Full text of Federal Open Market Committee Meeting Minutes, Transcripts, and Other Documents : Meeting, February 10-11, 1987 : Greenbook Part 1

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Strictly Confidential (FR) Class II FOMC

February 4,

SUMMARY AND OUTLOOK

Prepared for the Federal Open Market Committee
By the staff of the Board of Governors of the Federal Reserve System

1987

DOMESTIC NONFINANCIAL DEVELOPMENTS

Recent developments.

Incoming data, on balance, suggest that economic

activity has continued to expand at a'moderate pace.

Basic trends in wage

and price inflation appear to have changed little in recent months, although
world oil prices and industrial commodity prices have turned up.
The industrial sector of the economy showed some vigor toward the end of
the year.

The index of industrial production rose 0.5 percent in December,

and for the fourth quarter as a whole was up at a 3-1/4 percent annual rate-the largest quarterly increase since late 1984.

The recent gains were wide-

spread, with particularly sharp increases in home goods and defense and space
equipment.

In contrast, production of business equipment has yet to show any

improvement from its generally lackluster performance of the past year.
Employment growth strengthened in the fourth quarter, with nonfarm
payroll employment increasing about 260,000 per month.
services again provided the bulk of the new jobs.

Hiring in finance and

However, employment in the

manufacturing sector posted average monthly gains of nearly 30,000 last
quarter, after declining throughout much of the year, and the factory workweek remained at a high level.

The civilian unemployment rate declined

0.2 percentage point in December to 6.7 percent.
Consumer spending in real terms declined slightly in the fourth quarter,
reflecting a drop in new car and truck sales from the torrid pace of the
third quarter.

Excluding motor vehicles, spending for other goods and

services advanced at nearly a 2-1/2 percent annual rate, about the same pace
as in the third quarter but considerably less than earlier in the year.

With

both income and outlays in the household sector estimated to have edged down
I-1

in the fourth quarter, the personal saving rate remained at a low 2-3/4
percent.

After a brief tax-related surge in December, sales of domestically

produced new autos averaged just 5-1/2 million units at an annual rate
in the first 20 days of January, leading automakers to announce a new round
of sales incentives.
Capital outlays for equipment also were depressed by a falloff in business
purchases of autos and trucks in the fourth quarter.

However, the decline in

motor vehicles purchases was nearly offset by a small pickup in other equipment
spending, which was motivated, at least in part, by efforts to take advantage
of the more favorable depreciation schedules that were in effect for some
types of equipment placed in service by January 1.

Looking forward, new

orders for nondefense capital goods other than aircraft dropped last quarter,
suggesting there is likely to be a lull in spending in the early months of
the year.

Outlays for nonresidential construction have continued on a downtrend

in recent months, and the value of construction put-in-place in December was
more than 10 percent below a year earlier.
Manufacturers' inventories resumed their decline in December, after
increasing slightly in the previous month.

Inventories in the nonauto retail

sector, which had accumulated at a brisk pace in September and October,
declined in November, owing in part to the strength of sales in the retail
control group of stores.

However, abstracting from month-to-month variation,

the overall inventory picture has changed little in recent months, and there
is no evidence of significant imbalances in either manufacturing or trade.
Activity in the housing sector picked up toward year-end.

Sales of

both new and existing homes rose in December in response to lower mortgage
interest rates and--in the case of existing home sales--a tax incentive to

realize capital gains before the end of the year.

In addition, housing

starts jumped to a 1.8 million unit annual rate in December, after drifting
lower since early spring.

Single-family starts returned to near the pace

seen earlier in the year.

Multifamily starts also rebounded in December, but

declined 10 percent for the fourth quarter as a whole.

Given the high vacancy

rates and the negative effects of tax law changes on rental housing, the
December rise in multifamily starts should prove to be transitory.
The consumer price index rose 0.3 percent in November and 0.2 percent
in December, remaining within the range of monthly increases that has been
evident since late summer.

World crude oil prices jumped in mid-December, in

response to the latest agreement by OPEC members to restrict output.

Although

retail energy prices also turned up in December, the bulk of the effect of higher
oil prices is likely to show up in the first half of this year.

In contrast,

increases in consumer food prices slowed in December, following several
months of sharp gains.

Apart from food and energy, consumer prices rose 0.3

percent in both November and December, about in line with the 3-3/4 percent
pace registered for the year as a whole.
Wage increases, as measured by a wide variety of broad indexes, slowed
in 1986.

Compensation per hour in the nonfarm business sector rose 2-3/4

percent last year, nearly 1-1/4 percentage points less than in 1985.

At the

same time, productivity in the nonfarm business sector rose about 3/4 percent.
With wages decelerating further and productivity remaining on a slow uptrend,
unit labor costs were well-contained over the year.

Outlook.

The staff expects real GNP to increase about 2-1/4 percent

at an annual rate in the first quarter.

Further gains in exports are projected

to provide a significant stimulus to real GNP.

In contrast, domestic demands

are expected to rise at only a 1 percent annual rate in the current quarter,
virtually the same sluggish pace as in the fourth quarter.

Inflation, as

measured by the GNP fixed-weighted price index, is projected to accelerate a
bit, to about a 3 percent annual rate, reflecting sharp increases in energy
prices.
In terms of domestic demands, the primary impetus to activity is
expected to come from consumer spending for items other than autos, which
should continue to increase at the moderate pace posted in the second half
of

1986.

Demand in other sectors likely will be sluggish.

Business fixed

investment is expected to fall in the current quarter, as some equipment
purchases were advanced into the fourth quarter of last year; moreover,
nonresidential construction outlays are expected to move lower.

