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Collection: Paul A. Volcker Papers
Call Number: MC279

Box 13

Preferred Citation: Joint Economic Committee, 1982 November 24; Paul A. Volcker Papers, Box
13; Public Policy Papers, Department of Rare Books and Special Collections, Princeton University
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For release on delivery
10:00 A.M., E.S.T.
November 24, 1982

Statement by

Paul A. Volcker

Chairman, Board of Governors of the Federal Reserve System

before the

Joint Economic Committee

November 24, 1982

I appreciate this opportunity to discuss with you
today the current stance of monetary policy and some problems
for the future.

Before responding to certain questions directed

to me about monetary policy in your letters of October 18 and
November 17, Mr. Chairman, I should first emphasize that the
basic thrust and goals of our policy are unchanged since I
testified before the Congress on July 20.

The precise means

by which we move toward our goals must take account of all the
stream of evidence we have on the behavior of (and distortions
in) the various monetary aggregates, the economy, prices, interest
rates, and the like.

But we remain convinced that lasting recovery

and growth must be sought in a framework of continuing progress
toward price stability -- and that the process of money and credit
creation must remain appropriately restrained if we are to deal
effectively with inflationary dangers.
For that reason, we must continue to set forth targets
for growth in money and credit and to judge the provision of
bank reserves

our most important operating instrument -- in

the light of the trend in the growth of these aggregates.
This process necessarily involves continuing judgments about
just what growth in those magnitudes is appropriate in the
short and longer run, matters affected by institutional change
as well as by more fundamental economic factors.


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2

As you are aware, the current job of developing and
implementing monetary policy has been complicated by regulatory
decisions as well as by recent developments in the economy and
in our financial markets.

We have, as a consequence, (1) made

some technical modification in our operating procedures to cope
with obvious distortions in some of the monetary data -- particularly M1 -- and (2) accommodated growth in the various M's at
rates somewhat above the targeted ranges.
decisions was essentially technical.

The first of those

The latter decision is

entirely consistent with the view I expressed in testifying
before the Banking Committees in July that the Federal Open
Market Committee would tolerate "growth somewhat above the
targeted ranges .

. for a time in circumstances in which it

appeared that precautionary or liquidity motivations, during a
period of economic uncertainty and turbulence, were leading to
stronger than anticipated demands for money."
Unfortunately, the difficulties and complexities of the
economic world in which we live do not permit us the luxury of
describing policy in terms of a simple, unchanging numerical
rule.

For instance, the economic significance of any particular

statistic we label "money" can change over time -- partly because
the statistical definition of "money" is itself arbitrary and
the components of the money supply have differing degrees of
use as a medium of exchange and liquidity.

That doesn't make

much difference in a relatively stable economic, financial, and
institutional environment, but, at times of rapid change, like
the present, it can matter a great deal.


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varying lags -- never
We also have to take account of
tions today and their conac
n
ee
tw
be
-n
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is
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pr
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and
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d inflation and economic acti
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nancial structure itself.
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better captured by a few "yesbe
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e inflationary momentum
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price stability.
to continue progress toward
e indices this year have been
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ic
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-4-

recession on some prices -- most particularly commodities.
that
But there is, it seems to me, strong reason to believe
albeit
the progress toward price stability can be maintained -at a slower rate

as the economy recovers.

For a time, un-

s
employment and excess capacity should restrain costs and price
and, of more lasting significance, productivity growth should
improve from the poor performance of most recent years.

Taken

together, restraint on nominal wage increases and productivity
growth should moderate the increase in unit labor costs, which
account for about two-thirds of all costs.

Real incomes can

rise as inflation slows, paving the way for further progress
toward stability.
To be sure, as the economy grows, some factors holding
down prices over the past year or two will dissipate or be
reversed.

But large new "price shocks" in the energy or food

areas appear unlikely in the foreseeable future, suggesting
that a declining trend in the rise of unit labor costs should
be the most fundamental factor defining the price trend.
That analysis would not hold, however, if excessive
growth in money and credit over time came again to feed first
the expectation, and then the reality, of renewed inflation.
Too much has been "invested" in turning the inflationary
momentum to lose sight of the necessity of carrying through.
There are clear implications, as I will elaborate in a moment,
for fiscal as well as monetary policy.

(2) Yes, exceptional demands for liquidity can reasonably
be accommodated in a period of recession, high unemployment, and excess capacity -- but guidelines for
restrained money and credit growth remain relevant to
insure against renewed inflation.
A variety of specific and general evidence strongly
suggests that the desire to hold cash and other highly liquid
assets, relative to income, has increased this year.

Much of

the more rapid increase in M1 has been in interest-bearing NOW
accounts, which did not exist a few years ago but which provide
the basic elements of a savings, as well as transaction, account.


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With market interest rates falling, those accounts have been
relatively more attractive on interest rate grounds alone, and
they are a convenient means of storing liquidity at a time of
economic and financial uncertainty.

At the same time, the

broader aggregates appear to reflect some of the same liquidity
motivations, as well as the stronger savings growth in the wake
of the tax cut.
Most broadly, we can now observe, over a period of more
than a year, a distinct decline in "velocity" -- that is, the
relationship between the GNP and monetary aggregates.

The

velocity decline for Ml, which is likely to amount to about
1982,
3% from the fourth quarter of 1981 to the fourth quarter of
stands in sharp contrast to the average yearly rise in velocity
of 3-4% over the past decade; it will be the first significant

%

-6

_

decline in velocity in about 30 years.

M2 and M3 velocities --

which had been relatively trendless earlier -- have also declined
significantly.

While some tendency toward slower velocity is

not unusual in the midst of recession, the magnitude and persistence of the movement in 1982 is indicative of a pronounced
tendency to hold more liquid assets relative to current income.
Without some accommodation of that preference, monetary policy
at the present time would be substantially more restraining in
its effect on the economy than intended when the targets for
the various aggregates were originally set out earlier this
year.
At the same time, policy must take into account the
probability that the demands for liquidity will, in whole or
in major part, prove temporary, and that an excessive rise in
money or other liquid assets could feed inflationary forces
later.

Elements of judgment are inevitably involved in sorting

out these considerations -- judgments resting on analysis of
the economy, interest rates, and other factors.

But broad

guidelines for assessing the appropriate growth on the basis
of historical experience will surely remain relevant and
appropriate.
In that connection, I must note the implications of the
future Federal budgetary position.

To put the point briefly,

the prospect of huge continuing budgetary deficits, even as the
economy recovers, carries with it the threat of either excessive
liquidity creation and inflation in future years, or a "crowdingout" of other borrowers as monetary growth is restrained in the


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r

%

•


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-7-

face of the Treasury financing needs, or a combination of both.
The problems flowing from the future deficits are simply not
amenable to solution by monetary policy.

Moreover, the concern

engendered in the marketplace works in the direction of higher
interest rates today than would otherwise be the case, contrary
to the needs of recovery.

I know something of how difficult it

is to achieve further budgetary savings, but I must emphasize
again how important it is to see the deficit reduced as the
economy recovers.

The fact is those looming deficits are a

major hazard in sustaining recovery.
(3) Yes, lower interest rates are critically important
in supporting the economy and encouraging recovery
but we also want to be able to maintain lower
interest rates over time.

Since early summer, short-term interest rates have
generally declined by five to six percentage points, and
mortgage and most other long-term rates have dropped by three
to four percentage points.

While consumer loan rates administered

by banks and other financial institutions have lagged, they are
also now moving lower.

There are clear signs of a rise in home

sales and building in response to these interest rate declines,
and other sectors of the economy are benefiting as well.
We have also had experience in recent years of sharp
increases in interest rates curtailing economic activity at
times when recovery was incomplete and unemployment high.
Sudden large fluctuations in interest rates contribute to

-8-

other economic and financial distortions as well.

And no

rically
doubt the fact that many interest rates remain histo
high, relative to the current rate of inflation, reflects
the
continuing skepticism over prospects for carrying through
fight on inflation.
In this situation, the Federal Reserve has welcomed
ort
the declines in interest rates both because of the supp
reflect
they offer economic activity and because they seem to
a sense that the inflationary trend has changed.

However, we

d
do not believe that progress toward lower interest rates shoul
of
or for long in practice can -- be "forced" at the expense
excessive credit and money creation.

To attempt to do so

ed
would simply risk the revival of inflationary forces; renew
longerexpectations of inflation would soon be reflected in the
lasting
term credit markets, damaging prospects for the longexpansion we all want.


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Turning to your explicit questions, Mr. Chairman,
y-making
against this general background, I believe most polic
that
officials in the Federal Reserve share the general view
at a
economic recovery will be evident throughout 1983, but
ous
moderate rate of speed -- probably slower than during previ
post-recession years.

Unambiguous evidence that the recovery

g signs
is already underway is still absent, although encouragin
dity
are evident in some rise in housing, in the improved liqui
and wealth and reduced debt positions of consumers, and in
lizing
surveys reporting that attitudes and orders may be stabi

••••

•

-9

or improving.

The Federal deficit, while fraught with danger

for the future, is of course providing massive support for
incomes at present.
What is crucially important -- particularly in the
light of the experience of recent years -- is that we set
the stage for an expansion that can be sustained over a long
period, bringing with it strong gains in productivity and
investment and lasting improvement in employment.

I have

already emphasized the importance of progress toward price
stability to that outlook, and the evidence that, with
disciplined monetary and fiscal policies, we can sustain
that progress.
So far as the specific questions about monetary policy
in your October 18 letter are concerned, we have not, as you
know, set any new monetary targets for 1982.

Current trends

do indicate that the various M's will end the year above the
upper end of the target ranges, probably by 1/2 to 1% for M2
and M3 and more for M1 given the current distortions.
credit will be close to the mid-point of its range.
indicated at the start, the "overshoots

Bank

As I

in the context of

today's economic and financial condons, are consistent with
the approach stated in my July testimony.
No decision has been taken to change the tentative
targets for 1983.

That matter will, of course, be under

intensive scrutiny over the next two months, and the targets
will be announced in February.


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-10-

For the time being, we are placing much less emphasis
than usual on Ml.

That decision was precipitated in early

October entirely by the likelihood that the data would be
grossly distorted in that month by the maturity of a large
volume of All-Savers Certificates, part of the proceeds of
which might be expected to, at least temporarily, be placed
in checking accounts included in Ml.
In about three weeks, the introduction of a new ceilingless account at financial institutions -- highly liquid and
carrying significant transaction capabilities -- is likely to
distort further M1 data.

Judging by comments at the last

Depository Institutions Deregulation Committee meeting, that
account could rapidly be followed by a decision to approve
a ceiling-less account with full transaction capabilities.
These new accounts could have a large, but quite unpredictable,
influence on M1 for a number of months ahead as funds are reallocated among various accounts.

Moreover, the introduction

of market-rate transaction accounts will very likely result
in a different relationship and trend of M1 relative to GNP
over time.

Increasing confidence in the stability of prices

and a trend toward lower market interest rates might also
affect the desire to hold money over time.
Obviously, some judgments on those matters will be
necessary in setting a target for M1 in 1983 and in deciding
upon the degree of weight to he attached to changes in M1 in
our operations.


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Those problems should appropriately be

-11--

described as "technical" rather than "policy" in the sense
that we will need to continue to be concerned with the rate
of growth over time of the monetary aggregates, including
transactions balances.
The decisions taken in early October do point to greater
emphasis on M2 (and M3) in planning the operational reserve
path during this transitional period.

The link between reserves

and M2 is looser and more uncertain than in the case of Ml, in
large part because reserve requirements on accounts included in
M2, apart from transactions balances, are very low or non-existent.
(Transactions balances are about 17 percent of M2.)

Therefore

once a reserve path is set, deviations of M2 from a targeted
growth range may not, more or less automatically, be reflected
in as substantial changes in pressures on bank reserve positions
or in money markets as is the case with Ml.

Consequently,

"discretionary" judgments may be necessary more frequently in
altering a reserve path than when that reserve path is focused
more heavily on Ml.

In that technical sense, the operational

approach has necessarily been modified.
In sum, the broad framework of monetary targeting has
been retained, but greater emphasis is for the time being
placed on the broader aggregates.

The specific operating

technique that had been closely related to M1 has, by force
of circumstances, been conformed to that emphasis.

Obviously,

entirely apart from questions of economic doctrine and contending approaches to monetary control, so long as M1 is


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-12-

subjected to strong institutional distortions our techniques
must be adapted to take account of that fact.
An alternative operating approach suggested by some
of supplying and withdrawing reserves with the intent of
achieving a particular interest rate target would suffer
from several fundamental defects.*
c

The body of theory or practice does not
provide a sufficiently clear basis for
relating the level of a particular interest
rate to our ultimate objectives of growth and
price stability.

o

The implication that the Federal Reserve could
in fact achieve and maintain a particular level
of relevant interest rates in a changing economic
and financial environment is not warranted.

o

The very concept and measurement of a "real"
interest rate, as called for in some proposals,
is a matter of substantial ambiguity.

o

As a practical matter, attempts to target and fix
C) interest
rates would make more rigid and tend to
politicize the entire process of monetary policy.

*That was not, as sometimes mistakenly thought, the operating
approach used prior to October 1979. Then, reserves were provided with the aim of achieving and maintaining a particular
Federal funds rate thought to be consistent with targets for the
monetary aggregates. The Federal funds rate was a means to
achieving a monetary target and in principle was tc be handled
flexibly. In practice, among other difficulties, there appeared
to be a reluctance to permit rates to vary rapidly enough to
maintain control of the aggregates.


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A

-13-

In current circumstances, with huge budget deficits
looming, a requirement that the Federal Reserve
set explicit interest rate targets is bound to be
interpreted as inflationary, and the rekindling of
inflationary expectations will work against our
objective.
I realize the several legislative proposals addressed
to targeting interest rates would, on their face, seem to call
for interest rates as only one of several targets.

But interest

rates would certainly be the most obvious and sensitive target,
and those targets would be difficult to change.

Other evidence

for a need to "tighten" or "ease" would be subordinated, if not
ignored.
As we approach the target-setting process for 1983,
our objectives will -- indeed as required by law -- continue
to be quantified in terms of growth in relevant money and
credit aggregates.

We will have to decide how much weight to

place on M1 and other aggregates during a transitional period,
assuming new accounts continue to distort the data.

In reaching

and implementing those decisions, the members of the FOMC
necessarily rely upon their own analysis of the current and
prospective course of business activity; the interrelationships
among the aggregates, economic activity, and interest rates; and
the implications of monetary growth for inflation.

In other words,

the process is not a simple mechanical one, and it seems to me
capable of incorporating -- within a general framework of monetary
discipline -- the elements of needed flexibility.

We will also,

II

as part of that process, review whether technical adjustments


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-14-

the reserve paths
in procedures for establishing and changing
are appropriate.

I will be reporting our conclusions to the

Congress in February.
monetary
Mr. Chairman, you have suggested that our
single number,
targets might reasonably be specified as a
with a range above and below.

At times we have debated

oach (or setting
within the FOMC the wisdom of such an appr
e).
forth a single target number without a rang


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My own feeling

with or without
has been, and remains, that a single number,
precision, with the
a range, would convey a specious sense of
less arbitrary
result of greater pressure to meet a more or
developments during
number to maintain "credibility," even if
flexibility is
the year tend to indicate some element of
appropriate in pursuit of the targets.
h a range
To me, our present practice of setting fort
is preferable.

est
Where appropriate, we can and should sugg

r portion of
the probability of being in the upper or lowe
evolve in which
the range, or suggest what conditions could
an over or undersomething other than the mid-points (or even
shoot) would be appropriate.

That approach seems to me to

-- than a single
provide more information -- and more realism
.
number and is broadly consistent with present practice
ure
For similar reasons, I believe we need to meas
and target a variety of aggregates because, in a swiftly
misleading
changing economic environment, any single target can be
of total credit
In that connection, I believe an indication
could be
flows broadly consistent with the monetary targets
helpful.

bank
As you know, we now provide such estimates for

credit alone.

-15-

Given the limits of forecasting and analysis, and the
volatility of the data, I would question the usefulness of
further sectoral estimates.

Even with respect to total credit

flows, there is considerable looseness in relationships to
economic activity for periods as long as a year

and still

The theoretical framework relating

more for shorter periods.

credit flows to other variables such as the GNP or inflation
is less fully developed than in the case of monetary aggregates,
and credit flows are less directly amenable to control.

The

enormous flows across international borders pose large conceptual and statistical problems.

Our credit data are typically

less complete and up-to-date than monetary data.
However, so long as those difficulties and limitations
are recognized -- and some of them are relevant with respect
to the monetary aggregates as well -- I share the view that
analysis of credit flows can contribute to policy formulation.
To assist in that process, Iwill propose to the FOMC that
estimates of the expected behavior of a broad credit aggregate
be set forth alongside the monetary targets in our next report.
I do strongly resist the idea of the Federal Reserve as
an institution forecasting interest rates.

No institution or

individual is capable of judging accurately the myriad of
forces working on market interest rates over time.

Expeatational

elements play a strong role -- fundamentally expectations about
the course of economic activity and inflation, but also, in the
short run, expectations of Federal Reserve action.


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I

We could not

•

-16-

escape the fact that a central bank forecast of interest rates
would be itself a market factor.

To some degree, therefore,

in looking to interest rates and other market developments for
information bearing on our policy decisions, we would be looking
into a mirror.

Moreover, the temptation would always be present

to breech the thin line between a forecast and a desire or policy
intention, with the result that operational policy decisions
could be distorted.
While it seems to me inappropriate for a central bank
to regularly forecast interest rates, analysis of key factors
influencing credit conditions and prices can be helpful at
times.
past.

On occasion, we have provided such analysis in the
My concern about the outlook for fiscal policy is rooted

in major part in such analysis because the direction of impact
on interest rates seems to me unambiguous.

I have also, on a

number of occasions, indicated that the recent and even current
level of interest rates appears extraordinarily high, provided,
as I believe, we continue to make progress on the inflation
front.

Perhaps, in our semi-annual reporting, we can more

explicitly call attention to major factors likely to influence
short or long-term interest rates and the significance for
various sectors of the economy.

But I do not believe interest

rate forecasting would be desirable or long sustainable, and
would in fact be damaging to the policy process.


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-17-

Finally, Mr. Chairman, you have requested a "single
composite forecast" of the major economic variables by FOMC
members.

As you are well aware, our present practice is to

set forth a range of forecasts of individual FOMC members of
the nominal and real GNP, prices, and unemployment.

The fact

is
is we have no single "Federal Reserve" forecast, and there
force
no mechanism, within a Committee or Board structure, to
agreement on such a forecast by individual members bringing
different views, typically backed by separate staff analysis,
to the table.

A simple average -- possibly supported by no

one -- seems to me artificial.

The process of attempting to

force a consensus would certainly dilute the product.
I would put the point positively.

A range of forecasts

by individual FOMC members more accurately conveys the range
of uncertainty and contingencies that must surround any forecast.

The seeming neatness and coherence of a single forecast

too often obscures the reality that a variety of outcomes is
s
possible; the very essence of the policy problem is to asses
risks and probabilities -- what can go wrong as well as what
can go right.

A point forecast would likely be treated more

y
reverently than it would deserve, and could even distort polic
judgments in misguided efforts to "hit" a forecast.
I can understand your concern that a range of forecasts
ons
may be misleading if strongly influenced by "outlying" opini
rather than reflecting a more even dispersion of views.

For

t
that reason, I would be glad to explore with the Open Marke


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-18-

Committee a procedure by which we indicated the "central
tendency" of members' views -- assuming such a central
tendency exists -- as well as indicating the range of
opinions.

Conversely, if the forecasts were evenly

distributed within the range, we could so indicate.
believe that approach would meet the Jbjectives you seek in
a realistic and helpful manner.
In concluding this already long testimony, let me say
that we share the common goals of achieving, in the words of
the Employment Act of 1946 and the Humphrey Hawkins Act of
1978, "Maximum employment, production, and purchasing power"
and "full employment . . . (and) reasonable price stability."
Those objectives have eluded us for too many years.

We meet

again today in particularly difficult circumstances, and there
is a sense of frustration and uncertainty among many.
But I also happen to believe we have come a long way
toward laying the base for economic growth and stability;
economic recovery should characterize 1983, and that recovery
can mark the beginning of a long period of stable growth.
Obviously there are obstacles -- interest rates are
still too high; inflation is down but not out; there are
strains in our financial system; we face budget deficits that
are far too high; we are tempted to turn inwards or backwards
for quick solutions that ultimately can not work.

But it is

also plainly within our capacity to deal with those threats
provided only that we have a strong base of understanding among


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Federal Reserve Bank of St. Louis

-19-

us, that we resolve to act where action is necessary, and
that we have the patience and wisdom to refrain from actions
that can only be destructive.
You are leaving the Congress after 28 years, Mr. Chairman.
Through that time, you have consistently provided constructive
leadership to the effort to raise the level of economic discussion in general -- and of the dialogue between the Congress
and the Federal Reserve in particular.

I happen to believe

strongly in the independence that the Congress has provided
the Federal Reserve through the years -- but also in the need
for close and continuing communication with the Congress and
the Administration.

I presume that this is the last time I

will appear before you personally in this forum, but the
dialogue will continue to benefit from your efforts, your
initiative, and your sense of commitment in more ways than
you may realize.

_


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Federal Reserve Bank of St. Louis

For release on delivery
10:00 A.M., E.S.T.
November 24, 1982

Statement by

Paul A. Volcker
Chairman, Board of Governors of the Federal Reserve System

before the

Joint Economic Committee

November 24, 1982

4

I appreciate this opportunity to discuss with you
today the current stance of monetary policy and some problems
for the future.

Before responding to certain questions directed

to me about monetary policy in your letters of October 18 and
November 17, Mr. Chairman, I should first emphasize that the
basic thrust and goals of our policy are unchanged since I
testified before the Congress on July 20.

The precise means

by which we move toward our goals must take account of all the
stream of evidence we have on the behavior of (and distortions
in) the various monetary aggregates, the economy, prices, intere
st
rates, and the like.

But we remain convinced that lasting recovery

and growth must be sought in a framework of continuing progress
toward price stability -- and that the process of money and credit
creation must remain appropriately restrained if we are to deal
effectively with inflationary dangers.
For that reason, we must continue to set forth targets
for growth in money and credit and to judge the provision of
bank reserves

our most important operating instrument -- in

the light of the trend in the growth of these aggregates.
This process necessarily involves continuing judgments about
just what growth in those magnitudes is appropriate in the
short and longer run, matters affected by institutional change
as well as by more fundamental economic factors.


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IL

-2-

As you are aware, the current job of developing and
implementing monetary policy has been complicated by regulatory
decisions as well as by recent developments in the economy and
in our financial markets.

We have, as a consequence, (1) made

some technical modification in our operating procedures to cope
with obvious distortions in some of the monetary data -- particularly M1 -- and (2) accommodated growth in the various M's at
rates somewhat above the targeted ranges.
decisions was essentially technical.

The first of those

The latter decision is

entirely consistent with the view I expressed in testifying
before the Banking Committees in July that the Federal Open
Market Committee would tolerate "growth somewhat above the
targeted ranges .

. for a time in circumstances in which it

appeared that precautionary or liquidity motivations, during a
period of economic uncertainty and turbulence, were leading to
stronger than anticipated demands for money."
Unfortunately, the difficulties and complexities of the
economic world in which we live do not permit us the luxury of
describing policy in terms of a simple, unchanging numerical
rule.

For instance, the economic significance of any particular

statistic we label "money" can change over time -- partly because
the statistical definition of "money" is itself arbitrary and
the components of the money supply have differing degrees of
use as a medium of exchange and liquidity.

That doesn't make

much difference in a relatively stable economic, financial, and
institutional environment, but, at times of rapid change, like
the present, it can matter a great deal.


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‘.


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Federal Reserve Bank of St. Louis

-3 _

varying lags -- never
We also have to take account of
ons today and their conti
ac
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ee
tw
be
-n
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And we
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ial structure itself.
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-lf
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Perhaps the essence of the
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inflationary momentum
(1) Yes, we have broken the
effort will be essential
d
an
e
nc
la
gi
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ng
ui
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price stability.
to continue progress toward
dices this year have been
in
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,
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kn
As you
peak levels reached two or
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th
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ted.
ges as inflation has modera
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icular sectors of the econom
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pm
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ve
de
te
ra
ge
an
ch
ex
and

I

N


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-4

_

dities.
recession on some prices -- most particularly commo
believe that
But there is, it seems to me, strong reason to
-- dlbeit
the progress toward price stability can be maintained
at a slower rate -- as the economy recovers.

For a time, un-

and prices
employment and excess capacity should restrain costs
h should
and, of more lasting significance, productivity growt
.
improve from the poor performance of most recent years

Taken

ctivity
together, restraint on nominal wage increases and produ
which
growth should moderate the increase in unit labor costs,
account for about two-thirds of all costs.

