Congressional Testimony

FEDERAL RESERVE'S SECOND MONETARY POLICY REPORT FOR 1989 HEARING BEFORE THE COMMITTEE ON BANKING, HOUSING, AND UEBAN AFFAIRS UNITED STATES SENATE ONE HUNDRED FIRST CONGRESS FIRST SESSION ON OVERSIGHT ON THE MONETARY POLICY REPORT TO CONGRESS PURSU- ANT TO THE FULL EMPLOYMENT AND BALANCED GROWTH ACT OF 1978 AUGUST 1, 1989 Printed for the use of the Committee on Banking, Housing, and Urban Affairs U.S. GOVERNMENT PRINTING OFFICE WASHINGTON : 1989 For sale by the Superintendent of Documents, Congressional Sales Office U.S. Government Printing Office, Washington, DC 20402 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS DONALD W. RIEGLE, JR., Michigan, Chairman ALAN CRANSTON, California JAKE GARN, Utah PAUL S. SARBANES, Maryland JOHN HEINZ, Pennsylvania CHRISTOPHER J. DODD, Connecticut ALFONSE M. D'AMATO, New York; ALAN J. DIXON, Illinois PHIL GRAMM, Texas JIM SASSER, Tennessee CHRISTOPHER S. BOND, Missouri TERRY SANFORD, North Carolina CONNIE MACK, Florida RICHARD G- SHELBY, Alabama WILLIAM V. ROTH, JR., Delaware BOB GRAHAM, Florida NANCY LANDON KASSEBAUM, Kansas TIMOTHY £. WIRTH, Colorado LARRY PRESSLER, South Dakota JOHN F. KERRY, Massachusetts RICHARD H. BRYAN, Nevada KEVIN C. GOTTUEB, Staff Director LAMAE SMITH, Republican Staff Director and Economist STEVEN B. HARRIS, General Counsel (ID Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis CONTENTS TUESDAY, AUGUST 1, 1989 Opening statements of: Page Senator Sarbanes 1 Senator Dixon 2 Senator Shelby 2 Senator D'Amato 4 Senator Heinz 5 WITNESS Alan Greenspan, Chairman, Board of Governors, Federal Reserve System 5 Prepared statement 11 Economic and monetary developments thus far in 1989 11 Monetary policy and the economy into 1990 15 Monetary policy in perspective 18 Monetary policy report to Congress 19 Federal Reserve press release 32 Discussion: Quarters of growth under 2 percent 66 Economic Summit Conferences 67 Saving rates deficient 69 Social Security Trust Funds 69 Financing the S&L bailout 72 Money growth linked to inflation 75 On budget/off budget financing 76 Waiving the Budget Act 79 Market rates declining 82 Legislation to bring back the IRA 84 Mexico's debt 86 Interest rates and parity between economic partners 89 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis FEDERAL RESERVE'S SECOND MONETARY POLICY REPORT FOR 1989 TUESDAY, AUGUST 1, 1989 U.S. SENATE, COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS, Washington, DC. The committee met at 10:05 a.m., pursuant to notice, in room SD-628, Dirksen Senate Office Building, Senator Paul S. Sarbanes, presiding. Present: Senators Sarbanes, Sasser, Shelby, Graham, Heinz, D'Amato, Gramm, Mack, and Pressler. OPENING STATEMENT OF SENATOR SARBANES Senator SARBANES. The committee will come to order. I am very pleased to welcome Chairman Greenspan here this morning to testify on the Federal Reserve's monetary policy report to the Congress, This hearing was originally scheduled to be held a week ago, but the very deep involvement of this committee in the savings and loan bill made it necessary to delay that hearing. Senator Riegle had planned to be here this morning to chair the hearing, but an illness in his family made it impossible for him to be present. Nevertheless, he felt strong that the committee should proceed since we want to review the Federal Reserve's report, as we are going to do today prior to the August recess which is sched- uled to commence at the end of this week. It appears that the U.S. economy may be entering a rather pre- carious period. We have experienced growth, albeit slow growth, much of it for an extended period, but questions are now being raised whether that path is sustainable. The Federal Reserve now projects unemployment next year in the 5*/2 to 6 percent range and real GNP growth in the range of 1% to 2 percent. I think there is a serious question about whether the economy can maintain or sustain such a low level of growth while avoiding at the same time a further downturn, and we hope to examine that question with the Chairman this morning. Mr. Chairman, we look forward to hearing from you and your as- sessment of how the Federal Reserve is likely to deal with the cur- rent economic outlook. Before turning to you for your testimony, I will turn to my col- leagues and see if they have any statement they might wish to make. (it Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis STATEMENT OF SENATOR ALAN DIXON Senator DIXON. Mr. Chairman, I am pleased to be here this morning as the Senate Banking Committee conducts hearings on monetary policy with Federal Reserve Chairman Alan Greenspan. It has been quite a busy 6 months since we last heard from Chairman Greenspan. We all have been working hard on the thrift legislation. Chairman Greenspan has also been trying to engineer a "soft landing" for our economy. The Federal Reserve's efforts in this regard will, I hope, prove successful. Now that work on the thrift bill is almost complete, I wish to register my strong interest that the Banking Committee take up fi- nancial modernization legislation upon its return from the August recess. I believe that Chairman Greenspan has strong views on ex- panding bank powers. I would prefer to have Congress work its will than rely on the appropriate, yet incremental approach of the FED. Mr. Chairman, I hope that S. 305 will be at the top of your agenda for the committee when we reconvene in September. Thank you, Mr. Chairman. STATEMENT BY SENATOR RICHARD SHELBY Senator SHELBY. Mr. Chairman, let me commend you for schedul- ing this morning's hearing, I am glad that we have this opportuni- ty to meet with the Chairman of the Federal Reserve before the August recess commences, As always, Chairman Greenspan, it is a pleasure to have you before this committee. We are interested in what light you can shed on the direction of interest rates and the underlying situation of the economy. I have several concerns that I would like to men- tion briefly and I hope that we could discuss these issues during the discussion period. We in this committee and in Congress, the administration, the private sector, and in the academic community, all speak frequent- ly of the global economy, of the increasing interdependence among nations. We acknowledge that this evolution toward "international- ization" is inevitable and irreversible because it has been facilitat- ed by the rapid advancement in telecommunications and informa- tion technology, by improved transportation and as you point out in a particularly interesting statement, by the downsizing of eco- nomic output. We recognize this trend. However, I am concerned that we are not making adequate internal changes to respond to external pres- sures. Every American that drives a Japanese car or buys a VCR knows that the Pacific rim nations are eating our lunch in many traditionally American industries. We see Europe making impres- sive strides toward 1992 and a common market. Even Eastern bloc nations are making motions toward entering this new global market place. Yet, the U.S. remains hindered by macroeconomic problems. We have become, during the past 8 years, the world's largest debtor nation, rather than the world's largest creditor. We are saddled with an enormous budget deficit that greatly restricts our ability to fully address the competitive challenges that have been laid before us by our trading partners. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis That budget deficit eats away at our modest private savings rate to give us a dismal overall savings rate of 2.8 percent, the lowest of any major industrial nation. As recently as the mid-1970's, our per- sonal savings rate was 9.4 percent. At the same time, Japan's saving rate was at 17 percent, Germany's was at 14 percent and Canada's at 13.3 percent. While in 1986, the U.S. savings rate had plunged by more than 50 percent to 4 percent, Japan's savings rate remained high, at 16.4 percent, and Germany's at 13.4 percent. I point this out for two reasons. First, our personal savings rate is abysmal and cannot, for the health of our Nation, continue to stay so low. We must encourage Americans to save. Against the advice of experts, I have considered legislation to encourage saving which would do so by permitting an exclusion from personal income of the first $200 in dividends and interest earned. While I do not presume that this modest effort could turn around the sav- ings rate crisis, I believe that it would be a step in the right direc- tion. However, this income exclusion would cost the Federal Gov- ernment approximately $15 billion over a 5-year period. While this is not a huge sum, it is too much in this time of budget deficits. But I point out the savings rate for another reason and that is for its ultimate impact on the cost of capital for business. Industry in this Nation pays substantially more for the capital it needs for investing in long term projects than do businesses abroad. Conse- quently, U.S. businesses require that projects break even much quicker than their foreign competitors. This stems from a variety of factors, not the least of which is the emphasis in this country on short term profits. While Japanese cor- porations benefit from "webs" of stable shareholders who have in- vested for the long term, U.S. corporations must focus on quarterly reports. Just a couple of weeks ago, Norm Augustine of Martin Marietta testified that the publicly held ownership of his company, with a market capitalization, turned over every year. Mr. Augus- tine related Martin Marietta's experience of making significant ex- penditures on R&D several years ago, as part of its long term plan, only to have the stock price plummet. Fortunately, there was no threat of a takeover, the R&D paid off, and they are now consid- ered to have been wise. But the fact today is that so many companies do not have the luxury of taking a long term perspective. The cost of capital is too high to make many projects feasible, because investors demand consistently high returns. I believe that this short term outlook by investors is severely limiting our ability to compete in the global market. I am concerned that, while the Federal Government is cognizant of the challenge posed by the internationalization, it is doing far too little to assist the United States in meeting that challenge. The Federal deficit is our single largest problem. This dissaving in- creases interest rates and hamstrings our ability to respond to many issues. I would encourage you, in your capacity as guardian of the economy, to encourage the administration to make the budget deficit its No. 1 priority. In order to encourage long term investment, it seems necessary to bring back a capital gains structure that rewards investors for holding on to investments, while penalizing those who focus on Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis short-term trading. I am sure that you have some guidelines on this issue and I would be interested in your comments. As for the budget issue, I look forward to what you have to say about the optimal method of financing the savings and loan resolu- tion now that we are at this stage of the game. The administration and members of this committee have argued that waiving Gramm- Rudman will send a signal to foreign investors that the Federal Government is not serious about exercising fiscal restraint. This in turn could send interest rates up. I realize that you have responded to this subject before, but we are now in the situation of facing a month long recess without having acted on this legislation. I be- lieve that your comments would be constructive. Thank you, Mr. Chairman. OPENING STATEMENT OF SENATOR D'AMATO Senator D'AMATO. Mr. Chairman, I welcome Chairman Green- span and the news he brings. In the 6 months since the FED's last report on monetary policy, we have observed the effects of the Fed's steady hand on the money supply controls. Not long ago we heard dire predictions of inflationary cycles and an overheating economy based on low unemployment figures and high manufac- turing capacity utilization. Instead, the American economy has cooled considerably. Now the same doomsayers are predicting the opposite problem: a recession. When confronted with the ever vigilant prophets of doom, I am reminded of the rule about making predictions: if you predict often enough you will eventually be right about something. We all recognize that economics is a rough science and only time will tell whether we have achieved the illusive "soft landing". In any case, it appears now that Chairman Greenspan has steered a course in monetary policy that has slowed growth without choking off the robust economy which has created jobs and increases oppor- tunity for all Americans. And he is to be congratulated. Interest rates are declining, consumer spending is slowing and while unemployment has risen slightly, 180,000 new jobs were cre- ated in the month of June. So the economy continues to demon- strate the resilience of the American economy. We do have some problems that I believe the Government is at least partially responsible for and I would like to hear Dr. Green- span's thoughts on them. Despite the recent decline in interest rates, American businesses still face a competitive disadvantage be- cause of the high cost of capital for investment. One effect of our thin domestic capital pool is the decline in manufacturing produc- tivity over the past 12 months. I note that Dr. Greenspan's testimo- ny emphasizes the importance of productivity-enhancing invest- ment to our long-term national goals. We are in total agreement as to that. While the Federal deficit is surely a major factor in our high in- terest rates, the low rate of private savings is also a major cause of our high domestic cost of capital. Our tax code which taxes savings and investment while promot- ing consumption is one reason for our low savings rate. I believe this is a matter which we must address now. I know that Chairman Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis Greenspan is reluctant to support a revival of the Individual Re- tirement Account in the current deficit evnironment, and but I also know that he has been a leader in educating policy makers on this important matter of savings rates. Therefore, as always, I look for- ward to Dr. Greenspan's insightful testimony. Thank you, Mr. Chairman. Senator Heinz. OPENING COMMENT BY SENATOR HEINZ Senator HEINZ. Mr. Chairman, I don't wish to make a statement, but I do want to welcome Alan Greenspan back to the Senate Banking Committee. We have obviously many subjects we will want to discuss with you, Alan, and we obviously are interested in hearing the comments you will make in this your regular periodic report to the committee. It's good to have you here. Senator SARBANES. Senator Mack. Senator MACK. Welcome, Mr. Greenspan, and I look forward to your testimony. Senator SAEBANES. Mr. Chairman, we are ready to hear from you, please. STATEMENT OF ALAN GREENSPAN, CHAIRMAN, BOARD OF GOVERNORS, FEDERAL RESERVE SYSTEM Chairman GREENSPAN. Thank you very much, Mr. Chairman. I very much appreciate this opportunity to appear before you in connection with the Federal Reserve's semiannual Monetary Policy Report to the Congress. In my prepared remarks today I will adhere closely to the matter at hand—that is, monetary policy and the state of the Nation's economy. I will excerpt from my prepared remarks and request that the full text be included in the record, Senator SAEBANES. The full text will be so included. Chairman GREENSPAN. Over the course of this year the contours of the broad economic setting have changed. As a consequence, the stance of monetary policy also has shifted somewhat, although the fundamental objective of our policy has not. That objective remains to maximize sustainable economic growth, which in turn requires the achievement of price stability over time. At the time of our last report to the Congress in February of this year, we characterized the economy as strong with the risks on the side of a further intensifying of price pressures. In view of the di- mensions of the inflation threat, the Federal Reserve tightened policy further earlier this year. Additional reserve restraint was applied through open market operations and the discount rate was raised a half a percentage point. The determination to resist any pickup in inflation also mo- tivated the decision of the Federal Open Market Committee at its February meeting to lower the ranges for money and credit growth for 1989. Reflecting the economy's apparent strength and the tighter stance of policy, interest rates rose during the first quarter. Short- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis term market rates increased about a percentage point over the quarter leaving them up more than three points from a year earli- er, but long-term rates held relatively steady. By the beginning of the second quarter the outlook for spending and prices was becoming more mixed. Scattering indications of an emerging softening and economic activity began to appear prompt- ing market interest rates to pull back. Rates continued to fall as a variety of factors pointed to some lessening of price pressures in the period ahead. In particular, money growth weakened further, the underlying trend in inflation appeared to be less severe than markets had feared, the dollar con- tinued to climb and domestic demand slackened. Against this background, the Federal Reserve began to ease re- serve conditions in early June. The easing has consisted of several steps, the most recent of which took place last week. By the end of July, most short-term market rates had dropped more than IVz percentage points from their March peaks, and long-term interest rates were down somewhat less, with bond rates at their lowest levels in more than 2 years. Economic activity is estimated to have grown in the first half of this year at a rate somewhat below that of potential GNP. This stands in sharp contrast to the performance of the preceding 2 years during which growth proceeded at a pace that placed increas- ing pressures on labor and capital resources. Prices did accelerate in the first 6 months of this year, but most of the increase may be transitory, related to supply conditions in food and petroleum markets. After a gradual pickup over the pre- ceding 2 years, price inflation outside of food and energy held near its 1988 pace. The strength of the inflation pressures in 1988 and into 1989 was, of course, the motive for the progressive tightening of policy that the Federal Reserve undertook over that period. And the out- look for some reduction in these pressures owes in part to that policy restraint. The associated rise in market interest rates, beginning early last year, opened up wide opportunity costs of holding money assets and resulted in a sharp slowing of money growth. In addition to the effect of interest rates, several special factors played a role in slowing money growth and boosting velocity—that is, the ratio of nominal GNP to money. Probably the most impor- tant of these was the unexpectedly large size of personal tax liabil- ities in April. Many individuals evidently were surprised by the size of their liabilities and drew down their money balances below normal levels to make the required payments. The difficulties of the thrift industry also may have affected M2 growth. Late last year as public attention increasingly focused on the financial condition of the industry and its insurance fund, FSLIC insured institutions began to lose deposits at a significant rate. While most of the funds apparently were repositioned within M2 at commercial banks or money funds, this fact likely also had some dampening effect on that aggregate. Most recently, growth of the broader monetary aggregates has picked up markedly. The restraint imposed by the earlier rise in Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis market interest rates is fading and households appear to be re- building their tax depleted balances. The level of M2 on average in May was 1 percent above its fourth quarter base, but rapid growth in June and July has lifted the year-to-date increase to around the lower half of its 3 to 7 per- cent annual target cone. M3 also accelerated in June and July, placing it well into the lower half of its range. Looking ahead at the remainder of 1989 and into 1990, recent de- velopments suggest that