Full text of Federal Open Market Committee Meeting Minutes, Transcripts, and Other Documents : Meeting, September 27, 1994 : Transcript

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Meeting of the Federal Open Market Committee Meeting
September 27, 1994

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.,
PRESENT:

on Tuesday, September 27,
Mr.
Mr.
Mr.
Mr.
Mr.
Mr.
Mr.
Mr.
Mr.
Mr.
Ms.
Ms.

1994, at 9:00 a.m.

Greenspan, Chairman
McDonough, Vice Chairman
Blinder
Broaddus
Forrestal
Jordan
Kelley
LaWare
Lindsey
Parry
Phillips
Yellen

Messrs. Hoenig, Melzer, and Moskow and Ms. Minehan,
Alternate Members of the Federal Open Market
Committee
Messrs. Boehne, McTeer, and Stern, Presidents of
the Federal Reserve Banks of Philadelphia,
Dallas, and Minneapolis respectively
Mr.
Mr.
Mr.
Mr.
Mr.
Mr.
Mr.
Mr.

Kohn, Secretary and Economist
Bernard, Deputy Secretary
Coyne, Assistant Secretary
Gillum, Assistant Secretary
Mattingly, General Counsel
Patrikis, Deputy General Counsel
Prell, Economist
Truman, Economist

Messrs. Beebe, Goodfriend, Lindsey, Mishkin,
Promisel, Simpson, Stockton, and Ms. Tschinkel,
Associate Economists
Ms. Lovett, Manager for Domestic Operations, System
Open Market Account
Mr. Fisher, Manager for Foreign Operations, System
Open Market Account
Mr. Ettin, Deputy Director, Division of Research
and Statistics, Board of Governors
Mr. Slifman, Associate Director, Division of
Research and Statistics, Board of Governors

Mr. Madigan, Associate Director, Division of
Monetary Affairs, Board of Governors
Mr. Hooper, Assistant Director, Division of
International Finance, Board of Governors
Ms. Low, Open Market Secretariat Assistant,
Division of Monetary Affairs, Board of
Governors
Ms. Browne, Messrs. Davis, Dewald, Lang, Rolnick,
Rosenblum, and Vander Wilt, Senior Vice
Presidents, Federal Reserve Banks of Boston,
Kansas City, St. Louis, Philadelphia,
Minneapolis, Dallas, and Chicago respectively
Mr. Sniderman, Vice President, Federal Reserve Bank
of Cleveland
Ms. Krieger, Assistant Vice President, Federal
Reserve Bank of New York

Transcript of Federal Open Market Committee Meeting of
September 27, 1994
CHAIRMAN GREENSPAN. Who would like to move approval of the
minutes for the August meeting?
SPEAKER(?).

So move.

SPEAKER(?).

Second.

CHAIRMAN GREENSPAN.
President McDonough.

Without objection they are approved.

VICE CHAIRMAN MCDONOUGH. It is my pleasure, Mr. Chairman, to
move the election of Frederic Mishkin as associate economist. Rick,
as he is known to his friends, has just joined the Federal Reserve
Bank of New York as our head of Research. He is a distinguished
tenured professor at the Columbia Business School, and we are very
happy to have him join our staff.
CHAIRMAN GREENSPAN.
somebody like to second it?
SPEAKER(?).

We need a vote on that motion; would

Second.

CHAIRMAN GREENSPAN. Without objection. We welcome Rick to
this organization. Peter Fisher, would you start us off?
MR. FISHER.

[Statement--See Appendix.]

CHAIRMAN GREENSPAN.

Questions for Peter?

MR. BLINDER. I have just one, Peter. You mentioned the
potential responsiveness of dollar/yen to rhetoric as much as to what
happens on September 30th; whose rhetoric?
Let's take it as axiomatic
that it won't be Lloyd Bentsen's.
MR. FISHER.
I think it's rhetoric on either side--the United
States or Japan. And in this country it's rhetoric from anyone who is
perceived to be expressing the inner thinking of the Clinton
Administration.
MR. BLINDER.

Not Congresspersons?

MR. FISHER.
I don't think Congresspersons would be the
issue; but anyone who the market could plausibly think is expressing
the inner views of key Administration officials, whether in the
Treasury or elsewhere, could be a source of pain to the markets.
CHAIRMAN GREENSPAN.

President Broaddus.

MR. BROADDUS.
Peter, I have a question on the proposal in
the memorandum. The suggestion just struck me as unusual. Central
banks in these relationships normally deal with one another for strong
I was surprised that the Bundesbank wanted to move in this
reasons.
direction. I guess I'm just wondering if there is anything deeper
going on here that you can sense. Are they perhaps signaling or does

9/27/94

this imply somewhat less cooperation or a less cooperative spirit on
their part with us?
MR. FISHER. On the contrary, let me make a couple of points.
First, most major central banks are much more advanced than we in
having some direct dealings in foreign currency government securities
markets and in direct activity in those markets through private
custodians. I would say that we probably are the only G-10 country
that does not have an account with Euro custodians, just as an
example. That is a normal activity of most of the other central
banks. Indeed, the Bundesbank really has been, if you'll forgive the
expression, babysitting us by allowing us to keep rather large amounts
of reserves on their balance sheets. We have had quite preferential
treatment--

So, I really would turn the point around. I think that
direct participation in the government securities market is
increasingly the norm in terms of the investment of foreign currency
reserves.
MR. BROADDUS.
MR. FISHER.

They are operating in our markets?
They certainly operate in our markets in that

fashion--Joan could perhaps tell you more about that than I could-and certainly in the German market that has developed quite a bit over
the last five to eight years. We actually have been receiving quite

preferential treatment from the Bundesbank. So I would say in
response to your observation that their tolerance for the slow rate at
which I have been managing to move off their balance sheets shows
rather high levels of friendliness and cooperation.
CHAIRMAN GREENSPAN.

President McDonough.

VICE CHAIRMAN MCDONOUGH. I have a follow-up on Governor
Blinder's question.
If there were to be rhetoric of a warlike nature
from Japanese government officials, I would assume that the effect on
the dollar/yen could also be quite dramatic.
I meant to include that in my
MR. FISHER. Absolutely, yes.
initial remarks.
It could come from either side.
VICE CHAIRMAN MCDONOUGH. I think it might be worth reminding
the Committee that the present Minister of Trade and Industry has in
fact had some very tough comments to make, and he would be the
official who could very well be deemed to be the appropriate spokesman
from their side.
MR. FISHER. I would remind the Committee--as I think I
mentioned at our last meeting--that when the dollar dropped July 30th,
31st, and August 1st on the announcement of Super 301, my view was
that rhetoric coming from the Japanese side had caused that drop,
albeit as I mentioned last month in rather thin markets in New
Zealand.
CHAIRMAN GREENSPAN.

President Forrestal.

MR. FORRESTAL. Peter, on the memorandum, what kind of
increased risks do we incur by moving to a private party and not
working with the central bank?

9/27/94

MR. FISHER. Well, there are a couple of different layers of
risk we have to consider. On the one hand, the Bundesbank as a
custodian is really not remotely providing the level of service that
private sector custodians are capable of offering in terms of
attention to detail and quality.

It's a very big business and it's very hard for them to
manage.
It's not a business they are in, really. So, on one level we
reduce risks at a sort of operational level by going to a custodian
whose business it is to manage other people's securities and make sure
they are all in the right place at the right time. Another risk that
gets reduced is simply the importance of having the tri-partite agent
manage the collateral value--that is, ensuring that there is always
enough margin held for the repurchase agreement. Now, the Bundesbank
simply won't even provide that service. We would be doing that
ourselves at some remove from German market custody arrangements.
Those are two risks I would see going down quite a bit,
indeed with some services being made possible only by using private
sector custodians. The principal risk that we face is the rather
complex and subtle legal one of our confidence in the custody
arrangement. That is, do we have the confidence that the legal
underpinnings are such that the securities will always be our own, and
we won't have to worry about the loss of principal?
That is the
principal risk and one that the major providers of these custody
services know that they are in the business of addressing.

But the

whole RP process we will be going through is really focused on
ensuring that we have confidence in the custody arrangement.
The
final risk is the delivery-against-payment risk. Most of the private
sector solutions offer greater precision and clarity in reducing that

risk actually than the Bundesbank currently does, but we take comfort
under existing arrangements that it's the Bundesbank that is providing
us the service. But actually the Bundesbank does not currently assure
us

in any legal way that we have true delivery against payment for our

purchase of the few existing government securities with low remaining
maturities that we hold. I hope that's helpful.
CHAIRMAN GREENSPAN.

President Parry.

MR. PARRY. With regard to your answer to Al Broaddus, are
there more comprehensive changes in processes that would be desirable
than are proposed here?
If so, what stands in the way of implementing
them?
MR. FISHER. I will mention one thing that I may want to
bring back to the Committee in February. The System Foreign Account
is currently limited in its investments to maturities not exceeding
twelve months. When that limit was put in place, it was a simple and
relatively effective means of insuring that we did not take too much
price risk. But it also was based on the notion that we would make
sure we were always liquid. Now, in my view this has resulted in a
slight irony. We have accumulated a fair amount and have the
potential of accumulating more of the decayed securities with a
remaining life under one year--German government securities--since I
can't buy anything longer than 12 months. Now, while that limits the
price risk, it subjects me to rather high levels of liquidity risk.
This stuff is not highly liquid. In terms of having liquidity and the

9/27/94

assurance of being able to get out, I would much rather have some
portion of the System Account invested in actively traded five-year
issues, for example. What I have been intending to do, and this is
part of the process, is to exhaust my existing authority so I could
look this Committee in the face and say that to do any more of what I
need to do I need to change the maturity ceiling. And so I would very
much like to have the authority and the ability to invest in repos.
It's a very flexible, liquid instrument. Perhaps after we have begun
that process, we would consider changing the maturity ceiling to a
duration ceiling where the Committee would specify that the overall
portfolio should not have an average duration of longer than X and no
subportfolio should have a duration of longer than Y.
This would
permit having some small portion--10, 15, 20 percent--of the portfolio
invested in the actively traded five-year securities.
I'm not there
yet myself in terms of our management planning, but the repo business
is something, if we could get it organized, that would be the
principal, and really the only, next step I would see.
CHAIRMAN GREENSPAN. Could we arrange a facility with the
Bundesbank to discount those securities or to take a loan and use the
securities as collateral?
MR. FISHER. The Bundesbank officials are rather firm in not
wanting to give us any assurance of that. Now, whether they would if
asked is uncertain, but they are very firm in not giving us any
advance comfort.
CHAIRMAN GREENSPAN.
create liquidity.

The purpose of a central bank is to

MR. TRUMAN. They're reluctant to do it even in their own
market these days. You may have noticed that they just stopped
issuing short-term paper. We didn't know that was going to happen.
The proposal would take two steps forward, but at the same time take
one step back in terms of the overall goal. Notwithstanding President
Broaddus' comment, the goal is to get off the Bundesbank's balance
sheet,
So, to get off their balance sheet, given that they don't
offer any other kinds of facilities like the investments in dollars
that we offer, we are left with a limited number of options.
There is
one other consideration about how fast we should go and how we should
do this and that is that the Federal Reserve Bank of New York, of
course, also invests the foreign exchange reserves of the Treasury
Department. Although we are not tied to following exactly what they
do, I think it would be on the whole constructive to bring them along
at roughly the same time in this process. So, we think a wholesale
change in what we are doing would be more difficult. Peter and I have
had extensive discussions with the Treasury about their plans. On the
whole, I think they are pretty much on board. They may be just a
little behind us in terms of thinking this all the way through.
CHAIRMAN GREENSPAN.

Go ahead, Tom.

MR. MELZER. Thanks, Alan. Peter, are there practical
constraints in terms of how much we can do? In other words, if we put
all of our reserves into the repo market, I think we would probably be

9/27/94

in excess of 20 percent of the market. What would represent a
practical limit there?
Secondly, what are the practices in terms of
collateralizing a repo initially and what sort of mark-to-the-market
provisions do they have?
Is it comparable to our repo market here?
Starting with the last, yes, it is comparable.
MR. FISHER.
There is a range of practices that runs from being identical to our
market to being somewhat less collateralized at the margin than our
market. But the range exists. The repo market in European government
securities has really been evolving from infancy in-MR. MELZER.
in that regard?

So you could pretty much specify what you wanted

MR. FISHER. Yes.
Certainly we couldn't put all our reserves
into the repo market, and I wouldn't want to. I would imagine always
trying to have some balance between directly held or under repo
government securities in the BIS and perhaps some amount still at the
Bundesbank; we'll have to decide how much. Having a diversity of
institutional arrangements as well as maturities is part of our goal.
MS. LOVETT. We spent a lot of time talking to people in the
repo markets as we proceeded, and we learned some hard lessons in that
market here. I think there has been some concern that as these repo
markets are developing in Europe market participants have not quite
learned from our mistakes. So we have been trying, both at the
central bank level and with U.S. dealers who have a presence in these
markets overseas, to let them know how important it is to maintain
margin and all of the other good practices. As they are evolving,
they are taking a look at some of the early history here and learning
from it.
MR. MELZER.

Thank you.

CHAIRMAN GREENSPAN.

President McTeer.

MR. MCTEER. Peter, you said a good bit more than usual about
Is that just because they had an election
the Mexican peso this time.
in August or is this a reflection of the prospect that we are going to
be paying more attention as they increase their role as our trading
partner?
MR. FISHER. The length of my remarks this time was really
premised on the fact that we had gone to some efforts anticipating the
election and I wanted to follow through. I suppose I could have
summarized my remarks by saying how smoothly the Mexican markets and
the peso went through the election.
MR. TRUMAN. As a technical matter, we still have an offer
outstanding to the Bank of Mexico through the end of Friday of this
So that's another reason to keep the Committee
week, September 30.
updated on the situation.
MR. MCTEER. I understand that in May Mexico replaced Japan
as our second largest export market, but in July Japan took second
place back again.

9/27/94

MR. FISHER. Yes. My own focus on it is not following the
trade account as much as the anticipation that New York banks and
dealers, who are in the list of 100 firms planning to open offices in
Mexico City, will be trading peso instruments more actively. As a
footnote to that, I would note that I asked my counterpart at the Bank
of Mexico whether he wanted me to include the dollar/peso in our
turnover survey of the foreign exchange market.
Some banks had
suggested it to us,

I presented this conundrum to my counterpart and explained that
this survey was for next April. He thought about it and said, "yes."
CHAIRMAN GREENSPAN.
If not, Joan Levitt.
MS. LOVETT.

