The principal monetary policy making body in the United States is the Federal Open Market Committee (FOMC). It includes the members of the Board of Governors of the Federal Reserve and the Presidents of the regional Federal Reserve Banks. Its meetings are held in Washington, about eight times per year, and are chaired by Alan Greenspan, the Chairman of the Board of Governors. Click here for U.S. Monetary Policy: An Introduction and for a broader discussion of the Fed click on Purposes and Functions of the Federal Reserve System.
Will it decide to tighten or loosen monetary policy in 1999?
In recent years, the Fed has used the target for
the overnight Federal Funds rate as its primary monetary policy instrument.
That is, the FOMC sets a target and the Fed changes the supply of reserves
through open market operations in order to keep the Funds rate at or near
the target level. Starting in early 1994, fears of inflation led the Fed
to increase the Funds rate target seven times (by 25, 50 and on one occasion
75 basis points each time). The Fed Funds rate reached 6% in early 1995.
As fears of inflation receded and concern for economic growth increased,
the rate was then decreased in three 25 basis point steps. It reached 5.25%
in January 1996 and stayed at that level in 1996. In September 1996, there
was major concern that the economy was weakening and it was widely believed
that the Fed would loosen. Many observors were surprised that it did not
and expected the step to be taken after the election. The Fed left policy
unchanged at its last 1996 meetings on November 13th and December 17th.
Very robust economic growth in the fourth quarter of 1996 led to renewed fears of inflation in early 1997 but the Fed decided to leave the Fed Funds rate constant at the February 4-5th, 1997 meeting on the basis of no evidence of price or wage pressures in the economy. However, March the predominant concern of commentators has been that an overheated economy and the continuing asset bubble in the stock market would increase inflation and will lead the Fed to tighten. Greenspan's Humphrey-Hawkings testimony on Febraury 26 reinforced this concern and the Fed increased the Fed funds Rate by 25 basis points on March 25th to a level of 5.5%. While the economy ended up growing very fast in the first quarter of 1997 (+4.9), the Fed kept the Fed Funds rate fixed at the May 20 meeting on the basis of the expectation of slowdown in the second quarter and as there was no signal of an inflation resurgence. The rate was unchanged at the July meeting of the FOMC since, as expected, the economy had slowed down in the second quarter to an annualized 3.3% growth and as wage and price inflation remained subdued. The Fed maintained the Fed Funds rate unchanged at the August 19 meeting as there were no signals of accelerating inflation. At the September 30 the Fed maintained the Fed Funds target at 5.5% in spite of signals that third quarter growth might be rapid: inflation was not show any signs of revival. The third quarter GDP growth turned out to be 3.3% and unemployment rate fell further to 4.7% in the fall. In spite of signals of tightness in the labor market, Fed policy at the Nov 12 FOMC meeting was strongly affected by the worsening of the Asian crisis and its contagion to international stock markets in late October: the Fed kept the Fed Funds target steady to calm jittery international investors. The lack of inflationary pressures in spite of very high employment growth in November and the expected slowdown of the US economy as a consequence of the Asian crisis also weighed in the Fed decision.
Moved by lower inflation numbers and the deepening financial crisis in Asia, the FOMC decided on December 16 to leave the Fed Funds rate unchanged. The Fed policy board's decision, taken at its last meeting of the year, was widely expected. It left the fed funds rate at 5.5 percent. The fed funds rate was last raised in March, then the first hike in more than two years. The Fed was likely influenced by forecasts that the Asia crisis will slow U.S. growth by anywhere from a quarter percentage point to three-quarters of a percentage point during 1998. That would slow economic expansion from the 4 percent seen over the past year to a more sustainable rate. The move was also widely expected following Labor Department statistics released the same day that showed inflation being very low in November. The consumer price index rose only 1.7% in 1997, down from 3.3% in 1996, the lowest inflation rate since 1986. Also, Fed Governor Laurence Laurence Meyer suggested in a speech on January 8, 1998 that monetary policy in 1998 might actually be eased as a consequence of the Asian crisis. ``A much larger spillover from the Asian crisis could encourage an easing. Continued above-trend growth and a further rise (in labor market) utilization rates, on the other hand, could encourage further tightening,'' he said.
The Fed Fund Rate was left at 5.5% at the March 1998 meeting of the FOMC in spite of many indicators that the economy had not slowed down in the first quarter in spite of the Asian crisis. The Q1-98 GDP growth estimate (released at the end of April) turned out to be a strong 4.2% but GDP price inflation fell to an annualized 0.9%, another sign that inflation is very low.
The April 1998 employment report showed continued strength in the economy with the unemployment rate falling from 4.7% to 4.3%. Despite the strength evident in April's 1998 employment report, most economists doubt that Fed policy makers will lift rates at the May 19 FOMC meeting. However, economists said that several aspects of the April employment report likely will trouble the Fed: Another month of rapid growth in payrolls; a 4.4% rise in hourly earnings over the last year; and an unemployment rate that's uncomfortably low at 4.3%. While the report bolsters the case for an eventual tightening of monetary policy, the timing of such an event depends on Fed Chairman Alan Greenspan. At the very least, the April employment data will reinforce the split between Fed officials who argue for higher interest rates and those who support unchanged policy. The need to evaluate Asia's impact on the U.S. economy may not prove strong enough to keep the Fed on hold for long. At his Humphrey-Hawkins testimony in February, Greenspan indicated that the Fed would have to wait until the spring to fully assess the impact of Asia's economic crisis on the U.S.
