Monetary Policy Report

)ltr.~ . 0 '1'1 z_ July 21, 1992 1992 MONET ARY POLICY OBJECTIVES Midyear Review of the Federal Reserve Board I . July 21, 1992 1992 MONET ARY POLICY OBJECTIVES This Executive Summary provides highlights of the Board's Midyear Review to the Congress on the Full Employment and Balanced Growth Act of 1978. Contents Section Page Testimony of Alan Greenspan Chairman, Federal Reserve Board 3 The U.S. Economy and Monetary Policy 3 The U.S. Economic Outlook 7 Recent Behavior of the Monetary Aggregates 8 Prospective Behavior of the Monetary Aggregates 11 Concluding Remarks 12 Monetary Policy and the Economic Outlook for 1992 and 1993 13 Monetary Objectives for 1992 and 1993 13 Economic Projections for 1992 and 1993 14 Developments in 1992 17 Testimony of Alan Greenspan Chairman, Federal Reserve Board Mr. Chairman and members easings of reserve conditions of the Committee, I am should help to shore up the pleased to have this opportu economy, and coming in the nity to present the Board's context of a solid trend semiannual report on toward lower inflation, have monetary policy to the contributed to laying a Congress. Earlier this month, foundation for a sustained when the Federal Open expansion of the U.S. Market Committee formulated economy. its plans and objectives for the next year and a half, it did so against the backdrop of The U.S. Economy and Monetary Policy an economy still working its Our recent policy moves were just the way through serious struc latest in a series of twenty-three tural imbalances that have separate easing steps, beginning more than three years ago. In total, short inhibited the pace of economic term market interest rates have been expansion. In light of the reduced by two-thirds. The federal resulting sluggishness in the funds rate, for example, has declined from almost 10 percent in mid-1989 to economy and of persistent 3¼ percent currently. The discount weakness in credit and rate has been cut to 3 percent-a twenty-nine year low. Despite the money, the System on July 2 cumulative size of these steps, the cut the discount rate by economic recovery to date nonetheless has been very hesitant. Based on ½ percentage point, and experience over the past three or four eased reserve market condi decades, most forecasters would have predicted that a reduction of the tions commensurately. These magnitude seen in short-term interest actions followed a reduction rates, nominal and real, during the past three years would by now have in the federal funds rate in been associated with a far more early April. The recent robust economic expansion. 3 Clearly the structural imbalances in In some markets for physical assets, the economy have proven more such as office buildings, a severe severe and more enduring than many oversupply emerged, and prices had previously thought. The economy plummeted. In others, such as still is recuperating from past excesses residential housing, average price involving a generalized overreliance appreciation unexpectedly came to a on debt to finance asset accumulation. virtual standstill, and prices fell Many of these activities were based substantially in some regions. Firms largely on inflated expectations of that had been subject to leveraged future asset prices and income buyouts based on overly optimistic growth. In short, an overbuilding and assumptions about the future values at which assets could be sold began overbuying of certain capital and to encounter debt servicing problems. consumer goods was made possible More generally, disappointing by overleverage. And, when realities earnings and downward adjustment inevitably fell short of expectations, in the values of assets brought about businesses and individuals left with reduced net worth positions and debt-burdened balance sheets worsened debt-repayment burdens. diverted cash flows to debt repay Creditors naturally pulled back from ment at the expense of spending, making risky loans and investments, while lenders turned considerably and as pressures mounted on lenders' more cautious. earnings and capital, some features of This phenomenon is not unique to a "credit crunch" appeared. With the United States. To a greater or borrowers themselves becoming more lesser extent, similar adjustments have cautious about taking on more debt, gripped Japan, Canada, Australia, the as well as about spending, credit United Kingdom, and a number of flows to nonfederal sectors dimin northern European countries. For the ished appreciably. first time in a half century or more, It is not that this process was several industrial countries have been unforeseeable in the latter years of the confronted at roughly the same time 1980s. The sharp increase in debt and with asset-price deflation and the the unprecedented liquidation of inevitable consequences. Despite corporate equity clearly were unsus widespread problems, we seem to tainable and would eventually require have at least avoided the crises that a period of adjustment. What was historically have been associated with unclear was the point at which such periods in the past. financial problems would begin In the United States especially, to constrain spending and how important economic dynamics ensued strong those constraints would be. as the speculative acquisition of physical assets financed by debt outpaced fundamental demands. 