Full text of Monetary Policy Oversight : House of Representatives Hearings : Conduct of Monetary Policy: Report of the Federal Reserve Board Pursuant to the Full Employment and Balanced Growth Act of 1978, P.L. 95-523 and The State of the Economy : Hearing Before the Committee on Banking and Financial Services, U.S. House of Representatives, One Hundred Sixth Congress, First Session, July 22, 1999

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CONDUCT OF MONETARY POLICY
Report of the Federal Reserve Board pursuant to the
Pull Employluent and Balanced Growth Act of 1978
P.L. 95-523
anH The State of the Economy

HEARING
BEFORE THE

COMMITTEE ON BANKING AND
FINANCIAL SERVICES
U.S. HOUSE OF REPRESENTATIVES
ONE HUNDRED SIXTH CONGRESS
FIRST SESSION

JULY 22, 1999
Printed for the use of the Committee on Banking and Financial Services

Serial No. 106-33

U.S. GOVERNMENT PRINTING OFFICE
WASHINGTON : 1999

For sate by the U.S. Government Priming Office
Superintendent of Documents, Congressional Sales Office, Washington, DC 20402
ISBN 0-16-059947-4




HOUSE COMMITTEE ON BANKING AND FINANCIAL SERVICE?
JAMES A. LEACH, Iowa, Chairman
BILL McCOLLUM, Florida, Vice Chairman
JOHN J. LAFALCE, New York
MARGE BOUKEMA, New Jersey
BRUCE F. VENTO, Minnesota
DOUG K. BEREUTER. Nebraska
BARNEY FRANK, Massachusetts
RICHARD H. BAKER, Louisiana
PAUL E. KANJORSKI, Ffeii&ylvania
RICK LAZIO, New York
MAXINE WATERS, CaHfornfa '
SPENCER BACHUS III, Alabama
CAROLYN B. MALONEY, New York
MICHAEL N. CASTLE, Delaware
LUIS V. GUTIERREZ, Illinois
PETER T. KING, New York
NYDIA M. VELAZQUEZ, New York
TOM CAMPBELL, California
MELVIN L. WATT, North Carolina
EDWARD R. ROYCE, California
GARY L. ACKERMAN, New York
FRANK D. LUCAS, Oklahoma
KEN BENTSEN, Texas
JACK METCALF, Washington
JAMES H. MALONEY, Connecticut
ROBERT W. N£Y, Ohio
DARLENE HOOLEY, Oregon
BOB BARB, Georgia
JULIA M. CARSON, Indiana
SUE W. KELLY, New York
ROBERT A. WEYGAND, Rhode Island
RON PAUL, Texas
BRAD SHERMAN, California
DAVE WELDON, Florida
MAX SANDLIN, Texas
JIM RYUN, Kansas
GREGORY W. MEEKS, New York
MERRILL COOK, Utah
BARBARA LEE, California
BOB RILEY, Alabama
VIRGIL H. GOODE JR., Virginia
RICK HILL, Montana
FRANK R. MASCARA, Pennsylvania
STEVEN c. LATOURETTE, owo
JAY INSLEE, Washington
DONALD A. MANZULLO, Illinois
JANICE D. SCHAKOWSKY, Illinois
WALTER B. JONES JR., North Carolina
DENNIS MOORE, Kansas
PAUL RYAN, Wisconsin.
CHARLES A- GONZALEZ, Texas
DOUG OSE, California
STEPHANIE TUBES JONES, Ohio
JOHN E. SWEENEY, New York
JUDY BIGGERT. Illinois
MICHAEL E. CAPUANO, Massachusetts
LEE TERRY, Nebraska
BERNARD SANDERS, Vermont
MARK GREEN, Wisconsin
PATRICK J. TOOMEY, Pennsylvania




(II)

CONTENTS
Page
Hearing held on;
July 22, 1999
Appendix:
July 22, 1999

1
43
WITNESSES
THURSDAY, JULY 22, 1999

Greenspan, Hon. Alan, Chairman, Board of Governors, Federal Reserve
System

f

APPENDIX
Prepared statements:
Leach, Hon. James A
Paul, Hon. Ron
Greenspan, Hon. Alan

44
47
48

ADDITIONAL MATERIAL SUBMITTED FOR THE RECORD
Sanders, Hon. Bernard:
Congressional Budget Office Preliminary Estimates of Effective Tax
Rates, July 15, 1999
Greenspan, Hon. Alan:
Monetary Policy Report To the Congress Pursuant to the Full Employment and Balanced Growth Act of 1978, July 22, 1999
Written response to questions from Representative Bentsen
Written response to questions from Representative Mascara




(III)

96
69
65
66

CONDUCT OF MONETARY POLICY
THURSDAY, JULY 22, 1999

U.S. HOUSE OF REPRESENTATIVES,
COMMITTEE ON BANKING AND FINANCIAL SERVICES,
Washington, DC.
The committee met, pursuant to call, at 11:00 a.m., in room
2128, Rayburn House Office Building, Hon. James A. Leach,
[chairman of the committee], presiding.
Present: Chairman Leach; Representatives McCollum, Roukema,
Bachus, Castle, Royce, Lucas, Kelly, Paul, Cook, Riley, Ryan, Ose,
Sweeney, Biggert, Terry, Green, Toomey, LaFalce, Vento, Frank,
Kanjorski, Waters, Sanders, C. Maloney of New York, Watt,
Bentsen, J. Maloney of Connecticut, Hooley, Sherman, Sandlin,
Lee, Goode, Mascara, Inslee, Schakowsky, Moore, and Capuano.
Chairman LEACH. The committee meets today to receive the
Semiannual Report of the Board of Governors of the Federal
Reserve System on the Conduct of Monetary Policy and the State
of the Economy, as is mandated in the Full Employment and
Balanced Growth Act of 1978.
Chairman Greenspan, welcome back to the House Banking Committee. To ensure that all Members have an opportunity to question Chairman Greenspan, it is the intention of the Chair to limit
opening statements to the Chairman and Ranking Member of the
Full Committee, as well as the Subcommittee on Domestic and
International Monetary Policy. All other opening statements will be
included for the record.
This is our second Humphrey-Hawkins hearing this year and the
last such hearing mandated under current law. As Members may
recall, the Semiannual Report is one of several thousand reports,
including approximately one-hundred under the jurisdiction of this
committee, which are scheduled to sunset on December 31 under
broad legislation approved by Congress four years ago.
As Chairman of the committee of jurisdiction, let me emphasize
that I believe these Humphrey-Hawkins hearings are the most important oversight hearings conducted by the Congress. The Federal
Reserve System has become, in effect, a fourth branch of Government, and the reports to this committee and its Senate counterpart
by the Chairman of the Fed have become the chief mechanism for
democratic review of the monetary policy decisions of the Federal
Reserve.
To discontinue these oversight hearings would be congressionally
negligent. The Fed should not be de-democratized.
Thus, it is my intention to move forward with legislation
immediately after the August break to require continued semi(1)




annual Humphrey-Hawkins hearings by the Federal Reserve on
the Conduct of Monetary Policy. In addition, certain selected other
reports by Federal banking, housing, and international financing
agencies will be reauthorized.
We meet today, at a propitious moment, to review the Fed's conduct of monetary policy. The current economic expansion is now
one-hundred months old. It is already the longest peacetime expansion in American history and in six months could become the longest expansion ever recorded anywhere. Despite robust domestic demand, core inflation is running into a 34-year low.
Over the past several years, the economy has performed in a way
that has defied historical precedents and modern academic theory.
Perhaps the most significant macro-economic views of the last generation is that the Fed appears to have concluded that we are in
an economic terra incognita and that the productivity gains associated with the unprecedented age of information technology means
that past economic modeling doesn't fit today's circumstances. Yesterday's models may fit tomorrow's, but for the moment, belt-tightening interest rates don't seem to be necessary to curb an inflation
that hasn't emerged with the low levels of unemployment that were
once assumed to trigger it.
To some degree, luck has been a factor on the inflation front,
with a silver lining appearing in what otherwise were dark clouds
in the world economy. Last summer's troubles abroad impoverished
a lot of people in Asia and Russia, but the crisis pushed down the
prices of goods that we buy from these countries, boosting America's consumer purchasing power.
In addition, more restrained congressional spending—producing
surpluses rather than deficits—has helped high-tech investors find
capital at credible rates, even though America's saving rate has declined to a negative level.
More fundamentally, the economy has been propelled by gains in
productivity.
I would just like to conclude by stressing that there are two
Americas, however, and that on the farm side in the Midwest we
are experiencing difficulties associated with the deflation. And Congress, in my judgment, is going to have to act forthrightly on the
agricultural problem, including the approval of Fast Track trade
authority.
I would also like to comment on an issue involving another base
of the committee, and that is gold. It is my intention to move swiftly on a debit relief initiative immediately following the August
break, but I would stress that it is unlikely that the committee will
endorse the Administration's proposal to authorize the IMF to sell
10 percent of its gold holdings as a method of payment for debt relief for the world's poorest countries. Debt relief is a societal and
indeed moral imperative, but care must be taken not to jeopardize
the mining industry that provides many of the most stable jobs in
the developing world.
At this point, let me turn to Mr. LaFalce, our distinguished
Ranking Member. I would ask unanimous consent to expand my
statement as well as Mr. LaFalce's and to put in the record anyone
else's statement.




[The prepared statement of Hon. James A. Leach can be found
on page 44 in the appendix.]
Mr. SANDERS. Mr. Chairman, reserving the right to object, I
would respectfully request that any Member who wants to make an
opening statement have a minute-and-a-half to do so. I know that
you want to get on to the questioning, I don't know how many
Members do, but I think it is appropriate that any Member have
at least a minute-and-a-half to make a statement.
Chairman LEACH. I appreciate the gentleman's request. The gentleman has led in that concern at each Humphrey-Hawkins hearing. But opening statements are at the discretion of the Chair and
it is the belief of the Chair that we are better off holding opening
statements to the four institutional positions, and that the gentleman would be allowed to comment as he sees fit during the fiveminute question and answer session.
Mr. LaFalce.
Mr. LAFALCE. I thank the Chairman. I thank him for his opening
statement, too. In large part I associate myself with his remarks.
I am especially pleased that we will be marking up the bill that
we have co-sponsored on debt relief as soon as we return in September. I think it is extremely important. As a matter of fact, I
can't think of anything that we could do that is more important to
help the people in the highly indebted impoverished countries in
the world.
I also want to join in the high praise that was recently given
both by President Clinton and Vice President Gore to Chairman
Greenspan for his outstanding stewardship of the Federal Reserve
Board and the conduct of domestic international monetary policy
during his tenure as Chairman. You have done an outstanding job,
Chairman Greenspan, and we are all very grateful for that fact.
This is now the 99th month of economic expansion, the longest
peacetime expansion in American history. We have reason to be
pleased, but we do not have reason to be overconfident. We need
to work to continue this prosperity. It is not inevitable. We also
must work, primarily within the Congress and the Administration,
to make sure that this prosperity is shared by all. This has not
happened and we must address this.
But I am profoundly concerned that the Congress might be taking actions today that could jeopardize our future economic prosperity. I am concerned about the economic implications of the massive and, in my judgment, very misguided tax cut proposal proposed by some of our colleagues.
In the first year of this Administration, it worked with the 93rd
Congress to control the record deficits of the 1980's and put us on
a clear and consistent path toward economic prosperity. We have
been successful. It would be foolhardy in the extreme to jeopardize
that success. A massive tax cut at this juncture, I believe, would
be fiscally irresponsible and threaten the economic growth that we
are now enjoying.
I appreciate very much that both the Administration and the
Congressional Budget Office are estimating a Government surplus
over the next decade. But these are projections, projections of what
could be under a very highly suspect set of assumptions. They are
not forecaster predictions of what actually will be.




If there is a surplus, I do not think that we should throw this
surplus away on huge tax cuts, especially since the preponderance
of those cuts would go to those already very well off. Further, that
projected surplus is premised on further significant cuts in spending for education, defense, and the environment, cuts that are problematic at best. Those cuts would also deter us from taking the
meaningful steps that we should to shore up Social Security and
Medicare.
Chairman Greenspan, I hope during the course of your testimony
or certainly in response to questions, you would address certain
issues. First of all, what are your thoughts on the likelihood of the
projected surplus becoming a reality? Second, you have said before
that placing priority on Government debt reduction would be a
sounder economic policy than massive tax cuts. I am anxious to
know if that remains your view. Third, I would like to know what
effect an approximate trillion dollar tax cut over a ten-year period
might have on interest rates and on your ability to conduct the
type of domestic and international monetary policy you would like
to.
There are a number of other subjects in which I am interested,
but time is limited so I will just mention two additional ones.
First, yesterday the Department of Commerce announced that
our trade deficit had ballooned to a record $23.1 billion in May, one
month. I understand the economic theory that suggests this may
not be a problem, but I am nevertheless concerned that this trade
deficit reflects reliance on the United States, either alone or certainly overwhelmingly amongst all of the other industrialized nations, to help pull the world out of a recession; that we are by far
the primary and most exclusive escape valve.
As everyone knows, our current account has swelled as well, reflecting primarily capital inflows associated with global financial
problems. I am concerned that this has led to our having the highest short-term interest rates amongst the G—7 and that our shortand long-term interest rates, though nominally low, are still very
high in a real sense, once inflation is taken into account.
And as a second additional concern, earlier this year many analysts suggested that the international economic and financial crisis
was over. I remain skeptical about that. Japan's economy has not
recovered. Germany's is in recession, and other European Monetary
Union economies are suffering. Russia's economy remains a basket
case and Latin America is still vulnerable.
I want to thank you and your staff for being very helpful to us,
my staff, in monitoring all of these situations and I look forward
to your thoughts on these and other issues.
Mr. GREENSPAN. Thank you very much.
Chairman LEACH. Thank you, John.
Mr. Bachus.
Mr. BACHUS. Thank you, Mr. Chairman. Welcome, Mr. Chairman.
Chairman Greenspan, you have focused on productivity a lot.
You have talked about technology, the advances we have had in
technology. And I think we all tried to figure out when that might
slow and if it will slow. I am curious as to what the Federal Reserve's predictions or outlook or how you track productivity as far




as looking into the future. I saw this morning where I think Internet growth may have finally slowed. I would like your comments
on where you think maybe we are on the S-curve as far as innovation. I know biotech, there is an explosion of activity in that regard,
and whether that is something that is sustainable for five, ten, fifteen or twenty more years or whether we may be at the end of a
wave there.
Mr. LaFalce mentioned the $21.3 billion trade deficit. I think we
all realized that is not sustainable. It has obviously brought a lot
of good-quality products to American citizens. We have all benefited from it.
I have a chart here of raw industrial costs and I thought I would
ask you about this chart. Basically it shows that we had kind of
a flat raw industrial cost until about September of 1997. And then
we had a dramatic downward trend in raw industrial cost until the
end of February of this year. It has flattened out again. That to me
indicates that we have sort of had the wind at our back with falling
costs and cheap foreign goods perhaps even aiding in that. And
then technology innovation, all of those, bringing down the price of
computers.
But I am wondering if this particularly—I know that is a gauge
that you pay a lot of attention to. I am going to ask you about the
significance that that at least appears on the chart that raw industrial cost may have stopped their fall and have flattened out.
The last thing that I want to ask you about is again what Mr.
LaFalce mentioned, and that is the global situation. This morning
there was a survey out that deflation, that there is evidence again
of deflation again in Japan. So things may not be as good. That is
one survey. As here, we have one survey showing one thing one
day and another the next. But I am curious as to your opinion on
the world economy, Europe, Latin America, the Far East, and how
you see that affecting our economy. Just maybe some thoughts on
that. I will be interested in hearing your comments.
I will close by saying I think that, as others have said, we are
in the longest peacetime expansion in the history of this country.
In fact, in February it will be longest economic expansion in the
history of pur country. It is a record-setting economy. I think you
are the chief architect of that sound monetary policy, and I want
to commend you on that.
And in that regard, I want to say this. I know that the Fed has
this super-secret high-tech econometric modeling system over there
where you plot plausible scenarios in the U.S. economy. I would
like to ask you to go back this afternoon and have your top economist feed two "what ifs" into this multi-million dollar computer and
examine near-term—give us near-term and long-term results of
this.
Here are the two scenarios. Number one is Greenspan is renominated as Chairman of the Federal Reserve. And number two, you
are not renominated.
So could you feed that in and could your economist run those two
scenarios and get back to us on the results of that?
Mr. GREENSPAN. Is that supposed to be a dummy variable?
Mr. BACKUS. If you would rather reply in writing, I appreciate
that. I appreciate that very much.




Chairman LEACH. I thank the distinguished Chairman for his
macro-economic query.
Ms. Waters.
Ms. WATERS. Mr. Chairman and Members and Mr. Greenspan, a
few days ago President Clinton was in South Central Los Angeles
and it was the last stop on a tour that he made around the country
to talk about his new markets initiative. He came basically to the
area where you have been, Mr. Greenspan. If you recall, you were
my guest and you created such a stir when you came to South Central Los Angeles. Hundreds of photographers came, the community
leadership was there. You encouraged CEOs of some of the major
banks to be there. And we talked about the lack of growth and economic development in inner cities and in that community in particular. So really the President was following on the tails of the
tour that you made there and the conversations and the discussions that we had at that time about the fact that the well-performing economy in this country had missed inner cities and other
areas. I think the President went on an Indian reservation, and so
forth.
So we remain puzzled about what to do. The President's new initiative may offer a glimmer of hope, but I am wondering as we are
trying to figure out how to get investment in these inner cities so
that we can reduce the awesome unemployment rate that still exists among young blacks—about a 35 percent rate, I am told. And
if you factor in incarceration and some other things, it is about 50
percent. At the same time that I am trying to figure that out, and
perhaps you and others, we have to guard against and we have to
be a little bit worried about whether or not you are going to raise
interest rates and what that will mean to poor communities. In addition to that, we have to be concerned about a Congress of the
United States that is now discussing a huge budget surplus and
the desire by some of my colleagues to give great tax cuts to somebody, I suspect the rich and the more fortunate of our society.
I would like you, in your presentation to us, to comment on the
discussion that is going on, and if there is a big tax cut or rebate
what will that do to interest rates, what will that do to the economy. I want you to specifically help us to understand whether or
not it is going to drive up interest rates if in fact we have this tax
cut. I want to know if you have any new thoughts about what we
can do to spur investment in the inner cities so that we can deal
with the still unconscionable unemployment. And I want you to
commit that you are not going to raise the interest rates, no matter
what.
Thank you. I yield back the rest of my time.
Chairman LEACH. Well, thank you, Ms. Waters.
Mr. Chairman, please proceed.
STATEMENT OF HON. ALAN GREENSPAN, CHAIRMAN, BOARD
OF GOVERNORS, THE FEDERAL RESERVE SYSTEM

Mr. GREENSPAN. Thank you very much, Mr. Chairman, and other
Members of this committee for the opportunity to present the Federal Reserve semiannual report on monetary policy.
To date, 1999 has been an exceptional year for the American
economy, but a challenging one for American monetary policy.




Through the first six months of this year, the U.S. economy has
further extended its remarkable performance. Almost a millionand-a-quarter jobs were added to payrolls on net, and gross domestic product apparently expanded at a brisk pace, perhaps near that
of the prior three years.
At the root of this impressive expansion of economic activity has
been a marked acceleration in productivity of our Nation's work
force. This productivity growth has allowed further healthy advances in real wages and has permitted activity to expand at a robust clip while helping to foster price stability.
Last fall, the Federal Open Market Committee eased monetary
policy to counter a seizing-up of financial markets that threatened
to disrupt economic activity significantly. As those markets recovered, the FOMC had to assess whether that policy stance remained
appropriate. By late last month when it became apparent that
much of the financial strain of last fall had eased, that foreign
economies were firming, and that the demand in the United States
was growing at an unstainable pace, the FOMC raised its intended
Federal funds rate a quarter of a percentage point, to 5 percent.
To have refrained from doing so, in our judgment, would have put
the U.S. economy's expansion at risk.
If nothing else, the experience of the last decade has reinforced
earlier evidence that a necessary condition for maximum sustainable economic growth is price stability. While product prices have
remained remarkably restrained in the face of exceptionally strong
demand and expanded potential supply, it is imperative that we do
not become complacent.
The already shrunken pool of job-seekers and the considerable
strength of aggregate demand suggest that the Federal Reserve
will need to be especially alert to inflation risks. Should productivity fail to continue to accelerate and demand growth persist or
strengthen, the economy could overheat. That would engender inflationary pressures and put the sustainability of this unprecedented period of remarkable growth in jeopardy. One indication
that inflation risks were rising would be a tendency for labor markets to tighten still further. But the FOMC also needs to continue
to assess whether the existing degree of pressure in these markets
is consistent with sustaining our low inflation environment. If new
data suggest that it is likely that the pace of costs and price increases will be picking up, the Federal Reserve will have to act
promptly and forcefully so as to preclude imbalances from arising
that would only require a more disruptive adjustment later—one
that could impair the expansion and bring into question whether
the many gains already made can be sustained.
Data becoming available this year have tended to confirm that
productivity growth has stepped up. It is this acceleration of productivity over recent years that has explained much of the surprising combination of a slowing in inflation and sustained rapid real
growth. Increased labor productivity has directly limited the rise of
unit labor costs and accordingly damped pressure on prices. This
good inflation performance, reinforced also by falling import prices,
in turn has fostered further declines in inflation expectations over
recent years that bode well for pressures on costs and prices going
forward.




8

In testimony before this committee several years ago, I raised the
possibility that we were entering a period of technological innovation that occurs perhaps once every fifty or one-hundred years. The
evidence then was only marginal and inconclusive. Of course, tremendous advances in computing and telecommunications were apparent, but their translations into improved overall economic efficiency and rising national productivity were conjectural at best.
That American productivity growth has picked up over the past
five years or so has become increasingly evident. Non-farm business productivity—on a methodologically consistent basis—grew at
an average rate of a bit over 1 percent per year in the 1980's. In
recent years productivity growth has picked up to more than 2 percent, with the past year averaging about 2Va percent.
To gauge the potential for similar, if not larger, gains in productivity going forward, we need to attempt to arrive at some understanding of what has occurred to date. A good deal of the acceleration in output-per-hour has reflected the sizable increase in the
stock of labor-saving equipment. But that is not the whole story.
Output has grown beyond what normally would have been expected
from increased inputs of labor and capital alone. Business restructuring and the synergies of the new technologies have enhanced
productive efficiencies. They have given businesses greater ability
to pare costs, increase production flexibility, and expand capacity
that are arguably the major reasons why inflationary pressures
have been held in check in recent years.
Other factors contributing to subdued inflation have included the
one time fall in the prices of oil, other commodities, and imports
more generally. In addition, a breakdown of barriers to cross-border
trade, owing both to the new technologies and to the reduction of
Government restrictions on trade, has intensified the pressures of
competition, helping to contain prices. Coupled with a decline in
military spending worldwide, this has freed up resources for more
productive endeavors, especially in a number of previously nonmarket economies.
Despite the remarkable progress witnessed to date, history counsels us to be quite modest about our ability to project the future
path and pace of technology and its implications for productivity
and economic growth. We must remember that the pickup in productivity is relatively recent, and a key question is whether that
growth will persist at a high rate, drop back toward the slower
standard of much of the last twenty-five years, or climb even more.
By the last I do not just mean that productivity will continue to
grow, but that it will grow at an increasingly faster pace through
a continuation of the process that has so successfully contained inflation and supported economic growth in recent years.
The business and financial community does not as yet appear to
sense a pending flattening in this process of increasing productivity
growth. This is certainly the widespread impression imparted by
corporate executives and it is further evidenced by the earnings
forecasts of more than 1,000 securities analysts who regularly follow S&P 500 companies on a firm-by-firm basis. Except for a short
hiatus in the latter part of 1998, analysts' expectations of five-year
earnings growth have been revised up continually since early 1995.
If anything, the pace of those upward revisions has quickened of




9

late. Analysts and the company executives they talk to appear to
be expecting that unit costs will be held in check or even lowered
as sales expand. Hence, implicit in upward revisions of their forecasts, when consolidated, is higher expected national productivity
growth.
That said, we must also understand the limits to this process of
productivity-driven growth. To be sure, the recent acceleration in
productivity has provided an offset to our taut labor markets by
holding unit costs in check and by adding the competitive pressures
that have contained prices. But once output-per-hour growth stabilizes, even if at a higher rate, any pickup in the growth of nominal compensation-per-hour will translate directly into a more rapid
rate of increase in unit labor costs, heightening the pressure on
firms to raise prices of the goods and services they sell. Thus,
should the increments of gains in technology that have fostered
productivity slow, any extant pressures in the labor market should
ultimately show through to product prices.
Meanwhile, though, the impressive productivity growth of recent
years also has had important implications for the growth of aggregate demand. If productivity is driving up real incomes and profits
and hence gross domestic income, then gross domestic product
must mirror this rise with some combination of higher sales of
motor vehicles, other consumer goods, new homes, capital equipment, and net exports. By themselves, surges in economic growth
are not necessarily unsustainable—provided they do not exceed the
sum of the rate of growth in the labor force and productivity for
a protracted period. However, when productivity is accelerating it
is very difficult to gauge when an economy is in the process of overheating.
In such circumstances, assessing conditions in the labor market
can be helpful in forming those judgments. Employment growth
has exceeded the growth of working-age population this past year
by almost one-half percentage point. It implies that real GDP is
growing faster than its potential. To an important extent, this excess of growth of demand over supply owes to the wealth effect as
consumers increasingly perceive their capital gains in the stock and
housing markets as permanent and evidently, as a consequence,
spend part of them.
There can be little doubt that if the pool of job-seekers shrinks
sufficiently, upward pressures on wage costs are inevitable, short—
as I have put it previously—of a repeal of the law of supply and
demand. Such cost increases have invariably presaged rising inflation in the past and presumably would in the future, which would
threaten the economic expansion.
By themselves, neither rising wages nor swelling employment
rolls pose a risk to sustained economic growth. Indeed, the Federal
Reserve welcomes such developments and has attempted to gauge
its policy in recent years to allow the economy to realize its full enhanced potential. In doing so, however, we must remain concerned
with evolving short-run imbalances that can constrain long-term
economic expansion and job growth.
In its deliberations this year, the FOMC has had to wrestle with
the issue of what policy setting has the capacity to sustain this remarkable expansion now in its ninth year. For monetary policy to




10

foster maximum sustainable economic growth, it is useful to preempt forces of imbalance before they threaten economic stability.
But this may not always be possible. The future at times can be
too opaque to penetrate. When we can be preemptive, we should be,
because modest preemptive actions can obviate more drastic actions at a later date that could destabilize the economy.
Preemptive policymaking is equally applicable in both directions,
as has been evident over the years both in our inclination to raise
interest rates when the potential for inflationary pressures emerge,
as in the spring of 1994, or to lower rates when the more palpable
risk was economic weakness, as in the fall of last year. This
evenhandedness is necessary because emerging adverse trends may
fall on either side of our long-term objective of price stability.
In the face of uncertainty, the Federal Reserve at times has been
willing to move policy based on an assessment that risks to the
outlook were disproportionately skewed in the one direction or the
other rather than on a firm conviction that, absent action, the economy would develop imbalances. For instance, both the modest policy tightening of the spring of 1997 and some portion of the easing
of last fall could be viewed as insurance against potential adverse
economic outcomes.
As I have already indicated, by its June meeting the FOMC was
of the view that the full extent of this insurance was no longer
needed. It also did not believe that its recent modest tightening
would put the risks of inflation going forward completely into balance. However, given the many uncertainties surrounding developments on both the supply and demand side of the economy, the
FOMC did not want to foster the impression that it was committed
in short order to tightening further. Rather, it judged that it would
need to evaluate the incoming data for more signs that further imbalances were likely to develop.
As a result of our Nation's ongoing favorable economic performance, not only has the broad majority of our people moved to a
higher standard of living, but a strong economy also has managed
to bring into the productive work force many who had for too long
been at its periphery. The unemployment rate for those with less
than a high school education has declined from 10% percent in
early 1994 to 6% percent today, twice the percentage point decline
in the overall unemployment rate. These gains have enabled large
segments of our society to obtain skills on the job and the self-esteem associated with work.
The questions before us today, Mr. Chairman, are what macroeconomic policy settings can best extend this favorable performance. No doubt, a monetary policy focused on promoting price stability over the long run and a fiscal policy focused on enhancing national saving by accumulating budget surpluses have been key elements in creating an environment fostering the capital investment
that has driven the gains to productivity and living standards. I
am confident that by maintaining this discipline, policymakers in
the Congress, in the Executive Branch, and at the Federal Reserve
will give our vital U.S. economy its best chance of continuing its
remarkable progress.
Thank you very much, Mr. Chairman. I would appreciate it if my
full remarks were included for the record.




