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FEDERAL RESERVE'S SECOND MONETARYPOLICY
REPORT FOR 1993
HEARING
BEFORE THE
COMMITTEE ON
BANKING, HOUSING, AND URBAN AFFAIRS
UNITED STATES SENATE
ONE HUNDRED THIRD CONGRESS
FIRST SESSION
ON
OVERSIGHT ON THE MONETARY POLICY REPORT TO CONGRESS PURSUANT TO THE FULL EMPLOYMENT AND BALANCED GROWTH ACT OF
1978
JULY 22, 1993
Printed for the use of the Committee on Banking, Housing, and Urban Affairs
U.S. GOVERNMENT PRINTING OFFICE
WASHINGTON : 1993
COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAmS
DONALD W. RIEGLE, Jfl., Michigan, Chairman
PAUL S. SARBANES, Maryland
ALFONSE M. D'AMATO, New York
CHRISTOPHER J. DODD, Connecticut
PHIL GRAMM, Texas
JIM SASSER, Tennessee
CHRISTOPHER S. BOND, Missouri
RICHARD C. SHELBY, Alabama
CONNIE MACK, Florida
JOHN F. KERRY, Massachusetts
LAUCH FAIRCLOTH, North Carolina
RICHARD H. BRYAN, Nevada
ROBERT F. BENNETT, Utah
BARBARA BOXER, California
WILLIAM V. ROTH, JR., Delaware
BEN N1GHTHORSE CAMPBELL, Colorado
PETE V. DOMENICI, NDW Mexico
CAROL MOSELEY-BRAUN, Illinois
PATTY MURRAY, Washington
STEVEN B. HAKIMS, Staff Director and Chief Counsel
HOWARD A. MENELL, Republican Staff Director
PATRICK J. LAWLER, Chief Economist
CYNTHIA E. LASKER, Professional Staff Member
IjAURA SIMONE UHGEB, Republican Counsel
PAMELA RAY-STRUNK, Professional Staff Member
WAYNE A. ABERNATHY, Republican Economist
EDWARD M. MAI.AN, Editor
CONTENTS
THURSDAY, JULY 22, 1993
Page
Opening statement of Chairman Ricgle
Prepared statement
Opening statements, comments, or prepared statements of:
Senator D'Amato
Senator Sarbanes
Senator Roth
Senator Faircloth
Senator Sasser
Senator Bennett
Senator Mack
Senator Kerry
Senator Gramm
Senator Bond
1
61
4
6
9
10
10
12
12
14
16
36
WITNESS
Alan Greenspan, Chairman, Federal Reserve, Board of Governors, Washington, DC
Prepared statement
Monetary Policy Report to the Congress
Response to written questions of:
Senator Riegle
Senator Bennett
(HI)
18
61
68
95
Ill
FEDERAL RESERVE'S SECOND MONETARY
POLICY REPORT FOR 1993
THURSDAY, JULY 22, 1993
U.S. SENATE,
COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS,
Washington, DC.
The committee met at 10:05 a.m., in room SD-538 of the Dirksen
Senate Office Building, Senator Donald W. Riegle, Jr. (chairman of
the committee) presiding.
OPENING STATEMENT OF CHAIRMAN DONALD W. RIEGLE, JR.
The CHAIRMAN. The committee will come to order.
Before we start our hearing this morning with Fed Chairman
Greenspan, I want to announce for the record that the committee
will be voting to favorably report the following nominations: Arthur
Levitt, to be Chairman of the Securities and Exchange Commission; Alan Blinder and Joseph Stiglitz, to be members of the President's Council of Economic Advisers; Richard Carnell, to be the Assistant Secretary of the Treasury for Financial Institutions; Susan
Gaffney, to be Inspector General of the Department of Housing and
Urban Development; and G. Edward DeSeve, to be the Chief Financial Officer of the Department of Housing and Urban Development.
So if there is no objection, the period of voting will begin now and
it will extend until this hearing concludes. If a quorum of Members
arrives to cast their votes in that time, the nominations will be reported to the full Senate today. Without objection, then, we will
proceed in that fashion.
Let me now welcome our Fed Chairman, AJan Greenspan, back
to the committee today. We appreciate his appearance.
There is no issue that's probably more important that comes before this committee in terms of dealing with the economy than the
oversight of the Federal Reserve Board and monetary policy.
The President has properly and necessarily made economic policy
and economic growth his top priority. All of the public opinion polls
that one can see show that that is how the American people view
it as well.
At the present time, we are working to get the deficit reduction
package in place. I am serving as one of the conferees from the Finance Committee in that effort. In fact, we'll be working on it just
a little bit later this morning and I may ask Chairman Sarbanes
to sit in for me when I'm called in to that Senate-House Conference
Committee.
(1)
I think it's fair to say that it's not possible to accomplish the
minimum level of job growth of 8 million new private-sector jobs
over the next 4 years if we don't have both our fiscal and monetary
policy well synchronized.
In fact, if we have a fiscal policy that is contractionary then we
must have a compensating adjustment in monetary policy or we
will not see the economic growth and job creation that the country
needs.
I just want to say at this point, Mr. Chairman, we've got a very
serious job problem in the country. You've been reading and follow
the news carefully. Just this week, major companies announced
that they are shearing off many employees. Procter & Gamble is
a recent example, but there are many more.
I'm running into a situation in my home State of Michigan, The
University of Michigan is certainly one of America's, and probably
the world's, flagship universities. We've got students coming out
with straight 4.0 averages, a lot of extracurricular activities, very
fine records, worked their way through school in many cases with
the help and sacrifice of their families, circulating their resumes
and not findings any jobs and, in many cases, going back to move
in with their parents after working their way to a very fine record
in college. That's one manifestation of the problem.
Another manifestation of the problem is that there are a lot of
people that are either losing ground or losing jobs—people that
earn anywhere from, say, $40,000 to $150,000 a year.
Fortune magazine, Business Week, a lot of the major business
periodicals have been running cover stories on this situation as
people are being washed out of the job market—a lot of it in California due to defense cutbacks and bank consolidations and so
forth. But the pattern, while it differs a bit from one area of the
country, to the next is a very large pool of unemployed people, including the new people coming into the work force and finding it
very difficult to find work.
This is unusual at this stage of a presumed recover . We *e
talked before—I won't get the charts out here now—but we've had
a situation where in past recoveries, we've had job growth that has
not only regained jobs lost during the recession, but would have us
way up in positive ground in terms of net job additions to the economy. We have not seen that this time.
You have commented on that before. You've said, in effect, and
I'm just sort of paraphrasing what I've heard you say to us and
others, that we have new economic conditions on our hands.
They're global in scope. It's hard to understand exactly what's
going on in terms of why we're not getting the kind of robust job
recovery at least this late after the onset of a recession, such as we
have seen in other business cycles.
In any event, there is great anxiety about it out in the country.
The polls that I've seen indicate that fully 80 percent-plus of the
American people think we're on the wrong economic track going
into the future, and they're very uncertain about it and they're
holding back in certain ways just in terms of their decisions—both
their buying and investment decisions.
As you well know, even though interest rates right now are quite
low, we're not seeing the kind of normal spurt in new home buying
and new home construction that one might expect from such a significant reduction in long-term interest rates.
I deduce from that that people are feeling very uncertain about
their circumstances. Most families have two wage-earners now and
if one or both are in jeopardy of losing their jobs or experiencing
cutbacks in hours, it makes them, I think, very unlikely to feel that
they can tackle a new home purchase.
So we've not seen that element of recovery coming along as one
might have expected that it would with mortgage interest rates
down where they are at the present time.
In this picture, I keep hearing comments coming from the Fed,
some from individual members of the Fed, some from the Fed overall policy directives, that there appears to be a very keen concern
or a worry about inflation.
I look around the landscape and I don't see much inflation. In
fact, I see a lot of deflation. I see deflation in commercial real estate properties. I see deflation in gasoline prices. I see it in building rents for commercial space. I see it in housing prices. It's not
just in one or two States. I see a lot of deflation in wages. There
are a lot of people that are sliding backward just in terms of their
real incomes.
So, when I look out on the landscape and I see all these deflationary pressure—that's not the whole story, but there's a lot of
it—it's awfully hard to net out from that, come back and say, there
is some looming inflationary threat. And yet, that seems to be the
signal that is coming out. I don't know whether that's a conscious
desire or whether it's accidental, but I think that the Fed is clearly
giving the signal that it has a heightened anxiety about inflation
really causing a problem for us here in the foreseeable future.
Frankly, I don t see it. I know we had a couple of months of data
early in the year that appear to be anomalies, but I think we need
more job lift and I think we need more economic lift. I would hope
that the Fed would not get into a monetary tightening situation
that would choke off this struggling recovery, such as it is.
We're just not getting the kind of job growth that I think we
should be seeing. I would hope that monetary policy, especially as
we're trying to reduce this deficit by about $500 billion over what
it otherwise would be over the next 5 years, will work in a way to
provide some lift to the economy and not work in a way that would
counteract that and put more drag on it,
I might just say to vou that we had before us just a matter of
a few days ago two colleagues of yours from the economics profession—in fact, we had actually four. But Henry Kaufman was here,
who I know you know and respect, as he does you, and Paul Samuelson. We had the two nominees for the Council of Economic Advisers—Alan Blinder and Joseph Stiglitz, both, I think it's fair to
say, esteemed economists.
They don't detect any inflationary pressure out there and are
very much concerned that we are not doing enough to get some lift
into the economy—not that we overheat it, or if there is anything
overheated at this time, I'd like you to tell me where it is today
because I'm certainly not seeing that.
So I would hope that you could tell us today what the Fed can
do to perhaps get a little more muscle into the economic recovery
and if you see some serious inflationary concern out there that is
escaping me and I think many others here, I'd like to hear what
that is.
I'll put the rest of my statement in the record.
Senator D'Amato.
OPENING STATEMENT OF SENATOR ALFONSE M, D'AMATO
Senator D'AMATO, Thank you very much, Mr. Chairman.
First of all, Mr. Chairman, I join you in welcoming our Federal
Reserve Board Chairman, Alan Greenspan, to the committee to discuss the issues vital to this Nation and our economic well-being.
Mr. Chairman, as you know, we have discussed and worked together to deal with this problem. There is still a credit crunch for
small businesses. The choke-hold on small business credit is strangling our economy. And when we talk about the creation of jobs,
that s where it's going to come from, from the small businesses of
America.
So notwithstanding lower interest rates, they will not help the
small business community nearly as much as they could without
there being credit.
I strongly believe that the best long-term solution to the credit
crunch is to open up the capital markets to small businesses by facilitating securitization and the development of a secondary trading
market in securities backed by small business loans.
Securitization of residential mortgages has eliminated the credit
crunch for our Nation's home buyers. And at one point in time,
there was a credit crunch. It wasn't easy to get mortgages. But
using that technology has opened up tens of billions of dollars.
That's why I introduced, and a majority of this committee has introduced legislation that would remove unnecessary regulatory impediments to the securitization of small businesses.
For the past few months, I've worked very closely with you, Mr.
Chairman. I want to thank you and the staff, and our staffs have
made some great progress, and with Chairman Greenspan and
other bank regulators, to develop a way to change the current capital rules in order to increase the availability of credit by the method which I just indicated, and doing it in a way which will not impact on the soundness and safety of our Nation's institutions.
I'm pleased
The CHAIRMAN. Would you just yield at that point to let me say
that I agree with you on that point and we're working together on
that. We'd like the help of the Fed in refining that proposal to
make sure that we've got something we can enact and that will
work.
Senator D'AMATO. Well, thank you, Mr. Chairman. To that extent, I'm very pleased with the progress that we've made with the
regulators. Chairman Greenspan's cooperation has been outstanding and he's continued to support this effort.
We really are down to the minor points, some very technical
points that I think we can come to an agreement with because we
don't want to move forward without the support of the Federal Reserve. The Federal Reserve's blessing is important. And the administration has been cooperative in this area.
I believe with all of the business of job creation that we talk
about, and programs to put people to work, if we're going to do that
with Federal dollars, that's not the way to get this economy going.
The way to do it is to clear out the blockage of the arteries, so
to speak. Make it possible for that capital to flow so that small
businesses can get credit where they are creditworthy, so that we
can encourage banks to become involved in this activity where now
they are discouraged unnecessarily.
I hope that we can move toward this. I want to thank the Chairman for his cooperation. We've called and he has responded, and
we've made some great progress. It's not always easy. There's pride
of authorship. There's fear. There's protection of the system that
exists. Institutional mentalities are generally, whether it's in the
Senate of the United States or in the private sector, are skeptical
of change. We've done it this way. It's been sound. It's been efficient. We know there are problems and we change it. And so, it has
been that give and take. But we've made, I want to report to the
committee that we've made some very real progress, and I want to
thank the Chairman for it.
I might take just another minute in saying, I've reviewed the
Chairman's extensive testimony that he has submitted and I agree
completely with the Chairman's observations that a credible and effective fiscal package would promise an improved outlook for sustained, long-term interest rates and a better environment for the
private sector and investment.
However, we will never achieve either objective for full employment or balanced growth without a credible and effective fiscal
package. And we certainly don't have them under the administration's budget.
The administration's budget has not proposed a sound fiscal
place for us to start. It has not corrected the material deficiencies.
And as to the shaping up, it's a combination of tax increases and
spending increases.
That's not going to promote either a balanced economic growth
or generate jobs. No nation has ever taxed itself into prosperity.
The answer is we've got to cut spending. And we're not cutting
spending nearly enough. Aside from the military cuts in spending,
there's almost no cuts. We haven't frozen spending. We haven t
really gone after programs that are marginal in light of our economic interest. If we really want to get this economy going and
send a real message to the economic community, let's cut spending.
And we don't have the necessity of increasing taxes. That's the answer. That's where we have to go.
And so, while we can claim that we've reduced what the deficiency or the deficit would have been by $500 billion, the fact of
the matter is that at the end of that 5-year period of time, the
curve just begins to go right back up in terms of those deficits and
we haven't really addressed the major problem. And that is cutting
spending.
The other day, I had a Taxasaurus on the floor of the Senate.
That was a big carnivorous animal that wants more and more
taxes. Well, let me tell you—his big brother is coming out. I just
haven't decided when to show him. But he's growing. He is
Spendasaurus Rex, the king of spending. And let me tell you, he
has a voracious appetite for your money. And he doesn't stop. I'm
telling you, Spendasaurus is coming out. I'm just not sure whether
I'll bring him out today or next weelt, but he's coming out, and he's
there. He's growing in my office, literally. He's just thirsting over
the money. He hears the new programs—national service program.
Talking about national service—you come, you work, you help,
you get a little stipend. I didn't know you got $22,000 for national
service.
I have to tell you something. As my friend, Mayor Koch would
say, the poverty pimps in New York, they're going to be happy with
this national service. They're lining up. They re licking their chops.
So Spendasaurus Rex is coming out. And we ought to kill him.
Slay him. Kill him. If you kill him, then you're going to get this
economy to grow.
Thank you, Mr. Chairman.
The CHAIRMAN. Senator Sarbanes.
OPENING STATEMENT OF SENATOR PAUL S. SARBANES
Senator SARBANES. Mr. Chairman, I'm pleased to join with you
in welcoming Chairman Greenspan to the committee for what I
hope will be a very serious discussion of what the Nation's economic outlook is and what the Nation's economic policies ought to
be.
Chairman Greenspan's testimony this week comes at a significant time. The House-Senate Conference Committee on the budget
reconciliation bill is meeting right now, so to speak, and there is
a reasonable prospect that Congress will complete action on a very
substantial deficit reduction package within the next 2 weeks. If
that occurs, then a critical step would have been taken toward putting our country's fiscal policy on a sounder footing.
Now I've not seen the movie, "Jurassic Park," so I'm not going
to get into a dissertation on dinosaurs, as my colleague has done
a little bit here this morning.
Let me say that the deficit reduction package represents both
very substantial cuts in spending and also increases in revenue.
The increases in revenue, 80 percent of them will come from people
with incomes over $100,000 a year. In other words, it will come
from the very top end of the income scale. That's 80 percent of
those revenues. Most of the balance will come from whatever energy tax there is, which now looks increasingly like a fairly modest
increase in the gasoline tax.
Now, assuming this very important step in fiscal policy, if s actually one that's been urged on us repeatedly by the Chairman and
bv others in its broad outlines. We've consistently been told the
Congress has to have a fiscal policy that is addressed toward deficit
reduction. Of course, that's contractionary in its impact on the
economy and therefore, it carries with it the risk of pulling spending out of the income stream, public spending through the cuts and
private spending through the revenue increases. Although the fact
that most of it is at the top significantly ameliorates that since
most of those people are in a position to adjust their spending habits on the basis of accumulated wealth in order to sustain their consumption, an option not available to low- and middle-income people.
The question will then arise as to what is the appropriate monetary policy to complement the fiscal policy adopted by the Congress
and the President. And of course, that is the issue which we will
be addressing here today and it's a very important issue, indeed.
The Chairman appeared on Tuesday before the House and we
had the next day a story headlined, "Long Rates Soar as Aftershock
of Greenspan's Speech Takes Toll on Bonds."
So the real-life impacts in terms of the effort to read the tea
leaves and divine what the Federal Reserve and the Open Market
Committee may do with respect to monetary policy, as we get a
contracting fiscal policy.
This committee held a hearing on July 1, 1993, in which we had
Paul Samuelson, the very distinguished professor of economics at
MIT, and the first recipient of the Nobel Prize for economics, and
Henry Kaufman, one of Wall Street's most respected financial analysts, before us to testify. I want to take just a moment, Mr. Chairman, to help set the stage for this hearing to quote just briefly
from their testimony. PauISamuelson said and I quote:
Coordinating Federal Reserve monetary policy with austere fiscal deficit reduction
can be the single most important path for the 1990's. Leaning against the wind of
inflationary overheating is a vital duty of the Federal Reserve as the central bank.
It goes along with the Fed's vital duty to lean against the winds of self-aggravating
recession.
The hardest task for an intelligent and responsible Federal Reserve will be to distinguish between micro-caused inflation due to one-time supply shocks and tax
changes, and macro-caused inflation brought on by diminished slack in personal
power and productive capacity.
On July 1, 1993, the weight of the evidence is against our economy as being one
constrained by resource scarcity and on the verge of macro-overheating. Later, when
and if the weight of the evidence shifts, that will be the good time to pump gently
on the brakes. That time is not now.
Now, similarly, Henry Kaufman stated, and I quote him;
A more systematic analysis of the present inflationary potential within the U.S.
economy does not justify either exaggerated inflationary expectations or a preemptive tightening by the Federal Reserve. Inflation, as depicted in the most commonly watched measure, the Consumer Price Index, is exaggerating actual price
pressures. Inflation is not found in the business community and it is not revealed
in speculative activity in the great majority of product markets.
There is no evidence whatsoever of a surge in credit demand on the part of those
wishing to finance speculative holdings of inventories, commodities, or real estate,
in contrast to the conditions that prevailed during the previous run-up in the rate
of inflation in the late 1970's.
There is no evidence of tightening in labor markets that would presage an escalation of wage settlements. To the contrary, as I have detailed, laoor markets are
soft.
And Henry Kaufman went on to say, and I continue to quote
him:
The time will come, no one knows precisely when, perhaps in 1994, perhaps not
until 1995 or 1996, when the business recovery will have matured. Exceas capacity
will have been worked off. Labor markets will become tauter. The economic recovery
abroad will have begun. Commodity prices will have turned higher across the board.
Real estate prices will have firmed. And credit demands will have become conspicuously stronger.
Then we will want the Federal Reserve to act with dispatch and determination
to resist forcibly any build-up of inflationary pressures.
But none of those circumstances prevail today.
Now, Mr. Chairman, from mid-1991 until December 22, 1992, the
Federal Open Market Committee generally voted to tilt toward easing in the conduct of monetary policy. This meant that the FOMC
8
authorized the Chairman of the Federal Reserve, at his discretion,
to lower the Federal funds rate by as much as Vfe percent
At its meeting on December 22, the FOMC voted to shift toward
a so-called symmetric policy, which indicates no tilt toward either
lower or higher interest rates. This symmetric policy was
reaffirmed in meetings of the Open Market Committee on February
2 and March 23, 1993.
However, at its meeting on May 18, the Open Market Committee
voted to tilt toward higher short-term interest rates, presumably—
I don't know—out of concern for inflation figures that came out for
the first 4 months of this year.
In the 2 months since the May meeting, we have had reports of
virtually no inflation for May and June, but discouraging reports
on industrial production, consumer confidence, purchasing managers' forecasts, foreign growth, and other measures.
Although the FOMC met again on July 6 and 7, we will not learn
for sometime whether they have maintained a tilt toward higher
interest rates or return to a symmetric position.
Now I want to address just very briefly because it's come up, this
notion that interest rates are very low. And I know an assertion
is made with respect to the Federal funds rate as being perhaps
even negative, somewhat positive. But the fact of the matter is, and
I want to quote now from the daily economic comment from Goldman, Sachs following the Chairman's testimony on Tuesday before
the House.
The fact that the Federal funds rate—because this is often cited
to show that there's been a very accommodative monetary policy.
And people keep saying, well, that shows that interest rates are
very low and so forth.
The fact that the Federal funds rate is at or below the rate of inflation does not
imply that monetary policy is too accommodative. What matters is the cost of credit
faced by households and business, which ia much higher.
Now, the fact is if you look at the real prime rate, which is the
nominal rate less the 12 month CPI change, what we find is that
the real prime rate, which has come down through the 1980's,
thank heavens, but is still high in an historical comparison. This
begins in 1956 and comes forward. And in fact, part of that is because the banks are maintaining for this point in a recession a
larger spread between the Federal funds rate and the rate that
they're charging to their customers, the real prime rate.
That spread has been larger at this point in a recovery than has
historically been the case. And as a consequence, in part because
of that, the real prime rate, which is actually the relevant rate for
economic activity. The Federal funds rate is the rate at which the
banks can get their money. This is the rate in real terms that people are paving out on the street in order to get credit, in order to
engage in economic activity. And as I say, this rate historically is
not low.
Now, finally, let me simply say to the Chairman that in light of
the economic conditions which I quoted before described by Paul
Samuelson and Henry Kaufman in their very compelling testimony
before this Committee, and indeed, in light of the very headwinds
that Chairman Greenspan has talked about before in his testimony, coming from fiscal retrenchment and balance sheet restruc-
turing in the economy, it seems to me incumbent on the Federal
Keserve to do its part to maintain strong growth and job creation.
I look forward to exploring this and other issues with the Chairman this morning.
Thank you very much.
The CHAIRMAN. Thank you.
Senator Roth.
OPENING STATEMENT OP SENATOR WILLIAM V, ROTH, JR.
Senator ROTH. Well, thank you, Mr. Chairman. It's always a
pleasure to welcome Mr. Greenspan.
During the last couple of months, I, like everybody else, have
been listening carefully to the President as he attempted to explain
how precisely the largest tax increase in history, coupled with the
largest 4-year increase in the national debt, are going to stimulate
economic growth and spur job creation. What I near disturbs me
greatly.
As you listen this morning, I think it's a fair statement that everyone seems to agree that, taken alone, the tax increase we are
preparing to enact will substantially slow economic growth for
sometime to come.
It's been already brought out, independent economic analysis of
the Clinton proposal show, for example, that it would reduce the
rate of economic growth by about one-fourth, destroy hundreds of
thousands of jobs. Indeed, some of the most articulate defenders of
the President's plan are on this committee and they acknowledge,
as we just heard, their concern that the reconciliation bill will dramatically slow economic activity. In fact, right here in this committee room, my colleagues on several occasions have expressed their
fear that we face a real danger of recession as a direct consequence
of the Clinton economic package.
Now, as I listen to my colleagues and to spokespeople for the administration, it comes down to this—the President's economic program will slow economic activity, even perhaps to the point of
bringing on a recession. Therefore, it's up to the Fed to offset and
counteract this highly contractionary fiscal policy with loose monetary policy.
Mr. Chairman we're going to all be very interested in what you
have to say on this matter. Is it your view that, as Mr. Samuelson
says, monetary policy rather than fiscal policy should be the major
macro-economic weapons for assuring a healthy recovery?
Or is it your view that, everything else constant, economic
growth will be maximized over the long run if the central bank focuses on producing and maintaining price-level stability?
Mr. Chairman, this economic strategy is not a riverboat gamble.
It's a guaranteed snake eyes for the economy. It won't work. Markets are too sensitive and too sophisticated to be fooled by some of
the ploys being suggested and if we attempt to put this economic
strategy into play of loose monetary policy, we could very well, it
seems to me, end up with the worst of both worlds—reduced economic growth, even to the point of recession, and higher inflation.
Thank you, Mr, Chairman.
The CHAIRMAN. Thank you, Senator Roth.
Senator Faircloth.
10
OPENING STATEMENT OF SENATOR LAUCH FAIRCLOTH
Senator FAIRCLOTH. Thank you, Mr. Chairman. And thank you,
Mr. Greenspan, for being with us.
I want to thank you for giving your service to the country in
serving in the capacity you do because it certainly is not an easy
job ana it's not one free of anxiety.
You have been a dedicated fighter of inflation since you've been
with the Federal Reserve and I want to thank you for it and I hope
you will maintain that policy. It would be so easy to be mesmerized
into believing that loose money would bail us out of an economic
downturn.
I think the exact opposite is true, and that's the reason I'm so
concerned, as so many of us are, that the budget package that's
coming through involves enormous tax increases. And they're real
tax increases. They're real money. They're going to take money out
of the economy. The so-called cuts are absolutely a facade. They
simply do not exist. And until we face reality and really cut spending, with the exception of the defense budget, everything else is a
facade. There's no cut. They talk about it as if they were going to
cut the budget, but, in its simplest terms, if they got $1,000 last
year, they ask for $1,500 this year, they get $1,400, and they wail,
they had a budget cut.
We're going to have to really cut it.
I hope you will maintain the strict and very close surveillance of
the economy and guard against inflation because inflation is somewhat akin to a snake. You don't really see him until he bites you.
It's there before you find it. And I hope you'll maintain that position and 1 thank you for your service.
The CHAIRMAN. Senator Sasser, chairman of the Budget Committee.
OPENING STATEMENT OF SENATOR JIM SASSER
Senator SASSER. Thank you, Mr. Chairman.
I want to welcome our good friend, the Chairman, Dr. Greenspan, here this morning. I always look forward to his presentation
of the semiannual monetary policy report.
I am particularly eager to hear your thoughts today, Dr. Greenspan, on the coordination of monetary policy and fiscal policy. In
my judgment, this coordination has probably never been more critical than it is right now.
Now, following the bold leadership of the administration, the
Congress is on the eusp of enacting a record $500 million deficit reduction package. We've learned that we can't balance the budget by
depriving the Federal Treasury of revenues. We've learnea that
with the tax cut of 1981, which benefited primarily the wealthy in
this country, and we're still reeling from that today. We won't dwell
on past history. We simply have to play the hand that's been dealt
us.
Now this deficit reduction package that this administration has
presented has been applauded by our allies around the world.
When this President went to the G-7 meeting, he could speak with
boldness and with confidence for the first time in well over a decade that the U.S. Government was moving to get its fiscal house
11
in order as our allies had been urging us to do for many, many
years.
Wall Street applauds this deficit reduction package that this administration has proposed. They think that it is a necessary step,
as I read Wall Street and the financial circles, in getting our fiscal
house in order.
So we're heading down the road of necessary fiscal contraction.
We're doing it to put this Government on a sound financial footing
once again. The stakes are very high. Millions of jobs and the future living standards of tens of millions of Americans are on the
line. We can't afford failure.
In 1990, we entered into a bipartisan deficit reduction agreement. But that agreement was overwhelmed by a recession and
subsequent stagnation. Our timing today seems to be a little better.
The economy is slowly but surely coming out of recession; whereas,
as we learned in 1990, just as we entered into the budget agreement, the economy was falling into recession or, as a matter of fact,
was already in one, but we weren't aware of it.
Then in 1990, there wrs concern about rising oil prices because
Iraq had overwhelmed Kuwait and we were worried about them
overwhelming Saudi Arabia.
Well, today, oil prices are down. And more generally, as a recent
Merrill-Lynch analysis concluded, and I quote from that analysis:
The latest price reports were downright deflationary.
Now, the timing is better but it's certainly not perfect as far as
the recovery is concerned because it's a very slow one. In fact, the
first quarter real GDP grew at just seven-tenths of 1 percent, disappointing. And last week, Dr. Greenspan, as you know, the Fed
reported that industrial production fell in June for the first time
since last September,
So, clearly, as Senator Sarbanes and I have worried out loud in
times past, fiscal contraction entails down-side risk. And this is
where, Dr. Greenspan, I must urge once again that the Fed must
pick up the slack.
In my judgment, if we're going to get this deficit down, if we're
going to keep the economy moving, then the Federal Reserve has
got to be a full partner in this endeavor. And monetary coordination with the fiscal contractionary movements of the Federal Government I think are essential.
This does not mean that we expect the Fed to act tomorrow, although I, for one, would frankly welcome it. But I think the Fed
must stand ready to act decisively if the down-side risk that we're
talking about actually becomes a down-side reality.
Coordination of fiscal policy and monetary policy is essential. In
fact, it is critical and crucial to the success of this deficit reduction
plan, in my judgment, and for the health of our economy.
So, Mr. Chairman, as always, I look forward to hearing from Dr.
Greenspan. He's always informative. He's always very perceptive in
his comments. I always learn a lot from what he has to say.
Thank you.
The CHAIRMAN. Thank you very much.
Senator Bennett.
12
OPENING STATEMENT OF SENATOR ROBERT F. BENNETT
Senator BENNETT. Thank you, Mr. Chairman.
I too welcome Dr. Greenspan.
As a newcomer to the Senate, I'm primarily attending these
things in order to learn. I have discovered from the debate today
and others that I'm going to have to learn a new vocabulary. Where
I come from, some of the comments that are made in the name of
economics strike a somewhat difficult tone.
We've heard, for example, that the 1981 Tax Act deprived the
Treasury of revenues. Where I come from, if you look at the fact
that the revenues have been goinc up every year since 1981, you.
have a hard time understanding that. But I will learn. I'm trying
hard to pick up the new jargon.
There is one thing I do know and the one comment I will make,
and then go on to hear Dr. Greenspan. Small business grows a
whole lot better on internally generated funds than it does on borrowed funds. We do a whole lot better if the small businessman is
able to keep the funds he earns than if he has to pay those funds
to the Government and then go out and borrow the difference.
I would hope that we would keep that in mind as we face this
whole question of how jobs are created.
Thank you, Mr. Chairman.
The CHAIRMAN. Thank you very much.
Senator Mack.
OPENING STATEMENT OF SENATOR CONNIE MACK
Senator MACK. Thank you, Mr. Chairman. Welcome, Mr. Greenspan.
I'd like to set the record straight on Chairman Greenspan and
the Clinton tax package. The news media continues to report Mr.
Greenspan's ringing endorsement of that plan. They're wrong.
Wednesday's New York Times was but another example of the incorrect reporting on what Mr. Greenspan has said about the President's tax plan.
The Times reported that Mr. Greenspan used his testimony on
Tuesday, "to badger Congress to approve the Clinton administration's plan to cut the deficit by $500 billion over 5 years."
I've listened to Mr. Greenspan's comments and past testimony
before this committee. I have read his testimony that he presented
to the House Banking Committee 2 days ago. Nowhere has he said
that he endorses, supports, or otherwise approves of the Clinton
plan. And I might just stop and put this in political terms that
maybe all of us would understand.
If Ronald Reagan had come to Florida to speak on my behalf and
failed to use the terms either support or endorse, the headlines the
next day would have reported that President Reagan failed to endorse or support Candidate Mack in his quest.
Nowhere has he advocated that the Clinton plan will actually result in $500 billion in real deficit reduction. Nowhere has he
claimed that the make-up of the Clinton plan, which doesn't cut
spending and is overwhelming tax increases, is the right one. In
fact, although Mr. Greenspan has been characteristically careful in
describing his position on the Clinton plan, he has been clear to
warn of the negative effects of higher taxes.
13
Let me read some of the recent quotes from Mr. Greenspan. In
March of this year, before the Senate Finance Committee, he said,
and I quote:
Stabilizing the deficit-to-GDP ratio solely from the receipt side, not to mention reducing it, will necessarily require ever increasing tax rates.
Let me underscore tax rates.
This would surely undercut incentives for risk-taking and inevitably, dampen the
long-term growth and tax revenue potential of our economy. The gap between
spending and revenues will not close under such conditions.
Thus, there is no alternative to achieving much slower growth of outlays if deficit
control is our objective.
On Tuesday, before the House Banking Committee, Mr. Greenspan said, and again I quote:
Although expectations of a significant, credible decline in the budget deficit have
induced lower long-term interest rates and favorably affected the economy, the positive influence thus far is apparently being at least partially offset by some business
spending reductions as a conscience of concern about the effects of pending tax
increases.
And further quote:
It seems that the prospective cuts in the deficit are having a variety of substantial
economic effects well in advance of any actual change in taxes or in projected outlay.
Moreover, uncertainty about the final shape of the package may itself be injecting
a note of caution into private spending plans.
Contrary to what has been reported, these statements do not convey endorsement of the Clinton package. They tell us that we need
to cut spending first because the threat of higher taxes will punish
the economy and not lower the deficit.
I'm convinced that the lower interest rates that we have seen in
recent months are not because the economy is enthusiastically welcoming the prospect of deficit reduction. Instead, I believe that the
tax threat from the Clinton plan has so staggered the economy,
that interest rates have fallen in the prospect of a no-growth future.
If Congress is serious about reducing the deficit—and let me clarify. If the conferees are serious about reducing the deficit, they will
throw out the Clinton tax plan and cut spending first. That s the
only path to serious deficit reduction.
And just one further comment with respect to my colleagues' continual effort to pursue the Fed with respect to an accommodating
monetary policy.
It seems to me that, based on your own words, that a contraction
will take place as a result of the deficit plan that has been put forward. To me, that translates into fewer goods. If you're going to
have a policy that is going to create fewer goods, it seems to me
that it's insane to suggest that you should at the same time increase money supply, which is the clearest definition for inflation—
more dollars chasing fewer goods.
And so I state to the Chairman, I think it is important that you
continue to express the independence of the Fed and follow the
course that you believe is in the best long-term interest of this
country.
The CHAIRMAN. Thank you.
Senator Kerry.
Senator SARBANES. Will the Senator yield to me for a second?
Senator KERRY. I'd be delighted to.
14
Senator SARBANES. Since the last comment apparently referred
to some comments on this side.
Obviously, the overall impact on the workings of the economy is
going to be affected both by fiscal and monetary policy.
Now if you're trying to bring the deficit down, which is now recognized as a major objective, you have to have a fiscal policy that
seeks to do that. And that's what the President is trying to accomplish with a balanced program of spending cuts and revenue increases.
I know my colleagues constantly assert that's not the case, but
that's just not true. This is a package that has significant spending
cuts in it and it has significant revenue increases.
