Full text of Paul A. Volcker Papers : Joint Economic Committee Testimony : June 15, 1982, Box 13, Item c237

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Collection: Paul A. Volcker Papers
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Box 13

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For release on delivery
10:00 A.M., E.D.T.
June 15, 1982

Statement by

Paul A. Volcker

Chairman, Board of Governors of the Federal Reserve System

before the

Joint Economic Committee

June 15, 1982

N
•

cpg,
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I am pleased to appear before this Committee to discuss
the conduct of monetary policy.

In particular, I would like to

focus on the monetary aggregates targeting framework in light of
recent experience.
The Federal Reserve began reporting to the Congress
specific numerical "targets" for the growth of the monetary
aggregates in 1975.

You will recall Congress had urged such

an approach in House Concurrent Resolution 133.

Subsequently,

the reporting of growth targets for the aggregates was formalized
in law with the enactment of the Full Employment and Balanced
Growth Act of 1978, commonly referred to as the Humphrey-Hawkins
Act.

That law requires the Federal Reserve to present annual

targets for monetary and credit aggregates to the Congress each
February, and to review those targets and formulate tentative
objectives for the coming calendar year each July.

The choice

of the appropriate measures to "target," as well as the qua
tative expression of those targets, are, of course, a matter for
the Federal Reserve to decide.
The development of this formal reporting framework,
focusing on the growth of certain monetary and credit variables,
was a reflection in part of changes in attitudes toward monetary
policy that occurred in the 1970s, and in part of a desire to
improve communications and reporting about our intentions and
policies.

The worsening inflation problem focused increased

attention on the critical linkage over the longer run between
money growth and prices.

There was a growing sense among some

that earlier "conventional" views of a trade-off between inflation and growth were no longer compatible with actuality,
at least over the medium and longer run, and that inflation
had emerged as a major economic problem.

A number, including

some members of Congress, placed increased emphasis on restraining
growth of the monetary aggregates over time as a means of dealing
with inflation, and urged establishing our intentions in that
respect over a longer period of time ahead.

More generally,

aggregate targeting was thought to provide the Congress with
a more clearly observable measure of performance against
intentions, which in turn implied that targets should not be
changed frequently, or without clear justification.
The formulation of specific monetary aggregates targets
also has been consistent with the goals and approach of the
Federal Reserve.

A basic premise of monetary policy is that

inflation cannot persist without excessive monetary growth,
and it is our view that appropriately restrained growth of money
and credit over the longer run is critical to achieving the
ultimate objectives of reasonably stable prices and sustainable
economic growth.

While other policies must be brought to bear

as well, the specific annual targets announced periodically by
the Federal Reserve have reflected efforts to reconcile and
support these goals.
It seems to me implicit in an aggregate targeting approach,
as urged by the Congress, that interest rates in themselves are not

%
r

-3-

the dominant immediate objective or focus in assessing the
posture of monetary policy, even though that remains the instinct
of many.

Interest rates are, of course, highly important economic

variables, and they are intimately involved in the process by
which the supply of money and other liquid assets are reconciled
in the market with the demands for liquidity derived from the
growth of the economy, inflation, and other factors.

But interest

rates are also importantly influenced by other forces as well,
including expectations about inflation, about future interest
rates, the budgetary posture, and other factors.

The experience

of the seventies emphasized some of the pitfalls and shortcomings
of using interest rates as a guide for policy, particularly in an
environment of generally rapid and rising inflation and correspondingly uncertain price expectations.

In those circumstances,

it is especially difficult to gauge the stimulative or restrictive
influence associated with a given level of nominal interest rates.
Recognition of these difficulties was an important element in the
decision by the Federal Reserve to adopt procedures in October 1979
that placed emphasis, even in the shorter-run, on the supply of
reserves rather than primarily on short-term interest rates as
operational guides toward achieving an appropriate degree of
monetary control.
While all these considerations have suggested the use
of the framework of monetary aggregates targeting, we need also
to be conscious of the fact that the world as it is requires
elements of judgment, interpretation, and flexibility in judging

developments in money and credit and in setting appropriate
targets.

One reason for that is the impact of financial

innovations on the growth of particular measures of money and
the relationships among them.

In recent years, generally high

and variable interest rates, and the continuing process of
technological change and the deregulation of depository institutions
have provided powerful stimulus for far-reaching changes in the
financial system.

The proliferation of new financial instruments

and the development of increasingly sophisticated cash management
techniques have created a need to adjust the definitions of the
monetary aggregates from time to time and to reassess the relationship of the various measures to one another and to other economic
variables.

A somewhat separable matter conceptually (but in

practice hard to distinguish) is that businesses or families may
shift their preferences among various financial assets in a manner
that may alter the economic significance of particular changes in
any given measure of "money" or "credit."
Use of monetary targeting procedures is justified on
the presumption that "velocity" -- that is, the ratio between
a given measure of money and the nominal GNP -- is reasonably
predictable over relevant periods.

At the same time, it can be

readily observed that, in the short run of a quarter or two, velocity is highly variable.

Those short-run deviations from trend need

to be assessed cautiously, for they commonly are reversed over a
period of time.

However, we cannot always assume a rigid relation-

ship between money and the economy that, in fact, may not exist

%
.
5-

over a cycle or over longer periods of time, especially when
technology, interest rates, and expectations are changing.

Conse-

quently, it is appropriate that the Federal Open Market Committee
reconsider on a continuing basis, both the appropriateness of
its annual targets and the implications of shorter-run deviations
of actual changes from the targeted track.
The introduction of NOW accounts nationwide last year
was illustrative of some of the difficulties arising from a
changing financial structure.

To some degree, the Federal

Reserve was able to anticipate the impact.

It was obvious,

for example, that the rapid spread of NOW accounts, by drawing
some money from savings accounts as well as demand deposits,
would have important effects on the Ml aggregate, and last
year's targets allowed for such effects.

However, after

accounting for these shifts into NOW accounts, the growth of
the several aggregates was considerably more divergent than
was anticipated, with Ml running relatively low while the
increase in some of the broader aggregates was a bit above their
annual objectives.

Taking into account all of the financial

innovations affecting the aggregates -- particularly the
depressing effects on Ml of extraordinarily rapid growth in
money market mutual funds -- and the relatively rapid growth of
M2 and M3, we found the pattern of slow growth in Ml acceptable.
Indeed, last year's experience seems to me a clear illustration
of the need to consider a variety of money measures, rather than
focusing exclusively on a single aggregate such as Ml.

•

Thus far this year, the monetary aggregates have behaved
more consistently, although Ml is running a bit stronger than
anticipated relative to the other aggregates.

With the major

shift into NOW accounts, in terms of new accounts opened, mostly
behind us, one source of distortion has been removed from the
data.

But I would also note that, as a result of that "structural"

shift, NOW accounts and other interest-paying checkable deposits
have grown to be almost 20 percent of Ml, and there is evidence
that the cyclical behavior of Ml has been affected to some extent
by this change in composition.
While Ml is meant to be a measure of transactions balances,
NOW accounts also have some characteristics of a savings account
(including similar "ceiling" interest rates).

This year there

has been a noticeable increase in the public's desire to hold a
portion of their saving

in highly liquid forms, probably

reflecting recession uncertainties.

As a result, NOW accounts

have grown particularly fast, accounting for the great bulk of
the growth in Ml, and at the same time the rapid decline in savings
deposits has ceased.

Overall, Ml growth so far this year has been

somewhat more rapid than a "straight line" path toward the annual
target would imply.

To the extent the relatively strong demand

for Ml reflects transitory precautionary motives, allowing some
additional growth of money over this period has been consistent
with our general policy intentions.

In arriving at such a judgment, the pattern of growth
in the broader aggregates should be considered.

There also

have been important institutional changes in recent years
affecting the behavior of M2 and M3.

For example, an in-

creasingly large share of the components of M2 that are not
also included in Ml pay market-determined interest rates.
This reflects the spectacular growth of money market funds in
recent years as well as the increasing availability at banks
and thrift institutions of small-denomination time deposits
with interest rate ceilings tied to market yields.

An important

consequence is that cyclical or other changes in the general
level of interest rates do not have as strong an influence on
the growth of M2 as in the past.
The broader aggregates are presently at or just above
the upper end of the ranges of growth set forth for the year as
a whole.

In February, we reported to the Congress that M2 and

M3 would appropriately be in the upper half of their ranges, or
at or even slightly above the upper end, should regulatory changes
and the possibility of stronger savings flows prove to be important.
In that regard, I must point out we have yet to go through a full
financial cycle with such a large money fund industry or
with the regulatory and legal changes recently introduced.
In these circumstances, it is clear that interpreting the
performance of the monetary and credit aggregates must be
assessed against the background of economic and financial
developments generally -- including the course of and prospects
for business activity and prices, patterns of financing, and
liquidity in various sectors, the international scene, and
interest rates.

It is in that broader context that we have

not believed that the growth of the various Ms has been
unduly large so far this year.
The point I am making is that a large number of factors
have impinged -- and in all likelihood will continue to impinge on the growth of the monetary aggregates, possibly in the process
modifying the relationship of any particular measure of "money"
to economic performance.

The relationships have been good enough

over a period of time to justify a presumption of stability -but I do believe we must also take into account a wide range of
financial and nonfinancial information when assessing whether
the growth of the aggregates is consistent with the policy
intentions of the Federal Reserve.

The hard truth is that

there inevitably is a critical need for judgment in the conduct
of monetary policy.
Looking back at the last

.ew years, money growth has

certainly fluctuated rather sharply from time to time in the
United States (and, I might note, in other countries as well).
As I earlier noted, relationships have also been affected by a
variety of financial innovations.

But the trend over reasonable

spans of time has generally been consistent with the announced
targets of the Federal Reserve, and the restrained growth has,
in my judgment, contributed importantly to the now clear progress
toward reducing inflation.

This longer-run and broader perspective

is what should be kept in mind when considering growth in the

aggregates.

The tentative decision (not yet implemented)to publish

the Ml data in the form of four-week moving averages is designed
to divert undue attention from the statistical "noise" in the
weekly movements in Ml and to encourage knowledgeable observers
to focus on broader trends in the whole family of aggregates.
One obvious frustration in the current circumstances
is that interest rates, particularly longer-term rates, still
are painfully high despite the protracted weakness in the real
economy and a marked deceleration in the measured rate of inflation.
With the unemployment rate currently at a new postwar high, there
is an understandable inclination to want to get interest rates
down quickly to encourage a rebound in activity.
Nothing would please me more than for interest rates to
decline, and the progress we are making on inflation, as it is
sustained, should powerfully work in that direction.

But, I

also know that it would be shortsighted for the Federal Reserve
to abandon a strong sense of discipline in monetary policy in an
attempt to bring down interest rates.

It may be that the immediate

effect of encouraging faster growth in the aggregates would be
lower interest rates -- particularly in short-term markets.

But

over time, the more important influence on interest rates
particularly longer-term interest rates

is the climate of

expectations about the economy and inflation, and the balance
of savings and investment.

In that context, an effort to drive

interest rates lower by money creation in excess of longer-run
needs and intentions would ultimately fail in its purpose and
would threaten to perpetuate policy difficulties and dilemmas of
the past.

-10•
, it
When long-term interest rates decline decisively
udes about
will be an indication of an important change in attit
the prospects for the economy.

One essential element in this

will be
process must be a widespread conviction that inflation
contained over the long run.

The decline in inflation evident in

all of the broadly based price indices over the past year is highly
encouraging.

For example, in the 12-month period ending in April,

2 percent compared to 10 percent over the previous
/
the CPI rose 61
12 months.

Over the past few months, the CPI has been virtually

stable.
But it is also evident that some particular elements
inable;
accounting for the sharp reduction in inflation are not susta
markets,
they have been achieved in a period of recession and slack
s that
and have reflected some sizable declines in energy price
now appear behind us.

