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CONDUCT OF MONETARY POLICY
(Report of the Federal Reserve Board pursuant to the
Full Employment and Balanced Growth Act of 1978,
P.L. 95-523.)
HEARING
BEFORE THE
SUBCOMMITTEE ON
DOMESTIC MONETARY POLICY
OF THE
COMMITTEE ON BANKING, FINANCE AND
IJBBAN AFFAIRS
HOUSE OF REPRESENTATIVES
ONE HUNDRED FIRST CONGRESS
SECOND SESSION
FEBRUARY 20, 1990
Printed for the use of the Committee on Banking, Finance and Urban Affairs
Serial No. 101-76
U,S. GOVERNMENT PRINTING OFFICE
WASHINGTON : 1990
For sale by the Superintendent of Documents, Congressional Sales Office
U.S. Government Printing Office, Washington, DC 20402
HOUSE COMMITTEE ON BANKING, FINANCE AND URBAN AFFAIRS
HENRY B. GONZALEZ, Texas, Chairman
FRANK ANNUNZIO, Illinois
WALTER E. FAUNTROY, District of
Columbia
STEPHEN L. NEAL, North Carolina
CARROLL HUBBARD, Jr., Kentucky
JOHN J. LAFALCE, New York
MARY ROSE OAKAR, Ohio
BRUCE F. VENTO, Minnesota
DOUG BARNARD, JR., Georgia
ROBERT GARCIA, New York
CHARLES E. SCHUMER, New York
BARNEY PRANK, Massachusetts
RICHARD H. LEHMAN, California
BRUCE A. MORRISON, Connecticut
MARCY KAPTUR, Ohio
BEN ERDREICH, Alabama
THOMAS R. CARPER, Delaware
ESTEBAN EDWARD TORRES, California
GERALD D. KLECZKA Wisconsin
BILL NELSON, Florida
PAUL E. KANJORSKI Pennsylvania
ELIZABETH J. PATTERSON, South Carolina
C. THOMAS McMILLEN, Maryland
JOSEPH P. KENNEDY fl, Massachusetts
FLOYD H. FLAKE, New York
KWEISI MFUME, Maryland
DAVID E. PRICE, North Carolina
NANCY PELOSI, California
JIM McDERMOTT, Washington
PETER HOAGLAND, Nebraska
RICHARD E. NEAL, Massachusetts
CHALMERS P. WYLIE. Ohio
JIM LEACH, Iowa
NORMAN D. SHUMWAY, California
STAN PARRIS, Virginia
BILL McCOLLUM, Florida
MARGE RQUKEMA, New Jersey
DOUG BEREUTER, Nebraska
DAVID DREIER, California
JOHN HILER, Indiana
THOMAS J. RIDGE, Pennsylvania
STEVE BARTLETT, Texas
TOBY ROTH, Wisconsin
ALFRED A. (AD McCANDLESS, California
JIM SAXTON, New Jersey
PATRICIA F. SAIKI, Hawaii
JIM BUNNING, Kentucky
RICHARD H. BAKER, Louisiana
CLIFF STEARNS, Florida
PAUL E. GILLMOR, Ohio
BILL PAXON, New York
SUBCOMMITTEE ON DOMESTIC MONETARY POLICY
STEPHEN L. NEAL, North Carolina, Chairman
DOUG BARNARD, JR., Georgia
BILL McCOLLUM, Florida
HENRY B. GONZALEZ, Texas
JIM LEACH, Iowa
FRANK ANNUNZIO.Illinois
JIM BUNNING, Kentucky
PETER HOAGLAND, Nebraska
(ID
CONTENTS
Page
Hearing held on:
February 20, 1990
Appendix;
February 20, 1990
1
29
WITNESSES
TUESDAY, FEBRUARY 20, 1990
Greenspan, Alan, Chairman, Board of Governors of the Federal Reserve
System
APPENDIX
Prepared statement:
Greenspan, Alan
30
ADDITIONAL MATERIAL SUBMITTED FOR THE RECORD
Board of Governors of the Federal Reserve System, report entitled "Monetary
Policy Report to Congress Pursuant to the Full Employment and Balanced
Growth Act of 1978," dated February 20, 1990
Record of Policy Actions of the Federal Open Market Committee, meeting
held on February 6-7, 1990
(IHl
47
76
CONDUCT OF MONETARY POLICY
Tuesday, February 20, 1990
HOUSE OF REPRESENTATIVES,
SUBCOMMITTEE ON DOMESTIC MONETARY POLICY,
COMMITTEE ON BANKING, FINANCE AND URBAN AFFAIRS,
Washington, DC.
The subcommittee met pursuant to call at 10 a.m. in room 2128,
Rayburn House Office Building, Hon. Stephen L. Neal [chairman of
the subcommittee] presiding.
Present; Chairman Neal, Representatives Barnard, Hoagland,
and Leach.
Also Present: Representatives Roukema and Saiki.
Chairman NEAL, I would like to call this meeting of the Subcommittee on Domestic Monetary Policy to order.
This morning we are pleased to welcome the Chairman of the
Federal Reserve Board, Alan Greenspan, for his presentation of the
Federal Reserve Semi-Annual Monetary Policy Report to the Congress.
Mr. Chairman, welcome. I want to welcome you and I want to
commend you for continuing to follow take the course that you and
the other Governors are taking concerning the long-term health of
our economy. You must take the long view when all the temptations around here are to take the short-term view of things. Nothing is more important for the future health of our economy than a
monetary policy that aims for price stability, which I know you are
pursuing. This long view will be very important for the economic
well-being of our country for many years to come.
I would like to bring you up to date if I can, on House Joint Resolution 409, our legislation which would set zero inflation as the
primary goal, primary function of monetary policy. You have endorsed the legislation in testimony last year before us. Since that
time several Nobel prize winning economists have endorsed it, several regional Federal Reserve Bank presidents have endorsed it,
and a number of other prominent economists have endorsed this
legislation.
Of course, I am delighted by that. I don't know how long it will
take, but at some point we have the opportunity of getting the Congress behind this long-term view also. As you well know, if we can
achieve price stability and low inflation, we can expect enormous
benefits to our economy—the lowest possible interest rates, the
maximum sustainable growth in our economy, maximum sustainable employment, maximum sustainable savings and investment
and productivity. I think all of these things we want for our economy.
(l)
So I wanted to report to you that we are coming along with our
legislation. I wish I could tell you when we will get it passed. I
don't know that, but we will certainly keep working on it. I would
like to yield at this time to our distinguished ranking Member, if
he has any comments to make.
Mr. LEACH, Mr. Chairman, I have no further comments, but I
would like to certainly share your views of Mr. Greenspan. We appreciate your coming this morning.
Chairman NEAL. Thank you, sir. Mr. Chairman, we will put your
entire statement in the record and would welcome your proceeding
as you will.
STATEMENT OF ALAN GREENSPAN, CHAIRMAN, BOARD OF
GOVERNORS OF THE FEDERAL RESERVE SYSTEM
Mr. GREENSPAN. Well, thank you very much, gentlemen. I certainly appreciate the opportunity to testify today on the Federal
Reserve's Semi-Annual Monetary Policy Report to the Congress.
My prepared remarks discuss our monetary policy actions and
plans in the context not only of the current and projected state of
the economy, but also against the background of our longer-term
objectives and strategy for achieving them.
The final section of the testimony addresses some issues for monetary policy raised by the increasingly international character of financial markets.
Last year marked the 7th year of the longest peacetime expansion of the U.S. economy on record. Some 2Vfe million jobs were created, and the civilian unemployment rate held steady at 5*/4 percent. Inflation was held to a rate no faster than that in recent
years, but unfortunately no progress was made in 1989 toward
price stability. Thus, while we can look back with satisfaction at
the economic progress made last year, there is still important work
to be done.
About a year ago, Federal Reserve policy was in the final phase
of a period of gradual tightening, designed to inhibit a buildup of
inflation pressures. Interest rates moved higher through the
winter, but started down when signs of more restrained aggregate
demand and of reduced potential for higher inflation began to
appear. As midyear approached, a marked strengthening of the
dollar on foreign exchange markets further diminished the threat
of accelerating inflation. New economic data suggested that the
balance of risks had shifted toward the possibility of an undue
weakening in economic activity.
With M2 and M3 below the lower bounds of their annual ranges
in the spring, the Federal Reserve in June embarked on a series of
measured easing steps that continued through late last year.
Across the maturity spectrum, interest rates declined further, to
levels about IVfe percentage points below March peaks. Reductions
in inflation expectations and reports of a softer economy evidently
contributed to the drop in rates in longer-term markets.
The decrease in short-term rates lifted M2 to around the middle
of its annual range in the latter part of the year.
So far this year,
the Federal funds rate has remained around 81A percent, but rates
on Treasury securities and longer-term private instruments have
reversed some of their earlier declines. Investors have reacted to
stronger-than-expected economic data, a runup in energy prices,
and increasingly attractive investment opportunities abroad, especially in Europe.
Monetary policy was conducted again last year with an eye on
long-term policy goals, and economic developments in 1989 were
consistent with the Federal Reserve's medium-term strategy for
reaching them. The ultimate objective of economic policy as I have
stated before is to foster the maximum sustainable rate of economic growth. By ensuring stable prices, monetary policy can play its
most important role in promoting economic progress.
The strategy of the Federal Open Market Committee (FOMC) for
moving toward this goal remains the same—to restrain growth in
money and aggregate demand in coming years enough to establish
a clear downward tilt to the trend of inflation and inflation expectations, while avoiding a recession.
If past patterns of monetary behavior persist, maintaining price
stability will require an average rate of M2 growth over time approximately equal to the trend growth in output. During the transition, the decline of market interest rates in response to the moderation in inflation would boost the public's demand for M2 relative to nominal spending, lowering M2 velocity. M2 growth over
several years accordingly may show little deceleration, and it could
actually speed up from time to time, as interest rates decline in fits
and starts. Hence, the FOMC would not expect to lower its M2
range mechanically each and every year in the transition to price
stability.
This qualitative description of our medium-term strategy is easy
to state, but actually implementing it will be difficult. Unexpected
developments no doubt will require flexible policy responses. Any
such adjustments will not imply a retreat from the medium-term
strategy or from ultimate policy goals.
Rather, there will be mid-course corrections that to keep the
economy and prices on track. The easing of reserve pressures starting last June is a case in point. Successive FOMC decisions to ease
operating policy were intended to forestall an economic downturn,
the chances of which seemed to be increasing as the balance of
risks shifted away from greater inflation.
The FOMC was in no way abandoning its long-term goal of price
stability, instead, it sought financial conditions that would support
the moderate economic expansion judged to be consistent with
progress toward stable prices. In the event, output growth was sustained last year, although in the 4th quarter a major strike at
Boeing combined with the first round of production cuts in the
auto industry accentuated the underlying slowdown.
On the inflation side, price increases in the second half were appreciably lower than those in the first. Against this background,
the Federal Reserve Governors and the Presidents of Reserve
Banks foresee continued moderate economic expansion over 1990,
consistent with conditions that will foster progress toward price
stability over time. At its meeting earlier this month, the FOMC
selected ranges for growth in money and debt it believes will promote this outcome.
My testimony last July indicated the very preliminary nature of
the tentative ranges chosen for 1990, given the uncertain outlook
for the economy, financial conditions, and appropriate growth of
money and debt. With the economic situation not materially different from what was anticipated at that time, the FOMC reaffirmed
the tentative 3 to 7 percent growth range for M2 in 1990 that it set
last July.
This range, which is the same as that used in 1989, is expected
by most FOMC members to produce somewhat slower growth in
nominal GNP this year. The declines in short-term interest rates
through late last year can be expected to continue to boost the public's demands for liquid balances in M2, at least for a while longer.
M2 growth over 1990 thus may be faster than in recent years, and
M2 velocity could well decline over the four quarters of the year,
absent a pronounced firming in short-term market interest rates.
In contrast with M2, the range for M3 has been reduced from its
tentative range set last July. The new M3 range of 2Va to 6l/2 percent is intended to embody the same degree of restraint as the M2
range, but it was lowered to reflect the continued decline in thrift
assets and funding needs now anticipated to accompany the ongoing restructuring of the thrift industry.
The committee's best judgment is that money and debt growth
within these annual ranges will be compatible with a moderation
in the expansion of nominal GNP. Most FOMC members and other
Reserve Bank presidents foresee real GNP growing 1% to 2 percent
over the year as a whole. Such a rate would be around last year's
moderate pace, excluding the rebound in agricultural output from
the 1988 drought.
A slight easing of pressures on resources probably is in store. Inflation pressures should remain contained, even though the decline
in the dollar's value over the past-half year likely will reverse
some of the beneficial effects on domestic inflation stemming from
the dollar's earlier appreciation. The CPI this year is projected to
increase 4 to 4 ¥2 percent, as compared with last year's 4Vb percent.
Experience has shown such macroeconomic forecasts to be subject to a variety of risks. Assessing the balance of risks between
production shortfalls and inflation pressures in the current outlook
is complicated by several cross-currents in the domestic and international economic and financial situation.
One risk is that the weakness in economic activity evident
around year-end may tend to cumulate, causing members forecasts
about production and employment this year to be overly optimistic.
However, available indicators of near-term economic performance
suggest that the weakest point may have passed.
The inventory correction in the auto industry—a rapid one involving a sharp reduction in motor vehicle assemblies in January
coupled with better motor vehicle sales—seems to be largely
behind us. Industrial activity outside of motor vehicles appears to
be holding up. Production of business equipment, where evidence
has accumulated of some stability— if not an increase—in orders
for capital goods, is likely to support manufacturing output in
coming months.
From these and similar data, one can infer the beginnings of a
modest firming in economic activity. While we cannot be certain
that we are as yet out of the recessionary woods, such evidence
warrants at least guarded optimism.
There are, however, other undercurrents that continue to signal
caution. One that could disturb the sustainability of the current
economic expansion has been the recent substantial deterioration
in profit margins. A continuation of this trend could seriously undercut the still expanding capital goods market. However, if current signs of an upturn in economic activity broaden, profit margins can be expected to stabilize.
A more deep-seated concern with respect to the longer-run viability of the expansion is the increase in debt leverage. Although the
trends of income and cash flow may have turned the corner, the
structure of the economy's financial balance sheet weighs increasingly heavily on the dynamics of economic expansion.
In recent years, business debt burdens have been enlarged
through corporate restructurings, and as a consequence interest
costs as a percent of cash flow has risen markedly. Responding to
certain well-publicized debt-servicing problems, creditors have
become more selective in committing funds for these purposes.
Within the banking industry, credit standards have been tightened
for merger and LBO loans, as well as for some other business customers. Credit for construction projects reportedly has become less
available because of FIRREA-imposed limits and heightened concerns about overbuilding in a number of real estate markets.
Among households, too, debt-servicing burdens have risen to historic highs relative to income, and delinquency rates have moved
up of late. Suppliers of consumer and mortgage credit appear to
have tightened lending terms a little. Real estate values have softened in some locales, although prices have maintained an uptrend
in terms of the national averages, especially for single-family residences. These and other financial forces merit careful monitoring.
While welcome from a supervisory perspective, more cautious lending does have the potential for damping aggregate demand.
It is difficult to assess how serious a threat increased leverage is
to the current levels of economic activity. Clearly, should the economy fall into a recession, excess debt service costs would intensify
the problems of adjustment. But it is unlikely that in current circumstances strains coining from the economy's financial balance
sheet can themselves precipitate a downturn. As I indicated in my
prepared text, Mr. Chairman, we expect nonfinancial debt growth
to continue to slow from its frenetic pace of the mid-1980's. This
should lessen the strain and hopefully the threat to the economy.
Among other concerns, recent events have highlighted the complex interactions between developments in the U.S. economy and
financial markets and those in the other major industrial countries. Specifically, the parallel movements in long-term interest
rates here and abroad over the early weeks of 1990 have raised
questions: To what extent is the U.S. economy subject to influences
from abroad? To what extent, as a consequence, have we lost control over our economic destiny? The simple answer to these questions is that the U.S. economy is influenced from abroad to a substantially greater degree than, say, two or three decades ago, but
U.S. monetary policy is, nonetheless, able to carry out its responsibilities effectively.
6
The post-war period has seen markedly closer ties among the
world's economies. Markets for goods have become increasingly,
and irreversibly, integrated as a result of the downsizing of economic output and the consequent expansion of international trade.
The past decade, in particular, also has witnessed the growing integration of financial markets around the world.
Advancing technology has fostered the unbundling and transfer
of risk and engendered a proliferation of new financial products.
Cross border financial flows have accordingly accelerated at a pace
in excess of global trade gains. This globalization of financial markets has meant that events in one market or in one country can
affect within minutes developments in markets throughout the
world.
More integrated and open financial markets have enabled all
countries to reap the benefits of enhanced competition and improved allocation of capital. Our business can raise funds almost
anywhere in the world. Our savers can choose from a lengthening
menu of investments as they seek the highest possible return on
their funds. Our financial institutions enjoy wider opportunities to
compete.
In such an environment, a change in the expected rate of return
on financial assets abroad naturally can affect the actions of borrowers or lenders in the United States. In response, exchange
rates, asset prices, and rates of return all may adjust to new
values.
Strengthened linkages among world financial markets affect all
markets and all investors. Just as U.S. markets are influenced by
developments in markets abroad, foreign markets are influenced by
events here. These channels of influence do not depend on whether
a country is experiencing a deficit or a surplus in its current account.
In today's financial markets, the net flows associated with current account surpluses and deficits are only the tip of the iceberg.
What are more important are the huge stocks of financial claims—
more than $1.5 trillion held in the United States by foreigners and
more than $26 trillion of dollar-denominated claims on U.S. borrowers held by U.S. residents. This is in addition to the vast quantities of assets held in foreign currencies abroad. It is these holdings that can respond to changes in actual and expected rates of
return.
In recent years we have seen several instances in which rates of
return have changed essentially simultaneously around the world.
For example, stock prices moved together in October 1987 and
1989, and in 1990 bond yields have risen markedly in many industrial countries.
However, we must be cautious in interpreting such events, and
in drawing implications for the United States. Frequently, such
movements occur in response to a common worldwide influence.
Currently, the world economy is adjusting to the implications of
changes in Eastern Europe, where there are tremendous new opportunities to invest and promote reconstruction and growth. Those
opportunities, while contributing to the increase in interest rates
in the United States, also open up new markets for our exports.
Moreover, despite globalization, financial markets do not necessarily move together—they also respond to more localized influences. Over 1989, for example, bond yields in West Germany and
Japan rose about a percentage point, while those in the United
States fell by a similar amount. The contrast between 1989 and
1990 illustrates the complexity of relationships among financial
markets.
Interactions can show through in movements in exchange rates
as well as interest rates, and changes in the relative prices of
assets depend on a variety of factors, including economic developments and inflation expectations in various countries as well as
monetary and fiscal policies both here and abroad.
The influence of economic policies abroad and other foreign developments on the U.S. economy is profound, and the Federal Reserve must carefully take them into account when considering its
monetary policy. But these influences do not fundamentally constrain our ability to meet our most important monetary policy objectives.
Developments within U.S. financial markets remain the strongest influence on the asset prices and interest rates determined by
those markets and, through them, on the U.S. economy. Exchange
rates absorb much of the impact of developments in foreign asset
markets, permitting U.S. interest rates to reflect primarily domestic economic conditions.
Exchange rates influence the prices of products that do, or can,
enter into international trade. Such factors can bring about
changes in the composition of production between purely domestic
goods and services and those entering international trade, and they
can affect aggregate price movements for a time.
However, the overall pace of spending and output in the United
States depends on the demands upon all sectors of the U.S. economy taken together. And our inflation rate, over time, depends on
the strength of those demands relative to our ability to supply
them out of domestic production. Because the Federal Reserve is
able to affect short-term interest rates in U.S. financial markets, it
is able to influence the pace of economic activity in the short run
and inflationary pressures longer term. To be sure, monetary
policy must currently balance more factors than in previous decades. But our goals are still achievable.
Monetary policy is only one tool, however, and it cannot be used
successfully to meet multiple objectives. The Federal Reserve, for
example, can address itself to either domestic prices or exchange
rates but cannot be expected to achieve objectives for both simultaneously. Monetary policy alone is not readily capable of addressing
today's large current account deficit, which is symptomatic of underlying imbalances among saving, spending, and production
within the U.S. economy.
Continued progress in reducing the Federal deficit is a more appropriate instrument to raise domestic saving and free additional
resources for productive investment. The long-term health of our
economy requires the balanced use of monetary and fiscal policy in
order to reach all of the nation's policy objectives.
[The prepared statement of Mr. Greenspan can be found in the
appendix.]
Chairman NEAL, Thank you very much for your very interesting
testimony.
Mr. Chairman, let me start by asking you a couple of questions
about our legislation to achieve zero inflation over the next 5
years. As we have held hearings on this proposal, and otherwise
asked for comments from economists and others, it has seemed to
me that broadly three objections have emerged as having some
merit. I would like for you to comment briefly on each of them, if
you would. If you see any others I would like to hear them, but so
far it seems to me that these three emerge.
The first is that if we were to achieve zero inflation over the next
5 years, that would cause a recession. It seems clear to me that the
policies needed to achieve zero inflation over that period of time
would not cause a recession, but I would certainly like for you to
comment on it. A second sort of problem with the idea that we
have heard is that inflation and interest rates today poses no problem—somehow the economy and people have adjusted to them and
it is all right to have inflation running at 5 percent, to have longterm treasury rates at 8 or 9 percent, to have credit card rates at
17 plus percent and business and consumer rates up over 10 percent. I don't think that is all right, but I would like for you to comment on that also. A third sort of objection to the idea has been
that the Fed must stay entirely independent and that Congress
should have no role in setting this overall policy goal, and that
would have to include the administration also because, as you
know, our legislation is legislation, would require a presidential
signature.
