31

The FOMC in 1992: A Monetary

WEAK, HESITANT AND protracted recov-ery was under way during 1992. Heal grossdomestic product (GDP) did not regain itsprerecession level until third quarter 1992, ayear and a half after the recession’s trough. Onthe whole, however, incoming data were lessnegative during 1992 than in 1991 and the Fed-eral Open Market Committee (FOMC) generallydisplayed more confidence that the economywas growing in 1992.’ As concern about a fur-ther economic downturn receded, troublingaspects of the monetary aggregates’ behaviorbecame more prominent in FOMC deliberations.

Since mid-1991, an unusual combination ofvery slow M2 growth and rapid growth ofreserves and Ml has drawn considerable atten-tion.’ The juxtaposition of fast Ml and reservegrowth and slow M2 growth was an importantconundrum for policymakers in 1992: Was slowM2 growth constricting economic recovery(though slowing inflation at the same time), orwas rapid Ml growth a signal of future infla-tionary pressure (though perhaps supportingrapid recovery)? These worst-case interpreta-

tions highlight the range of uncertainty raisedby anomalous behavior of an important set ofindicators.

The article begins with an outline of majoreconomic developments in 1992 followed by anexamination of the aforementioned monetaryconundrum. These first two sections provide abackdrop for more detailed discussion in thethird section of the eight FOMC meetings andpolicy actions taken between meetings. Becausediscussion of monetary policy often uses poten-tially ambiguous terms such as easing, I have in-cluded a shaded insert, “Translating the FOMCPolicy Directives,” which explains how some ofthese terms are used in FOMC directives and indiscussions of monetary policy.

ECONOMIC DEVELOPMENTS IN1992

A month-by-month account of economic de-velopments makes it is easy to lose sight ofbroader patterns. Figure 1 illustrates some ofthese patterns. A wide-angle view reveals that

‘The FOMC comprises the seven governors of the FederalReserve System, the president of the Federal ReserveBank of New York, and, on a rotating basis, the presidentsof four of the other 11 regional Federal Reserve Banks.The seven remaining presidents attend the meetings andpresent their views but do not vote.

‘Ml comprises currency, traveler’s checks and checkabledeposits. M2 combines Ml with savings deposits, moneymarket mutual funds, small time deposits, and somesmaller items.

Joseph A. Rifler

Joseph A. Ritter is an economist at the Federal Reserve Bankof St. Louis. Leslie Sanazaro provided research assistance.

Conundrum

32

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the 1991-92 recovery was the slowest sinceWorld War 11, with gr-owth below the long-runaverage for’ several quarters and little employ-ment growth. A narrower focus highlights thefact that the economy was substantially strongerin 1992 than in 1991 and that the second halfof 1992 was substantially stronger than the firsthalf, despite pessimistic expectations frommidyear onward. An important featur’e of 1991and 1992 was the dramatic fall of interest rates(see figure 2). A notable aspect of this declinewas the sharp steepening of the yield curve;short-term interest rates fell much mon-c thanlong-term r’ates. The increase in the rate spreadbetween 10-year and three-month Treasuryrates following the business cycle trough in

March 1991, for’ example, is larger than that inany postwar recovery period.

The U.S. economy ended 1991 with a whim-per: GDP grew at an annual rate of less than0.6 percent in the fourth quarter. The FOMCended the year with a significant easing thatcoincided with a I percentage point cut in thediscount rate.’ The federal funds rate thenhovered around 4 percent until April (see figure2). During the fit-st months of 1992 new eco-nomic data suggested that the risk of slidingback into recession had n’eceded; indeed itturned out that the economy grew at a 3 per-cent rate in the first quarter.

M2 started the year with a month of strong

‘Throughout this article the terms ease and easing used inconnection with specific policy actions have a narrowmeaning that is spelled out in the shaded insert “Translat-ing the FOMC Policy Directives.” In other instances, easy

and tight are used in a more general way to refer to theoverall stance of monetary policy, a much less well-definedconcept.

33

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growth but then began to decline. In April, fall-ing M2, together with “indications that the eco-nomic expansion was not as strong as its paceearly in the year,” prompted an easing action.~Immediately following this action, the federalfunds rate fell substantially but then stabilizedaround 3.75 percent until the end of June.

Data for’ April and May were more positive,but many indicators for June (released aroundthe beginning of July) led to a swing towardpessimism. Industrial production, employment,retail sales, MI and M2 all tilted down. The

growth of real GDP had fallen to only 1.5 per-cent in the second quarter’. Both the Board staffand private forecasters became more pessimisticabout growth prospects for the second half ofthe year. The private sector Blue Chip consen-sus forecasts for GDP growth in the second halfof the year made in June, July and Augustwere 3.2 percent, 3.0 percent and 2.8 percent,respectively.’

At the beginning of July the Board of Gover-nors cut the discount rate from 3.5 percent to3.0 percent. This was accompanied by open

4See Federal Reserve press release July 2, 1992, p. 4. Thepress releases referred to in the remainder of this articleare dated March 29, 1991; April 3, 1992; May 22, 1992; July2, 1992; August 21, 1992; October 9, 1992; November 20,1992; December 24, 1992; and February 5, 1993. All pressreleases will be referred to by date. Reserve requirementson transactions deposits were reduced from 12 percent to10 percent on April 2. The reduction was intended to“strengthen the financial condition of banks and thereby

improve their access to capital markets, thus putting themin a better position to extend credit” (Federal ReserveBulletin, April 1992, p. 272). The change apparently had nosignificant effect on monetary aggregates and no bearingon the decision to ease later in the month.

‘See Eggert (1992).

34

Figure 1

Growth of Real GDP During Recoveries

Seasonally Adjusted Annual Rates (in Percent)

8

7

6

5

4

3

2

1

0

-1

-2

-.3

-4

Growth of Nonfarm Payroll Employment During Recoveries

Seasonally Adjusted Annual Rates (in Percent)6

5

4

3

2

1

0

—1

-3

-4

0 1 2 3 4 5 6 7Quarters After NBER Troughs

0 1 2 3 4 5 6 7Quarters After NBEA Troughs

Note: Average includes all postwar recessions before 1991 except the 1980 recession.