Progress toward reducing the underlying

trend in costs, while real, has been slower.

We have seen some

polls that suggest many Americans do not in fact appreciate that
inflation has slowed at all.
to fact.

That impression is plainly contrary

But it is perhaps indicative of how deep seated impressions

it
and expectations of inflation had become by the late 1970s, and
is suggestive of the concern of renewed higher inflation rates as
economic activity recovers.

No doubt those concerns continue to

affect investment judgments and interest rates.
In this situation, one key policy objective must be to
in
"build in" what has so far been a partly cyclical decline

-11-

inflation, to encourage further reductions in the rate of
increase in nominal costs and wages, and then to establish
clearly a trend toward price stability.

That approach seems

to me essential to encourage and sustain lower long-term interest
rates, which will, in turn, be important in sustaining economic
growth.
While monetary policy is only one of the instruments that
can be brought to bear in restoring price stability, it is both
necessary to that effort and widely recognized to be such.

These

circumstances emphasize the need to avoid excessive monetary growth,
with the threat it would bring that the heartening progress against
inflation would prove only temporary.
I think that it also is quite clear that the prospect
of huge and rising budget deficits as the economy recovers has
been another element in the current situation rag concerns
about long-term pressures on interest rates.

I take encouragement

from the efforts of the House and Senate to begin to come to grips
with this problem.

At the same time, we are all aware of how much

remains to be done, not only to reach agreement on a budget resolution
for fiscal 1983, but to take the action necessary to implement such
a resolution in appropriation and revenue legislation.

Moreover,

as you well know, further legislation will be needed beyond
that affecting fiscal 1983 to assure elements in the structural
deficit are brought more firmly under control.
Let me emphasize that a strong program of credible budget
restraint will itself w5rk in the direction 5f l5wer interest rates.

-12-

The perception that future credit demands by the Federal
Government would be lower would reinforce the emerging
expectations of less inflation.

The threat that huge deficits

would preempt the bulk of the net savings the economy seems
likely to generate in the years ahead -- with the likely consequence of exceptionally high real interest rates continuing -would be dissipated.

Confidence would be enhanced that monetary

policy will be able to maintain a non-inflationary course,
without squeezing of homebuilding, business investment, and
other interest-sensitive sectors of the economy, and without
excessive financial strains in the economy generally.

And by

dealing with very real concerns about the future financial
environment, budgetary action would be an important support to
the recovery today.
In summary, casting monetary policy objectives in terms
of the aggregates has been a useful discipline and also has been
helpful in communicating to Congress, the markets, and the general
public the intent and results of the Federal Reserve actions.
At the same time, we must retain some element of caution in their
interpretation; the monetary targets convey a sense of simplicity
that may not always be justified in a complex economic and
financial environment.

There is far from universal appreciation

of the fact that the economic significance of particular aggregates
is constantly evolving in response to rapid changes in financial
markets and practices.

Consequently, the Federal Reserve is

continually faced with difficult judgments about the implications
for the economy.

-13-

As you know, the Federal Open Market Committee soon
will be meeting to review the annual targets for the monetary
aggregates for 1982 and to formulate tentative targets for 1983.
I would not presume to anticipate the precise decisions that
will be made by the Committee.

A wide array of financial and

nonfinancial information will be reviewed in the process of
considering the specific objectives.

And, while I do not

anticipate any significant change in our operating procedures
in the near term, we will also continue to assess and reassess
the means by which our policies are implemented.

However, I do

believe that you can assume that the decisions that do emerge
from this review will reflect our continued commitment to disciplined monetary policy in the interest of sustaining progress
toward price stability -- and, not incidentally, of encouraging
a financial climate conducive to achieving and sustaining lower
interest rates.
We can not yet claim victory against inflation, in
fact or in public attitudes.

But I do sense substantial progress

and a clear opportunity to reverse the debilitating pattern of
growing inflation, slowing productivity, and rising unemployment
of the 1970s.

The challenge is to make this recession not another

wasted, painful episode, but a transition to a sustained improvement
in the economic environment.
Central to that effort is an appropriate course for fiscal
and monetary policy -- a course appropriate, and seen to be
appropriate, for the years ahead.

Critical elements in that effort

-14-

are the commitments to gain control of the federal budget and
to maintain appropriate monetary restraint.

Those policies

provide the best -- indeed the only real -- assurance that
financial market conditions will be conducive to a sustained
period of economic growth and rising employment and productivity.
In the long years to come, we want to look back to our present
circumstances and know that the pain and uncertainty of today
have, in fact, been a turning point to something much better.

GRowTH OF TARGETED MRY AGGREGATEs
(PERCEN
CHANGE)

COUNTRY
***********
***CANADA

TARGETED
AGGREGATE
*********

TARGET
PERIOD
**************

N:1

PRESENT
AUG.-OCT. 1980

4-6

DEC. 1982
DEC. 1981

12.5-13.5X

FRANCE

TARGET
**********

FROM TARGET
BASE PERIOD
***********

OVER LAST
12 MONTHS
*********

OVER LAST
6 MONTHS
*********

OVER LAST
3 MONTHS
*********

LAST
OBSERVATION
***********

-2.5

2.9

-4.0

MARCH

20.8

12.5

11.2

20.8

MARCH

9.6

APRIL

GERMANY

CBM

Q4 1982
Q4 1981

4-7%

7.5

4.7

6.2

JAPAN

M2*

Q2 1982
Q2 1981

10%

7.0

9.8

6.7

APRIL

SWITZERLAND

ADJUSTED
CB%!

1982
1981

-.5

1.6

7.0

APRIL

UNITED
KINGDOM

APR. 1983
FEB. 1982

8-12%

-3.6

3.9

3.5

APRIL

Lm3

APR. 1983
FEB. 1982

8-12%

6.8

12.6

7.0

APRIL

PSL2

APR. 1983
FEB. 1982

8-12%

6.7

11.4

7.2

9.7

MARCH

Q4 1982
Q4 1981

2.5-5.5%

8.9

4.4

9.3

3.6

APRIL

04 1982
Q4 1981

6-9%

10.0

9.1

10.4

8.8

APRIL

UNITED
STATES

*****************************************A******************************

*FoRECAST GROwTH OF ki2.

TARGETS ARE NOT SET.

ALL DATA SEASONALLY ADJUSTED EXCEPT FOR SWITZERLAND.
ALL GROWTH RATES COkTOUNDED AND ANNUALIZED.

***As a result of statistical reporting problems in the calculation of the
Canadian
aggregates, particularly
with respect to Ml, the Bank of Canada has decided not to publish the seasonally monetary
adjusted monthly averages for the
various monetary aggregates for kpril unitl they discover
the sources of reporting discrepancies.
http://fraser.stlouisfed.org/
r
Federal Reserve Bank of St. Louis

-6M.4

4: Rates of Growth of Alternative Monetary Aggregates: 1974-1981
(percent change, fourth quarter to fourth quarter)

Aggregate
+
M1
M1B
M2
M3

1975
1974

1976
1975

1977
1976

1978
1977

1979
1978

1980
1979

1981
1980

21.10
16.81
14.89
13.78

2.43
1.71
13.28
19.20

10.19
9.13
12.04
14.21

10.66
8.51
12.32
16.21

4.22
2.34
17.29
18.53

9.37
8.41
16.45
10.77

-3.81
-5.33
15.39
16.87

France

M1+
M2

15.26
17.70

10.69
14.16

9.35
13.03

12.05
12.74

10.84
13.60

8.78
10.41

15.34
12.27

Germany

M1
M2
M3+
CBM

15.17
-0.39
8.90
9.47

6.47
8.37
9.72
9.07

10.38
9.51
10.25
9.44

13.39
13.77
11.31
11.94

4.42
7.60
5.78
6.38

4.49
9.25
5.92
4.76

-1.73
9.73
5.34
3.55

M1
M2

10.25
22.28

21.25
21.28

20.33
20.62

24.98
22.76

25.12
21.21

11.95
11.49

8.63
8.99

M1
M2

10.90
14.51

14.74
14.34

5.92
10.53

12.29
12.61

5.61
10.26

-1.43
7.82

9.51
10.38

Adj. CBM+
M1
M2

3.64
5.46
n.a.

2.33
7.49
n.a,

7.43
5.13
6.93

30.04
22.74
8.81

-13.80
-2.38
11.25

-0.48
-4.35
14.92

-2.45
-7.34
14.54

23.92
9.37
8.78
n.a.

13.50
13.16
10.79
11.75

19.03
6.92
7.48
8.81

15.29
14.89
13.95
14.51

10.89
12.65
12.99
14.46

4.03
18.14
19.13
13.08

9.50
21.46
14.64
12.28

4.98
12.17

6.19
13.60

8.17
11.45

8.22
8.24

7.41
8.43

7.33
9.16

2.28
9.48

Country
Canada

Italy

Switzerland

United Kingdom

United States

+
*

+
M1
M3+
LM3
PSL2
+*
M1 +
M2

Currently targeted aggregate.
1981 data are Ml-B, shift adjusted.

•

June 11, 1982

To:

Board of Governors

From:

Don Winn A Li

o The Budget Resolution adopted yesterday by the
House contains language about monetary policy identical to that
adopted earlier by the Senate:
"Sec. 310. It is the sense of the Congress that
if the Congress acts to restore fiscal responsibility and reduces projected deficits in a substantial and permanent way, then the Federal
Reserve Open Market Committee shall reevaluate
its monetary targets in order to assure that
they are fully complementary to a new and more
restrained fiscal policy."

o Attached is a copy of the letter that the trade
groups have sent to Senator Garn.

o The House Securities Subcommittee yesterday, in
connection with the CFTC reauthorization bill, adopted an
amendment putting the Federal Reserve in charge of a major
two-year study of financial futures and stock index futures.
The CFTC, SEC, and Treasury are to assist in the study. The
Subcommittee also adopted an amendment requiring joint approval
of stock index futures by the SEC as well as the CFTC.
Attached is a copy of the amendment prescribing the
study to be conducted by the Federal Reserve.

Attachments
cc: Messrs. Axilrod, Bradfield, Coyne, Kichline, Schwartz, Soss,
Wiles, Kohn, Plotkin

June 9, 1982

The Honorable Jake Garn
Chairman
Committee on Banking, Housing
and Urban Affairs
5300 Dirksen Senate Office Building
Washington, D.C. 20510
Dear Mr. Chairman:
Banking, Housing and Urban
ate
Sen
the
on
s
gue
lea
col
r
you
and
We urge you
process on the major financial
ve
ati
isl
leg
the
ue
tin
con
to
tee
mit
Can
Affairs
lly we request you to schedule
ica
cif
Spe
.
you
ore
bef
ues
iss
ons
uti
instit
2531, and S. 2532.
promptly a meeting to vote on S. 1720, S.
, but we are confident that the
We may not be able to agree on all issues
work, produce a result that all of
political process can, if permitted to
common threat to the institutions
us will be able to accept. The greatest
the status -quo. There
nge
cha
to
e
don
be
l
wil
g
hin
not
t
tha
we represent is
is no better time to act than now.
Sincerely,
7

)
Lt

Roy G. G
U.S. L

•1 -

en, Chairman
f Savings

Llewellyn Je
American Banker

sociations

si ent
ociation

N. Cugini, Chairman
Union National Association

'resident
Robert B. 0 ien,
National Savings and Loan League

irman
Bruning,
Charles
l
Community Banking Leaders Counci
American Bankers Association

ames F. Aylward,esident
America
Mortgage Bankers Association of

Aesr•
Anderson, President
og
Ass ciation of Reserve City Bankers

-Furlong Bal an, Chairman
ies
Association of Bank Holding Compan
•

/1„,
7
,1
Herbert W. Gray, Chainnan
National Association of NUt
Savings Banks

tchinson, President
J.
tional Association of Federal
redit..Unions

en
a o
Board of Directors
Dealer Bank Association

JH412

AMENDMENT TO H.R. 5447
OFFERED BY

(References to pages and lines are references to pages
and lines of the bill as reported by the Committee on
Agriculture)

Page 72, strike out line 13 and all that follows through
line 19 on page 74, and insert in lieu thereof the following
new section:

2
3
4

STUDY OF THE COMMODITY FUTURES INDUSTRY

SEC. 237.