Let me say those are the three main arguments we have heard
the most of. There is, however, a fourth that I would like to you
comment on also: that somehow there are other goals that are
more important, that is to say that the Fed ought to attempt to
control a particular foreign exchange rate for the dollar; or that
the Fed ought to shoot for a particular level of short-term interest
rates; or that it ought to shoot for a particular level of growth in
the economy as opposed to zero inflation.
So I guess there are really four questions that I would like for
you to comment on, if you would.
Mr. GREENSPAN. Well, Mr. Chairman, let me address them seriatim. We have, of course, given considerable thought to the question
of endeavoring to bring inflation down to noninflationary levels,
which we define as any particular price level which removes the
uncertainties with respect to future inflation from economic decision-making.
It is our view that over a period of years we see no difficulty in
bringing the inflation rate down from where it exists currently to a
noninflationary level in the context of continued economic growth
and the avoidance of a recession. Were the change needed to reach
price stability required significantly greater, then I think the odds
of our being able to do it without recession would be probably
lower than any of us would find acceptable. But having brought
the inflation rate down from double-digits to under 5 percent, the
next stage, while difficult, is still achievable in our judgment without bringing on recession.
Chairman NEAL. Well, I specifically mentioned 5 years.
9
Mr. GREENSPAN. I would say 5 years. As I have indicated to you
privately and otherwise, I don't like to cite specific numbers with
respect to each year or each particular period. I think there is sufficient complexity in the economy and the adjustment process that
if we are short of the goal at any particular time, I don't think that
is as critical as getting it right.
Chairman NEAL. Yes, sir, I quite agree with you.
Mr. GREENSPAN, The second question which presumes that the
current inflation rate, the level of interest rates, and the current
state of our financial markets is tolerable, is based on the assumption that the markets will stay where they are.
I have serious question that they can. In other words, it is plausible and in fact realistic to believe that, if you have a noninflationary environment—that is a steady state type of environment which
has built into it a structure which can sustain it. One cannot say
the same thing about an inflation rate which is approaching 5 percent, or somewhat under, but still close enough to that.
We are in an area where it is very easy to start inflation accelerating. I think the major reason we want to come down from this
level is not that it is perceived to be doing great damage—although
I think it is doing more damage than people realize—but that the
risks of it accelerating from here are larger than I think we should
be willing to tolerate. An acceleration in inflation when it takes
hold is very difficult to restrain. The ultimate impact of accelerating inflation on employment, on the level of economic growth, and
on the stability of the system is just too large, in my judgment, to
be tolerable.
The third question is should Congress interfere in Federal Reserve policy. Well, Mr. Chairman, we would like as much flexibility
as we can possibly have, but there is the Constitution of the United
States which accords authority to the Congress, and that is Congress' judgment.
Our view basically is that we would like as much flexibility to
attain our goals as possible, but this is an authority that comes to
us from the Congress and the Constitution, and our judgment in
this respect has to be tempered by the view of the Congress, and as
a citizen, I think that is right and fully support it in that context.
Finally, as to the issue of whether other goals are more important, there is difficulty in knowing which particular goal affects
which structure of the economy. We believe that holding the rate
of inflation under control is far more important than any other
variable largely because its effect is very significant. As I indicated
in my earlier remarks, the maintenance of a noninflationary environment is a necessary condition and a major contributor toward
maximum feasible economic growth and employment.
It also probably is the particular goal which would stabilize exchange rates because, as I have indicated in past testimony before
this committee, one of the major goals of the G-7, for example, is
to seek domestic price stability, rather, as the easiest, most effective way of achieving long-term exchange rate stability. So in that
sense seeking price stability is also a means of seeking long-term
exchange rate stability.
It is also the way of achieving the lowest nominal and real interest rates rather than to seek to achieve those directly. It is far su-
10
perior to achieve low rates through a noninflationary environment
so that while these other goals are clearly important, the interaction between those key goals and inflation, in my judgment, runs
largely from inflation to those goals. Therefore it is far more effective to endeavor to control the degree of inflation and inflation expectations in an economy to achieve those goals than to endeavor
to try to move directly to achieve them.
Chairman NEAL. Thank you, sir, very much.
Mr. Leach?
Mr. LEACH. Thank you, Mr, Chairman.
First, let me thank you for an extraordinarily fulsome report.
Congress, by statute, gives you that responsibility. The report you
have presented to us reflects very much a personal philosophy, as
well as an institutional one. We in Congress ought to be appreciative of the fact that the Federal Reserve is one of the few institutions that takes its responsibilities seriously in complying with the
whole spectrum of reports we legislate.
Having said that, let me ask a possibly unfair question: In
achieving a balance between lower rates of inflation and higher
growth, would it be more effective if Congress were to balance its
budget or to pass a law calling for zero rates of inflation?
Mr. GREENSPAN. The first is superior to the latter.
Mr. LEACH. I am not as sympathetic as some to pejorative legislation. The real task we have to do is to work on the deficit. Central
bankers have a tendency, and I think it is part of the confidence
inspiring aspect of their jobs, to stress stability in price levels and
stability in exchange rates, and point out the relationship between
those two stabilities and economic growth.
The real ball game is rates of economic growth, not stability in
exchange rates or stability in price levels. Here, your report is, I
must say, extraordinarily optimistic. You, in effect have hinted
that the new figures the Fed is receiving indicates the economy is
picking up, particularly in the industrial sector. You have also suggested that in the long term you can effectively do your job, which
is something that lots of other institutions in American society
have a hard time suggesting.
The bottom line though is your suggestion that the rate of
growth for the economy this year will be 1% to 2 percent. Is that
an impressive goal for the Federal Reserve Board? If one turns
around the sageness of stability arguments and suggests a rate of
growth for the economy of, let's say, % percent greater than that
stated. Would you have a little different policy or do you think this
is a policy that is most likely to achieve that objective as well?
Mr. GREENSPAN. Well, Congressman, let me just say that our
goal is not 1% to 2 percent growth. That is the forecast of the
members of the FOMC and the non-Member presidents as to what
they perceive our overall policies are likely to achieve with respect
to the economy as a whole.
Our basic policy, if you want to put it in those terms, essentially
operates on the money supply, and it is quite conceivable that we
can have an expansion of money supply, an improved inflation
outlook, and a significantly higher real rate of growth than !3/4 to 2
percent.
11
In other words, we are not seeking to make the growth rate 1%
to 2. What we are seeking is to try to maintain a stable monetary
environment, and it may well be that in that environment the forecast that the FOMC is making is too pessimistic.
I want to emphasize that it is not an integral part of our policy
nor is it what we are endeavoring to seek. We don't vote on that
forecast. We basically just report it.
Mr. LEACH. Well, I did note in your statement at several points,
and I have never seen this from you before that the assessment of
a majority of the Open Market Committee believes something.
Let me ask you what you believe. What do you think the rate of
growth of the economy will be this year?
Mr. GREENSPAN. It is difficult to answer. Our main crucial goal
at this particular point is to put behind us that significant weakening which created a degree of deterioration throughout the latter
part of 1989 and to restore some stability. While I think it is premature to argue that that has been achieved, I think that the evidence of recent weeks is more encouraging than otherwise.
I don't find it very useful to put a specific number down on a
forecast because I am not terribly certain what it means. I used to
be in the forecasting business, and I was forced to do that and was
always concerned about the degree of refinement that that forecast
implied when the truth of the matter is, all that economists can do
is get a sense of relationships and approximations, and if we can
come out even reasonably close in that direction, I think that is as
good as we can do.
I have no reason to believe that the number will be different
from the average of the FOMC. I hope it will be higher. It may
very well be higher, but that is not, as I emphasized before, a
number we work with.
Mr. LEACH. I appreciate that very much, and I must say that I
appreciate your optimism in referencing the higher side rather
than the lower. I am reminded of Harold Shaprio, who is the President of Princeton and formerly headed an econometric modeling
team at Michigan. He likes to say that they did a study once at
Michigan on their forecasts and over about a 30-year period they
had about 2 or 3 years in which they predicted a downturn in the
economy.
And he said that prediction led the nightly news. Every time
they predicted an up tick they got no attention. So it may not be
news worthy that you are not predicting a downturn, but I appreciate that you are not.
Mr. Chairman, if I could ask one modest question on a little different subject, and this is more on the micromanagement side of
financial regulation. As you know, the Fed has moved in a somewhat novel direction in authorizing several Canadian banks to operate in ways in this country that American commercial banks
cannot, by allowing certain nontraditional activities to be conducted in a subsidiary of the bank, instead of in an affiliate of the
bank.
Is that a trend that you suspect to continue? Does this decision
set a precedent not only for other foreign banks but vis-a-vis U.S.
banks? What is the Fed's view on this particular issue and what
was
12
Mr. GREENSPAN. Mr. Leach, what we endeavor to do is to follow
national treatment as closely as we can; that is, that there is a
level playing field for all people in the business whether or not
they are domestic or foreign.
On occasion the structure of foreign banking institutions is different from ours and it is often not easy to make the principle applicable. What we try to do in a number of regulations is to find as
close an approximation as we can to the spirit of national treatment.
We have no endeavor to create precedents which create superior
positions for foreign institutions relative to domestic. On the contrary, we work very hard to make certain, as best we can, that
there are no differences of that nature.
Mr. LEACH. Well, I appreciate that perspective, I would only
stress that there are kind of two different ways of looking at camparable treatment. The Europeans are saying comparable national
treatment is for us to treat their banks the way they treat ours.
We say national treatment allows foreign banks in this country
to operate the same way as American commercial banks do. The
minute we lay down a precedent of giving a foreign entity different
treatment than our own national banks, then we lay down a precedent which allows other foreign entities to suggest that they should
to be treated in the same way. My own sense is that this decision
sets a minor precedent that ought to be looked at with a great deal
of caution.
Thank you, Mr. Chairman.
Chairman NEAL. Thank you.
Mr. Chairman, in answering Mr. Leach's first question about the
budget deficit, you didn't mean to imply, did you, that if we don't
balance the budget we somehow ought not to strive to achieve zero
inflation?
Mr. GREENSPAN. He merely asked me, gave me a choice, one or
two.
Chairman NEAL. Which legislation would you pass, right,
Mr. GREENSPAN. I am sure you would choose one also.
Chairman NEAL. I must say I certainly would, although I don't
think we have to make that choice. That is what I am trying to get
at. You are not implying that there has to be.
Mr. GREENSPAN. No. In fact, I have been supportive of both one
and two for a long time.
Chairman NEAL. Exactly. I would also point out that if we could
achieve zero inflation and in fact if we would make it clear we
were going to achieve zero inflation that that could have a very
positive impact on balancing the budget because it would mean
lower interest rates. Now that interest on the national debt is the
third biggest item in the budget deficit, if we can lower the interest
rate the Government pays on that we will reduce the budget deficit. So they work hand in glove.
Mr. Barnard?
Mr. BARNARD. Thank you, Mr, Chairman.
Welcome, Mr. Chairman, to the very, very fine report of what
the Federal Reserve did accomplish 1989 and certainly your policies and goals for 1990,
13
On page 4 of your statement you say that approaching price stability may involve a period of expansion. I need your speech writer
for me sometimes. It says here, if you read it, approaching price
stability may involve a period of expansion in activity at a rate
below the growth in the economy's potential, thereby relieving
pressures on resources.
You got me coming, and then you got me going on that particular statement.
Mr, GREENSPAN. We have many two-handed economists, even
speech writers.
Mr. BARNARD. That is good to know, especially in this day and
age. Does that mean that the inflation that we are experiencing at
the very beginning of this year seems to be in keeping not with
your policies, but in other words you are sympathetic with that
rate of inflation increase that we experienced?
Mr. GREENSPAN. Well, the inflation rate so far this year has been
horrendous. Last year or this year?
Mr. BARNARD. This year.
Mr. GREENSPAN. No, this year I would say as best we can judge,
looking at the details of the price structure, the big surge in inflation which has occurred is essentially constrained to energy and
food and has not spilled over into other parts of the economy. So
while we are disturbed by this extraordinary surge, in our judgment it has not seemingly embedded itself either in higher wage or
other costs.
Mr. BARNARD. So the Fed at this particular point does not see
the need to try to rush to remedy monetary policy?
Mr. GREENSPAN. I know of no action we have taken which has
responded to those individual price movements.
Mr. BARNARD. Mr. Chairman, does the Fed agree with the projections of economic growth and inflation that are currently in the administration's budget proposal. Do you think that they are optimistic?
Mr. GREENSPAN. Well, I think that you have to look at those forecasts in a different context. As I have said previously, administration forecasts presuppose the implementation of all of the President's recommendations, including a very significant reduction in
the Federal budget deficit. And as I have said to other committees
of the Congress, this particular set of forecasts, given the presumption that the Congress passes the President's budget in total, is not
an unreasonable forecast.
Now, one can say that is an unrealistic expectation and may not
happen, and surely in detail will not happen. But that is a different question. So in the sense of an internally consistent forecast, it
is not one which I would have great quarrel with.
Obviously, we don't agree with that forecast, but the reason we
don't agree with it is that we are not required in our view to
assume what the administration does assume. Granted that, I
think that they have done a job which is a reasonably sensible, balanced approach to the economic outlook.
Mr. BARNARD. If we rushed, and I use that word selectively, if we
rushed to take Social Security off of budget, and which would immediately increase the deficit by 67 to $70 billion, how do you see
that affecting growth?
14
Mr. GREENSPAN. You mean growth?
Mr. BARNARD. Yes, economic growth.
Mr. GREENSPAN. I think the action of doing it as such is probably
not something which would have any material effect unless and
until the markets presumed that action on the actual deficit would
occur as a consequence of that. If the markets perceive that a
major reduction in long-term budget expenditures is underway by
statute, I think we would find a remarkable response.
I think long-term interest rates would fall as inflation expectations would fall, and we would get very significant benefits from
that occurring. But we have to distinguish between shuffling the
various techniques we employ to measure the budget process and
the real actions with respect to those things which affect savings
and investment in the economy and Federal borrowing requirements.
Mr. BARNARD, but you expect interest rates in the long run to be
reduced, but principally by expectations?
Mr. GREENSPAN. No. I would say the mere fact of moving the
Social Security Trust Funds off budget and allowing, let's assume,
Gramm-Rudman-Hollings to apply to the non-Social Security
aspect of the budget would not in itself do anything unless the
markets believed that the Congress was serious in meeting those
goals,
I think that there is a degree of skepticism in the markets which
can be addressed, in my judgment, only by action.
Mr. BARNARD. Mr. Chairman, as a regulator, are you concerned
with the depressed condition of real estate in the Northeast and
how it is affecting the banking system in that area?
Mr. GREENSPAN. Most certainly we are. In fact, we have monitored very closely the whole New England real estate environment,
and have been looking at it in some considerable detail. We have
been looking at the bank holding companies in New England also
in some detail, and are trying to get as much information, judgment and sense of the markets as we conceivably can muster.
Mr. BARNARD. Mr. Chairman, my time has expired, but I would
like to ask one other question, which I think is very significant to
something you said. As I understand it, the Fed has out for comment the ability of bank holding companies to underwrite corporate equity.
Would you like to address, just indicated how the Fed feels about
that?
Mr. GREENSPAN. Well, let me just tell you specifically what it is
we are doing. A year ago when we granted so-called section 20 authorizations to underwrite corporate debt, we also indicated that
we did not think at that time that the underwriting of corporate
equity would be a appropriate and that, in a year, we would review
that issue with the implication that if we thought it was the appropriate thing to do, we would go ahead, but only after Federal Reserve examiners reviewed the processes of those involved in corporate debt underwriting to make certain that their particular procedures and organizations were adequate to field equity as well.
Several days ago, the Federal Reserve Board authorized the Federal Reserve Bank of New York to begin to examine the individual
banks who have made application to see whether in fact they have
15
created a structure which in our judgment would match our requirements of safety and soundness in such underwriting activities.
I presume that examination activity will begin within several
weeks, and when the examinations are complete, it will come back
to the Board, and the Board will make a judgment at that particular time as to whether or not individual applications should be
moved forward or not.
Mr. BARNARD, That examination is examination of underwriting
corporate debt?
Mr. GREENSPAN. It is to see how they have underwritten corporate debt and whether or not they will have the facilities and technical capabilities, in the judgment of the Board, to move forward
into equities.
Mr. BARNARD. This year that has elapsed now, has there been
any significant—have you noticed anything significant which you
feel the Fed would change its policy on underwriting corporate
debt? I mean, are you happy with the results of the permission?
Mr. GREENSPAN. That is one of the things we plan to be looking
at. I know of nothing at this stage which suggests anything negative, and I did not sense anything from my colleagues on the Board
to suggest that any of them had altered their basic view that it
would be desirable to move forward, provided our criteria were
met.
Mr. BARNARD, Mr. Chairman, just to satisfy some of the critics—
of which I am certainly not one, I applause what the Fed is doing—
but during this period of time you have periodically examined bank
holding companies to determine the structure in which they are
underwriting this corporate debt?
Mr. GREENSPAN. When reviews have been taking place, they are
general reviews.
Mr, BARNARD. All of these underwritings done in separate subsidiaries?
Mr. GREENSPAN. That is correct. That is required.
Mr. BARNARD. Have I got time for one more question, Mr. Chairman?
Chairman NEAL. Yes.
Mr. BARNARD. Mr. Chairman, I was interested in the story which
indicated that had Drexel Burnham Lambert not gone into bankruptcy, that there was a possibility that the Fed would come to
their assistance. Did I read that wrong?
Mr. GREENSPAN. Well, I can't say that you read it wrong if somebody wrote it. I could merely indicate to you that there is serious
question about the accuracy of such a statement.
Mr. BARNARD. Well, I was thinking so, too, but I notice it was
given wide publicity that the Federal Reserve was contemplating
coming to the aid of Drexel Burnham Lambert, I said now certainly they are not going to underwrite junk bonds now.
That was my last question. Thank you.
Mr. GREENSPAN. Let me just say, Mr. Barnard, that the basic
concern of the Federal Reserve is not in individual institutions, but
in the system, and our concern is always concentrated strictly on
making certain that individual firm problems don't spill over into
corrosive effects on the financial system, and
16
Mr, BARNARD. But they would not have had access to the discount window?
Mr. GREENSPAN. That is correct. They would not have.
Chairman NEAL. Mr. Chairman, I would like to ask you to
expand your comments on the line of questioning that Mr. Leach
pursued, because it seems to me that he has touched on a most important point concerning the conduct of monetary policy, and that
is this question of the ideal policy. It is my understanding that
achieving and maintaining zero inflation and price stability provides the ideal condition for maximum sustainable economic
growth—that there is no other condition that will better assure
that we can sustain economic growth at its maximum level and
price stability. I would say the same thing about employment.
Wouldn't you find that the majority of economists would agree
with these ideas that I am expressing now, that that is the way to
achieve maximum sustainable economic growth is to maintain
price stability. That to maintain maximum sustainable employment, that the essential condition for that is zero inflation and
price stability. I believe that you could say that about the maximum level of savings, and therefore, of investment and productivity growth. Don't we know enough now about the way our economy
works to say with a high degree of certainty that we can maximize
sustainable economic growth, employment, savings, investment,
and so on, all the things that we are talking about, including exchange rate stability by achieving and maintaining zero inflation
and price stability?
Mr. GREENSPAN. Well, Mr. Chairman, let me distinguish between
a necessary condition and a sufficient condition. I would say—and I
would certainly include myself in this—that a very substantial majority of economic analysts would argue that a noninflationary environment is a necessary condition for maximum sustainable economic growth and employment and a variety of other things. I
would not—and I would think they would not—say it is sufficient,
because it is very easy to envisage an economy with very significant amounts of Government controls, various different types of inefficiencies, extremely unstable fiscal policies and budgets, in
which we would not achieve those goals.
Chairman NEAL. But we are talking about monetary policy.
Mr. GREENSPAN. If you are talking about monetary policy, the
long-term optimum monetary policy which can contribute most to
these various is to maintain a noninflationary environment.
Chairman NEAL. Thank you.
Mrs. Saiki.
Mrs. SAIKI. Thank you, Mr. Chairman.
I would like to add my appreciation for the soft landing, Mr.
Chairman, of 1989, but looking forward as decisions have to be
made up here on the Hill in the context of our concern for the rate
of growth, I would like to ask you a question which may be a little
unfair, but I would like your personal opinion as to whether a
change in the treatment of capital gains promotes growth in our
economy. Are we really going to make money as the Treasury suggests? I am sorry, would we make money for the Treasury as OMB
suggests, or are we going to lose revenues as CBO suggests?
I would like to have your opinion on this.
17
Mr, GREENSPAN. Well, I have always supported a cut in the capital gains tax rate because I don't think it is a productive tax for a
market system of the type that we have. I think that a lower capital gains tax would basically over the long run be productive in
that it would add to long-term economic growth.
I have also said that I, nonetheless, supported the 1986 tax
reform compromise, which, as you know, eliminated the preference
for capital gains as part of the package which brought the marginal tax rates down very substantially, and I still support that. In
other words, if I am given the choice of a capital gains tax cut financed by higher marginal tax rates, I wouldn't think that would
be a particularly good idea.
With respect to the issue of whether or not these are revenue
gainers or revenue losers, the estimates are based on a very sensitive set of calculations which refer to the expected so-called unlocking of existing capital gains and the willingness on the part of individuals who have unrealized capital gains to, in fact, realize them
if the tax rate falls. Obviously were they to do that, they would be
paying taxes which they would not otherwise be paying, and that
in a sense adds to tax revenues rather than losing them.
The sensitivity of those assumptions is very high, meaning very
small changes in assumptions can create very significant changes
in the revenue picture. I have seen estimates on both sides with
very small differences in assumptions, and I am personally unable
to make a choice as to what is an appropriate estimate, because I
have not myself looked at or felt comfortable with the particular
details that were presented. So I would just basically say I am generally supportive of the overall principle, hope we can implement
it, but would not like to see it done in the context of unwinding
what I thought was a very effective Tax Reform Act of 1986.
