FOMC Minute — 2003-12-09

Minutes of the Federal Open Market Committee


December 9, 2003



A meeting of the Federal Open Market Committee was held in the offices of the Board of Governors of the Federal Reserve System in Washington, D.C., on Tuesday, December 9, 2003, at 9:00 a.m.

	
	

	
	


Present:Mr. Greenspan, Chairman
    Mr. Geithner, Vice Chairman
      Mr. Bernanke
      Ms. Bies
Mr. Broaddus
Mr. Ferguson
Mr. Gramlich 
Mr. Guynn
Mr. Kohn
Mr. Moskow
Mr. Olson
Mr. ParryMr. Hoenig, Mses. Minehan and Pianalto, Messrs. Poole and Stewart, 
       Alternate Members of the Federal Open Market Committee



  Messrs. McTeer and Santomero, Presidents of the Federal Reserve Banks of 
        Dallas and Philadelphia respectively 
      
Mr. Reinhart, Secretary and Economist
Mr. Bernard, Deputy Secretary
Ms. Smith, Assistant Secretary
Mr. Mattingly, General Counsel
Ms. Johnson, Economist
Mr. Stockton, Economist


       Mr. Connors, Ms. Cumming, Messrs. Eisenbeis, Goodfriend, Howard, Madigan, 
        Struckmeyer, and Wilcox, Associate Economists 
      
Mr. Kos, Manager, System Open Market Account

Mr. Ettin, Deputy Director, Division of Research and Statistics, Board of Governors
 
Messrs. Slifman and Oliner, Associate Directors, Division of Research and    
                 Statistics, Board of Governors
       Messrs. Clouse, Kamin, and Whitesell, Deputy Associate Directors, Divisions 
        of Monetary Affairs, International Finance, and Monetary Affairs, respectively, 
        Board of Governors 
      
Mr. English, Assistant Director, Division of Monetary Affairs,   
          Board of Governors 
 
Mr. Hambley, Assistant to the Board and Director for Congressional Liaison, 
         Office of Board Members, Board of Governors
       Mr. Skidmore, Special Assistant to the Board, Office of Board Members, Board 
        of Governors 
      Mr. Nelson, Senior Economist, Division of Monetary Affairs, Board 
        of Governors

       Mr. Luecke, Senior Financial Analyst, Division of Monetary Affairs, Board 
        of Governors 
      Mr. Kumasaka, Financial Analyst, Division of Monetary Affairs, 
        Board of Governors

       Ms. Low, Open Market Secretariat Assistant, Division of Monetary Affairs, 
        Board of Governors 
      Messrs. Lyon and Werkema, First Vice Presidents, Federal Reserve 
                                        Banks of Minneapolis and Chicago respectively

      Messrs. Fuhrer and Hakkio, Ms. Mester, Messrs. Rasche and 
         Rosenblum, Senior Vice Presidents, Federal Reserve Banks of 
         Boston, Kansas City, Philadelphia, St. Louis, and Dallas 
         respectively

