Monetary Policy Report

\ I ) I I ebruan 19, 1992 1992 '' MONETARY POL I C-Y OBJECTIVES Summary Report of the Federal Reserve Board \ \ I \ \ r, r- Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis February 19, 1992 1992 MONET ARY POLICY OBJECTIVES This Executive Summary provides highlights of the Board's Review to the Congress on the Full Employment and Balanced Growth Act of 1987. Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Contents Section Page Testimony of Alan Greenspan Chairman, Federal Reserve Board 3 Macroeconomic Performance and Monetary Policy in 1991 4 Balance Sheet Adjustments 6 Economic Expansion and Money and Credit Growth in 1992 11 Concluding Comments 12 Monetary Policy and the Economic Outlook for 1992 15 Monetary Policy for 1992 15 Economic Projections for 1992 17 Monetary and Financial Developments in 1991 20 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Testimony of Alan Greenspan Chairman, Federal Reserve Board 'Mr. Chairman and members Looking forward, though, there are reasons to believe that business of the Committee, I am activity should pick up. Indeed, pleased to present the Federal anecdotal reports and early data seem to be indicating that spending is Reserve' s Monetary Policy starting to firm in some sectors. A Report to the Congress. The number of measures suggest that the balance sheets of many households policy decisions discussed in and businesses have been strength the report were made against ened, a development that should facilitate spending in the recovery. the backdrop of a troubled Similarly, banks and other lenders economy. The recovery that have taken steps to bolster their capital positions so that they will be seemed to be in train at the able to supply the credit to support time of our last report to additional spending. And, most recently, broad measures of money Congress stalled, job losses have strengthened. Moreover, there have mounted, and confidence are clear signals that core inflation rates are falling, implying the pros remains low. pect that within the foreseeable future we will have attained the lowest rates of inflation in a generation, an encouraging indicator of future gains in standards of living for the Ameri can people. Still, the outlook remains particularly uncertain. This means that we at the Federal Reserve have to be particularly sensitive to signs that the anticipated strengthening in business activity is not emerging and be prepared to act should the need arise. As background, I would like to discuss our recent economic perfor mance, reviewing in some detail the causes of the disappointments we've experienced, and the important balance-sheet adjustments in process that promise eventually to support a resumption of sustainable economic growth. Digitized for FRASER https://fraser.stlouisfed.org 3 Federal Reserve Bank of St. Louis Macroeconomic Performance Over the third quarter, however, and Monetary Policy in 1991 evidence began to surface that the recovery had not taken hold. The Following the contraction of economic impetus to consumer sentiment and activity in the autumn of 1990 that spending that was provided by the resulted from the invasion of Kuwait completion of the Gulf war seemed to and the subsequent sharp rise in oil ebb, and consumer outlays turned prices, economic activity continued to down again. Businesses, apparently decline in the first quarter of 1991. In caught by surprise by this develop response to the weakening of activity ment, saw their inventories back up and anemic money growth, the in the late summer and fall. With Federal Reserve eased policy substan demand slackening, businesses tially over late 1990 and into early engaged in another round of layoffs 1991. and private nonfarm payrolls declin~d By the spring, many signs pointed over the second half of 1991 while the to economic recovery. The quick and civilian unemployment rate rose to successful conclusion of the Gulf war 7.1 percent. bolstered consumer confidence. In addition, growth of the mone Growth of the money stock was tary_ aggregat~s slowed unexpectedly strengthening. Homebuilding had during the third quarter. Expansion of begun to stir, consumer spending had M2 virtually ceased, while M3 turned up, and industrial production actually contracted-a nearly unprece was advancing. The lower interest dented occurrence. Judging from our rates and the retracing of the earlier surveys of banks, other contacts in the jump in oil prices appeared to be financial industry, and anecdotal providing support for an expansion of information from borrowers, the aggregate demand. In these circum supply of credit for many borrowers stances, the odds appeared to favor a remained quite tight, particularly for continued moderate recovery in jobs those firms without access to open and employment during 1991. market sources of funds. Moreover, private credit demands weakened further. Digitized for FRASER https://fraser.stlouisfed.org 4 Federal Reserve Bank of St. Louis Against this background, and with Despite substantial decreases in signs that inflationary pressures were interest rates in late 1990 and diminishing, the Federal Reserve took throughout 1991, however, M2 a number of steps to ease policy growth was only about 3 percent in further in the second half of 1991. 