Full text of Monetary Policy Oversight : Senate Hearings : Federal Reserve's Second Monetary Policy Report for 1989 : Hearing Before the Committee on Banking, Housing, and Urban Affairs, United States Senate, One Hundred First Congress, First Session

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FEDERAL RESERVE'S SECOND MONETARY POLICY
REPORT FOR 1989

HEARING
BEFORE THE

COMMITTEE ON
BANKING, HOUSING, AND UEBAN AFFAIRS
UNITED STATES SENATE
ONE HUNDRED FIRST CONGRESS
FIRST SESSION
ON

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

AUGUST 1, 1989

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

U.S. GOVERNMENT PRINTING OFFICE
WASHINGTON : 1989
For sale by the Superintendent of Documents, Congressional Sales Office
U.S. Government Printing Office, Washington, DC 20402

COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS
DONALD W. RIEGLE, JR., Michigan, Chairman
ALAN CRANSTON, California
JAKE GARN, Utah
PAUL S. SARBANES, Maryland
JOHN HEINZ, Pennsylvania
CHRISTOPHER J. DODD, Connecticut
ALFONSE M. D'AMATO, New York;
ALAN J. DIXON, Illinois
PHIL GRAMM, Texas
JIM SASSER, Tennessee
CHRISTOPHER S. BOND, Missouri
TERRY SANFORD, North Carolina
CONNIE MACK, Florida
RICHARD G- SHELBY, Alabama
WILLIAM V. ROTH, JR., Delaware
BOB GRAHAM, Florida
NANCY LANDON KASSEBAUM, Kansas
TIMOTHY £. WIRTH, Colorado
LARRY PRESSLER, South Dakota
JOHN F. KERRY, Massachusetts
RICHARD H. BRYAN, Nevada
KEVIN C. GOTTUEB, Staff Director
LAMAE SMITH, Republican Staff Director and Economist
STEVEN B. HARRIS, General Counsel

(ID

CONTENTS
TUESDAY, AUGUST 1, 1989
Opening statements of:
Senator Sarbanes
Senator Dixon
Senator Shelby
Senator D'Amato
Senator Heinz

Page
1
2
2
4
5
WITNESS

Alan Greenspan, Chairman, Board of Governors, Federal Reserve System
Prepared statement
Economic and monetary developments thus far in 1989
Monetary policy and the economy into 1990
Monetary policy in perspective
Monetary policy report to Congress
Federal Reserve press release
Discussion:
Quarters of growth under 2 percent
Economic Summit Conferences
Saving rates deficient
Social Security Trust Funds
Financing the S&L bailout
Money growth linked to inflation
On budget/off budget financing
Waiving the Budget Act
Market rates declining
Legislation to bring back the IRA
Mexico's debt
Interest rates and parity between economic partners

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FEDERAL RESERVE'S SECOND MONETARY
POLICY REPORT FOR 1989
TUESDAY, AUGUST 1, 1989

U.S. SENATE,
COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS,
Washington, DC.
The committee met at 10:05 a.m., pursuant to notice, in room
SD-628, Dirksen Senate Office Building, Senator Paul S. Sarbanes,
presiding.
Present: Senators Sarbanes, Sasser, Shelby, Graham, Heinz,
D'Amato, Gramm, Mack, and Pressler.
OPENING STATEMENT OF SENATOR SARBANES

Senator SARBANES. The committee will come to order.
I am very pleased to welcome Chairman Greenspan here this
morning to testify on the Federal Reserve's monetary policy report
to the Congress,
This hearing was originally scheduled to be held a week ago, but
the very deep involvement of this committee in the savings and
loan bill made it necessary to delay that hearing.
Senator Riegle had planned to be here this morning to chair the
hearing, but an illness in his family made it impossible for him to
be present. Nevertheless, he felt strong that the committee should
proceed since we want to review the Federal Reserve's report, as
we are going to do today prior to the August recess which is scheduled to commence at the end of this week.
It appears that the U.S. economy may be entering a rather precarious period. We have experienced growth, albeit slow growth,
much of it for an extended period, but questions are now being
raised whether that path is sustainable. The Federal Reserve now
projects unemployment next year in the 5*/2 to 6 percent range and
real GNP growth in the range of 1% to 2 percent.
I think there is a serious question about whether the economy
can maintain or sustain such a low level of growth while avoiding
at the same time a further downturn, and we hope to examine that
question with the Chairman this morning.
Mr. Chairman, we look forward to hearing from you and your assessment of how the Federal Reserve is likely to deal with the current economic outlook.
Before turning to you for your testimony, I will turn to my colleagues and see if they have any statement they might wish to
make.
(it

STATEMENT OF SENATOR ALAN DIXON

Senator DIXON. Mr. Chairman, I am pleased to be here this
morning as the Senate Banking Committee conducts hearings on
monetary policy with Federal Reserve Chairman Alan Greenspan.
It has been quite a busy 6 months since we last heard from
Chairman Greenspan. We all have been working hard on the thrift
legislation. Chairman Greenspan has also been trying to engineer a
"soft landing" for our economy. The Federal Reserve's efforts in
this regard will, I hope, prove successful.
Now that work on the thrift bill is almost complete, I wish to
register my strong interest that the Banking Committee take up financial modernization legislation upon its return from the August
recess. I believe that Chairman Greenspan has strong views on expanding bank powers. I would prefer to have Congress work its will
than rely on the appropriate, yet incremental approach of the FED.
Mr. Chairman, I hope that S. 305 will be at the top of your agenda
for the committee when we reconvene in September.
Thank you, Mr. Chairman.
STATEMENT BY SENATOR RICHARD SHELBY

Senator SHELBY. Mr. Chairman, let me commend you for scheduling this morning's hearing, I am glad that we have this opportunity to meet with the Chairman of the Federal Reserve before the
August recess commences,
As always, Chairman Greenspan, it is a pleasure to have you
before this committee. We are interested in what light you can
shed on the direction of interest rates and the underlying situation
of the economy. I have several concerns that I would like to mention briefly and I hope that we could discuss these issues during
the discussion period.
We in this committee and in Congress, the administration, the
private sector, and in the academic community, all speak frequently of the global economy, of the increasing interdependence among
nations. We acknowledge that this evolution toward "internationalization" is inevitable and irreversible because it has been facilitated by the rapid advancement in telecommunications and information technology, by improved transportation and as you point out
in a particularly interesting statement, by the downsizing of economic output.
We recognize this trend. However, I am concerned that we are
not making adequate internal changes to respond to external pressures. Every American that drives a Japanese car or buys a VCR
knows that the Pacific rim nations are eating our lunch in many
traditionally American industries. We see Europe making impressive strides toward 1992 and a common market. Even Eastern bloc
nations are making motions toward entering this new global
market place.
Yet, the U.S. remains hindered by macroeconomic problems. We
have become, during the past 8 years, the world's largest debtor
nation, rather than the world's largest creditor. We are saddled
with an enormous budget deficit that greatly restricts our ability to
fully address the competitive challenges that have been laid before
us by our trading partners.

That budget deficit eats away at our modest private savings rate
to give us a dismal overall savings rate of 2.8 percent, the lowest of
any major industrial nation. As recently as the mid-1970's, our personal savings rate was 9.4 percent. At the same time, Japan's
saving rate was at 17 percent, Germany's was at 14 percent and
Canada's at 13.3 percent. While in 1986, the U.S. savings rate had
plunged by more than 50 percent to 4 percent, Japan's savings rate
remained high, at 16.4 percent, and Germany's at 13.4 percent.
I point this out for two reasons. First, our personal savings rate
is abysmal and cannot, for the health of our Nation, continue to
stay so low. We must encourage Americans to save. Against the
advice of experts, I have considered legislation to encourage saving
which would do so by permitting an exclusion from personal
income of the first $200 in dividends and interest earned. While I
do not presume that this modest effort could turn around the savings rate crisis, I believe that it would be a step in the right direction. However, this income exclusion would cost the Federal Government approximately $15 billion over a 5-year period. While this
is not a huge sum, it is too much in this time of budget deficits.
But I point out the savings rate for another reason and that is
for its ultimate impact on the cost of capital for business. Industry
in this Nation pays substantially more for the capital it needs for
investing in long term projects than do businesses abroad. Consequently, U.S. businesses require that projects break even much
quicker than their foreign competitors.
This stems from a variety of factors, not the least of which is the
emphasis in this country on short term profits. While Japanese corporations benefit from "webs" of stable shareholders who have invested for the long term, U.S. corporations must focus on quarterly
reports. Just a couple of weeks ago, Norm Augustine of Martin
Marietta testified that the publicly held ownership of his company,
with a market capitalization, turned over every year. Mr. Augustine related Martin Marietta's experience of making significant expenditures on R&D several years ago, as part of its long term plan,
only to have the stock price plummet. Fortunately, there was no
threat of a takeover, the R&D paid off, and they are now considered to have been wise.
But the fact today is that so many companies do not have the
luxury of taking a long term perspective. The cost of capital is too
high to make many projects feasible, because investors demand
consistently high returns. I believe that this short term outlook by
investors is severely limiting our ability to compete in the global
market.
I am concerned that, while the Federal Government is cognizant
of the challenge posed by the internationalization, it is doing far
too little to assist the United States in meeting that challenge. The
Federal deficit is our single largest problem. This dissaving increases interest rates and hamstrings our ability to respond to
many issues. I would encourage you, in your capacity as guardian
of the economy, to encourage the administration to make the
budget deficit its No. 1 priority.
In order to encourage long term investment, it seems necessary
to bring back a capital gains structure that rewards investors for
holding on to investments, while penalizing those who focus on

short-term trading. I am sure that you have some guidelines on
this issue and I would be interested in your comments.
As for the budget issue, I look forward to what you have to say
about the optimal method of financing the savings and loan resolution now that we are at this stage of the game. The administration
and members of this committee have argued that waiving GrammRudman will send a signal to foreign investors that the Federal
Government is not serious about exercising fiscal restraint. This in
turn could send interest rates up. I realize that you have responded
to this subject before, but we are now in the situation of facing a
month long recess without having acted on this legislation. I believe that your comments would be constructive.
Thank you, Mr. Chairman.
OPENING STATEMENT OF SENATOR D'AMATO

Senator D'AMATO. Mr. Chairman, I welcome Chairman Greenspan and the news he brings. In the 6 months since the FED's last
report on monetary policy, we have observed the effects of the
Fed's steady hand on the money supply controls. Not long ago we
heard dire predictions of inflationary cycles and an overheating
economy based on low unemployment figures and high manufacturing capacity utilization. Instead, the American economy has
cooled considerably. Now the same doomsayers are predicting the
opposite problem: a recession.
When confronted with the ever vigilant prophets of doom, I am
reminded of the rule about making predictions: if you predict often
enough you will eventually be right about something.
We all recognize that economics is a rough science and only time
will tell whether we have achieved the illusive "soft landing". In
any case, it appears now that Chairman Greenspan has steered a
course in monetary policy that has slowed growth without choking
off the robust economy which has created jobs and increases opportunity for all Americans. And he is to be congratulated.
Interest rates are declining, consumer spending is slowing and
while unemployment has risen slightly, 180,000 new jobs were created in the month of June. So the economy continues to demonstrate the resilience of the American economy.
We do have some problems that I believe the Government is at
least partially responsible for and I would like to hear Dr. Greenspan's thoughts on them. Despite the recent decline in interest
rates, American businesses still face a competitive disadvantage because of the high cost of capital for investment. One effect of our
thin domestic capital pool is the decline in manufacturing productivity over the past 12 months. I note that Dr. Greenspan's testimony emphasizes the importance of productivity-enhancing investment to our long-term national goals. We are in total agreement as
to that.
While the Federal deficit is surely a major factor in our high interest rates, the low rate of private savings is also a major cause of
our high domestic cost of capital.
Our tax code which taxes savings and investment while promoting consumption is one reason for our low savings rate. I believe
this is a matter which we must address now. I know that Chairman

Greenspan is reluctant to support a revival of the Individual Retirement Account in the current deficit evnironment, and but I also
know that he has been a leader in educating policy makers on this
important matter of savings rates. Therefore, as always, I look forward to Dr. Greenspan's insightful testimony.
Thank you, Mr. Chairman.
Senator Heinz.
OPENING COMMENT BY SENATOR HEINZ

Senator HEINZ. Mr. Chairman, I don't wish to make a statement,
but I do want to welcome Alan Greenspan back to the Senate
Banking Committee. We have obviously many subjects we will
want to discuss with you, Alan, and we obviously are interested in
hearing the comments you will make in this your regular periodic
report to the committee.
It's good to have you here.
Senator SARBANES. Senator Mack.
Senator MACK. Welcome, Mr. Greenspan, and I look forward to
your testimony.
Senator SAEBANES. Mr. Chairman, we are ready to hear from
you, please.
STATEMENT OF ALAN GREENSPAN, CHAIRMAN, BOARD OF
GOVERNORS, FEDERAL RESERVE SYSTEM

Chairman GREENSPAN. Thank you very much, Mr. Chairman.
I very much appreciate this opportunity to appear before you in
connection with the Federal Reserve's semiannual Monetary Policy
Report to the Congress.
In my prepared remarks today I will adhere closely to the matter
at hand—that is, monetary policy and the state of the Nation's
economy.
I will excerpt from my prepared remarks and request that the
full text be included in the record,
Senator SAEBANES. The full text will be so included.
Chairman GREENSPAN. Over the course of this year the contours
of the broad economic setting have changed. As a consequence, the
stance of monetary policy also has shifted somewhat, although the
fundamental objective of our policy has not. That objective remains
to maximize sustainable economic growth, which in turn requires
the achievement of price stability over time.
At the time of our last report to the Congress in February of this
year, we characterized the economy as strong with the risks on the
side of a further intensifying of price pressures. In view of the dimensions of the inflation threat, the Federal Reserve tightened
policy further earlier this year.
Additional reserve restraint was applied through open market
operations and the discount rate was raised a half a percentage
point. The determination to resist any pickup in inflation also motivated the decision of the Federal Open Market Committee at its
February meeting to lower the ranges for money and credit growth
for 1989.
Reflecting the economy's apparent strength and the tighter
stance of policy, interest rates rose during the first quarter. Short-

term market rates increased about a percentage point over the
quarter leaving them up more than three points from a year earlier, but long-term rates held relatively steady.
By the beginning of the second quarter the outlook for spending
and prices was becoming more mixed. Scattering indications of an
emerging softening and economic activity began to appear prompting market interest rates to pull back.
Rates continued to fall as a variety of factors pointed to some
lessening of price pressures in the period ahead. In particular,
money growth weakened further, the underlying trend in inflation
appeared to be less severe than markets had feared, the dollar continued to climb and domestic demand slackened.
Against this background, the Federal Reserve began to ease reserve conditions in early June. The easing has consisted of several
steps, the most recent of which took place last week. By the end of
July, most short-term market rates had dropped more than IVz
percentage points from their March peaks, and long-term interest
rates were down somewhat less, with bond rates at their lowest
levels in more than 2 years.
Economic activity is estimated to have grown in the first half of
this year at a rate somewhat below that of potential GNP. This
stands in sharp contrast to the performance of the preceding 2
years during which growth proceeded at a pace that placed increasing pressures on labor and capital resources.
Prices did accelerate in the first 6 months of this year, but most
of the increase may be transitory, related to supply conditions in
food and petroleum markets. After a gradual pickup over the preceding 2 years, price inflation outside of food and energy held near
its 1988 pace.
The strength of the inflation pressures in 1988 and into 1989
was, of course, the motive for the progressive tightening of policy
that the Federal Reserve undertook over that period. And the outlook for some reduction in these pressures owes in part to that
policy restraint.
The associated rise in market interest rates, beginning early last
year, opened up wide opportunity costs of holding money assets
and resulted in a sharp slowing of money growth.
In addition to the effect of interest rates, several special factors
played a role in slowing money growth and boosting velocity—that
is, the ratio of nominal GNP to money. Probably the most important of these was the unexpectedly large size of personal tax liabilities in April. Many individuals evidently were surprised by the
size of their liabilities and drew down their money balances below
normal levels to make the required payments.
The difficulties of the thrift industry also may have affected M2
growth. Late last year as public attention increasingly focused on
the financial condition of the industry and its insurance fund,
FSLIC insured institutions began to lose deposits at a significant
rate. While most of the funds apparently were repositioned within
M2 at commercial banks or money funds, this fact likely also had
some dampening effect on that aggregate.
Most recently, growth of the broader monetary aggregates has
picked up markedly. The restraint imposed by the earlier rise in

market interest rates is fading and households appear to be rebuilding their tax depleted balances.
The level of M2 on average in May was 1 percent above its
fourth quarter base, but rapid growth in June and July has lifted
the year-to-date increase to around the lower half of its 3 to 7 percent annual target cone. M3 also accelerated in June and July,
placing it well into the lower half of its range.
Looking ahead at the remainder of 1989 and into 1990, recent developments suggest that the balance of risks may have shifted
somewhat away from greater inflation. Even so, inflation remains
high, clearly above our objective. Any inflation that persists will
hinder the economy's ability to perform at peak efficiency and to
create jobs.
Consequently, monetary policy will need to continue to focus on
laying the groundwork for gradual progress toward price stability.
Such an outcome need not imply a marked downturn in the economy, and policy will have to be alerted to any emerging indications
of a cumulative weakening of activity.
However, progress in inflation and optimum growth over time
also require that our productive resources not be under such pressures that their prices continue to rise without abating. In light of
historical patterns of labor and capital growth and productivity,
this progress very likely will be associated with a more moderate
and, hence, sustainable expansion in demand than we experienced
in 1987 and 1988.
At its meeting last month, the Federal Open Market Committee
determined that a combination of continued economic growth and
reduced pressures on prices would be prompted by growth of
money and debt in 1989 within the annual ranges that were set in
February.
Moreover, it tentatively decided to maintain these same ranges
through 1990. The specified ranges both for this year and next
retain the 4-percentage-point width first instituted for the broader
aggregates in 1988. Considerable uncertainties about the behavior
of money and credit remain, and the greater breadth allows for a
range of paths for these aggregates as financial and economic developments may warrant.
In view of the apparent variability, particularly over the short
run, in the relationships between the monetary aggregates and the
economy, policy will continue to be carried out with attention to a
wide range of economic and financial indicators, The complex
nature of the economy and the chance of false signals demand that
we cast our net broadly—gathering information on prices, real activity, financial and foreign exchange markets, and related data.
Over the remainder of the year, M2 should continue to be supported by the decline in interest rates of recent months which,
along with the growth of income, is likely to result in an expansion
of that aggregate well within its target range. We also expect M3
to strengthen from its rate of growth over the first half of the year
moving up into the middle of its target range by year end.
Growth of money and debt within the 1989 ranges is expected to
be consistent with nominal GNP rising this year at a pace not too
far from last year's increase according to the projections of the
Federal Open Market Committee members and other presidents of

