Fomc 20030625 Material

Appendix 1: Materials used by Mr. Reinhart

June 24-25, 2003 163 of 211

Exhibit 1

Costs associated with a low overnight nominal interest rate

Compressing rateson those instrumentsthat typically providereturns below the overnightfederal funds rate.

Thinning brokering; and

Fostering the misimpression thatmonetary policy has become ineffective.

Federal funds rate

0369

121518

1955 1960 1965 1970 1975 1980 1985 1990 1995 2000

annu

al av

erage

perce

nt

Selected interest ratesMay 20, 2003

0 0.2 0.4 0.6 0.8 1 1.2 1.4

Intended funds

RP

I/O MMMF

Retail MMMF

MMDA

Super NOW

percentSource: Bank Rate Monitor

June 24-25, 2003 164 of 211

Exhibit 2

The Implementation of Monetary Policy

Monetary policy actions are implemented byaltering the Federal Reserve System's balance sheet.

Combined balance sheet of the Federal Reserve SystemBillions of U.S. dollars, 6/11/2003ASSETS LIABILITIES & CAPITALTreasury securities 652 Currency 693of which: Deposits Bills 238 of depositories 21 Notes & bonds 399 of U.S. Treasury 7

Loans to depositories 0.06 Other liabilities 20Other assets 89 & capital

Changes in the size of the balance sheet

are reflected directly in the overnight federal funds rate until it is driven to zero

Changes in the composition of the balance sheet

potentially could influence term premiums

Both could influence expectations about the expected pathof policy.

June 24-25, 2003 165 of 211

Exhibit 3

The Transmission of Monetary Policy

The principal channel of transmission of monetary policy to spending is through the prices and returns of long-lived assets. Those returns depend on the current and expected future path of short-term interest rates as well as riskpremiums. Some economists argue that the quantity of liquidityhas an effect on spending independent of its influenceon the current overnight interest rate.

Three forms of monetary impetus

The Committee can provide impetus to the economy atan unchanged current short-term interest rate

By encouraging investors to expect short rates to be lower in the future than they currentlyanticipate, and

By shifting relative supplies to affect risk premiums.

If the overnight rate is already at zero, the Committee may be able toprovide additional impetus to the economy

By oversupplying reserves at the zero funds rate.

June 24-25, 2003 166 of 211

Exhibit 4

Shaping interest rate expectations

How can the Federal Reserve encourage lower interest rate expectations?

Commitment can take two forms

Unconditional commitment

The Committee pledges to hold short-term rates at a low level for x period of time.

Conditional commitment

The Committee pledges to hold short-term rates at a low level until y happens.

Caveats

Words ultimately have to be matched by deeds for the public to believe. The Committee may be concerned about its credibility.

Expected short-term nominal interest ratesimplied by swap yields, June 3, 2003

0.8

1.8

2.8

3.8

4.8

spot 1 2 3 4 5 6 7 8 9

years ahead

perce

nt

Swap yield curveJune 3, 2003

0.81.31.82.32.83.33.8

1 2 3 4 5 6 7 8 9 10

perce

nt

June 24-25, 2003 167 of 211

Exhibit 5

Altering the composition of the central bank balance sheet

Acquiring longer-term securities

could lower risk premiums on Treasury securities, and

may convince investors that the Committee intends to keep interest rates low becauselengthening the maturity of the portfolio would impose capital losses in the futureshould the Committee put policy on a firmer course than currently anticipated.

The Committee could alter the composition of the System Open Market Account

indirectly, by instructing the Desk to tilt its purchases toward longer-term issues (perhaps by targetinga longer average maturity of the System Open Market Account), or

directly, by putting a ceiling on one or more points along the structure of interest rates.

Caveats

There is little empirical evidence to suggest that relative supplies influence risk premiums. Purchases of securities might have to be massive to enforce a ceiling if investors cameto doubt that the FOMC would keep interest rates low. At that point, there would be a risk that the targeted securities would becomedisconnected from the rest of the yield curve and private rates.

Why should a central bank issuing a fiat currency care about capital gains or losses?

Average Maturity of Treasury Debt

01020304050607080

1955 1958 1961 1964 1967 1970 1973 1976 1979 1982 1985 1988 1991 1994 1997 2000

mont

hs

Held by the System

Held by the public

June 24-25, 2003 168 of 211

Exhibit 6

Altering the size of a central bank's balance sheet

A central bank usually eases monetary policy by expanding the stock of reserves. Currently, most central banks calibrate their easing in terms of the priceof reserves--i.e., the overnight federalfunds rate.

The Committee could switch its focus fromthe price of reserves to the quantity of reserves (or the growth of reserves).

to drive the funds rate to zero andpossibly provide further monetarystimulus by oversupplying reservesat the zero funds rate.

Oversupplying reserves could affect the economy

by lowering the returns on the assets purchased to supply those extra reserves,

by convincing market participants that the overnight interest rate will be kept low, and

by working through a quantity channel, if it exists.