Real incomes can

ess
rise as inflation slows, paving the way for further progr
toward stability.
To be sure, as the economy grows, some factors holding
down prices over the past year or two will dissipate or be
reversed.

But large new "price shocks" in the energy or food

areas appear unlikely in the foreseeable future, suggesting
d
that a declining trend in the rise of unit labor costs shoul
be the most fundamental factor defining the price trend.
That analysis would not hold, however, if excessive
growth in money and credit over time came again to feed first
n.
the expectation, and then the reality, of renewed inflatio
Too much has been "invested" in turning the inflationary
momentum to lose sight of the necessity of carrying through.
There are clear implications, as I will elaborate in a moment,
for fiscal as well as monetary policy.

\


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Federal Reserve Bank of St. Louis

_

5-

(2) Yes, exceptional demands for liquidity can reasonably
be accommodated in a period of recession, high unemployment, and excess capacity -- but guidelines for
restrained money and credit growth remain relevant to
insure against renewed inflation.
A variety of specific and general evidence strongly
suggests that the desire to hold cash and other highly liquid
assets, relative to income, has increased this year.

Much of

the more rapid increase in M1 has been in interest-bearing NOW
accounts, which did not exist a few years ago but which provide
the basic elements of a savings, as well as transaction, account.
With market interest rates falling, those accounts have been
relatively more attractive on interest rate grounds alone, and
they are a convenient means of storing liquidity at a time of
economic and financial uncertainty.

At the same time, the

broader aggregates appear to reflect some of the same liquidity
motivations, as well as the stronger savings growth in the wake
of the tax cut.
Most broadly, we can now observe, over a period of more
than a year, a distinct decline in "velocity" -- that is, the
relationship between the GNP and monetary aggregates.

The

velocity decline for Ml, which is likely to amount to about
1982,
3% from the fourth quarter of 1981 to the fourth quarter of
stands in sharp contrast to the average yearly rise in velocity
of 3-4% over the past decade; it will be the first significant

r

a

-6

decline in velocity in about 30 years.

M2 and M3 velocities --

which had been relatively trendless earlier -- have also declined
significantly.

While some tendency toward slower velocity is

not unusual in the midst of recession, the magnitude and persistence of the movement in 1982 is indicative of a pronounced
tendency to hold more liquid assets relative to current income.
Without some accommodation of that preference, monetary policy
at the present time would be substantially more restraining in
its effect on the economy than intended when the targets for
the various aggregates were originally set out earlier this
year.
At the same time, policy must take into account the
probability that the demands for liquidity will, in whole or
in major part, prove temporary, and that an excessive rise in
money or other liquid assets could feed inflationary forces
later.

Elements of judgment are inevitably involved in sorting

out these considerations

judgments resting on analysis of

the economy, interest rates, and other factors.

But broad

guidelines for assessing the appropriate growth on the basis
of historical experience will surely remain relevant and
appropriate.
In that connection, I must note the implications of the
future Federal budgetary position.

To put the point briefly,

the prospect of huge continuing budgetary deficits, even as the
economy recovers, carries with it the threat of either excessive
liquidity creation and inflation in future years, or a "crowdingout" of other borrowers as monetary growth is restrained in the


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•


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7-

face of the Treasury financing needs, or a combination of both.
The problems flowing from the future deficits are simply not
amenable to solution by monetary policy.

Moreover, the concern

engendered in the marketplace works in the direction of higher
interest rates today than would otherwise be the case, contrary
to the needs of recovery.

I know something of how difficult it

is to achieve further budgetary savings, but I must emphasize
again how important it is to see the deficit reduced as the
economy recovers.

The fact is those looming deficits are a

major hazard in sustaining recovery.
(3) Yes, lower interest rates are critically important
in supporting the economy and encouraging recovery

1=111

but we also want to be able to maintain lower
interest rates over time.

Since early summer, short-term interest rates have
generally declined by five to six percentage points, and
mortgage and most other long-term rates have dropped by three
to four percentage points.

While consumer loan rates administered

by banks and other financial institutions have lagged, they are
also now moving lower.

There are clear signs of a rise in home

sales and building in response to these interest rate declines,
and other sectors of the economy are benefiting as well.
We have also had experience in recent years of sharp
increases in interest rates curtailing economic activity at
times when recovery was incomplete and unemployment high.
Sudden large fluctuations in interest rates contribute t5

8-

.
other economic and financial distortions as well

And no

historically
doubt the fact that many interest rates remain
ects
high, relative to the current rate of inflation, refl
through the
continuing skepticism over prospects for carrying
fight on inflation.
In this situation, the Federal Reserve has welcomed
support
the declines in interest rates both because of the
to reflect
they offer economic activity and because they seem
a sense that the inflationary trend has changed.

However, we

s should
do not believe that progress toward lower interest rate

•••••

expense of
or for long in practice can -- be "forced" at the
excessive credit and money creation.

To attempt to do so

renewed
would simply risk the revival of inflationary forces;
in the longerexpectations of inflation would soon be reflected
long-lasting
term credit markets, damaging prospects for the
expansion we all want.
Turning to your explicit questions, Mr. Chairman,
policy-making
against this general background, I believe most
ral view that
officials in the Federal Reserve share the gene


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, but at a
economic recovery will be evident throughout 1983
moderate rate of speed
post-recession years.

probably slower than during previous
Unambiguous evidence that the recovery

uraging signs
is already underway is still absent, although enco
liquidity
are evident in some rise in housing, in the improved
and in
and wealth and reduced debt positions of consumers,
be stabilizing
surveys reporting that attitudes and orders may

••• P I
•
woo

1

-9

or improving.

-

The Federal deficit, while fraught with danger

for the future, is of course providing massive support for
incomes at present.
What is crucially important -- particularly in the
light of the experience of recent years -- is that we set
the stage for an expansion that can be sustained over a long
period, bringing with it strong gains in productivity and
investment and lasting improvement in employment.

I have

already emphasized the importance of progress toward price
stability to that outlook, and the evidence that, with
disciplined monetary and fiscal policies, we can sustain
that progress.
So far as the specific questions about monetary policy
in your October 18 letter are concerned, we have not, as you
know, set any new monetary targets for 1982.

Current trends

do indicate that the various M's will end the year above the
upper end of the target ranges, probablyto 1% for M2
and M3 and more for M1 given the current distortions.
credit will be close to the mid-point of its range.

Bank

As I

indicated at the start, the "overshoots," in the context of
today's economic and financial condons, are consistent with
the approach stated in my July testimony.
No deon has been taken to change the tentative
targets for 1983.

That matter will, of course, be under

intensive scrutiny over the next two months, and the targets
will be announced in February.


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1

•

-10-

For the time being, we are placing much less emphasis
than usual on Ml.

That decision was precipitated in early

October entirely by the likelihood that the data would be
grossly distorted in that month by the maturity of a large
volume of All-Savers Certificates, part of the proceeds of
which might be expected to, at least temporarily, be placed
in checking accounts included in Ml.
In about three weeks, the introduction of a new ceilingless account at financial institutions -- highly liquid and
carrying significant transaction capabilities -- is likely to
distort further M1 data.

Judging by comments at the last

Depository Institutions Deregulation Committee meeting, that
account could rapidly be followed by a decision to approve
a ceiling-less account with full transaction capabilities.
These new accounts could have a large, but quite unpredictable,
influence on M1 for a number of months ahead as funds are reallocated among various accounts.

Moreover, the introduction

of market-rate transaction accounts will very likely result
in a different relationship and trend of M1 relative to GNP
over time.

Increasing confidence in the stability of prices

and a trend toward lower market interest rates might also
affect the desire to hold money over time.
Obviously, some judgments on those matters will be
necessary in setting a target for M1 in 1983 and in deciding
upon the degree of weight to be attached to changes in M1 in
our operations.


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Those problems should appropriately be

-11-

described as "technical" rather than "policy" in the sense
that we will need to continue to be concerned with the rate
of growth over time of the monetary aggregates, including
transactions balances.
The decisions taken in early October do point to greater
emphasis on M2 (and M3) in planning the operational reserve
path during this transitional period.

The link between reserves

and M2 is looser and more uncertain than in the case of Ml, in
large part because reserve requirements on accounts included in
M2, apart from transactions balances, are very low or non-existent
(Transactions balances are about 17 percent of M2.)

Therefore

once a reserve path is set, deviations of M2 from a targeted
growth range may not, more or less automatically, be reflected
in as substantial changes in pressures on bank reserve positions
or in money markets as is the case with Ml.

Consequently,

"discretionary" judgments may be necessary more frequently in
altering a reserve path than when that reserve path is focused
more heavily on Ml.

In that technical sense, the operational

approach has necessarily been modified.
In sum, the broad framework of monetary targeting has
been retained, but greater emphasis is for the time being
placed on the broader aggregates.

The specific operating

technique that had been closely related to M1 has, by force
of circumstances, been conformed to that emphasis.

Obviously,

entirely apart from questions of economic doctrine and contending approaches to monetary control, so long as M1 is


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-12--

subjected to strong institutional distortions our techniques
must be adapted to take account of that fact.
An alternative operating approach suggested by some
of supplying and withdrawing reserves with the intent of
achieving a particular interest rate target would suffer
from several fundamental defects.*
•

The body of theory or practice does not
provide a sufficiently clear basis for
relating the level of a particular interest
rate to our ultimate objectives of growth and
price stability.

o

The implication that the Federal Reserve could
in fact achieve and maintain a particular level
of relevant interest rates in a changing economic
and financial environment is not warranted.

o

The very concept and measurement of a "real"
interest rate, as called for in some proposals,
is a matter of substantial ambiguity.

o

As a practical matter, attempts to target and fix

0 interest
rates would make more rigid and tend to
politicize the entire process of monetary policy.

*That was not, as sometimes mistakenly thought, the operating
approach used prior to October 1979. Then, reserves were provided with the aim of achieving and maintaining a particular
Federal funds rate thought to be consistent with targets for the
monetary aggregates. The Federal funds rate was a means to
achieving a monetary target and in principle was tc be handled
flexibly. In practice, among other difficulties, there appeared
to be a reluctance to permit rates to vary rapidly enough to
maintain control of the aggregates.


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-13-

o

In current circumstances, with huge budget deficits
looming, a requirement that the Federal Reserve
set explicit interest rate targets is bound to be
interpreted as inflationary, and the rekindling of
inflationary expectations will work against our
objective.

I realize the several legislative proposals addressed
to targeting interest rates would, on their face, seem to call
for interest rates as only one of several targets.

But interest

rates would certainly be the most obvious and sensitive target,
and those targets would be difficult to change.

Other evidence

for a need to "tighten" or "ease" would be subordinated, if not
ignored.
As we approach the target-setting process for 1983,
our objectives will -- indeed as required by law -- continue
to be quantified in terms of growth in relevant money and
credit aggregates.

We will have to decide how much weight to

place on M1 and other aggregates during a transitional period,
assuming new accounts continue to distort the data.

In reaching

and implementing those decisions, the members of the FOMC
necessarily rely upon their own analysis of the current and
prospective course of business activity; the interrelationships
among the aggregates, economic activity, and interest rates; and
the implications of monetary growth for inflation.

In other words,

the process is not a simple mechanical one, and it seems to me
capable of incorporating -- within a general framework of monetary
discipline -- the elements of needed flexibility.

We will also,

'I

as part of that process, review whether technical adjustments


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-14-

ve paths
in procedures for establishing and changing the reser
are appropriate.

I will be reporting our conclusions to the

Congress in February.
Mr. Chairman, you have suggested that our monetary
er,
targets might reasonably be specified as a single numb
with a range above and below.

At times we have debated

ng
within the FOMC the wisdom of such an approach (or setti
forth a single target number without a range).


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My own feeling

without
has been, and remains, that a single number, with or
the
a range, would convey a specious sense of precision, with
arbitrary
result of greater pressure to meet a more or less
ts during
number to maintain "credibility," even if developmen
y is
the year tend to indicate some element of flexibilit
appropriate in pursuit of the targets.
To me, our present practice of setting forth a range
is preferable.

Where appropriate, we can and should suggest

the probability of being in the upper or lower portion of
the range, or suggest what conditions could evolve in which
undersomething other than the mid-points (or even an over or
shoot) would be appropriate.

That approach seems to me to

single
provide more information -- and more realism -- than a
number and is broadly consistent with present practice.
For similar reasons, I believe we need to measure
and target a variety of aggregates because, in a swiftly
changing economic environment, any single target can be misleading
In that connection, I believe an indication of total credit
flows broadly consistent with the monetary targets could be
helpful.

As you know, we now provide such estimates for bank

credit alone.

a

-15-

Given the limits of forecasting and analysis, and the
volatility of the data, I would question the usefulness of
further sectoral estimates.

Even with respect to total credit

flows, there is considerable looseness in relationships to
economic activity for periods as long as a year
more for shorter periods.

and still

The theoretical framework relating

credit flows to other variables such as the GNP or inflation
is less fully developed than in the case of monetary aggregates,
and credit flows are less directly amenable to control.

The

enormous flows across international borders pose large conceptual and statistical problems.

Our credit data are typically

less complete and up-to-date than monetary data.
However, so long as those difficulties and limitations
are recognized -- and some of them are relevant with respect
to the monetary aggregates as well -- I share the view that
analysis of credit flows can contribute to policy formulation.
To assist in that process, Iwill propose to the FOMC that
estimates of the expected behavior of a broad credit aggregate
be set forth alongside the monetary targets in our next report.
I do strongly resist the idea of the Federal Reserve as
an institution forecasting interest rates.

No institution or

individual is capable of judging accurately the myriad of
forces working on market interest rates over time.

Expeatational

elements play a strong role -- fundamentally expectations about
the course of economic activity and inflation, but also, in the
short run, expectations of Federal Reserve action.


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We could not

%

-16-

escape the fact that a central bank forecast of interest rates
would be itself a market factor.

To some degree, therefore,

in looking to interest rates and other market developments for
information bearing on our policy decisions, we would be looking
into a mirror.

Moreover, the temptation would always be present

to breech the thin line between a forecast and a desire or policy
intention, with the result that operational policy decisions
could be distorted.
While it seems to me inappropriate for a central bank
to regularly forecast interest rates, analysis of key factors
influencing credit conditions and prices can be helpful at
times.
past.

On occasion, we have provided such analysis in the
My concern about the outlook for fiscal policy is rooted

in major part in such analysis because the direction of impact
on interest rates seems to me unambiguous.

I have also, on a

number of occasions, indicated that the recent and even current
level of interest rates appears extraordinarily high, provided,
as I believe, we continue to make progress on the inflation
front.

Perhaps, in our semi-annual reporting, we can more

explicitly call attention to major factors likely to influence
short or long-term interest rates and the significance fur
various sectors of the economy.

But I do not believe interest

rate forecasting would be desirable or long sustainable, and
would in fact be damaging to the policy process.


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%

4

-17-

Finally, Mr. Chairman, you have requested a "single
composite forecast" of the major economic variables by FOMC
members.

As you are well aware, our present practice is to

set forth a range of forecasts of individual FOMC members of
the nominal and real GNP, prices, and unemployment.

The fact

is we have no single "Federal Reserve" forecast, and there is
no mechanism, within a Committee or Board structure, to force
agreement on such a forecast by individual members bringing
different views, typically backed by separate staff analysis,
to the table.

A simple average -- possibly supported by no

one -- seems to me artificial.

The process of attempting to

force a consensus would certainly dilute the product.
I would put the point positively.

A range of forecasts

by individual FOMC members more accurately conveys the range
foreof uncertainty and contingencies that must surround any
cast.

The seeming neatness and coherence of a single forecast

is
too often obscures the reality that a variety of outcomes
s
possible; the very essence of the policy problem is to asses
risks and probabilities -- what can go wrong as well as what
can go right.

A point forecast would likely be treated more

policy
reverently than it would deserve, and could even distort
judgments in misguided efforts to "hit" a forecast.
I can understand your concern that a range of forecasts
ons
may be misleading if strongly influenced by "outlying" opini
.
rather than reflecting a more even dispersion of views

For

Market
that reason, I would be glad to explore with the Open


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0

-18-

Committee a procedure by which we indicated the "central
tendency" of members' views -- assuming such a central
tendency exists -- as well as indicating the range of
opinions.

Conversely, if the forecasts were evenly

distributed within the range, we could so indicate.
believe that approach would meet the Jbjectives you seek in
a realistic and helpful manner.
In concluding this already long testimony, let me say
that we share the common goals of achieving, in the words of
the Employment Act of 1946 and the Humphrey Hawkins Act of
1978, "Maximum employment, production, and purchasing power"
and "full employment . . . (and) reasonable price stability."
Those objectives have eluded us for too many years.

We meet

again today in particularly difficult circumstances, and there
is a sense of frustration and uncertainty among many.
But I also happen to believe we have come a long way
toward laying the base for economic growth and stability;
economic recovery should characterize 1983, and that recovery
can mark the beginning of a long period of stable growth.
Obviously there are obstacles -- interest rates are
still too high; inflation is down but not out; there are
strains in our financial system; we face budget deficits that
are far too high; we are tempted to turn inwards or backwards
for quick solutions that ultimately can not work.

But it is

also plainly wn our capacity to deal with those threats -provided only that we have a strong base of understanding among


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•••••••


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Federal Reserve Bank of St. Louis

-19--

us, that we resolve to act where action is necessary, and
that we have the patience and wisdom to refrain from actions
that can only be destructive.
You are leaving the Congress after 28 years, Mr. Chairman
Through that time, you have consistently provided constructive
leadership to the effort to raise the level of economic discussion in general -- and of the dialogue between the Congress
and the Federal Reserve in particular.

I happen to believe

strongly in the independence that the Congress has provided
the Federal Reserve through the years -- but also in the need
for close and continuing communication with the Congress and
the Administration.

I presume that this is the last time I

will appear before you personally in this forum, but the
dialogue will continue to benefit from your efforts, your
initiative, and your sense of commitment in more ways than
you may realize.


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Federal Reserve Bank of St. Louis

For release on delivery
10:00 A.M., E.S.T.
November 24, 1982

Statement by

Paul A. Volcker
Chairman, Board of Governors of the Federal Reserve System

before the

Joint Economic Committee

November 24, 1982

I appreciate this opportunity to discuss with you
today the current stance of monetary policy and some problems
for the future.

Before responding to certain questions directed

to me about monetary policy in your letters of October 18 and
November 17, Mr. Chairman, I should first emphasize that the
basic thrust and goals of our policy are unchanged since I
testified before the Congress on July 20.

The precise means

by which we move toward our goals must take account of all the
stream of evidence we have on the behavior of (and distortions
in) the various monetary aggregates, the economy, prices, interest
rates, and the like.

But we remain convinced that lasting recovery

and growth must be sought in a framework of continuing progress
toward price stability -- and that the process of money and credit
creation must remain appropriately restrained if we are to deal
effectively with inflationary dangers.
For that reason, we must continue to set forth targets
for growth in money and credit and to judge the provision of
bank reserves

our most important operating instrument -- in

the light of the trend in the growth of these aggregates.
This process necessarily involves continuing judgments about
just what growth in those magnitudes is appropriate in the
short and longer run, matters affected by institutional change
as well as by more fundamental economic factors.


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Federal Reserve Bank of St. Louis

2-

•

As you are aware, the current job of developing and
implementing monetary policy has been complicated by regulatory
decisions as well as by recent developments in the economy and
in our financial markets.

We have, as a consequence, (1) made

some technical modification in our operating procedures to cope
with obvious distortions in some of the monetary data -- particularly MI -- and (2) accommodated growth in the various M's at
rates somewhat above the targeted ranges.
decisions was essentially technical.

The first of those

The latter decision is

entirely consistent with the view I expressed in testifying
before the Banking Committees in July that the Federal Open
Market Committee would tolerate "growth somewhat above the
targeted ranges .

. for a time in circumstances in which it

appeared that precautionary or liquidity motivations, during a
period of economic uncertainty and turbulence, were leading to
stronger than anticipated demands for money."
Unfortunately, the difficulties and complexities of the
economic world in which we live do not permit us the luxury of
describing policy in terms of a simple, unchanging numerical
rule.

For instance, the economic significance of any particular

statistic we label "money" can change over time -- partly because
the statistical definition of "money" is itself arbitrary and
the components of the money supply have differing degrees of
use as a medium of exchange and liquidity.

That doesn't make

much difference in a relatively stable economic, financial, and
institutional environment, but, at times of rapid change, like
the present, it can matter a great deal.


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•


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Federal Reserve Bank of St. Louis

r
t of varying lags -- neve
un
co
ac
ke
ta
to
ve
ha
so
al
We
conactions today and their
n
ee
tw
be
-n
io
is
ec
pr
th
known wi
orary
y to disentangle the temp
tr
to
ve
ha
We
r.
te
la
s
sequence
among
trends in relationships
nt
te
is
rs
pe
re
mo
om
fr
al
ic
and cycl
d economic activity.
an
n
io
at
fl
in
d
an
y
ne
mo
different measures of
developments abroad
of
ce
an
ic
if
gn
si
e
th
te
And we have to evalua
counts and the exchange
ac
e
ad
tr
in
d
te
ec
fl
re
as well as at home, as
ncial structure itself.
na
fi
e
th
in
s
in
ra
st
of
d
rate, an
ich we
onomic environment in wh
ec
e
th
,
ts
es
gg
su
is
th
As
a
cannot be condensed into
lf
se
it
cy
li
po
or
-set policy
the
t. Perhaps the essence of
en
em
at
st
l
na
io
ns
me
di
esimple, on
estter captured by a few "y
be
be
n
ca
ch
oa
pr
ap
r
ou
d
problem an
but" phrases.
e inflationary momentum
th
en
ok
br
ve
ha
we
s,
Ye
(1)
ial
and effort will be essent
e
nc
la
gi
vi
ng
ui
in
nt
co
t
bu
ward price stability.
to
ss
re
og
pr
ue
in
nt
co
to
en
indices this year have be
e
ic
pr
d
oa
br
e
th
,
ow
kn
As you
o or
e peak levels reached tw
th
of
ss
le
or
lf
ha
t
ou
running at ab
growth
sinflationary process,
di
is
th
of
rt
pa
As
o.
three years ag
e 6 to
terms has declined to th
l
na
mi
no
in
on
ti
sa
en
mp
in worker co
has
growth in nominal income
er
ow
sl
at
th
t
bu
-ea
7 percent ar
rated.
s as inflation has mode
ge
wa
al
re
er
gh
hi
th
wi
been consistent
omy
ular sectors of the econ
ic
rt
pa
in
ds
en
tr
st
co
Price and
the process of disin
gs
la
rt
pa
in
ng
ti
ec
are mixed -- refl
ional
wage contracts, internat
ng
lo
of
s
ct
fe
ef
e
th
inflation,
mediate effects of
im
e
th
d
an
,
ts
en
pm
lo
ve
and exchange rate de


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Federal Reserve Bank of St. Louis

4-

s.
recession on some prices -- most particularly commoditie
that
But there is, it seems to me, strong reason to believe
-- albeit
the progress toward price stability can be maintained
at a slower rate -- as the economy recovers.

For a time, un-

and prices
employment and excess capacity should restrain costs
d
and, of more lasting significance, productivity growth shoul
improve from the poor performance of most recent years.

Taken

together, restraint on nominal wage increases and productivity
growth should moderate the increase in unit labor costs, which
account for about two-thirds of all costs.

Real incomes can

rise as inflation slows, paving the way for further progress
toward stability.
To be sure, as the economy grows, some factors holding
down prices over the past year or two will dissipate or be
reversed.

But large new "price shocks" in the energy or food

areas appear unlikely in the foreseeable future, suggesting
that a declining trend in the rise of unit labor costs should
be the most fundamental factor defining the price trend.
That analysis would not hold, however, if excessive
growth in money and credit over time came again to feed first
the expectation, and then the reality, of renewed inflation.
Too much has been "invested" in turning the inflationary
momentum to lose sight of the necessity of carrying through.
There are clear implications, as I will elaborate in a moment,
for fiscal as well as monetary policy.

5

(2) Yes, exceptional demands for liquidity can reasonably
be accommodated in a period of recession, high unemployment, and excess capacity -- but guidelines for
restrained money and credit growth remain relevant to
insure against renewed inflation.
A variety of specific and general evidence strongly
suggests that the desire to hold cash and other highly liquid
assets, relative to income, has increased this year.

Much of

the more rapid increase in M1 has been in interest-bearing NOW
accounts, which did not exist a few years ago but which provide
the basic elements of a savings, as well as transaction, account.


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With market interest rates falling, those accounts have been
relatively more attractive on interest rate grounds alone, and
they are a convenient means of storing liquidity at a time of
economic and financial uncertainty.

At the same time, the

broader aggregates appear to reflect some of the same liquidity
wake
motivations, as well as the stronger savings growth in the
of the tax cut.
Most broadly, we can now observe, over a period of more
than a year, a distinct decline in "velocity" -- that is, the
relationship between the GNP and monetary aggregates.

