A Federal Reserve Board Governor Looks at the Economy
Ferguson, Roger W., Jr., Business Credit
EDITOR'S NOTE: The following article is excerpted from the remarks of Governor Ferguson at the National Economic Association Forum in New York City on January 3, 1999.
In the spirit of old year endings and new year beginnings, I would like to review last year's economic performance, highlight some prospects for the upcoming year's economic performance, and raise some topics related to the underpinnings of macroeconomics and monetary policy. Of course, the views that I am about to express are my own, and do not reflect those of the FOMC [Federal Open Market Committee] nor those of the Board of Governors.
Last Year's Economic Performance
The last 12 months have been a most challenging time in general, and particularly from the standpoint of monetary policy. We started the first half of the year with a focus on the cross winds of strength and international weakness that seemed to be buffeting the United States economy. Domestic demand was particularly strong, led by consumption expenditures, which grew at a six percent annual rate in both the first and second quarters of the year. However, consumption was not the only engine driving the spectacular performance of the first half of 1998.
Business fixed investment, paced by spending on producers' durable equipment, rose at more than a 22 percent annual rate in the first quarter and by nearly 13 percent in the second quarter. Additionally, the housing sector expanded at a robust 15 percent annual rate or more in both the first and second quarters. During much of 1997, long-term interest rates had trended downward, and by early 1998 rates on fixed-rate mortgages were close to their lowest levels in 25 years. Similarly, the rise in equity prices over much of 1997 and the first half of 1998 provided ample incentive for consumption by raising the value of household assets and improving the general sense of financial well-being of our citizens, as well as lowering the cost of capital faced by businesses.
This domestically driven good news was counterbalanced by a sense of foreboding from Asia. During the first half of 1998, the net export drag, due in large part to the turmoil in Asia, subtracted about 2 percentage points from GDP growth. The trade deficit grew to well over $200 billion, again at an annual rate.
For the March through July FOMC meetings last year, the Committee maintained a bias toward raising interest rates, but did not actually take action. The sense of the FOMC was that the tightness in labor markets and general growth of demand would be likely to create upward pressures on wage growth and eventually on the rate of inflation. However, uncertainty regarding the degree and timing of impact from the Asian crises, and the fact that inflation was actually subdued, allowed us to adopt a "wait and see" posture.
The second half of 1998 provided a very different configuration of events that created the need for some monetary policy action. Interestingly, the catalyst was not directly Asia or a slowing economy from net export drag. It was the indirect impact of Asia, working through a Russian debt moratorium and ruble devaluation, that provided the impetus for an easing in U.S. short term interest rates. By the end of August, financial markets in the United States had become quite unsettled, with an open and obvious flight to quality and liquidity creating a risk of undue credit tightening for private sector borrowers. The flight to liquidity was evidenced in unusually wide spreads between U.S. government securities of similar risk characteristics and the flight to quality showed through in unusually wide spreads between securities of differing risk characteristics.
More recently, we have seen some signs of easing of financial market stresses and some unwinding of the associated flight to quality encouraged, in part, by policy actions of many central banks around the world, and by a stronger sense that the world's major industrial countries, the G7, are beginning to address a number of the factors that have contributed to uncertainty and volatility in financial markets around the globe. …