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CONDUCT OF MONETARY POLICY
Report of the Federal Reserve pursuant to the
Full Employment and Balanced Growth Act of 1978,
PJL. 95-523, and
The State of the Economy
HEARING
BEFORE THE
SUBCOMMITTEE ON
ECONOMIC GROWTH AND CREDIT FORMATION
OF THE
COMMITTEE ON BANKING, FINANCE AND
URBAN AFFAIRS
HOUSE OF REPRESENTATIVES
ONE HUNDRED THIRD CONGRESS
SECOND SESSION
FEBRUARY 22, 1994
Printed for the use of the Committee on Banking, Finance and Urban Affairs
Serial No. 103-118
U.S. GOVERNMENT PRINTING OFFICE
76-S94 CC
WASHINGTON : 1994
HOUSE COMMITTEE ON BANKING, FINANCE AND URBAN AFFAIRS
HENRY B. GONZALEZ, Texas, Chairman
JAMES A. LEACH, Iowa
STEPHEN L. NEAL, North Carolina
BILL MCCOLLUM, Florida
JOHN J. LAFALCE, New York
MARGE ROUKEMA, New Jersey
BRUCE F. VENTO, Minnesota
DOUG BEREUTER, Nebraska
CHARLES E. SCHUMER, New York
THOMAS J. RIDGE, Pennsylvania
BARNEY FRANK, Massachusetts
TOBY ROTH, Wisconsin
PAUL E. KANJORSKI, Pennsylvania
ALFRED A. (AL) McCANDLESS, California
JOSEPH P. KENNEDY II, Massachusetts
RICHARD H. BAKER, Louisiana
FLOYD H. FLAKE, New York
JIM NUSSLE, Iowa
KWEISI MFUME, Maryland
CRAIG THOMAS, Wyoming
MAXINE WATERS, California
SAM JOHNSON, Texas
LARRY LAROCCO, Idaho
DEBORAH PRYCE, Ohio
BILL ORTON, Utah
JOHN LINDER, Georgia
JIM BACCHUS, Florida
JOE KNOLLENBERG, Michigan
HERBERT C. KLEIN, New Jersey
RICK LAZIO, New York
CAROLYN B. MALONEY, New York
ROD GRAMS, Minnesota
PETER DEUTSCH, Florida
SPENCER BACKUS, Alabama
LUIS V. GUTIERREZ, Illinois
MIKE HUFFINGTON, California
BOBBY L. RUSH, Illinois
LUCILLE ROYBAL-ALLARD, California
MICHAEL CASTLE, Delaware
THOMAS M. BARRETT, Wisconsin
PETER KING, New York
ELIZABETH FURSE, Oregon
BERNARD SANDERS, Vermont
NYDIA M. VELAZQUEZ, New York
ALBERT R. WYNN, Maryland
CLEO FIELDS, Louisiana
MELVIN WATT, North Carolina
MAURICE HINCHEY, New York
CALVIN M. DOOLEY, California
RON KLINK, Pennsylvania
ERIC FINGERHUT, Ohio
SUBCOMMITTEE ON ECONOMIC GROWTH AND CREDIT FORMATION
PAUL E. KANJORSKI,
STEPHEN L. NEAL, North Carolina
JOHN J. LAFALCE, New York
BILL ORTON, Utah
HERBERT C. KLEIN, New Jersey
NYDIA M. VELAZQUEZ, New York
CALVIN M. DOOLEY, California
RON KLINK, Pennsylvania
ERIC FINGERHUT, Ohio
Pennsylvania, Chairman
THOMAS J. RIDGE, Pennsylvania
BILL McCOLLUM, Florida
TOBY ROTH, Wisconsin
JIM NUSSLE, Iowa
MARGE ROUKEMA, New Jersey
PETER KING, New York
(ID
CONTENTS
Page
Hearing held on:
February 22, 1994
Appendix:
February 22, 1994
1
37
WITNESSES
TUESDAY, FEBRUARY 22, 1994
Greenspan, Hon. Alan, Chairman, Federal Reserve System
APPENDIX
Prepared statements:
Kanjorski, Hon. Paul E
Greenspan, Hon. Alan
38
42
ADDITIONAL MATERIAL SUBMITTED FOR THE RECORD
Greenspan, Hon. Alan:
Board of Governors of the Federal Reserve System "Monetary Policy
Report to the Congress Pursuant to the Full Employment and Balanced
Growth Act of 1978," February 22, 1994
Letter to Congressman John J. LaFalce, dated February 25, 1994, enclosing material recfuested at the hearing
National summary of the January 1994 Senior Loan Officer Opinion
Survey on Bank Lending Practices
Credit Availability for Small Businesses and Small Farms
Letter to Congressman Stephen L. Neal, dated April 1, 1994, enclosing
excerpts from Hon. Greenspan's statement before the Senate Committee on Banking, Housing and Urban Affairs on March 2, 1994
(III)
58
89
90
118
158
THE CONDUCT OF MONETARY POLICY
TUESDAY, FEBRUARY 22, 1994
HOUSE OF REPRESENTATIVES,
SUBCOMMITTEE ON ECONOMIC GROWTH
AND CREDIT FORMATION,
COMMITTEE ON BANKING, FINANCE AND URBAN AFFAIRS,
Washington, DC.
The subcommittee met, pursuant to notice, at 10:03 a.m., in room
2128, Rayburn House Office Building, Hon. Paul E. Kanjorski
[chairman of the subcommittee] presiding.
Present: Chairman Kanjorski, Representatives Neal, LaFalce,
Klein, Dooley, Fingerhut, Roth, and Nussle.
Also present: Representatives Bachus and Thomas.
Chairman KANJORSKI. The subcommittee will come to order.
The subcommittee meets today to receive the semiannual report
of the Federal Reserve System on economic and monetary policy as
mandated under the Full Employment Balanced Growth Act of
1978.
I want to welcome Chairman Greenspan back before the subcommittee today. Since we last met to discuss monetary policy in
July, there have been major developments in our Nation, the economy, and the Federal Reserve and the Federal Open Market
Committee.
Much of the economic news of the last 6 months has been encouraging:
Inflation remains low. In January the Consumer Price Index was
unchanged. In the fourth quarter of 1993 it increased at an annual
rate of only 1.9 percent; and for the last 2 years it has increased
only 3 percent per year, the lowest rate in many years.
Labor costs, which are a major predictor of future inflation, remain stable.
Unemployment continues to decline.
The Gross Domestic Product continues to grow. Gross Domestic
Product grew 2.9 percent in 1993, and preliminary data suggests
it grew between 5.9 percent and 7 percent in the fourth quarter of
1993.
Until the Federal Reserve's action on February 4, interest rates
remained low. At the end of 1993 interest rates for virtually all maturities hovered at or below the rates of 6 months or 1 year earlier.
Bank and thrift profits are up, and the costs of S&L cleanup is
dropping.
And, finally, but no less importantly, the Federal deficit is being
significantly reduced. Passage of President Clinton's Deficit Reduc(l)
tion bill has substantially reduced both current and future Federal
deficits.
While there has been progress on many fronts, areas of concern
remain.
Commercial industrial lending by banks remains stagnant. Even
with orders and new home construction up, total commercial lending by banks remains virtually unchanged.
The California earthquake and unusual snow storms and cold
weather in the East may depress first quarter economic activity.
The Fed increased the Federal funds rate by one-fourth of 1 percent on February 4, triggering an increase in short-term interest
rates and a 96-point drop in the Dow Jones industrial average. The
Dow's drop was the largest 1-day drop in 2 years and was not temporary. More than 2 weeks later, the Dow is still 80 points, or 2
percent, below the level it closed on February 3.
It is clear that stock and bond traders are very unsettled by recent developments. In the words of one news report, "It appears
that, rather than reassuring traders and investors, the Federal Reserve has managed to leave them with a worse case of jitters."
What concerns me most, and what I hope Chairman Greenspan
will explain today, is why did the Fed raise short-term interest
rates when there has been no evidence that inflation is increasing?
In addition to the fact that most recent CPI figures indicate that
inflation is frozen in its tracks, inflation data is no worse today
than it was when Chairman Greenspan last reported to us in July.
In fact, actual inflation performance is at the absolute low end of
the range Chairman Greenspan predicted last July.
Why did the Federal Reserve increase the Federal funds rate
when inflation is at or below the rate you predicted? How are economic conditions today different from last July? And if the inflation
rate was not a problem in 1993, why is it suddenly a problem in
1994 when the basic rate remains unchanged?
Like many Americans, I am concerned that the Federal Reserve's
action may impede or even end our slow economic recovery. I know
that Federal Reserve economists have models which predict the
economic consequences of the Fed's February 4 action. I hope that
Chairman Greenspan will describe for us today what the Fed's
model projects and what he will—and that he will provide a detailed description of that model for the record.
Since the Federal Reserve has tightened monetary policy in the
absence of data suggesting that inflation is increasing, it is incumbent on the Chairman to advise us what types of circumstances in
the future would warrant similar action by the Fed. If inflation remains at the 3 percent level, can we expect the Fed to raise the
Federal funds rate again or take other action to contract the money
supply?
Another area that concerns me is the Federal Open Market Committee's continued inability to meet its projections for M2 and M3
growth. Leaving aside the arguments over whether the Federal
Open Market Committee's targets for M2 and M3 are too high, too
low or too broadly defined, it sounds to me that the FOMC consistently fails in any meaningful way to keep M2 and M3 in the ranges
they predict.
This inability to meaningfully meet broad targets that the Federal Reserve itself selects does not inspire confidence in the Fed.
Chairman Greenspan, why isn't the Fed doing a better job meeting its monetary targets?
If, as Chairman Greenspan has reported to us on several occasions, the Fed has less confidence than in the past in the value of
M2 and M3 as economic indicators, I hope he will also report to us
today what steps the Fed is taking to identify or define an acceptable substitute. We need to know what measuring sticks the Fed
is using so we can evaluate the performance of the economy as well
as the performance of the Fed.
Finally, the Federal Reserve has been very vocal in recent
months in suggesting that it is imperative that the Fed continue
in its role as a regulator of financial institutions and that banks
should be able to choose not only whether they have a Federal or
a State charter but also whether their primary Federal regulator
should be the Federal Reserve or the administration's proposed
Federal Banking Commission.
Some critics have suggested that the three-way regulatory
scheme advocated by the Feds perpetuates unnecessary overlap
and duplication and also makes it easier for financial institutions
to play one regulator off against another. Many of these same critics contend that this least common denominator approach to financial regulation was a major contributor to the S&L crisis.
In what other regulated industry does the regulated entity not
only get to choose between Federal and State regulation but also
gets to choose which Federal regulator they want? What makes
bank regulation so different from securities regulation, food and
drug regulation, and nuclear powerplant regulation? What public
purpose is served by allowing banks to choose that other regulated
industries do not have?
Again, let me welcome you back before the subcommittee, Chairman Greenspan. There are clearly a number of important issues
which we must discuss, and I look forward to hearing your
testimony.
[The prepared statement of Mr. Kanjorski can be found in the
appendix.]
Chairman KANJORSKI. Mr. Roth, do you have an opening statement?
Mr. ROTH. Thank you very much, Mr. Chairman. Because it is
such an important hearing, let me be very brief.
I want to join the chairman and the other members, Chairman
Greenspan, to welcome you before our subcommittee. I think that
when you raised interest rates and the stock market fell 96 points
on that day, I think all of us in Congress realized that you have
more power over the economy than we do. And, of course, that is
of great concern to us.
And what we are basically interested in is what formula did you
use to justify the interest rate increase and are you going to use
that formula again? In other words, what is in store for us down
the road? And what is in store for people who have money in the
market?
The market is, many of us believe, rather high now, and what
kind of assurances can we give people who have money in the mar-
ket? Are interest rates going to stabilize? Are they going to increase? What kind of activity are we going to have?
You covered, and we had hearings on this before, about how the
Fed goes through the process of making decisions. And everything
is clouded. There is a tremendous shroud of secrecy around it. And
we in the Goneness are saying, we have got to have some more assurances. We have got to have some sort of a gauge by which we
can see what is unfolding here.
Now, you covered your justification for raising interest rates on
February 4 in expectations of inflation. Well, what I would like to
know is, what formula was used to arrive at that decision; and,
again, is that formula going to be utilized again?
Many of us feel that you are taking the punchbowl away as the
guests are still taking their coats off. The economy is just coming
out of a slump, and we want a strong economy. We feel that interest rates—raising interest rates is not the route to take. But that
is why your testimony here is so important for us today, so that
you can answer some of the questions that we have and so that we
also have some sort of a gauge for what action will follow
henceforth.
Thank you, Mr. Chairman.
Chairman KANJORSKI. Mr. LaFalce from New York.
Mr. LAFALCE. Thank you very much.
I think the chairman did an excellent job of outlining the primary issues of concern to us, and I anxiously await your testimony
to, in part, respond to those concerns.
Thank you.
Chairman KANJORSKI. Thank you, Mr. LaFalce.
Mr. Bachus.
Mr. BACHUS. Thank you, Mr. Chairman.
Chairman Greenspan, I am interested in why we—why you increased the rates on the Fed funds, but I am also interested in
where you see the long-term trend going. And I plan to ask you
some questions about that.
But two things which have not been mentioned thus far are, as
you know, the Senate this week will consider the balanced budget
amendment. And I want to ask you what you consider the effect
of the deficit, which in 1985, the last time they considered such an
amendment, the deficit stood at $2.1 trillion. Today it is $4.5 trillion. I want to get your views on how you think that deficit affects
the economy.
And, also, there has been a lot of discussion about the trade deficit with Japan. I want to know what our monetary policy in relationship with that deficit is and what effect that deficit has on our
monetary policy.
Chairman KANJORSKI. Thank you, Mr. Bachus.
Mr. Klein of New Jersey.
Mr. KLEIN. Yes, thank you, Mr. Chairman.
Chairman Greenspan, I want to thank you, and I look forward
with great anticipation to your testimony.
While it is quite obvious that the stock market has continued to
go up, I think that there is a great dichotomy between the large
companies of this country, big business and their economic health
as compared with the small- and medium-size companies. I con-
tinue to hear from small- and medium-size businesses the same
concerns and the same anxieties that they have had throughout the
down slump of the last several years. And I share with our chairman the comments that he has raised but, most particularly, the
concern about raising interest rates in light of very, very little inflation and the very strong need for continued credit on the part
of small- and medium-size businesses. And I would particularly
like you to address that concern as well as others in your
testimony.
Thank you very much.
Chairman KANJORSKI. Thank you, Mr. Klein.
Mr. Thomas of Wyoming.
Mr. THOMAS. Thank you, Mr. Chairman. I appreciate being allowed to sit in here. I am not on your subcommittee.
Welcome, sir. All of us are interested, of course, in what you have
to say.
It was interesting that the President reacted, I believe, to the increase by saying short-term interest increases didn't bother him
but long-term ones did. Since February 4, the long-term interest
rate has gone up from 6.2 to 6.6. I understand this to be a substantial increase. Like Mr. Roth, it seems to me that most anyone
ought to be able to take a look at a formula, a sort of a formula,
and get a notion as to what the Fed might be doing in general,
what kinds of factors that you could expect would cause a change.
It would be interesting to have you comment on that.
And I don't know whether you will get into it or not, but the regulatory structure of banking is also a matter of interest, and that
would be interesting to have you comment.
Glad to have you here, sir. Thank you.
Chairman KANJORSKI. Thank you very much, Mr. Thomas.
Mr. Dooley of California.
Mr. DOOLEY. Thank you, Mr. Chairman. I have no statement.
Chairman KANJORSKI. Thank you very much.
Mr. Chairman, we are ready for your statement.
STATEMENT OF HON. ALAN GREENSPAN, CHAIRMAN,
FEDERAL RESERVE SYSTEM
Mr. GREENSPAN. Thank you very much, Mr. Chairman and members of the subcommittee. I am pleased to appear today to present
the Federal Reserve semiannual monetary policy report to the Congress. I would request, Mr. Chairman, that the full report be included for the record, from which I will excerpt.
Chairman KANJORSKI. Without objection, so ordered.
Mr. GREENSPAN. In the 7 months since I gave the previous Humphrey-Hawkins testimony, the performance of the U.S. economy
has improved appreciably. Private-sector spending has surged,
boosted in large part by very favorable financial conditions. With
mortgage rates at the lowest level in a quarter of a century, housing construction soared in the latter part of 1993. Consumer spending, especially on autos and other durables, has exhibited considerable strength. Business fixed investment has maintained its previous rapid growth. Important components of gross domestic
product growth in the second half of last year represented one-time
upward adjustments to the level of activity in certain key sectors,
and, with output in these areas unlikely to continue to climb as
steeply, significant slowing in the rate of growth this year is widely
expected. In addition, the southern California earthquake and severe winter weather may have dulled the force of the favorable
trends in spending in January and February. Nonetheless, as best
we can judge, the economy's forward momentum remains intact.
The strengthening of demand has been accompanied by favorable
developments in labor markets. In the second half of the year, employment continued to post moderate gains, and the unemployment
rate fell further, bringing its decrease over the full year to nearly
1 full percentage point. The unemployment rate in January apparently declined again on both the old and new survey bases.
On the inflation front, the deterioration evident in some indicators in the first half of 1993 proved transitory.
For the year as a
whole, the Consumer Price Index rose 23/4 percent, the smallest increase since the big drop in oil prices in 1986. Broader inflation
measures covering purchases by businesses as well as consumers
rose even less.
While declining oil prices contributed to last year's good readings, inflation measured by the CPI excluding food and energy also
diminished slightly further, to just over a 3 percent rate for the
whole year. In January the CPI remained quite well behaved on
the whole.
Not all signs have been equally favorable, however. For example,
a number of commodity prices have firmed noticeably in recent
months. And indications that such increases may be broadening engendered a backup in long-term interest rates in recent days. In
particular, the Philadelphia Federal Reserve Bank's survey showing a marked increase in prices paid by manufacturers early this
year was taken as evidence of a more general emergence of inflationary pressures.
It is important to note, however, that in the past such price data
have often been an indication more of strength in new orders and
activity than a precursor of rising inflation throughout the economy. In the current period, overall cost and price pressures still appear to remain damped. Wages do not seem to be accelerating despite scattered reports of some skilled worker shortages, and advances in productivity early this year are holding down unit labor
costs. Moreover, while private borrowing has picked up, broad
money—to be sure a highly imperfect indicator of inflation in recent years—has continued to grow slowly.
Nonetheless, markets appear to be concerned that a strengthening economy is sowing the seeds of an acceleration of prices later
this year by rapidly eliminating the remaining slack in resource
utilization. Such concerns were reinforced by forecasts that recent
data suggest that revised estimates of fourth quarter GDP to be released next week will show upward revisions from the preliminary
5.9 percent annual rate of growth. Rapid expansion late last year,
it is apparently feared, may carry over into a much smaller deceleration of activity in 1994 than many had previously expected.
But it is too early to judge the degree of underlying economic
strength in the early months of 1994. Anecdotal evidence does indicate continued underlying strength in manufacturers' new orders
and production, but we will have a better reading on new orders
on Thursday when preliminary data for January are released.
The labor markets are signaling a somewhat less buoyant degree
of activity as initial claims for unemployment insurance in recent
weeks have moved up a notch. Clearly, the Federal Reserve will
have to monitor carefully ongoing developments for indications of
potential inflation or a strengthening in inflation expectations. As
I have often noted, if the Federal Reserve is to promote long-term
growth, we must contribute, as best we can, to keeping inflation
pressures contained.
In this regard, a clear lesson we have learned over the decades
since World War II is the key role of inflation expectations in the
inflation process and in the overall performance of the macroeconomy. As I indicated in my testimony before the Joint Economic
Committee last month, until the late 1960's, economists often paid
inadequate attention to expectations as a key determinant of inflation. Unemployment and inflation were considered simple tradeoffs.
A lower rate of unemployment was thought to be associated with
a higher, though constant, rate of inflation. Conversely, a higher
rate of unemployment was associated with a lower rate of inflation.
But the experience of the past three decades has demonstrated
that what appears to be a tradeoff between unemployment and inflation is quite ephemeral and misleading. Attempts to force-feed
the economy beyond its potential have led in the past to rising inflation as expectations ratcheted higher and, ultimately, not to
lower unemployment, but to higher unemployment, as destabilizing
forces and uncertainties associated with accelerating inflation induced economic contraction. Over the longer run, no tradeoff is evident between inflation and unemployment. Experience both here
and abroad suggests that lower levels of inflation are conducive to
the achievement of greater productivity and efficiency and, therefore, higher standards of living.
In fact, lower inflation historically has been associated not just
with higher levels of productivity but with faster growth of productivity as well. Why inflation and productivity growth are linked in
this way empirically is not clear. To some extent, higher productivity growth may help to damp inflation for a time by lessening increases in unit labor costs. But the process of cause and effect in
all likelihood runs the other way as well. Lower inflation and inflation expectations reduce uncertainty in economic planning and diminish risk premiums for capital investment. They also clarify the
signals from movements in relative prices, and they encourage effort and resources to be devoted to wealth creation rather than
wealth preservation. Many people do not have the knowledge of, or
access to, ways of preserving wealth against inflation. For them,
low inflation avoids an inequitable erosion of living standards.
The reduced inflation expectations of recent years have been accompanied by lower bond and mortgage interest rates, slower actual inflation, falling unemployment, and faster trend productivity
growth. The implication is clear: When it comes to inflation expectations, the nearer zero, the better.
It follows that price stability, with inflation expectations essentially negligible, should be a long-run goal of macroeconomic policy.
We will be at price stability when households and businesses need
8
not factor expectations of changes in the average level of prices into
their decisions. How those expectations form is not always easy to
discern, and they can for periods of time appear to be at variance
with underlying economic forces. But history tells us that it is economic and financial forces and their consequences for realized inflation that ultimately shape inflation expectations.
Fiscal and monetary policy are important among those forces and
have contributed to the decline in inflation expectations in recent
years along with decreases in long-term interest rates. The actions
taken last year to reduce the Federal budget deficit have been instrumental in this regard. Although we may not all agree on the
specifics of the deficit reduction measures, the financial markets
are apparently inferring that, on balance, the Federal Government
will be competing less vigorously for private saving in the years
ahead.
Concerns that the deficit is out of control have diminished. In the
extreme, explosive Federal debt growth makes an eventual resort
to the printing press and inflationary finance difficult to resist. By
shrinking any perceived risk of this outcome, the deficit reduction
package apparently had a salutary effect on long-term inflation
expectations.
The Federal Reserve's policies in recent years also have helped
to damp inflation and expectations. We were able to do so, even
while adopting an increasingly accommodative policy stance. By
placing our actions in the context of a thorough analysis of the prevailing situation and of a longer term underlying strategy, our
move to greater accommodation could be seen as what it was—a
deliberate effort to counter the various "headwinds" that were retarding the advance of the economy rather than a series of shortterm actions taken without consideration for potential inflation
consequer es over time.
As I discussed with this subcommittee last July, the longer run
strategy implies that the Federal Reserve must take care not to
overstay an accommodative stance as the headwinds abate. But determining when a policy stance is becoming too accommodative is
not an easy matter. Unfortunately, although subdued inflation is
the hallmark of a successful monetary policy, current broad inflation readings are actually of limited use as a guide to the appropriateness of current policy instrument settings. Patently, price
measurements over short time spans are subject to transitory special factors.
More important, monetary policy affects inflation only with a significant lag. That a policy stance is overly stimulative will not become clear in the price indexes for perhaps a year or more. Accordingly, if the Federal Reserve waits until actual inflation worsens
before taking countermeasures, it would have waited far too lone.
At that point, modest corrective steps would no longer be enough
to contain emerging economic imbalances and to avoid a buildup of
inflation expectations and a significant backup of long-term interest rates. Instead, more wrenching measures would be needed, with
unavoidable adverse side effects on near-term economic activity.
Inflation expectations likely have more of a forward-looking character than do measures of inflation itself, and, in principle, could
be used as a direct guide to policy. But available surveys have lim-
ited coverage and are subject to sampling error. As I have testified
previously, price-indexed bonds of various maturities, which would
indicate underlying market inflation expectations, would be a useful adjunct to our information base for making monetary policy,
provided there was a sufficiently broad and active market for them.
In addition, the price of gold, which has been especially sensitive
to inflation concerns, the exchange rate, and the term structure of
interest rates can give important clues about changing
expectations.
Of course, a number of factors in addition to inflation expectations affect all of these indicators to a degree. Short- and long-term
rates, for example, tend to be highly correlated through time, in
part because they are responding to the same business cycle pressures. Thus, when the Federal Reserve tightens reserve market
conditions, it is not surprising to see some upward movement in
long-term rates, as an aspect of the process that counters the imbalances tending to surface in the expansionary phase of the business cycle.
The test of successful monetary policy in such a business cycle
phase is our ability to limit the upward movement of long-term
rates from what it would otherwise have been with less effective
policy. Moderate to low long-term rates, with rare exceptions, are
an essential ingredient of sustainable long-term economic growth.
When we take credible steps to head off inflation before it can
begin to intensify, the effects on long-term rates are muted.
By contrast, when Federal Reserve action is seen as lagging behind the need to counter a buildup of inflation pressures, long rates
have tended to move sharply higher, as eventually happened in the
late 1970's. This suggests an important conclusion: Failure to tighten in a timely manner will lead to higher than necessary nominal
long-term rates as inflation expectations intensify. Ultimately,
short-term rates will be higher as well if policy initiatives lag behind inflation pressures. The higher short-term rates are required
not only to take account of rising inflation expectations but also to
provide the additional restraint on real rates necessary to reverse
the destabilizing inflation process.
For decades, the monetary aggregates, especially M2, provided
generally reliable early warning signals of emerging inflationary
imbalances. But, as I have discussed in detail in previous testimonies and will touch on later in this statement, the signals they
have sent in recent years have been effectively jammed by structural changes in financial markets and the unusual nature of the
current business cycle.
Our monetary policy strategy must continue to rest, then, on ongoing assessments of the totality of incoming information and appraisals of the probable outcomes and risks associated with alternative policies. Our purpose over the longer run is to help the economy grow at its greatest potential over time. To do so, we must
move toward a posture of policy neutrality, that is, a level of real
short-term rates consistent with sustained economic growth at the
economy's potential. That level, of course, is difficult to discern and,
obviously, is not a fixed number but moves with developments
within the economic and financial markets.
10
Over a period of several years starting in 1989, the Federal Reserve progressively eased its policy stance, in the process reducing
real short-term rates to around zero by the autumn of 1992. We
undertook those easing actions in response to evidence of a variety
of unusual restraints on spending. Households and nonfinancial
businesses on the borrowing side and many lenders, including depository institutions, were suffering from balance sheet strains.
These difficulties stemmed from previous overleveraging combined
with reductions in net worth from impairments to asset quality,
through, for example, falling values of commercial real estate. Corporate restructuring and defense cutbacks compounded the problems of the economy by reducing job opportunities and fostering a
more general sense of insecurity about employment prospects.
The deliberate maintenance of low short-term rates for a considerable period was intended to decrease the drag on the economy
created by these headwinds. Households and businesses could refinance outstanding debt at much reduced interest cost. In addition,
lower rates and improved performance by borrowers would take the
pressure off of depository institutions, helping them recapitalize.
Low interest rates, along with reduced financial strains, would encourage private spending to pick up the slack left by defense cuts.
Once financial positions were well on the road to recovery and employment and confidence began to recover, it was believed that the
economic expansion would gain self-sustaining momentum. At that
point abnormally low real short-term rates should no longer be
needed.
As the Federal Open Market Committee surveyed the evidence
at its February 4 meeting, a consensus developed that the balance
of risks had, in fact, shifted. Debt repayment burdens had been
lowered enough to unleash strong aggregate demand in the economy. Real short-term rates close to zero appeared to pose an unacceptable risk of engendering future problems. We concluded that
our policy stance could be made slightly less accommodative without threatening either the continued improvement in balance sheet
structures or, ultimately, the achievement of solid economic
growth.
Indeed, the firming in reserve market pressures was undertaken
to preserve and protect the ongoing economic expansion by forestalling a future destabilizing buildup of inflationary pressures,
which in our judgment would eventually surface if the level of policy accommodation that prevailed throughout 1993 were continued
indefinitely. We viewed our move as low-cost insurance.
The projections of the FOMC members suggest a continuation of
good economic performance in 1994, with reasonable growth and
subdued inflation. The central tendencies of the economic forecasts
made by the Governors and Bank presidents imply expectations
that economic growth this year likely will be 3 percent or slightly
higher. With this kind of growth, a further edging down of the unemployment rate from its January reading is viewed as a distinct
possibility. Inflation, as measured by the overall CPI, is seen as rising only a little compared with 1993, even though last year's benefit from falling oil and tobacco prices may not be repeated, and last
year's crop losses could raise food prices in 1994.
11
There are, of course, considerable risks to this generally favorable outlook. Some observers have pointed to downside risks to economic activity associated with fiscal restraint and weak foreign
economies. I believe these factors will have some effects, but they
are likely to be less than feared. As for fiscal restraint, a good portion of the negative impact of last year's budget bill may already
be behind us, as some households and businesses have adjusted
their behavior to the new structure of taxes and to curtailments in
defense and other budget programs.
The concern about weak foreign economies relates to the strength
of foreign demand for U.S. exports going forward. Many of our
major trading partners have been experiencing economic difficulties. But some already appear to be pulling out of recession, and
a number of others seem to have improved prospects. Moreover,
containing inflation will keep increases in production costs of traded goods made in the United States subdued, so that our products
will remain competitive in world markets. With competitive goods
and an improving world economy, the growth of U.S. exports
should strengthen this year, lessening the drag from the external
sector on our output growth.
There are upside risks as well. Inventories have reached a low
level relative to sales, suggesting the possibility of a boost to production from inventory rebuilding beyond that currently anticipated. In addition, with both borrowers and lenders in stronger financial condition, low interest rates have proven a powerful stimulant to spending.
While we were reasonably convinced at the last FOMC meeting
that a zero real Federal funds rate put real short-term rates below
a "neutral level," we cannot tell this subcommittee, with assurance,
precisely where the level of neutrality currently resides. To promote sustainable growth, history suggests that real short-term
rates are more likely to have to rise than fall from here. I cannot,
however, tell you at this time when any such rise will occur. I
would hope that part of any increase in real short-term rates ultimately would be accomplished through further declines in inflation
expectations rather than through higher nominal short-term rates.
In assessing our policy stance, we will continue to monitor developments in money and credit, but in 1994, as in 1993, the FOMC
is unlikely to be able to put a great deal of weight on the behavior
of these aggregates relative to tneir ranges. We have set the ranges
as best we can in an evolving financial situation to be consistent
with our objectives for sustained growth and low inflation.
Based on our experience in 1993 and expectations about financial
relationships for 1994, the FOMC judges that the growth of money
and credit this year will stay within the annual ranges set previously last July, which were reaffirmed at its meeting early this
month. Specifically, these ranges call for growth of 1 to 5 percent
for M2, zero to 4 percent for M3 and 4 to 8 percent for domestic
nonfinancial sector debt.
In conclusion, Mr. Chairman, the Federal Reserve has welcomed
both the strengthening activity and the generally subdued price
trends, because the intent of pur monetary policy in recent years
has been to foster precisely this kind of healthy economic performance. Looking forward, our policy approach will be to endeavor to
12
select on a continuing basis the monetary instrument settings that
will minimize economic instabilities and maximize living standards
over time. The outlook, as a result of subdued inflation and still
low long-term interest rates, is the best we have seen in decades.
It is important that we do everything we can to turn that favorable
outlook into reality.
Thank you very much, Mr. Chairman.
[The prepared statement of Mr. Greenspan can be found in the
appendix.]
Chairman KANJORSKI. Thank you very much, Mr. Chairman. I
suspect you will.
The questions of the subcommittee members in their opening
statements regard the question that since economic factors are not
significantly different today than they were in July 1993 when you
testified, what is the basis for the increase that was issued by the
Open Market Committee on February 4? Is there some model, some
definition, other than
Mr. GREENSPAN. Mr. Chairman, in fact, I would point out that
the economy is actually doing better at this stage than we had expected last July. Certainly, the second half of 1993 was far stronger
that we had expected, especially in the fourth quarter, where, as
I indicated in my prepared statement, there are a number of forecasts out there which suggest that the gross domestic product for
the fourth quarter will be revised up from its 5.9 percent rate.
The basic question which you posed, I would reverse. I would say
if, as in our judgment—which I think is confirmed very appreciably
by history—an accommodative stance eventually engenders an acceleration of inflationary pressures, the question is more to the
point focused on if the economy is strong enough so that we can
move away from our accommodative stance, then the reasons for
doing that become increasingly strong.
It was the judgment of the FOMC that the economy has done
precisely that, that we are beginning to see ever-increasing evidence that the economic recovery is well-entrenched. And if that argument holds, which I believe the evidence strongly supports, then
the question really gets to the issue: What basis do we have for
continuing the accommodative policy which we had?
And, as a consequence of that, even though we recognize—as you
point out and indeed as I make clear in my statement—that there
is no immediate evidence of accelerating price inflation at this particular time, the question essentially is not what inflation is now,
which as somebody said recently is looking in a rearview mirror,
but what are the processes which are developing which will affect
the rate of inflationary pressures later on. And it is that question
which we are addressing.
We are focusing increasingly at this stage on the outlook for 1995
and beyond, and we want to make certain that our monetary policy
addresses that outlook in a manner which sustains what is really
the most extraordinarily positive pattern of economic growth, interest rates, and inflation that we have seen in several decades.
Chairman KANJORSKI. I appreciate that, and, of course, the entire Congress supports long-term growth, low interest rates. But we
do worry about whether this is an analysis based initiative or
13
whether there is some objective tool by which we can anticipate
and the financial markets of the world will anticipate.
You cite in your testimony the exam that many of you used, the
Philadelphia reserve numbers, but then go on to discount that, that
those numbers generally indicate economic recovery and stability.
Mr. GREENSPAN. Not necessarily stability. But what I want to
point out is that the evidence shows that those are very valuable
indicators but more so for new orders and short-term activity than
for any indication that inflation is occurring. They do, however,
tend to also be used in certain measures to Forecast inflation, but
my impression basically is that they have tended in the past to reflect that particular acceleration in the economy which in past periods has tended largely to create a sense of pressure on capacity,
shortages, and price inflation.
But I must say, Mr. Chairman, history also tells us that inflation
requires financial tinder, which at the moment, as I see it, is lacking, and I know of no inclination on the part of the Federal Reserve
to supply it.
So our basic view is that we see this process of acceleration that
is occurring in the economy, and we want to make certain that, unlike periods in the past, that it does not engender a set of inflationary pressures.
Chairman KANJORSKI. This is inoculation, when the
subsequent
Mr. GREENSPAN. Yes. If one uses the analogy, what we are endeavoring to do is to find a proper policy stance which will create
an environment in which maximum sustainable economic growth is
possible.
Chairman KANJORSKI. At what point, however, can we separate
when the economy drives inflation or the expectation from when
the Federal policy drives the expectation of inflation?
Mr. GREENSPAN. Mr. Chairman, we have had innumerable periods in our history in which we have had very strong economic activity without inflation. And the reason that that has occurred is
that we did not have accommodative monetary policies or excessive
credit growth which spilled over into excessive growth in the monetary aggregates. So while there have been, unquestionably, periods
in the past when the growth in the economy has, been related to
strong inflationary increases because it was associated with increases in money and credit, that is not a necessary consequence
of economic growth. And it is our view that what we would like to
foster is—or replicate, I might say—the high growth and low inflation numbers of those previous periods.
And this goes back decades and generations, where we have had
very considerable economic strength, prolonged expansions in economic activity, without inflationary imbalances occurring, and
these situations occurred to a very large extent because we did not
have the financial tinder which too often has been the basis for accelerating an expansionary economy which created major imbalances and eventually led to a significant economic contraction.
Chairman KANJORSKI. Mr. Chairman, when we last talked, I was
worried about the impact of the earthquakes and the cold weather
during the first quarter of 1994. And for the most part you assured
me at that time that the indicators you were reading showed that
14
the economy, in spite of those conditions, was growing at a fast
rate or relatively fast rate relative to past years.
But you also indicated to me that you felt the effect of the increase would only be on short-term rates, not long-term rates, and
we have seen over the last several days an increase of four-tenths
of 1 percent, I believe, on long-term interest rates. Could you give
us some explanation of whether that was a misreading on your
part or has some phenomenon occurred?
Mr. GREENSPAN. Basically, the evidence of the slowing down in
the rate of growth coming off the fourth quarter so far to date has
raised the possibility that we may not be moving very rapidly to
what is the consensus of a real growth rate of approximately 3 percent. It is that concern in the market that has led to a considerable
amount of discounting of the possibility.
In other words, if the probability were even less than 50-50 that
coming off this very high fourth-quarter growth rate down to the
expected more moderate growth rate then the markets will tend to
discount the possibility that the growth rate will be stronger and
that the possibility of inflationary acceleration would be greater
and, hence, the market moved up.
I think what was unanticipated in the marketplace, and indeed
by most everybody, was the extent to which we went through the
period of the earthquake and the weather with an economy as
strong as we have had. Industrial production in January was somewhat higher than expected, and the weekly data for the month of
February still show that it is moving forward.
Now, if, as may well be the case, the growth rate does come down
to where we all expect it—and there are no reasons to believe that
that is not, in fact, the case—then we are likely to see adjustments
in the outlook and in the markets.
Chairman KANJORSKI. Thank you very much, Mr. Chairman. My
time has just expired.
If I may say, I am going to recognize in order of arrival the subcommittee members first, and then those members that are sitting
with us that are not members of the subcommittee on the basis of
their arrival time; and I recognize Mr. Roth of Wisconsin.
Mr. ROTH. Thank you very much, Mr. Chairman.
Mr. Greenspan, I think the reason we ask you these pointed
questions is because we are very much interested in your testimony
and going to Alan Greenspan is like going to the oracle of Delphi
to find out what is going to happen with the economy.
I was wondering, are you getting us ready for somewhat—if not
a recession, a downturn in the economy? It says the level of activity
in certain key sectors and with the output of these areas unlikely
to climb as steeply, a significant slowing of the rate of growth is
expected.
Can you shed more light on that?
Mr. GREENSPAN. Sure. Congressman, as you go back to the summer of last year, indeed when I was here the last time, we had
motor vehicle sales and housing at moderate levels. As the second
half accelerated, both of these, and in fact there is an interrelation
between the two, moved up very sharply, and indeed contributed
to a very substantial part of the rate of growth of gross domestic
product in the second half.
15
We have now arrived at levels of car and truck sales and of housing starts which are really quite high. They may go higher, but
they almost surely will not continue the rate of growth which they
experienced earlier. So, if the maior thrust in the economy during
the second half was the motor vehicle and residential construction
market, and they are going to slow down very dramatically, clearly,
the total has to slow down.
Notice that is not to say by any means that the slowdown is to
a level which is subnormal. On the contrary, it is the expectation
of the members of the FOMC that the growth rate will be at 3 percent or slightly higher, which is enough to cause a continued further decline in the unemployment rate.
