Economic Report President

significantly increase expenditures on Social Security and governmenthealth programs over the next several decades. The emergence of abudget surplus offers the opportunity to prepare for this challenge.Indeed, the unified budget surplus includes the current excess ofreceipts over benefit payments in the Social Security system, whichamounted to $99 billion in fiscal 1998. (Apart from the Social Securitysystem, the Federal Government had a deficit of $30 billion in 1998,producing the unified surplus of $69 billion.) The Administration hasstated that none of the unified surplus should be used until the futuresolvency of Social Security is assured. The President has repeatedlyreaffirmed this commitment to “save Social Security first,” and he presenteda specific proposal for Social Security reform in his recent Stateof the Union address.Monetary PolicyIn conducting monetary policy during 1998, the main focus of theFederal Reserve’s concerns shifted from a potential reversal of thefavorable trend of inflation to a potential weakening of economic activity.When the year began, the target Federal funds rate—the ratebanks charge each other for overnight loans—stood at 5.5 percent,where it had been for the preceding 9 months. However, the surge ineconomic growth during the first several months of the year heightenedthe concern of the Federal Open Market Committee (FOMC, theFederal Reserve’s principal monetary policy decisionmaking body) thatintensifying use of the economy’s resources might lead to a buildup ofinflationary pressures. The FOMC did not adjust the Federal fundsrate in response, but it noted in March that a tightening of monetarypolicy was more likely than an easing in the months ahead.Despite a slowing of growth in the second quarter, the FOMCbelieved that the balance of risks still pointed to the possibility of risinginflation over time. It therefore maintained a bias toward futuremonetary tightening. Indeed, labor costs accelerated during 1998 in avery tight labor market. However, the rapid deterioration in financialconditions in the late summer and fall persuaded the Federal Reservethat a much less restrictive monetary policy was appropriate. TheFOMC dropped its bias toward tightening at its August meeting, cutthe Federal funds rate by 25 basis points (0.25 percentage point) at itsSeptember meeting, did so again in mid-October in an unusualbetween-meeting move, and lowered the funds rate yet again at itsNovember meeting. In both October and November the FederalReserve Board also cut the discount rate—the rate it charges banks toborrow from the Fed—by 25 basis points, to maintain the discountrate’s traditional position below the funds rate. The easing of monetarypolicy was not a reaction to any observed weakness of economic activitybut rather a preemptive or forward-looking action intended to sustainthe expansion. The cumulative 75-basis-point reduction in the46