Mrs. SAIKI. Are you saying then, Mr. Chairman, that the gains
that we may see with this kind of a plan that the administration
has proposed will be a short term gain?
Mr. GREENSPAN. Well, not necessarily. I think that clearly most
everybody has short, up-front realizable capital gains, and one
would assume that one would get the maximum effect of unlocking
at the earliest possible point. But I have not looked at the details of
the calculation sufficiently to give you a good judgment as to
whether those are statistically as good as they can be.
I have no reasons to believe that they are otherwise. In other
words, they have good people over there making professional judgments, and I would have every reason to believe that those estimate are as good as you can get.
Mrs. SAIKI. Thank you.
Chairman NEAL. Mrs. Roukema.
Mrs. ROUKEMA. Thank you, Mr. Chairman.
Chairman Greenspan, I regret that I was unable to be here for
the bulk of your testimony, bit I do note on page 7 that you allude
to the fact that you anticipate less feverish activity, less feverish
pace, with respect to merger and acquisitions, and I assume here
you are alluding also perhaps—I am not sure, but perhaps—to the
component of that activity that has been related to junk bonds, and
evidently you have taken into account the most recent effects of
18
the junk bond in the Drexel Burnham Lambert fall, et cetera, into
your calculations.
Would you be willing to go any further in terms of giving a prognosis as to what the future—the effect of this activity, lessened activity is going to have on the future financial markets? Are we
going to see more of abuse in terms of the consequences of the junk
bond debacle here? Or don't you like the use of my word "debacle"?
Mr. GREENSPAN. I wouldn't choose to use it. I don't actually
think there is a debacle here. I think what we are looking at is the
satiation of the potential for significant restructuring on a profitable basis. I think a year or two ago, before this committee or the
full committee, as I recall. I discussed the relationship between the
rise in real interest rates that occurred in the early 1980s, the imbalances that that created with respect to the optimization of the
various different parts of corporations, and argued that the process
of trying to reestablish balance was the major reason why the very
big surge in mergers, acquisitions, and restructurings occurred.
I think that what we have seen since is a very substantial degree
of activity in trying to reestablish balance in a number of different
firms, and that took as part of it a very large amount of conversion
of equity to debt.
We have had an extraordinarily large amount of liquidation of
equity financed by debt, in many respects financed by junk bonds.
In fact, one can say where do junk bonds fit into the balance sheet,
and to a very substantial extent, they have displaced equity. In
that sense, I think I have argued that that is unfortunate, since the
capital asset relationships in corporations have undergone a weakening.
Having said that, there is no question that there are valuable
places for less than investment grade corporate bonds, and I think
there have been a number of firms which have effectively used
them to finance their balance sheet structure and probably have
done better than they would have if junk bonds did not exist.
My impression basically is that we will work our way through
this turmoil that we have seen in these markets and that it will
eventually simmer down. We will find that rather than $200 billion
outstanding, we will probably have somewhat less. But junk bonds
will be an available part of the overall financing structure of
American business, because I do think that they serve a useful purpose. I think their issuance may have gotten somewhat out of hand
for a while, but I think over the long run they are a logical niche
in the system, and I would expect that that is what is going to
happen.
Mrs. ROUKEMA. So your prognosis is that after some initial turmoil the patient will stabilize, and not without too much problem
with respect either to pensions or other kinds of investment instruments?
Mr. GREENSPAN. I don't think so. Obviously there are certain institutions that have a bit too much in the way of lower grade securities, but remember that those securities are still a relatively
small part of the total investment scene. As a result of that, while
there are a handful of institutions which have a disproportionately
large amount of such instruments, that is not generally the case,
19
and I would be most surprised if we had any secondary repercussions which could destabilize the total system.
Mrs. ROUKEMA. Well, good. I am happy to hear your assessment.
Thank you, Mr. Chairman.
Chairman NEAL. Mr. Chairman, on the question of junk bonds,
isn't it true that there are only 1,300 or 1,400 companies in the
whole United States that can issue bonds that are considered by
the rating agencies to be investment grade bonds, and by definition, everything else is a junk bond? Do you remember that
number?
Mr. GREENSPAN. I am not sure that that actually is a real
number in the sense that it is a measure of the number of companies which have investment ratings. I am not sure that those who
have not issued bonds are in that number, but that is, I believe, a
published number, and I will submit that for the record.
[Chairman Greenspan subsequently furnished the following information for the record:]
At the end of September 1989, approximately 1,350 corporate issuers were rated
as investment grade by Moody's Investors Service. This figure represents all issuing
entities, including subsidiaries of parent corporations, having a rate of Baa or above.
The number of entities actively issuing bonds may be considerably smaller.
Chairman NEAL. Anyway, the point I am trying to make, it is a
relatively small number compared to the total number of companies in the United States.
Mr. GREENSPAN. Oh, yes, it is a relatively small number.
Chairman NEAL. It seems to me that those who want to refer to
all these other bonds as junk bonds, would not have been pressed
to refer to those other companies as junk companies. I don't think
they are junk companies. Many of them are the growing companies
attracting new investment, producing new products, employment,
and it is just a shame to attach this pejorative to their debt issues.
They couldn't provide those jobs and so on without being able to
attract some capital. It is certain the development of this market
in less than investment grade debt is a positive one, it seems to me,
not a negative one. Some of this debt has been used in a negative
way, but certainly not most of it.
Mr. GREENSPAN. Mr. Chairman, I think it has been somewhat
over-done, but the mere fact that it has been overdone does not undercut the fact that it does serve certain useful purposes.
Chairman NEAL. Well, vital purposes, it seems to me. It provides
jobs for our people, competitiveness in the world economy.
I have been critical and I believe you have also, of efforts to use
monetary policy to what a lot of people refer to as stabilization the
foreign exchange value of the dollar. In other words, to have that
as a primary objective of monetary policy, and as far as I know,
that stabilizing exchange rate has not played any kind of distorting
role in the recent conduct of monetary policy. And I raise this at
this time because it does seem to me that soon we may face some
real uncertainty and turbulence in exchange rates.
The recent proposal that West Germany and East Germany form
a monetary union, it seems to me, will certainly introduce considerable uncertainty in the exchange rates of this new German mark
vis-a-vis the dollar. Do you agree that we should not use monetary
20
policy to stabilize this rate, but should rather let financial markets
determine the value?
Mr. GREENSPAN. Well, Mr. Chairman, in our directives we list
the various different factors which we consider in determining
policy, and we do look at the exchange rate as an element which
will affect the domestic economy and therefore subject to decisions
with respect to policy. But in that particular context, how the Federal Open Market Committee will respond to various different scenarios that can emerge in the months ahead, as a consequence of
the growing imminence of the merger of East and West Germany,
is as yet too soon to make a judgment.
The reason I say that is that it is such a complex set of relationships that I wouldn't want to focus precisely on how policy will
move in the event of significant changes abroad. AH I can say to
you is that the fundamental purpose of policy remains the stabilization of the domestic economy and the creation of a noninflationary environment. How we would specifically react to significant
movements of an unstabilizing nature—should they occur and I
must tell you I don't believe that they are in the realm of "what
would you do if." There are a long series of contingencies that the
Federal Reserve has outlined, and we even have several committees which look into various "what ifs." But they are really so complex that unless and until we are actually looking at a specific
event, it is really very difficult to know what optimum policy at
that point is, because it is likely to depend very concretely on the
particular events of that time.
Chairman NEAL. Mr. Chairman, as you know, I have been very
complimentary of what you and most of the other Board members
are trying to do and I support your public statements in terms of
achieving zero inflation, price stability, and so on, but now I want
to ask you when can we expect a little more progress? If you will
look at your own charts in the back of your testimony this morning—the top chart is the GNP price deflator, the bottom one is the
consumer price index, and what that shows is that since 1984,
except for the year 1986—which was a year in which the bottom
really dropped out of oil prices—the average rate of inflation has
been about what it is today. That is to say, it has been somewhere
in that range of 4 to 5 percent. We both said many times that that
is intolerably high level of inflation, and that maintaining a level
of inflation at that rate does enormous damage to the economy.
It keeps interest rates much higher than they should be, than
they could be. It lowers our possible growth rate. It lowers the rate
of employment, makes us save less than we otherwise would, and
so on. So I would just like to know when can we expect to see some
progress in terms of reducing the rate of inflation?
Mr. GREENSPAN. Mr. Chairman, I have hesitated to make a specific forecast merely because the particular complexity of the economy at any particular point in time means that it will respond differently to various different types of monetary policies. Our general thrust is to keep pressure on, endeavor to gradually bring the
rate down, but I have purposely avoided with you in earlier conversations citing a specific set of price goals independent of everything
else.
21
I think we do intend, and think it is crucially important, to bring
the rate of inflation down to a noninflationary level for all the reasons we have discussed on numerous occasions, and I think that is
the fundamental thrust of our long-term policy. We are biased in
that direction, obviously, over the long run. But having said that,
we want to be certain that we do not in the process inadvertently
destabilize the economy, and as a consequence, I think that if we
were to set specific goals of where we think prices should be at any
time, we would probably find that we were not optimizing our
policy over the long run.
So all I can say, Mr. Chairman, is that our view is that the direction of inflation has got to be down, but I don't think it is productive to set specific goals as to where we would like to see it at each
point in time.
Chairman NEAL. Well, I know the difficulty with that, but I sure
would encourage you to do all you reasonably can. Certainly I don't
want to see us in any way destabilize the economy, certainly I do
not want to see a recession. However, I think we ought to be able
to achieve this goal of price stability without creating a recession.
A recession would create unnecessary pain, and would sap our
will to achieve the goal. But, it seems to me that we can achieve
more progress than we have, and that it would benefit all of our
people, and I just hope that we can move in that direction more
forcefully than we have.
Mr, Leach.
Mr. LEACH. Thank you, Mr. Chairman. I want to take a little different perspective, and let me just suggest, and I am hesitant as a
representative of the minority to be partisan, but, Mr. Chairman,
the last Democratic President served from 1977 to 1981.
The inflation rates were in the double digits. Here they are 4
percent during a time period in which Congress, which is the primary body in American society responsible for fiscal deficits, ran
extraordinary deficits. One can agree or disagree with the Federal
Reserve Board in all sorts of ways at various points in time. But in
terms of maintaining 4 percent inflation, given the level of deficits
from the fiscal side, is a mighty impressive performance, and I
don't think anyone on this panel ought to be misled into thinking
that a lot better job could have been done.
It is very impressive what the FED has done to curb inflation. I
would like to turn, though, to the subject which I didn't know was
going to be raised today and relate it back to the Drexel Burnham
and junk bond issue. Frankly, Mr. Chairman, I think the term
"junk" is too cheerful a term to apply to these bonds.
A junk bond implies something that maybe the buyer may not
get a full rate of return. Well, these are more than "junk"; they
are dung heap bonds. The reason I say that is that Congress knows
better than any other institution that it isn't solely the saver that
is losing money, although the savers are losing some. In the S&L
collapse, it is Congress and the taxpayer that are is bailing out
these bonds. That means they are not just junk; they are dung
heaps.
Now, beyond that, Mr. Chairman, you have noted that junk
bonds from time to time provide smaller businesses equity at a
little lower rates than they would otherwise receive, and there are
22
some cases that that is good for the economy, good for the smaller
businesses.
On the other hand, the Chairman of the Federal Reserve Board
has pointed out that disproportionately these bonds have been used
to replace equity with debt and to the degree that they have been
used to replace equity with debt, they are dung heaps for the economy as a whole.
Now, coming back to the Drexel issue which was raised, I was a
little surprised, Mr. Chairman, that you didn't come down a little
more firmly. The fact is the Federal Reserve Board does have extraordinary power and can in one way or another intervene and
has a legal mandate to intervene to assist far more than the banking sector if it is in the interest of the economy.
Well, my view is the social case for saving rogue elephants is
non-existent, and the economic case is also in this particular circumstance very weak as well. The failure of large institutions of
any variety can be destabilizing, but it strikes me the failure of bad
actors, especially ones which feast off over leveraging of the economy can be stabilizing rather than destabilizing. I would certainly
hope that there is no hint that the Government is prepared to
come in in an extraordinary way and prop up a particular financial
institution whose social purpose, has ill-served the economy in the
last decade and the replication of which will ill-serve it in the next.
I just want to raise the flag of concern against dung heap bonds
and against the institutions that have propagated them on the
American economy,
Mr. GREENSPAN. I think it is important to distinguish among the
uses to which a significant number of the junk bonds or whatever
you want to call them have been applied. Clearly, they have been
to a very substantial extent displacing equity. For reasons which I
discussed in my prepared remarks, I think the leveraging of corporate America is creating financial strains, a factor with which I
personally feel uncomfortable and I have felt uncomfortable with it
for quite a long period of time.
One can say that an evaluation of the junk bonds issued to date
would come out decidedly mixed at best, but I think you have to
distinguish between what they have been used for and what they
can be used for, and my remarks with respect to them refers essentially to the latter because those types of instruments may be the
best means by which certain small to medium-sized businesses can
finance themselves. Consequently I think it is important not to
throw all of that process under one classification.
There are actually large variety of differences among various different types of junk bonds. It seems like silliness, but there are
high-grade junk bonds and low-grade junk bonds, and the markets
will eventually make those particular distinctions.
With respect to Drexel, there was not at any time any desire on
the part of those involved in the U.S. Government, relevant to this
issue, who considered bailing out Drexel. I think that the issue of
bailing out any institution is a very serious issue.
My judgment is we probably do it far more often than we should.
I am certain that is the case, and I don't think that there was any
inclination at all in this regard.
23
Mr. LEACH. Well, I appreciate that very much, and I would only
make one very minor distinction. There is a difference between
high grade and low grade, but there is also a distinction between
high purpose and low purpose.
You can have a higher grade junk bond, which is used to displace
equity or capital with debt, and you can have a lower grade junk
bond, which is not designed in that fashion.
Mr. GREENSPAN. I would agree with that.
Mr. LEACH. Coming back to the responsibility of Congress, one of
the great questions given the overleveraging tribulations of the last
decade is whether we want to change the mix of our tax policy. I
don't know if you are prepared to comment on this, but one of the
issues that many of us are concerned with is whether we ought perhaps, to lower the corporate rate in exchange for eliminating some
aspects of tax deducibility of interest.
Does that strike you as a reasonable kind of tradeoff?
Mr. GREENSPAN. Well, I have always argued, Mr. Leach, that one
of the problems we have in our system that inhibits savings, which
I consider the most crucial short-fall our system now has, is the
double taxation of dividends, and in fact the whole structure of corporate taxation. Any means that we can find to bring down the
level of double taxation of dividends—and I don't want to comment
specifically on mechanisms now because they are all very complex
and require a good deal of thought—but I think that process, which
is unfortunately expensive with respect to revenues, is something
that we should nonetheless be looking carefully at.
If you are looking at a way of improving the structure of taxation in this country and in the broadest sense focusing on improving national savings, looking at that process and hopefully revamping it could be a very productive endeavor, in my judgment.
Mr. LEACH. Thank you.
Chairman NEAL. Mr. Barnard?
Mr. BARNARD. Mr. Chairman, on page 12 of your testimony you
enumerated to some degree international financial markets and its
effect on monetary policy, and then on page 12 you said that crossborder financial flows have accordingly accelerated at a pace in
excess of global trade gains.
This globalization of financial markets has meant that events in
one market or in one country can affect within minutes developments in markets throughout the world. I would direct a question
having to do with the recent announcements that—example, with
the German currency union of East Germany and West Germany.
We are seeing various reports on the West German mark that it is
getting exchange in narrow ranges from the East German mark,
I am not asking for your predictions, but do you feel that it will
be somewhere between four to eight east marks for every one
German mark?
Mr. GREENSPAN. Are you talking about the exchange rate between ost-marks and deutsche-marks?
Mr. BARNARD. Yes.
Mr. GREENSPAN. I can't answer that question because the choice
that is involved is a very difficult one. The problem which they
have is the extraordinary movement of people from East to West
Germany. That is largely caused by the perceived differential in
24
the standards of living between the two, and the choice of where
you set that exchange rate creates a major problem because clearly
from the West Germans' point of view, if the exchange rate is set
in favor of the East German mark, that means the addition to the
West German money supply then becomes larger.
But if the rate is set too low, meaning for the East German
mark, it means that the real wage in West German marks is still
very low and as a consequence we are very likely to get a continuation of the immigration flow, and I think both parties are most
anxious to stabilize that.
Mr. BARNARD. But in spite of that effort, isn't it somewhat inescapable that we are going to see higher interest rates in Germany,
either from borrowing or otherwise?
Mr. GREENSPAN. It is not clear to what the extent to which the
current run up in rates has discounted perspective events or not.
There is always an inclination to look at an economic development
and then project interest rates as though there are not other participants in the market who have not already made that judgment
and taken actions in the markets.
It is only when you can perceive an event which the rest of the
market has not perceived that you are likely to be able to forecast
where rates will or will not go, and it is just as conceivable at this
stage that rates could go in the other direction because they may
have been over-discounting what in fact the ultimate results may
be.
So I don't think one can make that statement necessarily. There
are tremendous degrees of uncertainty with respect to the process
going on in Central Europe at this stage, and I think that we forecasters require a large element of humility when observing that
phenomenon.
Mr. BARNARD. In discussing the aspects that are going on in
Eastern Europe, you indicated in your remarks that even in the
past we have seen tremendous reactions in other countries, and
still we have been able to manage monetary policy without any
problem, taking into effect those responsible.
That was on page 11, A former OMB Director, however, has said
that he is concerned that the interest rates in Germany are going
to be such that we could "lose the control of our monetary policy."
Now, you don't have that fear?
Mr. GREENSPAN. No, I do not, Mr. Barnard.
Mr. BARNARD. My last question, Mr. Chairman, would be that in
response to the vast changes in the globalization situation, are we
moving fast enough in this country to address the banking laws
that stand in between our institutions becoming—being able to
serve the international financial marketplace?
Mr. GREENSPAN. I think not.
I think that we are lagging somewhat, and I think that if we
could accelerate—move toward repeal of Glass-Steagall, for example—I think we would achieve a much improved financial structure
which would enable us to compete increasingly effectively in the
international arena.
Mr. BARNARD. We probably wouldn't be as subject to national
treatment limitations as might develop in the future if we don't do
that?
25
Mr. GREENSPAN, I can't answer that, but I would say that basically this issue of Glass-Steagall should be fairly high up on the
agenda for our considerations.
Mr. BARNARD. Thank you, sir.
Chairman NEAL. I am going to try to address a point Mr. Leach
made without engaging in partisan wrangling. I hope I will be successful at that. I mean it in this way. One reason I take it up,
frankly, is that it seems to me that it is important that on this subject of monetary policy that we have a clear historical understanding of how these things work. And Mr. Leach is absolutely correct
that under a Democratic administration during the late 1970s the
Federal Reserve ran a very high rate of inflation, and it was a mistake.
But the role of the President in that was in appointing the Chairman of the Federal Reserve System. He appointed the Chairman
who guided that policy, and when it was recognized that that policy
was incorrect, President Carter appointed Paul Volcker as Chairman of the Federal Reserve and gave him the specific mandate of
lowering the rate of inflation, which he did.
Inflation is a monetary phenomenon, and it was caused by the
Fed and it was then ground out of the system at least from its
double digits to its current levels by the FED. And both of those
Fed chairmen were named by President Carter, the one that created much of it and the one who solved much of the problem.
Now, on the question of the role of the Congress in setting and
establishing budget deficits, it is important to set the historical
record straight. The President, under our system, has enormous
power in this regard. President Reagan was the most persuasive
President, I guess, clearly since Roosevelt,
The Congress did grant him pretty much what he wanted, and
these policies he wanted had a lot to do with the deficit. In fact he
created much of the deficit that we have today—tripled the national debt in 8 years.
Now, it is true that that couldn't have happened unless Congress
went along with it. I am trying not to be overly partisan, but to try
to say that that was something that the Congress did and that the
President had no impact on it just seems to me misses the point
entirely.
I would like to yield to my friend if he disagrees with anything I
have said.
Mr. LEACH, Well, I think that several of your comments are thoroughly valid. I would only suggest, though, that despite the exhortations of anyone from the outside, whether they be the President
of the United States or a wife, the U.S. Congress has its own responsibilities to administer.
A President cannot spend a dime that we do not appropriate and
cannot raise revenue that we do not authorize. The Congress of the
United States has the primary responsibility for defining whether
or not there is a fiscal deficit. Now, the gentleman in the chair is
entirely correct in noting that we have had a very persuasive
President,
He is entirely correct that under that Presidency the deficit rose
dramatically, But I will be darned if I do not think that all of us
should understand that it is our job to run the fiscal policy of the
26
United States of America. If we fail we cannot simply blame a popular President, We must blame ourselves.
Chairman NEAL. Well, I have to agree with part of that, too. Let
me pursue it one more minute, I voted against the Reagan budget.
I said at the time I thought it would create a huge deficit. I underestimated by far the amount of the deficit, but I am a Member of
this body.
What role do I play in it? What is my responsibility there? It was
passed overwhelmingly. I think all Republicans voted for it, and
there were enough Democrats to put the policy over the top. A majority of democrats voted against it. Well, where does the responsibility lie?
Mr. LEACH. Well, if the gentleman would yield, let me just stress
that I consider the gentleman from North Carolina to be one of the
most distinguished Members of this body, and one for whom I hold
in high regard. I do not want to level any personal criticisms, but I
think collectively all of us have to recognize that even though we
are Vias of a particular body, we are accountable for the body
itself. The Congress of the United States committed some egregious
errors in the 1980's, and they can't be denied.
Chairman NEAL. I thank the gentleman.
Mr. Hoagland?
Mr. HOAGLAND. Well, thank you, Chairman Neal, for recognizing
me.
Welcome, Chairman Greenspan, to the committee. It is a pleasure to see you this morning. You might recall, Chairman Greenspan, it was about a year ago when you gave some testimony before
this committee that caused the stock market to go up 25 to 30
points, and I told you the story about how pleased my mother was.