The Commodity Exchange Act is amended by

adding at the end thereof the following new section:
"SEC. 23. (a)(1) The Board of Governors of the Federal

Reserve shall organize and conduct, with the assistance of

the Commodity Futures Trading Commission, the Securities and

Exchange Commission, and the Secretary of the Treasury, a

study and investigation of the structure, participation,

uses, and effects on the economy, of trading in contracts of

sale of commodities (including commodities which are rights

and interests in evidences of indebtedness, foreign

currency, securities, any group or index of securities,

other financial instruments, and related instruments, such

as options) for future delivery, including--

"(A) the number, types, and characteristics of

JH412
2
1

speculators, arbitrageurs, and hedgers engaged in such

trading, the purposes for which such persons utilize

such trading, and the financial resources devoted to

each of these trading activities;

"(B) the impact of speculation in such trading on

the accuracy, liquidity, and stability of cash and

contract prices, and the conditions under which such

speculation may have adverse effects on these

objectives, particularly with respect to the increased

10
11

volume of such trading;
"(C) the consequences that present and anticipated

volumes of trading in such contracts and related

instruments have, if any, on formation of real capital

in the economy (particularly that of a long-term nature)

the structure of liquidity in credit markets, interest

rates, and inflation;

"(D) the sufficiency of the public policy tools

available to the Commission or other agencies to limit

or curtail any such trading activity which is found

likely to have a harmful effect on national economic

goals;

"(E) the economic purposes, if any, served by such

trading, including the extent to which such contracts

and related instruments are utilized for hedging and

risk aversion purposes or for speculation;

JI-1412
3
the adequacy of investor protections afforded
2

to participants in designated markets for such trading;
the impact, if any, of such contracts and

related instruments on the markets for evidences of

indebtedness, foreign currency, and securities and on

the formation of real capital;
the extent to which such contracts and related

instruments may be utilized to manipulate, or to profit

from the manipulation of, the markets for evidences of

indebtedness, foreign currency, and securities;
the nature and consequences, if any, of

perceived disparities between the regulation of such

contracts and related instruments traded in contract

markets regulated by the Commission and the regulation

of functionally equivalent instruments traded in markets

regulated by the Securities and Exchange Commission; and
the operation of the pilot program established

under subsection

"(2) Not later than March 31, 1984, the Board of

Govenors of the Federal Reserve shall submit to the Congress

and transmit to the Commission a preliminary report

describing the results of the part of such study relating to

trading in contracts of sale of commodities which are rights

and interests in any group or index of securities and

related instruments, for future delivery. The Board of

JH412
4
1
2
3

Governors shall include in such report-"(A) findings with respect to the economic
benefits, if any, that have resulted from such trading;

"(B) a description of any adverse effects on the

underlying markets in securities, on the formation of

real capital, and on investor protection, that may have

resulted from such trading; and

"(C) recommendations as to Whether such trading

should be permitted to continue after the termination of

the pilot program established under subsection (b)(1),

and, if continuation of such trading is recommended,

whether any legislation or regulatory action applicable

to such trading is necessary to mitigate any adverse

effects found to have resulted from such trading or is

necessary to eliminate any perceived disparities between

the regulation of such trading and the regulation of

trading in other comparable instruments.

"(3) Not later than September 30, 1984, the Board of

Governors of the Federal Reserve shall submit to the

Congress a report describing the results of such study. The

Board of Governors shall include in such report an

assessment of the impacts of the activities studied and

recommendations for any legislation and regulatory action.

24
25

"(b)(1) For the period beginning on the date of the
enactment of the Futures Trading Act of 1982 and ending

JH412
5

September 30, 1984, all boards of trade designated, before

or after the date of the enactment of the Futures Trading

Act of 1982, as contract markets for trading in contracts in

rights or interests in a group or index of securities for

future delivery shall be subject to a pilot program with .

respect to such trading, to be established by the Commission

by rule, regulation, or order. Under such pilot program, the

Commission shall closely monitor such trading and shall make

an assessment of the impact, if any, of such trading on the

markets in the underlying securities and on the process of

forming real capital.

"(2) If the Board of Governors of the Federal Reserve

recommends, in the preliminary report transmitted under

subsection (a)(2), that trading in such contracts be

terminated or that other regulatory or legislative action be

taken, then the Commission shall submit a report to the

Congress, not later than September 30, 1984, containing a

plan to implement the recommendations of the Board of

Governors or a statement of reasons in support of the

Commission's opinion that such recommendations should not be

implemented.".

•

-8-

LABOR PRODUCTIVITY AND COSTS, NONFARM BUSINESS SECTOR
(Percent change at annual rates; based on seasonally adjusted data)

Compensation
per hour
From
From
previous
year
period
earlier

•

Output
per hour
From
From
previous
year
period
earlier

Unit
labor costs
From
From
previous
year
period
earlier

1979-QI
QII
QIII
QIV

9.2
9.8
9.8
9.9

10.9
10.4
8.6
9.7

-.1
-.8
-1.0
-.9

-.9
-1.6
-1.1
-.2

9.3
10.7
11.0
10.9

11.9
12.1
9.7
9.9

1980-QI
QII
QIII
QIV

9.7
9.9
10.1
10.1

10.3
11.3
9.0
9.8

-.6
-1.0
.2
.2

.3
-2.9
3.6
-.2

10.4
11.0
9.9
9.9

9.9
14.6
5.3
10.1

1981-QI
QII
QIII
QIV

10.5
10.0
10.2
9.3

11.7
9.6
9.5
6.3

1.2
2.3
.9
-.8

4.4
1.4
-1.7
-6.9

9.2
7.6
9.2
10.1

7.0
8.1
11.5
14.1

8.3

7.9

-1.7

10.2

7.3

1982-QI

Peak-to-peak changes: 1
1948-Q4
1953-Q2
1957-Q3
1960-Q2
1969-Q4
1973-Q4

1953-Q2
1957-Q3
1960-Q2
1969-Q4
1973-Q4
1980-Q1

5.7
4.6
4.2
4.9
7.0
9.0

2.7
1.7
2.3
2.5
2.5
.7

1. These time periods represent the intervals between NBER-designated
business cycle peaks.

2.9
2.8
1.8
2.4
4.4
8.3

June 7, 1982

-9Average Hourly Earnings Index*
Production workers private nonfarm industries
Per cent changes; based on seasonally adjusted indexes
Mir

Total
private
nonfarm

Period 1

Manufacturing
_

Changes over year
1973
1974
1975
1976
1977
1978
1979
1980
1981

•

5.0
8.0
5.0
6.8
4.1
7.6
6.7
7.7
8.1

6.4
10.4
8.7
7.4
8.3
8.5
8,7
10.9
8.8

6.3
9.1
7.4
7.3
7.5
8.4
8.0
9.6
8.4

Transportation
and public
utilities

Contract
construction

Total
trade

Services

7.4
8.8
9.0
8.1
9.2
7.3
8.9
9.3
8.5

6.3
8.8
6.5
7.1
7.4
9.6
7.5
8.8
7.1

6.2
8.3
7.0
7.6
7.1
7.6
7.6
9.5
9.1

Half-yearly changes at compound annual rates
1979:

1st half
2nd half

7.6
8.4

9.0
8.3

7.4
6.1

6.4
11.6

7.5
7.5

6.1
9.2

1980:

1st half
2nd half

9.5
9,7

10.9
10.9

7.4
8.1

8.3
10.4

8.8
8.7

9.4
9.6

1981:

1st half
2nd half

8.9
7.9

9.4
8.2

7.4
8.9

10.0
7.0

8.1
6.1

9.0
9.3

III
Quarterly changes at compound annual rates
1980-Q1
Q2
Q3
Q4

9.0
10.0
9.2
10.3

10.2
11.6
12.0
9.8

4.6
10.2
7.4
8.8

7.6
8.9
7.0
13.9

9.7
7.9
9.1
8.4

8.5
10.2
7.4
11.8

1981-Q1
Q2
Q3
Q4

9.3
8.5
8.5
7.3

9.4
9.4
8.7
7.7

9.2
5.7
8.9
8.8

9,1
11.0
6.4
7.7

9.1
7.1
8.0
4.3

9.1
8.9
9.3
9.2

1982-Q1

6.5

8.7

9.1

7.4

3.8

5.1

6.4
10.0
6.5
10.1
4.0
2.6
.2
9.9

-4.5
6.7
4.0
3.4
3.0
2.7
7.3
9.4

9.6
11.3
3.5
6.7
2.7
1.3
11.3
10.7

i
Monthly changes at annual rates
1981:

1982:

October
November
December
January
February
March
April
May

4.7
9.0
3.9
11.6
.9
3.5
6.6
9.4

5.5
8.1
4.1
16.3
2.0
6.4
6.5
6.8

11.1
8.5
8.1
29.3
-17.5
1.6
2.3
5.6

,
__,..._
*Excludes effects of fluctuations in overtime premiums in manufacturing and of shifts of workers between industries.
1 For periods of longer than one month the changes are based on quarterly averages of final quarter of preceding
period to final quarter of period indicated.

FR 712-N Rev. 4/81

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GROWTH RATES OF KEY BANKING AND MONETARY AGGREGATES

(Daily averages, percent annual rates, seasonally adjusted)

June 11, 1982
,

QIV '81
YEAR OVER YEAR
4
TO
1
LATEST LATEST:LATEST YEAR TO LATEST
MONTH 4 WKS.I3 MOS. DATE MONTH

RESERVE AGGREGATES
MONETARY BASE*
NONBORROWED RESERVES*
TOTAL RESERVES*

(May) (tM d i(MaTi.
av-i5.9
7.6
4.3

q1-11
ZY

MEMORANDA: ANNUAL GROWTH
QIV TO QIV
r
,

(May)

1979

1980 i 1981

YEAR OVER YEAR

1979

1980

1981

6.1
7.7
4.5

5.7
5.0
4.5

7.7
4.8
4.8

7.7
4.0
5.4

7.6
0.0
2.5

8.8
7.8
7.1

4.9
6.8
4.3

7.6
0.3
1.6

8.3
5.8
5.8

6.8
6.9
6.5

MONETARY AGGREGATES
AND BANK CREDIT
M1

5.1
(4.5)

5.3

5.0
(4.3)

5.8
(4.7)

6.7

7.4

7.3

5.0
(2.3)

7.7

6.3

7.0
(4.7)

9.4

n.a.

9.4

9.7

8.4

9.2

9.5

8.5

8.3

9.8

10.2

n.a.

10.3

10.5

9.6

9.8

10.0

11.4

10.3

9.3

11.6

8.4

n.a.

8.8

8.5

1/
8.5-

12.6

8.0

8.8

13.5

8.5

9.6

6.6

6.9

6.2

6.3

8.5

9.4

5.6

9.8

BANK CREDIT

MEMORANDUM
CURRENCY

9.2
7.3
I
I
I
NOTE: FIGURES IN PARENTHESES REPRESENT GROWTH ADJUSTED FOR SHIFTS FROM NON-M1 SOURCES TO OCD
ACCOUNTS IN 1981.
* RESERVES SERIES ARE ADJUSTED FOR CHANGES IN REGULATIONS D AND M.
N.A.--NOT AVAILABLE.

LATEST MONTH OVER THE DECEMBER-JANUARY BASE.

