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Internatlonal Developments and Monetary pollcy
l{. Lee Hoskl ns , Pres I dent
Federal Reserve Bank of Cleveland
Boston Assoclatlon of Buslness Economlsts
Boston, Massachusetts
May 23, 1988
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Internationaì considerations have taken on a more promlnent role
recently in
economìc
policy decisions around the world. Partly this refìects
the growing interdependence and openness
trade and capital
nations, characterized by large
flows. It also reflects the problems of the day,
particularly the serious international
l'le now seem
among
imbalances
that currently
to be on a path towards redressing the global trade
imbaìances. A long journey remains, and the conditions that
when we reach
today. I
exi st.
our destination
will
depend on the
sense an increasing uneasiness
will
policy choices
be
in
pìace
we make
in financial markets about
policymakers' willingness to maintaÍn the progress they have made towards
achieving price
stability.
This uneasiness does not stem as much from recent
price or money-growth trends, as from a sense that future economic policies
wllì not be adequate to manage the difficult transition ahead. Central
continue to establish multiple objectives
lmportance they attach
Tonight,
monetary
I vill
for
nronetary
banks
policy and to alter the
to each.
review what
I
believe is the appropriate role for
policy ln an international context.
I will
argue
that an emphasis
on
price stabllity both in the United States and abroad not only could reduce
price uncertainty, but could also keep us on the desired path of adjustment in
our international
accounts.
-2Correctlnq Internatlonaì Imbalances
late 1985, the exchange market began to vlew trends in global trade
By
imbalances and
exlsting exchange-rate configurations as unsustainable.
Protectionist sentlments were growlng, and the dollar had begun to
depreciate.
to global trade imbalances relies on
pol icies in both defictt and surplus countries and on
The standard textbook remedy
expenditure-adjustment
exchange-rate management. Domestlc expenditure patterns began to adJust ln
late 1985, but the market did not vlew these adJustments as proceeding qulckly
enough, and completely enough,
exchange
rates.
to obviate a sharp realignment in dollar
By mid-1986, Germany and Japan became increasingly concerned
about the impact that the
dollar's rapld depreciation could
economles. Exports vere an ìmportant source
countries.
markets
of
economic growth
By mid-1986, Germany and Japan were lntervenlng
in
in
1986 and
result
was an
acceleratlon in the growth of their
1987. For exampìe, central-bank
percent annual rate
and 6.0 percent
in
money
in
in .l986 and 1987 compared to
these years
respectively.
money
Germany greu
upper targets
their
both
exchange rate
-- at tlmes ln very large amounts -- to slow the dollar's
One
depreciation.
supplies in
at nearìy an 8
of 5.5
Money growth (M2 & CDs)
accelerated from an 8 percent annual growth rate
ll
have on
in late
percent
ln
Japan
ì985 to approximately
ln 1987. Other countries, notably Canada and the Unlted
Kingdom, also intervened to slow the dollar's decline and consequently
percent late
experi enced accel erati ng rnoney-growth rates
money
(Ml) grew rapidìy in
r 987.
1985 and 1986,
.
Meanwhi ì
well
above
e, i n the Uni ted States,
target, before sìowing in
-3-
0n the Path of AdJustment
To
date, the effect of these policies has been to put us on the path to
adjustment. The dollar
now stands approximately
at ìts
ì980 leveì, before our
serious trade balance problems began. Real net exports in the United States
have begun
in
demand
to adjust, as have real net exports in
many
Germany and
Japan.
forelgn countries, especially in Japan, has improved.
the stlmulative policies undertaken to date not only are foreign
Domestic
Given
economies
likely to continue expanding, but growth probably will accelerate.
The IMFs
recent l,lorld Economic Outlook shows domestic demand in most foreign countries
growing as the export sector slows and malntainlng overall
acceptabl
I
e
real growth at
an
pace.
do not mean
abroad does seem
to
to suggest that a boom is in progress abroad. But growth
be picklng up, and exceeding expectations
in
most
countries with the possible exception of hlest Germany. Although high levels
of
unemployment and excess capacity
with the recent shift in real
exist, these countries
exchange
rates,
have coped well
and economic Arowth, led by
domestic demand, has picked up.
In the United States, domestic demand slowed in
sector
became
1987 and the export
the drivlng force for real growth. Recent data, however, show
strong rebound in consumption growth. The U.S. economy appears strong,
a
and
is low by recent yardsticks.