Caveats

A long-run association does not provide much guidance about the short-runperformance of the economy, implying it would be difficult to calibrate the effectsof policy and risks confusing market participants. The public has to be convinced that the increase in reserves will stick around, so there stillwill be a communications challenge.

overnight Supplyinterestrate

Demand

Reserves

overnight Supplyinterestrate

Demand

Reserves

June 24-25, 2003 169 of 211

Exhibit 7

Some precedents

The Federal Reserve has always appreciated the importance of correctly aligning market expectations.

The Federal Reserve operates in all segments of the Treasury market, and from 1942 to 1951 enforced a ceiling on the yield curve.

The Federal Reserve targeted nonborrowed reserves from 1979 to 1982.

Expected federal funds rate

0.81

1.21.41.61.8

May

-03

Jul-0

3

Sep-

03

Nov

-03

Jan-

04

Mar

-04

May

-04

Jul-0

4

Sep-

04

Note: Futures rates less 1 b.p. per month term premium

perce

nt

5-May

6-May

Federal Reserve Holdings of U.S. Treasury SecuritiesTotal

0

5

10

15

20

25

1938 1943 1948 1953 1958 1963 1968 1973 1978 1983 1988 1993 1998

perce

nt, n

et de

bt ou

tstan

ding

Monetary Base

-5

0

5

10

15

20

1960 1963 1966 1969 1972 1975 1978 1981 1984 1987 1990 1993 1996 1999 2002

annu

al pe

rcent

chan

ge

. . . and by maturity

0

25

50

75

100

1942 1946 1950

perce

nt, n

et de

bt ou

tstan

ding

BillsNotes

Y2K Options sold by the Desk

0 50 100 150 200 250

12/23 to 12/29

12/30 to 1/5

1/6 to 1/12

for w

eek of

$billions of notional value

June 24-25, 2003 170 of 211

Exhibit 8

Issues regarding sequencing

These forms of monetary policy stimulus could be put in place

Once the overnight rate has already been driven to zero; As a way of driving the overnight rate to zero; or Before the overnight rate hits zero (and perhaps as a resultit need never get there).

Other alternatives

The Federal Reserve could

lower the primary credit rate and loosen other discount window policies;

purchase other assets, perhaps including by seeking legislation to expand its authority; or

coordinate policy with the Treasury.

June 24-25, 2003 171 of 211

Exhibit 9

Four questions

Are there any alternatives that the Committee particularlyfavors for additional study?

Are there any alternatives that should be dropped immediatelyfrom consideration?

How does the Committee assess the costs of very low nominal overnight interest rates, and are they such that an alternative policy should be put in place at a funds rate above zero?

How should the Committee’s assessment of these policy alternatives be conveyed to the public in the months ahead?

June 24-25, 2003 172 of 211

Appendix 2: Materials used by Mr. Kos

June 24-25, 2003 173 of 211

Exhibit 1

The F.R. Balance Sheet & Domestic Financial Portfolio

Combined balance sheet of the Federal Reserve SystemBillions of U.S. dollars, 6/11/2003

ASSETS LIABILITIES & CAPITALTreasury securitiesof which:BillsNotes and bondsTIIS

RPs

Loans to depositories

Other Assets

Total Assets

652

23839914

32

<1

60

744

F.R. NotesDeposits

of depositoriesof U.S. Treasury

Reverse RPsin the market

Other liabilities

Capital

Total Liabilities& Capital

659

296

0

32

18

744

The Domestic Financial Portfolio includes

* Outright Holdings of Treasury Securities (domestic SOMA)

* RPs, and Reverse RPs arranged in the market

Working Assumption

* only operate in assets currently authorized to hold

June 24-25, 2003 174 of 211

Exhibit 2Size and Composition of SOMA Holdings of Treasury Securities by Remaining Maturity

Millions of Dollars Millions of Dollars700,000 700,000

600,000 600,000

500,000 More Than 10 Years 500,000

400,000 5 to 10 Years 400,000

1 to 5 Years

300,000 300,000Less Than 1 Year: Coupons

200,000 Bills 200,000

100,000 - 100,000

1941 1946 1951 1956 1961 1966 1971 1976 1981 1986 1991 1996 2001

Percent Percent100% 100%

More Than 10 Years

90% 90%

80% 80%

70% 70%

60% 60%

50% 50%

40% 40%

30% 30%

20% 20%Bills

10% 10%

0% 0%1941 1946 1951 1956 1961 1966 1971 1976 1981 1986 1991 1996 2001

Data from 1971 to 1978 are at an annual frequency.

