Full text of Federal Open Market Committee Meeting Minutes, Transcripts, and Other Documents : Meeting, September 23, 1986 : Greenbook Part 1

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Strictly Confidential (FR) Class II FOMC

September 17,

SUMMARY AND OUTLOOK

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

1986

DOMESTIC NONFINANCIAL DEVELOPMENTS

Recent developments.

The pace of economic activity appears to have

improved somewhat in recent months.

At the same time, inflation rates

are still quite moderate, despite a temporary spurt in food prices and a
firming in world oil prices.
The August labor market reports show that gains in employment last
month were more balanced across industries than had been the case earlier
this year.

Nonfarm payroll employment rose 200,000--240,000 after adjust-

ing for strike activity.

Although service-producing establishments

accounted for two-thirds of the increase, construction employment also
was up substantially, and manufacturing jobs rose for the first time since
January.

The civilian unemployment rate edged down again in August to 6.8

percent, nearly 1/2 percentage point below the second-quarter average.
Some firming in industrial activity also is apparent in revised data
for the index of industrial production, which now shows that,

rather than

declining, output was flat in June and rose 0.3 percent in July.

In August,

industrial production is estimated to have edged higher by 0.1 percent.
In particular, output of business as well as defense and space equipment rose
considerably faster in July than previously reported, and further gains
occurred in August.

Production of consumer goods, other than motor vehicles,

also posted solid gains over the two-month period.
Domestic auto production, however, dropped in August as General
Motors lengthened their plant closings for model changeover.

Excessive

dealer inventories prompted GM in late August to launch a new round of
financing incentives and rebates designed to clean up stocks prior to the
introduction of 1987 models.

Consumer response to these incentives,
I-1

which were matched by other domestic car makers, was spectacular: sales
of domestic cars surged at a 17 million unit annual rate in early September.
Sales of imported cars remained robust in August as well, averaging 3.3
million units (annual rate) for a second month.
Apart from autos, consumer spending looks to be remaining quite
buoyant in the third quarter.

Nominal retail sales of goods other than

autos, gasoline, and building materials rose 1/4 percent further in August
after increases of about 1/2 percent in each of the preceding two months.
General merchandisers, in particular, reported another sizable gain in
sales in August.

Underlying the strength in consumer spending this year

has been the pickup in real income growth and the lagged effects of
earlier increases in household financial wealth.
Although consumers continue to report favorable attitudes
toward homebuying, the backup in mortgage rates over the summer apparently
cut into home sales.

New home sales in July dropped to a level 16 percent

below the very strong second-quarter average while existing home sales
remained at about the advanced second-quarter pace.

Through August, the

level of residential construction was relatively well-maintained, as starts
totaled 1.8 million units (annual rate).

Single-family starts in August,

at 1.2 million units, remained close to their vigorous first-half average
while multifamily starts held fairly steady at a level significantly
below the pace earlier in the year.
In the business sector, spending on structures remained sluggish
through July.

Although the contraction in oil and gas-well drilling

shows some signs of ending, the downtrend in commercial and industrial

building is continuing, as the adjustment to high vacancy rates and expected
tax reform occurs.

The value of nonresidential construction put-in-place

(which excludes drilling) fell in July for the fifth time in six months.
Business outlays for equipment, however, appear to have improved a bit in
recent months, as shipments of nondefense capital goods in July reached a
level 1 percent above the second-quarter average.

Moreover, new orders

were up in both June and July, offsetting much of the drop during the
preceding three months; computer manufacturers, notably, have experienced
a rebound in bookings.
Developments in agricultural and energy markets have dominated recent
news on inflation.

Food prices moved up sharply over the summer owing to

tighter pork supplies and weather-related disruptions in the poultry industry.

The CPI for food rose 0.9 percent in July, and producer prices of

food at both the finished and farm levels increased sharply during July and
August.

Since mid-August, however, upward pressures on meat prices appear

to have eased.
The effect of rapidly rising food prices on recent inflation measures
has been offset largely by weakness in energy prices.
petroleum-based products were still falling in July.

Retail prices of
The August PPI, which

was priced at mid-month, reported a double-digit jump in the wholesale
price of fuel oil, but another small decline for gasoline.

Apart from food

and energy, price increases for most other consumer and business items
remain similar to these earlier in the year.
energy, rose 0.4 percent in July.

The CPI, excluding food and

The August PPIs for finished consumer

goods other than food and energy and for capital equipment each rose 0.1

percent.

Prices of intermediate materials were, on balance, down slightly.

Outlook.

The staff now expects that real GNP will grow at around

a 3 percent annual rate in the current quarter.

In the auto sector, the

step-up in purchases now under way is being met by a drawdown in stocks,
and, on balance, this sector likely will be a slight drag on real GNP in
the third quarter.

However, continued gains in other consumer outlays,

rising defense purchases, further increases in spending on homebuilding,
and a strengthening in export growth are projected to combine to provide
a boost to domestic production.