Reserve Banks. These projections, however, incorporate somewhat
more inflation and less real growth than we experienced in 1988.
The central tendency of the projections of 2 to 2V2 percent real
GNP growth over the 4 quarters of this year implies continued
moderate economic growth throughout the year. For the year as a
whole, these projections anticipate that growth is likely to be
strongest in the investment and export sectors of the economy with
expansion of consumer expenditures and Government purchases
rather subdued.
A sectoral pattern of growth such as this would in fact serve the
nation's longer-term needs by contributing to a better external balance.
Fundamentally, improvement in our international payments position requires productivity enhancing investment and a higher national savings rate. In this regard the Federal Government can
play a significant, positive role by reducing the budget deficit.
The outlook for inflation this year, as reflected in the central
tendency of the projections expressed at the FOMC meeting, is for
a 5 to 5V2 percent increase in the consumer price index. A figure in
this range would represent the highest annual inflation rate in the
United States since 1981. This is a source of concern to the Federal
Reserve. Yet this rate is below that experienced in the first 6
months, and hence this implies a considerable slowing over the remainder of the year, reflecting earlier monetary policy restraint
and a prospective moderation in food and energy prices.
Federal Reserve policy is focused on laying the groundwork for
more definite progress in reducing inflation pressures in 1990,
while continuing support for the economic expansion. The ranges
provisionally established for growth of money and debt next year
are consistent with these intentions.
Although the 1990 ranges do not represent another step in the
gradual multiyear lowering of ranges, the Federal Reserve's intent
to make further progress against inflation remains intact. Uncertainties about the outlook suggested a pause in the process of reducing the ranges. However, the committee recognizes that our
goal of price stability will require additional downward adjustments in these ranges over time.
Of course, as we draw closer to 1990, the economic and financial
conditions prevailing will become clearer, allowing us to approach
our decisions on the ranges with more confidence. Hence, the current ranges for money and credit growth in 1990 should be viewed
as very preliminary.
The economic projections for 1990 made by the Governors and
the Reserve Bank presidents center in a range of 1% to 2 percent
real GNP growth and 4V& to 5 percent inflation for next year. Naturally, as I have already noted, there are considerable uncertainties surrounding forecasts for 1990,
The Federal Reserve is committed to doing its utmost to ensure
prosperity and rising standards of living over the long run. Given
the powers and responsibilities of the Central Bank, that means,
most importantly, maintaining confidence in our currency by maintaining its purchasing power.
The principal role of monetary policy is to provide a stable background against which economic decisions can be made. A stable,

predictable price environment is essential to ensure that resources
can be put to their best use and ample investment for the future
can be made.
In the long run, the link between money and prices is unassailable. That link is central to the mission of the Federal Reserve, for
it reminds us that without the acquiescence of the Central Bank,
inflation cannot take root. Ultimately, the monetary authorities
must face the responsibility for lasting price trends.
While oil price shocks, droughts, higher taxes or new government regulations may boost broad price indexes at one time or another, sustained inflation requires at least the forbearance of the
Central Bank.
Moreover, as many nations have learned, inflation can be corrosive. As it accelerates, the signals of the market system lose their
value, financial assets lose their worth and economic progress becomes impossible.
Thankfully, this bleak scenario is not one that we in the United
States are confronting. We do, however, face a difficul balancing
act. The economy has prospered in recent years. The economic expansion has proven exceptionally durable, employment has surpassed all but the most optimistic expectations, and the underlying
inflation rate, after coming down quickly in the early 1980's, has
accelerated only modestly. But now signs of softness in the economy have shown up.
Accordingly, it is prudent for the Federal Reserve to recognize
the risk that such softness conceivably could accumulate and
deepen, resulting in a substantial downturn in activity. We also
recognize, however, that a degree of slack in labor and product
markets will ease the inflationary pressures that have built up.
So our policy under current circumstances is not oriented toward
avoiding a slowdown in demand, for a slowing from the unsustainable rates of 1987 and 1988 is probably unavoidable. Rather what we
seek is to avoid an unnecessary and destructive recession.
The balance that we must strike is to support moderate growth
of demand in the near term while concurrently progressing toward
our long-term goal of a stable price level.
Admittedly, the balance we are seeking is a delicate one. I wish I
could say that the business cycle had been repealed, but some day,
some event will end the extraordinary string of economic advances
that has prevailed since late 1982. For example, an inadvertent,
excess accumulation of inventories or an external supply shock
could lead to a significant retrenchment in economic activity.
Moreover, I cannot rule out a policy mistake as the trigger for a
downturn. We at the Federal Reserve, for example, might fail to
restrain a speculative surge in the economy or fail to recognize
that we are holding reserves too tight for too long.
Given the lags in the effects of policy, forecasts inevitably are involved and thus errors inevitably arise. Our job is to keep such

errors to an absolute minimum. An efficient policy is one that
doesn't lose its bearings, that homes in on price stability over time,
but that copes with and makes allowances for any unforeseen
weakness in economic activity. It is such a policy that the Federal
Reserve will endeavor to pursue.
Thank you very much.
[The complete prepared statement of Chairman Greenspan
follows:!

For release on delivery
10:00 a.m., B.D.T.
July 20, 1SB9

Mr. Chairman and Heaters of the Committee:

I appreciate

this opportunity to appear before you in connection with the
Federal Reserve's semiannual Monetary Policy Report to

leonomie *Bd Houtiry Mrvlopaenti Tbvu Far in 1X9

broad economic setting have changed-

As a consequence, the

although the fundamental objective of our policy has not.
That objective renains to maxiniie sustsinabla economic
of the

Committee on Banking, Finance and Urban Affairs

stability over tine.

U.S. House of Representatives
July 20, 1989

inflationary pressures night be building. Moreover,
increases in food and crude oil prices vere raising the
major inflation indexes.

the Federal Reserve tightened policy further early this
year.

Additional reserve restraint was applied through open

pftucantage psUit.

Tilt determination to resist any pickup in

Mar

June Mid again in early July.

By aid-July* most shott-ta

the third
duced,

Economic activity apparently grew in the first half

stability over tine.

had a marked impact on growth of the monetary aggregates.

nearly 1-1/2 million new jobs met »dded to payrolls.

And

this occurred apparently without triggering an acceleration
in wages.

up over the preceding t"o years, pr

the caae earlier in the expansion.

n signifleant moderation

provided a notable offset to these coat pressures.
there is son* logic in abstracting from then a prices, which

balance, it appears that firms have continued to experience

are quite volatile and can be dominated over the short run

inflation cycle begins or why it may persist.

Short-run

on both the demand and the supply eides of the economy.

the na

tightening of policy that the Federal Reserve undertook
tint period.

Afcd the outlook for aoaa reduction in that

laat year, opened up wide "opportunity" costs of holding

But

-7-

gro-th.

More recently, growth at the broader nonetary
nj^rfBjttes hu pickaxi up Ba.Ek.c4lY* t-» rutiiirit inpuswi by

balances.

households appear to be rebuilding their tu-deplatad
balancea. *s of Kay, K2 h«d risen at juat a 1 percent rate
from ita fourth-quarter Baae, but the 6-3/J percent r»te of

several apecial factora played a role in slowing money
GNP to nonay. Probably the moat important of these trap the
una*o*ct«<iLy ltig« sii» oi personal tax liabilitiea in
April. Many individuals evidently were durpriaed by the
balances below normal iBvelo to make the required paymetita.
Aa the IRS cashed those odeclts, H2 regisntrsd outright

cent
annual target cone.

M3 roae at a 3-1/2 percent rate through

June, at the lone! end of itn range.

The litest data on

continued into July.

monetary aggregates, declined at a 3-1/2 percent rate
through June,

The unuaual o^op in Ml ataamed from aizable

declines in NOW accounts and dauind deposits.

HOH accounta

attention increaaingly loouaad on the financial condition of
apring and by the high le"el of interest ratea, "hich dren

other t.ypea of accounta cboae offering rates adjuated upward
nor* quickly-

apparently were repoa

The decline in deiaand dapoaita was related in

part to a reduction in b«.Ltnc«B that b^fiiitftAaee are xaguired

oome damping
a sot amount of services, higher market ratas translats into
lower required balances.

-S-

taittatiraly decided to maintain thaae aane ranges thcough

HM*tuy Policy ma th* loonoay into 1910

1990.
The specified rangea. both foi thip yiar and next,

1890, recent development;] auggest thst the balance of risks

ratain the 4-percent»g«-point «dth first instituted for the
broader aggregfttea in 1986.

Considarable uncertainties

about the behavior of mcnay and credit remain, and the

Any Inflation
ability to pe

•ggregntea aa financial and econonic dBvelop»entB nay

Conaaquently,

warrant.

Uncectainties about the link between the narrow

in the economy, and policy Mill have to be Alert to any

In view of the apparent variability, particularly

without

monetary dggregvtfla &nd t^A ecencany, policy will continue to

labor and

and the chance of falae signals denutnd that we caat our net
austain«ble, eipanaton in d«und than He experienced in 1987
financial and foreign exchange Market s, and related data.

and 193S.

•hile tha nonetary aggregates day not b« preeminent

pconoted by growth of money and debt in 19fl9 within the
annual rangea that vere aet in February.

Moreover, it

exhibit unusual strength or weakness relative to pagt

heavily on the Federal HoDe Loan Banks for their funding 13

of the year, moving up into the middle of ica target range
one or Another of tha monetary aggregates, is an important

by year- end.

Our

factor in the performance of the economy over the shorter
CUP and over the long run broadly determines the rate of

measure that « monitor, the debt of domestic nonfinsncial
sectors* has gco^ci pt about an B percent rate this year,

Alt

near the midpoint of its 6-1/2 to 10-1/2 percent range.

interest ratea in recent months, *lonq vith. thfl continued
growth of income, should provide support for that aggregate

tne

particular, xe expac

institutions have subsided, and enactment of legislation

pro^ectior-Br of 2 to Z-W2 percept re>l GBP growth over the

depo

industry ijifficulties alao have iBpli.CBti.ono for Mi.

Kitli

daposits flowing in again, thrifts "ill not have to rely so

-12-

economy, with expansion of consumer expenditures and

in ooney
hould thst be

markets are less intense than in recent yearar velocity
a better external b«lsnca.

Fundament »lly, improvement in

our international paym»nts position requires productivityenhancing' investment afKi a higher nazlen&l aavifig rate.

money gronth, perhaps in the top half of the range, would be

positive role by reducing the budget deficit.

cy of ths proje

the
Fader*! Reserve,

let this rate is belox that experienced in

over the rsn»inder of the year, reflecting aarliar oonetary

energy prices.

money and credit growth in 1990 should ba viewed 53 vary
preliminary,
The economic projections for 1990 made by the
governors And Reserve Bank presidents center in a range of

l'\/2 to 2 percent real <3n> growth and <-l/2 to 5 percent

Ultimately?

the

shocks, droughts, higher tanes, or ne» government
regulations n»y boost bro*d price indeisa at one tine

will ba affected by • l*rg« number of influences, including
importantly the budget deficit.

Ittnatuy Policy In Eer*p»ctlv»

optionally durable, employment has surpassed all but the

to ensure that resources can be put to their beat use and
vably could
In the long run, the link: between money ui<3 price

slack in labor and product markets will ease the

-16-

Far use M 10:00 a.m., E.D.T.
Thursday
July 20, 1669

alowdown in demand, for a Blowing from the unauatainabla
atas of 19B7 and 19BB is probably unavoidable.

Rather -hat

Board of Governors of the Federal Reserve System

oderate growth of demand in the near t«tnr while

Monetary Policy Report to Congress
Pursuant to the
Full Employment and Balanced Growth Act of 1978
July 20, 1989

•, but that cop*a vith

Section 1: Monetary Policy and the EC

; Outlook tor 1989 and 199Q

As 1 989 began, & reduction in inflationary presaurea

Letter of Transmittal

was io he sustained. Monetary policy during 1988 had
been directed toward reducing ihe niks of an escalation

took an uddinonal *rna|| casing step in early July Hus
helped bring about i further decline In markerratesof
retraced die increases dial had occurred earlier m Hie

flic Board'* report to Ihe Congren in February of ihis
'fl percentage poinl from thei r December levels, while
potni on balance

Monetary Objective! lor 1969 and 1090
BOARD OF GOVERNORS OF THE

unfavorable trends in unit labor cosls over the preced-

1(1 February ihe Federal Open Marker Commmee
pcrccniiige priint beln« ihat o( 1983 and ranges fur Ml

THE 9PE*KEP OF THE HOUSE OF REPRESENTATIVES

was raised 'i percentage point in Lure February En

htiKhthe ranges hadbeen bo^ereJ Ai ihe same time,

Full Employment artel B|l*nc«<I Qro*ih Ael 0' T970

ened further. Wilh M? miming noticeably beJow Us.
urge! range for Ihe year Aggregate demand (or good*
and services moderaled, reducing someu'riai the srraina

Table of Content*

bec'use oE the effects &( die firming or policy thiuugh
Lare 1983 anJ inio 1484 In addition lu ihe influence nf
ihe higher interest yam on desired holdings of money,
however, several special factor*- including Ihe difnCUlliCi Of the thrill mdusli) and a drawdown of tiqu id
mcnu-uppfar lo have (Unher reduced money r>al-

SttUon l;

Sflcttan i:
Section 3:

Monetary PoUcj and the economic Outlook far 1989 ind 1990

The Performance af the Economy during me Fim Half o< \9&9
Monetary Policy and Financial DcvcloprrvriK

during ihe FUHI Half of 1489

unchanged in [he neighborhood of 5t pcrceuE-the

i=iii=i

By June, rrmncygro*Tji had picked up. Nonetheless.
Mi ended die ouarrer just 2 percent t\ an annual rate
ilo 7 percent annual growth range. In Juneh M3 was al

with 19B8, though by les* than the monetary sggit
gareSideHhabgrUwrlabourSperceDlsa (JT fhLS >*«],

provide reserve* shghlly more generously tiirough

agreed ID retain the current unges for growth of inoney

fangn of Growth for MantUfy *od CredH A0gi*g*t«

nlc Pro|«ctloni for 1 *

,
FOMC Utmbef • and Othar FRB PrstkJenti

nrbfkmtllor 1MW

Admlnlitritlo

NomlnaJ GNP
RHlGNP
dndder* in I9ft9 TtiE Co[runi[l« anticipates thai by
the fourth quarter a|j unree aggregate* will tie *e,l
within (hose ran jes The more rapid growth in M2 ind

Economic Pro^ctlons for 1 MB and 1990

Coniumar prici IndflK

serve Bank president believe [haithe monetary ranges
e*lend through lf\f second half The iccrnr decline* n

1990
growth The cenTTdl leudencr of [he forecasu 19 (Or
MZ expansion Ucly aim 10 IK boosted by a further
replenishing of liquid balances depleted by la< payment, [his HEjregarc is expected lu gro* a [tnlc fesler

wgh
For 1990, the Commiiiec provmonally decided tu
for« for 1989 The Committee recogniled ihm [he
half 11 uncertain, in partlCUJaf, il is unclear U IhH

The
should
(.UEUribute lo a d^mptFLg ft inflation in 1^0, allhough
the Board members ind Bank presidents also JIT
antlCLpSlirig wine ncar-lcnn relief ffoni ihc special
problems [hat boosted price* in [he firs! half of thli
year larger crops ItlcE ihii yur should result in mUEc

