Statement by Thomas C. Melzer, President, Federal Reserve Bank of St. Louis, before the Committee on Banking, Housing and Urban Affairs, U.S. Senate, March 10, 1993.
At the Federal Reserve Bank of St. Louis, we monitor economic conditions in both the nation and the Eighth Federal Reserve District, which includes the State of Arkansas and parts of Illinois, Indiana, Kentucky, Mississippi, Missouri, and Tennessee.(1) Reserve Banks monitor the national and regional economies in a variety of ways. For example, we routinely collect economic information from various official sources, both private and public.
Because of the lags in published data, we also attempt to acquire more timely information through informal means. By interacting regularly with District individuals--in 1992, Research Department economists and I participated in approximately 150 programs in our District--we learn firsthand about economic conditions. Through these programs as well as our daily interaction with the District community, we gather information on economic conditions from consumers, labor leaders, homebuilders, bankers, educators, and business people from both small and large firms. Besides collecting information, we solicit opinions and questions on banking and monetary policies, as well as learn how they may be affecting individuals in the District. Although frequently anecdotal, this information can sometimes signal an important trend before it is apparent in the published data.
ECONOMIC STRUCTURE OF THE DISTRICT
Let me note some facts about the Eighth District economy. Based on the most recent county data, the District share of personal income in the nation is 4.3 percent. If we include each of the seven District states in its entirety, that share is 13.3 percent. Per capita disposable personal income levels in District states are below the national average.
The economies of the Eighth District and the nation are very diverse and roughly similar in structure. Some differences, however, are worth noting. Table 1 compares the composition of output for the Eighth District and the entire United States.(2) The table shows the following:
* The Eighth District tends to be more manufacturing-intensive in both durable and nondurable goods than the United States. Nondurables sectors in the District with comparatively high production include rubber and plastic products, food, apparel, paper products, and chemicals. Durables sectors with comparatively high output include transportation equipment--particularly motor vehicles--fabricated metals and wood products.
* The District economy is a major agricultural producer, supplying significant portions of the national output of corn, cotton, rice, and soybeans.
* Transportation services are a relatively important contributor to the District economy, reflecting an extensive network of navigable rivers, the strong presence of railroads, and such airline transportation companies as Federal Express and United Parcel Service.
RECENT ECONOMIC PERFORMANCE IN THE EIGHTH DISTRICT
Although the 1990-91 recession and restructuring have affected both the national and Eighth District economies, the District has fared somewhat better than the nation.
Pockets of Strength
One of the characteristics of a diverse economy is that, even when an economy slows, some regions or sectors may moderate the slowdown. This situation has been observed in our area in recent years, as certain pockets within the District have grown rapidly, bolstering the economic fortunes of our District. Examples follow:
* Northern Arkansas has experienced substantial economic growth in the past few years. The northwestern part is home to some of the nation's fastest-growing companies: Wal-Mart, Tyson Foods, and J.B. Hunt Transport Services. Nucor, as well as several small steel manufacturers, have located in northeastern Arkansas.
* Bowling Green, Kentucky, has attracted major industrial plants, including International Paper and the James River Corporation.
* Memphis, already a significant transportation and distribution center, has exhibited substantial real growth. In December, total payroll employment was 1.8 percent higher than year earlier, real retail sales were up 31 percent, and the area unemployment rate stood at 5.5 percent, well below the 7 percent national average.
Employment, Unemployment, and Restructuring
Payroll employment data provide a useful measure with which to compare the Eighth District and the nation during the recession and the recovery to date. U.S. payroll employment fell at a 2.2 percent annual rate during the recession from July 1990 to March 1991. District employment declined as well but at one-half the national rate. In contrast to previous recovery periods, U.S. payroll employment has essentially remained unchanged since the March 1991 recession trough, whereas Eighth District payroll employment has grown, although only at a 0.5 percent annual rate.
The employment growth comparison for the District and the United States is repeated in unemployment data. The increase in the District unemployment rate in the 1990-91 recession was only two-thirds that in the nation. In the recovery, the unemployment rate for the District fell to 5.8 percent by the end of 1992--its prerecssion level--while the unemployment rate for the United States remained well above its prerecession level.
Increases in District service-sector employment in the aftermath of the recent recession more than offset the continued job losses in the goods-producing sector. District foods-producing employment, after decreasing at a 6.4 percent rate during the recession, has continued to fall in the recovery, although at a significantly reduced annual rate of 0.1 percent. In contrast to the District experience, national job growth in services has not been enough to make up for job losses in manufacturing.