the balance of risks may have shifted somewhat away from greater inflation. Even so, inflation remains high, clearly above our objective. Any inflation that persists will hinder the economy's ability to perform at peak efficiency and to create jobs. Consequently, monetary policy will need to continue to focus on laying the groundwork for gradual progress toward price stability. Such an outcome need not imply a marked downturn in the econo- my, and policy will have to be alerted to any emerging indications of a cumulative weakening of activity. However, progress in inflation and optimum growth over time also require that our productive resources not be under such pres- sures that their prices continue to rise without abating. In light of historical patterns of labor and capital growth and productivity, this progress very likely will be associated with a more moderate and, hence, sustainable expansion in demand than we experienced in 1987 and 1988. At its meeting last month, the Federal Open Market Committee determined that a combination of continued economic growth and reduced pressures on prices would be prompted by growth of money and debt in 1989 within the annual ranges that were set in February. Moreover, it tentatively decided to maintain these same ranges through 1990. The specified ranges both for this year and next retain the 4-percentage-point width first instituted for the broader aggregates in 1988. Considerable uncertainties about the behavior of money and credit remain, and the greater breadth allows for a range of paths for these aggregates as financial and economic de- velopments may warrant. In view of the apparent variability, particularly over the short run, in the relationships between the monetary aggregates and the economy, policy will continue to be carried out with attention to a wide range of economic and financial indicators, The complex nature of the economy and the chance of false signals demand that we cast our net broadly—gathering information on prices, real ac- tivity, financial and foreign exchange markets, and related data. Over the remainder of the year, M2 should continue to be sup- ported by the decline in interest rates of recent months which, along with the growth of income, is likely to result in an expansion of that aggregate well within its target range. We also expect M3 to strengthen from its rate of growth over the first half of the year moving up into the middle of its target range by year end. Growth of money and debt within the 1989 ranges is expected to be consistent with nominal GNP rising this year at a pace not too far from last year's increase according to the projections of the Federal Open Market Committee members and other presidents of Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis Reserve Banks. These projections, however, incorporate somewhat more inflation and less real growth than we experienced in 1988. The central tendency of the projections of 2 to 2V2 percent real GNP growth over the 4 quarters of this year implies continued moderate economic growth throughout the year. For the year as a whole, these projections anticipate that growth is likely to be strongest in the investment and export sectors of the economy with expansion of consumer expenditures and Government purchases rather subdued. A sectoral pattern of growth such as this would in fact serve the nation's longer-term needs by contributing to a better external bal- ance. Fundamentally, improvement in our international payments po- sition requires productivity enhancing investment and a higher na- tional savings rate. In this regard the Federal Government can play a significant, positive role by reducing the budget deficit. The outlook for inflation this year, as reflected in the central tendency of the projections expressed at the FOMC meeting, is for a 5 to 5V2 percent increase in the consumer price index. A figure in this range would represent the highest annual inflation rate in the United States since 1981. This is a source of concern to the Federal Reserve. Yet this rate is below that experienced in the first 6 months, and hence this implies a considerable slowing over the re- mainder of the year, reflecting earlier monetary policy restraint and a prospective moderation in food and energy prices. Federal Reserve policy is focused on laying the groundwork for more definite progress in reducing inflation pressures in 1990, while continuing support for the economic expansion. The ranges provisionally established for growth of money and debt next year are consistent with these intentions. Although the 1990 ranges do not represent another step in the gradual multiyear lowering of ranges, the Federal Reserve's intent to make further progress against inflation remains intact. Uncer- tainties about the outlook suggested a pause in the process of re- ducing the ranges. However, the committee recognizes that our goal of price stability will require additional downward adjust- ments in these ranges over time. Of course, as we draw closer to 1990, the economic and financial conditions prevailing will become clearer, allowing us to approach our decisions on the ranges with more confidence. Hence, the cur- rent ranges for money and credit growth in 1990 should be viewed as very preliminary. The economic projections for 1990 made by the Governors and the Reserve Bank presidents center in a range of 1% to 2 percent real GNP growth and 4V& to 5 percent inflation for next year. Nat- urally, as I have already noted, there are considerable uncertain- ties surrounding forecasts for 1990, The Federal Reserve is committed to doing its utmost to ensure prosperity and rising standards of living over the long run. Given the powers and responsibilities of the Central Bank, that means, most importantly, maintaining confidence in our currency by main- taining its purchasing power. The principal role of monetary policy is to provide a stable back- ground against which economic decisions can be made. A stable, Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 9 predictable price environment is essential to ensure that resources can be put to their best use and ample investment for the future can be made. In the long run, the link between money and prices is unassail- able. That link is central to the mission of the Federal Reserve, for it reminds us that without the acquiescence of the Central Bank, inflation cannot take root. Ultimately, the monetary authorities must face the responsibility for lasting price trends. While oil price shocks, droughts, higher taxes or new govern- ment regulations may boost broad price indexes at one time or an- other, sustained inflation requires at least the forbearance of the Central Bank. Moreover, as many nations have learned, inflation can be corro- sive. As it accelerates, the signals of the market system lose their value, financial assets lose their worth and economic progress be- comes impossible. Thankfully, this bleak scenario is not one that we in the United States are confronting. We do, however, face a difficul balancing act. The economy has prospered in recent years. The economic ex- pansion has proven exceptionally durable, employment has sur- passed all but the most optimistic expectations, and the underlying inflation rate, after coming down quickly in the early 1980's, has accelerated only modestly. But now signs of softness in the econo- my have shown up. Accordingly, it is prudent for the Federal Reserve to recognize the risk that such softness conceivably could accumulate and deepen, resulting in a substantial downturn in activity. We also recognize, however, that a degree of slack in labor and product markets will ease the inflationary pressures that have built up. So our policy under current circumstances is not oriented toward avoiding a slowdown in demand, for a slowing from the unsustaina- ble rates of 1987 and 1988 is probably unavoidable. Rather what we seek is to avoid an unnecessary and destructive recession. The balance that we must strike is to support moderate growth of demand in the near term while concurrently progressing toward our long-term goal of a stable price level. Admittedly, the balance we are seeking is a delicate one. I wish I could say that the business cycle had been repealed, but some day, some event will end the extraordinary string of economic advances that has prevailed since late 1982. For example, an inadvertent, excess accumulation of inventories or an external supply shock could lead to a significant retrenchment in economic activity. Moreover, I cannot rule out a policy mistake as the trigger for a downturn. We at the Federal Reserve, for example, might fail to restrain a speculative surge in the economy or fail to recognize that we are holding reserves too tight for too long. Given the lags in the effects of policy, forecasts inevitably are in- volved and thus errors inevitably arise. Our job is to keep such Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 10 errors to an absolute minimum. An efficient policy is one that doesn't lose its bearings, that homes in on price stability over time, but that copes with and makes allowances for any unforeseen weakness in economic activity. It is such a policy that the Federal Reserve will endeavor to pursue. Thank you very much. [The complete prepared statement of Chairman Greenspan follows:! Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis For release on delivery J 10 u : l 0 y 0 20 a , . m 1 . S , B 9 B.D.T. Mr. Chairman and Heaters of the Committee: I appreciate this opportunity to appear before you in connection with the Federal Reserve's semiannual Monetary Policy Report to leonomie *Bd Houtiry Mrvlopaenti Tbvu Far in 1X9 broad economic setting have changed- As a consequence, the although the fundamental objective of our policy has not. That objective renains to maxiniie sustsinabla economic of the Committee on Banking, Finance and Urban Affairs stability over tine. U.S. House of Representatives July 20, 1989 inflationary pressures night be building. Moreover, increases in food and crude oil prices vere raising the major inflation indexes. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis the Federal Reserve tightened policy further early this year. Additional reserve restraint was applied through open pftucantage psUit. Tilt determination to resist any pickup in Mar June Mid again in early July. By aid-July* most shott-ta the third duced, stability over tine. Economic activity apparently grew in the first half had a marked impact on growth of the monetary aggregates. nearly 1-1/2 million new jobs met »dded to payrolls. And this occurred apparently without triggering an acceleration in wages. up over the preceding t"o years, pr Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis the caae earlier in the expansion. n signifleant moderation provided a notable offset to these coat pressures. On there is son* logic in abstracting from then a prices, which balance, it appears that firms have continued to experience are quite volatile and can be dominated over the short run inflation cycle begins or why it may persist. Short-run on both the demand and the supply eides of the economy. But the na tightening of policy that the Federal Reserve undertook tint period. Afcd the outlook for aoaa reduction in that laat year, opened up wide "opportunity" costs of holding Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis -7- gro-th. More recently, growth at the broader nonetary nj^rfBjttes hu pickaxi up Ba.Ek.c4lY* t-» rutiiirit inpuswi by balances. households appear to be rebuilding their tu-deplatad balancea. *s of Kay, K2 h«d risen at juat a 1 percent rate several apecial factora played a role in slowing money from ita fourth-quarter Baae, but the 6-3/J percent r»te of GNP to nonay. Probably the moat important of these trap the cent una*o*ct«<iLy ltig« sii» oi personal tax liabilitiea in annual target cone. M3 roae at a 3-1/2 percent rate through April. Many individuals evidently were durpriaed by the June, at the lone! end of itn range. The litest data on balances below normal iBvelo to make the required paymetita. continued into July. Aa the IRS cashed those odeclts, H2 regisntrsd outright monetary aggregates, declined at a 3-1/2 percent rate through June, The unuaual o^op in Ml ataamed from aizable declines in NOW accounts and dauind deposits. HOH accounta attention increaaingly loouaad on the financial condition of apring and by the high le"el of interest ratea, "hich dren other t.ypea of accounta cboae offering rates adjuated upward nor* quickly- The decline in deiaand dapoaita was related in apparently were repoa part to a reduction in b«.Ltnc«B that b^fiiitftAaee are xaguired oome damping a sot amount of services, higher market ratas translats into lower required balances. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis -S- HM*tuy Policy ma th* loonoay into 1910 taittatiraly decided to maintain thaae aane ranges thcough 1990. 1890, recent development;] auggest thst the balance of risks The specified rangea. both foi thip yiar and next, ratain the 4-percent»g«-point «dth first instituted for the broader aggregfttea in 1986. Considarable uncertainties Any Inflation about the behavior of mcnay and credit remain, and the ability to pe Conaaquently, •ggregntea aa financial and econonic dBvelop»entB nay warrant. Uncectainties about the link between the narrow in the economy, and policy Mill have to be Alert to any In view of the apparent variability, particularly without monetary dggregvtfla &nd t^A ecencany, policy will continue to labor and and the chance of falae signals denutnd that we caat our net austain«ble, eipanaton in d«und than He experienced in 1987 and 193S. financial and foreign exchange Market s, and related data. •hile tha nonetary aggregates day not b« preeminent pconoted by growth of money and debt in 19fl9 within the exhibit unusual strength or weakness relative to pagt annual rangea that vere aet in February. Moreover, it Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis heavily on the Federal HoDe Loan Banks for their funding 13 of the year, moving up into the middle of ica target range one or Another of tha monetary aggregates, is an important by year- end. factor in the performance of the economy over the shorter Our CUP and over the long run broadly determines the rate of measure that « monitor, the debt of domestic nonfinsncial Alt sectors* has gco^ci pt about an B percent rate this year, near the midpoint of its 6-1/2 to 10-1/2 percent range. Me interest ratea in recent months, *lonq vith. thfl continued growth of income, should provide support for that aggregate tne particular, xe expac institutions have subsided, and enactment of legislation depo pro^ectior-Br of 2 to Z-W2 percept re>l GBP growth over the industry ijifficulties alao have iBpli.CBti.ono for Mi. Kitli daposits flowing in again, thrifts "ill not have to rely so Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis -12- economy, with expansion of consumer expenditures and in ooney hould thst be markets are less intense than in recent yearar velocity a better external b«lsnca. Fundament »lly, improvement in our international paym»nts position requires productivity- money gronth, perhaps in the top half of the range, would be enhancing' investment afKi a higher nazlen&l aavifig rate. In positive role by reducing the budget deficit. cy of ths proje the Fader*! Reserve, let this rate is belox that experienced in over the rsn»inder of the year, reflecting aarliar oonetary energy prices. money and credit growth in 1990 should ba viewed 53 vary preliminary, The economic projections for 1990 made by the governors And Reserve Bank presidents center in a range of Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis l'\/2 to 2 percent real <3n> growth and <-l/2 to 5 percent Ultimately? the shocks, droughts, higher tanes, or ne» government regulations n»y boost bro*d price indeisa at one tine will ba affected by • l*rg« number of influences, including importantly the budget deficit. Ittnatuy Policy In Eer*p»ctlv» optionally durable, employment has surpassed all but the to ensure that resources can be put to their beat use and vably could In the long run, the link: between money ui<3 price slack in labor and product markets will ease the Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis -16- Far use M 10:00 a.m., E.D.T. alowdown in demand, for a Blowing from the unauatainabla Thursday July 20, 1669 atas of 19B7 and 19BB is probably unavoidable. Rather -hat Board of Governors of the Federal Reserve System oderate growth of demand in the near t«tnr while Monetary Policy Report to Congress Pursuant to the Full Employment and Balanced Growth Act of 1978 July 20, 1989 •, but that cop*a vith Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis Section 1: Monetary Policy and the EC ; Outlook tor 1989 and 199Q As 1 989 began, & reduction in inflationary presaurea took an uddinonal *rna|| casing step in early July Hus was io he sustained. Monetary policy during 1988 had helped bring about i further decline In marker rates of Letter of Transmittal been directed toward reducing ihe niks of an escalation retraced die increases dial had occurred earlier m Hie flic Board'* report to Ihe Congren in February of ihis 'fl percentage poinl from thei r December levels, while potni on balance Monetary Objective! lor 1969 and 1090 BOARD OF GOVERNORS OF THE unfavorable trends in unit labor cosls over the preced- 1(1 February ihe Federal Open Marker Commmee pcrccniiige priint beln« ihat o( 1983 and ranges fur Ml THE 9PE*KEP OF THE HOUSE OF REPRESENTATIVES was raised 'i percentage point in Lure February En htiKhthe ranges hadbeen bo^ereJ Ai ihe same time, Full Employment artel B|l*nc«<I Qro*ih Ael 0' T970 ened further. Wilh M? miming noticeably beJow Us. urge! range for Ihe year Aggregate demand (or good* bec'use oE the effects &( die firming or policy thiuugh and services moderaled, reducing someu'riai the srraina Lare 1983 anJ inio 1484 In addition lu ihe influence nf ihe higher interest yam on desired holdings of money, however, several special factor*- including Ihe difn- Table of Content* CUlliCi Of the thrill mdusli) and a drawdown of tiqu id mcnu-uppfar lo have (Unher reduced money r>al- SttUon l; Monetary PoUcj and the economic Outlook far 1989 ind 1990 unchanged in [he neighborhood of 5t pcrceuE-the Sflcttan i: The Performance af the Economy during me Fim Half o< \9&9 i=iii=iBy June, rrmncygro*Tji had picked up. Nonetheless. Section 3: Monetary Policy and Financial DcvcloprrvriK Mi ended die ouarrer just 2 percent t\ an annual rate during ihe FUHI Half of 1489 ilo 7 percent annual growth range. In Juneh M3 was al with 19B8, though by les* than the monetary sggit gareSideHhabgrUwrlabourSperceDlsa (JT fhLS >*«], provide reserve* shghlly more generously tiirough agreed ID retain the current unges for growth of inoney Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis fangn of Growth for MantUfy *od CredH A0gi*g*t« nlc Pro|«ctloni for 1 * , nrbfkmtllor 1MW FOMC Utmbef • and Othar FRB PrstkJenti Admlnlitritlo NomlnaJ GNP RHlGNP dndder* in I9ft9 TtiE Co[runi[l« anticipates thai by Economic Pro^ctlons for 1 MB and 1990 Coniumar prici IndflK the fourth quarter a|j unree aggregate* will tie *e,l within (hose ran jes The more rapid growth in M2 ind serve Bank president believe [haithe monetary ranges e*lend through lf\f second half The iccrnr decline* n 1990 growth The cenTTdl leudencr of [he forecasu 19 (Or M re Z pl e e n x is p h a i n n s g io o n f U li c q l u y id a b im ala n 10 c e I s K d b e o p o le st t e e d d b by y a la < fu p rt a h y e - r /winfi ou*n*r ro fovnn ment, [his HEjregarc is expected lu gro* a [tnlc fesler The should Nominal Qftf (.UEUribute lo a d^mptFLg ft inflation in 1^0, allhough n«al GNP the Board members ind Bank presidents also JIT ConiuiTHr pri antlCLpSlirig wine ncar-lcnn relief ffoni ihc special problems [hat boosted price* in [he firs! half of thli year larger crops ItlcE ihii yur should result in mUEc wgh peaking of crude mJ priiCS SUggCbU the likelihood of wmcsnfkmns in consumer energy prices. Thiia,ie[ajl For 1990, the Commiiiec provmonally decided tu d L e nf r l aU o Q f D t h sh is U u y I e d a b r r , c D a n n s d id c ih rB e l H < y .e s n l [ o rH w l e r le O n V d c e r n lh c c v re o m f a C in P - I for« for 1989 The Committee recogniled ihm [he t E o o m rc p tf a ls r U fc l ( w O i r t h I9 i B h 9 c / m a^, n r a c w rh h a o n le 6 i p s e 5 rc H en I i 5 r 4 a re p o e b n s e er n v r e - d irltet [his ;> , ; b po u r l ts o( goods and S half 11 uncertain, in partlCUJaf, il is unclear U IhH through May 'Hieforeca^ fur ihcCPl in !9W«nler more dirficuK to achieve in the penod aheudi [he likely to trend higher or lower nejt year Although thK are Offset by those asHnia[ed wiUi die more recent incnnneclion *llh il& nud-wssion updflJC of UW budget outlook, does noi Jiflcr greatly [rorathcprjicciioinof [he FOMC membere. NominaJ GNP is near the upper ends of |he FOMC cenunJ-tendencj ranges for 19B9 ihar ii n seeking, Jl ^ill recvaluarc ihc ranges nexi and l990,biirwi[hanHre[avn[ableniuijfr«lDi]ipiii Surveys of business plans suggest thai capital spending Vfriui inflation, especiallj 111 1990 There appears to c fin ii u J D s c iH ia ia l L m LO u n - ke T u he i n O 1 U 9 tl * u 0 oL s h (n ou r ld sp h e a n v d e in c g u , u p iA ri e ce d s s , o m un e d - of ihe Federal Reserve and [he economic forecast of die cxpecied i n I ight of decl ining le^tls of capacny u*e ind mn. b[a&iliiy. bur also on ihe determinauoii of U S cared [hat K sharea Ihc view ihai [he nuintenuice of antl-Lnflationar} monetary policy i* a precondirjon lot efficiency a require thai ihc radS" for maacy and credit growth be Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 3 p*r«ni, hirt n remain* Urge by him Section 2: The Performance of the Economy during the First Half of 1989 i«Mrr SUch as htuilflB ifd buSine** invesnnrni TtLC ftdenceintheU 5 HontmiVrptniculailyamongfinan- cial maikci ptrUeLpurB At UK iame DDK, reduced ii) deceleraicd substantial)? m itie fiucliaJfot LffK* the Group uf Seven UnancBminiiten -nd «uirjl hanfc demand* by iheledcm government (or crcdii.»]]]trM mrctuie ihf niBCHl L99I budget ttrgcT. jo& creation wa* oinbhlcrjWe-ne;irl> l 'A million iriai undcnnined Uie ndjusuneni process noultl be ployment rate, RuL-tnaling around 5'* percent, re- iihuned mlhc lowest range bince The early |9lQs nW ro tc lolldr hut teen Urgcr. bc^dUHe I. S hildlion hk< ilKTeHSe Ihal had occurred eajlier in the year In Detcnibet UK dollar began m rebound, ami n row \omc".nflt. The apprct-LdlLWn of The dol lar Irimugti ihe firil IkUf of I9R^ *a^ rrequcn||> AWI by ^nrccrted monetary auihoritieh During December, and in ihc ficii quarter of ihis Tlie U S merchandise trade deficii in ihe Fusi jelillinetl^iteninf afU S moneiir> policy Repunsof rare, Significant^ hcncrthan the figure TorlhC foutlh •hdf FfdCfi] Reserve pohty wiiuld be tightened Will essentially Unchanged frnin the firs!