      Messrs. Bryan, Elsasser, Sullivan, and Weber, Vice Presidents, Federal 
        Reserve Banks of Cleveland, New York, Chicago, and Minneapolis respectively 
      Mr. Trehan, Economist, Federal Reserve Bank of San FranciscoBy unanimous vote, the minutes of the meeting of the Federal 
        Open Market Committee held on October 28, 2003, were approved. 
      Advice had been received that Mr. Timothy F. Geithner had been elected 
        by the directors of the Federal Reserve Bank of New York as a member of 
        the Federal Open Market Committee for the period commencing November 14, 
        2003, and ending December 31, 2003, and that he had executed his oath 
        of office. 
      By unanimous vote, Timothy F. Geithner was elected to serve as Vice Chairman 
        until the first regularly scheduled meeting of the Committee after December 
        31, 2003, with the understanding that in the event of the discontinuance 
        of his official connection with a Federal Reserve Bank or the Board of 
        Governors, he would cease to have any official connection to the Committee. 
      The Manager of the System Open Market Account reported on recent developments 
        in foreign exchange markets. There were no open market operations in foreign 
        currencies for the System's account in the period since the previous meeting. 
      The Manager also reported on developments in domestic financial markets 
        and on System open market transactions in government securities and securities 
        issued or fully guaranteed by federal agencies during the period October 
        28, 2003, through December 8, 2003. By unanimous vote, the Committee ratified 
        these transactions. 
      Real GDP appeared to be advancing at a solid rate in the fourth quarter, 
        albeit well below its extraordinary pace in the third quarter. Consumer 
        spending appeared to be on a flatter trajectory, but spending for equipment 
        and software and residential construction continued to surge. Meanwhile, 
        the labor market had finally shown signs of some improvement in recent 
        months, and activity in the industrial sector was continuing to rise. 
        Consumer price inflation remained quiescent: The twelve-month change in 
        core consumer prices was notably lower than the increase during the preceding 
        year. 
      Private nonfarm payrolls rose moderately in November, although by less 
        than the substantial gains in September and October. The increases in 
        November were fairly widespread, with notable advances in temporary help 
        services, nonbusiness services, and construction. Although employment 
        continued to fall in manufacturing, the losses had tapered off since the 
        first half of the year. The average workweek and aggregate hours worked 
        by nonfarm employees increased significantly, and the average level of 
        nonfarm employee hours in October and November was noticeably above the 
        average in the third quarter. The unemployment rate fell to 5.9 percent 
        in November, down from a recent peak of 6.4 percent at midyear. 
      Industrial production grew solidly in the third quarter, and the momentum 
        continued in October apart from the production of motor vehicles and parts, 
        which fell back from an elevated third-quarter level. High-tech output 
        accelerated in the third quarter to the fastest pace since the middle 
        of 2000, and production gains continued at a rapid pace in October. Outside 
        the manufacturing sector, unseasonably warm weather contributed to an 
        increase in output at utilities in October, while mining production declined 
        a bit, largely reflecting a decrease in the production of crude oil. Capacity 
        utilization edged up in October but remained well below its longer-term 
        average. 
      Consumer spending slipped a little on balance in September and October 
        after soaring in July and August. Much of the recent decline was the result 
        of a pullback in purchases of motor vehicles; elsewhere, expenditures 
        were about unchanged in September and rose modestly in October. Spending 
        was supported by the upturn in employment, continued impetus from the 
        recently enacted tax cuts, improved confidence, and a level of wealth 
        that was considerably above that of earlier in the year. 
      Housing activity surged in October. Single-family housing starts reached 
        a record high, while multifamily starts moved down but remained in line 
        with the average pace during the previous two years. Sales of existing 
        single-family homes in October were only a bit below the record level 
        set in September. The pace of new home sales also remained brisk in October, 
        albeit down somewhat from September. 
      The data on orders for, and shipments of, nondefense capital goods through 
        October suggested continued momentum in spending on equipment and software, 
        which grew in the third quarter at the fastest pace since 1998. Robust 
        gains in spending were posted in the third quarter in all the major categories 
        except aircraft. The gains were associated with recent increases in business 
        output and corporate cash flow and with a decline this year in the user 
        cost of capital. Shipments of high-tech equipment climbed further in October, 
        while shipments in other nondefense sectors excluding aircraft edged down. 
        New orders of nondefense equipment excluding aircraft in October continued 
        the upward trend in place since the beginning of the year and were consistent 
        with ongoing gains in equipment spending. Outlays for the construction 
        of private-sector nonresidential buildings fell a bit in October, but 
        the extended contraction in spending on nonresidential construction appeared 
        to be ending. Nominal spending on office space edged up in September and 
        October, while outlays for the construction of other commercial buildings 
        moved lower. Expenditures on institutional buildings changed little in 
        recent months. 
      Real nonfarm inventories fell moderately in the third quarter after declining 
        substantially in the second. Manufacturers liquidated stocks by a larger 
        amount in the third quarter than in the previous quarter but added slightly 
        to their inventories in October. Wholesalers and retailers (excluding 