/winfi ou*n*r ro fovnn
Nominal Qftf
n«al GNP
ConiuiTHr pri

peaking of crude mJ priiCS SUggCbU the likelihood of
wmcsnfkmns in consumer energy prices. Thiia,ie[ajl
LnflaUQD shUuIdbrcDnsidcrBlHy slower OV crlhc remainder of this year, and ihe <.en[rHl lendencv of CPI
EorctflsU (Or I9B9/ a^, a whole is 5 HI 54 penenrtomparfcl with ihc mnrc rhan 6 perceni rare observed
through May 'Hieforeca^ fur ihcCPl in !9W«nler

;>;ports o( goods and S
irltet [his
,bul
more dirficuK to achieve in the penod aheud i [he
are Offset by those asHnia[ed wiUi die more recent

likely to trend higher or lower nejt year Although thK

ihar ii n seeking, Jl ^ill recvaluarc ihc ranges nexi
ciiJ siHiaLLOn The OUtluoL (nr spending, prices, und
finuDcial mu-keu in 19*0 should have cuuiAed some-

incnnneclion *llh il& nud-wssion updflJC of UW budget
outlook, does noi Jiflcr greatly [rorathcprjicciioinof
[he FOMC membere. NominaJ GNP is near the upper
ends of |he FOMC cenunJ-tendencj ranges for 19B9
and l990,biirwi[hanHre[avn[ableniuijfr«lDi]ipiii
Vfriui inflation, especiallj 111 1990 There appears to
of ihe Federal Reserve and [he economic forecast of die
cared [hat K sharea Ihc view ihai [he nuintenuice of
antl-Lnflationar} monetary policy i* a precondirjon lot

require thai ihc radS" for maacy and credit growth be

Surveys of business plans suggest thai capital spending

cxpecied i n I ight of decl ining le^tls of capacny u*e ind

efficiency a

mn. b[a&iliiy. bur also on ihe determinauoii of U S

Section 2: The Performance of the Economy during the First Half of 1989

3 p*r«ni, hirt n remain* Urge by him
i«Mrr SUch as htuilflB ifd buSine** invesnnrni TtLC
ftdenceintheU 5 HontmiVrptniculailyamongfinancial maikci ptrUeLpurB At UK iame DDK, reduced
demand* by iheledcm government (or crcdii.»]]]trM

ii) deceleraicd substantial)? m itie fiucliaJfot LffK*

the Group uf Seven UnancBminiiten -nd «uirjl hanfc

mrctuie ihf niBCHl L99I budget ttrgcT.

jo& creation wa* oinbhlcrjWe-ne;irl> l 'A million

iriai

undcnnined Uie ndjusuneni process noultl be

ployment rate, RuL-tnaling around 5'* percent, reiihuned mlhc lowest range bince The early |9lQs

ro
tc
lolldr hut teen Urgcr. bc^dUHe I. S hildlion hk<

ilKTeHSe Ihal had occurred eajlier in the year In
Detcnibet UK dollar began m rebound, ami n row
\omc".nflt. The apprct-LdlLWn of The dol lar Irimugti ihe
firil IkUf of I9R^ *a^ rrequcn||> AWI by ^nrccrted
monetary auihoritieh
During December, and in ihc ficii quarter of ihis

Tlie U S merchandise trade deficii in ihe Fusi

jelillinetl^iteninf afU S moneiir> policy Repunsof

rare, Significant^ hcncrthan the figure TorlhC foutlh

•hdf FfdCfi] Reserve pohty wiiuld be tightened Will

essentially Unchanged frnin the firs!-iniarref pice

Heal GhP • Excluding Drought Effaclfl

For«ign E«en«ng« vulus of tin U.S. Dollar'

U.S. Real Uercnandist TraO>

U.S. Current Account

IT
1 1 1 1 1 III

_L_

dKHigh nor w rapidly u in 1968 Export gains have
bwi broadly based. wiihootablE increases frnagncul™f*l good*, induHna] supplies, tapiol food*, and

brlow cbe pice of t9B8 IB a whale 4 weakmmg m
purctauu of furaifiiie and ippUoncn likely was rrDC*-*"— -"•»-

m«kEBteljr]n fid, average iraportial' products ofhsr
tha° petrofeuin in April ana1 Miy *erc teti tfun H
pPrrjru above UnitfourTh-quarterr»te Notabk dt-

E>«
-

and Aiiiomouve products, So far in 1989, the value of

b> fl unoll increuc in physical ralume The furtive
improve mem In ihe U.S. nude balance in the fini five
monihi o( ihis year reftctii • aumbri of factors, mn^r
I*K iln*er gro*ili of U.S. icavuy, ihe contLrunig. if
dimiMihed, beoelil Ini U S price mmpcULV«neu
fn"n ihe dept^'a|1D|1 "' UK doJ'" Uiioufth the end of
1987. and ihe ftsLrant titn ihe i«fnt EIK in theaoffii
P*"cfld on pncfs af non-Qii impom
<nrnicr[oi]23tnLLi«i The incrasc fmtn Ihe fourth
qiurler me wu men Chin KceunKiJ for ty c«pbtil
muf|in( ftum tfie Artfafi mppoKMlGa Setting a/dt
faJtf knsei, ihr turteni tcwuni bfllincf ih |hc fini
quaricr ?hc^ed i dflitii Of S10B billion, UL improveNurly ill of fliii irapmvecwnl icsulird Eroro ihr
n*f"Hi*]n(Df [heunJ* fleficii- Prclimirurj mlormauofi

U.S. Tnasuiy seeuriuu ud corporaw bonds and

nurnift] kvcli over ihe year, afrcr the drought-induced.
rcdiKUuju m L^S8 Witb hiring duwn m lb« spring,
increases in »fl|« aod saUncn unenaJ naLccibly,
qhawLQg vintfLilly no growth in r«l Wrn^. AIM,
J

hnlds appear lo cuvc •doped*, more CBULOUS jfiending
alUKfl, LJtouf h Jltlso Should be nmed ihal Ihc prrBonal
wvin| nee h»rcmainal below the nonnioElhe 196Di
Reiidenual c
HpQEI?
Jibe

^ and t,

rate, which began in M*y, likely *ill be reflected in

Slatf,
nurty Eifll f irf The ovenll n» in ihe GNP during ihe lim

,r , ft,

upswing since re*chins • fimy-ycir lo* m mid-|i>B7.
SrvrHl nnlBnalioiu Kiv^ {ftt\ nmpOUnde^ Air the
recent Hw, among (hem the lower Level nf household
nei wonh reltlive ED income since the stock nuilci
bKa\ of 1987, higher caib o<( coD&umfir cinLir (espeLziHlly in ifKrlu tcmiH, bcciuv nf The phise-dmm oi
LnlfiCttdcductibilLtjO, and loncerru ilsMii a potential

perctnt from their 19B8 p*ce.

|° >hf s«ond quarrn1 proftaWy »« negligible, lx>*^f, BE icil aft eipncti maj have Ixpin m be deprc^dj ty ihc last ID U.5 pntc iompttitivcwEs
"M^uifd widi Uir cumulative rise m inr dyllHi sin«

row nearly a full percentage point during foe early
the finihflllol 1999 reflated 1 de«kralidn in «n-

mi AftMs wu [educed In recent ycaci, relatively lo*

&">Un encofnnaiiinj *. vAntiy of durable md nondur*bk gfofe Despite tiK widcipiCBd ivjiHihilitv of
*pt3id ftnincmg dcali ind other incrnilvri. *ile of

household! lo fivor thiE insliuincni far home pur-

X-

1 U percentage point

and have remained high, [n an effort to reduce the

rmllofhe year from the already Low level recorded, m
198E Mulrjfamily housing production has been lim-

have enhanced sales incentives. Qualitative repons

die T*J Reform Act of 1986, nhith. by Curtailing

firms appear lo have hem rollnwinscaiKious inventory

minv rf the financial advantages JESKialed with investment in rcnial housing, sharply reduced Its aftertax

policies tnd; problems of excess siocku seem TO be

profitability

In [he first quarter of 1989, before-la* CiunumK.
prarits nf nnnJinancLal coTporalions decimal, in par!

The 0u*lnwa Sector

limited

In contrast lo [he household wctcir business capital
spending strengthened in early 1989. responding in

pan rohigh levels of capacity utilization in ihe United

profits *as spread over most types of businesses. Ihe
[Jlgest d&luie w-u in the manu fairing f^n- whuh
had! especially ^rong gaios in both 19H? and 19A8.

Slates and ID inlernarinnfll pressures m lower costs In

Meanu'tule, corporate tax liabilities edgfd up id ihe

the first quarter of 19S9, real business fixed investment

firsl quarler, owing in pan to higher profit generaled!

rose ar an annual rare of 7 ^percent and inch spending

fnimtlie nsc in puces of inventories- The combination

sZrTqu^r 11KrHLWd "lt*Iar"BlJ>

ced'uTeo' ih7^efinila7clhI'flohw H" non financial

meni ^go^

Pamcularlj noteworthy m [hTfiS

quarter was a sharp n*e in outlays for industrial
machinery

sloped and prrductivity ddcnoca[ed. fhe drop in

Th* Govarnmant Sector

Increases in that area, which includes
In the first quarter, real federal purchases of goods

spending for ftbncated metal products, engmei. tur-

bines, and! a vaiiely D( other lypes nf indu^lnaJ appara-

and services, the pan of federal outlay b diet is counted

tus, have been exceptionally strong since mid-1937

dircttly in GNP, were virtually unchanged- Slri:h pur-

Spending forriigh-ledinology equipment also has been

chases arc dnmma«d hy defense; nominal spending

robust. Computer oulkys deulenled during the i«

authonty in diis arett has been virTiutlly fiar since 1984.

oiHlrialfof I9BH, pnssihly reflecting some hesitation on

and pnhuremenl of sane major new weapon system?

pace of new product aonounceiiieirU, hut spending was

11 winding do*n. As a result, real militir)1 purchases
have fallen and in the first, quarter were Dearly 5 percent

up considerably m UK fiisi quarrer, and another gain

below the mid-1987 peak. The decline m defense

appears in train for the second qmneT

spending has been partially offset by increase^ in other

the putof poceniml purchasers inresponseio ihe rapid

federal purchases. Inventories heErlb-r die Commodity
, "Sln^^^ltal^'^r™™

(ludavs for construcnon ofoffictind odicr ujnuner

quarter, but die rate of decline has been slaving (on i
as [he effects or I i7i summer's drought have dissipated.

mained bekow thai of dw 1985- 66 period . depressed by

excess space in rruoy aceis. And, while rhe. nsc in
energy prices led to wme .r*T«« in oil and g*>
H

Spending for Ihc space program iiid lor tu and

inuiugrarjou enforcemenl alto has men.

On a unified budget l^is, <oul nommal outlays Tor

vecy lo» compared *Llh (hat of the early ! JttCK.

above die comparable year-earlier toul

Invcnlorv investment slowed over Ihe firal five
monthtni'iqjH ai bu^ir^ws adlliaied «i[ti flppHiCdl

end IVBR and then dropped sharply mine first half of

rsrii™^yTi'^Knzz°^' ^
been gonccnbaEed m the Aircraft and other capital
goods industries , where producnon his risen and order

backlogs arc laige In stilus!, in the retail sector,

Spending

Erlaied to die thrift jniSnitinn problem spiKcdi at yearthis year. On the other hand, growth hu continued in

Security) and m net interest outlays
l-ederal receipts have grown even more rapidly rfum
furlays, ouoyed by increases in employment and in-

Nonf*rm Payrall Employmeni
nonu'Uhheld UK collections in April BftJ May, the
possible eiplanauons relate HI ihe Tat Re form Acl at
1986 and i nclude greairr-rnin-utticipaced effccri from

personal ia* rate* *ai |u|Ly phastd in In addition,
realizalions uf uiabk capital gains may have been
hefty Last year because oltfie large numbc[ ofcorporate

-flfln n flfl
n The

IP consictiablf upwatd pressure Sntw uthrr expend i-

iviges over rhe year ended in March, and local compensation ptr hour - *ag« aid salaries plus ncneriu - was
up 4 4 pciveilT over lhal period, inlhrdiTiC range a* me

tnleEdl sector. growlTi itt *iaie sod local outlays his
ugher
raic in rhr F

experi

effici

Libor Markets
atwut 1 p-i(f[||h unit coils had decl ined easier in ihe

Hnd payroll employment gmwlh dnjppcil hflfV to

Price D^vflioprmniB
larger lhan arc Tit* fy 10 Se imlaiTitJ. ^[vcn c(w umfcr-

inde< for a.|| Item;, abroaJ-basedmeasurclnrEinJihed

laigeslD^rr ihe L&Utse Of tlui business etpiPSIOll

pcrccni Uirough. May, compared with ihe 4^ prrcem
pdtt in I9g7 >nd l^SS. The producer pri« index lor
finished ^uods recorded an even more pronounced

The uioderalton in [lie gnj^lhi of Ihc demand fur

and energy in lhal indeK. However, iht Underlying

ratenlaiQund JH percent, fihoulthf iameasm l^BS

Unemployment Rate

•I be a bi« fJLlur in Ihe (m
s ir Msska anJ .n ihe Nonh Se,, -iJiltd io pnt-t

j |S

Pro<luc» Prlc« kir InuimtdlMt Uatmiall pKMnten«9« N
Eicludlng FooO Hid Enwfly
pit*M«t pwod, ^

—1

nn
1

n n
1

Section 3: Monetary Policy and Financial Developments

Short-Twin fnt*rt*t FWi>

during the Firil Halt ol 1989

,eakeni

• (Mir
(liMTWr

demand of Ihc re,olulLon of die mils in Jle thrift

polLn mil 1989
Inltrtlt Rit»

Trie implementation OT Monetary Parley
A* ilOlfJ prcvuH^Jy, devtlifpmenls «rl^ jn 1989

belief [banripcctrd The doUlf »1 so may KavegHinnl

H^grCfrilfs weakened further in Apn] andearlf May.
reflKling Uif drawdown .jf Liquid tulnncts LO niak?
In Mdy, M? fclHotiiflo^^r ed^e D( ihc parallel hund

hillni:98B

Rongu and Actual Monty Growth

Hm « Mir
Aato erf Oruurtn

™°

than uflKtiing their fiiv-i|iurWr rise The bond markel

1 B Pmnt °*

19!S lcvrltl 3locip

""' """"""d *"' W"1 "Ewnl

yf LES rlic diumg The s&xitxj quarter, although remaining *ell above Its Level at >CHf-end I9BX

Thi Behavior of thfl Monvtttry
AggrtgHH
1850

—1
°

1
N

L 1
F

l
O

psh over the finihilfDflM!). rtBHiingthctlfKiii.!
incruus through March in m&rkel JlUcrcsl Talei if la-

l
N

large la» piemen" b^ individuals. Frftm [he fourth
quarter nf I4B3 through Jiinr. MI ajged up ar an

U3
R4M at Growth
.1W

*o»

_
19WQ4to, BW0 2
3^P*C*nl
TOSaOflnJurw
3'k P*fCBnl

lirBely limn i comttriiilioii of cuntinued Incicasrs in
market^te.^^ar.dum.suj.yslow.pw^d^usrment of flies pjjd on retail -kepoait! VleUsoUNOW

^^^ in Manh, while rhoie on other liquid
depoEiis- saving! and Money Market Depoii.i Aclounts lMMDAa)-rose aboui U and | percmtaBf

penod- RaiBB on Email Cme accounts ificreawd much

OUt Ihc (irsl k|UJner These outflows apparently dcpcnod, bill the bulk dime funds llfcety remained wiUim

to
The tncitued opponunLiy losls of the fini pan of
the year continued to damp money growth miD the

jMr

[hey ico failed B keep up wilh UK use In mukct yields,
j-vfj

back insured deposits fully, PS UC-mSLired IhnH Ensti-

year's part of 5^ pcrccnl. M2 velocity iDic iharpj>
throkfgh tlir Icccmd qiuner.
^ „«,!„„,„, of HI „,flufira,lfami u^mej

42SO

7.6^-

deposing1 nervousneiE about the problems Of UK thrift
industry were playing* file 100 Although UK Presi-

fcirte

of flic iJjjjpiJl«*5 Jp [he «d;iii[iB.*oi o/ re-

late April and into May ts UK payrnenncorninuel 10
flo*S o[uvirL£i and HMD A balances accelerated, and
awes begin to bounce ^.ct in laie May, Ixwevti, as

refLectedcaininued regulatory pressure] on thnf1 uuti-

1
0

1
N

ten

1
D

1
J

L 1
F

l
A

l
M

l
J

j_
J

,*»

i
*

i
S

l
O

i
N

D
aggresslvc pricing polici« More biuadly, UH slow
upwltd adrustmenE ol deposit rales, eapTCtilly on
MMPAs. *nd savings depoattH-alsa reflecM UK

, markel inlTTCSl tiles headed i
Yields on small tune dtpotits lagged this move, md

through nuncompetltive lenden lellbick, andgrowrh.
anniiaJ rate of more than 20 pprccnl Tor UK quarter