1991, the same as the sluggish pace of Through both open market operations expansion of nominal GDP. M3 rose and reductions in the discount rate, only 1¼ percent. Both aggregates money market interest rates were ended the year only modestly above lowered nearly two percentage points the lower bounds of their respective between August and December. annual ranges. Growth of domestic These monetary policy actions, nonfinancial sector debt, at 4¾ per building on those over the previous cent, also was near the lower bound 2½ years, have resulted in a large of its monitoring range. Outside the cumulative reduction of interest rates. federal sector, debt increased less than The federal funds rate has declined 3 percent for the year in reflection not nearly 6 percentage points from its only of depressed spending but also cyclical peak, and the discount rate by of a deleveraging in the household 3½ percentage points. Other short and business sectors and financial term interest rates have fallen sub difficulties of many state and local stantially as well. The prime rate also governments. has been reduced appreciably, but by The behavior of the monetary somewhat less than market rates as aggregates in 1991 relative to other commercial banks have sought to economic variables was somewhat bolster lending margins. In longer puzzling. Doubtless, part of the slow term markets, bond and mortgage money growth was related to the yields have dropped about 1¼ per weakness in borrowing and spending. centage points on balance from their But even after taking account of weak cyclical highs, with much of the spending, growth of money was decline coming in the latter half of unusually slow. The velocity of M2 1991. The decreases in interest rates was about unchanged over the year appear to have given stock prices a rather than falling as would ordi boost as.w ell, with most major narily be expected in circumstances of indexes rising to record levels early sharp declines in short-term market this year. · interest rates. It appears that certain interest rate relationships gave households incentives to limit their money holdings. Commercial banks, Digitized for FRASER https://fraser.stlouisfed.org 5 Federal Reserve Bank of St. Louis restraining their own balance sheets Thus, a number of factors reduced in response to weak loan demand and the public's demands for monetary in an attempt to conserve capital, balances in 1991. Some of these lowered deposit interest rates appre factors tended to raise the velocity of ciably, especially late in the year. money, so that to an extent slow On the other hand, interest rates growth of M2 was not reflected in on consumer debt, particularly income flows. But the pattern of when adjusted for the lack of tax money and credit growth over the deductibility, remained relatively last half of the year appeared also to high. As a result, many households stem importantly from forces depres apparently used deposit balances to sing spending and economic activity, pay off or to avoid taking on con which the Federal Reserve attempted sumer credit. Als9, the steep yield to counter through easing money curve and the attractive returns market conditions. recorded by bond mutual funds, as well as impressive gains in the stock Balance Sheet Adjustments market, apparently led many house holds to shift funds out of deposits Understanding these forces and the and into capital market instruments, appropriate role for monetary policy which are not included in the mone under the circumstances requires tary aggregates. stepping back several years. As I have Finally, a brisk pace of activity by discussed with you previously, the the Resolution Trust Corporation 1980s saw outsized accumulation of appears to have depressed the certain kinds of real assets and even monetary aggregates, especially M3. more rapid growth of debt and When the RTC takes savings and loan leverage. To a degree, this buildup of assets onto its own balance sheet, balance sheets was a natural and they are financed with Treasury economically efficient outcome of securities, rather than depository deregulation and financial innovation. liabilities. In effect, the RTC has taken It also may have reflected a lingering on some of the role of thrift institu inflation psychology from the 1970s tions, but its liabilities are not that is, people may have expected a included in the monetary aggregates. rapid increase in the general price In addition, the disruption of banking level, and especially in the prices of relationships as institutions are specific real assets, such as real estate resolved, including the abrogation of properties, that would make debt some time deposit contracts, seems to financed purchases profitable. lead investors to reassess their portfolio allocation and, in some cases, to shift funds out of deposits. Digitized for FRASER https://fraser.stlouisfed.org 6 Federal Reserve Bank of St. Louis But in retrospect, the growth of debt The 1980s also witnessed a dra and leverage was out of line with matic increase in desired leverage of subsequent economic expansion and the business sector, which fostered a asset price appreciation. Indeed, the wave of mergers and buyouts. These burden of debt relative to income transactions typically involved mounted as asset values, especially substantial retirements of equity for real property, declined or stag financed through issuance of debt; nated. In part, our current economic equity retirements in the nonfinancial adjustments can be seen as arising out corporate sector exceeded new equity of a process in which debt is being issuance by a staggering $640 billion realigned with a more realistic in the 1984-1990 period. Such restruc outlook for incomes and asset values. turings often were based, at least in Rapid rates of debt-financed asset part, on a well-founded quest for accumulation were broad-based increased efficiency, and gains were during the 1980s. For example, achieved by a number of firms. households purchased cars and other However, many of these deals also consumer goods at a brisk pace. were predicated on overly optimistic Although household income was assumptions about what the economy increasing swiftly in this period, the could deliver-that rapid economic growth of expenditures was faster. growth could continue without Household saving rates dropped from setback and that asset prices would about 8 percent at the beginning of always rise. the decade to a 4 to 5 percent range A primary example of the accumu by its end. This was reflected in part lation of debt and real assets occurred in burgeoning consumer installment in commercial real estate markets. In credit, which expanded at an average the early 1980s, when space was in annual rate of 15 percent between unusually short supply, commercial 1983 and 1986. In addition, mortgage real estate received an additional debt expanded at an 11 percent pace push from the Economic Recovery between 1983 and 1989. Most of this Tax Act, which provided an accelera increase was against existing homes, tion of depreciation allowances for representing borrowing against rising capital goods. While an adjustment values either in the process of home was appropriate and overdue, that for turnover or as owners borrowed commercial structures was excessive, against higher equity. Mortgage resulting in tax lives that were far borrowing also financed a substantial shorter than economic fundamentals amount of buying of new homes, would dictate. This shift in incentives which in some parts of the country at led to a surge in debt-financed times seemed to be motivated more commercial construction during the by speculative considerations than by 1980s. fundamental needs. 