4 Forecasts of difficulties with debt and Indeed, considerable progress in this strained balance sheets had surfaced regard has become evident for both from time to time over the past households and businesses. The much decade. But only in recent years did it more subdued rate of household and become apparent that debt leverage business credit expansion has reduced had reached its limits, inducing the leverage of both sectors. House consumers and businesses to retrench. hold debt service payments as a Moreover, the degree of retrenchment percent of disposable personal income has turned out to be much greater have retraced around one-half of the than experience since World War II runup that occurred during the would have suggested. previous expansion, and further The successive monetary easings progress appears in train. Similarly, have served to counter these contrac nonfinancial corporations' gross tionary forces, fending off the classic interest payments as a percent of cash "bust" phase that seemed invariably flow are estimated to have retraced to follow speculative booms in much of the roughly 10 percentage pre-World War II economic history. point increase that occurred in the During those severe episodes, sharp expansion. The improvements in declines in output and income were balance sheets, together with the associated with a freezing up of credit beneficial effects of lower interest availability, widespread bankruptcies rates, have been reflected in reduced by borrowers, and closings of newly delinquencies on consumer loans and insolvent financial institutions. Thus, home mortgages, increased upgrad balance sheets were cleansed only ings of firms' debt ratings, and through the massive writing off of narrowed quality spreads on corpo loans, involving a widespread rate securities. Furthermore, lower destruction of creditor capital. interest rates, along with two reduc To be sure, elements of this tions in reserve requirements, have historical process have been at work appreciably cut the funding cos.ts of in recent years, but the monetary depository lenders, materially policy stimulus since mid-1989 has improved interest margins, and forestalled such a severe breakdown. fostered the replenishment of deposi Lower interest rates have lessened tory institution capital. repayment burdens through the Although greatly moderating the refinancing and repricing of outstand potential adverse effects of the ing debt, and together with higher necessary adjustment process on stock prices have facilitated the economic activity, monetary stimu restructuring of balance sheets. lus also has stretched out the period over which adjustments will occur. 5 A more drawn out adjustment of Against that background, more rapid impaired balance sheets, as we now or forceful easing actions more than are experiencing, obviously is much likely would have been interpreted by preferable to the alternative: an market participants as risking a adjustment through massive financial resurgence of inflation. That would and economic contraction. Yet the have led to higher rather than lower ongoing corrective process has meant long-term interest rates. As I have that the economic expansion has been indicated many times before this hobbled in part by the continued Committee, lower long-term rates are restraint on spending by still over crucial in promoting progress toward leveraged and hence cautious debtors. more stable balance sheet structures Balance sheets ultimately will reach in support of sustained economic comfortable configurations, but even expansion. before then we should experience a In fact, long-term interest rates quickening pace of economic activity have stayed disturbingly high in the as the grip of debt burden pressures face of sharply lower short-term rates. begins to relax. Last year I character A greater decline in long rates would ized this process as the economy have encouraged additional restruc struggling against a SO-mile-an-hour turing of business and household headwind. Today its speed is decid balance sheets and fostered stronger edly less, but still appreciable. spending on business fixed invest Uncertainty about how far the ment goods, housing, and consumer process of balance-sheet adjustment durables. Bond yields have not come would have to go and for how long down more primarily because the spending retrenchment of over investors have been inordinately leveraged debtors would continue has worried about future inflation risks. been a factor in shaping Federal While they seem to exhibit only Reserve policy over the past few modest concern over a reemergence years. This uncertainty has been of stronger inflation during the next shared by many other observers, who, few years, investors apparently fear a based on past experience, were resurgence further in the future, to a somewhat skeptical about the strength large extent as a consequence of and persistence of spending restraint expected outsized budget deficits by both the private and public exerting pressure for monetary sectors, and dubious about the accommodation. persistence of disinflationary forces. 6 Other forces have added to the The U.S. Economic Outlook restraint on the economy associated Clearly in this environment, with with balance sheet adjustments. The conflicting forces of expansion and scaling back of defense spending ~as contraction continuing to vie for been retarding near-term econormc supremacy, any projection must be growth. A significant reallocation of viewed as tenuous. In this context, the resources is an inevitable consequence central tendencies of the projections of of the phase-down of defense spend Federal Reserve Board members and ing, involving the redeploym:nt of Reserve Bank presidents are given in military personnel as well as_ m~us the Board's report. They project that trial and technological capacity mto the economic expansion is likely to civilian activities. Such shifting of strengthen moderately, to a range of resources away from military produc 2¾ to 3 percent over 1993. Such a tion promises a welcome boost to pace is expected to reduce the long-run prospects for the nation's unemployment rate noticeably over productivity and growth. Nonethe the next year and a half. This outlook less, the process of transition involves is supported by several consider- . significant frictions and lags, and