Now any projection solely on the basis of fiscal policy as to what
will happen to the economy leaves out an important dimension to
our economic growth because if you have a monetary policy that
provides an expansionary opportunity, it can offset and, indeed,
prevail over a fiscal policy which is trying to get at the deficit problem, which people have argued for years needs to be addressed.
So you have to take the combination of your fiscal and monetary
policy in order to make a calculation as to the direction in which
the economy is likely to go.
Now the good news on the interest rates on the bonds is very
helpful to the economy. Now, you've got plenty of capacity. So the
extra boost vou get from the monetary policy can easily be translated into additional production. That's the fact of the matter.
If people use this monetary policy and lower interest rates to engage in economic activity, which is one of the premises of this approach, there's plenty of slack in the economy in terms of industrial
capacity and workers to respond to that demand. So that's not inflationary. You're not, as Kaufman said in his quote, you're not
anywhere close to pressing up against either the laoor supply or industrial capacity.
I thank the Senator.
OPENING STATEMENT OF SENATOR JOHN F. KERRY
Senator KERRY. I'm delighted. Mr. Chairman, thank you very
much.
I listened to part of the dialog on television before coming over
here and I picked some of the last parts of it which I guess this
discussion inevitably winds up becoming somewhat partisan, which
none of us I suppose should be too surprised about around here.
At least it ought to be based somewhat on the truth. And the
truth is that over the last years, when we had a Republican President who made a hell of a lot of noise about the deficit, I don't remember those appropriation bills coming back here with vetoes on
them. They could have. Time and again, they could have. But they
didn't.
Every bit of that spending has the signature of the President of
the United States on it, who was a Republican for those 12 years.
It didn't have to. Could have sent it back in a veto time and again.
Never happened. Rarely happened, I should say.
The fact is that we're spending what we're spending because a
Republican President put his signature and signed it into law, time
and again.
15
So here we have the largest deficit reduction package in history.
Not one spending cut offered by the Republicans when it was in the
committee. Not one at the Finance Committee. Basically, the Republican Party has walked away from this effort, said, we're not
going to vote for anything. It's tax and spend, tax and spend.
There isn't one person of intelligence in America that I know of
who looks at this economy who says that you can do this without
finding some revenue, that you have to find some revenue.
Now I'd love to make an arrangement here where we have an
agreement that we will go to the floor of the Senate and the House
and let 51 votes carry the day and put it all up for a vote. Let's
vote. Vote on the Ag Department stuff.
We tried to have a vote the other day on the wood and mohair
subsidy. The Senator from Texas was one of those down there defending it, saying, by God, the money comes from tariffs. Therefore,
taxpayers aren't really paying for it.
But the fact is $675 million is scored and because it's scored, we
have to find that $675 million somewhere else. It's not money that
goes to education. It's not money that goes for the capital gains reduction. It's not money that goes into something else because the
$675 million is scored elsewhere, so we have to find it elsewhere.
It does cost the taxpayer some money.
The Senator from Texas didn't vote for that because he's got people down in Texas. He's got one farmer down there who got
$661,000 worth of that subsidy by dividing it up into four partnerships in his own family.
So Americans are paying for a 1954-passed national strategy to
have mohair in our uniforms when we don't have any mohair in
our uniforms in America any more.
Does the average American wonder why we look like fools up
here? This is ridiculous.
And where is the Republican Party? We're not going to vote on
it. We're just going to call the Democrats tax and spenders. Now
that's terrific. No wonder we have a predicament here.
I'll tell you, I think everybody in this country understands what's
happening. 25,000 more jobs were lost today. We just read it in the
papers today. We've got a slow recovery in America and we are contracting spending. We're doing exactly what Mr. Greenspan said to
do—reduce spending. We're doing it. The largest spending reductions, $250, $260 billion worth, more in spending cuts than we
have in taxes.
Now I don't like the number of taxes. I also am convinced we can
get more spending cuts. No question about it. But you could eliminate 100 percent of the domestic discretionary budget of the entire
Federal Government and you'd still have $150 billion of deficit,
folks.
Now I am concerned with respect to this hearing, which was not
meant to be about that, per se. The Chairman was before the
House the other day. The Fed has released its minutes from the
Open Market Committee meeting of 6 weeks ago, indicating that
the concern at the Fed now appears to be the potential of inflation
again.
And I'm reminded of the consistency of our fighting past wars,
fighting the current war by using the strategy of the past war.
16
The problem is that at this moment we're contracting spending,
we're really not doing what we ought to do in terms of investment
in this country, and we have a gap in investment relative to where
we were in the great years of growth and expansion after World
War II. We are looking at other nations outstrip us in research and
development and investment, infrastructure, far greater than we
are, at least relative to GNP, GDP today. Now suddenly, when
we're still in this very slow recovery, with major loss of jobs, the
signals coming from the Fed are relative to potentially increasing
interest rates.
Now I think you're too astute and I think the Fed as an institution is too astute to see the short-term rates change, at least in
short order here.
But the question is whether the message is the right message at
this point. The question is whether the policy ought not to be more
visibly articulated as looking for expansion and for availability of
credit and for encouraging people to do some of the things that
they're not willing to do today.
If the message is going to be one that we're going to see a tightening on the monetary side and restraint there at the same time
that we have the kind of restraint we have on the fiscal side, I do
not see how we're going to see anything but more of those headlines of loss of jobs in the order of the 25,000 that we read about
today.
I think that is the critical subject matter of this hearing. Senator
Sarbanes and the Chairman have expressed their concerns about
it. I just want to underscore that.
Mr. Chairman, I look forward to the discussion with you today
on this question of the monetary response relative to these other
tough choices we are making up here.
Thank you, Mr. Chairman.
The CHAIRMAN. Senator Gramm of Texas.
OPENING STATEMENT OF SENATOR PHIL GRAMM
Senator GRAMM. Mr. Chairman, thank you for the recognition.
I'm going to make a few responses to the comments that have just
been made.
First of all, Republicans offered 73 amendments in the Budget
Committee and on the floor of Congress to the President's budget,
including two comprehensive substitutes. Each of those amendments had to do with cutting spending.
I would agree with my colleague from Massachusetts that President Reagan and President Bush did not veto enough spending
bills. But I voted to sustain each and every one of those vetoes, and
I do not ever remember my colleague from Massachusetts ever voting to sustain one of them.
So it's one thing to criticize Presidents for not vetoing spending
bills, but the point is that we do have a problem and the problem
is spending. And we're not going to deal with the spending problem
by raising taxes.
It is obvious to me, Chairman Greenspan, in listening to all this
discussion, that you are going to be under immense pressure to
reinflate the American economy.
17
I don't believe for a second that you can impose the taxes contained in the Clinton economic program and not have the economy
stagger under the weight of those taxes. And it is clear in listening
to our colleagues here today, it's clear in listening to the administration that they plan to ask the Federal Reserve to bail them out
by inflating the American economy.
We have an independent Fed to protect the American economy
and the American people from just that kind of political pressure.
I think there's only one thing worse that we could do in this
whole economic mess that we're about to create, and that is expand
the monetary base rapidly. Try to hold interest rates down artificially low, and in the progress, you reignite inflation so that we replay the economic horrors of the 1970's.
I have absolute confidence, Mr. Chairman, that you are not going
to allow that to happen. And I want you to know that you have
support in Congress.
I think we need a monetary policy that is trying to promote full
employment. But if the fiscal policy of the country, by imposing
taxes on people who do the work, pay the taxes and pull the wagon,
ends up pushing us into a situation where people are not saving,
are not investing, are not creating jobs, the worst thing we could
do in trying to deal with that mess would be to inflate the American economy and to overlay inflationary pressures on top of it.
I think that that would be an economic nightmare and one that
probably, no matter what happens in the 1994 elections or the 1996
elections, we're not going to be able to fix easily.
So, in your hands, to a very large extent, rests the decision as
to whether we make worse what I believe will be an economic
downturn from this new tax and spend program, slow, sluggish
growth because of the tax burden and because of wealth redistribution, and because there's no fundamental change in the spending
pattern of the country. I think what you do is going to determine
whether that becomes a worse economic mess. I am glad that you
have the independence to exercise public policy in the public interest, and I have no doubt that you're going to do it.
Senator KERRY, Mr. Chairman, could I just, point of privilege,
clarify a few things so the record is clear here?
The CHAIRMAN. Senator Kerry.
Senator KERRY. I said that there was no offering of an amendment in the Finance Committee, and that is accurate. There was
nothing offered by Republicans in the Finance Committee.
On the floor, what was offered was a very generic and general,
nonspecific spending reduction effort and everybody complained
about the lack of specificity.
Third, the vetoes of the President that were offered by President
Bush and President Reagan were not over the spending, with one
exception, I believe. They were over abortion. And that is why they
were vetoed, because the DC appropriations and others had abortion spending in them.
I am confident the President of the United States has sufficient
ability—in fact, all this talk about a line-item veto—he basically
has one today. The President doesn't want a bill because there are
ten items of pork in it, the President has always had the power,
18
and usually has been successful, in saying to us, I'm going to veto
this bill if you don't take these five items of pork out of it.
And unless there's a sufficient consensus and a sufficient broad
fabric built within that legislation so that enough Senators' States
and Congressmen's districts are contained in it, the President can
usually have those items taken out, and because of the massive importance of the rest of the spending in the bill, we want the bill
badly enough, we pass it without those items. That rarely happens.
You know it and I know it. And we would be a hell of a lot better
off if it did.
Senator GRAMM. Mr. Chairman, may I respond?
The CHAIRMAN. One final comment here.
Senator Gramm.
Senator GRAMM. Let me just give you a perfect example. President Reagan vetoed the highway bill because he thought the level
of funding was too high. That veto was overridden.
In 1973 more amendments were offered to the tax bill, to the
budget, and to the so-called economic stimulus package, there were
plenty of spending cuts. The bottom line is everybody talks about
spending cuts. Rarely does anybody make one.
Senator KERRY. But the problem is we've got to do this 60-vote
joke around here. If we would go in there with 51 votes and just
put the item up or down and live by it, I think we'd be a lot better
off, Senator, and I'm willing to do that.
Let's put it all up for 51 votes and get away from this super-majority routine that even allows you to get to the vote.
Senator BENNETT. Mr. Chairman, can we hear from Chairman
Greenspan.
The CHAIRMAN. I think that's a good suggestion.
[Laughter.]
I think there will be additional spending cuts and we'll all have
a chance to vote on them.
We're going to make your full statement a part of the record.
Chairman Greenspan, we'd like to hear from you now.
Senator KERRY. Are you going to accept any more of these invitations?
[Laughter.]
Senator MACK. You could come an hour later.
[Laughter.]
STATEMENT OF ALAN GREENSPAN, CHAIRMAN, FEDERAL
RESERVE, WASHINGTON, DC
Mr. GREENSPAN. I know you're not quite certain I believe this,
but I really appreciate being invited to the panel to discuss the
Federal Reserve's semiannual monetary policy report to Congress.
[Laughter.]
Mr. Chairman, my remarks this morning will cover the current
monetary policy and economic settings, as well as the Federal Reserve's longer-term strategy for contributing, to the best of our
abilities, to the Nation's economic well-being.
As the economic expansion has progressed somewhat fitfully, our
earlier characterization of the economy as facing stiff head winds
has appeared increasingly appropriate. Doubtless the major head
wind in this regard has oeen the combined efforts of households,
19
businesses, and financial institutions to repair and to rebuild their
balance sheets following the damage inflicted in recent years as
weakening asset values exposed excessive debt burdens.
But there have been other head winds as well. The build-down
of national defense has cast a shadow over particular industries
and regions of the country. Spending on nonresidential real estate
dropped dramatically in the face of overbuilding and high vacancy
rates and has remained in the doldrums. At the same time, corporations across a wide range of industries have been making efforts to pare employment and expenses in order to improve productivity and their competitive positions.
In the past several years, as these influences have restrained the
economy, they have been balanced in part by the accommodative
stance of monetary policy and, more recently, by declines in longterm interest rates as the prospects for credible Federal deficit cuts
improved. From the time monetary policy began to move toward
ease in 1989 to now, short-term interest rates have dropped by
more than two-thirds and long-term rates have declined substantially as well. All along the maturity spectrum, interest rates have
come down to their lowest levels in 20 or 30 years, aiding the repair of balance sheets, bolstering the cash flow of borrowers, and
providing support for interest-sensitive spending.
The process of easing monetary policy, however, had to be closely
controlled and generally gradual, because of the constraint imposed
by the marketplace's acute sensitivity to inflation. As I pointed out
in my February testimony to the Congress, there is a constraint
that did not exist in an earlier time. Monetary policy in recent
years has had to remain alert to the possibility that an ill-timed
easing could be undone by a flair-up of inflation expectations, pushing long-term interest rates higher and short-circuiting essential
balance sheet repair.
The cumulative monetary easing over the last 4 years has been
very substantial. Since last September, however, no further steps
have been taken, as the stance of policy has appeared broadly appropriate to the evolving economic circumstances.
That stance has been quite accommodative, especially judging by
the level of real short-term interest rates in the context of, on average, moderate economic growth. Short-term real interest rates have
been in the neighborhood of zero over the last three quarters. In
maintaining this accommodative stance, we have been persuaded
by the evidence of persistent slack in labor and product markets,
increasing international competitiveness, and the decided absence
of excessive credit and monetary expansion. The forces that engendered past inflationary episodes appear to be have been lacking to
date.
Yet, some of the readings on inflation earlier this year were disturbing. It appeared that prices might be accelerating, despite
product market slack and an unemployment rate noticeaoly above
estimates of the so-called "natural" rate of unemployment—that is
the rate at which price pressures remain roughly constant. In the
past, the existing degree of slack in the economy had been consistent with continuing disinflation.
However, the inflation outcome, history tells us, depends not only
on the amount of slack remaining in labor and product markets,
20
but on other factors as well, including the rate at which that slack
is changing. Near the end of last year, about the time many firms
probably were finalizing their plans for 1993, sales and capacity
utilization were moving up markedly and there was a surge of optimism about future economic activity. This may well have set in motion a wave of price increases which showed through to broad
measures of prices earlier this year.
Moroever, inflation expectations, at least by some measures, appear to have tilted upward this year, possibly contributing to price
pressures. The University of Michigan survey of consumer attitudes, for example, reported an increase in the inflation rate expected to prevail over the next 12 months from about 3% percent
in the fourth quarter of last year to nearly 4Vfe percent in the latest
quarter. Preliminary data imply some easing of such expectations
earlier this month, but the sample from which those data are derived is too small to be as yet persuasive. Moreover, the price of
gold, which can be broadly reflective of inflationary expectations,
has risen sharply in recent months. And at times this spring, bond
yields spiked higher when incoming news about inflation was most
discouraging.
The role of expectations in the inflation process is crucial. Even
expectations not validated by economic fundamentals can themselves add appreciably to wage and price pressures for a considerable period.
The Federal Open Market Committee became concerned that inflation expectations and price pressures, unless contained, could
raise long-term interest rates and stall economic expansion. Consequently, at its meeting in May, while affirming the more accommodative policy stance in place since last September, the FOMC
also deemed it appropriate to initiate a so-called asymmetric directive. Such a directive, with its bias in the direction of a possible
firming of policy over the intermeeting period, does not prejudge
that action will be taken—and indeed none occurred. But it did indicate that further signs of potential deterioration of the inflation
outlook would merit serious consideration of whether short-term
rates needed to be raised slightly from their relatively low levels
to ensure that financial conditions remained conducive to sustained
growth.
Certainly, the May and June price figures have helped assuage
concerns that new inflationary pressures had taken hold. Nonetheless, on balance, the news on inflation so far this year as a whole
must be characterized as disappointing.
In assessing the stance of monetary policy and likelihood of persistent inflationary pressures, the FOMC took account of the
downshift in the pace of economic expansion earlier this year.
While a slowdown from the unsustainably rapid growth in the
latter part of last year had been anticipated, the deceleration was
greater than expected. Smoothing through the quarterly pattern,
however, the economy appears to have accelerated gradually over
the past 2 years, to maintain a pace of growth that should yield
further reductions in the unemployment rate. Consequently, the
evidence remains consistent with our diagnosis that the underlying
forces at work are keeping the economy generally on a moderate
upward track. However, as I have often emphasized, not all of the
21
old economic and financial verities have held in the current expansion, and changes in fiscal policy will have uncertain effects going
forward. Thus, caution in assessing the path for the economy remains appropriate.
Financial conditions have improved considerably, lessening the
need for balance sheet restructuring that has been damping economic activity for several years now. By no means is the process
over, but good progress has been made. On the other hand, the
economies of a number of our major trading partners have been
quite weak, constraining the growth of demand for our exports.
Although expectations of a significant, credible decline in the
budget deficit have induced lower long-term interest rates and favorably affected the economy, the positive influence thus far is apparently being at least partly offset by some business spending reductions as a consequence of concerns about the effects of pending
tax increases.
It seems that the prospective cuts in the deficit are having a variety of substantial economic effects well in advance of any actual
change in taxes or in projected outlays. Moreover, uncertainty
about the final shape of the package may itself be injecting a note
of caution to private spending plans.
To be sure, the conventional wisdom is that budget deficit reduction restrains economic growth for a time, and I suspect that is
probably correct. However, over the long run, such wisdom points
in the opposite direction. In fact, one can infer that recent declines
in long-term interest rates are bringing forward some of these anticipated long-term gains. As a consequence, the timing and magnitude of any net restraint from deficit reduction is uncertain. Patently, the overall economic effect of fiscal policy, especially when
combined with the uncertainties of the forthcoming health reform
package, has imparted a number of unconventional unknowns to
the economic outlook.
Assuming, however, we constructively resolve over time the
major questions about Federal budget and health care policies,
with the further waning of earlier restraints on growth, the U.S.
economy should eventually emerge healthier and more vibrant
than in decades.
Over the last 2 years, the forces of restraint on the economy have
changed, but real growth has continued with one sector of the economy after another taking the lead. Against this background, Federal Reserve Board Governors and Reserve Bank presidents project
that the U.S. economy will remain on the moderate growth path it
has been following as the expansion has progressed, and inflation
will come in at or just above 3 percent this year and next.
In addition to focusing on the outlook for the economy at its July
meeting, the FOMC, as required by the Humphrey-Hawkins Act,
set ranges for the growth of money and debt for this year and, on
a preliminary basis, for 1994. One premise of the discussion of the
ranges was that the uncharacteristically slow growth of the broad
monetary aggregates in the last couple of years—and the atypical
increases in their velocities—would persist for a while longer. To
an important degree, the behavior of M2 has reflected structural
changes in the financial sector. Depository credit has been weak,
necessitating little bidding for deposits, and depositors in any case
22
have been drawn to the higher returns on capital market instruments, including bonds and stock mutual funds.
In this context, the FOMC lowered the 1993 ranges for M2 and
M3 to 1 to 5 percent and to 0 to 4 percent, respectively. This represents a reduction of one percentage point in the M2 range and
a Vz percentage point for M3. Even with these reductions, we
would not be surprised to see the monetary aggregates finish the
year near the lower ends of their ranges.
As I have emphasized in a similar context in February, the lowering of the ranges is purely a technical matter; it does not indicate, nor should it be perceived as, a shift of monetary policy in the
direction of restraint.
In reading the longer-run intentions of the FOMC, the specific
ranges need to be interpreted cautiously. The historical relationships between money and income, and between money and the
price level have largely broken down, depriving the aggregates of
much of their usefulness as guides to policy.
At least for the time being, M2 has been downgraded as a reliable indicator of financial conditions in the economy, and no single
variable has yet been identified to take its place.
In these circumstances, it is especially prudent to focus on
longer-term policy guides. One important guidepost is real interest
rates, which have a key bearing on longer-run spending decisions
and inflation prospects.
In assessing real rates, the central issue is their relationship to
an equilibrium interest rate, specifically the real rate level that, if
maintained, would keep the economy at its production potential
over time. Rates persisting above that level, history tells us, tend
to be associated with slack, disinflation, and economic stagnation—
below that level with eventual resource bottlenecks and rising inflation, which ultimately engenders economic contraction. Maintaining the real rate around its equilibrium level should have a stabilizing effect on the economy, directing production toward its longterm potential.
The level of the equilibrium real rate—or more appropriately, the
equilibrium term structure of real rates—cannot be estimated with
a great deal of confidence, though with enough to be useful for
monetary policy. Real rates, of course, are not directly observable,
but must be inferred from nominal interest rates and estimates of
inflation expectations.
The most important real rates for private spending decisions almost surely are the longer maturities. Moreover, the equilibrium
rate structure responds to the ebb and flow of underlying forces affecting spending. So, for example, in recent years, the appropriate
real rate structure doubtless has been depressed by the head winds
of balance sheet restructuring and fiscal retrenchment. Despite the
uncertainties about the levels of equilibrium and actual real interest rates, rough judgments about tnese variables can be made and
used in conjunction with other indicators in the monetary policy
process. Currently, short-term rates most directly affected by the
Federal Reserve are not far from zero; long-term rates, set primarily by the market, are appreciably higher, judging from the
steep slope of the yield curve and reasonable suppositions about inflation expectations. This configuration indicates that market par-
23
ticipants anticipate that short-term real rates will have to rise as
the head winds diminish if substantial inflationary imbalances are
to be avoided.
While the guides we have for policy may have changed recently,
our goals have not. As I have indicated many times to this committee, the Federal Reserve seeks to foster maximum sustainable economic growth and rising standards of living. And in that endeavor,
the most productive function the central bank can perform is to
achieve and maintain price stability.
Inflation is counterproductive in many ways. Of particular importance, increased inflation has been found to be associated with reduced growth of productivity, apparently in part because it
confounds relative price movements and obscures price signals.
Compounding this negative effect, under the current tax code, inflation raises the effective taxation of savings and investment, discouraging the process of capital formation. Since productivity
growth is the only source of lasting increases in real incomes and
because even small changes in growth rates of productivity can accumulate over time to large differences in living standards, its association with inflation is of key importance to policymakers.
Senator SARBANKS [presiding!. Mr. Chairman, people are melting
away from here, not because of anything you're saying, but because
there's a vote on the floor of the Senate. We were keeping it going
in the hopes to finish your statement, then we could resume the
questioning when we return. But obviously, that's not going to be
the case.
I think we're going to have to take just a short recess, return,
and take the balance of your statement, and then go to questions.
So if you'll just hold on, we'll be able to resume very shortly.
Mr. GREENSPAN. Certainly.
[Recess.]
The CHAIRMAN. Mr. Chairman, I understand that you were close
to completing your statement when the committee had to recess for
this rollcall vote on the Senate floor. And if that's correct, I'm going
to have you resume now and make whatever closing remarks you
wish.
Mr. GKKENSPAN. Yes, that is correct, Mr. Chairman. I have been
discussing; the issue of inflation and growth of productivity.
The link, between the control of inflation and the growth of productivity underscores the importance of providing a stable backdrop for the economy. Such an environment is especially important
for an increasingly dynamic market economy, such as ours, where
technology and telecommunications are making rapid advances.
New firms, new products, new jobs, new industries, and new markets are continually being created and they are unceremoniously
displacing the old ones. The U.S. economy is a dynamic system, always renewing itself. Central planning of the type that prevailed
in post-war Eastern Europe and the Soviet Union represented one
attempt to fashion an economic system that eliminated this competitive churning and its presumed wastefulness. But when that
system eliminated the risk of failure, it also stifled the incentive to
innovate and to prosper.
Risk-taking is crucial in the process that leads to a vital and progressive economy. Indeed, it is a necessary condition for wealth ere-
24
ation. In a market economy, competition and innovation interact;
those firms that are slow to innovate or to anticipate the demands
of the consumer are soon left behind. The pace of churning differs
by industry, but it is present in all. At one extreme, firms in the
most high-tech areas must remain constantly on the cutting edge,
as products and knowledge become rapidly obsolete. Many products
that were at technology's leading edge, say 5 years ago, are virtually unsalable in today's markets. In high-tech fields, leadership
can shift rapidly. In some markets where American firms were losing share just a few years ago, we have regained considerable
dominance, and, more generally, it appears that the pace of dynamism has been accelerating.
The possibility of failure has productive side effects, encouraging
economic agents to do their best to succeed. But there are nonproductive and unnecessary risks as well. There is no way to avoid
risk altogether, given the inherently uncertain outcomes of all business and household decisions. But many uncertainties and risks do
not foster economic progress, and where feasible, should be suppressed. A crucial risk in this category is that induced by inflation.
To allow a market economy to attain its potential, the unnecessary
instability engendered by inflation must be quieted.
A monetary policy that aims at price stability permits low longterm interest rates and helps provide a stable setting to foster the
investment and innovation by the private sector that are a key to
long-run economic growth.
Clearly, the behavior of many of the forces acting on the economy
over the course of the last business cycle have been different from
what had gone before. The sensitivity of inflation expectations has
been heightened and, as recent evidence suggests, businesses and
households may be becoming more forward-looking with respect to
fiscal policies as well.
I believe we are on our way toward re-establishing the trust in
the purchasing power of the dollar that is crucial to maximizing
and fulfilling the productive capacity of this Nation. The public,
however, clearly remains to be convinced. Survey responses and financial market prices embody expectations that the current lower
level of inflation not only will not be bettered, it will not even persist. But there are glimmers of hope that trust is re-emerging. For
example, issuers have found receptive markets in recent months for
50-year bonds, and yesterday, even 100-year bonds. This had not
happened in decades. The reopening of that market may be read
as one indication that some investors once again believe that inflationary pressures will remain subdued.
Mr. Chairman, it is my belief that, with fiscal consolidation and
with the monetary policy path that we have charted, the United
States is well positioned to remain at the forefront of the world
economy well into the next century.
Thank you very much.
The CHAIRMAN. Thank you very much, Mr. Chairman.
Let me refer to those 100-year bonds that you just made reference to. Those were, and are, being offered by the Walt Disney
Company.
Mr. GKEKNSPAN. That's correct.
25
The CHAIRMAN. Quoting from the article in yesterday's Wall
Street Journal, they say that bond traders were surprised to hear
that the entertainment concern is expecting to sell $150 million of
100-year bonds at a yield of only about 7Vz percent, barely 0.95
percentage points above the 30-year U.S. Treasury bonds. I can see
why they would find that quite a striking circumstance. I find it
that way. But then further down in the article, it says:
But demand for the issue is said to be brisk and there is even some talk that the
offering size might be increased.
Mr. GREENSPAN. In fact, it was.
The CHAIRMAN. So it sounds to me as if certainly the investors
in these bonds—this is 100 years into the future and at a rate that
is less than a full percentage point above that of the Government
rate. It sounds to me as if at least the people buying these bonds
are not laying awake at night fearing a surge of inflation.
Mr. GREENSPAN. I think that's correct, Mr. Chairman. This is one
of the more important indicators that the longer-term inflation expectations which have so bedeviled our economy and financial markets seem to be receding, and that's a very good sign.
The CHAIRMAN. So is that the same thing as saying, if they are
receding, that we are not facing a serious inflation threat at this
time?
Mr. GRKKNSPAN. The evidence that we have at this point certainly confirms what all of us are aware of, that the fundamentals
seem to be quite subdued.
The problem that we at the Federal Reserve had and the reason
for our asymmetric directive was that what we were looking at earlier this year was a surprising upturn in price indexes wholly inconsistent with all previous relationships between prices and the
slack in product markets and in labor markets.
What was of increasing concern to us at that time was that it
was possible, and we underline the word possible, that some new
forces may have been emerging which had not had any validity in
the past and which we had not observed emerging.
And what was fairly apparent as we tried to figure out why, for
example, wages were rising faster than they would have in the context of the historical relationships was that there was a degree of
inflation expectation embodied in both the wage side and the price
side that broke the connection between the so-called fundamentals
and the actual price changes. It was our view that that could possibly create a problem for us.
In the event, it turned out not to be the case, that is, as best we
can judge looking at the May and especially the June data, there
has been a clear simmering down of that process.
The CHAIRMAN. So, as you say, it was not the case. The concern
that arose earlier in the year, later data caused you to decide that
that was not the signal of some disturbing new situation.
Mr. GREENSPAN. The specific data were clearly much improved,
and we'll be looking, I must say, at the next 2 or 3 months to see
how they evolve to confirm that.
But there was another element involved in our asymmetric directive which is a longer-term question. It really gets down to the
issue I discussed in my prepared remarks, namely, that leaving
aside the question of the real prime rate which Senator Sarbanes
26
raised and which I will respond to when he gets back, the evidence
indicates that we cannot maintain a zero real short-term rate indefinitely into the future as the economy finally unwinds from its
strained balance sheets and expect that the economy will maintain
a balanced long-term growth.
So the signal we were endeavoring to send is that somewhere out
there, there is going to have to be a rise in real short-term rates.
This obviously can occur if, as is possible, and we would certainly
hope, inflation falls further, which would, in effect, not increase
current nominal short-term rates, but would make them higher in
real terms or, failing that, a rise in nominal short-term rates would
be required.
We don't know where or when such changes are implicit for stability purposes. "We do know that if the general concept of how the
economy is functioning and our diagnosis of it are essentially correct, that at some point, the economy will start to improve as the
balance sheet restraints fall off. And I must say that growth, per
se, doesn't necessarily engender inflationary pressures, but we
have to be vigilant to make certain that that fact does not occur.
Our major concern is that we do not inadvertently fall into the
experience of the late 1970's and early 1980's, when we were way
behind the curve, did not anticipate the degree of inflationary expansion that was going on, and the tragic results of that, I think,
are much too extraordinary for us to even conceive of facing them
again.
So the signal we are endeavoring to send here is that, at some
point, real rates are going to have to move up for two reasons. One,
for the general overall stability, but also because of the increasing
and, I think, very credible evidence that low inflation means rapid
growth and productivity.
And to the extent that the central bank can contribute something
to the longer-term growth of this economy, it clearly is suggested
that to the extent that we can keep inflation subdued, we will
maximize growth and productivity, and that is a major factor in
the long-term growth of this economy and in the growth of employment and standards of living.
The CHAIRMAN. That's not the same thing, is it, as asserting that
this is sort of a one-legged stool, that if you've got inflation beaten
down to a deminimus level, that we can take our eye off other
things.
I mean, if you have a situation where you've got widespread unemployment, declining living standards for many people, other
basic problems in your economy of an absence of sufficient growth
and reinvestment, can't you have other problems that can unhorse
the economy, other than just—I mean, obviously, you've got to pay
attention to inflation. It looks to me like the Fed pays about 99.9
percent of its time to inflation and the rest of the time to employment and growth and the other things.
Now that may be a perception that's
Mr. GREENSPAN. I hope it's a gross exaggeration.
The CHAIRMAN. But I think more and more people are coming to
feel that the tilt is so strongly on the side of people laying awake
nights worrying about the inflation problem arriving—and I don't
27
just say this to you. Other members of the Fed, in their public comments, certainly give that impression.
Now, maybe they don't mean to or maybe that's just part of what
they think or maybe their comments are being exaggerated in the
press. But the bottom line of it is that we almost never hear the
Fed talking very much about getting the employment levels up and
the unemployment levels down.
In the conversations, inevitably, the inflation issue is usually the
first issue raised, the middle issue raised, and usually the last
issue raised. And then if there's a little bit dropped in around the
edges about growth and recovery and rebuilding the job base, it's
sort of a residual in the conversation.
I think there is that pattern that's developed. I'm a little concerned about it, quite frankly, because I see an awful lot of people
finding their living standards hollowed out. A lot of people are
working harder and are earning less for it.
We've had real wages for most workers in the society remain
quite stagnant now over a very long period of time. I don't see
them "contributing to inflation or inflationary pressure." For the
moment, I'll put health care costs in a separate category because
I think that has been an inflation driver, but not everybody gets
health care coverage.
So that problem has got to be dealt with in and of itself. But
when I look at just strict wages per hour for workers and I watch
the productivity improvements as well, I find a lot of people in the
society working harder, producing more, and earning less.
That to me is a real concern. It's an economic concern over and
above what constitutes a fair return for work, but it also, I think,
has major bearing on people's faith in the economic system and in
the future and whether or not, for example, today, even with very
low long-term mortgage interest rates, a person feels as if they can
go out and buy a house, either for the first time or maybe trade
up because their family has gotten larger and they need a larger
house, but they're reluctant to do so because they don't have very
much confidence in their own economic future.
And so I think there is an asymmetry in the policies, if you will,
where the focus on inflation is being the driver that, in a sense, in
the end, has to equilibrate everything, I think overstates and
makes too simple the relationship of that one item to a far more
complex economic picture.
Then when you throw in on top of that the record high unemployment rates that we're seeing in Europe today, which I'm concerned about, and I think we all ought to be concerned about, and
the slack in our own economy—when I look at the areas of the
economy that are going through a deflation or a water-treading
process, and those areas where we see inflation, I see more deflationary areas than I see inflationary areas.
What am I missing?
Mr. GREENSPAN. First of all, let me just say that we don't look
at the issue of inflation or growth as separate questions. Our concern about inflation essentially relates to our concern that if it
were to reassert itself, it would stifle growth, create unemployment
and induce economic contraction.
28
So what we're looking for is to try to find the best policy, and
we obviously can only affect part of the system, that, as I said in
my prepared remarks, sustains long-term economic growth.
The reason we raise issues about inflation is to make certain
that the system does not put various bottlenecks in place which induce a variety of negative consequences.
Now in my testimony today, last February, and earlier, we've
gone to a very extraordinary extent in trying to explain why we believe we have the type of sluggish economic growth we are involved
with.
It looks increasingly the case that what we indicated was the nature of the problem that confronted us, a year or \Vz or 2 years
ago, was correct. As I said back then, the best way to come to grips
with strained balance sheets is to bring interest rates down gradually so that long-term rates can come down, short-term rates can
come down, and we can accelerate the repair of those balance
sheets, which, in my judgment, is a necessary condition for the resumption of viable economic growth, increased jobs, and a strong
long-term outlook.
I don't view the issue of inflation independently of the process of
creating sustained, long-term economic growth. It's part of the
process. The reason why I am raising the issue more today is because, in the past, we've discussed why we were bringing rates
down. Rates have now been stable since September. This is the
longest time that I remember that we have been able to hold to a
stable rate.
The CHAIRMAN. Is that partly due to weak loan demand?
Mr. GREENSPAN. No.
The CHAIRMAN. Well, the banks keep telling us that. The banks
tell us there is weak loan demand. Virtually every single bank says
that.
Now, the borrowers
Mr. GREENSPAN. I'm not referring to short-term credit demands,
I'm referring to our policy. In other words, our ability to maintain
a stable policy since last September merely is the result of our
judgment that that's the appropriate stance given the outcome of
the economy.
The CHAIRMAN. Yes. But my point to you is if you've got continuing weak demand out there for credit that's not, in effect, taking
out larger and larger loans, doesn't that help keep the interest rate
down? Isn't the slack economy part of why your low interest rate
process is succeeding? You've got a sick economy.
Mr. GREENSPAN. The reason why we are as low as we are is precisely because the demand for loans and other financial instruments is subdued. And indeed, the problem that we have in the
longer run is in order to facilitate the repair of balance sheets, we
have been forced to bring rates in real terms below what we perceive is their equilibrium.