Well, I just flew in from Omaha this morning, just got here
about a half hour ago. And my mother reminded me last night that
you would be testifying this morning and wanted me to give you an
opportunity,
I know she will be pleased with the optimistic forecast that you
have made here, but if you would like to elaborate on that in any
respect, I know she would be pleased, and I would be pleased to
hear that.
Mr. GREENSPAN, Well, all I can say to you, Mr. Hoagland, is I
would like to convey to your mother my best wishes and felicitations, and I hope that when she conies to visit you I will get to
meet her.
Mr. HOAGLAND. Well, she does follow you quite closely, Mr.
Chairman, and she will appreciate that. And I appreciate it as well,
Mr. Chairman, on a different note, I think a number of us were
somewhat alarmed at the testimony that we heard from the General Accounting Office and the Congressional Budget Office about 2Vz
weeks ago on the progress of the RTC. We were told then that as
of, I think it was—I believe the date was January 15th, that only
about 46 institutions had been closed, that those were by and large
small institutions with assets in the $200 million to $250 million
range, totaling only about $10 billion; that there were hundreds of
sick institutions still out there, many of which had billions of dollars of assets.
27
I wonder what you think needs to be done in order to speed up
the process, if there is anything that we here in Congress should be
doing, what recommendations you might have for your colleagues
in the administrative branch.
Mr. GREENSPAN. We at the Oversight Board and the ETC Board
are programming at this particular stage a significant acceleration
of activity. If that fails to materialize to the satisfaction of the Congress, then I think that the Congress would want to take a much
closer look and find a way in which that could be accelerated. However, at the moment, as I understand it, there is a significant increase in scheduled activity in that respect.
Mr. HOAGLAND. Have you had an opportunity to discuss with Mr.
Kearney his reasons for leaving, Mr. Greenspan, and does that increase or decrease your concern about the way things are proceeding now?
Mr. GREENSPAN. I did speak to Mr. Kearney on it, and I think he
repeated to me what he has said in public; namely, that his judgment as to what the particular role of the chief executive of the
RTC Oversight Board was was different from the view of the Oversight Board, and I think that it was regrettable.
I think it was an honest misunderstanding. I don't think that
communication was obviously as adequate as one could have made
it. I was sorry to see him resign. I don't consider it a major set-back
in the forward thrust of the organization. The work of the Oversight Board continues a pace and hopefully the transition will
appear to be nothing more than a blip.
Mr, HOAGLAND. One criticism we are hearing here in Congress is
that there are some different agencies involved in approving any
given transaction, some overlapping lines of authority, and a general paralysis that is resulting from a fear of excessive criticism from
the Banking Committee and other institutions should a large thrift
be taken on and the resolution of that be imperfect in some respect
or another?
Mr. GREENSPAN. I frankly don't know how valid the criticism is.
We have a problem but we knew we had it right from the beginning—that the structure of the RTC and the Oversight Board is not
the type of structure that one would set up for a private corporation.
You would not have two boards, in effect, but I think it was the
Congress' judgment that even though there is a clear increase in
complexity and a decline in managerial efficiency to put this type
of complex structure in place, I think it was the judgment of the
administration and the Congress that when you are dealing with
huge amounts of taxpayer money that there has got to be some political oversight to the system, and that political oversight does
create a slowdown.
It creates a more complex decision-making process than would
exist in the private sector, but I think it is a very understandable
tradeoff. I don't think it would be appropriate to put in the hands
of an independent agency huge amount of taxpayer funds without
the appropriate layering of political control on top of it.
We have to recognize that that political control has a cost, and
the cost is some inefficiency, so it is a tradeoff that was made when
28
FIRREA was first established. I think if you went back to square
one you would probably have come out roughly the same.
It is up to us to make that system work, and I trust that the
speculations in the press and elsewhere that everyone is afraid to
move turns out to be inaccurate.
Mr. HOAGLAND. So you are satisfied that no structural changes
need to be made at least at this point?
Mr. GREENSPAN. That's correct, Mr. Hoagland. For the moment I
would say let's watch the way this evolves. If it fails to meet the
Congress' expectations, then I think it should be reviewed, but I
have no reason to believe at this stage that that will in fact be the
case.
Mr. HOAGLAND. Are you also satisfied, Mr. Chairman, that men
and women in the highest jobs in the administration are giving
this problem the attention and the concern that it needs and deserves?
Mr. GREENSPAN. I don't know whether I can answer that very
specifically. I will say this, that the various people within the Government—Secretary of the Treasury, the Deputy Secretary of the
Treasury, the Under Secretary of Domestic Affairs, and the Federal Reserve Board at various different levels—are heavily committed to this process and, needless to say, the FDIC has taken on a
very large operation.
Mr. HOAGLAND, Well, thank you, Mr. Chairman. Thank you.
Chairman NEAL. Mr. Leach?
Mr. LEACH. I want to thank our chairman for spending so much
time with us. Thank you.
Chairman NEAL. Mr. Chairman, I have no further questions. I
want to thank you also for coming this morning and keep up the
good work. Just more of it.
The subcommittee stands adjourned subject to the call of the
Chair.
[Whereupon, at 12:10 p.m., the hearing was adjourned, subject to
the call of the Chair.]
29
APPENDIX
F e b r u a r y - 2 0 , 1990
30
ror releave on delivery
10:00 A.M. EST
February 20, 1990
Tettittony by
Alan Greenspan
Chairnan
Board of Governor* of the Federal Reserve System
before the
Subcomnittee on Domestic Monetary Policy
House Cooaittee on Banking, Finance and Urban Affairs
U.S. Bouse of Representatives
February 20, 1990
Mr. Chairman and Members of the Committee, I appreciate the
opportunity to testify today on the Federal Reserve's semiannual Monetary
Policy Report to the Congress.
My prepared remarks discuss our monetary
policy actions and plans in the contest not only of the current and projected state of the economy, but also against the background of our
longer-term objectives and strategy for achieving them.
The final sec-
tion of the testimony addresses some issues for monetary policy raised by
the increasingly international character of financial markets.
Bcononic and Monetary Policy Dev«lopn»ntB in 1969
Last year marked the seventh year of the longest peacetime
expansion of the U.S. economy on record.
Some 2-1/2 million jobs were
created, and the civilian unemployment rate held steady at 5-1/4 percent,
Inflation was held to a rate no faster than that in recent years,
but unfortunately no progress was made in 1989 toward price stability.
Thus, while we can look back with satisfaction at the economic progress
made last year, there is still important work to be done.
About a year ago, Federal Reserve policy was in the final phase
of a period of gradual tightening, designed to inhibit a buildup of
inflation pressures.
Interest rates moved higher through the winter, but
started down when signs of more restrained aggregate demand and of
reduced potential for higher inflation began to appear,
A3 midyear
approached, a marked strengthening of the dollar on foreign exchange
markets further diminished the threat of accelerating inflation.
New
economic data suggested that the balance of risks had shifted toward the
possibility of an undue weakening in economic activity.
With M2 and M3
32
-2-
below the lower bounds of their annual ranges in the spring, the Federal
Reserve in June embarked on a series of measured easing steps that continued through late last year. Across the maturity spectrum, interest
rates declined further, to levels about 1-1/2 percentage points below
March peaks.
Reductions in inflation expectations and reports of a
softer economy evidently contributed to the drop in rates in longer-term
markets.
The decrease in short-term rates lifted M2 to around the middle
of its annual range in the latter part of the year.
Efforts under the
Financial Institutions Reform, Recovery, and Enforcement Act of 1989
(FIRRBA) to close insolvent thrift institutions and strengthen undercapitalized thrifts led to a cutback of the industry's assets and funding
needs.
This behavior held down M3 growth in the second half of the year,
and that aggregate ended the year around the lower end of its annual
range.
The restructuring of the thrift industry did not, however, seem
to appreciably affect the overall cost and availability of residential
mortgage credit, as other suppliers of this credit stepped into the
breach.
In the aggregate, the debt of nonfinancial sectors slowed
somewhat, along with spending, to a rate just below the midpoint of its
annual range.
So far this year, the federal funds rate has remained around
8-1/4 percent, but rates on Treasury securities and longer-term private
instruments have reversed some of their earlier declines.
Investors have
reacted to stronger-than-expected economic data, s runup in energy
33
prices/ and increasingly attractive investment opportunities abroad,
especially in Europe.
Tha Ultimata Objective* and Medium-Term Strategy of Monetary Policy
Monetary policy was conducted again last year with an eye on
long-run policy goals, and economic developments in 1989 were consistent
with the Federal Reserve's medium-term strategy for reaching them.
The
ultimate objective of economic policy la to foster the maximum sustainable rate of economic growth,
This outcome depends on market mechanisms
that provide incentives for economic progress by encouraging creativity,
innovation, saving, and investment.
Markets perform these tasks moat
effectively when individuals can reasonably believe that by forgoing
consumption or leisure in the present they can reap adequate rewards in
the future.
Inflation insidiously undermines such confidence.
It raises
doubts in people's minds about the future real value of their nominal
savings and earnings, and it distorts decision-making.
Faced with
inflation, investors are more likely to divert their attention to
protecting the near-term purchasing power of their wealth.
Modern-day
examples of economies stunted by rapid inflation are instructive.
In
countries with high rates of inflation, people tend to put their savings
in foreign currencies and conovodities rather than in the financial
investments and claims on productive assets that can best foster domestic
growth.
By ensuring stable prices, monetary policy can play its most
important role in promoting economic progress.
The strategy of the Federal Open Market Committee (FOMC) for
moving toward this goal remains the same—to restrain growth in money and
34
-4-
aggregate demand in coming years enough to establish a clear downward
tilt to the trend of inflation and inflation expectations, while avoiding
a recession. Approaching price stability may involve a period of expansion in activity at a rate below the growth in the economy's potential,
thereby relieving pressures on resources. Once some slack develops, real
output growth can pick up to around its potential growth rate, even as
inflation continues to trend down. Later, as price stability is
approached, real output growth can move still higher, until full resource
utilization is restored.
While these are the general principles, no one can be certain
what path for the economy would, in practice, accompany the gradual
approach to price stability.
One key element that would minimize the
costs associated with the transition would be a conviction of participants in the economy that the anti-inflation policy is credible, that is,
likely to be effective and unlikely to be reversed.
Stability of the general price level will yield important loagrun benefits.
Nominal interest rates will be reduced with the disap-
pearance of expectations of inflation, and real interest rates likely
will be lower as well, as less uncertainty about tbe future behavior of
overall prices induces a greater willingness to save.
Higher saving and
capital accumulation will enhance productivity, and the trend growth in
real GNP will be greater than would be possible if the recent inflation
rate continued.
35
If past patterns of monetary behavior persist, maintaining price
stability will require an average rate of M2 growth over tiaie approximately equal to the trend growth in output.
During the transition, the
decline of market interest rates in response to the moderation in inflation would boost the public's demand for M2 relative to nominal spending,
lowering H2 velocity.
M2 growth over several years accordingly may show
little deceleration, and it could actually speed up from time to time, as
interest rates decline in fits and starts.
Hence, the FOMC would not
expect to lower its M2 range mechanically each and every year in the
transition to price stability.
This qualitative description of our medium-term strategy is easy
to state, but actually implementing it will be difficult.
Unexpected
developments no doubt will require flexible policy responses.
Any such
adjustments will not imply a retreat from the medium-term strategy or
front ultimate policy goals.
Rather, they will be mid-course corrections
that attempt to keep the economy and prices on track.
The easing of
reserve pressures starting last June is a case in point.
Successive FQMC
decisions to ease operating policy were intended to forestall an economic
downturn, the chances of which seemed to be increasing as the balance of
risks shifted away from greater inflation.
doning its long-run goal of price stability.
The FOMC was in no way abanInstead, it sought finan-
cial conditions that would support the moderate economic expansion judged
to be consistent with progress toward stable prices.
In the event, out-
put growth was sustained last year, although in the fourth guarter a
major strike at Boeing combined with the first round of production cuts
36
-6-
in the auto industry accentuated the underlying slowdown.
On the infla-
tion aide, price increases in the second half were appreciably lower than
those in the first.
Although the CPI for January, to be announced tomor-
row, probably trill show a sizable jump in energy and food prices in the
wake of December's cold snap, a reversal is apparently underway.
Monetary Policy and th« Kconomlc Outlook for 1990
Against this background, the Federal Reserve Governors and the
Presidents of Reserve Banks foresee continued moderate economic expansion
over 1990, consistent with conditions that will foster progress toward
price stability over time.
At its meeting earlier this month, the FOMC
selected ranges for growth in money and debt it believes will promote
this outcome.
My testimony last July indicated the very preliminary nature of
the tentative ranges chosen for 1990, given the uncertain outlook for the
economy, financial conditions, and appropriate growth of money and debt.
With the economic situation not materially different from what was
anticipated at that time, the FCWC reaffirmed the tentative 3 to 7 percent growth range for M2 in 1990 that it set last July.
This range,
which is the same as that used in 1989, is expected by most FOMC members
to produce somewhat slower growth in nominal GSP this year.
The declines
in short-term interest rates through late last year can be expected to
continue to boost the public's demands for liquid balances in M2, at
least for a while longer. M2 growth over 1990 thus may be faster than in
recent years, and M2 velocity could well decline over the four quarters
37
of the year, absent a pronounced firming in short-term market interest
rates.
In contrast with M2, the range for M3 has been reduced from ita
tentative range set last July.
The new M3 range of 2-1/2 to 6-1/2 per-
cent is intended to embody the same degree of restraint as the M2 range,
but it was lowered to reflect the continued decline in thrift assets and
funding needs now anticipated to accompany the ongoing restructuring of
the thrift industry.
This asset runoff began in earnest in the second
half of last year, so its magnitude was not incorporated into the tentative M3 range for 1990 set last July.
The bulk of the mortgage and real
estate assets that thrifts will shed are expected to be acquired by the
Resolution Trust Corporation and diversified investors other than depository institutions.
Such assets thus will no longer be financed by
monetary instruments included in M3.
In addition, commercial banks are
likely to be more cautious in their lending activities, reducing their
need to issue wholesale managed liabilities included in M3.
These
influences should retard the growth of M3 relative to M2 again this year.
The debt of domestic nonfinancial sectors is expected to decelerate along with nominal GNP for a fourth straight year, and the Committee
chose to lower the monitoring range for this aggregate to 5 to 9 percent
for 1990.
Merger and acquisition activity has retreated from the fever-
ish pace of recent years, reflecting some well-publicized difficulties of
restructured firms and more caution on the part of creditors.
All other
things equal, less restructuring activity and greater use of equity
38
finance imply reduced corporate borrowing.
An ebbing of growth in house-
hold debt also seams probable.
Over the last decade, money and debt aggregates have become less
reliable guides for the Federal Reserve in conducting policy.
The veloc-
ities of the aggregates have ranged widely from one quartet or one year
to the next, in response to interest rate movements and special factors.
In the coming year, the effects of the contraction of the thrift industry
on the velocity of M3, and to a lesser extent on that of M2, are especially difficult to predict.
While recognizing that the growth rates of
the broader monetary aggregates over long periods are still good indicators of trends in inflation, the FOMC will continue to take an array of
factors into account in guiding operating policy.
Information about
emerging patterns of inflationary pressure, business activity, and conditions in domestic and international financial markets again will need to
supplement monetary data in providing the background for decisions about
the appropriate operating stance.
The Committee's best judgment is that money and dsbt growth
within these annual ranges will be compatible with a moderation in the
expansion of nominal G1W.
Most FOMC members and other Reserve Bank pres-
idents foresee real GNP growing 1-3/4 to 2 percent over the year as a
whole.
Such a rate would be around last year's moderate pace, excluding
the rebound in agricultural output from the 1988 drought.
ing of pressures on resources probably is in store.
A slight eas-
Inflation pressures
should remain contained, even though the decline in the dollar's value
over the past half-year likely will reverse some of the beneficial
39
effects on domestic inflation stemming from the dollar's earlier appreciation.
The CPI this year ie projected to increase 4 to 4-1/2 percent, as
compared with last year's 4-1/2 percent.
Rifki to ttM tcononic Outlook
Experience has shown such raacroeconomic forecasts to be subject
to a variety of risks.
Assessing the balance of risks between production
shortfalls and inflation pressures in the current outlook is complicated
by several cross-currents in the domestic and international economic and
financial situation.
One risk is that the weakness in economic activity evident
around year-end may tend to cumulate, causing members' forecasts about
production and employment this year to be overly optimistic.
However,
available indicators of neat-terra economic performance suggest that the
weakest point may have passed.
The inventory correction in the auto
industry—a rapid one involving a sharp reduction in motor vehicle
assemblies in January coupled with better motor vehicle sales—seems to
be largely behind us.
Industrial activity outside of motor vehicles
appears to be holding up.
Production of business equipment, where evi-
dence has accumulated of some stability—if not an increase—in orders
for capital goods, is likely to support manufacturing output in coming
months.
Housing starts were depressed in December by severely cold
weather in much of the country.
But starts bounced back strongly in
January, in line with the large gain in construction employment last
month.
From these and similar data, one can infer the beginnings of a
modest firming in economic activity.
While we cannot be certain that we
40
-10-
are as yet out of the recessionary woods, such evidence warrants at least
guarded optimism.
There are, however, other undercurrents that continue to signal
caution.
One that could disturb the attainability of the current eco-
nomic expansion has been the recent substantial deterioration in profit
margins.
A continuation of this trend could seriously undercut the still
expanding capital goods market.
However, if current signs of an upturn
in economic activity broaden, profit margins can be expected to stabilize.
A more deep-seated concern with respect to the longer-run viability of the expansion is the increase in debt leverage.
Although the
trends of income and cash flow may have turned the corner, the structure
of the economy's financial balance sheet weighs increasingly heavily on
the dynamics of economic expansion.
In recent years, business debt
burdens have been enlarged through corporate restructurings, and as a
consequence interest costs as a percent of cash flow has risen markedly.
Responding to certain well-publicized debt-servicing problerasr creditors
have become more selective in coamitting funds for these purposes.
Within the banking industry, credit standards have been tightened for
merger and LBO loans, as well as for some other business customers.
Credit for construction projects reportedly has become less available
because of FIRREA-imposed limits and heightened concerns about overbuilding in a number of real estate markets.
Among households, too, debt-servicing burdens have risen to
historic highs relative to income, and delinquency rates have moved up of
41
-iilate.
Suppliers of consumer and mortgage credit appear to have tightened
lending terms a little.
Real estate values have softened in some
locales, although prices have maintained an uptrend in terms of the
national averages, especially for single-family residences.
These and
other financial forces merit careful monitoring. While welcome from a
supervisory perspective, more cautious lending does have the potential
for damping aggregate demand.
It is difficult to assess how serious a threat increased leverage is to the current levels of economic activity.
Clearly, should the
economy fall into a recession, excess debt service costs would intensify
the problems of adjustment.
But it is unlikely that in current circum-
stances strains coming from the economy's financial balance sheet can
themselves precipitate a downturn.
As I indicated earlier, we expect
nonfinancial debt growth to continue to slow from its frenetic pace of
the mid-1980s.
This should lessen the strain and hopefully the threat to
the economy.
International financial Mattatc and Monetary Policy
Among other concerns, recent events have highlighted the complex
interactions between developments in the U.S. economy and financial markets and those in the other major industrial countries.
Specifically,
the parallel movements in long-term interest rates h«re and abroad over
the early weeks of 1990 have raised questions:
To what extent is the
U.S. economy subject to influences from abroad?
To what extent, as a
consequence, have we lost control over our economic destiny?
The simple
answer to these questions is that the U.S. economy is influenced from
42
-12-
abroad to a substantially greater degree than, say, two or three decades
ago, but U.S. monetary policy is, nonetheless, able to carry out its
responsibilities effectively.
The post-war period has seen markedly closer ties among the
world's economies.
Markets for goods have become increasingly, and
irreversibly, integrated as a result of the downsizing of economic output
and the consequent expansion of international trade.
The past decade, in
particular, also has witnessed the growing integration of financial markets around the world.
Advancing technology has fostered the unbundling
and transfer of risk and engendered a proliferation of new financial
products.
Cross border financial flows have accordingly accelerated at a
pace in excess of global trade gains.
This globalization of financial
markets has meant that events in one market or in one country can affect
within minutes developments in markets throughout the world.
More integrated and open financial markets have enabled all
countries to reap the benefits of enhanced competition and improved
allocation of capital.
the world.
Our businesses can raise funds almost anywhere in
Our savers can choose from a lengthening menu of investments
as they seek the highest possible return on their funds.
Our financial
institutions enjoy wider opportunities to compete.
In such an environment, a change in the expected rate of return
on financial assets abroad naturally can affect the actions of borrowers
or lenders in the United States.
In response, exchange rates, asset
prices, and rates of return all may adjust to new values.
43
-13-
Strengthened linkages among world financial markets affect all
markets and all investors.
Just as U.S. markets are influenced by devel-
opments in markets abroad, foreign markets are influenced by events here.
These channels of influence do not depend on whether a country is
experiencing a deficit or a surplus in its current account.
In today's
financial markets, the net flows associated with current account surpluses and deficits ace only the tip of the iceberg.
What are more
important are the huge stocks of financial claims—more than $1.5 trillion held in the United States by foreigners and more than $26 trillion
of dollar-denominated claims on U.S. borrowers held by U.S. residents.
This is in addition to the vast quantities of assets held in foreign
currencies abroad.
It is these holdings that can respond to changes in
actual and expected rates of return.
In recent years we have seen several instances in which rates of
return have changed essentially simultaneously around the world.
For
example, stock prices moved together in October 1987 and 1989, and in
1990 bond yields have risen markedly in many industrial countries.
However, we must be cautious in interpreting such events, and in
drawing implications for the United States.
Frequently, such movements
occur in response to a common worldwide influence.
Currently, the world
economy is adjusting to the implications of changes in Eastern Europe,
where there are tremendous new opportunities to invest and promote
reconstruction and growth.