        those selling motor vehicles and parts) built up inventories in the third 
        quarter, and, for wholesalers, the stockbuilding continued in October 
        (data on retail inventories in October were unavailable). Still, inventory-sales 
        ratios in all three categories declined a bit further in the third quarter 
        from already very low levels. 
      The international trade deficit increased in September as imports of 
        goods and services rose more than exports. Recent data suggested that 
        a recovery had taken hold in the major foreign industrial countries. Growth 
        in real GDP picked up in the third quarter in the euro area, the United 
        Kingdom, and Canada, and indicators in Japan were consistent with continued 
        economic expansion. 
      Core consumer price inflation remained subdued in October, although it 
        was up from even lower levels in the first part of the year, when it was 
        depressed by transitory factors. Over the twelve months ending in October, 
        core consumer prices rose only slightly and noticeably less than in the 
        previous twelve-month period. Total twelve-month consumer inflation was 
        unchanged over the period owing to accelerations in food and energy prices. 
        Producer prices for both core and total finished goods posted unusually 
        large increases in October, reflecting in part a sizable advance in the 
        prices of motor vehicles. Twelve-month core producer price inflation, 
        however, was on balance unchanged over the year ending October, although 
        the twelve-month change in overall producer prices stood well above its 
        year-earlier level owing to a jump in food and energy price inflation. 
        With regard to labor costs, the average hourly earnings of production 
        or nonsupervisory workers on private nonfarm payrolls rose slightly in 
        the twelve months ending in November; the increase was a bit below that 
        in the previous twelve months. By contrast, the increase in the employment 
        cost index for hourly compensation in private industry for the twelve 
        months ending in September was a bit higher than a year earlier, reflecting 
        a pickup in benefit costs. 
      At its meeting of October 28, 2003, the Federal Open Market Committee 
        adopted a directive that called for maintaining conditions in reserve 
        markets consistent with keeping the federal funds rate at around 1 percent. 
        In reaching this decision, the Committee members generally perceived the 
        upside and downside risks to the attainment of sustainable growth for 
        the next few quarters to be roughly equal; however, they viewed the probability, 
        though minor, of an unwelcome fall in inflation as exceeding that of a 
        rise in inflation from its already low level. The Committee judged that, 
        on balance, the risk of inflation becoming undesirably low remained the 
        predominant concern for the foreseeable future. In those circumstances, 
        the Committee believed that policy accommodation could be maintained for 
        a considerable period. 
      The Committee's decision at the October meeting to leave its target for 
        the federal funds rate unchanged had been widely anticipated, and rates 
        on near-dated federal funds futures were virtually unchanged. However, 
        the Committee's retention of both an unchanged risk assessment and its 
        indication that policy could remain accommodative for a considerable period, 
        which market participants apparently had seen as less certain outcomes, 
        precipitated a brief rally in Treasury markets. Over the intermeeting 
        period as a whole, intermediate- and longer-term Treasury yields were 
        basically unchanged. Upward movements in response to data releases showing 
        an economy building momentum were offset by the market response to several 
        statements by policymakers reiterating that policy could remain accommodative 
        and to the November employment report, which included a smaller gain in 
        private nonfarm payrolls than market participants had expected. Yields 
        on investment-grade corporate securities were also essentially unchanged, 
        while yields on speculative-grade securities declined, continuing the 
        narrowing of their risk spreads. Major equity indexes were up moderately 
        over the intermeeting period. 
      The exchange value of the dollar, as measured by the major currencies 
        index, declined somewhat, on net, over the intermeeting period. The dollar 
        had appreciated in late October and early November following several stronger-than-expected 
        U.S. economic data releases. But the dollar depreciated, on net, over 
        the remainder of the intermeeting period, reflecting concerns about an 
        escalation of trade frictions prompted by the U.S. imposition of import 
        quotas on Chinese textiles, the ability of the United States to continue 
        to finance its current account deficit, and risks stemming from developments 
        in Afghanistan, Iraq, and Turkey. 
      M2 contracted significantly in November for the third consecutive month. 
        A sizable part of the declines in these three months appeared to be due 
        to the falloff in mortgage refinancing activity and the resulting reductions 
        in associated deposit balances. In addition, rising equity markets may 
        have made M2 accounts relatively less attractive. 
      The staff forecast prepared for this meeting indicated that the economic 
        expansion was likely to be sufficiently robust to reduce economic slack 
        substantially in coming quarters. Accommodative financial conditions, 
        fiscal stimulus, and substantial gains in structural productivity would 
        continue to provide significant impetus to business and consumer spending 
        over the months ahead. In addition, businesses appeared to be shedding 
        some of the caution that had characterized their behavior for the previous 
        three years. As a consequence, with sales, profits, and stock prices higher, 
        the liquidation of inventories appeared to be ending, and the strengthening 
        of capital investment and pickup in hiring already evident in the data 
        were projected to continue. Even though the unemployment rate was projected 
        to decline over coming quarters, some slight downward pressure on core 