7 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Financial institutions, of course, Together, these developments participated in this process by lending resulted in declines in the value of heavily; indeed, their aggressive assets and growing problems in lending behavior probably contrib servicing the associated debt out of uted to the speed of debt accumula current income. Because of the runup tion. During the economic expansion, in leverage over previous years, these bank credit expanded at an average problems have been more severe than annual rate of nearly 9 percent, well might be expected just from the in excess of the growth of nominal slowing in income and spending. And income. Banks lent heavily against the difficulties of both borrowers and real estate collateral, for corporate lenders have fed back on spending, restructurings, and for consumer exacerbating the economic downturn credit, and, in addition, for more during the Gulf crisis, and inhibiting traditional business purposes. Life the recovery. insurance companies also expanded Faced with mounting financial their portfolios rapidly, with growth problems and uncertainty about the in real estate loans especially future, people's natural reaction is to prominent. withdraw from commitments where By the end of the 1980s, the possible and to conserve and even inevitable correction was upon us. build savings and capital. Both The economy was operating close to households and businesses, concerned capacity, so that growth had to slow about their economic prospects, over to a pace more in line with its the past two years or so have taken a long-run potential. Inflation did not number of measures to reduce drains pick up much, contrary to what some on their cash flow and to lower their might have expected as capacity was exposure to further surprises. Part of approached. In the commercial real this process has involved unusually estate sector, soaring vacancy rates conservative spending patterns and and a change in tax law in 1986 part has involved the early stages of a brought the boom to an end, produc restructuring of financial positions. ing sharp decreases in prices of office Businesses, for example, have buildings in particular. strived to reduce fixed costs. To do this, they have cut back staffing levels and closed plants. They have tried to decrease production promptly to keep inventories in line. Firms also have taken steps to lower their risk exposures by restructuring their sources of funds to reduce leverage, enhance liquidity, and cut down on interest obligations. Digitized for FRASER https://fraser.stlouisfed.org 8 Federal Reserve Bank of St. Louis The response of households has The Federal Reserve has taken a been analogous. To increase their net number of measures to facilitate worth, households have taken steps to balance sheet restructuring and increase their savings by restraining adequate flows of credit. Together expenditures. To reduce interest with other supervisors, we have expenses, they have paid down directed examiners to consider not consumer debt, and as long-term only the current market value of interest rates have declined, they have collateral against performing loans, refinanced mortgages and other debt but the overall quality of the credits. at lower interest rates. We also have met on numerous Lenders too have drawn back. With occasions with bankers as well as capital impaired by actual and bank examiners to clarify bank prospective losses on loans, especially supervisory policies and to emphasize on commercial real estate, banks and the importance of banks continuing to other intermediaries have not only lend and take reasonable risks. adopted much more cautious lending Monetary policy also has in part standards, but also have attempted to been directed in recent quarters to hold down asset growth and bolster supporting balance sheet restructuring capital. They have done so in part by that is laying the groundwork for aggressively reducing what they pay renewed, sustained, economic for funds, by more than they have expansion. We recently reduced reduced what they charge for credit. reserve requirements on transactions Like other businesses, they have taken deposits. This will free up some funds steps to pare expenses generally, for lending or investment and should including reducing work forces and over time enhance the ability of banks looking for cost-saving consolidations and their customers to build capital. with other institutions. To a consider In addition, lower short-term able extent, this response has been interest rates clearly have been rational and positive for the long-term helpful to debtors, but their contribu health of our financial intermediaries. tion to the restructuring process But in many cases it seems to have would be relatively muted if long gone too far, impelled to an extent by term rates had not also declined at the reaction of supervisors to the the same time and stock prices were deteriorating situation. not buoyant. Reductions in short-term rates that were expected very soon to be reversed or that were not seen as consistent with containing inflation would contribute little to the strength ening of balance sheets fundamental to enhancing our long-term economic Digitized for FRASER prospects. https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 9 In part because we have seen corporate debt burdens are presum declines in long- as well as short-term