35

Figure 2Interest Rates

Percent

8.5

8.0

7.5

7.0

6.5

63

5-5

53

4-5

4,0

3-5

3M

2,5

Note:Vertical lines mark FOMC meeting dates.

market operations “directed at allowing the fullamount of the reduction to be reflected in moneymarket rates.” The federal funds rate then fellabout a 0.5 percentage point. The federal fundsrate subsequently averaged about 3.25 percentuntil September. These two actions constitutedthe most significant policy move of the year.

Though many indicators turned up in July(and clown again in Augu.st), M2 continued tofall despite the actions taken at the beginning of.luly. In response to the flagging M2 growth andto continuing signs of sluggish economic growth,another easing action was implemented in earlySeptember? ‘i’he federal funds rate remainedhigher than expected following this action hutsettled down to around 3.0 percent by the endof October and remained there for the re-mainder of the year.’ Positive M2 growth re-sumed during the second half of the year,supported by rapid growth of reserves, but

‘October 9, 1992 press release, p. 4.7November 20, 1992 press release, p. 4.‘November 20, 1992 press release, p. 4.‘This issue is treated extensively in Bullard (1992).

turned negative again in December and into 1993.The second half of 1992 is a case study in the

difficulty of making policy on the basis of fore-casts and month-by-month changes in economicdata.~‘I’he downturn that threatened at midyearnever- materialized; the economy grew at a 3.4percent rate in the third quarter- and 4.7 percentin the fourth. ‘t’his was not apparent during thethird quarter, however, and in fact private fore-casters remained pessimistic until late in theyear. The July and September easing actionswere taken partly on •the premise •that the econ-omy was weakening (and partly in response •toflagging M2 growth), yet economic growth inthe second half of the year ended up muchstronger than during the first half of the year.1°

THE MONETARY CONUNDRUM

During the p-ast two years, M2 has grownslowly by past standards and has frequently

“Most estimates indicate that it takes at least six months forany effects of monetary policy actions to be apparent in thelevel of real output, so it is unlikely that strong growth inthe second half of 1992 was the result of the July policyactions.

Percent

1991J F M A M J J A SO N D J F MA M J J A S ON D

1992

36

Figure 3

M2 and M2 Growth Ranges

Billions of Dollars, Seasonally Adjusted

3700

3650

3600

3550

3500

3450

3400

3350

3300

1991

Note: Vertical lines mark FOMC meeting dates. Pre-benchmark data.

been near or below the growth ranges set bythe FOMC (see figure 3).” The slow overallgrowth of M2 has been accompanied by rapidgrowth of Ml and reserves (see figure 4).Reserve growth follows a pattern similar to Ml,though at higher levels. From December 1991 toDecember 1992 M2 grew by 1.8 percent1 MIgrew by 14.1 percent, and total reserves grewby 19.6 percent. Much of the difference be-tween Ml and M2 growth rates can be tracedto money market mutual funds and small timedeposits (components of M2 but not of Ml),which fell substantially during this period.

The FOMC’s stated policy objectives are to“foster price stability and promote sustainablegrowth in output.” Monetary aggregates, partic-ularly M2, are closely monitored by the FOMC

partly because of their historically close rela-tionship (by macroeconomic standards) withnominal GDP. The growth rate of nominal GDPis approximately equal to the growth of realGDP plus the inflation rate. Nearly all macro-economists agree that money’s long-run effectalmost entirely on the price level; that is, theonly thing a central bank can do for the econo-my in the long run is to keep the inflation ratelow. Though many macroeconomists argue thatshort-run economic growth can be bought atthe expense of future inflation, almost all agreethat higher growth induced in this way cannotbe sustained in the long run.” ‘the records ofFOMC meetings indicate that Committee discus-sions take for granted that monetary policy hasan effect on real economic activity in the shortrun.”

is

“Data on the monetary aggregates were benchmarked atthe end of 1992. All monetary data in both text and chartsof this article are pre-benchmark data.

“Economists who agree with this statement as a theoreticalproposition can be subdivided into those who think thatmonetary policy can help stabilize real GDP and those whothink that the attempt is likely to be counterproductive inpractice, even if it is possible in principle.

“The April 3 press release, for example, states, ‘The mem-bers generally agreed that enough monetary stimulus prob-ably had been implemented to foster the desired upturn ineconomic activity ... “ (p. 16).

N DJFMAMJ J ASONDJ FMAMJ JASON D1992

37

Figure 4Growth of Ml and M2

Seasonally Adjusted Annual Rates

Note: Horizontal bars indicate FOMC meetings (right end) and last available data(left end). Pre-benchmark data.

In recent years many economists and policy-makers have agreed that it is desirable to use amonetary aggregate as an intermediate indicatorof the thrust of monetary policy. Unfortunately,the economic theory underlying these conclu-sions is not specific enough to recommend theuse of any particular monetary aggregate. Anideal monetary aggregate has a strong connec-tion with policvmakers’ goals but is also closelyrelated to their actions, primarily open marketoperations. No single aggregate has met bothcriteria consistently over time. For several years

the FOMC has paid closer attention to M2 be-cause it has been a somewhat better indicatorof the long-run growth of nominal income. 14

The Federal Reserve has more direct influenceover Ml, however, because its checkabledeposit component is closely tied to the level ofreserves.” That there is a tighter link betweenFederal Reserve actions and narrower aggregatessuch as Ml has persuaded some economists aridpolicyrnakers to give relatively more weight tonarrower aggregates in evaluating the stance ofmonetary policy.’’

“During the early 1980s the FOMC paid close attention toMl. In 1982, they began to place more emphasis on M2but still set Ml growth ranges. In 19B7 they decided to quitsetting Ml targets, citing “uncertainties about its underly-ing relationship to the behavior of the economy and itssensitivity to a variety of economic and financial circum-stances.” See Federal Reserve Board of Governors (1967).

“It should be noted, however, that one of the factors thatled the FOMC to begin to de-emphasize Ml in the early19805 was the difficulty in controlling the aggregate duringa period of rapid deregulation and financial innovation.