Non-oil imports are projected to be

little changed after surging in the second quarter.

Inflation, as measured

by the GNP fixed-weighted price index, is expected to average 2-3/4 percentsomewhat higher than last quarter-owing to the uptick in food prices and
the considerably smaller declines in energy prices.
Over the remaining five quarters of the projection, the staff's
outlook for real activity and inflation is essentially unchanged from the
last Greenbook, as are the underlying policy assumptions.

Growth rates of

M2 and M3 this year are expected to be near the upper ends of their ranges
and next year to be well within the tentative ranges.

Interest rates are

not anticipated to change substantially from current levels.

For fiscal

policy, the staff continues to expect a shift toward restraint next year
after the deficit reaches a record $224 billion in fiscal 1986.

We

assume that the Congress will meet, on paper, the requirements to avoid
an automatic sequester of funds.

But given our economic forecast and our

assessment of the likely spending out of authorized programs, we expect
the level of the deficit to turn out to be around $175 billion in fiscal 1987.

Growth of real GNP is expected to average a bit under 4 percent in
the final quarter of this year and 3 percent in 1987.

In part, the

slightly stronger growth anticipated for the end of 1986 reflects the projected
increase in auto production between the third and fourth quarters as well
as an assumption that the effect of pending tax law changes will result
in some shifting of 1987 spending into 1986.

Over the projection horizon,

however, the key element supporting domestic production is the projected
improvement in net exports.

With the dollar continuing to decline at a

moderate rate over the period, demand for foreign goods is expected to be
limited by rising import prices, and U.S. goods are expected to become
more competitive in export markets.

The effect is to add more than a

percentage point (annual rate) to GNP growth throughout the last five
quarters of the projection.
Domestic spending is projected to decelerate over the remainder of
the projection.

Consumer spending is expected to expand considerably

less rapidly than in recent quarters, as income growth slows and the
effect of the late-1985 and early-1986 runup in household net worth
fades.

In the business sector, although demand for equipment is

anticipated to firm a bit next year, the downswing under way in commercial construction is likely to hold overall capital spending unchanged.
In contrast to 1985 and 1986, residential construction is not expected to
contribute to GNP next year, as the decline in multifamily starts largely
The

offsets a continued high level of new single-family construction.
decline in both the commercial and the multifamily areas reflects a
response to high vacancy rates and assumed tax law changes.

The staff's outlook for the path of inflation continues to depend
importantly on the firming in world oil prices and the anticipated acceleration in prices of non-oil imports.

Owing to the rebound in crude oil

prices, consumer energy prices are projected to rise at a 3 percent rate in
1987 after an expected decline of 12-1/2 percent this year.

And, prices of

non-oil imports, which began to move up at the end of last year, are
anticipated to show double-digit rates of increase later this year and
throughout 1987.

Other inflation trends are projected to be more moderate:

food price increases are expected to be relatively small, and unit labor
costs in the nonfarm business sector are anticipated to rise at around a
2-3/4 percent rate in 1987.

On balance, the GNP fixed-weighted price index

is projected to rise 3-1/4 percent over the four quarters of 19 8 7 --up from
a 2-1/2 percent rate this year, but still less than the 3-3/4 percent pace
that prevailed from 1983 to 1985.
Details of the staff projection are shown in the accompanying tables.

September 17, 1986
CONFIDENTIAL - FR

CLASS II FOMC

STAFF GNP PROJECTIONS

Percent changes, annual rate
-------------------------------------------------------------------

Nominal GNP

----

Real GNP

GNP
deflator

GNP fixed-weighted
price index

Unemployment
rate
(percent)

8/13/86
9/17/86
8/13/86
9/17/86
8/13/86
9/17/86
8/13/86
9/17/86
8/13/86
---------------------------------------------------------------------------------------------------------------------