        consumer price inflation was anticipated in the forecast, given ongoing 
        slack in resource utilization. 
      In the Committee's discussion of current and prospective economic developments, 
        members referred to widespread indications that the pickup in the economic 
        expansion was broadening and becoming more entrenched. The members noted 
        that spending by households had remained strong even as the effects of 
        tax cuts and mortgage refinancing began to wane. And with business confidence 
        on the mend, investment outlays had increased rapidly and employment had 
        revived. While assessments by individual members of the likely pace of 
        the expansion going forward differed somewhat, they generally expected 
        growth to run at a rate that would trim slack in labor and goods markets 
        over the forecast period, assuming no major shocks to the economy. Factors 
        supporting this view included stimulative monetary and fiscal policies, 
        accommodative conditions in financial markets, building business confidence, 
        a rebound in profits, and the effects on the external sector of the weaker 
        dollar and pickup in growth abroad. While downside risks to the outlook 
        had diminished, some members remained concerned that spending could slow 
        somewhat next year as the effects of fiscal stimulus and mortgage refinancing 
        faded. Rapid productivity growth also could limit employment gains and 
        so weigh on consumer confidence. With relatively strong economic growth 
        nonetheless seemingly more assured, members regarded the risks to inflation 
        as more nearly balanced than earlier in the year. 
      In their comments about recent developments around the nation, members 
        reported improving economic conditions in virtually all regions, with 
        strength in household spending increasingly augmented by gains in business 
        outlays. Consumer spending remained firm, and residential construction 
        continued at a high level. Committee members' business contacts generally 
        expressed increasing confidence that the expansion would be sustained, 
        and they anticipated further increases in investment outlays and employment 
        going forward. Even in manufacturing, which had lagged the recovery in 
        the rest of the economy until recently, output was rising in many subsectors 
        and employment displayed signs of stabilizing. Some members reported an 
        easing of downward pressures on prices in selected industries, but anecdotal 
        reports suggested that competition, including especially competition from 
        foreign producers, continued to constrain pricing. 
      In their comments about the outlook for demand in key sectors of the 
        economy, members indicated greater confidence that the sizable gains in 
        business spending in recent quarters would continue. It now appeared that 
        the increase in outlays for equipment and software in the third quarter 
        was even larger than had been thought, and data on orders and shipments, 
        as well as anecdotal reports, pointed to further increases. These gains 
        owed to rising business confidence, substantial gains in profits and cash 
        flow, and accommodative financial markets. In addition, businesses were 
        expected to step up investment outlays next year in advance of the expiration 
        of temporary tax incentives. Some members noted that the commercial real 
        estate sector, which had been very weak with high vacancy rates and falling 
        rents, was showing signs of bottoming, as the strengthening economy boosted 
        demand for office and retail space. 
      An easing of business caution was also suggested by growing indications 
        that business firms were shifting from inventory liquidation to restocking. 
        With the level of inventories still quite low relative to sales and sales 
        expected to strengthen further, a number of members noted that inventory 
        investment could be expected to contribute to growth in aggregate demand 
        in coming quarters. 
      Household spending had remained solid even as the effects of tax refunds 
        and mortgage refinancing, which had boosted spending substantially in 
        the summer, waned. While consumption spending had slowed earlier in the 
        fall, retail contacts suggested some strengthening more recently and reported 
        that holiday sales appeared to be running somewhat above last year's pace. 
        Looking forward, members anticipated that consumer spending would be supported 
        by further gains in employment as well as by substantial tax refunds in 
        the first half of next year. And with the expansion picking up momentum, 
        the risk of a slowdown in such spending clearly seemed to have diminished. 
        Some members pointed, however, to signs of increased financial stress 
        that could limit the ability of many households to hold spending at recent 
        levels, especially if incomes did not rise at a robust pace in line with 
        current forecasts. In the housing sector, activity remained elevated despite 
        some increase in mortgage rates since early summer. 
      Members anticipated that growth in federal government spending, which 
        had been boosted in recent quarters by a buildup in defense outlays, would 
        slow going forward, while budget pressures would continue to limit increases 
        in state and local spending. Although fiscal policy more generally would 
        probably continue to strengthen aggregate demand next year, this effect 
        was expected to diminish somewhat even though very large deficits were 
        likely to persist. Over a longer horizon, some members expressed concern 
        about the possible adverse effects of such deficits on financial markets 
        and the economy. 
      In their remarks about the external sector of the economy, members noted 
        that an improvement in the economic outlook in many foreign economies, 
        as well as the lower dollar, was likely to foster a pickup in exports. 
        While some of the improvement abroad was probably the result of faster 
        growth in the United States, domestic demand in several major trading 
        partners appeared to be strengthening. Nonetheless, the value of U.S. 
        imports was likely to continue to exceed that of exports by a wide margin, 
