Statement by Alan Greenspan, Chairman, Board of Governors of the Federal Reserve System, before the Committee on the Budget, U.S. House of Representatives, February 24, 1993 - Statements to Congress - Transcript

Federal Reserve Bulletin, April, 1993

I very much appreciate the opportunity to meet with you today, especially in view of the crucial budgetary issues now before the Congress. As you know, in the last few days I have given detailed testimony on the conduct of monetary policy in 1992 and our plans for 1993. Accordingly, I shall be rather general today in discussing monetary policy, focusing instead on the economic outlook and the relationship between fiscal policy and monetary policy.

Our economy recently has made considerable progress in overcoming structural imbalances and improving the prospects for sustainable long-run growth. The Federal Reserve has contributed to this progress by easing the stance of monetary policy in a measured fashion and thus helping to encourage appreciable declines in long-term interest rates. As I will be discussing considerable imbalances in the economy remain, and the uncertainties are sizable. But, on balance, the prospects are reasonably good for continued economic growth and declines in unemployment in 1993. We at the Federal Reserve intend to continue to conduct policy in such a way as to support the economic expansion while containing inflation and making further progress toward price stability. This policy approach should help promote sustainable long-term growth of our economy.

Fiscal policy similarly can contribute to sustainable and robust economic growth. The President's budget proposals have promoted anticipation in the markets that there will be genuine progress in the reduction of federal budget deficits. This anticipation has been the most important factor behind the very significant recent declines in intermediate- and long-term interest rates. These lower rates are a striking reminder that reducing federal deficits will free up private savings, reduce the cost of credit to private borrowers, and encourage accumulation of capital that will help enhance growth in the future.

To provide some background for discussion of future monetary and fiscal policies, I would first like to review recent economic developments and the conduct of monetary policy. I will then turn to the economic outlook and our monetary policy plans for 1993 and conclude with some comment son fiscal policy and its relationship with monetary policy.

RECENT ECONOMIC DEVELOPMENTS

Our economy has experienced considerable impediments to growth in the past few years. In my view, adjustments to certain imbalances and structural changes in the economy have been important causes of the sluggish performance of the economy until recently.

As I have often noted, balance sheet adjustments have been a key element. By the late 1980s, balance sheets had been weakened considerably by the large runup in debt over the previous seven years or so. But, in addition, actual declines in asset prices - particularly in commercial real estate prices but, in many locales, in housing prices as well - unambiguously signaled a serious imbalance between demands and supplies for certain structures. These declines, in turn, represented a significant reduction in the wealth of many firms and households. These entities, and many others who experienced difficulties servicing debt, typically responded by restraining expenditures on real goods and services, reducing the forward momentum of the economy.

The difficulties of borrowers and declines in real estate values spilled over onto the financial institutions that financed such purchases. With loan losses mounting and under pressure from the markets and regulators to improve their capital ratios, those institutions tightened terms and standards on many types of loans. The reduced available of credit limited the ability of certain smaller and medium-sized firms to expand and contributed to the weakening of the economy.

After the invasion of Kuwait and the associated jump in the oil prices and drop in the confidence, a recession began. From peak to trough, real gross domestic product declined 2 1/4 percent. Total employment declined considerably, industrial production fell, and capacity utilization dropped.

Although an economic recovery began in spring 1991, it was rather anemic. Some of the factors that had earlier weakened the economy continued to weigh on aggregate demand, particularly efforts by businesses and households to bring down debt burdens, the reduced availability of business credit, and the hangover in the commercial real estate sector. In addition, state and local governments, faced with a recession-induced decline in revenues, retrenched. And real federal defense purchases, after having peaked in 1987, have moved down considerably, depressing demand further. As a result, real gross domestic product (GDP) expanded at only a 1.6 percent average annual rate during the first five quarters of the recovery. As real GDP growth was below the expansion of the economic my's potential to produce, unemployment continued to rise substantially.

More recently, however, the expansion has shown somewhat more vigor. Real GDP rose at a 3 1/2 percent rate in the third quarter and is currently estimated to have increased at a 3 3/4 percent rate in the fourth quarter. And data that have become available since this estimate was prepared suggest that the fourth-quarter growth could well be revised up substantially. Halfway through the first quarter, we appear to be growing at a somewhat slower pace than in the second half of last year.