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June 29-30, 2004
A meeting of the Federal Open Market Committee was held in the offices of the Board of Governors
of the Federal Reserve System in Washington, D.C., on Tuesday, June 29, 2004, at 2:30 p.m. and
continued on Wednesday, June 30, 2004, at 9:00 a.m.
Mr. Greenspan, Chairman
Mr. Geithner, Vice Chairman
Mr. Bernanke
Ms. Bies
Mr. Ferguson
Mr. Gramlich
Mr. Hoenig
Mr. Kohn
Ms. Minehan
Mr. Olson
Ms. Pianalto
Mr. Poole
Ms. Cumming, Messrs. McTeer, Moskow, Santomero, and Stern, Alternate Members
of the Federal Open Market Committee
Mr. Guynn and Ms. Yellen, Presidents of the Federal Reserve Banks of Atlanta and
San Francisco respectively
Mr. Lacker, President-Elect of the Federal Reserve Bank of Richmond
Mr. Reinhart, Secretary and Economist
Mr. Bernard, Deputy Secretary
Ms. Smith, Assistant Secretary
Mr. Mattingly, General Counsel
Ms. Johnson, Economist
Mr. Stockton, Economist
Messrs. Connors, Fuhrer, Hakkio, Howard, Madigan, Sniderman, Slifman, Tracy, and
Wilcox, Associate Economists
Mr. Kos, Manager, System Open Market Account
Messrs. Oliner and Struckmeyer, Associate Directors, Division of Research and
Statistics, Board of Governors
Messrs. Clouse and Whitesell, Deputy Associate Directors, Division of Monetary

Affairs, Board of Governors
Mr. Kamin, 1/ Deputy Associate Director, Division of International Finance, Board of
Messrs. Gagnon 1/ Leahy, 1/ and Sheets, Assistant Directors, Division of
International Finance, Board of Governors
Mr. English, Assistant Director, Division of Monetary Affairs, Board of Governors
Mr. Simpson, Senior Adviser, Division of Research and Statistics, Board of
Mr. Thomas, 1/ Section Chief, Division of International Finance, Board of Governors
Ms. Kusko 2 / and Mr. Zakrajsek, Senior Economists, Divisions of Research and
Statistics and Monetary Affairs respectively, Board of Governors
Mr. Carpenter, 2/ Economist, Division of Monetary Affairs, Board of Governors
Mr. Skidmore, Special Assistant to the Board, Office of Board Members, Board of
Mr. Luecke, Senior Financial Analyst, Division of Monetary Affairs, Board of
Ms. Low, Open Market Secretariat Assistant, Division of Monetary Affairs, Board of
Mr. Lyon, First Vice President, Federal Reserve Bank of Minneapolis
Mr. Judd, Executive Vice President, Federal Reserve Bank of San Francisco
Messrs. Eisenbeis, Evans, Goodfriend, Mses. Mester and Perelmuter, 1/ Messrs.
Rolnick and Rosenblum, Senior Vice Presidents, Federal Reserve Banks of Atlanta,
Chicago, Richmond, Philadelphia, New York, Minneapolis, and Dallas respectively
Ms. Goldberg 1/ and Mr. Thornton, Vice Presidents, Federal Reserve Banks of New
York and St, Louis respectively
By unanimous vote, the minutes of the meeting of the Federal Open Market Committee held
on May 4, 2004, were approved.
The Manager of the System Open Market Account reported on recent developments in
foreign exchange markets. There were no open market operations in foreign currencies for
the System's account in the period since the previous meeting.
The Manager also reported on developments in domestic financial markets and on System
open market transactions in government securities and securities issued or fully guaranteed
by federal agencies during the period May 4, 2004, through June 29, 2004. By unanimous

vote, the Committee ratified these transactions.