June 24-25, 2003 175 of 211

Exhibit 3

Targeting a Positive Federal Funds Rate

plotted values reflect experience with excesslevels and target funds rates since 1985

Period-Average Excess Reserves (bil. $)

10-9-876-5-4-3-2-1-

June 24-25, 2003 176 of 211

Exhibit 4

Alternative Approaches for Conducting Monetary Policy

Change the Composition of the Balance Sheet

- Extend Average Maturity of the domestic SOMA

- Set Ceilings on Treasury Yields

- Use of Derivative Instruments

* excess reserves stay low and can target a positive funds rate

June 24-25, 2003 177 of 211

Exhibit 5

Issues Associated with Alternative Approaches

* Operating Objectives

* Instruments and Market Intervention Techniques

* Achieving Policy Objectives

* Exit Strategies

* Co-Ordination with Treasury Debt Management

* Potential for Capital Losses

June 24-25, 2003 178 of 211

Exhibit 6

Extend Average Maturity of the Domestic SOMA

* redeem $200 billion of bills over six months (=$8 bn. per week)

* buy 3- to 10-year coupon issues (equal percentage holdings of each issue)

* this extends average maturity of SOMA from 42 to 64 months

* but eliminates most liquidity in the domestic SOMA

SOMA Holdings

Value of Holdings* Now H After 6 months

350300

50

Bills 0-3 3-10 10-30

Bills, and Coupons by Years to Maturity

Percent of Outstanding Supply* Now E After 6 months

50%

40%

30% -20% -

10% -

Bills 0-3 3-10 10-30

Bills, and Coupons by Years to Maturity

June 24-25, 2003 179 of 211

Exhibit 7

Ceilings on Treasury Yields

Design Issues

* Ceiling structures: step function; smooth function; discrete points, etc.

* Desk Operations: "Hard" versus "Soft" ceilings

* Broader Policy Context

- the primary mechanism for influencing longer term yields

- supports commitment to a path of future short-term rates

Structure of Ceilings

3

2.5

2

V 1 .5

0.5

01 2 3 5 10

Years to M aturity

June 24-25, 2003 180 of 211

Exhibit 8

Use of Derivative Instruments

Types of Instruments

* Sell options and forwards on term RPs with future settlement dates

* Sell put options on Treasury Securities

=> Best structure determined by other specific operating objectives

June 24-25, 2003 181 of 211

Exhibit 9

Reverse RPs and Higher Requirements

Reverse RPs and higher requirements are additional tools that:

- blow up the size of the balance sheet

- but can still target a positive funds rate

Expand Level of Reverse RPs

* term operations, regular auction cycle

* financing through primary dealers' balance sheets may be a constraint

* replacing long-term Treasury debt with a short-term nonnegotiable debt

* but it may just recycle Treasury debt

June 24-25, 2003 182 of 211

Exhibit 10

Expanding Excess Reserves

Policies that entail an expansion of excess reserves

- also blow up the size of the balance sheet

- and push the funds rate to near-zero

High Excess as an Explicit Objective: Quantitative Easing

* achieved with an orderly purchase of Treasury securities

* could be paired with an objective to extend the maturity of the SOMA

June 24-25, 2003 183 of 211

Exhibit 11

Summary Observations

June 24-25, 2003 184 of 211

Appendix 3: Materials used by Mr. Kos

June 24-25, 2003 185 of 211

0.501.001.502.002.503.003.504.004.505.005.506.00

Sep-03 Mar-04 Sep-04 Mar-05 Sep-05 Mar-06 Sep-06 Mar-07 Sep-07 Mar-08 Sep-080.501.001.502.002.503.003.504.004.505.005.506.00

Implied Rates on Eurodollar Futures ContractsComparison of May 5, June 16 and June 23, 2003 5-Year Projections PercentPercent

June 16, 2003May 5, 2003

Source: Bloomberg

U.S. Treasury YieldsApril 1, 2003 - June 23, 2003

3.00

3.25

3.50

3.75

4.00

4.25

4/1 4/15 4/29 5/13 5/27 6/103.00

3.25

3.50

3.75

4.00

4.25

10-Year NotePercent Percent

0.75

1.00

1.25

1.50

1.75

2.00

4/1 4/15 4/29 5/13 5/27 6/100.75

1.00

1.25

1.50

1.75

2.00

2-Year Note PercentPercent

Source: Bloomberg Source: Bloomberg

6/3 Chairman’s comments to IMC


Option-Adjusted Spreads of U.S. Corporates to 10-Year TreasuriesApril 1, 2003 - June 23, 2003