        and the resulting large current account deficits and their potential correction 
        added to uncertainty about the longer-term prospects for the U.S. economy. 
      In their review of the outlook for prices, members generally anticipated 
        that persisting, though decreasing, margins of slack in labor and goods 
        markets and further gains in productivity would keep inflation low, with 
        a number of members seeing a small further decline in inflation as a distinct 
        possibility. Even if growth proved fairly robust, downward pressure on 
        prices could come from a narrowing of profit margins, which were currently 
        quite high, or from further surprising strength in productivity, which 
        would reduce labor costs. In addition, some members noted that the current 
        unemployment rate likely understated the slack in labor markets, since 
        the labor market participation rate had fallen significantly of late, 
        and changes in payment and hiring practices had perhaps reduced the level 
        of unemployment that could be sustained without upward pressure on wages. 
        However, with growth now seen as more assured, downward risks to inflation 
        were viewed as considerably reduced relative to earlier in the year, and 
        the risk of a pernicious deflation in which declining prices reinforced 
        weakness in demand - a risk that the members had always viewed as small 
        - was now regarded by most as virtually nil. Indeed, the weaker dollar, 
        higher commodity prices, and outsized increases in benefit costs were 
        seen as suggesting some countervailing upward pressure on costs and prices 
        even though changes in exchange rates and commodity prices generally had 
        not had a large effect on retail prices in the past. Members also expressed 
        concern about the potential for an increase in inflation expectations 
        given highly stimulative macroeconomic policies and economic growth that 
        seemed to be gathering momentum. Some noted that the rise in recent months 
        in inflation compensation, as measured by the difference between the yields 
        on nominal and indexed Treasury securities, could potentially point in 
        this direction. Nonetheless, on balance, most members currently considered 
        the upside risks to inflation to be a bit less pressing than those on 
        the downside for the next few quarters. 
      In the Committee's discussion of policy for the intermeeting period ahead, 
        all the members favored an unchanged policy that continued to incorporate 
        a target of 1 percent for the federal funds rate. The data and anecdotal 
        evidence becoming available since the last meeting had made the members 
        more confident that robust growth in economic activity would persist. 
        Nonetheless, they felt that the currently accommodative policy stance 
        remained appropriate in a period characterized by very low inflation, 
        wide margins of unused labor and other resources, and still considerable 
        uncertainty about the speed with which those margins would be worked down. 
        In these circumstances, inflationary pressures appeared likely to remain 
        subdued well into the future. To be sure, the Committee needed to remain 
        attentive to any indications of rising inflation pressures and to be prepared 
        to adjust its policy stance if emerging economic conditions warranted 
        such a move. At some point, a move in the direction of a less accommodative 
        and more neutral policy posture might well be necessary should the apparently 
        vigorous expansion continue and over time promote fuller utilization of 
        resources. For the near term, however, members saw substantial benefit 
        in maintaining an unchanged policy stance and considerable risk in taking 
        preemptive action that could prove to be unneeded against potential inflation, 
        with associated costs to economic performance. 
      In their discussion of the announcement to be issued shortly after this 
        meeting, the members agreed that in addition to updating to reflect recent 
        economic developments, some rewording was needed to reflect their evolving 
        assessment of the risks to the economy. In light of the recent acceleration 
        in economic activity and their expectations of relatively robust growth 
        ahead, the members believed that the clearest way to convey their changed 
        assessment was to note that the risks of substantial disinflation had 
        diminished appreciably. While a number of members saw some slight further 
        disinflation as the most plausible outcome, no one expected a material 
        change in inflation. All could agree that the risks of further disinflation 
        were substantially reduced and close to balance for overall inflation. 
        In the circumstances, most members endorsed a proposal to delete as no 
        longer necessary the previous summary statement relating to the risks 
        to growth and inflation taken together. 
      Views differed with regard to the reference in recent statements to maintaining 
        an accommodative monetary policy "for a considerable period." A number 
        of members argued that its deletion would serve to enhance the Committee's 
        flexibility to adjust monetary policy at a later date when that was deemed 
        appropriate on the basis of evolving economic circumstances. A majority, 
        however, preferred to retain the phrase, at least for now. They noted 
        that the changes in their assessment of risk would convey the evolving 
        views of the Committee and they believed the "considerable period" reference 
        still accurately conveyed the Committee's policy intentions. Given the 
        decision to retain the reference in question, all the members saw merit 
        in associating it more clearly with economic conditions, specifically 
        the persistence of quite low inflation and slack in resource use, as opposed 
        to having it appear to be linked only to the passage of time. 
      At the conclusion of the discussion, the Committee voted to authorize 
        and direct the Federal Reserve Bank of New York, until it was instructed 
        otherwise, to execute transactions in the System Account in accordance 
        with the following domestic policy directive. 
       