ably in prospect. Restraint on invento rates and increases in equity prices, ries and other spending has contrib progress has been made in balance uted to this result by keeping outlays sheet restructuring, and hopefully in close alignment with internally more is in train. As a result of lower generated funds. And the strengthen interest rates, household debt service ing of balance sheets is paying off in as a percent of disposable personal terms of credit evaluations. Down income has fallen in the past year, grades of nonfinancial firms, though from about 19½ to about 18½ percent. still greater than upgrades, are well Moreover, further declines are in below the levels of last winter and prospect as more refinancing occurs spring, and upgrades have risen and as interest costs on floating-rate slightly. debt, such as adjustable-rate mort The condition of our financial gages, gradually reflect current institutions also is improving. In the interest rates. banking sector, wider interest margins In the business sector, similar seemed to be boosting profits by the patterns can be observed. With end of last year. In addition, many corporate bond rates close to their institutions have taken difficult but lowest levels in more than a decade, a necessary measures to control large number of firms in recent noninterest expenses. Reflecting an months have called, retired, and improved earnings outlook and a replaced a considerable volume of generally favorable equity market, the high-cost debt. A flood of issuance of stock prices of large banks have longer-term debt and equity shares doubled on average from their 1990 has reduced dependence of firms on lows, and the premium paid by many short-term obligations. A number of money-center banks on uninsured the equity deals constituted so-called debentures has dropped several "reverse LBOs"- the deleveraging of percentage points. Increased share highly leveraged and therefore rather prices have spurred a number of risky firms. The ratio of corporate holding companies to sell substantial debt to equity in book value terms volumes of new equity shares in the has only begun to edge down, but the market, contributing to a significant increase in equity, together with the rise of capital ratios in the banking lower level of interest rates, has system, despite still-large provisions enabled many corporations to make for loan losses. Measures of bank significant headway in lowering liquidity, such as the ratio of securi interest expenses over the past two ties to loans in bank portfolios, have years, and further decreases in risen appreciably, signalling an improved ability of banks to lend. Digitized for FRASER https://fraser.stlouisfed.org 10 Federal Reserve Bank of St. Louis The balance-sheet adjustments that An especially fav0rable aspect of are in progress in the financial and the outlook is that for inflation. The nonfinancial sectors alike are without central tendency of the Board mem parallel in the post-war period. Partly bers' and Reserve Bank Presidents' for that reason, assessing how far the forecast is that inflation, as measured process has come and how far it has by the Consumer Price Index, will be to go is extraordinarily difficult. As in the neighborhood of 3 to 3½ per increasingly comfortable financial cent over the four quarters of 1992, structures are built, though, the compared with a 3 percent rise in restraint arising from this source 1991. However, the CPI was ·held eventually should begin to diminish. down last year by a retracing of the In any case, the nature and speed of sharp runup in oil p~ices that resulted balance sheet restructuring are from the Gulf crisis. Consequently, important elements that we will need our oµtlook anticipates a significant to continue to monitor on a day-by improvement in the so-called core day basis in assessing whether further rate of inflation. With appropriate adjustments to the stance of monetary economic policies, the prospects are policy are appropriate. good for further declines in 1993 and beyond even as the economy expands. Economic Expansion and To support these favorable out Money and Credit Growth comes for economic activity and in 1992 inflation, the Committee reaffirmed Against this background of significant the ranges for M2, M3, and debt that progress in balance-sheet strengthen it had selected on a tentative basis ing as well as lower real interest rates, last July-that is, 2½ to 6½ percent the Board members and Reserve Bank for M2, 1 to 5 percent for M3, and 4½ Presidents expect a moderate upturn to 8½ percent for debt, measured on a in economic activity during 1992, fourth-quarter-to-fourth-quarter basis. although in the current context the These are the same as the ranges used outlook remains particularly uncer for 1991. The 1992 ranges were chosen tain. According to the central ten against the backdrop of anomalous dency of these views, real output monetary behavior during the last should grow between 1¾ and two years. Since 1989, M2 has posted 2½ percent this year. The unemploy widening shortfalls from the levels ment rate is projected to begin historical experience indicates would declining, finishing the year in the have been compatible with actual vicinity of 6¾ to 7 percent. nominal GDP and short-term market interest rates. Digitized for FRASER 11 https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis The appropriate pace of M2 growth Nonfinancial debt growth is likely within its range during 1992 thus will to be a little faster than last year's depend on the intensity with which 4¾ percent increase. The wider forces other than nominal GDP tum federal deficit in prospect for 1992 out to affect money demand. Deposi will increase Treasury borrowing. tory institutions are likely to continue Assuming output and incomes are reducing their rates on retail deposits again expanding, balance sheets in in lagged response to the steep somewhat better condition, and credit declines in money market yields conditions no longer tightening, the before year-end. Those deposit-rate borrowing of households and busi reductions could be significant, nesses may pick up a