Mr. Greenspan presents an update on economic conditions in the United States  (Central Bank Articles and Speeches, 10 Jun 98)
Central bank: fed | Type: speech | Date: 1998-06-10

Mr.

Greenspan presents an update on economic conditions in the United States Testimony of the Chairman of the Board of Governors of the US Federal Reserve System, Mr. Greenspan, before the Joint Economic Committee of the US Congress on 10/6/98.Mr. Chairman and members of the Committee, I am pleased to have the opportunity present an update on economic conditions in the United States.Such an assessment cannot be made in isolation but rather depends critically on happening in the rest of the world and how those developments affect the performance of the A economy.

In my previous appearance before this Committee last October, my remarks focused mainl the turbulence that was then evident in world financial markets and, in particular, on the p had emerged in a number of Asian economies.

The tentative assessment offered then was tha economies of Asia were in for some trying times but that the situation did not seem likely to expansion of this country's economy.That assessment, I believe, still is essentially correct, although uncertaintie degree of restraint that will be coming from abroad remain substantial.

Earlier this year, the most of the Asian countries seemed to be stabilizing in some respects, but, as the events of weeks have demonstrated, the restoration of normally functioning economies will not necessa smoothly.

In some cases, the adjustments that are needed to improve external balances and t existing misallocations of resources have been accompanied by sharp increases in inflatio unemployment, abrupt cutbacks in living standards, and increases in uncertainty and insecur heightened social and political pressures that can develop in such circumstances not only intro complications into economic policymaking but also make it even more difficult to foresee h processes of adjustment will play out across the afflicted economies.That the American economy would be affected to some degree by spillover from t problems in Asia was never in doubt, even though the timing and magnitude of the impact hav difficult to predict with much confidence.

Many months ago, businesses in this country anticipating a worsening of our trade balance with the Asian countries, and incoming economic d since confirmed those expectations.

Meanwhile, other influences on trade -- such as the st demand growth in the United States and a dollar that has been strong against a wide array of cu have persisted.

In total, US exports of goods and services turned down in real terms in the fi 1998, the first such decline in four years, and real imports of goods and services continued rapidly.

The combined effect of these changes exerted a drag of 2½ percentage points on th growth rate of real GDP last quarter.

Weaknesses in Asia appear to account for approximately of that deterioration.

Not only have export volumes been affected, but producers in both in agriculture also are having to adjust to the lower product prices that have come with slower growth abroad and the increase in the competitiveness of foreign producers induced lar depreciations of their currencies.But even with substantial drag from the external sector, the US economy has cont to expand at a robust pace.

In the first quarter, real GDP grew even faster than it ha Employment has continued to increase rapidly this year, and the unemployment rate has fallen reaching its lowest level since 1970.

Incomes have continued to climb, and gains in house business expenditures have been exceptionally strong.

Although the data on hours worked sugge growth of the economy has likely slowed this quarter from the first quarter's torrid pace, t slowdown remains in question.

Evidence to date of a moderation in underlying domestic spending sparse.The strength of domestic spending has been fueled, in part, by conditions in f markets.

Although real short-term interest rates have been rising, equity prices have moved s credit has been readily available at slender margins over Treasury interest rates, and nomina interest rates have remained near the lowest levels of recent decades.

Rapid growth of money ta further indication that financial conditions are accommodating strong domestic spending, alt still are uncertain how reliable that relationship will prove to be over time.In short, our economy is still enjoying a virtuous cycle, in which, in the c subdued inflation and generally supportive credit conditions, rising equity values are provid for spending and, in turn, the expansion of output, employment, and productivity-enhancing investment.

The hopes for accelerated productivity growth have been bolstering expectations corporate earnings and thereby fueling still further increases in equity values.The essential precondition for the emergence, and persistence, of this virtuous arguably the decline in the rate of inflation to near price stability.

Continued low product and expectations that it will persist have brought increasing stability to financial markets perceptions that the degree of risk in the financial outlook has been moving ever lowe perceptions, in turn, have reduced the extra compensation that investors require for making l taking ownership positions in, private firms.To a considerable extent, investors seem to be expecting that low inflation and productivity growth will allow the extraordinary growth of profits to be extended into the dis Indeed, expectations of per share earnings growth over the longer term have been undergoing co upward revision by security analysts since 1994.