The

velocity decline for Ml, which is likely to amount to about
of 1982,
3% from the fourth quarter of 1981 to the fourth quarter
stands in sharp contrast to the average yearly rise in velocity
of 3-4% over the past decade; it will be the first significant

6-

decline in velocity in about 30 years.

M2 and M3 velocities --

which had been relatively trendless earlier -- have also declined
significantly.

While some tendency toward slower velocity is

not unusual in the midst of recession, the magnitude and persistence of the movement in 1982 is indicative of a pronounced
tendency to hold more liquid assets relative to current income.
Without some accommodation of that preference, monetary policy
at the present time would be substantially more restraining in
its effect on the economy than intended when the targets for
the various aggregates were originally set out earlier this
year.
At the same time, policy must take into account the
probability that the demands for liquidity will, in whole or
in major part, prove temporary, and that an excessive rise in
money or other liquid assets could feed inflationary forces
later.

Elements of judgment are inevitably involved in sorting

out these considerations -- judgments resting on analysis of
the economy, interest rates, and other factors.

But broad

guidelines for assessing the appropriate growth on the basis
of historical experience will surely remain relevant and
appropriate.
In that connection, I must note the implications of the
future Federal budgetary position.

To put the point briefly,

the prospect of huge continuing budgetary deficits, even as the
economy recovers, carries with it the threat of either excessive
liquidity creation and inflation in future years, or a "crowdingout" of other borrowers as monetary growth is restrained in the


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•


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Federal Reserve Bank of St. Louis

7

face of the Treasury financing needs, or a combination of both.
The problems flowing from the future deficits are simply not
amenable to solution by monetary policy.

Moreover, the concern

engendered in the marketplace works in the direction of higher
interest rates today than would otherwise be the case, contrary
to the needs of recovery.

I know something of how difficult it

is to achieve further budgetary savings, but I must emphasize
again how important it is to see the deficit reduced as the
economy recovers.

The fact is those looming deficits are a

major hazard in sustaining recovery.
(3) Yes, lower interest rates are critically important
in supporting the economy and encouraging recovery
but we also want to be able to maintain lower
interest rates over time.

Since early summer, short-term interest rates have
generally declined by five to six percentage points, and
mortgage and most other long-term rates have dropped by three
to four percentage points.

While consumer loan rates administered

by banks and other financial institutions have lagged, they are
also now moving lower.

There are clear signs of a rise in home

sales and building in response to these interest rate declines,
and other sectors of the economy are benefiting as well.
We have also had experience in recent years of sharp
increases in interest rates curtailing economic activity at
times when recovery was incomplete and unemployment high.
Sudden large fluctuations in interest rates contribute to

1

8_

other economic and financial distortions as well.

And no

ly
doubt the fact that many interest rates remain historical
high, relative to the current rate of inflation, reflects
gh the
continuing skepticism over prospects for carrying throu
fight on inflation.
In this situation, the Federal Reserve has welcomed
ort
the declines in interest rates both because of the supp
they offer economic activity and because they seem to reflect
a sense that the inflationary trend has changed.

However, we

d
do not believe that progress toward lower interest rates shoul

•MINkli.

or for long in practice can -- be "forced" at the expense of
excessive credit and money creation.

To attempt to do so

ed
would simply risk the revival of inflationary forces; renew
erexpectations of inflation would soon be reflected in the long


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ng
term credit markets, damaging prospects for the long-lasti
expansion we all want.
Turning to your explicit questions, Mr. Chairman,
ing
against this general background, I believe most policy-mak
officials in the Federal Reserve share the general view that
at a
economic recovery will be evident throughout 1983, but
previous
moderate rate of speed -- probably slower than during
post-recession years.

Unambiguous evidence that the recovery

raging signs
is already underway is still absent, although encou
liquidity
are evident in some rise in housing, in the improved
in
and wealth and reduced debt positions of consumers, and
stabilizing
surveys reporting that attitudes and orders may be

.4*

4
-9

or improving.

The Federal deficit, while fraught with danger

for the future, is of course providing massive support for
incomes at present.
What is crucially important -- particularly in the
light of the experience of recent years -- is that we set
the stage for an expansion that can be sustained over a long
period, bringing with it strong gains in productivity and
investment and lasting improvement in employment.

I have

already emphasized the importance of progress toward price
stability to that outlook, and the evidence that, with
disciplined monetary and fiscal policies, we can sustain
that progress.
So far as the specc questions about monetary policy
in your October 18 letter are concerned, we have not, as you
know, set any new monetary targets for 1982.

Current trends

do indicate that the various M's will end the year above the
upper end of the target ranges, probably by 1/2 to 1% for M2
and M3 and more for M1 given the current distortions.
credit will be close to the mid-point of its range.

Bank

As I

indicated at the start, the "overshoots," in the context of
today's economic and financial conditions, are consistent with
the approach stated in my July testimony.
No deon has been taken to change the tentative
targets for 1983.

That matter will, of course, be under

intensive scrutiny over the next two months, and the targets
will be announced in February.


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-10-

For the time being, we are placing much less emphasis
than usual on Ml.

That decision was precipitated in early

October entirely by the likelihood that the data would be
grossly distorted in that month by the maturity of a large
volume of All-Savers Certificates, part of the proceeds of
which might be expected to, at least temporarily, be placed
in checking accounts included in Ml.
In about three weeks, the introduction of a new ceilingless account at financial institutions -- highly liquid and
carrying significant transaction capabilities -- is likely to
distort further M1 data.

Judging by comments at the last

Depository Institutions Deregulation Committee meeting, that
account could rapidly be followed by a decision to approve
a ceiling-less account with full transaction capabilities.
These new accounts could have a large, but quite unpredictable,
influence on M1 for a number of months ahead as funds are reallocated among various accounts.

Moreover, the introduction

of market-rate transaction accounts will very likely result
in a different relationship and trend of M1 relative to GNP
over time.

Increasing confidence in the stability of prices

and a trend toward lower market interest rates might also
affect the desire to hold money over time.
Obviously, some judgments on those matters will be
necessary in setting a target for M1 in 1983 and in deciding
upon the degree of weight to be attached to changes in M1 in
our operations.


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Those problems should appropriately be

•
-11-

described as "technical" rather than "policy" in the sense
that we will need to continue to be concerned with the rate
of growth over time of the monetary aggregates, including
transactions balances.
The decisions taken in early October do point to greater
emphasis on M2 (and M3) in planning the operational reserve
path during this transitional period.

The link between reserves

and M2 is looser and more uncertain than in the case of Ml, in
large part because reserve requirements on accounts included in
M2, apart from transactions balances, are very low or non-existent.
(Transactions balances are about 17 percent of M2.)

Therefore

once a reserve path is set, deviations of M2 from a targeted
growth range may not, more or less automatically, be reflected
in as substantial changes in pressures on bank reserve positions
or in money markets as is the case with Ml.

Consequently,

"discretionary" judgments may be necessary more frequently in
altering a reserve path than when that reserve path is focused
more heavily on Ml.

In that technical sense, the operational

approach has necessarily been modified.
In sum, the broad framework of monetary targeting has
been retained, but greater emphasis is for the time being
placed on the broader aggregates.

The spec operating

technique that had been closely related to M1 has, by force
of circumstances, been conformed tc that emphasis.

Obviously,

entirely apart from questions of economic doctrine and contending approaches to monetary control, so long as M1 is


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•
-12-

subjected to strong institutional distortions our techniques
must be adapted to take account of that fact.
An alternative operating approach suggested by some
of supplying and withdrawing reserves with the intent of
achieving a particular interest rate target would suffer
from several fundamental defects.*
•

The body of theory or practice does not
provide a sufficiently clear basis for
relating the level of a particular interest
rate to our ultimate objectives of growth and
price stability.

•

The implication that the Federal Reserve could
in fact achieve and maintain a particular level
of relevant interest rateschanging economic
and financial environment is not warranted.

•

The very concept and measurement of a "real"
interest rate, as called for in some proposals,
is a matter of substantial ambiguity.

•

As a practical matter, attempts to target and fix

C) interest
rates would make more rigid and tend to
politicize the entire process of monetary policy.

*That was not, as sometimes mistakenly thought, the operating
approach used prior to October 1979. Then, reserves were provided with the aim of achieving and maintaining a particular
Federal funds rate thought to be consistent with targets for the
monetary aggregates. The Federal funds rate was a means to
achieving a monetary target and in principle was tc be handled
flexibly. In practice, among other difficulties, there appeared
to be a reluctance to permit rates to vary rapidly enough to
maintain control of the aggregates.


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4IP

-13-

In current circumstances, with huge budget deficits
looming, a requirement that the Federal Reserve
set explicit interest rate targets is bound to be
interpreted as inflationary, and the rekindling of
inflationary expectations will work against our
objective.
I realize the several legislative proposals addressed
to targeting interest rates would, on their face, seem to call
for interest rates as only one of several targets.

But interest

rates would certainly be the most obvious and sensitive target,
and those targets would be difficult to change.

Other evidence

for a need to "tighten" or "ease" would be subordinated, if not
ignored.
As we approach the target-setting process for 1983,
our objectives will -- indeed as required by law -- continue
to be quantified in terms of growth in relevant money and
credit aggregates.

We will have to decide how much weight to

place on M1 and other aggregates during a transitional period,
assuming new accounts continue to distort the data.

In reaching

and implementing those decisions, the members of the FOMC
necessarily rely upon their own analysis of the current and
prospective course of business activity; the interrelationships
among the aggregates, economic activity, and interest rates; and
the implications of monetary growth for inflation.

In other words,

the process is not a simple mechanical one, and it seems to me
capable of incorporating -- within a general framework of monetary
discipline -- the elements of needed flexibility.

We will also,

It

as part of that process, review whether technical adjustments


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-14-

the reserve paths
in procedures for establishing and changing
are appropriate.

I will be reporting our conclusions to the

Congress in February.
tary
Mr. Chairman, you have suggested that our mone
le number,
targets might reasonably be specified as a sing
with a range above and below.

At times we have debated

setting
within the FOMC the wisdom of such an approach (or
forth a single target number without a range).

My own feeling

with or without
has been, and remains, that a single number,
ision, with the
a range, would convey a specious sense of prec
less arbitrary
result of greater pressure to meet a more or


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lopments during
number to maintain "credibility," even if deve
ity is
the year tend to indicate some element of flexibil
appropriate in pursuit of the targets.
h a range
To me, our present practice of setting fort
is preferable.

Where appropriate, we can and should suggest

portion of
the probability of being in the upper or lower
ve in which
the range, or suggest what conditions could evol
over or undersomething other than the mid-points (or even an
shoot) would be appropriate.

That approach seems to me to

a single
provide more information -- and more realism -- than
.
number and is broadly consistent with present practice
For similar reasons, I believe we need to measure
and target a variety of aggregates because, in a swiftly
eading
changing economic environment, any single target can be misl
total credit
In that connection, I believe an indication of
could be
flows broadly consistent with the monetary targets
helpful.

As you know, we now provide such estimates for bank

credit alone.

-15-

Given the limits of forecasting and analysis, and the
volatility of the data, I would question the usefulness of
further sectoral estimates.

Even with respect to total credit

flows, there is considerable looseness in relationships to
economic activity for periods as long as a year -- and still
more for shorter periods.

The theoretical framework relating

credit flows to other variables such as the GNP or inflation
is less fully developed than in the case of monetary aggregates,
and credit flows are less directly amenable to control.

The

enormous flows across international borders pose large conceptual and statistical problems.

Our credit data are typically

less complete and up-to-date than monetary data.
However, so long as those difficulties and limitations
are recognized -- and some of them are relevant with respect
to the monetary aggregates as well -- I share the view that
analysis of credit flows can contribute to policy formulation.
To assist in that process, Iwill propose to the FOMC that
estimates of the expected behavior of a broad credit aggregate
be set forth alongside the monetary targets in our next report.
I do strongly resist the idea of the Federal Reserve as
an institution forecasting interest rates.

No institution or

individual is capable of judging accurately the myriad of
forces working on market interest rates over time.

Expeotational

elements play a strong role -- fundamentally expectations about
the course of economic activity and inflation, but also, in the
short run, expectations of Federal Reserve action.


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We could not

%

*
-16-

escape the fact that a central bank forecast of interest rates
would be itself a market factor.

To some degree, therefore,

in looking to interest rates and other market developments for
information bearing on our policy decisions, we would be looking
into a mirror.

Moreover, the temptation would always be present

to breech the thin line between a forecast and a desire or policy
intention, with the result that operational policy decisions
could be distorted.
While it seems to me inappropriate for a central bank
to regularly forecast interest rates, analysis of key factors
influencing credit conditions and prices can be helpful at
times.
past.

On occasion, we have provided such analysis in the
My concern about the outlook for fiscal policy is rooted

in major part in such analysis because the direction of impact
on interest rates seems to me unambiguous.

I have also, on a

number of occasions, indicated that the recent and even current
level of interest rates appears extraordinarily high, provided,
as I believe, we continue to make progress on the inflation
front.

Perhaps, in our semi-annual reporting, we can more

explicitly call attention to major factors likely to influence
short or long-term interest rates and the significance for
various sectors of the economy.

But I do not believe interest

rate forecasting would be desirable or long sustainable, and
would in fact be damaging to the policy process.


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Federal Reserve Bank of St. Louis

%

411111

114.-

-17-

Finally, Mr. Chairman, you have requested a "single
composite forecast" of the major economic variables by FOMC
members.

As you are well aware, our present practice is to

set forth a range of forecasts of individual FOMC members of
the nominal and real GNP, prices, and unemployment.

The fact

is we have no single "Federal Reserve" forecast, and there is
no mechanism, within a Committee or Board structure, to force
agreement on such a forecast by individual members bringing
different views, typically backed by separate staff analysis,
to the table.

A simple average -- possibly supported by no

one -- seems to me artificial.

The process of attempting to

force a consensus would certainly dilute the product.
I would put the point positively.

A range of forecasts

by individual FOMC members more accurately conveys the range
of uncertainty and contingencies that must surround any forecast.

The seeming neatness and coherence of a single forecast

too often obscures the reality that a variety of outcomes is
possible; the very essence of the policy problem is to assess
risks and probabilities -- what can go wrong as well as what
can go right.

A point forecast would likely be treated more

reverently than it would deserve, and could even distort policy
judgments in misguided efforts to "hit" a forecast.
I can understand your concern that a range of forecasts
may be misleading if strongly influenced by "outlying" opinions
rather than reflecting a more even dispersion of views.

For

that reason, I would be glad to explore with the Open Market


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-18-

Committee a procedure by which we indicated the "central
tendency" of members' views -- assuming such a central
tendency exists -- as well as indicating the range of
opinions.

Conversely, if the forecasts were evenly

distributed wn the range, we could so indicate.

I

believe that approach would meet the Jbjectives you seek in
a realistic and helpful manner.
In concluding this already long testimony, let me say
that we share the common goals of achieving, in the words of
the Employment Act of

Si.1

and the Humphrey Hawkins Act of

1978, "Maximum employment, production, and purchasing power"
and "full employment . . . (and) reasonable price stability."
Those objectives have eluded us for too many years.

We meet

again today in particularly difficult circumstances, and there
is a sense of frustration and uncertainty among many.
But I also happen to believe we have come a long way
toward laying the base for economic growth and stability;
economic recovery should characterize 1983, and that recovery
can mark the beginning of a long period of stable growth.
Obviously there are obstacles -- interest rates are
still too high; inflation is down but not out; there are
strains in our financial system; we face budget deficits that
•
are far too high; we are tempted to turn inwards or backwards
for quick solutions that ultimately can not work.

But it is

also plainly wn our capacity to deal with those threats -provided only that we have a strong base of understanding among


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Federal Reserve Bank of St. Louis

-19-

us, that we resolve to act where action is necessary, and
that we have the patience and wisdom to refrain from actions
that can only be destructive.
You are leaving the Congress after 28 years, Mr. Chairman.
Through that time, you have consistently provided constructive
leadership to the effort to raise the level of economic discussion in general -- and of the dialogue between the Congress
and the Federal Reserve in particular.

I happen to believe

strongly in the independence that the Congress has provided
the Federal Reserve through the years -- but also in the need
for close and continuing communication with the Congress and
the Administration.

I presume that this is the last time I

will appear before you personally in this forum, but the
dialogue will continue to benefit from your efforts, your
initiative, and your sense of commitment in more ways than
you may realize.

gia•


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Federal Reserve Bank of St. Louis

For release on delivery
10:00 A.M., E.S.T.
November 24, 1982

Statement by

Paul A. Volcker

Chairman, Board of Governors of the Federal Reserve System

before the

Joint Economic Committee

November 24, 1982

I appreciate this opportunity to discuss with you
today the current stance of monetary policy and some problems
for the future.

Before responding to certain questions directed

to me about monetary policy in your letters of October 18 and
November 17, Mr. Chairman, I should first emphasize that the
basic thrust and goals of our policy are unchanged since I
testified before the Congress on July 20.

The precise means

by which we move toward our goals must take account of all the
stream of evidence we have on the behavior of (and distortions
in) the various monetary aggregates, the economy, prices, interest
rates, and the like.

But we remain convinced that lasting recovery

and growth must be sought in a framework of continuing progress
toward price stability -- and that the process of money and credit
creation must remain appropriately restrained if we are to deal
effectively with inflationary dangers.
For that reason, we must continue to set forth targets
for growth in money and credit and to judge the provision of
bank reserves

our most important operating instrument -- in

the light of the trend in the growth of these aggregates.
This process necessarily involves continuing judgments about
just what growth in those magnitudes is appropriate in the
short and longer run, matters affected by institutional change
as well as by more fundamental economic factors.


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•

2-

As you are aware, the current job of developing and
implementing monetary policy has been complicated by regulatory
decisions as well as by recent developments in the economy and
in our financial markets.

We have, as a consequence, (1) made

some technical modification in our operating procedures to cope
with obvious distortions in some of the monetary data -- particularly M1 -- and (2) accommodated growth in the various M's at
rates somewhat above the targeted ranges.
decisions was essentially technical.

The first of those

The latter decision is

entirely consistent with the view I expressed in testifying
before the Banking Committees in July that the Federal Open
Market Committee would tolerate "growth somewhat above the
targeted rangestime in circumstances in which it
appeared that precautionary or liquidity motivations, during a
period of economic uncertainty and turbulence, were leading to
stronger than anticipated demands for money."
Unfortunately, the difficulties and complees of the
economic world in which we live do not permit us the luxury of
describing policy in terms of a simple, unchanging numerical
rule.

For instance, the economic significance of any particular

statistic we label "money" can change over time -- partly because
the statistical definon of "money" is itself arbitrary and
the components of the money supply have differing degrees of
use as a medium of exchange and liquidity.

That doesn't make

much differencerelatively stable economic, financial, and
institutional environment, but, at times of rapid change, like
the present, it can matter a great deal.


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Federal Reserve Bank of St. Louis

of varying lags -- never
We also have to take account
ntions today and their co
ac
n
ee
tw
be
-n
io
is
ec
pr
th
wi
known
ary
y to disentangle the tempor
tr
to
ve
ha
We
r.
te
la
s
ce
sequen
s among
nt trends in relationship
te
is
rs
pe
re
mo
om
fr
al
ic
cl
and cy
tivity.
d inflation and economic ac
an
y
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mo
of
es
ur
as
me
t
en
er
diff
abroad
gnificance of developments
si
e
th
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ha
And we
accounts and the exchange
e
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te
ec
fl
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,
as well as at home
nancial structure itself.
fi
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,
rate
ic environment in which we
As this suggests, the econom
a
-- cannot be condensed into
lf
se
it
cy
li
po
or
-cy
li
set po
the
ent. Perhaps the essence of
em
at
st
l
na
io
ns
me
di
eon
,
simple
tter captured by a few "yes
be
be
n
ca
ch
oa
pr
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problem
but" phrases.
the inflationary momentum
en
ok
br
ve
ha
we
s,
Ye
)
(1
d effort will be essential
but continuing vigilance an
price stability.
to continue progress toward
en
e indices this year have be
ic
pr
d
oa
br
e
th
,
ow
kn
u
yo
As
e peak levels reached two or
th
of
ss
le
or
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ha
t
ou
ab
running at
owth
disinflationary process, gr
is
th
of
rt
pa
As
o.
ag
s
three year
6 to
terms has declined to the
l
na
mi
no
in
on
ti
sa
en
mp
co
in worker
s
growth in nominal income ha
er
ow
sl
at
th
t
bu
-ea
ar
7 percent
rated.
wages as inflation has mode
al
re
er
gh
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th
wi
nt
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been cons
omy
icular sectors of the econ
rt
pa
in
ds
en
tr
st
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Price
the process of disin
gs
la
rt
pa
in
ng
ti
ec
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are mixed -- re
cts, international
ra
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wa
ng
lo
of
s
ct
inflation, the effe
immediate effects of
e
th
d
an
,
ts
en
pm
lo
ve
de
and exchange rate


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Federal Reserve Bank of St. Louis

4-

_

s.
recession on some prices -- most particularly commoditie
that
But there is, it seems to me, strong reason to believe
dlbeit
the progress toward price stability can be maintained -at a slower rate -- as the economy recovers.

For a time, un-

prices
employment and excess capacity should restrain costs and
should
and, of more lasting significance, productivity growth
improve from the poor performance of most recent years.

Taken

ty
together, restraint on nominal wage increases and productivi
growth should moderate the increase in unit labor costs, which
account for about two-thirds of all costs.

Real incomes can

rise as inflation slows, paving the way for further progress
toward stability.
To be sure, as the economy grows, some factors holding
down prices over the past year or two will dissipate or be
reversed.

But large new "price shocks" in the energy or food

areas appear unlikely in the foreseeable future, suggesting
that a declining trend in the rise of unit labor costs should
be the most fundamental factor defining the price trend.
That analysis would not hold, however, if excessive
growth in money and credit over time came again to feed first
the expectation, and then the reality, of renewed inflation.
Too much has been "invested" in turning the inflationary
momentum to lose sight of the necessity of carrying through.
There are clear implications, as I will elaborate in a moment,
for fiscal as well as monetary policy.

•
_

5-

(2) Yes, exceptional demands for liquidity can reasonably
be accommodated in a period of recession, high unemployment, and excess capacity -- but guidelines for
restrained money and credit growth remain relevant to
insure against renewed inflation.
A variety of specific and general evidence strongly
suggests that the desire to hold cash and other highly liquid
assets, relative to income, has increased this year.

Much of

the more rapid increase in M1 has been in interest-bearing NOW
accounts, which did not exist a few years ago but which provide


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the basic elements of a savings, as well as transaction, account.
With market interest rates falling, those accounts have been
relatively more attractive on interest rate grounds alone, and
they are a convenient means of storing liquidity at a time of
economic and financial uncertainty.

At the same time, the

broader aggregates appear to reflect some of the same liquidity
motivations, as well as the stronger savings growth in the wake
of the tax cut.
Most broadly, we can now observe, over a period of more
than a year, a distinct decline in "velocity" -- that is, the
relationship between the GNP and monetary aggregates.

The

velocity decline for Ml, which is likely to amount to about
3% from the fourth quarter of 1981 to the fourth quarter of 1982,
stands in sharp contrast to the average yearly rise in velocity
of 3-4% over the past decade; it will be the first significant

r

-6

decline in velocity in about 30 years.

M2 and M3 velocities --

which had been relatively trendless earlier -- have also declined
significantly.

While some tendency toward slower velocity is

not unusual in the midst of recession, the magnitude and persistence of the movement in 1982 is indicative of a pronounced
tendency to hold more liquid assets relative to current income.
Without some accommodation of that preference, monetary policy
at the present time would be substantially more restraining in
its effect on the economy than intended when the targets for
the various aggregates were originally set out earlier this
year.
At the same time, policy must take into account the
probability that the demands for liquidity will, in whole or
in major part, prove temporary, and that an excessive rise in
money or other liquid assets could feed inflationary forces
later.

Elements of judgment are inevitably involved in sorting

out these considerations -- judgments resting on analysis of


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the economy, interest rates, and other factors.

But broad

guidelines for assessing the appropriate growth on the basis
of historical experience will surely remain relevant and
appropriate.
In that connection, I must note the implications of the
future Federal budgetary position.

To put the point briefly,

the prospect of huge continuing budgetary deficits, even as the
economy recovers, carries with it the threat of either excessive
liquidity creation and inflation in future years, or a "crowdingout" of other borrowers as monetary growth is restrained in the


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-7-

face of the Treasury financing needs, or a combination of both.
The problems flowing from the future deficits are simply not
amenable to solution by monetary policy.

Moreover, the concern

engendered in the marketplace works in the direction of higher
interest rates today than would otherwise be the case, contrary
to the needs of recovery.

