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Statement by Robert T. Parry, President, Federal Reserve Bank of San Francisco, before the Committee on Banking, Housing, and Urban Affairs, U.S. Senate, March 10, 1993.

I am pleased to appear before the Committee on Banking, Housing, and Urban Affairs to testify on economic conditions in the Twelfth Federal Reserve District and in the nation, as well as on the conduct of monetary policy.

This testimony first treats the recent economic performance of the District as a whole and then details activity in each of the nine states within the District: Alaska, Arizona, California, Hawaii, Idaho, Nevada, Oregon, Utah, and Washington. Charts of trends in population, personal income, employment and unemployment rates, and bank lending activity for the District and for each state, as well as tables detailing sectoral employment and construction statistics, are in the appendix.(1) The testimony concludes with a discussion of national developments and the conduct of monetary policy.

TWELFTH FEDERAL RESERVE DISTRICT

Employment in the District fell slightly between January 1992 and January 1993, as the weakness in California and Hawaii offset the moderate job growth reported in the other seven states in the District, including the more robust performances in Utah, Nevada, and Idaho.

The District's unemployment rate, which had been running in line with that of the nation over the last several years, was 8.7 percent in January 1993, or 1.6 percentage points above the national average. This high rate largely reflects California's 9.5 percent unemployment rate in January 1993.

The recession in the region was felt most strongly in manufacturing and construction, particularly in California. Manufacturing employment in the District has fallen 8.4 percent--a loss of 259,000 jobs since January 1991.2 Construction employment has fallen even faster, dropping 12.8 percent since January 1991--a loss of 124,000 jobs. Between January 1992 and January 1993, the decline in manufacturing employment showed no sign of abating, as employment fell 3.2 percent; the decline in construction employment, however, slowed somewhat, to 3.0 percent.

Services and state and local government are the only sectors to have reported steady job gains since January 1991. Between January 1991 and January 1993, employment in those two sectors rose 3.0 percent (159,000 jobs) and 6.0 percent (164,000 jobs) respectively. Growth in these sectors has slowed recently; employment in January 1993 was up 2.2 percent in services and 0.4 percent in state and local government from the levels of a year earlier.

Most other sectors have shown weakness in the District as a whole. The utilities and communications sectors have been downsizing, resulting in considerable employment declines. The finance, insurance, and real estate sector also has reported net job losses over the past few years because of weakness in real estate and the consolidation of the banking industry, although this sector did show a modest gain over the twelve months ending in January 1993. Trade employment also has been a major source of job losses as a consequence of weak consumer spending and consolidation of the retail sector. Employment in trade declined 0.2 percent in January from the level of a year earlier, bringing the level of employment down 1.3 percent from the level in January 1991. Federal government employment also contributed to weakness in the District, falling 1.9 percent between January 1992 and January 1993.

Weakness in the District was mitigated somewhat by growth in activities related to foreign trade. For example, total import and export traffic in California rose to $192.5 billion in 1992, an increase of 10.1 percent over 1991 and an increase of 16.2 percent over 1990. Oregon and Washington also have seen growth in import and export traffic, although not at the pace of California.(3)

The performance of the banking industry in the District has been mixed. Earnings ratios at California and Arizona banks were below the national average last year, while the other states in the District posted very strong earnings. Banks in California, Nevada, and to some extent Arizona, continued to have relatively high volumes of problem loans. Lending at commercial banks in the District, which held up very well in the recent recession, has deteriorated in the past couple of years, though banks in a number of states have continued to expand loans.

Alaska

Alaska's dependence on oil, fisheries, and other natural resources makes its economy the most volatile of the Twelfth District states; it is subject to large swings in economic activity related to commodity prices but is relatively unlinked to national business cycles. During the 1989-92 period, employment growth was 4.5 percent in 1989, 6.1 percent in 1990, 2.1 percent in 1991, and 0.5 percent in 1992. The unemployment rate in January 1993 stood at 8.4 percent--below its year-earlier level of 9.5 percent. Some of Alaska's recent volatility is attributable to the activity stimulated by the 1989 oil spill and the associated clean-up and payments. Thereafter, however, several basic industries were hampered, making economic activity more sluggish.

In contrast to the weakness in 1992, employment rose sharply in January 1993, to a level 2.1 percent above a year earlier. Manufacturing employment rose 4.0 percent, reflecting strength in durable goods employment. Pulp and paper employment, however, showed little change over the year, and seafood processing employment declined 8.5 percent after rapid expansion in previous years. The fall-off in seafood processing was due, in part, to lower-than-normal catches of pink salmon.

A 5.9 percent decline in mining employment over the year reflects the sluggish world demand for minerals, and energy exploration remains constrained by environmental considerations. However, there are some plans for energy development in 1993, including construction of a gas reinjection facility on the North Slope. A discovery in the Beaufort Sea is potentially large enough to justify a sixty-mile connection to the Alaska Pipeline.

Finally, sluggish construction employment reflects the overall slow economy. A pickup in residential building permits (26.5 percent) and nonresidential construction awards (414 percent) in January 1993 from a year earlier, however, suggests that 1993 may see some improvement in this sector.

Sectors showing job growth over the twelve months ending January 1993 included transportation (1.6 percent), trade (1.5 percent), services (3.4 percent), and federal employment (3.2 percent). With respect to government employment, however, uncertainty exists as to the impact of further defense cutbacks on military bases that have so far survived. Furthermore, sluggish conditions in energy markets are restraining the main source of state government financing--oil revenues--and are constraining state government employment to zero growth.