9/17/86

Annual changes:
<1>
<1>

1984
1985
1986
1987

4.0
3.7
2.8
2.9

4.0
3.7
2.8
2.9

Quarterly changes:
1985

Q1
Q2
Q3
Q4

<1>
<1>
<1>
<1>

6.8
5.8
6.8
5.8

7.3
7.3
7.2
7.0

7.3
7.3
7.2
7.0

1986

Ql <1>
Q2 <1>
Q3
Q4

6.2
3.2
5.0
5.7

7.1
7.2
7.0
6.9

7.1
7.2
6.9
6.8

Q1
Q2
Q3
Q4

6.0
6.1
6.1
6.4

6.8
6.7
6.7
6.6

6.7
6.6
6.6
6.6

987

Two-quarter changes: <2>
1985

Q2 <1>
Q4 <1>

6.3
6.3

6.3
6.3

2.7
3.1

2.7
3.1

3.9
3.2

3.9
3.2

3.5
3.1

3.5
3.1

.1
-. 3

.1
-. 3

1986

Q2 <1>
Q4

4.7
5.4

4.6
5.3

2.4
3.0

2.2
3.4

2.3
2.4

2.3
2.5

2.3
2.2

2.5
1.7

.2
-. 3

.2
-. 4

1987

Q2
Q4

6.0
6.3

5.9
6.1

3.2
3.2

3.0
3.0

3.2
3.3

3.2
3.3

2.7
3.0

2.9
3.0

-. 2
-.1

-. 2
.0

-1.3
-. 2
-. 1
-. 3

-1.3
-. 2
-. 2
-.2

Four-quarter changes: <3>
1984
Q4 <1>
8.5
1985
Q4 <1>
6.3
1986
Q4
5.0
1987
Q4
6.2
---------------------------------------------<1> Actual.
<2> Percent change from two quarters earlier.
<3> Percent change from four quarters earlier.

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

September 17, 1986
GROSS NATIONAL PRODUCT AND RELATED ITEMS
(seasonally adjusted; annual rate)

CONFIDENTIAL - FR
CLASS II FOMC

I

I

Projection
1985

Units

Q3

1986
Q4

Q1

02

1987
Q3

Q4

Q1

Q2

Q3

Q4

I

I

EXPENDITURES
Nominal GNP
Real GNP

Billions of S
Billions of 82$

Real GNP
Gross domestic purchases
Final sales
Private dom. final purchases

Percent change

4030.5
3603.8

4087.7
3622.3

4149.2
3655.9

4179.8
3661.5

4232.9
3688.7

4288.4
3723.2

4349.4
3750.1

4413.5
3778.1

4477.8
3806.4

4546.9
3835.0

4.1
4.6
6.1
4.8

2.1
4.0
2.7
3.4

3.8
3.0
-1.3
.9

.6
3.2
3.8
5.6

3.0
2.2
5.6
4.9

3.8
2.5
.9
-.6

2.9
1.8
2.3
1.8

3.0
1.9
2.6
1.8

3.0
1.7
3.0
1.7

3.0
1.7
3.0
1.7

Personal consumption expend.
Durables
Nondurables
Services

5.3
23.8
1.2
3.2

1.7
-11.1
1.6
6.0

3.6
-1.8
6.5
3.2

6.5
16.4
8.4
2.4

5.3
17.9
3.3
3.0

-.7
-17.1
2.6
2.5

2.6
2.6
2.2
3.0

2.4
2.5
2.2
2.6

1.9
1.8
1.9
1.9

1.7
1.8
1.5
1.8

Business fixed investment
Producers' durable equipment
Nonresidential structures
Residential structures

.1
2.6
-4.6
11.7

12.5
18.7
.3
3.4

-15.1
-17.0
-10.8
11.0

-2.3
19.9
-38.6
13.5

2.0
7.9
-11.4
7.3

-.9
1.2
-6.1
1.2

-.6
1.0
-4.9
-2.7

1.3
3.5
-4.3
-5.1

1.8
3.5
-2.9
-.7

1.5
3.5
-3.9
3.0

Exports
Imports

-5.8
.3

8.2
23.3

7.1
.2

-5.6
16.5

8.2
.4

11.4
-.6

14.0
2.5

12.0
1.4

15.8
2.2

15.0
2.4

Government purchases
Federal
Defense
State and local

13.9
26.0
15.8
5.1

10.0
22.7
-4.7
.3

-12.3
-27.5
-1.0
2.6

9.8
11.9
20.3
8.4

3.7
6.4
6.7
1.5

1.3
1.4
2.7
1.2

-1.0
-4.1
-1.1
1.5

.3
-1.2
-.5
1.5

1.4
.9
1.1
1.8

1.2
.4
.8
1.9

Change in business inventories
Nonfarm
Net exports
inal GNP

Billions of 82$
Billions of 82$
Billions of 82$
Percent change

.7
1.4
-113.8

-5.2
16.1
-132.0

39.9
37.0
-125.9

11.6
8.2
-150.5

-11.5
-11.5
-143.8

14.3
17.5
-132.9

19.8
20.0
-123.3

24.0
24.0
-113.8

24.0
24.0
-101.4

25.0
25.0
-89.6

6.8

5.8

6.2

3.0

5.2

5.4

5.8

6.0

6.0

6.3

97.9
7.2

98.7
7.0

99.4
7.1

99.8
7.2

100.4
6.9

100.9
6.8

101.5
6.7

102.1
6.6

102.7
6.8

103.2
6.6

1.8
80.1

2.0
79.9

1.2
80.0

-2.1
79.5

1.6
79.6

3.5
79.8

2.8
79.9

3.1
80.0

3.2
80.1

3.3
80.2

1.69
12.31
9.40
2.90

1.77
10.24
6.84
3.40

2.00
10.65
7.84
2.81

1.91
11.22
8.18
3.05

1.80
13.11
9.83
3.28

1.72
10.29
6.97
3.32

1.67
10.47
7.40
3.07

1.67
10.90
7.70
3.20

1.68
11.00
7.80
3.20

1.70
11.00
7.80
3.20

LOYMENT AND PRODUCTION
------------------------Nonfarm payroll employment
Unemployment rate

Millions

Industrial production index
Capacity utilization rate-mfg.

