Text of Greenspan's Speech
Remarks by Federal Reserve Chairman Alan Greenspan at
the 1997 Haskins Partners Dinner of the Stern School of
Business, New York University, New York City on
Thursday:
I am pleased to accept this year's Charles Waldo Haskins
Award and have the opportunity to address this
distinguished audience on current monetary policy.
A central bank's raising interest rates is rarely popular. But
the Federal Reserve's action on March 25, to tighten the
stance of monetary policy, seems to have attracted more
than the usual share of attention and criticism. I believe the
critics of our action deserve a response. So tonight, I
would like to take a few minutes to put this action in the
broad context of the Fed's mandate to promote the stable
financial environment that will encourage economic growth.
The Federal Open Market Committee raised rates as a
form of insurance. It was a small prudent step in the face
of the increasing possibility that excessive credit creation,
spurred by an overly accommodative monetary policy,
might undermine the sustained economic expansion. That
expansion has been fostered by the maintenance of low
inflation. But the persisting -- indeed increasing -- strength
of nominal demand for goods and services suggested to us
that monetary policy might not be positioned appropriately
to avoid a buildup of inflationary pressures and imbalances
that would be incompatible with extending the current
expansion into 1998, and hopefully beyond. Even if it
should appear in retrospect that we could have skirted the
dangers of credit excesses without a modest tightening,
the effect on the expansion would be small, temporary,
and like most insurance, its purchase to protect against
possible adverse outcomes would still be eminently
sensible.
For the Federal Reserve to remain inactive against a
possible buildup of insidious inflationary pressures would
be to sanction a threat to the job security and standards of
living of too many Americans. As I pointed out in testimony
before the Congress in March, the type of economy that
we are now experiencing, with strong growth and tight
labor markets, has the special advantage of drawing
hundreds of thousands of people onto employment
payrolls, where they can acquire permanent work skills.
Under less favorable conditions they would have remained
out of the labor force, or among the long-term unemployed.
Moreover, the current more-than-six-year expansion has
enabled us to accelerate the modernization of our
productive facilities.
It has long been the goal of monetary policy to foster the
maximum sustainable growth in the American economy. I
emphasize sustainable because it is clear from our history
that surges in growth financed by excessive credit creation
are, by their nature, unsustainable, and, unless contained,
threaten the underlying stability of our economy. Such
stability, in turn, is necessary to nurture the sources of
permanent growth.
The Federal Reserve, of late, has been criticized as being
too focused on subduing nonexistent inflation and, in the
process, being willing to suppress economic growth, retard
job expansion, and inhibit real wage gains. On the
contrary, our actions to tighten money market conditions
in 1994, and again in March of this year, were directed at
sustaining and fostering growth in economic activity, jobs,
and real wages. Our goal has never been to contain
inflation as an end in itself. Prices are only signals of how
the economy is functioning. If inflation had no effect on
economic growth, we would be much less concerned
about inflationary pressures.
But the evidence is compelling that low inflation is
necessary to the most favorable performance of the
economy. Inflation, as is generally recognized throughout
the world, destroys jobs and undermines productivity
gains, the foundation for increases in real wages. Low
inflation is being increasingly viewed as a necessary
condition for sustained growth.
It may be an old cliche, but you cannot have a vibrant
growing economy without sound money. History is
unequivocal on this.
The Federal Reserve has not always been successful at
maintaining sound money and sustained growth, and the
lessons have been costly. The Federal Reserve's policy
actions, the evidence demonstrates, affect the financial
markets immediately, but work with a significant lag of
several quarters or more on output and employment, and
even longer on prices. Too often in the past, policymakers
responded late to unfolding economic developments and
found they were far behind the curve, so to speak; as a
result, their policy actions were creating or accentuating
business cycles, rather than sustaining expansion. Those
who wish for us, in the current environment, to await
clearly visible signs of emerging inflation before acting are
recommending we return to a failed regime of monetary
policy that cost jobs and living standards.