At this meeting, the Committee discussed staff papers and presentations on adjustment of the
U.S. external accounts. At more than $500 billion, the deficits in trade and current account
balances are quite large in comparison with aggregate income. Financing of the deficits had
recently included both large foreign private purchases of U.S. securities and increased
foreign official inflows. The sizable current account deficit could be viewed as reflecting
very low levels of national saving, in both its government and private components, in relation
to investment opportunities in the United States that were very attractive. The staff noted that
outsized external deficits could not be sustained indefinitely. However, the historical
evidence indicated that such deficits could be quite persistent, and the adjustment of
imbalances was not necessarily imminent. The adjustment, once under way, might well
proceed in a relatively benign fashion, particularly if fiscal, monetary, and trade policies were
appropriate, but the possibility that the adjustment could involve more wrenching changes
could not be ruled out. In any case, a movement toward balance in the trade and current
accounts would likely have effects that differ appreciably across sectors of the U.S. economy.
Members of the Committee noted that monetary policy was not well equipped to promote the
adjustment of external imbalances but could best contribute by maintaining an environment
of price stability that would foster maximum sustainable economic growth. Fiscal policy had
a potentially larger role to play by promoting an increase in national saving, but the
adjustment would involve shifts in demand and output both domestically and abroad, and
changes to U.S. fiscal policy alone probably would not be sufficient to foster the adjustment.
The information reviewed at this meeting suggested that the economy continued to expand at
a solid pace during the second quarter. Although growth in consumer spending appeared to
have slowed somewhat, the demand for housing increased from its robust first-quarter pace.
Business fixed investment, boosted by surging outlays on equipment and software, also grew
rapidly. The labor market improved further during the quarter, with large gains in
employment registered in April and May. Core consumer price inflation picked up, reflecting
in part the pass-through of substantial advances in energy prices and non-energy import
The labor market rebounded strongly in recent months. Private nonfarm payrolls grew
rapidly in April and May, with hiring widespread across industries. The manufacturing sector
appeared to be on a more solid footing, as manufacturers added jobs in each of the past four
months after more than three years of declines. Aggregate hours moved up in both April and
May, bringing the level of hours substantially above its trough of last summer. Despite the
recent strength in hiring, the unemployment rate changed little in recent months, and the
labor force participation rate remained low.
Industrial production accelerated in April and May after a sizable advance in the first quarter.
Output at utilities surged in the latter month, reflecting weather-related factors, and factory
output excluding motor vehicles, buoyed by strong gains in both high-tech manufacturing
industries and in most non-high-tech industries, expanded sharply in both months. In
contrast, the production of motor vehicles declined as automakers trimmed outsized
inventory positions. Capacity utilization moved higher but stayed below its long-run average.
Growth in real consumer spending appeared to have slowed somewhat in recent months from
its first-quarter pace. Although outlays for motor vehicles in May more than retraced their
April decline and purchases of services advanced at an appreciable rate, spending on

nondurable goods remained sluggish. Despite higher energy prices, real disposable personal
income continued its uptrend in recent months, benefiting from an improved labor market
and last year's tax cut. Home prices also continued to rise at a rapid pace, contributing
importantly to increases in household wealth. Survey measures of consumer confidence
moved up in June from already favorable levels.
Activity in the housing market increased in April and May despite a considerable rise in
mortgage interest rates. Single-family housing starts edged above their rapid first-quarter
pace, and sales of both new and existing homes reached record levels in May. In the volatile
multifamily sector, housing starts fell somewhat in May, but, more generally, construction
activity in this sector had been surprisingly resilient in light of the high vacancy rate for such
Business investment spending appeared to have advanced at a brisk pace in the second
quarter, as rising output, low user cost of capital, and increased corporate cash flow
continued to foster a favorable environment for capital spending. Although new orders and
shipments of nondefense capital goods excluding aircraft dipped in May, both series
remained on a solid uptrend, and, with orders exceeding shipments, backlogs continued to
grow. Spending on transportation equipment, which dropped in the first quarter, appeared to
rebound in recent months, while outside the transportation and high-tech sectors, increases in
spending moderated from their rapid first-quarter pace. After declining in the first quarter,
overall investment in nonresidential structures appeared to pick up a little in the second
quarter, though the performance of the major types of construction remained mixed.