in ations, including the stimulus now m the meantime the falloff of the train from recent interest rate declines military budget has represented a and the progress being made by drag on aggregate demand. At the borrowers and lenders in repairing same time, budgetary problems strained balance sheets. Some pent-up among states and localities have . demand for business capital goods, forced painful cutbacks by those uruts housing, and consumer durables and burdensome tax increases as well. should surface as the incentives for In addition, the noticeable slow spending retrenchment abate. down in economic growth in other In our judgment, the interest rate major industrial countries since declines to date, working to offset mid-1990 has further tended to spending constraints related to depress demand for goods and balance-sheet strains, should not services produced in the United endanger the further ebbing of States. Fortunately, continued rapid inflationary pressures. Even as economic growth on the part of the anticipated strengthening of developing countries, whose import~ economic activity occurs, monetary from the United States have grown m policy will continue to promote relative importance, has prevented a ongoing progress toward the . . greater weakening in the expansion of longer-run objective of price stability, our exports. which should lay the foundation for sustained economic expansion. 7 The financial fundamentals, such as The weakness of the broad monetary money and credit growth, point to a aggregates appears importantly to continuation of disinflationary trends, have reflected the variety of pressures and the central tendency of our that rechannelled credit flows away projections for CPI inflation next year from depository institutions, lessening is 2¾ to 3¼ percent. Were this to be their need to issue monetary liabili realized, inflation would be about ties. The public, in the process of back to a pace last seen on a sus restructuring and deleveraging tained basis around a quarter century balance sheets, found that monetary ago. As I often have noted to this assets had become less attractive Committee, the most important relative to certain nonmonetary contribution the Federal Reserve can financial assets or to debt repayment. make to encouraging the highest The reduced depository intermedia sustainable growth the U.S. economy tion stemmed from emerging prob can deliver over time is to provide a lems of asset quality, which in tum backdrop of reasonably stable prices prompted both the pulling back of on average for business and house depositories from lending and hold decision-making. responses by regulators that rein forced those tendencies. One such response was the shutting down or Recent Behavior of the sale of insolvent thrift institutions. In Monetary Aggregates the process, some $90 billion of thrift The relationship between money and assets have been taken onto the books spending also has been profoundly of the Resolution Trust Corporation, affected by the process of balance where they are funded by govern sheet restructuring. The broad ment securities instead of depository monetary aggregates, M2 and M3, liabilities. The managed liabilities of currently stand below their annual depositories have been most affected growth ranges, despite the earlier by this shift. However, retail deposi substantial declines in short-term tors also have been induced to shift interest rates. My previous testi into other instruments by the abroga monies to the Congress noted that tion of their original contracts by aberrant monetary behavior emerged acquiring institutions and the conse in 1990 and has since intensified. quent disruption of their banking We at the Federal Reserve have relationships. expended a great deal of effort in studying this phenomenon, and have made some progress in understanding it. To summarize our findings to date: 8 At banks and solvent thrifts as especially large banks-have con well, problems of asset quality, served capital by reducing dividends. especially for commercial real estate, Banks have regained access to capital were mounting as the 1980s came to a markets and have significantly rebuilt close. Banks reacted by tightening their capital positions. Intermediation their nonprice lending terms and costs and pressures to bolster capital, credit standards appreciably and however, have been further elevated widening the spread of lending rates by the added restrictions contained in relative to costs of funds. Upward the FDIC Improvement Act. Partly as pressure on bank loan rates was a consequence, lending spreads have augmented as investors, concerned stayed relatively high, as suggested about adequate bank capitalization, by a prime rate that is a substantial raised risk premiums on bank debt 2¾ percentage points above the and short-term managed liabilities. In federal funds rate. Recent survey addition, regulatory initiatives, such responses suggest that nonprice terms as stricter capital standards, higher and lending standards, though not insurance premiums, and more tightening further, also have remained intense supervisory scrutiny, raised stringent. the cost of depository intermediation. Bank lending has shown few signs Reserve requirement cuts have of strengthening, as demands for represented only a partial offset. As bank loans have stayed dormant. The intermediation costs rose, banks internal cash flows of nonfinancial further increased loan spreads and businesses have strengthened, and redoubled efforts to securitize loans many firms have raised substantial and otherwise constrain expansion in funds in equity markets, so overall their balance sheets. credit demands have been light. More recently, the decline in Large firms, especially those with short-term market rates, combined good credit ratings, have preferred with the improvement in