Thank you, Mr. Chairman.

CHAIRMAN GREENSPAN.
I'm sorry.
MS. LOVETT.
Appendix.]

Okay, any further questions for Peter?

Did I say "Levitt?"

I answer to either.

CHAIRMAN GREENSPAN.

I meant "Lovett."

[Laughter]

[Statement--See

Questions for Joan?

MR. PARRY. In the intermeeting period there has been a lot
of discussion of the exact wording of the announcement that we made in
August. Do you think that that has had any impact either on Desk
operations or in markets in general?
MS. LOVETT.
The part of the statement that was released in
August that has captured a lot of attention--and some people have
likened it to the sort of attention that Talmudic scholars give--is
the "for a time" phraseology. The rest of the announcement followed
the format of earlier announcements.
It has not had an impact on our
operations; it has not affected us in any way that differs from the
That is to say, people see that the Committee
earlier announcements.
has been announcing its policy moves and that has tended perhaps to
give us a little more flexibility in our day-to-day operations. I'd
say more than a little flexibility until we come right up to a
Committee meeting. What we have noticed is that each time we come up
to a Committee meeting, there is still this question about whether we
are paving the way for a policy change. That has not dissipated. The
"for a time" concept immediately after the August meeting was taken by
That was the
most people in the market to mean until November 15.
"nuance" that they put on the statement. But as you can see from the
data that have come out since the August meeting and the market's
reaction to it, I don't think they feel that the Committee is hardIt has been a factor in that people perhaps have
bound by it.
responded more slowly to the data on the theory that, having said
this, the Committee would like a longer period of time to review
information as it comes in.
So, the response to the numbers, say the
PPI number, was muted because (a) it was the first number like this
and (b) since it was the first, the Committee presumably would want
more evidence. But I don't think the market thinks that the Committee
would overlook the data if it were overwhelmingly conclusive.

9/27/94

CHAIRMAN GREENSPAN.

President Jordan.

MR. JORDAN. Joan, for most of this year I have been trying
to understand the behavior of the yield curve, in particular the part
between the 1-year and 2-year maturities. After our February action,
we saw a sharp steepening over the next several weeks between the
1-year and the 2-year rates. After the mid-August tightening action,
we saw a complete pass-through initially on the short end--everything
shifted up--without the 2-year moving. In fact, we even got a rally
So we got a flattening of the yield
from the 2-year maturity on out.
curve between one year and two years. Now it has widened back out
again to the point that last Friday we had a 100 basis point spread
So, the 1-year rate, one
between the 1-year bill and the 2-year note.
year forward, is 7-1/2 percent. I look at that and shrug my
shoulders. I don't know what to make of that discontinuity in the
yield curve. From 2 years out to 30 years I don't see anything odd
about the yield curve; under one year I don't see anything odd. But I
can't make sense out of the 1-year to 2-year sector. Can you?
MS. LOVETT. I don't want to use a technical argument here
because I don't think technical arguments carry weight for long
periods of time, but I will say that an awful lot of money has been
kept in the short end of the market because people are very cautious;
most people feel that rates are going higher still, and the short end
The 2-year rate in particular has
has been a beneficiary of that.
been the subject of some debate in the market. A lot of people look
at the spread of the 2-year note over the funds rate as being too
narrow to be sustained, but that abstracts from the fact that there
has been a fair amount of interest in staying short. That perhaps is
what has kept that segment of the curve relatively low. Bill rates
were so low that the segment that you point to between one and two
years may have been depressed beyond what fundamentals would call for.
People are questioning the spread of the 2-year rate over the federal
funds rate at this stage of the cycle, given the prospect of further
Fed moves. And I think some people feel it's hovering around the low
end because of defensive moves.
MR. KOHN. Beyond the technical aspect, the issue I believe
is what the market is building in for our prospective actions. As new
data have come in, market participants have built in a steeper
trajectory of Federal Reserve tightening actions not only over the
next few months, taking out the effects of "for a time," but for the
years beyond that. Certainly, since early this year, we have seen
huge moves in these intermediate-term forward rates because of the
strength of the economy and changing market estimates of the likely
Federal Reserve action needed to counter the inflation pressures.
MS. LOVETT. We see, as I mentioned, that people have
ratcheted up somewhat further their views about prospective
tightening. We see that in the futures contracts for December and in
market commentaries. We see it through early next year. Not
everyone, as I mentioned, is completely sure about where prices are
going to be. There is still a fairly wide discrepancy in that.
CHAIRMAN GREENSPAN.

Any further questions for Joan?

9/27/94

MR. BROADDUS. Joan, the two camps you mentioned at the end
of your statement--is that majority 51 percent or 85 percent?
Seriously, can you give any sense of what the majority is?
MS. LOVETT. At the time I first wrote this earlier, I would
have described it as a narrow majority, but over the past week or so I
would say it probably has become a more comfortable majority.
I think
that's the way things have shifted over the past week.
People really
got caught up in the numbers released last week. They were a big
surprise.
MR. BROADDUS.

Thank you.

CHAIRMAN GREENSPAN. Further questions?
If not, would
somebody like to move to ratify the actions taken since the last
meeting?
VICE CHAIRMAN MCDONOUGH.
SPEAKER(?).

So move.

Second.

CHAIRMAN GREENSPAN. Without objection.
the staff report and Messrs. Prell and Truman.
MR. PRELL.
Appendix.]
MR. TRUMAN.

Thank you, Mr. Chairman.

[Statement--See

[Statement--See Appendix.]

CHAIRMAN GREENSPAN.
MR. BLINDER.

Let's move on now to

Questions for either gentleman?

I have a couple.

CHAIRMAN GREENSPAN.

Go ahead.

MR. BLINDER. I have a couple of questions for Mike. I
should have asked these yesterday at the Board briefing but I forgot.
The first question is not meant to be a joke, but has to do with the
employment report that's coming out at the beginning of next month and
the baseball strike. What are you expecting the baseball strike to do
to that number?
What do you project that number to be?
MR. PRELL. Implicit in the third-quarter payroll forecast is
an increase of about 250,000 for September.
MR. BLINDER.

Working in the strike?

MR. PRELL. This includes in essence no particular assumption
for the strike. We have made some back-of-the-envelope calculations,
and it is conceivable that it could have a measurable effect.
But
many of these people are part-time who might have found something else
to do. We had the start of the exhibition season for football; they
may have been employed as vendors for football games.
There just seem
to be too many imponderables here to make it a very big factor in the
estimate for September.
CHAIRMAN GREENSPAN. Of course, personal income and wages and
salaries collapsed!
[Laughter]

9/27/94

MR. PRELL.

There would be some loss of hours.

CHAIRMAN GREENSPAN.
infinity for that group.
MR. BLINDER.
MR. PRELL.

The average hourly earnings approach is

It's not the players that were-It could be a few tens of thousands, conceivably.

MR. BLINDER. I raise it because there was a lot of talk in
the summer that the World Cup was adding to employment.
I said to
myself baseball's got to be bigger than the World Cup--in America,
anyway.
MR. PRELL.
In retrospect, the numbers through August looked
as if there might have been a World Cup effect--if you look at the
areas of employment that might have been sensitive to that. There was
that falloff in August. So, there might be some upside bias, all
other things equal, in our forecast because we didn't make allowance
for a big effect from the baseball strike.
MR. BLINDER. Okay. The second question has to do with
Okun's Law and the 2-year projection.
From the end of 1994 to the end
of 1996 you have in the Greenbook forecast roughly a 2 percent real
GDP growth.
If potential is growing at 2-1/2 percent, that suggests a
gap of a percentage point which suggests to me a rise in the
unemployment rate conditioned on that forecast of about 1/2
percentage point.
You seem only to have about a 1/4 percentage point
rise. I was just wondering about that.
MR. PRELL. We are, I think, well aligned with Okun's Law
models if you take where we are as the jumping point.
MR. BLINDER.

From now.

Clearly, you can get a variety of results
MR. PRELL. Right.
depending on what your starting point is, but we looked at this both
in terms of the simple rule of thumb of an Okun's Law model working
from where we are as well as in terms of models that can reach back a
ways and take into account some of the errors that have occurred and
so on. This looks as well aligned as our forecasts ever are, gauging
this by our miscellaneous Okun's Law models.
MR. BLINDER.

Okay, thank you.

MR. PRELL. I should note, Dave Stockton reminds me, that
implicit in this forecast is potential output growth more like 2-1/3
percent than 2-1/2 percent.
MR. BLINDER.

That's almost enough to square the circle right

there.
MR. PRELL.
MR. BLINDER.

I'm sorry, I should have noted that.
Thanks.

CHAIRMAN GREENSPAN.

President Parry.

-10-

9/27/94

MR. PARRY. I'd like to ask a question about imports. In the
forecast for the third and fourth quarters the growth rates of imports
are the lowest we've seen since, I think, about 1991.
Clearly, the
direction of effects from exchange rates is supportive of this, but it
seems as though it's a rather unrealistic slowing given the strength
of final demand in this country.
MR. TRUMAN. I think that's right if you just rely on the
microeconomic indicators.
There are three factors that I think would
produce essentially this result. One is that we had what we think is
a bulge in consumer goods imports in the second quarter. We suspect
that has to do with either some combination of China or spread of
sanctions against China, and/or movements in the seasonals in terms of
the timing of imports as they relate to fall purchases.
MR. PARRY.

So they showed up in inventories?

MR. TRUMAN. Part of that has shown up in the level of
inventories coming out of the third quarter. The second factor is
that there also was a bulge in oil imports in the second quarter--this
certainly is a big difference in terms of 1987 dollars.
And again we
are getting the effects, in fact we are looking for a decrease, in the
third quarter as inventories have gone down a bit.
The third factor
is that there was also a considerable increase in imports of
computers, which in real terms had a big impact. And consistent with
that, we are anticipating in the July data at least a drop-off in
computer imports.
So, some of that has to do with these longer-term
factors, but the sharp change relates to our interpretation of these
volumes.
MR. PARRY.

I see.

MR. PRELL. Mr. Chairman, I might bring to the Committee's
attention a late-breaking piece of news here this morning. The
Conference Board released its survey for September. The headline is
that consumer confidence registered its third consecutive monthly loss
in September, declining 2 points.
In June the index had registered
The punch line in this release is that
92.5 but it is now at 88.4.
"the current level of consumer confidence has been associated in the
almost 30-year history of the survey with a reasonably lively
So it's consistent with the notion that consumer sales have
economy."
slipped a bit but are not far below the higher levels that we reached
earlier this year.
CHAIRMAN GREENSPAN.

President McTeer.

MR. MCTEER. Mike, this is a follow-up to Bob Parry's earlier
question to Joan. In Part II of the Greenbook, Section III-1, there
is a sentence that says:
"The press release announcing the August
policy moves was widely interpreted as indicating that subsequent
action was on hold, at least for a few months, and longer-term rates
Is that saying that you think the rates
initially fell somewhat."
fell because of the "on hold" phrase as opposed to the action itself?
MR. PRELL. Well, this is open to varying interpretations!
Certainly, as we perceived it, that announcement has been
[Laughter]
an element in the sense that it gave traders a period of safety in
which they didn't have to worry that every bit of incoming economic

9/27/94

-11-

data would necessarily carry with it the risk of a tightening action.
So, they probably were a little more relaxed about the near-term
outlook.
CHAIRMAN GREENSPAN. I think there's an interesting answer to
that. Most of those adjustments that we `see are the dealer responses
as distinct from those of the retail pension funds and the like.
If
you are a dealer and you believe that the chance of the Federal
Reserve lowering rates approaches zero, all of the unexpected shocks
have got to be on the up side. So if you're taking a long position
in, say, 10- or 30-year securities for a trading play and you know
that we are not going to do anything for a while, that is one
discontinuity you don't have to be concerned about. But if there's a
concern, if there is a Damocles Sword overhanging the system, you are
very reluctant to hold inventories net long. And as a consequence of
that, it is very likely to be a combination of both of those.
In
other words, the 50 basis points implies that we will not be active
for a while, and then the statement reinforces that. That is just
another way of saying to the bond dealers that it's safe to hold
inventories, at least so far as potential unexpected Fed policy is
concerned.
MR. MCTEER. It's sort of interesting that we seem to be in a
situation where we could get a positive market reaction either by
tightening or announcing we are not going to tighten.
CHAIRMAN GREENSPAN. I think both. I think the notion is
that we tightened and said we are not going to tighten further. It's
an effect of the tightening and the statement that nothing is going to
happen thereafter. That was essentially our basic thrust as you
remember at the last meeting, and I think the markets responded to
that double effect.
MR. KOHN. You can see in the fed funds futures that we
showed on the chart in the Bluebook that futures for the next few
months went up because we tightened by more than people expected, but
the rate then sort of flattened out and it was revised down for the
months farther out. Whether that was the result of the announcement
I think it
or of the tightening action is a little hard to sort out.
was also a bit of a knee-jerk reaction. The last time the Fed
announced something like this, in May, intermediate- and longer-term
rates went down, and so as soon as markets saw something like that
repeated, those rates started to decline. Within three days the
decline had been reversed, though the subsequent rise in rates didn't
really occur until much later.
CHAIRMAN GREENSPAN. I think bond dealers would prefer that
(1) the Fed never did anything, (2) that no one released any
statistics, and (3) that everything was trading incrementally. Under
those conditions they would feel comfortable. Any further questions?
Cathy.
MS. MINEHAN. I'm interested in the change that you mentioned
between August and now. You gave several reasons and the material
we've been getting gives several reasons. But in your mind can you
prioritize what was the main reason why your forecast and the implicit
amount of tightening changed as much as they did from August to now?

-12-

9/27/94

And what do you think most hangs in the balance subsequent to this
meeting? What data coming in are you most looking at?
MR. PRELL. Well, I think I highlighted the numbers that
struck us as most important.
MS. MINEHAN.

Is there one out of that?