little, although especially if banks are not seeking their overall posture probably will retail deposits, given their continued remain cautious. caution in extending credit and Will these ranges for money and borrowers' continued preference for credit growth prove to be appropri longer-term sources of credit to ate? Obviously, we believe that the strengthen balance sheets. With the answer is yes. But I should reempha effects of lower deposit rates contrib size the sizable uncertainties that uting to further shifts of funds into prevail. The ongoing process of longer-term mutual funds and into balance sheet restructuring may affect debt repayment, and with the RTC spending, as well as the relationship remaining active in resolving troubled of various measures of money and thrifts, the velocity of M2 could credit to spending, in ways we are increase this year, independently of not anticipating. In assessing mone changes in market interest rates. tary growth in 1992, the Federal The ongoing restructuring of Reserve will have to continue to be depository institutions, as in the last sensitive to evolving velocity patterns. two years, is likely to continue to have an even larger influence on M3 Concluding Comments than on M2 growth. Assets previously on the books of thrifts that are Our focus, quite naturally and acquired by the RTC will be financed appropriately, has been on our by Treasury debt rather than the immediate situation-the causes of liabilities of thrifts. Managed liabilities the recent slowdown and the pros in M3 should continue to be more pects for returning to solid growth depressed by resolution activity than this year. However, as we move retail CDs. The reaffirmed range for forward, we cannot lose sight of M3 growth thus remains lower than the crucial importance of the longer for M2. run performance of the economy. Digitized for FRASER 12 https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis As I have noted before, much of the the balance sheets of many financial difficulty and dissatisfaction with our intermediaries themselves were not economy comes from a sense that it is robust; many lacked adequate capital not delivering the kind of long-term to continue to lend to good credit improvement in living standards we risks in the face of losses from their have come to expect. The contribution previous lending mistakes. Our monetary policy can make to address emphasis on improving the capitaliza ing this deficiency is to provide a tion of depository institutions over financial background that fosters time, where we have already made saving and investment and sound substantial progress, should help balance sheet structures. Removing bolster their ability to lend both in over time the costs and uncertainties good times and bad. We could make associated with ongoing inflation further strides in strengthening our encourages productivity-enhancing depository institutions through investment. Moreover, inflation tends removal of outmoded constraints on to promote leverage and over their behavior. By loosening strictures accumulation of real assets as a hedge on the ability of these firms to against increases in price levels; compete across arbitrary boundaries progress toward price stability of product line and geography, we provides a backdrop for borrowing would improve their profitability and and lending decisions that lead to capital. Their strengthened position strong balance sheets, far less apt to should augment their ability to lend magnify economic disturbances. and potentially could reduce A crucial aspect of our recent demands on the federal safety net. economic performance is the difficult Finally, we should consider situation of our financial sector. carefully the effects of the extremely Clearly, some of the weakness of the low rates of national saving that we economy over the past two years have experienced for a decade. arose from the restraint on the supply Certainly, low personal and corporate of credit-the so-called credit crunch. saving rates have contributed to the Both depository institutions and other deterioration in balance sheets that financial intermediaries made some of has impaired our economic perfor the same mistakes of judgment about mance in recent years. The large the likely appreciation of asset prices stocks of federal debt that have been as did borrowers. In addition, though, built up, too, likely have adversely affected our economic prospects by putting upward pressure on real interest rates and thus stunting the growth of the capital stock, on which our future incomes depend. Digitized for FRASER https://fraser.stlouisfed.org 13 Federal Reserve Bank of St. Louis In considering the various fiscal deficits and boosting private saving options that are before you as and monetary policies aimed at members of the Congress, I urge you noninflationary growth, we can to keep in mind their long-term achieve the strong economic perfor implications for national saving. mance that our fellow citizens rightly Through a combination of fiscal expect. policies directed at reducing budget Digitized for FRASER 14 https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Monetary Policy and the Economic Outlook for 1992 Monetary Objectives for 1992 Taking account of these effects, the Committee has deemed the ranges for In formulating its objectives for 1992 ten~atively adopted last July as monetary policy for 1992, the Federal ~ppropnate for achieving its objec Open Market Committee has sought tives. The M2 range for 1992 is 2½ to to promote a sustainable upturn in 6½ percent, unchanged from 1991. ec~nomic activity while continuing to Demands for M2 relative to income build upon the hard-won gains would be damped if, as seems likely, against inflation that have already banks and thrifts continue to reduce been made. The task of translating deposit rates in lagged response to these objectives into specific ranges the decline that has occurred in for money and debt continues to be market rates. These deposit-rate complicated by the ongoing restruc reductions could be especially large if turings of depositories and by the credit continues to be