Mr. ROTH. Thank you. Trie Fed gets blamed for a lot of things
and so when I was reading in some of our leading newspapers the
stock market's downturn last week was blamed in part on the recent rise in short- and long-term interest rates and fears that further rate increases are coming. Do you agree with the analysts who
state that the long awaited stock market correction has arrived?
Mr. GREENSPAN. Congressman, I used to forecast what the stock
market was doing and with some foolishness answer questions like
that when I was a private citizen. Having chosen not to respond
to those questions, and I think that having not responded in 6Vz
years, has stood me in good stead. So I must apologize for withdrawing from the theatre, if I may say so.
Mr. ROTH. Do you think that the stock market is overvalued
based on earnings today?
Mr. GREENSPAN. I repeat my previous answer.
Mr. ROTH. Well, in your testimony, you put a tremendous
amount of emphasis on inflation. It seems to me you almost have
a phobia when it comes to inflation. Do you see the Fed focusing
maybe too much on inflation and to the detriment of an expanding
economy?
Mr. GREENSPAN. Congressman, the concept of phobia presupposes an irrational response. I would submit to you that on the
basis of all we have been able to glean about how our system
works, the most virulent element to create economic distress and
unemployment is inflationary pressures which have been allowed
to get out of hand. So, if you are going to say are we very much
concerned about the issue of inflation as the central bank, I certainly hope so.
Mr. ROTH. So that means if I read in the newspaper that inflation is going up, that means that the Fed might be in for another
round of interest rate increases?
Mr. GREENSPAN. What it is that we dp in the market is dependent on a lot of things, but you can certainly assume that if we perceive that inflationary pressures are rising, it is very important for
the stability of this economy that we respond to try to contain it.
Mr. ROTH. Thank you, Mr. Chairman.
Chairman KANJORSKI. Mr. LaFalce.
Mr. LAFALCE. Thank you, Mr. Chairman.
Dr. Greenspan, prior to the fourth quarter of calendar 1993, most
economists were predicting a GNP increase of approximately 3 percent; is that correct?
Mr. GREENSPAN. That is correct.
16
Mr. LAFALCE. So now it looks as if most economists were approximately 100 percent off.
Mr. GREENSPAN. That is an arithmetically fair statement.
Mr. LAFALCE. All right. Good. It really brings to mind the validity of all these economic assumptions that we have in budget forecasting and the balanced budget constitutional amendments that
estimates can be so far off, it turning out to be approximately 6
percent. But let me not go off on to the balanced budget argument.
Let me ask you some other questions.
You put almost all of your argument for increasing the rates on
dealing with inflationary expectations, but to what extent were you
concerned with this huge increase in GNP in the fourth quarter?
And suppose it had come in at approximately 3, 3.5, 4 percent, do
you think that that adherence to economic prognostications would
have been an indication that inflationary expectations were not so
great?
Is there a relationship between inflationary expectations and this
virtual doubling of the prognostications?
Mr. GREENSPAN. Let me just say that while it is certainly correct
that virtually all forecasters missed the extent of the acceleration
in the fourth quarter, the forecasts have been generally correct in
describing the quality of what the recovery is all about, and what
is happening.
What I think happened is that growth was compressed and the
compression was not foreseen, and that is where the mistake occurred. But I don't consider it an important mistake. Important
mistakes in economic forecasting are when you think things are
up and they go down. But when they happen faster or slower
§yoing
a moderate amount, that is not a surprise. There is no way that
a forecaster
Mr. LAFALCE. One hundred percent is not exactly moderate—a
doubling.
Mr. GREENSPAN. I can't deny that the word "moderate" may be
a bit inappropriate here.
Mr. LAFALCE. Let me get to my point. I am looking to the future
and trying to figure out what the Fed is going to do for various reasons. And you place primary emphasis on inflationary expectations.
In determining what inflationary expectations are, it seems to
me that on page 7 you look to price-indexed bonds of various maturities. If there were a sufficient market for them, you conclude, inferentially I believe, that there is not a broad enough market for
that to be a criteria.
Then you say, "In addition to the price of gold, which has been
especially sensitive to inflation concerns, exchange rates, and the
term structure of interest rates can give important clues to changing expectations."
I have some qualms about using those as criteria. Are you using
those as criteria? Of what validity is it to use the price of gold?
Isn't that primarily a guessing game, the same way that investing
in the stock market is a guessing game where mob psychology is
at least as important as real indicators. The exchange rate is often
determined by the decisions of governments, it seems to me, and
dependent upon trade balances, and trade balances or imbalances
often lead to adjustments in exchange rates, and so forth.
17
Mr. GREENSPAN. I don't think so, Congressman. I think that
what the price of gold reflects is a basic view of the desire to hold
real hard assets versus currencies. It is different. Gold is a different type of commodity because virtually all of the gold that has
ever been produced still exists and, therefore, changes in the levels
of production have very little effect on the ongoing price, which
means that it is wholly a monetary demand phenomenon since it
is a store of value, not something which is used to a very large extent in industry.
So it is a store of value measure which has shown a fairly consistent lead on inflation expectations and has been over the years
a reasonably good indicator, among others, of what inflation expectations are doing. It does this better than commodity prices or a
lot of other things. Because of the fact that we have lost the monetary aggregates as a major tool, we are seeking anything which
gives us insight into the process; and what history does tell us is
that gold is a useful indicator thereof.
Mr. LAFALCE. If you were to put all of those items you mentioned
on page 7 in a basket, how much would the criteria of gold weigh
in that basket?
Mr. GREENSPAN. I wouldn't say that you weigh them in any particular way.
Mr. LAFALCE. It sounds to me that you are giving primary attention to the price of gold as an indicator of inflationary expectations.
Mr. GREENSPAN. No, not necessarily. I think what we need are
confirmations of various, different indications. Look, the price of
gold on occasion has materially deviated from where one would
nave expected it to be. It is not a perfect indicator, but it is a very
good indicator you can use, unless we were on the gold standard,
which is a wholly different type of regime. One can argue, and I
happen to be one of those who believes, that things were a lot better in many respects back when we had stable gold prices. But the
issue that we have to confront here is a very complex economy, one
which is extraordinarily dynamic and one which is global in nature,
and one which has very major interactions with foreign economies.
And I will tell you, any indicators of any particular aspects or
measures which give us forewarning of what events may eventually
be are very useful. And I should say to you that we will not dispense with them unless and until they prove to be inadequate to
their task. We don't have enough of them to basically have the
great luxury of picking and choosing.
Mr. LAFALCE. My time has expired. Thank you.
Chairman KANJORSKI. Thank you. We will now go to Mr. Nussle.
Mr. NUSSLE. Thank you, Mr. Chairman. I think most of my questions have been answered by the written testimony, I would like
to yield to my colleagues that were here first. I appreciate the courtesy, but I would like to extend it to them. They were here before
I was.
Chairman KANJORSKI. We are going to continue in order, Mr.
Nussle. We are now going to Mr. Klein of New Jersey.
Mr. KLEIN. Thank you very much, Chairman Kanjorski.
As I indicated in my opening statement, I am very concerned
about the small- and medium-sized business sector of the economy.
And my own personal observations are that they still have a dif-
18
ficult time in terms of availability of credit. Bank lending is statistically very, very low with respect to those.
And I would ask you, first of all, whether you have any observations on that score; and second, what the effect of the increase in
short-term rates would be on that sector because I am troubled
about it.
Mr. GREENSPAN. Congressman, first of all, let me say that I fully
agree with the point you are making that small- and medium-sized
business are crucial to this economy. Indeed, it is where the innovation occurs and it is where the employment occurs. In fact, it is
the part of the system which is the most dynamic and may, in fact,
be the most important element in economic growth, certainly in recent years.
We have a reasonably good recovery in the small business area.
In fact, nonfarm proprietors' income has been rising fairly rapidly
over the last couple of years. That is usually a fairly good observation of proprietorships and partnerships and small corporations
will tend to move pretty much in that direction. And there is no
question that they have benefited from lower interest rates.
Indeed, it was the credit crunch which emerged, as you know, in
the latter part of the 1980's, which was a major element which directed us to start to move rates lower well before any weakness in
economic activity occurred. And the reason that we did is that we
were observing in the small business community a real contraction
in the availability of credit, and we knew that the commercial
banks were effectively the sole source of funds for many of them,
whereas larger corporations were able to get financing in the capital markets.
We were not fully successful in taking the credit crunch from its
severity down to zero, but we did prevent it, in my judgment, from
getting worse, and we did contribute to a major ease of the crunch
in the last year or so. Indeed, our estimates that we get on the degree of credit availability from our senior loan officers survey does
suggest that in the last several quarters there has been a marked
easing in the availability of loans to small business.
We also have seen in recent months, after a very prolonged period of virtually no change, total business loans, commercial and industrial loans, starting to move up and a substantial part of that
has been going to the small business community.
Are they fully out of the woods at this stage? I think not. I agree
with you that there are still problems there. And I do think that
the improvements that are occurring in the economy generally are
working their way throughout the system, both small and large
firms, and I think we will see that the situation there will continue
to improve.
The various surveys that are available from the associations
which are connected with small business show that credit availability has been improving for them, but it is still not to some of the
levels that existed at an earlier time.
My impression, basically, of the issue of whether a small increase
in short-term interest rates would have an impact on small business lending is I frankly doubt it. There has been very little evidence that loan rates have gone up in any appreciable manner
which would affect them. But more importantly, they, like all other
19
businesses, indeed like everybody in the economy, are very severely
hurt if inflationary pressures emerge and the economy goes into a
swoon.
So, in summary, Congressman, if there was any segment of the
economy which we were focusing on, that we wanted to see do well,
it was small- and medium-sized business.
Mr. KLEIN. Well, just one other question, and I realize my time
has expired because your answer was lengthy, but since you are in
some doubt as to what the effect is on small business and mediumsized business, you point out on page 6, that there is a significant
time lag between the effect of any monetary policy, the institution
of the policy, and the effect of the policy, indeed a lag of a year or
more. Assuming for the moment that the policy is incorrect, the increase in the interest rates was an incorrect policy, would it be true
then that you would not understand or perceive the effect of that
incorrect policy for a year or more and it would be very difficult to
correct that mistake, if indeed it were a mistake?
Mr. GREENSPAN. Yes, I agree with that, Mr. Klein. The correct
policies show up as beneficial a year or so out and incorrect policies
the same. And it is precisely that issue that the Federal Open Market Committee has to address. At its meeting on February 4, we
concluded that the balance of risks were such that were we not to
move, that that failure to move would have been an incorrect policy
in which that incorrect policy's effects would show up a year out.
And it was in our judgment that the balance of risk very severely
suggested that we were far safer for our purposes to sustain the
recovery to move up a notch than not to do so.
Mr. KLEIN. Thank you very much, Mr. Chairman.
Chairman KANJORSKI. Thank you, Mr. Klein. I am going to recognize Mr. LaFalce for 10 seconds.
Mr. LAFALCE. Dr. Greenspan, could you please amplify your response to Mr. Klein in writing, giving some of the data, the surveys
that you were referring to with respect to small business for this
subcommittee and for me as chairman of the Small Business
Committee?
Mr. GREENSPAN. I would be glad to do that.
[The information referred to can be found in the appendix.]
Chairman KANJORSKI. Mr. Neal.
Mr. NEAL. Chairman Greenspan, I would like to congratulate you
on taking this early action to ward off future inflation. This quarter
point increase couldn't possibly hurt anyone. What hurts is letting
inflation get out of control and then having to go up on interest
rates to control it. And I think it is—certainly this is another argument for keeping the Fed out of the political process. Those of us
in the political process are always under pressure to do what is
most appealing for the short term. We can't help it. That is sort
of built into our system.
And we have set up your institution so that with long terms and
a good deal of isolation from that everyday political pressure, you
can take the longer view. And I commend you for doing it and you
and all the rest of your associates, I hope that you will always do
that. I mean it is so important to our economy.
I think of Mr. Roth's earlier comments and I would try to put
those in a little more positive light. What we have learned is that
20
the benefits of low or preferably no inflation are quite incredible,
and in fact give us everything else we want. I mean with low inflation, ultimately we will get the lowest possible sustainable longterm interest rates and snort-term interest rates. If we had no inflation at all, zero inflation, then long rates would probably be 3
percent and short rates would be almost nothing, somewhere between 1 and 3 percent, we would have accomplished the essential
element necessary for the maximum level of sustained economic
growth, the maximum sustainable level of employment, the highest
rates of savings, the most competitive possible position that we
could maintain in international trade, the most efficiency in our
economy.
There is no element of our economy that wouldn't benefit from
the lowest possible rates of inflation, if I understand it correctly,
and I, of course, would like to get you to comment on it. But, the
tradeoff that you have there is between sometimes having to do
what may be politically unpopular, raise the short rate a little bit,
the tradeoff between that and the possibility of continuing to get
lower and lower inflation and lower and lower interest rates, more
sustainable growth and so on. Isn't that the tradeoff?
It just seems so clear to me that in a nutshell we get every possible benefit we can get from monetary policy, and they are very
considerable, by focusing on low inflation. It is the low inflation
that gives us everything else we want, including low sustainable
interest rates, growth, savings, efficiency, competitiveness, and so
on, and every now and then you do have to make a little adjustment in order to sustain that.
Isn't that about it? Is it true that we get all these other benefits
from low inflation? Isn't that the goal? Shouldn't that be the goal
of Fed policy?
Mr. GREENSPAN. I agree with that, Congressman. One of the important things that we have all learned over the last decade, the
last two decades, is the fact that there is no downside to low inflation so far as long-term growth is concerned. It is consistent with
maximum, sustainable economic growth, the lowest level of sustainable unemployment and from what we can gather from most
recent studies, the highest level of growth in productivity which
leads to higher standards of living. And I would say that you could
not argue that very readily, say 20 or 30 years ago.
It is the evidence of recent decades which has created a much
more important insight into what low inflation creates for an economy than we had in the earlier postwar period.
Mr. NEAL. I think that is an important point because I think this
is something relatively new. And it is almost like the discovery of
antibiotics for disease or the discovery that good nutrition and exercise is good for the human body. I mean, this is a very important
discovery for our economy, and it is inherently verified in recent
years. And almost nothing is more important, it seems to me, in
terms of understanding how our economy works and what we can
do to make it work better over time. Isn't that right?
What I am asking about now is not only the fact of it, but the
magnitude of the importance of this discovery.
Mr. GREENSPAN. Congressman, you have to remember that back
in the early postwar years, the conventional wisdom was that a
21
mildly increasing rate—I should say, a moderate rate of inflation—
actually greased the wheels of economic growth and that lower levels of inflation were actually detrimental to the efficiency of the
system. That has clearly been demonstrated to be false.
Mr. NEAL. It was also thought that you could increase employment by increasing inflation, which is another mistake, I believe.
Mr. GREENSPAN. Yes, that is absolutely the case, and that is no
longer accepted by anybody as a long-term proposition. But I do
think that it is very interesting to see the change in attitudes of
what the optimum inflation path for an economy is. And while
there is no doubt, there continues to be significant disagreement
among economists about, for example, is there much gained in economic efficiency as you go below a 5 percent inflation rate. We are
now at a point where everybody agrees that over 5 percent is detrimental and an increasing number of analysts are concluding that
as we go below 5 percent, the evidence increasingly suggests that
there are benefits there as well.
Mr. NEAL. Thank you.
Chairman KANJORSKI. Thank you very much Mr. Neal.
Mr. Bachus.
Mr. BACHUS. Thank you, Mr. Chairman.
Chairman Greenspan, you know—I am not sure the people in the
audience know—that a 1978 law requires you to come before this
subcommittee twice a year to give a report on the economy and on
the conduct of monetary policy. There is another law that was
passed in 1989 that requires you to come back before this subcommittee twice a year as a member of the RTC Oversight Committee and give testimony.
And as you know, several Republicans on this subcommittee are
very concerned that those hearings have not been conducted. Have
you been contacted to appear before this subcommittee concerning
those RTC oversight hearings?
Chairman KANJORSKI. Will the gentleman yield?
The gentleman is far out of the realm of this hearing with this
question. And I am very disappointed that the Chair invites members of the full committee, minority and majority, to join in this
session and to use it for the intentions for which it was scheduled
and not for political purposes, and I ask the gentleman to withdraw
his question at this point and pursue the course of conduct and
questions for which Mr. Greenspan is before this subcommittee to
answer.
Mr. BACHUS. Mr. Chairman, I will honor that request.
Let me say this, at the February 3 hearing when you made the
decision to increase the Fed funds rate, you broke with tradition
and announced that decision immediately. There was almost as
much speculation, as much comment by the press over the decision
to go public immediately as there was with the rate increase. Could
you please discuss in more detail the reasons behind your decision
to immediately go public so soon this time?
I know Chairman Gonzalez, the Wall Street Journal at least said
that he claimed credit for your immediate disclosure and there was
a lot of speculation that there was some pressure of disclosure. I
mean certain people on this subcommittee have pushed for more
22
disclosure and in fact one of the last times you testified before us
you argued for the ability not to go public so quickly.
Could you comment on this? And also some people are saying
that this announcement has set a new precedent and that you will
now be going and announcing these decisions almost immediately
in the future.
Mr. GREENSPAN. We have not changed any of our Federal funds
rate or discount rate readings for well over a year; and indeed,
have not raised the funds rate for 5 years. And as I commented before this subcommittee in discussing this question, we have basically two approaches to moving rates when rates are being moved.
One is with the discount rate in which we make an announcement when we move the discount rate, and indeed we do it basically for the purpose of essentially making a very important point
so that we have effectively—some of us like to say—hit the gong.
We are doing something. We have chosen not to do that with the
Federal funds rate because there are also advantages in being able
to calibrate certain types of money market moves which are not
punctuated with an announcement.
We were confronted with the issue of making what is clearly a
very important move—actually it was the February 4 part of the
February 3 and 4 meeting. And we decided that we thought it inappropriate to move the discount rate, but we did want to make an
announcement, we did want to have an announcement effect so
that we chose at that point to announce the change in the Federal
funds rate.
As a spokesman for the Federal Reserve indicated at that time,
this was not meant as a precedent as such. Congressman, we are
in the process of reviewing as we have for the last year—and hopefully will have some conclusions reasonably soon—our general approach to a number of different things with respect to disclosure.
And this, obviously, is one of the issues that is on the table. But,
it was not meant at that time as a precedent. It was meant to convey a very specific monetary policy purpose.
Mr. BACKUS. My last question, and Chairman, if I could have—
I guess my time was not taken by the first question.
Chairman KANJORSKI. The first question is nonexistent. You may
have your full time.
Mr. BACKUS. I understand that Vice Chairman Mullins and Governor Angell actually argued for a full half-point increase in Fed
funds at that February meeting. And many economists have actually stated that Fed funds could rise to 4 percent without damaging
the economy, and in fact that that is where Fed funds are probably
headed.
Could you basically tell me what the primary arguments for
higher rates that were made by these two Governors were; what
their arguments were, first of all? And second of all, could you
comment on those economists who are saying that Fed funds are
headed for 4 percent rate?
Mr. GREENSPAN. Congressman, neither Governor Angell nor Vice
Chairman Mullins chose to attend the February 3 and 4 meeting,
because it is a convention of the FOMC that you try to leave a sufficient gap in time between when you leave and when you are
going to access to internal distributions of the FOMC, so neither
23
one of them were there at the time. I would not like to go further
on any issue of discussion of interest rates and their impact over
and above the fairly detailed instruction, which I hope I was able
to be forthcoming on in the content of my formal statement.
Mr. BACHUS. All right. Thank you, Mr. Chairman.
Chairman KANJORSKI. Thank you, Mr. Bachus.
Mr. Chairman, if I could ask you a question now. At what point
would an increase in economic activity in a given year be allowable
and at what point would it be discouraged?
Could the American economy grow by 4 percent and not have inflationary pressures of 5 percent? Is there some magic number?
Mr. GREENSPAN. There are a lot of people that calculate what is
called potential economic growth in which they try to put together
changes in population, and that, the labor force. And it is really effectively growth in the labor force plus the growth in productivity.
And most of the numbers in that respect over the long term,
whether or not it is the CBO, the Council of Economic Advisers,
private people, or ourselves, are roughly 2.5 percent.
The difficulty, however, is that the productivity gains are not
very easy to project over the lone term. Indeed, you can often get
a much stronger growth and not know that the potential has gone
up until well after the fact. But let me say generally with respect
to the issue of growth, I don't think it is appropriate to try to look
at any particular growth rate and say that is too high, we must
bring it down, because you really don't know that it is engendering
inflationary instabilities until you look at the inner core, the structure of what is going on.
And if, indeed, growth is being caused by improved efficiency or
improved productivity, it is not one which one should be concerned
about. And so rather than look at a specific number, we tend to
look at the internal workings of the economy, and make judgments
as to whether any particular pace is essentially unsustainable or
not.
Chairman KANJORSKI. As you know, many Americans look at the
Chinese economy growing at 8 and 9 percent and they wonder why
the American economy, a more mature economy, cannot grow at
that rate. But there seems to be some measure that you use, and
all of us, even with the budgetary considerations, seem to work
around the magical number of 3 percent. That seems to be the
number that without fear of exacerbating inflation or that we are
approaching full production, that would generally maintain stability in the economy. Is that^-—
Mr. GREENSPAN. What the budget forecasts try to do, because the
requirement is essentially to project the budget over a 5- or 8-year
period, is to try to get a judgment as to where the long-term growth
path is likely to be without specifically focusing on any individual
year's growth as being above or below, because you can't forecast
that that easily, but you can get a general thrust.
We know that the underlying forces in the Chinese economy are
running up far faster than ours basically because their productivity
is so strong, and because they start from such a low base that they
have a lot of room to grow so that their potential is clearly much
superior to ours. But what we endeavor to do is project this longer
term growth and from it calculate the receipts for various different
24
elements in the budget as a consequence of that, and what that
sort of growth would imply with respect to the expenditure side.
But I don't think that it is necessarily a projection by either OMB
or CBO of what they perceive to be the natural growth rate or potential growth rate.
Chairman KANJORSKI. Regarding the rate staying at around 3
percent, and we seem to congratulate ourselves on that, even
though at the early part of the Second World War recovery it was
significantly lower than 3 percent, this seems to have become the
accepted level. Is there any impact you can see that we are having
through public policy on cost of living adjustments being built in,
indexing tax laws and should the Congress reexamine that policy?
Mr. GREENSPAN. I don't think that there is a general agreement
that 3 percent is acceptable, because the trouble with modest rates
of inflation, and 3 percent is a modest rate of inflation, is that
there is a tendency, if it goes on indefinitely, to accelerate. So I
wouldn't want to claim that I would consider that 3 percent is a
long-term, stable rate of inflation.
There is another issue which you are alluding to, Mr. Chairman,
which is that the 3 percent or whatever we are using for the CPI,
probably overestimates the actual underlying rate of inflation. And
it does so because as statisticians have demonstrated that if you
have a fixed index, which means that the effect of price changes
are the same irrespective of the shift in consumption behavior, you
tend to have an upward bias in the price index.
Similarly, we have not fully succeeded in getting the improvements in quality from biasing I should say to get the improvements
in quality out of the price indexes. And tHere are a number of other
reasons why the indexes probably are anywhere from a half—some
people think it is 1.5—percent higher than the actual cost-of-living
increase.
So there has been some discussion among economists that the
adjustment, both to the expenditure cost of living adjustments, and
to the tax structure, is probably higher than the actual true cost
of living experienced by either the beneficiaries or the taxpayers
who have their rates adjusted by that index.
Chairman KANJORSKI. Thank you very much, Mr. Chairman.
Mr. Roth.
Mr. ROTH. Thank you, Mr. Chairman. And Chairman Greenspan,
you have been very generous with your time this morning. I have
two short questions and then I have a conclusion to see if you
would agree with that.
We start out talking about the formula the Fed uses and so on.
Is it accurate to say—am I right or would you agree that what you
are telling us here today is that the old rules for the Fed really
don't apply anymore? Maybe that is stating it incorrectly. It is that
the old rules may apply, but they are not as defined as they were
in the past?
Mr. GREENSPAN. There is no question that the way monetary policy was implemented in the past based upon the data systems and
the financial information that existed back then is not the same as
the procedures that we use today.
Mr. ROTH. So the Fed is moving into uncharted water to some
degree?
25
Mr. GREENSPAN. To some degree. I hope that the reason we are
doing so is that we have learned a number of lessons about how
monetary policy, both here and abroad, functions which has very
significantly added to our arsenal of information. And, hopefully,
we are learning from it, and taking those actions which we have
observed in the past are more appropriate. We didn't know a number of things 30 years ago about how economies respond to various
different types of monetary policies.
Mr. ROTH. Now, the question that I have, you obviously have
given this a good deal of thought and thought this through. Do you
have a game plan pretty well in mind: If this happens, I am going
to do this; if this happens, we are going to do that? Like a football
coach, you have a game plan? Have you in your mind thought this
through pretty well? Is there a game plan where variables come
into play?
Mr. GREENSPAN. Obviously, we cannot implement monetary policy if we don't have a conceptual understanding of a structure of
how we think the economy is behaving and how it will behave in
the months and years ahead, because if we don't have, then we are
flying blind. It is true that we do not have the monetary aggregates
in the manner that was so helpful in the past, but that is not to
say we do not have a conceptual structure; if you want to say
"game plan" as to how the system would work, you are correct because obviously our judgment is if we do X, Y is likely to happen.
And along the way, we will be inevitably taking actions or not taking actions depending upon how we envisage the economy responding to not only monetary and fiscal policy but external forces as
well.
Mr. ROTH. I don't want to be adversarial, I am just looking for
an answer here. You had mentioned searching for zero inflation.
Mr. Neal is worshipping at the altar—and fine—of zero inflation.
Would it be fair to say that the Fed is really saying may be, inflation is what we are focusing on. Therefore, we are wedded to a
tight money policy?
Mr. GREENSPAN. No, actually I wouldn't say that, Congressman.
I would say that what we are wedded to is the path of policy which
will engender the highest long-term sustainable rate of growth in
this economy. Remember that it is the real variables that matter.
It is not money as such. It is not prices. It is not interest rates.
It is our standard of living. That is what it is all about.
The financial system is a mechanism which enables us to move
forward, and the way the central bank functions is through the financial system. I would not say that our basic focus is tight money.
I would say that our basic focus is to set the financial conditions
which maximize long-term, sustainable economic growth.
There are occasions when, if there are distortions in the system
like the credit crunch, in our judgment rates should come down
and be accommodative and deliberately accommodative.
Mr. ROTH. What I was striking at, years ago the political debate
used to be are you for tight money or easy money and I would say
in today's formula if we turned the clock back and they hear this
debate they would say, well, they are for tight money.
26
Mr. GREENSPAN. I am thankful that debate is behind us and
those terms don't have terribly much usefulness anymore. At least
I hope.
Mr. ROTH. Thank you, Mr. Chairman.
Chairman KANJORSKI. Thank you, Mr. Roth.
Mr. Neal of North Carolina.
Mr. NEAL. Thank you, Mr. Chairman. I was going to put it exactly in those terms. I was making a note to myself in response to
Mr. Kanjorski's comment about the growth level in China. It seems
to me the focus should be exactly as you put it, on our standard
of living, and the economic prosperity. And what we have learned—
and I think I misspoke a little bit earlier. This is not really a new
discovery.
This is a reaffirmation of something that I think that most economists hail to be true throughout most of our history, is that we are
best served by low inflation. And we went through a period, I guess
starting during the Great Depression and for some period after
when we thought it was a good idea to sort of use monetary policy
to fine tune the economy and that we might actually enhance our
standard of living today by focusing on something, energy prices tomorrow, and interest rates some other day, on something else.
I think that we have reaffirmed that the way we get everything
that we want in terms of economic policy that the Fed can deliver—it can't deliver it all—in terms of enhancing our standard of
living is to give us low inflation. You give us low inflation, you enhance our standard of living. That is the emphasis.
And certainly—I want to commend our chairman for his very
thoughtful approach to this whole subject and to the hearings and
to this major responsibility, because this is so important to our
standard of living. China has had opportunity to grow because they
started at such a low level, but their standard or living is nothing
like ours and it won't be for a long time.
Ultimately, I don't even know what their rate of inflation is now.
I know that many years ago they had a dedication to no inflation.
They weren't going to let it get out of hand. I understand they have
let it get out of hand lately, and if they have then, of course, that
will detract from their standard of living.
And one other point I want to make before yielding to the chairman, the real beneficiaries of this are low- and moderate-income
people, working people, because these are the people who have the
least ability to deal with inflation. I mean, I remember even in the
high inflation times of the late 1970's and into the 1980's that sophisticated investors could make money under any circumstances.
It was the working guy that had a heck of a time or a small businessman. I am sorry Mr. LaFalce is not here at this moment, although I know he Knows this—it is the small business guy who
can't adjust prices rapidly and adjust to inflation. Where a big business or a monopoly or an oligarchic situation would probably maintain a price level in light 01 even high inflation, a small business
guy can't.
I know. I ran a small business during a high inflation time and
it was very hard for me to go up in prices in a way that would keep
up with it. Anyway, the point is I just think you are right on target
when you say that the goal is our high standard of living and what
27
we have learned and reaffirmed empirically is that the way to enhance our standard of living is to keep inflation down.
I do want to ask you one specific question before I yield, if I may.
There is a letter to the editor here in the New York Times, I believe
this is, and it is signed by Mr. Jeffrey Moore, who is the director
of Center for International Business Cycle Research at Columbia
University. And he says that—I am paraphrasing now, but he says
that Columbia University has developed a very reliable series of
leading inflation indicators that have—individually and collectively
have a stellar record in predicting cycle turning points in inflation
and he mentioned some of them.
For example, in January, commodity price inflation rose sharply.
The percentage of purchasing managers reporting higher prices
jumped from 51 to 60 percent. These indicators that he mentioned
are a composite of leading indicators that were developed by Columbia University and this index has had an extraordinary reliable
record of forecasting upturns and downturns in inflation, and that
this indicator rose sharply last month and is growing at its fastest
pace in 10 years. I wasn't familiar with this index. I am sure you
are.
Is it as reliable as he says? Is this something that you look at?
Mr. GREENSPAN. We are in the process of looking at it. And what
I am not aware of is whether or not such things as other financial
variables which express monetary expansion are excluded and yet
may actually be part of the cause of the process. In other words,
it may be that the index is a good projector of economic activity.
And if economic activity has a large element of monetary accommodation in it, that will engender inflation.
As I said earlier, that is not a necessary result—I should say if
the economy expands, it doesn't necessarily mean that inflation is
expanding, but it would if there was financial tender in the process. I must say, I will look at this very closely because Prof. Geoffrey Moore taught me Statistics I.
Mr. NEAL. No kidding.
Mr. Roth wanted me to yield.
Mr. ROTH. Thank you. Speaking of professors, we used to have
debates in our universities about, you know, zero inflation versus
jobs. In other words, you had to have some inflation to create jobs.
It was good for the job climate if you had some inflation. Is that
all heresy today?
Mr. GREENSPAN. Yes.
Mr. ROTH. It is?
Mr. NEAL. May I just say on that level, I think this is a very important point because there are a lot of people that still think that
the way to increase employment is to increase inflation levels. But
it is just not sustainable. That is the point.
Sure, you can jump up employment levels for a brief period of
time, I think the chairman would agree, by stimulating up the
economy. You just can't sustain it. Then you have a correction in
the economy, and most of those same people are then unemployed.
Isn't that about what happens? So, sure you can do it temporarily,
you just can't sustain?
Chairman KANJORSKI. Mr. Bachus of Alabama.
28
Mr. BACKUS. Mr. Chairman, in my opening remarks, I talked
about the Senate considering a balanced budget amendment at the
present time. And as you—if you listen to it, there are a lot of
moral arguments for why we shouldn't have a budget deficit, but
I want to talk about the economic reasons, not the moral reasons,
and ask you for some comment.
I read today where former Senator Paul Tsongas made this remark. He said that the deficit threatens our future productivity by
sopping up private savings that ought to be invested to create
greater wealth in years to come. And it is this idea that the deficit
obviously has a negative effect on private savings and, therefore,
future productivity. And I have heard before arguments that for
every billion dollars of deficit we eliminate 20,000 or 30,000 jobs in
the private sector or we retard the growth of jobs in the private
sector.
And my question to you is this: What is the economic impact of
the deficit? What—and I am going to just pose four or five questions, all of which you can—I think you can answer one or as many
as necessary.
One is, what is the effect of the deficit on interest rates? What
is the effect of the deficit on inflation? What is the effect of the deficit on job formation in the private sector? And probably maybe
something that summarizes all of that, what is the effect of the deficit on future economic growth?
Mr. GREENSPAN. Congressman, as I have testified before this
subcommittee and others over the years, most of these issues have
come up, and let's see if I can just basically summarize.
The deficit, basically, is a corrosive force in the economy which,
as Senator Tsongas mentioned, tends to drain private saving. If the
diversion of the saving were into productive assets, then one would
have to weigh whether or not the private saving were employed
more efficiently than public. But I regret to say that there is very
little evidence to suggest that the public investments that have
been involved in the diversion have been anywhere near as productive as the loss that occurs as a consequence to private savings,
that is, the diverting of private saving from private investment into
public investment or spending, whatever we choose to term it.
The deficit is inflationary if it is accommodated by the central
bank. That is, to the extent that you are dealing with a very large
amount of Federal borrowing, if it overwhelms the private system
and there are pressures for the central bank to buy the debt, as
has occurred very often in many countries over the decades, you
get a major increase in inflation. And, indeed, virtually all of the
hyperinflations that we have seen around the world occurred as a
consequence of that particular process.
The issue of jobs is a little more difficult, in the sense that it is
not evident over the long run that the unemployment rate is significantly affected one way or the other. So that what we are looking at is not the job issue as crucial, but the real earnings and the
standard of living are affected. In other words, your job may not
be eliminated, but your income will be less in real terms if the deficit is diverting resources from private investment into public
spending.
29
And I think that is the lesson for the fixture. The evident concern
that many have had about the deficit, including the President, is
that at the current services budget, at least as of last year, was accelerating to the point where, if left unattended, it had within it
the seeds of an explosionary expansion of Federal debt, with the
potential consequences, as I said in my opening statement, of having to go to the printing presses to finance it.
Mr. BACHUS. Do you say the deficit is a threat to our future economy? And I think you have probably answered that as a yes.
Mr. GREENSPAN. Yes, indeed.
Mr. BACHUS. Mr. Chairman, I have one question about the trade
deficit, and I can reserve that for later, but I think it is an important question. And if I could proceed or if you would rather me——
Chairman KANJORSKI. Let's continue the rounds on the 5-minute
rule.
Mr. BACHUS. Sure. Thank you.
Thank you, Mr. Chairman.
Chairman KANJORSKI. It is so tempting to get into the budget
amendment. I will pass on it.
Mr. Greenspan, in the latter part of my opening remarks I talked
about the need for regulatory reform. And I know that from reading some of the most recent editorials in The Washington Post and
otherwise, some of the jurisdictions debating that issue in town are
starting to draw definable support areas. I notice that the Federal
Reserve certainly did from the Post editorial.
I do favor regulatory reform. I think it is essential that we start
reducing the cost of regulation on the various banking institutions
involved and to get some structure here that does not have so
much overlap. I guess I am asking your opinion or I would ask you
to respond to the question of in what other regulatory agency that
you are aware of does the industry get to choose from between Federal and State regulation? And then if they do choose Federal regulation, do they get to choose between the regulators?
It seems to me that there is some special favor available here or
special accommodation of favor there in our banking institutions
that do cost additional monies to other institutions and perhaps begets favoritism or vying for their business, if you will. Could you
respond to that?
Mr. GREENSPAN. First of all, it is certainly true that in our Federal system there are a number of activities you cannot have other
than a single regulator. For example, Federal Communications
Commission, when it is distributing its bands, can't have another
regulator sitting there and doing the same thing. Similarly, in our
case, there can only be one monetary policy in an economy and that
by its very nature can only be done by one agency.
The difference is in the financial system. It varies. For example,
while it is certainly true that the Securities and Exchange Commission is the major rulemaker of certain aspects of our financial system, the actual supervision and regulation and examination is done
by the self-regulatory organizations—the New York Stock Exchange, and the American Stock Exchange, National Association of
Securities Dealers. And in that respect individual companies and
individual members can choose to be in one regime or another. So
there is an element of choice involved there.
76-694 0 - 9 4 - 2
30
The crucial question, however, which you raise, which is one that
we address and are concerned about, is what used to be called the
issue of basically shopping for form of competition in laxity, if I
may put it that way. There is that potential problem.
In our judgment, however, it is very significantly contained by
the fact that the statutes under which we function very much inhibit the degree to which any of the agencies can endeavor to attract clients, if I may put it that way. And, indeed, it is the culture
of the Federal Reserve not to do that, and that the element of
choice that we consider so important in a regulatory system essentially is an inhibition on arbitrary actions and arbitrary procedures
and processes by regulators.
In our judgment, the problem that exists from the question of
choice is very easily controlled by the statutes. And, indeed, we
have had a number of Federal regulators now, and there is very
little in the way of that type of problem evident in today's markets.
Chairman KANJORSKI. Mr. Greenspan, would you not attribute
some portion of the S&L disaster to the fact that we had different
regulators on the Federal level and the State level and each of the
various States had different levels of regulation?
Mr. GREENSPAN. First of all, we had a single Federal regulator.
But I don't think that the analogy of that particular type of situation is really relevant to this. That was a debacle which was
caused, basically, by very fundamental economic forces. The existence of a depository institution which had long-term assets and
short-term liabilities, an institution which can exist only in a noninflationary environment, a specialized type of institution which,
when confronted with inflationary pressures, began to have a major
problem associated with it.
And, as you may recall, Mr. Chairman, in the early 1980's when,
marked to market, that industry probably had zero capital or probably very significant negative capital. There were a number of actions that were taken both by the Congress and by the State agencies which tried to grow their way out of that problem. And with
the very substantial difficulties associated with it.
I would not think that is a relevant model to determine what
banking structure should look like because banks are not like savings and loans in the sense that, while there is some mismatch of
a minor nature between asset and liability maturities, it is very
minor, and the types of difficulties that occurred in the savings and
loan area, I do not think, are applicable to banking regulation and,
therefore, would not consider that something which would give me
grave concern.
Chairman KANJORSKI. Mr. Roth.
Mr. ROTH. Well, Mr. Chairman, it looks like we are winding
down our testimony and Q and A today. But before we leave I want
to go back to one of our previous hearings we had here on Capitol
Hill when the chairman of the full committee had the legislation
dealing with the Federal Reserve legislation to open up the Federal
Reserve's meetings, deliberations and so on. Since that meeting,
have you given some thought to how we should open up the Federal Reserve? I mean, after all, it has got tremendous impact and
power over our economy and over the lives of every American.
31
I was just wondering, since that hearing, what have been some
of your thoughts about the Fed and what the people should know
about the Federal Reserve?