Percent change

Housing Starts
Auto sales
Domestic
Foreign

Millions
Millions

Percent*

Percent*

Millions

Millions

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

Percent change
Percent change
Percent*

3.0
-4.0
4.2

7.4
2.6
4.4

6.0
6.5
5.0

6.4
7.4
5.1

4.0
-.2
3.8

6.3
2.2
4.4

5.9
2.1
4.3

6.2
1.7
4 4

6.7
2.1
.4.1

6.3
1.8
4.1

Corp. profits with IVA & CCAdj
Profit share of GNP

Percent change
Percent*

36.2
7.4

-13.7
7.0

16.0
7.1

-6.8
7.0

-5.6
6.8

6.9
6.8

-8.0
6.6

-1.4
6.5

-3.9
6.8

2.0
6.2

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

Billions of S

-197.5
59.5

-217.6
62.5

-201.6
70.0

-236.9
59.9

-201.2
57.1

-207.3
58.0

-183.7
58.9

-173.3
80.4

-167.5
60.7

-159.9
61.2

2.5
2.8
2.7
2.6
3.5

3.6
4.0
4.3
4.3
4.9

2.5
2.5
1.6
1.5
4.3

2.5
1.9
.3
-1.7
3.4

2.0
2.7
3.3
2.8
3.3

1.5
2.4
3.4
3.5
3.4

2.8
3.2
3.6
3.9
4.0

2.9
3.2
3.7
3.6
4.1

2.8
3.2
3.8
3.8
4.4

3.2
3.3
3.5
3.7
4.4

2.2
3.2
1.0

-3.5
3.7
7.4

4.3
3.1
-1.2

-.5
2.2
2.8

1.3
2.7
1.4

2.2
3.0
.8

.4
3.4
3.0

.7
3.5
2.8

.9
3.6
2.7

1.0
3.7
2.7

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

Not at an annual rate.

Percent change

September 17, 1986
CONFIDENTIAL - FR
CLASS II FOMC

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

1979

1980

1981

1982

1983

1984

1985

1986

1987

2508.2
3192.4

2732.0
3187.1

3052.6
3248.8

3166.0
3166.0

3405.7
3279.1

3765.0
3489.9

3998.1
3585.2

4212.6
3682.3

4446.9
3792.4

-1.9
.3
.8

6.5
8.4
3.7
7.7

2.9
9.0
1.8
2.3

EXPENDITURES

Nominal GNP
Real GNP

Billions of $
Billions of 82$

Real GNP
Gross domestic purchases
Final sales
Private dom. final purchases

Percent change*

.6
-. 4
2.2
1.3

Personal consumption expend.
Durables
Nondurables
Services

5.0
1.6
12.0

Exports
Imports

-. 2

-1.7

1.4
-3.8
.8
3.5

Business fixed investment
Producers' durable equipment
Nonresidential structures
Residential structures