And the only issue that I am raising with respect to the question
of having to go back up at some point, and I frankly don't know
when that is, is that we're going to have to restore a balance. And
that will occur as we perceive that the balance sheet strain, which
is the reason why we are as low as we are, is beginning to unwind.
At that point, loan demand hopefully will be far more normal.
29
The CHAIRMAN. But with so much slack in the economy in so
many areas, that doesn't necessarily mean you're going to get an
inflationary surge when that happens. There's great pressure
downward on wage rates and on a lot of other things. And so, I
guess I want you again to identify for me, if you can, areas of the
economy where you see inflationary aspects. I see deflationary aspects.
Mr. GREENSPAN. That's true. They exist.
The CHAIRMAN. Well, which ones do you see that are in the deflationary category?
Mr. GREENSPAN. I would say we still have evidence of continued
either deflation or disinflation in the commercial real estate area.
We had, but we seem to be in a sort of relatively flat price stability
in residential real estate. There's a very slight upward movement,
clearly far less than we have perceived in the past.
Capital assets related to real estate have also been generally, I
would say, quite weak. And since they are a major part of our economy, that is a not irrelevant consideration. It shows up, I might
add, partly in the Consumer Price Index, in the owner-equivalent
rent, which is 19 percent of the total index, and which tends to reflect the market values of residential real estate. So it spills over
into these other indexes as well.
The CHAIRMAN. Apart from gold, and that's in a different category. We were told that the Chinese are buying gold for reasons
of their own, and that's distorting the market. I don't want to get
off into a discussion on gold unless you think it's highly relevant.
Setting that aside, are there other areas where there are embedded inflationary pressures within our economy today that we really
need to worry about, that are rearing their heads and where we
should right now take an early warning sign? Do you see it in
wages? Do you see it in energy costs? Do you see it in any of the
fundamentals
Mr. GREENSPAN. INods in the negative.]
The CHAIRMAN. You're shaking your head no.
Mr. GREENSPAN. I don't see them at the moment. The question
is not the current state. I said that about emerging inflationary
pressures after the episode earlier this year which might be explainable by the acceleration of economic activity late last year
which engendered the inflationary expectations that we pick up in
the various different surveys.
Excluding that, it's very difficult to find any particular area. Our
concern is not with the existing state, but to keep vigilance to make
certain that we do not allow elements of inflation to emerge to a
point that they will create imbalances, and it's there where we are
most concerned.
But you're asking factually, are there any immediate areas
where those problems exist? The answer is, aside from the
expectational areas, and gold would be in part in one of those, one
does not find it. And obviously
The CHAIRMAN. You don't find it?
Mr. GREENSPAN. Do not. I can find individual prices. Steel prices
have gone up. We've had a lot of commodity, different
commodity
30
The CHAIRMAN. But in terms of the thrust of my question, you
don't see it.
Mr. GREENSPAN. I do not.
The CHAIRMAN. All right. And I appreciate that. I'm about to finish and yield to Senator Bennett.
If, on the one hand, then, you're not able to identify pockets of
inflationary pressure that really concern you right now, but by the
same token, you do identify pockets of deflationary activity that
we're still working our way through.
When I hear that, that causes me to say that, on balance, we've
got probably more deflationary activity working its way through
than we do inflationary pressure.
Mr. GREENSPAN. The extent of decline that is currently going on
in the areas which you've called disinflationary, when averaged
against the other areas of the economy, do not produce inflationary
surges or real problems, but that doesn't mean prices are stable.
There are a number of areas of the economy which are rising.
Health costs, for example, are still rising. They ve come down from
their rate of increase and that's obviously quite encouraging. But
if you had an overall price index which would include both gross
domestic product items and capital items, the index would still be
going up, not down.
The CHAIRMAN, Well, I think you'll find out across the highways
and byways of America, just in terms of how people feel, not the
folks in suspenders on Wall Street and others, as important as they
may be to the system, but I'm just talking about rank and file citizens across the country. They re very uneasy. All the data shows
it. The most recent consumer confidence data shows it.
But these polls that show people with this great anxiety about
the future, say it another way.
I would say to you, for most rank and file citizens, in, terms of
their balance sheets, they see deflationary pressures or they're sort
of running in place.
Mr. GREENSPAN. That's basically the reason why the so-called
head winds are so important, that people who have found themselves in an overborrowed state, or
The CHAIRMAN. Or an underincome state.
Mr. GREENSPAN. Either an underincome or a falling asset state,
they have been pulling back. And that's not been an insignificant
element, and it is the reason why this recovery has been so extraordinarily subnormal.
The CHAIRMAN. Well, when you take somebody whose house values decline by 20 percent, and where both the husband and wife
are working and now one or both are out of work, it doesn't make
for a very happy outlook. And we've got more and more people in
that category.
Somehow, we've got to punch up the unemployment side of this.
I think the country s got to be able to feel better about its economic
prospects and it's got to be more widely shared.
We just can't have—one of the things that bothers me and this
may just be my philosophy—is that there are some people who are
really doing awfully well in the current circumstance and there are
a very large number of people who basically are sliding backward
and their living standards are being hollowed out, and we're not
31
doing much to change that, quite frankly, other than to exchange
polite commentary about it.
The public, I think, is getting very exasperated about it as measured by a lot of things.
Senator Sarbanes.
Senator SARBANES. Mr. Chairman, I'd just observe that it's the
people that are doing quite well that the President is calling upon
to make a contribution to the deficit reduction program.
The CHAIRMAN. And properly so.
Senator SARBANES. Because it is on them that, in effect, the increased revenue burden will falJ, And I think it is appropriate to
do that.
The CHAIRMAN. Senator Bennett.
Senator BENNETT. Thank you, Mr. Chairman.
Mr. Chairman—transferring the title—may I take advantage of
your being here to get a little insight, and as I indicated in my
opening statement, add to my own education?
We've seen a very clear demonstration in the committee here
today that the number-one concern around here is deficit reduction.
And we've had a lot of statements made for a lot of reasons about
the best way to do that.
Coming from where I come from, I see a circumstance that
strikes me as a clear win/win deficit reduction, a proposal that will
bring more revenue to the Treasury and stimulus to the economy,
which will produce, ultimately, more revenue to the Treasury. I'm
talking about the capital gains tax rate.
As I understand it, 15 percent of something is alot more money
than 28 percent of nothing. And we hold the capital gains rate at
28 percent. The Senate increased the capital gains tax rate prior
to going to conference on the reconciliation bill.
I think we're going to continue to get a high percentage of nothing when we could swell the Treasury if we were to lower the capital gains tax rate. But every time anybody says that, the computers that we use to make our decisions for us around here score it
differently than what I consider to be obvious common sense.
So I'm asking you, as an economist, as well as the Nation's
central banker, but maybe you'll have to put your banker's hat
aside and put on your economist's hat for a minute—first, am I
right that a decrease in the capital gains tax burden would produce
increased revenue for the Treasury, and stimulate the economy?
And if I am right, why don't the computers agree?
Mr. GREENSPAN. Senator, I've said before this committee on numerous occasions that my preferred position was a zero tax on capital gains, largely because I think it's an unproductive form of taxation. So I have not been focusing very closely on the whole issue
of revenues received from the tax, per se.
The reason why there are big differences in estimates is that
very small changes in assumptions create very large alterations in
the revenues that are received from the individual tax.
My impression is, looking at most of the standard models that
create those revenues, that they're probably substantially underestimating the degree of receipts that would occur.
But I've never argued that the reason to lower the capital gains
tax or index it retroactively or, in my case, preferably, eliminate it,
32
has had anything to do with the revenue question. It's an important element in engendering the type of risk-taking which I consider so crucial to the maintenance of an economic system.
I took special time to put in my prepared remarks here that I
view the economy as a continuously churning system, renewing itself very Quickly, a process which indeed seems to be accelerating.
And if that is in fact the case, then for us to maintain our international and domestic competitive edge, incentives to risk-taking
are essential.
As I said in my prepared remarks, a necessary condition for the
creation of wealth is risk-taking because you have to devise actions
to be taken in the future, and unless you do that, there's no way
to create wealth.
So I would argue that, as I have numerous times before this committee, we should look at this question far more closely than we
have.
Senator BENNETT. Well, I would certainly endorse a zero rate on
capital gains. I understand that's the case in a number of other
countries where their growth has been faster than ours. But as an
interim step toward that goal, would it make some sense to, either
through indexing past gains or lowering the rate, move—well, let
me
Would it make sense as an interim step toward that goal, to take
some kind of reduction?
Mr. GREENSPAN. Senator, I'm not going to talk about any of the
details of the existing budget discussions as I indicated when I was
here 6 months ago.
Since I have discussed this at great length prior to that, obviously, I would argue in favor of retrospective indexing, mainly on
the grounds that nominal capital gains are essentially the result of
two components. One is the real gain and the second is the depreciation of the currency. It strikes me that if one can make the argument that one should tax the real gain, it's very difficult to make
the argument that somebody should be taxed because the currency
is depreciating.
And it's in that context which I think that indexing capital gains
is a sensible approach, if the rate is going to be more than zero.
Senator BENNETT. I see. Thank you very much, Mr. Chairman.
The CHAIRMAN. Thank you.
Senator Sarbanes. And when I come to Senator Bond, I'm going
to give Senator Bond some extra time so that he can make an
opening comment.
Senator SARBANES. Mr. Chairman, I'd just point out, in light of
the discussion that just took place, that even on the premises of
Senator Bennett, that zero percent of something and 28 percent of
nothing, work out to the same, bring you out to the same point.
Mr. Chairman, the first thing I want to do is read into the record
a paragraph in your statement, of which you read only the first
sentence because I think it's important that the whole possible scenario be laid out. And I'm now quoting from your statement on
page 7:
Assuming, however, we constructively resolve over time the major questions about
Federal budget and health care policies—and let me interject, it's an important part
of the President's program, that the next step be to address the health care issue,
which would of course address some of the inflation concern you expressed with re-
33
spect to rising health care costs since the centra] element of the President's proposal
in that area will be health care costs containment. And that's the next step, to follow on the budget decision, and that has both important health care implications
and important economic and budget implications, as I think we all recognize. And
in fact, is the second piece to in effect bring the deficit down, actually to phase it
out over time.
That's the remaining part of the piece of the puzzle that has to
be put into place. The President is very much committed to that.
But let me just go back to your statement.
Assuming, however, we constructively resolve over time the major questions about
Federa] budget and health care policies, with the further waning of earlier restraints on growth, the U.S. economy should eventually emerge healthier and more
vibrant than in decades.
The balance sheet restructuring are both financial and nonfinancial establishments in recent years, should leave the various sectors of the economy in much better shape and better able to weather untoward developments.
Similarly, the ongoing efforts by corporations to pare expenses are putting our
firms and our industries in a better position to compete both within the U.S. market
and globally. And after a period of some dislocation, the contraction in the defense
sector ultimately will mean a freeing up of resources for more productive uses.
Finally, a creditable and effective fiscal package would promise an improved outlook for sustained lower long-term interest rates and a better environment for private sector investment.
All told, the productive capacity of the economy will doubtless be
higher and its resilience greater.
Now it's my understanding that this is in effect what the President is trying to achieve. The President is trying to achieve a credible and effective fiscal package which would promise an improved
outlook for sustained, lower, long-term interest rates and a better
environment for private sector investment. He's concerned about
enhancing the competitive ability of our firms and industries in the
U.S. market and globally.
He recognizes that while there is some dislocation in the contraction in the defense sector, and we've proposed a conversion strategy
to ease that dislocation and to shift those resources, those highly
trained and skilled people out of defense work over into the civilian
sector.
But as you say here, ultimately will mean a freeing up of resources for more productive uses. The balance sheet restructuring
will strengthen various sectors of the economy.
So out of all of that, I think will come an economy healthier and
more vibrant than in decades.
Now, obviously, the concern that's been expressed here, and
Chairman Sasser indicated it earlier, is that, as we try to address
this deficit problem that has been handed to the President, a very
large proportion, we at the same time have to be concerned of how
does the economy continue to move forward? And of course, we're
looking there for impetus on the monetary side in order to keep
this thing working.
Now let me just ask a few questions. I want to quote some of
your colleagues in the field. That's sometimes the best way to get
at some of these points.
Paul McCracken, only a day or two ago, in an article in The Wall
Street Journal, says—and I'm quoting him now—"there is no mystery about the unsatisfactory current performance of the U.S. economy."
34
The problem is a basic macropolicies we have been pursuing. Our
monetary policies have so limited the expansion of the money supply, that we have had a shrinking money stock in real terms. The
anemic pace of the recovery from the 1990-91 recession, is not
therefore surprising. You've got the economic performance that was
to be expected from the policies pursued.
Now, of course, you're just departing from M2. I just want to discuss that a bit. I'm not a big monetarist and I don't know necessarily that I get its passage from the scene. But, anyhow, it's the
standard that's been used and I want to just try to address it here
for the moment.
The red line is the—it's actually where M2 is. These dotted lines
were your previous targets, 2 percent to 6 percent.
As I understand it, the Fed has now revised the targets to these
blue lines, 1 percent to 5 percent. And I'm just a little curious, I
want you generally to address this quote of McCracken. I'd be interested. I m sort of curious why you didn't revise your targets
down a little further. So you could have gotten the red line up
above the blue line.
[Laughter.]
If you'd have done that, if you'd come in at Vz a percent to 5 percent or even 0 to 4 percent, you would have gotten your red line,
where your money supply is, in your target range.
I'm just struggling to understand why we didn't do that. I quote
this story thatMcCracken told in a hearing we had here about
these target ranges and about getting into them. And he says, and
I'm now quoting him:
Federal Reserve policy reminds me of that old story of the man who stopped for
gasoline at a station, noticed many targets on a building, each with a bullet right
through the bull's eye. And he said, "My word. Who is the marksman who can hit
it that way?'
The station attendant said, 'Well, he's the village simpleton and he's standing
right there. Ask him how he does it.'
And so, he was asked. And he said, 'Why, it's very simple. I shoot and then I draw
the target right around it.'
[Laughter.]
Well, you didn't quite do it here, and I just wondered why you
just didn't go ahead and do it, and we'd have had this red line up
above the blue line. You'd have said, we're within our target range.
Mr. GREENSPAN. The reason, Senator, is had we lowered it, you
would have read me that story. And I thought I was fending that
off.
[Laughter.]
But obviously, I failed.
[Laughter.]
But in all seriousness, the issue that is involved here is whether
or not M2 is and has been a valid indicator of economic performance in the last 2 or 3 years. The evidence as of, say, the end of
last year, would suggest that it was probably correct to assume
that M2 was becoming increasingly faulty. Six months later, it's becoming extraordinarily persuasive. And what I'm saying here is
that if M2 were functioning the way it had in the past, then Professor McCracken's viewpoint would be most appropriate.
But I think that M2 or the monetary aggregates have veered off
so significantly, that, indeed, if the old relationships were still in
35
place and we actually had numbers of the type that you show on
that chart, this economy would be going down in real terms.
What has happened is that what we used to relate was so-called
income velocity, which is income over M2, as a function of shortterm interest rates and the relationship was very close. You chart
those relationships now, income velocity goes straight up as interest rates go down, or technically, opportunity costs. And it is very
apparent visually that the relationship has completely broken
down.
My own impression is that the reason for that is largely the balance sheet problems that we have been having and I am not at all
convinced that when the balance sheets are repaired, that we will
not find that M2 is back where it used to be.
In other words, I have not yet given up on M2 ultimately. I'm
just saying, in this environment in recent years, because of the
very special nature of what's happening to the balance sheet, that
M2 is a very faulty indicator. And to use it as a measure of monetary policy is and has been inappropriate.
So, therefore, I would disagree with my old friend Paul
McCracken basically on technical reasons. It rests wholly on how
one evaluates the importance of the monetary aggregates. In my
view, that is the basis of his evaluation and the basis of his statement.
Senator SARBANES. Mr. Chairman, my time is up. Let me just
make this observation.
What you're now doing in your statement is substituting a new
sort of benchmark, which is this equilibrium interest rate. I'm not
sure this exercise is where we ought to be going. Why don't we simply take your unemployment projections, your growth projections,
and your inflation projections and discuss those as what ought to
be the goals or objectives of monetary policy? Then we can IOOK and
the Fed could say, well, we want to project this inflation rate with
this unemployment rate and this growth rate.
Now, people could start asking the question, well, wait a second.
That may not be the best mix. Maybe the mix ought to be a somewhat different inflation rate, a better unemployment rate, a better
growth rate.
It seems to me then we're dealing with real things that actually
impact very directly on people's lives and we could begin then to
discuss monetary policy in the context of broader economic policy.
I apologize.
The CHAIRMAN. Well, I want to go to Senator Bond. Do you have
a comment on that and we can come back to it.
Mr. GREENSPAN. I just merely wanted to indicate, Senator that
obviously, we look at all of these variables. But there are other
forces in the economy which move all of those key variables and
you can't really make the assumption because it's not credible, that
changes in monetary policy can do all of those various things.
But I certainly agree with you that, basically, there is a real
world out there and that when we use things like M2 or real interest rates, these are intermediate indicators to try to, in effect, finetune monetary policy, if I may use that term, to the real-world conditions. That does not mean that we are not looking or shouldn't
be looking at all of those real variables for obvious reasons that if
36
we had focused solely on M2, we would have no relationship to the
real economy, as I understand it now.
The CHAIRMAN. Let's come back to that.
Senator Bond, I've asked to double the time period for you because you've been very patient. If you need more time than that,
let me know.
OPENING STATEMENT OF SENATOR CHRISTOPHER S. BOND
Senator BOND. Thank you, Mr. Chairman. I hope to be able to
stir enough trouble in the time you've generously allotted me.
I apologize. I had wanted to be here to hear the entire discussion
today, but there was a mark-up in appropriations in a subcommittee on which I am the ranking member.
I welcome Chairman Greenspan. We always benefit from your
economic and monetary advice. Since, apparently, we have been
ranging widely over a number of areas, I would apologize if you
have already dealt with some of the areas that I would like to discuss. But for my own elucidation, I wanted to get your advice on
several matters.
There has been, rightly so, I think, much discussion from this
side of the table about the problems with the economy and unemployment and low incomes.
I believe that perhaps too much credit is being foisted upon monetary policy, whereas, in fact, I believe that fiscal policy and proposed fiscal policy has had a very significant impact.
And I will tell you that, anecdotally, as I have talked to people
in business in my State and I've had a lot of time recently to talk
with many people in my State, mostly looking at the floods, I have
heard businesses, businessmen and women, small businesses and
large businesses, saying, we are scared to death of the tax package
that you are about to foist on us and the possible burdens that new
taxes or new mandates of health care would put on us. And as a
result, we can't afford to make the decision to hire new people.
A small manufacturer of marble fixtures in the Springfield, Missouri, area told me that they had put off plans for a 50,000-foot expansion that would hire six more people because they felt that
these taxes and the burdens would make it unprofitable.
I've read recently in the summary of reports from the regional
Fed Banks, that in the St. Louis area, the decline in business confidence and consumer confidence was cited as a result of the pending tax bill, plus the prospects of health care reform, as being one
of the impediments to economic growth in the area.
I note that you said on page 6 that expectations of a significant
credible decline in the budget deficit have induced lower long-term
interest rates. But the positive influence is apparently at least
partly offset by some business spending reductions as a consequence of concerns about the effects of pending tax increases.
In addition—skipping down a couple of lines—uncertainty about
the outlook for health care reform may be affecting spending, at
least by that industry.
This is the long way of getting around to a question.
As I read the report, the day before yesterday, in The New York
Times, it seemed to imply that the Fed Chairman was saying that
37
we must approve the specific plan for a deficit reduction of $500
billion over 5 years.
As I have understood your testimony, you have not stated that
we need all these taxes. You have stated that we need to get our
fiscal house in order. Am I closer to the truth or is the previous
source which I mentioned closer to the truth?
Mr. GREENSPAN. First, as I've indicated here in February and repeated several times before the Congress, a credible—underline
credible—budget deficit reduction, in my judgment, is crucial to the
long-term health of this economy. There are a lot of important effects, including lower long-term interest rates.
Second, I have eschewed getting involved in the details of the
composition of the budget. I have hopefully stayed away from being
supportive of any particular vehicle that has come before the Congress, whether it be the President's or other initiatives that have
come before either house of the Congress.
I nonetheless indicated that I think there are certain principles
involved in how one comes at the problem. The major issue—I
think it was quoted by your colleague from Florida very much earlier—is that, under current law, expenditures are growing faster
than the tax base after defense expenditures bottom out in the latter part of the 1990's.
And it is clearly the case that unless we bring expenditure
growth back down to the growth of the tax base, we will not be able
to fundamentally solve the long-term burgeoning budget deficit
problem. But aside from that and a few other related arithmetical
questions relevant to budget deficit reduction, I've tried to stay
away from either commenting on any particular initiative, including the President's.
Senator BOND. But I do take it from your comments that you feel
a credible plan has to deal with the entitlement, the increase in entitlements or mandated spending that we see taking the deficit
back up again, even if the Congress were to adopt and the President to sign the tax increase package that is now in conference.
Mr. GREENSPAN. Yes. As I indicated to the House Banking Subcommittee on Tuesday, and actually here in February, the particular packages that are being discussed, even the $500 billion package, does not address fully the upturn in the deficit as a percent
of the gross domestic product in the latter part of the decade and
into the early part of the next century.
The problem that we have got is, arithmetically, that the excess
above the growth of the tax base is in Medicare and Medicaid, and
if one can bring those budget items into line with the growth of the
GDP in nominal terms, then that will be adequate to bring the expenditure level down.
However, if reform is unable to bend this very rapidly growing
share of Medicare and Medicaid as a percent of the GDP from
growing rapidly to being flat, meaning it still continues up, then
we'll be required to address other areas of the budget at the turn
of the century to make sure that total expenditures do not rise faster than the tax base because that's an unsustainable position.
Senator BOND. I would agree with you. And while we would like
to have your public support for the package that Senator Dole and
Senator Domenici introduced to eliminate the budget deficit by cut-
38
ting spending, we realize you are not doing that, but we also appreciate very much having on the record that you are not endorsing
the taxation plan put forth by the President or passed by the Senate.
I would note also that while we throw around the figures, $500
billion, everybody knows that $500 billion is smoke and mirrors
and there are elements which we've already enacted into law.
They're credit for interest savings. And the real tax cuts are a significant portion, the spending cuts—tax increases are a significant
portion, The spending cuts do not occur until 1997 and 1998.
I also wanted to comment on the question of—I guess it's the ultimate in static analysis.
Our colleague from Utah, Senator Bennett, said 28 percent of
nothing is nothing. My good friend from Maryland said, zero percent of a whole lot, I think he said, is equivalent to the same thing.
And that's the way I think the joint tax evaluates things like capital gains reductions because if you had zero capital gains or if
you've cut capital gains to 15 percent, setting aside the capital
gains tax revenues, would not the added incentive for risk-taking,
the freeing up of capital, provide economic growth and jobs that
would in fact add revenues to the Treasury, absent any of the revenues from capital gains?
Mr. GREENSPAN. Senator, that's always been my position and the
reason why I've argued that the effective rate on capital gains is
best at zero.
Senator BOND. Mr. Chairman, I appreciate that very much. I just
want to ask one quick question on the administration s Community
Development Bank bill.
The Community Development Financial Institutions would be, in
a sense, competing with regular financial institutions. Would that
have an impact on the CRA obligations of banks who are competing
with these Community Development Banks? And I apologize, but
I just wanted to get this on the record.
Mr. GREENSPAN. Yes. I don't think that that has as yet been fully
resolved by the administration. We'll have to await the specific recommendations that will be coming from the Treasury and from the
Comptroller of the Currency.
Senator BOND. Thank you, sir.
The CHAIRMAN. Thank you very much.
Senator Sasser, chairman of the Budget Committee.
Senator SASSER. Thank you very much, Mr. Chairman.
Dr. Greenspan, in your prepared remarks, which I read very
carefully prior to this meeting here today, and then listened to you
deliver, you point out that the drop in long-term interest rates following the aggressive deficit reduction program that the administration is now presently pursuing, that the drop in long-term interest rates have had a positive effect on the economy. You indicate
that in your statement.
But you also indicate in your statement, and this is disturbing,
that it's being offset at least partly by the effect of pending tax increases. Specifically, you say that business is reducing their spending in anticipation of some of the tax increases.
Now, there has been a very aggressive and unrelenting campaign—we saw some of it here today—mounted to convince Amer-
39
lean business and individuals that their taxes are going to go
through the roof.
I know of one poll run by a very reputable polling organization
that indicates that over one-half of the people, over 50 percent of
the people in this country think their income taxes are going to go
up, when, in fact, income tax rates are being increased on less than
2 percent of the population. Less than 2 percent of the population
are going to have their income tax rates go up.
Now on the business side of the ledger, this aggressive campaign
to misinform has gotten so out of hand, that The Wall Street Journal—of all publications, a highly respected publication, has had two
articles to dispel the view that small business is going to be smitten an economic death blow by these taxes.
They've got an article here entitled, headlined: "Foes of Clinton's
Tax Boost Proposals Mislead the Public and Firms on the Small
Business Aspects." They go ahead to indicate in the graph here
that with regard to small business taxpayers, only 4.3 percent are
going to see their taxes go up and a substantial percentage are
going to see their taxes go down.
Senator SARBANES. Would the Senator yield on that very point?
Senator SASSER. I'd be pleased to.
Senator SARBANES. In this very article, they had a small business
owner who came in at a news conference to complain about the
higher taxes. It turns out here taxes are not going to go up, not
going to go up at all under the Clinton program. In fact, they may
go down because there's some write-offs for small business that are
provided in the Clinton program and some other incentives for
small business. So a lot of small business people are in fact going
to end up paying lower taxes.
Now the Treasury doesn't dispute the fact that well-off small
business owners will pay higher income taxes, just as will well-off
bankers, orthodontists, and Exxon Corporation executives. But only
about 4 percent of those taxpayers who report some business income on their tax returns, and that includes partners in law firms
and investment banks, make sufficient money to be hit by the higher tax rates—4 percent.
And we're hearing this drumbeat that the taxes of small business
are going to go up. Four percent will go up and the taxes for a lot
of the others will go down because of the other small business features of the Clinton economic program.
Senator SASSER. Well, I couldn't agree more. And this propaganda effort is one of the most impressive I've seen. I think Joseph
Goebbels, if he was still around, would envy the effectiveness of
this propaganda campaign that's been unleashed across this country to misinform the American people about the magnitude of these
increases.
Now my question to you, Mr. Chairman, to the extent that the
American people have been mislead, and to the extent that businesses have been mislead in anticipation of these taxes, is this not
having a dampening effect on economic activity?
Don t you think that the perceived impact of these taxes is infinitely greater or much greater than the impact the actual proposals
under consideration will have?
40
Mr. GREENSPAN. We don't have evidence to make that judgment.
The only reason that we know that this phenomenon exists is we
pick it up anecdotally in our various surveys. We are picking up
a fairly broad amount of it.
But we have no way of knowing other than articles such as you
quote whether the individuals who are taking economic actions are
correctly or incorrectly evaluating what the potential tax would be
under the President's program,
Senator SARBANES. But it is plausible—if you're finding that you
think economic activity is being impacted by the expectation of this
measure, that if they are being given false expectations about what
the measure would do, that economic activity is then being falsely
inhibited, as it were, because people would then be acting because
they have a mistaken notion of what's coming. That's quite plausible, is it not?
Mr. GREENSPAN. The issue that I'm raising is I don't know the
extent to which people are misunderstanding the nature of the bill.
Senator SARBANES. Right. Well, clearly, from this story, a number of people are doing exactly that. A lot of small business people
think they're going to be hit by this thing, and now it's being explained to them that they're not going to be hit at all.
Senator SASSER. Mr. Chairman, my time is expired. But could
you yield me some more time in view of the fact that Senator
Sarbanes
The Chairman. By all means.
[Laughter.]
I willyield you
Senator SARBANES. Take that from my next round.
[Laughter.]
The CHAIRMAN. —more time.
Senator SASSER. I thank Senator Sarbanes for making these
points. They are very valid points and they are points that need
to be made.
I might say, anecdotally, to reinforce what you inferred that you
were picking up, as I go around my State, I have these—let everybody know I'm going to be in a certain place at a certain time. I'm
going to be in the courthouse in Lebanon, Tennessee, at 12 noon.
Anybody wants to come talk to me about something, they can come
there.
I'm being flooded by small business people coming in there, irate,
think their taxes are going to be raised through the roof. You sit
down and explain the proposal to them. First, there's disbelief because of what they've been picking up, newsletters that have been
mailed to them by small business organizations, grossly misinforming them.
Then when you finally convince them that their taxes are not
going to be raised or, indeed, they may go down, there's a sense of
enormous relief. So, anecdotally, I can testify to the fact that it's
out there. And I think it is having a chilling effect on business activity at a certain level, as you have indicated.
Now, Dr. Greenspan, we do see long-term rates coming down and
that's a matter of great satisfaction to all of us and I'm certain it's
a matter of great satisfaction to you and your colleagues at the Fed
41
because you have long advocated policies that would bring down
long-term rates.
There are some here who would like to derail this deficit reduction endeavor that we're all engaged in, or most of us, or a majority
of us are engaged in.
If those who wish to derail this deficit reduction effort are successful, let's just say in the next 2 weeks we can't pass the reconciliation, the budget reconciliation conference report in their
house.
In your judgment, what would be the reaction of the financial
markets to just a meltdown, and what would be the effect on the
economy?
Mr. GREENSPAN. As I indicated to a similar question in the
House the other day, it's clearly negative, Senator. I don't know the
order of magnitude or the dimensions, but the best I can judge,
there is built into the current long-term interest rate level an expectation that however this process evolves, at the end of it is a
credible budget deficit reduction, or one at least that materially alters the path. If that view is frustrated, I would suspect that rates
would work their way back up with clear negative consequences.
Senator SASSER. I think it's very important that someone of your
stature and prestige make that statement and that that be known
across the country and it be known here in this body, and in the
other house, that it is of crucial importance to the economy and to
long-term rates that we pass a package here that produces credible
deficit reduction.
One final short question, Mr. Chairman.
The CHAIRMAN. Could I just ask one thing related to that, if Senator Kerry will be patient with me?
As I understand that exchange, I take it that it would be your
view that the financial markets now, in sort of helping to set the
interest rate environment that we now see out there, are anticipating that a deficit reduction effort will be put in place that is very
close to the $500 billion that is on the table. That is now currently
essentially the basic market expectation, is it not?
Mr. GREENSPAN. I would say that the markets believe that some
credible budget deficit program, without specifying what the composition would be because I don't think you can tell that, will be
enacted.
The implication of veering off the standard of the $500 billion,
in my judgment, is clearly one which the markets would take quite
negatively.
The CHAIRMAN. Yes. Now, but related to that, if this process
were to hit the wall here and collapse at the present time—I mean,
the current timetable is to have this done within the next 2 weeks.
If that should not happen, if we should hit an impasse and this
thing goes into limbo, I would think that would create a real shock
to the financial markets, wouldn't it?
Mr. GREENSPAN. If it's not clear that the process is still functioning and is still likely to come up with a credible reduction at the
end of the day, then, yes, the answer is it would have quite a negative impact.
The CHAIRMAN. Thank you. Thank you, Senator Sasser. Now you
had one more thing you wanted to bring up.
42
Senator SASSER. One quick question because I'm impinging on
my friend, Senator Kerry, here.
Dr. Greenspan, I want to read a short paragraph from The Wall
Street Journal article. You'd think I was selling subscriptions to
The Wall Street Journal here today, but
[Laughter.]
Senator SARBANES. This is a news article, not an editorial, I take
it.
Senator SASSER. It is a news article. That's correct.
Dr. Greenspan, I want to read a short paragraph from The Wall
Street Journal article regarding your testimony before the House
Banking Committee, and then ask you a question about it. The
Wall Street Journal reporter quotes you as saying:
With unemployment still high, factories operating far from full capacity, and
international competition stiff, Mr. Greenspan made clear that the Fed doesn't see
any reason for inflation to get worse.
But he said that the Fed should respond to fears of inflation, even if unjustified.
Now, I have some difficulty in following that logic because if we
respond to unjustified fears, don't we run the risk, really, of validating those fears?
Would we be better advised to work diligently to dispel those unjustified fears and not fuel them? And I'm concerned about a substantial downside risk to responding to a phantom inflation out
there.
Mr. GREENSPAN. That is a shortcut of a statement I actually had
in my presentation today, in which I was reflecting the fact that
even inflation expectations which are unfounded could have significant effects.
For example, if there was a general, broad and inappropriate expectation of inflation on the part of a number of people in a wagebargaining stance and they, as a consequence, created a much
higher wage rate increase than would otherwise be the case, that
would feed into the system and could have a life of its own.
Now I was not saying that we should respond to that, I was
merely indicating that that is the context in which monetary policy
must function. Whether one responds or not really depends on
whether or not you think it's a bubble, whether you think responding will have any effect.
But I would certainly not argue that one would automatically respond to such a thing for exactly the reasons that you suggest.
Senator SARBANES. Would I be irrational if I were a labor negotiator at the bargaining table and someone said, well, look at this.
The Open Market Committee has shifted from a neutral policy to
an asymmetrical policy and they expect to perhaps raise interest
rates. The reason they expect to do that is they think there's going
to be an inflation problem.
And I say, ah ha. The Fed thinks there's going to be an inflation
problem. I'd better take that into account here at the bargaining
table as I try to negotiate my wage package. Consequently, the Fed
in effect helps to feed the inflation prospect instead of where I
might otherwise say, well, the Fed doesn't think there's going to be
inflation. They've got a kind of a neutral policy. I'm not going to
push you now on lowering the rates, but they've got a neutral pol-
43
icy and therefore, I don't have to build that into my bargaining expectations.
Mr. GREENSPAN. No, I think it's the other way around, actually.
If they perceive that we are vigilant and would suppress inflation
when it emerged, then my real wage increase does not have to be
augmented by an inflation premium.
But even having said that, just let me say that an asymmetric
directive is not an indication that we expect inflation to accelerate.
The purpose of that, as I indicated when I think you were out of
the room, is essentially in the event that it occurs. But we're not
projecting that it indeed will be the case.
Senator SARBANES. Well, it's Senator Kerry's turn. Both Kaufman and Samuelson, I'll come back to it in the next round, address
this very point and the answer you've just given. And it was their
conclusion to the contrary, that in fact, rather than dampening inflationary expectations, it may well contribute to that.
Mr. GREENSPAN. I must say I find no evidence to support that
view.
Senator SASSER. I'll defer to Senator Kerry. He has some charts.
The CHAIRMAN. Senator Kerry.
Senator KERRY. They're probably your charts.
[Laughter.]
Mr. Chairman, I want to pick up from where both Senator Sarbanes and Senator Sasser have been in this discussion, particularly
with the view to a paragraph on page 4, your third paragraph in
your testimony.
You asked the question, why, for example, despite an above-normal rate of unemployment and permanent lay-offs, have uncertainties about job security not led to further moderation in wage increases?
