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https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  Collection: Paul A. Volcker Papers Call Number: MC279  Box 13  Preferred Citation: Joint Economic Committee, 1982 November 24; Paul A. Volcker Papers, Box 13; Public Policy Papers, Department of Rare Books and Special Collections, Princeton University Library Find it online: http://finclingaids.princeton.edu/collections/MC279/c225 and https://fraser.sdouisfed.org/archival/5297 The digitization ofthis collection was made possible by the Federal Reserve Bank of St. Louis. From the collections of the Seeley G. Mudd Manuscript Library, Princeton, NJ These documents can only be used for educational and research purposes ("fair use") as per United States copyright law. By accessing this file, all users agree that their use falls within fair use as defined by the copyright law of the United States. 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Policy on Digitized Collections Digitized collections are made accessible for research purposes. Princeton University has indicated what it knows about the copyrights and rights of privacy, publicity or trademark in its finding aids. However, due to the nature of archival collections, it is not always possible to identify this information. Princeton University is eager to hear from any rights owners, so that it may provide accurate information. When a rights issue needs to be addressed, upon request Princeton University will remove the material from public view while it reviews the claim. Inquiries about this material can be directed to: Seeley G. Mudd Manuscript Library 65 Olden Street Princeton, NJ 08540 609-258-6345 609-258-3385 (fax) mudd@princeton.edu   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  For release on delivery 10:00 A.M., E.S.T. November 24, 1982  Statement by  Paul A. Volcker  Chairman, Board of Governors of the Federal Reserve System  before the  Joint Economic Committee  November 24, 1982  I appreciate this opportunity to discuss with you today the current stance of monetary policy and some problems for the future.  Before responding to certain questions directed  to me about monetary policy in your letters of October 18 and November 17, Mr. Chairman, I should first emphasize that the basic thrust and goals of our policy are unchanged since I testified before the Congress on July 20.  The precise means  by which we move toward our goals must take account of all the stream of evidence we have on the behavior of (and distortions in) the various monetary aggregates, the economy, prices, interest rates, and the like.  But we remain convinced that lasting recovery  and growth must be sought in a framework of continuing progress toward price stability -- and that the process of money and credit creation must remain appropriately restrained if we are to deal effectively with inflationary dangers. For that reason, we must continue to set forth targets for growth in money and credit and to judge the provision of bank reserves  our most important operating instrument -- in  the light of the trend in the growth of these aggregates. This process necessarily involves continuing judgments about just what growth in those magnitudes is appropriate in the short and longer run, matters affected by institutional change as well as by more fundamental economic factors.   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  2  As you are aware, the current job of developing and implementing monetary policy has been complicated by regulatory decisions as well as by recent developments in the economy and in our financial markets.  We have, as a consequence, (1) made  some technical modification in our operating procedures to cope with obvious distortions in some of the monetary data -- particularly M1 -- and (2) accommodated growth in the various M's at rates somewhat above the targeted ranges. decisions was essentially technical.  The first of those  The latter decision is  entirely consistent with the view I expressed in testifying before the Banking Committees in July that the Federal Open Market Committee would tolerate "growth somewhat above the targeted ranges .  . for a time in circumstances in which it  appeared that precautionary or liquidity motivations, during a period of economic uncertainty and turbulence, were leading to stronger than anticipated demands for money." Unfortunately, the difficulties and complexities of the economic world in which we live do not permit us the luxury of describing policy in terms of a simple, unchanging numerical rule.  For instance, the economic significance of any particular  statistic we label "money" can change over time -- partly because the statistical definition of "money" is itself arbitrary and the components of the money supply have differing degrees of use as a medium of exchange and liquidity.  That doesn't make  much difference in a relatively stable economic, financial, and institutional environment, but, at times of rapid change, like the present, it can matter a great deal.   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  varying lags -- never We also have to take account of tions today and their conac n ee tw be -n io is ec pr th wi known y y to disentangle the temporar tr to ve ha We r. te la s ce en sequ s among tent trends in relationship is rs pe re mo om fr al ic cl cy and vity. d inflation and economic acti an y ne mo of es ur as me t en er diff abroad significance of developments e th te ua al ev to ve ha we And counts and the exchange ac e ad tr in d te ec fl re as , me as well as at ho nancial structure itself. fi e th in s in ra st of d an , te ra ic environment in which we As this suggests, the econom a -- cannot be condensed into lf se it cy li po or -cy li po set e t. Perhaps the essence of th en em at st l na io ns me di eon , simple better captured by a few "yesbe n ca ch oa pr ap r ou d an m le prob but" phrases. e inflationary momentum th en ok br ve ha we s, Ye ) (1 effort will be essential but continuing vigilance and price stability. to continue progress toward e indices this year have been ic pr d oa br e th , ow kn u yo As e peak levels reached two or th of ss le or lf ha t ou ab at running th disinflationary process, grow is th of rt pa As o. ag s ar three ye to terms has declined to the 6 l na mi no in on ti sa en mp co in worker s growth in nominal income ha er ow sl at th t bu -ea ar t 7 percen d. ges as inflation has moderate wa al re er gh hi th wi nt te is been cons ular sectors of the economy ic rt pa in ds en tr st co d an Price in the process of disgs la rt pa in ng ti ec fl re are mixed -ional ng wage contracts, internat lo of s ct fe ef e th n, io at fl in fects of pments, and the immediate ef lo ve de te ra ge an ch ex d an   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  -4-  recession on some prices -- most particularly commodities. that But there is, it seems to me, strong reason to believe albeit the progress toward price stability can be maintained -at a slower rate  as the economy recovers.  For a time, un-  s employment and excess capacity should restrain costs and price and, of more lasting significance, productivity growth should improve from the poor performance of most recent years.  Taken  together, restraint on nominal wage increases and productivity growth should moderate the increase in unit labor costs, which account for about two-thirds of all costs.  Real incomes can  rise as inflation slows, paving the way for further progress toward stability. To be sure, as the economy grows, some factors holding down prices over the past year or two will dissipate or be reversed.  But large new "price shocks" in the energy or food  areas appear unlikely in the foreseeable future, suggesting that a declining trend in the rise of unit labor costs should be the most fundamental factor defining the price trend. That analysis would not hold, however, if excessive growth in money and credit over time came again to feed first the expectation, and then the reality, of renewed inflation. Too much has been "invested" in turning the inflationary momentum to lose sight of the necessity of carrying through. There are clear implications, as I will elaborate in a moment, for fiscal as well as monetary policy.  (2) Yes, exceptional demands for liquidity can reasonably be accommodated in a period of recession, high unemployment, and excess capacity -- but guidelines for restrained money and credit growth remain relevant to insure against renewed inflation. A variety of specific and general evidence strongly suggests that the desire to hold cash and other highly liquid assets, relative to income, has increased this year.  Much of  the more rapid increase in M1 has been in interest-bearing NOW accounts, which did not exist a few years ago but which provide the basic elements of a savings, as well as transaction, account.   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  With market interest rates falling, those accounts have been relatively more attractive on interest rate grounds alone, and they are a convenient means of storing liquidity at a time of economic and financial uncertainty.  At the same time, the  broader aggregates appear to reflect some of the same liquidity motivations, as well as the stronger savings growth in the wake of the tax cut. Most broadly, we can now observe, over a period of more than a year, a distinct decline in "velocity" -- that is, the relationship between the GNP and monetary aggregates.  The  velocity decline for Ml, which is likely to amount to about 1982, 3% from the fourth quarter of 1981 to the fourth quarter of stands in sharp contrast to the average yearly rise in velocity of 3-4% over the past decade; it will be the first significant  %  -6  _  decline in velocity in about 30 years.  M2 and M3 velocities --  which had been relatively trendless earlier -- have also declined significantly.  While some tendency toward slower velocity is  not unusual in the midst of recession, the magnitude and persistence of the movement in 1982 is indicative of a pronounced tendency to hold more liquid assets relative to current income. Without some accommodation of that preference, monetary policy at the present time would be substantially more restraining in its effect on the economy than intended when the targets for the various aggregates were originally set out earlier this year. At the same time, policy must take into account the probability that the demands for liquidity will, in whole or in major part, prove temporary, and that an excessive rise in money or other liquid assets could feed inflationary forces later.  Elements of judgment are inevitably involved in sorting  out these considerations -- judgments resting on analysis of the economy, interest rates, and other factors.  But broad  guidelines for assessing the appropriate growth on the basis of historical experience will surely remain relevant and appropriate. In that connection, I must note the implications of the future Federal budgetary position.  To put the point briefly,  the prospect of huge continuing budgetary deficits, even as the economy recovers, carries with it the threat of either excessive liquidity creation and inflation in future years, or a "crowdingout" of other borrowers as monetary growth is restrained in the   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  r  %  •   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  -7-  face of the Treasury financing needs, or a combination of both. The problems flowing from the future deficits are simply not amenable to solution by monetary policy.  Moreover, the concern  engendered in the marketplace works in the direction of higher interest rates today than would otherwise be the case, contrary to the needs of recovery.  I know something of how difficult it  is to achieve further budgetary savings, but I must emphasize again how important it is to see the deficit reduced as the economy recovers.  The fact is those looming deficits are a  major hazard in sustaining recovery. (3) Yes, lower interest rates are critically important in supporting the economy and encouraging recovery but we also want to be able to maintain lower interest rates over time.  Since early summer, short-term interest rates have generally declined by five to six percentage points, and mortgage and most other long-term rates have dropped by three to four percentage points.  While consumer loan rates administered  by banks and other financial institutions have lagged, they are also now moving lower.  There are clear signs of a rise in home  sales and building in response to these interest rate declines, and other sectors of the economy are benefiting as well. We have also had experience in recent years of sharp increases in interest rates curtailing economic activity at times when recovery was incomplete and unemployment high. Sudden large fluctuations in interest rates contribute to  -8-  other economic and financial distortions as well.  And no  rically doubt the fact that many interest rates remain histo high, relative to the current rate of inflation, reflects the continuing skepticism over prospects for carrying through fight on inflation. In this situation, the Federal Reserve has welcomed ort the declines in interest rates both because of the supp reflect they offer economic activity and because they seem to a sense that the inflationary trend has changed.  However, we  d do not believe that progress toward lower interest rates shoul of or for long in practice can -- be "forced" at the expense excessive credit and money creation.  To attempt to do so  ed would simply risk the revival of inflationary forces; renew longerexpectations of inflation would soon be reflected in the lasting term credit markets, damaging prospects for the longexpansion we all want.   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  Turning to your explicit questions, Mr. Chairman, y-making against this general background, I believe most polic that officials in the Federal Reserve share the general view at a economic recovery will be evident throughout 1983, but ous moderate rate of speed -- probably slower than during previ post-recession years.  Unambiguous evidence that the recovery  g signs is already underway is still absent, although encouragin dity are evident in some rise in housing, in the improved liqui and wealth and reduced debt positions of consumers, and in lizing surveys reporting that attitudes and orders may be stabi  ••••  •  -9  or improving.  The Federal deficit, while fraught with danger  for the future, is of course providing massive support for incomes at present. What is crucially important -- particularly in the light of the experience of recent years -- is that we set the stage for an expansion that can be sustained over a long period, bringing with it strong gains in productivity and investment and lasting improvement in employment.  I have  already emphasized the importance of progress toward price stability to that outlook, and the evidence that, with disciplined monetary and fiscal policies, we can sustain that progress. So far as the specific questions about monetary policy in your October 18 letter are concerned, we have not, as you know, set any new monetary targets for 1982.  Current trends  do indicate that the various M's will end the year above the upper end of the target ranges, probably by 1/2 to 1% for M2 and M3 and more for M1 given the current distortions. credit will be close to the mid-point of its range. indicated at the start, the "overshoots  Bank  As I  in the context of  today's economic and financial condons, are consistent with the approach stated in my July testimony. No decision has been taken to change the tentative targets for 1983.  That matter will, of course, be under  intensive scrutiny over the next two months, and the targets will be announced in February.   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  -10-  For the time being, we are placing much less emphasis than usual on Ml.  That decision was precipitated in early  October entirely by the likelihood that the data would be grossly distorted in that month by the maturity of a large volume of All-Savers Certificates, part of the proceeds of which might be expected to, at least temporarily, be placed in checking accounts included in Ml. In about three weeks, the introduction of a new ceilingless account at financial institutions -- highly liquid and carrying significant transaction capabilities -- is likely to distort further M1 data.  Judging by comments at the last  Depository Institutions Deregulation Committee meeting, that account could rapidly be followed by a decision to approve a ceiling-less account with full transaction capabilities. These new accounts could have a large, but quite unpredictable, influence on M1 for a number of months ahead as funds are reallocated among various accounts.  Moreover, the introduction  of market-rate transaction accounts will very likely result in a different relationship and trend of M1 relative to GNP over time.  Increasing confidence in the stability of prices  and a trend toward lower market interest rates might also affect the desire to hold money over time. Obviously, some judgments on those matters will be necessary in setting a target for M1 in 1983 and in deciding upon the degree of weight to he attached to changes in M1 in our operations.   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  Those problems should appropriately be  -11--  described as "technical" rather than "policy" in the sense that we will need to continue to be concerned with the rate of growth over time of the monetary aggregates, including transactions balances. The decisions taken in early October do point to greater emphasis on M2 (and M3) in planning the operational reserve path during this transitional period.  The link between reserves  and M2 is looser and more uncertain than in the case of Ml, in large part because reserve requirements on accounts included in M2, apart from transactions balances, are very low or non-existent. (Transactions balances are about 17 percent of M2.)  Therefore  once a reserve path is set, deviations of M2 from a targeted growth range may not, more or less automatically, be reflected in as substantial changes in pressures on bank reserve positions or in money markets as is the case with Ml.  Consequently,  "discretionary" judgments may be necessary more frequently in altering a reserve path than when that reserve path is focused more heavily on Ml.  In that technical sense, the operational  approach has necessarily been modified. In sum, the broad framework of monetary targeting has been retained, but greater emphasis is for the time being placed on the broader aggregates.  The specific operating  technique that had been closely related to M1 has, by force of circumstances, been conformed to that emphasis.  Obviously,  entirely apart from questions of economic doctrine and contending approaches to monetary control, so long as M1 is   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  -12-  subjected to strong institutional distortions our techniques must be adapted to take account of that fact. An alternative operating approach suggested by some of supplying and withdrawing reserves with the intent of achieving a particular interest rate target would suffer from several fundamental defects.* c  The body of theory or practice does not provide a sufficiently clear basis for relating the level of a particular interest rate to our ultimate objectives of growth and price stability.  o  The implication that the Federal Reserve could in fact achieve and maintain a particular level of relevant interest rates in a changing economic and financial environment is not warranted.  o  The very concept and measurement of a "real" interest rate, as called for in some proposals, is a matter of substantial ambiguity.  o  As a practical matter, attempts to target and fix C) interest rates would make more rigid and tend to politicize the entire process of monetary policy.  *That was not, as sometimes mistakenly thought, the operating approach used prior to October 1979. Then, reserves were provided with the aim of achieving and maintaining a particular Federal funds rate thought to be consistent with targets for the monetary aggregates. The Federal funds rate was a means to achieving a monetary target and in principle was tc be handled flexibly. In practice, among other difficulties, there appeared to be a reluctance to permit rates to vary rapidly enough to maintain control of the aggregates.   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  A  -13-  In current circumstances, with huge budget deficits looming, a requirement that the Federal Reserve set explicit interest rate targets is bound to be interpreted as inflationary, and the rekindling of inflationary expectations will work against our objective. I realize the several legislative proposals addressed to targeting interest rates would, on their face, seem to call for interest rates as only one of several targets.  But interest  rates would certainly be the most obvious and sensitive target, and those targets would be difficult to change.  Other evidence  for a need to "tighten" or "ease" would be subordinated, if not ignored. As we approach the target-setting process for 1983, our objectives will -- indeed as required by law -- continue to be quantified in terms of growth in relevant money and credit aggregates.  We will have to decide how much weight to  place on M1 and other aggregates during a transitional period, assuming new accounts continue to distort the data.  In reaching  and implementing those decisions, the members of the FOMC necessarily rely upon their own analysis of the current and prospective course of business activity; the interrelationships among the aggregates, economic activity, and interest rates; and the implications of monetary growth for inflation.  In other words,  the process is not a simple mechanical one, and it seems to me capable of incorporating -- within a general framework of monetary discipline -- the elements of needed flexibility.  We will also,  II  as part of that process, review whether technical adjustments   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  -14-  the reserve paths in procedures for establishing and changing are appropriate.  I will be reporting our conclusions to the  Congress in February. monetary Mr. Chairman, you have suggested that our single number, targets might reasonably be specified as a with a range above and below.  At times we have debated  oach (or setting within the FOMC the wisdom of such an appr e). forth a single target number without a rang   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  My own feeling  with or without has been, and remains, that a single number, precision, with the a range, would convey a specious sense of less arbitrary result of greater pressure to meet a more or developments during number to maintain "credibility," even if flexibility is the year tend to indicate some element of appropriate in pursuit of the targets. h a range To me, our present practice of setting fort is preferable.  est Where appropriate, we can and should sugg  r portion of the probability of being in the upper or lowe evolve in which the range, or suggest what conditions could an over or undersomething other than the mid-points (or even shoot) would be appropriate.  That approach seems to me to  -- than a single provide more information -- and more realism . number and is broadly consistent with present practice ure For similar reasons, I believe we need to meas and target a variety of aggregates because, in a swiftly misleading changing economic environment, any single target can be of total credit In that connection, I believe an indication could be flows broadly consistent with the monetary targets helpful.  bank As you know, we now provide such estimates for  credit alone.  -15-  Given the limits of forecasting and analysis, and the volatility of the data, I would question the usefulness of further sectoral estimates.  Even with respect to total credit  flows, there is considerable looseness in relationships to economic activity for periods as long as a year  and still  The theoretical framework relating  more for shorter periods.  credit flows to other variables such as the GNP or inflation is less fully developed than in the case of monetary aggregates, and credit flows are less directly amenable to control.  The  enormous flows across international borders pose large conceptual and statistical problems.  Our credit data are typically  less complete and up-to-date than monetary data. However, so long as those difficulties and limitations are recognized -- and some of them are relevant with respect to the monetary aggregates as well -- I share the view that analysis of credit flows can contribute to policy formulation. To assist in that process, Iwill propose to the FOMC that estimates of the expected behavior of a broad credit aggregate be set forth alongside the monetary targets in our next report. I do strongly resist the idea of the Federal Reserve as an institution forecasting interest rates.  No institution or  individual is capable of judging accurately the myriad of forces working on market interest rates over time.  Expeatational  elements play a strong role -- fundamentally expectations about the course of economic activity and inflation, but also, in the short run, expectations of Federal Reserve action.   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  I  We could not  •  -16-  escape the fact that a central bank forecast of interest rates would be itself a market factor.  To some degree, therefore,  in looking to interest rates and other market developments for information bearing on our policy decisions, we would be looking into a mirror.  Moreover, the temptation would always be present  to breech the thin line between a forecast and a desire or policy intention, with the result that operational policy decisions could be distorted. While it seems to me inappropriate for a central bank to regularly forecast interest rates, analysis of key factors influencing credit conditions and prices can be helpful at times. past.  On occasion, we have provided such analysis in the My concern about the outlook for fiscal policy is rooted  in major part in such analysis because the direction of impact on interest rates seems to me unambiguous.  I have also, on a  number of occasions, indicated that the recent and even current level of interest rates appears extraordinarily high, provided, as I believe, we continue to make progress on the inflation front.  Perhaps, in our semi-annual reporting, we can more  explicitly call attention to major factors likely to influence short or long-term interest rates and the significance for various sectors of the economy.  But I do not believe interest  rate forecasting would be desirable or long sustainable, and would in fact be damaging to the policy process.   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  -17-  Finally, Mr. Chairman, you have requested a "single composite forecast" of the major economic variables by FOMC members.  As you are well aware, our present practice is to  set forth a range of forecasts of individual FOMC members of the nominal and real GNP, prices, and unemployment.  The fact  is is we have no single "Federal Reserve" forecast, and there force no mechanism, within a Committee or Board structure, to agreement on such a forecast by individual members bringing different views, typically backed by separate staff analysis, to the table.  A simple average -- possibly supported by no  one -- seems to me artificial.  The process of attempting to  force a consensus would certainly dilute the product. I would put the point positively.  A range of forecasts  by individual FOMC members more accurately conveys the range of uncertainty and contingencies that must surround any forecast.  The seeming neatness and coherence of a single forecast  too often obscures the reality that a variety of outcomes is s possible; the very essence of the policy problem is to asses risks and probabilities -- what can go wrong as well as what can go right.  A point forecast would likely be treated more  y reverently than it would deserve, and could even distort polic judgments in misguided efforts to "hit" a forecast. I can understand your concern that a range of forecasts ons may be misleading if strongly influenced by "outlying" opini rather than reflecting a more even dispersion of views.  For  t that reason, I would be glad to explore with the Open Marke   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  -18-  Committee a procedure by which we indicated the "central tendency" of members' views -- assuming such a central tendency exists -- as well as indicating the range of opinions.  Conversely, if the forecasts were evenly  distributed within the range, we could so indicate. believe that approach would meet the Jbjectives you seek in a realistic and helpful manner. In concluding this already long testimony, let me say that we share the common goals of achieving, in the words of the Employment Act of 1946 and the Humphrey Hawkins Act of 1978, "Maximum employment, production, and purchasing power" and "full employment . . . (and) reasonable price stability." Those objectives have eluded us for too many years.  We meet  again today in particularly difficult circumstances, and there is a sense of frustration and uncertainty among many. But I also happen to believe we have come a long way toward laying the base for economic growth and stability; economic recovery should characterize 1983, and that recovery can mark the beginning of a long period of stable growth. Obviously there are obstacles -- interest rates are still too high; inflation is down but not out; there are strains in our financial system; we face budget deficits that are far too high; we are tempted to turn inwards or backwards for quick solutions that ultimately can not work.  But it is  also plainly within our capacity to deal with those threats provided only that we have a strong base of understanding among   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  -19-  us, that we resolve to act where action is necessary, and that we have the patience and wisdom to refrain from actions that can only be destructive. You are leaving the Congress after 28 years, Mr. Chairman. Through that time, you have consistently provided constructive leadership to the effort to raise the level of economic discussion in general -- and of the dialogue between the Congress and the Federal Reserve in particular.  I happen to believe  strongly in the independence that the Congress has provided the Federal Reserve through the years -- but also in the need for close and continuing communication with the Congress and the Administration.  I presume that this is the last time I  will appear before you personally in this forum, but the dialogue will continue to benefit from your efforts, your initiative, and your sense of commitment in more ways than you may realize.  _   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  For release on delivery 10:00 A.M., E.S.T. November 24, 1982  Statement by  Paul A. Volcker Chairman, Board of Governors of the Federal Reserve System  before the  Joint Economic Committee  November 24, 1982  4  I appreciate this opportunity to discuss with you today the current stance of monetary policy and some problems for the future.  Before responding to certain questions directed  to me about monetary policy in your letters of October 18 and November 17, Mr. Chairman, I should first emphasize that the basic thrust and goals of our policy are unchanged since I testified before the Congress on July 20.  