channeled evolving attitudes towards credit on outside depositories, and in this case the part of borrowers and lenders. relatively modest growth in M2 ' The Committee believes that the would be adequate to support a rechanneling of credit flows away satisfactory outcome for the economy. from depository institutions could On the other hand, as the balance well continue to produce slower sheets and capital positions of growth in the broad monetary depositories continue to improve, aggregates than normally would be banks and thrifts may adopt a associated with a given path for generally more accommodative nominal GDP. posture with respect to credit exten sions and would therefore have greater need for retail deposits. In Ranges of Growth of Monetary and that event, somewhat faster growth of Credit Aggregates 1 M2 would be appropriate. (Percentage change, fourth quarter to fourth quarter) 1990 1991 1992 M2 3 to 7 2½ to 6½ 2½ to 6½ M3 1 to 5 1 to 5 1 to 5 Debt 5 to 9 4½ to 8½ 4½ to 8½ Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 15 On balance, the Committee's M2 The thrift industry is expected to range for 1992 allows room for a contract further as activity by the variety of developments in the Resolution Trust Corporation contin intermediation process and thus in ues apace, and banks, faced with the behavior of monetary velocity. continued-though moderating Flexibility in interpreting M2 within pressures on capital positions, will its range is particularly important at still be somewhat hesitant to expand. this time, in light of the ongoing and At the same time, additional house unpredictable shifts in the patterns of holds are likely to refinance credit usage and financial intermedia adjustable-rate mortgages with tion that likely will continue to buffet fixed-rate obligations that can easily our financial system. Looking ahead be securitized, and corporations will to future years, the Committee also probably continue to tum to equity recognizes that the range for M2 markets and long-term bonds rather growth may eventually have to be than bank loans. As a result, deposi lowered in order to put in place the tory funding needs are likely to monetary and credit conditions remain damped relative to the pace of consistent with price level stability. economic activity, and the velocity of The target range for M3 for 1992 M3 should consequently rise further. remains at 1 to 5 percent. Although The monitoring range for the credit growth is expected to pick up aggregate debt of domestic nonfinan somewhat in 1992, in line with a cial sectors for 1992 is 4½ to 8½ per firming of economic activity, much cent, also unchanged from 1991. of this credit likely will be financed Federal government borrowing is outside the depository system. expected to remain heavy in 1992, given the large budget deficit. Debt growth of nonfederal sectors, how ever, should remain fairly subdued relative to economic activity, as borrowers and lenders alike maintain a cautious approach to leverage, stemming in part from a desire to make further repairs to damaged balance sheets. Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Economic Projections for 1992 they anticipate that the trend toward price stability, which now appears to Although the long-standing structural be rooted more securely, will be problems that aborted the fledgling sustained through this year. recovery last summer clearly are The forecasts of most of the being addressed, the speed of their governors and presidents for growth resolution-and the associated of real gross domestic product are in restraint on economic growth-is a range of 1¾ to 2½ percent mea quite difficult to gauge, augmenting sured from the fourth quarter of 1991 the usual uncertainties in assessing to the fourth quarter of 1992. With the economic outlook. On the whole, employers likely to be cautious about however, the members of the Board hiring until they are fully persuaded of Governors and the Reserve Bank of _the sustained vitality of the upturn, Presidents believe that, with the gams in employment are expected to easing of monetary conditions to date come slowly. Thus, only a small providing considerable impetus to the improvement in the unemployment economy, the most likely outcome is rate is anticipated this year, with the for a moderate reacceleration of central tendency of projections being activity over 1992. At the same time I Economic Projections for 1992 1991 FOMC Members and Measure Actual other FRB Presidents Administration Range Central Tendency Percentage Nominal GDP 3.2 4 to 6 4½ to 5¾ 5.4 change, fourth quarter Real GDP .2 1½ to 2¾ 1¾ to 2½ 2.2 to fourth quarter:1 Consumer Price Index 2.9 2½ to 3½ 3 to 3½ 3.1 Average level in the fourth Unemployment rate2 6.9 6¾ to 7¼ 6¾ to 7 6.8 quarter, percent:3 1. Actual for the fourth quarter of the 2. All urban consumers. preceding year to the fourth quarter of the year 3. Percentage of the civilian labor force. indicated. Digitized for FRASER https://fraser.stlouisfed.org 17 Federal Reserve Bank of St. Louis a range of 6¾ to 7 percent for the Civilian Unemployment Rate fourth quarter of 1992. With regard to Quarterly average, percent inflation, the central tendency range for the CPI increase this year is 3 to 3½ percent. These forecasts are, in ---------------8 general, very similar to the projections presented by the Administration in the fiscal year 1993 budget. Indeed, the Administration's forecast for nominal GDP is well within the Committee's central tendency range ------ --- - ----- 4 and thus appears to be quite consis tent with the FOMC's monetary ranges. In their discussion earlier this 1986 1987 1988 1989 1990 1991 month of the economic outlook, the Board members and Reserve Bank presidents observed that the effects of It is also expected that the drags on recent job losses and weak consumer growth from credit supply disrup confidence are likely to restrain tions and from the restructuring of activity in the near term. Under the household and business balance circumstances, the Board members sheets will begin to lessen over the and Bank presidents stressed that year. As noted above, this is obvi