-13-

MONETARY AGGREGATES AND BANK CREDIT
(Percent annual rates of change)

M1
Fourth quarter to
fourth quarter
1978

Monetary Aggregates
M2

Bank
Credit

8.3

8.2

11.3

13.3

7.4

8.4

9.8

12.6

1979

7.3

9.2

10.0

8.0

1980

5.0
(2.3)1

9.5

11.4

8.82

1981

8.2

8.8

11.7

12.4

7.7

8.5

10.3

13.5

1979

6.3

8.3

9.3

8.5

1980

7.0
(4.7)1

9.8

11.6

9.6 2

1981

8.3

11.2

8.7

5.7

8.8

9.2

5.82

10.4

9.7

8.6

9.52

April

11.0

9.7

11.4

9.32

-2.7

9.5

9.9

8.82

May

6.7

9.7

9.6

8.54

Annual average to
annual average
1978

Recent Periods
1981--QIII
QIV
1982--QI

1981 QIV-May
Longer-run ranges
1979 QIV-1980 QIV
1980 QIV-1981 QIV

23
/
4 to 61
2 to 61
1
3/

6 to 9

to 91
61,
2

6 to 9

2
/
2 to 91
1
6/

6 to 9

6 to 95
2
1
6. 5 to 9/
6 to 9
2
1
2 to 5/
1
2/
1981 QIV-1982 QIV
out of savings deposits into other
1. Adjusted for the effects of shifts
checkable deposits.
domestic offices to International
2. Adjusted for shifts of assets from
Banking Facilities (IBFs).
o other checkable deposits in 1980
3. When this range was set, shifts int
effect on M1 growth. As the year prowere expected to have only a limited
checkable deposits more actively, and
gressed, however, banks offered other
to these accounts. Such shifts are
more funds than expected were directed
over 1980 by at least 1/2 percentage
estimated to have increased M1 growth
point more than had been anticipated.
wth from the base period through
4. May over December-January base. Gro
domestic offices to IBFs since
May adjusted for shifts of assets from
January is 9.8 percent.
m the December 1981-January 1982
5. Range for bank credit is growth fro
2.
average level through fourth quarter 198

Removal Notice
The item(s) identified below have been removed in accordance with FRASER's policy on handling
sensitive information in digitization projects due to copyright protections.

Citation Information
Document Type: News service reports
Citations:

Number of Pages Removed: 5

Associated Press. "Bank for International Settlements Sees Difficulties in Cutting Budget
Spending." June 14, 1982.
Associated Press. "BIS Calls for Wage Curbs to Check Rise of Unemployment." June 14,
1982.

Federal Reserve Bank of St. Louis

https://fraser.stlouisfed.org

For release on delivery
10:00 A.M., E.D.T.
June 15, 1982

Statement by

Paul A. Volcker

Chairman, Board of Governors of the Federal Reserve System

before the

Joint Economic Committee

June 15, 1982

I am pleased to appear before this Committee to discuss
the conduct of monetary policy.

In particular, I would like to

You will recall Congress had urged such

an approach in House Concurrent Resolution 133.

Subsequently,

the reporting of growth targets for the aggregates was formalized
in law with the enactment of the Full Employment and Balanced
Growth Act of 1978, commonly referred to as the Humphrey-Hawkins
Act.

That law requires the Federal Reserve to present annual

targets for monetary and credit aggregates to the Congress each
February, and to review those targets and formulate tentative
objectives for the coming calendar year each July.

The choice

of the appropriate measures to "target," as well as the quantitative expression of those targets, are, of course, a matter for
the Federal Reserve to decide.
The development of this formal reporting framework,
focusing on the growth of certain monetary and credit variables,
was a reflection in part of changes in attitudes toward monetary
policy that occurred in the 1970s, and in part of a desire to
improve communications and reporting about our intentions and
policies.

The worsening inflation problem focused increased

attention on the critical linkage over the longer run between
money growth and prices.

There was a growing sense among some

-2-

A number, including

More generally,

A basic premise of monetary policy is that

While other policies must be brought to bear

as well, the specc annual targets announced periodically by
the Federal Reserve have reflected efforts to reconcile and
support these goals.
It seems to me implicit in an aggregate targeting approach,
as urged by the Congress, that interest rates in themselves are not

the dominant immediate objective or focus in assessing the
posture of monetary policy, even though that remains the instinct
of many.

Interest rates are, of course, highly important economic

But interest

rates are also importantly influenced by other forces as well,
including expectations about inflation, about future interest
rates, the budgetary posture, and other factors.

The experience

In those circumstances,

-4

developments in money and credit and in setting appropriate
targets.

One reason for that is the impact of financial

innovations on the growth of particular measures of money and
the relationships among them.

In recent years, generally high

and variable interest rates, and the continuing process of
tutions
technological change and the deregulation of depository insti
have provided powerful stimulus for far-reaching changes in the
financial system.

The proliferation of new financial instruments

ement
and the development of increasingly sophisticated cash manag
techniques have created a need to adjust the definitions of the
relationmonetary aggregates from time to time and to reassess the
mic
ship of the various measures to one another and to other econo
variables.

A somewhat separable matter conceptually (but in

may
practice hard to distinguish) is that businesses or families
r
shift their preferences among various financial assets in a manne
in
that may alter the economic significance of particular changes
any given measure of "money" or "credit."
Use of monetary targeting procedures is justified on
the presumption that "velocity" -- that is, the ratio between
a given measure of money and the nominal GNP -- is reasonably
predictable over relevant periods.

At the same time, it can be

veloreadily observed that, in the short run of a quarter or two,
city is highly variable.

Those short-run deviations from trend need

over a
to be assessed cautiously, for they commonly are reversed
period of time.

However, we cannot always assume a rigid relation-

ship between money and the economy that, in fact, may not exist

over a cycle or over longer periods of time, especially when
technology, interest rates, and expectations are changing.

Conse-

To some degree, the Federal

Reserve was able to anticipate the impact.

It was obvious,

However, after

Taking into account all of the financial

-6-

Thus far this year, the monetary aggregates have behaved
more consistently, although Ml is running a bit stronger than
anticipated relative to the other aggregates.

With the major

shift into NOW accounts, in terms of new accounts opened, mostly
behind us, one source of distortion has been removed from the
data.

But I would also note that, as a result of that "structural"

This year there

has been a noticeable increase in the public's desire to hold a
portion of their saving

in highly liquid forms, probably

reflecting recession uncertainties.

As a result, NOW accounts

have grown particularly fast, accounting for the great bulk of
the growth in Ml, and at the same time the rapid decline in savings
deposits has ceased.

Overall, Ml growth so far this year has been

somewhat more rapid than a "straight line" path toward the annual
target would imply.

To the extent the relatively strong demand

for Ml reflects transitory precautionary motives, allowing some
additional growth of money over this period has been consistent
with our general policy intentions.

In arriving at such a judgment, the pattern of growth
in the broader aggregates should be considered.

There also

have been important institutional changes in recent years
affecting the behavior of M2 and M3.

For example, an in-

An important

In February, we reported to the Congress that M2 and

M3 would appropriately be in the upper half of their ranges, or
at or even slightly above the upper end, should regulatory changes
and the possibility of stronger savings flows prove to be important.
In that regard, I. must point out we have yet to go through a full
financial cycle with such a large money fund industry or
with the regulatory and legal changes recently introduced.
In these circumstances, it is clear that interpreting the
performance of the monetary and credit aggregates must be
assessed against the background of economic and financial
developments generally -- including the course of and prospects
for business activity and prices, patterns of financing, and
liquidity in various sectors, the international scene, and
interest rates.

It is in that broader context that we have

has been
not believed that the growth of the various Ms
unduly large so far this year.

factors
The point I am making is that a large number of
have impinged

-and in all likelihood will continue to impinge

ibly in the process
on the growth of the monetary aggregates, poss
ure of "money"
modifying the relationship of any particular meas
to economic performance.

The relationships have been good enough

stability -over a period of time to justify a presumption of
wide range of
but I do believe we must also take into account a
g whether
financial and nonfinancial information when assessin
policy
the growth of the aggregates is consistent with the
intentions of the Federal Reserve.

The hard truth is that

the conduct
there inevitably is a critical need for judgment in
of monetary policy.
has
Looking back at the last few years, money growth
time in the
certainly fluctuated rather sharply from time to
s as well).
United States (and, I might note, in other countrie
affected by a
As I earlier noted, relationships have also been
variety of financial innovations.

But the trend over reasonable

the announced
spans of time has generally been consistent with
ed growth has,
targets of the Federal Reserve, and the restrain
clear progress
in my judgment, contributed importantly to the now
toward reducing inflation.

This longer-run and broader perspective

growth in the
is what should be kept in mind when considering

aggregates.

The tentative decision (not yet implemented)to publish

But, I

also know that it would be shortsighted for the Federal Reserve
to abandon a strong sense of discipline in monetary policy in an
attempt to bring down interest rates.

It may be that the immediate

effect of encouraging faster growth in the aggregates would be
lower interest rates -- particularly in short-term markets.

But

over time, the more important influence on interest rates
particularly longer-term interest rates

is the climate of

expectations about the economy and inflation, and the balance
of savings and investment.

In that context, an effort to drive

interest rates lower by money creation in excess of longer-run
needs and intentions would ultimately fail in its purpose and
would threaten to perpetuate policy difficulties and dilemmas of
the past.

-10-

When long-term interest rates decline decisively, it
will be an indication of an important change in attitudes about
the prospects for the economy.

One essential element in this

process must be a widespread conviction that inflation will be
contained over the long run.

The decline in inflation evident in

all of the broadly based price indices over the past year is highly
encouraging.

For example, in the 12-month period ending in April,

2 percent compared to 10 percent over the previous
/
the CPI rose 61
12 months.

Over the past few months, the CPI has been virtually

stable.
But it is also evident that some particular elements
accounting for the sharp reduction in inflation are not sustainable;
they have been achieved in a period of recession and slack markets,
and have reflected some sizable declines in energy prices that
now appear behind us.

Progress toward reducing the underlying

trend in costs, while real, has been slower.

We have seen some

polls that suggest many Americans do not in fact appreciate that
inflation has slowed at all.
to fact.

That impression is plainly contrary

But it is perhaps indicative of how deep seated impressions

and expectations of inflation had become by the late 1970s, and it
is suggestive of the concern of renewed higher inflation rates as
economic activity recovers.

No doubt those concerns continue to

affect investment judgments and interest rates.
In this situation, one key policy objective must be to
"build in" what has so far been a partly cyclical decline in

-11-

inflation, to encourage further reductions in the rate of
increase in nominal costs and wages, and then to establish
clearly a trend toward price stability.

That approach seems

These

circumstances emphasize the need to avoid excessive monetary growth,
with the threat it would bring that the heartening progress against
inflation would prove only temporary.
I think that it also is quite clear that the prospect
of huge and rising budget deficits as the economy recovers has
been another element in the current situation raising concerns
about long-term pressures on interest rates.

I take encouragement

from the efforts of the House and Senate to begin to come to grips
with this problem.

At the same time, we are all aware of how much

remains to be done, not only to reach agreement on a budget resolution
for fiscal 1983, but to take the action necessary to implement such
a resolution in appropriation and revenue legislation.

Moreover,

-12-

The perception that future credit demands by the Federal
Government would be lower would reinforce the emerging
expectations of less inflation.

The threat that huge deficits

Confidence would be enhanced that monetary

And by

There is far from universal appreciation

of the fact that the economic significance of particular aggregates
is constantly evolving in response to rapid changes in financial
markets and practices.

Consequently, the Federal Reserve is

continually faced with difficult judgments about the implications
for the economy.

-13-

A wide array of financial and

nonfinancial information will be reviewed in the process of
considering the specific objectives.

And, while I do not

anticipate any significant change in our operating procedures
in the near term, we will also continue to assess and reassess
the means by which our policies are implemented.

However, I do

But I do sense substantial progress

and a clear opportunity to reverse the debilitating pattern of
growing inflation, slowing productivity, and rising unemployment
of the 1970s.

The challenge is to make this recession not another

Critical elements in that effort

-14-

are the commitments to gain control of the federal budget and
to maintain appropriate monetary restraint.