The precise means  by which we move toward our goals must take account of all the stream of evidence we have on the behavior of (and distortions in) the various monetary aggregates, the economy, prices, intere st rates, and the like.  But we remain convinced that lasting recovery  and growth must be sought in a framework of continuing progress toward price stability -- and that the process of money and credit creation must remain appropriately restrained if we are to deal effectively with inflationary dangers. For that reason, we must continue to set forth targets for growth in money and credit and to judge the provision of bank reserves  our most important operating instrument -- in  the light of the trend in the growth of these aggregates. This process necessarily involves continuing judgments about just what growth in those magnitudes is appropriate in the short and longer run, matters affected by institutional change as well as by more fundamental economic factors.   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  IL  -2-  As you are aware, the current job of developing and implementing monetary policy has been complicated by regulatory decisions as well as by recent developments in the economy and in our financial markets.  We have, as a consequence, (1) made  some technical modification in our operating procedures to cope with obvious distortions in some of the monetary data -- particularly M1 -- and (2) accommodated growth in the various M's at rates somewhat above the targeted ranges. decisions was essentially technical.  The first of those  The latter decision is  entirely consistent with the view I expressed in testifying before the Banking Committees in July that the Federal Open Market Committee would tolerate "growth somewhat above the targeted ranges .  . for a time in circumstances in which it  appeared that precautionary or liquidity motivations, during a period of economic uncertainty and turbulence, were leading to stronger than anticipated demands for money." Unfortunately, the difficulties and complexities of the economic world in which we live do not permit us the luxury of describing policy in terms of a simple, unchanging numerical rule.  For instance, the economic significance of any particular  statistic we label "money" can change over time -- partly because the statistical definition of "money" is itself arbitrary and the components of the money supply have differing degrees of use as a medium of exchange and liquidity.  That doesn't make  much difference in a relatively stable economic, financial, and institutional environment, but, at times of rapid change, like the present, it can matter a great deal.   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  ‘.   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  -3 _  varying lags -- never We also have to take account of ons today and their conti ac n ee tw be -n io is ec pr th known wi disentangle the temporary to y tr to ve ha We r. te la s sequence g trends in relationships amon nt te is rs pe re mo om fr al ic and cycl ty. inflation and economic activi d an y ne mo of es ur as me t en differ ad ificance of developments abro gn si e th te ua al ev to ve ha And we change in trade accounts and the ex d te ec fl re as , me ho at as ll as we ial structure itself. nc na fi e th in s in ra st of d an rate, ic environment in which we om on ec e th , ts es gg su is th As cannot be condensed into a -lf se it cy li po or -cy set poli Perhaps the essence of the t. en em at st l na io ns me di eon simple, er captured by a few "yestt be be n ca ch oa pr ap r ou d an problem but" phrases. inflationary momentum (1) Yes, we have broken the effort will be essential d an e nc la gi vi ng ui in nt co t bu price stability. to continue progress toward dices this year have been in e ic pr d oa br e th , ow kn As you peak levels reached two or e th of ss le or lf ha t ou ab running at th disinflationary process, grow is th of rt pa As o. ag s three year to rms has declined to the 6 te l na mi no in on ti sa en mp co in worker s growth in nominal income ha er ow sl at th t bu -ea ar 7 percent ted. ges as inflation has modera wa al re er gh hi th wi nt te is been cons y icular sectors of the econom rt pa in ds en tr st co d an e Pric in the process of disgs la rt pa in ng ti ec fl re are mixed -ional ng wage contracts, internat lo of s ct fe ef e th n, io at fl in cts of ents, and the immediate effe pm lo ve de te ra ge an ch ex and  I  N   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  -4  _  dities. recession on some prices -- most particularly commo believe that But there is, it seems to me, strong reason to -- dlbeit the progress toward price stability can be maintained at a slower rate -- as the economy recovers.  For a time, un-  and prices employment and excess capacity should restrain costs h should and, of more lasting significance, productivity growt . improve from the poor performance of most recent years  Taken  ctivity together, restraint on nominal wage increases and produ which growth should moderate the increase in unit labor costs, account for about two-thirds of all costs.  Real incomes can  ess rise as inflation slows, paving the way for further progr toward stability. To be sure, as the economy grows, some factors holding down prices over the past year or two will dissipate or be reversed.  But large new "price shocks" in the energy or food  areas appear unlikely in the foreseeable future, suggesting d that a declining trend in the rise of unit labor costs shoul be the most fundamental factor defining the price trend. That analysis would not hold, however, if excessive growth in money and credit over time came again to feed first n. the expectation, and then the reality, of renewed inflatio Too much has been "invested" in turning the inflationary momentum to lose sight of the necessity of carrying through. There are clear implications, as I will elaborate in a moment, for fiscal as well as monetary policy.  \   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  _  5-  (2) Yes, exceptional demands for liquidity can reasonably be accommodated in a period of recession, high unemployment, and excess capacity -- but guidelines for restrained money and credit growth remain relevant to insure against renewed inflation. A variety of specific and general evidence strongly suggests that the desire to hold cash and other highly liquid assets, relative to income, has increased this year.  Much of  the more rapid increase in M1 has been in interest-bearing NOW accounts, which did not exist a few years ago but which provide the basic elements of a savings, as well as transaction, account. With market interest rates falling, those accounts have been relatively more attractive on interest rate grounds alone, and they are a convenient means of storing liquidity at a time of economic and financial uncertainty.  At the same time, the  broader aggregates appear to reflect some of the same liquidity motivations, as well as the stronger savings growth in the wake of the tax cut. Most broadly, we can now observe, over a period of more than a year, a distinct decline in "velocity" -- that is, the relationship between the GNP and monetary aggregates.  The  velocity decline for Ml, which is likely to amount to about 1982, 3% from the fourth quarter of 1981 to the fourth quarter of stands in sharp contrast to the average yearly rise in velocity of 3-4% over the past decade; it will be the first significant  r  a  -6  decline in velocity in about 30 years.  M2 and M3 velocities --  which had been relatively trendless earlier -- have also declined significantly.  While some tendency toward slower velocity is  not unusual in the midst of recession, the magnitude and persistence of the movement in 1982 is indicative of a pronounced tendency to hold more liquid assets relative to current income. Without some accommodation of that preference, monetary policy at the present time would be substantially more restraining in its effect on the economy than intended when the targets for the various aggregates were originally set out earlier this year. At the same time, policy must take into account the probability that the demands for liquidity will, in whole or in major part, prove temporary, and that an excessive rise in money or other liquid assets could feed inflationary forces later.  Elements of judgment are inevitably involved in sorting  out these considerations  judgments resting on analysis of  the economy, interest rates, and other factors.  But broad  guidelines for assessing the appropriate growth on the basis of historical experience will surely remain relevant and appropriate. In that connection, I must note the implications of the future Federal budgetary position.  To put the point briefly,  the prospect of huge continuing budgetary deficits, even as the economy recovers, carries with it the threat of either excessive liquidity creation and inflation in future years, or a "crowdingout" of other borrowers as monetary growth is restrained in the   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  •   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  7-  face of the Treasury financing needs, or a combination of both. The problems flowing from the future deficits are simply not amenable to solution by monetary policy.  Moreover, the concern  engendered in the marketplace works in the direction of higher interest rates today than would otherwise be the case, contrary to the needs of recovery.  I know something of how difficult it  is to achieve further budgetary savings, but I must emphasize again how important it is to see the deficit reduced as the economy recovers.  The fact is those looming deficits are a  major hazard in sustaining recovery. (3) Yes, lower interest rates are critically important in supporting the economy and encouraging recovery  1=111  but we also want to be able to maintain lower interest rates over time.  Since early summer, short-term interest rates have generally declined by five to six percentage points, and mortgage and most other long-term rates have dropped by three to four percentage points.  While consumer loan rates administered  by banks and other financial institutions have lagged, they are also now moving lower.  There are clear signs of a rise in home  sales and building in response to these interest rate declines, and other sectors of the economy are benefiting as well. We have also had experience in recent years of sharp increases in interest rates curtailing economic activity at times when recovery was incomplete and unemployment high. Sudden large fluctuations in interest rates contribute t5  8-  . other economic and financial distortions as well  And no  historically doubt the fact that many interest rates remain ects high, relative to the current rate of inflation, refl through the continuing skepticism over prospects for carrying fight on inflation. In this situation, the Federal Reserve has welcomed support the declines in interest rates both because of the to reflect they offer economic activity and because they seem a sense that the inflationary trend has changed.  However, we  s should do not believe that progress toward lower interest rate  •••••  expense of or for long in practice can -- be "forced" at the excessive credit and money creation.  To attempt to do so  renewed would simply risk the revival of inflationary forces; in the longerexpectations of inflation would soon be reflected long-lasting term credit markets, damaging prospects for the expansion we all want. Turning to your explicit questions, Mr. Chairman, policy-making against this general background, I believe most ral view that officials in the Federal Reserve share the gene   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  , but at a economic recovery will be evident throughout 1983 moderate rate of speed post-recession years.  probably slower than during previous Unambiguous evidence that the recovery  uraging signs is already underway is still absent, although enco liquidity are evident in some rise in housing, in the improved and in and wealth and reduced debt positions of consumers, be stabilizing surveys reporting that attitudes and orders may  ••• P I • woo  1  -9  or improving.  -  The Federal deficit, while fraught with danger  for the future, is of course providing massive support for incomes at present. What is crucially important -- particularly in the light of the experience of recent years -- is that we set the stage for an expansion that can be sustained over a long period, bringing with it strong gains in productivity and investment and lasting improvement in employment.  I have  already emphasized the importance of progress toward price stability to that outlook, and the evidence that, with disciplined monetary and fiscal policies, we can sustain that progress. So far as the specific questions about monetary policy in your October 18 letter are concerned, we have not, as you know, set any new monetary targets for 1982.  Current trends  do indicate that the various M's will end the year above the upper end of the target ranges, probablyto 1% for M2 and M3 and more for M1 given the current distortions. credit will be close to the mid-point of its range.  Bank  As I  indicated at the start, the "overshoots," in the context of today's economic and financial condons, are consistent with the approach stated in my July testimony. No deon has been taken to change the tentative targets for 1983.  That matter will, of course, be under  intensive scrutiny over the next two months, and the targets will be announced in February.   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  1  •  -10-  For the time being, we are placing much less emphasis than usual on Ml.  That decision was precipitated in early  October entirely by the likelihood that the data would be grossly distorted in that month by the maturity of a large volume of All-Savers Certificates, part of the proceeds of which might be expected to, at least temporarily, be placed in checking accounts included in Ml. In about three weeks, the introduction of a new ceilingless account at financial institutions -- highly liquid and carrying significant transaction capabilities -- is likely to distort further M1 data.  Judging by comments at the last  Depository Institutions Deregulation Committee meeting, that account could rapidly be followed by a decision to approve a ceiling-less account with full transaction capabilities. These new accounts could have a large, but quite unpredictable, influence on M1 for a number of months ahead as funds are reallocated among various accounts.  Moreover, the introduction  of market-rate transaction accounts will very likely result in a different relationship and trend of M1 relative to GNP over time.  Increasing confidence in the stability of prices  and a trend toward lower market interest rates might also affect the desire to hold money over time. Obviously, some judgments on those matters will be necessary in setting a target for M1 in 1983 and in deciding upon the degree of weight to be attached to changes in M1 in our operations.   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  Those problems should appropriately be  -11-  described as "technical" rather than "policy" in the sense that we will need to continue to be concerned with the rate of growth over time of the monetary aggregates, including transactions balances. The decisions taken in early October do point to greater emphasis on M2 (and M3) in planning the operational reserve path during this transitional period.  The link between reserves  and M2 is looser and more uncertain than in the case of Ml, in large part because reserve requirements on accounts included in M2, apart from transactions balances, are very low or non-existent (Transactions balances are about 17 percent of M2.)  Therefore  once a reserve path is set, deviations of M2 from a targeted growth range may not, more or less automatically, be reflected in as substantial changes in pressures on bank reserve positions or in money markets as is the case with Ml.  Consequently,  "discretionary" judgments may be necessary more frequently in altering a reserve path than when that reserve path is focused more heavily on Ml.  In that technical sense, the operational  approach has necessarily been modified. In sum, the broad framework of monetary targeting has been retained, but greater emphasis is for the time being placed on the broader aggregates.  The specific operating  technique that had been closely related to M1 has, by force of circumstances, been conformed to that emphasis.  Obviously,  entirely apart from questions of economic doctrine and contending approaches to monetary control, so long as M1 is   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  -12--  subjected to strong institutional distortions our techniques must be adapted to take account of that fact. An alternative operating approach suggested by some of supplying and withdrawing reserves with the intent of achieving a particular interest rate target would suffer from several fundamental defects.* •  The body of theory or practice does not provide a sufficiently clear basis for relating the level of a particular interest rate to our ultimate objectives of growth and price stability.  o  The implication that the Federal Reserve could in fact achieve and maintain a particular level of relevant interest rates in a changing economic and financial environment is not warranted.  o  The very concept and measurement of a "real" interest rate, as called for in some proposals, is a matter of substantial ambiguity.  o  As a practical matter, attempts to target and fix  0 interest rates would make more rigid and tend to politicize the entire process of monetary policy.  *That was not, as sometimes mistakenly thought, the operating approach used prior to October 1979. Then, reserves were provided with the aim of achieving and maintaining a particular Federal funds rate thought to be consistent with targets for the monetary aggregates. The Federal funds rate was a means to achieving a monetary target and in principle was tc be handled flexibly. In practice, among other difficulties, there appeared to be a reluctance to permit rates to vary rapidly enough to maintain control of the aggregates.   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  -13-  o  In current circumstances, with huge budget deficits looming, a requirement that the Federal Reserve set explicit interest rate targets is bound to be interpreted as inflationary, and the rekindling of inflationary expectations will work against our objective.  I realize the several legislative proposals addressed to targeting interest rates would, on their face, seem to call for interest rates as only one of several targets.  But interest  rates would certainly be the most obvious and sensitive target, and those targets would be difficult to change.  Other evidence  for a need to "tighten" or "ease" would be subordinated, if not ignored. As we approach the target-setting process for 1983, our objectives will -- indeed as required by law -- continue to be quantified in terms of growth in relevant money and credit aggregates.  We will have to decide how much weight to  place on M1 and other aggregates during a transitional period, assuming new accounts continue to distort the data.  In reaching  and implementing those decisions, the members of the FOMC necessarily rely upon their own analysis of the current and prospective course of business activity; the interrelationships among the aggregates, economic activity, and interest rates; and the implications of monetary growth for inflation.  In other words,  the process is not a simple mechanical one, and it seems to me capable of incorporating -- within a general framework of monetary discipline -- the elements of needed flexibility.  We will also,  'I  as part of that process, review whether technical adjustments   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  -14-  ve paths in procedures for establishing and changing the reser are appropriate.  I will be reporting our conclusions to the  Congress in February. Mr. Chairman, you have suggested that our monetary er, targets might reasonably be specified as a single numb with a range above and below.  At times we have debated  ng within the FOMC the wisdom of such an approach (or setti forth a single target number without a range).   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  My own feeling  without has been, and remains, that a single number, with or the a range, would convey a specious sense of precision, with arbitrary result of greater pressure to meet a more or less ts during number to maintain "credibility," even if developmen y is the year tend to indicate some element of flexibilit appropriate in pursuit of the targets. To me, our present practice of setting forth a range is preferable.  Where appropriate, we can and should suggest  the probability of being in the upper or lower portion of the range, or suggest what conditions could evolve in which undersomething other than the mid-points (or even an over or shoot) would be appropriate.  That approach seems to me to  single provide more information -- and more realism -- than a number and is broadly consistent with present practice. For similar reasons, I believe we need to measure and target a variety of aggregates because, in a swiftly changing economic environment, any single target can be misleading In that connection, I believe an indication of total credit flows broadly consistent with the monetary targets could be helpful.  As you know, we now provide such estimates for bank  credit alone.  a  -15-  Given the limits of forecasting and analysis, and the volatility of the data, I would question the usefulness of further sectoral estimates.  Even with respect to total credit  flows, there is considerable looseness in relationships to economic activity for periods as long as a year more for shorter periods.  and still  The theoretical framework relating  credit flows to other variables such as the GNP or inflation is less fully developed than in the case of monetary aggregates, and credit flows are less directly amenable to control.  The  enormous flows across international borders pose large conceptual and statistical problems.  Our credit data are typically  less complete and up-to-date than monetary data. However, so long as those difficulties and limitations are recognized -- and some of them are relevant with respect to the monetary aggregates as well -- I share the view that analysis of credit flows can contribute to policy formulation. To assist in that process, Iwill propose to the FOMC that estimates of the expected behavior of a broad credit aggregate be set forth alongside the monetary targets in our next report. I do strongly resist the idea of the Federal Reserve as an institution forecasting interest rates.  No institution or  individual is capable of judging accurately the myriad of forces working on market interest rates over time.  Expeatational  elements play a strong role -- fundamentally expectations about the course of economic activity and inflation, but also, in the short run, expectations of Federal Reserve action.   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  We could not  %  -16-  escape the fact that a central bank forecast of interest rates would be itself a market factor.  To some degree, therefore,  in looking to interest rates and other market developments for information bearing on our policy decisions, we would be looking into a mirror.  Moreover, the temptation would always be present  to breech the thin line between a forecast and a desire or policy intention, with the result that operational policy decisions could be distorted. While it seems to me inappropriate for a central bank to regularly forecast interest rates, analysis of key factors influencing credit conditions and prices can be helpful at times. past.  On occasion, we have provided such analysis in the My concern about the outlook for fiscal policy is rooted  in major part in such analysis because the direction of impact on interest rates seems to me unambiguous.  I have also, on a  number of occasions, indicated that the recent and even current level of interest rates appears extraordinarily high, provided, as I believe, we continue to make progress on the inflation front.  Perhaps, in our semi-annual reporting, we can more  explicitly call attention to major factors likely to influence short or long-term interest rates and the significance fur various sectors of the economy.  But I do not believe interest  rate forecasting would be desirable or long sustainable, and would in fact be damaging to the policy process.   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  %  4  -17-  Finally, Mr. Chairman, you have requested a "single composite forecast" of the major economic variables by FOMC members.  As you are well aware, our present practice is to  set forth a range of forecasts of individual FOMC members of the nominal and real GNP, prices, and unemployment.  The fact  is we have no single "Federal Reserve" forecast, and there is no mechanism, within a Committee or Board structure, to force agreement on such a forecast by individual members bringing different views, typically backed by separate staff analysis, to the table.  A simple average -- possibly supported by no  one -- seems to me artificial.  The process of attempting to  force a consensus would certainly dilute the product. I would put the point positively.  A range of forecasts  by individual FOMC members more accurately conveys the range foreof uncertainty and contingencies that must surround any cast.  The seeming neatness and coherence of a single forecast  is too often obscures the reality that a variety of outcomes s possible; the very essence of the policy problem is to asses risks and probabilities -- what can go wrong as well as what can go right.  A point forecast would likely be treated more  policy reverently than it would deserve, and could even distort judgments in misguided efforts to "hit" a forecast. I can understand your concern that a range of forecasts ons may be misleading if strongly influenced by "outlying" opini . rather than reflecting a more even dispersion of views  For  Market that reason, I would be glad to explore with the Open   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  0  -18-  Committee a procedure by which we indicated the "central tendency" of members' views -- assuming such a central tendency exists -- as well as indicating the range of opinions.  Conversely, if the forecasts were evenly  distributed within the range, we could so indicate. believe that approach would meet the Jbjectives you seek in a realistic and helpful manner. In concluding this already long testimony, let me say that we share the common goals of achieving, in the words of the Employment Act of 1946 and the Humphrey Hawkins Act of 1978, "Maximum employment, production, and purchasing power" and "full employment . . . (and) reasonable price stability." Those objectives have eluded us for too many years.  We meet  again today in particularly difficult circumstances, and there is a sense of frustration and uncertainty among many. But I also happen to believe we have come a long way toward laying the base for economic growth and stability; economic recovery should characterize 1983, and that recovery can mark the beginning of a long period of stable growth. Obviously there are obstacles -- interest rates are still too high; inflation is down but not out; there are strains in our financial system; we face budget deficits that are far too high; we are tempted to turn inwards or backwards for quick solutions that ultimately can not work.  But it is  also plainly wn our capacity to deal with those threats -provided only that we have a strong base of understanding among   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  •••••••   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  -19--  us, that we resolve to act where action is necessary, and that we have the patience and wisdom to refrain from actions that can only be destructive. You are leaving the Congress after 28 years, Mr. Chairman Through that time, you have consistently provided constructive leadership to the effort to raise the level of economic discussion in general -- and of the dialogue between the Congress and the Federal Reserve in particular.  I happen to believe  strongly in the independence that the Congress has provided the Federal Reserve through the years -- but also in the need for close and continuing communication with the Congress and the Administration.  I presume that this is the last time I  will appear before you personally in this forum, but the dialogue will continue to benefit from your efforts, your initiative, and your sense of commitment in more ways than you may realize.   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  For release on delivery 10:00 A.M., E.S.T. November 24, 1982  Statement by  Paul A. Volcker Chairman, Board of Governors of the Federal Reserve System  before the  Joint Economic Committee  November 24, 1982  I appreciate this opportunity to discuss with you today the current stance of monetary policy and some problems for the future.  Before responding to certain questions directed  to me about monetary policy in your letters of October 18 and November 17, Mr. Chairman, I should first emphasize that the basic thrust and goals of our policy are unchanged since I testified before the Congress on July 20.  The precise means  by which we move toward our goals must take account of all the stream of evidence we have on the behavior of (and distortions in) the various monetary aggregates, the economy, prices, interest rates, and the like.  But we remain convinced that lasting recovery  and growth must be sought in a framework of continuing progress toward price stability -- and that the process of money and credit creation must remain appropriately restrained if we are to deal effectively with inflationary dangers. For that reason, we must continue to set forth targets for growth in money and credit and to judge the provision of bank reserves  our most important operating instrument -- in  the light of the trend in the growth of these aggregates. This process necessarily involves continuing judgments about just what growth in those magnitudes is appropriate in the short and longer run, matters affected by institutional change as well as by more fundamental economic factors.   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  2-  •  As you are aware, the current job of developing and implementing monetary policy has been complicated by regulatory decisions as well as by recent developments in the economy and in our financial markets.  We have, as a consequence, (1) made  some technical modification in our operating procedures to cope with obvious distortions in some of the monetary data -- particularly MI -- and (2) accommodated growth in the various M's at rates somewhat above the targeted ranges. decisions was essentially technical.  The first of those  The latter decision is  entirely consistent with the view I expressed in testifying before the Banking Committees in July that the Federal Open Market Committee would tolerate "growth somewhat above the targeted ranges .  . for a time in circumstances in which it  appeared that precautionary or liquidity motivations, during a period of economic uncertainty and turbulence, were leading to stronger than anticipated demands for money." Unfortunately, the difficulties and complexities of the economic world in which we live do not permit us the luxury of describing policy in terms of a simple, unchanging numerical rule.  