Mr. GREENSPAN. First of all, Congressman, let me say that when
you have a central bank in a democratic society which has to be
independent if it is going to have the appropriate authorities to
maintain policy, then to the extent that the institution is independent, it should be accountable to the legislature and the electorate.
And the question here gets down to the tradeoff that exists between our efficiencies of deliberation which requires, in my judgment, that we have the ability within our group to be open, frank
and not worry about talking in public because of the concern we
would have of its effect on the market. So we are caught in this
situation where we have got to maintain maximum deliberative capabilities but still recognize that, if we wish to be independent, we
nave to be accountable.
And it is that sort of issue which we have been working on for
well over a year. And we are making some progress in that regard,
and I think we are going to find certain things which are not necessary for preserving our deliberative processes and which I think
we could probably divulge more so than we have been doing. But
that has not been concluded yet. We still have a number of things
to do.
And one of the reasons we can't do it piecemeal is that they are
all related to one another, and we are trying to find what we hope
to be the appropriate balance. It is not easy, but I think that the
issue that is involved here is a necessity for accountability if we
wish to maintain an independent central Dank.
Mr. ROTH. So, basically, a policy is evolving now. And if I understand you correctly, you are giving this some thought. Then you are
going to make some statement or something in the future?
Mr. GREENSPAN. Yes, exactly.
Mr. ROTH. Thank you very much, Mr. Chairman.
Chairman KANJORSKI. Mr. Neal.
Mr. NEAL. On that question, it seems to me that the—I mean,
obviously, there are different levels of accountability. But you have
accountability to not misspend money and not—I mean, that your
salary levels are reasonable and all that.
But the most important level of accountability, it seems to me,
ought to be how well you are meeting the most important goal of
your monetary responsibility, which is low inflation. I mean, it
seems to me we miss the point if we try to shift away from that
somehow.
I mean, when we go to a mechanic to fix our car, we want him
to get the car running right. We don't ask him to let us look over
his shoulder down into the pistons. I mean, it wouldn't do us any
good anyway. Certainly, wouldn't do me any good because I dont
have the foggiest notion of how all that works, and I don't care.
What I want is the fixer. I want my dentist to fix the teeth right.
I want everybody else to do their job right.
That is what our focus ought to be here, and we shouldn't lose
sight of it. I hope we do that.
I want to ask, Mr. Kanjorski
Mr. GREENSPAN. Can I just comment on that?
32
Mr. NEAL. Please, yes, sir.
Mr. GREENSPAN. I don't disagree with the basic thrust of how one
evaluates the central bank. The ultimate evaluation is not how we
do it, but what we do, obviously.
I was actually responding to Congressman Roth's question in a
much more narrow sense. I thought he was asking about strictly
the issue of disclosure, if I understood him correctly. Not the broader question. And I was trying to respond only to that issue, which
is a much narrower question than you are raising.
Mr. NEAL. Exactly.
Mr. Kanjorski raised the issue of regulatory reform, and I just
wondered if you would want to comment briefly on that. As I understand it, the reason you think it is important that the Fed keep
a hand in the regulatory structure is so that you will be able to
better fulfill your responsibilities as lender of last resort or the responsibility tnat you have been given to help sort things out when
our economy gets into crisis situations, as it has on several occasions and may again.
Is that what your concern is? Or I wonder if you would elaborate
a little bit on that.
Mr. GREENSPAN. Yes. There are basically two issues, Congressman. The first is that, as lender of last resort, we are in a position
where, in the event of a financial crisis it is we who have to in real
time act decisively in real time to contain it or, hopefully, in advance to prevent the issue from arising.
We have found over the years that our hands-on supervision and
regulation has given us a body of information and a set of relationships with the financial system in very great detail so that, when
confronted with a major crisis, we know which buttons to push and
where the problems may conceivably arise. If we did not have that
expertise of supervision and regulation and did not have the continuing supervisory role that we have, I am not certain that we
would be as capable of containing those crises as I think we have
been over the years.
Second, we also gain a very important amount of information
from our examination and supervision of banks, both large and
small. And that has been very helpful to us in formulating monetary policy.
And, in our judgment, while we certainly agree that some consolidation of the Federal regulatory banking agencies is desirable,
that there are benefits to be derived from that and it is addressing
real problems which I think have to be resolved, in our judgment,
virtually all of the benefits that can be derived in consolidating to
a single Federal banking regulator would accrue to a system in
which there were two regulators and, in which the Federal Reserve
was one. And it is especially important because we also bring to
the supervisory process a judgment of its impact on the economy.
And, for example, our regulations and rulemaking which were
associated with the credit crunch focused substantially on our recognition of how do we make the banking system function better.
Our concern is, without the Federal Reserve's presence in that
process or some other economic agency's presence in that process,
that banking supervision and regulation would become a structure
of rules which would not appropriately capture the important role
33
which banking has in the financing of small- and medium-sized
businesses in this country.
Mr. NEAL. May I just say, it seems to me that it might be useful
if you could detail how your regulatory role helped you deal with,
say, the stock market crash of 1987 or, say, go back and take a look
at the time that your predecessor, Mr. Volcker, intervened to help
stabilize the savings and loan crisis or your reaction during an oil
price jump, some of those things where we might have your
thoughts on the Fed's practical experience in some of these areas.
Mr. GREENSPAN. I will be glad to do that.
Mr. ROTH. Would the gentleman yield for a quick comment?
Mr. NEAL. Yes, sir.
Mr. ROTH. Thank you, Mr. Neal, I appreciate it.
This question of openness of the Fed, I think, is very important.
I was just going to mention in response to Mr. Neal that I was
speaking in the oroad sense because I think that this is a big issue
and because this affects everyone's lives.
Mr. Neal, you had mentioned that if the Fed takes care of inflation, I don't care how they do it. Well, that is almost like saying
I don't care what the government does as long as the trains run
on time. That didn't work well with the government, and it
wouldn't work well with the Fed either.
So I just want to get this parting comment in, that this openness
of the Fed, I think, is very important because the American people
are very much affected by what the Fed does.
Mr. NEAL. Another example you might try to detail for us would
be the LDC debt situation. I just think some of these specific examples would help us.
Mr. GREENSPAN. Yes, there are a number of episodes which go
back to, in the last 15 years, the LDC debt crisis, the Ohio savings
and loan crisis, the stock market crash, the junk bond problem that
we had with Drexel Burnham, all I think would have been materially affected—or I should say how we handled those would have
been materially affected had we not had hands-on supervision and
regulatory authorities.
Mr. NEAL. If we could just understand that better, it would help.
Thank you.
Mr. GREENSPAN. I will be glad to.
Chairman KANJORSKI. Mr. Chairman, if you would do that for
the record, we would appreciate it.
Mr. GREENSPAN. Yes, why don't I do it for the record?
[The information referred to can be found in the appendix.]
Chairman KANJORSKI. Mr. Bachus.
Mr. BACHUS. Thank you, Mr. Chairman.
Chairman Greenspan, one of the most disturbing things about
the report, the monetary report, is what vou say about trade. And
I think on page 4 you say that imports from abroad will continue
to increase at a brisk pace and that we can expect, at least shortterm, for exports of goods and services to decline, which—is
that
Mr. GREENSPAN. The rate of growth of exports would be less than
the rate of growth of imports.
Mr. BACHUS. Which means a growing trade deficit?
Mr. GREENSPAN. Yes.
34
Mr. BACHUS. Let me ask you this. Are you factoring into that—
vou know, we have had a pretty—the course of energy prices has
been very favorable. We have had declining energy prices for the
last year, and yet our trade deficit is going up. And if energy prices
turn around and the future course is up or even flat, I think it can
even have a greater effect on our trade deficit.
And then we have the problem of our 1993 harvest is less than
we had anticipated. We are not going to—we are going to have—
some of our agricultural export items are in tight supply.
Mr. GREENSPAN. I think that is correct, sir.
Mr. BACHUS. So it could actually be worse than even maybe we
were predicting a few months ago. But my question is maybe not
how bad it is. I think by all estimates the trade deficit is growing,
and my question to you is, what effect is that going to have on our
economy or on our interest rates?
Mr. GREENSPAN. Remember that to a large extent one's trade
deficit or current account deficit, which is the broader definition, is
a very complex issue which is affected to a very substantial extent
by the relationship between our domestic saving and our domestic
investment. In other words, if we have to bring in capital to finance
our domestic investment, that is another way of saying we have got
a current account deficit. The arithmetic requires that. So it is not
always clear which of these various elements is causing the process
to occur.
It is different, however, from the budget deficit issue. The budget
deficit issue is unequivocal in the sense that if the budget deficit
gets too large, it becomes a very corrosive force on the economy.
The issue of the trade deficit is somewhat different. In other
words, without stipulating what is causing it or what the elements
involved in it are, it is not in and of itself something which is negative to the economy. Indeed, the United States imported a huge
amount of capital in the 19th century to finance the growth in this
country, and I guess even though we didn't have data in those
days, we had a current account deficit of substantial proportion for
a long period.
It really depends on what it does. In other words, if the capital
that comes in that is implicitly the other side of the deficit—is
highly productive, it is by no means clear that that is bad. So you
can't say in and of itself a trade deficit or a current account deficit
is bad. It surely does not, as some argue, shift jobs out of the society, because when our unemployment rate was low, we had a very
high deficit—I mean trade deficit.
And, clearly, you know, you can't argue that if our deficit were
less that employment would have been higher because it wouldn't
have been. It couldn't have been.
So it is a very complex question, and I hope that we are aware
that trade deficits per se are not something evil. It used to be when
we had mercantilist views of the world several hundred years ago,
and regrettably in many areas still today, that one considered one's
trade surplus as a measure of the wealth or effectiveness of an
economy. That clearly was not true then. It is not true today.
Mr. BACHUS. Mr. Chairman, let me just—you talked about the
Nation's savings rate is probably more important. What is the outlook for our Nation's savings rate?
35
Mr. GREENSPAN. I would say to a large extent, Congressman, it
probably depends on the budget deficit. Because to the extent that
we lower the budget deficit, the private national saving rate, which
is really the crucial number, will tend to rise. And of all of the various policies which we thought about over the years which would
enhance the saving rate, there turns out to be none which is likely
to be as effective as just bringing down the budget deficit.
Mr. BACKUS. And that would have a positive effect on our savings rate and that should be more our concern than
Mr. GREENSPAN. Very much so.
Mr. BACKUS. All right. Thank you, Mr. Chairman.
Chairman KANJORSKI. On that point, Mr. Chairman, I think in
your testimony you congratulate the President and Congress in the
action taken last July. And you call the attention of this subcommittee, and I think in your report, to the fact that this was the
first courageous activity taken to turn around the rate of increase
in the deficit and that this course is in fact the proper course. Is
that correct?
Mr. GREENSPAN. As I testified before this subcommittee and
other committees of the Congress, while I may not have agreed—
as, indeed, I think nobody fully agreed with the details of the budget processes that were finally hammered out here—the markets
very clearly viewed deficit reduction as positive in the sense that
there would be, as a consequence of that action, less claim on the
Nation's saving than would otherwise have been the case.
Chairman KANJORSKI. Do you want the opportunity to express
your opinion on whether or not you favor a constitutional amendment for balanced budget or would you prefer
Mr. GREENSPAN. I have testified on this issue innumerably in the
past, Mr. Chairman, and will very succinctly say that I do think
that there is a bias in our budgetary processes which creates the
tendency for a rate of increase in outlays which probably exceeds
chronically the rate of increase of the tax base and there is a problem there which has to be addressed.
I don't think that endeavoring to constrict expenditures after
they have been appropriated is a very useful activity because, as
you know better than anyone, once you have an authorization and
an appropriation process which pushes funds through the system,
to try to reduce it at that point is exceptionally difficult.
So I have argued that if we are to go to a constitutional amendment—and I have done this fairly consistently over a long number
of years—I would favor that we address this bias through the requirements of super majorities on both authorizations, appropriations and outlays, in an endeavor to require that you get programs
which are considered effective and useful, that you require more
than the standard majority. In my judgment, that would effectively
reduce the bias and, accordingly, tend to create a much easier
budgetary process in the future.
Chairman KANJORSKI. All right.
Mr. Chairman, we are going to soon get an opportunity to leave
for lunch. I am going to ask you one more question.
As occurred on February 4 when the FOMC announced its determination to raise the rate, can we anticipate that this is a new procedure or process or precedent that you will follow in the future re-
36
garding meetings of the FOMC? That if there is an increase, it will
be announced that day, or immediately after the meeting? Or do
you intend to hold it as you have in the past until some future
date? And if you could tell us why as to either.
Mr. GREENSPAN. As I mentioned in answer to one of the questions of vour colleagues, the issue of precedent was not addressed
in that decision. That is, we had a very specific reason at that specific time to decide that we wanted to have an announcement effect, as well as a rate effect, which we ordinarily have not done,
indeed had never done, with respect to the Federal funds rate.
That was not meant to be a precedent.
We are, however, discussing a number of these issues—and this
reflects my conversation with Congressman Roth—that will go over
these and make decisions, hopefully sooner rather than later, as to
what our approach is going to be, and find ways, having rethought
all of these things, to implement when we announce, what we
announce, how we announce and the timeliness of various
announcements.
Chairman KANJORSKI. I conclude from your testimony, Mr.
Chairman, that you are more optimistic than you are pessimistic
about the future of the economy, both short term and long term,
and that you think that we are in better shape than we have been
in several decades in terms of our economic house being in order;
is that correct?
Mr. GREENSPAN. That is correct, Mr. Chairman.
Chairman KANJORSKI. Well, we hope that your reading of the tea
leaves is correct, Mr. Chairman. We will have to stand by you as
long as that authority rests on your shoulders.
Thank you for coming before the subcommittee and being as accommodating as you have been. Thank you very much.
Mr. GREENSPAN. Thank you.
[Whereupon, at 12:32 p.m., the hearing was adjourned.]
37
APPENDIX
February 22, 1994
38
Opening Statement
The Honorable Paul E. Kanjorski, Chairman
Subcommittee on Economic Growth & Credit Formation
Semi-Annual Hearing on the Conduct of Monetary Policy
February 22,1994
The Subcommittee meets today to receive the semi-annual report of the Board of
Governors of the Federal Reserve System on economic and monetary policy as mandated under
the Full Employment and Balanced Growth Act of 1978, popularly known as the HumphreyHawkins Act.
Under the Humphrey-Hawkins Act, the Federal Reserve is required to set forth:
1. A review and analysis of recent developments affecting economic trends in the
Nation, including changes in the exchange rate;
2. The objectives and plans of the Board of Governors and the Federal Open Market
Committee with respect to the ranges of growth or diminution of the money supply, taking into
account past and prospective developments in employment, unemployment, production,
investment, real income, productivity, international trade, and prices; and
3. The relationship between the Federal Reserve's plans and the short-term goals set
forth in the most recent Economic Report of the President, and any goals set by the Congress.
I want to welcome Chairman Greenspan back before the Subcommittee today. Since we
last met to discuss monetary policy in July there have been major developments in our nation, the
economy, and at the Federal Reserve and the Federal Open Market Committee.
Much of the economic news of the last six months has been encouraging:
• Inflation remains low - In January the Consumer Price Index was unchanged. In the
fourth quarter of 1993 it increased at an annual rate of only 1.9%; and for the last two years it has
increased only 3% per year, the lowest rate in many years.
• Labor costsr which are a good predictor of future inflation,, remain stable — Both
Unit Labor Costs and the Employment Cost Index were unchanged in 1992 and 1993. Unit labor
costs increased even more slowly than inflation, rising only 2% each year.
39
• Unemployment continues to decline — While last month's change in the way
unemployment data is collected and reported make year-to-year comparisons more difficult, it is
clear that the unemployment rate continues to drop, and total civilian employment continues to
increase significantly. Just since President Clinton took office, total employment has grown by
3.5 million jobs.
• The Gross Domestic Product (GDP) continues to grow - GDP grew 2.9% in 1993.
It grew at a rate of at least 4.5% in the second half of the year and preliminary data suggest it
grew at between 5.9% and 7% in the fourth quarter of 1993. Furthermore, most of the growth
came about as a result of increased sales, not as additions to inventory.
• Until the Federal Reserves* actions of February 4. interest rates remained low At the end of 1993 interest rates for virtually all maturities hovered at, or below, the rates of six
months and a year earlier. Stability was the watchword for interest rates in 1993. In 1993, for
example the discount rate and the prime rate remained unchanged all year at 3% and 6%
respectively, home mortgage rates dropped from 7.8% to 6.8%, and 3-month T-Bill rates never
varied far off 3%.
• Bank and thrift profits are up and the cost of the S&L clean-up is dropping The FDIC's Bank Insurance Fund (BIF) is back in the black, and S&L clean-up costs continue to
decline, not increase. With the passage of the RTC Completion Act, it is expected that no
additional tax dollars will be necessary to resolve past problems. In addition to a third
consecutive quarter of record profits, assets and deposits at financial institutions have grown
modestly, problem loans have decreased, and capital has increased. For the first three quarters of
1993, 95% of all banks were profitable and earned a total of $31.4 billion, compared to the
relatively small $840 million lost by the 5% of banks that were unprofitable. And finally, but no
less importantly,
• The federal deficit is being significantly reduced - Passage of President Clinton's
deficit reduction bill has substantially reduced both current and future federal deficits.
While there has been progress on many fronts, areas of concern remain:
• Commercial and industrial lending by banks remains stagnant — Even with
orders and new home construction up, total commercial lending by banks remains virtually
unchanged.
• The California earthquake and the unusual snow storms and cold weather in the
East may depress first quarter economic activity — Many businesses and individuals lost
income and saw their energy costs increase substantially in January and early February.
• The Fed increased the Federal Funds Rate by 1/4 of 1% on February 4
triggering an increase in short tcrfti interest rates and a 96 point drop in the Pow Jones
industrial average. The Dow's drop was the largest one-day drop in two years, and was not
temporary, more than two weeks later the Dow is still 80 points, or 2%, below the level it closed
on February 3. It is clear that stock and bond traders are very unsettled by recent developments.
40
In the words of one news report, "...it appears that rather than reassuring traders and investors,
the Federal Reserve has managed to leave them with a worse case of the jitters."
What concerns me the most, and what I hope Chairman Greenspan will explain today, is;
Why did the Fed raise short term interest rates when there has been no evidence that inflation is
increasing? In addition to the fact that the most recent CPI figures indicate that inflation is
frozen in its tracks, inflation data is no worse today than it was when Chairman Greenspan
last reported to us in July. Tn fflCti flfit^fll inflation performance is at the absolute low end of the
range Chairman Greenspan, predicted last July.
Why did the Federal Reserve increase the Federal Funds Rate -when inflation is at or
below the rate you predicted? How are economic conditions today different from last July? If
the inflation rate was not a problem in 1993, why is it suddenly a problem in 1994 when the
basic rate remains unchanged?
Like many Americans, I am concerned that the Federal Reserve's action may impede or
even end our slow economic recovery. I know that Federal Reserve economists have models
which predict the economic consequences of the Fed's February 4 action. I hope that Chairman
Greenspan will describe for us today what the Fed's model projects, and that he will provide a
detailed description of that model for the record.
Since the Federal Reserve has tightened monetary policy in the absence of data
suggesting that inflation is increasing, it is incumbent on Chairman Greenspan to advise us what
types of circumstances in the future would warrant similar action by the Fed? If inflation
remains at the 3% level, can we expect the Fed to raise the Federal Funds Rate again, or take
other action to contract the money supply?
Another area that concerns me is the Federal Open Market Committee's continued
inability to meet its projections for M-2 and M-3 growth. Leaving aside the arguments over
whether the ^ >MC's targets for M-2 and M-3 are too high or too low, or whether the range the
FOMC uses for its projections is too wide, it astounds me that the FOMC consistently fails in
any meaningful way to keep M-2 and M-3 in the ranges they predict. Furthermore, in recent
years the FOMC is consistently below the range it predicts.
This inability to meaningfully meet broad targets which the Federal Reserve itself selects
does not inspire confidence in the Fed.
Chairman Greenspan, why isn 't the Fed doing a better job of meeting its monetary
targets?
If, as Chairman Greenspan has reported to us on several occasions, the Fed has less
confidence than in the past in the value of M-2 and M-3 as economic indicators, I hope he will
also report to us today on what steps the Fed is taking to identify or define an acceptable
substitute. We need to know what measuring sticks the Fed is using, so that we can evaluate the
performance of the economy, as well as the performance of the Fed.
41
Finally, the Federal Reserve has been very vocal in recent months in suggesting that it is
imperative that the Fed continue in its role as a regulator of financial institutions and that banks
should be able to choose not only whether they have a federal or a state charter, but also whether
their primary federal regulator should be the Federal Reserve or the Administration's proposed
Federal Banking Commission.
Some critics have suggested that the three-way regulatory scheme advocated by the Fed
perpetuates unnecessary overlap and duplication, and also makes it easier for financial
institutions to play one regulator off against another. Many of these same critics contend that
this "least common denominator" approach to financial regulation was a major contributor to the
S&L crisis.
In \vhat other regulated industry does the regulated entity not only get to choose between
federal and state regulation, but also gets to choose -which federal regulator they want? What
makes bank regulation so different from securities regulation, food and drug regulation, and
nuclear power plant regulation? What public purpose is served by allowing banks a choice that
other regulated industries do not have?
Again, let me welcome you back before the Subcommittee, Chairman Greenspan. There
are clearly a number of important issues which we must discuss, and I look forward to hearing
your testimony.
42
For use at 10:00 a.m. EST
Tuesday
February 22. 1994
Testimony by
Alan Greenspan
Chairman
Board of Governors of the Federal Reserve System
before the
Subcommittee on Economic Growth and Credit Formation
of the
Committee on Banking, Finance and Urban Affairs
U.S. House of Representatives
February 22. 1994
43
Mr. Chairman and members of the Subcommittee, I am pleased to
appear today to present the Federal Reserve's semiannual monetary
policy report to the Congress.
In the seven months since I gave the previous HumphreyHawkins testimony, the performance of the U.S. economy has improved
appreciably.
Private-sector spending has surged, boosted in large
part by very favorable financial conditions.
With mortgage rates at
the lowest level in a quarter century, housing construction soared in
the latter part of 1993.
Consumer spending, especially on autos and
other durables, has exhibited considerable strength.
Business fixed
investment has maintained its previous rapid growth.
Important com-
ponents of GDP growth in the second half of last year represented onetime upward adjustments to the level of activity in certain key sectors, and, with output in these areas unlikely to continue to climb as
steeply, significant slowing in the rate of growth this year is widely
expected.
In addition, the Southern California earthquake and severe
winter weather may have dulled the force of the favorable trends in
spending in January and February.
Nonetheless, as best we can judge,
the economy's forward momentum remains intact.
The strengthening of demand has been accompanied by favorable
developments in labor markets.
In the second half of the year, em-
ployment continued to post moderate gains, and the unemployment
rate
fell further, bringing its decrease over the full year to nearly 1
percentage point.
The unemployment rate in January apparently de-
clined again on both the old and new survey bases.
On the inflation front, the deterioration evident in some
indicators in the first half of 1993 proved transitory.
For the year
as a whole, the Consumer Price Index rose 2-3/4 percent, the smallest
44
increase since the big drop in oil prices in 1986.
Broader inflation
measures covering purchases by businesses as veil as consumers rose
even less.
While declining oil prices contributed to last year's good
readings, inflation measured by the CPI excluding food and energy also
diminished slightly further, to just over a 3 percent rate for the
whole year.
whole.
In January the CPI remained quite well behaved on the
Not all signs have been equally favorable, however.
For
example, a number of commodity prices have firmed noticeably in recent
months.
And indications that such increases may be broadening
engendered a back-up in long-term interest rates in recent days.
In
particular, the Philadelphia Federal Reserve Bank's survey showing a
marked increase in prices paid by manufacturers early this year was
taken as evidence of a more general emergence of inflation pressures.
It is important to note, however, that in the past such price
data have often been an indication more of strength in new orders and
activity than a precursor of rising inflation throughout the economy.
In the current period, overall cost and price pressures still appear
to remain damped.
Wages do not seem to be accelerating despite
scattered reports of some skilled-worker shortages, and advances in
productivity early this year are holding down unit labor costs.
Moreover, while private borrowing has picked up. broad money--to be
sure a highly imperfect indicator of inflation in recent years--has
continued to grow slowly.
Nonetheless, markets appear to be concerned that a strengthening economy is sowing the seeds of an acceleration of prices later
this year by rapidly eliminating the remaining slack in resource
utilization.
Such concerns were reinforced by forecasts that recent
45
data suggest that revised estimates of fourth-quarter GDP to be released next week will show upward revisions from the preliminary 5.9
percent annual rate of growth.
Rapid expansion late last year, it is
apparently feared, may carry over into a much smaller deceleration of
activity in 1994 than many had previously expected.
But it is too early to judge the degree of underlying economic strength in the early months of 1994.
Anecdotal evidence does
indicate continued underlying strength in manufacturers' new orders
and production, but we will have a better reading on new orders on
Thursday when preliminary data for January are released.
The labor
markets are signalling a somewhat less buoyant degree of activity as
initial claims for unemployment insurance in recent weeks have moved
up a notch.
Clearly, the Federal Reserve will have to monitor care-
fully ongoing developments for indications of potential inflation or a
strengthening in inflation expectations.
As I have often noted, if
the Federal Reserve is to promote long-term growth, we must contribute, as best we can. to keeping inflation pressures contained.
In this regard, a clear lesson we have learned over the decades since World War II is the key role of inflation expectations in
the inflation process and in the overall performance of the macroeconomy.
As I indicated in my testimony before the Joint Economic
Committee last month, until the late 1960s, economists often paid
inadequate attention to expectations as a key determinant of
inflation.
Unemployment and inflation were considered simple
tradeoffs.
A lower rate of unemployment was thought to be associated
with a higher, though constant, rate of inflation: conversely, a
higher rate of unemployment was associated with a lower rate of
inflation.
46
But the experience of the past three decades has demonstrated
that what appears to be a tradeoff between unemployment and inflation
is quite ephemeral and misleading.
Attempts to force-feed the economy
beyond its potential have led in the past to rising inflation as expectations ratcheted higher and. ultimately, not to lower unemployment, but to higher unemployment, as destabilizing forces and uncertainties associated with accelerating inflation induced economic con^
traction.
Over the longer run, no tradeoff is evident between infla-
tion and unemployment.
Experience both here and abroad suggests that
lower levels of inflation are conducive to the achievement of greater
productivity and efficiency and, therefore, higher standards of
living.
In fact, lower inflation historically has been associated not
just with higher levels of productivity, but with faster growth of
productivity as well.
Why inflation and productivity growth are
linked this way empirically is not clear.
To some extent higher
productivity growth may help to damp inflation for a time by lessening
increases in unit labor costs.
But the process of cause and effect in
all likelihood runs the other way as well.
Lower inflation and
inflation expectations reduce uncertainty in economic planning and
diminish risk premiums for capital investment.
They also clarify the
signals from movements in relative prices, and they encourage effort
and resources to be devoted to wealth creation rather than wealth
preservation.
Many people do not have the knowledge of, or access to,
ways of preserving wealth against inflation; for them, low inflation
avoids an inequitable erosion of living standards.
The reduced inflation expectations of recent years have been
accompanied by lower bond and mortgage interest rates, slower actual
47
inflation, falling unemployment, and faster trend productivity growth.
The implication is clear: when it comes to inflation expectations, the
nearer zero, the better.
It follows that price stability, with inflation expectations
essentially negligible, should be a long-run goal of macroeconomic
policy.
We will be at price stability when households and businesses
need not factor expectations of changes in the average level of prices
into their decisions.
How those expectations form is not always easy
to discern, and they can for periods of time appear to be at variance
with underlying economic forces.
But history tells us that it is
economic and financial forces and their consequences for realized
inflation that ultimately shape inflation expectations.
Fiscal and monetary policy are important among those forces
and have contributed to the decline in inflation expectations in
recent years along with decreases in long-term interest rates.
The
actions taken last year to reduce the federal budget deficit have been
instrumental in this regard. Although we may not all agree on the
specifics of the deficit reduction measures, the financial markets are
apparently inferring that, on balance, the federal government will be
competing less vigorously for private saving in the years ahead.
Concerns that the deficit is out of control have diminished.
In the
extreme, explosive federal debt growth makes an eventual resort to the
printing press and inflationary finance difficult to resist.
By
shrinking any perceived risk of this outcome, the deficit reduction
package apparently had a salutary effect on longer-term inflation
expectations.
The Federal Reserve's policies in recent years also have
helped to damp inflation and inflation expectations.
We were able to
48
do so, even while adopting an increasingly accommodative policy
stance.
By placing our actions in the context of a thorough analysis
of the prevailing situation and of a longer-term underlying strategy,
our move to greater accommodation could be seen as what it was--a
deliberate effort to counter the various "headwinds" that were
retarding the advance of the economy rather than a series of shortterm actions taken without consideration for potential
inflation
consequences over time.
As I discussed with this Subcommittee last July, this longerrun strategy implies that the Federal Reserve must take care not to
overstay an accommodative stance as the headwinds abate.
But deter-
mining when a policy stance is becoming too accommodative is not an
easy matter.
Unfortunately, although subdued inflation is the hall-
mark of a successful monetary policy, current broad inflation readings
are actually of limited use as a guide to the appropriateness of current instrument
settings.
Patently, price measurements over short
time spans are subject to transitory special factors.
More important,
monetary policy affects inflation only with a significant lag.
That a
policy stance is overly stimulative will not become clear in the price
indexes for perhaps a year or more.
Accordingly, if the Federal
Reserve waits until actual inflation worsens before taking countermeasures, it would have waited far too long.
At that point, modest
corrective steps would no longer be enough to contain emerging economic imbalances and to avoid a build-up of inflation expectations and
a significant back-up of long-term interest rates.
Instead, more
wrenching measures would be needed, with unavoidable adverse side
effects on near-term economic activity.
49
Inflation expectations likely have more of a forward-looking
character than do measures of inflation itself, and. in principle,
could be used as a direct guide to policy.
But available surveys have
limited coverage and are subject to sampling error.
As I have tes-
tified previously, price-indexed bonds of various maturities, which
would indicate underlying market inflation expectations, would be a
useful adjunct to our information base for making monetary policy,
providing there were a sufficiently broad and active market for them.
In addition, the price of gold, which has been especially sensitive to
inflation concerns, the exchange rate, and the term structure of
interest rates can give important clues about changing expectations.
Of course, a number of factors in addition to inflation
expectations affect all of these indicators to a degree.
Short- and
long-term rates, for example, tend to be highly correlated through
time, in part because they are responding to the same business cycle
pressures.
Thus, when the Federal Reserve tightens reserve market
conditions, it is not surprising to see some upward movement in longterm rates, as an aspect of the process that counters the imbalances
tending to surface in the expansionary phase of the business cycle.
The test of successful monetary policy in such a business-cycle phase
is our ability to limit the upward movement of long-term rates from
what it would otherwise have been with less effective policy.
Moder-
ate to low long-term rates, with rare exceptions, are an essential
ingredient of sustainable long-term economic growth.
When we take
credible steps to head off inflation before it can begin to intensify,
the effects on long-term rates are muted.
By contrast, when Federal
Reserve action is seen as lagging behind the need to counter a buildup
of inflation pressures, long rates have tended to move sharply higher.
50
as eventually happened in the late 1970s.
conclusion:
This suggests an important
Failure to tighten in a timely manner will lead to higher
than necessary nominal long-term rates as inflation expectations
intensify.
Ultimately, short-term rates will be higher as well if
policy initiatives lag behind inflation pressures.
The higher short-
term rates are required not only to take account of rising inflation
expectations, but also to provide the additional restraint on real
rates necessary to reverse the destabilizing inflation process.
For decades, the monetary aggregates, especially M2, provided
generally reliable early warning signals of emerging
imbalances.
inflationary
But, as I have discussed in detail in previous testimon-
ies and will touch on later in this statement, the signals they have
sent in recent years have been effectively jammed by structural
changes in financial markets and the unusual nature of the current
business cycle.
Our monetary policy strategy must continue to rest, then, on
ongoing assessments of the totality of incoming information and
appraisals of the probable outcomes and risks associated with alternative policies.
Our purpose over the longer run is to help the economy
grow at its greatest potential over time.
To do so, we must move
toward a posture of policy neutrality--that is, a level of real shortterm rates consistent with sustained economic growth at the economy's
potential.
That level, of course, is difficult to discern and,
obviously, is not a fixed number but moves with developments within
the economy and financial markets.
Over a period of several years starting in 1989, the Federal
Reserve progressively eased its policy stance, in the process reducing
real short-term interest rates to around zero by the autumn of 1992.
51
We undertook those easing actions in response to evidence of a variety
of unusual restraints on spending.
Households and nonfinancial busi-
nesses on the borrowing side and many lenders, including depository
institutions, were suffering from balance-sheet strains.
These dif-
ficulties stemmed from previous overleveraging combined with reductions in net worth from impairments to asset quality, through, for
example, falling values of commercial real estate.
Corporate restruc-
turing and defense cutbacks compounded the problems of the economy by
reducing job opportunities and fostering a more general sense of
insecurity about employment prospects.
The deliberate maintenance of low short-term rates for a
considerable period was intended to decrease the drag on the economy
created by these headwinds.
Households and businesses could refinance
outstanding debt at much reduced interest cost.
In addition, lower
rates and improved performance by borrowers would take the pressure
off of depository institutions, helping them recapitalize.
Low inter-
est rates, along with reduced financial strains, would encourage private spending to pick up the slack left by defense cutbacks.
Once
financial positions were well on the road to recovery, and employment
and confidence began to recover, it was believed that the economic
expansion would gain self-sustaining momentum.
At that point abnor-
mally low real short-term real rates should no longer be needed.
As the Federal Open Market Committee (FOMC) surveyed the
evidence at its February 4 meeting, a consensus developed that the
balance of risks had. in fact, shifted.
Debt repayment burdens had
been lowered enough to unleash strong aggregate demand in the economy.
Real short rates close to zero appeared to pose an unacceptable risk
of engendering future problems.
We concluded that our policy stance
52
10
could be made slightly less accommodative without threatening either
the continued improvement in balance-sheet structures or, ultimately,
the achievement of solid economic growth.
Indeed, the firming in
reserve market pressures was undertaken to preserve and protect the
ongoing economic expansion by forestalling a future destabilizing
buildup of inflationary pressures, which in our judgment would eventually surface if the level of policy accommodation that prevailed
throughout 1993 were continued indefinitely.
We viewed our move as
low-cost insurance.
The projections of the FOMC members suggest a continuation of
good economic performance in 1994, with reasonable growth and subdued
inflation.
The central tendencies of the economic forecasts made by
governors and Bank presidents imply expectations that economic growth
this year likely will be 3 percent or slightly higher.
With this kind
of growth, a further edging down of the unemployment rate from its
January reading is viewed as a distinct possibility*
Inflation, as
measured by the overall CPI, is seen as rising only a little compared
with 1993, even though last year's benefit from falling oil and
tobacco prices may not be repeated, and last year's crop losses could
buoy food prices in 1994.
There are, of course, considerable risks to this generally
favorable outlook.
Some observers have pointed to downside risks to
economic activity associated with fiscal restraint and weak foreign
economies; I believe these factors will have some effects, but they
are likely to be less than feared.
As for fiscal restraint, a good
portion of the negative impact of last year's budget bill may already
be behind us. as some households and businesses have adjusted their
53
ii
behavior to the new structure of taxes and to curtailments in defense
and other budget programs.
The concern about weak foreign economies relates to the
strength of foreign demand for U.S. exports going forward.
Many of
our major trading"partners have been experiencing economic difficulties.
But some already appear to be pulling out of recession and a
number of others seem to have improved prospects.
Moreover, contain-
ing inflation will keep increases in production costs of traded goods
made in the United States subdued, so that our products will remain
competitive in world markets.
With competitive goods and an improving
world economy, the growth of U.S. exports should strengthen this year,
lessening the drag from the external sector on our output growth.
There are upside risks as well.
Inventories have reached a
low level relative to sales, suggesting the possibility of a boost to
production from inventory rebuilding beyond that currently anticipated.
In addition, with both borrowers and lenders in stronger
financial condition, low interest rates have proven a powerful stimulant to spending.
While we were reasonably convinced at the last FOMC
meeting that a zero real federal funds rate put real short rates below
a "neutral" level, we cannot tell this Subcommittee, with assurance,
precisely where the level of neutrality currently resides.
To promote
sustainable growth, history suggests that real short-term rates are
more likely to have to rise than fall from here.
I cannot, however,
tell you at this time when any such rise would occur: I would hope
that part of any increase in real short-term rates ultimately would be
accomplished through further declines in inflation expectations rather
than through higher nominal short-term rates.
54
In assessing our policy stance, we will continue to monitor
developments in money and credit, but in 1994 as in 1993 the FOMC is
unlikely to be able to put a great deal of weight on the behavior of
these aggregates relative to their ranges.
We have set the ranges as
best we can in an evolving financial situation to be consistent with
our objectives for sustained growth and low inflation.
Based on our experience in 1993 and expectations about financial relationships for 1994, the FOMC judges that the growth of money
and credit this year will stay within the annual ranges set provisionally last July, which were reaffirmed at its meeting early this month.
Specifically, these ranges call for growth of 1 to 5 percent for M2. 0
to 4 percent for M3. and 4 to 8 percent for domestic nonfinancial
sector debt.
The ranges are the same as the final specifications
established last July for 1993.
The final specifications for last year had gone through two
rounds of technical downward adjustment after they were first set
provisionally in July 1992.
These downward revisions reflected the
FOMC's recognition that the relationship between spending and money
holdings was departing markedly from historical norms.
Financial
intermediation was moving away from past patterns, as flows of funds
were increasingly being rechanneled away from banks toward securities
markets, notably via bond and stock mutual funds.
Also, banks were
relying more heavily on nondeposit funding sources, such as equity and
subordinated debt, as they strengthened their capital positions.
In the event, growth of M2 and M3 last year came in above the
lower bounds of their reduced ranges with only 1/2 percentage point to
'spare.
M2 grew at 1-1/2 percent and M3 at 1/2 percent over the year
as a whole.
Even so, nominal GDP advanced more than 5 percent over
55
13
the year, extending rapid increases in the velocities of broad money
through another year.
The discrepancy between the growth rates of
nominal GDP and broad money diminished some from that of 1992, but was
still unusual in the face of steady short-term interest rates.
Somewhat faster growth of M2 and M3 this year than last year
may be in prospect.
The governors* and presidents' outlook calls for
a small stepup in nominal spending, and the factors depressing growth
of the broader aggregates relative to the expansion of spending could
well abate to some degree.
In particular, the diversion of savings
from retail deposits and money funds toward bond and stock mutual
funds may lessen, as household portfolios more fully complete the
adjustment to the latter*s heightened availability.
Now that banks
have achieved healthier capitalization, they may more readily issue
large time deposits instead of equity and subordinated debt to support
stepped-up loan growth.