Those policies

FOR RELEASE UPON DELIVERY
EXPECTED AT 9:30 A.M.
THURSDAY, JUNE 10, 1982

STATEMENT OF BERYL W. SPRINKEL
UNDER SECRETARY OF THE TREASURY FOR MONETARY AFFAIRS
BEFORE THE
JOINT ECONOMIC COMMITTEE
WASHINGTON, D.C.
Thursday, June 10, 1982

Congressman Reuss, Senator Jepsen, and distinguished members
of the Committee, I am pleased to be here today to discuss
interest rates and monetary policy.

Monetary Policy and High Interest Rates

The Federal Reserve's announced policy to reduce the rate of
money growth is absolutely necessary in order to assure that the
progress made to date on inflation will continue into the future.
The Administration supports completely the Federal Reserve's policy
which calls for a deceleration of money growth.

Their announced

policy and money growth target ranges are appropriate and consistent
with our goal of achieving noninflationary economic growth.

The economy has borne the burden of high interest rates
for many years.
late 1978.

The prime rate has been in double digits since

We are all well aware of the extreme hardship these

-2ly in
rates have imposed on the economy in general and particular
interest—sensitive sectors.
should they be minimised.

These hardships cannot be denied nor

To the contrary, we understand and

the economic
share the concerns of the Congress and the public about
distress caused by high interest rates.

Sympathy, however, does not solve the problem.

Nor does

political rhetoric about the evils of high interest rates.

We are

ngful
all certainly eager to have interest rates fall, but a meani
underlying
and permanent decline is possible only when we remove the
at
causes of the pressures which have maintained interest rates
high levels.

The fundamental cause of high nominal interest rates is inflaof
tion and inflationary expectations and the fundamental cause
inflation is excessive monetary expansion.

This is why a credible,

permanent deceleration of money growth is imperative.

Monetary

discipline is a prerequisite to the price stability and lower
essential
interest rates that we all desire and all recognize as
for real economic growth.

Despite a dramatic decline in inflation over recent months,
market interest rates remain high.

It has therefore become common-

inflation
place to compare current market interest rates to current
than
rates and to conclude that real interest rates are higher
they have been since the great depression.

•

-3It is true that the difference between current interest and
inflation rates is higher now than since 1933.

It is not, however,

the difference between current interest and inflation rates that is
relevant to economic activity.

Business and investment decisions

are based on the rate of inflation that is expected to occur over
the life of an investment.

In an ideal world of price stability,

the expected and current rates of inflation would be equal, or
nearly so.

In the current environment this is not the case, as

financial market participants have not adjusted their inflationary
ed.
expectations downward as rapidly as actual inflation has declin

Similarly, during the mid-1970's, inflationary expectations
were not adjusted upward as rapidly as actual inflation accelerated.
Despite rising inflation rates, future inflation rates were
for several years consistently underestimated.

The difference

between market interest rates and actual inflation rates was,
therefore, negative.

This experience, coupled with the

effective
repeated failure of government to deliver on promises of
markets'
anti-inflationary policies, had a profound effect on the
expectations about future inflation.

inflation in
Just as the markets' failure to anticipate rising
relative to
the 1970's kept market interest rates artifically low,
high
actual inflation rates at the time, the expectation that
factor
inflation rates will continue in the future is a primary
in keeping interest rates high now.

This is the legacy of a deca:1L

a
-.4-

logy and expectaof accelerating inflation -- inflationary psycho
utions.
tions are deeply embedded in our economic behavior and instit
Interest rates will fall only when financial market participants
become convinced that inflation will not resurge and therefore
adjust their inflationary expectations downward, in line with
p.

current inflation rates.

This will require economic policies and actions

but
that, not only yield continued progress on actual inflation,
also minimize uncertainty about future policy.

If we want interest

rates to fall -- and we most certainly do --- then three things
are vital.

First, the Federal Reserve must continue to pursue its

l
policy of noninflationary money growth; to reiterate, the Federa
that
Reserve has the unqualified support of the Administration in
policy.

Second, the Federal Reserve should make a stronger effort

to reduce the significant, sharp swings in money growth which have
slowed the adjustment of market expectations to the basic antiinflationary monetary policy.

Third, the Congress and the Adminis-

tration must come to a meaningful agreement on the budget; by
meaningful, I mean actions which clearly indicate that the Federal
spending.
government has the discipline to limit the growth of public
will foreWithout that discipline, the credit and investment markets
see ongoing government revenue and financing problems.
imply higher taxes and/or more inflation in the future.

These prol,leTs-

-5The Proposals to Accelerate Money Growth

Any reacceleration of money growth would have disastrous
effects on our long-run goal of price stability and permanently
lower interest rates.

Instead, faster money growth would soon

rekindle inflationary pressures and refuel inflationary expectations.
•

Interest rates would rise quickly and rapidly, reducing greatly the
potential for future output and employment growth.

The Administration,

therefore, strongly opposes any proposal to increase the rate of
money growth or to raise the money growth targets.

The record of the 1970's clearly shows that a little more
inflation cannot be traded for more production and employment over
the long run.

Any boost to production and employment that comes

from accelerating money growth is temporary because faster money
growth causes inflation and pushes interest rates up.
effects of excessive money growth

The lasting

accelerating inflation,

escalating interest rates and a deterioration of the incentives to
save and invest -- are powerful and pervasive deterrents to sustained
economic growth.

Sustainable economic expansion requires a financial

system based on a reliable dollar.

That means monetary discipline.

Over the past year uncertainty about economic policy in general
factor
and long-run monetary policy in particular has been an important
in keeping interest rates high, even as inflation has fallen.
Reaccelerating money growth or raising the money growth targets
would only add to that uncertainty.

It would signal to the finan-

cial markets that their worst fears and doubts are true -- that the

-6Government cannot be relied on to adhere to noninflationary monetary
policy over the long run; that anyone who bets on inflation coming
down and staying down (that is, anyone who lends money ;at a lower
interest rate) can count on losing that money.

This is the skepti-

cism that has worked to keep rates high as inflation has declined.
A sgstained increase in the rate of money growth or an increase in
the money growth targets would reinforce and justify that skepticism,
add to the intransigence of inflationary expectations, and thereby
Push rates higher than they already are.

Furthermore, the fact that suggestions to increase money growth
are being offered and discussed adds to the uncertainty and skepticism
about future monetary policy intentions.

Discussions, proposals and

political pressures to increase money growth are themselves contributing to the problem of high interest rates by adding to the
markets' fears that the Fed will give in to the pressures and
return to inflationary money growth.

It is useful, I believe, to review why it is that we set targets
for monetary growth.

In the first instance, the purpose of money

growth targets is to provide discipline and an explicit measure
against which to judge a central bank's performance.

In addition,

effective money growth targets tell the financial markets, and
business and investment planners, what they can expect from the
central bank in the year or years ahead.

In countries that have

been successful at long-term money growth targetting -- such as

-7-

Switzerland, Japan and West Germany -- the certainty and stability
associated with setting and consistently achieving announced money
targets has contributed to high rates of saving, investment and
ecS nomic growth.

In those countries, the targets have become a

meaninSful policy statement on which the business and investment
coMW1unities can rely; predictable monetary trends minimize uncertainty
anI provide a stable economic background in which savers and investors
can more confidently plan and commit resources.

When they began to implement the current policy of slowing the
trend growth of money, the Federal Reserve unfortunately had no
such record of consistency.

While signcant problems remain,

the Federal Reserve has been able over the past year and a half to
build the credibty of their commitment to achieving a nonThat gain in credibility

inflationary rate of monetary expansion.
would quickly be eroded by an

increase in the money targets, or

actions to allow above-target money growth over the long run.

The value of money growth targets

•••

in imposing discipline

and acting as a messenger of the Fed's intentions

alm

is greatly

diminished if they are consistently not achieved or if they are
chanI-d at will.

This was recognized by the Congress and

acknowledged in the provisions of the Humphrey-Hawkins Act, which
requires the Federal Reserve to set annual monetary targets at the
beginning of each year.

This move ended the prior practice of

"base drift," where targets were reset every three months, and
provided no discipline on monetary creation.

In the current

environment, the continuing n --d f5r stable and credible monetary

policy cannot be overstated.

Monetary targetting can be an important

•

device for promoting credibility and reducing uncertainty, but
it cannot serve that function if we consistently excuse errors and
redefine the targets.

_Those who advocate reaccelerating money growth or raising the
targets are misinformed when they assert that these changes are
the route to lower interest rates.

Anyone who still believes that

high interest rates are the result of "tight" monetary policy has
When the prime

not been paying much attention to recent history.

rate first broke the 20% level in the spring of 1980, money had
increased 7.8% over the preceding year.

During the second half of

1980, money grew at an annual compound rate in excess of 13% -the highest rate ever recorded for a six-month period -- and in
December the prime rate reached its all-time high of 21-1/2%.

In the six months ending in April of this year, M1 grew at an
annual compound rate of 9.1%, well above the Fed's announced targets.
This cannot be characterized as "tight" money; by historical standards,
this is an extremely rapid rate of money growth.

Yet interest

rates have not fallen since last fall; in fact, they began to rise
in November when the accelerated pace of money growth became evident.
By comparison, in the preceding six-month period ending last
October, M1 actually fell slightly; interest rates began to fall
last summer and fell dramatically during the fall.

Excluding the

period of time in 1980 when interest rates were artificially depressed
by credit controls, the longest and largest decline in interest

November 1981; that
rates since 1974-75 occurred from July to
monetary restraint.
decline coincided with a period of sustained
notion that high interest
The record clearly contradicts the common
policy.
rates are the result of 'tight' monetary

ce interest rates
'The belief that faster money growth will redu
between money and
is based on a fundamental and common confusion
credit.

want to
Those who advocate faster money growth really

increase real credit growth.

The Administration shares that goal

to achieve that aim
and the economic recovery program is designed
saving.
by providing incentives for increased real
growth will not do it.

Faster money

Faster money growth would not provide more

ce the interest rates
real credit to the housina market or redu
which a small business must pay to borrow.

Faster money growth

provides only more money, not more credit.

Indeed, faster money

it would be available,
growth would probably mean that less real cred
The way to

rates.
and it certainly means higher nominal interest
ng.
increase credit availability is to stimulate savi

The government

ng and by removing
can contribute through tax -incentives to savi
the greatest disincentive to save of all

4=,

inflation.

y growth would
Thus, the proposed "solution" of increasing mone
it situation worse.
make our high interest rate-tight cred

The

ed by an actual or
inflation and inflationary expectations caus
d, first, push interest
threatenP1 acceleration of money growth woul
her erode incentives to save
rates higher; second, it would furt

and thereby further restrict the supply of credit flowing into
financial markets and institutions.

;

The Budget Deficit

•••

Concern about the size and resolution of the deficit problem
is also adding to financial market uncertainty and reinforcing
sensitivity in the credit markets to any indication that monetary
discipline might be relaxed.

In this sense, the deficit issue

is helping to keep interest rates high.

Despite the now-common

belief that any method for reducing the budget deficit will assurc
that interest rates fall, we cannot count on that happening unless
the budget resolution is a meaningful one.

That is, a budget

resolution that acknowledges the burden that the uncontrolled
growth of government spending imposes on society and the economy.

The Federal government will face continuing budget crises
until we move effectively to contain the growth of government
spending.

In the past decade, government spending has grown more

rapidly than the economy as a whole, rising as a share of GNP froT
20% in 1970 to 23% in 1981, and to over 24% in early 1982.

We must face the fact that any government spending -- no matter
how well-intentioned its goals or beneficial its impact
costs on the economy.

imposes

In the short term, government spending car,

be financed three ways -- through taxation, by creating new money
or by borrowing.

Ultimately, however, only two sources of revenue

-11--

can erode
are available -- direct taxation or inflation. Taxation
tives of
incentives of individuals to work and save and the incen
business to produce and invest.

