Greenspan discusses economic fallout of Sept. 11 events

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The following is excerpted from Federal Reserve Chairman Alan Greenspan's testimony on monetary policy and economic outlook to the Joint Economic Committee of the U.S. House of Representatives Oct. 17. |ret||ret||tab|

We in the United States have assumed ourselves to be fairly well-insulated from terrorism or, at most, subject to limited and sporadic episodes similar to those previously observed in Europe. |ret||ret||tab|

We have been aware of the possibility for losses on a much greater scale. But I suspect that those possibilities were deemed so remote that they were never seriously incorporated into most conventional assessments of economic risk. |ret||ret||tab|

The shock of the tragedies at the World Trade Center and the Pentagon has reshaped those assessments of risk and required an abrupt realignment of prices in many markets to reflect the expected costs of operating in what we now recognize as a more hostile world. |ret||ret||tab|

These circumstances pose a difficult challenge for business decision making, not so much because the costs are inordinately large, but because the events, which have potentially substantial consequences, are so uncertain. |ret||ret||tab|

Insurance deals with this problem by spreading the risk and converting potential large, unknown costs into a steady stream of known insurance premiums that facilitates the forward planning so essential to an effective business operation. |ret||ret||tab|

Obviously, sharp increases in insurance premiums for all forms of businesses are to be expected. Some higher insurance costs, in effect, will be borne implicitly rather than explicitly, as firms choose to self-insure, at least in part, rather than lay off all of this risk in the marketplace. |ret||ret||tab|

These higher insurance costs, both explicit and implicit, endeavor to anticipate future losses. But in addition, they cover the physical capital and labor resources businesses will be required to devote to enhanced security and to increased redundancies as protection against interruption of supplies or production. |ret||ret||tab|

For example, the degree of comfort businesses have in allowing inventories to shrink to minimal levels in a just-in-time supply chain is lessened. In this regard, increased security threats, not pooled through insurance, have exactly the opposite effect on productivity than that which is gained by an improvement in information technology. In addition to the loss of human life and capital assets, these are important collateral costs associated with the new threats that we now face. |ret||ret||tab|

The pronounced rise in uncertainty also has damped consumer spending and capital investment; households and businesses, confronted with heightened uncertainty, have pulled back from the marketplace, though that withdrawal has been partial and presumably temporary. The very great economic uncertainties that have arisen in the current environment have also, at least temporarily, resulted in a widening of bond spreads on high-yield instruments. |ret||ret||tab|

Markets across our economy will adjust to the altered perceptions of risk that we now confront. Critical to that adjustment process is the behavior of consumers and businesspeople. Behavior is difficult to predict in circumstances such as those we have experienced in the past five weeks. |ret||ret||tab|

Although it is difficult to determine with any precision, it seems quite likely that a significant repricing of risk has already found its way into our markets, as many economic decisions are responding to shifting market signals. But these adjustments in prices and in the associated allocation of resources, when complete, represent one-time level adjustments, without necessary implications for our longer-term growth prospects. |ret||ret||tab|

Indeed, the exploitation of available networking and other information technologies was only partially completed when the cyclical retrenchment of the past year began. High-tech equipment investment at elevated rates of return will, most likely, resume once very high uncertainty premiums recede to more normal levels. |ret||ret||tab|

The level of productivity will presumably undergo a one-time downward adjustment as our economy responds to higher levels of perceived risk. But once the ad-justment is completed, productivity growth should resume at rates in excess of those that prevailed in the quarter-century preceding 1995. |ret||ret||tab|

It is worth noting that increased production to enhance security will be counted in measured output without contributing to our standards of living, as was the case during our military buildup of the Cold War. Our productivity measures have always endeavored to capture increased efficiency, not increased well-being. |ret||ret||tab|

We are, in effect, using part of our increase in efficiency to supply increased security. Of course, given the heightened risks we face, these investments in security are quite sound. In any event, such costs are likely to fall short of those we incurred for security at the height of the Cold War. |ret||ret||tab|

Nobody has the capacity to fathom fully how the effects of the tragedy of Sept. 11 will play out in our economy. But in the weeks ahead, as the shock continues to wear off, we should be able to better gauge how the dynamics of these events are shaping the immediate economic outlook. |ret||ret||tab|

For the longer term, prospects for ongoing rapid technological advance and associated faster productivity growth are scarcely diminished. Those prospects, born of the ingenuity of our people and the strength of our system, fortify a promising future for our free nation. [[In-content Ad]]