asset quality bond markets over banks as a that was partly associated with the place to borrow. Meanwhile, modest economic expansion, has households, feeling the strain of debt considerably boosted bank earnings. service burdens, have rechannelled Banks also have strengthened their cash flows away from retail deposits financial condition by improving their to the repayment of consumer liquidity position and by taking steps debt at banks and other lenders. that should reduce noninterest expenses over the long run through restructuring and, in some cases, consolidation. A number of banks- 9 They were also encouraged to can be seen as an aspect of the entire deleverage their balance sheets by the process of rechannelling credit flows wider spread between consumer loan away from depositories and of rates and retail deposit rates, which restructuring the public's balance was accentuated on an after-tax basis sheets. However, the disintermedia by the phase-out of the tax tion and restructuring forces, which deductibility of interest payments on have acted powerfully to depress the consumer loans. growth of money, have exerted a less With little need for new funding, powerful constraint on spending; that banks and thrifts have lowered rates is, slower money growth has not on retail time deposits, especially on tended to show through percentage intermediate- and long-term accounts, point for percentage point to reduced by more than market rates have nominal GDP expansion. Accordingly, declined. Under regulatory pressure, these disintermediation and restruc banks also have cut back reliance on, turing forces have tended to boost the and returns to, brokered deposits. velocity of the broader aggregates. Even on NOW accounts, savings Increasing M3 velocity has been deposits, and money market deposit evident for some years, but the accounts, where inflows have tendency for M2 velocity to rise strengthened, returns on the larger was obscured until recent quarters accounts-likely involving the most by the opposing influence of declines interest-sensitive depositors-have in short-term market rates. Lower dropped much faster than have the short rates reduced the potential most common rates paid. The returns given up by holding liquid comparatively high returns on M2 balances, thereby providing longer-term debt and equity instru support to demands for M2 and ments also have drawn household countering the emerging tendency assets out of retail deposits. Bond and for its velocity to increase. But M2 stock mutual funds in particular have velocity appears to have registered an recorded substantial inflows. appreciable increase in the first half of Thus, the weakness in the broader this year, and the Federal Reserve has monetary aggregates, which has been had to take the emerging behavior of even more pronounced this year, velocity into account in deciding how much weight to place on slow M2 growth in guiding its policy actions. 10 Prospective Behavior of the Any decline in long-term market rates Monetary Aggregates could dissuade households from reaching for better returns out the Looking ahead, the recent increases in yield curve beyond M2 maturities, M2 velocity may well continue, and thereby bolster M2 demands even although the uncertainties in this more than it would spending. This regard are considerable. Returns on would further offset the tendency for short-term market instruments disintermediation and deleveraging to relative to rates on M2 balances have raise M2 velocity. All told, predicting dropped to unprecedented lows. either the share of depository inter Depositories may well reduce liquid mediation in overall credit flows or deposit rates further to restore the share of money in the public's longer-run relationships with money market rates. Should this occur, the overall demand for financial assets is resulting shifts in assets would reduce currently more difficult than usual. M2 demand without much influenc Against this background of consid ing spending, further boosting the erable uncertainty about evolving velocity of this aggregate. The monetary relationships, the Commit velocity of M2 also would tend to tee retained the current ranges for increase if any pickup in credit money and credit growth this year. availability at banks associated with These growth ranges are 2½ to stronger economic expansion were 6½ percent for M2, 1 to 5 percent for funded out of their sizable holdings M3, and 4½ to 8½ percent for debt. of liquid securities and newly issued On a provisional basis, the same managed liabilities rather than ranges also were carried over to next through recourse to retail deposits. year. Another significant imponderable If velocities were to show little involves the public's demand for M2 further increase, then growth of the balances. The extent to which house monetary aggregates within these holds will continue to repay or avoid specified ranges for both years would debt by drawing down M2 balances is be consistent with the achievement of difficult to foresee with any precision, noninflationary economic expansion. as one cannot accurately gauge The reduction in short-term interest households' desired leverage posi rates resulting from our recent policy tions. An early completion of house action enhances the odds on money hold balance-sheet adjustments growing within these ranges. On the would help to restore incentives other hand, if the unusual velocity to build liquid money balances, increases seen so far this year were to cutting into increases in M2 velocity. persist over the next six quarters, then growth of M2 and M3 around or even below the lower bounds of their ranges could still be acceptable. 