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, July 18, 1996 - review of US economy for first half 1996, forecast for future - Statements to the Congress - Transcript

Federal Reserve Bulletin, Sept, 1996

Statement by Alan Greenspan, Chairman, Board of Governors of the Federal Reserve System, before the Committee on Banking, Housing, and Urban Affairs, US. Senate, July 18, 1996.

Before I take this opportunity to discuss the performance of the U.S economy and the conduct of monetary policy, I would first like to thank the chairman and the other members of this committee for their support during my confirmation process.(1) I am grateful for the opportunity to serve the nation in this capacity for another term.

REVIEW OF THE FIRST HALF OF 1996

Nineteen ninety-six has been a good year for the American economy. By all indications, spending and production were robust in the first half of this year. Gross domestic product increased at a 2 1/2 percent annual rate in the first quarter. Partial data suggest a significantly stronger increase in the second quarter, as the economy, as expected, accelerated out of its soft patch around the turn of the year. During the second quarter, industrial production rose at an annual rate of 5 1/2 percent, and manufacturers are currently running their plant and equipment at utilization rates that are a touch above their postwar averages. About 1.4 million workers have been added to nonfarm payrolls in the first six months of the year, and the unemployment rate fell to 5.3 percent in June.

Even though the U.S. economy is using its productive resources intensively, inflation has remained quiescent. The core inflation rate, measured by the consumer price index less food and energy prices, at a 2.8 percent annual rate over the first six months of the year, is about 1/2 percentage point slower than the same period one year ago. While increases in energy prices have boosted the overall CPI inflation rate to 3.5 percent thus far in 1996, a partial reversal of the jump in petroleum product prices observed in the first half appears to be in train. I shall be discussing in greater detail later some possible reasons for this favorable inflation experience and offering some thoughts about how long it might last.

Economic activity thus far this year has turned out to be better than many analysts expected. An important supporting factor, as I pointed out in February, was favorable conditions in financial markets in the latter part of 1995 and early 1996. Intermediate- and longer-term interest rates were low. Among the influences accounting for this were optimism about prospective budget-deficit reduction, small easings of the stance of monetary policy in the second half of 1995 and early 1996, and the possibility of a further moderation in credit demands owing to a potentially soft economy. Credit remained readily available, with banks and other lenders in financial markets generally pursuing credit opportunities aggressively. And a rising stock market reduced the cost of capital to businesses and bolstered household balance sheets.

Looking forward, there are a number of reasons to expect demands to moderate and economic activity to settle back toward a more sustainable pace in the months ahead.

First, the bond markets have taken a turn toward restraint this year as they have responded to incoming data depicting an economy that was stronger than had been anticipated. Intermediate and longer-term interest rates have risen from I percentage point to 1 1/4 percentage points since January.

Second, the value of the dollar on foreign exchange markets has appreciated significantly on a trade-weighted basis against the currencies of other industrial countries over the past year or so. This appreciation importantly reflects the market perception that the U.S. economy has been performing better than those of many of our major trading partners. The rise in the dollar helps to keep down price pressures, but it also tends to divert domestic demand toward imported goods and damp exports some.

Third, the support to economic growth provided by expenditures on durable goods, both for household consumption and business fixed investment, is likely to wane in coming quarters. Consumer spending in the past few years has been boosted as households have made up for the purchases of big-ticket items that they had deferred during the recession and the early, weaker phase of the recovery. Five years after the business cycle trough, however, we should expect that this pent-up demand has been largely exhausted. Moreover, many households have built up sizable debt burdens in recent years, and coping with debt repayments could hold down their spending. The business sector has been adding considerably to capacity, opportunities to invest profitably in new capital should be increasing less rapidly, as final demand slows some.

While these are all good reasons to anticipate that economic growth will moderate some, the timing and extent of that downshift are uncertain. We have not, as yet, seen much effect of the rise in interest rates on, for example, the housing market. In many other aspects, financial market conditions remain quite supportive to domestic spending, and the economies of many foreign countries are showing signs of achieving more solid growth, which should help support our export sales. Moreover, and perhaps of most relevance, a desire to build inventories could add significantly to production in the near term. Data available for 1996 through May show that inventories were reduced relative to sales and are now fairly lean in many important industries. Although the use of just-in-time inventory and production systems encourages purchasing managers to keep stocks lean, any evidence that deliveries of previously ordered goods are being delayed for extended periods would quickly alert companies to the need for higher safety stocks. Indeed, indications of some mounting delivery delays in June do raise warning flags in this regard. The reversal of earlier draw-downs in inventories, of course, could potentially impart an important boost to incomes and production as we enter the second half of the year. The economy is already producing at a high level - and some early signs of pressures on resources are emerging, especially in the labor market.