MR. PRELL. I think our sense of the momentum in the consumer
sector was altered by the combination of the August retail sales and
the upward revisions to the prior months. Private economists had
become very enthusiastic about the signs that consumers really had
moved to a more cautious spending posture. So this certainly
suggested that there was still a willingness to spend and also a
willingness to borrow; we still have considerable growth in consumer
credit, and consumer sentiment is holding up well.
So, I think our
perception of where the consumer is has been altered. I noted two
other factors:
One, at least through the current period--this does
not necessarily tell you very much about the next few months--there is
a considerably greater degree of strength in manufacturing than we had
perceived earlier; and, secondly, the housing data just have not shown
the erosion of activity that we had anticipated. We still see things
as slipping but not at the pace that we had expected earlier.
So this certainly suggests that one of the key channels
through which we would have thought that interest rates would damp
aggregate demand is not working with the force that we had
anticipated. This has its corollary, too, in all probability, in the
fact that purchases of household furnishings and appliances have
remained very strong; that was the notably strong element in the
consumer spending report through August. There just has been no sign
of tapering off there. So, those were key factors suggesting greater
momentum in aggregate demand. At the same time, the employment data
and the initial claims suggested that we were still getting a lot of
growth in payrolls. In all likelihood, we were getting a little
tighter labor market than we might have anticipated. On top of that-MS. MINEHAN. You don't have to go through your whole
presentation! I was just looking for-MR. PRELL. Right, capacity utilization is much higher. So,
given the momentum, given the slack, we have felt that somewhat
greater tightening is probably needed in order to hold the pressures
in the economy down to something like those we had in the forecast by
the latter part of 1995.
MS. MINEHAN. And what would you be looking for in the next
data coming in? Would you be looking particularly at the consumer
side?
MR. PRELL. We will be looking at all of these things. We
currently are anticipating some bounceback in orders for nondefense
capital goods. If we got another very weak report, it might cause us
to revise our view of what the trend is in capital spending, which has
been giving good impetus to the expansion. Obviously, we'll be
looking at those other indicators of response to interest rates, which
might be the housing sector and consumer durables. And we'll be
looking at what goes on in the financial markets to see how things are
proceeding through those channels.

9/27/94

-13-

CHAIRMAN GREENSPAN.
Further questions for either gentleman?
President Forrestal.
If not, who would like to start the round table?
MR. FORRESTAL. Thank you, Mr. Chairman. As I have been
reporting for several months now, activity in the Atlanta District
remains quite healthy and we see that trend continuing in the future.
We are benefiting not only from the cyclical gains in activity that
have been experienced around the country, but also from continued inmigration from other parts of the country. On the retail side, the
back-to-school sales were mixed, but retailers nonetheless are quite
optimistic. Many of them are adding to their inventories and they
expect strong hcliday sales.
As a matter of fact, they are looking at
nominal sales gains of 6 to 9 percent. Automobile dealers are
confirming that model shortages constrained sales over the summer, but
they are confident that the problem is being solved, and they expect
sales to accelerate in the fourth quarter. Those constraints, as we
know, are basically in the popular models. Tourism has been mixed in
the District. We have had quite a lot of rain and that has
contributed to weakness in the central and southern Florida areas,
which has been a negative. Also, the slowdown in visitors to Florida
from Europe has not been completely offset by growth in travel from
Latin America and Asia.
Manufacturing activity also rebounded in August after a lull
in July--that's a seasonal factor. The strength is pretty much across
the board--in motor vehicles, chemicals, health care, textiles,
carpets, and paper. The weaknesses are in apparel and military
contracts. The outlook for capital expenditures is improving;
manufacturers in the District actually are adding to capacity and the
District continues to attract new facilities from elsewhere. On the
other hand, weak natural gas prices incrementally pushed down District
rig counts and, with the price of natural gas being below $2, that
probably will continue. On the housing side, we did have a
deceleration of sales of single-family homes throughout the District,
but prices are moving up nonetheless, and that's in the face of
inventory shortages.
Construction was hampered by the bad weather
that I already have mentioned. Multifamily markets continue to
improve and the occupancy rate is increasing around the District
generally. Commercial real estate is doing somewhat better, although
activity remains at somewhat low levels.
In financial services,
commercial lending demand is stronger than it has been, and it is
about offsetting the softness that we are seeing in consumer loans.
Growth in District payroll employment has been about half a percent
higher than in the nation as a whole.
On the price front, we are getting reports of rising prices
of raw materials. This is not something very new; we have been
hearing this for a while, but the reports of rising raw materials
prices and other input prices are increasing. Nevertheless, our
contacts are reporting that they are not able to pass these higher
costs through to finished goods because of competitive pressures.
On the national economy, our forecast continues to be
somewhat stronger over the entire forecast horizon than the one shown
in the Greenbook, although we too see a deceleration in growth. Part
of the difference is the assumption about monetary policy. We did not
build in any additional tightening of rates. But I think we also have
a difference because of our view of the policy lags in the price

-14-

9/27/94

determination process. We have inflation edging higher until at least
the middle of 1996, and that's partly due to our estimate that the
responses to policy changes made so far will take a little longer to
feed through. We do see a cyclical peak in the CPI sometime during
1996.
Our forecast really incorporates the view that the current
pressure on prices is due to aggregate demand growing more quickly
than aggregate supply.
We believe that our efforts to reduce inflation over time may
already have filtered into price- and wage-setting behaviors so that
these cyclical pressures are seen as temporary as opposed to a
sustained trend toward higher inflation.
I think the recent behavior
of labor costs, after a long period of falling unemployment, provides
some support for this position. If this is the case, perhaps we can
tolerate some small rise in inflation as the business expansion
matures. It is possible, of course, that wage and price
determinations are dominated by institutional features that, as has
been discussed, in part involve an inertia to all of these processes.
If this view is correct, once inflation starts rising and people build
higher inflation into their expectations so that it persists
indefinitely in the absence of forceful policy action, we have to act
in a way that shows an absolute zero tolerance for higher inflation.
It seems to me, Mr. Chairman, that our policy behavior over
the last several years, perhaps going back as far as 15 years, has
increased our credibility as inflation fighters. From this
standpoint, the outlook would strike me as one that we should be
pleased with. This is a picture, it seems to me, of an economy
entering the mature stages of a business expansion and moving toward a
peak in its rate of growth with very few imbalances.
It is an economy
where the rate of inflation also rises to a peak, but one that is
significantly lower than in previous expansions and that, it seems to
me, is quite desirable. It is possible that, in this optimistic
framework, the structural responses to our past policies may have
raised the economy's potential to grow as well.
I think both of these
scenarios, whether you adopt the inertia or the cyclical peak thesis,
are reasonable interpretations of recent data, but at this point it
strikes me pretty forcefully that it's simply too early to determine
whether we should be worried or not. Thank you.
CHAIRMAN GREENSPAN.

Thank you.

President Parry.

MR. PARRY. Mr. Chairman, a number of signals suggest that
economic conditions in the Twelfth District are improving. The
current data indicate that the number of payroll jobs in the District
rose 1.2 percent over the 12 months through August, the strongest
annual growth that we have seen since 1990. Moreover, payroll
employment data for a number of states are expected to be revised up
substantially when the 1994 state benchmarks are released next March.
We already know that there will be large upward revisions in
California, Arizona, and Washington, and several other western states
may see substantial revisions as well.
I should note that systematic
revisions in the state data do not necessarily mean that national
payroll series also will be revised up, since the national figures
already include bias adjustments that generally are not used in
compiling the individual state data. Utah, Nevada, and Idaho had the
nation's fastest growth in payroll employment during the past 12

9/27/94

-15-

months. In Oregon, Washington, and Arizona, the pace of growth is
less robust but appears to be picking up.
In California, it now looks as though the economy bottomed
out and remained essentially flat roughly from early through mid-1993.
At the last couple of FOMC meetings, we pointed to the bottom as being
at the end of 1993, but these revisions in payroll data have changed
that picture somewhat.
However, the subsequent recovery that we have
seen has been slow, sporadic, and uneven across sectors. While retail
sales jumped 2.4 percent in the first quarter of this year, they fell
back .6 percent in the second quarter. The unemployment rate remained
stuck around 9 percent, just a little less than the present rate.
Aerospace manufacturing continues to shed jobs at a double-digit
annual rate.
Turning to the national economy, real GDP growth appears to
have slowed somewhat from the robust pace in the first half of this
year. However, growth is likely to average slightly above its
potential rate in this half of the year. Moreover, at present levels
of short-term interest rates, I would expect to see a modest increase
in the pace of the expansion in 1995, putting growth a bit above the
potential rate in that year also. Labor and product markets currently
appear to be tight. This impression was reinforced by the sizable
increase in capacity utilization rates in the most recent release.
While estimates of what constitutes full utilization in product or
labor markets are inherently uncertain, it seems safe to say that
without a further increase in short-term rates such as that contained
in the Greenbook, there is a significant risk that inflation will be
on an upward trend in the next few years. Thank you.
CHAIRMAN GREENSPAN.

President Boehne.

MR. BOEHNE. The Third District economy continues to grow at
a moderate pace, less strongly than the rest of the nation. Total
employment is growing, although slowly. Retail sales are expanding
with strength notably in durables, particularly in autos. Residential
construction on the whole is flat--down a little in some areas, up a
little in others. Manufacturing continues to do well; it is growing,
but not quite as fast as earlier in the year. Banks are reporting
increasing loan volumes including increases in lending to small
businesses. There also are reports of a fairly general slippage in
underwriting standards--always the bank down the street, not the bank
you're talking to.
The outlook suggests that the pace of growth in
the District will continue to moderate, although I must say I am
hearing more concern about what rising interest rates might do to
business prospects. We clearly have gotten people's attention; higher
rates are on their minds, and they are talking more about it.
Wage
pressures remain subdued. Except for input prices, inflationary
pressures have not changed much in the District. The competitive
environment stressed over and over by business people seems to be
making it difficult to pass on higher input prices.
My reading of the national economy is that the expansion is
slowing but that we are likely to get more growth than we expected for
the next quarter or two rather than less. The strength in retail
sales coupled with that in business equipment and faster growth among
our trading partners provide the underpinnings for continued growth in
demand and job creation. And with excess capacity dwindling, the

-16-

9/27/94

inflation risks are clearly in view. The major uncertainty, however,
is what lies beyond the next quarter or two when some of the
slackening of pent-up demand and lagged effects of previous interest
rate hikes will be felt more fully. The skewing toward greater upside
risk may well continue beyond this year or there may develop more of a
balance between too much or too little demand going into next year.
For that reason, it strikes me that this is a time where we ought to
have additional monitoring of economic developments as the preferred
course.
CHAIRMAN GREENSPAN.

Vice Chairman.

VICE CHAIRMAN MCDONOUGH. The economy of the Second District
actually improved over the last several weeks. Retailers were quite
pleased with August sales--reporting year-to-year gains of 3 to 8
percent depending somewhat on the area. Demand in interest-sensitive
markets such as housing, cars, and light trucks slowed, however.
In
the labor markets, the unemployment rate fell a bit in August to 6.9
percent in New York and 6 percent in New Jersey, and payrolls grew in
July by 30,000 in New York and 10,000 in New Jersey. People are
worried about personal income tax collections going forward; as a
proxy for personal income, they grew by 3 percent in New York and 5
percent in New Jersey in the most recently available months.
Something that has improved, perhaps at the expense of Florida, is
tourism which has rebounded in New York City. A possible explanation
is that the press is playing up very strongly the "law and order"
approach of the new mayor and the new police commissioner. Although
the crime statistics have not changed very much, people are feeling
safer. The hotel room occupancy rate is up to 77.6 percent, which is
a 5-year high. The New York airports are bustling and Broadway
attendance is up 15 percent compared to last year. The convention
business is coming back.
On the negative side, it appears that there is a hole of
about $1 billion in New York City's budget for this year, which is now
into its third month, and so there will be a further reduction in City
Perhaps more
employment.
The talk is a cutback of about 7,000 jobs.
important over the longer run for the financial services industry is
that Swiss Banc Corporation has just announced that it is going to be
moving a good deal of its activities, including its trading, to a
building that is being constructed in Stamford, Connecticut, a place
that already has a lot of empty buildings. When their new building is
finished in 1997, they will be moving most of their New York-based
activities there. As I think all of you know, the conventional wisdom
has been that trading activities have to be in places like Manhattan
or the City of London, and so for a major bank like Swiss Banc
Corporation to be flying in the teeth of that conventional wisdom is
really quite important. If it caught on, it could take a lot of very
highly rewarded jobs out of New York City where they are very much
needed.
The national economy appears to have less near-term momentum
than we thought earlier, but fundamentally our forecast is about where
we were at the last meeting. That is, we expect growth of real GDP to
stay in the 2-1/4 to 2-1/2 percent range in the second half of this
year and into 1995.
So, we have a soft landing occurring but probably
not soon enough to avoid a pickup in consumer price inflation from
roughly 2-3/4 percent in 1994 to around 3-1/4 percent in 1995.

-17-

9/27/94

Although we believe the risks in this forecast are fairly well
balanced, there is a range of uncertainty about the strength of growth
over the rest of 1994.
In particular, as the Greenbook would suggest,
there is a significant risk of stronger near-term growth than we are
projecting. So, an alternative path of short-term interest rates,
other than staying where they are, may in fact be necessary to combat
the inflationary tendencies that could come up. What we are really
concerned about is that the near-term risks to our forecast are
symmetric but we think they are quite large, since the strength and
sustainability of the rebound in consumer spending are unknown.
Given the firming of the price data and the significant risk
that a surge of consumption could push growth above 3 percent, we
think that there are two alternative feasible paths for policy. One
would be to stay about where we are and the other would be to firm
policy at an appropriate time by about 50 basis points. As we
compared our forecast with that of the Greenbook, what we came down to
was that the Greenbook forecast looks like our upside number. That
is, if all the risks that we see for stronger economic growth were to
materialize, we would be about where the Greenbook is. We don't deny
that that is possible, but it is the upside rather than the midpoint
of our forecast.
So, I think we are as far away from the Greenbook
forecast as has been the case since I have been attending these
meetings.
CHAIRMAN GREENSPAN.

President Broaddus.