11 In any case, the current ranges In light of the difficulties predicting represent a way station on the road to velocity, signals conveyed by mone reasonable price stability. Even with a tary data will have to continue to be return to the traditional secular interpreted together with other stability of M2 velocity, the midpoint sources of information about eco of the current ranges would still be nomic developments. higher than needed to support long-run economic growth in the Concluding Remarks context of price stability. And, if velocity increases do in fact occur I expect that the economic expansion during a transition period to a higher will soon gain momentum, which long-run equilibrium level, then lower inflation should help to ranges somewhat lower than the maintain. Although the economy still current specifications would be is working its way through structural warranted over this interval. But in impediments to more vigorous light of the considerable uncertainties activity, the advances that already about neater-term velocity develop have been made in this regard augur ments, the Federal Open Market well for the future. Banks and other Committee did not commit itself to lenders, having made considerable new, respecified ranges for M2 or M3 strides in rebuilding capital, have for 1992. Such a respecification would greater capacity to meet enlarged carry the presumption that the new credit demands. The strengthening of range was clearly more consistent household finances to date has with broader economic objectives, and established a firmer foundation for in view of the uncertain relationships future consumer outlays. And the involved, the FOMC did not wish to restructuring of business balance convey that impression. This year's sheets so far, together with improved ranges were carried forward on a labor productivity and profitability, provisional basis for 1993, until such has better positioned producers to time as additional experience and support sustainable output gains. analysis could be brought to bear on These gains would be even larger if the issue of monetary behavior. In the federal government can make any event, the FOMC will revisit the significant progress toward bringing issue of its money and credit ranges the budget into balance, releasing for 1993 no later than its meeting saving for productive private invest next February. By then more evi ment, and brightening further the dence will have accumulated about prospects for ongoing advances in evolving monetary relationships. living standards for all Americans. 12 Monetary Policy and the Economic Outlook for 1992 and 1993 Monetary Objectives The Committee also reaffirmed the for 1992 and 1993 existing 1992 monitoring range for the aggregate debt of domestic nonfinan In reviewing the annual ranges for cial sectors. The more cautious the monetary aggregates in 1992, the attitudes toward borrowing that have Committee noted the substantial damped credit growth this year, and uncertainties created by the unusual the improving balance sheets of behavior of M2 and M3 velocity thus borrowers, should lay the ground far this year. If portfolio shifts ebb ~or~ for sustained economic expan and more normal relationships of s10n m years to come. depository credit to spending begin to The ongoing structural changes in emerge, growth of the monetary the financial system and the tentative aggregates within the existing ranges nature of the recovery greatly would be consistent with the Commit complicated the task of choosing tee's objectives for making progress ranges for the coming year. The toward price stability and fostering Committee recognized that the range economic growth. However, it is for M2 probably would need to be unclear whether the forces giving rise reduced at some point to be consis to the unusual behavior of the tent with the Federal Reserve' s aggregates will wane in coming lon~-~un objective of reasonable price months or continue unabated. Faced stab1hty. However, pending further with these uncertainties, the Commit analysis of the recent relationship of tee chose to retain the 2½ to 6½ per money stock movements to income cent range for M2 and the 1 to and interest rates, the Committee 5 percent range for M3 announced chose to carry forward the 1992 earlier this year for 1992. ranges for the monetary aggregates and debt as provisional ranges for 1993. Ranges of Growth of Monetary and Credit Aggregates (Percentage change, fourth quarter to fourth quarter) Provisional 1991 1992 for 1993 M2 2½ to 6½ 2½ to 6½ 2½ to 6½ M3 1 to 5 1 to 5 1 to 5 Debt 4½ to 8½ 4½ to 8½ 4½ to 8½ 13 Economic Projections moderate pace and job growth is for 1992 and 1993 sufficient to impart a downward tilt to the unemployment rate. In 1993, The members of the Board of Gover output growth is expected to pick up nors and the Reserve Bank presidents, slightly further from the 1992 pace, all of whom participate in the bringing additional small reductions discussions of the Federal Open in the unemployment rate. Inflation Market Committee, generally believe likely will hold to a gradual down that the most likely scenario for the ward trend over the next year and a economy in the second half of 1992 is half. one in which real GDP increases at a Economic Projections for 1992 and 1993 FOMC Members and Measure other FRB Presidents 1992 Range Central Tendency Percentage Nominal GDP 5 to 6¼ S¼ to 6 change, fourth quarter Real GDP 2 to 3¼ 2¼ to 2¾ to fourth quarter: Consumer Price Index 3 to 3½ 3 to 3½ Average level in the fourth Civilian unemployment rate 7 to 7½ 7¼ to 71/2 quarter, percent: 1993 Range Central Tendency Percentage Nominal GDP 4½ to 7 5½ to 6¼ change, ____________________ ::__::_.