Not only does this decrease the

, but it also
ability of the economy to support government spending
.
increases pressure for even more government spending

Money creation

also erodes
causes inflation and inflationary expectations, which
incentives to save and invest.
result is the same.

The method is different, but the

In addition, excessive money growth leads to

growth.
high interest rates which choke-off real economic

are to
Therefore, the situation can be stated simply: if we
the
allow government spending to grow unchecked as it has over
erating
past several decades, we must be willing to accept accel
it)
inflation (and the escalating interest rates that go with
and/or high and rising tax rates.

There are no other choices and

heeded as a
the current situation in financial markets should be
sign that the public is aware.

ist,
The financial markets fear that if large deficits pers
ing" the deficit
the Federal Reserve will be pressured into "monetiz
y.
and thereby financing spending by creating new mone

These fears

need for
are aggravated by Congressional statements about the
faster money growth.

The financial markets are already extremely

money growth.
concerned that the Fed will revert to inflationary
to
Any signals that the Fed is coming under political pressure
h again
do so only adds to the concern that inflationary money growt

very.
will, be used to boost an economic reco

That skepticism helps

keep interest rates high.

al Policy
There is No Trade-Off Between Monetary and Fisc

•

y growth rest
Some proposals to reaccelerate the rate of mone

al restraint can be
on the premise that a greater degree of fisc
traded for some degree of monetary ease.

This implies that monetary

other and that a
and fiscal policies can be substituted for each
monetary policy.
budget compromise can be paired with an easing of
and distinct
The role of monetary policy in the economy is separate
from the role of fiscal policy.
versus less of the other.

It is not a matter of more of one

Instead, prudent noninflationary monetary

viewed as complepolicy and disciplined fiscal policy should be
economic growth.
mentary policies to promote price stability and

and fiscal
The division of responsibility between monetary
policies is clear.

The role of monetary policy is to restore the

on, to eliminate
soundness of the dollar or, in the popular jarg
inflation.

supply
That requires holding the growth of the money

l of the economy.
in line with the long-term growth potentia

The

is to encourage
role of fiscal policy, in the current environment,
stment, in order
a shift in resource use from consumption to inve
potential.
to stimulate growth of the economy's productive

Reduc-

the two together provide
tion of inflation reinforces that effort and
job opportunities and
the necessary ingredients for expanded
increased standards of living.

During the past year the Federal Reserve has made progress
toward establishing a credible, noninflationary monetary policy.
They have not yet totally achieved that goal and their record
could be improved.

Money growth continues to be extremely volatile.

Given the current budgetary uncertainty and the history of monetary
policy in the 1960's and '70's, such erratic money growth has encouraged skepticism about long-run monetary control.

The Treasury has

gathered substantial evidence that the markets' reaction to
variable money growth has been a major factor in maintaining the
high levels of interest rates.

In my view, the Federal Reserve

could reduce monetary volatility by making technical changes in
their operating procedures.

But with these caveats aside, the Federal Reserve has, on
balance, reduced the rate of money growth toward a noninflationary
pace.

Monetary policy is moving in a direction that is consistent

with sustained, noninflationary economic growth.

It is now up to

those of us who are responsible for the rest of economic policy to
follow suit.

That means we must persevere in bringing the growth

of government spending under control.

It also means that we must

stop cajoling the Federal Reserve to return to the inflationary
policies of the past.

While the transition to lower inflation has

been made more costly than necessary, the odds are that the worst
is behind us.

It is now imperative that we not throw away the

gains, by repeating the same mistake that has been made frequently
on the
in the past -- the mistake of presuming that turning
ills.
monetary spigot provides the cure for all our economic

The problem in the financial markets is basically one in which
es
a policy of an undisciplined government spending, which requir
inflation to be sustained, is colliding with a mormtary policy that
is no longer providing inflationary money growth.

In the past

a tax
decade, government spending has been financed by inflation and
system that guaranteed ever-rising tax revenues.

As long as infla-

ed
tion accelerates, proliferating government spending can be financ
without prospective large budget deficits.

But the Federal Reserve

has now curtailed inflationary money growth and the Government
can no longer count on inflation to finance increased spending.

Proposals to reaccelerate money growth are equivalent to
a,ivocating a return to accelerating inflation.

It is important

derina
that we recognize, and remember, the economic costs of surren
The very sectors that are suffering now

to continued inflation.
41Mk.

farmers, the auto industry, small businesses, home builders,

and the thrift industry -- would only be damaged further by a
There is evidence of the insidious effects

resurgence of inflation.

of inflation all around us.

Our lagging saving rate, declining

productivity, and our inability to compete with many foreign
producers

these are all legacies of a decade of inflation.

We will never cure these fundamental problems by continuing to
pursue the inflationary policies of the past.

4
4

June 10, 1982

To:
Thru:
From:

Chairman yorker
Don Winni4
Tony Cole_„4

The JEC continued its hearings on "The Future of
Monetary Policy" this week with testimony from a panel of
economists on Tuesday and from James Pierce and Beryl Sprinkel
on Thursday. Mr. Richmond was the only member joining Chairman
Reuss for the hearings. A brief summary of the testimony
follows. All of the witnesses, with the exception of Secretary
Sprinkel, were very critical of the Federal Reserve.

Tuesday
Albert T. Sommers (Chief Economist, The Conference Board)
o There are rates of credit creation that would clearly
represent a monetary inducement to inflation. However, monetary
Policy cannot stop an inflation whose causes are upstream from
money itself; and the effort to do so can be immensely costly.
o That a certain amount of inflation is required for a developed
mixed economy to maintain satisfactory levels of output, employment, and growth begins to be a responsible conclusion.
o High rates are caused by the present budget situation, rate
volatility (which is a result of the way the Federal Reserve conducts policy), and the expectation of restraint, rather than
the actual growth of Ml.
o Suggests a program including (1) a pragmatic monetary policy
directed toward the maintenance of growth in jobs and output,
allowing for some persistent, non-cumulative inflation; (2) a
revised tax program increasing the burden on consumption; and
(3) restoring the deficit to a sustainable level (2% of GNP).

Harvey D. Wilmeth (VP--Northwestern Mutual Life Ins. Co.)
o The simple monetary cure for inflation requires a full scale
deflationary depression to do its job. Current monetary policies
are on a collision course with any material recovery.
o It is time to reconsider the decision to let market forces
discipline the money and credit system.
o Presents the "Monetary Policy Index" (the ratio of the increase
in debt to the money supply--states that in 1952 this ratio was
$.25 of credit expansion per $1.00 of money and in 1981 there

was $1.10 of new debt per dollar of money supply) to explain high
rates.--'The higher the Monetary Policy Index, the higher the
interest rates needed to clear the new issues markets . . . Any
permanent reduction in interest rates requires a permanent
reduction in the Monetary Policy Index."
o Suggests a new program for separate control of money and
"near money" (such as savings accounts and other interest-bearing
liabilities) by the Federal Reserve in order to control both
interest rates and inflation.--"It must be possible to limit credit
expansion at the same time that the growth rate of the narrow
money supply is increased. Japan, Germany and Switzerland appear
able to do this."
o Predicts that short-term rates would fall to single digits
within 60 days and long-term rates could reach that level in less
than a year if his proposal were adopted.

John H. Hotson (University of Waterloo, Ontario)
o All Reaganomics and monetarism have to offer us is depression.
Rising interest rates are accelerating the economy into financial
collapse. Nominates Paul Volcker as the foremost candidate for
recall (to Princeton) and "retrofit." We need easy monetary and
fiscal policies now to avert a depression.
o Cites Canadian experience as evidence that U.S. policies
do not work. The C.P.I. rise in April fell to 6.6% in the U.S.,
but continued at 11.3% in Canada. "Since Canada has even more
ferocious interest rates (which are non-deductible for house
owners and consumers) than the U.S. and a negative growth of Ml,
Canada should have less inflation than the U.S."
o Suggests the need to design income policies that will give
us full employment and stable prices.
o Proposes a combination of tax and interest rate cuts combined
with credit and incomes controls to channel expenditure into
real investment rather than consumption and price hikes.

The questions Chairman Reuss posed to the above panel
were identical to those he pursued at the first day of hearings
last week. Reuss described the Federal Reserve as practicing a
modern version of bloodletting and asked each witness to condemn
the Federal Reserve both for setting an unrealistically low M1
target and for over shooting the target. Each was also asked to
comment on the monetary policy language contained in the budget
resolutions.--"If you were a member of the FOMC would you have
any trouble responding with a mild raising of the target? Is

there any doubt about the ability of mortal men and a woman to
do that?" Chairman Reuss also asked rhetorically--"Since the
FOMC is composed of 12 people of honesty, integrity and
intelligence, how do you explain their failure with one exception, Governor Nancy Teeters, to confess error? How can these
fine gentlemen remain so much in error?"
Mr. Richmond, stating that capital investment is down
50% and that high interest rates is the big problem, commented
"I don't blame the Federal Reserve as much as everyone seems
to blame them. I blame the Federal Government policies. The
Federal Government should reduce deficits by raising taxes to
get interest rates down."

Thursday
James L. Pierce (University of California, Berkeley)
o Current monetary policy is u•nsustainable and is not the
appropriate means for promoting economic growth and price
stability. Current budgetary
•
policies have made the situation
even more untenable.
o The change in operating procedures in 1979 was a serious
policy error.
o Growth of M1 of 2-1/2 to 5-1/2% is too low to produce a
meaningful economic recovery.
o The longer that monetary policy remains so restrictive, and
the harder that it must battle against the effects of tax cuts,
high military spending and rising deficits, the more unbalanced
the economy becomes. Eventually monetary policy will have to be
more expansionary. The longer that the inevitable is postponed,
the larger is likely to be the ultimate expansion of money and
credit growth. This could easily lead to a resurgence of rapid
inflation.

Beryl Sprinkel
The Federal Reserve's announced policy to reduce the rate
of money growth is absolutely necessary in order to assure that
the progress made to date on inflation will continue into the
future. The Administration supports completely the Federal
Reserve's policy which calls for a deceleration of money growth.
Their announced policy and money growth target ranges are
appropriate and consistent with our goal of achieving noninflationary economic growth.
I

-4-

o If we want interest rates to fall, three things are vital:
(1) the Federal Reserve must continue to pursue its policy of noninflationary money growth; (2) the Federal Reserve should make a
stronger effort to reduce the significant, sharp swings in money
growth which have slowed the adjustment of market expectations to
the basic anti-inflationary monetary policy; and (3) the Congress
and the Administration must come to a meaningful agreement on
the budget.
o The Administration strongly opposes any proposal to increase
the rate of money growth or to raise the targets.

Reuss asked Mr. Pierce his standard question concerning
the failure of the Federal Reserve to hit the M1 target, but did
not receive the standard response. Pierce commented that this
failure was the inevitable consequence of Congress demanding and
the Federal Reserve establishing targets that it cannot really
achieve no matter how hard it tries ("Although it doesn't always
try real hard."). Chairman Reuss responded that the Congressional
directive is not at fault, but rather the Federal Reserve has
picked unrealistically low targets, and that, in any event, he did
not want to get into an argument over who shares the guilt.
Reuss next asked Pierce how he would respond to the
monetary policy language contained in the budget resolution if he
were on the FOMC ("A consummation devoutly to be wished."). Pierce
responded that he'd be "delighted" with the resolution and that
he was very disappointed with Chairman Volcker's statements that
there would be no compromise. Reuss replied--"I thought that
Volcker said he'd obey a resolution, but the Wall Street Journal
editorial writers who have access to his mind others don't have
say that's not so."
Pursuing this line, Reuss next commented--"Suppose at
the next FOMC meeting Governor Teeters, a very right minded person,
states that the FOMC has now heard from Congress that the targets
are bad and that the FOMC has to raise them. What would you say?"
Pierce responded that he would agree and that the Federal Reserve
should publicly announce that decision. Pierce further stated
that the Federal Reserve should not be ordered by Congress to
do this, but should do it on its own initiative in view of the
new budget policies.
By the time Reuss got to Mr. Sprinkel, he seemed to
have run out of energy. Perhaps he felt that it would be useless
to pursue his standard line of questioning with Sprinkel. In
any event, questions directed to Mr. Sprinkel focused on foreign
exchange intervention. Sprinkel did, however, agree with Reuss
that the failure to stay within the M1 target range is disquieting to the markets.