500

550

600

650

700

4/1 4/15 4/29 5/13 5/27 6/10500

550

600

650

700

High Yield and EMBI+Basis Points Basis Points

120

130

140

150

160

170

4/1 4/15 4/29 5/13 5/27 6/10120

130

140

150

160

170

Investment Grade Basis PointsBasis Points

Source: Lehman BrothersSource: Merrill Lynch,JP Morgan Chase



EMBI+ Spread

High Yield

5/6 FOMC 5/6 FOMC

5/6 FOMC 5/6 FOMC

June 23, 2003

June 24-25, 2003 186 of 211

U.S. Equity IndicesApril 1, 2003 - June 23, 2003

100

105

110

115

120

125

4/1 4/8 4/15 4/22 4/29 5/6 5/13 5/20 5/27 6/3 6/10 6/17100

105

110

115

120

125

Index4/1/03 = 100

Source: Bloomberg 6/3 Chairman’scomments to IMC

S&P 500

DJ Industrial Average

Nasdaq

Index4/1/03 = 100

90

100

110

120

130

140

150

4/1 4/8 4/15 4/22 4/29 5/6 5/13 5/20 5/27 6/3 6/10 6/1790

100

110

120

130

140

150

Select Emerging Market Equity IndicesApril 1, 2003 - June 23, 2003

Index4/1/2003 = 100

Index4/1/2003 = 100

Korea Composite

Mexican Bolsa

Source: Bloomberg 5/6 FOMC

Merval

90

100

110

120

130

140

4/1 4/8 4/15 4/22 4/29 5/6 5/13 5/20 5/27 6/3 6/10 6/1790

100

110

120

130

140

Select Global Equity IndicesApril 1, 2003 - June 23, 2003

Index4/1/2003 = 100

Index4/1/2003 = 100

DAX DJ Euro Stoxx

Source: Bloomberg 6/3 Chairman’scomments to IMC

FTSE

Nikkei

5/6 FOMC

6/9 Freddie Macmanagement change

5/6 FOMC 6/6 ECB rate cut-50 bp

Hang Seng

Brazil Bovespa

TSE 300

June 24-25, 2003 187 of 211

Euro-Dollar Exchange RateApril 1, 2003 - June 23, 2003

1.05

1.10

1.15

1.204/1 4/8 4/15 4/22 4/29 5/6 5/13 5/20 5/27 6/3 6/10 6/17

1.05

1.10

1.15

1.20

U.S. Dollars per Euro(inverted scale)

U.S. Dollars per Euro(inverted scale)

Source: Bloomberg

5/6 FOMC

115

116

117

118

119

120

121

122

4/1 4/8 4/15 4/22 4/29 5/6 5/13 5/20 5/27 6/3 6/10 6/17115

116

117

118

119

120

121

122Yen per U.S. DollarYen per U.S. Dollar

Dollar-Yen Exchange Rate April 1, 2003 - June 23, 2003

Source: Bloomberg

85

90

95

100

105

110

Jan-99 Jul-99 Jan-00 Jul-00 Jan-01 Jul-01 Jan-02 Jul-02 Jan-0385

90

95

100

105

110

Trade Weighted U.S. DollarJanuary 1, 1999 - June 23, 2003 PercentPercent

Source: Bloomberg (BoG index)

5/12 and 5/19Treasury Secretary Snow comments on the USD

5/30 and 6/2President Bush reiterates “strong dollar” policy

5/6 FOMC 5/12 and 5/19Treasury Secretary Snow comments on the USD

5/30 and 6/2President Bush reiterates “strong dollar” policy

Japanese InterventionSince May 6: $36.89bYTD: $56.37b

June 24-25, 2003 188 of 211

Euro-Area 3-Month Deposit Rates and RatesImplied by Traded Forward Rate Agreements

April 1, 2003 - June 23, 2003LIBOR Fixing 3M Forward 6M Forward 9M Forward

1.50

1.75

2.00

2.25

2.50

2.75

4/1 4/8 4/15 4/22 4/29 5/6 5/13 5/20 5/27 6/3 6/10 6/171.50

1.75

2.00

2.25

2.50

2.75

Percent Percent

0

50

100

150

200

250

300

Jan-01 May-01 Sep-01 Jan-02 May-02 Sep-02 Jan-03 May-030

50

100

150

200

250

300

Index of Euro Corporate Spreads to German Government DebtJanuary 1, 2001 - June 23, 2003 Basis

PointsBasisPoints

AA

BBB

A

AAA

JapanJanuary 1, 2003 - June 23, 2003

0.40

0.50

0.60

0.70

0.80

0.90

1.00

1/1 2/1 3/1 4/1 5/1 6/10.40

0.50

0.60

0.70

0.80

0.90

1.0010-Year JGB YieldPercent Percent

15

20

25

30

35

1/1 2/1 3/1 4/1 5/1 6/115

20

25

30

35

BOJ CurrentAccount Balances Yen TrillionYen Trillion


5/16 Resona Holdings

4/1 Beginning of new fiscal year

Actual balance

5/16 Resona Holdings

6/6 ECB rate cut-50 bp

5/6 FOMC

Shaded band = target balance

June 24-25, 2003 189 of 211

80

85

90

95

100

105

110

115

120

1/1 1/16 1/31 2/15 3/2 3/17 4/1 4/16 5/1 5/16 5/31 6/1580

85

90

95

100

105

110

115

120

Index1/1/03 = 100

Page 5

20

30

40

50

60

1/1 1/16 1/31 2/15 3/2 3/17 4/1 4/16 5/1 5/16 5/31 6/1520

30

40

50

60

GSE 10-Year Debt Spread to 10-Year Treasury NoteJan 1, 2003 - June 23, 2003 Basis PointsBasis Points

