Statement by Alan Greenspan, Chairman, Board of Governors of the Federal Reserve System - semi-annual report to Congress on monetary policy, February 20, 1996 - Statements to the Congress

Federal Reserve Bulletin, April, 1996 by Alan Greenspan

Statement by Alan Greenspan, Chairman, Board Governors of the Federal Reserve System, before the Subcommittee on Domestic and International Monnetray Policy, Committee on Banking and Financial Services, U.S. House of Representatives, February 20, 1996

I appreciate the opportunity to appear before this committee to present the Federal Reserve's semi-annual report on monetary policy.(1)

The U.S. economy performed reasonably well in 1995. One and three-quarter million new jobs were added to payrolls over the year, and the unemployment rate was at the lowest sustained level in five years. Despite the relatively high level of resource utilization, inflation remained well contained, with the consumer price index (CPI) rising less than 3 percent - the fifth year running at 3 percent or below. A reduction in inflation expectations, together with anticipation of significant progress toward eliminating federal budget deficits, was reflected in financial markets, where long-term interest rates dropped sharply and stock prices rose dramatically over the year.

This outcome was influenced, in part, by monetary policy actions taken by the Federal Reserve in recent years. Responding to evidence that inflationary pressures were building, we progressively raised short-term interest rates over 1994 and early 1995. Rates had been purposely held at quite low, stimulative levels in 1993. We moved in 1994 to levels more consistent with sustainable growth. Our intent was to be preemptive - to head off an incipient increase in inflationary pressures and to forestall the emergence of imbalances that so often in the past have undermined economic expansions.

As we entered the spring of 1995, it became increasingly evident that our policy was likely to succeed. Although various price indexes were rising a bit more rapidly, there were indications that pressures would not continue to intensify and might even reverse to a degree. Moderating overall demand growth left businesses with excess inventories. In response, firms initiated production cutbacks to prevent serious inventory imbalances, and the growth of economic activity slowed substantially. With inflation pressures apparently receding, the previous degree of restraint in monetary policy was no longer deemed necessary, and the Federal Open Market Committee (FOMC) consequently implemented a small reduction in reserve market pressures last July.

During the summer and early fall, aggregate demand growth strengthened. As a result, business stocks of raw materials and finished goods appeared somewhat better aligned with sales. In sum, the economy, as hoped, appeared to have moved onto a trajectory that could be maintained - one less steep than in 1994, when the rate of growth was clearly unsustainable, but one that nevertheless would imply continued significant growth in employment and incomes.

Importantly, the performance of the economy seemed to be consistent with maintaining low inflation. Despite the step-up in growth and the relatively high levels of resource utilization, measured inflation abated a little, and many of the signs that had been pointing toward greater price pressures gradually disappeared. Expectations of both near- and longer-term inflation fell substantially over the second half of the year, as gauged by survey results as well as by the downward movements in longer-term interest rates. The fall in bond rates was also encouraged by improving prospects for significant progress in reducing the federal budget deficit. The declines in actual and expected inflation meant that maintaining the existing nominal federal funds rate would raise real short-term interest rates, implying a slight effective firming in the stance of monetary policy. Such a shift would have been particularly inappropriate because economic growth near the end of the year seemed to be slowing, and some FOMC members were concerned about the risks of prolonged sluggishness. Consequently, the Committee decided in December that a further reduction in the funds rate was warranted.

Information becoming available in late December and January raised additional questions about the prospective pace of expansion. The situation was difficult to judge, partly because economic statistics were more sparse than usual, mainly because of the government shutdowns. In addition, harsh weather in January disrupted both data flows and patterns of economic activity. But several indicators-including initial claims for unemployment insurance, purchasing managers' surveys, and consumer confidence measures - appeared to signal some softening in the economy. Consonant with this pattern, some Reserve Bank presidents reported that they seemed to be detecting anecdotal indications of weakness in the expansion within their Districts with somewhat greater frequency than previously. Moreover, growth in several of our major trading partners seemed to be lagging, which could tend to moderate demand for exports.

A number of factors have prompted the recent tendency toward renewed weakness. Some are clearly quite transitory - related, for example, to bad weather or to the federal government shutdown. Others may be somewhat more significant but still temporary. The constraint on government spending while permanent budget authorizations are being negotiated is one. Another may be a temporary reduction in output in some industries as businesses have further adjusted inventories to disappointing sales. As I noted last July, the change in the pace of inventory investment when the economy shifts gears can be substantial. Inventory investment surged in 1994 and into the early months of 1995 but proceeded to fall markedly throughout the rest of the year. This has placed significant downward pressure on output, which should lift as inventory adjustments subside. But for the moment, the pressures remain in the motor vehicle industry and elsewhere.