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For release on delivery 4:30 P.M. E.S.T. March 10, 1989 "MONETARY POLICY PRIORITIES" by Edward W. Kelley, Jr. Member Board of Governors of the Federal Reserve System before the Public Securities Association Washington, D.C. March 10, 1989 A great deal of attention has been given to various indicators that might help us to understand the state of our economic health and how to conduct appro priate monetary policy. By way of background to this continuing might dialogue, it be useful to briefly focus on our national long-term economic goals and how monetary policy might best contribute toward reaching them in the face of a host of important new complexi ties , many of which are totally exogenous to the central banking process. The basic goals of monetary policy are established by the Full Employment and Balanced Growth Act of 1978, which specifies macroeconomic policy objectives for all of the Federal Reserve System. government, It specifies including the Federal a variety of desirable conditions that center around the concept of sustained economic growth which is very clearly and appropriately the overarching goal of economic policy. institutional and legal signed toward that end. framework is Much of our accordingly de One of the conditions, which constitutes a primary responsibility and objective for the Federal Reserve through its authority to set monetary policy, is reasonable price stability. Reasonable price stability, defined here as a noninf lationary price environment, is an essential requisite for sustainable long-term growth. pre History is -2- crystal clear on that point. Inflation spawns economic inefficiencies which, in turn, create uncertainties and risks in the decision-making process. investment, encourages decisions, diverts investment and pursuits real a resources toward designed purchasing bias to This toward away short-term from productive over-consumption protect power. against These inhibits and the other erosion conditions of preclude satisfactory economic performance over time. In the short tensions between progress toward overly run, of course, near-term price restrictive there economic policy often performance stability. monetary are For and example, might down inflation to low levels very quickly. well an drive But in the process such a policy would run the risk of inducing a deep recession. In today's environment this could seriously inhibit progress toward solving a variety of critical financial and other economic problems. On the other side of the coin, an overly expansionary monetary policy might, for a time, raise the level of output but if that occurred when (such utilization rates were already posture could easily release as now) resource at high levels such inflationary a pressures. Then the economy could be off on a boom-and-bust roller -3- coaster which would ultimately be self which, as we saw in the early part defeating of this and decade, might require rather draconian measures to set right. Obviously neither of these two scenarios represents an acceptable alternative and the principal challenge facing monetary policymakers over time is to develop strategies that work toward long-term objec tives while avoiding the pitfalls on both sides of the road. Before speculating on how policy making might best be approached, it is useful to keep in mind some of the complexities found in today's environment which compli cate the process. There are at least three groups of considerations. First, many uncertainties about the domestic nonfinancial economy make confident analysis difficult. Our understanding of the current state of affairs at any given moment in time is limited by the quality and inevitable tardiness of available statistics. Given our imperfect understanding of the structural dynamics of our evolving economy, the net impact of the enumer able factors difficult, if that importantly not impossible, affect the to predict. economy is These in clude, for example, such concerns as weather effects on food production, OPEC energy pricing, and fiscal and -4- foreign policy decisions. financial innovations, Second, a host while hopefully of recent beneficial in terms of enhancing long-run economic efficiency, add to the problem. Deregulation has changed much of the legal and financial landscape in ways that continue to evolve and are still unclear. and products such as junk bonds, collateralized mortgage ative securities, New financial concepts leveraged buy-outs, obligations and other deriv are so new that their macroeconomic impact is as yet unable to be assessed. A third area is the recent globalization of capital markets and the much greater impact on our trade of goods and services. economy of international As a result, U.S. markets are now more sensitive to developments emanating from abroad. Due to these tighter linkages, disruptions in one country can quickly spill over into others. While these developments offer great hope for a better world tomorrow, they substantially complicate the consider ation of appropriate policy today. How then is monetary policy to be formulated this dynamic dependent environment goals are in where long-range, short-term tension, outright conflict, one with another? is necessary to be clear about ends in inter if not First of all, it and means. stated above, sustainable long-term growth is the As -5- primary social stability is objective a of critically economic policy. important Price precondition to achieving that end, and experience has taught us to be ever vigilant short-run as not to this inevitably long-term setbacks. policy that within a lose control leads prices to in the unacceptable However, as a means toward an end, seeks price context of of stability must the overall be social structured good. To repeat, price stability cannot ever be ignored, but its pursuit must consistently consider upon which it plays its role. the larger stage A good example of this is the modification made to monetary policy immediately following the stock market break of October, 1987. Let me suggest best to proceed. two tactical have just as to how First, seek to keep the trends moving in the correct direction. I concepts outlined, In light of the complexities this is more consistently reliable than overemphasis on achieving any particular condition at any particular time. keep the trend of economic We should attempt to growth slanted upward as much of the time as possible while recognizing that the speed of advance will vary. we should work to keep the Similarly, with inflation, long-term trend pointed toward zero, realizing that in some economic conditions it may be more productive over time to accept somewhat -6- slower short-term progress. work toward fluctuations call this shrinking around the "staying off The the second tactic magnitude trends. the The of is to economic newspaper might roller coaster" while statisticians might refer to it as "reducing the size of the standard deviation." For the policymaker considering sustainable growth, it means avoiding boomand-bust episodes. In considering inflation, it means ensuring that there will be no breakout on the up side while maintaining conditions for steady long-term reduction. In pursuing order. many the above, three mind sets are in First, we must exercise caution in light of the inevitable standing uncertainties of events and policy must remain flexible forces acting necessitates factors. and their interactions. in in varying ways a changing mix incomplete light of under Second, the on the economy, of appropriate myriad which policy And third, growing out of the above, a focus on judging which factors should receive how much weight in the short-term, in order to best move toward the long-term goal. It is interesting to track the Federal Open Market Committee's evolving perceptions of appropriate policy emphasis. This can be done by examining the FOMC's -7- domestic policy directives which always Committee's concerns in priority order. in recent years have recite the Such variables included inflation, strength of the expansion, monetary aggregates, exchange rates, and financial market conditions. In 1985 and 1986 concern for inflation was well down the list during a period which saw rapid reductions in inflationary pressures. From late 1985 through the spring of 1987 against the backdrop of a sharp depreciation of change rates took center highest priority. concern from May stage, Inflation 1987 reemerged throughout period provides how shocks can intrude quickly required. dollar, ex going from lowest utilization continued to increase. through this the as 1988, the as to main resource The one exception an excellent example of and flexible responses may be Following the stock market break of October 1987, financial market considerations went from totally off the list to the top consideration through the spring of 1988. confidence has This has more recently receded as returned. the past eighteen months, It is interesting that the strength of the economy has remained in a prominent second place position the Committee recognized for the importance of a as main tainable rate of economic growth as key to the solution -8- of many national problems, while each one of the other considerations has moved up and down in emphasis. To summarize, our nation's primary long-term goal for economic policy is to achieve a high level of sustainable long-term growth and many forces are acting to influence and work toward this end. A necessary precondition is the existence of price stability, and here not so many helpful institutional elements are in place. It is here that the Federal Reserve has assumed a primary role and it is here that the Federal Reserve must make its primary economic success. grate a shifting contradictory effective exercise To do this, kaleidoscope short-term long-term of contribution judgment as to our nation's it must seek to inte of factors strategy. to complex into The the and often a coherent key skill proper and is the order and weighting of priorities as circumstances evolve.
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