MR. BROADDUS. In the latter weeks of summer through late
August, there were some indications of a deceleration in overall
activity in our District. We saw some slowing in retail sales and
some softening in manufacturing and service-sector activity. That was
reflected in our Beigebook summary this month. But the more recent
reports from business contacts, directors, and others now seem to
suggest that this slowing, if it occurred at all, was transitory and
that the expansion in our region is back on track. At all three of
our September board meetings--in Baltimore, Charlotte, and Richmond-director comments were generally positive across industries and across
regions within the District. Consumer spending, including back-toschool sales, seems to be strong. Manufacturing activity appears to
have reaccelerated. Tourist activity, Bill, also has been strong in
our District. Nonresidential construction activity is continuing to
improve. A few days ago, we got reports that a couple of large firms
in Charlotte have committed to build 800,000 square feet of additional
warehouse space in the next couple of months.
On the residential
side, we are seeing a measurable increase in apartment construction.
We had not seen that for some time. So, again, after a lull it looks
to us as though the overall pace of activity in our region has moved
back up.
The apparently renewed strength in our District economy
currently seems, to me at least, to be consistent with the strength of
Taken as a
the most recent national data on production and sales.
whole, this information suggests to me that the deceleration in the
national economy that appeared in the summer was temporary and that
the expansion overall still has a lot of momentum. In this situation,
I think the 3 percent projected growth rate of real GDP for the second
half of the year is plausible, but as I think you said, Mike, it could
be higher. Of course, the full impact of our earlier policy actions

9/27/94

-18-

The sense I get from our
this year probably has not been felt yet.
directors and other business contacts is that the interest rate
increases that have accompanied these earlier actions are likely to be
associated with, at most, a fairly modest decline in the growth of the
national economy in the months ahead. The strong recent growth in
investment activity, both fixed and inventory investment, is certainly
not suggestive of a business expansion that is about to run out of
steam.
Mr. Chairman, let me just make a couple of comments with
respect to the inflation outlook. I don't disagree with the
Greenbook's inflation projection, but it's a bit unsettling to me that
the staff is now projecting a consumer price inflation rate of about
3-3/4 percent by the first quarter of next year. I find it even more
disturbing that for the first time we are beginning to see, not a lot,
but a fair number of private forecasts of inflation rates of 4 percent
or higher toward the end of 1995.
Moreover, it seems clear that
inflation expectations are rising at least in the financial markets.
The bond rate is now at its highest level since back in the 1990-1991
recession despite our August move.
I recognize that a lot of things
can affect bond rates in the short run, but a bond rate that is
persistently over 7-3/4 percent, as it has been now for some time,
suggests to me that the longer-term inflation expectations of market
participants is something closer to 4 percent than the 3 percent rate
for the CPI that the staff is projecting for the second half of 1995
and on into 1996. That says to me that we still have a credibility
gap. Market participants do not yet seem to be convinced that we are
going to take the actions we need to take to achieve our own internal
inflation forecast. So, I think it's essential that we find a way to
reaffirm our commitment to price stability at an early date.
Let me just say very briefly, Mr. Chairman, that one way to
deal with the credibility problem might be to consider announcing
explicit multi-year inflation rate targets leading to price stability.
as has been done in some other countries--say 3 percent for 1995,
2-1/2 percent for 1996, and so forth. Right now, it seems to me, we
are between a rock and a hard place, between a lingering credibility
problem, on the one hand, and the concerns that a lot of people
understandably have about further tightening action on the other. If
we announced explicit inflation targets and committed ourselves
clearly to achieving those targets, that might buy us a little more
flexibility at least with respect to the timing of our short-term
policy actions.
In the absence of something like this, though, I
think we need seriously to consider some sort of policy action later
in the meeting.
CHAIRMAN GREENSPAN.

Governor Lindsey.

MR. LINDSEY. Thank you, Mr. Chairman. I tend to concur with
both the staff and the markets that both nominal and real fed funds
will be higher six months from now than they are today. That doesn't
mean we should feel any compelling need to move today. And what I
would like to do is to take a look at what I think are two important
events that will take place between now and our next meeting, and they
were touched on by Peter Sternlight earlier on [Laughter]-MS. LOVETT.

Do you mean me?

9/27/94

-19-

MR. LINDSEY.

Oh, I'm sorry!

MS. MINEHAN.

It's ghosts.

MR. LINDSEY. His ghost is here; he is haunting me.
good, so much for my credibility!

"Levitt."

MR. BLINDER.

Let the transcript be amended!

MR. LINDSEY.

Yes, if that's possible.

CHAIRMAN GREENSPAN.
[Laughter]

Okay,

That's okay, Peter was replaced by Joan

MR. LINDSEY. I would highlight two dates. The first is
That's the deadline
September 30th and that was mentioned earlier.
for the negotiations between the United States and Japan and the issue
of rhetoric comes up. I think the situation there has worsened in the
last few weeks and that has to do with the changing perception of the
bargaining position of the two countries. Beginning with the United
States, I think it is clear to the Administration that its
confrontational approach to the Japanese has been an unmitigated
disaster. The U.S. bargaining position today is substantially weaker
than it was 12 or 18 months ago. We used what would normally be a
weapon of last resort, dollar devaluation, and we used it inexpertly,
Indeed, the
and the Japanese economy seems to have survived it.
market reaction to this inexpert diplomacy has been so adverse that it
has hurt the Administration's claim to have brought long-term interest
rates down. The political ramifications have been negative and I
think that fact is now widely appreciated within the Administration.
So as of a few weeks ago the Administration, from what I was told, was
looking for a graceful way of surrendering. In effect, the Japanese
were told that they could basically set the terms as long as they made
noises about how painful those terms were, the intent being to save
face for the United States.
It's
On the Japanese side, the choice is a tougher one.
whether to take that offer and presumably buy peace for the rest of
In general,
this Administration's term or to try for something more.
I think politicians over there seem inclined to favor a deal that
would be sufficiently mild to get them through the next Japanese
elections, but it would have to be demonstrably mild. I think the
current LDP-socialist alliance, which represents the anti-reformist
portion of Japanese politics, would find it a particularly sweet irony
to score such a victory, given that this Administration failed to cut
a deal with two clearly more pro-United States and pro-reform
governments earlier in the year. However, some politicians and the
bureaucracy see enormous potential for getting even more by holding
out, and I think this was what the hawkish comments suggested earlier.
The fact that the United States has been defeated by the Japanese is
widely appreciated in the Japanese government, and as a result the
option is there for a humiliation of the United States that would be
made clear by a negotiated defeat, which so far has not entered U.S.
political consciousness. The gains for the Japanese by forcing a
humiliating set of terms on this Administration or at least avoiding a
face-saving exit by the Administration would mean not just two years
of peace, but perhaps a period of peace lasting several
Administrations. That would mean in effect that future politicians

-20-

9/27/94

would have been scared from using Japan-bashing as a weapon. Of
course, this Administration can't accept humiliating terms five weeks
before our elections, so the possibility that neither side may blink
is I think pretty high, and the result for the markets could be
tumultuous.
The second date that we should be paying attention to is
October 16th, which is the date of the German federal elections. I am
a bit of a political poll junkie and those polls coupled with the
Bavarian elections on Sunday suggest to me that Mr. Kohl is unlikely
clearly to win a fourth term. Too many things have to go right. The
Free Democrats have to make the 5 percent threshold to get into
Parliament; I think they probably will, but it's no sure thing. The
PDS, which is the Party of Democratic Socialism--my, how names change
--probably won't get the 5 percent, but they are probably going to get
into Parliament another way, which is to win three seats outright, as
they probably will in East Germany by direct vote, and get their full
proportional share. So, somehow they have to fail to get those three
seats.
The far right has to fail to make the 5 percent threshold as
well. And assuming all these things go right, the blue/yellows or the
Christian Democrat/Free Democrat vote has to be greater than the
red/greens, or Social Democrat/ecologist vote. Any one of those
events may be likely, but I think the chances of all of them going the
right way seem to be quite small.
As a result, I think what we are
going to see is the Christian Democrats and Social Democrats agreeing
to a coalition. The markets know what that means, namely an inexpert,
compromising, and vacillating German government for four years with
the growth of both right and left on the fringes. That would not be
good for Europe; it would not be good for Germany; it would not be
good for the bond markets.
In sum, if things go wrong on September 30th, we could face
some combination of foreign currency bond market problems. If things
go wrong on October 16th, I think the result would be a short-term
appreciation of the dollar coupled with a general sell-off in
In either event, the
worldwide debt markets in the longer term.
potential need for an adjustment in U.S. rates is possible.
I'm going
to be quite specific.
I made my views on the efficacy of foreign
exchange intervention fairly clear several meetings ago, and I won't
go into that again, but my suggestion this time is that if
intervention is requested, we make explicit that it be accompanied by
a change in policy and in particular that it be accompanied by a
change in policy of 50 basis points. Frankly, Mr. Chairman, I think
that having that be the policy of this Committee would strengthen your
negotiating power in resisting what most people in this room find
distasteful.
But hopefully we will survive both September 30th
without a need for foreign exchange intervention and October 16th.
And if we do so, no rate increase would be needed and we can come back
to the normal considerations of monetary policy in November.
CHAIRMAN GREENSPAN.

President Minehan.

MS. MINEHAN. New England's recovery remains respectable in
terms of the data, but the pace and feel of economic growth lead me to
conclude that we may still be experiencing the lull that we thought
In July, employment growth
was there nationally during the summer.
was just under 2 percent for the region as a whole over the previous
year or nearly a full percentage point below national levels. Earlier

9/27/94

-21-

in the year, regional growth had tracked national levels a little more
closely. As in the past, employment growth in the region varies
considerably by state, with Massachusetts and New Hampshire employment
growing at just under 3 percent, that in Connecticut nearly flat, and
Vermont and Rhode Island employment beginning to flatten as well.
Growth in service jobs remains dominant, with two-thirds of the job
growth in New England over the last year occurring in services.
However, we are beginning to see an upturn in manufacturing, a fact
that has engendered some optimism. Consumer confidence rose slightly
in August, but here again it is not what it was earlier in the year.
In general, New Englanders have expressed less of a sense of growing
optimism over the past year than is true nationwide, with local
consumer confidence readings moving up less than 10 points versus over
double that for the nation as a whole.
Perhaps these consumer
confidence figures account for the general spending malaise reported
by our retail Beigebook contacts.
Continuing this tale of moderating growth, construction
employment has been essentially flat for three months, new housing
activity is slowing, and significant commercial construction has yet
to materialize. However, both housing permits and the value of
residential construction contracts remain considerably above year-ago
levels. Retailers and manufacturing contacts report very little cost
pressure in contrast to more widespread reports of raw materials cost
increases six weeks before. And where there are price increases, we
also see the inability due to competition to pass on those price
increases. Finally, while the overall volume of District bank lending
is growing at a pace over that of 1993, such lending in the
commercial, real estate, and personal loan categories is growing at a
quite moderate pace compared to national trends.
I don't think that
has anything to do with the banks' willingness to lend because we hear
the same kinds of things that people hear nationally--that there may
be some deterioration in the credit standards at the bank down the
street. There has been some news about that locally in the papers,
but we don't see a tremendous degree of growth in the actual bank
lending data.
I should note two bright spots:
First, there was a great
summer tourist season in the Northeast, similar to New York, with
reports from Maine, the Boston area, and Cape Cod quite strong.
Second, commercial real estate markets seem to be tightening, at least
in specific areas. Vacancy rates in downtown Boston have declined
substantially and some experts are predicting new construction as
early as a couple of years from now, with serious renovations of older
buildings in the meantime. That contrasts very sharply from what
people were thinking when I first arrived in Boston three years ago.
At that time, people were talking about sort of a 10-year horizon
before anybody would risk building something new in Boston.
On the national scene, we concur with the Greenbook that the
prospects for the third and fourth quarters look stronger than
expected. Labor markets are tight; external growth is stronger.
Inflation, while perhaps not accelerating as yet, has stabilized and
may be showing signs of turning upward. So we are in harmony with the
forecast of increased rates over the last half of the year, but the
amount and the timing we believe are an issue. Looking at a range of
private sector forecasts, none seems to project as much tightening as
the Greenbook though they achieve similar rates of GDP growth and a

9/27/94

-22-

moderation of inflation during 1995.
So, we are a little agnostic
about the degree of tightening, but we agree that the risks are on the
up side.
CHAIRMAN GREENSPAN.

Thank you.

President Jordan.

MR. JORDAN. The District economy is quite strong overall.
In fact, there really isn't an area or sector of the District that I
would call weak. Tourism has been very good; maybe it's a spillover
from New York, I don't know, but everybody talks about having had a
record year of tourism, especially in northeast and northwest Ohio.
Agriculture had its third good year in a row, which means all the ag
sector banks have done very well.
In fact, all of the banks in the
District are reporting that they are in very good shape; this is the
strongest year in decades. Residential construction is very good. We
have had some reports of increasing house prices, but we hear mostly
about increased building activity and not concerns about prices.
Nonresidential construction has picked up a fair amount and that
relates to capacity issues that I want to come back to in a moment.
Motor vehicle production essentially is at capacity, whether it's
trucks or autos.
All of the suppliers as well as the assemblers are
saying that they are at capacity levels and expect to stay there for
at least the balance of the year. Retail sales were quite good
through Labor Day but then dropped off for the balance of September-not in a way that worries people, but there was a noticeable slowing
of activity. Labor markets generally are characterized as tight
throughout the District. Even some areas that were complaining before
about being sluggish or soft now say that there has been a pickup. In
some communities, people associated with retail or fast food
operations actually complain about a shortage of teenagers, if you can
imagine such a thing!
[Laughter]
MS. MINEHAN.

A shortage of teenagers who want to work.

MR. JORDAN. We were especially interested in the question of
capacity in the manufacturing sector and put the question directly to
a broad array of manufacturers--the whole spectrum whether it's
capital goods, machine tools, motor vehicle-related, and so on.
Consistently, reports are that they are at capacity and are looking to
expand capacity. Then we turned the question to pricing, and we found
In fact, it was the rare exception where somebody
no pattern at all.
said that price increases were going to be a response to capacity
limits and backlogs. They really want to increase their ability to
meet the demand that they see through output, not price increases.
That led me to be very curious about the Wall Street versus the Main
Street attitudes. When we look at bond yields, mortgage rates, the
price of gold, the exchange rate--all these sorts of things suggest an
inflation premium. So, we asked people--directors, small businesses,
large manufacturing companies, other nonmanufacturing businesses-whether they were more concerned about inflation, less, or the same
And with only one exception out
compared to two or three months ago.
of dozens of business people we talked to, they said the same or down,
with the majority saying down. So from a Main Street standpoint,
people are not acting or sounding as though they think that inflation
is picking up. In that sense, I don't think we have lost ground in
terms of trying to achieve a situation where inflation is not a major
factor in decisions of households or businesses.

