter]
MS. MINEHAN. "We are not yet panicking!"
VICE CHAIRMAN MCDONOUGH. I don't think we will make you our press secretary!
MR. BROADDUS. I'm expressing my preferences!
CHAIRMAN GREENSPAN. President Jordan.
MR. JORDAN. Thank you, Mr. Chairman. Jack Guynn said he was still debating when
he left for the airport yesterday. I'm still debating now! Clearly, based on what I said earlier, if the
reason for not lowering the funds rate is because we're waiting for the unemployment rate to go up,
then I can't agree with that. So if the press statement is going to make any reference to continued
tightness in the labor markets, then I would disagree with that. But I guess I won't know what the
press statement is going to say until after we vote on this. So I may have to guess as to how it will-CHAIRMAN GREENSPAN. I can tell you that the preliminary press statement does not
include such a reference.
MR. JORDAN. Okay. The other reason for not moving is because it's awkward to go
from a balance of risks toward inflation to a balanced risks statement, which would seem to be out of
tune with reality. I would find that troubling. And I've always thought that whenever we reached
the point where we had to announce a balance of risks toward weakness and we didn't act, it was
going to be a problem for us. It puts the burden on us to explain why we didn't do anything if we
saw the balance of risks as weighted toward weakness. Why we didn't act is going to have to be
explained, whether we do it in the press statement or in remarks people make subsequently.

CHAIRMAN GREENSPAN. May I ask you a question? Why don't we have that
problem, no matter which direction we see the risks, every time we move to an asymmetric
statement?
MR. JORDAN. That's why I don't like being asymmetric!
CHAIRMAN GREENSPAN. Okay. Sorry! [Laughter]
VICE CHAIRMAN MCDONOUGH. He is very consistent.
CHAIRMAN GREENSPAN. I know!
SPEAKER(?). He is very predictable. [Laughter]
MR. JORDAN. And my final point, speaking of predictability, is that what apparently is
expected out there is that we would change the language this time, and then everybody could read
into that that we would change policy the next time. And I don't like being predictable. [Laughter]
I would like to do the unpredictable thing--what is not fully anticipated in the market today--and that
is to lower the rate. I think that would give us a lot more mileage than waiting to ease until after it's
well anticipated that we will ease at the next meeting or in between meetings.
CHAIRMAN GREENSPAN. Governor Ferguson.
MR. FERGUSON. Thank you, Mr. Chairman. I support your recommendation for the
reason you put forward, which in some sense has tended to be forgotten as we've gone around the
table. We are in a period, I believe, of great uncertainty. And I think it's not illegitimate for us to
recognize some uncertainty by saying that we tend to think the risks are in one direction. On the
other hand, it's not inappropriate to wait for a little confirmation. When we originally thought
through this complex set of issues on the language and so forth, we all knew we might get in this
position. And as abominable as that terrible article was in the Wall Street Journal, I think it did get
the concept, and lo and behold the world did not fall apart.

So I'm actually very comfortable with exactly where you are. It reflects uncertainty and it
reflects the reality of a tough conversation. The markets will not think us foolish for not jumping
based on what is anecdotal evidence, but we are warning them--or in some sense maybe comforting
them--that we are awake and alive and if things work out in a certain way, we’re prepared to
respond. So I am quite comfortable with your proposal.
CHAIRMAN GREENSPAN. Governor Meyer.
MR. MEYER. Thank you, Mr. Chairman. I support your recommendation. I continue to
believe that a period of below-trend growth is constructive, but I'm mindful of the downside risks we
face today. I think one reason for being cautious about moving immediately is that the markets
already anticipate a move early next year and a cumulative easing of 100 basis points over the course
of next year. I don't think we should do or say anything at this meeting that would disconfirm or
unwind those expectations, but neither do I believe that it would be particularly constructive to
escalate them further. So, I think this is the right move for now. But this period of uncertainty is a
time when the incoming data may be very revealing, and an intermeeting move could certainly be a
possibility.
CHAIRMAN GREENSPAN. President McTeer.
MR. MCTEER. Predictably, let me say that a quarter point is not much, and I really think
we need to get started earlier rather than later. I agree with most of what Bill Poole said about the
current situation. One thing he said was that we are not going to learn much in early January except
the employment-unemployment numbers. We actually had a decline in employment last month on
the household measure. You once said, Mr. Chairman, that we always make one move too many. If
we lowered the funds rate a quarter point now, we’d remove just half of our last increase. If we
expect to act by telephone, I'm afraid it will look as if we decided at that point that we made a

mistake today. On the other hand, I came into this meeting expecting the outcome to be a balanced
risk statement and this is better than that! [Laughter]
CHAIRMAN GREENSPAN. I think a majority is in favor of no change in rates and the
balance of risks toward the down side. Read the appropriate language.
MR. BERNARD. The wording is on page 14 of the Bluebook: "The Federal Open
Market Committee seeks monetary and financial conditions that will foster price stability and
promote sustainable growth in output. To further its long-run objectives, the Committee in the
immediate future seeks conditions in reserve markets consistent with maintaining the federal funds
rate at an average of around 6-1/2 percent." And for the balance of risks sentence in the press
release: "Against the background of its long-run goals of price stability and sustainable economic
growth, and of the information currently available, the Committee believes that the risks are
weighted mainly toward conditions that may generate economic weakness in the foreseeable future."
CHAIRMAN GREENSPAN. Call the roll.
MR. BERNARD.
Chairman Greenspan
Vice Chairman McDonough
President Broaddus
Governor Ferguson
Governor Gramlich
President Guynn
President Jordan
Governor Kelley
Governor Meyer
President Parry

Yes
Yes
Yes
Yes
Yes
Yes
Yes
Yes
Yes
Yes

CHAIRMAN GREENSPAN. Let me indicate that the next meeting is going to be a rather
long one because our agenda is quite lengthy. We will be meeting at 9 a.m. on both Tuesday and
Wednesday, which is longer than usual, so I'll give you all a heads up. Let's go to lunch.
MR. KOHN. The announcement?

CHAIRMAN GREENSPAN. Oh, I'm sorry. That tells you how hungry I am! [Laughter]
MR. GRAMLICH. Could I suggest a change in one word?
CHAIRMAN GREENSPAN. Sure.
MR. GRAMLICH. The seventh line begins with "financial markets suggest that
economic"--it says "growth" and I’d like to substitute "activity." The reason is that we are, I believe,
still arguing and are mainly of the view that we continue to be in the midst of a productivity shock. I
think this is more about activity than growth.
CHAIRMAN GREENSPAN. What's the opinion? Does anybody support that?
MR. GRAMLICH. I'd rather be redundant than misleading.
VICE CHAIRMAN MCDONOUGH. I think most people, unlike experts, understand
growth more than activity.
MR. KOHN. I don't know whether slowing activity actually means a decline.
CHAIRMAN GREENSPAN. Slowing activity means the level as distinct from-MS. MINEHAN. Yes, as opposed to the growth.
CHAIRMAN GREENSPAN. What we basically would be saying is that the economy is
going down. We don't have that view.
MS. MINEHAN. We think we have moderating growth.
CHAIRMAN GREENSPAN. Further suggestions? If not, let's go to lunch.
END OF MEETING

Full text of Federal Open Market Committee Meeting Minutes, Transcripts, and Other Documents : Meeting, December 19, 2000 : Transcript

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