My concern is that we have made onìy part of the adjustments necessary.
unemployment
to elimlnate the trade balance without a resurgence in ìnfìation both here and
abroad. Through the dollar's depreciation, the terms of trade have been
-4-
aìtered and a shift in worldwide
demand towards
U.S. goods and services ls
underway. Through expansionary policies abroad, our major trad'ing partners
have begun
to increase
domestic expenditures, but a counterbalancing reductlon
in domestic expenditures in the United
States has yet to be made.
the future resource demands -- domestic and foreign
at a point in the adJustment
--
be
How
satisfied?
will
Ne stand
process where policy choices must be made, both
here and abroad.
Pri ce Uncertai nti
es
Concern about the choices
that world policymakers might make is
manifested in recent uncertainty about
inflation.
The
rapid growth in
money,
against a backdrop of continuing real economic growth, the disappearance of
margin
of
commodity
excess capacity here
in the United States, and a firming
a
in
prices, has increased concern about the future prospects for
inflatlon, not only in the United
United Kingdom. Evidence of this
States but also ln Germany, Japan, and the
concern rras found
in a steepening of
most
industrial countries yield curves last year as well as in moves by the Federal
Reserve to drain liquidity ìast summer and early fall. The stock-market crash
lnterrupted these rnoves and resulted ln a temporary increase in global
I
iquidity. Inflatlon
concerns subsided immedlately fol loning
crash, but have recently resurfaced as the
real
economìc
activity
have not proved
effects of the crash
on
to be discernible.
in the major developed countries provìde littìe
yet of a serious acceleration of gìobal lnflation. However, it is
Recent price trends
evidence
dampenlng
the stock-market
E
clear that
Most
not making further progress towards reducing lnflation.
we are
fndustrial countries currently are experiencing inflation rates of
approximately 4 percent
-- or slightìy higher.
exceptions. In these countri es,
Germany and Japan are
, after decl f ni ng i n I ate I 986
and early ì987, are rising at approximately a one percent annual rate. France
and
Italy
have demonstrated
in recent years.
Consumer
consumer pri ces
a substantial moderation in their inflation rates
prÌces in the United States accelerated
but they are rising at a modest pace relative to the experience
in 1987,
of the late
I 970s.
risk is that forelgn inflation rates may converge towards the
infìation rate experienced in the United States. This may not be surprislng
The
given the relative slze
dollar
to
inflation largely will
vhere demand will
inflation trends
yillingness of
the
ly to el iminate inflation.
dolìar depreciation potentially has begun to redress global
trade imbalances.
growi ng.
the importance of
depend increasingly on the
united States to reduce and eventual
The sharp
and
rates to foreign economies. The outcome of norldwide efforts
exchange
reduce
of the United States'economy
hle
are on a path where real growth abroad
shlft
more and more tovards U.S. goods and
remain moderate, uncertainty about
is
conilnuing
and
services. l{hile
future inflation is
-6-
theory, however, warns that nominal exchange-rate deprecÍations
can Íntensify price pressures and ultimately wlll fail to improve trade
Economic
imbalances
if
not accompanied by appropriate adjustments in domestic
countries must increase
deficit and surplus countries. Deficit
private savlngs relatlve to investment and reduce
thelr
deficit.
expenditure trends in both the
government budget
Surplus countries must increase prlvate
and
public consumption. consequentìy, our Journey ls bringing us closer and
closer to an inevitable crossroads, and we must choose dovn whlch path we wlll
travel.
inflailon, the other does not.
The path leading to renewed inflation is one yhere we fail to institute
the necessary mix of monetary and fiscal policles to reduce domestic
One path leads
to
renewed
expendltures. The exchange-rate change increasingly ra'ises
U.S. goods and servlces, both by reducing U.S.
increasing foreign
demand
demand
for forelgn
for
goods and by
for U.S. goods. However, trìthout a counterbalancìng
demand
slowing in real domestlc expenditures, domestic capaclty eventually
unable to accommodate
inflation
this shift in
ttouìd accelerate
-- offsettlng
the
lnitial
many
demand
patterns. If this
were
wlll be
to occur,
-- lnitially in the United States and later abroad
competitive effects
this polnt the trade deficlt
of the dollar depreciatlon.