I know something of how difficult it

is to achieve further budgetary savings, but I must emphasize
again how important it is to see the deficit reduced as the
economy recovers.

The fact is those looming deficits are a

major hazard in sustaining recovery.
(3) Yes, lower interest rates are critically important
in supporting the economy and encouraging recovery
but we also want to be able to maintain lower
interest rates over time.

Since early summer, short-term interest rates have
generally declined by five to six percentage points, and
mortgage and most other long-term rates have dropped by three
to four percentage points.

While consumer loan rates administered

by banks and other financial institutions have lagged, they are
also now moving lower.

There are clear signs of a rise in home

sales and building in response to these interest rate declines,
and other sectors of the economy are benefiting as well.
We have also had experience in recent years of sharp
increases in interest rates curtailing economic activity at
times when recovery was incomplete and unemployment high.
Sudden large fluctuations in interest rates contribute to

8-

other economic and financial distortions as well.

And no

rically
doubt the fact that many interest rates remain histo
high, relative to the current rate of inflation, reflects
the
continuing skepticism over prospects for carrying through
fight on inflation.
In this situation, the Federal Reserve has welcomed
the declines in interest rates both because of the support
ct
they offer economic activity and because they seem to refle
a sense that the inflationary trend has changed.

However, we

d
do not believe that progress toward lower interest rates shoul

.1•M• OMB

or for long in practice can -- be "forced" at the expense of
excessive credit and money creation.

To attempt to do so

would simply risk the revival of inflationary forces; renewed
expectations of inflation would soon be reflected in the longerng
term credit markets, damaging prospects for the long-lasti
expansion we all want.


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Turning to your explicit questions, Mr. Chairman,
g
against this general background, I believe most policy-makin
officials in the Federal Reserve share the general view that
at a
economic recovery will be evident throughout 1983, but
moderate rate of speed -- probably slower than during previous
post-recession years.

Unambiguous evidence that the recovery

signs
is already underway is still absent, although encouraging
are evident in some rise in housing, in the improved liquidity
and wealth and reduced debt positions of consumers, and in
lizing
surveys reporting that attitudes and orders may be stabi

P
•04

-9

or improving.

The Federal deficit, while fraught with danger

for the future, is of course providing massive support for
incomes at present.
What is crucially important -- particularly in the
light of the experience of recent years -- is that we set
the stage for an expansion that can be sustained over a long
period, bringing with it strong gains in productivity and
investment and lasting improvement in employment.

I have

already emphasized the importance of progress toward price
stability to that outlook, and the evidence that, with
disciplined monetary and fiscal policies, we can sustain
that progress.
So far as the specific questions about monetary policy
in your October 18 letter are concerned, we have not, as you
know, set any new monetary targets for 1982.

Current trends

do indicate that the various M's will end the year above the
upper end of the target ranges, probably by 1/2 to 1% for M2
and M3 and more for M1 given the current distortions.
credit will be close to the mid-point of its range.

Bank

As I

indicated at the start, the "overshoots," in the context of
today's economic and financial conditions, are consistent with
the approach stated in my July testimony.
No decision has been taken to change the tentative
targets for 1983.

That matter will, of course, be under

intensive scrutiny over the next two months, and the targets
will be announced in February.


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-10-

For the time being, we are placing much less emphasis
than usual on Ml.

That decision was precipitated in early

October entirely by the likelihood that the data would be
grossly distorted in that month by the maturity of a large
volume of All-Savers Certificates, part of the proceeds of
which might be expected to, at least temporarily, be placed
in checking accounts included in Ml.
In about three weeks, the introduction of a new ceilingless account at financial institutions -- highly liquid and
carrying significant transaction capabilities -- is likely to
distort further M1 data.

Judging by comments at the last

Depository Institutions Deregulation Committee meeting, that
account could rapidly be followed by a decision to approve
a ceiling-less account with full transaction capabilities.
These new accounts could have a large, but quite unpredictable,
influence on M1 for a number of months ahead as funds are reallocated among various accounts.

Moreover, the introduction

of market-rate transaction accounts will very likely result
in a different relationship and trend of M1 relative to GNP
over time.

Increasing confidence in the stability of prices

and a trend toward lower market interest rates might also
affect the desire to hold money over time.
Obviously, some judgments on those matters will be
necessary in setting a target for M1 in 1983 and in deciding
upon the degree of weight to be attached to changes in M1 in
our operations.


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Those problems should appropriately be

-11-

described as "technical" rather than "policy" in the sense
that we will need to continue to be concerned with the rate
of growth over time of the monetary aggregates, including
transactions balances.
The decisions taken in early October do point to greater
emphasis on M2 (and M3) in planning the operational reserve
path during this transitional period.

The link between reserves

and M2 is looser and more uncertain than in the case of Ml, in
large part because reserve requirements on accounts included in
M2, apart from transactions balances, are very low or non-existent.
(Transactions balances are about 17 percent of M2.)

Therefore

once a reserve path is set, deviations of M2 from a targeted
growth range may not, more or less automatically, be reflected
in as substantial changes in pressures on bank reserve positions
or in money markets as is the case with Ml.

Consequently,

"discretionary" judgments may be necessary more frequently in
altering a reserve path than when that reserve path is focused
more heavily on Ml.

In that technical sense, the operational

approach has necessarily been modified.
In sum, the broad framework of monetary targeting has
been retained, but greater emphasis is for the time being
placed on the broader aggregates.

The specific operating

technique that had been closely related to M1 has, by force
of circumstances, been conformed to that emphasis.

Obviously,

entirely apart from questions of economic doctrine and contending approaches to monetary control, so long as M1 is


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1

-12--

subjected to strong institutional distortions our techniques
must be adapted to take account of that fact.
An alternative operating approach suggested by some
of supplying and withdrawing reserves with the intent of
achieving a particular interest rate target would suffer
from several fundamental defects.*
The body of theory or practice does not
provide a sufficiently clear basis for
relating the level of a particular interest
rate to our ultimate objectives of growth and
price stability.
o

The implication that the Federal Reserve could
in fact achieve and maintain a particular level
of relevant interest rates in a changing economic
and financial environment is not warranted.

o

The very concept and measurement of a "real"
interest rate, as called for in some proposals,
is a matter of substantial ambiguity.

o

As a practical matter, attempts to target and fix

0 interest
rates would make more rigid and tend to
politicize the entire process of monetary policy.

*That was not, as sometimes mistakenly thought, the operating
approach used prior to October 1979. Then, reserves were provided with the aim of achieving and maintaining a particular
Federal funds rate thought to be consistent with targets for the
monetary aggregates. The Federal funds rate was a means to
achieving a monetary target and in principle was tc be handled
flexibly. In practice, among other difficulties, there appeared
to be a reluctance to permit rates to vary rapidly enough to
maintain control of the aggregates.


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-13-

o

In current circumstances, with huge budget deficits
looming, a requirement that the Federal Reserve
set explicit interest rate targets is bound to be
interpreted as inflationary, and the rekindling of
inflationary expectations will work against our
objective.

I realize the several legislative proposals addressed
to targeting interest rates would, on their face, seem to call
for interest rates as only one of several targets.

But interest

rates would certainly be the most obvious and sensitive target,
and those targets would be difficult to change.

Other evidence

for a need to "tighten" or "ease" would be subordinated, if not
ignored.
As we approach the target-setting process for 1983,
our objectives will -- indeed as required by law -- continue
to be quantified in terms of growth in relevant money and
credit aggregates.

We will have to decide how much weight to

place on M1 and other aggregates during a transitional period,
assuming new accounts continue to distort the data.

In reaching

and implementing those decisions, the members of the FOMC
necessarily rely upon their own analysis of the current and
prospective course of business activity; the interrelationships
among the aggregates, economic activity, and interest rates; and
the implications of monetary growth for inflation.

In other words,

the process is not a simple mechanical one, and it seems to me
capable of incorporating -- within a general framework of monetary
discipline -- the elements of needed flexibility.

We will also,

I t

as part of that process, review whether technical adjustments


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-14-

reserve paths
in procedures for establishing and changing the
are appropriate.

I will be reporting our conclusions to the

Congress in February.
Mr. Chairman, you have suggested that our monetary
number,
targets might reasonably be specified as a single
with a range above and below.

At times we have debated

setting
within the FOMC the wisdom of such an approach (or
forth a single target number without a range).

My own feeling

with or without
has been, and remains, that a single number,
ision, with the
a range, would convey a specious sense of prec
arbitrary
result of greater pressure to meet a more or less
ents during
number to maintain "credibility," even if developm
ibility is
the year tend to indicate some element of flex


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appropriate in pursuit of the targets.
a range
To me, our present practice of setting forth
is preferable.

Where appropriate, we can and should suggest

portion of
the probability of being in the upper or lower
in which
the range, or suggest what conditions could evolve
or undersomething other than the mid-points (or even an over
shoot) would be appropriate.
provide more information

That approach seems to me to
and more realism -- than a single

number and is broadly consistent with present practice.
For similar reasons, I believe we need to measure
and target a variety of aggregates because, in a swiftly
changing economic environment, any single target can be misleading
it
l
In that connection, I believe an indication of tota cred
d be
flows broadly consistent with the monetary targets coul
helpful.

As you know, we now provide such estimates for bank

credit alone.

-15-

Given the limits of forecasting and analysis, and the
volatility of the data, I would question the usefulness of
further sectoral estimates.

Even with respect to total credit

flows, there is considerable looseness in relationships to
economic activity for periods as long as a year
more for shorter periods.

and still

The theoretical framework relating

credit flows to other variables such as the GNP or inflation
is less fully developed than in the case of monetary aggregates,
and credit flows are less directly amenable to control.

The

enormous flows across international borders pose large conceptual and statistical problems.

Our credit data are typically

less complete and up-to-date than monetary data.
However, so long as those difficulties and limitations
are recognized -- and some of them are relevant with respect
to the monetary aggregates as well -- I share the view that
analysis of credit flows can contribute to policy formulation.
To assist in that process, Iwill propose to the FOMC that
estimates of the expected behavior of a broad credit aggregate
be set forth alongside the monetary targets in our next report.
I do strongly resist the idea of the Federal Reserve as
an institution forecasting interest rates.

No institution or

individual is capable of judging accurately the myriad of
forces working on market interest rates over time.

Expeatational

elements play a strong role -- fundamentally expectations about
the course of economic activity and inflation, but also, in the
short run, expectations of Federal Reserve action.


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Federal Reserve Bank of St. Louis

We could not

•
-16-

escape the fact that a central bank forecast of interest rates
would be itself a market factor.

To some degree, therefore,

in looking to interest rates and other market developments for
information bearing on our policy decisions, we would be looking
into a mirror.

Moreover, the temptation would always be present

to breech the thin line between a forecast and a desire or policy
intention, with the result that operational policy decisions
could be distorted.
While it seems to me inappropriate for a central bank
to regularly forecast interest rates, analysis of key factors
influencing credit conditions and prices can be helpful at
times.
past.

On occasion, we have provided such analysis in the
My concern about the outlook for fiscal policy is rooted

in major part in such analysis because the direction of impact
on interest rates seems to me unambiguous.

I have also, on a

number of occasions, indicated that the recent and even current
level of interest rates appears extraordinarily high, provided,
as I believe, we continue to make progress on the inflation
front.

Perhaps, in our semi-annual reporting, we can more

explicitly call attention to major factors likely to influence
short or long-term interest rates and the significance for
various sectors of the economy.

But I do not believe interest

rate forecasting would be desirable or long sustainable, and
would in fact be damaging to the policy process.


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411

-17-

Finally, Mr. Chairman, you have requested a "single
composite forecast" of the major economic variables by FOMC
members.

As you are well aware, our present practice is to

set forth a range of forecasts of individual FOMC members of
the nominal and real GNP, prices, and unemployment.

The fact

is we have no single "Federal Reserve" forecast, and there is
no mechanism, within a Committee or Board structure, to force
agreement on such a forecast by individual members bringing
different views, typically backed by separate staff analysis,
to the table.

A simple average -- possibly supported by no

one -- seems to me artificial.

The process of attempting to

force a consensus would certainly dilute the product.
I would put the point positively.

A range of forecasts

by individual FOMC members more accurately conveys the range
of uncertainty and contingencies that must surround any forecast.

The seeming neatness and coherence of a single forecast

too often obscures the reality that a variety of outcomes is
possible; the very essence of the policy problem is to assess
risks and probabilities -- what can go wrong as well as what
can go right.

A point forecast would likely be treated more

reverently than it would deserve, and could even distort policy
judgments in misguided efforts to "hit" a forecast.
I can understand your concern that a range of forecasts
may be misleading if strongly influenced by "outlying" opinions
rather than reflecting a more even dispersion of views.

For

that reason, I would be glad to explore with the Open Market


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Federal Reserve Bank of St. Louis

IL

-18-

Committee a procedure by which we indicated the "central
tendency" of members' views -- assuming such a central
tendency exists -- as well as indicating the range of
opinions.

Conversely, if the forecasts were evenly

distributed within the range, we could so indicate.

I

believe that approach would meet the ibjectives you seek in
a realistic and helpful manner.
In concluding this already long testimony, let me say
that we share the common goals of achieving, in the words of
the Employment Act of 1946 and the Humphrey Hawkins Act of
1978, "Maximum employment, production, and purchasing power"
and "full employment . . . (and) reasonable price stability."
Those objectives have eluded us for too many years.

We meet

again today in particularly difficult circumstances, and there
is a sense of frustration and uncertainty among many.
But I also happen to believe we have come a long way
toward laying the base for economic growth and stability;
economic recovery should characterize 1983, and that recovery
can mark the beginning of a long period of stable growth.
Obviously there are obstacles -- interest rates are
still too high; inflation is down but not out; there are
strains in our financial system; we face budget deficits that
are far too high; we are tempted to turn inwards or backwards
for quick solutions that ultimately can not work.

But it is

also plainly wn our capacity to deal with those threats -provided only that we have a strong base of understanding among


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Federal Reserve Bank of St. Louis

•

-19-

us, that we resolve to act where action is necessary, and
that we have the patience and wisdom to refrain from actions
that can only be destructive.
You are leaving the Congress after 28 years, Mr. Chairman.
Through that time, you have consistently provided constructive
leadership to the effort to raise the level of economic discussion in general -- and of the dialogue between the Congr
ess
and the Federal Reserve in particular.

I happen to believe

strongly in the independence that the Congress has provided
the Federal Reserve through the years -- but also in the need
for close and continuing communication with the Congress and
the Administration.

I presume that this is the last time I

will appear before you personally in this forum, but the
dialogue will continue to benefit from your efforts, your
initiative, and your sense of commitment in more ways than
you may realize.


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For release on delivery
10:00 A.M., E.S.T.
November 24, 1982

Statement by

Paul A. Volcker
Chairman, Board of Governors of the Federal Reserve System

before the

Joint Economic Committee

November 24, 1982

I appreciate this opportunity to discuss with you
today the current stance of monetary policy and some problems
for the future.

Before responding to certain questions directed

to me about monetary policy in your letters of October 18 and
November 17, Mr. Chairman, I should first emphasize that the
basic thrust and goals of our policy are unchanged since I
testified before the Congress on July 20.

The precise means

by which we move toward our goals must take account of all the
stream of evidence we have on the behavior of (and distortions
in) the various monetary aggregates, the economy, prices, interest
rates, and the like.

But we remain convinced that lasting recovery

and growth must be sought in a framework of continuing progress
toward price stability -- and that the process of money and credit
creation must remain appropriately restrained if we are to deal
effectively with inflationary dangers.
For that reason, we must continue to set forth targets
for growth in money and credit and to judge the provision of
bank reserves

our most important operating instrument -- in

the light of the trend in the growth of these aggregates.
This process necessarily involves continuing judgments about
just what growth in those magnitudes is appropriate in the
short and longer run, matters affected by institutional change
as well as by more fundamental economic factors.


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-2-

As you are aware, the current job of developing and
implementing monetary policy has been complicated by regulatory
decisions as well as by recent developments in the economy and
in our financial markets.

We have, as a consequence, (1) made

some technical modification in our operating procedures to cope
with obvious distortions in some of the monetary data -- particularly MI -- and (2) accommodated growth in the various M's at
rates somewhat above the targeted ranges.
decisions was essentially technical.

The first of those

The latter decision is

entirely consistent with the view I expressed in testifying
before the Banking Committees in July that the Federal Open
Market Committee would tolerate "growth somewhat above the
targeted ranges .

. for a time in circumstances in which it

appeared that precautionary or liquidity motivations, during a
period of economic uncertainty and turbulence, were leading to
stronger than anticipated demands for money."
Unfortunately, the difficulties and complexities of the
economic world in which we live do not permit us the luxury of
describing policy in terms of a simple, unchanging numerical
rule.

For instance, the economic significance of any particular

statistic we label "money" can change over time -- partly because
the statistical definition of "money" is itself arbitrary and
the components of the money supply have differing degrees of
use as a medium of exchange and liquidity.

That doesn't make

much difference in a relatively stable economic, financial, and
institutional environment, but, at times of rapid change, like
the present, it can matter a great deal.


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4

4


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Federal Reserve Bank of St. Louis

-

3-

varying lags -- never
We also have to take account of
coneen actions today and their
tw
be
-n
io
is
ec
pr
th
wi
n
ow
kn
ary
try to disentangle the tempor
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We
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te
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en
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se
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nt trends in relationship
te
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rs
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om
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an
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io
at
fl
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different measures
developments abroad
of
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an
ic
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And we have to ev
accounts and the exchange
e
ad
tr
in
d
te
ec
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as
,
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as well as at ho
financial structure itself.
rate, and of strains in the
ic environment in which we
As this suggests, the econom
a
-- cannot be condensed into
lf
se
it
cy
li
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or
-cy
li
po
set
the
ent. Perhaps the essence of
em
at
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io
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eon
,
le
simp
better captured by a few "yes
be
n
ca
ch
oa
pr
ap
r
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an
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le
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but" phrases.
e inflationary momentum
th
en
ok
br
ve
ha
we
s,
Ye
)
(1
d effort will be essential
but continuing vigilance an
price stability.
to continue progress toward
en
e indices this year have be
ic
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e
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,
ow
kn
u
yo
As
or
the peak levels reached two
of
ss
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is
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e 6 to
l terms has declined to th
na
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-ea
ar
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rated.
wages as inflation has mode
al
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ns
been co
sectors of the economy
ar
ul
ic
rt
pa
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ds
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tr
st
Price and co
dispart lags in the process of
are mixed -- reflecting in
ational
ng wage contracts, intern
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immediate effects of
e
th
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,
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en
pm
lo
ve
de
and exchange rate


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Federal Reserve Bank of St. Louis

s.
recession on some prices -- most particularly commoditie
that
But there is, it seems to me, strong reason to believe
-- albeit
the progress toward price stability can be maintained
at a slower rate -- as the economy recovers.

For a time, un-

prices
employment and excess capacity should restrain costs and
d
and, of more lasting significance, productivity growth shoul
.
improve from the poor performance of most recent years

Taken

ty
together, restraint on nominal wage increases and productivi
which
growth should moderate the increase in unit labor costs,
account for about two-thirds of all costs.

Real incomes can

rise as inflation slows, paving the way for further progress
toward stability.
To be sure, as the economy grows, some factors holding
down prices over the past year or two will dissipate or be
reversed.

But large new "price shocks" in the energy or food

areas appear unlikely in the foreseeable future, suggesting
that a declining trend in the rise of unit labor costs should
be the most fundamental factor defining the price trend.
That analysis would not hold, however, if excessive
growth in money and credit over time came again to feed first
the expectation, and then the reality, of renewed inflation.
Too much has been "invested" in turning the inflationary
momentum to lose sight of the necessity of carrying through.
There are clear implications, as I will elaborate in a moment,
for fiscal as well as monetary policy.

...
-5-

(2) Yes, exceptional demands for liquidity can reasonably
be accommodated in a period of recession, high unemployment, and excess capacity -- but guidelines for
restrained money and credit growth remain relevant to
insure against renewed inflation.
A variety of specific and general evidence strongly
suggests that the desire to hold cash and other highly liquid
assets, relative to income, has increased this year.

Much of

the more rapid increase in M1 has been in interest-bearing NOW
accounts, which did not exist a few years ago but which provide
the basic elements of a savings, as well as transaction, account.
With market interest rates falling, those accounts have been
relatively more attractive on interest rate grounds alone, and
they are a convenient means of storing liquidity at a time of
economic and financial uncertainty.

At the same time, the

broader aggregates appear to reflect some of the same liquidity
motivations, as well as the stronger savings growth in the wake
of the tax cut.
Most broadly, we can now observe, over a period of more
than a year, a distinct decline in "velocity" -- that is, the
relationship between the GNP and monetary aggregates.

The

velocity decline for Ml, which is likely to amount to about
1982,
3% from the fourth quarter of 1981 to the fourth quarter of
stands in sharp contrast to the average yearly rise in velocity
of 3-4% over the past decade; it will be the first significant


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9

-6

decline in velocity in about 30 years.

M2 and M3 velocities --

which had been relatively trendless earlier -- have also declined
significantly.

While some tendency toward slower velocity is

not unusual in the midst of recession, the magnitude and persistence of the movement in 1982 is indicative of a pronounced
tendency to hold more liquid assets relative to current income.
Without some accommodation of that preference, monetary policy
at the present time would be substantially more restraining in
its effect on the economy than intended when the targets for
the various aggregates were originally set out earlier this
year.
At the same time, policy must take into account the
probability that the demands for liquidity will, in whole or
in major part, prove temporary, and that an excessive rise in
money or other liquid assets could feed inflationary forces
later.

Elements of judgment are inevitably involved in sorting

out these considerations -- judgments resting on analysis of
the economy, interest rates, and other factors.

But broad

guidelines for assessing the appropriate growth on the basis
of historical experience will surely remain relevant and
appropriate.
In that connection, I must note the implications of the
future Federal budgetary position.

To put the point briefly,

the prospect of huge continuing budgetary deficits, even as the
economy recovers, carries with it the threat of either excessive
liquidity creation and inflation in future years, or a "crowdingout" of other borrowers as monetary growth is restrained in the


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7-

face of the Treasury financing needs, or a combination of both.
The problems flowing from the future deficits are simply not
amenable to solution by monetary policy.

Moreover, the concern

engendered in the marketplace works in the direction of higher
interest rates today than would otherwise be the case, contrary
to the needs of recovery.

I know something of how difficult it

is to achieve further budgetary savings, but I must emphasize
again how important it is to see the deficit reduced as the
economy recovers.

The fact is those looming deficits are a

major hazard in sustaining recovery.
(3) Yes, lower interest rates are critically important
in supporting the economy and encouraging recovery
but we also want to be able to maintain lower
interest rates over time.

Since early summer, short-term interest rates have
generally declined by five to six percentage points, and
mortgage and most other long-term rates have dropped by three
to four percentage points.

While consumer loan rates administered

by banks and other financial institutions have lagged, they are
also now moving lower.

There are clear signs of a rise in home

sales and building in response to these interest rate declines,
and other sectors of the economy are benefiting as well.
We have also had experience in recent years of sharp
increases in interest rates curtailing economic activity at
times when recovery was incomplete and unemployment high.
Sudden large fluctuations in interest rates contribute to

-8

other economic and financial distortions as well.

And no

rically
doubt the fact that many interest rates remain histo
high, relative to the current rate of inflation, reflects
gh the
continuing skepticism over prospects for carrying throu
fight on inflation.
In this situation, the Federal Reserve has welcomed
ort
the declines in interest rates both because of the supp
to reflect
they offer economic activity and because they seem
a sense that the inflationary trend has changed.

However, we

s should
do not believe that progress toward lower interest rate

ONO 411=1.

se of
or for long in practice can -- be "forced" at the expen
excessive credit and money creation.

To attempt to do so

ed
would simply risk the revival of inflationary forces; renew
the longerexpectations of inflation would soon be reflected in
lasting
term credit markets, damaging prospects for the longexpansion we all want.
Turning to your explicit questions, Mr. Chairman,
y-making
against this general background, I believe most polic
view that
officials in the Federal Reserve share the general


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at a
economic recovery will be evident throughout 1983, but
g previous
moderate rate of speed -- probably slower than durin
post-recession years.

Unambiguous evidence that the recovery

g signs
is already underway is still absent, although encouragin
liquidity
are evident in some rise in housing, in the improved
in
and wealth and reduced debt positions of consumers, and
stabilizing
surveys reporting that attitudes and orders may be

-9

or improving.

The Federal deficit, while fraught with danger

for the future, is of course providing massive support for
incomes at present.
What is crucially important -- particularly in the
light of the experience of recent years -- is that we set
the stage for an expansion that can be sustained over a long
period, bringing with it strong gains in productivity and
investment and lasting improvement in employment.

I have

already emphasized the importance of progress toward price
stability to that outlook, and the evidence that, with
disciplined monetary and fiscal policies, we can sustain
that progress.
So far as the specific questions about monetary policy
in your October 18 letter are concerned, we have not, as you
know, set any new monetary targets for 1982.