Those opportunities, while contributing to
the increase in interest rates in the United States, also open up new
markets fox our exports.
44
-14Moreover, despite globalization, financial markets do not
necessarily move together—they also respond to more localized influences.
Over 1989, for example, bond yields in West Germany and Japan
rose about a percentage point, while those in the United States fell by a
similar amount.
The contrast between 1989 and 1990 illustrates the com-
plexity of relationships among financial markets.
Interactions can show
through in movements in exchange rates as well as interest rates, and
changes in the relative prices of assets depend on a variety of factors,
including economic developments and inflation expectations in various
countries as well as monetary and fiscal policies here and abroad.
The importance of foreign economic policies for domestic economic conditions has given rise in recent years to a formalized process
of policy coordination among the major industrial countries.
The purpose
of such coordination is to help policymakers achieve better performance
in their national economies.
It begins with improved communication among
authorities about economic developments within each country.
It includes
systematic analysis of the likely impact of these developments on the
economies of the partner countries and on variables such as exchange
rates that are inherently jointly determined in international markets.
Within such a framework, it is possible to consider alternative choices
for economic policies and to account explicitly for the impacts of likely
policy measures in one country on the other economies.
The influence of economic policies abroad and other foreign
developments on the U.S. economy is profound, and the Federal Reserve
must carefully take them into account when considering its monetary
45
-15policy.
But these influences do not fundamentally constrain oui ability
to meet out most important monetary policy objectives.
Developments
within U.S. financial markets remain the strongest influence on the asset
prices and interest rates determined by those markets and, through them,
on the U.S. economy.
Exchange rates absorb much of the impact of devel-
opments in foreign asset markets, permitting U.S. interest rates to
reflect prijnarily domestic economic conditions.
Exchange rates influence
the prices of products that do, or can, enter into international trade.
Such factors can bring about changes in the composition of production
between purely domestic goods and services and those entering international trade, and they can affect aggregate price movements for a time,
However, the overall pace of spending and output in the United
States depends on the demands upon all sectors of the U.S. economy taken
together.
And our inflation rate, over time, depends on the strength of
those demands relative to our ability to supply them out of domestic
production.
Because the Federal Reserve is able to affect short-term
interest rates in D.S. financial markets, it is able to influence the
pace of economic activity in the short-run and inflationary pressures
longec-term-
To be sure, monetary policy must currently balance more
factors than in previous decades.
But our goals are still achievable.
Monetary policy is only one tool, however, and it cannot be used
successfully to meet multiple objectives.
The Federal Reserve, for
example, can address itself to either domestic prices or exchange rates
but cannot be expected to achieve objectives for both simultaneouslyMonetary policy alone ia not readily capable of addressing today's large
46
-16current account deficit, which is symptomatic of underlying imbalances
among saving, spending, and production within the O.S, economy.
Con-
tinned progress in reducing the federal deficit is a more appropriate
instrument to raise domestic saving and free additional resources for
productive investment.
The long-term health of our economy requires the
balanced use of monetary and fiscal policy in order to reach all of the
nation's policy objectives.
47
For use at 10:00 a.m., E.S.T.
Tuesday
February 20,1990
Board of Governors of the Federal Reserve System
"
Monetary Policy Report to Congress
Pursuant to the
Full Employment and Balanced Growth Act of 1978
February 20, 1990
48
Letter of Transmittal
BOARD OF GOVERNORS OF THE
FEDERAL RESERVE SYSTEM
Washington, D.C., February 20, 1990
THE PRESIDENT OF THE SENATE
THE SPEAKER OF THE HOUSE OF REPRESENTATIVES,
The Board ol Governors Is pleased to submit Its Monelary Policy Report to the Congress pursuant to the
Full Employment and Balanced Growth Act of 1978.
Sincerely,
Alan Greenspan, Chairman
49
Table of Contents
Page
Section 1:
Monetary Policy and the Economic Outlook for 1990
I
Section 2:
The Performance of Die Economy in 1989
4
Section 3:
Monetary and Financial Developments During 1989
50
Section 1: Monetary Policy and the Economic Outlook for 1990
The U.S. economy recorded its seventh consecutive
year of expansion in 1989, Although growth was
slower than in the preceding two years, it was sufficient
to support the creation of 2'/4 million jobs and to hold
the unemployment rate steady at 5W percent, the
lowest reading since the early 1970s. On the external
front, the trade and current account deficits shrank
further in 1989. And while inflation remained undesirably high, the pace was less than many analysts-and,
indeed, most members of the Federal Open Market
Committee (FOMC}—had predicted, owing in part to
the continuing diminution in longer-range inflation
expectations.
In 1989, monetary policy was tailored to the changing contours of the economic expansion and the potential for inflation. Early in the year, as for most of 1988,
the Federal Reserve tightened money market conditions in order to prevent pressures on wages and prices
from building. Market rates of interesi rose relative to
those on deposit accounts, and unexpectedly large tax
payments in April and May drained liquid balances,
restraining the growth of the monetary aggregates in
the first half of the year. By May, M2 and M3 lay below
the lower hounds of the annual target ranges established by the FOMC.
Around midyear, risks of an acceleration in inflation
were perceived to have diminished as pressures on
industrial capacity had moderated, commodity prices
hat! leveled out, and (he dollar had strengthened on
exchange markets, reinforcing the signals conveyed by
the weakness in the monetary aggregates. In June, the
FOMC began a series of steps, undertaken with care to
avoid excessive inflationary stimulus, that trimmed
1 lh percentage points from short-term interest rates by
year-end. Longer-term interest rates moved down by a
like amount, influenced by both the System's easing
and a reduction in inflation expectations.
Growth of M2 rebounded to end the year at about the
midpoint of the 1989 target range. Growth of M3,
however, remained around the lower end of its range,
as a contraction of the thrift industry, encouraged by
the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (FIRREA), reduced needs to
lap M3 sources of funds. The primary effect of the
shrinkage of the thrift industry's assets was a rechanneling of funds in mortgage markets, rather than a
reduction in overall credit availability; growth of the
nonfinancial sector debt aggregate monitored by the
FOMC was jusi a bit slower in the second half than in
the first, and this measure ended the year only a little
below the midpoint of its range.
Thus far this year, the overnight rate on federal
funds has held at %Vt percent, but other market rates
have risen. Increases of as much as Vi percentage point
have been recorded at the longer end of the maturity
specirum. The bond markets responded to indicators
suggesting a somewhat greater-than-anticipated buoyancy in economic activity — which may have both
raised expected real returns on investment and renewed some apprehensions about the outlook for inflation. The rise in yields occurred in the context of a
genera) runup in international capital market yields,
which appears to have been in part a response to
emerging opportunities associated with the opening of
Eastern Europe; this development had particularly
notable effecls on the exchange value of the West
German mark, which rose considerably relative to the
dollar, the yen, and other non-EMS currencies.
Monetary Policy tor 1990
The Federal Open Market Committee is committed
to the achievement, over time, of price siability. The
importance of this objective derives from the fact that
the prospects for long-run growth in the economy are
brightest when inflation need no longer be a material
consideration in the decisions of households and firms.
The members recognize that certain short-term factors—notably a sharp increase in food and energy
prices - are likely to boost inflation early this year, but
anticipate that these factors will not persist. Under
these circumstances, policy can support further economic expansion without abandoning Ihe goal of price
stability.
To foster the achievement of those objectives, the
Committee has selected a target range of 3 to 7 percem
for M2 growth in 1990. Growth in M2 may be more
rapid in 1990 than in recent years, and yet be consistent
with some moderation in the rate of increase in nominal
income and restraint on prices; in particular, M2 may
grow more rapidly than nominal GNPin the first part of
this year in lagged response to last year's interest rate
movements. Eventually, however, slower M2 growth
will be required to achieve and maintain price stability.
The Committee reduced the M3 range to 2 W to 6%
percent to take account of the effects of the restructuring of the thrift industry, which is expected to continue
in 1990. A smaller proportion of mortgages is likely to
be held at depository institutions and financed by
51
Ranges of Growth for Monetary and Credit Aggregates
1988
1989
1990
M2
4 to 8
3to7
3107
M3
4 to 8
Debt
7to11
Percent change,
fourth quarter to fourth quarter
elements in M3; thrift institution assets should continue to decline, as some solvent thrifts will be under
pressure to meet capital standards and insolvent thrifts
will continue to be shrunk and closed, with a portion of
their assets carried, temporarily, by the government.
While some of the assets shed by thrifts are expected to
be acquired by commercial banks, overall growth in
the asset portfolios of banks is expected to be moderate, as these institutions exercise caution in extending
credit. An increase in lender-and borrower— caution
more generally points to some slowing in the pace at
which nonfinancial sectors take on debt relative to their
income in 1990. In particular, recent developments
suggest that leveraged buyouts and other transactions
that substitute debt for equity in corporaie capital
structures will be noticeably less important in 1990
than in recent years. Moreover, a further decline in the
federal sector's deficit is expected to reduce credit
growth this year. In light of these considerations, the
Committee reduced the monitoring range for debt of
the nonfinancial sectors to 5 to 9 percent.
The setting of targets for money growth in 1990 is
made more difficult by uncertainty aboui developments
affecting thrift institutions. The behavior of M3 and, to
a more limited extent, M2 is likely to be affected by
such developments, but there is only limited basis in
experience to gauge the likely impact. In addition, in
interpreting the growth of nonfinancial debi, the Committee will have to take into account the amount of
Treasury borrowing (recorded as part of the debt
aggregate) used to carry the assets of failed thrift
institutions, pending their disposal. With these questions adding to the usual uncertainties about the relationship among movements in the aggregates and
output and prices, the Committee agreed that, in
implementing policy, they would need to continue to
consider, in addition to the behavior of money, indicators of inflationary pressures and economic growth, as
2</z to 614
6Vjto10Va
5to9
well as developments in financial and foreign exchange
markets.
Economic Projections for 1990
The Committee members, and other Reserve Bank
presidents, expect that growth in the real economy will
be moderate during 1990. Most project real GNP
growth over the four quarters of the year to be between
1 X and 2 percent—essentially the same increase as in
1989, excluding the bounceback in farm output after
the 1988 drought. It is expected that this pace of
expansion will be reflected in some easing of pressures
on domestic resources; the central tendency of forecasts is for an unemployment rate of5Vi to534 percent
in the fourth quarter.
Certain factors have caused an uptick in inflation
early this year. Most notably, prices for food and
energy increased sharply as the year began, reflecting
the impact of the unusually cold weather in December,
However, these run-ups should be largely reversed in
coming months, and inflation in food and energy prices
for the year as a whole may not differ much from
increases in other prices.
Given their importance in determining the trend of
overall costs, a deceleration in the cost of labor inputs
is an integral part of any solid progress toward price
stability. Nominal wages and total compensation have
grown relatively rapidly during the past two years,
while increases in labor productivity have diminished.
With prices being constrained by domestic and international competition, especially in goods markets, profit
margins have been squeezed to low levels. A restoration of more normal margins ultimately will be necessary if businesses are to have the wherewithal and
incentive to maintain and improve the stock of plant
and equipment,
Unfortunately, the near-term prospects for amoderation in labor cost pressures are not favorable. Com-
52
Economic Projections for 1990
1989 Actual
FOHC Members and
Other FRB Presidents
Range
Administration
Central
Tendency
Percent change,
fourth quarter to fourth quarter
Nominal GNP
Real GNP
Consumer price index
6.4
2.4
4,5
4lo7
1 to 2V4
3Va to 5
5Va to 6Vz
13/4 lo a
4 to 4Va
7.0
2.6
4.11
Average level in the
fourth quarter, percent
Unemployment rate
5.3
5Vz to 6V2
51/z to 53A
5.4 a
1. CPKW.FOMCforeCBslsareforCPMJ.
2. Percent at total labor (orce. including armed forces resting in the United States.
pensation growth is being boosted in the first half of
1990 by an increase in social security taxes and a hike
in the minimum wage. The anticipated easing of pressures in the labor market should help produce some
moderation in the pace of wage increases in the second
half of 1990, but the Committee will continue to
monitor closely the growth of labor costs for signs of
progress in this area.
Finally, the recent depreciation of the dollar likely
will constitute another impetus to near-term price
increases, reversing the restraining influence exerted
by a strong dollar through most of last year. Prices of
imported goods, excluding oil, increased in the fourth
quarter after declining through the first three quarters
of 1989. The full effect of this upturn likely will not be
felt on the domestic price level until some additional
time has passed.
Despite these adverse elements in the near-term
picture, the Committee believes lhat progress toward
price stability can be achieved over time, given the
apparently moderate pace of activity. In terms of the
consumer price index, most members expect an increase of between 4 and 4V4 percent, compared with
the 4.5 percent advance recorded in 1989.
Relative lo the Committee, the Administration currently is forecasting more rapid growth in real and
nominal GNP. At the same time, the Administration's
projection for consumer price inflation is at the low end
of the Committee's central tendency range. In its
Annual Report, the Council of Economic Advisers
argues thai, if nominal GNP were to grow at a 7 percent
annual rale this year-as the Council is projectingthen M2 could exceed its target range, particularly if
interest rates fall as projected in the Administration
forecast. As suggested above, monetary relationships
cannot be predicted with absolute precision, but the
Council's assessment is reasonable. And, although
most Committee members believe that growth in
nominal GNP more likely will be between 5'/4 and
6 Vi percent, a more rapid expansion in nominal income
would be welcome if i) promised to be accompanied by
a declining path for inflation in 1990 and beyond.
53
Section 2: The Performance of the Economy in 1989
Real GNP grew 2 lfi percent over the four quarters of
1989, 2 percent after adjustment for the recovery in
farm output from the drought losses of the prior year.
This constituted a significant downshifting in the pace
of expansion from the unsustainably rapid rates of
1981 and 1988, which had carried activity to the point
lhat inflationary strains were beginning to become
visible in the economy. As the year progressed, clear
signs emerged that pressures on resource utilization
were easing, particularly in the industrial sector. Nonetheless, the overall unemployment rate remained at
5.3 percent, the lowest reading since 1973, and inflation remained at 4 '/4 percent despite the restraining influence of a dollar Ihat was strong for most of the year.
The deceleration in business activity last year reflecled, to some degree, the monetary tightening from
early 1988 through early 1989 that was undertaken
with a view toward damping the inflation forces. Partly
as a consequence of that lightening, the U.S. dollar
appreciated in the foreign exchange markets from early
1988 through mid-1989, contributing to a slackening
of foreign demand for U.S. products. At the same time,
domestic demand also slowed, more for goods than for
services. Reflecting these developments, the slowdown in activity was concentrated in the manufacturing
sector; Factory employment, which increased a total of
90,000 over the first three months of 1989, declined
195,000 over the remainder of the year, and growth in
manufacturing production slowed from 5Vi percent in
1988 to only 134 percent last year. Employment in
manufacturing fell further in January of this year, but
that decline was largely attributable to temporary
layoffs in the automobile industry and most of the
affected workers have since been recalled.
As noted above, the rate of inflation was about the
same in 1989 as it had been in the preceding two years.
While the appreciation of the U.S. dollar through the
first half of the year helped io hold down the prices of
imported goods, the high level of resource utilization
continued to exert pressure on wages and prices. In thai
regard, the moderation in the expansion of real aclivity
during 1989 was a necessary development in establishing an economic environment more conducive to
progress over time toward price stability.
The Household Sector
Household spending softened significantly in 1989,
with a marked weakening in the demand for motor
vehicles and housing. Real consumer spending on
goods and services increased 2 !4 percent over the four
quaners of 1989, IVi percentage points less than in
1988, Growth in real disposable income slowed last
year, but continued to outstrip growth in spending,
and, as a result, the personal saving rate increased to
5% percent in the fourth quarter of 1989.
The slackening in consumer demand was concentrated in spending on goods. Real spending on durable
goods was about unchanged from the fourth quarter of
1988 to the four* quarter of 1989-after jumping
8 percent in the prior year—chiefly reflecting a slump
in purchases of motor vehicles. Spending on nondurable goods also decelerated, increasing only Vi percent
in 1989after a 2 percent advance in 1988. Trie principal
support to consumer spending came from continued
large gains in outlays for services. Spending on medical care moved up 7'A percent in real terms last year,
and now constitutes 11 percent of total consumption
expenditures—up from 8 percent in 1970. Outlays for
other services rose 3 W percent, with sizable increases
in a number of categories.
Sales of cars and light trucks fell % million units in
1989, to 14V4 million. Most of the decline reflected
reduced sales of cars produced by U.S.-owned automakers; a decline in sales of imported automobiles was
about offset by an increase in sales of foreign nameplates produced in U.S. plants. The slowing in motor
vehicle sales was most pronounced during the fourth
quarter of 1989, reflecting a "payback" for sales that
had been advanced into the third quarter and a relatively large increase in sticker prices on !9<9Q-model
cars. Although part of this increase reflected the inclusion of additional equipment—notably the addition of
passive restraint systems to many models -consumers
nevertheless reacted adversely to the overall increase
in prices. Beyond these influences, longer-run factors
appear to have been damping demand for autos and
light trucks during 1989; in particular, the robust pace
of sales earlier in ihe expansion seems to have satisfied
demand pent up during the recessionary period of the
early 1980s. The rebuilding of the motor vehicle slock
suggests that future sales are likely to depend more
heavily on replacement needs.
Residential investment fell in real terms through the
first three quaners of 1989, and with only a slight
upturn in the fourth quarter, expenditures decreaseri
6 percent on net over the year. Construction was
weighed down throughout 1989 by the overbuilding
that occurred in some locales earlier in the decade.
Vacancy rates were especially high for multifamily
54
Real GNP
Percent change, Q4 to 04
D rought-Adjusted
1984
1985
1966
1987
1988
Industrial Production
1989
Index, 1977- JOO
160
Jan.
140
120
100
1984
1985
1986
1987
Implicit Deflator for GNP
1964
1935
1988
1989
Percent change, Q4 to Q4
1986
1987
1988
1989
55
Real Income and Consumption
Percent change, Q4 to Q4
glpReal Disposable Personal Income
f [ Real Personal Consumption Expenditures
1984
1985
1986
1987
Personal Saving
1984
1989
Percent of disposable income
1985
Private Housing Starts
1988
1986
1987
1988
1989
Annual fate, millions of units, quarterly average
2.4
1.6
0.8
1984
1985
1986
1987
1966
1989
56
rental and condominium units. In the single-family
sector, affordability problems constrained demand,
dramatically so in those areas in which home prices had
soared relative to household income.
Mortgage interest rates declined more than a percentage point, on net, between ihe spring of 1989 and the
end of the year, helping 10 arrest the contraction in
housing activity; however, the response to the easing in
rates appears to have been muted somewhat by a
reduction in the availability of construction credit,
likely reflecting, in part, the lightening of regulatory
standards in the thrift industry and the closing of a
number of insolvent institutions. Exceptionally cold
weather also hampered building late in the year, but a
sharp December drop in housing starts was followed
by a record jump inactivity last month.
The Business Sector
Business fixed investment, adjusted for inflation,
increased only 1 percent at an annual rate during the
second half of 1989 after surging 1\ percent during
the first half. Although competitive pressures forced
many firms to continue seeking efficiency gains through
capital investment, the deceleration in overall economic growth made the need for capacity expansion
less urgent, and shrinking profits reduced the availability of internal finance.
Spending on equipment moved up briskly during the
first half of 1989, with particularly notable gains in
outlays for information processing equipment—computers, photocopiers, telecommunications device;,, and
the like. However, equipment outlays were flat in the
second half of the year; growth in the information
processing category slowed sharply, and spending in
most other categories was either flat or down. Purchases of motor vehicles dropped sharply in the fourth
quarter from the elevated levels of the second and third
quarters. There were a few exceptions to the general
pattern of weakness during the second half- Spending
on aircraft was greater in the second half of 1989 than
in the first half, and would have increased still more
had it not been for the strike at Boeing. Outlays for
tractors and agricultural machinery moved up smartly;
spending on farm equipment has been buoyed by the
substantial improvements over the past several years in
the financial health of the agricultural sector. Over the
four quarters of 1989, ratal spending on equipment
increased 6 percent in real terms - about 1 percentage
point below the robust pace of 1988.
Business spending for new construction edged down
A percent in real terms during 1989-the second
consecutive yearly decline. Commercial construction.
L
which includes office buildings, was especially weak;
vacancy rates for office space remain at high levels in
many areas, lowering prospective returns on new
investment. Outlays for drilling and mining, which had
dropped 20 percent over the four quarters of 1988,
moved down further in the first quarter of 1989; later in
the year, drilling activity revived as crude oil prices
firmed. The industrial sector was the most notable
exception to the overall pattern of weakness: Real
outlays increased 11 percent in 1989, largely owing to
construction that had been planned in 1987 and 1988
when capacity in many basic industries tightened substantially and profitability was improving sharply.
As noted above, the slowdown in investment spending during the second half of last year likely was
exacerbated by the deterioration in corporate cash
flow. Before-tax operating profits of nonfmandal corporations dropped 12 percent from the fourth quarter
of 1988 to the third quarter of 1989 (latest data
available); after-tax profits were off in about the same
proportion. Reflecting the increased pressures from
labor and materials costs—arid a highly competitive
domestic and international environment—pre-tax domestic profits of nonfinancial corporations as a share of
gross domestic product declined to an average level of
8 percent during the first three quarters of 1989, the
lowest reading since 1982. At the same time, taxes as a
share of pre-tax operating profits increased to an
estimated 44 percent in the first three quarters of 1989;
since 1985. this figure has retraced a bit more than half
of its decline from 54 percent in 1980.