“Members of the Shadow Open Market Committee (a groupof academic and business economists not affiliated withthe Federal Reserve System) have often expressed theseviews in their critiques of FOMC policy.

35 35

J FMAMJJASONDJ FMAMJJASOND1991 1992

38

The juxtaposition of rapid growth of Ml andreserves with the slow growth of Ma was themonetary conundrum policymakers faced in1992. Though the Committee no longer sets atarget range for Ml, this is more than an arcanetechnical issue: If the relationship between Maand nominal GDP had broken down, the slowgrowth of Ma might be misleading, and therapid growth of reserves and Ml might signalincreasing future inflation. If not, the slowdownof M2 might reliably signal slow growth ofnominal income that could endanger the eco-nomic recovery in the short run and causedeflation in the long run.

An observer who was convinced that the rela-tionship between M2 and nominal GDP had notbroken down, even temporarily, might arguethat, though the growth of Ml and reserves washigh by historical standards, it was inadequateand that monetary policy was not sufficientlyexpansionary. Another observer, convinced thatthere had been a breakdown of the link betweenM2 and nominal GDP, might argue that slow M2growth was not a cause for concern, but thatrapid Ml growth signaled future inflation. Mostobservers saw more uncertainty and found theirown views somewhere between these extremes.

Why Did M2 Slow Dramatically?

Most hypotheses about the proximate causesof the slowdown in M2 growth point to changesin relative returns on Ma assets. Interest rateson assets included in the M2 aggregate but notin Ml fell relative to interest rates on other as-sets, and the public therefore preferred to holdthese other assets. Portfolios were adjusted intwo directions. Because the opportunity cost ofholding transactions balances (mostly MI assets)relative to other Ma assets had declined, thepublic could afford the convenience of largertransactions balances, thus increasing MI whilethe non-Ml components of Ma declined. Perhapsmost important was the movement in the otherdirection, from M2 assets, such as small timedeposits, to higher-yielding alternatives not in-cluded in the Ma aggregate.”

The movement of interest rates on non-Micomponents of Ma relative to other assets wascaused partly by the sharp widening of thespread between short- and long-term interestrates (M2 assets tend to have relatively short

maturities) and partly by various factors thatdepressed Ma interest rates relative to those onother assets of comparable maturities. One ofthese factors may have been slack demand forbank loans. Firms and consumers faced withuncertain demand and income appeared reluc-tant to borrow at current interest rates. Banks,seeing the return on new loans little aboveTreasury yields, were unwilling to bid updeposit rates. The slack demand for bank loansmay also reflect a long-run decline in depositoryinstitutions’ share of total intermediation.

It has also been argued that various regulato-ry changes, including higher capital require-ments, higher deposit insurance premiums andcloser regulatory scrutiny of portfolios, have in-creased the cost of bank intermediation, drivinga larger wedge between the rates charged andthe rates paid by depository institutions.

Though the relevance of many of these factorshas been apparent for several years, the lack ofhistorical precedent has made it extremelydifficult to predict the magnitude and durationof their influence on Ma.

Did the Relationship between M2and Nominal GDP Change?

The relationship between M2 and nominalGDP is summarized by M2 velocity, the ratio ofnominal GDP to Ma. If nominal GDP grows atthe same rate as Ma, velocity is constant. Whennominal GDP grows more quickly (slowly) thanMa, velocity increases (decreases). HistoricallyMa and nominal GDP have grown at approxi-mately the same rate when averaged over longintervals. In the short run, when nominal GDPand Ma growth rates often differ, M2 velocityhas usually moved in the same direction as theopportunity cost of holding Ma assets, as shownin figure 5. The opportunity cost measure shownis the difference between the three-monthTreasury bill rate (representing assets not in-cluded in Ma) and a weighted average of the in-terest rates paid on M2 assets. Simple economicreasoning suggests that, all else equal, as thetrue opportunity cost rises, consumers and busi-nesses should decrease the quantity of Ma assetsthey hold. They may, for example, substituteTreasury bills, which are not in Ma, for smalltime deposits, which are in Ma. This substitutioncauses M2 to fall and M2 velocity to rise.

“One such high-yield alternative for many firms and con-sumers was to pay off or avoid debt.

Figure 5M2 Velocity and Opportunity Cost

Log Scale

1.80

1.75

1 ~70

1.65

t60

‘L55

1 50

39

Quarterly Averages

Figure 5 shows a substantial rise in M2 veloci-ty during 1991 and 1992. This would not beparticularly remarkable (several similar episodesare shown) except that the opportunity costmeasure moved in the opposite direction. Theunprecedented size and duration of the diver-gence of these vat’iables have been interpretedas evidence that the relationship between Maand nominal GDP may have changed. If thiswere true, it would then be difficult to discet-nthe implications of the slow growth of Ma. Thisuncertainty about the link between Ma andnominal GDP led some ohservets and policy-makers to give added weight to other variablesin assessing the stance of monetary policy. Con-cerns about rapid Ml and reserve growth werereinforced by the general steepening of theyield curve during the year, which appeared toindicate market expectations of rising short-terminterest rates. The expected incteases couldmean that the investors required a premium to

compensate for rising expected inflation or thateconomic recovery was expected to drive realinterest rates higher. Either interpretation woulditnply that monetat-y policy had been sufficientlyexpansionary despite the evidence of slow Magrowth.

A different interpretation of the divergencebetween Ma velocity and opportunity cost isthat the relationship has always been morecomplicated than figure 5 implies, but only re-cently has this become important.” The break-down in the relationship might be only anartifact of mismeasurement of the opportunitycost variable and does not necessarily imply abreak between Ma and nominal GDP.

The argument starts by observing that inpt-inciple the entire spectrum of intet-est rates isgermane to an individual’s decision to hold aparticular Ma asset. In the opportunity costmeasure shown in figure 5 the three-month

Log Scale

65

5-5

4.5

3-5

2.5

1_S

0.51959616365676971737577798183868789911993

“Feinman and Porter (1992) develop this argument indepth.