At
would no longer lmprove and could begin to
deterlorate agafn. The growing U.S. internatlonal debt could impìy a further
slowlng in the growth of our standard
of living,
of our future GNP would service our foreign
The
effect could even snowbaìl
lf
uncertai nty about pol i cy encouraged a
as an increaslng proportion
debts.
the acceleration in U.S. inflation
and
fl i ght from hol di ng dol I ar-denoml nated
-7-
assets. In
1987, private
foreign investors
began
to
show an increased
reluctance to hold dollar-denominated assets. Interest-rate spreads
dollar depreciated further.
and the
The inflow
widened
of foreign capital in
recent
years has helped to finance private and publlc credit demand 1n the United
States. Unless a reduction in foreign capital inflows is
increase in U.S. savings (including a reductlon
deficit),
If
an
in the federal budget
U.S. investment growth could slow.
we want
policles that
us to
matched by
shift
to avoid traveling
down
this inflationary path,
we must adopt
reduce domestlc expenditure growth, encourage savings, and allow
resources
to the export sector as foreign
demands
for our products
rise. In thìs case, prices will not rlse and offset the terms-of-trade effect
assoclated with the recent exchange-rate depreciatlon. This scenario does not
imply a reduction in our long-run growth, but
it
does imply a trade-off of
current consumptìon for future consumption.
The Role
I
of
Monetarv Policv
have already lndicated
that the recent uncertainty about inflation
of the recent price numbers. l,lhile there
of future problems, prlce and wage behavior
does not stem solely from a reading
are worrisome signs and harblngers
has been better than past experience might suggest. Moreover, glven the
shifts in recent years in the short-run linkages between money and prices, it
ìs not clear that the uncertainty stems ìn large part from the past rapid
growth of money. Nhile these events certainly are important, the chief source
-8-
of
concern about
future path
the long-run prospects for inflation is uncertainty about
poì i cymakers wi I
I
the
take.
It is lmportant, therefore, that the Federal Reserve System and other
central banks commit and persistentìy pursue a goal of prlce stabilization.
Central banks throughout the industrlallzed trorld continue to pursue muìttple
objectives including price stabi
I
ity,
exchange-rate obJectives, and output
to tlme to change focus and emphasis among these
of this failure to assert the pre-eminence of a "zero
growth, and tend from time
goaìs.
The consequence
inflation" obJective is that the market cannot be certain about the future
course
of
monetary policy.
The basic
level.
objective of monetary policy should be to stabilize the price
Monetary
and services
policy can do little directly to affect the supply of
goods
to the publlc; these depend on the supply of productive
resources. Central banks can affect the price level and can
encourage
investment, employment, and real economic growth by providing a stable price
env i ronment.
l'lhen
central banks lose credibiìity by failing to commit to
a
zero-inflation obJective and following through with credible actions to
achieve
it,
they create uncertainty. Individuals become more cautious about
looking ahead. They become reluctant to proceed yith plans
entail fixed
commitments
or balance-sheet
exposure
in
some
if
those plans
future period when
inflation might be different than anticipated today. They seek a risk premìum
and pursue alternatlves that pay off quickìy. The information that prices,
wages, and
interest rates provlde can become clouded and resources can be
mi saì I ocated
.
-9-
l^lhen
central banks stabi
I i ze
pri ce I evel s, they create a heal thy
environment
for private
declsionmaking and resource
contracts.
They insure
that
allocation. They prevent
inflation from becoming rlorse and they prevent inflation expectatlons from
becoming embedded in wages, in long-term interest rates, and in other fixed
efficlent
medium
of
money
exchange, and
serves
its purpose as a unit of account, an
a stable store of value.
Therefore, recent uncertainty about Ìnflatlon
price trends, nor does
depend on
it
depend on
recent trends in
credi bÍ I ì ty
of central
money
the
amount
growth.
It
of
is not rooted ln recent
excess capacity, nor does
depends
it
primarily on the
banks' pri ce goal s.
Conclusion
Inflation presented a persistent threat to global growth ln the 1970s.
The
ultimate lesson of the
things at
alì tlmes.
inflation
and unemployment
direction.
decade was
Attempts
that central
banks could not do
to shift the focus of
failed to achieve lasting
monetary
success
l'le learned that monetary pol icy can contrlbute
indirectly by providtng a stable price
l,le have gone through
policy
all
between
in either
to real growth only
envlronment.
a protracted, and palnfuì, period in the 1980s of
reducing tnflation to a'low
Kingdom, the United States,
level. In many countries -- Germany, the United
Japan -- much of the success of that effort was a
result of a demonstrated willingness to eliminate inflation despite continued
weakness
in real output and hlgh levels of
unemployment.
-l 0-
In the past few years, we have been fortunate. l^le have lnltlated
pollcles that have begun to redress our global trade imbalances wtthout
aggravatlng
lnflatlon.
Our good fortune
clearly is being stretched.
Federal Reserve and forelgn central banks must reafflrm
actlons a commltment to prlce stablttty.
ln
The
statements and ln
@FedFRASER