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Fed Chairman Alan Greenspan Testifies Before House Financial Services Committee

Aired February 28, 2001 - 9:40 a.m. ET


LEON HARRIS, CNN ANCHOR: We want to get some more on Greenspan right now.

Our Peter Viles is standing by in Washington, where Alan Greenspan is prepared to move markets.

What's the word, Peter?

PETER VILES, CNN CORRESPONDENT: He sure is, Leon. He spoke 15 days ago to a Senate committee about the economy. Usually he comes back to the house and says exactly the same thing. That testimony in about a half an hour.

And there are some slight changes, changes in his view of the economy over the past 15 days. He will say, according to his prepared remarks, that the economy has entered a retrenchment that has yet to run its full course. So whatever slowdown we're in right now, it's not over, he will tell the House sometime in the next half hour or so.

The key moment in this committee hearing will come when one of the 70 members of this committee asks Alan Greenspan, are we now in a recession? He did not answer that question in his prepared remarks. He did answer it 15 days ago when he said, quote, "at the moment, no, we are not in a recession."

But that's the moment to listen for later today here on Capitol Hill -- Leon.

HARRIS: Peter, do you expect him to come out with a clear answer, since he's been dancing around that particular issue?

VILES: He was pretty clear 15 days ago when he said, no, we're not in a recession. And what he has said is the key is: Is the consumer still confident at some level enough to make future decisions about buying homes or buying cars? And what he does say in this testimony is that the consumer, rather, still is buying cars, still is buying homes, does not appear to have completely thrown in the towel on this economy.

So if you had to guess, you would say that he would not say we're in a recession right now.

HARRIS: OK, good deal. Well, the guessing will be over in a few minutes, we hope. And you see there a live -- there's a live shot we have from the room. And we understand Mr. Greenspan is testifying even as we speak. Let's listen in.


ALAN GREENSPAN, FEDERAL RESERVE CHAIRMAN: ... certainly appreciate this opportunity to present the Federal Reserve's semi- annual 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 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 inflationary environment necessary to foster investment and advances in productivity.

With signs of softness still patently in evidence at the time of its January meeting, the Federal Open Market Committee retained its sense that downside risks predominate. The exceptional degree of slowing so evidence toward the end of last year, perhaps in part the consequence of adverse weather, seemed less evident in January and February. Nonetheless, the economy appears to be on a track well below the productivity enhanced rate of growth of its potential. And even after the policy actions we took in January, the risk continued skewed toward the economy's remaining on a path inconsistent with satisfactory economic performance.

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 online 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 ever shorter time frame.

This very rapidity with which the current adjustment is proceeding raises another concern, of a different nature. While technology has quickened production adjustments, human nature remains unaltered. We respond to a heightened pace of change and its associated uncertainty in the same way we always have. We withdraw from action, postpone decisions, and generally hunker down until a renewed, more comprehensible basis for acting emerges. In its extreme manifestation, many economic decisionmakers not only become risk averse but attempt to disengage from all risk. This precludes taking any initiative, because risk is inherent in every action. In the fall of 1998, for example, the desire for liquidity became so intense that financial markets seized up. Indeed, investors even tended to shun risk-free, previously issued Treasury securities in favor of highly liquid, recently issued Treasury securities.

But even when decisionmakers are only somewhat more risk averse, a process of retrenchment can occur. Thus, although prospective long- term returns on new high-tech investment may change little, increased uncertainty can induce a higher discount of those returns and, hence, a reduced willingness to commit liquid resources to illiquid fixed investments.

Such a process presumably is now under way and arguably may take some time to run its course. It is not that underlying demand for Internet, networking, and communications services has become less keen.

Indeed, as I noted earlier, some suppliers seem to have reacted late to accelerating demand, have overcompensated in response, and then have been forced to retrench -- a not unusual occurrence in business decisionmaking.

A pace of change outstripping the ability of people to adjust is just as evident among consumers as among business decision-makers. When consumers become less secure in their jobs and finances, they retrench as well.

It is difficult for economic policy to deal with the abruptness of a break in confidence. There may not be a seamless transition from high to moderate to low confidence on the part of businesses, investors and consumers. Looking back at recent cyclical episodes, we see that the change in attitudes has often been sudden. In earlier testimony, I likened this process to water backing up against a dam that is finally breached. The torrent carries with it most remnants of certainty and euphoria that built up in earlier periods.

This unpredictable rending of confidence is one reason that recessions are so difficult to forecast. They may not be just changes in degree from a period of economic expansion, but a different process engendered by fear. Our economic models have never been particularly successful in capturing a process driven in large part by nonrational behavior.