Just how far these developments will go,
however, is difficult to predict, so the prospective relationship
between spending and broad money remains highly uncertain.
The FOMC
will continue ta monitor the behavior of money supply measures for
evidence about underlying economic and financial developments more
generally, but it will still have to base its assessments regarding
appropriate policy actions on a wide variety of economic indicators.
Among those indicators, the Federal Reserve will again pay
attention to credit market developments, especially for any light they
can shed on the strength of household and corporate balance sheets and
spending propensities.
The overall debt aggregate put in a repeat
performance last year, again growing by around 5 percent, even as the
advance of nominal GDP moderated to a similar pace.
But this steady
56
debt growth incorporated an upturn in private borrowing, as the borrowing of the federal government slackened.
Households in particular
showed a heightened willingness to take on debt to help finance strong
purchases of homes and consumer durables.
At the same time, massive
mortgage refinancings at much reduced interest rates contributed to
further reductions in household debt-service burdens relative to
income to a level last seen in the mid-1980s.
For businesses as well,
the bite taken out of cash flow by interest payments was shrunk to a
size last observed in the mid-1980s, partly through the refinancing of
higher-cost debt and continued equity issuance.
Although
business
borrowing firmed a little, it remained subdued, as enough internal
funds were available to finance the bulk of hefty capital expenditures .
Looking ahead, federal borrowing is scheduled to diminish
further this year, partly reflecting deficit reduction measures.
Borrowing by nonfederal sectors should continue to strengthen, prodded
by the anticipated pickup in nominal GDP and the healthier
financial
condition already attained by households and businesses.
In conclusion, the Federal Reserve has welcomed both the
strengthening in activity and the generally subdued price trends,
because the intent of our monetary policy in recent years has been to
foster precisely this kind of healthy economic performance.
Looking
forward, our policy approach will be to endeavor to select on a continuing basis the monetary instrument settings that will minimize
economic instabilities and maximize living standards over time.
The
outlook, as a result of subdued inflation and still low long-term
interest rates, is the best we have seen in decades.
It is important
57
15
that we do everything we can to turn that favorable outlook into
reality.
58
For use at 10:00 a.m., E.S.T.
Tuesday
February 22,1994
Board of Governors of the Federal Reserve System
Monetary Policy Report to the Congress
Pursuant to the
Full Employment and Balanced Growth Act of 1978
February 22,1994
59
Letter of Transmittal
BOARD OF GOVERNORS OF THE
FEDERAL RESERVE SYSTEM
Washington, D.C., February 22,1994
THE PRESIDENT OF THE SENATE
THE SPEAKER OF THE HOUSE OF REPRESENTATIVES
The Board of Governors is pleased to submit its Monetary Policy Report to the Congress, pursuant to the
Full Employment and Balanced Growth Act of 1978.
Sincerely,
Alan Greenspan, Chairman
60
Table of Contents
Page
Section 1: Monetary Policy and the Economic Outlook
1
Section 2: The Performance of the Economy in 1993
5
Section 3:
Monetary and Financial Developments in 1993
19
61
Section 1: Monetary Policy and the Economic Outlook
Nineteen ninety-three turned out to be a favorable
year for the U.S. economy, with notable gains in real
output, declines in joblessness, and a further small
drop in the rate of inflation. Financial conditions conducive to growth prevailed throughout 1993 and gave
considerable impetus to activity. With the Federal
Reserve keeping reserve market pressures unchanged, short-term interest rates held steady during
the year at unusually low levels, especially when
measured relative to inflation or inflation expectations. In addition, long-term rates declined further,
partly in response to actions taken by the Congress
and the Administration to put the federal deficit on a
more favorable trend.
Against this backdrop, households and businesses
were able to take further steps to reduce the burden of
servicing debt, and more expansive attitudes toward
spending and the use of credit seemed to take hold.
Spending in the interest-sensitive sectors of the economy surged ahead, with particularly large advances in
residential investment, business outlays for fixed capital, and consumer durables. The growth of real GDP
picked up sharply in the second half, and the increases
for all of 1993 cumulated to about 23A percent according to initial estimates. In the labor market, employment moved up at a moderate pace, and the unemployment rate dropped almost a percentage point over
the year. As measured by the consumer price index,
the rate of inflation edged lower last year, as unfavorable reports in the first few months of 1993 gave way
to more subdued readings thereafter. The performance
of the U.S. economy stood in sharp contrast to the
continued sluggish growth in many of the other industrial countries and helped to buoy the trade-weighted
value of the dollar on foreign exchange markets.
In conducting policy through 1993, the Federal
Open Market Committee recognized that it was maintaining a very accommodative stance in reserve markets. Reserve conditions had been eased to this degree
over the prior four years to counter the effect of some
unusual factors restraining aggregate demand. The
Committee recognized that, as these forces abated,
short-term interest rates would likely have to rise to
forestall inflationary pressures that would eventually
undermine the expansion.
Toward the end of 1993 and into early 1994,
incoming data on the economy and credit flows have
increasingly conveyed a picture of considerable
underlying strength. The marked speedup of growth
in the economy has been reducing spare capacity, as
76-694 0 - 9 4 - 3
is evident in the recent declines in unemployment and
increases in capacity utilization rates in industry.
Moreover, while movements in broadly based price
indexes have remained relatively favorable, there also
have been undercurrents suggesting that the process
of disinflation might be stalling out. In particular,
after slowing considerably in 1992, nominal increases
in hourly compensation—comprising wages and
benefits—fell no further in 1993, and long-term inflation expectations remain stubbornly above recent
inflation rates. Also, commodity prices generally have
firmed in recent months.
Earlier this month, the Federal Reserve concluded
that the weight of the evidence indicated that undiminished monetary stimulus posed the threat that
capacity pressures would build in the foreseeable
future to the point where imbalances would develop
and inflation would begin to pick up. At its February
1994 meeting, the Federal Open Market Committee
determined that it was time to move to a slightly
less accommodative stance. While the discount rate
remained at 3 percent, the federal funds rate edged up
to trade around 3'/4 percent, a little above the prevailing rate of inflation.
Strength in spending last year was supported by
increased borrowing by both households and businesses. Continuing declines in a number of interest
rates, which sparked considerable refinancing of existing obligations, helped to trim debt service burdens
for both sectors, undoubtedly facilitating the pickup
in borrowing and spending. Indicators of financial
stress, including loan default rates and bankruptcy
filings, took a decided turn for the better in 1993.
Borrowing by households was robust enough to raise
the ratio of debt to disposable income; business debt,
held down in part by equity issuance, declined relative to income. The debt of all nonfinancial sectors is
estimated to have grown about 5 percent last year, the
same as in 1992, as a diminution in the net funding
needs of the federal government was about offset by
the pickup in private demands. This growth placed
the debt aggregate in the lower half of its 4 to 8 percent monitoring range.
The growth of M2 slowed in 1993, albeit considerably less than the deceleration in nominal GDP. For
the year, M2 advanced 1 '/2 percent, placing it a little
above the lower bound of its 1 to 5 percent annual
growth cone. M3 expanded '/2 percent, the same pace
as in 1992, and a bit above the lower bound of its 0 to
4 percent annual range. The ranges had been adjusted
62
Ranges for Growth of Monetary and Debt Aggregates1
Percent
Aggregate
1992
1993
1994
M2
21/2-61/2
1-5
1-5
M3
1-5
0-4
0-4
41/2-81/2
4-8
4-8
Debt2
1. Change from average for fourth quarter of preceding
year to average for fourth quarter of year indicated. Ranges
for monetary aggregates are targets; range for debt is a monitoring range.
down by the Federal Open Market Committee during
1993. The adjustments were technical in nature and
reflected the Committee's judgment as to the extent
of the ongoing distortions of financial flows relative
to historical patterns, and of consequent increases in
velocities—that is, the ratios of nominal GDP to
money.
The special factors shaping the growth of the monetary aggregates included a marked preference by
borrowers for capital market financing, rather than
bank loans, and a configuration of market returns that
enticed investors away from the traditional financial
products offered by depositories. Bond and stock
mutual funds were the primary beneficiaries of this
shift, with inflows into such funds in 1993 setting a
new record. This continuing redirection of credit
flows has rendered the movements of the broad
monetary aggregates less representative of the pace of
nominal spending than was evident in the longer
historical record. In 1993, nominal GDP grew a shade
more than 5 percent, or 3% percentage points above
the rate of expansion of M2 and 4'/2 percentage points
above that of M3.
Most of the increase in the broad aggregates
was recorded in their Ml component, which grew
10'/2 percent in 1993, as low money market and
deposit interest rates provided little reason to forgo
the liquidity of transaction deposits. At times during
the year, declines in longer-term market rates produced waves of mortgage refinancing, an activity that
is associated with temporary flows through the transaction deposits that are counted in Ml. In addition,
the currency component expanded at about the same
rate as the Ml total, spurred by considerable demands
from abroad. The double-digit expansion in Ml
deposits pushed reserves up at a \2Vi percent rate in
1993, while the monetary base, which includes
2. Domestic nonfinancial sector,
reserves and currency, increased 10!/2 percent, the
same rate that was posted in the previous year.
Money and Debt Ranges for 1994
At its July 1993 meeting, the Committee had provisionally chosen the same ranges for 1994 as it had
established for 1993—1 to 5 percent for M2 and
0 to 4 percent for M3 and a monitoring range of
4 to 8 percent for the domestic nonfinancial debt
aggregate. At that time, the Committee noted that
disturbances to the historical relationships between
the aggregates and spending required that the actual
determination of these ranges for 1994, in February of
this year, be made in light of additional experience
and analysis.
As noted above, the velocities of M2 and M3
increased further in 1993, but at a slower rate than in
the previous year. This deceleration might indicate
that the forces that had distorted the aggregates over
the past few years, while still potent, were beginning
to wane. The yield curve, although quite steep, now
offers investors less inducement to move outside M2
in the search for better returns than at any time in the
past three years. Additionally, firms, having strengthened their financial positions, may feel more comfortable taking on shorter-term obligations and, so, may
direct more of their business to depositories. Banks,
which are better capitalized and more liquid, should
be in a strong position to meet those needs. Still,
capital markets will provide attractive alternatives to
the depository sector, suggesting that the forces tending to divert funds from depositories—and to raise the
velocities of the monetary aggregates—will continue
to be important. However, the strength of these forces,
and whether or how quickly they might be abating,
remains difficult to judge.
63
Economic Projections of FOMC Members and Other FRB Presidents for 1994
Percent
Item
Range
Central
tendency
Change, fourth quarter
to fourth quarter1
Nominal GDP
Real GDP
Consumer price index2
4?/4-71/2
21/2-33/4
1
2 /4-4
3-3V4
About 3
61/2-63/4
61/2-€3/4
Average level, fourth quarter
Civilian unemployment rate3
1. Change from average for fourth quarter of preceding
year to average for fourth quarter of year indicated.
Against this background, the Federal Open Market
Committee at its most recent meeting reaffirmed the
annual growth ranges for the money and credit aggregates that had been chosen provisionally last July.
The annual ranges appear to be sufficiently wide to
encompass growth of M2 and M3 consistent with
Committee members' expectations for nominal
income under a variety of alternatives for the behavior of the velocities of the aggregates. If the forces
depressing the demand for money relative to income
were to persist unabated in 1994, M2 and M3 might
be in the lower portion of their cones; should M2 and
M3 move closer to their former alignments with
spending—buoying the demands for those aggregates
and depressing their velocities—then outcomes in the
upper portion of the ranges would be expected. The
Committee will watch the monetary aggregates
closely during the course of the year for evidence on
unfolding economic and financial conditions. But,
given uncertainties about velocity behavior, that information will necessarily be assessed in combination
with a variety of other financial and economic indicators as the Committee formulates policy. Through
1994, as was true last year, the Committee's primary
concern will be to foster financial conditions that help
to contain price pressures and to sustain economic
expansion, and it will have to assess the rates of
money growth consistent with these objectives as the
year goes on.
Debt growth, which has moved in closer alignment with nominal income over the past few years
than have the monetary aggregates, will again be
monitored in light of a 4 to 8 percent annual range.
With the federal sector's demands on the pool of
2. All urban consumers.
3. Civilian labor force.
saving diminishing, the Committee envisions that an
unchanged range would be associated with some
pickup in borrowing by the private sector. Healthier
balance sheets, lighter debt service burdens, heavier
capital spending, and more eager lenders should all
act to boost the expansion of nonfederal debt. Overall,
the debt of the nonfinancial sectors is expected to
grow again at about the pace of nominal income.
Economic Projections for 1994
In general, the governors and Reserve Bank presidents anticipate that 1994 will be another year of
progress for the economy, with low inflation and
financial market conditions continuing to provide a
setting conducive to sustaining moderate economic
growth and rising employment opportunities.
The Federal Reserve officials' forecasts of real
GDP growth over the four quarters of 1994 span a
range of 2'/2 percent to 3% percent, with the central
tendency of the forecasts being 3 to 3 VA percent. The
governors and Reserve Bank presidents anticipate
that the rise in real GDP will be accompanied by a
further increase in labor productivity. Nonetheless,
employment gains are expected to be sufficient to
bring about some further reduction in the degree of
labor market slack over the four quarters of the year.
Forecasts of the unemployment rate in the fourth
quarter of 1994 span a range of 6'/2 percent to 63/4 percent. Because of changes in survey design, a comparable rate for the fourth quarter of last year is not
available; however, the Bureau of Labor Statistics has
estimated that the fourth-quarter rate would have
exceeded 7 percent on the new basis.
64
The sectoral composition of growth in 1994 may
well resemble that of 1993. The financial adjustments
of recent years have left households better positioned
and more willing to boost spending. Moreover, with
employment rising, real income growth should be
supportive of increased consumer expenditures in the
coming year, despite the higher taxes confronting
some households. Business investment seems likely
to be pushed ahead by ongoing efforts to modernize
and by further declines in computer prices. By contrast, further cuts in federal outlays for defense likely
will continue to be a restraining factor on the growth
of aggregate demand. With the passage of time, the
more accommodative monetary policies now in place
in a number of countries, together with the moderate
fiscal stimulus in Japan, are likely to lead to a gradual
pickup in the rates of growth of foreign industrial
countries and U.S. exports. However, U.S. imports
from abroad will likely continue to move up at a brisk
pace. Net exports of goods and services thus may
decline somewhat further, albeit at a slower rate than
they have over the past year.
The majority of the governors and Bank presidents
expect inflation in 1994 to run a shade higher than in
1993. Most of their forecasts for the rise in the consumer price index are close to 3 percent, although the
full range of forecasts extends from a low of 2'/4 percent to a high of 4 percent. Several developments are
likely to work against better inflation performance in
1994. In agriculture, a poor harvest in 1993 has left
some crops in very tight supply, and the risk of
unfavorable food price developments is greater than it
has been in recent years. In addition, although the
future course of energy prices is uncertain, a repeat of
last year's declines, which helped to hold down the
overall CPI, cannot be counted on. More fundamentally, the recent narrowing of the degree of slack in
the labor and product markets suggests that competitive pressures damping wage and price increases will
be less strong and less pervasive than they have been
recently.
The central tendencies of the forecasts of GDP
growth, unemployment, and inflation are quite similar
to the projections put forth by the Administration in
its recent reports. Moreover, insofar as the Administration's numbers were predicated, in pan, on the
assumption that short-term interest rates would rise
modestly in 1994, the recent tightening action by the
Federal Reserve does not appear to be inconsistent
with the Administration's outlook.
Prospects for sustained growth over the longer run
have been bolstered by policy actions on a number of
fronts. Considerable work remains to be done, however. Although recent fiscal measures have been helpful in bringing about declines in the federal budget
deficit, the Congress and the Administration still must
deal with some difficult issues to ensure that the
deficit is kept on a downward course through the
latter part of the 1990s and into the next century. In
the area of trade policy, the nation's long-standing
support of an open world trading system was
reaffirmed this past year in the form of passage of the
North American Free Trade Agreement and the agreement in the Uruguay Round—actions that will yield
important benefits over time not only to the United
States but also to its trading partners. Nonetheless,
serious obstacles to free trade still remain. On a wide
range of regulatory issues, the Congress and the
Administration face decisions that have the potential
to promote—or to damage—the flexibility in labor
and product markets and the processes of innovation
and investment that are so critical to long-run economic progress. In the area of monetary policy, the
challenge is to build on the favorable price performance of late in a situation in which the economy will
likely be operating closer to full capacity than it has in
recent years. With success in keeping the economy on
course toward the long-run goal of price stability, the
prospects for sustained expansion will be greatly
enhanced.
65
Section 2: The Performance of the Economy in 1993
The economy recorded significant gains in 1993,
lifted, as in 1992, by a surge in activity in the latter
part of the year. Job creation picked up, and the
unemployment rate fell appreciably. Inflation continued to trend lower.
trend lower. The federal budget deficit declined somewhat in fiscal 1993, but remained quite large both in
absolute terms and relative to nominal GDP. The
combined deficit in the operating and capital accounts
of state and local governments increased further.
The rise in real GDP over the year amounted to
2.8 percent, according to the Commerce Department's first estimate. For a second year, the growth of
activity was propelled chiefly by rapid gains in the
investment outlays of households and businesses.
Households boosted their purchases of homes and
motor vehicles considerably, and spending for household durables also rose rapidly. Business investment
in computers continued to grow at an extraordinary
pace in 1993, and outlays for other types of capital
equipment strengthened. Investment in nonresidential
structures, which had gone through a protracted
decline in the latter part of the 1980s and early 1990s,
rose moderately last year. Bolstered by the gains in
these sectors, the four-quarter rise in the final purchases of households and businesses amounted to
about 5 percent in real terms in 1993, matching the
large 1992 rise. Not since the 1983-84 period had
private final purchases exhibited a comparable degree
of strength.
Growth of the economy continued to be significantly influenced in 1993 by the changing patterns of
transactions with foreign economies. The weakness of
activity in a number of foreign countries that are
major trading partners of the United States tended to
slow the rise of U.S. exports of goods and services. At
the same time, a significant portion of the rise in
domestic spending in this country continued to translate into rapid increases in imports. Net exports of
goods and services thus fell for the second year in a
row, after a run of several years in which real export
growth had outpaced the growth of real imports by a
considerable margin.
Real GDP
The Household Sector
Percent change, annual rate
_Q
1989
1991
1993
The increase in private spending in 1993 was augmented by a pickup in the spending of state and local
governments, especially for construction. By contrast,
real federal purchases of goods and services—the part
of federal spending that is included in GDP—fell
sharply, as outlays for national defense continued to
The CPI rose 2.7 percent over the four quarters of
1993, after increases of about 3 percent in both 1991
and 1992. Price increases were damped last year by
falling oil prices, near-stable prices for nonoil imports, and a further rise in labor productivity, which
held down production costs in the domestic economy.
Consumer spending recorded a second year of
brisk growth in 1993. Support for the rise in expenditures came from declines in interest rates and moderate increases in real incomes. Household balance
sheets continued to strengthen in 1993 and debt servicing burdens diminished, easing the financial strains
that had inhibited spending earlier in the 1990s.
In real terms, the 1993 advance in personal consumption expenditures amounted to about 3 percent,
measured to the year's fourth quarter from the fourth
quarter of the previous year. After surging in late
1992, growth of real outlays slowed in the first quarter of 1993. Whatever tendency there may have been
for a "payback" after a period of unusually rapid
growth was reinforced by a severe late-winter storm
on the East Coast, which temporarily hurt retail sales.
Thereafter, spending proceeded at a relatively strong
pace over the remaining three quarters of the year.
Consumer expenditures for motor vehicles
increased 6 percent in real terms over the four quarters of 1993, after rising 9 percent the previous year.
The advance in expenditures continued to come partly
66
Income and Consumption
Percent change, annual rate
[] Real Disposable Personal Income
U Real Personal Consumption Expenditures
Jfllt
1989
1991
1993
from the replacement needs of persons who had put
off buying vehicles earlier in the 1990s, as well as
from growth in consumers' desired stock of vehicles.
Increasingly, buyers have opted for vans, light trucks,
and other vehicles instead of cars, and annual sales of
these vehicles in 1993 reached the highest level on
record. Car sales also rose, but remained well below
previous highs. Data for January of this year showed
strong gains in the unit sales of both cars and trucks.
Expenditures for a number of other types of durable goods also rose rapidly in 1993. Outlays for
furniture and appliances scored further hefty gains, in
conjunction with sharp increases in sales of new and
existing homes. Consumer purchases of home computers and other electronic equipment remained on a
steep uptrend. In total, outlays for durable goods other
than motor vehicles increased nearly 9 percent over
the year, after a rise of 10 percent in 1992. Other
types of consumer expenditures, which typically
exhibit less cyclical variation than do the outlays for
durables, rose moderately, on balance, during 1993.
Consumer purchases of nondurable goods increased
about P/4 percent, after a jump of more than 3'/2 percent in 1992. Spending for services rose 23/4 percent
during 1993, the same increase as reported for the
previous year.
Real income continued to advance in 1993,
although its trend was masked by tax considerations
that had caused a sizable volume of bonuses that
would have been paid to workers in early 1993 to be
shifted into the latter part of 1992. Abstracting from
these shifts in timing, the beneficial effects of continued economic expansion showed through in most
categories of income, much as they had in 1992.
Wage and salary accruals, a measure of income as it is
earned, rather than as it is disbursed, rose about
4'/2 percent in nominal terms over the four quarters of
1993, considerably outpacing the rate of inflation for
the second year in a row. Further gains also were
reported over the course of 1993 in dividends and in
the income of proprietors, both farm and nonfarm.
Transfer payments, which tend to vary inversely with
the state of the economy, slowed in 1993, after rising
at rates of 10 percent or more in each of the four
previous years. Interest income, which had declined
on net in 1991 and 1992, edged up slightly over the
four quarters of 1993. Because of the shift in timing
of bonuses, growth of real disposable income in 1993
was less than in 1992. However, the cumulative gain
over the two-year period was about 6 percent, a clear
step-up from the performance of the three previous
years, when real income growth had averaged less
than 1 percent per year.
The personal saving rate—measured as the percentage of nominal aftertax income disbursements that
are not used for consumption or other outlays—
declined nearly 2 percentage points, on net, over the
course of 1993. However, the saving rate in late 1992
had been temporarily elevated by the aforementioned
speedup of bonus payments. Looking through that
blip of late 1992, a downward drift still is evident in
the saving rate from mid-1992 to the end of 1993.
Such a pattern is not uncommon when economic
recovery is taking hold and consumer purchases of
durable goods are rising rapidly. In effect, households
have been holding part of their saving in the form of
consumer durables, which, at the time of purchase,
are counted fully as consumption in the national
accounts, but which in reality will yield households a
flow of services over time.
Consumer reliance on credit picked up in 1993.
The volume of consumer credit outstanding rose
3
5 /4 percent during the year, after three years in which
credit growth had been quite subdued. Growth of
consumer credit was especially rapid in the final
quarter of the year—about 9 percent at an annual rate.
The mortgage debt of households rose about 7 percent
from the end of 1992 to the end of 1993, slightly more
than in either of the two previous years.
Continued improvement was evident on the asset
side of household balance sheets in 1993. As in 1992,
the total nominal value of household assets increased
at a pace moderately faster than the rate of inflation.
Large increases in stocks and bonds boosted the nominal holdings of financial assets, more than offsetting
a reduction in the aggregate holdings of deposits and
credit market instruments. The nominal value of
67
tangible assets was lifted by heavy investment in
consumer durables and residential structures and by a
rise in the average price of existing residential properties. With the jump in growth of consumer credit and
the slight pickup in the growth of home mortgage
debt, household liabilities rose somewhat faster than
in 1992. Nonetheless, net worth appears to have
increased, probably in real terms as well as in nominal terms. The incidence of financial stress among
households diminished further in 1993, as delinquency rates on various types of household debt continued to decline, in some cases to the lowest levels
since the first half of the 1970s. According to survey
data, households' own assessments of their financial
situations have improved of late, with some survey
readings the most upbeat in more than three years.
increased about 18 percent from the second quarter to
the fourth quarter, rising to the highest quarterly level
since 1979. Although housing starts fell sharply in
January, the decline probably was in large measure a
reflection of the unusually bad weather across the
country last month. According to survey data, consumers' assessments of home-buying conditions continued to be very upbeat in January and early February. Builders' ratings of the market edged down a
touch in early 1994, but remained at a very favorable
level.
Private Housing Starts
Annual rate, millions of units
Quarterly average
Residential investment increased about 8 percent in
real terms over the four quarters of 1993, building on
the 18 percent rise of 1992. As in 1992, most of the
advance came from increased construction of new
single-family homes. The construction of multifamily
housing continued to be adversely affected by a persistent overhang of vacant rental units.
In the single-family market, impetus for activity
continued to come mainly from declines in mortgage
interest rates, which, by autumn, had dropped to the
lowest levels in more than two decades. Fairly sharp
declines in mortgage interest rates took place early in
the year, but the effect of those declines on housing
activity was apparently short-circuited for a time by a
number of influences. A severe blizzard on the East
Coast in mid-March temporarily waylaid the start-up
of construction in that region, and a huge runup in
lumber prices during late winter also may have discouraged some new construction for a while. Concerns about the possible loss of jobs perhaps continued to deter some potential homebuyers. Other buyers
may simply have been holding back, waiting to see
how far rates eventually would fall.
In any event, the effects of the drop in mortgage
rates began to show through with greater force over
the summer and fall, and considerable strength had
emerged by year-end in all the major indicators of
single-family housing activity. Sales of existing
homes rose almost without interruption from April
on. By the fourth quarter they had climbed to the
highest level on record (the series goes back to 1968).
Sales of new homes proceeded in somewhat choppier
fashion from month to month, but by the end of the
year they had moved well toward the upper end of
their historical range. Housing construction also
strengthened. The number of single-family starts
1.5
0.5
1987
1989
1991
1993
Activity in the multifamily housing market
remained depressed in 1993. In the mid-1980s, tax
incentives and relatively easy availability of credit
encouraged overbuilding in many locales. The proportion of multifamily rental units that were vacant
soared and has remained high subsequently, even as
construction of multifamily units has dwindled. Starts
of these units reached the lowest levels on record
early in 1993, and they picked up only modestly
thereafter, despite restoration of tax credits for lowincome units.
The Business Sector
The year 1993 saw appreciable gains in most
important barometers of business activity. Output of
the nonfarm business sector increased 33/4 percent
during the year, the same as the rise during 1992.
Profits rose further, and business balance sheets continued to strengthen. Capital spending surged.
In the industrial sector, production rose 4'/4 percent
during 1993, the largest advance in six years. Gains of
at least moderate proportions were reported in each
68
quarter of 1993. The gain in the year's final quarter
was quite large—on the order of 6!/2 percent at an
annual rate. Output of business equipment held to a
strong uptrend throughout the year, as did the production of materials that are used as inputs in the durable
goods industries. Output of construction supplies rose
moderately in the first half of the year and at a
stronger pace in the second half. Motor vehicle assemblies also rose appreciably, with strength early in
1993 and in the year's final quarter more than offsetting a stretch of sluggishness through the middle part
of the year. By contrast, output of consumer goods
other than motor vehicles rose only modestly, and
production of defense and space equipment fell
9'/2 percent further, extending a downward trend that
began in 1987. In January of this year, industrial
production rose 0.5 percent. Severe winter weather
and the California earthquake cut into the growth of
production in the manufacturing sector in January, but
the output of utilities was boosted by increased heating requirements. Underlying support for industrial
production is coming from large gains in new orders
that were reported toward the end of 1993.
Before-tax Profit Share of
Gross Domestic Product*
Percent
10
i
1987
i
1989
i
i
1991
i
i
1993
•Profits from domestic operations with inventory valuation and
capital consumption adjustments divided by gross domestic
product of nonfinancial corporate sector.
100
Corporate profits, which had surged in 1992,
increased an additional 61/2 percent over the first three
quarters of 1993 and appear to have risen further in
the year's final quarter. Financial institutions in general continued to benefit in 1993 from the persistence
of a relatively wide margin between their cost of
funds and the interest rates on their assets; insurers'
profits suffered less drag from natural disasters than in
1992, the year of hurricane Andrew. The profits of
nonfinancial corporations moved up slightly further
over the first three quarters, boosted by the rise in the
volume of output over that period. Operating profits
per unit of output held fairly steady, close to the high
level reached in the final quarter of 1992. Although
nonfinancial corporations raised their prices by only a
small amount over those three quarters, they were
able to maintain unit profit margins through continued tight control over costs. Gains in productivity
restrained the rise in unit labor costs, and net interest
expenses per unit of output continued to decline.
The amount of spare capacity in the industrial
sector continued to diminish in 1993 and early 1994.
The utilization rate in January was 83.1 percent. The
rate has increased more than two percentage points
during the past year, to the highest level since the
second half of 1989. In manufacturing, capacity use
in primary processing industries has been running
above its long-run average for more than a year, and
the rate of utilization in advanced processing industries recently has moved up into line with its long-run
average.
Business fixed investment increased about IS percent in real terms over the four quarters of 1993, after
a rise of 7'/2 percent in 1992. A spectacular increase
in outlays for office and computing equipment
accounted for about one-half of the 1993 gain. Business expenditures for these items increased more than
25 percent in nominal terms over the year, the steepest annual gain since 1984, and the rise in real terms
was greater still. Technological advances embodied in
the latest computers made them far more powerful
than equipment that had been at the forefront only a
few years ago, and highly competitive market conditions kept prices on a downward course. More real
Industrial Production
Index 1987 = 100
110
105
1991
1993
69
Real Business Fixed Investment
Percent change, annual rate
[] Structures
30
| Producers' Durable Equipment
20
-ni
1991
10
0
10
1993
computing power thus continued to become ever more
accessible, and the many businesses eager to boost
labor productivity and overall operating efficiency
provided a huge market for the new products.
Excluding office and computing equipment, outlays
for capital equipment increased about 11 percent in
real terms during 1993, the biggest rise in ten years.
Business expenditures for motor vehicles advanced
about 13 percent, as investment in trucks, which had
strengthened considerably in 1992, climbed further.
Factories producing heavy trucks were operating at or
near full capacity at year-end. Spending for communication equipment also advanced sharply, as did the
real outlays for many other types of machinery and
equipment. Diminished slack in many industries and
expectations of continued business expansion were
among the chief factors giving rise to the increase in
these outlays. Ample cash flow from internal operations provided a ready source of finance.
Commercial aircraft was the most notable exception to the general upward trend in equipment spending. Outlays for aircraft plunged in the second half of
1993, and survey data suggest that spending will
remain weak in 1994. The reductions in outlays had
been foreshadowed by earlier declines in new orders
for commercial aircraft, and producers of aircraft
have been scaling back their operations for some
time.
Business investment in structures rose nearly 5 percent in 1993, the first annual increase since 1989.
Declines in the intervening years had cumulated to
about 18 percent. Within the sector, divergent trends
were evident once again. Outlays for the construction
of office buildings fell for the sixth consecutive year,
to a level two-thirds below the peak of the mid-1980s.
Several indicators suggested, however, that the worst
of the decline in office construction might be over.
The rate at which real outlays fell in 1993 was much
smaller than the declines of the three previous years.
In addition, the national vacancy rate for office buildings, while still quite high, moved down somewhat;
improvement was most noticeable in suburban areas,
where vacancy rates previously had been the highest.
The value of contracts for construction of office building firmed over the course of 1993. Prices of office
buildings continued to trend lower, but survey data
suggest that the rate of decline has eased in at least
some markets.
Investment increased for most other types of structures in 1993. Outlays for industrial structures, which
had declined sharply in 1991 and 1992, rose about
8 percent, on net, over the four quarters of 1993.
Outlays for commercial structures other than office
buildings increased fairly briskly for a second year;
by the fourth quarter, they had retraced about 40 percent of the steep decline that took place during 1990
and 1991. Investment in drilling also rose in 1993, as
incentives from rising prices for natural gas apparently offset the disincentives associated with falling
oil prices. Spending for other types of structures rose
by a small amount in the aggregate.
Swings in business inventory investment played
only a small role in the economy in 1993. Inventory
accumulation in the nonfarm business sector picked
up in the early part of the year, but thereafter, the rate
of stockbuilding slowed. Accumulation for the year as
a whole was of only modest proportions, especially
when compared with the rates of buildup seen during
previous business expansions. Conceivably, the usual
cyclical patterns in inventory change have been
Changes in Real Nonfarm Business Inventories
Annual rate, billions of 1987 dollars
30
H nnfl
T
30
J
1
1989
1
1
1991
1
1993
U
60
70
tempered to some degree by the more sophisticated
inventory control procedures that have become widespread in the business sector in recent years. Toward
year-end, inventories appeared to be comfortably
aligned with sales in most industries and were lean in
some. Most notable among the latter were the stocks
of motor vehicles, which were drawn down by production delays through the summer and strength in
sales through the latter part of the year. In view of
those developments, producers of motor vehicles have
scheduled a further hefty rise in production for the
current quarter, with assemblies slated to move up to
the highest quarterly rate in more than fifteen years.
In the farm sector, inventories declined in 1993.
Stocks were pulled down by weather-related reductions in crop output, especially in parts of the Midwest, where the worst flood of the century caused
millions of acres to be left idle and cut deeply into
yields on the acres that were planted. Inventories of a
number of major field crops are in tight supply, in
some cases the tightest since the mid- 1970s. Farmers
whose crops were hurt by weather suffered income
losses in 1993, while the producers whose crops were
not hurt benefited from rising prices. Total net farm
income thus appears to have held in the range of other
recent years, at a level well within the extremes of
either boom or bust.
Trends in business finance remained favorable in
1993. Business expenditures for fixed capital and
inventories were financed almost entirely with funds
generated internally, and, in the aggregate, the relatively little external financing that did take place came
partly from positive net issuance of equity. Growth of
debt was slow, both in absolute terms and relative to
the high rates of debt growth seen in the 1980s. With
little growth in debt and interest rates down, the
portion of business cash flow required for die repayment of principal and interest declined further in
1993. All this seemed to auger well for sustained
expansion of the business sector and the economy.
The Government Sector
Federal purchases of goods and services, the portion of federal outlays that are included in GDP, fell
more than 6 percent in real terms over the four quarters of 1993. Real outlays for national defense, which
have been trending down since 1987, declined nearly
9 percent over the year. Growth of nondefense outlays fell slightly, on net, after fairly sizable increases
in each of the three previous years. The level of real
federal purchases in the fourth quarter of 1993 was
down about 10 percent from the peak of six years ear-
Real Federal Purchases
Percent change, 04 to Q4
10
1991
1993
20
Her. Real defense purchases dropped about 20 percent over that six-year stretch.
Total federal outlays, measured in nominal terms in
the unified budget, rose 2 percent in fiscal 1993, the
smallest increase in six years. Outlays for defense fell
about 2!/£ percent in nominal terms, and net interest
payments were down slightly—the first decline in that
category since 1961. Net expenditures for deposit
insurance, which had been slightly positive in 1992,
were negative in fiscal 1993, held down, in part, by
delays in funding the activities of the Resolution
Trust Corporation. Federal spending for income security slowed from the rapid pace of 1991 and 1992, as
economic expansion led to a reduction in outlays for
unemployment compensation and a less rapid rate of
increase in outlays for food stamps. Growth in federal
expenditures for Medicare and other health programs
also slowed, but their rate of increase continued to
exceed the growth of nominal GDP by a considerable
margin.
Growth of federal receipts picked up a bit in fiscal
1993, to a pace roughly matching that of nominal
GDP growth. Combined receipts from individual
income taxes and social insurance taxes, which
account for about 80 percent of total federal receipts,
rose about 5'/2 percent, after a gain of 3 percent in
fiscal 1992. Receipts from corporate income taxes,
which account for about half of the remaining
receipts, increased more than 17 percent in fiscal
1993, after only a small gain in the previous fiscal
year.
Taken together, the slowing of federal outlays and
the pickup of receipts led to a decline in the size of
the federal budget deficit in fiscal 1993, after three
71
Federal Unified Budget Deficit
Billions of dollars
Fiscal years
300
200
100
1989
1991
1993
years of sharp increases. The 1993 deficit amounted
to $255 billion and was equal to 4.0 percent of nominal GDP. The previous year, the deficit had amounted
to $290 billion and was equal to 4.9 percent of
nominal GDP. In fiscal 1989, toward the end of the
last economic expansion, the size of the deficit relative to nominal GDP had reached a cyclical low of
2.9 percent.
In the state and local sector, receipts moved up
about in step with the growth of nominal GDP in
1993, but state and local expenditures rose still faster.
In nominal terms, the increases in spending cumulated to a rise of about 63/4 percent over the four
quarters of the year. State and local transfer payments
to persons have slowed from the extraordinary rates
of increase seen in the early 1990s, a reflection of
improvement in the economy and intensified efforts
among state and local governments to tighten control
over these types of outlays. Nonetheless, the rate of
rise in these payments remained in excess of 10 percent in 1993. Nominal purchases of goods and services rose moderately, but at a pace somewhat faster
than that of 1992. The deficit in the combined operating and capital accounts of state and local governments widened further during the first three quarters
of the year, from an end-of-1992 level that already
was quite sizable; in the fourth quarter, the deficit
apparently shrank, but not by enough to fully retrace
the earlier increases.
In real terms, purchases of goods and services by
state and local governments increased 3 percent over
the four quarters of 1993, after gains of about 1 1 /2 percent per year in both 1991 and 1992. State and local
expenditures for structures rose more than 9 percent
in real terms over the year, according to preliminary
data. Some of the spending went for the repair or
replacement of structures that had been damaged in
recent natural disasters, such as the summer floods in
the Midwest. In addition, the efforts of state and local
governments to cope with the needs of growing populations prompted increased investment in schools,
highways, and other state and local facilities. Low
interest rates probably convinced state and local officials to undertake more of this new construction in
1993 than they would have otherwise. Growth in
other types of state and local purchases continued to
be fairly restrained in 1993. Employee compensation,
which makes up roughly two-thirds of state and local
purchases, rose about 1 '/4 percent in real terms during
the year, the same as in 1992. Employment growth in
the state and local sector was slow by historical
standards again in 1993, and increases in hourly compensation were relatively small. State and local purchases of goods rose only moderately.
Real State and Local Purchases
Percent change, Q4 to Q4
1989
1991
1993
The External Sector
The trade-weighted foreign exchange value of the
U.S. dollar, measured in terms of the other Group-ofTen (G-10) currencies, rose nearly 6 percent on balance from December 1992 to December 1993. The
dollar's 1993 rise in real terms (that is, adjusted for
movements in relative consumer prices) was slightly
greater than its rise in nominal terms, as US inflation exceeded weighted-average inflation in the other
G-10 countries by about '/2 percent. The dollar's rise
continued into the early weeks of 1994, but by midFebruary it had fallen back to a level a bit below its
average in December 1993.