Current trends

do indicate that the various M's will end the year above the
upper end of the target ranges, probably by 1/2 to 1% for M2
and M3 and more for M1 given the current distortions.
credit will be close to the mid-point of its range.

Bank

As I

indicated at the start, the "overshoots," in the context of
today's economic and financial conditions, are consistent with
the approach stated in my July testimony.
No decision has been taken to change the tentative
targets for 1983.

That matter will, of course, be under

intensive scrutiny over the next two months, and the targets
will be announced in February.


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-10-

For the time being, we are placing much less emphasis
than usual on Ml.

That decision was precipitated in early

October entirely by the likelihood that the data would be
grossly distorted in that month by the maturity of a large
volume of All-Savers Certificates, part of the proceeds of
which might be expected to, at least temporarily, be placed
in checking accounts included in Ml.
In about three weeks, the introduction of a new ceilingless account at financial institutions -- highly liquid and
carrying significant transaction capabilities -- is likely to
distort further M1 data.

Judging by comments at the last

Depository Institutions Deregulation Committee meeting, that
account could rapidly be followed by a decision to approve
a ceiling-less account with full transaction capabilities.
These new accounts could have a large, but quite unpredictable,
influence on M1 for a number of months ahead as funds are reallocated among various accounts.

Moreover, the introduction

of market-rate transaction accounts will very likely result
in a different relationship and trend of M1 relative to GNP
over time.

Increasing confidence in the stability of prices

and a trend toward lower market interest rates might also
affect the desire to hold money over time.
Obviously, some judgments on those matters will be
necessary in setting a target for M1 in 1983 and in deciding
upon the degree of weight to he attached to changes in M1 in
our operations.


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Those problems should appropriately be

-11-

described as "technical" rather than "policy" in the sense
that we will need to continue to be concerned with the rate
of growth over time of the monetary aggregates, including
transactions balances.
The decisions taken in early October do point to greater
emphasis on M2 (and M3) in planning the operational reserve
path during this transitional period.

The link between reserves

and M2 is looser and more uncertain than in the case of Ml, in
large part because reserve requirements on accounts included in
M2, apart from transactions balances, are very low or non-existent.
(Transactions balances are about 17 percent of M2.)

Therefore

once a reserve path is set, deviations of M2 from a targeted
growth range may not, more or less automatically, be reflected
in as substantial changes in pressures on bank reserve positions
or in money markets as is the case with Ml.

Consequently,

"discretionary" judgments may be necessary more frequently in
altering a reserve path than when that reserve path is focused
more heavily on Ml.

In that technical sense, the operational

approach has necessarily been modified.
In sum, the broad framework of monetary targeting has
been retained, but greater emphasis is for the time being
placed on the broader aggregates.

The specific operating

technique that had been closely related to M1 has, by force
of circumstances, been conformed to that emphasis.

Obviously,

entirely apart from questions of economic doctrine and contending approaches to monetary control, so long as M1 is


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-12-

subjected to strong institutional distortions our techniques
must be adapted to take account of that fact.
An alternative operating approach suggested by some
of supplying and withdrawing reserves with the intent of
achieving a particular interest rate target would suffer
from several fundamental defects.*
o

The body of theory or practice does not
provide a sufficiently clear basis for
relating the level of a particular interest
rate to our ultimate objectives of growth and
price stability.

o

The implication that the Federal Reserve could
in fact achieve and maintain a particular level
of relevant interest rates in a changing economic
and financial environment is not warranted.

o

The very concept and measurement of a "real"
interest rate, as called for in some proposals,
is a matter of substantial ambiguity.

o

As a practical matter, attempts to target and fix

0
interest rates would make more rigid and tend to
politicize the entire process of monetary policy.

*That was not, as sometimes mistakenly thought, the operating
approach used prior to October 1979. Then, reserves were provided with the aim of achieving and maintaining a particular
Federal funds rate thought to be consistent with targets for the
monetary aggregates. The Federal funds rate was a means to
achieving a monetary target and in principle was tc be handled
flexibly. In practice, among other difficulties, there appeared
to be a reluctance to permit rates to vary rapidly enough to
maintain control of the aggregates.


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-13-

In current circumstances, with huge budget deficits
looming, a requirement that the Federal Reserve
set explicit interest rate targets is bound to be
interpreted as inflationary, and the rekindling of
inflationary expectations will work against our
objective.
I realize the several legislative proposals addressed
to targeting interest rates would, on their face, seem to call
for interest rates as only one of several targets.

But interest

rates would certainly be the most obvious and sensitive target,
and those targets would be difficult to change.

Other evidence

for a need to "tighten" or "ease" would be subordinated, if not
ignored.
As we approach the target-setting process for 1983,
our objectives will -- indeed as required by law -- continue
to be quantified in terms of growth in relevant money and
credit aggregates.

We will have to decide how much weight to

place on M1 and other aggregates during a transitional period,
assuming new accounts continue to distort the data.

In reaching

and implementing those decisions, the members of the FOMC
necessarily rely upon their own analysis of the current and
prospective course of business activity; the interrelationships
among the aggregates, economic activity, and interest rates; and
the implications of monetary growth for inflation.

In other words,

the process is not a simple mechanical one, and it seems to me
within a general framework of monetary

capable of incorporating

discipline -- the elements of needed flexibility.

We will also,

I I

as part of that process, review whether technical adjustments


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-14-

e paths
in procedures for establishing and changing the reserv
are appropriate.

I will be reporting our conclusions to the

Congress in February.
Mr. Chairman, you have suggested that our monetary
targets might reasonably be specified as a single number,
with a range above and below.


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At times we have debated

g
within the FOMC the wisdom of such an approach (or settin
forth a single target number without a range).

My own feeling

t
has been, and remains, that a single number, with or withou
with the
a range, would convey a specious sense of precision,
ary
result of greater pressure to meet a more or less arbitr
number to maintain "credibility," even if developments during
the year tend to indicate some element of flexibility is
appropriate in pursuit of the targets.
To me, our present practice of setting forth a range
is preferable.

Where appropriate, we can and should suggest

the probability of being in the upper or lower portion of
the range, or suggest what conditions could evolve in which
something other than the mid-points (or even an over or undershoot) would be appropriate.

That approach seems to me to

provide more information -- and more realism -- than a single
number and is broadly consistent with present practice.
For similar reasons, I believe we need to measure
and target a variety of aggregates because, in a swiftly
changing economic environment, any single target can be misleading
In that connection, I believe an indication of total credit
flows broadly consistent with the monetary targets could be
helpful.

As you know, we now provide such estimates for bank

credit alone.

-15-

Given the limits of forecasting and analysis, and the
volatility of the data, I would question the usefulness of
further sectoral estimates.

Even with respect to total credit

flows, there is considerable looseness in relationships to
economic activity for periods as long as a year -- and still
more for shorter periods.

The theoretical framework relating

credit flows to other variables such as the GNP or inflation
is less fully developed than in the case of monetary aggregates,
and credit flows are less directly amenable to control.

The

enormous flows across international borders pose large conceptual and statistical problems.

Our credit data are typically

less complete and up-to-date than monetary data.
However, so long as those difficulties and limitations
are recognized -- and some of them are relevant with respect
to the monetary aggregates as well -- I share the view that
analysis of credit flows can contribute to policy formulation.
To assist in that process, Iwill propose to the FOMC that
estimates of the expected behavior of a broad credit aggregate
be set forth alongside the monetary targets in our next report.
I do strongly resist the idea of the Federal Reserve as
an institution forecasting interest rates.

No institution or

individual is capable of judging accurately the myriad of
forces working on market interest rates over time.

Expeatational

elements play a strong role -- fundamentally expectations about
the course of economic activity and inflation, but also, in the
short run, expectations of Federal Reserve action.


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Federal Reserve Bank of St. Louis

We could not

\

-16-

escape the fact that a central bank forecast of interest rates
would be itself a market factor.

To some degree, therefore,

in looking to interest rates and other market developments for
information bearing on our policy decisions, we would be looking
into a mirror.

Moreover, the temptation would always be present

to breech the thin line between a forecast and a desire or policy
intention, with the result that operational policy decisions
could be distorted.
While it seems to me inappropriate for a central bank
to regularly forecast interest rates, analysis of key factors
influencing credit conditions and prices can be helpful at
times.
past.

On occasion, we have provided such analysis in the
My concern about the outlook for fiscal policy is rooted

in major part in such analysis because the direction of impact
on interest rates seems to me unambiguous.

I have also, on a

number of occasions, indicated that the recent and even current
level of interest rates appears extraordinarily high, provided,
as I believe, we continue to make progress on the inflation
front.

Perhaps, in our semi-annual reporting, we can more

explicitly call attention to major factors likely to influence
short or long-term interest rates and the significance for
various sectors of the economy.

But I do not believe interest

rate forecasting would be desirable or long sustainable, and
would in fact be damaging to the policy process.


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a
-17-

Finally, Mr. Chairman, you have requested a "single
composite forecast" of the major economic variables by FOMC
members.

As you are well aware, our present practice is to

set forth a range of forecasts of individual FOMC members of
the nominal and real GNP, prices, and unemployment.

The fact

is we have no single "Federal Reserve" forecast, and there is
no mechanism, within a Committee or Board structure, to force
agreement on such a forecast by individual members bringing
different views, typically backed by separate staff analysis,
to the table.

A simple average -- possibly supported by no

one -- seems to me artificial.

The process of attempting to

force a consensus would certainly dilute the product.
I would put the point positively.

A range of forecasts

by individual FOMC members more accurately conveys the range
of uncertainty and contingencies that must surround any forecast.

The seeming neatness and coherence of a single forecast

too often obscures the reality that a variety of outcomes is
possible; the very essence of the policy problem is to assess
risks and probabilities -- what can go wrong as well as what
can go right.

A point forecast would likely be treated more

reverently than it would deserve, and could even distort policy
judgments in misguided efforts to "hit" a forecast.
I can understand your concern that a range of forecasts
may be misleading if strongly influenced by "outlying" opinions
rather than reflecting a more even dispersion of views.

For

that reason, I would be glad to explore with the Open Market


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Federal Reserve Bank of St. Louis

-18-

Committee a procedure by which we indicated the "central
tendency" of members' views -- assuming such a central
tendency exists -- as well as indicating the range of
opinions.

Conversely, if the forecasts were evenly

distributed within the range, we could so indicate.
believe that approach would meet the ibjectives you seek in
a realistic and helpful manner.
In concluding this already long testimony, let me say
that we share the common goals of achieving, in the words of
the Employment Act of 1946 and the Humphrey Hawkins Act of
1978, "Maximum employment, production, and purchasing power"
and "full employment . . . (and) reasonable price stability."
Those objectives have eluded us for too many years.

We meet

again today in particularly difficult circumstances, and there
is a sense of frustration and uncertainty among many.
But I also happen to believe we have come a long way
toward laying the base for economic growth and stability;
economic recovery should characterize 1983, and that recovery
can mark the beginning of a long period of stable growth.
Obviously there are obstacles -- interest rates are
still too high; inflation is down but not out; there are
strains in our financial system; we face budget deficits that
are far too high; we are tempted to turn inwards or backwards
for quick solutions that ultimately can not work.

But it is

also plainly within our capacity to deal with those threats
provided only that we have a strong base of understanding among


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Federal Reserve Bank of St. Louis

-19-

us, that we resolve to act where action is necessary, and
that we have the patiabce and wisdom to refrain from actions
that can only be destructive.
You are leaving the Congress after 28 years, Mr. Chairman.
Through that time, you have consistently provided constructive
leadership to the effort to raise the level of economic discussion in general -- and of the dialogue between the Congress
and the Federal Reserve in particular.

I happen to believe

strongly in the independence that the Congress has provided
the Federal Reserve through the years -- but also in the neea
for close and continuing communication with the Congress and
the Administration.

I presume that this is the last time I

will appear before you personally in this forum, but the
dialogue will continue to benefit from your efforts, your
initiative, and your sense of commitment in more ways than
you may realize.


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,(/•t..4•011,1


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L. 44
1

e


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Federal Reserve Bank of St. Louis

For release on delivery
10:00 A.M., E.S.T.
November 24, 1982

Statement by

Paul A. Volcker

Chairman, Board of Governors of the Federal Reserve System

before the

Joint Economic Committee

November 24, 1982

I appreciate this opportunity to discuss with you
today the current stance of monetary policy and some problems
for the future.

Before responding to certain questions directed

to me about monetary policy in your letters of October 18 and
November 17, Mr. Chairman, I should first emphasize that the
basic thrust and goals of our policy are unchanged since I
testified before the Congress on July 20.

The precise means

by which we move toward our goals must take account of all the
stream of evidence we have on the behavior of (and distortions
in) the various monetary aggregates, the economy, prices, interest
rates, and the like.

But we remain convinced that lasting recovery

and growth must be sought in a framework of continuing progress
toward price stability -- and that the process of money and credit
creation must remain appropriately restrained if we are to deal
effectively with inflationary dangers.
For that reason, we must continue to set forth targets
for growth in money and credit and to judge the provision of
bank reserves

our most important operating instrument -- in

the light of the trend in the growth of these aggregates.
This process necessarily involves continuing judgments about
just what growth in those magnitudes is appropriate in the
short and longer run, matters affected by institutional change
as well as by more fundamental economic factors.


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-2-

As you are aware, the current job of developing and
implementing monetary policy has been complicated by regulatory
decisions as well as by recent developments in the economy and
in our financial markets.

We have, as a consequence, (1) made

some technical modification in our operating procedures to cope
with obvious distortions in some of the monetary data -- particularly M1 -- and (2) accommodated growth in the various M's at
rates somewhat above the targeted ranges.
decisions was essentially technical.

The first of those

The latter decision is

entirely consistent with the view I expressed in testifying
before the Banking Committees in July that the Federal Open
Market Committee would tolerate "growth somewhat above the
targeted ranges .

. for a time in circumstances in which it

appeared that precautionary or liquidity motivations, during a
period of economic uncertainty and turbulence, were leading to
stronger than anticipated demands for money."
Unfortunately, the difficulties and complexities of the
economic world in which we live do not permit us the luxury of
describing policy in terms of a simple, unchanging numerical
rule.

For instance, the economic significance of any particular

statistic we label "money" can change over time -- partly because
the statistical definition of "money" is itself arbitrary and
the components of the money supply have differing degrees of
use as a medium of exchange and liquidity.

That doesn't make

much difference in a relatively stable economic, financial, and
institutional environment, but, at times of rapid change, like
the present, it can matter a great deal.


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3

We also have to take account of varying lags -- never
known with precision -- between actions today and their consequences later.

We have to try to disentangle the temporary

and cyclical from more persistent trends in relationships among
different measures of money and inflation and economic activity.
And we have to evaluate the significance of developments abroad
as well as at home, as reflected in trade accounts and the exchange
rate, and of strains in the financial structure itself.
As this suggests, the economic environment in which we
set policy -- or policy itself -- cannot be condensed into a
simple, one-dimensional statement.

Perhaps the essence of the

problem and our approach can be better captured by a few "yesbut" phrases.
(1) Yes, we have broken the inflationary momentum
but continuing vigilance and effort will be essential
to continue progress toward price stability.
As you know, the broad price indices this year have been
running at about half or less of the peak levels reached two or
three years ago.

As part of this disinflationary process, growth

in worker compensation in nominal terms has declined to the 6 to
7 percent area -- but that slower growth in nominal income has
been consistent with higher real wages as inflation has moderated.
Price and cost trends in particular sectors of the economy
are mixed -- reflecting in part lags in the process of disinflation, the effects of long wage contracts, international
and exchange rate developments, and the immediate effects of

p
_ 4-

recession on some prices -- most particularly commodities.
But there is, it seems to me, strong reason to believe that
the progress toward price stability can be maintained -- albeit
at a slower rate -- as the economy recovers.

For a time, un-

employment and excess capacity should restrain costs and prices
and, of more lasting significance, productivity growth should
improve from the poor performance of most recent years.

Taken

together, restraint on nominal wage increases and productivity
growth should moderate the increase in unit labor costs, which
account for about two-thirds of all costs.

Real incomes can

rise as inflation slows, paving the way for further progress
toward stability.
To be sure, as the economy grows, some factors holding
down prices over the past year or two will dissipate or be
reversed.

But large new "price shocks" in the energy or food

areas appear unlikely in the foreseeable future, suggesting
that a declining trend in the rise of unit labor costs should
be the most fundamental factor defining the price trend.
That analysis would not hold, however, if excessive
growth in money and credit over time came again to feed first
the expectation, and then the reality, of renewed inflation.
Too much has been "invested" in turning the inflationary
momentum to lose sight of the necessity of carrying through.
There are clear implications, as I will elaborate in a moment,
for fiscal as well as monetary policy.


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Federal Reserve Bank of St. Louis

_ 5-

(2) Yes, exceptional demands for liquidity can reasonably
be accommodated in a period of recession, high unemployment, and excess capacity -- but guidelines for
restrained money and credit growth remain relevant to
insure against renewed inflation.

A variety of specific and general evidence strongly
suggests that the desire to hold cash and other highly liquid
assets, relative to income, has increased this year.

Much of

the more rapid increase in M1 has been in interest-bearing NOW
accounts, which did not exist a few years ago but which provide
the basic elements of a savings, as well as transaction, account.
With market interest rates falling, those accounts have been
relatively more attractive on interest rate grounds alone, and
they are a convenient means of storing liquidity at a time of
economic and financial uncertainty.

At the same time, the

broader aggregates appear to reflect some of the same liquidity
motivations, as well as the stronger savings growth in the wake
of the tax cut.
Most broadly, we can now observe, over a period of more
than a year, a distinct decline in "velocity" -- that is, the
relationship between the GNP and monetary aggregates.

The

velocity decline for Ml, which is likely to amount to about
3% from the fourth quarter of 1981 to the fourth quarter of 1982,
stands in sharp contrast to the average yearly rise in velocity
of 3-4% over the past decade; it will be the first significant


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-6-

decline in velocity in about 30 years.

M2 and M3 velocities --

which had been relatively trendless earlier -- have also declined
significantly.

While some tendency toward slower velocity is

not unusual in the midst of recession, the magnitude and persistence of the movement in 1982 is indicative of a pronounced
tendency to hold more liquid assets relative to current income.
Without some accommodation of that preference, monetary policy
at the present time would be substantially more restraining in
its effect on the economy than intended when the targets for
the various aggregates were originally set out earlier this
year.
At the same time, policy must take into account the
probability that the demands for liquidity will, in whole or
in major part, prove temporary, and that an excessive rise in
money or other liquid assets could feed inflationary forces
later.

Elements of judgment are inevitably involved in sorting

out these considerations -- judgments resting on analysis of
the economy, interest rates, and other factors.

But broad

guidelines for assessing the appropriate growth on the basis
of historical experience will surely remain relevant and
appropriate.
In that connection, I must note the implications of the
future Federal budgetary position.

To put the point briefly,

the prospect of huge continuing budgetary deficits, even as the
economy recovers, carries with it the threat of either excessive
liquidity creation and inflation in future years, or a "crowdingout" of other borrowers as monetary growth is restrained in the


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Federal Reserve Bank of St. Louis

7

face of the Treasury financing needs, or a combination of both.
The problems flowing from the future deficits are simply not
amenable to solution by monetary policy.

Moreover, the concern

engendered in the marketplace works in the direction of higher
interest rates today than would otherwise be the case, contrary
to the needs of recovery.

I know something of how difficult it

is to achieve further budgetary savings, but I must emphasize
again how important it is to see the deficit reduced as the
economy recovers.

The fact is those looming deficits are a

major hazard in sustaining recovery.
(3) Yes, lower interest rates are critically important
in supporting the economy and encouraging recovery

111.. OMB

but we also want to be able to maintain lower
interest rates over time.

Since early summer, short-term interest rates have
generally declined by five to six percentage points, and
mortgage and most other long-term rates have dropped by three
to four percentage points.

While consumer loan rates administered

by banks and other financial institutions have lagged, they are
also now moving lower.

There are clear signs of a rise in home

sales and building in response to these interest rate declines,
and other sectors of the economy are benefiting as well.
We have also had experience in recent years of sharp
increases in interest rates curtailing economic activity at
times when recovery was incomplete and unemployment high.
Sudden large fluctuations in interest rates contribute to

I,

%
-8 _

other economic and financial distortions as well.

And no

doubt the fact that many interest rates remain historically
high, relative to the current rate of inflation, reflects
continuing skepticism over prospects for carrying through the
fight on inflation.
In this situation, the Federal Reserve has welcomed
the declines in interest rates both because of the support
they offer economic activity and because they seem to reflect
a sense that the inflationary trend has Changed.

However, we

do not believe that progress toward lower interest rates should
or for long in practice can -- be "forced" at the expense of
excessive credit and money creation.

To attempt to do so

would simply risk the revival of inflationary forces; renewed
expectations of inflation would soon be reflected in the longerterm credit markets, damaging prospects for the long-lasting
expansion we all want.
Turning to your explicit questions, Mr. chairman,
against this general background, I believe most policy-making
officials in the Federal Reserve share the general view that
economic recovery will be evident throughout 1983, but at a
moderate rate of speed -- probably slower than during previous
post-recession years.

Unambiguous evidence that the recovery

is already underway is still absent, although encouraging signs
are evident in some rise in housing, in the improved liquidity
and wealth and reduced debt positions of consumers, and in
,


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Federal Reserve Bank of St. Louis

surveys reporting that attitudes and orders may be stabilizing


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Federal Reserve Bank of St. Louis

-9

or improving.

The Federal deficit, while fraught with danger

for the future, is of course providing massive support for
incomes at present.
What is crucially important -- particularly in the
light of the experience of recent yearsthat we set
the stage for an expansion that can be sustained over a long
period, bringing with it strong gains in productivity and
investment and lasting improvement in employment.

I have

already emphasized the importance of progress toward price
stability to that outlook, and the evidence that, with
disciplined monetary and fiscal policies, we can sustain
that progress.
So far as the specific questions about monetary policy
in your October 18 letter are concerned, we have not, as you
know, set any new monetary targets for 1982.

Current trends

do indicate that the various M's will end the year above the
upper end of the target ranges, probably by 1/2 to 1% for M2
and M3 and more for M1 given the current distortions.
credit will be close to the mid-point of its range.
indicated at the start, the "overshoots

Bank

As I

in the context of

today's economic and financial conditions, are consistent with
the approach stated in my July testimony.
No deon has been taken to change the tentative
targets for 1983.

That matter will, of course, be under

intensive scrutiny over the next two months, and the targets
will be announced in February.


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Federal Reserve Bank of St. Louis

-10-

For the time being, we are placing much less emphasis
than usual on Ml.

That decision was precipitated in early

October entirely by the likelihood that the data would be
grossly distorted in that month by the maturity of a large
volume of All-Savers Certificates, part of the proceeds of
which might be expected to, at least temporarily, be placed
in checking accounts included in Ml.
In about three weeks, the introduction of a new ceilingless account at financial institutions -- highly liquid and
carrying significant transaction capabilities -- is likely to
distort further M1 data.

Judging by comments at the last

Depository Institutions Deregulation Committee meeting, that
account could rapidly be followed by a decision to approve
a ceiling-less account with full transaction capabilities.
These new accounts could have a large, but quite unpredictable,
influence on M1 for a number of months ahead as funds are reallocated among various accounts.

Moreover, the introduction

of market-rate transaction accounts will very likely result
in a different relationship and trend of M1 relative to GNP
over time.

Increasing confidence in the stability of prices

and a trend toward lower market interest rates might also
affect the desire to hold money over time.
Obviously, some judgments on those matters will be
necessary in setting a target for M1 in 1983 and in deciding
upon the degree of weight to be attached to changes in M1 in
our operations.

Those problems should appropriately be

I

-11-

described as "technical" rather than "policy" in the sense
that we will need to continue to be concerned with the rate
of growth over time of the monetary aggregates, including
transactions balances.
The decisions taken in early October do point to greater
emphasis on M2 (and M3) in planning the operational reserve
path during this transitional period.

The link between reserves

and M2 is looser and more uncertain than in the case of Ml, in
large part because reserve requirements on accounts included in
M2, apart from transactions balances, are very low or non-existent.
(Transactions balances are about 17 percent of M2.)

Therefore

once a reserve path is set, deviations of M2 from a targeted
growth range may not, more or less automatically, be reflected
in as substantial changes in pressures on bank reserve positions
or in money markets as is the case with Ml.

Consequently,

"discretionary" judgments may be necessary more frequently in
altering a reserve path than when that reserve path is focused
more heavily on Ml.

In that technical sense, the operational

approach has necessarily been modified.
In sum, the broad framework of monetary targeting has
been retained, but greater emphasis is for the time being
placed on the broader aggregates.

