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

Perhaps reflecting these unusual influences, we have yet to see early signs in prices themselves of intensifying pressures, despite anecdotal and statistical evidence that the amount of operating slack in our economy has been at low levels by historical standards for some time. Among the encouraging indicators, industrial commodity prices have remained roughly flat, and the list of reported shortages of materials has been exceptionally small. This pattern is consistent with the view that American businesses, by and large, have felt comfortable that inflation has been subdued, and it offers little evidence of the advance buying and expanded commitments that would come if businesses were expecting significant price pressures in the reasonably near future.

Nonetheless, there are early indications that this episode of favorable inflation developments, especially with regard to labor markets, may be drawing to a close. The surprising strength in the employment cost index for wages and salaries in the first quarter raises the possibility that workers, willingness to surrender wage gains for job security may be lessening. Wage data since March have been somewhat difficult to read. Average hourly earnings clearly accelerated in the second quarter. However, in looking at those figures, one must be mindful that they can reflect not only changes in wage rates but also shifts in the composition of employment. And in recent months, a significant part, although not all of the pickup, has been accounted for by a tendency for employment to shift to relatively high-pay industries, such as durable goods manufacturing. Whether such shifts also imply a correspondingly higher level of output per worker will determine whether unit labor costs also accelerated to impart upward pressures to price inflation. Increases in pay, of course, are not inflationary so long as they are matched by gains in productivity. Without question, we would applaud such trends, which increase standards of living. However, wage gains that increase unit costs and are eaten up by inflation help no one and ultimately place economic growth in jeopardy.

Clearly, in this environment, the Federal Reserve has had to become especially vigilant to incipient inflation pressures that could ultimately threaten the health of the expansion. The relatively good inflation performance of the past few years, as best we can judge, owes, in part, to transitional forces that are only temporarily damping the wage-price inflation process. We cannot be confident that we can ascertain when that process will come to an end. This makes policy responses more difficult than usual because, as always, the impact of policy will be felt with a significant lag. Of course, if the economy grows so strongly as to strain available resources, transitional forces notwithstanding, history persuasively indicates that Imbalances will develop that will bring the expansion to a halt.

THE FOMC'S OUTLOOK FOR THE REMAINDER

OF 1996 AND 1997

The forecasts of the governors of the Federal Reserve Board and presidents of the Federal Reserve Banks for economic performance over the remainder of this year and the next reflect the view that sustainable economic growth is likely in store. The growth rate of real GDP is most commonly seen as between 2 1/2 percent and 2 3/4 percent over the four quarters of 1996 and 1 3/4 percent to 2 1/4 percent in 1997. Given the strong performance of real GDP in the last two quarters, this outcome implies slower growth in the second half of this year. Nonetheless, for the remainder of this year and the next in these projections, the unemployment rate remains in the range of the past 1 1/2 years. Inflation, as measured by the four-quarter percentage change in the consumer price index, is expected to be 3 percent to 3 1/4 percent in 1996. The governors and bank presidents, however, view the prospects for inflation to be more favorable going forward. The expected reversal of some of the recent run-up in energy prices would contribute to that result, but policymakers' forecasts also reflect their determination to hold the line on inflation. The central tendency of their inflation forecasts for 1997 is 2 3/4 to percent, returning to the range from 1991 to 1995.