Full text of Monetary Policy Oversight : Senate Hearings : Federal Reserve's First Monetary Policy Report for 1992 : Hearing Before the Committee on Banking, Housing, and Urban Affairs, United States Senate, One Hundred Second Congress, Second Session

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FEDERAL RESERVE'S FIRST MONETARY POLICY
REPORT FOR 1992

HEARING
BEFORE THE

COMMITTEE ON
BANKING, HOUSING, AND URBAN AFFAIKS
UNITED STATES SENATE
ONE HUNDRED SECOND CONGRESS
SECOND SESSION
ON

OVERSIGHT ON THE MONETARY POLICY REPORT TO CONGRESS PURSUANT TO THE FULL EMPLOYMENT AND BALANCED GROWTH ACT OF
1978

FEBRUARY 25, 1992

Printed for the use of the Committee on Banking, Housing, and Urban Affairs

U.S. GOVERNMENT PRINTING OFFICE
52-899 ±5

WASHINGTON : 1992

For sale by the U.S. Government Printing Office
Superintendent of Documents, Congressional Sales Office, Washington. DC 20402




ISBN 0-16-039124-5

COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS
DONALD W. RIEGLE, JR., Michigan, Chairman
JAKE GARN, Utah
ALAN CRANSTON, California
ALFONSE M. D'AMATO, New York
PAUL S. SARBANES, Maryland
CHRISTOPHER J. DODD, Connecticut
PHIL GRAMM, Texas
CHRISTOPHER S. BOND, Missouri
ALAN J. DIXON, Illinois
CONNIE MACK, Florida
JIM SASSER, Tennessee
WILLIAM V. ROTH, JR., Delaware
TERRY SANFORD, North Carolina
RICHARD C. SHELBY, Alabama
PETE V- DOMENICI, New Mexico
NANCY LANDON KASSEBAUM, Kansas
BOB GRAHAM, Florida
ARLEN SPECTER, Pennsylvania
TIMOTHY E. WIRTH, Colorado
JOHN F. KERRY, Massachusetts
RICHARD H. BRYAN. Nevada
STEVEN B. HARRIS, Staff Director and Chief Counsel
LAMAR SMITH, Republican Staff Director and Economist
PATRICK J. LAWLEH, Chief Economist
EDWARD M. MALAN, Editor




(II)

CONTENTS
TUESDAY, FEBRUARY 25, 1992
Page

Opening statement of Chairman Riegle
Opening statements of:
Senator Gramm
Senator Dixon
Senator Graham
Prepared statement
Senator Wirth
Senator Sanford
Senator Sasser
Senator Domenici
Senator Sarbanes
Senator Kassebaum
Senator D'Amato

1
4
5
6
6
7
8
13
14
15
30
42

WITNESS
Alan Greenspan, Chairman, Board of Governors, Federal Reserve System,
Washington, DC
Prepared statement
Macroeconomic performance and monetary policy in 1991
Balance sheet adjustments
Economic expansion and money and credit growth in 1992
Concluding comments
Monetary Policy Report to the Congress




(HI)

9
54
56
59
66
68
71

FEDERAL RESERVE'S FIRST MONETARY
REPORT FOR 1992
TUESDAY, FEBRUARY 25, 1992

U.S. SENATE,
COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS,
Washington, DC.
The committee met, pursuant to notice, at 10:10 a.m., in room
SD-538 of the Dirksen Senate Office Building, Senator Donald W.
Riegle, Jr. (chairman of the committee) presiding.
OPENING STATEMENT OF CHAIRMAN DONALD W. RIEGLE, JR.

The CHAIRMAN. The committee will come to order.
Let me welcome all those in attendance this morning and particularly our witness this morning, the Fed Chairman, Alan Greenspan.
Let me begin by expressing the regret of Senator Garn that he is
not here this morning. His flight last night from Salt Lake City
was cancelled because of mechanical problems and there was no
other flight available for him to take to be here by this hour this
morning.
So he regrets that and asked that I express that to you.
This is a very important hearing this morning in that we will
take testimony on the Fed's semiannual monetary policy report to
the Congress.
This testimony comes 19 months after the beginning of a recession from which there has been no real recovery, and 3 years since
we last saw a quarterly Domestic Product growth rate of as much
as 2 percent. The economy has clearly been performing at a very
low and insufficient rate now for an extended period of time.
Your prepared remarks today indicate, as you have said other
places recently, that you are now beginning to see some signs of
greater strength in the economy, some modest stirrings of a pickup. We'll want to discuss those with you in some detail today so
that we don't either over-estimate or under-estimate exactly what
those signs may indicate.
Certainly, I hope, and this committee would hope, that you're
right, that we are seeing growing strength in the economy. I must
say it's awfully hard to identify from the vantage point that I have.
Last year, we had some signs and as you know, you indicated to
us at one point that you thought earlier in the middle of last year
that maybe things were starting to pick up and then that didn't
really materialize.
(1)




The latest data on new unemployment claims and new mortgage
applications indicate that any improvement that we may be seeing
could be brief and that it might in fact vanish.
I think we've got to take whatever steps we can to get a recovery
going and to sustain it and to get back on a strong upward growth
track.
The lead story in the morning news today and last night has to
do with these major plant closings announced by General Motors.
They're a matter of very great concern to anyone who pays attention to the erosion and destruction of more and more of our industrial base.
It's a very sad story for America when any major industrial
plant, a state-of-the-art plant that's been around for decades, is
eliminated, is closed and 4,000 or more workers per plant are told
that they're no longer needed and there's no replacement work for
them.
In Michigan yesterday, plant closings were announced that will
eliminate over 9,000 jobs in the months ahead for people working
for General Motors in the automobile industry. Two of those
plants, the Willow Run plant, very much in the news, and one in
Flint, Michigan, my hometown, a V-8 engine plant, will involve
the loss in each case of over 4,000 jobs.
These are workers with 10, 20, 30 years of experience, some of
the most skilled workers in our society. You may have seen them
yesterday, distraught, in tears in many cases because their lives
are being taken apart professionally and there is no alternative
work for them.
I must say that, as I look at the effect of all of our Government
policies, and particularly monetary policy, I am the most distressed
about the fact that we're not able to provide enough jobs for our
people in America.
"We've got now some 16 million people in America who need fulltime work and can't find it.
The other day, in Alan Dixon's hometown of Chicago, there was
a hotel that announced that it was opening up and it had a few
jobs to offer. Several thousand people turned out in sub-zero temperatures and a snowstorm, standing for blocks in line trying to
submit a job application for one of those jobs.
We then later saw the same thing happen in Los Angeles. They
had a job fair out there. There were a few jobs being advertised at
the job fair. Several thousand people came. They were in line again
for many blocks. Many couldn't even get into the building to try to
compete for one of those jobs.
And just yesterday, we saw this situation, the competition between this automobile plant in Arlington, Texas, and the one in
Willow Run, Michigan, a situation which reflects the fact that
there are not enough jobs to go around in this country. And so,
someone was bound to lose. But when that happens, I think America loses.
We have among the laws of this country the Humphrey-Hawkins
law that sets as a national goal an effort to have policies in place
that will employ our people, that will provide an opportunity for
people to go out and earn a living, provide for themselves, provide




for their families, and provide the economic strength that the country needs.
The country today is limping badly economically. I got a letter
the other day from a worker in another facility in Michigan that
told me about a 31-year-old man who had been out of work,
couldn't find replacement work, had a family, was distraught, committed suicide.
That's not an uncommon situation.
The family violence, the broken families, people having to go out
and become vagabonds across the country looking for work, is a
sorry commentary on our failure to put in place a national economic recovery plan that can get people to work.
There is a lack of a sense of urgency in this town because this
town is too insulated and remote from the problem. There are too
many people in Washington whose employment is secure and who
are very remote from these problems and do not understand them
in human terms.
I think that's a dangerous condition for the country and it's inflicting great hardship on people across the United States.
Against that background, the Fed report indicates that the
money growth that the Fed plans to provide will only be enough to
allow the economy to grow by roughly 2 percent this year. I don't
think, frankly, that's a sufficiently high goal for the country and
we ought to be putting in place policies that allow us to set and
reach a higher goal.
By the Fed's own calculation, that will not be enough to appreciably lower the unemployment rate from its current recession
peak. In fact, the Fed's report points out that its economic projections are consistent with the administration's own outlook. And
their forecast, even assuming that the President's recovery package
were to be enacted in every detail, would only bring the average
unemployment rate down this year from 7.1 percent to 6.9 percent.
Now let me repeat that, because when I first saw this in the
President's budget report, I thought it was a misprint. But it says
in here that if all of the economic initiatives being suggested are
adopted, that unemployment will come down, according to the official Bush administration estimates from 7.1 percent to 6.9 percent.
In other words, the administration's plan says it will come down
2
Aoths of 1 percent over this calendar year. To offer that as the
goal for the country that we ought to aim for and build our policy
to support tragically misreads the situation in the country and how
serious the unemployment problem is out there.
I don't understand why it is that that should be the path that we
put ourselves on in terms of an economic recovery strategy.
With inflation now running below 3 percent and, by some indications, actually declining, it is not clear to me what is preventing us
from having a more aggressive economic growth strategy, including
a more aggressive strategy at the Federal Reserve.
I might say that even that very weak economic recovery that is
being projected depends upon the Fed hitting its money growth
target. In terms of the information that we've been given by the
Fed, for the past 5 years, the Federal Reserve has consistently undershot the mid-point of its target range for M2, one measurement
of money supply. And cumulatively, that's an undershot of more




than 6 percent over that length of time, which I think can be
argued, had that not occurred, would have helped us sustain a
much stronger economy.
Last year, the Fed's report "stressed," and I quote, in its words,
that "M2 expansion noticeably above the lower end of the range
likely would be needed to foster a satisfactory performance of the
economy in 1991."
But that didn't happen.
Now the Chairman said to us just now before starting the hearing that the money supply numbers in the last few months have
been higher and he's more encouraged by them. He can elaborate
on that here, and that there have been some changes in the past
data.
But I've got to say that when the Fed consistently comes in at
the low end of its own money supply range month after month,
year after year, I think that becomes part of the problem.
I don't suggest by that that it's an easy problem to solve, but I
think it has to be solved in combination with other things.
Frankly, I don't think it's acceptable, nor should it be acceptable
to the Fed, to say that an unemployment rate near 7 percent at the
end of this year is something that's good for America or that we
ought to just swallow hard and accept.
We've got to do better than that. Mr. Chairman, you're one of
the leaders in this country in the area of policy who can make an
impact on unemployment and who has got to show I think a great
sense of urgency on the unemployment situation.
We just can't tolerate these numbers going on month after
month after month after month. These are real people. There are
real lives being torn apart. I think more has to be done to deal
with it. The suffering, if we could put it in dollar terms, is almost
beyond measure.
Last month, when you were here, you told us that we did not
need any fiscal stimulation, that the monetary stimulation already
in place, in your judgment, would be sufficient.
I must say to you that if 2 percent growth is what we're likely to
get out of what is now out there in the way of monetary stimulus, I
think that's selling the country short. That's going to bring us in
well below where we need to be and it's going to leave us with an
accumulating set of problems, human problems and economic problems, that are of great concern to me.
Let me now yield and go in the order in which members have
arrived. Let me start first with Senator Gramm for his comments.
OPENING STATEMENT OF SENATOR PHIL GRAMM
Senator GRAMM. Thank you, Mr. Chairman.
Chairman Greenspan, I look forward to hearing your report this
morning. I think everybody is concerned about the economy. I
think the magic of the right economic policy is not only what
policy can help us jump-start the economy, but also put the economy on the road to sustained economic expansion.
I have continued to be concerned about the low rate of growth in
the money supply. My problem is that we have had such a changing make-up of what is used for all the functions that we have seen




money used for in the past, that I have a very difficult time determining what is the right definition of money to look at in terms of
gauging the amount of liquidity in the economy.
But one thing that I share with the Chairman is that at least in
terms of our monetary targets, that we always seem to have been
on the low end of those targets.
Had I had the power to control the money supply, and I'm glad
that I don't. I support the position that we have taken that the control of the money supply should be outside the hands of politicians.
But I would have liked to have seen the money supply grow faster
in the last 12 months than it has. I am more concerned about that
than I am about the discount rate. But my concern is somewhat
tempered by the fact that we have had a dramatic change in the
monetary instruments of the country and it's hard for me to ferret
out exactly where we are on that subject.
I am deeply concerned about the economy. I had hoped that we
could adopt the President's economic stimulus package. I know
that there are those who are concerned that such a package is not
needed given the level of monetary stimulus.
I think it is needed. And I think the good thing about it is the
President's package is well structured so that it is certainly not
going to do the economy any long-term harm.
I can't say the same for the package that has been reported by
the House Ways and Means Committee, which would make the tax
system more progressive, which would permanently raise $91 billion in taxes over a 5-year period, which would give a short-term
tax cut, but then would take that money back after the election,
leaving the total level of taxes up $191 billion.
I would assume that you would agree that that would be harmful
to the economy under any circumstances and certainly under the
current circumstances.
But I'm glad you're here today. I look forward to hearing what
you have to say.
The CHAIRMAN. Senator Dixon from Illinois.
OPENING STATEMENT OF SENATOR ALAN J. DIXON

Senator DIXON. Mr. Chairman, I'm pleased to be here this morning as the committee hears from the Chairman of the Federal Reserve Board, Alan Greenspan, on the state of our economy and our
future economic prospects.
The Federal Reserve exercises considerable power over the economy. And I think it's imperative that this power be used to achieve
vigorous, sustainable, real economic growth. It's also important for
the Federal Reserve to act decisively when the situation demands
it.
As I've stated before, I think the Fed was somewhat slow to recognize the seriousness of our current recession and act decisively to
address it.
But though we will talk a lot this morning about monetary
policy and its impact on the economy, we must not lose sight of the
fact that the Federal Reserve cannot by itself solve all of our economic problems.




6

No matter what the Fed does with the money supply and interest rates, it cannot offset the fact that our international competition has a strong industrial policy and we do not. It cannot by itself
restore American productivity growth to what it should be. It
cannot by itself correct our low savings rate. It cannot by itself
ensure that every American has access to high quality health care
and the opportunity to obtain a job that a family can live on, buy a
home on, and educate their children on.
If the United States is to be able to compete in the ever tougher
international area—and let there be no mistake, there is no other
choice, we must compete—we have to be willing to abandon old
theories that no longer fit the changed realities. We have to be
willing to try new ideas. We have to avoid letting ideology artificially narrow our range of choices.
Most importantly, we have to begin acting now to address the
fundamental long-term problems that this recession has so clearly
exposed.
I thank the Chair.
The CHAIRMAN. Thank you very much.
Senator Graham from Florida.
OPENING STATEMENT OF SENATOR BOB GRAHAM

Senator GRAHAM. Thank you, Mr. Chairman.
Mr. Chairman, I have a statement that I would like to submit for
the record. But to supplement that, it seems to me that what is
missing is a sense of urgency in terms of our national economic
leaders,
I have spent all of my life in Florida and in my adult life, I have
never seen the sense of despair that is so evident today. Not only
have we suddenly been transformed from one of the most prosperous and growing States in the country to a State with one of its
highest levels of unemployment in the Nation, but a sense of lack
of hope and optimism for the future is increasingly pervasive.
I spent some time on Saturday with a gentleman who sells building supplies. He was commenting about how difficult his business
has been. And I said, hasn't the reduction in interest rates on
homes made it possible for there to be more construction? And he
said, no, because people won't buy a house regardless of the interest rate if they don't feel secure in their own economic future and
their ability to continue to meet those obligations. And so they are
reluctant to take on obligations.
I think that we need to have economic policies that will substantively deal with the immediate issue of job creation, the longer
term issues of quality and competitive jobs and in so doing, give a
sense of leadership, hope and purpose to the American people.
As we get into an analysis of your remarks and some questions, I
hope that we can have the benefit of your ideas as to what we
ought to be doing as a national government in order to play a role
in those reforms.
PREPARED STATEMENT OF SENATOR BOB GRAHAM

Mr. Chairman, the people of Florida are very concerned about
the economy. In my adult life I have never seen so many Floridians




who are hurting because of the loss of employment, and are also
concerned about the future of their jobs, the future of their families, their community, their State and Nation.
The Federal Government's responsibility is to focus on an agenda
to rebuild America's economic strength to allow our country to
compete well into the 21st century. Our Government should proceed on a dual track by developing" both a long-term and short-term
strategy.
For the short-term Congress needs to consider what can be done
to lift the economy out of its current recession. We need to know
what we can do which would have an impact in the next 6 to 18
months.
Several weeks ago, this committee heard from the new head of
the Resolution Trust Corporation, Mr. Albert Casey. Mr. Casey,
when asked what he thought the causes of the current recession
are and what are the prescriptions, answered as follows:
What I see is that the economy is suffering from a lack of job creation. We
bemoan and bewail the fact that we do not have consumer confidence. The reason
we do not have consumer confidence, in my opinion, is the fact that the people do
not feel assured of their income status. So I feel that job creation is the secret to us
coming out of this situation.

I agree with that analysis. The focus of our short-term economic
agenda must be on job creation, giving Americans the opportunity
to get back to work and to rebuild a sense of confidence in their
future. In fact, I introduced six bills on January 23, 1992, which are
targeted at short-term job creation and economic recovery.
I look forward to today's hearing to listen to Chairman Greenspan's thoughts on what he feels the causes of the current recession are and what the prescriptions in both the short-run and longrun for the improvement of the American economy should be.
The CHAIRMAN. Thank you.
Senator Wirth?
OPENING STATEMENT OF SENATOR TIMOTHY E. WIRTH

Senator WIRTH. Thank you, Mr. Chairman.
Mr. Greenspan, thank you again for being with us this morning.
It seems you spend a great deal of time with this committee. We
appreciate your being here.
There seems to be broad agreement everywhere that we have to
invest more, we have to follow an investment rather than a consumption strategy, we have to focus more on education and our
own productivity. There seems to be broad agreement on that and
concern if we can get there.
Coupled with that is a concern reflected, I think, in the Chairman's opening remarks, that we also have to do something quite
immediately, and yet, we don't have the tools to do something immediately.
We have this enormous deficit run up in the last decade. We
have a huge debt overhang and an increasing interest on the debt
which normally we might be able to use that money as a stimulative approach to this economy, but we don't seem to be able to do
that now. We're caught between this kind of short-term dilemma of
being unable to do anything and this need for very long restructuring.




Added to that are the concerns that I continue to hear over and
over and over again about the inability of people to borrow money.
Our financial institutions are still deeply constrained. It is very
hard for small businesses, very hard for others to get access to our
financial institutions. And yet, it appears that there's lots of money
around.
There's a troubled sense out there, Mr. Chairman, which I'm
sure you hear as well. I think that was reflected in the comments
of Chairman Riegle, reflected in the comments of my colleagues
here.
We look forward to hearing from you today and hearing your
prognosis as to where we might go.
I might finally note, Mr. Chairman, it's interesting. In Mr.
Greenspan's opening comments, he talks about—it's a very cautious statement, as he is a cautious man. Saying the prospective incipient recovery could peter out. There are clear signals—this is a
remark that maybe we're not coming out of this as some have suggested we are.
Anyway, we're pleased to have you here and I look forward to
hearing your testimony.
Thank you, Mr. Chairman.
The CHAIRMAN. I have a statement from Senator Sanford for the
record.
OPENING STATEMENT OF SENATOR TERRY SANFORD
Senator SANFORD. Thank you, Mr. Chairman.
Mr. Greenspan, I, too, would like to welcome you back to this
committee to give your semiannual report on monetary policy. I
look forward to your insights, perhaps more than ever before because this economy is in trouble.
It is interesting to note that in the Fed's last monetary policy
report of the 101st Congress approximately 19 months ago, we were
talking about the longest peacetime expansion of the U.S. economy.
At that hearing, I pointed out that if the budget deficits continued
as projected, we would add another trillion dollars to the national
debt in only 5 years. Yet, here we are, 19 months later immersed in
the longest recession—hopefully we are approaching the end—since
the end of World War II. And we've just received a budget that
shows that the national debt is projected to increase by $1 trillion
in the next 2 years.
What is equally distressing to me is the virtual unanimity of
opinion:
That the recovery is going to be slow and painful.
That growth will be at a level of approximately one-third as
robust [if that is the right word] as prior recoveries.
That 5 years will pass before the economy reaches what is generally considered full employment.
And that because of these annual record breaking deficits, the
Federal Government is virtually incapable of providing any
meaningful fiscal stimulus, as it has done in prior recessions.
There also seems to be broad based agreement among the many
economists who have testified before numerous committees both
here in the Senate and in the House that fiscal stimulants tend to




9

be less effective than anticipated because they rarely take effect
until after the recovery is well underway. In addition, the impact
of fiscal stimulants is subject to varying and conflicting interpretations. So, monetary policy is usually credited as being the most effective tool to control the ebbs and flows of the economy and its
cyclical nature. From what I understand, Mr. Greenspan, you subscribe to this general theory and for that reason have been advocating a policy of "stay the course."
The entire country was struck with your articulation of the deep
rooted discontent being felt by the American people. It certainly
echoed what North Carolinians are telling me. I suppose that
raises several critical questions:
How do we remedy the situation? Or in other words,
What additional steps can the Fed take?
What can or must Congress do?
What must the American people do or be asked to do?
And how long will it take?
As you know, I am particularly interested in halting the incidence of bank failures. I have advocated early intervention, including RFC-type of investments in viable but marginally capitalized
banks, to keep the losses from expanding geometrically. The ripple
effect of a bank failure on a community is usually much deeper
than the impact of other business failures. I believe that our country's economic health is directly linked to the health of its banks
and other financial institutions.
Similarly, the credit crunch is not only threatening businesses
which are suffering, as they usually do, from the stress of the recession, but healthy businesses are nervous about their banking relationships and access to ongoing financing needs. This is an issue
of immense importance to our Nation. As perhaps the Nation's
most visible banking regulator, your views and prescriptions are
widely disseminated and respected.
I hope you will address all of these issues directly and offer us
your suggestions to cure, or to begin to cure, our Nation's economic
woes. I want to hear whatever you have to say, even if the cure is
unpleasant. I have learned in my recent travel around North Carolina that the people are willing to take the medicine if we tell
them the truth and offer long term solutions to our problems.
I look forward to your testimony and to having an opportunity to
ask you some questions.
Thank you, Mr. Chairman.
The CHAIRMAN. Thank you. Chairman Greenspan, we'll make
your full statement a part of the record and we'd like your comments now.
STATEMENT OF ALAN GREENSPAN, CHAIRMAN, BOARD OF
GOVERNORS, FEDERAL RESERVE SYSTEM, WASHINGTON, DC

Mr. GREENSPAN. Thank you very much, Mr. Chairman.
I'm pleased to appear before this committee to present the Federal Reserve's monetary policy report to the Congress.
The CHAIRMAN. Could I ask you, if I may interrupt, just to pull
the mike a little closer because I want to make sure that folks in
the back of the room can hear you. Thank you.




10

Mr. GREENSPAN. The policy decisions discussed in this report
were made against the backdrop of a troubled economy. The recovery that seemed to be in train at the time of our last report to Congress stalled, job losses have mounted, and confidence remains low.
Looking forward, there are reasons to believe that business activity should pick up. Indeed, anecdotal reports and early data seem
to be indicating that spending is starting to firm in some sectors.
These signs should not be exaggerated. The prospective incipient
recovery could peter out, as indeed the much more vigorous recovery of last spring petered out.
There are nonetheless distinct financial indications of improvement at this time. Moreover, there are clear signals that core inflation rates are falling, implying the prospect that within the foreseeable future, we will have attained the lowest rates of inflation
in a generation.
Still, the outlook remains particularly uncertain. This means
that we at the Federal Reserve have to be particularly sensitive to
signs that the anticipated strengthening and business activity is
not emerging and be prepared to act should the need arise.
The uncertainty stems in large measure from the unprecedented
balance sheet adjustments now underway. Understanding these adjustments and the appropriate role for monetary policy under the
circumstances requires stepping back several years.
As I've discussed with you previously, Mr. Chairman, the 1980's
saw outsized accumulation of certain kinds of real assets and even
more rapid growth of debt and leverage. To a degree, this build-up
of balance sheets was a natural and economically efficient outcome
of deregulation and financial innovation. It also may have reflected
a lingering inflation psychology from the 1970's.
That is, people may have expected a rapid increase in the general price level and especially in the prices of specific real assets that
would make debt financed purchases profitable.
But in retrospect, the growth of debt and leverage was out of line
with subsequent economic expansion and asset price appreciation.
Indeed, the burden of debt relative to income mounted as asset
values, especially for real property, declined or stagnated.
In part, our current economic adjustments can be seen as arising
out of a process in which debt is being realigned with a more realistic outlook for incomes and asset values.
A primary example of the accumulation of debt and real assets
occurred in commercial real estate markets. In the early 1980's,
when space was in unusually short supply, commercial real estate
received an additional push from the Economic Recovery Tax Act,
which provided an acceleration of depreciation allowances for capital goods.
While an adjustment was appropriate and overdue, that for commercial structures was excessive, resulting in tax lives that were
far shorter than economic fundamentals would dictate. This shift
in incentives led to a surge in debt-financed commercial construction during the 1980's. Financial institutions, of course, participated in this process. Banks lent heavily against real estate collateral
for corporate restructurings and for consumer credit and, in addition, for more traditional business purposes.




11
Life insurance companies also expanded their portfolios rapidly
with growth in real estate loans especially prominent.
By the end of the 1980's, the inevitable correction was upon us.
The economy was operating close to capacity, so that growth had to
slow to a pace more in line with its long-run potential.
In the commercial real estate sector, soaring vacancy rates and a
change in tax laws in 1986 brought the boom to an end producing
sharp decreases in prices of office buildings in particular.
These developments resulted in declines in the value of assets
and growing problems in servicing the associated debt out of current income. Because of the run-up in leverage over the previous
years, these problems have become more severe than might be expected just from the slowing in income and spending.
And the difficulties of both borrowers and lenders have fed back
on spending, exacerbating the economic downturn and inhibiting
the recovery.
Faced with mounting financial problems and uncertainty about
the future, people's natural reaction is to withdraw from commitments, where possible, and to conserve and even build savings and
capital. Both households and businesses, concerned about their economic prospects over the past 2 years or so, have taken a number
of measures to reduce drains on their cash flow and to lower their
exposure to further surprises.
Part of this process has involved unusually conservative spending patterns and part has involved the early stages of a restructuring of financial positions.
Businesses have cut back staffing levels and closed plants. They
have tried to decrease production promptly to keep inventories in
line. Firms also have taken steps to lower their risk exposures by
restructuring their sources of funds to reduce leverage, enhance liquidity, and cut down on interest obligations.
The response of households has been to increase their net worth
by restraining expenditures. To reduce interest expenses, they have
paid down consumer debt and as long-term interest rates have declined, they have refinanced mortgages and other debt at lower interest rates.
Lenders too have drawn back. With capital impaired by actual
and prospective losses on loans, especially on commercial real
estate, banks and other intermediaries have not only adopted much
more cautious lending standards, but also have attempted to hold
down asset growth and bolster capital.
To a considerable extent, this response has been rational and
positive for the long-term health of our financial intermediaries.
But in many cases, it seems to have gone too far, impelled to an
extent by the reaction of supervisors to the deteriorating situation.
The Federal Reserve has taken a number of measures to facilitate balance sheet restructuring and adequate flows of credit. With
other supervisors, we have directed examiners to consider not only
the current market value of collateral against performing loans,
but the overall quality of credits. We also have met on numerous
occasions with bankers as well as bank examiners to clarify bank
supervisory policies and to emphasize the importance of banks continuing to lend and take reasonable risks.