In addition,

residential construction expenditures are projected to decline in lagged
response to the earlier drop in starts.

New car sales are projected to

decline further in the current quarter; but with assemblies likely to run
ahead of sales, the weakness in sales will be partially offset by a buildup
in auto inventories.
The policy assumptions underlying the staff projection are much the
same as in the last Greenbook.

With respect to monetary policy, M2 and M3

are assumed to grow at rates well within their tentative ranges this year and
grow a bit more slowly in 1988.

Interest rates are projected to change

little in the near term, but to drift a bit higher by the end of the

projection period.

Congress is assumed to enact deficit-reducing measures for

fiscal year 1988 similar in magnitude to those enacted last year, leading
fiscal policy to exert a restraining influence on aggregate demand over the
projection horizon.

The federal budget deficit, which reached $221 billion

in fiscal year 1986, is projected to decline to about $180 billion and $150 billion
in fiscal years 1987 and 1988, respectively.
Real GNP is projected to increase about 2-3/4 percent in both 1987 and
1988.

The growth activity over this period is driven, in large measure,

by the anticipated effects of the depreciation of the foreign exchange value
of the dollar.

Increased competitiveness in world markets is expected to

propel U.S. export growth at double-digit rates over the next two years.
Moreover, the projected increase in import prices, occasioned by the drop in
the value of the dollar, is likely to shift domestic demand away from foreign
production and toward goods and services produced in the United States.
Meanwhile, the growth in domestic demands is expected to slow to a
1-1/2 percent annual rate, on average, in both 1987 and 1988.

With the rise

in import prices likely to damp real income gains, consumer spending is
projected to slow to about a 1-1/2 percent rate across the projection horizon,
well below the 3-1/2 to 4 percent average rate of increase over the past four
years.

Government purchases also slow considerably, reflecting the restrictive

turn in fiscal policy.

In contrast, equipment spending is projected to

grow moderately, as domestic production expands, modernization efforts continue,
and the cost of capital edges lower.

In the near term, residential

construction activity is expected to be held down by the influence
law changes on multifamily construction;
starts should have reached bottom.

of tax

but by midyear, multifamily

Single-family construction is expected to

provide some stimulus to overall activity over the next two years.

Overbuilding

in the office sector probably will continue to depress nonresidential construction
outlays over the projection horizon.
The contours of the staff price projection are shaped importantly by
the depreciation of the exchange rate and a firming of world oil prices.

The

GNP fixed-weighted price index is projected to accelerate from about 2-1/2
percent in 1986 to about 3 percent in 1987 and 3-3/4 percent in 1988.

In-

creases in nonpetroleum import prices are expected to rise further in 1987
and maintain a double-digit pace throughout 1988.

Moreover, world oil prices,

which had averaged about $12.25 per barrel in the second half of last year,
are expected to average near $17.00 per barrel over the projection horizonsomewhat below their current market levels.

However, the adverse effects of

these developments on inflation are damped somewhat by the remaining margin
of slack in labor and product markets.

February 4, 1987
CONFIDENTIAL - FR
CLASS II FOMC

STAFF GNP PROJECTIONS
Percent changes, annual

.....................................................................................................

Nominal GNP

12/10/86

2/4/87

Real GNP

12/10/86

2/4/87

rate

GNP
deflator

GNP fixed-weighted
price index

12/10/86

2/4/87

12/10/86

2/4/87

Unemployment
rate
(percent)

12/10/86

2/4/87

............................................................................................................................

Annual changes:
1985

<1>

6.2

1986

<1>

5.4

1987
1988

5.1

Quarterly changes:
1986

1987

1988

Ql <1>
Q2 <1>

6.2
2.6

Q3 <1>

6.4

Q4 <1>

3.9

Q1

5.2

Q2

5.5

Q3
Q4

5.6
5.7

6.9
6.9
6.8
6.7

6.7
6.7
6.6
6.6

Q1
Q2
Q3
Q4

Two-quarter changes: <2>
Q2 <1>

4.3

Q4 <1>

5.2

1987

Q2
Q4

5.4
5.7

1988

Q2
Q4

1986

5.4
6.1

2.5
3.0

2.5
3.0

2.1
2.3

2.1
2.6

2.1
2.2

2.1
2.3

.2
-.2

.0
-. 2

3.0
2.8

3.0
3.1

2.8
2.6

2.8
3.0

-. 1
-. 2

-. 2
-.1

-. 2
.0
-. 3

-.2
-.2
-. 3

Four-quarter changes: <3>
1985
1986
1987
1988

Q4 <1>
Q4 <1>
Q4
Q4

6.3
4.8
5.5

<1> Actual.
<2> Percent change from two quarters earlier.
<3> Percent change from four quarters earlier.

-. 1

February 4,

1987

GROSS NATIONAL PRODUCT AND RELATED ITEMS
(Seasonally adjusted; annual rate)