Freddie Mac and Fannie Mae Equity Prices Jan 1, 2003 - June 23, 2003

Source: Bloomberg

Source: Bloomberg

Freddie Mac

Fannie Mae

Index1/1/03 = 100

Freddie Mac

Fannie Mae

Freddie Mac vs. Fannie Mae SpreadsApril 1, 2003 - June 23, 2003

-10

-5

0

5

10

15

4/1 4/15 4/29 5/13 5/27 6/10-10

-5

0

5

10

15

MBSBasis Points Basis Points

-10

-5

0

5

10

15

4/1 4/15 4/29 5/13 5/27 6/10-10

-5

0

5

10

15

10-Year Debt Yield Basis PointsBasis Points



6/9 Freddie Mac management change


1/22 Freddie Mac announcement of earnings restatement


1/22 Freddie Mac announcement of earnings restatement

5/6 FOMC

5/6 FOMC

5/6 FOMC5/6 FOMC

S&P 500

June 24-25, 2003 190 of 211

Appendix 4: Materials used by Mr. Oliner, Ms. Johnson, and Mr. Wilcox

June 24-25, 2003 191 of 211

STRICTLY CONFIDENTIAL (FR) CLASS I-FOMC*

Material for

Staff Presentation on the Economic Outlook June 24, 2003 *Downgraded to Class II upon release of the July 2003 Monetary Policy Report.

June 24-25, 2003 192 of 211

June 24-25, 2003 193 of 211

June 24-25, 2003 194 of 211

1991 1993 1995 1997 1999 2001 2003200

300

400

500

600Filings per 100,000 persons

Personal Bankruptcy Rate*

Quarterly, annual rate

*Based on data through June 14.

Q2*

1991 1993 1995 1997 1999 2001 20031.5

2.5

3.5

4.5Percent

Auto loans at finance companies

Household loans at commercial banks*

Apr.

Q1

Household Delinquency Rates

* Consumer and residential real estate loans.

1991 1993 1995 1997 1999 2001 2003

0

1

2

3

4

5

6Percent of mortgage debt

-150

-100

-50

0

50

100

150

200

250Basis points

Monthly

Coupon gap*

Refinancing volume

*30-year fixed mortgage rate minus average rate on mortgages in GSE pools.

Mortgage Market Indicators

June

June

1980 1984 1988 1992 1996 2000 200415

16

17

18

19Percent of DPI

NBER peak

1980 1984 1988 1992 1996 2000 200415

16

17

18

19Percent of DPI

Augmented Debt Service Burden*

Quarterly

*Standard series augmented to include rent payments, auto lease payments, property taxes, and homeowners’ insurance.

1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004-6

-4

-2

0

2

4

6

8

10Percent

NBER peak

1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004-6

-4

-2

0

2

4

6

8

10Percent

Four-quarter percent change

Real House Prices*

*OFHEO repeat sales index deflated by core PCE chain-weight price index.

Chart 3

Household Financial ConditionsJune 24-25, 2003 195 of 211

1999 2000 2001 2002 2003-20

-10

0

10

20

30

40

50

BondsCommercial paper and C&I loans*

Monthly rate

Billions of dollarsComponents of Net Debt Financing,Nonfinancial Corporations

Q1Q2e

* Seasonally adjusted. e Staff estimate.

1989 1991 1993 1995 1997 1999 2001 200323

25

27

29

31

33

35Percent

3

4

5

6

7

8

9

10

Debt Ratios for Nonfinancial CorporationsPercent

* Current debt equals short-term notes and the portion oflong-term debt due within one year. Source. Compustat.

Debt to Assets

Current Debt to Assets*

Q1

Q1

1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 30

40

50

60

70

80

90

100Percent of after-tax cash flow

Investment Grade

Speculative Grade

Debt Service Obligation of Nonfinancial Corporations*

Median firm in each period

* Ratio of interest expense plus current debt to after-tax cash flow. Source. Compustat.

Q1

Q1

Defined-Benefit Pension Plans

● Contributions by S&P 500 firms tripledin 2002, reaching $45 billion.

● Funding gap is concentrated amonginvestment-grade firms.

● Even for these firms, last year’scontributions amounted to only a smallpart of their cash flow.

1998 1999 2000 2001 2002 20030.0

0.5

1.0

1.5

2.0

2.5Percent

0

50

100

150

200

250

300Basis PointsMarket Indicators of Corporate Financial Positions

Monthly

May

June

Ten-YearBBB Yield

Spread

KMV ExpectedYear-Ahead

Defaults*

* Weighted by firm-level liabilities. Excludes defaulted firms.

Chart 4

Corporate Financial ConditionsJune 24-25, 2003 196 of 211

June 24-25, 2003 197 of 211

Chart 6

Financial Developments

70

80

90

100

110

Nominal Dollar Indexes

Major currencies*

Broad**

2001 2002 2003 *Trade-weighted average against major foreign currencies.**Includes major currencies and other important trading partners.