40

Treasury bill rate represents yields on all non-Ma assets. For the three-month rate to captureall of the relevant movements in these yields, in-terest rates on all non-Ma assets must move inparallel with it. Figure 5 shows that this ap-proach has worked well historically, but changesin returns on non-Ma assets in recent yearsmay no longer be summarized by movements inthe Treasury bill rate. On this view the diver-gence between Ma velocity and the measure ofopportunity cost shown in figure 5 does not in-dicate a breakdown in the long-run relationshipbetween Ma and nominal GDP. Rather this im-plies that the recent rise in velocity—like previ-ous episodes—is temporary, induced largely bythe widening of the difference in yields onshort- and long-term assets and the consequentfailure of this measure to capture the true op~portunity cost of Ma. If so, M2 velocity may falland Ma growth may accelerate when the differ-ence narrows. However, wariness about short-run growth of Ma as an indicator of nominalGOP growth is still warranted.

One effort to implement this line of reasoningempirically by estimating an opportunity costusing a broader set of non-Ma yields concludesthat “seen against the background of a morecomplete accounting of relevant interest ratemargins, the recent behavior of Ma is not near-ly as anomalous as suggested by the standardmodel.”” The authors note, however, that theirstudy does not entirely resolve the puzzle.

i’he FOMC did not take a radical position onthe question of whether Ma was growing tooslowly. Though the record of every 199a meet-ing indicates substantial concern over this issue,every 1992 policy directive called for maintain-ing the “existing degree of pressure on reservepositions” (see table 1). On the other hand, thelargest move toward ease occurred in early Julyafter Ma fell below the lower bound of itsgrowth range. Moreover, every easing actionfollowed a period in which M2 declined or itsgrowth fell significantly below expected levels.

Members of the FOMC expressed a range ofviews about whether the Fed should ease enoughto ensure that Ma growth rebounded to the bot-tom of its growth range. Jerry Jordan, presidentof the Federal Reserve Bank of Cleveland, main-tained that it is particularly important to

“Feinman and Porter (1992), p. 21.2cwhen such consultations take place, they are noted in the

record of the next meeting. Less formal consultations maytake place, but not be noted in the record.

achieve Ma growth in the target range and votedagainst the proposed directive at two meetingsfor this reason. Governor Lawrence Lindseyjoined him once in his dissent.

At the other end of the spectrum GovernorJohn LaWare and the president of the FederalReserve Bank of St. Louis, Thomas Meizer, vot-ed against policy directives on four occasionsbecause they felt that a bias toward ease wasinappropriate during the second half of theyear. They believed that slow Ma growth wassending a misleading signal and that earlier eas-ing actions by the FOMC would be sufficient tosupport economic recovery, despite slow Magrowth.

DETAILED CHRONOLOGY OF

FOMC ACTIVITY

The FOMC meets eight times each year. Atthe end of each meeting the Committee issues adirective to the Federal Reserve Bank of NewYork to guide open market operations until thenext meeting. The Committee typically gives theChairman some flexibility to initiate policy ac-tions between meetings (during 1992 all actionswere taken between meetings). These actionsare sometimes agreed on during a conferencecall among the members, but this was not doneduring 199a.’°

A summary of each meeting, the record ofpolicy actions, is released to the public shortlyafter the next meeting. The record is also pub-lished in the Federal Reserve Bulletin. The shad-ed insert explains some of the language used inthe monetary policy directives and discussionsof monetary policy.

The following summaries of FOMC meetingsand policy actions between the meetings are in-tended to give a sense of the main concerns ofthe Comnuttee and the information available atthe time. In general the most recent economicinformation available to the FOMC is for a peri-od that ended at least one month before themeeting. The main exceptions to this are in-terest rates, which can be observed daily, andsome data that are collected and assembled bythe Federal Reserve System—for example, com-ponents of the industrial production index andthe monetary aggregates. Figure 8 shows some

41

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eases itars voted iS S For IMSt seeltadlsous$104 t I fle$tngnn Ibe text or tlflppeSlx‘4~a~se8d’p ~b~rd~mat,. ,‘\ ‘‘, ‘~ “ , , ‘‘44/7//N ‘‘4” , / ~,44

/ ‘4 4 4 4 4 4 N, , ,, 4 4 ‘4 4 ‘4 N,’,’,, ,of the monthly economic data regularly consi-dered by the Committee. Short horizontal linesin each chart illustrate the data lags faced bythe Committee. (This device is used in figure 4as well.) ‘the right end indicates the meetingdate and the left end shows last data availableto the Committee at the time of the meeting. Inaddition to this delay, most data series are sub-ject to revision after their initial release. Figure6 plots the current revisions of the data, butsignificant inconsistencies between the originalrelease and the revised data are noted below.‘I’ahle 1 provides an overview of the direction ofmonetary policy during 1991 and 1992.

February 4-5, 1992, Meeting

The Committee’s first task of the year was toset growth ranges for the monetary aggregates.

A growth range of 2.5 percent to 8.5 percentfor Ma had been tentatively set in July 1991.For several years before 1991 the FOMC hadbeen gradually lowering the range toward a lev-el consistent with price stability. Several mem-bers expressed a preference for resuming thistrend as a signal of the Committee’s commit-ment to price level stability, though all foundthe current range acceptable. Because of puz-zling recent behavior of Ma (discussed above),uncertainty was expressed over- how monetarygrowth in these target ranges would affect eco-nomic activity and inflation. The membersjudged, however, that the 2.5 percent to 6.5percent range would “provide adequate leewayand operational flexibility to accommodate asatisfactory economic performance.” They not-ed, however, that “the substantial uncertainties

“April 3, 1992 press release, p. 12.

42

Figure 6Monthly Economic Indicators

Growth of Nonfarm Payroll Employment

Seasonally Adjusted Annual Rates

Growth of Industrial Production

Seasonally Adjusted Annual Rates

Consumer Price Index Inflation

Seasonally Adjusted Annual Rates

-2

J F MA MJ JASON D Jr MAM J JASON U1991 1992

J FM AM J JASON D JF MA M J JASON 01991 1992

U

6

4

2

J FMAMJ JASON DJ FMAMJ J ASOND1991 1992

Note: Horizontal bars indicate FOMC meetings (right end) and last available data (left end).