I wish it were otherwise, but there is no alternative to
basing policy on what are, unavoidably, uncertain
forecasts. As I have indicated to the Congress, we do not
base policy on a single best-estimate forecast, but rather
on a series of potential outcomes and the possible effects
of alternative policies, including judgments of the
consequences of taking a policy action that might, in the
end, have turned out to be less than optimal.
I viewed our small increase in the federal funds rate on
March 25 as taken not so much as a consequence of a
change in the most probable forecast of moderate growth
and low inflation for later this year and next, but rather to
address the probability that being wrong had materially
increased.
In the same sense that it would be folly not to endure the
small immediate discomfort of a vaccination against the
possibility of getting a serious disease, it would have been
folly not to take this small prudent step last March to
reduce the probabilities that destabilizing inflation would
re-emerge. The risk to the economy from inaction came to
outweigh the risk from action.
To be sure, 1997 is not 1994 when the Fed was forced to
tighten monetary conditions very substantially to avoid
accommodating rising inflation. Current financial conditions
are much less accommodative than they were in 1994. Yet
we must be wary. While there is scant evidence of any
imminent resurgence of inflation at the moment, there also
appears to be little slack in our capacity to produce.
Should the expected slowing in the growth of demand fail
to materialize, we would need to address any emerging
pressures in product and credit markets.
To understand the problems of capacity restraint, I should
like to spend a few moments on what we have learned over
the years about economic growth and the conditions
necessary to foster it.
First it is useful to distinguish between two quite different
types of economic growth. One is true, sustainable growth,
the other is not. True growth reflects the capacity of the
economic system to produce goods and services and is
based on the growth in productivity and in the labor force.
That growth contrasts with the second type, what I would
call transitory growth. An economy producing near
capacity can expand faster for a short time through excess
credit creation. But this is not growth in any meaningful
sense of promoting lasting increases in standards of living
for our nation. Indeed, it will detract from achieving our
long-term goals. Temporary fluctuations in output owing to
say, inventory adjustments, but not financed through
excess credit, will quickly adjust on their own and need
not concern us as much, provided policy is appropriately
positioned to foster sustainable growth.
When excessive credit fostered by the central bank
finances excess demand, history tells us destabilizing
inflationary pressures eventually emerge. For a
considerable portion of the nineteenth and early twentieth
centuries, inflationary credit excesses and prices were
contained by a gold standard and balanced budgets. Both,
however, were deemed too constraining to the achievement
of wider social goals as well as for other reasons, and
instead the Federal Reserve was given the mandate of
maintaining the appropriate degree of liquidity in the
system.
Over the long haul, the economy's growth is effectively
limited to the expansion of capacity based on productivity
and labor force growth. To be sure, it is often difficult to
judge whether observed growth is soundly based on
productivity or arises from transitory surges in output
financed in many cases by excess credit, but this is in
part what making monetary policy is all about.
In that regard and in the current context, how can we be
confident we at the Federal Reserve are not inhibiting the
nation reaching its full growth potential?
One way is to examine closely the recent economic
record. Only two and a half years ago, rising commodity
prices, lengthening delivery times, and heavy overtime
indicated that our productive facilities were under some
strain to meet demand. To be sure, since early 1995,
those pressures have eased off. However, given the good
pace of economic expansion since then, it would stretch
credulity to believe that capacity growth has accelerated at
a sufficient pace to produce a large degree of slack at this
moment. Capacity utilization in industry is a little below its
level through much of 1994, and pressures in product
markets have remained tame. However, falling
unemployment rates and rising overtime hours -- as well as
anecdotal reports -- unambiguously point to growing
tightness in labor markets.