The answer that you offer us is the "deep-seated anticipations
understandably harbored by workers that inflation is likely to
reaccelerate in the near-term and undercut their real wages."
Now, again, I don't know many labor bargainers, nor do I know
many workers who have expressed any fear whatsoever to me or
to anyone that they are about to have their wages undercut by inflation. I'd like to show you a couple of charts that seem to contradict that notion.
Here are the real average hourly earnings of Americans from
1980 and this is their descent up until 1993. This is what's happened to the American worker.
Now that was not because of inflation in 1980 that that happened. It's because of the recession. It's because of the transition
in our economy. It's because of the lack of investment. The diminishment in productivity. It's a whole bunch of things. But certainly,
no American is going to sit there and say, inflation has hurt my
prospects in the last 10 years.
Moreover, real median family income in America, Mr. Chairman,
I don't think you would suggest that between 1940 and 1967, the
rate of increase was too low, would you? It was a rate of increase
of 2.8 percent.
Mr. GREENSPAN. 1947.
Senator KERRY. 1947 to 1967. From 1967 to 1973, it went down
to 2.6 percent to 2,8 percent a year. From 1973 to 1979, it was 0.6
44
percent. From 1979 to 1989, that 10 years during which the wages
went down, here's what happened to family income—0.4 percent increase.
And Mr. Chairman, 1989, 1990, and through now, it's decreasing.
That's what's happening to the wages of Americans, family income
of Americans.
Now you add to that the prospect of what's happening to the
work force, 1960-65, we had 25 percent of the work force with low
wages in America. And thanks to investment, thanks to growth in
the economy, that came down, until 1980. And in 1980, at the same
time as you have a diminishment in American wages, a diminishment in the hourly wage, a diminishment in the family income, you
have a very significant increase in the percentage of American
workers between the ages of 18 and 34 who are in low-wage jobs
and an increase in all workers in low-wage jobs.
Now I don't hear any of them, and none of these statistics support the notion that they're sitting around saying, oh, my God, inflation is going to undercut me. They're trying to catch up.
I really ask you to share with us what the meaning of these statistics is against their current predicament in the work place and
this marginal evidence, which, incidentally, was contradicted by
the May and June figures, I believe. It's not there.
Mr. GREENSPAN. Let me tell you exactly where that paragraph
is coming from. When we look at wage changes relative to various
measures of slack in the labor market, we find that the actual
change in wage compensation levels, in fact, is running somewhat
higher than past historical relationships would have suggested.
The question that we ask, why would that be so? What is a potential hypothesis? And this is one hypothesis which comes from
the University of Michigan survey of consumer attitudes in which
the question that is asked is what is your expectation of inflation
over the next year?
And as I cited in the paragraph just previous to this one, the expectation was
for a rise from the fourth quarter of last year a year
forward of 33/4 percent inflation, and this increased to 4Yz percent
in the second quarter.
So what I'm saying is how can we explain the fact that historical
relationships have veered off?
This is one potential explanation. Whether it's the only one, I
don't know. But the fact of the matter is we do have difficulty trying in our models and evaluations to explain why the rate of increase in compensation per hour is at the somewhat elevated level
that it is relative to where those models would have expected it to
be.
Senator KERRY. When you offer to us as a rational for a discussion about a tighter monetary policy and the potential of raising interest rates and sending the message that both Senator Sarbanes
and Senator Sasser have heralded as potentially having a countereffect. Yet, you have not a focus group or a poll in which you ask
a question of an American, do you think inflation may set in, given
the experience of the 1970's and given the general perceptions of
Washington, given the lack of success we've had in dealing with the
budget deficit. But I don't believe that is what is driving any bar-
45
gaming at the table or driving the fundamental insecurity that the
American worker has.
That security is driven and, in fact, their reaction to taxes is not
properly derived from an increase in taxes in America. Indeed, we
have gone from 70 percent down to 28 percent, and 33 percent for
some in the bubble. We've had the greatest reduction in the tax
burden in the history of this Nation. Yet, Americans think they're
overtaxed.
What you and others have not really addressed, I think, and
aren't addressing in this current predicament, is what those charts
show, which is really what Americans are indicating.
They can't pay for things because their wages are not buying as
much. They're working harder and less able to make ends meet.
And they're taking it out on taxes because that's the one horribly
evident place from which their money gets taken from them
unwillingly, but it is not in fact the problem, as increasingly, people are beginning to see.
Domestic discretionary spending has gone down as a proportion
of gross domestic product since the 1960's. We were spending 15
point some percent back then. Now we're at 11 point some percent.
What has gone up, we all know, are entitlements and interest on
the debt.
I think when you suggest here that the wage-earners—that inflation might come and there's a reason and the reason is that, as you
have put it, the answer appears to lie at least in part in the deepseated anticipations of workers that inflation is going to
reaccelerate, I just think you're wrong, Mr. Chairman.
The CHAIRMAN. Just before you respond, might I just add one
point to this because I think this sort of gets to the heart of a debate that we've been having here for some period of time.
I think the Fed has a great focus on balance sheets and John
Kerry's talking about what's happening on the income statement.
And those are the two documents that matter. If you have assets,
if you're in a situation where you've accumulated assets, you may
have more focus on the balance sheet, in some respects, than you
do on the income statement.
If you're somebody that works for a living and hasn't accumulated very much and your living standard is going backward and
you're not able to earn very much because your wages are dropping
or because your spouse in the family has lost their second job, it's
a job and it's the income side that you really have to focus on.
And I think, unfortunately, there's an elitism that's gotten embedded in our policy where we think much more about what's happening to the person who's got a large accumulation of assets and
how they feel about inflation than we do about the question of this
hollowing out of the job base of the country, and that more and
more people can't earn a decent living.
I don't know how we get them into the equation. But I don't
think they've been put into the equation and I think your charts
are absolutely on the money.
I thank you for yielding.
Mr. GREENSPAN. I must disagree, seriously. The issue that we're
raising here in this paragraph is a very narrow statistical question.
46
If you're asking me am I aware of the elements that are involved
in the labor markets, the very great difficulties that have emerged,
the issue of temporary employment, the insecurities that are involved, all of the various things that we pick up in all of these various surveys, let me say to you that I am acutely aware of that and
process that all the time.
We look at the questions of the income distribution effect that
Senator Kerry was raising and these are crucial aspects of the way
the American economy is evolving.
The issue that is addressed here is a very narrow statistical
question that gets to the point that the inflation in the early part
of the year, which I must say occurred at higher levels both in compensation and in prices than past history would have indicated, requires that we ask ourselves why? What is there different about
the current period than in past years? And all I am saying is, what
evidence we have—and I grant you, it may not be conclusive—does
suggest that individuals who are reporting to the University of
Michigan survey—and it's the best source of data that we have—
indicate a rate of inflation expectation which is greater than one
would ordinarily expect coming out of our evaluations.
I'm saying that what we're raising here or what I'm putting in
the text is an endeavor to explain an analytical phenomenon. We
are surely not insensitive to questions that you raise and indeed,
I'm quite familiar with the data.
Senator KERRY. Well, did it occur to you or does it occur to you
that the average American or anybody answering that kind of survey would lump under the concept of inflation because they don't
have an understanding of all these other things happening, all
these other things?
Mr. GREENSPAN. Yes, of course.
Senator KERRY. But that doesn't mean that that should be expressed as a rationale for your policy because you know better.
Mr. GREENSPAN. No, it's not—this is not an issue of our policy.
This is an analytical question of endeavoring to try to understand
why the
Senator KERRY, The very next sentence says, "The Federal Open
Market Committee became concerned that inflation expectations
and price pressures, unless contained, could raise long-term"
Mr. GREENSPAN. That's correct.
Senator KERRY. This is the rationale.
Mr. GREENSPAN. No, no. But it's the overall expectations question generally. Now observe that what we're trying to say is the
only explanation that we could surface as to why these data were
behaving the way they were was this break between the fundamentals, on the one hand, and prices, wages, and other elements on the
other.
The only thing that's in the middle is psychology. And so we're
asking the question, is it credible that what we are dealing with
is an inflation psychology issue?
Senator KERRY. I understand that.
Mr. GREENSPAN. And that's the reason why the
Senator KERRY. My time is expired. I truly do understand that.
But what you are saying on this page, and what you've said in the
preceding page in the preceding paragraph—the role of expecta-
47
tions in the inflation process is crucial. And as Senator Sarbanes
and Senator Sasser said, you're reacting to this possibility, to the
fear.
Mr, GREENSPAN. If certain events occur to create not only an inflation psychology, but real inflation as a consequence, then we
might—and I underline the word might—have to react because if
we don't, then we are risking an upturn in long-term interest rates
and a decline in the economy.
Senator KERRY. I understand. But there is such a thing as deflation, is there not? There is such a thing as deflation.
Mr. GREENSPAN. Of course.
Senator KERRY. And what I have shown you are curves that
show deflation. The minute you turn around from the deflation, in
a sense, and come back to a level of equilibrium, the fact that
you've gone up to get there doesn't mean you're in an inflation
cycle.
Mr. GREENSPAN. I agree with that.
Senator KERRY. But you're beginning to treat it and your statistics treat it as if you are.
Senator SARBANES. That's right.
Senator KERRY. So you automatically react right away and say,
oh, my God, we've got to maybe contract and send the message that
interest rates may go up and everybody says, uh oh, that's going
to condition a whole set of behavior.
What we're trying to say to you, Mr. Chairman, very respectfully,
because I know you're better at this than I am and you know more
about it than I do, but just from my common sense and lay person's
approach, I am deeply concerned that that kind of foundation for
your approach is not taking into account thoroughly what has really happened out there in the last 10 years and what is.
Also, the global aspect of it, which we haven't even—I haven't,
certainly—touched on with you. Clearly, we can't impact that from
a fiscal approach. And the interrelationship is so significant, John
Keynes said that there's an inevitability to a capitalist system ultimately providing more supply than demand. That's what we've got
in the world now. How do you kick in the demand?
Well, if we're contracting fiscally, and we're cutting as we are,
and we're going to raise a little tax, that's not so good for the demand side. So where are you left?
It seems to me that you're left on the monetary side. And if the
monetary side is talking about suddenly holding back the brakes
or putting on the brakes, we've got a big problem, I think.
Mr. Chairman, thank you for the extra time.
The CHAIRMAN. I want to make sure you've had the time you feel
you need because others have taken time. So if you need more
time, we'll certainly accommodate you.
Senator KERRY. No. I appreciate it. I'm late for everything I have
to do.
The CHAIRMAN. All right. Very good.
Senator Sarbanes.
Senator KERRY. I appreciate it.
Senator SARBANES. Well, Mr. Chairman, I want to commend Senator Kerry because I think he's really pursued a very important
line of questioning. I want to follow up with it. And I want to do
48
it by making reference to the testimony we received only a few
weeks ago from Henry Kaufman, who is regarded as a distinguished analyst of economic conditions. I want to suggest very respectfully to the Chairman that there is a quite reasonable and rational body of opinion that is taking issue with the Fed, at least
up to a point.
At the outsides of this debate, I don't think there's a difference.
But in the middle of it, there's some difference and that's important
because we're in a very critical stage with respect to the economy.
We're going to try to do a major deficit reduction program which
you've sat at the table and told us is absolutely necessary. We are
coming to grips with issues that have been ducked for a long time.
It's being done in a very balanced way and it involves a lot of tough
decisions, contrary to the drumbeat in here today about no spending cuts. That's not correct.
In fact, this package has more spending cuts in it than it has tax
increases. But it's an effort to put the two together in order to have
a very significant, credible deficit reduction program.
But for it to work to reduce the deficit, let alone provide jobs and
economic growth, the economy has to keep moving. And if we're
going to constrain fiscal policy, the only place we can find to get
economic movement in the economy is from an accommodating
monetary policy.
Now Kaufman said, and I'm going to quote him, not at great
length, but at some length because I want to get this thinking out
and give the Chairman a chance to respond to it. He says:
I believe that in the global context that I have described, the Federal Reserve
should be able to pursue these joint objectives for at least the time being by maintaining the present degree of monetary accommodation.
The joint objectives he's talking about are sustained economic expansion and continuing downward pressure on the rate of inflation.
He thinks those joint can be accomplished with the present degree
of monetary accommodation.
It may also find the opportunity of taking advantage of the coming global deescalation in interest rates to edge the Federal funds rate somewhat lower, particularly
if the U.S. dollar continues to display the kind of strength in the foreign exchange
markets that it has in recent days.
Then he goes on to say:
What I do not favor is a preemptive move toward restraint on the pretext that
this would somehow shore up the Federal Reserve's credibility in the financial markets and in so doing, relax market concerns about inflation prospects.
I have great doubts about conditioning policy on something as ill-defined as the
notion of credibility. It is a policy argument that has an unfortunate tone of selfrighteousness rather than a firm analytical grounding. As a policy position, it is especially bizarre at the present time when, if anything, the financial markets have
shown themselves to be quite comfortable with the overall stance of monetary policy.
He says:
I also reject the proposition that a modest rise in the level of the Federal funds
rate would have little significance for the economy, and so that such a preemptive
move by the Federal Reserve would be costless. To the contrary, a higher Federal
funds rate would translate into higher interest payments by businesses and households, specifically those with adjustable rate mortgages, a higher dollar in the foreign exchange markets, and some downward pressure on share prices.
All would weaken growth prospects.
And then, finally:
49
I also take issue with the assertion that a small increase in the Federal funds
rate this summer would be welcomed by the financial markets and would accordingly lead to a decline in bond yields. Perhaps. But equally likely is that the bond
market would interpret such a rise in the Federal funds rate as the first of a number of future increases and market participants might easily react by pushing bond
yields higher.
Maybe such a preemptive move would reassure the financial markets that the
Central Bank was determined to quell inflation, and so would reduce inflationary
expectations. But it is equally likely that the market would suspect that the Federal
Reserve was in possession of information not yet publicly disclosed, indicating the
upcoming new inflation news was going to be sour. Under that scenario, the rise
in the Federal funds rate could magnify inflationary expectations, precipitating a
sell-off of bonds.
Then we get the story the day after you testify earlier in the
week, "Long Rates Soar as Aftershock of Greenspan's Speech Takes
Toil on Bonds."
Mr. GREENSPAN. What's the source of that?
Senator SARBANES. The American Banker.
Mr. GREENSPAN. Because, you know, I looked at the rates. Longterm rates actually, as I recall, didn't they go down or were unchanged, essentially unchanged from the time when my presentation was made to the end of the day?
Senator SARBANES. I'll read you the article. The article may be
inaccurate, and if so, I'm happy to be corrected.
Long-term interest rates surged Wednesday, a belated reaction to Federal Reserve
Board Chairman Alan Greenspan's inflation alarm of the day before. Market analysts said concern about upcoming sales of Treasury securities and heavy issuance
of competing long-term debt by corporations also exerted pressure.
I want to lay it all out here.
In late trading, the price of the Government's 30-year bond fell Vsths of a point,
raising the yield
Mr. GREENSPAN. No, that was yesterday. In other words, is that
today's paper?
Senator SARBANES. This is July 22.
Mr. GREENSPAN. Yes. Let me
Senator SARBANES. That's today's paper and it's about what happened yesterday. You testified on Tuesday.
Mr. GREENSPAN. Yes, but
Senator SARBANES. Let me just finish the quote and then I'd be
happy for you
Mr. GREENSPAN. Sure.
Senator SARBANES. And they then go on to indicate the changes
that took place. The Wall Street Journal says:
Bond Prices Plunge on Wave of New Issuance. Concerns About Fed's Policy on Interest Rates. Also contributing to the plunge were concerns about the Federal Reserve's policy toward interest rates in the wake of Fed Chairman Alan Greenspan's
comments to the House Banking Committee on Tuesday.
Mr. GREENSPAN. I'm reading The Wall Street Journal here and
it basically says:
Yesterday, the bond market was assailed on several fronts. Analysts said traders
knocked prices of long-term bonds lower on fears that the Clinton administration's
deficit reduction plans may hit some snags.
This is page C-l of today's Wall Street Journal.
I will say this
Senator SARBANES. I want to find the page from which this article comes and I'll give that to you shortly.
50
Mr. GREENSPAN. That would be helpful. The Wall Street Journal,
I presume, would be saying the same thing in the same place.
Senator SARBANES. Well, we've got to read our Journal very carefully here.
[Laughter.]
This article, as I said, "Bond Prices Plunge on Wave of New Issuance, Concerns About Fed's Policy on Interest Rates."
Mr. GREENSPAN. That's today's paper?
Senator SARBANES. Yes*, page C-21, Wall Street Journal, Thursday, July 22.
Mr. GREENSPAN. I think they ought to perhaps talk to each other.
[Laughter.]
Senator SARBANES. Yesterday's paper, July 21, on page C-l,
says:
Stock and bond prices tumbled after Mr. Greenspan told the House Banking Committee that although inflation moderated in May and June, overall inflation news
had been disappointing because of increases earlier in the year. Bond traders drove
the price of the Treasury benchmark 30-year issue down more than half a point,
et cetera.
That's Wednesday, July 21, page C-l. The other article is Thursday, July 22, page C-21.
Mr. GREENSPAN. And I will say that it immediately recovered.
What happened was that bond dealers were selling, but the retail
trade obviously came in and bought. At the end of the day, the
bond market was unchanged.
But the truth of the matter is here we're all guessing
Senator SARBANES. I thought the bond market was down—at the
end of yesterday, it was unchanged?
Mr. GREENSPAN. Unchanged. At the close of business on
Tuesday
Senator SARBANES. How about yesterday?
Mr. GREENSPAN. Yesterday, the bond market was down about
%ths of a point.
Senator SARBANES. OK. Sometimes it takes time for your—I
don't quite know how to describe them.
[Laughter.]
For your comments to sort of make their way through.
Mr. GREENSPAN. Perhaps I'd better speak more quickly.
[Laughter.]
Senator SARBANES. These articles are here and we quoted one
another the relevant pages. But what about the basic argument
that Kaufman's making, Kaufman and Samuelson made?
Mr. GREENSPAN. Yes.
Senator SARBANES. It seemed to me to be an argument with a
good deal of merit to it.
Mr. GREENSPAN. First of all, let me say, I don't know where this
concept of a "preemptive strike" comes from. That's not monetary
policy. I don't understand it.
If he's raising the questions about rates, there are occasions
when short-term rates go up and long-term rates go up, and sometimes short-term rates go up and long-term rates go down, that's
a factually correct statement. Indeed, I would say most of what you
quoted from Henry Kaufman I happen to agree with, with respect
to an evaluation of what is going on.
51
We probably disagree on the question of his basic notion of monetary policy with respect to the international coordination. But it's
an arguable case.
It is a potential policy instrument, policy initiative directed at a
specific type of problem. One may argue that one should do it or
one should not do it. But those are very technical questions and I
can't say to you I can argue strenuously on either side. It's a debatable question.
Indeed, we debate these issues all the time. And I don't want to
subscribe to everything that Henry Kaufman said. There are some
things I do disagree with. But as the general rule, I think he's talking the same language we all talk.
Senator SARBANES. Thank you, Mr, Chairman.
The CHAIRMAN. Let me just finish today, Chairman Greenspan,
by saying you've been very patient, as you always are, and we appreciate that and we appreciate the way in which you're willing to
engage us in serious discussion here.
Obviously, the participation by Members today is another illustration that you've seen times before about the fact that we care
very deeply about these issues. We want to try to reach some meeting of the minds, to the extent that that is possible, given the fact
that we have oversight here and you function in an independent capacity.
I want to just finish with this point. I don't want to be misunderstood on what I said before because my point about the focus on
the balance sheet versus the income statement was not directed
and anchored narrowly on that one technical point.
I think there is a built-in, long-term bias in our economic policy
at the top of our Government and I think it's true at the Fed, to
care more about balance sheets than to care about income statements, and to care more about people who hold assets than those
that are struggling to try to acquire some assets and pay the bills.
Now, you may not like that characterization
Mr. GREENSPAN. No. I hope it's not true.
The CHAIRMAN. Well, I hope it's not true, too. But it sure tends
to feel and look that way. And especially in light of the data that's
accumulated both prior to your watch, the long-term, gut-level data
in terms of how the economy is functioning for real people and real
families who never get their name in the paper versus how it
works as you come on up the income and asset scale.
And we all know that policy around here tends to get driven by
who has the power and who has the influence and it's nothing new.
We've seen it over a long period of time.
I hear all this talk about preparing balance sheets, and we've
done a Jot of work here with you to write law to prepare bank
sheets and other balance sheets in every way we can. I think we've
made a lot of progress in that area.
You've got a terrible problem with income statements for rank
and file people in the country, and I don't see much sign that that's
on the Fed's radar screen. It may be in some amorphous, sort of
broad level way. But in terms of really articulating it and driving
policy to make sure that income, job-producing income is making
its way to a large number of people in the country, the full employment side of the charge, and I don't mean people who are counted
52
as employed who work 1 hour a week, as our data now allows them
to be counted as employed if they work 1 hour a week. But people
who are in fact work and not working sliding down a real income
curve such as John Kerry had a minute ago.
That's why I think you're seeing so much disillusionment in the
society. It's not so much a matter of people feeling that their asset
base is washing out from under them, although there is some drop
in residential rates and so forth. It is that their earning prospects
in the future for themselves and their children are looking mighty
bleak.
I mentioned earlier today the student coming out of the University of Michigan with a straight 4.0 and all of the good extracurricular activities, the family sacrificing, the student working
their way through school, coming out unable to find a job, move
back in with dad and mom. Pretty disillusioning. And that is more
and more the story of what's going on out there.
Somehow or another, we've got to get more job growth going. I'm
not saying that is the responsibility of the Federal Reserve Board
alone or even your overwhelming responsibility. But I have to tell
you that I see too little emphasis in that area, in deference to a
concern of other sorts. We've got to have more people at work earning incomes here in America, not in Mexico or Japan or Timbuktu,
but in this country.
We don't have a very good policy mix in place to get that to happen. It's very difficult because there are a whole lot of factors at
work at the same time.
I would like to see a Federal Reserve Board and Federal Reserve
Board leadership, not just from you, but from the others, that are
asking themselves the question, how do we get a real surge in job
growth and real income growth for people in America, people who
have very modest balance sheets or no balance sheets, but who we
would like to have after 5 years or 10 years have a balance sheet
where they can not only pay their bills for their family and their
health care costs, but to accumulate some money in a 401(k) or retirement account and have some prospect of having a decent retirement.
That is receding from more and more people in this country at
the present time, and it's a source of great anxiety and anguish to
people that they are in that circumstance. And it's relatively new.
We did not experience that in the rush after the end of World War
II. But as we've gotten into the 1980's and now into the 1990's,
that is more and more the story for a growing number of people
in this country no matter how hard they work or how much they
prepare themselves to go out and work.
I talk about the new graduates. I've got workers in Michigan
with 10 or 20 or 30 years of seniority, every bit as talented and
smart as any of us in this room today, who are now thrown out of
the work force and cannot find comparable work and have been
pushed down the wage scale and are compressed down toward the
minimum wage scale of living. It's very, very destructive to our
country and to our future and to them.
That is part of what's coming back through that University of
Michigan data. The University of Michigan data is reflecting a de-
53
teriorating sense of well-being about the economic future for themselves and for their kids.
We've got to do something that finally works its way back
through to the job side. I'd like to almost have another hearing
where we didn't talk for 1 minute on inflation and we talked for
maybe 3 hours about what it takes to get a significant spurt in job
growth in America and how the Fed sees that happening, and how
you're planning for it, and how your policies are designed to cause
that to happen and what your employment growth goals are in
Federal Reserve policy, and how we move ourselves to a point of
full employment, how we get the unemployment rate below 6 percent and without the phantom counting of people who, in a sense,
are working part-time or a fraction of the week who end up being
recorded as employed, when, in fact, they're not employed.
So that's part of the tension I think we all witnessed in the last
election. The fact that Clinton got 43 percent and Perot got 19 percent and the incumbent administration got the relatively modest
amount that was left, I think was principally rooted in this economic anxiety.
Somehow out of this, we've got to come up with a formulation
that gets job growth going again here in America. We need American jobs. We need a lot of them and we need them at higher income levels. If the Fed can help us get that going for just the part
that you can play, you will have done a tremendous service to this
country.
Senator SARBANES. Mr. Chairman.
The CHAIRMAN. Senator Sarbanes.
Senator SARBANES. I just want to add to what Chairman Riegle
has said.
In your own statement, the Fed is expecting unemployment to
edge lower to around 63/4 percent by the end of this year, and to
perhaps a shade lower by the end of next year. That's your own
sort of working premise on unemployment.
Now obviously, we think that's inadequate. We're very concerned
by that.
Mr. GREENSPAN. I would say that so do we.
Senator SARBANES. Let me finish. For this year as a whole,
FOMC participants see inflation at or just above 3 percent and
most of them have about the same forecast for next year.
Now I would submit to you, Mr. Chairman, with this kind of expectation on the unemployment rate and this kind of expectation
on the inflation rate, the FOMC's current monetary policy ought
not to be asymmetrical in the direction of tightening interest rates,
tilting toward higher short-term interest rates.
I know you didn't act off the May 18 directive, as it were, but,
nevertheless, that represented the tilt. It would seem to me—I
frankly think you should tilt in the other direction. But, at a minimum, it seems to me, in the light of these expectations, on the unemployment rate and the growth figure to which the unemployment rate is related, and your expectations on inflation, the policy
ought to be symmetrical. Because I would read these figures and
say to myself, well, you know, we constantly worry about inflation.
I don't want to minimize that.
54
But looking at these figures, I'd have to say that the more pressing problem—both problems are always there. But with these figures, the more pressing problem is how to bring this unemployment rate down. And obviously, if we constrain fiscal policy, our
only recourse, in a sense, is to get a monetary policy that helps to
provide some economic activity.
I think that's why Senator Riegle is saying there's a perception
that there's a disconnect between the thinking of the Fed in its
board rooms and sort of what's happening to the ordinary American out on the street in terms of jobs.
I don't say you're not concerned about it. I certainly think you're
concerned about it, you personally. And I would hope that that exists within the Fed system, although I think there are some people
within the system who don't recognize the unemployment as a reasonable goal and think their only goal is the price level and want
a zero inflation rate. That's their working premise.
But it seems to me, given where we are now, given your own projections here, it really calls for—I don't know what you did at the
July meetings because we don't know those results. But I don't
think that a current tilt toward higher interest rates is warranted
under the economic circumstances.
The CHAIRMAN. We now have, Chairman Greenspan, more people
on food stamps in America than we've ever had in our history, just
to give you one very powerful statistic as to what's going on out
there where people live and are trying to get by each day.
The other day, and I'll finish with this, the other day I went back
to my old neighborhood on the east side of Flint, Michigan where
I grew up. It is on the industrial east side where everybody worked
in the Buick auto plants. And on the corner of Franklin and Dakota Avenue, five houses down from where I spent the first 20
years of my life, in a street full of small, bungalow houses, there
is a 24-hour-a-day laundromat on that corner. And as I saw it and
thought about it, it dawned on me that the reason it's there is that
many, many people in the neighborhood now can't afford to have
their own washing machines where they live.
We pretty much all had washing machines, the old Maytag kind
with the roller to wring out the water 40 years ago when I was
growing up in that neighborhood. But today, a larger and larger
number of people in that neighborhood can't afford something as
basic as a washing machine. So they're going down to the corner
and dropping their quarters in to wash their clothes in a 24-hourday laundromat.
To me, it was a very powerful illustration of the fact that we're
sliding backward. Now I grant you, that is a tiny, microfact. But
we could stay here for the next 5 months and I could fill in the picture with other illustrations that are as powerful as that, like the
food stamp rolls today.
So I would ask you to take the message back to some of the other
people on the Fed who probably aren't having difficulty finding jobs
for their kids, if their kids are of employment age, and who may
be up on an economic plateau where all-night laundromats in
neighborhoods like I'm describing in Flint are very far removed
from what they might otherwise see or know.
55
We've got to have more jobs in this country and there is an obligation for everybody on that board to care about it and to have that
factor in, every bit as much as any other single element, whether
it be inflation-fighting or any other one item that anybody wants
to talk about.
The people are waiting for that. They're expecting that. Even
though you folks are not elected directly by the public, there is an
accountability factor there and I hope everybody around that table
understands it. I think you do. And so, I'm not making the comment to suggest otherwise. But I have less confidence when it
comes to the rest of the crowd.
Thank you very much.
On the vote on the nomination of Alan S. Blinder, to be a member of the Council of Economic Advisers, the Clerk will call the roll.
The CLERK. The Chairman.
The CHAIRMAN. Aye.
The CLERK. Mr. Sarbanes.
Senator SARBANES. Aye.
The CLERK. Mr. Dodd.
Senator DODD. (Aye, by proxy.)
The CLERK. Mr. Sasser.
Senator SASSER. Aye.
The CLERK. Mr. Shelby.
Senator SHELBY. (Aye, by proxy.)
The CLERK. Mr. Kerry.
Senator KERRY. Aye.
The CLERK. Mr. Bryan.
Senator BRYAN. (Aye, by proxy.)
The CLERK. Mrs. Boxer.
Senator BOXER. Aye.
The CLERK. Mr. Campbell
Senator CAMPBELL. (Aye, by proxy.)
The CLERK. Ms. Moseley-Braun.
Senator MOSELEY-BRAUN. (Aye, by proxy.)
The CLERK. Mrs. Murray.
Senator MURRAY. (Aye, by proxy.)
The CLERK. Mr. D'Amato.
Senator D'AMATO. Aye.
The CLERK. Mr. Gramm.
Senator GRAMM. Aye.
The CLERK. Mr. Bond.
Senator BOND. Aye.
The CLERK. Mr. Mack.
Senator MACK. Aye.
The CLERK. Mr. Faircloth.
Senator FAIRCLOTH. Aye.
The CLERK. Mr. Bennett.
Senator BENNETT. Aye.
The CLERK. Mr. Roth.
Senator ROTH. Aye.
The CLERK. Mr. Domenici.
Senator DOMENICI. (Aye, by proxy.)
The CLERK. The vote is unanimous, Mr. Chairman. Nineteen
ayes.
56
The CHAIRMAN, Very good. Next, we will vote on the nomination
of Joseph E. Stiglitz, to be a member of the Council of Economic
Advisers.
The Clerk will call the roll.
The CLERK. The Chairman.
The CHAIRMAN. Aye.
The CLERK. Mr. Sarbanes.
Senator SARBANES. Aye.
The CLERK. Mr. Dodd.
Senator DODD. (Aye, by proxy.)
The CLERK. Mr. Sasser.
Senator SASSER. Aye.
The CLERK. Mr. Shelby.
Senator SHELBY. (Aye, by proxy.)
The CLERK. Mr. Kerry.
Senator KERRY. Aye.
The CLERK. Mr. Bryan.
Senator BRYAN. (Aye, by proxy.)
The CLERK. Mrs. Boxer.
Senator BOXER. Aye.
The CLERK. Mr. Campbell.
Senator CAMPBELL. (Aye, by proxy.)
The CLERK. Ms. Moseley-Braun.
Senator MOSELEY-BRAUN. (Aye, by proxy.)
The CLERK. Mrs. Murray.
Senator MURRAY. (Aye, oy proxy.)
The CLERK. Mr. D'Amato.
Senator D'AMATO. Aye.
The CLERK. Mr. Gramm.
Senator GRAMM. Aye.
The CLERK. Mr. Bond.
Senator BOND. Aye.
The CLERK. Mr. Mack.
Senator MACK. Aye.
The CLERK. Mr. Faircloth.
Senator FAIRCLOTH. Aye.
The CLERK. Mr. Bennett.
Senator BENNETT. Aye.
The CLERK. Mr. Roth.
Senator ROTH. Aye.
The CLERK. Mr. Domenici.
Senator DOMENICI. (Aye, by proxy.)
The CLERK. The vote is unanimous, Mr. Chairman. Nineteen
ayes.
The CHAIRMAN. Next, we will vote on the nomination of Arthur
Levitt, Jr., to be chairman of the Securities and Exchange Commission.
The Clerk will call the roll.
The CLERK. The Chairman.
The CHAIRMAN. Aye.
The CLERK. Mr. Sarbanes.
Senator SARBANES. Aye.
The CLERK. Mr. Dodd.
Senator DODD. (Aye, by proxy.)
57
The CLERK. Mr. Sasser.
Senator SASSER. Aye.
The CLERK. Mr. Shelby.
Senator SHELBY. (Aye, by proxy.)
The CLERK. Mr. Kerry.
Senator KERRY. Aye.
The CLERK. Mr. Bryan.
Senator BRYAN. (Aye, by proxy.)
The CLERK. Mrs. Boxer.
Senator BOXER. Aye.
The CLERK. Mr. Campbell.
Senator CAMPBELL. (Aye, by proxy.)
The CLERK. Ms. Moseley-Braun.
Senator MOSELEY-BRAUN. (Aye, by proxy.)
The CLERK. Mrs. Murray.
Senator MURRAY. (Aye, by proxy.)
The CLERK. Mr, D'Amato.
Senator D'AMATO. Aye.
The CLERK. Mr. Gramm.
Senator GRAMM. Aye.
The CLERK. Mr. Bond.
Senator BOND. Aye.
The CLERK. Mr. Mack.
Senator MACK. Aye.
The CLERK. Mr. Faircloth.
Senator FAIRCLOTH. Aye.
The CLERK. Mr. Bennett.
Senator BENNETT. Aye.
The CLERK. Mr. Roth.
Senator ROTH. Aye.
The CLERK. Mr. Domenici.
Senator DOMENICI. (Aye, by proxy.)
The CLERK. The vote is unanimous, Mr. Chairman. Nineteen
ayes.
The CHAIRMAN. Very good. Next, we will vote on the nomination
of Richard Scott Carneli, to be assistant secretary of the Treasury
for Financial Institutions.
The Clerk will call the roll.
The CLERK. The Chairman.
The CHAIRMAN. Aye.
The CLERK. Mr. Sarbanes.
Senator SARBANES. Aye.
The CLERK. Mr. Dodd.
Senator DODD. (Aye, by proxy.)
The CLERK. Mr. Sasser.
Senator SASSER. Aye.
The CLERK. Mr. Shelby.
Senator SHELBY. (Aye, by proxy.)
The CLERK. Mr. Kerry.
Senator KERRY. Aye.
The CLERK. Mr. Bryan.
Senator BRYAN. (Aye, by proxy.)
The CLERK. Mrs. Boxer.
Senator BOXER. Aye.
58
The CLERK. Mr. Campbell.
Senator CAMPBELL. (Aye, by proxy.)
The CLERK. Ms, Moseley-Braun.
Senator MOSELEY-BRAUN. (Aye, by proxy.)
The CLERK. Mrs. Murray.
Senator MURRAY. (Aye, by proxy.)
The CLERK. Mr. D'Amato.
Senator D'AMATO. Aye.
The CLERK. Mr. Gramm.
Senator GRAMM. Aye.
The CLERK. Mr. Bond.
Senator BOND. Aye.
The CLERK. Mr. Mack.
Senator MACK. Aye.
The CLERK. Mr. Faircloth.