For instance, the economic significance of any particular  statistic we label "money" can change over time -- partly because the statistical definition of "money" is itself arbitrary and the components of the money supply have differing degrees of use as a medium of exchange and liquidity.  That doesn't make  much difference in a relatively stable economic, financial, and institutional environment, but, at times of rapid change, like the present, it can matter a great deal.   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  •   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  r t of varying lags -- neve un co ac ke ta to ve ha so al We conactions today and their n ee tw be -n io is ec pr th known wi orary y to disentangle the temp tr to ve ha We r. te la s sequence among trends in relationships nt te is rs pe re mo om fr al ic and cycl d economic activity. an n io at fl in d an y ne mo different measures of developments abroad of ce an ic if gn si e th te And we have to evalua counts and the exchange ac e ad tr in d te ec fl re as well as at home, as ncial structure itself. na fi e th in s in ra st of d rate, an ich we onomic environment in wh ec e th , ts es gg su is th As a cannot be condensed into lf se it cy li po or -set policy the t. Perhaps the essence of en em at st l na io ns me di esimple, on estter captured by a few "y be be n ca ch oa pr ap r ou d problem an but" phrases. e inflationary momentum th en ok br ve ha we s, Ye (1) ial and effort will be essent e nc la gi vi ng ui in nt co t bu ward price stability. to ss re og pr ue in nt co to en indices this year have be e ic pr d oa br e th , ow kn As you o or e peak levels reached tw th of ss le or lf ha t ou running at ab growth sinflationary process, di is th of rt pa As o. three years ag e 6 to terms has declined to th l na mi no in on ti sa en mp in worker co has growth in nominal income er ow sl at th t bu -ea 7 percent ar rated. s as inflation has mode ge wa al re er gh hi th wi been consistent omy ular sectors of the econ ic rt pa in ds en tr st co Price and the process of disin gs la rt pa in ng ti ec are mixed -- refl ional wage contracts, internat ng lo of s ct fe ef e th inflation, mediate effects of im e th d an , ts en pm lo ve and exchange rate de   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  4-  s. recession on some prices -- most particularly commoditie that But there is, it seems to me, strong reason to believe -- albeit the progress toward price stability can be maintained at a slower rate -- as the economy recovers.  For a time, un-  and prices employment and excess capacity should restrain costs d and, of more lasting significance, productivity growth shoul improve from the poor performance of most recent years.  Taken  together, restraint on nominal wage increases and productivity growth should moderate the increase in unit labor costs, which account for about two-thirds of all costs.  Real incomes can  rise as inflation slows, paving the way for further progress toward stability. To be sure, as the economy grows, some factors holding down prices over the past year or two will dissipate or be reversed.  But large new "price shocks" in the energy or food  areas appear unlikely in the foreseeable future, suggesting that a declining trend in the rise of unit labor costs should be the most fundamental factor defining the price trend. That analysis would not hold, however, if excessive growth in money and credit over time came again to feed first the expectation, and then the reality, of renewed inflation. Too much has been "invested" in turning the inflationary momentum to lose sight of the necessity of carrying through. There are clear implications, as I will elaborate in a moment, for fiscal as well as monetary policy.  5  (2) Yes, exceptional demands for liquidity can reasonably be accommodated in a period of recession, high unemployment, and excess capacity -- but guidelines for restrained money and credit growth remain relevant to insure against renewed inflation. A variety of specific and general evidence strongly suggests that the desire to hold cash and other highly liquid assets, relative to income, has increased this year.  Much of  the more rapid increase in M1 has been in interest-bearing NOW accounts, which did not exist a few years ago but which provide the basic elements of a savings, as well as transaction, account.   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  With market interest rates falling, those accounts have been relatively more attractive on interest rate grounds alone, and they are a convenient means of storing liquidity at a time of economic and financial uncertainty.  At the same time, the  broader aggregates appear to reflect some of the same liquidity wake motivations, as well as the stronger savings growth in the of the tax cut. Most broadly, we can now observe, over a period of more than a year, a distinct decline in "velocity" -- that is, the relationship between the GNP and monetary aggregates.  The  velocity decline for Ml, which is likely to amount to about of 1982, 3% from the fourth quarter of 1981 to the fourth quarter stands in sharp contrast to the average yearly rise in velocity of 3-4% over the past decade; it will be the first significant  6-  decline in velocity in about 30 years.  M2 and M3 velocities --  which had been relatively trendless earlier -- have also declined significantly.  While some tendency toward slower velocity is  not unusual in the midst of recession, the magnitude and persistence of the movement in 1982 is indicative of a pronounced tendency to hold more liquid assets relative to current income. Without some accommodation of that preference, monetary policy at the present time would be substantially more restraining in its effect on the economy than intended when the targets for the various aggregates were originally set out earlier this year. At the same time, policy must take into account the probability that the demands for liquidity will, in whole or in major part, prove temporary, and that an excessive rise in money or other liquid assets could feed inflationary forces later.  Elements of judgment are inevitably involved in sorting  out these considerations -- judgments resting on analysis of the economy, interest rates, and other factors.  But broad  guidelines for assessing the appropriate growth on the basis of historical experience will surely remain relevant and appropriate. In that connection, I must note the implications of the future Federal budgetary position.  To put the point briefly,  the prospect of huge continuing budgetary deficits, even as the economy recovers, carries with it the threat of either excessive liquidity creation and inflation in future years, or a "crowdingout" of other borrowers as monetary growth is restrained in the   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  •   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  7  face of the Treasury financing needs, or a combination of both. The problems flowing from the future deficits are simply not amenable to solution by monetary policy.  Moreover, the concern  engendered in the marketplace works in the direction of higher interest rates today than would otherwise be the case, contrary to the needs of recovery.  I know something of how difficult it  is to achieve further budgetary savings, but I must emphasize again how important it is to see the deficit reduced as the economy recovers.  The fact is those looming deficits are a  major hazard in sustaining recovery. (3) Yes, lower interest rates are critically important in supporting the economy and encouraging recovery but we also want to be able to maintain lower interest rates over time.  Since early summer, short-term interest rates have generally declined by five to six percentage points, and mortgage and most other long-term rates have dropped by three to four percentage points.  While consumer loan rates administered  by banks and other financial institutions have lagged, they are also now moving lower.  There are clear signs of a rise in home  sales and building in response to these interest rate declines, and other sectors of the economy are benefiting as well. We have also had experience in recent years of sharp increases in interest rates curtailing economic activity at times when recovery was incomplete and unemployment high. Sudden large fluctuations in interest rates contribute to  1  8_  other economic and financial distortions as well.  And no  ly doubt the fact that many interest rates remain historical high, relative to the current rate of inflation, reflects gh the continuing skepticism over prospects for carrying throu fight on inflation. In this situation, the Federal Reserve has welcomed ort the declines in interest rates both because of the supp they offer economic activity and because they seem to reflect a sense that the inflationary trend has changed.  However, we  d do not believe that progress toward lower interest rates shoul  •MINkli.  or for long in practice can -- be "forced" at the expense of excessive credit and money creation.  To attempt to do so  ed would simply risk the revival of inflationary forces; renew erexpectations of inflation would soon be reflected in the long   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  ng term credit markets, damaging prospects for the long-lasti expansion we all want. Turning to your explicit questions, Mr. Chairman, ing against this general background, I believe most policy-mak officials in the Federal Reserve share the general view that at a economic recovery will be evident throughout 1983, but previous moderate rate of speed -- probably slower than during post-recession years.  Unambiguous evidence that the recovery  raging signs is already underway is still absent, although encou liquidity are evident in some rise in housing, in the improved in and wealth and reduced debt positions of consumers, and stabilizing surveys reporting that attitudes and orders may be  .4*  4 -9  or improving.  The Federal deficit, while fraught with danger  for the future, is of course providing massive support for incomes at present. What is crucially important -- particularly in the light of the experience of recent years -- is that we set the stage for an expansion that can be sustained over a long period, bringing with it strong gains in productivity and investment and lasting improvement in employment.  I have  already emphasized the importance of progress toward price stability to that outlook, and the evidence that, with disciplined monetary and fiscal policies, we can sustain that progress. So far as the specc questions about monetary policy in your October 18 letter are concerned, we have not, as you know, set any new monetary targets for 1982.  Current trends  do indicate that the various M's will end the year above the upper end of the target ranges, probably by 1/2 to 1% for M2 and M3 and more for M1 given the current distortions. credit will be close to the mid-point of its range.  Bank  As I  indicated at the start, the "overshoots," in the context of today's economic and financial conditions, are consistent with the approach stated in my July testimony. No deon has been taken to change the tentative targets for 1983.  That matter will, of course, be under  intensive scrutiny over the next two months, and the targets will be announced in February.   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  -10-  For the time being, we are placing much less emphasis than usual on Ml.  That decision was precipitated in early  October entirely by the likelihood that the data would be grossly distorted in that month by the maturity of a large volume of All-Savers Certificates, part of the proceeds of which might be expected to, at least temporarily, be placed in checking accounts included in Ml. In about three weeks, the introduction of a new ceilingless account at financial institutions -- highly liquid and carrying significant transaction capabilities -- is likely to distort further M1 data.  Judging by comments at the last  Depository Institutions Deregulation Committee meeting, that account could rapidly be followed by a decision to approve a ceiling-less account with full transaction capabilities. These new accounts could have a large, but quite unpredictable, influence on M1 for a number of months ahead as funds are reallocated among various accounts.  Moreover, the introduction  of market-rate transaction accounts will very likely result in a different relationship and trend of M1 relative to GNP over time.  Increasing confidence in the stability of prices  and a trend toward lower market interest rates might also affect the desire to hold money over time. Obviously, some judgments on those matters will be necessary in setting a target for M1 in 1983 and in deciding upon the degree of weight to be attached to changes in M1 in our operations.   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  Those problems should appropriately be  • -11-  described as "technical" rather than "policy" in the sense that we will need to continue to be concerned with the rate of growth over time of the monetary aggregates, including transactions balances. The decisions taken in early October do point to greater emphasis on M2 (and M3) in planning the operational reserve path during this transitional period.  The link between reserves  and M2 is looser and more uncertain than in the case of Ml, in large part because reserve requirements on accounts included in M2, apart from transactions balances, are very low or non-existent. (Transactions balances are about 17 percent of M2.)  Therefore  once a reserve path is set, deviations of M2 from a targeted growth range may not, more or less automatically, be reflected in as substantial changes in pressures on bank reserve positions or in money markets as is the case with Ml.  Consequently,  "discretionary" judgments may be necessary more frequently in altering a reserve path than when that reserve path is focused more heavily on Ml.  In that technical sense, the operational  approach has necessarily been modified. In sum, the broad framework of monetary targeting has been retained, but greater emphasis is for the time being placed on the broader aggregates.  The spec operating  technique that had been closely related to M1 has, by force of circumstances, been conformed tc that emphasis.  Obviously,  entirely apart from questions of economic doctrine and contending approaches to monetary control, so long as M1 is   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  • -12-  subjected to strong institutional distortions our techniques must be adapted to take account of that fact. An alternative operating approach suggested by some of supplying and withdrawing reserves with the intent of achieving a particular interest rate target would suffer from several fundamental defects.* •  The body of theory or practice does not provide a sufficiently clear basis for relating the level of a particular interest rate to our ultimate objectives of growth and price stability.  •  The implication that the Federal Reserve could in fact achieve and maintain a particular level of relevant interest rateschanging economic and financial environment is not warranted.  •  The very concept and measurement of a "real" interest rate, as called for in some proposals, is a matter of substantial ambiguity.  •  As a practical matter, attempts to target and fix  C) interest rates would make more rigid and tend to politicize the entire process of monetary policy.  *That was not, as sometimes mistakenly thought, the operating approach used prior to October 1979. Then, reserves were provided with the aim of achieving and maintaining a particular Federal funds rate thought to be consistent with targets for the monetary aggregates. The Federal funds rate was a means to achieving a monetary target and in principle was tc be handled flexibly. In practice, among other difficulties, there appeared to be a reluctance to permit rates to vary rapidly enough to maintain control of the aggregates.   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  4IP  -13-  In current circumstances, with huge budget deficits looming, a requirement that the Federal Reserve set explicit interest rate targets is bound to be interpreted as inflationary, and the rekindling of inflationary expectations will work against our objective. I realize the several legislative proposals addressed to targeting interest rates would, on their face, seem to call for interest rates as only one of several targets.  But interest  rates would certainly be the most obvious and sensitive target, and those targets would be difficult to change.  Other evidence  for a need to "tighten" or "ease" would be subordinated, if not ignored. As we approach the target-setting process for 1983, our objectives will -- indeed as required by law -- continue to be quantified in terms of growth in relevant money and credit aggregates.  We will have to decide how much weight to  place on M1 and other aggregates during a transitional period, assuming new accounts continue to distort the data.  In reaching  and implementing those decisions, the members of the FOMC necessarily rely upon their own analysis of the current and prospective course of business activity; the interrelationships among the aggregates, economic activity, and interest rates; and the implications of monetary growth for inflation.  In other words,  the process is not a simple mechanical one, and it seems to me capable of incorporating -- within a general framework of monetary discipline -- the elements of needed flexibility.  We will also,  It  as part of that process, review whether technical adjustments   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  -14-  the reserve paths in procedures for establishing and changing are appropriate.  I will be reporting our conclusions to the  Congress in February. tary Mr. Chairman, you have suggested that our mone le number, targets might reasonably be specified as a sing with a range above and below.  At times we have debated  setting within the FOMC the wisdom of such an approach (or forth a single target number without a range).  My own feeling  with or without has been, and remains, that a single number, ision, with the a range, would convey a specious sense of prec less arbitrary result of greater pressure to meet a more or   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  lopments during number to maintain "credibility," even if deve ity is the year tend to indicate some element of flexibil appropriate in pursuit of the targets. h a range To me, our present practice of setting fort is preferable.  Where appropriate, we can and should suggest  portion of the probability of being in the upper or lower ve in which the range, or suggest what conditions could evol over or undersomething other than the mid-points (or even an shoot) would be appropriate.  That approach seems to me to  a single provide more information -- and more realism -- than . number and is broadly consistent with present practice For similar reasons, I believe we need to measure and target a variety of aggregates because, in a swiftly eading changing economic environment, any single target can be misl total credit In that connection, I believe an indication of could be flows broadly consistent with the monetary targets helpful.  As you know, we now provide such estimates for bank  credit alone.  -15-  Given the limits of forecasting and analysis, and the volatility of the data, I would question the usefulness of further sectoral estimates.  Even with respect to total credit  flows, there is considerable looseness in relationships to economic activity for periods as long as a year -- and still more for shorter periods.  The theoretical framework relating  credit flows to other variables such as the GNP or inflation is less fully developed than in the case of monetary aggregates, and credit flows are less directly amenable to control.  The  enormous flows across international borders pose large conceptual and statistical problems.  Our credit data are typically  less complete and up-to-date than monetary data. However, so long as those difficulties and limitations are recognized -- and some of them are relevant with respect to the monetary aggregates as well -- I share the view that analysis of credit flows can contribute to policy formulation. To assist in that process, Iwill propose to the FOMC that estimates of the expected behavior of a broad credit aggregate be set forth alongside the monetary targets in our next report. I do strongly resist the idea of the Federal Reserve as an institution forecasting interest rates.  No institution or  individual is capable of judging accurately the myriad of forces working on market interest rates over time.  Expeotational  elements play a strong role -- fundamentally expectations about the course of economic activity and inflation, but also, in the short run, expectations of Federal Reserve action.   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  We could not  %  * -16-  escape the fact that a central bank forecast of interest rates would be itself a market factor.  To some degree, therefore,  in looking to interest rates and other market developments for information bearing on our policy decisions, we would be looking into a mirror.  Moreover, the temptation would always be present  to breech the thin line between a forecast and a desire or policy intention, with the result that operational policy decisions could be distorted. While it seems to me inappropriate for a central bank to regularly forecast interest rates, analysis of key factors influencing credit conditions and prices can be helpful at times. past.  On occasion, we have provided such analysis in the My concern about the outlook for fiscal policy is rooted  in major part in such analysis because the direction of impact on interest rates seems to me unambiguous.  I have also, on a  number of occasions, indicated that the recent and even current level of interest rates appears extraordinarily high, provided, as I believe, we continue to make progress on the inflation front.  Perhaps, in our semi-annual reporting, we can more  explicitly call attention to major factors likely to influence short or long-term interest rates and the significance for various sectors of the economy.  But I do not believe interest  rate forecasting would be desirable or long sustainable, and would in fact be damaging to the policy process.   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  %  411111  114.-  -17-  Finally, Mr. Chairman, you have requested a "single composite forecast" of the major economic variables by FOMC members.  As you are well aware, our present practice is to  set forth a range of forecasts of individual FOMC members of the nominal and real GNP, prices, and unemployment.  The fact  is we have no single "Federal Reserve" forecast, and there is no mechanism, within a Committee or Board structure, to force agreement on such a forecast by individual members bringing different views, typically backed by separate staff analysis, to the table.  A simple average -- possibly supported by no  one -- seems to me artificial.  The process of attempting to  force a consensus would certainly dilute the product. I would put the point positively.  A range of forecasts  by individual FOMC members more accurately conveys the range of uncertainty and contingencies that must surround any forecast.  The seeming neatness and coherence of a single forecast  too often obscures the reality that a variety of outcomes is possible; the very essence of the policy problem is to assess risks and probabilities -- what can go wrong as well as what can go right.  A point forecast would likely be treated more  reverently than it would deserve, and could even distort policy judgments in misguided efforts to "hit" a forecast. I can understand your concern that a range of forecasts may be misleading if strongly influenced by "outlying" opinions rather than reflecting a more even dispersion of views.  For  that reason, I would be glad to explore with the Open Market   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  -18-  Committee a procedure by which we indicated the "central tendency" of members' views -- assuming such a central tendency exists -- as well as indicating the range of opinions.  Conversely, if the forecasts were evenly  distributed wn the range, we could so indicate.  I  believe that approach would meet the Jbjectives you seek in a realistic and helpful manner. In concluding this already long testimony, let me say that we share the common goals of achieving, in the words of the Employment Act of  Si.1  and the Humphrey Hawkins Act of  1978, "Maximum employment, production, and purchasing power" and "full employment . . . (and) reasonable price stability." Those objectives have eluded us for too many years.  We meet  again today in particularly difficult circumstances, and there is a sense of frustration and uncertainty among many. But I also happen to believe we have come a long way toward laying the base for economic growth and stability; economic recovery should characterize 1983, and that recovery can mark the beginning of a long period of stable growth. Obviously there are obstacles -- interest rates are still too high; inflation is down but not out; there are strains in our financial system; we face budget deficits that • are far too high; we are tempted to turn inwards or backwards for quick solutions that ultimately can not work.  But it is  also plainly wn our capacity to deal with those threats -provided only that we have a strong base of understanding among   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  -19-  us, that we resolve to act where action is necessary, and that we have the patience and wisdom to refrain from actions that can only be destructive. You are leaving the Congress after 28 years, Mr. Chairman. Through that time, you have consistently provided constructive leadership to the effort to raise the level of economic discussion in general -- and of the dialogue between the Congress and the Federal Reserve in particular.  I happen to believe  strongly in the independence that the Congress has provided the Federal Reserve through the years -- but also in the need for close and continuing communication with the Congress and the Administration.  I presume that this is the last time I  will appear before you personally in this forum, but the dialogue will continue to benefit from your efforts, your initiative, and your sense of commitment in more ways than you may realize.  gia•   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  For release on delivery 10:00 A.M., E.S.T. November 24, 1982  Statement by  Paul A. Volcker  Chairman, Board of Governors of the Federal Reserve System  before the  Joint Economic Committee  November 24, 1982  I appreciate this opportunity to discuss with you today the current stance of monetary policy and some problems for the future.  Before responding to certain questions directed  to me about monetary policy in your letters of October 18 and November 17, Mr. Chairman, I should first emphasize that the basic thrust and goals of our policy are unchanged since I testified before the Congress on July 20.  The precise means  by which we move toward our goals must take account of all the stream of evidence we have on the behavior of (and distortions in) the various monetary aggregates, the economy, prices, interest rates, and the like.  But we remain convinced that lasting recovery  and growth must be sought in a framework of continuing progress toward price stability -- and that the process of money and credit creation must remain appropriately restrained if we are to deal effectively with inflationary dangers. For that reason, we must continue to set forth targets for growth in money and credit and to judge the provision of bank reserves  our most important operating instrument -- in  the light of the trend in the growth of these aggregates. This process necessarily involves continuing judgments about just what growth in those magnitudes is appropriate in the short and longer run, matters affected by institutional change as well as by more fundamental economic factors.   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  •  2-  As you are aware, the current job of developing and implementing monetary policy has been complicated by regulatory decisions as well as by recent developments in the economy and in our financial markets.  We have, as a consequence, (1) made  some technical modification in our operating procedures to cope with obvious distortions in some of the monetary data -- particularly M1 -- and (2) accommodated growth in the various M's at rates somewhat above the targeted ranges. decisions was essentially technical.  The first of those  The latter decision is  entirely consistent with the view I expressed in testifying before the Banking Committees in July that the Federal Open Market Committee would tolerate "growth somewhat above the targeted rangestime in circumstances in which it appeared that precautionary or liquidity motivations, during a period of economic uncertainty and turbulence, were leading to stronger than anticipated demands for money." Unfortunately, the difficulties and complees of the economic world in which we live do not permit us the luxury of describing policy in terms of a simple, unchanging numerical rule.  For instance, the economic significance of any particular  statistic we label "money" can change over time -- partly because the statistical definon of "money" is itself arbitrary and the components of the money supply have differing degrees of use as a medium of exchange and liquidity.  That doesn't make  much differencerelatively stable economic, financial, and institutional environment, but, at times of rapid change, like the present, it can matter a great deal.   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  of varying lags -- never We also have to take account ntions today and their co ac n ee tw be -n io is ec pr th wi known ary y to disentangle the tempor tr to ve ha We r. te la s ce sequen s among nt trends in relationship te is rs pe re mo om fr al ic cl and cy tivity. d inflation and economic ac an y ne mo of es ur as me t en er diff abroad gnificance of developments si e th te ua al ev to ve ha And we accounts and the exchange e ad tr in d te ec fl re as , as well as at home nancial structure itself. fi e th in s in ra st of d an , rate ic environment in which we As this suggests, the econom a -- cannot be condensed into lf se it cy li po or -cy li set po the ent. Perhaps the essence of em at st l na io ns me di eon , simple tter captured by a few "yes be be n ca ch oa pr ap r ou d an problem but" phrases. the inflationary momentum en ok br ve ha we s, Ye ) (1 d effort will be essential but continuing vigilance an price stability. to continue progress toward en e indices this year have be ic pr d oa br e th , ow kn u yo As e peak levels reached two or th of ss le or lf ha t ou ab running at owth disinflationary process, gr is th of rt pa As o. ag s three year 6 to terms has declined to the l na mi no in on ti sa en mp co in worker s growth in nominal income ha er ow sl at th t bu -ea ar 7 percent rated. wages as inflation has mode al re er gh hi th wi nt te is been cons omy icular sectors of the econ rt pa in ds en tr st co d an Price the process of disin gs la rt pa in ng ti ec fl are mixed -- re cts, international ra nt co ge wa ng lo of s ct inflation, the effe immediate effects of e th d an , ts en pm lo ve de and exchange rate   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  4-  _  s. recession on some prices -- most particularly commoditie that But there is, it seems to me, strong reason to believe dlbeit the progress toward price stability can be maintained -at a slower rate -- as the economy recovers.  