Congressional Testimony

CONDUCT OF MONETARY POLICY Report of the Federal Reserve Board pursuant to the Full Employment and Balanced Growth Act of 1978, P.L. 95-523 and The State of the Economy HEARING BEFORE THE SUBCOMMITTEE ON ECONOMIC GROWTH AND CREDIT FORMATION OF THE COMMITTEE ON BANKING, FINANCE AND URBAN AFFAIRS HOUSE OF REPRESENTATIVES ONE HUNDRED THIRD CONGRESS FIRST SESSION JULY 20, 1993 Printed for the use of the Committee on Banking, Finance and Urban Affairs Serial No. 103-55 U.S. GOVERNMENT PRINTING OFFICE 70-449^ WASHINGTON I 1993 For sale by the U.S. Government Printing Office Superintendent of Documents, Congressional Sales Office, Washington, DC 20402 ISBN 0-16-043353-3 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis HOUSE COMMITTEE ON BANKING, FINANCE AND URBAN AFFAIRS HENRY B. GONZALEZ, Texas, Chairman STEPHEN L. NEAL, North Carolina JAMES A. LEACH, Iowa JOHN J. LAFALCE, New York BILL McCOLLUM, Florida BRUCE F. VENTO, Minnesota MARGE ROUKEMA, New Jersey CHARLES E. SCHUMER, New York DOUG BEREUTER, Nebraska BARNEY FRANK, Massachusetts THOMAS J. RIDGE, Pennsylvania PAUL E. KANJORSKI, Pennsylvania TOBY ROTH, Wisconsin JOSEPH P. KENNEDY II, Massachusetts ALFRED A. (AL) McCANDLESS, California FLOYD H. FLAKE, New York RICHARD H. BAKER, Louisiana KWEISI MFUME, Maryland JIM NUSSLE, Iowa MAXINE WATERS, California CRAIG THOMAS, Wyoming LARRY LAROCCO, Idaho SAM JOHNSON, Texas BILL ORTON, Utah DEBORAH PRYCE, Ohio JIM BACCHUS, Florida JOHN LINDER, Georgia HERBERT C. KLEIN, New Jersey JOE KNOLLENBERG, Michigan CAROLYN B. MALONEY, New York RICK LAZIO, New York PETER DEUTSCH, Florida ROD GRAMS, Minnesota LUIS V. GUTIERREZ, Illinois SPENCER BACKUS, Alabama BOBBY L. RUSH, Illinois MIKE HUFFINGTON, California LUCILLE ROYBAL-ALLARD, California MICHAEL CASTLE, Delaware THOMAS M. BARRETT, Wisconsin PETER KING, New York ELIZABETH FURSE, Oregon NYDIA M. VELAZQUEZ, New York BERNARD SANDERS, Vermont ALBERT R. WYNN, Maryland CLEO FIELDS, Louisiana MELVIN WATT, North Carolina MAURICE HINCHEY, New York CALVIN M. DOOLEY, California RON KLINK, Pennsylvania ERIC FINGERHUT, Ohio SUBCOMMITTEE ON ECONOMIC GROWTH AND CREDIT FORMATION PAUL E. KANJORSKI, Pennsylvania, Chairman STEPHEN L. NEAL, North Carolina THOMAS J. RIDGE, Pennsylvania JOHN J. LAFALCE, New York BILL McCOLLUM, Florida BILL ORTON, Utah TOBY ROTH, Wisconsin HERBERT C. KLEIN, New Jersey JIM NUSSLE, Iowa NYDIA M. VELAZQUEZ, New York MARGE ROUKEMA, New Jersey CALVIN M. DOOLEY, California PETER KING, New York RON KLINK, Pennsylvania ERIC FINGERHUT, Ohio Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis CONTENTS Hearing held on: July 20, 1993 1 Appendix: July 20, 1993 WITNESSES TUESDAY, JULY 20, 1993 Greenspan, Alan, Chairman, Board of Governors of the Federal Reserve System APPENDIX Prepared statements: Kanjorski, Hon. Paul E 42 Greenspan, Alan 45 ADDITIONAL MATERIAL SUBMITTED FOR THE RECORD Board of Governors of the Federal Reserve System, "Monetary Policy Report to the Congress Pursuant to the Full Employment and Balanced Growth Act of 1978" 62 (m) Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis THE CONDUCT OF MONETARY POLICY TUESDAY, JULY 20, 1993 HOUSE OF REPRESENTATIVES, SUBCOMMITTEE ON ECONOMIC GROWTH AND CREDIT FORMATION, COMMITTEE ON BANKING, FINANCE AND URBAN AFFAIRS, Washington, DC. The subcommittee met, pursuant to notice, at 10:05 a.m., in room 2128, Rayburn House Office Building, Hon. Paul E. Kanjorski [chairman of the subcommittee] presiding. Present: Chairman Kanjorski, Representatives Neal, LaFalce, Orton, Klein, Velazquez, Dooley, Fingerhut, McCollum, Roth, Nussle, and Roukema. Also present: Representatives Charles E. Schumer and Joe Knol- lenberg. Chairman KANJORSKI. The subcommittee will come to order. We meet today to receive the semiannual report of the Federal Reserve on the economy and monetary policy, mandated by the Full Employment Balanced Growth Act of 1978. Much of the eco- nomic news of the last 6 months has been relatively good, and en- couraging. Inflation remains low, as we saw in May, one-tenth of 1 percent. The interest rate remains low, a 30-year low on the Treasury rate at 6.5 percent, thus freeing up billions of dollars for payment of pri- vate debt and for reorganization of businesses and other such en- couraging areas of our economy. We have had a refinancing pace second to none in the Nation's history, and a great deal of it not going to consumption, but to pay off debt and to put our financial houses in order. As we view the banking profits and the thrift plans for the S&L cleanup, we notice that the end is in sight. The BIF fund is in the black for the first time since 1985, and by those successes, we are certainly encouraged. We anticipate, howev- er, that there are problems that still remain. Some of those prob- lems, of course, unemployment remains relatively stuck at 7 per- cent. We have certainly a stagnant commercial industrial lending program of $600 billion going on. This subcommittee has held hearings in western Pennsylvania and Ohio and in eastern Pennsylvania, and one of the strong cur- rents of those hearings is that the credit crunch still remains, and it is strangling small- and medium-sized businesses. To that end, we look forward to hearing from the Chairman as to what plans the Federal Reserve has for that. (1) Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis We have, since we have last met, introduced legislation, H.R. 2600, the Secondary Market bill introduced on July 1, and we plan hearings in September. The Secondary Market bill, of course, is an attempt to bring Fannie Mae or Freddie Mac to business loans, community development loans, and free up the needed capital to provide the money necessary for the Clinton system laws programs of the next decade. With all that comes from massive rains in the Middle West of the country and the floods that we have all witnessed over the last several weeks with some farms and with great sympathy, we hope that this will not materially destroy the economic conditions of the Middle West and we trust that the Federal Government will come to the rescue with sufficient funds to stimulate the farm economy and the business economy of that section of the country. Our hearts go out to the people in the flood zone of the United States because I myself have had experience with the Agnes flood in 1972. The district I represent suffered over $2 billion damage during that flood. And that would be equivalent today of one dis- trict suffering about $6 billion in economic damage, which was hor- rendous and took us more than 15 years to recover from. Whatever this Congress can do, and I am sure whatever the President can do, and we hope the Federal Reserve will help to bring the flood conditions as back to—area as back to normal as possible. We look forward to hearing from Chairman Greenspan today as to whether or not the inflationary fears that have been experienced and commented on in our last hearing are less important in the Federal Reserve mind, and that the concentration may be had on assisting in removal of the credit crunch. We think that certainly the activities of the Federal Reserve have been remarkably successful in keeping down inflation. We hope they haven't been too successful. We hope that the activities of the Open Market Committee and their concern with inflation will not go to the extent of impinging the economic expansion the country needs. We hope to hear from the Chairman today as to what the future course and recommendations of that committee will be and how they can cooperate with the Congress, with the President, in bring- ing about a reasonable recovery to the American economy. And with that, I welcome the Chairman, and in addition, we have with us several additional members of the Banking Commit- tee. First of all, I should recognize Mr. Ridge, who is still on an air- plane at this time, but will be here shortly, we understand. For an opening statement, if I may, have Mr. Roth. [The prepared statement of Mr. Kanjorski can be found in the appendix.] Mr. ROTH. Thank you, Mr. Chairman. Mr. Chairman, I have an opening statement, but in the interest of time, I would ask that my statement be introduced into the record so that we could get to the Chairman's testimony and then have more time for questions. Chairman KANJORSKI. Without objection, so ordered. Mr. ROTH. I appreciate your positive review of the economy this morning, Mr. Chairman. I would just say that among the key Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis issues facing us here on Capitol Hill are the largest tax increase in history and taxing Social Security, the middle class, and small busi- ness. I hope we could get some illumination on some of these issues this morning, Mr. Chairman. Chairman KANJORSKI. Thank you very much, Mr. Roth. The ranking Member present today and chairman of the Small Business Committee, Mr. LaFalce. Mr. LAFALCE. I am anxious to hear Chairman Greenspan so I will not have any opening statements. Thank you. Chairman KANJORSKI. The gentlelady from New Jersey. Mrs. ROUKEMA. Well, what can I say, Mr. Chairman? I did not have a formal statement, but I will observe that a lot has happened and yet nothing has happened since the Chairman was here in Feb- ruary. It will be—I will observe that much of what you predicted in February has come to pass, but I am looking forward to hearing your evaluation and assessment regarding the Reconciliation Pro- gram, the budget and tax proposal as it is presently before Con- gress, and other indications of economic recovery. Certainly, some- body has been successful at keeping inflation low, and we appreci- ate that. We are ready to hear your testimony, Mr. Chairman. Thank you. Chairman KANJORSKI. Thank you. The gentleman from Utah, Mr. Orton. Mr. ORTON. Thank you. I will follow the trend of everyone else and yield any time I have back for the Chairman's testimony. Chairman KANJORSKI. Thank you very much, Mr. Orton. And the gentleman from New Jersey, Mr. Klein. Mr. KLEIN. Yes, thank you, Mr. Chairman. I too am most anx- ious to hear what the Chairman has to say and I will therefore re- frain from my opening remarks. Chairman KANJORSKI. Thank you very much, Mr. Klein. The gentlelady from New York, Ms. Velazquez. Ms. VELAZQUEZ. Thank you, Mr. Chairman, and welcome to Chairman Greenspan. As we meet today, we see and hear signs of the low but contin- ued economic recovery. However, some of the data coming to us in- dicates that although we see recovery and job creation, employ- ment in some of the areas hardest hit by the recession such as New York State have not yet reached prerecession levels. I cannot help but wonder whether we will ever reach those levels again. Did we as a region fully recover in terms of job growth or did the recession leave us with a permanent shrinkage of the job base in certain regions? These are difficult questions, but impor- tant ones which I hope your words today may shed some light on. I look forward to your testimony. Thank you, Mr. Chairman. Chairman KANJORSKI. I thank the lady from New York. The gentleman from California, Mr. Dooley. Mr. DOOLEY. I have no statement, Mr. Chairman. Thank you. Chairman KANJORSKI. One additional member of the subcommit- tee has just arrived, Mr. McCollum from Florida. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis Mr. McCoLLUM. I just want to welcome Chairman Greenspan, look forward to these hearings with you. We look forward to what you have to say. Chairman KANJORSKI. And we have the gentleman from Michi- gan, Mr. Knollenberg. Mr. KNOLLENBERG. Mr. Chairman, thank you very much, and welcome, Mr. Greenspan. The only point I will make is the one I have been making for quite some time—and the evidence continues to be, I think, somewhat dramatic to me—that our economy really is somewhat weak, even though we had a glowing report here. And the thing I point to is the fact that early in the year, the Fed forecast that the GDP growth was estimated to be somewhere in the neighborhood of 3 and 3.75 percent. I notice by the figures that have been released here very recently that for the first quar- ter of 1993, that we are sitting at 0.7 percent. That concerns me. That doesn't show growth. In fact, it indicates there may be a warning that this massive tax increase that Congress proposed may be enough to drown us. We are getting drowned in some other areas, but this is perhaps a fi- nancial drowning. I don't want us to repeat the mistakes that were made in 1990 with the tax increase, and I think that raising taxes will further slow the economy, destroy the job situation, make things difficult. So those are my concerns and I look forward as well to your tes- timony. Thank you. Thank you, Mr. Chairman. Chairman KANJORSKI. Thank you. And now I believe we have heard from everyone on the subcommittee, with a great deal of speed, if you'll note, Mr. Chairman, less than 9 minutes. And now we are looking forward to hearing from the Federal Reserve. Mr. Greenspan. STATEMENT OF ALAN GREENSPAN, CHAIRMAN, BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM Mr. GREENSPAN. Thank you very much, Mr. Chairman. I request that the full record of my remarks be included and I will excerpt from them. Chairman KANJORSKI. Without objection, so ordered. Mr. GREENSPAN. It is always a pleasure to appear before this sub- committee to discuss the Federal Reserve's semiannual monetary policy report. My remarks this morning will cover the current monetary policy and economic settings, as well as the Federal Re- serve's longer term strategy for contributing, to the best of our abilities, to the Nation's economic well-being. As the economic expansion has progressed somewhat fitfully, our earlier characterization of the economy as facing stiff headwinds has appeared increasingly appropriate. Doubtless, the major head- wind in this regard has been the combined efforts of households, businesses, and financial institutions to repair and to rebuild their balance sheets following the damage inflicted in recent years as weakening asset values exposed excessive debt burdens. But there have been other headwinds as well. The builddown of national defense has cast a shadow over particular industries and Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis regions of the country. Spending on nonresidential real estate dropped dramatically in the face of overbuilding and high vacancy rates, and has remained in the doldrums. At the same time, corpo- rations across a wide range of industries have been making efforts to pare employment and expenses in order to improve productivity and their competitive positions. In the past several years, as these influences have restrained the economy, they have been balanced in part by the accommodative stance of monetary policy and, more recently, by declines in longer term interest rates as the prospects for credible Federal deficit cuts improved. From the time monetary policy began to move toward ease in 1989 to now, short-term interest rates have dropped by more than two-thirds and long-term rates have declined substan- tially, too. All along the maturity spectrum, interest rates have come down to their lowest levels in 20 or 30 years, aiding the repair of balance sheets, bolstering the cash-flow of borrowers, and providing support for interest sensitive spending. The process of easing monetary policy, however, had to be closely controlled and generally gradual, because of the constraint imposed by the marketplace's acute sensitivity to inflation. As I pointed out in my February testimony to the Congress, this is a constraint that did not exist in an earlier time. Monetary policy in recent years has had to remain alert to the possibility that an ill-timed easing could be undone by a flareup of inflation expectations, pushing long-term interest rates higher, and short-circuiting essential bal- ance sheet repair. The cumulative monetary easing over the last 4 years has been very substantial. Since last September, however, no further steps have been taken, as the stance of policy has appeared broadly ap- propriate to the evolving economic circumstances. That stance has been quite accommodative, especially judging by the level of real short-term interest rates in the context of, on aver- age, moderate economic growth. Short-term real interest rates have been in the neighborhood of zero over the last three-quarters. In maintaining this accommodative stance, we have been persuaded by the evidence of persistent slack in labor and product markets, increasing international competitiveness, and the decided absence of excessive credit and monetary expansion. The forces that engen- dered past inflationary episodes appear to have been lacking to date. Yet, some of the readings on inflation earlier this year were dis- turbing. It appeared that prices might be accelerating despite prod- uct market slack and an unemployment rate noticeably above esti- mates of the so-called natural rate of unemployment—that is, the rate at which price pressures remain roughly constant. In the past, the existing degree of slack in the economy had been consistent with continuing disinflation. However, the inflation outcome, history tells us, depends not only on the amount of slack remaining in labor and product mar- kets, but on other factors as well, including the rate at which that slack is changing. Near the end of last year, about the time many firms probably were finalizing their plans for 1993, sales and capac- ity utilization were moving up markedly and there was a surge of optimism about future economic activity. This may well have set in Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis motion a wave of price increases, which showed through to broad measures of prices earlier this year. Moreover, inflation expectations, at least by some measures, appear to have tilted upward this year, possibly contributing to price pressures. The University of Michigan survey of consumer at- titudes, for example, reported an increase in the inflation rate ex- pected to prevail over the next 12 months from about 3% percent in the fourth quarter of last year, to nearly 4% percent in the second quarter. Preliminary data imply some easing of such expec- tations earlier this month, but the sample from which those data are derived is too small to be persuasive. Moreover, the price of gold, which can be broadly reflective of inflationary expectations, has risen sharply in recent months. And at times this spring, bond yields spiked higher when incoming news about inflation was most discouraging. The role of expectations in the inflation process is crucial. Even expectations not validated by economic fundamentals can them- selves add appreciably to wage and price pressures for a consider- able period. The Federal Open Market Committee became concerned that in- flation expectations and price pressures, unless contained, could raise long-term interest rates and stall economic expansion. Conse- quently, at its meeting in May, while affirming the more accommo- dative policy stance in place since last September, the FOMC also deemed it appropriate to initiate a so-called asymmetric directive. Such a directive, with its bias in the direction of a possible firming of policy over the intermeeting period, does not prejudge that action will be taken—and indeed none occurred. But it did indicate that further signs of a potential deterioration of the inflation out- look would merit serious consideration of whether short-term rates needed to be raised slightly from their relatively low levels to ensure that financial conditions remained conducive to sustained growth. Certainly, the May and June price figures have helped assuage concerns that new inflationary pressures had taken hold. Nonethe- less, on balance, the news on inflation this year must be character- ized as disappointing. In assessing the stance of monetary policy and the likelihood of persistent inflationary pressures, the FOMC took account of the downshift in the pace of economic expansion earlier this year. While a slowdown from the unsustainably rapid growth in the latter part of last year had been anticipated, the deceleration was greater than expected. Smoothing through the quarterly pattern, however, the economy appears to have accelerated gradually over the past 2 years, to maintain a pace of growth that should yield further reductions in the unemployment rate. Consequently, the evidence remains consistent with our diagnosis that the underlying forces at work are keeping the economy gener- ally on a moderate upward track. However, as I have often empha- sized, not all the old economic and financial verities have held in the current expansion, and changes in fiscal policy will have uncer- tain effects going forward. Thus caution in assessing the path for the economy remains appropriate. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis Financial conditions have improved considerably, lessening the need for balance sheet restructuring that has been damping eco- nomic activity for several years now. By no means is the process over, but good progress has obviously been made. On the other hand, the economies of a number of our major trading partners have been quite weak, constraining the growth of the demand for our exports. Although expectations of a significant, credible decline in the budget deficit have induced lower long-term interest rates and fa- vorably affected the economy, the positive influence thus far is ap- parently being at least partly offset by some business spending re- ductions as a consequence of concerns about the effects of pending tax increases. It seems that the prospective cuts in the deficit are having a va- riety of substantial economic effects, well in advance of any actual change in taxes or in projected outlays. Moreover, uncertainty about the final shape of the package may itself be injecting a note of caution into private spending plans. To be sure, the conventional wisdom is that budget deficit reduc- tions restrain economic growth for a time, and I suspect that that probably is correct. However, over the long run, such wisdom points in the opposite direction. In fact, one can infer that the recent declines in long-term interest rates are bringing forward some of these anticipated long-term gains. As a consequence, the timing and magnitude of any net restraint from deficit reduction is uncertain. Patently, the overall economic effect of fiscal policy, especially when combined with the uncertain- ties of the forthcoming health reform package, has imparted a number of unconventional unknowns to the economic outlook. Assuming, however, we constructively resolve over time the major questions about Federal budget and health care policies, with the further waning of earlier restraints on growth, the U.S. economy should eventually emerge healthier and more vibrant than in decades. Over the last 2 years, the forces of restraint on the economy have changed, but real growth has continued, with one sector of the economy after another taking the lead. Against this background, Federal Reserve Board of Governors and Reserve bank presidents project that the U.S. economy will remain on the moderate growth path it has been following as the expansion has progressed, and in- flation will come in at or just above 3 percent this year and next. In addition to focusing on the outlook for the economy at its July meeting, the FOMC, as required by the Humphrey-Hawkins Act, set ranges for the growth of money and debt for this year and, on a preliminary basis, for 1994. One premise of the discussion of the ranges was that the uncharacteristically slow growth of the broad monetary aggregates in the last couple of years—and the atypical increases in their velocities—would persist for a while longer. To an important degree, the behavior of M2 has reflected structural changes in the financial sector. Depository credit has been weak, necessitating little bidding for deposits. And depositors, in any case, have been drawn to the higher returns on capital market instru- ments, including bond and stock mutual funds. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis In this context, the FOMC lowered the 1993 ranges for M2 and M3—to 1 to 5 percent and zero to 4 percent, respectively. This rep- resents a reduction of 1 percentage point in the M2 range and one- half percentage point for M3. Even with these reductions, we would not be surprised to see the monetary aggregates finish the year near the lower ends of their ranges. As I emphasized in a similar context in February, the lowering of the ranges is purely a technical matter. It does not indicate, nor should it be perceived as, a shift of monetary policy in the direction of restraint. In reading the longer run intentions of the FOMC, the specific ranges need to be interpreted cautiously. The historical relation- ships between money and income, and between money and the price level, have largely broken down, depriving the aggregates of much of their usefulness as guides to policy. At least for the time being, M2 has been downgraded as a reliable indicator of financial conditions in the economy, and no single variable has yet been identified to take its place. In these circumstances, it is especially prudent to focus on longer term policy guides. One important guidepost is real interest rates, which have a key bearing on longer run spending decisions and in- flation prospects. In assessing real rates, the central issue is their relationship to an equilibrium interest rate, specifically, the real rate level that, if maintained, would keep the economy at its production potential over time. Rates persisting above that level, history tells us, tend to be associated with slack, disinflation, and economic stagnation— below that level with eventual resource bottlenecks and rising in- flation, which ultimately engenders economic contraction. Main- taining the real rate around its equilibrium level should have a stabilizing effect on the economy, directing production toward its long-term potential. The level of the equilibrium real rate—or more appropriately the equilibrium term structure of real rates—cannot be estimated with great confidence, though with enough to be useful for monetary policy. Real rates, of course, are not directly observable, but must be inferred from nominal interest rates and estimates of inflation expectations. The most important real rates for private spending decisions almost surely are the longer maturities. Moreover, the equilibrium rate structure responds to the ebb and flow of underly- ing forces affecting spending. So, for example, in recent years, the appropriate real rate structure doubtless has been depressed by the headwinds of balance sheet restructuring and fiscal retrenchment. Despite the uncertainties about the levels of equilibrium and actual real rates, rough judgments about these variables can be made and used in conjunction with other indicators in the mone- tary policy process. Currently, short-term real rates, most directly affected by the Federal Reserve, are not far from zero; long-term rates, set primarily by the market, are appreciably higher, judging from the steep slope of the yield curve and reasonable suppositions about inflation expectations. This configuration indicates that market participants anticipate that short-term real rates will have to rise as the headwinds diminish, if substantial inflationary imbal- ances are to be avoided. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis While the guides we have for policy may have changed recently, our goals have not. As I have indicated many times to this subcom- mittee, the Federal Reserve seeks to foster maximum sustainable economic growth and rising standards of living. And in that en- deavor, the most productive function the central bank can perform is to achieve and maintain price stability. Inflation is counterproductive in many ways. Of particular im- portance, increased inflation has been found to be associated with reduced growth of productivity, apparently in part because it con- founds relative price movements and obscures price signals. Com- pounding this negative effect, under the current Tax Code, infla- tion raises the effective taxation of savings and investment, dis- couraging the process of capital formation. Since productivity growth is the only source of lasting increases in real incomes and because even small changes in growth rates of productivity can ac- cumulate over time to large differences in living standards, its as- sociation with inflation is of key importance to policymakers. The link between the control of inflation and the growth of pro- ductivity underscores the importance of providing a stable back- drop for the economy. Such an environment is especially important for an increasingly dynamic market economy, such as ours, where technology and telecommunications are making rapid advances. New firms, new products, new jobs, new industries, and new mar- kets are continually being created, and they are unceremoniously displacing older ones. The U.S. economy is a dynamic system, always renewing itself. Central planning of the type that prevailed in postwar Eastern Europe and the Soviet Union represented one attempt to fashion an economic system that eliminated this com- petitive churning and its presumed wastefulness. But when that system eliminated the risk of failure, it also stifled the incentive to innovate and to prosper. Risk taking is crucial in the process that leads to a vital and pro- gressive economy. Indeed, it is a necessary condition for wealth cre- ation. In a market economy, competition and innovation interact; those firms that are slow to innovate or to anticipate the demands of the consumer are soon left behind. The pace of churning differs by industry, but it is present in all. At one extreme, firms in the most high-tech areas must remain constantly on the cutting edge, as products and knowledge become rapidly obsolete. Many products that were at technology's leading edge, say 5 years ago, are virtual- ly unsalable in today's markets. In high-tech fields, leadership can shift rapidly. In some markets where American firms were losing share just a few years ago, we have regained considerable domi- nance. More generally, it appears that the pace of dynamism has been accelerating. The possibility of failure has productive side effects, encouraging economic agents to do their best to succeed. But there are nonproductive and unnecessary risks as well. There is no way to avoid risk altogether, given the inherently uncertain outcomes of all business and household decisions. But many uncertainties and risks do not foster economic progress, and where feasible should be suppressed. A crucial risk in this category is that in- duced by inflation. To allow a market economy to attain its poten- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 10 tial, the unnecessary instability engendered by inflation must be quieted. A monetary policy that aims at price stability permits low long- term interest rates and helps provide a stable setting to foster the investment and innovation by the private sector that are key to longrun economic growth. Clearly, the behavior of many of the forces acting on the econo- my over the course of the last business cycle have been different from what had gone before. The sensitivity of inflation expecta- tions has been heightened, and, as recent evidence suggests, busi- ness and households may be becoming more forward-looking with respect to fiscal policies as well. Mr. Chairman, I believe we are on our way toward reestablishing the trust in the purchasing power of the dollar that is crucial to maximizing and fulfilling the productive capacity of this Nation. The public, however, clearly remains to be convinced. Survey re- sponses and financial market prices embody expectations that the current lower level of inflation not only will not be bettered, it will not even persist. But there are glimmers of hope that trust is ree- merging. For example, issuers have found receptive markets in recent months for 50-year bonds. This had not happened in dec- ades. The reopening of that market may be read as one indication that some investors once again believe that inflationary pressures will remain subdued. It is my firm belief that, with fiscal consolidation and with the monetary policy path that we have charted, the United States is well positioned to remain at the forefront of the world economy well into the next century. Thank you, Mr. Chairman. I am available to answer whatever questions you would like to proffer. [The prepared statement of Mr. Greenspan can be found in the appendix.] Chairman KANJORSKI. Thank you very much, Mr. Chairman. The questions for those members present will first be in the order of seniority of the subcommittee, and then at the end of the subcom- mittee's questioning, any nonsubcommittee members or members of the full committee. Mr. Chairman, I take it that at the Federal Reserve, you sought full commitment to address the question of long-term inflation rates. And that certainly is an admirable course. But the impact this might have on that success or failure will be reflective here, what happens in Congress before the August recess. We will be facing an important vote on the Deficit Reduction bill. And my question to you would be, one, is it important that the Deficit Reduction bill pass? And what will the consequences for the economy be if it does not? Mr. GREENSPAN. Mr. Chairman, I think it is important that some major, credible Deficit Reduction bill be passed, because I believe that, as I indicated in my prepared testimony, there is an expecta- tion in the market that a credible initiative will eventually emerge from the process which has been going on for the last 6 months or so. I fear, should that expectation be thwarted, that the markets would respond in a negative fashion. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 11 Chairman KANJORSKI. Do you have an opinion of just how nega- tive this will be, Mr. Chairman? Mr. GREENSPAN. It is extraordinarily difficult to tell. But remem- ber that when we moved into this period of inflation concerns sev- eral years ago, the major problem that confronted the markets was the growing awareness that after defense expenditure reductions came to an end in the latter part of the 1990's, the underlying thrust of expenditures and revenues would create a deficit which was growing as a percent of the Gross Domestic Product, and that results in fundamentally an unstable financial condition as we get to the turn of the century. As a consequence, what we observed was an extraordinary infla- tion premium embodied in longer term interest rates and indeed, as you may remember, we got to a very extraordinary slope in the so-called term structure of interest rates, where despite the fact that short-term interest rates were coming down, long-term inter- est rates, even though they did come down, remained stubbornly high. The market's belief that something of a credible nature would emerge out of the debates that have been going on is what has tilted long-term rates down in the last several months. And that expectation, is clearly related to a credible budget deficit reduction outcome of this whole process. Chairman KANJORSKI. Well, there are forces in the conference, some of the issues in the conference—and I am going to direct myself one further question—that indicate that a reduction of $400 billion as opposed to $500 billion over 5 years is just as acceptable. Do you have an opinion on that? Mr. GREENSPAN. Yes. I think not. The problem that we have is a very substantial one. Even the legislative initiatives which have been put on the table from both sides of the aisle in this debate do not complete the requirement of removing that upward bias in the deficit toward the end of the century. I realize, of course, that health care reform is an obvious major issue in this. But it is also clear that we are going to have to take another shot at the deficit. In other words, we need more than one tranche in budget deficit reduction to get it flattened out. If the markets perceive that we are backing off the size of the commit- ment in this first tranche, I think that they will react appropriate- ly negatively. The role of the Congress and the administration to finally bring the process to success, requires a fairly large commit- ment, indeed something not very different from what is contem- plated in the current variety of bills. And my view is that—even though I have not commented and will not comment on the details of the particular program—that the $500 billion program is probably about the right size for the first tranche of what I view as a two-tranche or maybe a multi- tranche endeavor to finally bring this budget problem under con- trol. Chairman KANJORSKI. I want to comment on your answer, be- cause I agree with you, Mr. Greenspan. And I think that it is es- sential that the Congress and the administration show the nerve to the American people to take this necessary first hit. And what most Americans don't seem to understand, I learn from my town Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 12 meetings, is that they think we are reducing the debt, as opposed to the deficit. After all the pain and anguish that we seem to be going through here in town, when it is all said and done, the debt is still going to be $1 trillion higher after this administration than it is right now. We are actually trying to reduce the increase in the debt by a half a trillion dollars. This is a hard-sell issue out there. The American people don't seem to understand that. But as I understand your last answer, once we get the first half trillion in, that the Congress and the President, after a period of* time allowing for the economy to further stabilize, will have to go back to contribute more to deficit reduction in order to turn down the increasing rate of the deficit. Mr. GREENSPAN. Yes, sir. Chairman KANJORSKI. And do you think that the President's timing, in terms of reduction per period of time to control the defi- cit, is about right, or would you progress at a faster speed? Some of our colleagues, particularly on the other side, have been struck with the idea that we can contain the deficit overnight and it can be done magically, we can cut it right out. Mr. GREENSPAN. I can't comment on other people's characteriza- tion, but I can indicate to you that whereas we may have had some time slack several years ago to come to grips with it, as I indicated in February to this subcommittee, I think time is running out. It is a very long-term project. It is not something which is going to be completed overnight, but unless we come to grips with it fairly quickly, I don't see how we are going to get it done in a manner which will reach successful conclusion without ultimate disruption to economic processes. Chairman KANJORSKI. And in discussions that we have had, not on the public record, I seemed to gain the impression that your feeling is that the best we can do is show the way toward deficit reduction, and that will reduce the long-term interest rates in such a manner that it would infuse a great deal of capital into our system to allow for the economic growth and productivity that you talked about in your testimony; is that correct? Mr. GREENSPAN. Yes, indeed. I would say that while obviously there are other factors involved in the recent declines in long-term interest rates, in my judgment, the issue of expected credible defi- cit reduction at the end of this process is the major factor which is inducing the decline in rates and is a major factor in the support of economic activity which, although quite subdued in the first quar- ter, is clearly accelerated in the second quarter. The outlook is one which seems moderately favorable and I would attribute the de- cline in long-term interest rates as a major factor in that process. Chairman KANJORSKI. Thank you very much, Mr. Chairman. I would now like to go to my colleague, Mr. McCollum of Florida. Mr. McCoLLUM. Thank you very much, Mr. Chairman. Chairman Greenspan, last February you predicted or the Federal Reserve predicted a Gross Domestic Product growth in the range of 3 to 3.75 percent for this year we are in now. And up to this point, it has been less than 1 percent. I noticed in your testimony today, you say that the Federal Re- serve predicts for the quarters from last—the end of 1992 fourth Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 13 quarter through the fourth quarter of 1993, an average growth in GDP of about 2.5 percent. Does that mean that you are looking at upward of 4 percent GDP growth rate the second half of this year to compensate for this very slow start, or what is it—what does it translate to? Mr. GREENSPAN. It is still too early to make a really firm esti- mate of the second quarter GDP. But it is clearly somewhat in excess of 2.5 percent growth. And depending on how the data for the month of June in certain key areas come down, there is a fairly large range of where the basic growth rate in the second quarter will have turned out. But we are clearly somewhere running about 3 percent, if one uses all the various measures we are trying to focus on. Now, that clearly is not something which I would consider to be adequate, but in the context of the balance sheet restraints that we still have and the difficulties of our export markets resulting from the weakness abroad, it is not a bad performance. Would we like to see better? Obviously, we would like to see better. Mr. McCoLLUM. Do you see better? I guess that was the question. In other words, you are saying the second quarter—the first quar- ter was less than 1 percent. You think the second quarter is closer to 3 percent, and therefore you are expecting it to stay at that level or higher for the balance of the year in order to get you that 2.5 percent average? Mr. GREENSPAN. Yes, well, roughly. I don't want to characterize the specific estimates for the second half, but remember that the first quarter was abnormally low for a number of short-term rea- sons. First of all, even though there has been a decline in defense expenditures programmed by the various authorizations and appro- priations of the Congress, there was a particular deceleration that occurred in the first quarter, which had a major impact on the GDP number. That, I might add, is stabilized in the second quarter. And, obviously, we had some extraordinary bad weather condi- tions in the first quarter. So in that sense, the first quarter was clearly far underrepresenting what basically has been the thrust of this recovery, which, while not very powerful, has been reasonably supportive of cumulative recovery. Mr. McCoLLUM. We have got some bad weather conditions right now that are going to have an impact on the GDP, aren't we, with the flooding in the Midwest and the drought in the East, and all of that in the agricultural community? Mr. GREENSPAN. We will have some, but not as great as those that occurred in the first quarter by a significant order of magni- tude. Mr. McCoLLUM. Let me ask you a different type of question rela- tive to your comments about the impact of the tax or anticipated tax increases on business and business decisions. I know in the past, on numerous occasions, you have stated your personal prefer- ence for reducing the spending side of the equation to tax increases in the deficit battle, although you have always emphasized your overall commitment to basic deficit reduction. Is this tax plan that now is being debated in the format that seems to be most likely to go ahead of having the tax increases up 70-449 - 94 - 2 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 14 front and any spending reductions out 3 or 4 years, is that going to have a significant impact on business in a negative way that would be better if we had the tax—I should say, spending cuts balanced up front? Would it not, in your opinion, be better if we could bal- ance them? Mr. GREENSPAN. Congressman, I am going to repeat what I said here 6 months ago when the original budget proposals were put on the table. As central bankers, our basic concern is getting the Fed- eral borrowing requirement down because of its destabilizing ef- fects on economic activity. I also said that I favored significant emphasis on the expenditure side for a very important statistical reason or numerical reason. Namely, that if you take a look at the current services spending trend, as we move into the latter part of the 1990's, the growth in expenditures is greater than the growth in the tax base or the Gross Domestic Product, in nominal dollars. And even though a significant part of that is in health care, the major principle involved is that unless that path of growth in out- lays is slowed down, there is no tax increase which will effectively reduce the long-term budget deficit problem. So my central point is that if you have to increase taxes to sup- port the ever-rising percentage increase in spending as a percent of the GDP, you ultimately cannot succeed because as tax rates or the tax base continuously rise to support that spending, the economy at some point will run into some difficulty. So irrespective of how one looks at this question, there is no al- ternative to slowing the rate of expenditure, bringing it back in line to the percentage increase in the tax base or nominal Gross Domestic Product. Mr. McCoLLUM. And may I assume then that it does concern you that the spending reductions and the slowing of that spending growth are delayed in what has been proposed up here by the Senate and the House this year? Mr. GREENSPAN. I am sorry, would you repeat that? Mr. McCoLLUM. Well, does it bother you that the spending reduc- tion side of deficit reduction has been delayed, I think in the neigh- borhood of 2, 3, 4 years, in the proposals currently pending out of the Senate and the House as opposed to Mr. GREENSPAN. I can't respond to that without specifically com- menting on the proposals that are before the Congress. I will let it stand as I said it, as best I can. Mr. McCoLLUM. Thank you, Mr. Chairman. You are being very diplomatic. Chairman KANJORSKI. The gentleman from New York, Mr. La- Falce. Mr. LAFALCE. Thank you very much, Mr. Chairman. Chairman Greenspan, I welcome your warm endorsement of the basic budget plan submitted by President Clinton, which is now in conference. And I think you pointed out quite clearly how that is only one-half the battle when you pointed out that the huge in- creased Mr. GREENSPAN. I know you are being a little facetious, but let's put it on the table, I was endorsing nothing. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 15 Mr. LAFALCE. It was a good try. But it seems to me that you were certainly calling for the control of health care costs, because that is the largest single component of the spending increases that are projected over the future years that you expressed concern about. And so imperative of not only dealing with this budget proposal of the President in a successful manner, but also dealing with health care reform, the largest component being costs, health cost controls. I am going to ask you to respond to three comments that some constituents of mine have made to me and see how you would handle them. And all of them want me to oppose the President's basic budget initiative. First, they argue, you can't tax your way to prosperity, and that is basically what you are doing. And you attempted that, you being the Congress, in 1990, and look what happened to the economy in 1990. So I am curious how you would distinguish between what was done between President Bush and bipartisan Congress in 1990 and what happened then, and what we are doing today. And second, some of them would argue that the whole effort for the President's budget proposal was based upon his assertion that there has been a change in the budget deficit figures from precam- paign to postcampaign, but now it would appear that the budget deficit for this fiscal year, and perhaps next fiscal year, might be lower than the revised estimate that gave rise to these specific budget proposals, and therefore perhaps it is not as important to come in with as much of a deficit reduction measure in the early years, as long as we are consistent with the outer years. And the third point, so much concern has been raised about this being a jobless recovery, that it appears that this clearly was true when the President was inaugurated in late January, but the recent figures with respect to new jobs are somewhat encouraging, and therefore perhaps we don't need the type of action that is being called for now. How would you respond to those three charges, statements, argu- ments? Mr. GREENSPAN. First of all, Congressman, the debate on the out- come of the 1990 Budget bill is under extraordinary dispute. My own impression is that a number of the elements that were in that 1990 compromise to restrain expenditures by putting different re- straints and caps on various programs, have indeed worked, and that there is no question that a substantially lower level of outlays has occurred as a consequence of the 1990 budget agreement. What was fundamentally wrong in that period was a very ex- traordinary underestimate of what the long-term budget outlook was. It was indeed in my judgment, especially in retrospect, far worse than the data that was evolved at that time and used to evaluate how the budget deficit would proceed. The problem of the deficit back then clearly was substantially underestimated. As a consequence of that, we are seeing, as the Congressional Budget Office appropriately indicated, a major reduction from what it otherwise would have been as a consequence of that act. Clearly, what was expected then has not evolved. And part of that, but only Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 16 part and perhaps significantly less than half, resulted from lower economic estimates than in fact were the case. It is my judgment that there is an additional level of outlays which must be added to the current services budget, which would take into account the fact that there are administrative and judi- cial actions that are taken coupled with add-ons which occur as a consequence of congressional action, which are biased toward in- creased spending. And that number is not added to the basic long- term budget projection. That is part of the reason why the 1990 agreement looked to be so badly off. A goodly part was that they failed to recognize how bad the outlook at that point basically was. With respect to your second point, the problem, long term, is very substantial. The changes that are involved in the fiscal budget deficits for fiscal 1993 and 1994 are really quite small and essen- tially irrelevant to the long-term problems that confront us. And I would say they are not something which should induce us to pull back our endeavor to trim the deficit. Finally, there has been a better job outlook. We went back and revised the data and found that the employment shortfalls that we thought existed were not fully there and that the employment put- look has indeed been better than we have expected. In fact, since the end of 1991, there have been an increase of 2 million jobs. But that is again a short-term phenomenon. The problem we are dealing with in the longer run is not affect- ed by these conditions. And it is the longer run to which the budget deficit issue has to be addressed. Mr. LAFALCE. Thank you very much. Chairman KANJORSKI. Thank you very much, Mr. LaFalce. We now go to Mr. Roth, the gentleman from Wisconsin. Mr. ROTH. Thank you very much, Mr. Chairman. Chairman Greenspan, in your testimony this morning you point to—and I think very appropriately—the rapidity of change. Tech- nology 5 years ago would be virtually unsalable today. And that would lead us, I suppose, to the conclusion that we have got to do whatever we can to encourage our entrepreneurs and risk-takers to provide the jobs our people need. Wouldn't you say that would be correct? Mr. GREENSPAN. Most certainly. Mr. ROTH. Now, in this bill that is before us, this Tax bill that some of my colleagues were referring to, we have capital gains tax increase, we have individual tax increase, we have energy tax in- crease, we have increase of all kinds, yet at no time in our previous history where we have had these increases have we strengthened our economy. And certainly this wouldn't give incentive to our risk-takers and our entrepreneurs. So wouldn't you say that this bill is going to have a wet blanket effect on our economy? Mr. GREENSPAN. I can't comment on the specific aspects. Mr. ROTH. Sure you can. Mr. GREENSPAN. I can, but I won't. But, Mr. Roth, I think that I have indicated, before this subcommittee, that the capital gains tax should either be indexed retroactively, lowered, or preferably elimi- nated. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 17 And the basic reason why I have argued before this subcommit- tee in the past on that question, well in advance of these budget initiatives, is that the underlying nature of this economy is, as I describe it in my prepared remarks, an extraordinarily dynamic continuously renewing economy, which requires incentives for people to take the types of risks that create wealth and increase standards of living. So that is a position that I have held over the years and clearly continue to hold. When we are beyond this question of the budget issues, I trust that a more appropriate evaluation of the issues of capital gains and the question of how they should be handled with respect to maximum wealth creation will be addressed. Mr. ROTH. Well, I appreciate that comment. And yes, you have been consistent in your statements over the years as far as capital gains tax is concerned. You know, we had TIFRA, where we are going to get $3 in spending cuts for every dollar in tax increases, we had that $99 billion tax increase, you remember. Then, of course, we had other increases. And then 1990, as has been pointed to before here, we had another tax increase. And basically what concerns me about the legislation before us is, in your testimony, you talk about a long-range view. And I agree with that, I can see that. But even with this Tax bill, and even with the best estimates, we are going to have a $6 trillion def- icit after it is all said and done by 1996, 1997. Aren't you concerned about that? Mr. GREENSPAN. The level of the debt? Mr. ROTH. The level of the debt, yes. Mr. GREENSPAN. Certainly, I am. There are two aspects to the concerns one should have about the budget deficit. One, obviously, is the deficit, per se, as a percent of the Gross Domestic Product and its impact on financial markets. But the level of the debt from which the service costs emerge is also critical in evaluating precise- ly what type of deficit reduction we need. Because what is evident by very simple arithmetical relation- ships, as we project what is going on indefinitely into the future, is that the system breaks down. Mr. ROTH. Yes, I take an opportunity to tour a lot of our small businesses that we have in our home State and other parts of the country. And I am always impressed; that is why I was impressed with your testimony here on page 14 talking about the entrepre- neurs and rapidity of change. This rapidity of change is something I don't think we focus on enough, we are not sensitive to enough. Because it is such a dynamic economy. Therefore, I would like to ask you, what one thing could we do on Capitol Hill to help our entrepreneurs and our risk takers? What advice would you give us in this subcommittee and as a Con- gress? Mr. GREENSPAN. I would say what I indicated previously; namely, to review the incentives that we create for the creation of new wealth and risk taking, and remember that this is a—as I say in my written text—that this economy is churning at a very rapid rate, there is a great deal of risk that is being taken and a great deal of it which creates losses. But all of the wealth that we create occurs as a consequence of risk taking. Every action that any indi- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 18 vidual householder or businessman takes which is a commitment to the future is of necessity at risk because we cannot know for sure how various actions we will take will come out. If we can induce people to be willing to take those risks, to create wealth—if we can induce an acceleration of that process—we will induce the acceleration of economic growth and standards of living. Mr. ROTH. Thank you, Mr. Chairman. Chairman KANJORSKI. The gentleman from Utah, Mr. Orton. Mr. ORTON. Thank you, Mr. Chairman, and welcome, Chairman Greenspan. I appreciate your testimony with regard to the impor- tance of deficit reduction, and would like to follow up briefly with a couple of questions on that subject. You indicated you would not recommend that we lower pur target from $500 billion to $400 billion or less in deficit reduction. Would there be a negative result on the economy if we increased our target and actually increased the deficit reduction beyond $500 billion in 5 years, to, say, $600 or $650 billion in deficit reduction? Is $500 billion about the right target or do we risk having nega- tive impact if we go higher than that? Mr. GREENSPAN. I must say that were you to put more in, I would not be terribly concerned. One of the reasons is that history tells us that there is always considerable slippage after the fact. And if one buttressed it in part with an add-on, it probably would not be bad policy. My suspicion is that it would be extraordinarily difficult to do and the pressures are clearly on the other side. The content of my testimony is mainly to reinforce where we are, but if the Congress in its wisdom decided to increase it, I should certainly find that not discomforting. Mr. ORTON. It is an uphill task, politically, but there are those of us here who are attempting to do that. I also would have a ques- tion about the way in which we achieve deficit reduction. We either have to do it by reducing spending or increasing taxes. I am wondering if there is a quantifiable difference between those two methods on the economy in the way that we pull money out of the economy through deficit reduction. Is there a more nega- tive impact as a result of reducing Federal spending or as a result of pulling more money out of the system through increasing taxes? Mr. GREENSPAN. Congressman, this is a highly debatable issue amongst economists. You can get views on both sides. The conven- tional wisdom is that if you leave out the question of expectations and the sort of advance effect I have described, then you basically impact the economy more by lowering spending than in raising taxes. I must say, I am not overly persuaded by the evidence on that myself, and I do think that the anticipatory aspects of tax in- creases, for example, create an expectation of permanent tax levels which will impact on business spending over a much longer period of time. Now, it is true that the same phenomenon holds when you reduce expenditures as well. So it works in both directions. So it is very difficult in any specific instance to prove conclusively one way or the other. If you bring five or six economists here and you ask Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 19 them, I can guarantee you will get 10 different answers on this subject. Mr. ORTON. We can hedge our bets by doing some of each, appar- ently. Mr. GREENSPAN. My inclination, as I indicated to an earlier ques- tion, is that the problem that we have over the long run is that there is an expenditure increase projected by current law which is in excess of the increase in the tax base, which means that first and foremost, we have to make certain that the expenditure growth slows down or we will not solve this problem. The tax ques- tion is really secondary, because we have got to get the expenditure path reduced first. Mr. ORTON. And I think that is critical. I would like to shift to just one other point before my time expires, and that has to do with the availability of capital and credit. In order to have an ex- panding economy, we must have access to capital and credit. This subcommittee has been holding hearings regarding the credit crunch as it is called, the lack of availability of credit. Obvi- ously, the policy of the Fed has been to keep inflation low and keep interest rates down. I am wondering if you have any opinion upon the credit crunch. First of all, do you think it does exist? if it does exist, what is driv- ing that credit crunch? Is it a lack of demand for credit from the private sector? Is it some policy that the Federal Reserve has that is keeping tight credit? Or is it the process, the banking regulatory process, the need to increase capital and the RTC collapse? Or is it a combination of all or something different? And if you don't have time, I would be happy to receive a written comment from you on it as well. Mr. GREENSPAN. Let me just say very quickly, it is not reasona- ble to assume that Federal Reserve monetary policy is involved here. And the reason I say that is that not only have interest rates come down extraordinarily, but in the many instances where indi- vidual banks have endeavored to increase their market share by lowering their interest rates, they failed. In other words, it does not appear as though this credit problem that we have, and indeed I think we have one, is a function in any material sense of the level of interest rates, because the market in that sense has been tested quite considerably. I think the real prob- lem is, as I have indicated to this subcommittee on many occasions, the result of a period of extraordinary rise in debt to financing rising assets. After the value of the assets fell, mainly in commercial real estate collateral, you ended up with commercial banks with very strained balance sheets themselves and fearful of the state of their capital, which has led many of them to hold back and to tighten their lending policies, which only very recently have shown evi- dence of easing. But there has also been this extraordinary holding back on the part of borrowers who, having overborrowed, have been very reluc- tant to get back into the market. We at the Federal Reserve have done a number of things in conjunction with the other regulators, and some of it, I think, is helpful. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 20 But, fundamentally, this is a psychological problem. People have been frightened and it takes a while for it to wear off. It is in the process of wearing off, but I would scarcely argue that the so-called credit crunch phenomenon is over. It is not. Mr. ORTON. Thank you, Mr. Chairman. Chairman KANJORSKI. Next, the gentlelady from New Jersey, Mrs. Roukema. Mrs. ROUKEMA. Thank you, Mr. Chairman. Chairman Greenspan, Mr. Orton and, to some extent Mr. McCol- lum, have asked the questions that I wanted to ask. I was particu- larly interested in your response on the credit crunch and I would hope that we could work along. I do believe it is psychological and I think there is time that is needed to work this out. But there may be some suggestions you can make for congres- sional action and Fed action. And if there are followups that you are going to be directing to this subcommittee, to Mr. Orton, I would hope that you would share that with the whole committee. I think it is an extremely important issue for all of us. The other question really on my mind was this question of the ratio of spending to—spending to tax reductions in the budget. And that was the center of my concern. I would like to make a couple of observations and perhaps you will respond. I think you made a very coherent and excellent presentation on the interest rate ques- tion, and its relationship to, using your words, the credible deficit reduction, and if we don't have credible deficit reduction, we are going to see all kinds of negative effects and particularly on inter- est rates. But I would like to observe, although you have been cautious in being—not wanting to be too specific on the questions of spending versus tax increases, and I am not one of those Republicans that say "read my lips, no new taxes/' but I do feel and I wish that we had had more support from the business community and other economists, that the voices haven't been loud and clear enough on constraint on spending. In fact, I would like to have seen strong statements calling for moratoriums on any new spending. I find that this budget proposal is remarkably weak on the spending side in the fact that with the exception of Medicare—which is what I am going to get to—with the exception of Medicare, there has been no real restraint on spending as far as I can tell. They haven't cut out any real big projects, nothing that costs any real money. They nibbled away here and there a little bit, and worse than that, they have actually proposed some new spending programs that have the potential of growing into capped entitlements, which I find extraordinary, when we are facing the kind of debt and defi- cit reduction needs that we are facing. To that extent, the ratio is not good in my opinion and to that extent there is too much of a reliance on new taxes rather than on spending restraint first and then looking at the capital side. But you have made a very accurate statement and I am afraid none of us really want to accept it, that the current services growth over time will be greater than the growth of the tax base. And I guess we will find that out, what, in 1996 or 1997 or what- ever that date is. It is not too far in the future. What disturbs me Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 21 is, and you referred to the health plan, what disturbs me is people are too easily talking about capping health care costs almost as though that is going to be an elixir. It may be the sine qua non, but I don't think it is the elixir to our problems. But I have got to say, nobody seems to acknowledge that no matter what we do in reforming health care, and I do think there are some cost controls, that the population is getting older and this is going to be not only draconian, but an unfair share of the burden if we look to that elixir despite the growth in the aging population in this country. And I don't know whether I have asked you a question or want you to comment. I would love to have you comment on it. But I think we are fooling ourselves if we believe that we are going to find great savings at that point in time. And I wish we would all come to the reality of cutting costs now in this budget reconcilia- tion, but I don't see much hope for that. Mr. Chairman. Mr. GREENSPAN. Let me just comment that arithmetically, one finds that the excess of growth in spending under current services is all over the medical care area. The Mrs. ROUKEMA. All in the medical care area? Mr. GREENSPAN. Yes. In other words, by excess over the rate of growth of Mrs. ROUKEMA. Yes, I see. Mr. GREENSPAN. Of gross domestic product in nominal terms. If, and this is the important if, if you could stabilize the proportion of health care that is in the budget as a percent of the growth domes- tic product, then effectively you would slow down the rate of spend- ing enough. But as you point out, the underlying thrust of health care is sug- gestive of an outcome which is more likely to be that it is still in- creasing as a share, even though it may be increasing less fast than it is today. Should that occur, and it is a hypothetical, obviously, it then means arithmetically that you have to reduce the remainder of expenditures to a rate of increase less than the increase in the tax base. And if on top of this—I raise the issue that I raised earlier—the current services expenditure projections tend to exclude these add- ons which occur. Indeed, the most appropriate projection of budget outlays is not the current services projection, because that stipu- lates what would happen under current law and under current reg- ulations. What history tells us is that that assumption never prevails. There are always changes, either judicial or administrative, in the way programs are administered, and the bias of those judgments and rulings is always higher. The presumption that the Congress does not add anything is also an inappropriate assumption. So all in all, my concerns and the reason why I raise these issues is a major concern about the longer term, and one of the reasons I raise the question about the 1990 agreement is I think we are un- derestimating the longer term pattern of spending. Therefore, there is all the more reason why we have to come to grips with the spending question and why, irrespective of what is done on the tax Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 22 side, coming to grips with spending is an essential ingredient to re- solving the long-term budget problem. Mrs. ROUKEMA. Well, thank you, Mr. Chairman. I appreciate what you just said and I didn't want any of my questions to be in- terpreted as feeling that you have been less than forward thinking and less than articulate in stating again exactly what you do mean about the spending restraint. I only made the point because I feel that there are too few in the business community and among economists who are speaking as forthrightly on the spending side, and I think we have lost a unique opportunity at this point in time, in this particular budget, to set the path finally. The Medicare question is another issue. Thank you, Mr. Chairman. Chairman KANJORSKI. We will now hear from the gentleman from California, Mr. Dooley. Mr. DOOLEY. Thank you, Mr. Chairman, and Chairman Green- span. To follow up on the comments of Congressman Orton, both the Republican proposal and President Clinton's budget proposal will not ever take us to what would be. If I interpreted your statement correctly, until we make balanc- ing the budget a fundamental objective, we drive the deficit to zero and start to make attempts to reduce the national debt and the servicing of that debt, we are still going to be facing some underly- ing problems that will affect how rapidly our economy can im- prove. Is that correct? Mr. GREENSPAN. What we want to do is at least stabilize the ratio of debt to gross domestic product. But remember, that would presuppose a deficit, because the debt is nonetheless growing. Ideally, I would like to see either the budget in balance or, as I have indicated in earlier testimony before the Banking Committee it would be useful if this country could run a surplus because of our low savings rate. While I have not surfaced this idea in recent testimony on the ground that it seemed sort of not exactly appropriate, it should be our goal. That would mean obviously that we bring the total debt down. Mr. DOOLEY. So if that is our goal, then you wouldn't subscribe that it would be an appropriate policy that we can live with a defi- cit that is 2 percent of GDP? Mr. GREENSPAN. If you want to put it in those terms, yes, we could live with it. I mean it would not create a great problem for the economy, we would be operating at much lower levels of effi- ciency, because 2 percent of the GDP put in private productive cap- ital assets rather than in financing the deficit is not a choice I have great difficulty in making. I don't want to say that we would run into a real major problem, but we obviously would be functioning far less efficiently than we would if we had the budget in balance or in surplus. Mr. DOOLEY. What would be your anticipation of the impact on the interest rates, 30-year bond, if Congress in the next year or two did make the commitment to get to a balanced budget in a decade, or by the end of this century? Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 23 Mr. GREENSPAN. As the markets have demonstrated, if they sense that there is true credible action about to occur in the Con- gress, then the markets will move in advance of that. I don't want to forecast where interest rates can or would go, but it should be obvious that from the extraordinary improvements in corporate and household balance sheets that have occurred as a consequence of the lower long-term interest rates, that more of the same would clearly be most helpful to the American economy. Mr. DOOLEY. I think certainly a great deal of credit for the reduc- tion in interest rates has to be attributed to some of the commit- ment or the perceived commitment of Congress and the administra- tion to reduce the deficit. But would not the financial community also respond if they felt that the economy was not going to be im- proving to expectations, that interest rates would also be a bit lower? Mr. GREENSPAN. Yes. There is obviously a question that if the markets presume that the economy was weakening, obviously you would get, other things equal, lower long-term interest rates. And there is no question that some of the reduction that we have seen in recent months does reflect that. But remember that when the economy was far weaker, you know, 18 months, 2 years ago, long-term rates were much higher than they are now. So you can't argue that that could be a really very substantial determinant. But I don't deny it is part of the fairly extraordinary decline that we have had in long-term rates. Mr. DOOLEY. Thank you very much. Chairman KANJORSKI. We will now go to the final member of the subcommittee present, Mr. Neal, and then Mr. Knollenberg, we will go to you. Mr. NEAL. Thank you, sir, Mr. Chairman. Chairman Greenspan, I noticed in your testimony that you had lowered the target range for M2, and I imagine that that will at- tract some attention and some comment. And I am just thinking back, I am remembering when we originally put into law the re- quirement that you focus on the Ms. I think most economists thought then that the growth rates of the monetary aggregates were very good predictors of inflation. In fact they had been for a long time, but in recent years those rela- tionships have broken down considerably. And although they may be good over long periods of time and so on, as short-term predictors those relationships have broken down. And I am just wondering if it wouldn't be much better for us to simply focus on inflation as a target, as opposed to these other indi- cators. I know you touched on the great benefits of price stability in your testimony, but we know now that we can get the greatest sus- tained economic growth and the greatest sustained job creation, the lowest sustainable interest rates, the highest sustained levels of savings and investment and productivity and so on, by low infla- tion. And since we know that and we know that if we think the goal of monetary policy ought to be to sustain economic growth and sus- tain job creation, we know the goal ought to be low inflation, I am just wondering if we wouldn't be better targeting that. It just Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 24 seems to me that we run the risk of there being a lot of discussion about something that is in today's environment essentially irrele- vant. Anyway, that is one question. And I would just like for you to comment briefly on it. And I would like to ask you another ques- tion before my time goes away. And that has to do with the ETC legislation. As you know, we are probably pretty close to trying to get that past the House. It has passed our subcommittee, passed the full committee, with very good support. But I would like to ask you to comment on what you think would happen if we didn't pass ETC legislation. I, personally, think it would be quite negative for the economy at large in terms of re- duced confidence, and especially bad for the financial system. But I would ask you please to comment on both of these. Mr. GREENSPAN. Congressman, let me start with the ETC and then go back to the issue of inflation and M2. The current esti- mates with respect to the costs to the American taxpayer as a con- sequence of not resolving the institutions that the ETC would be scheduled to resolve is, as I believe the Secretary of the Treasury indicated yesterday, $3 million a day, or roughly $1 billion a year. And the reason for that is that it costs more to fund the liability of these institutions than it would if Treasury bill rates, for example, were employed. The basic issue here is that the deposits have been guaranteed in these institutions. These are liabilities of the American Govern- ment, now. It is nothing that is going to happen in the future. They are already the liabilities of the government. The form of the legis- lation to allow funding for the ETC is essentially to move those li- abilities from a high cost area to a lower cost area. So in that sense, the failure to fund the ETC is just adding to the costs of something which the American Government, that is the American people, are already obligated for. So it strikes me that it is very poor public policy to be paying more to fund these liabilities which are liabilities of the government by the present means, when we have it in our capability of funding them at a cheaper level. Mr. NEAL. Isn't there a long-term cost, the potential for longer term cost also? That is, if people thought we weren't going to make good on this promise that we made for almost 60 years to guaran- tee their deposits, in other words, if we weren't paying someone who Mr. GREENSPAN. I don't think that anyone believes and I don't think that it is probably even conceivable that we are not going to pay the deposits or in fact the interest on the deposits, because that is not an issue as far as I can judge. The question is whether we do it in a sensible manner or in a nonsensible manner and at the moment the lack of funding of the ETC strikes me as most inappropriate government policy. Mr. NEAL. I notice my red light is on. Would the chairman allow an answer to that other question about the Chairman KANJORSKI. Yes, absolutely. Mr. GREENSPAN. As I have indicated many times to you and in this subcommittee and in other committees, Congressman, we per- ceive that if our fundamental goal of monetary policy is to create sustained economic growth, the evidence is becoming increasingly Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 25 persuasive that a necessary condition to achieve that is low infla- tion or stable prices. And the reason, as I indicated in my prepared text, is that clear- ly productivity is involved here and living standards and growth are crucial. So we are acutely aware of the inflationary pressures that could emerge and could do great damage to the economy, as indeed it did as we all remember back in the 1970's. I trust we are not going to allow that to happen again. The pur- pose of the monetary aggregates has been historically to try to create a set of data which signals when those inflationary pres- sures are beginning to emerge. And the various measures that we have employed, including this model we call P-star, which relates the general price level over the longer run to the M2 trend values, has broken down. If it were working, it would give us a longer term view of the posture of monetary policy relative to the rate of in- crease in the price level. I should hope that when these balance sheet strains and other forces which are so disturbing our financial system are removed, that M2 or something close to it will reemerge as a useful tool and the P-star model will again be a functioning tool for monetary policy. So while I certainly agree that inflation is a crucial variable, it is a lagging variable as economists like to say. And we need some- thing well in advance to suggest when these processes are emerg- ing so that the actions we take to suppress incipient inflation can be very modest, and not have any disruptive effects, because we do them in a manner which is gradual, we don't allow the type of surging inflationary instabilities that occurred in the past which required draconian action to bring them under control. Mr. NEAL. Thank you. Chairman KANJORSKI. Thank you very much, Mr. Chairman. We now go to the gentleman from Michigan, Mr. Knollenberg. Mr. KNOLLENBERG. Thank you, Mr. Chairman. Chairman Greenspan, thank you for testifying here this morn- ing. I particularly enjoyed some of your comments. I know some that you were particularly cautious on. And I guess I would like to go back to one of those items that you were somewhat cautious on. I know it is a followup to some questions that were raised here already, but being last on the pole here, I have the advantage of having some of my questions answered and then perhaps one or two that aren't, or weren't. Now, you seem to imply that you were skeptical, that there was much distinction between reducing the deficit via taxes or through cutting spending. Mr. GREENSPAN. No, I think I was raising the question of the impact on the economy. Mr. KNOLLENBERG. Impact on the economy, all right. Mr. GREENSPAN. My predilections, as I have indicated before the committee before and especially in the context of my hearings 6 months ago, was that I would prefer expenditure reduction because over the long run that is a more effective way of restraining the deficit. I was merely responding to the question relevant to the impact on economic activity and the difficulties economists have in Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 26 making the judgment as to the tradeoffs of the impact of spending reductions on economic activity and tax increases on economic ac- tivity. Mr. KNOLLENBERG. Well, one of the things that—and I appreciate the correction on that. I didn't mean to imply differently. But would you not agree that when it comes to the entrepreneur, to the job creator, to small business, and, for example, in my district in the 1980's, in fact through all of Michigan and particularly in my district, all of the net new jobs were created by small business? Mr. GREENSPAN. That is true all over the country. Mr. KNOLLENBERG. That is true all over. I don't suggest it is a unique situation in my State. But it would seem to me, and I would hope that I would get your agreement on this, that taxes are more of a negative, they hazard the small business person much more than the matter of spending cuts. And, for example, you know, if we are going to see any economic growth, I know that one of the reasons that we are here this morn- ing is to talk about that and we also made reference, and I did in my opening comment, to the fact that the predictions have fallen short by some margin. I think 3 to 3.25 predicted, it is actually less than 1 percent. And I might even suggest to you that perhaps one of the reasons that the growth hasn't been that great, at least from my perspec- tive in my district, is that people are weary, they are reticent, they are holding back, they are concerned about the future. And it would seem to me that if we are going to see economic growth, that we have to be particularly sensitive to taxes and taxes on the small business person because they are the ones that have created the jobs. And frankly, right now, they are not. And I just ask your comments, if you would agree in part. Mr. GREENSPAN. I certainly indicated in my written testimony that there is evidence to suggest that a number of capital projects, small and large, are on hold because of the uncertainty with re- spect to the tax possibilities. The reason I raise the issue as being not all that easy to answer is that while I have no doubt that ex- pected increasing taxation of small business is a negative—indeed one finds by any survey that that clearly is the case—it is also the indication that respective reductions in expenditures have been negative. For example, the reduction in defense expenditures has had an extraordinarily strong negative impact in southern Califor- nia. As I have indicated in past testimony before this subcommittee, all taxation is negative. In other words, it reduces levels of econom- ic activity one way or another. I don't deny that there are second- ary effects and a number of people will argue that environmental effects are improved or a variety of other things, but as a general first proposition, I would say that any taxation suppresses econom- ic activity. And to the extent that you impose taxation on risk taking, you do it in spades as far as I am concerned. Mr. KNOLLENBERG. That is what we are doing. Mr. GREENSPAN. But what we have as a result of any deficit re- duction, to the extent that it reduces interest rates, specifically long-term rates and mortgage market rates, it has a very obvious offsetting effect. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 27 The reason this is a very complex issue is that we have anticipa- tions having a major impact on economic activity in advance of the first dollar of tax increase or first dollar of expenditure reduction. And what we are observing is how extraordinary markets are and people are in responding to these expectations. I think we have to take those issues in consideration. Mr. KNOLLENBERG. Thank you, Chairman Greenspan. Mr. Chair- man, thank you. Appreciate your comments. Chairman KANJORSKI. Thank you, Mr. Knollenberg. The gentleman from New Jersey, Mr. Klein. Mr. KLEIN. Thank you very much, Mr. Chairman. Chairman Greenspan, I certainly welcome you and admire your leadership in this area. The low interest rates which we have been experiencing during the past several years have certainly been de- signed, or I shouldn't say designed, but should normally have had the effect of stimulating business activity. There has not been as much responsiveness to those low interest rates as one might expect. Is there any reason to believe that per- haps other measures should be taken in order to stimulate business activity? Is there some question about the correctness of the low in- terest rate policy or is it a matter of a continuation of the low in- terest rate policy along with other stimuli? But how do we get a more significant increase in the economic activity? Mr. GREENSPAN. Congressman, as I indicated in my prepared tes- timony, indeed as I have argued before this subcommittee on innu- merable occasions in the past, it is the requirement of households and businesses to restore some balance to their balance sheets, if I may put it that way, which got so badly strained as a consequence of the rise in debt which was used to finance assets whose value subsequently declined. That has had a remarkably consistent continuing repressive effect on economic growth. I have used the term "50-mile-an-hour headwinds," which is what we are running up against. Clearly, one of the issues that is involved here is that as a consequence of this, the historical response of the economy to lower interest rates has not been clearly replicated. We have seen far less in the way of economic expansion as a consequence of lower rates than would historically have been the case. Having said that, it is also true that the decline that has oc- curred in intermediate and longer term rates, especially mortgage rates, has had a very pronounced effect in giving us the growth that we actually see, which while not as strong as we would like, is stronger than anyplace in the industrialized world at this point. The problem is to try to get the balance sheets repaired as quick- ly as possible. That is going to take time, but it is working. And it is working in a very steady pace. Debt service burdens are down. This has increased the cash-flow of consumers. We see some definite improvement in the equity debt ratios of corporations as they finance very heavily in the market for in- creased equity. So things are clearly gradually coming back into place. We are trying to accelerate the process by trying to see if we can free lending at a faster pace than it would normally occur as a consequence of these balance sheet repairs. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 28 And we have, in conjunction with the other regulators, instituted what I like to call a character loan, a vehicle or basket which has enabled a number of banks to start to lend with less in the way of required documentation. We can go through, and indeed we have and will, go through a number of initiatives in conjunction with the other regulators to try to ease what is still a very obvious credit crunch. And we will continue to do that until the issue is finally and fun- damentally resolved. But in my judgment, what is at the core of the economic problem in this country, short-term, is the strained balance sheets, the unwillingness to borrow on the part of house- holds and businesses, to in fact create increased economic growth. All of this means that there is something fundamentally askew in the system, which requires repair. But what is clear is that low intermediate mortgage rates, long-term rates, are the most impor- tant in the short run to get the economy back on a solid footing. Therefore, we are endeavoring to focus on those areas of the economy which enhance the improvement of the balance sheets of the system, which is the most important thing to get the economy back on a much more solid footing. Mr. KLEIN. I am told that my time is expired, but Chairman Kanjorski has generously given me permission to ask one addition- al followup question. And I would just ask you this: I noticed that there are many, many businesses that are seeking credit that had difficulty obtain- ing credit. I am not talking about those that are the targets of our community banking legislation that was announced last week. I am talking about small- and medium-size businesses that are really the best hope for generating new jobs for the economy. How do we deal with the credit crunch as it affects those people? Mr. GREENSPAN. I certainly agree that that is a problem, and indeed it is an issue which has bedeviled us for quite a long while. We are trying to take what regulatory initiatives we can. And we have been endeavoring to create an environment in which lending can start to take hold. Some progress is clearly obvious. Even though the total commer- cial and industrial loans have been remarkably flat with maybe just a slight up tilt, that is a net figure. From what we can judge, there has been a significant reduction in business loans to larger businesses which leads us to suspect that the loans to small busi- nesses are finally beginning to show a little bit of buoyancy, but nowhere near enough to suggest that the credit crunch that has been our concern for so long is behind us. But there is evidence that there is progress being made. In other words, we are not just pushing and pushing and nothing is happen- ing. We have been pushing and pushing and finally getting modest trends occurring. It is clearly subnormal so far as credit growth is concerned. Credit availability is still, judging from the anecdotal evidence we pick up, less than we would like. So it is just going to be a con- tinuous process by which we will push as much as we can and hope that as the balance sheets finally improve, that we will get a re- stored financial system. We don't at this point have that as yet. Mr. KLEIN. Thank you very much. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 29 Chairman KANJORSKI. Now, we will go to Mr. Schumer from New York. Mr. SCHUMER. Well, thank you, Mr. Chairman. I certainly appre- ciate your invitation to the members of the full committee who don't sit on this subcommittee to be here. And thank you, Mr. Chairman. I think that you, as always, are walking this very deli- cate tightrope with grace and success, I guess. Let me first talk a little bit again about the deficit and the budget plan. I understand that my colleagues were basically en- gaged in the debate, is it better to do tax increases or cuts. To me, that is beside the point. It reminds me, I think, of Winston Church- ill, once talking about two pachyderms in a natural act, it is not how they do it, but any wonder they do it at all. And here we have come closer than ever before to getting some real deficit reduction. I ask you to comment just on this in a minute. But that there are real numbers there, this is the first time I have seen that the num- bers are not faked, that they made honest and even conservative guesses. So many people are jaundiced by all the other attempts to reduce the budget, but when we sat here when we saw the num- bers come down, saw that the numbers weren't really accurate. They were stretched to the optimistic side, that never happened. That is not true in this budget, and I think if we do it one way or another we will get some real deficit reduction. But my concern relates to the question of the fact that the econo- my is softer and squishier than maybe we thought even 3 or 4 months ago, that even your own estimates evidently have come down in terms of growth from 3 to 2 ¥2. The question is not whether we should do deficit reduction, but many people have come to me, particularly in the last month or two, and said, yes, we should do deficit reduction, but the timing is bad, that because the economy is soft or because the recovery is less robust than what everyone thought, to do the deficit reduction now, whether January 1 of last year or July 1 of this year, is wrong. And so my question to you is this, could you comment on that generally, and what would you think of an idea proposed by some that says we should enact the deficit plan this year, but then change its enactment date, move the enactment date a year up, give the economy time to grow before cuts—before the cuts and the taxes bite, but at the same time give people the assurance that on the books there are real laws that will affect deficit reduction? So your comments on those two things, first the accuracy of the numbers compared to previous times, and their more conservative nature, and second, this proposal for some kind of not change in the budget plan, but delay in its—enacting it now, but delaying its effective date. Mr. GREENSPAN. As I indicated 6 months ago when the Presi- dent's program came up, I said in effect that I thought his econom- ic assumptions were credible, that they are within a range of judg- ments which subsequently proved to be what more optimistic than Mr. SCHUMER. Are they more credible than previous ones that this Congress Mr. GREENSPAN. I would say probably yes. I mean it 70-449 - 94 - 3 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 30 Mr. SCHUMER. That is a strong statement for you. Mr. GREENSPAN. The reason I say probably, yes, is that there has been an inclination in recent years to move in a better direction. I thought that some of the estimates in, you know Mr. SCHUMER. Previous years? Mr. GREENSPAN. Well, I was about to say maybe 10 years ago, were really a little bit more difficult to swallow than some of those in recent years. But I thought that some of the estimates made by the Council of Economic Advisers in the Bush administration were also far more credible than had been previously the case. I don't think that we have got a problem now of what we used to call rosy scenarios. That is not our problem. Our problems are the real fundamental spending difficulties that exist. I would not agree, incidentally, that the economic outlook is worse now than it was 3 months ago. I think that we have been going in fits and starts. The expansion accelerates, decelerates. The first quarter data were extraordinarily weak because we had a surprisingly sharp drop in defense expenditures and awful weath- er. The second quarter is clearly accelerated significantly from that level. It is not running at a fast pace, but at a reasonably moderate pace. If one waits for the "ideal time" to balance the budget, it will never occur. Unless you come to grips with the issue now—if we seriously be- lieve that we are going to confront this issue but not now, always later—that process will just continue indefinitely. I think we have run out of time. I said that here 6 months ago. I didn't mean it in the context of weeks or months, but in this particular timeframe. And if we don't come to grips with this issue realistically now, we will always find reasons not to do it. Mr. SCHUMER. You are not, to paraphrase, you are not worried that taking money out of the economy at this point in time will inhibit whatever—or inhibit sufficiently to not do it, whatever re- covery is going on now? Mr. GREENSPAN. Mr. Schumer, what the evidence indicates, which is really quite different from what a lot of us would have expected, is that we are getting a very substantial positive effect from the expectation of credible budget deficits, which is offsetting a goodly part of the so-called fiscal drag. Now, there are other aspects which I indicated in my prepared testimony which offset that as well, but looking at the full balance of all of this, the economy is not running at a particularly fast pace, the unemployment rate is too high, it is coming down too slowly, this is not a vibrant economy by any means. But it is clearly not one that is about to tilt over into a signifi- cant state of weakness or contraction, and it certainly is not an economy that one would hesitate to maintain a long-term budget deficit reduction. It is an economy which would not inhibit long- term deficit reduction in my judgment. Mr. SCHUMER. OK. Just one final question. The chairman has again been nice enough to allow me that, even though the time is up. You mentioned this a minute ago. I guess the great fear that not only many of us have but out there in the public, too, is the jobs question. No one has laid out a scenario to me, left, right, center. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 31 Our companies are getting leaner and meaner and that is good in an international economy, they are more productive, we all agree with that. The cost of that is laying off millions of people in relatively good jobs. Where are the new jobs going to come from? Mr. GREENSPAN. Well Mr. SCHUMER. No one has given a very good answer about that that is reassuring that me. Mr. GREENSPAN. Let me say this, first of all, we have had a net increase in jobs of about 2 million since the end of 1991. One of the reasons why I took some time in my written testimony to empha- size the extent to which the dynamism of the American economy is, if anything, accelerating, is to try to stress the fact that this system is continuously renewing itself, and that basically jobs are being created all over the place in new areas where history says you could find none. The data indicate that we create new job openings of about 400,000 a week. That is the obverse of initial claims which are roughly the same order of magnitude. This system is churning at an extraordinarily rapid pace and what history tells us is that basi- cally if you have a stable economic environment, investments will rise to the point that the unemployment rate will come down to what we call the natural rate. In a sense, people will become employed. We cannot say in ad- vance where it will occur, in other words, in which industries or in what levels, but that it will occur is undeniable if history is any guide. And one of the problems that we have in this type of ques- tion is we cannot say what types of goods are going to be produced 5 years from now. In fact, if we tried to forecast 5 years ago what we would be pro- ducing today, we would have been off in remarkable orders of mag- nitude. Similarly, we cannot say exactly where all the jobs will be in some detail, except that if the environment is stable, that they will be there. It is too costly to an economy to have people unemployed. It is profitable to somebody to hire somebody who is unemployed. And that is the way the system works. Mr. SCHUMER. Thank you, Mr. Chairman. Chairman KANJORSKI. Thank you very much, Mr. Schumer. The subcommittee has been so nice to you today, Mr. Chairman, that I have got to throw in another question. You have done some- thing unique at the Fed. You have succeeded in unifying Dr. Sam- uelson and Dr. Friedman, in both charging the Fed with overly re- stricting monetary policy. I think Dr. Friedman says that you are only paying lip service to meeting the monetary policy targets. We want to give you an op- portunity to respond to economists on both sides of the spectrum. Mr. GREENSPAN. I must say that these are very prominent econo- mists who have done great service to the profession and to the American economy and they are both very good friends of mine. And the arguments we may have are technical and economic. I do think they are wrong, nonetheless. I say so largely because in many instances their view of the state of monetary restriction, in my judgment, and I must say in the judgment of my colleagues, Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 32 is one that fundamentally differs from the points of view that we have taken. It really gets to how one evaluates the problems we had with the monetary aggregates and how to evaluate them and what their role has been in the system. So I will leave it at that. Chairman KANJORSKI. Thank you, Mr. Chairman. Mr. Green- span, we have heard some today, even some of my colleagues, inter- change the word "deficit" for debt. This is not uncommon, as we travel to and from our constituencies. Most people have difficulty comprehending some of the terminol- ogy used to describe the situation that our economy is in. And I have heard people even here on the panel today saying that the largest tax increase in history is being proposed. These exaggerated statements seem to go unanswered, but perhaps haven't we created a false impression in the country as a whole, and perhaps even in the world, that since we seem to have no base for comparison, we are leaving people with the opportunity to speak hyperbole that really is not accurate? To compare a tax increase in dollar terms today to dollar terms of 1982 is of little relevancy. Obviously, there are more people today, the dollar is worth less today, the gross domestic product is greater today than it was. And I want to run through a few things by you and then give you a question. I often hear how terrible the economy is today relative to the end of the Second World War, and yet as I look back on the Second World War, we had a $350 billion debt and gross domestic product of roughly $350 billion, so we had a one to one ratio. Whereas today we have a $4.2 trillion debt, but we have a $6.2 trillion gross domestic product, which is a two-thirds to one ratio, significantly different. Adding to that the end of World War II, we only had 120 million Americans, today we have 250 million Ameri- cans, a decidedly larger and more complicated country. What it really is drawing me to is why hasn't the Federal Re- serve, or have you and we just missed your voice, or why haven't the more enlightened parts of the business community commanded that the Federal Government go to a more representative budget- ing style, truly reflective of the difference between a capital budget and an operating budget? So many of us, when we agree with the President that there are advantages to making investments that are reflected in the capital budget, we do so because we believe that long-term net investment creates wealth for the country and creates just a better quality of life for everyone, as opposed to operating with difficulty or imbal- ances which may be using tomorrow's wealth to satisfy needs of today. Why isn't there a greater hue and cry from the Federal Re- serve and others to separate these economic distinctions? Obviously, the purchase or the implementation of a highway system is something that should not be charged off in 1 year. And how are we ever going to get away from the excessive misstate- ments of people using wrong comparisons if we do not get a more plausible budgetary strategy in this country? Mr. GREENSPAN. Mr. Chairman, there are differences between ac- counting in the private sector and accounting in the public sector. And indeed we do have estimates in the Federal budget process of Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 33 these various different types of investments. You can look through the appendices of the budget document and find fairly detailed analyses of what parts of government outlays are quasi investment type goods and under various classifications. But there is a fundamental question here which is important to address. And that is that as far as the financial markets are con- cerned, as far as the impact on interest rates, as far as the impact on financial stability, there is very little difference between fund- ing a project for capital purposes or for consumption purposes. The reason basically is that in the private sector a capital project is self-financing, meaning there are revenues which come directly from that project to repay the debt that has been incurred for the purpose of funding that particular project. To the extent that there are such projects in the Federal Govern- ment, that is, those which raise revenue, then there is an argu- ment in favor of a capital budget for those projects. But the vast variety of what we loosely call investment expenditures are very indirect in their impact on the economy, education, and a variety of other related sorts of issues, and do not directly have measurable cash-flows which are usable to repay the debt which was incurred. As a consequence, the financial markets tend not to make those distinctions, and probably will not unless we fund projects in a manner in which they would be self-financing. The classic case is the toll road, for example, in a State or municipal funding area. So, while I do think there are useful applications for capital budgeting in the Federal Government, I think we have to be very careful to recognize that there are major differences between the private and the public sectors, and be particularly wary of defining items as in- vestment rather than consumption and put them off budget be- cause the markets will not put them off budget, they will count them. My own counsel here is to be very careful in changing the budg- etary system. In my judgment the unified budget accounting system, while clearly having many flaws associated with it, has served us rather well over the years. Chairman KANJORSKI. But is it not creating internal confusion within the government itself as to whether or not we are going to be making decisions for investment or decisions for consumption? It is really a field day for the hypocrite to argue that internally a dollar spent is a dollar spent, when in fact if it is a dollar spent for some long-term investment purpose as compared to some immedi- ate consumption purpose, it may be a significant difference as to the long term well-being of the country. Mr. GREENSPAN. Mr. Chairman, I certainly don't deny that there are significant differences between various items in the budget outlay side of our accounts, depending on what they are used for. I don't question that. And I think that appropriate budget policy should very clearly make determinations of the appropriate composition of what we spend our resources on. I am only raising the question that so far as the financial markets are concerned, and this is relevant to what the Federal Reserve is interested in, that there appears to be no meaningful distinction being made unless projects are self-fi- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 34 nancing in a cash sense, not in a long term very difficult to meas- ure sense. Chairman KANJORSKI. I believe that the gentleman from Florida has another question. Mr. McCollum. Mr. MCCOLLUM. Thank you, Mr. Chairman. Chairman Greenspan, a lot of water has gone under the bridge in terms of words since I last asked you a few questions at the begin- ning of this hearing, and a lot of it has to do with tax and spend matters more than it has to do with monetary policy, although they are certainly interrelated. I would note in deference to the Chairman's comments about sta- tistics, one seems to be a pretty sound one that has out there that some of us remain finding useful and cause us to be skeptical about the current proposals in terms of the deficit reduction plan; that is, that since World War II, I think I am right, that for every dollar in tax increases that has occurred, the Congress has enacted, we have increased spending by about $1.57. And I think the public is concerned about that. It probably is re- flected in the business decisions you noted to us today in terms of anticipation of what is going to happen when you are really going to see over the next 3 or 4 years is substantial increase in taxes and whichever version apparently comes out of the House/Senate Conference on this budget deal, and you are going to see no real spending reductions at least planned for during that period of time, until virtually the end of the Clinton administration. And I just would submit that while there will be a great debate that will go on, I am not going to ask you a further question about this, this has been the heart I think of why you have been asked so many questions today on this subject. It is just a concern, how this reaction is in the business community and in the American public eye, skepticism about really getting deficit reduction, really hap- pening when so much is dependent upon early tax increases as op- posed to real spending reductions in the plan. Now, I do have a question or two, though, for you, that remain unanswered today. One of them has to do with your comment earli- er that the price of gold is sharply increased recently and you indi- cated in your testimony that was one of the concerns that the Fed- eral Reserve had in its monetary policymaking. My question, and what I want to ask you is, is this in your judg- ment a reflection of inflationary pressures at the moment? Is it, as some technical analysts say, a technical move that it would actual- ly go over $400 an ounce to some figure, that that is just in the nature of the beast for this cycle of gold to do that? Is it reflective of a contraction in the supply of gold because as we had a few years ago the Russians pulled in their horns on their gold supply? Do you have any data that could tell us what the forces at play are in this recent rise in the price of gold? Mr. GREENSPAN. There is considerable dispute amongst analysts about what causes gold prices to move. My own view is that the basic supply of gold in place essentially approximates all the gold that has ever been produced, going back to antiquity. And that therefore short-term changes in the supply and demand for gold, unlike the effect on other commodities, cannot have a major impact. From which I conclude that the substantial part of Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 35 the price change that occurs in gold is from the demand side, meaning if the supply is fundamentally fixed by the huge stock that exists, then the price changes as a consequence of demand. I have always interpreted the changes not on a day-by-day basis or even a week-by-week basis, as being a reflection of concerns about inflation because essentially what the gold price reflects is a concern about the purchasing power of currency or money. And while its ability to forecast changes in inflation is quite open to dispute, there is nonetheless a key question of whether it is a good measure of inflation expectations. And in that regard, it is something which we clearly have to look at because it is a measure which is not replicated in other forms. We obviously look at a wide variety of issues. But clearly, despite the narrowness of the gold market and even though it tends to be highly volatile and in many respects seems to reflect short-term supply and demand characterizations, over the longer run I think that it tells us something fundamentally about the view of the sta- bility of the currency. Mr. McCoLLUM. You and I discussed this over the years and I certainly concur that gold is a significant factor in terms of a meas- ure device. It can't be the only one and we even talked about a commodity basket that you have alluded to using from time to time as one of those many other things you look at besides the Ms. I wanted to ask one other question about a so-called Ron curve theory that you may be familiar with, and I have never been in the Presence of your testimony when you addressed that question. And am curious to know what you think of this theory. I want to state it as succinctly as I know it. It is that as government spending rises as a share of the gross domestic product, its contribution to eco- nomic growth slowly diminishes until it reaches a point where it actually retards economic growth. Are you familiar with this theory? Mr. GREENSPAN. I am not familiar with it in that particular form. I have heard of many different versions of that. It is essen- tially the notion that as the government share of the economy in- creases, the share that is available to the private sector decreases, and that unless you are to argue that capital productivity in the government sector is superior to the private sector, then clearly you end up with total gross domestic product slowing down. The classic case is a centrally planned economy where by defini- tion government controls 100 percent of the output. The experi- ences we have had in recent decades with that type of economic or- ganization clearly, if you want to call this a curve, fixes one point of where that curve is. But I am sure you will find that there is very great dispute within the economics profession as to where various different changes in government share of the GDP impact on economic activ- ity. Mr. McCoLLUM. But in principle that basic statement I read you, whatever it is called, I guess it is named after Richard Ron, the former economist down at the Chamber, is not divergent from your general view? Mr. GREENSPAN. No. If you are asking whether or not at some point the share of GDP which goes to government can come to the Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 36 point where it slows economic growth, the evidence of that is un- questioned. Sweden, for example, very recently has run into a prob- lem where they have perceived that the size of the government has been a retardation factor in their economic growth pattern. Mr. McCoLLUM. If the chairman would permit me, I would like just one last question. And it is a followup to what Mr. Neal asked you about on the Resolution Trust Corporation, only to this extent, because I don't want to get into a long discussion. We will go debate that on the floor here in a few days I guess. But I am curious, since he raised it, if you can switch your hat over there to that field again, is there a rationale that you are fa- miliar with of why the $7 to $10 billion that is sitting there in the cash holdings of the ETC or in the cash holdings available for re- solving these institutions has not been used at all in the last few months to resolve any of the 84, 85 of these institutions in conser- vatorship? That question has been raised of me several times lately, and I don't have a good answer for it one way or the other. Mr. GREENSPAN. I am not familiar with the particular issue, but I do know that they like to keep some spare resources in the event of some unanticipated event which might require action on their part. What the appropriate reserve is, frankly, I don't have a good judgment. Mr. McCoLLUM. I am just curious if you knew. That is all. I am not going to take more of your time. You've been very good to be with us today as always and we ap- preciate your coming up here, reporting to us. It is always fascinat- ing to me, as I said earlier on. I sat in several of these with you and it is a very good appearance, a very positive one I think for the Nation. Thank you very much. Thank you, Mr. Chairman. Chairman KANJORSKI. Thank you, Mr. McCollum. Mr. Chairman, I have just a few more questions and then we will let you get back to work. We have noticed that the activities of the Federal Open Market Committee meeting of May 18 were rather quickly leaked, although the transcript is usually kept from the public eye for some 60 days. And as you know, there have been suggestions that in order to not give certain people benefits with leaks, that the minutes of that committee be made immediately available so there is no one that gets a decided advantage. I guess what I would like to ask is whether there has been any determination as to who has had an advantage as a result of those leaks on May 18? And what can we expect the Fed to do to prevent future leaks? Mr. GREENSPAN. Obviously, we have been concerned about the problem. Leaks are a very serious matter and there is no question that to the extent that they occur, they are unfair to the public and potentially disruptive of the policymaking process. And I don't think it helps public confidence in the central bank to have every once in a while something leak out which is inappro- priate. We have reaffirmed our concerns and reaffirmed our poli- cies to make certain as best we can that that does not happen. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 37 The problem that we have in releasing the directive early or the minutes early is that in my judgment, and I think the judgment of my colleagues, is it significantly inhibits the efficiency of policy- making. The major issue is that in our deliberations, what we try to do is to create alternative paths that policy might take in the intermedi- ate period, depending on certain events that could occur. If we were to publish that immediately, the financial markets would re- spond and adjust to expectations of how we might or might not behave. That would make it very difficult for us to actually act, be- cause if, for example, we said under conditions A or B we might do something, and the markets interpreted that we might, then there would be an immediate adjustment in market rates. If we chose not to take action, then the markets would have to come down very sharply. And in our judgment that would create a degree of instability in the system which we find unacceptable. If it turns out that we were required to publish in advance, or I should say immediately, all of the deliberations, we could not use those contingencies. We would find ourselves probably with what we call symmetric directives, meaning on the one hand and on the other hand, and we wouldn't have any various different contingencies spelled out. We probably would act only after meeting, and we would meet far more often. That would be a far less efficient means of imple- menting the policies that we are trying to implement. We certainly recognize that in a democratic society it is very important for the central bank to communicate wherever possible not only what we do, but why we are doing it. And we hope that the minutes, which I think are really quite in- formative and capture the real essence of what those discussions were, does that. I would hope that we are not required to publish them immediately, because I think they would turn out to be very bland and the process of policy would indeed be undercut in my judgment. Chairman KANJORSKI. I understand the argument against the publishing of the minutes. But I am unsure that I fully have heard an answer as to what the Fed is doing about closing the leaks. Am I to understand that maybe this subcommittee could be help- ful in examining how those leaks operate? Should we examine that question? Mr. GREENSPAN. We have focused on this question a great deal recently. Obviously, it is something which we find very disturbing. I hope that we have put into place sufficient controls at this stage to eliminate leaks in the future. I don't know that for certain, but I suspect we may have. And I would hope that, as the months go by, it will become increasingly clear that we have succeeded in that endeavor. Chairman KANJORSKI. I am not going to ask you to spell out the controls, because obviously that would allow people to void the con- trols. But it is going to be my responsibility or the subcommittee to watch very closely, Mr. Chairman, and if there isn't a correction of that, to impose ourselves in some way to either find out what is happening, or to allow everyone to have the leaks simultaneously. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 38 And I tend to agree with you, that it will make the Federal Re- serve meeting its commitment far more difficult, but I don't know that we will have an alternative. Certainly, the pressure along that line is building up, contrary to your position. Mr. GREENSPAN. I appreciate your concerns, and I certainly ap- preciate your desires to be of assistance in this regard. Chairman KANJORSKI. Finally, I guess I am going to close with one last question. I do not know if you or your staff has had the opportunity to study H.R. 2600, the Secondary Market bill, which this subcommittee introduced about 2 weeks ago, establishing a sec- ondary market for business loans, both small, medium, and large, and for community development loans of various types. I was curious if you have any position on it or whether you have had the opportunity to study it. Mr. GREENSPAN. Well, earlier in the session, Mr. Chairman, I ex- pressed concerns about the fact that the credit crunch has not been fully resolved, that the financial system has not as yet adjusted to the balance sheet strains, and it is probably going to be a while before we can say we are back in some semblance of equilibrium in this regard. I must say that the area of greatest concern is in small business lending, because those are the types of establishments that do not have access to the capital markets as large corporations do, and can't finance independently of the banking system. There is no question in my mind that were we able to create a viable small business secondary market, it would facilitate small business lending. As I think I may have indicated to you before, Mr. Chairman, as I view the general thrust of your initiative, it is to essentially clear away some of the legal impediments that exist in the marketplace in a manner similar to that which was done with respect to the secondary market in home mortgages. So long as the development of a secondary market is created without direct or indirect government subsidies, either through a federally sponsored agency or through other subsidy means, I think it could be a very useful initiative to assist the financial market- place. I would emphasize that we have to be careful not to try to subsi- dize this market, because to the extent that it is a usable and viable market, as indeed I think it is, it will develop by itself. And if we find that we are creating subsidies, we are not going to be able to get out from under them. Once you get them in, they are very difficult to unwind. So I would try to emphasize, Mr. Chairman, that it is important that in evolving such legislation, that we be careful that subsidies not be involved and that what the structure of the facilitation is to clear away impediments which do exist in the creation of these markets. Because if that could be done, I think it would be a major contribution to the financial system. Chairman KANJORSKI. Thank you very much, Mr. Chairman. I am certainly pleased to hear your position on this issue. I wanted to compliment you in your report today. I felt that it was extremely bipartisan. Presently, we are in a struggle in the Con- gress which appears, unfortunately, to be very partisan at the time, Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 39 and I think most often that the American people are curious as to whether or not we can ever escape our partisan nature. But I think your testimony today indicates that although you come from an appointment of a prior administration, at least the Federal Reserve has the capacity to present a bipartisan position on the question of balancing the budget or reducing the deficit. I compliment you on that. I appreciate your report. I think it has been forthright, and I believe it indicates that the Federal Reserve is going to cooperate with the administration and the Congress in every way it can to move the recovery along, but in an organized, stable way, so that we do not suffer hyperinflation, nor should we experience undue economic trauma in the Nation as a whole. As a Member of Congress representing a small district in Penn- sylvania, I want to thank you for your appropiate position on this and for your report today. Mr. GREENSPAN. Thank you very much, Mr. Chairman. Chairman KANJORSKI. The subcommittee stands adjourned. [Whereupon, at 12:45 p.m., the hearing was adjourned.] Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 41 A P P E N D IX July 20, 1993 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 42 Opening Statement The Honorable Paul E. Kanjorski, Chairman Subcommittee on Economic Growth & Credit Formation Semi-Annual Hearing on the Conduct of Monetary Policy July 20,1993 The Subcommittee meets today to receive the semi-annual report of the Board of Governors of the Federal Reserve System on economic and monetary policy as mandated under the Full Employment and Balanced Growth Act of 1978, popularly known as the Humphrey-Hawkins Act. Under the Humphrey-Hawkins Act, the Federal Reserve is required to set forth: 1. A review and analysis of recent developments affecting economic trends in the Nation, including changes in the exchange rate; 2. The objectives and plans of the Board of Governors and the Federal Open Market Committee with respect to the ranges of growth or diminution of the money supply, taking into account past and prospective developments in employment, unemployment, production, investment, real income, productivity, international trade, and prices; and 3. The relationship between the Federal Reserve's plans and the short-term goals set forth in the most recent Economic Report of the President, and any goals set by the Congress. I want to welcome Chairman Greenspan back before the Subcommittee today. Since we last met to discuss monetary policy in February there have been major developments in our nation, the economy, the Congress, and at the Federal Reserve and the Federal Open Market Committee. Much of the economic news of the last six months has been encouraging: • Inflation remains low - The latest two months' Consumer Price Index numbers, 1/1 Oth of 1% in May and no change in June, are the lowest numbers since the bottom of the 1991 recession. • Interest rates remain low - The 30-year Treasury rates have fallen to almost 6.5% - the lowest level since the Treasury began regular sales of 30-year bonds in 1977. The three-month T- bill rate hovers around 3%. Home mortgage rates are also at twenty year lows, with 30-year fixed rate mortgages at just over 7%. • Refinancings continue at an almost unprecedented pace - saving consumers and businesses tens of billions of dollars in interest costs. This makes it possible for consumers and businesses alike to reduce their debt burden, to increase their savings, and to stimulate the economy by making new purchases. Three-and-one-half million families refinance their mortgages in 1992, Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 43 seven times more refinancings than occurred in 1991, and the refinancing boom is continuing in 1993. The average refinancing saves consumers at least 2% in interest thus reducing the overall debt burdens by $20 to $30 billion a year. Fannie Mae surveys indicate that for home mortgages 45% of this reduced debt burden is going into savings, 35% is being used to pay off other bills, and 10% is being used to increase consumption. • Bank and thrift profits are up and the cost of the S&L clean-up is dropping - The FDIC's Bank Insurance Fund (BEF) is back in the black, and for the first time since 1985 clean-up costs are going down, not up, and the end may actually be in sight. Over the last two years, bank assets and deposits have grown modestly, problem loans have decreased by more than a quarter (from $104 billion to $74.6 billion), the proportion of problems loans exceeding loan loss reserves has been slashed by more than 50% (from $46 billion to $19.8 billion), and capital has increased by r.lmost a quarter (from $239 billion to $292 billion). • Both houses of the Congress have passed major deficit reduction legislation - While the margin may not have been as large or as bi-partisan as we might have liked, the deficit reduction is real, there is no smoke-and-mirrors, the numbers are headed in the right direction, and this will be the largest deficit reduction package in the history of our nation. While there has been progress on many fronts, storm clouds remain in sight: • Unemployment - remains stuck at 7%. While this is a 10% improvement from a year ago when the rate was 7.7%, there has been virtually no change in recent months. • Commercial & industrial lending - also remains stagnant at just under $600 billion. As the Subcommittee's field hearings in Nanticoke City and Cranberry Township, Pennsylvania, and Ashtabula, Ohio, have indicated, small- and medium-sized businesses are still having difficulty securing and retaining lines of credit. This is particularly troubling because robust economic recovery will continue to be held back unless significant improvements are made in this area. Despite the assurances we have received from many in the commercial banking industry, there is no question in my mind that the business credit crunch is very real and represents a significant impediment to economic recovery. Hopefully the series of regulatory steps announced by the Clinton Administration will have a positive effect in making more credit available. I should also note that this Subcommittee is making substantial progress in developing legislation to assist in the creation of an active and broad secondary market for business, commercial, and community development debt and equity investments. On July 1, a number of my colleagues joined me in introducing H.R. 2600. Hearings on this legislation are planned for September, and I look forward to its timely consideration by the Subcommittee. • Also of particular concern has been the recent flooding in the midwest and heat waves in the east. Billions of dollars of crops, homes and businesses have been destroyed, substantially increasing the need for credit and disaster assistance at a time when collateral has been destroyed and we are trying to reduce the deficit. Normal supply lines have been cut or disrupted, and transportation costs for products will escalate. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 44 As Chairman Greenspan is aware, critics of the Federal Reserve contend that its repeated inability to meet even the low-end estimates for monetary growth have contributed to the sluggishness of the economic recovery and the stubborn resistance of the unemployment rate. Given the magnitude of the disaster in our nation's heartland, it is imperative that Chairman Greenspan explain today how the Federal Reserve will work with President Clinton and the Congress to ensure the families, farmers, and businessmen in the flood-ravaged midwest that they will have access to the credit they need to rebuild, at rates they can afford. Unfortunately, the federal government cannot afford to replace every home and business that has been flooded, and we cannot make farmers whole for the crops they have lost. That makes the availability of affordable credit even more important than it normally is. As the representative of a district which suffered from a similarly devastating flood in 1972. I know how disruptive a flood is and how important credit is to the rebuilding process. Like all Americans, my heart goes out to those in the flood region. I hope that in his testimony today, Chairman Greenspan will spell out the specific steps that the Federal Reserve and the Federal Open Market Committee are prepared to take to ensure that affordable credit is available to the families, farmers and businesses whose lives and livelihoods have been irreparably damaged by the rising waters of the Mississippi and its tributaries. Finally, during its May 18 meeting, a majority of the Open Market Committee expressed a probably unwarranted concern that inflation was rising. As a result it also gave what I believe is virtually unprecedented authority to the Chairman to make changes "on the understanding that the Committee would have a chance to discuss any possible policy action." I would appreciate it if Chairman Greenspan would comment on whether or not the inflationary fears expressed at the May 18 meeting have proven warranted; whether he used the extraordinary authority he was given at that meeting, and if so, how; and whether or not we can expect that in the future the Open Market Committee will continue to delegate such broad discretion to the Chairman. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 45 For use at 9:45 a.m. EDT Tuesday July 20, 1993 Testimony by Alan Greenspan Chairman Board of Governors of the Federal Reserve System before the Subcommittee on Economic Growth and Credit Formation of the Committee on Banking, Finance and Urban Affairs U.S. House of Representatives July 20, 1993 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 46 Thank you for this opportunity to discuss the Federal Reserve's semiannual monetary policy report to the Congress. My remarks this morning will cover the current monetary policy and economic settings, as well as the Federal Reserve's longer-term strategy for contributing, to the best of our abilities, to the nation's economic well-being. As the economic expansion has progressed somewhat fitfully, our earlier characterization of the economy as facing stiff head winds has appeared increasingly appropriate. Doubtless the major head wind in this regard has been the combined efforts of households, businesses, and financial institutions to repair and to rebuild their balance sheets following the damage inflicted in recent years as weakening asset values exposed excessive debt burdens. But there have been other head winds as well. The build-down of-national defense has cast a shadow over particular industries and regions of the country. Spending on nonresidential real estate dropped dramatically in the face of overbuilding and high vacancy rates and has remained in the doldrums. At the same time, corporations across a wide range of industries have been making efforts to pare employment and expenses in order to improve productivity and their competitive positions. These efforts have been prompted in part by innovative technologies, which have been applied to almost every area of economic endeavor, and have boosted investment. However, their effect on jobs and wages through much of the expansion also has made households more cautious spenders. In the past several years, as these influences have restrained the economy, they have been balanced in part by the accommodative stance of monetary policy and, more recently, by declines in longer-term interest rates as the prospects for credible Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 47 federal deficit cuts improved. From the time monetary policy began to move toward ease in 1989 to now, short-term interest rates have dropped by more than two-thirds and long-term rates have declined substantially, too. All along the maturity spectrum, interest rates have come down to their lowest levels in twenty or thirty years, aiding the repair of balance sheets, bolstering the cash flow of borrowers, and providing support for interest-sensitive spending. The process of easing monetary policy, however, had to be closely controlled and generally gradual, because of the constraint imposed by the marketplace's acute sensitivity to inflation. As I pointed out in my February testimony to the Congress, this is a constraint that did not exist in an earlier time. Before the late 1970s, financial market participants and others apparently believed that, while inflationary pressures might surface from time to time, the institutional structure of the U.S. economy simply would not permit sustained inflation. But as inflation and, consequently, long- term interest rates soared into the double digits at the end of the 1970s, investors became painfully aware that they had underestimated the economy's potential for inflation. As a result, monetary policy in recent years has had to remain alert to the possibility that an ill-timed easing could be undone by a flare-up of inflation expectations, pushing long-term interest rates higher, and short- circuiting essential balance sheet repair. The cumulative monetary easing over the last four years has been very substantial. Since last September, however, no further steps have been taken, as the stance of policy has appeared broadly appropriate to the evolving economic circumstances. That stance has been quite accommodative, especially judging by the level of real short-term interest rates in the context of, on Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 48 average, moderate economic growth. Short-term real interest rates have been in the neighborhood of zero over the last three quarters. In maintaining this accommodative stance, we have been persuaded by the evidence of persistent slack in labor and product markets, increasing international competitiveness, and the decided absence of excessive credit and money expansion. The forces that engendered past inflationary episodes appear to have been lacking to date. Yet some of the readings on inflation earlier this year were disturbing. It appeared that prices might be accelerating despite product market slack and an unemployment rate noticeably above estimates of the so-called "natural" rate of unemployment--that is, the rate at which price pressures remain roughly constant. In the past, the existing degree of slack in the economy had been consistent with continuing disinflation. However, the inflation outcome, history tells us, depends not only on the amount of slack remaining in labor and product markets, but on other factors as well, including the rate at which that slack is changing. If the economy is growing rapidly, inflation pressures can arise, even in the face of excess capacity, as temporary bottlenecks emerge and as workers and producers raise wages and prices in anticipation of continued strengthening in demand. Near the end of last year, about the time many firms probably were finalizing their plans for 1993, sales and capacity utilization were moving up markedly and there was a surge of optimism about future economic activity. This may well have set in motion a wave of price increases, which showed through to broad measures of prices earlier this year. Moreover, inflation expectations, at least by some measures, appear to have tilted upward this year, possibly contributing to price pressures. The University of Michigan survey of consumer attitudes, Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 49 for example, reported an increase in the inflation rate expected to prevail over the next 12 months from about 3-3/4 percent in the fourth quarter of last year to nearly 4-1/2 percent in the latest quarter. Preliminary data imply some easing of such expectations earlier this month, but the sample from which those data are derived is too small to be persuasive. Moreover, the price of gold, which can be broadly reflective of inflationary expectations, has risen sharply in recent months. And at times this spring, bond yields spiked higher when incoming news about inflation was most discouraging. The role of expectations in the inflation process is crucial. Even expectations not validated by economic fundamentals can themselves add appreciably to wage and price pressures for a considerable period, potentially derailing the economy from its growth track. Why, for example, despite an above-normal rate of unemployment and permanent layoffs, have uncertainties about job security not led to further moderation in wage increases? The answer appears to lie at least in part in the deep-seated anticipations understandably harbored by workers that inflation is likely to reaccelerate in the near term and undercut their real wages. The Federal Open Market Committee (FOMC) became concerned that inflation expectations and price pressures, unless contained, could raise long-term interest rates and stall economic expansion. Consequently, at its meeting in May, while affirming the more accommodative policy stance in place since last September, the FOMC also deemed it appropriate to initiate a so-called asymmetric directive. Such a directive, with its bias in the direction of a possible firming of policy over the intermeeting period, does not prejudge that action will be taken--and indeed none occurred. But it Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 50 did indicate that further signs of a potential deterioration of the inflation outlook would merit serious consideration of whether short- term rates needed to be raised slightly from their relatively low levels to ensure that financial conditions remained conducive to sustained growth. Certainly the May and June price figures have helped assuage concerns that new inflationary pressures had taken hold. Nonetheless, on balance, the news on inflation this year must be characterized as disappointing. Despite disinflationary forces and continued slack, the rate of inflation has at best stabilized, rather than easing further as past relationships would have suggested. In assessing the stance of monetary policy and the likelihood of persistent inflationary pressures, the FOMC took account of the downshift in the pace of economic expansion earlier this year. This downshift left considerable remaining slack in the economy and promised that the adverse price movements prompted by the acceleration in growth late last year likely would diminish. While a slowdown from the unsustainably rapid growth in the latter part of last year had been anticipated, the deceleration was greater than expected. A surprisingly precipitous drop in defense spending, a sharp deterioration in net exports, a major blizzard, and some inevitable retrenchment by consumers converged to yield only meager gains in output in the first quarter. But growth apparently picked up in the second quarter, and nearly one million net new jobs were created over the first half. Smoothing through the quarterly pattern, the economy appears to have accelerated gradually over the past two years, to maintain a pace of growth that should yield further reductions in the unemployment rate. Consequently, the evidence remains consistent with our diagnosis that the underlying forces at Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 51 work are keeping the economy generally on a moderate upward track. However, as I have often emphasized, not all the old economic and financial verities have held in the current expansion, and changes in fiscal policy will have uncertain effects going forward. Thus, caution in assessing the path for the economy remains appropriate. Financial conditions have improved considerably, lessening the need for balance sheet restructuring that has been damping economic activity for several years now. By no means is the process over, but good progress has been made. Debt service burdens, eased by lower interest rates and lower debt-equity ratios, have fallen substantially in both the business and household sectors. On the other hand, the economies of a number of our major trading partners have been quite weak, constraining the growth of demand for our exports. Although expectations of a significant, credible decline in the budget deficit have induced lower long-term interest rates and favorably affected the economy, the positive influence thus far is apparently being at least partly offset by some business spending reductions as a consequence of concerns about the effects of pending tax increases. It seems that the prospective cuts in the deficit are having a variety of substantial economic effects, well in advance of any actual change in taxes or in projected outlays. Moreover, uncertainty about the final shape of the package may itself be injecting a note of caution into private spending plans. In addition, uncertainty about the outlook for health care reform may be affecting spending at least by that industry. To be sure, the conventional wisdom is that budget deficit reduction restrains economic growth for a time, and I suspect that Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 52 probably is correct. However, over the long run, such wisdom points in the opposite direction. In fact, one can infer that recent declines in long-term interest rates are bringing forward some of these anticipated long-term gains. As a consequence, the timing and magnitude of any net restraint from deficit reduction is uncertain. Patently, the overall economic effect of fiscal policy, especially when combined with the uncertainties of the forthcoming health reform package, has imparted a number of unconventional unknowns to the economic outlook. Assuming, however, we constructively resolve over time the major questions about federal budget and health care policies, with the further waning of earlier restraints on growth, the U.S. economy should eventually emerge healthier and more vibrant than in decades. The balance sheet restructuring of both financial and nonfinancial establishments in recent years should leave the various sectors of the economy in much better shape and better able to weather untoward developments. Similarly, the ongoing efforts by corporations to pare expenses are putting our firms and our industries in a better position to compete both within the U.S. market and globally. And after a period of some dislocation, the contraction in the defense sector ultimately will mean a freeing up of resources for more productive uses. Finally, a credible and effective fiscal package would promise an improved outlook for sustained lower long-term interest rates and a better environment for private sector investment. All told, the productive capacity of the economy will doubtless be higher, and its resilience greater. Over the last two years, the forces of restraint on the economy have changed, but real growth has continued, with one sector of the economy after another taking the lead. Against this Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 53 background, Federal Reserve Board governors and Reserve Bank presidents project that the U.S. economy will remain on the moderate growth path it has been following as the expansion has progressed. Their forecasts for real GDP average around 2-1/2 percent from the fourth quarter of 1992 to the fourth quarter of 1993, and cluster around 2-1/2 to 3-1/4 percent over the four quarters of 1994. Reflecting this moderate rise and the outlook for labor productivity, unemployment is generally expected to edge lower, to around 6-3/4 percent by the end of this year, and to perhaps a shade lower by the end of next year. For this year as a whole, FOMC participants see' inflation at or just above 3 percent, and most of them have about the same forecast for next year. In addition to focusing on the outlook for the economy at its July meeting, the FOMC, as required by the Humphrey-Hawkins Act, set ranges for the growth of money and debt for this year and', on a preliminary basis, for 1994. One premise of the discussion of the ranges was that the uncharacteristically slow growth of the broad monetary aggregates in the last couple of years--and the atypical increases in their velocities --would persist for a while longer. M2 has been far weaker than income and interest rates would predict. Indeed, if the historical relationships between M2 and nominal income had remained intact, the behavior of M2 in recent years would have been consistent with an economy in severe contraction. To an important degree, the behavior of M2 has reflected structural changes in the financial sector: The thrift industry has downsized by necessity, and commercial banks have pulled back as well, largely reflecting the burgeoning loan losses that followed the lax lending of earlier years. With depository credit weak, there has been little bidding for deposits, and depositors in any case have been drawn to Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 54 the higher returns on capital market instruments. Inflows to bond and stock mutual funds have reached record levels, and, to the extent that these inflows have come at the expense of growth in deposits or money market mutual funds, the broad monetary aggregates have been depressed. In this context, the FOMC lowered the 1993 ranges for M2 and M3--to 1 to 5 percent and 0 to 4 percent, respectively. This represents a reduction of 1 percentage point in the M2 range and 1/2 percentage point for M3. Even with these reductions, we would not be surprised to see the monetary aggregates finish the year near the lower ends of their ranges. As I emphasized in a similar context in February, the lowering of the ranges is purely a technical matter; it does not indicate, nor should it be perceived as, a shift of monetary policy in the direction of restraint. It is indicative merely of the state of our knowledge about the factors depressing the growth of the aggregates relative to spending, of the course of the aggregates to date, and of the likelihood of various outcomes through the end of the year. While the lowering of the range reflects our judgment that shifts out of M2 will persist, the upper end of the revised range allows for a resumption of more normal behavior or even some unwinding of M2 shortfalls. The FOMC also lowered the 1993 range for debt of the domestic nonfinancial sectors, by 1/2 percentage point, to 4 to 8 percent. The debt aggregate is likely to come in comfortably within its new range, as it continues growing about in line with nominal GDP. The new ranges for growth of money and debt in 1993 were carried over on a preliminary basis into 1994. In reading the longer-run intentions of the FOMC, the specific ranges need to be interpreted cautiously. The historical Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 55 relationships between money and income, and between money and the price level have largely broken down, depriving the aggregates of much of their usefulness as guides to policy. At least for the time being, M2 has been downgraded as a reliable indicator of financial conditions in the economy, and no single variable has yet been identified to take its place. At one time, M2 was useful both to guide Federal Reserve policy and to communicate the thrust of monetary policy to others. Even then, however, a wide range of data was routinely evaluated to assure ourselves that M2 was capturing the important elements in the financial system that would affect the economy. The FOMC never single-mindedly adhered to a narrow path for M2, but persistent and sizable deviations of that aggregate from expectations were a warning sign that policy and the economy might not be interacting in a way that would produce the desired results. The so-called "P-star" model, developed in the late 1980s, embodied a long-run relationship between M2 and prices that could anchor policy over extended periods of time. But that long-run relationship also seems to have broken down with the persistent rise in M2 velocity. M2 and P-star may reemerge as reliable indicators of income and prices once the yield curve has returned to a more normal configuration, borrowers' balance sheets have been restored and traditional credit demands resume, savers have adjusted to the enhanced availability of alternative investments, and depositories finally reach a comfortable size relative to their capital and earnings. In the meantime, the process of probing a variety of data to ascertain underlying economic and financial conditions has become even more essential to formulating sound monetary policy. This general approach obviously has its weaknesses. When examining many Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 56 indicators, some can always be found that counsel against actions that later appear to have been necessary. In these circumstances, it is especially prudent to focus on longer-term policy guides. One important guidepost is real interest rates, which have a key bearing on longer-run spending decisions and inflation prospects. In assessing real rates, the central issue is their relationship to an equilibrium interest rate, specifically the real rate level that, if maintained, would keep the economy at its production potential over time. Rates persisting above that level, history tells us, tend to be associated with slack, disinflation, and economic stagnation--below that level with eventual resource bottlenecks and rising inflation, which ultimately engenders economic contraction. Maintaining the real rate around its equilibrium level should have a stabilizing effect on the economy, directing production toward its long-term potential. The level of the equilibrium real rate--or more appropriately the equilibrium term structure of real rates--cannot be estimated with a great deal of confidence, though with enough to be useful for monetary policy. Real rates, of course, are not directly observable, but must be inferred from nominal interest rates and estimates of inflation expectations. The most important real rates for private spending decisions almost surely are the longer maturities. Moreover, the equilibrium rate structure responds to the ebb and flow of underlying forces affecting spending. So, for example, in recent years the appropriate real rate structure doubtless has been depressed by the head winds of balance sheet restructuring and fiscal retrenchment. Despite the uncertainties about the levels of equilibrium and actual real interest rates, rough judgments about Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 57 these variables can be made and used in conjunction with other indicators in the monetary policy process. Currently, short-term real rates, most directly affected by the Federal Reserve, are not far from zero; long-term rates, set primarily by the market, are appreciably higher, judging from the steep slope of the yield curve and reasonable suppositions about inflation expectations. This configuration indicates that market participants anticipate that short-term real rates will have to rise as the head winds diminish, if substantial inflationary imbalances are to be avoided. While the guides we have for policy may have changed recently, our goals have not. As I have indicated many times to this Committee, the Federal Reserve seeks to foster maximum sustainable economic growth and rising standards of living. And in that endeavor, the most productive function the central bank can perform is to achieve and maintain price stability. Inflation is counterproductive in many ways. Of particular importance, increased inflation has been' found to be associated with reduced growth of productivity, apparently in part because it confounds relative price movements and obscures price signals. Compounding this negative effect, under the current tax code, inflation raises the effective taxation of savings and investment, discouraging the process of capital formation. Since productivity growth is the only source of lasting increases in real incomes and because even small changes in growth rates of productivity can accumulate over time to large differences in living standards, its association with inflation is of key importance to policymakers. The link between the control of inflation and the growth of productivity underscores the importance of providing a stable backdrop for the economy. Such an environment is especially important for an Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 58 increasingly dynamic market economy, such as ours, where technology and telecommunications are making rapid advances. New firms, new products, new jobs, new industries, and new markets are continually being created, and they are unceremoniously displacing the old ones. The U.S. economy is a dynamic system, always renewing itself. It is extraordinary that the system overall is as stable as it is, considering the persistent process of change in the structure of our economy. For example, a frequently cited figure is the two million new jobs that have been created since the end of 1991. This is a net change, however, which masks the many millions who found, lost, and changed jobs over the same period. Currently, people are being hired at a pace of approximately 400,000 per week, with job losses running modestly below that figure. Such vast churning in the nation's labor markets is a normal and ultimately a productive process. Central planning of the type that prevailed in post-war Eastern Europe and the Soviet Union represented one attempt to fashion an economic system that eliminated this competitive churning and its presumed wastefulness. But when that system eliminated the risk of failure, it also stifled the incentive to innovate and to prosper. Central planning fostered stasis: In many respects, the eastern-bloc economies marched in place for more than four decades. Risk-taking is crucial in the process that leads to a vital and progressive economy. Indeed, it is a necessary condition for wealth creation. In a market economy, competition and innovation interact; those firms that are slow to innovate or to anticipate the demands of the consumer are soon left behind. The pace of churning differs by industry, but it is present in all. At one extreme, firms in the most high-tech areas must remain constantly on the cutting edge, as products and knowledge become rapidly obsolete. Many Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 59 products that were at technology's leading edge, say five years ago, are virtually unsalable in today's markets. In high-tech fields, leadership can shift rapidly. In some markets where American firms were losing share just a few years ago, we have regained considerable dominance. In one case, U.S. firms have seized a commanding lead in just two years in the new laptop computer market, and now account for more than 60 percent of U.S. sales last year, triple the figure for Japanese firms. More generally, it appears that the pace of dynamism has been accelerating. As one indication, the average economic life expectancy of new capital equipment has been falling. The average life of equipment purchased in 1982, for example, was 16-1/2 years. By 1992 that figure had declined to 14-1/2 years, a drop more than twice as large as that over the preceding decade. In addition, telecommunications technology is obviously quickening the' decision- making process in both financial and product markets. In such a rapidly changing marketplace, the agile survive by being flexible. One aspect of this flexibility has been the spread of "just-in-time" inventory controls at manufacturing firms. Partly as a result of innovations in inventory control techniques, the variability of inventories relative to total output appears to be on a downtrend. The possibility of failure has productive side effects, encouraging economic agents to do their best to succeed. But there are nonproductive and unnecessary risks as well. There is no way to avoid risk altogether, given the inherently uncertain outcomes of all business and household decisions. But many uncertainties and risks do not foster economic progress, and where feasible should be suppressed. A crucial risk in this category is that induced by inflation. To Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 60 allow a market economy to attain its potential, the unnecessary instability engendered by inflation must be quieted. A monetary policy that aims at price stability permits low long-term interest rates and helps provide a stable setting to foster the investment and innovation by the private sector that are key to long-run economic growth. In pursuing our objectives, we must remain acutely aware that the structure of the economy has been changing and growing ever more complex. The relationships between the key variables in the economy are always shifting to a degree, and this evolution presents an ongoing challenge to the business leader, to the econometric modeler, and to those responsible for the conduct of economic policy. Clearly, the behavior of many of the forces acting on the economy over the course of the last business cycle have been different from what had gone before. The sensitivity of inflation expectations has been heightened, and, as recent evidence suggests, businesses and households may be becoming more forward-looking with respect to fiscal policies as well. I believe we are on our way toward reestablishing the trust in the purchasing power of the dollar that is crucial to maximizing and fulfilling the productive capacity of this nation. The public, however, clearly remains to be convinced: Survey responses and financial market prices embody expectations that the current lower level of inflation not only will not be bettered, it will not even persist. But there are glimmers of hope that trust is reemerging. For example, issuers have found receptive markets in recent months for fifty-year bonds. This had not happened in decades. The reopening of that market may be read as one indication that some investors once again believe that inflationary pressures will remain subdued. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 61 It is my firm belief that, with fiscal consolidation and with the monetary policy path that we have charted, the United States is well-positioned to remain at the forefront of the world economy well into the next century. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 62 For use at 9:45 a.m., E.D.T. Tuesday July 20,1993 Board of Governors of the Federal Reserve System Monetary Policy Report to the Congress Pursuant to the Full Employment and Balanced Growth Act of 1978 July 20, 1993 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 63 Letter of Transmittal BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM Washington, D.C., July 20, 1993 THE PRESIDENT OF THE SENATE THE SPEAKER OF THE HOUSE OF REPRESENTATIVES The Board of Governors is pleased to submit its Monetary Policy Report to the Congress, pursuant to the Full Employment and Balanced Growth Act of 1978. Sincerely, Alan Greenspan, Chairman Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 64 Table of Contents Page Section 1: Monetary Policy and the Economic Outlook for 1993 and 1994 1 Section 2: The Performance of the Economy in 1993 6 Section 3: Monetary and Financial Developments in 1993 1<7 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 65 Section 1: Monetary Policy and the Economic Outlook for 1993 and 1994 In February, when the Federal Reserve prepared its With the exception of business fixed investment, the monetary policy plans for 1993, the broad trends in slowdown cut across the major categories of final the economy appeared favorable. After a hesitant demand. After stepping up their spending in late beginning, the economic expansion had picked up 1992, consumers became more pessimistic about their steam in the latter part of 1992, while inflation economic prospects and more cautious in their spend- seemed still to be headed downward. Most members ing decisions; the uncertainty surrounding the efforts of the Federal Open Market Committee (FOMC) and to reduce the federal deficit may have been a factor in nonvoting presidents anticipated that 1993 would be a the weakening of household sentiment. Housing activ- good year for growth and would also see further ity, which also had been exceptionally strong late last progress toward price stability. year, hit a lull—even before the March blizzard on the East Coast—and real defense purchases plunged. As the year has unfolded, however, the economy's Moreover, net exports deteriorated sharply, as exports performance has fallen short of these expectations. declined and imports surged; the drop in exports was Economic growth has slowed appreciably from the attributable in part to continued weak growth in some pace late last year; in part, this has reflected a retreat other industrial countries and in part was an adjust- in business and consumer confidence and the effects ment to the big increase in late 1992. on our trade balance of weakness in a number of other industrial countries. Like most private forecasters, the The more recent statistical indicators, taken Board members and Bank presidents generally have together, point to a resumption of moderate growth in trimmed their projections of growth in real gross real GDP in the second quarter. Most notably, on the domestic product (GDP) for the year as a whole, positive side, the increase in aggregate hours worked although they continue to foresee increases in output for the quarter as a whole—a useful indicator of large enough to extend the reduction in the unemploy- movements in overall output—was the largest of the ment rate that began last summer. Events on the price current expansion. Sales of motor vehicles also exhib- side also have been disappointing. The inflation rate ited considerable vigor. But other key indicators were in the first part of this year was higher than in late less robust. In particular, after allowing for the effects 1992. There is evidence that some of the pickup in the of the blizzard, consumer spending on items other consumer price index (CPI) may have reflected diffi- than motor vehicles was lackluster, and housing activ- culties in seasonal adjustment, and price data for the ity improved only modestly. In the manufacturing past couple of months have been much more favor- sector, orders generally remained soft, and factory able. Nonetheless, a broad array of indicators points output, after having posted solid gains over the pre- to a leveling out of the underlying inflation trend. ceding seven months, is estimated to have declined somewhat over May and June. In this circumstance, and with short-term interest rates unusually low, especially when compared with Broad measures of inflation picked up in early inflation, the Federal Reserve recognized a need to be 1993, with monthly increases through April in the alert to the possibility that the balance of risks in the upper part of the range of the past couple of years. economy could shift soon in a direction dictating Although readings on consumer and producer prices some firming of policy; failure to act in a timely were much more favorable in May and June, the manner could lead to a buildup of inflationary pres- cumulative price and wage data for the year to date sures, to adverse reactions in financial markets, and suggest that underlying inflation has flattened out, ultimately to the disruption of the growth process. To after trending down over the preceding two years. this point, however, the moderate thrust of aggregate Excluding the especially volatile food and energy demand and considerable slack in the economy, taken components, the twelve-month change in the CPI has together with the more subdued price data of late, do held in the range of 3*/4 to 31/2 percent since the not suggest that a sustained upswing in inflation is at summer of 1992. hand. Accordingly, the Federal Reserve has not ad- In financial markets, short-term interest rates have justed its monetary policy instruments. changed little so far in 1993, while intermediate- and The pace of economic growth in the final quarter of long-term interest rates have fallen three-quarters to 1992 was not expected to be sustained, but the slow- one percentage point to their lowest levels in over ing in the first quarter of 1993 was surprisingly sharp. twenty years. The decline in longer-term rates seems Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 66 largely to have been a response to the enhanced their part, have continued to shift funds into capital prospects for credible fiscal' restraint, though the markets, attracted by still-high returns in these mar- slower pace of economic expansion may also have kets relative to earnings on deposits. Inflows into played a role. Falling interest rates have helped stock bond and equity mutual funds have run at record market indexes set new records. Despite a decline in levels this year, and banks have facilitated investing the dollar versus the yen, the average value of the in mutual fund products by increasingly offering them dollar on a trade-weighted basis relative to G-10 in their lobbies. As a consequence of these various currencies has risen, on balance, since the end of forces, M2 increased at only a 3A percent annual rate 1992. Although foreign intermediate-term interest from its fourth-quarter 1992 average through June, rates have been down, on average, about as much as while M3 fell slightly. The sum of M2 and estimated U.S. interest rates, short-term rates abroad have household holdings of long-term mutual funds grew decreased substantially relative to U.S. rates, as for- at about a 43/4 percent rate from the fourth quarter eign monetary authorities have taken steps to bolster through June, little changed from the pace of recent weak economies. years. Declining U.S. market interest rates contributed to Debt growth has edged up this year, despite a robust growth in narrow measures of money and in deceleration in nominal spending, perhaps buoyed by reserves over the first half of the year, but broad improvements in financial positions achieved over the monetary aggregates were very weak and their veloc- past few years by both borrowers and lenders. Invest- ities continued to show exceptional increases. Credit ment outlays are estimated to have exceeded the demands on depositories remained quite subdued internal funds of corporations for the first time in two relative to spending, considerable depository credit years, while household borrowing has picked up rela- was funded from nonmonetary sources, and savers tive to spending. In addition, Treasury financing needs continued to demonstrate a marked preference for have remained heavy. Nevertheless, nonfinancial debt capital market instruments over money stock assets. growth has been running at only a 5 percent rate this year. In part owing to the drop in bond and stock yields, as well as to the desire to strengthen balance sheets, corporate borrowers have continued to concentrate Monetary Objectives for 1993 and 1994 credit demands on long-term securities markets, using In reviewing the annual ranges for the monetary the proceeds in part to repay bank loans; business aggregates in 1993, the FOMC noted that the rela- loans at banks have not grown this year, although tionship of broadly defined money to income has con- there were tentative signs of a pickup over May and tinued to depart from historical patterns. The annual June. Total lending and credit growth at banks has velocities of these aggregates last fell in 1986, and risen only slightly from the depressed pace of 1992, their prolonged upward movements since then and these institutions have therefore not needed to strongly suggest breaks from previous long-run trends pursue deposits. Thrifts have continued to contract, of flat velocity for M2 and slowly decreasing veloc- but at a much slower pace than in recent years. ity for M3. The rise in the velocity measures has been Banks have eased lending standards for smaller particularly surprising in the last four years, a period firms for several quarters and recently relaxed stan- of declining interest rates, normally associated with a dards for medium- and large-sized firms as well. An reduction in velocity. increased willingness to lend on the part of banks has In February, anticipating that further balance sheet been associated with considerably more comfortable restructuring and portfolio shifts from deposits to capital positions. Banks have continued to strengthen mutual funds would result in further increases in their balance sheets by issuing large volumes of velocity, the FOMC lowered the 1993 growth ranges equity and subordinated debt, while retaining a sub- for M2 and M3 by one-half percentage point from the stantial amount of earnings. As a result, the portion of provisional ranges set in July 1992. In fact, velocities the industry that is well-capitalized (taking account of of the broad monetary aggregates have been espe- supervisory ratings as well as capital ratios) increased cially strong; in the first quarter of 1993, the veloci- from about one-third at the end of 1991 to more than ties of M2 and M3 posted substantial increases of two-thirds by March 1993. 6'/4 percent and 8 percent, respectively, and appear to In turning to equity and other nondeposit funds, have recorded additional, but smaller, gains in the banks have reduced the share of depository credit that second quarter. As a consequence, at its meeting this is financed by monetary liabilities. Depositors, for month, the Committee reduced the 1993 range for M2 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 67 Ranges for Growth of Monetary and Credit Aggregates 1993 1993 1992 (As of February) (As of July) 1994 Percentage change, fourth quarter to fourth quarter M2 21/2 to 61/2 2 to 6 1 to 5 1 to 5 M3 1 to 5 1/2 tO 41/2 Oto4 Oto4 Debt 41/2 to 81/2 41/2 to 81/2 4 to 8 4 to 8 by an additional percentage point and the range for the deliberations of the Federal Open Market Com- M3 by another one-half percentage point, leaving mittee, generally anticipate that economic activity them at 1 to 5 percent for M2 and 0 to 4 percent for will strengthen in the second half of 1993 and con- M3. tinue to expand moderately in 1994. The growth of The reductions of these growth ranges represented output is likely to be accompanied by further gains in further technical adjustments in response to actual productivity, but increases in employment are pro- and anticipated increases in velocity and not a shift in jected to be large enough to keep the unemploy- monetary policy, which remains focused on fostering ment rate moving down. Inflation is not expected to sustainable economic expansion while making contin- change materially over this period. ued progress toward price stability. With further sub- The forecasts of the Board members and Reserve stantial increases in velocities, continued sluggish Bank presidents for economic growth in 1993 are expansion of M2 and M3, which are now at the lower somewhat weaker than in February, mainly because ends of their revised ranges, would be consistent with of the shortfall in real growth in the first quarter. Most an acceptable track for the economy. Also at the July expect output gains over the balance of the year to be meeting, the annual monitoring range for the domes- large enough to result in a four-quarter change in real tic nonfinancial debt aggregate was reduced by one- gross domestic product in the range of 2!/4 to 2% per- half percentage point to 4 to 8 percent; growth in this cent; for 1994, the central tendency of the forecasts aggregate is likely to continue to be roughly in line spans a range of 2'/2 to 3'/4 percent. The civilian with that of nominal GDP. unemployment rate, which averaged 7 percent in the While the future behavior of the velocities of broad second quarter of 1993, is projected to fall to the area money aggregates was recognized to be difficult to of 63/4 percent by the fourth quarter of this year and to predict with precision at a time of ongoing structural drop slightly further over the course of 1994. changes in the financial sector, it appears likely that Recent developments in the financial sphere should the forces contributing to the unusual strength in be conducive to the sustained increases in spending velocities will continue for some time, and the FOMC projected for the quarters ahead. The financial posi- carried forward the revised 1993 ranges for the mone- tions of many households and businesses have con- tary and debt aggregates to 1994 as well. With consid- tinued to improve, and banks are showing signs of erable uncertainty persisting about the relationship of greater willingness to make loans. Short-term interest the monetary aggregates to spending, the behavior of rates are relatively low, and the appreciable declines the aggregates relative to their annual ranges will in long-term interest rates over the past several likely be of limited use in guiding policy over the months should further the process of balance sheet next eighteen months, and the Federal Reserve will adjustment and are anticipated to provide consider- continue to utilize a broad range of financial and able impetus to business investment and residential economic indicators in assessing its policy stance. construction. It is likely that business investment also will continue to be bolstered by the ongoing push to Economic Projections for 1993 and 1994 improve products and boost efficiency through the use The members of the Board of Governors and the of state-of-the-art equipment. Moreover, with at least Reserve Bank presidents, all of whom participate in a moderate pickup in average growth in foreign Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 68 Economic Projections for 1993 and 1994 FOMC Members and Other FRB Presidents Range Central Tendency 1993 Percentage change, fourth quarter to fourth quarter Nominal GDP 4% to 61/4 5 to 53/4 Real GDP 2 to 3V2 21/4 to 2% Consumer price index 3 to 31/2 3 to 31/4 Average level in the fourth quarter, percent Civilian unemployment rate 61/2 to 7 1994 Percentage change, fourth quarter to fourth quarter Nominal GDP 4V 2 to 6% 5 to 61/2 Real GDP 2 to 31/4 21/2 to 31/4 Consumer price index 2 to 41/4 3 to 31/2 Average level in the fourth quarter, percent Civilian unemployment rate 61A to 7 61/2 to 63A industrial countries, the external sector should be will be known shortly, uncertainties about health care exerting a less negative influence on economic activ- reform are not anticipated to be resolved fully for ity in the United States. some time. Despite the improvement in financial conditions, Most Board members and Bank presidents expect there are reasons to be cautious about the near-term the rise in the consumer price index over the four outlook. Efforts this year to bring the federal budget quarters of 1993 to be in the range of 3 to 3'/4 percent, deficit under control already have helped to ease about the same as the increase over the four quarters pressures on long-term interest rates, and a successful of 1992. At this stage, the food and energy sectors are agreement to reduce deficits significantly will pro- not expected to have much effect, on balance, on the duce substantial benefits over the longer run. But such broad price measures in 1993, but the flooding in the actions also are expected to exert some restraint on Midwest raises the risk of higher food prices in the aggregate demand this year and next. Government quarters ahead. For 1994, the central tendency fore- outlays for defense will continue to contract, extend- cast is for CPI inflation in the range of 3 to 3'/2 per- ing the dislocations and disruptions that have been cent, not much different than in 1992 and 1993. evident for some time in industries and regions that depend heavily on military spending. Prospects for The fundamentals remain consistent with addi- higher taxes may already be influencing the behavior tional disinflation; businesses continue to focus on of some households and businesses, and the constraint controlling costs, and slack in labor and product mar- is likely to intensify in 1994. In addition, uncertainties kets is anticipated to decrease only gradually in the about prospective federal policies reportedly are period ahead. However, the disappointing price per- weighing on businesses and consumers; although the formance in the first half of the year suggests that outcome of the Congressional budget deliberations further progress will not come easily—in part perhaps Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 69 because inflation expectations remain high. Lowering costs they impose are crucial to reestablishing the inflation and inflation expectations over time, and disinflation trend of the past couple of years and achieving sustained reductions in long-term interest allowing the economy to perform at its full potential. rates, will depend importantly on a monetary policy that remains committed to fostering further progress The Administration has not yet released the mid- toward price stability. The performance of prices and year update to its economic and budgetary projec- the economy also will depend on government policies tions. However, statements by Administration offi- in other areas. Namely, a sound fiscal policy, a judi- cials suggest that the revised forecasts for real growth cious approach to foreign trade issues, and regulatory and inflation in 1993 and 1994 are not likely to differ policies that preserve flexibility and minimize the significantly from those of the Federal Reserve. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 70 Section 2: The Performance of the Economy in 1993 Economic activity has continued to advance in fits cutbacks, the process of balance sheet adjustment and starts. After posting robust gains in the second goes on, as do the restructuring efforts under way at half of 1992, real gross domestic product (GDP) rose many large firms. Moreover, the continued disap- at an annual rate of less than 1 percent in the first pointing economic performance of some major for- quarter of 1993. The slowing in activity was evident eign industrial countries is taking a toll on US in a broad range of production and spending indica- exports. Finally, uncertainties about prospective fed- tors. The more recent data suggest that the economy eral policies on a variety of fronts, although difficult expanded at a firmer pace in the second quarter, to measure, are reportedly making some businesses although growth probably was not as rapid as in the and consumers reluctant to make major hiring and second half of last year. spending commitments. News on the price side was also worrisome in the Real GDP first half of the year. Month-to-month movements in Percent change, annual rate prices were on the high side through April, but they moderated in May and June. The more favorable recent data helped to ease concerns that a significant pickup in inflation was under way. Nonetheless, the disinflation process seemingly has stalled, with under- lying inflation, as measured by the twelve-month n. n change in the consumer price index (CPI) excluding food and energy, holding in a narrow band between TJ 3'/4 and 3'/2 percent since last summer. The Household Sector Growth of consumer spending on goods and ser- vices continued in a stop-and-go pattern in early 1993: It hit a lull in the first quarter after surging in 1989 1991 1993 the second half of 1992. Averaging through the quar- terly data, consumption grew at about a 3 percent annual rate pace over those three quarters, and avail- To some extent, the slackening in economic activ- able data point to a moderate increase in the second ity in the first quarter of 1993 can be interpreted as a quarter. Housing activity appears to have revived in pay back after two quarters of strong growth. In recent months, after sagging earlier in the year. particular, much of the slowing was in consumer spending, where large gains in the second half of Income and Consumption 1992 had outpaced income growth by a substantial Percent change, annual rate margin. In addition, there was a sharp contraction in defense spending; although real defense purchases [] Real Disposable Personal Income clearly will remain on a downtrend for some time, the first-quarter plunge followed a spurt in the second [] Real Personal Consumption Expenditures half of 1992 and is not likely to be repeated in coming quarters. In the external sector, exports declined in the first quarter after a big increase late last year, while imports rose markedly. Activity was also depressed, especially in the housing sector, by unusually bad rfl weather last winter. LU Moderate growth in real GDP appears to have resumed in the second quarter. Nonetheless, experi- ence thus far in 1993 has underscored that the imped- iments to a more rapid pace of economic expansion 1989 1991 1993 over the near term remain sizable. Besides defense 'Percent change, 1992:Q4 to May 1993, at an annual rate. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 71 Consumer spending increased only about 1 percent Real disposable income has remained on the mod- at an annual rate in real terms in the first quarter. erate uptrend that has been evident for the past several Outlays for goods were especially weak, down at quarters: In May, it stood about 21A percent above the about a 2 percent annual rate; although a part of the level of a year earlier. Growth in wages and salaries drop was probably attributable to the severe blizzard has stayed relatively sluggish despite the firmer pace on the East Coast in March, signs of some retreat in of employment growth this year. Meanwhile, transfer spending had already appeared in January and Febru- payments have continued to expand, although recent ary. Meanwhile, spending on services remained on increases have been diminished by a drop in unem- the moderate uptrend that had been evident for the ployment insurance benefits as the number of unem- past few years. ployed has declined. Interest income, which fell appreciably over 1992, has only edged down thus far Spending rose appreciably in April, spurred by a this year. post-blizzard bounce-back in outlays for motor vehi- Household financial positions have continued to cles and other goods. Demand for motor vehicles show signs of improvement. The value of household remained strong through June, resulting in an average assets has been buoyed by the rising stock market, sales pace for the quarter of almost 14'/2 million units while debt growth has remained moderate. Moreover, (annual rate)—the highest since early 1990. Sales reductions in interest rates have continued to lower were boosted by the replacement needs of households debt-servicing burdens; when measured in relation to that put off buying vehicles during the 1990-91 reces- disposable income, the repayment burden has fallen sion and the early recovery period. In addition, price back to the levels of the mid-1980s. The incidence of increases—at least for models with domestic name- financial stress among households also appears to plates, which have accounted for almost all of the rise have eased further. Delinquency rates on consumer in sales this year—have been relatively small, and loans generally dropped again in the first quarter and financing terms favorable. Meanwhile, real spending are down significantly from their recent peaks, and on goods other than motor vehicles appears to have delinquencies on home mortgages are at the low end posted a moderate gain for the quarter as a whole, and of the range of the past decade. outlays for services rose slowly through May. Housing activity turned surprisingly soft in the first The downshift in overall spending growth this year quarter, after a burst at the end of 1992. However, the does not appear to be attributable to any worsening of most recent monthly indicators suggest that the sector the current trends in household incomes and financial remains on a path of gradual expansion. In the single- positions, but it has coincided with a deterioration in family area, both starts and sales of new homes fell consumer confidence. In contrast to the ebullience back at the beginning of the year and remained below evident last fall, surveys conducted by the University trend through March. Single-family starts rebounded of Michigan and the Conference Board this year have in April and edged up further in May, lifting the found respondents more pessimistic about their job and income prospects. Spending may also have been Private Housing Starts crimped by smaller-than-usual tax refunds—or larger Annual rate, millions of units tax bills—this year. Although the change in withhold- ing schedules in March 1992 raised workers' take- Quarterly average home pay, and thus provided the wherewithal to fund additional purchases last year, many households may 1.5 well have found themselves less liquid than usual in early 1993. More fundamentally, the slowing in spending appears to reflect a return to trend after a surge that outstripped the rise in real disposable Single-family income in the second half of last year. Indeed, after having risen somewhat over the preceding couple of years, the personal saving rate dropped from 51A per- 0.5 cent in the second quarter of 1992 to 4!/2 percent in the fourth quarter, in the lower part of the range of recent years. The saving rate retraced some of that decline in the first quarter, but it appears to have 1987 1989 1991 1993 fallen back in the spring. •April-May average. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 72 average level for the two months about 5 percent figure of about 15 percent in the mid-1980s. Despite above the first-quarter pace; new home sales gyrated the reduced production in the past several years, in the spring but also were higher, on average, than in vacancy rates and rents have not yet shown clear the first quarter. signs of tightening for the nation overall. By contrast, improvements to all existing housing units have Undoubtedly, some of the recent improvement trended up over the past year and now account for reflects a reversal of transitory factors that damped nearly one-fourth of total residential construction homebuilding in the first quarter. The East Coast expenditures. blizzard delayed both builders and their customers in March; in addition, the weather for the nation as a The Business Sector whole was slightly worse than usual in January and February. Lumber prices ran up sharply between Oc- Developments in the business sector generally tober and March: As measured by the producer price were favorable in the first half of 1993. Business index (PPI), prices rose about one-third over that fixed investment continued to grow briskly, boosted period, and spot market quotes for some lumber prod- by ample profits and cash flow, the relatively low cost ucts more than doubled. The jump in lumber costs, of capital, and ongoing efforts to improve productiv- which has since been reversed, seems not to have left ity. Meanwhile, business balance sheets strength- much of a mark on the prices recorded in sales ened further as growth of business debt remained transactions; indeed, the inability of builders to pass relatively slow and many firms continued to take along the cost increases may have accounted for some advantage of lower bond yields and high stock prices of the disruption in construction activity. to enhance liquidity by funding out short-term In any event, low mortgage rates clearly are help- liabilities. ing to stimulate housing demand. Interest rates on Real business fixed investment increased at a fixed-rate home mortgages, like most other long-term 13 percent annual rate in the first quarter of 1993. interest rates, fell to near their twenty-year lows last Real outlays for equipment posted another healthy winter and have since declined further; initial rates on gain, and investment in structures, which had been on adjustable-rate mortgages have been the lowest since a protracted decline for some time, was about un- these loans first became widely available at the begin- changed for a second quarter. The indicators in hand ning of the 1980s. Given the trends in house prices, suggest that real business fixed investment remained these interest rates have pushed the cost of home strong in the second quarter. purchase—as measured by the share of household income needed to make the mortgage payments on an Equipment spending has continued to be a main- average home—to the lowest levels since the mid- stay of economic growth. It rose at an annual rate of 1970s. about 18 percent in real terms in the first quarter, after a 12'/2 percent rise over the course of 1992. Real Nonetheless, the trends in house prices this year— small rises in some markets, declines in others—have not been a uniform positive for demand, mainly Real Business Fixed Investment because they have muted the investment motive for Percent change, annual rate owning a home. Moreover, although most respon- dents to the Michigan survey in recent months [] Structures reported that it was a good time to buy a house, only about one-third of those who already owned homes - [] Producers' Durable - thought it was a good time to sell. In fact, industry Equipment reports suggest that first-time homebuyers have accounted for an unusually large share of all home n n r- u purchases in the past two years, and that sales and by prices in many localities have been strongest at the lower end of the market. _ 10 Construction of multifamily housing this year has been at its lowest level since the 1950s. These structures—most of which are intended for rental use—now account for less than 5 percent of total 1 1 1 1 1 1 20 1989 1991 1993 residential investment expenditures, compared with a "Percent change, 1992:Q4 to 1993:Q1, at an annual rate. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 73 outlays for computers and related devices have con- Changes in Real Nonfarm Business Inventories tinued to soar; since early 1991, they have roughly Annual rate, billions of 1987 dollars doubled, boosted by product innovations, extensive price-cutting by computer manufacturers, and the ongoing efforts of businesses to achieve efficiencies through the utilization of new information-processing 30 technologies. However, demand for other, more tradi- tional types of equipment also began to grow around nlln the middle of 1992 and continued to expand in early 1993. Domestic purchases of aircraft spurted in the first quarter; but, given the financial problems beset- ting the airlines, this increase will likely be reversed 30 in coming quarters. Investment in nonresidential structures appears to be stabilizing after several years of steep declines. _| | J-1 60 Construction outlays were essentially flat in real terms 1989 1991 1993 over the fourth and first quarters, and the advance indicators suggest that the bottom has been reached or is close at hand. Trends within the construction sector pre-tax profits earned by nonfinancial corporations on have been divergent. In the office sector, the excess of their domestic operations weakened after a fourth- unoccupied space remains huge, and spending contin- quarter surge, but they still stood nearly 35 percent ues to contract. However, spending for commercial above the cyclical low reached in 1991; the upswing structures other than office buildings, which also had in these profits over the past two years has reflected fallen sharply over the past several years, has appar- primarily a combination of restraint in labor costs and ently turned the corner, because of both the stronger reductions in net interest expenses. Domestic profits pace of retail sales over the past year and the ongoing of financial corporations have been buffeted in recent shift of retailing activity to large suburban stores. quarters by the losses that insurance companies sus- Outlays for industrial construction have not exhibited tained from major natural disasters; without such the normal cyclical rebound—mainly because utiliza- losses, domestic financial profits in the first quarter tion of existing capacity has tightened only would have surpassed the high reached in the first gradually—but they seem, at least, to be leveling out. quarter of 1992. Meanwhile, activity in the public utilities sector has continued to trend up, mainly because of capacity expansion at electric utilities but also because of the installation of pollution abatement technology, which Before-tax Profit Share of the Clean Air Act requires be in place by 1995. In Gross Domestic Product* contrast, drilling activity remains depressed. Nonfinancial Corporations Nonfarm business inventories, which had shown only small changes, on net, since the middle of 1991, rose considerably last winter and spring. Although the buildup early in the year was likely motivated in part by the need to replenish stocks drawn down by sur- prisingly strong sales in late 1992, some of the recent increase may be attributable to softer-than-expected sales. Notably, the inventory-sales ratio for non-auto retail stores remained in May around the high end of the range of recent years. By contrast, inventories at factories and at wholesale trade establishments gener- ally seem to be reasonably well aligned with sales. I l L I I After advancing markedly over the course of 1992, 1987 1989 1991 1993 economic profits of U.S. corporations were little 'Profits from domestic operations with inventory valuation and capital consumption adjustments divided by gross domestic changed overall in the first quarter of 1993. The product of nonfinancial corporate sector. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 74 The farm economy has been beset by numerous spending was also quite weak in the first eight months weather disruptions so far this year. In the first quar- of FY1993. Outlays for Medicare and Medicaid con- ter, severe weather in some regions retarded livestock tinued to rise rapidly; however, the increase so far this production and damaged fruit and vegetable crops. In year—about 10 percent—was only half as large as the many regions, spring planting was hampered by wet one in the preceding year. The deceleration in health weather, and, in parts of the Midwest, continued care spending appears to stem, in part, from federal heavy rains around mid-year caused major flooding. regulations issued in 1992 that limit the states' ability Because of the planting delays and the floods, uncer- to shift Medicaid costs to the federal government. tainties about acreage and yields are considerably Federal purchases of goods and services—the part greater than usual for this time of year, and farmers in of federal spending included directly in gross domes- the flooded regions obviously have suffered financial tic product—declined at an annual rate of 18 percent losses. in real terms in the first quarter of 1993. A sharp Despite the weather-related supply disruptions, decrease in defense spending more than accounted for farm income and farm financial conditions for the the drop. Real defense purchases have been falling nation as a whole seem to have held up reasonably noticeably since early 1991, but the decline has been well in the first half of 1993. On average, farm prices erratic; at least part of the first-quarter plunge can be in the first half were slightly above those of a year interpreted as a correction after a few quarters of earlier, with declines for farm crops being offset by surprisingly strong spending. Meanwhile, real non- higher prices for livestock. Farm subsidies, which defense purchases have been almost flat over the past have been running well above their 1992 pace, have couple of quarters. been lifting farm income and cash flow, and farm investment in new machinery has picked up. The Real Federal Purchases recent jump in crop prices—a consequence of the Percent change, annual rate flooding—will boost the incomes of the many farm producers whose crops are still in good condition. n The Government Sector IT Governments at all levels continue to struggle with budgetary difficulties. At the federal level, the uni- fied budget deficit over the first eight months of FY1993—the period from October to May—totaled $212 billion, somewhat less than during the compa- 10 rable period of FY1992. However, excluding deposit insurance and adjusting for the inflow of contribu- tions to the Defense Cooperation Account in FY1992, the eight-month deficit was about $230 billion in both 20 fiscal years. In the main, the underlying deficit has 1989 1991 1993 failed to drop because the restraint in discretionary "Percent change, 1992:Q4 to 1993:Q1, at an annual rate. spending that was legislated in 1990 and the deficit- closing effects of stronger economic activity have been offset by continued large increases in spending Federal receipts in the first eight months of FY 1993 for entitlement programs. were about 5 percent greater than in the same period of a year earlier; the rise was roughly the same as that In total, federal outlays in the first eight months of in nominal GDP. Boosted by the upswing in business FY1993 were only about 2 percent higher than during profits, corporate taxes rose sharply. However, they the same eight months of FY1992. Outlay growth was account for less than one-tenth of total receipts, and damped significantly by a sharp swing in net outlays growth in other categories was only moderate in the for deposit insurance that was attributable largely to aggregate. the improved health of depository institutions. In fact, so far this year, receipts from insurance premiums and States and localities continue to face sizable budget proceeds from sales of assets taken over by the gov- deficits: As measured in the National Income and ernment have exceeded by $18'/2 billion the gross Product Accounts (NIPA), the combined deficit (net outlays to resolve troubled institutions. Defense of social insurance funds) in the sector's operating Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 75 Real State and Local Purchases year. Also, these governments have lately been reluc- Percent change, annual rate tant to raise taxes, after the sizable hikes they enacted in 1990 and 1991. All told, the sector's own-source general receipts, which comprise income, corporate, and indirect business taxes, rose 5 percent over the four quarters ended in the first quarter of 1993, about the same that nominal GDP increased. The External Sector Since December 1992, the trade-weighted foreign exchange value of the dollar has risen about 5 per- cent, on balance, in terms of the currencies of the other Group of Ten (G-10) countries. This net increase has reflected much larger movements in the dollar's value against individual currencies: In partic- 1989 1991 1993 ular, a sharp decline against the Japanese yen was "Percent change, 1992:Q4 to 1993:Q1, at an annual rate. more than offset by substantial increases against major European currencies. and capital accounts has been stuck around $40 bil- Relative to the monthly average for December lion since late 1990. These outsized deficits have 1992, the dollar has declined nearly 15 percent against persisted despite ongoing efforts by many govern- the yen to record lows, prompting heavy Japanese ments to adjust spending and taxes. As at the federal official purchases of dollars and moderate dollar pur- level, deficit reduction has been complicated by the chases by U.S. authorities. The strengthening of the upsurge in payments to individuals for health and yen has occurred despite the weak performance of the income support; in the first quarter of 1993, state and Japanese economy and market expectations that Japa- local transfer payments for Medicaid and Aid to Fam- nese short-term interest rates will remain near histori- ilies with Dependent Children (in nominal terms) cally low levels over the next year; it seems to be were nearly 20 percent above those of a year earlier. based largely on the perception that Japan's external The deficit-reduction efforts of state and local gov- surplus, which has grown rapidly over this period, is ernments in recent quarters have been concentrated not sustainable. on the spending side. Their purchases of goods and Against the German mark, the dollar has risen services were nearly flat in real terms in the first almost 10 percent since December, reflecting a sub- quarter of 1993 and have changed little, on net, since early 1992. Outlays for construction, which fell at an annual rate of 7 percent, on average, in the fourth and Foreign Exchange Value of the U.S. Dollar * first quarters, have been especially weak. For all Index, March 1973 = major categories except sewer and water, outlays in recent months have been running significantly below year-earlier levels. State and local employment has continued to expand at the somewhat slower pace that 125 has been evident since 1991, while these governments have continued to hold the line on wages and benefits. The approximately 3l/2 percent increase in state and local compensation rates over the year ended in March was similar to the rise for workers in private industry; by contrast, in the 1980s, state and local 75 workers received increases that, on average, were more than a percentage point per year greater than those in private industry. 50 Receipts of state and local governments, restrained 1987 1989 1991 1993 by the relatively tepid cyclical upswing in the sector's *lndex of weighted average foreign exchange value of U.S. dollar in terms of currencies of other G-10 countries. Weights are based tax bases, have grown only moderately over the past on 1972-76 global trade of each of the 10 countries. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 76 stantial easing of German interest rates and the expec- U.S. Real Merchandise Trade tation of further declines in light of the sharp contrac- Annual rate, billions of 1987 dollars tion in German economic activity. The dollar has also appreciated against other European currencies, and it has remained little changed against the Canadian dollar. 500 Economic activity in the major foreign industrial countries generally has been sluggish so far this year. The recovery in Canada now seems to be reasonably well established, and real GDP in the United King- dom has been growing slowly. However, continental Europe remained in recession in the first quarter, with 300 a sizable reduction in real GDP in western Germany; recent indicators point to continued weakness in the second quarter. After falling for much of 1992, Japa- 200 nese real GDP rose in the first quarter, in large part 1987 1989 1991 1993 reflecting the effects of earlier fiscal measures; how- ever, indicators for the second quarter are mixed, and the appreciation of the yen will likely result over time rapid growth of U.S. domestic final demand in the in a drag on net exports. second half of 1992 and inventory restocking this Unemployment rates have continued to rise (into year. In addition, the prices of non-oil imports, reflect- the double-digit range in many instances) in the coun- ing the lagged effects of the appreciation of the dollar tries still in recession; even in the countries showing during the last quarter of 1992, fell somewhat in the signs of recovery, unemployment has remained high. first quarter; much of that decline appears to have Partly as a consequence, wage pressures have ebbed, been reversed in the second quarter. The price of oil and underlying inflation has continued to decelerate, imports fluctuated in a relatively narrow range over on average. A notable exception is western Germany, the first half of 1993. Mild weather and strong OPEC where the CPI rose more than 4 percent over the production pushed oil prices down early in the year, twelve months ended in June, partly because of an but prices subsequently retraced the decline on signs increase in the value-added tax early this year and that OPEC would effectively curb production. large increases in the prices of housing services. Recently, oil prices have dropped on Kuwait's deci- sion not to participate in OPEC's quota allocations for In contrast to the overall weakness of activity in the third quarter and speculation that Iraq may be foreign industrial countries, real growth so far this allowed to resume exporting sooner than had been year in major developing countries, especially in Asia, expected. appears to have remained at around the strong pace of 1992. The merchandise trade deficit widened to $116 bil- lion (at an annual rate) in the first quarter of 1993, After expanding rapidly at the end of 1992, real nearly $10 billion greater than in the second half of merchandise exports declined during the first quarter 1992; it increased somewhat further in April and of 1993, but they bounced back to their fourth-quarter May, on average. With moderate increases in net 1992 high in April and May. Shipments to developing direct investment income receipts and a slight further countries, which had risen sharply over 1992, dropped widening of the surplus on net service transactions, back during the January-to-May period. In the aggre- the current account deficit rose somewhat less than gate, exports to industrial countries rose somewhat in the trade deficit, to $89 billion (annual rate) in the first the first five months of 1993, but Canada and the quarter, compared with $83 billion in the second half United Kingdom accounted for most of the increase. of 1992. Real merchandise imports, extending the rapid pace Net capital inflows recorded in the first quarter of of growth recorded over the four quarters of 1992, 1993 were largely attributable to substantial increases rose sharply over the first five months of 1993. Trade in foreign official assets held in the United States, in computers continued to soar and was responsible particularly in those of some newly industrializing for about one-third of the increase in merchandise Asian economies and of certain Latin American coun- imports. More broadly, imports were boosted by the tries. Net private capital inflows were relatively small. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 77 U.S. Current Account Payroll Employment Annual rate, billions of dollars Net change, millions of jobs, annual rate Total Nonfarm n 60 180 1987 1989 1991 1993 1989 1991 1993 Private foreigners added significantly to their hold- associated with sizable increases in health insurance ings of U.S. securities, particularly Treasury bonds. premiums and in other fringe benefits; uncertainties However, U.S. net purchases of foreign bonds reached about the future course of government policies may record levels, and net purchases of foreign stocks, also be contributing to the reluctance of some firms to although down from peak levels reached in the last expand their permanent full-time work forces. half of 1992, remained heavy. New bond issues by Moreover, firms are relying increasingly on tempo- foreigners in the United States also were very strong. rary workers, in part because doing so affords them Capital inflows associated with foreign direct greater flexibility in responding to fluctuations in investment in the United States recovered substan- demand for their products. Indeed, employment at tially in the first quarter but remained far below the personnel supply firms, which consist largely of peaks reached in 1989. Foreign direct investment in temporary-help agencies, rose more than 150,000 the United States apparently has been deterred by between December and June. Over the past two years, unfavorable returns realized on earlier investments the increase has been about 500,000; thus, although and by financial market conditions less favorable to these firms currently account for less than 2 percent of acquisitions. In contrast, capital outflows associated total payroll employment, they are responsible for with U.S. direct investment abroad remained strong. one-quarter of the increase in total employment over this period. Labor Market Developments Job gains in the first half of 1993 also reflected a The labor market showed signs of improvement in continuation of the steady uptrend in employment in the first half of 1993. According to the payroll sur- health services. In addition, gains occurred at trade vey, employment increased about 1 million; this num- establishments, construction payrolls improved with ber compares with a rise about 600,000 over the sec- the recent stronger housing activity, and there were ond half of last year and brings the total increase scattered increases in services other than health and since the cyclical low in 1991 to about 2 million. personnel supply. Nonetheless, job gains have continued to fall far Meanwhile, manufacturing employment declined short of the norms set by earlier business cycle expan- further, on balance, over the first six months of the sions. For example, only in May did payroll employ- year. Although factory output increased steadily ment return to its pre-recession peak, two years after through April, firms relied mainly on a combination the cyclical trough; by contrast, recessionary job of productivity improvements and longer workweeks losses typically have been reversed within the first to meet their output objectives; in May and June, year of the expansion. Job growth has continued to be output decreased somewhat. Job losses in the first half restrained by the temperate pace of economic activity were concentrated in the durable goods sector, with and employers' ongoing efforts to improve productiv- particular weakness at producers of aircraft and motor ity. In addition, firms are confronting cost pressures vehicles. Since its last peak in January 1989, manu- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 78 Civilian Unemployment Rate Output per Hour Percent change, Q4 to Q4 Nonfarm Business Sector n n" fin n LJ~ - 2 I I I I I I I I 1987 1991 1993 1987 1989 1991 1993 "Percent change, 1992:Q1 to 1993:Q1. facturing employment has fallen about P/4 million; noticeably larger than the norms for the past decade. layoffs in defense-related industries (those industries Productivity growth in the manufacturing sector, that depend on defense expenditures for at least where downsizing and restructuring efforts have been 50 percent of their output) have accounted for about under way for some time, has continued to be espe- one-fifth of the decrease in total factory payrolls. cially impressive, totaling more than 5 percent over Employment as measured by the monthly survey of the past year. households rose about 900,000 over the first six Labor compensation has tilted up of late. The em- months of the year—essentially the same as in the ployment cost index for private industry—a measure payroll series. The number of unemployed fell appre- that includes wages and benefits—rose at an annual ciably at the beginning of the year, and the civilian rate of 41/4 percent over the first three months of the unemployment rate dropped from 7.3 percent in De- year. Even so, the data are volatile, and the total cember to 7.0 percent in February; it has shown little increase since March 1992 amounted to only 31/: per- change since that time. cent; by contrast, this index had risen 4'A percent over The civilian labor force expanded only modestly the preceding twelve months, and, as recently as early over the first six months of 1993—less than 1 percent at an annual rate. Labor force growth continued to be damped by the relatively small increase in the Employment Cost Index * working-age population. In addition, perceptions of Percent change, Dec. to Dec. meager employment opportunities evidently contin- Total Compensation ued to deter many potential job seekers. The labor force participation rate, which measures the percent- age of the working age population that is either em- ployed or looking for work, spurted in late spring; however, this spurt followed a sharp decline earlier in the year, and the level at mid-year was about the same as that in late 1992. Output-per-hour in the nonfarm business sector declined at an annual rate of 11/2 percent in the first quarter, echoing the sharp deceleration in output. Nonetheless, the first-quarter drop followed a string of sizable increases; all told, the rise in productivity over the year ending in the first quarter of 1993 1987 1989 1991 1993 amounted to 11/2 percent—smaller than the gains a 'E n m d p h l o o u y s m e e h n ol t d c o w s o t r i k n e d r e s x . for private industry, excluding farm recorded earlier in the economic expansion, but still "Percent change, March 1992 to March 1993. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 79 1990, the twelve-month change had exceeded 5 per- Consumer Prices* cent. The increase in wages over the past year was Percent change, Dec. to Dec. less than 3 percent, whereas the cost of fringe bene- fits, pushed up by the steep rise in the cost of medical insurance and by higher payments for workers' com- pensation, rose more rapidly. Primarily because of the drop in productivity, unit labor costs deteriorated markedly in the first quarter, but they still were up less than 2 percent over the past year. Price Developments Inflation exhibited considerable month-to-month volatility in the first half of the year. Broad mea- sures of inflation picked up somewhat in early 1993, with monthly readings through April in the upper part of the range of the past couple of years. However, 1987 1989 1991 1993 •Consumer price index for alt urban consumers. price changes at the consumer and the producer lev- "Percent change, June 1992 to June 1993. els were small in May and June. Cutting through the monthly data, the disinflation process evident in 1991 and 1992 seems to have stalled, with underlying in several regions of the country. By late spring, these inflation, as measured by the twelve-month change in supply problems had abated, and the June CPI the CPI excluding food and energy, holding in the brought price declines in food categories where the range of 3'/4 to 3'/2 percent that has prevailed since sharpest upward pressures previously had been evi- last summer. The total CPI, held down by essen- dent. Since the end of June, however, farm crop prices tially flat energy prices, has risen 3 percent over the have moved up in response to the severe flooding in past twelve months. the Midwest. The increases in crop prices have already been reflected in the form of large advances in The CPI for food increased at an annual rate of some commodity price indexes and have raised the 2 percent in the first half of 1993, a shade above the possibility that renewed upward pressures on con- rate of increase during 1992. Meat prices jumped sumer food prices could soon emerge. sharply during the first few months of the year as production fell short of year-earlier levels. In addi- Consumer energy prices changed little, on net, over tion, the prices of fresh vegetables were boosted dur- the first half of the year. With world oil markets ing the spring by weather-related production setbacks remaining relatively quiescent, the price of West- Consumer Prices Excluding Food and Energy* Consumer Food Prices* Percent change, Dec. to Dec. Percent change, Dec. to Dec. 1987 1989 1991 1993 1987 1989 1991 1993 'Consumer price index for all urban consumers. "Consumer price index for all urban consumers. "Percent change, June 1992 to June 1993. "Percent change, June 1992 to June 1993. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 80 Consumer Energy Prices* about half of non-energy services and had posted Percent change, Dec. to Dec. some unsustainably small increases last summer. However, the substantial deceleration in medical care prices (for both goods and services) that has been in train over the past few years extended into 1993. In 10 fact, the CPI for medical care rose only about 6 per- n cent over the twelve months ended in June; this increase was among the smallest of the past decade. n U To some extent, the higher underlying CPI inflation rates in the first half of 1993 may be a statistical phenomenon that will be reversed in the second half: 10 Indeed, over the past several years, price increases early in the year have tended to exceed those for the year as a whole, even after seasonal adjustment by the BLS. But, even allowing for this phenomenon, infla- 20 tion seems to have leveled out. The lack of further 1987 1989 1991 1993 "Consumer price index for all urban consumers. deceleration is puzzling in light of the considerable "Percent change, June 1992 to June 1993. slack in labor and product markets. One possible explanation is that the pickup in economic activity Texas intermediate generally fluctuated between $18 late last year may have triggered a round of price and $20 per barrel but has weakened recently. Retail increases; if so, some deceleration in prices is likely prices for refined petroleum products changed fairly in the wake of the subdued performance of the econ- little on the whole through April and dropped, on omy in the first half. Another may be the apparent balance, in May and June. Residential natural gas failure of inflation expectations, as measured by vari- prices rose considerably over the first half, in part ous surveys of consumers and businessmen, to reflect because of inventory adjustments associated with last fully the reduction in actual inflation over the past few winter's colder-than-usual weather; although recent years; although the survey measures vary consider- declines in wellhead prices suggest that some of the ably, respondents seem to share a sense that inflation increase at the retail level may be retraced in coming has bottomed out. months, over the longer haul, natural gas prices are being supported by an ongoing shift toward the use of Prices received by domestic producers have slowed cleaner-burning fuels. in recent months, after undergoing a pickup earlier in the year. All told, the twelve-month change in the All told, the CPI excluding food and energy producer price index for finished goods other than increased at an annual rate of 31/2 percent over the food and energy was less than 2 percent in June, first half of the year, after rising 3 percent over the down somewhat from a year earlier. At earlier stages second half of 1992. The CPI for goods soared in of processing, where price movements tend to track January and February, with large increases reported cyclical fluctuations in demand, prices of intermediate for several items. Apparel prices jumped early in the materials (excluding food and energy) firmed a little year, in part because strong sales in late 1992 limited early in the year, but they subsequently moderated; the need for post-Christmas markdowns. Some retail- although the pattern was exaggerated by the spike in ers may also have seen opportunities to widen profit lumber prices, it was evident for some other materials margins on other merchandise; the recent decrease in as well. In commodity markets, prices of precious prices of home furnishings, for example, suggests that metals have moved up sharply over the past couple of not all of these increases stuck. months, and some scattered increases have been evi- Increases in prices of non-energy services were dent elsewhere. More broadly, however, industrial steadier but also somewhat larger than in 1992. Part commodity prices were down slightly, on net, over of the step-up was in shelter costs, which account for the first half of the year. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 81 Section 3: Monetary and Financial Developments in 1993 Monetary policy in 1993 has been directed to- firms, and financial institutions continued to im- ward the goal of sustaining the economic expansion prove, although money and credit growth remained while preserving and extending the progress made weak. Wage and price data suggested a continuing toward price stability in recent years. In the first half trend toward lower inflation. Intermediate- and long- of the year, economic activity slowed markedly from term interest rates had declined somewhat, in part the very rapid pace of the fourth quarter, while infla- reflecting a view that the new Administration's fis- tion indicators fluctuated widely. Although inflation cal stimulus package was likely to be modest and that readings were a source of concern for the Federal material reductions in future deficits were in pros- Open Market Committee, the intensification of price pect. The economic outlook remained clouded, how- pressures did not seem likely to be sustained over an ever, by uncertainties regarding details of fiscal pol- extended period, and reserve conditions were kept icy plans, continued restructuring and downsizing of unchanged. With short-term rates steady, prices of large businesses, and lingering restraints on credit fixed-income securities were buoyed by prospects for supplies. At its early February meeting, the Federal significant fiscal restraint and by a slowing of the eco- Open Market Committee decided that its directive to nomic expansion, although fears of a pickup in infla- the domestic open market desk should retain a sym- tion at times prompted partial reversals in bond rates. metric stance regarding possible reactions over the in- Yield spreads on private securities relative to Trea- termeeting period to incoming indicators; such a sury rates remained historically narrow, and stock directive, which implied no presumption in how price indexes set new records. quickly changes in operations should be made toward tightness or ease, had been instituted in December, The monetary aggregates have been sluggish this following directives that had been biased toward eas- year, as both the share of depository institutions in ing over much of the previous two years. overall debt finance and the proportion of depository credit funded with monetary liabilities have fallen Economic activity appeared to decelerate in the further. The reduced role for depositories largely re- early months of the year, however, in part because of flects weak demands for loans and deposits by the adverse weather conditions, with softness in retail public. Corporate borrowers have continued to issue sales, housing starts, and nonresidential construction. heavy volumes of stocks and bonds in part to pay Bank credit was failing to expand significantly, while down bank debt, while households have withdrawn broad money was declining owing both to temporary deposits to invest in bond and equity funds that factors and a weak underlying trend. Although short- finance inter alia corporate issuers. After two years of term interest rates were little changed, bond markets no growth, bank loans weakened further early this rallied further on weaker economic activity and year, but increased fairly vigorously in May and June, improved prospects for fiscal restraint, which would posting a modest net gain for the first six months of reduce the government's demand for credit. Long- the year. The growth of nonfinancial sector debt so far term rates fell to the lowest levels in almost twenty this year has edged up from the subdued pace of years in early March, before backing up somewhat on 1992, despite a deceleration of nominal spending, as reports of a second month of substantial increases in investment spending is estimated to have exceeded consumer and producer prices. The drop in interest the internal funds of corporations, household borrow- rates buoyed stock markets to record highs and con- ing has picked up relative to spending, and Treasury tributed to a small decline in the weighted-average financing needs have remained heavy. value of the dollar. The dollar depreciated substan- tially against the yen, as market attention focused on The Implementation of Monetary Policy Japan's growing trade surplus. Early in the year, incoming data suggested that the Signs of price pressures were a concern for the faster pace of economic activity that had emerged in FOMC, but the fundamentals of continued slack in the third quarter of 1992 had been maintained through labor and capital utilization, subdued unit labor costs, year-end. Indicators of industrial production, retail and protracted weakness in credit and broad money sales, business fixed investment, and residential con- suggested that a higher trend inflation rate was not struction activity all posted solid gains. Financial setting in. With the economy slowing, reserve pres- impediments to the expansion appeared to be dimin- sures were kept unchanged and a symmetric policy ishing as the balance sheets of households, business directive was retained at the meeting in March. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 82 After pausing in March, producer and consumer Monetary and Credit Flows prices leaped again in April. Long-term interest rates Growth of the broad money measures was quite backed up further in response; the price of gold slow over the first half of 1993, falling below the surged, and the dollar fell more rapidly. With the subdued pace of 1992, and leaving them near the Japanese authorities buying dollars in foreign lower arms of the revised growth cones for 1993. exchange markets, the U.S. Treasury and the Federal This deceleration, however, did not reflect a modera- Reserve also purchased dollars for yen in late April. tion in overall credit flows or a tightening in finan- After extended weakness, the monetary aggregates cial conditions. Rather, it resulted from a further jumped in early May by more than could be explained diversion of credit flows from depository institu- by temporary factors. tions as well as continued financing of depository At its May meeting, the FOMC was confronted credit through capital accumulation rather than depos- with weak output growth and intensified inflation its. Indeed, growth of the debt of all nonfinancial readings. It was difficult to identify reasons for this sectors is estimated to have edged up this year—to juxtaposition. Price increases by business firms in 5 percent—despite an apparent slowing in nominal early 1993 could have reflected optimism engendered GDP. Continued substantial demand for credit by the by strong demand conditions in the second half of 1992 or an upward adjustment of inflation expecta- tions. However, considerable slack remained in labor M2: Annual Ranges and Actual Growth and product markets, and the pace of economic activ- Billions of dollars ity had slowed markedly. The Committee concluded Range set in February that no policy adjustment was needed at its meeting, - Range set in July 3750 but the risks of increased inflation and inflation expec- tations warranted a directive that contemplated a rela- 3700 tively prompt tightening of reserve pressures if signs 3650 of intensifying inflation continued to multiply. 3600 The subsequent readings on inflation for May and June were subdued; moreover, evidence of heightened 3550 inflation expectations did not emerge in markets for fixed-income securities. Consequently, the stance of 3500 monetary policy was not changed following the May FOMC meeting. The dollar rebounded on foreign 3450 exchange markets in June and early July in the wake 3400 of the fall of the Japanese government and evidence O N D J F M A M J J A S O ND that economic conditions in Europe had deteriorated 1992 1993 further. M3: Annual Ranges and Actual Growth On balance, since the beginning of the year, short- Billions of dollars term interest rates are little changed, while intermediate- and long-term rates have fallen three- -- Range set in February quarters to one percentage point to the lowest levels - — Range set in July 4400 in over twenty years. In particular, the thirty-year 4350 Treasury bond has reached a low of 6.54 percent, while the ten-year Treasury note has touched 5.71 per- 4300 cent, its lowest level since 1971. The fixed-rate thirty- year mortgage interest rate has dropped to 7.16 per- 4250 cent, a record low in the 22-year history of the series. 4200 The fall in intermediate-term interest rates in the United States was roughly matched on average 4150 abroad, and the trade-weighted value of the dollar in terms of G-10 currencies has increased about 5 per- 4100 cent from its December average, as overseas econo- 4050 mies weakened and foreign short-term rates declined O N D J F M A M J J A S O ND substantially. 1992 1993 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 83 Debt: Annual Ranges and Actual Growth marketable debt and repay bank loans. Stresses asso- Billions of dollars ciated with the restructuring of the economy and the -- Range set in February earlier buildup of debt linger. However, downgrad- _ — Range set in July 12800 ings of corporate debt by rating agencies have dropped well below the peak levels of a few years ago, and a growing number of firms have received upgradings, as corporate cash flows have strength- 12400 ened substantially relative to interest expenses. Debt service burdens of households also have con- 12200 tinued to decline relative to disposable income, as households have repaid high interest debt or taken 12000 advantage of lower rates to refinance. Indeed, the decline in long-term interest rates during the year has 11800 brought a new surge of refinancings of mortgages. With balance sheets improved, households have 11600 O N DJ F M A MJ J A S O ND become somewhat more willing to borrow, and con- 1992 1993 sumer credit has begun growing moderately after two federal government as well as more comfortable Debt Service Burden of Households financial positions and consequent signs of a greater willingness to borrow and lend by private sectors Total Debt Service* as a Percentage likely supported debt expansion. Nevertheless, over- _of Disposable Personal Income 19 all debt growth remains in the lower portion of its revised 4 to 8 percent annual range for 1993. Non- federal debt growth has expanded at a still modest 3'/4 percent pace, after two years of even weaker 17 growth. Taking advantage of low long-term interest rates and the strong stock market, businesses have issued 15 an exceptionally large volume of bonds and equity; the proceeds have been used mainly to refund other i I I i i I 13 1981 1983 1985 1987 1989 1991 1993 Interest Expense Burden of * Debt service is a Federal Reserve staff estimate of scheduled Nonfinancial Corporations payments of principal and interest on home mortgage and consumer debt. Total Net Interest Payments as a Percent of Cash Flow* plus Net Interest Payments years of weakness. Some of that growth, though, may Quarterly reflect heavy promotion of credit cards carrying spe- 30 cial incentives for use in transactions, such as "frequent-flier miles" or merchandise discounts. Net mortgage debt is estimated to have grown only a bit more than the modest rate of 1992. Gross issuance of state and local government debt has been particularly robust this year. However, 20 refunding volume has accounted for nearly 70 percent of the offerings, compared with about 45 percent in 1992, a record year for refundings. Net debt of state I I I l I I 15 and local governments has grown only moderately 1981 1983 1985 1987 1989 1991 1993 again in 1993. The budgetary situations of some state * Cash flow is defined as depreciation plus retained earnings (book values). Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 84 and local governments have improved, as tax receipts ers by decreasing interest expenses and boosting eco- have been stronger than expected, but severe financial nomic activity, thereby reducing loan loss provisions problems remain in other locales. for banks. Banks posted record earnings in 1992 and remained very profitable in early 1993; prices of their With corporate borrowers still relying heavily on shares on equity markets have risen substantially. financing through capital markets, and depository lending spreads over market rates remaining high, the Thrift institutions have continued to contract in trend decline in the share of total credit flows pro- 1993, though at a much slower pace than over the last vided by depository institutions was extended through four years. A lack of funding for the Resolution Trust the first half of 1993. From the fourth quarter of 1992 Corporation caused a hiatus in the closure of institu- to June, bank credit expanded at a 414 percent annual tions under its conservatorship. However, privately rate, only a modest pickup from the sluggish pace of operated thrifts have not expanded and the industry the previous two years. Securities acquisitions ac- continues to consolidate. counted for most of the expansion, as loans increased at only a !3/4 percent rate. The growth of bank securi- Slower growth in nominal GDP, moderate demand ties portfolios in part reflects additions to holdings of for credit relative to spending, and the reduced share securitized mortgage and consumer loans; bank of credit provided by depositories have all contributed financing of consumer spending and real estate trans- to the lack of significant growth in the broad mone- actions is thus stronger than indicated by bookings of tary aggregates this year. Another factor inhibiting loans in those sectors. While commercial and indus- money growth has been continued substantial funding trial loans have been about flat on balance so far this of bank and thrift assets with subordinated debt and year, a few signs of easing in bank lending terms and equity issues, as well as retained earnings—all a conditions have recently emerged, and business loans byproduct of ongoing efforts to build capital posi- rebounded in May and June. Judging by business loan tions. While about a third of the industry (by asset growth at smaller banks so far this year, a pickup has volume) had capital ratios and supervisory ratings occurred in lending to smaller nonfinancial firms. high enough at the end of 1991 to be considered Thus, the continuing weakness in overall business well-capitalized, more than two-thirds were so posi- loan growth does not appear to be driven primarily by tioned by early 1993. About $10 billion was added to restrictive supply conditions, but rather by the prefer- bank equity and subordinated debt during the first ence of larger firms to fund through capital markets. quarter, about the same pace as in 1992; data on new debt and equity issues indicate another sizable gain Lower market interest rates over the past few years over the second quarter. have helped strengthen the financial positions of banks and thrifts. The lower rates have resulted in Depositories have also recently relied more heavily capital gains on securities and improved interest on other nondeposit sources of funds. Weak econo- margins—as deposit rates have fallen more than lend- mies and credit demand abroad have prompted the ing rates. Lower rates also have helped bank borrow- U.S. offices of foreign banks to draw more funding Domestic Bank Assets by Capital Category Adjusted for overall supervisory ratings^ End of Year March Capital Category 1991 1992 1993 Percent Well Capitalized 34 68 70 Adequately Capitalized 45 22 20 Undercapitalized 21 10 10 1. Adjustments to capital categories were made according to the rule of thumb of downgrading a bank by one category for low a examina- tion rating by its supervisory agency (CAMEL 3, 4, or 5). Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 85 from overseas, and the domestic offices of U.S. banks Key elements affecting money growth relative to to reduce foreign lending this year. Overall shifts nominal income may be seen in a decomposition of from deposits to other sources of funding may be M3 velocity in the four-panel chart below. The top driven partly by regulatory inducements—including left panel depicts the moderation in overall borrowing higher insurance premiums on deposits and incentives in the economy; after several years of declines, the to bolster capital. But changes in investor preferences ratio of nominal GDP to total nonfinancial debt, or from short-term deposits to longer-term debt and debt velocity, has been rather stable since 1990, as equity may also be playing a role in motivating the debt growth has slowed to about the pace of GDP restructuring of bank and thrift sources of funds. growth. The top right panel shows the reduced role of Decomposition of M3 Velocity (Ratio scales) Ratio of Nominal GDP Ratio of Total Nonfinancial Debt to Total Nonfinancial Debt to Depository Credit 0.60 3.0 2.8 0.55 2.6 0.50 2.4 0.45 2.2 J | L_ 0.40 LJ L 2,0 1989 1991 1993 1989 1991 1993 Ratio of Depository Credit to M3 Velocity of M3 1.2 1.8 1.7 1.0 1.5 1.4 0.9 1.3 0.8 1.2 1989 1991 1993 1989 1991 1993 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 86 depositories in providing even the more moderate mutual funds with those on money balances remains volume of total credit; the ratio of total nonfinancial an open question. debt to depository credit has risen sharply over the Shifts into mutual funds have become much easier last three years. Higher costs and attempts to recoup and less costly for households, most notably because past capital losses led to higher bank loan rates rela- many banks have begun offering mutual funds for tive to market rates after 1988 and stricter nonprice sale in their lobbies. While many banks now offer terms and standards, while declines in long-term inter- discount brokerage services, a survey by the Federal est rates and a strong stock market, along with the Reserve found that larger banks have recently been impetus to repair balance sheets, induced firms to turn making special efforts to promote mutual fund invest- to capital markets for financing. The bottom left panel ments among their depositors. An increasing number shows the increased reliance on equity and other of banks have sponsored their own mutual funds or nondeposit funding by banks and thrifts, as well as entered into exclusive sales relationships with non- some declines in money market mutual funds; the bank sponsors of funds. Some banks have promoted ratio of depository credit to M3 has been rising since these products as a defensive measure to retain long- the second quarter of 1992. The velocity of M3 (GDP run relationships with valued depositors. In other divided by M3), in the bottom right panel, is the cases, however, banks have promoted funds as part of product of the other three ratios. In the late 1980s, M3 a strategy to earn fee income without booking assets, velocity departed from its traditional declining trend, thereby avoiding the need to raise additional capital. increasing at about a 2 percent annual rate as the Substitution between money and long-term mutual depository sector began playing a smaller role in funds appears to have become evident in the aggre- financing credit growth. The growth of M3 velocity gate data in recent years. There was little increase in picked up to 5*A percent in 1992 and perhaps a such funds from 1987 through 1990, but large inflows somewhat faster rate in the first half of 1993. since then, at the same time that accretions to M2 Greater reliance by borrowers on capital markets balances declined. A comparison of the quarterly has been facilitated by concurrent shifts in saving growth rates of M2 and the sum of M2 and bond and preferences away from monetary assets and into capi- stock funds shows that growth of the sum has not tal market investments. Such portfolio realignments weakened as dramatically as that of M2 over the last are evident in record inflows to bond and stock mu- two and half years; it has averaged nearly a 5 percent tual funds, and money balances were also likely in- annual rate, compared with less than 2 percent for vested directly in stocks and bonds. The incentives M2. Although adding mutual funds and M2 together captures some substitution out of M2 in recent years. for what appears to be an extraordinary adjustment of household portfolios are varied. Interest rates paid on retail time deposits, NOW accounts, and money mar- ket deposit accounts (MMDAs) have fallen well Changes in M2 and Stock and Bond below any rate offered since the inception of deregu- Mutual Fund Balances lated deposits in the early 1980s, and savings deposit Billions of dollars, SAAR rates are now the lowest in more than thirty years. G Net change in M2 The shock effect of historically low deposit interest • Net change in stock and bond funds 400 rates caused many depositors to investigate alterna- tive investments. With the yield curve extraordinarily steep, much higher returns have been available in Net change in M2 plus recent years on longer-term investments. A bond or stock and bond funds stock mutual fund offers a chance to earn these higher 200 yields, but still enjoy liquidity features, including in some cases a check-writing facility. However, invest- ment in such a mutual fund carries with it a higher risk of loss as well, because unlike monetary assets, its principal value fluctuates with market prices. In- deed, the higher yield on bonds relative to short-term I I I I i I instruments probably anticipates some capital losses. 1985 1987 1989 1991 1993 Whether all households accurately assess relative Note: Mutual fund balances are valued at current market prices. These data exclude IRA and Keogh balances and institutional risks when comparing returns recently earned on holdings. Half-year at an annual rate for 1993. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 87 Growth Rates of M2 and M2 plus refinancing began to bolster demand deposits and Stock and Bond Funds MMDAs in April, as mortgage servicers increased Percent, SAAR balances temporarily before making remittances to Quarterly data investors in mortgage-backed securities. The seasonal factor distortions began to reverse that month as well. However, substantial shortfalls in individual nonwith- M2 plus stock and bond funds held tax payments relative to recent years produced an offsetting restraint to money growth in April, as the buildup of balances required to pay taxes was smaller than that incorporated into seasonal factors. Even excluding estimated effects of these special factors, however, underlying growth of money through the first four months of the year was far weaker than historical relationships would suggest. Despite continued heavy inflows to bond and equity funds in May, the monetary aggregates surged, 1985 1987 1989 1991 1993 boosted in part by a reversal of the tax effects and an intensification of mortgage refinancing activity. How- ever, the aggregates decelerated substantially in June, and by more than might be suggested by a waning of the total remains quite volatile, indicating that other tax and mortgage refinancing effects. forces have affected both M2 and mutual funds. Partly as a consequence, the relationship of the total to In 1993, household portfolio adjustments differed aggregate spending is subject to considerable uncer- somewhat from their previous pattern. In the past, the tainty. Investments in bond and stock funds are them- realignment of household wealth toward capital mar- selves subject to potentially volatile capital gains and ket investments had mainly involved shifts from losses. More fundamentally, the responses of the pub- money market mutual funds and small time deposit lic, now holding vastly expanded mutual funds, to a accounts. At the same time, outflows from those variety of interest rate and stock price movements has accounts had also gone into NOW and savings depos- yet to be tested. its, the interest rates on which were falling only slowly as market rates declined. This year, the sum of Because weakness in the demand for broad money all these M2 balances has fallen at about the same rate has largely resulted from shifts of portfolio prefer- as in 1992, but a slower runoff of small time deposits ences rather than changes in spending intentions, it and money funds has been offset by a sharp decelera- has not been reflected in comparable weakness in tion in the growth of NOW and savings deposits. nominal GDP. Furthermore, the effects of a declining Catch up declines in interest rates on liquid deposits share for depositories in overall credit growth have may account for part of their slower growth. Some been substantially offset by increased funding through nontransactions balances held in NOW and MMDA capital markets, where households now invest a larger deposits have likely been shifted into bond and equity share of wealth, The velocity of M2 has experienced funds. It may be that some depositors who do not extraordinary and unpredictable surges, reducing its ordinarily shop for small rate advantages have been value as a guide to policy. Traditional models of induced to make basic portfolio adjustments because velocity based on the difference between short-term of the historically low deposit interest rates and the market interest rates and interest rates on deposits and increased ease of making investments in capital mar- money market mutual funds, and even broader models ket instruments. that take account of longer-term interest rates and after-tax loan rates faced by households, cannot Partly as a result, narrow measures of money have explain the full 4 percent rise in M2 velocity in 1992, decelerated this year, but their expansion has re- nor what may be a somewhat faster rate of increase in mained rapid. Ml has grown at a 9'/2 percent rate the first half of 1993. from the fourth quarter of 1992 through June, com- pared with 14'/4 percent in 1992. Reserves, now held Money growth in the first quarter was depressed in exclusively against transaction deposits, have grown part by the effects of several temporary factors, at an 11 percent pace compared with 20 percent in including distortions of seasonal factors and a lull in 1992. The monetary base has slowed by much less, mortgage refinancing. A renewed surge of mortgage Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 88 M2 Velocity and Opportunity Cost Percentage points, ratio scale 1.75 1.68 - 1.54 1985 1987 1991 1993 Percentage points, ratio scale 3 1.75 - 2.5 1.68 - M2 Velocity 1.5 1.0 1.54 1.47 0.5 1985 1987 1989 1991 1993 Note: Opportunity costs are two-quarter moving averages. "Estimated difference between a weighted average of competing *3-month T-bill rate less weighted average rate paid on M2. rates (3-month T-bill, 5-year T-note, after-tax auto loan rate) and a weighted average of rates paid on M2 components. because of continued strong foreign demand for cur- quarter of 1992 through June 1993, well below the rency this year. lower end of its growth cone set in February. The FOMC monitored the behavior of M2 carefully over With reduced strength in its Ml component, and in the first half of the year, but in light of actual and savings and MMDAs, as well as continued runoffs of expected strength of velocity, determined that actions small time deposits and retail money funds, M2 has to boost M2 growth were not needed to achieve the grown at only a 3/4 percent annual rate from the fourth Committee's underlying objectives for prices and the "' \ .-.L*... j Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 89 economy. The aggregate is near the lower arm of the time deposits have continued to fall, and the halt in revised annual growth cone established in July, and if reductions in short-term rates has ended the rapid velocity continues to increase substantially, M2 may growth of institutional money funds, as their slower- well come in toward the lower end of the revised adjusting yields have come down to their usual rela- growth range for the year. tionship to market interest rates. From the fourth quarter of 1992 through June, M3 fell at about a The non-M2 portion of M3 has declined this year at 1A percent annual rate; it lies slightly below its revised nearly the same pace as the previous two years. Large annual growth cone. Growth of Money and Debt Total Nonfederal domestic domestic nonfinancial nonfinancial M1 M2 M3 debt debt Annually, fourth quarter to fourth quarter (Percentage changes) 1980 7.4 8.9 9.5 9.5 9.0 1981 5.4(2.5)1 9.3 12.3 10.0 9.7 1982 8.8 9.1 9.9 9.3 7.4 1983 10.4 12.2 9.9 11.4 8.8 1984 5.5 8.1 10.8 14.3 13.9 1985 12.0 8.7 7.6 13.8 13.3 1986 15.5 9.3 8.9 14.0 13.7 1987 6.3 4.3 5.8 10.1 10.4 1988 4.3 5.3 6.4 9.2 9.6 1989 0.6 4.7 3.7 8.2 8.5 1990 4.3 4.0 1.8 6.8 5.9 1991 8.0 2.8 1.1 4.4 2.5 1992 14.3 1.8 0.3 4.8 2.9 Semiannually (annual rate)2 1993 H1 Quarterly (annual rate)2 1993 Q1 6.6 -2.0 3.8 4.4 3.0 Q2 10.6 2.2 2.4 5.7 3.6 Fourth quarter 1992 to June 1993 (annual rate) 9.5 0.8 -0.3 5.13 3.33 1. Adjusted for shift to NOW accounts in 1981. 3. 1992:Q4-1993:May for debt aggregates. 2. From average for preceding quarter to average for quarter indicated. Second quarter debt aggregates estimated on data through May. 25 O 70-449 (96) Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Alan Greenspan (1993, July 19). Congressional Testimony. Testimony, Federal Reserve. https://whenthefedspeaks.com/doc/testimony_19930720_chair_conduct_of_monetary_policy_report_of

@misc{wtfs_testimony_19930720_chair_conduct_of_monetary_policy_report_of,
  author = {Alan Greenspan},
  title = {Congressional Testimony},
  year = {1993},
  month = {Jul},
  howpublished = {Testimony, Federal Reserve},
  url = {https://whenthefedspeaks.com/doc/testimony_19930720_chair_conduct_of_monetary_policy_report_of},
  note = {Retrieved via When the Fed Speaks corpus}
}