12

Monetary policy also has in part been directed in recent quarters
to supporting balance sheet restructuring that is laying the groundwork for renewed, sustained economic expansion.
We recently reduced reserve requirements on transaction balances. This will free up some funds for lending or investing and
should over time enhance the ability of banks and their customers
to build capital.
In addition, lower short-term interest rates clearly have been
helpful to debtors. But reductions in short-term rates that were expected very soon to be reversed or that were not seen as consistent
with containing inflation would contribute little to the strengthening of balance sheet fundamentals to enhance our long-term economic prospects.
In part because we have seen declines in long- as well as shortterm rates, and increases in equity prices, progress has been made
in balance sheet restructuring. Household and debt service has
fallen appreciably as a result of lower interest rates, refinancings
and equity issuance.
The condition of our financial institutionsse also is improving.
An improved earnings outlook and a generally favorable equity
market have spurred a number of holding companies to sell substantial volumes of new shares, contributing to a significant rise of
capital ratios in the banking system, despite still large provisions
for loan losses.
The balance sheet adjustments that are in progress in the financial and nonfinancial sectors alike are without parallel in the postwar period. Partly for that reason, assessing how far the process
has come and how far it has to go is extraordinarily difficult.
As increasingly comfortable financial structures are built,
though, the restraint arising from this source eventually should
begin to diminish.
In any case, the nature and speed of balance sheet restructuring
are important elements that we will need to continue to monitor
on a day-by-day basis in assessing whether further adjustments to
the stance of monetary policy are appropriate.
Against this background of significant progress in balance sheet
strengthening, as well as lower real interest rates, the Board members and Reserve Bank presidents expect a moderate upturn in economic activity during 1992, although in the current context, the
outlook remains particularly uncertain.
According to the central tendency of these views, real output
should grow between 1% and 2l/2 percent this year. The unemployment rate is projected to begin declining, finishing the year in the
vicinity of 6% to 7 percent.
An especially favorable aspect of the outlook is that for inflation.
The central tendency of the Board members' and Reserve Bank
presidents' forecast is that inflation, as measured by the Consumer
Price Index, will be in the neighborhood of 3 to SVa percent over
the four quarters of 1992, compared with a 3 percent rise in 1991.
However, the CPI was held down last year by a retracing of the
sharp run-up in oil prices that resulted from the Gulf crisis.
Consequently, our outlook anticipates a significant improvement
in the so-called core rate of inflation. With appropriate economic




13

policies, the prospects are good for further declines in 1993 and
beyond, even as the economy expands.
To support these favorable outcomes for economic activity and
inflation, the committee reaffirmed the ranges for M2, M3, and
debt that it had selected on a tentative basis last July. These are
the same as the ranges used in 1991.
The 1992 ranges were chosen against the backdrop of anomalous
monetary behavior during the past 2 years, which seems to be related in part to the balance sheet adjustments I have been discussing.
The appropriateness for the ranges for monetary and credit
growth and the appropriate pace for growth relative to the ranges
thus will depend on how the ongoing process of balance sheet restructuring affects spending, as well as the relationship of various
measures of money and credit to spending.
Our focus, quite naturally and appropriately, has been on our immediate situation—the causes of the recent slowdown and the prospects for returning to solid growth this year.
However, as we move forward, we cannot lose sight of the crucial
importance cf the longer run performance of the economy. As I
have noted before, much of the difficulty and dissatisfaction with
our economy comes from a sense that it is not delivering the kind
of long-term improvement in living standards we have come to
expect.
The contribution monetary policy can make to addressing this
deficiency is to provide a financial environment of reasonable price
stability. Through a combination of fiscal policies directed at reducing budget deficits and monetary policies aimed at noninflationary
growth, we can achieve the strong economic performance that our
fellow citizens rightly expect.
Thank you, Mr. Chairman.
The CHAIRMAN. Thank you, Chairman Greenspan.
I'm going to call on the other members that are now present for
any opening comments before we begin the question period.
Senator Sasser?
OPENING STATEMENT OF SENATOR JIM SASSER

Senator SASSER. Thank you very much, Mr. Chairman.
I want to this morning welcome the distinguished Chairman of
the Federal Reserve Board, Dr. Greenspan, before the committee
and just say, Dr. Greenspan, I apologize for being a little late here
in your opening statement.
I was pleased to see that your recent pronouncements that are
more optimistic about the economy's prospects than you had been
in the past. I think you've been quoted as saying that you're beginning to see some stirring in the economy.
Now that's good. But the downside to that is that the press, at
least according to the press, when you see stirrings, that means
that interest rates are not going to go down any further in the foreseeable future.
Now, I haven't seen those stirrings. We haven't seen it in my
area.




14

Just to give you an example, the Knoxville News Centinel in my
home State of Tennessee reported just the other day that 9,000
people showed up and applied for 600 jobs in a manufacturing
plant that opened in Piney Flats, TN. This manufacturing plan was
paying $4 an hour. So those are hardly, just marginally livable
wages. But 9,000 people, Mr. Chairman, showed up to apply for just
a few hundred jobs.
Now we heard testimony just the other day before the Senate
Appropriations Committee from Dr. Herbert Stein and Dr. Charles
Schultze, two distinguished economists that I'm sure you're very familiar with, and they both indicated to us that interest rates have
room to come down further and that in past recessions, real interest rates have often been negative during the course of the recession.
And I might add that Dr. Stein indicated that he sees no signs of
recovery at all. Of course, Dr. Stein I believe was chairman of the
Council of Economic Advisers—was it under President Ford or Eisenhower? I forget.
Mr. GREENSPAN. It was under Nixon.
Senator SASSER. Under President Nixon.
Mr. GREENSPAN. And partly under Ford.
Senator SASSER. So I'm concerned. Now, last July, Dr. Greenspan, you told us that, and I quote: "Today, there are compelling
signs that the recession is behind us."
Now that was last July. Now you see some stirring in the economy. But I don't think we can be sure enough about what's happening not to take some further steps to bring these rates down.
I might add, Dr. Greenspan, I'm not sure you're aware of this,
but it was just announced at 10 this morning that there's been a
large, unexpected drop in consumer confidence in February. The
Conference Board that conducts the survey indicates that the consumer confidence level, Mr. Chairman, is now at the lowest level
ever recorded since they began measuring consumer confidence in
1967, and there has been a drop from the January level down. So
that is not good news.
So my message to the Chairman this morning is I hope that he
can take another look at the interest rate pictures, and I think,
given the precarious situation this economy is in, we need a further reduction.
Thank you, Mr. Chairman.
The CHAIRMAN. Thank you, Senator Sasser.
Senator Domenici?
OPENING STATEMENT OF SENATOR PETE V. DOMENICI
Senator DOMENICI. Mr. Chairman, let me thank you for being so
accommodating. I wouldn't have expected that we would give an
opening statement, so I will make mine brief.
There are many things that I would like to say, but let me just
make a couple of observations and then I will follow up on them
further.
My recollection is the last time you were before us, you said one
of the real problem areas that deserved serious watching and look-




15

ing over was the real estate in the United States and what was
happening to it.
It s rather hard for many of us to explain to our constituents
what real estate, which is generally not thought of as part of the
working man's problem, how it relates to the American economy
and our recovery.
I would hope that when my turn comes, that you might answer
that in a way that we might all understand as to its impact on
growth and growth's impact on jobs.
Having said that, I wonder whether or not the banking situation,
while it has obviously stabilized in terms of the banks and they are
doing better as banks, I wonder if the American banking system is
still reluctant to lend money to feed the growth in our kind of economic activities. And if they aren't, I'm interested in knowing how
you arrive at that. And if they are still reluctant, why are they.
And I guess last, I'm very concerned about a happening in the
banks and I don't quite understand it, so I hope we'll get an answer
if we have time. And that's why the portfolio of banks, that which
they have investments in, has grown so much of late in terms of
the portion of the investment that's in bonds and Treasuries.
I know that's security, but obviously, banks weren't always prone
to take the most secure for most of their portfolio. They took risks
with their business community. And I kind of wonder why that is
and perhaps you can explain it later.
Thank you, Mr. Chairman.
The CHAIRMAN. Thank you, Senator Domenici.
Senator Kerry?
Senator KERRY. Mr. Chairman, I don't have an opening.
The CHAIRMAN. Very good.
Senator Sarbanes?
OPENING STATEMENT OF SENATOR PAUL S. SARBANES

Senator SARBANES. Thank you very much, Mr. Chairman. I'll be
very brief.
Chairman Greenspan, I am disturbed, to put it mildly, with the
latest figures that Senator Sasser reported that have come from
the Conference Board, this further drop in consumer confidence.
Actually, quite a significant drop, as I understand it, from 50 percent to 46 percent. It really puts it at the lowest level in almost 25
years, almost a quarter of a century.
Mr. Chairman, when my turn comes to questioning, I hope that I
can still be here. I have one of those mornings with a lot of conflicting engagements. But let me just read you something that appeared in the Washington Post on February 18, 1992, because it
really underscores a concern I have.
And I'm now quoting.
In December, after the Fed dramatically and unexpectedly cut by a full percentage point its discount rate, the interest rate at which Federal Reserve Banks lend
money to financial institutions, rates on long-term U.S. Treasury securities fell significantly, as did those on corporate bonds and 30-year fixed-rate home mortgages.
The cut left the discount rate at 3.5 percent, the lowest level since 1964. Mortgage
rates dipped to 8 percent, setting off a stampede of homeowners to refinance old
higher-rate loans and sparking a surge of sales of both new and older homes. Corporate treasurers rushed to lock in the low rates and issued more new bonds in January than in any other month in history. But the low rates lasted only a few weeks.




16
Rates on 30-year Treasury bonds, which dipped below 7.4 percent, by last week had
rebounded to 7.9 percent. Angry homeowners wanted to know where their 8 percent
mortgage money had gone.

And then this is the critical paragraph.
Financial analysts cited a variety of factors for the jump in long-term rates, including a statement by Greenspan at his confirmation hearing that while he could
not be certain, he believed that the December cut in short-term rates would be
enough to get, the economy moving again. If renewed recovery is just around the
corner, analysts said, investors have no reason to expect further declines in longterm rates, especially with a $400 billion Federal budget deficit forcing the Treasury
to sell unprecedented amounts of securities.

Now, my concern is that, unfortunately, the signals that you
have sent over the last couple of months since what I think the
Journal called a conversion to rival Ebeneezer Scrooge that took
place just before Christmas time when you made the 1-point cut in
the discount rate. But your then position that everything was fine,
in a sense, nothing more needed to be done, sent a signal that in
effect you were expecting a turn up. Your anticipation was that
rates would come back up again and that the long-term market
took that signal and behaved accordingly.
And while I know that the market operates independently of the
Fed, that nevertheless, the Fed helped to contribute to this increase of at least half a point in the long-term rates.
And when my turn comes to question, if I can still be here, Mr.
Chairman, I hope to address that. And if I'm not, I hope the Chairman will respond to it in writing to the committee.
The CHAIRMAN. Very good.
Senator Mack has just arrived, but I want to give him an opportunity to make an opening comment, should he wish to do so.
Senator MACK. Thank you, Mr. Chairman. I have no opening
comment at this point and I'll await my turn to raise some questions.
The CHAIRMAN. Very good. Chairman Greenspan, you've heard
Senator Sasser and Senator Sarbanes make the point that the Conference Board consumer confidence data apparently out this morning is at its lowest point since they started that survey many,
many years ago. And if I understand it correctly, it's dropped from
50 percent in the previous month to 46 percent in February.
Am I quoting that properly?

Senator SASSER. Yes, those are the figures that were given to me.
Mr. GREENSPAN. It's actually 50.2 percent to 46.3 percent.
The CHAIRMAN. All right, 50.2 percent to 46.3 percent. Is that in
fact, so far as you know, the lowest level it's been since they've
been doing this survey?
Mr. GREENSPAN. As far as I'm concerned, for the Conference
Board survey, it is. It will be important to see what type of confirmation we get from the University of Michigan survey, which will
be out, I believe, later this week.
But as far as I recall, that is correctly the lowest level for the
Conference Board survey. And I must agree with you, I find it
quite disturbing.
The CHAIRMAN. You find it quite disturbing.
Mr. GREENSPAN. I do, indeed, yes.




17

The CHAIRMAN. Well, I do, too. That's a big drop, from 50 percent
to 46 percent. This is a very well established measurement effort
that goes on.
What does that say to us? What interpretation do we give that if
in fact the numbers are right? In 1 month, to see that kind of a
drop. That's nearly a 10 percent drop, if you will, from 50 percent
to 46 percent.
Mr. GREENSPAN. I think we have to be aware that the University
of Michigan survey is showing similar weakness in consumer confidence, but not at the levels that the Conference Board index is. The
reason is they're measuring somewhat different things.
As I understand it, the Conference Board index has got more emphasis on the notion of job availability and the sense of job opportunities than the University of Michigan does. Since there's clear
indication that the weakness is in that area, it's showing up particularly in that index more than the University of Michigan's.
The CHAIRMAN. Well, jobs are disappearing all over the country.
I mentioned the GM plant closings of yesterday. You heard about
the case down in Tennessee that Senator Sasser just cited. We had
major job reductions announced last week by Boeing, the week
before by United Technologies.
Virtually every major company in America is reducing, making
permanent reductions in their work forces. And I'm seeing that
with most of the medium-sized and small companies as well. It's
not just limited to the large companies.
Jobs are disappearing all over the country. Reading your statement today, I see you're obviously very cautious. You say the signs
of any pick-up in the economy "should not be exaggerated/' that
the prospective incipient recovery could peter out as it did last
spring.
You say here, the outlook remains particularly uncertain. That's
on the first page of your statement. And then over on page 12, you
say, while there might be a moderate upturn in economic activity
during this year, in the current context, the outlook remains particularly uncertain.
I think that given your own statements and given everything
that we can see, more has to be done. I don't think that standing
pat is getting the job done. I think you're getting a message back
through this consumer data. As you point out, you'll be getting the
University of Michigan data a little bit later. But I think you're
getting a message back that there's a lack of confidence in the
country and that the widespread unemployment is a major problem in America.
It's a problem to the individuals who are having to try to cope
with it and who do not have alternative job opportunities.
I don't think you're going to get confidence turned around in any
meaningful way until we start getting people back to work. In fact,
I would assert that the level of unemployment is now so high and
has gone on so long, that it's contributing to increasing the deficit.
The deficit is larger than it would be otherwise if we were having
higher growth and more people back to work. What more can you
do?
Mr. GREENSPAN. Well, I think there are basically two tools that
are involved here.




18
First of all, remember that the basic level of economic activity is,
in historical terms, not as negative as the state of confidence is, as
I've mentioned to this committee previously. That is not something
which I consider encouraging; I find it, on the contrary, an issue of
concern.
The rate of lay-offs, the rate of job losses is, if our data are anywhere near accurate, well below where they were in 1982, well
below where they were in 1975. And yet, what we have is a degree
of concern about job security which is as great, if not greater, than
those past periods.
I think what we are learning is that the concern is really for the
longer term, as well as for the short-term.
When we went into a recession in the past, there was a significant sharp reduction in jobs, but they came back reasonably quickly and the general expectation of people was that a lay-off was
merely that, a lay-off, not a job loss.
I think there's a different attitude now and I think that explains
why. Whereas, if you look at the raw data on labor conditions, it's
very difficult to find any sense of the discouragement that one
picks up in these various consumer attitude surveys.
The CHAIRMAN. Let me just take a minute to try to explain what
I think is going on here, and then I'm going to yield to my colleagues.
Jobs are disappearing everywhere you look. And the jobs that
are disappearing are good jobs. They're high value-added jobs,
many of them in the manufacturing base. They pay wages well
above the minimum wage. Many of them have health benefits.
Many of them have pension plans.
Those are the jobs that are disappearing, and they're disappearing in all 50 States. There's not a State in which that's not happening. There's not an industry that I know of in which that's not happening, except possibly for health care, where cost are out of control because we haven t reformed the system.
So you've got a major loss of good jobs in the country.
People who were displaced are finding that they can only get
jobs at a lower skill level and a lower income level. You've got engineers that end up driving taxi cabs. You have teachers who can't
find work teaching and are maybe working in a hamburger place.
What you're having is some movement of people who become unemployed at a higher skill and wage level down the scale into
lesser job opportunities, below their skill level and at lower wages.
The people of the country are trying to tell us something and
they're trying to say something to you and to the Federal Reserve,
as they are to the President and to the Congress.
And that is that there is a deep economic sickness in the country. Jobs are disappearing. These are not temporary lay-offs. These
are permanent lay-offs. These are permanent job reductions. It's
IBM and it's United Technologies and it's Sears & Roebuck and it's
General Motors and it's Boeing, the "who's who" of American companies.
We don't have a strategy right now to do something about it and
I think you have to do more, quite frankly. I think every policy
arm of the Government has to do more. We've got to have an aggressive economic strategy coming out of the Government as a




19

whole. We've got to have a more aggressive monetary policy strategyI think you're too passive, quite frankly. I don't say that just to
you, but I think the response of the Federal Reserve Board has
been very modest, very guarded, very slow, and I think not adequate to the problem.
The message you're getting back from the public is that they
want more done because the sickness out there is more pervasive
and deeper than we've seen before.
You yourself have said it. You've said you've not seen economic
conditions like these and confidence problems like these ever
before in your professional lifetime.
There has to be a link between that observation and what people
are reacting to and experiencing in their own lives when they tell
us that and we get that message. We're going to have to do something that goes beyond what we normally do to try to respond to it.
I don't understand how there's a disconnection between the signals we're getting and the policy response that we're making in
return to the signals. You've got to explain that here today. You've
got to tell us why we can't do more when more is needed.
Mr. GREENSPAN. I think the general view of economists—and this
is quite pervasive throughout the profession although not unanimous by any means—is that the economy will start to quicken
sometime in the second quarter.
If that is in fact the case, we will be coming out of this particular
period with perhaps a degree of momentum which, while scarcely
adequate to bring the unemployment rate down this year—I don't
think that's going to be very easy to do—at least puts us on a path
where we'll get some reasonably solid growth.
I think the basic concern that economists generally have had,
and I certainly have shared that view and do as I've said before
this committee, is that what is occurring is an extraordinary reaction to the very heavy debt expansions and declines in asset values
that occurred in the latter part of the 1980's.
That is, we are going through a type of adjustment which, as
Senator Wirth said in his opening remarks and with which I agree,
is quite different from anything we have looked at.
The CHAIRMAN. Yes, but Mr. Chairman, if that's so, and people
are drawing down their debt levels and getting stronger in terms of
their balance sheets, why is confidence plummeting?
What you're saying to us just doesn't add up. The public is
saying to you as well, it doesn't add up. There's a great anxiety out
there.
Mr. GREENSPAN. No, I don't quite agree with that. I would say
that one of the reasons why the rebalancing is taking place, why
consumers, households and businessmen are in effect restructuring
their balance sheet is a general concern.
If that consumer confidence were not low, then I don't think we
would be seeing the significant retrenchment in consumer credit
that we have seen, in the endeavor on the part of households to
lower their debt service charges.
So I don't consider that particular relationship unexplainable.
That to me is part of the process that we're observing.




20

The CHAIRMAN. I'm over my time and I appreciate my colleagues' forbearance on that.
Senator Domenici?
Senator DOMENICI. I wonder if—did you want to go ahead of me
and you can use my time for your opening remarks?
Senator MACK. No, no. You go ahead. I've got time. I'll wait.
Senator DOMENICI. Let me say to our Chairman, I think there
are at least two reasons for us having a situation where the consumer confidence continues to decline, as compared with the economic facts.
One of them is a message from the citizens of the United States,
not only about the current state of their employment or unemployment, but rather, about no confidence in the future. I think that's
the difference. Americans have always had a degree of confidence
in the future. I think they have no reason, in their opinion, to have
much confidence in their Government. And I use the word Government. I don't use just the President. I use Government.
They know that this enormous deficit has to mean something.
Our lack of manufacturing prowess has to mean something.
So I think that's one of the main reasons and frankly, the signals
that we continue to give to them, some of us, is that we want to fix
the economy right now and we want to do some things to make
people feel like the economy is fixed by doing some immediate
things.
They are more concerned with hearing from us, what are we
going to do to make America's economy stronger over the long
haul? And I continue to say that the net savings of the United
States is so low compared to comparable countries, that that's the
principal negative for the long term.
And that's hard to explain, but it's the opposite of being in debt
so much. If we weren't in debt so much, the net savings would be
higher. If that were the case, business would have a much better
opportunity, as I understand it, looking as I can look at what
people have to say about our kind of economy.
Therefore, it seems to me that we ought to be concerned about
the future of the debt of the United States, even as we talk about
tomorrow's problem and today's problem.
Having said that, let me return to my questions of you regarding
the banking system. I have one sitting here next to me that's much
more expert and I hope he talks about the banking situation with
you.
But I wanted to ask, why are banks putting so much of their
available resources into portfolios of bonds and Treasuries, as compared to other times? What's leading them to that?
Mr. GREENSPAN. First of all, I think what they are getting is a
significant increase in liabilities as the money supply increases as
is typical in a period of weak economic activity.
What tends to happen is that holdings of bonds, usually U.S.
Treasury instruments, or bills or other types of securities, tend to
be a reserve that eventually is supposed to be employed for purposes of lending. But, as a consequence, (1) of the weak economy
and (2) the very strong desire on the part of business to reduce
short-term debt, we are getting a considerably, extraordinarily




21

heavy volume of corporate debt being issued to replace short-term
liabilities, a large part of that obviously being bank loans.
So at this particular stage, I would say that it's not so much that
there is a significant desire to invest in those instruments, per se,
but alternate means of lending are not materializing, and that explains a goodly part of that particular process.
I might say, parenthetically, Senator, there are those who say
that because, in the risk-based capital analysis, Government securities are not charged with the capital requirements of, say, business
loans, that there is a tendency toward Government securities.
I think that's probably partly correct, but it's by no means a
large part of this explanation.
Senator DOMENICI. I had heard that was the principal reason. If
you have any objective evidence that it isn't, if such is available,
I'd like for you to put it in the record at your convenience.
Mr. GREENSPAN. Surely.
[Chairman Greenspan subsequently submitted the following information for the record:]
Casual inspection of the aggregate balance sheet data suggests risk-based capital
guidelines have substantially influenced banks' asset composition, since U.S. Treasury and agency obligations have been a growing share of bank credit since around
the time that risk-based capital considerations became an important potential influence on banks' asset management. However, this development, which is typical of
the late stages of recessions and early recoveries, in part at least is clearly the cyclical reflection of weak loan demand. In an attempt to distinguish between the attractiveness of Government securities based on their qualities of availability and liquidity, on the one hand, and on their favorable impact on risk-based capital ratios, on
the other, banks were grouped by risk-based capital ratios. If banks with relatively
low risk-based capital ratios, or capital ratios below BIS guidelines, have a relatively
strong incentive to improve this ratio, then such banks might be expected to have a
comparatively strong demand for Government and agency securities, regardless of
the state of loan demand.
The table illustrates that, over two recent periods, banks with low risk-based capital ratios actually raised the share of low risk-weight assets in their portfolios by
less than better capitalized banks. A likely reason for the reluctance of these banks
to shift their portfolios toward low risk-weight assets is their very low levels of profitability, which would have been depressed even further if low risk-weight and lowyield assets had been substituted for higher risk-weight, higher-yield assets.
As for the better-capitalized banks, their acquisitions of low risk-weight assets did
not appear to be motivated primarily by a desire to boost risk-based capital ratios.
In 1991, for example, banks that began the year with risk-based capital ratios above
12 percent raised the share of their portfolios accounted for by U.S. Treasury and
agency securities by more than those banks with capital ratios in the neighborhood
of 8 percent. This suggests that the banking system s recent acquisitions of Government securities primarily reflects low loan demand rather than a reluctance to acquire assets with high risk weights.

PERCENTAGE POINT CHANGES IN THE RATIO OF Low-WEIGHT TO
TOTAL ASSETS

[ALL COMMERCIAL BANKS, BY RISK-BASED CAPITAL RATIONS]
Risk-Based Capital Ratio

3/31/90 to
12/31/90

Under 8 percent

01

8 oercent and over

25
.45




12/31/90
to 12/31/
91

1.08
1.04
2.48

22

PERCENTAGE POINT CHANGES IN THE RATIO OF Low-WEIGHT TO
TOTAL ASSETS—CONTINUED

[ALL COMMERCIAL BANKS, BY RISK-BASED CAPITAL RATIONS]
Risk-Based Capital Ratio

3/31/90 to
12/31/90

1.07

-.39
.45

.26

12/31/90
to 12/31/
91

1.45
3.28
2.32
2.53

Note: Low-weight assets include U.S. Treasury securities; obligations of U.S.
Government and U.S. Government-sponsored agencies; and general obligation securities issued by States and political subdivisions.

Senator DOMENICI. With reference to—let's leave the real estate
for a minute, other than a general question.
Has the precipitous drop in real estate values been abated? Is it
continuing? Is it regional? What is your assessment?
Mr. GREENSPAN. As of the latest data that we have, which is
through the last several months, there is no evidence yet that
we've hit bottom.
There is some evidence that the impact of those real estate
values on the portfolios of commercial banks are stabilizing, but we
have got no concrete evidence which suggests that commercial
values are stabilizing and even remotely showing signs of turning
up.
Senator DOMENICI. You indicated last time that one part of real
estate has led us out of recoveries on a number of occasions, and
that's homebuilding. Homebuilding is going up in America in
terms of starts.
Nonetheless, are we justified in seeking additional incentives for
homebuyers such as proposed in the President's package?
Mr. GREENSPAN. As I've indicated here before, I'm not supportive
at this stage of a number of fiscal measures in this particular area.
However, there's no question that were that done, it would add
to starts. I would suggest, however, that if the Congress is going to
move in this direction, that it do so relatively promptly and decide
one way or the other because there is some evidence to suggest
that even though there is an expectation that if some form of housing credit is put into the law, it will be retroactive to February 1.
There's enough uncertainty about that to raise some concerns
about people holding back pending an evaluation of what type of
legislation would be forthcoming.
Senator DOMENICI. Thank you very much, Mr. Chairman.
The CHAIRMAN. Senator Graham?
Senator GRAHAM. Thank you, Mr. Chairman.
To put a human face on the reason why I believe we have this
tremendous lack of confidence, I had an unanticipated meeting recently with a Floridian whose history over the last 3 years is essentially this.




23

He'd worked for 20 years for Eastern Airlines and had reached a
position where he was earning $16 an hour. When the airline went
down, his job was terminated. He was out of work for the better
part of 18 months, during which time he had to declare personal
bankruptcy, lost his home.
He now is employed. In fact, he's employed twice. He has two 25hour-a-week jobs, each of which pays close to minimum wage. Because they are both part-time, he has no health insurance and
therefore, lives with the anxiety of what will happen to himself
and his children in the event that there is an illness.
Now that man doesn't show up on the unemployment statistics.
He's employed. In fact, he's working 10 hours more a week than he
was 3 years ago. But he's working at approximately 25 percent of
the hourly income and without the benefits that he had had.
How do you tell that man that he's supposed to have confidence
in the future and to do the sorts of things for his own economic
well-being that will in turn stimulate an economic recovery?
I think that man symbolizes what's happened literally millions of
times in this country and which has contributed, is in fact the principal cause for this attitude of uncertainty, lack of optimism and
lack of hope.
I would have to say that your statement today would not give
that gentleman a great deal of encouragement. You state on page
12 that the board members and reserve bank presidents "expect a
moderate upturn in economic activity during 1992, although in the
current context the outlook remains particularly uncertain. According to the central tendency
of these views, real output should
grow between 1% and 2:/2 percent this year, the unemployment
rate is projected to begin declining, finishing the year in the vicinity of 3% and 7 percent."
I believe the most recent unemployment statistic was 7.1 percent,
so you are not anticipating any significant recovery in terms of employment over the balance of 1992.
In that paragraph, what were your underlying assumptions in
terms of any public policy actions that might be taken in 1992, or
were those projections based on a continuation of the status quo?
Mr. GREENSPAN. Well, Senator, those data are the results of a
survey that we take every 6 months of the views of the presidents
of the reserve banks and the individual members of the board of
governors.
We do not stipulate to them what particular assumptions they
should make. We don't give them a uniform set of assumptions, but
let them make their own judgments. So that we don't have knowledge of what economic or policy assumptions they would make.
This is essentially a view of the individual banks' forecasts and
must be taken in that particular context.
I must say that it's not our goal per se; it is essentially a judgment as to what is likely to be the outcome over the next four
quarters.
Senator GRAHAM. Well, were your views one of the contributors
to his consensus?
Mr. GREENSPAN. Actually, I'm not in those numbers. I tend to be
pretty much in line with the staff estimate since I contribute to
that particular process.