Weekly

Index, Jan. 30, 2002 = 100

70

80

90

100

110

Nominal Exchange RatesFor. cur./U.S.$

Weekly

Yen

Euro

C$

2001 2002 2003

Index, Jan. 30, 2002 = 100

-2

-1

0

1

2

3

4

5

Long-term Interest Rate Differentials*U.S. minus foreign

Germany

Japan

Canada

*10-year Treasury yields minus foreign government bond yields.2001 2002 2003

Weekly

Percentage points

5

15

25

35

45

55

65

75

5

10

15

20

25

EMBI+ Spreads

2001 2002 2003

Brazil

Argentina

Weekly

Percentage points Percentage points

40

60

80

100

120

140

160

Stock PricesEmerging Markets

2001 2002 2003

Mexican Bolsa

Korean Kospi

H.K. Hang Seng

Weekly

Index, July 2, 2001 = 100

40

60

80

100

120

140

160

Stock PricesIndustrial Countries

S&P 500

TOPIX

DJ Euro Stoxx

2001 2002 2003

Weekly

Index, July 2, 2001 = 100

June 24-25, 2003 198 of 211

Chart 7

Effects of U.S. Dollar Depreciation

2002 2003-0.5

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

Import price inflation

PCE inflation

Constant Short-Term Interest Rates U.S. PCE Inflation and Import Price Inflation

Percentage point contribution, AR

2002 20030.0

0.2

0.4

0.6

0.8

1.0

U.S. Real GDP GrowthPercentage point contribution, AR

2002 2003-0.5

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

Import price inflation

PCE inflation

Taylor Rule Case U.S. PCE Inflation and Import Price Inflation

Percentage point contribution, AR

2002 20030.0

0.2

0.4

0.6

0.8

1.0

U.S. Real GDP GrowthPercentage point contribution, AR

Effects in Foreign Countries

*Exchange rates and short-term interest rates at 2002:Q1 values.**Taylor Rules govern short-term interest rates. Exchange rates react.

(Contribution in percentage points, AR)

PCE Inflation Real GDP Growth

2002 2003

Fixed* Taylor** Fixed Taylor

2002 2003

Fixed Taylor Fixed Taylor

Canada -.1 .4 -2.7 .0 -.3 .0 -.8 .7

Euro area -.9 -.7 -3.6 -1.6 -.5 -.3 -2.8 -1.2

Japan -.4 -.4 -.3 .0 -.5 -.4 -.3 .0

U.K. -.2 -.2 .3 -.1 -.3 -.3 -.8 -.6

Dev. Asia .7 .6 2.0 .8 -.2 -.2 2.7 1.8

Mexico 2.7 .6 5.4 -.2 2.5 .5 6.4 -.1

June 24-25, 2003 199 of 211

Chart 8

Monetary Policy Stance Abroad

2002 2003 2004-3

-2

-1

0

1

2

*(Actual GDP - Potential GDP)/Potential GDP.

Euro Area

Output Gap*Percent

2002 2003 2004-3

-2

-1

0

1

2

*(Actual GDP - Potential GDP)/Potential GDP.

Canada

Output Gap*Percent

0

1

2

3

4

5

Q2 Q3 Q4 Q1 Q22002 2003

Policy Rate

June 2002 Greenbook

3-month euribor futures (week of June 26, 2002)

Actual and Projected Policy RatesPercent

0

1

2

3

4

5

Q2 Q3 Q4 Q1 Q22002 2003

Policy Rate

June 2002 Greenbook

3-month Banker’s Acceptances futures (week of June 26, 2002)

Actual and Projected Policy RatesPercent

0

1

2

3

4

5

6

7

8

*Weights of 1/2 each on output gap and difference of inflation from 2 percent.**6-quarter ahead staff forecast for headline inflation.

Q2 Q3 Q4 Q1 Q22002 2003

Policy Rate

Taylor Rule #1

Taylor Rule #2**

Policy Rates Implied by Taylor Rules*Percent

0

1

2

3

4

5

6

7

8

*Weights of 1/2 each on output gap and difference of inflation from 2 percent.**6-quarter ahead staff forecast for headline inflation.