Despite the sluggish economy, banking conditions in Alaska are relatively good. The return on assets (1.61 percent) and return on equity (12.67 percent) were above the national averages (0.93 percent and 12.24 percent respectively).(4) At the end of last year, problem loans at large commercial banks stood at 2.3 percent of total loans, compared with a national average of 5.1 percent, and are below the national average in all major categories.5 Bank lending in the state also has held up in the past couple of years compared with bank lending nationwide.

Arizona

Arizona's economy posted solid employment gains in the past year, with employment in January up 2.6 percent from the level of a year earlier. The economy has shown job growth in the services sector and in construction, while manufacturing has continued to slide. The unemployment rate for the state has risen in recent months. In January, the unemployment rate stood at 8.0 percent, having risen steadily from 6.5 percent in September 1992.

Construction activity has become a relative bright spot in Arizona, with employment up 7.3 percent between January 1992 and January 1993. Construction employment is up to 83,000 workers, the highest level since 1990. This increase represents a gain of 6,000 workers since the bottom of August 1991. Compared with the peak reached in January 1986, however, employment is down 29.5 percent (34,400 jobs).

The recent gains in construction employment in the state are attributed to growing strength in the residential market, particularly in Tucson. It appears, therefore, that the long construction recession in Arizona that followed the overbuilding in the mid-1980s may be ending. During that period, residential and nonresidential construction fell sharply. Raw land prices fell as much as 70 percent in some areas. The overbuilding was largely the result of over-optimistic population projections. Population in Arizona grew about 4 percent in the mid-1980s, but the pace was slower in 1990 (1.6 percent), 1991 (1.8 percent), and 1992 (2.6 percent, estimated). Downtown office vacancy rates remained high in Phoenix and Tucson at the end of 1992, however, at 24.7 and 24.8 percent respectively, compared with an average national rate of 17.6 percent.

Manufacturing in Arizona has been suffering through defense-related cuts, with employment falling 10.2 percent (19,000 jobs) since the peak in June 1988. Aerospace employment has been hit the hardest, with employment down 17.1 percent since peaking in July 1990, but closure of other high-tech facilities (including IBM) also has contributed to the sector's weakness.

The Tucson area is expected to benefit (in a relative sense) from further consolidation of the defense and aerospace industries now located in California. Hughes has announced plans to consolidate its missiles division in the Tucson area (largely transferring weapons programs currently located in San Diego that were acquired from General Dynamics), and it is considering moving other units there as well.

In contrast to manufacturing, trade employment rose 2.1 percent between January 1992 and January 1993, services employment rose 4.4 percent, and state and local government employment rose 3.3 percent. The foreign trade picture also looks like a source of new strength in the near term. Trade with Mexico has been rising sharply in recent years, boosted during the 1980s by the growth of the maquiladora (or "twin plant") program along the border. In 1992, trade with Mexico reached $983 million, or 20 percent of Arizona's total exports. Most contacts from the region report high expectations of further trade gains with Mexico, particularly if the North American Free Trade Agreement is ratified.

Part of the explanation for the weakness of some sectors of Arizona's economy involves links to the Southern California market. Southern California is the largest market for goods and services from Arizona; many key firms operating in Arizona are headquartered in California, and California is the source of many of Arizona's tourists. Thus, weakness in California is having a direct impact on growth in Arizona.

The banking sector is reflecting some of the changes under way in the Arizona economy. Improving conditions in real estate can be seen in a decline in problem loans in that sector. In the fourth quarter of 1992, problem loans at large commercial banks equaled 4.7 percent of all loans, and 6.7 percent of real estate loans were problem loans. This contrasts with the 5.0 percent and 9.1 percent ratios reported at the end of 1991. Equity capital at Arizona banks rose in 1992, while return on assets jumped to 0.33 percent, compared with only 0.18 percent a year earlier. Total bank loans were unusually strong in the early 1990s, boosted, in part, by credit card operations as well as by bank acquisitions of savings and loan associations. In 1992, the disposition of assets in connection with bank mergers appears to have contributed to a decline in the reported volume of total loans in the first part of the year. In the second half of the year, total bank loans rose somewhat. The volume of business loans held by commercial banks declined in the first three quarters of 1992 but showed some signs of life in the last quarter of the year.

According to the Arizona Blue Chip forecast, Arizona's economy is expected to pick up in 1993. The consensus forecast predicts job growth of 2.4 percent and real personal income growth of 3.3 percent, boosted by continued strength in retailing and in the housing sector.

California

California is in its longest and deepest recession since World War II, and the first since 1970 in which its performance has been worse than the nation's. The state has lost more than 568,000 jobs since January 1991, a decline of 4.7 percent.6 Although employment nationally grew 0.9 percent between February 1992 and February 1993, California's employment declined 1.3 percent, a loss of 182,000 jobs. Even in the robust job report of February, in which national employment rose by 365,000, California's employment fell by 4,600. Moreover, the unemployment rate remains stubbornly high, at 9.8 percent in February 1993. Construction and aerospace have gotten much of the blame for the state's economic troubles and with good reason.

The defense sector has been hit hard by cutbacks. Real defense spending in California has fallen 13 percent since its 1988 peak. Aerospace employment has fallen 28.2 percent since the beginning of 1991--a loss of 65,000 jobs. The role of defense cuts in this recession brings to mind the cycle of 1970, when a national recession was accompanied by the defense cutbacks associated with winding down the Vietnam War. In that episode, cutbacks in California's defense spending continued until 1975; yet California began its recovery in February 1971, just two months after the U.S. economy began to expand in December 1970. At that time, defense accounted for 11 1/2 percent of the state's production, much more than the 7 percent defense provides today. So, even without a pick-up--or even a leveling off--in defense spending, California managed to stage a robust recovery. This suggests that if defense cuts were the state's only problem, then California's economy would be expected to recover along with the national economy.