Spending on office buildings and manufacturing structures continued to be depressed by high
vacancy rates, while outlays for commercial buildings moved up in conjunction with declines
in vacancy rates for such structures. In addition, judging by the number of natural gas drilling
rigs in operation, spending on drilling and mining structures rose in recent months.
The pace of inventory accumulation remained subdued. Although the book value of
manufacturing and trade inventories increased appreciably in the first quarter and continued
to rise at about the same pace in April, the recent large increases in the book-value data were
due importantly to a jump in the price of oil and a run-up in the prices of intermediate
materials. Inventory-sales ratios in manufacturing and retail trade edged higher in April but
remained near their historical lows; meanwhile, inventory-sales ratios in the wholesale trade
sector trended lower.
The U.S. international trade deficit reached a new record in April, reflecting in large part a
sharp decline in exports of goods. The fall in goods exports was widespread, with notable
decreases in capital goods, industrial supplies, and agricultural products. Exports of services,
in contrast, increased in April. Imports of goods edged higher, as a large decline in the value
of imported oil was offset by an increase in imports of non-oil products, and imports of
services increased. Real GDP in the major foreign industrial countries expanded at a healthy
pace in the first quarter. Indicators of economic activity in the second quarter for Canada and
the United Kingdom were also favorable, whereas those for the euro area were somewhat
mixed. Japan's economy, supported by robust private domestic demand and rising consumer
confidence, evidently continued to expand strongly in the second quarter. Mainly as a result
of higher energy prices, consumer price inflation moved up a bit in the second quarter in
Canada, the United Kingdom, and the euro area, while slight deflation persisted in Japan.
Consumer price inflation turned up this year from the very low rates registered in 2003, both

for overall measures and for those that exclude food and energy. Overall consumer prices
rose more quickly than core prices, reflecting the direct contributions of substantial increases
in prices of food and energy. But the step-up in core inflation was also due in part to the
pass-through of higher energy and import costs into core consumer prices. Some survey
measures of short-term inflation expectations moved higher in recent months, but
longer-term expectations remained reasonably well contained. Commodity prices escalated
sharply during the early months of 2004, but indexes of spot prices for industrial materials
and for wholesale gasoline retreated appreciably in recent weeks. Meanwhile, labor costs
appeared to have turned up in the first half of the year. Hourly compensation in private
industry rose in the first quarter at the same rate as in 2003, but with the pace of productivity
advance moderating, unit labor costs moved higher. In April and May, increases in average
hourly earnings of production or nonsupervisory workers on private nonfarm payrolls
exceeded the monthly gains registered in the first quarter and were well above the increases
in the fourth quarter of 2003.
At its meeting on May 4, 2004, the Federal Open Market Committee decided to leave its
target for the federal funds rate unchanged at 1 percent. The Committee retained its
assessment that the upside and downside risks to the attainment of sustainable growth were
roughly equal, but it announced that the risks to the goal of price stability had moved into
balance. The Committee also noted that output had continued to expand at a solid pace, new
hiring had appeared to pick up, and although incoming data on inflation showed that it had
moved somewhat higher, longer-term inflation expectations had remained well contained.
Reflecting these developments, the Committee concluded that it could remove policy
accommodation at a pace that was likely to be measured.
The Committee's decision at its May meeting to leave the intended level of the federal funds
rate unchanged had been fully anticipated by market participants. Likewise, the replacement
of the sentence in the announcement reporting that the Committee could be patient in
removing policy accommodation with one indicating that policy accommodation can be
removed at a pace that is likely to be measured had little net effect on money market futures
rates on the day of the announcement. Over the balance of the intermeeting period, however,
market participants marked up significantly the extent of expected policy tightening in
response to data that indicated robust gains in employment and spending and somewhat
elevated inflation, as well as to comments by Committee members providing reassurance that
policy would be tightened as necessary to contain any incipient inflationary pressures.