N'onfarm business inventory investment averaged
S21 billion in 1989. Although the average pace of
accumulation last year was slower than in 1988. the
pattern across sectors was somewhat uneven. Some
of the buildup in stocks took place in industries — such
as aircraft-whcre orders and shipments have been
strong for some time now. But inventories in some
other sectors became uncomfortably heavy at times
and precipitated adjustments in orders and production. The clearest area of inventory imbalance at the
end of the year was at auto dealers, where stocks of
domestically produced automobiles were at 1.7 million units in December—almost three months' supply
at the sluggish fourth-quarter sales pace. In response,
the domestic automakers implemented a new round of
sales incentives and cut sharply the planned assembly
rate for the first quarter of 1990. Elsewhere in the
retail sector, inventories moved up substantially relative to sales at general merchandise outlets. Overall,
however, most sectors of the economy have adjusted
fairly promptly to the deceleration in sales, and
57
Real Business Rxed Investment
Percent change, O4 to Q4
40
^|j Structures
reproducers' Durable Equipment
20
1984
1985
1966
1987
20
1988
1989
Changes in Real Business Inventories
Annual rate, billions of 1982 dollars
90
Total Norriarm
45
1984
1985
1986
1987
1968
After-tax Profit Share oi Gross Domestic Product'
1989
Percent
Nonfinancial Corporations
1984
1985
1986
1987
1988
Ratio o( profits tram domestic operations with inventory valuation and
capilaf consumption adjustments to gross domestic product o( nonfinancial
corporal^ sector.
1989
45
58
appear to have succeeded in preventing serious overhangs from developing.
The Government Sector
Budgetary pressures continued to restrain the growth
of purchases at all levels of government. At die federal
level, purchases fell 3 percent in real terms over [he
four quartersof 1989, lower defense purchases accounting for the bulk of the decline. Nondefense purchases
also declined in real terms from the fourth quarter of
1988 to the fourth quarter of 1989; increases in such
areas as the space program and drug interdiction were
more than offset by general budgetary restraint that
imposed real declines on most other discretionary
programs.
In terms of [he unified budget, the federal deficit in
fiscal year 1989 was $152 billion, slightly smaller than
in 1988. Growth in total federal outlays, which includes transfer payments and interest costs as well as
purchases of goods and services, picked up a bit in
fiscal year 1989. Outlays were boosted at the end of the
fiscal year by the initial $9 billion of spending by (he
Resolution Trust Corporation. On the revenue side of
the ledger, growth in federal receipts aho increased in
fiscal 1989. The acceleration occurred in the individual
income tax category, but strong increases also were
recorded in corporate and social security tax payments.
Purchases of goods and services al the stateand local
level increased 2 Vi percent in real terms over the four
quarters of 1989, down more lhan a percentage point
from the average pace of the preceding five years.
Nonetheless, (here were some areas of growth. Spending for educational buildings increased, and employment in the state and local sector rose 350.000 over the
year, largely driven by a pickup in hiring by schools.
Despite the overall slowdown in the growth of purchases, the budgetary position of the state and local
sector deteriorated further over the year; the annualized deficit of operating and capital accounts, which
excludes social insurance funds, increased S6 billion
over the firs! three quarters of 1989 and appears to have
worsened further in ihc fourth quarter.
The External Sector
The U.S. external deficits improved somewhat in
1989, but not by as much as in 1988, On a bafance-ofpaymenls basis, the deficit on merchandise trade fell
from an annual rate of S128 billion in the fourth quarter
of 1988 (and $127 billion for the year as a whole) to
$114 billion in the first quarter of 1989. Thereafter,
there was no further net improvement. The appreciation in the foreign exchange value of the dollar between
early 1988 and mid-1989 appears 10 have played an
important role in inhibiting farther progress on the
trade front. During the first three quarters of 1989, the
current account, excluding the influence of capital
gains and losses thai are largely caused by currency
fluctuations, showed a deficit of $106 billion at an
annual rate-somewhat below the $124 billion deficit
in the comparable period of 1988.
Measured in (erms of the other Group of Ten
currencies, the foreign exchange value of the U.S.
dollar ift December 198(J was about 3 percent above its
leve] in December 1988, but the dollar has moved
lower thus far in 1990, In real terms, the net apprecialion of the dollar during 1989 in terms of the other G-10
currencies was about 5 percent, as consumer prices
rose somewhat faster here than abroad, on average.
Over the year, the dollar moved lower on balance
against the currencies of South Korea, Singapore, and
especially Taiwan. From a longer perspective, the
modest uptrend on balance in the dollar over the past
two years marked a sharp departure from the substantial weakening seen during ihe 1985-1987 period.
The behavior of the dollar differed greatly between
the two halves of 1989, In the first half, the dollar
appreciated 12 percent in terms of (he other G-10
currencies, while depreciating against the currencies,
of South Korea and Taiwan. The dollar fluctuated
during the summer, and later in the year unwound most
of the prior appreciation, as U.S. interest rates eased
relative to rates abroad and in response to concerted
intervention in exchange markets in the weeks immediately after the September meeting of Group of Seven
officials and to events in Eastern Europe. In the second
half of ihe year, the dollar rose against the currencies of
South Korea and Taiwan while depreciating in terms of
the Singapore dollar. Over the course of J9S9, the
dollar appreciated nearly 16 percent again.si the Japanese yen and 14 percent against ihe Briij.sh pound, but it
depreciated slightly against the German mark, the
Canadian dollar, and most other major currencies.
On a GNP basis, merchandise exports increased
about 11 percent in real terrm over !he four quarters of
1989 —roughly 4 percentage poims less than in 1988.
This deceleration took place despite continued strong
growth in economic activity in most foreign industrial
countries (wiih the exception of Canada and the United
Kingdom), and appears to have reflected, in large part,
ihe effect on U.S. competitiveness of the dollar's
appreciation and more rapid U.S. inflation over (988
and much of 1989. Exports were also depressed in the
fourth quartet of 1989 by a number of special factors
including the Boeing strike. The volumeof agricultural
exports increased about II percent in 1989-abit faster
59
Foreign Exchange Value of the U.S. Dollar *
Index, March 1973.100
170
150
130
110
90
70
1984
1985
1986
U.S. Real Merchandise Trade
1987
1988
1989
Annual rate, billions of 1982 dollars
600
EDO
Imports
/
400
300
Exports
200
100
1984
1985
1986
1987
U.S. Current Account
1988
1989
Annual rate, billions of dollars
50
50
100
150
200
1984
1985
1986
1987
1988
Index of weighted average foreign exchange value ol U.S. dollar in letms
ol cutiendes ol Die oilier G-10 countries. Weights are 1972-76 global
trade of each of the 10 countnes
' Average ot first three quarters of 1989, at an annual rale.
1989
60
even than the robust pace of 1988. The value of
agricultural exports rose much less, however, as agricultural export prices reversed the drought-induced
increases of the previous year.
Merchandise imports excluding oil expanded about
7 percent in real terms during 1989, with much of the
rise accounted for by imports of computers. Imports of
oil increased 6 percent from the fourth quarter of 1988
to the fourth quarter of 1989, to a rate of 8,3 million
barrels per day. At the same time, the average price per
barrel increased almost 40 percent, and the nation's bill
for foreign oil jumped 45 percent.
The counterpart of the current account deficit of
$106 billion at an annual rate over the first three
quarters of 1989 was a recorded net capital inflow of
about $60 billion at an annual rate and an unusually
large statistical discrepancy, especially in the second
quarter. More than half of the recorded net inflow of
capital reflected transactions in securities, as foreign private holdings of U.S. securities rose nearly
£50 billion (half of the increase being in holdings of
U.S. Treasury securities), while U.S. holdings of
foreign securities increased a bit less than $20 billion.
Net direct investment accounted for another substantial portion of the inflow; foreign direct investment
holdings in the U.S. rose more than $40 billion, and
U.S. holdings abroad rose only half as much. Over the
first three quarters of 1989, foreign official assets in the
United States increased almost $15 billion, but this
increase was more than offset by the increase in U.S.
official holdings of assets abroad, largely associated
with U.S. intervention operations to resist the dollar's
strength.
Labor Markets
Employment growth slowed in the second half of
1989; nonetheless, nonfarm payrolls increased nearly
2'/i million during the year. The bulk of this expansion
occurred in the service-producing sector. By contrast,
the manufacturing sector shed 100,000 jobs. These job
losses were more than accounted for by declines in the
durable goods industries, and appeared to reflect the
slump in auto sales, the weakening in capital spending,
and the effecis of a stronger dollar on exports and
imports.
Despite the slowdown in new job creation, the
overall balance of supply and demand in the labor
market remained steady over the year. The civilian
unemployment rate, which had declined about K percentage point over the twelvemonths of 1988, finished
1989 at 5.3 percent—unchanged from twelve months
earlier. Moreover, there was no increase in the number
of "discouraged" workers-those who say they would
re-enter the labor force if they thought they could find a
job. Nor was there any net increase in workers who
accepted part-time employment when they would have
preferred full-time. The proportion of the civilian
population with jobs reached an historic high.
Reflecting the tightness of labor markets and the
persistence of inflation expectations in the 4 to 5 percent range, according to surveys, the employment cost
index for wages and salaries in nonfarm private industry increased 4M perceniover the 12 months of 1989about the same as in 1988. Benefit costs continued to
rise more rapidly than wages and salaries last year,
with health insurance costs remaining a major factor;
nonetheless, the rate of growth in overall benefit costs
slowed in 1989, in part because of a smaller increase in
social security taxes than in J988. Total compensation-including both wages and salaries and benefits—
rose434 percent during 1989. Compensation growth in
the service-producing sector—at 5 percent—continued
to outpace the gain in the goods-producing sector by
about ^4 percentage point.
A slowdown in the growth of productivity often
accompanies a softening in the general economy, and
productivity gains were lackluster in 1989. Output per
hour in the private nonfarm business sector increased
only 'A percent over the four quarters of the year—
1 percentage point below the rate of increase in 1988.
In the manufacturing sector, productivity gains during
the first half of 1989 kepi pace with the 1988 average of
3 percent; in the second half, however, productivity
growth slowed to an annual rate of 2 'A percent,
Reflecting both the persistent growth in hourly compensation and the disappointing developments in productivity, unit labor costs in private nonfarm industry
rose 5 percent over the four quarters of 1989-the
largest increase since 1982.
Price Developments
Inflation in consumer prices remained in the neighborhood of 4'^ percent for the third year in a row, as
the level of economic activity was strong and continued
to exert pressures on available resources. During the
first half of the year, overall inflation was boosted by a
sharp runup in energy prices and a cany-over from
1988 of drought-related increases in food prices. However, inflation in food prices slowed during the second
half, and energy prices retraced about a third of the
earlier run-up. Prices for imported goods excluding oil
were little changed over 1989, on net, and acted as a
moderating influence on consumer price inflation.
61
Nonfarm Payroll Employment
Net change, millions ol persona, O4 lo O4
|^j Man irfactu ring
1984
1965
1986
1987
Civilian Unemployment Rate
19S4
1985
1988
1989
Quarterly average, percent
1986
1987
Employment Cost Index *
1988
1989
12-month percent change
Total Compensation
1984.
1985
1986
1987
1968
' Employment Cost Index for privaia industry. «xdudtng (arm and household
workers.
1989
62
GNP Fixed-weight Prices
1984
1985
Percent change, Q4 to Q4
1986
1987
Producer Prices for Finished Goods
1984
1985
1988
1989
Percent change, Q4 to Q4
1986
1987
1988
1989
Consumer Prices*
Percent change, Q4 to CM
1984
1985
1986
1987
' Consumer Price Index for all urban consumers.
1988
1989
63
Food prices increased 5 V4 percent at the retail level,
slightly more than in 1988 when a number of crops
were severely damaged by drought. Continued supply
problems in some agricultural markets in 1989—notably a poor wheat crop and a shortfall in dairy production - likely prevented adeceleration from the droughtinduced, rate of increase in 1988. At the same time,
increases in demand, including sharp increases in
exports of some commodities, also appear to have
played a role. Still another impetus to inflation in the
food area last year evidently came from [he continuing
rise in processing and marketing costs.
Consumer energy prices surged 17 percent at an
annual rate during the first six months of 1989, before
dropping back 6 percent in the second half. During the
first half of the year, retail energy prices were driven up
by increases in the cost of crude oil. The increase in
gasoline prices at mid-year was exaggerated by the
introduction of tighter standards governing the composition of gasoline during summer months. Gasoline
prices eased considerably in the second half, reflecting
a dip in crude oil prices and the expiration of the
summer-time standards. Taking the twelve months of
1989 as a whole, the increase in retail energy prices
came to a bit more than 5 percent. Heating oil prices
jumped sharply at the turnof the year, reflecting a surge
in demand caused by December's unusually cold
weather. The spike in hearing fuel prices largely reversed itself in spot markets during January of this
year, but crude oil prices remained at high levels.
Consumer price increases for items other than food
and energy remained at about 4Vj percent in 1989,
Developments in this category likely would have been
less favorable had the dollar not been appreciating in
foreign exchange markets through the first half of
1989. The prices of consumer commodities excluding
food and energy decelerated sharply, and this slowdown was particularly marked for some categories
where import penetration is high, including apparel
and recreational equipment. Given the dollar's more
recent depreciation, however, the moderating effect of
import prices on overall inflation may be diminishing.
Indeed, prices for imported goods excluding oil turned
up in the fourth quarter of 1989, after declining earlier
in the year. In contrast to goods prices, the prices of
nonenergy services—which make up half of the overall
consumer price index—increased 5 'A percent in 1989.
W percentage point more than in 1988. The pickup in
this category was led by rents, medical services, and
entertainment services.
At the producer level, prices of finished goods
increased 7 lfi percent at an annual rate during the first
half-almost twice the pace of 1988- before slowing
to a 2 'A percent annual rate of increase over the second,
half. In large part, developments in this sector reflected
the same sharp swings in energy prices that affected
consumer prices. At earlier stages of processing, the
index for intermediate materials excluding food and
energy decelerated sharply during the first half of the
year, and then edged down in the second half. For the
year as a whole, this index registered a net increase of
only 1 percent, compared with more than 7 percent in
1988. The sharp deceleration in this category appears
to have reflected a relaxation of earlier pressures on
capacity in the primary processing industries, and the
influence of the rising dollar through the first half of
last year. Also consistent with the weakening in the
manufacturing sector and the strength of the dollar, the
index for crude nonfood materials excluding energy
declined 3% percent over the year, and spot prices for
industrial metals moved sharply lower during the year,
owing in part to large declines for steel scrap, copper,
and aluminum.
64
Consumer Food Prices *
1934
1935
Pares rtt change, Q4 to 04
1986
1987
Consumer Energy Prices *
1988
1989
Percent change, Q4 to 04
IS
15
I
I
1964
1985
1936
1937
Consumer Prices Excluding Food and Energy *
1988
1989
Percent change, Q4 to Q4
|j;p) Services Less Energy
^J Commodities Less Food and Energy
1984
1
1985
1986
Consumer Price Indax foi all urban consumer.
1987
1988
1939
65
Section 3: Monetary and Financial Developments During 1989
In 1989, the Federal Reserve continued to pursue a
policy aimed at containing and ultimately eliminating
inflation while providing support for continued economic expansion. In implementing that policy, the
Federal Open Market Committee maintained a flexible
approach to monetary targeting, with policy responding to emerging conditions in Hie economy and financial markets, as well as to the growth of the monetary
aggregates relative to their established target ranges.
This flexibility has been necessitated by the substantial
variability in the short-run relationship between ihe
monetary aggregates and economic performance; however, when viewed over a longer perspective, those
aggregates are still useful in conveying information
about price developments.
As the year began, monetary policy was following
through on a set of measured steps begun a year earlier
to check inflationary pressures. By then, however,
evidence of a slackening in aggregate demand, along
with sluggish growth of the monetary aggregates,
suggested that the year-long rise in short-term interest
rates was noticeably restraining the potential for more
inflation. But, after a 'A percentage point increase in
the discount rate at the end of February, the Federal
Reserve took no further policy action until June. Over
the balance of 1989, the Federal Reserve moved
toward an easing of money market conditions, as
indications mounted of slack in demand and lessened
inflation pressures. The easing in reserve availability induced declines in short-term interest rates of
IVi percentage points; money growth strengthened
appreciably, and M2 was near the middle of its target
range by the end of 1989. The level of M3, on the other
hand, remained around the lower bound of its range,
with its weakness mostly reflecting the shifting pattern
of financial intermediation as the thrift industry retrenched. The growth of nonfinancial debt was trimmed
to 8 percent in 1989, about in line with the slowing in
the growth of nominal GNP, and ended the year at the
midpoint of its monitoring range.
Implementation of Monetary Policy
In the opening months of the year, the Federal Open
Market Committee excended the move toward restraint
that had begun almost a year earlier, seeking to counter
a disquieting intensification of inflationary pressures.
Policy actions in January and February, restraining
reserve availability and raising the discount rate,
prompted a further H percentage point increase in
short-term market interest rates. Longer-term rates,
however, moved up only moderately; the tightening
apparently had been widely anticipated and was viewed
as helping to avoid an escalation in underlying inflation. Real short-term interest rates—nominal rates
adjusted for expected price inflation-likely moved
higher, though remaining below peak levels earlier in
the expansion; these gains contributed to a strengthening of the foreign exchange value of the dollar over this
period, while the growth of the monetary aggregates
slowed as the additional pol icy restraint reinforced the
effects of actions in 1988.
As evidence on prospective trends in inflation and
spending became more mixed in the second quarter,
theCommittee refrained from further tightening and in
June began to ease pressures on reserve markets. As
the information on the real economy, along with the
continued rise in the dollar, suggested that the outlook
for inflation was improving, mos! long-term nominal
interest rates fell as much as 3 percentage point from
their March peaks; the yield on the bellwether thirtyyear Treasury bond moved down to about 8 percent by
the end of June. The decline in interest rates outstripped ihe reduction in most measures of investors'
inflation expectations, so that estimaied real interest
rates fell from their levels of earlier in the year. These
declines in nominal and real interest rates, however,
were not accompanied by declines in the foreign
exchange valueof the dollar. Rather, because of betlerthan-expected trade reports and political turmoil
abroad, the dollar strengthened further.
In July, when the FOMC met for its semiannual
review of the growth ranges for money and credit, M2
andM3 lay at or a bit below the lower bounds of their
target cones. This weakness, reinforcing the signals
from prices and activity, contributed lo the Committee's decision to take additional easing action in reserve
markets. The Committee reaffirmed Ihe existing annual target ranges for the monetary and debt aggregates
and tentatively retained those ranges for the next year,
since they were likely to encompass money growth that
would foster hjrther economic expansion and moderation of price pressures in 1990.
Late in the summer, longer-term interest rates turned
higher, as several economic data releases suggested
reinvigorated inflationary pressures. With growth in
the monetary aggregates rebounding, the Committee
kept reserve conditions about unchanged until the
direction of the economy and prices clarified.
Beginning in October, amid indications of added
risks of a weakening in the economic expansion, the
66
Short-Term Interest Rates
Percent
18
Monthly
16
14
12
10
Three-month Treasury bill
Coupon equivalent
1982
1983
1984
1985
1966
1987
1988
Long-Term Interest Rates
1989
Percent
Monthly
18
16
14
12
Thirty-year Treasury bond
1982
1983
1984
Observations are monlhly averages of daily data;
laal observation for January 1990.
1985
ID
1986
1987
1988
1989
67
FOMC reduced pressures on reserve markets in ihree
separate steps, which nudged the federal funds
rate down to around 814 percent by year-end, about
1 'A percenfage points below its level when incremental
tightening ceased m February. Over those ten months,
other short- and long-term nominal interest rates fell
about 1 to 1W percentage points; and most major stock
price indexes reached record highs at the turn of the
year, more than recovering the losses that occurred on
October 13. Reflecting some reduction in inflation
anticipations over the same period, estimated shortand long-term real interest rates fell somewhat less
than nominal rates, dropping probably about Vi to
M percentage point. Still, most measures of short-and
long-term real interest rates remained well above their
trough levels of 1986 and 1987-leveU that had preceded rapid growth in the economy and a buildup of
inflationary pressures.
Over the last three months of the year and into
January 1990, the foreign exchange value of the dollar
declined substantially from its high, which was reached
around midyear and largely sustained through September, The dollar fell amid concerted intervention undertaken by the G-7 countries in the weeks immediately
after a meeting of the finance ministers and central
bank governors of these countries in September. The
dollar continued to decline in response to the easing of
short-term interest races on dollar assets and increases
in rates in Japan and Germany. The German currency
rate rose particularly sharply as developments in Eastera Europe were viewed as favorable for the West
German economy, attracting global capital flows. Rising interest rales in Germany likely contributed to an
increase in bond yields in the United States early in
1990, even as U.S. short-term rates remained essentially unchanged. More important, however, for the
rise in nominal, and likely real, long-term rates in the
United States were incoming data pointing away from
recession in the economy and from any abatement in
price pressures, especially as oil prices moved sharply
higher.
Behavior of Money and Credit
Growth in M2 was uneven over 1989, with marked
weakness in the firsl part of the year giving way 10
robust growth thereafter. On balance over the year, M2
expanded 4& percent, down from 5 W percent growth
in 1988, placing it about at the midpoint of its 1989
target range of 3 to 7 percent. The slower rate of
increase in M2 reflected some moderation in nominal
income growth as well as the pattern of interest rates
and associated opportunity costs of holding money,
with the efFectsof increases in 1988 and 1989 outweighing the later, smaller, drop in rates.
M2 has grown relatively slowly over the past three
years, as the Federal Reserve has sought to ensure
progress over time toward price stability. There appears to be a fairly reliable long-term link between M2
and future changes in inflation. One method of specifying lhat link is to estimate the equilibrium level of
prices implied by the current level of M2, assuming
mat real GNP is at its potential and velocity is at its
long-run average, and compare that to actual prices.
The historical record suggests that inflation tends to
rise when actual prices are below the equilibrium level
and to moderate when equilibrium prices are below
actual. At the end of 1986, the equilibrium level of
prices was well above the actual level, reinforcing the
view that the risks weighed on the side of an increase in
inflation; at the end of 1989, that equilibrium price had
moved into approximate equality with the actual price
level, indicating that basic inflation pressures had
steadied.