Velocity erf Money and Debt
Growth ot Money wd
Dttltol
demMfe

fowth guwv loath g
1B7S

1982
1963
1BB4

19S7
1988

-0.4
-5.5

Range for Debt and Adual Debt and Mon»y Growth
responded somewhat more slowly ihan loose it buikb
th

derm

uTfl

•

CradH Fkwri
Ttteaggicfete dchi of iJtuDcHic nonfloanciaJ scctorH

Tld Vj/Lr

already moved their nmds elsewhere, overall deposit
balances at FSLIC-ttisured thrift institutions stabilized
m the second quarter
M,1 grew ai u annual rate of 3^ percent from the

fourth quarter of USE year in June, placing it at the
Lower bound of as urgel range- (n tfie first utmcler,

ing range and down somewhat from iu I9BS pace, Tbe
grow*, of fefleral sector debt slowed as m receipts

al» moderated, partly in response to higher levels of
market interest raid over mitth ol me Rrfl half Of Ihe
year. Household borrowing sa mongage murkets

sloped as increases in lending rates dajnped housing
demand, while the paee of tonsumer borrowing
slackened along with [he deceleration m con±umpt1iKi

bolstered somewhat by bank funding needs generated

by strong demand. EOF business Joans- Added demand

SpenoinBMottgage Lending by thrift institutions did not ap-

for commeicial and industrial loins stemmed both

from merger-relaWd financing! and torn ihifts 10

pear to be unusually weak Ln the first few moiuhi of

short-term borrowing by businessei facing name long-

I9S9, given the prevaduig interest rates These inEUtutions coped WJtfl weak deposit fiows by running off

term interest rates tnd investor concerns tboui "Event
risk"-lhe possibility that a firm's deal obligations
uouCtf be iigru(tc*ri[/y downgraded 111 a OjrmfBlr:
buyout Or resiructurinji Acting lo damp M3 growth

cash and investments and, tfircugh [he first quarter.
•irpping up horrowinj from the Federal Hume Loan

Banks. Despite Signs of a rediKUOD in mortgage lend-

u*er the first quarter however was heavy reLance by

ing; activity by ihcH institutions m the second quarter.

thrift institutions Qn Federal Home Loan Bank ad-

ihe overall availability of housing- credit did nor appear
to be iipunctnlly impaired

vances and other borrowingi . whtch are not intluled in
the riKiney stuck M3 growth edged do*n a bit m the
second quarter *"th some easing of banl credit demands and strong growth in government dfcpositsalso not included Jii the money stock- resulting from

[he large volume of taapayrnenQ. B> June, fawevet.
M3 had rebounded as tax effects unwound

Spreads between rates on both fiud-raie mortgages
and mortgage-backed securities and rain on Treasury
1

in&uumenls of comparable murunt) did widen over ihe

first si* months of ihe year, with some market nacncifKStS rtportftjlr fearing ihrl ivjC-fcale li^uldaiions of
mortgage-backed securities by troubled thrift institu-

tions could adversely affect die market fbi ihose instruReflecting interest-rate and tM-relaled cflecTS, M t

ments. Howflve^ tbe widening also may have reflected

declined at an anrtuaJ rate of 1W percent from die

other developments: a getcral increase in uncertainty

fourth quarter ol i^SS. co June. BaJanccs in other

about rnovctnetns. in long-term interest tatet land

checkable deposits, which hid moved down j imle

therefore about proipeciive prepaymejih), and tbe

over ihe first qilBrlfr in resporoe 10 hLgher opportunity
ousur dropped SLibtburiiilly in Late Apn] andeuly May

flattening of [he yield curve, which discouraged issuance of derWaine mortgage instrument^ and Ihus

is OK la* fayotena cJeand. Donand deposus also

reduced demand lor tiv underlying mortgage-backed

declined on baLance over the tint half of fte yeai.

securities

because oppoTtunhy costs increased1 and because Ihe
balances biameuea are required rohold tocDtnpensiilc

Total borrowing by nonuiunciaL businesao in die

their banks [OE services fell After chang» in market

Qm half of Ihe year wucfoie to us J9BS pace Credit
demands ajnbnued 10 be buoyed by liuble merger-

ratei of interest, banks often adjim wiih 4 Ug Ihe

reLated. bnncing in the fits quarter, and in ipparent

"eanungi trcdn' rates nvd to deiennute ft* level of

pickup in capital eipenditum iDcreaBed buHinesii borrowing in the second quarter even u trcdii demands
related, to mergers and retrrucDinng), while still snone,
jawjJ * btf. Bffviff of JuvcHw /tar of event risk

required comprnwii]£ balances ; mus, dunnwud ad-

jusdnenK to compenHlmg baUncc* can rxnnnue for

fxnztiiiKi&tr'niiitfiitstsbtvtfttpfrdriUpi

The

barge personal tai pirmenls ulto ajTecied bousehold

Inggend by fee RJR-NabiKQ acquisition In late 1988

demand-deposit balances. Laic in the quarter, how-

as well as higher long-tena ntea ihraugji much of ihe

ever, both demand and other checkable dcpouis begin

period, corporate borrowing was concenEraled m shortmatcricy vehjclet. Commercial paper issuance surged

raiesover the second [fuarter.

during- the fira half nf ihe year; buiracvGi alao relied
on bank loans, altolt to • leueT eUent. In raponie to

A thorn event nil, mmy flnnt i^m
y tut, or they brought LUUH to ourixt wilh sHtJj
ptiuociviih so-called paiMDpuEi, MrmHiiifjdwiP'K
IP prowci »pinit negative e&ecti<Hi bondholder! &™
future restructuring!. Toward the ml of die ir£<n
quarter, wilfa ihe introduction of UKK protection! ™
UK decline inrtte*, bm^mra flMDong in ihecttp^
raw bond mirker wu oc ihr upowinj

Kd iunaiKf of tw-eifjnpt
Incil gDvemnmU (ell ibirply over total of UK first
halfoflHQ [nvcfloi demand fer nm-cwn^ >«uii«• reouined strong utf. «Hb diminUtal supply, Uw
nw of lu-CKanpt ID cmubk yield* fell b ib toweit
Ictcl HIHC L9£4- this nQu PJK s«ntf*hat iBs in lie
KCDIH] Quarwr, wbec ibt decline In kmi'Umi Lumen
jKtvnyuxJ • pickup of issuance of boodj to rue new

FEDERAL RESERVE press release

For imnedlate release

July 28. 1989

The Federal Reserve Board today adapted two amendments
to Regulation cc, which implements the Expedited Funds
Availability Act, regarding the treatment of bank payable through

e nee Its.
The amendments are designed to help ease the
operational difficulties and lessen the risks imposed on banks as

payable through checks must be treated as local or nonlocal based
on the location oC the hanK on wnlch they are written rather than
the payable through bank.
The two amendments require:
(1)

bank payable through checks to be conspicuously

digits of tha nine-digit routing number of the
bank on which the check is written and the
legend "payable through" followed by the name

FEDERAL RESERVE SYSTEM
1! CFB Part 229

BIB 7100-AB01

a bank issuing payable through checks to bcai
the risk of loss lor return of such checks from
,1 nonlocal payable through bank, to the extent

AGENCY:

Board of to*.

ACTION:

Final raj*.

SUMMARY;

of the Fedeml EH

The Board 1

the check had been returned expeditiously by the

Attachment

FOR FUHTREH INFORMATION CONTACT:

Loui«e L. ftosanmn, Asaiatant

EtephanlH Martin, Attorney (202/4S2-319S), Legal Divi«ioni for

Deaf, Eacneetlna Bill or forothea ThOBpaon (20I/<52-3!J4).

SUPPLEMENTARY INFORMATION I
The Board has adopted tvo arnendruent9 to Regulation CC,
which:
checks written on an account at one ban*-' but payable through
(1)

Require bank payable through checks to Inanother bank vere to b* considered local or nonlocal under
conspicuously labeled with the name, location, and
bated on the location of the bank designated as the payable
on which the chec* if urittan and the legend "payable
through" followed by the name and location of the
payable through bankr and

(2)

through checks being returned by o nonlocal payable
through bank on the bank on which such checks are

nonlocal payable through bank took longer than would
checks by depositary banks because it uould have permitted them

payable through bank encoded on a check, which indicates the
check processing region in which the payable through bank is
regulation,
enflmenta will become effective on February j., 1991, andl

ally on the basis of that number.

the payable through bank as the paying ban* and thus allowing

according to the location of the payable through bank, tha Credit

31290, Auguat IB, 19SB).

The intarim rule applied the court's

One hundred fifty-five comments were received on the

objected to the treatment of bank payable through checks as local

suggested variouE means of addressing these operational proble
end nskB.
en though they vould generally be OspoaiCad in 4 bar,* local to

On November ~L, 19S8, the Board adopted the interiir

the
generally treated as ncnlucul* a large number of credit unic
that offer payable through share drnlt accounts HDUia be

djjstry Return Item Advisory Group, which includes

August 18, 1938, the Board adopted Interia amenduentB to

sociatione, and ctedit unions.

The Board issued the proposals

comment to gain further Infornatiun concerning whether the
DISCUSBIOB
fied regulation and to improve the check system by speeding

would impose undue burden*, on the banks on which bank

The four proposals fur vhich the Board requested
Credit unions
Corporations
Require bank payable through checks to bear t routing
Members of Cungr

number in the MICR (Magnetic Ink Character Recognition]

Require bank payable through checks to be

r.uinber of the bunk on which the check in written and the
legend "payable through" followed by the name and JocatLon
of the payable through bank*

payable through check is written and
Place the risk of IOBB for return of bank payable thruugh
checks being returned by a nonlocal payable through bank
on the bank on which, such checkG art mitten, ta the
extent that the return from the nonlocal payable through
-'
check had been returned expeditiously by the ban* on which
it is written.

This number does not include
Reserve Banks and duplicate

a £rom Federal
from the same

to the extent that the return of a payable through check from the
nonlocal payable through bank took longer than would have been

bank payable through checks, including those checks collected
outside the Federal Reserve.

Require bank_payable through cheek* to be conspicuously

It would also require that such

Hid be establishes.

the hank, on which the check la written and the legend 'payable

SI opposed it.
The conunentcrs in support of the conspicuous labeling
requirement stated that Identification would aid In compliance
through bonk and tha bank on which the chsck is written must be
included on the checX.
Othei than the routing number of the ban* on vhich the

of payable through checks, although it bould not pernat their
identification on an automated basis.

of CloviB, 92 N.M. 37, 582 P.3d 609. 23 UCC Rep. SBrv. 124S

The Bank administration

-' (Continued)
Bank check pr

iny region as, and (3) a Re

availability than the address ass
number in magnetic ink on the ite

bank payable through checks.'

clearings, such as misrouted items.-

The Independent Bankers

Association of America indicated that coicimmity banKere would

oo
would prove helpful vhen processing damaged checks.

Wells Facgo

of America supported thic proposal, but noted, "Most community
destroyed .

. ." For example, the name and location of the

payable through ban* may be needed in those cases whare the

The majority of cocunenters that supported the
conspicuous labeling proposal Indicated that they pcefe

automated clearinghouse (ACID transfers to or ti

through cheths woulo not provide my

incremental significant

CUNA
9, CUNA

checks other than bank payaWe through ehecle.

of the bank on which the payable through check is uritte

identify the chec* processing region In which the tan* on

face of the ch«cK, balou Che BBount line and above the
paying bank.

expenses due to tile visual inspection requited which would be

thit proposal.

These commentyrs indicated that without the

because they vould have to manually process the payable through
roppbal states that it encouraged manual handling.

A nuiobei ot

items deposited, and manually make.- float adjustment3 for chare
draft or payable through Items."

labeling requirement could have an adverse impact on the
acceptance of payable through drafts.

The Chicago clearinghouse

Association, thicago, Illinois, commented, "IhiE requirement
vould make obvious visual distinction between a regular check and

is written and the legend 'payable through' followed by the
and location of th= payable through bank.

This rule become

through checks baing returned by a nonlocal payable through banK
on the bank on vhich such checks are written, to the extent that
ept for the first four dioite of the routing numbe

the return from the nonlocal payable through bank took longer
IhajL would have been required if the check had b^en returned

payable through checks

at of reissuance should be minimal-

This proposal would

that would require bank payable through checks to be
conspicuously labeled with the name, location, and first four
dlgiti of the routing number of the bank on which which the check

inappropriate to allow issuers of 'payable through' checks to

eturn on the fourUi day) our annual expoauce from the

proposal requiring a local routing nunber in the MICH line could

N)
to the bank on which the payable through check in written], .

the payable through bank—or the processing bank—haa the

appropriate cause of that risk, but are concerned about the

an, stated, "the

rule and are ur.fiet the S2,501j amount covered by the lorge-dclla

bank on which the Chech is written would only be responsible foiIOESCH that occurred between the time that the check would have

these proposals [the conapicuoUH libeling proponal or the
the payable through bank'

It the payable through bank complies

with the current notice of nonpayment requirement for returned
checks of $2,500 or more and the depositary bank takes action to
The Chase Manhattan Corporation, New Yoik. New York,

minimize its risk upon receipt of the notice, no loss should
occur that could be allocated to the bank on which the check is

payable through system."

less than 52,500 and thus

od by the notlet of

CUNA also Bug

banking day on which the check was presented to the paying ban*

ed it the check had bsen rtturned under the

day'u deposit.

determination of whether return of a check IB enpeditlnUB under
the forward collection teat is made based on the manner by which
tests to determine whether a check hat bean recuijned
expeditiously.

Undtr the two-day/four-day test, a check la

anytime there was A DISPUTE for a loss, we've never hed one in 20
years, tJic receiving inetitutiun could simply claim = delayed
processing schedule.

A tracking mechanism would be required."

ollection teat could not be used as a standard for expeditious
etuin by the payable through bank.
Bank cOPimefiteirB opposed to the proposal shifting the
iali of IOBE to the Lank on which the payable through cfiecfc is

of any evidtllce of actual losses which would justify the presumed

loss to ths bank on vhich the payable through check is written.

consented. Tirst Virginia does nut favor this proposal, us it
regulation.
The Board also requested comment oh the appropriate

A number uf

Southern Nevada State Savings i Credit Union, Las Vegas, Nevada,

after adoption.
Require bank payable through checlia to be presentable
opo^al

_and_be»_r_a local routing npjber in the_MICB_ line.

the
that requiring a local payable through bank is most consistent
unions to encode their ovn routing numbers on their checks or
that of a local payablt through bank.
The Boaid specifically requested comment on the cost

payable through checks BO that the benefits ana costs of this
proposal could bt more fully assessed.

Seven hundred ttoenty-tvo

eomoent letters addressed this proposal.

Two hundred eighty-two

will be served.'

niuaion tor the

practical or comprehensible way to describe to

through checks account for less than 31 of the processed check

processed.

(Bus

proposal] not only confirms the axiom, 'If it

to identify payable through checks and place the appropriate
holds on euch checfca.

These proceourea Include U) having the

goals of EFAA.'

naofwr in tke HICK line was the only proposal that placed the
coded in the JHCH line.

The Bank Administration Imticute

time and expense °f processing payable through checks on the Jj

propoasl were adopted.

AmSouth Bank. Birmingham. Alabame,

much human intervention as possible and allows payable through
-'
eptlon items.'

A survey by Board staff identified 65 routing nmnbers that
are vead on bank oayabl^ chroqgh checks.

(through requiring a local loutin? number in the MICE line] of
about £225,ODD pet year.

apply holds on a caee-by-casa or axcept.ion buDis.

The sax study

This i« the labor expanse we would

Incur if ve have to visually Inspect all items deposited, and

coocdination with the Federal Reserve, which indicated that 75

through. Lt*»«.*

the option to apply holds on a oase-by-caee or exception basis

citicEip, Mew Sort, (Jew York, stated, "As for

tc determine those checks on which nolda should be imposed.
Thus, the need for a method to apply automated holds appears to

ntial

It*.
Uhds to determine whsther or net an iteu in a payable through

proportion of all chacllB deposited.

checks, these banks Have indicated a high level of concern about
the

total mutbex oi items procesittd by all barJ;e in the course of

uit - abaant
nonlocal p*yable through banks Mould increase this risk by

to the local schedules under the regulation.
permitted in the regulation.

According to . study conducted by

In addition, bangs

could be liable for exceeding the maximum availability schedules

Payable throiujh baflKb have iodiciitcj that many
cclltCLinq b^nka receive dvaLlabi L jty Tor pjyaLle thcoucjh cnecks
local banltB.

drawn oil d ncnlocal paysblt through hari* equivalent to that fur

tli.

opo&al than they

Some b.±iik comments re notud that this propo&JLl vould

WhilB we have not

thus* ayntena.

They explained that the payable through share

trvice& only through the us

e-through nyfcttjm.

There tic ^th^i aoluticma that

veil for almoBt IS /*ara and has allov#tf thooeanda of crffdit

'. - . the diHtfantlentent u£ che

through system to Che degree suggested by the

that it

ilatai

would charge approximately 5 3 0 , 0 0 0 per yeat to Proc

ersay. noteiS

jppro*inwtely 510,300 assessed by Chase Manhattan Bank to perform

cks but

similar services.

Another credit union estimated that current

2) poor reporting capatilitian and longvr cioe luya Ic

their SDull ftile and voluiw-

TfL4 IBEK FetJ^rdZ Cre^Jt Union,

change in routing number requires the additional coat u± au*i

•BendDents uould be cunt prohibitive due to iJicraafltd proceBsing

process checka wit?i both tits eld and new routing numbers. The

costs* risk involved, are? a&dltlon*l e t f t f f

cogt ausociated vlt.h dUAl processing will vary baaed on the time

need..."

and ddta procft-aalng

en
K>
of payable through fcfink, Itfi adaption could prompt Local banks tc

iseal banks may not have the incentive to ketp coats down for Che
credit unlpn issuing payable through check a because nsny of those

uld have an
ce of bank.

held bf

the credit union.