        "The Federal Open Market Committee seeks monetary and financial conditions 
          that will foster price stability and promote sustainable growth in output. 
          To further its long-run objectives, the Committee in the immediate future 
          seeks conditions in reserve markets consistent with maintaining the 
          federal funds rate at an average of around 1 percent." 
      
      The vote encompassed the following statements concerning the risks to 
        the Committee's outlook for economic growth and inflation. These statements 
        would be included in the press release to be made available shortly after 
        the meeting. 
      
        The Committee perceives that the upside and downside risks to the attainment 
          of sustainable growth for the next few quarters are roughly equal. The 
          probability of an unwelcome fall in inflation has diminished in recent 
          months and now appears almost equal to that of a rise in inflation. 
        
        Votes for this action: Messrs. Greenspan, Geithner, 
          Bernanke, Ms. Bies, Messrs. Broaddus, Ferguson, Gramlich, Guynn, Kohn, 
          Moskow, Olson, and Parry. 
        Vote against this action: None. 
      
      At this meeting Mr. Ferguson reported on the progress of the working 
        group that was charged at the October 28 meeting with developing some 
        specific proposals regarding how best to communicate the Committee's assessment 
        of the outlook for economic activity and inflation. The working group 
        had solicited and received comments from the members of the Board of Governors 
        and from the presidents of the Federal Reserve Banks regarding potential 
        approaches for improving communications with the public and enhancing 
        thereby the latter's understanding of monetary policy decisions. It was 
        agreed that the working group, with the assistance of staff at the Board 
        of Governors and the Federal Reserve Banks, would prepare more detailed 
        proposals together with supporting staff documentation for consideration 
        at a later meeting of the Committee. 
      It was agreed that the next meeting of the Committee would be held on 
        Tuesday- Wednesday, January 27-28, 2004. 
      The meeting adjourned at 2:00 p.m. 
       
        
          Vincent R. Reinhart
          Secretary