But there are other problems as well. Construction and real estate also have been hit hard this time around. More than a quarter of the construction jobs (31 percent) that existed in California in January 1991 are gone today. This amounts to 140,000 jobs lost. Residential construction activity has fallen sharply. In 1992, the number of housing permits issued in California was just a little more than one-third of the 1986 peak, and the number of existing homes sold was well below the 1989 peak. In addition, home prices have fallen significantly in many parts of the state.

Commercial real estate is in even worse shape, with high vacancy rates and low absorption in many markets. Property values in some cases are reported to have fallen below replacement cost. Moreover, rents for some office buildings are barely covering operating costs. Consequently, very little commercial space is being built at present.

California real estate and construction activity is likely to remain weak during the next few years, mainly because the commercial real estate sector suffers from serious overbuilding. Nevertheless, an increase in the number of large commercial sales in recent months provides some encouragement that conditions in some markets may be stabilizing.

There are some promising signs on the residential side as well. Lower interest rates are strengthening residential sales. The number of home sales in the state is well above what it was a year ago. And some improvement in residential construction is noted. Although the number of housing permits issued has been declining more or less continuously since the beginning of 1990, the consensus forecast is that the number will be almost 20 percent higher in 1993 than it was in 1992.

One consequence of the stress in California real estate is the burgeoning number of problem loans for banks in the state. For example, in the fourth quarter of 1992, large California banks' problem loan ratio for commercial real estate loans was 9.5 percent, much higher than the national ratio of 6.7 percent. As a result of the large volume of troubled loans, California banks have had to set aside significant loan-loss reserves, which has affected earnings. The return on assets (ROA) for all California banks was a modest 0.58 percent in 1992. That compares with a good ROA of 0.93 percent for large banks nationally. Earnings problems have been especially evident among community banks (assets less than $300 million) in Southern California, which as a group posted a net loss for 1992. Last year also marked the second year in a row that loans at commercial banks in California contracted more sharply than they did nationally. The decline during the past two years offset the relatively high lending activity at banks in the state during 1990.

A host of public sector issues has moved to center stage as much of the state's economy has become more and more troubled. Foremost among them are budget problems for state and local governments. Projections suggest that putting together a budget will be as difficult this summer as it has been for the past two years. In addition, concerns about the state's business climate have increased in recent years. Critics cite a costly and inefficient workers' compensation system as well as stringent environmental regulations and bureaucratic "red tape."

While a few sectors have been cited as the major sources of California's weak performance, the weakness in employment is actually quite broad-based, extending to a wide range of service, manufacturing, and financial industries. Wholesale and retail trade lost 132,000 jobs, a 4.5 percent decline since January 1991, and non-aerospace manufacturing lost 172,000 jobs, a 9.3 percent decline.

One somewhat mitigating factor in the state has been the expansion of international trade, thanks to the importance of the state's ports in facilitating that trade. In 1991, Los Angeles reported import-export traffic of $121.8 billion, 12.4 percent of the nation's total. San Diego reported another $10.2 billion (1 percent of the nation's total), while San Francisco handled $60.5 billion (6.2 percent of the total).(7) In 1992, the state as a whole saw an increase in import-export traffic of 10.1 percent.

Most of the state's weakness has been relatively concentrated in Southern California (Los Angeles, Orange, Riverside, Ventura, San Diego, and San Bernardino counties). In Los Angeles County, where the job losses have been greatest, the number of jobs is now 7.2 percent lower than it was in January 1991. Job losses are worse in Southern California, partly because construction and real estate problems have been more severe in this region and partly because defense is a much more important part of the economy in Southern California than it is in most other parts of the state. But as has been the case statewide, Southern California has seen employment decline across a broad range of industries, including services, retail trade, financial services, and non-aerospace manufacturing.

Other parts of California have fared better than the southern part of the state, but they are hardly immune from stress. For example, the greater San Francisco Bay Area continued to grow for a few months after Southern California turned down. Since January 1991, the Bay Area has lost about 4 1/2 percent of its jobs; this is still worse than the national economy, where employment growth has been flat since January 1991. And in recent months, a larger share of the state's job losses are outside Southern California. Southern California accounted for 84 percent of total job losses from January 1991 to April 1992, but in the more recent period between April and December 1992, it accounted for only 60 percent of the losses.

Downward adjustments in defense are likely to last for a few more years, and problems in commercial real estate are expected to last even longer. The state government is going to face difficult choices, which seem certain to complicate California's short-term problems. The main positive factors for significant improvement during the next couple of years are the improved demand from the national economy and expanding international trade that will continue to boost trade-related business, particularly in Southern California. Moreover, population growth in 1992 was estimated to have been 2.2 percent, double the national rate.

Hawaii

The Hawaiian economy has been hit hard since the last recession began. After registering year-over-year employment growth in the late 1980s in the range of 4 percent to 6 percent, employment has declined. In January 1993, employment fell 1.4 percent below the level of a year earlier.

Weakness in employment has raised the state's January unemployment rate to 4.0 percent. While unemployment is low relative to the levels of most states, it is high relative to the 2.0 to 2.5 percent rates registered before the recession began.

Weakness in the economy can be traced directly to the factors that contributed to the recession in the rest of the country. The onset of the Gulf War had an immediate impact on tourism, leading to monthly employment declines in February, March, and April 1991 at annualized rates of 5.6, 1.6, and 3.1 percent respectively. Part of this effect can be traced to a sharp reduction in visitors from Japan, where public policy discouraged travel to Hawaii during the hostilities.