=.._:..:...:. ____ fourth quarter Real GDP 2½ to 3½ 2¾ to 3 to fourth _____________________ :__:__:.:....: _____ quarter: Consumer Price Index 2½ to 4 2¾ to 3¼ Average level in the fourth Civilian unemployment rate 6½ to 7¼ 6½ to 7 quarter, percent: 14 In quantifying their views of the In the market for commercial real prospects for economic growth, the estate, which has been the most Board members and Reserve Bank striking area of weakness in the presidents ended up with forecasts economy in recent quarters, down that are somewhat stronger than in ward pressures on the prices of February. A large majority of them existing properties seem to have see the most likely outcome for this begun to diminish, and the rate of year as being one in which real gross decline in new construction appears domestic product rises 2¼ percent to to be slowing. In addition, businesses 2¾ percent over the four quarters of and households also have made 1992; the central tendency of the considerable progress in strengthen forecasts for 1993 spans a range of ing their finances, and even though 2¾ to 3 percent. With regard to the that improvement evidently has not unemployment rate, the central yet generated more expansive tendency of the governors' and Bank attitudes toward spending and presidents' forecasts for the fourth investing, such a shift probably will quarter of 1992 covers a range of 7¼ be forthcoming at some point. An to 7½ percent, as compared with the obvious risk in the outlook is that second-quarter average of 7½ percent; these, and the other, structural the corresponding central tendency adjustments could persist with greater range for the final quarter of 1993 is intensity than is anticipated; but, 6½ to 7 percent. alternatively, a faster resolution of the The achievement of the projected structural problems-and a stronger GDP growth will depend in part on pickup of the economy-is not out of the progress in resolving the various the question either. structural adjustments noted earlier. The governors and Bank presidents In general, the Board members and expect the rise in the consumer price Reserve Bank presidents believe that index over the four quarters of 1992 these structural problems will to end up in the range of 3 to continue to exert negative drag on 3½ percent. Although an increase the economy in coming quarters, but of this magnitude is to the high side that their force will gradually lessen. of that which was realized in 1991, On that score, some of the recent inflation rates were held down last trends have been encouraging. year by the unwinding of the oil price shock that had occurred in 1990. 15 Core inflation this year is expected to Real GDP be lower than it was in 1991, and Percent change, annual rate most Board members and Reserve Bank presidents believe that sustained progress toward the containment of costs and a further easing of inflation expectations will keep the trend rate of price increase on a course of gradual slowing next year as well. With neither food nor energy prices anticipated to depart in any meaning ful way from the broad trends of inflation, the total CPI also is ~xpected to slow in 1993, dropping mto a range of 2¾ to 3¼ percent, 1989 1990 1991 1992 according to the central tendency of the FOMC participants' forecasts. Earlier this year, in the Economic The Federal Reserve, for its part, can Report of the President and the Budget, best contribute to the achievement the Administration issued forecasts of those objectives by keeping its that showed nominal GDP growth in sight firmly on the long-run goal of 1992 and 1993 that falls within the price stability. But the longer-range ranges anticipated by Federal Reserve progress of American living standards officials. Consequently, there would will depend upon more than mone appear to be no inconsistency tary stability. Sound fiscal policies between the System's plans for and an open world trading system are monetary policy and the short-term essential if we are to enhance capital goals of the Administration. formation and achieve the greatest Looking more toward the long possible productivity of our human term, the prospect of a sustained and physical resources. period of declining inflation, together with a resolution of the many structural problems that currently afflict the economy, suggests the opportunity for substantial economic gains and a broadening prosperity. 16 Developments in 1992 Household Sector Debt Service Relative to Economic activity has increased on Disposable Personal Income* balance since the beginning of the Percent year, but rather hesitantly in recent months, and inflationary pressures Total Debt Service as a Percentage of _Di_·s...._p_os_ab_l_eP_e_rs_o_na_l_In_co_rn_e.....:(...:::Qu_a_rt....:..e~rlyl..!..) ___ have continued to abate. Against this 19 backdrop-and with money and credit exhibiting renewed weakness in the second quarter-the Federal Reserve has eased money market conditions twice-in April and again in early July. The descent of domestic interest rates, which began in 1989, has now carried nominal yields on many market instruments to the lowest levels in two or three decades. In mid-February, when the Board 1980 1982 1984 1986 1988 1990 1992 ,. Debt service is a staff estimate of scheduled presented its last semiannual report principal and interest payments on home mortgage on monetary policy to the Congress, and consumer debt. the economy seemed to be struggling to regain forward momentum. Growth had come almost to a Chief among those structural impedi standstill in the final quarter of 1991, ments were persistent problems in and, while a hint of improvement was commercial real estate markets, evident in some of the indicators that budgetary stress at all levels of were available in mid-February, government, a downsizing of the convincing signs of a strengthening of defense industry, exceptional caution activity had not yet appeared. among financial intermediaries, and Moreover, in looking ahead at that ongoing efforts of businesses and time, it seemed likely that growth households to reduce the level of would continue to be retarded by the their indebtedness. still incomplete resolution of major At the same time, however, structural adjustments in a variety of considerable impetus to activity sectors, financial and nonfinancial. was thought to be already in train, partly as a result of the substan tial easing of money market condi tions that the System had imple mented in the second half of 1991. 