Statement by Alan Greenspan, Chairman, Board of Governors of the Federal Reserve System, before the Committee on Banking, Housing, and Urban Affairs, U.S. Senate, February 19, 1993 - Statements to Congress - Transcript

Federal Reserve Bulletin, April, 1993

I appreciate this opportunity to discuss with you developments in the economy and the conduct of monetary policy. Nineteen ninety-two saw an improved performance of our economy. The expansion firmed and inflation moderated. Some of the structural impediments to growth seemed to diminish. In n particular, the financial condition of house-holds firms, and financial institutions improved. In addition, confidence rebounded late in the year.

Nevertheless, the expansion seemed to exhibit little momentum through much of 1992, unemployment remained high, and money and credit growth was sluggish. In response, the Federal Reserve took steps to increase the availability of bank reserves on several occasions. These actions brought short-term interest rates to their lowest levels in thirty years. Long-term interest rates also fell in 1992 and in early 1993, as inflation expectations gradually moderated and optimism developed about a potential for genuine progress in reducing federal budget deficits.

Our economy has been held back in the past few years by a variety of structural factors that have not been typical of post-World-War II business cycles - certainly not occurring all at once. These factors have included record debt burdens, overbuilding in commercial real estate, and a substantial cutback in defense spending. We have not been alone in this. Other major industrial countries have also been experiencing unusual impediments to growth, and by comparison the recent performance of the U.S. economy has been relatively good. Our monetary policy actions have been directed at facilitating adjustments to these developments and have in the progress improved our economy's prospects for long-run sustainable growth. Significant hurdle, of course, still remain to be overcome in the short run. Nonetheless, in the view of the vast majority of business analysts, prospects appear reasonable for continued economic expansion and further declines in the unemployment rate. The tasks of the monetary and fiscal authorities alike will be not only to support this prospective growth but also to set policies to enhance the capacity of our economy to produce rising living standards over time. Before discussing the outlook in more detail, I will reflect on how monetary policy has interacted with the forces that have shaped developments over recent years.

Recent Economic Developments and

Monetary Policy in Perspective

I have often noted before this committee the distinctly different nature of the current business cycle. Several extraordinary factors contributed to the earlier weakening in the economy and have worked against a brisk and normal rebound from the recession.

Balance sheet restructuring has been, perhaps, the most important of these factors. In the 1980s, debt growth, hand in hand with rising asset prices, considerably exceeded that of income, and debt burdens rose to record levels. Debt-financed construction in the commercial real estate market was an extreme manifestation of this development, but it was apparent as well in other sectors of the economy.

The development of these imbalances should not be entirely surprising. The economy grew continuously for nearly eight years - from late 1982 through mid-1990, the longest peacetime expansion on record. In this unusual period of uninterrupted growth, unrealistic expectations of what the economy could deliver seem to have developed. In addition, households and businesses apparently were skeptical that inflation would continue to decline and, based on their experience during the 1970s, may even have expected it to rebound. As a consequence, many may have shaped on expectations of inflation-induced based on expectations of inflation-induced appreciation of asset prices rather than on more fundamental economic considerations. In the commercial real estate sector, assessments of profit potential that were formed during the first half of the 1980s simply went too far, leading to an unavoidable period of retrenchment.

The difficulties faced by borrowers in servicing their debts as the expansion slowed and the leveling out or decline in asset prices prompted many to cut back expenditures and divert abnormal proportions of their cash flows to debt repayment. This, in turn, fed back into slower economic growth. In addition, financial institutions were faced with impaired equity positions, owing to sizable loan losses as well as more stringent supervision and regulation and demands by investors and regulators for better capital ratios. In response, they limited the availability of credit with particular effects on smaller businesses. During the past year or so, however, considerable progress has been made in strengthening balance sheets in both the nonfinancial and financial sectors. Moreover, by some measures the rate of deterioration of the commercial real estate industry might be slowing, and prices in this sector may soon begin to stabilize. Such developments should contribute to the sustainability of the expansion in the period ahead.