For a time, un-  prices employment and excess capacity should restrain costs and should and, of more lasting significance, productivity growth improve from the poor performance of most recent years.  Taken  ty together, restraint on nominal wage increases and productivi growth should moderate the increase in unit labor costs, which account for about two-thirds of all costs.  Real incomes can  rise as inflation slows, paving the way for further progress toward stability. To be sure, as the economy grows, some factors holding down prices over the past year or two will dissipate or be reversed.  But large new "price shocks" in the energy or food  areas appear unlikely in the foreseeable future, suggesting that a declining trend in the rise of unit labor costs should be the most fundamental factor defining the price trend. That analysis would not hold, however, if excessive growth in money and credit over time came again to feed first the expectation, and then the reality, of renewed inflation. Too much has been "invested" in turning the inflationary momentum to lose sight of the necessity of carrying through. There are clear implications, as I will elaborate in a moment, for fiscal as well as monetary policy.  • _  5-  (2) Yes, exceptional demands for liquidity can reasonably be accommodated in a period of recession, high unemployment, and excess capacity -- but guidelines for restrained money and credit growth remain relevant to insure against renewed inflation. A variety of specific and general evidence strongly suggests that the desire to hold cash and other highly liquid assets, relative to income, has increased this year.  Much of  the more rapid increase in M1 has been in interest-bearing NOW accounts, which did not exist a few years ago but which provide   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  the basic elements of a savings, as well as transaction, account. With market interest rates falling, those accounts have been relatively more attractive on interest rate grounds alone, and they are a convenient means of storing liquidity at a time of economic and financial uncertainty.  At the same time, the  broader aggregates appear to reflect some of the same liquidity motivations, as well as the stronger savings growth in the wake of the tax cut. Most broadly, we can now observe, over a period of more than a year, a distinct decline in "velocity" -- that is, the relationship between the GNP and monetary aggregates.  The  velocity decline for Ml, which is likely to amount to about 3% from the fourth quarter of 1981 to the fourth quarter of 1982, stands in sharp contrast to the average yearly rise in velocity of 3-4% over the past decade; it will be the first significant  r  -6  decline in velocity in about 30 years.  M2 and M3 velocities --  which had been relatively trendless earlier -- have also declined significantly.  While some tendency toward slower velocity is  not unusual in the midst of recession, the magnitude and persistence of the movement in 1982 is indicative of a pronounced tendency to hold more liquid assets relative to current income. Without some accommodation of that preference, monetary policy at the present time would be substantially more restraining in its effect on the economy than intended when the targets for the various aggregates were originally set out earlier this year. At the same time, policy must take into account the probability that the demands for liquidity will, in whole or in major part, prove temporary, and that an excessive rise in money or other liquid assets could feed inflationary forces later.  Elements of judgment are inevitably involved in sorting  out these considerations -- judgments resting on analysis of   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  the economy, interest rates, and other factors.  But broad  guidelines for assessing the appropriate growth on the basis of historical experience will surely remain relevant and appropriate. In that connection, I must note the implications of the future Federal budgetary position.  To put the point briefly,  the prospect of huge continuing budgetary deficits, even as the economy recovers, carries with it the threat of either excessive liquidity creation and inflation in future years, or a "crowdingout" of other borrowers as monetary growth is restrained in the   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  -7-  face of the Treasury financing needs, or a combination of both. The problems flowing from the future deficits are simply not amenable to solution by monetary policy.  Moreover, the concern  engendered in the marketplace works in the direction of higher interest rates today than would otherwise be the case, contrary to the needs of recovery.  I know something of how difficult it  is to achieve further budgetary savings, but I must emphasize again how important it is to see the deficit reduced as the economy recovers.  The fact is those looming deficits are a  major hazard in sustaining recovery. (3) Yes, lower interest rates are critically important in supporting the economy and encouraging recovery but we also want to be able to maintain lower interest rates over time.  Since early summer, short-term interest rates have generally declined by five to six percentage points, and mortgage and most other long-term rates have dropped by three to four percentage points.  While consumer loan rates administered  by banks and other financial institutions have lagged, they are also now moving lower.  There are clear signs of a rise in home  sales and building in response to these interest rate declines, and other sectors of the economy are benefiting as well. We have also had experience in recent years of sharp increases in interest rates curtailing economic activity at times when recovery was incomplete and unemployment high. Sudden large fluctuations in interest rates contribute to  8-  other economic and financial distortions as well.  And no  rically doubt the fact that many interest rates remain histo high, relative to the current rate of inflation, reflects the continuing skepticism over prospects for carrying through fight on inflation. In this situation, the Federal Reserve has welcomed the declines in interest rates both because of the support ct they offer economic activity and because they seem to refle a sense that the inflationary trend has changed.  However, we  d do not believe that progress toward lower interest rates shoul  .1•M• OMB  or for long in practice can -- be "forced" at the expense of excessive credit and money creation.  To attempt to do so  would simply risk the revival of inflationary forces; renewed expectations of inflation would soon be reflected in the longerng term credit markets, damaging prospects for the long-lasti expansion we all want.   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  Turning to your explicit questions, Mr. Chairman, g against this general background, I believe most policy-makin officials in the Federal Reserve share the general view that at a economic recovery will be evident throughout 1983, but moderate rate of speed -- probably slower than during previous post-recession years.  Unambiguous evidence that the recovery  signs is already underway is still absent, although encouraging are evident in some rise in housing, in the improved liquidity and wealth and reduced debt positions of consumers, and in lizing surveys reporting that attitudes and orders may be stabi  P •04  -9  or improving.  The Federal deficit, while fraught with danger  for the future, is of course providing massive support for incomes at present. What is crucially important -- particularly in the light of the experience of recent years -- is that we set the stage for an expansion that can be sustained over a long period, bringing with it strong gains in productivity and investment and lasting improvement in employment.  I have  already emphasized the importance of progress toward price stability to that outlook, and the evidence that, with disciplined monetary and fiscal policies, we can sustain that progress. So far as the specific questions about monetary policy in your October 18 letter are concerned, we have not, as you know, set any new monetary targets for 1982.  Current trends  do indicate that the various M's will end the year above the upper end of the target ranges, probably by 1/2 to 1% for M2 and M3 and more for M1 given the current distortions. credit will be close to the mid-point of its range.  Bank  As I  indicated at the start, the "overshoots," in the context of today's economic and financial conditions, are consistent with the approach stated in my July testimony. No decision has been taken to change the tentative targets for 1983.  That matter will, of course, be under  intensive scrutiny over the next two months, and the targets will be announced in February.   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  -10-  For the time being, we are placing much less emphasis than usual on Ml.  That decision was precipitated in early  October entirely by the likelihood that the data would be grossly distorted in that month by the maturity of a large volume of All-Savers Certificates, part of the proceeds of which might be expected to, at least temporarily, be placed in checking accounts included in Ml. In about three weeks, the introduction of a new ceilingless account at financial institutions -- highly liquid and carrying significant transaction capabilities -- is likely to distort further M1 data.  Judging by comments at the last  Depository Institutions Deregulation Committee meeting, that account could rapidly be followed by a decision to approve a ceiling-less account with full transaction capabilities. These new accounts could have a large, but quite unpredictable, influence on M1 for a number of months ahead as funds are reallocated among various accounts.  Moreover, the introduction  of market-rate transaction accounts will very likely result in a different relationship and trend of M1 relative to GNP over time.  Increasing confidence in the stability of prices  and a trend toward lower market interest rates might also affect the desire to hold money over time. Obviously, some judgments on those matters will be necessary in setting a target for M1 in 1983 and in deciding upon the degree of weight to be attached to changes in M1 in our operations.   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  Those problems should appropriately be  -11-  described as "technical" rather than "policy" in the sense that we will need to continue to be concerned with the rate of growth over time of the monetary aggregates, including transactions balances. The decisions taken in early October do point to greater emphasis on M2 (and M3) in planning the operational reserve path during this transitional period.  The link between reserves  and M2 is looser and more uncertain than in the case of Ml, in large part because reserve requirements on accounts included in M2, apart from transactions balances, are very low or non-existent. (Transactions balances are about 17 percent of M2.)  Therefore  once a reserve path is set, deviations of M2 from a targeted growth range may not, more or less automatically, be reflected in as substantial changes in pressures on bank reserve positions or in money markets as is the case with Ml.  Consequently,  "discretionary" judgments may be necessary more frequently in altering a reserve path than when that reserve path is focused more heavily on Ml.  In that technical sense, the operational  approach has necessarily been modified. In sum, the broad framework of monetary targeting has been retained, but greater emphasis is for the time being placed on the broader aggregates.  The specific operating  technique that had been closely related to M1 has, by force of circumstances, been conformed to that emphasis.  Obviously,  entirely apart from questions of economic doctrine and contending approaches to monetary control, so long as M1 is   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  1  -12--  subjected to strong institutional distortions our techniques must be adapted to take account of that fact. An alternative operating approach suggested by some of supplying and withdrawing reserves with the intent of achieving a particular interest rate target would suffer from several fundamental defects.* The body of theory or practice does not provide a sufficiently clear basis for relating the level of a particular interest rate to our ultimate objectives of growth and price stability. o  The implication that the Federal Reserve could in fact achieve and maintain a particular level of relevant interest rates in a changing economic and financial environment is not warranted.  o  The very concept and measurement of a "real" interest rate, as called for in some proposals, is a matter of substantial ambiguity.  o  As a practical matter, attempts to target and fix  0 interest rates would make more rigid and tend to politicize the entire process of monetary policy.  *That was not, as sometimes mistakenly thought, the operating approach used prior to October 1979. Then, reserves were provided with the aim of achieving and maintaining a particular Federal funds rate thought to be consistent with targets for the monetary aggregates. The Federal funds rate was a means to achieving a monetary target and in principle was tc be handled flexibly. In practice, among other difficulties, there appeared to be a reluctance to permit rates to vary rapidly enough to maintain control of the aggregates.   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  -13-  o  In current circumstances, with huge budget deficits looming, a requirement that the Federal Reserve set explicit interest rate targets is bound to be interpreted as inflationary, and the rekindling of inflationary expectations will work against our objective.  I realize the several legislative proposals addressed to targeting interest rates would, on their face, seem to call for interest rates as only one of several targets.  But interest  rates would certainly be the most obvious and sensitive target, and those targets would be difficult to change.  Other evidence  for a need to "tighten" or "ease" would be subordinated, if not ignored. As we approach the target-setting process for 1983, our objectives will -- indeed as required by law -- continue to be quantified in terms of growth in relevant money and credit aggregates.  We will have to decide how much weight to  place on M1 and other aggregates during a transitional period, assuming new accounts continue to distort the data.  In reaching  and implementing those decisions, the members of the FOMC necessarily rely upon their own analysis of the current and prospective course of business activity; the interrelationships among the aggregates, economic activity, and interest rates; and the implications of monetary growth for inflation.  In other words,  the process is not a simple mechanical one, and it seems to me capable of incorporating -- within a general framework of monetary discipline -- the elements of needed flexibility.  We will also,  I t  as part of that process, review whether technical adjustments   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  -14-  reserve paths in procedures for establishing and changing the are appropriate.  I will be reporting our conclusions to the  Congress in February. Mr. Chairman, you have suggested that our monetary number, targets might reasonably be specified as a single with a range above and below.  At times we have debated  setting within the FOMC the wisdom of such an approach (or forth a single target number without a range).  My own feeling  with or without has been, and remains, that a single number, ision, with the a range, would convey a specious sense of prec arbitrary result of greater pressure to meet a more or less ents during number to maintain "credibility," even if developm ibility is the year tend to indicate some element of flex   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  appropriate in pursuit of the targets. a range To me, our present practice of setting forth is preferable.  Where appropriate, we can and should suggest  portion of the probability of being in the upper or lower in which the range, or suggest what conditions could evolve or undersomething other than the mid-points (or even an over shoot) would be appropriate. provide more information  That approach seems to me to and more realism -- than a single  number and is broadly consistent with present practice. For similar reasons, I believe we need to measure and target a variety of aggregates because, in a swiftly changing economic environment, any single target can be misleading it l In that connection, I believe an indication of tota cred d be flows broadly consistent with the monetary targets coul helpful.  As you know, we now provide such estimates for bank  credit alone.  -15-  Given the limits of forecasting and analysis, and the volatility of the data, I would question the usefulness of further sectoral estimates.  Even with respect to total credit  flows, there is considerable looseness in relationships to economic activity for periods as long as a year more for shorter periods.  and still  The theoretical framework relating  credit flows to other variables such as the GNP or inflation is less fully developed than in the case of monetary aggregates, and credit flows are less directly amenable to control.  The  enormous flows across international borders pose large conceptual and statistical problems.  Our credit data are typically  less complete and up-to-date than monetary data. However, so long as those difficulties and limitations are recognized -- and some of them are relevant with respect to the monetary aggregates as well -- I share the view that analysis of credit flows can contribute to policy formulation. To assist in that process, Iwill propose to the FOMC that estimates of the expected behavior of a broad credit aggregate be set forth alongside the monetary targets in our next report. I do strongly resist the idea of the Federal Reserve as an institution forecasting interest rates.  No institution or  individual is capable of judging accurately the myriad of forces working on market interest rates over time.  Expeatational  elements play a strong role -- fundamentally expectations about the course of economic activity and inflation, but also, in the short run, expectations of Federal Reserve action.   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  We could not  • -16-  escape the fact that a central bank forecast of interest rates would be itself a market factor.  To some degree, therefore,  in looking to interest rates and other market developments for information bearing on our policy decisions, we would be looking into a mirror.  Moreover, the temptation would always be present  to breech the thin line between a forecast and a desire or policy intention, with the result that operational policy decisions could be distorted. While it seems to me inappropriate for a central bank to regularly forecast interest rates, analysis of key factors influencing credit conditions and prices can be helpful at times. past.  On occasion, we have provided such analysis in the My concern about the outlook for fiscal policy is rooted  in major part in such analysis because the direction of impact on interest rates seems to me unambiguous.  I have also, on a  number of occasions, indicated that the recent and even current level of interest rates appears extraordinarily high, provided, as I believe, we continue to make progress on the inflation front.  Perhaps, in our semi-annual reporting, we can more  explicitly call attention to major factors likely to influence short or long-term interest rates and the significance for various sectors of the economy.  But I do not believe interest  rate forecasting would be desirable or long sustainable, and would in fact be damaging to the policy process.   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  411  -17-  Finally, Mr. Chairman, you have requested a "single composite forecast" of the major economic variables by FOMC members.  As you are well aware, our present practice is to  set forth a range of forecasts of individual FOMC members of the nominal and real GNP, prices, and unemployment.  The fact  is we have no single "Federal Reserve" forecast, and there is no mechanism, within a Committee or Board structure, to force agreement on such a forecast by individual members bringing different views, typically backed by separate staff analysis, to the table.  A simple average -- possibly supported by no  one -- seems to me artificial.  The process of attempting to  force a consensus would certainly dilute the product. I would put the point positively.  A range of forecasts  by individual FOMC members more accurately conveys the range of uncertainty and contingencies that must surround any forecast.  The seeming neatness and coherence of a single forecast  too often obscures the reality that a variety of outcomes is possible; the very essence of the policy problem is to assess risks and probabilities -- what can go wrong as well as what can go right.  A point forecast would likely be treated more  reverently than it would deserve, and could even distort policy judgments in misguided efforts to "hit" a forecast. I can understand your concern that a range of forecasts may be misleading if strongly influenced by "outlying" opinions rather than reflecting a more even dispersion of views.  For  that reason, I would be glad to explore with the Open Market   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  IL  -18-  Committee a procedure by which we indicated the "central tendency" of members' views -- assuming such a central tendency exists -- as well as indicating the range of opinions.  Conversely, if the forecasts were evenly  distributed within the range, we could so indicate.  I  believe that approach would meet the ibjectives you seek in a realistic and helpful manner. In concluding this already long testimony, let me say that we share the common goals of achieving, in the words of the Employment Act of 1946 and the Humphrey Hawkins Act of 1978, "Maximum employment, production, and purchasing power" and "full employment . . . (and) reasonable price stability." Those objectives have eluded us for too many years.  We meet  again today in particularly difficult circumstances, and there is a sense of frustration and uncertainty among many. But I also happen to believe we have come a long way toward laying the base for economic growth and stability; economic recovery should characterize 1983, and that recovery can mark the beginning of a long period of stable growth. Obviously there are obstacles -- interest rates are still too high; inflation is down but not out; there are strains in our financial system; we face budget deficits that are far too high; we are tempted to turn inwards or backwards for quick solutions that ultimately can not work.  But it is  also plainly wn our capacity to deal with those threats -provided only that we have a strong base of understanding among   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  •  -19-  us, that we resolve to act where action is necessary, and that we have the patience and wisdom to refrain from actions that can only be destructive. You are leaving the Congress after 28 years, Mr. Chairman. Through that time, you have consistently provided constructive leadership to the effort to raise the level of economic discussion in general -- and of the dialogue between the Congr ess and the Federal Reserve in particular.  I happen to believe  strongly in the independence that the Congress has provided the Federal Reserve through the years -- but also in the need for close and continuing communication with the Congress and the Administration.  I presume that this is the last time I  will appear before you personally in this forum, but the dialogue will continue to benefit from your efforts, your initiative, and your sense of commitment in more ways than you may realize.   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  For release on delivery 10:00 A.M., E.S.T. November 24, 1982  Statement by  Paul A. Volcker Chairman, Board of Governors of the Federal Reserve System  before the  Joint Economic Committee  November 24, 1982  I appreciate this opportunity to discuss with you today the current stance of monetary policy and some problems for the future.  Before responding to certain questions directed  to me about monetary policy in your letters of October 18 and November 17, Mr. Chairman, I should first emphasize that the basic thrust and goals of our policy are unchanged since I testified before the Congress on July 20.  The precise means  by which we move toward our goals must take account of all the stream of evidence we have on the behavior of (and distortions in) the various monetary aggregates, the economy, prices, interest rates, and the like.  But we remain convinced that lasting recovery  and growth must be sought in a framework of continuing progress toward price stability -- and that the process of money and credit creation must remain appropriately restrained if we are to deal effectively with inflationary dangers. For that reason, we must continue to set forth targets for growth in money and credit and to judge the provision of bank reserves  our most important operating instrument -- in  the light of the trend in the growth of these aggregates. This process necessarily involves continuing judgments about just what growth in those magnitudes is appropriate in the short and longer run, matters affected by institutional change as well as by more fundamental economic factors.   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  -2-  As you are aware, the current job of developing and implementing monetary policy has been complicated by regulatory decisions as well as by recent developments in the economy and in our financial markets.  We have, as a consequence, (1) made  some technical modification in our operating procedures to cope with obvious distortions in some of the monetary data -- particularly MI -- and (2) accommodated growth in the various M's at rates somewhat above the targeted ranges. decisions was essentially technical.  The first of those  The latter decision is  entirely consistent with the view I expressed in testifying before the Banking Committees in July that the Federal Open Market Committee would tolerate "growth somewhat above the targeted ranges .  . for a time in circumstances in which it  appeared that precautionary or liquidity motivations, during a period of economic uncertainty and turbulence, were leading to stronger than anticipated demands for money." Unfortunately, the difficulties and complexities of the economic world in which we live do not permit us the luxury of describing policy in terms of a simple, unchanging numerical rule.  For instance, the economic significance of any particular  statistic we label "money" can change over time -- partly because the statistical definition of "money" is itself arbitrary and the components of the money supply have differing degrees of use as a medium of exchange and liquidity.  That doesn't make  much difference in a relatively stable economic, financial, and institutional environment, but, at times of rapid change, like the present, it can matter a great deal.   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  4  4   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  -  3-  varying lags -- never We also have to take account of coneen actions today and their tw be -n io is ec pr th wi n ow kn ary try to disentangle the tempor to ve ha We r. te la s ce en qu se s among nt trends in relationship te is rs pe re mo om fr al ic cl cy d an d economic activity. an n io at fl in d an y ne mo of different measures developments abroad of ce an ic if gn si e th te ua al And we have to ev accounts and the exchange e ad tr in d te ec fl re as , me as well as at ho financial structure itself. rate, and of strains in the ic environment in which we As this suggests, the econom a -- cannot be condensed into lf se it cy li po or -cy li po set the ent. Perhaps the essence of em at st l na io ns me di eon , le simp better captured by a few "yes be n ca ch oa pr ap r ou d an m le prob but" phrases. e inflationary momentum th en ok br ve ha we s, Ye ) (1 d effort will be essential but continuing vigilance an price stability. to continue progress toward en e indices this year have be ic pr d oa br e th , ow kn u yo As or the peak levels reached two of ss le or lf ha t ou ab at running owth disinflationary process, gr is th of rt pa As o. ag s three year e 6 to l terms has declined to th na mi no in on ti sa en mp co er in work owth in nominal income has gr er ow sl at th t bu -ea ar 7 percent rated. wages as inflation has mode al re er gh hi th wi nt te is ns been co sectors of the economy ar ul ic rt pa in ds en tr st Price and co dispart lags in the process of are mixed -- reflecting in ational ng wage contracts, intern lo of s ct fe ef e th n, io at infl immediate effects of e th d an , ts en pm lo ve de and exchange rate   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  s. recession on some prices -- most particularly commoditie that But there is, it seems to me, strong reason to believe -- albeit the progress toward price stability can be maintained at a slower rate -- as the economy recovers.  For a time, un-  prices employment and excess capacity should restrain costs and d and, of more lasting significance, productivity growth shoul . improve from the poor performance of most recent years  Taken  ty together, restraint on nominal wage increases and productivi which growth should moderate the increase in unit labor costs, account for about two-thirds of all costs.  Real incomes can  rise as inflation slows, paving the way for further progress toward stability. To be sure, as the economy grows, some factors holding down prices over the past year or two will dissipate or be reversed.  But large new "price shocks" in the energy or food  areas appear unlikely in the foreseeable future, suggesting that a declining trend in the rise of unit labor costs should be the most fundamental factor defining the price trend. That analysis would not hold, however, if excessive growth in money and credit over time came again to feed first the expectation, and then the reality, of renewed inflation. Too much has been "invested" in turning the inflationary momentum to lose sight of the necessity of carrying through. There are clear implications, as I will elaborate in a moment, for fiscal as well as monetary policy.  ... -5-  (2) Yes, exceptional demands for liquidity can reasonably be accommodated in a period of recession, high unemployment, and excess capacity -- but guidelines for restrained money and credit growth remain relevant to insure against renewed inflation. A variety of specific and general evidence strongly suggests that the desire to hold cash and other highly liquid assets, relative to income, has increased this year.  Much of  the more rapid increase in M1 has been in interest-bearing NOW accounts, which did not exist a few years ago but which provide the basic elements of a savings, as well as transaction, account. With market interest rates falling, those accounts have been relatively more attractive on interest rate grounds alone, and they are a convenient means of storing liquidity at a time of economic and financial uncertainty.  