What started in the summer of 1997 as a regional economic and financial crisis in East Asia developed into a global financial turmoil by the summer of 1998. By August 1998, Japan was in a serious recession and there were concerns that the failure to pursue banking and structural reforms may lead to a further fall of the yen. That could have eventually triggered a devaluation of the Chinese currency, followed by renewed pressures on the Hong Kong dollar peg leading to another round of stagflationary competitive devaluations in the entire Asian region. The economic recession in East Asia was severe and spreading from the crisis countries (Korea, Indonesia, Thailand and Malaysia) to Hong Kong, Singapore, the Philippines and Taiwan with economies slowing down throughout the East Asian region.
The Indian subcontinent was fragile with Pakistan having serious external balance and debt problems and India also facing economic difficulties.
Russia was in a serious economic crisis following the the collapse of the ruble, the decision to unilaterally reschedule the domestic currency public debt and impose capital controls. A crisis in Eastern Europe could have affected Western Europe where the current economic recovery is solid but not very rapid.
The crisis in Russia led to rapid contagion contagion to Latin America by the end of August: Venezuela's and Brazil's currencies came under pressure and stock markets throughout the region were significantly down. While Latin American economies are structurally stronger than Russia, investors became increasingly averse to risk. The concern was that a devaluation in Brazil could lead to contagion and currency devaluations in Venezuela, Argentina, Chile, Colombia and Mexico. Emerging market spreads over Treasuries rose sharply after the Russian crisis, to about 1500 basis points, and in September came close to their highs during the 1995 Mexican peso crisis. The appetite for risk of international investors had sharply fallen and there was a major retrenchment from emerging markets towards safe haven assets and from stocks towards liquidity.
Even advanced industrial countries were not been spared. The fall in commodity prices led to currency devaluations in Canada, Australia and New Zealand; the latter two were already headed towards a recession given their tight trade links with East Asia. In Latin America, the fall in oil prices hit Mexico and Venezuela, the fall in copper prices hurt Chile and Peru while the fall in agricultural prices affected Argentina. Globally, all commodity exporters were hurting.
Economic fundamentals were still very strong in the US but the global turmoil was expected to lead to a growth slowdown in the US; the stock fall in the stock market in the summer was already reflecting such a possibility of an economic slowdown. The contagion from Russia to Latin America seriously affected capital markets even in the U.S. and Europe. The losses incurred by financial institutions in Russia and emerging markets and the near collapse of
LTCM led to a serious liquidity squeeze in US capital markets. By September 1998, the risks of a global recession in 1999 had significantly increased.
The international capital markets experienced a severe crisis in August and September with concerns about a global financial meltdown.
The U.S. Fed responded to the global crisis by reducing interest rates three times between September and November 1998 for a total of 75 basis points, signaling a strong commitment to prevent a global and US crisis and minimize the risks of a liquidity crisis in the US. The US Fed rate cut was followed by a series of uncoordinated interest rate reductions in Japan, Canada, several European countries and 20 other countries around the world; this helped to restore liquidity and confidence of investors and markets in October and November. The recovery in confidence is signaled by several develpments: the emerging markets sovereign spreads over Treasuries fell from 1500 basis points to 1100 basis points; spreads over Treasuries of US corporate bonds also fell significantly; and stock markets recovered in the US, Latin America, Asia and the rest of the emerging markets.
While monetary conditions were eased in the winter of 1998 following the concerns about the effects of the global crisis on the US economy, the performance of the US economy remained very strong throughout 1998 with growth being over 6% in the last quarter of 1998. Labor markets remained tight with the lowest unemployment rate in 30 years. At the same time there was no evidedence of an increase wage and price inflation, a quite remarkable performance given the strong growth of output and employment. In the first quarter of 1999, the economy appeared to continue its path of sustained growth with low inflation.
To answer the question about what the Fed will do next, it would be useful to look at some discussions of the Fed's recent decision making. For example look at the commentary around FOMC meeting dates made by some major Wall Street economists such as the First Union Bank; the Morgan Stanley Global Economic Forum; or Dr. Ed Yardeni's Economics Network. Some broader discussion of the economy and monetary policy can be found in the Federal Reserve Bank of Cleveland's monthly Economic Trends.
Some hints about the Fed's own intentions and thoughts can be found in the Minutes of the Federal Open Market Committee. The minutes of each meeting are not released until the Friday after the following meeting. However, the minutes of the important previous FOMC meetings are available. Also, available are the Fed's semi-annual Monetary Policy Report to Congress on monetary policy and the economy (last issued in February, 1999) and the companion Greenspan's testimony.
In addition, the twelve regional Federal Reserve Banks collect information on the economy which is gathered together before the FOMC meeting and made public. The Beige Book is released before each FOMC meeting and can be found on the web. See also a WSJ article on 1/27/97 discussing the variables considered by Chairman Greenspan in deciding whether to change interest rates.
Of course, discussion and speculation concerning
a change in policy will be in the newspapers and it would make sense to
keep an eye on The
Economist, the Wall Street Journal or The