The specific operating

technique that had been closely related to M1 has, by force
of circumstances, been conformed to that emphasis.

Obviously,

entirely apart from questions of economic doctrine and contending approaches to monetary control, so long as M1 is


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Federal Reserve Bank of St. Louis

-12-

subjected to strong institutional distortions our techniques
must be adapted to take account of that fact.
An alternative operating approach suggested by some
of supplying and withdrawing reserves with the intent of
achieving a particular interest rate target would suffer
from several fundamental defects.*
o

The body of theory or practice does not
provide a sufficiently clear basis for
relating the level of a particular interest
rate to our ultimate objectives of growth and
price stability.

o

The implication that the Federal Reserve could
in fact achieve and maintain a particular level
of relevant interest rates in a changing economic
and financial environment is not warranted.

o

The very concept and measurement of a "real"
interest rate, as called for in some proposals,
is a matter of substantial ambiguity.

o

As a practical matter, attempts to target and fix
interest rates would make more rigid and tend to
politicize the entire process of monetary policy.

*That was not, as sometimes mistakenly thought, the operating
approach used prior to October 1979. Then, reserves were provided with the aim of achieving and maintaining a particular
Federal funds rate thought to be consistent with targets for the
monetary aggregates. The Federal funds rate was a means to
achieving a monetary target and in principle was to be handled
flexibly. In practice, among other difficulties, there appeared
to be a reluctance to permit rates to vary rapidly enough to
maintain control of the aggregates.


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-13-

•

In current circumstances, with huge budget deficits
looming, a requirement that the Federal Reserve
set explicit interest rate targets is bound to be
interpreted as inflationary, and the rekindling of
inflationary expectations will work against our
objective.

I realize the several legislative proposals addressed
to targeting interest rates would, on their face, seem to call
for interest rates as only one of several targets.

But interest

rates would certainly be the most obvious and sensitive target,
and those targets would be difficult to change.

Other evidence

for a need to "tighten" or "ease" would be subordinated, if not
ignored.
As we approach the target-setting process for 1983,
our objectives will -- indeed as required by law -- continue
to be quantified in terms of growth in relevant money and
credit aggregates.

We will have to decide how much weight to

place on M1 and other aggregates during a transonal period,
assuming new accounts continue to distort the data.

In reaching

and implementing those deons, the members of the FOMC
necessarily rely upon their own analysis of the current and
prospective course of business activity; the interrelationships
among the aggregates, economic activity, and interest rates; and
the implications of monetary growth for inflation.

In other words,

the process is not a simple mechanical one, and it seems to me
capable of incorporating -- within a general framework of monetary
discipline -- the elements of needed flexibility.


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We will also,

as part of that process, review whether technical adjustments


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-14-

in procedures for establishing and changing the reserve paths
are appropriate.

I will be reporting our conclusions to the

Congress in February.
Mr. Chairman, you have suggested that our monetary
targets might reasonably be specified as a single number,
with a range above and below.

At times we have debated

within the FOMC the wisdom of such an approach (or setting
forth a single target number without a range).

My own feeling

has been, and remains, that a single number, with or without
a range, would convey a specious sense of precision, with the
result of greater pressure to meet a more or less arbitrary
number to maintain "credibility," even if developments during
the year tend to indicate some element of flexibility is
appropriate in pursuit of the targets.
To me, our present practice of setting forth a range
is preferable.

Where appropriate, we can and should suggest

the probability of being in the upper or lower portion of
the range, or suggest what conditions could evolve in which
something other than the mid-points (or even an over or undershoot) would be appropriate.

That approach seems to me to

provide more information -- and more realism -- than a single
number and is broadly consistent with present practice.
For similar reasons, I believe we need to measure
and target a variety of aggregates because, in a swiftly
changing economic environment, any single target can be misleading:.
In that connection, I believe an indication of total credit
flows broadly consistent with the monetary targets could be
helpful.

As you know, we now provide such estimates for bank

credit alone.

-15-

Given the limits of forecasting and analysis, and the
volatility of the data, I would question the usefulness of
further sectoral estimates.

Even with respect to total credit

flows, there is considerable looseness in relationships to
economic activity for periods as long as a year
more for shorter periods.

and still

The theoretical framework relating

credit flows to other variables such as the GNP or inflation
is less fully developed than in the case of monetary aggregates,
and credit flows are less directly amenable to control.

The

enormous flows across international borders pose large conceptual and statistical problems.

Our credit data are typically

less complete and up-to-date than monetary data.
However, so long as those difficulties and limitations
are recognized -- and some of them are relevant with respect
to the monetary aggregates as well -- I share the view that
analysis of credit flows can contribute to policy formulation.
To assist in that process, Iwill propose to the FOMC that
estimates of the expected behavior of a broad credit aggregate
be set forth alongside the monetary targets in our next report.
I do strongly resist the idea of the Federal Reserve as
an institution forecasting interest rates.

No institution or

individual is capable of judging accurately the myriad of
forces working on market interest rates over time.

Expectational

elements play a strong role -- fundamentally expectations about
the course of economic activity and inflation, but also, in the
short run, expectations of Federal Reserve action.


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We could not


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-16-

escape the fact that a central bank forecast of interest rates
would be itself a market factor.

To some degree, therefore,

in looking to interest rates and other market developments for
information bearing on our policy decisions, we would be looking
into a mirror.

Moreover, the temptation would always be present

to breech the thin line between a forecast and a desire or policy
intention, with the result that operational policy decisions
could be distorted.
While it seems to me inappropriate for a central bank
to regularly forecast interest rates, analysis of key factors
influencing credit conditions and prices can be helpful at
times.
past.

On occasion, we have provided such analysis in the
My concern about the outlook for fiscal policy is rooted

in major part in such analysis because the direction of impact
on interest rates seems to me unambiguous.

I have also, on a

number of occasions, indicated that the recent and even current
level of interest rates appears extraordinarily high, provided,
as I believe, we continue to make progress on the inflation
front.

Perhaps, in our semi-annual reporting, we can more

explicitly call attention to major factors likely to influence
short or long-term interest rates and the significance for
various sectors of the economy.

But I do not believe interest

rate forecasting would be desirable or long sustainable, and
would in fact be damaging to the policy process.
:

•


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Federal Reserve Bank of St. Louis

-17-

Finally, Mr. Chairman, you have requested a "single
composite forecast" of the major economic variables by FOMC
members.

As you are well aware, our present practice is to

set forth a range of forecasts of individual FOMC members of
the nominal and real GNP, prices, and unemployment.

The fact

is we have no single "Federal Reserve" forecast, and there is
no mechanism, within a Committee or Board structure, to force
agreement on such a forecast by individual members bringing
different views, typically backed by separate staff analysis,
to the table.

A simple average -- possibly supported by no

one -- seems to me artificial.

The process of attempting to

force a consensus would certainly dilute the product.
I would put the point positively.

A range of forecasts

by individual FOMC members more accurately conveys the range
of uncertainty and contingencies that must surround any forecast.

The seeming neatness and coherence of a single forecast

too often obscures the reality that a variety of outcomes is
possible; the very essence of the policy problem is to assess
risks and probabilities -- what can go wrong as well as what
can go right.

A point forecast would likely be treated more

reverently than it would deserve, and could even distort policy
judgments in misguided efforts to "hit" a forecast.
I can understand your concern that a range of forecasts
may be misleading if strongly influenced by "outlying" opinions
rather than reflecting a more even dispersion of views.

For

that reason, I would be glad to explore with the Open Market


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-18-

Committee a procedure by which we indicated the "central
tendency" of members' views -- assuming such a central
tendency exists -- as well as indicating the range of
opinions.

Conversely, if the forecasts were evenly

distributed within the range, we could so indicate.

I

believe that approach would meet the objectives you seek in
a realistic and helpful manner.
In concluding this already long testimony, let me say
that we share the common goals of achieving, in the words of
the Employment Act of 1946 and the Humphrey Hawkins Act of
1978, "Maximum employment, production, and purchasing power"
and "full employment . . . (and) reasonable price stability."
Those objectives have eluded us for too many years.

We meet

again today in particularly difficult circumstances, and there
is a sense of frustration and uncertainty among many.
But I also happen to believe we have come a long way
toward laying the base for economic growth and stability;
economic recovery should characterize 1983, and that recovery
can mark the beginning of a long period of stable growth.
Obviously there are obstacles -- interest rates are
still too high; inflation is down but not out; there are
strains in our financial system; we face budget deficits that
are far too high; we are tempted to turn inwards or backwards
for quick solutions that ultimately can not work.

But it is

also plainly within our capacity to deal with those threats
provided only that we have a strong base of understanding among


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Federal Reserve Bank of St. Louis

-19-

us, that we resolve to act where action is necessary, and
that we have the patience and wisdom to refrain from actions
that can only be destructive.
You are leaving the Congress after 28 years, Mr. Chairman.
Through that time, you have consistently provided constructive
leadership to the effort to raise the level of economic discussion in general -- and of the dialogue between the Congress
and the Federal Reserve in particular.

I happen to believe

strongly in the independence that the Congress has provided
the Federal Reserve through the years -- but also in the need
for close and continuing communication with the Congress and
the Administration.

I presume that this is the last time I

will appear before you personally in this forum, but the
dialogue will continue to benefit from your efforts, your
initiative, and your sense of commitment in more ways than
you may realize.


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Federal Reserve Bank of St. Louis

For release on delivery
10:00 A.M., E.S.T.
November 24, 1982

Statement by

Paul A. Volcker

Chairman, Board of Governors of the Federal Reserve System

before the

Joint Economic Committee

November 24, 1982


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Federal Reserve Bank of St. Louis

I appreciate this opportunity to discuss with you
today the current stance of monetary policy and some problems
for the future.

Before responding to certain questions directed

to me about monetary policy in your letters of October 18 and
November 17, Mr. Chairman, I should first emphasize that the
basic thrust and goals of our policy are unchanged since I
testified before the Congress on July 20.

The precise means

by which we move toward our goals must take account of all the
stream of evidence we have on the behavior of (and distortions
in) the various monetary aggregates, the economy, prices, interest
rates, and the like.

But we remain convinced that lasting recovery

and growth must be sought in a framework of continuing progress
toward price stability -- and that the process of money and credit
creation must remain appropriately restrained if we are to deal
effectively with inflationary dangers.
For that reason, we must continue to set forth targets
for growth in money and credit and to judge the provision of
bank reserves

our most important operating instrument -- in

the light of the trend in the growth of these aggregates.
This process necessarily involves continuing judgments about
just what growth in those magnitudes is appropriate in the
short and longer run, matters affected by institutional change
as well as by more fundamental economic factors.


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2-

As you are aware, the current job of developing and
implementing monetary policy has been complicated by regulatory
decisions as well as by recent developments in the economy and
in our financial markets.

We have, as a consequence, (1) made

some technical modification in our operating procedures to cope
with obvious distortions in some of the monetary data -- particularly M1 -- and (2) accommodated growth in the various M's at
rates somewhat above the targeted ranges.
decisions was essentially technical.

The first of those

The latter decision is

entirely consistent with the view I expressed in testifying
before the Banking Committees in July that the Federal Open
Market Committee would tolerate "growth somewhat above the
targeted ranges .

. for a time in circumstances in which it

appeared that precautionary or liquidity motivations, during a
period of economic uncertainty and turbulence, were leading to
stronger than anticipated demands for money."
Unfortunately, the difficulties and complexities of the
economic world in which we live do not permit us the luxury of
describing policy in terms of a simple, unchanging numerical
rule.

For instance, the economic significance of any particular

statistic we label "money" can change over time -- partly because
the statistical definition of "money" is itself arbitrary and
the components of the money supply have differing degrees of
use as a medium of exchange and liquidity.

That doesn't make

much difference in a relatively stable economic, financial, and
institutional environment, but, at times of rapid change, like
the present, it can matter a great deal.


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Federal Reserve Bank of St. Louis

3

We also have to take account of varying lags -- never
known with precision -- between actions today and their consequences later.

We have to try to disentangle the temporary

and cyclical from more persistent trends in relationships among
different measures of money and inflation and economic activity.
And we have to evaluate the significance of developments abroad
as well as at home, as reflected in trade accounts and the exchange
rate, and of strains in the financial structure itself.
As this suggests, the economic environment in which we
set policy -- or policy itself

cannot be condensed into a

simple, one-dimensional statement.

Perhaps the essence of the

problem and our approach can be better captured by a few "yesbut" phrases.
(1) Yes, we have broken the inflationary momentum
but continuing vigilance and effort will be essential
to continue progress toward price stability.
As you know, the broad price indices this year have been
running at about half or less of the peak levels reached two or
three years ago.

As part of this disinflationary process, growth

in worker compensation in nominal terms has declined to the 6 to
7 percent area -- but that slower growth in nominal income has
been consistent with higher real wages as inflation has moderated.
Price and cost trends in particular sectors of the economy
are mixed -- reflecting in part lags in the process of disinflation, the effects of long wage contracts, international
and exchange rate developments, and the immediate effects of

;


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Federal Reserve Bank of St. Louis

-4-

recession on some prices -- most particularly commodities.
But there is, it seems to me, strong reason to believe that
the progress toward price stability can be maintained -- albeit
at a slower rate -- as the economy recovers.

For a time, un-

employment and excess capacity should restrain costs and prices
and, of more lasting significance, productivity growth should
improve from the poor performance of most recent years.

Taken

together, restraint on nominal wage increases and productivity
growth should moderate the increase in unit labor costs, which
account for about two-thirds of all costs.

Real incomes can

rise as inflation slows, paving the way for further progress
toward stability.
To be sure, as the economy grows, some factors holding
down prices over the past year or two will dissipate or be
reversed.

But large new "price shocks" in the energy or food

areas appear unlikely in the foreseeable future, suggesting
that a declining trend in the rise of unit labor costs should
be the most fundamental factor defining the price trend.
That analysis would not hold, however, if excessive
growth in money and credit over time came again to feed first
the expectation, and then the reality, of renewed inflation.
Too much has been "invested" in turning the inflationary
momentum to lose sight of the necessity of carrying through.
There are clear implications, as I will elaborate in a moment,
for fiscal as well as monetary policy.

:


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Federal Reserve Bank of St. Louis

-5-

(2) Yes, exceptional demands for liquidity can reasonably
be accommodated in a period of recession, high unemployment, and excess capacity -- but guidelines for
restrained money and credit growth remain relevant to
insure against renewed inflation.

A variety of specific and general evidence strongly
suggests that the desire to hold cash and other highly liquid
assets, relative to income, has increased this year.

Much of

the more rapid increase in M1 has been in interest-bearing NOW
accounts, which did not exist a few years ago but which provide
the basic elements of a savings, as well as transaction, account.
With market interest rates falling, those accounts have been
relatively more attractive on interest rate grounds alone, and
they are a convenient means of storing liquidity at a time of
economic and financial uncertainty.

At the same time, the

broader aggregates appear to reflect some of the same liquidity
motivations, as well as the stronger savings growth in the wake
of the tax cut.
Most broadly, we can now observe, over a period of more
than a year, a distinct decline in "velocity" -- that is, the
relationship between the GNP and monetary aggregates.

The

velocity decline for Ml, which is likely to amount to about
3% from the fourth quarter of 1981 to the fourth quarter of 1982,
stands in sharp contrast to the average yearly rise in velocity
over the past decade; it will be the first significant


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6

decline in velocity in about 30 years.

M2 and M3 velocities --

which had been relatively trendless earlier -- have also declined
signcantly.
not unusual

While some tendency toward slower velocity is

na midst of recession, the magnitude and per-

sistence of the movement in 1982 is indicative of a pronounced
tendency to hold more liquid assets relative to current income.
Without some accommodation of that preference, monetary policy
at the present time would be substantially more restraining in
its effect on the economy than intended when the targets for
the various aggregates were originally set out earlier this
year.
At the same time, policy must take into account the
probability that the demands for liquidity will, in whole or
in major part, prove temporary, and that an excessive rise in
money or other liquid assets could feed inflationary forces
later.

Elements of judgment are inevitably involved in sorting

out these considerations -- judgments resting on analysis of
the economy, interest rates, and other factors.

But broad

guidelines for assessing the appropriate growth on the basis
of historical experience will surely remain relevant and
appropriate.
In that connection, I must note the implications of the
future Federal budgetary position.

To put the point briefly,

the prospect of huge continuing budgetary deficits, even as the
economy recovers, carries with it the threat of either excessive
liquidity creation and inflation in future years, or a "crowdingout" 5f 5ther borrowers as monetary growth is restrained in the


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7-

face of the Treasury financing needs, or a combination of both.
The problems flowing from the future deficits are simply not
amenable to solution by monetary policy.

Moreover, the concern

engendered in the marketplace works in the direction of higher
interest rates today than would otherwise be the case, contrary
to the needs of recovery.

I know something of how difficult it

is to achieve further budgetary savings, but I must emphasize
again how important it is to see the deficit reduced as the
economy recovers.

The fact is those looming deficits are a

major hazard in sustaining recovery.
(3) Yes, lower interest rates are critically important
in supporting the economy and encouraging recovery
but we also want to be able to maintain lower
interest rates over time.

Since early summer, short-term interest rates have
generally declined by five to six percentage points, and
mortgage and most other long-term rates have dropped by three
to four percentage points.

While consumer loan rates administered

by banks and other financial institutions have lagged, they are
also now moving lower.

There are clear signs of a rise in home

sales and building in response to these interest rate declines,
and other sectors of the economy are benefiting as well.
We have also had experience in recent years of sharp
increases in interest rates curtailing economic activity at
times when recovery was incomplete and unemployment high.
Sudden large fluctuations in interest rates contribute to

•

Inb.

-8-

other economic and financial distortions as well.

And no

doubt the fact that many interest rates remain historically
high, relative to the current rate of inflation, reflects
continuing skepticism over prospects for carrying through the
fight on inflation.
In this situation, the Federal Reserve has welcomed
the declines in interest rates both because of the support
they offer economic activity and because they seem to reflect
a sense that the inflationary trend has changed.

However, we

do not believe that progress toward lower interest rates should
or for long in practice can -- be "forced" at the expense of
excessive credit and money creation.

To attempt to do so

would simply risk the revival of inflationary forces; renewed
expectations of inflation would soon be reflected in the longerterm credit markets, damaging prospects for the long-lasting
expansion we all want.
Turning to your explicit questions, Mr. Chairman,
against this general background, I believe most policy-making
officials in the Federal Reserve share the general view that
economic recovery will be evident throughout 1983, but at a
moderate rate of speed -- probably slower than during previous
post-recession years.

Unambiguous evidence that the recovery

is already underway is still absent, although encouraging signs
are evident in some rise in housing, in the improved liquidity
and wealth and reduced debt positions of consumers, and in
,


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surveys reporting that attitudes and orders may be stabilizing


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-9

or improving.

The Federal deficit, while fraught with danger

for the future, is of course providing massive support for
incomes at present.
What is crucially important -- particularly in the
light of the experience of recent years -- is that we set
the stage for an expansion that can be sustained over a long
period, bringing with it strong gains in productivity and
investment and lasting improvement in employment.

I have

already emphasized the importance of progress toward price
stability to that outlook, and the evidence that, with
disciplined monetary and fiscal policies, we can sustain
that progress.
So far as the specific questions about monetary policy
in your October 18 letter are concerned, we have not, as you
know, set any new monetary targets for 1982.

Current trends

do indicate that the various M's will end the year above the
upper end of the target ranges, probably by 1/2 to 1% for M2
and M3 and more for M1 given the current distortions.
credit will be close to the mid-point of its range.

Bank

As I

indicated at the start, the "overshoots," in the context of
today's economic and financial conditions, are consistent with
the approach stated in my July testimony.
No decision has been taken to change the tentative
targets for 1983.

That matter will, of course, be under

intensive scrutiny over the next two months, and the targets
will be announced in February.


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-10-

For the time being, we are placing much less emphasis
than usual on Ml.

That decision was precipitated in early

October entirely by the likelihood that the data would be
grossly distorted in that month by the maturity of a large
volume of All-Savers Certificates, part of the proceeds of
which might be expected to, at least temporarily, be placed
in checking accounts included in Ml.
In about three weeks, the introduction of a new ceilingless account at financial institutions -- highly liquid and
carrying significant transaction capabilities -- is likely to
distort further M1 data.

Judging by comments at the last

Depository Institutions Deregulation Committee meeting, that
account could rapidly be followed by a decision to approve
a ceiling-less account with full transaction capabilities.
These new accounts could have a large, but quite unpredictable,
influence on M1 for a number of months ahead as funds are reallocated among various accounts.

Moreover, the introduction

of market-rate transaction accounts will very likely result
in a different relationship and trend of M1 relative to GNP
over time.

Increasing confidence in the stability of prices

and a trend toward lower market interest rates might also
affect the desire to hold money over time.
Obviously, some judgments on those matters will be
necessary in setting a target for M1 in 1983 and in deciding
upon the degree of weight to be attached to changes in M1 in
our operations.

Those problems should appropriately be

-11-

described as "technical" rather than "policy" in the sense
that we will need to continue to be concerned with the rate
of growth over time of the monetary aggregates, including
transactions balances.
The decisions taken in early October do point to greater
emphasis on M2 (and M3) in planning the operational reserve
path during this transitional period.

The link between reserves

and M2 is looser and more uncertain than in the case of Ml, in
large part because reserve requirements on accounts included in
M2, apart from transactions balances, are very low or non-existent.
(Transactions balances are about 17 percent of M2.)

Therefore

once a reserve path is set, deviations of M2 from a targeted
growth range may not, more or less automatically, be reflected
in as substantial changes in pressures on bank reserve positi
ons
or in money markets as is the case with Ml.

Consequently,

"discretionary" judgments may be necessary more frequently
in
altering a reserve path than when that reserve path is focuse
d
more heavily on Ml.

In that technical sense, the operational

approach has necessarily been modified.
In sum, the broad framework of monetary targeting has
been retained, but greater emphasis is for the time being
placed on the broader aggregates.

The specific operating

technique that had been closely related to M1 has, by force
of circumstances, been conformed to that emphasis.

Obviously,

entirely apart from questions of economic doctrine and contending approaches to monetary control, so long as M1 is


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NkI\

-12-

subjected to strong institutional distortions our techniques
must be adapted to take account of that fact.
An alternative operating approach suggested by some
of supplying and withdrawing reserves with the intent of
achieving a particular interest rate target would suffer
from several fundamental defects.*
o

The body of theory or practice does not
provide a sufficiently clear basis for
relating the level of a particular interest
rate to our ultimate objectives of growth and
price stability.

o

The implication that the Federal Reserve could
in fact achieve and maintain a particular level
of relevant interest rates in a changing economic
and financial environment is not warranted.

o

The very concept and measurement of a "real"
interest rate, as called for in some proposals,
is a matter of substantial ambiguity.

o

As a practical matter, attempts to target and fix
interest rates would make more rigid and tend to
politicize the entire process of monetary policy.

*That was not, as sometimes mistakenly thought, the operating
approach used prior to October 1979. Then, reserves were provided with the aim of achieving and maintaining a particular
Federal funds rate thought to be consistent with targets for the
monetary aggregates. The Federal funds rate was a means to
achieving a monetary target and in principle was to be handled
flexibly. In practice, among other difficulties, there appeared
to be a reluctance to permit rates to vary rapidly enough to
maintain control of the aggregates.


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-13-

o

In current circumstances, with huge budget deficits
looming, a requirement that the Federal Reserve
set explicit interest rate targets is bound to be
interpreted as inflationary, and the rekindling of
inflationary expectations will work against our
objective.

I realize the several legislative proposals addressed
to targeting interest rates would, on their face, seem to call
for interest rates as only one of several targets.

But interest

rates would certainly be the most obvious and sensitive target,
and those targets would be difficult to change.

Other evidence

for a need to "tighten" or "ease" would be subordinated, if not
ignored.
As we approach the target-setting process for 1983,
our objectives will -- indeed as required by law -- continue
to be quantified in terms of growth in relevant money and
credit aggregates.

We will have to decide how much weight to

place on M1 and other aggregates during a transitional period,
assuming new accounts continue to distort the data.

In reaching

and implementing those decisions, the members of the FOMC
necessarily rely upon their own analysis of the current and
prospective course of business activity; the interrelationships
among the aggregates, economic activity, and interest rates; and
the implications of monetary growth for inflation.

In other words,

the process is not a simple mechanical one, and it seems to me
capable of incorporating -- within a general framework of monetary
discipline -- the elements of needed flexibility.

We will also,

as part of that process, review whether technical adjustments


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-14-

in procedures for establishing and changing the reserve paths
are appropriate.

I will be reporting our conclusions to the

Congress in February.
Mr. Chairman, you have suggested that our monetary
targets might reasonably be specified as a single number,
with a range above and below.

At times we have debated

within the FOMC the wisdom of such an approach (or setting
forth a single target number without a range).