At the same time, the  broader aggregates appear to reflect some of the same liquidity motivations, as well as the stronger savings growth in the wake of the tax cut. Most broadly, we can now observe, over a period of more than a year, a distinct decline in "velocity" -- that is, the relationship between the GNP and monetary aggregates.  The  velocity decline for Ml, which is likely to amount to about 1982, 3% from the fourth quarter of 1981 to the fourth quarter of stands in sharp contrast to the average yearly rise in velocity of 3-4% over the past decade; it will be the first significant   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  9  -6  decline in velocity in about 30 years.  M2 and M3 velocities --  which had been relatively trendless earlier -- have also declined significantly.  While some tendency toward slower velocity is  not unusual in the midst of recession, the magnitude and persistence of the movement in 1982 is indicative of a pronounced tendency to hold more liquid assets relative to current income. Without some accommodation of that preference, monetary policy at the present time would be substantially more restraining in its effect on the economy than intended when the targets for the various aggregates were originally set out earlier this year. At the same time, policy must take into account the probability that the demands for liquidity will, in whole or in major part, prove temporary, and that an excessive rise in money or other liquid assets could feed inflationary forces later.  Elements of judgment are inevitably involved in sorting  out these considerations -- judgments resting on analysis of the economy, interest rates, and other factors.  But broad  guidelines for assessing the appropriate growth on the basis of historical experience will surely remain relevant and appropriate. In that connection, I must note the implications of the future Federal budgetary position.  To put the point briefly,  the prospect of huge continuing budgetary deficits, even as the economy recovers, carries with it the threat of either excessive liquidity creation and inflation in future years, or a "crowdingout" of other borrowers as monetary growth is restrained in the   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  7-  face of the Treasury financing needs, or a combination of both. The problems flowing from the future deficits are simply not amenable to solution by monetary policy.  Moreover, the concern  engendered in the marketplace works in the direction of higher interest rates today than would otherwise be the case, contrary to the needs of recovery.  I know something of how difficult it  is to achieve further budgetary savings, but I must emphasize again how important it is to see the deficit reduced as the economy recovers.  The fact is those looming deficits are a  major hazard in sustaining recovery. (3) Yes, lower interest rates are critically important in supporting the economy and encouraging recovery but we also want to be able to maintain lower interest rates over time.  Since early summer, short-term interest rates have generally declined by five to six percentage points, and mortgage and most other long-term rates have dropped by three to four percentage points.  While consumer loan rates administered  by banks and other financial institutions have lagged, they are also now moving lower.  There are clear signs of a rise in home  sales and building in response to these interest rate declines, and other sectors of the economy are benefiting as well. We have also had experience in recent years of sharp increases in interest rates curtailing economic activity at times when recovery was incomplete and unemployment high. Sudden large fluctuations in interest rates contribute to  -8  other economic and financial distortions as well.  And no  rically doubt the fact that many interest rates remain histo high, relative to the current rate of inflation, reflects gh the continuing skepticism over prospects for carrying throu fight on inflation. In this situation, the Federal Reserve has welcomed ort the declines in interest rates both because of the supp to reflect they offer economic activity and because they seem a sense that the inflationary trend has changed.  However, we  s should do not believe that progress toward lower interest rate  ONO 411=1.  se of or for long in practice can -- be "forced" at the expen excessive credit and money creation.  To attempt to do so  ed would simply risk the revival of inflationary forces; renew the longerexpectations of inflation would soon be reflected in lasting term credit markets, damaging prospects for the longexpansion we all want. Turning to your explicit questions, Mr. Chairman, y-making against this general background, I believe most polic view that officials in the Federal Reserve share the general   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  at a economic recovery will be evident throughout 1983, but g previous moderate rate of speed -- probably slower than durin post-recession years.  Unambiguous evidence that the recovery  g signs is already underway is still absent, although encouragin liquidity are evident in some rise in housing, in the improved in and wealth and reduced debt positions of consumers, and stabilizing surveys reporting that attitudes and orders may be  -9  or improving.  The Federal deficit, while fraught with danger  for the future, is of course providing massive support for incomes at present. What is crucially important -- particularly in the light of the experience of recent years -- is that we set the stage for an expansion that can be sustained over a long period, bringing with it strong gains in productivity and investment and lasting improvement in employment.  I have  already emphasized the importance of progress toward price stability to that outlook, and the evidence that, with disciplined monetary and fiscal policies, we can sustain that progress. So far as the specific questions about monetary policy in your October 18 letter are concerned, we have not, as you know, set any new monetary targets for 1982.  Current trends  do indicate that the various M's will end the year above the upper end of the target ranges, probably by 1/2 to 1% for M2 and M3 and more for M1 given the current distortions. credit will be close to the mid-point of its range.  Bank  As I  indicated at the start, the "overshoots," in the context of today's economic and financial conditions, are consistent with the approach stated in my July testimony. No decision has been taken to change the tentative targets for 1983.  That matter will, of course, be under  intensive scrutiny over the next two months, and the targets will be announced in February.   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  -10-  For the time being, we are placing much less emphasis than usual on Ml.  That decision was precipitated in early  October entirely by the likelihood that the data would be grossly distorted in that month by the maturity of a large volume of All-Savers Certificates, part of the proceeds of which might be expected to, at least temporarily, be placed in checking accounts included in Ml. In about three weeks, the introduction of a new ceilingless account at financial institutions -- highly liquid and carrying significant transaction capabilities -- is likely to distort further M1 data.  Judging by comments at the last  Depository Institutions Deregulation Committee meeting, that account could rapidly be followed by a decision to approve a ceiling-less account with full transaction capabilities. These new accounts could have a large, but quite unpredictable, influence on M1 for a number of months ahead as funds are reallocated among various accounts.  Moreover, the introduction  of market-rate transaction accounts will very likely result in a different relationship and trend of M1 relative to GNP over time.  Increasing confidence in the stability of prices  and a trend toward lower market interest rates might also affect the desire to hold money over time. Obviously, some judgments on those matters will be necessary in setting a target for M1 in 1983 and in deciding upon the degree of weight to he attached to changes in M1 in our operations.   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  Those problems should appropriately be  -11-  described as "technical" rather than "policy" in the sense that we will need to continue to be concerned with the rate of growth over time of the monetary aggregates, including transactions balances. The decisions taken in early October do point to greater emphasis on M2 (and M3) in planning the operational reserve path during this transitional period.  The link between reserves  and M2 is looser and more uncertain than in the case of Ml, in large part because reserve requirements on accounts included in M2, apart from transactions balances, are very low or non-existent. (Transactions balances are about 17 percent of M2.)  Therefore  once a reserve path is set, deviations of M2 from a targeted growth range may not, more or less automatically, be reflected in as substantial changes in pressures on bank reserve positions or in money markets as is the case with Ml.  Consequently,  "discretionary" judgments may be necessary more frequently in altering a reserve path than when that reserve path is focused more heavily on Ml.  In that technical sense, the operational  approach has necessarily been modified. In sum, the broad framework of monetary targeting has been retained, but greater emphasis is for the time being placed on the broader aggregates.  The specific operating  technique that had been closely related to M1 has, by force of circumstances, been conformed to that emphasis.  Obviously,  entirely apart from questions of economic doctrine and contending approaches to monetary control, so long as M1 is   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  -12-  subjected to strong institutional distortions our techniques must be adapted to take account of that fact. An alternative operating approach suggested by some of supplying and withdrawing reserves with the intent of achieving a particular interest rate target would suffer from several fundamental defects.* o  The body of theory or practice does not provide a sufficiently clear basis for relating the level of a particular interest rate to our ultimate objectives of growth and price stability.  o  The implication that the Federal Reserve could in fact achieve and maintain a particular level of relevant interest rates in a changing economic and financial environment is not warranted.  o  The very concept and measurement of a "real" interest rate, as called for in some proposals, is a matter of substantial ambiguity.  o  As a practical matter, attempts to target and fix  0 interest rates would make more rigid and tend to politicize the entire process of monetary policy.  *That was not, as sometimes mistakenly thought, the operating approach used prior to October 1979. Then, reserves were provided with the aim of achieving and maintaining a particular Federal funds rate thought to be consistent with targets for the monetary aggregates. The Federal funds rate was a means to achieving a monetary target and in principle was tc be handled flexibly. In practice, among other difficulties, there appeared to be a reluctance to permit rates to vary rapidly enough to maintain control of the aggregates.   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  -13-  In current circumstances, with huge budget deficits looming, a requirement that the Federal Reserve set explicit interest rate targets is bound to be interpreted as inflationary, and the rekindling of inflationary expectations will work against our objective. I realize the several legislative proposals addressed to targeting interest rates would, on their face, seem to call for interest rates as only one of several targets.  But interest  rates would certainly be the most obvious and sensitive target, and those targets would be difficult to change.  Other evidence  for a need to "tighten" or "ease" would be subordinated, if not ignored. As we approach the target-setting process for 1983, our objectives will -- indeed as required by law -- continue to be quantified in terms of growth in relevant money and credit aggregates.  We will have to decide how much weight to  place on M1 and other aggregates during a transitional period, assuming new accounts continue to distort the data.  In reaching  and implementing those decisions, the members of the FOMC necessarily rely upon their own analysis of the current and prospective course of business activity; the interrelationships among the aggregates, economic activity, and interest rates; and the implications of monetary growth for inflation.  In other words,  the process is not a simple mechanical one, and it seems to me within a general framework of monetary  capable of incorporating  discipline -- the elements of needed flexibility.  We will also,  I I  as part of that process, review whether technical adjustments   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  -14-  e paths in procedures for establishing and changing the reserv are appropriate.  I will be reporting our conclusions to the  Congress in February. Mr. Chairman, you have suggested that our monetary targets might reasonably be specified as a single number, with a range above and below.   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  At times we have debated  g within the FOMC the wisdom of such an approach (or settin forth a single target number without a range).  My own feeling  t has been, and remains, that a single number, with or withou with the a range, would convey a specious sense of precision, ary result of greater pressure to meet a more or less arbitr number to maintain "credibility," even if developments during the year tend to indicate some element of flexibility is appropriate in pursuit of the targets. To me, our present practice of setting forth a range is preferable.  Where appropriate, we can and should suggest  the probability of being in the upper or lower portion of the range, or suggest what conditions could evolve in which something other than the mid-points (or even an over or undershoot) would be appropriate.  That approach seems to me to  provide more information -- and more realism -- than a single number and is broadly consistent with present practice. For similar reasons, I believe we need to measure and target a variety of aggregates because, in a swiftly changing economic environment, any single target can be misleading In that connection, I believe an indication of total credit flows broadly consistent with the monetary targets could be helpful.  As you know, we now provide such estimates for bank  credit alone.  -15-  Given the limits of forecasting and analysis, and the volatility of the data, I would question the usefulness of further sectoral estimates.  Even with respect to total credit  flows, there is considerable looseness in relationships to economic activity for periods as long as a year -- and still more for shorter periods.  The theoretical framework relating  credit flows to other variables such as the GNP or inflation is less fully developed than in the case of monetary aggregates, and credit flows are less directly amenable to control.  The  enormous flows across international borders pose large conceptual and statistical problems.  Our credit data are typically  less complete and up-to-date than monetary data. However, so long as those difficulties and limitations are recognized -- and some of them are relevant with respect to the monetary aggregates as well -- I share the view that analysis of credit flows can contribute to policy formulation. To assist in that process, Iwill propose to the FOMC that estimates of the expected behavior of a broad credit aggregate be set forth alongside the monetary targets in our next report. I do strongly resist the idea of the Federal Reserve as an institution forecasting interest rates.  No institution or  individual is capable of judging accurately the myriad of forces working on market interest rates over time.  Expeatational  elements play a strong role -- fundamentally expectations about the course of economic activity and inflation, but also, in the short run, expectations of Federal Reserve action.   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  We could not  \  -16-  escape the fact that a central bank forecast of interest rates would be itself a market factor.  To some degree, therefore,  in looking to interest rates and other market developments for information bearing on our policy decisions, we would be looking into a mirror.  Moreover, the temptation would always be present  to breech the thin line between a forecast and a desire or policy intention, with the result that operational policy decisions could be distorted. While it seems to me inappropriate for a central bank to regularly forecast interest rates, analysis of key factors influencing credit conditions and prices can be helpful at times. past.  On occasion, we have provided such analysis in the My concern about the outlook for fiscal policy is rooted  in major part in such analysis because the direction of impact on interest rates seems to me unambiguous.  I have also, on a  number of occasions, indicated that the recent and even current level of interest rates appears extraordinarily high, provided, as I believe, we continue to make progress on the inflation front.  Perhaps, in our semi-annual reporting, we can more  explicitly call attention to major factors likely to influence short or long-term interest rates and the significance for various sectors of the economy.  But I do not believe interest  rate forecasting would be desirable or long sustainable, and would in fact be damaging to the policy process.   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  a -17-  Finally, Mr. Chairman, you have requested a "single composite forecast" of the major economic variables by FOMC members.  As you are well aware, our present practice is to  set forth a range of forecasts of individual FOMC members of the nominal and real GNP, prices, and unemployment.  The fact  is we have no single "Federal Reserve" forecast, and there is no mechanism, within a Committee or Board structure, to force agreement on such a forecast by individual members bringing different views, typically backed by separate staff analysis, to the table.  A simple average -- possibly supported by no  one -- seems to me artificial.  The process of attempting to  force a consensus would certainly dilute the product. I would put the point positively.  A range of forecasts  by individual FOMC members more accurately conveys the range of uncertainty and contingencies that must surround any forecast.  The seeming neatness and coherence of a single forecast  too often obscures the reality that a variety of outcomes is possible; the very essence of the policy problem is to assess risks and probabilities -- what can go wrong as well as what can go right.  A point forecast would likely be treated more  reverently than it would deserve, and could even distort policy judgments in misguided efforts to "hit" a forecast. I can understand your concern that a range of forecasts may be misleading if strongly influenced by "outlying" opinions rather than reflecting a more even dispersion of views.  For  that reason, I would be glad to explore with the Open Market   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  -18-  Committee a procedure by which we indicated the "central tendency" of members' views -- assuming such a central tendency exists -- as well as indicating the range of opinions.  Conversely, if the forecasts were evenly  distributed within the range, we could so indicate. believe that approach would meet the ibjectives you seek in a realistic and helpful manner. In concluding this already long testimony, let me say that we share the common goals of achieving, in the words of the Employment Act of 1946 and the Humphrey Hawkins Act of 1978, "Maximum employment, production, and purchasing power" and "full employment . . . (and) reasonable price stability." Those objectives have eluded us for too many years.  We meet  again today in particularly difficult circumstances, and there is a sense of frustration and uncertainty among many. But I also happen to believe we have come a long way toward laying the base for economic growth and stability; economic recovery should characterize 1983, and that recovery can mark the beginning of a long period of stable growth. Obviously there are obstacles -- interest rates are still too high; inflation is down but not out; there are strains in our financial system; we face budget deficits that are far too high; we are tempted to turn inwards or backwards for quick solutions that ultimately can not work.  But it is  also plainly within our capacity to deal with those threats provided only that we have a strong base of understanding among   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  -19-  us, that we resolve to act where action is necessary, and that we have the patiabce and wisdom to refrain from actions that can only be destructive. You are leaving the Congress after 28 years, Mr. Chairman. Through that time, you have consistently provided constructive leadership to the effort to raise the level of economic discussion in general -- and of the dialogue between the Congress and the Federal Reserve in particular.  I happen to believe  strongly in the independence that the Congress has provided the Federal Reserve through the years -- but also in the neea for close and continuing communication with the Congress and the Administration.  I presume that this is the last time I  will appear before you personally in this forum, but the dialogue will continue to benefit from your efforts, your initiative, and your sense of commitment in more ways than you may realize.   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  ,(/•t..4•011,1   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  L. 44 1  e   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  For release on delivery 10:00 A.M., E.S.T. November 24, 1982  Statement by  Paul A. Volcker  Chairman, Board of Governors of the Federal Reserve System  before the  Joint Economic Committee  November 24, 1982  I appreciate this opportunity to discuss with you today the current stance of monetary policy and some problems for the future.  Before responding to certain questions directed  to me about monetary policy in your letters of October 18 and November 17, Mr. Chairman, I should first emphasize that the basic thrust and goals of our policy are unchanged since I testified before the Congress on July 20.  The precise means  by which we move toward our goals must take account of all the stream of evidence we have on the behavior of (and distortions in) the various monetary aggregates, the economy, prices, interest rates, and the like.  But we remain convinced that lasting recovery  and growth must be sought in a framework of continuing progress toward price stability -- and that the process of money and credit creation must remain appropriately restrained if we are to deal effectively with inflationary dangers. For that reason, we must continue to set forth targets for growth in money and credit and to judge the provision of bank reserves  our most important operating instrument -- in  the light of the trend in the growth of these aggregates. This process necessarily involves continuing judgments about just what growth in those magnitudes is appropriate in the short and longer run, matters affected by institutional change as well as by more fundamental economic factors.   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  -2-  As you are aware, the current job of developing and implementing monetary policy has been complicated by regulatory decisions as well as by recent developments in the economy and in our financial markets.  We have, as a consequence, (1) made  some technical modification in our operating procedures to cope with obvious distortions in some of the monetary data -- particularly M1 -- and (2) accommodated growth in the various M's at rates somewhat above the targeted ranges. decisions was essentially technical.  The first of those  The latter decision is  entirely consistent with the view I expressed in testifying before the Banking Committees in July that the Federal Open Market Committee would tolerate "growth somewhat above the targeted ranges .  . for a time in circumstances in which it  appeared that precautionary or liquidity motivations, during a period of economic uncertainty and turbulence, were leading to stronger than anticipated demands for money." Unfortunately, the difficulties and complexities of the economic world in which we live do not permit us the luxury of describing policy in terms of a simple, unchanging numerical rule.  For instance, the economic significance of any particular  statistic we label "money" can change over time -- partly because the statistical definition of "money" is itself arbitrary and the components of the money supply have differing degrees of use as a medium of exchange and liquidity.  That doesn't make  much difference in a relatively stable economic, financial, and institutional environment, but, at times of rapid change, like the present, it can matter a great deal.   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  3  We also have to take account of varying lags -- never known with precision -- between actions today and their consequences later.  We have to try to disentangle the temporary  and cyclical from more persistent trends in relationships among different measures of money and inflation and economic activity. And we have to evaluate the significance of developments abroad as well as at home, as reflected in trade accounts and the exchange rate, and of strains in the financial structure itself. As this suggests, the economic environment in which we set policy -- or policy itself -- cannot be condensed into a simple, one-dimensional statement.  Perhaps the essence of the  problem and our approach can be better captured by a few "yesbut" phrases. (1) Yes, we have broken the inflationary momentum but continuing vigilance and effort will be essential to continue progress toward price stability. As you know, the broad price indices this year have been running at about half or less of the peak levels reached two or three years ago.  As part of this disinflationary process, growth  in worker compensation in nominal terms has declined to the 6 to 7 percent area -- but that slower growth in nominal income has been consistent with higher real wages as inflation has moderated. Price and cost trends in particular sectors of the economy are mixed -- reflecting in part lags in the process of disinflation, the effects of long wage contracts, international and exchange rate developments, and the immediate effects of  p _ 4-  recession on some prices -- most particularly commodities. But there is, it seems to me, strong reason to believe that the progress toward price stability can be maintained -- albeit at a slower rate -- as the economy recovers.  For a time, un-  employment and excess capacity should restrain costs and prices and, of more lasting significance, productivity growth should improve from the poor performance of most recent years.  Taken  together, restraint on nominal wage increases and productivity growth should moderate the increase in unit labor costs, which account for about two-thirds of all costs.  Real incomes can  rise as inflation slows, paving the way for further progress toward stability. To be sure, as the economy grows, some factors holding down prices over the past year or two will dissipate or be reversed.  But large new "price shocks" in the energy or food  areas appear unlikely in the foreseeable future, suggesting that a declining trend in the rise of unit labor costs should be the most fundamental factor defining the price trend. That analysis would not hold, however, if excessive growth in money and credit over time came again to feed first the expectation, and then the reality, of renewed inflation. Too much has been "invested" in turning the inflationary momentum to lose sight of the necessity of carrying through. There are clear implications, as I will elaborate in a moment, for fiscal as well as monetary policy.   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  _ 5-  (2) Yes, exceptional demands for liquidity can reasonably be accommodated in a period of recession, high unemployment, and excess capacity -- but guidelines for restrained money and credit growth remain relevant to insure against renewed inflation.  A variety of specific and general evidence strongly suggests that the desire to hold cash and other highly liquid assets, relative to income, has increased this year.  Much of  the more rapid increase in M1 has been in interest-bearing NOW accounts, which did not exist a few years ago but which provide the basic elements of a savings, as well as transaction, account. With market interest rates falling, those accounts have been relatively more attractive on interest rate grounds alone, and they are a convenient means of storing liquidity at a time of economic and financial uncertainty.  At the same time, the  broader aggregates appear to reflect some of the same liquidity motivations, as well as the stronger savings growth in the wake of the tax cut. Most broadly, we can now observe, over a period of more than a year, a distinct decline in "velocity" -- that is, the relationship between the GNP and monetary aggregates.  The  velocity decline for Ml, which is likely to amount to about 3% from the fourth quarter of 1981 to the fourth quarter of 1982, stands in sharp contrast to the average yearly rise in velocity of 3-4% over the past decade; it will be the first significant   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  -6-  decline in velocity in about 30 years.  M2 and M3 velocities --  which had been relatively trendless earlier -- have also declined significantly.  While some tendency toward slower velocity is  not unusual in the midst of recession, the magnitude and persistence of the movement in 1982 is indicative of a pronounced tendency to hold more liquid assets relative to current income. Without some accommodation of that preference, monetary policy at the present time would be substantially more restraining in its effect on the economy than intended when the targets for the various aggregates were originally set out earlier this year. At the same time, policy must take into account the probability that the demands for liquidity will, in whole or in major part, prove temporary, and that an excessive rise in money or other liquid assets could feed inflationary forces later.  Elements of judgment are inevitably involved in sorting  out these considerations -- judgments resting on analysis of the economy, interest rates, and other factors.  But broad  guidelines for assessing the appropriate growth on the basis of historical experience will surely remain relevant and appropriate. In that connection, I must note the implications of the future Federal budgetary position.  To put the point briefly,  the prospect of huge continuing budgetary deficits, even as the economy recovers, carries with it the threat of either excessive liquidity creation and inflation in future years, or a "crowdingout" of other borrowers as monetary growth is restrained in the   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  7  face of the Treasury financing needs, or a combination of both. The problems flowing from the future deficits are simply not amenable to solution by monetary policy.  