-iniarref pice Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis Heal GhP • Excluding Drought Effaclfl For«ign E«en«ng« vulus of tin U.S. Dollar' U.S. Real Uercnandist TraO> CO U.S. Current Account IT 11 111 III _L_ I J_ Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis dKHigh nor w rapidly u in 1968 Export gains have brlow cbe pice of t9B8 IB a whale 4 weakmmg m bwi broadly based. wiihootablE increases frnagncul- purctauu of furaifiiie and ippUoncn likely was rr- ™f*l good*, induHna] supplies, tapiol food*, and DC*-*"— -"•»- t m ha « ° k E p B et t r e o l f j e r u ]n in f i i d n , A av p e r r i a l g a e n a i 1 r a M po i r y t ia * l e ' r p c ro d te u t c i ts t o fu fh n s r H E>« pPrrjru above Unit fourTh-quarter r»te Notabk dt- - and Aiiiomouve products, So far in 1989, the value of nurnift] kvcli over ihe year, afrcr the drought-induced. ,r , ft, rcdiKUuju m L^S8 Witb hiring duwn m lb« spring, i m b m > o p n f r l i o h u v i n e o o m ( l l e i h m i i n s I c n y r e e ih a u e r c U r e i . n f S t c p . t h n ii u y s • d i c e a a u b l m al r a b a n r l i c u e m o f i e n f a th T ct e h o e r fi s n , f u i m r f t n iv i ^ v e r e i q n h c a r w e L a Q se g s v i i n n tf » L f il l l | y « n a o o d g r s o a w U t n h c n i n u n r« en l a W J r n n a ^ L . c A ci I b M ly , , I*K iln*er gro*ili of U.S. icavuy, ihe contLrunig. if J | dimiMihed, beoelil Ini U S price mmpcULV«neu f 1 n 9 " 87 n . i a h n e d d i e h p e t f ^ ts ' L a r |1 a D n |1 t " tit ' n U i K h e d o i« J f '" n t U E iio IK uf t i h n t t h h e e a e o n f d f i o i f u S p rv sw rH in l g n si n n l c B e n r a e l * io c i h u in K s i • v f ^ i m {f y tt - \ yc n i m r l p o O * U m nd e m ^ i d A -| i i r > B th 7 e . P*"cfld on pncfs af non-Qii impom recent Hw, among (hem the lower Level nf household nei wonh reltlive ED income since the stock nuilci < qi n u r r n le ic r r [ m oi e ] 2 w 3t u nL m Li e « n i T Ch h i e n i K nc c r e a u s n c K i f J m f t o n r Ih ty e f c o « u p r b th til b L L z K n iH l a l f l i y \ C i o t n t f d i c 1 f d K 9 u 8 c r 7 t l , i u b h i l i t L g c h t m j e O i r H , c , a a b n i d c b c l i o o u < n ( v c c e o n r D f r & u T u h m i e l s f p i M r h c i i i s i n e a L - d p ir m o t ( e e m n sp t i o e a - i l m f q a u J u a t r f f i | c i r n k n ( ? s f h t e c u i ^ , m e i d h tf r i i e t d u A f r l r t i t e t f i n a i i f O i t f m c S w p 1 p u 0 o B n K i M b i b l l G f l l i l a o i n n c , S f U e L t i t h i i m n |h g p c r a o v f / i d e n - t i h a w l n U v l K d i s n f l a | , p n L p e J e e t a o u r h f » l h o r J c c l u m t v ls a c o i • n S d a h o l o p u b e l e d d l * o b w , e m n t o h m r e e e n d C o B i n h U n a L l i O o I U h E S c l j h p f e i r e r n 1 B 9 d o 6 i n n D a g i l Nurly ill of fliii irapmvecwnl icsulird Eroro ihr n*f"Hi*]n(Df [heunJ* fleficii- Prclimirurj mlormauofi Reiidenual c HpQEI? Jibe ^ and t, U.S. Tnasuiy seeuriuu ud corporaw bonds and rate, which began in M*y, likely *ill be reflected in J I I I L Slatf, nurty Eifll f irf The ovenll n» in ihe GNP during ihe lim perctnt from their 19B8 p*ce. |° >hf s«ond quarrn1 proftaWy »« negligible, lx>*- ^f, BE icil aft eipncti maj have Ixpin m be de- prc^dj ty ihc last ID U.5 pntc iompttitivcwEs "M^uifd widi Uir cumulative rise m inr dyllHi sin« row nearly a full percentage point during foe early X- the finihflllol 1999 reflated 1 de«kralidn in «n- mi AftMs wu [educed In recent ycaci, relatively lo* &">Un encofnnaiiinj *. vAntiy of durable md non- household! lo fivor thiE insliuincni far home pur- dur*bk gfofe Despite tiK widcipiCBd ivjiHihilitv of *pt3id ftnincmg dcali ind other incrnilvri. *ile of Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 1 U percentage point and have remained high, [n an effort to reduce the rmllofhe year from the already Low level recorded, m 198E Mulrjfamily housing production has been lim- have enhanced sales incentives. Qualitative repons die T*J Reform Act of 1986, nhith. by Curtailing firms appear lo have hem rollnwinscaiKious inventory minv rf the financial advantages JESKialed with invest- policies tnd; problems of excess siocku seem TO be ment in rcnial housing, sharply reduced Its aftertax limited profitability In [he first quarter of 1989, before-la* CiunumK. TJ prarits nf nnnJinancLal coTporalions decimal, in par! The 0u*lnwa Sector sloped and prrductivity ddcnoca[ed. fhe drop in In contrast lo [he household wctcir business capital profits *as spread over most types of businesses. Ihe p sp a e n nd i r n o g h s i t g re h ng l th e e v n e e l d s i o n f e c a a rly p a 1 c 9 i 8 ty 9. u re ti s li p z o a nd ti in o g n i n in ihe United [ h J a l d g ! e s es t p d e & c l i u al i l e y w ^ - ro u n in g th g e a io m s a n in u f b a o i t r h in 1 g 9H f ? ^ a n n - d w 19 h A u 8 h . Slates and ID inlernarinnfll pressures m lower costs In Meanu'tule, corporate tax liabilities edgfd up id ihe t r h os e e f ir a s r t a q n u a a n r n te u r a o l f r a 1 r 9 e S o 9 f , 7 r e ^ a p l e b r u c s e in n e t s s a f n ix d e i d nc in h v s e p s e tm nd e i n n t g f fn irs im l q tl u ie a r n le s r c , i o n w p i u n c g e i s n o p f a in n v t e o n t h o ig rie h s e - r T p h r e o f c i o t m ge b n in e a ra ti l o ed n ! sZrTqu^r 11KrHLWd "lt*Iar"BlJ> ced'uTeo' ih7^efinila7clhI'flohw H" non financial meni ^go^ Pamcularlj noteworthy m [hTfiS q m u ac a h r in te er r y w I a nc s r ea a se s s h i a n rp th a n t * a e re a i , n w h o i u ch tl a i y n s cl ud f e o s r industrial Th* Govarnmant Sector to spending for ftbncated metal products, engmei. tur- In the first quarter, real federal purchases of goods bines, and! a vaiiely D( other lypes nf indu^lnaJ appara- and services, the pan of federal outlay b diet is counted tus, have been exceptionally strong since mid-1937 dircttly in GNP, were virtually unchanged- Slri:h pur- Spending forriigh-ledinology equipment also has been chases arc dnmma«d hy defense; nominal spending robust. Computer oulkys deulenled during the i« authonty in diis arett has been virTiutlly fiar since 1984. o th iH e l p ri u al t f o o f f p I9 o B ce H n , im pn l s p s u ih rc ly ha r s e e fl r e s c i t n in r g e s s p o o m n e s h e e i o s i i t h a e tio r n ap o i n d a 11 n d w p in n d h in u g re d m o e * n n l . o A f s s a a n r e e s m u a lt j , o r r e a ne l w m w ili e ti a r) p 1 o n p u s r y c s h t a e s m e ? s pace of new product aonounceiiieirU, hut spending was have fallen and in the first, quarter were Dearly 5 percent up considerably m UK fiisi quarrer, and another gain below the mid-1987 peak. The decline m defense appears in train for the second qmneT spending has been partially offset by increase^ in other federal purchases. Inventories heErlb-r die Commodity ,(lu d"aSvs folrn co^nst^ruc^nolnt oafoflf^ict'in^dr o™dicr ujn™uner quarter, but die rate of decline has been slaving (on i as [he effects or I i7i summer's drought have dissipated. m ex a c i e n s e s d s b p e a k c o e w i t n h a r i r u o o f d y w a 1 ce 98 is 5 . - A 6 n 6 d p , e r w io h d il . e d e rh p e re . s n s s e c d b in y S in p u en iu di g ng ra r fo jo r u I h e c n f s o pa r c c e e m pr e og n ra l m al t i o iid h a l s o r m t e u n a . nd energy prices led to wme .r*T«« in oil and g*> On a unified budget l^is, <oul nommal outlays Tor vecy lo» compared *Llh (hat of the early !HJttCK. above die comparable year-earlier toul Spending Invcnlorv investment slowed over Ihe firal five Erlaied to die thrift jniSnitinn problem spiKcdi at year- mrsonrthitin™i'iqjH ^aiy buT^ir^i'w^s Kadlliaiezd «zi[t°i ^flpp'H ^iCdle th n i d s y I e V a B r R . a O n n d t t h h e e n o th d e ro r p h p a e n d d s , h g a r r o p w ly t h m h in u e c o fi n rs ti t n u h e a d lf i o n f n been gonccnbaEed m the Aircraft and other capital Security) and m net interest outlays goods industries , where producnon his risen and order l-ederal receipts have grown even more rapidly rfum backlogs arc laige In stilus!, in the retail sector, furlays, ouoyed by increases in employment and in- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis Nonf*rm Payrall Employmeni nonu'Uhheld UK collections in April BftJ May, the possible eiplanauons relate HI ihe Tat Re form Acl at 1986 and i nclude greairr-rnin-utticipaced effccri from personal ia* rate* *ai |u|Ly phastd in In addition, realizalions uf uiabk capital gains may have been -flfln n flfl hefty Last year because oltfie large numbc[ of corporate n The iviges over rhe year ended in March, and local compen- IP consictiablf upwatd pressure Sntw uthrr expend i- sation ptr hour - *ag« aid salaries plus ncneriu - was Unemployment Rate up 4 4 pciveilT over lhal period, inlhrdiTiC range a* me tnleEdl sector. growlTi itt *iaie sod local outlays his ugher raic in rhr F experi effici Libor Markets atwut 1 p-i(f[||h unit coils had decl ined easier in ihe Hnd payroll employment gmwlh dnjppcil hflfV to Price D^vflioprmniB larger lhan arc Tit* fy 10 Se imlaiTitJ. ^[vcn c(w umfcr- inde< for a.|| Item;, abroaJ-basedmeasurclnrEinJihed pcrccni Uirough. May, compared with ihe 4^ prrcem laigeslD^rr ihe L&Utse Of tlui business etpiPSIOll p fin d i t s t h e in d I ^ 9 u g o 7 d s > n r d e c l^ o S rd S e . d T h a e n p e r v o e d n u c m er o r p e ri p « ro n in o d u e n x c e lo d r The uioderalton in [lie gnj^lhi of Ihc demand fur and energy in lhal indeK. However, iht Underlying ratenlaiQund JH percent, fihoulthf iameasm l^BS Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis •I be a bi« fJLlur in Ihe (m s ir Msska anJ .n ihe Nonh Se,, -iJiltd io pnt-t j |S Pro<luc» Prlc« kir InuimtdlMt Uatmiall pKMnten«9« N Eicludlng FooO Hid Enwfly pit*M«t pwod, ^ — 1 n n n n 1 1 1 1 1 1 1 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis Section 3: Monetary Policy and Financial Developments Short-Twin fnt*rt*t FWi> during the Firil Halt ol 1989 ,eakeni • (Mir (liMTWr demand of Ihc re,olulLon of die mils in Jle thrift polLn mil 1989 Inltrtlt Rit» 00 Trie implementation OT Monetary Parley A* ilOlfJ prcvuH^Jy, devtlifpmenls «rl^ jn 1989 belief [banripcctrd The doUlf »1 so may KavegHinnl H^grCfrilfs weakened further in Apn] andearlf May. reflKling Uif drawdown .jf Liquid tulnncts LO niak? In Mdy, M? fclHotiiflo^^r ed^e D( ihc parallel hund hillni:98B Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis Rongu and Actual Monty Growth in Hm « Mir Aato erf Oruurtn than uflKtiing their fiiv-i|iurWr rise The bond markel ™° 1 B Pmnt °* 19!S lcvrltl 3locip ""' """"""d *"' W"1 "Ewnl yf LES rlic diumg The s&xitxj quarter, although remain- ing *ell above Its Level at >CHf-end I9BX T A h gg i B rt e g h H av H ior of thfl Monvtttry d in e d p u o s s tr i y n g w 1 e n r e e r v p o l u a s y n in ei g E * a f b il o e u t 1 t 0 h 0 e p A ro lt b h l o em ug s h O U f U K K P th re r s if i t - 1850 psh over the finihilfDflM!). rtBHiingthctlfKiii.! incruus through March in m&rkel JlUcrcsl Talei if la- back insured deposits fully, PS UC-mSLired IhnH Ensti- — 1 1 1 1 L 1 I ll ° N D j F U t u j j aS O NO large la» piemen" b^ individuals. Frftm [he fourth OUt Ihc (irsl k|UJner These outflows apparently dc- quarter nf I4B3 through Jiinr. MI ajged up ar an U3 pcnod, bill the bulk dime funds llfcety remained wiUim year's part of 5^ pcrccnl. M2 velocity iDic iharpj> 42SO throkfgh tlir Icccmd qiuner. to 7.6^- R4M at Growth ^ „«,!„„,„, of HI „,f luf ira,l fami u^mej _ lirBely limn i comttriiilioii of cuntinued Incicasrs in .1W 19W 3^ Q P 4 *C to * , n B l W 02 m m e a n r t k o e f t f ^ lie te s . ^ p ^ jj a d r o .d n u re m ta .s il u -k j e .y po s a lo it! w V .p le w U ^ s d oU ^u N s O r W - The tncitued opponunLiy losls of the fini pan of the year continued to damp money growth miD the *o» TOSaOflnJurw jMr ^^^ in Manh, while rhoie on other liquid 3'k P*fCBnl depoEiis- saving! and Money Market Depoii.i Ac- ^^ lounts lMMDAa)-rose aboui U and | percmtaBf ^^ penod- RaiBB on Email Cme accounts ificreawd much late April and into May ts UK payrnenncorninuel 10 [hey ico failed B keep up wilh UK use In mukct yields,flo*S o[uvirL£i and HMD A balances accelerated, and j-vfj fcirte of flic iJjjjpiJl«*5 Jp [he «d;iii[iB.*oi o/ re- awes begin to bounce ^.ct in laie May, Ixwevti, as refLectedcaininued regulatory pressure] on thnf1 uuti- 1 1 1 1 L 1 l l l j_ i i l i 0 teNn D J F M A M J,*»J * S O ND aggresslvc pricing polici« More biuadly, UH slow upwltd adrustmenE ol deposit rales, eapTCtilly on , markel inlTTCSl tiles headed i MMPAs. *nd savings depoattH-alsa reflecM UK Yields on small tune dtpotits lagged this move, md through nuncompetltive lenden lellbick, andgrowrh. anniiaJ rate of more than 20 pprccnl Tor UK quarter Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis Velocity erf Money and Debt Growth ot Money wd Dttltol demMfe fowth guwv loath g 1B7S 1982 1963 1BB4 19S7 1988 -0.4 -5.5 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis Range for Debt and Adual Debt and Mon»y Growth responded somewhat more slowly ihan loose it buikb CradH Fkwri th derm uTfl • Tld Vj/Lr Ttteaggicfete dchi of iJtuDcHic nonfloanciaJ scctorH a ba lre la a n d ce y s m a o t v F e S d L t I h C e - i t r ti s n u m re d d s t e h ls ri e ft w i h n e s r t e itu , ti o o v n e s ra s l t l a d b e il p iz o e s d it i g n r g ow ra * n , g o e f a n fe d fl e d r o a w l n se s c o to m r e w de h b a t t f s r l o o m we i d u a I9 s B m S p a re c c e e , i T p b ts e m the second quarter al» moderated, partly in response to higher levels of M,1 grew ai u annual rate of 3^ percent from the market interest raid over mitth ol me Rrfl half Of Ihe L fo ow u e r r t h b ou q n u d a o rt f e a r s o ur f g e U l S E ra n y ge e - a r ( n i t n fie J f u irs n t e u , tm p c l l a er c , ing it at the d y s e e l m o a p a r n . e d d , H w a o s h u i l s i e n e c h t r h e o e a l d s p e ae s b e o in r o r f o le w t n on i d n s in u g m g e s r a r a b te m o s r o r o n d w g a in j a n g g p e e d m h u o r u k s e in ts g b b o y l st s er t e ro d n s g om d e e w m ha a t n b d y . b a E n O k F fu b n u d s in in g e n s e s e d J s o g a e n n s er - a te A d dded demand s S la p c e ke n n o e in d B al - ong with [he deceleration m con±umpt1iKi for commeicial and industrial loins stemmed both Mottgage Lending by thrift institutions did not ap- from merger-relaWd financing! and torn ihifts 10 pear to be unusually weak Ln the first few moiuhi of short-term borrowing by businessei facing name long- I9S9, given the prevaduig interest rates These inEUtu- term interest rates tnd investor concerns tboui "Event tions coped WJtfl weak deposit fiows by running off risk"-lhe possibility that a firm's deal obligations cash and investments and, tfircugh [he first quarter. uouCtf be iigru(tc*ri[/y downgraded 111 a OjrmfBlr: •irpping up horrowinj from the Federal Hume Loan buyout Or resiructurinji Acting lo damp M3 growth Banks. Despite Signs of a rediKUOD in mortgage lend- u*er the first quarter however was heavy reLance by ing; activity by ihcH institutions m the second quarter. thrift institutions Qn Federal Home Loan Bank ad- ihe overall availability of housing- credit did nor appear vances and other borrowingi . whtch are not intluled in to be iipunctnlly impaired the riKiney stuck M3 growth edged do*n a bit m the Spreads between rates on both fiud-raie mortgages second quarter *"th some easing of banl credit de- and mortgage-backed securities and rain on Treasury mands and strong growth in government dfcposits- in&uumenls of comparable murunt)1 did widen over ihe also not included Jii the money stock- resulting from first si* months of ihe year, with some market nacnci- [he large volume of taapayrnenQ. B> June, fawevet. fKStS rtportftjlr fearing ihrl iv jC-fcale li^uldaiions of M3 had rebounded as tax effects unwound mortgage-backed securities by troubled thrift institu- tions could adversely affect die market fbi ihose instru- Reflecting interest-rate and tM-relaled cflecTS, M t ments. Howflve^ tbe widening also may have reflected declined at an anrtuaJ rate of 1W percent from die other developments: a getcral increase in uncertainty fourth quarter ol i^SS. co June. BaJanccs in other about rnovctnetns. in long-term interest tatet land checkable deposits, which hid moved down j imle therefore about proipeciive prepaymejih), and tbe over ihe first qilBrlfr in resporoe 10 hLgher opportunity flattening of [he yield curve, which discouraged issu- ousur dropped SLibtburiiilly in Late Apn] andeuly May ance of derWaine mortgage instrument^ and Ihus is OK la* fayotena cJeand. Donand deposus also reduced demand lor tiv underlying mortgage-backed declined on baLance over the tint half of fte yeai. securities because oppoTtunhy costs increased1 and because Ihe Total borrowing by nonuiunciaL businesao in die balances biameuea are required rohold tocDtnpensiilc Qm half of Ihe year wucfoie to us J9BS pace Credit their banks [OE services fell After chang» in market demands ajnbnued 10 be buoyed by liuble merger- ratei of interest, banks often adjim wiih 4 Ug Ihe reLated. bnncing in the fits quarter, and in ipparent "eanungi trcdn' rates nvd to deiennute ft* level of pickup in capital eipenditum iDcreaBed buHinesii bor- required comprnwii]£ balances ; mus, dunnwud ad- rowing in the second quarter even u trcdii demands jusdnenK to compenHlmg baUncc* can rxnnnue for related, to mergers and retrrucDinng), while still snone, fxnztiiiKi&tr'niiitfiitstsbtvtfttpfrdriUpi The jawjJ * btf. Bffviff of JuvcHw /tar of event risk barge personal tai pirmenls ulto ajTecied bousehold Inggend by fee RJR-NabiKQ acquisition In late 1988 demand-deposit balances. Laic in the quarter, how- as well as higher long-tena ntea ihraugji much of ihe ever, both demand and other checkable dcpouis begin period, corporate borrowing was concenEraled m short- matcricy vehjclet. Commercial paper issuance surged during- the fira half nf ihe year; buiracvGi alao relied raiesover the second [fuarter. on bank loans, altolt to • leueT eUent. In raponie to Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis FEDERAL RESERVE press release A thorn event nil, mmy flnnt i^m Kd iunaiKf of tw-eifjnpt Incil gDvemnmU (ell ibirply over total of UK first y tut, or they brought LUUH to ourixt wilh sHtJj halfoflHQ [nvcfloi demand fer nm-cwn^ >«uii- ptiuociviih so-called paiMDpuEi, MrmHiiifjdwiP'K «• reouined strong utf. «Hb diminUtal supply, Uw IP prowci »pinit negative e&ecti<Hi bondholder! &™ nw of lu-CKanpt ID cmubk yield* fell b ib toweit future restructuring!. Toward the ml of die ir£<n Ictcl HIHC L9£4- this nQu PJK s«ntf*hat iBs in lie quarter, wilfa ihe introduction of UKK protection! ™ KCDIH] Quarwr, wbec ibt decline In kmi'Umi Lumen UK decline inrtte*, bm^mra flMDong in ihecttp^ raw bond mirker wu oc ihr upowinj jKtvnyuxJ • pickup of issuance of boodj to rue new For imnedlate release July 28. 