My own feeling

has been, and remains, that a single number, with or without
a range, would convey a specious sense of precision, with the
result of greater pressure to meet a more or less arbitrary
number to maintain "credibility," even if developments during
the year tend to indicate some element of flexibility is
appropriate in pursuit of the targets.
To me, our present practice of setting forth a range
is preferable.

Where appropriate, we can and should suggest

the probability of being in the upper or lower portion of
the range, or suggest what conditions could evolve in which
something other than the mid-points (or even an over or undershoot) would be appropriate.

That approach seems to me to

provide more information -- and more realism -- than a single
number and is broadly consistent with present practice.
For similar reasons, I believe we need to measure
and target a variety of aggregates because, in a swiftly
changing economic environment, any single target can be misleading:.
In that connection, I believe an indication of total credit
flows broadly consistent with the monetary targets could be
helpful.

As you know, we now provide such estimates for bank

credit alone.

#

-15-

Given the limits of forecasting and analysis, and the
volatility of the data, I would question the usefulness of
further sectoral estimates.

Even with respect to total credit

flows, there is considerable looseness in relationships to
economic activity for periods as long as a year -- and still
more for shorter periods.

The theoretical framework relating

credit flows to other variables such as the GNP or inflation
is less fully developed than in the case of monetary aggregates,
and credit flows are less directly amenable to control.

The

enormous flows across international borders pose large conceptual and statistical problems.

Our credit data are typically

less complete and up-to-date than monetary data.
However, so long as those difficulties and limitations
are recognized -- and some of them are relevant with respect
to the monetary aggregates as well -- I share the view that
analysis of credit flows can contribute to policy formulation.
To assist in that process, Iwill propose to the FOMC that
estimates of the expected behavior of a broad credit aggregate
be set forth alongside the monetary targets in our next report.
I do strongly resist the idea of the Federal Reserve as
an institution forecasting interest rates.

No institution or

individual is capable of judging accurately the myriad of
forces working on market interest rates over time.

Expectational

elements play a strong role -- fundamentally expectations about
the course of economic activity and inflation, but also, in the
short run, expectations of Federal Reserve action.


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We could not


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-16-

escape the fact that a central bank forecast of interest rates
would be itself a market factor.

To some degree, therefore,

in looking to interest rates and other market developments for
information bearing on our policy deons, we would be looking
into a mirror.

Moreover, the temptation would always be present

to breech the thin line between a forecast and a desire or policy
intention, with the result that operational policy decisions
could be distorted.
While it seems to me inappropriate for a central bank
to regularly forecast interest rates, analysis of key factors
influencing credit conditions and prices can be helpful at
times.
past.

On occasion, we have provided such analysis in the
My concern about the outlook for fiscal policy is rooted

in major part in such analysis because the direction of impact
on interest rates seems to me unambiguous.

I have also, on a

number of occasions, indicated that the recent and even current
level of interest rates appears extraordinarily high, provided,
as I believe, we continue to make progress on the inflation
front.

Perhaps, in our semi-annual reporting, we can more

explicitly call attention to major factors likely to influence
short or long-term interest rates and the significance for
various sectors of the economy.

But I do not believe interest

rate forecasting would be desirable or long sustainable, and
would in fact be damaging to the policy process.
:

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‘..


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I

-17-

Finally, Mr. Chairman, you have requested a "single
composite forecast" of the major economic variables by FOMC
members.

As you are well aware, our present practice is to

set forth a range of forecasts of individual FOMC members of
the nominal and real GNP, prices, and unemployment.

The fact

is we have no single "Federal Reserve" forecast, and there is
no mechanism, within a Committee or Board structure, to force
agreement on such a forecast by individual members bringing
different views, typically backed by separate staff analysis,
to the table.

A simple average -- possibly supported by no

one -- seems to me artificial.

The process of attempting to

force a consensus would certainly dilute the product.
I would put the point positively.

A range of forecasts

by individual FOMC members more accurately conveys the range
of uncertainty and contingencies that must surround any forecast.

The seeming neatness and coherence of a single forecast

too often obscures the reality that a variety of outcomes is
possible; the very essence of the policy problem is to assess
risks and probabilities -- what can go wrong as well as what
can go right.

A point forecast would likely be treated more

reverently than it would deserve, and could even distort policy
judgments in misguided efforts to "hit" a forecast.
I can understand your concern that a range of forecasts
may be misleading if strongly influenced by "outlying" opinions
rather than reflecting a more even dispersion of views.

For

that reason, I would be glad to explore with the Open Market


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Federal Reserve Bank of St. Louis

-18-

Committee a procedure by which we indicated the "central
tendency" of members' views -- assuming such a central
tendency exists -- as well as indicating the range of
opinions.

Conversely, if the forecasts were evenly

distributed within the range, we could so indicate.

I

believe that approach would meet the objectives you seek in
a realistic and helpful manner.
In concluding this already long testimony, let me say
that we share the common goals of achieving, in the words of
the Employment Act of 1946 and the Humphrey Hawkins Act of
1978, "Maximum employment, production, and purchasing power"
and "full employment . . . (and) reasonable price stability."
Those objectives have eluded us for too many years.

We meet

again today in particularly difficult circumstances, and there
is a sense of frustration and uncertainty among many.
But I also happen to believe we have come a long way
toward laying the base for economic growth and stability;
economic recovery should characterize 1983, and that recovery
can mark the beginning of a long period of stable growth.
Obviously there are obstacles -- interest rates are
still too high; inflation is down but not out; there are
strains in our financial system; we face budget deficits that
are far too high; we are tempted to turn inwards or backwards
for quick solutions that ultimately can not work.

But it is

also plainly within our capacity to deal with those threats
provided only that we have a strong base of understanding among

•••


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-19-

us, that we resolve to act where action is necessary, and
that we have the patience and wisdom to refrain from actions
that can only be destructive.
You are leaving the Congress after 28 years, Mr. Chairman.
Through that time, you have consistently provided constructive
leadership to the effort to raise the level of economic discussion in general -- and of the dialogue between the Congress
and the Federal Reserve in particular.

I happen to believe

strongly in the independence that the Congress has provided
the Federal Reserve through the years -- but also in the need
for close and continuing communication with the Congress and
the Administration.

I presume that this is the last time I

will appear before you personally in this forum, but the
dialogue will continue to benefit from your efforts, your
initiative, and your sense of commitment in more ways than
you may realize.


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Federal Reserve Bank of St. Louis

For release on delivery
10:00 A.M., E.S.T.
November 24, 1982

Statement by

Paul A. Volcker

Chairman, Board of Governors of the Federal Reserve System

before the

Joint Economic Committee

November 24, 1982


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Federal Reserve Bank of St. Louis

I appreciate this opportunity to discuss with you
today the current stance of monetary policy and some problems
for the future.

Before responding to certain questions directed

to me about monetary policy in your letters of October 18 and
November 17, Mr. Chairman, I should first emphasize that the
basic thrust and goals of our policy are unchanged since I
testified before the Congress on July 20.

The precise means

by which we move toward our goals must take account of all the
stream of evidence we have on the behavior of (and distortions
in) the various monetary aggregates, the economy, prices, interest
rates, and the like.

But we remain convinced that lasting recovery

and growth must be sought in a framework of continuing progress
toward price stability -- and that the process of money and credit
creation must remain appropriately restrained if we are to deal
effectively with inflationary dangers.
For that reason, we must continue to set forth targets
for growth in money and credit and to judge the provision of
bank reserves

our most important operating instrument -- in

the light of the trend in the growth of these aggregates.
This process necessarily involves continuing judgments about
just what growth in those magnitudes is appropriate in the
short and longer run, matters affected by institutional change
as well as by more fundamental economic factors.

2-

As you are aware, the current job of developing and
implementing monetary policy has been complicated by regulatory
decisions as well as by recent developments in the economy and
in our financial markets.

We have, as a consequence, (1) made

some technical modification in our operating procedures to cope
with obvious distortions in some of the monetary data -- particularly MI -- and (2) accommodated growth in the various M's at
rates somewhat above the targeted ranges.
decisions was essentially technical.

The first of those

The latter decision is

entirely consistent with the view I expressed in testifying
before the Banking Committees in July that the Federal Open
Market Committee would tolerate "growth somewhat above the
targeted ranges .

. for a time in circumstances in which it

appeared that precautionary or liquidity motivations, during a
period of economic uncertainty and turbulence, were leading to
stronger than anticipated demands for money."
Unfortunately, the difficulties and complexities of the
economic world in which we live do not permit us the luxury of
describing policy in terms of a simple, unchanging numerical
rule.

For instance, the economic significance of any particular

statistic we label "money" can change over time -- partly because
the statistical definition of "money" is itself arbitrary and
the components of the money supply have differing degrees of
use as a medium of exchange and liquidity.

That doesn't make

much difference in a relatively stable economic, financial, and
institutional environment, but, at times of rapid change, like
the present, it can matter a great deal.


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0


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4

-3-

We also have to take account of varying lags -- never
known with precision -- between actions today and their consequences later.

We have to try to disentangle the temporary

and cyclical from more persistent trends in relationships among
different measures of money and inflation and economic activity.
And we have to evaluate the significance of developments abroad
as well as at home, as reflected in trade accounts and the exchange
rate, and of strains in the financial structure itself.
As this suggests, the economic environment in which we
set policy -- or policy itself -- cannot be condensed into a
simple, one-dimensional statement.

Perhaps the essence of the

problem and our approach can be better captured by a few "yesbut" phrases.
(1) Yes, we have broken the inflationary momentum
but continuing vigilance and effort will be essential
to continue progress toward price stability.
As you know, the broad price indices this year have been
running at about half or less of the peak levels reached two or
three years ago.

As part of this disinflationary process, growth

in worker compensation in nominal terms has declined to the 6 to
7 percent area -- but that slower growth in nominal income has
been consistent with higher real wages as inflation has moderated.
Price and cost trends in particular sectors of the economy
are mixed -- reflecting in part lags in the process of disinflation, the effects of long wage contracts, international
and exchange rate developments, and the immediate effects of


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-4-

recession on some prices -- most particularly commodes.
But thereseemsstrong reason to believe that
the progress toward price stability can be maintained -- albeit
at a slower rate -- as the economy recovers.

For a time, un-

employment and excess capacity should restrain costs and prices
and, of more lasting signance, productivity growth should
improve from the poor performance of most recent years.

Taken

together, restraint on nominal wage increases and productivity
growth should moderate the increase in unit labor costs, which
account for about two-thirds of all costs.

Real incomes can

rise as inflation slows, paving the way for further progress
toward stability.
To be sure, as the economy grows, some factors holding
down prices over the past year or two will dissipate or be
reversed.

But large new "price shocks" in the energy or food

areas appear unlikely in the foreseeable future, suggesting
that a declining trend in the rise of unit labor costs should
be the most fundamental factor defining the price trend.
That analysis would not hold, however, if excessive
growth in money and credit over time came again to feed first
the expectation, and then the reality, of renewed inflation.
Too much has been "invested" in turning the inflationary

momentum to lose sight of the necessity of carrying through.
There are clear implications, as I will elaborate in a moment,
for fiscal as well as monetary policy.

;


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5

(2) Yes, exceptional demands for liquidity can reasonably
be accommodated in a period of recession, high unemployment, and excess capacity -- but guidelines for
restrained money and credit growth remain relevant to
insure against renewed inflation.

A variety of specific and general evidence strongly
suggests that the desire to hold cash and other highly liquid
assets, relative to income, has increased this year.

Much of

the more rapid increase in M1 has been in interest-bearing NOW
accounts, which did not exist a few years ago but which provide
the basic elements of a savings, as well as transaction, account.
With market interest rates falling, those accounts have been
relatively more attractive on interest rate grounds alone, and
they are a convenient means of storing liquidity at a time of
economic and financial uncertainty.

At the same time, the

broader aggregates appear to reflect some of the same liquidity
motivations, as well as the stronger savings growth in the wake
of the tax cut.
Most broadly, we can now observe, over a period of more
than a year, a distinct decline in "velocity" -- that is, the
relationship between the GNP and monetary aggregates.

The

velocity decline for Ml, which is likely to amount to about
3% from the fourth quarter of 1981 to the fourth quarter of 1982,
stands in sharp contrast to the average yearly rise in velocity
of 3-4% over the past decade; it will be the first significant


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Federal Reserve Bank of St. Louis

6

decline in velocity in about 30 years.

M2 and M3 velocities --

which had been relatively trendless earlier -- have also declined
significantly.

While some tendency toward slower velocity is

not unusual in the midst of recession, the magnitude and persistence of the movement in 1982 is indicative of a pronounced
tendency to hold more liquid assets relative to current income.
Without some accommodation of that preference, monetary policy
at the present time would be substantially more restraining in
its effect on the economy than intended when the targets for
the various aggregates were originally set out earlier this
year.
At the same time, policy must take into account the
probability that the demands for liquidity will, in whole or
in major part, prove temporary, and that an excessive rise in
money or other liquid assets could feed inflationary forces
later.

Elements of judgment are inevitably involved in sorting

out these considerations -- judgments resting on analysis of
the economy, interest rates, and other factors.

But broad

guidelines for assessing the appropriate growth on the basis
of historical experience will surely remain relevant and
appropriate.
In that connection, I must note the implications of the
future Federal budgetary position.

To put the point briefly,

the prospect of huge continuing budgetary deficits, even as the
economy recovers, carries with it the threat of either excessive
liquidity creation and inflation in future years, or a "crowdingout" of other borrowers as monetary growth is restrained in the


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7-

face of the Treasury financing needs, or a combination of both.
The problems flowing from the future deficits are simply not
amenable to solution by monetary policy.

Moreover, the concern

engendered in the marketplace works in the direction of higher
interest rates today than would otherwise be the case, contrary
to the needs of recovery.

I know something of how difficult it

is to achieve further budgetary savings, but I must emphasize
again how important it is to see the deficit reduced as the
economy recovers.

The fact is those looming deficits are a

major hazard in sustaining recovery.
(3) Yes, lower interest rates are critically important
in supporting the economy and encouraging recovery
but we also want to be able to maintain lower
interest rates over time.

Since early summer, short-term interest rates have
generally declined by five to six percentage points, and
mortgage and most other long-term rates have dropped by three
to four percentage points.

While consumer loan rates administered

by banks and other financial institutions have lagged, they are
also now moving lower.

There are clear signs of a rise in home

sales and building in response to these interest rate declines,
and other sectors of the economy are benefiting as well.
We have also had experience in recent years of sharp
increases in interest rates curtailing economic activity at
times when recovery was incomplete and unemployment high.
Sudden large fluctuations in interest rates contribute to


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8-

-

other economic and financial distortions as well.

And no

doubt the fact that many interest rates remain historically
high, relative to the current rate of inflation, reflects
continuing skepticism over prospects for carrying through the
fight on inflation.
In this situation, the Federal Reserve has welcomed
the declines in interest rates both because of the support
they offer economic activity and because they seem to reflect
a sense that the inflationary trend has changed.

However, we

do not believe that progress toward lower interest rates should -or for long in practice can -- be "forced" at the expense of
excessive credit and money creation.

To attempt to do so

would simply risk the revival of inflationary forces; renewed
expectations of inflation would soon be reflected in the longerterm credit markets, damaging prospects for the long-lasting
expansion we all want.
Turning to your explicit questions, Mr. Chairman,
against this general background, I believe most policy-making
officials in the Federal Reserve share the general view that
economic recovery will be evident throughout 1983, but at a
moderate rate of speed -- probably slower than during previous
post-recession years.

Unambiguous evidence that the recovery

is already underway is still absent, although encouraging signs
are evident in some rise in housing, in the improved liquidity
and wealth and reduced debt positions of consumers, and in
surveys reporting that attitudes and orders may be stabilizing

-9

or improving.

The Federal deficit, while fraught with danger

for the future, is of course providing massive support for
incomes at present.
What is crucially important -- particularly in the
light of the experience of recent years -- is that we set
the stage for an expansion that can be sustained over a long
period, bringing with it strong gains in productivity and
investment and lasting improvement in employment.

I have

already emphasized the importance of progress toward price
stability to that outlook, and the evidence that, with
disciplined monetary and fiscal policies, we can sustain
that progress.
So far as the specific questions about monetary policy
in your October 18 letter are concerned, we have not, as you
know, set any new monetary targets for 1982.

Current trends

do indicate that the various M's will end the year above the
upper end of the target ranges, probably by 1/2 to 1% for M2
and M3 and more for M1 given the current distortions.
credit will be close to the mid-point of its range.

Bank

As I

indicated at the start, the "overshoots," in the context of
today's economic and financial conditions, are consistent with
the approach stated in my July testimony.
No decision has been taken to change the tentative
targets for 1983.

That matter will, of course, be under

intensive scrutiny over the next two months, and the targets
--•


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will be announced in February.


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-10-

For the time being, we are placing much less emphasis
than usual on Ml.

That decision was precipitated in early

October entirely by the likelihood that the data would be
grossly distorted in that month by the maturity of a large
volume of All-Savers Certificates, part of the proceeds of
which might be expected to, at least temporarily, be placed
in checking accounts included in Ml.
In about three weeks, the introduction of a new ceilingless account at financial institutions -- highly liquid and
carrying significant transaction capabilities -- is likely to
distort further M1 data.

Judging by comments at the last

Depository Institutions Deregulation Committee meeting, that
account could rapidly be followed by a decision to approve
a ceiling-less account with full transaction capabilities.
These new accounts could have a large, but quite unpredictable,
influence on M1 for a number of months ahead as funds are reallocated among various accounts.

Moreover, the introduction

of market-rate transaction accounts will very likely result
in a different relationship and trend of M1 relative to GNP
over time.

Increasing confidence in the stability of prices

and a trend toward lower market interest rates might also
affect the desire to hold money over time.
Obviously, some judgments on those matters will be
necessary in setting a target for M1 in 1983 and in deciding
upon the degree of weight to be attached to changes in M1 in
our operations.

Those problems should appropriately be

-11-

described as "technical" rather than "policy" in the sense
that we will need to continue to be concerned with the rate
of growth over time of the monetary aggregates, including
transactions balances.
The decisions taken in early October do point to greater
emphasis on M2 (and M3) in planning the operational reserve
path during this transitional period.

The link between reserves

and M2 is looser and more uncertain than in the case of Ml, in
large part because reserve requirements on accounts included in
M2, apart from transactions balances, are very low or non-existent
.
(Transactions balances are about 17 percent of M2.)

Therefore

once a reserve path is set, deviations of M2 from a targeted
growth range may not, more or less automatically, be reflected
in as substantial changes in pressures on bank reserve positions
or in money markets as is the case with Ml.

Consequently,

"discretionary" judgments may be necessary more frequently in
altering a reserve path than when that reserve path is focused
more heavily on Ml.

In that technical sense, the operational

approach has necessarily been modified.
In sum, the broad framework of monetary targeting has
been retained, but greater emphasis is for the time being
placed on the broader aggregates.

The specific operating

technique that had been closely related to M1 has, by force
of circumstances, been conformed to that emphasis.

Obviously,

entirely apart from questions of economic doctrine and contending approaches to monetary control, so long as M1 is


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-12-

subjected to strong institutional distortions our techniques
must be adapted to take account of that fact.
An alternative operating approach suggested by some
of supplying and withdrawing reserves with the intent of
achieving a particular interest rate target would suffer
from several fundamental defects.*
o

The body of theory or practice does not
provide a sufficiently clear basis for
relating the level of a particular interest
rate to our ultimate objectives of growth and
price stability.

o

The implication that the Federal Reserve could
in fact achieve and maintain a particular level
of relevant interest rates in a changing economic
and financial environment is not warranted.

o

The very concept and measurement of a "real"
interest rate, as called for in some proposals,
is a matter of substantial ambiguity.

o

As a practical matter, attempts to target and fix
interest rates would make more rigid and tend to
politicize the entire process of monetary policy.

*That was not, as sometimes mistakenly thought, the operating
approach used prior to October 1979. Then, reserves were provided with the aim of achieving and maintaining a particular
Federal funds rate thought to be consistent with targets for the
monetary aggregates. The Federal funds rate was a means to
achieving a monetary target and in principle was to be handled
flexibly. In practice, among other difficulties, there appeared
to be a reluctance to permit rates to vary rapidly enough to
maintain control of the aggregates.


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-13-

o

In current circumstances, with huge budget deficits
looming, a requirement that the Federal Reserve
set explicit interest rate targets is bound to be
interpreted as inflationary, and the rekindling of
inflationary expectations will work against our
objective.

I realize the several legislative proposals addressed
to targeting interest rates would, on their face, seem to call
for interest rates as only one of several targets.

But interest

rates would certainly be the most obvious and sensitive target,
and those targets would be difficult to change.

Other evidence

for a need to "tighten" or "ease" would be subordinated, if not
ignored.
As we approach the target-setting process for 1983,
our objectives will -- indeed as required by law -- continue
to be quantified in terms of growth in relevant money and
credit aggregates.

We will have to decide how much weight to

place on M1 and other aggregates during a transitional period,
assuming new accounts continue to distort the data.

In reaching

and implementing those decisions, the members of the FOMC
necessarily rely upon their own analysis of the current and
prospective course of business activity; the interrelationships
among the aggregates, economic activity, and interest rates; and
the implications of monetary growth for inflation.

In other words,

the process is not a simple mechanical one, and it seems to me
capable of incorporating -- within a general framework of monetary
discipline -- the elements of needed flexibility.

We will also,

as part of that process, review whether technical adjustments

-14-

in procedures for establishing and changing the reserve paths
are appropriate.

I will be reporting our conclusions to the

Congress in February.
Mr. Chairman, you have suggested that our monetary
targets might reasonably be specified as a single number,
with a range above and below.

At times we have debated

within the FOMC the wisdom of such an approach (or setting
forth a single target number without a range).

My own feeling

has been, and remains, that a single number, with or without
a range, would convey a specious sense of preon, with the
result of greater pressure to meet a more or less arbitrary
number to maintain "credibility

even if developments during

the year tend to indicate some element of flexibility is
appropriate in pursuit of the targets.
To me, our present practice of setting forth a range
is preferable.

Where appropriate, we can and should suggest

the probability of being in the upper or lower portion of
the range, or suggest what condons could evolve in which
something other than the mid-points (or even an over or undershoot) would be appropriate.

That approach seems to me to

provide more information -- and more realism -- than a single
number and is broadly consistent with present practice.
For similar reasons, I believe we need to measure
and target a variety of aggregates because,, in a swiftly
changing economic environment, any single target can be misleading:.
In that connection, I believe an indication of total credit
flows broadly consistent with the monetary targets could be
helpful.

As you know, we now provide such estimates for bank

credit alone.

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—

e

-15-

Given the limits of forecasting and analysis, and the
volatility of the data, I would question the usefulness of
further sectoral estimates.

Even with respect to total credit

flows, there is considerable looseness in relationships to
economic activity for periods as long as a year -- and still
more for shorter periods.

The theoretical framework relating

credit flows to other variables such as the GNP or inflation
is less fully developed than in the case of monetary aggregates,
and credit flows are less directly amenable to control.

The

enormous flows across international borders pose large conceptual and statistical problems.

Our credit data are typically

less complete and up-to-date than monetary data.
However, so long as those difficulties and limitations
are recognized -- and some of them are relevant with respect
to the monetary aggregates as well -- I share the view that
analysis of credit flows can contribute to policy formulation.
To assist in that process, Iwill propose to the FOMC that
estimates of the expected behavior of a broad credit aggregate
be set forth alongside the monetary targets in our next report.
I do strongly resist the idea of the Federal Reserve as
an institution forecasting interest rates.

No institution or

individual is capable of judging accurately the myriad of
forces working on market interest rates over time.

Expectational

elements play a strong role -- fundamentally expectations about
;
the course of economic activity and inflation, but also, in the
short run, expectations of Federal Reserve action.


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,

We could not


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-16-

escape the fact that a central bank forecast of interest rates
would be itself a market factor.

To some degree, therefore,

in looking to interest rates and other market developments for
information bearing on our policy decisions, we would be looking
into a mirror.

Moreover, the temptation would always be present

to breech the thin line between a forecast and a desire or policy
intention, with the result that operational policy decisions
could be distorted.
While it seems to me inappropriate for a central bank
to regularly forecast interest rates, analysis of key factors
influencing credit conditions and prices can be helpful at
times.
past.

On occasion, we have provided such analysis in the
My concern about the outlook for fiscal policy is rooted

in major part in such analysis because the direction of impact
on interest rates seems to me unambiguous.

I have also, on a

number of occasions, indicated that the recent and even current
level of interest rates appears extraordinarily high, provided,
as I believe, we continue to make progress on the inflation
front.

Perhaps, in our semi-annual reporting, we can more

explicitly call attention to major factors likely to influence
short or long-term interest rates and the significance for
various sectors of the economy.