The fcedfoeti Tsj^nehlP CDiraimnity Credit

Corporation stilted, "It this approach wtre impleiriented, thtf
Federal Reserve System with its extensive processing faclllti

The Bo
by the

Right no longet be availabJe to nany of our maoibtirG because of
thrnuqh ban*, thereby alloving the payable throuch bank tn

equiring fcuch a propoeed amendment to Regulation CC."

Credit nnions and payable through ptocessors noted

outing number." Use of the BOOO aerie* of routing numbers would

adopt the proposal to require that payable through checka be
payable through a hanfc not located In the

the local routing number proposal without disrupting the national
payable through syettci.

Federal lieetrve check prLicassiog rogione-

The fourth and fifth

nciilii be the ohe^k digit.
6000 secies number and determine' two things.

Adoption of the NACS proposal would also requlra

Bjnka can deterni
doption of the JJACE proposal would itqulca banks issuing pay-tie

to assign. Only banks tiding payable through pr

- 4« -

Moptlon of the NACfl pcopoHl »Dld only b*n»£lt the

- 45 -

le.igthsii the availability scneaulfls, which would ba the r e s u l t of

The pr

collecting bank* because they would have to upgrade equipment to

he nectaaary to determine whether such check ia local or
nonlocal.

Thus, this alternative would provide ai,iy aurgin;

benefit to Gepositary banks and should not bt pursued at tti)
time.

i—by which all IBBUBIB of payable through items wishing to

local fedciaZ Reserve at ev&ry routing number that includes items

enpi^ce maBt convert ta UBLUQ a local paying agent for the

directory of these numbers.

S< and to en*ur« that the Icoow bear the rff\iting numbet of

vast Qis^arity of the items fet i.BBue.B

be difficult.

This woulQ permit automation Cor tne
AB previously Indicated,

depositary Dank gvnds the checks to nonlocal payable thtough
tftrough check* beat a local tenting number in the KICB line.

The

banks.

suggestion vonId be that the Implementation date bff extended ft

OS
Ktent thot Che pcoposnl IB employed, it wpuld allow banks to

The majority uf the oommentei'B that supported the direct
Authorize direct ptesentment to the bank on vtiich
uaYable_throuqB cheenB_flre^Hritten.

Currently, the law IB

unclear as to wheth*t a bank payable through check edii be.

of both the proposal requiring a local lout-ing number in the MICH
Une and the direcC prusentvent propusal.

presented directly to the bank on which it is written 01 whethe
such checks muBt bu ^rtiaented to the payable ttiroungh bar.K,

this proposal were adopted.

The Chicago Clearinghous

of pa}ail* tfcrcugh items tu tne paying institution at an optional
raethcd of collecting such items

forward collection process.

In joaiji coeesj the

However, we recognize that eoiae

Useful in the Case of large-dollar checks.

handling.

The Bank

Dy preaentir.g thess ittiBB ditectly, a b&tilt Gan tften

Code (CICCJ might suggest that a 'drawee bank1 (payor bank] may

h.-.nk when the. check ia not presented to the drawee by that bonk.

used primarily by banks that hjve both the rfcsourCes to pertorp

State Bank, OHOUO, Michigan, comnentea, "Allowing bdnics to

that banks way present oirectly to the bank on which the check
written.'

Have 3 fuil time enployee'e fsicj. including myself, who handle
Sxpunses involved would be a nuw safe, which uoulfl run about
5 6 , 0 0 0 to S I C , 0 0 0 . 0 0 .

A naV Htaff ptison at 512,000.00 per yea

and a^y exp^naefi ll^ouired through purchase of natf electronic
equipa-tnt.

Hy rifct income YTD for 198B IB 5 2 0 , 5 9 9 . 0 4 .

I 401 BUI

in the fleet place."

1,500 to 2 , 0 0 0 tmll credit unions. Many snail credit union*
in A zninljnurn daily cost per credit union of approxinj^ttfly &H
Th* daily cost to Mietouri credit unions would be 61.400 ur.iie

institution.)'

requiring a local routing number in the MICK line.

program if this proposal were adopted.

on an automated baflil.

The

Tha Maryland National Bank ccifJnented,

•Although ve conceptually tupport [the direct; presentment
proposal].

. vt could not support thin option in terms of an

option would not permit the automated processing o( the credit

special nonaiitomflted check handling will only weaken the check

high speed check sorting equipment, -and

run.

Depending on the internal cost structures of

- S4 -

items could range from SO.005 to SO.01; cents per item pa us.

He
through checka,"

cleared through one major national payable through processor*

tha

amendments to the flct. Tile United BN Credit Union, St. Paul,
Minnesota, stated, "Save the taxpayers raonty by sending your

the law.

They could emend the law to sal checks dr-wr on local

banks are local checks and cheeks drawn on nonlocal bankt. are
nonlocal checks, PERIOD.'

The Board supports an amendment to tha

which a cheek is drawn or through which a check, is payable.

this amendment were tne.ct.ed, the psvable through bank would be

determining whether a payable through check is a local or

through cheek can be presented directly to the bank on which it

A number of coiranenters requested the board to require
that Lank payable through checks be deposited with a special

number which is local to the paying bank Is not adopted by tn.e

banks to require that bank payable through checks be deposited in

tflrcu^h banfe,'

Thib would require an

LB appropriate to adopt aniend&enta dt thi

to alleviate the

nd the objectives
aised by the publi

fnta in response to the initial
of payable through chndcKa by depositary banks.

the agency of ftucti i&BUtti ancf a statement of any changes mfcde In
the proposed rule &K u itauit ol such comments ^re concail.e^ in

This purpo

infltitutiuna that uafc payable thiDagh checks because tfie

.nalyslo IS U . E . C . 6 0 J U 1 U ) ) SB B fle script ion of each of the
Foe thtj re^aona set out vn tt^t pxeanfcXv. ]2 CFR Part
223 ia propoasd to bu anenflfd as follovs;
PART 2 2 9 — AVftlLABTLITr OF FUN1JS AND COLLECTION OF CiiLCKS

s eonHidered by cht agency, arid 4 Etatiifcerit (,i the redeona why
cH one uf such altecnatjvea WiB ceiscteij.

At dencrltoefl in the

2 U.S.C. 4001 «t sgy.
In S 229.36. t)ie Beading is levjsed and

payable by jt to be payable through another b..nfc

(iij tatutned the check as paying bank
location of the payable through bank.

uith s 239.30(41! (1) .
Responsibility under thia paragraph enall be tze&

that date bankt thai 1st payable throughfcrriiigeinentsimjac
or pardyttjpjj ic-) of this section.

prfz^yrafih Id] Ut p 4 nvw heading is added to pataqtaph fdl , and
nuw pirlMjriph [d] (J) is adJea to read as follows:

Section ZL9.36 is amended by revising the

Section 229.36

oheck ih.it is payable !>}• a tank and payable through a paying

fe)

Piestntaient an.d_ laaiiance ijC chegfcs

Jgsugnce of payable through checks.

by ahich the check is payable, the ban* by uhi<_-h eJie ebeck is
use checXs that contain conspicuously on Chcir face the namt,

depositary bar.k tniough the payabae through ban* ne quickly ot

o£ t(l* ban* by vhich the chsck 15 payable anfl the leqenfi 'payable

the check would have been required Co be returned unaer

thtoush" fallQWiJtf by the name and location of the payable through

S *:S.30(a) had the bank by which the ohstk la payable -|i)

received the check aB plying bank on the day Che

payable thtoagh bank received the check; and

the location of the bank by which ths checfc is payable miftt be

it is printed in a type

ot smaller tha

(21
paragraph provider that the bank by *hich a payable through check

section to tht extent that the check ia riot returned through the
payable through banK afi quickly ^B would have been neceesary to
meet the requirenents of S 2S9.30la}(l) (the J-iayM-dv/ test)
requirements of this pfccatjraph, the ban* by whi-Ch the check is
payablff may be liaLle to the depositary banfc. QE others &£

bank on the day the payable through bank receivtd it.

provided in S j/9.38.

loaatioTi of the tanX by which a ehech is payable for purposes of

For example, a hunk by which J payable

The

the 2-day/4-day teat may be detecainei froni Mie location or the

SuBpart B, that would not have uccuneii hnfl the check net the
requirement6 of this paragraph.

The ban); by which the chesk. i

check.

(See S 229. JMe) and accompanying Commentary. I

HeEfcnsi.bill.ty nndsr paragraph

|fl) 12) does not Include

of a check to the payable through bank.

nonpayment to the tftpaaitttry bank by 4?00 p.uu on the second
buHinesa day following the banking day on which che check it
presented to the paying bank.

Even if a payoble through check in

through Bank as quickly as wauLd Rave Seen required had the check
been received by the Bunk by which it in payable, the deposit-aiy

notice of nonpayment.

Thus, ordinarily the bank by «hich *

contribution to danugaa under paragraphs Id)(11 and let ill

Reserve System, July 29, 1939.

Senator SARBANES. Thank you very much, Mr. Chairman.
In view of the number of members that are here, I think we will
do a 7-minute round, and then we can come back and do a second
round if members still wish to proceed, and I would ask the staff to
time us on that.
Mr. Chairman, I gather that while you've left the ranges for
monetary growth at the same figures as before, as I understand it,
what you're indicating is that you hope however to have growth at
levels within the range higher than they have been heretofore; is
that correct?
Chairman GREENSPAN. You mean heretofore meaning so far this
year?
Senator SARBANES. Yes.
Chairman GREENSPAN. Yes. In fact, both M2 and M3 are now
within the ranges, and we expect them to stay there for the remainder of this year.
Senator SARBANES. You hope to have them not at the low end of
the range, I take it.
Chairman GREENSPAN. I would think not. My impression is that
they will move toward the center of the range. It's difficult to forecast, but they could conceivably go above the center of the range.
Senator SARBANES. There are some who take the view that our
economy does not function very well at low growth rates and that
in fact sustaining a positive rate of growth under 2 percent without
slipping into a recession is very difficult to do.
QUARTERS OF GROWTH UNDER 2 PERCENT

First of all, I would like to ask you how many quarters of growth
under 2 percent do you anticipate?
Chairman GREENSPAN. It's very difficult to forecast, Mr. Chairman, It should occur through a good part of the forecast period if
one takes as the standard the forecast of the FOMC. But I don't
think we can forecast to a level of even one percentage point with
great accuracy. My impression is that we will be slow for a period,
but that we will pick up at some point. I would hate to designate
when that point might be, because I don't think we can in all reasonableness.
Senator SARBANES. Looking back historically, has the U.S. economy ever experienced a prolonged period of very slow growth without slipping into a recession?
Chairman GREENSPAN. I don't think so. And I think the reason
for that is largely that in past periods when we start to slow up, we
slow up in the context in which the markets expect that the economy will continue to move ahead. That does induce a significant
backing up of inventories and usually leads to the classical inventory recession which has been so characteristic of our past history.
It seems at the moment that inventories are in much better
shape than they typically are both with respect to levels and with
respect to growth, and while there is very minor evidence that in
certain areas of the economy there has been some backing up, in
general that has not been the case. I think that the expectation of
continued slowness has had the effect of adjustments occurring

before an unanticipated build-up of inventories or imbalances
occurs.
But I would certainly say that a necessary condition to keep a
moderate growth path in place is that the markets generally
assume that will be the case because if they assume significant acceleration and it doesn't occur, then the economy would back up
and turn down. At the moment that does not appear to be the case.
ECONOMIC SUMMIT CONFERENCES

Senator SARBANES. Do you think the Central Bank Governors
ought to be present at the Economic Summit Conferences?
Chairman GREENSPAN. You mean the one that was in Paris?
Senator SARBANES. Yes.
Chairman GREENSPAN. We never have been. I was at the first
Summit, in fact the first two Summits, as Chairman of the Council
of Economic Advisers. It has essentially been a vehicle by which
the President, the Secretary of the Treasury, and the Secretary of
State have carried the position of the U.S. Government.
I can argue on both sides of that. I think that I see no need for
Governors, Central Bank Governors to be there. We do, of course,
meet with the Finance Ministers in the regular G-7 meetings and,
as best as I can judge, all that is required with respect to coordination occurs at that point.
Senator SARBANES. Well, the Summits actually are getting more
and more away from economic issues. This Summit in fact, the first
communique dealt largely with political issues, and the major communique was devoted a third or more to environmental issues. And
there is a real question about, and we may change the purpose of
the Summits, and then we shouldn't call them Economic Summits,
but I guess the question is if they are to be Economic Summits, and
given the importance of monetary policy, whether having the
World Central Bank Governors also present wouldn't contribute to
maintaining that focus.
Chairman GREENSPAN. It is possible, Mr. Chairman. All I can say
to you is that I don't feel strongly one way or the other about it
because I think that we get our input in, as is necessary, as a
group, through the regular G-7 meetings.
Senator SARBANES. The IMF projected in April that the U.S. current account deficit would expand from $135 billion last year to
$139 billion this year and $154 billion next. This projection was
made before the recent rise in the dollar. If the dollar remains at
its present level, what do you believe will happen to the U.S. trade
and current account balances this year and next?
Chairman GREENSPAN. It's fairly clear that the strength in the
dollar has slowed the adjustment process. I don't think it has terminated it. I still think that there is considerable momentum in
the export markets. We still have unfilled orders for exports rising,
which means that new orders are coming in at a rate above the
actual shipments. That in a sense, says that the increase in the
value of the dollar has not significantly inhibited our exports just
yet. It is true that they have slowed from their pace of advance in
1988, but they are still fairly significant.

My view is that the adjustment process has to continue and I
think will continue perhaps after some pause, as I have indicated
in earlier periods, but ultimately I think the deficit will start to decline again, and my best guess is sometime next year in a significant way.
I think we have to be careful to remember that there is more involved in these adjustment processes than strictly the issue of exchange rates. The real fundamental adjustments have got to occur
with respect to the basic saving and investment balances, and
clearly the growth rates of the United States relative to our trading partners is a very significant factor in these adjustments.
So in summary let me just say that I would expect perhaps not
much in the way of movement in our trade balance in the months
ahead, but probably starting to continue to improve again after the
very dramatic improvement in the first half of 1988.
Senator SARBANES. Let me just ask this final question. Given the
very large borrowing that is associated with these continuing large
trade deficits, what does it portend for U.S. financial strength in
the world economy and the role the United States can play in resolving international economic problems?
Chairman GKEENSPAN. Well, Mr. Chairman, I think it's fairly apparent, despite the very large increase in external claims on the
United States, almost all denominated in dollars, that that has not
deterred the desire on the part of portfolio holders around the
world to continue to increase their dollar holdings.
Senator SARBANES. Has your policy at the Fed been constrained
by the need to keep the U.S. attractive to foreign lenders?
Chairman GREENSPAN. No. I would say that while obviously we
watch what the exchange rate is doing and its effect in the international markets, it is only when we view it as having a major
impact on domestic economic activity or inflation that we believe
that American economic policy need address the exchange rate in a
significant manner.
Senator SARBANES. Senator Heinz.
Senator HEINZ. Thank you, Mr. Chairman.
Chairman Greenspan, first I would like to compliment you for
your testimony at the bottom of page 14 and the top of page 15 for
the most articulate expression of why this country and why you or
whoever sits in your chair must do a very good job of fighting inflation. I think you have done the best job I've ever seen or heard
anyone do expressing more articulately the pernicious effects that
inflation can exact, particularly in a democracy like ours, and I do
commend you for that.
Chairman GREENSPAN. Thank you.
Senator HEINZ. You also, of course, point out quite correctly that
you don't want to win the battle and lose the war, by which I mean
kill inflation and kill the economy at the same time. You describe
that as a delicate balancing act, and so it is.
You indicate that over the long term, and here I cite page 12,
that fundamentally what will be required for this country to continue to grow and grow in real terms is to enhance investment and
have a higher national savings rate, and you say that most interestingly, that improvement in our international payments position

is going to require productivity enhancing investment and a higher
national savings rate.
Now one of the things you say we should do is reduce the federal
budget deficit, which certainly we agree with, but what else should
we do besides that?
Chairman GREENSPAN. Senator, when we finally get beyond the
immediate problems of the savings and loan difficulties, and when
hopefully we get our budget deficit resolved sooner rather than
later, it's important that economic policy in this country focus on
what is the most efficient element in our system, namely, an adequate level of saving.
SAVING RATES DEFICIENT

We at the Federal Reserve and I think other agencies of Government—the Council of Economic Advisers and the Treasury Department—obviously are beginning to look at the process in a manner
which interfaces with potential policy. We are relooking at the tax
incentive effects and we are looking at the structure of our markets to try to understand why is it that our saving rates are currently so deficient when it has not necessarily been so in America's
past.
On the contrary, in fact, between the Civil War and the World
War I our saving rates were the highest in the world. So there is
nothing culturally built into our society which requires that.
Senator HEINZ. Unless you think this country has changed.
Chairman GREENSPAN. Unless it has changed, which I doubt. I
mean I don't think it has changed enough to suggest that we
cannot restore the levels of saving that has characterized this country in earlier periods.
So while I can't address your question in a confident manner at
the moment, I should hope that within a reasonably short period
those of us who are looking at this process will be coming to the
Congress to offer suggestions which might be helpful.
Senator HEINZ. Do you anticipate doing that this calendar year?