Growth in tourism resumed after April 1991 but at a more subdued pace. Analysts in Hawaii attribute this weakness to the national recession, which caused travel plans to be curtailed. Especially important to tourism trends was weakness in California, which contributes as much as 30 percent of the mainland visitors to the islands. Weakness in California and slow growth in the rest of the country continued to keep tourism down in Hawaii in 1992. As a result, the state's overall employment declined in all but four months during 1992.

Two additional factors adversely affected the state's employment growth during the year. First, the "air-fare wars" in the summer of 1992 did not include the Hawaiian routes. Consequently, Hawaii suffered from a relative price disadvantage that favored mainland destinations. Second, Hurricane Iniki caused major damage to Kauai, forcing a large number of cancellations. Partially as a result of these factors, nominal personal income dropped at an annualized rate of 6.6 percent between the second and third quarters of 1992.

Problems in Japan also have had widespread impacts on the Hawaiian economy. Japan's financial market difficulties have had direct repercussions on nonresidential construction activity in Hawaii. Construction employment fell 4.7 percent in January 1993 from the level of a year earlier, despite rebuilding efforts associated with Kauai. Housing prices have remained high (the fourth quarter 1992 median price of $352,000 in Honolulu remains by far the highest in the country), but appreciation has slowed. Moreover, although visitor counts from Japan have generally held up (except during the Gulf War), there is growing concern that, with rising job insecurity in Japan, Japanese tourists may begin to grow more cautious.

Some recent signs of improvement are noted in the construction sector, however. During the twelvemonth period ending in January, the number of residential permits rose 49.8 percent. The value of nonresidential construction awards jumped sharply after the hurricane, although the value of new awards has returned to more normal levels since October. These trends offer hope for renewed construction employment during 1993.

Employment declined in most major sectors between January 1992 and January 1993. Employment fell 3.8 percent in the federal government sector (which accounts for a relatively large 6.2 percent of the total work force in Hawaii), 3.1 percent in trade, 2.0 percent in manufacturing, and 1.3 percent in services. State and local government employment rose 1.6 percent during this period.

The ratio of problem loans has risen slightly at Hawaiian banks, but conditions remain strong relative to other states in the District. Data for large commercial banks in the state show the problem loan ratio for all loans rising to 3.1 percent in 1992 from 1.7 percent a year earlier. However, the return on assets in 1992, 1. 13 percent, was about the same as in 199 1. Lending at commercial banks in Hawaii expanded much more rapidly than it did nationwide during the past two years, although loan growth in the state was below the very rapid pace set in the late 1980s and in 1990.

Idaho

The Idaho economy has been one of the strongest performers in the District--and in the nation--in recent years. The state has successfully attracted manufacturing activity, and a growing influx of population has created a construction boom.

Employment in Idaho grew 3.9 percent between January 1992 and January 1993, continuing the strong pace of growth reported in 1991 (3.4 percent), 1990 (4.6 percent), and 1989 (5.4 percent). Of particular note were the 5.1 percent expansion in manufacturing jobs and the 16.0 percent expansion in construction employment, which contrast strongly with negative trends seen in these sectors in the District as a whole. Reflecting the strong jobs performance, the Idaho unemployment rate stood at 6.4 percent in January 1993.

Growth in Idaho manufacturing in 1992 occurred principally in durable goods industries, which saw employment expand 8.4 percent. Particularly strong job growth was seen in industrial machinery (22.3 percent) and electronic equipment (6.4 percent). Nondurable goods industries registered 2.6 percent growth, reflecting relatively weak conditions in food processing and pulp and paper. Printing and publishing employment rose only 0.2 percent over the year, while food processing employment fell 0.6 percent. Contacts report that the strength of Idaho manufacturing is due, in part, to firms moving in from other states.

Relatively low housing and labor costs continue to attract manufacturing firms to the state. Median house prices are appreciating at a rapid rate but remain below the national average. For example, the median home price in Boise rose nearly 11 percent in 1992 but stands at a moderate $87,300, compared with the national median price of $103,900. Larger price increases, however, are reported for other communities, especially in northern Idaho.

Other sectors showing growth in January 1993 from the level of a year earlier include trade (4.0 percent) and services (4.6 percent). The growth in services, in part, reflects growing tourism. Sectors that are faring less well include mining, timber, and food processing. Employment in mining--chiefly silver, gold, and phosphates--has declined steadily since 1990, reflecting weak mineral prices; in January 1993, employment was down 4.0 percent from a year earlier. Employment in lumber and wood products rose 5.9 percent in 1992, but that level is down 9.7 percent from its peak in March 1990.

Idaho's agricultural sector has performed reasonably well, especially considering the drought conditions that have affected several western states in recent years. In the 1992 water year, Idaho received only 29 percent of its normal precipitation, the lowest on record. Reflecting reduced production, total farm income in 1992 is expected to decline somewhat from 1991's level. Heavy precipitation in winter 1992-93, however, has significantly alleviated the water shortage and promises a favorable outlook for 1993. In addition, rising potato prices are supporting the farm sector.

The overall health of the Idaho economy is reflected in favorable conditions in banking. At the end of 1992, problem loans at large commercial banks stood at 2.1 percent of loans, compared with a national average of 5.1 percent. Bank profitability in the state also was high last year, with a return on assets of 1.24 percent compared with a national average 0.93 percent. Growth in loans, including business loans, at Idaho's commercial banks has been well above the average for the nation in recent years.

Nevada

Economic activity in Nevada has grown throughout the national recession and weak recovery period. In January 1993, the Nevada economy posted a 4.4 percent employment gain from the level of a year earlier, with strong gains registered in September, November, and January.