43

surrounding the outlook for Ma suggested thatthe Committee would have to approach mone-tary developments with a great deal of flexibili-ty over the year ahead.” Growth ranges of 2.5percent to 6.5 percent for M2 and 1 percent to5 percent for MS were approved unanimously.

In setting policy for the weeks until the nextmeeting, there was clear consensus that no dra-matic action should be taken, particularly sincesignificant easing had been undertaken late in1991. Nonetheless, the Committee expressedconcern about the uncertain state of the econo-my. Though there were some positive signals,nonfarm payroll employment had been flat inDecember, and both retail sales and industrialproduction had fallen slightly in November andDecember.” The pace of inflation had continuedto decline. The economic projection prepared bythe Board staff predicted “a recovery of eco-nomic activity.”~

Some members expressed concern about therecent erratic behavior of M2. A staff analysisindicated that M2 could be expected to growmore rapidly given current conditions.

However, expansion of Ma probably wouldcontinue to be restrained by the aggressivereductions by depository institutions in theiroffering rates on deposit components of this ag-gregate and the continuation of related shifts ofM2 funds into higher-yielding capital market in-struments. In addition, the expected pickup inthe pace of RTC resolutions over the balance ofthe first quarter would tend to moderate thegrowth of Ma and especially M3. To the extentthat subdued growth of the broader aggregateswere to reflect such special influences, therewould not be significant adverse implicationsfor the overall performance of the economy.”

The Committee voted to maintain existing con-ditions in reserve markets but, with the possibil-ity of deteriorating economic conditions inmind, voted for a bias toward easing.

March 31, 1992, Meeting

New economic data did not clarify the eco-nomic situation following the February 4—5meeting. Nonfarm payroll employment droppedslightly in January but reversed itself in Febru-

ary. Industrial production followed a similar butmore pronounced pattern. Strong retail salesand shipments of nondefense capital goodsprovided some bright spots in the January andFebruary data. Prices were increasing at aboutthe same rate as a year earlier. The economicprojection prepared by the Board staff predicted“continued recovery in economic activity.”26Reports on economic conditions in the 12 dis-tricts tended to support this point of view.

While short-term rates had held steady sincethe last meeting, longer-term rates jumped sub-stantially, particularly at intermediate maturities(figure 2). In the apparent absence of an intend-ed or unintended action raising short-term rates,the Committee viewed the jump as a sign thatmarkets were interpreting other economic newsas evidence of growing economic momentum.’7

The Committee was troubled by the renewalof weak Ma growth. After significant easing latein 1991, M2 growth was relatively robust inJanuary and February, but it appeared that M2had quit growing or possibly declined in March(data for the end of March were not yet availa-ble), contrary to expectations at the previousmeeting. Some members were concerned thatslow growth of Ma, should it continue, “couldsignal that monetary policy was not positionedto support a satisfactory expansion.”” Some ob-served that it was the behavior of M2 and M3rather than economic conditions that persuadedthem in favor of bias toward ease in the direc-tive.’”

The Committee unanimously adopted anotherdirective biased toward ease, though a minorityof members would have favored a symmetricdirective in view of evidence of a strengtheningeconomy. The majority, however, “remainedconcerned about the vulnerability of the expan-sion to a variety of risks.”°

April Easing

In early April it became clear that M2 had infact begun to decline during March. Togetherwith “indications that the economic expansionwas not as strong as its pace early in the year”this led to a decision to ease monetary condi-

“April 3, 1992 press release, p. 13.~ revisions indicate a slight increase in retail sales.‘4April 3, 1992 press release, p. 6.‘5April 3, 1992 press release, p. 18.

‘7May 22, 1992 press release, p. 4.‘“May 22, 1992 press release, p. 12.‘“May 22, 1992 press release, p. ia‘“May 22, 1992 press release, p. 11.

‘“May 22, 1992 press release, p. 5.

44

tions in early April.” Besides Ma, retail saleswas the only prominent economic indicator thatturned down. Employment and industrial pro-duction both t-ose during March. After this eas-ing action the federal funds rate fell more than0.5 percentage points from around 4.0 percent,but it eventually stabilized around 3.75 percent.

May 19, 1992, Meeting

Payroll employment and industrial productionincreased through April, continuing the trendstarted at the beginning of the year. Retail salesrebounded from a March drop, and there wasevidence that fixed investment was picking upafter an April drop in shipments.” The staff pro-jection was again “continuing recovery.” Over-all, the evidence suggested a modest recoverywith a broad base across regions and industries.

Once again the behavior of the monetary ag-gregates was a central focus of concern. BothM2 and M3 contracted during March and fromMarch to April, leaving them below the levelsexpected by the Committee at its March 31meeting.’~Though many thought that tem-porary technical considerations accounted forpart of this decline, some Committee membersregarded the weakness of M2 and M3 as “in-dicative of an increase in the downside risks tothe expansion.” Others felt instead that “a vari-ety of developments ... seemed to have alteredprevious relationships between M2 and M3 andmeasures of spending and income.”” Therefore“satisfactory economic expansion would tend tobe consistent with weaker growth and a highervelocity of M2 than would be suggested byhistorical relationships.”~Some members felt inaddition that “the strength of Ml and reserves- -- could raise questions about the consistency ofcurrent monetary policy with progress towardprice stability.””

Though some members would have preferredbias toward ease, whereas others preferred totilt the directive toward restraint, the Committeeagreed unanimously on a policy of unchangedpressure in reserve markets with symmetriclanguage -

June 30—July 1, 1992, Meeting

Through May, payroll employment and indus-trial production continued the weak upwardtrend started at the beginning of the year, sug-gesting that expansion continued at a verymodest pace. However, “recent information sug-gested some weakening in the expansion.””Growth of consumption expenditures in particu-lar had slowed significantly. The staff projectionpredicted a “modest pickup in economic growthover the second half of the year.”4°Membersreported that the expansion continued to be ge-ographically broadly based, though there weresignificant exceptions, notably California.

