I am pleased to welcome Federal Reserve Chairman Alan Greenspan to testify before the Joint Economic Committee on the economic outlook and monetary policy.
Given the sensitivity of the situation in international financial markets, we recognize that Chairman Greenspan must be constrained and circumspect in his comments, and for similar reasons my statement will focus on longer term issues related to monetary policy.
Two key factors to keep in mind in the current situation are the underlying strength of the economy and the able leadership of the Federal Reserve. Economic growth is healthy, and inflation and unemployment are quite low. In addition, the Federal Reserve demonstrated in 1987 that when necessary it can handle market disruptions superbly, and eliminate negative fallout on the economy. Economic growth actually increased in the fourth quarter of 1987. Currently, the outlook for the U.S. economy remains very positive.
The business cycle expansion that began in the second quarter of 1991 continues to produce economic and employment gains with no end in sight. This business cycle expansion is due to the hard work of millions of workers and business persons across this nation. To the extent policy factors are relevant, monetary policy has been the central factor sustaining the economic expansion.
As the Federal Reserve gradually squeezed inflation over the last 6 years, interest rates and the unemployment rate have both declined. The anti-inflationary monetary policy of the Federal Reserve has paved the way to prosperity without inflation. The central error in postwar economic policy -- the notion of a tradeoff between inflation and unemployment -- has been refuted during the last two business cycle expansions. Low inflation is a foundation of sustained economic and employment growth and it fosters lower, not higher, unemployment.
Credible disinflation tends to lower interest rates, reduce uncertainty premiums, stabilize financial markets and thereby bolster interest rate sensitive sectors of the economy. Lower inflation promotes efficient operation of the price system, and in many ways, works like a tax cut. All of these factors contribute to sustaining the economic expansion. Chairman Greenspan and his colleagues at the Federal Reserve deserve a great amount of credit for reducing inflation in a gradual manner and thereby promoting the many economic benefits that have resulted.
Some seem confused about the co-existence of low inflation and low unemployment. They seek an explanation in a "new economy" or a "new era." But new, revolutionary developments are not necessary to explain current circumstances. Rather, old truths will suffice; specifically, low inflation is good for economic growth and works to lower unemployment. On the other hand, a loose monetary policy ultimately leads to higher inflation and higher unemployment, as was demonstrated in the late 1970s.
Inflation is not caused by economic growth. As Milton Friedman and F.A. Hayek noted, inflation is a monetary phenomenon. If monetary policy is not overly expansionary, there will not be inflation. Only when artificial economic growth is caused by an inflationary monetary policy is there reason for concern.
Nonetheless, I believe we must be vigilant about inflation and monetary policy must pre-empt inflation before it emerges. Here at the Joint Economic Committee we monitor the usual price index measures but also forward-looking indicators of inflation such as commodity prices, bond yields, and the value of the dollar. Neither the conventional nor forward-looking inflation indicators justify a change in Federal Reserve policy at this time.
Overall, the thrust of Federal Reserve policy has been very successful in recent years. Current Federal Reserve policy seems consistent with a policy of setting an inflation band of about 0 to 2.5 percent. This is a sound approach that has also been successfully adopted by a number of other central banks around the world.
This policy of inflation targeting would be institutionalized under legislation I have introduced. The formidable achievements of the Federal Reserve under Chairman Greenspan should be locked in so price stability and low interest rates can be assured for future generations.
Return Home