Nevada's unemployment rate has tended to remain below the national average in recent years. It rose to a high of 7.5 percent in August 1992 but has subsequently fallen. In January, the unemployment rate dropped to 6.8 percent.

Nevada's performance was strong, although highly variable, in the late 1980s, as year-over-year employment gains ranged from 4 percent to 9 percent until the end of 1989. Employment growth slowed during the Gulf War and the national recession, dropping year-over-year growth for the state to a low of 0.6 percent in January 1992. Since that time, employment growth has picked up sharply.

The construction industry has had the most dramatic variations, reflecting the start-up and completion of several major new casinos. Construction employment rose from about 25,000 in 1985 to more than 48,000 in early 1990. Employment dropped off to below 40,000 at the end of 1991 but climbed to more than 44,000 in January 1993, an increase of 11.4 percent.

Trade and services are especially important sectors in Nevada, accounting for 64 percent of total employment, compared with 50 percent of employment nationally. January 1993 data show trade employment up 2.7 percent over the levels of a year earlier. Services employment was weak in the middle of 1992 but increased sharply in January 1993, resulting in an increase of 3.6 percent over the level of a year ago.

Strength was reported in the state and local government sector, where employment rose 4.3 percent between January 1992 and January 1993. Employment has risen nearly 50 percent in that sector since 1985, with strong periods of gains mirroring the pattern of total employment.

Manufacturing employment in Nevada was positive, unlike most other parts of the District, rising 4.8 percent in January 1993 from the level of a year earlier. Manufacturing accounts for only a small share of the total economy in Nevada--4 percent of total employment--so the increase in employment translated into a gain of 1,200 jobs.

Employment in Nevada's finance, insurance, and real estate sector rose 5.2 percent between January 1992 and January 1993. The banking and finance sector reported an employment increase of 5.8 percent, and insurance and real estate posted a 4.8 percent gain. Moreover, Nevada's commercial banks reported improving conditions, with the return on assets rising from a strong 1.5 percent in 1991 to a very strong 2.9 percent in 1992, although the share of problem loans rose from 5.5 percent in 1991 to 7.2 percent in 1992. Loans at Nevada commercial banks have contracted sharply during the past few years. The data on outstanding loans, however, significantly overstate the weakness in lending activity. The level of total loans was affected by sales of credit card loans in 1990 and 1991. In 1992, such loan sales also apparently depressed the level of total loans at commercial banks in Nevada. In the case of business loans, loan reclassifications appear to account for much of the net decline over the past few years. Taking these special factors into account suggests that bank lending in Nevada in recent years has been much closer to the pattern observed nationally. More recent reports also suggest that bank lending activity has begun to pick up in the state.

Although Nevada's overall economy currently is reporting healthy growth, there are concerns about its near-term future. Construction activity has been very brisk, particularly in the construction of very large hotel-casinos. Construction employment accounts for 6.7 percent of the total work force. That compares with an average of about 4 percent nationally. The concern, therefore, is that some overbuilding may be occurring in the hotel and casino sectors. Investors appear to be looking for continued above-normal increases in population and tourism, which may or may not materialize. (Population growth in 1992 was estimated to be 4.0 percent.)

Nevada has attempted to diversify its economy away from gaming in recent years. The gaming industry accounts for 26 percent of all jobs in Nevada and contributes 41 percent of the state's general fund revenues. In fact, many of the new casinos are designed as theme parks targeted more at families. Nevada also has encouraged the migration of service-intensive firms, such as credit card processing and telemarketing businesses. Nevada also hopes to expand its connections to Los Angeles, developing plans for a high speed train between Los Angeles and Las Vegas.

Oregon

Employment growth in Oregon was somewhat better than the nation's, although conditions in the state varied across regions and sectors. In general, service and technology-oriented urban areas had gradual expansion. Smaller towns dependent on the traditional lumber and wood-products industry, however, remained economically depressed.

Employment in Oregon rose 1.9 percent in January 1993 from the level of a year earlier, an improvement over the 0.2 percent decline seen in 1991. The expansion, however, is modest, compared with the 2.7 percent rise in 1990 and the 4.0 percent growth rates seen in the late 1980s. An influx of migrants from other states--including job-seekers from neighboring California--continues to swell Oregon's population and labor force. Reflecting both this immigration and the generally slow economy, Oregon's unemployment rate stood at 8.8 percent in January 1993.

The manufacturing sector was stagnant over the last year, as manufacturing jobs fell 0.4 percent between January 1992 and January 1993. Within manufacturing, however, conditions were mixed. In 1992, employment fell in industrial machinery (- 1.1 percent), instruments (- 9.6 percent), primary metals (- 9.2 percent) and food products (- 4.4 percent), while it rose in electronics (up 6.1 percent).(8)

Of particular note is the continuing decline of lumber and wood products and other industries reliant on timber supply. The sale of timber grown on public lands has been dramatically curtailed because of court-ordered environmental restrictions. Employment in the lumber and wood-products industry fell 2.3 percent between January 1992 and January 1993 and has declined 22 percent from its recent peak in mid-1989. Pulp and paper employment declined 2.1 percent between January 1992 and January 1993. Contacts report that small towns reliant on these industries are under severe economic stress with no relief in sight because of the continuing restricted supply of lumber.

