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Statement by J. Alfred Broaddus, Jr., President, Federal Reserve Bank of Richmond, before the Committee on Banking, Housing, and Urban Affairs, U.S. Senate, March 10, 1993.

I am pleased to be here today to discuss economic activity in the Fifth Federal Reserve District--the region served by the Federal Reserve Bank of Richmond--and to describe my views on monetary policy. I will begin with some background information on the District economy. Subsequently, I will review some recent regional economic trends, summarize current economic conditions in the District, and conclude with a brief statement of my basic views on monetary policy.


The Fifth District includes Maryland, the District of Columbia, Virginia, North Carolina, South Carolina, and all but the northwestern spur of West Virginia. The Federal Reserve Bank of Richmond has branch offices in Baltimore and Charlotte, regional check processing centers in Charleston, West Virginia, and Columbia, South Carolina, and a special facility in Culpeper, Virginia.

The Fifth District is home for about 10 percent of the U.S. population. The District's fine transportation networks (including its three major seaports: Baltimore, Charleston, and Hampton Roads-Norfolk), favorable climate, and proximity to major domestic markets combine to make the region especially attractive to business. The District is headquarters for several major nonfinancial corporations and some of the nation's largest and most rapidly growing banking organizations. Collectively, the Fifth District ranks fourth among Federal Reserve Districts in terms of both the total assets and the market capitalization of its banking organizations. The District is also the location of thousands of farms and small businesses, many community banks, and an unusually large number of strong colleges and universities.

Our Bank has identified three distinct regional economies in the District. One includes south central Virginia, North Carolina, and South Carolina and is characterized by substantial manufacturing activity. North Carolina leads the nation in the proportion of payroll employment in manufacturing, and South Carolina is close behind. Textiles heads the list in value of output among the manufacturing industries in this region. The area's strong manufacturing base also includes such other industries as chemicals, machinery, electronic equipment, tobacco products, and furniture.

The second regional economy consists of Maryland, most of Virginia, and the District of Columbia. This region is heavily dependent on federal government activity, especially defense purchases. Employment stemming from federal nondefense purchases is also important in this area, as is federal government employment of civilian and military personnel.

The third region is West Virginia. West Virginia's economy is based largely on coal, which explains the state's comparative advantage in the production of chemicals and primary metals. Lumber and wood products are other West Virginia industries that have enjoyed especially rapid growth in recent years.

The economies of these three regions have some elements in common, such as their strong tourist industries. The Fifth District is known for its many scenic and historic areas and for its mountain and seashore resorts. Tobacco is grown in many parts of the District, as it has been since colonial times. Although domestic tobacco consumption has declined, exports of both tobacco leaves and manufactured tobacco products continue to rise. Other agricultural products in the District range from peaches in South Carolina, where the harvest often exceeds Georgia's, to poultry production in North Carolina, Virginia, and Maryland. The Chesapeake Bay usually produces a plentiful harvest of fish, crabs, and oysters, although the oyster harvest has been quite low in recent years.


The table accompanying my testimony summarizes the behavior of employment and real personal income in Fifth District states since the early 1980s.(1) The table shows that the decade of the 1980s, after its early recession, brought strong growth in both employment and income to most of the District. This growth was spurred in the northern part of the District by the defense buildup and the concurrent real estate boom and in the southern part by foreign and domestic investment in manufacturing. West Virginia, however, recorded a more modest increase in jobs and very little increase in income during the 1980s, largely because of job losses in the coal industry.

Employment and real personal income declined throughout the District during the 1990-91 recession, as they did in most of the country. Job market conditions have improved since the end of the recession, although only North Carolina and West Virginia experienced significant employment growth through the end of 1992. Employment actually continued to fall sharply in Maryland in this period. Real personal income grew moderately in the District from the recession trough through the third quarter of 1992 (the last quarter for which data are available), and here also the performance of North Carolina and West Virginia was strongest. In agriculture, data on cash receipts suggest that real farm income in the District was virtually unchanged in 1992 from 1991 but higher than in earlier years.


The latest data and anecdotal economic information available to us indicate that the pace of the recovery in the Fifth District has quickened in recent months. Consumer spending was strong during the Christmas season, and more recent information suggests that spending has held up well since then. The housing industry has also been improving for many months, and the decline in mortgage rates in recent weeks has given home sales an added boost. Manufacturers responding to our regular mail survey report that District factory activity improved during the first six weeks of 1993 after several months of little change.