11
[The prepared statement of Hon. Alan Greenspan can be found
on page 48 in the appendix.]
Chairman LEACH. Without objection, so ordered.
Let me just begin by noting that Ms. Waters asked if you would
promise never to raise interest rates, which I suspect is as likely
as asking liberal Members of Congress to never ever raise spending
or taxes.
But that aside, the question that I have is will the Federal Reserve Board of the United States be as vigilant in combating deflation as it has been vigilant in combating inflation? As we look at
American history, particularly the Great Depression, we saw an example of deflation. As we look around the world, possibly Japan
has suffered a bit from deflation today. And in the farm belt, there
is real deflation in aspects of agricultural policy. My concern is, is
this a concern of the Fed; and if it becomes evident in the statistics,
is the Fed prepared to act in this area as well?
Mr. GREENSPAN. Most certainly, Mr. Chairman. As I indicated in
my prepared remarks, the evidence is becoming increasingly persuasive that price stability is that which contributes to maximum
sustainable growth. It is our judgment, based on the evidence, that
both inflation and deflation create levels of uncertainty which inhibit capital investment, economic growth, and stability. And in our
view, both must be avoided if our goal is maximum sustainable economic growth.
Chairman LEACH. Thank you.
My second question is an esoteric one that relates to a conference
that is about to take place on banking modernization. A year ago
you testified before the Senate that the Federal Reserve Board favored elimination of the unitary loophole. Is that still your position?
Mr. GREENSPAN. It is, Mr. Chairman.
Chairman LEACH. Thank you very much.
Mr. LaFalce.
Mr. LAFALCE. I thank the Chair.
I have to point out that provisions in the law which explicitly call
for a certain course of conduct or legal structure are not loopholes.
They are provisions of the law, especially if they have been in existence for 30 or 40 years. You may not like them, but you
mischaracterize them when you refer to them as a loophole.
Having said that, let's return to the questions that I posed in my
opening statements. First of all, there has been a lot of talk, by
both the Democratic Administration and the Republican Congress,
about surpluses. I suspect these surpluses are in large part a mirage.
What are your thoughts on the likelihood of the so-called surplus
ever coming about, becoming a reality?
Mr. GREENSPAN. Congressman, projecting five or ten years out is
a very precarious activity, as I think that we have demonstrated
time and time again. If you look at the assumptions that are employed by both OMB and CBO, they are not unreasonable. I
wouldn't say they are reasonable, I would say they are not unreasonable. I use that phraseology purposely because the range
Mr. LAFALCE. That is why I purposely used the word "likelihood."




12

Mr. GREENSPAN. The range of error on those types of projections
are quite large. For example, we observe that there has been a very
significant proportion of increased revenues in recent years, which
is the consequence of what is euphemistically called technical adjustments, which is essentially factors that we cannot explain. If
we were to presume that those uncertainties, those technical adjustments which are plus at the moment—they have been in the
area of plus 1 percent of the GDP, which is not an insignificant
number.
Mr. LAFALCE. It is a rather large number.
Mr. GREENSPAN. This is a regularly reversed sign. Indeed, we are
not certain at all that that is the absolute upper magnitude, so that
there is a great deal of uncertainty about the range of possibilities
with respect to what that surplus will look like, if it continues to
exist.
Mr. LAFALCE. Well, given the tremendous uncertainty, and given
the precarious nature of the projections, would you recommend that
we pass a tax cut of approximately $1 trillion over the next ten
years?
Mr. GREENSPAN. Mr. LaFalce, I remain where I was last time I
was here and the time before. I think that the reduction that is occurring in the Federal debt at this stage as a consequence of the
ongoing surplus is an extraordinarily effective force for good in this
economy. It has moved interest rates lower than they otherwise
would have been. The cost of capital is lower. And for a number
of other reasons, I think it has been a major factor in the expansion of economic growth.
As I have said before, I would therefore prefer—because we are
being confronted with a very large demographic change down the
road, which means the ratio of retirees to workers is going to go
up very dramatically—that our emphasis be on national savings,
which creates capital investment, which creates increasing productivity and therefore the capacity, when finally the baby boomers retire, so that their standard of living will be kept high without creating problems in growing standards of living for our working population.
Mr. LAFALCE. Chairman Greenspan, would it be unreasonable
for me to conclude that you have just said no?
Mr. GREENSPAN. I was about to conclude. Therefore, as I have
said previously, my first priority, if I were given such a priority,
is to let the surpluses run. As I have said before, my second priority is if you find that as a consequence of those surpluses, they
tend to be spent, then I would be far more in the camp of cutting
taxes, because the least desirable is using those surpluses for expanding outlays.
Mr. LAFALCE. Thank you.
Chairman LEACH. Mrs. Roukema.
Mrs. ROUKEMA. Thank you, Mr. Chairman. I am glad that you
added that qualification there about surpluses tending to be spent,
because that has been an endemic problem here in our Congress.
I don't want to go into every bit of the tax cut question and know
there is going to be a lot of questions on both sides here, but having been one of those Republicans that worked with the committee,
the Ways and Means Committee, over several hours yesterday, and




13

one that is equally concerned about bringing down the debt and the
cost to all of us of the continuing debt. We tried to work out a proposal. You and I had some conversations as to what—not what the
general purposes of the proposal were, but exactly how it would be
worked out. Whether the proposal is tied to interest rates or tied
to the public debt was the issue.
I want to give you an opportunity for a general statement on
this, because it relates to the question that you just answered regarding national savings. The tax bill—in particular on the Senate
side—is very much targeted toward national savings; increasing
national savings.
People like myself that were involved in those negotiations yesterday were very concerned that we shouldn't be having some portions of the tax cut, if we are not able to demonstrate a reduction
in the national debt; whether it is measured by the interest rates
or whether it is measured by the total amount of debt. It seems to
me that is good policy, and therefore, we had integrated into the
tax bill a proposal that anything for the first—I think it is six or
seven years, and it is in the tax bill—would trigger a delay or a
postponement of the across-the-board tax cut. In other words, there
would be no tax cut across the board for any of those first years
unless we demonstrated that surpluses had been used to reduce
the debt.
No tax bill is perfect, but I would think that this would be a
great plus in terms of how we balance out the need for more national savings and block the unfortunate prospect of surpluses increasing Government spending.
So I wonder if you could just make a general statement on that,
recognizing that you haven't yet seen the precise language, but in
principle we are talking about putting debt payment—reducing
debt payment as a priority over the across-the-board tax cuts.
Mr. GREENSPAN. Congresswoman, I definitely agree that a trigger is a very useful device in this particular problem, which, I must
admit, is really sort of a highly favorable type of problem to be confronted with considering all of the years that we have been trying
to confront the deficit.
I would add one other important element. At some point, I don't
know when that is going to be, this economy is going to slow down
and perhaps slow down quite significantly. The business cycle is
not dead, and all of the technology with which we are dealing and
which is very crucial doesn't really relate to the dynamics of the
business cycle, only to long-term growth. At that point I would suspect that a significant tax cut mainly of marginal tax rates and
capital gains tax rates might be a very useful and timely vehicle
to sustain an economy which is otherwise weakening.
So in the way in which you devise the law, I would not only keep
a trigger for making certain that, in effect, that we do have the
surpluses before you reduce taxes, but we also had better be keeping in mind the fact that we can get some very powerful positive
incentives imparted to an economy which is weakening by an
across-the-board marginal tax cut and a capital gains tax cut,
which would be far more difficult to do if we didn't have the surplus. But if we have the surplus, we have the capacity to very substantially alter the tax structure in a way which would be a posi-




14

tive fiscal policy for us. So I would really add that to your contingencies of when it would be appropriate to allow the tax cut to
emerge.
Mrs. ROUKEMA. Thank you very much. I do appreciate that. It is
certainly very helpful. We will apply the wisdom of it. Thank you.
Chairman LEACH. Thank you, Mrs. Roukema.
Mr. Vento.
Mr. VENTO. Thank you, Mr. Chairman. It is always a pleasure
to be in a debate and discussion with our Republican colleagues as
they give us a lot of the Republican hyperbole and generally shower the Federal Reserve Board, and you specifically, Mr. Greenspan,
with credit in a noble effort to deny any credit to the Administration with regards to our remarkable economic performance. I think
you are due some of that credit, but I think a goodly part of it is
due to a functioning of a responsible Congress and Executive as
well as an independent Fed. We might disagree on monetary policy,
as we have most recently, as you immodestly raised interest rates
while at the same time, large trillion dollar tax cuts are being considered here for the next ten years.
I heard that next year, in the year 2000, we may actually have
an on-budget surplus. That surplus may be surging out of control.
So our remarkable economic performance is what we are talking
about today. But you know, as my professor told me, he stated—
and I've always remembered—that "nobody lives on the average."
We are really reminded of that in the Midwest as we look at the
sectorial displacements that are going on with regards to the rural
economy. I don't represent farmers, I just come from them. So I feel
deeply and very, very concerned about what is happening there as
we look at all of the aspects of this economy in terms of record
trade deficits, which are backloading the cost of today's positive
economic news.
And as we look at programs nationally which disinvest in people—you were quick to point out—productivity. But if I remember
my economics right, it was capital, research and investment in people. I would expect the last one is perhaps the most important. We
are charged with that through the Federal Government's fiscal policy. I know monetary policy you can't do much other than with student loan interest rates, but we really have a responsibility.
As we look at poverty in our society, we have knocked it down.
Frankly, 20 percent of our children are under the poverty line.
That is twice the number that are in poverty. Twenty percent of
our children live in poverty.
The lack of health care coverage, the number of housing problems that we have, are greatly accelerated with 5.3 million families
living in inadequate and poor housing.
And, of course, we have the weakened advocacy roles of labor
unions because of changes in the economy and other legal factors.
And we have the merger phenomena we all see going on, which
seems to me to weaken the very basic markets that we advocate.
Everyone likes free enterprise, they don't like to practice it so
much. They don't like the part about losing money. Certainly we
at the Federal Government, the Federal Reserve, must be free to
address the monetary policy and the integral independent function
to which reasonable people may disagree, but also of course the fis-




15

cal policy. And this fiscal policy, is topic A of the discussion on the
floor today as we move forward with this practically trillion-dollar
change in terms of what is going down.
Last, in an effort to try and gain a majority on the floor, we have
now apparently tied the fiscal policy to the monetary policy train.
It has been hitched up, welded together as it were, and placed on
this automatic pilot. This, in essence, surrenders, in my judgment,
our constitutional responsibility and that of the Executive upon the
altar of monetary policy.
Indeed we could say to the people that we represent, "Look,
Mom, no hands." The fiscal locomotive will follow, would be welded,
as I said, to these non-elected individuals' actions of the Federal
Reserve Board, led by, of course, our revered Chairman today. Who
knows who tomorrow?
The Federal Reserve Board, which disavows establishing interest
rates, masks its actions and decisions in the cloak and clothing of
market-oriented responses. In reality, frankly, that garment has
worn paper-thin as the Fed has nakedly stepped forward in the
past; and, just most recently, with such actions as preemptive
strikes in judgments, a market irrational exuberance.
I don't deny you that role. I think it is an important role. I think
what you did and your governor did in New York with the hedge
fund problem was very important. I just wish that there would be
a little more candor with regards to admitting to the role that was
played.
We need a full functioning team, in my judgment, not one that
is surrendered and subservient, and not one that places the socalled crown jewel decision of policy on the Federal Reserve Board
midnight express train. That is my concern.
What do you think, Mr. Chairman, about our decisions that are
predicated on other things in terms of monetary policy? Do you
think it is important from an economic sense that Congress remain
responsive and have the decisionmaking ability to in fact exercise
sound fiscal judgments with regards to productivity investment in
people, with regards to housing, with regards to the litany of issues
that I have expressed here?
Mr. GREENSPAN. I certainly do, Congressman. Congress has to
make decisions on what the fiscal policy of this country is, and because you have created effectively a central bank to which you delegate the responsibility of monetary policy, it is important that
Congress continuously oversee what we do. Because as you point
out, we are not elected representatives, we are appointed. What we
endeavor to do is carry out the will of the Congress as mandated
by the law. That, in my judgment, requires—and indeed necessitates—appropriate oversight on the part of the Congress.
Mr. VENTO. My time is expired.
Chairman LEACH. Thank you.
Before turning to Mr. Bachus, I would say that he asked the
question what the Fed computers would indicate if the Chairman
wasn't reappointed. I have asked staff to check our Cray computers
in the Banking offices. They have indicated by the year 2008, there
would be a 6.32 percent reduction in the GDP. So then we asked
it should the Chairman be reappointed and it came out with a little
card that said, "no brainer."




16

Mr. Bachus.
Mr. BACHUS. What you are saying, Mr. Chairman, is that in our
models it is not a dummy factor.
We talked about the surpluses here this morning. You have been
asked about—you have commented it is difficult to project surpluses. I would most definitely agree. I would say to my colleagues
on both sides of the aisle that if we don't have Social Security reform and real Social Security reform, there are not going to be any
surpluses. I think that we can certainly project that. I am not going
to ask you to comment on that or try to draw you into that.
I asked you about the trade deficit, the $21.3 billion record trade
deficit. Is that sustainable? What are the ramifications? We have
got a strong dollar right now. Can that continue?
Mr. GREENSPAN. The issue of what has the broader definition,
namely the current account deficit which is essentially what we
borrow from abroad, or what is invested from abroad, which is the
other side of that, is becoming an increasingly larger proportion of
the GDP.
We have obviously asked ourselves how long could that be sustained without inducing imbalances to the structure of our economy. One of the reasons for it is the fact that we have a far higher
sensitivity to import goods; namely, that the relationship between
imports and domestic income is far more sensitive in the United
States than it is abroad. What that means is that if you have a
generally flat world economy, the United States would continue to
import more and create a larger deficit, offset by larger surpluses
abroad.
In other words, our elasticity to import is out of whack. If you
put that into a computer indefinitely and if you project indefinitely
into the future, you get very large numbers.
Nonetheless, what we see is the fact that in the current environment, as I point out in my prepared remarks, a goodly part of the
opening up of the current account deficit is apparently being driven
by the high rates of return on new facilities in the United States,
largely high-tech type facilities, which has attracted capital to the
United States, kept the dollar strong—which is one way that you
know this is in fact what is happening. And the result of that, effectively—because capital is being moved into the United States—
is that it necessitates that the current account deficit, meaning the
difference between exports of goods and services on the one hand
and imports of goods and services, widens; meaning a higher proportion of imports relative to exports.
Theoretically, that obviously cannot go on indefinitely. Something
has got to give somewhere. And where it apparently will give at
some point in the future is a lesser inclination to hold dollar claims
on the United States. At the moment, there is almost no evidence
that that is the case. Indeed, it is the other way around. So the
first sign that we may be in some difficulty would be a disinclination on the part of foreigners to continue to purchase dollar-denominated assets in the quantity in which they are, on net balance.
Mr. BACHUS. I have handed you a chart showing the raw industrial cost and they basically are flat through about October of 1997.
Then there is a steep decline through March of 1999. Then we see
a flattening out again. I think what the flattening out shows is that




17

we are not—you are not—it is not having an influence one way or
the other. But how significant
Mr. GREENSPAN. Well, we have looked at these data in some detail. We obviously find them useful but, strangely, in ways different
from the ways that most people would think. Because we are becoming increasingly high tech—an economy which is more conceptual than physical—the impact of commodity prices on the general
price level is overwhelmed by the high-tech price effects. As has
been mentioned on many occasions before this committee, the
prices of computers, software, and telecommunications equipment
are all going down as we move toward this outer edge of technology.
I find the raw industrial component of the Commodity Research
Bureau (CRB) futures index, which is what we measured here, actually is a pretty good measure of what industrial activity is likely
to do. You are talking about, I presume, what is happening to steel
scrap, copper wire bar—not so much wire anymore, but copper, aluminum—these are all highly sensitive industrial commodities
which tend to fluctuate far more than general industrial production. These prices tend to reflect the order intake that is going on,
which in turn is not a bad measure of what activity is.
So as we go to a more impalpable economy, things far less physical than they were 50 years ago, the actual impact of industrial
commodities on the general price level diminishes, but they are
nonetheless fairly important indicators to tell us what is going on
in still a very significant part of our economy; namely, basic industrial activity.
Chairman LEACH. Thank you.
Mr. Frank.
Mr. FRANK. Preliminarily, Mr. Chairman, I was interested in
your comment in response to Ms. Waters' comment of the proclivity
of Democrats to increase spending. And I was particularly interested in how that would fit with your strong plea for increased agricultural spending. So I don't know whether that passage is some
further switch, although I guess it does reflect the view that to
many of my conservative friends, agricultural spending is somehow
exempt from Government spending.
On that point, I was very pleased to see Mr. Greenspan repeat
a point that he has made before on page 3—page 5 rather—where
he notes that the decline in military spending worldwide has freed
up resources for more productive endeavors. We have a mistaken
view around here that military spending somehow has, as a partial
justification, the effect of stimulating the economy. It is important
if you need it for defense, but as Mr. Greenspan has noted on several occasions, it is a negative rather than a positive, everything
else being equal in terms of the economy.
Chairman LEACH. If the gentleman would yield, this gentleman
acknowledges sin, but he does believe that it is rooted in Biblical
aphorisms; that is, that we want to move from swords into plow
shares spending.
Mr. FRANK. Are you going to put that up on the wall, too, like
you voted to put everything else up on the wall in the Bible?
The question is, though, about preemption. I find much of the
statement is very admirable and I appreciate you talking about the




18

social importance of bringing people into the economy. You have
been on the periphery, and I appreciate your acknowledgment that
preemption is a two-way street, as you did I think when we had
the international crisis in 1997 when you raised interest rates to
preempt depression or recession.
But I have a question about preemption. The tone of the statement, the tone of much of what the Federal Reserve has said, is
to acknowledge that there are no present indicators of inflation and
no indicators that it is coming. The argument for preemption is,
and I understand it, that a little now would be better than a lot
later. But it assumes in part—and this has all been part of the argument for preemption—that inflation was a particularly infectious
problem in the economy. The argument for preemption has often
been that once inflation begins, it is too late to try to stop it, that
you must in effect preempt it because it travels so fast.
The point I would make is this. In your statement you have a
couple of arguments which I think note that is no longer as much
the case. For example, on page 5, "The consequent erosion of pricing power has imparted an important imperative to hold down
costs."
On page 2, "The good inflation performance reinforced by fallen
import prices has fostered further declines in inflation expectations
over recent years."
There have been, as you noted, structural changes in the economy over and above technological change: deregulation; removal of
oligopoly and semi-monopoly. My point would be this. Isn't it the
case that many of the same factors that have reduced inflation, in
fact, also not destroy, but lessen the infectiousness of inflation? In
other words, the diminution of inflation is in part a diminution of
inflationary expectations of reactions built into the economy, and it
does seem to me that that weakens somewhat one of the arguments for preemption which was, oh, my God it is too late, you
can't be a little bit inflationary, and so forth.
So to what extent do the factors that have changed the economy,
that have helped reduce inflation, also alter one of the arguments
that says do you really have to pounce on it like a hawk? Which
I must say I think applies to some of the other members of the
FOMC rather than to yourself.
Mr. GREENSPAN. Well, Congressman, it is not at all clear the extent to which the degree of infection was as virulent as a lot of us
thought it was indeed in the past. It is an open question. The issue
of preemption, as I point out in my remarksMr. FRANK. To clarify, Mr. Greenspan, if I could on that point,
what you are acknowledging, it seems to me, is that it is less virulent than people thought it used to be. Whether they are correct
in thinking that or not, we can debate. But clearly it is not now
as virulent as people thought it used to be.
Mr. GREENSPAN. Yes. And it is also the case that the issue of
being preemptive is something which, by definition, we really ought
to be if we can. I mean, the alternative is to say we perceive things
occurring and we won't do anything about it. So it is an issue of
the capacity to perceive that something may be emerging and decide whether something is desirable to do.




19

Mr. FRANK. I understand. But the preemption, the more preemptive you get, the less reality you need to trigger the preemption. I
think I understand that reality is one of the more important factors, given the negative factors that preemption can have.
Mr. GREENSPAN. Most of the time we can't be preemptive because, as I point out in my remarks, the future is opaque. It is very
difficult to forecast successfully. We do not believe that it is appropriate for us to act until we have a reasonable conviction that certain imbalances will arise.
Mr. FRANK. I appreciate that very much. I think preemption has
been somewhat overrated. One other question which you may not
want to answer, or convey in writing if we run out of time. You
talk about the trend in the economy. For instance, page 11, "Mechanisms are in place that should help to slow the growth of spending and will pace more consistent with that of potential output
growth." And you acknowledge that our capacity for growth appears to be greater than it was. There has been an increase. You
talk here that you expect the growth rate of real GDP to be between 3V2 and 394 percent. What is it? What is the potential output growth rate of the economy? At what rate can we grow without
giving you agita?
Mr. GREENSPAN. I will answer the question in a very unusual
way.
Mr. FRANK. Like, directly?
Mr. GREENSPAN. That would give you a heart attack.
Mr. FRANK. It would, it would.
Mr. GREENSPAN. We cannot tell at any particular point in time
what the actual potential is, because it is a very difficult thing to
measure. But it shouldn't be our concern. Our concern should be
the imbalances that emerge, not an issue of a judgment as to what
a fixed rate of growth is and, beyond that, problems of imbalances.
Mr. FRANK. That is very important. I appreciate that. I must say
I was under a misapprehension, I think maybe others were, and I
appreciate the indulgence, briefly, Mr. Chairman, because I do
think that many had thought—some of the financial writers talk
about a number. You speak 2 and 2V2 percent. It is now 3 percent.
What you are saying is that the number is actually irrelevant in
the sense that the number is the product of these forces and you
wouldn't get the forces. So that people should not get too concerned
if it is 3, 3V2, or 4.
Mr. GREENSPAN. I don't. Other people do.
Mr. FRANK. If you don't, a lot of people don't. Thank you.
Chairman LEACH. Mr. Castle.
Mr. CASTLE. Thank you, Mr. Chairman, and thank you, Chairman Greenspan. Unfortunately, I have been over in the Intelligence Committee and haven't heard all of what you have said. I
want to talk about an important matter on the House floor today
that we are going to be dealing with shortly and that is obviously
of tremendous interest to you, of overwhelming interest to the
United States of America, and that is the tax cut package of $792
billion.
First, my understanding from all you have said here today and
you have always said in the past is that you believe that debt retirement is probably the best thing that we could do; and if not




20

that, perhaps the thing that could really get us in trouble from
your perspective is to spend it all. That is a generalization, but I
want to know what your thoughts are about the specifics of a tax
cut of that magnitude. I am not interested in the individual subject
matters therein. One could kick that in terms of who benefits and
who does not.
But this is a tax cut of significant proportions and I am sure
that—or I would hope, because it is both in the House and the Senate the same number—that you and your folks have spent some
time analyzing not only—how you predict ten years, I don't know,
but not only projecting what is happening over the next ten years,
but even the out ten years. I would be interested in your views on
that.
Mr. GREENSPAN. As I indicated earlier, it is very difficult to
project with any degree of conviction when you get out beyond
twelve or eighteen months. As a consequence, if you try to simulate
what is going on out there, you need to answer an awful lot of
questions which we don't have the answers to.
For example, as I indicated in my prepared remarks, the rate of
productivity growth has been increasing; that is, the rate of growth
itself has been rising. The normal projections that we make with
respect to what the economy will be doing in the longer run requires that we have a very firm judgment on what the long-term
productivity growth is.
I would submit at the moment we don't have that good judgment,
so that the potential, if you want to put it that way, of what the
economy is doing and therefore what the impact of a specific type
of cut in taxes will do is not easy to judge.
As I said earlier, I think that we would be well-advised to be prepared in the event of the next weakening of the economy—which
as I indicated is bound to occur. I don't know when it is. I hope
it is extended out very significantly into the future. But there will
come a time. And because of the fact that we have seen such a remarkable expansion in the surplus and a reduction in the debt,
which is a very positive effect as a consequence, I can very readily
see that we will get out to a period where the debt has been reduced very significantly—indeed, according to some of the projections to zero—and at that point I would think that all of the surplus would be going to tax reduction.
Mr. CASTLE. Let me be specific on this. I don't know if you agree
with CBO or have looked at CBO's estimates that we are going to
have an on-budget surplus of $996 billion over the next ten years
or not, but I would like to know, if you have and if you have, if
you agree with our estimates.
That involves two things. It involves not only revenue projections
but predicting the behavior of Congress in terms of spending habits. If that is the case, are we safe in allocating 80 percent of that
now for tax reductions, or is that a step too far at this point? Or
what are your views
Mr. GREENSPAN. Congressman, I don't want to get into the specific details of any of the bills up there, but I will say the following:
that we do know a significant amount of the revenue projections
presuppose what I was mentioning before, namely, the so-called
technical adjustment. The technical adjustment, as I indicated ear-




21
her, is a euphemism for our lack of understanding of the relationship between what is going on in the economy generally and what
happens to tax receipts.
There are very complex reasons for that degree of uncertainty.
We can make usual adjustments on average, and what has happened to those usual adjustments in the last four or five years is
that they have been wrong. Very significantly wrong.
If you go back and look at the long-term projections of the budget
deficit four or five years ago, it looks remarkably unlike what is actually happening. And so I think we have to understand if you are
dealing with a level of outlays and receipts approaching $2 trillion,
very small changes in your estimate on either side of those come
together and they can create a very significant deficit. As a consequence, our ability to project is weakened.
That is the reason why I have argued that we ought to allow the
surplus to run the debt down. Remember, if we reduce the debt, for
every dollar we reduce it we are increasing the capacity to borrow
it back by one dollar. So you always have the capability of, if need
be, letting the surplus run, run down the debt to the public, and
then if we decide at some later date that there is some structural
positive force there, we can borrow all of that back and cut taxes
with it if we so choose. So it is not an issue that that decision has
to be made immediately.
There is nothing that I can see that would be lost by allowing
the process to delay unless, as I have indicated many times, it appears that the surplus is going to become a lightning rod for major
increases in outlays. That is the worst of all possible worlds from
a fiscal policy point of view and that, under all conditions, should
be avoided.
I have great sympathy for those who wish to cut taxes now to
preempt that process, and indeed if it turns out that they are right,
then I would say moving on the tax front makes a good deal of
sense to me. I hope that that is not true. In any event, I think that
we can wait a short while to make a judgment whether it is true.
Mr. CASTLE. Thank you, Mr. Chairman. I yield back, Mr. Chairman.
Chairman LEACH. Thank you very much.
Mr. Kanjorski.
Mr. KANJORSKI. Thank you, Mr. Chairman.
Mr. Greenspan, I am starting to suffer from a problem of thinking that, rather than being in the House of Representatives, I am
in the House of Orwell. Some thirteen months ago the House of
Representatives passed a resolution to terminate the tax code by
219-to-9. I suspect that vote was rather along party lines. Today we
are about to add 500 pages to that tax code.
It seems to me that all hope of simplification has now disappeared. While we are on this tremendous march to hand out the
benefits of the surplus that none of us is certain is going to occur
over the next ten years, we cannot spend the time to solve the
problems of Social Security, Medicare, defense spending, and other
programs that seem to have had a high priority prior to this time.
Just last week I had occasion to travel across America with the
President. I visited places like the Mississippi Delta, where 44 percent of the people do not even continue on past high school and all




22

suffer from relatively high unemployment and very low income. I
visited areas of Kentucky, where the income borders just a little
above the minimum wage and they are obviously not sharing in the
prosperity that presently exists in America. I visited the Indian
tribe country of South Dakota where 75 percent of the adult population is unemployed.
Then I had occasion to witness some inner-city Hispanic communities, newly-arrived in this country, and becoming part of the
American opportunity, as it were. Finally, I visited youths who, a
few years ago, were in gangs and are now studying computer technology, helping to design automobiles and doing things that are
really, surprisingly, pleasurably, shocking.
However, we have been focused on this theme today of tax cuts,
and I go back to what I said about the House of Orwell. One day
we were for devolution. Then I go out and I find Mississippi, the
50th-ranked State in education, and very poor. Here we can test
this methodology and determine how is is being used on the State
level to help things out. We have this dry run on the national level
to get out of education, to get out of these responsibilities and turn
them back to the States. But yet we have these bad problems,
these serious devolution problems.
I know in the past you have expressed dissatisfaction with the
ongoing shift of income distribution toward the very highest earners. As you know, two-thirds of the benefits of this tax bill on the
floor today go to the top 10 percent of earners in this country, those
people earning over $115,000. It hardly promotes what you would
call a shift in the distribution of income to solve the imbalances
that obviously have been exacerbated by the prosperity of the last
few years.
How is monetary policy, under the present conditions, affecting
this trend and what might be done to address the shift in the future? More specifically, would the President's plan to promote economic growth in our underserved areas, harnessing the power of
the private sector's capital markets, help us to achieve the goal of
evening the income distribution across all wage earners? Can you
express your opinion on that?
Mr. GREENSPAN. Congressman, first of all, let me say that the
shift toward concentration of income, which has been quite pronounced from the early periods of the expansion, is now at least
flattening out. In other words, it is not progressing in the last couple of years, largely as a consequence of a significant number—as
I indicated in my prepared remarks—of people, for example, with
less than a high school education moving into the work force, learning skills, and getting up on the first step of the ladder to economic
capability.
The basic problem that I am concerned about, as you mentioned,
is that we should be moving to a society where the broad segment
of society believes that the distribution of rewards are fair. And the
issue of fairness is a very subjective issue, but I think that it really
means that people earn what they get. And what is good about our
society is that it has never, as best I can judge, been envious of
those who make huge amounts of income, because they have
earned them. There is always concern about the unearned income,
and I think that is a very legitimate issue.