The growth of M2 and M3 was still weak inMay, and available information for June indicat-ed contraction, leaving the aggregates below thelower end of the growth ranges.

The policy record indicates that at the June30—July 1 meeting, FOMC members had morediverse opinions about policy for the immediatefuture than at the May meeting. Some memberspreferred an immediate easing of policy. Ofthose who preferred easing, some emphasized“the recent indications of some slowing in theexpansion and the already considerable slack inthe economy,” whereas others highlighted “thedesirability of taking relatively prompt action tofoster growth in the broad measures of moneywithin the Committee’s ranges for the year.”4’The Committee voted to return to a directive bi-ased toward ease. John LaWare and ‘I’homasMelzer objected to the asymmetric directive be-cause “the current stance of monetary policywas not impeding an expansion consistent withthe economy’s long-run potential”~’and becausein the context of the previous symmetric direc-tive it “suggested an excessive emphasis onshort-term economic developments that mightundermine the credibility of the System’s long-run policies.”4’

The Committee also reaffirmed the 1992growth ranges for M2, M3 and total domesticnonfinancial debt and tentatively decided tomaintain the same growth ranges for 1993.

“July 2, 1992 press release, p. 4.“Revised retail sales data show a slight decline in April.“July 2, 1992 press release, p. 6.‘4July 2, 1992 press release, p. 6.“July 2, 1992 press release, p. 11.‘“July 2, 1992 press release, p. 11.‘7July 2, 1992 press release, p. 12.

‘“July 2, 1992 press release, p. 12.‘“August 21, 1992 press release, p. 7.40August 21, 1992 press release, p. 5.4’August 21, 1992 press release, p. 17.4’August 21, 1992 press release, p.21.43August 21, 1992 press release, p. 21.

45

July Easing

The day after the FOMC meeting (July 2) theDepartment of Labor reported that payroll em-ployment had fallen by 117,000 (1.3 percent atan annual rate) in June after four months ofslow growth.~~Also on July 2 the Board ofGovernors voted to lower the discount ratefrom 3.5 percent to 3.0 percent, and open mar-ket operations were implemented to let the fed-eral funds rate fall by a comparable amount.4’Figure 2 shows that the federal funds rate,which had hovered around 3.75 percent, fellsharply to about 3.25 percent. There was no tel-ephone conference regarding this change in theintermeeting policy.

August 18, 1992, Meeting

At its August 18 meeting, the Committee con-cluded that though expansion continued, itspace had slowed.~°July payroll employment hadreversed the June decline, but both numberswere propped up by temporary hiring in a newfederally sponsored summer jobs program. In-dustrial production followed the same pattern—recovery in July from a June drop. Retail salesincreased moderately in July following a second-quarter slowing, while shipments of nondefensecapital goods rose sharply in June. Market in-terest rates at all maturities fell substantiallyduring July following the easing action butprobably also reflected the sluggishness of theexpansion. The staff projection pointed to a con-tinuing pattern of “subdued economic expan-sion.’47 Some members noted that “they couldnot identify any sector of the economy thatseemed primed to provide the impetus neededfor a vigorous expansion,” though they noted“considerable progress - -- toward redressingearlier over-expansion and credit excesses.”4”

Members expressed considerable optimismabout the inflation outlook, citing “increasinglypersuasive evidence of slower rates of increasein wages and prices.”4”

The monetary aggregates remained an impor-tant concern. M2 and M3 contracted further inJuly and continued below the lower end of the

growth ranges. Following the easing in earlyJuly, Ml (which had fallen during June) began aperiod of rapid growth in July.

Some members felt further easing was in ord-er, but a majority favored an unchanged policythat recognized the potential for conditions war-ranting easing. ‘rhe behavior of the broad mone-tary aggregates was regarded as a significantfactor “in favor of careful consideration of” fur-ther easing.’°

A directive biased toward ease was adoptedwith support from some members who favoreda symmetric directive. John LaWare and ThomasMelzer voted against this action citing reasonssimilar to those mentioned in their previousdissent.

September Easing

In early September, after slower-than-expectedresponse of M2 to the July easing and economicdata (including a sharp increase in initial unem-ployment insurance claims) that continued to in-dicate sluggish economic growth, an easingaction was implemented. For technical reasonsthe federal funds rate remained higher than ex-pected following this action, but it settled toaround 3.0 percent by the end of October.”

October 6, 1992, Meeting

The policy record for the October meetinggives a picture of economic developments verysimilar to that from the previous meeting—“economic activity was expanding at a subduedpace.” Nonfarm payroll employment fell slight-ly in August and again in September, thoughthe latter partly reflected the end of the sum-mer jobs program mentioned above.” Industrialproduction fell in August and partial informa-tion for September “suggested further weak-ness.” Consumption seemed to have slowedthrough August after a period of robust growth.Shipments of nondefense capital goods slowedduring July and August, a sign of possiblerenewed weakness in investment. The staffprojection “indicated that economic activitywould expand at a slow pace in the current

44See U.S. Department of Labor (1992). Revised data show aless substantial fall of 0.18 percent.

45October 9, 1992 press46October 9, 1992 press47October 9, 1992 press48October 9, 1992 press49October 9, 1992 press

release, p. 4.release, p. 1.release, p. 6.release, p. 6.release, p. 10.

‘“October 9, 1992 press release, p. 12.“November 20, 1992 press release, p. 4.

“November 20, 1992 press release, p. 1.“Subsequent revision to the employment data made the

September drop into a slight rise as shown in Figure 6.November 20, 1992 press release, p. 1.

46

quarter” but would pick up gradually in 1993.’~Many members again worried that, “No impor-tant sector of the economy seemed poised toprovide much impetus to business activity ...“

Several members felt that recent volatility insome asset markets, particularly the foreign ex-change market, underscored the risks of poten-tially adverse developments.’” On the plus sidethey noted that declines in the dollar anddomestic interest rates “suggested improvedconditions for greater expansion.”~The infla-tion outlook continued to be favorable.