CONFIDENTIAL - FR
CLASS II FOMC

...............................................................
1986
Units

Q3

Projection

1987
Q4

Q1

1988
Q4

Q1

Q2

Q3

Q2

Q3

4383.0
3749.0

4448.1
3776.3

4514.1
3804.5

4584.1
3830.3

4653.4
3855.4

4721.9
3880.6

Q4

EXPENDITURES
Nominal GNP
Real GNP

Billions of $
Billions of 82$

Nominal GNP

Percent change

4794.0
3906.1

4240.7
3686.4

4268.4
3702.4

4320.3
3722.9

6.4

Gross domestic purchases

2.8
2.6
3.7

2.6
1.7
2.1
.9

5.0
2.2
2.5
1.0

5.9
2.8
3.0
1.6

6.1
2.9
3.0
1.7

6.1
3.0
3.1
1.7

6.4
2.7
2.8
1.5

6.2
2.6
2.7
1.3

6.0
2.6
2.5
1.4

6.2
2.7
2.7
1.7

Final sales
Private dom. final purchases

4.5
5.6

3.0
-.5

-. 1
-. 8

2.6
2.1

2.7
2.1

3.0
2.0

2.7
1.7

2.6
1.3

2.8
1.6

2.6

Personal consumption expend.
Durables
Nondurables

-. 3
-10.6

2.4
3.4
1.9
2.4

2.1
3.7
1.1

2.4

-.5
-10.1
.4
2.3

1.9
2.8
1.4
2.0

1.7
2.7
1.6
1.6

1.2
.0
1.2
1.6

1.3
.0
1.5
1.6

1.4

44.6
-. 9

Business fixed investment
Producers' durable equipment
Nonresidential structures
Residential structures

-2.1
1.2
-9.8
9.7

-3.0
-2.8
-3.4
4.3

-2.5

2.2

2.1
4.0
-2.5
3.0

2.2

2.1
4.0
-2.7
1.1

2.2
4.0
-2.7
3.7

2.2

-3.5
-3.6

3.1
4.0
.8
-3.8

-2.7
5.4

Exports
Imports

13.3
17.3

16.1
4.8

9.0
-1.5

8.3
-2.1

4.5
2.5

13.2
30.2
-4.4
1.1

-2.7
-7.8
3.0
1.8

-1.3
-5.5
.0
2.2

-4.7
-2.8
2.3

9.8
13.8
-145.0

11.9

13.9

-8.6
-163.3

-11.5
4.2
-155.6

14.9
-134.3

-123.5

100.3
6.9

101.1
6.9

101.5
6.7

102.0
6.7

102.5
6.6

Real GNP
Gross domestic product

6.7

Services

Government purchases
Federal
Defense
State and local
Change in business inventories

Nonfarm
Net exports

17.2
6.1

Billions of 82$
Billions of 82$
Billions of 82$

-. 3

2.0
1.6
-2.1

2.4

4.0

-2.3
1.9
11.0
-. 2
-. 9

14.9

4.0

-2.5
.6

1.7

.2
1.6
1.6
4.0

12.7
.9

11.3
-. 1

12.4
.6

13.3
1.9

10.7
2.4

.4
-2.2
-3.2
2.6

.3
-2.4
-3.4
2.4

1.0
-1.3
-2.0
2.8

1.4
-. 3
-1.3
2.8

1.5
-. 1
-. 3

2.8

14.6
15.6
-100.5

15.2
16.2
-88.3

13.5
14.5
-76.6

13.7
14.7
-67.9

103.0
6.6

103.5

103.9
6.6

104.4
6.5

104.8
6.5

14.5
15.5
-112.2

'LOYMENT AND PRODUCTION
arm payroll employment
nemployment rate

Millions
Percent*

Industrial production index
Capacity utilization rate-mfg.

Percent change
Percent*

Housing Starts
Auto sales

Millions
Millions
Millions
Millions

Domestic
Foreign

6.6

1.9
79.7

3.3
79.9

4.9
80.4

3.2
80.6

3.4
80.8

3.4
81.0

3.4
81.2

3.4
81.3

3.5
81.4

3.4
81.5

1.75
12.91
9.43

1.67
11.32

1.65
10.23
7.29

1.66
10.70
3.20

1.72
10.95
7.65
3.30

1.73
11.00
7.70
3.30

1.74
11.00
7.70
3.30

1.74
11.00
7.70
3.30

1.74
11.00

2.94

1.70
10.90
7.60
3.30

4.0
-2.4
3.2

5.2
2.5
3.3

6.6
2.4
3.4

6.6
2.4
3.5

5.1
-.1
3.2

5.6
1.8
3.3

6.1

-3.7
6.8

9.6
7.0

7.1
7.0

3.47

7.66
3.66

7.50

7.70
3.30

INCOME AND SAVING
Nominal personal income
Real disposable income
Personal saving rate

Percent change
Percent change
Percent*

1.8
-3.1
2.8

4.0
2.7

6.9
6.9
4.4

Corp. profits vith IVA & CCAdj
Profit share of GNP

Percent change
Percent*

12.7
7.1

7.3
7.2

-6.4
7.0

Federal govt. surplus/deficit
State and local govt. surplus

Billions of $

-. 5

-173.4
55.3

15.3
7.0
-173.3
58.4

15.4
7.1
-175.6
60.9

-6.4

6.9
-174.0

-197.4
64.0

-191.4
50.4

-224.2
56.1

3.6
2.6
3.0
2.6

1.0
2.6
3.2
2.8
4.1

2.6
2.9
3.8
4.6
3.3

3.0
3.1
3.5
3.5
3.6

3.0
3.1
3.4
3.6
4.1

3.0
3.1
3.5
3.7
4.1

3.5
4.0
4.1
4.2
4.7

-1.7
3.1
4.9

2.0
3.0
1.0

1.0
3.1
2.1

1.1
3.2
2.1

1.3
3.3
2.0

1.1
4.9
3.8

63.3

1.1
3.3
13.1
7.1

-154.4
63.6

-151.7
65.0

-146.8

3.4
3.7
4.2
4.1
4.6

3.3
3.7
4.1
4.3
4.8

3.5
3.7

66.8

PRICES AND COSTS
CNP implicit deflator
GNP fixed-weight price index
Cons. & fixed invest, prices
CPI
Exc. food and energy

Percent change

3.6

4.2
4.4

4.9

Nonfarm business sector

Output per hour
Compensation per hour
'nit labor costs
. at an annual rate.