These rising expectations have, in turn, dr prices sharply higher and credit spreads lower, perhaps to levels that will be difficult to economic conditions remain exceptionally favorable -- more so than might be anticipated from h relationships.

In any event, primarily because of the rise in stock prices, about $12 tril added to the value of household assets since the end of 1994.

Probably only a few percent largely unrealized capital gains have been transformed into the purchase of goods and se consumer markets.

But that increment to spending, combined with the sharp increase in equ investment, which has stemmed from the low cost of both equity and debt relative to expected p capital, has propelled the economy forward.

The current economic performance, with its combina strong growth and low inflation, is as impressive as any I have witnessed in my near half-centu observation of the American economy.The consequences for the American worker have been dramatic and, for the most p highly favorable.

A great many chronically underemployed people have been given the opportun work, and many others have been able to upgrade their skills as a result of work experience, increases in on-the-job training, or increased enrollment in technical programs.

Welfare recipi to have been absorbed into the work force in significant numbers.Government finances have improved as well.

The taxes paid on huge realized cap gains and other incomes related to the stock market, coupled with taxes on markedly higher c profits, have joined with restraint on spending to produce a unified federal budget surplus time in nearly three decades.

April's budget surplus of $125 billion was the largest monthly record.

Widespread improvement also has been evident in the financial positions of state governments.The fact that economic performance strengthened as inflation subsided should not been surprising, given that risk premiums and economic disincentives to invest in productiv diminish as product prices become more stable.

But the extent to which strong growth and high utilization have been joined with low inflation over an extended period is nevertheless ext Indeed, the broadest measures of price change indicate that the inflation rate moved down fur first quarter of this year, even as the economy strengthened.

Although declining oil prices co this result, pricing leverage in the goods-producing sector more generally was held in check industrial capacity, reduced demand in Asia that, among other things, has led to a sof commodity prices, and a strong dollar that has contributed to bargain prices on many import elements in this mix clearly were transitory, and the very recent price data suggest that con inflation has moved up in the second quarter.

But, even so, the rate of rise remains quitoverall.

At this point, at least, the adverse wage-price interactions that played so central a inflation higher in many past business expansions -- eventually bringing those expansions to a not appear to have gained a significant toe-hold in the current expansion.There are many reasons why the wage-price interactions have been so well-containe this expansion.

For one thing, increases in hourly compensation have been slower to pick up tha other recent expansions, although, to be sure, wages have started to accelerate in the past co as the labor market has become tighter and tighter.In the first few years of the expansion, the subdued rate of rise in hourly comp seemed to be, in part, a reflection of greater concerns among workers about job security.

We to have moved beyond that period of especially acute concern, though the flux of technology leave many workers with fears of job skill obsolescence and a willingness to trade wage gain security.

This may explain why, despite the recent acceleration of wages, the resulting compensation has fallen short of what the experience of previous expansions would have led anticipate given the current degree of labor market tightness.

In the past couple of years workers have not had to press especially hard for nominal pay gains to realize sizable increa real wages.

In contrast to the pattern that developed in several previous business expansi workers required substantial increases in pay just to cover increases in the cost of living, co have been generally well-behaved in the current expansion.

Changes this past year in prices goods and services have been among the smallest of recent decades.In addition, the rate of rise in the cost of benefits that employers provide to been remarkably subdued over the past few years, although a gradual upward tilt has become ev late.

A variety of factors -- including the strength of the economy and rising equity values, reduced the need for payments into unemployment trust funds and pension plans, and the restruc the health care sector -- have been working to keep benefit costs in check in this expansion. medical area at least, the most recent developments suggest that the favorable trend may ha course.

The slowing of price increases for medical services seems to have come to a halt, at time, and, with the cost-saving shift to managed care having been largely completed, the pot businesses to achieve further savings in that regard appears to be rather limited at this poin been a few striking instances this past year of employers boosting outlays for health b substantial amounts.A couple of years ago -- almost at the same time that increases in total compensation began trending up in nominal terms -- evidence of a long-awaited pickup in the gr labor productivity began to show through more strongly in the data; and this accelerated i output per hour has enabled firms to meet workers' real wage demands while holding the line increases.

Gains in productivity usually vary with the strength of the economy, and the favora that we have observed during the past two years or so, when the economy has been growing rapidly, surely overstate the degree of pickup that can be sustained.

But evidence continues t the trend has picked up, even if the extent of that improvement is as yet unclear.