Senator FAIRCLOTH. Aye.
The CLERK. Mr. Bennett.
Senator BENNETT. Aye.
The CLERK. Mr. Roth.
Senator ROTH. Aye.
The CLERK. Mr. Domenici.
Senator DOMENICI. (Aye, by proxy.)
The CLERK. The vote is unanimous, Mr. Chairman. Nineteen
ayes.
The CHAIRMAN. Very good. Next, we will vote on the nomination
of Susan GafTney, to be inspector general of the Department of
Housing and Urban Development.
The Clerk will call the roll.
The CLERK. The Chairman.
The CHAIRMAN. Aye.
The CLERK. Mr. Sarbanes.
Senator SARBANES. Aye.
The CLERK. Mr. Dodd.
Senator DODD. (Aye, by proxy.)
The CLERK. Mr. Sasser.
Senator SASSER. Aye.
The CLERK. Mr. Shelby.
Senator SHELBY. (Aye, by proxy.)
The CLERK. Mr. Kerry.
Senator KERRY. Aye.
The CLERK. Mr. Bryan.
Senator BRYAN. (Aye, by proxy.)
The CLERK. Mrs. Boxer.
Senator BOXER. Aye.
The CLERK. Mr. Campbell.
Senator CAMPBELL. (Aye, by proxy.)
The CLERK. Ms. Moseley-Braun.
Senator MOSELEY-BRAUN. (Aye, by proxy.)
The CLERK. Mrs. Murray.
Senator MURRAY. (Aye, by proxy.)
The CLERK. Mr. D'Amato.
Senator D'AMATO. Aye.
The CLERK. Mr. Gramm.
Senator GRAMM. Aye.
59
The CLERK. Mr. Bond.
Senator BOND. Aye.
The CLERK. Mr. Mack.
Senator MACK. Aye.
The CLERK. Mr. Faircloth.
Senator FAIRCLOTH. Aye.
The CLERK. Mr. Bennett.
Senator BENNETT. Aye.
The CLERK. Mr. Roth.
Senator ROTH. Aye.
The CLERK. Mr. Domenici.
Senator DOMENICI. (Aye, by proxy.)
The CLERK. The vote is unanimous, Mr. Chairman. Nineteen
ayes.
The CHAIRMAN. And finally, we will vote on the nomination of G.
Edward DeSeve, to be the chief financial officer of the Department
of Housing and Urban Development.
The Clerk will call the roll.
The CLERK. The Chairman.
The CHAIRMAN. Aye.
The CLERK. Mr. Sarbanes.
Senator SARBANES. Aye.
The CLERK. Mr. Dodd.
Senator DODD. (Aye, by proxy.)
The CLERK. Mr. Sasser.
Senator SASSER. Aye,
The CLERK. Mr. Shelby.
Senator SHELBY, (Aye, by proxy.)
The CI.ERK. Mr. Kerry.
Senator KERRY. Aye.
The CLERK. Mr. Bryan.
Senator BRYAN. (Aye, by proxy.)
The CLERK. Mrs. Boxer.
Senator BOXER. Aye.
The CLERK. Mr. Campbell.
Senator CAMPBELL. (Aye, by proxy.)
The CLERK. Ms. Moseley-Braun.
Senator MosELEY-BHAUN. (Aye, by proxy.)
The CLERK. Mrs. Murray.
Senator MURRAY. (Aye, by proxy.)
The CLERK. Mr. D'Amato.
Senator D'AMATO. Aye.
The CLERK. Mr. Gramm.
Senator GRAMM. Aye.
The CLERK. Mr. Bond.
Senator BOND. Aye.
The CLERK. Mr. Mack.
Senator MACK. Aye.
The CLERK. Mr. Faircloth.
Senator FAIRCLOTH. Aye.
The CLERK. Mr. Bennett.
Senator BENNETT. Aye.
The CLERK, Mr. Roth.
Senator ROTH. Aye.
60
The CLERK. Mr. Domenici.
Senator DOMENICI. (Aye, by proxy.)
The CLERK. The vote is unanimous, Mr. Chairman. Nineteen
ayes.
The CHAIRMAN. Let me just say before we adjourn, I'd like to announce for the record that all six of the nominations pending before
the committee today have been ordered favorably reported to the
Senate by unanimous votes, and those nominations will be filed in
the Senate this afternoon.
The committee stands in recess.
[Whereupon, at 1:47 p.m., the committee was recessed.!
[Prepared statement, Monetary Policy Report to Congress, and
response to written questions follow:]
61
OPENING STATEMENT OP SENATOR DONALD W. R1EGLE, JR.
This morning the Committee welcomes Alan Greenspan, Chairman of the Federal
Reserve Board, to testify on the Federal Reserve's plans and objectives for monetary
policy. No issue the Committee deals with is more important than policies to improve the condition of our economy. And no Government policies have a larger impact on the economy than monetary policy.
The President has made economic policy his top priority, and polls show it is the
top priority of the American people. Right now, in Congress, we are working hard
to put the President's program into action. But it will be impossible to achieve the
goals of that program, including especially the creation of 8 million jobs over the
next 4 years, without the cooperation of the Federal Reserve.
The Fed's monetary policy report, released Tuesday, raises in my mind some questions about that. The Fed's decisionmakers believe that, despite the economy's continuing weakness, their policies will produce economic growth in 1993 and 1994 at
only about the economy's trend rate of growth. Consistent with that, they expect
little improvement in the unemployment rate, which they expect will be near 63/i percent throughout next year, possibly slightly lower by the end of the year. So more
than 3Vfc years after this anemic recovery began, the unemployment rate would be
just V2 percentage point lower than it was at the recession's worst point.
As I read the report, the Fed is saying that is the best we can do. Even with these
plodding growth rates, the Fed's projections show inflation edging up this year and
next. The clear implication is that any faster growth would lead to higher inflation.
That is a very important and troubling conclusion. If it's correct, it pushes off indefinitely the time when Americans can enjoy what we have come to think of as a
healthy economy. And it makes the achievement of the goal for 8 million new jobs
doubtful, I hope you are wrong. But before you act on this judgment, I'd like to better understand what it is based on.
Your own report says, "The (undamentals remain consistent with additional disinflation." That means you would normally expect that, in an economy as weak as
ours is now, inflation would tend to decrease. And when we look at what is actually
going on in the economy, we see that commodity prices measured by the Journal
of Commerce Index, have gone down 5 percent in the past 4 months; we see oil
prices down more than 20 percent over the past year; we see the producer price
index increasing at a rate of less than 2V2 percent so far this year, and we see virtually no change in consumer prices in the past 2 months. Capacity utilization is
low; wage increases are small. Even despite the 2 bad months earlier this year for
the CPl, the CPI's inflation rate has still averaged no worse than last year. None
of our witnesses earlier this month, neither Nobel laureate Paul Samuelson, financial market expert Henry Kaufman, nor Council of Economic Advisers nominees
Alan Blinder and Joseph Stiglitz, saw any evidence that there was significant risk
of a near-term acceleration of inflation.
Of greater concern to me is the risk that we may not even get the growth the
Fed is anticipating. Despite the lowest mortgage rates in 20 years, housing starts
remain below last December's rate. The Feds industrial production index declined
last month after no growth the previous month. Increasingly weak foreign economies and budget cutbacks in defense have kept other sectors of the economy down.
Instead of fearing higher inflation from excessive growth, I wonder why the Fed is
not concentrating on ensuring growth adequate to guarantee new jobs and reduce
unemployment.
TESTIMONY BY ALAN GREENSPAN
CHAIRMAN, BOARD OF GOVERNORS OP THE FEDERAL RESERVE SYSTEM
JULY 22, 1993
Thank you for this opportunity to discuss the Federal Reserve's semiannual monetary policy report to the Congress. My remarks this morning will cover the current
monetary policy and economic settings, as well as the Federal Reserve's longer-term
strategy for contributing, to the best of our abilities, to the Nation's economic wellbeing.
As the economic expansion has progressed somewhat fitfully, our earlier characterization of the economy as facing stiff head winds has appeared increasingly appropriate. Doubtless the major head wind ia this regard has been the combined efforts of households, businesses, and financial institutions to repair and to rebuild
their balance sheets following the damage inflicted in recent years as weakening
asset values exposed excessive debt burdens.
62
But there have been other head winds as well. The build-down of national defense
has cast a shadow over particular industries and regions of the country. Spending
on nonresidential real estate dropped dramatically in the face of overbuilding and
high vacancy rates and has remained in the doldrums. At the same time, corporations across a wide range of industries have been making efforts to pare employment and expenses in order to improve productivity and their competitive positions.
These efforts have been prompted in part by innovative technologies, which have
been applied to almost every area of economic endeavor, and have boosted investment. However, their effect on jobs and wages through much of the expansion also
has made households more cautious spenders.
In the past several years, as these influences have restrained the economy, they
have been balanced in part by the accommodative stance of monetary policy and,
more recently, by declines in longer-term interest rates as the prospects for credible
Federal deficit cuts improved. From the time monetary policy began to move toward
ease in 1989 to now, short-term interest rates have dropped by more than twothirds and long-term rates have declined substantially, too. All along the maturity
spectrum, interest rates have come down to their lowest levels in twenty or thirty
years, aiding the repair of balance sheets, bolstering the cash flow of borrowers, and
providing support for interest-sensitive spending.
The process of easing monetary policy, however, had to be closely controlled and
generally gradual, because of the constraint imposed by the marketplace's acute sensitivity to inflation. As I pointed out in my February testimony to the Congress, this
is a constraint that did not exist in an earlier time. Before the late 1970's, financial
market participants and others apparently believed that, while inflationary pressures might surface from time to time, the institutional structure of the U.S. economy simply would not permit sustained inflation. But as inflation and, consequently, long-term interest rates soared into the double digits at the end of the
1970's, investors became painfully aware that they had underestimated the economy's potential for inflation. Aa a result, monetary policy in recent years has had to
remain alert to the possibility that an ill-timed easing could be undone by a flareup of inflation expectations, pushing long-term interest rates higher, and shortcircuiting essential balance sheet repair.
The cumulative monetary easing over the last four years has been very substantial. Since last September, however, no further steps have been taken, as the stance
of policy has appeared broadly appropriate to the evolving economic circumstances.
That stance has been quite accommodative, especially judging by the level of real
short-term interest rates in the context of, on average, moderate economic growth.
Short-term real interest rates have been in the neighborhood of zero over the last
three quarters. In maintaining this accommodative stance, we have been persuaded
by the evidence of persistent slack in labor and product markets, increasing international competitiveness, and the decided absence of excessive credit and money expansion. The forces that engendered past inflationary episodes appear to have been
lacking to date.
Yet some of the readings on. inflation earlier this year were disturbing. It appeared that prices might be accelerating despite product market slack and an unemployment rate noticeably above estimates of the so-called "natural" rate of unemployment—that is, the rate at which price pressures remain roughly constant. In the
past, the existing degree of slack in the economy had been consistent with continuing disinflation.
However, the inflation outcome, history tells us, depends not only on the amount
of slack remaining in labor and product markets, but on other factors as well, including the rate at which that slack is changing. If the economy is growing rapidly,
inflation pressures can arise, even in the face of excess capacity, as temporary bottlenecks emerge and as workers and producers raise wages and prices in anticipation of continued strengthening in demand. Near the end of last year, about the
time many firms probably were finalizing their plans for 1993, sales and capacity
utilization were moving up markedly and there was a surge of optimism about future economic activity. This may well have set in motion a wave of price increases,
which showed through to broad measures of prices earlier this year.
Moreover, inflation expectations, at least by some measures, appear to have tilted
upward this year, possibly contributing to price pressures. The University of Michigan survey ol consumer attitudes, for example, reported an increase in the inflation
rate expected to prevail over the next 12 months from about 3% percent in the
fourth quarter of last year to nearly 4Vz percent in the second quarter. Preliminary
data imply some easing of such expectations earlier this month, but the sample from
which those data are derived is too small to be persuasive. Moreover, the price of
gold, which can be broadly reflective of inflationary expectations, has risen sharply
63
in recent months. And at times this spring, bond yields spiked higher when incoming news about inflation was most discouraging.
The role of expectations in the inflation process is crucial. Even expectations not
validated by economic fundamentals can themselves add appreciably to wage and
price pressures for a considerable period, potentially derailing the economy from its
growth track.
Why, for example, despite an above-normal rate of unemployment and permanent
layoffs, have uncertainties about job security not led to further moderation in wage
increases? The answer appears to lie at least in part in the deep-seated anticipations understandably harbored by workers that inflation is likely to reaccelerate in
the near term and undercut their real wages.
The Federal Open Market Committee (FOMC) became concerned that inflation expectations and price pressures, unless contained, could raise long-term interest rates
and stall economic expansion. Consequently, at its meeting in May, while affirming
the more accommodative policy stance in place since last September, the FOMC also
deemed it appropriate to initiate a so-called asymmetric directive. Such a directive,
with its bias in the direction of a possible firming of policy over the intermeeting
period, does not prejudge that action will be taken—and indeed none occurred. But
it did indicate that further signs of a potential deterioration of the inflation outlook
would merit serious consideration of whether short-term rates needed to be raised
slightly from their relatively low levels to ensure that financial conditions remained
conducive to sustained growth.
Certainly the May and June price figures have helped assuage concerns that new
inflationary pressures had taken hold. Nonetheless, on balance, the news on inflation this year must be characterized as disappointing. Despite disinflationary forces
and continued slack, the rate of inflation has at best stabilized, rather than easing
further as past relationships would have suggested.
In assessing the stance of monetary policy and the likelihood of persistent inflationary pressures, the FOMC took account of the downshift in the pace of economic
expansion earlier this year. This downshift left considerable remaining slack in the
economy and promised that the adverse price movements prompted by the acceleration in growth late last year likely would diminish.
While a slowdown from the unsustainably rapid growth in the latter part of last
year had been anticipated, the deceleration was greater than expected. A surprisingly precipitous drop in defense spending, a sharp deterioration in net exports, a
major blizzard, and some inevitable retrenchment by consumers converged to yield
only meager gains in output in the first quarter. But growth apparently picked up
in the second quarter, and nearly one million net new jobs were created over the
first half. Smoothing through the quarterly pattern, the economy appears to have
accelerated gradually over the past two years, to maintain a pace of growth that
should yield further reductions in the unemployment rate. Consequently, the evidence remains consistent with our diagnosis that the underlying forces at work are
keeping the economy generally on a moderate upward track. However, as I have
often emphasized, not all the old economic and financial verities have held in the
current expansion, and changes in fiscal policy will have uncertain effects going forward. Thus, caution in assessing the path for the economy remains appropriate.
Financial conditions have improved considerably, lessening the need for balance
sheet restructuring that has been damping economic activity for several years now.
By no means is the process over, but good progress has been made. Debt service
burdens, eased by lower interest rates and lower debt-equity ratios, have fallen substantially in both the business and household sectors. On the other hand, the economies of a number of our major trading partners have been quite weak, constraining
the growth of demand for our exports.
Although expectations of a significant, credible decline in the budget deficit have
induced lower long-term interest rates and favorably affected the economy, the positive influence thus far is apparently being at least partly offset by some business
spending reductions as a consequence of concerns about the effects of pending tax
increases.
It seems that the prospective cuts in the deficit are having a variety of substantial
economic effects, well in advance of any actual change in taxes or in projected outlays. Moreover, uncertainty about the final shape of the package may itself be injecting a note of caution into private spending plans. In addition, uncertainty about
the outlook for health care reform may be affecting spending at least by that industry.
To be sure, the conventional wisdom is that budget deficit reduction restrains economic growth for a time, and I suspect that probably is correct. However, over the
long run, such wisdom points in the opposite direction. In fact, one can infer that
recent declines in long-term interest rates are bringing forward some of these antici-
64
pated long-term gains. As a consequence, the timing and magnitude of any net restraint from deficit reduction is uncertain. Patently, the overall economic effect of
fiscal policy, especially when combined with the uncertainties of the forthcoming
health reform package, has imparted a number of unconventional unknowns to the
economic outlook.
Assuming, however, we constructively resolve over time the major questions about
Federal budget and health care policies, with the further waning of earlier restraints on growth, the U.S. economy should eventually emerge healthier and more
vibrant than in decades. The balance sheet restructuring of both financial and nonfinancial establishments in recent years should leave the various sectors of the economy in much better shape and better able to weather untoward developments. Similarly, the ongoing efforts by corporations to pare expenses are putting our firms and
our industries in a better position to compete both within the U.S, market and globally. And alter a period of some dislocation, the contraction in the defense sector
ultimately will mean a freeing up of resources for more productive uses. Finally, a
credible and effective fiscal package would promise an improved outlook for sustained lower long-term interest rates and a better environment for private sector investment. All told, the productive capacity of the economy will doubtless be higher,
and its resilience greater.
Over the last two years, the forces of restraint on the economy have changed, but
real growth has continued, with one sector of the economy after another taking the
lead. Against this background, Federal Reserve Board governors and Reserve Bank
presidents project that the U.S. economy will remain on the moderate growth path
it has been following as the expansion has progressed. Their forecasts for real GDP
average around 2Vfc percent from the fourth quarter of 1992 to the fourth quarter
of 1993, and cluster around 2V4 to 3V* percent over the four quarters of 1994. Reflecting, this moderate rise and the outlook for labor productivity, unemployment is
generally expected to edge lower, to around 6% percent by the end of this year, and
to perhaps a shade lower by the end of next year. For this year as a whole, FOMC
participants see inflation at or just above 3 percent, and most of them have about
the same forecast for next year.
In addition to focusing on the outlook for the economy at its July meeting, the
FOMC, as required by the Humphrey-Hawkins Act, set ranges for the growth of
money and debt for this year and, on a preliminary basis, for 1994. One premise
of the discussion of the ranges was that the uncharacteristically slow growth of the
broad monetary aggregates in the last couple of years—and the atypical increases
in their velocities—would persist for a while longer. M2 has been far weaker than
income and interest rates would predict. Indeed, if the historical relationships between M2 and nominal income had remained intact, the behavior of M2 in recent
years would have been consistent with an economy in severe contraction. To an important degree, the behavior of M2 has reflected structural changes in the financial
sector: The thrift industry has downsized by necessity, and commercial banks have
pulled back as well, largely reflecting the burgeoning loan losses that followed the
lax lending of earlier years. With depository credit weak, there has been little bidding for deposits, and depositors in any case have been drawn to the higher returns
on capital market instruments. Inflows to bond and stock mutual funds have
reached record levels, and, to the extent that these inflows have come at the expense of growth in deposits or money market mutual funds, the broad monetary aggregates have been depressed.
In this context, the FOMC lowered the 1993 ranges for M2 and M3—to 1 to 5
percent and 0 to 4 percent, respectively. This represents a reduction of 1 percentage
point in the M2 range and Vfe percentage point for M3. Even with these reductions,
we would not be surprised to see the monetary aggregates finish the year near the
lower ends of their ranges.
As I emphasized in a similar context in February, the lowering of the ranges is
purely a technical matter; it does not indicate, nor should it be perceived as, a shift
of monetary policy in the direction of restraint. It is indicative merely of the state
of our knowledge about the factors depressing the growth of the aggregates relative
to spending, of the course of the aggregates to date, and of the likelihood of various
outcomes through the end of the year. While the lowering of the range reflects our
judgment that shifts out of M2 will persist, the upper end of the revised range allows for a resumption of more normal behavior or even some unwinding of M2
shortfalls. The FOMC also lowered the 1993 range for debt of the domestic nanfinancial sectors, by H percentage point, to 4 to 8 percent. The debt aggregate is
likely to come in comfortably within its new range, as it continues growing about
in line with nominal GDP. The new ranges for growth of money ana debt in 1993
were carried over on a preliminary basis into 1994.
65
In reading the longer-run intentions of the POMC, the specific ranges need to be
interpreted cautiously. The historical relationships between money and income, and
between money and the price level have largely broken down, depriving the aggregates of much of their usefulness as guides to policy. At least for the time being,
M2 has been downgraded as a reliable indicator of financial conditions in the economy, and no single variable has yet been identified to take its place.
At one time, M2 was useful both to guide Federal Reserve policy and to communicate the thrust of monetary policy to others. Even then, however, a wide range
of data was routinely evaluated to assure ourselves that M2 was capturing the important elements in the financial system that would affect the economy. The FOMC
never single-mindedly adhered to a narrow path for M2, but persistent and sizable
deviations of that aggregate from expectations were a warning sign that policy and
the economy might not be interacting in a way that would produce the desired results. The so-called "P-star" model, developed in the late 1980's, embodied a longrun relationship between M2 and prices that could anchor policy over extended periods of time. But that long-run relationship also seems to have broken down with
the persistent rise in M2 velocity.
M2 and P-star may reemerge as reliable indicators of income and prices once the
yield curve has returned to a more normal configuration, borrowers' balance sheets
nave been restored and traditional credit demands resume, savers have adjusted to
the enhanced availability of alternative investments, and depositories finally reach
a comfortable size relative to their capital and earnings. In the meantime, the process of probing a variety of data to ascertain underlying economic and Financial conditions has become even more essential to formulating sound monetary policy. This
general approach obviously has its weaknesses. When examining many indicators,
some can always be found that counsel against actions that later appear to have
been necessary.
In these circumstances, it is especially prudent to focus on longer-term policy
guides. One important guidepost is real interest rates, which have a Key bearing on
longer-run spending decisions and inflation prospects.
In assessing real rates, the central issue is their relationship to an equilibrium
interest rate, specifically the real rate level that, if maintained, would keep the
economy at its production potential over time. Rates persisting above that level, history tells us, tend to be associated with slack, disinflation, and economic stagnation—below that level with eventual resource bottlenecks and rising inflation, which
ultimately engenders economic contraction. Maintaining the real rate around its
equilibrium level should have a stabilizing effect on the economy, directing production toward its long-term potential.
The level of the equilibrium real rate—or more appropriately the equilibrium term
structure of real rates—cannot be estimated with a great deal of confidence, though
with enough to be useful for monetary policy. Real rates, of course, are not directly
observable, but must be inferred from nominal interest rates and estimates of inflation expectations. The most important real rates for private spending decisions almost surely are the longer maturities. Moreover, the equilibrium rate structure responds to the ebb and flow of underlying forces affecting spending. So, for example,
in recent years the appropriate real rate structure doubtless has been depressed by
the head winds of balance sheet restructuring and fiscal retrenchment. Despite the
uncertainties about the levels of equilibrium and actual real interest rates, rough
judgments about these variables can be made and used in conjunction with other
indicators in the monetary policy process. Currently, short-term real rates, most directly affected by the Federal Reserve, are not far from zero; long-term rates, set
primarily by the market, are appreciably higher-Judging from the steep slope of the
yield curve and reasonable suppositions about inflation expectations. This configuration indicates that market participants anticipate that short-term real rates will
have to rise as the head winds diminish, if substantial inflationary imbalances are
to be avoided.
While the guides we have for policy may have changed recently, our goals have
not, As I have indicated many times to this Committee, the Federal Reserve seeks
to foster maximum sustainable economic growth and rising standards of living. And
in that endeavor, the most productive function the central bank can perform is to
achieve and maintain price stability.
Inflation is counterproductive in many ways. Of particular importance, increased
inflation has been found to be associated with reduced growth of productivity, apparently in part because it confounds relative price movements and obscures price
signals. Compounding this negative effect, under the current tax code, inflation
raises the effective taxation of savings and investment, discouraging the process of
capital formation. Since productivity growth is the only source of lasting increases
in real incomes and because even small changes in growth rates of productivity can
66
accumulate over time to large differences in living standards, its association with
inflation is of key importance to policymakers.
The link between the control of inflation and the growth of, productivity underscores the importance of providing a stable backdrop for the economy. Such an environment is especially important for an increasingly dynamic market economy, such
as ours, where technology and telecommunications are making rapid advances. New
firms, new products, new jobs, new industries, and new markets are continually
being created, and they are unceremoniously displacing the old ones. The U.S. economy is a dynamic system, always renewing itself. It is extraordinary that the system
overall is as stable as it is, considering the persistent process of change in the structure of our economy. For example, a frequently cited figure is the two million new
jobs that have been created since the end of 1991. This is a net change, however,
which masks the many millions who found, lost, and changed jobs over the same
period. Currently, people are being hired at a pace of approximately 400,000 per
week, with job losses running modestly below that figure. Such vast churning in the
Nation's labor markets is a normal and ultimately a productive process.
Central planning of the type that prevailed in post-war Eastern Europe and the
Soviet Union represented one attempt to fashion an economic system that eliminated this competitive churning and its presumed wastefulness. But when that system eliminated the risk of failure, it also stifled the incentive to innovate and to
prosper. Central planning fostered stasis: In many respects, the eastern-bloc economies marched in place for more than four decades.
Risk-taking is crucial in the process that leads to a vital and progressive economy.
Indeed, it is a necessary condition for wealth creation. In a market economy, competition and innovation interact: those firms that are slow to innovate or to anticipate the demands of the consumer are soon left behind. The pace of churning differs
by industry, but it is present in all. At one extreme, firms in the most high-tech
areas must remain constantly on the cutting edge, as products and knowledge become rapidly obsolete. Many products that were at technology's leading edge, say
five years ago, are virtually unsalable in today's markets. In high-tech fields, leadership can shift rapidly. In some markets where American firms were losing share
just a few years ago, we have regained considerable dominance. In one case, U.S.
firms have seized a commanding lead in just two years in the new laptop computer
market, and now account for more than 60 percent of U.S. sales last year, triple
the figure for Japanese firms.
More generally, it appears that the pace of dynamism has been accelerating. As
one indication, the average economic life expectancy of new capital equipment has
been falling. The average life of equipment purchased in 1982, for example, was
IGVfc years. By 1992 that figure haa declined to 14Va years, a drop more than twice
as large as that over the preceding decade. In addition, telecommunications technology is obviously quickening the decision-making process in both financial and
product markets.
In such a rapidly changing marketplace, the agile survive by being flexible. One
aspect of this flexibility has been the spread of "just-in-time" inventory controls at
manufacturing firms. Partly as a result of innovations in inventory control techniques, the variability of inventories relative to total output appears to be on a
downtrend.
The possibility of failure has productive side effects, encouraging economic agents
to do their best to succeed. But there are nonproductive and unnecessary risks as
well. There is ao way to avoid risk altogether, given the inherently uncertain outcomes of all business and household decisions. But many uncertainties and risks do
not foster economic progress, and where feasible should be suppressed. A crucial
risk in this category is that induced by inflation. To allow a market economy to attain its potential, the unnecessary instability engendered by inflation must be quieted.
A monetary policy that aims at price stability permits low long-term interest rates
and helps provide a stable setting to foster the investment and innovation by the
private sector that are key to long-run economic growth. In pursuing our objectives,
we must remain acutely aware that the structure of the economy has been changing
and growing ever more complex. The relationships between the Key variables in the
economy are always shifting to a degree, and this evolution presents an ongoing
challenge to the business leader, to the econometric modeler, and to those responsible for the conduct of economic policy.
Clearly, the behavior of many of the forces acting on the economy over the course
of the last business cycle have been different from what had gone before. The sensitivity of inflation expectations has been heightened, and, as recent evidence suggests, businesses and households may be becoming more forward-looking with respect to fiscal policies as well.
67
I believe we are on our way toward reestablishing the trust in the purchasing
power of the dollar that is crucial to maximizing and lulfilling the productive capacity of this Nation. The public, however, clearly remains to be convinced: Survey responses and financial market prices embody expectations that the current lower
level of inflation not only will not be bettered, it will not even persist. But there
are glimmers of hope that trust is reemerging. For example, issuers have found receptive markets in recent months for fifty-year bonds. This had not happened in
decades. The reopening of that market may "be read as one indication that some investors once again believe that inflationary pressures will remain subdued.
It is my firm belief that, with fiscal consolidation and with the monetary policy
path that we have charted, the United States is well-positioned to remain at the
forefront of the world economy well into the next century.
68
For us* at 9:45 a.m.. E.D.T.
TiMsday
July 20,1993
Board of Governors of the Federal Reserve System
Monetary Policy Report to the Congress
Pursuant to the
Full Employment and Balanced Growth Act of 1978
July 20, 1993
Letter of Transmittal
BOARD OF GOVERNORS OF THE
FEDERAL RESERVE SYSTEM
Washington. D C., July 20. 1993
THE PRESIDENT OF THE SENATE
THE SPEAKER OF THE HOUSE OF REPRESENTATIVES
The Board of Governors is pleased 10 submit its Monetary Policy Report to the Congress, pursuant to the
Full Employment and Balanced Growth Act of 1978.
Sincerely
Alan Greenspan, Chairman
69
Table of Contents
Page
Section 1: Monetary Policy and the Economic Outlook for 1993 and 1994
Section 2;
The Performance of the Economy in 1993
Section 3:
Monetary and Financial Developments in 1993
1
6
'^
70
Section 1: Monetary Policy and the Economic Outlook for 1993 and 1994
In february, when the Federal Reserve prepared its
monetary policy plans for 1993, the broad trends in
the economy appeared favorable. After a hesitant
beginning, the economic expansion had picked up
steam in the latter part of 1992, while inflation
seemed still to be headed downward. Most members
of the Federal Open Market Committee (FOMC) and
nonvoting presidents anticipated that 1993 would be a
good year for growth and would also see further
progress toward price stability.
As the year has unfolded, however, the economy's
performance has fallen short of these expectations.
Economic growth has slowed appreciably from the
pace late last year; m pan. this has reflected a retreat
in business and consumer confidence and the effects
on our trade balance of weakness in a number of other
industrial countries. Like most private forecasters, the
Board members and Bank presidents generally have
trimmed their projections of growth in real gross
domestic product (GDPi for the year as a whole,
although they continue to foresee increases in output
large enough to extend the reduction in the unemployment rate that began last summer. Events on the price
side also have been disappointing. The inflation rate
in the first part of this year was higher than in late
1992. There is evidence that some of the pickup in the
consumer price index iCPl) may have reflected difficulties in seasonal adjustment, and price daia for the
past couple of months have been much more favorable. Nonetheless, a broad array of indicators points
to a leveling out of the underlying inflation trend.
In this circumstance, and with short-term interest
rates unusually low, especially when compared with
inflation, the Federal Reserve recognized a need to be
alert to [he possibility that the balance of risks in the
economy could, shift soon in a direction dictating
some finning of policy; failure to act m a timely
manner could lead to a buildup of inflationary pressures, to adverse reactions m financial markeis. aiwi
ultimately to the disruption of the growth process. To
this point, however, the moderate thrust of aggregate
demand and considerable slack m the economy, takiin
together with the more subdued price data of late, do
not suggest that a sustained upswing m inflation is at
hand. Accordingly, the Federal Reserve has not adjusied its monetary policy instruments.
The pace of economic growth in the final quarter of
1992 svas not expected to be sustained, but the slowing in the first quarter of 1993 was surprisingly sharp.
With the exception of business fued investment, the
slowdown cut across the major categories of final
demand. After stepping up their spending in late
1992, consumers became more pessimisiic about their
economic prospects and more cautious in their spending decisions; the uncertainty surrounding the efforts
to reduce the federal deficit may have been a factor in
the weakening of household sentiment. Housing activity, which also had been exceptionally strong late last
year, hit a lull—even before the March blizzard on the
East Coast—and real defense purchases plunged.
Moreover, net exports deteriorated sharply, as exports
declined and imports surged; the drop in exports was
attributable in pan to continued weak growth in some
other industrial countries and in pan was an adjustment to the big increase in late 1992.
The more recent statistical indicators, taken
together, poml to a resumption of moderate growth in
real GDP in the second quarter. Most notably, on the
positive side, the increase in aggregate hours worked
foe the quanci as a whale—a useful indicator of
movements m overall output—was the largest of the
current expansion. Sales of motor vehicles also exhibited considerable vigor. But othei key indicators were
less robust. In particular, after allowing for the effects
of the blizzard, consumer spending on items other
than, motor vehicles was lackluster, and housing activity improved only modestly. In the manufacturing
sector, orders generally remained soft, and factory
output, after having powed w>lid gains ovei ihe preceding seven months, is estimated to have declined
somewhat over May and June.
Broad measures of inflation picked up in early
1993. with monthly increases through April in the
upper pad of the range of the past couple of years.
Although readings on consumer and producer prices
were much more favorable in May and June, the
cumulative price and wage data for the year to date
suggest lhal underlying inflation has flattened out,
after trending down over the preceding two years.
Excluding the especially volatile food and energy
componems. the twelve-month change in the CP1 has
held in the range of V/j to 3[/: percent since the
summer of 1992
In financial markets, shon-ierm interest rates have
changed little so far in 1993. while intermediate- arid
long-term interest rates have fallen three-quarters to
one percentage point to their lowest levels in over
twenty years. The decline in longer-term rales seems
71
largely to have been a response to the enhanced
prospects for credible fiscal restraint though the
slower pace of economic expansion may also have
played a role. Falling interest rales have helped slock
market indexes set new records. Despite a decline in
the dollar versus the yen. the average value of the
dollar on a trade- weighted basis relative to G-10
currencies has risen, on balance, since the end of
1992. Although foreign intermediate -term interest
rates have been down, on average, aboul as much as
their pan. have continued 10 shift lunds into capital
markets, attracted by still-high returns in these markets relative to earnings on deposits. Inflows inlo
bond and equity mutual funds have run at record
levels this year, and banks have facilitated investing
in mutual fund products by increasingly offering them
in their lobbies. As a consequence of these various
forces. M2 increased at only a J/j percent annual rate
from its tounh-quaner 1992 average through June.
while M3 fell slightly. The sum of M2 and estimated
U.S. interest rates, short-term rates abroad have
household holdings of long-term mutual funds grew
decreased substantially relative to U.S. rates, as foreign monetary authorities have taken steps to bolster
weak economies.
at about a 43/4 percent rate from the fourth quarter
through June, little changed from the pace of recent
years.
Declining U.S. market interest rates contributed to
robust growth in narrow measures of money and in
reserves over the tirst half of the year, but broad
monetary aggregates were very weak and their velocities continued to show exceptional increases. Credit
demands on depositories remained quite subdued
relative to spending, considerable depository credit
was funded from nonmonetary sources, and savers
continued to demonstrate a marked preference for
capital market instruments over money slock assets.
Debt growth has edged up this year, despite a
deceleration in nominal spending, perhaps buoyed by
improvements in financial positions achieved over the
past few years by both borrowers and lenders. Investment outlays are estimated to have exceeded ihe
internal funds of corporations for the tirst time in two
years, while household borrowing has picked up relalive to spending. In addition. Treasury financing needs
have remained heavy Nevertheless, nonfinancial debt
growth has been running at only a 5 percent rate this
In part owing to the drop in bond and stock yields,
as well as to the desire to strengthen balance sheets.
corporate borrowers have continued to concemrale
credii demands on long-ierm securities markets,, using
Monetary Objectives for 1993 and 1994
.
.
,
.
. . .
..
_,
there were tentative signs ot a pickup
over May and
.
_ . , ,.
_,
,. r
,
, . ,
iionship
ot broadlv
broadlv detined
detined monev
monev to
to income
income has
has conconnshipr ot
, ,
,.