Other sectors in Oregon are similarly mixed. Employment in January 1993 was down 3.6 percent in construction and up 0.5 percent in transportation from the level of a year earlier. Trade employment rose 2.5 percent, boosted by a 14 percent increase in the dollar volume of exports from the state. Robust conditions were recorded in finance, insurance, and real estate (FIRE) (3.4 percent) and services (3.8 percent). Tourism is reported strong. The robust FIRE and service job growth is centered in the larger urban areas. These sectors--together with stronger manufacturing sectors--have led to stronger economies in the larger cities relative to the small lumber-based towns. This strength is reflected in house price appreciation of 14.9 percent in Eugene and 11.9 percent in Portland in 1992. Overall residential building permits, however, were down 13.4 percent in 1992.

Despite the recent drought, agriculture in Oregon performed well, with tree fruit crops benefiting from extra sunshine. Reduced river flows, however, resulted in cutbacks in hydroelectric production; combined with a recent shutdown of a nuclear power plant, this forced utilities to purchase power from other states and raise electric rates. Heavy precipitation during the 1992-93 winter should help alleviate these conditions.

Also of concern for Oregon's immediate future are the issues of state and local government financing. Measure 5, a recently passed property tax limit, has resulted in financial stresses at all levels of government, particularly in education. Although there are efforts to find alternative funding sources, the process remains gridlocked.

Banking conditions in Oregon are good, despite the mixed economic picture. In 1992, the return on assets was 1.27 percent (compared with the national average of 0.93) and the return on equity was 13.44 percent (compared with a national average of 12.24 percent). Within loan categories, problem loans at Oregon commercial banks are below the national average in all sectors but agriculture. Total loan growth at commercial banks in Oregon was above the national average in 1992, although business loans at banks in the state contracted more sharply than they did nationwide.

In general, the outlook for Oregon's economy is favorable. It is less reliant on aerospace and defense-related industries than its neighbor states of Washington and California. Quality of life remains high, and living costs remain relatively low, attracting both workers and firms. Areas dependent on timber-related industries, however, face continued hardship for the foreseeable future.

Utah

Utah has enjoyed a period of prosperity during the past two and a half years, despite the weakness seen nationally. Utah's unemployment rate in January 1992 was relatively low, at 5.1 percent. Between July 1990 and January 1993, the number of jobs in Utah grew 7.9 percent, and during the past year, Utah employment grew 3.4 percent. Perhaps even more impressive, 1992 was the fifth consecutive year during which employment in Utah grew 3 percent or more. That is the first time in more than fifty years that Utah has seen such an extended period of rapid growth.

The strength in Utah extends across most major sectors of the state's economy. Since July 1990 the number of jobs has grown 7.4 percent in wholesale and retail trade; 11.1 percent in finance, insurance, and real estate; and 13.6 percent in services. Growth has been rapid in the information processing industry, which includes catalog operations, credit card processing, and airline reservations. Software also has contributed significantly to the strong growth. Both WordPerfect and Novell are located in northern Utah, as are many smaller software producers. Moreover, software jobs pay about twice as much as the statewide average wage.

Tourism has provided an additional source of growth in recent years. One study estimated that tourism brought $2.9 billion into the state in 1991, providing 8 percent of the state's total jobs. A huge snowfall this winter should result in substantial increases in tourism this year, with skiers coming to the state to enjoy the first deep snows in several years.

In recent years, migration patterns have changed in Utah's favor. From 1984 to 1990, more people moved out of Utah than moved in. In contrast, both 1991 and 1992 saw nearly 20,000 more people move into Utah than move out. The net immigration accounted for more than two-fifths of Utah's population growth, boosting the total growth rate to more than 2 1/2 percent in 1992.

Manufacturing activity has not fared as well as most other industries in Utah; manufacturing employment fell 1.7 percent in January 1993 from the level of a year earlier. Cutbacks in defense spending explain a good portion of the decline. Nevertheless, within the manufacturing sector--some industries showed gains--especially growth industries, such as airbags.

Construction employment in Utah has been quite strong, growing 36.2 percent since the middle of 1990. One reason for this performance is that Utah suffered through major real estate problems during the mid- 1980s, which led to little building in the state and falling values. The limited building activity in the recent past and the population growth in Utah have led to very strong residential construction activity. Home values have risen about 10 percent in the Salt Lake City area during each of the past two years. Most of the construction has been single-family home s. In contrast, multifamily markets are just now reaching the point where the space built during the early 1980s has been absorbed. Residential markets still look solid. Vacancy rates are low, and credit quality in mortgage portfolios continues to be excellent.

In the nonresidential area, the past few years have seen significant building activity as well. Fewer large office buildings are likely to be built during the next few years, but a major renovation at the Kennecott Smelter near Salt Lake City is expected to pump around $800 million in construction spending into the economy during the next few years. In a state in which the annual value of nonresidential construction awards has totaled between $300 million and $400 million since 1987, the Kennecott project represents a major contribution to the state's economy.

One result of relatively strong construction activity and solid real estate markets is that financial institutions report good credit quality and strong earnings. At the end of 1992, large commercial banks in Utah had a problem loan ratio of only 2.1 percent, compared with 5.1 percent nationally. Credit quality was strong across a broad range of loan types. Moreover, profits of Utah banks were significantly better than the national average in 1992. While the return on assets (ROA) averaged a solid 0.93 percent nationally, ROA for Utah banks was much higher, at 1.51 percent. Lending activity at commercial banks in Utah over the past few years generally has been stronger than nationally, though this was not the case in 1992.

Over all, the Utah economy is in excellent shape, and the prospects for continued economic health during the next few years are good.

Washington

Washington's recent economic performance has slowed from the robust growth seen in the late 1980s. The state's economy--particularly in the Puget Sound area--has been hit recently by weakness in aerospace. Not all the reports are negative, however, as communities in eastern Washington are experiencing robust growth.