Profits are up and nonperforming loans are down at the District's banks. Our recent telephone survey of financial institutions indicated that both business and consumer loan activity increased during the first six weeks of 1993, although half of the commercial loan officers surveyed said that stiffer regulatory requirements were still limiting their lending activity. Small business members of our Bank's Small Business and Agricultural Advisory Council report that credit is still tight despite ample opportunities, in their view, for banks to make good start-up business loans. District farmers are evidently finding adequate credit available in federal programs.

Let me comment now on recent developments in individual state economies. South Carolina has been recovering at a moderate but steady pace. Retail sales--including sales of new cars--have risen in recent weeks, as have sales of new and existing homes. Textile manufacturers are now operating at capacity and exporting some of their production. BMW's choice this past October of the Greenville-Spartanburg area as the site for its new U.S. plant has sparked increased business activity in that vicinity. Along the seashore, tourism has revived somewhat, and business is better. In Columbia, bankers report increased commercial loan demand. On the negative side, the air force base at Myrtle Beach has been closed and parts of South Carolina are vulnerable to possible further defense cuts.

Our contacts in North Carolina report improving conditions and greater business and consumer optimism regarding the outlook. The improvement is especially evident in retailing, housing, and manufacturing but extends also to commercial construction. In Charlotte, for example, one of our sources recently complained that a scarcity of large blocks of vacant office space was discouraging some businesses from locating in the city, and he bemoaned the absence of speculative builders of commercial real estate. In Raleigh, office vacancy rates are among the lowest in the nation. Furniture manufacturers in North Carolina are enjoying their best year in many years, and increases in new orders point to continued good business in this industry in the months ahead.

Economic conditions in Virginia appear to be improving at a faster pace than earlier in the recovery. The gains are reflected in a recent pickup in state government revenues, which has permitted a modest pay increase for state employees. Retail sales and the construction of single-family homes in the state are showing continued gains. The Northern Virginia and Tidewater areas, which have been the hardest hit by defense cuts, seem to be recovering despite continued job losses due to reduced defense purchases. Vacancy rates for office buildings in the state's urban areas have declined somewhat, especially in the suburbs. Vacancy rates are still high, however, in central cities.

Economic activity in the District of Columbia, which began to show some signs of turning up early last year, continues to improve slowly. Much consolidation of Washington's financial institutions has taken place, and their performance has improved considerably, although some problems remain. The local government continues to be mired in fiscal difficulties brought on by population declines and by the movement of business and government activity to the suburbs. Even so, the mood among our business contacts in Washington is positive. One favorable sign is a pickup in tourist activity. Another is the relative scarcity of office space in Washington, which has led to plans for some new government and commercial construction.

In Maryland, indications that the economy has bottomed out are tempered by concern about shortfalls in state government revenues and by additional layoffs at defense contracting plants such as those of Westinghouse and Martin Marietta. On the positive side, activity at the Port of Baltimore, which earned its first profit in four years in 1992, is rising modestly. Also, the residential real estate market finished 1992 with a good fourth-quarter performance, and building permits in the state were up 26 percent in 1992 over 1991. One homebuilder who has not built speculatively in two years now indicates that he is planning to resume building without advance buyer contracts.

Business activity in West Virginia has been improving steadily in recent weeks, and our business contacts in the state are upbeat about prospects for the months ahead. The state's lumber industry, which has benefited from strong export demand, is experiencing record production. Production is also at capacity levels in some wood products industries. One hardwood flooring plant operating with double shifts and with all its production pledged was recently asked if it had anything at all to sell. "Only rejects," the customer was told. He bought them.

Until last month, West Virginia's coal production was proceeding at a near-record pace, although employment in the industry was still declining because of the continued shift to capital-intensive extraction. From February 2 through March 2 a strike idled a small but significant portion of the industry, and output was about 10 percent below the same period a year earlier. Coal prices were not affected until the end of February, however, when spot prices rose somewhat as fear that the strike might spread prompted electric power companies to add to their coal stockpiles. On March 2, striking miners agreed to return to work while talks continued.