Q2 Q3 Q4 Q1 Q22002 2003

Policy Rate

Taylor Rule #1

Taylor Rule #2**

Policy Rates Implied by Taylor Rules*Percent

June 24-25, 2003 200 of 211

Chart 9

U.S. External Outlook

2001 2002 2003 200490

95

100

105

June 03 Greenbook

Jan. 03 GreenbookBroad Index

Real Exchange Rate OutlookIndex, 2001:Q1 = 100

2002 2003 2004-3

-2

-1

0

1

2

3

ExportsImports

Contribution to U.S. GDP GrowthPercentage points

1996 1998 2000 2002 2004-7

-5

-3

-1

1

-700

-500

-300

-100

100

Level

Percent of GDP

Current Account Balance Percent Billions of dollars

of which:

of which:

2002 2003:Q1

1. Official capital, net 91 1442. Private capital, net 437 307 of which: 3. For. purch. of U.S. sec. 388 2584. Equities 55 -135. U.S. purch. of for. sec. 16 -1036. Equities -18 -1337. For. D.I. in U.S. 40 1038. U.S. D.I. abroad -138 -116

Financial Flows Billions of dollars, AR

Real GDP Growth: Industrial CountriesPercent, SAAR*

*Years are Q4/Q4; half years are Q2/Q4 or Q4/Q2.**Aggregates weighted by shares of U.S. exports.

2002 2003 H2 H1 H2

1. Total Foreign** 2.1 0.6 2.6 3.4

2. Indust. countries 1.9 1.0 1.8 2.5

of which:

3. Euro Area 0.8 0.2 0.7 2.0

4. Japan 2.1 0.2 0.2 1.0

5. Canada 2.2 1.7 2.9 3.2

6. United Kingdom 2.9 0.9 1.8 2.5

2004

Real GDP Growth: Developing CountriesPercent, SAAR*

*Years are Q4/Q4; half years are Q2/Q4 or Q4/Q2.**Aggregates weighted by shares of U.S. exports.

2002 2003 H2 H1 H2

1. Total Developing** 2.4 -0.0 3.8 4.82. Developing Asia 4.4 1.3 4.5 5.7 of which:3. China 7.1 6.2 7.2 8.14. Korea 6.1 0.5 5.7 5.4

5. Latin America 0.7 -1.5 3.3 4.4 of which:6. Mexico 1.1 -0.7 2.8 5.07. Brazil 3.5 0.9 2.7 3.0

2004

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June 24-25, 2003 202 of 211

June 24-25, 2003 203 of 211

June 24-25, 2003 204 of 211

Chart 13

ECONOMIC PROJECTIONS FOR 2003

FOMC

Range CentralTendency

Staff

-------------Percentage change, Q4 to Q4------------

Nominal GDP February 2003

Real GDP February 2003

PCE Prices February 2003

3½ to 4¾ (4½ to 5½)

2¼ to 3(3 to 3¾)

1 to 1¾

(1¼ to 1¾)

3¾ to 4½(4¾ to 5)

2½ to 2¾(3¼ to 3½)

1¼ to 1½(1¼ to1½)

4.1(4.8)

2.9(3.6)

1.3(1.3)

--------------Average level, Q4, percent---------------

Unemployment rate February 2003

6 to 6¼(5¾ to 6)

6 to 6¼(5¾ to 6)

6.1(6.1)

Central tendencies calculated by dropping high and low three from ranges.

ECONOMIC PROJECTIONS FOR 2004

FOMC

Range CentralTendency

Staff

-------------Percentage change, Q4 to Q4------------

Nominal GDP Real GDP

PCE Prices

4¾ to 6½

3½ to 5¼

¾ to 2

5¼ to 6¼

3¾ to 4¾

1 to 1½

6.5

5.3

.8

--------------Average level, Q4, percent---------------

Unemployment rate 5½ to 6¼

5½ to 6

5.4

June 24-25, 2003 205 of 211

Appendix 5: Materials used by Mr. Reinhart

June 24-25, 2003 206 of 211

Exhibit 1

Expected Federal Funds Rates* Percent- 3.5

June 24, 2003sIt I I I u I a t I t t * I l lI l Il

June Oct. Feb. June Oct. Feb.

2003 2004*Estimates from federal funds and eurodollar futures

June Oct.2005

Probability of Policy Action Implied by OptionPrices on Federal Funds Futures

May 5 Jun 24

-percent-

1. Easing

2. 25 bp

3. 50 bp

4. No Change

42 99

17 45

25 54

Implied Distribution of Federal Funds Rate Derivedfrom Option Prices on Eurodollar Futures* Percent

Sune 9A 243 I

I

May 5, 2003

-3

0.25 0.50 0.75 1.001.25 1.501.75 2.00 2.25 2.50 2.75 3.00*Estimates from options on eurodollar futures contracts, adjusted toestimate expectations for the federal funds rate, five months hence.

Probability the Federal Funds Rate will be at orBelow 0.50 Percent in Five Months* Percent

Dec. Jan. Feb. Mar. Apr. May June

2002 2003*Estimates from options on eurodollar futures contracts, adjusted toestimate expectations for the federal funds rate.

Selected Equity Indexes12/02/02 = 100

Selected Ten-year Yields

k -. BBB*

AA*

N Treasury

Percent

FOMC -1

a..

- ..

Dec. Jan. Feb. Mar. Apr. May June

2002 2003*AA and BBB rates based on yield curves derived from Merrill Lynch data.

Dec. Jan. Feb. Mar. Apr. May June2002 2003

June 24-25, 2003 207 of 211

Exhibit 2

The Case for Easing 25 Basis Points

+ Ratify at least a portion of the easing currently built into market prices.