For this reason, changes in consumer confidence will require close scrutiny in the period ahead, especially after the steep fall- off of recent months. But for now at least, the weakness in sales of motor vehicles and homes has been modest, suggesting that consumers have retained enough confidence to make longer-term commitments. As I pointed out earlier, expected earnings growth over the longer-run continues to be elevated. Obviously, if the forces contributing to long-term productivity growth remain intact, the degree of retrenchment will presumably be limited. In that event, prospects for high productivity growth should, with time, bolster both consumption and investment demand. Before long in this scenario, excess inventories would be run-off to desired levels. Higher demand should also facilitate the working-off of a presumed excess capital stock, though doubtless at a more modest pace.

Still, as the Federal Open Market Committee noted in its last announcement, for the period ahead, downside risks predominate. In addition to the possibility of a break in confidence, we don't know how far the adjustment of the stocks of consumer durables and business-capital equipment has come. Also, foreign economies appear to be slowing, which could damp demands for exports, and continued nervousness is evident in the behavior of participants in financial markets keeping risks spreads relatively elevated.

Because the advanced supply-chain management and flexible manufacturing technologies may have quickened the pace of adjustment in production and incomes, and correspondingly increased the stress on confidence, the Federal Reserve has seen the need to respond more aggressively than had been our wont in earlier decades. Economic policy making could not, and should not, remain unaltered in the face of major changes in the speed of economic progress. Fortunately, the very advances in technology that have quickened economic adjustments have also enhanced our capacity for real-time surveillance.

In summary then, although the sources of long-term strength of our economy remain in place, excesses built up in 1999 and early 2000 have engendered a retrenchment that has yet to run its full course.

This retrenchment has been prompt, in part because new technologies have enabled businesses to respond more rapidly to emerging excesses. Accordingly, to foster financial conditions conducive to the economy's realizing its long-term strengths, the Federal Reserve has quickened the pace of adjustment of its policy.

Thank you, Mr. Chairman, and I request that the remainder of my remarks be included for the record.

REP. MICHAEL OXLEY (R-OH), CHAIRMAN: Without objection, so ordered, Mr. Chairman.

And let me recognize myself for five minutes.

Mr. Chairman, back when...

HARRIS: All right, we've been listening this morning to Fed Chairman Alan Greenspan there this morning giving his assessment of the economy. And we've been listening to see whether or not this also has foretold some sort of cut in interest rates, which is what the markets have been waiting for.

And as we go now to our Deborah Marchini at the CNN financial news desk in New York, who's been listening as well. I believe the headline here this morning is that things may have slowed down right now, but the picture in the future does look rosy. And if things stay as they are right now, things should recover on the road. Is that how you read it, Deborah?

DEBORAH MARCHINI, CNN CORRESPONDENT: Somewhat, Leon. The chairman is trying to tread a very fine line here. He wants to tell people that the economy has weakened since he last testified before Congress on Feb. 13, but he doesn't want to scare consumers because consumer confidence has fallen for five straight months. So he's walking a fine line.

He did say that the economy appears to be on a track well below what it had been before, or well below potential. And even after the two interest rate cuts that the Fed took in January, the risks are still that the economy will perform unsatisfactorily.

That's as much as we can get Greenspanspeak trimmed down into plain English. What it means is that even after the Fed cut rates twice, it realizes that the economy is not exactly on a track towards normal, sustainable growth. The implications of that are that the Federal Reserve will have to cut rates again.

But at the same time, he did try to reassure people. He did say that consumer spending and business investments haven't exactly fallen off a cliff. He did acknowledge, though, that consumer confidence has dropped very sharply. And whereas before he was not concerned so much about consumer confidence, he now says it is something that the Federal Reserve has to watch closely going forward -- Leon.

HARRIS: Yes, and as I read it, too, I heard him say that, for now, that the weakness in home sales and car sales is modest. Does -- now -- and those are the two sectors that basically are hit first the hardest and get the biggest impact from any interest rate cuts. Are you reading this as saying there will not be any interest rate cut for now, or there will be one, or there will be one later? What do you think?

MARCHINI: There will not be one right this minute. There may not be one today, but it sounds like there is going to be another one soon. The open question, Leon, is whether the Federal Reserve will appear -- will appear pressed to act before its meeting on March 20 or whether it can wait until the March 20 meeting. That, presumably, will depend on what else the Federal Reserve sees.

I'm not an economist paid to analyze this man's utterances. But having followed them basically since 1987 when he became Federal Reserve chairman, I can tell you that my reading of this would be they're tempted to wait for just a little bit more data before they make a decision.

It is pretty clear, though, that the Federal Reserve is leaning toward moving, and moving quickly. He says the pace of economic change has speeded up because of technology, and that the Fed's reaction time has to speed up, too. So I don't think we're going to be waiting too long for that rate cut. HARRIS: And I have no problem at all in taking your interpretation.

MARCHINI: All right.

HARRIS: You're much better at it than we are. Thanks much. Good to see you again, Deb.

MARCHINI: Good to see you, Leon. Thanks.

HARRIS: Take care. We'll talk to you later on.



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