23

I can't comment very specifically on the President's program, because I am not sufficiently knowledgeable about the specific detail.
But as I mentioned to your colleague to your right many times in
the past, I believe that we should be very proactive in endeavoring
to find means to get equity into those areas of our society where
the level of productiveness—the level of employment is low and the
amount of capital investment is subnormal. And in my judgment,
the way to come at this is to try to create the same forces of economic incentives which have done so much to the vast proportion
of our economy and apply it to the inner cities and apply it to those
areas of our economy which are falling far short, which is what I
hope most would like to see.
Chairman LEACH. Thank you, Mr. Kanjorski.
Mr. Royee.
Mr. ROYCE. Thank you, Mr. Chairman.
Chairman Greenspan, the first question that I would ask you is,
some of the Asian countries that were in crisis seem to be recovering, others not so well. What is your assessment of the region's
economies and what, if anything, we should be doing to promote
Asia's economic recovery?
Second, I am well aware of your views on capital gains tax relief,
but for those who haven't heard it, could you tell us your views on
capital gains taxes and what the effective rate should be?
Lastly, high taxes do cause distortions in the economy. What we
will probably end up with here, in terms of the Congress, the vote
in the Congress, is something that sets aside two-thirds of the surplus for Social Security and Medicare and the other one-third for
tax relief. But probably we will tie that to some type of tax trigger
where, if the surplus continues to grow, one-third would be for tax
relief.
The question I have is, if it comes down to the two different
choices, the Archer plan or the Roth plan, they both address distortions in the economy, but the Archer plan addresses higher marginal rates and that reduces incentives to work and reduces the return on savings and thus reduces economic growth. The Roth plan,
on the other hand, reduces the distortion in savings and capital formation by creating the tax free savings accounts and allows individuals to receive the full pretax return, and this causes the creation of additional capital and increases productivity and increases
real wages. So we have got a choice here between the 401(k) plans
and the IRAs and the Roth plan, to go from 15 to 14 percent, versus the Archer plan that has the 10 percent rate on the lower capital gains and the reduction of the inheritance tax over time.
Which of those—in terms of distortions in the economy, which of
those would be preferable if we do come up to making a choice between them?
Thank you, Mr. Chairman.
Mr. GREENSPAN. Congressman, with respect to your question on
Asia, I think that the evidence does indicate that there has been
significant recovery in some of the countries. Certainly in South
Korea there has been fairly dramatic increase in both industrial
production and gross domestic product. The other areas of East
Asia are also recovering somewhat slightly less so than South
Korea.




24

In all cases, there is considerable concern, however, that that
very fact is probably lessening the intensity of the willingness to
create the types of reforms that they are going to need in those
economies to prosper in the years ahead. And I am fairly well convinced that the economic policymakers within those governments
are acutely aware of that problem and are concerned about it. One
can only hope that the areas where progress has been most significant, namely where they have opened up their economies and done
the types of things which in the long term are very productive, they
will continue to do so.
With respect to the capital gains taxes, I have said here before
that I think the capital gains tax is a very poor tax to raise revenue. I think it inhibits capital allocation and capital productivity;
and as a consequence, if it is a bad tax, the obvious rate should
be zero. That is where I come out.
On the issue of the choices of the various different types of tax
cuts, I don't wish to characterize the plans of either of the two people who are both good friends of mine for a long period of time. I
will merely repeat what I have said in the past, namely, I very
strongly favor that tax cuts be directed at marginal tax rates and
at capital gains tases, largely because I think to enhance economic
growth and maintain the type of viability that we have seen in this
economy in recent years, we should be focusing on incentives and
incentives largely are reflected in their impacts at the margin.
Mr. ROYCE, Thank you, Mr. Chairman.
Chairman LEACH. Thank you, Mr. Royce.
Ms. Waters.
Ms. WATERS. Thank you very much.
Mr. Greenspan, Mr. Kanjorski and others have talked with you,
raised questions about the intractable problems of the inner cities
and areas where the economy is not performing in the glorious
ways that you have described overall—about the overall economy.
And this problem persists. You mentioned that there was a flattening out of the gap, or the haves and have-nots. But my latest information shows that the richest 1 percent of Americans now control
40.1 percent of America's wealth, and that is double the 19.9 percent of wealth the top 1 percent held in 1976, -I believe it is, or
1996. So it does not appear that there is a flattening out, and if
that is not correct, please correct me.
Second, when you talk about maximum sustainable growth, is
there anything that prevents against a discussion about a surplus
being used for the poorest of our society in some ways? For example, there are people that come with capital formation plans that
talk about Government providing capital, not giving it, but providing capital that would be used for loans and investments to entrepreneurs and business persons who cannot get capital from our traditional institutions, and the Government being paid back because
there is a strong belief that this capital can be invested in ways
that can reap profits and the money can be paid back. But there
is never any discussion.
Of course, we discuss the debt and why it is important, perhaps,
to have the surplus pay down the debt. But can you discuss any
positives relative to surpluses being used for investment in these
communities that were described on this tour by Mr. Kanjorski in




25

ways that can help fuel—that would be helpful to the economy? I
never hear that kind of discussion, as you talk about what it takes
for maximum sustainable growth. I would like to know if you can
entertain some discussion in that area.
Second, Mr. Frank alluded to some comments or discussion about
the agricultural community and investment, I suppose, of dollars
that would go into the agricultural community. We have seen historically that Government dollars spent in the agricultural community have grown the ability of fanners to produce wealth in this
country, whether it was the old electrification or investment in infrastructure that would support agriculture. It appears to have
been very, very productive in this country in the same communities
where we are talking about a lack of capital, a lack of investment.
I know your response about what equity investment can do.
Aside from that, can you also discuss what perhaps it could mean
for investment to close the digital divide and the computer gap, so
that we don't continue to have these communities fall further and
further behind. It appears that unless these communities are
wired, unless they can build what is referred to as backbone or
have portals, and so forth, that again this new technology is going
to elude these communities and create more poverty.
So I would like to hear some discussion about Government investment in capital formation, moneys that will be paid back, can
be paid back with interest; but the capital is not available in these
traditional institutions, so it has got to come from somewhere. And
while we allude to what good equity investment can do, it is just
not forthcoming. They who have it don't do it.
Can Government play any role in that?
Mr. GREENSPAN. Well, Congresswoman, let me say first, there is
no question that in the agricultural area there has been a very dramatic increase indeed. Productivity growth in agriculture far exceeds the rate of growth in the rest of the economy. It is a very
questionable proposition, however, in my judgment, that that has
been the consequence of Government programs. I don't think so.
A substantial part of what has been going on there is the result
of many technologies which have occurred outside of agriculture
and happen to apply in the agricultural area—biotech, electronic,
and computer-type of technologies.
I do think the same type of focus in the inner cities is an appropriate issue. My own priorities are twofold. I think, one, you cannot
have a dramatically extended type of high-tech capital stock without the people there who know how to use it and can function with
that technology. So in my judgment, the crucial issue is education,
to get people to know how to use and apply these things. I don't
think it automatically happens if you put a computer in front of
somebody that they learn how to use it. That is effectively a presumption which, in my judgment, doesn't work, and I have had
considerable unfortunate experiences in that regard.
We have to build up basic learning skills in math, in all numerical types of professions, to enable people to address this new hightech reality. If you cannot do that, if you cannot get the people to
do that, if you cannot get the resources to do that, it is going to
be hard to get the investment in those particular areas.




26

I am not very sanguine about Government finding a way to create investment which somehow the private sector does not perceive
to be desirable and end up with some new, great, higher standard
of living. All of our experience, regrettably, with Government investment where private sector does not wish to go, both in the
United States and, I might add, elsewhere, has been, in my judgment, most ineffective.
What we have got to keep focusing on is the issue of getting private investment in our inner cities. I will reemphasize, it has got
to be largely equity investment. There is too much debt being engendered and subsidized in our inner cities and in our lower-income communities. We have got to create incentives, because it is
only in that way, I am convinced, that we can move these economies up to a viable level which gets them into the mainstream of
the American economy.
It is a crucial priority, I think it is very important that that be
done. Unless all Americans perceive that our society works, I don't
think that we can look forward to having a functioning system the
way that we would want it to be.
So, I fully agree with your purposes. I don't think that endeavoring to try to get Government programs to do it will succeed. We
have done that time and time again in the past, and I think we
have failed in doing so. And I think that we have to try to do something different, because we cannot take continuing failure time and
time again without creating huge levels of discouragement among
people. That would be terribly destabilizing to our society.
Ms. WATERS. Mr. Chairman, I wish I had more time to really engage Mr. Greenspan in some of the comments that he just made.
I don't have that time. I hope that I will have time to get with him
to talk about subsidies, irrigation, sponsored activities by Government, electrification, SBICs that have fueled MCI and others, because it is all Federal. It is all Federal.
And beyond that, certainly education is extremely important, and
we have got to push and fight for it. But I want to tell you about
young folks graduating from high school in Silicon Valley, who are
making $70,000 and $80,000 a year the first year, not because they
are not capable of doing so, but simply because the investment was
there and the opportunities were there. Now is not the time, I don't
have the time, but I certainly want to talk to you about that.
Mr. GREENSPAN. I would be most interested in discussing that
with you.
Chairman LEACH. The Chair would simply note the gentleladys
contributions to this committee have been extraordinary, and I
would hope that the staff, in particular, would be willing to come
up and speak at any time with the lady.
Dr. Paul.
Dr. PAUL. Thank you, Mr. Chairman. I appreciate this opportunity.
First, I would like to say that I hope the Humphrey-Hawkins requirement continues; I think that is important. I do also note that
frequently at these hearings we don't talk much about monetary
policy, which is the purpose of the meeting. We frequently talk
about taxes and welfare spending.




27

I would like to concentrate more on the monetary policy and the
value of the dollar. There are some economists who in the past,
such as Mises, von Hayek, as well as Friedman have emphasized
that inflation is a monetary phenomenon and not a CPI phenomenon, it is not a labor cost phenomenon. When we incessantly talk
about this, whether it is the Federal Reserve, the Treasury, Congress, or the financial markets, we really distract from the source
of the problem and the nature of our business cycle.
I certainly agree that technology has given us a free ride and has
allowed us this leverage, but we have also been permitted a lot of
inflation, that is, the increase in the supply of money and credit.
Since 1987, we have had a tremendous increase in money. The
monetary base has doubled; M3 has gone up $2.5 trillion. This
money has gone into the economy, but we have reassured ourselves
that the CPI has been stable so therefore everything is OK. Yet the
CPI has gone up 44 percent since 1987.
Real growth in the GDP has not been tremendous. It is about 2.3
per year. But we have had a tremendous increase in capitalization
of our stock market going from $3.5 trillion up to $14 trillion. That
is where the money is going. This generates revenues to the Government. This has helped us with our budgetary problems.
At the same time, we ignore the fact that hard money people emphasize that not everybody benefits, and there has been a lot of
concern expressed that people are left behind, farmers are left behind, the marginal workers are left behind. Some people suffer
more from a higher CPI than others. These are all monetary phenomena that we tend to ignore.
But you have admitted here today and in the past that the business cycle is alive and well and that we shouldn't ignore it—in your
opening statement, you said that we should be especially alert to
inflation risks. I think that we certainly should be. And you have
expressed concern today and at other times about the current account deficit, and this is getting worse, not better. Our trade balances are off. But I would suggest maybe we have seen some early
signs of serious problems because foreign central bank holdings
now of our dollars have dwindled to a slight degree. In 1997, they
were holding over $650 billion and they are slightly below $600 billion. At the same time, we have seen the income from our investments dwindle to a negative since 1997. So I think the problems
are certainly there.
But I would like to talk a little bit more about, or ask you a question about, this balance of trade and the value of the dollar, because history shows that these dollars eventually will come back.
And you have assumed that, that they will, but that essentially the
problem that we got into in 1979 and 1980, there is no guarantee
that that won't happen again. That means that the markets will
drive interest rates up, we will have domestic inflation, the value
of the dollar will go down.
My question is, what will your monetary policy be under the circumstances? In 1979 and 1980, you were—not you, but the Fed—
was forced to take interest rates as high as 21 percent to save the
dollar. My suggestion is, it is not so much that we should anticipate a problem, but the problem is already created by all of the inflation in the past twelve years and that we have generated this




28

financial bubble worldwide and we have to anticipate that. When
this comes back, we are going to have a big problem. We will have
to deal with it.
My big question is, why would you want to stay around for this?
It seems like I would get out while the getting is good.
Mr. GREENSPAN. Dr. Paul, you are raising an issue which a significant number of people have been raising over the years and for
which, frankly, we are not quite sure what the answers are. It is
by no means clear, for example, that one can trace the increase in
money supply, which presumably has not reflected itself in CPI,
into stock values. A lot of people say it is happening and a lot of
people assume that is what it is, but the evidence is not clear by
any means.
Dr. PAUL. May I interrupt, please? Did you not write that that
was the case with the 1920's and that was the problem that led to
our Depression?
Mr. GREENSPAN. No, I didn't raise the issue that it was in effect
the money supply, per se. What I was arguing many, many years
ago, and I still think, is that in 1927 involving ourselves with an
endeavor to balance the flow of gold in favor of Britain at that
time, we did create a degree of monetary ease which was one of the
possible creators of speculation in the market in 1928 and 1929.
What is not evident in today's environment is anything like that
is going on.
We cannot trace money supply to a speculative bubble. If a bubble, in fact, turns out to be the case, after the fact, we will have
a considerable amount of evaluation of where it came from. But as
I have said before this committee and, indeed, before the Congress
on numerous occasions, we are uncertain as to the extent to which
there is a bubble because, as I said in my prepared remarks, to
presume there is a bubble of significant proportions at this particular stage and that the bubble isn't significant doesn't have any
meaning; we have to be saying that we know far more than the
millions of very sophisticated investors in the markets. And I have
always been very reluctant to conclude that.
We do know that a significant part of the rise in prices reflects
rising expected earnings, and a goodly part of that is a very major
change in the view of where productivity is going. What we do not
know is whether it is being overdone or to what extent it is being
overdone.
I have always said I suspect it is, but firm, hard evidence in this
area is very difficult to come by. It is easy to get concerned about
it on the basis of all sorts of historical analogies, but when you get
to the hard evidence, we do know that inflation is a monetary phenomenon, but what we have a very great difficulty in knowing is
how to measure what that money is.
Remember, M2, Ml, all of that are proxies for the money that
people are talking about when they are referring to money being
the creator of inflation. We have had great difficulty in filtering out
of our database a set of relationships which we can call true
money. It is not MZM, that is, money with zero maturity, it is not
M2, it is not Ml, it is not M3, because none of those work in a way
which would essentially describe what basically Hayek and Fried-




29

man and others have been arguing, and I think quite correctly, on
this issue.
[The prepared statement of Hon. Ron Paul can be found on page
47 in the appendix.]
Chairman LEACH. Thank you very much, Dr. Paul.
Mr. Sanders.
Mr. SANDERS. Thank you, Mr. Chairman.
It is nice to see you again, Mr. Greenspan. I have just a few
questions that I would like to ask, Mr. Greenspan.
In 1973, the average American worker earned $502 a week. In
1998—with a good increase, I should add, over 1997—the average
weekly income was $442, 12 percent less than in 1973. So if the
average worker is earning 12 percent less in 1998 compared to
1973, if the typical married couple is now working 247 hours more
in 1996 than in 1989—we have seen people all over this country
working two or three jobs, and so forth—I don't quite understand;
maybe I live in a different world than my colleagues—how the
economy is booming. That is question number one.
Number two, we talked a little bit about the distribution of
wealth. The wealthiest 1 percent of our population now owns more
wealth than the bottom 95 percent. One man, as I understand it,
owns more wealth than the bottom 40 percent of our population.
CEOs now earn over 400 times more money than do their workers;
and we continue to have, by far, the most unequal distribution of
wealth in the entire world, proliferation of millionaires, and 22 percent of our children living in poverty. Please be as direct as you can
in a moment: How do we address this growing inequality of wealth
and income in this country?
Third, you made a statement a moment ago that income distribution was leveling out. I have in front of me a recent CBO report
that just came out last week. What it says is that between 1991
and 1999 the top 1 percent of family income went from 12 percent
to 15 percent, a very significant increase, whereas every other
quintile—lower second, middle fourth—sort of declined in their percentage of income.
Mr. Chairman, I would like to submit that chart to the record.
It seems that income distribution in this country is not leveling
out, but the rich are continuing to gain more and more.
[The information can be found on page 96 in the appendix.]
The other question that I have is, a couple of years ago you and
I dialogued, and I know you were public upon this, about your
views on the minimum wage. You and some other people argued
that if we raise the minimum wage from $4.25 an hour to $5,15,
there would be more unemployment and more inflation. But the
fact of the matter is, unemployment is lower than it has been in
many years. There is virtually no inflation.
Is it still your view that we should not raise the minimum wage
so that our lowest-wage workers can escape from poverty?
You, a moment ago, I think reiterated your views on capital
gains tax cuts. It seems to me that the evidence is pretty clear,
however, that capital gains tax cuts primarily benefit the wealthiest Americans. According to an analysis by Citizens for Tax Justice, the wealthiest 10 percent of all Americans would enjoy more
than 90 percent of the capital gains tax cuts in the House tax bill




30

which is before us today. If we are honestly concerned about addressing the growing gap between the rich and the poor, why
would we give upper-income people the lion's share of tax cuts?
The bottom line of my questioning, Mr. Greenspan, is, I do not
agree with my friends here. I do not agree with what I see on television every day, that the economy is booming for the middle class
and the working families of this country. I think people are
stressed out. They are working incredibly long hours. In many instances, they are working for lower real wages than was the case
before. I think that we have an obscenely unfair distribution of
wealth in this country where so few have so much and so many
have no health care, having a hard time sending their kids to college.
These are a few of the points that I would very much appreciate
your speaking about.
Mr. GREENSPAN. Congressman, let me come at this seriatim.
First of all, the numbers that you are using on decline in the average worker's income, I believe come from a faulty set of data that
are being published by the BLS in that if you look at real per capita income, you indeed find there is significant growth and that
this is a statistical problem, which we nave been struggling with
for a while, as to what to do with that set of data.
Second, on the CBO numbers, I was referring to the last two
years. The numbers you were referring to, or the CBO was referring to, were the last eight years. Indeed, from 1991 to 1997, I suspect that that is correct. It has not been correct in the last couple
of years where the increased concentration, as best I can judge, has
not been occurring. It has stabilized and may even flatten out.
We do not yet have detailed data for this year, and as a consequence, it can only be a conjecture. I merely reflected the fact in
looking at, as I indicated earlier, the unemployment rate of those
who tend to be in the lower income groups, that my impression is
that when those data come out, you will find in the last couple of
years that the economy has had an extraordinarily positive effect
in this direction.
On the issue of wealth and the like, let me just say that a crucial
question I think you have to answer is whether or not if somebody
gets wealthy, it is at your expense. This is not a zero sum game.
What we have seen is a very dramatic increase in overall wealth
in the United States, and while I do not deny that there are very
major holdings of wealth by individuals, it is by no means clear to
me that these have in any way been extracted from other people
in the society. They are the consequence of new ideas, new wealth
creation, and have been fundamental factors in pulling the whole
economy up. I would in no way consider that that is a negative
force in a free society that we experience and, I hope, enjoy.
On the issue of the minimum wage, I still hold to what I said
previously. I never argued, nor would I, that in a period of strong
pressures in the labor market, which is indeed what we have been
seeing recently, that you find any result from the minimum wage
on the issue of employment. Indeed, I think that it is very unlikely
when these labor markets are as tight as they are, that the minimum wage has a significant effect in preventing people from getting on the lower ends of the economic ladder to get a job.




31

My concern is that when the labor markets begin to weaken,
those people who are not allowed by law to accept a wage beneath
a certain number can find no job. As a consequence, they do not
get on the first rung of the ladder, cannot achieve job skills, cannot
achieve the self-esteem that is necessary to move up the ladder.
I do not perceive that the minimum wage is something which is
a benevolent force for people in the lower part of our income
groups. I frankly think that it is something that deprives them of
gaining what they should be obtaining by right, and I do not consider the minimum wage as a positive force in our society. I think
it is precisely counterproductive to what you suggest it is trying to
do.
Mr, SANDERS. I certainly wish we had the time to engage in a
dialogue on this, because I think that you are wrong in many instances. I would just simply say, Mr. Chairman, that I think there
is something profoundly wrong when we read in the papers—last
week in The 'Washington Post, some 40,000 kids in this city, in the
District of Columbia, go hungry—and at the same time, we have
a proliferation of millionaires and billionaires. And there are those
who want to cut back on taxes for the richest people and, therefore,
cut back on programs like nutrition programs. I think that is
wrong and fundamentally flawed.
Chairman LEACH. Mr. McCollum.
Mr. McCOLLUM. Thank you, Mr. Chairman.
Chairman Greenspan, in a section of your testimony entitled
"Near-Term Outlook," the quotes are in here that the bank presidents and the governors expect the growth rate of real GDP to be
between 3.5 and 3.75 percent over the four quarters of 1999 and
2.5 to 3 percent in 2000. The unemployment rate is expected to remain in the range of the past eighteen months; we talk about the
unemployment rate remaining in that range for the next eighteen
months.
I assume in the context—I am asking if I am correct to assume
that the preceding statement about the GDP rate in 2000 that we
are talking about, the expected unemployment rate, to remain in
this past range is for the period of the next eighteen months. In
other words, your near-term outlook when we talk about the unemployment rate, you are talking about the anticipation of it remaining the same for the year 2000. In other words, we are looking
ahead eighteen months here in this portion of your testimony; is
that correct?
Mr. GREENSPAN. That is correct. That is a result of a poll of the
presidents and the governors as to what they view the outlook to
be from their point of view.
Mr. McCOLLUM. That is what I was getting at. I just wanted to
make sure that I had the timeframe you were looking at for all of
us. There is no mention of there being polls, so I am going to ask
your opinion on this, because I don't see it here as a polling part.
Is there any sign for this next eighteen months, on this nearterm outlook, of a slowdown in the rate of productivity in the economy, or is it expected, in your judgment, to continue, based on current signs for this period? I am not talking about the next eighteen
months, roughly the same.




32

Mr. GREENSPAN. We don't ask the individual presidents and governors for their forecast of productivity. I guess we could infer it
by looking at the relationship between their growth rate and their
unemployment rate and knowing that the labor force is growing at
a reasonable rate, but we haven't done that.
My presumption is that in all of the numbers there is a reasonably good growth in productivity, but I do not know nor can I infer
what the numbers implicit in their forecast would be.
Mr. McCOLLUM. I understand that, but I am just asking you personally now, do you see any sign in the slowing of the
Mr. GREENSPAN. I am sorry. I didn't catch that.
The answer is, I have not; in other words, the productivity
growth in the very latest data with which we are dealing shows no
evidence of which I am aware that suggests an imminent slowdown.
Mr. McCOLLUM. In the next paragraph of their outlook, it says,
for the nearest term, "Inflation, as measured by the fourth quarter
percent change in the Consumer Price Index, is expected to be 2.25
to 2.5 percent over the four quarters of this year. CPI increases
thus far in 1999 have been greater than average in 1998, but the
governors and bank presidents do not anticipate a further pickup
in inflation going forward." .
I assume this also is the context of the next eighteen months.
Mr. GREENSPAN. That is correct, yes.
Mr. McCOLLUM. It also goes on to say, "An abatement of the recent run-up in energy prices would contribute to such a pattern,
but policymakers' forecasts also reflect their determination to hold
the line on inflation through policy actions if necessary." But I assume, again going back to your perspective on this-—not theirs, because theirs is not obviously here for me to ask this of—that there
is no reason to anticipate that there is going to be a pickup of inflation going forward over the next eighteen months, whether there
are any policy changes or not. There is nothing out there right now
to anticipate inflation being picked up, is there, Mr. Chairman,
over the next eighteen months at this moment?
Mr. GREENSPAN. Well, as I have said many times, our ability to
forecast is really quite limited. What we can do and, hopefully, do
well, is try to evaluate what is currently going on in trying to infer
what that might imply about the future; and hopefully—I hope at
least—that our monetary policy reflects that. In other words, we
cannot know—nor can anybody precisely know—what the economy
is going to look like eighteen months from today. We don't need to
know that, provided we can be aware of what is currently developing and how it is likely to go. We are, of necessity, always dealing
with probabilities, and it is a judgment of cost-benefit analysis and
probabilities which govern our specific actions.
Mr. McCOLLUM. Mr. Chairman, I have been in these hearings
enough with you to know better than to ask, nor do I want to imply
that I am asking, any prediction about policy in terms of Federal
Reserve Board. But what I am wanting to tie down here, so I fully
understand this in the same context as I have asked the other
questions, is that over the next eighteen months—at the present
moment, as things stand today, not as they might change—is there
no reason to anticipate, based upon what I am seeing here, that the




33

and the bank presidents have said, to anticipate any ingovernors
ation picking up, whether there is any action taken or not.

Mr. GREENSPAN. Mr. McCollum, I have a problem with the question in the sense that there are always reasons to be concerned, if
you are a central banker, that inflation will be picking up. If we
become complacent and say there is really no reason, then I think
we could get ourselves in trouble. I certainly would hope that inflationary forces will remain submerged. I certainly would hope that
if we begin to see them emerge, we will take action to forestall
that.
Mr. McCOLLUM. I hope you do, too.
I don't want to quibble over words. My only point was this: At
this moment, this day, at this hour, there is no reason to anticipate
that, at this moment, based on what we see now. That is what you
are saying, that is what the Board of Governors
Mr. GREENSPAN. I am saying that the forecast that you are alluding to is the projection of the governors and the presidents. I don't
want to characterize that, Congressman.
Mr. McCOLLUM. I understand. I am not trying to quibble. I just
wanted to make sure that I put in that context that we are looking
at eighteen months.
Mr. GREENSPAN. Correct.
Mr. McCOLLUM. Thank you.

Chairman LEACH. Thank you, Mr. McCollum.

Mrs. Maloney.