-.3
2.3
2.6

1.0
4.2

3.2

February 4,

CONFIDENTIAL - FR
CLASS II FOMC

1987

GROSS NATIONAL PRODUCT AND RELATED ITEMS
(Seasonally adjusted; annual rate)
Projection
Units

1980

1981

1982

1983

1984

1985

3279.1

3765.0
3489.9

3998.1
3585.2

4208.5
3676.5

4416.4
3763.2

1986

1987

1988

EXPENDITURES
Nominal GNP
Real GNP

Billions of $
Billions of 82$

Real GNP
Gross domestic product
Gross domestic purchases

Percent change*

3052.6
3248.8

Services
Business fixed investment

Producers' durable equipment
Nonresidential structures
Residential structures
Exports
Imports
Government purchases
Federal

Defense
State and local

3405.7

4688.4
3868.1

-1.9
-1.6
-. 8

6.5
6.6
8.4

4.6
4.9
5.9

2.9
3.1
3.9

2.2
2.5
2.8

2.8
2.9
1.5

2.7
2.7
1.5

-. 2
-1.7

.1
-. 3

.3
.8

3.7
7.7

4.4
5.3

4.0
4.2

2.4
2.8

2.0
1.3

2.7
1.6

-. 1

.2
-3.3
.5
.9

2.9
1.8
2.3

5.4
14.7
4.4
3.9

3.6
8.8
2.2
3.3

3.5
6.2
2.0
3.9

4.0
9.9
3.4
2.6

1.5

-5.6
-1.4
2.4

1.4
.7
1.5
1.6

-4.8
-6.5
-1.8
-14.2

5.6
2.2
11.7
-22.4

-11.3
-12.5
-9.1
4.9

10.8
20.9
-4.8
38.1

14.7
16.0
12.1
5.3

6.5
8.1
3.3
7.8

-5.4
-. 6
-15.7
9.8

.5
-8.8

2.4
4.9

5.8
23.8

5.5
16.5

-3.2
5.6

6.2
9.3

10.2
-. 7

11.9
1.2

1.0
3.1
3.1
-. 3

2.9
9.5
7.6
-1.3

3.8
8.2
8.8
.6

-2.7
-8.1
5.1
1.5

7.7
14.2
6.8
3.1

8.4
14.3
5.9
3.7

3.3
1.8
7.2
4.6

-1.1
-5.1
-. 8
2.2

1.1
-1.0
-1.8
2.7

23.9
19.0
49.4

-24.5
-23.1
26.3

-6.4
-19.9

59.2
54.3
-83.6

9.0
10.9
-108.2

10.8
10.9
-149.7

3.1

10.4

8.5

6.3

-1.1

Personal consumption expend.
Durables
Nondurables

3166.0
3166.0

.6
.3
.8

-. 1'

.3

Final sales
Private dom. final purchases

Change in business inventories
Nonfarm

2732.0
3187.1

Net exports

Billions of 82$
Billions of 82$
Billions of 82$

-6.9
-2.3
57.0

Nominal GNP

Percent change*

9.9

9.3

9.0

-13.8
-5.9

-. 1

4.4

-. 4

1.6
2.1
1.2
2.5
-1.9
-. 7

12.5
14.8
-128.8
5.8

2.2
4.0
-2.6
2.7

14.3
15.3
-83.3
6.2

EMPLOYMENT AND PRODUCTION
-------------------------

Nonfarm payroll employment
Unemployment rate

Millions
Percent

90.4
7.1

91.2
7.6

89.6
9.7

90.2
9.6

94.5
7.5

97.6
7.2

Industrial production index
Capacity utilization rate-mfg.

Percent change*
Percent

-. 8
79.3

-1.0
78.3

-7.7
70.3

14.3
74.0

6.6
80.5

1.7
80.1

1.1
79.8

3.7
80.7

3.5
81.3

Housing

Millions
Millions
Millions
Millions

1.30
9.04
6.62
2.42

1.10
8.56
6.24
2.32

1.06
8.00
5.77
2.23

1.71
9.18
6.77
2.41

1.76
10.43
7.97
2.46

1.74
11.09
8.24
2.84

1.83
11.52
8.28
3.25

1.68
10.69
7.51
3.18

1.74
11.00
7.70
3.30

Nominal personal income
Real disposable income
Personal saving rate

Percent change*
Percent change*
Percent

12.0
1.1
7.1

9.2
.7
7.5

5.3
1.0
6.8

7.8
5.1
5.4

8.4
4.2
6.3

6.1
1.9
5.1

4.4
2.4
3.9

5.7
2.3
3.6

5.9
1.3
3.3

Corp. profits with IVA & CCAdj
Profit share of GNP

Percent change*
Percent

-6.8
6.5

2.3
6.2

70.1

6.6
7.0

7.8
7.0

7.6
7.1

4.6
7.0

5.6
7.0

Federal govt. surplus/deficit
State and local govt. surplus

Billions of $

-204.0
60.8

Starts

Auto sales
Domestic
Foreign

100.2
7.0

102.2
6.7

104.2
6.5

INCOME AND SAVING

-61.3
26.8

-63.8
34.1

-19.1
4.7

6.3

-145.9
35.1

-176.0
47.5

-170.0
68.5

-198.0
61.7

-186.6
57.7

-156.7
64.7

PRICES AND COSTS
GNP implicit deflator
GNP fixed-weight price index
Cons. & fixed invest, prices
CPI
Exc. food and energy
Nonfarm business sector
Output per hour
Compensation per hour
Unit labor costs