" Work down resource slack quicker.

+ View the costs of insurance as low given that inflation expectationsare well contained.

Unemployment Rate in the Greenbook

Alternative1.25 percentfunds rate

Baseline1 percent -funds rate

Percent-n 6.4

16.0

I I I I I I I I I l I I I I I I I

Mar. June Oct. Jan. Apr. July Oct. Jan.2003 2004

Inflation Expectations Percent

June Oct. Feb. May Aug. Dec. Apr.

2001 2002 2003*Median five to ten-year inflation expectations. **Measured as the inflation rateat which the price of the indexed security equals the value of a portfolio ofzero-coupon securities that replicates its payments.

Alternative Simulations of the FRB/US ModelUnemployment Rate Percent PCE Inflation (ex. food and energy)*

---- Pause until 2005- - - Pause until 2006

Pause until 2007

!I .

2001 2002 2003 2004 2005 2006 2007 2008

- Pause until 2005- - - Pause until 2006

Pause until 2007

I , ,, I ,I.I .1l I.. .1 '3

2001 2002 2003 2004 2005 2006 2007 2008

*Four-quarter percent change.

Percent

I

June 24-25, 2003 208 of 211

Exhibit 3

The Case for Easing 50 Basis Points

Re-establish the degree of monetary policy accommodation of late last year.

Fatten the cushion of inflation protection from the zero bound.

Provide needed stimulus if the Greenbook assessment of aggregate demand is too optimistic.

Actual Real Federal Funds Rate and Range of Estimated Equilibrium Real Rates

[Quarterly A

Historical Average: 2.68(1966Q1-2003Q1)

Il ll lI liI l lI l Ilii i

Percent

V Actual Real Funds Rate

TIIS-Based Estimate

-- ---- --- --- ---- --- --- --- ---- --- --- ---- ---...... .... ... ... ...

Current Rate* 25 b.p. Easing

50 b.p. Easing -

I I I I I I I I I I I I I I I I I III I I I I I I I I I I I

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003

erest Rate Prescription From a Private Sector Forecasts.... ... ...... Pe.....t Private Sector ForecastsF-orwara-LooKing i aylor- I ype Policy Ruie

- Actual funds rate End of. .--- Interest rate prescription estimationV.4 period

1. Merrill Lynch (6/6/03)

2. Bear Steams (6/12/03)

3. Morgan Stanley (6/19/03)

4. JP Morgan Chase (6/17/03)

5. Goldman Sachs (6/18/03)

6. Memo: Greenbook

2004

Q4/Q4 Q4leal GDP Unemp. Rate

3.80 6.00

4.21 5.60

4.90 5.50

2.80 6.00

2.00 6.50

5.30 5.40

1988 1990 1992 1994 1996 1998 2000 2002

Inti"'"'"

June 24-25, 2003 209 of 211

Exhibit 4

The Case for Keeping the Funds Rate Unchanged

* View easing as unnecessary because

-- Considerable fiscal impetus is in train.

-- The Greenbook is too gloomy about investment.

-- Put some weight on the recent rapid expansion of liquidity.

Fiscal Impetus Percent of GDP

1961 1967 1973 1979 1985 1991 1997 2003

Equipment and Software SpendingRelative to Economic Troughs Index, trough=100

- Average History-- Current Episode

.......... Greenbook Forecast

* £ *80-4 -2 0 2 4 6 8 10 12

Current episode trough is assumed to be 2001:Q4; historical troughsincluded are 1970q4, 1975ql, 1982q4, 1991q1.

Real M2 and Real Bank Credit* Percent

1960 1963 1966 1969 1972 1975 1978 1981 1984 1987 1990 1993 1996 1999 2002

*Seasonally adjusted. Real values calculated using the GDP deflator. Shading indicates regions declared by the National Bureau ofEconomic Research as recessions.

June 24-25, 2003 210 of 211

Exhibit 5The Assessment of Risks

On May 6th, the Committee

+ Separated the risk assessment,

-- Risks regarding its objective of sustainable economic growth

-- Risks regarding its objective of price stability

-- Balance of those two risks

+ Voted only on the policy rate

A Proposal

Return to the practice of voting on the assessment of risks

Choose among generic formulations of the three sentences

Allow discretion to the drafters

For Today's Choice

+ At a funds rate of 3/4, 1, or even1-1/4 percent,

-- Growth rate risks are balanced

-- Inflation risks are to the downside

-- Balance to the downside

+ Arguably, at a funds rate of 3/4 percent,

-- Risks may be seen as balanced

MMS Survey Results

Fraction of Respondents

Target Rate

0.75 1.00

Balance of Risks

Downside

Neutral

0.29

0.21

0.42

0.08

Total 0.50 0.50

Total

0.71

0.29

1.00

June 24-25, 2003 211 of 211

Fomc 20030625 Material

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