24

But the part that I would say would reflect my view is that this
is an extremely difficult period to make economic projections.
Hopefully, we may be underestimating what's going on. But I think
it's just as likely that we might be failing to even attain those
levels that we're talking about.
That's the reason why I think it's crucially important, as I've
said previously, that this situation be monitored on a very detailed,
immediate basis and which, as I've indicated previously, I spend
more of my time trying to find out what is going on in the monetary policy area and its relationship to the economy than I do in
getting involved in forecasts. I think it's crucially important that
we not be misled by what's happening currently.
Senator GRAHAM. I think it's always desirable to monitor, but
monitor is a relatively distanced activity. That's John Madden up
in the press box giving color commentary. We need the head coach
on the field who is giving some leadership and direction.
What, if anything, would you recommend to the head coach
based on the monitoring that you have been doing as to what steps
we could take that would have a positive impact on the numbers
that your consensus indicate would be occurring, which I would describe as being less than anemic, and would give some hope to this
gentleman that I just described who is so representative of what's
happening to Americans?
Mr. GREENSPAN. Well, Senator, I would say that we have to look
at it from two basic governmental policy areas.
First, obviously, from my point of view is what we do with respect to monetary policy. As I've said, we have accelerated monetary ease throughout the second half of 1991. We have finally
moved money supply growth onto a more acceptable path, although
it's only been since last September that it has moved in that area.
We are aware of the fact that the amount of monetary stimulus
that is in the pipeline may not be enough. The judgment we made
back in December is that it should, but emphasized we may be mistaken and as a consequence, more might be required to be done.
And I would say that stance remains in place. As the economy
shows some signs of edging higher, we are looking at that development in the context of our particular actions.
But I will say to you as I've said in the past and I would like to
emphasize this morning, that any signs that are suggestive that we
are not recovering as we think we should, further action will be
taken. And obviously, the data that came out this morning were
not consistent with our view that things are developing on a generally expansionary mode.
I would say to you also that there are other facts that are evolving which seem to be quite positive, but it is much too soon to
make a judgment that recovery is solidly on its path.
And finally, let me say, Senator, that I trust the economy will do
better than what these forecasts are showing and that certainly, in
1993, by all of the evidence that we have, we should be in a period
of definite acceleration.
Senator GRAHAM. But is the answer that we're going to be left
with John Madden's analysis, or are we going to have a direction
to the leadership on the field as to action to take?




25

Mr. GREENSPAN. When we're talking from the point of view of
monetary policy, when we act, it will be announced. I don't want to
get involved in an evaluation until we are prepared to do something very specific.
I might say further that clearly, the fiscal side is an area which
we have discussed and is not irrelevant to this consideration. And I
think that there is a great deal of discussion going on within the
Congress, within the Government, on this issue as well.
The CHAIRMAN. Mr. Chairman, I think it's very dangerous to
leave the economy on the knife edge this way. I really think so.
Senator Mack?
Senator MACK. Mr. Chairman, if I can, I'd like to yield a little
time to Senator Domenici?
The CHAIRMAN. Yes, by all means.
Senator DOMENICI. If I can take just a minute of his time. I can't
wait for the next round of questions.
But I might just carry the distinguished Senator from Florida,
the way he has described things just a little further and say there's
another part of it. There's a fellow up in the press box and there's
the coach. But then there's a team. And the team seems to me to
be unwilling to respond.
Maybe one might say, while everything's in the doldrums,
they've gone to sleep. As a matter of fact, the first time they are
called upon to play, they produce a package for the recovery like
the U.S. House has produced, which no one thinks will contribute
to the recovery, but will add $34 billion to the deficit, put $90 billion in new taxes on and give the taxpayers credit for about $45 of
it in a lend-lease program of a tax cut—you give it to them for 2
years.
So I'm not at all sure whether we ought to wait around for the
coach or whether we ought to expect a little bit better performance
from the team.
Thank you for yielding to me.
Senator MACK. Yes, certainly.
Mr. Greenspan, when I was down in Florida this weekend, I held
a series of meetings with respect to the credit crunch, to the economy, and to real estate values.
The message clearly is that the economy is not improving in
Florida. In fact, it's getting worse.
There are all kinds of different signals that are being sent. One
of the senior lenders of a financial institution told me that, in essence, it would take a lot of courage on the part of his lending officers to even approach the lending committee with a loan that was
in real estate. Another banker told me 25 percent of their assets
are in Fed funds.
The CHAIRMAN. 25 percent?
Senator MACK. 25 percent of their assets are in Fed funds.
Another told me that their loan portfolio is 30 percent below
what it was a year ago.
Now, I know it's always fashionable to beat up on the Chairman
of the Federal Reserve. But that's not my intent because I really
seriously question how much further you could go.
In all due respect, Mr. Chairman, you've indicated that the Fed
has been rather timid, but the reality is, I've seen things done by




26

the Fed that I'd never dreamed would happen before—the number
of reductions in the discount rate, the reductions in reserve requirements, and bringing Fed funds down to the level where they
are now. As people at this hearing have asked, what good does it do
to bring down interest rates if nobody's going to lend the money?
Now I remember a hearing that we had in here maybe a year,
year and a half ago. The members of our committee from the
Northeast were railing about the failure of credit to flow into the
economy.
But I would suggest again, as a fellow who was in the business of
lending money, that one of the responsibilities of a lender is to
evaluate risk. It's that simple. Your job is to try to evaluate risk.
I've got to say, I think one of the things that's going on in the
banking community is they're evaluating the risk in the economy
not from the Federal Reserve's perspective, but from what they see
this Congress doing. There looking at what we've done with respect
to changing tax laws—reverting back to previous periods and
changing the rules.
Nobody knows what to expect in the future. They're worried
about what might happen here in Washington.
So my thrust is not to beat up on the Chairman of the Federal
Reserve, but I would say to the Chairman, I think it would be helpful for you to say to us, there's another part of economic policy.
There's monetary policy and there's fiscal policy, and you guys
have got to do something on the fiscal side. You've got to do something responsible with respect to the tax rates. Tax rates are going
to affect growth. Tax rates are going to affect investment. Tax
rates are going to affect savings.
That's where the responsibility lies.
I hear people in my State crying out that Government is impeding their opportunity with burdensome regulations. So, I would
ask—is there room for the Fed to move or, in fact, is the Fed correct in saying it's really up to us to do something?
Mr. GREENSPAN. No, there is room for the Fed to move if we
have to move further. It's not that we are at zero, so to speak. And
I do think that the actions that we have taken to date are beginning to have a very material impact on the balance sheet restructuring which, in my judgment, is the fundamental problem which
is restraining this economic structure.
Senator MACK. But Mr. Chairman, what's happening is that, yes,
we are building up liquidity, but we're building up the liquidity in
the banks. They're not lending the money.
Mr. GREENSPAN. I'm concerned about the issue of building up liquidity in households and in private businesses.
To be sure, the banks are building up huge amounts of liquidity.
But that's not the issue I'm referring to. And what I'm saying is
that, from what we can see, the extraordinary decline in interest
rates is finally beginning in the last 2 or 3 months to have a very
material effect on restoring balance sheets which were badly
strained, to a position much closer to where normal economic activity and risk can materialize.
I don't think we're there yet. I think that's one of the problems
that we have. But clearly, I think we have gone a considerable way
in that direction.




27

Senator MACK. Would it make it easier for the Chairman of the
Federal Reserve if there was some response on the fiscal side?
Mr. GREENSPAN. I'm a little concerned, as I've indicated before,
not about the particular programs that are on the table of late, but
about a bidding war which would create a significant increase in
the long-term Federal deficit, and that is unquestionably one of the
factors which is holding real long-term interest rates at levels
higher than they otherwise would be.
And I would consider that the long-term rate is a crucial issue
with respect to the restructuring of balance sheets. And I'm telling
you that whatever it is that is done on the fiscal side—and as I've
said previously, I'm not a great supporter of doing very much in
this respect—I would urge that the Congress do what is to be done
as quickly as possible, largely because the uncertainty that is being
created by various different programs out there. I do not think this
is having a useful effect on the markets.
Senator MACK. One of the areas that the Chairman of the committee mentioned is the number of jobs that are being lost. And
you named Sears, Boeing and General Motors—a lot of large companies.
But let me just say to both chairmen that the kinds of businesses
being closed and the kinds of jobs that are being lost in our State
are not big businesses.
The CHAIRMAN. Right.
Senator MACK. They're the small, mom and pop operations that
have been overwhelmed by Government involvement and Government regulation.
You can go across north Florida to little towns like Bristol, FL,
whose only means of providing jobs is in the timber industry. The
red cockaded woodpecker, an endangered species lives there. The
people in Bristol believe they're going to lose their jobs and their
businesses.
You can go into Cross City, FL, where regulations concerning
how people can fish and what they can fish for are putting families
out of business that have been in those businesses for generations.
You can go into Sarasota, FL, where people have lost their jobs
in the boat industry because the Congress of the United States
passed a luxury tax intended to make the wealthy pay more.
Do you know what they call the luxury tax in Sarasota, FL?
They call it the lay-off tax, because the wealthy decided they
weren't going to pay that increased cost. As a result, the poor guy
who was out there working hard all day long has lost his job.
I think that there is more to fiscal policy than just tax policy.
There's the regulatory side.
Frankly, Mr. Chairman, I think it would be helpful if we heard
from you that there are two sides to this issue.
Mr. GREENSPAN. I have been strongly supportive of removing regulations where they are destructive of economic growth. I've been
supportive of that for all of my professional life.
I think that as far as the banking industry is concerned, in the
context of safety and soundness, that we give as much flexibility as
we can to the commercial banking industry. And I'm also concerned about a regulatory environment nationwide which can inhibit especially small business in expanding because, as I think you




28

and other members of this committee have argued on numerous occasions, it's small business where a considerable amount of the job
creation resides.
Senator MACK. Well, just a last comment.
The CHAIRMAN. Sure. Please.
Senator MACK. You mentioned flexibility. And I would respond
that we heard statements from two different sources at this hearing with respect to the lack of flexibility. First, bankers said that
they have less flexibility to work out problem loans because of regulators looking over their shoulders. Second, the regulators said
they have less flexibility to deal with these problems because of the
regulations which the Congress has imposed on them.
I thank you, Mr. Chairman.
The CHAIRMAN. You know, Senator Mack, I agree with you. You
may have been out of the room, but when I cited the big company
job reductions, I also made the point that among medium sized and
small companies, I'm seeing the same thing.
It's interesting. The Small Business Federation the other day
came in and said that their major problem right now at the top of
the list is the increase of health care costs, and it is one of the
areas where Government presumably might help get some cost controls in place that would ease some of those burdens.
If I may say before yielding to Senator Sasser, the balance sheet
issue, Mr. Chairman, is an important issue. But so is the income
statement issue. This may be part of where the problem is.
If there's an erosion on the income statement side, in terms of
disposable income, which is money after taxes that people have to
spend, if that's dropping or threatened at the same time that
there's some marginal improvement in the balance sheet condition,
you can find that either you're treading water or you're actually
finding that you're not getting ahead of the game.
It would be a mistake to assume that people who refinance home
mortgages are finding that that by itself is enough of an offset of
the damage that either is happening or may happen on the income
statement side of the equation.
I'd urge you to look at both of those.
Mr. GREENSPAN. I agree with that statement.
The CHAIRMAN. Senator Sasser?
Senator SASSER. Thank you, Mr. Chairman.
Dr. Greenspan, we've heard here this morning, I think, some
transparent efforts to transfer responsibility for doing something
about this recession to the Congress.
The truth is that the Congress is not responsible for this recession. Nor has it done anything so far to get us out of this recession.
Because we in the Congress agreed in the budget summit agreement with the administration that we were going to maintain a lid
on how we operated over here, and that we were passing the baton
to monetary policy, to govern this economy.
Now, we've fallen off into a long recession. You yourself state
this morning that it's unclear as to when and if we're going to get
out of it in the near term.
We're relying on monetary policies to move us out of this recession. I'm wanting to know when monetary policy is going to work




29

and I want to know if we're going to get lower rates and if lower
rates will move us.
We've been told in times past that we can't take the rates down
below a certain level because of the necessity to borrow money
from foreigners to finance the deficit. Perhaps that's been true because in 1988, foreigners purchased 41 percent of our foreign debt.
In 1989, they purchased 35 percent.
But in 1990, that was down to only 4 percent of Treasury debt
being purchased by foreigners, according to my numbers, up slightly to 14 percent in 1991.
Now we don't have the problem of trying to attract the foreign
investment apparently to finance the deficit. So why not go ahead
and bring the rates down? Why play sort of Russian roulette here
with the economy? What have we got to lose by bringing these
rates down and seeing if monetary policy will do it?
Then if monetary policy won't do it, then we're going to have to
move in a stimulative way to try to stimulate the economy.
Mr. GREENSPAN. First of all, let me just say that I agree with
your conclusion; namely, that the issue of financing our current account deficit is not a problem. It's the much more general thing.
And that is reflected in the fact that the exchange rate has not
been particularly weak in this most recent period.
What we are trying to do is to create a sense of stability in the
system which will set the groundwork for a solid economic recovery.
It is important to understand that we have eased very considerably to a point now where we are beginning to get a significant acceleration in the money supply. We've had, as I indicated earlier, a
5 percent growth in M2 since September and a goodly part, something more than that, very recently, and obviously, a very strong
growth in Ml and the other variables.
There has been an effect, a positive effect, from monetary policy
on the economy. We can see the impact in the housing industry.
We can see it in the corporate sector. We can see it in a number of
different areas.
We are having an effect. The question basically is are we having
enough of an effect and is more required? And that is an issue that
is on a day-by-day evaluation process by the Federal Open Market
Committee and the Federal Reserve Board.
Senator SASSER. Well, I just would submit to you, Mr. Chairman,
that time is running out on monetary policy. We hear our colleague from Florida state to us that the banks in his area are not
lending. They've got the money but they're not lending.
We've not getting the uptick in the economy out of monetary
policy that we think we ought to get, or at least I think we ought
to get. And we're hearing from most unlikely sources.
As I indicated earlier, Dr. Herbert Stein, a conservative economist by anybody's definition, who appeared just last week before
the Appropriations Committee, on which I serve, and here's what
he said, and I quote him.
The sluggishness and uncertainty of the performance of the economy in the past
few months have, in my opinion, raised a legitimate question about whether we will
soon see the usual strong recovery without additional measures to stimulate the
economy. I believe such measures are needed.




30

Now that's a direct quote from Dr. Stein. He is saying, yes, the
first weapon is monetary policy. But apparently, he is now starting
to despair that the monetary policy will work. And if I quote him
correctly, and I think I do, he's now saying that we ought to look in
the direction of stimulative measures, that when we talk about
stimulative measures, fiscal measures, that's where the Congress
comes in.
We've done nothing so far, and we're still relying on monetary
policy. I would submit, Mr. Chairman, that I see no reason why we
can't bring the rates down further in this recession. I don't see that
we've got anything to lose, and see if our monetary policy is going
to power us out of this over the next month or two.
And even if we get a recovery going, by all of the predictions IVe
seen, it's going to be an anemic recovery. I think what this country
needs is not an anemic recovery. We need to come out of this recession with a slingshot recovery, one that will put our people back in
good jobs and get our economy moving ahead in a noninflationary
way.
In other words, if you bring the rates down, you can always take
them back up.
Now what's wrong with that argument? If we don't get the
growth out of monetary policy, then we're going to have to go the
stimulative route and that's going to mean increasing the deficit
some more.
Mr. GREENSPAN. I think you are reproducing the types of discussions that are going on within the Federal Reserve and within the
Government generally.
The reason that we decided to move on reserve requirements a
few days ago was precisely because we considered that the lending
issue, which had been of increasing concern to us, required additional action on our part.
Senator SASSER. Do you believe that reducing the reserve requirements, will that be as effective or more effective than lowering the discount rate?
I ask that as a question of information.

Mr. GREENSPAN. The discount rate is not as important as lowering the Federal funds rate, the actual interest.
Senator SASSER. The Federal funds rate. That's what I meant to
say.
Mr. GREENSPAN. The answer is, no, it has a different effect. It
does not in and of itself ease the economy generally. It directly affects the margins and lending propensities of the commercial
banks, which obviously has a positive effect, but is not as effective
as lowering the funds rate.
Senator SASSER. Well, my time has expired. Thank you, Mr.
Chairman.
The CHAIRMAN. Senator Kassebaum?
OPENING STATEMENT OF SENATOR NANCY LANDON KASSEBAUM

Senator KASSEBAUM. Chairman Greenspan, I would just like to
say in the little bit of time that I've been here, I appreciate the fact
that you don't try and create a rosy scenario. And I mean that
with great sincerity. I think your analysis is a very honest one




31

when you say that the economy shows signs of edging higher. I
think that, indeed, many of us tend to believe that. What is reflected is still a loss of confidence in the public that perhaps we know
where we're going.
I would suggest that one of the reasons there's some confusion is
we ourselves, from a fiscal policy standpoint and our own actions
in Congress, aren't sure whether we want to create in one bill
something that encourages spending as well as encourages savings.
It is a little difficult to do that in one bill.
I think that there is something that does get lost, to a certain
extent. We come back to it but we just simply, I think, lose sight of
the fact that what has had an uptick in just 1992 is the deficit, to
$400 billion projection now. That is the biggest drain on savings
that there could possibly be.
Without coming to terms with that, we're never going to be able
to take advantage of this tepid sort of re-emergence of the economy. But we all know that. It s easier to sort of look for a scapegoat
somewhere else, I guess.
One of the reasons I think we're floundering with the best approach, and that's reflected, I think, in a certain uncertainty in the
public as well, when we've not been able to put a focus on what we
think might work best.
My question is off on an entirely different direction. The Japanese stock index is about half of what it was 2 years ago. To a certain extent, it's interesting because I suppose Japan is going
through some of the same readjustments that we went through in
their real estate markets, in their stock markets, and back to more
realistic levels.
Should there be any concern about this happening? And perhaps
the Japanese, in a desire to restore cash flow, would withdraw
their securities from the Treasury.
Mr. GREENSPAN. From the U.S. Treasury, you mean.
Senator KASSEBAUM. Yes.
Mr. GREENSPAN. Well, Senator, we've already seen a very significant response on the part of Japanese banks and investors as a
consequence of these significant declines in (1) stock prices and (2)
real estate values in Japan. The amount of lending that the Japanese have been extending in the United States has come down
quite considerably. And I think we've all seen the dramatic decline
in their real estate investments in the United States.
Senator KASSEBAUM. But is it not true, Mr. Chairman, and I
don't know, that their portfolios still hold a large amount of U.S.
Treasuries, monetary treasuries?
Mr. GREENSPAN. That's correct. And we have not seen any evidence that suggests to us that we have a difficulty in that regard.
Senator KASSEBAUM. So you feel that what they've undertaken at
home has really restored their balance.
Mr. GREENSPAN. Obviously, that's a forecast that is very difficult
to make at this distance. But clearly, they've taken measures
which have addressed the problems which they consider that they
have.
Senator KASSEBAUM. Thank you. I think most of the other questions have been thoroughly exhausted.
Thank you.




32

The CHAIRMAN. Thank you, Senator Kassebaum.
Senator Sarbanes?
Senator SARBANES. Thank you very much, Mr. Chairman.
Chairman Greenspan, right at the bottom of the first page of
your statement here today, you say, and I quote:
Still, the outlook remains particularly uncertain. This means that we at the Federal Reserve have to be particularly sensitive to signs that the anticipated strengthening in business activity is not emerging and be prepared to act should the need
arise.

Now what action do you have in mind if the need should arise?
Mr. GREENSPAN. If the need should arise, I would say that we
would probably be moving the funds rate down. Obviously, I'm not
sure that we need to do the discount rate, but if that occurs, that's
available as well.
Senator SARBANES. All right. I thought that's probably what you
were going to do. So my question really follows along, I thought the
very concisive line of questioning that Senator Sasser put to you.
Why not move the fund rate down now? Here's the Catch-22.
You're saying, don't do anything on the fiscal side, as I hear you,
essentially. Leave it to monetary policy.
Chairman Riegle pointed out, monetary policy doesn't seem to be
working and the messages are coming in very strong from across
the country that there's a big problem. Consumer confidence continues to plunge.
Your failure to move even more vigorously and monetary policy
is going to precipitate action on the fiscal front which you say you
don't want to see happen. So you create a Catch-22 situation.
Now Senator Sasser quoted Herb Stein, I thought, who, in effect,
indicated that that was apparently the direction in which he was
going to move.
When Jim Tobin was before us back about a month ago, he said,
and I quote him:
I would like to emphasize that there is little upside risk in stimulative monetary
and fiscal demand management for the next 2 years. That is, there is a small likelihood that Chairman Greenspan is going to find the economy so exuberant an a step
up of inflation so threatening, that the Fed will need to slam on the monetary
breaks.
The down-side risk—continued sluggishness or further recession—is asymmetrically large.

Now, if, by your own statement, what you would do is move
down the Federal funds rate if the economy seems to be continuing
to have trouble and if lots of people are saying, well, the economy
seems to be continuing to have trouble, what's the down-side of
trying to move down the Federal funds rate?
Mr. GREENSPAN. Well, Senator, first let me say that I think that
monetary policy is working, as I've indicated before.
What monetary policy in this particular context should be focused on doing is trying to eliminate the restraints to growth
which exist in the system at this stage. And I would argue that
they are predominantly from the debt and balance sheet side, although I acknowledge that the point that Chairman Riegle made
with respect to a proper balance in looking at both income and balance sheets is an appropriate evaluation.




33

As best we can judge, we are getting a significant effect in the
markets.
Senator SARBANES. Well, why not get a more significant effect?
Mr. GREENSPAN. The question that you have to answer is whether or not, were we to move further, whether the response would be
fully positive. When we moved on reserve requirements the other
day, we got a very ambiguous response out of the financial markets.
Senator SARBANES. Well, I repeat, then, what I quoted to you at
the outset of the hearing.
Financial analysts cited a variety of factors for the jump in longterm rates, including a statement by Greenspan at his confirmation hearing that while he could not be certain, he believed that
the December cut in short-term rates would be enough to get the
economy moving again.
If a new recovery is just around the corner, analysts said, investors have no reason to expect further declines in long-term rates.
Mr. GREENSPAN. That is the view of a number of analysts. It is
not the view of the total community, if I may put it that way.
The crucial issue that we have got to be careful about is to make
certain that we create a degree of stability in the financial system
in all respects, not only with respect to money supply, but with respect to the relationship of various different segments of the financial system, such that we set the stage for a solid and prolonged
expansion in economic activity, not one that is very quickly imbalanced.
Senator SARBANES. Well, if you don't move this economy out of
the recession, you're going to precipitate or provoke or prompt
other actions to take place which may work against this long-term
objective.
You're not going to get very far if the papers keep running stories that say, "GM Loses Record 4.5 Billion. Names 12 plants to be
closed."
That's on the front page of this morning's paper. GM's loss, the
worst annual loss for an American corporation in history, brought
last year's total loss for the big three—GM, Chrysler and Ford—to
$7.7 billion.
It seems to me that there's very little down-side risk of trying to
move the rates. Otherwise, as Tobin said, continued sluggishness or
further recession, that's an asymmetrically large risk to be taking
in this situation.
Let me ask one other line of questioning because I want to get
this in.
The Fed recently issued a report that indicated that there had
been a concentration of income and wealth at the upper end of the
scale over the last decade of significant dimensions. Is that correct?
Mr. GREENSPAN. That is correct, Senator.
Senator SARBANES. Now, I'm very worried about that for this
reason.
And I notice that many of the President's tax proposals would do
the same thing. The notion is you give additional money at the top
and somehow, it works its way down, trickles its way down into the
economy, and that then somehow provides you a stimulus. It's not




34

clear to me that that's going to work. In fact, I don't think it will
work.
I think one of the problems is this growing inequity in income
and wealth so that we are losing a middle class society or a mass
purchasing society. And that what you have is an increasing concentration of the available financial resources in fewer hands. They
may invest it in a productive way. They may not. In many respects,
they are not doing so. There's been a speculative frenzy through
the last decade that has helped to create this debt overhang about
which you've talked and about which you're quite concerned.
Now the reason is that I'm concerned by this particular chart
and its significance.
This is real after tax income per capita. It's a 3-year change in
real disposable income per capita. So, in other words, this tracks
over a 3-year period because obviously, over a 1-year period, if you
move into a significant downturn, there have been instances in
which you've had a drop in real after tax income per capita.
But what this chart shows is that, taking the 3-year period,
which helps you to even out the ups and downs, we now for the
first time in the post-war period, have a negative figure, which
means that for most Americans, not the people at the very top, but
most Americans are finding that their real disposable income is
less now than it was 3 years ago.
So that their income situation is being squeezed.
So you have two problems. One is you have this unemployment
rate at 7.1 percent, the highest in this recession. Not as high as in
some previous recessions, but of course, you have to add to that
people who have dropped out of the work force and aren't looking
for work. And the record number of people working part-time, 6.7
million who want to work full-time.
And if you factor all of them in, we have a comprehensive unemployment rate of 10.8 percent.
So the unemployment rate is much more pervasive than the 7.1
percent figure would indicate.
But on top of that, you have a situation in which people who do
have jobs face two anxieties or apprehensions. One is that they're
not going to have a job. Here's GM saying 12 plants are to be
closed. That hasn't happened yet, but they've now announced it.
There are workers at these 12 plants all across America who now
know that their job is going—going, going, and it's going to be gone
fairly soon.
So that's the one problem. So even if you have a job, you're in
apprehension that you're going to lose the job.
Second, even if you have a job, and perhaps you're not in apprehension that you're going to lose your job, your income situation is
deteriorating.
The CHAIRMAN. You're sliding backward.
Senator SARBANES. Yes. Your standard of living is dropping.
Mr. GREENSPAN. That's one of the reasons this long-term consumer concern is as deep-seated as it is. There is a sense that the
longer term is not developing in a way which the average household has historically been expecting.