-. 1

-1.1

13.7
3.4

-7.2

-. 1

-5.6
-1.4
2.4
-4.8
-6.5
-1.8
-14.2
.5
-8.8

.1

Government purchases
Federal
Defense
State and local

1.0
3.1
3.1

-. 3

3.3
.4

-. 3

.6
.8
.1

-. 3
.2
-3.3
.5
.9

5.6
2.2
11.7
-22.4
2.4
4.9
2.9
9.5
7.6
-1.3

4.6
5.9
4.4
5.3

2.9

5.4
14.7
4.4
3.9

3.6
8.8
2.2
3.3

3.5
6.2
2.0

-11.3
-12.5
-9.1
4.9

10.8
20.9
-4.8
38.1

14.7
16.0
12.1
5.3

-13.8
-5.9

5.8
23.8

5.5
16.5

-2.7
-8.1
5.1
1.5

7.7
14.2
6.8
3.1

-6.4
-.1
-19.9

59.2
54.3
-83.6

-. 8

3.8
8.2
8.8
.6

-24.5

3.9
4.0

4.2

3.9

-17.8
8.1

14.2
2.1

8.4

.3
-3.3
6.9
3.4

.5
-1.0
.1
1.7

14.3

5.9
3.7

9.9

9.3

3.1

10.4

8.5

6.3

89.8
5.8

90.4
7.1

91.2
7.8

89.6
9.7

90.2
9.6

94.5
7.5

.9
84.6

79.3

-1.0
78.3

-7.7
70.3

14.3
74.0

6.6
80.5

1.72
10.68
8.36
2.32

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

11.4

.5
6.8

12.0
1.1
7.1

9.2
.7
7.5

5.3
1.0
6.8

2.3
6.2

Nominal GNP

Percent change*

-23.1
26.3

1.0
2.9
-4.0
-1.4

5.1
3.9

9.5

10.4
3.6

2.1

-3.2
5.8

49.4

15.0

2.2
2.2
1.9
2.3

2.8
5.2
2.8

3.3
7.8

23.9
19.0

Billions of 82$

3.6

-4.3

57.0

Billions of 82S
Billions of 82$

3.0
1.8
2.7
1.8

6.5
8.1

-6.9
-2.3

Change in business inventories
Nonfarm
Net exports

2.8
2.7
2.2
2.7

9.0
10.9
-108.2

13.6
12.8
-138.3

23.2
23.3
-107.0

4.9

6.0

97.6

100.1

7.2

7.0

102.4
6.6

EMPLOYMENT AND PRODUCTION

Nonfarm payroll employment
Unemployment rate

Millions

Industrial production index
Capacity utilization rate-mfg.

Percent change*

Housing Starts
Auto sales
Domestic
Foreign

Millions

Percent

Percent
Millions
Millions

Millions

-. 8

2.41

1.76
10.43
7.97
2.46

1.7

1.0

80.1

79.7

1.74
11.09

1.86
11.32
8.20
3.11

8.24
2.84

3.1
80.0
1.68
10.84
7.68
3.17

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

Percent change*
Percent change*

Corp. profits with IVA & CCAdj
Profit share of GNP

Percent change*
Percent

-10.7
8.0

-6.8
6.5

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

Billions of $

-16.1
27.6

-61.3
26.8

Percent

-63.8

34.1

7.8
5.1
5.4

-19.1
4.7

70.1
6.3

-145.9

-176.0
47.5

35.1

8.4
4.2
6.3

6.1

6.6
7.0

7.8
7.0

-170.0
68.5

1.9

5.1

-198.0
61.7

5.7
3.9
4.6
2.2
6.9

6.3
1.9
4.1
-2.9
6.4

61.3

-171.1"
60.3

-211.7

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*

8.9
8.8
9.5
12.7
10.7

9.9
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

2.1
2.4
2.1
1.5
3.6

2.9
3.3
3.6
3.8
4.2

-2.7
9.7
12.7

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

1.8
2.7
.9

.7
3.5
2.8

* Percent changes are from fourth quarter to fourth quarter.

-. 3

September 17, 1986

CONFIDENTIAL FR CLASS II
FEDERAL SECTOR ACCOUNTS
(Billions of dollars)
---

Fiscal

Year
1985*

FY1987e
FY1986e
FRB
FRB
Admin1 Staff Admin1 Staff

CY1986e
CY
FRB
1985* Staff

1985
IV*

I I*

II*

FRB Staff Estimates_

1986
III

IV

I

I

1987
II

I

III

I

Not seasonally adjusted
Budget receipts 2
Budget outlays - 2
Surplus/deficit(-)
to be financed 2

745
961

776
990

177
252

180
241

215
245

196
254

185
250

197
250

239
253

209
254

-216

-213

-75

-61

-30

-57

-65

-53

-14

-45

51
-12
-8

55
-2
5

12

25

27

17

15

20

30

-2

5

5

4

5

6

6

734
946

765
995

768
992

831
975

829
1006

212

-230

-224

-144

-177

Means of financing deficit:
Borrowing from public
197
Cash balance decrease
13
1
Other

235
-3
-2

234
-10
0

144
0
0

175
-3
4

224
-13
5

200
14
0

17

20

27

20

30

31

17

31

20

n.a.

13

n.a.

21

20

12

5

Cash operating balance,
end of period
Memo:

Sponsored agency
borrowing

NIPA Federal Sector
Receipts

Expenditures
Purchases
Defense
Nondefense
All other expend.
Surplus/deficit(-)
High-employment surplus/
deficit(-) evaluated
at 6 percent unemp.

Seasonally adjusts d annual rates
771
963
341
254
88
621
191

-151

810
1025
367
273
94
658
-214

n.a.

810
1024
369
274
95
655
-214

-177

890
1033
375
290
84
658
-143

n.a.

866
1049
379
291
88
670
-183

787
985
354
259
95
631
-198

819
1031
368
279
89
663
-212

806
1023
381
268
113
643
-218

800
1002
356
266
89
646
-202

806
1043
367
278
89
676
-237

828
1029
373
283
90
656
-201

844
1051
376
287
89
675
-207

860
1043
377
290
88
666
-184

874
1047
379
292
87
668
-173

887
1054
382
294
88
672
-167

-152

-159

-175

-180

-167

-197

-163

-173

-151

-143

-140

__
*--actual
Note:
1.

I
e--estimated

n.a.--not available

Details may not add to totals due to rounding
id-Session Review of the 1987 Bud

(August 1987).