The main factor behind the strengthening of the
dollar last year appears to have been the general
72
Foreign Exchange Value of the U.S. Dollar *
Index, March 1973 = 100
125
100
75
50
1987
1989
1991
1993
'Index of weighted average foreign exchange value of U.S. dollar
in terms of currencies of other G-10 countries. Weights are based
on 1972-76 global trade of each of the 10 countries.
downward revision in perceptions of the strength of
economic activity in a number of foreign countries
while activity in the United States seemed to be
improving on balance, especially in the latter part of
the year. The weakening of activity abroad contributed to large declines in interest rates in the foreign
G-10 countries, both in absolute terms and relative to
levels of interest rates in the United States. On average, foreign short-term rates fell nearly 3 percentage
points relative to U.S. rates last year, and foreign
long-term rates fell about 1 percentage point relative
to U.S. rates. Foreign short-term rates have changed
little on average during the first few weeks of 1994,
while long-term rates have edged higher.
The dollar rose ° percent against the mark and by
similar amounts against other currencies in the
exchange rate mechanism (ERM) of the European
Monetary System during 1993. It appreciated a bit
further, on balance, in early 1994. Potential existed
for much greater divergence of dollar exchange rates
against these currencies as the result of a widening
of permitted fluctuation margins following the ERM
crisis last summer. Strains developed in the ERM in
July and August on growing expectations that weakness in the French economy and an anticipated recovery of the German economy would cause French
authorities to reduce interest rates ahead of German
rates. Growing pressure on the French, Belgian,
Danish, and Iberian currencies led to massive foreign
exchange intervention, sharp increases in short-term
interest rates in those countries, and in early August, a
substantial widening of the ERM margins. Later, market pressures eased and interest rates returned to their
pre-crisis levels as it became clear that these countries
would not make use of the wider margins to ease
policy, and as the German economy showed signs of
weakening further.
The pound, which had depreciated sharply against
the dollar in late 1992 after U.K. authorities pulled it
from the ERM and substantially lowered interest
rates, fell an additional 4 percent relative to the dollar
during 1993. The Italian lira depreciated nearly
20 percent against the dollar last year, reflecting market concerns over political uncertainties and massive
budget deficits in Italy. Similar concerns, although on
a smaller scale, contributed to the Canadian dollar's
depreciation against the U.S. dollar of about 4 percent
during 1993.
The Japanese yen was the only currency of a foreign G-10 country to appreciate against the dollar in
1993, rising on balance about 11 percent. The dollaryen exchange rate appeared to be subject to two
conflicting sets of pressures last year. During the first
eight months of the year, the dollar depreciated nearly
20 percent against the yen, as market attention
appeared to be focused mainly on the rising Japanese
external surplus and perceived political pressures
from abroad, particularly from the United States, to
reduce this surplus. The dollar reached a low of
almost 100 yen per dollar last August. At that point,
statements by U.S. officials expressing concern over
the implications of the yen's strength for Japanese
growth, accompanied by U.S. intervention support for
the dollar, appeared to shift the market's main focus
from these external considerations back toward the
Japanese domestic economy. Over the latter part of
the year, as economic activity in Japan continued to
weaken and Japanese interest rates moved lower, the
dollar rose against the yen, partially offsetting its
earlier decline. That uptrend was halted in February,
however, in the face of renewed trade tensions
between the United States and Japan, and the dollar
fell back close to the low reached in August.
The dollar depreciated slightly in real terms on
average against the currencies of major U.S. trading
partners among developing countries in Latin America and East Asia in 1993. The Mexican peso rose
6 percent, despite a period of downward pressure
amid uncertainty about the outcome of the U.S. Congressional vote on the North American Free Trade
Agreement as that vote drew near. The rise in the
peso's inflation-adjusted exchange value has cumulated to nearly 35 percent since 1989, reflecting in
part a strong inflow of capital from abroad stimulated
by domestic reforms, declining world interest rates,
and the anticipated positive influence of NAFTA on
73
Mexico's real growth. The Brazilian cruzeiro rose
fairly strongly in real terms against the dollar, as
substantial nominal depreciation of the cruzeiro did
not keep pace with the even more rapid domestic
inflation in that country. Meanwhile, the Hong Kong
dollar rose in real terms and the Taiwan dollar fell.
with the trade deficit, moving from a deficit of
$66 billion in 1992 to nearly $105 billion at an annual
rate over the first three quarters of 1993. Net service
receipts and net investment income receipts both
remained little changed over this period.
Growth of real GDP in the major industrial countries picked up somewhat, on average, during 1993
from depressed levels in 1992. Growth was lifted as
economic recoveries in Canada and the United Kingdom gained some momentum. However, output in
Japan and most of continental Europe remained sluggish at best, showing either small increases or small
declines for most of the year. The weakness of real
activity in the foreign Group-of-Six industrial countries put further downward pressure on CPI inflation,
which receded to roughly 2 percent on average last
year. Further declines in interest rates in most of these
countries during the past year should enhance the
prospects of recovery in the coming year. The major
developing countries in Asia continued to grow rapidly, fueled in part by exceptionally strong growth in
China. Real growth in Mexico fell to near zero,
however, reflecting the depressing effects of policy
restraint aimed at containing inflationary pressures
and, for a time, growing uncertainty about whether
NAFTA would be implemented.
U.S. Real Merchandise Trade
The nominal U.S. merchandise trade deficit widened to more than $130 billion in 1993, compared
with $96 billion in 1992. Imports grew much faster
than exports, partly because the U.S. economic recovery gained momentum while economic growth in U.S.
export markets was sluggish on average. The appreciation of the dollar also tended to depress real net
exports. The current account worsened about in line
U.S. Current Account
Annual rate, billions of dollars
m
60
120
m
180
1987
1989
1991
1993
Annual rate, billions of 1987 dollars
600
- 300
1987
1989
1991
1993
200
U.S. merchandise exports grew 33/4 percent in real
terms over the four quarters of 1993, based on the
initial fourth-quarter estimate from the national
income and product accounts. Exports changed little,
on net, over the first three quarters of the year, but
strengthened in the fourth quarter, as shipments of
machinery and automotive products increased. The
growth of computer exports in real terms slowed from
the very rapid pace of recent years, but still posted an
increase of more than 15 percent. Agricultural exports
declined as a result of reduced U.S. output in the 1993
crop year. By region of the world, the rise in merchandise exports during 1993 was more than accounted for
by increased shipments to Canada, the United Kingdom, and Mexico. Shipments to the sluggish economies in continental Europe and Japan declined somewhat, while the growth of exports to developing
countries in Asia slowed from the rapid pace of 1992.
Merchandise imports grew about 14 percent in real
terms during 1993. The growth in imports was
broadly based across commodity categories. Computers accounted for one-third of the growth in real
terms, but imports of consumer goods, machinery,
automotive products and industrial supplies all rose
strongly as well. Import prices declined slightly during 1993, reflecting a sharp decline in the price of oil
imports. The average price of non-oil imports rose
only slightly, reflecting low inflation abroad and the
rise in the dollar.
74
In the first three quarters of 1993, recorded net
capital inflows balanced only part of the substantial
U.S. current account deficit, as net statistical errors
and omissions were positive and large. Sizable net
shipments of U.S. currency to foreigners, which are
not recorded in the U.S. international accounts, contributed to the positive net errors and omissions.
Payroll Employment
Net change, millions of jobs, annual rate
Total Nonfarm
Net official capital inflows amounted to $48 billion.
G-10 countries accounted for part of the inflows. In
addition, various developing countries, particularly in
Latin America, experienced large private capital flows
into their countries and added substantially to their
official holdings in the United States.
Net private capital inflows into the United States
were negligible in the first three quarters of 1993.
However, reflecting the continued internationalization
of financial markets, both inflows and outflows grew.
U.S. net purchases of foreign securities reached a
record $96 billion, about evenly divided between
stocks and bonds. Most of these net purchases were
accounted for by Western Europe, Canada, and Japan;
developing countries in Asia and Latin America
accounted for a small but growing share of total U.S.
net purchases of foreign stocks and bonds. Foreign
private net purchases of U.S. government securities
and corporate bonds remained strong; foreign asset
holders also resumed making net purchases of U.S.
corporate stocks. In addition, capital inflows from
foreign direct investors in the United States resumed
in the first three quarters of 1993, while capital outflows by U.S. direct investors abroad remained strong.
Labor Market Developments
The labor market strengthened in 1993, as economic expansion began to translate more forcefully
into increased job creation. Payroll employment, a
measure of jobs that is derived from a monthly survey of establishments, rose almost 2 million over the
twelve months of the year. While this gain was only
of moderate size in comparison to annual increases in
many years of the 1970s and 1980s, it was about
twice the increase of 1992. The increase in employment in January of this yea;* apparently was held
down by bad weather.
Hiring picked up in most major sectors in 1993.
The number of jobs in retail and wholesale trade
increased about one-half million, the largest annual
rise since 1988, and the number of jobs in finance,
insurance, and real estate picked up a bit, after a
five-year period that had encompassed three years
of sluggish growth and two years of unprecedented
1989
1991
1993
reductions. Construction employment rose 200,000,
after three years of sharp declines.
The services industry added about 1.2 million new
jobs in 1993. More than one-third of the increase
came at firms that supply services to other businesses.
Of these firms, the ones exhibiting by far the most
rapid growth were personnel supply firms—
companies that essentially lease the services of their
employees to other businesses, usually on a temporary basis. Many companies requiring additional labor
apparently have been attracted by the flexibility of
such arrangements, as well as by cost advantages, at
least over the short run. Elsewhere in the services
industry, health services continued to generate a substantial number of new job opportunities in 1993,
even though the gain was not quite as large as those
of other recent years. Small to moderate employment
gains also were reported during the year at firms
supplying a wide variety of other types of services.
Manufacturing employment continued to decline in
1993, but at a slower pace than in any of the three
previous years. Although manufacturers boosted output considerably, the gain was achieved mainly
through another sizable rise in factory productivity.
Labor input in manufacturing reportedly increased
only slightly, and the gain took the form of a lengthened workweek, rather than increased hiring. By the
latter part of the year, the average workweek in manufacturing had reached 41% hours, the longest since
World War II. Hiring did pick up late in the year,
however, and a further rise in the number of factory
jobs was reported in January of this year. Reliance of
manufacturers on workers from personnel supply
firms reportedly has increased; because these workers
are carried on the payrolls of the personnel firms,
75
actual labor input in manufacturing was greater than
the data indicate.
Significant improvement in labor market conditions also was evident in data from the monthly
survey of households. The measure of employment
that is derived from this survey rose 2'/z million over
the twelve months of 1993, after an increase of about
V/2 million during the previous year. At the same
time, the number of unemployed persons fell more
than 1 million over the course of 1993, and the
civilian unemployment rate declined nearly a full
percentage point. Because of changes in the design of
the monthly survey of households, the official rate
reported for January of this year—6.7 percent—is not
comparable with the official rates for 1993 or previous years. However, the Bureau of Labor Statistics
has indicated that, abstracting from the changes in
survey design, the unemployment rate probably fell in
January, with estimates of the size of the decline
ranging from 0.1 percentage point to 0.3 percentage
point. The aim of the new survey is to achieve more
precise classification of persons whose labor market
situations may not have been accurately captured by
the questions included in the old survey.
Civilian Unemployment Rate
but did not seek it because of a perceived lack of job
openings changed little over the course of 1993. In
addition, the number of persons outside the labor
force and not wanting a job rose about 0.8 percent
during the year, pulled up, in part, by a sharp increase
in the number of retirees. Workers whose careers
were cut short by business restructurings and defense
cutbacks probably augmented the normal flow of
workers into retirement. Growth in the number of
persons not wanting a job because of attendence in
school also increased during 1993, according to data
from the old survey. To the extent that these persons
have been honing their job skills, their lack of current
participation in the labor force could turn into a
positive factor for the economy over the longer run.
The slowing of nominal increases in hourly compensation came to a halt in 1993. The employment
cost index for private industry—a labor cost measure
that includes wages and benefits and covers the entire
nonfarm business sector—increased 3.6 percent from
December of 1992 to December of 1993, about the
same as the rise of the previous year. Wages rose
3.1 percent over the year, one-half percentage point
more than in 1992, and the growth of benefits slowed
only a little, to 5.0 percent. Compensation gains
picked up for workers in some white-collar occupations, notably sales workers and managers. Slightly
bigger gains than in 1992 also were realized by workers in some blue-collar occupations. By contrast, the
rate of compensation growth held steady in service
occupations and edged down in some blue-collar
occupations in which fewer specialized skills are
required. The overall rise in hourly compensation
during 1993 exceeded the rise in consumer prices by
Employment Cost Index *
Percent change, Dec. to Dec.
1987
1989
1991
1993
Growth of the civilian labor force—the sum of
persons who are employed and those who are looking
for work—was relatively sluggish again in 1993. The
rise over the four quarters of the year was 1.2 percent,
only slightly faster than the rate of growth of the
working-age population. Over the past four years,
labor force growth has averaged less than 1 percent
per year, and the labor force participation rate has
edged down slightly, on net. Based on data from the
old survey, the number of persons who desired work
1987
1989
1991
1993
'Employment cost index for private industry, excluding farm
76
about 1 percentage point Hourly wage gains more
than kept pace with inflation, and die value of benefits
provided to workers by their employers continued to
rise rapidly in real terms.
Labor productivity continued to increase in 1993,
albeit less rapidly than in the earlier stages of the
cyclical expansion. According to preliminary data,
output per hour in the nonfarm business sector rose
1.5 percent during the year, after large increases in
both 1991 and 1992. Although part of the gain in
output per hour over this three-year period is no doubt
a reflection of normal cyclical processes, the data also
seem to suggest that the longer-run trend in productivity is tilting up a bit more sharply than in the 1970s
and 1980s, a payoff to heavy investment by business
in new information technologies, to the rising skill of
workers in exploiting those technologies, and, perhaps, to the more quiescent inflation environment of
recent years. With gains in labor productivity offsetting part of the 1993 increase in compensation per
hour, unit labor costs in the nonfarm business sector
increased just 1.3 percent, a shade less than in 1992.
Output per Hour
Percent change. Q4 to Q4
Nonfarm Business Sector
n
m
Consumer Prices*
Percent change. Q4 to Q4
1987
1989
1991
•Consumer price index for all urban consumers.
1993
1992. Scattered upward price pressures showed up in
the commodity markets from time to time during
1993; late in the year and in early 1994, these
increases became more widespread. Producer prices
picked up somewhat in January, but prices at the
retail level were unchanged, on balance.
The patterns of price change for items other than
food and energy were more checkered in 1993 than
they had been in 1992, a year when deceleration was
widespread among both commodities and services.
The CPI for commodities other than food and energy
rose only 1.6 percent over the four quarters of 1993, a
percentage point less than in 1992. Within this category, the CPI for tobacco fell 5 percent 'in 1993, after
many years of large increases, as the inroads being
made by generic brands in that market forced major
Consumer Prices Excluding Food and Energy*
Percent change. Q4 to Q4
1987
1989
1991
1993
- 6
Price Developments
Inflation edged down a bit further in 1993. The
2.7 percent rise in the CPI over the four quarters of
the year was the smallest increase since 1986, and die
four-quarter rise of 3.1 percent in the CPI excluding
food and energy was the smallest increase in that
measure in more than twenty years. At die same time,
however, progress toward lower inflation was sporadic during the year, and the slowing of price
increases was less widespread than it had been in
1987
1989
1991
•Consumer price index for all urban consumers.
1993
77
suppliers to alter their basic pricing strategies. Prices
of apparel rose less than 1 percent during 1993, an
even smaller increase than in 1992. By contrast, the
prices of motor vehicles moved up somewhat faster
than in 1992; the price rise for trucks was the largest
of recent years. The CPI for non-energy services
increased 3.8 percent over the four quarters of 1993,
about the same as the rise during the previous year.
The index for medical care services slowed for the
third year in a row, but airfares rose sharply for a
second year. Price increases for other services generally were little different from those of 1992, with
small deceleration for some items and small acceleration for others.
Food prices picked up in 1993. The consumer price
index for food increased 2.7 percent over the four
quarters of the year, an acceleration of about a percentage point from the pace of the two previous years.
Because price increases in those two previous years
had been held down, in part, by unusually favorable
supply developments in agriculture, some pickup of
food price inflation might have been in store for 1993
even had weather conditions been no worse than
average. In the event, the weather was unusually bad.
Severe winter weather disrupted livestock production
early in the year; drought in the Eastern States hurt
crop production in that region during the summer;
and flooding of historic severity in the Missouri and
Mississippi River Basins cut deeply into output of
some of the nation's major field crops. At retail,
effects of the various supply disruptions showed
through in the prices of meats, poultry, and fresh
produce. Price increases for other foods, which
account for by far the larger share of total food in the
CPI, showed almost no acceleration in 1993; most of
Consumer Food Prices*
Percent change. Q4 to Q4
1987
1989
1991
'Consumer price index for all urban consumers.
1993
the value added in production of these other foods
comes from nonfarm inputs.
Consumer Energy Prices*
Percent change. Q4 to Q4
10
u
n
10
20
1987
1989
1991
'Consumer price index for all urban consumers.
1993
Consumer energy prices declined 0.4 percent over
the four quarters of 1993, after rising only moderately
in 1992. With world oil production outstripping
demand, crude oil prices fell sharply during the last
three quarters of 1993, to levels in December that
were about 25 percent below those of a year earlier.
Gasoline prices, after increasing in the early part of
1993, turned down in March and fell for six additional months thereafter. The string of declines was
interrupted in October when federal gasoline taxes
were raised, but they resumed once again in November and continued through year-end. Average pump
prices for the fourth quarter were about 4 percent
below tHe level of a year earlier. Fuel oil prices fell
about 3 percent over the same period. Prices of the
service fuels—electricity and natural gas—increased
during 1993. The rise in electricity prices over the
year amounted to 1.7 percent, slightly less than the
increase posted in 1992. Natural gas prices rose nearly
5 percent for the second year in a row; consumption
of natural gas has picked up in recent years, after
trending lower through much of the 1970s and a large
part of the 1980s. Since the end of last year, oil prices
have changed little, on net, as an upswing in prices
during the first few weeks of 1994 has been reversed
by more recent declines. The CPI for energy continued to fall in January.
The producer price index for finished goods, which
includes both consumer goods and capital equipment
and covers only the prices received by domestic
producers, increased just 0.2 percent over the four
78
quarters of 1993. An identical increase was reported
in the PPI for finished goods other than food and
energy; the increase in this measure was the smallest
in its history, which goes back to 1974. As at retail,
price increases for these domestically-produced goods
were held down, in part, by the sharp drop in prices of
tobacco products. More broadly, competition from
imports and further increases in labor productivity in
manufacturing were important elements in pricing
restraint. The prices of intermediate materials excluding food and energy rose 1.6 percent over the four
quarters of 1993, a small step-up from the pace of the
previous year.
In the markets for raw commodities and other
primary inputs, scattered upward price pressures
emerged from time to time during the first three
quarters of 1993, and fairly widespread increases
were reported in the year's final quarter and into early
1994. The producer price index for crude materials
excluding food and energy thus moved up sharply
over the year, by about 10 percent in all. The weight
of these inputs in GDP is quite small, however, and,
in the absence of more general cost pressures,
increases in their prices usually do not impart much
upward thrust to the prices of finished goods.
Inflation expectations, as reported in various surveys of consumers and other respondents, flared up
for a time during 1993, but retreated in the latter part
of the year. According to one such survey, conducted
by the University of Michigan Survey Research Center, the rate of price increase expected one year into
the future moved up from an average of 3.8 percent in
the final quarter of 1992 to an average of 4.7 percent
in the third quarter of 1993. The rise was fully
reversed in the fourth quarter, however. A similar but
much less pronounced swing in expectations was
evident in some other surveys as well. The surveys
have continued to show one-year expectations of price
change running somewhat higher than the actual
increases of recent years. Longer-run expectations of
price change have remained higher still, with the
Survey Research Center's series on average inflation
rates that are expected over a five-to-ten year horizon
holding in a range of 41/2 percent to 5 percent, according to surveys conducted in the second half of 1993
and early 1994.
79
Section 3: Monetary and Financial Developments in 1993
Financial repair continued in 1993, amid increasing signs that borrowers and lenders were more comfortable with their balance-sheet positions. Households, in particular, and firms, to a lesser extent,
stepped up their borrowing as the year progressed.
Depository institutions, for their part, were sufficiently encouraged by the stronger economy and the
improvement in their own financial conditions to ease
the terms and conditions of credit for businesses and
households.
Nonetheless, with efforts to strengthen financial
positions continuing, financing remained concentrated
in capital markets, largely bypassing banks and thrifts.
In part spurred by the higher returns available in those
markets, investors found bonds and stocks to be more
attractive alternatives than deposits; flows into bond
and stock mutual funds were at record levels last year.
As a consequence, the monetary aggregates continued
to grow quite slowly relative to the expansion of
nominal income. Recognizing the ongoing redirection
of financial flows relative to historical norms, the
Federal Open Market Committee (FOMC) lowered
the annual ranges for M2 and M3 for 1993 in two
technical adjustments totalling 1 '/2 percentage points
for M2 and 1 percentage point for M3 in February and
July 1993. Uncertainty about the extent and duration
of the unusual change in velocity meant that growth
in the aggregates could not be relied upon to guide
changes in reserve conditions, and the FOMC continued to employ a wide variety of information about
financial and economic conditions for this purpose.
Assessing the incoming information, the Federal
Reserve judged that no change was needed in reserve
and money market conditions during 1993 to sustain
the economic expansion without engendering inflationary pressure. With money market rates remaining
in a range not much, if at all, above the core rate of
inflation, however, the members of the FOMC viewed
that a tightening in reserve conditions at some point
would likely be needed to avoid pressures on capacity
and'a pickup in inflation.
Concerns about a buildup of inflationary momentum increased in the spring, and, over the three
months from mid-May until mid-August, instructions
from the FOMC to the Federal Reserve Bank of New
York indicated that there was a greater likelihood that
money market conditions should be tightened as
opposed to eased before the next scheduled meeting
of the FOMC. Those concerns again came to the fore
as 1994 opened. Considerable underlying strength in
aggregate demand and dwindling levels of excess
capacity to meet that demand raised the risk that
inflation pressures would strengthen down the road,
derailing the expansion. Consequently, in February,
the FOMC tightened reserve conditions for the first
time in five years, nudging short-term rates up 1/4 percentage point.
The Implementation of Monetary Policy
Most short-term interest rates ended 1993 where
they had begun the year, at quarter-century lows that
had resulted from the substantial easing in reserve
conditions engineered by the Federal Reserve from
1989 to 1992. The rate charged for adjustment borrowing at the discount window remained at 3 percent, and the federal funds rate traded around the
same level. Despite the stability of short-term interest rates, longer-term interest rates fell as much as
1 percentage point over the course of 1993, to settle at
levels not seen on a sustained basis since the late
1960s. Investors apparently were encouraged by the
prospects for low inflation and reduced federal budget deficits. Helped by the decline in long-term rates
and by brighter earnings reports, the stock market
enjoyed strong gains.
In February 1993, the first FOMC meeting of the
year, incoming information suggested that the economy had exhibited considerable strength in the fourth
quarter of 1992. In the event, final estimates for the
last quarter of that year put the increase in real GDP
at a 53/4 percent annual rate and the growth of nominal
Short-Term Interest Rates
Monthly
14
Federal Funds
10
Three-month Treasury Bill
Coupon Equivalent
I
I
I
I
I
1983
1985 1987 1989
Last observation is for January 1994.
I
i
1991
I
I
1993
80
Long-Term Interest Rates
Monthly
16
Home Mortgage
Prirnsry Conventional
12
Thirty-year Treasury Bond
i
i
i
i
i
i
i
i
1983
1985
1987
1989
Last observation is tor January 1994.
i
i
1991
i
i
i
1993
GDP in excess of 9 percent. Final demand was seen to
be strong, paced by household consumption and business investment. With slack relative to capacity still
considerable—the unemployment rate averaged
7'/4 percent (on the old basis)—price pressures were
not perceived to be likely. The expansion of the
monetary aggregates had faltered around the turn of
the year, but the sense was that special factors—
importantly including a decline of mortgage prepayments that constricted the level of transactions
deposits—accounted for some of the weakness.
Against this backdrop, it appeared to the members of
the FOMC that unchanged reserve conditions would
support economic expansion and still be consistent
with further declines in inflation and inflationary
expectations. Moreover, the situation did not seem to
call for a presumption of the likely direction of any
intermeeting adjustment in reserve conditions; such a
symmetric directive had been issued to the Account
Manager of the System Open Market Account at the
end of the December 1992 meeting as well.
Investor confidence in the longer-term prospects in
capital markets apparently strengthened in the weeks
that followed, owing in part to a growing perception
that significant progress in reducing the path of future
budget deficits might be in the offing. By the time of
the March Committee meeting, bond yields had fallen
appreciably, touching levels last observed in 1973,
with the largest declines posted at the longest maturities. Indicators of real activity suggested some slowing from the torrid fourth-quarter pace, but, in labor
markets, payroll employment had strengthened and
the unemployment rate had moved down further.
Readings on inflation sparked some concern about the
potential for a buildup of inflationary momentum.
With fundamental forces still suggesting further disinflation, however, and with those concerns not evident
in capital market indicators, or in the exchange value
of the dollar, which remained relatively steady, the
FOMC retained its symmetric directive.
In May, Committee members were confronted with
ambiguous indicators of economic activity, prices,
and the financial aggregates, which were all made
more confusing by a spell of bad weather that had
distorted somewhat the seasonal patterns of spending
and production. As for the prices of goods and services, while it was thought by many analysts that the
major indexes were distorted by difficulties in seasonal adjustment, data releases showing a variety of
price and labor compensation indexes on the high side
of investor expectations still roiled financial markets.
Slack in the economy remained appreciable, which
weighed against any pickup in inflation, but inflation
expectations were in danger of ratcheting higher, with
possible adverse consequences for inflation itself.
Meanwhile, the latest readings on the monetary aggregates showed a burst of growth in early May, but
tax-induced distortions and a surge in prepayments of
mortgage-backed securities made this information
particularly difficult to interpret. In the view of a
majority of the members of the FOMC, wage and
price developments were sufficiently worrisome to
warrant positioning policy for a move toward restraint
should signs of mounting inflation pressures continue
to multiply. While they saw no immediate need to
alter the degree of reserve, pressure, they agreed that
current conditions made it easier to envisage a tightening as opposed to an easing over the intermeeting
period, a sense that was embodied in an asymmetric
policy directive.
In advance of the July meeting of the FOMC, the
unemployment rate had moved back up to 7 percent
(on the old basis), while industrial production had
been little changed over the preceding few months.
The surge in the monetary aggregates in May apparently had not marked a trend toward more rapid
expansion in broad measures of money. Overall, the
evidence pointed toward a sustained economic expansion and some ebbing of the recent upsurge in inflationary pressures. News in that vein, along with
progress in Congress toward adoption of a deficitreduction package, had fostered a drop in longer-term
bond yields in the days leading up to the meeting. The
durability of that improvement in market sentiment
remained an open question, however. Monetary policy could be viewed as relatively expansive in light of
the behavior of a variety of other indicators, including
81
the growth in narrow measures of the monetary aggregates and reserves and the low levels of money market interest rates, both in nominal and, in particular, in
real terms. In such an environment, Committee members agreed that it was necessary to remain especially
alert to the potential for a pickup in inflation. As a
result, the FOMC decided to retain the current degree
of restraint in the reserve market and an asymmetric
tilt toward tightening in the policy directive.
At the time of the August meeting of the Committee, readings on inflation were encouraging: Consumer prices had changed little and producer prices
had fallen over recent months. Data on spending and
production had a weakish cast and the persistence of
the sluggishness in the second quarter had become
more apparent. These data releases had bolstered
investor confidence in the prospects for continued
disinflation, while the recently passed legislation on
the federal budget offered the promise of meaningful
cuts in the deficit over the next several years. Accordingly, longer-term yields fell about 40 basis points.
The resulting capital gains apparently added to the
allure of stock and bond mutual funds, thereby weakening M2, which only edged up in July. At this
meeting, policymakers saw existing reserve conditions as consistent with their goals. Moreover, the
dissipation of the inflation threat and the encouraging
downward tilt to expectations of inflation suggested
to members of the FOMC that the risks were more
evenly balanced than of late. As a result, the Committee reverted to a symmetric directive—instructions
that carried no presumption as to the direction of
an intermeeting move—which they subsequently
retained for the remainder of 1993.
Leading up to the September FOMC meeting, the
unemployment rate had edged lower, to 6.7 percent
(old basis), housing starts had declined and retail
sales were flat in real terms. Substantial drags on
economic growth remained: cutbacks in the defense
sector, uncertainties regarding the effects of other
government policies that had the potential to raise
labor and production costs, and slow growth on average in the foreign industrial economies. However,
sources of stimulus were also apparent: the cumulative spur to spending of low interest rates, especially
at longer maturities; the lessening of balance-sheet
constraints on households and firms; and the improving financial condition of the depository sector, which
was making credit more available. Given these conflicting influences on spending, the Committee determined that leaving reserve conditions unchanged
would be most consistent with maintaining sustainable economic growth.
The incoming data in advance of the last two
Committee meetings of 1993 indicated a robust nearterm expansion in activity with no immediate inflationary pressure. While there was a sense that, with
reserves ample and money-market rates at the low
end of the range of experience over the past three
decades, the next move in policy would be to tighten,
the members of the Committee agreed that, until
trends became clearer, the current stance of policy
should be maintained. The prospects of heightened
credit demands and forecasts of looming capacity
pressures pushed up longer-term interest rates about
3
/s percentage points from their yearly lows set in
mid-October. Over that same span, the dollar showed
notable strength on foreign exchange markets.
Most market rates held at these higher levels as the
FOMC met for the first time in 1994. Readings on
activity suggested that 1993 had ended the year on a
very strong note, with real GDP expanding about
6 percent at an annual rate in the fourth quarter and
reports suggesting that some of this momentum had
carried over into 1994. Slack in labor and product
markets had been reduced considerably, and the prices
of a number of commodities important in the production of durable goods and in construction had begun
to move higher. With that backdrop, the Committee
decided that it was time to trim back some of the
stimulus provided by the current low level of shortterm interest rates before it fed through to higher
inflation. The Account Manager was directed to
tighten reserve conditions, and the federal funds rate
moved up to a range around 3'/4 percent, while the
discount rate remained at 3 percent.
Money and Credit Flows
The long expansion of the 1980s was associated
with growth of total debt of domestic nonfinancial
sectors that was about 1 '/2 times the pace of nominal GDP growth. In the wake of this phenomenal
leveraging, the recession and tepid economic recovery from 1990 to 1992 were importantly a balancesheet phenomenon that was reflected in a slowing in
debt growth. In retrospect, it is apparent that this
deceleration in debt was one symptom of the general dissatisfaction of both borrowers and lenders
with their financial conditions, a concern that also led
to some restraint on spending and asset accumulation. Nineteen ninety-three saw some lessening of this
restraint, and the growth of the debt of the nonfinancial sectors expanded 5 percent, about in line with
nominal GDP. This performance put the debt aggregate in the lower portion of its 4 to 8 percent moni-
82
Debt: Annual Monitoring Range and Actual Growth
Billions of dollars
Indicators of Nonfarm Nonfinancial
Corporate Sector Finances
Debt to Sector GDP
Percent
12800
12600
Quarterly
12400
70
12200
12000
60
11800
O N D
1992
A M
J J A S
O
11600
1993
toring range, a range that had been set at the first
meeting of the year.
The debt of the nonfederal sectors (nonfinancial
businesses, households, and state and local governments) expanded 33/4 percent last year. For nonfinancial corporations, a pickup in fixed investment and
inventory investment outpaced increases in internally
generated funds, pushing the financing gap into positive territory after two years of negative readings; as
those firms sought outside funds, they turned in the
main to long-term debt markets, but net equity issuance remained sizable as well. However, the debt
markets in 1993 saw far more activity than the net
requirements for external funds implied. Low longerterm rates induced many firms to refinance existing
obligations, pushing gross public debt issuance by
nonfinancial firms above $190 billion.
Percent
- 4
- 2
I I I I I I I I I I I I I I I l l l l I I I
1975
1980
1985
1990
1980
1985
1990
Debt Service to Sector GDP
Percent
Quarterly
l I l l l l l l l l l i
1975
Nonfinancial Corporate Financing Gap
as a Percent of Total GDP
1975
1980
1985
1990
Earlier efforts to restructure balance sheets, along
with the opportunities afforded by lower long-term
rates to refinance existing obligations, apparently put
households in a better position to take on new debt in
1993. With debt-service burdens holding at about
16 percent of income, or about 21A percentage points
below the peak set at the end of the previous decade,
and loan rates declining substantially, households
assumed new liabilities rapidly enough, on net, to
push up the ratio of their total liabilities to disposable
income to just under 90 percent in 1993. The largest
swing was in the consumer credit category, as households evidently became more confident of the sustainability of the economic expansion and made
previously-delayed purchases of durable goods, especially autos. The record volume of mortgage origina-
83
Indicators of Household Sector Finances
Household Deposits as a Percent of
Household Assets
Debt to Disposable Income
Percent
Quarterly
Quarterly
85
25
75
20
65
I I I I I I I I I I I I I I I I I I I I I I
1975
1980
1985
55
15
1990
provided by longer maturity instruments that were
mostly available from outside the depository sector.
Debt Service to Disposable Income
Quarterly
15
I I I I I I I I I I I I I I I I I I I I
1975
1980
1985
1990
Depository institutions, pressed by their own
balance-sheet problems, were unaggressive in seeking
deposits and extending credit in the early 1990s. But,
by 1993, commercial banks had made substantial
strides in improving their capital standing. About
three-quarters of the assets at commercial banks were
on the books of well-capitalized institutions as of
September 1993, 2'/2 times the proportion at the end
of 1990. Partly as a consequence, banks reported on
Federal Reserve surveys a substantial easing of terms
and standards on business and consumer loans during
the year. However, borrowers, endeavoring to lock in
longer-term funds, which are not typically supplied
13
tions mostly involved refinancings, but with a pickup
in construction activity and some cashing out of
equity in the process of refinancing, home mortgages
expanded 7 percent, on net, last year. Overall, this
pickup in liabilities was dwarfed by a substantial
expansion of the asset side of the household balance
sheet last year, raising net worth to a level about
43/4 times that of disposable income. Within those
assets, households continued to shun deposits in favor
of the investment products of nonbank intermediaries,
notably mutual funds and insurance companies. As a
result, deposits shrank to under 20 percent of total
household assets, a post-World-War-II low. Much of
the declining role for deposits probably owed to the
pattern of financial returns, with investors, confronted
by a steep yield curve, seeking out the higher yields
I I I I I I I I I I I I I I I I I I I I I I
1975
1980
1985
1990
Net Percentage of Domestic Loan
Officers Reporting Tightening Standards for
Commercial and Industrial Loans
By Size of Firm Seeking Loan
60
40
20
+
0
Small
\^>
20
1990
1991
1992
1993
84
Assets of Domestic Banks, by Capital Category, Adjusted for Overall Supervisory
Ratings, as a Proportion of All Such Assets
Percent*
Year-end
Category
1990
1991
1992
September
1993
Well capitalized
30.4
34.4
67.8
73.3
Adequately capitalized
38.5
45.1
21.8
17.8
Undercapitalized
31.1
20.5
10.3
8.9
1. Adjustments to capital categories were made according to the rule of thumb of downgrading a bank by one category for a low examination rating by its supervisory agency (CAMEL 3, 4, or 5).
by banks, continued to rely heavily on capital markets, keeping the need of depositories to fund asset
expansion subdued. Depository credit did expand
modestly in 1993, marking a substantial rebound from
the declines posted in the previous three years. The
increase in depository credit exceeded the growth of
deposit funds, as depositories made extensive use of
equity, subordinated debt, and other nondeposit funds
to finance the expansion of depository balance sheets.
Bank credit increased 5 percent last year, after two
years of growth in the neighborhood of 3'/2 percent,
while thrift credit contracted only modestly. Indeed,
thrift credit is estimated to have expanded in the
second half of the year, pulled up by extensions of
loans by credit unions that outweighed continuing,
albeit slackening, runoffs at savings and loans.
Slow expansion of depository credit, together with
the increased reliance by banks on nondeposit funds,
damped the growth of M3 in 1993. From the fourth
quarter of 1992 to the fourth quarter of 1993, M3
grew '/2 percent, ending the year a little above the
lower bound of its annual range of 0 to 4 percent. This
range had been adjusted down for technical reasons to
acknowledge the appreciable upward trend to M3
velocity over the past few years, which accompanied
Growth of Domestic Nonfinancial Debt and Depository Credit*
i i i i i i i i i i i i i i i i i i i i i i
1960
1965
* Four quarter growth rates.
1970
1975
1980
1985
1990
85
M3: Annual Range and Actual Growth
Brifions of dollars
4350
4300
4250
4200
4150
O N D J
1992
F M A M J J A S O N D
1993
4100
the shrinking role of depositories in intermediating
funds. The part of M3 exclusive to that aggregate
declined 3l/2 percent on a fourth-quarter-to-fourthquarter basis, held down by a steep drop in institutiononly money market mutual funds. Overall, M3 velocity rose at a 4'/2 percent annual rate in 1993, down
almost 2 percentage points from the previous year.
The velocity of M2 rose at a 3% percent annual
rate in 1993 after increasing nearly 5 percent in 1992.
The rise in velocity last year was posted even as the
return on many competing short-term assets remained
relatively constant, and it was this ongoing drift
upward in the ratio between nominal GDP and the
aggregate that led the FOMC to reduce the annual
growth range for M2 from the 2-to-6 percent spread
that was set in February to the l-to-5 percent range
M2: Annual Range and Actual Growth
Billions of dollars
3700
3600
3500
__j—i—I—\—i—i—t—i—i—i—i—i—»—i_J 3400
O N D J F M A M J J A S O N D
1992
1993
that was ultimately in effect. In the event, M2 grew
\l/i percent from the fourth quarter of 1992 to the
fourth quarter of 1993, slowing slightly from the
2 percent growth rate in 1992. Even this anemic
expansion was accounted for in part by special factors. In particular, foreign demands for currency were
strong and transactions deposits were boosted late in
the year by a surge in mortgage refinancings that
followed when mortgage rates fell to levels not seen
in a generation. Refinancings are associated with the
temporary parking of funds in transactions and other
highly liquid deposit accounts.
Especially after taking account of such special factors, the growth of M2 was quite subdued in 1993,
owing in large part to the attractiveness of capital
market instruments. Although the bond market rally
trimmed as much as 1 percentage point from longerterm yields, the term structure still retained an abnormally steep tilt through all of 1993. Some investors
were willing to expose themselves to the greater price
risk inherent in capital market mutual funds in the
pursuit of higher average returns. Commercial banks
took some measures to keep those customers, if not
those deposits: Many banks made it possible to buy
stock and bond mutual funds in their lobbies. Promotion of these services picked up and some banks
sponsored their own mutual funds or established
exclusive marketing arrangements with mutual fund
companies, undoubtedly encouraging the diversion of
deposits to mutual funds.