To sum up, the Fifth District economy is on the mend, apparently even in the northern part of the District, which was hit hardest by overbuilding and defense cuts. Conditions are better in retailing, housing, and manufacturing. The improvement in the District economy has also benefited District banks, which in the aggregate are in their best condition since before the recession began.


Turning to my views on monetary policy, I believe that the primary goal of policy is to promote economic growth and employment and that the Federal Reserve can best pursue this goal by fostering a stable aggregate price level over time. Inflation constrains growth by interfering with the market's ability to allocate resources to their most productive uses. In addition, inflation results in arbitrary and unfair redistributions of income and wealth that cause social tensions and weaken the fabric of our society. Moreover, rising inflation is invariably followed by corrective policy actions that depress economic activity, sometimes--as in the early 1980s--severely. This stop-go pattern retards technological progress and thereby slows the longer-run rise in our standard of living.

Substantial progress has been made in reducing inflation and interest rates since the early 1980s. The inflation rate has declined from more than 10 percent in 1980 to around 3 percent today, and the thirty-year Treasury bond rate has fallen from above 14 percent to below 7 percent. I believe that the large decline in long-term rates over this period reflects at least in part a significant increase in the credibility of the Federal Reserve's disinflationary strategy. The current thirty-year Treasury bond rate, however, remains well above the 3 percent rate prevailing in the 1950s, when the price level was reasonably stable, which suggests that the public still fears that inflation will persist at 3 percent or 4 percent in the years ahead. In my estimation a fully credible policy to achieve price-level stability would bring long-term rates down further and provide an important additional stimulus to economic activity. In this regard, I should note my belief that passage of the Neal Amendment would strengthen greatly the Federal Reserve's effort to achieve full credibility for its longer-term objectives.

Against this background, I believe firmly that specific monetary policy actions taken in the short run should be evaluated within the framework of our long-run goal for price-level stability. In particular, the annual targets for the monetary aggregates should be seen as a means of helping the Federal Reserve attain its longer-term objectives rather than as ends in themselves. The targets play a useful role in signaling our long-run commitment to a stable price level, and we should continue to lower the targets gradually until they are fully consistent with this objective. In making our short-run policy decisions, however, we should not adhere slavishly to the targets, in my judgment, when technical developments or institutional changes appear clearly to be altering the relationship between GDP growth and money growth--such as occurred in 1992, when nominal GDP grew at a rate of more than 5 1/2 percent while M2 grew at a rate of only 2 percent.

In making our short-run policy decisions we also need to be mindful that actions that weaken the credibility of our commitment to price-level stability can have perverse effects on interest rates and economic activity. The Federal Reserve directly influences only a small number of short-term interest rates. As I mentioned earlier, long-term interest rates, which have a greater influence on economic behavior, are determined in large part by the public's inflation expectations. If we want to foster low long-term rates, with all their benefits to the economy, we must make policy decisions that the public views as consistent with longer-term price level stability.

I should note here that while I believe that the System's short-run policy actions need to be conditioned at all times by our longer-term objectives, I also recognize that these actions must be taken in the context of current developments in the economy. If market forces are putting downward pressure on short-term interest rates, then we must allow short-term rates to fall in reflection of those forces, as indeed we have over the past several years. I think it is futile, however, to base our policy actions on the notion that monetary policy can eliminate or nearly eliminate short-run fluctuations in economic activity, which occur for a wide variety of reasons. Actual experience over the past thirty years provides little, if any, support for this idea. In particular, history suggests that attempts to stimulate economic activity in the short run without regard to the possible inflationary consequences result eventually in higher inflation and the depressing corrective actions that I mentioned earlier.

To sum up, my view is that monetary policy should seek to promote real economic growth and employment by achieving and maintaining price-level stability. The Federal Reserve's day-to-day policy actions should be consistent with this goal, and the System should do whatever it can to increase and enhance. the credibility of this strategy. (1.) The attachment to this statement is available from the Federal Reserve Bank of Richmond, Richmond, VA 23261.
COPYRIGHT 1993 Board of Governors of the Federal Reserve System
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Title Annotation:Statements to the Congress
Publication:Federal Reserve Bulletin
Article Type:Transcript
Date:May 1, 1993
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