Chairman GREENSPAN. I frankly don't know. I will say to you we
are looking at the problem now, but my impression is it's probably
more for the 1990 legislative period.
Senator HEINZ. Well, let me encourage you, Chairman Greenspan, to do so. As you point out, we will be dealing with the next
budget cycle early on next year, and it sounds to me like you hope
to have something to us before we begin deliberations on the President's next budget and I hope that's true.
Chairman GREENSPAN. All I will say to you, Senator, is it is a
very difficult problem. It's one which has exasperated economists
for a number of years, but we will endeavor to do so.
Senator HEINZ. That sounds only fair after all the exasperations
that economists cause for everybody else, Mr. Chairman.
SOCIAL SECURITY TRUST FUNDS

But let me ask you about a specific issue. Right now the Social
Security Trust Funds are generating annual surpluses in the neighborhood of, for fiscal year 1990, for example, around $70 billion
excess revenues over expenditures. Being the Chairman, as you

were, of the National Commission on Social Security Solvency, you
well know that the purpose of having those annual surpluses was
to, in effect, to have a reserve that would be sufficient to help pay
the benefits for the baby boom generation when they retire without
having to increase payroll taxes to unaffordably high levels.
Unfortunately, Congress is now treating that income, that surplus income, as if it is deficit reduction. It is used to reduce the calculation of the budget deficit and in the Gramm-Rudman-Hollings
numbers.
Clearly, if we continue to do that, we will report a string of
budget deficit numbers that is lower than the string of increases in
the Federal debt because we will be writing, in addition to the
usual pieces of paper that says I, Uncle Sam, owe you, the public, a
lot of money, we will at the same time be writing the Social Security Trust Fund an increasingly large number of similar pieces of
paper, and the only difference is that it will be the Social Security
Trustees who hold the paper rather than the general public
It seems to me that there is an outstanding opportunity for the
United States to increase its saving rate if we would stop the practice of spending the annual Social Security surplus as if it was deficit reduction and in fact we actually saved it.
Now that would mean that by 1993 under Gramm-Rudman if we
do our job we get down to a zero deficit. If we did not spend that
money as we are now, we would actually be running in aggregate
terms a surplus, and it would be a modest surplus. It would be
under a hundred billion dollars a year.
My recollection is that the National Economic Commission disagreed on everything except one thing. The one thing they agreed
upon is that we shouldn't spend the Social Security Trust Fund reserves like we are now.
My question to you is this. First, do you agree with the National
Economic Commission and then their membership on that point
and, second, since some people say a surplus is deflationary and
can slow down the economy, is that true and, to the extent it is
true, how do we deal with that?
Chairman GREENSPAN. Well, Senator, let me answer the second
question first.
In today's environment it's credible to me that a surplus, and
hopefully a chronic surplus, in our unified budget account would be
deflationary. Obviously the British at this particular stage have a
very large surplus and there is no evidence that that in fact, in and
of itself, has been deflationary. It need not be and shouldn't be.
Senator HEINZ. Is the other side of the coin, that deficits need
not be inflationary and it depends how you finance them? If you
finance them by printing money, they are inflation, and if you hold
the line on credit, they are not?
Chairman GREENSPAN. It depends, in part, on a number of other
facets of what is going on in the economy. Very specifically, because our private saving rate is low, were we to add to the aggregate national saving rate, the saving coming from the Federal Government, that would not be a level of saving which would be so inordinately large as to cause, as economists like to say, fiscal drag
on the system.

Senator HEINZ. So we should look at the aggregate amount of
saving and not just what the Federal Government is doing?
Chairman GREENSPAN. Exactly.
Senator HEINZ. The same way as we should look at the aggregate
amount of debt.
Chairman GREENSPAN. Yes. It is the same issue from different
sides. The problem that exists with respect to the Social Security
surplus issue is not the desirability of saving it. In fact, saving it
all would be highly useful to the American monetary policy.
There is a technical problem which causes me concern and leads
me to the worry that Congress would not be able to hold to that
position. That is the growing and, by the year 2000, very large intragovernmental interest payment from the U.S. Treasury into the
Social Security Trust Fund. A very substantial part of the accumulated Social Security surplus, say by the year 2010 or 2015, turns
out to be that interest payment, an interest on interest.
As a consequence of that, if one looks at this tremendous increase in the annual Social Security surplus and with a very large
and growing part of that being interest payments from the Treasury, the other side of the same process is that there is a growing
acceleration of interest payments from the Treasury to the Social
Security Trust Funds, which when you consolidate them washes
out and doesn't appear in the numbers.
So what concerns me is that that acceleration of interest, the intragovernmental interest would make the non-Social Security deficit increasingly large and very difficult to handle, and I'm fearful
that were that to occur, we would then abandon the whole process.
So I would be inclined to try to find a means by which if we are
going to literally save parts or all of the Social Security surplus,
which I think is highly desirable, that we keep in mind that other
process and make certain
Senator HEINZ. The net interest problem.
Chairman GREENSPAN. Exactly, and make sure that we don't get
upended by this extraordinary accounting process that would be
going on.
Senator HEINZ. That strikes me, if the Chairman, and I see the
red light is on, will permit me, that strikes me as a question of
management accounting for the Congress to consider, not that
that's our strongest field, mind you, but I don't think that with the
brain power that we've got that that problem need sink the ship. It
seems to me to be a solvable, if not necessarily facile problem to
solve.
Chairman GREENSPAN. Yes, and one solution is to save the noninterest part of the growth in the Social Security Trust Funds,
Senator HEINZ. Yes.
Thank you very much, Mr. Chairman.
Senator GRAHAM of Florida [presiding]. Thank you, Senator.
Following the rule of first-come/first-question, it is now my opportunity to question.
I am going to ask questions in three areas. One is the savings
and loan issue, second is the Third World debt and, finally international interest parity.
Starting with the first question, in February of this year we had
a discussion on the administration's projections as to how much the

savings and loan industry could contribute to the bailout plan, specifically as to whether the projection of a 7-percent deposit growth,
which was assumed in the administration's projection, was realistic.
In your testimony today you state on page 6 that FSLIC insured
institutions began losing deposits at a significant rate. These deposit withdrawals were particularly strong in the first quarter of this
year.
Based on the history that has occurred since February, do you
have any further comments as to whether you believe a 7-percent
deposit growth rate is a reasonable expectation for the savings and
loan industry?
Chairman GREENSPAN. Mr. Chairman, it clearly is on the high
side, but I wouldn't necessarily say that the experience that we
have had in recent months in any way alters the probability of how
that growth will emerge. It's fairly clear that until we have gotten
through the problem of reconstituting a number of these associations and restoring the confidence that we believe consumers will
again have in thrift institutions, until that is done, it's not easy to
see what track of growth will occur in those institutions.
While 7 percent is probably on the high side, it is technically
achievable, and I wouldn't automatically rule it out.
It is certainly true that if you lower that assumption, you get
somewhat different assumptions about the sources and uses of
funds with respect to the so-called bailout, but I don't think they
are of an order of magnitude which concerns me greatly.
Senator GRAHAM. The consequence of lowering the expected rate
of growth of depository insured funds within the savings and loan
industry is to reduce the level of contribution which the industry
can make toward the bailout and therefore increase the portion of
the bailout which will be paid by the taxpayers; is that correct?
Chairman GREENSPAN. That is correct, Mr. Chairman.
Senator GRAHAM. Given what has in fact occurred to the industry over the last 3 to 4 quarters, which has been a decline in deposit base, what percentage increase would be required for the next 3
or 4 years in order to recapture what has been lost and accelerate
to the average of the 7 percent upon which the industry contribution is currently predicated?
Chairman GREENSPAN. If I may, Mr. Chairman, I would like to
put that in the record because I don't recall offhand exactly what
the percentage change is to bring us back to the long-term level
projected in the official document but I will submit that for the
record.
[Chairman Greenspan subsequently submitted the following in
response to a question from Senator Graham:]
In view of the decline in total deposits at FSLIC-insured institutions over the last
several quarters, deposit growth would have to accelerate to roughly a 9-percent
rate over the next 3 or 4 years in order to lift growth to a 7-percent average from its
September 1988 base.
FINANCING OF THE S&L, BAILOUT

Senator GRAHAM. One of the consequences of an understatement
of what the industry can contribute and therefore an increase in
what the taxpayers contribution will be would be the potential

that the level of taxpayer contribution which is contemplated in
the current Conference Committee report will be deficient and we
would have to have another round of taxpayer contributions towards the overall financing of the bailout.
In that context, I would like to go to the question of the most
appropriate means of financing the taxpayers' portion, and specifically whether it should be paid through some immediate or relatively short-term contribution, such as a proposal that was voted on
in the House of a short-term tax increase in order to immediately
finance the taxpayers' portion, or if we go to a longer-term provision, whether it should be financed through direct Federal borrowing or through the use of an independent agency.
You have recently written to the Congress recommending the
third approach, which is the use of an independent agency. Could
you assess, particularly in the context of the possibility that additional taxpayer financing will be required in part due to the slower
than anticipated growth of the S&L industry deposits what you
think the ramifications of those three approaches would be, and a
further explanation of your preference for approach No. 3.
Chairman GREENSPAN. Mr. Chairman, let me repeat what I believe I said in an earlier meeting of this committee. We don't know
exactly what the actual cost of the so-called bailout will be. We
know within a rough approximation, more than adequate to know
the form of the legislative structure that should be instituted, and I
must say that I believe that the general configuration that has
come up in the Senate and in the House does meet the requirements that I envisaged for financing and restructuring the industry.
Even if we knew exactly what the cost would be, it wouldn't help
us. We are going to have to relook at this issue in a couple of years
to fine tune it, either reducing or increasing the commitments that
would be involved. And it is not only the rate of growth in thrift
deposits which affects that estimate, but perhaps a far greater element will be whether or not the underlying losses that are currently estimated are larger or smaller than anticipated. So we really
will not know until a later time. So I merely suggest to you that
how that is met is something which we probably will not know
enough about for at least a year and maybe 2 years,
I originally and continue to support the so-called off-budget
means of financing, the one embraced by the full Senate. The
reason is wholly an issue of Gramm-Rudman-Hollings and fiscal responsibility and has, of course, nothing whatever to do with the
savings and loan issue per se.
My basic concern with the on-budget with exemption alternative
is not whether it is on-budget or off-budget, but it's the exemption
process itself which I am fearful could become too general and used
in a variety of other vehicles of financing which would ultimately
break down the Gramm-Rudman-Hollings process.
I obviously could not have that objection, and technically do not
on the question if one wanted to finance the whole savings and
loan thing with taxes. I don't think it's a practical thing to do, and
I'm not supportive of it, but it would not be an issue of a GrammRudman-Hollings exemption.

It is far more difficult to replicate the off-budget alternative, as I
see it, and, hence, far more supportive of budgetary discipline implicit in Gramm-Rudman-Hollings. In addition, of course, it does
lock in the thrift industry's contributions to the bailout process,
which would be somewhat more difficult with the so-called onbudget exemption procedure.
Senator GRAHAM. One final question. A concern which is implicit,
in your letter of July 12 and the comment that you've just made is
that the capital markets would respond adversely to what would be
appear to be a weakening of our resolve to achieve budget balance
and discipline.
What would be the principal specific indicators of that adverse
market reaction that you would point us to, particularly in the
period of the last week since the Conference Committee has decided to recommend to the full Congress an on-budget approach to financing the S&L bailout?
Chairman GREENSPAN. I think the issue is not so much the specific choice that would affect the markets, but it's the concern that
would emerge if it was perceived that fiscal responsibility was
breaking down in this country.
I think the progress that has been made in recent years in bringing down the budget deficit has been a marked factor, an important factor in the reduction in long-term nominal interest rates. I
would look for signals which somehow suggested that there was a
disaffection within the financial markets both domestically and
internationally.
Senator GRAHAM. And have there been any signals that you
would point us to?
Chairman GREENSPAN. Not to my knowledge at this stage. There
is still confidence that we are moving toward a fiscally responsible
reduction in our deficit.
Senator GRAHAM. Senator Mack.
Senator MACK. Thank you.
Again, welcome, Mr, Chairman.
In the last 5 or 6 years or so we have, the Congress and the country have pretty much focused on fiscal policy deficit reduction tax
policy spending as a percentage of GNP.
I believe we are at a point where we need to focus on monetary
policy, the direction towards zero inflation and low interest rates.
A sustainable long-term growth that will lead us into the 21st Century I think is important, and for that reason I commend you on
refocusing our attention on monetary policy and in difficult times
are willing to take the heat in order continue that policy of reducing inflation.
I know that in the past you have said that we can't focus solely
on the M's engaging monetary policy and that we ought to pay attention to what the markets are telling us as well, commodity
prices, currencies, bond prices and even gold.l We have seen recently, for example, the gold price over the past 1 /z years declining from
roughly 480 to below 375, and commodity prices have begun to be
reduced.
I just would be interested in what are you looking at beyond the
M's and what are these indicators, such as the ones that I've men-

tioned, commodity prices and currencies and bond prices telling
you about the state of the economy?
Chairman GREENSPAN. Well, so far as inflation is concerned, over
the long run I think the evidence unquestionably points to the fact
that inflation is fundamentally a monetary problem. If our goal is
to basically reduce inflation essentially to zero, which has the
effect of bringing real interest rates down to a minimum, then I
think we have to look at the various financial indicators of which
money supply is one and credit and other elements are other factors.
We have devised a rather simplistic money supply analysis procedure which is one of the things we look at as sort of a gross proxy
which says to us that one can achieve stable prices over the long
run if the rate of growth of M2 is the same as the rate of growth of
the potential in the economy.
Now that is a rough proxy for where we ultimately want to be,
and it's our belief that if we get there in a stable manner, we will
have inflation to a point where it is no longer acting as a corrosive
force on our society or creating a level of real interest rates that
are higher than we should wish to tolerate.
So far as the economy is concerned, other than inflation, it is our
view that if we can achieve a stable noninflationary environment,
that that is the major contribution that monetary policy can contribute to economic growth. That is not to say that there are many
other elements that are involved. The tax issues and fiscal issues
clearly are very crucially important as is regulation and a wide variety of a number of issues which we have discussed over the years.
But the essential long-term contribution that monetary policy
can make to a stable, growing America with increasing real incomes and increasing standards of living is to make sure that we
have a sound currency.
Senator MACK. In your response again you talked about quantifying I guess monetary growth as kind of the target that we're shooting for, but didn't respond to the other indicators I guess that I
raised. I mean does that provide you with information as to whether you're on target or not on target?
Chairman GREENSPAN. In the short run it clearly does. The
extent to which various elements in the economy are exhibiting excessive speculative pressures or compression does tell us what types
of demands are going to be put on the financial system and, hence,
what type of inflation pressures will ultimately emerge as a consequence.
MONEY GROWTH LINKED TO INFLATION

Senator MACK. In stating that monetary policy or money growth
clearly is linked to prices, is it fair to say that the growth in the
money supply, and I've forgotten the specific dates, but in 1987 and
1988 fueled the inflation that we experienced earlier this year or
that we're experiencing now?
Chairman GREENSPAN. Well, there are some who would argue
that the excess growth hi money supply in 1985 and 1986 have
done so. I think it's an arguable point, but clearly there is some
spillover from rates of growth which are too high into the price

level, if they start from a point in which the level of money supply
is excessive. It's not only the rate of growth that is relevant, but
the level from which that acceleration occurs, according to our
studies.
Senator MACK. Do I draw from your earlier response that the objective then of the Federal Reserve with respect to money growth
would be somewhere in the 2 to 3 percent range, and I'm talking
about long term?
Chairman GREENSPAN. I would say ultimately yes. The target
ranges that we view would ultimately be brought down into that
range if we are committed to achieve a stable price level.
Senator MACK. Just me just raise one additional question, and
again it goes back to your indicating the relationship between
money and prices is without question, and we have already talked
about again trying to quantify money growth is difficult, or the
money supply is difficult.
There was a lead article in the Wall Street Journal editor page
on June 29 by John Mueller. He argued that worldwide measure of
the supply of dollars, which he calls the world dollar base, is more
important in predicting U.S. growth and inflation than the domestic money supply numbers.
Did you happen to see that or are you familiar with that argument, and what is your response to it?
Chairman GREENSPAN. I am. I think it's an intriguing argument.
The problem that I have with it is it doesn't work as well as one
would think it did. Most of these money supply relationships work
over the longer run and have not been very useful as indicators
over the shorter run.
I mean, for example, a comparable notion is that the exchange
rates should be a function of the ratio of the money supplies of the
two different nations whose currencies are involved, and one would
argue that obviously the more money you create of say dollars
versus yen, the weaker the dollar should be. The trouble is the
numbers don't work out that way, and I would say similar things
with respect to that particular concept.
It is an interesting notion, and I think one should look at the socalled dollar base, which includes the dollar holdings of the Central
Banks around the world as well as numbers in our domestic
system, but I think you have to be terribly careful not to read too
much into them as an indicator of what the world is all about.Senator MACK. Thank you, Mr. Chairman.
Senator GRAHAM. Senator Shelby.
Senator SHELBY. Thank you.
ON BUDGET/OFF BUDGET FINANCING

Mr. Chairman, you've talked about it before, about on-budget and
off-budget financing, and I believe, as it has been alluded to here
today, that's going to be a fundamental question that we're going
to have to face first whether we're going to waive the Budget Act
in the Senate regarding the savings and loan financing, on budget/
off budget.
I have my colleague from Texas here, and I'm sure we'll talk
about it. He talks about it and does it well.