The Congressional Budget Office baseline estimates published in

st ndicate recepts of
lion and $828 billion, and outlays of $991 billion and $1012 billion in FY1986
and FY1987, respectively.
2. 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.
3. Checks issued less checks paid accrued items and other transactions.
4. Sponsored agency borrowing includes net debt issuance by Federal Home Loan Banks FHLMC (excluding participation
certificates), FN
(excluding mortgage-backed securities), Federal Land Banks, Federal Intermediate Credit BaVks, Banks
for C6opratives, and Student Loan Marketing Association marketable debt on payment basis. The Administration s
definition of borrowing by these agencies is somewhat broader.

DOMESTIC FINANCIAL DEVELOPMENTS

Recent developments.

Short-term interest rates fell early in the

intermeeting period, after the cut in the discount rate by one-half
point to 5-1/2 percent on August 20, but long-term rates were little
changed.

Later, however, signs of a pickup in U.S. economic activity in

the context of continued strong growth in the monetary aggregates, and
less weakness than previously thought in the German and Japanese economies,
formed the backdrop for a reassessment by market participants of the
financial outlook.

Rates began to back up, particularly among longer-term

securities; price declines for bonds and equities gathered considerable
momentum for a brief period when inflation fears apparently mounted.
On balance, short-term rates are 10 to 40 basis points below their levels
at the time of the last FOMC meeting and well below previous lows for this
year; long-term bond yields have risen noticeably, as much as one-half
percentage point in the case of Treasury securities.
The broader monetary aggregates decelerated somewhat in August,
following spurts in July, but their growth remained strong.

M2 growth of

10-1/2 percent and M3 growth of 8-1/4 percent (annual rates) kept both
aggregates around the upper ends of their annual growth ranges.

M1 grew

at a 20-1/4 percent pace in August and the 38 percent spurt in its other
checkable deposit component was the largest contributor to the growth of
all of the aggregates.

Banks and thrifts have been hesitant to lower

their offering rates on OCDs and saving accounts below the old regulatory
ceilings, and MMDA rates have fallen only gradually.

Consequently, the

opportunity costs of holding OCDs and the other liquid components of M2
are quite narrow and these accounts seem to be drawing wealth both from
I-11

I-12
marketable instruments and from small time deposits, which registered the
largest of four consecutive monthly declines.
In concert with the signs of a pickup in domestic economic activity
in the current quarter, growth of nonfinancial debt also appears to be
somewhat faster.

In the nonfinancial business sector, short-term borrowing,

particularly in the commercial paper market, increased, after being
quite slack earlier in the year when the sharp decline in long-term rates
was prompting firms to extend the maturity of their debt.

Meanwhile,

long-term bond issuance remained fairly strong in August, likely bolstered
by continued heavy net equity retirements.

Bond issuance has slackened

thus far in September, however, with the backup in corporate rates.
In the tax-exempt sector, borrowing surged in July and rose even
further in August, prompted primarily by a desire to bring public-purpose
issues to market ahead of September 1 limitations on refunding and arbitrage activities that were expected to be in the tax reform bill.

Heavy

offerings, and uneasiness about other possible implications of tax reform,
pushed tax-exempt yields to unusually high levels relative to other
yields in late spring and early summer.

The conclusion of the tax reform

conference cleared the air and both yield spreads and issuance have
dropped off sharply since mid-August.
In the household sector, net mortgage borrowing appears to have
increased in the current quarter.

Major mortgage lenders report a large

volume of applications, despite some falloff in the pace of refinancings.
Given such reports and the record rate of mortgage originations at thrifts
in July, it seems likely that earlier loan processing bottlenecks have

eased.

The lion's share of loan growth has been in fixed-rate loans, as

I-13

borrowers have continued to prefer these instruments in an environment
of comparatively low mortgage rates.
Consumer installment credit growth in July, at 11-1/2 percent,
remained marginally below the pace in the first half of the year; exclusive
of automobile credit, however, the recent slowing has been more marked.
During the past year of repeated concessions in auto financing, growth of
this component has accounted for a disproportionate share of the installment credit total.

With income and employment growing unevenly across

the country and total household debt growing rapidly, both mortgage and
installment credit delinquencies rose in the second quarter--credit card
delinquencies soaring to a record level.
In the federal sector, Treasury financing returned to normal patterns
after Congress raised the debt ceiling just before Labor Day.

Borrowing

this quarter is likely to amount to $54 billion (not seasonally adjusted),

as the Treasury conserves its cash balance prior to seasonally large fourthquarter needs.

For the current fiscal year, the federal deficit will set

a new record, and total borrowing from the public is likely to amount to

$234 billion.
Outlook.

Special factors are boosting debt growth in the current

quarter, particularly in the household and state and local sectors.

By

late in the year and early next year, however, these factors are likely
to wane, slowing debt growth considerably.
The most immediate factor lifting the pace of debt growth is the
special financing incentive program in place in the automobile industry.
These programs, which will expire in early October, are accelerating
purchases and associated borrowing, and their end should restrain growth

I-14

somewhat later in the year.