Revisions to policy expectations showed through to interest rates on nominal Treasury
securities, which increased commensurately. Yields on inflation-indexed Treasury securities
rose almost as much as those on their nominal counterparts, leaving inflation compensation
only slightly higher, on net, by the end of the intermeeting period. Yields on investment- and
speculative-grade corporate securities rose about the same amount as those on comparable
Treasuries, leaving risk spreads about unchanged. Generally positive economic news and
further improvements in the outlook for corporate earnings evidently offset the influence of
higher interest rates, and major equity indexes edged higher over the intermeeting period. In
foreign exchange markets, the dollar depreciated somewhat against major currencies, and it
rose a bit against an index of currencies of other major U.S. trading partners.
M2 continued to expand rapidly in May. The upswing in M2 growth since late winter
stemmed in part from the temporary effects of mortgage refinancing, which boosted liquid
deposits over this period, though M2 was also buoyed by strong gains in nominal income. In

recent months, a rebound in currency growth and reduced portfolio shifts by households from
monetary assets to equities and bonds also supported the expansion of M2. The growth of
M2 slowed appreciably during the first half of June. Commercial bank credit decelerated in
May, reflecting a contraction in bank holdings of securities and a slowdown in the growth of
loans. The slowing in loan growth was concentrated mainly in real estate credits and was due
partly to heavy securitizations.
The staff forecast prepared for this meeting suggested that the economy would continue to
expand at a solid pace through 2005. Monetary policy was expected to support economic
activity over the projection period, and fiscal policy was anticipated to remain
accommodative through 2004. Moreover, persisting strong gains in structural productivity
would likely continue to provide significant impetus to spending. With firms shedding their
unusual caution of the past few years, further large additions to payrolls over the next several
quarters were anticipated, followed by a gradual moderation in the rate of increase in
employment. Strong profits, sustained increases in aggregate demand, and a favorable
financing environment were expected to keep business spending on equipment and software
on a healthy upward trajectory over the forecast period. The impending expiration of the
partial-expensing tax provision was likely to provide an additional boost to capital spending
later this year, although the shifting forward of some investment was expected to dampen
capital spending in early 2005. In addition, inventory investment was forecast to increase
gradually in order to bring changes in stocks closer in line with rising sales. Robust
employment growth and the cumulative productivity gains of recent years were expected to
contribute to strong advances in real disposable income, sustaining the expansion of
consumption spending over the forecast period. Core inflation was projected to fall back later
this year from its pace in the first five months and to remain low in 2005, as the transitory
effects of higher energy and non-oil import prices waned.
In the Committee's discussion of current and prospective economic conditions, members
commented that the evidence accumulated over the intermeeting period continued to portray
an economy that was expanding briskly and was likely to continue to do so for some time.
Business and consumer expenditures were on a strong uptrend, and related growth in output
was associated with notable improvement in labor market conditions and in manufacturing
activity. Members saw the persistence of a relatively vigorous expansion in overall economic
activity as a likely prospect in the context of continuing stimulus from fiscal and monetary
policies, accommodative financial conditions, growing business optimism, favorable
consumer sentiment, and robust increases in productivity. Solid increases in economic
activity and employment should in turn provide ongoing support to business and consumer
spending. Members acknowledged that their favorable outlook for economic activity was
based on the assumption that major terrorist disruptions would be averted.
In light of the strength of economic activity and recent indications of somewhat increased
price pressures, the members focused particular attention on the outlook for inflation. They
referred to statistical and anecdotal evidence that on the whole pointed to some recent
acceleration of consumer prices and to some increase in near-term inflation expectations.
Factors cited in this regard included large increases in prices of energy and intermediate
materials, both of which appeared to be passing through at least in part to core consumer
prices. Members referred to some limited inflationary impetus as well from the depreciation
of the dollar and larger increases in labor compensation. Considerable uncertainty still
surrounded the overall extent to which competitive pressures would allow producers to pass

through rising costs to prices of finished goods; anecdotal reports suggested that the ability of
many producers to do so was increasing but was far from universal at this point. With regard
to the prospective course of inflation, members suggested that some of the rise in core
inflation in recent months appeared to have resulted from what might well prove to be
transitory factors, notably including increases in energy and other import prices, which were
not seen as likely to persist and indeed might be partially reversed. Just how much slowing of
price increases was likely after some relatively elevated readings was difficult to forecast.