Mrs. MALONEY. Thank you, Mr. Chairman, and welcome, Mr.
Greenspan. I am interested in the international effects of raising
the Federal funds rate. In the current issue of economic review of
the Federal Reserve Board of Atlanta, there is an article entitled
"Understanding Recent Crises in Emerging Markets." and in this
article, they place an emphasis on the rapid rise of the U.S. dollar
between 1995 and 1997 as a prominent cause of the Asian crisis
in 1997. I would like to quote, and I quote now, "Changes in the
value of the dollar had a direct effect on the economics at the center of the Asian crisis because all those countries were tying their
own exchange rates fairly closely to the dollar."
If the Fed continues to raise the Federal funds rate as it has recently done, how soon do you think there will be increased capital
inflows to the United States and increased demand for the United
States dollar and then increasing value for the United States dollar; and what effect will such a policy have on the economies in
Asia and South America, which are trying to recover?
Mr. GREENSPAN. Well, Congresswoman, if I understand you correctly, what you are saying is that because a number of countries
chose to lock their currencies into the dollar, but didn't take the
types of policies that would be required to maintain the type of discipline that would be necessary to tie into the dollar, the cause of
their problems is the Federal Reserve. It strikes me that if you try
to lock your currency into a hard currency, you have the obligation
to develop policies that are consistent with that. There is no way
of getting the advantages of a hard currency without taking the actions which a country which hosts the hard currency are taking.
I object to a view which stipulates that somehow we are responsible for those who wish to tie their currencies to ours, but not do




34

what is required to achieve the stability that is implicit in that. I
don't frankly think that is true. I think the characterization that
you imply in that or what
Mrs. MALONEY. As I said, I was quoting from the
Mr. GREENSPAN. All they are saying is, the exchange rate was
running against them. They had several choices. They could have
floated their exchange rate, they could have done many things, but
I object to that sort of analysis. I object largely because it presupposes that we are in charge of other people's policies; and we
shouldn't be.
We want to be as helpful as we can. Over the years we have tried
to create environments where we can be helpful where we can, but
I do not believe that the presumption that the central bank of the
United States is responsible for the rest of the world is an idea that
we should foster, because I am concerned that were we to do that,
we would become the central bank not for the United States, but
for the rest of the world.
I do not think that is proper for us, and I certainly do not think
it is proper for those with whom we deal in international financial
markets or in trade.
Mrs. MALONEY. So, finally, what part do these concerns, if any,
play in the current development of the Federal monetary policy?
Mr. GREENSPAN. Congresswoman, I have mentioned time and
time again that it is good economic sense for us to remember that
we are the central bank of the United States, that our focus has
got to be on the stability and viability of the American economy.
We are not without awareness of the impacts; one, that we have
on others or two, they have on us. And we endeavor in various
international fora to find comity among ourselves in integrating
policies, one government, one central bank, to another. But the bottom line has got to be that we cannot be the central bank for others. Our problems are difficult enough in the United States.
Mrs. MALONEY. So you don't look at international concerns, only
American concerns.
Finally, in today's Wall Street Journal there is an article where
they welcome more immigration to alleviate the tight labor market.
How do you feel about that? Did you see the article?
Mr. GREENSPAN. Yes, I did. I have always been of the view that
we have always been a country which has people—indeed, everybody, except for a very small proportion of our society—that have
roots in other countries. I have always thought that under conditions such as we now confront that we should be very carefully focused on the contribution which skilled people from abroad, unskilled people from abroad, can contribute to this country, as they
have for generation after generation.
Mrs. MALONEY. I have heard you testify many times that the
tight labor markets will lead to inflation, yet we seem to have astonishingly low unemployment. It is 4.3 percent right now, and we
are creating 170,000 new jobs a month. Could you comment on
that? Do you see that moving toward inflation, or do you feel there
is a new phenomenon in our economy with high technologies?
Mr. GREENSPAN. If you look at the figures, what we are seeing
is that it is the acceleration in productivity which has had such an
extraordinary effect on our economy that, indeed, what it has done




35

is enabled us to grow at a fairly pronounced clip. It has kept inflationary pressures in check. A number of forces, which I described
in my prepared remarks, join in with accelerating productivity to
sustain a low inflation rate. And, indeed, the only point I make in
my prepared remarks, which I have made previously, is that the
total pool of those who are job-seekers—in wnich I include the official unemployed, plus a significant number of people who are not
in the labor force, but nonetheless say they would like a job—the
combination of those two has been declining.
And the point that I have been making for quite a while is I
don't know where that is—the level where that will trigger market
pressures. But I do know, because the law of supply and demand
has got to work eventually, that there is a point at which, if that
pool of people seeking jobs continues to decline, at some point it
must have an impact.
If we can open up our immigration rolls significantly, that clearly
will make that less and less of a potential problem.
Mrs. MALONEY. My time is up. Maybe we will have a second
round. Thank you very much.
Chairman LEACH. Thank you, Mrs. Maloney.
Mr. Cook.
Mr. COOK. Yes, thank you, Mr. Chairman.
Chairman Greenspan, a $1 trillion tax cut, or $792 billion tax cut
over ten years, like we are going to be voting on today, seems like
an awfully large tax cut until you consider that in light of approximately $28 trillion to $30 trillion of Government spending that is
going to take place during the next ten years and a gross domestic
product that will be going through this country of about $125 trillion over that same ten years.
And my question to you is: Is this tax cut that we are considering
today not kind of a modest attempt, but rather positive step toward
trying to create some incentive for boosting private savings and investment, something that you have always been very concerned
about?
Mr. GREENSPAN. As I have commented before, Congressman, in
the short run, I think not. If our purpose is increasing private savings at this particular point, we are probably going to do it at a
considerably greater pace if we allow the surpluses to run and Government debt to run down.
Over the longer run, you can only get savings through the private sector. And eventually what you need is to get a significant
amount of incentives to increase the aggregate level of output,
which will engender the amount of savings that you need to create
capital investment.
I think we are in a very special period now, one of the extraordinarily rare periods where I, who have always advocated at any
time marginal tax rate cuts and, indeed, as I have indicated to
your colleague, a zero capital gains tax, am saying, hold off for a
while.
And the reason I am saying that is that I think that the timing
is not right. We will need a very important reduction in marginal
tax rates and in the capital gains tax rate at some point in the future when this economy inevitably falters; because I argue that the
business cycle is not dead, I just don't know when it is going to




36

turn. I frankly don't have a clue, because at the moment, we are
exceptionally well balanced. I just know that human nature being
what it is, eventually something is going to happen.
I want to be sure that we are at that point prepared to initiate
very substantial cuts in marginal tax rates, and hopefully, a major
reduction in the capital gains tax rates because at that point, I
think that will be the most effective means that we can have to regenerate the economy and keep the long-term growth path moving
higher.
Mr. COOK. Keeping in mind that this tax cut now has some kind
of a trigger mechanism to make sure the debt doesn't really increase.
Mr. GREENSPAN. Which I approve. I think that is a very good
idea.
Mr. COOK. I really fail to see what is wrong with moving on that
path simultaneously. In other words, clearly, this tax cut is at least
a chance to build private savings and investment. But what are the
best ways of stimulating the things that you have been so worried
about over the years, and that is the lack of private savings and
investment—what is the best plan for that?
Mr. GREENSPAN. I think that the best way at the moment, in the
short run, is to allow the surpluses to run for a while. And the reason I say that, as I said before, is that all we are doing is postponing decisions. Because if the Government debt goes down, as I said
before, for every dollar it goes down, you are increasing the borrowing capacity of the Federal Government by that amount. And I see
no reason why we have to make decisions crucially at this point
until we are sure that we really have got the surplus in tow.
The range of error on our forecasting capacity in the fiscal area
is not very impressive. Once we know we really have got it locked
in place and, hopefully, if we are not being confronted with large
numbers of spending programs which try to eat up the surplus, I
think at that point we can basically focus on getting important tax
cuts in place.
As I said previously, the only thing which would get me to be
strongly in favor of major tax cuts now is if I became concerned
that the surplus was going to be employed for increasing spending
programs. I hope that is not the case. If that occurs, then I must
admit that I would change my view, and I would be strongly in
favor of tax cuts now. I think it is the second-best alternative.
To me, currently, the first-best is to allow the surpluses to run
and the Government debt to run down.
Chairman LEACH. The gentleman's time has expired. And I
thank him.
I would like to make an announcement and a proposal to the
committee. I have been informed that we are going to have a series
of three and possibly four votes on the floor in about ten minutes,
which means the committee can go about fifteen minutes. And I
think these votes will take close to an hour on the tax bill. And
what I would like to propose is that we divide time, we have five
Members that have not spoken at three minutes each. And I think
it is unfair, but I think it is fairer than leaving someone out. Would
there be objection to that?




37

If not, that is the way we will proceed, and let me turn to Mr,
Watt.
Mr. WATT. Thank you, Mr. Chairman.
I find myself always being exhilarated and depressed when I
hear Mr. Greenspan give his presentation, and I don't know which
one is greater. My depression, I think, always is centered around
this question of employment and whether we can both grow the
economy. Maybe the title of the Full Employment and Balanced
Growth Act of 1978, which is what you come to report on every
year, really is somewhat at odds, based on my understanding of
where you come down on this every year.
The concern I have is, on page 2 of your testimony you have a
statement: "One indication that inflation risks are rising would be
a tendency for labor markets to tighten further." I have heard
you—the first time you gave this report, and I was on this committee, I was kind of shocked to hear you say that you thought, as I
recall, that if unemployment fell below 5, 5.5 percent, that was
going to be dangerous.
And, of course, I guess that is in the context, over time, that I
have come to understand that productivity has to be growing more
than—in exchange for reducing unemployment, productivity has to
be growing to keep inflation from taking place, I take it that is
what you are saying.
What is this "tighten further"—well, let me not ask that question, but ask the question: Why is it that it is always the unemployment that is scary and not the earnings growth that is scary?
It seems to me that all of this is a function of inputs and who
gets what out of the growth. Wages are what the working people
get out of growth. Earnings are what the capital gets out of the
growth. Yet, on page 7 when you say "Except for a short hiatus in
the latter part of 1998, analysts' expectations of five-year earnings
growth have been revised up." You seem to suggest that is a wonderful thing.
What is the interplay here and where do we get to a point where
we say—or do we ever get to a point that we say that earnings may
be outrageously high as opposed to wages being outrageously high
or unemployment being too low?
Chairman LEACH. The Chairman has 30 seconds to respond.
Mr. GREENSPAN. It is unfortunate, because I think the Congressman is raising a very important and, I think, a very thoughtful
issue.
Let me say just very quickly that over the years, the ratio of
profits to employee compensation tends to be very stable. The reason for this is that the markets are working in a manner in which,
when profits go up, so do wages, but both are determined by the
degree of productivity in the system. Real per capita income of the
average American tends to move very closely with national productivity.
And one of the things about a market economy which works so
effectively is it does tend to distribute income between profits and
wages and compensation in a remarkably stable way. There is a lot
to be said about this issue, and I think it creates considerable concern, because it makes it appear that if wages go up, that that is
bad. It is not. If real wages go up, that is good. If nominal wages




38

go up in the context of inflation, that is bad, because it means real
wages are not moving at all.
Chairman LEACH. Mrs. Kelly.
Mrs. KELLY. Thank you. Thank you for being here.
In your last appearance before the committee in May, I asked
you about the latest news on the trade deficit, which had then set
a new record of $19.7 billion. On Tuesday, the Department of Commerce came out with even higher trade deficit numbers, $21.3 billion. It seems as though we are seeing a trend here.
And the last time I asked you about this, you said: "the longterm equilibrium is working against us, but so far it appears longterm. There is very little, if any, evidence that there is anything
immediate to create a problem for us."
In your reply to Mr. Bachus' question about the trade deficit, you
said: "Theoretically, this cannot go on indefinitely. It will result in
a lesser ability to hold dollar claims."
How much bigger do you think the trade deficit would need to
get before foreign investors relocate their portfolios out of the dollar
denominated assets?
Mr. GREENSPAN. I don't know the answer to that question, nor
do I know anyone who does. I would merely repeat what I said to
you the last time. So far, the current account is increasingly negative—the trade deficit is increasingly negative but it is being offset
by increasing desire on the part of foreigners to invest money in
the United States at rates of return which they perceive to be superior to what they can get elsewhere. So, as long as you can finance
the deficit, it creates no imbalances.
I must assume that somewhere it is going to change, but so far,
it has been really quite impressive.
Mrs. KELLY. What policy changes, if any, would be effective in
closing the trade gap? Do you want to—will you be willing to answer that?
Mr. GREENSPAN. I would, if I could. It is a very tough set of questions, and I think the Chairman is suggesting that I had better
limit my remarks. The bottom line is sound general monetary and
fiscal policies are the best way of approaching this issue. The one
thing we do not want to do is engage in protectionism or any other
related restriction of movement of goods and services or capital because, in my judgment, that will turn out to be counterproductive.
Mrs. KELLY. Thank you.
Thank you, Mr. Chairman.
Chairman LEACH. Thank you, Mrs. Kelly.
Mr. Bentsen.
Mr. BENTSEN. Thank you, Mr. Chairman,
Chairman Greenspan, let me follow up on your comments regarding the sound monetary and fiscal policy. First of all, you sort of
sound like a Keynesian today.
Mr. GREENSPAN. I hope not.
Mr, BENTSEN. I am not saying that in terms of a criticism, I am
sure there are many who would. And I do have some other questions regarding monetary policy that I will ask for the record, and
I will get those to your staff.
In response to Mrs. Roukema and our colleague from Utah, you
had commented that it probably would be better to hold off on the




39

tax cuts that we are debating or getting ready to vote on on the
floor. In your statement, you talk about the action that the Open
Market Committee took recently to push up the Fed funds rate because of fear that the economy, having rebounded from the Russian
crisis and the Asian crisis, now appears to be on the verge of possibly overheating.
You indicate that in the short run you don't see this tax plan as
increasing investment—or private savings; thus, it would appear
that you see it as increasing demand or increasing consumption
and thus demand. Is that where we are heading with this tax cut?
Second of all, what is your faith or how strong do you believe in
the assumptions that have been made with respect to the on-budget surplus—not just one year, but five years and ten years; and
what risks are there to the general economy of having locked in a
tax cut that we then have to borrow more to pay for, and does that
devalue the value of U.S. debt and the U.S. dollar?
Mr. GREENSPAN. Well, let me say, first, Congressman, I think
that the first principle that one should apply in this type of outlook
is that you should not commit contingent potential resources to irreversible uses. And as a consequence of this, as I indicated to your
colleagues earlier, the probabilities of errors around the forecasts
we can make—surpluses, deficits, five, six or eight years out—are
very large.
Now, I don't think that the issue really at this stage necessarily
comes to grips with the problem of demand-side or supply-side
issues here, because most of the tax cut proposals do not really
take on any volume for quite a while. So you cannot really argue
that the proposal is to cut taxes next month. That is not what is
being proposed.
These are long-term tax proposals which have, at root, a concern
that unless the surpluses are absorbed, they will be used for increased outlays.
I happen to have a very considerable sympathy with that particular concern, and as a consequence, I think that the notion of
using a potential trigger in that regard is essential.
But I will repeat, I would prefer that we allow the deficit to run
down and, hopefully, that that, in turn, would not engender a
whole new series of spending programs, because were that to happen, I think that we would be getting into serious difficulties.
Mr. BENTSEN. Thank you, Mr. Chairman.
Chairman LEACH. Mr. Ryan.
Mr. RYAN. Given the fact that our beepers just went off to vote
for this tax cut, I will pursue that line of questioning instead of
something else that we wanted to talk about.
Mr. Greenspan, several times in the past you have talked about
the dynamic effects associated with certain types of tax cuts, specifically income tax rate cuts, capital gains tax cuts. In modern history, every time Congress has passed those kinds of tax cuts, we
have actually stimulated economic growth and raised revenues
from those very taxes. One of the things that I am hearing here
from all of my colleagues and yourself is that we need to make sure
that these surpluses actually materialize, and when these surpluses materialize, that will give us the chance of paying down
publicly held debt and paying down the private debt.




40

Now, given the fact that that this current budget reduces $6 of
debt for every $1 in tax cuts over the next five years, we are
achieving substantial debt reduction; that is, $6 of debt reduction
for $1 of tax reduction, and the tax reduction that we are imposing
and voting on in a few minutes are the very tax cuts that in the
past and present you have advocated as ones that increase economic growth and actually increase revenue growth.
Wouldn't you say that this is the best chance, from a fiscal policy
standpoint, of ensuring that these surpluses actually do materialize, that growth continues, that jobs are filled, taxes are being paid,
and the surpluses actually do materialize?
Mr. GREENSPAN. Well, Congressman, I start with the presumption that for a large number of reasons, not the least of which is
the incentives that we have created in this economy, we have got
a remarkable acceleration in technology innovations and new types
of capital investment at very high rates of return.
I do not foresee the need at this particular stage to argue the
question as to whether new taxes or cuts will enhance this. I think
it is going at the moment probably about as fast as we can do it
technologically. So I would far prefer to hold off on significant further tax cuts to when we will need them to keep this process going.
So I am not against tax cuts as such. On the contrary, I have
argued for decades the great advantage of reducing taxes, and I am
sort of quite pleased that that has become, to a certain extent, the
conventional wisdom. It is merely the timing that I refer to. And
at this particular time, the first priority, in my judgment, should
be getting the debt down, letting the surpluses run, and, as has
been suggested here, to put in contingency plans so that in the
event that that is happening, that you could move forward at a
later date with tax cuts provided that there is an additional trigger
in there in the event that the economy is moving down.
Chairman LEACH. We have to move to the next two speakers.
Mr. RYAN. I yield back the balance of my time.
Chairman LEACH. I want to thank you, Paul, for being here the
whole day; and I know how frustrated you are.
Mr. Sandlin.
Mr. SANDLIN. Thank you, Mr. Chairman.
I will go quickly on that same subject, since we are talking about
the tax cuts, as Mr. LaFalce mentioned earlier today, recently interest rates were raised in an apparent attempt to hedge against
anticipated inflation. If these tax cuts that my colleague is talking
about, if $800 billion to $1 trillion are unleashed on the economy,
what effect would that have on interest rates? And if there are, in
fact, some sort of savings, would not those savings be more than
outstripped by the additional cost of the interest?
Mr. GREENSPAN. It is very difficult to judge in the abstract what
individual fiscal policies will do. We can in the theoretical sense;
I haven't found that very effective. I think that what we in the
Federal Reserve would be doing is, as we always do, observe what
is happening to the economy and respond to the economy.
You can argue effectively on both sides of this issue, and I don't
think that we need to come out with a judgment one way or the
other, because our response is not going to be to taxes; one way or
the other, it is going to be what is happening in the economy.




41

Mr. SANDLIN. But you must think that inflation is slowed by an
increase in the interest rate or you wouldn't do it. If there is money
unleashed on the economy, the economy will be fueled and grow
and interest rates will increase, and so it seems that American
families and business will see a slight savings in tax, but with the
interest rates being escalated, that will more than offset it.
Mr. GREENSPAN. I understand the concern you have, and a lot of
people hold that particular point of view.
It is not easy to make a judgment in a particular case, especially
with the degrees of unknowns that we have with respect to the rate
of growth of productivity out there and a number of other elements,
which are quite relevant to the decision of how a tax cut will affect
the economy.
Mr. SANDLIN. Would you agree that you raised interest rates to
hedge against anticipated inflation?
Mr. GREENSPAN. We mainly raised rates to restore levels of rates
to where we thought they ought to be, granted that the actions we
took last fall were to a substantial extent to address a seizing-up
in the financial system which has gradually dissipated.
Mr. SANDLIN. I assume the time is about out. Let me move to
something else.
Chairman LEACH. Very quickly.
Mr. SANDLIN. Then I will take that as a cue and thank you for
responding. I yield back the balance of my time.
Chairman LEACH. I want to give Mrs. Lee a chance. And I thank
you, too. You have been terrific.
Mrs. Lee.
Mrs. LEE. Thank you, Mr. Chairman.
Good morning. It is good to see you again, Mr. Greenspan. You
pointed out in your statement that the employment rate for those
with less than a high school education has declined from 10.75 percent in 1994 to 6.75 percent today, which is a very positive statistic. But we do know that many of these individuals are minimumwage earners with little or no benefits and some are really part of
the working poor.
Now, as Congresswoman Waters pointed out earlier, not much
attention is being given to use some of our surplus to help raise
the standard of living for the poor, for children, for those who really have not benefited from this tremendous economic boom. And I
agree that we should use most of the surplus or a large part for
debt reduction, but that does, of course, reduce interest rates for
middle- to upper-income individuals, but those that don't have
credit cards, that don't have mortgages and that don't have incomes that will allow for them to benefit from our economic boom
still are not part of the mix.
So what I am just asking you once again is, I believe I heard you
clearly say to Congresswoman Waters that there should not be
really many strategies you believe that utilize the surplus for the
benefit of those individuals who have not really benefited, but that
it should be the private sector's responsibility only?
Mr. GREENSPAN. Congresswoman, the central thrust of my argument is that we have had program after program which hasn't
worked, and I think that creates discouragement. And merely to
take a number of programs which haven't worked and just add to




42

them because it makes it appear as though we are doing something
I think is counterproductive. I think we have got to really make
certain that what we do does what we want it to do, and that is
crucial to me.
And so it is easy to talk in terms of Government programs, but
they just haven't worked. We have got to find a way for the private
sector to get in there, get real jobs, get things working and not
have another failure. That is my major concern.
Mrs. LEE. Thank you very much, Mr. Chairman.
Chairman LEACH. Thank you, Mrs. Lee.
And, Mr. Chairman, I thank you very much. This brings to a conclusion the Humphrey-Hawkins hearing, and we are very appreciative of your patience, your judgment, and the professionalism of
the Federal Reserve Board. Thank you.
Mr. GREENSPAN. Thank you very much, Mr. Chairman.
Chairman LEACH. The hearing is adjourned.
[Whereupon, at 1:54 p.m., the hearing was adjourned.]







APPENDIX

May 22, 1999

(43)

44

CURRENCY
Committee on Banking
and Financial Services
James A. Leach, Chairman
For Immediate Release:
Thursday, July 22,1999

Contact; David Rookd or Andrew Parjneatier
(202) 226-0471
Opening Statement
Of Representative Junes A. Leach
Chairman, Committee on Banking and Financial Services
Humphrey-Hawkins Hearing on the Conduct of Monetary Policy

The Committee meets today to receive (he semiannual report of the Board of Governors of the Federal
Reserve System on the conduct of monetary policy and the state of the economy, as mandated in the Full
Employment and Balanced Growth Act of 1978.
Chairman Greenspan, welcome back to the House Banking Committee. To ensure that all Members
have an opportunity to question Chairman Greenspan, it is the intention of the Chair to limit opening
statements to die Chairman and Ranking Member of the full committee, as well as the Subcommittee on
Domestic and International Monetary Policy. All other opening statements will be included for the
record.
This is our second Humphrey-Hawkins hearing this year and the last such hearing mandated under
current law. As Members may recall, this semiannual report b one of several thousand reports,
including approximately 100 under the jurisdiction of this Committee, which are scheduled to snnset on
Dec. 31 under broad legislation approved by Congress four yean ago.
As Chairman of the Committee of jurisdiction, let me emphasis that I believe these Humphrey-Hawkins
Bearings are the most important oversight hearings conducted by the Congress. The Federal Reserve
System has become, In effect, a fourth branch of government, and the reports to this Committee and its
Senate counterpart by the Chairman of the Federal Reserve Board have become the chief mechanism for
democratic review of the monetary policy decisions of the Fed.
To discontinue these oversight hearings would be Congressionalry negligent The Fed should not be dedemocratized.




45

Thus it is my intention to move forwird with legislation immediately after the August break to require
continued semiannual Humphrey-Hawkins reporting by the Fed on the conduct of monetary policy. In
addition, certain selected other reports by federal banking, housing and international financing agencies
wilt be re-authorized.
We meet today at a propitious moment to review to the Federal Reserve's conduct of monetary policy.
The current economic expansion is now 100 months old. It is already the longest peacetime expansion in
American history, and in six months, could become the longest expansion ever recorded anywhere.
Despite robust domestic demand, core inflation Is running at a 34-year low.
Over the past several years, the economy has performed in a way that has defied historical precedents
and modern academic theory. Perhaps the most significant macro-economic news of the last generation
is that the Fed appears to have concluded that we are ID economic terra incognita and that the
productivity gains associated wtth this unprecedented age of Information technology means that past
economic modeling doesn't fit today's circumstances. Yesterday's models may fit tomorrow's, but for
the moment belt-tightening interest rates don't seem to be necessary to curb an inflation that hasn't
emerged with the low levels of unemployment that were once assumed to trigger it
To some degree, luck has been a factor on the inflation front, with a silver lining appearing in what
otherwise were dark clouds in the world economy. Last summer's troubles abroad impoverished a lot of
people in Asia and Russia, but the crises pushed down the prices of the goods we buy from these
countries, boosting the American consumers' purchasing power.
In addition, more restrained Congressional spending - producing surpluses rather than deficits - has
helped high tech investors find capital at credible rates even though America's savings rate has declined
to a negative level.
More fundamentally, the economy has teen propelled by gains in productivity. And far from tapering
off, as one would expect after such a long period of expansion, the pace of productivity increases has
apparently been accelerating. As a result, unit costs appear to be going down even as labor costs are
going up in atight- and tightening - labor market
The inventive genius of our engineers and the heavy investment of our corporations in software and
hardware innovations have greatly increased our ability to make affordable things, with the result that

There are two Americas: one enjoying increasing prosperity; the other, largely associated with industries
involved with basic commodity production, experiencing a dispiriting recession. While new issues of
software companies are selling at hundred-fold multiples, agriculture is on its back. Restrained inflation
may be the macro-economic order of the day, but deflation characterizes the Farm Belt

Many of us believe Congress has little choice but to act forth rightly on the agricultural problem,
including approval of fast-track trade authority. But before closing, I'd like to comment briefly on an




46
issue involving Mother bask commodity, and that fa gold. It Is my Intention to move swIIUy on a debt
relief initiative immediately following the August break, bmt I wonld itreit that H is unlikely that the
Committee will endone the AdraiBbtratton'i proposal to authorize the International Monetary Fmnd to
sell 10 percent of its gold hoUmgi ai a method of payment for debt relief for the world's poorest
countries.
Debt relief Is a societal, indeed moral, Imperative, but care roust be taken not to jeopardize the mining
industry that provide* many of the most stable jobs In the developing world.
At this point, I'd Bite to recognize the Ranking Member, Mr. LaFalce for an opening statement




47
Opening Statement of Rep. Ron Paul
Full Committee Hearing on the Conduct of Monetary Policy
House Committee on Banking and Financial Services
July 22,1999
Chairman Leach, Ranking Member LaFalce, thank you for the opportunity to address an
issue of great importance to me and my constituents. The economic prosperity of many
parts of this country, and in particular, parts of my district, is tied to agricultural markets.
Inappropriate monetary meddling is having a disastrous effect, Of course, these concerns
of monetary structures and policies affecting agriculture are not new.
David Schoenbrod (professor at New York Law School and an adjunct scholar at the
Cato Institute) wrote an interesting article last year (AThe Yellow Brick Beltway,@ The
Wall Street Journal, November 27, 1998) explaining the film AThe Wizard of Oz@
(based on the 1900 book by L. Frank Baum) as a parable of William Jennings Bryan=s
campaign for bimetallism (using both silver and gold to back the dollar). The use of the
Scarecrow as a farmer, who thinks he has no brains only to learn he always had them, is a
populist message that Aordinary people can take care of themselves if they realize their
full potential, work together and do not put themselves in the thrall of self-professed
experts wielding the powers of government.©
Such artistic imageries aside, Murray Rothbard=s classic book, America=s Great
Depression, explains how government manipulation of the price of credit hurts farmers.
Government policy in the 1920s aimed to encourage farm export, raise farm subsidies,
subsidize cheap credit to farmers and subsidize farm cooperatives. Such government
interventions lead to crop restrictions and other distortions in an attempt to Astabiljze@
prices. Such efforts failed to stabilize farm commodity prices and incurred great losses
for the Treasury. During the Great Depression, farmers probably suffered from the
money managers= tricks at least as much as anyone else.
More recently, during the debate over additional funding for the International Monetary
Fund, proponents for more government management of money and credit shed crocodile
tears for the farmers. I argued against such funding because (1) IMF-recommended
currency devaluations price our agricultural goods out of the market, (2) IMF money
subsidizes our agricultural competitors, and (3) IMF bailout countries have higher
protectionist barriers than other countries (The Heritage Foundation Backgrounder No.
1178, May 11, 1998, AAgricultural Exports and the IMF: Separating Myth from
Reality®). The National Family Farm Coalition points out that following IMF
devaluation guidelines exacerbates our agricultural trade deficits. Agricultural exports to
Mexico fell by 22% in 1995, while imports from Mexico rose 32%, one year after the
peso bailout and currency devaluation of over 40%. US agricultural exports to IMF
bailout countries dried up during the Asian crises.
To aid our farmers and others, we should pursue sound monetary and credit policies.




48
For release on delivery
11:00 a.m.E.D.T.
July 22, 1999




Statement of
Alan Greenspan
Chairman
Board of Governors of the Federal Reserve System
before the
Committee on Banking and Financial Services
U.S. House of Representatives
July 22, 1999

49
Thank you, Mi. Chairman and other members of the Committee, for this opportunity to
present the Federal Reserve's semiannual report on monetary policy.
To date, 1999 has been an exceptional year for the American economy, but a challenging
one for American monetary policy. Through the first six months of this year, the U.S. economy
has further extended its remarkable performance; Almost 1-1/4 million jobs were added to
payrolls on net, and gross domestic product apparently expanded at a brisk pace, perhaps near
that of the prior three years.
At the root of this impressive expansion of economic activity has been a marked
acceleration in the productivity of our nation's workforce. This productivity growth has allowed
further healthy advances in real wages and has permitted activity to expand at a robust clip while
helping to foster price stability.
Last fall, the Federal Open Market Committee (FOMC) eased monetary policy to counter
a seizing-up of financial markets that threatened to disrupt economic activity significantly. As
those markets recovered, the FOMC had to assess whether that policy stance remained
appropriate By late last month, when it became apparent that much of the financial strain of last
fall had eased, that foreign economies were firming, and that demand in the United States was
growing at an unsustainable pace, the FOMC raised its intended federal funds rate 1/4 percentage
point, to 5 percent. To have refrained from doing so in OUT judgment would have put the U.S.
economy's expansion at risk.
If nothing else, the experience of the last decade has reinforced earlier evidence that a
necessary condition for maximum sustainable economic growth is price stability While product
prices have remained remarkably restrained in the face of exceptionally strong demand and
expanding potential supply, it is imperative that we do not become complacent.




50
The already shrunken pool of job-seekers and considerable strength of aggregate demand
suggest that the Federal Reserve will need to be especially alert to inflation risks. Should
productivity fail to continue to accelerate and demand growth persist or strengthen, the economy
could overheat. That would engender inflationary pressures and put the sustainability of this
unprecedented period of remarkable growth in jeopardy. One indication that inflation risks were
rising would be a tendency for labor markets to tighten further. But the FOMC also needs to
continue to assess whether the existing degree of pressure in these markets is consistent with
sustaining our low-inflation environment. If new data suggest it is likely that the pace of cost and
price increases will be picking up, the Federal Reserve will have to act promptly and forcefully so
as to preclude imbalances from arising that would only require a more disruptive adjustment
later—one that could impair the expansion and bring into question whether the many gains already
made can be sustained.