With tight labor markets and little slack in product
markets, we are led to conclude that significant persistent
strength in the growth of nominal demand for goods and
services, outstripping the likely rate of increase in
capacity, will presumably be resisted by higher market
interest rates. If, instead, that demand is accommodated
for a time by a step up in credit expansion facilitated by
monetary policy, increasing pressures on productive
resources would sow, as they have in the past, the seeds
of even higher interest rates and a consequent subsequent
economic retrenchment.
This, then, was the context for our recent action. We saw
a significant risk that monetary policy was not positioned
to promote sustainable economic expansion, and we took
a small step to increase the odds that the good
performance of the economy can continue.
There is another point of view of the current context that
merits consideration. It is the notion that, owing largely to
technological advance and to freer international trade, the
conventional notions of capacity are becoming increasingly
outmoded, and that domestic resources can be used
much more intensively than in the past without added price
pressures. There is, no doubt, a substantial element of
truth in these observations, as I have often noted in the
past. Computer and telecommunication based
technologies are truly revolutionizing the way we produce
goods and services. This has imparted a substantially
increased degree of flexibility into the workplace, which in
conjunction with just-in-time inventory strategies and
increased availability of products from around the world,
has kept costs in check through increased productivity.
Our production system and the notion of capacity are far
more flexible than they were ten or twenty years ago.
Nonetheless, any inference that our productive capacity is
essentially unlimited is clearly unwarranted. As I pointed
out earlier, judging from a number of tangible signs of
strains on facilities, we were producing near capacity in
early 1995, and it is just not credible that an economy as
vast and complex as that of the United States could have
changed its underlying structure in the short time since
then.
If we consider the current rate of true, sustainable growth
unsatisfactory, are there policies which could augment it?
In my view, improving productivity and standards of living
necessitates increasing incentives to risk taking. To
encourage people to take prudent risks, the potential
rewards must be perceived to exceed the possible losses.
Maintaining low inflation rates reduces the levels of future
uncertainties and, hence, increases the scope of
investment opportunities. It is here that the Federal
Reserve can most contribute to long-term growth.
Other government policies also can affect these
perceptions. For example, lower marginal tax rates and
capital gains taxes would increase the return to successful
investments and, thus, the incentive to initiate them. In
addition, coming to grips now with the outsized projected
growth in entitlement spending in the early years of the
next century could have a profound effect on current
expectations of stability. Early actions could bring real
long-term interest rates down, also increasing the scope of
investment opportunities. And, clearly, removing the federal
deficit's drain on private savings would help to finance such
private investment.
Deregulation, by increasing the flexibility in the deployment
of our capital and management resources, can also make
a decided contribution to growth. The deregulation of
telecommunications, motor and rail transport, utilities, and
financial services, to name a few, may have done more to
foster America's competitive market efficiencies than we
can readily document.
Finally, though not a function of government policies, is the
continued good pace of productivity growth this late in the
business expansion. This cyclical pattern is contrary to
our experience and it suggests there may be an
undetected delayed bonus from technical and managerial
efficiencies coming from the massive advances in
computer and telecommunications technology applications
over the last two decades. If so, it is important that we
nurture it with adequate incentives -- at a minimum,
eschew regulations and taxation that reduce most
incentives -- for this may well be one source of our low
inflation environment.
While productivity improvement through capital investment
and technological advance is clearly central to the process
of economic growth, the pace and quality of labor force
expansion is additive to productivity growth in achieving
overall gains in GDP. Hence, appropriate upgrading of
skills through education and training should go with any
menu to expand economic growth.
Looking ahead, there are many reasons to be optimistic
about the economy's prospects.
For a vast nation such as ours at the cutting edge of
technology, a large pickup in productivity growth is difficult
to envisage. But appropriate incentives advancing that
cutting edge can augment growth in a material way. And
cumulatively, over time even a modest acceleration in
productivity would very significantly improve the standards
of living of our children.
The twenty-first century will pose many challenges to our
ingenuity to develop new and sophisticated ways of
creating economic value. But with the competitive benefits
of increasingly open markets, I have little doubt we
Americans will meet the challenge admirably. |