9/27/94

-23-

I'm puzzled by the international financial markets. One way
of reading them is that we are seeing a hike in inflation concerns and
awareness in those markets.
Regarding the national economy, I still am not inclined to
think of what has happened in the past four quarters as a classic
increase in aggregate demand fueled by monetary/fiscal stimulus or
something like that. A year ago, we had gone through a significant
period, several quarters at least, of a disappointing economy. And we
were waiting for the rebound--waiting for economic activity to pick
up--and were getting to the point of thinking it was not going to
happen. The Greenbook forecast for a year ago had a middling
expansion out through 1994. We then got the pickup and we have had
four quarters of fairly good growth. But I choose to interpret the
majority of that as having been the effect of a transitory increase in
the level of economic activity in response to, if you will, the
diminishing of the head winds--the depressants being less of a factor
--rather than being fueled by aggregate demand kinds of factors as in
the past. There may be some element of that.
If so, we have to say
with the advantage of hindsight that if we think this pickup basically
has been demand-driven, then we overstayed our accommodative policies
late last year and early this year--that we were fighting against the
head winds longer than maybe was necessary and should have backed off
the accelerator a little sooner.
But I don't think that is the lion's share of the way to
interpret this.
If I am right about what these last four quarters
have told us, then as this transitory increase in economic activity is
completed, the rate of change naturally will diminish. Second
derivatives have to go negative. I don't see signs that tell me that
we have to use the term "tightened too little" or necessarily even
"too late."
I would have expected that if moving up to the 4-3/4
percent level from the 3 percent level in the funds rate was behind
the curve, then we would have seen symptoms of that in reserves,
central bank money, demand deposits, other things suggesting that
there was something in the marketplace moving equilibrium interest
rates up much faster than we were moving. I don't see that out there.
As implied in my question earlier to Joan, the yield curve may play a
part in that. Why does the yield curve from three months out to a
year look okay? What we have been doing on the funds rate does not
look to me like either too low a level or one that came up too slowly.
But I have problems with what happens between the 1-year and the
2-year maturities. Why is the 1-year forward rate for the 1-year
maturity 7-1/2 percent?
It leaves me in a position of thinking that
we should not totally neglect the information that is coming from
reserves, money, and credit and debt measures that say that right now
we are in a good position; give it a little more time.
CHAIRMAN GREENSPAN.

President Hoenig.

MR. HOENIG. Thank you, Mr. Chairman. The Tenth District
economy remains strong, but there are some signs of slowing. By that
I mean slowing to a pace more in line with the national rate, so the
regional economy is still very strong overall. We are seeing some
slowdown in residential construction which suggests that some of the
earlier policy moves may be having an effect, but the slowing is
modest. We also are seeing some slowdown in the ag area and what
happens there will depend a lot on prices. Our energy sector remains

-24-

9/27/94

sluggish. On the other side, we have manufacturing that is very
Our services
strong, especially the durables side and automobiles.
Commercial
industry is very strong and our retail sector is strong.
construction, in contrast to residential, appears to remain fairly
good, and we still are seeing some scattered shortages in the labor
market. We also are hearing continued comments about resource price
pressures in steel and in paper manufacturing. This has been going on
long enough that individuals in these firms feel that something has to
give. Their margins are coming under pressure and how much more they
can be squeezed is on their minds. So, in contrast perhaps to our
other contacts, I think they are thinking about inflation.
As we look forward, we do think the District economy will
continue generally strong. There may be some further slowing,
particularly in the construction area, but we think manufacturing will
remain good in the context of strong national demand and as the
foreign sector has its effect on our manufacturing. Overall,
conditions in our District are generally good and I think they will
stay that way for some time.
On the national level, we see growth slowing slightly this
year, but we think it will stay above the potential rate and remain
above 3 percent on the year. We think that's also true for inflation
as we end out the year. Looking beyond that, and assuming we hold
monetary policy unchanged, we see some slowing of the expansion next
year toward the natural rate. But we still see an environment where
inflation is rising in a 3 to 3-1/4 percent range. So that is a
concern to us as we look to the future for the economy, especially as
we see our own District remaining fairly strong. Thank you.
CHAIRMAN GREENSPAN.

President Moskow.

MR. MOSKOW. Mr. Chairman, economic activity in the Seventh
District remains relatively strong. Most reports indicate an
expectation of continued growth in the near term, with the possible
exception of residential construction. Manufacturing activity remains
robust but has been impacted by capacity constraints as has been
mentioned before. Most of these constraints in automobile production
should be resolved this fall except for some selected, very popular
models where shortages are expected to continue into next year. Auto
suppliers in the District report that orders remain very strong and
that production is "maxed out."
The heavy duty truck industry is also
at capacity. Our contacts in retailing generally report that sales
growth has continued at about the slower pace seen in the second
quarter, with several noting some improvement more recently.
Retailers generally are optimistic about sales over the rest of this
year. For the most part, inventories are in good shape, and many
retailers indicate that they plan to increase their stocks in the near
future. Competitive forces continue to hold down prices to consumers.
Demand for
Labor markets in our District have continued to firm up.
temporary workers in our region is very strong, with these firms
having to pay wages that are 5 to 10 percent higher than last year to
Recruitment costs may be rising more generally. We
attract workers.
have had reports of bonuses being paid to hire engineers and truck
drivers, for example.
However, we have had few reports of any
significant upward pressure on the wages of permanent workers. Some
employers reported that they do not expect higher union wage demands

-25-

9/27/94

in the coming months, and others believe that they can offset higher
wages through productivity increases.
Purchasing managers throughout the District report that
prices have been in an upward trend this year. Increases in prices
for container board, chemicals, and aluminum have been particularly
Some manufacturers have fixed-price
pronounced in recent months.
supply contracts that protect them from price increases for the
remainder of this year. For example, auto and commercial equipment
manufacturers will now be negotiating new steel supply contracts for
next year. However, manufacturing contacts at our recent meeting in
Milwaukee contirued to express skepticism that inflationary pressures
would prove significant or long-lasting, citing the intense and
continued competitive pressures that have been mentioned here before.
Agricultural conditions in the District remain quite favorable.
Estimates which had already pointed to a near record corn crop and a
record soybean crop have been raised slightly. These crops are
maturing at a faster than normal rate, reducing the possibility of
harvest losses.
Our overall macroeconomic outlook for the second half of 1994
is largely consistent with the Greenbook. We concur with the
Greenbook assessment that little slack remains in the economy. The
only difference concerns the quarterly pattern of real growth. We
expect slightly weaker real GDP growth in the third quarter followed
by slightly stronger growth in the fourth quarter, and this
discrepancy primarily reflects differing assessments of the timing of
production patterns in the automotive sector.
If I could, I just want to comment on the U.S./Japan
negotiations and the September 30 deadline.
CHAIRMAN GREENSPAN. Do you want us to ask what your
affiliation is in this regard?
MR. MOSKOW. Just an observer from Chicago at this point
without having had any contact with any of the participants. These
are complex negotiations, as we know, under at least two different
statutes. I think that Governor Lindsey's scenario is possible, but I
would say the probability is higher that the parties will reach
agreement on some of the issues.
If that's true, then I would not
expect any major negative impact on the currency markets.
CHAIRMAN GREENSPAN.

President Stern.

MR. STERN. Thank you, Mr. Chairman. First, with regard to
the Ninth District economy, the objective measures of economic
activity suggest that the regional economy remains strong. The
anecdotal evidence--of course there is always a danger of paying too
much attention to that--suggests that activity has even picked up
another notch, which is pretty remarkable because the regional economy
has been operating at quite an accelerated pace for an extended period
of time. Nevertheless, business people seem quite positive about
recent developments virtually across the board. Labor markets have
tightened further and jobs are certainly readily available. Despite
those circumstances, there is still no widespread evidence of building
inflationary or wage pressures, but I think it is fair to say that
there are more scattered indications of growing inflation and wage

9/27/94

-26-

pressures.
It is by no means widespread, as I suggested, but as we
listen to people comment about input prices and about what is
happening in specific labor markets and so forth, there certainly is
more talk today about inflation than there was a few months ago.
Even
some of the business people who have been quite skeptical of our
concerns about inflation, thinking that we might be worried about a
phantom, have started to acknowledge that there may be a little more
to it than they at least thought earlier.
It's also true that when we
talk to bankers--I think this came across in the FAC minutes but it
comes across almost everywhere--if anything credit is a good deal more
readily available today to small and medium-size businesses than it
was a year ago or even less.
It does not appear that our moves toward
higher interest rates have had any restraining effect in that sector.
With regard to the national economy, it may be slowing, but
not very much in my view, although I will admit that depending on how
the inventory numbers play out, we could get some readings of real GDP
that suggest a slowing. My reading of the incoming data at the
national level suggests there is a good deal of momentum in the
expansion.
I guess the only way I can describe it is that it looks
strong.
I do think this will be accompanied by some acceleration of
inflation as the Greenbook suggests.
Bob Forrestal raised an
interesting point that this may be just a temporary, cyclical spike
that we need not get very worried about. But it seems to me that
identifying whether it's a temporary spike as opposed to something
more durable may turn out to be exceedingly difficult, and certainly
history doesn't provide very much comfort on that score.
CHAIRMAN GREENSPAN.

President McTeer.

MR. MCTEER. Eleventh District business conditions remain
good and essentially unchanged from my last several reports.
There
are no significant new straws in the wind except perhaps on the
fashion front where I understand that mohair is gaining in popularity.
I'm told that the Eleventh District produces 90 percent of the
country's mohair.

hair!

We have a lot of

MR. KELLEY.
[Laughter]

"mos."

[Laughter]

That shows you how much demand there is for more

MR. MCTEER. There's a lot of dust being raised by companies
getting ready to do business in Mexico under NAFTA, and unfortunately
there are some signs of non-tariff restrictions replacing tariffs as a
barrier to trade.
In August, I reported complaints by some small banks of very
We have had
aggressive competition in lending from larger banks.
people examining that more carefully and their early reports are that
that is more a matter of price and spreads than standards.
I can't really add to anything that has been provided to us
or reported here today on the national economy except my caution that
we should keep an eye on the further slowing of all of the monetary
aggregates and bank reserves, especially in the context of a fiscal
I understand
policy that's not as expansive as we used to see it.
that that has not been a problem today, but we shouldn't forget about
the aggregates; we should see what is going on there and keep them in
mind.

-27-

9/27/94

CHAIRMAN GREENSPAN.

President Melzer.

MR. MELZER. Thanks, Alan. Despite hopes to the contrary,
Projected strength in
the fact is that inflation has turned up.
demand, which is a view we would certainly associate ourselves with,
may well add further to inflationary strains.
In the past three
months, both retail sales growth and industrial production have
accelerated. Payroll employment growth continues to be strong.
Correspondingly, as has been mentioned, capacity utilization has risen
well above its 1967 through 1993 average of about 82 percent. A
rebound in auto production in August and recent announcements of auto
sales and production schedules point to improving growth in industrial
output through the end of this year.
In the Eighth District, auto production has been booming in
the third quarter, and producers recently have boosted production
plans for the fourth quarter. Production at Ford and Chrysler plants
in St. Louis is planned to rise by about 11 percent from the third
quarter and by more than 2 percent from year-ago boom levels. Auto
industry officials continue to see sales constrained by supply as
producers reduce output in some areas to retool and make capacity
improvements.
Overall in the Eighth District, there has been some
leveling in economic activity but at a very high level inasmuch as we
had recovered to near capacity far faster than the nation as a whole.
Nonetheless, employment in the District remains robust as the
unemployment rate hovers near its lowest level since August 1974.
Reports of labor shortages in certain trades and geographic areas are
increasing in my judgment. For example, in the construction trades,
there are now reports of shortages throughout the District. In
certain areas that had been very successful in attracting new
business--areas like Bowling Green, Kentucky and Jackson, Tennessee-regional development efforts are being altered to reassure new and
expanding businesses about the continuing availability of labor.
Jackson, for example, recently has announced a six-month hiatus in
recruiting large business prospects.
In some areas, there are
shortages even of unskilled labor, although these are being offset in
certain cases by hiring immigrant laborers from Mexico, for example in
northwest Arkansas. Turnover rates are very high. Firms report
having to hire two to three apparently qualified workers--and that
implies screening a lot more--at this unskilled labor level for every
one that pans out. While reports of wage pressures have been isolated
so far, broader-based pressures seem incipient given these
developments in labor markets.
Business executives in the District are also seeing evidence
of price pressures from rising costs of steel, paper products, and a
variety of raw materials from both foreign and domestic sources.
Despite continued competition in product markets that limits their
ability to pass on costs, it would not take much, in my judgment, to
In fact, an
crystallize price increases in such an environment.
interesting aside, somewhat contrary to the report of the view of the
National Association of Manufacturers, is the view I am getting from
manufacturers in our District. They perceive that the marketplace
they are operating in is so competitive that to enable them to stay
competitive, they would like us to take action to contain what they
see as emerging price and wage pressures.

-28-

9/27/94

One final area I wanted to comment on is inventories. Of
course, many economists have been concerned that the second-quarter
buildup foreshadows slower demand growth ahead. However, again based
on conversations I have had with business executives in the Eighth
District, my general sense is that the buildup was intended. Let me
give you just one example. Last week we had a meeting outside of St.
Louis, and a manufacturer of steel for industrial and commercial
buildings with operations not only in our District but the upper
Midwest and the West told me that his lead times from suppliers are
now two to three times above what he would normally expect and that he
in turn has pushed out his delivery schedules for his customers to
probably twice what they normally would be. As a result, to prevent
further delays in meeting his customers' demands, he has begun to
order raw materials in anticipation of orders that really have not
materialized. I will say, however, that when I asked him whether he
was willing to build speculative inventories based on the prospect of
further increases in prices of materials, he said no. By the way, he
has seen two steel price increases so far this year totaling 10 to 12
percent and another increase has been announced and seems very likely
for the beginning of the year, So far, all that is going on, at least
in this sample of one, is the building of additional inventories
against expected final orders.
CHAIRMAN GREENSPAN.

This is a manufacturer of what?

MR. MELZER. Steel products for industrial and commercial
buildings--warehouses, light industrial buildings, strip shopping
centers, that sort of product.
To conclude, I'm very concerned about inflation no matter
what measure one looks at.
In July and August, consumer prices
accelerated to an annual rate of 4.1 percent and producer prices to an
annual rate of more than 6 percent.
Inflation is certainly headed in
the wrong direction if price stability is our goal.
CHAIRMAN GREENSPAN.

Governor LaWare.

MR. LAWARE. Mr. Chairman, I suspect that the death yesterday
of the Administration's health care reform scheme may well result in a
reversal of some of the recent declines in consumer confidence. On
the other hand, the upcoming election will tend to focus attention on
voter dissatisfaction with government and support continued
uncertainty. My own view is that the export sector may in fact do
better than the Greenbook forecast, and consumers may continue recent
spending patterns more strongly than the Greenbook projects.
The
abrupt drop in GDP growth projected by the staff for 1995 seems to me
to be inconsistent with the projected levels for autos and housing
starts. As a result, I continue to believe growth in 1995 will be
somewhat stronger than the staff forecast and may indeed require
further restrictive action by the Committee. But I'm not convinced
that we have yet seen the full impact of our previous policy moves or
that the future direction of policy is clear enough at this time
without more hard data. I certainly admire the inflation reduction
and containment achieved in some other countries, but I find the
social price paid in those countries in terms of prolonged recession
and very high unemployment unacceptable for the United States.
I
would rather pursue a more moderate course designed to ratchet core
inflation down over time and not be distractedly concerned by

-29-

9/27/94

occasional temporary upward blips in the CPI. Consequently, I think
we need more information and a very sensitive foot on the brakes.
CHAIRMAN GREENSPAN.