M2 and M3 began to grow again in August,but only slowly. The weak growth appeared tohave continued into September, and both ag-gregates were expected to finish September be-low the bottom end of the growth range.

The same range of opinions on policy for theimmediate future was expressed. The policyrecord, however, indicates a clear shift towardease in the balance of members’ opinions. Thoughthe policy directive contains exactly the samewording stating a bias toward ease, the recordindicates that a majority of the Committee sup-ported a directive “strongly” biased toward pos-sible ease, with “a decided presumption of someeasing,” and with “a marked bias toward possi-ble easing.”” Four members voted against thedirective. John LaWare and Thomas Melzer fa-vored a symmetric directive for the reasonsstated at previous meetings, adding their con-cern that an easing action might destabilize thedollar.’” Mr. Melzer was also concerned thatcontinued rapid Ml growth might jeopardizeprogress toward price stability. Two other Com-mittee members, Jerry Jordan and GovernorLawrence Lindsey, favored immediate easingsufficient to “achieve the Committee’s pre-announced target growth for M2.””0 They indi-cated that this action should be accompanied byan announcement that the growth range wouldbe lowered in 1993 to signal that the easing didnot indicate a discounting of the FOMC’s goal ofprice stability.

November 17, 1992, Meeting

More optimism about the pace of economicactivity was evident at this meeting: “economicactivity had been expanding at a moderatepace.””’ Nonfarm payroll employment had risenslightly in October following two months ofdeclines, Industrial production rose in October“following a modest increase in the third quart-er.”°2(The July increase had offset slight declinesin August and September.) Stronger retail salesin September and October, stronger housingsales and starts, and anecdotal evidence all sug-gested stronger overall consumption spending.Another strong increase in outlays for producers’durable equipment in the third quarter impliedrenewed strength in investment. Increasing in-terest rates, particularly at intermediate maturi-ties, suggested that the more optimistic outlookwas shared by financial markets. The staffprojection “suggested a continuing expansion ineconomic activity.””’ In discussion “the membersindicated that they were encouraged by thesomewhat more positive tone in the latest eco-nomic reports and by the signs of improvingbusiness and consumer confidence.””~

Ma growth picked up in October. Combinedwith the more favorable economic reports, thishad deterred a move toward ease despite thestrong presumption in favor of ease at the Oc-tober meeting. Further easing had been expectedby financial markets, and correction of this ex-pectation was regarded as partly responsible forthe rise in interest rates.

Many members preferred a symmetric policyfor the upcoming weeks, believing that “risks tothe expansion were now fairly evenly balanced.””’Others still preferred a bias toward ease, butwithout the strong presumption understood atthe previous meeting. The Committee onceagain adopted a directive biased toward ease.Jordan, LaWare and Melzer voted against thisaction for reasons similar to those expressed atthe previous meeting.

‘4November 20,“November 20,‘“The European

September 16.‘Thjovember 20,‘“November 20,‘“November 20,““November 20,

1992 press release, p. 6.1992 press release, p. 7.Exchange Rate Mechanism collapsed on

1992 press release, p. 7.1992 press release, pp. 10, 11 and 13.1992 press release, p. 16.

1992 press release, p. 15.

“‘December 24, 1992 press release,“‘December 24. 1992 press release,“‘December 24, 1992 press release,“4December 24, 1992 press release,“‘December 24, 1992 press release,

p. 1.p. 1.p. 6.p. 7.p. ia

47

December 22, 1992, Meeting

As figure 1 indicates, real GDP rose signifi-cantly in the third quarter and the available evi-dence for the fourth quarter indicated that thispattern was continuing. Nonfarm payroll em-ployment again rose slightly in November. In-dustrial production also increased. Retail salesrose sharply through November, and sales andstarts of single-family homes showed sizablegrowth.”” Shipments of nondefense capital goodscontinued to expand. Yields on long-term bondsfell, but this was attributed to favorable marketreaction to “indications that the incoming Ad-ministration would give emphasis to reducingthe federal budget deficit over time,” ratherthan to the weakening recovery. “~The staffprojection “suggested a continuing expansion ineconomic activity” but also indicated that themomentum of the expansion would be partly

- offset by weaker export demand.”” Reportsfrom most regions reinforced a picture of “in-creasingly robust business conditions,” thoughthere were notable exceptions, again includingCalifornia.

M2 slowed once again in November, and thisweakness appeared to continue into December.A staff analysis pointed to sluggish growth ofM2 and M3 and substantial slowing in thegrowth of Ml during the coming months.

The Committee felt that recent positive de-velopments warranted “a shift toward a morebalanced approach to possible intermeetingchanges in policy.””” Though noting considerableuncertainty about the future course of theeconomy, “members observed that the next poli-cy move might be in either direction.”” Despitethe slower Ma growth, a symmetric directivewas unanimously adopted.7’

SUMMARY

For much of 1992, stronger economic perfor-mance seemed just around the corner. Threetimes during the year, in April, July, and Sep-

tember, combinations of faltering M2 growthand possibly slowing economic activity prompt-ed easing actions. The July action accompanieda half-point discount rate reduction. The econo-my was growing fairly quickly by the end ofthe year, despite forecasters’ midyear pes-simism.

Although the FOMC devoted a good deal of at-tention to anomalous behavior of Ma, the ag-gregate ended the year slightly below the lowerend of its growth range. Various factors led todoubt about the reliability of Ma as an indicatorof economic activity and inflation, but the impli-cations of slow Ma growth combined with rapidgrowth of reserves and Ml during 1992 are notyet known.

REFERENCES

Bullard, James B. ‘The FOMC in 1991: An Elusive Recovery?’this Review (March—April 1992), pp. 41—61.

Egged, Robert J. (ed). Blue Chip Economic Indicators,Capitol Publications, Inc., Vol. 17 (JunelAugust 1992).

Federal Reserve Board of Governors. “Monetary PolicyReport to the Congress,” Federal Reserve Bulletin (April1987), pp. 239—54.