economic developments need to be ously an area of substantial uncer monitored closely to guard against tainty. However, as household and the possibility that the economy corporate debt loads diminish in an might falter. Nonetheless, the mone environment of stronger economic tary stimulus already in train is activity, and as lower interest rates expected to provide effective support continue to ease financing burdens of for economic growth this year, and in borrowers, consumers and businesses this regard the early indications of a should be poised to participate more marked pickup in residential real fully in the economic expansion. estate activity and a rise in retail sales Moreover, the problems of credit are a particularly favorable sign. availability that have plagued the economy over the past couple of years should begin to ease in 1992 as the economic recovery takes hold and lenders become more confident about extending credit. 18 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Personal Saving instituted last year. Meanwhile, the Percent of disposable income, quarterly average external sector is expected to have a relatively neutral net influence on domestic production this year; foreign demand-particularly from Mexico ---------------6 \ rv\C and developing countries in Asia --v-. should continue to boost export growth, but the anticipated pickup in ---v----- 4 domestic purchases is likely to draw in additional imports as well, limiting the potential for further substantial ---------------2 improvement in the trade balance. Only a minority of Board members and Reserve Bank Presidents foresee a smaller increase this year in the 1987 1988 1989 1990 1991 overall CPI than the 3 percent rise experienced in 1991. But the pickup Nonetheless, the pace of expansion in inflation suggested by the 3 to this year is expected to remain 3½ percent central-tendency range is weaker than in previous business deceptive: the underlying trends of cycle recoveries. In large part, this price movement are more favorable. expectation reflects some still unre solved economic and financial imbalances in particular segments of Consumer Prices* Percent change, Dec. to Dec. the economy. The persistent overhang of space in office and other commer cial buildings undoubtedly will inhibit new construction in that sector - 6 for some time. In addition, the budgetary constraints that have - - - capped government spending are 4 likely to linger; a good many states and localities are finding that budget - gaps are reopening, despite the 2 spending cuts and tax increases they n 1986 1987 1988 1989 1990 1991 *Consumer price index for all urban consumers. Digitized for FRASER https://fraser.stlouisfed.org 19 Federal Reserve Bank of St. Louis The CPI was held down to a substan Monetary and Financial tial degree last year by the unwinding Developments in 1991 of the energy price shock that When the Federal Reserve presented followed Iraq's invasion of Kuwait in its midyear monetary policy report to August 1990, and further sharp Congress last July, a moderate declines in energy prices do not economic upturn was under way. appear likely in the current environ Consumer spending and housing ment. However, an ongoing decelera activity had risen considerably since tion in prices is evident for a wide the winter, bolstered by the decline in range of other goods and se~ices, oil prices, by a rebound in consu?1er and with ihflationary tendencies confidence in the wake of the allied under considerable restraint from victory in the Persian Gulf conflict, several factors-including further and by lower interest rates. Invento moderation in labor cost growth, ries had been trimmed appreciably, continued slack in industrial product orders were rising, and businesses, markets, and small increases in while still cautious, had begun to import priees-" core" inflation _is increase employment and production. expected to ·move down appreciably The key monetary aggregates had in 1992. Indeed, this trend should accelerated and were around the carry into 1993-a pattern that bodes middle of their 1991 target ranges. well for the achievement of a bal With the stance of monetary policy anced, sustained economic expansion. seemingly conducive to an upturn in economic activity, the Federal Reserve, after having progressively reduced pressures on reserve posi tions earlier in the year, maintained a more neutral money market posture in the spring and early summer. Digitized for FRASER https://fraser.stlouisfed.org 20 Federal Reserve Bank of St. Louis Rea GDP The faltering of the recovery Percent change, annual rate process apparently owed to a variety of forces, some of which were operating well before the oil price - shock of 1990 tipped the economy - - 2 into recession. In a sluggish economy n and amid unexpectedly weak asset ~ r, n 0 + values-particularly in real estate- - deteriorating financial positions of debt-laden households and corpora tions further damped credit demands 2 and aggregate spending. Financial ~ intermediaries, chastened by their negative experience with earlier loans, ~ became more hesitant about extend 1989 1990 1991 ing new credit; the resultant tighter lending standards deepened the As the year wore on, however, the slowdown in economic activity and incipient recovery lost its momentum. inhibited the subsequent recovery. In Consumer spending turned down, the government sector, where deficits and business and consumer sentiment remained large, not only at the began to erode. Inventories at federal level, but also in many state wholesale and retail trade establish and local jurisdictions, efforts to curb ments began to increase relative to spending and increase revenues sales, inducing a new outbreak of constituted a further drag on aggre production adjustments and lay-offs gate demand in the short run. that continued through year-end. Inflation, meanwhile, moved down Although the economy-as measured over the second half of 1991. Weak by its real gross domestic product demand reduced pressures in both continued to grow in the second half labor and product markets, and, after of the year, the pace of expansion