At the end of 1993, assets in stock and bond mutual
funds totalled about $P/2 trillion, up $400 billion
from year-end 1992. About one-half of the December
1993 total was held by institutions and in retirement
accounts—two categories generally not in M2. M2
plus the remainder of stock and bond funds expanded
at around a 5l/z percent annual rate in 1993, roughly
in line with nominal GDP over that period.
Ml grew at a 10'/a percent pace last year, spurred
on by double-digit increases in currency and demand
deposits. As noted above, the former was importantly
boosted by foreign demands, while the latter was
closely related to swings in mortgage refinancing. MI
velocity declined at a 43/4 percent annual rate, despite
the relative stability of money market interest rates. In
contrast, the narrow aggregate's velocity had followed the path of short rates down during the easing
of monetary policy from 1989 to 1992. Altogether,
the drop in Ml velocity in recent years illustrates both
its high interest-rate sensitivity and the fairly loose
relationship of Ml with interest rates and income.
With the rapid expansion of transactions deposits,
86
Monetary Velocities and Opportunity Costs
Percentage points, ratio scale
Ratio scale
7
6
5
1.78
4
1.72
3
1.66
1.6
1.54
1.48
1985
1987
1991
Ratio scale
1993
Percentage points, ratio scale
14
7.25
M1 Velocity
7
10
6.75
6.5
6.25
6
5.75
1985
1987
1989
'Two-quarter moving average. Assumes zero return on demand deposits.
1991
1993
87
Growth Rates of M2 and M2 Plus
Stock and Bond Funds
1985
1987
M1: Actual Growth
1989
1991
Percent
total reserves grew at a 121A percent annual rate last
year, down from the 20 percent pace posted in 1992.
Adding in the increase in currency results in a
10'/2 percent growth rate for the monetary base in
1993, the same performance as the previous year.
Confronted with this rapid expansion in transaction
deposits, and therefore required reserves, and directed
by the FOMC to keep reserve market pressures
unchanged over all of 1993, the Domestic Desk at the
Federal Reserve Bank of New York added about
$35 billion of securities, on net, to the System Open
Market Account over the course of the year. In keeping with previous FOMC instructions, those purchases were weighted more heavily than in the past
toward longer-maturity instruments. As a result, the
average maturity of the Treasury securities held by
the Federal Reserve moved up slightly over 1993 to
3.2 years.
1993
Average Maturity of Treasury Debt
Billions of dollars
Annual
Held by Public
1150
1100
1050
O N D J F M A M J J A S O N D
1992
1993
1000
M I I I I M I I I I I I I I I I I I I M I I I I I I I I I I II
1960
1965
1970
1975
1980
1985
1990
88
Growth of Money and Debt
Percent
Period
M1
M2
M3
7.4
5.4 (2.5)
8.8
8.9
9.3
9.2
12.4
Domestic
nonfinancial
debt
Annual,
fourth quarter to fourth quartet
1980
2
1981
1982
1983
1984
10.4
5.5
12.0
15.5
1985
1986
1987
1988
1989
6.3
4.3
.6
4.2
7.9
1990
1991
1992
1993
14.3
10.5
12.2
8.1
9.6
9.9
9.9
10.9
8.7
9.3
4.3
5.3
4.8
7.6
8.9
5.7
6.3
3.8
4.0
2.9
1.9
1.4
1.7
1.2
.5
.6
9.1
9.9
9.6
12.0
14.0
14.2
13.4
10.3
9.0
7.8
6.6
4.6
5.0
4.9
Quarter (annual rate)3
1993:Q1
Q2
Q3
Q4
8.3
10.7
12.0
9.4
1. From average for fourth quarter of preceding year to
average for quarter of year indicated.
2. M1 adjusted for shin to NOW accounts in 1981.
-1.3
2.2
2.6
2.1
-3.2
2.1
1.1
2.4
4.0
4.5
5.7
5.2
3. From average for preceding quarter to average for quarter indicated.
89
BOARD OF GOVERNORS
OF THE
FEDERAL RESERVE SYSTEM
WASHINGTON, 0. C. 20551
ALAN GREENSPAN
CHAIRMAN
February 25, 1994
The Honorable John J. LaFalce
House of Representatives
Washington, D.C.
20515
Dear Congressman:
At the hearing on Tuesday before the Subcommittee on
Economic Growth and Credit Formation, you requested information
about financing conditions for small businesses.
enclosed materials will be useful.
be of further assistance.
Enclosures
I hope that the
Please let me know if I can
90
BOARD OF GOVERNORS
OF THE
FEDERAL RESERVE SYSTEM
WASHINGTON D.C. 20551
DIVISION OF MONETARY AFFAIRS
February 10, 1994
TO:
HEADS OF RESEARCH AT ALL FEDERAL RESERVE BANKS
Enclosed are copies of a national summary of the January 1994
Senior Loan Officer Opinion Survey on Bank Lending Practices for
distribution to respondents.
Enclosures
91
The January 1994 Senior Loan Officer
Opinion Survey on Bank Lending Practices
The January 1994 Senior Loan Officer Opinion Survey on Bank
Lending Practices posed questions about changes in bank lending
standards and terms, about changes in loan demand by businesses and
households, and about several bank balance sheet items.
Included in
the survey were fifty-nine domestic commercial banks and eighteen U.S.
branches and agencies of foreign banks.
The survey results again showed an easing of terms and
standards on loans to businesses and households by a significant
proportion of respondents.
Banks reported easing terms and standards
on commercial and industrial loans to firms of all sizes, although
somewhat fewer banks reported such easing than did so in the November
survey.
Standards for commercial real estate loans were little
changed. Respondents reported increased willingness to make loans to
individuals and a small net easing of standards on home mortgage
loans.
A significant number of respondents reported an increase in
credit demand over the past three months.
The number of respondents
reporting stronger demand for commercial and industrial loans rose
sharply relative to the November survey: firms of all sizes increased
their demand.
The banks also reported a small net increase in demand
for credit lines over the past three months.
Household demand for
credit, particularly installment credit, was stronger at several
banks.
Special questions on the survey addressed the distribution of
bank loans by type of loan, bank holdings of state and local taxexempt securities, and bank loans to brokers and dealers.
1. This document was prepared in the Division of Monetary Affairs
(William B. English, with research assistance by Andrew D. Cohen),
Board of Governors of the Federal Reserve System. In the footnotes
that follow, table 1 refers to the responses of the domestically
chartered banks and table 2 to those of the U.S. branches and agencies
of foreign banks.
92
Business Lending
Commercial and industrial loans.
About an eighth of the
domestic survey respondents reported having eased standards for
approving commercial and industrial loans and lines of credit for
customers of all sizes over the previous three months.
For large <
medium-sized borrowers the proportion doing so was smaller than ii<
November survey, but the fraction reporting eased standards for s.ma
borrowers increased.
The proportion of U.S. branches and agencies
foreign banks that reported having eased lending standards was
somewhat larger than the fraction of domestic banks that did so.
Many banks reported having eased terms on loans and 1ines
credit over the past three months, although the fraction doing so <•
somewhat lower than in the November survey.
The two terms eased j;;.
frequently were the spreads of loan rates over base rates and the
costs of credit lines.
Roughly 40 percent of the respondents e a s e ;
these terms for large and middle-market customers, but less than .'
percent did so for small businesses.
Smaller percentages of
respondents eased other terms, including loan covenants and
collateralization requirements, as well as raised the maximum size
credit lines.
The percentage of foreign respondents that eased
lending terms was somewhat smaller than the percentage of domestic
banks that eased terms for large and middle-market firms.
The respondents indicated that the easing of lending teiiu.,
and standards was primarily the result of a more favorable econoin;.
outlook and increased market competition. A substantial number oi
respondents also pointed to an improvement in their bank's expected
capital position. A few of the foreign respondents noted that weak
demand in their home; market allowed them to incrcacc lending in tht;
United States.
Considerably larger fractions of the domestic respondent::,
than in the November survey reported stronger demand for business
loans by firms in all size groups. Loan demand of large business ;:
which was relative].1/ weak in the last survey because of increased
nonbank financing, showed a substantial rebound. The respondents
generally attributed the stronger demand to borrower needs to finai;
inventories and investment in plant and equipment.
Branches and
2. Table 1, questions 1-5 and 10-16; table 2, questions
8.
93
agencies of foreign banks also reported a net increase in demand for
commercial and industrial loans, although it was more limited than the
one that the domestic respondents reported.
A few domestic and
foreign respondents also noted an increase in demand for lines of
credit, as opposed to loans, over the past three months.
Real estate loans.
Domestic and foreign respondents both
indicated that credit standards for commercial real estate loans had
eased slightly.
The domestic respondents reported a small net easing
of standards for all types of commercial real estate loans--the first
such easing since the questions were added to the survey in 1990.
These responses are consistent with indications of firming markets for
commercial real estate in some parts of the country and with the
decline in delinquency rates on bank real estate loans over the past
two years.
Foreign respondents reported a small net easing of
standards on construction and land development loans and loans to
finance other nonfarm, nonresidential real estate. Their terms for
other types of commercial real estate loans were unchanged.
Lending to Households4
The fraction of domestic banks reporting increased
willingness to make consumer loans in the January survey was about
twice as large as in November.
On net, nearly 30 percent of
respondents reported greater willingness to make consumer installment
loans, and a similar percentage was more willing to make general
purpose consumer loans, including home equity loans. A few banks
reported having eased standards for approving mortgage applications
for purchasing houses over the past three months.
Demand for household credit appears to have strengthened from
November to January. The respondents reported a significant net
strengthening of demand for consumer installment loans, and a slightly
smaller pickup in demand for home mortgages. In both cases, however,
the number of banks reporting stronger demand was somewhat below the
level in the November survey. The respondents also reported no net
decline in demand for home equity loans over the past three months.
In November, the banks had reported a net decline in demand for home
3. Table 1. questions 6 and 7; table 2, questions 4 and 5.
4. Table 1, questions 8, 9, and 17-19.
76-694 0 - 9 4 - 4
94
equity loans, possibly because of paydowns employing the proceeds from
refinancings of first mortgages.
The January survey asked for information on several balance
sheet items. First, the respondents were asked to provide the
distribution of their business loan portfolios among four categories.
The domestic banks reported that "floating-rate loans with stated
maturities" accounted for more than 60 percent of the dollar amount of
their outstanding business loans at the end of 1993.
"Fixed rate
loans with stated maturities excluding overnight loans" were the next
biggest category, followed by "demand loans."
The smallest category
was "overnight loans," which accounted for less than 5 percent of the
total.
The foreign respondents generally reported larger shares of
fixed-rate loans and smaller shares of demand loans.
On average,
demand loans were reported to remain on banks' books for about a year.
The second set of questions was about banks' holdings of taxexempt municipal securities.
After six years of contraction following
tax law changes in 1986. holdings of these securities have increased
in recent months.6
According to the respondents, nearly half of
the tax-exempt securities on their books were purchased before the
1986 tax changes and so are grandfathered-under the old tax rules.
The bulk of the remaining holdings are "bank-qualified"
securities.
The banks that reported an expansion in their
holdings of tax-exempt securities indicated that the increase
represented primarily purchases of bank-qualified instruments. The
respondents explained that they had purchased tax-exempt securities
because the yields on these instruments had increased relative to
those on comparable taxable securities and also because improved
profitability at their banks made tax-exempt securities more
attractive.
5. Table 1. questions 20-27: table 2, questions 9-17.
6. Until the 1986 changes, banks were allowed to deduct 80 percent
of the costs of funding tax-exempt securities from taxable income.
For most tax-exempt instruments acquired after August 7. 1986. banks
are not allowed to deduct any of the funding costs.
7. Bank-qualified tax-exempt securities are those issued by
municipalities whose annual issuance is less than $10 million. These
instruments retain the favorable pre-1987 tax treatment of municipals.
95
A LinrJ _>et of questions focused on the surge in security
loaiij during 1993.
Most of the banks reporting growth in security
loans indicated that: it resulted primarily from increased funding
needs of bickers 1 and dealers.
A few respondents also noted that
broker and dealer financing had shifted away from other sources, in
some casct.s because their bank offered more aggressive terms.
Finally, th*- foreign respondents were asked for the causes of
the increase (if any) in their net borrowing from their parent bank,
its n o n - U . S . o f f i c e s , and their own international banking facility
since mid - J 9('l .
In aggregate. U.S. branches and agencies of foreign
banks h a v e significantly increased such borrowing over this period.
More than h a l f of th^ f o r e i g n respondents reported increased net
borrowing from t h e s rj sources.
They generally attributed the increase
to the relatively Inexpensive funding available in their home country.
A few of the respondents pointed to changes in their organizations'
practice::-; for. booking certain assets and liabilities, or to the
corii-oiida tiion of thc-ir organizations' funding or investment
activities.
96
Measures of Supply and Demand
For Commercial and Industrial Loans
Net Percentage of Domestic Respondents
Tightening Standards for C&l Loans
(by Size of Firm Seeking Loan)
Q2
Q3
1990
04
Q1
02
1991
03
04
Q1
Q2
Q3
Q4
Q1
1992
Q2
Q3
1993
Q4
Q1
1994
Net Percentage of Domestic Respondents
Reporting Stronger Demand for C&l Loans
(by Size of Firm Seeking Loan)
Q3
1993
Q4
Q1
1994
Q2
97
Table 1
SENIOR LOAN OFFICER OPINION SURVEY ON BANK LENDING PRACTICES
AT SELECTED LARGE BANKS IN THE UNITED STATES
(Status of policy as of January 1994)
(Number of banks and percent of banks answering question)
(By volume of total domestic assets, in $ billions, as of September 30,19931)
NOTE: Questions 1 through 9 of this survey deal with changes in your bank's lending policies over the last three months. If lending
policies at your bank have not changed in the last three months, they should be marked "unchanged" even if, for example, these policies remain restrictive relative to longer-term norms. By the same token, if your bank's lending policies have been eased in the last
three months, they should be marked as "easier" even if, for example, they nevertheless remain restrictive relative to longer-term
norms.
1. In the last three months, how have your bank's credit standards for approving applications for C&l loans or credit lines-other than
those to be used to finance mergers and acquisitions-from large corporate, middle market and small business customers changed?
(Please report changes in enforcement of existing standards as changes in standards. The middle market has been categorized as
consisting of firms with annual sales of between $50 and $250 million; in answering this question, refer either to this definition or to
any other that may be employed at your bank; please indicate the definition used if it is other than the one suggested. "Large" borrowers would then be those larger than middle market customers and "small" borrowers those that are smaller.)
a. for large firms
All Respondents
$10.0 and over
Banks
Banks
Pet
Pet
Under $10.0
Banks
Pet
Tightened considerably
0
0.0
0
0.0
0
Tightened somewhat
1
1.7
1
2.9
0
0.0
Basically unchanged
49
84.5
28
80.0
21
91.3
Eased somewhat
8
13.8
6
17.1
2
8.7
Eased considerably
0
0.0
0
0.0
0
0.0
Total
58
100.0
35
100.0
23
100.0
0.0
b. for middle market firms
All Respondents
$10.0 and over
Banks
Banks
Pet
Pet
Under $10.0
Banks
Pet
Tightened considerably
0
0.0
0
0.0
0
Tightened somewhat
0
0.0
0
0.0
0
0.0
Basically unchanged
50
86.2
30
88.2
20
83.3
16.7
0.0
Eased somewhat
8
13.8
4
11.8
4
Eased considerably
0
0.0
0
0.0
0
0.0
Total
58
100.0
34
100.0
24
100.0
1. As of September 30,1993, 35 respondents had domestic assets of $10 billion or more; combined assets of these banks
totaled $938.9 billion, compared to $1.1 trillion for the entire panel of 59 banks, and $3.2 trillion for all domestically chartered federally insured commercial banks
Note: In questions 5a, 5b, 24a, 24b, 26, and 27 "mean" refers to average rank, with 1 most important, 2 next most important
and so on.
98
c. for small businesses
All Respondents
Banks
Pet
$10.0 and over
Banks
Pet
Under $10.0
Banks
Pet
0.0
Tightened considerably
0
0.0
0
0.0
0
Tightened somewhat
0
0.0
0
0.0
0
0.0
Basically unchanged
50
87.7
28
84.8
22
91.7
Eased somewhat
7
12.3
5
15.2
2
8.3
Eased considerably
0
0.0
0
0.0
0
0.0
Total
57
100.0
33
100.0
24
100.0
2. With respect to applications for C&l loans or credit lines-other than those to be used to finance mergers and acquisitions-from
large corporate firms that your bank currently is willing to approve, please indicate how terms have changed in the last three months
with respect to:
a. maximum size of credit lines
All Respondents
Banks
Pet
$10.0 and over
Banks
Pet
Under $10.0
Banks
Pet
Decreased considerably
0
0.0
0
0.0
0
Decreased somewhat
3
5.2
1
2.9
2
8.7
Basically unchanged
37
63.8
20
57.1
17
73.9
Increased somewhat
18
31.0
14
40.0
4
17.4
Increased considerably
0
0.0
0
0.0
0
0.0
Total
58
100.0
35
100.0
23
100.0
0.0
b. costs of credit lines
AH Respondents
$10.0 and over
Banks
Banks
Pet
Pet
Under $10.0
Banks
Pet
0.0
Increased considerably
0
0.0
0
0.0
0
Increased somewhat
0
0.0
0
0.0
0
0.0
Basically unchanged
35
60.3
22
62.9
13
56.5
Decreased somewhat
23
39.7
13
37.1
10
43.5
Decreased considerably
0
0.0
0
0.0
0
0.0
Total
58
100.0
35
100.0
23
100.0
c. spreads of loan rates over base rates
AH Respondents
$10.0 and over
Banks
Banks
Pet
Pet
Under $10.0
Banks
Pet
Increased considerably
0
0.0
0
0.0
0
Increased somewhat
0
0.0
0
0.0
0
0.0
Basically unchanged
28
48.3
15
42.9
13
56.5
nnrraaeorl
en cnuhat
L/ocroasou somownai
30
51.7
20
57.1
10
43.5
Decreased considerably
0
0.0
0
0.0
0
0.0
Total
58
100.0
35
100.0
23
100.0
0.0
99
d. loan covenants
All Respondents
$10.0 and over
Banks
Banks
Pet
Pet
Under $10.0
Banks
Pet
Tightened considerably
0
0.0
0
0.0
0
0.0
Tightened somewhat
0
0.0
0
0.0
0
0.0
Basically unchanged
45
77.6
25
71.4
20
87.0
Eased somewhat
11
19.0
9
25.7
2
8.7
Eased considerably
2
3.4
1
2.9
1
4.3
Total
58
100.0
35
100.0
23
100.0
e. collateralization requirements
All Respondents
$10.0 and over
Banks
Banks
Pet
Pet
Under $10.0
Banks
Pet
Tightened considerably
0
0.0
0
0.0
0
Tightened somewhat
1
1.7
0
0.0
1
4.3
Basically unchanged
53
91.4
31
88.6
22
95.7
0.0
0.0
Eased somewhat
4
6.9
4
11.4
0
Eased considerably
0
0.0
0
0.0
0
0.0
Total
58
100.0
35
100.0
23
100.0
3. With respect to applications for C&l loans or credit lines-other than those to be used to finance mergers and acquisitions-from
middle market firms that your bank currently is willing to approve, please indicate how terms have changed in the last three months
with respect to:
a. maximum size of credit lines
Alt Respondents
$10.0 and over
Banks
Banks
Pet
Pet
Under $10.0
Banks
Pet
Decreased considerably
0
0.0
0
0.0
0
Decreased somewhat
0
0.0
0
0.0
0
0.0
Basically unchanged
42
72.4
25
73.5
17
70.8
29.2
0.0
Increased somewhat
16
27.6
9
26.5
7
Increased considerably
0
0.0
0
0.0
0
0.0
Toial
58
100.0
34
100.0
24
100.0
b. costs of credit lines
All Respondents
$10.0 and over
Banks
Banks
Pet
Pet
Under $10.0
Banks
Pet
Increased considerably
0
0.0
0
0.0
0
0.0
Increased somewhat
0
0.0
0
0.0
0
0.0
Basically unchanged
37
63.8
22
64.7
15
62.5
Decreased somewhat
20
34.5
11
32.4
9
37.5
1
1.7
1
2.9
0
0.0
58
100.0
34
100.0
24
100.0
Decreased considerably
Total
100
c. spreads of loan rates over base rates
AH Respondents
Banks
Pet
$10.0 and over
Banks
Pet
Under $10.0
Banks
Pet
Increased considerably
0
0.0
0
0.0
0
Increased somewhat
0
0.0
0
0.0
0
0.0
Basically unchanged
34
58.6
20
58.8
14
58.3
Decreased somewhat
23
39.7
13
38.2
10
41.7
1
1.7
1
2.9
0
0.0
58
100.0
34
100.0
24
100.0
Decreased considerably
Total
0.0
d. loan covenants
All Respondents
Banks
Pet
$10.0 and over
Banks
Pet
Under $10.0
Banks
Pet
Tightened considerably
0
0.0
0
0.0
0
Tightened somewhat
0
0.0
0
0.0
0
0.0
Basically unchanged
50
86.2
29
85.3
21
87.5
Eased somewhat
7
12.1
4
11.8
3
12.5
Eased considerably
1
1.7
1
2.9
0
0.0
58
100.0
34
100.0
24
100.0
Total
0.0
e. collateralizaticn requirements
All Respondents
Banks
Pet
$10.0 and over
Banks
Pet
Under $10.0
Banks
Pet
Tightened considerably
0
0.0
0
0.0
0
Tightened somewhat
2
3.4
1
2.9
1
4.2
Basically unchanged
54
93.1
31
91.2
23
95.8
0.0
0.0
Eased somewhat
2
3.4
2
5.9
0
Eased considerably
0
0.0
0
0.0
0
0.0
Total
58
100.0
34
100.0
24
100.0
4. With respect to applications for C&l loans or credit lines from small businesses that your bank currently is willing to approve, please
indicate how terms have changed in the last three months with respect to:
a. maximum size of credit lines
AH Respondents
$10.0 and over
Banks
Banks
Pet
Pet
Under $10.0
Banks
Pet
0.0
Decreased considerably
0
0.0
0
0.0
0
Decreased somewhat
0
0.0
0
0.0
0
0.0
Basically unchanged
52
91.2
29
87.9
23
95.8
Increased somewhat
5
8.8
4
12.1
1
4.2
Increased considerably
0
0.0
0
0.0
0
0.0
Total
57
100.0
33
100.0
24
100.0
101
b. costs of credit lines
All Respondents
$10.0 and over
Banks
Banks
Pet
Pet
Under $10.0
Banks
Pet
Increased considerably
0
0.0
0
0.0
0
0.0
Increased somewhat
0
0.0
0
0.0
0
0.0
Basically unchanged
49
86.0
27
81.8
22
91.7
Decreased somewhat
7
12.3
5
15.2
2
8.3
Decreased considerably
1
1.8
1
3.0
0
0.0
57
100.0
33
100.0
24
100.0
Total
c. spreads of loan rates over base rates
All Respondents
Banks
Pet
$10.0 and over
Banks
Pet
Under $10.0
Banks
Pet
ncreased considerably
0
0.0
0
0.0
0
Increased somewhat
0
0.0
0
0.0
0
0.0
Basically unchanged
46
80.7
25
75.8
21
87.5
Decreased somewhat
10
17.5
7
21.2
3
12.5
Decreased considerably
1
1.8
1
3.0
0
0.0
57
100.0
33
100.0
24
100.0
Total
0.0
d. loan covenants
All Respondents
$10.0 and over
Banks
Banks
Pet
Pet
Under $10.0
Banks
Pet
Tightened considerably
0
0.0
0
0.0
0
Tightened somewhat
1
1.8
0
0.0
1
4.2
Basically unchanged
49
86.0
28
84.8
21
87.5
Eased somewhat
7
12.3
5
15.2
2
8.3
Eased considerably
0
0.0
0
0.0
0
0.0
Total
57
100.0
33
100.0
24
100.0
0.0
e. collateralization requirements
All Respondents
$10.0 and over
Banks
Banks
Pet
Pet
Under $10.0
Banks
Pet
Tightened considerably
0
0.0
0
0.0
0
Tightened somewhat
1
1.8
0
0.0
1
4.2
Basically unchanged
53
93.0
31
93.9
i 22
91.7
Eased somewhat
3
5.3
2
6.1
1
4.2
Eased considerably
0
0.0
0
0.0
0
0.0
Total
57
100.0
33
100.0
24
100.0
0.0
102
6. a Iv your t. .•<.,!.
-i lending standards or loan terms over the last three months (as described in t( iestions 1 to 4) what
were the main reasons? (Please rank.)
All Respondents
Banks
Mean
$10.0 and over
Banks
Mean
Under $10.0
Banks
Mean
A deterioration in your hank's capital position
0
0.0
0
0.0
0
0.0
A deterioration in your bank's expected capital position owing to a
decline in the quality of your loan portfolio or other factors
0
0.0
0
0.0
0
0.0
A IPTS favorable economic outlook
0
0.0
0
0.0
0
0.0
A worsening or industry specific problems
0
0.0
0
0.0
0
0.0
Othot
3
1.0
2
1.0
1
1.0
Total
3
1
2
Si; h yum bank &££ci Cither its lending standards or loan terms over the last three months vas described in qu< stions 1 to 4) what
we,-* tha main reasons? (Ptease rank.)
All Respondents
$10.0 and over
Banks
Banks
Mean
Mean
Under $10.0
Banks
Mean
An impiovement in your l .;<l\ ^ capital position
4
2.5
3
2.7
1
2,0
An improvement in you bank's expected capital position owing to an
improvement in th«? qu u ; , <>i -our loan portfolio or other factors
8
2.0
5
2.4
3
1.3
A more favorable eco*. •.•>.• oviOook
13
1.5
10
1-5
3
1.7
A bssoning of industi: ,
7
2.6
4
3.0
3
2.0
Giber
23
1.4
17
1.2
. 6
2.2
Total
31
i. problems
9
22
6 In the last three rnoiiiii*
-A' have your bank's credit standards changed for appr
ations for construction and land
development loans? (Please import changes in enforcement of existing standards as changes in standards.)
All Respondents
$10.0 and over
Banks
Banks
Pet
Pet
Under $10.0
Banks
Pet
Tighiuned considerably
0
0.0
0
0.0
0
Tiniifc'ned somewhat
2
3.4
1
2.9
1
Basically unchanged
53
Eas.'Ki somewhat
2
3.4
1
2.9
1
EujuJ considerably
1
1.7
0
00
1
42
58
100.0
34
100.0
24
100.0
Total
91.4
32
94.1
21
0.0
4.2
87.5
4.2
103
7. Apart from construction and land development loans, in the last three months, how have your bank's credit standards changed for
approving applications for nonfarm nonresidential real estate loans used to finance: (Please report changes in enforcement of existing standards as changes in standards.)
a. commercial office buildings
All Respondents
$10.0 and over
Banks
Banks
Pet
Pet
Under $10.0
Banks
Pet
Tightened considerably
0
0.0
0
0.0
0
Tightened somewhat
0
0.0
0
0.0
0
0.0
Basically unchanged
55
94.8
32
94.1
23
95.8
Eased somewhat
3
5.2
2
5.9
1
4.2
Eased considerably
0
0.0
0
0.0
0
0.0
Total
58
100.0
34
100.0
24
100.0
0.0
b. industrial structures
All Respondents
$10.0 and over
Banks
Banks
Pet
Pet
Under $10.0
Banks
Pet
Tightened considerably
0
0.0
0
0.0
0
Tightened somewhat
0
0.0
0
0.0
0
0.0
Basically unchanged
53
91.4
31
91.2
22
91.7
8.3
0.0
Eased somewhat
5
8.6
3
8.8
2
Eased considerably
0
0.0
0
0.0
0
0.0
Total
58
100.0
34
100.0
24
100.0
c. other nonfarm nonresidential properties
All Respondents
$10.0 and over
Banks
Banks
Pet
Pet
Under $10.0
Banks
Pet
0.0
Tightened considerably
0
0.0
0
0.0
0
Tightened somewhat
0
0.0
0
0.0
0
0.0
Basically unchanged
56
96.6
33
97.1
23
95.8
Eased somewhat
2
3.4
1
2.9
1
4.2
Eased considerably
0
0.0
0
0.0
0
0.0
Total
58
100.0
34
100.0
24
100.0
8.a. In the last three months, how have your bank's credit standards changed for approving mortgage applications from individuals to
purchase homes? (Please report changes in enforcement of existing standards as changes in standards.)
All Respondents
$10.0 and over
Banks
Banks
Pet
Pet
Under $10.0
Banks
Pet
Tightened considerably
0
0.0
0
0.0
0
Tightened somewhat
1
1.8
0
0.0
1
4.2
Basically unchanged
50
90.9
29
93.5
21
87.5
Eased somewhat
4
7.3
2
6.5
2
8.3
Eased considerably
0
0.0
0
0.0
0
0.0
Total
55
100.0
31
100.0
24
100.0
*
0.0
104
8.b. If your bank has tightened its standards for approving mortgage loan applications from individuals, please indicate which of the
following measures this involved: (more than one may apply)
All Respondents
Banks
Pet
Under $10.0
Banks
Pet
0.0
Higher income standards to qualify
0
0.0
0
Higher downpayments
0
0.0
0
0.0
More stringent appraisal requirements
1
100.0
1
100.0
Other
1
100.0
1
100.0
Total
1
100.0
1
100.0
9.a. Please indicate your bank's wiingness to make general purpose loans to individuals now as opposed to three months ago.
"Loans to individuals" here include standard consumer instalment loans phis loans taken down under home equity lines of credit.
All Respondents
Banks
Pet
$10.0 and over
Banks
Pet
Under $10.0
Banks
Pet
Much more
3
5.3
2
6.1
1
4.2
Somewhat more
15
26.3
12
36.4
3
12.5
About unchanged
38
66.7
19
57.6
19
79.2
Somewhat less
1
1.8
0
0.0
1
4.2
Much less
0
0.0
0
0.0
0
0.0
Total
57
100.0
33
100.0
24
100.0
9.b. Please indicate your bank's wifingness to make consumer installment loans now as opposed to three months ago.
AH Respondents
Banks
Pet
$10.0 and over
Banks
Pet
Under $10.0
Banks
Pet
Much more
2
3.4
1
2.9
1
4.2
Somewhat more
16
27.6
13
38.2
3
12.5
About unchanged
39
67.2
20
58.8
19
79.2
Somewhat less
1
1.7
0
0.0
1
4.2
Much less
0
0.0
0
0.0
0
0.0
Total
58
100.0
34
100.0
24
100.0
NOTE. Questions 10 through 19 deal with changes in your customers' demand for credit over the last three months.
10. Please characterize the demand for business loans from large corporate customers in the last three months compared with
demand in the preceding three months. Apart from normal seasonal variation, this loan demand in the last three months was:
Al Respondents
Banks
Pet
$10.0 and over
Banks
Pet
Under $10.0
Banks
Pet
Substantially stronger
0
0.0
0
0.0
0
0.0
Moderately stronger
19
33.3
14
40.0
5
22.7
About the sane
32
56.1
17
48.6
15
68.2
6
10.5
4
11.4
2
9.1
0
0.0
0
0.0
0
0.0
57
100.0
35
100.0
22
100.0
Total
105
11 .a. If large corporate customer loan demand strengthened in the last three months, please indicate all primary reasons that apply.
All Respondents
$10.0 and over
Banks
Banks
Pet
Pet
Under $10.0
Banks
Pet
Customer inventory financing needs increased
10
55.6
6
46.2
4
80.0
Customer investment in plant or equipment increased
10
55.6
7
53.8
3
60.0
Customer financing at other banks decreased
2
11.1
2
15.4
0
0.0
Customer financing at nonbank financial institutions or in capital
markets decreased
1
5.6
0
0.0
1
20.0
Other
6
33.3
6
46.2
0
0.0
Total
18
100.0
13
100.0
5
100.0
11 .b. If large corporate customer loan demand weakened, in the last three months, please indicate all primary reasons that apply.
All Respondents
Banks
Pet
$10.0 and over
Banks
Pet
Under $10.0
Banks
Pet
Customer inventory financing needs decreased
1
16.7
1
25.0
0
0.0
Customer investment in plant or equipment decreased
1
16.7
1
25.0
0
0.0
Customer financing at other banks increased
3
50.0
3
75.0
0
0.0
Customer financing at nonbank financial institutions or in capital
markets increased
6
100.0
4
100.0
2
100.0
Other
0
0.0
0
0.0
0
0.0
Total
6
100.0
4
100.0
2
100.0
12. Please characterize the demand for business loans from middTe market firms in the last three months compared with demand in
the preceding three months. Apart from normal seasonal variation, this loan demand in the last three months was:
All Respondents
$10.0 and over
Banks
Banks
Pet
Pet
Under $10.0
Banks
Pet
Substantially stronger
0
0.0
0
0.0
0
0.0
Moderately stronger
20
34.5
11
32.4
9
37.5
About the same
35
60.3
22
64.7
13
54.2
Moderately weaker
3
5.2
1
2.9
2
8.3
Substantially weaker
0
0.0
0
0.0
0
0.0
Total
58
100.0
34
100.0
24
100.0
13.a If middle market customer loan demand strengthened in the last three months, please indicate all the primary reasons that
apply.
All Respondents
$10.0 and over
Banks
Banks
Pet
Pet
Under $10.0
Banks
Pet
Customer inventory financing needs increased
15
75.0
7
63.6
8
88.9
Customer investment in plant or equipment increased
15
75.0
7
63.6
8
88.9
Customer financing at other banks decreased
2
10.0
2
18.2
0
0.0
Customer financing at nonbank financial institutions or in capital
markets decreased
1
5.0
1
9.1
0
0.0
Other
2
10.0
2
18.2
0
0.0
Total
20
100.0
11
100.0
9
100.0
106
in the last three months, please indicate all the primary reasons that apply.
All Respondents
Banks
Pet
$10.0 and over
Banks
Pet
Under $10.0
Banks
Pet
Customer inventory financing needs decreased
2
66.7
1
100.0
1
50.0
Customer investment in plant or equipment decreased
2
66.7
1
100.0
1
50.0
Customer financing at other banks increased
2
66.7
1
100.0
1
50.0
Customer financing at nonbank financial institutions or in capital
markets increased
2
66.7
1
100.0
1
50.0
Other
0
0.0
0
0.0
0
0.0
Total
3
100.0
1
100.0
2
100.0
14. Please characterize the demand for business loans from small businesses in the last three months compared with demand in ti
preceding three months. Apart from normal seasonal variation, this loan demand in the last three months was:
All Respondents
$10.0 and over
Banks
Banks
Pet
Pet
Under $10.0
Banks
Pet
Substantial* stronger
0
0.0
0
0.0
0
0.0
Moderately stronger
17
29.8
10
30.3
7
29.2
About the same
38
66.7
21
63.6
17
70.8
2
3.5
2
6.1
0
0.0
0
0.0
0
0.0
0
0.0
57
100.0
33
100.0
24
100.0
Total
15.a. If smaH business customer loan demand stmnoihenad in the last three months, please indicate all the primary reasons that
apply.
AH Respondents
$10.0 and over
Banks
Banks
Pet
Pet
Under $10.0
Banks
Pet
Customer inventory financing needs increased
14
82.4
8
80.0
6
85.7
Customer investment in plant or equipment increased
13
76.5
7
70.0
6
85.7
Customer financing at other banks decreased
4
23.5
1
10.0
3
42.9
Customer financing at nonbank financial institutions or in capital
markets decreased
1
5.9
1
10.0
0
0.0
Other
1
5.9
1
10.0
0
0.0
Total
17
100.0
10
100.0
7
100.0
w loan demand weakened in the last three months, please indicate all the primary reasons that apply.
AH Respondents
$10.0 and over
Banks
Banks
Pet
Pet
Customer inventory financing needs decreased
1
50.0
1
50.0
Customer investment in plant or equipment decreased
1
50.0
1
50.0
Customer financing at otfier banks mcreased
0
0.0
0
0.0
Customer financing at nonbank financial institutions or in capital
Tianuns mcrou mn
1
50.0
1
50.0
Other
1
50.0
1
50.0
Total
2
100.0
2
100.0
107
16 Plfjast! characterize the demand for lines of credit, as opposed to business loans, from commercial and industrial firms in the last
three months compared with demand in the preceding three months. Apart from normal seasonal variation, demand for lines of credit
in the last three months was:
All Respondents
$10.0 and over
Banks
Banks
Pet
Pet
Under $10.0
Banks
Pet
Substantially stronger
0
0.0
0
0.0
0
0.0
Moderately stronger
9
15.3
6
17.1
3
12.5
About the same
45
76.3
26
74.3
19
79.2
Moderately weaker
5
8.5
3
8.6
2
8.3
Substantially weaker
0
0.0
0
0.0
0
0.0
Total
59
100.0
35
100.0
24
100.0
17. Please characterize the demand for residential mortgages to purchase homes in the last three months compared with demand in
the preceding three months. Apart from normal seasonal variation, this loan demand in the last three months was:
All Respondents
$10.0 and over
Banks
Banks
Pet
Pet
Under $10.0
Banks
Pet
Substantially stronger
0
0.0
0
0.0
0
0.0
Moderately stronger
18
31.0
14
41.2
4
16.7
About the same
32
55.2
17
50.0
15
62.5
Moderately weaker
8
13.8
3
8.8
5
20.8
Substantially weaker
0
0.0
0
0.0
0
0.0
Total
58
100.0
34
100.0
24
100.0
18. Please characterize the demand for home equity lines of credit in the last three months compared with demand in the preceding
three months. Apart from normal seasonal variation, this loan demand in the last three months was:
All Respondents
$10.0 and over
Banks
Banks
Pet
Pet
Under $10.0
Banks
Pet
Substantially stronger
1
1.9
0
0.0
1
Moderately stronger
8
14.8
7
21.2
1
4.8
About the same
36
66.7
20
60.6
16
76.2
14.3
4.8
Moderately weaker
9
16.7
6
18.2
3
Substantially weaker
0
0.0
0
0.0
0
0.0
Total
54
100.0
33
100.0
21
100.0
19. Please characterize the demand for consumer installment loans in the last three months compared with demand in the preceding
three months. Apart from normal seasonal variation, this loan demand in the last three months was:
All Respondents
$10.0 and over
Banks
Banks
Pet
Pet
Under $10.0
Banks
Pet
Substantially stronger
0
0.0
0
0.0
0
0.0
Moderately stronger
19
33.3
11
33.3
8
33.3
About the same
33
57.9
19
57.6
14
58.3
Moderately weaker
5
8.8
3
9.1
2
8.3
Substantially weaker
0
0.0
0
0.0
0
0.0
Total
57
100.0
33
100.0
24
100.0
108
NOTE: Questions 20 to 27 refer to certain balance sheet items at your bank.
20. At year end. what was the approximate percentage distribution of the total dollar volume of commercial and industrial loans currently on your bank's books among the folowing categories: loans without stated maturities (i.e., demand loans), floating-rate loans
with stated maturities, fixed-rate loans with stated maturities excluding overnight loans, and overnight loans? (Percentages should
add to 100.)