Let's talk about on budget/off budget and the growth of offbudget money in borrowing. It seems to me that whether it's on
budget or off budget basically, that the money is being borrowed
from a market out there, partly our sayings, but not enough as you
say, and rightly so, and partly the savings of the Japanese and the
Swiss and the Germans and others in international markets.
But no matter what happens, if it's on budget or off budget,
whether it's a savings and loan situation or anything else, that
money is out there and it's capital that has to be raised somewhere
in the market, am I correct on that?
Chairman GREENSPAN. Yes, Senator.
Senator SHELBY. OK. What is the downside, the real downside of
putting this on budget versus off budget, and I'm talking about the
savings and loan bailout, is it more political than economic, or is it
some of both?
Chairman GREENSPAN. Well, remember that the crucial issue of
on budget is an on-budget with a Gramm-Rudman-Hollings exemption. That's crucial.
Senator SHELBY. I understand that.
Chairman. GREENSPAN. It's the exemption which is the problem.
Senator SHELBY. But is that exemption political in nature or economic or some of both?
Chairman GREENSPAN. It's political.
Senator SHELBY. It's political and not economic?
Chairman GREENSPAN. Yes, that's correct. The sole concern that
I have with respect to this issue reflects the maintenance of the
Gramm-Rudman-Hollings process which, aside from all its faults,
has turned out to be the one mechanism that we have in this country to maintain fiscal discipline, and that is a political process. And
to the extent that we undercut that, we are undercutting the viability of the financial system and economic stability in the future.
Senator SHELBY. Is a central question there whether GrammRudman is a steel band or perhaps a rubber band?
Chairman GREENSPAN. I'm concerned that it may be no band.
Senator SHELBY. No band. If it's waived and continues to be
waived, it would be meaningless as a major thrust?
Chairman GREENSPAN. That is my major concern, Senator.
Senator SHELBY. But going back to the off budget, how much
money within certain figures, and I know you probably don't have
it before you, have we borrowed, our agencies have borrowed off
budget? How much money is owed off budget? I know there has
been phenomenal growth there.
Chairman GREENSPAN. My recollection is that the so-called federally sponsored credit agencies, which are essentially off-budget
items, are something under a trillion dollars.
Senator SHELBY. Under a trillion?
Chairman GREENSPAN. Yes, but not as much as I would like it to
be. I think that's correct, 900-and-some odd.
Senator SHELBY. Can you furnish that information for the record
and to this Senator.
Chairman GREENSPAN. Yes.
[Chairman Greenspan subsequently submitted the following in
response to a question from Senator Shelby:]

78
As of the end of the last fiscal year, the federally sponsored credit agencies had
about $330 billion of debt outstanding. In addition, two of the agencies had issued
$388 billion of mortgage pass-through securities on which they had guaranteed the
interest and principal. Adding the value of the pass-throughs to the direct debt of
the agencies—and then subtracting the $55 billion of assets held by the sponsored
agencies that were either insured directly by the Federal Government or were debt
obligations of the U.S. Treasury—yields $663 billion, which is OMB's measure of
sponsored-agency debt outstanding. In addition, the Federal Government had another $550 billion of guaranteed loans outstanding, resulting in a total of over $1.2
trillion of federally assisted debt.

Senator SHELBY, So you say it's under a trillion dollars, and then
our own budget is 2.8?
Chairman GREENSPAN. Well, actually, no. The on-budget is modestly over two net, meaning excluding the public debt that is
owned by the U.S. Government itself in its various trust funds.
Senator SHELBY. Let me get into another aspect of financing
while I'm here and we've talked about it, and you've talked about
it every time you've been before the committee, and I think rightly
so, dealing with our fundamental problem of lack of savings. In
other words, with the lack of savings in this country, we have to
look outwardly to finance our deficit, which is a problem.
When we did we first start financing a lot of our deficit from
international sources in recent times?
Chairman GREENSPAN. That last phrase did change my answer,
Senator, because obviously we've financed a goodly part of our 19th
century investment
Senator SHELBY. Sure, I know that. I'm speaking in recent times,
and let's say in the I980's. Until 1980 were we able to internally
finance our deficit by our own savings?
Chairman GREENSPAN. Yes. We did not reach a current account
deficit until recent years.
Senator SHELBY. And what is that current account deficit now
roughly?
Chairman GREENSPAN. Well, it's obviously well over $100 billion.
Senator SHELBY. And growing, it is not?
Chairman GREENSPAN. No, I don't think so.
Senator SHELBY. Do you think it's receding?
Chairman GREENSPAN. I think it will recede some.
Senator SHELBY. And do you attribute some of that receding to
the Gramm-Rudman discipline measure that the Senator from
Texas has authored and tried to keep in line, some discipline?
Chairman GREENSPAN. It's conceivable, but my concern rests
upon reducing the Federal budget deficit. My concern is essentially
the short-term Federal Government deficit and its effect on the financial markets and its effect on long-term inflation in this country and very specifically its relationship to the savings and investment balance. The major problem with our deficit is that it has
subtracted from our domestic saving and made it very difficult for
us to maintain productivity enhancing capital investment.
Senator SHELBY. Does that run up the cost of our capital investment, too?
Chairman GREENSPAN. In one sense you could say that the cost
of capital is higher, meaning not the prices of the capital goods, but
the real cost of capital is higher because that Federal Government
deficit is higher.

Senator SHELBY. Last, as the captain of the big rig out there, the
economy and being the guardian of the economy, how is the soft
landing coming along? It looks good now. Is it going to make it?
Chairman GREENSPAN. Well, I'm observing the phenomenon.
Clearly the information we have to date has been favorable. I think
we will make it, but I've been in the forecasting business for much
too long to
Senator SHELBY. You've been very good at it.
Chairman GREENSPAN. Well, perfection is something to which we
strive, but don't manage to achieve, and I think policy is on the
right track. I think that what we are doing is the correct thing,
and what we have done I think is the correct thing. I think we
have succeeded in diffusing inflationary pressures and I think we
have been correct in backing off as we have.
Senator SHELBY. By policy are you referring to the monetary
policy?
Chairman GREENSPAN. Yes, I'm talking about monetary policy
only. Whether that achieves the ideal configuration of economic activity that we are seeking, I think is not yet evident, and we really
will not be able to know the answer to that question until well into
next year.
Senator SHELBY. My time has expired. Thank you.
Senator SASSER [presiding]. Senator Gramm.
Senator GRAMM. Thank you.
Mr. Chairman, let me thank you for coming here, and I hope you
will forgive us if we are like the graduate students who come to get
the old professor to give them what the right answer is, I remember often telling my graduate students when they would get in an
argument that I wasn't sure what the answer was.
WAIVING THE BUDGET ACT

But I want to go back and try to touch on the key vote that we
are about to take here in the Senate, and that is waiving the
Budget Act to allow consideration of the Banking bill. Obviously
it's something, as my mother would say, we have all prayed over.
I would like to begin by talking about this on budget/off budget,
and I would like to outline very succinctly what I see the two plans
as being composed of, and then I would like to ask your assessment
as we have used the term under the First Bank of the United
States, under the Second Bank of the United States and under the
Independent Treasury since about 1840 which of these two plans
would by traditional definitions be on budget and off budget?
The President's plan is a plan whereby the industry borrows $50
billion. They are liable for that $50 billion and they take existing
assets and buy a zero coupon bond which matures in 30 years on
the exact day that the $50 billion note that they are liable for matures. So they incur a liability which is 100 percent collateralized
by a Government zero coupon bond.
The Treasury agrees over 30 years to pay interest on that note,
and every penny of that interest every day that it is outlayed is
counted as an outlay of the Treasury, is part of the deficit and is
counted under the Gramm-Rudman-Hollings Deficit Reduction
Law. That's the President's plan.

The alternative plan is a plan that says the Government, not the
industry, would borrow the $50 billion. Clearly that is an outlay of
the Treasury. So the deficit goes up by $50 billion. But having done
that, and all interest is paid and all interest is counted on budget
the same as the President's plan, but having incurred the liability
of $50 billion. Then it says that in essence is a good deficit and we
are not counting it in with that bad deficit, and we are not counting it as part. We'll have it, but we won't count it when we're
measuring whether we are meeting deficit reduction targets.
Now my argument would be that a fully collateralized private liability that is 100 percent collateralized with a zero coupon bond
would never in the history of the United States have been called a
liability of the Treasury or called off-budget financing. On the
other hand, I think saying we have a deficit, but we are not going
to count it, that if that is not the essence of off-budget financing, I
don't know what is.
So as I see it, not that these terms have any meaning other than
their sort of PR impact, but it seems to me that it's hard to call the
President's plan by the traditional definition off budget and it is
hard to call the alternative plan on budget.
Would you give us your views on that issue as a person who has
looked at this thing and looked at the economics of it for many
years.
Chairman GREKNSPAN. I think one of the problems that I have
with this whole concept is that I would use slightly different criteria for so-called on-budget/off-budget—criteria that have been employed for many years by the Department of Commerce in the calculation of Federal spending and Federal deficit in the context of
the national income accounts.
The economically significant difference really rests with whether
or not the trend's action is a financial one and affects the financial
asset and liability accounts of the Federal Government or whether
it affects the purchase of goods and services.
And in the current context, since the liability that the U.S. Government now has with respect to the savings and loan issue is already there, meaning the full faith and credit of the U.S. Government is behind those thrift deposits and those institutions which
have inadequate assets marked to market, in that sense we already
have a Federal obligation. It is a financial obligation affecting the
balance sheet.
What we are proposing to do to substitute for those deposit liabilities is a financial transaction which fills the hole on the asset side
with U.S. Government credit. That item, when it occurs, will not
appear as an outlay, as I understand it, in the national income accounts largely because it will be a financial transaction. It will be a
movement of financial assets and liabilities and, hence, not a socalled purchase transaction. That is where I think the distinction
critically lies with respect to the issue of on budget and off budget,
and in that respect it would clearly be an off-budget transaction.
Senator GRAMM. I'm not sure, which one are you talking about?
Chairman GREENSPAN. The financial transaction would appear
off-budget in either respect because it will reflect a financial transaction only, as I understand the way the accounts will be made.

Senator GRAMM. You don't believe that the borrowing of the industry full collateralized by the zero coupon bond is a liability in
any sense of the Treasury?
Chairman GREENSPAN. Well, certainly in a sense that what is involved there is the purchase of a zero coupon bond. It is a liability
in that sense. But I certainly agree with the position you're taking
with respect to keeping it off-budget.
Senator GRAMM. So you really see the issue as coming down to
the issue of the kind of precedent you set when you say this is a
necessary deficit and so we are going to do it, but we're not going
to count it toward deficit reduction. Your concern would be the
next week you could do that for nuclear waste
Chairman GREENSPAN. Yes.
Senator GRAMM [continuing]. And the next week you could do it
for the war on drugs and the next week you could do it for housing.
Chairman GREENSPAN. It's far more difficult to replicate the type
of off-budget financing which you are recommending than it is to
replicate an on-budget with an exemption. To that extent, and only
to that extent, is the issue very crucially one of fiscal discipline,
and my concern is that being on budget with an exemption has a
more negative impact on fiscal responsibility than any form of vehicle which would endeavor to replicate the administration's financing vehicle.
Senator GRAMM. Thank you.
Senator SASSER. Thank you, Senator Gramm.
I want to welcome you this morning before the committee, Mr.
Chairman. In my view, you're testifying this morning at a critical
time for our economy. The economic indicators, in my judgment,
are not good. Economic growth is down to 1.7 percent annual real
rate, and in June industrial production dipped by 2/10ths of one
percent, retail sales fell by 4/10ths of one percent and housing and
autos have been down from some time. So the trend is downward.
And when we look at the Fed's monetary policy, I'm pleased to
see that we see some recent easing, three-quarters of a point, and
that's welcome. But we have to look at the three point increase in
rates that began about a year ago and factor that into the overall
effect. There was a lot of tightening over the past year, and over
the past 2 years we have had the slowest money growth since the
1950's.
Even the distinguished journalist, Alan Murry, of the Wall
Street Journal, is saying that the so-called soft landing that we'll
get if we're lucky is going to feel like a recession to a lot of people,
and one of your colleagues over at the Fed, Martha Seger, is saying
that it's going to be very difficult to land the aircraft in a nice
gentle way. Instead Ms. Seger says we may take a wing off. I hope
she's wrong, and Ms, Seger has been wrong before.
But from a fiscal perspective the soft landing could increase the
budget deficit by an additional $25 billion, which would be of great
concern to me and I expect to you and most other observers. Obviously should the economy experience a hard crash landing, we'll
have a severely worsened deficit situation.
Now, Mr. Chairman, the Purchasing Manager Survey was released just a few moments ago and it points to continued slowing.
The Purchasing Indicator came in a 46, which was below expecta-

tions, as I understand it, and below the 50 percent threshold for
the third month in a row.
In view of that, and if we get July statistics that indicate job
growth is continuing to decline, can we anticipate some further
easing on the part of the Fed in the coming weeks and coming
months?
MARKET RATES DECLINING

Chairman GREENSPAN. Well, Mr. Chairman, let me just first say
that the relevant rates in the market which are affecting the economy are the market rates, and here, as I pointed out in my formal
testimony, short-term money market rates are down a percentage
point and a half since March. And, most importantly, long-term
rates are at their lowest level in 2 years.
So in the sense of interest rates impacting on the economy, longterm interest rates have not gone up and in fact have been edging
lower for quite a while, and this impacts on the mortgage market
and on capital investment and has a very profound effect on overall activity.
It is certainly the case that we did move up short-term rates by 3
percentage points, and that had an effect on variable rate mortgages and some effect on housing. But I think the extent of how
much impact we have had is not yet clear and will not be for a
while.
Money supply growth was very slow for a good period of time
after being excessively fast for a while, and in recent weeks has actually accelerated into double digit areas. So it has moved back up
quite appreciably,
I can't forecast what Federal Reserve policy will be. It will
depend to a very substantial extent on the evolution of economic
events in the months ahead.
Senator SASSER. Well, frankly, Mr. Chairman, I really didn't
expect you to answer that question. If you had, we would probably
have had a rush for the telephones here by the journalists and
others in this room.
In response to Senator Gramm's question you indicated that you
favor financing the FSLIC bailout off budget, and that's well
known. You have written a number of us and told us that. And as I
understand your rationale principally, you believe that exempting
the spending associated with the FSLIC problem from GrammRudman would establish a precedent for other spending programs
to be exempted. I think you may have reiterated that here this
morning, and this in turn puts pressure on interest rates, and it
would cost the Government much more with escalating interest
rates than the $150 million or so that the on-budget treatment supposedly saves per year. That's one rationale.
But as I understood the thrust of your statement this morning,
your primary concern with the on-budget concept is that we escape
the discipline of Gramm-Rudman if we put it on budget and then
exempt it. Is that a fair statement?
Chairman GREENSPAN. Yes. Mr. Chairman, my major concern is
the exemption issue. It is possible that the off-budget vehicle which
has been recommended by the Treasury could be replicated and

could create some fiscal problems, but it is very clear that it is far
more difficult to do that, It is more unlikely that we will get an
erosion of the Gramm-Rudman-Hollings process from replicating
the off-budget vehicle in financing the bailout than an on budget
with an exemption. It is strictly a political question in the sense
that it is politically difficult to replicate, as far as I can see, the onbudget recommendations of the administration and very easy to request on budget with exemption if that becomes an oft-used and a
desired vehicle. I think our fiscal discipline will erode, and I think
that will be very costly to the Nation.
Senator SASSER, Well, Dr. Greenspan, I very much appreciate
your candor in telling us that it is to some extent or to a large
extent, in your judgment, a political question as opposed to an economic question.
Let me just follow it up with this question. There is some conversation here in the Congress about raising the Gramm-Rudman-Hollings' targets for 1991 and 1992. What would be your reaction to
raising the Gramm-Rudman-Hollings for 1991 and 1992 and what
would be the effect of that, in your judgment?
Chairman GREENSPAN. I would be opposed, Mr. Chairman, on the
grounds that if you proceed to raise them, I think for all practical
purposes the markets will assume that the process is dead and that
fiscal responsibility has been significantly eroded in this country. I
think it's the type of action which I would be most inclined to
avoid if possible.
Senator SASSER. Let me impose on my colleagues, Mr. Chairman,
to ask one more question on this whole question of on-budget/offbudget for FSLIC because it is a very important decision and some
of us, and in fact we are all going to have to make that decision
again here in just a very few days.
Some of the proponents of on-budget financing have argued that
we can save a lot by going on budget because you wouldn't have to
lock into the 30-year bonds the way you do when you finance off
budget. They say if it's Treasury financed we could borrow short
now when the interest rates are relatively high, and then come
back in when the rates fall, as is generally anticipated they will do,
and borrow long in a year or so when the rates are low. And they
argue that if you go off-budget and lock yourself into these longterm bonds, you're not going to have that kind of flexibility.
Now my question to you is, is this a valid analysis, and would on
budget save much more because it is more flexible?
Chairman GREENSPAN. I would like to engage in that discussion,
Mr. Chairman, but you will observe that implicit in any answer I
give to that question would be a forecast of interest rates, and I'm
not about to get involved with that.
Senator SASSER. Well, I thought we were going to get you involved in that for just a moment, Mr. Chairman, but you saw
through the question. [Laughter.]
But in the academic discussion that rates were to fall, would this
analysis have any validity? You would be betting that the rates are
coming down.
Chairman GREENSPAN. I think there are really basically two
questions here. One is the maturity of the borrowing. In the offbudget plan there is a presumption of longer-term borrowing colla-