.•
,
unued to depart irom historical pauerns. TTThe annual
, ..
. . .
the proceeds in pan to repay bank loans; business
. , ,
,.
,.
,
loans at banks have not grown this year, although
June. Total lending and credit growth at banks has
, , . , , ,
, ,
.
. ,„„_
risen onlv sliehtlv from the depressed pace ot i .
, , '
. '
.
,
.
, ,
and ihese institutions ha\e therelore nol needed m
_,
.
,
pursue deposits. Thntis have continued to contract,
,
, .
.
but at a much slower pace than in recent years.
In reviewing the annual ranees lor me monetary
"",,,,,, i_ ,-,-,.,
i ,_,_
i.i.
ii ''
aaareaates
areaates in 1W3, the FOMC^ notedi that
the
rela, " , . . , . . . .
,
•
? ,
,
,-- „ -- ,„„velocities ot these aggregates last tell
in [986, and
,
their prolonged upward movements since then
,
,
, ,
sironely suggest breaks Irom previous long-run trends
.•
, . . • . . - ,
, ; , ,
,
ot QHal velocitv lor MZ and slowiv decreasing \eioc.
'
°
ity tor M3. The nse in the velocity measures has been
Banks have eased lending standards for smaller
particularly surprising in the last four years, a period
firms for several quarters and recently relaxed standards for medium- and large-sized firms as well. An
of declining interest rates, normally associated with a
reduction in \elocil>.
increased willingness to lend on the pan of banks has
,- . ,
,
. - L I
, _ .
• , ; , . ,
,_
li February, anticipating that further balance inoet
been associated with considerablv more comlonable
."
_ , ,
".
.
restructuring and portfolio ihilts Irom deposits to
capital positions. Hanks nave continued to strengthen
, . .
^
. ,
.
,
,
rnuiual l u n d s would result in lunher increases m
their b a a nee sheet-, hv issuing laree volumes ol
,
,-mr- ,
, >. i ,.,-,
i,
, . ,
' t
,., \elocitv. the FOMC lowered the 1W arowlh ranees
L
equitv and siiburdmjied debt, while retaining a sub. , • _,,,,,
, ...
•
.
,
. l o r M2 and M.' b\ one-hall percentage point train (he
stantial amountol earnings. As a result, the ponion ol
.
'
. , , , , , ; '
,,
.
provisional ranees set in J u l v 199J In tact, velocities
Ihe mdusirv lhai is well-capiiali/ed ( t a k m c account o t
, - . , , "
'
,
,.
. ,
- .
ol Ihe broad monelurv jiisregaies h a v e buen e^Dcsupervisorv ratings as well as capiul ratios J increased
.
.
~ ,
,-,„,,
,
ciallv strony; in the first uuaner ol 19'i.v the velocitrom jboul one-lhird at the end m 1411 to more than
' ,. , .,
....
, ,
, . , , .
, ,
ties ot M2 and M3 posted substantial increases ot
two-thirds by March 1993.
,,
,^
,
D-'J percent and s percent, respectively, and appear to
In turning to equity and other nondeposit funds.
have recorded additional, but smaller, gains in the
banks have reduced the share of depository credit that
second quarter. As a consequence, at its meeting this
is financed by monetary liabilities. Depositors, for
month, the Committee reduced the 1993 range for M2
72
Ranges for Growth of Monetary and Credit Aggregates
1993
1993
(As of February)
(As of July)
Percentage criange,
lourin quarter to fourth quarter
M2
2'/2 to 6V;
2 to 6
1 to 5
1 to 5
M3
1 to 5
'A to 4V:
0 to 4
0 to 4
Debt
4Vfe to SVz
4*108*
4 to 8
4 to 8
by an additional percentage point and the range for
M3 by anolher one-half percentage point, leaving
Ihem at I 10 5 percent for M2 and 0 to 4 percent for
M3.
The reductions of these growth ranges represented
further lechnical adjustments in response to actual
and anticipated increases in velocity and not a shift in
monetary policy, which remains focused on fostering
sustainable economic expansion while making continued progress toward pnce stability. With further substantial increases in velocities, continued sluggish
expansion of M2 and M3. which are now at the lower
ends of their revised ranges, would be consistent with
an acceptable track for the economy. Also ai the July
meeting, the annual monitoring range for lhe domeslie nonlinancial debt aggregate was reduced by onehalf percentage point to 4 to 8 percent; growih m ihis
aggregate is likely lo continue to be roughly in line
with that of nominal GDP.
While the future behavior of the velocities of broad
money aggregates was recognized to be difficult 10
predict wuh precision at a lime of ongoing structural
changes in lhe financial sector, it appears likely that
the forces contributing lo lhe unusual strength in
velocities will continue for some time, and the FOMC
earned forward the revised 1993 ranges for the monelary and debi aggregates lo 1994 as well. Wiih considerable uncertainly persisnng about the relationship of
(he monetary aggregates 10 spending, lhe behavior of
lhe aggregates relative to their annual ranges w i l l
likelv be ol limited use in guiding policy over lhe
ne\t eighteen month-., and the Federal Reserve will
continue to utilize a broad range oi financial and
economic indicators in assessing us policy stance
Economic Projections for 1993 and 1994
The members of the Board of Governors and the
Reserve Bank presidents, all of whom participate in
the deliberations of lhe Federal Open Market Committee, generally anticipate that economic activity
will strengthen in the second half of 1993 and conlinue 10 expand moderately in 1994. The growth of
ouipul is likely lo be accompanied by further gams in
productivity, but increases in employment are projected to be large enough to keep the unemployment rale moving down. Inflation is not expected to
change materially over this period.
The forecasts of the Board members and Reserve
Bank presidents for economic growth in 1993 are
somewhat weaker than in February, mainly because
ot the shortfall in real growth in the first quarter. Most
expect output gains over (he balance of the year to be
large enough to result in a four-quarter change in real
gross domestic product in the range of 2Vi to 2J/J percent; for 1994. the central tendency of the forecasts
spans a range of 2V: 10 3'A percent. The civilian
unemployment rate, which averaged 7 percent in the
second quaner of 1993. is projected to fall to lhe area
of 6-'/4 percent by lhe fourth quaner of this year and lo
drop slightly further over lhe course of 1994
Recent developments in the financial sphere should
be conducive to the sustained increases in spending
projected for lhe quarters ahead. The financial positions of many households and businesses have continued 10 improve, and banks are showing signs of
greater willingness to make loans. Short-term inlerest
rates are relatively low. and the appreciable declines
in long-term interest rates over Ihe pasi several
months should further the process of balance sheet
adjustment and are anticipated to provide considerable impetus to business investment and residential
construciion. It is likely that business investment also
will continue lo be bolstered by lhe ongoing push to
improve products and boost efficiency through lhe use
of slale-of-(he-art equipment. Moreover, with ai least
a moderate pickup in average growth in foreign
73
Economic Projections for 1993 and 1994
FOMC Member* and Other FRB Presidents
Range
Central Tendency
4% to 6'/4
2 to 3Vfe
5 to S¥t
2'/4 to 2y,
3 to 3V.
1993
Percentage change,
fourth quarter to fourth quarter
Nominal GDP
Real GOP
Consumer price index
Average level in the
fourth Quarter, percent
Civilian unemployment rate
3 to 3Vi
6'/a 10 7
1994
Percentage change,
fourth quarter to fourth quarter
Nominal GDP
Real GDP
Consumer price index
Average level in the
fourth Quarter, percent
Civilian unemployment rate
4Vi to 6%
2 10 3V.
2 to 4%
5 to 6V;
2'/2 to 3V.
3 to 3Va
6Vi to 7
6V; to 6^
industrial countries, the external sector should be
exerting a less negative influence on economic activity in the United States.
will be known shortly, uncertainties about health care
reform are not anticipated to be resolved fully for
some time.
Despite the improvement in financial conditions,
there are reasons to be cautious about the near-term
outlook. Efforts this year to bring the federal budget
deficit under control already have heiped to ease
pressures on long-term interest rates, and a successful
agreement to reduce deficits significantly will produce substantial benefits over the longer run. But such
actions also are expected to exen some restraint on
aggregate demand this year and nest. Government
outlays for defense will conlinue to contract, extending the dislocations and disruptions thai have been
evident for some time m industries and regions ihai
Jepend heavily on military spending. Prospects for
higher taxes may already be influencing the behavior
of some households and businesses, and the constraint
is likely to intensify in 1994. In addition, uncertainties
about prospective federal policies reportedly are
weighing on businesses and consumers: although (he
outcome of Ihe Congressional budget deliberations
Most Board members and Bank presidents expect
the me in the consumer price index over the four
quarters of 1993 to be in the range of 3 to 3'/J percent,
about the same as the increase over the four quarters
of 1992. At this stage. Ihe food and energy sectors are
not expected to have much effect, on balance, on the
broad price measures in 1993. but the Hooding in the
Midwest raises the nsk nt" higher food prices in the
charters ahead. For 1994. the central tendency forecast is for CP1 inHaiion in the range of 3 to I1/: percent, not much different than tn 1992 and 1993.
The fundamentals remain consistent with additional disinflation: businesses continue to locus on
conirolling costs, and slack m labor and product markets is anticipated to decrease only gradually in the
period ahead. However, ihe disappointing price performance in the Jirst half of Ihe year suggests that
further progress will nol come easily—in part perhaps
74
because inflation expectations remain high. Lo*enng
inflation and inflation expectations over lime, and
achieving sustained reductions in long-term interest
rales, will depend importantly on a moneiary policy
that remains committed to fostering further progress
toward price stability. The performance of prices and
the economy also will depend on government policies
in other ateas. Namely, a sound fiscal policy, a judicious approach to foreign trade issues, and regulatory
policies ihat preserve flexibility and minimize the
cosls they impose are crucial to reestablishing ihe
disinflation trend or [he past couple of yean and
allowing the economy to perform at its full potential,
The Administration has not yet released the midyear update to its economic and budgetary projeclions. However, statements by Administration officials suggest that the revised forecasts for real growth
and inflation in 1993 and 1994 are not likely to differ
significantly from those of the Federal Reserve.
75
Section 2: The Performance of the Economy in 1993
Economic activity has continued 10 advance in tits
and starts. Afier posting robust gains in the second
half of 1992. real gross domestic product (GDP) rose
a! an annuai rate of Jess JJian 1 percent in the first
quarter of 1993. The slowing in activity was evident
in a broad range of production and spending indicators. The more recent data suggest that the economy
expanded at a firmer pace in the second quarter,
although growth probably was nol as rapid as in the
second half of last vear.
Real GDP
Percent cnange, annual rale
ZT
n
cutbacks, the process of balance sheet adjuiuneni
goes on. us do the restructuring efforts under way at
many large firms. Moreover, the continued disappointing economic performance of some major foreign industrial countries is taking a toll on U.S
exports. Finally, uncertainties about prospective federal policies on a variety of fronts, although difficult
to measure, are reportedly making some businesses
and consumers reluctant to make major hiring and
spending commitments.
News on the pnce side was afso womsome in ihe
first half of the year. Mo nth-to-mo nth movements in
prices were on the high side through Apnl. but they
moderated in May and June. The more favorable
recent data helped to ease concerns that a significant
pickup in inflation was under way. Nonetheless, the
disinflation process seemingly has stalled, with underlying inflation, as measured by Ihe twelve-montfi
change in the consumer pnce index (CPI) excluding
food and energy, holding in a narrow band between
3!4 and 3'-': percent since last summer.
The Household Sector
To some extent, the slackening in economic activity in the first quarter of 1993 can be interpreted as a
pay back after two quarters of strong growth. In
particular, much of the slowing was in consumer
spending, where large gams in the second half of
1992 had outpaced income growth by a substantial
margin. In addition, there was a sharp contraction in
defense spending; although real defense purchases
clearly will remain on a downtrend for some time, (he
first-quarter plunge followed a spurt in the second
half of 1992 and is not likely lo be repeated in coming
quarters. In the external sector, exports declined in the
first quarter after a big increase laie last year, while
imports rose markedly Activity was also depressed,
especially in the housing sector, by unusually bad
weather fast winter.
Moderate growth in real GDP appears 10 havu
resumed in the second quarter. Nonetheless, experience thus far in 1993 has underscored (nai [he impediments to a more rapid pace of economic expansion
over the near term remain sizable. Besides defense
Groivih of consumer spending on goods and services continued in a stop-and-go pattern in early
1993: It hit a l u l l in the first quarter after surging in
the second half of 1992. Averaging through the quarterly data, consumption grew ai about a 3 percent
annual rate pace over those three quarters, and available data point lo a moderate increase in the second
quarter. Housing aamiy appears 10 have revised in
recent months, after sagging earlier in the year.
Income and Consumption
Perceni change, annual 'ale
!_] Real Disposable Personal Income
[_] Heal Personal Consumption Expenditures
rfl
1989
1991
cenl change. 1992 QaioMay 1993. ai;
1993
76
Consumer spending increased only about I percent
21 an annual rate in real terms in the first quarter
Outlays for goods were especially weak, down ai
about a 2 percent annual rate: although a part of the
drop was probably attributable lo ihe severe blizzard
on the East Coast in March, signs of some retreat in
spending had already appeared in January and February. Meanwhile, spending on services remained on
the moderate upfrend that had been evident for the
pas! few years.
Spending lose appreciably in April, spurred by a
post-blizzard bounce-back in outlays for motor vehicles and other goods. Demand for motor vehicles
remained strong through June, resulting in an average
sales pace for the quarter of almost I41/; million units
(annual rate)—the highest since early 1990. Sales
were boosted by the replacement needs of households
that put off buying vehicles during the 1990-91 recession and the early recovery period. !n addition, price
increases—at least for models with domestic nameplates, which have accounted for almost all of the rise
in sales this year—have been relatively small, and
financing terms favorable. Meanwhile, real spending
on goods other than motor vehicles appears lo nave
posted a moderate gain for the quarter as a whole, and
outlays for services rose slowly through May.
The downshift in overall spending growth this year
does nol appear lo be attributable to any worsening of
[he current trends in household incomes and financial
positions, but ii has coincided with a deterioration in
consumer confidence. In contrast lo ihe ebullience
evident last fall, surveys conducted by the University
of Michigan and the Conference Board this year have
found respondents more pessimistic about then job
and income prospects. Spending may also have been
crimped by smaller-than-usual tax refunds—or larger
tax bills—this year. Although the change in withholding schedules in March 1992 raised workers' takehome pay, and thus provided the wherewithal to fund
additional purchases last year, many households may
well have found themselves less Liquid ihan usual in
early 1993 More fundamentally, the slowing in
spending appears to reflect a return to trend after a
surge that outstripped the rise in real disposable
income in the second half of last year. Indeed, after
having nsen somewhat over the preceding couple of
years, the personal saving rate dropped from 5'/i percent in the second quartet of 1992 to 41/: percent in
Ihe fourth quarter, in the lower pan of Ihe range of
recenl years. The saving rale retraced some of lhat
decline in the first quarter, but it appears to have
fallen back in the spring.
Real disposable income has remained on the moderate uptrend that has been evident for the past several
quarters: In May, it stood about 2'/4 percent above the
level of a year earlier. Growth in wages and salaries
has stayed relatively sluggish despite the firmer pace
of employment growth this year. Meanwhile, transfer
payments have continued to expand, although recent
increases have been diminished by a drop in unemployment insurance benefits as the number of unemployed has declined. Interest income, which fell
appreciably over 1992. has only edged down thus far
this year.
Household financial positions have continued to
show signs of improvement. The value of household
assets has been buoyed by the rising slock market,
while debl growth has remained moderate. Moreover,
reductions in interest rates have continued to lower
debt-servicing burdens; when measured In relation to
disposable income, the repayment burden has fallen
back to the levels of the mid-1980s. The incidence of
financial stress among households also appears 10
have eased further. Delinquency rates on consumer
loans generally dropped again in the first quarter and
are down significantly from their recent peaks, and
delinquencies on home mortgages are at the iow end
ol the range of Ihe past decade.
Housing activity turned surprisingly soft in the first
quartei. after a buist at Ihe end of 1992. However, the
most recent monthly indicators suggest that the sector
remains on a palh of gradual expansion. In the singlefamily area, both starts and sales of new homes fell
back at the beginning of Ihe year and remained below
trend through March. Single-family starts rebounded
in April and edged up further in May, lifting the
Private Housing Starts
Annual rue. millions of units
Quarterly average
Singte-1 amity
1987
•A0ni-May average.
1989
1991
77
average level for the two months about 5 percent
above the first-quarter pace: new home sales gyra(ed
in the spring but also were higher, on average, than in
the first quarter,
Undoubtedly, some of the recent improvement
reflects a reversal of transitory factors (hat damped
homebuilding in the first quarter, The East Coast
biizzard delayed both builders and iheir customers in
March: in addition, the weather for the nation as a
whole was slightly worse than usual in January and
February. Lumber prices ran up sharply between October and March: As measured by the producer price
index (PP1), prices rose aboui one-third over that
period, and spot market quotes for some lumber products more than doubled. The jump in lumber costs,
which has since been reversed, seems not to have left
much <t( a mark on the prices recorded in sales
transactions; indeed, the inability of builders to pass
along Jhe cost increases may have accounted for some
of the disruption in construction activity
In any event, low mortgage rales clear))* are helping to stimulate housing demand. Interest rates on
fixed-rate home mortgages, like most other long-term
interest rates, fell to near their twenty-year lows last
winter and have since declined further; initial rates on
adjustable-rate mortgages have been the lowest since
these loans first became widely available at the beginning of the 1980s. Given the trends in house prices,
these interest rates have pushed the cost of home
purchase—as measured by (he share of household
income needed to make the mortgage payments on an
average home—to the lowest levels since the mid1970s.
Nonetheless, (he [rends in house pnces this year-—
small rises in some markets, declines in others—have
not been a uniform positive for demand, mainly
because they have muled the investment motive for
owning a home. Moreover, although most respondents to the Michigan survey in recent months
reported thai it was a good time to buy a house, only
about one-third of those who already owned homes
thought it was a good time to sell. In fact, industry
repots suggest ihat firsi-time homebuyers have
accounted for an unusually large share of all home
purchases in the past two years, and that sales and
prices in many localities have been strongest ai the
lower end of the market.
Construction of multifamily housing (his >ear has
been at its lowest level since the 1950s. These
structures—most of which are intended lor rental
use—now account for less than 5 percent of total
residential investment expenditures, compared with a
figure of about 15 percent in the mid-1980s. Despite
(he reduced production in the past several years,
vacancy rales and rents have not yet shown clear
signs of tightening for the nation overall. By contrast,
improvements to all existing housing units have
trended up over ihe past year and now account for
nearly one-fourth of total residential construction
expenditures.
The Business Sector
Developments in the business sector generally
were favorable in the first half of 1993. Business
fixed investment continued to grow briskly, boosted
by ample profits and cash flow, the relatively low cost
of capital, and ongoing efforts to improve productivity. Meanwhile, business balance sheets strengthened further as growth of business debt remained
relatively slow and many firms continued to take
advantage of lower bond yields and high slock pnces
to enhance liquidity by funding out short-term
liabilities.
Real business fixed investment increased at a
13 percent annual rate in the first quarter of 1993.
Real outlays for equipment posted another healthy
gain, and investment in structures, which had been on
a protracted decline for some time, was about unchanged for a second quarter. The indicators in hand
suggest that real business h*ed investment remained
strong in the second quarter.
Equipment spending has continued to be a mainstay of economic growth. It rose at an annual rate of
about 18 percent in real [ernw in the first quarter, after
a 121/: percent rise over the course of 1992. Real
Real Business Fixed Investment
1
Percent change, annual rate
Q Structures
- (^Producers' Durable
Equip merit
[
nu
_
n -4
1 i
J
j
i
1989
'991
*
1993
'•Percent cnanga. IS3S.Q4 to '993 Ol. al an annual rate
78
outlays (or computers ami related devices have continued to soar; since early 1991. they have roughly
doubled, boosted by product innovations, extensive
price-cutting by computer manufacturers, and the
ongoing efforts of businesses to achieve efficiencies
through the utilization of new in formation-processing
technologies. However, demand for other, more traditional types of equipment also began lo grow around
the middle of (992 and continued to expand in earty
1993. Domestic purchases of aircraft spurted in ihe
first quarter; but. given the financial problems besetting the airlines, this increase will likely be reversed
in coming quarters.
Investment in nonresideniial structures appears to
be stabilizing after several years ot' steep decline*.
Construction outlays were essentially flat in real terms
over trie fourth and first quarters, and the advance
indicator suggest that the bottom has been reached or
is close at. hand. Trends within the construction sector
have been divergent, tn the office sector, the excess of
unoccupied space remains huge, and spending continues to contract. However, spending for commercial
Structures other than office buildings, which also had
fallen sharply over Ihe past several years, has apparently turned ihe comer, because of both the stronger
pace of retail sales ovei the past year and the ongoing
shift of reiailmg activity to large suburban stores.
Outlays for industrial construction have not exhibited
[he normal cyclical rebound—mainly 6ecnu.se utilizat i o n of e x i s t i n g c a p a c i t y has tightened o n l y
gradually—but they seem, at least, :o be leveling out.
Meanwtiile, activity in the public utilities sector lias
continued to trend up, mainly because of capacity
expansion al electric utilities but also because of ihe
installation of pollution abatement technology, which
ihe Clean Air Act requires be in place by 1995. In
contrast, drilling activity remains depressed.
Changes in Real Nonfarm Business Inventories
Annual rat*, billions ol 1987 Sollara
Jifln
pre-tax profits earned by nonfinancial corporations on
their domestic operations weakened after a fourthquarter surge, but they still stood nearly. 35 percent
above the cyclical low reached in 1991; the upswing
in these profits over the past two years has reflected
primarily a combination of restraint in labor costs and
reductions in net interest expenses. Domestic profits
of financial corporations have been buffeted in recent
quarters by the losses that insurance companies sustained from major natural disasters; without ^uch
losses, domestic financial profits in the first quarter
would have surpassed the high reached in the first
quarter of 1992.
Before-lax Profit Share of
Gross Domestic Product*
Nonl'arm business inventories, which had shown
only small clianges. on net. since the middle of 1141.
rose considerably last winter and spring. Although the
buildup early in the year was likely motivated in pan
by the need to replenish stocks drawn down b> surprisingly strong sales in late 1942. some of the recent
increase may be attributable to softer-than-expected
sales Notably, the inventory-sales ratio for non-iuw
retail stores remained m May around the high end ot
the range of [ecent years. By contrast, inventories at
factories and at wholesale trade establishments generally seem to be reasonably well aligned with sales.
After advancing markedly over the course of 1992.
economic profits of U.S. corporations were little
changed overall in the fir-it quarter of 1993. The
198?
1989
1991
1993
'Profits 'rom domestic operations *"tti 'nwaflK*Y *atoahon and
capna) consumption ad|u£[menTs drvid^d by gross domestic
product of nonfprrancial cotiorala saaw
79
The (arm economy has been besei by numerous
weather disruptions so far this year. In ihe first quarler, severe weather in some regions retarded livestock
production and damaged fruit and vegetable crops. In
many regions, spring planting was hampered by wet
weather, and, in parts of the Midwest, continued
heavy rains around mid-year caused major flooding.
Because of the planting delays and the floods, uncertainties about acreage and yieids are considerably
greater than usual for this lime of year, and farmers in
the flooded regions obviously have suffered financial
losses.
Despiie Ihe weather-related supply disruptions,
farm income and farm financial conditions for ihe
nation as a whole seem to have held up reasonably
well in the first half of 1993. On average, farm prices
in the first half were slightly above those of a year
earlier, with declines for farm crops being offset by
higher prices for livestock. Farm subsidies, which
have been mnning well above iheir 1992 pace, have
been lifting farm income and cash flow, and farm
investment in new machinery has picked up. The
receni jump in crop prices—a consequence of the
flooding—will boost ihe incomes of the many farm
producers whose crops are still in good condition.
spending was aiso quite weak in the firs! eight inonihs
of FY 199.1. Outlays for Medicare and Medicaid continued to nse rapidly; however, ihe increase so tar this
year—-about 10 percent—was only hall as large as the
one in the preceding year. The deceleration in health
care spending appears 10 siem. in part, from federal
regulations issued in 1992 that limit ihe suites' ability
to shift Medicaid costs to the federal government.
Federal purchases of goods and icrvices—(he pan
of federal spending included directly in gross domestic product—declined at an annual rate of 18 percent
in real lerras in the first quarter of 1993. A sharp
decrease in defense spending more lhan accounted for
the drop. Real defense purchases have been falling
noticeably since early 199!. but the decline has been
erratic: at least part of the first-quarter plunge can be
interpreted as j correction after a few quarters uf
surprisingly strong spending. Meanwhile, real nondefense purchases have been aJrnosr fla( over (he pa.\r
couple of quarters
Real Federal Purchases
Percent ctiange. annual rate
The Government Sector
Governments al all levels continue to struggle with
budgetary difttcuifies. Af the federal level, the unified budget deficit over the first eight months of
FY1993—ihe period from October to May—totaled
S212 billion, somewhat less than during the comparable period of FY1992. However, excluding deposit
insurance and adjusting for (he inflow of contributions to the Defense Cooperation Account in FYI992.
Ihe eight-month deficit was about $230 billion in both
fiscal years. In the main, the underlying deficit has
failed to drop because the restraint in discretion an,'
spending that was iegisiaied in 1990 and the deficitclosing effects of stronger economic activity have
been offset by continued large increases m spending
for entitlement programs.
In total, federal outlays in the first eight months of
FY1993 were only about 2 percent higher lhan during
ihe same eight months of FY1992. Outlay growth was
damped significantly by a sharp swing in net outlays
for deposit insurance that ivas attributable larseh to
the improved health of depository institutions. In fact.
so far this year, receipts from insurance premiums and
proceeds from sales of assets taken over by the ao\emrneni have exceeded by SIS1/: billion ihe gross
ouriavs to resoli-e troubled institutions Defense
LJ
1989
1991
"Percemctrangs. (992 O4iD 1993 01. at;
1993
31 rate
Fedtrai receipts in ihe first eight months of FY1W3
were about 5 percent greater than in the same period
ot" a year earlier: the rise <*4* roughly the -.aine as thai
in nominal GDP Boosted hv the upswing m busme%\
profits, corporate taxes rose sharply. However, trie;,
account for less than one-tenm ol total receipt-,, and
growth in other categories ^as onK moderate in the
aggregate.
Stale.<» and localities continue iu (ace sizable budget
deficits: As measured in the National Income und
Product Accounts <N|RAh [he combined detic.it in^i
of social insurance fundsi in the sector's operating
80
Real Siaie and Local Purchases
PercarU
year. AU>o. these governments have laiely been reluctant to raise taxes, after the sizable hikes they enacted
in (990 and 1991. All told, the sector's own-source
general receipt.*, which comprise income, corporate,
and indirect business taxes, rose 5 percent over the
four quarters ended in the first quarter of 1993. about
the same that nominal GDP increased.
The External Sector
1939
1991
•Kent ctiafige. 1992 CM to 1993 Oi.at;
and capital accounts has heen iiuck around S40 billion since late 1990 These oulsized deficits have
per/listed despite ongoing efforts by many governments U> adjust spending and taxes. As at the federal
level. deficit reduction has been complicated by (he
upsurge in payments to individuals toe health and
income support: in the first quarter of 1993. state and
local transfer pav merits for Medicuid and Aid to Familiei vmh Dependent Children ( i n nominal terms)
were nearly 20 percent above (how <ii j year earlier.
The deficit-reduction effons ol" Mate and local governments in recent quarters liave been concmtaied
on the spending side. Their purchases of goods anil
services were nearly flat in real terms in the first
quartet of 1993 anil h^e changed linle. on net. since
early IfW. Outlays for construction. *hien fell al an
annual rate of 7 percent, on average, in the fourth and
firsi quarters, have been especially weak. For all
major categories except sewer and water, outlays in
recent months ha>.e been running significantly below
year-earlier levels. State and local employment has
continued 10 expand at the somewhat slower pace (hat
has been evident since 1991. w h i l e these governments
ha\e continued to hoid ihe line on wages and benefits.
The jpproumateK 3'-: percent increase in state and
local compensation rates over the year ended in
March wa-, similar to the rise for workers in pruate
industry' hy cuntTaM. in itie 19ftt)s. state and local
workers recencd increases that, on average, ivere
more than a percentage point per year greater than
those in private industry
Receipts of state and local grnernments. restrained
by the relatively tepid cyclical u p s w i n g in the sector's
tax bases,, have gro*n only moderately over the pust
Since December 1992, the trade-weigh ted foreign
exchange value of Ihe dollar has risen about 5 percent, on balance, in terms of the currencies, of the
other Group of Ten (G-IO) countries. This net
increase has reflected much larger movements in the
dollar\ value against individual currencies: In particular, a sharp decline against itie Japanese yen was
more than offset by substantial increases agaimt
major European currencies.
Relative to tlie monthly average tor December
1992. (he dollar has declined nearly 15 percent against
the yen to record lows, prompting heavy Japanese
official purchases of dollars and moderate doiiar purchases by L'.S. authorities. The strengthening of the
yen has occurred despite the weak performance of the
Japanese economy and market expectations that Japanese short-term interest rates will remain near historically low levels over the next year; it seem^ to be
based largely on the perception that Japan's external
iurpius. which has growri rapidly over this period, is
not sustainable.
Against the German mark, the dollar has risen
almost 10 percent since December, reflecting a sub-
Foreign Exchange Value ol the U.S. Dollar *
indai. March 1973 = IQQ
198T
19{ J
5991
1993
•Index of "Bigtrleo average i >re>gn excnange varueof U S dollar
r G-10 couriiries wsighis are baseo
an 1972-76 global trade of <
81
stantial easing of German interest rales and the expeclauon of funher declines in light of [he sharp contraction in German economic activity. The dollar has also
appreciated against other European currencies, and it
has remained little changed against the Canadian
dollar.
Economic activity in the major foreign industrial
countries generally has been sluggish so far ihis year.
The recovery in Canada now seems lo be reasonably
well established, and real GDP in mi; United Kingdom has been growing slowly. However, continental
Europe remained in recession in the first quarter, with
a sizable reduction in real GDP in western Germany;
recent indicators point to continued weakness in the
second quarter. After falling for much of 1992. Japanese real GDP rose in the firsi quarter, in large part
reflecting the effects of earlier fiscal measures; however, indicators for the second quarter are mixed, and
the appreciation of the yen will likely result over time
in a drag on nel exports.
Unemployment rates have continued to rise (into
the double-digit range in many instances] in the countries still in recession; even in the countries showing
signs of recovery, unemployment has remained high.
Partly as a consequence, wage pressures have ebbed,
and underlying inflation has continued to decelerate,
on average. A notable exception is western Germany,
where the CPI rose more than 4 percent over the
twelve months ended in June, partly because of an
increase in the value-added tax early this year and
large increases in the prices of housing services.
In contrast to the overall weakness of activity in
foreign industrial countries, real growth so tar this
year in major developing countries, especially in Asia,
appears to have remained at around the strong pace of
1992.
U.S. Real Merchandise Trade
Annual ran. billion! ol 1M7 dollars
pods
1989
rapid growth of U.S. domestic final demand m the
second half of 1992 and inventory restocking this
year. In addition, the prices of non-oil imports, reflecting the lagged effects of the appreciation of the dollar
during the last quarter of 1992. fell somewhat in the
first quarter; much of that decline appears to have
been reversed in the second quarter. The price of oil
imports fluctuated in a relatively narrow range over
the first half of 1993. Mild weather and strong OPEC
production pushed oil prices down early in the year,
but prices subsequently retraced the decline on signs
that OPEC would effectively curb production.
Recently, oil prices have dropped on Kuwait's decision not to participate in OPEC's quota allocations for
the third quarter and speculation that Iraq may be
allowed lo resume exporting sooner than had been
expected.
After expanding rapidly at the end of 1992, real
merchandise exports declined during the first quarter
of 199?. but they bounced back to their fourth-quarter
1992 high in April and May. Shipments to developing
countries, which hud men sharply over 1992. dropped
back during the January-to-May period. In the aggregate, exports to industrial countries rose somewhat in
(he lirst rive months of 1993. hut Canada and [he
United Kingdom accounted for most or the increase.
The merchandise trade deficit widened to SI 16 billion (at an annual rate) in the first quarter of 1993.
nearly S10 billion greater than in the second half of
1992; it increased somewhat further in April and
May, on average. With moderate increases in net
direct investment income receipts and a slight further
widening of the surplus on nel service transactions,
the current account deficit rose somewhai less than
the trade deficit, to SS'I billion ( j n n u a l ratej in the first
quarter, compared w i t h ^S.1 ^-.,'.^m in ihe second lull
of 1992.
Real merchandise imports, extending the rapid pace
of growth recorded over the tour quarters of 1992,
rose sharply over the first five months of 1993 Trade
in computers continued to soar and was responsible
for about one-third of the increase in merchandise
imports. More broadly, imports were boosted by the
Net capital inflows recorded in the iirsi quarter of
lO'l? were largely attributable to substantial increases
in foreign official ;isscts hold in the United St;iies,
particularly in those of some newK industrializing
Asian economies und of certain Latin American countries. Net private capital inflows were relatively small.
82
U.S. Current Account
Payroll Employment
Annual rail. Mfcong o< OoMra
Nvi change, millions ol jobs, annual rate
Total Nonlarm
nfl
Private foreigners added significantly 10 their holdings of U.S. securities, particularly Treasury bonds.
However. U.S. net purchases of foreign bonds reached
record levels, and net purchases of foreign slocks,
although down from peak levels reached in the last
half of 1992, remained heavy. New bond issues by
foreigners in the United States also were very strong.
Capital inflows associated with foreign direct
investment in the United Stales recovered substantially in the first quarter but remained far below the
peaks reached in 1989. Foreign direct investment in
the United States apparently has been deterred by
unfavorable returns realized on earlier investments
and by financial market conditions less favorable to
acquisitions. In contrast, capital outflows associated
with U.S. direct investment abroad remained strong.
Labor Market Developments
associated with sizable increases in health insurance
premiums and in other fringe benefits; uncertainties
about ihe future course of government policies may
also be contributing to the reluctance of some firms to
expand their permanent full-time work forces.
Moreover, firms are relying increasingly on temporary workers, in pan because doing so affords them
greater flexibility in responding to fluctuations in
demand for their products. Indeed, employment at
personnel supply firms, which consist largely of
temporary-help agencies, rose more than 150.000
between December and June. Over the past two years,
the increase has been about 500,000; thus, although
these firms currently account for less than 2 percent of
total payroll employment, they are responsible for
one-quarter of the increase in total employment over
this period.
The labor market showed signs of improvement in
the first half of 1993. According to the payroll survey, employment increased about 1 million: this number compares with a rise about 600.000 over the second half of last year and brings ihe total increase
since the cyclical low in 1991 to about 2 million.
Job gains in the firsl half of 1993 also reflected a
continuation of the steady uptrend in employment m
health services. In addition, gains occurred at trade
establishments, construction payrolls improved with
the recent stronger housing activity, and there were
scattered increases in services other than health and
personnel supply.
