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

THE RANGES FOR THE DEBT AND MONETARY

AGGREGATES

The Committee selected provisional ranges for the monetary aggregates in 1997 that once again encompass the growth rates associated with conditions of approximate price stability, provided that these aggregates act in accord with their historical relationships with nominal income and interest rates. These ranges are identical to those endorsed for 1996 - 1 percent to 5 percent for M2 and 2 percent to 6 percent for M3. The Committee reaffirmed its range of 3 percent to 7 percent for the debt of the domestic nonfinancial sectors for this year and chose the same range provisionally for next year. The Committee's expectations for inflation and nominal GDP expansion in 1996 and 1997 suggest growth of the monetary aggregates at the upper ends of their benchmark ranges as a distinct possibility this year and next, though debt should be in the middle portion of its range.

The experience of the first part of the 1990s - when money growth diverged from historical relationships with income and interest rates - severely set back most analysts, confidence in the usefulness of M2. Recently, there have been tentative signs that the historical relationship linking the velocity of M2 - or the ratio of nominal GDP to the money stock - to the cost of holding My assets has reasserted itself. For now, though, the Committee is satisfied with watching these developments carefully, waiting for more compelling evidence that My has some predictive content in forecasting current and prospective spending. Such evidence, however, at best will only accumulate gradually over time.

BUDGETARY POLICY

Monetary policy is, of course, only one factor shapping the macroeconomic environment. I thus would be remiss if I did not again emphasize the critical importance to our nation's economic welfare of continuing to reduce our federal budget deficit. We have made significant and welcome progress on this score in recent years. But unless further legislative steps are taken, that progress will be reversed. Inevitably, such changes will require addressing the consequences for entitlement spending of the anticipated shift in the nation's demographics in the first few decades of the next century. Lower budget deficits are the surest and most direct way to increase national saving. Higher national saving would help to lower real interest rates, spurring spending on capital goods so as to put cutting-edge technology in the hands of more American workers. With a greater volume of modern equipment at their disposal, American workers will be able to produce goods that compete even more effectively on world markets.

The rally in capital markets last year that trimmed as much as 2 percentage points from longer-term Treasury yields was almost surely, in part, a response to the developing positive dialogue on deficit reduction. While the backup in intermediate@ and longer-term market interest rates this year has mostly reflected the unexpected vigor of economic activity, market participants must also have been struck by the dying out of serious discussions that might lead to a bipartisan agreement to eliminate the budget deficit over time.