Moreover, the concern  engendered in the marketplace works in the direction of higher interest rates today than would otherwise be the case, contrary to the needs of recovery.  I know something of how difficult it  is to achieve further budgetary savings, but I must emphasize again how important it is to see the deficit reduced as the economy recovers.  The fact is those looming deficits are a  major hazard in sustaining recovery. (3) Yes, lower interest rates are critically important in supporting the economy and encouraging recovery  111.. OMB  but we also want to be able to maintain lower interest rates over time.  Since early summer, short-term interest rates have generally declined by five to six percentage points, and mortgage and most other long-term rates have dropped by three to four percentage points.  While consumer loan rates administered  by banks and other financial institutions have lagged, they are also now moving lower.  There are clear signs of a rise in home  sales and building in response to these interest rate declines, and other sectors of the economy are benefiting as well. We have also had experience in recent years of sharp increases in interest rates curtailing economic activity at times when recovery was incomplete and unemployment high. Sudden large fluctuations in interest rates contribute to  I,  % -8 _  other economic and financial distortions as well.  And no  doubt the fact that many interest rates remain historically high, relative to the current rate of inflation, reflects continuing skepticism over prospects for carrying through the fight on inflation. In this situation, the Federal Reserve has welcomed the declines in interest rates both because of the support they offer economic activity and because they seem to reflect a sense that the inflationary trend has Changed.  However, we  do not believe that progress toward lower interest rates should or for long in practice can -- be "forced" at the expense of excessive credit and money creation.  To attempt to do so  would simply risk the revival of inflationary forces; renewed expectations of inflation would soon be reflected in the longerterm credit markets, damaging prospects for the long-lasting expansion we all want. Turning to your explicit questions, Mr. chairman, against this general background, I believe most policy-making officials in the Federal Reserve share the general view that economic recovery will be evident throughout 1983, but at a moderate rate of speed -- probably slower than during previous post-recession years.  Unambiguous evidence that the recovery  is already underway is still absent, although encouraging signs are evident in some rise in housing, in the improved liquidity and wealth and reduced debt positions of consumers, and in ,   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  surveys reporting that attitudes and orders may be stabilizing   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  -9  or improving.  The Federal deficit, while fraught with danger  for the future, is of course providing massive support for incomes at present. What is crucially important -- particularly in the light of the experience of recent yearsthat we set the stage for an expansion that can be sustained over a long period, bringing with it strong gains in productivity and investment and lasting improvement in employment.  I have  already emphasized the importance of progress toward price stability to that outlook, and the evidence that, with disciplined monetary and fiscal policies, we can sustain that progress. So far as the specific questions about monetary policy in your October 18 letter are concerned, we have not, as you know, set any new monetary targets for 1982.  Current trends  do indicate that the various M's will end the year above the upper end of the target ranges, probably by 1/2 to 1% for M2 and M3 and more for M1 given the current distortions. credit will be close to the mid-point of its range. indicated at the start, the "overshoots  Bank  As I  in the context of  today's economic and financial conditions, are consistent with the approach stated in my July testimony. No deon has been taken to change the tentative targets for 1983.  That matter will, of course, be under  intensive scrutiny over the next two months, and the targets will be announced in February.   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  -10-  For the time being, we are placing much less emphasis than usual on Ml.  That decision was precipitated in early  October entirely by the likelihood that the data would be grossly distorted in that month by the maturity of a large volume of All-Savers Certificates, part of the proceeds of which might be expected to, at least temporarily, be placed in checking accounts included in Ml. In about three weeks, the introduction of a new ceilingless account at financial institutions -- highly liquid and carrying significant transaction capabilities -- is likely to distort further M1 data.  Judging by comments at the last  Depository Institutions Deregulation Committee meeting, that account could rapidly be followed by a decision to approve a ceiling-less account with full transaction capabilities. These new accounts could have a large, but quite unpredictable, influence on M1 for a number of months ahead as funds are reallocated among various accounts.  Moreover, the introduction  of market-rate transaction accounts will very likely result in a different relationship and trend of M1 relative to GNP over time.  Increasing confidence in the stability of prices  and a trend toward lower market interest rates might also affect the desire to hold money over time. Obviously, some judgments on those matters will be necessary in setting a target for M1 in 1983 and in deciding upon the degree of weight to be attached to changes in M1 in our operations.  Those problems should appropriately be  I  -11-  described as "technical" rather than "policy" in the sense that we will need to continue to be concerned with the rate of growth over time of the monetary aggregates, including transactions balances. The decisions taken in early October do point to greater emphasis on M2 (and M3) in planning the operational reserve path during this transitional period.  The link between reserves  and M2 is looser and more uncertain than in the case of Ml, in large part because reserve requirements on accounts included in M2, apart from transactions balances, are very low or non-existent. (Transactions balances are about 17 percent of M2.)  Therefore  once a reserve path is set, deviations of M2 from a targeted growth range may not, more or less automatically, be reflected in as substantial changes in pressures on bank reserve positions or in money markets as is the case with Ml.  Consequently,  "discretionary" judgments may be necessary more frequently in altering a reserve path than when that reserve path is focused more heavily on Ml.  In that technical sense, the operational  approach has necessarily been modified. In sum, the broad framework of monetary targeting has been retained, but greater emphasis is for the time being placed on the broader aggregates.  The specific operating  technique that had been closely related to M1 has, by force of circumstances, been conformed to that emphasis.  Obviously,  entirely apart from questions of economic doctrine and contending approaches to monetary control, so long as M1 is   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  -12-  subjected to strong institutional distortions our techniques must be adapted to take account of that fact. An alternative operating approach suggested by some of supplying and withdrawing reserves with the intent of achieving a particular interest rate target would suffer from several fundamental defects.* o  The body of theory or practice does not provide a sufficiently clear basis for relating the level of a particular interest rate to our ultimate objectives of growth and price stability.  o  The implication that the Federal Reserve could in fact achieve and maintain a particular level of relevant interest rates in a changing economic and financial environment is not warranted.  o  The very concept and measurement of a "real" interest rate, as called for in some proposals, is a matter of substantial ambiguity.  o  As a practical matter, attempts to target and fix interest rates would make more rigid and tend to politicize the entire process of monetary policy.  *That was not, as sometimes mistakenly thought, the operating approach used prior to October 1979. Then, reserves were provided with the aim of achieving and maintaining a particular Federal funds rate thought to be consistent with targets for the monetary aggregates. The Federal funds rate was a means to achieving a monetary target and in principle was to be handled flexibly. In practice, among other difficulties, there appeared to be a reluctance to permit rates to vary rapidly enough to maintain control of the aggregates.   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  -13-  •  In current circumstances, with huge budget deficits looming, a requirement that the Federal Reserve set explicit interest rate targets is bound to be interpreted as inflationary, and the rekindling of inflationary expectations will work against our objective.  I realize the several legislative proposals addressed to targeting interest rates would, on their face, seem to call for interest rates as only one of several targets.  But interest  rates would certainly be the most obvious and sensitive target, and those targets would be difficult to change.  Other evidence  for a need to "tighten" or "ease" would be subordinated, if not ignored. As we approach the target-setting process for 1983, our objectives will -- indeed as required by law -- continue to be quantified in terms of growth in relevant money and credit aggregates.  We will have to decide how much weight to  place on M1 and other aggregates during a transonal period, assuming new accounts continue to distort the data.  In reaching  and implementing those deons, the members of the FOMC necessarily rely upon their own analysis of the current and prospective course of business activity; the interrelationships among the aggregates, economic activity, and interest rates; and the implications of monetary growth for inflation.  In other words,  the process is not a simple mechanical one, and it seems to me capable of incorporating -- within a general framework of monetary discipline -- the elements of needed flexibility.   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  We will also,  as part of that process, review whether technical adjustments   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  -14-  in procedures for establishing and changing the reserve paths are appropriate.  I will be reporting our conclusions to the  Congress in February. Mr. Chairman, you have suggested that our monetary targets might reasonably be specified as a single number, with a range above and below.  At times we have debated  within the FOMC the wisdom of such an approach (or setting forth a single target number without a range).  My own feeling  has been, and remains, that a single number, with or without a range, would convey a specious sense of precision, with the result of greater pressure to meet a more or less arbitrary number to maintain "credibility," even if developments during the year tend to indicate some element of flexibility is appropriate in pursuit of the targets. To me, our present practice of setting forth a range is preferable.  Where appropriate, we can and should suggest  the probability of being in the upper or lower portion of the range, or suggest what conditions could evolve in which something other than the mid-points (or even an over or undershoot) would be appropriate.  That approach seems to me to  provide more information -- and more realism -- than a single number and is broadly consistent with present practice. For similar reasons, I believe we need to measure and target a variety of aggregates because, in a swiftly changing economic environment, any single target can be misleading:. In that connection, I believe an indication of total credit flows broadly consistent with the monetary targets could be helpful.  As you know, we now provide such estimates for bank  credit alone.  -15-  Given the limits of forecasting and analysis, and the volatility of the data, I would question the usefulness of further sectoral estimates.  Even with respect to total credit  flows, there is considerable looseness in relationships to economic activity for periods as long as a year more for shorter periods.  and still  The theoretical framework relating  credit flows to other variables such as the GNP or inflation is less fully developed than in the case of monetary aggregates, and credit flows are less directly amenable to control.  The  enormous flows across international borders pose large conceptual and statistical problems.  Our credit data are typically  less complete and up-to-date than monetary data. However, so long as those difficulties and limitations are recognized -- and some of them are relevant with respect to the monetary aggregates as well -- I share the view that analysis of credit flows can contribute to policy formulation. To assist in that process, Iwill propose to the FOMC that estimates of the expected behavior of a broad credit aggregate be set forth alongside the monetary targets in our next report. I do strongly resist the idea of the Federal Reserve as an institution forecasting interest rates.  No institution or  individual is capable of judging accurately the myriad of forces working on market interest rates over time.  Expectational  elements play a strong role -- fundamentally expectations about the course of economic activity and inflation, but also, in the short run, expectations of Federal Reserve action.   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  We could not   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  -16-  escape the fact that a central bank forecast of interest rates would be itself a market factor.  To some degree, therefore,  in looking to interest rates and other market developments for information bearing on our policy decisions, we would be looking into a mirror.  Moreover, the temptation would always be present  to breech the thin line between a forecast and a desire or policy intention, with the result that operational policy decisions could be distorted. While it seems to me inappropriate for a central bank to regularly forecast interest rates, analysis of key factors influencing credit conditions and prices can be helpful at times. past.  On occasion, we have provided such analysis in the My concern about the outlook for fiscal policy is rooted  in major part in such analysis because the direction of impact on interest rates seems to me unambiguous.  I have also, on a  number of occasions, indicated that the recent and even current level of interest rates appears extraordinarily high, provided, as I believe, we continue to make progress on the inflation front.  Perhaps, in our semi-annual reporting, we can more  explicitly call attention to major factors likely to influence short or long-term interest rates and the significance for various sectors of the economy.  But I do not believe interest  rate forecasting would be desirable or long sustainable, and would in fact be damaging to the policy process. :  •   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  -17-  Finally, Mr. Chairman, you have requested a "single composite forecast" of the major economic variables by FOMC members.  As you are well aware, our present practice is to  set forth a range of forecasts of individual FOMC members of the nominal and real GNP, prices, and unemployment.  The fact  is we have no single "Federal Reserve" forecast, and there is no mechanism, within a Committee or Board structure, to force agreement on such a forecast by individual members bringing different views, typically backed by separate staff analysis, to the table.  A simple average -- possibly supported by no  one -- seems to me artificial.  The process of attempting to  force a consensus would certainly dilute the product. I would put the point positively.  A range of forecasts  by individual FOMC members more accurately conveys the range of uncertainty and contingencies that must surround any forecast.  The seeming neatness and coherence of a single forecast  too often obscures the reality that a variety of outcomes is possible; the very essence of the policy problem is to assess risks and probabilities -- what can go wrong as well as what can go right.  A point forecast would likely be treated more  reverently than it would deserve, and could even distort policy judgments in misguided efforts to "hit" a forecast. I can understand your concern that a range of forecasts may be misleading if strongly influenced by "outlying" opinions rather than reflecting a more even dispersion of views.  For  that reason, I would be glad to explore with the Open Market   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  -18-  Committee a procedure by which we indicated the "central tendency" of members' views -- assuming such a central tendency exists -- as well as indicating the range of opinions.  Conversely, if the forecasts were evenly  distributed within the range, we could so indicate.  I  believe that approach would meet the objectives you seek in a realistic and helpful manner. In concluding this already long testimony, let me say that we share the common goals of achieving, in the words of the Employment Act of 1946 and the Humphrey Hawkins Act of 1978, "Maximum employment, production, and purchasing power" and "full employment . . . (and) reasonable price stability." Those objectives have eluded us for too many years.  We meet  again today in particularly difficult circumstances, and there is a sense of frustration and uncertainty among many. But I also happen to believe we have come a long way toward laying the base for economic growth and stability; economic recovery should characterize 1983, and that recovery can mark the beginning of a long period of stable growth. Obviously there are obstacles -- interest rates are still too high; inflation is down but not out; there are strains in our financial system; we face budget deficits that are far too high; we are tempted to turn inwards or backwards for quick solutions that ultimately can not work.  But it is  also plainly within our capacity to deal with those threats provided only that we have a strong base of understanding among   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  -19-  us, that we resolve to act where action is necessary, and that we have the patience and wisdom to refrain from actions that can only be destructive. You are leaving the Congress after 28 years, Mr. Chairman. Through that time, you have consistently provided constructive leadership to the effort to raise the level of economic discussion in general -- and of the dialogue between the Congress and the Federal Reserve in particular.  I happen to believe  strongly in the independence that the Congress has provided the Federal Reserve through the years -- but also in the need for close and continuing communication with the Congress and the Administration.  I presume that this is the last time I  will appear before you personally in this forum, but the dialogue will continue to benefit from your efforts, your initiative, and your sense of commitment in more ways than you may realize.   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  For release on delivery 10:00 A.M., E.S.T. November 24, 1982  Statement by  Paul A. Volcker  Chairman, Board of Governors of the Federal Reserve System  before the  Joint Economic Committee  November 24, 1982   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  I appreciate this opportunity to discuss with you today the current stance of monetary policy and some problems for the future.  Before responding to certain questions directed  to me about monetary policy in your letters of October 18 and November 17, Mr. Chairman, I should first emphasize that the basic thrust and goals of our policy are unchanged since I testified before the Congress on July 20.  The precise means  by which we move toward our goals must take account of all the stream of evidence we have on the behavior of (and distortions in) the various monetary aggregates, the economy, prices, interest rates, and the like.  But we remain convinced that lasting recovery  and growth must be sought in a framework of continuing progress toward price stability -- and that the process of money and credit creation must remain appropriately restrained if we are to deal effectively with inflationary dangers. For that reason, we must continue to set forth targets for growth in money and credit and to judge the provision of bank reserves  our most important operating instrument -- in  the light of the trend in the growth of these aggregates. This process necessarily involves continuing judgments about just what growth in those magnitudes is appropriate in the short and longer run, matters affected by institutional change as well as by more fundamental economic factors.   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  2-  As you are aware, the current job of developing and implementing monetary policy has been complicated by regulatory decisions as well as by recent developments in the economy and in our financial markets.  We have, as a consequence, (1) made  some technical modification in our operating procedures to cope with obvious distortions in some of the monetary data -- particularly M1 -- and (2) accommodated growth in the various M's at rates somewhat above the targeted ranges. decisions was essentially technical.  The first of those  The latter decision is  entirely consistent with the view I expressed in testifying before the Banking Committees in July that the Federal Open Market Committee would tolerate "growth somewhat above the targeted ranges .  . for a time in circumstances in which it  appeared that precautionary or liquidity motivations, during a period of economic uncertainty and turbulence, were leading to stronger than anticipated demands for money." Unfortunately, the difficulties and complexities of the economic world in which we live do not permit us the luxury of describing policy in terms of a simple, unchanging numerical rule.  For instance, the economic significance of any particular  statistic we label "money" can change over time -- partly because the statistical definition of "money" is itself arbitrary and the components of the money supply have differing degrees of use as a medium of exchange and liquidity.  That doesn't make  much difference in a relatively stable economic, financial, and institutional environment, but, at times of rapid change, like the present, it can matter a great deal.   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  3  We also have to take account of varying lags -- never known with precision -- between actions today and their consequences later.  We have to try to disentangle the temporary  and cyclical from more persistent trends in relationships among different measures of money and inflation and economic activity. And we have to evaluate the significance of developments abroad as well as at home, as reflected in trade accounts and the exchange rate, and of strains in the financial structure itself. As this suggests, the economic environment in which we set policy -- or policy itself  cannot be condensed into a  simple, one-dimensional statement.  Perhaps the essence of the  problem and our approach can be better captured by a few "yesbut" phrases. (1) Yes, we have broken the inflationary momentum but continuing vigilance and effort will be essential to continue progress toward price stability. As you know, the broad price indices this year have been running at about half or less of the peak levels reached two or three years ago.  As part of this disinflationary process, growth  in worker compensation in nominal terms has declined to the 6 to 7 percent area -- but that slower growth in nominal income has been consistent with higher real wages as inflation has moderated. Price and cost trends in particular sectors of the economy are mixed -- reflecting in part lags in the process of disinflation, the effects of long wage contracts, international and exchange rate developments, and the immediate effects of  ;   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  -4-  recession on some prices -- most particularly commodities. But there is, it seems to me, strong reason to believe that the progress toward price stability can be maintained -- albeit at a slower rate -- as the economy recovers.  For a time, un-  employment and excess capacity should restrain costs and prices and, of more lasting significance, productivity growth should improve from the poor performance of most recent years.  Taken  together, restraint on nominal wage increases and productivity growth should moderate the increase in unit labor costs, which account for about two-thirds of all costs.  Real incomes can  rise as inflation slows, paving the way for further progress toward stability. To be sure, as the economy grows, some factors holding down prices over the past year or two will dissipate or be reversed.  But large new "price shocks" in the energy or food  areas appear unlikely in the foreseeable future, suggesting that a declining trend in the rise of unit labor costs should be the most fundamental factor defining the price trend. That analysis would not hold, however, if excessive growth in money and credit over time came again to feed first the expectation, and then the reality, of renewed inflation. Too much has been "invested" in turning the inflationary momentum to lose sight of the necessity of carrying through. There are clear implications, as I will elaborate in a moment, for fiscal as well as monetary policy.  :   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  -5-  (2) Yes, exceptional demands for liquidity can reasonably be accommodated in a period of recession, high unemployment, and excess capacity -- but guidelines for restrained money and credit growth remain relevant to insure against renewed inflation.  A variety of specific and general evidence strongly suggests that the desire to hold cash and other highly liquid assets, relative to income, has increased this year.  Much of  the more rapid increase in M1 has been in interest-bearing NOW accounts, which did not exist a few years ago but which provide the basic elements of a savings, as well as transaction, account. With market interest rates falling, those accounts have been relatively more attractive on interest rate grounds alone, and they are a convenient means of storing liquidity at a time of economic and financial uncertainty.  At the same time, the  broader aggregates appear to reflect some of the same liquidity motivations, as well as the stronger savings growth in the wake of the tax cut. Most broadly, we can now observe, over a period of more than a year, a distinct decline in "velocity" -- that is, the relationship between the GNP and monetary aggregates.  The  velocity decline for Ml, which is likely to amount to about 3% from the fourth quarter of 1981 to the fourth quarter of 1982, stands in sharp contrast to the average yearly rise in velocity over the past decade; it will be the first significant   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  6  decline in velocity in about 30 years.  M2 and M3 velocities --  which had been relatively trendless earlier -- have also declined signcantly. not unusual  While some tendency toward slower velocity is  na midst of recession, the magnitude and per-  sistence of the movement in 1982 is indicative of a pronounced tendency to hold more liquid assets relative to current income. Without some accommodation of that preference, monetary policy at the present time would be substantially more restraining in its effect on the economy than intended when the targets for the various aggregates were originally set out earlier this year. At the same time, policy must take into account the probability that the demands for liquidity will, in whole or in major part, prove temporary, and that an excessive rise in money or other liquid assets could feed inflationary forces later.  Elements of judgment are inevitably involved in sorting  out these considerations -- judgments resting on analysis of the economy, interest rates, and other factors.  But broad  guidelines for assessing the appropriate growth on the basis of historical experience will surely remain relevant and appropriate. In that connection, I must note the implications of the future Federal budgetary position.  To put the point briefly,  the prospect of huge continuing budgetary deficits, even as the economy recovers, carries with it the threat of either excessive liquidity creation and inflation in future years, or a "crowdingout" 5f 5ther borrowers as monetary growth is restrained in the   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  7-  face of the Treasury financing needs, or a combination of both. The problems flowing from the future deficits are simply not amenable to solution by monetary policy.  Moreover, the concern  engendered in the marketplace works in the direction of higher interest rates today than would otherwise be the case, contrary to the needs of recovery.  I know something of how difficult it  is to achieve further budgetary savings, but I must emphasize again how important it is to see the deficit reduced as the economy recovers.  The fact is those looming deficits are a  major hazard in sustaining recovery. (3) Yes, lower interest rates are critically important in supporting the economy and encouraging recovery but we also want to be able to maintain lower interest rates over time.  Since early summer, short-term interest rates have generally declined by five to six percentage points, and mortgage and most other long-term rates have dropped by three to four percentage points.  While consumer loan rates administered  by banks and other financial institutions have lagged, they are also now moving lower.  There are clear signs of a rise in home  sales and building in response to these interest rate declines, and other sectors of the economy are benefiting as well. We have also had experience in recent years of sharp increases in interest rates curtailing economic activity at times when recovery was incomplete and unemployment high. Sudden large fluctuations in interest rates contribute to  •  Inb.  -8-  other economic and financial distortions as well.  And no  doubt the fact that many interest rates remain historically high, relative to the current rate of inflation, reflects continuing skepticism over prospects for carrying through the fight on inflation. In this situation, the Federal Reserve has welcomed the declines in interest rates both because of the support they offer economic activity and because they seem to reflect a sense that the inflationary trend has changed.  However, we  do not believe that progress toward lower interest rates should or for long in practice can -- be "forced" at the expense of excessive credit and money creation.  To attempt to do so  would simply risk the revival of inflationary forces; renewed expectations of inflation would soon be reflected in the longerterm credit markets, damaging prospects for the long-lasting expansion we all want. Turning to your explicit questions, Mr. Chairman, against this general background, I believe most policy-making officials in the Federal Reserve share the general view that economic recovery will be evident throughout 1983, but at a moderate rate of speed -- probably slower than during previous post-recession years.  