Nonetheless, job gains have continued to fall far
short ot the norms set by earlier business cycle expansions. For example, only m May diJ payroll employment return lo us pre-recession peak, two years al'ter
the cyclical trough: by contrast, recessionary job
losses typically have been reveised within ihe first
year of the expansion. Job growth has continued to be
reslramed by the temperate pace of economic activity
and employers' ongoing efforts to improve productivity. In addition, firms are confronting cost pressures
Meanwhile, manufacturing employment declined
further, on balance, over the first six months of the
>ear. Although factory output increased steadily
through Apnl. firms relied mainly on a combination
of productivity improvements and longer workweeks
to meet their output objectives; m May and June,
output decreased somewhat. Job losses in the first half
were concentrated in the durable goods sector, with
particular weakness at producers of aircraft and motor
vehicles. Since its last peak in January 1989. manu-
83
Civilian Unemployment Rate
Output per Hour
Percent criange. Q4 to Q4
Nont arm Business Sector
—i
- j_
ry -
1989
facturing employment has fallen about l-'/j million;
layoffs m defense-related industries (those industnes
thai depend on defense expenditures for at least
50 percent of their output! have accounted for about
one-fifth of the decrease in total factory payrolls.
Employment as measured by the monthly survey of
households rose about 900,000 ovet the first six
months of the year—essentially the same as in the
payroll series. The number of unemployed fell appreciably ai the beginning of the year, and the civilian
unemployment rate dropped from 7.3 perceni in December to 7.0 percent in February; it has shown iittfe
change since that time.
The civilian labor force expanded only modestly
over the first six months of 1993—less than 1 percent
at an annual rate. Labor force growth continued to be
damped by the relatively small increase in the
working-age population. In addition, perceptions ot
meager employment opportunities evidently continued 10 deter many potential job seeker!,. The labor
force participation rate, which measures the percentage of the working age population that is either employed or looking for work, spurted in late spring;
however, this spun followed a sharp decline earlier in
ihe >ear. and the level at mid-year was about the same
as [hat m late 1992
Outpui-per-hour in the nontarm business secior
declined at an annual rale of I 1 ' : percent in the lirsi
quarter, echoing ihe sharp deceleration in output.
Nonetheless, the first-quarter drop followed a string
of sizable increases; aJJ (old. [fie ri-,e ;n produciiufi
over the year ending m the hrst quarter of 1991
amounted 10 I 1 /; percent—-.mailer than the gams
recorded earlier in the economic expansion, but still
1987
1989
n
-
n"
1991
perceni Changs. 1992 Qi 10 1993Q1
noticeably larger than the norms for the past decade.
Productivity growth in the manufacturing sector.
where downsizing and restructuring efforts have been
under way lor some time, has continued to he especially impressive, totaling more than 5 percent over
the past year.
Labor compensation has tilted up of late. The employment cost index for private industry—a measure
llwt includes wages and benefits—rose at an annual
rale of 4L/> percent over ihe first three months of the
vear. Even so. the data are volatile, and the total
increase since March 1992 amoumed to only 3'.': percent; by contrast, this index had nsen 4'/i percent over
the preceding twelve rnonths, and. us recently as early
Employment Cost Index "
Petceni change. Dec. 10 Dec
Total Compensation
84
1990, the twelve-monih change had exceeded 5 percent. The increase in wages over the past year was
less than 3 percent, whereas the cost of fringe benefiis, pushed up by the steep rise in the cost of medical
insurance and by higher payments for workers' compensation, rose more rapidly. Primarily because of the
drop in productivity, unit labor cosis deteriorated
markedly in ih« first quartet, bui \hej> still were up
less than 2 percent over the past year.
Consumer Prices'
Percent cnang*. Dec. 10 Dec.
Price Developments
Inflation exhibited considerable month-to-month
volatility in the first half of the year. Broad measures of inflation picked up somewhat in early 1993.
with monthly readings through April in the upper part
of the range of the pasi couple of years. However,
pnee changes at the consumer and the producer levels were small in May and June. Culling through the
monthly data, the disinflation process evident in 1991
and 1992 seems to have stalled, with underlying
mftalion. as. measured by the iwelve-monlh change in
the CP! excluding food and energy, holding in the
range of 3'/i to 31/; percent that has prevailed since
last summer. The total CPI. held down by essentially flat energy prices, has risen 3 percent over the
past twelve months.
The CPI for food increased at an annual rate of
2 percent in the first half of 1993. a shade above the
rate of increase during 1992. Meat prices jumped
sharptv during the first few months of the year as
production fell short of year-earlier levels. In addition, the prices of fresh vegetables were boosted during the spring by weather-related production setbacks
Consumer Prices Excluding Food and Energy"
1987
1989
in several regions of the country. By late spring, these
supply problems had abated, and the June CPI
brought price declines in food categories where the
sharpest upward pressures previously had been evident. Since the end of June, however, farm crop prices
have moved up in response to the severe flooding m
the Midwest, The increases in crop prices have
already been reflected in the form of large advances in
some commodity price indexes and have raised the
possibility thai renewed upward pressures on consumer food prices could soon emerge.
Consumer energy prices changed little, on net. over
the first half of the year. With world oil markets
remaining relatively quiescent, the price of WestConsumer Food Prices'
Percent change, Dec, to Dec
Percent cnanga, Dec lo Dec
1989
lei lor all urtan (
une 1992 tfl Jun*
1991
"Consume! D"ce inde> tor all urBan consurru
-Percent cnange. June 1992 to June 1993.
1987
1989
1991
'Consumer pnce inflai (or all urban consumer
3 H, June 1993
85
Consumer Energy Prices*
Percent change. Dec. to Dec
n
1987
1989
1991
1993
'Consumer pirc^ NHTQ* to> aJI uitxa) consumers.
"Percent ctiange, June 1992toJun8 1993
Texas intermediate generally fluctuated between $18
and $20 per barrel but has weakened recently. Retail
prices for refined petroleum products changed fairly
little on the whole through Apnl anil dropped, an
balance, in May and June. Residential natural gas
prices rose considerably over the first half, in pan
because of inventory adjustments associated with lasi
winter's colder-lhan-usual weather; although recent
declines in wellhead prices suggest that some of the
increase a( the retail level may be retraced in coming
months, over the longer haul, natural gas prices are
being supported by an ongoing shift toward ihe use of
cleaner-burning fuels.
All told, the CP1 excluding food and energy
increased at an annual rate of 3V: percent over (he
first half of the year, after rising 3 percent over the
second half of 1992. The CPl for goods soared in
January and February, wnh large increases reported
for several items. Apparel prices jumped early in the
vear, in part because strong sales in late 1992 limited
the need for post-Christmas markdowns. Some retailers may also have seen opportunities to widen profit
margins on other merchandise; the recent decrease in
prices of home furnishings, tor example, suggests that
not all of these increases stuck.
Increases in prices of non-energy services were
Headier but also somewhat larger than in 1992. Part
of the step-up was in shelter costs, which account for
about half of non-energy services and had posted
some unsustainably small increases last summer.
However, the substantial deceleration in medical care
prices i for both goods and services) that has been in
tram over the past few years extended into 1993. In
fact, the CPl for medical care rose only about 6 percent over the twelve months ended in June; this
increase was among (he smaJksi of the past decade.
To some extent, the higher underlying CP! inflation
rates in the first half of 1993 may be a statistical
phenomenon that will be reversed in tJw second half:
Indeed, over the past several years, price increases
early in the, year have tended to exceed those for the
year as a whole, even after seasonal adjustment by the
BLS. But. even allowing for this phenomenon, inflation seems to have leveled out. The lack of further
deceleration is puzzling in light of the considerable
slack in labor and product markets. One possible
explanation is that the pickup in economic activity
late last year may have triggered a round of pnce
increases: if so, some deceieranon in prices is likely
in the wake of the subdued performance of the economy in the first half. Another may be the apparent
failure of inflation expectations, as measured by Carious surveys of consumers and businessmen, to reflect
fully the reduction in actual inflation oier the pasi few
years; although the survey measures •-ary considerably, respondents seem to share a sense that inflation
has bottomed out
Prices receded by domestic producers ha^e slowed
in recent months, after undergoing a pickup earlier in
the year. AH (oid. (he twelve-month change in the
producer price index for finished goods other than
food anil energy Mas less than 2 percent in June,
down somewhat from a year earlier. At earlier stages
of processing, where price movements lend to track
cyclical fluctuations in demand, prices of intermediate
materials (excluding food and energy! firmed a little
early in the year, but they subsequently moderated:
although the pattern was exaggerated by the spike m
lumber prices, it was evident for sume other materials
as well In oommodiiv iniiike:-.. prices of precious
metals have moved up sharply o\er the past couple of
months, und some scattered increases have i>een evident elsewhere. More broadly, however, industrial
commodity prices were down ^liahth. on net. over
(he (ifit half of (he ve-ir.
86
Section 3: Monetary and Financial Developments in 1993
Monetary policy in I993 has been, directed toward the goal of sustaining the economic expansion
while preserving and extending the progress made
toward price stability in recent years. In ihe fitst half
of the year, economic activity stowed markedly from
the very rapid pace of the fourth quartet, while inflation indicators fluctuated widely. Although inflation
readings were a source of concern for the Federal
Open Market Committee, ihe intensification of price
pressures did not seem likely to be sustained over an
extended period, and reserve conditions were Kept
unchanged. With short-term rates steady, pnces of
fixed-income securities were buoyed by prospects for
significant fiscal restraint and by a slowing of the economic expansion, although fears of a pickup in inflation at times prompted paniai reversals in bond rates.
Yield spreads on private securities relative to Treasury rates remained historically narrow, and stock
price indexes sel new records.
The monetary aggregates have been sluggish this
year, as both the share of depository institutions in
overall debt finance and the proportion of depository
credit funded with monetary liabilities have fallen
further. The reduced tote for depositories largely reflects weak demands for loans and deposits fey the
public. Corporate borrowers have continued to issue
heaiy volumes of stocks and bonds m pan 10 pay
down bank debt, while households have withdrawn
deposits to invest in bond and equity funds thai
finance truer alia corporate issuers. After two years of
no growth, bank loans weakened further early this
year. bu( increased fairly vigorously in May and June,
posting a modest net gain for the first six months of
the year. The growth of nonfinancial sector debt so far
this year has edged up from the subdued pace oi
1992, despite a deceleration of nominal spending, as
investment spending is estimated to have exceeded
5ne internal funds of corporanons. household borrowing has picktd up relative to spending, and Treasury
financing needs have remained heavy
firms, and financial institutions continued to improve, although money and credit growth remained
weak, Wage and pnce data suggested a continuing
trend toward lower inflation. Intermediate- and long,
term interest rates had declined somewhat, in pan
reflecting a view that the new Administration's fiscal stimulus package was likely to be modest and that
material [eductions in future deficits were in prospect. The economic outlook remained clouded, however, by uncertainties regarding details of fiscal policy plans, continued restructuring and downsizing of
laige businesses, and lingering restraints on credit
supplies. At its eariy February meeting, the Federal
Open Market Cornrnitwe decided that its directive to
the domestic open market desk should retain a svmmetnc stance regarding possible reactions over the mtermeetmg period to incoming indicators; such a
directive, which implied no presumption in how
quickly changes in operations should be made toward
lightness or ease, had been instituted in December,
following directives that had been biased toward easing over much of [he previous two years.
The implementation of Monetary Policy
Economic activity appeared to decelerate in the
early months of the year, however, in part because of
adverse weather conditions, with softness in retail
sales, housing starts, and nonresidential construciion.
Bank credit was failing to expand significantly, while
broad money was declining owing both to temporary
factors and a weak underlying trend. Although ^honterm interest rates were little changed, bond markets
rallied further on weaker economic activity and
improved prospects for fiscal restraint, which would
reduce the government's demand for credit. Longterm rates fell 10 the lowest le\ets in almost twenty
years in early March, before backing up somewhat on
reports of a second month of substantial increases in
consumer and producer prices. The drop in interest
rates buoyed stock markets to record highs and contributed lo a small decline in the weighted-average
value of the dollar. The dollar depreciated substantially against the >en. as market attention focused an
J-jpan's growing trade surplus.
Early in the year, incoming data suggested itmi the
faster pace of economic activity (tut had emerged in
the third quarter of 1992 had been maintained through
year-end. Indicators of industrial production, retail
sales, business fixed investment, and residential construction activity all posted solid gains. Financial
impediments 10 the expansion appealed In be diminishing as the balance sheets of households, business
Signs of pnce pressures were a concern for ilxe.
FOMC. hut Ihe fundamentals of continued slack m
labor and capital utilization, subdued unit labor cosis,
and protracted weakness in credit and broad money
suggested thai a higher trend inflation rate was not
setting in. With Ihe economy slowing, reserve pressures were kept unchanged and a symmetric policy
directive was retained at the meeting in March.
87
After pausing in March, producer and consumer
prices leaped jgam in April. Long-term interest rates
backed up lurther in response; the price of go)J
surged. and the dotfur fell more rapidly. With [he
Japanese authorities buying dollar*, in foreign
exchange markets, the US. Treasury and ihe Federal
Reserve jlso purchased dollars for yen in late Apnl
After mended weakness, the monetary aggregates
jumped in early May by more than could be explained
by temporary factors.
At its May meeting, (tie FOMC was confronted
with weak output growth and intensified inflation
readings. !< was difficult, to identify reasons for this
juxiaposilion. Price increases by business firms in
early 1993 could have reflected optimism engendered
by strong demand conditions in the second hull' of
1992 or an upward adjust mem of inflation expectjiions. However, considerable stack remained in labor
and product markets, and ihe pace of economic atuvny had slowed markedly. Trie Commillee concluded
that no policy adjustment »ai needed at its meeting,
but ihe nski of increased inflation and inflation expectations warranted a directive that contemplated a relalively prompt tightening of reserve pressures if signs
of intensifying inflation continued to multiply.
The subsequent readings an inflation for May and
June were subdued; moreover, evidence of heightened
inflation ex pec tat ions did not emerge in markets for
fixed-income securiiiei,. Consequently, ihe stance of
monetary policy was not changed following the May
FOMC meeting. The dollar rebounded on foreign
exchange markets in June and early July in the wake
of the fall of the Japanese government and evidence
that economic conditions in Europe haci deteriorated
furtherOn balance, since the beginning of the year, shorllerrn interesi rates are l i t t l e c h a n g e d , w h i l e
intermediate- and long-term rates have fallen threequarters to one percentage point to the lowest let eh
in over twenty years. In particular, the thirty-year
Treasury bond has reached a low of 6.54 percent.
while the ten-year Treasury iwie has louched 5.T1 percent, its lowest level unce 1971. The tised-rate thirtyyear mortgage interest rate has dropped to 7.16 percent, a record low in ihe 22-year history 1 of the \eriev
The fall in intermediate-term interest rates in ihe
United Stales was roughly matched on average
abroad, and the trade-weighted value of' the dollar in
terms of G-1Q currencies has increased about 5 peieent from its Decemfier aierage. as overseas economies weakened anil foreign .short-term rates declined
substantially.
Monetary and Credit Flows
Growth of the broad money measures teas ijuilc
slow over the first naif of 1993, falling below the
suhdued pace ot 1992, and leaving them near ihe
lower itrms of (he revised growth cones tor 1993
This deceleration, however, did not reflect a moderaIJOD in overall credit flows or a tightening in financial conditions. Rather, it resulted from a further
diversion of credit flows from depository institutions as well as continued financing of depository
credit through capital accumulation rather than deposits. Indeed, growth of the debt of ail nonlinanci.il
sectors is estimated to hai-e edged up ihis year—lo
5 percent—despite an apparent slowing in nominal
GDP. Continued substantial demand for credit by the
M2' Annual Ranges and Actual Growth
Billions ot *)«ars
O N O J
1992
F
M
A
M
J
J
A S Q N O
1993
M3: Annual Ranges and Actual Growth
Billions ol
88
Debt. Annual Ranges and Actual Growth
Billions of dollars
marketable debt and repay bank, loans. Stresses associated with the restructuring of ihe economy and the
earlier buildup of debt linger. However, downgrading of corporate debt by rating agencies have
dropped well below ihe peak levels of a few years
ago. and a growing number of firms have received
upgradings, as corporate cash flows have strengthened substantially relative to interest expenses.
Debt service burdens of households also have continued 10 decline relative lo disposable income, as
households, have repaid high interest debt or taken
advantage of lower rates to refinance. Indeed, the
decline in long-term interesi rates during the year has
brought a new sutge of refinancings of mortgages.
With balance sheets improved, households have
become somewhat more willing to borrow, and consumer credit has bejun growing moderately after two
federal government is *ttl as more comfortable
financial positions' and consequent signs of a greater
Debt Service Burden of Households
willingness 10 borrow and lend by private sectors
Total Debt Service' as a Percentage
.of Disposable Persona! Income
likely supported <iebi expansion. Nevertheless, overall debt growth remains in ihe lower portion ot its
revised 4 to 8 percent annual range for 1993. Nonfederal debt growth has expanded a: a still modest
3'/4 percent pace, after two years of even weaker
growth.
Taking advantage of low long-term interest rates
and the strong iiwk market. businesses have issued
an exceptionally large volume of bonds and equity,
the proceeds have been used mainly to refund other
Interest Expense Burden of
N on financial Corporations
Total Net intetesl Payments as a percent
of Cash Flow' plus Net Interest Payments
Quarterty
1981
1983
1985
1987
1989
1991
1993
• DePi service a a Federal Reserve staff estimate ot scheduled
paymenls of principal ana interest an home monqaf]fl
years of weakness. Some of that growth, though, may
reflect heavy promotion of credit cards canning special incentives for use in transactions, such as
"frequent-flier miles" or merchandise discounts. Net
mortgage debi is estimated to ha\e grown oniy a bit
more than the modest rate of 1992.
Gross issuance or' stjte and local government debt
ha;, been particular)} robust this year. However,
refunding volume has accounred for nearly 70 percent
ot Ihe offenngs. compared with about 45 percent in
1992. J record year for refumiings Net debt of state
1981
1983
1985
1987
1989
" Cash flo* is cteiined as aenrecianofi plus rera
earnings (book valuesj
and local governments has groi^n only moderaiely
again in 1993. The budgetary situations of some slate
89
ers by decreasing interest expenses and boosting economic activity, ihereby reducing loan loss provisions
for banks. Banks posted record earnings in IW2 iind
remained very profitable in early J993; prices of their
shares on equity matkets have risen substantially.
and local governments have improved, ai lax receipts
have been stronger ihan expected, bin severe financial
problems remain in oihei locales.
With corporate borrowers still relying heavily on
financing ihrougb capital markets, and depository
lending spreads over market rates remaining high, ihe
trend decline in ihe share of total credit flows provided by depository institunons was extended Ihrough
ihe first half of (993. From ihe fourth quarter of 1992
to June, bank credit expanded at a 4Vi percent annual
rale, only a modest pickup from the sluggish pace of
ihe previous two years. Securities acquisitions accounted for most of ihe expansion, as loans increased
at only a \Vt percent rate. The growth of bank securities portfolios in pan reflects additions to holdings of
secumi2ed mortgage and consumer loans; bank
financing o!' consumer spending and real estate transactions is thus stronger than indicated by bookings of
loans in those sectors. While commercial and industrial loans have been aboui fla! on balance so far this
year, a few signs of easine in bank lending terms and
conditions have recently emerged, and business loans
rebounded in May and June. Judging by business loan
growth at smaller banks so far this year, a pickup hat
occurred in lending to smaller nonfinancial firms.
Thus, the continuing weakness in overall business
loan growih does not appear to be driven primarily by
restrictive supply conditions, but rather by the preference of larger firms to fund through capital markets.
Thrift institutions have continued to contract in
!993. though at a much .slower pace than over ihe lasi
four vears. A lack of funding for the Resolulion TRJSI
Corporation caused a hiatus in the closure of institutions under its conservatorship. However, pnvaiely
operated thrifts have not expanded arid the imiu«r>
continues 10 con solid ate.
Slower growth in nominal GDP. moderate demand
for credit relative to spending, and (he reduced share
of credit provided by depositories have all contributed
to the lack of significant growth in the broad rnunetary aggregates ihis year. Another factor inhibiting
money growth has been continued subsiantial funding
of bank and thrift assets with subordinated deb; and
equity issues, as wed as retained earnings—all a
byproduct of ongoing efforts 10 build capiial positions. While about a third of Ihe industry (by asset
volume) had capital ratios and supervisory ratings
high enough at the end of 1991 10 be considered
well-capitalized, more ihan two-third1; were .so poMlioned bv early 1993. About $10 billion was added to
batik equity and subordinated debi during the Hrit
quarter, aboui ihe same pace as m 1992, data on new
debt and equity issues indicate anoihcr Mzable gain
over Ihe second quarter.
Lower market interest rates over ihe past tew years
have helped strengthen the financial positions ot"
banks and thrifts. The lower rates have resulted in
capital gains on securities and improved interest
margins—as deposit rates have fallen more ihan lending rates. Lower rates also have helped bank borrow-
Depositories have also recently relied more heavily
on other nondeposii sources of funds. Weak economies and credit demand abroad have prompted the
US. offices of foreign banks w draw more funding
Domestic Sank Assets by Capital Category
Ad/usted tor overall supervisory ratings1
End of Year
1931
1992
March
1993
Well Capitalized
34
68
70
Adequately Capitalized
46
22
20
Undercapitalized
21
10
10
Capital Category
Percent
] Adjustment lo capital categories were ma<JH according ID me njifl at ItnjmO ol downqraaing a ba
On falmg by il5 supervisory agency (CAWEt 3. 4. or 5J
90
from overseas, and the domestic offices of U.S. banks
lo reduce foreign lending this year- Overall shifts
from deposits 10 other sources of funding may be
driven, panly by regulatory inducements—including
higher insurance premiums on deposits and incentives
to bolster capital. But changes in investor preferences
from short-term deposits to longer-term debt and
equity may also be playing a role in motivating the
restructuring of bank and Ihnft sources of funds.
Key elements affecting money growth relative to
nominal income may be seen in a decomposition of
M3 velocity in (he foui-panel chan below. The top
left panel depicts the moderation in overall borrowing in the economy; after several years of declines, the
laiio of nominal GDP to total nonfinancial debt, or
debt velocity, has been father stable since 1990, as
debt growth has slowed to about the pace of GDP
growth. The top right panel shows the reduced role of
Decomposition of M3 Velocity (Ratio scales)
Ralio ol Nominal GDP
Ratio of Total Nonfinancial DeDI
to Total Nonfinancial DeDI
to Depository Credil
0.60
3.0
0.55
050
2.4
1989
1991
Ratio of Depository Credit to M3
1993
1989
Velocity ot M3
1991
91
depositories in providing even the more moderate
volume of tola) credit; the ratio of toia) nonfinancial
debl !o depository credit has nsen sharply over the
last three years. Higher costs and attempts to recoup
past capital losses led to higher bank loan rates relative to market rates after 1988 and stricter nonpnce
terms and standards, while declines in long-(erm interest rates and a strong stock market, along with the
impetus 10 repair balance shews, induced firms to turn
to capital markets for financing. The bottom left panel
shows the increased reliance on equity and other
nondeposit funding by banks and thrifts, as well as
some declines in money market mutual funds; the
ratio of depository credit (o M3 has been rising since
the second quarter of 1992. The velocity of M3 (GDP
divided by M3X in the bottom right panel, is the
product of the oiher three ratios. In the late 1980s. M3
velocity departed from its traditional declining trend,
increasing at about a 2 percent annual rate as the
depository sector began playing a smaller role in
financing credit growth. The growth of M3 velocity
picked up to 5 L /J percent in 1992 and perhaps a
somewhat faster rate in the first half of 1993.
Greater reliance by borrowers on capital markets
has been facilitated by concurrent shifts in saiing
preferences away from monetary assets and into capital market investments. Such portfolio realignments
are evident in record inflows to bond and stock mutual funds, and money balances were also likely invested directly in stocks and bonds. The incentives
for what appears to be an extraordinary adjustment of
household portfolios are varied. Interest rates paid on
retail time deposits. NOW accounts, and money market deposit accounts (MMDAsI have fallen well
below any rate offered since the inception of deregulated deposits in the early 1980s, and savings deposit
rates are now the lowest in more (hart thirty year1..
The shock effect of historically low deposit interest
rates caused many depositors to investigate alternauve investments. With the yield curve extraordinarily
steep, much higher returns have been available m
recent years on longer-rerm investments. A bond or
stock mutual fund offers a chance to earn these higher
yields, but still enjoy liquidity features, including in
some cases a check-writing facility. However. i n \ e t i ment in such a mutual fund carries with it LI higher
nsk of loss as well, because unlike monetary asset-,
its principal value fluctuates with market prices. Indeed, the higher yield on bonds relative to short-term
instruments probably anticipates some capital losses.
Whether ail households accurately assess relatue
risks when comparing returns recently earned on
mutual tunds with those on money balances remains
an open question
Shifts into mutual funds ha\e become much easier
and less costly for households, most notably because
many banks have begun offering mutual funds for
sale in their lobbies. While many banks now offer
discount brokerage services, a survey by the Federal
Reserve found that larger banks have recently been
making special efforts to promote mutual fund investments among their depositors. An increasing number
of banks have sponsored their own mutual funds or
entered into exclusive sales relationships with nonbank sponsors of funds. Some banks have promoted
Ihese products as a defensive measure to retain longrun relationships with valued depositors. In other
cases, however, banks have promoted funds as part of
a strategy to earn fee income without hooking assets,
thereby avoiding the need to raise additional capital.
Substitution between money and long-term mutual
funds appears to have become evident in the aggregate data in recent years. There was lutic increase in
such funds from 1987 through 1990. but large inflows
unce ihen. at ihe same time that accretions to M2
balances declined. A comparison of the quarterly
growth rates of M2 and the sum of M2 and bond and
Mock funds shows that growth of the sum has not
\\eakened as dramatically as that of M2 over the last
tvio and half yean, it has averaged nearK a 5 percent
annual rate, compared with less than 2 percent for
M2. Although adding mutual funds and M2 together
captures some substitution ou; of M2 in recent years.
Changes in M2 and Stock and Bond
Mutual Fund Balances
Billions of dollars. SAAR
C Mel change in M2
• Wet change in stock and bond funds
1985
1987
1989
1991
1993
Nore: Mutual tuna balances are valued at curreni market gnces
These qata exclude tBA and KaogTt D3Janc£s ana instiluiional
Holdings Hall-year ai an annual 'ale lor 1993
"00
92
refinancing began to bolster demand deposits and
MMDAs in April, as mortgage servicers increased
balances temporarily before making remittances to
investor in mortgage-backed securities. The seasonal
factor distortions began to reverse that month as well.
However, substantial shortfalls in individual nonwitfiheld tax payments relative to recent years produced
an offsetting restraint lo money growth in April, as
the buildup of balances required to pay taxes was
smaller than that incorporated into seasonal factors.
Even excluding estimated effects of these special
factors, however, underlying growth of money
through the first four month!, of the year was far
weaker than historical relationships would suggest.
Growth Rales at M2 and M2 plus
Stock and Bond Funds
1985
1987
1989
1991
1993
the loial remains quite volatile, indicating [hat other
forces have aftected both M2 and mutual funds. Paitlj
as a consequence, ihe relalionship of Ihe lota] to
aggregate spending is subject to considerable uncertainty Investments in bond and stock funds are themselves subject to potentially \olatile capita! gains and
losses. More (uiulamentally, ihe responses of the public, now holding lastly expanded mutual funds, to i
variety of interest rate and stock price movements has
>e> lobe tested.
Because weakness in the demand for broad money
has largely resulted irorn shifts of portfolio preferences rather than changes in spending intentions, it
has not been reflected in comparable weakness in
nominal GDP. Furthermore, the effects of a declining
share lor depositories in overall credit growth have
been substantially offset by increased 1'undmg through
capital markets, where households now invest a larger
share of wealth. The velocity of M2 has experienced
emraord)nan and unpredictable surges, reducing its
value as a guide to policy. Traditional models of
velocity based on the difference between short-term
market interest rates and interest rates on deposits and
money market mutual funds, and even broader models
(hat take account of longer-term in\ere*.i raies anil
after-tax loan rates faced by households, cannot
explain ihe full 4 percent rise in M2 velocity in 1492,
not vvruW may be a somewhat faster rate of increase in
the first hall of 1991
Money growth in the tirsl quarter was depressed in
pan by the effects of several temporary
toois.
including distortion* of seasonal factors and a lull in
mortgage refinancing. A renewed surge of mortgage
Despite continued heavy inflows to bond and equity
funds in May, the monetary aggregates surged,
boosted in pan by a reversal of die tax effects and an
inieniilicaiion of mortgage refinancing activity. However, the aggregates decelerated substantially ifi Jufie.
and by more than might be suggested by a waning of
tax and mortgage refinancing effects.
in 1993, household portfolio adjustments differed
somewhat t'rom their previous pattern. In the past, the
realignment of household wealth inward capital market investments had mainly involved shifts, from
money market mutual funds and small time deposit
accounts. At the same time, outflows from those
accounts had also gone into NOW and savings deposits, the interest rates on which were failing only
slowly as market rates declined. This year, the sum of
all itiese M2 balances has fallen at about the same rate
as in 1992, but a slower runoff of small lime deposits
and money funds has been offset by a sharp deceleration in the growth of NOW and savings deposits.
Catch up declines in interest rales on liquid deposits
may account for pan of iheir slower growth. Some
nontransactions balances held in NOW and MMDA
deposits have likely been shifted into bond and equity
funds, ll may be that some depositors who do not
ordinarily shop tot small raie advantages have been
induced to make basic portfolio adjustments because
of the historically low deposit interest rates and the
increased ease of making investments in capital market instruments.
Partly as j result, narrow measures of money have
decelerated this year, but then expansion has remained rapid. Ml has grown at a 91/; percent rale
from the fourth quarter of 1992 through June, computed tmti l-l'/i percent in 1992. Reserves, now held
exclusively against transaction deposits, have grown
at an II percent pace compared with 20 percent m
1W2. The monetary base has slowed by much less,
93
M2 Velocity and Opportunity Cost
1991
1993
Percentage points, ratio scale
because of continued strong foreign demand for currency this year.
Wiih reduced strength in it>, M 1 component, and in
savings and MMDAs, as well as continued runoffs of
small time deposits and retail money funds. M2 has
grown ai only a '/-> percent annual rate from the fourth
quarter ot 1992 through June 1993. u.ell below, ihe
lo*ei end of its growth cone «i in February. The
FOMC monitored th« behavior of M2 carefully over
the first half of the year, bul in light of actual and
expected strength of velocity, determined that actions
to boost M2 growth were nol needed to achieve the
Committee's underlying objectives For prices and the
94
economy. The aggregate is near the lower arm of ihe
revised annual growth cone established in July, and if
velocity continues 10 increase substantially. M2 may
well come in toward itie lower end of the revised
growth range for the year.
The non-M2 portion of M3 has declined this year at
nearly the same pace as the previous (wo years. Large
time deposits have continued lo fall, and the halt in
reductions in short-term rates has ended the rapid
growth of institutional money funds, as theit stowetadjusting yields have come down lo their usual telationship to market interest rates. From the fourth
quarter of 1992 through June, M3 fell at about a
V* percent annual rate: it lies slightly below its revised
annual growth cone.
Growth ot Money and Debt
Ml
M2
Annually,
fourth Quarter to fourth quarter
1980
1981
1982
1983
1984
1985
1986
M3
Nonfedera!
domestic
nonfinancial
debt
(Percentage changes)
7.4
5.4(2.5)'
8.8
8-9
9.3
9.1
9.5
9.5
12.3
10.0
9.9
9.9
10.4
12.2
5.5
8.1
8.7
9.3
10.8
14.3
4.3
5.3
4.7
4.0
2.8
1.8
Q1
6.6
-2.0
02
10.6
9.5
12.0
15.5
1987
1988
1989
1990
1991
1992
Total
domestic
nonflnancial
debt
6.3
4.3
0.6
4.3
8.0
9.3
9.0
9.7
7.4
9.8
11.4
14.3
13.8
14.0
13.9
13.3
13.7
5.8
6.4
3.7
1.8
1.1
0.3
10.1
10,4
9.2
8.2
6.8
4.4
4.8
9,6
8.5
5.9
2.5
2.9
2.2
3.8
2.4
4.4
5.7
3.0
3.6
0.8
-0.3
5.13
3.3=
7.6
8.9
Semiannual^
(annual rate)2
1993
H1
Quarterly
/annual rale/1
1993
Fourth quarter '992
to June 1993
(annual rate)
' fldjusTeaforsnifi to WOW accounts in 1981
Second qualar 0BQI aggregates e^tarovad on data ihraugn Ma
J Q4-I993 May lor deBI aggrsgaM
95
RESPONSE TO WRITTEN QUESTIONS OF SENATOR RTEGLE
FROM ALAN GREENSPAN
Q.I. Your testimony indicates that you plan to focus your monetary
policy more on real interest rates. You stated, "the equilibrium
term structure of real rates cannot be estimated with a great deal
of confidence, though with enough to be useful for monetary policy." The purpose of this hearing was to have you express your
plans and objectives more specifically. Would you tell us:
(a) How are you measuring real interest rates? (b) What do you
think the equilibrium term structure of real rates is? (c) What is
your strategy for adjusting real interest rates relative to equilibrium rates over the next 18 mouths?
A.1. The real rate of interest is defined as the nominal interest rate
less the expected rate of inflation. Several complications arise in
measuring and using real interest rates. First, a number of real interest rates probably have individual significance for various types
of spending. These real rates correspond to the variety of financial
instruments, which differ by term to maturity, duration, credit
quality, liquidity, taxability, call options, and other features. Any
single real rate is an imperfect proxy for all real rates. Second,
there are no direct, unambiguous measures of the expected inflation embodied in nominal interest rates. Consequently, analysts
are forced to rely on survey-based measures of inflation expectations, which may be subject to various biases, or on actual inflation
data, in which case analysts must assume that households and
businesses base their expectations on recent experience with inflation.
Equilibrium real rates are defined as the interest rates that, if
maintained, would result in full employment and constant inflation. More broadly, an entire structure of equilibrium real interest
rates can be defined, with the elements of the structure corresponding to the various real interest rates alluded to in the previous
paragraph. For example, term premiums will lead to differences between equilibrium short-term real rates and equilibrium long-term
real rates, and default premiums will cause differences between
equilibrium rates on corporate bonds and equilibrium rates on
Treasury bonds. A complicating factor relating to the use of equilibrium real rates is that they may vary over time in response to
changes in underlying influences such as desires to save, changes
in technology affecting productivity, non-interest-rate terms of credit, and fiscal policy. A central bank needs to take account of these
variations in conducting monetary policy.
The following charts provide selected measures of real interest
rates; the various series use short- and long-term nominal rates
combined with measures of inflation expectations that are based either on survey data or on recent actual inflation. The various
measures of short-term real rates show similar movements, as do
long-term real rates, but they display appreciable differences in
their levels. Generally, the charts indicate that real interest rates
are at the lower ends of their ranges since the late 1970's.