The CHAIRMAN. Isn't that another way of saying, if you'll yield,
though, that the traditional monetary response, as you've taken it
step by step, may not be adequate to respond to this problem?
Don't you have to yourself acknowledge that at some point,
you've employed monetary policy tools step by step, but monetary
policy isn't sufficient by itself to get the job done.
Don't you at some point have to concede that something more
needs to be done here?
I think you've got an obligation here.
Senator SARBANES. Well, Mr. Chairman, let me make this observation on that very point.
It was not until the Fed took down the discount rate just before
Christmas by a full point, your so-called Ebeneezer Scrooge conversion, that the amount of ease on the discount rate by the Fed in
this recession became comparable—not greater than, but comparable to the amount of ease by the Federal Reserve on the discount
rate in earlier recessions in the post-war period, up until that
point.
In fact, the Fed's easing of policy measured by the percentage
change in the discount rate compared with previous recessions was
in fact tighter.
Now with that one point cut, you now are in the same range as
in previous recessions. But in this recession, fiscal policy in effect
has been neutralized, unlike those previous recessions in which
fiscal policy was also used to provide a stimulus.
And you in fact have urged that fiscal policy be neutralized.
So you have a situation in which the Fed was following a tighter
monetary policy than in previous recessions and there was no stimulative fiscal policy.
Now with the December action, the Fed is now following a monetary policy that is comparable to previous recessions. But there's
still no stimulative fiscal policy.
That then raises the question, either the Fed—if the fiscal policy
is going to remain neutralized, needs to have an easier monetary
policy, or if the Fed is going to hold it where it is, you're going to
get some sort of stimulative fiscal policy.
Isn't that a logical question to put to the Fed?
Mr. GREENSPAN. Yes. Certainly, if the economy does not show
definite signs of picking up so it's not an ambiguous recovery fairly
soon, I would say that is a very legitimate question to raise.
The CHAIRMAN. Well, what does "fairly soon" mean?
Mr. GREENSPAN. I would say that as we approach the spring.
The CHAIRMAN. We're approaching the spring. It's the end of
February.
Mr. GREENSPAN. February is not the spring, Mr. Chairman.
The CHAIRMAN. No. You said approaching the spring. What do
you have in mind?
Mr. GREENSPAN. I stand to be corrected. I would say sometime
during the second quarter.
The CHAIRMAN. You mean, you think—is that the same thing as
saying that you think we have to stand pat through the first part
of the second quarter before we decide whether this policy is working?




36

Mr. GREENSPAN. No. I would say that if this economy is beginning to move, we should see signs of that within an issue of weeks,
not months.
The CHAIRMAN. Well, this income statement problem that Senator Sarbanes has just illustrated, is, I think, part of the analysis
that's been missing, so to speak.
You've said time and time again that we're in an unprecedented
condition. We're in a situation, the likes of which you've not seen
before. You've been very forthright about that, and I think that's
been a very useful statement for you to make.
By the same token, with this unprecedented situation, as adverse
as it is, we're nevertheless making traditional responses. We're
trying the same traditional doses of medicine to treat a condition
unlike any we've seen before.
To date, at least, the traditional approaches have not done the
job. Back in the middle of last year, you thought maybe they were
starting to work and you saw some glimmerings then. They pretty
much faded away and now we're back and you see some glimmerings now, but you're not certain about it. In fact, you're very uncertain about it and you go to great pains today to make sure that
nobody misunderstands the fact that you're not guaranteeing this
recovery. Is that a fair summary thus far?
Mr. GREENSPAN. As I've said in recent weeks, there are positive
signs, but we have to be careful not to assume that there's more
there than we're seeing.
The CHAIRMAN. But there's no guarantee here that this policy is
going to work, is there?
Mr. GREENSPAN. There's never a guarantee.
The CHAIRMAN. I understand. But you're specifically making it
clear here today
Mr. GREENSPAN. I'm saying of the particular structure or policies
that we can contemplate, the policy that we at the Federal Reserve
have been on over those last 6 or 9 months, is focused specifically
on balance sheet problems. And that, in our judgment, is where the
real severe problem lies.
But there's something different about this as well. Remember
that we were concerned about this balance sheet issue and the extraordinary debt expansion at a much earlier stage. And as a consequence, in part, because of that sort of phenomenon, we started
to ease in the spring of 1989, and as a consequence of that, we have
been going down at a much more moderate base than would typically be the case during a recession.
But, again, this is a different type of recession. I know it doesn't
feel this way and I don't feel this way, but in fact, the gross national product has been positive for the last three quarters.
Now, to be sure, it's a wholly inadequate recovery and it's been
consistent with the rise in the unemployment rate, with the rate of
job loss that none of us feel comfortable with. But it is different
from an economy which is going down and one which is continuing
to erode and which most monetary policy analogies have been
drawn.
The truth of the matter is that it is very difficult to actually
make judgments as to how monetary policy matches previous peri-




37

ods with respect to the degree of ease that we have initiated, going
back to the spring of 1989.
It is true that there have been periods when the real short-term
rate of interest has been negative. It's close to zero now.
It is also true that we've been at the bottom of cycles in which
the short-term rate of interest was significantly above where it is
now. We're not out of the middle range of that particular issue.
So that there is something different about this thing, which
means that we are evaluating what we're doing in the context of
the type of economy which we have not seen in the post-World War
II period.
Senator SARBANES. Mr. Chairman?
The CHAIRMAN. I'll yield briefly. I want to stay on this course,
though.
Senator SARBANES. I just waift to throw one further dimension
into this consideration,
How worried are you that there's going to be a world-wide recession, in light of the slowdown and stagnation that now seems to be
taking place in other industrial countries? And what is the significance of that for us?
To the extent we had any growth last year in the economy, it
came from the export sector. Now exports are down. U.S. exports
fell in November and December. And if we look at the situation
now in other major trading partners, they all are showing a decline
in industrial production over the last 3 months.
Now how worried are you that we're going to confront a situation in which there's a synchronized downturn taking place around
the world?
Mr. GREENSPAN. That's obviously an issue that we're always concerned about and one of the reasons why we spend a good deal of
time in consultation with our colleagues abroad.
It is certainly the case that in northern Europe, in North America and Japan, we have seen similar types of balance sheet problems, Property markets abroad in many areas—this excludes some
parts of Germany and France—have behaved in a manner not as
bad as ours, but showing many similar signs.
But having said that, we don't see at this stage the synchronous
of a world-wide problem because, indeed, as we have weakened, as
the Canadians have weakened, as the British have weakened, there
has been stability in Europe. And even though Japan has slowed
down its rate of growth, it is not in the situation that the English
speaking countries.
The issue that you raise is one that we're always concerned
about and frankly, one of the major reasons why we have a G-7
summit, why we have G-7 finance ministers and central bank governors—essentially, to coordinate and to evaluate the particular
synchronousness of the various different economies and try to
avoid the type of problem which you very rightfully raise concerns
about.
Senator SARBANES. Well, they met at that motel near Kennedy
Airport. And I have to say to you, Mr. Chairman, it was like they
were whistling in the wind. They walked out of there with a communique that really said nothing. And since then, you've had fur-




38

ther deterioration in these important indicators in these various
countries.
That was a nothing meeting. In fact, they tried to hide it, so to
speak. They sort of nipped in and out of—where was it? Garden
City?
Mr. GREENSPAN. Garden City.
Senator SARBANES. Garden City, Long Island.
The CHAIRMAN. The press was on their way out there to find it
and by the time they got there, the meeting was over and everybody was gone.
Senator SARBANES. They'd all scattered and they were in the airplane terminal and getting put of town.
That was some G-7 meeting, I have to say to you, in the light of
this challenge.
The CHAIRMAN. Let me not take any more time now.
Senator Graham?
Senator GRAHAM. [Nods in the negative.]
The CHAIRMAN. Then I want to come back to what I was talking
about a minute ago. Let me try to indicate what I think another
problem is that we have here.
The Fed really has multiple responsibilities, and you have one as
a bank regulator at a time when the banking system has got major
problems that have accumulated and some major risks in the banking system.
You also have this monetary policy responsibility and this macroeconomic policy responsibility through what is done with money
supply and interest rates.
I can see how at times these can conflict with one another. What
may be required for one may be different than what may be required for the other. And if that happens, I can see why, depending
upon the balance of view within the Fed, you might tilt one way
versus the other way. It might solve one problem, but have the
effect of making the other problem worse.
We've got some of that going on here. Some of that may be unavoidable simply because the banking problem is of such a size and
dimension that it's really unprecedented. We recently had to pass
legislation to loan the deposit insurance fund for the banking
system $70 billion and we had to put in certain emergency authorities that you asked for to respond to, hopefully, avoidable bad
events in the banking system.
The effort to try to shore up the banking system and to try to
reliquify the banks and deal with balance sheet problems, particularly among the big banks, I think may have caused the Fed to
take its eye off the macroeconomic requirements of the economy at
an unprecedented time, where analysis is particularly difficult,
where historical situations are not necessarily of great use in looking at what's going on today.
I've been very struck by the number of times where you have
said, in frankness in congressional hearings, including before this
committee, that the mixture of economic and financial circumstances are different than any that you have seen in your adult
lifetime, and that they are creating effects, confidence problems
and other things that go beyond anything in our contemporary experience.




39

You've said it over and over again.
I think today that we in our own ways are saying the same thing
to you. Senator Mack was saying that he's seeing things in Florida
that are outside the scope of experience that he's seen, at least in
any recent time. That's certainly true in what I'm seeing in my
part of the country, but I see that across the 50 States now.
In the effort to try to deal with the financial structure problem
in banking institutions, we have underplayed the need to come up
with an effective macroeconomic strategy to stabilize the country
on the income and job side. Some of it is due to the huge trade deficits we have and the fact that certain U.S. industries have been
targeted by other countries and are disappearing here. That's leading to some of this unemployment.
The danger here is that if we don't deal with stabilizing this
economy on the employment side, we run the risk that this recession can turn into something worse, a depression. And in fact,
we've got some depression elements now in some areas of the economy.
I regularly hear that from people in the commercial real estate
business.
We're approaching that in the automobile industry. I am very
struck by the fact that with these nine plant closings, General
Motors, the largest manufacturing company in America, will have
been cut in half in terms of the size of its workforce since 1985.
Last year in this country, of cars purchased by citizens, not fleet
sales to rental car companies or to units of Government, just cars
purchased by citizens, one-half were foreign cars.
When you look at the erosion of the domestic automobile base,
the companies and the job base, the credit rating downgrades, the
fact now that the domestic auto industry will have lost something
on the order of $10 billion over the last 5 quarters—you talk about
unprecedented conditions. And it's not certain that we're going to
be able to pull out of that tailspin in an orderly way.
Closing plants does not by any means necessarily stop the erosion of market share, which is what we're seeing here.
The Fed and the policy makers at the top of our Government, of
which you are one, have got to come up with a macroeconomic
strategy that really starts to lift this economy.
I think to set a 2-percent growth rate is a weak response considering what we've been through and the need to get ourselves back
up to a level where we can compete internationally and hold our
job base, hold our national income base.
We ought to be targeting something like 4 percent annual
growth.
Can we get to a 4-percent growth rate?
Mr. GREENSPAN. I don't think that we've been talking about 4
percent because we do have a significant slowing down in the labor
force. But I think where the central focus has been with respect to
growth is clearly in the area of productivity, finding ways in which
we can increase output per work hour. Strictly for demographic
reasons and, more importantly, having essentially absorbed the
desire on the part of women to get into the work force, we have
now arrived at a point where the labor force growth is going to
match the adult population to a substantial extent, which means




40

that it's going to be a good deal slower than it's been over the
years.
It is the case, and this will be especially true of women, that
having far more experience in the work force, their productivity
will begin to accelerate and that will be an important element in
raising the long-term productivity and growth rate of the United
States.
But I do think
The CHAIRMAN. Chairman Greenspan
Mr. GREENSPAN. Just let me say that the issue you raise, Mr.
Chairman, is a crucial one, in the sense that we can spend much
too much time concerned about short-term forces. If we fail to look
where it is we're going to come out and where it is that we are
going, we may succeed, or proximately succeed, in the short-term,
and find ourselves in a very difficult long-term situation with respect to world competition, with respect to standards of living of
the United States, and very specifically, with respect to the issue
that Senator Sarbanes was raising relative to the distribution of
income because I think implicit in all of this is an understanding
that education is a crucial issue.
And the evidence that we have with respect to why we are getting a dispersion of incomes or, more exactly, a concentration of incomes, is that the premium that people are able to earn because of
college degrees over and above high school degrees is widening.
That is a force which I think is not very encouraging to the
structure of this society.
So I would argue that part of our productivity view, part of our
general long-term endeavors should recognize that our educational
system is an economic policy.
The CHAIRMAN. And whether you have an income or not has a
huge bearing on whether you can get advanced education.
You've got people all over the State of New York, from Senator
D'Amato's State, and all over the State of Michigan, who want to
go on for advanced education and don't have the incomes to do it;
families are scraping, a lot of time at very low wage jobs.
A lot of the women that are working obviously work because
they want to work professionally. But there are a vast number that
are working because there's a need for an income supplement because of the backslide in wages of the other wage earner in the
household.
You've got this problem and I don't see any recognition of it. I
see a failure to recognize the erosion of the job base and the earning power of people in the country. It's sophistry to talk about advanced education, as important as it is, if we can't pay for it, if
people don't have the money to pay for it.
The Humphrey-Hawkins law says that we're supposed to be
aiming for an unemployment rate in this country of 3 percent if we
take one age classification of workers, or 4 percent if we take another classification.
That's the national goal we've set for ourselves. We did that because that's what makes a strong Nation.
Our unemployment rate now is almost twice as high as that. In
fact, I think if we were calculating it accurately, it's far more than
twice as high as that.




41

You and I and the people in this room, for the most part, are insulated from that fact because we're not caught directly in that dilemma. More and more American people are. And they re saying to
us in every way they know how to say it, that something's got to be
done to get them out of that situation. Otherwise, America is going
to keep sliding backward.
National public opinion polls in the New York Times and other
papers say that 80 percent of the American people think that we're
on the wrong economic track going into the future and they want
to get off and onto a different track.
I think that statistic is a powerful message conveying the public's dissatisfaction as to what they actually see happening in their
lives,
And with all due respect, I think our discussion today doesn't
close the gap in terms of being able to say to the American people,
here's a policy response that's going to bring this unemployment
rate down substantially and quickly. I don't hear that.
What I'm hearing is that your answer is that people should be
patient, that we're trying the traditional remedies that we've tried
in the past, even though this is an unconventional situation. We
haven't seen signs yet that it's really working. A little bit here but
that could disappear, and so we're hedging that. We're saying that
it may very well evaporate on us again.
I frankly don't know how we can say that to the people at this
time. I don't know how you can say it. I don't know how the President can say it. And the people aren't buying it.
When we vote on your nomination here in a couple of days,
you're going to be confirmed by this committee, but I daresay, if
there were a public referendum on it, I think they're ready to vote
people out. They might well vote you out, deservedly or not, and
the Fed out because they don't see the policies working.
Our obligation is to have policies that work, not policies that
might work or policies that, given enough time and patience, have
the chance of working.
I think people are saying, look, we've had that. Now we need
policies that we know will work.
I ask you to go back and take another look because if the Federal
funds rate, as you said to Senator Sarbanes, is the next step you'd
take and it might help on the margin, let's find out if it will help
on the margin. Let's try to get this confidence level going up rather
than going down.
And if that isn't going to do it, then I think you've got to break
out of some of your own long-term thinking and say that maybe we
do have a problem that's going to require some kind of a fiscal response, as much as that may be anathema to you.
If you or I had to go home tonight and say to members of our
family, I'm sorry that I'm not able to find work. I'm sorry I've been
unemployed for 8 or 10 or 12 months, or a year or 2 years. I'm
sorry we don't have enough food around this table tonight to feed
everybody properly.
If we had to do that, we'd have a much greater sense of urgency
about this problem.
There are millions of Americans who have training, who have
education, who have good work records, and who are in that situa-




42

tion this very day. We're sitting here without an ability to respond
to their problem now. I just don't think that's adequate.
Senator D'Amato?
OPENING STATEMENT OF SENATOR ALFONSE M. D'AMATO

Senator D'AMATO. Thank you, Mr. Chairman.
Mr. Chairman, I'd like to make some observations and maybe
ask one question. I recall Chairman Greenspan, more than 18
months ago raising the question of why the Federal Reserve was
not bring down the discount rate. I recall an exchange with you
and even at one point asking what world were you observing. That
in the real world, businesses were failing, people were hurting, and
that your concern for inflation was absolutely inappropriate at that
time given the real conditions that existed.
Now we can say that the interest rates have come down. There
has been an improvement for those people who are able to refinance their debt and the refinancing will give them additional expendable income.
I have to say that lower interest rates came much later than
they should have and done in a manner that created untold and
unnecessary pain to many individuals and members of the business
community.
The overregulatory zeal is in large part to blame for the credit
crunch. I can understand moving away from tax regulation, but to
make a radical change from regulation to overzealous regulation
has created much uncertainty.
The change in regulatory philosophy can be compared to a
person sailing a boat for the first time. Someone who has never
navigated and makes the boat zig and zag. I understand that this is
an imperfect situation and that it is one that is often beyond the
control of the Federal Reserve, the regulators, and Congress.
Among those areas we could change and provide some help and
relief, however, the record clearly reflects that the Federal Reserve
was continually late in acting. By not acting, the Fed exacerbated
the problem.
So we had to wait an inordinate period of time for the interest
rates to come to a level where it began to ease the pain for many.
But the pain is still there for many people.
Mr. Chairman, today, in the real estate market, specifically commercial construction, where there is not an overhang developers
cannot get mortgages. The examiners continue to conduct overzealous examinations, notwithstanding that you and the other regulators have attempted to get the message to the examiners to ease
up.
Businessman after businessman, developers and others, have told
me that their line of credit is still awfully thin and in many cases
is being pulled.
What can the Fed do to get credit to those people in the business
community who are credit worthy, who do have projects that
should receive funding?
It makes no sense to simply reduce interest rates when banks
refuse to make loans. Banks want to engage in nonrisk activities




43

only. The safest of the safe activities involves banks buying Treasuries, and that's what the banks have been doing.
Can't the Fed and other regulators set a policy where by institutions that withdraw from commercial lending activities will not get
the benefit of the discount rate of interest and the proposed lower
rate of reserves?
It would seem to me that we should look to implement a policy
that would encourage banks to make prudent loans and not simply
buy Treasuries to improve their balance sheet.
Mr. GREENSPAN. Well, Senator, you are raising an issue which I
think is causing considerable concern amongst the regulators. It's a
very frustrating experience and I think you characterize it quite
correctly.
The action we took the other day to lower reserve requirements
addresses this issue in part. But you're quite correct that making
reserves available or lowering interest rates, if it doesn't come out
the other end, has got a rather lukewarm impact.
We have tried where we can. For example, we were concerned
about the highly leveraged loan classification which we thought
was creating an adverse impact of the nature that you suggested,
and we are in the process of eliminating that.
The really very crucial issue rests in the question of the classification of loans in real estate. And the problem that we have got is
that there are clearly real estate loans which are highly desirable,
profitable, viable loans which individual banks, in part reflecting
fears of various rating agencies and securities people, are afraid to
put on the books as real estate. And that is causing difficulties
which we are endeavoring to try to ameliorate.
The success that we have had has been a good deal less than we
would like by any means.
Senator D AMATO. Marginal,
Mr. GREENSPAN. And we are meeting fairly often to try to address this subject and see what we can do. But I agree with you, at
this stage, that the results have been marginal.
Senator D'AMATO. Mr. Chairman, let me suggest to you that
when I am home and meet with various people in the business
community, their across-the-board observation is that the rate reductions have not generated much, if any, new loan activity.
The one thing that Fed policy has brought about is improving
banks' balance sheets. The banks are earning money without risk
which is fine—it has some benefits.
If we are also looking to pass on a benefit to the consumers, to
the borrowers, we haven't done that yet.
If your purpose is to stimulate loan activity, it would seem to me
that along with the carrot should go the stick.
You might be loathe to look to exercise that kind of regulatory
power, but it would seem to me that it is necessary. I don't know if
you have done it, but you might want to call in the various financial institutions and indicate to them that the administration and
the regulators are not undertaking certain policies just so banks
can improve their balance sheet without providing opportunities
for financial growth to the private sector.
That's not what the system's about. Have you thought about
that?




44

Mr. GREENSPAN. Yes, we have.
Senator D'AMATO. Have you called them in?
Mr. GREENSPAN. Well, no, we haven't. Obviously, the examiners
are talking about this.
Senator D'AMATO. This has got to be with you and the guys who
got us in this mess.
Mr. GREENSPAN. We have discussed a number of these issues. Remember, we don't have the statutory authority to
Senator D'AMATO. But you've got a lot of authority and a lot of
power, Mr. Chairman. Don't be so self-effacing.
Mr. GREENSPAN. Well, we have considerable authority and the
question is are we endeavoring to find ways to convince bankers to
make real estate loans per se?
Senator D'AMATO. Right.
Mr. GREENSPAN. A lot of them are highly undesirable.
Senator D'AMATO. We understand that.
Mr. GREENSPAN. But to make ones which are profitable and productive to the system.
Senator D'AMATO. And sound. Well, Mr. Chairman, let me just
repeat it again.
If indeed you have embarked upon a course of action to get the
interest rates down to spur the economy it makes no sense to me
that banks are not making loans.
As it relates to continuing in the construction business, developers who cannot get permanent mortgages say that they will never
again undertake a new development. That is thousands of people
throughout the country, tens of thousands, who will not be employed in construction. I am referring to projects where there are
needs, legitimate needs, not overdevelopment. This results in loss
to the tax base on the Federal level and the local level. It also results in people being out of work in all of the related industries.
This adds up to a real problem considering that the real estate
and construction industry, adds up to close to 30 percent of the
GNP.
When you have the kind of drag on such a large portion of the
gross national product, you will inevitably have economic doldrums
and not the kind of recovery we have expected.
It seems to me that the Federal Reserve has an obligation to say
to these people that they will not get the lower reserve requirements, or the benefit of the Fed discount window if they do not
make loans available to credit worthy applicants. Otherwise, what
is your policy? Am I wrong or right? If I'm wrong, tell me.
Mr. GREENSPAN. No, I think you're raising the right issues, but
there are a number of related issues which obviously we have to be
very careful about to maintain the safety and soundness of the
banking system.
Senator D'AMATO. Right.
Mr. GREENSPAN. And the viability of the market system as such.
Senator D'AMATO. Mr. Chairman, you're not going to get the
banks to loosen up unless you let them know that there's some
type of penalty attached with their failure to make loans available.
Right now, there is no incentive for banks to lend money. There
is only a penalty. The penalty is the regulator coming in and questioning a bank about making real estate loans to a particular




45

person. The penalty of lending is also placing capital at risk. If
indeed you can make an investment, a Government security where
there's no risk, why lend money?
If we're going to help the banks and if the banks are going to be
federally insured, we have an obligation and the ability to say that
this isn't just a free market per se when there are Government
guarantees involved.
I would hope that we would be more aggressive marketing the
program you are implementing to ease reserve requirements and
the regulators acting together to ease credit. Indeed, the easing of
credit has not sufficiently made monies available where they
should be. Even shopping centers that are 97 percent rented, with
AAA tenants can't get permanent financing.
I give you that as an example although you will find similar stories and cases in area after area of the country. These anecdotal
situations add up to describe the state of the economy—an incredible depression.
I'm simply going to say to you that if you drop the interest rates
down another 2 points—we are not yet at historic lows.
Even if you do reduce the discount rate and reserve requirements it will have no effect unless you back it up with a policy that
says, hey fellas, we're not giving you these opportunities to simply
improve your balance sheet.
The Fed's goal is not to simply see that the balance sheets of the
banks improve. The Fed's goal is to see that credit worthy people
get credit in the form of loans.
Is that true or not?
Mr. GREENSPAN. [Nods in the affirmative.]
Senator D'AMATO. For the record, the Chairman nodded his head
yes.
Thank you, Mr. Chairman.
The CHAIRMAN. A couple of other things before we finish today.
One of the other members raised the issue of the luxury tax on
boats and I want to just touch on it with you for a minute.
This is sort of a personal question. I don't mean it to be an offensive question to you. Have you ever owned a boat that cost more
than $100,000? I'll explain the question in a minute.
Mr. GREENSPAN. No, Mr. Chairman, I have not.
The CHAIRMAN. I didn't picture you speeding around in one of
those boats.
[Laughter.]
I didn't ask the question thinking the answer would be yes. I
haven't, either, and most people don't because to get to the point
where you can own a boat that costs $100,000 or more, you not only
have to be able to pay for the boat, but you've got to be able to pay
to dock and maintain the boat and deal with it in the wintertime.
It's very expensive to run a big boat just in terms of the amount of
gasoline and so forth that you use.
Senator D'AMATO. And you certainly can't do it on the salary of
a U.S. Senator, right?
The CHAIRMAN. Well, or I would assume the salary of the Chairman of the Fed.
In any event, as you may know, we have a luxury tax now on
boats in this country that sell for more than $100,000. If you buy a




46

boat that sells for $90,000, there is no luxury tax. It only starts on
those boats that sell for over $100,000.
Now, the point was made that there's been a very sharp fall off
in the sale of these big boats. That usually happens during a recession, as there have been for a lot of other things. The question is
how much the luxury tax on the margin is responsible for that.
I want to just explain to you for a minute how it works and then
I want to ask your opinion as an economist.
Let's say you went out tomorrow to buy a boat that costs
$110,000. The luxury tax on that would be a thousand dollars because you pay the 10 percent luxury tax on the cost of the boat
above the $100,000 figure.
So the $110,000 boat would cost you $111,000.
My question to you would be, is it likely that because a boat costs
$110,000 versus $111,000, the sales of those boats will be cut in
half?
Mr. GREENSPAN. Well, it's obvious that a less than 1 percent increase cannot contract the market by 50 percent. It's hard for me
to evaluate this without having all of the additional data. It's clear
that the boat market was declining well in advance of the tax and
there's a lot of competitive relationships between boats that are
made here and boats that are made in foreign shipyards.
So that it's very tough to get an idea of what the incidence of the
taxes concern. But if you're asking me as an economist, does a less
than 1 percent tax on a luxury item of that sort have the possibility of contracting the demand significantly, the answer is of course
not.
The CHAIRMAN. We make these boats in Michigan, a boating
State. We border on the Great Lakes, of course, and other States
that are on the water also have boating industries. We've had some
impact due to this luxury tax in terms of people being laid off in
this area.
If you take a $200,000 boat, the luxury tax would be $10,000, so
that would boost the price of that boat from $200,000 to $210,000.
Now the $10,000 is a bigger dollar figure. To have enough money to
buy a $200,000 boat and maintain it, pay the insurance on it and
everything else, you've got to have an awful lot of discretionary
income, unless that's your business purpose. I don't know what percentage of the American people are in the market for boats that
sell for more than $200,000, but I've got to believe that it's a tiny,
tiny fraction.
I just thought that I, having been asked about that issue, would
raise it with you.
I want to finish with this. I posed this general question to you
just before Senator D'Amato started.
You're a very wise man. You've been at this a long time. I'd like
to think that you're not somebody that's going to be the prisoner of
conventional thinking if unconventional thinking is required by
unusual circumstances.
Aren't we perhaps at a point where it's time to start thinking
about doing something new and different on the margin here,
maybe outside the scope of your direct decisions, but in a broad
macroeconomic sense, to get this country really on a strong and
certain growth track?