Governor Kelley.

MR. KELLEY. Thank you, Mr. Chairman. First, very briefly a
quick summary of where I am:
The inflation news since the last FOMC
meeting certainly has not been very helpful, but I don't think there
is much evidence that inflation is going to take off on us.
We may
have some inflation creep on our hands as the Greenbook suggests, and
I'll speak a little more to that in a second. In real activity, as
Mike Prell and many others have observed, there is an impressive and,
certainly to me and perhaps others, a surprising amount of momentum
still out there and that may be slowing. When we gathered last time,
we tightened 50 more basis points and that, of course, is only just
now going to start to have an impact. The impact of earlier
tightenings is, of course, still in the process of unfolding. So in
short, I think we have an interlude here to see what develops.
The
slowing may spread and stretch out a little. On the other hand, it
may turn out to be very brief and we may continue to get very strong
data that may call for another move rather soon.
If I can take one more minute, Mr. Chairman, let me share
with you a concern that I have. If inflation creeps up at all, and it
certainly appears that that is likely, many here could regard that as
insignificant or temporary and not be terribly concerned about it.
But I think we probably need to be prepared for a rather major and
stronger bout of inflation jitters in the economy, and we may want to
think about how we might be able to handle that. There is a
perception that the economy is in a very mature, perhaps even a late,
stage in the cyclical expansion. Everyone perceives that we are
operating more or less at capacity now. For a long time in this
country, people would expect in a period like this to see inflation
I think that until we actually
take hold and be at its most virulent.
go through a full cycle without a substantial inflationary surge,
there is going to be a concern that history will repeat itself, and I
can understand that. And if inflation starts to show some upward
creep, there almost inevitably will be some concern that, okay, the
game is on, here we go again.
First of all, it could
There are at least two risks in that.
have a certain self-fulfilling prophecy element to it through the
expectations channel and it may make itself stronger than it needs to
Second, I can see it forcing long rates
be or might inherently be.
considerably higher than we are comfortable with or think that they
ought to be through an enlarged inflation premium. That could be an
overly and unnecessarily negative event.
So, I have a concern
regarding what we may be looking at in the marketplace in the near
future, Mr. Chairman. Even if we are not terribly concerned based on
the specific evidence that we see at hand, I think there could be some
market concerns that would work their way through the economy in a
negative way.
CHAIRMAN GREENSPAN.

Governor Yellen.

MS. YELLEN.
I agree with the central message of the
Greenbook that most of the new information that has accumulated during
the last six weeks points to continued strength in aggregate demand.

9/27/94

-30-

The incoming data do not yet provide any significant evidence of a
sufficient slowdown in real GDP growth. However, this is not based on
a great deal of evidence. A lot more data will be coming in over the
next month that will clarify whether this impression is correct or
not.
I personally am concerned that we have put quite a bit of
restraint into the pipeline, a good share of it quite recently, and it
may yet make its impact felt. Under the Greenbook assumption of an
additional 100 basis point rise in the funds rate, I am considerably
more pessimistic than the Greenbook about the 1996 forecast for real
growth. For example, in the MPS model the impact of such a tightening
becomes really discernible only after about four quarters, namely by
early 1996. And after eight quarters, such a rise would take about
0.9 percent off real GDP. That leaves me with a sense that a forecast
of 2.2 or 2.3 percent real growth in 1996 may be overly optimistic
with that added restraint.
A key question now concerns the behavior of prices--whether
there is evidence at this stage that inflation is accelerating. This
in my view is an especially important issue given our concern with
inflation as an ultimate policy goal and also the feeling that the
economy is operating at close to potential where there is a decided
risk that inflation could begin to creep up. But here my analysis
differs somewhat from the staff forecast. In particular, I think we
are seeing and will continue to see for a time an increase in the
relative prices of raw materials and imported goods. These higher
prices will feed through into the CPI for a period of time, causing a
temporary increase in the rate of inflation but not a permanent
increase in the trend inflation rate, or worse yet, an acceleration in
inflation.
I think the increase in inflation will be temporary even
if there is only enough restraint to hold the unemployment rate at its
present level, roughly the natural rate given staff estimates. And I
think the markets have overreacted to the increase in producer prices
in August.
Now, the Greenbook is also forecasting that consumer price
inflation will be up for the next three quarters and then will return

to roughly 3 percent by the end of 1995, and I agree with that
forecast. My difference with the Greenbook concerns whether or not a
period of unemployment in excess of the natural rate is needed to get
I think not, but the Greenbook thinks that
inflation back into line.
it will require a period of unemployment in excess of the natural rate
in the latter half of 1995 and 1996 to subdue inflation, and that's
something more than a quibble because it does govern one's view about
how much additional restraint it is going to take to hold inflation at
its present level.
To elaborate just a bit, I think we are witnessing now a
perfectly normal cyclical phenomenon, namely, the relative prices of
primary commodities and raw materials tend naturally to increase with
the level of domestic and more importantly world economic activity.
The prices of these materials have been increasing rapidly all year,
but from initially depressed levels.
I expect these prices to rise
further due to faster global growth, but then I expect them to stop
rising once economic activity stabilizes. Similarly, we have had a
significant depreciation of the dollar, which is causing and will
probably continue to cause for a time a rise in the level of import
prices.
But the staff doesn't expect the dollar depreciation to

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9/27/94

continue and so we should expect import prices also to rise and then
stop rising.
My conclusion is that these shocks should feed into faster
CPI inflation only for a time, and once the adjustment is complete,
I expect this to
inflation should revert toward its previous level.
occur even if the CPI increase feeds partially through into wages,
although the greater this feedback, the longer this temporary burst in
I agree with Governor Kelley that there is a
inflation will persist.
danger that inflationary expectations can overreact. Historically, I
think the evidence on the likely pass-through of temporary price
shocks into wages is quite inconclusive.
The only caveat I want to add in this analysis is that I'm
assuming along with the Greenbook that the unemployment rate is not
going to be allowed to fall below the natural rate--and that means not
very much lower than it currently is--for any significant period of
time. With respect to the question of whether or not we are below the
natural rate, I think wage behavior provides the best direct evidence.
The fact that wages have been so well-behaved, with average hourly
earnings rising only 0.2 percent last month, for example, convinces me
that we have not overshot the natural rate.
CHAIRMAN GREENSPAN.

Governor Blinder.

MR. BLINDER. I have only a few points to make and since
probably half the people around the table are as hungry as I am, I
will make them quickly. I wasn't planning to say anything about the
trade negotiations; but since it was brought up, and lest silence be
construed as assent, let me just say that I disagree 99-1/2 percent
with what my colleague, Governor Lindsey, said in his assessment of
what's likely-CHAIRMAN GREENSPAN.

It means you agree with him on 1/2

percent?
MR. BLINDER.
it at tha.

I think 1/2 percent is on track, and I'll leave

On the forecast, largely for reasons having to do with
inventories, which I brought up at the last FOMC meeting and certainly
with the staff, I would look for the third quarter to be weaker than
in the Greenbook. By pure arithmetic, some of that difference is
going to show up in a stronger fourth quarter. So, this is not a
major disagreement. But, on balance, it leads me to a somewhat weaker
second half of 1994 than the Greenbook forecast. Conversely, I'd
expect a bit stronger first half of 1995 than the Greenbook. Note
that the projected further tightenings of monetary policy built into
the Greenbook forecast could not possibly be slowing down the economy
So, whatever is in the staff forecast for
in the first half of 1995.
the first half of next year has to have been built in by the previous
tightenings. I don't think we have tightened enough to slow the
economy down to 1.8 percent in the first half of next year.
Accordingly, I'd expect the first half of 1995 to be a bit stronger
than in the Greenbook. But over the next year there may not be much
difference between the way I see things evolving and the way the
Now, for the eight quarters
Greenbook sees things evolving in total.
in 1995 and 1996, the average growth rate in the Greenbook is about 2

9/27/94

-32-

If we
percent.
I don't find that to be a very satisfactory target.
have not yet overshot capacity, and I don't believe we have although
one can't dismiss that hypothesis completely, the economy does not
need to grow at 2 percent for two years in order to keep inflation
from rising. If we have already overshot, then indeed we do need
something like that.
Regarding inflationary pressures, I think we should realize,
maybe more than we do, how concentrated the industrial pressures are
in the United States right now. There are lots of stories coming out
of the manufacturing core of the economy about tight markets, very
strong capacity utilization, strong order books, good sales, etc.
They are all true. But they are very much concentrated in durables
manufacturing, which in round numbers is 10 to 12 percent of value
added in the U.S. economy. If you look at the demand side rather than
the production side and look back at the last year, we have had
buoyant growth over the year, which has scared a lot of people. The
four quarters ending in the second quarter of 1994 had a growth rate
of 4 percent.
It's the only time that we have had a four-quarter
period with growth as high as 4 percent in this entire business
recovery. In previous business recoveries, one four-quarter period of
4 percent would not have scared anybody and, indeed, would have left
the FOMC thinking that things weren't looking that great.
More important than the 4 percent, I want to call attention
to the fact that that growth was highly concentrated. I looked at
these numbers last night.
I knew the qualitative story, but I was
surprised at the quantitative dimension. We all know where it was
concentrated--in business fixed investment, consumer durables, and
housing. Those three sectors account for roughly 1/4 of GDP on the
spending side.
I'm not talking about value added weights because a
lot of that is imports, which is a point I'm coming to. Those three
sectors of the GDP over the last four quarters registered an 11.3
This means by the laws of arithmetic that the
percent rate of growth.
rest of the economy, the other 75 percent, registered a 1.6 percent
growth rate over that period.

Those three sectors, of course, leaving

aside housing for now, are where the price pressures are--either
current or incipient.
If you looked at the Greenbook forecast for the
next two quarters and took housing out of the fast-growing sector, the
result would be even more extreme. We don't expect housing to be part
of the fast-growing sector going forward; the staff doesn't; none of
us do. But, leaving housing in the fast-growing sector, those three
sectors in the Greenbook forecast are projected in the second half of
this year to grow at a 6 percent rate and the rest of the economy at a
1.8 percent rate.
If I moved housing over the sectoral line, that
spread would be exaggerated because we are expecting a slowdown in
housing.
Regarding the point that I was making about inflationary
pressures, many people in popular discussions point to international
capacity as a safety valve on U.S. inflation. This is greatly
exaggerated because roughly 90 percent of what we consume or use is
produced at home. The place where it has the most validity, however,
is exactly where the pressures are right now--in business fixed
investment, where over 40 percent is imported, and consumer durables
where I don't remember the fraction that is imported. Those are
It is in this
precisely the sectors where we are seeing pressure.

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9/27/94

very limited part of the economy where the international safety valve
is most important.
Finally, I want to align myself fully with the comments Jerry
Jordan made earlier. I have been worried for some time, and I am
becoming increasingly worried, about the disjuncture between the Main
Street view of inflation and the Wall Street view of inflation.
I
None of us is sure this
just want to point out an implication:
disjuncture is actually a fact; I suspect it is, as Jerry does, but it
If it is a fact, the implication is that
is hard to know for sure.
real interest rates look a lot higher on Main Street than they do on
Wall Street, and we should be mindful of that. If that hypothesis is
correct, that's likely to mean that there is more punch in what we
have already done than we realize. Thank you.
CHAIRMAN GREENSPAN.

Finally, Governor Phillips.

MS. PHILLIPS. I guess I am left to bat clean-up in an era of
a baseball strike, and I'm not quite sure where that leaves me! The
economy clearly is going into the fourth year of this upturn and the
third year with above-potential GDP growth. As Governor Blinder just
described, we are seeing a lot of the strength in manufacturing of
consumer durables and in business investment, especially equipment
spending. The labor markets appear very strong. Job generation has
totaled over 3 million jobs this past year. Housing activity clearly
has slowed. The question is more on the consumer side. We appear to
be seeing some slowdown there. As we have heard around the table,
there is some disagreement regarding the extent of the slowdown, where
it is and so on. Part of this may be that consumers have worked
through the bulge in their pent-up demands following the recession and
also have worked through the housing bulge when people buy lots of
consumer durables following their housing purchases. I think most
people would suspect that we should be seeing some slowdown. I was a
little surprised to see the discussions of a potential Christmas spree
spending now being reported. The international picture should be
strengthening and at least not be a drag on the economy. I certainly
recognize that this is not a large part of the U.S. economy because we
have such a large domestic economy. Nevertheless, looking at these
various pressures, it's a bit hard to escape the conclusion that most
of the slack in labor and product markets is used up, and we are
starting to see the effects on the price side.
I think we are beyond
the point of a preemptive strike. Barron's yesterday was even talking
about urging people to dig back into their closets and find their
"Win" buttons.
[Laughter]
MR. BLINDER.

We each have one, Mr. Chairman!

[Laughter]

MS. PHILLIPS. Then you are well prepared. I think some of
the numbers that have already been cited here recognize that we are
seeing some show-through of price pressures even in the CPI,
particularly in the last couple of months. We have all been citing
producer price pressures in the last few months, and there are lots of
good statistics to quote with respect to producer prices and also
commodity prices.
While much of the pressure on commodity prices has
not shown through to final consumption prices, it would nevertheless
be a danger signal if commodity and other producer prices stayed at
I think it is
elevated levels for a sustained period of time.
interesting that the argument on inflation now appears to have shifted

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9/27/94

somewhat. There appears to be fairly broad acknowledgement that we
are seeing more price increases. The question now appears to be
whether the increase is permanent or a short-term cyclical blip.
Maybe because Bob Forrestal went first today, he was the first to
surface this argument. But I quote Gary Stern's stern warning about
the problems of identifying whether it is a blip or whether it is more
incipient or creeping price increases, something that's likely to
infect the CPI for the long term and in fact move on into the wage
sector.
Turning to the financial market side, the stock markets, I
think, have shown quite amazing resilience in light of the interest
rate increases. Stock prices are being sustained, I think, by
earnings at this point, so we are getting a healthier relationship
between prices and earnings.
Bond markets are certainly nervous, and
I think this is well demonstrated by Peter Fisher's art work in his
charts, but it's not the wild roller coaster that we saw in the first
part of this year, at least for the United States. Bank credit
markets are showing significant strength. So, when all is said and
done and perhaps with a mild caveat for mortgage markets, the capital
markets are producing a cost of capital that is clearly supportive of
investment and expansion.
Now, while all of these signs for the economy appear very
strong and the recent revisions have been upward as is certainly well
documented in the Greenbook, I think there are some clouds on the
horizon--the so-called downside risks. We have already talked about
the spending slowdowns. We still have some pressures in the labor
markets on account of the whole re-engineering story. We have defense
and other sources of fiscal restraint and the continuing need to
address whether the deficit is going to be coming back into play,
particularly for the out years. Much of the strength that we have
seen, I think, is dependent on productivity gains, and it's
questionable as to whether or not we are going to continue on the
1990s trajectory for productivity or whether we will revert to the
1980s trajectory. Balance sheet strains could reemerge following the
strong credit growth and the merger and acquisition activity that we
are seeing. Finally, I'd mention the monetary aggregates.
It's hard
to believe that the weakness that we are seeing in the monetary
On balance, I think the
aggregates is not going to have some effect.
outlook looks good, but there are downside risks.
CHAIRMAN GREENSPAN.
break for coffee and return.

