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BEHIND THE SCENES AT THE FEDERAL OPEN MARKET COMMITTEE Remarks by Robert P. Forrestal President and Chief Executive Officer Federal Reserve Bank of Atlanta Community Bankers Association of Georgia Annual Meeting Southampton, Bermuda September 20, 1994 Introduction This morning I have been asked to enlighten you as to what goes on "Behind the Scenes at the Federal Open Market Committee" or, as it is better known, the FOMC. I will try to discharge my duty, although I believe the assigned title of my talk promises more than I can offer in public. That is because I am not at liberty to tell you what Alan Greenspan— particular or members of the committee, including myself— said about interest rates at our last meeting in August. Although we have announced the results of our recent meetings, it is still important that the deliberations themselves not be commented on so that they may continue to take place in an atmosphere that encourages open discussion of different views. I will be glad, though, to explain how the FOMC works and what kind of serious thought and planning goes into each meeting. In order to do that, I must start with some background on the structure of the Federal Reserve and the formulation of monetary policy.jP I. A Federal Reserve Bank like the one in Atlanta is involved in three main functions. A. Bank directors such as yourselves are probably more familiar with two of these functions: 2 1. 2. B. Providing financial services to depository institutions and the federal government to foster an efficient and safe payments system. Supervising and regulating the activities of banks to ensure the safety and soundness of the nation's financial system. But the Federal Reserve also has another critically important function. 1. 2. II. It contributes to economic growth by formulating and implementing monetary policy. As a brief reminder, monetary policy is one of the two tools of macroeconomic policy, the other being the government's fiscal policy. Overview of System's Structure A. The Fed has a dual nature that makes it at once public and private in its operations. B. Partially reflected in the differences between the Board of Governors in Washington and the 12 District Banks. 1. 2. C. III. Board members are appointed by the President with the advice and consent of Congress. Alan Greenspan is chairman of the Board of Governors. The newest governors are Alan Blinder and Janet Yellen. District Banks are organized like private corporations: governed by their own boards of directors, sell services to banks through our financial services business. Presidents are elected by boards, but must be approved by the Board of Governors. Public-service type activities, such as the supervision and regulation of banks and monetary-policy formulation, are jointly carried out by the Board and the District Banks. Monetary Policy Formulation and Implementation A. The Fed seeks to influence anticipated economic activity by affecting the demand for and supply of money and credit. 1. Principally, when we push up the federal funds rate— rate at which the banks borrow from one another— effect is to increase other short-term the 3 interest rates. This increase in rates tends to dampen the demand for credit at banks, which, in turn, slows down the economy. 2. A major point about the process of devising this strategy bears emphasis: b. c. IV. A sa result of this lag, monetary policy must be based on a forecast of the economy and also of factors outside of our control. Thus, the environment of the policymaker is dominated by uncertainty. This uncertainty is also why we want to have so much information and so many points of view at the meeting: The more we have, the better. As it is, we have 12 different forecasts-one from each Reserve Bank, as well as one from the Board of Governors. The Make-Up of the Federal Open Market Committee (FOMC) A. Open Market Committee meetings have been held in some form since the 1920s, but the FOMC as we know it today was established by the Banking Act of 1935. B. Meetings are held eight times a year or about every six weeks. The last one was held in August, and the next meeting will be held next Tuesday, September 27. C. Members are the seven Governors and five of the 12 District Banks' presidents. 1. 2. I am a voting member this year. The last time was 1991. 3. The president of the New York Fed is always a voting member of the FOMC. The other presidents serve one-year terms on a rotating basis. However, I do not mean to overemphasize this distinction since all members attend and participate verbally, and the process is one of consensus-building, not just majority rule. 4 V. Preparing for an FOMC Meeting A. As a voting member, I bring to the meeting my view of what is going on in the Southeast and my preferences for monetary policy, based on what I know and believe about the economy in this region. I base my views on a number of sources: Meetings and discussions with bankers, business leaders, consumer and labor leaders, and other representatives in their districts.ff| a. b. In addition, directors of the Atlanta Fed and its branches in Birmingham, Jacksonville, Miami, Nashville, and New Orleans report monthly on very recent developments in their industries and localities. c. 2. I get a chance to discuss the regional and local economies with many of these people at our board of director meetings in Atlanta. I also travel to our various branches. I also meet regularly with our Financial Institutions Advisory Committee and our Advisory Council on Small Business, Agriculture, and