1989 The Federal Reserve Board today adapted two amendments to Regulation cc, which implements the Expedited Funds Availability Act, regarding the treatment of bank payable through e nee Its. The amendments are designed to help ease the operational difficulties and lessen the risks imposed on banks as payable through checks must be treated as local or nonlocal based 05 to on the location oC the hanK on wnlch they are written rather than the payable through bank. The two amendments require: (1) bank payable through checks to be conspicuously digits of tha nine-digit routing number of the bank on which the check is written and the legend "payable through" followed by the name Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis FEDERAL RESERVE SYSTEM 1! CFB Part 229 BIB 7100-AB01 a bank issuing payable through checks to bcai the risk of loss lor return of such checks from ,1 nonlocal payable through bank, to the extent AGENCY: Board of to*. of the Fedeml EH ACTION: Final raj*. SUMMARY; The Board 1 the check had been returned expeditiously by the CO Attachment FOR FUHTREH INFORMATION CONTACT: Loui«e L. ftosanmn, Asaiatant EtephanlH Martin, Attorney (202/4S2-319S), Legal Divi«ioni for Deaf, Eacneetlna Bill or forothea ThOBpaon (20I/<52-3!J4). Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis SUPPLEMENTARY INFORMATION I The Board has adopted tvo arnendruent9 to Regulation CC, which: checks written on an account at one ban*-' but payable through (1) Require bank payable through checks to In- another bank vere to b* considered local or nonlocal under conspicuously labeled with the name, location, and bated on the location of the bank designated as the payable on which the chec* if urittan and the legend "payable through" followed by the name and location of the payable through bankr and (2) through checks being returned by o nonlocal payable through bank on the bank on which such checks are CO nonlocal payable through bank took longer than would checks by depositary banks because it uould have permitted them payable through bank encoded on a check, which indicates the check processing region in which the payable through bank is regulation, enflmenta will become effective on February j., 1991, andl ally on the basis of that number. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis the payable through bank as the paying ban* and thus allowing according to the location of the payable through bank, tha Credit 31290, Auguat IB, 19SB). The intarim rule applied the court's One hundred fifty-five comments were received on the objected to the treatment of bank payable through checks as local CO cn suggested variouE means of addressing these operational proble end nskB. en though they vould generally be OspoaiCad in 4 bar,* local to On November ~L, 19S8, the Board adopted the interiir the generally treated as ncnlucul* a large number of credit unic that offer payable through share drnlt accounts HDUia be djjstry Return Item Advisory Group, which includes August 18, 1938, the Board adopted Interia amenduentB to sociatione, and ctedit unions. The Board issued the proposals Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis comment to gain further Infornatiun concerning whether the DISCUSBIOB fied regulation and to improve the check system by speeding would impose undue burden*, on the banks on which bank The four proposals fur vhich the Board requested Credit unions Corporations Require bank payable through checks to bear t routing Members of Cungr number in the MICR (Magnetic Ink Character Recognition] 21 Require bank payable through checks to be r.uinber of the bunk on which the check in written and the legend "payable through" followed by the name and JocatLon of the payable through bank* payable through check is written and Place the risk of IOBB for return of bank payable thruugh checks being returned by a nonlocal payable through bank on the bank on which, such checkG art mitten, ta the extent that the return from the nonlocal payable through -' This number does not include a £rom Federal check had been returned expeditiously by the ban* on which Reserve Banks and duplicate from the same it is written. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis to the extent that the return of a payable through check from the nonlocal payable through bank took longer than would have been bank payable through checks, including those checkscollected outside the Federal Reserve. It would also requirethat such Require bank_payable through cheek* to be conspicuously Hid be establishes. the hank, on which the check la written and the legend 'payable SI opposed it. The conunentcrs in support of the conspicuous labeling requirement stated that Identification would aid In compliance through bonk and tha bank on which the chsck is written must be included on the checX. Othei than the routing number of the ban* on vhich the of payable through checks, although it bould not pernat their identification on an automated basis. The Bank administration -' (Continued) of CloviB, 92 N.M. 37, 582 P.3d 609. 23 UCC Rep. SBrv. 124S Bank check pr iny region as, and (3) a Re availability than the address ass number in magnetic ink on the ite Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis bank payable through checks.' clearings, such as misrouted items.- The Independent Bankers Association of America indicated that coicimmity banKere would CoOo would prove helpful vhen processing damaged checks. Wells Facgo of America supported thic proposal, but noted, "Most community destroyed . . ." For example, the name and location of the payable through ban* may be needed in those cases whare the The majority of cocunenters that supported the conspicuous labeling proposal Indicated that they pcefe Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis automated clearinghouse (ACID transfers to or ti through cheths woulo not provide my incremental significant CUNA 9, CUNA checks other than bank payaWe through ehecle. of the bank on which the payable through check is uritte identify the chec* processing region In which the tan* on face of the ch«cK, balou Che BBount line and above the paying bank. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis expenses due to tile visual inspection requited which would be thit proposal. These commentyrs indicated that without the because they vould have to manually process the payable through roppbal states that it encouraged manual handling. A nuiobei ot items deposited, and manually make.- float adjustment3 for chare draft or payable through Items." labeling requirement could have an adverse impact on the acceptance of payable through drafts. The Chicago clearinghouse Association, thicago, Illinois, commented, "IhiE requirement vould make obvious visual distinction between a regular check and Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis is written and the legend 'payable through' followed by the and location of th= payable through bank. This rule become through checks baing returned by a nonlocal payable through banK on the bank on vhich such checks are written, to the extent that ept for the first four dioite of the routing numbe the return from the nonlocal payable through bank took longer IhajL would have been required if the check had b^en returned payable through checks at of reissuance should be minimal- This proposal would that would require bank payable through checks to be conspicuously labeled with the name, location, and first four inappropriate to allow issuers of 'payable through' checks to dlgiti of the routing number of the bank on which which the check Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis eturn on the fourUi day) our annual expoauce from the proposal requiring a local routing nunber in the MICH line could N) to the bank on which the payable through check in written], . the payable through bank—or the processing bank—haa the appropriate cause of that risk, but are concerned about the Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis an, stated, "the rule and are ur.fiet the S2,501j amount covered by the lorge-dclla bank on which the Chech is written would only be responsible foi- IOESCH that occurred between the time that the check would have these proposals [the conapicuoUH libeling proponal or the CO the payable through bank' It the payable through bank complies with the current notice of nonpayment requirement for returned checks of $2,500 or more and the depositary bank takes action to The Chase Manhattan Corporation, New Yoik. New York, minimize its risk upon receipt of the notice, no loss should occur that could be allocated to the bank on which the check is payable through system." less than 52,500 and thus od by the notlet of Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis CUNA also Bug banking day on which the check was presented to the paying ban* ed it the check had bsen rtturned under the day'u deposit. determination of whether return of a check IB enpeditlnUB under the forward collection teat is made based on the manner by which tests to determine whether a check hat bean recuijned expeditiously. Undtr the two-day/four-day test, a check la Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis anytime there was A DISPUTE for a loss, we've never hed one in 20 years, tJic receiving inetitutiun could simply claim = delayed processing schedule. A tracking mechanism would be required." ollection teat could not be used as a standard for expeditious etuin by the payable through bank. Bank cOPimefiteirB opposed to the proposal shifting the iali of IOBE to the Lank on which the payable through cfiecfc is of any evidtllce of actual losses which would justify the presumed loss to ths bank on vhich the payable through check is written. consented. Tirst Virginia does nut favor this proposal, us it regulation. The Board also requested comment oh the appropriate A number uf Southern Nevada State Savings i Credit Union, Las Vegas, Nevada, Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis after adoption. Require bank payable through checlia to be presentable _and_be»_r_a local routing npjber in the_MICB_ line. opo^al the that requiring a local payable through bank is most consistent unions to encode their ovn routing numbers on their checks or that of a local payablt through bank. The Boaid specifically requested comment on the cost payable through checks BO that the benefits ana costs of this proposal could bt more fully assessed. Seven hundred ttoenty-tvo eomoent letters addressed this proposal. Two hundred eighty-two will be served.' niuaion tor the through checks account for less than 31 of the processed check practical or comprehensible way to describe to Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis processed. (Bus proposal] not only confirms the axiom, 'If it to identify payable through checks and place the appropriate holds on euch checfca. These proceourea Include U) having the goals of EFAA.' naofwr in tke HICK line was the only proposal that placed the coded in the JHCH line. The Bank Administration Imticute time and expense °f processing payable through checks on the Jj propoasl were adopted. AmSouth Bank. Birmingham. Alabame, much human intervention as possible and allows payable through -' A survey by Board staff identified 65 routing nmnbers that are vead on bank oayabl^ chroqgh checks. eptlon items.' Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis (through requiring a local loutin? number in the MICE line] of apply holds on a caee-by-casa or axcept.ion buDis. The sax study about £225,ODD pet year. This i« the labor expanse we would Incur if ve have to visually Inspect all items deposited, and coocdination with the Federal Reserve, which indicated that 75 through. Lt*»«.* citicEip, Mew Sort, (Jew York, stated, "As for the option to apply holds on a oase-by-caee or exception basis tc determine those checks on which nolda should be imposed. Thus, the need for a method to apply automated holds appears to ntial It*. 00 Uhds to determine whsther or net an iteu in a payable through proportion of all chacllB deposited. checks, these banks Have indicated a high level of concern about the total mutbex oi items procesittd by all barJ;e in the course of uit - abaant nonlocal p*yable through banks Mould increase this risk by to the local schedules under the regulation. In addition, bangs permitted in the regulation. According to . study conducted by Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis could be liable for exceeding the maximum availability schedules Payable throiujh baflKb have iodiciitcj that many cclltCLinq b^nka receive dvaLlabi L jty Tor pjyaLle thcoucjh cnecks local banltB. drawn oil d ncnlocal paysblt through hari* equivalent to that fur tli. opo&al than they Some b.±iik comments re notud that this propo&JLl vould WhilB we have not Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis thus* ayntena. They explained that the payable through share trvice& only through the us e-through nyfcttjm. There tic ^th^i aoluticma that veil for almoBt IS /*ara and has allov#tf thooeanda of crffdit '. - . the diHtfantlentent u£ che through system to Che degree suggested by the Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis that it would charge approximately 530,000 per yeat to Proc ersay. noteiS jppro*inwtely 510,300 assessed by Chase Manhattan Bank to perform cks but similar services. Another credit union estimated that current ilatai 2) poor reporting capatilitian and longvr cioe luya Ic their SDull ftile and voluiw- TfL4 IBEK FetJ^rdZ Cre^Jt Union, change in routing number requires the additional coat u± au*i •BendDents uould be cunt prohibitive due to iJicraafltd proceBsing process checka wit?i both tits eld and new routing numbers. The costs* risk involved, are? a&dltlon*l etftff and ddta procft-aalng cogt ausociated vlt.h dUAl processing will vary baaed on the time need..." Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis en K> of payable through fcfink, Itfi adaption could prompt Local banks tc iseal banks may not have the incentive to ketp coats down for Che credit unlpn issuing payable through check a because nsny of those uld have an ce of bank. held bf the credit union. The fcedfoeti Tsj^nehlP CDiraimnity Credit Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis Corporation stilted, "It this approach wtre impleiriented, thtf Federal Reserve System with its extensive processing faclllti The Bo by the Right no longet be availabJe to nany of our maoibtirG because of thrnuqh ban*, thereby alloving the payable throuch bank tn equiring fcuch a propoeed amendment to Regulation CC." Credit nnions and payable through ptocessors noted Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis outing number." Use of the BOOO aerie* of routing numbers would adopt the proposal to require that payable through checka be payable through a hanfc not located In the the local routing number proposal without disrupting the national payable through syettci. Federal lieetrve check prLicassiog rogione- The fourth and fifth nciilii be the ohe^k digit. Adoption of the NACS proposal would also requlra 6000 secies number and determine' two things. Bjnka can deterni doption of the JJACE proposal would itqulca banks issuing pay-tie to assign. Only banks tiding payable through pr Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis - 4« - - 45 - Moptlon of the NACfl pcopoHl »Dld only b*n»£lt the le.igthsii the availability scneaulfls, which would ba the result of The pr collecting bank* because they would have to upgrade equipment to he nectaaary to determine whether such check ia local or nonlocal. Thus, this alternative would provide ai,iy aurgin; benefit to Gepositary banks and should not bt pursued at tti) time. i—by which all IBBUBIB of payable through items wishing to local fedciaZ Reserve at ev&ry routing number that includes items enpi^ce maBt convert ta UBLUQ a local paying agent for the directory of these numbers. This woulQ permit automation Cor tne S< and to en*ur« that the Icoow bear the rff\iting numbet of vast Qis^arity of the items fet i.BBue.B AB previously Indicated, be difficult. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis depositary Dank gvnds the checks to nonlocal payable thtough tftrough check* beat a local tenting number in the KICB line. The banks. suggestion vonId be that the Implementation date bff extended ft cn OS Ktent thot Che pcoposnl IB employed, it wpuld allow banks to The majority uf the oommentei'B that supported the direct Authorize direct ptesentment to the bank on vtiich uaYable_throuqB cheenB_flre^Hritten. Currently, the law IB of both the proposal requiring a local lout-ing number in the MICH unclear as to wheth*t a bank payable through check edii be. Une and the direcC prusentvent propusal. presented directly to the bank on which it is written 01 whethe such checks muBt bu ^rtiaented to the payable ttiroungh bar.K, this proposal were adopted. The Chicago Clearinghous Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis of pa}ail* tfcrcugh items tu tne paying institution at an optional raethcd of collecting such items In joaiji coeesj the forward collection process. However, we recognize that eoiae Useful in the Case of large-dollar checks. The Bank handling. Dy preaentir.g thess ittiBB ditectly, a b&tilt Gan tften Code (CICCJ might suggest that a 'drawee bank1 (payor bank] may h.-.nk when the. check ia not presented to the drawee by that bonk. used primarily by banks that hjve both the rfcsourCes to pertorp State Bank, OHOUO, Michigan, comnentea, "Allowing bdnics to that banks way present oirectly to the bank on which the check written.' Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis Have 3 fuil time enployee'e fsicj. including myself, who handle Sxpunses involved would be a nuw safe, which uoulfl run about 56,000 to SIC,000.00. A naV Htaff ptison at 512,000.00 per yea and a^y exp^naefi ll^ouired through purchase of natf electronic equipa-tnt. Hy rifct income YTD for 198B IB 520,599.04. I 401 BUI 00 in the fleet place." 1,500 to 2,000 tmll credit unions. Many snail credit union* in A zninljnurn daily cost per credit union of approxinj^ttfly &H Th* daily cost to Mietouri credit unions would be 61.400 ur.iie institution.)' Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis requiring a local routing number in the MICK line. The program if this proposal were adopted. The on an automated baflil. Tha Maryland National Bank ccifJnented, •Although ve conceptually tupport [the direct; presentment proposal]. . vt could not support thin option in terms of an option would not permit the automated processing o( the credit special nonaiitomflted check handling will only weaken the check high speed check sorting equipment, -and run. Depending on the internal cost structures of Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis - S4 - items could range from SO.005 to SO.01; cents per item pa us. He through checka," cleared through one major national payable through processor* tha amendments to the flct. Tile United BN Credit Union, St. Paul, Minnesota, stated, "Save the taxpayers raonty by sending your the law. They could emend the law to sal checks dr-wr on local banks are local checks and cheeks drawn on nonlocal bankt. are nonlocal checks, PERIOD.' The Board supports an amendment to tha which a cheek is drawn or through which a check, is payable. If this amendment were tne.ct.ed, the psvable through bank would be determining whether a payable through check is a local or through cheek can be presented directly to the bank on which it A number of coiranenters requested the board to require that Lank payable through checks be deposited with a special number which is local to the paying bank Is not adopted by tn.e banks to require that bank payable through checks be deposited in Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis tflrcu^h banfe,' Thib would require an it LB appropriate to adopt aniend&enta dt thi Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis nd the objectives to alleviate the aised by the publi fnta in response to the initial of payable through chndcKa by depositary banks. This purpo the agency of ftucti i&BUtti ancf a statement of any changes mfcde In the proposed rule &K u itauit ol such comments ^re concail.e^ in infltitutiuna that uafc payable thiDagh checks because tfie .nalyslo IS U.E.C. 60JU1U)) SB B fle script ion of each of the Foe thtj re^aona set out vn tt^t pxeanfcXv. ]2 CFR Part 223 ia propoasd to bu anenflfd as follovs; PART 229 — AVftlLABTLITr OF FUN1JS AND COLLECTION OF CiiLCKS s eonHidered by cht agency, arid 4 Etatiifcerit (,i the redeona why 1. cH one uf such altecnatjvea WiB ceiscteij. At dencrltoefl in the Oh1i 2 U.S.C. 4001 «t sgy. In S 229.36. t)ie Beading is levjsed and payable by jt to be payable through another b..nfc Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis (iij tatutned the check as paying bank location of the payable through bank. uith s 239.30(41! (1) . Responsibility under thia paragraph enall be tze& that date bankt thai 1st payable through fcrriiigeinentsi mjac or pardyttjpjj ic-) of this section. prfz^yrafih Id] Ut p 4 nvw heading is added to pataqtaph fdl , and nuw pirlMjriph [d] (J) is adJea to read as follows: a. Section ZL9.36 is amended by revising the Section 229.36 Piestntaient an.d_ laaiiance ijC chegfcs oheck ih.it is payable !>}• a tank and payable through a paying fe) Jgsugnce of payable through checks. by ahich the check is payable, the ban* by uhi<_-h eJie ebeck is use checXs that contain conspicuously on Chcir face the namt, depositary bar.k tniough the payabae through ban* ne quickly ot o£ t(l* ban* by vhich the chsck 15 payable anfl the leqenfi 'payable the check would have been required Co be returned unaer thtoush" fallQWiJtf by the name and location of the payable through S *:S.30(a) had the bank by which the ohstk la payable -- |i) received the check aB plying bank on the day Che the location of the bank by which ths checfc is payable miftt be payable thtoagh bank received the check; and Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis it is printed in a type ot smaller tha (21 paragraph provider that the bank by *hich a payable through check section to tht extent that the check ia riot returned through the payable through banK afi quickly ^B would have been neceesary to meet the requirenents of S 2S9.30la}(l) (the J-iayM-dv/ test) requirements of this pfccatjraph, the ban* by whi-Ch the check is payablff may be liaLle to the depositary banfc. QE others &£ bank on the day the payable through bank receivtd it. The provided in S j/9.38. For example, a hunk by which J payable loaatioTi of the tanX by which a ehech is payable for purposes of the 2-day/4-day teat may be detecainei froni Mie location or the SuBpart B, that would not have uccuneii hnfl the check net the requirement6 of this paragraph. The ban); by which the chesk. i check. (See S 229. JMe) and accompanying Commentary. I HeEfcnsi.bill.ty nndsr paragraph |fl) 12) does not Include of a check to the payable through bank. nonpayment to the tftpaaitttry bank by 4?00 p.uu on the second buHinesa day following the banking day on which che check it presented to the paying bank. Even if a payoble through check in through Bank as quickly as wauLd Rave Seen required had the check been received by the Bunk by which it in payable, the deposit-aiy Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis notice of nonpayment. Thus, ordinarily the bank by «hich * contribution to danugaa under paragraphs Id)(11 and let ill Reserve System, July 29, 1939. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 66 Senator SARBANES. Thank you very much, Mr. Chairman. In view of the number of members that are here, I think we will do a 7-minute round, and then we can come back and do a second round if members still wish to proceed, and I would ask the staff to time us on that. Mr. Chairman, I gather that while you've left the ranges for monetary growth at the same figures as before, as I understand it, what you're indicating is that you hope however to have growth at levels within the range higher than they have been heretofore; is that correct? Chairman GREENSPAN. You mean heretofore meaning so far this year? Senator SARBANES. Yes. Chairman GREENSPAN. Yes. In fact, both M2 and M3 are now within the ranges, and we expect them to stay there for the re- mainder of this year. Senator SARBANES. You hope to have them not at the low end of the range, I take it. Chairman GREENSPAN. I would think not. My impression is that they will move toward the center of the range. It's difficult to fore- cast, but they could conceivably go above the center of the range. Senator SARBANES. There are some who take the view that our economy does not function very well at low growth rates and that in fact sustaining a positive rate of growth under 2 percent without slipping into a recession is very difficult to do. QUARTERS OF GROWTH UNDER 2 PERCENT First of all, I would like to ask you how many quarters of growth under 2 percent do you anticipate? Chairman GREENSPAN. It's very difficult to forecast, Mr. Chair- man, It should occur through a good part of the forecast period if one takes as the standard the forecast of the FOMC. But I don't think we can forecast to a level of even one percentage point with great accuracy. My impression is that we will be slow for a period, but that we will pick up at some point. I would hate to designate when that point might be, because I don't think we can in all rea- sonableness. Senator SARBANES. Looking back historically, has the U.S. econo- my ever experienced a prolonged period of very slow growth with- out slipping into a recession? Chairman GREENSPAN. I don't think so. And I think the reason for that is largely that in past periods when we start to slow up, we slow up in the context in which the markets expect that the econo- my will continue to move ahead. That does induce a significant backing up of inventories and usually leads to the classical invento- ry recession which has been so characteristic of our past history. It seems at the moment that inventories are in much better shape than they typically are both with respect to levels and with respect to growth, and while there is very minor evidence that in certain areas of the economy there has been some backing up, in general that has not been the case. I think that the expectation of continued slowness has had the effect of adjustments occurring Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 67 before an unanticipated build-up of inventories or imbalances occurs. But I would certainly say that a necessary condition to keep a moderate growth path in place is that the markets generally assume that will be the case because if they assume significant ac- celeration and it doesn't occur, then the economy would back up and turn down. At the moment that does not appear to be the case. ECONOMIC SUMMIT CONFERENCES Senator SARBANES. Do you think the Central Bank Governors ought to be present at the Economic Summit Conferences? Chairman GREENSPAN. You mean the one that was in Paris? Senator SARBANES. Yes. Chairman GREENSPAN. We never have been. I was at the first Summit, in fact the first two Summits, as Chairman of the Council of Economic Advisers. It has essentially been a vehicle by which the President, the Secretary of the Treasury, and the Secretary of State have carried the position of the U.S. Government. I can argue on both sides of that. I think that I see no need for Governors, Central Bank Governors to be there. We do, of course, meet with the Finance Ministers in the regular G-7 meetings and, as best as I can judge, all that is required with respect to coordina- tion occurs at that point. Senator SARBANES. Well, the Summits actually are getting more and more away from economic issues. This Summit in fact, the first communique dealt largely with political issues, and the major com- munique was devoted a third or more to environmental issues. And there is a real question about, and we may change the purpose of the Summits, and then we shouldn't call them Economic Summits, but I guess the question is if they are to be Economic Summits, and given the importance of monetary policy, whether having the World Central Bank Governors also present wouldn't contribute to maintaining that focus. Chairman GREENSPAN. It is possible, Mr. Chairman. All I can say to you is that I don't feel strongly one way or the other about it because I think that we get our input in, as is necessary, as a group, through the regular G-7 meetings. Senator SARBANES. The IMF projected in April that the U.S. cur- rent account deficit would expand from $135 billion last year to $139 billion this year and $154 billion next. This projection was made before the recent rise in the dollar. If the dollar remains at its present level, what do you believe will happen to the U.S. trade and current account balances this year and next? Chairman GREENSPAN. It's fairly clear that the strength in the dollar has slowed the adjustment process. I don't think it has ter- minated it. I still think that there is considerable momentum in the export markets. We still have unfilled orders for exports rising, which means that new orders are coming in at a rate above the actual shipments. That in a sense, says that the increase in the value of the dollar has not significantly inhibited our exports just yet. It is true that they have slowed from their pace of advance in 1988, but they are still fairly significant. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 68 My view is that the adjustment process has to continue and I think will continue perhaps after some pause, as I have indicated in earlier periods, but ultimately I think the deficit will start to de- cline again, and my best guess is sometime next year in a signifi- cant way. I think we have to be careful to remember that there is more in- volved in these adjustment processes than strictly the issue of ex- change rates. The real fundamental adjustments have got to occur with respect to the basic saving and investment balances, and clearly the growth rates of the United States relative to our trad- ing partners is a very significant factor in these adjustments. So in summary let me just say that I would expect perhaps not much in the way of movement in our trade balance in the months ahead, but probably starting to continue to improve again after the very dramatic improvement in the first half of 1988. Senator SARBANES. Let me just ask this final question. Given the very large borrowing that is associated with these continuing large trade deficits, what does it portend for U.S. financial strength in the world economy and the role the United States can play in re- solving international economic problems? Chairman GKEENSPAN. Well, Mr. Chairman, I think it's fairly ap- parent, despite the very large increase in external claims on the United States, almost all denominated in dollars, that that has not deterred the desire on the part of portfolio holders around the world to continue to increase their dollar holdings. Senator SARBANES. Has your policy at the Fed been constrained by the need to keep the U.S. attractive to foreign lenders? Chairman GREENSPAN. No. I would say that while obviously we watch what the exchange rate is doing and its effect in the interna- tional markets, it is only when we view it as having a major impact on domestic economic activity or inflation that we believe that American economic policy need address the exchange rate in a significant manner. Senator SARBANES. Senator Heinz. Senator HEINZ. Thank you, Mr. Chairman. Chairman Greenspan, first I would like to compliment you for your testimony at the bottom of page 14 and the top of page 15 for the most articulate expression of why this country and why you or whoever sits in your chair must do a very good job of fighting infla- tion. I think you have done the best job I've ever seen or heard anyone do expressing more articulately the pernicious effects that inflation can exact, particularly in a democracy like ours, and I do commend you for that. Chairman GREENSPAN. Thank you. Senator HEINZ. You also, of course, point out quite correctly that you don't want to win the battle and lose the war, by which I mean kill inflation and kill the economy at the same time. You describe that as a delicate balancing act, and so it is. You indicate that over the long term, and here I cite page 12, that fundamentally what will be required for this country to con- tinue to grow and grow in real terms is to enhance investment and have a higher national savings rate, and you say that most inter- estingly, that improvement in our international payments position Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis is going to require productivity enhancing investment and a higher national savings rate. Now one of the things you say we should do is reduce the federal budget deficit, which certainly we agree with, but what else should we do besides that? Chairman GREENSPAN. Senator, when we finally get beyond the immediate problems of the savings and loan difficulties, and when hopefully we get our budget deficit resolved sooner rather than later, it's important that economic policy in this country focus on what is the most efficient element in our system, namely, an ade- quate level of saving. SAVING RATES DEFICIENT We at the Federal Reserve and I think other agencies of Govern- ment—the Council of Economic Advisers and the Treasury Depart- ment—obviously are beginning to look at the process in a manner which interfaces with potential policy. We are relooking at the tax incentive effects and we are looking at the structure of our mar- kets to try to understand why is it that our saving rates are cur- rently so deficient when it has not necessarily been so in America's past. On the contrary, in fact, between the Civil War and the World War I our saving rates were the highest in the world. So there is nothing culturally built into our society which requires that. Senator HEINZ. Unless you think this country has changed. Chairman GREENSPAN. Unless it has changed, which I doubt. I mean I don't think it has changed enough to suggest that we cannot restore the levels of saving that has characterized this coun- try in earlier periods. So while I can't address your question in a confident manner at the moment, I should hope that within a reasonably short period those of us who are looking at this process will be coming to the Congress to offer suggestions which might be helpful. Senator HEINZ. Do you anticipate doing that this calendar year? Chairman GREENSPAN. I frankly don't know. I will say to you we are looking at the problem now, but my impression is it's probably more for the 1990 legislative period. Senator HEINZ. Well, let me encourage you, Chairman Green- span, to do so. As you point out, we will be dealing with the next budget cycle early on next year, and it sounds to me like you hope to have something to us before we begin deliberations on the Presi- dent's next budget and I hope that's true. Chairman GREENSPAN. All I will say to you, Senator, is it is a very difficult problem. It's one which has exasperated economists for a number of years, but we will endeavor to do so. Senator HEINZ. That sounds only fair after all the exasperations that economists cause for everybody else, Mr. Chairman. SOCIAL SECURITY TRUST FUNDS But let me ask you about a specific issue. Right now the Social Security Trust Funds are generating annual surpluses in the neigh- borhood of, for fiscal year 1990, for example, around $70 billion excess revenues over expenditures. Being the Chairman, as you Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 70 were, of the National Commission on Social Security Solvency, you well know that the purpose of having those annual surpluses was to, in effect, to have a reserve that would be sufficient to help pay the benefits for the baby boom generation when they retire without having to increase payroll taxes to unaffordably high levels. Unfortunately, Congress is now treating that income, that sur- plus income, as if it is deficit reduction. It is used to reduce the cal- culation of the budget deficit and in the Gramm-Rudman-Hollings numbers. Clearly, if we continue to do that, we will report a string of budget deficit numbers that is lower than the string of increases in the Federal debt because we will be writing, in addition to the usual pieces of paper that says I, Uncle Sam, owe you, the public, a lot of money, we will at the same time be writing the Social Securi- ty Trust Fund an increasingly large number of similar pieces of paper, and the only difference is that it will be the Social Security Trustees who hold the paper rather than the general public It seems to me that there is an outstanding opportunity for the United States to increase its saving rate if we would stop the prac- tice of spending the annual Social Security surplus as if it was defi- cit reduction and in fact we actually saved it. Now that would mean that by 1993 under Gramm-Rudman if we do our job we get down to a zero deficit. If we did not spend that money as we are now, we would actually be running in aggregate terms a surplus, and it would be a modest surplus. It would be under a hundred billion dollars a year. My recollection is that the National Economic Commission dis- agreed on everything except one thing. The one thing they agreed upon is that we shouldn't spend the Social Security Trust Fund re- serves like we are now. My question to you is this. First, do you agree with the National Economic Commission and then their membership on that point and, second, since some people say a surplus is deflationary and can slow down the economy, is that true and, to the extent it is true, how do we deal with that? Chairman GREENSPAN. Well, Senator, let me answer the second question first. In today's environment it's credible to me that a surplus, and hopefully a chronic surplus, in our unified budget account would be deflationary. Obviously the British at this particular stage have a very large surplus and there is no evidence that that in fact, in and of itself, has been deflationary. It need not be and shouldn't be. Senator HEINZ. Is the other side of the coin, that deficits need not be inflationary and it depends how you finance them? If you finance them by printing money, they are inflation, and if you hold the line on credit, they are not? Chairman GREENSPAN. It depends, in part, on a number of other facets of what is going on in the economy. Very specifically, be- cause our private saving rate is low, were we to add to the aggre- gate national saving rate, the saving coming from the Federal Gov- ernment, that would not be a level of saving which would be so in- ordinately large as to cause, as economists like to say, fiscal drag on the system. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 71 Senator HEINZ. So we should look at the aggregate amount of saving and not just what the Federal Government is doing? Chairman GREENSPAN. Exactly. Senator HEINZ. The same way as we should look at the aggregate amount of debt. Chairman GREENSPAN. Yes. It is the same issue from different sides. The problem that exists with respect to the Social Security surplus issue is not the desirability of saving it. In fact, saving it all would be highly useful to the American monetary policy. There is a technical problem which causes me concern and leads me to the worry that Congress would not be able to hold to that position. That is the growing and, by the year 2000, very large in- tragovernmental interest payment from the U.S. Treasury into the Social Security Trust Fund. A very substantial part of the accumu- lated Social Security surplus, say by the year 2010 or 2015, turns out to be that interest payment, an interest on interest. As a consequence of that, if one looks at this tremendous in- crease in the annual Social Security surplus and with a very large and growing part of that being interest payments from the Treas- ury, the other side of the same process is that there is a growing acceleration of interest payments from the Treasury to the Social Security Trust Funds, which when you consolidate them washes out and doesn't appear in the numbers. So what concerns me is that that acceleration of interest, the in- tragovernmental interest would make the non-Social Security defi- cit increasingly large and very difficult to handle, and I'm fearful that were that to occur, we would then abandon the whole process. So I would be inclined to try to find a means by which if we are going to literally save parts or all of the Social Security surplus, which I think is highly desirable, that we keep in mind that other process and make certain Senator HEINZ. The net interest problem. Chairman GREENSPAN. Exactly, and make sure that we don't get upended by this extraordinary accounting process that would be going on. Senator HEINZ. That strikes me, if the Chairman, and I see the red light is on, will permit me, that strikes me as a question of management accounting for the Congress to consider, not that that's our strongest field, mind you, but I don't think that with the brain power that we've got that that problem need sink the ship. It seems to me to be a solvable, if not necessarily facile problem to solve. Chairman GREENSPAN. Yes, and one solution is to save the non- interest part of the growth in the Social Security Trust Funds, Senator HEINZ. Yes. Thank you very much, Mr. Chairman. Senator GRAHAM of Florida [presiding]. Thank you, Senator. Following the rule of first-come/first-question, it is now my op- portunity to question. I am going to ask questions in three areas. One is the savings and loan issue, second is the Third World debt and, finally interna- tional interest parity. Starting with the first question, in February of this year we had a discussion on the administration's projections as to how much the Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 72 savings and loan industry could contribute to the bailout plan, spe- cifically as to whether the projection of a 7-percent deposit growth, which was assumed in the administration's projection, was realis- tic. In your testimony today you state on page 6 that FSLIC insured institutions began losing deposits at a significant rate. These depos- it withdrawals were particularly strong in the first quarter of this year. Based on the history that has occurred since February, do you have any further comments as to whether you believe a 7-percent deposit growth rate is a reasonable expectation for the savings and loan industry? Chairman GREENSPAN. Mr. Chairman, it clearly is on the high side, but I wouldn't necessarily say that the experience that we have had in recent months in any way alters the probability of how that growth will emerge. It's fairly clear that until we have gotten through the problem of reconstituting a number of these associa- tions and restoring the confidence that we believe consumers will again have in thrift institutions, until that is done, it's not easy to see what track of growth will occur in those institutions. While 7 percent is probably on the high side, it is technically achievable, and I wouldn't automatically rule it out. It is certainly true that if you lower that assumption, you get somewhat different assumptions about the sources and uses of funds with respect to the so-called bailout, but I don't think they are of an order of magnitude which concerns me greatly. Senator GRAHAM. The consequence of lowering the expected rate of growth of depository insured funds within the savings and loan industry is to reduce the level of contribution which the industry can make toward the bailout and therefore increase the portion of the bailout which will be paid by the taxpayers; is that correct? Chairman GREENSPAN. That is correct, Mr. Chairman. Senator GRAHAM. Given what has in fact occurred to the indus- try over the last 3 to 4 quarters, which has been a decline in depos- it base, what percentage increase would be required for the next 3 or 4 years in order to recapture what has been lost and accelerate to the average of the 7 percent upon which the industry contribu- tion is currently predicated? Chairman GREENSPAN. If I may, Mr. Chairman, I would like to put that in the record because I don't recall offhand exactly what the percentage change is to bring us back to the long-term level projected in the official document but I will submit that for the record. [Chairman Greenspan subsequently submitted the following in response to a question from Senator Graham:] In view of the decline in total deposits at FSLIC-insured institutions over the last several quarters, deposit growth would have to accelerate to roughly a 9-percent rate over the next 3 or 4 years in order to lift growth to a 7-percent average from its September 1988 base. FINANCING OF THE S&L, BAILOUT Senator GRAHAM. One of the consequences of an understatement of what the industry can contribute and therefore an increase in what the taxpayers contribution will be would be the potential Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 73 that the level of taxpayer contribution which is contemplated in the current Conference Committee report will be deficient and we would have to have another round of taxpayer contributions to- wards the overall financing of the bailout. In that context, I would like to go to the question of the most appropriate means of financing the taxpayers' portion, and specifi- cally whether it should be paid through some immediate or rela- tively short-term contribution, such as a proposal that was voted on in the House of a short-term tax increase in order to immediately finance the taxpayers' portion, or if we go to a longer-term provi- sion, whether it should be financed through direct Federal borrow- ing or through the use of an independent agency. You have recently written to the Congress recommending the third approach, which is the use of an independent agency. Could you assess, particularly in the context of the possibility that addi- tional taxpayer financing will be required in part due to the slower than anticipated growth of the S&L industry deposits what you think the ramifications of those three approaches would be, and a further explanation of your preference for approach No. 3. Chairman GREENSPAN. Mr. Chairman, let me repeat what I be- lieve I said in an earlier meeting of this committee. We don't know exactly what the actual cost of the so-called bailout will be. We know within a rough approximation, more than adequate to know the form of the legislative structure that should be instituted, and I must say that I believe that the general configuration that has come up in the Senate and in the House does meet the require- ments that I envisaged for financing and restructuring the indus- try. Even if we knew exactly what the cost would be, it wouldn't help us. We are going to have to relook at this issue in a couple of years to fine tune it, either reducing or increasing the commitments that would be involved. And it is not only the rate of growth in thrift deposits which affects that estimate, but perhaps a far greater ele- ment will be whether or not the underlying losses that are current- ly estimated are larger or smaller than anticipated. So we really will not know until a later time. So I merely suggest to you that how that is met is something which we probably will not know enough about for at least a year and maybe 2 years, I originally and continue to support the so-called off-budget means of financing, the one embraced by the full Senate. The reason is wholly an issue of Gramm-Rudman-Hollings and fiscal re- sponsibility and has, of course, nothing whatever to do with the savings and loan issue per se. My basic concern with the on-budget with exemption alternative is not whether it is on-budget or off-budget, but it's the exemption process itself which I am fearful could become too general and used in a variety of other vehicles of financing which would ultimately break down the Gramm-Rudman-Hollings process. I obviously could not have that objection, and technically do not on the question if one wanted to finance the whole savings and loan thing with taxes. I don't think it's a practical thing to do, and I'm not supportive of it, but it would not be an issue of a Gramm- Rudman-Hollings exemption. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 74 It is far more difficult to replicate the off-budget alternative, as I see it, and, hence, far more supportive of budgetary discipline im- plicit in Gramm-Rudman-Hollings. In addition, of course, it does lock in the thrift industry's contributions to the bailout process, which would be somewhat more difficult with the so-called on- budget exemption procedure. Senator GRAHAM. One final question. A concern which is implicit, in your letter of July 12 and the comment that you've just made is that the capital markets would respond adversely to what would be appear to be a weakening of our resolve to achieve budget balance and discipline. What would be the principal specific indicators of that adverse market reaction that you would point us to, particularly in the period of the last week since the Conference Committee has decid- ed to recommend to the full Congress an on-budget approach to fi- nancing the S&L bailout? Chairman GREENSPAN. I think the issue is not so much the spe- cific choice that would affect the markets, but it's the concern that would emerge if it was perceived that fiscal responsibility was breaking down in this country. I think the progress that has been made in recent years in bring- ing down the budget deficit has been a marked factor, an impor- tant factor in the reduction in long-term nominal interest rates. I would look for signals which somehow suggested that there was a disaffection within the financial markets both domestically and internationally. Senator GRAHAM. And have there been any signals that you would point us to? Chairman GREENSPAN. Not to my knowledge at this stage. There is still confidence that we are moving toward a fiscally responsible reduction in our deficit. Senator GRAHAM. Senator Mack. Senator MACK. Thank you. Again, welcome, Mr, Chairman. In the last 5 or 6 years or so we have, the Congress and the coun- try have pretty much focused on fiscal policy deficit reduction tax policy spending as a percentage of GNP. I believe we are at a point where we need to focus on monetary policy, the direction towards zero inflation and low interest rates. A sustainable long-term growth that will lead us into the 21st Cen- tury I think is important, and for that reason I commend you on refocusing our attention on monetary policy and in difficult times are willing to take the heat in order continue that policy of reduc- ing inflation. I know that in the past you have said that we can't focus solely on the M's engaging monetary policy and that we ought to pay at- tention to what the markets are telling us as well, commodity prices, currencies, bond prices and even gold. We have seen recent- ly, for example, the gold price over the past 1 l/z years declining from roughly 480 to below 375, and commodity prices have begun to be reduced. I just would be interested in what are you looking at beyond the M's and what are these indicators, such as the ones that I've men- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 75 tioned, commodity prices and currencies and bond prices telling you about the state of the economy? Chairman GREENSPAN. Well, so far as inflation is concerned, over the long run I think the evidence unquestionably points to the fact that inflation is fundamentally a monetary problem. If our goal is to basically reduce inflation essentially to zero, which has the effect of bringing real interest rates down to a minimum, then I think we have to look at the various financial indicators of which money supply is one and credit and other elements are other fac- tors. We have devised a rather simplistic money supply analysis proce- dure which is one of the things we look at as sort of a gross proxy which says to us that one can achieve stable prices over the long run if the rate of growth of M2 is the same as the rate of growth of the potential in the economy. Now that is a rough proxy for where we ultimately want to be, and it's our belief that if we get there in a stable manner, we will have inflation to a point where it is no longer acting as a corrosive force on our society or creating a level of real interest rates that are higher than we should wish to tolerate. So far as the economy is concerned, other than inflation, it is our view that if we can achieve a stable noninflationary environment, that that is the major contribution that monetary policy can con- tribute to economic growth. That is not to say that there are many other elements that are involved. The tax issues and fiscal issues clearly are very crucially important as is regulation and a wide va- riety of a number of issues which we have discussed over the years. But the essential long-term contribution that monetary policy can make to a stable, growing America with increasing real in- comes and increasing standards of living is to make sure that we have a sound currency. Senator MACK. In your response again you talked about quantify- ing I guess monetary growth as kind of the target that we're shoot- ing for, but didn't respond to the other indicators I guess that I raised. I mean does that provide you with information as to wheth- er you're on target or not on target? Chairman GREENSPAN. In the short run it clearly does. The extent to which various elements in the economy are exhibiting ex- cessive speculative pressures or compression does tell us what types of demands are going to be put on the financial system and, hence, what type of inflation pressures will ultimately emerge as a conse- quence. MONEY GROWTH LINKED TO INFLATION Senator MACK. In stating that monetary policy or money growth clearly is linked to prices, is it fair to say that the growth in the money supply, and I've forgotten the specific dates, but in 1987 and 1988 fueled the inflation that we experienced earlier this year or that we're experiencing now? Chairman GREENSPAN. Well, there are some who would argue that the excess growth hi money supply in 1985 and 1986 have done so. I think it's an arguable point, but clearly there is some spillover from rates of growth which are too high into the price Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 76 level, if they start from a point in which the level of money supply is excessive. It's not only the rate of growth that is relevant, but the level from which that acceleration occurs, according to our studies. Senator MACK. Do I draw from your earlier response that the ob- jective then of the Federal Reserve with respect to money growth would be somewhere in the 2 to 3 percent range, and I'm talking about long term? Chairman GREENSPAN. I would say ultimately yes. The target ranges that we view would ultimately be brought down into that range if we are committed to achieve a stable price level. Senator MACK. Just me just raise one additional question, and again it goes back to your indicating the relationship between money and prices is without question, and we have already talked about again trying to quantify money growth is difficult, or the money supply is difficult. There was a lead article in the Wall Street Journal editor page on June 29 by John Mueller. He argued that worldwide measure of the supply of dollars, which he calls the world dollar base, is more important in predicting U.S. growth and inflation than the domes- tic money supply numbers. Did you happen to see that or are you familiar with that argu- ment, and what is your response to it? Chairman GREENSPAN. I am. I think it's an intriguing argument. The problem that I have with it is it doesn't work as well as one would think it did. Most of these money supply relationships work over the longer run and have not been very useful as indicators over the shorter run. I mean, for example, a comparable notion is that the exchange rates should be a function of the ratio of the money supplies of the two different nations whose currencies are involved, and one would argue that obviously the more money you create of say dollars versus yen, the weaker the dollar should be. The trouble is the numbers don't work out that way, and I would say similar things with respect to that particular concept. It is an interesting notion, and I think one should look at the so- called dollar base, which includes the dollar holdings of the Central Banks around the world as well as numbers in our domestic system, but I think you have to be terribly careful not to read too much into them as an indicator of what the world is all about.- Senator MACK. Thank you, Mr. Chairman. Senator GRAHAM. Senator Shelby. Senator SHELBY. Thank you. ON BUDGET/OFF BUDGET FINANCING Mr. Chairman, you've talked about it before, about on-budget and off-budget financing, and I believe, as it has been alluded to here today, that's going to be a fundamental question that we're going to have to face first whether we're going to waive the Budget Act in the Senate regarding the savings and loan financing, on budget/ off budget. I have my colleague from Texas here, and I'm sure we'll talk about it. He talks about it and does it well. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 77 Let's talk about on budget/off budget and the growth of off- budget money in borrowing. It seems to me that whether it's on budget or off budget basically, that the money is being borrowed from a market out there, partly our sayings, but not enough as you say, and rightly so, and partly the savings of the Japanese and the Swiss and the Germans and others in international markets. But no matter what happens, if it's on budget or off budget, whether it's a savings and loan situation or anything else, that money is out there and it's capital that has to be raised somewhere in the market, am I correct on that? Chairman GREENSPAN. Yes, Senator. Senator SHELBY. OK. What is the downside, the real downside of putting this on budget versus off budget, and I'm talking about the savings and loan bailout, is it more political than economic, or is it some of both? Chairman GREENSPAN. Well, remember that the crucial issue of on budget is an on-budget with a Gramm-Rudman-Hollings exemp- tion. That's crucial. Senator SHELBY. I understand that. Chairman. GREENSPAN. It's the exemption which is the problem. Senator SHELBY. But is that exemption political in nature or eco- nomic or some of both? Chairman GREENSPAN. It's political. Senator SHELBY. It's political and not economic? Chairman GREENSPAN. Yes, that's correct. The sole concern that I have with respect to this issue reflects the maintenance of the Gramm-Rudman-Hollings process which, aside from all its faults, has turned out to be the one mechanism that we have in this coun- try to maintain fiscal discipline, and that is a political process. And to the extent that we undercut that, we are undercutting the via- bility of the financial system and economic stability in the future. Senator SHELBY. Is a central question there whether Gramm- Rudman is a steel band or perhaps a rubber band? Chairman GREENSPAN. I'm concerned that it may be no band. Senator SHELBY. No band. If it's waived and continues to be waived, it would be meaningless as a major thrust? Chairman GREENSPAN. That is my major concern, Senator. Senator SHELBY. But going back to the off budget, how much money within certain figures, and I know you probably don't have it before you, have we borrowed, our agencies have borrowed off budget? How much money is owed off budget? I know there has been phenomenal growth there. Chairman GREENSPAN. My recollection is that the so-called feder- ally sponsored credit agencies, which are essentially off-budget items, are something under a trillion dollars. Senator SHELBY. Under a trillion? Chairman GREENSPAN. Yes, but not as much as I would like it to be. I think that's correct, 900-and-some odd. Senator SHELBY. Can you furnish that information for the record and to this Senator. Chairman GREENSPAN. Yes. [Chairman Greenspan subsequently submitted the following in response to a question from Senator Shelby:] Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 78 As of the end of the last fiscal year, the federally sponsored credit agencies had about $330 billion of debt outstanding. In addition, two of the agencies had issued $388 billion of mortgage pass-through securities on which they had guaranteed the interest and principal. Adding the value of the pass-throughs to the direct debt of the agencies—and then subtracting the $55 billion of assets held by the sponsored agencies that were either insured directly by the Federal Government or were debt obligations of the U.S. Treasury—yields $663 billion, which is OMB's measure of sponsored-agency debt outstanding. In addition, the Federal Government had an- other $550 billion of guaranteed loans outstanding, resulting in a total of over $1.2 trillion of federally assisted debt. Senator SHELBY, So you say it's under a trillion dollars, and then our own budget is 2.8? Chairman GREENSPAN. Well, actually, no. The on-budget is mod- estly over two net, meaning excluding the public debt that is owned by the U.S. Government itself in its various trust funds. Senator SHELBY. Let me get into another aspect of financing while I'm here and we've talked about it, and you've talked about it every time you've been before the committee, and I think rightly so, dealing with our fundamental problem of lack of savings. In other words, with the lack of savings in this country, we have to look outwardly to finance our deficit, which is a problem. When we did we first start financing a lot of our deficit from international sources in recent times? Chairman GREENSPAN. That last phrase did change my answer, Senator, because obviously we've financed a goodly part of our 19th century investment Senator SHELBY. Sure, I know that. I'm speaking in recent times, and let's say in the I980's. Until 1980 were we able to internally finance our deficit by our own savings? Chairman GREENSPAN. Yes. We did not reach a current account deficit until recent years. Senator SHELBY. And what is that current account deficit now roughly? Chairman GREENSPAN. Well, it's obviously well over $100 billion. Senator SHELBY. And growing, it is not? Chairman GREENSPAN. No, I don't think so. Senator SHELBY. Do you think it's receding? Chairman GREENSPAN. I think it will recede some. Senator SHELBY. And do you attribute some of that receding to the Gramm-Rudman discipline measure that the Senator from Texas has authored and tried to keep in line, some discipline? Chairman GREENSPAN. It's conceivable, but my concern rests upon reducing the Federal budget deficit. My concern is essentially the short-term Federal Government deficit and its effect on the fi- nancial markets and its effect on long-term inflation in this coun- try and very specifically its relationship to the savings and invest- ment balance. The major problem with our deficit is that it has subtracted from our domestic saving and made it very difficult for us to maintain productivity enhancing capital investment. Senator SHELBY. Does that run up the cost of our capital invest- ment, too? Chairman GREENSPAN. In one sense you could say that the cost of capital is higher, meaning not the prices of the capital goods, but the real cost of capital is higher because that Federal Government deficit is higher. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 79 Senator SHELBY. Last, as the captain of the big rig out there, the economy and being the guardian of the economy, how is the soft landing coming along? It looks good now. Is it going to make it? Chairman GREENSPAN. Well, I'm observing the phenomenon. Clearly the information we have to date has been favorable. I think we will make it, but I've been in the forecasting business for much too long to Senator SHELBY. You've been very good at it. Chairman GREENSPAN. Well, perfection is something to which we strive, but don't manage to achieve, and I think policy is on the right track. I think that what we are doing is the correct thing, and what we have done I think is the correct thing. I think we have succeeded in diffusing inflationary pressures and I think we have been correct in backing off as we have. Senator SHELBY. By policy are you referring to the monetary policy? Chairman GREENSPAN. Yes, I'm talking about monetary policy only. Whether that achieves the ideal configuration of economic ac- tivity that we are seeking, I think is not yet evident, and we really will not be able to know the answer to that question until well into next year. Senator SHELBY. My time has expired. Thank you. Senator SASSER [presiding]. Senator Gramm. Senator GRAMM. Thank you. Mr. Chairman, let me thank you for coming here, and I hope you will forgive us if we are like the graduate students who come to get the old professor to give them what the right answer is, I remem- ber often telling my graduate students when they would get in an argument that I wasn't sure what the answer was. WAIVING THE BUDGET ACT But I want to go back and try to touch on the key vote that we are about to take here in the Senate, and that is waiving the Budget Act to allow consideration of the Banking bill. Obviously it's something, as my mother would say, we have all prayed over. I would like to begin by talking about this on budget/off budget, and I would like to outline very succinctly what I see the two plans as being composed of, and then I would like to ask your assessment as we have used the term under the First Bank of the United States, under the Second Bank of the United States and under the Independent Treasury since about 1840 which of these two plans would by traditional definitions be on budget and off budget? The President's plan is a plan whereby the industry borrows $50 billion. They are liable for that $50 billion and they take existing assets and buy a zero coupon bond which matures in 30 years on the exact day that the $50 billion note that they are liable for ma- tures. So they incur a liability which is 100 percent collateralized by a Government zero coupon bond. The Treasury agrees over 30 years to pay interest on that note, and every penny of that interest every day that it is outlayed is counted as an outlay of the Treasury, is part of the deficit and is counted under the Gramm-Rudman-Hollings Deficit Reduction Law. That's the President's plan. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 80 The alternative plan is a plan that says the Government, not the industry, would borrow the $50 billion. Clearly that is an outlay of the Treasury. So the deficit goes up by $50 billion. But having done that, and all interest is paid and all interest is counted on budget the same as the President's plan, but having incurred the liability of $50 billion. Then it says that in essence is a good deficit and we are not counting it in with that bad deficit, and we are not count- ing it as part. We'll have it, but we won't count it when we're measuring whether we are meeting deficit reduction targets. Now my argument would be that a fully collateralized private li- ability that is 100 percent collateralized with a zero coupon bond would never in the history of the United States have been called a liability of the Treasury or called off-budget financing. On the other hand, I think saying we have a deficit, but we are not going to count it, that if that is not the essence of off-budget financing, I don't know what is. So as I see it, not that these terms have any meaning other than their sort of PR impact, but it seems to me that it's hard to call the President's plan by the traditional definition off budget and it is hard to call the alternative plan on budget. Would you give us your views on that issue as a person who has looked at this thing and looked at the economics of it for many years. Chairman GREKNSPAN. I think one of the problems that I have with this whole concept is that I would use slightly different crite- ria for so-called on-budget/off-budget—criteria that have been em- ployed for many years by the Department of Commerce in the cal- culation of Federal spending and Federal deficit in the context of the national income accounts. The economically significant difference really rests with whether or not the trend's action is a financial one and affects the financial asset and liability accounts of the Federal Government or whether it affects the purchase of goods and services. And in the current context, since the liability that the U.S. Gov- ernment now has with respect to the savings and loan issue is al- ready there, meaning the full faith and credit of the U.S. Govern- ment is behind those thrift deposits and those institutions which have inadequate assets marked to market, in that sense we already have a Federal obligation. It is a financial obligation affecting the balance sheet. What we are proposing to do to substitute for those deposit liabil- ities is a financial transaction which fills the hole on the asset side with U.S. Government credit. That item, when it occurs, will not appear as an outlay, as I understand it, in the national income ac- counts largely because it will be a financial transaction. It will be a movement of financial assets and liabilities and, hence, not a so- called purchase transaction. That is where I think the distinction critically lies with respect to the issue of on budget and off budget, and in that respect it would clearly be an off-budget transaction. Senator GRAMM. I'm not sure, which one are you talking about? Chairman GREENSPAN. The financial transaction would appear off-budget in either respect because it will reflect a financial trans- action only, as I understand the way the accounts will be made. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 81 Senator GRAMM. You don't believe that the borrowing of the in- dustry full collateralized by the zero coupon bond is a liability in any sense of the Treasury? Chairman GREENSPAN. Well, certainly in a sense that what is in- volved there is the purchase of a zero coupon bond. It is a liability in that sense. But I certainly agree with the position you're taking with respect to keeping it off-budget. Senator GRAMM. So you really see the issue as coming down to the issue of the kind of precedent you set when you say this is a necessary deficit and so we are going to do it, but we're not going to count it toward deficit reduction. Your concern would be the next week you could do that for nuclear waste Chairman GREENSPAN. Yes. Senator GRAMM [continuing]. And the next week you could do it for the war on drugs and the next week you could do it for housing. Chairman GREENSPAN. It's far more difficult to replicate the type of off-budget financing which you are recommending than it is to replicate an on-budget with an exemption. To that extent, and only to that extent, is the issue very crucially one of fiscal discipline, and my concern is that being on budget with an exemption has a more negative impact on fiscal responsibility than any form of ve- hicle which would endeavor to replicate the administration's fi- nancing vehicle. Senator GRAMM. Thank you. Senator SASSER. Thank you, Senator Gramm. I want to welcome you this morning before the committee, Mr. Chairman. In my view, you're testifying this morning at a critical time for our economy. The economic indicators, in my judgment, are not good. Economic growth is down to 1.7 percent annual real rate, and in June industrial production dipped by 2/10ths of one percent, retail sales fell by 4/10ths of one percent and housing and autos have been down from some time. So the trend is downward. And when we look at the Fed's monetary policy, I'm pleased to see that we see some recent easing, three-quarters of a point, and that's welcome. But we have to look at the three point increase in rates that began about a year ago and factor that into the overall effect. There was a lot of tightening over the past year, and over the past 2 years we have had the slowest money growth since the 1950's. Even the distinguished journalist, Alan Murry, of the Wall Street Journal, is saying that the so-called soft landing that we'll get if we're lucky is going to feel like a recession to a lot of people, and one of your colleagues over at the Fed, Martha Seger, is saying that it's going to be very difficult to land the aircraft in a nice gentle way. Instead Ms. Seger says we may take a wing off. I hope she's wrong, and Ms, Seger has been wrong before. But from a fiscal perspective the soft landing could increase the budget deficit by an additional $25 billion, which would be of great concern to me and I expect to you and most other observers. Obvi- ously should the economy experience a hard crash landing, we'll have a severely worsened deficit situation. Now, Mr. Chairman, the Purchasing Manager Survey was re- leased just a few moments ago and it points to continued slowing. The Purchasing Indicator came in a 46, which was below expecta- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 82 tions, as I understand it, and below the 50 percent threshold for the third month in a row. In view of that, and if we get July statistics that indicate job growth is continuing to decline, can we anticipate some further easing on the part of the Fed in the coming weeks and coming months? MARKET RATES DECLINING Chairman GREENSPAN. Well, Mr. Chairman, let me just first say that the relevant rates in the market which are affecting the econ- omy are the market rates, and here, as I pointed out in my formal testimony, short-term money market rates are down a percentage point and a half since March. And, most importantly, long-term rates are at their lowest level in 2 years. So in the sense of interest rates impacting on the economy, long- term interest rates have not gone up and in fact have been edging lower for quite a while, and this impacts on the mortgage market and on capital investment and has a very profound effect on over- all activity. It is certainly the case that we did move up short-term rates by 3 percentage points, and that had an effect on variable rate mort- gages and some effect on housing. But I think the extent of how much impact we have had is not yet clear and will not be for a while. Money supply growth was very slow for a good period of time after being excessively fast for a while, and in recent weeks has ac- tually accelerated into double digit areas. So it has moved back up quite appreciably, I can't forecast what Federal Reserve policy will be. It will depend to a very substantial extent on the evolution of economic events in the months ahead. Senator SASSER. Well, frankly, Mr. Chairman, I really didn't expect you to answer that question. If you had, we would probably have had a rush for the telephones here by the journalists and others in this room. In response to Senator Gramm's question you indicated that you favor financing the FSLIC bailout off budget, and that's well known. You have written a number of us and told us that. And as I understand your rationale principally, you believe that exempting the spending associated with the FSLIC problem from Gramm- Rudman would establish a precedent for other spending programs to be exempted. I think you may have reiterated that here this morning, and this in turn puts pressure on interest rates, and it would cost the Government much more with escalating interest rates than the $150 million or so that the on-budget treatment sup- posedly saves per year. That's one rationale. But as I understood the thrust of your statement this morning, your primary concern with the on-budget concept is that we escape the discipline of Gramm-Rudman if we put it on budget and then exempt it. Is that a fair statement? Chairman GREENSPAN. Yes. Mr. Chairman, my major concern is the exemption issue. It is possible that the off-budget vehicle which has been recommended by the Treasury could be replicated and Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis could create some fiscal problems, but it is very clear that it is far more difficult to do that, It is more unlikely that we will get an erosion of the Gramm-Rudman-Hollings process from replicating the off-budget vehicle in financing the bailout than an on budget with an exemption. It is strictly a political question in the sense that it is politically difficult to replicate, as far as I can see, the on- budget recommendations of the administration and very easy to re- quest on budget with exemption if that becomes an oft-used and a desired vehicle. I think our fiscal discipline will erode, and I think that will be very costly to the Nation. Senator SASSER, Well, Dr. Greenspan, I very much appreciate your candor in telling us that it is to some extent or to a large extent, in your judgment, a political question as opposed to an eco- nomic question. Let me just follow it up with this question. There is some conver- sation here in the Congress about raising the Gramm-Rudman-Hol- lings' targets for 1991 and 1992. What would be your reaction to raising the Gramm-Rudman-Hollings for 1991 and 1992 and what would be the effect of that, in your judgment? Chairman GREENSPAN. I would be opposed, Mr. Chairman, on the grounds that if you proceed to raise them, I think for all practical purposes the markets will assume that the process is dead and that fiscal responsibility has been significantly eroded in this country. I think it's the type of action which I would be most inclined to avoid if possible. Senator SASSER. Let me impose on my colleagues, Mr. Chairman, to ask one more question on this whole question of on-budget/off- budget for FSLIC because it is a very important decision and some of us, and in fact we are all going to have to make that decision again here in just a very few days. Some of the proponents of on-budget financing have argued that we can save a lot by going on budget because you wouldn't have to lock into the 30-year bonds the way you do when you finance off budget. They say if it's Treasury financed we could borrow short now when the interest rates are relatively high, and then come back in when the rates fall, as is generally anticipated they will do, and borrow long in a year or so when the rates are low. And they argue that if you go off-budget and lock yourself into these long- term bonds, you're not going to have that kind of flexibility. Now my question to you is, is this a valid analysis, and would on budget save much more because it is more flexible? Chairman GREENSPAN. I would like to engage in that discussion, Mr. Chairman, but you will observe that implicit in any answer I give to that question would be a forecast of interest rates, and I'm not about to get involved with that. Senator SASSER. Well, I thought we were going to get you in- volved in that for just a moment, Mr. Chairman, but you saw through the question. [Laughter.] But in the academic discussion that rates were to fall, would this analysis have any validity? You would be betting that the rates are coming down. Chairman GREENSPAN. I think there are really basically two questions here. One is the maturity of the borrowing. In the off- budget plan there is a presumption of longer-term borrowing colla- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 84 teralized by a zero coupon bond. In on-budget it would tend to be the usual average configuration of bills, notes, and bonds, and it would be submerged in the total system. It is indeed relevant where one forecasts interest rates to know which of the two, strictly from that point of view, is the cheapest for the American people. Leaving aside the forecast of interest rates, there is nonetheless an additional cost if we were, say, matching a long-term off-budget financing vehicle and an on- budget long-term financing vehicle, which would be, say, $150 mil- lion a year differential, depending on how many basis points addi- tional cost. The present value of that difference—meaning the amount of money you need up front to invest so that the interest received on that investment, plus the amortization—would pay the difference between the two types of bonds. That number is something be- tween $1 billion and $!Va billion, and it strikes me as a very small insurance policy for the improved fiscal discipline that is embodied in the off-budget vehicle relative to the on-budget vehicle. Senator SASSER. Thank you, Mr. Chairman. Senator D'Amato, Senator D'AMATO. Mr. Chairman, I want to first commend you for that last question and