Greenspan details forces affecting economic recovery

The following excerpt is condensed from the April 17 testimony of Federal Reserve Board Chairman Alan Green-span on "Monetary policy and the economic outlook" before the Joint Eco-nomic Committee, U.S. Congress.

Forces shaping the economy

With the rise in world crude oil prices since the middle of January, higher energy costs are again sapping the purchasing power of households. To the extent that the increase in energy prices is limited in dimension ... the negative effects on spending in the aggregate should prove to be small. However, a price hike that drove oil prices well above existing levels for an appreciable period of time would likely have more far-reaching consequences. ...

Another factor likely to dampen the growth of consumer spending in the period ahead is the change in overall household financial positions over the past two years. Household wealth relative to income has dropped from a peak multiple of about 6.3 at the end of 1999 to around 5.3 currently. ...

Although high-income households should not experience much strain in meeting their debt-service obligations, others might. Indeed, repayment difficulties have already increased, particularly in the subprime markets for consumer loans and mortgages. Delinquency rates may well worsen as a delayed result of the strains on household finances over the past two years. Large erosions, however, do not seem likely. ...

Perhaps most central to the outlook for consumer spending will be developments in the labor market, which has improved some in recent months. The pace of layoffs quickened last fall, especially after Sept. 11, and the unemployment rate rose sharply. But layoffs have diminished noticeably in 2002, and payrolls grew again in March.

Over the longer haul, incomes and spending are driven most importantly by the behavior of labor productivity. And here the most recent readings have been very encouraging. Typically, labor productivity declines when output is cut back and businesses are reluctant to proportionately reduce their work forces.

However, output per hour continued to grow last year. Indeed, it rose at an annual rate of 5-1/2 percent in the fourth quarter of last year and appears to have posted another sharp advance in the first quarter. ...

In housing markets, low mortgage interest rates and favorable weather have provided considerable support to home building in recent months. Moreover, attractive mortgage rates have bolstered the sales of existing homes and the extraction of capital gains embedded in home equity that those sales engender.

Low rates have also encouraged households to take on larger mortgages when refinancing their homes. Drawing on home equity in this manner is a significant source of funding for consumption and home modernization. The pace of such extractions likely dropped along with the decline in refinancing activity that followed the backup in mortgage rates that began in early November.

Mortgage rates have gone back down again in recent weeks and are at low levels. This should continue to underpin activity in housing. ...

The technological advances contributing to the gains in productivity that we have achieved over the past year should provide support not only to the household sector but also to the business sector through a recovery in corporate profits and capital investment.

The retrenchment in capital spending over the past year and a half was central to the sharp slowing in overall activity. These cutbacks in capital spending interacted with, and were reinforced by, falling profits and equity prices.

Business managers, with little opportunity to raise prices, have moved aggressively to stabilize cash flows by trimming workforces. These efforts have limited any rise in unit costs, attenuated the pressure on profit margins, and ultimately helped to preserve the vast majority of private-sector jobs. To the extent that businesses are successful in boosting profits and cash flow, capital spending should begin to recover more noticeably.

Part of the reduction in pricing power observed in this cycle should be reversed as firming demand enables businesses to take back large price discounts. ...

Recent evidence suggests that a recovery in at least some forms of high-tech investment is under way. Production of semiconductors, which in the past has been a leading indicator of computer production, turned up last fall.

Expenditures on computers rose at a double-digit annual rate in real terms in the fourth quarter. But investment expenditures in the communications sector, where overcapacity was substantial, as yet show few signs of increasing, and business investment in some other sectors, such as aircraft, hit by the drop in air travel, will presumably remain weak in 2002. On balance, the recovery this year in overall spending on business fixed investment is likely to be gradual.

The U.S. economy has displayed a remarkable resilience over the past six months in the face of some very significant adverse shocks. But the strength of the economic expansion that is under way remains to be clarified. ... With the growth of productivity well maintained and inflation pressures largely absent, the foundation for economic expansion has been laid.