All Respondents
$10.0 and over
Mean
pet*
Mean
pet*
Banks
Banks
Under $10.0
Banks
Mean
pet*
Loans without stated maturities
35
9.7
20
9.1
15
12.1
Floating-rate loans with stated maturities
46
63.0
25
65.0
21
55.0
21.5
Fixed-rate loans with stated maturities exctaing overnight loans
45
20.8
25
20.7
20
Overnight loans
27
4.6
16
3.0
11
11.4
Total
47
100.0
26
100.0
21
100.0
•Weighted by the volume of commercial and industrial loans oustanding as of December 29,1993 (reported separately).
21. How long on average do commercial and industrial loans without a stated maturity date (i.e.. demand loans) stay on your bank's
books before being repaid or renegotiated?
AH Respondents
Banks
Pet
$10.0 and over
Banks
Pet
Under $10.0
Banks
Pet
10.0
MO days
4
8.9
2
8.0
2
11 -30 days
3
6.7
3
12.0
0
0.0
31 -60 days
1
2.2
1
4.0
0
0.0
61 -90 days
4
8.9
3
12.0
1
5.0
91-180 days
2
4.4
0
0.0
2
10.0
30.0
181 days to one year
14
31.1
8
32.0
6
More than one year
17
37.8
8
32.0
9
45.0
Total
45
100.0
25
100.0
20
100.0
22. Of your bank's holdings of tax-exempt securities issued by states and political subdivisions in the United States at year end,
approximately what percent was accounted for by: (Percentages should add to 100.)
All Respondents
$10.0 and over
Mean
pet*
Mean
pet*
Banks
Banks
Under $10.0
Banks
Mean
pet*
Tax-exempt securities acquired before August 7, 1986 (80 percent of
whose funding costs therefore are deductible from your bank's taxable
income under the terms of the Tax Reform Act of 1986)
46
46.6
27
46.9
19
45.7
"Bank qualified" instruments, that is. tax-exempt obligations acquired
37
40.3
23
39.0
14
44.4
to less than $10 million (80 percent of whose funding costs also are
deductible from your bank's taxable income under the terms of the Tax
Reform Act of 1986)
Other tax-exempt instruments
20
13.0
13
14.1
7
9.9
Total
50
100.0
30
100.0
20
100.0
•Weighted by the volume of tax-exempt securities held as of December 29,1993 (reported separately).
109
23. During 1993, holdings of tax-exempt securities at banks nationwide began to expand, following over six years of contraction. Over
the second half of 1993, did holdings of tax-exempt securities at your bank
AH Respondents
$10.0 and over
Pet
Banks
Under $10.0
Pet
Banks
Pet
Banks
Expand
12
21.8
7
21.9
5
Remain essentially unchanged or contract
43
78.2
25
78.1
18
78.3
Total
55
100.0
32
100.0
23
100.0
21.7
24.a. If your bank's holdings of these securities expanded, did the strength primarily reflect (Please rank.)
AH Respondents
$10.0 and over
Banks
Banks
Mean
Under $10.0
Mean
Mean
Banks
1.0
A cessation or slowing in runoffs of instruments acquired before August
7,1986
2
1.5
1
2.0
1
Increased holdings of "bank qualified- instruments
8
1.0
4
1.0
4
1.0
Increased holdings of other tax-exempt instruments
3
1.0
3
1.0
0
0.0
Total
7
12
5
24.b. If your bank's holdings of "bank qualified" or other tax-exempt securities expanded, to what do you attribute the increase?
(Please rank.)
All Respondents
$10.0 and over
Banks
Banks
Mean
Under $10.0
Banks
Mean
Mean
2.0
6
1.5
4
1.3
2
3
1.0
1
1.0
2
1.0
3.0
1
2.0
2.0
1
1.0
comparable taxable securities
The increased attractiveness of these securities resulting from higher
profits at your bank
The increased attractiveness of these securities resulting from the
exhaustion of your bank's net operating loss carryforwards
2
2.5
1
Other
4
1.8
3
Total
10
6
4
25. Credit extended to nonbank brokers and dealers in securities expanded rapidly in the second half of last year at banks nationwide, mainly in the form of reverse repurchase agreements but also as loans for purchasing and carrying securities. Please indicate
the growth of these types of credit at your bank in the second half of 1993 compared to the first half.
AH Respondents
Banks
Pet
$10.0 and over
Banks
Pet
Under $10.0
Banks
Pet
Faster in the second half than in the first half
19
35.8
17
53.1
2
9.5
The same or slower in the second half than in the first half
34
64.2
15
46.9
19
90.5
Total
53
100.0
32
100.0
21
100.0
110
26. If your bank's credit outstanding to nonbank brokers and dealers advanced more strongly in the second half of last year, which of
the following were important reasons? (Please rank.)
All Respondents
$10.0 and over
Banks
Banks
Mean
Mean
Under $10.0
Mean
Banks
Increased demand for such credit stemming from increased financing
needs of dealers
13
1.2
12
1.2
1
1.0
Actions taken by your bank to ease terms and otherwise increase the
availability of credit to brokers and dealers
5
2.6
4
2.8
1
2.0
A shift by brokers and dealers away from other sources of credit and to
your bank for reasons other than changes in the cost and availability of
this credit from your bank
3
2.3
2
2.0
1
3.0
Other
7
1.0
6
1.0
1
1.0
Total
18
16
2
27. If your bank benefited from a shifting of borrowing by brokers and dealers to your bank and away from competing sources of
financing, what were the major sources from which they shifted? (Please rank.)
All Respondents
$10.0 and over
Banks
Banks
Mean
Mean
Money center banks
0
0.0
0
0.0
Regional banks
0
0.0
0
0.0
Branches and agencies of foreign banks
1
1.0
1
1.0
Commercial paper issued by broker/dealers
0
0.0
0
0.0
Money market mutual funds
0
0.0
0
0.0
Pension funds
0
0.0
0
0.0
Other nonbank financial corporations
0
0.0
0
0.0
Nonfinancial corporations
0
0.0
0
0.0
State and local governments
0
0.0
0
0.0
Other(s)
0
0.0
0
0.0
Total
1
1
Ill
Table 2
SENIOR LOAN OFFICER OPINION SURVEY ON BANK LENDING PRACTICES
AT SELECTED BRANCHES AND AGENCIES OF FOREIGN BANKS IN THE UNITED STATES
(Status of policy as of January 1994)
(Number of banks and percent of banks answering question)
(By volume of total domestic assets, in $ billions, as of September 30, 19931)
NOTE: Questions 1 through 5 of this survey deal with changes in your bank's lending policies over the last three months. If lending
policies at your bank have not changed in the last three months, they should be marked "unchanged" even if, for example, these policies remain restrictive relative to longer-term norms. By the same token, if your bank's lending policies have been eased in the last
three months, they should be marked as •easier" even if. for example, they nevertheless remain restrictive relative to longer-term
norms.
1. In the last three months, how have your bank's credit standards for approving applications for C&l loans or credit lines-other than
those to be used to finance mergers and acquisitions-changed? (Please report changes in enforcement of existing standards as
changes in standards.)
AH Respondents
Banks
Pet
Tightened considerably
0
Tightened somewhat
0
0.0
Basically unchanged
14
77.8
22.2
0.0
Eased somewhat
4
Eased considerably
0
0.0
Total
18
100.0
2. With respect to applications for C&l loans or credit lines-other than those to be used to finance mergers and acquisitions-that your
bank currently is willing to approve, please indicate how terms have changed in the last three months with respect to:
a. maximum size of credit lines
AN Respondents
Banks
Pet
Decreased considerably
0
Decreased somewhat
0
0.0
Basically unchanged
16
88.9
Increased somewhat
2
11.1
Increased considerably
0
0.0
Total
18
100.0
0.0
1. As of September 30,1993. respondents had combined assets of $84.9 billion, compared to $481.8 billion for all foreignrelated banking institutions in the United States.
Note: In questions 3a, 3b, 14a, 14b, 16, and 17 "mean" refers to average rank, with 1 most important, 2 next most important
and so on.
112
b. costs of credit lines
All Respondents
Banks
Pet
Increased considerably
0
Increased somewhat
0
0.0
Basically unchanged
12
66.7
Decreased somewhat
6
33.3
Decreased considerably
0
0.0
Total
18
100.0
0.0
c. spreads of loan rates over base rates
All Respondents
Banks
Pet
0.0
ncreased considerably
0
Increased somewhat
0
0.0
Basically unchanged
11
61.1
Decreased somewhat
7
38.9
Decreased considerably
0
0.0
Total
18
100.0
d. loan covenants
All Respondents
Banks
Pet
Tightened considerably
0
Tightened somewhat
0
0.0
Basically unchanged
18
100.0
Eased somewhat
0
00
Eased considerably
0
0.0
Total
18
100.0
0.0
i. collateralization requirements
All Respondents
Banks
Pet
Tightened considerably
0
0.0
Tightened somewhat
0
0.0
100.0
Basically unchanged
18
Eased somewhat
0
0.0
Eased considerably
0
0.0
Total
18
100.0
113
3.a If your bank tiflbtaoad either Hs lending standards or loan farms over the last three months (as described in questions 1 and 2),
what were the main reasons? (Please rank.)
(No response.)
3 b. If your bank fittol either its lending standards or loan terms over the last three months (as described in questions 1 and 2),
what were the main reasons? (Please rank.).
Al Respondents
Banks
Mean
An improvement in your parent bank's capital position
1
1.0
An expected improvement in your parent bank's capital position owing
to an improvement in the quality of its loan portfolio or other factors
2
1.5
A more favorable economic outlook
3
1.7
A lessening of industry specific problems
2
3.0
Other
6
2.0
Total
7
4. In the last three months, how have your bank's credit standards changed for approving applications for construction and land
development loans? (Please report changes in enforcement of existing standards as changes in standards.)
Al Respondents
Banks
Pet
Tightened considerably
0
Tightened somewhat
0
0.0
0.0
Basically unchanged
15
88.2
F cu4 «
2
11.8
hat
Eased considerably
0
0.0
Total
17
100.0
5. Apart from construction and land development loans, in the last three months, how have your bank's credit standards changed for
approving applications for nonfarm nonresidential real estate loans used to finance: (Please report changes in enforcement of existing standards as changes in standards.)
a. commercial office buildings
Al Respondents
Banks
Pet
Basically unchanged
0
0
17
100.0
Eased somewhat
0
0.0
Eased considerably
0
17
100.0
Tightened considerably
Tightened somewhat
Total
0.0
0.0
0.0
114
b. industrial structures
All Respondents
Banks
Pet
Tightened considerably
0
Tightened somewhat
0
0.0
Basically unchanged
17
100.0
Eased somewhat
0
0.0
Eased considerably
0
0.0
Total
17
100.0
C.O
c. other nonfarm nonresidential properties
All Respondents
Banks
Pet
Tightened considerably
0
0.0
Tightened somewhat
0
0.0
Basically unchanged
16
94.1
Eased somewhat
1
5.9
Eased considerably
0
0.0
Total
17
100.0
NOTE: Questions 6 through 8 deal with changes in your customer's demand for credit over the last three months.
6. Please characterize the demand for business loans in the last three months compared with demand in the preceding three months.
Apart from normal seasonal variation, this loan demand in the last three months was:
All Respondents
Banks
7.a. If loan demand
Pet
Substantially stronger
0
0.0
Moderately stronger
4
22.2
About the same
12
667
Moderately weaker
2
11.1
Substantially weaker
0
0.0
Total
18
100.0
in the last three months, please indicate all primary reasons that apply.
Al1 Respondents
Banks
Pet
Customer inventory financing needs increased
3
100.0
Customer investment in plant or equipment increased
3
100.0
Customer financing at other banks decreased
1
33.3
Customer financing at nonbank financial institutions or in capital
markets decreased
1
33.3
Other
0
0.0
Total
3
100.0
115
7.b. If loan demand weakened in the last three months, please indicate all primary reasons that apply.
AN Respondents
Banks
Pet
Customer inventory financing needs decreased
0
Customer investment in plant or equipment decreased
0
0.0
Customer financing at other banks increased
0
0.0
Customer financing at nonbank financial institutions or in capital
markets increased
2
100.0
Other
0
0.0
Total
2
100.0
0.0
8. Please characterize the demand for lines of credit, as opposed to business loans, from commercial and industrial firms in the last
three months compared with demand in the preceding three months. Apart from normal seasonal variation, demand for lines of credit
in the last three months was:
AH Respondents
Pet
Banks
Substantially stronger
0
0.0
Moderately stronger
2
11.1
About the same
15
83.3
1
5.6
Substantially weaker
0
0.0
Total
18
100.0
NOTE: Question 9 refers to net borrowing by your bank from your parent bank, its non-U.S. offices, and your own IBF. In aggregate,
branches and agencies of foreign banks have significantly increased such borrowing since mid-199.1.
9.a. Since mid-1991 how has the share of your bank's total liabilities accounted for by aggregate net borrowing from your parent
bank, its non-U.S. offices, or your own IBF changed?
AH Respondents
Banks
Increased
Basically unchanged or decreased
Total
12
66.7
6
33.3
18
100.0
9.b. If such borrowing has increased, please indicate the primary reasons for the increase.
(7 of the respondents provided answers.)
Pet
116
NOTE: Questions 10 to 17 refer to certain balance sheet items at your bank.
10. At year end, what was the approximate percentage distribution of the total dollar volume of commercial and industrial loans currently on your bank's books among the following categories: loans without stated maturities (i.e.. demand loans), floating-rate loans
with stated maturities, fixed-rate loans with stated maturities excluding overnight loans, and overnight loans? (Percentages should
add to 100.)
All Respondents
Banks
Mean
pet*
6
3.2
Floating-rate loans with stated maturities
18
51.6
41.8
Loans without stated maturities
Fixed-rate loans with stated maturities excluding overnight loans
18
Overnight loans
10
5.4
Total
18
100.0
'Weighted by the volume of commercial and industrial loans outstanding as of
December 29, 1993 (reported separately).
11. How long on average do commercial and industrial loans without a stated maturity date (i.e., demand loans) stay on your bank's
books before being repaid or renegotiated?
All Respondents
Banks
Pet
1-10 days
1
11 -30 days
1
16.7
31 -60 days
2
33.3
6 1-90 days
0
0.0
91 -180 days
0
0.0
181 days to one year
0
0.0
More than one year
2
33.3
Total
6
100.0
16.7
12. Of your bank's holdings of tax-exempt securities issued by states and political subdivisions in the United States at year end,
approximately what percent was accounted for by: (Percentages should add to 100.)
AH Respondents
Mean
Banks
pet
Tax-exempt securities acquired before August 7, 1986 (80 percent of whose funding costs therefore
are deductible from your bank's taxable income under the terms of the Tax Reform Act of 1986)
1
100.0
"Bank qualified'' instruments, that is, tax-exempt obligations acquired after August 7, 1986 of issuers
whose total annual issuance amounts to less than $10 million (80 percent of whose funding costs also
are deductible from your bank's taxable income under the terms of the Tax Reform Act of 1986)
0
0.0
Other tax-exempt instruments
0
0.0
Total
1
100.0
117
13 During 1993. holdings of tax-exempt securities at banks nationwide began to expand, following over six years of contraction. Over
the second half of 1993. did holdings of tax-exempt securities at your bank
All Respondents
Pet
Banks
Expand
0
0.0
Remain essentially unchanged or contract
5
100.0
Total
5
100.0
14.a If your bank's holdings of these securities expanded, did the strength primarily reflect (Please rank.)
(No response.)
14.b. If your bank's holdings of "bank qualified' or other tax-exempt securities expanded, to what do you attribute the increase?
(Please rank.)
(No response.)
15 Credit extended to nonbank brokers and dealers in securities expanded rapidly in the second half of last year at banks nationwide, mainly in the form of reverse repurchase agreements but also as loans for purchasing and carrying securities. Please indicate
the growth of these types of credit at your bank in the second half of 1993 compared to the first half.
All Respondents
Banks
Pet
Faster in the second half than in the first half
1
10.0
The sarine or slower in the second half than in the first half
9
90.0
10
100.0
Total
16. If your bank's credit outstanding to nonbank brokers and dealers advanced more strongly in the second naff of last year, which of
the following were important reasons? (Please rank.)
AH Respondents
Mean
Banks
Increased demand for such credit stemming from increased financing needs of dealers
1
1.0
Actions taken by your bank to ease terms and otherwise increase the availability of credit to brokers and dealers
0
0.0
A shift by brokers and dealers away from other sources of credit and to your bank for reasons other than
changes in the cost and availability of this credit from your bank
0
0.0
Other
0
0.0
Total
1
17. If your bank benefitted from a shifting of borrowing by brokers and dealers to your bank and away from competing sources of
financing, what were the major sources from which they shifted? (Please rank.)
(No response.)
118
CREDIT AVAILABILITY
for
SMALL BUSINESSES AND SMALL FARMS
Submitted by
The Board of Governors of the
Federal Reserve System
December 31,1993
119
CREDIT AVAILABILITY FOl^ SftA^T. BUSINESSES AND SMALL FARMS
Section 477 of the Federal Deposit Insurance Corporation
Improvement Act requires that the Federal Reserve collect and publish
annually information on the availability of credit to small businesses
and small farms.
The charts in this report provide detailed data on
credit flows and terms of business loans at depository institutions,
including information on small farm and business loans.
The data are
from Reports of Condition and Income (Call Reports), Federal Reserve
surveys of banks. Census Bureau and private sector surveys of
businesses, and the flow of funds accounts.
Where available,
information on other sources of finance for small businesses and farms
also is shown.
The text summarizes trends in the cost and flow of
credit to small businesses and small farms during 1993 as reflected in
these charts.
On balance, total business debt grew slowly in 1993 with
borrowers focusing on balance sheet restructuring, and lenders
pursuing cautious policies while strengthening loan portfolios and
capital positions.
A strong stock market during the year induced
heavy equity issuance by nonfinancial firms, including record volumes
of initial public offerings.
Corporate borrowers also issued
substantial volumes of new bonds, with proceeds in many cases used to
refinance higher-yield debt and to pay down bank loans.
Such paydowns
by big companies were a major source of weakness in commercial and
industrial loans at banks.
Although the availability of credit for
1. The Federal Reserve also is conducting a survey of small
businesses, including minority-owned small businesses. Data from this
survey, which will be available late next year, should provide the
basis for broader analyses of credit availability to small businesses
across a spectrum of industries, locations, ownership, and size
categories.
120
small businesses appears to have eased a bit, based on surveys of bank
lending terms, banks still were cautious and maintained interest rates
on small business loans at high spreads over market interest rates.
Nonetheless, credit did not appear to be an important factor
constraining small businesses, many of which were not eager to take on
additional debt in light of uncertain prospects for sales and profit
growth.
Demand for credit by small farms also remained low, despite
growing farm incomes and improved returns to this sector.
Commercial
banks continued to expand their portfolios of farm loans this year,
and survey data suggest that credit for small farms was amply
available at rate spreads comparable to those on larger loans.
CREDIT AVAILABILITY FOR SMALL BUSINESSES
Depository Credit Flows.
Data from the 1989 National Survey
of Small Business Financing (NSSBF) suggest that small businesses, in
the aggregate, obtain almost half their external debt financing from
commercial banks.
Thus, it is appropriate when assessing credit
availability for small firms to focus first on credit extended by
banks.
Recent changes in total business loans at banks are shown in
Chart 1 for the United States as a whole and for major geographic
regions.
The data in the chart highlight the weakness in
aggregate business lending by commercial banks since 1989.
As shown
in Chart 1, outstanding business loans at banks fell more than $12
2. Business loans in Chart 1 include commercial and industrial
loans; nonfarm. nonresidential loans secured by real estate; and
construction and land development loans. These components are -shown
separately in Chart 2. Many small businesses also rely on bank credit
in the form of personal or home equity loans; personal loans used for
business purposes, however, are impossible to distinguish from
personal loans for other purposes in the bank reports and hence are
not included.
121
Chart 1
U.S. Commercial Banks
w
Change in Business Loans by Regiion
(September to September)
SBillions
20
1989
1990
1991
1992 1993
1989
1990
1991 1992
Southeast
—I 30
10
20
1989
1990
1991
1992 1993
1989
Source: dl ftoporti
•Bmhm? loam indud* oontmnM ^ WurtM tore; rontem. ftm.mlof.mara
1990
1991
1992 1993
122
billion, or about 1.5 percent, in the year ending September 30, 1993.
This drop followed a cumulative decline of nearly $100 billion in the
two.previous years.
Chart 2 breaks out the change in business loans
into its major components.
As indicated in the last column of the
chart, the contraction this year reflects a further sizable drop in
construction and land development loans; such loans outstanding
totaled about $68 billion-at the «nd of September 1993, down from $87
billion a year earlier and more than $135 billion outstanding in late
1989.
Banks, especially in New England and the far West, have
continued to reduce their portfolios of construction loans, as such
loans are repaid or written off and not replaced, in response to the
sharp deterioration in real estate values since the late 1980s.
Although there have been some reports of a reemergence of lending for
real estate development, the magnitude of these efforts likely remains
small and scattered.
In addition to the fall in construction loans, commercial and
industrial (Cfrl) loans contracted more than $6 billion over this
period.
The weakness in C&I loans also was most pronounced at banks
in the Northeast and the West.
In contrast, business loans in the
Southeast, Southwest, and Midwest together increased slightly more
than 4 percent, a moderate pace overall and a marked improvement over
the previous two years.
The aggregate contraction in business loans reflects a number
of factors affecting the supply of and the demand for bank credit.
On
the demand.side, many corporations have moved away from bank credit in
the process of restructuring their balance sheets.
As interest rates
on corporate bonds dropped to their lowest levels in two decades and
stock prices reached new highs (Chart 3), the capital markets appeared
to offer large firms attractive financing alternatives.
Record
123
Chart!
•
Business Loans At u.&. commercial uanKS
Region
.
Type of Loan
Nonfarm,
Construction
nonresidential
and land
.real estate
development
Number of
banks
Total
business
Commercial
and
industrial
11,101
761.0
428.9
263.9
68.2
(Billions of dollars)
Total U.S.
Northeast
724
195.8
119.4
61.4
15.0
Southeast
1,958
157.0
75.9
63.8
17.3
Midwest
6^54
245.8
1493
78.8
17.7
Southwest
1,141
395
25.2
11.2
3.1
724
122.8
592
48.6
15.0
West
Change from year earlier
Total U.S.
11,101
-12J
(Billions of dollars)
-6.4
12.9
-19.0
-12.9
0.4
-7.3
Northeast
724
Southeast
1,958
5.5
3.8
4.0
-2.3
Midwest
(tf54
11.1
5.2
6.8
-0.9
Southwest
1,141
1.2
0.3
West
Source: Call Reports
724
-19.8
1.8
-11.0
-3.7
U
0.3
-8.8
124
Chart3
Interest Rates and Stock Prices
SELECTED LONG-TERM INTEREST RATES
Percent
Weekly
HOME MORTGAGE
Primary Conventional
—/V
*
f
\
/Pririau>
CORPORATE BONDS A UTILITY
- flecently Offered
(Friday)
•A,
,,-AJ \\\\
H\
A *+-~\ V
\l
I
*-t
V
TREASURY BONDS
30-year Constant Maturity
(Friday)
\ /
\
I Ii » I II l I II III I III l
I
1989
V^ ^V '
1990
1993
SELECTED STOCK INDEXES
Weekly
NASDAQ COMPOSITE
(right scale)
3600
2800
700
600
DOW JONES INDUSTRIALS
(left scale)
2400
2000
200
1992
125
volumes of new stocks and bonds were issued during the year, with
proceeds in many cases used to retire old debt and to repay bank
loans.
Many large firms viewed fixed-rate bonds as a cheaper and more
flexible source of credit than bank loans which frequently carry
restrictive covenants.
As indicated in Chart 4. manufacturing
corporations reduced their bank debt by $9 billion in the year ending
September 30. 1993.
Most of this decline occurred at larger
companies, those with assets of $25 million or more; indeed, the
largest manufacturers, those with assets of $1 billion or more, paid
down $4-1/2 billion in bank loans.
These large firms at the same time
increased their outstanding long-term debt by $14 billion (not shown).
Although very large manufacturers rely on bank loans for only 16
percent of their external credit needs, they have a notable effect on
bank loan flows because of their size.
Smaller manufacturers, those
with less than $25 million in assets, also restricted their use of
bank credit but much less dramatically than the large firms.
Viewed, in longer-run perspective (lower panels of chart 4),
the recent reduction in the share of bank debt at large manufacturing
firms does not appear unusually sharp.
The decline in the share at
very small (less than $5 million in total assets) manufacturers was
been somewhat steeper, especially over the past year.
This decline
reflects a modest reduction in bank credit accompanied by a greater
increase in their nonbank, long-term debt.
As with the large firms,
many small manufacturers likely found markets and institutional
investors more receptive to their security placements.
June Call Report Data: Small Business Loans.
Data collected
for the first time on the June 1993 Call Reports pfovide an
approximate measure of the amount of bank lending to small businesses
across all industries, not just in manufacturing.
76-694 O - 94 - 5
Chart 5 shows the
126
Chart 4
Bank Debt Of Manufacturing Corporations
Asset size
of
Amount outstanding,
September 1993
firm
from
Change
year
earlier
Percent of
total debt
offirms1
Billions of dollars
Less than $5 million
173
-IX)
39.0
$5 to $25 million
25.1
.1
45.7
$25 million to $1 billion
101.6
-3.5
41.7
$1 billion or more
107.8
-4.6
15.6
251.8
-9.0
24.4
All manufacturers
Bank Loans as a Percent of Total Debt
(4-quartwmowiQ averages)
Small Manufacturing Firms
1978
1975
1990
1987
1981
Large Manufacturing Firms
(om$1Uten)
1993
—I 20
10
I
I
1975
1978
1. Tbtal debt inctadMtr»de debt and e^od^
ISSSf: u!?Bi!!£S!^^
r, 1993
I
1994
I
I
I
»
I
lM*fetillltlMI
127
amount of credit extended to businesses by size of the loan or by size
of the total credit commitment for loans made under a line of credit
or commitment.
(The upper panel shows commercial and industrial
loans, and the lower panel shows loans secured by nonfarm,
nonresidential real estate.)
Although the relationship between loan
size and business size is not precise, evidence suggests that there is
a strong positive correlation.
For example, in the 1989 NSSBF. 80
percent of loans to businesses with less than $1 million in annual
sales were under $100.000.
In contrast, only 15 percent of loans to
firms with sales of $10 million or more fell in this small size
category.
It is reasonable to assume that most of the loans of
$100,000 or less, shown in Chart 5, are loans to small businesses.
In
addition, many loans between $100,000 and $1 million are to small
businesses.
The data in Chart 5 indicate that commercial banks with total
assets of less than $100 million primarily make small business
loans.
In addition, close to half the dollar volume of business loans
at the banks with assets of $100 to $300 million are in amounts of
$100,000 or less and about 86 percent of these loans are under $1
3. In this regard, it is important to note that the term "small
business" is not well-defined, and quite different definitions may
be appropriate depending on the context. A firm with $50 to $100
million in annual sales generally would be too small to issue bonds
and equity in public securities markets and likely would find it
difficult to place its issues privately. From the perspective of a
commercial bank, a business with less than $10 million in annual sales
likely would be considered small, while companies with sales of $50 to
$100 million would be "middle market".. For assessing credit flows to
low income areas, firms with $1 million in annual sales may be more
appropriate. Data from the 1989 National Survey of Small Business
Finance indicate that about three-fourths of small businesses have
less than $1 million in annual sales and fewer than twenty employees.
128
Charts
•
Business Loans At U.S. Commercial Banks
Amount Outstanding as of June 30, 1993
Original amount
of loan or line
of credit or
commitment
(Thousands of dollars)
.
Asset size of bank
(Millions of dollars)
<$100
$100
to
$300
-
$300
to
$1,000
$1,000
to
$5,000
>$5,000
All banks
Commercial and industrial loans
(Billions of dollars)
21.8
17.7
10.7
9.6
Greater than $100 thru $250
3.2
4.5
4.3
5.5
Greater than $250 thru $1,000
3.7
7.6
9.0
12.9
22.2
55.4
122
36.2
4iQ
213.1
275.6
73.0
261.5
434.5
$100 or less
Greater than $1,000
Total C&I loans
&2
44
29.6
342
17.6
8.6
77.4
26.1
Loans secured by nonfarm, nonresidential properties
(Billions of dollars)
$100 or less
15.7
14.4
6.8
4.4
5.0
46.2
7.2
25.8
21.6
65.7
Greater than $100 thru $250
3.8
53
4.4
Greater than $250 thru $1,000
6.4
11.8
11.7
14.2
Li
IS
1A&
123.2
212
37.0
123
35.6
28.8
52.5
108.6
260.9
Greater tha- i,000
Total nonfarm, nonres. loans
Source: Call Reports
5.1
129
million.
Banks in these two size groups compose roughly 90
percent of all domestic commercial banks; however, their C&I and
nonfarm. nonresidential real estate loans account for less than 20
percent of the total of such loans at all domestic banks.
Although
far fewer in number, larger banks provide 80 percent of total business
X
loans and more than 40 percent of small ($100,000 or less) business
loans in the chart.
The loan-size data offer insights into the amount of loans
outstanding to small businesses, but because they have been reported
for only one date this year, they cannot shed light on net credit
flows during the year.
Some information can be gleaned, however, by
looking at the growth pattern of business loans at those institutions
that lend almost exclusively to smaller businesses.
On the June Call
Report, about 6.400 banks indicated that virtually all of their
business loans were in amounts, or under lines, of less than $100,000.
Chart 6 indicates that these banks had outstanding about $73 billion
in business loans at the end of September, an increase of more than 6
percent from the year before.
Thus, while aggregate business loans
were running off in 1993, this subset of banks maintained and
increased their lending to small customers.
A word of caution is
warranted: the numbers in Chart 6 should not be interpreted as the
total amount of bank lending to small businesses because they do not
include loans at banks that have a mix of large and small customers.
As noted.earlier, large banks account for a sizable share of small
4. There are legal limits on the amount of credit that a bank can
extend to a single borrower; national banks, for example, are
prohibited from extending to one borrower unsecured credit in excess
of 10 percent of its "unimpaired" capital.
Thus, a bank with a
portfolio of $100 million and a capital-to-loan ratio of .05 could not
lend more than $500,000 (0.1 x 0.05 x $100 million) to a single
customer.
This limits the potential for small banks to accommodate
large business customers.
130
Chart 6
.
Business Loans At U.S. Commercial Banks
With Mostly Small Loans1
.
Type of Loan
Region
Number of
banks
Total
business
Commercial
and
industrial
Nonfaim,
Construction
nonresidential
and land
•real estate development
Amount outstanding, September 30, 1993
(Billions of dollars)
Total U.S.
Northeast
6,389
73.1
343
31.6
7.2
233
4.6
1.9
2.5
0.2
Southeast
1,031
19.5
7.9
9.2
2.4
Midwest
4,186
36.0
18.2
14.9
2.9
Southwest
733
72
3.4
3.1
0.7
West
206
5.8
2.9
1.9
1.0
Change from year earlier
(Billions of dollars)
Total U.S.
Northeast
6,389
233
4.4
-0.4
0.8
-0.4
2.8
0.8
0.0
0.0
Southeast
1,031
1.5
0.4
0.9
0.2
Midwest
4,186
2.1
0.5
1.4
0.2
Southwest
733
0.4
0.0
0.2
0.2
West
206
0.8
03
0.3
0.2
1. Banks are thaw that reported on the June 30^ 1993, Call Report that virtually all their businea Joans »
lines of credit or commitment at, lev than $100,000.
Source: Call Reports
is oC or u
131
loans and it is not possible to determine from only one Call Report if
their outstanding small business loans increased or decreased over the
year.
The data in Chart 6, nonetheless, are consistent with other
evidence suggesting that much of the recent weakness in bank
commercial and industrial loans reflects paydowns of loans at large
institutions, likely associated with portfolio restructuring by
midsized and large corporate borrowers.
Terms of Lending. Conceptually, to determine whether
weakness in business loans reflects lack of demand by borrowers or
a contracting supply by lenders, one would look at the prices and
terms applied to loan transactions.
If bank lending rates are low
relative to the bank's cost of funds or to competing sources of
credit, and if other loan terms are easy, sluggish loan growth is more
likely to reflect weak borrower demand.
In contrast, high costs of
bank loans, and tight collateral and other lending terms, suggest that
suppliers may be restraining growth.
In either event, interpretation
of pricing information must take into account other factors that
affect credit terms, especially adjustments for risk.
Generally,
aggregate loan flows reflect a combination of supply and demand
pressures, and there are no simple, risk-adjusted, price and credit
measures that distinguish unambiguously the source of these pressures.
Survey data, however, provide some evidence on recent changes in bank
willingness to lend and on demands for bank credit.
As noted below,
such surveys, coupled with information on bank loan rates, paint a
picture of a credit environment for business borrowers that is more
hospitable in 1993, but one in which both borrowers and lenders remain
cautious about expanding debt use.
The Federal Reserve's periodic Senior Loan Officer Opinion
Survey on Bank Lending Practices poses a number of questions to large
132
banks about changes in their lending standards, loan terms, and loan
demand for large, medium and small businesses.
Recent surveys
indicate that most of these banks stopped tightening their lending
terms and standards for commercial and industrial loans in mid-1992;
during 1993. virtually none of the respondent banks reported any
tightening, and an increasing number reported some easing.
In the
November 1993 survey, about a quarter of the domestic bank respondents
reported reductions in the price of credit and credit lines for small
businesses and somewhat fever reported easing other terms, including
loan covenants, credit line size, and collateral requirements.
Indices of the net percentage of respondent banks that reported
tightening fell to zero for firms of all sizes last year and have
moved down further in 1993 (Chart 7).5
Nonetheless, the survey
does not reveal an appreciable unwinding of the firm standards the
banks adopted in earlier years.
The tightening of lending standards
for commercial real estate loans reported in 1990 and 1991 also
appears to have ended (Chart 8); except for a few reports of easing,
however, the survey provides little evidence that the appreciable
earlier firming in commercial real estate standards has reversed.
The Senior Loan Officer Opinion Survey is somewhat mixed with
regard to the demand for business loans in 1993.
Although between 15
and 25 percent of bank respondents noted some pickup in demand by
large companies in the May. August, and November surveys, an almost
equal share reported lower loan demand, which they attributed in many
cases to the shift by large businesses from banks to capital markets.
Twenty-five to thirty percent of the banks reporting in these months
indicated that demand by mid-sized and small firms -was stronger, while
5. The net percentage is the percentage of respondents that
reported tightening standards over the three months prior to the
survey date less the percentage that reported easing standards.
Chart?
Senior Loan Officer Opinion Survey
Commercial and Industrial Loans
Net Percentage of Domestic Respondents Tightening Standards
(by Size of Firm Seeking Loan)
Percent
Large Firms
Medium Firms
Small Firms
- 20
- -20
Q 2 Q 3 Q 4 Q 1 Q 2 Q 3 Q 4 Q 1 Q 2 Q 3 Q 4 Q 1 Q 2 Q 3 Q 4 Q 1
1990
1991
1992
1993
Net Percentage of Domestic Respondents Reporting Stronger Demand
(by Size of Firm Seeking Loan)
Percent
Large Firms
Medium Firms
Small Firms
40
30
20
10
0
V
-10
•20
-30
04
1991
Q1
Q2
Q3
1992
Q4
Q1
Q2
Q3
1993
Q4
Charts
—^^—
Senior Loan Officer Upinion survey
—
Commercial Banks Reporting Changes in Credit Standards
in the Three Months Prior to the Survey Month
(Percent of total respondents)1
Commercial Real Estate Loans
Survey
month
1990 August
October
1991 January
August
October
1992 January
May
August
November
1993 January
May
August
November
Office buildings
Tightened
Eased
74
60
48
28
20
14
10
5
5
7
9
5
5
0
0
0
0
0
2
0
0
0
0
2
2
2
Industrial structures
Tightened
Eased
63
59
45
26
10
3
12
0
2
2
7
5
3
0
0
0
0
0
2
2
2
2
2
5
9
9
Other
Eased
Tightened
66
61
46
28
14
7
11
7
5
2
7
5
4
Construction and Land
Development Loans
Eased
Tightened
0
0
0
0
0
2
0
0
0
0
5
7
12
1. The percentage of responses in the "basically unchangecT-category is not shown. For simplicity of presentation, the percentages that
"tightened somewhat" and "tightened considerably" have been combined, as have the percentages that "eased somewhat" and "eased considerably."
Source: Federal Reserve Board, "Senior Loan Officer Opinion Survey on Bank Lending Practices," mimeo, various issues
75
66
47
29
15
11
11
11
5
2
5
3
2
0
0
0
2
0
0
2
4
2
2
7
5
7
135
about half this number thought it was weaker.
At the same time,
sample surveys taken by the National Federation of Independent
Business (NFIB) indicated little or no pickup in credit use among its
members, mostly small and mid-sized businesses.
The percentage of
NFIB firms who identified themselves as regular borrowers dropped
below one-third in July to a record low for the twenty-year history of
the survey, and edged up only slightly in October (Chart 9).
Concerns
about credit availability remained well down on the list of problems
cited by NFIB firms, with only 8 percent of respondents indicating
that credit was harder to obtain and only 2 percent citing financing
difficulties as their most important problem.
The average interest
rate on short-term loans reported by NFIB borrowers fell to 8.3
percent during the year, but ticked up slightly to 8.5 percent in the
October survey.
Interest rates, however, were not cited by
respondents as a reason for pessimism; rather they expressed concerns
about general business conditions and the outlook for sales growth.
Interest rates on shorter-term small business loans are
typically tied to the prime rate.
Thus, the five percentage point
decline in the prime rate since 1989 has greatly reduced the cost of
borrowing for many firms.
Still, the prime rate remains unusually
high relative to market interest rates, as indicated by the nearly 300
basis point spread of the prime over the federal funds rate (Chart
10).
Data from the Federal Reserve's Survey of Terms of Bank Lending
to Business further suggest that, while banks have been fairly
6. William C. Dunkelberg. National Federation of Independent
Business, 1993 Quarterly Economic Surveys. The NFIB conducts
quarterly surveys in the first month of each quarter. The October
1993 survey covered about 2,100 businesses.
7. In a recent Federal Reserve survey, about a quarter of the
volume of newly extended small loans carried fixed interest rates,
while close to 70 percent were variable-rate prime-based loans. The
remaining few were variable-rate loans that were tied to market rates
other than the prime.
136
Chart 9
Loan Availability
NFIB Quarterly Survey Results
RESPONDENTS WHO BORROW REGULARLY*
Percent
Quarterly
50
40
30
\/
20
1992
1993
as a percent of al survey respond
1989
1990
1991
•Number of flrms that indicate they borrow at least once every tvee month*.