Percent change*

9.8
10.1
12.5
12.2

8.7
8.5
8.2
9.6
10.2

5.2
5.0
4.4
4.5
5.2

3.6
3.9
3.3
3.3
4.3

3.6
3.9
3.6
4.1
4.8

3.3
3.6
3.4
3.5
4.3

2.2
2.4
2.0
1.3
3.8

2.9
3.1
3.6
3.8
3.8

3.4
3.8
4.2
4.2
4.8

1.0
10.9
9.8

-. 6
8.3
9.0

1.0
7.3
6.2

3.6
3.3

1.0
4.3
3.2

.2
3.9
3.7

.7
2.7
2.0

1.4
3.1
1.8

1.0
4.1
3.1

9.9

* Percent changes are from fourth quarter to fourth quarter.

-. 3

February 4, 1987

CONFIDENTIAL - FR
CLASS II FOMC

GROSS NATIONAL PRODUCT AND RELATED ITEMS
(Net changes, billions of 1982 dollars)
Projection

Projection
1986
------------

1987
------------------------------

1988
------------------------------

1985
1986
1987
1988
(fourth quarter to fourth quarter,

Q3

Q4

Q1

Q2

Q3

Q4

Ql

Q2

Q3

Q4

Real GNP
Gross domestic product
Gross domestic purchases

25.0

16.0

20.5

23.2

19.3

23.0

26.1
27.0

27.3
27.3

28.2
28.7

25.9
25.8

25.1
25.1

25.1
24.1

25.5
25.5

101.9
107.6

34.4

8.3

10.0

15.4

16.5

16.8

14.2

13.0

13.4

16.8

141.2

Final sales
Private dom. final purchases

40.4
41.6

27.2
-4.2

-. 8
-6.2

24.0
15.9

25.3
16.2

27.6
15.4

25.8
13.5

24.5
10.4

26.8
12.4

25.3

Personal consumption expend.
Durables
Nondurables
Services

39.6

-2.9

12.8

11.6

10.7

-10.3
.8

3.1
4.1

3.4
2.4

2.6
3.0

2.5
3.5

7.0

6.6

-1.5
-10.5
4.3
4.7

14.4

34.5
-1.9

7.2

7.0

6.0

4.8

Business fixed investment
Producers' durable equipment
Nonresidential structures
Residential structures

-2.4
1.0
-3.4
4.5

-3.4
-2.3
-1.1
2.1

-2.8
-1.7
-1.1
-1.8

3.4
3.2
.2
-1.9

2.5
3.2
-.7
.9

Change in business inventories
Nonfarm
Farm

-15.4
-19.6
4.2

-11.2
12.8
-24.0

21.3
9.6
11.7

2.1
1.1
1.0

-9.4
11.4
20.9

7.7
14.1
6.3

10.6
8.4
-2.1

10.7
7.9
-2.8

Net exports
Exports
Imports
Goverment purchases
Federal
Defense
Nondefense
State and local

10.8
10.6
-.3

net change)

101.6
100.6

103.7

102.1
106.0
58.6

141.1
122.5

86.4

76.1

85.3

41.3

102.4
49.9

7.5

80.0

93.4

37.2

34.7

,0
2.6

20.2
16.7

34.3
29.0

-1.4
13.7

2.7
12.9

4.9

43.1

30.1

24.9

19.1

-25.9
-1.9
-24.0
17.8

5.5
7.9
-2.4
-1.4

9.9
13.2
-3.3
5.3

-39.1

-6.3

-17.8
-21.3

-11.9
5.6

26.0
11.3

-39.3

-23.6

13.6

29.3
24.4
4.9
13.2

11.3
12.5
1.2
.8
-1.9
-2.1
.2
2.7

11.7
11.5
-.1

12.1
12.9
.8

11.7
14.3
2.6

8.8
12.0
3.2

.6
-2.0
-2.2
2.6

I

43.4

44.3

39.4
-4.0

50.7
6.5

22.4
46.0

57.9

24.7

-8.7

43.4

6.3
17.2

-18.0
-2.0

-10.9
18.4

-16.0
9.3

14.5

57.3

14.7

-12.1
27.1

13.4
30.0

.2

80.1
87.9

February 4,

CONFIDENTIAL FR CLASS II

1987

FEDERAL SECTOR ACCOUNTS
(Billions of dollars)
FRB Staff Estimates
Fiscal
Year
1986*

FY1987e
FRB
Admin' Staff

FY1988e
FRB
Admin' Staff

CY1987e
CY
FRB
1986* Staff

1986
IV*

1988
II

1987
I

II

III

IV

I

Not seasonally adjusted
2

Budget receipt?
Budget outlays
Surplus/deficit(-)
to be financed

769
990

842
1016

828
1009

917
1024

898
1046

782
992

-221

-173

-181

-108

-148

-210

Means of financing:
Borrowing from public
Cash alance decrease
Other
Cash operating balance,
end of period
Memo:

Sponsored agency
borrowing

836
1014

190
254

197
250

236
250

206
255

198
259

208
261

266
258

226
268

-177

-64

-53

-14

-49

-61

-54

9

-42

215
0
-5

153
16
9

69
1
-5

31
19
3

26
-8
-3

51
-5
3

45
10
6

56
0
-2

-1
-5
-3

44
-5
3

31

20

25

20

25

31

15

31

12

20

25

15

15

20

25

14

n.a.

15

n.a.