Unambiguous evidence that the recovery  is already underway is still absent, although encouraging signs are evident in some rise in housing, in the improved liquidity and wealth and reduced debt positions of consumers, and in ,   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  surveys reporting that attitudes and orders may be stabilizing   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  -9  or improving.  The Federal deficit, while fraught with danger  for the future, is of course providing massive support for incomes at present. What is crucially important -- particularly in the light of the experience of recent years -- is that we set the stage for an expansion that can be sustained over a long period, bringing with it strong gains in productivity and investment and lasting improvement in employment.  I have  already emphasized the importance of progress toward price stability to that outlook, and the evidence that, with disciplined monetary and fiscal policies, we can sustain that progress. So far as the specific questions about monetary policy in your October 18 letter are concerned, we have not, as you know, set any new monetary targets for 1982.  Current trends  do indicate that the various M's will end the year above the upper end of the target ranges, probably by 1/2 to 1% for M2 and M3 and more for M1 given the current distortions. credit will be close to the mid-point of its range.  Bank  As I  indicated at the start, the "overshoots," in the context of today's economic and financial conditions, are consistent with the approach stated in my July testimony. No decision has been taken to change the tentative targets for 1983.  That matter will, of course, be under  intensive scrutiny over the next two months, and the targets will be announced in February.   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  -10-  For the time being, we are placing much less emphasis than usual on Ml.  That decision was precipitated in early  October entirely by the likelihood that the data would be grossly distorted in that month by the maturity of a large volume of All-Savers Certificates, part of the proceeds of which might be expected to, at least temporarily, be placed in checking accounts included in Ml. In about three weeks, the introduction of a new ceilingless account at financial institutions -- highly liquid and carrying significant transaction capabilities -- is likely to distort further M1 data.  Judging by comments at the last  Depository Institutions Deregulation Committee meeting, that account could rapidly be followed by a decision to approve a ceiling-less account with full transaction capabilities. These new accounts could have a large, but quite unpredictable, influence on M1 for a number of months ahead as funds are reallocated among various accounts.  Moreover, the introduction  of market-rate transaction accounts will very likely result in a different relationship and trend of M1 relative to GNP over time.  Increasing confidence in the stability of prices  and a trend toward lower market interest rates might also affect the desire to hold money over time. Obviously, some judgments on those matters will be necessary in setting a target for M1 in 1983 and in deciding upon the degree of weight to be attached to changes in M1 in our operations.  Those problems should appropriately be  -11-  described as "technical" rather than "policy" in the sense that we will need to continue to be concerned with the rate of growth over time of the monetary aggregates, including transactions balances. The decisions taken in early October do point to greater emphasis on M2 (and M3) in planning the operational reserve path during this transitional period.  The link between reserves  and M2 is looser and more uncertain than in the case of Ml, in large part because reserve requirements on accounts included in M2, apart from transactions balances, are very low or non-existent. (Transactions balances are about 17 percent of M2.)  Therefore  once a reserve path is set, deviations of M2 from a targeted growth range may not, more or less automatically, be reflected in as substantial changes in pressures on bank reserve positi ons or in money markets as is the case with Ml.  Consequently,  "discretionary" judgments may be necessary more frequently in altering a reserve path than when that reserve path is focuse d more heavily on Ml.  In that technical sense, the operational  approach has necessarily been modified. In sum, the broad framework of monetary targeting has been retained, but greater emphasis is for the time being placed on the broader aggregates.  The specific operating  technique that had been closely related to M1 has, by force of circumstances, been conformed to that emphasis.  Obviously,  entirely apart from questions of economic doctrine and contending approaches to monetary control, so long as M1 is   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  NkI\  -12-  subjected to strong institutional distortions our techniques must be adapted to take account of that fact. An alternative operating approach suggested by some of supplying and withdrawing reserves with the intent of achieving a particular interest rate target would suffer from several fundamental defects.* o  The body of theory or practice does not provide a sufficiently clear basis for relating the level of a particular interest rate to our ultimate objectives of growth and price stability.  o  The implication that the Federal Reserve could in fact achieve and maintain a particular level of relevant interest rates in a changing economic and financial environment is not warranted.  o  The very concept and measurement of a "real" interest rate, as called for in some proposals, is a matter of substantial ambiguity.  o  As a practical matter, attempts to target and fix interest rates would make more rigid and tend to politicize the entire process of monetary policy.  *That was not, as sometimes mistakenly thought, the operating approach used prior to October 1979. Then, reserves were provided with the aim of achieving and maintaining a particular Federal funds rate thought to be consistent with targets for the monetary aggregates. The Federal funds rate was a means to achieving a monetary target and in principle was to be handled flexibly. In practice, among other difficulties, there appeared to be a reluctance to permit rates to vary rapidly enough to maintain control of the aggregates.   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  -13-  o  In current circumstances, with huge budget deficits looming, a requirement that the Federal Reserve set explicit interest rate targets is bound to be interpreted as inflationary, and the rekindling of inflationary expectations will work against our objective.  I realize the several legislative proposals addressed to targeting interest rates would, on their face, seem to call for interest rates as only one of several targets.  But interest  rates would certainly be the most obvious and sensitive target, and those targets would be difficult to change.  Other evidence  for a need to "tighten" or "ease" would be subordinated, if not ignored. As we approach the target-setting process for 1983, our objectives will -- indeed as required by law -- continue to be quantified in terms of growth in relevant money and credit aggregates.  We will have to decide how much weight to  place on M1 and other aggregates during a transitional period, assuming new accounts continue to distort the data.  In reaching  and implementing those decisions, the members of the FOMC necessarily rely upon their own analysis of the current and prospective course of business activity; the interrelationships among the aggregates, economic activity, and interest rates; and the implications of monetary growth for inflation.  In other words,  the process is not a simple mechanical one, and it seems to me capable of incorporating -- within a general framework of monetary discipline -- the elements of needed flexibility.  We will also,  as part of that process, review whether technical adjustments   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  -14-  in procedures for establishing and changing the reserve paths are appropriate.  I will be reporting our conclusions to the  Congress in February. Mr. Chairman, you have suggested that our monetary targets might reasonably be specified as a single number, with a range above and below.  At times we have debated  within the FOMC the wisdom of such an approach (or setting forth a single target number without a range).  My own feeling  has been, and remains, that a single number, with or without a range, would convey a specious sense of precision, with the result of greater pressure to meet a more or less arbitrary number to maintain "credibility," even if developments during the year tend to indicate some element of flexibility is appropriate in pursuit of the targets. To me, our present practice of setting forth a range is preferable.  Where appropriate, we can and should suggest  the probability of being in the upper or lower portion of the range, or suggest what conditions could evolve in which something other than the mid-points (or even an over or undershoot) would be appropriate.  That approach seems to me to  provide more information -- and more realism -- than a single number and is broadly consistent with present practice. For similar reasons, I believe we need to measure and target a variety of aggregates because, in a swiftly changing economic environment, any single target can be misleading:. In that connection, I believe an indication of total credit flows broadly consistent with the monetary targets could be helpful.  As you know, we now provide such estimates for bank  credit alone.  #  -15-  Given the limits of forecasting and analysis, and the volatility of the data, I would question the usefulness of further sectoral estimates.  Even with respect to total credit  flows, there is considerable looseness in relationships to economic activity for periods as long as a year -- and still more for shorter periods.  The theoretical framework relating  credit flows to other variables such as the GNP or inflation is less fully developed than in the case of monetary aggregates, and credit flows are less directly amenable to control.  The  enormous flows across international borders pose large conceptual and statistical problems.  Our credit data are typically  less complete and up-to-date than monetary data. However, so long as those difficulties and limitations are recognized -- and some of them are relevant with respect to the monetary aggregates as well -- I share the view that analysis of credit flows can contribute to policy formulation. To assist in that process, Iwill propose to the FOMC that estimates of the expected behavior of a broad credit aggregate be set forth alongside the monetary targets in our next report. I do strongly resist the idea of the Federal Reserve as an institution forecasting interest rates.  No institution or  individual is capable of judging accurately the myriad of forces working on market interest rates over time.  Expectational  elements play a strong role -- fundamentally expectations about the course of economic activity and inflation, but also, in the short run, expectations of Federal Reserve action.   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  We could not   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  -16-  escape the fact that a central bank forecast of interest rates would be itself a market factor.  To some degree, therefore,  in looking to interest rates and other market developments for information bearing on our policy deons, we would be looking into a mirror.  Moreover, the temptation would always be present  to breech the thin line between a forecast and a desire or policy intention, with the result that operational policy decisions could be distorted. While it seems to me inappropriate for a central bank to regularly forecast interest rates, analysis of key factors influencing credit conditions and prices can be helpful at times. past.  On occasion, we have provided such analysis in the My concern about the outlook for fiscal policy is rooted  in major part in such analysis because the direction of impact on interest rates seems to me unambiguous.  I have also, on a  number of occasions, indicated that the recent and even current level of interest rates appears extraordinarily high, provided, as I believe, we continue to make progress on the inflation front.  Perhaps, in our semi-annual reporting, we can more  explicitly call attention to major factors likely to influence short or long-term interest rates and the significance for various sectors of the economy.  But I do not believe interest  rate forecasting would be desirable or long sustainable, and would in fact be damaging to the policy process. :  x ‘..   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  I  -17-  Finally, Mr. Chairman, you have requested a "single composite forecast" of the major economic variables by FOMC members.  As you are well aware, our present practice is to  set forth a range of forecasts of individual FOMC members of the nominal and real GNP, prices, and unemployment.  The fact  is we have no single "Federal Reserve" forecast, and there is no mechanism, within a Committee or Board structure, to force agreement on such a forecast by individual members bringing different views, typically backed by separate staff analysis, to the table.  A simple average -- possibly supported by no  one -- seems to me artificial.  The process of attempting to  force a consensus would certainly dilute the product. I would put the point positively.  A range of forecasts  by individual FOMC members more accurately conveys the range of uncertainty and contingencies that must surround any forecast.  The seeming neatness and coherence of a single forecast  too often obscures the reality that a variety of outcomes is possible; the very essence of the policy problem is to assess risks and probabilities -- what can go wrong as well as what can go right.  A point forecast would likely be treated more  reverently than it would deserve, and could even distort policy judgments in misguided efforts to "hit" a forecast. I can understand your concern that a range of forecasts may be misleading if strongly influenced by "outlying" opinions rather than reflecting a more even dispersion of views.  For  that reason, I would be glad to explore with the Open Market   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  -18-  Committee a procedure by which we indicated the "central tendency" of members' views -- assuming such a central tendency exists -- as well as indicating the range of opinions.  Conversely, if the forecasts were evenly  distributed within the range, we could so indicate.  I  believe that approach would meet the objectives you seek in a realistic and helpful manner. In concluding this already long testimony, let me say that we share the common goals of achieving, in the words of the Employment Act of 1946 and the Humphrey Hawkins Act of 1978, "Maximum employment, production, and purchasing power" and "full employment . . . (and) reasonable price stability." Those objectives have eluded us for too many years.  We meet  again today in particularly difficult circumstances, and there is a sense of frustration and uncertainty among many. But I also happen to believe we have come a long way toward laying the base for economic growth and stability; economic recovery should characterize 1983, and that recovery can mark the beginning of a long period of stable growth. Obviously there are obstacles -- interest rates are still too high; inflation is down but not out; there are strains in our financial system; we face budget deficits that are far too high; we are tempted to turn inwards or backwards for quick solutions that ultimately can not work.  But it is  also plainly within our capacity to deal with those threats provided only that we have a strong base of understanding among  •••   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  -19-  us, that we resolve to act where action is necessary, and that we have the patience and wisdom to refrain from actions that can only be destructive. You are leaving the Congress after 28 years, Mr. Chairman. Through that time, you have consistently provided constructive leadership to the effort to raise the level of economic discussion in general -- and of the dialogue between the Congress and the Federal Reserve in particular.  I happen to believe  strongly in the independence that the Congress has provided the Federal Reserve through the years -- but also in the need for close and continuing communication with the Congress and the Administration.  I presume that this is the last time I  will appear before you personally in this forum, but the dialogue will continue to benefit from your efforts, your initiative, and your sense of commitment in more ways than you may realize.   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  For release on delivery 10:00 A.M., E.S.T. November 24, 1982  Statement by  Paul A. Volcker  Chairman, Board of Governors of the Federal Reserve System  before the  Joint Economic Committee  November 24, 1982   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  I appreciate this opportunity to discuss with you today the current stance of monetary policy and some problems for the future.  Before responding to certain questions directed  to me about monetary policy in your letters of October 18 and November 17, Mr. Chairman, I should first emphasize that the basic thrust and goals of our policy are unchanged since I testified before the Congress on July 20.  The precise means  by which we move toward our goals must take account of all the stream of evidence we have on the behavior of (and distortions in) the various monetary aggregates, the economy, prices, interest rates, and the like.  But we remain convinced that lasting recovery  and growth must be sought in a framework of continuing progress toward price stability -- and that the process of money and credit creation must remain appropriately restrained if we are to deal effectively with inflationary dangers. For that reason, we must continue to set forth targets for growth in money and credit and to judge the provision of bank reserves  our most important operating instrument -- in  the light of the trend in the growth of these aggregates. This process necessarily involves continuing judgments about just what growth in those magnitudes is appropriate in the short and longer run, matters affected by institutional change as well as by more fundamental economic factors.  2-  As you are aware, the current job of developing and implementing monetary policy has been complicated by regulatory decisions as well as by recent developments in the economy and in our financial markets.  We have, as a consequence, (1) made  some technical modification in our operating procedures to cope with obvious distortions in some of the monetary data -- particularly MI -- and (2) accommodated growth in the various M's at rates somewhat above the targeted ranges. decisions was essentially technical.  The first of those  The latter decision is  entirely consistent with the view I expressed in testifying before the Banking Committees in July that the Federal Open Market Committee would tolerate "growth somewhat above the targeted ranges .  . for a time in circumstances in which it  appeared that precautionary or liquidity motivations, during a period of economic uncertainty and turbulence, were leading to stronger than anticipated demands for money." Unfortunately, the difficulties and complexities of the economic world in which we live do not permit us the luxury of describing policy in terms of a simple, unchanging numerical rule.  For instance, the economic significance of any particular  statistic we label "money" can change over time -- partly because the statistical definition of "money" is itself arbitrary and the components of the money supply have differing degrees of use as a medium of exchange and liquidity.  That doesn't make  much difference in a relatively stable economic, financial, and institutional environment, but, at times of rapid change, like the present, it can matter a great deal.   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  0   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  4  -3-  We also have to take account of varying lags -- never known with precision -- between actions today and their consequences later.  We have to try to disentangle the temporary  and cyclical from more persistent trends in relationships among different measures of money and inflation and economic activity. And we have to evaluate the significance of developments abroad as well as at home, as reflected in trade accounts and the exchange rate, and of strains in the financial structure itself. As this suggests, the economic environment in which we set policy -- or policy itself -- cannot be condensed into a simple, one-dimensional statement.  Perhaps the essence of the  problem and our approach can be better captured by a few "yesbut" phrases. (1) Yes, we have broken the inflationary momentum but continuing vigilance and effort will be essential to continue progress toward price stability. As you know, the broad price indices this year have been running at about half or less of the peak levels reached two or three years ago.  As part of this disinflationary process, growth  in worker compensation in nominal terms has declined to the 6 to 7 percent area -- but that slower growth in nominal income has been consistent with higher real wages as inflation has moderated. Price and cost trends in particular sectors of the economy are mixed -- reflecting in part lags in the process of disinflation, the effects of long wage contracts, international and exchange rate developments, and the immediate effects of   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  -4-  recession on some prices -- most particularly commodes. But thereseemsstrong reason to believe that the progress toward price stability can be maintained -- albeit at a slower rate -- as the economy recovers.  For a time, un-  employment and excess capacity should restrain costs and prices and, of more lasting signance, productivity growth should improve from the poor performance of most recent years.  Taken  together, restraint on nominal wage increases and productivity growth should moderate the increase in unit labor costs, which account for about two-thirds of all costs.  Real incomes can  rise as inflation slows, paving the way for further progress toward stability. To be sure, as the economy grows, some factors holding down prices over the past year or two will dissipate or be reversed.  But large new "price shocks" in the energy or food  areas appear unlikely in the foreseeable future, suggesting that a declining trend in the rise of unit labor costs should be the most fundamental factor defining the price trend. That analysis would not hold, however, if excessive growth in money and credit over time came again to feed first the expectation, and then the reality, of renewed inflation. Too much has been "invested" in turning the inflationary  momentum to lose sight of the necessity of carrying through. There are clear implications, as I will elaborate in a moment, for fiscal as well as monetary policy.  ;   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  5  (2) Yes, exceptional demands for liquidity can reasonably be accommodated in a period of recession, high unemployment, and excess capacity -- but guidelines for restrained money and credit growth remain relevant to insure against renewed inflation.  A variety of specific and general evidence strongly suggests that the desire to hold cash and other highly liquid assets, relative to income, has increased this year.  Much of  the more rapid increase in M1 has been in interest-bearing NOW accounts, which did not exist a few years ago but which provide the basic elements of a savings, as well as transaction, account. With market interest rates falling, those accounts have been relatively more attractive on interest rate grounds alone, and they are a convenient means of storing liquidity at a time of economic and financial uncertainty.  At the same time, the  broader aggregates appear to reflect some of the same liquidity motivations, as well as the stronger savings growth in the wake of the tax cut. Most broadly, we can now observe, over a period of more than a year, a distinct decline in "velocity" -- that is, the relationship between the GNP and monetary aggregates.  The  velocity decline for Ml, which is likely to amount to about 3% from the fourth quarter of 1981 to the fourth quarter of 1982, stands in sharp contrast to the average yearly rise in velocity of 3-4% over the past decade; it will be the first significant   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  6  decline in velocity in about 30 years.  M2 and M3 velocities --  which had been relatively trendless earlier -- have also declined significantly.  While some tendency toward slower velocity is  not unusual in the midst of recession, the magnitude and persistence of the movement in 1982 is indicative of a pronounced tendency to hold more liquid assets relative to current income. Without some accommodation of that preference, monetary policy at the present time would be substantially more restraining in its effect on the economy than intended when the targets for the various aggregates were originally set out earlier this year. At the same time, policy must take into account the probability that the demands for liquidity will, in whole or in major part, prove temporary, and that an excessive rise in money or other liquid assets could feed inflationary forces later.  Elements of judgment are inevitably involved in sorting  out these considerations -- judgments resting on analysis of the economy, interest rates, and other factors.  But broad  guidelines for assessing the appropriate growth on the basis of historical experience will surely remain relevant and appropriate. In that connection, I must note the implications of the future Federal budgetary position.  To put the point briefly,  the prospect of huge continuing budgetary deficits, even as the economy recovers, carries with it the threat of either excessive liquidity creation and inflation in future years, or a "crowdingout" of other borrowers as monetary growth is restrained in the   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  7-  face of the Treasury financing needs, or a combination of both. The problems flowing from the future deficits are simply not amenable to solution by monetary policy.  Moreover, the concern  engendered in the marketplace works in the direction of higher interest rates today than would otherwise be the case, contrary to the needs of recovery.  I know something of how difficult it  is to achieve further budgetary savings, but I must emphasize again how important it is to see the deficit reduced as the economy recovers.  The fact is those looming deficits are a  major hazard in sustaining recovery. (3) Yes, lower interest rates are critically important in supporting the economy and encouraging recovery but we also want to be able to maintain lower interest rates over time.  Since early summer, short-term interest rates have generally declined by five to six percentage points, and mortgage and most other long-term rates have dropped by three to four percentage points.  While consumer loan rates administered  by banks and other financial institutions have lagged, they are also now moving lower.  There are clear signs of a rise in home  sales and building in response to these interest rate declines, and other sectors of the economy are benefiting as well. We have also had experience in recent years of sharp increases in interest rates curtailing economic activity at times when recovery was incomplete and unemployment high. Sudden large fluctuations in interest rates contribute to   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  8-  -  other economic and financial distortions as well.  And no  doubt the fact that many interest rates remain historically high, relative to the current rate of inflation, reflects continuing skepticism over prospects for carrying through the fight on inflation. In this situation, the Federal Reserve has welcomed the declines in interest rates both because of the support they offer economic activity and because they seem to reflect a sense that the inflationary trend has changed.  However, we  do not believe that progress toward lower interest rates should -or for long in practice can -- be "forced" at the expense of excessive credit and money creation.  To attempt to do so  would simply risk the revival of inflationary forces; renewed expectations of inflation would soon be reflected in the longerterm credit markets, damaging prospects for the long-lasting expansion we all want. Turning to your explicit questions, Mr. Chairman, against this general background, I believe most policy-making officials in the Federal Reserve share the general view that economic recovery will be evident throughout 1983, but at a moderate rate of speed -- probably slower than during previous post-recession years.  Unambiguous evidence that the recovery  is already underway is still absent, although encouraging signs are evident in some rise in housing, in the improved liquidity and wealth and reduced debt positions of consumers, and in surveys reporting that attitudes and orders may be stabilizing  -9  or improving.  The Federal deficit, while fraught with danger  for the future, is of course providing massive support for incomes at present. What is crucially important -- particularly in the light of the experience of recent years -- is that we set the stage for an expansion that can be sustained over a long period, bringing with it strong gains in productivity and investment and lasting improvement in employment.  I have  already emphasized the importance of progress toward price stability to that outlook, and the evidence that, with disciplined monetary and fiscal policies, we can sustain that progress. So far as the specific questions about monetary policy in your October 18 letter are concerned, we have not, as you know, set any new monetary targets for 1982.  Current trends  do indicate that the various M's will end the year above the upper end of the target ranges, probably by 1/2 to 1% for M2 and M3 and more for M1 given the current distortions. credit will be close to the mid-point of its range.  Bank  As I  indicated at the start, the "overshoots," in the context of today's economic and financial conditions, are consistent with the approach stated in my July testimony. No decision has been taken to change the tentative targets for 1983.  That matter will, of course, be under  intensive scrutiny over the next two months, and the targets --•   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  will be announced in February.   https://fraser.stlouisfed.org . p Federal Reserve Bank of St. Louis  -10-  For the time being, we are placing much less emphasis than usual on Ml.  That decision was precipitated in early  October entirely by the likelihood that the data would be grossly distorted in that month by the maturity of a large volume of All-Savers Certificates, part of the proceeds of which might be expected to, at least temporarily, be placed in checking accounts included in Ml. In about three weeks, the introduction of a new ceilingless account at financial institutions -- highly liquid and carrying significant transaction capabilities -- is likely to distort further M1 data.  