Signs technological transformation of the economy are all around us, and the benefits are evident n high-tech industries but also in production processes that have long been part of our industriaNotwithstanding a reasonably optimistic interpretation of the recent produc numbers, it would not be prudent to assume that rising productivity, by itself, can non-inflationary future.

Certainly wage increases, per se, are not inflationary.

To be avoid that exceed productivity growth, thereby creating pressure for inflationary price increase eventually undermine economic growth and employment.

Because the level of productivity is tie important degree to the physical stock of capital, which turns over only gradually, increases growth of productivity probably also occur rather gradually.

By contrast, the potential acceleration of nominal hourly compensation is surely greater.

Still, a strong signal of infla building because of compensation increases markedly in excess of productivity gains has not ye emerged in this expansion.

Among nonfinancial corporations, our most reliable source of conscosts, trends in costs seem to have accelerated from their lows, but the rates of increase in costs and total unit costs are still quite low.Nonetheless, as I have noted in previous appearances before Congress, I re concerned that economic growth will run into constraints as the reservoir of unemployed available to work is drawn down.

The annual increase in the working-age population (from 16 years of age), including immigrants, has been approximately 1 percent a year in recent ye employment, measured by the count of persons who are working rather than by the count of jo been rising 2 percent a year since 1995 despite the acceleration in the growth of output per h between employment growth and population growth, amounting to about 1.2 million a year on ave has been made up, in part, by a decline in the number of individuals who are counted as unemp those persons who are actively seeking work -- of approximately 700,000 a year, on average, end of 1995.

The remainder of the gap has reflected a rise in labor force participation that to a decline of more than 500,000 a year in the number of individuals (age 16 to 64) wanting not actively seeking one.

Presumably, many of the persons who once were in this group have recently become active and successful job-seekers as the economy has strengthened, thereby prev still sharper drop in the official unemployment rate.

In May, the number of persons aged 16 wanted to work but who did not have jobs was 9.7 million on a seasonally adjusted basis, slig than 5½ percent of the working-age population.

This percentage is a record low for the series, became available in 1970.The gap between the growth in employment and that of the working-age population w inevitably close.

What is crucial to sustaining this unprecedented period of prosperity is closing occurs in a disruptive or gradual, balanced manner.

The effects of the crisis in Asia certainly damp net exports further, potentially moderating the growth of domestic production a employment.

The strength of domestic spending that has been bolstering output growth and the for labor also could ebb if recent indications of a narrowing in domestic profit margins were be the forerunner of a reassessment of the expected rates of return on plant and equipment. prospects for the return to capital would not only affect investment directly but could consumption as stock prices adjusted to a less optimistic view of earnings prospects.

Finally, unsustainable rise of inventories that has been evident in recent quarters will be slowing at perhaps abruptly.

An easing of the demand for labor would be an expected consequence of a slo in either final sales or inventory accumulation.

Of course, the demand for labor that is cons particular rate of output growth also could be lowered if productivity were to continue to acce on the supply side of the labor market, faster growth of the labor force could emerge as th delayed retirements or increased immigration.If developments such as these do not bring labor demand into line with its sust supply, tighter economic policy may be necessary to help guard against a buildup of pressures derail the current prosperity.

Fortunately, fiscal policy has been moving toward restraint to although recent budgetary discussions do not appear to be focused on extending that tendency. policy might need to tighten if demand were to continue to exhibit few signs of abating n thereby threatening to place still further strains on our labor markets.

We at the Feder recognizing the powerful forces of productivity growth and global restraint on inflation, perceived to date the need to tighten policy in response to strong demand, beyond what has through falling inflation's upward pressure on the real federal funds rate and the modest inc nominal rate that we initiated in March of 1997.

But, we are monitoring the evolving forces ve to determine whether the recent acceleration of costs, albeit moderate, is likely to prove tra start of a more worrisome pattern that may well require a response.In summary, Mr. Chairman, our economy has remained strong this year despite evide of substantial drag from Asia, and, at the same time, inflation has remained low.

As I have in set of circumstances is not what historical relationships would have led us to expect at this business expansion, and while it is possible that we have, in a sense, moved 'beyond history have to be alert to the possibility that less favorable historical relationships will eventhemselves.

That is why we are remaining watchful for signs of potential inflationary imbalan as the economy continues to perform more impressively than it has in a very long time.