RECENT DEVELOPMENTS
A number of important forces have been shaping recent developments in the U.S.
economy. One has been a recovery of financial markets from the disruptions of last fall. By the
end of 1998, the extreme withdrawal from risk-taking and consequent seizing-up of markets had
largely dissipated. This year, risk spreads have narrowed further—though generally not to the
unrealisticaily low levels of a year ago—and a heavy volume of issuance in credit markets has
signaled a return to their more-normal functioning. Equity prices have risen to new highs and, in
the process, have elevated price-earnings ratios to historic levels.
Abroad, many financial markets and economies also have improved. Brazil weathered a
depreciation of its currency with limited fallout on its neighbors. In Asia, a number of the




51
emerging market economies seemed to be reviving after the trying adjustments of the previous
year or so Progress has not been universal, and in many economies prospects remain clouded,
depending importantly on the persistence of efforts to make fundamental reforms whose necessity
had been made so painfully obvious in the crises those economies endured. Nonetheless, the
risks of further major disruptions to financial and trade flows that had concerned the FOMC when
it eased policy last fall have clearly diminished. Improving global prospects also mean that the
U.S. economy will no longer be experiencing declines in basic commodity and import prices that
held down inflation in recent years.
In the domestic economy, data becoming available this year have tended to confirm that
productivity growth has stepped up. It is this acceleration of productivity over recent years that
has explained much of the surprising combination of a slowing in inflation and sustained rapid real
growth. Increased labor productivity has directly limited the rise of unit labor costs and
accordingly damped pressures on prices. This good inflation performance, reinforced also by
falling import prices, in turn has fostered further declines in inflation expectations over recent
years that bode well for pressures on costs and prices going forward.
In testimony before this committee several years ago, I raised the possibility that we were
entering a period of technological innovation that occurs perhaps once every fifty or one-hundred
years. The evidence then was only marginal and inconclusive. Of course, tremendous advances in
computing and telecommunications were apparent, but their translations into improved overall
economic efficiency and rising national productivity were conjectural at best. While the growth of
output per hour had shown some signs of quickening, the normal variations exhibited by such data
in the past were quite large. More intriguing was the remarkable surge in capital investment after




52
1993, especially in high-tech goods, a full two years after a general recovery was under way. This
suggested a marked increase in the perceived prospective rates of return on the newer
technologies
That American productivity growth has picked up over the past five years or so has
become increasingly evident. Nonfarm business productivity (on a methodologically consistent
basis) grew at an average rate of abit over 1 percent per year in the 1980s. In recent years,
productivity growth has picked up to more than 2 percent, with the past year averaging about
2-1/2 percent.
To gauge the potential for similar, if not larger, gains in productivity going forward, we
need to attempt to arrive at some understanding of what has occurred to date. A good deal of the
acceleration in output per hour has reflected the sizable increase in the stock of labor-saving
equipment. But that is not the whole story. Output has grown beyond what normally would have
been expected from increased inputs of labor and capital alone. Business restructuring and the
synergies of the new technologies have enhanced productive efficiencies. American industry quite
generally has shared an improved level of efficiency and cost containment through high-tech
capital investment, not solely newer industries at the cutting edge of innovation. Our century-old
motor vehicle industry, for example, has raised output per hour by a dramatic 4-1/2 percent
annually on average in the past two years, compared with a lackluster 1-1/4 percent on average
earlier this decade. Much the same is true of many other mature industries, such as steel, textiles,
and other stalwarts of an earlier age. This has confirmed the earlier indications of an underlying
improvement in rates of return on the newer technologies and their profitable synergies with the
existing capital stock.




53
These developments have created a broad range of potential innovations that have granted
firms greater ability to profitably displace costly factors of production whenever profit margins
have been threatened. Moreover, the accelerating use of newer technologies has markedly
enhanced the flexibility of our productive facilities. It has dramatically reduced the lead times on
the acquisition of new equipment and enabled firms to adjust quickly to changing market
demands. This has indirectly increased productive capacity and effectively, at least for now,
eliminated production bottlenecks and the shortages and price pressures they inevitably breed.
This greater ability to pare costs, increase production flexibility, and expand capacity are
arguably the major reasons why inflationary pressures have been held in check in recent years.
Others have included the one-time fall in the prices of oil, other commodities, and imports more
generally. In addition, a breaking down of barriers to cross-border trade, owing both to the new
technologies and to the reduction of government restrictions on trade, has intensified the
pressures of competition, helping to contain prices. Coupled with the decline in military spending
worldwide, this has freed up resources for more productive endeavors, especially in a number of
previously nonmarket economies.
More generally, the consequent erosion of pricing power has imparted an important
imperative to hold down costs. The availability of new technology to each company and its rivals
affords both the opportunity and the competitive necessity of taking steps to reduce costs, which
translates on a consolidated basis into increased national productivity.
The acceleration in productivity owes importantly to new information technologies. Prior
to this IT revolution, most of twentieth-century business decisionmaking had been hampered by
limited information. Owing to the paucity of timely knowledge of customers' needs, the location




54
of inventories, and the status of material flows throughout complex production systems,
businesses built in substantial redundancies.
Doubling up on materials and staffing was essential as a cushion against the inevitable
misjudgments made in real time when decisions were based on information that was hours, days,
or even weeks old. While businesspeople must still operate in an uncertain world, the recent
years' remarkable surge in the availability of real-time information has enabled them to remove
large swaths of inventory safety stocks, redundant capital equipment, and layers of workers, white
arming them with detailed data to fine-tune specifications to most individual customer needs.
Despite the remarkable progress witnessed to date, history counsels us to be quite modest
about our ability to project the future path and pace of technology and its implications for
productivity and economic growth. We must remember that the pickup in productivity is
relatively recent, and a key question is whether that growth will persist at a high rate, drop back
toward the slower standard of much of the last twenty-five years, or climb even more. By the last
I do not just mean that productivity will continue to grow, but that it will grow at an increasingly
faster pace through a continuation of the process that has so successfully contained inflation and
supported economic growth in recent years.
The business and financial community does not as yet appear to sense a pending flattening
in this process of increasing productivity growth. This is certainly the widespread impression
imparted by corporate executives. And it is further evidenced by the earnings forecasts of more
than a thousand securities analysts who regularly follow S&P 500 companies on a firm-by-firm
basis, which presumably embody what corporate executives are telling them. While the level of
these estimates is no doubt upwardly biased, unless these biases have significantly changed over




55
time, the revisions of these estimates should be suggestive of changes in underlying economic
forces. Except fora short hiatus in the latter part of 1998, analysts' expectations of five-year
earnings growth have been revised up continually since early 1995. If anything, the pace of those
upward revisions has quickened of late. True, some of that may reflect a pickup in expected
earnings of foreign affiliates, especially in Europe, Japan, and the rest of Asia. But most of this
year's increase almost surely owes to domestic influences.
There are only a limited number of ways that the expected long-term growth of domestic
profits can increase, and some we can reasonably rule out. There is little evidence that company
executives or security analysts have significantly changed their views in recent months of the
longer-term outlook for continued price containment, the share of profits relative to wages, or
anticipated growth of hours worked. Rather, analysts and the company executives they talk to
appear to be expecting that unit costs will be held in check, or even lowered, as sales expand.
Hence, implicit in upward revisions of their forecasts, when consolidated, is higher expected
national productivity growth.
Independent data on costs and prices in recent years tend to confirm what aggregate data
on output and hours worked indicate: that productivity growth has risen. With price inflation
stable and domestic operating profit margins rising, the rate of increase in total consolidated unit
costs must have been falling.
Even taking into account the evidence of declining unit interest costs of nonfinancial
corporations, unit labor cost increases (which constitute three quarters of total unit costs) must
also be slowing. Because until very recently growth of compensation per hour has been rising,
albeit modestly, it follows that productivity growth must have been rising these past five years, as




56
well. Accelerating productivity is thus evident in underlying consolidated income statements of
nonfinancial corporations, as well as in our more direct, though doubtless partly flawed, measures
of output and input.
That said, we must also understand the limits to this process of productivity-driven
growth. To be sure, the recent acceleration in productivity has provided an offset to our taut
labor markets by holding unit costs in check and by adding to the competitive pressures that have
contained prices. But once output-per-hour growth stabilizes, even if at a higher rate, any pickup
in the growth of nominal compensation per hour will translate directly into a more-rapid rate of
increase in unit labor costs, heightening the pressure on firms to raise the prices of the goods and
services they sell. Thus, should the increments of gains in technology that have fostered
productivity slow, any extant pressures in the labor market should ultimately show through to
product prices.
Meanwhile, though, the impressive productivity growth of recent years also has had
important implications for the growth of aggregate demand. If productivity is driving up real
incomes and profits~and, hence, gross domestic income-then gross domestic product must
mirror this rise with some combination of higher sales of motor vehicles, other consumer goods,
new homes, capital equipment, and net exports. By themselves, surges in economic growth are
not necessarily unsustainable-provided they do not exceed the sum of the rate of growth in the
labor force and productivity for a protracted period. However, when productivity is accelerating,
it is very difficult to gauge when an economy is in the process of overheating.
In such circumstances, assessing conditions in the labor market can be helpful in forming
those judgments. Employment growth has exceeded the growth in working-age population this




57
past year by almost V* percentage point. While somewhat less than the spread between these
growth rates over much of the past few years, this excess is still large enough to continue the
further tightening of labor markets. It implies that real GDP is growing faster than its potential.
To an important extent, this excess of the growth of demand over supply owes to the wealth
effect as consumers increasingly perceive their capital gains in the stock and housing markets as
permanent and, evidently as a consequence, spend part of them, an issue to which I shall return
shortly.
There can be little doubt that, if the pool of job seekers shrinks sufficiently, upward
pressures on wage costs are inevitable, short—as I have put it previously-of a repeal of the taw of
supply and demand. Such cost increases have invariably presaged rising inflation in the past, and
presumably would in the future, which would threaten the economic expansion.
By themselves, neither rising wages nor swelling employment rolls pose a risk to sustained
economic growth. Indeed, the Federal Reserve welcomes such developments and has attempted
to gauge its policy in recent years to allow the economy to realize its full, enhanced potential. In
doing so, we must remain concerned with evolving shorter-run imbalances that can constrain
long-run economic expansion and job growth.
With productivity growth boosting both aggregate demand and aggregate supply, the
implications for the real market interest rates that are consistent with sustainable economic growth
are not obvious. In fact, current real rates, although somewhat high by historical standards, have
been consistent with continuing rapid growth in an environment where, as a consequence of
greater productivity growth, capital gains and high returns on investment give both households
and businesses enhanced incentives to spend




58
OTHER CONSIDERATIONS
Even if labor supply and demand were in balance, however, other aspects of the economic
environment may exhibit imbalances that could have important implications for future
developments. For example, in recent years, as a number of analysts have pointed out, a
significant shortfall has emerged in the private saving with which to finance domestic investment
in plant and equipment and houses.
One offset to the decline in household saving out of income has been a major shift of the
federal budget to surplus. Of course, an important part of that budgetary improvement, in turn,
owes to augmented revenues from capital gains and other taxes that have flowed from the rising
market value of assets. Still, the budget surpluses have helped to hold down interest rates and
facilitate private spending.
The remaining gap between private saving and domestic investment has been filled by a
sizable increase in saving invested from abroad, largely a consequence of the technologically
driven marked increase in rates of return on U.S. investments. Moreover, in recent years, with
many foreign economies faltering, U.S. investments have looked particularly attractive. As U.S.
international indebtedness mounts, however, and foreign economies revive, capital inflows from
abroad that enable domestic investment to exceed domestic saving may be difficult to sustain
Any resulting decline in demand for dollar assets could well be associated with higher market
interest rates, unless domestic saving rebounds.




59
NEAR-TERM OUTLOOK
Going forward, the Members of the Federal Reserve Board and presidents of the Federal
Reserve Banks believe there are mechanisms in place that should help to slow the growth of
spending to a pace more consistent with that of potential output growth. Consumption growth
should slow some, if, as seems most likely, outsized gains in share values are not repeated. In that
event, businesses may trim their capital spending plans, a tendency that would be reinforced by the
higher level of market interest rates that borrowers now face. But with large unexploited
long-term profit opportunities stemming from still-burgeoning innovations and falling prices of
many capital goods, the typical cyclical retrenchment could be muted
Working to offset somewhat this anticipated slowing of the growth of domestic demand,
our export markets can be expected to be more buoyant because of the revival in growth in many
of our important trading partners.
After considering the various forces at work in the near term, most of the Federal Reserve
governors and Bank presidents expect the growth rate of real GDP to be between 3-1/2 and
3-3/4 percent over the four quarters of 1999 and 2-1/2 to 3 percent in 2000. The unemployment
rate is expected to remain in the range of the past eighteen months.
Inflation, as measured by the four-quarter percent change in the consumer price index, is
expected to be 2-1/4 to 2-1/2 percent over the four quarters of this year. CPI increases thus far in
1999 have been greater than the average in 1998, but the governors and bank presidents do not
anticipate a further pickup in inflation going forward. An abatement of the recent run-up in
energy prices would contribute to such a pattern, but policymakers' forecasts also reflect their




60
determination to hold the line on inflation, through policy actions if necessary. The central
tendency of their CPI inflation forecasts for 2000 is 2 to 2-1/2 percent.

PREEMPTIVE POLICYMAKING
In its deliberations this year, the FOMC has had to wrestle with the issue of what policy
setting has the capacity to sustain this remarkable expansion, now in its ninth year. For monetary
policy to foster maximum sustainable economic growth, it is useful to preempt forces of
imbalance before they threaten economic stability But this may not always be possible—the
future at times can be too opaque to penetrate. When we can be preemptive, we should be,
because modest preemptive actions can obviate more drastic actions at a later date that could
destabilize the economy.
I should emphasize that preemptive policyraaking is equally applicable in both directions,
as has been evident over the years both in our inclination to raise interest rates when the potential
for inflationary pressures emerged, as in the spring of 1994, or to lower rates when the more
palpable risk was economic weakness, as in the fall of last year. This even-handedness is
necessary because emerging adverse trends may fall on either side of our long-run objective of
price stability. Stable prices allow households and firms to concentrate their efforts on what they
do best: consuming, producing, saving, and investing A rapidly rising or a falling general price
level would confound market signals and place strains on the system that ultimately may throttle
economic expansion.
In the face of uncertainty, the Federal Reserve at times has been willing to move policy
based on an assessment that risks to the outlook were disproportionately skewed in one direction
or the other, rather than on a firm conviction that, absent action, the economy would develop




61
imbalances. For instance, both the modest policy tightening of the spring of 1997 and some
portion of the easing of last fall could be viewed as insurance against potential adverse economic
outcomes.
As I have already indicated, by its June meeting the FOMC was of the view that the full
extent of this insurance was no longer needed. It also did not believe that its recent modest
tightening would put the risks of inflation going forward completely into balance However,
given the many uncertainties surrounding developments on both the supply and demand side of
the economy, the FOMC did not want to foster the impression that it was committed in short
order to tighten further Rather, it judged that it would need to evaluate the incoming data for
more signs that further imbalances were likely to develop.
Preemptive policymaking requires that the Federal Reserve continually monitor economic
conditions, update forecasts, and appraise the setting of its policy instrument. Equity prices figure
importantly in that forecasting process because they influence aggregate demand. As I testified
last month, the central bank cannot effectively directly target stock or other asset prices. Should
an asset bubble arise, or even if one is already in train, monetary policy properly calibrated can
doubtless mitigate at least part of the impact on the economy. And, obviously, if we could find a
way to prevent or deflate emerging bubbles, we would be better off. But identifying a bubble in
the process of inflating may be among the most formidable challenges confronting a central bank,
pitting its own assessment of fundamentals against the combined judgment of millions of
investors
By itself, the interpretation that we are currently enjoying productivity acceleration does
not ensure that equity prices are not overextended. There can be little doubt that if the nation's




62
productivity growth has stepped up, the level of profits and their future potential would be
elevated. That prospect has supported higher stock prices. The danger is that in these
circumstances, an unwarranted, perhaps euphoric, extension of recent developments can drive
equity prices to levels that are unsupportable even if risks in the future become relatively small.
Such straying above fundamentals could create problems for our economy when the inevitable
adjustment occurs. It is the job of economic policymakers to mitigate the fallout when it occurs
and, hopefully, ease the transition to the next expansion.

CENTURY DATE CHANGE PREPARATIONS
I would be remiss in this overview of near-term economic developments if I did not relay
the ongoing efforts of the Federal Reserve, other financial regulators, and the private sector to
come to grips with the rollover of their computer systems at the start of the upcoming century.
While I have been in this business too long to promise that 2000 will open on an entirely
trouble-free note, the efforts to address potential problems in the banking and financial system
have been exhaustive. For our part, the Federal Reserve System has now completed remediation
and testing of all its mission-critical applications, including testing its securities and funds-transfer
systems with our thousands of financial institution customers.
As we have said previously, while we do not believe consumers need to hold excess cash
because we expect the full array of payment options to work, we have taken precautions to ensure
that ample currency is available. Further, the Federal Reserve established a special liquidity
facility at which sound depository institutions with good collateral can readily borrow at a slight
penalty rate in the months surrounding the rollover The availability of this back-stop funding




63
should make depository institutions more willing to provide loans and lines of credit to other
financial institutions and businesses and to meet any deposit withdrawals as this century closes.
The banking industry is also working hard, and with evident success, to prepare for the
event. By the end of May, 98 percent of the nation's depository institutions examined by Federal
Financial Institutions Examination Council agencies were making satisfactory progress on their
Year 2000 preparations. The agencies are now in the process of examining supervised institutions
for compliance with the June 30 milestone date for completing testing and implementation of
remediated mission-critical systems Supervisors also expect institutions to prepare business
resumption contingency plans and to maintain open lines of communication with customers and
counterparties about their own radiness. The few remaining laggards among financial
institutions in Year 2000 preparedness have been targeted for additional follow-up and, as
necessary, will be subject to formal enforcement actions.

CONCLUSION
As a result of our nation's ongoing favorable economic performance, not only has the
broad majority of our people moved to a higher standard of living, but a strong economy also has
managed to bring into the productive workforce many who had for too long been at its periphery.
The unemployment rate for those with less than a high-school education has declined from
10-3/4 percent in early 1994 to 6-3/4 percent today, twice the percentage point decline in the
overall unemployment rate These gains have enabled large segments of our society to obtain
skills on the job and the self-esteem associated with work.
The questions before us today are what macroeconomic policy settings can best extend
this favorable performance. No doubt, a monetary policy focused on promoting price stability




64
over the long run and a. fiscal policy focused on enhancing national saving by accumulating budget
surpluses have been key elements in creating an environment fostering the capita) investment (hat
has driven the gains to productivity and living standards. I am confident that by maintaining this
discipline, policymakers in the Congress, in the executive branch, and at the Federal Reserve will
give our vital U.S. economy its best chance of continuing its remarkable progress.




65
Chairman Greenspan subsequently submitted the following in response to written questions
from Congressman Bentsen following the July 22, 1999, hearing:
Q. 1. Mr. Chairman, the Blue Book (Monetary Policy Report to the Congress]
states that while risk spreads between investment-grade corporate debt securities
and Treasuries have narrowed since last fall, such spreads between non-investmentgrade securities have not narrowed to their pre-August level. To what do you
attribute this disparity?
A.I. As of July 19, 1999—the latest daily observation included in the Monetary
Policy Report to the Congress-risk spreads based on the Merrill Lynch AA and BBB
investment-grade bond indexes were 11 and 37 basis points wider than on July 31, 1998,
respectively. The spread for Merrill Lynch's below-investment-grade bond index,
however, was 109 basis above its pre-August 1998 level (table, column 4). Two factors
help explain why these risk spreads did not narrow to the same degree:
(i)

Credit quality indicators, particularly changes in bond ratings, for the highestrated investment-grade bonds have improved in recent months, in part
reflecting expectations of increased profits as a result of mergers. However,
the default rate on below-investment-grade securities has risen noticeably this
year.

(ii) Perhaps influenced by last fall's financial market turmoil, investors might have
adopted a more cautious stance towards below-investment-grade bonds,
requiring higher compensation for bearing the greater risk associated with
them. Indeed, during the first half of 1998, yield spreads on such securities
were near their lows for the decade, prompting some market analysts to
question whether investors might have been underestimating the riskiness of
their portfolios.
Q.2. The Blue Book also states thai commercial bank lending spreads have also not
returned to pre-August levels; why is that?
A.2. The same factors that have influenced spreads on corporate bonds have also
been affecting bank lending spreads. Indeed, credit spreads in capital market instruments,
discussed in the answer to the first question, have not returned to pre-August 1998 levels,
and themselves are factors thai bank lending officers may consider in loan pricing
decisions. In addition, some loan spreads were at below-average levels in the first half of
1998, and a number of analysts then had raised concerns that they were too narrow:
Banking industry regulators had expressed such worries in a regulatory letter issued earlier
in the summer of 1998, encouraging banks to reassess their attitudes towards credit risk.
Third, charge-off and delinquency rates on bank loans, while still relatively low, have been
rising in recent quarters. Lastly, it is possible that the events of last fall have led banks to
reexamine their lending postures, much as have investors in bond markets.




66
Humphrey-Hawkins Teslimony
Rep. Frank Mascara's Questions for Chairman Greenspan
July 22, 1999

Q.I. You have stated today that reduction of the national debt has had an extraordinary
affect in the expansion of economic growth and that this is important for future
growth and price stability. You also responded to a question about the trigger by
noting that during economic downturn, capital gains and marginal rate lax cuts
could have a very positive effect on the economy when funded by surplus. Do you
then believe that it is short-sighted and harmful to enact tax cuts that consume the
entire surplus and eliminate the ability of Congress to respond to an economic
downturn in a manner that does not explode our national debt?
A.I. As I have noted on a number of occasions since last fall, when the prospect of
meaningful surpluses first began to become a feature of short-run economic forecasts, the
best possible course is to let those surpluses accumulate for a time. The direct result would
be a significant reduction in the publicly held federal debt, which would free up capital for
private investment. Such investment has played a crucial role in supporting the accelerated
productivity growth that has raised living standards and damped inflation in recent years.
Tax cuts would best be held in reserve until we are more assured that the projected
surpluses are being realized, and they could well be a useful tool at some future time when
aggregate demand is at risk of falling short of what our economy can accommodate. This
certainly is not the circumstance we are confronted with today.




67
Q.2.

In your statement you noted that productivity keeps rising. If Mr. Baehus' figures
are correct that import prices are falling, what is causing the upward pressure on
inflation which could trigger interest rate increases? Shouldn't prices be failing?
Shouldn't some of these decreasing costs he seen in consumer prices?
A.2. Steeper productivity gains have damped inflation. But, even with the

enlarged increases in output per worker hour, the growth of output has exceeded the pace
of expansion in the supply of workers and labor markets have tightened. Should that
process continue, the pressures of demand on supply are likely to lead to a stepup in the
pace of wage hikes relative to the rise in productivity-resulting in accelerated unit labor
cost increases. All else equa), unless prices are restrained even more than they have been
by competition from imports, domestic inflation will tend to rise.

Q.3. I have been, and continue to be, critical of our trade policies that continue to create
massive trade deficits—over $23 billion in May. I have a serious problem with the
steel dumping that has cost over 10,000 steelworkers their jobs (the recent trade
agreements with Russia and Brazil notwithstanding). In my opinion those
steelworkers' jobs have been sacrificed to keep the Russian economy and Asian
economies afloat enabling them to repay their debts and avoid default on their IMF
loans and investments of the private sector. Do you believe that the recent Russian
trade agreement is a satisfactory response to the illegal dumping problem facing our
steel industry? Does this type of action represent a government's best means to
challenge illegal subsidies?

A.3. You raise some important policy issues about the potential costs of free trade.
But please note that the large U.S. trade deficit is little affected by trade policy. While
trade policy can affect the composition of exports and imports, the trade balance is
determined primarily by movements in domestic saving and investment. The U.S. trade
deficit, or more exactly the related current account deficit, will decline only if domestic




68
savings increase or domestic investment declines. Moreover, the benefits of free trade are
abundant: it promotes the movement of capital and labor into their most productive uses,
strengthens competitive forces, facilitates innovation, and raises living standards. Indeed,
the experience of many countries in recent years shows a strong positive relationship
between openness to trade and income growth. Openness may also help to alleviate
inflationary pressures by enhancing price competition.
Judgements with respect to the US-Russia trade agreement are very difficult. I do
not believe I can add effectively to the dialogue.




For use at 11:00 a.m., E.D.T.
Thursday
July 22, 1999

Board of Governors of the Federal Reserve System

'•3&iBS&s
••:*«. Re**.-

Monetary Policy Report to the Congress
Pursuant to the
Full Employment and Balanced Growth Act of 1978
July 22, 1999




70

Letter of Transmittal

BOARD OF GOVERNORS OF THE
FEDERAL RESERVE SYSTEM
Washington, D.C., July 22. 1999
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




71
Table of Contents
Page
Monetary Policy and the Economic Outlook
Economic and Financial Developments in 1999




72

Monetary Policy Report to the Congress
Repon submitted to the Congress on July 22, 1999,
pursuant to the Full Employment and Balanced
Growth Act of 1978

MONETARY POLICY AND THE ECONOMIC
OUTLOOK
The US. economy has continued to perform well in
1999. The ongoing economic expansion has moved
into a near-record ninth year, with real output expanding vigorously, the unemployment rate hovering
around lows last seen in 1970, and underlying trends
in inflation remaining subdued. Responding to the
availability of new technologies at increasingly
attractive prices, firms have been investing heavily in
new capital equipment: this investment has boosted
productivity and living standards while holding down
the rise in costs and prices.
Two of the major threats faced by the economy in
late 1998—economic downturns in many foreign
nations and turmoil in financial markets around the
world—receded over the first half of this year. Economic conditions overseas improved on a broad front.
In Asia, activity picked up in the emerging-market
economies that had been battered by the financial
crises of 1997. The Brazilian economy—Latin
America's largest—exhibited a great deal of resilience with support from the international community,
in the wake of the devaluation and subsequent floating of the real in January. These developments, along
with the considerable easing of monetary policy in
late 1998 and early 1999 in a number of regions,
including Europe, Japan, and the United States, fostered a markedly better tone in the world's financial
markets. On balance, U.S. equity prices rose substantially, and in credit markets, risk spreads receded
toward more typical levels. Issuance of private debt
securities ballooned in late 1998 and early 1999, in
part making up for borrowing [hat was postponed
when markets were disrupted.
As these potentially contractionary forces dissipated, the risk of higher inflation in the United States
resurfaced as the greatest concern for monetary policy. Although underlying inflation trends generally
remained quiescent, oil prices rose sharply, other
commodity prices trended up, and prices of non-oil




imports fell less rapidly, raising overall inflation rates.
Despite improvements in technology and business
processes that have yielded striking gains in efficiency, the robust growth of aggregate demand,
fueled by rising equity wealth and readily available
credit, produced even tighter labor markets in the first
half of 1999 than in the second half of 1998. If this
trend were to continue, labor compensation would
begin climbing increasingly faster than warranted by
productivity growth and put upward pressure on
prices. Moreover, the Federal Open Market Committee (FOMC) was concerned that as economic activity
abroad strengthened, the firming of commodity and
other prices might also foster a less favorable inflation environment. To gain some greater assurance
that the good inflation performance of the economy
would continue, the Committee decided at its June
meeting to reverse a portion of the easing undertaken
last fall when global financial markets were disrupted; the Committee's target for the overnight federal funds rate, a key indicator of money market
conditions, was raised from 4% percent to 5 percent.
Monetary Policy, Financial Markets, and the
Economy over the First Half of 1999
The FOMC met in February and March against the
backdrop of continued rapid expansion of the U.S.
economy. Demand was strong, employment growth
was brisk, and labor markets were tight. Nonetheless,
price inflation was still low, held in check by a substantial gain in productivity, ample manufacturing
capacity, and low inflation expectations.
Activity was supported by a further settling down
of financial markets in the first quarter after a period
of considerable turmoil in the late summer and fall of
1998. In that earlier period, which followed Russia's
moratorium on a substantial portion of its debt payments in mid-August, the normal functioning of US.
financial markets had been impaired as investors cut
back sharply their ctedit risk exposures and market
liquidity dried up. The Federal Reserve responded
to these developments by trimming its target for the
overnight federal funds rate by 75 basis points in
three steps. In early 1999, the devaluation and subsequent floating of the Brazilian real in mid-January

73
Monetary Policy Report to the Congress D July 1999

Selected inierest

NOTE. TTte dflia ait daily Vertical lines indicate the <!*>& OR vwtmh **
Federal Reserve announced a rnooeiary policy action. The dales wi the horizon-

iri wre art those en which eifter the FOMC held a scheduled mee
policy action was announced Last observations an? for July 19 1949

heightened concerns foe a while, but mavket conditions overall improved considerably.
At ils February and March meetings, the FOMC
left the stance of monetary policy unchanged. The
Committee expected ihat the growth of output might
well slow sufficiently to bring production into close
enough alignment with the economy's enhanced
potential to forestall the emergence of a trend of rising inflation. Although domestic demand was still
increasing rapidly, it was anticipated to moderate
over time in response to the buildup of large stocks
of business equipment, housing units, and durable
goods and more restrained expansion in wealth in the
absence of appreciable further increases in equity
prices. Furthermore, the FOMC, after taking account
of the near-term effects of the rise in crude oil prices,
saw few signs that cost and price inflation was in the
process of picking up- The unusual combination of
very high labor resource utilization and sustained low
inflation suggested considerable uncertainty about the
relationship between output and prices. In this environment, the Committee concluded that it could wail
for additional information about the balance of risks
to the economic expansion.
By the time of the May FOMC meeting, demand
was still showing considerable forward momentum,
and growth in economic activity still appeared to
be running in excess of the rate of increase of the
economy's \ong-run capacity to expand output. Borrowers' heavy demands for credit were being met on
relatively favorable terms, and wealth was further
boosted by rapidly rising equity prices. Also, the
economic and financial outlook for many emergingmarket countries was brighter. Trends in inflation
were still subdued, although consumer prices—even

apart from a big jump in energy prices—were
reported to have registered a sizable rise in April.
At its May meeting, the FOMC believed thai these
developments tilted the risks toward further robust
growth that would exert additional pressure on
already taul labor markets and ultimately show
through to inflation. Moreover, a turnaround in oil
and other commodity markets mean) [hat prices of
these goods would no longer be holding down inflation, as they had over Ihe past year. Yet, the economy
to date had shown a remarkable ability to accommodate increases in demand without generating greater
underlying inflation trends, as the continued growth
of labor productivity had helped to contain cost pressures. The uncertainty about the prospects for prices,
demand pressures, and producliviiy was large, and
the Committee decided to defer any policy action.
However, in light of its increased concern about
the outlook for inflation, the Committee adopted
an asymmetric directive tilted toward a possible firming of policy. The Committee also wanted to inform
the public of ihis significant revision in its view, and
it announced a change in the directive immediately
after the meeting. The announcement was the first
under the Committee's policy of announcing changes
in the tilt of the domestic directive when it wants to
communicate a major shift in its view about the
balance of risks to the economy or the likely direction
of ils future actions.
In the lime leading up to the FOMC's June meeting, economic activity in the United Stales continued
to move forward at a brisk pace, and prospects in a
number of foreign economies showed additional
improvement. Labor markets lightened slightly further. The federal funds rale, however, remained at




74
Board of Governors of the Federal Reserve System

the lower level established in November 1998, when
the Committee took its last of three steps to counter
severe financial market strains. With those strains
largely gone, the Committee believed that the time
had come to reverse some of thai accommodation,
and it raised the targeted overnight federal funds rate
25 basis points, lo 5 percent. Looking ahead, the
Committee expected demand to remain strong, but
it also noted the possibility that a further pickup in
productivity could allow the economy to accommodate this demand for some time without added inflationary pressure. In light of these conflicting forces
in the economy, the FOMC returned to a symmetric
directive. Nonetheless, with labor markets already
tight, the Committee recognized that it needed to stay
especially alert lo signs that inflationary forces were
emerging that could prove inimical to the economic
expansion.
Economic Projections for 1999 and 2000
The members of the Board of Governors and the
Federal Reserve Bank presidents see good prospects
for sustained, solid economic expansion through next
year. For this year, the central tendency of their
forecasts of growth of real gross domestic product is
3'/a percent lo 33/4 percent, measured as (he change
I.