Federal Reserve press releases, “Record of Policy Actions ofthe Federal Open Market Committee?’ (March 29, 1991;April 3, 1992; May 22, 1992; July 2, 1992; August 21, 1992;October 9, 1992; November 20, 1992; December 24, 1992;and February 5, 1993).

Feinman, Joshua N., and Richard D. Porter. “The ContinuingWeakness in M2?’ Finance and Economics Discussion Ser-ies working paper 209 (Board of Governors of the FederalReserve System, September 1992).

McDonough, William J., Spence Hilton and Peter Kretzmer.“Monetary Policy and Open Market Operations during1992?’ Federal Reserve Bank of New York Quarterly Review(Spring 1993), pp. 89—114.

Sternlight, Peter D., Cheryl Edwards and R. Spence Hilton.“Monetary Policy and Open Market Operations during1991,” Federal Reserve Bank of New York Quarterly Review(Spring 1992), pp. 72—95.

U.S. Department of Labor, Bureau of Labor Statistics. “TheEmployment Situation: June 1992?’ News (July 2, 1992),p. 1.

““A later revision of the data show, a fall in retail sales inNovember.

“‘February 5, 1993 press release, p. 10.““February 5, 1993 press release, p. 6.““February 5, 1993 press release, p. 12.‘“February 5, 1993 press release, p. 12.‘1The language of the directive differed slightly from the May

directive. See table 1.

48

AppendixFOMC Dissents

This appendix contains the exact text of mem-bers reasons for voting against FOMC directives.

February 4-5, 1992

No dissents.

March 31, 1992

No dissents.

May 19, 1992

No dissents.

June 30—July 1, 1992

Messrs. Laware and Melzer dissented becausethey judged an asymmetric directive, with abias toward easing, as being inappropriate atthis time. In their view, the current stance ofmonetary policy was not impeding an expansionconsistent with the economy’s long-run poten-tial. In addition, a bias toward ease, especially inthe context of the Committee’s decision at theMay meeting to adopt a symmetrical directive,suggested an excessive emphasis on short-termeconomic developments that might underminethe credibility of the System’s long-run policies.They were concerned that such a loss of credi-bility could have adverse effects on the dollar inforeign exchange markets and on long-term in-terest rates in domestic markets. Mr. Melzeralso believed that, if additional easing were un-dertaken, a greater policy reversal ultimatelywould be necessary, making the attainment ofsustainable economic growth more difficult inthe long run.

August 18, 1992

Messrs. LaWare and Meizer dissented becausethey did not favor a directive that was biasedtoward possible easing during the intermeetingperiod. In their view, monetary policy alreadywas appropriately stimulative, as evidenced inpart by the low level of short-term interestrates and by the rapid growth in reserves sinceearly this year, and was consistent with the pro-motion of economic growth in line with theeconomy’s long-run potential. Business and con-sumer confidence were in fact at low levels, hutthey reflected a variety of problems facing theeconomy that were unrelated to the stance ofmonetary policy. Accordingly, what was needed

at this point was a more patient monetarypolicy—one that was less predisposed to react tonear-term weakness in economic data and thatallowed more time for the effects of earlier eas-ing actions to be reflected in the economy. In-deed, an easing move in present circumstancesmight well stimulate inflationary concerns byreducing confidence in the System’s willingnessto pursue an anti-inflationary policy and thuscould have adverse repercussions on domesticbond markets and further damaging effects onthe dollar in foreign exchange markets.

October 6, 1992

Messrs. Jordan and Lindsey preferred immedi-ate action by the Committee to increase theavailability of bank reserves sufficiently toachieve the Committee’s pre-announced targetgrowth for Ma in 1992. Such reserve provisionwould likely be associated with further declinesin short-term market interest rates. They be-lieved that this policy action by the Committeeshould be accompanied by an announcement ofreductions of the upper and lower limits of therange for M2 growth in 1993. They felt that itwas important to make clear that near-term ac-tion to increase M2 expansion was not an aban-donment of the long-term objective ofnon-inflationary monetary growth.

Messrs. LaWare and Meizer dissented becausethey did not want to bias the directive towardpossible easing during the intermeeting period.In their view, a variety of indicators, includingthe level of short-term interest rates and thegrowth of reserves, suggested that monetarypolicy already was positioned to foster an ex-pansion in economic activity consistent with theeconomy’s long-run potential. Moreover, furthereasing at this time woitid incur a substantialrisk of destabilizing the dollar in the foreign ex-change markets. In these circumstances, theyfavored a steady monetary policy that was notdisposed to react to near-term weakness in eco-nomic data and that allowed more time for theeffects of earlier easing actions to be felt in theeconomy. Mr. Meizer also expressed concernthat the progress already made toward achiev-ing price stability might be jeopardized if veryrapid growth in Ml were to continue.

November 17, 1992

Mr. Jordan dissented because he preferredtaking immediate action to increase the availabil-ity of bank reserves sufficiently to raise M2

49

growth to a pace more consistent with the Com-mittee’s annual range. Because desirable M2 ex-pansion in line with the Committee’s objectiveswould be likely to fall within a lower rangenext year, he would announce concurrently areduction in the 1993 range to make clear thatnear-term action to increase M2 expansion wasnot an abandonment of the long-term objectiveof non-inflationary monetary growth.

Messrs. Laware and Melzer dissented becausethey did not want to bias the directive towardpossible easing during the intermeeting period.In their view, recent developments pointed to astrengthening economy, and they favored asteady policy that was not predisposed to reactto near-term weakness in economic or monetarydata. More time was needed to evaluate the ef-fects of prior monetary policy actions, and they

were concerned that the adoption of a morestimulative policy over the near term might wellestablish a basis for greater inflation later. Mr.Melzer was concerned that rapid growth in to-tal hank reserves, the monetary base, and Mlover the last two years might already have laida foundation for accelerating nominal GDPgrowth and a reversal of the disinflationarytrend. In addition, he noted that policy errorscan easily be made at this stage of the businesscycle. In an economic expansion, efforts toresist increases in the federal funds ratethrough large reserve injections eventually leadto higher inflation and higher nominal interestrates.

December 22, 1992

No dissents.

,, ~v, .1