20

14

15

5

1

4

5

5

5

5

5

NIPA Federal Sector

Receipts
Expenditures
Purchases
Defense
Nondefense
All other expend.
Surplus/deficit(-)

Seasonally adjusted annual rates

815
1025
368
275
94
657
-211

High-employment surplus/
deficit -) evaluated
-173
at 6 percent unemp.

875
1061
385
291
94
676
-186

n.a.

862
1052
381
288
93
672
-191

-151

968
1089
395
301
94
694
-121

n.a.

*--actual

Note:
1.

926
1090
387
293
94
703
-164

826
1030
367
278
89
663
-204

873
1059
382
290
92
677
-187

852
1043
376
282
94
667
-191

842
1066
381
289
93
685
-224

874
1048
383
291
92
665
-173

879
1053
382
291
91
670
-173

896
1071
383
291
92
689
-176

920
1094
387
293
94
707
-174

940
1094
388
293
95
706
-154

949
1100
390
294
95
711
-152

-129

-166

-148

-151

-184

-133

-135

-139

-139

-120

-118

-

--

e--estimated

----

n.a.--not available

Details may not add to totals due to rounding

Budget of the United States Government , Fiscal Year 1988 (January 1987). The Congressional Budget Office baseline estimates
published in January indicated receipts of $834 and $900 billion, outlays of $1008 and $1069 billion, and deficits of $174
and $169 billion in FY1987 and FY1988, respectively.
Includes outlays formerly classified as off-budget (e.g. Federal Financing Bank and Strategic Petroleum Reserve) and social
security receipts and outlays classified as off-budget under current law.
Checks issued less checks paid accrued items, and other transactions.
Sponsored agency borrowing includes net debt issuance by Federal Home Loan Banks, Federal Home Loan Mortgage Corporation
(excluding participation certificates), Federal National Mortgage Association (excluding mortgage-backed securities),
Farm Credit Banks, and Student Loan Marketing Association marketable debt. The Administration s definition of borrowing
by these agencies is somewhat broader.

Domestic Financial Developments

Recent developments.

Short-term interest rates generally have returned

to about the levels prevailing at the time of the mid-December FOMC meeting,
having retraced the run-up through late December associated with the taxrelated surge in financial transactions and with quarter-end balance sheet
positioning by depository institutions and other firms.

In longer-term

markets, bond rates reacted little to year-end pressures and to the drop
in the exchange value of the dollar.

More recently, however, Treasury

bond rates have moved nearly 15 basis points above their December FOMC
levels, given market reactions to incoming economic news in the context
of the approaching midquarter refunding.

Long-term corporate rates have

fallen on balance since the last FOMC meeting, reflecting a moderation in

bond issuance and expectations that a falloff in merger activity may
reduce downgradings in coming months.

Tax-exempt bond yields have declined

by even more than corporates as private-purpose issuance slowed abruptly
in January.
A bulge in demand deposits in December that accompanied a taxrelated surge in bank lending and other financial transactions propelled
Ml growth to nearly a 30 percent annual rate.

As the special factors

waned in January, demand deposits ran off, and Ml growth was cut by
almost two-thirds despite a further acceleration of currency and NOW
accounts.

M2 growth likewise was boosted to double-digits in December,

with its slowing in January restrained by a pickup of inflows to its
nontransactions component.

M3 growth in January remained close to its

higher December pace as commercial bank issuance of large CDs spurted to
help fund the further surge in bank loans.
I-12

1-13
Much of this strength in bank credit in December and in January was
in the business loan component.

Business borrowing was elevated to finance

share retirements associated with the flurry of merger activity and other
corporate restructurings late in December.

In addition, the rise around

year-end in Eurodollar and commercial paper rates above the prime rate
induced corporations to substitute business loans at U.S. banking offices
for borrowing from foreign branches of U.S. banks and the commercial paper
market.

The overall strength in short-term borrowing since November has

more than offset some weakening on balance in bond issuance by nonfinancial
corporations.

New stock offerings by nonfinancial firms strengthened

further in December but receded in January, as issuers had not yet responded
to the advance in stock prices last month.
Mortgage activity picked up late last year, prompted by further
declines in interest rates and by incentives to sell appreciated real
estate before year-end, when less favorable capital gains and depreciation
provisions became effective.

Federally related issuance of mortgage pass-

through securities increased in December to establish a new record in the
fourth quarter.

Real estate lending at commercial banks swelled in December

and continued heavy in January, evidently owing in part to the growing use
of home equity lines of credit, which substitute in many cases for consumer
credit.

Revolving credit, which is mostly credit card debt, actually

declined in December.

Overall consumer credit outstanding edged up in

December only because of a step-up in auto credit associated with taxrelated spike in car sales that month.

I-14
Gross tax-exempt bond issuance temporarily strengthened in December
on sizable offerings of private-purpose housing and industrial development
bonds permitted under 1986 volume limits.

As such issues fell off in

January, gross offerings of municipal securities retreated last month,
despite continued large issuance of refunding bonds.

A more than seasonal

slackening in federal borrowing was evident in January, when Treasury
bills were paid down.

The federal deficit in January was narrowed by

unusually large tax payments by individuals on capital gains realized
late last year.
Outlook.

The growth of debt of nonfinancial sectors through the

current quarter is likely to remain well below the bloated pace of late
last year.

Federal borrowing over the rest of this quarter will be

restrained by a rundown in the Treasury's unusually large cash balance
and by the boost to revenues from the final installment on March 15 of
higher corporate taxes stemming from the retroactive repeal of the investment tax credit.
remain subdued.