Economic projections for 1999 and 2000

Federal Res«vc govetnon
and Reserve Bank prendemi
Indicator

**»««.
n^
1*

Cemral
tendency

1999
Cfiangt, fourth quarter
lo fourth quartr'1
Nomat*! GDP
Real GDP
Consumer pn« index ' . .

4S4-J1*
Wr-t
i*i-;rt

i-5»
J'A-JW
iy.-l',4

Average bvet
ffourth
-\ *quarter ,
Civilian unenqiloynicix

Change, Jot/nth quarter
to fourth flmi/wr?
Nomimi GDP
. ...
Real GDP
ComunKt price indev'
Avtragf

Intl.

Civilian unemployment

4-4K
1. From the Mid-Session Review of the budget
2. Ctange hvnt mrsfe for fourth qiurbr of p
fourth ffuvier of yttf indicated




4.8
J-!
2.4

between the fourth quarters of 1998 and 1999. For
2000. the forecasts of real GDP are mainly in
ihe 2'A percent to 3 percent range. With this pace
of expansion, the civilian unemployment rate is
expected to remain close to the recent 4V4 percent
level over the next six quarters.
The increases in income and wealth dial have
bolslered consumer demand over the first half of this
year and the desire to invest in new high-technology
equipment that has boosted business demand during
ihe same period should continue to stimulate spending over the quarters ahead. However, several factors
are expected to exert some restraint on the economy's
momentum by next year. With purchases of durable
goods by both consumers and businesses having
risen still further and running at high levels, the
stocks of such goods probably are rising more rapidly
lhan is likely to be desired in the longer run, and
the growth of spending should moderate. The
increase in market interest rates should help to damp
spending as well. And unless the extraordinary gains
in equity prices of the past few years are extended,
the impetus to spending from increases in wealth will
diminish.
Federal Reserve policymakers believe that this
year's rise in the consumer price index (CPI) will be
larger than that in 1998. largely because of the
rebound in retail energy prices that has already
occurred. Crude oil prices have moved up sharply,
reversing the decline posted in 1998 and leading to a
jump in the CPI this spring. For next year, the FOMC
participants expect the increase in the CPI lo remain
around this year's pace, with a central tendency of
2 percent to 2>/2 percent. Futures market quotes suggest that the prevailing expectation is that the rebound
in oil prices has run its course now, and ample
industrial capacity and productivity gains may help
limit inflationary pressures in coming months as well.
With labor utilization very high, though, and demand
still strong, significant risks remain even after the
recent policy finning that economic and financial
conditions may turn out to be inconsistent with keeping costs and prices from escalating.
Although interest rates currently are a bit higher
than anticipated in the economic assumptions underlying the budget projections in the Administration's
Mid-Session Review, there is no apparent tension
between the Administration's plans and the Federal Reserve policymakers' views. In fact. Federal
Reserve officials project somewhat faster growth in
real GDP and slightly lower unemployment rates into
2000 than the Administration does, while the Administration's projections for inflation are within the
Federal Reserve's central tendencies.

75
Monetary Policy Report to the Congress D July 1999

2. Ranges for growth of monetary and debt aggregates
Perctni
ngfKfUe

KK
M3
DeW.

1998

i-i

2-6
3-7

1999

1-5

1-4
3-7

Provisional ft*
3000

i-s
•>-*

3-7

NofE. Change from avenge for fourth quarto of pmxdine ycflr I1
for founb quarter <Jl yon indicnted.

Money and Debt Ranges for 1999 and 2000
At its meeting in late June, the FOMC reaffirmed the
ranges for 1999 growth of money and debt that it had
established in February: 1 percent to 5 percent for
M2, 2 percent to 6 percent for M3, and 3 percent to
7 percent for debt of the domestic nonfinancial seclors. The FOMC set the same ranges for 2000 on a
provisional basis.
As has been the case since the mid-1990s, the
FOMC views the ranges for money growth as benchmarks for growth under conditions of price stability
and the historically typical relationship between
money and nominal income. The disruption of the
historically typical pattern of ihe velocities of M2
and M3 (the ratio of nominal GDP 10 the aggregates)
during the 1990s implies that the Committee cannot
establish, with any confidence, specific target ranges
for expected money growth for a given year that will
be consistent with the economic performance that
it desires. However, persistently fast or slow money
growth can accompany, or even precede, deviations
from desirable economic outcomes. Thus, the behavior of the monetary aggregates, evaluated in the context of other financial and nonfinancial indicators,
will continue to be of interest to Committee members
in their policy deliberations.
The velocities of M2 and M3 declined again in the
first half of this year, albeit more slowly than in 199S.
The Committee's easing of monetary policy in the
fall of 1998 contributed to the decline, but only to a
modest extent. It is not clear what other factors led to
the drop, although the considerable increase in wealth
relative to income resulting from the substantial gains
in equity prices over the past few years may have
played a role. Investors could be rebalancing their
portfolios, which have become skewed toward equities, by reallocating some wealth to other assets,
including those in M2.
Even if ihe velocities of M2 and M3 were to return
to their historically typical patterns over the balance
of 1999 and in 2000, M2 and M3 likely would be
at the upper bounds of, or above, their longer-term
price-stability ranges in both years, given the Com-




mittee's projections of nominal GDP growth. This
relatively rapid expansion in nominal income reflects
faster expected growth in productivity than when the
price-stability ranges were established in the mid1990s and inflation that is still in excess of price
stability. The more rapid increase in productivity, if it
persists for a while and is sufficiently large, might in
the future suggest an upward adjustment to the money
ranges consistent with price stability. However, considerable uncertainty attends the trend in productivity, and the Committee chose not to adjust the ranges
at its most recent meeting.
Debt of the nonfinancial sectors has expanded at
roughly the same pace as nominal income this year—
its typical pattern. Given the stability of this relationship, the Committee selected a growth range for the
debt aggregate that encompasses its expectations for
debt growth in both years. The Committee expects
growth in nominal income io slow in 2000, and with
it, debt growth. Nonetheless, growth of this aggregate
is projected to remain within the range of 3 percent to
7 percent.

ECONOMIC AND FINANCIAL
IN 1999

DEVELOPMENTS

The economy has continued to grow rapidly so far
this year. Real gross domestic product rose more than
4 percent at an annual rate in the first quarter of 1999,
and available data point to another significant gain
in the second quarter.1 The rise in activity has been
]. All figures from the national income and product accounts cited
here are subject 10 change in the quinquennial benchmark revisions
slated f« this fall.

Change in real GDP

k,
NOTE. to this chart and ui subsequent charts ihat *how ihc c
real GDP, changes are measured from the final quaitei of ihe previ
the final quarter of the period radicated

76
Board of Governors of she Federal Reserve System

The Household Sector

as measured, for example, by the University of
Michigan Survey Research Center (SRC) and Conference Board surveys—has remained quite upbeat in
this environment.
Growth of consumer spending in the first quarter
was strong in all expenditure categories. Outlays
for durable goods rose sharply, reflecting sizable
increases in spending on electronic equipment (especially computers) and on a wide range of other goods,
including household furnishings. Purchases of cars
and light trucks remained at a high level, supported
by declining relative prices as well as by the fundamentals that have buoyed consumer spending more
generally. Outlays for nondurable goods were also
robust, reflecting in part a sharp increase in expenditures for apparel. Finally, spending on services
climbed steeply as well early this year, paced by
sizable increases in spending on recreation and brokerage services. In the second quarter, consumers
apparently boosted their purchases of motor vehicles
further. In all, real personal consumption expenditures rose at more than a 4 percent annual rate in
April and May, an increase that is below the firstquarter pace but is still quite rapid by historical
standards.

Consumer Spending

Wealth and saving

brisk enough 10 produce further substantial growth of
employment and a reduction in the unemployment
rate to 4'A percent. Growth in output has been driven
by strong domestic demand, which in lum has been
supported by further increases in equity prices, by the
continuing salutary effects of government saving and
inflows of foreign investment on the cost of capital,
and by more smoothly functioning financial markets
as the turbulence that marked the latter pan of 1998
subsided. Against the background of the easing of
monetary policy last fall and continuing robust
economic activity, investors became more willing to
advance funds to businesses; risk spreads have
receded and corporate debt issuance has been brisk.
Inflation developments were mixed over the first
half of the year. The consumer price index increased
more rapidly owing to a sharp rebound in energy
prices. Nevertheless, price inflation outside of the
energy area generally remained subdued despite the
slight further tightening of labor markets, as sizable
gains in labor productivity and ample industrial
capacity held down price increases.

Real personal consumption expenditures surged
6% percent at an annual rate in the first quarter, and
more recent data point to a sizable further advance in
the second quarter. The underlying fundamentals for
the household sector have remained extremely favorable. Real incomes have continued to rise briskly
with strong growth of employment and real wages,
and consumers have benefited from substantial gains
in wealth. Not surprisingly, consumer confidence—
Change in real income and consumption
1982

Disposable personal income
Personal consumption expenditure

1994

1995




1996

1997

1986

NOTE. The weilA-io-incomc raoois ihe ratio of net wonh of household* ID
disposable personal income

1998

1999

Real disposable income increased at an annual rate
of y/i percent in the first quarter, with the strong
labor market generating marked increases in wages
and salaries. Even so, income grew less rapidly than
expenditures, and the personal saving rate declined
further; indeed, by May the saving rate had moved
below negative 1 percent. Much of the decline in the
saving rate in recent years can be explained by the
sharp rise in household net worth relative to disposable income that is associated with the appreciation

77
Monetary Policy Report to the Congress Q July 1999

Private housing starts

I

I

of households' slock market assets since 1995. This
rise in wealth has given households the wherewithal
to spend at levels beyond what current incomes
would otherwise allow. As share values moved up
further in the first half of this year, the wealth-toincome ratio continued to edge higher despite the
absence of saving out of disposable income.
Residential Investment
Housing activity remained robust in the first half of
this year. In the single-family sector, positive fundamentals and unseasonably good weather helped boost
starts to a pace of 1.39 million units in the first
quarter—the highest level of activity in twenty years.
This extremely strong level of building activity
strained the availability of labor and some materials;
as a result, builders had trouble achieving the usual
seasonal increase in the second quarter, and starts
edged off to a still-high pace of 1.31 million units.
Home sales moderated in the spring: Sales of both
new and existing homes were off some in May from
their earlier peaks, and consumers' perceptions of
homebuying conditions as measured by the Michigan
SRC survey have declined from the very high marks
recorded in late 1998 and early this year. Nonetheless, demand has remained quite robust, even in the
face of a backup in mortgage interest rates: Builders'
evaluations of new home sales remained very high at
mid-year, and mortgage applications for home purchases showed strength into July.
With strong demand pushing up against limited
capacity, home prices have men substantially,
although evidence is mixed as to whether the rate of
increase is picking up. The qualky-adjusted price of
new homes rose 5 percent over the four quarters




ended in I999:Q1, up from 3L/4 percent over the
preceding four-quarter period. The repeat sales index
of existing home prices also rose about 5 percent
between I998:Q1 and 1999:Q1, but this series posted
even larger increases in the year-earlier period. On
the cost side, tight supplies have led to rising-prices
for some building materials; prices of plywood, lumber, gypsum wallboard, and insulation have all moved
up sharply over the past twelve months. In addition,
hourly compensation costs have been rising relatively
rapidly in the construction sector.
Starts of multifamily units surged to 384,000 at an
annual rate in the first quarter and ran at a pace a bit
under 300,000 units in the second quarter. As in the
single-family sector, demand has been supported by
strong fundamentals, builders have been faced with
tight supplies of some materials, and prices have
been rising briskly: Indeed, apartment property values
have been increasing at around a 10 percent annual
rate for three years now.
Household Finance
In addition to rising wealth and rapid income growth,
the strong expenditures of households on housing and
consumer goods over the first half of 1999 were
encouraged by the decline in interest rates in the
latter part of 1998. Households borrowed heavily to
finance spending. Their debt expanded at a 9VS percent annual rate in the first quarter, up from the
83/j percent pace over 1998, and preliminary data for
the second quarter indicate continued robust growth.
Mortgage borrowing, fueled by the vigorous housing
market and favorable mortgage interest rates, was
particularly brisk in the first quarter, with mortgage
debt rising at an annual rate of 10 percent. In the
second quarter, mortgage rates moved up considerably, but preliminary data indicate that borrowing
was still substantial.
Consume! credit growth accelerated in the first half
of 1999. It expanded at about an 8 percent annual rate
compared with 5W percent for all of 1998. The
growth of nonrevolving credit picked up, reflecting
brisk sales and attractive financing rates for automobiles and other consumer durable goods. The expansion of revolving credit, which includes credit card
loans, slowed a bit from its pace in 1998.
Households apparently have not encountered added
difficulties meeting the payments associated with
their greater indebtedness, as measures of household
financial stress improved a bit on balance in the first
quarter. Personal bankruptcies dropped off considerably, although part of the decline may reflect

78
Board of Governors of At Federal Reserve System

Delinquency rates on household loans

1990

iwa

1994

tfmt. Tie daa o
SOUITE. Dura on otdil cud delinquenriei ait from bonk Call RtpocB: dam
on nito tan dcboqueiKW He from Ihc Big Thm mionakcn: daa on nmttgage debiic|DaKX4 KB front the Maigage Bankets A»ociMiOb.

the aftermath of a surge in filings in late 1998 that
occurred in response to pending legislation that
would limit the ability of certain debtors to obtain
forgiveness of their obligations. Delinquency rales on
several types of household loans edged lower. Delinquency and charge-off rates on credit card debt
moved down from their 1997 peaks but remained at
historically high rates. A number of banks continued
to tighten credit card lending standards this year, as
indicated by banks' responses to Federal Reserve
surveys.

The Business Sector
Fixed Investment
Real business fixed investment appears to have
posted another huge increase over the first half of
Change in real business fixed investment
tocenL •*•*! rut
G Structure
• Pmdiicm' dmtbte equipment

1994

1995




1996

19?!

199*

1999

1999. Investment spending continued to be driven
by buoyant expectations of sales prospects as well
as by rapidly declining prices of computers and
other high-tech equipment. In recent quarters, spending also may have been boosted by the desire to
upgrade computer equipment in advance of the rollover to the year 2000. Real investment has been
rising rapidly for several years now; indeed, the
average increase of 10 percent annually over the past
five years represents the most rapid sustained expansion of investment in more than thirty years.
Although a growing portion of this investment has
gone to cover depreciation on purchases of shortlived equipment, the investment boom has led to a
notable upgrading and expansion of the capital stock
and in many cases has embodied new technologies.
These factors likely have been important in the nation's improved productivity performance over the
past few years.
Real outlays for producers' durable equipment
increased at an annual rate of 9!/i percent in the first
quarter of the year, after having surged nearly 17 percent lasc year, and may well have re-accelerated
in the second quarter. Outlays on communications
equipment were especially robust in the first quarter,
driven by the ongoing effort by telecommunications
companies to upgrade their networks to provide a
full range of voice and data transmission services.
Purchases of computers and other information processing equipment were also up notably in the first
quarter, albeit below last year's phenomenal spending
pace, and shipments of computers surged again in
April and May. Shipments of aircraft to domestic
carriers apparently soared in the second quarter, and
business spending on motor vehicles, including
medium and heavy trucks as well as light vehicles,
has remained extremely strong as well.
Real business spending for nonresidentiat structures has been much less robust than for equipment,
and spending trends have varied greatly across sectors of the market. Real spending on office buildings
and lodging facilities has been increasing impressively, while spending on institutional and industrial
structures has been declining—the last reflecting
ample capacity in the manufacturing sector. In the
first quarter of this year, overall spending on structures was reported in the national income and product
accounts to have moved up at a solid 53/4 percent
annual rate, reflecting a further sharp increase in
spending on office buildings and lodging facilities.
However, revised source data indicate a somewhat
smaller first-quarter increase in nonresident] al construction and also point to a slowing in activity in
April and May from the first-quarter pace.

79
Monetary Policy Repori to ihe Congress D July 1999

Change m nonfarm business inventories

Before-tax profits of nonftnancial corporations
as a share of GDP

Ilklllll!
1994

I99S

1996 1997 1998

1999
1977

1980

1989

1983

1992

1995.

Inventory Investment
Inventory-sales ratios in many industries dropped
considerably early this year, as the pace of siockbuilding by nonfarm businesses, which had slowed
notably over 1998, remained well below the surge of
consumer and business spending in the first quarter.
Although production picked up some in the spring,
final demand remained quite strong, and available
monthly data suggest that businesses accumulated
inveniories in April and May at a rate not much
different from the modest firsl-quarter pace.
In the motor vehicle sector, makers geared up
production in the lauev part of 1998 lo boost inventories from their low levels after last summer's
strikes. Nevertheless, as with the business sector
overall, motor vehicle inventories remained on the
lean side by historical standards in the early part of
this year as a result of surprisingly strong vehicle
sales. As a consequence, manufacturers boosted the
pace of assemblies in the second quarter to the high-

est level in twenty years. With no noticeable signs of
a slowing in demand, producers have scheduled thirdquarter output to remain at the lofty heights of the
second quarter.

Corporate Profits and Business Finance
The economic profits of nonfinancial U.S. corporations rose considerably in the firs! quarter, even after
allowing for the depressing effect in the fourth
quarter of payments associated with the settlement
between the tobacco companies and the stales.
Despite the growth of profits, capital expenditures by
nonfinancial businesses continued lo outstrip internal
cash flow. Moreover, borrowing requirements were
enlarged by the net reduction in equity outstanding,
as the substantial volume of retirements from merger

Gross corporate txind issuance

1

1

Hllllll.lllllllll
I

F




M

1998

c opoanoiH. wiih inventory vabiakm and capiiat
coammpaon adjustment), divided by the prosj domestic producr or the nan.
financial corporate sector

A

M

J

J

A

S

O

N

D

J

F

M

A

M

J

80
Board of Governors of the Federal Reserve System

Spreads of corporate bond yields
over Treasury security yields

M A M J 1
1999
Han. The data art daily The spicod for below-invetoneK-gnde txndi
compare die yield on UK Merrill Lynch Muter U high-yield bond indei
compcnile with the yKid from Ihe wrn-yea-Treasury CHHUtf-maturily Knn:
(he other two ipreods compare yields on the appropriate Menill Lynch indexes
wiih lhal on a ten-year Tieaiuiy wcuriiy. LKI otuervaBom ire for July 19,
1999.

activity and share repurchase programs exceeded the
considerable volume of gross issuance of both initial
and seasoned public equities. As a result, businesses
continued to borrow at a brisk pace: Aggregate debt
of the nonfinancial business sector expanded at a
9'/> percent annual rate in the first quarter. As financial market conditions improved after the turmoil of
the fall, businesses returned to the corporate bond
and commercial paper markets for funding, and corporate bond issuance reached a record high in March.
Some of the proceeds were used to pay off bank
loans, which had soared in the fall, and these repayments curbed the expansion of business loans at
banks. Partial data for the second quarter indicate
thai borrowing by nonfinancial businesses slowed
somewhat.
Risk spreads have receded on balance this year
from their elevated levels in the latter part of 1998.
From the end of December 1998 through mid-July,
investment-grade corporate bond yields moved up
from historically low levels, but by less than yields
on comparable Treasury securities, and the spread
between these yields narrowed to a level somewhat
above that prevailing before the Russian crisis. The
rise in investment-grade corporate bond yields was
restrained, by investors' apparently increased willingness to hold such debt, as growing optimism about
the economy and favorable earnings reports gave
investors more confidence about the prospective
financial health of private borrowers. Yield spreads
on below-investment-grade corporate debt over comparable Treasury securities, which had risen consider-




ably in the latter part of 1998, also retreated. But in
mid-July, these spreads were still well above the thin
levels prevailing before the period of financial turmoil but in line with their historical averages.
In contrast 10 securities market participants, banks'
attitudes toward business lending apparently became
somewhat more cautious over the first half of the
year, according to Federal Reserve surveys. The average spread of bank lending rates over the FOMC's
intended federal funds rate remained elevated. On
net, banks continued to tighten lending terms and
standards this year, although the percentage that
reported tightening was much smaller than in the
fall.
The overall financial condition of nonfinancial
businesses was strong over the first half of the year,
although a few indicators suggested a slight deterioration. In the first quarter, the ratio of net interest
payments to corporate cash flow remained close to
the modest levels of 1998, as low interest rates continued to hold down interest payments. Delinquency
rates for commercial and industrial loans from banks
ticked up, but they were still modest by historical
standards. Similarly, over the first half of the year,
business failures—measured as the ratio of liabilities
of failed businesses to total liabilities—stepped up
from the record low in 1998. The default rale on
below-investment-grade bonds rose to its highest
level in several years, an increase stemming in part
from defaults by companies whose earnings were
impaired by the drop in oil and other commodity
prices last year. The total volume of business debt
that was downgraded exceeded slightly the volume of
debt that was upgraded.

The Government Sector
Federal Government
The incoming news on the federal budget continues
to be quite favorable. Over the first eight months of
fiscal year 1999—the period from October through
May—the unified budget registered a surplus of about
£41 billion, compared with $16 billion during the
comparable period of fiscal 1998. If the latest projections from the Office of Management and Budget and
the Congressional Budget Office are realized, the
unified budget for fiscal 1999 as a whole will show a
surplus of around $100 billion to $120 billion, or
more than 1 percent of GDP—a striking turnaround
from the outsized budget deficits of previous years,
which approached 5 percent of GDP in the early
1990s.

81
Monetary Policy Report to the Congress D July 1999

Federal receipts and expenditures as a share of nominal GDP

J_J-

I -L

I

I -1- I

>-l

'

NOTE. Data on receipt* and expenditure* are from the unified budget. Valu
fat 1999 an estimates from ihcCBO'i July I economic and budget updat.

As a result of this turnaround, the federal government is now contributing positively to the pool of
national saving. In fact, despite the recent drop in the
personal saving rate, gross saving by households,
businesses, and governments has remained above
17 percent of GDP in recent quarters—up from the
14 percent range that prevailed in the early 1990s.
This well-maintained pool of national savings,
together with the continued willingness of foreigners
to finance our current account deficits, has helped
hold down the cost of capital, thus contributing to our
nation's investment boom.
This year's increase in the federal surplus has
reflected continued rapid growth of receipts in combination with a modest increase in outlays. Federal
receipts were 5 percent higher in the first eighl
months of fiscal 3999 than in the year-earlier period.
With profits leveling off from last year, receipts of
corporate taxes have stagnated so far this fiscal year

However, individual income tax payments are up
appreciably, reflecting the solid gains in household
incomes and perhaps also a rise in capital gains
realizations large enough to offset last year's reduction in capital gains tax rates. At the same time,
federal outlays increased only 2'A percent in nominal
terms and barely at all in real terms during the first
eight months of the fiscal year, relative to the comparable year-earlier period. Spending growth has been
restrained in major portions of both the discretionary
(notably, defense) and nondiscretionary (notably, net
interest, social security, and Medicare) categories—
although [his year's emergency supplemental spending bill, at about $14 billion, was somewhat larger
than similar bills in recent years.
As for the part of federal spending that is counted
in GDP, real federal outlays for consumption and
gross investment, which had changed little over the
past few years, declined at a 2 percent annual rate
in the first quarter of 1999. A drop in real defense
outlays more than offset a rise in nondefense expenditures in the first quarter. And despite the military
action in the Balkans and the recent emergency
spending bill, defense spending appears to have
declined in the second quarter as well.
Federal debt held by private investors as a share
of nominal OOP

National saving as a share of nominal GDP

1978

1983

1WJ

1998

NOTE. Federal <Wn held by private Tnveiion is grou federal debt leas debc
held by federal govemmnil accounts and ihe Federal R«er« System. The
iitat ft* 1W» i> «B mbnae bucd cm toe CbO'i July 1 economic and budget
update

Nmt.
tod gavaamenu.




The budget surpluses of the past two years have
led to a notable decline in the stock of federal debt
held by private investors as a share of GDP. Since
its peak in March 1997, the total volume of Treasury
debt held by private investors has fallen by nearly
$130 billion. The Treasury has reduced its issuance
of interest-bearing marketable debt in fiscal 1999.

82
Board of Governors of the Federal Reserve System

The decrease has been concentrated in nominal coupon issues; in 1998, by contrast, the Treasury retired
both bill and coupon issues in roughly equal measure. Offerings of inflation-indexed securities have
remained an important part of the Treasury's overall
borrowing program; Since the beginning of fiscal
1999, the Treasury has sold nearly $31 billion of such
securities.

U.S. current account

0
— TO

—

1994

199S

1996

250

1997

and 2'/2 percent of GDP for 1998. A widening of the
deficit on trade in goods and services, to $215 billion
at an annual rate in the first quarter from $173 billion
in the fourth quarter of 1998, accounted for the
deterioration in the current account balance. Data for
April and May indicate that the trade deficit increased
further in the second quarter.
The quantity of imports of goods and services
again grew vigorously in the first quarter. The annual
rate of growth of imports, at 131A percent, continued
the rapid pace seen over 1998 and reflected the
strength of U.S. domestic demand and the effects of
past dollar appreciation. Imports of consumer goods,
automotive products, computers, and semiconductors
were particularly robust. Preliminary data for April
and May suggest that real import growth remained
strong, as nominal imports rose steadily and non-oil
import prices posted a moderate decline.
The volume of exports of goods and services
declined at an annual rate of 5 percent in the first
quarter. The decline partially reversed the strong
increase in the fourth quarter of last year. The weakChange in real imports and exports of goods and services

Trade and the Current Account




ISO

— 300

External Sector

The current account deficit reached $274 billion at an
annual rate in the first quarter of 1999, a bit more
than 3 percent of GDP, compared with $221 billion

100

—

— 203

State and Local Governments
The fiscal condition of state and local governments
has remained quite positive as well. Revenues have
been boosted by increases in tax collections due
to strong growth of private-sector incomes and
expenditures—increases that were enough to offset
an ongoing trend of tax cuts. Meanwhile, outlays
have continued to be restrained. In all, at the state
level, fiscal 1999 looks to have been the seventh
consecutive year of improving fiscal positions; of (he
forty-six states whose fiscal years ended on June 30,
all appear to have run surpluses in their general
funds.
Real expenditures for consumption and gross
investmeni by states and localities, which had been
rising only moderately through most of 1998, jumped
at a 7Va percent annual rate in the first quarter of this
year. This increase was driven by a surge in construction expenditures that was helped along by unseasonably favorable weather, and spending data for April
and May suggest that much of this rise in construction spending was offset in the second quarter. As for
employment, state and local governments added jobs
over the first half of the year at about the same pace
as they did last year.
Debt of state and local governments expanded at a
5*/z percent rate in the first quarter. The low interest
rate environment and strong economy encouraged the
financing of new projects and the refunding of outstanding higher-rate debt. Borrowing slowed to a
more modest pace in the second quarter, as yields on
long-dated municipal bonds moved up, but by less
than those on comparable Treasury securities. The
credit quality of municipal securities improved further over the first half of the year, with more issues
being upgraded than downgraded.