Labor to exchange views on business and credit conditions in the region. Our economists on the Atlanta staff conduct their own research on the regional economy as well as on macroeconomic and financial matters that affect the national economy. We have a briefing prior to the FOMC meeting to discuss their views. a. b. At this meeting, we discuss economic and business conditions in the Southeast. Then we move on to reports on recent macroeconomic developments in the national and international economy. We also have a report about domestic financial markets. c. The economists on our staff provide me with a detailed report on current economic conditions; their forecast based on a small forecasting model that projects GDP, employment, and prices; and their recommendations on monetary policy. As appropriate, during this briefing we also debate other factors that might affect the economy, such as health care reform. 5 d. B. Other information used during this briefing includes our Southeastern Manufacturers Survey, which gives some insight into the expectations of manufacturing companies located in the Southeast, regarding such items as future pricing and hiring moves. Just as my staff and I prepare for the meeting, the Board of Governors staff prepares an elaborate forecast of the economy based on a large-scale model of the economy. 1. 2. A full-scale simulation that projects for a period of 4 to 8 quarters is done eight times a year. 3. VI. The forecast indicates the income, employment, and inflation that are expected to be consistent with a particular policy and assumptions about exogenous factors. We receive this information in advance of the FOMC, so that I can compare our own staff forecast to that of the Board staff, as do other Reserve Bank presidents. I also compare our forecasts to those done by others in the financial community. My point here is that the Board of Governors' forecast is not taken to be the one and only forecast worth attention. How an FOMC Meeting Works A. Now let me actually describe what goes on in the meeting: 1. 2. 3. 4. 5. 6. B. Here are some details about what affects the vote of an FOMC member. 1. Report of foreign desk Domestic operations Summary of staff outlook Extensive discussion of the economic forecasts of each District Bank along with discussion of the Board's staff forecast and the Beigebook, which is a compilation of what businesses around the country are saying Policy alternatives as suggested by the Board materials and our own Atlanta Fed briefing materials Go-round and vote Key point to remember: Over the long run, our objective has been to ensure sustainable growth while reducing inflation. 6 2. In the short run, FOMC members must keep in mind two variables: a. b. 3. What do we expect to happen in the economy? What effects have we not seen yet for actions we have already taken? This question relates to the lag in monetary policy changes that I mentioned earlier. For example, looking at the forecast, if we expect income growth to accelerate to an unsustainable pace, we might want to make policy more restrictive to prevent a build-up in inflation. a. b. 4. Several alternatives: for instance, we could act now. Or we could restrain growth a little bit now, raising the possibility that more might need to be done later. Members then incorporate their own judgments of the economy, as well as their policy preferences, into their decision. a. b. Those less certain about the degree of change in the economy could opt for gradual adjustments. c. VII. Those FOMC members who are fairly certain the economy is accelerating would choose to tighten. Those who disagree with the forecast could choose to make no change in policy. What Happens after the FOMC Meeting A. The New York Fed Trading Desk Manager is informed of the FOMC’s decision in the form of a directive so that the desk can appropriately implement monetary policy. In recent months, we have also announced any significant changes directly after the meeting. 1. After the August meeting, we released publicly an announcement of the action we had taken. a. The announcement said that the Board of Governors had approved an increase in the discount rate (the rate the District Banks charge banks to borrow money) and that the FOMC agreed that this increase also would be allowed to push up the federal funds rate. 7 b. We took these measures because of evidence of continuing strength in the economic expansion and because of high levels of resource utilization, which are causing inflationary pressures to build. 2. You may look for copies of the full directive from this meeting and others in the F e d e r a l R e s e r v e B u lle tin . As a record of policy actions, they can give you a picture of what data FOMC members considered to be the most relevant economic data during a given period. 3. One other wrinkle to the decision: The committee can adjust the language of the directive to suggest the likely direction of changes to monetary policy before the next FOMC meeting. B. C. VIII. Finally, each voting president in turn is charged with monitoring the Fed's open market operations, which involves a daily conference call. The New York desk manager typically discusses current financial market conditions and the proposed trading action for the day. Preparations begin again for the next FOMC meeting. Conclusion, Questions and Answers That concludes my discussion of what happens before, during, and after a meeting of the Federal Open Market Committee. I would be happy to field any questions you may have.
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