-5-

Mr. Richmond asked Sprinkel a number of questions on
the Administration's tax policies--once again focusing on his
concern that rates will not come down until the deficit is
reduced.
Copies of the Pierce and Sprinkel testimonies are
attached.

Attachments
cc: Messrs. Axilrod, Prell, Soss

STATEMENT BY

JAMES L. PIERCE
PROFESSOR OF ECONOMICS
UNIVERSITY OF CALIFORNIA, BERKELEY

BEFORE THE

JOINT ECONOMIC COMMITTEE OF CONGRESS
WASHINGTON, D.C.
JUNE 10, 1982

I am here today to add my voice to those who
are critical
of current monetary policy.

I believe that this policy is

unsustainable and that it is not the appropria
te means for
promoting economic groWth and price stabil
ity. Current budgetary
policies have made the situation even more
untenable.
There has never been any doubt that monetary
policy could
dramatically reduce inflation. With suffic
iently restrictive
growth in the supply of money and credit
, the housing market could
be destroyed, consumers could be prevented fro
m purchasing
automobiles and other durable goods, business pro
fits could be
wiped out, and business fixed investment cou
ld be depressed.
This would throw millions of people out
of work. The total effect
of a sufficiently restrictive monetary policy
would be a deep
recession which would eliminate the enthus
iasm of labor and
management for raising wages and prices.
This story, which became reality, demonstrates
that inflation
can be reduced relatively quickly.
is at what cost and for how long?

The natural question, however,
Social pressures mount to get

the economy out of its depressed state.

These pressures can

ultimately produce highly stimulative polici
es such as those that
followed the 1974-75 recession. The stimulati
ve policies rekindle
inflation and the economy ends up back where
it started with high
inflation. I fear that the Federal Reserve has sta
rted the
economy on just such a painful trip.
A case could be made for a harsh monetary policy
if it could
be maintained long enough to wring inflation out
of the economy

-2
and if the economy could grow at a sustained noninflationary
pace thereafter.

This appears to be the hope of the Federal

Reserve and of the Reagan Administration.

I believe that it is

highly unlikely that the strategy will be successful.
economy starts to

When the

recover, there must be some monetary

accommodation or the recovery will be very weak.

The monetary

growth targets of the Federal Reserve are simply not high enough
to promote a sustained, healthy economy expansion.

Unemployment

will remain high and housing and other interest-sensitive
sectors will remain depressed as the economy struggles against
the effects of a highly restrictive monetary policy.

This, in

turn, will retard the growth of tax revenues and make budget
deficits even larger.
It is unlikely that this situation will be tolerated
indefinitely.

The longer that monetary policy remains so

restrictive, and the harder that it must battle against the
effects of tax cuts, high military spending and rising deficits,
the more unbalanced the economy becomes.
policy will have to be more expansionary.

Eventually monetary
The longer that the

inevitable is postponed, the larger is likely to be the ultimate
expansion of money and credit growth.
a resurgence of rapid inflation.

This could easily lead to

This prospect is one

interpretation of why long-term interest rates have remained so
high.

There is obviously massive uncertainty on Wall Street

about future monetary policy and there is a real fear of a
resurgence of high inflation.

3
The Federal Reserve made a serious pol
icy error when in late
1979 it embarked on its increasingly res
trictive and
nonsustainable policies. Its current
monetary growth targets
are simply a continuation of this policy
. I believe that there
must be an increase in money growth to
a more sustainable level.
Growth of M. of 21
/
2 to 51
/
2 percent is too low, to produce a
meaningful economic recovery. I also bel
ieve that there must be
a better mix between monetary and fis
cal policies. The stimulative
effects of tax cuts and increases in def
ense spending will push
real interest rates higher, and the
massive deficits will further
these increases. The current mix of mon
etary and fiscal policies
makes no macroeconomic sense and this
fact has not been lost on
financial markets.
Both the Federal Reserve and the Reagan
Administration seem
adamant about sticking to their guns.
Steadfastness can be a
virtue; stubbornness can be a vice. I fai
l to see the public
benefit from the government sticking to
its guns if it ends up
shooting off our feet.
Whenever there is a proposal to increase
the rate of money
growth, the monetarist chorus chants tha
t this will increase
interest rates, not decrease them. This pre
diction has become
the new conventional wisdom espoused by
the Administration, the
Federal Reserve, and by some Wall Street
pundits. It is
important to see the element of truth
in this assertion in order
to see its fallacies. -It is true that a hig
h rate of money
growth that is sustained over a substantial
period of time produces

•

-4
a high rate of inflation.

When inflation is high, nominal

interest rates are also high because lenders must be compensated
for the declining purchasing power of their money.

Thus,

ultimately, and in the long run, high rates of money growth are
associated with high interest rates.

This observation tells us

nothing, however, about the consequences of a rise in money
growth from its current low level to one that is more consistent
with sustained economic recovery.
It is also true that under the Fed's new operating procedur
week-by-week fluctuations in the quantity of money produce
movements in interest rates in the same direction.

For example,

a non -Policy-induced bulge in Ml produces a temporary increase
in interest rates.

This occurs because the Fed does not provide

sufficient nonborrowed reserves to support the bulge in money.
Interest rates rise as banks are driven into the discount windol,
Under the current operating procedures, market participants
spend a fortune on forecasting weekly movements in Ml, and they
react sharply to any large unexpected movements.

It is importa

to note that there is nothing irrational about this behavior.
Substantial profits are earned by those who correctly anticipat
short-term movements in money.

It should also be noted that th

market's response has nothing to do with inflationary
expectations.

Participants realize that the bulge in money wil

produce a temporary rise in interest rates under the Fed's
operating procedures and th_ey act on this knowledge.
Now let me turn to the question ot why short-term interest
rates are so high.

Here the answer is straightforward and it h

little or nothing to do with inflationary expectations.

Since

the Federal Reserve established its anti-inflation policy in
late 1979, the growth - in M1 has, on average, been less than the
rise in prices.

Money has not grown rapidly enough to support

even a constant level of economic activity.

The decline in real

money balances has produced high interest rates.

While economic

activity has declined, so have real money balances, and interest •
rates have remained high.

Put another way, the supplies of

reserves and of short-term credit have not grown enough to support
the high level of credit demand

in the economy.

This demand is

not the result of an economic boom and high inflation, but rather,
it is a consequence of falling business profits and a liquidity
squeeze.

The result is high interest rates.

Finally, the bulge in M1 growth that occurred earlier this
year appears to be the result of an increase in the liquidity
desires of the public stemming from the recession and from fear
about the financial system.

Conventional economic theory

predicts that such an increase in money demand will raise interest
rates unless there is complete accommodation by the Fed.

Since

the accommodation was not complete, the demand shift served to
increase upward pressure on interest rates.
The simple fact of the matter is that the financial system
is starved for money and, as a result, interest rates are high.
This means that a policy-induced increase in money growth will
push down short-term interest rates.

Faster reserve and money

growth will increase the supply of credit and short-term interest
rates will fall.

6
The issue ot long-term interest rates is mor
e difficult to
deal with.

There obviously is a great deal of uncertain
ty

concerning the -long-run inflation rate, and the
long-run
performance of the economy.

Many borrowers and lenders are

unwilling to take long-term positions.
It is important to note, however, to the ext
ent that high
long-term interest rates are the result of exp
ectations of high
inflation in the future, the market is implic
itly assuming that
future monetary policy will be highly expans
ionary. If this is
the case, a moderate easing of monetary policy
at this time is
hardly consistent with a further rise in lon
g-term interest rates.
It is double counting to assert that long-t
erm interest rates
are high because the market expects massive eas
ing in policy, and
then to claim that any easing of policy will
raise interest rates
further.
I believe that long-term interest rates will com
e down only
as the government achieves balanced and sustai
nable macroeconomic
policies.

Uncertainty can be reduced by sensible polici
es, but

there is little in current policy that builds pub
lic trust.

FOR RELEASE UPON DELIVERY
EXPECTED AT 9:30 A.M.
THURSDAY, JUNE 10, 1982
STATEMENT OF BERYL W. SPRINKEL
UNDER SECRETARY OF THE TREASURY FOR MONETARY AFFAIRS
BEFORE THE
JOINT ECONOMIC COMMITTEE
WASHINGTON, D.C.
Thursday, June 10, 1982
ers
Congressman Reuss, Senator Jepsen, and distinguished Memb
to discuss
of the Committee, I am pleased to be hear today
interest rates and monetary policy.

Monetary Policy and High Interest Rates

The Federal Reserve's announced policy to reduce the rate of
money growth is absolutely necessary in order to assure that the
re.
progress made to date on inflation will continue into the futu
cy
The Administration supports completely the Federal Reserve's poli
which calls for a deceleration of money growth.

Their announced

consistent
policy and money growth target ranges are appropriate and
th.
with our goal of achieving noninflationary economic grow

rates
The economy has borne the burden of high interest
for many years.
late 1978.

The prime rate has been in double digits since

We are all well aware of the extreme hardship thee

•

rates have imposed on the economy in general and particularly in
interest-sensitive sectors.
should they be minimized.

These hardships cannot be denied nor

To the contrary, we understand and

share the concerns of the Congress and the public about the economic
distress caused by high interest rates.

Sympathy, however, does not solve the problem.

Nor does

political rhetoric about the evils of high interest rates.

We are

all certainly eager to have interest rates fall, but a meaningful
and permanent decline is possible only when we remove the underlying
causes of the Pressures which have maintained interest rates at
high levels.

The fundamental cause of high nominal interest rates is inflation and inflationary expectations and the fundamental cause of
inflation is excessive monetary expansion.

This is why a credible,

permanent deceleration of money growth is imperative.

Monetary

disciplineprerequisite to the price stability and lower
interest rates that we all desire and all recognize as essential
for real economic growth.

Despite a dramatic decline in inflation over recent months,
market interest rates remain high.

It has therefore become common-

place to compare current market interest rates to current inflation
rates and to conclude that real interest rates are higher than
they have been since the great depression.

-3It is true that the difference between current interest and
inflation rates is higher now than since 1933.

It is not, however',

the difference between current interest and inflation rates that is
relevant to economic activity.

Business and investment decisions

are based on the rate of inflation that is expected to occur over
the life of an investment.

In an ideal world of price stability,

the expected and current rates of inflation would be equal, or
nearly so.

In the current environment this is not the case, as

financial market participants have not adjusted their inflationary
expectations downward as rapidly as actual inflation has declined.

The difference

between market interest rates and actual inflation rates was,
therefore, negative.

This experience, coupled with the

repeated failure of government to deliver on promises of effective
anti-inflationary policies, had a profound effect on the markets'
expectations about future inflation.

Just as the markets' failure to anticipate rising inflation in
the 1970's kept market interest rates artifically low, relative to
actual inflation rates at the time, the expectation that high
inflation rates will continue in the future is a primary factor
in keeping interest rates high now.

This is the legacy of a decade :

of accelerating inflation

inflationary psychology and expecta-

.
tions are deeply embedded in our economic behavior and institutions

Interest rates will fall only when financial market participants
become convinced that inflation will not resurge and therefore
adjust their inflationary expectations downward, in line with
current inflation rates.

The task before us -- the Administration, the Congress and the
Federal Reserve -- is to pursue policies that will hasten the
downward adjustment of inflationary expectations and allow interest
rates to fall.. This will require economic policies and actions
that, not only yield continued progress on actual inflation, but
also minimize uncertainty about future policy.