47

Mr. GREENSPAN. Mr. Chairman, I think that when we have a situation of the type that we have now with property values falling,
with balance sheets creating different types of effects than we have
seen in the past, I think all economists are looking at the question
that you have raised.
It's my judgment that, so long as the evidence continues to be
available, what we are doing is working. We should hold off
making any radical changes in policy implementation until we've
concluded that whatever it is that we are doing no longer has a
reasonable expectation of restoring us to a particularly viable balance.
We at this point, if one wants to take a benevolent view of the
way things are emerging, have the capability of coming out of this
in a highly stable economic environment, one in which we will not
be involved in a cold war, one in which we can look forward to significant growth in this economy and rising standards of living.
As things now stand, we are still on that track. I have not yet
certainly convinced myself that we are at a point where a radical
shift in policy is required.
If we get to a point where it is becoming evident that the conventional policy tools are not doing the job that we think they ought to
be doing, then I think we should be looking at alternate means.
At the moment, I would say that is premature.
The CHAIRMAN. Well, Mr, Chairman, I would submit to you,
we've got a serious erosion in our job position in the United States.
We're losing higher paying jobs all over the place, among companies of all sizes. People find replacement work generally at a level
below their skill level.
That is a trend that's now in place, and I don't see it changing.
And I'm not hearing business leaders tell me that it's changing,
On top of that, while we've got the benefit of the end of the cold
war and hopefully, a reduction in defense spending and some kind
of a peace dividend, we've got an enormous conversion problem because we have a whole military industrial complex that's been in
place to support that activity, which means there's high value
added work, involving high wages and high skills, that is not
needed anymore.
That part of the economy, quite substantial, needs replacement
work and there's really nothing out there that I can see that shows
where that all is going to go. In fact, what I see in related type activity is job shrinkage, like the plant closings that were announced
yesterday.
We don't have a conversion strategy that we have developed or
have put forward. We're assuming that somehow or another, magically, the Adam Smith type invisible hand will sort this all out and
the state-of-the-art, highly skilled, large work forces and factories
and so forth will gravitate over into something else.
I don't know how to make this urgent to the top policy makers in
our Government because they have this almost perfect detachment
from the problem. The problem involves millions of people. It's all
around us. It's increasing the deficit because of so many people unemployed and underemployed, and there's really no plan to get
them back on track and reabsorbed somewhere where they've got




48

high value added work, where they have high incomes and they
are able to contribute to a higher national income.

We have these hearings over and over again. They're civilized, as
they should be. But the baseline data is not giving us the kind of
evidence that you need. It isn't just the evidence of coming out of a
recession and getting up to some kind of an anemic 2 percent
growth rate. After the kind of recession that we have had, typically, when we come out, we come out at a much higher growth level.
We're not even anticipating that out of the President's plan, or
even the Fed's plan.
Add to that what Senator Sarbanes was talking about. Real disposable personal income per capita has not only been dropping, but
is now at the lowest point at any time since 1950.
That is a trend line that I think is extremely important. Not just
important. It's destabilizing. It starts to cut sort of the guts out of
our economic system. And the faith out of it as well because people
can work harder and harder and not get ahead. They can send a
second wage-earner in the family to work, or even a third wageearner in a family to work, and find out their disposable income as
a family unit isn't where it was even 15 or 20 years ago.
We need an economic plan for America. I don't know how else to
say it. People want it. They're desperate for it. That's the reason
that President Bush is in trouble today in the polls. You analyze
the data. You're a data analyst. You'll see that it's the economic
concerns that are at the heart of that.
You have to help fashion a plan. You're one of the few people
around with a big enough mind and enough experience to be able
to move outside the conventional mode of thinking and reconsider
in terms of how to get America off these declining trend lines.
The issue here is not to get back to an anemic 2 percent real
growth rate and hold it for four quarters or for five quarters and
then go back into the tank again. The projections of the size of the
deficit, even with 2 percent growth rates, is horrendous. We're
going to be buried under such a mountain of debt. We've got a balance sheet problem that's getting worse by the day.
We've got to get people to work. We've got to have a job strategy.
Now, we need your help in devising one. But if you don't recognize the need and speak out for it, we're probably not going to get
it done.
I want you to be able to come in here today and say on the basis
of all of your professional work experience, we've analyzed this
every which way and we've talked with the President, the other
leaders in the private sector, business leaders, and labor leaders.
We've got a plan here that we know will work. We are absolutely
confident it will work. We're going to get back on a growth track
that's going to enable us to match the growth track of our industrial competitors.
We're going to be able to match what we see Europe doing.
We're going to be able to match what we see Japan doing in the
future. And here's our plan. Here's how we're going to put it into
effect.
Yes, there are some new elements to it, but it's good for America.
We're going to get our people to work. We're going to get our un-




49

employment down to the Humphrey-Hawkins levels that are laid
out in law.
If you were saying that today, you know what would happen to
the consumer confidence numbers? Instead of going like this [indicating], they'd start going like this.
With your characteristic measured response and caution and
being elliptical in the responses and so forth, the public reaction
will be that that's not going to get it done because the nature of
the problem is too big, too deep, there's too many facets to it, it's
too perverse.
We need some help from you. You're one of the few people in
this country that can give some leadership on this question right
now at a time when it really matters. If you don't do it, I'm not
sure where it's going to come from.
Mr. GREENSPAN. OK.
Senator D'AMATO. Mr. Chairman?
The CHAIRMAN. Senator D'Amato?
Senator D'AMATO. I just want to pursue two things. First, I
would like to make an observation.
A lot of the problem with this issue is perception. We passed the
luxury tax to place 10 percent surtax on boats that sold for more
than $100,000, on vehicles over $30,000, along with furs and jewels
and airplanes. What we did may not be quite measurable in terms
of the economic fall-out, but we once again gave consumers a
reason, to say, no, you're not going to take advantage of me.
I can assure the Chairman that, although it may not be a significant percentage of the boating population in terms of numbers,
there are large numbers of people that buy boats for well over
$100,000—for even $200,000, $300,000, $400,000, and $500,000. Many
of these people have simply said, if you're going to charge me a 10
percent premium for this item, I'm not going to buy it.
That's a fact.
I live in one of the boating capitals of the world—Long Island.
I've watched the boats come in and out of our harbors—boats that
are owned by the people of Nassau and Suffolk and Queens and
Brooklyn and the visitors that come to our shores. I want to tell
you that the prevalent feeling about the luxury tax is that as a
matter of principle, people of affluence have simply said, I'm not
going to pay 10 percent.
The luxury tax certainly put a dampener on purchasing luxury
items.
What we wound up doing was not getting the rich guy which is,
by the way, a rather perverse philosophy. We shouldn't be just
trying to get the rich guy or impose a tax on success. People should
pay their fair share, but we have entered into a new kind of very
troubling, very divisive attitude where, instead of encouraging success, we're looking to get people who have been successful.
In the long run, luxury tax is one area where Congress has had a
devastating impact on my State. One of the great centers of diamonds and jewelry, it has been devastated because, again, exactly
the people who have expendable income said, I'm not going to pay
that 10 percent premium.
You may say it's not much, 10 percent over $10,000. To me, it's
the principle. If one were to go to the diamond exchange he would




50

see that working middle class families are impacted by this legislation—the people who produce and who sell merchandise, et cetera,
are impacted because less purchasing of luxury items means job
losses.
So we didn't end up getting wealthy people with the luxury tax.
We didn't make them pay a premium because they just said, the
heck with you. We're not going to partake. I think this has been a
fairly consistent pattern with the luxury tax.
One of the things we can do to help that situation, given the fact
that we've seen such a lag, is to repeal that obnoxious type of tax.
We shouldn't repeal the tax just as it relates to boats, but as it
relates to autos and furs and everything else because taxing items
is not the way to encourage growth and economic activity and employment.
I would like to address with the Chairman, if I might, the question of the tax credit for first time homebuyers because I believe
that could have a very significant impact on the growth of the
housing market—not maybe in the totality of the entire economy
but certainly, in sales and in increasing the values of one- and twofamily owner-occupied homes.
I would like the Fed to study the impact a $5,000 credit on first
time homebuyers would have on the housing market?
What, 'if any, impact would the tax credit have as it relates to
the creation of jobs over the next 24-month period of time. I think
that's the kind of thing the American people would like to know.
Mr. GREENSPAN. We've obviously looked at that and concluded,
as I indicated in an earlier question, that such a credit would obviously have some job effects since it would clearly have some acceleration of home sales and home construction as a consequence.
It probably would borrow a bit from the future in that part of
the effect would be to move up the purchases of homes into the relevant tax credit period.
I did make another point, Senator, with respect to that. Whether
or nut Congress decides to go ahead with that, it should make that
decision fairly quickly because we are beginning to get some evidence, albe't somewhat mixed as well, that people are holding off
pending whether that law will pass.
And so I would urge you to come to a fairly quick conclusion on
this question because whether one likes this credit or not, the one
thmg nobody likes is to have uncertainty out there which would
create problems for the market and lose jobs and lose construction.
Senator D'AMATO. I agree with the Chairman on that point. I
think that's very important that we act expediently. One way or
the other, even if we have to take some of the proposals and act on
them piecemeal, let's enact them.
If we don't consider the tax initiatives soon, the uncertainty acts
as a drag on the economy. There are people today who are holding
off some type of economic activity in anticipation of some future
tax benefit.
What a sorry situation we have created—when we need the help
the most, we have actually been exacerbating the economy's problems as the result of indecision.
First time homebuyers are probably reluctant to purchase for
fear that they might forego a tax benefit, notwithstanding that in




51

most cases, we have enacted this type of legislation with some retroactivity.
The American public and first time homebuyers probably don't
realize that there would most likely be a retroactivity provision.
Nor would you as an investment adviser or an attorney, counsel
your client to go ahead and purchase—particularly when there is
the possibility of $5,000 credit for a first time homebuyer.
So I think that the element of uncertainty and its effect on the
housing market is an important observation. I thank the Chairman
for his usual courtesy and for an opportunity to share my thoughts.
I'm wondering, Mr. Chairman, if there is any way of working out
an economic model that might give us some idea as to how many
jobs have been lost in what geographic areas.
Is there some way to get some kind of projection?
Mr. GREENSPAN. Well, there are several models around. We have
done some work, as a lot of others have. Why don't I put in the
record some of the results that we have concluded as a consequence
of our evaluation.
Senator D'AMATO. I'd very much appreciate that.
Thank you, Mr. Chairman.
[Chairman Greenspan subsequently supplied the following information for the record:]
The tax credit should add to housing activity over the near term. Some potential
first time homebuyers no doubt would accelerate their purchases to qualify for the
credit. Judging from past experience, most of the homes purchased by the first time
buyers will be existing homes; but the increased demand for new homes in response
to the tax credit should trigger additional production, because the current inventory
of unsold new homes is lean.
Despite its attractions, the proposed tax credit would have some negative effects.
By inducing some people to switch to owning from renting during the next year or
two, the tax credit would reduce demand for multifamily rental housing, an already
depressed segment of the housing market in which production has been low and
mortgage default rates high. In addition, the proposal is expensive, in terms of forgone tax revenues, with most of the credits likely going to homebuyers who would
have made their purchases anyway.
The proposed tax credit will affect the timing of decisions but will not appreciably
increase housing demand over the long run. Home purchases and even household
formations moved forward to take advantage of the credit will be largely offset by
reduced purchases and household formations after the next year or two.
Several organizations have attempted to quantify the impacts of the proposed tax
credit- Two major question marks complicating all these efforts, including ours at
the Federal Reserve, are: (1) How many households will move the timing of their
purchases forward into 1992 to take advantage of the credit? and (2) Will consumers
and lenders treat the credit as if it were cash? Available data and historical experience give us little hard evidence on these issues.
Regarding the timing effects, we do know from the Census Bureau's American
Housing Survey that, of the 4.6 million households that moved into owner-occupied
housing units in 1989, 1.7 million were first time homebuyers. Of these first time
buyers, roughly three-quarters purchased a previously occupied home. It seems
likely that l.o to 2.0 million households would be first time buyers this year even
without the tax credit. However, there is no adequate basis for determining how
many additional buyers would move their decision forward and purchase this year
instead of in 1993 or later.
The second question is whether the tax credit will have the same effect as cash.
The Census Bureau estimates that, in 1988, only 6 million of the Nation's 38 million
renter households could qualify for a mortgage to purchase a modestly priced home
in their region. Analysis by the National Association of Home Builders suggests
that $5,000 in cash would enable an additional 1.6 million renter households to qualify. The tax credit likely would be valued less than cash by both consumers and
lenders. But how much the credit would be discounted is uncertain.




52
Because of these and other uncertainties, estimates of the housing market effects
of the proposal differ greatly. At the high end, the National Association of Home
Builders estimates the proposal would increase single family housing starts by 25
percent (or almost 250,000 units) this year. Owing to offsetting reductions in multifamily construction and payback effects in late 1993 and 1994, the NAHB's estimate
of the effect on total starts over the 3 year period is much lower: a 4 percent increase. At the low end of the range of estimates we've seen, the forecasting firm
DRI projects a much smaller short-run impact: a rise of 35,000 in single family
starts in 1992 and 5,000 units in 1993. DRI does not estimate any offsetting effects
on multifamily rental construction, nor do they quantify the payback effect of later
years.
The uncertainties about consumer and market reactions to the proposal leave me
reluctant to offer a precise numerical projection, but my judgment is that the construction impact of the proposed tax credit would be closer to the low end of the
range of estimates than to the high end.
What about the employment effects? A rule of thumb that could be applied to the
estimate of the starts effect is that every1 additional housing start should generate
roughlj l.i person-years of employment. Of course, because of the housing market
"payback" in subsequent years, any near-term gain in employment will tend to be
reductd in those years.
Even the short-run employment effects depend on how the tax credit is financed.
If the tpx revenue lost were to be offset through cutbacks in spending on other Federal programs, or through a tax increase, the resulting job losses would need to be
netted against the direct gains in construction employment.
Finally, I would like to reiterate one point I made during my appearance before
the committee: However the Congress decides to act on this proposed tax credit, the
decision should be made promptly. Builders and consumers may be expected to
delay their decisions until the tax consequences are clear. The current uncertainty
is more detrimental to the housing market than either decision the Congress will
make on this proposal.

The CHAIRMAN. Senator D'Amato, I just want to show you this
one thing. This is out of the President's budget report which was
just sent up here the other day, where they scored here how much
the plan, the President's economic plan, if enacted in total, will improve the unemployment situation.
You can see here, it will take it down on the average for the year
1992, from what they estimate to be 7.1 percent down to 6.9 percent. So it's two-tenths of 1 percent.
Now, obviously, that's some improvement. But the issue is, do we
need something that goes beyond that because the unemployment
in States like yours and mine is just so much higher?
Senator D'AMATO. 1 think we do need something more—clearly.
That is one of the reasons I mentioned this issue to Mr. Greenspan.
When the Fed has invested so much effort to finally get the interest rates down. We need to work harder to make loans available to
credit worthy borrowers. The depth of this recession has been remarkable. Last evening I was at a dear friend's, one of the first clients I represented when I came out of law school, a very, very, very
successful businessman. He breathed a sigh of relief because he's
getting" a $24 million mortgage, that he is hopefully closing on at
the end of this week. Otherwise, he'd be in a terrible situation, because although he had gotten a construction loan, and is totally
rented, he had great difficulties getting permanent financing.
This person is a large, successful developer.
1
A Department of Labor survey suggests that approximately 30 hours of employment are generated for ever* Si,000 in construction spending on single-family housing. If construction costs
(cxdudir.ji land costal average $100,000 got the typical house purchased by a first time buyer,
then each hour-i generates 3,000 hours of employment. Annual hours for full-time workers average roughly 1,900. so each house would generate approximately IVa person-years of employment.




53

Across this Nation, however, the same story is told over and over
again—by the small business community and the small real estate
developers.
Talk about loss of consumer confidence, these are the only stories
you hear.
That is why I think, Mr. Chairman, that unless we get that
credit out to the public, to those who need it and to those who are
credit worthy, we're just going to continue to be mired in this recession for a long period of time and there will be a lot more pain
attached with it.
The CHAIRMAN. Mr. Chairman, we'll have some questions for you
for the record from some of the members of the committee, and we
ask you to respond to those in writing.
The committee stands in recess.
[Whereupon, at 1:17 p.m., the committee was recessed.]
[Prepared statement of Alan Greenspan and Monetary Policy
Report to Congress follow:]




54

Testimony by
Alan Greenspan
Chairman. Board of Governors of the Federal Reserve System




before the
Committee on Banking, Housing. and Urban Affairs
U.S. Senate

February 25. 1992

55
Mr. Chairman and members of the Committee, I am pleased to
present the Federal Reserve's Monetary Policy Report to the Congress.
The policy decisions discussed in the report were made against the
backdrop of a troubled economy.

The recovery that seemed to be in

train at the time of our last report to Congress stalled, job losses
have mounted, and confidence remains low.
Looking forward, though, there are reasons to believe that
business activity should pick up.

Indeed, anecdotal reports and early

data seem to be indicating that spending is starting to firm in some
sectors.

These signs should not be exaggerated; the prospective

incipient recovery could peter out, as indeed the much more vigorous
recovery of last spring petered out.

There are nonetheless distinct

financial indications of improvement at this time.

A number of

measures suggest that the balance sheets of many households and
businesses have been strengthened, a development that should
facilitate spending in a recovery. Similarly, banks and other lenders
have taken steps to bolster their capital positions so that they will
be able to supply the credit to support additional spending.
most recently, broad measures of money have strengthened.

And.

Moreover,

there are clear signals that core inflation rates are falling,
implying the prospect that within the foreseeable future we will have
attained the lowest rates of inflation in a generation, an encouraging
indicator of future gains in standards of living for the American
people.

Still, the outlook remains particularly uncertain.

This

means that we at the Federal Reserve have to be particularly sensitive
to signs that the anticipated strengthening in business activity is
not emerging and be prepared to act should the need arise.




56

As background, I would like to discuss our recent economic
performance, reviewing in some detail the causes of the disappointments we've experienced, and the important balance-sheet adjustments
in process that promise eventually to support a resumption of
sustainable economic growth.
Macroeconomjc Performance and Mo_ne.tary Policy in 1991
Following the contraction of economic activity in the autumn
of 1990 that resulted from the invasion of Kuwait and the subsequent
sharp rise in oil prices, economic activity continued to decline in
the first quarter of 1991.

In response to the weakening of activity

and anemic money growth, the Federal Reserve eased policy substantially over late 1990 and into early 1991.
By the spring, many signs pointed to economic recovery.

The

quick and successful conclusion of the Gulf war bolstered consumer
confidence.

Growth of the money stock was strengthening.

Homebuild-

ing had begun to stir, consumer spending had turned up, and industrial
production was advancing.

The lower interest rates and the retracing

of the earlier jump in oil prices appeared to be providing support for
an expansion of aggregate demand.

In these circumstances, the odds

appeared to favor a continued moderate recovery in jobs and employment
during 1991.
Over the third quarter, however*, evidence began to surface
that the recovery had not taken hold.

The impetus to consumer senti-

ment and spending that was provided by the completion of the Gulf war
seemed to ebb. and consumer outlays turned down again.

Businesses,

apparently caught by surprise by this development, saw their inventories back up in the late summer and fall.

With demand slackening,

businesses engaged in another round of layoffs, and private nonfarm




57

payrolls declined over the second half of 1991 while the civilian
unemployment rate rose to 7.1 percent.
In addition, growth of the monetary aggregates slowed unexpectedly during the third quarter.

Expansion of K2 virtually csased,

while M3 actually contracted--a nearly unprecedented occurrence.
Judging from our surveys of banks, other contacts in the financial
industry, and anecdotal information from borrowers, the supply of
credit for many borrowers remained quite tight, particularly for those
firms without access to open market sources of funds.

Moreover, pri-

vate credit demands weakened further.
Against this background, and with signs that inflationary
pressures were diminishing, the Federal Reserve took a number of steps
to ease policy further in the second half of 1991.

Through both open

market operations and reductions in the discount rate, money market
interest rates were lowered nearly two percentage points between
August and December.
These monetary policy actions, building on those over the
previous 2-1/2 years. have resulted in a large cumulative reduction of
interest rates.

The federal funds rate has declined nearly 6 percent-

age points from its cyclical peak, and the discount rate by 3-1/2
percentage points.
stantially as well.

Other short-terra interest rates have fallen subThe prime rate also has been reduced appreciably,

but by somewhat less than market rates as commercial banks have sought
to bolster lending margins.

In longer-term markets, bond and mortgage

yields have dropped 1 to 2 percentage points on balance from their
cyclical highs, with much of the decline coming in the latter half of
1991.

The decreases in interest rates appear to have given stock

prices a boost as well, with most major indexes rising to record
levels early this year.




58

Despite substantial decreases in interest rates in late 1990
and throughout 1991, however, M2 growth was only about 3 percent in
1991, the same as the sluggish pace of expansion of nominal GDP.
rose only 1-1/4 percent.

M3

Both aggregates ended the year only modestly

above the lower bounds of their respective annual ranges.

Growth of

domestic nonfinancial sector debt, at 4-3/4 percent, als* was near the
lower bound of its monitoring range.

Outside the federal sector, debt

increased less than 3 percent for the year in reflection not only of
depressed spending but also of a deleveraging in the houiehold and
business sectors and financial difficulties of many stat« and local
governments.
The behavior of the monetary aggregates in 1991 relative to
other economic variables was somewhat puzzling.

Doubtless, part of

the slow money growth was related to the weakness in borrowing and
spending.

But even after taking account of weak spending, growth of

money was unusually slow.

The velocity of M2 was about unchanged over

the year rather than falling as would ordinarily be expected in circumstances of sharp declines in short-term market interest rates.

It

appears that certain interest rate relationships gave households
incentives to limit their money holdings.

Commercial banks, restrain-

ing their own balance sheets in response to weak loan deaand and in an
attempt to conserve capital, lowered deposit intetest rates appreciably, especially late in the year.

On the other hand, interest rates

on consumer debt, particularly when adjusted for the lack of taxdeductibili-ty, remained relatively high.

As a result, many households

apparently used deposit balances to pay off or to avoid taking on
consumer credit.

Also, the steep yield curve and the attractive

returns recorded by bond mutual funds, as well as impressive gains in
the stock market, apparently led many households to shift funds out of




59

deposits and into capital market instruments, which are not included
in the monetary aggregates.
Finally, a brisk pace of activity by the Resolution Trust
Corporation appears to have depressed the monetary aggregates, especially M3.

When the RTC takes savings and loan assets onto its own

balance sheet, they are financed with Treasury securities, rather than
depository liabilities.

In effect, the RTC has taken on some of the

role oi thrift institutions, but its liabilities are not included in
the monetary aggregates.

In addition, the disruption of banking

relationships as institutions are resolved, including the abrogation
of some time deposit contracts, seems to lead investors To reassess
their portfolio allocation and, in some cases, to shift funds out of
deposits.
Thus, a number of factors reduced the public's demands for
monetary balances in 1991.

Some of these factors tended to raise the

velocity of money, so that To an extent slow growth of M2 was not
reflected in income flows.

But the pattern of money and credit growth

over the the last half of the year appeared also To stem importantly
from forces depressing spending and economic activity, which the
Federal Reserve attempted to counter through easing money market conditions .
Balance Sheej:Adjustments
Understanding these forces and the appropriate role for monetary policy under the circumstances requires stepping back several
years.

As I have discussed with you previously, the 1980s saw out-

sized accumulation of certain kinds of real assets and even more rapid
growth of debt and leverage.

To a degree, this buildup of balance

sheets was a natural and economically efficient outcome of deregulation and financial innovation.




It also may have reflected a lingering

60

inflation psychology from the 1970s--that is, people may have expected
a rapid increase in the general price level, and especially in the
prices of specific real assets, such as real estate properties, that
would make debt-financed purchases profitable.

But in retrospect, the

growth of debt and leverage was out of line with subsequent economic
expansion and asset price appreciation.

Indeed, the burden of debt

relative to income mounted as asset values, especially for real property, declined or stagnated.

In part. our current economic adjust-

ments can be seen as arising out of a process in which debt is being
realigned with a more realistic outlook for incomes and asset values.
Rapid rates of debt-financed asset accumulation were broadbased during the 1980s.

For example, households purchased cars and

other consumer goods at a brisk pace.

Although household income was

increasing swiftly in this period, the growth of expenditures was
faster.

Household saving rates dropped from about 8 percent at The

beginning of the decade to a 4 to 5 percent range by its end.

This

was reflected in part in burgeoning consumer installment credit, which
expanded at an average annual rate of 15 percent between 1983 and
1986.

In addition, mortgage debt expanded at an 11 percent pace

between 1983 and 1989.

Most of this increase was against existing

homes, representing borrowing against rising values either in the
process of home turnover or as owners borrowed against higher equity.
Mortgage borrowing also financed a substantial amount of buying of new
homes, which in some parts of the country at times seemed to be motivated more by speculative considerations than by fundamental needs.
The 1980s also witnessed a dramatic increase in desired
leverage of the business sector, which fostered a wave of mergers and
buyouts.

These transactions typically involved substantial retire-

ments of equity financed through issuance of debt; equity retirements




61

in the nonfinancial corporate sector exceeded new equity issuance by a
staggering $640 billion in the 1984-1990 period.

Such restructurings

often were based, at least in part, on a well-founded quest for
increased efficiency, and gains were achieved by a number of firms.
However, many of these deals also were predicated on overly optimistic
assumptions about what the economy could deliver--that rapid economic
growth could continue without setback and that asset prices would
always rise.
A primary example of the accumulation of debt and real assets
occurred in commercial real estate markets.

In the early 1980s. when

space was in unusually short supply, commercial real estate received
an additional push from the Economic Recovery Tax Act, which provided
an acceleration of depreciation allowances for capital goods.

While

an adjustment was appropriate and overdue, that for commercial structures was excessive, resulting in tax lives that were far shorter than
economic fundamentals would dictate.

This shift in incentives led to

a surge in debt-financed commercial construction during the 1980sFinancial institutions. of course, participated in this process by lending heavily: indeed, their aggressive lending behavior
probably contributed to the speed of debt accumulation.

During the

economic expansion, bank credit expanded at an average annual rate of
nearly 9 percent, well in excess of the growth of nominal income.
Banks lent heavily against real estate collateral, for corporate
restructurings, and for consumer credit, and, in addition, for more
traditional business purposes.

Life insurance companies also expanded

their portfolios rapidly, with growth in real estate loans especially
prominent.
By the end of the 1980s, the inevitable correction was upon
us.

The economy was operating close to capacity, so that growth had




62

to slow to a pace more in line with its long-run potential.

Inflation

did not pick up much, contrary to what some might have expected as
capacity was approached. In the commercial real estate sector, soaring vacancy rates and a change in tax law in 19S6 brought the boom to
an end, producing sharp decreases in prices of office buildings in
particular.
Together, these developments resulted in declines in the
value of assets and growing problems in servicing the associated debt
out of current income-

Because of the runup in leverage over previous

years, these problems have been more severe than might be expected
just from the slowing in income and spending.

And the difficulties of

both borrowers and lenders have fed back on spending, exacerbating
the economic downturn during the Gulf crisis, and inhibiting the
recovery.
Faced with mounting financial problems and uncertainty about
the future, people's natural reaction is to withdraw from commitments
where possible and to conserve and even build savings and capital.
Both households and businesses, concerned about their economic prospects, over the past two years or so have taken a number of measures
to reduce drains on their cash flow snd to lower their exposure to
further surprises.

Part of this process has involved unusually con-

servative spending patterns and part has involved the early stages of
a restructuring

of financial positions.

Businesses, for example, have strived to reduce fixed costs.
To do this, they have cut back staffing levels and closed plants.
They have tried to decrease production promptly to keep inventories in
line.

Firms also have taken steps to lower their risk exposures by

restructuring their sources of funds to reduce leverage, enhance
liquidity, and cut down on interest obligations.




63

The response of households has been analogous.

To increase

their net worth, households have taken steps to increase their savings
by restraining expenditures.

To reduce interest expenses, they have

paid down consumer debt, and as long-term interest rates have
declined, they have refinanced mortgages and other debt at lower
interest rates.
Lenders too have drawn back.

With capital impaired by actual

and prospective losses on loans, especially on commercial real estate,
banks and other intermediaries have not only adopted much more cautious lending standards, but also have attempted to hold down asset
growth and bolster capital.

They have done so in part by aggressively

reducing what they pay for funds, by more than they have reduced what
they charge for credit.

Like other businesses, they have taken steps

to pare expenses generally, including reducing work forces and looking
for cost-saving consolidations with other institutions.

To a con-

siderable extent, this response has been rational and positive for the
long-term health of our financial intermediaries.

