Statements to the Congress - Alan Greenspan to the House Committee on Ways and Means

Federal Reserve Bulletin, May, 1991

Statements to the Congress I am pleased to have the opportunity to appear before you again. As you know, the Federal Reserve's semiannual "Monetary Policy Report to the Congress" and testimony, which were submitted to the Congress two weeks ago, provided an extensive review of recent and prospective economic developments and of monetary policy actions and intentions. [1] Rather than take you through the details of that report this morning, I would like, first, to focus on a few of the most critical considerations affecting the outlook for the economy and the formulation of monetary policy and, then, to turn briefly to budgetary issues.

THE ECONOMIC OUTLOOK AND

MONETARY POLICY

The recently available readings on business activity indicate that the economic contraction that began during the latter part of 1990 has continued in recent months. However, the incoming information, on balance, does not suggest that the recession is becoming more serious than we thought a month ago when we formulated our economic projections for 1991. At that time, the "central tendency" forecast of the Federal Open Market Committee (FOMC) members and other Reserve Bank presidents anticipated an upturn in real activity later this year, with real GNP ending 1991 between 3/4 percent and 1 1/2 percent higher than it was in the fourth quarter of 1990.

In discussing those projections, we stressed the extent to which uncertainties associated both with the situation in the Gulf and with several unresolved problems in the economy made the outlook unusually difficult to assess; to a somewhat lesser extent, that is still the case. Certainly, the successful end to the hostilities in the Gulf has removed a troublesome uncertainty and should provide some lift to consumer and business confidence. But the other factors that we noted earlier--concerns about credit availability and problems in real estate markets--continue to restrain activity and to weigh imporrantly on business thinking.

The restraint on credit availability at depository institutions represents a continuing clear risk to the outlook and, therefore, is a critical challenge for policy. To date, our assessment is that reduced demand for credit stemming from the weakness in real activity accounts for most of the recent contraction in bank lending. Nonethless, developments on the supply side also have had a noticeable effect. The surveys of senior loan officers that are conducted by the Federal Reserve at three-month intervals have shown progressive tightening of business credit terms since last spring. Banks reprot that they have been applying more stringent credit standards and have made the price and nonprice terms of business credit less favorable to a wide range of customers.

Several factors underlie these changes in lending practices. Given the uncertain economic environment, banks are appropriately taking a closer look at prospective borrowers in some specific industries. But what is of most concern to us is restraint on lending by commercial bankers to otherwise creditworthy customers. For borrowers whose riskiness has been essentially unaffected by the recession or by developments in specific markets, the reluctance of banks to lend seems to arise from attempts to bolster capital positions. Banks are trying to raise capital--asset ratios, or at least hold down declines in those ratios that might result from losses on outstanding loans. In some cases, loan losses and pressures on capital may be exacerbated by the degree to which examination standards are forcing loans to be written down inappropriately or by market reaction to aggregated data on problem credits on certain categories of loans.

Information from our surveys and estimates of funds supplied in financial markets indicate that the majority of those borrowers who have been turned away or who have been discouraged from borrowing at depository institutions have been able to find financing elsewhere. But one must assume that the alternatives, when they exist, are only available at a higher price. The problems of locating other sources of credit may be especially severe for some types of borrowers--small businesses and those in commercial real estate, for instance--who may not have ready access to securities markets. How much production has been lost as a result of sound projects cut back or unable to go forward because of a rise in financing costs or because of an actual or feared lack of financing is difficult to assess. But it is clear that the restraint on credit availability, along with the deterioration in profits, began to enter importantly in business decisionmaking even before the onset of the recession.

Several steps that should relieve constraints on credit supplies have been taken by the Federal Reserve. These steps include lowering interest rates, reducing reserve requirements, and working with other depository supervisory agencies to identify and correct practices that may be unnecessarily discouraging the flow of funds to creditworthy borrowers. Taken together, these steps may well prove sufficient to foster the growth of credit needed to finance economic expansion. But we recognize the risk that problems in this area could persist and could warrant further actions.