the Chairman for his explanation and putting some very real perspective without just politicizing one way or the other, and I'm not suggesting that you've engaged in that. But so often I think the proponents of whether it be on budget or off budget get into rather simplistic answers and that you did us a great service, Mr. Chairman, in your asking the ques- tion and the Chairman's response. I'm not going to ask you about soft landings or crash landings. Rather you have been a constant force, Mr. Chairman, for encour- aging increased savings. I believe it's one of the great problems that we have—capital formation or the lack of it. Merrill Lynch just did a study recently which indicated that as a result of doing away with the IRA they estimate that we lost some- thing in the area of $135 billion in additional savings. Some folks in Treasury would dispute that I know, but that's their study. LEGISLATION TO BRING BACK THE IRA Senator Dodd and I have been exploring a plan to introduce leg- islation to bring back a form of the IRA with a modification that we would allow the $2,000 contribution, but instead of permitting a total deduction at whatever your rate is, permitting a 15-percent credit, in essence limiting it to a $300 credit for $2,000 that is saved. Do you have any suggestions or any modification which could be made to improve the savings incentives, whether it be by IRA or any other area? Chairman GREENSPAN. Well, Senator, as I indicated earlier, we at the Federal Reserve and the analysts at the Treasury Depart- ment and at the Council of Economic Advisers are looking into the question of how can we improve the basic saving of this society be- cause I think we would fully subscribe to your view that it is the Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 85 crucial issue which is involved in the longer-term economic outlook for the country. I haven't yet seen a satisfactory set of proposals because we haven't had a chance to really examine them, but I have indicated that when we get there and when we have something we feel is useful and helpful to the Senate and to the House of Representa- tives we will, of course, be bringing them forth. One of the crucial issues with the IRA's is the determination of how much private saving is actually generated net. In other words, as we all know, for the IRA to basically create saving it has got to be a replacement of consumption for saving, and in a sense you've got to be able to say that we bought $200 less goods at some point and took those moneys and put it into the IRA account, because merely shifting from one account to another in the financial mar- kets doesn't have any effect. We haven't yet come to a conclusion of exactly how much of the IRA is real saving and how much of it is merely a shift. Senator D'AMATO. Can I ask you, Mr. Chairman, to have your people take a look at that Merrill Lynch study and give us an anal- ysis? Chairman GREENSPAN. Certainly, we will. I'm not familiar with it, but we'll look at it. Senator D'AMATO. We'll send you a copy of that. It's very inter- esting. Let me ask you one other thing and shift a little bit to Gramm- Rudman. One of our colleagues asked whether or not adjusting the targets, what you would think about that in 1991-92. I share your concern. I think that would be a disaster. It would send the wrong signal to the marketplace, to the international marketplace that we are no longer wed to a program of reducing the annual deficit. Let me ask you to rate Gramm-Rudman and its effectiveness. What would be the situation, in your opinion, were we not to have had Gramm-Rudman in place these past years? Chairman GREENSPAN. It is very difficult, Senator, to make that judgment, and clearly it is not the ideal vehicle for fiscal restraint, but it works, and with all of its bells and whistles it seems to be the only thing we can construct which will work. I don't know how much difference it has made with respect to where the deficits would be, but I think it's substantial. I couldn't put a number on it, but I must say to you I feel much more com- fortable with that vehicle in place and functioning if our purpose is to get the budget deficit down significantly than were it eviscerated in any way. Senator D'AMATO. Would I be incorrect in saying it's your obvi- ous impression that there are those in the financial community who view this as, let's say, that last wall of resistance to unre- strained spending? Chairman GREENSPAN. I would say that there are clearly a number of analysts within the financial community which if they saw the Gramm-Rudman-Hollings process swept aside would be very concerned about the fiscal viability of our budgetary process. Senator D'AMATO. I thank you once again for giving us the op- portunity of listening to you and asking you some questions as it Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 86 relates to the economy and some of those things that are rather es- oteric with so many, and I thank the Chairman. Senator SASSER. Thank you, Senator D'Amato. MEXICO'S DEBT Mr. Chairman, let me turn your attention south of the border just a moment. We've come up with a new plan on Mexico's debt, and the recently announced accord on Mexico's foreign debt I think does offer some hope that Mexico's debt load can be reduced with- out too negatively impacting on American bank creditors. But I must say to you that I'm concerned that debt reduction is only one of three options that the banks are being offered. The other two options are reductions of interest that is paid on the in- debtedness and new lending. Now a lot of observers think that the option that the banks are going to choose, or most banks are going to choose is going to be new lending because if they reduce debt they are going to have to take a hit on their capital and write that off. If they reduce rates, they will have to take a hit in their income statement, and that will depress the price of their stock, and the easiest and the course of least resistance would be to just simple make new loans to Mexico, which is essentially the old Baker plan. But in the final analysis, this is not going to get, in my view, Mexico's debt reduced, and that really is the goal that we have to be pushing for, and that is to reduce this overhanging Mexican debt for political reasons in Mexico and for our own external politi- cal needs, and also to face reality here in our own country with regard to how much of this debt is actually collectable and how much the Mexicans can actually afford to pay off. How do we get serious about this Mexican debt reduction, in your view, and how do you think the plan that is being offered now is going to work, and how serious is this whole Mexican debt prob- lem? Chairman GREENSPAN. Well, Mr. Chairman, actually I think the agreement that was reached is a very important one and one which I think will be most helpful to Mexico's economy. I don't agree that the major part of the commitments will be so- called new money. From what we can observe looking at it from bank to bank, perhaps a little more than 20 percent will be new money and the rest will be either debt reduction or debt service re- duction which has the same effect in lowering the external commit- ments of the Mexican Government. As best I can judge, the agreement is going to be most useful to Mexican finances and I think helpful to the banks in the sense that they are restructuring their holdings in way which I think will be beneficial. So actually I look at the agreement in a rather positive manner, and I think it was a very difficult agreement to reach, but it bal- anced the interests of Mexico and their creditor banks in a way which I think one wouldn't expect to come off that way. The way I would look at it is as a major element to support Mexican growth, and the most successful way to bring debt down as a burden on one's economy is really economic growth. And I Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 87 think that this will enhance the capability of the Mexican Govern- ment in so doing, and my view is that if things continue as they appear to be moving that within a reasonable period of time the Mexican Government and certainly the private sector will be fi- nancing in the so-called voluntary markets, and in fact there is al- ready some indication that private institutions will be able to fi- nance at some reasonable interest rates. So I'm somewhat pleased by this process and think that consider- able success was achieved by striking that agreement. Senator SASSER. Mr. Chairman, Senator D'Amato referred a moment ago to the problem we have with the low savings rate here in the United States and this is something that has plagued us for a long time. The low savings rate, as you know, has gotten even worse in the decade of the 1990's. There are a lot of reasons, in my view, why we Americans save less than our counterparts in other countries. One reason I some- times think is the highly developed marketing techniques that we have here in the United States and the explosion in the use of credit cards. Another I think is the decline of real income in families. We see now that many times it takes two wage earners to sustain the standard of living that one wage earner did in the past, and in order to maintain their standard of living that they are accustomed to that they will go deeper and deeper into debt. But there are some tiny, little scintillas of hope on the horizon with regard to savings. Some commentators seem to think that there has been some indication in the last few months that the sav- ings rate might be improving. Have you detected this and, in your view, what could be occasioning it if you agree with the assess- ment? Are consumers retrenching for fear of a recession or have they satisfied their needs for consumption, or is it just simply the fact that real incomes are going up and now they have more to save? Chairman GREENSPAN. We don't know the answer to that yet, Mr. Chairman, but clearly the rise in the saving rate has been long overdue and it has been obviously one of the elements involved in the slowed retail sales markets, but it's difficult to know which is cause and which is effect. I think that if we can sustain these saving rates, which are higher than we would have forecast earlier in the year, I think it would be beneficial, and I think it clearly is something which will assist us in the long term if it can be maintained. Part of the softness in retail sales has occurred because the saving rate has been rising. If it merely stabilizes at this point and real incomes continue to rise, then consumption clearly will accel- erate some. So it doesn't necessarily follow that if retail sales pick up that the saving rate must go down. In fact, we can basically maintain a relatively higher savings than we have had and still have room for some pick up in expenditures. Senator SASSER. If real income would continue to go up, you could still have retail sales going up while at the same time the savings rate could go up if they have more real disposable income. Chairman GREENSPAN. Yes, that's correct, Mr. Chairman. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis Senator SASSEK. Senator Graham, do you have any further ques- tions? Senator GRAHAM. Thank you, Senator. I have two areas of inquiry. One is to follow up on the question that you asked relative to the Mexico debt agreement. Mr, Chairman, when we discussed the issue of Third World debt earlier this year, the question was asked what would be the criteria by which you would evaluate our management of the Third World issue, and you suggested three items in summary. One, that the economic policies of the debtor nation should bring them into a position to be able to move into markets on a long term or intermediate term borrowing at rates which they could readily service. Two, a restoration or normal borrowing/lending relationships be- tween the debtor nations and the international commercial bank- ing system. And, three, that debtor nations which had done better than others, but which had been contaminated by the process, and you gave the example of Columbia, would find that their productive ef- forts were fully appreciated in the marketplace. Applying these three criteria to the Mexican situation, how well would you say that the initial formulation of the plan will be, and what data or other objective indicators will you be looking for to see if the plan in operation fulfills these three criteria? Chairman GREENSPAN. Well, Senator, I think that the Mexicans have moved toward a sensible and potentially productive economic policy, and that in fact is one of the major reasons why the inter- national financial institutions, the banks, the Fund and the World Bank have been endeavoring to be as supportive as possible. I see no reason to expect that those policies, sensible policies, will not continue in the context of this agreement, especially with, the ability to reduce external financial requirements. If that occurs, as we have every reason to believe it will under this agreement, then I think that sound economic policies will then lead to meeting the second criterion, namely, the capability of moving into the finan- cial markets in a voluntary way and borrow at rates which are serviceable. Indeed, we already see some evidence that that may be in the process of occurring. Interest rates in Mexico in peso terms have fallen quite significantly since the agreement, and there has been for the first time in a very long time a private financing at an in- terest which was not intolerable as it would have been in dollars a while back. I think that process will continue. It's too early to make a judgment on the so-called contamination effect, but I hope at some point that we will see that also working in an effective manner, but it is much too early to make that sort of judgment at this date. Senator GRAHAM. Do you see any further activities by your agency or would you recommend such by other agencies, including to the Congress in the form of tax modifications or otherwise, that would be appropriate to reinforce the Brady plan? Chairman GREENSPAN. I think that has already been done in the sense that we have structured our policies in a manner which we believe are supportive of the Brady plan. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis INTEREST RATES AND PARITY BETWEEN ECONOMIC PARTNERS Senator GRAHAM. Mr. Chairman, I have one final area of in- quiry, and that is the question of interest rates and parity between the United States and our major economic partners, specifically Japan. Over the last 5 years the differential in interest rates between the United States and Japan has been in a range of 3 to 6 percent. Today we are at the lower end of that interest rate differential. What has sustained the interest rate difference between the United States and Japan, and what, if any, United States policy initiatives could we take in order to achieve a closer and sustained basis of parity in interest rates? Chairman GREENSPAN. The major reason why the Japanese in- terest rates have been lower than ours is that their saving propen- sities are so much higher than ours. Over the last decade or so the cost of capital in Japan in real terms has been markedly lower than it has been here where infla- tion instabilities and concerns about the economy generally have induced a risk premium in the cost of capital in the United States which put us substantially above the Japanese, and that reflects itself in nominal interest rates, mainly on the long end of the market. And until there is a substantial alteration in that process, it is very difficult to conceive of a joining of the two rates. Not only do the real rates have to converge, but clearly the inflation rates have to as well because while the real rate differential exists and is a major factor in the spread, the fact that the inflation rate in Japan in recent years has been markedly below ours reflects itself in a higher inflation premium in our long-term rates relative to yen-de- nominated rates. So there are really two factors which are required to bring us into equality. One is the real rates and the other is the inflation rates, and both require that our saving rates converge or at least come much closer together. So I would think that the issue of inducing saving is perhaps over the long run the major element which would bring the nomi- nal interest rates into long-term parity. Senator GRAHAM. Mr. Chairman, I believe I understood in re- sponse to a question by Senator Heinz that on behalf of the Board and the administration that there is a study underway on the issue of what policy initiatives might be taken to encourage increased savings rates in this country. Chairman GREENSPAN. Yes. There is no formal procedure that has yet been initiated, but we are all independently looking at the process in full recognition that that will become a major item on the agenda for economic policy for this country in the years ahead. Senator GRAHAM. Well, I applaud and encourage your efforts in that regard and will look forward to your recommendations. Chairman GREENSPAN. Thank you. Senator GRAHAM. Thank you, Mr. Chairman. Senator SASSER. Thank you, Senator Graham. Mr. Chairman, one final question, and then we'll conclude these hearings and let you get on with your lunch somewhere. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 90 It has been interesting to note how phrases develop over time in economics, and we've got a new phrase now called soft landing. The question I've got is what is a so-called soft landing? We noted the other day that the president of the Cleveland Fed- eral Reserve Bank was quoted as saying that the goal of the Fed is not a soft landing. He says that the objective of the Federal Re- serve Board is price stability, and of course we have seen in other times that when we get into price stability we may have a deflation in some areas of the economy. Tell this committee this morning what you would characterize as a soft landing. Chairman GREENSPAN. Well, first, Mr. Chairman, let me reiter- ate what the basic objective of monetary policy is. As I stipulated in my formal remarks and earlier to this commit- tee, we view economic policy generally and monetary policy very specifically to be focused on maintaining long-term sustainable eco- nomic growth. A necessary condition to achieve that is a non-infla- tionary environment. So over the long term we view the zero inflation notion or the noninflationary environment as a necessary condition to make sure the economy grows at its maximum possible rate. A soft landing is a term which has emerged which essentially tries to define an economic condition in which unstable inflation- ary pressures are contained without simultaneously throwing the economy into a recession. Historically when we have speculative imbalances and inflation- ary pressures, any endeavor to contain them has led to a dramatic backing up of inventories, a slowing of the economy and a reces- sion. That is now termed a hard landing. A soft landing is one in which the inflationary instability con- tainment is made without the economy going into a severe contrac- tion. Senator SASSER. I suppose we could characterize the downturn of 1982 as a crash landing if we were assigning degrees of severity. That was the worse recession. Chairman GREENSPAN. It was not a soft landing. Senator SASSEK. Not a soft landing. [Laughter.] Well, on that note, Mr. Chairman, I want to express my appre- ciation to you this morning for appearing before the committee. It has been a pleasure to see you again and a pleasure to have you here. Chairman GREENSPAN. Thank you very much, Mr. Chairman, Senator SASSER. This committee is adjourned. [Whereupon, at 12:07 p.m., the committee adjourned, subject to the call of the Chair.] Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Alan Greenspan (1989, July 31). Congressional Testimony. Testimony, Federal Reserve. https://whenthefedspeaks.com/doc/testimony_19890801_chair_federal_reserves_second_monetary_policy

@misc{wtfs_testimony_19890801_chair_federal_reserves_second_monetary_policy,
  author = {Alan Greenspan},
  title = {Congressional Testimony},
  year = {1989},
  month = {Jul},
  howpublished = {Testimony, Federal Reserve},
  url = {https://whenthefedspeaks.com/doc/testimony_19890801_chair_federal_reserves_second_monetary_policy},
  note = {Retrieved via When the Fed Speaks corpus}
}