CREDIT MORE DIFFICULT TO OBTAIN (NET)*
Percent
—i 30
Quarterly
24
New England
18
12
_L
1989
I
1990
I
I
1991
1992
1993
•OfbofTowwwho80ug«credrtint>»p^thr»»nx>nt»8,ti«proportk)o that reported more difficulty in obtaining credft lees
Source! National Federation of Independent Hmlnois
137
aggressive in lowering interest spreads on large loans, they have not
reduced such spreads for their smaller borrowers.
For example, as
shown in Chart 10, average yields on floating-rate loans made under
commitments of $20 million or more have narrowed from 75 to near 10
basis points over prime since 1991.
In contrast, for loans of less
than $100,000 not made under commitment, the average spread over prime
has fluctuated narrowly around 175 basis points this year, slightly
above its average over the previous two years.
Private loan rates
include some premia to compensate lenders for risk, and the reluctance
of banks to lower their rates may reflect concern that, despite the
improving economic environment, new loans entail more risk as credit
standards and nonprice terms are eased.
Taken together, the evidence from the bank and private sector
surveys suggests that banks have eased credit standards and costs
measurably for large businesses, perhaps spurred by the increased
competition for these customers from the capital markets and other
private source's-.
Indeed, despite the banks' more accommodative
postures, large companies have continued to pay down bank debt while
issuing bonds and equity in substantial volume.
While some banks have
begun to ease terms and standards for small businesses as well, they
have not aggressively lowered lending rates to small firms.
Small
businesses, however, have not cited current levels of interest rates
as a major deterrent to borrowing; those that view credit as hard to
obtain still are more likely to refer to difficulty in meeting lending
8. A few large banks have announced programs specifically aimed at
attracting smaller business customers. These efforts might include:
training branch managers to screen and process small business loans;
setting up divisions that specialize in small business lending; and
working with state and local programs to promote small business
lending. There are no data to assess the overall impact of such
programs. Some may increase the total flow of credit to small
businesses; others may mostly shift flows among lenders.
138
Chart 10
Yield Spreads at Commercial Banks
Sgread of Prime Rate Over Federal Funds Rate
Basis Points
350
300
250
200
150
1983
1984
1985
1986
1987
1988
1989
1990
i 1 i i i I i i—
1991
1992 1993
Spread of Loan Rate Over Prime Rate
Floating-Rate, Prime-Based Loans
100
Basis Points
—1 200
Loans under $100,000 not made under commitment
150
Loans of $20 million or more made under commitment
50
i
1986
I
1987
I
1988
1989
1990
Source: Federal Reserve Board, Quarterly Survey of Terms of Bank Lending
1991
1992
1993
139
standards or collateral and documentation requirements than to high
interest rates.
Moreover, many small businesses appear reluctant to
expand their debt owing to continued uncertainty about their own
business prospects and the economy in general.
Information on the financial condition of large commercial
banks suggests that the trend toward loosening credit standards should
continue.
As indicated in Chart 11, delinquency rates and charge-off
rates for all types of loans--consumer, real estate, and commercial
and industrial--have fallen markedly from their 1991 peaks: for C&I
loans, delinquency rates in the third quarter of 1993 were at their
lowest level in the ten-year history of the bank series.
Moreover,
bank profits remain near record levels this year, and the capital
positions of most banks have moved well above minimum ranges.
Nonbank Credit Sources.
As noted above, bank loans account
for perhaps half the credit extended to small businesses.
In
addition, small firms rely on credit from nonbank depository
institutions and finance companies, on trade credit and on loans from
family and friends.
Figures from the Federal Reserve's flow of funds
accounts provide a breakdown of the major sources of market and trade
credit for nonfinancial businesses generally and the differences
between corporate and noncorporate borrowers (Chart 12) .
The nonfarm, noncorporate business sector in the upper panel
of Chart 12 comprises partnerships, sole proprietorships, tax-exempt
cooperatives, and individuals who receive rental income on
nonresidential structures.
The average size of businesses in this
sector is appreciably smaller than of those in the corporate
Chart 11
Delinquency and Charge-Off Rates at Large Banks
(Seasonally adjusted)
Delinquency rates by type of loan
Charge-off rates by type of loan
Real estate
2.0
C&l
1.5
0.5
1982
1984
1986
1990
1992
1982
1984
1986
1988
1990
Note: Data are from FFIEC's quarterly Reports ol Condition and Income lor banks with at least $300 million in assets, and for all banks with foreign offices. Delinquent loans include those past
due 30 days or more and stil accruing interest, as wen as those on nonaccrual status. Delinquency rates are averages of the beginning and end of each quarter. Charge-off rates are
annualized. net of recoveries, divided by average outstanding loans. Delinquency rate series began 1982 CM. charge-off rate series began 1982 Q1.
1992
141
Chart 12
Credit Market Debt Of Noncorporate Businesses
(Billions of dollars outstanding at period end)
1.
Total market debt
2.
Mortgages
3.
Bank loans 1
4.
Other loans
2
1993
Q3
Selected vears
1991
1990
1992
1219
1192
1155
1132
667
876
868
832
817
99
126
112
108
105
81
143
217
212
215
210
36
57
82
78
85
93
1980
1985
449
909
293
75
Memo:
5. Trade debt
1. Includes only bank loans extended without real estate as collateral.
2. Includes loans from finance companies and all other nonmortgage loans that are not extended by banks.
Source: Federal Reserve Board, Flow of Funds Accounts
Credit Market Debt Of Nonfinancial Corporatio is
(Billions of dollars outstanding at period end)
1.
Total market debt
1
Selected vears
1990
1991
1992
1993
Q3
1980
1985
877
1505
2375
2362
2406
2434
1316
2.
2.
412
131
705
114
1123
1201
1268
Mortgages
209
209
184
177
3.
Bank loans 2
230
424
555
531
519
509
4.
Other loans 3
104
262
488
421
435
432
348
486
659
663
699
710
Bonds
Memo:
5. Trade debt
1. Includes industrial revenue and corporate bond issues.
2. Includes only bank loans extended without real estate as collateral.
3. Includes commercial paper, loans from finance companies, and all other nonmortgage loans that are not extended by banks.
Source: Federal Reserve Board, Flow of Funds Accounts
76-694 O - 94 - 6
142
-12-
sector.9
Mortgage debt, about two-thirds of which is provided by
banks and nonbank savings institutions, composes the bulk of credit
used by noncorporate businesses.
Commercial and industrial loans from
banks provide about 10 percent of the market credit used by these
businesses.
Savings associations also make a small amount of
commercial and industrial loans and mortgage loans secured by nonfarm,
nonresidential real estate (Chart 13). • Such loans are included,
respectively, in "other loans" and in "mortgages" in Chart 12.
For
1993. the flow of funds data show very little change in the volume of
commercial and industrial loans to noncorporate businesses, while
commercial mortgages continued to contract.
The banking data imply
that most of the mortgage contraction was in construction and land
development loans which continued to be written down at large and
small banks.
The bulk of "other loans" to noncorporate businesses is from
finance companies, many of which specialize in equipment loans or
leasing and in financing auto dealer inventories.
Lending by finance
companies remained relatively flat in 1992 and 1993 (Chart 14). x To
the extent that weak loan growth at banks may have reflected unusually
tight lending standards, business borrowers would be expected to turn
to alternative sources such as finance companies for credit.
While
some firms likely have done so, the lack of growth in aggregate
finance company loans appears to confirm that demands for shorter-term
credit by businesses generally have been weak.
For nonfinancial corporations. Chart 12 shows a somewhat
different debt pattern.
Total borrowing by these firms edged up in
9. Thus, sales or business receipts of corporations filing income
tax returns in 1990 averaged $2.7 million: those of partnerships
averaged $311.000; and those of sole proprietorships averaged $49.000.
Virtually all sole proprietorships and 96 percent of partnerships had
sales receipts of less than $1 million.
143
Chart 13
Business Loans At Savings Associations*
Amount Outstanding as of June 30,1993
™^™^
•"•^^™"
Original amount of
loan or line of credit
or commitment
(Thousands of dollars)
Asset size of institution
(Millions of dollars)
<$300
$30041,000
>$1,000
All
Commercial and industrial loans
(Amount, billions of dollars)
$100 or less
.6
.6
.9
2.1
Greater than $100 thru $250
.2
.2
.4
.8
Greater than $250 thru $1,000
.2
.3
1.0
1.5
Greater than $1,000
2
A
L6
22
1.2
1.5
3.9
6.6
Total C&I loans
Loans secured by nonfarm, nonresidential properties
(Amount, billions of dollars)
$100 or less
2.1
1.1
.8
4.0
Greater than $100 thru $250
1.2
1.2
1.2
3.6
Greater than $250 thru $1,000
2.7
3.4
8.2
14.3
Greater than $1,000
12
12
IfiJ
212
7.3
8.9
26.9
43.1
Total nonfarm, nonres. loans
•Data are from 1,835 savings associations regulated by the Office of Thrift Supervision.
144
Chart 14
•
Business Credit Growth at Finance companies
(Annual growth, September to September, percent)
—
Memo:
Level, Sept 1993
(BflUoas of dollars)
1991
1992
1993
1. Total financing
3.4
-.1
2
301.6
2.
7.6
2.0
1.0
152.6
95.1
53.8
Equipment
3.
Motor vehicles
13
3.0
1.4
4.
Other business
-2.8
-9.7
-3.9
Note: IndodttpoobofMcaiittedMMtt.
Source: Federal Knave Baud
Business Credit of Finance Companies
(Seasonally adjusted)
Levels
$ Billions
340
-Total BuriMMCrwft
•Total BustoMt Crwft toss Whotosste Auto
320
300
280
260
240
220
200
1890
1981
1982
1883
180
145
1993, owing almost entirely to an increase in bond debt.
Commercial
and industrial loans, in contrast, fell, as did commercial mortgage
debt.
In the aggregate, corporations lengthened the maturity
structure of their liabilities, paid down bank loans, and refinanced
high-cost debt in 1993.
Moreover, corporations took advantage of a
strong stock market to issue appreciable amounts of new equity this
year (not shown), further enabling them to ^build capital and reduce
debt burdens.
Equity Finance.
Concerns are frequently expressed about the
availability of financing for new or start-up small businesses.
The
risks associated with lending to a business that has no established
credit record or operating experience are such that most depository
institutions are unwilling to extend credit without substantial
collateral, guarantees, or capital.
Equity provided by informal
"angel" investors and by venture capital firms may fill the
capital void for some new or young firms that have potential for
strong growth."
Data on financing provided by angel investors are not
collected routinely, but estimates from one source suggest that about
$10 billion was provided to more than 30,000 firms in 1992.10
Such
investments typically are made to firms in the very early stages of
development and precede financing that might come from venture capital
funds.
Estimates of the volume of funds raised and disbursed by
private venture capital funds are shown in Chart 15.
Most of
these funds are limited partnerships that raise money for investments
in the early expansion stages of a business.
In 1992, forty-one funds
10. Estimates of William E. Wetzel, Director of the Center for
Venture Research, Whittemore School of Business and Economics,
University of New Hampshire.
11. Data on venture capital funds are from Venture Capital
Journal.
146
Chart 15
1
Venture Capital Funds
Disbursements
New money raised
pniinM.nf.tinll**«
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993 HI
—_
2.73
2.61
233
332
322
3.97
3.85
4.18
2.95
2.40
1.85
1.27
338
230
136
234
na
235
1.29
Funds raising
new money
Companies
89
101
77
77
110
84
na
1236
1410
1388
1512
1740
1530
1465
1176
financed
_
232
3.46
3.30
_.
na
30
41
29
792
1093
na
aa-Not available
Source: Venture Capital Jounul
ruwic irfoss uomesnc iNonnnanaai Equity issuance
.
(Bfllions of dollars, annual rates)
1993
1990
1991
1992
HI
H2*
4.0
11.9
15.0
15.2
22,6
2.
32
.8
6.0
5.9
93
5.7
123
3.
23
17^
4^
J2.4
44^
48.4
54.8
64.1
1.
Total IPOs
Small company IPOs
Other IPOs1
Memo:
4. Ibtal equity issuance
•Datati
LReVe
Source: federal Rwerve Board
147
-14-
raised about $2.5 billion and disbursed roughly this amount among
1,093 small companies.
Of total disbursements, about $600 million
went to companies in the early stage of development.
New money raised
in the first half of 1993 totaled $1.3 billion, a pace roughly in line
with the previous year.
Typically in the past ten years, between
1,000 and 1,500 new or growing firms annually have received equity
financing from venture capital funds .Many successful venture-backed companies are likely to merge
or be acquired by large businesses at a later stage of their
development.
Others, however, may eventually go public through an
initial public offering (IPO) of stock.
In the first half of 1993,
about 71 venture-backed companies issued IPOs; this is near the robust
pace of 1992 when 151 venture companies issued IPOs for the year as a
whole.
The average asset valuation for these 151 firms was just over
$100 million.
Most IPOs of venture-backed businesses are in the range
of $20 to $100 million.
In addition to venture-backed companies, other expanding
small businesses found equity markets highly receptive to IPOs in
1993.
As indicated in the lower panel of Chart 15, small companies
thus far in 1993 have issued nearly $15 billion of IPOs at an annual
rate, well above the last three years and an extremely heavy volume by
historical standards.
CREDIT AVAILABILITY FOR SMALL FARMS
Growth of Farm Debt. The farm sector receives
substantial
amounts of credit from a number of sources, including commercial
banks, the Farm Credit System (FCS), the Farmers Home Administration
(FmHA), life insurance companies, and merchants and dealers.
Total
farm debt edged up slightly through the first three quarters of 1993
148
Chart16
Outstanding Farm Debt by Lender Type
Billions of dollars
220
200
180
160
140
120
100
80
60
40
FMHA
~T"T~ i i i • I I I I t i
1977
1980
1983
1986
1989
1992
- 20
149
-15-
(Chart 16).
The volume of farm loans at commercial banks continued to
grow at near the 5 percent annual pace seen since about 1988.
Although lending by the Farm Credit System has edged up slightly in
recent years, loan volume has remained far below the level seen in the
early 1980s before the onset of debt problems associated with the
deterioration in farm financial conditions in the early and mid-1980s.
The loan portfolio of the FmHA has continued to shrink-as the agency
has dealt with its troubled farm debt and as it has shifted its focus
from direct lending toward loan guarantees.
New Data from the June Call Report.
Small commercial banks--
those with assets totaling less than $100 million—held $10.6 billion
of loans secured by farm real estate, roughly half of the $20.6
billion outstanding at all U.S. banks (Chart 17).
Of this volume of
farm real estate loans outstanding at small banks, more than 80
percent represented loans that were originally in amounts of less than
$100,000.
By contrast, large banks, with more than $5 billion in
assets, held few farm real estate loans, and most of these were
greater than $500,000 in size.
The distribution of farm production loans--those farm loans
that are not secured by agricultural real estate--has a pattern
similar to that of farm real estate loans.
Small banks held a bit
more than half of the total volume of these loans, and most were in
amounts of less, than $100,000.
Large banks held a fairly small share
of such loans, and most were larger than $500,000.
The differences in size of farm loans between large and small
banks reflect, in part, regional differences: small banks predominate
in the Midwest, where farms generally are of moderate size, whereas
large banks tend to dominate agricultural lending in the West, where
Chart 17
Farm Real Estate and Production Loans Outstanding, by Size of Loan
and Asset Size of Bank, June 30,1993
Original amount of
loan or line of credit
or commitment
(Thousands of dollars)
Asset Size of Bank
(Millions of dollars)
All
Banks
Less than
$100
$500$4,999
$100$499
Greater than
$5,000
Loans secured by farm real estate
(Amount, billions of dollars)
$100 or less
13.23
8.56
3.58
0.79
0.30
$101- $250
2.93
1.27
1.00
0.41
0.25
$251 -$500
1.82
0.59
0.63
0.33
0.26
Greater than $500
2.61
0.21
0.49
0.64
1.27
20.60
10.64
5.70
2.17
2.09
Total
Farm production loans
(Amount, billions of dollars)
$100 or less
23.38
15.89
5.25
1.54
0.70
$101 -$250
3.41
1.51
0.92
0.54
0.44
$251 -$500
2.25
0.77
0.61
0.41
0.45
Greater than $500
6.34
0.41
0.60
1.60
3.73
35.38
18.58
7.38
4.09
5.33
Total
s
151
farms typically are much larger.
Nonetheless, it is important to keep
in mind that the vast majority of farm loans are less than $100,000.
Growth in the volume of farm loans at banks with mostly small
farm loans has been similar to that at other banks (Chart 18).
For
both sets of institutions, the volume of farm loans other than for
real estate began to expand in about 1988, when the farm economy was
making a rapid recovery.
Also, as mentioned earlier, the FCS-was
shedding loan volume rapidly in 1987 and 1988, and many former FCS
borrowers who were worried about the health of the FCS reportedly
refinanced loans with debt from other lenders, including commercial
banks.
In recent years, the growth of farm non-real estate debt at
both groups of banks has slowed to about a 3 percent annual pace.
The volume of loans secured by farm real estate grew rapidly
at all banks in the latter 1980s.
Some of this growth likely came as
bankers, worried about farm financial conditions, sought real estate
collateral for loans that previously might have been unsecured.
Indeed, the volume of loans secured by farm real estate expanded very
rapidly in the mid-1980s as the volume of farm production loans
declined.
Subsequently, the rate of growth slowed fairly steadily
through the autumn of 1993.
yprmg of Banks Lending to Farmers.
During the first full
week of the second month of each quarter, the Federal Reserve System
conducts a survey of farm loans of $1,000 or more that were made by
commercial banks.
The data for individual loans include a number of
price and nonprice terms and the amount.
While the data include no
information regarding the financial condition of the borrower-information important in the assessment of the availability of
credit--some general observations may be drawn.
In addition, given
the new Call Report data on small farm loans, the survey panel can be
152
Chart 18
Growth of Farm Loans at Commercial Banks
Nonreal Estate Loans
20
Percentage Chang*. September to September
15
10
10
I
1986
J
J_
I
1987
1988
1989
I
1990
I
1991
I
1992
15
1993
Real Estate Loans
—I 28
Percentage Change, September to September
BentewNhmeMyt
Ofwrbante
20
16
12
1986
1987
1988
•Banks «wtraportodon fte June 1993 Cel Report tMft
1989
1990
1991
1992
1993
153
divided into banks specializing in small farm loans and other banks,
and the terms of loans made at each type of bank can be compared.
For farm loans of less than $100.000 that were made under a
prior commitment, rates of interest have continued to be around 4-1/2
percentage points above the one-year Treasury yield in 1993, while the
spread for larger loans was about 1 percentage point less (Chart 19).
For small loans not made under a commitment, the spread has been about
5-1/2 percentage points during the same period, about 1/2 percentage
point greater than otherwise-similar, larger loans.
The general
magnitude of these spreads has persisted since 1990.
The survey data
indicate that a growing proportion of farm loans are made under a
prior commitment.
Over the past two or three years, the spread on small loans
at banks that identified themselves on the June 1993 Call Report as
making mostly small farm loans generally has drifted up relative to
the spread on small loans at other banks.
The current size of the
spread is 1 percentage point, toward the upper end of the range seen
since the mid 1980s.
Reserve Bank Surveys.
Several Federal Reserve Banks conduct
quarterly surveys of farm credit conditions at commercial banks.
The
size of the surveys varies considerably--ranging from about 400 banks
in the Chicago and Kansas City Districts to about 30 banks in the
Richmond District.
In addition, the wording of questions often
differs slightly between surveys.
Nevertheless, many of the questions
related to the availability of agricultural credit are similar and
shed light on differences among the regions.
The most recent readings from these surveys indicate that few
banks tightened collateral requirements last year in each Federal
Reserve District that posed this question (Chart 20).
Indeed, the
154
Chart 19
Rates of Interest on Farm Loans
(Spread over 1 Yr. Treasuries)
Farm Loans Made Under Commitment
I
1986
II
ill
1987
Percent
1988
II
1990
1989
1991
1992
1993
Farm Loans Not Made Under Commitment
Percent
1987
I
I
I I
1986
1988
1989
1990
i I II
I
1991
1992
1993
1991
1992
1993
Farm Loans Less than $100 Thousand
Bmto wNh irnHy «mltermtow*•
I i
1986
1987
1988
1989
1990
Source: Survey of T«m§ of Bank Undbig to Ftemra
y *ttMirterntornWM» ml.
155
Chart 20
Percentage of Banks Reporting that the Amount of
Collateral Required on Farm Loans was Higher Than One Year Ago
CHICAGO DISTRICT
DALLAS DISTRICT
Percent
80
|—
70
—
60
—
50
—
Percent
40
30
20
—
10
—
I I I I I i I I I I I I I I II
1978
1983
1988
KANSAS CITY DISTRICT
I I I I I I I I I I I I I I II
1993
1978
1983
1988
RICHMOND DISTRICT
Percent
1993
Percent
80
80
70
70
60
I i i I I I I I I I I I I I I I
1978
1988
1993
50
50
40
40
30
30
20
20
10
10
I I I I I I I I I I M I I II
1978
1988
1993
156
proportion of banks that reported higher collateral requirements fell
during 1993 in all these Districts, some to the lowest levels seen
since the 1970s.
Another indicator of the willingness of banks to lend to
farmers is the proportion that referred a loan to a nonbank credit
agency such as the FmHA or FCS (Chart 21).
Since 1988, banks
reporting this statistic seem to have become less likely to send
potential customers to alternative institutional sources of
agricultural credit.
Along with the decline in the number of banks
that reported more stringent collateral requirements, this apparent
drop in referrals seems consistent with the notion that banks
generally are making credit available to farm borrowers.
<ftiippnT-v.
in recent years, farm incomes and returns have
remained fairly high by historical standards.
Nonetheless, farmers
show little interest in taking on new debt, and values of farm real
estate have remained flat.
In general, the new data from bank Call
Reports do not highlight any stark differences in the expansion of
farm debt between banks that make mainly small farm loans and other
banks; both have been increasing substantially their portfolio of farm
loans in recent years.
Furthermore, survey data indicate that spreads
on large and small farm loans have been holding steady in recent years
at both types of banks.
Taken together, these data suggest that ample
credit is available from banks at terms that are similar to those
offered when the availability of credit was not a major concern.
157
Chart 21
Percentage of Banks Reporting that Referrals to
Nonbank Credit Agencies were Higher Than One Year Ago
MINNEAPOLIS DISTRICT
_
DALLAS DISTRICT
i i i i i i i i i i i i i i ii
1978
1983
1988
1993
1978
1983
1988
RICHMOND DISTRICT
KANSAS CITY DISTRICT
—i 64
1993
Percent
—I 64
r—
48
32
16
16
I I I I I I I I I I I I I i II
I II
1978
1978
1983
1993
I II I I
1963
1988
1993
158
B O A R D OF G O V E R N O R S
OF THE
FEDERAL RESERVE SYSTEM
WASHINGTON, D. C. 20551
ALAN GREENSPAN
CHAIRMAN
April 1, 1994
The Honorable Stephen L. Neal
Committee on Banking, Finance and
Urban Affairs
House of Representatives
Washington, D.C. 20515
Dear Congressman:
At the recent Humphrey-Hawkins hearing, you requested
that I provide examples of how important the Federal Reserve's
direct involvement in bank supervision and regulation has been to
the management and resolution of episodes of financial market
stress.
In my recent testimony before the Senate Banking
Committee on regulatory consolidation, I detailed a number of
examples of how intimate knowledge of financial markets, gained
by the Federal Reserve's hands-on regulatory and supervisory
responsibilities, has enabled us to respond quickly and effectively to problems that emerged in financial markets. The
relevant pages from my testimony are enclosed.
I hope this information's—helpful,
inperely,
Enclosure
159
EXCERPTS FROM STATEMENT OF ALAN GREENSPAN
BEFORE
COMMITTEE ON BANKING, HOUSING AND URBAN AFFAIRS
MARCH 2,1994
Removing the Federal Reserve from supervision and regulation would
greatly reduce its ability to forestall financial crises and to manage a crisis once it
occurs. In a crisis, the Fed, to be sure, could always flood the market with liquidity
through open market operations and discount window loans; at times it has stood ready
to do so, and it does not need supervision and regulation responsibilities to exercise
that power. But while often a necessary response to a crisis, such an approach may be
costly, destabilizing, and distortive to economic incentives, as well as being insufficient.
Supervision and regulation responsibilities give the Fed insight and the authority to use
less blunt and more precisely calibrated techniques to manage such crises and, more
importantly, to avoid them. The use of such techniques requires both the clout that
comes with supervision and regulation and the understanding of the linkages among
supervision and regulation, prudential standards, risk taking, relationships among
banks and other financial market participants, and macrostability.
Crisis Management
Our financial system—market oriented and characterized by innovation
and rapid change—imparts significant benefits to our economy. But one of the
consequences of such a dynamic system is that it is subject to episodes of stress.
Recent examples include a series of international debt crises, a major stock market
crash, the collapse of the most important player in the junk bond market, the virtual
160
collapse of the S&L industry, and extensive losses at many banking institutions. In such
situations the Federal Reserve provides liquidity, if necessary, and monitors
continuously the condition of depository institutions to contain the secondary
consequences of the problem. The objectives of the central bank in crisis management
are to contain financial losses and prevent a contagious loss of confidence so that
difficulties at one institution do not spread more widely to others. The focus of its
concern is notio avoid the failure of entities that have made poor decisions or have had
bad luck, but rather to see that such failures—or threats of failures—do not have broad
and serious impacts on financial markets and the national, and indeed the global,
economy.
The types of financial crises that arise from time to time are rarely
predictable and almost always different. The Fed's ability to respond expeditiously to
any particular incident depends on the experience and expertise that it has
accumulated over the years about the specifics of our system and its authority to act on
that knowledge. In responding to a crisis or heading off potential crises, the Federal
Reserve continuously relates its supervisor-based knowledge of how individual banks
work with its understanding of the financial system and the economy as a whole.
This does not necessitate comprehensive information on each individual
banking institution, but it does require that the Fed know in depth how institutions of
various sizes and other characteristics are likely to behave and what resources are
available to them in the event of severe financial stress. It currently gains this insight by
having a broad sample of banks subject to its supervision and through its authority over
bank holding companies.
161
The Federal Reserve employs its accumulated experience and expertise
in large measure to work with other regulators here and abroad and with private parties
to build strong institutional structures resilient to the inevitable strains that hit financial
systems. For example, in consultation with the other agencies, the Fed uses its
comprehensive economic knowledge to ensure that the economic consequences of
proposed rules are considered. In addition, the Fed's leadership with G-10 central banks has led to higher and more consistent capital standards and vastly improved
criteria for payment system management.
The Fed plays the key role when systemic breakdown threatens. Such
episodes invariably create fear and uncertainty in the financial markets. Fear of
counterparty risk escalates, and the threat of paralysis in financial markets and the
breakdown of payment and credit arrangements that underpin them become all too
real. It is important that a regulatory authority fully familiar with the dynamic
international economic and financial forces in play be available to counsel and urge
rational responses—and, as a last resort, provide liquidity. If regulatory authority is
vested in a single agency and little in the central bank, our nation's ability to forestall or
to respond efficiently and effectively to a crisis would surely be impaired.
Perhaps a few examples of Federal Reserve involvement in past crisis
management would help illustrate and clarify these points.
In early 1990, the parent of the leading dealer in junk bonds, Drexel
Burnham, failed, with potential significant impacts on financial markets. The Fed's
concern was not for the failure of a particular securities firm, but rather the impact that
failure might have on other financial institutions and on the functioning of capital
markets essential to economic growth and job creation.
162
From the central bank's perspective, the greatest threat was potential
gridlock in the system of paying for, and delivering, securities. Orderly liquidation of
DrexeTs substantial holdings, especially of mortgage-backed securities, was nearly
stymied by the fears of market participants who became exceedingly reluctant to deliver
securities or make payments to Drexel or finance its securities position. This caution,
while entirely understandable, could have brought the liquidation process to a standstill.
Had this occurred, capital markets would have been disrupted and the financial system
would have become more vulnerable in the future to the slightest whiff of problems at
any major market player.
The key to preventing gridlock was the cooperation of clearing banks,
through whose books most of the payments and securities flowed, and who are the
back-up source of credit to the securities markets. Because of its ongoing supervisory
relationships and knowledge of the payment system's infrastructure, the Federal
Reserve Bank of New York had the access, contacts, and in-depth knowledge of these
institutions that enabled it to address this complex problem. The Fed understood the
potential problems of Drexel's counterparties and clearing banks and had established
close working relationships with key personnel. The Fed was able to use its knowledge
and relationships to work with the banks and securities firms to identify developing
problems, and fashion procedures that enabled securities to be transferred and credit
to be extended to facilitate an orderly winding down of Drexel without adverse effects
on innocent bystanders or adding to the overall fragility of the financial markets.
Another example of Federal Reserve involvement in crisis management is
the record stock market break of October 19,1987, a drop paralleled by similar price
declines in all major stock markets of the world. These events represented a serious
threat to the stability of the global financial system. Formulating and carrying out
163
actions to maintain the integrity of the banking system, and thus limit the damage
inflicted by the drop in stock prices, required a variety of skills and powers. Particularly
crucial were the Federal Reserve's knowledge of financial markets, its contacts with
foreign central banks and with U.S. securities and commodities regulators, and its
experience with supervising and regulating banking institutions and the payment
system, all working hand-in-hand with its monetary policy.
Perhaps most visibly, early on October 20, the Federal Reserve issued a
statement indicating that it stood ready to provide liquidity to the economy and financial
markets. In support of that policy, the Federal Reserve conspicuously and aggressively
added reserves to the banking system on a daily basis through the end of the month.
These actions were taken as a central bank and could have been taken without
supervisory and regulatory authority.
However, the Fed's actions went far beyond the provision of reserves,
the System took a number of other steps that drew on its expertise in the operation of
markets and the payment system and in assessing the financial strength of important
participants. These included increased surveillance of the U.S. government securities
market, and more frequent contact with participants and regulators at the Treasury and
elsewhere. But a focal point of these actions was the banking system. Drawing on its
supervisory experience, the Fed immediately assessed the funding and risk
characteristics of major banking organizations to help identify any emerging problems.
Federal Reserve examiners on-site in major banking institutions obtained information
rapidly on potentially significant lending losses and emerging liquidity pressures.
Examiners were also sent into firms directly affected by an options dealer that had
suffered large losses. To detect the development of any bank runs, the Federal
Reserve monitored currency shipments to all depository institutions. Frequent contact
164
with counterparts in other major financial centers kept both the Fed and foreign
authorities informed about developments in markets and at international banks and
other financial firms.
The credit relationships between banks and securities firms received
particular attention. To obtain information about securities credit, the Federal Reserve,
through its examiners, was in frequent contact with both banks and securities firms
regarding the liquidity and funding of broker/dealers. Securities dealers' need for credit
was expected to rise, but with substantial losses likely from the large drop in stock
prices both firms and their customers would have less collateral to secure borrowing.
In its discussions, the Fed recognized that banks needed to make sound credit
judgments in the circumstances, but it also stressed the systemic problems that would
develop if the credit needs of solvent, but illiquid, firms were not met.
Problems in the futures and options markets, in particular, illustrated the
relationship between the banks and the securities firms, as concern grew that gridlock
was being approached in the settlement systems of the Chicago exchanges after large
margin calls on October 19 and 20. At the time, margin calls were collected through
four settlement banks in Chicago. Clearinghouse members were unable to fund their
accounts at the settlement banks in time to meet the margin calls. Owing to the
unusual size of the margin calls to certain large clearing members, the settlement
banks were unwilling to confirm those members' payments to the clearinghouse until
they could verify that funds had been received to cover the payments from the New
York banks at which the relevant clearing firms maintained their principal banking and
credit relationships. At the same time, the New York bankers were already concerned
about rumors regarding the creditworthiness of their customers and had little time to
fully understand the exposures that the securities firms had across other lines of activity
165
such as foreign exchange, risk arbitrage, and block trading. Telephone calls placed by
officials of the Federal Reserve Bank of New York to senior management of the major
New York City banks helped to assure a continuing supply of credit to the clearinghouse
members, which enabled those members to make the necessary margin payments.
While it is difficult to determine how the situation would have evolved in
the absence of these actions, it seems reasonable that the risk of even more disruptive
developments would have increased. The Federal Reserve's ability to reach judgments
about what actions were necessary depended critically on both its supervisory and its
economic knowledge of financial markets, banking institutions, and payment systems
and the Fed's credibility with market participants accumulated through many years of
operating in the markets and supervising banks.
The collapse of state chartered, privately insured thrift systems in the
states of Ohio and Maryland in the mid-1980s were other incidents in which the
Federal Reserve drew heavily on its supervisory resources and experience in carrying
out its crisis management responsibilities. When the largest of 71 privately insured
institutions in Ohio was reported to have suffered heavy losses due to fraudulent
securities transactions, depositor runs were triggered at the affected institution and
confidence in the viability of the insurance fund was undermined. These developments
led to runs at many other institutions insured by the fund. Within two weeks, the
Governor of Ohio had closed all of these institutions, and a law was then enacted that
permitted their reopening only if they were able to obtain federal deposit insurance.
Maryland's problems followed within months, as the collapse of the Ohio
system raised concerns about the ability of the private insurer of 101 state-chartered
savings institutions in Maryland to cover losses if they were to arise. Those concerns
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received confirmation when the two largest of these institutions were found to be
insolvent due to fraud and other abusive practices. Once again, depositor runs at the
insolvent institutions and at other institutions insured by the fund forced the closing of
all, with their reopening conditioned on their being found eligible to access the Federal
Reserve's discount window. Additionally, the state promptly enacted legislation that
required these institutions to obtain federal insurance, be merged with an insured
institution, or to be liquidated.
Responding to requests for assistance from the governors of each of
these states, the Federal Reserve assembled examiners from throughout the System
—with a sizable contingent of examiners from the OCC and FD1C joining in the case of
Maryland—to help resolve the crises. Under the Federal Reserve's general direction,
examiners entered virtually all affected institutions in both states to evaluate assets that
might serve as collateral for discount window loans, to monitor deposit outflows and
currency drains from the institutions, and to assess their financial condition.
Simultaneously, the Federal Reserve took steps to ensure that currency was
strategically placed in selected areas of each state to permit quick delivery to
institutions experiencing heavy cash withdrawals. Because of these efforts, the System
was able to extend discount window loans expeditiously when institutions encountered
serious liquidity problems, to process checks, ACH payments and the wire transfers of
the institutions prudently and effectively, and to meet all requests for currency.
The Federal Reserve also served as advisor to state authorities and a
facilitator of discussions with major depositories that sought to find solutions to these
problem situations. In short, the Federal Reserve's broad mandate for economic
stability, coupled with its operational experience in markets and supervision, played an
instrumental role in resolving each crisis in as orderly a manner as possible, and
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effectively contained the potential for spillover effects on federally insured depositories
and other financial institutions.
A final example is the Mexican debt crisis of 1982, which marked the
beginning of a generalized debt problem in the less developed countries in the 1980s
that threatened the world's financial system and economic growth. The Federal
Reserve recognized the potential for problems because of both its expertise and its
intimate role in banking supervision. Bank and bank holding company supervisory
reports and the judgment of Federal Reserve examiners provided vital information
regarding the fact that exposures to countries that were susceptible to payments
difficulties were well in excess of the capital of many banks. Not just the largest U.S.
banks, but also many smaller banks were significantly involved; in totaH more than 150
U.S. banks had exposure to Mexico. When the Latin American debt crisis broke
publicly in 1982 with a potential default by Mexico on more than $50 billion in claims
held by international commercial banks, the Fed was positioned to act quickly to
organize the international provision of liquidity support while a more permanent solution
was worked out. The Fed could respond quickly and comprehensively because of the
practical knowledge gained from hands-on examination of banks, its deep involvement
in the country-risk examination process, and its extensive contacts with foreign central
banks.
After the initial phase of the debt crisis, tension developed between two
seemingly conflicting considerations. On the one hand, the financial strength of the
banking system needed to be protected and restored in light of the potential losses by
banks on their exposures to developing countries. On the other hand, if at least
conditional access by developing countries to funding from hundreds of U.S. and
foreign banks were not maintained, those countries would not have been able to work
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out their problems in an orderly fashion. The collapse of those countries' ability to
renegotiate their debts would have increased the likelihood of widespread bank failures
in the United States and around the world, threatened the stability of the global financial
and trading system, and worsened the already tenuous growth prospects of the
industrial countries.
The Federal Reserve, by virtue of its combined responsibilities for
oversight of the financial and the dollar payment systems on the one hand, and
maintenance of macroeconomic stability on the other, was in a unique position to
recognize these complex interactions and incorporate these considerations effectively
in its supervisory actions. Through its active involvement in the daily supervisory
process of a broad cross-section of U.S. banks, the Fed had the perspective and the
knowledge to ensure that general supervisory policies, which often were initiated to
deal with other concerns, did not impair overall efforts to resolve the LDC debt problem.
Working with the Treasury and foreign central banks, the Federal Reserve understood
that over an appropriate time horizon considerations of financial prudence and
macroeconomic stability were not, in fact, conflicting but rather required the same
patient responses. Indeed, the Fed took the lead in coordinating a response by the
U.S. bank supervisory agencies that avoided overaction to the Mexican crisis. In
particular, U.S. commercial banks were not penalized for their participation in a
constructive solution to the systemic threat posed by that crisis.
This last experience illustrates a point anticipated earlier. An agency with
the sole or primary goal of prudential supervision and regulation, and without
responsibility for the economic consequences of its own actions, will of necessity tend
to focus almost entirely on a narrow view of safety and soundness. It will be severely
criticized by the Congress and others if a bank fails on its watch; it will not receive credit
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for avoiding other failures in unusual circumstances by being flexible. It will not have
the market experts—the economists and other specialists who spend their careers
understanding evolving institutions and instruments and how they react during adversity
and crisis. It is the combining of the Fed's supervisory knowledge with that of these
other experts and its broad macroeconomic responsibilities that facilitates—indeed,
requires—the balancing of the prudential supervision of banks against the broader
economic implications that surround a crisis.
Monetary Policy
While crises arise only sporadically, the Federal Reserve is involved in
monetary policy on an ongoing basis. In this area, too, the Fed's role in supervision
and regulation provides an important perspective to the policy process. Monetary
policy works through financial markets to affect the economy, and depository institutions
remain a key element in those markets. Indeed, banks and thrifts are more important in
this regard than might be suggested by a simple arithmetic calculation of their share of
total credit flows. While securities markets of different types handle the lion's share of
credit flows these days, banks are the backup source of liquidity to many of the
securities firms and large borrowers participating in these markets. Moreover, banks at
all times are the most important source of credit to most small- and intermediate-sized
firms that do not have ready access to securities markets. These firms are the catalyst
for U.S. economic growth and the prime source of new employment opportunities for
our citizens. The Federal Reserve must make its monetary policy with a view to how
banks are responding to the economic environment.
Factors affecting banks, quite apart from monetary policy, can have major
implications for their behavior and for the economy. Important among these factors are
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