96
CPait i
Short-tarm Real Interest Rales
RMJ Fadwai Fund* flai*
Mann*
1966
1971
1978
1981
1986
' Feaatai Funoj ram minus mro« monm moving averaqa at past rnflaOon. as mBasureO by tn« CPI IMS food and en«gy.
- Thre*-monin Did raM on a coupon Muvaiant Daia loos a loui-guvar moving avarag* of Oast infUDon. as
By me PCE aaltotor
. Oanoies most lacam vajuas uiing laaui availaDM inlaaon flaca.
97
Chart 2
One-Year Real Interest Rates
On*-Yaar T-Sil Minus Ona-Yur Inflation Expectation* (Michigan)
MomMy
Qn«-Yw I-Bill Minu* On»-Y««r Inflation Expactaiioni (Philadelphia F«d)
Monthly
On»-Year T-8il1 Minus Change in th« CPI from Thrw Momfi* Prior"
Momniy
tiao mi >MI isu >i» IMS 199*
• ASAfN8£R quinvi* luviv UJIB 1990 Qv phiiiotiona Ftoic* R««vi6vi* um* ttUKian
auanVT innuon noiouan.
" CPI QWIMO TO iioudi loco ra *r\nqi
HCAU: f-Gil ,t en a ^uoon-«9urvat«m Dam
. Oimin mini FtunT •MKIT r-bt* 'a» >ni "vni ricnn innanon tiatcaao".
i moji mm
98
Ghana
Long-Term Real Interest Rates
RM! Corpora* Bond RUB*
f A Cotpomt Bono)
I97B
1973
IBM
10t1
19U
19*4
iSflS
'IMS
138'
:9U
1989
T99O
1991
r>ii uoow M« niMUrH itvrw nllMDn ipKtDonf by m» Hotv &urv«v untrt Aon w Tn» PhrfUKn* Ptaw ^aBB>«
99
Chan 4
After-tax Real Rate of Interest*
ai-*xwnpt Bond Flat*
w
II M M
II
1W7
19M
• MaoOft AAA Mn^M Borar YWO ta« l (Itn y*« o< CPI MMdn.
"T—mi —rt-T-imr«iii_iamjl«M«t
100
Not only actual but equilibrium real rates probably have shifted
over the last fifteen years. In the first half of the 1980's, for example, substantial fiscal stimulus likely increased equilibrium real
rates. By the early 1990's, however, a number of forces were restraining spending, including the efforts of households, businesses,
and financial institutions to strengthen their balance sheets, which
had become strained during the previous decade by heavy reliance
on debt. It was in view of these forces that the Federal Reserve
took measured actions over the past few years to lower short-term
real interest rates to historically low levels, encouraging a gradual
downward trend in long-term interest rates and abetting the process of balance-sheet adjustment. As this adjustment has progressed, the restraint on spending has eased somewhat; still, attitudes toward credit remain quite cautious and recent legislation
confirms that Federal fiscal policy will continue to be moderately
restrictive. For these reasons, it is possible that the equilibrium
structure of real interest rates is now somewhat lower than we
have experienced for many years.
Nevertheless, a range of experience in a variety of economic situations strongly suggests that the current real short-term interest
rates of about zero are below the levels toward which they ultimately will need to move to be consistent with achievement of the
Nation's economic objectives over time. A lesson of the 1970's was
that maintaining very low real short-term rates for long periods of
time is likely to be incompatible with stable economic conditions.
When and by how much real short-term interest rates will eventually need to rise will depend on economic developments and inflation pressures. In any case, it is worth noting that a change in real
interest rates does not necessarily imply a commensurate movement in nominal interest rates; real interest rates can rise either
because nominal rates increase or inflation expectations decrease.
Particularly in view of the current unreliability of the monetary
aggregates, the Federal Reserve must monitor a wide range of variables in assessing economic trends and inflation pressures. Although estimates of real interest rates (and their equilibrium values) are subject to considerable uncertainty, they have considerable
economic significance and can usefully be included in the indicators
employed in conducting monetary policy.
Q.2. The situation in the economies of Europe and Japan appears
poor and deteriorating. Unemployment in Europe is the highest
since World War II. How serious is the risk that these economies
will remain depressed for some time or weaken significantly more
and what are the potential consequences for our economy?
A.2. Economic activity in Europe and Japan has been quite weak
on average since early 1992. However, the experiences of individual
countries have differed; for example, in the United Kingdom recession started in late 1990 and recovery has already begun, while in
western Germany recession began in mid-1992 and recovery is not
yet clearly established. Unemployment rates are very high in Europe, but in many European countries rates are below those in the
1982-1983 recession. Activity is likely to recover only moderately
in Europe and Japan during the remainder of this year and next.
Moreover, there are risks that even a weak recovery will prove elu-
101
sive. Such an outcome could result from consumer confidence remaining depressed, from lackluster business spending as a result
of slow credit growth or weak profits, or, in some countries, from
the further effects of falling commercial and residential property
values. Continued slow growth in Japan and our European trading
partners would lessen demand for U.S. goods and services. However, much of the recent growth in U.S. exports has been to other
parts of the world, such as East Asia, Mexico, and Canada. Strong
economic growth in these areas—or continued recovery in the case
of Canada—should help to sustain growth our exports.
Q.3. Recently we had some dramatic revisions in the employment
data. You have raised concerns about bias in the inflation data.
These are critical data series which you use in making your policy
decisions. Are we providing the best data we can? What should we
be doing to improve these data?
A.3. The quality of economic statistics has been a longstanding concern of the users of such data, both within the Federal Government
and in the business community. In 1989, a working group consisting of the producers and users of economic statistics in the Federal
Government put forth a program designed to address such concerns, by improving the quality of Government statistics. This socalled "Boskin initiative" resulted in a package of high priority
projects that included, among other things, improving the existing
labor market surveys and developing new techniques to incorporate
quality adjustment in price indexes.
The statistical agencies have, within the limits of their budgets,
been successful in addressing the concerns raised by the working
group on statistics. For example, the Bureau of Labor Statistics
(BLS) has succeeded in raising response rates for the first estimate
of monthly employment growth from 35 percent in the mid-1980's
to 85 percent in 1992. Consequently, the initial revision to the employment estimate has fallen from an average of nearly 60,000
(without regard to sign) between 1981 and 1990 to about 35,000 in
1991 and 1992. Similarly, the Bureau of Economic Analysis has
made considerable progress in incorporating better estimates of
computer prices into the National Income and Product Accounts.
Such estimates will not only improve measures of Gross Domestic
Product, but will also lead to better estimates of inflation and productivity. Some progress has been made as well in improving statistics on the growing service sector, where there previously had
been a shortage of useful data.
Nonetheless, there is considerable room for further improvement.
As you point out, there have been some sizable revisions in the
payroll employment figures recently. One notable example was the
upward revision to employment growth from April 1992 through
the end of last year. This upward revision reflected judgmental adjustments to the bias adjustment factors used by the BLS to estimate employment changes in establishments systematically not
covered by its sample (mostly births and deaths of establishments.)
Although the adjustments to the bias factors were based on preliminary information from unemployment insurance tax data, the
judgmental nature of revision suggests that strengthening this part
of the estimation procedure mightnave a high payoff.
102
Of course, the statistical agencies generally are well aware of
weaknesses in their methodology (of which the BLS bias adjustment methodology is just one example), and most agencies have
under way limited research programs to attempt to improve their
statistical series. Unfortunately, however, these agencies generally
do not receive sufficient funds from Congressional appropriations to
undertake major improvement programs. Given the extensive use
of these data by policymakers and others, the potential benefits
from an increase in funding for Federal statistical agencies would
likely be quite large but, of course, such an initiative would have
to be weighed against other objectives in the context of the current
tight budgetary situation.
Q.4. Over the past 2 years, banks have improved their capital ratios considerably, and continue to benefit from low short-term interest rates and steep yield curves. Yet securities holdings at banks
continue to rise and business loan volume continues to shrink. Is
the credit crunch still an important factors in the economy? If so,
what is driving it?
A.4. The marked weakness in business loan growth over the last
few years has reflected several factors. Overall demand for credit
by businesses has been weak, as internally generated cash flows
have tended to exceed expenditures on investment and inventories.
Also, businesses in the process of strengthening their balance
sheets have used the proceeds of bond and equity issuance to pay
down bank loans and other types of short-term debt.
In addition, banks restricted the availability of credit by tightening their standards and terms for business lending in 1990 and
1991. However, surveys and other information suggest that banks
had largely ceased tightening lending standards by late 1991 and
lending terms during 1992. Some modest signs of easing emerged
in 1992, Over the past six months or so, banks appear to have
eased terms and standards somewhat more aggressively and consistently. During this period, the runoff of business loans that had
characterized 1991 and 1992 appears to have about ceased, and
loans have expanded on balance over the past three months. This
pickup may reflect a turnaround in the relation between businesses' internal cash flow and expenditures, as well as the easing
of banks' lending terms and standards.
Nevertheless, credit remains more costly and more difficult to obtain for small- and medium-sized businesses than it was several
years ago. Despite some recent easinjg, banks' standards for extending credit remain high, no doubt reflecting a chary attitude stemming from large loan losses during the recessions. Moreover, banks'
efforts to maintain higher capital ratios, partly in response to market pressures, recent legislation, and forthcoming regulations, likely are prompting banks to continue to require wider spreads over
funding costs than they have historically during economic expansions.
Prudent attitudes toward credit on the part of both lenders and
borrowers are appropriate and welcome, but adequate credit availability is essential for economic growth. The Federal Reserve continues to work with the other Federal banking agencies to ensure
103
that regulatory and supervisory practices are not inappropriately
inhibiting the extension of credit.
Q.5. On July 15, President Clinton asked the bank and thrift regulators to reform the enforcement process for the Community Reinvestment Act The goal is to increase CRA's effectiveness by emphasizing performance rather than process, improving examination
quality, and stepping up sanctions against institutions with consistently poor performance. Have the regulators begun this process? Can you share with us your views on where the process might
lead us?
A.5. Yes, the regulators have begun reviewing the Community Reinvestment Act, the regulations that implement the act, and the
supervisory enforcement process. We are currently seeking opinions
from the public on how to make the CRA supervisory process more
effective. To facilitate this process, the Federal regulatory agencies
are holding a series of public meetings concerning CRA around the
country in August and September. Tnese meetings will be held in:
Washington DC, San Antonio, Texas, Los Angeles, California, Albuquerque, New Mexico, New York City, Henderson, North Carolina,
and Chicago, Illinois.
In addition to the public meetings, the agencies also have met
with banking organizations and community groups. The purpose of
the meetings is to gather ideas on improving the regulations that
implement CRA and the examination process. Information obtained
in the meetings will be used in our work to reform the CRA regulations and the supervisory process to increase community reinvestment and eliminate necessary paperwork.
Q.6. Despite increased attention by banking regulators in recent
months to the problem of credit discrimination, in the first half of
1993, 93 percent of banks and thrifts rated under the Community
Reinvestment Act got one of the top two grades. How do you account for these high ratings given the Boston Fed study and other
evidence of unequal access to credit?
A-6. A bank's compliance with fair lending laws is certainly reflected in its CRA rating. In fact, a bank's CRA record is evaluated
in terms of 12 assessment factors, two of which deal directly with
discriminatory practices. Of course, discriminatory practices would
in all likelihood adversely affect a bank's CRA rating.
While it is true that the majority of our banks presently have
satisfactory or outstanding CRA ratings, we attribute these high
ratings, at least in part, to the positive effect our specialized
consumer affairs examinations have had on our banks. Since 1979,
the Board has had a specialized consumer compliance program and
specially trained compliance examiners, separate from our safety
and soundness responsibilities. As part of the CRA examination
process, Federal Reserve examiners not only look for weaknesses in
a bank's CRA program and make recommendations for improvement, but also strive to educate bank personnel in the administration and implementation of an effective program. This process occurs even in cases where banks are rated satisfactory or better and
extends beyond the regularly scheduled CRA examination.
For example, System examiners provide banks with technical assistance through one-on-one conversations, advisory visits, and by
104
speaking at industry functions. In addition, each Federal Reserve
Bank has a Community Affairs department which works directly
with State member banks to provide technical information on community development and related programs.
The frequency of examinations also fosters satisfactory CRA performance. A bank rated "satisfactory" for CRA. is examined approximately every 18 months. In contrast, the examination cycle for a
bank rated "needs to improve" is shortened to approximately 12
months, and for a bank rated "substantial noncompliance" is shortened even further to a 6 month period.
The Board does not condone credit discrimination and will not
tolerate its appearance in any State member bank. Over the last
year, we have undertaken a number of initiatives to strengthen our
fair lending examination process. One of these initiatives includes
a new procedure which utilizes a computer program and a regression analysis to assist with our fair lending evaluation. Specifically,
the computer program will help select for review minority and
nonminority applicants with comparable credit characteristics, but
whose loan applications may have been treated differently during
the loan granting process. While a comparison of minority and
nonminority applicants has been a major part of our procedures in
the past, our samples have always been selected manually. We believe that the computer program will enable us to look at more applicants quickly and result in a better loan sample for the fair lending portion of the examination.
Q.7. I was encouraged that the four regulatory agencies recently issued a statement that described stepped up efforts to combat lending discrimination. These efforts included increased examiner
training and use of statistical analysis—two improvements I have
advocated. But there was no mention of using testers, which has
been endorsed by the Office of the Comptroller of the Currency but
opposed by the Federal Reserve. Why does the Fed continue to oppose the use of testers to ferret out lending discrimination when we
use them successfully to combat housing discrimination?
A.7. As you have noted, the Board of Governors and the other regulatory agencies have been working to strengthen our fair lending
enforcement program. In fact, the Board carefully considered a
pilot mortgage testing project in 1991 and decided not to pursue it.
While we understand that some government agencies have documented the testing methodology in fair housing enforcement, nevertheless, the Board believes there would be substantial difficulties
in using testing to detect mortgage credit discrimination.
The Board has been concerned that using the testing methodology to examine the mortgage application process is likely to be very
expensive, creates research problems not present in testing for
housing discrimination, and involves other difficulties. We understand, nowever, that HUD and the OCC have plans to do a pilot
in this area. We will be very interested in the results of this pilot.
Q.8. The latest report of the Savings Association Insurance Fund
Industry Advisory Committee quotes senior FDIC officials as saying that failure of Congress to provide supplementary funding to
the SAIF would require deposit insurance premiums for thrifts to
exceed premiums for banks by 15 to 20 cents per hundred dollars
105
within a few years. The FDIC officials concluded that maintenance
of such differentials for a period of several years would virtually
eliminate the thrift industry. Do you agree?
A.8. As the clean up of troubled and insolvent thrifts nears completion through the efforts of the RTC, the thrift industry is regaining
its footing and may be on the way to more stable conditions. Return on assets in trie first quarter (excluding thrifts taken over by
the RTC) was 0.96 percent compared to 0.53 percent for the full
year 1992. Recent profitability, however, was aided by low interest
rates and a favorable yield curve.
It would be unfortunate then if that fragile recovery were impeded by a significant actual (or potential) differential between BIF
and SAIF deposit assessment rates. The current BIF and SAIF average assessment rates are both at the historically high level of approximately 25 basis points. The banking industry (BIF-insured
commercial banks and savings banks) was recently forecast by the
FDIC to experience a reduction in the assessment rate of 14 basis
points in four to six years. Given the intense competitive pressures
facing the banking industry, such a reduction would help the industry attract capital and remain competitive both domestically
and internationally.
In contrast the savings and loan industry, also facing intense
competitive pressures, is forecast to receive a 2 basis point increase
in the assessment rate and to remain at that level for at least 20
years. This phenomenon is largely the result
of the unfunded commitment to the Financing Corp (FICO)1 that currently consumes
about 40 percent of SAIF assessment revenue (accounting for 10
out of 25 basis points of the assessment rate.) That commitment
runs through the year 2019 and is estimated by the FDIC to have
a present value cost of over $8.5 billion. Even if the SAIF were
given the resources to be fully recapitalized at the same time as
the BIF, SAIF assessment rates (applied to the current level of insured deposits) would presumably need to be 10 basis points higher
than BIF to cover these FICO payments.
If adequate funds are not appropriated for the SAIF, it is likely
that SAIF member institutions would operate at an ongoing disadvantage to other financial concerns and consequently would be
less able to attract capital and to maintain their financial health.
If it becomes clear that surviving SAIF-insured thrift institutions
win be responsible, not only for recapitalizing SAIF from its nearzero net worth level, but also for the ongoing FICO payments,
these institutions would have strong incentives to convert to the
BIF or reduce their reliance on insured deposit funding by whatever means available.
Currently, there is a moratorium on institutions converting from
one insurance fund to the other. That moratorium, as specified
under FIRREA, is scheduled to expire in August of 1994. For the
past four years, bank holding companies have been allowed, under
certain circumstances, to acquire thrift institutions and convert
their deposit insurance from SAIF to BIF. However, FIRREA also
1
FICO was created by the Competitive Equality Banking Act of 1987 to recapitalize the
FSLIC through the issuance of bonds to the public. As provided for by FIRREA, FICO has an
ongoing claim on SAIF assessments through the year 2019 to fund interest payments on FICO
bonds.
106
specifies that converting institutions must pay exit and entrance
fees to the insurance funds.2 How the thrift industry will be affected by a BIF/SAIF premium differential will to some extent depend on whether the FIRREA moratorium on SAIF to BIF conversions is allowed to expire and the magnitude of entrance and exit
fees set by the FDIC at that time.
If the moratorium is extended, the SAIF assessment base still
seems likely to decline, as SAIF members take steps to reduce their
assessments. This could be done by reducing their reliance on insured deposits in favor of alternative funding sources such as Federal Home Loan Bank advances or repurchase agreements. Institutions may also attempt to offset SAIF premiums with riskier, high
yielding assets that may ultimately increase SAIF insurance losses.
An eroding assessment base or higher insurance losses would require the FDIC to raise SAIF assessment rates even higher, further contributing to the erosion of the assessment base. At some
point, assessment rates might be high enough to threaten the competitiveness and effective viability of marginal institutions. While
the assessment rate differential in itself might not be large enough
to eliminate the industry, the ongoing burden of the SAIF on the
savings and loan industry would act to encourage industry shrinkage and capital divestment.
If the moratorium is allowed to expire next year, the SAIF assessment base will also be affected by those thrifts that elect to
leave the SAIF by abandoning savings and loan
charters in favor
of savings bank or commercial bank charters.3 However, as a practical matter, the number of conversions may be limited by several
factors, especially the size of SAIF-to-BIF exit and entrance fees.
The BIF entrance fee is set at the ratio of BIF's net worth to insured deposits. Currently small at 5 basis points, the BIF entrance
fee will grow to as much
as 125 basis points of insured deposits as
the fund recapitalizes.4 The SAIF exit fee is currently 90 basis
points and is determined jointly by the FDIC and Treasury. In
making a SAIF-to-BIF conversion decision, institutions will gauge
whether the assessment rate differential between funds represents
a greater present value cost than paying entrance and exit fees
today.
Other factors affecting conversion rates include the adequacy of
an institution's supervisory rating or ownership restrictions (e.g.,
commercial and industrial companies may own savings and loans
but not banks.) In addition, other institutions may conclude that
the benefits of a savings and loan charter (i.e. interstate branching
rights) outweigh the assessment rate differential.
In any event, it seems likely that some thrifts, especially wellrun, well capitalized thrifts would be able to convert. A migration
3
Under the "Dakar" amendment to FIRREA, entrance and exit fees could be avoided by BHCs
through the payment of SAIF premiums on a hypothetical SAIF deposit bare after the merger.
There were approximately $80 billion in Oakar deposits as of December 31, 1992. In addition,
thrifts simply wishing to convert to a commercial bank charter could maintain SAIF insurance
through
the Sasser" amendment.
3
The conversion of a savings and loan charter to a commercial bank charter may be complicated by the IRS requirement for the recapture of past bad debt income tax deductions that
are available for thrifts and savings banks but not for commercial banks. For some institutions,
the resulting tax liability might be too large. Some institutions might choose therefore to convert
to a state savings bank charter to avoid this potential tax liability.
*As of June 30, 1993, the net worth of the fund was calculated to equal $6.8 billion or 35
basis points of insured deposits. An entrance fee of 35 basis points should become effective soon.
107
of such top quality thrifts arguably could leave SAIF with poorer
quality institutions and higher insurance losses relative to the assessment base. In addition, the combination of high entrance and
exit fees and high SAIF assessment rates would probably discourage BIF-insured institutions from acquiring marginal thrift institutions and result in higher SAIF insurance losses.
Therefore, even if SAIF receives fees large enough to satisfy an
exiting thrift's share of the FICO obligation, the remaining SAIFinsured institutions would still have to shoulder the remaining
FICO burden and the possibility of proportionally higher insurance
losses. The higher assessment rates needed to onset an eroding assessment base in both size and quality could undermine the long
term viability of institutions that are forced to remain SAIF-insured.
Q.9. This Committee has heard highly disturbing testimony concerning mortgage discrimination and the related problem of reverse
redlining. I had previously asked that the Federal Reserve conduct
field hearings to examine these important issues, but have yet to
receive a response. Will the Federal Reserve hold regional hearings
on mortgage discrimination and reverse redlining?
A.9. The Federal Reserve, along with the other financial regulators,
will be holding a series of public meetings around the country in
August and September to listen to the opinions of community
groups, financial institutions, as well as the general public, on how
we can better implement the CRA. We expect the topics of mortgage discrimination and reverse redlining will be addressed at
these meetings.
Q.10. The United States gives foreign banks and securities firms
the same competitive opportunities in our financial markets as domestic firms enjoy. On July 21, in testimony delivered before the
House Foreign Affairs committee, Under Secretary of the Treasury
Larry Summers testified about the U.S./Japan Framework discussions. Speaking on Japan's financial services market he stated:
"Access to financial markets for outsiders, whether they be foreign
or Japanese entrants is effectively limited. . . . The end result is
that U.S. firms, which are world class competitors in other markets, cannot break into the Japanese market."
He further noted that the Treasury Department has been negotiating with Japan about this matter for 10 years. At his own confirmation hearing Secretary of the Treasury Bentsen voiced concerns about foreign countries that take advantage of our open financial markets, yet do not give us a fair opportunity to compete
in theirs. He stated, ". . . the touchstone of our trade policy, including international negotiations on financial services, is that we
must demand reciprocity." (a) Do you agree with Secretary Bentsen
on this point? If not, why not? (b) Do you think our negotiating position to open foreign financial markets on behalf of U.S. firms
would be improved if we enacted the Fair Trade in Financial Service Act, a bill passed by the Senate several times, under which U.S.
authorities could deny applications from firms whose home countries discriminate against U.S. firms?
A, 10. It is unfortunately the case that financial markets in most
countries are not as open to foreign financial institutions as are
108
U.S. markets or as we would like. Efforts have been ongoing for
years, bilaterally and multilaterally, involving both the U.S. Treasury and the Federal Reserve, to ensure fair treatment for U.S.
firms in foreign financial markets. Significant progress has been
made—indeed, I believe more than often is recognized—but more
is needed.
In this context, the public policy issue is not whether further liberalization of foreign financial markets is desirable—it surely is—
but rather how best to achieve that objective. The Federal Reserve's position has been clear. We believe that the policy of national treatment, which is embodied in the International Banking
Act of 1978 and is the principle underlying international policies in
the areas of investment and trade in financial services, has served
us well. Because we permit foreign institutions who are able to provide financial services in our market in a safe and sound manner
to do so, U.S. financial markets are the most efficient, innovative,
and sophisticated in the world. Private and public consumers of financial services in this country have benefited greatly as a direct
result of that policy. It would be unwise in our judgment to jeopardize such clear benefits by abandoning our current policy in favor
of a policy of reciprocity, even if the latter might potentially add
to pressure on other countries to open their own markets further.
Instead, the Federal Reserve believes that the United States
should continue to impress upon other countries that liberalization
of their financial markets is a necessary element of a broadened
trading system. The ongoing Uruguay Round negotiations on trade
in financial services are an important element of that strategy.
I am confident that further liberalization of foreign financial
markets will take place because, ultimately, it is in the countries'
own interests, not just the interests of others, for them to open
their markets further and because foreign authorities will come to
recognize this fact. While the pace of liberation might be slower
than we would like, that does not in our judgment justify the enactment of the Fair Trade in Financial Services Act with all the
costs and risks such legislation would entail both for U.S. consumers of financial services and for the existing participation of U.S.
financial firms in markets abroad.
Q.ll. President Clinton has made reducing our overall trade deficit
with Japan an important goal, that is why he is pursuing this matter as a top priority in the U.SVJapan Framework discussions. Do
you agree that reducing that deficit by expanding opportunities for
U.S. exports in Japan is an important ingredient to the economic
growth strategy we are pursuing at home?
A.11. Any progress in opening markets abroad where barriers to
U.S. exports exist would be beneficial to both U.S. exports and the
growth of U.S. output. The U.S./Japan Framework discussions
could prove useful in this regard to the extent that they help to improve the access of internationally competitive U.S. exporters in
such sectors as telecommunications, financial services, and Government procurement in general. However, the benefits are not likely
to be large in macroeconomic terms. Indeed, we cannot depend on
developments in any one foreign market to resolve our trade imbalance and spur economic growth at home. Far more important will
109
be the headway that is made in stimulating our own national savings rate, particularly by reducing the government budget deficit.
Q.12. I understand that officials from the Federal Reserve's staff
regularly participate in the GATT discussions on financial services.
On July 2 Senators D'Amato, Sasser and I wrote to President Clinton expressing our concerns about the status of the draft GATT
test governing financial services. Our concern was that under that
text, which operates under the MFN principle, the United States
could "lock" its markets open while losing the authority to pursue
bilateral negotiations with countries that discriminate against our
financial services industries, (a) Are you familiar with this issue?
(b) If not, will you familiarize yourself with it and ensure that your
staff works to prevent free-riders in these GATT negotiations on financial services?
A.12. Federal Reserve staff worked closely with the Treasury Department to provide technical assistance in the GATT negotiations
on a regular basis in 1989 and 1990 and attended negotiating sessions during that time. Since 1991, staff have participated less frequently in the negotiations themselves although they have provided assistance to the Treasury when requested.
I am familiar with the fact that, under the proposed General
Agreement on Trade and Services (GATS) text, the principle of
"most-favored-nation" Cor MFN) would apply to an signatories to
the agreement. Under this principle, a party could not favor the
firms of any one country in allowing entry or operations without
extending the same benefits to firms of an countries that are parties to the agreement. As your question indicates, it has been stated that the application of the MFN principle would allow some
countries to take advantage of the open access to the U.S. market
without making similar open commitments for their own markets
("free-riding".)
Federal Reserve staff have not been directly involved in Uruguay
Round negotiating sessions on MFN issues as they relate to socalled "free-riders." It is my understanding that there will be a
major effort, on both a bilateral and multilateral basis, to obtain
additional market access commitments from other countries in the
coming months of the Uruguay Round negotiations. Federal Reserve staff is prepared to provide whatever assistance it can to the
U.S. Government negotiators on financial services.
Q.13. Dennis Encarnation, a professor at the Harvard Business
School, has "written a book about the U.S./Japan economic relationship entitled Rivals Beyond Trade. In this book he argues a
major reason for Japan's persistent trade surplus with our country
is related to the gross imbalance in direct investment. Japan, he
argues, followed policies of restricting U.S. investment in their
country while its firms expanded their investment here. Japanese
direct investment in the United States is almost four times as
great as U.S. investment in Japan—$87 billion versus just $23 billion. As a result, two-thirds of all American imports from Japan are
shipped "infra-company," i.e. from Nissan to its American subsidiaries, while the U.S. does not benefit from such "intra-company"
trade into Japan.
110
Do you think this point made by Mr. Encarnation about the relationship of investment and trade has merit? If so, what sort of policies should we adopt to get at this problem?
A.I3. Dennis Encarnation argues that Japanese firms have reaped
substantial advantages from past government regulations and the
current industrial structure—factors that have served to limit access of U.S. and other foreign competitors to the Japanese market.
According to Encarnation, the relevant concept of market access
must include direct investment as well as import penetration, particularly since a large part of international trade in manufactured
goods involves transactions between affiliated companies.
Encarnation maintains that U.S. exports to Japan have been limited by the relative absence of U.S. direct investment in majorityowned affiliates in Japan.
Extensive studies of U.S. direct investment abroad do support
Encarnation's argument that direct investment abroad and U.S. exports tend to be positively related. However, these studies, by and
large, would suggest the net effect is not very large; production by
the foreign affiliates of U.S. companies can substitute for U.S. exports as well as expand their market share. As Encarnation himself points out, the competitiveness of U.S.-based firms and the
competitiveness of the United States as a production location need
not move in unison. During the first half of the 1980's, U.S. multinational firms largely maintained their shares in world markets
through growing sales from their affiliates abroad while the U.S.
balance of trade deteriorated sharply.
Appropriate U.S. policies to improve access of U.S. firms to the
Japanese market would include encouraging the Japanese government to remove the remaining vestiges of government policies that
discourage foreign direct investment in Japan. Features of Japanese industrial structure, such as cross-owner ship of shares and
tight buyer-supplier relationships, present a more difficult problem.
However, it should be remembered that the overall trade balance
of a country largely reflects macroeconomic factors, in particular,
the balance between domestic investment and national savings. As
long as Japanese saving greatly exceeds domestic investment, Japan's trade surpluses will persist. Increased U.S. direct investment
in Japan could improve the U.S. trade balance only if it altered the
U.S. savings and investment balance.
Q.14. You state on page 14 of your prepared testimony: "In some
markets where American firms were losing share just a few years
ago, we have regained considerable dominance. In one case U.S.
firms have seized a commanding lead in just two years in the new
laptop computer market and now account for more than 60 percent
of U.S. sales last year, triple the figure for Japanese firms."
Does that mean U.S. firms now have a 60 percent share of the
U.S. domestic market for laptop computers and Japanese firms
have 20 percent? What share do we have of the Japanese market
for laptop computers compared with Japanese firms in that market?
A. 14. Data provided by a market research group for the U.S. computer industry show that since the United States entered the market for notebook computers in 1989, the U.S. share of the U.S. mar-
Ill
ket rose from 19 percent in 1989 to an estimated 64 percent in
1993. Over the same period the Japanese share of the U.S. market
fell from 67 percent to 12 percent.
While we do not have data about the market for notebook computers in Japan alone, we were provided with information about
the Pacific Basin countries as a group. Between 1989 (when U.S.
manufacturers entered the market) and 1993, the U.S. market
share increased from 1 percent to 23 percent; over the same period
the Japanese share declined from 98 percent to 70 percent, as
shown in the table below.
Notebook Computers: Percentage of Units Shipped by Manufacturer Location
(Percent)
U.S. Market
Pacific Basin Market
U.S.
Japan
Europe
Other
US.
Japan
Europe
Other
1988
0
80
20
0
0
99
1
0
1989
19
67
14
0
1
98
1
0
1990
42
44
7
7
24
4
10
0
•
0
62
2
14
98
1991
1992
75
64
16
1
20
74
•
23
70
1
•
5
12
8
24
1993
83
3
7
*/ Less than 1/2 percent.
Source:
InfoCorp, Computer Intelligence, 2880 Lakeside Drive, Suite 300, Santa Clara,
CA 95054-2816.
RESPONSE TO WRITTEN QUESTIONS OF SENATOR BENNETT
FROM ALAN GREENSPAN
Q,l. You indicated in your testimony that the sharp increase in
gold prices in recent months reflects heightened inflationary expectations. In the current environment, balancing out inflationary and
deflationary forces that may be at work in the world economy,
what gold price would satisfy you now that the market is not anticipating a loss in the dollar s purchasing power?
A.1. In my comments, I referred to a sharp increase in the price
of gold, along with the behavior of a variety of other indicators, as
signs of an apparent heightening of inflationary expectations. I did
not have in mind any particular gold price level that would signal
a market expectation of price stability.
112
Q.2. You indicated that recent policy directives have provided you
with inter-meeting authority to tighten monetary policy. Yet, you
also stated that the Fed's policy stance has not changed since last
September, remaining generally accommodative. Are you concerned
that this accommodative posture may now be contributing to inflationary expectations as reflected in the price of gold? If the present
gold price is indicative of inflationary expectations, how much more
must it rise before tightening becomes an appropriate policy response?
A.2. Our decision in May to create a directive for open market operations that was "asymmetric toward tightening' reflected two
considerations: first, that the indications over the early months of
1993 regarding the rate of inflation and inflationary expectations
were unfavorable, and second that short-term interest rates, adjusted for inflation, were unsustainably low and might have to be
raised sooner rather than later if inflationary pressures did not
subside. Our intention was to watch all of the incoming information
for further confirmation of the risks, with the behavior of gold
prices being one of many indicators that might shed light on the
matter. We did not have in mind any trigger point for this, or any
other particular variable, insofar as a possible reserve tightening
action was concerned.
Q.3. You testified that due to the continued unreliability of money
supply aggregates as a guidepost to monetary policy, the Fed would
look to indicators such as real interest rates. You also stated that
long-term rates are the most important for economic activity. How
does the Fed Intend to measure a real interest rate for 30-year
bonds given the difficulty of assessing inflationary expectations
over such a lengthy period? Does the price of gold contain useful
information with regard to inflation expectations for calculating the
real rate on long-term bonds?
A.3. We would not perceive the price of gold as providing a direct
indication of the inflation expectation that might be embodied in
the 30-year Treasury bond yield. You are quite right that estimating the inflation premium in long-term rates is problematic. We do
monitor a variety of surveys of inflation expectations; indeed, one
is carried out under our sponsorship by the University of Michigan
Survey Research Center in connection with its regular monthly
consumer sentiment survey. We also think that something may be
learned about changes in longer-rate inflation expectations by examining the behavior of the implicit forward short-term rates embedded in yield curve for long-term bonds; these are more likely to
reflect such expectations than those relating to shorter-range cyclical developments, which should play a major role in, say two- or
five-year Treasury notes.
Q.4. You have supported reduction, or even elimination, of the capital gains tax as a means to encourage risk-taking investment and
thus spur economic growth. Would you expect a change in the capital gains taxation—for example, to index gains for inflation both
prospectively and retroactively—to be welcomed in the market for
long-term Treasury securities, or would such a step to encourage
growth be considered inflationary and therefore lead to higher longterm interest rates, everything else being equal?
113
A.4.1 would not think that reduction or elimination of capital gains
taxes, in and of itself, would have a meaningful effect on inflation
expectations.
Q.5. Would you expect a deficit reduction program of less than
$500 billion to be regarded positively by the long-term bond market
if it included provisions to reduce the taxation of capital gains?
A.5. My belief was that it likely would prove costly, in terms of
near-term market reaction, if the Congress failed to pass a credible
deficit-reduction package in the neighborhood of what had been
long-discussed and generally anticipated. While it was my desire
not to go beyond that and get into the debate regarding the specific
revenue and spending components of such a package, I did restate
my long held position that a reduction in capital gains taxes would
be constructive for the economy.
@FedFRASER