In 1989, compositional shifts within M2 reflected
the pattern of interest rates, the unexpected volume of
lax payments in the spring, and the flow of funds out of
thrift deposits and into other instruments. Early in the
year, rising market interest rates buoyed the growth of
small-denomination time deposits at the expense of
more liquid deposits, as rates on the latter accounts
adjusted only sluggishly to the upward market movements. The unexpectedly large tax payments in April
and May contributed to the weakness in liquid instruments, as those balances also were drawn down to meet
tax obligations. As market interest rates fell, the
relative rate advantage reversed in favor of liquid
instruments and the growth in liquid deposits rebounded, boosted as well by the replenishment of
accounts drained by tax payments.
The MI component of M2 was especially affected by
the swings in interest rates and opportunity costs last
year, and in addition was buffeted by the effects of
outsized tax payments in April. After its 4U percent
rise in 1988, Ml grew only "A percent in 1989, with
much of the weakness in this transactions aggregate
occurring early in the year. By May, Ml had declined
at about a 2V4 percent annual rate from its fourthquarter 1988 level, reflecting a lagged response to
earlier increases in short-term interest rates and an
extraordinary bulgeinnet individual tax remittances lo
the Treasury. From May 10 December, Ml rebounded
at a 4 percent rate as the cumulating effects of falling
interest rates and post-tax-payment rebuilding boosted
demands for this aggregate. Ml velocity continued the
upward trend that resumed in 1987, increasing in the
68
M2 and M3: Target Ranges and Actual Growth
M2
Billions of doHars
3350
Rate of growth
3250
t988:4to1989:4
4.6 percent
3150
3%
3050
2950
I
O
I
L
N
D
J
I
I
F
M
A
M
J
1988
J
A
8
I
O
1
N
2850
D
1989
M3
Billions of dollars
4250
7.5%
4150
4050
3.5%
3950
3850
3750
J
O
I
N
1
D
J
1988
F
M
A
I
M
L
J
1989
I
J
1
A
I
S
I
O
L
N
3650
D
Rate of growth
1988:4 to 1989:4
3.3 percent
69
Inflation Indicator Based on M2
Ratio scale
Long-run equilibrium price level /f
given current M2 (P*) , - ;
1960
1966
1972
— 50
1978
1984
The current price level (P, the solid line) is the Implicit GNP deflator, which Is set to 100
In 1982.
The long-run equilibrium price level given current M2 (P*, the dashed line) is calculated
as P* - JM2 • V*)/Q*, where V* is an estimate of the long-run value of the GNP velocity of
M2—the mean of V2 from 1955:1 to 1988:1—and Q* Is a Federal Reserve Board staff
measure of potential real GNP.
The vertical lines mark the quarters when the difference between the current price level
(P) and the long-run equilibrium price level (P*) switches sign, and thus when inflation, with
a lag, tends to begin accelerating or decelerating.
For more details, see Jeffrey J. Hallman, Richard D. Porter, and David H. Small, M2 per
Unit of Potential GNP as an Anchor for the Price Level, Staff Studies 157 (Board of Governors of the Federal Reserve System. 1989).
70
first three quarters before turning down in the fourth
quarter of 1989.
The shift of deposits from thrift institutions to commercial banks and money fund shares owed, in part, to
regulatory pressures that brought down rates paid by
some excessively aggressive thrifts. Beginning in
August, the newly-created Resolution Trust Corporation (RTC) targeted some of its funds to pay down
high-cost deposits at intervened thrifts and began a
program of closing insolvent thrifts and selling their
deposits lo other institutions - for the most part, banks.
On balance, the weak growth of retail deposits at thrifts
appears to have been about offset by the shift jnto
commercial banks and money market mutual funds,
leaving M2 little affected overall by the realignment of
the thrift industry.
M3 was largely driven, as usual, by the funding
needs of banks and thrifts; under the special circumstances of ihe restructuring of the thrift industry, it was
a less reliable barometer of monetary policy pressures
than is normally the case. After expanding 6 lk percent
in 19S8, M3 bugged the lower bound of its 3l/i to
7 J /4 percent larger cone in 1989, closing the year about
3W percent above its fourth quaner-1988 base. In
1989, bank credit growth about matched the previous
year's 7 li percent increase, but credit at thrift institutions is estimated to have contracted a bit on balance
over the year, in contrast to its 6W percent growth in
1988. This weakness in thrift credit directly owed to
asset shrinkage at SAIF-insured savings and loan institutions; credit unions and mutual savings banks expanded their balance sheets in 1989. In addition, funds
paid out by the RTC to thrift institutions and to banks
acquiring thrift deposits directly substituted for other
sources of funds. As a result, thrifts lessened their
reliance on managed liabilities, as evidenced by the
14% percent decline over (he year in the sum of large
time deposits and RPs at thrifts. Institution-only money
market mutual funds were bolstered by a relative yield
advantage, as fund returns lagged behind declining
market interest rates in the second half of the year;
these funds provided the major source of growth for the
non-M2 component of M3_ On balance, the effects of
the thrift restructuring dominated the movements in
M3, and the rebound in M2 in the second half of the
year did not show through to this broader aggregate.
As a consequence, the velocity of M3 increased 3
percent in 1989, 1 'A percentage points faster than the
growth in M2 velocity, and its largest annual increase
in twenty years.
Many of the assets shed by thrifts were mortgages
and mortgage-backed securities, but this appears to
have had little sustained effect on home mortgage cost
and availability. The spread between the rate on primary fixed-rate mortgages and the rate on ten-year
Treasury notes rose somewhat early in the year, but
thereafter remained relatively stable. The share of
mortgages held in securitized form again climbed in
1989, facilitating the tapping of a base of investors.
Diversified lenders, acting in part through other intermediaries, such as federally-sponsored agencies,
mostly filled the gap left by the thrifts. However, some
shrinkage of credit available for acquisition, development, and construction appeared to follow from
FIRREA-imposed limits on loans by thrifts to single
borrowers, though the reduction in funds available for
ihese purposes probably also reflected problems in
some residential real estate markets.
Aggregate debt of the domestic nonfinancial sectors
grew at a fairly steady pace over 1989, averaging
8 percent, which placed it near the midpoint of its
monitoring range of 6'^ 10 ID1/; percent. Although the
annual growth of debt slowed in 1989, as it had during the preceding two years, it still exceeded the
6'/2 percent growth of nominal GNP. Federal sector
debt grew 7 ft percent, about!/; percentage point below
the 1988 increase—and the lowest rate of expansion in
a decade—as the deficit leveled off. Debt growth
outside the federal sector eased by more to average
S'-i percent, mostly because of a decline in the growth
of household debt. Mortgage credit slowed in line with
the reduced pace of housing activity, and consumer
credit growth, though volatile from month to month,
trended down through much of the year. The growth of
nonfinancial business debt slipped further below the
extremely rapid rates of the mid-1980s. Corporate
restructuring continued to be a major factor buoying
business borrowing, although such activity showed
distinct signs of slowing late in the year as lenders
became more cautious and the use of debt to require
equity ebbed.
The second half of 1989 was marked by the troubling
deterioration in indicators of financial stress among
certain classes of borrowers, with implications for the
profitability of lenders, including commercial banks.
In the third quarter, several measures of loan delinquency rates either rose sharply or continued on an
uptrend. Delinquency rates on closed-end consumer
loans at commercial banks and auto loans at "captive"
auto finance companies were close to historically high
levels. At commercial banks as a whole in 1989, both
delinquency and charge-off rates for real estate loans
were little changed from the previous year. Still,
problem real estate loans continued to be a drag on the
profitability of banks in Texas, Oklahoma, and Louisiana; in the second half, such loans emerged asa serious
71
Debt: Monitoring Range and Actual Growth
Debt
Billions of dollars
Rate of growth
10.5%
9950
1988:4 to 1989:4
8.1 percent
9650
6.5%
9350
9050
J
O
N
D
J
F
M
A
M
1988
J
J
A
S
O
I
N
8750
D
1969
M1: Actual Growth
Mi
Billions of dollars
840
Rate of growth
1988;4 to 1989:4
0.6 percent
760
I
O
N
I
D
1988
I
J
720
F
M
A
M
J
1989
J
A
S
O
N
D
72
Share of Residential Mortgage Debt Held as Securities
Percent
35
Quarterly through 1989:3
30
25
20
15
1980
1981
1982
1983
19B4
1985
1986
1987
1988
Rate Spread Between Primary Home Mortgages
and Ten-year Treasury Bonds
1389
Percent
Monthly
1980
1981
1982
1963
1984
1965
1986
1987
1988
1989
10
73
problem for banks in New England-On the other hand,
smaller, agriculturally oriented banks continued lo
recover from the distressed conditions of the mid1980s. Since 1987, agricultural banks have charged off
loans at well below the national rate, and their nonperforming assets represented a smaller portion of (heir
loans than that for the country as a whole.
The upswing in the profitability of insured commercial banks that began in 1988 only extended through the
first half of 1989. A slowing ii\ the buildup of loan-loss
provisions, along with improvemenls in interest-rate
margins, contributed to these gains, with the money
center banks showing the sharpest turnaround. Information for the second half of 1989, although still
incomplete, clearly points to an erosion of these profit
gains, in part, because of problems in the quality of
loans. Several money center banks sharply boosted
their loss provisions on loans to developing countries,
while evidence of rising delinquency rates on real
estate and consumer loans suggested more widespread
weakening. Despite these developments, the spread of
rates on bank liabilities, certificates of deposit and
Eurodollar deposits, over comparable Treasury bill
rates narrowed earlv in 1990.
74
Growth of Money and Debt (Percent Change)
M1
M2
M3
Debt ol
domestic
nortfinancla)
sectors
Fourth quarter to fourth quarter
1980
7.4
8.9
1981
5,4 (2.5)*
9.3
1982
8.8
9.1
9.5
12.3
9,9
9.8
9.5
10.2
9.1
11.1
1983
10.4
12,2
1984
5.4
7.9
1985
12.0
8.9
7.8
13.1
1986
15.5
9.3
9.1
13.2
10.6
14.2
1987
6.3
4.3
5.8
9.9
1988
4.3
5.2
6.3
9.2
1989
0,6
4.6
3.3
8.1
Q1
-0.1
2,3
3.9
8.4
Q2
-4.4
1.6
3.3
7.9
Quarterly growth rates
(annual rates)
1989
Q3
1.8
6.9
3.9
7.2
Q4
5.1
7.1
2.0
8.0
in parentheses is adjusted for enitts to NOW accounts in 1981.
75
Velocity of Money and Debt
(Quarterly)
M1
M2
Ratio scale
Ratio scale
7.5
1.4
1.2
4.5
0.8
1961
1968
1975
1982
M3
1989
1961
1968
1975
1982
Debt
Ratio scale
1989
Ratio scale
2
1
1.8
0,9
1.6
0.8
1.4
0.7
1.2
0.6
0.5
O.S
1961
1988
1975
1932
1989
0.4
1961
1968
1975
1932
1989
76
RECORD, QF_POLj;_CX. ACTIOHS _0g THE
OPEH- M&BKET _CCMJITTEE
_
1.
oft_Fgbruary 6-7,_ 1990
Ppmest ic_pjalicy^ directive
The information reviewed at this meeting suggested continued
but sluggish expansion in overall economic activity, with conditions
uneven across sectors.
Industrial activity remained weak, partly
because of the depressing effects of an inventory correction on
manufacturing output, while the service-producing sector of the economy
continued to grow moderately.
Aggregate price measures had increased
more slowly over most of the second half of 1989, but unusually cold
weather in December put temporary upward pressure on food and energy
prices. The latest data on labor compensation suggested no significant
change in prevailing trends.
Total nonfarm payroll employment increased substantially in
January aftet growing at a reduced pace on average in previous months.
Employment surged in the service-producing sector, and unusually warm
weather brought a rebound in hiring in the construction industry.
These
increases more than offset a large decline in factory jobs associated
with sizable short-term layoffs in the motor vehicle and related
industries. The civilian unemployment rate remained at the 5.3 percent
level that had prevailed over moat of 1969.
Partial data for January indicated that industrial production
fell sharply.
Automobile producers cut back temporarily on assemblies
to help reduce bulging inventories of unsold vehicles, and the January
thaw in the weather apparently brought a reduction in the generation of
77
electricity that more than reversed a December surge-
Abstracting from
a number of transitory factors affecting production in recent months,
industrial activity had changed little since the third quarter, although
recent orders data suggested some underlying support for manufacturing
output over the near term.
Total industrial capacity utilization
remained at a relatively high level in the fourth quarter but was down
somewhat from its level a year earlier.
Adjusted for inflation, consumer spending was little changed in
the fourth quarter.
Strong gains in spending for services offset
declines in purchases of consumer goods, especially new cars and light
trucks.
Although some of the strength in the services category
reflected temporarily high energy-related expenditures, spending for
medical and transportation services apparently remained strong
throughout the fourth quarter.
Near the end of the year, consumers
responded positively to incentive programs introduced by automakers to
reduce bloated inventories, and higher sales of domestically produced
cars carried over to January.
Residential construction in the fourth
quarter was little changed from its third-quarter
level, partly because
December's unusually cold weather depressed single-family housing starts
in that month.
Multifamily starts remained at a low level as vacancy
rates for such units moved still higher.
Business capital spending, adjusted for inflation, declined in
the fourth quarter because of strike activity in the aircraft industry
and sharply lower outlays for motor vehicles.
Spending for equipment
other than motor vehicles and aircraft rose; sizable increases were
registered for computers and communications equipment, and moderate
78
gains were evident for a wide variety of heavy machinery.
A pickup
toward the end of 1989 in new orders for equipment other than aircraft,
and the return to work of striking aircraft workers, pointed to some
improvement in equipment spending in the current quarter.
Hon-
cesidential construction activity apparently weakened a little in the
fourth quarter, partly reflecting the persisting high vacancy rates for
office and other commercial space.
Manufacturers' inventories fell in
December after moderate increases in the two previous months; for the
fourth quarter as a whole, increases in factory stocks were well below
those for previous quarters in 1989.
By contrast, nonauto retail
stockbuilding accelerated late in the year, and there were reports that
inventory-sales ratios at general merchandisers were higher than
desired.
The nominal U.S. merchandise trade deficit rose slightly in
November from a revised October level.
For the two months together, the
deficit was up substantially from the averages for both the third
quarter and the first nine months of 1989.
Total exports for the two-
month period were little changed from their third-quarter level as a
reduction in exports of aircraft, resulting from strike activity, offset
moderate increases in a broad array of other products.
Total imports
increased rapidly in October-November, with imports of capital goods
being especially strong.
Indicators of economic activity in major
foreign industrial countries were mixed during the fourth quarter of
1989.
Growth continued strong in Japan, and most indicators pointed to
79
-4-
renewed strength for Germany/ Italy, and France.
By contrast, growth
was sluggish in the United Kingdom and Canada.
Producer prices for finished goods jumped in December, largely
reflecting higher prices for energy products, most notably for heating
oil.
Abstracting from food and energy items, producer prices rose
faster in December than in November, but the rate of increase in the
fourth quarter as a whole remained at the reduced third-quarter pace.
At the consumer level, prices rose somewhat more rapidly toward the end
o£ 1989, and food and energy prices apparently increased substantially
further in January.
Among nonfood, non-energy categories, discounting
o£ apparel and home furnishings was more than offset by a sharp rise in
prices of new cars and by another month of sizable price increases for
services.
At its meeting on December 18-19, 1989, the Committee adopted a
directive that called for a slight easing in the degree of pressure on
reserve positions but that provided for giving equal weight to subsequent developments that might require some easing or tightening during
the intermeeting period.
Accordingly, the Committee agreed that
slightly greater or slightly lesser reserve restraint would be
acceptable during the intermeeting period, depending on progress toward
price stability, the strength of the business expansion, the behavior of
the monetary aggregates, and developments in foreign exchange and
domestic financial markets.
The contemplated reserve conditions were
expected to be consistent with growth of M2 and M3 over the four-month
period from November 1989 to March 1990 at annual rates of about 8-1/2
percent and 5-1/2 percent respectively.
80
Immediately after the Committee meeting, open market operations
were directed toward implementing the slight easing in the degree of
pressure on reserve positions called for by the Committee.
Reserve
conditions then remained essentially unchanged over the rest of the
intermeeting period.
Adjustment plus seasonal borrowing averaged a
little more than $300 million for the intermeeting period; the volume
was boosted by reserve shortfalls, borrowing by large banks over the
long holiday weekends, and, in the latter part of the interval,
borrowing by a sizabie bank whose normal access to liquidity had been
impaired.
The federal funds rate declined from about 8-1/2 percent at
the time of tha December meeting to around 8-1/4 percent shortly
thereafter; except for some firming in the last week of 1989 owing to
reserve shortfalls and year-end pressures, the funds rate remained in
the vicinity of that lower level.
Other private short-term market rates
also declined over the period, including a 1/2 percentage point drop in
the prime rate to 10 percent, while Treasury bill rates increased
somewhat.
Yields on intermediate- and long-term debt instruments rose
considerably over the intermeeting period.
Some stronger-than-
anticipated economic data and rising food and energy prices were
interpreted in the financial markets as pointing away from recession and
as suggesting little if any moderation in underlying inflation trends.
Increases in interest rates abroad probably also had an influence on
U.S. interest rates.
Stock prices approached new highs at the start of
the year but have fallen substantially since then.
81
In foreign exchange markets, the trade-weighted value of the
dollar in terms of the other G-10 currencies declined further over the
intermeeting period, as monetary conditions abroad tightened somewhat on
average while those in the United States eased slightly.
The dollar's
movements against individual currencies were mixed; most of its
depreciation occurred against the German mark, which continued to be
buoyed by developments in Eastern Europe, and against related European
currencies. On net, the U.S. dollar remained relatively firm against
the yen and the Canadian dollar; the latter declined sharply as Canadian
short-term interest rates edged lower amid signs of slow growth in the
Canadian economy and a consequent easing of inflation pressures.
Growth of M2, measured on a benchmarked and seasonally revised
basis, remained relatively strong in the fourth quarter of 1989; for the
year, this aggregate expanded at a rate a little below the middle of the
Committee's annual range.
Partly as a result of further contraction in
the assets and associated funding needs of thrift institutions, M3 grew
more slowly in the fourth quarter and, for the year, expanded at a rate
just below the lower bound of its annual range.
In January, both of the
broader aggregates increased at slower rates, A sharp drop in transactions deposits damped expansion of M2, even though retail-type savings
deposits remained strong and money market funds evidently benefited from
funds flowing out of weakening stock and bond markets. Growth of M3
in January slowed by less than that of M2.
The staff projection prepared for this meeting suggested that
the economy was likely to expand relatively slowly over the next several
quarters.
In the near term, production adjustments to eliminate excess
82
inventories, most notably in the motor vehicles industry, were expected
to depress manufacturing activity and overall growth; some pickup in the
expansion was anticipated after the inventory correction was completed,
but final gales were projected to continue growing at a relatively
sluggish pace.
Homebuilding might rebound somewhat in the near term
after being disrupted by December's cold weather, but prevailing
interest rates and possible cutbacks in construction lending by thrifts
likely would restrain residential construction activity throughout the
year.
The projection assumed that fiacal policy would be moderately
restrictive and that net exports would make little contribution to
growth of domestic production in 1990.
The expansion of consumer demand
would be damped by slow gains in employment and associated limited
growth in real disposable incomes.
With pressures on labor and other
production resources expected to ease only gradually, little improvement
was anticipated in the underlying trend of inflation over the next
several quarters.
In their discussion of the economic situation and outlook, the
Committee members generally agreed that continuing growth in economic
activity remained a reasonable expectation for the year ahead.
Several
observed that, on the whole, recent indicators of business conditions
provided some assurance that the expansion was no longer weakening and
indeed that a modest acceleration might be under way from the considerably reduced growth experienced in the fourth quarter.
The members
acknowledged that there were considerable risks, stemming mainly from
the financial side, of a weaker than projected expaneion, and some did
not rule out the possibility of a downturn.
In the latter connection,
83
several commented that they had observed a sense of unease and fragility
in the business and financial communities arising from such factors as
declining profit margins/ heavy debt burdens, and problems in certain
sectors of the financial markets that were contributing to greater
caution on the part of lenders and a reduced availability of credit to
some borrowers.
With regard to the outlook for inflation, members
remained generally optimistic that moderating pressures on labor and
other resources would lead in time to a lower rate of inflation.
However, most members saw little prospect that significant progress, if
any, would be made in reducing the underlying rate of inflation in the
quarters immediately ahead.
Indeed, in part because of temporary
pressures in the food and energy sectors, key measures of inflation
might well register larger increases in the near term before turning
down later.
In keeping with the usual practice at meetings when the
Committee establishes its longer-run ranges for growth of the monetary
and debt aggregates, the members of the Committee and the Federal
Reserve Bank presidents not currently serving as members had prepared
projections of economic activity, the rate of unemployment, and
inflation for the year 1990.
In making these forecasts, the members
took account of the Committee's policy of continuing restraint on demand
to resist any increase in inflation pressures and to foster price
stability over time.
For the period from the fourth quarter of 1989 to
the fourth quarter of 1990, the forecasts for growth of real GRP had a
central tendency of 1-3/4 to 2 percent, a pace close to that experienced
in 1989 excluding the direct effects of the rebound in farm output after
84
-9-
the drought in 1988.
Estimates of the civilian rate of unemployment in
the fourth quarter of 1990 were concentrated in a range of 5-1/2 to
5-3/4 percent.
The associated pressures on prices resulted in projected
increases in the consumer price index centered on rates of 4 to 4-1/2
percent for the year, compared with a rise of 4-1/2 percent in 1989.
Forecasts for growth of nominal GNP had a central tendency of 5-1/2 to
6-1/2 percent.
The forecasts assumed that changes in the foreign
exchange value of the dollar would not be of sufficient magnitude to
have a significant effect on the economy or prices during 1990.