But I do not believe interest

rate forecasting would be desirable or long sustainable, and
would in fact be damaging to the policy process.
;


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Federal Reserve Bank of St. Louis

•
-17-

Finally, Mr. Chairman, you have requested a "single
composite forecast" of the major economic variables by FOMC
members.

As you are well aware, our present practice is to

set forth a range of forecasts of individual FOMC members of
the nominal and real GNP, prices, and unemployment.

The fact

is we have no single "Federal Reserve" forecast, and there is
no mechanism, within a Committee or Board structure, to force
agreement on such a forecast by individual members bringing
different views, typically backed by separate staff analysis,
to the table.

A simple average -- possibly supported by no

one -- seems to me artificial.

The process of attempting to

force a consensus would certainly dilute the product.
I would put the point positively.

A range of forecasts

by individual FOMC members more accurately conveys the range
of uncertainty and contingencies that must surround any forecast.

The seeming neatness and coherence of a single forecast

too often obscures the reality that a variety of outcomes is
possible; the very essence of the policy problem is to assess
risks and probabilities -- what can go wrong as well as what
can go right.

A point forecast would likely be treated more

reverently than it would deserve, and could even distort policy
judgments in misguided efforts to "hit" a forecast.
I can understand your concern that a range of forecasts
may be misleading if strongly influenced by "outlying" opinions
rather than reflecting a more even dispersion of views.

For

that reason, I would be glad to explore with the Open Market


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Federal Reserve Bank of St. Louis

-18--

Committee a procedure by which we indicated the "central
tendency" of members' views -- assuming such a central
tendency exists -- as well as indicating the range of
opinions.

Conversely, if the forecasts were evenly

distributed within the range, we could so indicate.
believe that approach would meet the objectives you seek in
a realistic and helpful manner.
In concluding this already long testimony, let me say
that we share the common goals of achieving, in the words of
the Employment Act of 1946 and the Humphrey Hawkins Act of
1978, "Maximum employment, production, and purchasing power"
and "full employment . . . (and) reasonable price stability."
Those objectives have eluded us for too many years.

We meet

again today in particularly difficult circumstances, and there
is a sense of frustration and uncertainty among many.
But I also happen to believe we have come a long way
toward laying the base for economic growth and stability;
economic recovery should characterize 1983, and that recovery
can mark the beginning of a long period of stable growth.
Obviously there are obstacles -- interest rates are
still too high; inflation is down but not out; there are
strains in our financial system; we face budget deficits that
are far too high; we are tempted to turn inwards or backwards
for quick solutions that ultimately can not work.

But it is

also plainly within our capacity to deal with those threats
provided only that we have a strong base of understanding among

•


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-19-

us, that we resolve to act where action is necessary, and
that we have the patience and wisdom to refrain from actions
that can only be destructive.
You are leaving the Congress after 28 years, Mr. Chairman.
Through that time, you have consistently provided constructive
leadership to the effort to raise the level of economic discussion in general -- and of the dialogue between the Congress
and the Federal Reserve in particular.

I happen to believe

strongly in the independence that the Congress has provided
the Federal Reserve through the years -- but also in the need
for close and continuing communication with the Congress and
the Administration.

I presume that this is the last time I

will appear before you personally in this forum, but the
dialogue will continue to benefit from your efforts, your
initiative, and your sense of commitment in more ways than
you may realize.


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Federal Reserve Bank of St. Louis

For release on delivery
10:00 A.M., E.S.T.
November 24, 1982

Statement by

Paul A. Volcker

Chairman, Board of Governors of the Federal Reserve System

before the

Joint Economic Committee

OOP"
November 24, 1982


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Federal Reserve Bank of St. Louis

I appreciate this opportunity to discuss with you
today the current stance of monetary policy and some problems
for the future.

Before responding to certain questions directed

to me about monetary policy in your letters of October 18 and
November 17, Mr. Chairman, I should first emphasize that the
basic thrust and goals of our policy are unchanged since I
testified before the Congress on July 20.

The precise means

by which we move toward our goals must take account of all the
stream of evidence we have on the behavior of (and distortions
in) the various monetary aggregates, the economy, prices, interest
rates, and the like.

But we remain convinced that lasting recovery

and growth must be sought in a framework of continuing progress
toward price stability -- and that the process of money and credit
creation must remain appropriately restrained if we are to deal
effectively with inflationary dangers.
For that reason, we must continue to set forth targets
for growth in money and credit and to judge the provision of
bank reserves

our most important operating instrument -- in

the light of the trend in the growth of these aggregates.
This process necessarily involves continuing judgments about
just what growth in those magnitudes is appropriate in the
short and longer run, matters affected by institutional change
as well as by more fundamental economic factors.


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2

As you are aware, the current job of developing and
implementing monetary policy has been complicated by regulatory
decisions as well as by recent developments in the economy and
in our financial markets.

We have, as a consequence, (1) made

some technical modification in our operating procedures to cope
with obvious distortions in some of the monetary data -- particularly MI -- and (2) accommodated growth in the various M's at
rates somewhat above the targeted ranges.
decisions was essentially technical.

The first of those

The latter decision is

entirely consistent with the view I expressed in testifying
before the Banking Committees in July that the Federal Open
Market Committee would tolerate "growth somewhat above the
targeted ranges .

. for a time in circumstances in which it

appeared that precautionary or liquidity motivations, during a
period of economic uncertainty and turbulence, were leading to
stronger than anticipated demands for money."
Unfortunately, the difficulties and complexities of the
economic world in which we live do not permit us the luxury of
describing policy in terms of a simple, unchanging numerical
rule.

For instance, the economic significance of any particular

statistic we label "money" can change over time -- partly because
the statistical definition of "money" is itself arbitrary and
the components of the money supply have differing degrees of
use as a medium of exchange and liquidity.

That doesn't make

much difference in a relatively stable economic, financial, and
institutional environment, but, at times of rapid change, like
the present, it can matter a great deal.


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3-

-

We also have to take account of varying lags -- never
known with precision -- between actions today and their consequences later.

We have to try to disentangle the temporary

and cyclical from more persistent trends in relationships among
different measures of money and inflation and economic activity.
And we have to evaluate the significance of developments abroad
ge
as well as at home, as reflected in trade accounts and the exchan
rate, and of strains in the financial structure itself.
As this suggests, the economic environment in which we
set policy -- or policy itself -- cannot be condensed into a
simple, one-dimensional statement.

Perhaps the essence of the

problem and our approach can be better captured by a few "yesbut" phrases.
(1) Yes, we have broken the inflationary momentum
but continuing vigilance and effort will be essential
to continue progress toward price stability.
As you know, the broad price indices this year have been
running at about half or less of the peak levels reached two or
three years ago.

As part of this disinflationary process, growth

in worker compensation in nominal terms has declined to the 6 to
7 percent area -- but that slower growth in nominal income has
been consistent with higher real wages as inflation has moderated.
Price and cost trends in particular sectors of the economy
are mixed -- reflecting in part lags in the process of disl
inflation, the effects of long wage contracts, internationa
of
and exchange rate developments, and the immediate effects

:

-4

recession on some prices -- most particularly commodities.
But there is, it seems to me, strong reason to believe that
the progress toward price stability can be maintained -- albeit
at a slower rate -- as the economy recovers.

For a time, un-

employment and excess capacity should restrain costs and prices
and, of more lasting significance, productivity growth should
improve from the poor performance of most recent years.

Taken

together, restraint on nominal wage increases and productivity
growth should moderate the increase in unit labor costs, which
account for about two-thirds of all costs.

Real incomes can

rise as inflation slows, paving the way for further progress
toward stability.
To be sure, as the economy grows, some factors holding
down prices over the past year or two will dissipate or be
reversed.

But large new "price shocks" in the energy or food

areas appear unlikely in the foreseeable future, suggesting
that a declining trend in the rise of unit labor costs should
be the most fundamental factor defining the price trend.
That analysis would not hold, however, if excessive
growth in money and credit over time came again to feed first
the expectation, and then the reality, of renewed inflation.
Too much has been "invested" in turning the inflationary
momentum to lose sight of the necessity of carrying through.
There are clear implications, as I will elaborate in a moment,
for fiscal as well as monetary policy.


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5

(2) Yes, exceptional demands for liquidity can reasonably
be accommodated in a period of recession, high unemployment, and excess capacity -- but guidelines for
restrained money and credit growth remain relevant to
insure against renewed inflation.

A variety of specific and general evidence strongly
suggests that the desire to hold cash and other highly liquid
assets, relative to income, has increased this year.

Much of

the more rapid increase in M1 has been in interest-bearing NOW
accounts, which did not exist a few years ago but which provide
the basic elements of a savings, as well as transaction, account.
With market interest rates falling, those accounts have been
relatively more attractive on interest rate grounds alone, and
they are a convenient means of storing liquidity at a time of
economic and financial uncertainty.

At the same time, the

broader aggregates appear to reflect some of the same liquidity
motivations, as well as the stronger savings growth in the wake
of the tax cut.
Most broadly, we can now observe, over a period of more
than a year, a distinct decline in "velocity" -- that is, the
relationship between the GNP and monetary aggregates.

The

velocity decline for Ml, which is likely to amount to about
3% from the fourth quarter of 1981 to the fourth quarter of 1982,
stands in sharp contrast to the average yearly rise in velocity
of 3-4% over the past decade; it will be the first significant

-6-

decline in velocity in about 30 years.

M2 and M3 velocities --

which had been relatively trendless earlier -- have also declined
significantly.

While some tendency toward slower velocity is

not unusual in the midst of recession, the magnitude and persistence of the movement in 1982 is indicative of a pronounced
tendency to hold more liquid assets relative to current income.
Without some accommodation of that preference, monetary policy
at the present time would be substantially more restraining in
its effect on the economy than intended when the targets for
the various aggregates were originally set out earlier this
year.
At the same time, policy must take into account the
probability that the demands for liquidity will, in whole or
in major part, prove temporary, and that an excessive rise in
money or other liquid assets could feed inflationary forces
later.

Elements of judgment are inevitably involved in sorting

out these considerations -- judgments resting on analysis of
the economy, interest rates, and other factors.

But broad

guidelines for assessing the appropriate growth on the basis
of historical experience will surely remain relevant and
appropriate.
In that connection, I must note the implications of the
future Federal budgetary position.

To put the point briefly,

the prospect of huge continuing budgetary deficits, even as the
economy recovers, carries with it the threat of either excessive
liquidity creation and inflation in future years, or a "crowdingout" of other borrowers as monetary growth is restrained in the


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7-

face of the Treasury financing needs, or a combination of both.
The problems flowing from the future deficits are simply not
amenable to solution by monetary policy.

Moreover, the concern

engendered in the marketplace works in the direction of higher
interest rates today than would otherwise be the case, contrary
to the needs of recovery.

I know something of how difficult it

is to achieve further budgetary savings, but I must emphasize
again how important it is to see the deficit reduced as the
economy recovers.

The fact is those looming deficits are a

major hazard in sustaining recovery.
(3) Yes, lower interest rates are critically important
in supporting the economy and encouraging recovery
but we also want to be able to maintain lower
interest rates over time.

Since early summer, short-term interest rates have
generally declined by five to six percentage points, and
mortgage and most other long-term rates have dropped by three
to four percentage points.

While consumer loan rates administered

by banks and other financial institutions have lagged, they are
also now moving lower.

There are clear signs of a rise in home

sales and building in response to these interest rate declines,
and other sectors of the economy are benefiting as well.
We have also had experience in recent years of sharp
increases in interest rates curtailing economic activity at
times when recovery was incomplete and unemployment high.
Sudden large fluctuations in interest rates contribute to

Ni


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-8-

other economic and financial distortions as well.

And no

doubt the fact that many interest rates remain historically
high, relative to the current rate of inflation, reflects
continuing skepticism over prospects for carrying through the
fight on inflation.
In this situation, the Federal Reserve has welcomed
the declines in interest rates both because of the support
they offer economic activity and because they seem to reflect
a sense that the inflationary trend has changed.

However, we

do not believe that progress toward lower interest rates should
or for long in practice can -- be "forced" at the expense of
excessive credit and money creation.

To attempt to do so

would simply risk the revival of inflationary forces; renewed
expectations of inflation would soon be reflected in the longerterm credit markets, damaging prospects for the long-lasting
expansion we all want.
Turning to your explicit questions, Mr. Chairman,
against this general background, I believe most policy-making
officials in the Federal Reserve share the general view that
economic recovery will be evident throughout 1983, but at a
moderate rate of speed -- probably slower than during previous
post-recession years.

Unambiguous evidence that the recovery

is already underway is still absent, although encouraging signs
are evident in some rise in housing, in the improved liquidity
and wealth and reduced debt positions of consumers, and in
surveys reporting that attitudes and orders may be stabilizing

:


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9-

_

or improving.

The Federal deficit, while fraught with danger

for the future, is of course providing massive support for
incomes at present.
What is crucially important -- particularly in the
light of the experience of recent years -- is that we set
the stage for an expansion that can be sustained over a long
period, bringing with it strong gains in productivity and
investment and lasting improvement in employment.

I have

already emphasized the importance of progress toward price
stability to that outlook, and the evidence that, with
disciplined monetary and fiscal policies, we can sustain
that progress.
So far as the specific questions about monetary policy
in your October 18 letter are concerned, we have not, as you
know, set any new monetary targets for 1982.

Current trends

do indicate that the various M's will end the year above the
upper end of the target ranges, probably by 1/2 to 1% for M2
and M3 and more for M1 given the current distortions.
credit will be close to the mid-point of its range.

Bank

As I

indicated at the start, the "overshoots," in the context of
today's economic and financial conditions, are consistent with
the approach stated in my July testimony.
No decision has been taken to change the tentative
targets for 1983.

That matter will, of course, be under

intensive scrutiny over the next two months, and the targets
will be announced in February.

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For the time being, we are placing much less emphasis
than usual on Ml.

That decision was precipitated in early

October entirely by the likelihood that the data would be
grossly distorted in that month by the maturity of a large
volume of All-Savers Certificates, part of the proceeds of
which might be expected to, at least temporarily, be placed
in checking accounts included in Ml.
In about three weeks, the introduction of a new ceilingless account at financial institutions -- highly liquid and
carrying significant transaction capabilities -- is likely to
distort further M1 data.
•


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Judging by comments at the last

Depository Institutions Deregulation Committee meeting, that
account could rapidly be followed by a decision to approve
a ceiling-less account with full transaction capabilities.
These new accounts could have a large, but quite unpredictable,
influence on M1 for a number of months ahead as funds are reallocated among various accounts.

Moreover, the introduction

of market-rate transaction accounts will very likely result
in a different relationship and trend of M1 relative to GNP
over time.

Increasing confidence in the stability of prices

and a trend toward lower market interest rates might also
affect the desire to hold money over time.
Obviously, some judgments on those matters will be
necessary in setting a target for M1 in 1983 and in deciding
upon the degree of weight to be attached to changes in M1 in
our operations.

Those problems should appropriately be

•

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described as "technical" rather than "policy" in the sense
that we will need to continue to be concerned with the rate
of growth over time of the monetary aggregates, including
transactions balances.
The decisions taken in early October do point to greater
emphasis on M2 (and M3) in planning the operational reserve
path during this transitional period.

The link between reserves

and M2 is looser and more uncertain than in the case of Ml, in
large part because reserve requirements on accounts included in
M2, apart from transactions balances, are very low or non-existent.
(Transactions balances are about 17 percent of M2.)

Therefore

once a reserve path is set, deviations of M2 from a targeted
growth range may not, more or less automatically, be reflected
in as substantial changes in pressures on bank reserve positions
or in money markets as is the case with Ml.

Consequently,

"discretionary" judgments may be necessary more frequently in
altering a reserve path than when that reserve path is focused
more heavily on Ml.

In that technical sense, the operational

approach has necessarily been modified.
In sum, the broad framework of monetary targeting has
been retained, but greater emphasis is for the time being
placed on the broader aggregates.

The specific operating

technique that had been closely related to M1 has, by force
of circumstances, been conformed to that emphasis.

Obviously,

entirely apart from questions of economic doctrine and contending approaches to monetary control, so long as M1 is


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-12-

subjected to strong institutional distortions our techniques
must be adapted to take account of that fact.
An alternative operating approach suggested by some
of supplying and withdrawing reserves with the intent of
achieving a particular interest rate target would suffer
from several fundamental defects.*
o

The body of theory or practice does not
provide a sufficiently clear basis for
relating the level of a particular interest
rate to our ultimate objectives of growth and
price stability.

o

The implication that the Federal Reserve could
in fact achieve and maintain a particular level
of relevant interest rates in a changing economic
and financial environment is not warranted.

o

The very concept and measurement of a "real"
interest rate, as called for in some proposals,
is a matter of substantial ambiguity.

o

As a practical matter, attempts to target and fix
interest rates would make more rigid and tend to
politicize the entire process of monetary policy.

*That was not, as sometimes mistakenly thought, the operating
approach used prior to October 1979. Then, reserves were provided with the aim of achieving and maintaining a particular
Federal funds rate thought to be consistent with targets for the
monetary aggregates. The Federal funds rate was a means to
achieving a monetary target and in principle was to be handled
flexibly. In practice, among other difficulties, there appeared
to be a reluctance to permit rates to vary rapidly enough to
maintain control of the aggregates.


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In current circumstances, with huge budget deficits
looming, a requirement that the Federal Reserve
set explicit interest rate targets is bound to be
interpreted as inflationary, and the rekindling of
inflationary expectations will work against our
objective.
I realize the several legislative proposals addressed
to targeting interest rates would, on their face, seem to call
for interest rates as only one of several targets.

But interest

rates would certainly be the most obvious and sensitive target,
and those targets would be difficult to change.

Other evidence

for a need to "tighten" or "ease" would be subordinated, if not
ignored.
As we approach the target-setting process for 1983,
our objectives will -- indeed as required by law -- continue
to be quantified in terms of growth in relevant money and
credit aggregates.

We will have to decide how much weight to

place on M1 and other aggregates during a transitional period,
assuming new accounts continue to distort the data.

In reaching

and implementing those decisions, the members of the FOMC
necessarily rely upon their own analysis of the current and
prospective course of business activity; the interrelationships
among the aggregates, economic activity, and interest rates; and
the implications of monetary growth for inflation.

In other words,

the process is not a simple mechanical one, and it seems to me
capable of incorporating -- within a general framework of monetary
discipline -- the elements of needed flexibility.

We will also,

as part of that process, review whether technical adjustments


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-14-

in procedures for establishing and changing the reserve paths
are appropriate.

I will be reporting our conclusions to the

Congress in February.
Mr. Chairman, you have suggested that our monetary
targets might reasonably be specified as a single number,
with a range above and below.

At times we have debated

within the FOMC the wisdom of such an approach (or setting
forth a single target number without a range).

My own feeling

has been, and remains, that a single number, with or without
a range, would convey a specious sense of precision, with the
result of greater pressure to meet a more or less arbitrary
number to maintain "credibility," even if developments during
the year tend to indicate some element of flexibility is
appropriate in pursuit of the targets.
To me, our present practice of setting forth a range
is preferable.

Where appropriate, we can and should suggest

the probability of being in the upper or lower portion of
the range, or suggest what conditions could evolve in which
something other than the mid-points (or even an over or undershoot) would be appropriate.

That approach seems to me to

provide more information -- and more realism -- than a single
number and is broadly consistent with present practice.
For similar reasons, I believe we need to measure
and target a variety of aggregates because, in a swiftly
changing economic environment, any single target can be misleading:.
In that connection, I believe an indication of total credit
flows broadly consistent with the monetary targets could be
helpful.

As you know, we now provide such estimates for bank

credit alone.

-15-

Given the limits of forecasting and analysis, and the
volatility of the data, I would question the usefulness of
further sectoral estimates.

Even with respect to total credit

flows, there is considerable looseness in relationships to
economic activity for periods as long as a year -- and still
more for shorter periods.

The theoretical framework relating

credit flows to other variables such as the GNP or inflation
is less fully developed than in the case of monetary aggregates,
and credit flows are less directly amenable to control.

The

enormous flows across international borders pose large conceptual and statistical problems.

Our credit data are typically

less complete and up-to-date than monetary data.
However, so long as those difficulties and limitations
are recognized -- and some of them are relevant with respect
to the monetary aggregates as well -- I share the view that
analysis of credit flows can contribute to policy formulation.
To assist in that process, Iwill propose to the FOMC that
estimates of the expected behavior of a broad credit aggregate
be set forth alongside the monetary targets in our next report.
I do strongly resist the idea of the Federal Reserve as
an institution forecasting interest rates.

No institution or

individual is capable of judging accurately the myriad of
forces working on market interest rates over time.

Expectational

elements play a strong role -- fundamentally expectations about
the course of economic activity and inflation, but also, in the
_

short run, expectations of Federal Reserve action.


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We could not

-16-

escape the fact that a central bank forecast of interest rates
would be itself a market factor.

To some degree, therefore,

in looking to interest rates and other market developments for
information bearing on our policy decisions, we would be looking
into a mirror.

Moreover, the temptation would always be present

to breech the thin line between a forecast and a desire or policy
intention, with the result that operational policy decisions
could be distorted.
While it seems to me inappropriate for a central bank
to regularly forecast interest rates, analysis of key factors
influencing credit conditions and prices can be helpful at
times.
past.

On occasion, we have provided such analysis in the
My concern about the outlook for fiscal policy is rooted

in major part in such analysis because the direction of impact
on interest rates seems to me unambiguous.

I have also, on a

number of occasions, indicated that the recent and even current
level of interest rates appears extraordinarily high, provided,
as I believe, we continue to make progress on the inflation
front.

Perhaps, in our semi-annual reporting, we can more

explicitly call attention to major factors likely to influence
short or long-term interest rates and the significance for
various sectors of the economy.

But I do not believe interest

rate forecasting would be desirable or long sustainable, and
would in fact be damaging to the policy process.
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.


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-17-

Finally, Mr. Chairman, you have requested a "single
composite forecast" of the major economic variables by FOMC
members.

As you are well aware, our present practice is to

set forth a range of forecasts of individual FOMC members of
the nominal and real GNP, prices, and unemployment.

The fact

is we have no single "Federal Reserve" forecast, and there is
no mechanism, within a Committee or Board structure, to force
agreement on such a forecast by individual members bringing
different views, typically backed by separate staff analysis,
to the table.

A simple average -- possibly supported by no

one -- seems to me artificial.

The process of attempting to

force a consensus would certainly dilute the product.
I would put the point positively.

A range of forecasts

by individual FOMC members more accurately conveys the range
of uncertainty and contingencies that must surround any forecast.

The seeming neatness and coherence of a single forecast

too often obscures the reality that a variety of outcomes is
possible; the very essence of the policy problem is to assess
risks and probabilities -- what can go wrong as well as what
can go right.

A point forecast would likely be treated more

reverently than it would deserve, and could even distort policy
judgments in misguided efforts to "hit" a forecast.
I can understand your concern that a range of forecasts
may be misleading if strongly influenced by "outlying" opinions
rather than reflecting a more even dispersion of views.

For

that reason, I would be glad to explore with the Open Market

•


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Federal Reserve Bank of St. Louis

-18-

Committee a procedure by which we indicated the "central
tendency" of members' views -- assuming such a central
tendency exists -- as well as indicating the range of
opinions.

Conversely, if the forecasts were evenly

distributed within the range, we could so indicate.

I

believe that approach would meet the objectives you seek in
a realistic and helpful manner.
In concluding this already long testimony, let me say
that we share the common goals of achieving, in the words of
the Employment Act of 1946 and the Humphrey Hawkins Act of
1978, "Maximum employment, production, and purchasing power"
and "full employment . . . (and) reasonable price stability."
Those objectives have eluded us for too many years.

We meet

again today in particularly difficult circumstances, and there
is a sense of frustration and uncertainty among many.
But I also happen to believe we have come a long way
toward laying the base for economic growth and stability;
economic recovery should characterize 1983, and that recovery
can mark the beginning of a long period of stable growth.
Obviously there are obstacles -- interest rates are
still too high; inflation is down but not out; there are
strains in our financial system; we face budget deficits that
are far too high; we are tempted to turn inwards or backwards
for quick solutions that ultimately can not work.

But it is

also plainly within our capacity to deal with those threats
provided only that we have a strong base of understanding among


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us, that we resolve to act where action is necessary, and
that we have the patience and wisdom to refrain from actions
that can only be destructive.
You are leaving the Congress after 28 years, Mr. Chairman.
Through that time, you have consistently provided constructive
leadership to the effort to raise the level of economic discussion in general -- and of the dialogue between the Congress
and the Federal Reserve in particular.

I happen to believe

strongly in the independence that the Congress has provided
the Federal Reserve through the years -- but also in the need
for close and continuing communication with the Congress and
the Administration.

I presume that this is the last time I

will appear before you personally in this forum, but the
dialogue will continue to benefit from your efforts, your
initiative, and your sense of commitment in more ways than
you may realize.

;