But in many cases

it seems to have gone too far, impelled to an extent by the reaction
of supervisors to the deteriorating situation.
The Federal Reserve has taken a number of measures to facilitate balance sheet restructuring and adequate flows of credit.
Together with other supervisors, we have directed examiners to consider not only the current market value of collateral against performing loans, but the overall quality of the credits.

We also have met

on numerous occasions with bankers as well as bank examiners to clarify bank supervisory policies and to emphasize the importance of banks
continuing to lend and take reasonable risks.
Monetary policy also has in part been directed in recent
quarters to supporting balance sheet restructuring that is laying the




64

groundwork for renewed, sustained, economic expansion.

We recently

reduced reserve requirements on transactions deposits.

This will free

up some funds for lending or investment and should over time enhance
the ability of banks and their customers to build capital.
In addition, lower short-term interest rates clearly have
been helpful to debtors, but their contribution to the restructuring
process would be relatively muted if long-term rates had not also
declined at the same time and stock prices were not buoyant.

Reduc-

tions in short-term rates that were expected very soon to be reversed
or that were not seen as consistent with containing inflation would
contribute little to the strengthening of balance sheets fundamental
to enhancing our long-term economic prospects.
In part because we have seen declines in long- as well as
short-term rates and increases in equity prices, progress has been
made in balance sheet restructuring, and hopefully more is in train.
As a result of lower interest rates, household debt service as a percent of disposable personal income has fallen in the past year, from
about 19-1/2 to about 18-1/2 percent.

Moreover, further declines are

in prospect as more refinancing occurs and as interest costs on floating-rate debt, such as adjustable-rate mortgages, gradually reflect
current interest rates.
In the business sector, similar patterns can be observed.
With corporate bond rates close to their lowest levels in more than a
decade, a large number of firms in recent months have called, retired,
and replaced a considerable volume of high-cost debt.

A flood of

issuance of longer-term debt and equity shares has reduced dependence
of firms on short-term obligations.

A number of the equity deals

constituted so-called "reverse LBOs"--the deleveraging of highly
leveraged and therefore rather risky firms.




The ratio of corporate

65

debt to equity in book value terms has only begun to edge down, but
the increase in equity, together with the lower level of interest
rates, has enabled many corporations to make significant headway in
lowering interest expenses ovec the past two years, and further
decreases in corporate debt burdens are presumably in prospect.
Restraint on inventories and other spending has contributed to this
result by keeping outlays in close alignment with internally generated
funds.

And the strengthening of balance sheets is paying off in terms

of credit evaluations.

Downgrades of nonfinancial firms, though still

greater than upgrades, are well below the levels of last winter and
spring, and upgrades have risen slightly.
The condition of our financial institutions also is improving.

In the banking sector, wider interest margins seemed to be

boosting profits by the end of last year.

In addition, many institu-

tions have taken difficult but necessary measures to control noninterest expenses.

Reflecting an improved earnings outlook and a generally

favorable equity market, the stock prices of large banks have doubled
on average from the±r 1990 lows, and the premium paid by many moneycenter banks on uninsured debentures has dropped several percentage
points.

Increased share prices have spurred a number of holding

companies to sell substantial volumes of new equity shares in the
market, contributing to a significant rise of capital ratios in the
banking system, despite still-large provisions for loan losses. Measures of bank liquidity, such as the ratio of securities to loans in
bank portfolios. have risen appreciably, signalling an improved ability of banks to lend.
The balance-sheet adjustments that are in progress in the
financial and nonfinancial sectors alike are without parallel in the
post-war period.




Partly for that reason, assessing how far the

66

process has come and how far it has to go is extraordinarily difficult.

As increasingly comfortable financial structures are built,

though, the restraint arising from this source eventually should begin
to diminish.

In any case, the nature and speed of balance sheet

restructuring are important elements that we will need to continue to
monitor on a day-by-dsy basis in assessing whether further adjustments
to the stance of monetary policy are appropriate.
Economic Expansion and Money and Credit Growth in 1992
Against this background of significant progress in balancesheet strengthening as well as lower real interest rates, the Board
members and Reserve Bank Presidents expect a moderate upturn in
economic activity during 1992, although in the current context the
outlook remains particularly uncertain.

According to the central

tendency of these views, real output should grow between 1-3/4 and
2-1/2 percent this year.

The unemployment rate is projected to begin

declining, finishing the year in the vicinity of 6-3/4 to 7 percent.
An especially favorable aspect of the outlook is that for
inflation.

The central tendency of the Board members' and Reserve

Bank Presidents' forecast is tha.t inflation, as measured by the Consumer Price Index, will be in the neighborhood of 3 to 3-1/2 percent
over the four quarters of 1992, compared with a 3 percent rise in
1991.

However, the CFl was held down last year by a retracing of the

sharp runup in oil prices that resulted from the Gulf crisis.

Conse-

quently, our outlook anticipates a significant improvement in the socalled core rate of inflation.

With appropriate economic policies,

the prospects are good for further declines in 1993 and beyond even as
the economy expands.
To support these favorable outcomes for economic activity and
inflation, the Committee reaffirmed the ranges for K2, M3, and debt




67

that it had selected on a tentative basis last July--that is, 2-1/2 to
6-1/2 percent for M2, 1 to 5 percent for M3, and 4-1/2 to 8-1/2 percent for debt, measured on a fourth-quarter-to-fourth-quarter basis.
These are the same as the ranges used for 1991.

The 1992 ranges were

chosen against the backdrop of anomalous monetary behavior during the
last two years.

Since 1989, M2 has posted widening shortfalls from

the levels historical experience indicates would have been compatible
with actual nominal GDP and short-term market interest rates.
The appropriate pace of M2 growth within its range during
1992 thus will depend on the intensity with which forces other than
nominal GDP turn out to affect money demand.

Depository institutions

are likely to continue reducing their rates on retail deposits ±n
lagged response to the steep declines in money market yields before
year-end.

Those deposit-rate reductions could be significant, espe-

cially if banks ate not seeking retail deposits, given their continued
caution in extending credit and borrowers' continued preference for
longer-term sources of credit to strengthen balance sheets.

With the

effects of lower deposit rates contributing to further shifts of funds
into longer-term mutual funds and into debt repayment, and with the
RTC remaining active in resolving troubled thrifts, the velocity of M2
could increase this year, independently of changes in market interest
rates.
The ongoing restructuring of depository institutions, as in
the last two years, is likely to continue to have an even larger
influence on M3 than on M2 growth.

Assets previously on the books of

thrifts that are acquired by the RTC will be financed by Treasury debt
rather than the liabilities of thrifts.

Managed liabilities in M3

should continue to be more depressed by resolution activity than




68

retail CDs.

The reaffirmed range for M3 growth thus remains lower

than for M2.
Nonfinancial debt growth is likely to be a little faster than
last year's 4-3/4 percent increase.

The wider federal deficit in

prospect for 1992 will increase Treasury borrowing.

Assuming output

and incomes are again expanding, balance sheets in somewhat better
condition, and credit conditions no longer tightening, the borrowing
of households and businesses may pick up a little, although their
overall posture probably will remain cautious.
Will these ranges for money and credit growth prove to be
appropriate?

Obviously, we believe that the answer is yes.

should reemphasize the sizable uncertainties that prevail.

But I
The ongo-

ing process of balance sheet restructuring may affect spending, as
well as the relationship of various measures of money and credit to
spending, in ways we are not anticipating.

In assessing monetary

growth in 1992, the Federal Reserve will have to continue to be sensitive to evolving velocity patterns.
Gone luding Qpmnien:ts
Our focus, quite naturally and appropriately, has been on our
immediate situation--the causes of the recent slowdown and the prospects for returning to solid growth this year.

However, as we move

forward, we cannot lose sight of the crucial importance of the longerrun performance of the economy.

As I have noted before, much of the

difficulty and dissatisfaction with our economy comes from a sense
that it is not delivering the kind of long-term improvement in living
standards we have come to expect.

The contribution monetary policy

can make to addressing this deficiency is to provide a financial background that fosters saving and investment and sound balance sheet
structures.




Removing over time the costs and uncertainties associated

69

with ongoing inflation encourages productivity-enhancing investment.
Moreover, inflation tends to promote leverage and over-accumulation of
real assets as a hedge against increases in price levels; progress
toward price stabiliiy provides a backdrop for borrowing and lending
decisions that lead to strong balance sheets, far less apt to magnify
economic disturbances.
A crucial aspect of our recent economic performance is the
difficult situation of our financial sector.

Clearly, some of the

weakness of the economy over the past two years arose from the
restraint on the supply of credit — the so-called credit crunch.

Both

depository institutions and other financial intermediaries made some
of the same mistakes of Judgment about the likely appreciation of
asset prices as did borrowers.

In addition, though, the balance

sheets of many financial intermediaries themselves were not robust;
many lacked adequate capital to continue to lend to good credit risks
in the face of losses from their previous lending mistakes.

Our

emphasis on improving the capitalization of depository institutions
over time, where we have already made substantial progress, should
help bolster their ability to lend both in good times and bad.

We

could make further strides in strengthening our depository institutions through removal of outmoded constraints on their behavior.

By

loosening strictures on the ability of these firms to compete across
arbitrary boundaries of product line and geography, we would improve
their profitability and capital.

Their strengthened position should

augment their ability to lend and potentially could reduce demands on
the federal safety net.
Finally, we should consider carefully the effects of the
extremely low rates of national saving that we have experienced for a




70

decade.

Certainly, low personal and corporate saving rates have con-

tributed to the deterioration in balance sheets that has impaired our
economic performance in recent years.

The large stocks of federal

debt that have been built up, too, likely have adversely affected out
economic prospects by putting upward pressure on real interest rates
and thus stunting the growth of the capital stock, on which our future
incomes depend.

In considering the various fiscal options that are

before you as members of the Congress. I urge you to keep in mind
their long-term implications for national saving.

Through a combina-

tion of fiscal policies directed at reducing budget deficits and
boosting private saving and monetary policies aimed at noninflationary
growth. we can achieve the strong economic performance that our fellow
citizens rightly expect.




71
For use at 10:00 a.m., E.S.T.
Wednesday
February 19, 1992

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

February 19, 1992

Letter of Transmittal

BOARD OF GOVERNORS OF THE
FEDERAL RESERVE SYSTEM
Washington, D.C., February 19, 1992
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 ot 1978.
Sincerely.

Alan Greenspan, Chairman




72
Table of Contents
Pugf
Section 1:

Monetary Policy and the Economic Outlook for 1992

Section 2:

The Performance of ihe Economy in 1991

Section 3:

Monetary and Financial Developments in 1991




1

73
Section 1: Monetary Policy and the Economic Outlook for 1992
When the Federal Reserve presented its midyear
monetary policy report to Congress last July, a moderate economic upturn was under way. Consumer
spending and housing activity had risen considerably
since the winler, bolstered by the decline in oil prices,
by a rebound in consumer confidence in the wake of
the allied victory in the Persian Gulf conflict, and by
lower interest rates. Inventories had been trimmed
appreciably, orders were rising, and businesses, while
still cautious, had begun to increase employment and
production. The key monetary aggregates had accelerated and were around the middle of their 1991 target
ranges. With the stance of monetary policy seemingly
conducive to an upturn in economic activity, the
Federal Reserve, after having progressively reduced
pressures on reserve positions earlier in the year,
maintained a more neutral money market posture in
the spring and early summer.
As the year wore on. however, the incipient recovery lost its momentum. Consumer spending turned
down, and business and consumer sentiment began to
erode. Inventories at wholesale and retail trade establishments began to increase relative to sales, inducing
a new outbreak of production adjustments and layoffs that continued through year-end. Although the
economy—as measured by its real gross domestic
product—continued !o grow in the second half of
the year, the pace of expansion was only marginally
positive.
The faltering of the recovery process apparently
owed to a variety of forces, some of which were
operating well before the oil price shock of 1990
tipped the economy into recession. In a sluggish economy and amid unexpectedly weak asset values—
particularly in real estate—deteriorating financial
positions of debt-laden households and corporations
further damped credit demands and aggregate spending. Financial intermediaries, chastened by their negative experience with earlier loans, became more hesitant about extending new credit; the resultant tighter
lending standards deepened the slowdown in economic activity and inhibited the subsequent recovery.
In the government sector, where deficits remained
large, not only at the federal level, but also in many
state and local jurisdictions, efforts to curb spending
and increase revenues constituted a further drag on
aggregate demand in the short run.
Inflation, meanwhile, moved down over the second
half of 1991. Weak demand reduced pressures in both




labor and product markets, and, after some acceleration of wages and prices in 1989 and 1990, an underlying disinflationary trend has now been established.
Important in this process has been a reduction in
inflation expectations, visible not only in a variety of
survey data but also in the behavior of securities
markets.
With actual and prospective inflationary pressures
easing, economic activity flagging, and the broader
monetary aggregates weakening and growing near the
bottom of their target ranges, the Federal Reserve
resumed easing money market conditions in the second half of the year. As a result, the federal funds rate
fell from 5Vt percent in July to 4 percent by year-end,
and most other short-term rates followed suit; the
discount rate was also reduced over this period, from
5!/2 percent to 3'/i percent, the lowest rale m nearly
30 years. Long-term interest rates, which had failed to
respond to declines in money market rates in the early
months of the year, came down significantly in the
latter part of 1991, partly in response to the easing in
inflationary expectations. Although long-term rates
have backed up some in recent weeks, they remain
appreciably below the levels of last summer. The
decline in rates has helped reduce the financial burdens of highly-leveraged households and corporations, who have taken this opportunity to refinance
mortgages and to replace existing debt with new
lower-cost bonds. Lower interest rates also have contributed to an increase in stock prices, inducing firms
to boost equity issuance and (o pay down debt, further
strengthening their balance sheets. With the decline in
U.S. interest rates, the foreign exchange value of the
dollar has largely reversed the upward movement that
had occurred earlier in the year.
The unusually slow growth of the key monetary
and credit aggregates last year was, to a degree,
indicative of the continuing restraint on private credit
usage and spending. The aggregate debt of domestic
nonfinancial sectors—abstracting from federal government debt, which continued to grow briskly—
expanded only 2!A percent in 1991, the slowest advance in decades, and below the pace of nominal
GDP; households, nonfinancial businesses, and state
and local governments all retrenched, curbing spending and borrowing in order to buttress deteriorating
financial positions.
The weakness in the monetary aggregates M2 and
M3 reflected not only subdued overall credit usage but

74
Ranges for Growth of Monetary and Credit Aggregates
1990

1991

1992

M2

3 to 7

2V2 to 6Va

2Va to 6Vfe

M3

1 to5

1 to 5

1 to 5

Debt

51o 9

4'/2 to 8Va

4 /2 to 8'/2

Percentage change,
fourth quarter (o fourth quarter

also a continued decline in the share of credit intermediated by depositories. With the thrift industry contracting further, commercial banks exercising camion
in their credit extensions, and borrowing demand
concentrated in longer-term instruments, depository
credit continued to shrink a.s a share of overall credit
extensions. As a result, the velocity of M3—a monetary aggregate that comprises most of the liabilities
used by depositories to fund credit growth—increased
again in 1991, as M3 grew only 1 'A percent, near the
twittom of its target range. Depository restructuring
also restrained M2, which grew in line with nominal
GDP despite a steep drop in short-lent) market interest
rates, which ordinarily would have been expected to
depress the velocity of this aggregate. Banks, eager to
improve capital positions, reduced deposit rates more
than loan rales, increasing the incentive For households to pay down debt rather than to accumulate
monetary assets. Less aggressive pursuit of retail accounts by depositories also led investors to switch into
other financial assets, such as bond and stock mutual
funds. Flows into these funds helped finance credit
chat had formerly been intermediated by depositories,
facilitating shifts to longer-term borrowing and reducing the adverse effects of any retrenchment by banks
and thrifts on the cost and availability of credit to
many borrowers. However, some types of lending that
are not so easily rechanneled—such as construction
loans and credits to small and lower-rated businesses—
have been curtailed, and a number of borrowers now
face mute siringeni credit term^.
Monetary Objectives for 1992

In formulating its objectives for monetary policy
for 1992, the Federal Open Market Committee has
sought to promote a sustainable upturn in economic
activity while continuing to build upon the hard-won




1

gains against inflation that have already been made.
The task of translating these objectives into specific
ranges for money and debt continues to be complicated by the ongoing restructurings of depositories
and by the evolving attitudes towards credit on the
part of borrowers and lenders. The Committee believes that the rechanneling of credit flows away from
depository institutions could well continue to produce
slower growth in the broad monetary aggregates than
normally would be associated with a given path for
nominal GDP.
Taking account of these effects, the Committee has
deemed the ranges for I992 tentatively adopted la-st
July as appropriate for achieving its objectives. The
M2 range for I992 is 2Vi to 6Vi percent, unchanged
from 1991. Demands for M2 relative to income would
be damped if, as seems likely, banks and thrifts continue to reduce deposit rates in lagged response to the
decline that has occurred in market rates. These
deposit-rate reductions could be especially large if
credit continues to be channeled outside depositories,
and in this case, relatively modest growth in Ml
would be adequate to support a satisfactory outcome
for the economy. On the other hand, as the balance
sheets and capital positions of depositories continue to
improve, banks and thrifts may adopt a generally
more accommodative posture with respect to credit
extensions and would therefore have greater need for
retail deposits. In that event, somewhat faster growth
of M2 would be appropriate.
On balance, the Committee's M2 range for 1992
allows room for a variety of developments in the
intermediation process and thus in the behavior of
monetary velocity. Flexibility in interpreting M2
within its range is particularly important at this time,
in light of the ongoing and unpredictable shifts in the
patterns of credit usage and financial intermediation

75
Economic Projections for 1992

Measure

Memo:
1991 Actual

FOMC Members and
Other FRB Presidents

Range
Percentage change,
fourth quarter to fourth quarter'
Nominal GDP
Real GOP
Consumer price index 2
Average level in the
fourth quarter, percent3
Unemployment rate

3.2

Administration

Central
Tendency

2'/z to 3Vz

4Vfe to 5%
1%to2Vfe
3 to 3'/2

5.4
2.2
3.1

6% to 7V4

6% to 7

6.8

.2

4 to 6
1 te to 2V*

2.9

6.9

1 Actual fof the fourth quarter of the preceding year to the fourth quarter ot the year indicalea.
2 AN urban consumers
3. Percentage of the civilian labor force.

that likely will continue to buffer our financial system.
Looking ahead to future years;, the Committee also
recognizes thai the range for M2 growth may eventually have to be lowered in order to pul in place (he
monetary and credit conditions consistent with price
level stability.
The target range for M3 for 1992 remains at 1 to
5 percent. Although credit growth is expected to pick
up somewhat in 1992, in line with a firming of economic activity, much of this credit likely will be
financed outside the depository system. The thrift
industry is expected to contract further as activity by
the Resolution Trust Corporation continues apace, and
banks, faced with continued—though moderating-—
pressures on capital positions, will still be somewhat
hesitant to expand. At ihe same time, additional
households are likely to refinance adjustable-rate
mortgages with fixed-rate obligations that can easily
be securitued, and corporations will probably continue to turn to equity markets and long-term bonds
rather than bank loans. As a result, depository funding
needs are likely to remain damped relative to the pace
of economic activity, and the velocity of M3 should
consequently rise further.
The monitoring range for the aggregate debt of
domestic nonfinancial sectors for 1992 is 4V; 10
8'/2 percent, also unchanged from 1991. Federal governmenl borrowing is expected to remain heavy in
1992, given the large budget deficit. Debt growth of




nonfederal sectors, however, should remain fairly subdued relative to economic activity, as borrowers and
lenders alike maintain a cautious approach to leverage, stemming in pan from a desire to make further
repairs to damaged balance sheets,
Economic Projections for 1992

Although the long-standing structural problems thai
aborted the fledgling recovery last summer clearly are
being addressed, the speed of their resolution—and
Ihe associated restrain! on economic growth—is quite
difficult to gauge, augmenting the usual uncertainties
in assessing the economic outlook. On the whole,
however, the member* of the Board of Governors and
the Reserve Bank presidents believe that, with the
easing of monetary conditions to date providing considerable impetus lo the economy, the most likely
outcome is for a moderate reacceleration of activity
over 1992. At the same time, they anticipate that the
trend toward price stability, which now appears (o be
rooted more securely, will be sustained through this
year.
The forecasts of mosl of the governors and presidents for growth of real gross domestic product are in
a range of IVi to 2'Apercent measured from the fourth
quarter of 1991 to the fourth quarter of 1992. With
employers likely to be cautious about hiring until they
are fully persuaded of the sustained vitality of the

76
upturn, gains in employment are expected to come
slowly. Thus, only a small improvement in the unemployment race is anticipated this year, with the central
tendency of projections being a range of 6% to 7 percent for the fourth quarter of 1992. With regard to
inflation, the central tendency range for the CPI increase this year is 3 to 3W percent. These forecasts
are. in general, very similar \o the projections presented by the Administraiion in the fiscal year 1993
budget. Indeed, the Administration's forecast for nominal GDP is well within the Committee's central
tendency range and thus appears to be quite consistent
with the FOMC's monetary ranges.
In their discussion earlier this month of the economic outlook, the Board members and Reserve Bank
presidents observed that the effects of recent job
losses and weak consumer confidence are likely to
restrain activity in the near term. Under the circumstances, the Board members and Bank presidents
stressed that economic developments need to be monitored closely to guard against the possibility that the
economy might falter. Nonetheless, the monetary
stimulus already in train is expected to provide effective support for economic growth this year, and in this
regard the early indications of a marked pickup in
residential real estate activity and a rise in retail sales
are a particularly favorable sign.
It is also expected that the drags on growth from
credit supply disruptions and from the restructuring of
household and business balance sheets will begin to
lessen over the year. As noted above, this is obviously
an area of substantial uncertainty. However, as household and corporate debt loads diminish in an environment of stronger economic activity, and as lower
interest rates continue to ease financing burdens of
borrowers, consumers and businesses should be
poised to participate more fully in the economic expansion. Moreover, the problems of credit availability
that have plagued the economy over the past couple of
years should begin to ease in 1992 as the economic
recovery takes hold and lenders become more confident about extending credit.




Nonetheless, the pace of expansion this year is
expected to remain weaker than in previous business
cycle recoveries. In large pan. this expeciation reflects
some still unresolved economic and financial imbalances in particular segments of the economy. The
persistent overhang of space in office and other commercial buildings undoubtedly will inhibit new construction in that sector for some time. In addiiion, the
budgetary constraints that have capped government
spending are likely to linger; a good many states and
localities are finding that budget gaps are reopening,
despite the spending cuts and lax increases they instituted last year. Meanwhile, the external sector is
expected to have a relatively neutral net influence on
domestic production this year; foreign demandparticularly from Mexico and developing countries in
Asia—should continue to boost export growth, but the
anticipated pickup in domestic purchases is likely to
draw in additional imports as well, limiting the potential for further substantial improvement in the trade
balance.
Only a minority of Board members and Reserve
Bank presidents foresee a smaller increase this year in
the overall CPI than the 3 percent nse experienced in
1991. But the pickup in inflation suggested by the 3 to
3'/i> percent central-tendency range is deceptive: the
underlying trenJs of price movement are more favorable. The CPI was held down to a substantial degree
last year by the unwinding of the energy price shock
that followed Iraq's invasion of Kuwait in August
1990. and further sharp declines in energy prices do
noi appear likely in the current environment. However, an ongoing deceleration in prices is evident for a
wide range of other goods and services, and with
inflationary tendencies under considerable restraint
from several factors—including further moderation in
labor cost growth, continued slack in industrial product markets, and small increases in import prices—
"core" inflation is expected to move down appreciably in 1992. Indeed, this trend should carry into
1993—a pattern that bodes well for the achievement
of a balanced, sustained economic expansion.

77
Section 2: The Performance of the Economy in 1991
The year 1991 began with the U.S. economy in the
midst of recession. Activity had contracted sharply
after the jump in oil prices that followed Iraq's invasion of Kuwait in Augusi 1990, and this weakness
spilled inlo the first quarter with further reductions in
production and employment. By the spring, however,
economic data indicated thai the decline in economic
activity had bottomed oui. The rapid conclusion of the
Persian Gulf war boosted consumer confidence, and
the reversal of the earlier runup in oil prices and the
cumulative effects of declining interest rales were
providing support for an increase in household spending. Indeed, construction of single-family homes had
already turned up noticeably by April, and consumer
spending posted a moderate rise in the second quarter.
Although businesses continued to liquidate inventories at a fairly rapid pace, industrial production grew
steadily from April through July, and hiring activity
increased.
However, the pickup in the economy evident from
April to July failed to develop any momentum, as the
thrust to domestic demand initialed by the end of the
Gulf war dissipated during (he summer. The absence
of a more robust recovery likely reflected the drag on
aggregate demand from some longer-term economic
and financial adjustments. For example, imbalances
long evident in the commercial and multifamily construction sectors damped enthusiasm for new projects,
and ongoing difficulties in the financial sector continued to restrain credit availability; these influences
undoubtedly muted the stimulus that normally would
have been forthcoming from the decline in interest
rates. Fiscal restraint evident at all levels of government weighed on aggregate demand in a way not
typically observed in previous economic cycles. Significant restructurings of operations in a number of
sectors had the effect of retarding employment and
income growth, at (east in the short run. And concerns
about debt-servicing burdens as well as about economic prospects sustained a reluctance on the part of
businesses and consumers to borrow and increase
spending.
Despite iheir cautious planning, some businesses
experienced inventory backups in the late summer and
fall, necessitating another round of production adjustments. In part, the impact of these adjustments was
felt abroad as businesses cut back their imports of
foreign goods. However, domestic adjustments were
evident as well, and, apart from atypical weather
patterns thai temporarily increased Ihe demand for
electricity, industrial production was flat over the




Real GDP
Percent change, annual rale

1989

1990

1991

second half of the year. The sluggish pace of activity
in the industrial sector was joined by weakness in
other parts of the economy, and overall, the nation's
real gross domestic product is estimated to have risen
a scant 'A percent at an annual rate in the fourth
quarter of last year. In the labor market, layoffs proliferated once again, and the civilian unemployment rate
rose to 7.1 percent at the end of 199!.
The deterioration in both industrial activity and
nonfarm employment extended into this year, with
factory production down sharply in January and private payrolls edging beneath (he low of last April. On
the other hand, housing market activity appears to
have picked up somewhat since the beginning of the
year, and nominal retail sales rose about '/; percent in
January.
Inflation slowed in I99T, with consumer prices up
3 percent over the year, much less than the 6 percent
rise posted during 1990. In pan, the slowing in inflation reflected the sharp drop in oil prices early in the
year; consumer energy prices in December were
TA percent below their level at the end of 1990, wild
the decline concentrated in the first quarter of the
year. Food price inflation also moderated considerably, amounting to only 2 percent last year after three
years of increases in excess of 5 percent.
Even apart from food and energy, inflation now
appears to be on a downward trend. To be sure, there
were sizable increases in the CP1 excluding food and
energy early in the year, as higher federal extise taxes
and a passthrough of the sharp rise in energy prices
boosted prices for a variety of goods and services.

78
But, wiih the subsequent reversal in oil prices and no
further major tax hikes, price pressures eased visibly
beginning in (he spring. On balance, the CPI excluding food and energy rose less than 4 perceni at an
annual rate in the second half of 1991, well below the
5 perceni pace of 1990. Labor cost pressures also
diminished last year, although substantial increases in
health care expenses remained a problem for employers. As measured by the employment cost index,
nominal compensaiion per hour rose about 4'/i percent over 1991, somewhat less than the increases
recorded in each of the three previous years.

much of the overall decline in spending on durables;
indeed, the level of motor vehicle sales in 1991, at
12 Vi million units, was the lowest since 1983. Outlays
for other durable goods were down slighily over the
year, after a 1 '•h percent decline in 1990. As with total
spending, purchases of other durables picked up
somewhat in the spring and early summer, but then
fell in the fourth quarter as consumers retrenched.
Spending on nondurable goods also declined last year,
with expenditures down sharply in the fourth quarter,
especially for apparel. In contrast, outlays for services
continued to trend up at a pace similar to that registered in the two previous years.