Those who anticipated a noticeable deceleration emphasized the contribution of the one-time
price increases that had boosted inflation recently, persisting, albeit diminishing, margins of
unemployed labor and other productive resources, the anticipation of strong further gains in
productivity and declines in markups of goods prices over costs, and steady long-term
inflation expectations. Others tended to emphasize the changes in business attitudes and
expectations, the strength in labor compensation, and the tendency for underlying inflation
trends to be subject to considerable momentum that was unlikely to be reversed quickly.
Whatever their inflation forecasts, several noted that they now had less confidence in those
forecasts than earlier. A number of members qualified their inflation outlook by noting that
its realization likely would require an adjustment to monetary policy over time that brought
the latter to a neutral stance as the economy continued to move toward full utilization of its
In preparation for the midyear monetary policy report to Congress, the members of the Board
of Governors and the presidents of the Federal Reserve Banks submitted individual
projections of the growth of GDP, the rate of unemployment, and the rate of inflation for the
years 2004 and 2005. The forecasts of the rate of expansion in real GDP were concentrated in
the upper part of a 4 to 4-3/4 percent range for 2004, implying expectations by most
members of a pickup over the second half of the year; for 2005 the forecasts were in a
reduced range of 3-1/2 to 4 percent. These rates of growth were associated with ranges for
the civilian rate of unemployment of 5-1/4 to 5-1/2 percent in the fourth quarter of 2004 and
5 to 5-1/2 percent in the fourth quarter of 2005. Forecasts of the rate of inflation, as measured
by the core PCE price index, pointed to marginally higher rates of inflation encompassed by
ranges of 1-1/2 to 2 percent for this year and 1-1/2 to 2-1/2 percent for 2005.
In their comments about developments in key sectors of the economy, many of the members
emphasized the strength in business capital spending. Explanatory factors included the
sustained demand for business output, strong profit margins and cash flow, low capital costs,
and the partial-expensing tax provision. Weakness persisted, however, in the nonresidential
construction sector, though signs of improvement were emerging in some areas. Many
business contacts were expressing a marked degree of optimism about the outlook for
business activity in the second half of the year. Currently low inventory-to-sales ratios,
indeed reports of emerging bottlenecks in some markets, were expected to foster efforts to
rebuild inventories and thus add support to the expansion going forward.
Consumer outlays were rising more moderately in the second quarter and somewhat below
expectations. The slowing was not universal, however. Some members reported a
continuation of robust consumer expenditures in various parts of the country. Looking ahead,
members, in part echoing the sentiment of contacts among retailers, anticipated renewed
strength in consumer spending in the context of sizable further growth in employment and
disposable incomes and a generally high level of consumer confidence. In housing markets,
activity had remained at generally high levels, with only a few signs that rising mortgage

rates were beginning to hold down sales and construction. There was evidence in some areas
that inventories of unsold homes had risen. Members noted that persisting overall strength in
housing might to some extent be a response to expectations of further increases in mortgage
rates, implying that a slowdown might be likely later in the year.
Members commented that fiscal policy was continuing to provide appreciable impetus to the
economy, in part because of the incentives for business investment associated with the
partial-expensing tax legislation. Following the scheduled expiration of that legislation at the
end of this year and with more moderate gains in federal spending forecast in the absence of
new legislation, the federal budget was expected to become mildly contractionary in 2005,
although a marked degree of uncertainty surrounded this outlook. Many state and local
governments were increasing their spending more rapidly in response to brightening budget
Expanding foreign economies and the depreciation of the dollar were expected to foster
appreciable growth in U.S. exports, but with imports still considerably larger than exports,
the external sector was likely to make a measurable negative contribution to U.S. GDP
growth this year and next. On the inflation side, higher import prices and, importantly, the
rise in domestic and imported oil prices were adding to domestic inflationary pressures,
although improving oil supplies had recently contributed to somewhat lower domestic
gasoline prices.