Borrowing by state and local governments probably will
Even with rates on municipal bonds near the lowest

levels in more than seven years, refunding issues could taper off as the
initial reactions to recent interest rate declines play out.
For nonfinancial corporations, the gap between capital expenditures
and internal funds is likely to widen somewhat from the fourth-quarter
level, but net share retirements should remain substantially below their
fourth-quarter pace.

On net, business demands for credit probably will

be lighter this quarter, with the drop-off occurring in the short-term
area, especially at U.S. offices of commercial banks as more typical
patterns of borrowing in the commercial paper market and at offshore bank

I-15

branches are fully restored.

The current lower levels of corporate bond

rates, if maintained, could elicit some moderate strengthening of longterm debt issuance from the reduced January pace, perhaps enough to cause
the amount this quarter to exceed that of the fourth quarter.

The

persistence of higher stock prices would encourage increased flotation
of new equities, while retirements from mergers and other corporate
restructurings stay subdued.
Households are likely to maintain relatively strong mortgage
borrowing over the rest of this quarter.

Turnover of existing homes is

expected to remain heavy, though below the frantic pace of late last
year; rates quoted on conventional fixed-rate mortgages have moved down
almost to 9 percent, which is in more normal alignment with prevailing
long-term Treasury yields.

The general downward trend of consumer credit

growth in recent months is anticipated to continue this quarter in
association with the projected softness of spending on consumer durables
and the evident growing popularity of home equity loans.
Beyond the first quarter, aggregate domestic debt growth is projected
to remain below the 1986 pace-although not quite so "slow" as in the
opening months of the year.

Federal borrowing will pick up in the spring,

although Treasury cash needs for the year as a whole will be reduced by
the diminishing budget deficit.

State and local borrowing should be

restrained by the large amount of funds raised in 1985-86 in anticipation
of later uses.

Business borrowing will be comparable to the 1986 volume,

as a somewhat larger financing gap is offset by a reduced volume of
merger-related share retirements.

And overall household debt growth is

unlikely to be much different from the 1986 rate, with mortgage debt

1-16

stronger and consumer debt growth being held down in part by substitution
of home equity credit.

INTERNATIONAL DEVELOPMENTS

Recent developments.

The trade-weighted average foreign exchange

value of the dollar against G-10 currencies has declined about 8
percent, on balance, since the December FOMC meeting.

The dollar

declined sharply in early January, following release of preliminary
trade data that suggested a substantial worsening of the U.S.
merchandise trade balance in November and a variety of public statements
by U.S. and foreign officials regarding the appropriate value of the
dollar.

Subsequently, the dollar recovered somewhat in response to the

release of data giving a more favorable-than-expected December deficit
and revised data for November that indicate a narrower deficit
month.

in that

Since the December meeting, the dollar has declined 10 percent

against the mark, about 7 percent against the yen, and about 3-3/4
percent against the Canadian dollar.

The Desk intervened
for the U.S. account on one occasion, purchasing $50 million against
yen, which was split evenly between the System and the Exchange
Stabilization Fund.

A realignment of parities within the European

monetary grid was announced on January 11; the German mark and Dutch
guilder were revalued by 3 percent and the Belgian franc was revalued by
2 percent against all other currencies in the exchange-rate system.
Indicators of real economic activity in the major foreign
industrial countries continue to show low rates of expansion.

I-17

I-18

Provisional data estimate real GNP growth in 1986 at 2.5 percent in
Germany and 2 percent in France.

In Japan industrial production in the

fourth quarter averaged 1 percent below its level in the preceding
quarter while in Germany the fourth-quarter average of industrial
production was 0.3 percent below the third-quarter level.

The Japanese

cabinet has adopted a budget for the fiscal year beginning April 1 that
calls for only a slight increase in total nominal expenditure.

Tax

reform measures have been proposed that would lower marginal tax rates,
but offsetting increases in indirect taxes will leave revenue unchanged
for the coming fiscal year.

On January 23 the Bundesbank lowered its

discount and Lombard rates 1/2 percentage point each.

The Bundesbank

also raised reserve requirements and lowered quotas for discount
borrowing in order to absorb part of the large inflow of funds that
occurred prior to the EMS realignment.

On balance, these measures were

intended to bring about a lower level of market interest rates in
Germany.
Real GDP growth in the major developing countries was uneven in
1986.

Brazil adopted measures late in the year to slow its 7.7 percent

growth of real GDP while Argentina and Venezuela experienced relatively
strong growth of 5-1/2 percent and 3 percent, respectively, and Mexico
suffered a decline in real GDP of about 4 percent.

Argentina has

reached agreement with the IMF management for a stand-by arrangement,
and Nigeria's arrangement with the IMF has received final approval by
the Executive Board.

Both Brazil and the Philippines in January

concluded reschedulings of external debt with Paris Club creditors.
Efforts are continuing to complete commitments to the $7.7 billion

I-19

financing package for Mexico by the banks that have been reluctant to
participate.
U.S. merchandise trade data recently released indicate a
substantially lower November deficit than was originally suggested by
the preliminary figures and, based on preliminary data, a reduced
deficit in December.

The staff estimates that when all the data have

been revised, seasonally adjusted, and are put on a balance-of-payments
basis, the trade deficit in the fourth quarter will be about $157
billion (s.a.a.r.), slightly larger than in the third quarter.

The

value of both exports and non-oil imports appear to have increased about
4 percent.

Oil imports rose slightly in value, but declined in volume.

These data by themselves suggest there could be some upward revision to
the figure published for real GNP growth in the fourth quarter.
Growth of official reserve assets in the United States tapered off
to $1.4 billion in October and was negligible in November after
averaging $4 billion per month in the second and third quarters.