Home mortgage borrowing is expected to be

well sustained in coming months, given the projected strength in singlefamily home building.

Spreads between mortgage rates and bond yields

could narrow further from their historically large size as loan prepayments
slow and call premiums diminish.

The proposed tax reform bill has a

number of provisions that might tend to affect mortgage and consumer
financing in the future but no significant effect is expected in the near
term.
In the state and local sector, the pace of tax-exempt bond issuance
for public purposes should remain subdued after the rush to market during
the summer.

Private-purpose issuance of tax-exempts, however, is likely

to pick up for the rest of this year as authorities will strive to utilize
fully the borrowing room that is available under the 1986 caps.

(Much of

this private-purpose borrowing will show up in the flow-of-funds accounts
as liabilities of the household or business sector beneficiaries.)
In the federal sector, borrowing is expected to slow in the new
fiscal year as the deficit is reduced.

The time pattern of Treasury

financing could be disrupted once again, however, if congressional deliberations lead to a delay in enactment of a longer-term debt ceiling
increase.

Already, one auction has been postponed.

In the business sector, the pace of debt growth is likely to be
steadier.

The corporate financing gap is expected to widen gradually

later this year, lifted a bit by more rapid inventory accumulation, and
tax payments will be higher due to tax reform.

The dominant factor in

corporate debt growth will remain, however, large equity retirements.
Corporate restructuring shows no signs of slowing, and some mergers may

I-15

be accelerated to the fourth quarter to receive the more favorable treatment of capital gains and other tax benefits under current tax law than
under the new law.

INTERNATIONAL DEVELOPMENTS
Recent developments.

The dollar's weighted average foreign

exchange value changed little, on balance, since the last FOMC meeting.
Exchange rates were mainly affected by news on prospects for economic
activity in the United States and abroad.

Germany and Japan did not

follow the Federal Reserve's discount rate reduction, and short-term
interest rates in the United States declined moderately while foreign
rates were essentially unchanged.

Long-term interest rates in Germany

and Japan firmed somewhat after release of better-than-expected GNP
figures for the second quarter, but long rates in the United States rose
by substantially more.

Precious metals prices rose sharply, prompted by threatened supply
disruptions in South Africa and, reportedly, by some renewed fears of
future inflation in the United States.

Since August 1, platinum, gold,

and silver prices have risen by 27, 16, and 12 percent, respectively.
Most recent data on economic activity in foreign industrial
countries have been rather encouraging.

Second-quarter GNP growth rates

in Germany, Japan, France, Canada, and the United Kingdom were higher
than in the first quarter and generally better than expected.

Domestic

demand was substantially stronger than GNP in Germany and France,
indicating adjustment in real net exports.

I-16

In Japan, domestic demand

I-17
(excluding gold transactions) did not grow faster than GNP in the second
quarter, but real net exports were substantially lower than a year ago.
Despite the reduction in real net exports in most foreign
industrial countries, nominal trade and current account surpluses have
continued to grow, reflecting J-curve effects of the dollar's
depreciation over the past year and a half.
Economic activity in developing countries appears to be growing at
around a 3 percent rate, though somewhat slower than in 1985.

Inflation

continues to be a major problem in many countries, and Argentina and
Brazil have moved recently to tighten monetary policy.

Mexico obtained

a $1.6 bridge loan from foreign monetary authorities and commercial
banks, and, on August 31, drew $850 million on that facility, including
$210 million on the Federal Reserve swap network.

Mexico's negotiations

with commercial banks for $6 billion in new money are proceeding slowly
in the face of that country's demand for substantially easier terms in
the restructuring of old debt.
Preliminary figures for U.S. merchandise trade in July indicate a
substantially larger deficit than in previous months as non-oil imports
surged.

The staff believes that much of the surge in imports will prove

to be temporary.
In the second quarter, the U.S. current account was $138.9
billion at an annual rate, marginally larger than the deficit in the

first quarter (revised).

Smaller net deficits in merchandise trade,

military transactions and other services were more than offset by
increased net portfolio (interest) payments to foreigners, increased
unilateral transfers (largely U.S. government grants to developing

I-18

countries), and a reduction in income from U.S. direct investments
abroad (mainly from reduced earnings of petroleum affiliates).
The value of total U.S. exports rose 2 percent in the second
quarter, while the value of imports rose less than one percent.

Both

imports and, especially, exports, however, were distorted by gold
shipments relating to Japan's minting of a commemorative gold coin.
Excluding gold, the volume of nonagricultural exports declined 1/2
percent in the second quarter.