was some acceleration of wages and prices only marginally positive. in 1989 and 1990, an underlying disinflationary trend has now been established. Important in this process has been a reduction in inflation expectations, visible not only in a variety of survey data but also in the behavior of securities markets. Digitized for FRASER https://fraser.stlouisfed.org 21 Federal Reserve Bank of St. Louis With actual and prospective Long-Term Interest Rates inflationary pressures easing, eco Percent nomic activity flagging, and the Monthly broader monetary aggregates weaken ing and growing near the bottom of their target ranges, the Federal Reserve resumed easing money market conditions in the second half of the year. As a result, the federal funds rate fell from 5¾ percent in July to 4 percent by year-end, and most other short-term rates followed suit; the discount rate was also reduced over this period, from 5½ percent to 3½ percent, the lowest 1983 1985 1987 1989 1991 rate in nearly 30 years. Long-term Last observation is for the first two interest rates, which had failed to weeks of February 1992. respond to declines in money market rates in the early months of the year, Although long-term rates have backed came down significantly in the latter up some in recent weeks, they remain part of 1991, partly in response to the appreciably below the levels of last easing in inflationary expectations. summer. The decline in rates has helped reduce the financial burdens of highly-leveraged households and Short-Term Interest Rates Percent corporations, who have taken this opportunity to refinance mortgages Monthly and to replace existing debt with new lower-cost bonds. Lower interest rates also have contributed to an increase in stock prices, inducing firms to boost equity issuance and to pay down debt, further strengthening their balance sheets. With the decline in U.S. interest rates, the foreign exchange value of the dollar has largely reversed the upward move ment that had occurred earlier in the year. 1983 1985 1987 1989 1991 Last observation is for the first two weeks of February 1992. Digitized for FRASER 22 https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Foreign Exchange Value The weakness in the monetary of the U.S. Dollar* aggregates M2 and M3 reflected not Index, March 1973 = 100 only subdued overall credit usage but also a continued decline in the share of credit intermediated by deposito ries. With the thrift industry contract 125 ing further, commercial banks exercising caution in their credit extensions, and borrowing demand \ A• 100 ----lo~..-------------~~J -- concentrated in longer-term instru v ments, depository credit continued to ~n. shrink as a share of overall credit 75 extensions. As a result, the velocity of M3-a monetary aggregate that comprises most of the liabilities used 1986 1987 1988 1989 1990 1991 by depositories to fund credit growth ~Index of weighted average foreign exchange value increased again in 1991, as M3 grew G of - U 10 .S c . o d u o n ll t a ri r e i s n . W ter e m ig s h o ts f a c r u e r r 1 e 9 n 7 c 2 i - e 7 s 6 o g f l o o t b h a e l r trade only 1¼ percent, near the bottom of of each of the 10 countries. its target range. Depository restructur ing also restrained M2, which grew in line with nominal GDP despite a The unusually slow growth of the key steep drop in short-term market monetary and credit aggregates last interest rates, which ordinarily would year was, to a degree, indicative of have been expected to depress the the continuing restraint on private velocity of this aggregate. Banks, credit usage and spending. The eager to improve capital positions, aggregate debt of domestic nonfinan reduced deposit rates more than loan cial sectors-abstracting from federal rates, increasing the incentive for government debt, which continued to households to pay down debt rather grow briskly-expanded only 2¾ per than to accumulate monetary assets. cent in 1991, the slowest advance in Less aggressive pursuit of retail decades, and below the pace of accounts by depositories also led nominal GDP; households, nonfinan investors to switch into other financial cial businesses, and state and local governments all retrenched, curbing spending and borrowing in order to buttress deteriorating financial positions. Digitized for FRASER 23 https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis assets, such as bond and stock mutual of credit to many borrowers. How- funds. Flows into these funds helped ever, some types of lending that are finance credit that had formerly been not so easily rechanneled-such as intermediated by depositories, construction loans and credits to facilitating shifts to longer-term small and lower-rated businesses- borrowing and reducing the adverse have been curtailed, and a number of effects of any retrenchment by banks borrowers now face more stringent and thrifts on the cost and availability credit terms. Growth of Money and Debt (Percentage change) Debt of Domestic Ml M2 M3 Nonfinancial Sectors Fourth quarter to 1980 7.5 8.9 9.5 9.2 fourth quarter 1981 5.4 (2.5)* 9.3 12.3 9.9 1982 8.8 9.1 9.9 9.2 1983 10.4 12.2 9.9 11.3 1984 5.4 8.0 10.8 14.1 1985 12.0 8.7 7.6 13.8 1986 15.5 9.2 9.0 13.8 1987 6.3 4.3 5.9 10.4 1988 4.3 5.2 6.4 9.4 1989 0.6 4.8 3.6 8.2 1990 4.2 3.8 1.7 6.9 1991 8.0 3.1 1.3 4.7 Quarterly growth Ql 5.2 3.5 3.3 4.5 rates 1991 (annual rate) Q2 7.4 4.3 1.8 4.0 Q3 7.5 1.1 -1.1 4.9 Q4 11.1 3.3 1.2 5.2 *Figure in parentheses is adjusted for shifts to NOW accounts in 1981. Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis FRBl--44000--0292 Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis

Federal Reserve (1992, February 18). Monetary Policy Report. Monetary Policy Reports, Federal Reserve. https://whenthefedspeaks.com/doc/monetary_policy_report_19920219

@misc{wtfs_monetary_policy_report_19920219,
  author = {Federal Reserve},
  title = {Monetary Policy Report},
  year = {1992},
  month = {Feb},
  howpublished = {Monetary Policy Reports, Federal Reserve},
  url = {https://whenthefedspeaks.com/doc/monetary_policy_report_19920219},
  note = {Retrieved via When the Fed Speaks corpus}
}