July 15, 2003

Greenspan Before the House Financial Services Committee

Greenspan made two points that I did not really expect. The first is the Federal Reserve's new position that it still has "substantial" room to cut short-term interest rates, even though the target Federal Funds rate is now a low 1% per year. The second is that the Federal Reserve thinks that the accounting scandals have played a significant role in discouraging investment--in which case the failure of the Bush administration to take action and the great Harvey Pitt follies have been very expensive for the American economy.

Greenspan: Further interest rate cuts possible - Jul. 15, 2003: NEW YORK (CNN/Money) - The Federal Reserve could make further substantial cuts in interest rates, Alan Greenspan told Congress Tuesday, but the central bank chairman also said the Fed was not ready to take unusual steps such as buying Treasury bonds to give a lift to the economy. "With the target funds rate at 1 percent, substantial further conventional easings could be implemented if (Fed policy makers) judged such policy actions warranted," Greenspan said in remarks to the House Financial Services Committee. Greenspan also said the Fed, the nation's central bank, was ready to keep rates low for a "considerable" period of time to try to lift economic activity.

"The FOMC stands prepared to maintain a highly accommodative stance of policy for as long as needed to promote satisfactory economic performance," he said, referring to the Fed's policy-making body, the Federal Open Market Committee. In response to questions from members of the committee, Greenspan said he does not agree with those who believe that the federal funds rate could not easily go below 0.75 percent. The overnight bank lending rate -- the Fed's main tool for influencing rates and the economy -- stands at 1 percent, the lowest since 1958.

Greenspan said if the Fed doesn't find it is getting the impact from further rate cuts, then it is prepared to take non-traditional steps such as buying up Treasury bonds. "If it's necessary, we will do it," he said. "It's clear to us there is a downside limit zero being the ultimate lower bound." But he said he believed that time for that action was not yet here.

"Given the now highly stimulative stance of monetary and fiscal policy and well-anchored inflation expectations, the committee concluded that economic fundamentals are such that situations requiring special policy actions are most unlikely to arise," he said in his opening remarks. Greenspan's comments caused Treasury bond prices to sink, as his comment disappointed investors who had expected sooner direct action by the Fed in that area. The Fed cut its target for the fed funds rate when the central bank's policy makers met June 25 -- the 13th cut since the start of 2001 as the central bank has tried to help the world's largest economy fight off the effects of a recession, terrorist attacks, corporate scandals, war and more.

While some question whether further rate cuts would be effective, Greenspan said the central bank has studied the issue and decided that they would. But he also conceded that low rates so far have not lifted business activity as much as they might have in the past. "A pervasive sense of caution reflecting, in part, the aftermath of corporate governance scandals appears to have left businesses focused on strengthening their balance sheets and, to date, reluctant to ramp up significantly their hiring and spending," he told lawmakers. "As yet there is little evidence that the more accommodative financial environment has materially improved the willingness of top executives to increase capital investment," he said in his opening remarks...

Posted by DeLong at July 15, 2003 10:08 AM | TrackBack

Comments

Last time around, it was the war which was impeding the recovery he predicted. This time it's the aftermath of the corporate governance scandals. Wonder what excuse he'll come up with next time.

Posted by: Chuck Nolan on July 15, 2003 11:11 AM

The thought that the Fed could cut rates another couple of .25 points is not surprising. It is a more conservative move than buying up long term bonds.

I am surprised by the business scandal statement. Businesses invest when they can make return on profit. I see Japan in recession, most of Europe in recession and the US in overcapacity. In addition, the states are cutting back on purchases and raising taxes. Energy costs are rising, making mfg more expensive. These factors are definately squashing business investment. The corporate scandals should have more influence on the stock markets than they do. We are in another stock bubble and many retirement accounts are still overinvested in corporate stock. That does not suggest lack of investor confidence in business and the stock market.

Posted by: bakho on July 15, 2003 11:15 AM

The stock market rise appears to be led by moderate sized investors, corporate bonds were hot from May 2000 to June 2003. Investors such as Warren Buffett have no qualms about buying well valued assets. What is Alan Greenspan really thinking? What evidence is there that investment is being limited by the corporate scandals, severe though they have been?

Posted by: anne on July 15, 2003 11:25 AM

Remember, interest rate policy has to confront a Federal deficit that will add to about $900 billion this year and next. Yes, we are a large economy. No, this is not a small deficit. No, we will not grow our way out of deficit.