The Eighth District has not escaped employment restructuring. Substantial employment changes occurred in transportation equipment, including both automobile and aerospace manufacturers. Many of the changes in the District aerospace industry are directly related to reductions in spending on national defense. During the 1990-91 recession, employment in transportation equipment declined at an annual rate of 15.3 percent in the District and 8.9 percent nationally. Since the March 1991 recession trough, employment in this industrial classification has declined 3.4 percent in the nation but increased 0.4 percent in the District, an increase that is, nonetheless, below the norm for previous recoveries. Since mid-1990, McDonnell Douglas, the nation's largest defense contractor, has cut back employment in St. Louis by roughly 13,000. While many of those laid off have found jobs in St. Louis and elsewhere, manufacturing employment in St. Louis in 1992 was 5,000 below its level for 1991 and 21,200 below its level for 1990.
The economic health of the Eighth District is also reflected in the performance of its banks. Over the past decade, Eighth District banks have generally outperformed banks of similar size in other parts of the country. The somewhat better historical performance of District banks reflects their comparatively low ratios of overhead expenses to assets and ratios of loan losses to assets.
This historical pattern is repeated in recent national and District bank performance. In the third quarter of 1992, District banks recorded return on average assets--a measure of bank profitability--of 1.17 percent, well above the industry benchmark of 1 percent and the national average of 1.06 percent. District banks also outperformed the banks in the nation in terms of return on average equity, despite net interest margins that closely matched the national pattern.
Recent improvements in the spread between rates earned on loans and rates paid on deposits have undoubtedly contributed to the current strength in commercial bank earnings nationwide. Several other factors, however, account for the comparatively strong performance of District banks:
* Because the region's economy fared relatively well during the 1990-91 recession, District banks recorded lower levels of nonperforming loans as a percentage of each loan category--consumer, commercial and real estate--than did most of their national peers. Lower ratios of nonperforming loans generally translate into lower loan losses.
* The relatively small building boom, especially in commercial real estate, in the Eighth District during the mid- and late-1980s left District banks less subject to loan losses from real estate suffered by banks in other regions.
* The comparatively conservative composition of District bank real estate loan portfolios is reflected in relatively high proportions of first and second single-family mortgages in their real estate loan portfolios. Such loans tend to have lower nonperforming and loss rates than other types of real estate loans. Currently, nonperforming ratios for all types of real estate loans are lower at District banks than at national peer banks.
* Over the past five years, District banks have consistently had capital ratios that exceed regulatory minimums. At the end of the third quarter of 1992, only one of the District's 1,200 failed to meet the "adequately capitalized" requirement under the prompt corrective action provisions of the Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA). Even more impressive is the fact that only twelve District banks failed to meet the tougher well capitalized" standards under FDICIA. Because District banks generally have capital ratios that exceeds regulatory minimums, they are well-positioned to meet demands for loans and other banking services.
All in all, it is fair to say that the economy of the Eighth District has been relatively stable in light of national developments. The diverse nature of the District economy has contributed to this stability, with pockets of strength more than offsetting areas of weakness. Such overall stability is backed by. the strength of the banking sector. This optimistic evaluation does not ignore the significant structural adjustments that are occurring in certain sectors and regions. Nevertheless, in my judgment, were it not for these unusually large structural adjustments, economic growth in the District would be comparable with that of earlier recoveries.
VIEWS ON MONETARY POLICY
I would now like to turn to my views on monetary policy. As I stated initially, the monitoring of regional economic conditions provides useful insights that contribute to the monetary policymaking process. The input of Reserve Bank presidents, who are briefed on a broad range of economic viewpoints, enriches Federal Open Market Committee discussions of national economic conditions. Such deliberations provide the backdrop for formulating monetary policy. Nonetheless, monetary policy decisions necessarily must be made for the nation as a whole, regardless of the conditions in any one District.
In reaching judgments on policy, I try to keep several factors in mind. They include the following: the goals of economic policy, the role of monetary policy in achieving such goals, the usefulness and limitations of contercyclical monetary policy actions, and the importance of an indicator to gauge the thrust to monetary policy actions over time. I will discuss each of these issues briefly.
