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Alan Greenspan Addresses Congress on the State of the Economy

Aired February 13, 2001 - 10:30 a.m. ET


KYRA PHILLIPS, CNN ANCHOR: We're going to go to Greenspan and listen in to what he has to say before the Banking Committee.


ALAN GREENSPAN, FEDERAL RESERVE CHAIRMAN: 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 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 downward trend 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 costs and price pressures remained subdued, so that our front-loaded actions were unlikely to jeopardize the stable, low- inflation environment necessary to foster investment and advances in productivity.

The exceptional weakness so evident in a number of economic indicators toward the end of last year -- perhaps in part the consequence of adverse weather -- apparently did not continue in January. But with signs of softness still patently in evidence at the time of its January meeting, the FOMC retained its sense that the risks are weighted toward conditions that may generate economic weakness in the foreseeable future.

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 even 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 decision-makers not only become risk averse, but attempt to disengage from all risk. This precludes...

PHILLIPS: Fed Chairman Alan Greenspan speaking before the Senate Banking Committee with his economic outlook. Some good news, some bad news: overall, rate of growth in productivity and profits still up from a decade ago.

With are going to bring in our Fred Katayama. He is live on Capitol Hill. He has been following this too -- what do you, think, Fred?

FRED KATAYAMA, CNN CORRESPONDENT: Well, Kyra, Fed Chairman Alan Greenspan is painting a picture showing that the long-term outlook for the economy remains, in his words, quite favorable, but rather sluggish in the near term. He began his testimony by justifying or explaining why he took the dramatic step of making two interest rate cuts in January.

He noted, among other things, that energy -- high energy costs drained consumers and businesses of purchasing power. He noted that stock prices fell and that banks turned cautious on lending. He also noted that inventory, stockpiles at businesses had piled up to what he called excessively high levels. Having said that, he noted that the economy showed signs of improving in January. Having said that, he still says that there's still a risk of weakness in the foreseeable future.

Now, on the plus side, he notes that there is still improvements -- the prospects for improvements in productivity remain favorable. He notes that Wall Street is very bullish about the outlook for corporate earnings over the next three to five years. And he notes that corporate managers are optimistic about the long-term prospects for new technology. And he says that some of that new technologies, such as business-to-business communications, is helping business control costs, keeping costs in check.

He also notes that consumer confidence, while it has slipped a bit, is still consistent with economic growth -- Kyra.

PHILLIPS: All right, Fred Katayama, thank you very much.



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