In the Committee's discussion of policy for the intermeeting period, all of the members
indicated that they could support an upward adjustment in the target for the federal funds rate
from a level of 1 percent to 1-1/4 percent. Recent developments, notably the persistence of
solid gains in output and employment along with indications of some increase in inflation,
were seen as warranting a first step in the process of removing policy accommodation. The
timing and pace of further policy moves would depend, of course, on the members' reading
of the incoming economic information and their interpretation of its implications for
economic activity and inflation. In this regard, members commented that they could envision
a series of gradual or "measured" policy moves as likely to be consistent with the attainment
of the Committee's objectives for sustaining progress toward higher levels of resource
utilization and maintaining price stability. A few indicated, however, that their preference
would be to remove any characterization of possible future policy actions from the
Committee's statements. Partly reflecting anticipated monetary policy actions, financial
market conditions had tightened in recent months, but short-term interest rates were quite
low, especially when judged against the recent level of inflation. Depending on the rate at
which resource utilization increased and the level and trend of inflation, a more aggressive
pace toward reaching a neutral policy stance might be called for so as to provide assurance of
containing emerging inflationary pressures and averting the potential need for greater overall
tightening over time.
In the Committee's review of the announcement to be released shortly after this meeting,
members agreed that an updating of the reasons for its policy decision was desirable,
specifically by adding a reference to the possibility that some of the recent acceleration in
inflation might reflect transitory factors. The members also decided to modify the reference
to labor market conditions by referring in general terms to improved conditions rather than
more narrowly to a pickup in hiring to acknowledge the broad range of labor market
indicators considered by the Committee. They agreed to retain the assessments adopted at the
May meeting indicating that they viewed the upside and downside risks to both the

attainment of sustainable economic growth and to the goal of price stability as roughly in
balance for the next few quarters. However, with regard to the outlook for inflation, a number
of members emphasized that they would view the risks as tilted to the upside in the absence
of further policy tightening actions that would bring the stance of policy to a more neutral
setting. Many members also underscored their view that the statement should make clear that
the Committee would be prepared to respond to significant changes in economic prospects
and take actions that were deemed necessary to meet the Committee's commitment to
maintain price stability.
At the conclusion of the discussion, the Committee voted to authorize and direct the Federal
Reserve Bank of New York, until it was instructed otherwise, to execute transactions in the
System Account in accordance with the following domestic policy directive.
"The Federal Open Market Committee seeks monetary and financial conditions
that will foster price stability and promote sustainable growth in output. To
further its long-run objectives, the Committee in the immediate future seeks
conditions in reserve markets consistent with increasing the federal funds rate to
an average of around 1-1/4 percent."
The vote encompassed approval of the paragraph below for inclusion in the press statement
to be released shortly after the meeting:
"The Committee perceives the upside and downside risks to the attainment of
both sustainable growth and price stability for the next few quarters are roughly
equal. With underlying inflation still expected to be relatively low, the
Committee believes that policy accommodation can be removed at a pace that is
likely to be measured. Nonetheless, the Committee will respond to changes in
economic prospects as needed to fulfill its obligation to maintain price stability."
Votes for this action:Messrs. Greenspan, Geithner, Bernanke, Ms. Bies, Messrs.
Ferguson, Gramlich, Hoenig, Kohn, Ms. Minehan, Mr. Olson, Ms. Pianalto, and
Mr. Poole.
Vote against this action: None.
The next meeting of the Committee was scheduled to be held on Tuesday, August 10, 2004.
The meeting adjourned at 1:35 p.m.
Vincent R. Reinhart
1/ Attended portion of the meeting relating to the discussion of prospective external
adjustment. Return to text
2/ Attended portion of the meeting relating to the discussion of economic
developments.Return to text

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