—

19*4

199S

1996

1997

1998

1999

83
Monetary Policy Report to the Congress D July 1999

ness of economic activity in a number of U.S. trading
partners and the strength of the dollar damped
demand for US. exports. Declines were registered in
aircraft, machinery, industrial supplies, and agricultural products. Exports to Asia generally turned down
in ihe first quarter from the elevated levels recorded
in the fourth quarter, when they were boosted by
record deliveries of aircraft to the region. Preliminary
data for April and May suggest that real exports
advanced slightly.

Measures of labof i

Augmented unemployment me

Capital Account
Foreign direct investment in the United States and
U.S. direct investment abroad remained robust in the
firsi quartet, reflecting brisk cross-border merger and
acquisition activity. On balance, net capital flows
through direct investment registered a modest outflow in ihe first quarter compared with a huge net
inflow in the fourth quarter. Fourth-quarter inflows
were swollen by several large mergers. Net foreign
purchases of U.S. securities also continued lo be quite
sizable but again were well below the extraordinary
pace of the fourth quarter. Most of the slowdown in
the first quarter is attributable to a reduced demand
for Treasury securities on ihe part of private investors
abroad. But capital inflows from foreign official
sources also slowed in the first quarter. U.S. residents
on net sold foreign securities in the first quarter, but
at a slower rate than in the previous quarter.
The Labor Market
Employment and Labor Supply
Labor demand remained very strong during the first
half of 1999. Payroll employment increased about
Change in total nonfarm payroll employment

jliilli
1991

1993




1995

1997

1999

1970

1930

1990

1995

2000

NOTh. The augin^ou^uMmfki^rti^r™ isto mm^
Ihose who are not tn die labor force sod wam a job-divided by ihe civilian labor
forte plus ibose who art not in ihe labor force and want a job. The break In daia
af January 1^44 maits ihe imroducLJon of a redesigned &urve>'i dafa from ihal
poini on are n« dirceify comparable *irh (hose of earlier periods

200,000 per month on average, which, although less
rapid than the 244,000 pace registered over 1998, is
faster than the growth of the working-age population.
With the labor force participation rate remaining
about fiat at jusv over 67 percent, the unemployment
rate edged down further from an average of 4'/i percent in 1998 to 4W percent in the first half of this
year—the lowest unemployment rate seen in the
United States in almost thirty years. Furthermore, the
poo! of potential workers, including no! just the
unemployed but also individuals who are owl of the
labor force but report that they want a job, declined
late last year to the lowest share of the labor force
since collection of these data began in 1970—and it
has remained near that low this year. Not surprisingly, businesses in many parts of the country have
perceived workers lo be in very short supply, as
evidenced by high levels of help-wanted advertising
and surveys showing substantial difficulties in filling
job openings.
Employment gains in the private service-producing
sector remained sizable in the first six months of the
year and more than accounted for the rise in oonfarm
payrolls over this period. Payrolls continued to rise
briskly in the services industry, with firms providing
business services (such as help supply services and
computer services) adding jobs especially rapidly.
Job gains were quite sizable in retail trade as well.
Within the service-producing sector, only the finance,
insurance, and real estate industry has slowed the
pace of net hiring from last year's rate, reflecting,
in pan. a slower rate of job gains in the mortgage
banking industry as the refinancing wave has ebbed.
Within the goods-producing sector, the boom in

84
Board of Governors of the Federal Reserve System

construction activity pushed payrolls in that industry
higher in the first six months of this year. But in
manufacturing, where employment began declining
more lhan a year ago in the wake of a drop in export
demand, payrolls continued to fall in the first half of
1999; in all, nearly half a million factory jobs have
been shed since March ] 998- Despite these job losses,
manufacturing output continued to rise in the first
half of this year, reflecting large gains in labor
productivity.

Labor Costs and Productivity
Growth in hourly compensation, which had been on
an upward trend since 1995, appears to have leveled
off and, by some measures, has slowed in the past
year. According to the employment cost index (ECI),
hourly compensation costs increased 3 percent over
the twelve months ended in March, down from
3'/2 percent over the preceding twelve-month period.
Part of both the earlier acceleration and more recent
deceleration in the ECI apparently reflected swings in
commissions, bonuses, and other types of "variable"
compensation, especially in the finance, insurance,
and real estate industry. But in addition, part of the
recent deceleration probably reflects the influence of
restrained price inflation in tempering nominal wage
increases. Although down from earlier increases, the
3 percent rise in the ECI over the twelve months
ended in March was well above the rise in prices over
this period and therefore was enough to generate
solid gains in workers' real pay.
The deceleration in the ECI through March has
been most pronounced in the wages and salaries
Measures of the change in hourly compensation

Q Employment cos imfci
• Nonfnrocomptnsnuon per ho

199)

1994

199S

1W6

1997

1998

1994

NOTE. The EG is for private industry excluding farm and household worten. Nonfium compensation per hour is for ihe uoofcrm business sector Values
for 1999:Q1 «eperceni changes from 1998rQ] lol»9:QI.




component, whose twelve-month change slowed
V4 percentage point from a year earlier. More
recently, data on average hourly earnings of production or nonsupervisory workers may point to a leveling off, but no further slowing, of wage growth: This
series was up at about a 4 percent annual rate over the
first six months of this year, about the same as the
increase over 1998. Growth in the benefits component of the ECI slowed somewhat as well in the year
ended in March, to a 2'/i percent increase. However,
employers' costs for health insurance are one component of benefits that has been rising more rapidly of
late. After showing essentially no change from 1994
through 1996, the ECI for health insurance accelerated to a 33A percent pace over the twelve months
ended in March.
A second measure of hourly compensation—the
Bureau of Labor Statistics' measure of compensation
per hour in the nonfarm business sector, which is
derived from compensation information from the
national accounts—has been rising more rapidly than
the ECI in the past few years and has also decelerated
less so far this year. Nonfarm compensation per hour
increased 4 percent over the four quarters ended in
the first quarter of 1999, 1 percentage point more
than the rise in the ECI over this period. One reason
these two compensation measures may diverge is that
the ECI does not capture certain forms of compensation, such as stock options and hiring, retention, and
referral bonuses, whereas nonfarm compensation per
hour does measure these payments.3 Although the
two compensation measures differ in numerous other
respects as well, the series' divergence may lend
support to anecdotal evidence that these alternative
forms of compensation have been increasing especially rapidly in recent years. However, because nonfarm compensation per hour can be revised substantially, one must be cautious in putting much weight
on the most recent quarterly figures from this series.
Rapid productivity growth has made it possible
to sustain these increases in workers' compensation
without placing great pressure on businesses' costs.
Labor productivity in the nonfarm business sector
posted another sizable gain in [he first quarter of
1999, and the increase over the four quarters ended in
the first quarter of 1999 was 2Vi percent. Indeed,
productivity has increased at a 2 percent pace since
1995—well above the trend of roughly 1 percent per

2. However, nonfaim compensation per hour captures the gains
from the actual exen-ue of slock options, whereas for analyzing
compensation trends, one might prefer ID measure the value of the
options al the time [hey are granitd.

85
Monetary Policy Report to the Congress D July 1999

Change in outpm per hour

Change in unit labor costs

111 1nidi

I

1991 1992 1993 IW4 1995 1996

.
from I998Q1|U|999:QI

• The value (011999 Ql is Ihc pen

year that had prevailed over the preceding two
decades.1 This recent productivity performance is alt
the more impressive given that businesses are
reported to have had to divert considerable resources
toward avoiding computer problems associated with
ihe century date change, and given as well thai businesses may have had lo hire less-skilled workers than
were available earlier in the expansion when the pool
of potential workers was not so shallow. Part of the
strength in productivity growth over the pas! few
years may have been a cyclical response lo the rapid
growth of output over this period. But productivity
may also be reaping a more persistent payoff from the
hoom in business investment and the accompanying
introduction of newer technologies that have occurred over ihe past several years.
Even these impressive gains in labor productivity
may not have kepi up fully with increases in firms'
real compensation costs of late. Over the past two
years, real compensation, measured by Ihe ECI relative (o the price of nonfarm business output, has
increased the same hefty 2V4 percent per year as labor
productivity; however, measured instead using nonfarm compensation per hour, real compensation has
increased somewhat more than productivity over this
period, implying a rising share of compensation in
total national income. A persistent period of real
compensation increases in excess of productivity
3. About ]/4 percentage point of The improvement in productivity
growth since 1995 cw be tttifotted lo changes in price measurement.
The measure of real output underlying the productivity figures since
1995 is deflated using CPI components that have been constructed
using i geometric-weansfomwla,itrat i-oirfxments tend to rise less
rapidly than the CPI components that had been used in the output and
productivity data before 1995. These smaller CPI increases translate
inio more tapid growth of wKpW lad productivity m OIK laier period.




Noit. Noafxm busi
from I998:QI l o l W r

1997 1998 1999

•. The value for 1999:01 » «* faam chanfe

growth would reduce firms' capacity to absorb further wage gains without putting upward pressure on
prices.
Prices
Price inflation moved up in early 1999 from a level
in 199ft that was depressed by a transitory drop in
energy and other commodity prices. After increasing
only about 1 '/i percent over 1998, the consumer price
index rose at a 2'/i percent annual rate over ihe first
six months oi'this year, driven by a sharp turnaround
in prices of gasoline and heating oil. However, the
so-called "core" CPI, which excludes food and
energy items, rose at an annual rate of only 1.6 percent over this period—a somewhat smaller increase
than thai registered over 1998 once adjustment is
Change in consumer prices

• Published
D Research senes u si ig current methods

•Li
1996

1997

1998

1999

NoTt Consumer pnce index tot all urban consumers. The research ser
has been extended imp 1999 aang Of pibliitEd CPI. ""'shits la 1999.HI
percent change! from Decembn 1998 w June 1999 M an tmniial rale.

86
Board of Governors of the Federal Reserve System

price declines have not been repeated more recently.
This year's rise in energy prices is the clearest example, bui commodity prices more generally have been
Published
turning up of late. The Journal of Commerce indusi Research series using current methods
trial price index has moved up about 6 percent so far
this year after having declined about 10 percent last
year, with especially large increases posted for prices
of lumber, plywood, and steel. These price movements are starting to be seen at later stages of processing as well: The producer price index for intermediate materials excluding food and energy, which
gradually declined about 2 percent over the fifteen
months through February 1999, retraced about half of
that decrease by June. Furthermore, non-oil import
1992
1993 1994 1995
1996
1997 1998
1
prices, although continuing to fall this year, have
NOTL. Consumer price ino>( for all urban consumers The research set
moved down at a slower rate than that of the past
has been extended ,„„ (99** using the published CPI Vahm for IWHI ,
couple of years when the dollar was rising sharply In
percent changes from December 199S tolune 1999 at an annual rate
foreign exchange markets. Non-oil import prices
declined at a W* percent annual rate over the first
made for the effects of changes in CP1 methodology:
half of 1999, after having fallen at a 3 percent rate, on
According 10 a new research series from the Bureau
average, over 1997 and 1998.
of Labor Statistics (BLS), the core CPI would have
Some other broad measures of prices also showed
increased 2.2 percent over 1998 had 1999 methods
evidence of acceleration early this year. The chainbeen in place in that year.4
type price index for GDP—which covers prices of all
The moderation of the core CPI in recent years has
goods and services produced in the United States—
reflected a variety of factors thai have helped hold
rose at about a 1W percent annual rate in the first
inflation in check despite what has been by all
quarter, up from an increase of about I percent last
accounts a very tight labor market. Price increases
year. A portion of this acceleration reflected movehave been damped by substantial growth in manufacments in the chain-type price index for personal
turing capacity, which has held plant utilization rates
consumption expenditures (PCE) that differed from
in most industries at moderate (and in some cases
movements in the CPI.
subpar) levels, thereby reinforcing competitive pressures in product markets. Furthermore, rapid productivity growth helped hold increases in unit labor costs
X Alternative measures of price change
to low levels even as compensation growth was pickPercent, annual rale
ing up last year. The rise in compensation itself has
IW6-Q4
1998O4
1M7CH
been constrained by moderate expectations of inflaPncc measure
to
ID
ID
1M1.O4
149B-Q4
I999-Q1
tion, which have been relatively stable. According
to the Michigan SRC survey, the median of oneFiud-vtiglu
Consumer pncc indeii
1.9
1.5
15
year-ahead inflation expectations, which was about
Excluding food anuenergy
2.2
11
1.6
2'/i percent late last year, averaged 2% percent in the
first half of this year.
Grass domestic product . .
...
1.7
9
1.6
Gross domesuc purchases
1.3
.4
1.2
The quiescence of inflation expectations, at Jeasi
Personal ttrtuumpl"™ eiprabnires . .
15
.7
1.2
Excluding food and energy
1.6
1.3
1.2
through the early part of this year, in turn may have
come in part from the downward movement in overNIITE. A nued'Wejgbt index lues Quantity weight. from rhe jasc yem to
aggregate price? from each drfffffcf He 01 cate^cry- A chauHHK index U the
all inflation last year resulting from declines in prices
geomeiric avciage of twDfined-weight indejies andallDwsrhewagtKs lo change
of imports and of oil and other commodities. These
each yea Changes are based on quanerly aveiages.
Change in consumer prices excluding food and energy

JteUM.Mx.iuUK

4 The most important change this year was [he introduction of ihe
geometric-means formula 10 segregate price quotes within most of the
detailed item categories (The Laspeyres formula continues to be used
in constructing higher-level aggregates.) Although these geometricmeans CPIs wen introduced inin Ihe official CPI only in January of
this year, Ihe BLS generated the series on an eipenmenial basis going
back several years, allowing them [o be built into the national income
and product accounts back to 1995.




Although the components of the CPI are key inputs
into the PCE price index, the two price measures
differ in a variety of respects: They use different
aggregation formulas; the weights are derived from
different sources; the PCE measure does not utilize
all components of the CPI; and the PCE measure is

87
Monetary Policy Report 10 the Congress D July 1999

broader in scope, including not jusi the out-of-pocket
expenditures by households that are captured by itie
CPI, but also the portion of expenditures on items
such as medical care and education that are paid by
insurers or governments, consumption of ilems such
as banks' checking services that are provided without
explicit charge, and expenditures made by nonprofit
institutions. Although PCE prices typically rise a bit
less rapidly than the CPI, the PCE price measure was
unusually restrained relative to the CPI in the few
years through 1998, reflecting a combination of the
above factors.
Last year's sharp drop in retail energy prices and
the subsequent rebound this spring reflected movements in the price of crude oil. The spot price of West
Texas intermediate (WTI) crude oil, which had stood
at about $20 per barrel through most of 1997,
dropped sharply over 1998 and reached SI 1 per barrel by the end of the year, reflecting in part a weakening in demand for oil from the distressed Asian
nations and increases in supply from Iraq and other
countries. But oil prices jumped this year as the
OPEC nations agreed on production restraints aimed
at firming prices, and the WTI spot price reached $18
per barrel in April and has moved still higher more
recently. As a result, gasoline prices, which dropped
15 percent over 1998, reversed almost all of thai
decline over the first six months of this year-Prices of
heating fuel also rebounded after dropping in 1998.
In all, the CPI for energy rose at a 10 percent annual
rate over the December-to-June period.
Consumer food prices increased moderately over
the first six months of the year, rising at a 1% percent
annual rate. Despite the upturn in commodity prices
generally, farm prices have remained quite low and
have helped to hold down food price increases. Spot
prices of wheat, soybeans, and sugar have moved
down further this year from already depressed levels
at the end of 1998, and prices of corn and coffee have
remained low as well.
The CPI for goods other than food and energy
declined at about a V4 percent annual rate over the
first six months of 1999. after having risen VA percent over 1998. The 1998 increase reflected a sharp
rise in tobacco prices in December associated with
the settlement of litigation between the tobacco companies and the states; excluding tobacco, the CPI for
core goods was about flat last year. The decline in the
first half of this year was concentrated in durable
goods, where prices softened for a wide range of
items, including motor vehicles. The CPI for nonenergy services increased about 2V5 percent at an
annual rate in the first half, down a little from the
increase over 1998. Increases in the CPI for rent




Domestic nonfinancial debt: Annual range and actual level

of shelter have slowed thus far in 1999, rising at a
21A percent annual rate versus a 3V* percent rise lasl
year. However, airfares and prices of medical services both have been rising more rapidly so far this
year.

Debt and the Monetary Aggregates
Debt and Depository Intermediation
The total debt of the U.S. household, government,
and nonfinancial business sectors increased at about a
6 percent annual rate from the fourth quarter of 1998
through May, a little above the midpoint of its growth
range of 3 percent to 7 percent. Nonfederal debt
expanded briskly at about a 9 percent annual pace, in
association with continued strong private domestic
spending on consumer durable goods, housing, and
business investment. By contrast, federal debt contracted at a 3 percent annual rate, as budget surpluses
reined in federal government financing needs.
Credit extended by depository institutions slumped
over the first half of 1999, after having expanded
quite briskly in 1998. A fair-sized portion of the
expansion in 1998 came in the fourth quarter and
stemmed from the turmoil in financial markets. In
that turbulent environment, depository institutions
postponed securitization of mortgages, and businesses shifted their funding demand from securities
markets to depository institutions, where borrowing
costs in some cases were governed by pre-existing
lending commitments. Depository institutions also
acquired mortgage-backed securities and other private debt instruments in volume, as their yields evidently rose relative to depository funding costs. As

88
Board of Governors of the Federal Reserve System

M3; Annual range and actual level

financial stresses unwound, securitizalion resumed,
business borrowers relumed to securities markets,
add net purchases of securities slowed. From the
fourth quarter of 1998 through June, bank credit rose
at a 3 percent annuatized pace, after adjusting for the
estimated effects of mark-to-market accounting rules.

Monetary Aggregates
The growth of M3, the broadest monetary aggregate,
slowed appreciably over the first half of 1999. M3
expanded at a 6 perceni annual pace from the fourth
quarter of 1998 through June of this year, placing this
aggregate at the top of the 2 percent to 6 percent
price-stability growth range set by the FOMC at its
February meeting. With depository credit growing
modestly, depository institutions trimmed the managed liabilities included in M3, such as large time

deposits. Growth of institutional money market
mutual funds also moderated from its rapid pace in
1998. Rates on money market funds tend to lag the
movements in markel rales because the average rate
of return on the portfolio of securities held by the
fund changes more slowly man market rates. -In the
fall, rates on institutional money market funds did not
decline as fast as market rates after the Federal
Reserve eased monetary policy, and the growth of
these funds soared. As rates on these funds moved
back into alignment with market rates this year,
growth of these funds ebbed.
M2 advanced at a 6'/i percent annual rate from the
fourth quarter of 1998 through June. M2 growth had
been elevated in late 1998 by unsettled financial
conditions, which raised the demand for liquid money
balances, and by the easing of monetary policy, which
reduced the opportunity costs of holding the assets
included in the monetary aggregates. M2 growth
moderated over the first half of 1999, as the heightened demand for money waned; in June this aggregate was above its 1 percent to 5 percent pricestability growth range. The growth in M2 over the
first half of the year again outpaced that of nominal
income, although (he decline in M2 velocity—the
ratio of nominal income to M2—was at a slower rate
than in 1998. The decline this year reflected in part
a continuing lagged response to the policy easing in
the fall; however, the drop in M2 velocity was again
larger than predicted on the basis of the historical
relationship between the velocity of M2 and the
opportunity costs of holding H2—measured as the
difference between the rate on three-month Treasury
bills and the average return on M2 assets. The reasons for the decline of M2 velocity this year are not
M2 velocity and the opportunity cost of holding M2

M2: Annual range and actual level




! I I I I I I 1 I 1-J 1 L I I - L I J-l I - L L J
19T8
1M^
19gg
1993
1998

Han TV du> ire epHSnty. lie vrionty ct M3 ii fee nao at Hpi
fas daimiiK praba to ikt sot* of M2. Ito npponnoi) cot of Ml
ivcnit of tf* (Mom* baw«s tt* lane-nun* Tiw
B «B aufttitcbded IB H2.

89
Monetary Policy Report to the Congress D July 1999

4.

Growth of money and deb(
ftment
Period

Ml

Anituai'
1989
I9»

1994

.

M2

M3

Domerfic
noafinaflcuJ defa

6

i.1

tl

7.5

4.!

4.2

1.9

6.7

2.)

«

1.1

4.9

Quafter1\ (tiivuial ralfl '

¥nar'to-<bnr*

No-is. Ml cousins of currency, irtvelm cherts, demand depttili. ind other
checkable cfeporil. ^ cocBiHS of MI plus savings deponu ltncJiHB.n|! mooey
maikel deposit accounts), unatl-denominiitioii time deposits, and balances in
retail money nmtet funds. Ml coruiiu of MI pin iBje-dewmlnaboii time
deposit*, balaoca in institutional money market funds. IIP liabilities (overnight
ind i=ml ind Eurodollars [overnight ma tarn}- Debt couutt ot Of wusiBoding credii marfcei debt of Ihe U.S. government, stale and local govern-

. hnuebokh and nonprofit oraanii . nonfinandal busiiwases, and
foot
I . From ivenit i« (001*1 qoBR of pncn£n( ycB 10 iveragc for fomUi
quaner of year indicated
2, FIDOI gtvrage fot prec^diag quanet to iwige for quartet inb^JKcd.
1 From intnge for fnunJi qumltr of 199)1 to average for June (May in Die
case of domeiric noflfimndsJ driK).

clear; the drop extends a trend in velocity evident
since mid-1997 and may in pan owe to households'
efforts [o allocate some wealth to the assets included
in MZ, &uch as deposits and money market mutual
fund shares, after several years of substantial gains in
equity prices thai greatly raised the share of wealth
held in equities.
Ml increased at a 2 percent annualized pace from
[he fourth quarter of 1998 through June, in line with
its advance in 1998. The currency component of Ml
expanded quite rapidly. The strength appeared to
stem from domestic, rather than foreign, demand,
perhaps reflecting vigorous consumer spending,
although currency growth was more robust than
might be expected for the rise in spending. The
deposits in Ml—demand deposits and other checkable deposits—contracted further, as retail sweep programs continued to be introduced. These programs,
which first began in 1994, shift funds from a depositor's checking account, which is subject to reserve
requirements, to a special-purpose money market
deposit account, which is not- Funds are then shifted
back to the checking account when the depositor's
account balance falls below a given level. The
depository institution benefits from a retail sweep
program because the program cuts its reserve requirement and thus the amount of non-interest-bearing
reserve balances that it must hold at its Federal
Reserve Bank. New sweep programs depressed the
growth of Ml by about 5'A percentage points over
the first half of 1999, somewhat less than in previous

years because most of the depository institutions that
would benefit from such programs had already implemented them.
As a consequence of retail sweep programs, the
balances that depository institutions are required to
hold at the Federal Reserve have fallen about 60 percent since 1994. This development has the potential
to complicate reserve management by the Federal
Reserve and depository institutions and thus raise the
volatility of the federal funds rate. It would do so
by making the demand for balances ai Ihe Federal
Reserve more variable and less predictable. Before
the introduction of sweeps, the demand for balances
was high and stable because reserve balance requirements were large, and the requirements were satisfied by the average of daily balances held over a
maintenance period. With sweep programs reducing
required balances to low levels, depository institutions have found that they target balances in excess of
their required balances in order to gain sufficient
protection against unanticipated debits that could
leave their accounts overdrawn at the end of the day.
This payment-related demand for balances varies
more from day to day than the requirement-related
demand. Thus far, the greater variation in the demand
for balances has not made the federal funds rate
appreciably more volatile, in part reflecting the successful efforts of depository institutions and the Federal Reserve to adapt to lower balances. For its part,
the Federal Reserve has conducted more open market
operations that mature the next business day to bet-




90
Boon! of Govtnton of OK Fetleral Reserv* System

ter align daily supply with demand. Nonetheless,
required balances at the Federal Reserve could drop
to levels at which the volatility of the funds rate
becomes pronounced. One way to address the problem of declining required balances would be to petroil ihe Federal Reserve to pay interest on the reserve
balances that depository institutions hold. Paying
interest on reserve balances would reduce considerably the incentives of depository institutions to develop reserve-avoidance practices that may complicate the implementation of monetary policy.
US. Financial Markets

Implied volatilities

J

F M A M t

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

19^

Yields on Treasury securities have risen this year in
response to the ebbing of the financial market strains
of late 1998, surprisingly strong economic activity,
concerns about the potential for increasing inflation,
and the consequent anticipation of tighter monetary
policy. In January, yields on Treasury securities
moved in a narrow range, as lingering safe-haven
demands for dollar-denominated assets, owing in put
to the devaluation and subsequent floating of the
Brazilian real, about offset the effect on yields of
stronger-than-expected economic daia. Over subsequent months, however, yields on Treasury securities,
especially at intermediate and long maturities, moved
up substantially. The demand for the safest and most
liquid assets, which had pulled down Treasury yields
in the fall, abated as the strength in economic activity
and favorable earnings reports engendered optimism
about the financial condition of private borrowers and
encouraged investors to buy private securities. In
addition, rising commodity prices, tight labor markets, and robust economic activity led market participants lo conclude that monetary policy would need to
be tightened, perhaps in a series of steps. This view,
accentuated by Ibe FOMC's announcement after its
May meeting that it had adopted a directive lilted
toward tightening policy, also boosted- yields.
Between the end of 1998 and mid-July, Treasury
yields added about 80 basis points to 110 basis points,
on balance, with the larger increases in the intermediate maturities. The rise in Treasury bill rates,
anchored by the modest upward move in the FOMC's
target federal funds rate, was much less, about
10 basis points to 40 basis points.
The recovery in fixed-income markets over the first
half of the year was evident in a number of indicators
of market conditions. Market liquidity was generally
better, and volatility was lower. The relative demand
for the most liquid Treasury securities—the most
recently auctioned security at each maturity—was




]

I'm

NOTE- TT» dm at (My. Irapta-J mtaffioo me nfcrtirit from afbtfi
1999.

not so acute, and yields on these securities were in
somewhat closer alignment with yields on issues that
had been outstanding longer. Dealers were more willing to put capital at risk to make markets, and bidasked spreads in Treasury securities narrowed somewhat, though, in June they were still a bit wider than
had been typical. Market expectations of asset price
volatility, as reflected in prices on Treasury bond
options contracts, receded on balance. The implied
volatility of bond prices dropped off until April and
then turned back up, as uncertainty about the timing
and extent of a possibtt tightening of monetary policy increased.
Yields on inflation-indexed Treasury securities
have only edged up this year, and the spreads between
yields on nominal Treasury securities and those on
comparable inflation-indexed securities have widened considerably. Yields on inflation-indexed securities did not decline in late 1998 like those of their
nominal counterparts, in part because these securities
were not perceived as being as liquid as nominal
Treasury securities. Thus, as the safe-haven demand
for nominal Treasury securities unwound and nominal yields rose, yields on inflation-indexed securities
did not move up concomitantly. Moreover, these
yields were held down by some improvement in
the liquidity of Ihe market for inflation-indexed
securities, as suggested by reports of narrower bidasked spreads, which provided additional impetus
for investors to acquire these securities. Because of
such considerations, the value of the yielcLspread
between nominal and inflatton-jndexed "F^isury
securities as an indicator of inflation expectations is
limited. Nonetheless, the widening of the spread
this year may have reflected some rise in inflation
expectations.

91
Monetary Policy Report to the Congress Q July 1999

Major slock price indexes

to prices, as measured by the S&P 500 index, was
near the record low established in May. Meanwhile,
real interest rates, measured as the difference between
the yield on the nominal (en-yeat Treasury note and
a survey-based measure of inflation expectations,
moved up. Consequently, the risk premium for holding equities remained quite small by historical
standards.
Year 2000 Preparedness

Niiit. The <Wa IK daily. Lail observations are forluly 19. 1999.

Equity prices have climbed this year. Major equity
price indexes posted gains of 10 percent to 31 percent, on balance, between the end of 1998 and
July 16, when most of them established record highs.
The lift to prices from stronger-than-anticipa ted economic activity and corporate profits apparently has
offset the damping effect of rising bond yields. Prices
of technology issues, especially Internet slocks, have
risen considerably on net, despite some wide swings
in sentiment. Share prices of firms producing primary
commodities, which tumbled in the fall, rebounded to
post large price gains, perhaps because of the firming
of commodity prices amid perceptions that Asian
economies were improving. Consensus estimates of
earnings over the coming rwelve months have
strengthened, but in June the ratio of these estimates
Equity valuation and the ten-year real interest taw

I

Ten-yearrealinum ate "
June 2
I i I 1 L I I .1 t ( l i t ' _L ' l._j ' J
1980
1983
I9S6
1M9
1992
199i
IMS

NOTE. TlK(iittiremD«<Wy.Thei»™iip-pri™rniotib«i<dim!hel/B/E/S
bneraabonid. inc.. cnucuaE eflinme of earnings ottr the coming twelve
OKMhi. Tbc ml iMHefl ate a (be yield on OK (en-yev Treatmy me leu UK
mown at ten-yen nHibofl tifevgaaa from W Federal Retove Bank of
Philidetptiii sWwj n( Pnieuimial Foramen.