Household Spending—Consumption and
Residential Construction

The patterns of change among the components of
consumer spending—particularly the steep decline in
outlays for "big ticket" durable goods—underscore
the role of household balance sheet concerns in restraining economic growih last year. Household debt
burdens rose substantially during the 1980s, when
consumers stepped up spending on motor vehicles and
other consumer durables, often financing their purchases wilh credit. In some pans of the nation, this
spending boom spread to residential real estate as
well, with the associated borrowing, which was often
predicated on expectations of rapidly rising family
incomes, adding further to the financing burdens of
households. As income growth weakened over the
pasi year and a half, consumers struggled to meet the
monthly obligations on their accumulated debt, and
apparently deferred some discretionary spending in
(he process. This financial stress also was evidenced
by an increase in delinquency rates on consumer and
mortgage loans last year to levels comparable to Ihose
experienced in the previous two recessions.

With household finances adversely affected by job
losses and declining real incomes, real consumer
spending rose just V* percent over the year, the same
as in 1990. At the beginning of the year, consumer
purchasing power already had been sapped by the rise
in energy prices and by declines in employment. And.
while the retreat in oil prices then in progress and an
improvement in consumer confidence following the
end of (he Gulf war provided a boost to spending in
the spring, the failure of the recovery to take hold and
concerns about financial prospects and debt burdens
restrained spending in the second half of the year. On
balance, real consumer outlays edged down between
July and December, retracing pan of the rise that had
occurred during the spring and early summer.
The weakness in consumer spending over the past
year was particularly evident for durable goods. A
sharp drop in motor vehicle purchases accounted for

Income and Consumption
Percent change, annual rate
\^\ Real Disposable Personal Income
[] Real Personal Consumption Expenditures

n-i

1989




1990

1991

A renewed pessimism on the part of households
may also have contributed to the reluctance of consumers to step up spending over the latter pan of
1991. As noted previously, consumer confidence,
which was quite low at the beginning of the year, rose
markedly upon the conclusion of the Gulf war. However, as it became apparent that the anticipated recovery \tt the economy was not materializing and announcements of layoffs resumed, confidence turned
down, dropping especially shavpty toward the end of
the year. In January 1992, the Survey Research Center's index of consumer sentiment stood at the levels
of last winter, while the Conference Board's confidence index was below that seen in the 1981-82
recession. Many analysts observed that consumers
appeared to be more apprehensive than normally
might be expected, given the broad macroeconomic
circumstances—for example, the unemployment rate
has remained well below that reached in the early

79
Personal Saving
Percent oi disposable income, quarterly average

1991

1987

1980s—suggesting thai concerns about longer-run
economic prospects may have contributed to the
heightened anxiety among households last fall.
After dropping sharply in January, housing starts
posted a moderate recovery over the remainder of the
year, fueled by a reduction in mortgage rates 10 their
lowest levels since the 1970s. Sales of new and existing single-family homes rose over the year, with the
pickup in demand reportedly especially pronounced
from firsl-time buyers. Reflecting the strengthening in
demand, the excess supply of unsold new homes
diminished, and Ine pace of single-family housing
starts moved above 900.000 units al an annual rate by
the fourth quarter, an increase of more than 16 percent
from a year earlier. Nevertheless, production was well

Private Housing Starts
Annual rale, millions of units

Quarterly average

™*oio:o:-::i Multiramily xoiSSS?^!'?—1987




1989

1991

below thai of earlier years, and. despite the upturn in
activity, the single-family housing markel remains
softer than would be expected given recent mortgage
rates and the rising number of households in prime
homebuying ages. Continued lender caution about
granting land-acquisition and construction loans reportedly has damped production in some locales.
However, given the absence of significant price pressures in the housing market, restraint on the demand
for single-family homes, stemming from weak income
growth, concerns about employment prospects, and
poor conditions for home selling, likely has been a
more prominent influence on homebutlding than supply constraints.
In the muhifamily housing market, an excess supply of vacant units and restraints on credit availability
continued to depress construction last year. Starts of
muhifamily units fell about 30 percent over the twelve
months of 1991, and the number of starts during the
year was the lowest since the 1950s. There have been
numerous reports of restrictive lending practices
damping activity in this sector. But vacancy rates for
rental units remain exceptionally high—and rents
soft—suggesting that in many areas new project*
might well be of questionable economic viability.
Until market supplies begin to tighten discemibly,
activity in this segment of the market is unlikely to
show appreciable improvement.
Business Spending—Investment in

Inventories and Fixed Capital
In early 1991, the investment climate was dominated by the effects of the decline in the demand for
business output and the jump in energy prices during
the second half of 1990. With profit margins down
sharply and inventory imbalances emerging m a number of vectors, bu.sinesse'i reduced production and
employment substantially between October 1990 and
March 1991. Cutbacks were especially sharp in the
motor vehicle sector over that period, although output
of most other types of goods and materials turned
down as well.
By the spring, inventories generally were better
aligned with sales, and operating profits, while still
low, had turned up. As a result, the improvement in
aggregate demand in the second quarter was accompanied by an increase in business output, and industrial
production rose an average 0.7 percent per month
from April to July. Despite the firming in sales, businesses remained cautious, and inventory levels continued to decline through midyear.

80
from domestic suppliers, contributing lo the sluggish
pattern of manufacturing oulput in the fourth quarter.
By January of this year, factory production had
dropped back to its level of a year earlier, and the
operating rate in industry was back down to levels
[hat, prior lo last winter, had not been seen since the
brief industrial slump of 1986.

Before-tax Profit Share of
Gross Domestic Product*

Industrial Production
Index 1987=100

110
1987

1989

1991

'Profits from domestic operations with inventory valuation and
capital consumption adjustments divided by gross domestic
product of nonhnancial corporate sector.

105

In late summer, however, final demand slackened,
and after seven months of decline, business inventories accumulated at a substantial rale from September
through December. The rise in inventories was centered in wholesale and retail trade, and inventorysales ratios there moved into ranges that appeared
undesirably high in light of carrying costs and expected sales. A portion of the accumulation appeared,
to consist of goods ordered from abroad; indeed, a
partial reaction to the overhang may have been visible
in the sharp drop in nonoil imports, in November.
Nonetheless, retailers evidently also reduced orders

95

Changes in Real Nonfarm Business Inventories




ftnnual rate, billions of 1987 dollars

TT

n
30

1990

1991

1985

1987

1989

1991

Business investment m fixed capital fell 1 percent
in real terms over the four quarters of 1991. As is
typical during recessions, spending was inhibited by
weak profits, a rise in excess capacity, and uncertainly
regarding the outlook for sales. However, investment
outlays, last yeav alst\ \veve depressed by a desire on
the pan of many businesses to reduce debt burdens
and by a continued oversupply of office and other
commercial space. Even adjusting for cyclical considerations, last year's weak pace of investment appeared
to extend the relatively slow rate of capital formation
evident for some time. The capital stock in ihe nonresidential business sector, net of depreciation, has risen
about 2l/4 percent at an annual rate over the past
decade—down from 3Vj percent annually during the
previous decade. In part, this pattern has owed to a
shift toward shorter-lived assets—^uch as computers—
that depreciate more quickly. However, such outlays,
by generating a relatively high flow of capital services
per dollar of investment, have cushioned Che impact
on productivity of the slowing pace of capital formation. Even so, the quantity of investment, which has
also been depressed by large federal budget deficits
and the resulting low level of national saving, has

81
Real Business Fixed Investment
Percent change, annual rale

[] Structures
[J Producers' Durable Equipment

.1

J
1989

j
1990

LJ 30
1991

been i n i m i c a l to p r o d u c t i v i t y growth and thus to the
.idvanci' i>!' l i v i n g siand.irds.
Real spending lor equipment fell 3'-j percent over
I ' M . us o u t l a y s plunged in the tirst quarter and
••howed only limited improvement on net over the
remainder of the year. The strongest area in investment spending was computers, for which real outlays
increased more lhan 40 percent at an annual rate over
the second half ot [he year: these g;nns were driven by
new product introductions and by the substantial price
euts offered by computer manufacturers. In contrast.
buMne.ss investment in other types of equipment generally declined, on balance, over the >ear. Outlays for
industrial equipment continued to deteriorate as excess capacity limited expansion in the manufacturing
.sector, and business purchases of motor vehicles
dropped off sharply. In addition, domestic orders for
commercial aircraft plunged after midyear, as a number of domestic airlines trimmed investment plans.
Although the large backlog of unfilled orders that still
remains should sustain production and shipments for
some time, the slackening in demand indicated by the
sharp downturn in aircraft orders suggests that Ihe
growth surge in this sector may have run its course.
Nonresidential construction plummeted 15 percent
in real terms over the four quarters of 1991. The
contraction was broadly based, bur especially large
declines in outlays were evident for office buildings
and other commercial structures. Despite the sharp
cutbacks in construction in recent years, prices of
existing commercial properties have continued to fall,
contributing to the substantial stress evident in Ihe
financial sector. Of course, the fundamental problem
i.s the space overhang from the earlier overbuilding;
indeed, the vacancy rate for office buildings nationwide was still close to 20 percent at the end of the




year. However, a lack of liquidity in this market—in
particular, the reluctance of lenders to finance acquisitions of commercial properties—has made the adjustment still more difficult. Such problems are especially
acute in the markei lor office buildings, where appraised values have declined nearly 30 percent since
1985 and where lenders and developers generally
have shown little interest in new projects. For other
commercial structures—primarily shopping centers
and warehouses—the outlook is slightly less downbeat, with the data on new contracts and building
permits suggesting that the steepest declines may have
already occurred. Spending for industrial structures
also generally declined o\er Ihe year, as low rates of
c;i(XifJ!v u!Jli/;j(ii>n curtailed plain lor new factory
construction. Peiroleum drilling activity, meanwhile,
dropped sharph in response lo the decline in oil
prices
Federal hanking regulators hav e taken a number of
sleps to ensure that supervisory pressures do not
u n d u l y restrict real estate lending. The agencies have,
for example, addressed issues relating to accounting
and appraisal, to make sure that illiquid real estate
exposures are evaluated sensibly and consistently.
And, they have issued guidance to examiners and
simultaneously to bankers—emphasizing that banks
should not be criticized for renewing loans to creditworthy borrowers whose real estate collateral has
fallen in value—even when the banks need to build up
capital or reduce loan concentrations over time. However, with so adverse a supply-demand imbalance in
the property market, lenders understandably have
remained reluctant to bear the risks of real estate
exposures.

The Government Sector
Budgetary pressures were widespread in the government sector in 1991. At the federal level, the
unified budget deficit increased to $269 billion in
fiscal year 1991, up $48 billion from Ihe 1990 deficit.
In large part, the rise in the deficit was attributable to
the slowdown in economic activity, which reduced
tax receipis and increa.ved outlays fur income-support
programs such as unemployment insurance and food
stamps. However, as in 1990, the fiscal 1991 deficit
also was affected by special factors: a pickup in net
outlays for deposit insurance added to the deficit,
while one-time contributions from our allies to defray
the costs of Operations Desert Shield and Desert
Storm reduced it. Excluding deposit insurance and
these foreign contributions, the 1991 deficit totaled
$246 billion.

82
On the revenue side, federal tax receipts rose just
2 percent in fiscal 1991, the smallest increase in many
years. The slowing in receipts largely stemmed from
weak nominal income growth; indeed, personal income tax payments in 1991, which accounted for
nearly half of total receipts, were about the same as in
1990 despite changes in tax provision* that were
projected to raise S16 billion in new revenues.
Meanwhile, spending rose nearly 6 percent in fiscal
1991. Pan of the $,71 billion increase in nominal
federal outlays reflected the slightly more rapid pace
at which the Resolution Trust Corporation resolved
insolvent thrift insiitutions last year. In contrast, outlays were reduced hy allied contributions to the Defense Cooperation Account. These contributions,
which are scored as negative outlays in the budget
accounts, exceeded the outlays made in 1991 for U.S.
involvement in the conflict, the excess w i l l be put
toward (he replacement of munitions in 1992 and
beyond. Excluding deposit insurance and contribution^ of allies, outlays rose about 9 percent in fiscal
1991 Spending for health programs continued to rise
rapidly, elevated by large increases m health cure
cost- and in outlays for the Medicuid program. Among
other entitlement programs, outlays for social security
and other income-sup port programs, u-'hwli t«ge\hcr
account for one-third of total federal spending, rose
more than I I percent in fiscal 1991, reflecting substantial increases m the number of beneficiaries. In
contrast, declining interest rales reduced the growth
of interest payments on the federal debt. Defense
outlays —excluding foreign contributions—were up
5Vi percent between fiscal years 199(1 and 1991, as
the additional U.S. outlays for the Persian Gulf
conflict were only partially offset by the spending cuts
enacted m the IV90 budget agreement and in previous
years.
Federal purchases of goods and services, the portion of federal spending that is included directly jn
GDP. fell 3'/i percent in real terms over the four
quarters of 1991. Defense purchases jumped sharply
early in the year to support operations in !hc Persian
Gulf, but declined substantially over the remainder of
the year as the effects of scheduled cuts in defense
outlays were augmented by a dropoff in purchases for
Desert Storm; on net. defense purchases were down
about 41/: percent last year. In contrast, nondefense
purchases were up slightly in 1991: increases in law
enforcement, space exploration, and health research
offset a drawdown in inventories held by the Commodity Credit Corporation.
The fiscal position of state and local governments,
which had deteriorated sharply in 1990. remained




poor in 1991. The deficit in the combined operating
and capital accounts (excluding social insurance
funds) narrowed to $34 billion in the third quarter
from a high of nearly S41 billion in the fourth quarter
of 1990; the shrinkage of this deficit represents the
first major improvement since 1984, when the state
and. local budget surplus peaked. Even so. relative to
GDP, the deficit still is quite high on a historical basis.
The credit quality of state and local government debt
also continued 10 deteriorate last. year, as illustrated
by the downgrading of the genera! obligation debt
of eight states by one rating agency; most of the
rating changes were the direct result of budgetary
imbalances.
The poor fiscal position of state and local budgets
led lo both wvere restraiws on spending and sizable
tax hikes. Overall, real purchases of goods and services edged do\vn over the four quarters of 1991. In
nominal terms, total expenditures by these gosernrnents were up 4 percent last year, less than one-half
the average pace of recent years. Receipts rose an
estimated 7 percent over 1991. as numerous jurisdictions imposed a variety of new tax measures and
federal aid w state and local governments—-especially
for Medicaltl—increased substantially. Nonetheless.
many state and local governments continue to report
revenue shortfalls and spending overruns for ihe current fiscal year, setting the stage for another round of
budget-balancing measures ahead.
The External Sector
Measured in terms of Ihe other Group of Ten
(G-IOi currencies, the trade-weighted foreign exchange value of the U.S. dollar appreciated 14 percent, on balance, from December 1990 to July 1991,
reversing more than one-half of the decline that had
occurred from the middle of IW> to the end of 1990.
In large part, (he rise in the dollar over this period
reflected the quick end to the Gulf war and expectations of a recovery in the U.S. economy, as well as
developments in Eastern Europe that initially weighed
on the German mark. However, as the U.S. economic
recovery faltered in late summer and market participants viewed further easing actions by the Federal
Reserve as more likely, the dollar again turned down,
averaging in December 1991 only about 3 percent
above its level in December 1990. The dollar rehounded somewhat in January on market perceptions
of a diminished likelihood of an additional easing in
U.S. interest rates and expectations that German
authorities would not push their interest rates up
further.

83
Foreign Exchange Value of the U.S. Dollar *
index, March 1973 = 100

1987

1989

1991

•Index of weighted average foreign exchange value of U.S- (
in terms of currencies ot other G-1Q countries. Weights are
1972-76 global trade ol each of the 10 countries

On a bilateral basis, the dollar rose 19 perceni
against the mark between December 1990 and July
1991, amid disappointment about the effect of German unification on German inflation and trade. During the second half of last year. German monetary
policy tightened, and ihe dollar gave up much of its
previous gains, finishing the year just 4 percent above
its December 1990 level. Other currencies in the
European Monetary System generally moved with the
mark during 1991, although sterling slipped somewhat near year-end. The dollar declined about 4 perceni on net against the yen in 1991, as increasing
Japanese trade surpluses led lo the view that an appreciation of the yen would be welcomed by the
authorities.
The merchandise trade detkit narrowed K> less ihan
$75 hillion in 1991, compared with $108 billion in
1990; the trade deficit last year was the smallest since
1983. An especially large decline in the deficit wa.s
registered early in llic year, as the drop in oil prices
sharply reduced the value of imports. In addition,
trade flows during the first half" of 1991 were influenced by the weakening of U.S. activity (which reduced demand for imports), by continued growth
abroad (which boosted exports), and by the lagged
effects of the decline in dollar exchange rates that had
taken place in 1990. However, imports cose sharply in
the third quarter, and the trade deficit widened somewhat in the second half of the year. The current
account balance recorded a small surplus, on average,
doling ihe fust three quarters of 1991, LI sharp improvement from the $92 billion deficit in 1990. How-




ever, about half of that improvement resulted from
cash grants from foreign governments to support operations in the Persian Gulf; excluding these transfers,
the current account showed an average deficit of
$4H billion at an annual rate over the first ihree
quarters of 1991. The improvement, in the current
account (excluding transfers) was somewhat greater
than that in the trade balance owing lo a stieng\hening
ot net service receipts in areas such as travel, education, and professional services.
U.S. merchandise exports grew about 10 percent in
real terms over the four quarters of 1991, tempering
the production declines associated with the weakness
in domestic demand. Exports rose fairly strongly in
the second quarter, as high levels of investment in
countries such as Germany and Japan boosted exports
of computers and other capital equipment. Economicactivity in the major foreign industrial countries weakened as the yeat <*twe on, however, and •wilh a deterioration in the competitive position of U.S. companies
following the appreciation in the dollar over the firsi
halt of the year, export growth slowed markedly in the
Third quarter. Kx ports surged again in the fourth quarter, led by sales of computers, aircraft, and other
capital goods. However, some of the recent increase
appears to represent a bunching of sales rather than an
increase in economic activity abroad.
Merchandise imports excluding oil grew about
4 percent in real terms during 1991. Imports declined
eaily in the year as weak domestic spending reduced
the demand for foreign goods. As domestic demand in
the United States turned up in the spring, imports
rose—especially for automotive products, computers,
and consumer goods—and remained strong through

U.S. Current Account
Annual rate, billions ot dollars

1989

1991

84
U.S. Real Merchandise Trade
Annual rate, billions of 1987 dollars

475

Imports

350

225

100

1987

1989

the summer. With the subsequent weakening in demand, however, some of the additional import volume
apparently ended up on retailers' shelves. In response,
U.S. businesses reduced orders from abroad, and import growth slowed sharply over the fourth quarter.
The quantity of oil imports, which had plunged after
the sharp rise in oil prices in the fall of 1990. generally moved up through the third quarter as refiners
moved to rebuild inventories. However, oil import
volumes turned down again in the fourth quarter,
reflecting sluggish U.S. activity and unseasonably
warm weather.
The sharp reduction in the recorded U.S. current
account deficit in the first three quarters of 1991 was
mirrored by changes in recorded capital inflows and
the statistical discrepancy. The statistical discrepancy
in the international accounts, which had jumped to
$64 billion in 1990. declined to virtually zero in the
first three quarters of 1991.
Inflows of official capital were about matched by
outflows of private capital in the first three quarters of
1991. Net official inflows amounted to $16 billion
despite net intervention sales of dollars in foreign
exchange markets by the G-IO countries and a drawdown of reserves held in the United States by countries helping to cover the costs of Desert Storm; some
countries also financed their contributions by borrowing and liquidating investments in the Euromarkets.
Net private capital outflows were $18 billion in the
first three quarters, largely accounted for by banks. In
part, these outflows reflected the increased net demand for funds in the Euromarkets associated with
Desert Storm transfers. In addition, the elimination by
the Federal Reserve of certain reserve requirements in




December 1990 led some U.S. agencies and branches
of foreign banks to increase their issuance of large
time deposits in the United Stales and to reduce their
reliance on borrowing from abroad.
Securities transactions in the first three quarters of
1991 reflected the continued imernationali/aiion of
financial markets. Although the net inflow was modest, private foreigners added substantially to their
holdings of U.S. stocks and bonds, while U.S. residents bought a large volume of foreign stocks and
bonds. Reflecting interest rate developments that encouraged shifting from short- to long-term financing,
issues of foreign bonds in the United States and issues
of Eurobonds by U.S. corporations were both strong.
Capital outflows associated with U.S. direct investment abroad also were sizable, as U.S. investors positioned themselves to take advantage of EC 1992 and
participated in the privatization of previously stateowned enterprises in countries such as Mexico. In
contrast, foreign direct investment in the United States
was far below recent peaks; foreign takeovers of U.S.
businesses declined and reinvested earnings were depressed by the recession.

Labor Markets
Labor market conditions generally deteriorated in
1991. and the unemployment rate rose above 7 percent by the end of the year, the highest level since
1986. Employers had moved quickly to shed workers
when the recession took hold during the second half
of 1990. and this pattern continued into 1991, with
nonfarm payroll employment down sharply over the
first four months of the year. Economic conditions
improved in the spring, and labor demand turned up

Payroll Employment
Net change, millions of jobs, annual rate
Total Private Nonfarm

n

1989

1990

1991

85
fur a lime. Bui [he subsequent weakening in aclivily
in the late summer led to a renewed bout ol layoffs
that has continued into early 1992, retracing ihe job
gains revwtled fluting ihe spring ami summer.
The net job looses lasi year v.tre widespread by
industry and reflected both the cyclical weakness in
labor demand associated with the recession and more
fundamental efforts by many businesses to restructure
operations and permanently reduce the si/e of their
work force. Employment in manufacturing, which
began Us decline in W&9. i'ell more than 4(K},ffiW over
1941 with most of the losses in the durable goods
sector. The continued contraction in commercial
building depressed construction employment despite
Ihe moderate recovery in residential housing demand.
Efforts to restructure existing operations and to downsi/e workforce levels were evident in the finance,
insurance, and real estate sector as well, where job
losses last year stood in contrast to the past pattern ot"
continued hiring during recessions. Employment in
trade establishments also fell substantially over the
year, pushed down by the decline in consumer spending and the high degree of financial distress among
retailers. In contrast, employment in services continued to trend up over the latter part of the year, as
steady gains in health services rrwire than offset sluggish hiring in the more cyclically sensitive business
and personal service industries.
Reflecting the substantial declines in output aad
employment over the past year and a half, the unemployment rate rose more than 1 '/• percentage points
between July 1990 and December 1991, Moreover,
the distribution of job losses was especially wide as
compared with previous episodes of rising unemployment. Increases in unemployment were broadly based
across regions, industries, and occupations, and an
unusually large proportion appeared to constitute permanent layoffs.
Nonetheless, the rise in the jobless rdtc has been
less than in prior episodes of increaiing unernpiovment. This is, in part, because labor force growth h;is
been unusually slow over the past two years. In
particular, the labor force participation rate, which
stood al about f)6 percent at the beginning of this year,
is !/2 percentage point below its average during the
first half of 1990, This decline in participation appears
to contain some elements of a cyclical pattern: the
number of discouraged workers rose over the year,
and sizable increases were reported in the number of
retirees, perhaps reflecting to some extent a spate of
early retirement programs. However, the weak labor
force growth of recent years may also represent a
downshift in the trend rate of increase in labor supply




Civilian Unemployment Rate

1987

1989

1991

that—if not offset by productivity gains -could translate into a reduction in the rate of trend potential
output growth. In this regard, the composition of the
corresponding increase in nonpankipants is, in pan, u
favorable long-term development. There has been a
sharp rise in recent years in the number of individuals
who have left the labor force in order to attend school,
Although that increase may, to some degree, reflect
declining opportunity cost*, associated with the poor
job prospects of last year, recognition of the longerterm decline in relative wages among lower-skilled
workers may also have played a role. As these individuals reenter the labor force upon completion of their
schooling, their increased skills should boost labor
productivity and potential output in future years.
Efforts to increase labor productivity have also
intensified in the business community, if the aforementioned plans to reorgani/e corporate structures
and to downsize the labor force requirements of existing operations are successful, the possible outcome is
a significant improvement in the productivity trend,
much as occurred in the manufacturing sector after the
considerable compression of manufacturing organi/ations in the early 1980s. The performance of productivity, which rose about 1 percent in the nonfarm
business sector in 1991, has, been somewhat belter
than is typical in a weak economy. However, last
year's advance came after a decline in I9H9 and no
change in 1990. and it is difficult at this stage to
distinguish moie fundamental changes in productivity
trends from the apparent cyclical tendency last year
for employers to reduce labor inputs aggressively in
response to deteriorating sales.
With widespread layoffs and the unemployment
rate rising throughout the year, the upward pressures

86
Consumer Prices'

Employment Cost Index"

Percent change, Dec. to Dec.

Percent change. Dec. to Dec.
Total Compensation

1987
1989
1991
'Employment cost index for private industry, excluding farm
ana household worker;.

on wages thai had intensified between 1987 and mid1990 diminished somewhat over 1991. As measured
by the employment cost index, increases in hourly
compensation for private nonfarm workers rose
4T/i> percent over the four quarters of J99t, down from
more than 5 percent in the first half of 1990. The wage
and salary component of hourly compensation, which
rose 3 percent at an annual rate over the second half of
last year, exhibited the most deceleration. Although
employer costs for benefits have also decelerated from
their mid-1990 peak, increases in benefit costs—at
61/j percent in 1991—remained well above those for
wages alone. Expenses for health insurance have continued to spiral despite considerable efforts on the part
of employers 10 control costs by negotiating directly
with providers and by increasing workers' share of
health expenditures. Employer premiums for workers'
compensation insurance also rose sharply last year,
reflecting both a swelling in the number of claims and
the rapid pace of medical care inflation.

1987

1969

1991

•Consumer price index (or all urban consumers

Energy prices dropped sharply in 1991, mirroring
the changes in oil prices over the year. The CP1 for
energy fell 30 percent at an annual rate in the first
quarter of last year, as the sequence of events in the
Middle East reduced the posted price of West Texas
Intermediate crude oil from a peak of about $39 per
barrel in October of 1990 to less than $20 by February
of last year. Oil prices subsequently held near that
level, but gasoline prices firmed somewhat during the
summer as reduced imports and domestic refinery
problems led to some tightness in inventories. However, these forces were offset by declines in natural
gas and electricity rates, and energy prices changed
little, on balance, in the second and third quarters.

Consumer Energy Prices'
Percent change, Dec. to Dec.

Price Developments
Evidence mounted over this past year that a significant slowing of inflation is under way. The consumer
price index rose 3 percent over the year, about half the
rale of increase in 1990. A .shaip swing in energy
prices accounted lor a major part of this deceleration.
However, the elements of a more fundamental diminution of inflation were in place: labor cost increases
moderated; expectations of inflation eased; and upward pressures from import prices and industrial raw
material prices were virtually absent during the year.




n

1987
1989
'Consumer price index tor all urban consumers.

U

87
"Consumer Food Prices*

Consumer Prices Excluding Food and Energy'
Percent change, Dec. to Dec.

1987

1989

1991

'Consumer pnce inOe* tor all urban consumers.