The number of jobs in Washington grew 1.8 percent between January 1992 and January 1993, reflecting a strong increase in January employment. This performance follows the weak 0.8 percent growth reported in 1991. These rates are significantly below the pace of 1990 (2.7 percent) and 1989 (5.8 percent). Reflecting this slower job growth, Washington's unemployment rate rose to 7.8 percent in January 1993, up from 7.0 percent a year earlier and 5.9 percent at the end of 1990. Despite the slow job growth, population growth--tied to continuing high levels of immigration--remains strong, with the labor force growing 2.5 percent in 1992. Population growth in 1992 is estimated to have been 2.3 percent. Weakness in employment is centered in western Washington, with employment in Seattle falling 0.7 percent in 1992. In contrast, cities in eastern Washington are enjoying robust growth. The number of jobs in Spokane, for example, grew 2.8 percent in 1992.

The drop-off in Washington's jobs performance last year is largely attributable to a contraction in its aerospace-based manufacturing sector. The number of manufacturing jobs fell 1.9 percent in January 1993 from the level of a year earlier, after a 5.0 percent decline in 1991. Since peaking in April 1990, Washington's manufacturing sector has lost 31,000 jobs. (Between April 1990 and December 1992, aerospace employment declined by 9,000 jobs.) The majority of these jobs were linked to cutbacks at Boeing, where employment has dropped roughly 8,000 since Boeing's employment peaked in 1989. Furthermore, in mid-February, Boeing confirmed that it would eliminate 23,000 jobs in 1993 and another 5,000 during the first half of 1994. Of the total this year, 15,000 jobs will be cut in Washington State. These job reductions were widely expected after Boeing's announcement in late January that it would reduce production. The Boeing cutbacks are expected to have a negative impact on its suppliers, with layoffs already announced by smaller firms in Washington, Oregon, and Southern California.

Given the importance of Boeing for the Puget Sound economy, where it employs almost 100,000 aerospace workers, prospects for the company are watched carefully by regional analysts. In the short run, continued losses in the U.S. airlines industry and competition from overseas producers are undermining the $83 billion backlog of Boeing's "firm" orders. Several carriers have canceled or postponed delivery of jets in recent years. Responding to this slackening demand, Boeing has slowed production or is slowing production of all its airplane models, including the very profitable 747. Increased production in the near term is unlikely. Longer-run prospects for the company, however, are more favorable. Despite falling orders and competition from overseas, Boeing has maintained its traditional market share. In addition, the company is developing new fuel-efficient product lines tailored to the Asian-Pacific market, which is expected to be a major source of growth in air travel. The company also has begun discussions with European companies for joint development of a super jumbo carrier. While these developments bode well for the long-run survival of the company, current troubles in the airline industry suggest that cutbacks at Boeing will retard economic activity in Washington for the foreseeable future.

Outside aerospace, Washington's manufacturing activity is mixed. Compared with levels of a year earlier, employment rose 1.6 percent in industrial machinery and fell 3.4 percent in primary metals, 3.5 percent in instruments, and 2.7 percent in pulp and paper. Employment in lumber and wood products rose in January to a level of 3.2 percent above a year earlier, although employment was off 10.8 percent from the level reported in December 1989. The declines in the timber-related industries are linked to environmental limitations on harvesting from public lands and sluggish national demand. Other manufacturing sectors recording growth in the last year include electronics (0.9 percent), food and kindred products (3.0 percent), and fruits and vegetables (0.7 percent). Contacts report that prospects are good for high-tech sectors such as biotechnology and computer software production.

Other sectors outside manufacturing also are registering mixed performance. As in other District states, employment was down in mining (- 3.1 percent) in January, compared with that of a year earlier. Employment also contracted in finance, insurance, and real estate (- 0.7 percent). Job gains, however, were recorded in trade (2.5 percent), services (3.9 percent), and state and local government (3.1 percent). The agriculture sector in Washington has performed well in recent years, despite the drought that affects several western states. Recent precipitation has improved prospects for next year.

Washington's construction and real estate markets are mixed. Construction employment rose 2.4 percent in January from the level of a year earlier, as strength in residential construction offset continued weakness in nonresidential real estate. The strength in residential construction--driven in part, by needs to house Washington's growing population--is expected to continue into 1993. Residential permits at the end of 1992 were up 26 percent from their year-earlier level. In contrast, nonresidential construction awards were down 17.6 percent from a year earlier.

Much of the strength in Washington's construction remains centered in the eastern part of the state, where contacts report a construction boom in cities such as Spokane. House prices in Spokane appreciated 18 percent in 1992--driven by demand from immigration--but the median home price remains at a relatively affordable $80,000. Residential median sales prices in Seattle moved up slightly in the second half of 1992, after remaining flat for much of the previous two years, and stand at $147,000. Contacts attribute the relatively robust growth of central and eastern Washington to factors including affordable housing, immigration of firms from higher-cost states, and in the tri-cities area (Richland, Pasco, and Kennewick), a large multiyear clean-up project for the Hanford nuclear facility.

Washington's banking sector is performing well. Commercial bank profits in the state were above the national average in 1992, with a return on assets of 1.17 percent (versus 0.93 percent nationally) and a return on equity of 13.16 percent (versus 12.24 percent nationally). At the end of 1992, problem loans at large commercial banks stood at 4.7 percent of assets, below the national average of 5.1 percent and below the national average in all sectors but construction and farm loans. Problem construction loans--reflecting weak conditions in nonresidential real estate--stood at 19.1 percent versus a national average of 16.5 percent at the end of 1992. This ratio for banks in Washington was higher than for all other District states except California. Commercial bank loan growth has been sluggish during the past two years but still has outpaced the growth in bank lending nationwide.

