Statement by Cathy E. Minehan, President, Federal Reserve Bank of Boston, before the Subcommittee on Consumer Credit and Insurance of the Committee on Banking, Finance and Urban Affairs, U.S. House of Representatives, October 12, 1994, in Boston, Massachusetts - Statements to the Congress - Transcript

Federal Reserve Bulletin, Dec, 1994

I am pleased to present the views of the Federal Reserve Bank of Boston on the important issues you have raised on the cost of credit to consumers and small business in New England. These issues are especially important given this region's recent economic history.

The Massachusetts economy continues in a pattern of slow, steady growth. Since the bottom of the recession--two years ago--some 155,000 net new jobs have been created, and our recent rate of employment growth is virtually the same as the nation as a whole. A variety of other indicators also signal respectable growth--expanded help-wanted sections in newspapers, overtime work in the manufacturing sector, rising business incorporations, higher consumer spending, more housing activity, and increasing per capita income. And I am pleased to note that while the economy is growing, local inflation has been kept under control and real income growth has been stronger than that for the nation as a whole.

These signs of improvement deserve more attention than they have received. They are tangible indicators of economic progress. But I recognize that the purpose of this hearing is not necessarily to detail the economic recovery in Massachusetts or New England more broadly, but to address certain concerns as to the breadth and durability of that recovery. I will address three issues in this regard. First, what have the trends been as to the affordability and availability of credit to small businesses and consumers in New England? Second, if the indicators suggest that growth is solid and credit is both affordable and available, why don't residents feel better about the economy? And finally, what is the effect of rising interest rates on the prospects for continuing economic recovery?

First, it should be noted that both the affordability and availability of credit to consumers and small businesses have national and local components. Consumers typically borrow using credit cards, mortgage and home equity loans, and auto loans. Consumers may enter into these debt arrangements with local banking or financial institutions, but national secondary markets exist for all these types of credits. Increasingly larger shares of auto loans, credit card receivables, and, of course, mortgage loans are securitized. This process has enabled banks and other traditional lenders to households to continue to originate consumer loans even when they are unable to profitably fund these credits themselves. In addition, the securitization process has meant that the rates available to consumers are based on national markets. Rates on auto loans and credit cards have come down since the early 1990s, as documented in Governor Lindsey's testimony to you on this matter in June.

As he noted then--and this continues to be the case--consumer spending has fueled the national economic recovery. Favorable borrowing conditions have contributed to this growth in spending, which has been accompanied by growth in consumer installment and mortgage debt. Borrowing conditions should remain sufficiently favorable to maintain continued expansion in consumer spending, but the pace will moderate and the composition will shift. Some consumer rates respond more rapidly to general market rates than others, and some forms of spending are more sensitive to interest rates than others. Rates on credit cards are especially sticky. Mortgage rates, in contrast, are responsive, and higher mortgage rates have resulted in a leveling-off of housing activity both nationally and in Massachusetts.

For small businesses, both the cost and the availability of debt are more locally determined. However, since the "credit crunch" of the last recession, which severely restricted small business lending in New England, markets for such credit have become more competitive. Larger institutions have announced an increased focus on small business loans, smaller banks appear to be quite active, and we hear numerous anecdotes indicating that lending terms are increasingly competitive. Interestingly, we also hear that small business borrowers are not coming to the banks in the numbers expected, although we do not know whether this is because they are reluctant to take on debt after having survived the credit crunch or whether they have found alternative lending sources. Nevertheless, in Massachusetts, small business lending has grown about 10 percent over the past year despite increases in the prime rate, to which rates on many small business loans are tied.

Thus, both the broader economic data and data on consumer and business borrowing suggest solid economic growth in New England. Why is it that some people sense things are not as good as they might be? An improvement definitely has taken place over the past two years in how people in New England rate current economic conditions, but over this same period, national consumer confidence has risen nearly twice as sharply. Organizations such as the University of Massachusetts at Lowell and the Bank of Boston take polls of local businesses. These barometers continue to show improvement, and, if anything, they indicate that business leaders are more confident than those polled in the consumer surveys.