17 Among other effects, the decline in Industrial Production short- and long-term interest rates Index 1987 = 100 was reducing debt-servicing obliga tions and was facilitating needed balance sheet restructuring by borrowers and lenders. In assessing the situation as of last February, the -~~t-Jun-e 110 Board members and Reserve Bank presidents recognized that the uncertainties in the outlook were -------~--¥:._.____ __ 105 unusually large~ but they believed that a moderate pickup in output from the especially sluggish pace of the fourth quarter of 1991, coupled with further improvement in under 1989 1990 1991 1992 lying price trends, was the most likely prospect in 1992. In the event, economic growth did Economic growth, as measured by the move back into a moderate range in annualized rate of change in real the first quarter of 1992. After keeping gross domestic product, moved up to a tight grip on their expenditures 2¾ percent in the first quarter, the during the holiday shopping season, largest quarterly gain in more than consumers steppe1 up their spending three years. sharply in early 1992; simultaneously, The strength in final demand that purchases of new houses soared seemed to be emerging in the early ~purred in part by lower mortg;ge part of the year does not appear to interest rates. An unusually mild have carried through the second winter also helped to buoy activity in quarter, however. Households, January and February. Although restrained by a soft labor market and businesses were able to accommodate the lack of significant gains in real much of the burst in spending income, clamped down on their through a drawdown of inventories, spending after the burst early in the the rise in demand sparked a rebound year; real consumption expenditures in industrial output. Consumer appear to have grown little, if at all, sentiment, which had deteriorated in the second quarter, and new home in late 1991 and early 1992, began sales fell steadily from February to tilt back up in late winter and through May. In addition, exports, early spring, and business execu- which, over the past several years, tives expressed greater optimism. had been an area of strength in the economy, showed little growth over the first five months of 1992. 18 Although manufacturers boosted Inflationary forces have been muted production in April and May, they this year. Prices accelerated somewhat tended to do so more by stretching in the first quarter, but that flare-up the hours of their workers, rather proved to be short-lived, as increases than by adding employees to their in the consumer price index were payrolls. Declines in production small, on average, in the second became evident in the industrial quarter. The "core" rate of inflation, sector in June, as firms apparently as measured by the change in the moved quickly to forestall unintended CPI excluding food and energy, inventory accumulation. In the labor averaged 3.8 percent at an annual rate market, the data for May and June in the first six months of 1992; this showed a disturbing rise in the rate of rise was a little lower than the unemployment rate, to a level of average rate of increase during 1991, 7.8 percent. On the whole, the growth and it was considerably less than the of total output in the economy likely increase seen during 1990. With was positive again in the second inflation expectations down apprecia quarter-as it had been in each of the bly from recent highs, and with firms four preceding quarters. But, as the striving to reduce their costs on all Federal Reserve had anticipated at the fronts, a trend toward gradual start of the year, the drag from reduction in the rate of price increase ongoing structural adjustments has appears to be well established at the remained heavy. present time. Growth in the broad measures of money was quite weak in the second Consumer Prices Excluding quarter, leaving both M2 and M3 in Food and Energy* June below the lower bounds of their Percent change, Dec. to Dec. annual ranges. Measured from its average level in the fourth quarter of 1991, M2 increased at an annual rate of 1 ½ percent through June, while M3 --------------- 6 edged down at a rate of ¼ percent over that same period. As is dis cussed in more detail below, the ~-- 4 sluggishness of money during this period seemed to be more a reflection of changing patterns of finance than 2 of restraint on nominal income growth. Still, private credit growth also was relatively slow, and, in the 1986 1988 1990 1992 •Consumer price index for all urban consumers . ..P ercent change, June 1991 to June 1992. 19 context of renewed softness in the Foreign Exchange Value incoming data on spending and of the U.S. Dollar* production, the weakness in both Index, March 1973 = 100 money and credit added to concerns about the ongoing strength of the expansion. -------------- 125 In this environment, the System eased money market conditions \~~A~~ slightly in April and implemented a -"\JV-~ - 100 one-half percentage point reduction in the discount rate on July 2 along with \j "}une a commensurate further easing of -------------- 75 money market conditions. In total, short-term interest rates have declined about three-quarters of a percentage point since the beginning of the year. 1986 1988 1990 1992 Longer-term rates backed up early in •Index of wei$hted average foreign exchange value of U.S. dollar m terms of currencies of other the year as the economic expansion G-10 countries. Weights are based on 1972-76 appeared stronger than many people