Posted by: anne on July 15, 2003 11:38 AM

This does not bode well for the employment picture:

The Fed expects the economy to grow at a 2.5 percent to 2.75 percent inflation-adjusted rate in 2003, according to the central bank's forecast presented today. In February, the Fed forecast the economy would grow at a 3.25 percent to 3.5 percent rate. The Fed's forecasts measure growth between the fourth quarters of 2002 and 2003 and reflect the ``central tendency'' of forecasts by the five current governors and 12 district bank presidents.

This is certainly not enough to "grow" out of the deficit that is over 20% of budget.

Posted by: bakho on July 15, 2003 11:58 AM

GDP growth of even 3% is not enough to stem continued job cuts, nor is it close to enough to reverse the deficit growth. We need at least 3.5% GDP growth to keep up with productivity advances and labor force growth. The series of tax cuts simply will not allow us to grow out of deficit.

Stephen Roach suggests we are figuring out how to blame China -

http://www.morganstanley.com/GEFdata/digests/20030714-mon.html

Posted by: anne on July 15, 2003 12:15 PM

Bakho,

Yup, not fast enough to absorb new job market entrants. So, since the central tendencies range for the jobless rate is 6.0%-6.25%, lower than June's 6.4%...? The only way out of that I can see is that Fed staff are ignoring the June jobless rate as a one-time quirk. Except that the jobless rate was supposed to have risen, to catch up after not going anywhere during a period of sizable job loss. Are we looking at a slowing in the pace of productivity growth? Any ideas? The central tendencies figures are usually internally consistent, but these don't seem so.

Posted by: K Harris on July 15, 2003 01:03 PM

The big three in Dr. Greenspan's testimony all properly focused on the investment issue:

(1) If he believe the FED has room to further lower interest rates - then why not do this now?

(2) He is exactly right about the adverse consequences of the long-run fiscal fiasco as to national savings. I'm glad Congressman Franks kept coming back to this.

(3) And if the accounting scandal mentality is still hurting investment - doesn't that say putting more resources into an effective SEC under the Sarbanes legislation is a very wise expenditure of government spending?

So why is the White House not supporting the wise suggestions of Dr. Greenspan even more?

Posted by: Hal McClure on July 15, 2003 01:26 PM

The big three in Dr. Greenspan's testimony all properly focused on the investment issue:

(1) If he believe the FED has room to further lower interest rates - then why not do this now?

(2) He is exactly right about the adverse consequences of the long-run fiscal fiasco as to national savings. I'm glad Congressman Franks kept coming back to this.

(3) And if the accounting scandal mentality is still hurting investment - doesn't that say putting more resources into an effective SEC under the Sarbanes legislation is a very wise expenditure of government spending?

So why is the White House not supporting the wise suggestions of Dr. Greenspan even more?

Posted by: Hal McClure on July 15, 2003 01:29 PM

To answer your questions,

1) The Fed probably wants to keep at least a bit of powder dry in case of some unforeseen economic shock. It's hard to see how lowering the Fed Funds rate even more in the present climate is going to help much. The psychological effect of the Fed having some room to lower more is probably more important.

2) The gov't is supposed to run a deficit in a slow-growth period.

3) The Sarbanes "reforms" are a crock and everyone knows it. The SEC is already in an activist mode right now and, in my experience, it doesn't seem to be focussing on important issues.

Posted by: JT on July 15, 2003 01:41 PM

JT. I don't agree with you on the Sarbanes reform. You are correct as far as deficits during periods of high unemployment and I'd be for a policy of short-run stimulus followed by long-term restraint. But Bush has this backwards. His fiscal policy is not doing much as far as short-term stimulus but is imposing long-term fiscal expansion. This long-term fiscal expansion may be hurting the economy in the short-run by discouraging investment demand. But I really don't understand keeping one's powder dry. The FED should want the aggregate demand stimulus now, not later.

Posted by: Hal McClure on July 15, 2003 02:25 PM

In the late 1990s, stock prices were "irrational exuberance" not justified by earnings. The earnings picture today is just as bad and now AG thinks inflated stock prices are a good thing? He is losing his touch.

Posted by: bakho on July 15, 2003 02:44 PM

I also never understood the analogy between interest rates and a scarcity of ammunition. If the current stimulus attempt works then you shouldn't need any ammunition for later. If it doesn't work then you are first in a position to need more than you have. Isn't that what the Fed study of Japan concluded?

Posted by: snsterling on July 15, 2003 03:56 PM
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