13 February 2001, 18:14 Greenspan speach
WASHINGTON (MktNews) - The following is the first of three takes of
the Federal Reserve Board Chairman Alan Greenspan's semi-annual monetary
policy testimony to the Senate Banking Committee Tuesday:
I appreciate the opportunity this morning to present the Federal
Reserve's semiannual report on monetary policy.
The past decade has been extraordinary for the American economy and
monetary policy. The synergies of key technologies markedly elevated
prospective rates of return on high-tech investments, led to a surge in
business capital spending, and significantly increased the underlying
growth rate of productivity. The capitalization of those higher expected
returns boosted equity prices, contributing to a substantial pickup in
household spending on new homes, durable goods, and other types of
consumption generally, beyond even that implied by the enhanced rise in
real incomes.
When I last reported to you in July, economic growth was just
exhibiting initial signs of slowing from what had been an exceptionally
rapid and unsustainable rate of increase that began a year earlier.
The surge in spending had lifted the growth of the stocks of many
types of consumer durable goods and business capital equipment to rates
that could not be continued. The elevated level of light vehicle sales,
for example, implied a rate of increase in the number of vehicles on the
road hardly sustainable for a mature industry. And even though demand
for a number of high-tech products was doubling or tripling annually, in
many cases new supply was coming on even faster. Overall, capacity in
high-tech manufacturing industries rose nearly 50 percent last year,
well in excess of its rapid rate of increase over the previous three
years. Hence, a temporary glut in these industries and falling
prospective rates of return were inevitable at some point. Clearly, some
slowing in the pace of spending was necessary and expected if the
economy was to progress along a balanced and sustainable growth path.
But the adjustment has occurred much faster than most businesses
anticipated, with the process likely intensified by the rise in the cost
of energy that has drained business and household purchasing power.
Purchases of durable goods and investment in capital equipment declined
in the fourth quarter. Because the extent of the slowdown was not
anticipated by businesses, it induced some backup in inventories,
despite the more advanced just-in-time technologies that have in recent
years enabled firms to adjust production levels more rapidly to changes
in demand. Inventory-sales ratios rose only moderately; but relative to
the levels of these ratios implied by their downtrend over the past
decade, the emerging imbalances appeared considerably larger. Reflecting
these growing imbalances, manufacturing purchasing managers reported
last month that inventories in the hands of their customers had risen to
excessively high levels.
As a result, a round of inventory rebalancing appears to be in
progress. Accordingly, the slowdown in the economy that began in the
middle of 2000 intensified, perhaps even to the point of growth stalling
out around the turn of the year. As the economy slowed, equity prices
fell, especially in the high-tech sector, where previous high valuations
and optimistic forecasts were being reevaluated, resulting in
significant losses for some investors. In addition, lenders turned more
cautious. This tightening of financial conditions, itself, contributed
to restraint on spending.
Against this background, the Federal Open Market Committee (FOMC)
undertook a series of aggressive monetary policy steps. At its December
meeting, the FOMC shifted its announced assessment of the balance of
risks to express concern about economic weakness, which encouraged
declines in market interest rates. Then on January 3, and again on
January 31, the FOMC reduced its targeted federal funds rate 1/2
percentage point, to its current level of 5-1/2 percent. An essential
precondition for this type of response was that underlying cost and
price pressures remained subdued, so that our front-loaded actions were
unlikely to jeopardize the stable, low inflation environment necessary
to foster investment and advances in productivity.
The exceptional weakness so evident in a number of economic
indicators toward the end of last year (perhaps in part the consequence
of adverse weather) apparently did not continue in January. But with
signs of softness still patently in evidence at the time of its January
meeting, the FOMC retained its sense that the risks are weighted toward
conditions that may generate economic weakness in the foreseeable
future.
Crucial to the assessment of the outlook and the understanding of
recent policy actions is the role of technological change and
productivity in shaping near-term cyclical forces as well as long-term
sustainable growth.
The prospects for sustaining strong advances in productivity in the
years ahead remain favorable. As one would expect, productivity growth
has slowed along with the economy. But what is notable is that, during
the second half of 2000, output per hour advanced at a pace sufficiently
impressive to provide strong support for the view that the rate of
growth of structural productivity remains well above its pace of a
decade ago.
Moreover, although recent short-term business profits have softened
considerably, most corporate managers appear not to have altered to any
appreciable extent their long-standing optimism about the future returns
from using new technology. A recent survey of purchasing managers
suggests that the wave of new on- line business-to-business activities
is far from cresting. Corporate managers more generally, rightly or
wrongly, appear to remain remarkably sanguine about the potential for
innovations to continue to enhance productivity and profits. At least
this is what is gleaned from the projections of equity analysts, who,
one must presume, obtain most of their insights from corporate managers.
According to one prominent survey, the three- to five-year average
earnings projections of more than a thousand analysts, though exhibiting
some signs of diminishing in recent months, have generally held firm at
a very high level. Such expectations, should they persist, bode well for
continued strength in capital accumulation and sustained elevated growth
of structural productivity over the longer term.
The same forces that have been boosting growth in structural
productivity seem also to have accelerated the process of cyclical
adjustment. Extraordinary improvements in business-to- business
communication have held unit costs in check, in part by greatly speeding
up the flow of information. New technologies for supply-chain management
and flexible manufacturing imply that businesses can perceive imbalances
in inventories at a very early stage--virtually in real time--and can
cut production promptly in response to the developing signs of
unintended inventory building.
Our most recent experience with some inventory backup, of course,
suggests that surprises can still occur and that this process is still
evolving. Nonetheless, compared with the past, much progress is evident.
A couple of decades ago, inventory data would not have been available to
most firms until weeks had elapsed, delaying a response and, hence,
eventually requiring even deeper cuts in production. In addition, the
foreshortening of lead times on delivery of capital equipment, a result
of information and other newer technologies, has engendered a more rapid
adjustment of capital goods production to shifts in demand that result
from changes in firms' expectations of sales and profitability. A decade
ago, extended backlogs on capital equipment meant a more stretched-out
process of production adjustments.
Even consumer spending decisions have become increasingly
responsive to changes in the perceived profitability of firms through
their effects on the value of households' holdings of equities. Stock
market wealth has risen substantially relative to income in recent years
-itself a reflection of the extraordinary surge of innovation. As a
consequence, changes in stock market wealth have become a more important
determinant of shifts in consumer spending relative to changes in
current household income than was the case just five to seven years ago.
The hastening of the adjustment to emerging imbalances is generally
beneficial. It means that those imbalances are not allowed to build
until they require very large corrections. But the faster adjustment
process does raise some warning flags. Although the newer technologies
have clearly allowed firms to make more informed decisions, business
managers throughout the economy also are likely responding to much of
the same enhanced body of information. As a consequence, firms appear to
be acting in far closer alignment with one another than in decades past.
The result is not only a faster adjustment, but one that is potentially
more synchronized, compressing changes into an even shorter time frame.
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