If we want interest

rates to fall -- and we most certainly do --- then three things
are vital.

First, the Federal Reserve must continue to pursue its

policy of noninflationary money growth; to reiterate, the Federal
Reserve has the unqualified support of the Administration in that
policy.

Second, the Federal Reserve should make a stronger effort

to reduce the significant, sharp swings in money growth which have
slowed the adjustment of market expectations to the basic antiinflationary monetary policy.

Third, the Congress and the Adminis-

tration must come to a meaningful agreement on the budget; by
meaningful, I mean actions which clearly indicate that the Federal
ng.
government has the discipline to limit the growth of public spendi
Without that discipline, the credit and investment markets will fore-.
see ongoing government revenue and financing problems.
imply higher taxes and/or more inflation in the future.

These problems..

,
The Proposals to Accelerate Money Growth

Any reacceleration of money growth would have disastrous
effects on our long-run goal of price stability and permanently
lower interest rates.

Instead, faster money growth would soon

rekindle inflationary pressures and refuel inflationary expectations.
Interest rates would rise quickly and rapidly, reducing greatly the
potential for future output and employment growth.

The Administration,

therefore, strongly opposes any proposal to increase the rate of
money growth or to raise the money growth targets.

The recond of the 1970's clearly shows that a little more
inflation cannot be traded for more production and employment over
the long run.

Any boost to production and employment that comes

from accelerating money growth is temporary because faster money
growth causes inflation and pushes interest rates up.

The lasting

effects of excessive money growth -- accelerating inflation,
escalating interest rates and a deterioration of the incentives to
save and invest -- are powerful and pervasive deterrents to sustained
economic growth.

Sustainable economic expansion requires a financial

system based on a reliable dollar.

That means monetary discipline.

Over the past year uncertainty about economic policy in general
and long-run monetary policy in particular has been an important factor
in keeping interest rates high, even as inflation has fallen.
Reaccelerating money growth or raising the money growth targets
would only add to that uncertainty.

It would signal to the fir)an-

cial markets that their worst fears and doubts are true -- that the

-6Government cannot be relied on to adhere to noninflationary monetary
policy over the long run; that anyone who bets on inflation coming
down and staying down (that is, anyone who lends money at a lower
interest rate) can count on losing that money.

This is the skepti-

cism that has worked to keep rates high as inflation has declined.
A s'Ustained increase in the rate of money growth or an increase in
the money growth targets would reinforce and justify that skepticism,
add to the intransigence of inflationary expectations, anci thereby
push rates higher than they already are.

Furthermoi-e, the fact that suggestions to increase money growth
are being offered and discussed adds to the uncertainty and skepticism
about fut,Ire monetary policy intentions.

Discussions, proposals and

It is useful, I believe, to review why it is that we set targets
for monetary growth.

In the first instance, the purpose of money

growth targets is to provide dpline and an explicit measure
against which to judge a central bank's performance.

In addition,

effective money growth targets tell the financial markets, and
business and investment planners, what they can expect from the
central bank in the year or years ahead.

In countries that have

been successful at long-term m5ney 5rowth targetting -- such as

-7

In those countries, the targets have become a

meaningful policy statement on which the business and investment
coffmunities can rely; predictable monetary trends minimize uncertainty
and provide a stable economic background in which savers and investors
can more confidently plan and commit resources.

When they began to implement the current policy of slowing the
trend growth of money, the Federal Reserve unfortunately had no
such record of consistency.

While significant problems remain,

the Federal Reserve has been able over the past year and a half to
build the credibility of their commitment to achieving a noninflationary rate of monetary expansion.
would Quickly be eroded by an

That gain in credibility

increase in the money targets, or

actions to allow above-target money growth over the long run.

The value of money growth targets -- in imposing discipline
and acting as a messenger of the Fed's intentions -- is greatly
diminished if they are consistently not achieved or if they are
changed at will.

This was recognized by the Congress and

acknowledged in the provisions of the Humphrey-Hawkins Act, which
requires the Federal Reserve to set annual monetary targets at the
beginning of each year.

This move ended the prior practice of

"base drift," where targets were reset every three months, and .
provided no discipline on monetary creation.

In the current

environment, the continuing need for stable and credible monetary

policy cannot be overstated.

Monetary targetting can he an important

device for promoting credibility and reducing uncertainty, but
it cannot serve that function if we consistently excuse errors and
redefine the targets.

.Those who advocate reaccelerating money growth or raising the
targets are misinformed when they assert that these changes are
the route to lower interest rates.

Anyone who still believes that

high interest rates are the result of "tight" monetary policy has
not been paying much attention to recent history.

When the prime

rate first broke the 20% level in the spring of 1980, money had
increased 7.8% over the preceding year.

During the second half of

1980, money grew at an annual compound rate in excess of 13%
the highest rate ever recorded for a six-month period
December the prime rate reached its all-time high of

In the six months ending in April of this year, M1 grew at an
annual compound rate of 9.1%, well above the Fed's announced targets.
This cannot be characterized as

ght" money; by historical standards,

this is an extremely rapid rate of money growth.

Yet interest

Excluding the

period of time in 1980 when interest rates were artificially depressed'
by credit controls, the longest and largest decline in interest

-9rates since 1974-75 occurred from July to November 1981; that
decline coincided with a period of sustained monetary restraint.
The record clearly contradicts the common notion that high interest'
rates are the result of "tight" monetary policy.

' The belief that faster money growth will reduce interest rates
is based on a fundamental and common confusion between money and
credit.

Those who advocate faster money growth really want to

increase real credit growth.

The Administration shares that goal

and the economic recovery program is designed to achieve that aim
by providing incentives for increased real saving.
growth will not do it.

Faster money

Faster money growth would not provide more

real credit to the housing market or reduce the interest rates
which a small business must pay to borrow.

Faster money growth

provides only more money, not more credit.

Indeed, faster money

growth would probably mean that less real credit would be available,
The way to

and it certainly means higher nominal interest rates.
increase credit availability is to stimulate saving.

The government

can contribute through tax-incentives to saving and by removing
the greatest disincentive to save of all -- inflation.

Thus, the proposed "solution" of increasing money growth would
make our high interest rate-tight credit situation worse.

The

inflation and inflationary expectations caused by an actual or
threatened acceleration of money growth would, first, push interest
rates higher; second, it would further erode incentives to save

-10and thereby further restrict the supply of credit flowing into
financial markets and institutions.

The Budget Deficit

In this sense, the deficit issue

.is helping to keep interest rates high.

Despite the now-common

belief that any method for reducing the budget deficit will assure
that interest rates fall, we cannot count on that happening unless
the budget resolution is a meaningful one.

That is, a budget

resolution that acknowledges the burden that the uncontrolled
growth of government spending imposes on society and the economy.

The Federal government will face continuing budget crises
until we move effectively to contain the growth of government
spending.

In the past decade, government spending has grown more

rapidly than the economy as a whole, rising as a share of GNP from
20% in 1970 to 23% in 1981, and to over 24% in early 1982.

We must face the fact that any government spending
how well-intentioned its goals or beneficial its impact
costs on the economy.

no matter
imposes

In the short term, government spending can

be financed three ways -- through taxation, by creating new money
or by borrowing.

Ultimately, however, only two sources of revenue

1*-

-11-

are available -- direct taxation or inflation.

Taxation can erode

incentives of individuals to work and save and the incentives of
business to produce and invest.

•

Not only does this decrease the

ability of the economy to support government spending, but it also
increases pressure for even more government spending.

Money creation

causes inflation and inflationary expectations, which also erodes
incentives to save and invest.
result is the same.

The method is different, but the

In addition, excessive money growth leads to

high interest rates which choke-off real economic growth.

Therefore, the situation can be stated simply: if we are to
allow government spending to grow unchecked as it has over the
past several decades, we must be willing to accept accelerating
inflation (and the escalating interest rates that go with it)
and/or high and rising tax rates.

There are no other choices and

the current situation in financial markets should be heeded as a
sign that the public is aware.

The financial markets fear that if large deficits Persist,
the Federal Reserve will be pressured into "monetizing" the deficit
and thereby financing spending by creating new money.

These fears

are aggravated by Congressional statements about the need for
faster money growth.

The financial markets are already extremely

concerned that the Fed will revert to inflationary money growth.
Any signals that the Fed is coming under political pressure to
do so only adds to the concern that inflationary money growth again

-12-

will be used to boost an economic recovery.

That skepticism helps

keep interest rates high.

There is No Trade-Off Between Monetary and Fiscal Policy

Some proposals to reaccelerate the rate of money growth rest
on the premise that a greater degree of fiscal restraint can be
traded for some degree of monetary ease.

This implies that monetary

and fiscal policies can be substituted for each other and that a
.budget compromise can be paired with an easing of monetary policy.
The role of monetary policy in the economy is separate and distinct
from the role of fiscal policy.
versus less of the other.

It is not a matter of more of one

Instead, prudent noninflationary monetary

policy and disciplined fiscal policy should be viewed as complementary policies to promote price stability and economic growth.

The division of responsibility between monetary and fiscal
policies is clear.

The role of monetary policy is to restore the

soundness of the dollar or, in the popular jargon, to eliminate
inflation.

That requires holding the growth of the money supply

in line with the long-term growth potential of the economy.

The

role of fiscal policy, in the current environment, is to encourage
a shift in resource use from consumption to investment, in order .
to stimulate growth of the economy's productive potential.

Reduc-

tion of inflation reinforces that effort and the two together provide.
the necessary ingredients for expanded job opportunities and
increased standards of living.

-13-

•

V/ During the past year the Federal Reserve has made progress

toward establishing a credible, noninflationary monetary policy.
They have not yet totally achieved that goal and their record
could be improved.

Money growth continues to be extremely volatile.

Given the current budgetary uncertainty and the history of monetary
poricy in the 1960's and '70's, such erratic money growth has encouraged skepticism about long-run monetary control.

The Treasury has

gathered substantial evidence that the markets' reaction to
variable money growth has been a major factor in maintaining the
high levels of interest rates.

In my view, the Federal Reserve

could reduce monetary volatility by making technical changes in
their operating procedures.

But with these caveats aside, the Federal Reserve has, on
balance, reduced the rate of money growth toward a noninflationary
pace.

Monetary policy is moving in a direction that is consistent

with sustained, noninflationary economic growth.

It is now up to

those of us who are responsible for the rest of economic policy to
follow suit.

That means we must persevere in bringing the growth

of government spending under control.

It also means that we must

stop cajoling the Federal Reserve to return to the inflationary
policies of the past.

While the transon to lower inflation has

been made more costly than necessary, the odds are that the worst
is behind us.

It is now imperative that we not throw away the

gains, by repeating the same mistake that has been made frequently
in the past -- the mistake of presuming that turning on the
monetary spigot provides the cure for all our economic ills.

. .
-14,
The problem in the financial

I
is basically one in which

a policy of an undiscned government spending, which requires
inflation to be sustained, is colliding with a monetary policy . that
In the past

is no longer providing inflationary money growth.

decade, government spending has been financed by inflation and a tax
system that guaranteed ever-rng tax revenues.

As long as infla-

tion accelerates, proliferating government spending can be financed
without prospective large budget deficits.

But the Federal Reserve

has now curtailed inflationary money growth and the Government
'can no longer count on inflation to finance increased spending.

Proposals to reaccelerate money growth are equivalent to
advocating a return to accelerating inflation.

It is important

that we recognize, and remember, the economic costs of surrendering
to continued inflation.

The very sectors that are suffering now

-- farmers, the auto industry, small businesses, home builders,
and the thrift industry -- would only be damaged further by a
resurgence of inflation.

There is evidence of the

of inflation all aroUnd us.

dious effects

Our lagging saving rate, declining

productivity, and our inability to compete with many foreign
producers -- these are all legacies of a decade of inflation.
We will never cure these fundamental problems by continuing to
pursue the inflationary policies of the past.