global trade of each of the 10 countries. had expected, raising market concerns about a revival of inflationary pressures. However, in recent months Declining interest rates in recent many bond and mortgage rates have years have contributed to sizable retraced their earlier increases. Broad reductions in debt-service obligations, indexes of stock prices have remained as both long- and short-term debt has close to record levels. In foreign been rolled over or refinanced at exchange markets, the weighted lower rates. In addition, lower average value of the dollar, in terms long-term rates and high price of the currencies of other Group-of earnings ratios on stocks have Ten (G-10) countries, appreciated encouraged businesses to reduce the until early March, but recent depreci interest-rate risk and the uncertainty ation, occasioned primarily by a less associated with short-term funding robust outlook for the U.S. economy, by relying more heavily on issu- has left the dollar somewhat below its ance of long-term debt and equity. 1991 year-end level. 20 Long-Term Interest Rates Of course, not all parties have Percent benefitted from lower interest rates; households holding short-term Monthly deposits have experienced a sizable --------------- 18 decline in interest income. On balance, though, lower interest rates have helped households and busi nesses strengthen their balance sheets, thereby building a firmer financial foundation for future economic expansion. Efforts to return to more sustain Thirty-year Treasury bond able leverage positions have contrib uted to slow expansion of the debt of nonfederal sectors in the first half of 1982 1984 1986 1988 1990 1992 Last observation is for June 1992. this year. Heavy borrowing by the federal government has kept total debt expanding at the lower end of the Federal Open Market Committee's Households also have taken advan (FOMC) 4½ to 8½ percent monitoring tage of lower rates to refinance range, based on current estimates. existing debt, especially mortgages. In Depository credit remains especially addition, over-leveraged households, weak, reflecting not only muted facing' uncertain income and employ private loan demands, but also ment prospects and wide spreads continued caution among deposito between rates charged on consumer ries. Commercial banks no longer credit and yields on monetary assets, appear to be tightening their non have moved to limit debt growth. price terms of lending, but the degree The resulting improvements in the of credit restraint remains substantial financial conditions of households and spreads between loan rates and and businesses are evident in a the cost of funds remain unusually number of indicators: Delinquencies wide. Bank capital positions have on consumer loans and home mort improved substantially over the past gages have declined, ratings for a year; nonetheless, banks are likely to number of firms have been upgraded, continue working to bolster capital, and yield spreads have narrowed on partly as a consequence of incentives private fixed-income securities contained in the FDIC Improvement relative to Treasury obligations. Act. 21 The contraction of depository credit The rechanneling of credit flows has been mirrored by the meager away from depositories and the advance in the monetary aggregates. associated sluggish money growth This is seen clearly in M3, which have not been entirely benign; many includes most of the liabilities banks borrowers face higher costs and and thrifts use to fund loans and stricter terms of credit now than in other assets. But M2 also has been the past at given levels of market affected. Banks and thrifts have not interest rates. Nonetheless, weakness actively pursued deposit funding in of the monetary aggregates has not light of weak loan growth, and retail been associated with a similar degree deposit rates have fallen considerably of restraint on aggregate demand. over the course of the year. Consum Indeed, growth in nominal spending ers consequently have sought higher has considerably outpaced that of M2 yielding assets outside M2, including and M3; put differently, both mone those in the capital market where tary aggregates appear to have despite the greater risks involved registered sizable increases in their returns have appeared more attrac income velocities in the first half of tive. In addition, given the wide the year. The rise in M2 velocity is deposit-loan rate spreads, some M2 particularly notable, given the marked holders likely have opted to pay drop in short-term interest rates in the down debt rather than to hold latter part of 1991. Ordinarily, velocity monetary assets. tends to fall for a time after a decline in short-term rates. 22 Growth of Money and Debt (Percentage change) Debt of Domestic Ml M2 M3 Nonfinancial Sectors Annually, 1980 7.5 8.9 9.5 9.3 Fourth quarter to fourth quarter 1981 5.4 (2.S)· 9.3 12.3 10.1 1982 8.8 9.1 9.9 9.3 1983 10.4 12.2 9.9 11.4 1984 5.4 8.0 10.8 14.2 1985 12.0 8.7 7.6 13.9 1986 15.5 9.2 9.0 14.1 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 8.1 1990 4.2 4.0 1.7 7.0 1991 8.0 2.8 1.2 4.4 Quarterly Ql 16.5 4.3 2.2 3.8 (annual rate) 1992 Q2 9.9 0.0 -1.9 5.1 Semiannually, H1 13.4 2.1 0.2 4.5 fourth quarter to second quarter (annual rate) 1992 •Figure in parentheses is adjusted for shifts to NOW accounts in 1981. FRBl-44000--0792 23

Federal Reserve (1992, July 20). Monetary Policy Report. Monetary Policy Reports, Federal Reserve. https://whenthefedspeaks.com/doc/monetary_policy_report_19920721

@misc{wtfs_monetary_policy_report_19920721,
  author = {Federal Reserve},
  title = {Monetary Policy Report},
  year = {1992},
  month = {Jul},
  howpublished = {Monetary Policy Reports, Federal Reserve},
  url = {https://whenthefedspeaks.com/doc/monetary_policy_report_19920721},
  note = {Retrieved via When the Fed Speaks corpus}
}