The Federal Reserve and the banking system have
largely completed preparing technical systems to
ensure that they will function at the century date
change and are taking steps to deal with potential
contingencies. The Federal Reserve successfully
completed testing all of its mission-critical computer
systems for year 2000 compliance, including its securities and funds transfer systems. As a precaution to
assure the public that sufficient cash will be available
in the event that demand for U.S. currency rises
in advance of the century date change, the Federal
Reserve will increase considerably its inventory of
currency by late 1999. In addjdon, the Federal
Reserve established a Century Date Change Special
Liquidity Facility to supply collateral!zed credit
freely to depository institutions at a modest penalty to
market interest rates in the months surrounding the
rollover. This funding should help financially sound
depository institutions commit more confidently to
supplying loans to other financial institutions and
businesses in the closing months of 1999 and early
months of 2000.
All depository institutions have been subject to
special year 2000 examinations by their banking
supervisors to ensure their readiness. Banks, in turn,
have worked with their customers to encourage
year 2000 preparedness by including a review of a
customer's year 2000 preparedness hi their underwriting or loan-review standards and documentation.
According to the Federal Reserve's May 1999 Senior
Loan Officer Opinion Survey, a substantial majority
of the respondent banks have largely completed
year 2000 preparedness reviews of their material
customers. Most banks reported that only a small
ponton of iheir customers have not made satisfactory
progress.
Banks in the Federal Reserve's survey reported
little demand from their clients for special contingency lines of credit related to the century date
change, although many expect demand for such lines
to increase somewhat as the year progresses. Almost
all domestic respondents reported that they are will-

92
Board of Governors of the Federal Reserve System

ing to extend such credit lines, although in some
cases with tighter standards or terms.

International

Developments

Global economic prospects look considerably
brighter than they did only a few months ago. To
an important degree, this improvement owes to the
rebound in the Brazilian economy from the turmoil
experienced in January and February and to the fact
thai the fallout from Brazil on other countries was
much less than it might have been. The fear was that
ibe collapse of the Brazilian real last January would
unleash a spiral of inflation and further devaluation
and lead 10 a default on government domestic debt,
destabilizing financial markets and triggering an
intensified flight of capital from Brazil. In light of
events following the Russian debt moratorium and
collapse of the ruble lasl year, concern existed that a
collapse of the real could also have negative repercussions in Lafin America more broadly, and possibly even in global financial markets.
Developments in Brazil turned out belter than
expected over the weeks after the floating of the real
in January. Between mid-January and early March,
the real lost 45 percent of its value against the dollar,
reaching a low of 2.2 per dollar, but then started to
recover after the Brazilian central bank raised the
overnight interest rate from 39 percent to 45 percent
and made clear that it gave a high priority to fighting
inflation. By mid-May, the real had strengthened
to 1.65 per dollar, even while the overnight rate had

Brazilian financial indicators

Exchange rale index

] tMAMJ J A SOND J FMAMJ l A S O N D J FMAMI I

19OT

1998

IW9

NOTE. TIE nod iodn ii It* Bompa inten from the S*> Piolo Eidwigt
lu aiAaf 6ty of the mandi. The ovtntigtii iifem nlc b the tvunjt moodily
SEUC we. The CMtamjt me indu ii die *ma& moodily Wucml ndmaf
meo.idiiheUS.ddUv.




been cut, in steps, from its March high. The overnight
rate was reduced further, to 21 percent by the end of
June, but the real fell back only modestly and stood
at about 1.80 per dollar in mid-July. Brazil's stock
market also rose sharply and was up by about 65 percent in the year to date.
Several favorable developments have worked to
support the real and equity prices over the past few
months. Inflation has been lower man expected, with
consumer price inflation at an annual rate of around
8 percent for the first half of the year. Greater-lhanexpected real GDP growth in the first quarter, though
attributable in part to temporary factors, provided
some evidence of a bottoming out, and possible
recovery, in economic activity over (he first part of
this year. And in the fiscal arena, the government
posted a primary surplus of more than 4 percent of
GDP in the first quarter—well above the goal in the
International Monetary Fund program. The positive
turn of events has facilitated a return of the Brazilian
government and private-sector borrowers to international bond markets, albeit on more restrictive terms
than those of a year ago.
Since the middle of May. however, the road to
recovery in Brazil has become bumpier. The central
government posted a fiscal deficit in May that was
bigger than had been expected. In addition, court
challenges nave called into question fiscal reforms
enacted earlier this year that were expected to
improve the government's fiscal balance by about
1 percent of GDP. In May, the rise in US. interest
rates associated with the anticipated tightening in the
stance of U.S. monetary policy helped push Brady
bond yield spreads up more than 200 basis points.
Although they narrowed some in June they widened
recently on concerns about Argentina's economic
situation.
The Brazilian crisis did trigger renewed financial
stress throughout Latin America, as domestic interest
rates and Brady bond yield spreads increased shaiply
in January from levels that had already been elevated
by the Russian crisis. Nonetheless, these increases
were generally smaller than those that had followed
the Russian crisis, and as developments in Brazil
proved more positive than expected, financial conditions in the rest of me region stabilised rapidly. Even
so, the combination of elevated risk premiums and
diminished access to international credit markets.
as well as sharp declines in the prices of commodity exports, had significant consequences for GDP
growth, which began to slow or turn negative
throughout the region in late 1998 and early 1999.
Mexico appears to have experienced the least diminution in economic growth, Kfcely because of its

93
Monetary Policy Report 10 [he Congress D July 1999

strong trade links with the United States, where
growth has been robust. A flattening in Mexican
GDP in ilie final quarter of 1998 has given way 10
renewed, but moderate, growth more recently, and
the Mexican peso has appreciated by about 5]/i percent relative to the dollar since ihe start of the year.
By contrast, economic activity in Argentina declined
sharply in the first quarter, in pan because of the
devaluation and relatively weak economic activity
in Brazil, Argentina's major trading partner. More
recently ihe earlier recovery in Argentina's financial
markets appears 10 have backtracked as concern has
increased aboul the medium- to long-run viability of
(he currency peg to the dollar. Several countries in
the region, including Venezuela, Chile, and Colombia, also experienced sharp declines in output in ihe
first quarter, stemming in part from earlier declines in
oil and other commodity prices.
In emerging Asia, signs of recovery in financial
markets and in real activily are visible in most of the
countries that experienced financial crises in laic
1997. However, the pace and extent of recovery is
uneven across countries. The strongest recovery has
been in Korea. In 1998, the Korean won reversed
nearly half of its sharp depreciation of late 1997.
It has been liitle changed on balance this year, as
Korean monetary authorities have iniervened to moderate its further appreciation. Korean stock prices
have also staged an impressive recovery—moving up
about 75 percent so far in 1999. Sn the wake of its
financial crisis, output in Korea fell sharply, with
industrial production down about 15 percent by the
middle of las! year. Since then, however, production
has bounced back. With the pace of the recovery
accelerating ihis year, all of the post-crisis drop
in production has been reversed. This turnaround
reflects both the improvement in Korea's external
position, as the trade balance has swung into substantial surplus, and the government's progress in
addressing ihe structural problems in the financial
and corporate sectors thai contributed to the crisis.
Financial markets in the Southeast Asian countries
that experienced crises in 1997 (Thailand, Singapore,
Malaysia, Indonesia, and the Philippines) apparently
were little affected by spillover from Bra/.il's troubles
earlier this year and have recovered on balance over
the past year, with exchange rates stabili/ing and
stock prices moving higher. Financial conditions have
been weakest in Indonesia, in large pact a result of
political uncertainty; but even so, domestic interest
rates have dropped sharply, and the stock market has
staged an impressive rebound since April, The recovery of economic activity in these countries has been
slower and less robust than in Korea, possibly reftect-




Stock prices in developing Asian

J F M A M J J A SON!) J F M A M J J A S O N D I F M A . M I J
1997
'
IW8
1W9
\OTt Thedaiaaie f« the Ittllrodinp tey rfflK monlh The July obseivpnons are la July 19 Indctu arc capitalization-weighted flverajcs of all slocks
traded on a country's slock exchange

ing slower progress in addressing structural weaknesses in the financial and corporate sectors. However, activity appears to have bottomed out and has
recently shown signs of starting to move up in ihesc
countries.
Financial markets in China and Hong Kong experienced some turbulence at the start of the year when
Chinese authorities put the Guangdong International
Trust and Investment Corporation (G1TIC) into bankruptcy, leading to rating downgrades for some Chinese financial institutions, including the major state
commercial banks. The GITIC bankruptcy also raised
concerns about Hong Kong financial institutions,
which are heavy creditors to Chinese entities. These
concerns contributed to a substantial increase in yield
spreads between Hong Kong government debt and
U.S. Treasury securities and to a fall in the Hong
Kong stock market of about 15 percent. Spreads have
narrowed since, falling from about 330 basis points
on one-year debt in lale January to about 80 basis
points by mid-May, and have remained relatively
stable since then. Equity prices also rebounded
sharply, rising nearly 50 percent between rnidFcbruary and early May. Despite sizable volatility in
May and June, ihey are now roughly unchanged from
early May levels.
In Japan, a few indicators suggest that recovery
from a prolonged recession may be occurring. Principally, first-quarter GDP growth at an annual rate of
1.9 percent was recorded—the first positive growth
in six quarters. This improvement reflects in part a
shift toward more stimulative fiscal and monetary
policies. On Ihe fiscal front, the government
announced a set of measures at the end of last year
that were slated for implementation during 1999 and

94
Board of Governors of the Federal Reserve System

included permanent curs in personal and corporate
income taxes, various investment incentives, and
increases in public expenditures. The large-scale fiscal expansion and concern about increases in the
supply of government bonds caused bond yields 10
more than double laic lasl year and early this year, to
a level of aboul 2 percent on the ten-year bond.
In mid-February, primarily because of concern
about the prolonged weakness in economic activity
and pronounced deflationary pressures but also in
response (o the rising bond yields, ihe Bank of Japan
announced a reduction in the large! for ihe overnight
call-money rale and subsequently guided the rale lo
its present level of 3 basis points by early March.
This easing of monetary policy had a stimulative
effect on Japanese financial markets, with the yield
on the ten-year government bond falling more than
75 basis points, to 1.25 percent by mid-May. More
recently, the yield has risen to about 1.8 percent,
partially in response to the release of unexpectedly
strong first-quarter GDP growth. Supportive monetary conditions, coupled with restructuring announcements from a number of large Japanese firms and
growing optimism aboul the economic outlook, have
fueled a rise in the Nikkei from around 14,400 over
the first two months of (he year 10 over 18,500 in
mid-July.
The improved economic performance in Japan also
reflects some progress on addressing persistent problems in the financial sector. In March the authorities
injected T/i trillion yen of public funds into large
financial institutions and began to require increased
provisioning against bad loans as wetl as improved
financial disclosure. Although much remains to be
done, these actions appear to have stabilized conditions, al leasl temporarily, in the banking system, and
the premium on borrowing rates paid by leading
Japanese banks declined to /ero by March.
The yen strengthened in early January, supported
by the runup in long-term Japanese interest rates,
reaching about J 1 0 per dollar—its highest level in
more than two years. However, amid apparent intervention by the Japanese authorities, the yen retreated
to a level above 116 per dollar, and it remained near
that level until the mid-February easing of monetary
policy and Ihe subsequent decline of interest rates
when it depreciated to about 120 per dollar. In midJune, the Japanese authorities intervened in the foreign exchange market in an effort to limit appreciation of the yen after the surprisingly strong firstquarter GDP release increased market enthusiasm for
that currency. The authorities noted that a premature
strengthening of (he yen was undesirable and would
weigh adversely on economic recovery.




In the other major industrial countries, the pace
of economic growth this year has been mined. Economic developments in Canada have been quite
favorable. GDP rose 4'/4 percent at an annual rate in
the first quarter after a. fourth-quarter gain of 4Va percent, with production fueled by strong demand for
Canadian products from the United States. Core inflalion remains low, near the lower end of the Bank
of Canada's target range of 1 percent to 3 percent,
although overall inflation rose some in April and
May. Oil prices and other commodity prices have
risen, and the current account deficit has narrowed
considerably. These factors have helped the Canadian
dollar appreciate relative to the U.S. dollar by about
4 percent this year and have facilitated a cut in
short-term interest rates of 50 basis points by the
Bank of Canada. Along wiih rising long-term interest
rales elsewhere, long rates have increased in Canada
by about 30 basis points over the course of this year.
Even so, equity prices have risen about 12 percent
since the start of the year, although the rise in longterm rates has undercut some of the momentum in the
siock market.
In the United Kingdom, output was flat in the first
quarter, coming off a year in which GDP growth had
already slowed markedly. However, the effects of
aggressive interest rale reductions undertaken by the
Bank of England in late 1998 and earlier this year
appear to have emerged in the second quarter, with
gains in industrial production, retail sales volume,
and business confidence. Inflationary pressures have
been well contained, benefiting in part from the continued slrenglh in sterling; the Bank of England cut
interest rates, most recently in June, to reduce the
likelihood of inflation undershooting iis larget of
2'/2 percent. Consistent with expectations of an
upturn in growth, equity prices have risen more than
15 percent, and long-term bond yields have climbed
nearly 80 basis points since the end of last year.
First-quarter growfh in the JSuropean countries that
have adopted a common currency (euro area)
regained some momentum from its slow pace in late
1998 but was nevertheless below potential, as production continued to react to the decline in export
orders registered over the course of 1998 and in early
1999. Still, the drag on overall production from weak
export demand from Asia and eastern Europe appears
to have lifted a bit in the past few months, although
the signs of a pickup in growth were both tentative
and uneven across the euro area. In Germany, industrial production was higher in April and May than in
the preceding two months, and export orders were
markedly higher in those months than they had been
at any time since the spring of 1998. But in France,

95
Monetary Policy Report to the Congress D July 1999

which had been the strongest of the ihree largest
euro-area economies in 1998, GDP growth was a
meager 1 Vt perceni at an annual fate in the first
quarter, and industrial production slipped in April,
On average in the euro area, inflation has remained
quite tame, even as rising oil prices, a declining euro,
and, at least in Germany, an acceleration in wage
rales have raised inflationary pressures this year. The
low average rate of inflation as well as the still
sluggish pace of real activity in some of the euro-area
countries led the European Central Bank to lower the
overnight policy rate by 50 basis points in April, on
top of cuts in short-term policy rates made by the
national central banks late last year that, on average,
were worth about 60 basis points.
Notwithstanding Ihe easing of the policy stance,
long-term government bond yields have risen substantially from their January lows in the largest
economies of the euro area. Ten-year rates spiked in
early March along with U.S. rates, fell back some
through mid-May, and then resumed an upward
course around the time the FOMC adopted a tightening bias in mid-May. Since the middle of June, a
relatively sharp increase in yields has pushed them to
about 100 basis points above their values at the start
of the year and has narrowed what had been a growing interest rate differential between U.S. and European bonds. In addition to the pressure provided by
the increase in U.S. rates, the runup in European
yields likely reflects the belief that short-term rates
have troughed, as the incipient recovery in Asia not
only reduces the drag on European exports but also
attenuates deflationary pressures on European import
prices. Concern about the fall in the exchange value
of the euro may also have contributed to an assessment that the next move in short-term rales would be
\»p. Gains in equity prices so far this year—averaging
about \1Vi percent—are also suggestive of the belief
that economic activity may be picking up, although
the range in share price movements is fairly broad,
even considering only the largest economies: French
equity prices have risen about 20 percent, German
prices are up 13 percent, and Italian prices are up
only 5 percent.
The new European currency, the euto, came into
operation at the stan of the year, marking the beginning of Stage Three of European Economic and
Moneiary Union. The rates of exchange between the




Nominal dollar eichange rate indexes
M4n.la.unry IW = 100

Mapx cunercies

1 F M A M I ) A S O N D I F M A M J I A S O N D ) F M A M IJ

1991

1998

1W

NOTE. The data rat monthly iverages The euro-Area enchange rare rises rj
reused German mart before January 1999. The major currency infc* it t
UBOe-weighled avenge °f *e exchange value of die dollar agnin&l majo

euro and the currencies of the eleven countries adopting the euro were set on December 31; based on these
rates, the value of the euro at the moment of its
creation was $1.16675. Trading in the euro opened
on January 4, and after jumping on the first trading
day, its value has declined relative to the dollar
almosi steadily and is now about 13 perceni below its
initial value. The course of the euro-dollar exchange
rate likely has reflected in part the growing divergence in boll) the cyclical positions and, until
recently, long-term bond yields of the euro-area
economies and the United States. Concerns about
fiscal discipline in Italy—the government raised
its 1999 deficit-to-GDP target from-2.0 percent
to 2.4 percent—and about progress on structural
reforms in Germany and France have also been cited
as contributing to weakness in the euro, with the
European Central Bank recently characterizing
national governments' fiscal policy plans as
"unambitious."
On balance the dollar has appreciated more than
4W percent against an index of the major currencies
since the end of last year, owing mainly 10 its
strengthening relative to the euro. Nevertheless, it
remains below its recent peak in Augusl of last year
when the Russian debl moratorium and subsequent
financial market turmoil sent the dollar on a twomonth downward slide.

96

CONGffiSaONM-DUDCETOFnCE
US. CONGRESS
WASHINGTON, DC 20615

OmL.CripfMn
Olraetor

July 15,1999
MEMORANDUM
Preliminary Euiaum of Effective Tax Rates
The attached tables, prepared ai the request of die Committee on Ways and Means, provide
B££liffliafla csiimatcs of effective lax rates and shares of family income and taxes paid by income
category for ihe period from 1977 through 1995 and projected for 1999. The projections for 1999
art based on actual data tor 1995. The effective tax rate numbers for all years shown in the table
have bun published previously but the methodology used to estimate them has changed over unwIn particular, we have changed our method of allocating corporate taxes from one that split the
corporate income tax between workers and owners of capital to one that assigns the whole rax to
owners of capital.
As a result of the changed methodology, a table of effective tax rates derived from previously
published numbers would be inconsistent. The values in the attached table were all calculated based
on the newer methodology and thus provide comparable information across the period. Values for
more recent years match published tables, but values for earlier years differ from previous tables.
The table is labeled as preliminary because we are still in the process of making adjustments EO our
data bases and methodology. In particular, we are reviewing the measure of income used to classify
families. As indicated in the table footnotes, families are classified by adjusted family income,
which equals total cash income plus the employer share of Social Security and federal
unemployment insurance payroll taxes and the corporate income tax, adjusted for differences in
family size by the equivalence scale implicit in the official federal poverty thresholds. The income
measure excludes all income received in kind. Any chanecstoour measure of income, our basis for
ranking families, or our calculation of effective tax rates would lead to different values from those
shown in the tabte. so you should exercise caution in how you cite th* numbers. We are providing
the preliminary table only to ensure that comparable historical values are available rather than the
inconsistent values published over (he last ten years.
Federal taxes include individual and corporate income taxes, payroll taxes, and excise taxes.
Individual income taxes art; distributed directly to families paying those taxes. Payroll taxes are
distributed to families paying those taxes directly, or indirectly through their employers. Federal
excise taxes are distributed to families according to their consumption of the taxed good or service.
Corporate income taxes are distributed to families according to their share of capital income.

Artachmrnu




Preliminary Estimates of Effective Tax Rates
By Income CiUf**. l977-l9»«ndP<QjMw4 IW9
Income
Ctutory

Projected
1977

1979

19*1

I9R3

1915

,917

IW3

im

70.7

21 4

21.3
212
209
JI.7

212
71.1
21.2
21 .J
225

23.7
33,1
215
22.6
23.6

1919

1991

19.4

19.J

19-5

19.9
20.1
204
Mi

Number of Fimilfu (li mlllmmj
Loweti Qumiik
Second QviMiJe
Middle Qwimilt
Fourth Quiniilc
Hiftitu Qwimilt

17.4

All Fimiltfl

17.6
16,7

n«

16.0

172
Ift6

16.5

17.4

17.1
ll.l
17.5
17.1

10

19 1

M4

Ml

I.S
4-S
0.9

93
46
1.0

LwiMQwMt
Second Quftile
MiddXOsiniilc
FoudJi Qviitltlc
Hightfl QuJniilt

10.000
21,700
36,400
49,100
94.300

4,6011
21,200
U.700
50,400
91,300

1,900
1 1.700
34,600
4&.400
95,900

8.100
19,100
32,100
4S,W»
99.JOO

1,700
21,100
34,200
49.600
109.000

AIIFunilici

42.900

4WOO

47,000

42.000

125.000
166,000
1*6.000

130,000
179,000
3*9,OOU

UJ.OOO
161,000
167,000

111,000
112,000
435,000

Top 10*
lapWt
Topl%

16.7

IS?
M.7
156

19.6

It*
116
II)
11.7
200

11.9
19.3
203

20.5
19.6
199
21.1

89.3

91.1

957

9g7

102.1

104.7

107.2

1094

!!*,*

91

10.1
5,1
LO

102
5.1
10

104
S.7
1.0

10,6

10.9
54
1.0

ltt.9
J5
1.0

11.3
5.6
10

!!.«

1.0

1,700
11.MA
34.900
M.IOO
1 13.000

9,000
11.MO
35,000
50,900
111,000

1.400
20,60D
33.600
49,300
111,000

7.WO
19.400
12,300
49.000
114.000

1,100
20,100
33,300
49.600
170,000

J1JOO
li/400
53.000
133MO

44 JIM

41,400

46.MO

44,600

44.1U)

45.700

49,100

141,000
207,000
524,000

153,000
216.000
M4.000

I64.0M
236,000
635,000

153,000
217,000
547.000

151,000
IJ5,UOO
M4.000

ltl.000
144.000
660,000

111,000
174.000

50

10

54

5.9
1.3

AvmitFnln P«nlt)'lfK«nt<l*#S dolbn)

Top 10%
Top 5*
Top 1%




MOO

wjaoo

Preliminary Estimates of Shares of Family Income and Taxes Paid
By liKom* C»M|Ofy. 1971-1991 tivJPrOt*cleJ 1999
Income
Cuetory

1977

I9T9

19! 1

1913

I9S1

1917

1991

1993

1991

4

4

9

9
IS

14

1989

FiojttW
19M

Slum of Total PlnDy IrdWit (In prretnl)
Lowni QuoUik
Stwwd QuiMUr
MiddlrQuiMik
F«Mh QuiMffc
Hifhni QubMik

1
10
It

S
10
IS
32

4
(0
11

Ml

9
IS
21
11

4
9
IS
22
11

4
9
IS
22

4

S2

21
11

3
9
11
22
SI

100

too

KM

li

37
27
13

36
IS
11

41

33
49

100

100

100

100

100

31

31
22
10

31
22

31
14

33
IS

IS

10

n

12

17

22

14
11

1
9

}

53

9
14
21
54

IW

(00

M

n

31
31
14

M
31
11

•2
1
1
16
77

•3
1
1
It

11

"

All FimilKt
Top 10%
Topi*
ToplH

22
9

»
13

Shir*t efTolil Individual liKOmrTtt <)• pfrrtnl)
Lwta Ouiofilt
Second Quimik
Middle Quimik
Fourth QuMik
Hitheit Quhilik

9
It

•1
?
1
11

72

•1
3
9
17
73

71

71

100

!00

IW

100

100

100

100

52
19

H
43

M

ss

19

41

a

24

4!
23

46

21

44
14

49
39

X
T9

0
4
10
20
67

0
4
10
20
66

0
3
10
JO
61

0
3
9
19
it

too

100

100

100

topIWi

M)

TopiH

31
10

Ml
31
19

49
36
17

SI
38
10

0
1

10
20

0
1

a
u

-1
2

1*

"

All Ftmilitt

Tup 1%




37

Etli«»l«i ot Sham of Family Income and Ti*« Paid, tontinutd
By income C«<£ory, 1911- IWi MM) Project

1983

I9M

IW

I9W

Sh*ra ufToliI Ftdtrtl Tun (In jirrttnt)
Lftwtu QuiniiJt

3

2

6

6

7

6

e

1
6

V
J

11

11

]J

21
17

12
3.1
60

t
i
1)

22
U

12
30
60

12

22
iS

13
31
60

70
61

19
M

U

t

1

I

Middle Quinlile

1)

Found Quintilt

70

Hightil QwMilr

S9

2
7
11
31
SI

100

100

too

100

100

100

100

100

100

100

in

43

43
31

41

41

4.1

29
1)

29
14

41
39
1)

44
13
17

4?
J)

43
34
11

41
3»

4*
JT
21

StiondQuiniilc'

All Ktutiliet
Top I0*>
Top)',*
lopl%

2
7

12
16

16

12
16

16

V)

SOURCE Coneieuiwulhidgtt Office
h(-Ui l«ui)y tlHOmt B Ihf lurJ) of *ljel. 14/Bitt, wJ/-cmployjTirnl meant, itnts, iMablc •«! non-1 «xiblf inlcieu, divert*, i "I i
mni/«j ptvimmt Iimmc 4ha welodti <ht wvployn ihwtof SotuJSt(Uiiry»nd f«*r«] unonploymeni JMunncfptyiollUici, IIM) lh« corponlr neonidu.
l^« pMT>o«i<rfr»fl*i« by »dju*lrtr«nilvin<ooK(AFl)J^cwn< for r«h f«mfh(tt divide by Aepfwt^lhra^^
QvliMUti o
cquil nurnbtn irf pcoph Fimilinwiihttioop nt(»'ivt incofflcircexclNdcdftMnlhr low«»l income «itgofy bw included in Ihc loul.
Individual intonieiMmitdiinibulcddirccilj'lo Umlkt paying i host uiiti.
Ihroufh (licit taiptoytn Ftdn»](ictt*l»*w »re dBnihwediofnnilrti«tioiiiiii£ Wlfitii conwmpiiiuiof UK toiedgoadtH trrvict,
duttibuitd la ftmili«««oid«6 lo thtit J«it (•( (ipuri tnuavr,




I

1
11
)»

Preliminary Cffimftlciof Cffer 1iv< TB» Rales, innl
Pi uncled

Efferttyc l»dfcid<nl In t ant Tii Riif (In prrctit)
-03
*6
1J

14.3

33
6.)
87
I J.I

ni

39
!.7
6.3
67
14.11

107

107

10.1

10.9

IS9

16V

16.6

n.i

Ii6
161

fg.i

19,3

18,1

».9

16.1

10.1

10.9

111

11.1

16.)

17.4

11.1

11.0

I*.C

17.6

19.7

199

191
121

TOO
114

ni

7.1
143

6.0
146

1J.7

18.9

7.9
IS)
119

19.1

19.7

IB.9

21J

31.6

23.0

M.J

1J.9

M.2

27*

29,6

113
791

2J.S

».S

>2.6

23.1

14.7

14.1

276

»l

37.3

11 J

10.b

2i.l

as)

190

S7.4

)7.9

31.1

30.3

7t.1

1»,1

107
JM

na

16.1

16)

34.4

113

9.!.

17.1

i*i

All Fnuliu

[I.I

116

J}6

lop 10*
TopSW

11U

lap1%

I7A
19*
13)

116

117
200
310

LuwniQuimik
Siumd Ouiwik
Middfc Ouuiiik
Faufifc Quinftlc
Ht^icHQunilik

1.1
M7
111
W.S
?»I

14

K.O

H.9

1\0

19.3

19.)

11.1

16J

23.!
16.1

».V

210
246

21.3

31.2

17.9

14.J

16.4

All FwilKi

311

1V4

>J1

314

11,8

lap IDS

30.7

)O.S

ISO

?).?

3i,I

T*p«*
InplH

)3.4

»6

30.1

2i.7

»7

)?.}

JI.7

15.9

36
71
9.7

19,7

-0.1

).S
6.«

•*6
II
61
»7

61
09
1.4
14
161

m

-«.*

-19
33
4.J
(.9

•34
11
19
Kl
Hi

Of
39
75
104
161

LootklQiWIilc
Second Ou'mlk
Mrtdk Quimik
Fnunh Qvbiilk
Ht|Heii OuiDlilt

-01
39
».*
9.3

•(„'

19.«

EJtrtth* Totil Ftd*r*lT*i Hilt [!• pcmit)

o

11
14.1

in

10.2
IS.)

9.U
15.3

1.6
1)3

46

SOURCE, Conf.tsiioiwl Bvdjel Office

ht-lw Fmily iotwTKitiht turn of wag[i,i*l«rlc^ irfif-cmployiMiii Income, nnit, tiniblr and nun-tutibk iiwicu, dividend!, ft*\\ad cvfM pMt,Mid tU<juh
itwiki pivm««i tntaan llttt Include* ibc cmpkqti >hu< of Sot/d SetatUftrHt ftirjjl untnijitoynwit mlurtntt pgyiall Uiti, ind lh« eoqwitli Income lu
toi
oi i
|HirpoKJo(,»i*in|l>)1»diuiledf>™ily
u
hicwnt (An),iiwonif
.
tor uchfanlly It divided by I(K povfrty Itiitthold fu Ifamilyof IhU li«e. Qulttiln Moliin
U|U*1iiuinl>ti>olr*npfa, Fimilici wxh UTIKH nff«iivi incorx >rf citl«lfd finmlbt Inwcil income [»f(ixi*hu1 Included in Ihc
l«M-iAuf nc*iKin(tmdiilJ)tHJ»ed ditMllyio ftroili" [«>-m( ihoiiUsti Ptyioll liiuawdiMiibuird lo Imiilks p«ymg i
ihiou(ihihtn tmpioji^ lidctd (iiiititMiift flisiubuitiJkifitiiilnjactiHdinjiollxji comumplionDf
iluMihiilEdlotMiill»K<oidnii-<Dlhc!i bhm orttpiiil in torn*




lues ditttily, m induttily
t fwpa.Jt intomr incm