teralized by a zero coupon bond. In on-budget it would tend to be
the usual average configuration of bills, notes, and bonds, and it
would be submerged in the total system.
It is indeed relevant where one forecasts interest rates to know
which of the two, strictly from that point of view, is the cheapest
for the American people. Leaving aside the forecast of interest
rates, there is nonetheless an additional cost if we were, say,
matching a long-term off-budget financing vehicle and an onbudget long-term financing vehicle, which would be, say, $150 million a year differential, depending on how many basis points additional cost.
The present value of that difference—meaning the amount of
money you need up front to invest so that the interest received on
that investment, plus the amortization—would pay the difference
between the two types of bonds. That number is something between $1 billion and $!Va billion, and it strikes me as a very small
insurance policy for the improved fiscal discipline that is embodied
in the off-budget vehicle relative to the on-budget vehicle.
Senator SASSER. Thank you, Mr. Chairman.
Senator D'Amato,
Senator D'AMATO. Mr. Chairman, I want to first commend you
for that last question and the Chairman for his explanation and
putting some very real perspective without just politicizing one
way or the other, and I'm not suggesting that you've engaged in
that. But so often I think the proponents of whether it be on
budget or off budget get into rather simplistic answers and that
you did us a great service, Mr. Chairman, in your asking the question and the Chairman's response.
I'm not going to ask you about soft landings or crash landings.
Rather you have been a constant force, Mr. Chairman, for encouraging increased savings. I believe it's one of the great problems
that we have—capital formation or the lack of it.
Merrill Lynch just did a study recently which indicated that as a
result of doing away with the IRA they estimate that we lost something in the area of $135 billion in additional savings. Some folks
in Treasury would dispute that I know, but that's their study.
LEGISLATION TO BRING BACK THE IRA

Senator Dodd and I have been exploring a plan to introduce legislation to bring back a form of the IRA with a modification that
we would allow the $2,000 contribution, but instead of permitting a
total deduction at whatever your rate is, permitting a 15-percent
credit, in essence limiting it to a $300 credit for $2,000 that is
saved.
Do you have any suggestions or any modification which could be
made to improve the savings incentives, whether it be by IRA or
any other area?
Chairman GREENSPAN. Well, Senator, as I indicated earlier, we
at the Federal Reserve and the analysts at the Treasury Department and at the Council of Economic Advisers are looking into the
question of how can we improve the basic saving of this society because I think we would fully subscribe to your view that it is the

crucial issue which is involved in the longer-term economic outlook
for the country.
I haven't yet seen a satisfactory set of proposals because we
haven't had a chance to really examine them, but I have indicated
that when we get there and when we have something we feel is
useful and helpful to the Senate and to the House of Representatives we will, of course, be bringing them forth.
One of the crucial issues with the IRA's is the determination of
how much private saving is actually generated net. In other words,
as we all know, for the IRA to basically create saving it has got to
be a replacement of consumption for saving, and in a sense you've
got to be able to say that we bought $200 less goods at some point
and took those moneys and put it into the IRA account, because
merely shifting from one account to another in the financial markets doesn't have any effect.
We haven't yet come to a conclusion of exactly how much of the
IRA is real saving and how much of it is merely a shift.
Senator D'AMATO. Can I ask you, Mr. Chairman, to have your
people take a look at that Merrill Lynch study and give us an analysis?
Chairman GREENSPAN. Certainly, we will. I'm not familiar with
it, but we'll look at it.
Senator D'AMATO. We'll send you a copy of that. It's very interesting.
Let me ask you one other thing and shift a little bit to GrammRudman. One of our colleagues asked whether or not adjusting the
targets, what you would think about that in 1991-92. I share your
concern. I think that would be a disaster. It would send the wrong
signal to the marketplace, to the international marketplace that
we are no longer wed to a program of reducing the annual deficit.
Let me ask you to rate Gramm-Rudman and its effectiveness.
What would be the situation, in your opinion, were we not to have
had Gramm-Rudman in place these past years?
Chairman GREENSPAN. It is very difficult, Senator, to make that
judgment, and clearly it is not the ideal vehicle for fiscal restraint,
but it works, and with all of its bells and whistles it seems to be
the only thing we can construct which will work.
I don't know how much difference it has made with respect to
where the deficits would be, but I think it's substantial. I couldn't
put a number on it, but I must say to you I feel much more comfortable with that vehicle in place and functioning if our purpose is
to get the budget deficit down significantly than were it eviscerated
in any way.
Senator D'AMATO. Would I be incorrect in saying it's your obvious impression that there are those in the financial community
who view this as, let's say, that last wall of resistance to unrestrained spending?
Chairman GREENSPAN. I would say that there are clearly a
number of analysts within the financial community which if they
saw the Gramm-Rudman-Hollings process swept aside would be
very concerned about the fiscal viability of our budgetary process.
Senator D'AMATO. I thank you once again for giving us the opportunity of listening to you and asking you some questions as it

relates to the economy and some of those things that are rather esoteric with so many, and I thank the Chairman.
Senator SASSER. Thank you, Senator D'Amato.
MEXICO'S DEBT

Mr. Chairman, let me turn your attention south of the border
just a moment. We've come up with a new plan on Mexico's debt,
and the recently announced accord on Mexico's foreign debt I think
does offer some hope that Mexico's debt load can be reduced without too negatively impacting on American bank creditors.
But I must say to you that I'm concerned that debt reduction is
only one of three options that the banks are being offered. The
other two options are reductions of interest that is paid on the indebtedness and new lending.
Now a lot of observers think that the option that the banks are
going to choose, or most banks are going to choose is going to be
new lending because if they reduce debt they are going to have to
take a hit on their capital and write that off. If they reduce rates,
they will have to take a hit in their income statement, and that
will depress the price of their stock, and the easiest and the course
of least resistance would be to just simple make new loans to
Mexico, which is essentially the old Baker plan.
But in the final analysis, this is not going to get, in my view,
Mexico's debt reduced, and that really is the goal that we have to
be pushing for, and that is to reduce this overhanging Mexican
debt for political reasons in Mexico and for our own external political needs, and also to face reality here in our own country with
regard to how much of this debt is actually collectable and how
much the Mexicans can actually afford to pay off.
How do we get serious about this Mexican debt reduction, in
your view, and how do you think the plan that is being offered now
is going to work, and how serious is this whole Mexican debt problem?
Chairman GREENSPAN. Well, Mr. Chairman, actually I think the
agreement that was reached is a very important one and one which
I think will be most helpful to Mexico's economy.
I don't agree that the major part of the commitments will be socalled new money. From what we can observe looking at it from
bank to bank, perhaps a little more than 20 percent will be new
money and the rest will be either debt reduction or debt service reduction which has the same effect in lowering the external commitments of the Mexican Government.
As best I can judge, the agreement is going to be most useful to
Mexican finances and I think helpful to the banks in the sense that
they are restructuring their holdings in way which I think will be
beneficial.
So actually I look at the agreement in a rather positive manner,
and I think it was a very difficult agreement to reach, but it balanced the interests of Mexico and their creditor banks in a way
which I think one wouldn't expect to come off that way.
The way I would look at it is as a major element to support
Mexican growth, and the most successful way to bring debt down
as a burden on one's economy is really economic growth. And I

think that this will enhance the capability of the Mexican Government in so doing, and my view is that if things continue as they
appear to be moving that within a reasonable period of time the
Mexican Government and certainly the private sector will be financing in the so-called voluntary markets, and in fact there is already some indication that private institutions will be able to finance at some reasonable interest rates.
So I'm somewhat pleased by this process and think that considerable success was achieved by striking that agreement.
Senator SASSER. Mr. Chairman, Senator D'Amato referred a
moment ago to the problem we have with the low savings rate here
in the United States and this is something that has plagued us for
a long time. The low savings rate, as you know, has gotten even
worse in the decade of the 1990's.
There are a lot of reasons, in my view, why we Americans save
less than our counterparts in other countries. One reason I sometimes think is the highly developed marketing techniques that we
have here in the United States and the explosion in the use of
credit cards.
Another I think is the decline of real income in families. We see
now that many times it takes two wage earners to sustain the
standard of living that one wage earner did in the past, and in
order to maintain their standard of living that they are accustomed
to that they will go deeper and deeper into debt.
But there are some tiny, little scintillas of hope on the horizon
with regard to savings. Some commentators seem to think that
there has been some indication in the last few months that the savings rate might be improving. Have you detected this and, in your
view, what could be occasioning it if you agree with the assessment? Are consumers retrenching for fear of a recession or have
they satisfied their needs for consumption, or is it just simply the
fact that real incomes are going up and now they have more to
save?
Chairman GREENSPAN. We don't know the answer to that yet,
Mr. Chairman, but clearly the rise in the saving rate has been long
overdue and it has been obviously one of the elements involved in
the slowed retail sales markets, but it's difficult to know which is
cause and which is effect.
I think that if we can sustain these saving rates, which are
higher than we would have forecast earlier in the year, I think it
would be beneficial, and I think it clearly is something which will
assist us in the long term if it can be maintained.
Part of the softness in retail sales has occurred because the
saving rate has been rising. If it merely stabilizes at this point and
real incomes continue to rise, then consumption clearly will accelerate some. So it doesn't necessarily follow that if retail sales pick
up that the saving rate must go down. In fact, we can basically
maintain a relatively higher savings than we have had and still
have room for some pick up in expenditures.
Senator SASSER. If real income would continue to go up, you
could still have retail sales going up while at the same time the
savings rate could go up if they have more real disposable income.
Chairman GREENSPAN. Yes, that's correct, Mr. Chairman.

Senator SASSEK. Senator Graham, do you have any further questions?
Senator GRAHAM. Thank you, Senator.
I have two areas of inquiry. One is to follow up on the question
that you asked relative to the Mexico debt agreement.
Mr, Chairman, when we discussed the issue of Third World debt
earlier this year, the question was asked what would be the criteria
by which you would evaluate our management of the Third World
issue, and you suggested three items in summary.
One, that the economic policies of the debtor nation should bring
them into a position to be able to move into markets on a long
term or intermediate term borrowing at rates which they could
readily service.
Two, a restoration or normal borrowing/lending relationships between the debtor nations and the international commercial banking system.
And, three, that debtor nations which had done better than
others, but which had been contaminated by the process, and you
gave the example of Columbia, would find that their productive efforts were fully appreciated in the marketplace.
Applying these three criteria to the Mexican situation, how well
would you say that the initial formulation of the plan will be, and
what data or other objective indicators will you be looking for to
see if the plan in operation fulfills these three criteria?
Chairman GREENSPAN. Well, Senator, I think that the Mexicans
have moved toward a sensible and potentially productive economic
policy, and that in fact is one of the major reasons why the international financial institutions, the banks, the Fund and the World
Bank have been endeavoring to be as supportive as possible.
I see no reason to expect that those policies, sensible policies, will
not continue in the context of this agreement, especially with, the
ability to reduce external financial requirements. If that occurs, as
we have every reason to believe it will under this agreement, then
I think that sound economic policies will then lead to meeting the
second criterion, namely, the capability of moving into the financial markets in a voluntary way and borrow at rates which are
serviceable.
Indeed, we already see some evidence that that may be in the
process of occurring. Interest rates in Mexico in peso terms have
fallen quite significantly since the agreement, and there has been
for the first time in a very long time a private financing at an interest which was not intolerable as it would have been in dollars a
while back. I think that process will continue.
It's too early to make a judgment on the so-called contamination
effect, but I hope at some point that we will see that also working
in an effective manner, but it is much too early to make that sort
of judgment at this date.
Senator GRAHAM. Do you see any further activities by your
agency or would you recommend such by other agencies, including
to the Congress in the form of tax modifications or otherwise, that
would be appropriate to reinforce the Brady plan?
Chairman GREENSPAN. I think that has already been done in the
sense that we have structured our policies in a manner which we
believe are supportive of the Brady plan.

INTEREST RATES AND PARITY BETWEEN ECONOMIC PARTNERS

Senator GRAHAM. Mr. Chairman, I have one final area of inquiry, and that is the question of interest rates and parity between
the United States and our major economic partners, specifically
Japan.
Over the last 5 years the differential in interest rates between
the United States and Japan has been in a range of 3 to 6 percent.
Today we are at the lower end of that interest rate differential.
What has sustained the interest rate difference between the
United States and Japan, and what, if any, United States policy
initiatives could we take in order to achieve a closer and sustained
basis of parity in interest rates?
Chairman GREENSPAN. The major reason why the Japanese interest rates have been lower than ours is that their saving propensities are so much higher than ours.
Over the last decade or so the cost of capital in Japan in real
terms has been markedly lower than it has been here where inflation instabilities and concerns about the economy generally have
induced a risk premium in the cost of capital in the United States
which put us substantially above the Japanese, and that reflects
itself in nominal interest rates, mainly on the long end of the
market.
And until there is a substantial alteration in that process, it is
very difficult to conceive of a joining of the two rates. Not only do
the real rates have to converge, but clearly the inflation rates have
to as well because while the real rate differential exists and is a
major factor in the spread, the fact that the inflation rate in Japan
in recent years has been markedly below ours reflects itself in a
higher inflation premium in our long-term rates relative to yen-denominated rates.
So there are really two factors which are required to bring us
into equality. One is the real rates and the other is the inflation
rates, and both require that our saving rates converge or at least
come much closer together.
So I would think that the issue of inducing saving is perhaps
over the long run the major element which would bring the nominal interest rates into long-term parity.

Senator GRAHAM. Mr. Chairman, I believe I understood in response to a question by Senator Heinz that on behalf of the Board
and the administration that there is a study underway on the issue
of what policy initiatives might be taken to encourage increased
savings rates in this country.
Chairman GREENSPAN. Yes. There is no formal procedure that
has yet been initiated, but we are all independently looking at the
process in full recognition that that will become a major item on
the agenda for economic policy for this country in the years ahead.
Senator GRAHAM. Well, I applaud and encourage your efforts in
that regard and will look forward to your recommendations.
Chairman GREENSPAN. Thank you.
Senator GRAHAM. Thank you, Mr. Chairman.
Senator SASSER. Thank you, Senator Graham.
Mr. Chairman, one final question, and then we'll conclude these
hearings and let you get on with your lunch somewhere.

It has been interesting to note how phrases develop over time in
economics, and we've got a new phrase now called soft landing. The
question I've got is what is a so-called soft landing?
We noted the other day that the president of the Cleveland Federal Reserve Bank was quoted as saying that the goal of the Fed is
not a soft landing. He says that the objective of the Federal Reserve Board is price stability, and of course we have seen in other
times that when we get into price stability we may have a deflation
in some areas of the economy.
Tell this committee this morning what you would characterize as
a soft landing.
Chairman GREENSPAN. Well, first, Mr. Chairman, let me reiterate what the basic objective of monetary policy is.
As I stipulated in my formal remarks and earlier to this committee, we view economic policy generally and monetary policy very
specifically to be focused on maintaining long-term sustainable economic growth. A necessary condition to achieve that is a non-inflationary environment.
So over the long term we view the zero inflation notion or the
noninflationary environment as a necessary condition to make sure
the economy grows at its maximum possible rate.
A soft landing is a term which has emerged which essentially
tries to define an economic condition in which unstable inflationary pressures are contained without simultaneously throwing the
economy into a recession.
Historically when we have speculative imbalances and inflationary pressures, any endeavor to contain them has led to a dramatic
backing up of inventories, a slowing of the economy and a recession. That is now termed a hard landing.
A soft landing is one in which the inflationary instability containment is made without the economy going into a severe contraction.
Senator SASSER. I suppose we could characterize the downturn of
1982 as a crash landing if we were assigning degrees of severity.
That was the worse recession.
Chairman GREENSPAN. It was not a soft landing.
Senator SASSEK. Not a soft landing. [Laughter.]
Well, on that note, Mr. Chairman, I want to express my appreciation to you this morning for appearing before the committee. It
has been a pleasure to see you again and a pleasure to have you
here.
Chairman GREENSPAN. Thank you very much, Mr. Chairman,
Senator SASSER. This committee is adjourned.
[Whereupon, at 12:07 p.m., the committee adjourned, subject to
the call of the Chair.]

Full text of Monetary Policy Oversight : Senate Hearings : Federal Reserve's Second Monetary Policy Report for 1989 : Hearing Before the Committee on Banking, Housing, and Urban Affairs, United States Senate, One Hundred First Congress, First Session

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