The goals of economic policy include maximum sustainable growth of the economy, a high level of employment, and stability in the purchasing power of the dollar. At one time there was thought to be a tradeoff between policies pursuing growth and those aimed at price stability. We now know that maximum sustainable economic growth is achieved when changes in the price level cease to be a factor in economic decisionmaking. It is no accident that the most advanced industrial countries and the newly industrialized and fast-growing Asian economies have been comparatively successful in keeping price levels stable.
It cannot be emphasized too strongly that reasonably stable prices create an environment conducive to long-range planning, as resources are used productively and not expended on inflation hedges. Removing the distorting effects of inflation from real price signals enhances market efficiency. Low and stable inflation also helps to keep interest rates low by removing the premium that investors require to compensate themselves both for expected losses due to rising prices and for the risks of making long-term commitments in a world with price-level uncertainty.
ROLE OF MONETARY POLICY
In the long run, monetary policy only affects prices. Stimulative monetary policy actions cannot increase the economy's long-run growth. The potential for economic growth is determined by real factors such as the growth in the labor force, capital investment, and increases in productivity. Accordingly, the role of monetary policy in achieving our long-run economic goals is limited.
Countercyclical monetary policy, however, may be appropriate in the short turn. Monetary policy actions can lay the foundation for recovery by bolstering sagging monetary growth rates during a recession and can avoid an upward spiral in inflation and interest rates by moderating excessive monetary growth during an economic expansion. But monetary policy is a blunt tool. Both the magnitude and timing of the effects of countercyclical monetary policy actions on the real economy are uncertain. Excessive countercyclical monetary policy actions are destabilizing because they necessitate policy reversals down the road. Consequently, one must avoid sowing the seeds for the next inflation when fighting recession or sowing the seeds for the next recession when fighting inflation.
Monetary Policy Indicators
Finally, it is essential to have indicators of the thrust of monetary policy actions to gauge whether monetary policy has been excessively tight or easy. Such indicators should be tied closely to Federal Reserve actions, which primarily involve adding or draining reserves available to the banking system. This approach leads me to monitor the behavior of total reserves, the monetary base, and the MI monetary aggregate. These variables, observed over relatively long periods, provide a reasonable gauge of the stance of monetary policy.
The behavior of broader monetary and credit aggregates, such as M2, can also be useful in formulating and evaluating monetary policy. Averaged over three-to five-year intervals, M2 growth has been an indicator of the growth of nominal spending, although this relationship is now being reevaluated. But monetary policy is too complex to be described solely by the behavior of a single variable, especially one over which the Federal Reserve has only limited control.
The portion of M2 that is most directly affected by Federal Reserve actions, M1, has risen at double-digit rates during the past two years, as have total reserves and the adjusted monetary base. The slow overall growth of M2 has been due entirely to its non-M1 components, which Federal Reserve actions affect only indirectly. The growth of these components has been affected by the very steep yield curve, the rise in deposit insurance premiums, the need for higher capital ratios, increased regulatory oversight, weak credit demand, and continuation of the longer-run trend channeling credit away from depository intermediaries. Consequently, M2 growth has slowed despite the Federal Reserve's considerable efforts to raise it.
There is no simple rule for assessing the appropriateness of monetary policy at each point in time. Considerable judgement is required in setting policy. Thus, the Federal Open Market Committee benefits greatly from the diversity of views that are advanced under its current structure. Ultimately, the effectiveness of monetary policy must be evaluated based on results--and the record of the past decade is reasonably good. Despite unusually large federal budget deficits, complicated international developments, and significant financial market restructuring and disruptions, monetary policy has been successful in reducing inflation during a long period of moderate economic growth. Although set back by the recession and a slow recovery, monetary policy has made substantial progress in regaining credibility with respect to controlling inflation and has laid the foundation for a sustainable, low-inflationary expansion in the 1990s. No one can know what the future holds, but if accelerating inflation is behind us, the real economy will be on a firm footing for genuine progress in the years ahead. (1.) The attachment to this statement is available from the Federal Reserve Bank of St, Louis, St. Louis, MO 63166. (2.) For these purposes, the District's economic output is assumed to be composed of the total output of the states of Arkansas, Kentucky, Missouri, and Tennessee. This convention is used because the majority of economic activity in Indiana, Illinois, and Mississippi is not in the Eighth District. Moreover, the absence of timely data at the county level prevents the presentation of up-to-date data for only the Eighth District.
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|Title Annotation:||Statements to the Congress|
|Publication:||Federal Reserve Bulletin|
|Date:||May 1, 1993|
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