Thank you.

Coffee is available.

Let's

[Coffee break]
CHAIRMAN GREENSPAN.
MR. KOHN.

Don Kohn, would you start us off?

[Statement--See Appendix.]

CHAIRMAN GREENSPAN. Questions for Don?
If not, let me start
out.
I think the evidence is fairly solid that the industrial
momentum that we have been seeing in recent months has a head of steam
behind it; we can see it in the order books; we can see it in the
backlogs; it's fairly widespread. But as Governor Blinder pointed
out, the growth in industrial production this year clearly has been
concentrated to a significant extent in durable goods and has been

9/27/94

-35-

especially heavy in areas related to capital goods.
But these areas
are where inventories are rising most and why they are crucial to
measures of industrial pressures and overall pressures.
In tracing
this phenomenon over the last year or two, we are aware of a very
rapidly dropping inventory/sales ratio when calculated to exclude the
margins of trade. In other words, factory-valued inventories as a
ratio to consumption have been falling at a fairly dramatic rate until
very recently. Indeed, the decline has been enough to hold the level
of real inventories to a very slow growth path until very recently.
As we discussed at previous meetings, all we have to do arithmetically
is to take the "just-in-time" decline in inventory/sales ratios and
flatten them out and inventory investment surges.
Indeed, that is
what apparently is happening at this stage; it's where the secondquarter run-up in GDP occurred.
I'm a little skeptical that the reduction in the rate of
inventory investment in the third quarter is going to be all that
substantial. The reason rests on the question of whether increasing
backlogs suggest that lead times are stretching out, as Tom Melzer
pointed out with respect to his one-observation sample. The
stretching out is confirmed by the lagged deliveries, but it is not
confirmed by the lead times that are reported by purchasing managers.
So it's not clear yet exactly what the full state of play is, but it
is clear that lagged deliveries tend historically to have been a more
potent indicator of what the inventory situation really is.
In any
event, it's quite inconceivable that the August industrial production
increase of 0.7 percent was substantially or all an increase in
consumption. There is no evidence of that.
The implication is that
there was a substantial increase in inventories in August when one
factors in reasonable numbers on imports and exports of various
industrial materials.
That's not the same thing as saying that that is what is
going to show up in the deflated book value data. The inventories
implied in the industrial production numbers or the real inventory
data produced for autos, oil, some steel, and a variety of other
actually measured totals don't quite square with the book value data,
which tend to be a little flaky. My suspicion is that the deflation
process is very tricky as one goes from book value to constant
dollars; it's a weak statistic.
But I think both sets of data,
whether one is deriving them from the industrial data themselves or
from the book value data, show that the decline in inventory/sales
ratios has come to a halt and may very likely be tilting up ever so
slightly at this particular stage. This is what one would expect as
the economy begins to approach capacity limits and backlogs begin to
stretch out. The normative desired levels of inventories tend to rise
because obviously if firms are trying to protect their production
schedules, the time it takes to get deliveries of new materials from
suppliers will largely dictate what we used to call "safety stocks" in
evaluating the inventory situation. Safety stocks at this stage are
probably rising slightly. There is no evidence of major shifts, but
it's very unlikely with the backlogs picking up as they are that these
safety stock numbers are not moving at least somewhat higher. This
suggests that the second-quarter number, while it may be somewhat hard
to interpret, is not in any regard suggesting an overhang of
inventories or providing any evidence that those inventory
accumulations are unintentional.
If they were, we would see it in the
orders data. Although it may well be that the data we will see

9/27/94

-36-

tomorrow for durable goods orders will give us a different signal than
we have been getting, to date there's very little in the anecdotal
reports or in other data that suggests that orders have simmered down
in any material way.
The question on which I think we have to focus at this point
is whether there is an inventory recession threat at the end of this
cycle. Because if there is a significant pickup in inventories that
is perceived to be voluntary, past history has always raised the
question as to whether that pickup is overdone. It is unlikely, I
might say, that monetary policy can restrain inventory accumulation by
higher short-term interest rates. The reason basically is that since
inventories are there to protect production schedules, the
contemplation of inadequate stocks at any particular time weighs very
heavily on purchasing policies. There would need to be some
extraordinarily high interest rates to impede the accumulation of
inventories when they are perceived to be necessary for sustaining
production. In any event, it's fairly obvious that we are not dealing
with a loan availability problem because with the very high degree of
securities holdings by the commercial banking system we can get a very
large loan/deposit ratio increase with a big shift from securities
into loans and no bank credit expansion. So the factors subduing
inventory accumulation have to come from the final sales side. If
there is an effect, it's got to be because residential construction
and existing home sales are slowing down, with the result that sales
of household durables are slowing down. This means the realized
capital gain on the sale of existing homes that has a big impact on
durable goods spending is also going down. When that sort of thing
gets going, inventories will back up very quickly. Consequently, the
concern that one might have that the inventory building will be
overdone and lead to an inventory recession a year or two out becomes
essentially moot.
Price pressures are building with the rise in backlogs and
delayed deliveries. But I must say I was somewhat impressed--I don't
know if my memory is faulty--that while everyone around the table,
with few exceptions, was talking about stronger activity, even if you
chose different words, I did read your comments on inflation as
implying slightly less upward pressure on prices. There was
surprisingly little talk of more price pressures around the room. I'm
not sure one can make very much of this, but if prices were in the
process of accelerating at this stage, I think we would have heard
more around the room on that point. But that is scarcely a scientific
judgment.
One other important issue that I think we probably ought to
focus on at this stage is the extent to which profit margins are
rising. They are moving up, or at least they had moved up at a very
abrupt rate until very early this year, which is another way of saying
that unit consolidated costs have been rising much less than prices.
Indeed, if one looks at the data, as inadequate as they are in the
national income accounts, we are getting a spread of well over a
percentage point in the rate of change between unit costs on the one
hand and prices on the other. What that suggests is that productivity
obviously is moving up and unit labor costs are being contained. The
discussion we had previously indicated that the rising costs of raw
materials were not moving into final goods prices and that those
rising costs are being absorbed by the subdued behavior of unit labor

9/27/94

-37-

costs. But the presumption that there has been no pass-through at all
is belied by the fact that margins are opening up. When margins open
up, what we are observing is in effect an ability on the part of a lot
of producers to move the price level.
Now, we are saying that inflation is 3 percent. Well, 3
percent is not a small number; it is not small over the long run in
the consumer area. But granted it is not that good, it is less than
that for goods at the final CPI level; it is probably more than that
I was a little concerned, even though in the last
at the PPI level.
published report the CPI was reasonably contained, that the PPI core
number was somewhat higher. Moreover, it apparently was being held
down by still faulty seasonal adjustments, at least if we take our
If we doubly
doubly seasonally adjusted processes to heart.
seasonally adjust the seasonally adjusted rate of change of core PPI
inflation, the last observation was, I think, at least 0.1 percent
higher than the published number. So I think what we are observing is
the opening up of margins in much of the underlying structure. But
unit labor costs apparently have been so well contained by
productivity gains at this stage that cost pressures have not flowed
into final goods prices.
The question that we confront at this stage that has been
raised at this table, really for the first time in a broad sense--it
started with Bob Forrestal and everyone just sort of picked it up--is
the possibility of a short-term blip in the final goods price data.
If we look at business cycle patterns, we usually find that there is a
cycle in prices.
The question that we have to ask ourselves is how
much we care. How much are we concerned about it so long as the peakto-peak inflation rate in the business cycle gets progressively lower
and the trough-to-trough level of price inflation gets progressively
lower? That implies a long-term downtrend. But as a number of
comments around this table have indicated, we can not make the simple
presumption that we can get an inflation blip and say "Well, it's a
blip."
The trouble with most blips is that they can be identified as
such only in retrospect.
There are far more announced blips that
turned out to be permanent changes than there are blips in the
historical record. So, we have to be very careful about viewing a
blip as something that doesn't give us considerable concern.
However, it is true, with profit margins up to the highest
levels we have seen in well over a decade, that if pressures begin to
increase the rate of growth in unit costs, history also suggests that
there is a tendency for profit margins to start downward in the later
stages of the cycle. So there is a good deal of potential absorption
of final prices here that could occur as a consequence of declining
margins.
Indeed, there is a significant decline in profit margins in
the Greenbook, and as a consequence, while the staff forecast has a
very modest acceleration of inflation, implicitly the underlying costs
obviously are accelerating at a far faster pace.
I think that is a
reflection of an expectation of a slowdown in productivity gains,
which to date have been the major factor in suppressing the passthrough to final prices.
As a consequence of all of this, one has to ask why we are
this far into the business cycle expansion without the types of price
pressures that we have seen on previous occasions.
I raised this as
an issue before, and I'm beginning to suspect that we are going to

9/27/94

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find out whether or not the extraordinarily still muted money and
credit aggregates really matter.
In other words, we are approaching a
point where we will get interesting tests as to whether inflation is a
Phillips curve phenomenon or a monetary phenomenon. If we look at it
from a Phillips curve point of view or its equivalent, slack in the
industrial area, then we are on the edge of some severe inflationary
pressure if we are getting rising inventory accumulation. If,
however, we think that prices are a monetary phenomenon, we are more
likely to see the types of changes that occurred prior to the 1930s
where we had a noninflationary long-term environment largely locked in
by the gold standard, but periods of significant pressure during which
inflation never really took hold, because the credit aggregates never
really took hold, as they couldn't in that type of environment.
So,
this particular business cycle may be about to tell us a lot or, I
fear, it may be mushy where the end result will be somewhere in
between, so we won't learn very much. Reality tends to do that to us
more often than not!
I do think, as a number of you have mentioned, that the issue
of the subnormal growth in monetary and credit aggregates has to mean
something. There is something there. We have argued that M2 or M1
are awful as indicators and that the monetary base is terrible, but we
are in the business of creating money. We are a central bank. If we
think all of that is beside the point, I think we've got to worry
about a number of things we are doing.
It may turn out that it's
beside the point, but I don't think we can make that presumption.
My impression of what is going on, pending the outcome of
this academic debate, is that we have to assume that the pressures are
there; the risks of making alternate assumptions I think are just too
dangerous.
If that is in fact the case, I would agree with the
staff's version that more monetary policy restraint is probably to be
expected. The reason is that we have seen stronger GDP growth than we
had anticipated and we won't know until 1995 or beyond if what we are
looking at is a situation where monetary policy suddenly has turned
weaker as a restraining force, maybe because of the inventory

situation, or if the policy is as strong as ever but just more
delayed. We may find that there is some significant new underlying
strength in the economy, which is offsetting what has been a
significant impact from monetary policy actions already taken. It is
true that there are significant lags in monetary policy, but remember
It's not that nothing happens for a year
these are distributed lags.
or 15 months and then suddenly the effect is felt. There is a gradual
progression of effects. We have to presume at this particular stage
that we are running under the projected impact. If we assume that our
judgment about the basic economy's underlying strength ex monetary
policy has not changed significantly, that assumption is rather
dubious. But what this suggests is that we do know something about
the effects of monetary policy actions to date; we know that their
effects are there and moving. What we don't know, and will not fully
know until 1995 and later, is how powerful in retrospect the
underlying expansionary forces were.
My own impression of all of this is that I suspect we are
going to need to move further somewhere along the line.
I would doubt
very much that the degree of restraint that is in the pipeline at this
stage, including the significant rise in long-term interest rates over
and above what would ordinarily be expected from short-term interest

9/27/94

-39-

rate changes, is enough to give us the type of more subdued--excuse
the expression--"soft landing" that we would all like to see. I think
that the subdued money and credit growth does suggest that we are not
particularly behind the curve.
It's a difficult judgment to make, and
one that I don't think we have strong analytical tools to give us any
insight into.
We have another issue here that has been raised by a number
of people. Because of our statement "for the time being" in our last
move on August 17--which most people interpreted to mean that we would
not move at this meeting and would not move until the November 15th
meeting--we have to have strong evidence to move more quickly. My
suspicion is that we probably could get through to the November 15th
meeting. If we do move then, I think that would probably require us
to move another 50 basis points and probably move the discount rate as
well.
My own inclination at this stage is to go with "B" but be
asymmetric for the reason that Don Kohn was mentioning, namely, we
have a good deal of data coming in around the middle of October that
could very readily indicate that our underlying view of the momentum
of the economy was too soft and that this expansion is accelerating
faster than we had expected. If that occurs--if the data are an
undesirable surprise--there will be significant market turmoil. And
if we allow it to simmer for the whole month until the next meeting-remember, this is a seven-week interval--I think it could create
inflationary expectations that might be more difficult to rein in than
if we moved in mid-October. What I'm saying is that at this stage we
are getting close to the point where the data do matter because we've
been under restraint long enough that we should begin to see some
signs of its slowing impact on the expansion. If we don't start to
see that pretty soon, that will suggest that this economy is not
It's not all that
growing at 3 percent but closer to 4 percent.
difficult to engender that type of outlook. Now, I think that's a low
probability outcome, but I don't think it's one that can be readily
dismissed.
I have come to the conclusion, and I'd like to lay it out for
debate, that we should not move today. We don't have to and I don't
think it's appropriate to move today. We should be prepared to move
if necessary before our next meeting, but hopefully we will be able to
get through to the next meeting. If we are able to do that, I think
we will probably have managed policy better than we have any reason to
Obviously, if the numbers come out
believe we should be able to do.
in an adverse way, we will be on a telephone conference as usual for
the type of consultation and discussion that we have had in the past.
Vice Chairman.
VICE CHAIRMAN MCDONOUGH. Mr. Chairman, from what we know and
can observe today and based on the discussion around the table, I
think the right thing to do today is to retain interest rates at their
I think we have removed all the accommodation from
present level.
monetary policy and are the closest we can get to a neutral position.
I believe we removed it at the right time and along the right firming
path.
It is possible that the risks may be essentially balanced, but
they probably are not.
Therefore, I think an easing of interest rates
before the next meeting is highly unlikely, and a tightening of
monetary policy could be called for by incoming data over the

