Academic journal article Federal Reserve Bulletin , Vol. 78, No. 9
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 21, 1992
I am pleased to have this opportunity to present the Board's semiannual Monetary Policy Report to the Congress.(1) Earlier this month, when the Federal Open Market Committee (FOMC) formulated its plans and objectives for the next year and a half, it did so against the backdrop of an economy still working its way through serious structural imbalances that have inhibited the pace of economic expansion. In light of the resulting sluggishness in the economy and of persistent weakness in credit and money, the System on July 2 cut the discount rate V2 percentage point and cased reserve market conditions commensurately. These actions followed a reduction in the federal funds rate in early April. The recent casing of reserve conditions should help to shore up the economy and, coming in the context of a solid trend toward lower inflation, have contributed to laying a foundation for a sustained expansion of the U.S. economy.
THE U.S. ECONOMY AND MONETARY POLICY
Our recent policy moves were just the latest in a series of twenty-three separate casing steps that began more than three years ago. In total, short-term market interest rates have been reduced by two-thirds. The federal funds rate, for example, has declined from almost 10 percent in mid-1989 to 3V4 percent currently. The discount rate has been cut to 3 percent--a twenty-nine-year low. Despite the cumulative size of these steps, the economic recovery to date has nonetheless been very hesitant. Based on experience over the past three or four decades, most forecasters would have predicted that a reduction of the magnitude seen in short-term interest rates, nominal and real, during the past three years would by now have been associated with a far more robust economic expansion.
Clearly the structural imbalances in the economy have proved more severe and more enduring than many had previously thought. The economy still is recuperating from past excesses involving a generalized overreliance on debt to finance asset accumulation. Many of these activities were based largely on inflated expectations of future asset prices and income growth. In short, an overbuilding and an overbuying of certain capital and consumer goods were made possible by overleverage. And when realities inevitably fell short of expectations, businesses and individuals who were left with debt-burdened balance sheets diverted cash flows to debt repayment at the expense of spending, while lenders turned considerably more cautious.
This phenomenon is not unique to the United States. To a greater or lesser extent, similar adjustments have gripped Japan, Canada, Australia, the United Kingdom, and several northern European countries. For the first time in a half century or more, several industrial countries have been confronted at roughly the same time with asset-price deflation and the inevitable consequences. Despite widespread problems, we seem to have at least avoided the crises that historically have been associated with such periods in the past.
In the United States especially, important economic dynamics ensued as the speculative acquisition of physical assets financed by debt outpaced fundamental demands. In some markets for physical assets, such as office buildings, a severe oversupply emerged, and prices plummeted. In others, such as residential housing, average price appreciation unexpectedly came to a virtual standstill, and prices fell substantially in some regions. Firms that had been subject to leveraged buyouts based on overly optimistic assumptions about the future values at which assets could be sold began to encounter debt-servicing problems.
More generally, disappointing earnings and downward adjustment in the values of assets brought about reduced net worth positions and worsened debt-repayment burdens. …