In the Committee's discussion of developments bearing on the
economic outlook, the members emphasized that despite indications of
continuing growth in overall business activity, there were obvious areas
of weakness in the economy, notably in manufacturing across much of the
nation and in construction in many localities.
Business sentiment
appeared to have deteriorated in some areas, perhaps more than was
justified by actual developments.
While local business conditions were
clearly uneven, business activity was generally characterized as growing
on an overall basis in the various regions, including recent evidence of
a modest pickup in some previously depressed parts of the country.
With regard to individual sectors of the economy, the outlook
for retail sales was clouded to some extent by the uncertain prospects
for motor vehicles and the financial problems being experienced by some
major retailers; nonetheless, in the context of expected further gains
in disposable incomes, many members expected overall consumer spending
to be relatively well maintained.
Business inventories probably were
falling in the current quarter, largely reflecting sharp declines in
85
-10-
stocks of motor vehicles, but once the correction in that industry was
completed, some renewed increases in overall inventory investment were
anticipated in line with expanding sales.
Current indicators suggested
that business fixed investment might be reasonably well maintained, but
it also was noted that overbuilding of commercial real estate in many
areas would restrain overall nonresidential construction and more
generally that depressed profits and cash flows could limit gains in
business investment.
Concerning the outlook for residential con-
struction, conditions in local housing markets varied markedly and the
prospects for the nation were difficult to assess,
Negative develop-
ments included higher mortgage interest rates, a reduced availability of
financing for many developers, and the overhang of large inventories of
housing units held by the Resolution Trust Corporation (RTC1.
Nonetheless, housing demand was holding up in many areas and booming in
a few, and on balance most members expected little change this year in
overall expenditures for residential construction.
A number commented
that the prospects for exports were relatively bright; foreign demand
was reported to be robust for many types of goods, and overall exports
would be given some impetus over time by the depreciation of the dollar
over the past several months.
Turning to the outlook for inflation, members noted that broad
measures of labor compensation did not suggest any lessening of
pressures.
Unit labor costs appeared to be rising at a faster pace
recently than the underlying rate of inflation, squeezing profit
margins.
Commodity prices displayed mixed changes but generally
remained on a high plateau.
Business contacts and broader surveys
86
indicated a widespread expectation that the current rate of inflation
would continue.
Moreover, with higher social security taxes and a
rising minimum wage adding to labor costs and earlier increases in
producer food and energy costs not yet fully transmitted to retail
prices, some measures of inflation were expected to show sharper
increases over the near term.
On the other hand, reports from a number
of business contacts indicated that input prices, especially for raw
materials, had stabilized or declined in recent months.
More generally,
a number of members commented that continued limited growth in business
activity at a time of uncertainties and concerns associated with various
financial problems and declining real estate values in many areas should
contribute to some restraint in overall inflationary behavior.
Against the background of the members' views on the economic
outlook and in keeping with the requirements of the Full Employment and
Balanced Growth Ret of 19T8 (the Humphrey-Hawkins Act), the Committee
reviewed the ranges that it had established on a tentative basis in July
1989 for growth of the monetary and debt aggregates in 1990.
The
tentative ranges, which were unchanged from those for 1989, included
expansion of 3 to 7 percent for M2 and 3-1/2 to 7-1/2 percent for M3,
measured from the fourth quarter of 1989 to the fourth quarter of 1990.
The monitoring range for growth of total domestic nonfinancial debt had
been set at 6-1/2 to 10-1/2 percent, also unchanged from 1989.
With regard to M2, on which much of the discussion was focused,
a majority of the members concluded that retention of the tentative
range of 3 to 7 percent would best assure the flexibility that the
Committee was likely to need to implement its policy objectives during
87
-12-
the year, ft staff analysis prepared for this meeting indicated that,
were interest rates to remain near recent levels, a somewhat higher rate
of M2 growth than had occurred in any of the past three years was likely
to be consistent with some reduction in the expansion of nominal GNP.
According to this analysis, the lagged effects of earlier declines in
market interest rates would continue to boost K2 growth in the first
part of 1990, and the velocity of M2 was likely to fall for the year as
a whole.
To the extent that the projected weakness in H2 velocity
turned out to be correct, it implied M2 growth toward the upper end of
the tentative range on the basis of the central tendency of the members'
forecasts of nominal GNP.
Given this outlook, an unchanged range for M2 still left
considerable leeway for the Committee to embark on a more aggressive
policy to restrain inflation, should developments during the year
suggest an intensification of inflationary pressures or provide an
opportunity to t.ilt the implementation of policy toward greater
restraint and faster progress against inflation without impairing the
lorwaid momentum of the economy.
Thus, although the Committee
recognized that o^er time lower ranges and slower M2 growth would be
compatible with price stability, retention of the current range did rxot
signal a diminished determination to move toward the objective of price
•it abiJit-y.
PrfifertTj'rea for slightly higher or somewhat lower ranges for M2
-iiM.' wE-rf- expressed.
The arguments in favor of a higher range focused
f.n • he •is'.;; of a wcaKci economy than was anticipated curront ly and the
>•' Utlff) •-!(';•! i al jli( y ot iiioie maiifuvei ing room for an easing of short-run
88
-13-
policy if such were needed to help avert a cumulative deterioration in
economic activity.
In those circumstances, faster monetary growth would
not be inconsistent with the Committee's long-term commitment to price
stability.
Other members believed that a somewhat reduced range would
allow adequate growth in M2 to sustain moderate expansion in economic
activity and would provide a desirable signal of the System' s commitment
to an anti-inflationary policy.
In thi? connection, the credibility of
the System's anti-inflationary policy was seen as an important channel
for reducing inflationary expectations directly and thereby lessening
the economic costs and time needed to achieve price stability.
These
members expressed concern that growth around the upper end of a 3 to 7
percent range might well preclude any progress in reducing inflation
this year and might make it more difficult to achieve such progress
later.
For some of these members, however, a 3 to 7 percent range would
be acceptable if its upper limit was viewed as a firm constraint on
actual growth and if a clear explanation was made of the Committee's
commitment to achieve price stability over timeTurning to the ranges for M3 and debt, most of the members
indicated that they favored or could accept reductions from the tentative ranges that had been adopted in July 1989 for this year.
Some
reduction in the range for M3 was thought to be consistent with an
unchanged range for M2 for technical reasons associated with the
restructuring of the thrift industry and related shrinkage in thrift
institution balance sheets.
Declines in thrift institution assets and
associated funding needs, including liabilities in M3, now seemed likely
to be larger in 1990 than had been anticipated last summer, reflecting
89
-14-
continued efforts of solvent institutions to meet capital standards as
well as the closing of insolvent institutions.
Beyond that, while a
reduction in the M3 range, especially if it was limited, might have
little implication for policy, many members believed that the Committee
should take advantage of every opportunity to reduce its ranges toward
levels that were consistent with price stability.
With regard to the
monitoring range for total domestic nonfinancial debt, the members
expected the expansion of such debt to moderate for a fourth year in
1990, in large measure because of anticipated reductions in debt
creation associated with corporate merger arid acquisition activities but
also because of some probable ebbing in the growth of household debt.
The prospect of slower growth of debt was welcome, given concerns about
strains associated with highly leveraged borrowers and high debt
servicing obligations.
A few members indicated a preference for retaining the somewhat
higher ranges for M3 and debt that had been adopted on a tentative basis
for this year.
In their view, lowering those ranges would tend to send
potentially confusing signals, raising questions as to why the M2 range
was not reduced also.
Also, disparate adjustments in the ranges for the
various aggregates could foster an unwarranted impression of the
precision with which the Committee felt it could evaluate the ranges.
The members generally agreed that setting 1990 target ranges
for M2 and particularly for M3 was rendered more difficult by uncertainty about developments affecting thrift institutions, especially
given the relatively limited basis in past experience for gauging the
likely impact of such developments.
The establishment of an appropriate
90
-15-
range for the growth of nonfinancial debt also was complicated by
uncertainty about the extent to which Treasury borrowing would be used
to carry the assets of failed thrift institutions as opposed to funding
from financial-sector sources through the ETC,
With these questions
adding to the usual uncertainty about the relationship of movements in
the aggregates to broad measures of economic performance, the Committee
decided to retain the 4 percentage point width of the ranges.
It also
agreed that the implementation of policy should continue to take into
account, in addition to monetary growth and its velocity, indications of
inflationary pressures in the economy, the strength of business
activity, and developments in domestic and international financial
markets.
At the conclusion of the Committee's discussion, a majority of
the members indicated that they favored or could accept the M2 range for
1990 that had been established on a tentative basis in July 1989 and
reductions of one percentage point and 1-1/2 percentage points
respectively in the tentative ranges for M3 and nonfinancial debt.
Accordingly, the Committee approved the following paragraph relating to
its 1990 ranges for inclusion in the domestic policy directive:
The Federal Open Market Committee seeks monetary
and financial conditions that will foster price
stability, promote growth in output on a sustainable
basis, and contribute to an improved pattern of
international transactions. In furtherance of these
objectives, the Committee at this meeting established
ranges for growth of M2 and M3 of 3 to 1 percent and
2-1/2 to 6-1/2 percent respectively, measured from the
fourth quarter of 1989 to the fourth quarter of 1990.
The monitoring range for growth of tuLal domestic
nonfinancial debt was set at 5 to 9 percent for the
year. The behavior of the monetary aggregates will
continue to be evaluated in the light of progess
toward price stability, movements in their velocities,
and developments in the economy and financial markets.
91
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Votes for this action: Messrs. Greenspan,
Corrigan, fmgell, Boehne, Boykin, Johnson,
Kelley, and LaHare. Votes against this action:
Mi. Hoskins, Ms. Seger, and Mr, Stern.
Messrs. Hosking and Stetn dissented because they wanted a lower
range for M2,
They were concerned that growth around the upper end of a
3 to 7 percent range would not be compatible with progress in reducing
the rate of inflation this year.
An upper limit of 6 percent would be
preferable and would provide adequate room in their view for policy to
foster sustained economic expansion-
Mr. Hoskins also stressed the
desirability of a predictable and credible monetary policy, which he
believed should include persistent reductions in the ranges to levels
that would be consistent with stable prices.
The favorable effects of
such a policy on inflationary expectations would tend to lessen the
costs and also accelerate the achievement of price stability.
Ms. Seger dissented because she believed that the M2 range
should be raised to at least 3-1/2 to 1-1/2 percent.
In her view the
considerable downside risks to the expansion called for some added room
to accommodate the possible need for a more stimulative policy and
somewhat faster M2 growth than was contemplated by an unchanged range.
In particular, a shortfall in aggregate demands during the first half of
the year might well require some easing of policy aimed at countering
developing weakness in the economy.
In such circumstances, M2 growth
somewhat above 7 percent would not be inconsistent with the Committee's
anti-inflation objective.
She could accept unchanged ranges for growth
of M3 and nonfinancial debt, given the outlook foe somewhat slower
expansion of both aggregates in relation to M2 than the Committee had
anticipated in July 1989.
92
Turning to policy implementation for the intermeeting period
ahead, a majority of the members favored steady reserve conditions.
Given indications of some pickup in activity from the latter part of
1989, such a policy offered the best prospects at this point of
reconciling the Committee's objective of acceptable and sustained
economic growth with that of some reduction over time in inflationary
pressures on labor and other resources,
A tightening of policy might
have some advantages in terms of moderating monetary growth and
improving inflationary expectations/ but in this view such a policy
would incur too much risk of creating financial conditions that could
lead to a weaker economy.
Conversely/ significantly lower interest
rates could have inflationary consequences in an economy that already
was operating at relatively high employment levelsr partly through their
effects on the dollar in the foreign exchange markets.
Conditions in
the economy and in financial markets, both in the United States and
abroad, suggested that monetary policy needed to convey a sense of
stability.
Other members acknowledged that adjustments in monetary policy
needed to be made with a special degree of caution in current circumstances, but on balance they assessed the risks and the related
advantages and disadvantages of a change in policy somewhat differently.
In one view, the risks of a recession argued for a prompt adjustment
toward somewhat less monetary restraint/ especially given the need to
bolster relatively interest-sensitive sectors of the economy such as
housing and motor vehicles.
A differing view focused on the desir-
ability of a somewhat tighter policy at this juncture, particularly in
93
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light o£ the outlook for relatively little progress against inflation as
the business expansion tended to strengthen.
One member gave special
emphasis to the desirability of limiting M2 growth to a path closer to
the middle of the Conmittee's range for 1990 to help assure that
progress would be made this year in moderating inflationary pressures.
In the Committee's consideration of possible adjustments to the
degree of reserve pressure during the intermeeting period, a majority of
the members supported a directive that did not contain any bias toward
tightening or easing.
They felt that a symmetric instruction was
consistent at this point with their general preference for a stable
policy and that an intermeeting adjustment should be made only in the
event of particularly conclusive economic or financial evidence,
including a substantial deviation in monetary growth from current
expectations.
One member who preferred a slightly tighter policy
indicated that an unchanged policy that was biased toward restraint
would be acceptable.
Members noted that seasonal borrowing was likely to turn up
from its January lows so that some increase in the total of adjustment
plus seasonal borrowing would be associated with a given degree of
reserve restraint and a given federal funds rate.
It was understood
that some increase in the borrowing assumption would be made at the
start of the intermeeting period and that further adjustments might be
made later during the period, subject to the Chairman's review.
In
keeping with the usual practice, persisting borrowings by troubled
depository institutions that had not been classified as extended credit
would be treated as nonborrowed reserves in setting target growth paths
94
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for reserves. More generally, in light of the uncertainties that were
involved, the Manager would continue to exercise flexibility in his
approach to the borrowing assumption.
At the conclusion of the Committee's discussion, a majority of
the members indicated that they favored or could accept a directive that
called for an unchanged degree of pressure on reserve positions. Some
firming or some easing of reserve conditions would be acceptable during
the internetting period depending on progress toward price stability,
the strength of the business expansion, the behavior of the monetary
aggregates, and developments in foreign exchange and domestic financial
markets.
The reserve conditions contemplated by the Committee were
eKpected to be consistent with growth of M2 and M3 at annual rates of
around 7 and 3-1/2 percent respectively over the three-month period from
December to March. The members agreed that the intermeeting range for
the federal funds rate, which provides one mechanism for initiating
consultation of the Committee when its boundaries are persistently
exceeded, should be left unchanged at 6 to 10 percent.
At the conclusion of the Committee's meeting, the following
domestic policy directive was issued to the Federal Reserve Bank of Hew
York:
The information reviewed at this meeting suggests
that economic activity is continuing to expand despite
weakness in the industrial sector. Total nonfarm
payroll employment increased substantially in January
after growing at a reduced pace on average in previous
months,- a surge in the service-producing sector and a
weather-related rebound in construction were only
partly offset by a large decline in the manufacturing
sector. The civilian unemployment rate wag unchanged
at 5.3 percent. Partial data suggest that industrial
production in January was appreciably below its
average in the fourth quarter. Adjusted for
inflation, strong gains in consumer spending on
95
-20services in the fourth quarter offset declines in
consumer purchases of goods, especially motor
vehicles. Unusually cold weather depressed housing
starts appreciably in December, and residential
construction in the fourth quarter was little changed
from its third-quarter level. Business capital
spending, adjusted for inflation, declined in the
fourth quarter as a result of lower expenditures on
motor vehicles and strike activity in the aircraft
industry; spending on other types of capital goods was
strong, however, and new orders for equipment picked
up toward the end of the year. The nominal U.S.
merchandise trade deficit widened in October-November
from the third-quarter rate. Consumer prices had
risen somewhat more rapidly toward the end of 1989,
and prices of food and energy apparently increased
substantially further in January. The latest data on
labor compensation suggest no significant change in
prevailing trends.
Interest rates have risen in intermediate- and
long-term debt markets since the Committee meeting on
December 18-19; in short-term markets, the federal
funds rate has dsclined, and other short-term rates
show mixed changes over the period. In foreign
exchange markets, the trade-weighted value of the
dollar in terms of the other G-10 currencies declined
further over the intermeeting period; most of the
depreciation was against the German mark and related
European currencies, and there was little change
against the yen.
Growth of M2 slowed in January, almost entirely
reflecting a drop in transaction deposits. Growth of
M3 also slowed in January as assets of thrift institutions and their associated funding needs apparently
continued to contract. For the year 1989, M2 expanded
at a rate a little below the middle of the Committee's
annual range, and M3 grew at a rate slightly below the
lower bound of its annual range.
The Federal Open Market Committee seeks monetary
and financial conditions that will foster price
Stability, promote growth in output on a sustainable
basis, and contribute to an improved pattern of international transactions. In furtherance of these
objectives, the Committee at this meeting established
ranges for growth of M2 and M3 of 3 to 7 percent and
2-1/2 to 6-1/2 percent respectively, measured from the
fourth quarter of 1989 to the fourth quarter of 1990.
The monitoring range for growth of total domestic nonfinancial debt was set at 5 to 9 percent for the year.
The behavior of the monetary aggregates will continue
96
-21to be evaluated in the light of progress toward price
level stability, movements in their velocities, and
developments in the economy and financial markets.
In the implementation of policy for the immediate
future, the Committee seeks to maintain the existing
degree of pressure on reserve positions. Taking
account of progress toward price stability, the
strength of the business expansion, the behavior of
the monetary .aggregates, and developments in foreign
exchange and domestic financial markets, slightly
greater reserve restraint or slightly lesser reserve
restraint would be acceptable in the intermeeting
period. The contemplated reserve conditions are
expected to be consistent with growth of M2 and M3
over the period from December through March at annual
rates of about 1 and 3-1/2 percent respectively. The
Chairman may call for Committee consultation if it
appears to the Manager for Domestic Operations that
reserve conditions during the period before the next
meeting are likely to be associated with a federal
funds rate persistently outside a range of 6 to 10
percent.
Votes for the paragraph on short-term
policy implementation: Messrs. Greenspan,
Corrigan, Angel1, Boehne, Johnson, Kelley,
LaWare, and Stern. Votes against this
action: Messrs. Boykin and Hoskins and
Ms. Seger.
While taking account of the various elements of weakness and
fragility in the economy, Mr. Boykin dissented because he preferred a
policy directive tilted toward increased reserve pressures should
economic and financial conditions warrant.
This view was based on his
concerns regarding the lagged effects of policy actions and the risks of
delaying decisions until there was full confirmation of inflationary
pressures.
In this context, Mr. Boykin expressed his preference for
dealing promptly with inflation if the Committee wished to make
progress toward its long-stated goal of lowering the rate of inflation.
Mr. Hoskins dissented because he preferred some firming of
reserve conditions.
He recognized that there was some financial
97
-22-
fragility in the economy, but he believed that underlying inflation
pressures were relatively strong and that the balance of risks pointed
to a need for greater monetary restraint to curb such inflation.
He
emphasized the desirability of tightening monetary policy gradually to
reduce monetary growth to a pace closer to the midpoint of the
Coranittee's range for the year.
Ms. Seger's dissent reflected a preference for some easing of
reserve conditions at this point.
In her view, even a limited decline
in interest rates would provide timely assistance to relatively weak,
interest-sensitive sectors of the economy such as housing and motor
vehicles and would tend to sustain the expansion itself without adding
to inflation risks in the economy.
2. Review of Continuing Authorj^zatj.giis
The Committee followed its customary practice of reviewing all
of its continuing authorizations and directives at this first regular
meeting of the Federal Open Market Committee following the election of
new members from the federal Reserve Banks to serve for the year
beginning January 1, 1990.
The Committee reaffirmed the authorization
for foreign currency operations, the foreign currency directive, and the
procedural instructions with respect to foreign currency operations in
the forms in which they were currently outstanding.
Votes for this action: Messrs. Greenspan,
Corrigan, Angell, Boehne/ Boykin, Hoskins,
Johnson, Kelley, LaHare, Ms. Seger and Mr. Stern.
Votes against this action: Hone.
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3 . Authorization jor jjpmestic ppeji_Markgt_ Operations
On the recommendation o£ the Manager for Domestic Operations,
the Committee amended paragraph 1(a) of the authorization for domestic
open market operations to raise from $6 billion to $8 billion the limit
on intermeeting changes in System account holdings Of U.S. government
and federal agency securities.
The increase was the first permanent
change in the limit- since March 1985 when it was rai?ed from $4 billion
to $6 billion.
The Manager indicated that temporary increases had been
authorized more frequently in recent years and that the existing limit
also was approached more often during intermeeting intervals when no
temporary increase was requested.
A permanent increase to $8 billion
would reduce the number of occasions requiring special Committee action,
while still calling needs for particularly large changes to the
Committee's attention.
The Committee concurred in the Manager's view
that a §2 billion increase would be appropriate.
Accordingly, effective February 6, 1990, paragraph 1 (a) of the
authorization for domestic open market operations was amended to read as
follows:
1, The Federal Open Market Committee authorizes and directs the Federal
Reserve Bank of New York, to the extent necessary to carry out the most
recent domestic policy directive adopted at a meeting of the Committee:
(a) To buy or sell U. S. Government securities, including securities
of the Federal Financing Bank, and securities that are direct obligations of, or fully guaranteed as to principal and interest by, any
agency of the United States in the open market, from or to securities
dealers arid foreign and international accounts maintained at the Federal
Reserve Bank of New York, on a cash, regular, or deferred delivery
basis, for the System Open Market Account at market prices, and, for
such Account, to exchange maturing U. S. Government and Federal agency
securities with the Treasury or the individual agencies or to allow them
to mature without replacement; provided that the aggregate amount of
U. S. Government and Federal agency securities held in such Account
(including forward commitments) at the close of business on the day of a
meeting of the Committee at which action is taken with respect to a
99
-24-
domestic policy directive shall not be increased or decreased by more
than $8.0 billion during the period commencing with the opening of
business on the day following such meeting and ending with the close of
business on the day of the next such meeting;
Votes £or this action: Messrs. Greenspan,
Corrigan, Rngell, Boehne, Boykin, Hoskins,
Johnson, Kelley, LaHare, Ms. Seger and Mr. Stern.
Votes against this action: None.
@FedFRASER