-40-

9/27/94

intermeeting period. Therefore, I agree with your recommendation that
an asymmetric directive tilted toward tightening is appropriate.
I do not believe that the statement that we made after the
August meeting should keep us from tightening today if we really
thought it was the right thing to do.
I'm against tightening today
because I don't think it is the right thing to do. That statement
should not make us feel at all unwilling to change monetary policy
between meetings if the data indicate that is the appropriate step to
take.
I do believe making such statements makes sense; I think the
But the incoming
statement we made in August served a useful purpose.
data in the meantime may lead one to believe that waiting until the
November 15th meeting just may not be possible. On the other hand, I
am not at all convinced that the credibility argument demands, because
there's a greater probability of a tightening move than we might have
thought at the last meeting, that we have to tighten today. When the
next move takes place, as you already mentioned in your presentation,
it would likely be a move of 50 basis points. I agree very strongly
that that would be the appropriate move--that it should be either zero
or 50.
I think a 25 basis point move, if that should present itself
as an idea to anybody, could very easily and almost certainly would be
inappropriately construed as either indicating a degree of timidity,
which would not reflect the view of the Committee, or worse still
would indicate a compromise. So then somebody could write a learned
article about the hawks and the doves and who did what to whom, and
that at the end of the day we did 25 basis points because we couldn't
decide which of the other things to do.
CHAIRMAN GREENSPAN.
as a turkey.
[Laughter]

You mean the hawk and the dove combine

VICE CHAIRMAN MCDONOUGH. So, Mr. Chairman, I firmly agree
that "B" tilted toward tightening is the appropriate policy decision.
CHAIRMAN GREENSPAN.

President Hoenig.

MR. HOENIG. Mr. Chairman, I would support your
recommendation. However, I would note that there are inflationary
pressures in train. I think they are fairly evident, and we might be
well served if we were to act sooner. Therefore, I would support your
asymmetric proposal, and if the data come out at all strong, I would
encourage you to move before the November meeting.
CHAIRMAN GREENSPAN.

Governor Blinder.

MR. BLINDER. I'd also like to support your recommendation
and just say a few things. I do take seriously the fact that we, so
to speak, gave our marker in August, and we should only be willing to
take that marker back if the evidence was overwhelming that we
couldn't wait.
I think the evidence is not close to overwhelming.
The first sentence of the second paragraph of the Greenbook said "the
largest effects of the interest rate increases to date may yet lie
ahead, but whether they will prove sufficient to prevent a buildup of
inflationary pressures is unclear at this juncture."
I think that is
exactly right; I agree with that 100 percent. That says to me that
"B" asymmetric is the right policy. We have to remember that most of
this restraint is probably still in train and the price effects will
come even later.
I want to be clear--the reason that I support the

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9/27/94

asymmetry is not that I think there is a strong presumption that we
are going to have to move between meetings. We might; but as Bill
just said, the probability that we're going to reduce interest rates
before the next meeting is zero. The probability that we are going to
tighten is certainly not zero, and that for me makes it sensible to
have an asymmetric directive.
CHAIRMAN GREENSPAN.

President Forrestal.

MR. FORRESTAL. Mr. Chairman, since I believe that a blip is
a blip is a blip, I would support your recommendation. I, too, don't
think we're going to need to move in the intermeeting period, but I
think it's wise to have the asymmetry as an insurance policy. I agree
with your proposal.
CHAIRMAN GREENSPAN.

President Jordan.

MR. JORDAN. I'm comfortable with leaving the funds rate
unchanged at 4-3/4 percent. I don't prefer asymmetric directives.
I
would not dissent from it, but I have two concerns about it. One is
that an asymmetric directive toward restraint tends to get the
Committee associated with being anti-growth. That's because we have
to react to incoming data and the psychology of the market is driven
by the perception of those data in a context that tends to cast the
Committee as being anti-employment or anti-growth. Since I don't
think the purchasing power of money is reduced by more output or more
employment, I have trouble with that. My other concern is worrying
that the asymmetry is going to wind up being cited prematurely in some
publication or wire service as an indication that we have cocked the
gun again, and if that happens, I won't be very happy about it.
CHAIRMAN GREENSPAN.
asymmetry in the directive?

You are against the whole notion of

MR. JORDAN. Yes.
I think it gets us into a lot of trouble
because of the way it gets interpreted.
CHAIRMAN GREENSPAN.

President Parry.

MR. PARRY. Mr. Chairman, it seems obvious that since our
last meeting, pressures on capacity in product and labor markets have
grown as have prospects for higher inflation in the future. Thus, it
seems to me that we should raise the funds rate again fairly soon. I
don't think we have to do it today, but I certainly would prefer an
asymmetric directive tilted toward raising the rate if incoming data
imply greater pressures for future inflation. Thus, I would accept
your recommendation.
CHAIRMAN GREENSPAN.

Governor Lindsey.

MR. LINDSEY. I support what you propose, Mr. Chairman. I
normally don't like moving intermeeting, but I think the chances are
we probably should this time.
CHAIRMAN GREENSPAN.

Governor LaWare.

MR. LAWARE. I support your recommendation, Mr. Chairman. I
hope that in casting my vote I will be resolving in my own mind that

-42-

9/27/94

the Committee not be inhibited in any way in the timing of a move by
the proximity of the election.
CHAIRMAN GREENSPAN.
MR. BOEHNE.

President Boehne.

I agree with your recommendation.

CHAIRMAN GREENSPAN.

President Broaddus.

MR. BROADDUS. Mr. Chairman, I continue to think the economy
has a lot of momentum. In this situation, it seems to me that
inflation expectations are rising. The bond rate is now at its
highest point since the 1990-1991 recession. I don't know what the
curve looks like--I've never seen it.
I'm not sure what its character
is, but I think we are still behind it.
I think we are going to have
to move further, and frankly I just don't see a compelling reason to
delay that move. On the contrary, there is at least some risk in not
acting at this stage. Aggregate demand is strong and in that kind of
situation, especially if it strengthens further, inflation pressures
inevitably are going to grow, and inflationary expectations will grow.
Against that background, if past experience is any guide at all, that
could eventually put us in a situation where all the choices are bad.
We have been there before, and it's no fun.
So, I would prefer to
move. My choice would be alternative D.
CHAIRMAN GREENSPAN.
MR. BROADDUS.

"D"?

"D" as in David!

CHAIRMAN GREENSPAN.

President Stern.

MR. STERN. I find myself in substantial agreement with Al
Broaddus and for many of the same reasons.
It seems to me that the
economy has a good deal of momentum. I'm not at all confident that we
I think the
are moving toward a sustainable path at this point.
banking system is in the process of supporting rapid growth, and this
may well occur without any significant change in the size of its
balance sheet, just a change in composition. I think the evidence
suggests that, so far at least, we have not moved particularly early
or particularly forcefully relative to historical experience, so I'm
not persuaded that we're ahead of the curve. Finally, I hope I'm
wrong when I say this, but I'm concerned about our ability to analyze
the price data and come up with all these fine reasons why something
unusual is going on and the rise in prices won't last. We can tell
those kinds of tales, but I must say that that kind of analysis has
led to past policy errors, and I'm afraid I'm reminded of one of Yogi
Berra's expressions about "deja vu all over again."
CHAIRMAN GREENSPAN.

President Minehan.

MS. MINEHAN. I find myself very much torn at this stage. I
have a great deal of sympathy for what both President Broaddus and
President Stern have said. I feel, given that the economy has been
operating near full capacity for some months now and that the
statistics keep coming in much stronger than we anticipated, that the
data over the next couple of weeks are likely to be strong. On the
other hand, while I think the risks are on the up side, the timing of
further increases is something that has both an economic component to

-43-

9/27/94

it and a political component to it.
I would trust your judgment in
this sense that maybe the best timing would be a little later. So, I
would be in favor of your recommendation. I think the risks are on
the up side. I think it's likely that we'll move during the
intermeeting period. So, I would be in favor of the asymmetry as
well.
CHAIRMAN GREENSPAN.

President McTeer.

MR. MCTEER. I support your recommendation, Mr. Chairman, and
I do trust your judgment on timing, although I would like to associate
myself with Jerry Jordan on my general feelings toward asymmetric
directives.
CHAIRMAN GREENSPAN.

Governor Phillips.

MS. PHILLIPS.
I think a tightening probably is going to be
necessary at some point, but again the question is when.
I do give
credence to this question of credibility, and it seems to me that the
evidence is not persuasive that we need to move now. I prefer to give
the tightening that's in the pipeline a chance; again, I'd cite the
monetary aggregates.
So, I agree with alternative B and being
prepared to move. On balance, I'm not enamored with asymmetry, but I
think the chances of tightening in the intermeeting period are more
likely. So, I'd support that.
CHAIRMAN GREENSPAN.
MR. KELLEY.

Governor Kelley.

I support your recommendation, Mr. Chairman.

CHAIRMAN GREENSPAN.

President Moskow.

MR. MOSKOW. Mr. Chairman, I support the recommendation.
do not believe we should move today, but we certainly should be
prepared to do so between meetings.
CHAIRMAN GREENSPAN.

I

Governor Yellen.

MS. YELLEN. I support your proposal, Mr. Chairman. I think
it's conceivable that sufficient evidence could accumulate over the
next month or so to warrant a rate hike before our next meeting, but
it would take quite a bit to convince me that further tightening prior
to the next meeting is in order.
CHAIRMAN GREENSPAN.

President Melzer.

MR. MELZER. Alan, I'd favor "D" combined with a discount
rate increase; I'd do the 50 basis points now. I think it's necessary
to contain the emerging inflationary pressures, and I also think it's
necessary to make longer-term progress toward price stability. I
think, as you and others have observed, that waiting simply makes our
job more difficult and raises questions about credibility. I guess I
interpret financial market developments much as Al Broaddus did. With
the bond rate at the highest level since the recession and more
sensitivity in foreign exchange markets, I think credibility is an
issue. To the extent we lose it, it makes this process much more
expensive for everybody. It's not just a matter of the credibility of
the institution; what really matters is how it impacts the real world.

-44-

9/27/94

I think to the extent we maintain our credibility, longer rates will
be lower than they otherwise would be.
With respect to the language, I personally think there have
been significant developments, and I think there is a danger in that
sort of language. One can make the argument that the existence of
that language actually has undermined some of our credibility because
of concerns about whether in fact we would act on a timely basis. The
information in terms of the real economy, prices, and financial
markets frankly has been quite strong in this intermeeting period, as
far as I'm concerned.
Let me make one final comment about the monetary aggregates.
I, too, would normally be quite concerned about the very slow growth
of the narrower aggregates in 1994--as you know I tend to focus more
closely on the narrower aggregates that we can actually influence-but I think their growth has to be viewed in the context of a
tremendous monetary impulse in 1991 through 1993.
You have heard me
say it before, but the base grew $100 billion over that 3-year period.
I think in a sense there is a liquidity overhang and that needs to get
worked off.
I might also observe-CHAIRMAN GREENSPAN.

Does that include U.S. currency abroad?

MR. MELZER. Yes, that would be in the base. But in any
event, I view that as a very stimulative impulse, the effects of which
may still be playing through.
In the mid-1980s--actually I think it
was mid-1988 to mid-1989--we also had very slow growth in the base and
reserves for about a 1-year period. That was on top of two prior
years of very sluggish growth in the narrower aggregates. So my
feeling would be that, yes, growth of the narrow aggregates has been
slow, but in the scheme of things it hasn't been all that slow for
that long. I might also observe that there are, as you well know,
some very significant technical factors that are impacting Ml,
including in particular the mortgage refinancing phenomenon. Our
guess is that that took 7 percentage points of growth out of M1 in
August, and our best guess would be, abstracting from that, that M1
probably is growing somewhere in the area of 4 to 5 percent. But
we'll see.
I don't think on a short-run basis these aggregates are
particularly helpful to us in any event.
I think they have to be
looked at over long periods of time.
CHAIRMAN GREENSPAN. Okay, I think the modal consensus is on
"B" asymmetric. Would you read the language?
MR. BERNARD. I'll be reading the wording on page 13 in the
Bluebook:
"In the implementation of policy for the immediate future,
the Committee seeks to maintain the existing degree of pressure on
reserve positions.
In the context of the Committee's long-run
objectives for price stability and sustainable economic growth, and
giving careful consideration to economic, financial and monetary
developments, somewhat greater reserve restraint would or slightly
lesser reserve restraint might be acceptable in the intermeeting
period. The contemplated reserve conditions are expected to be
consistent with modest growth of M2 and M3 over the balance of the
year."
CHAIRMAN GREENSPAN.

Call the roll.

9/27/94

-45-

MR. BERNARD.
Chairman Greenspan
Vice Chairman McDonough
Governor Blinder
President Broaddus
President Forrestal
President Jordan
Governor Kelley
Governor LaWare
Governor Lindsey
President Parry
Governo- Phillips
Governor Yellen

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

CHAIRMAN GREENSPAN. Let me say that under our new procedure
for announcing our decisions, Don Kohn thinks that 2:15 p.m. is the
appropriate time to announce anything coming out of the meeting,
including a statement such as we have made in the past that no action
was taken. We violated that last time largely because we finished our
meeting early and a lot of staff members came into the Board Room from
outside, and security was an issue at that point. So, I request that
no one mention anything that occurred within this meeting even to your
associates outside until the 2:15 p.m. announcement time when Joe
Coyne, I gather, will be making the statement that the meeting is
over. Is that correct?
MR. COYNE.
did in July.

It will be something similar, I think, to what we

MR. KOHN. That is, we will say that the meeting is over and
we don't have any further announcement, rather than that we didn't
take any action.
CHAIRMAN GREENSPAN.

Yes, no further announcement.

MR. KOHN. Right. And the other point to remind the
Committee, Mr. Chairman, is that the asymmetry remains confidential
until seven weeks from Friday.

15.

CHAIRMAN GREENSPAN.
Okay, and the next meeting is November
Let's adjourn for lunch.
END OF MEETING