Net

purchases of U.S. Treasury obligations by foreigners other than official
reserve holders also fell in October and November, with a net outflow in
the latter month largely the result of net sales of $2 billion by
nonmonetary international organizations.

Private net foreign purchases

of U.S. corporate stocks and bonds also slowed in October and November.
Offsetting these reductions in capital inflows were net sales of foreign
securities by U.S. residents totalling $3.4 billion in October.
Outlook.

The staff projects a moderate decline in the value of the

dollar that will continue through the end of 1988, but notes the risk of
a sharper fall, as occurred in January, if market participants are

I-20

disappointed with the pace of adjustment of U.S. economic developments.
The staff outlook for the current account is for the deficit to be

reduced gradually after peaking in the current quarter.

In the first

quarter, a rise in the price of oil imports is expected to increase
their value to well above the fourth-quarter rate, largely accounting
for the increase in the current account deficit.

For the year 1987 as a

whole, the current account deficit is projected to be about $150
billion, slightly larger than the estimated outcome for 1986.

By the

fourth quarter of 1988, the current account balance in nominal terms is
projected to improve by more than $30 billion from the fourth quarter of
1986, with most of the improvement occurring during 1988.

Since import

prices are expected to rise considerably faster than export prices in
1987, the small change in nominal terms masks a substantial rise in real
net exports.

In 1988, similar improvement is expected in both nominal

and real terms.

Strictly Confidential (FR)
Class II FOMC
February 3, 1987
Outlook for U.S. Net Exports and Related Items
(Billions of Dollars, Seasonally Adjusted Annual Rates)
ANNUAL
1986- 1987-P 1988-P

1986
Q3-

Q1-

92-

1987
03-P

Q4-P

01-P

92-P

1988
Q3-P

Q4-P

1. GNP Exports and Imports 1/
Current $, Net
Exports of G+S
Imports of G+S

-105.7 -115.9
373.0
415.2
478.7 531.1

-89.9
487.7
577.6

-108.9 -115.6
370.8
383.4
479.7
499.0

-125.9 -118.6
-112.1 -106.9
393.2
405.6
422.0
440.1
519.1
524.1 534.1 547.1

-101.5
457.4
559.0

-93.1
476.8
569.9

-85.3
498.4
583.7

-79.8
518.0
597.9

Constant 82 $, Net
Exports of G+S
Imports of G+S

-149.7 -129.0
371.4 408.0
521.0 536.9

-83.6
456.0
539.6

-163.3 -155.6
371.2 385.3
534.5 540.8

-145.3 -134.6 -123.8 -112.4
393.7 401.5 412.1 424.7
538.9 536.1 535.8 537.0

-100.8
436.2
536.9

-88.6
449.1
537.7

-76.9
463.4
540.2

-68.2
475.4
543.5

-149.0 -152.1 -130.4

-150.7 -156.7

-162.4 -154.2 -148.5 -143.5

-139.5 -132.3 -127.0 -122.8

2. U.S. Merchandise Trade Balance 2/
Exports
Agricultural
Non-Agricultural

221.6
27.0
194.6

255.6
26.9
228.7

221.3
25.9
195.4

230.0

237.3

249.1

29.1
281.4

29.0
201.0

27.1

27.1

210.2

Imports
Petroleum and Products
Non-Petroleum

370.6
34.0
336.6

407.7
40.2
367.6

440.9
44.4
396.6

371.9
32.0
340.0

386.7
32.7
354.0

399.7
41.3
358.4

3. U.S. Current Account Balance
Of Whichs Net Investment Income

310.5

-142.8 -150.8 -127.6
21.9

13.0

2.3
4.1

2.2
3.9

2.0

2.2

-145.1 -152.5

11.2 --- . .- 22.0
. . . . .

. . . . . . . . . . . . . - --- -- -_

18.2 .

. . . .

222.0

261.5
26.7
234.8

274.5
26.8
247.7

288.9
27.9
261.0

303.6
28.8
274.9

318.2
29.8
288.4

331.4
30.1
301.3

403.3
38.8
364.5

410.0
39.3
370.7

418.1
41.3
376.7

428.-4
42.9
385.5

435.9
43.4
392.5

445.2
45.3
399.9

454.2
45.8
408.4

-158.7 -153.1 -147.1 -144.3
14.8

- . . . . . . .
.

-137.5 -129.9 -122.8 -120.1

12.8

12.6

11.7

11.4

2.1
3.9

2.0
3.9

1.7
4.0

2.4
4.3

2.5

2.8
- -

- - - - - - - - - - - - -

2.9

3.2- -

. . . . . . . . . . . . . . . . . - ------. . . . . . . . .

10.9
11.6
. . . . . . . . . .

11.0

. . . . . .

4. Foreign Outlook 3/
Real GNP--Ten Industrial 4/
Real GNP--NonOPEC LDC 5/
Consumer Prices--Ten Ind. 4/

- - - -. - - - - - - - - - -

2.1
4.1

1.7
4.1

2.9

0.1

- - - - - - - - - - - - - -

1.9
3.9

1.7
3.8

2.5
3.8

2.0

2.8

2.9
- - - -

- - - - - - - - - - - - - - -

1/ Economic activity and product account data.
2/ International accounts basis.
3/ Percent change, annual rates.
4/ Weighted by multilateral trade-weights of G-10 countries plus Switzerland;
5/ Weighted by share in NonOPEC LDC GNP.
Projected

- - - - - - - - - -

prices are not seasonally adjusted.

2.3
4.6

2.2
5.0

3.0

3.2

- - - - - - - - - - - -