Academic journal article Federal Reserve Bulletin

Monetary Policy Report to the Congress

Academic journal article Federal Reserve Bulletin

Monetary Policy Report to the Congress

Article excerpt

Monetary Policy Report to the Congress

Report submitted to the Congress on July 20, 1989, pursuant to the Full Employment and Balanced Growth Act of 1978.(1)


As 1989 began, a reduction in inflationary pressures appeared essential if the ongoing economic expansion was to be sustained. Monetary policy during 1988 had been directed toward reducing the risks of an escalation of inflation and inflation expectations, but at the time of the Board's report to the Congress in February of this year, success in that effort seemed far from assured.

Indeed, among the data reported in the early part of 1989 were very large increases in the producer and consumer price indexes, reflecting not only the effects of run-ups in oil and agricultural commodity prices, but also broader inflationary developments, including unfavorable trends in unit labor costs over the preceding year. Under the circumstances, with pressures on productive resources still intense, monetary policy was tightened further. Reserve availability was curtailed through open market operations, and the discount rate was raised 1/2 percentage point in late February. In response to these policy actions and to expectations that additional tightening moves might be needed, market interest rates climbed throughout the first quarter, and money growth was subdued.

Over the course of the second quarter, several indicators suggested the emergence of conditions that were more conducive to a future easing of inflationary pressures. Growth of the monetary aggregates weakened further, with M2 running noticeably below its target range for the year. Aggregate demand for goods and services moderated, reducing somewhat the strains on productive resources, especially in the industrial sector of the economy. The dollar exhibited considerable strength in the foreign exchange markets, portending a direct reduction in price pressures and slower growth in demands on domestic production capacity. Although the unemployment rate remained essentially unchanged in the neighborhood of 5 1/4 percent--the lowest level since the early 1970s--trends in wages and total compensation showed little, if any, further step-up, reflecting at least in part an awareness among workers and management of the need to contain costs in a highly competitive world economy. Meanwhile, prices of actively traded industrial commodities leveled out, enhancing the prospects for a broader slackening in the pace of inflation.

In this environment, interest rates turned down during the spring, as financial market participants responded not only to the better outlook for inflation but also in anticipation of an easing of monetary restraint by the Federal Reserve. The System began to provide reserves slightly more generously through open market operations at the beginning of June and took an additional small easing step in early July. This helped bring about a further decline in market rates of interest, which by mid-July generally had more than retraced the increases that had occurred earlier in the year. Most short-term interest rates were down about 1/2 percentage point from their December levels, while long-term rates had fallen as much as 1 percentage point on balance.

Monetary Objectives for 1989 and 1990

In February, the Federal Open Market Committee (FOMC) specified a range for M2 growth in 1989 that was a full percentage point below that of 1988 and ranges for M3 and debt that were 1/2 percentage point below those of the previous year (table 1). This was the third consecutive year in which the ranges had been lowered. At the same time, the Committee recognized that, in light of the continuing uncertainty regarding the shorter-term relation between monetary growth and changes in income and spending, a variety of indicators of inflation pressures and economic activity as well as the behavior of the aggregates would have to be considered in determining policy. …

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