The volume of non-oil imports rose 2

percent, while their prices rose at a 6-1/2 percent annual rate, the
third straight quarter of such increases.
Reported capital flows in July continued to show large net foreign
purchases of U.S. corporate bonds and stocks (nearly $6 billion).
Foreign net sales of U.S. Treasury securities in July were more than
accounted for by the World Bank; private foreigners added $1.4 billion

to their holdings even though Japanese residents' purchases were small.
Official reserve holdings in the United States increased by $4.5 billion
in July, mainly reflecting the investment of intervention purchases of
dollars by G-10 countries.
Outlook.

The staff continues to project a moderate decline in the

value of the dollar through the end of 1987, while noting the risks of a
sharper drop if market participants become discouraged over the slow
pace of reductions in the U.S. external imbalances in the face of narrow
long-term rate interest differentials.

The outlook for the U.S. current

account balance is somewhat weaker than in the last Greenbook.

A

substantial improvement in real net exports will be masked by substantial rises in import prices, limiting the improvement in the nominal

I-19

balance.

The rebound in economic activity abroad in the second quarter

was largely in accordance with staff projections and is consistent with
our continued outlook for moderate growth through 1987.

The U.S.

current account deficit for both 1986 and 1987 is projected to average
about $145 billion; the deficit is projected to grow to about $150
billion by 1986-Q4 and then be reduced to about $140 billion by 1987-Q4.

Strictly Confidential (FR)

Class II FOMC

September 17, 1986
Outlook for U.S. Net Exports and Related Items
(Billions of Dollars, Seasonally Adjusted Annual Rates)

1.GNP

Exports and Imports 1/
Current $, Net
Exports of G+S
Imports of G+S
Constant 82 $, Net

Exports of G+S
Imports of G+S

2. U.S. Merchandise Trade Balance 2/

ANNUAL
1985- 1986-P 1987-P

1985
Q3-

Q4-

Ql-

2-

19A6
Q3-P

Q4-P

QL-P

19287
42-P

Q3-P

Q4-P

-95.6
434.7
530.3

-89.4
454.4
543.8
-89.6
435.6
525.1

-97.6
426.2
523.8

-83.7 -105.3
362.3 368.2
446.0 473.6

-93.7 -100.2 -100.3 -104.5
374.8 367.9 374.2 384.1
468.5 468.1 474.5 488.6

-108.2 -138.3 -107.0
362.3 371.4 413.9
470.5 509.7 520.9

-113.8 -132.0
355.8 362.9
469.6 494.8

-125.9 -150.5 -143.8 -132.9
369.2 363.9 371.1 381.3
495.1 514.4 514.9 514.2

-123.3 -113.8 -101.5
394.1 405.4 420.6
517.3 519.2 522.0

-124.4 -147.7 -146.5

-126.7 -149.4

-145.8 -144.1 -149.6 -151.'2

-152.9 -149.3

-78.9
369.7
448.6

-99.7
375.2
474.9

-103.9 -101.6
400.4 415.4
504.3 516.9

-144.4

-139.3

Exports
Agricultural
Non-Agricultural

214.4
29.6
184.8

218.0
25.6
192.5

249.9
27.3
222.7

210.0
26.7
183.3

210.9
28.5
182.4

214.6
28.4
186.2

219.2
24.6
194.5

216.3
23.8
192.5

222.0
25.4
196.6

231.8
26.4
205.4

243.0
26.7
216.2

255.7
27.4
228.2

269.3
28.5
240.7

Imports
Petroleum and Products
Non-Petroleum

338.9
50.5
288.3

365.7
34.4
331.3

396.4
38.7
357.7

336.7
49.5
287.2

360.3
56.5
303.8

360.5
40.1
320.4

363.3
31.3
331.9

365.9
31.2
334.7

373.2
35.1
338.1

384.7
37.8
346.9

392.2
38.3
354.0

400.1
39.0
361.2

408.5
39.7
368.9

3. U.S.

Current Account Balance

OfWhich: Net Investment Income

-117.7 -143.6 -146.5

-113.8 -134.8

25.2

18.9

GNP--Ten Industrial 4/
Real
Real GNP--NonOPEC LDC 5/

2.8
3.4

2.7
3.2

2.8
4.1

3.0
2.9

Consumer Prices--Ten Ind. 4/

4.3

2.1

2.4

1.4

11.2

33.0

37.0

-136.2 -138.9 -146.7 -152.8
26.1

21.2

15.2

2.5
3.0

0.2
3.0

5.2
3.3

2.9
3.6

3.1

1.7

1.7

0.5

-151.3 -150.4 -145.0 -139.3
12.0

10.4

11.0

2.9
3.9

2.7
4.1

2.6
4.4

2.5
4.7

2.5
5.0

2.8

2.7

3.0

2.8

2.9

13.3

11.5

4. Foreign Outlook 3/

Economic activity and product account data.
International accounts basis.
Percent change, annual rates.
Heighted by multilateral trade-weights of 0-10 countries plus Switzerland; prices are not seasonally adjusted.
Weighted by share in NonOPEC LDC GNP.
Projected