NATIONAL ECONOMIC DEVELOPMENTS AND MONETARY POLICY

Analyses of the various regions of the country that are provided by all twelve of the District Bank presidents play an important role in formulating monetary policy. Taken together, these analyses help form an understanding of developments in the U.S. economy by providing an up-to-date, detailed base of information that supplements published national statistics. Because the tools of monetary policy--open market operations, changes in the discount rate, and occasionally, changes in reserve requirements--affect the economy broadly, the focus of policy must be on the national economy as a whole, Policy actions are transmitted to the economy through highly efficient and integrated national financial markets. Credit is allocated according to the private decisions of the many lenders and borrowers in these markets. The efficient allocation of credit in financial markets is an important element determining the efficiency with which our market economy operates.

Thus the Federal Reserve's actions in the markets affect the overall level of interest rates and availability of credit but are not aimed at how that credit is allocated. While each region of the country is affected by interest rates and the overall amount of credit available in the national economy, the effects of policy cannot be directed to particular geographical regions or industries.

Current economic conditions in California provide a good illustration of this point. As discussed above, the recession in California is strongly related to a number of "structural" problems, including the cutbacks in defense spending and the need in recent years to reduce the large state budget deficit. These problems will be helped by the national recovery that is under way. Stronger national economic growth will create more jobs to absorb displaced defense workers, and will reduce the budget deficit by raising state tax receipts. However, monetary policy is not an effective vehicle for directing credit to these particular sectors. My views on monetary policy must be based on an understanding of national economic conditions--an understanding that is enhanced by my regional perspective as well as by those of the other Reserve Bank presidents.

With respect to current monetary policy, our goal as always is to promote the maximum standard of living attainable for our citizens over the long run. In recent years, this has meant mitigating the size of the cyclical downswing through reductions in interest rates. However, in the long run the most significant contribution we can make to economic growth is by providing a low-inflation environment, and we have made progress in that area.

In formulating policy, we have faced several challenges recently, not the least of which has been the deterioration in the relationship between the monetary aggregates and spending on goods and services. Last year, both M2 and M3 grew sluggishly; at the same time, the pace of economic activity picked up, which meant that the velocity (spending per dollar) of both aggregates rose sharply, well above what historical relationships would suggest. The misleading signals provided by these aggregates mainly seem to reflect a desire by the public to hold liquid funds in high-yielding stock and bond mutual funds as well as to pay down consumer and mortgage debt. More strict supervision and regulation of depository institutions, which are essential to the long-run health of the industry, also may have contributed to the slow growth in M2 and M3. However, to a large extent, financial markets have been able to direct credit through channels other than the banking system so as to mitigate the effects of restructuring on overall economic activity.

Last year, we had to look beyond the aggregates in the formulation of monetary policy to a broad range of economic and financial indicators. Had policy in 1992 been aimed at pushing M2 and M3 up into their ranges, policy would have been so expansionary as to have risked eliciting fears of higher inflation. The response of financial markets to the possible inflationary consequences of overly expansionary monetary policies puts a limitation on how much the Federal Reserve can do to stimulate the economy. When it appears that the Federal Reserve is going too far in easing short-term interest rates, long-term rates rise, which is counterproductive to efforts to stimulate the pace of economic activity.

Thus, the Federal Reserve has had to find a delicate balance in recent years, allowing short-term interest rates to fall enough to promote economic expansion but not so much as to risk higher inflation. Developments in 1992 and thus far this year suggest that our efforts are paying off. The U.S. economy moved into a phase of sustained expansion last year, after the period of recession and slow growth in the preceding two years. The 3 percent growth in real GDP for last year as a whole was modest compared with what typically occurs in the early stages of expansions; however, it compares favorably with the 2 percent pace that appears to be sustainable for the U.S. economy in the long run and was well ahead of growth in most industrialized economies abroad.

The expanding economy last year generated growth in jobs, although at only a moderate pace, as the productivity of the work force registered large gains. However, the strong surge in jobs in February is encouraging. Moreover, the civilian unemployment rate did peak in the middle of 1992 and has been on a downward path since then. These declines are in fine with what would be expected based upon historical relationships between real GDP growth and changes in the unemployment rate, suggesting that substantial further declines in that rate can be expected as the expansion continues. Price developments last year were favorable. Excluding food and energy, consumer prices rose at a 3 percent rate, the lowest in twenty years.

I expect the patterns established in 1992 to continue this year and beyond, with moderate growth in real GDP accompanied by gradual declines in both unemployment and inflation. I believe that a major factor behind these favorable developments is the prudent easing of monetary policy that has been implemented to date. (1.) The attachment to this statement is available from the Federal Reserve Bank of San Francisco, San Francisco, CA 94120. (2.) Comparisons using data before 1991 should be viewed with caution. Employment data for California and the District are likely to be revised significantly to show fewer jobs before 1991. Changes in Bureau of Labor Statistics procedures revealed a serious overestimation of jobs in California before January 1991. (3.) These data refer to customs districts. (4.) The data on commercial banks for the fourth quarter of 1992 are preliminary. (5.) The data on problem loans are for banks with assets of more than $300 million. "Problems loans" are defined here and throughout the testimony as thirty days or more past due and as nonaccrual loans. (6.) This testimony compares California employment data between January 1991 and February 1993. According to current official data, California's employment peaked in May 1990. However, comparisons with pre-1991 data should be viewed with caution (see note 2, p. 453). (7.) These data refer to customs districts. (8.) January 1993 data for these sectors are not yet available.
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Title Annotation:Statements to the Congress
Publication:Federal Reserve Bulletin
Article Type:Transcript
Date:May 1, 1993
Words:9231
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