Price pressures again emerged in the fall as crude oil
prices trended up in September and October on concerns about supplies from the Soviet Union. Since
October, however, oil prices have retreated again,
with the most recent quotes at about $18 per barrel.
These latest reductions probably will show up at the
retail level in the first quarter of 1992; indeed, the
energy component of the producer price index fell
nearly 3 percent in January, and other preliminary
information points to sizable declines in both retail
gasoline and heating oil prices.
The CPI for food rose just 2 percent over 1991,
well below the increases of 5 to 5'/: percent observed
in the three previous years. In part, the subdued pace
of food price inflation reflect;, an increased supply of
livestock products. Beef production turned up last
year in response to the strong prices that prevailed in
the preceding few years, and supplies of pork and
poultry rase sharply; in response, meat and poultry
prices fell about 2 percent over the year. The deceleration in food prices also extended to food groups
where prices are influenced more by the cost of nonfarm inputs than by supply conditions in agriculture;
for example, the increase in the price of food away
from home lasl year was ihe smaJlesi since 1964.
Elsewhere, there were large monthly variations in
prices for fruits and vegetables, as adverse weather
conditions temporarily boosted prices in the first half
of the year and prices for some fresh vegetables
jumped toward the end of the year because of the
whitefiy infestation in California.
The consumer price index for items other than food
and energy rose 4'/2 percent in 1991, about % percentage point less than in 1990. The index was boosted




Percent Changs, Dae. to Dec.

1987

1989

'Consumer pnce index for all urOan consumers.

early in the year by increases in federal excise taxes
on cigarettes and alcoholic beverages and by an increase in postal rates. Price increases last winter also
were enlarged by the passthrough of the rise in energy
prices into a wide range of nonenergy goods and
services. However, the subsequent decline in energy
prices soon spread to the nonenergy sector, and except
for an uptick during the summer associated with some
bunching of price increases, this measure of core
inflation moderated significantly over the remainder
of the year.
Prices for nonenergy services decelerated considerably last year, rising 4V- percent after an increase of
6 percent in 1990. Reflecting weak real estate markets, rent increases slowed sharply, with both tenants'
rent and owners1 equivalent rent up less than 4 percent
last year. The drop in interest rates pushed down auto
financing costs more than 7 percent. And, after a brief
spurt early in the year, airfares receded as energy
costs fel! and the weak economy cut into demand;
more recently, however, airfares have turned up again
as carriers have reduced the availability of and increased restrictions on low-end "super-saver" fares.
In conirasi, prices for medical care services rose 8 percent over the year, while tuition costs and other school
fees were up nearly 10 percent.
The CPI for commodities excluding food and energy rose 4 percent in 1991, about '/2 percentage point
faster than in 1990. In large pan, the more rapid rate
of inflation in goods prices reflected the aforementioned hike in excise taxes and, despite weak sales,
larger increases in prices for both new and used cars.
However, a slowing in price increases was evident for

a number of other goods, notably apparel, household
paper products, and personal care items.
The easing of inflationary pressures has been even
more evident at earlier stages of processing. The
producer price index for finished goods edged down
over 1991 after an average 5 percent annual rate of
increase over the three preceding years; this index
posted another small decline in January of this year.
Falling prices for energy and consumer foods accounted for much of the overall deceleration last year.
But even apart from food and energy, producer prices
slowed lo a 3 percent pace. Prices for intermediate
materials excluding food and energy declined Vi percent over the year, reflecting declining fuel and petroleum feedstock costs, an easing of wage pressures,
and weak demand. The downturn in economic activity
also depressed industrial commodity markets last
year. After dropping sharply in the fourth quarter of
1990, spot prices for these commodities continued to
decline gradually over most of 1991.




Producer Prices for Intermediate Materials
Excluding Food and Energy
Percent change, Dec. lo Dec.

1987

1989

1991

89
Section 3: Monetary and Financial Developments in 1991
The principal objective of monetary policy this past
year has been to help lay the groundwork for a
sustainable expansion, without sacrificing the progress
against inflation thai had already been set in motion.
The Federal Reserve progressively eased money market conditions in 1991 amid signs of continued sluggish economic activity, weak growth in the broader
monetary and credit aggregates, and diminishing inflationary pressures. A more generous provision of
reserves through open market operations, coupled
with five separate reductions in Ihe discount rate—
which now stands at its lowest level in nearly 30
years—brought the federal funds rate and most other
short-term interest rates down about 3 percentage
points over the course of the year. These actions,
building on earlier easing efforts, pushed the federal
funds rate down to 4 percent, its lowest sustained
level since the 1960s and nearly 6 percentage points
below its most recent peak in the spring of 1989.
The faltering of the economic recovery in the second half of 1991 owed in part to an unusually cautious
approach to credit on the pan of both borrowers and
lenders. Efforts by debt-burdened households and
businesses to pare debt in order to strengthen balance
sheets that had been strained by the general slowdown
in income and by declines in property values exerted
further damping effects on credit demands and on
aggregate spending. Faced with deteriorating asset
values and pressures on capital positions, depositories
and other lenders maintained tighter lending standards
and were somewhat hesitant to extend credit. The

more circumspect attitude towards credit and spending on the part of borrowers and financial intermediaries was manifest in the behavior of the aggregate debt
of domestic nonfinancial sectors, which grew near
the bottom of the Federal Open Market Committee's
monitoring range despite burgeoning U.S. Treasury
borrowing. Not only was overall credit growth subdued, but credit flows continued to be rechanneled
away from depositories, reflecting Ihe more restrictive
lending standards at banks and thrifts as well as
efforts by borrowers to make greater use of longerterm debt and equity in order to strengthen their
balance sheets. Partly as a resuft, the monetary aggregates M2 and M3 also finished the year near the
bottoms of their target ranges.
To prevent these forces from stifling the recovery,
the Federal Reserve eased money market conditions
aggressively in the latter pan of the year. In light of
weak aggregate demand and reduced inflationary
potential, long-term interest rates—which had largely
failed to respond to monetary casings earlier in the
year—came down substantially towards the end of
1991. This decline prompted a flood of mortgage
refinancings and additional corporate and municipal
bond offerings, which helped reduce the financing
burdens of nonfederal sectors. Lower interest rates
also contributed to a major stock market rally, which
induced firms to boost equity issuance and pay down
debt, partially reversing the trend of the 1980s towards increased leverage that had severely stretched
corporate balance sheets.
On the whole, the nation made considerable
progress in strengthening its balance sheet in 1991.
Less reliance on debt, greater use of equity, and lower
financing costs have helped ease debt-servicing
burdens for many financially troubled households
and corporations. Although, to dale, the trend towards
deleveraging has exerted a restraining effect on aggregate spending, over lime, this trend should help put
consumers, firms, and financial intermediaries on a
sounder financial footing, paving the way for healthy,
sustainable economic growth.

Short-Term Interest Rates
Monthly

10

The Implementation of Monetary Policy
Three-month Treasury bill
Coupon equivalent
1983
1985
1987
1989
1991
Last observation is lor the first two weeks of February 1992.




The Federal Reserve eased money market conditions several times in the first few months of 1991,
extending the series of easing moves initiated in the
latter stages of 1990. Against a backdrop of further
declines in economic activity, abating price pressures,
weakness in the monetary aggregates early in the

90
year, and continuing credit restraint by banks and
other financial intermediaries, a more expansive open
markel posture was adopted, in conjunction with two
one-half percentage point reductions in the discount
rate, to engender a 125 basis point decline in the
federal funds rate over the first four months of the
year. Short-term Treasury rates generally followed
suit, and banks reduced the prime rate in three 50
basis point increments to 81/; percent.
Long-term interest rates, by contrast, were roughly
unchanged on balance over the first few months of the
year. At first, these rates fell somewhat in response to
the continued downturn in economic activity and
declining energy prices, especially in light of initial
successes in the Gulf war that ensured an unimpeded
flow of oil. Success in the initial phases of the war
also prompted a brief dip in the exchange value of the
dollar, as safe-haven demands thai had been propping
up the dollar's value in the face of falling interest rates
in the United States dissipated.
In March, bond yields drifted up on the post-war
rebound in consumer confidence and other evidence,
particularly from the housing industry, that an economic upturn was at hand. The improving outlook for
recovery also contributed to narrowing risk premiums
on private securities, especially on belo\v-investmenigrade issues, which had reached very high levels in
January. The debt and equity instruments of banks
performed especially well over this period, responding to lower short-term interest rates and the likelihood that an economic rebound would help limit the
deterioration in their loan portfolios. Moderate official
support for the dollar, better prospects for a U.S.
economic recovery, and a nse in U.S. long-term inter-

Long-Term Interest Rates
Monthly

Home mortgage
Primary conventional

10

Thirty-year Treasury bond

1983

1985

1987

1989

1991

Last observation is for the first two weeks of February 1992.




est rates relative to those abroad, together with an
uncertain economic and political situation overseas,
especially in the Soviet Union, helped to reverse the
dollar's slide on foreign exchange markets.
As evidence of a nascent economic recovery cumulated through the remainder of the spring and into
early summer, interest rates and the dollar continued
to firm, and quality spreads narrowed further. Although the increases in rates during this period were
most pronounced ai the long end of the maturity
spectrum, short-term rates backed up a bit as well as
prospects for additional monetary easings faded. Indeed, with the pace of economic activity apparently
quickening, and with the broader monetary aggregates
near the middles of their target ranges, the Federal
Reserve held money market conditions steady, as the
stimulus already in train seemed sufficient to support
an upturn in aggregate spending.
As the summer passed, however, the strength and
durability of the recovery appeared less assured. Aggregate spending, production, and employment began
to falter, easing wage and price pressures. Tn addition,
the broader monetary aggregates suddenly weakened
dramatically, with M2 coming to a virtual standstill
and M3 actually declining in the third quarter. The
softness in the aggregates was symptomatic of a
warier approach to spending and borrowing on the
part of households and corporations, whose balance
sheet problems were exacerbated by the stagnant
economy. In addition, credit standards at financial
intermediaries remained restrictive, and spreads between loan and deposit rates remained high by historical standards, reinforcing households' inclinations to
pay down debt rather than to accumulate assets.
To help ensure that these forces did not imperil the
recovery, the Federal Reserve moved to ease money
market conditions further during the latter part of the
year. Pressures on reserve positions were reduced
slightly in August and again in September, with the
latter move accompanied by a 50 basis point reduction
in the discount rate. With the economic climate remaining stagnant, price pressures subdued, and the
broader monetary aggregates still mired near the bottoms of their target ranges, the System's easing moves
became more aggressive in the fourth quarter, culminating in a full one-percentage-point reduction in the
discount rate on December 20. All told, these moves
combined to drive the federal funds rate down from
SYa percent in July to 4 percent by year-end. Most
other short-term interest rates declined by similar
magnitudes and the prime rate was reduced by 2 percentage poinis. to 6'/2 percent.

91
The decline in short-term interest rates, in combination with flagging economic activity, depressed credit
demands, and prospects for lower inflation, contributed to bringing long-term interest rates down significantly in the latter part of 1991. The thirty-year Treasury bond rate dropped about a percentage point over
the second half of the year, and mortgage interest
rates tumbled to their lowest levels in many years.
Declining imeresi rales prompted a spate of mortgage
refinancings, corporate and municipal bond offerings,
and a. major stock market rally, which propelled most
indexes to record highs. Although monetary growth
bounced back a bit in the fourth quarter, both M.2 and
M3 remained near the lower ends of their respective
growth cones. The dollar, which had begun to lose
ground in foreign exchange markets in the summer—
when the weakness in money and credit raised the
specter of additional casings of U.S. monetary policy—
depreciated further in the fourth quarter as the economic situation deteriorated and the pace of policy
casings thickened. Rising interest rates in Germany
also put downward pressure on the foreign exchange
value of me dollar. In January 1992, the dollar rebounded somewhat, reflecting an emerging view that
interest rale declines in the United States and interest
rate increases in Germany, might have come to an
end. The former view was also reflected in the U.S.
bond market, where rates retraced a portion of their
earlier declines, partly on brightening prospects for
the U.S. economy but also on concerns that impending fiscal stimulus w&y increase federal government
demands on credit markets.

Monetary and Credit Flows
Patterns of credit usage and financial intermediation, which began to shift even before the onset of
the economic downturn, continued to evolve in 1991,
distorting traditional relationships between overall
economic activity and the monetary and credit
aggregates.
These changes were evident in the behavior of the
aggregate debt of nonfinancial sectors, which expanded 4!/4 percent m 1991, leaving this aggregate
near the bottom of its monitoring range. Robust
growth in federal go\ernmem debt, owing to the
economic downturn and to additional outlays for federal deposit insurance, ma_sked an even weaker picture
for nonfederal debt. Households, nonfinancial corporaiions, and state and local governments accumulated
debt ai an anemic 23/i percent rate in 1991, the slowest
advance in decades and below even the sluggish
growth rate of nominal GDP.




Debt: Monitoring Range and Actual Growth
Billions <rf dollais

-

11000

- 10500

A

S O N D

10000

The small rise in nonfederal debt velocity last year
runs counter to the pattern seen in the 1980s, when the
accumulation of debt vastly outstripped growth in
nominal GDP. The rapid buildup of debt in the 1980s
was likely a result of the deregulation of interest rates
and financial innovations, which combined to lower
the cost of borrowing to households and businesses,
spawning a surge in leveraging activity. Greater debt
burdens may also have been accumulated under the
assumption that nominal income growth would be
sustained at !he elevated pace of the mid-1980s and

Debt Velocity
Quarterly

0.8

I I I I I 1 I 1 I 1 I I_L I I I I 1 I I I j_i I I I I I 1 I I 1
1960

1970

1980

1990

0.4

92
lhat the prices of assets, purchased with credit would
continue to climb.
In recent years, however, asset values and income
growth have fallen short of these expectations. In
particular, depressed commercial anil residential real
cs(a(e values, coupled will? slower income growth.

have eroded the net worth of some borrowers and
severely strained the ability of highly-leveraged
households and corpora (ions Co service debt. The.se
difficulties, in turn, have fed back on to the strength of
the financial intermediaries that extended the credit.
In an effort to bolster depleted capital positions, reduce financing burdens und shore up weakened bal-

Growth of Money and Debt (Percentage Change)

M1

M2

M3

Debtol
domestic
nonfinancial
sectors

Fourth quarter to fourth quarter
1980

7.5

B.9

1981

5.4 (2.5)'

9.3

1982

8.8

9.1

10.4

1983
1984

5.4

12.2
8.0

9.5
12.3

9.2
9.9

9,9

9.2

9,9

11.3

10,8

14.1

1985

12.0

8.7

7.6

13.8

1986

15.5

9.2

9.0

13.8
10.4

1987

6-3

4.3

5.9

1988

4.3

5.2

6.4

9.4

1989

0.6

4.8

3.6

8.2

1990

4.2

3.8

1.7

6.9

1991

8.0

3.1

1.3

4.7

01

5.2

3.5

3.3

4.5

Q2

7.4

4.3

1.8

4.0

Q3

7.5

1.1

Quarterly growth rates
(annual rates)
1991

Q4

11.1

'Figure in parenttieses Is adjusted tor shifts to NOW accounts In 1981.




3.3

-1.1

1.2

4.9
5.2

93
ance sheets, both borrowers and lenders have adopted
a more chary attitude lowards additional credit.
This more cautious approach to leverage has interacted with the sluggish pace of economic activity to
restrain borrowing across nearly all sectors of the
economy, Nonfinancial business sector debt, held in
check by the decline in financing needs associated
with weak aggregate demand and by efforts of debtladen firms to restructure their balance sheets, grew
only Vi percent in 1991. Taking advantage of a buoyant stock market, particularly in the latter part of the
year, corporations turned to equity financing; net
equity issuance for the year was positive for the first
time since 1983. and the ratio of the book value of
nonfinancial corporate debt to equity, which had
soared in the 1980s amid a flurry of corporate restructurings, actually turned down in 1991. Firms also took
advantage of lower interest rales to refinance higherrate long-term bonds and to reduce uncertainty about
their future financing burdens by substituting longterm debt for short-term borrowing. Overall, the mixture of less debt, more equity, and lower interest rates
had a salubrious effect on the financial positions of
many firms. Indeed, the ratio of interest payments to
cash flow for all nonfinancial firms declined in 1991,
reversing some of the runup seen in the late 1980s.
Consistent with an improving financial picture and
prospects of an economic rebound, quality spreads on
corporate issues narrowed considerably from iheir
peaks in early 1991, especially on below-investmentgrade securities. In addition, downgradings of corporate bonds dropped sharply in the third and fourth
quarters, although they still ran higher than the pace
of upgrades.
Deleveraging was also evident in the household
sector in 1991. Consumer credit declined as households reined in expenditures, curbed their accumulation of financial assets, and pared existing debt burdens- Households took advantage of declining interest
rates, particularly in the fourth quarter, by refinancing
outstanding mortgages; they also substituted home
equity loans for installment debt and other consumer
credit which carry higher financing costs and are no
longer tax deductible. By reducing their net accumulation of debt and refinancing a substantial volume of
their remaining borrowings at lower rates, households
were able lo ease their financing burdens, reducing the
ratio of scheduled debt payments to disposable personal income, which had risen sharply in the 1980s.
Even so. loan delinquency rates rose through much of
1991, albeit to levels not out of line with what was
seen in previous cyclical downturns. On the other side
of the ledger, many households with net creditor




positions saw their interest incomes decline last year.
Faced with intensifying budgetary pressures and
numerous downgradings, state and local governments
also put only limited net demands on credit markets in
1991. The outstanding debt of this sector grew but
3 percent last year, the smallest increase in more than
a decade. Gross issuance of municipal bonds was
substantial, however, as states and localities moved to
refinance debt at lower rates.
Efforts by borrowers to restructure balance sheets
by substituting long-term debt and equity for shortterm borrowing, along with more restrictive credit
standards by some lenders and the closing and shrinkage of troubled thrifts, have affected the channels
through which debt flows. In canicular, in recent
years there has been a major rerouting of credit flows
away from depository institutions. The decline in the
importance of depositories, when measured by the
credit they book relative to the total debl of nonfinancial sectors, has been striking, and this trend was
extended in 1991. Not only did the thrift industry
continue to contract, as the direct result of RTC
resolutions as well as the retrenchment of marginallycapitalized institutions, but commercial banks cut
back on their net credit extensions. Indeed, bank
credit increased only 4 percent, not even enough to
offset the continued runoff at thrifts. Weakness was
particularly evident in bank lending, which shrank
'/4 percent last year; banks' holdings of government
securities, by contrast, expanded at a rapid clip.
Although the shifting composition of bank asset
flows in 1991 was reminiscent of patterns seen in
previous periods of languid economic activity, the
magnitude of the downturn in loan growth lay year
was more pronounced than the usual experience. Apparently, loan growth was depressed not only by
reduced credit demands, but also by a mare restrained
bank lending posture. Faced with deterioration in the
quality of their assets, higher deposit insurance premiums, and more stringent requirements for capital,
banks retrenched, adopting a more cautious attitude
regarding credit extensions. Concerns about capital,
especially in light of rising loan delinquency rates and
mounting loan loss provisions, induced many banks to
continue tightening lending standards through the
early part of 1991 and lo maintain fairly restrictive
standards over the balance of the year.
A more prudent approach to capitalization and lending decisions is, in the main, a positive development
that ultimately will result in strengthened balance
sheets for the nation's depositories. Reflecting this
improved outlook, prices of outstanding bank debt
and equity increased markedly from their lows in late

94
Growth of Domestic Nonfinancial Debt and Depository Credit*

1960

1965

1970

1980

1985

1990

' Four quarter moving average.

1990 and early 1991. outperforming broader market
indexes. Bank profit;,, benefiting from wide spreads
between loan rates and deposit rates, also showed
improvement relative to the depressed levels of recent
years, although they remained low by broader historical standards.
To date, depository retrenchment appears to have
had some restraining effects on aggregate borrowing.
Of course, in some areas, much of the credil formerly
extended by banks and thrifts has been supplanted by
other intermediaries and by credit advanced directly
through securities markets, at little if any additional
cost to borrowers. For example, growing markets for
securitized loans largely have filled the vacuum created by depository restraint in ihe areas of residential
mortgage and consumer lending. Similarly, many
large businesses have turned to stock and bond markets to meet credit needs and to restructure balance
sheets, reducing their reliance on banks as well. Boih
banks and thrifts have cut back on other types of
lending that can less easily be rechanneled, however,
including construction and nonresidential real estate
loans, loans to highly leveraged and lower-rated borrowers, and loans to small and medium-sized businesses. Other financial intermediaries, including life
insurance companies, have been afflicted by some of
the same balance sheet problems plaguing depositories and have also curbed their lending to these sectors. As a result of (he pullback in credit supplies.




these borrowers now face somewhat more stringent
borrowing terms.
As in 1990, the retrenchment of banks and thrifts
and the associated redirection of credit flows away
from depositories continued in 1991 to have profound

M3 Velocity
Quarterly

1.8
1.6

1.4

1.2

1960

1970

0.8
1990

95
M3: Target Range and Actual Growth
Billions of dollars

4300

- 4200

O H

0

J

F M A M J

1990

J A S O N D

4000

1991

effects on the broad monetary aggregates and their
traditional lelalionships with aggregate economic activity. M3. which comprises most of the liabilities
used by banks and thrifts to fund credit expansion, has
been most affected by the reduced importance of
depository credit in funding spending. The velocity of
this aggregate, which declined through much of the
1980s, has trended up in recent years; this trend
continued in 1991, as M3 rose only 1 [A percent, well
below the pace of nominal GDP, leaving this aggregate near the bottom of its target range.
In the first few months of the year. M3 showed
surprising strength, boosted in pan by a firming of its
M2 component, which benefited from declining interest rates. The most important single factor contributing to strong M3 growth in the early part of 1991,
however, was the rebirth of the market for "Yankee
CDs"—large time deposits issued by foreign banks in
the United Stales. After the 3 percent reserve requirement against nonpersonal time deposits and net Euroborrowings was lifted at the end of 1990, foreign
banks showed a distinct preference for funding with
such instruments, rather than borrowing from their
overseas affiliates or in (he federal funds or RP markets. Domestic depositories, by contrast, faced with
high and rising U.S. deposit insurance premiums,
exhibited no inclination to alter their funding strategies in favor of large time deposits.
The surge in Yankee CD issuance, which totaled
nearly $40 billion over the first quarter, began to taper
off a bit as the year progressed, revealing the underlying weakness in M3. After slowing somewhat in the
second quarter, this aggregate contracted at a I '/i




percent annual rate in the third quarter, reflecting
feeble loan demand in a tepid economy as well as the
restructuring of depositories. The Resolution Trust
Corporation played a direct vole \n damping M3
growth by taking assets formerly held by thrifts and
funded with M3 deposits onto its own books and
financing them with Treasury securities. Although M3
rebounded a bit in the fourth quarter, in line with
some firming of bank credit, its growth remained
subdued.
The effects of depository restructuring on M2 remain imperfectly understood. In the past, the velocity
of M2 has tended to move in tandem with changes in a
simple measure of the opportunity cost of holding this
aggregate—that is, with changes in the returns on
alternative short-term investments relative to those
available on assets included in M2. Typically, when
the opportunity cost of holding M2 declines as decreases in money market interest rates outpace drops
in yields on deposits, holdings of M2 strengthen relative to expenditures—and velocity drops. In recent
years, however, this relationship appears to have
broken down, with the velocity of M2 holding up
despite a steep, persistent drop in this measure of
opportunity cost. This was particularly evident in
1991. when M2 expanded at about the same pace as
nominal GDP despite a significant decline in such
opportunity costs. M2 finished the year near the bottom of its target range and much weaker than would
be expected on the basis of historical relationships
among income, interest rates, and the public's appetite
for monetary assets.
In the early months of the year, M2 growth accelerated somewhat from its lackluster pace of late 1990.
Narrowing opportunity costs generated substantial
inflows to liquid deposits,, particularly those in Ml,
which more than offset continued runoffs in small
CDs. Money growth also was temporarily boosted by
strong foreign demands for U.S. currency as a safe
haven during the crisis in the Persian Gulf. Through
May, M2 growth remained broadly consistent with
the general configuration of opportunity costs and
income, and near the middle of its target range.
M2 began to slow in June, however, and stalled in
the third quarter, despite expansion in nominal income and further declines in opportunity costs.
Growth in this aggregate resumed in the following
quarter, fueled by a surge in transactions deposits
owing to additional declines in opportunity costs, but
inflows to M2 remained fairly weak, and this aggregate ended the year only a little above the bottom of
its target range.

96
M2 Velocity and Opportunity Cost
Ratio scale

1.68 -

1.61

1979

1963

1981

1985

1987

1989

1991

'Two-quarter moving average.

Although the unusual behavior of M2 relative to
income and opportunity costs has no! been fully explained, it surely is related to the restructuring of
financial flows and to the downsizing of the banking
system. With inflows of M2 deposits apparently tending to be more than sufficient to fund weak depository
credit growth, banks and thrifts seem to have pursued
additional retail deposits less aggressively than in the
past. Although rates offered on these deposits did not.

M2: Target Range and Actual Growth
Billions of dollars
Rate of Growth

3500

3400

- 3300

O N D J F M A M J J A S O N D

1990




1991

3200

until very recently, fall unusually rapidly in response
to declining market interest rates, depositories seem to
have acted in other ways to reduce the cost of funds,
including adjustments in advertising and marketing
strategies that would not show up in traditional measures of opportunity costs. In addition, by keeping
deposit rates very low relative to loan rates, partly in
an attempt to bolster profit margins while shrinking
their balance sheets, depositories provided households
with a greater incentive to finance spending by holding down Ihe accumulation of M2 assets rather than
by taking on new debt. This incentive likely reinforced the impetus to borrowing restraint stemming
from household concerns about their own balance
sheets.
The slowdown in M2 growth, particularly in the
third quarter, also appears to have been related to the
configuration of returns on financial assets. Yields on
small time deposits and money market mutual funds
largely tracked the downward path of market interest
rates, falling to their lowest levels since Ihe deregulation of deposit rates and prompting significant outflows from these components of M2. Although some
of these funds shifted into the liquid deposit components of M2—whose offering rates responded slowly,
as they normally do, to the declines in market interest
rates—a portion of these funds appear to have left the
aggregate. The primary lure seems to have been the
stock and bond markets, which offered higher returns,

in pan because of the sleep upward slope of the yield
curve. Indeed, inflows to stock and bond mutual funds
were robust throughout 1991, and especially since
midyear, when investors seemed particularly intern on
reaching for higher yields by lengthening the maturity
of their portfolios. Depositories, faced with weak loan
demand and pressures on capital positions, seemed
disinclined to compete aggressively for these funds by
offering competitive rates on longer-term CDs.

M1; Actual Growth
Billions of dollars

The rapid pace of activity by the Resolution Trust
Corporation also likely depressed M2 growth in the
third quarter, as it did throughout the year. The abrogation of existing retail CD contracts and ihe disruption of long-standing depositor relationships often
attending resolutions of failed thrift institutions may
have encouraged investors to reshape their portfolios,
substituting nonmonetary financial assets for M2
deposits.

- 820

O N D J
1990

Despite sluggish income growth. Ml expanded
8 percent in 1991, the swiftest advance since 1986.
Unlike M2. this aggregate has responded to declining
market interest rates about as would be expected
given historical relationships. Ml was boosted by
large inflows to NOW accounts, whose offering rates
responded very slowly, until the end of the year, to
declining market interest rates. Falling rates also
brought new life to demand deposits, as compensating

F M A . M J J A . S O M O
1991

balances to pay for bank services surged. Demand
deposits likely benefited as well from the pickup in
mortgage refinancings, because the proceeds from
mortgage prepayments are sometimes housed temporarily in demand accounts. Rapid growth in currency,
owing in pan to continued strong foreign demands,
also contributed 10 the strength in Ml, as well as in
the monetary base, which increased 8'A percent last
vear.

Velocity of Money

Ml

M2
Quarterly

- 6

1960

1970




1970

1990

25

1980

1990