Judging by comments at the last  Depository Institutions Deregulation Committee meeting, that account could rapidly be followed by a decision to approve a ceiling-less account with full transaction capabilities. These new accounts could have a large, but quite unpredictable, influence on M1 for a number of months ahead as funds are reallocated among various accounts.  Moreover, the introduction  of market-rate transaction accounts will very likely result in a different relationship and trend of M1 relative to GNP over time.  Increasing confidence in the stability of prices  and a trend toward lower market interest rates might also affect the desire to hold money over time. Obviously, some judgments on those matters will be necessary in setting a target for M1 in 1983 and in deciding upon the degree of weight to be attached to changes in M1 in our operations.  Those problems should appropriately be  -11-  described as "technical" rather than "policy" in the sense that we will need to continue to be concerned with the rate of growth over time of the monetary aggregates, including transactions balances. The decisions taken in early October do point to greater emphasis on M2 (and M3) in planning the operational reserve path during this transitional period.  The link between reserves  and M2 is looser and more uncertain than in the case of Ml, in large part because reserve requirements on accounts included in M2, apart from transactions balances, are very low or non-existent . (Transactions balances are about 17 percent of M2.)  Therefore  once a reserve path is set, deviations of M2 from a targeted growth range may not, more or less automatically, be reflected in as substantial changes in pressures on bank reserve positions or in money markets as is the case with Ml.  Consequently,  "discretionary" judgments may be necessary more frequently in altering a reserve path than when that reserve path is focused more heavily on Ml.  In that technical sense, the operational  approach has necessarily been modified. In sum, the broad framework of monetary targeting has been retained, but greater emphasis is for the time being placed on the broader aggregates.  The specific operating  technique that had been closely related to M1 has, by force of circumstances, been conformed to that emphasis.  Obviously,  entirely apart from questions of economic doctrine and contending approaches to monetary control, so long as M1 is   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  -12-  subjected to strong institutional distortions our techniques must be adapted to take account of that fact. An alternative operating approach suggested by some of supplying and withdrawing reserves with the intent of achieving a particular interest rate target would suffer from several fundamental defects.* o  The body of theory or practice does not provide a sufficiently clear basis for relating the level of a particular interest rate to our ultimate objectives of growth and price stability.  o  The implication that the Federal Reserve could in fact achieve and maintain a particular level of relevant interest rates in a changing economic and financial environment is not warranted.  o  The very concept and measurement of a "real" interest rate, as called for in some proposals, is a matter of substantial ambiguity.  o  As a practical matter, attempts to target and fix interest rates would make more rigid and tend to politicize the entire process of monetary policy.  *That was not, as sometimes mistakenly thought, the operating approach used prior to October 1979. Then, reserves were provided with the aim of achieving and maintaining a particular Federal funds rate thought to be consistent with targets for the monetary aggregates. The Federal funds rate was a means to achieving a monetary target and in principle was to be handled flexibly. In practice, among other difficulties, there appeared to be a reluctance to permit rates to vary rapidly enough to maintain control of the aggregates.   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  -13-  o  In current circumstances, with huge budget deficits looming, a requirement that the Federal Reserve set explicit interest rate targets is bound to be interpreted as inflationary, and the rekindling of inflationary expectations will work against our objective.  I realize the several legislative proposals addressed to targeting interest rates would, on their face, seem to call for interest rates as only one of several targets.  But interest  rates would certainly be the most obvious and sensitive target, and those targets would be difficult to change.  Other evidence  for a need to "tighten" or "ease" would be subordinated, if not ignored. As we approach the target-setting process for 1983, our objectives will -- indeed as required by law -- continue to be quantified in terms of growth in relevant money and credit aggregates.  We will have to decide how much weight to  place on M1 and other aggregates during a transitional period, assuming new accounts continue to distort the data.  In reaching  and implementing those decisions, the members of the FOMC necessarily rely upon their own analysis of the current and prospective course of business activity; the interrelationships among the aggregates, economic activity, and interest rates; and the implications of monetary growth for inflation.  In other words,  the process is not a simple mechanical one, and it seems to me capable of incorporating -- within a general framework of monetary discipline -- the elements of needed flexibility.  We will also,  as part of that process, review whether technical adjustments  -14-  in procedures for establishing and changing the reserve paths are appropriate.  I will be reporting our conclusions to the  Congress in February. Mr. Chairman, you have suggested that our monetary targets might reasonably be specified as a single number, with a range above and below.  At times we have debated  within the FOMC the wisdom of such an approach (or setting forth a single target number without a range).  My own feeling  has been, and remains, that a single number, with or without a range, would convey a specious sense of preon, with the result of greater pressure to meet a more or less arbitrary number to maintain "credibility  even if developments during  the year tend to indicate some element of flexibility is appropriate in pursuit of the targets. To me, our present practice of setting forth a range is preferable.  Where appropriate, we can and should suggest  the probability of being in the upper or lower portion of the range, or suggest what condons could evolve in which something other than the mid-points (or even an over or undershoot) would be appropriate.  That approach seems to me to  provide more information -- and more realism -- than a single number and is broadly consistent with present practice. For similar reasons, I believe we need to measure and target a variety of aggregates because,, in a swiftly changing economic environment, any single target can be misleading:. In that connection, I believe an indication of total credit flows broadly consistent with the monetary targets could be helpful.  As you know, we now provide such estimates for bank  credit alone.  https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis •••  —  e  -15-  Given the limits of forecasting and analysis, and the volatility of the data, I would question the usefulness of further sectoral estimates.  Even with respect to total credit  flows, there is considerable looseness in relationships to economic activity for periods as long as a year -- and still more for shorter periods.  The theoretical framework relating  credit flows to other variables such as the GNP or inflation is less fully developed than in the case of monetary aggregates, and credit flows are less directly amenable to control.  The  enormous flows across international borders pose large conceptual and statistical problems.  Our credit data are typically  less complete and up-to-date than monetary data. However, so long as those difficulties and limitations are recognized -- and some of them are relevant with respect to the monetary aggregates as well -- I share the view that analysis of credit flows can contribute to policy formulation. To assist in that process, Iwill propose to the FOMC that estimates of the expected behavior of a broad credit aggregate be set forth alongside the monetary targets in our next report. I do strongly resist the idea of the Federal Reserve as an institution forecasting interest rates.  No institution or  individual is capable of judging accurately the myriad of forces working on market interest rates over time.  Expectational  elements play a strong role -- fundamentally expectations about ; the course of economic activity and inflation, but also, in the short run, expectations of Federal Reserve action.   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  ,  We could not   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  -16-  escape the fact that a central bank forecast of interest rates would be itself a market factor.  To some degree, therefore,  in looking to interest rates and other market developments for information bearing on our policy decisions, we would be looking into a mirror.  Moreover, the temptation would always be present  to breech the thin line between a forecast and a desire or policy intention, with the result that operational policy decisions could be distorted. While it seems to me inappropriate for a central bank to regularly forecast interest rates, analysis of key factors influencing credit conditions and prices can be helpful at times. past.  On occasion, we have provided such analysis in the My concern about the outlook for fiscal policy is rooted  in major part in such analysis because the direction of impact on interest rates seems to me unambiguous.  I have also, on a  number of occasions, indicated that the recent and even current level of interest rates appears extraordinarily high, provided, as I believe, we continue to make progress on the inflation front.  Perhaps, in our semi-annual reporting, we can more  explicitly call attention to major factors likely to influence short or long-term interest rates and the significance for various sectors of the economy.  But I do not believe interest  rate forecasting would be desirable or long sustainable, and would in fact be damaging to the policy process. ;   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  • -17-  Finally, Mr. Chairman, you have requested a "single composite forecast" of the major economic variables by FOMC members.  As you are well aware, our present practice is to  set forth a range of forecasts of individual FOMC members of the nominal and real GNP, prices, and unemployment.  The fact  is we have no single "Federal Reserve" forecast, and there is no mechanism, within a Committee or Board structure, to force agreement on such a forecast by individual members bringing different views, typically backed by separate staff analysis, to the table.  A simple average -- possibly supported by no  one -- seems to me artificial.  The process of attempting to  force a consensus would certainly dilute the product. I would put the point positively.  A range of forecasts  by individual FOMC members more accurately conveys the range of uncertainty and contingencies that must surround any forecast.  The seeming neatness and coherence of a single forecast  too often obscures the reality that a variety of outcomes is possible; the very essence of the policy problem is to assess risks and probabilities -- what can go wrong as well as what can go right.  A point forecast would likely be treated more  reverently than it would deserve, and could even distort policy judgments in misguided efforts to "hit" a forecast. I can understand your concern that a range of forecasts may be misleading if strongly influenced by "outlying" opinions rather than reflecting a more even dispersion of views.  For  that reason, I would be glad to explore with the Open Market   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  -18--  Committee a procedure by which we indicated the "central tendency" of members' views -- assuming such a central tendency exists -- as well as indicating the range of opinions.  Conversely, if the forecasts were evenly  distributed within the range, we could so indicate. believe that approach would meet the objectives you seek in a realistic and helpful manner. In concluding this already long testimony, let me say that we share the common goals of achieving, in the words of the Employment Act of 1946 and the Humphrey Hawkins Act of 1978, "Maximum employment, production, and purchasing power" and "full employment . . . (and) reasonable price stability." Those objectives have eluded us for too many years.  We meet  again today in particularly difficult circumstances, and there is a sense of frustration and uncertainty among many. But I also happen to believe we have come a long way toward laying the base for economic growth and stability; economic recovery should characterize 1983, and that recovery can mark the beginning of a long period of stable growth. Obviously there are obstacles -- interest rates are still too high; inflation is down but not out; there are strains in our financial system; we face budget deficits that are far too high; we are tempted to turn inwards or backwards for quick solutions that ultimately can not work.  But it is  also plainly within our capacity to deal with those threats provided only that we have a strong base of understanding among  •   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  -19-  us, that we resolve to act where action is necessary, and that we have the patience and wisdom to refrain from actions that can only be destructive. You are leaving the Congress after 28 years, Mr. Chairman. Through that time, you have consistently provided constructive leadership to the effort to raise the level of economic discussion in general -- and of the dialogue between the Congress and the Federal Reserve in particular.  I happen to believe  strongly in the independence that the Congress has provided the Federal Reserve through the years -- but also in the need for close and continuing communication with the Congress and the Administration.  I presume that this is the last time I  will appear before you personally in this forum, but the dialogue will continue to benefit from your efforts, your initiative, and your sense of commitment in more ways than you may realize.   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  For release on delivery 10:00 A.M., E.S.T. November 24, 1982  Statement by  Paul A. Volcker  Chairman, Board of Governors of the Federal Reserve System  before the  Joint Economic Committee  OOP" November 24, 1982   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  I appreciate this opportunity to discuss with you today the current stance of monetary policy and some problems for the future.  Before responding to certain questions directed  to me about monetary policy in your letters of October 18 and November 17, Mr. Chairman, I should first emphasize that the basic thrust and goals of our policy are unchanged since I testified before the Congress on July 20.  The precise means  by which we move toward our goals must take account of all the stream of evidence we have on the behavior of (and distortions in) the various monetary aggregates, the economy, prices, interest rates, and the like.  But we remain convinced that lasting recovery  and growth must be sought in a framework of continuing progress toward price stability -- and that the process of money and credit creation must remain appropriately restrained if we are to deal effectively with inflationary dangers. For that reason, we must continue to set forth targets for growth in money and credit and to judge the provision of bank reserves  our most important operating instrument -- in  the light of the trend in the growth of these aggregates. This process necessarily involves continuing judgments about just what growth in those magnitudes is appropriate in the short and longer run, matters affected by institutional change as well as by more fundamental economic factors.   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  2  As you are aware, the current job of developing and implementing monetary policy has been complicated by regulatory decisions as well as by recent developments in the economy and in our financial markets.  We have, as a consequence, (1) made  some technical modification in our operating procedures to cope with obvious distortions in some of the monetary data -- particularly MI -- and (2) accommodated growth in the various M's at rates somewhat above the targeted ranges. decisions was essentially technical.  The first of those  The latter decision is  entirely consistent with the view I expressed in testifying before the Banking Committees in July that the Federal Open Market Committee would tolerate "growth somewhat above the targeted ranges .  . for a time in circumstances in which it  appeared that precautionary or liquidity motivations, during a period of economic uncertainty and turbulence, were leading to stronger than anticipated demands for money." Unfortunately, the difficulties and complexities of the economic world in which we live do not permit us the luxury of describing policy in terms of a simple, unchanging numerical rule.  For instance, the economic significance of any particular  statistic we label "money" can change over time -- partly because the statistical definition of "money" is itself arbitrary and the components of the money supply have differing degrees of use as a medium of exchange and liquidity.  That doesn't make  much difference in a relatively stable economic, financial, and institutional environment, but, at times of rapid change, like the present, it can matter a great deal.   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  3-  -  We also have to take account of varying lags -- never known with precision -- between actions today and their consequences later.  We have to try to disentangle the temporary  and cyclical from more persistent trends in relationships among different measures of money and inflation and economic activity. And we have to evaluate the significance of developments abroad ge as well as at home, as reflected in trade accounts and the exchan rate, and of strains in the financial structure itself. As this suggests, the economic environment in which we set policy -- or policy itself -- cannot be condensed into a simple, one-dimensional statement.  Perhaps the essence of the  problem and our approach can be better captured by a few "yesbut" phrases. (1) Yes, we have broken the inflationary momentum but continuing vigilance and effort will be essential to continue progress toward price stability. As you know, the broad price indices this year have been running at about half or less of the peak levels reached two or three years ago.  As part of this disinflationary process, growth  in worker compensation in nominal terms has declined to the 6 to 7 percent area -- but that slower growth in nominal income has been consistent with higher real wages as inflation has moderated. Price and cost trends in particular sectors of the economy are mixed -- reflecting in part lags in the process of disl inflation, the effects of long wage contracts, internationa of and exchange rate developments, and the immediate effects  :  -4  recession on some prices -- most particularly commodities. But there is, it seems to me, strong reason to believe that the progress toward price stability can be maintained -- albeit at a slower rate -- as the economy recovers.  For a time, un-  employment and excess capacity should restrain costs and prices and, of more lasting significance, productivity growth should improve from the poor performance of most recent years.  Taken  together, restraint on nominal wage increases and productivity growth should moderate the increase in unit labor costs, which account for about two-thirds of all costs.  Real incomes can  rise as inflation slows, paving the way for further progress toward stability. To be sure, as the economy grows, some factors holding down prices over the past year or two will dissipate or be reversed.  But large new "price shocks" in the energy or food  areas appear unlikely in the foreseeable future, suggesting that a declining trend in the rise of unit labor costs should be the most fundamental factor defining the price trend. That analysis would not hold, however, if excessive growth in money and credit over time came again to feed first the expectation, and then the reality, of renewed inflation. Too much has been "invested" in turning the inflationary momentum to lose sight of the necessity of carrying through. There are clear implications, as I will elaborate in a moment, for fiscal as well as monetary policy.   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  5  (2) Yes, exceptional demands for liquidity can reasonably be accommodated in a period of recession, high unemployment, and excess capacity -- but guidelines for restrained money and credit growth remain relevant to insure against renewed inflation.  A variety of specific and general evidence strongly suggests that the desire to hold cash and other highly liquid assets, relative to income, has increased this year.  Much of  the more rapid increase in M1 has been in interest-bearing NOW accounts, which did not exist a few years ago but which provide the basic elements of a savings, as well as transaction, account. With market interest rates falling, those accounts have been relatively more attractive on interest rate grounds alone, and they are a convenient means of storing liquidity at a time of economic and financial uncertainty.  At the same time, the  broader aggregates appear to reflect some of the same liquidity motivations, as well as the stronger savings growth in the wake of the tax cut. Most broadly, we can now observe, over a period of more than a year, a distinct decline in "velocity" -- that is, the relationship between the GNP and monetary aggregates.  The  velocity decline for Ml, which is likely to amount to about 3% from the fourth quarter of 1981 to the fourth quarter of 1982, stands in sharp contrast to the average yearly rise in velocity of 3-4% over the past decade; it will be the first significant  -6-  decline in velocity in about 30 years.  M2 and M3 velocities --  which had been relatively trendless earlier -- have also declined significantly.  While some tendency toward slower velocity is  not unusual in the midst of recession, the magnitude and persistence of the movement in 1982 is indicative of a pronounced tendency to hold more liquid assets relative to current income. Without some accommodation of that preference, monetary policy at the present time would be substantially more restraining in its effect on the economy than intended when the targets for the various aggregates were originally set out earlier this year. At the same time, policy must take into account the probability that the demands for liquidity will, in whole or in major part, prove temporary, and that an excessive rise in money or other liquid assets could feed inflationary forces later.  Elements of judgment are inevitably involved in sorting  out these considerations -- judgments resting on analysis of the economy, interest rates, and other factors.  But broad  guidelines for assessing the appropriate growth on the basis of historical experience will surely remain relevant and appropriate. In that connection, I must note the implications of the future Federal budgetary position.  To put the point briefly,  the prospect of huge continuing budgetary deficits, even as the economy recovers, carries with it the threat of either excessive liquidity creation and inflation in future years, or a "crowdingout" of other borrowers as monetary growth is restrained in the   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  7-  face of the Treasury financing needs, or a combination of both. The problems flowing from the future deficits are simply not amenable to solution by monetary policy.  Moreover, the concern  engendered in the marketplace works in the direction of higher interest rates today than would otherwise be the case, contrary to the needs of recovery.  I know something of how difficult it  is to achieve further budgetary savings, but I must emphasize again how important it is to see the deficit reduced as the economy recovers.  The fact is those looming deficits are a  major hazard in sustaining recovery. (3) Yes, lower interest rates are critically important in supporting the economy and encouraging recovery but we also want to be able to maintain lower interest rates over time.  Since early summer, short-term interest rates have generally declined by five to six percentage points, and mortgage and most other long-term rates have dropped by three to four percentage points.  While consumer loan rates administered  by banks and other financial institutions have lagged, they are also now moving lower.  There are clear signs of a rise in home  sales and building in response to these interest rate declines, and other sectors of the economy are benefiting as well. We have also had experience in recent years of sharp increases in interest rates curtailing economic activity at times when recovery was incomplete and unemployment high. Sudden large fluctuations in interest rates contribute to  Ni   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  -8-  other economic and financial distortions as well.  And no  doubt the fact that many interest rates remain historically high, relative to the current rate of inflation, reflects continuing skepticism over prospects for carrying through the fight on inflation. In this situation, the Federal Reserve has welcomed the declines in interest rates both because of the support they offer economic activity and because they seem to reflect a sense that the inflationary trend has changed.  However, we  do not believe that progress toward lower interest rates should or for long in practice can -- be "forced" at the expense of excessive credit and money creation.  To attempt to do so  would simply risk the revival of inflationary forces; renewed expectations of inflation would soon be reflected in the longerterm credit markets, damaging prospects for the long-lasting expansion we all want. Turning to your explicit questions, Mr. Chairman, against this general background, I believe most policy-making officials in the Federal Reserve share the general view that economic recovery will be evident throughout 1983, but at a moderate rate of speed -- probably slower than during previous post-recession years.  Unambiguous evidence that the recovery  is already underway is still absent, although encouraging signs are evident in some rise in housing, in the improved liquidity and wealth and reduced debt positions of consumers, and in surveys reporting that attitudes and orders may be stabilizing  :   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  9-  _  or improving.  The Federal deficit, while fraught with danger  for the future, is of course providing massive support for incomes at present. What is crucially important -- particularly in the light of the experience of recent years -- is that we set the stage for an expansion that can be sustained over a long period, bringing with it strong gains in productivity and investment and lasting improvement in employment.  I have  already emphasized the importance of progress toward price stability to that outlook, and the evidence that, with disciplined monetary and fiscal policies, we can sustain that progress. So far as the specific questions about monetary policy in your October 18 letter are concerned, we have not, as you know, set any new monetary targets for 1982.  Current trends  do indicate that the various M's will end the year above the upper end of the target ranges, probably by 1/2 to 1% for M2 and M3 and more for M1 given the current distortions. credit will be close to the mid-point of its range.  Bank  As I  indicated at the start, the "overshoots," in the context of today's economic and financial conditions, are consistent with the approach stated in my July testimony. No decision has been taken to change the tentative targets for 1983.  That matter will, of course, be under  intensive scrutiny over the next two months, and the targets will be announced in February.  -10-  For the time being, we are placing much less emphasis than usual on Ml.  That decision was precipitated in early  October entirely by the likelihood that the data would be grossly distorted in that month by the maturity of a large volume of All-Savers Certificates, part of the proceeds of which might be expected to, at least temporarily, be placed in checking accounts included in Ml. In about three weeks, the introduction of a new ceilingless account at financial institutions -- highly liquid and carrying significant transaction capabilities -- is likely to distort further M1 data. •   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  Judging by comments at the last  Depository Institutions Deregulation Committee meeting, that account could rapidly be followed by a decision to approve a ceiling-less account with full transaction capabilities. These new accounts could have a large, but quite unpredictable, influence on M1 for a number of months ahead as funds are reallocated among various accounts.  Moreover, the introduction  of market-rate transaction accounts will very likely result in a different relationship and trend of M1 relative to GNP over time.  Increasing confidence in the stability of prices  and a trend toward lower market interest rates might also affect the desire to hold money over time. Obviously, some judgments on those matters will be necessary in setting a target for M1 in 1983 and in deciding upon the degree of weight to be attached to changes in M1 in our operations.  Those problems should appropriately be  •  -11-  described as "technical" rather than "policy" in the sense that we will need to continue to be concerned with the rate of growth over time of the monetary aggregates, including transactions balances. The decisions taken in early October do point to greater emphasis on M2 (and M3) in planning the operational reserve path during this transitional period.  The link between reserves  and M2 is looser and more uncertain than in the case of Ml, in large part because reserve requirements on accounts included in M2, apart from transactions balances, are very low or non-existent. (Transactions balances are about 17 percent of M2.)  Therefore  once a reserve path is set, deviations of M2 from a targeted growth range may not, more or less automatically, be reflected in as substantial changes in pressures on bank reserve positions or in money markets as is the case with Ml.  Consequently,  "discretionary" judgments may be necessary more frequently in altering a reserve path than when that reserve path is focused more heavily on Ml.  In that technical sense, the operational  approach has necessarily been modified. In sum, the broad framework of monetary targeting has been retained, but greater emphasis is for the time being placed on the broader aggregates.  The specific operating  technique that had been closely related to M1 has, by force of circumstances, been conformed to that emphasis.  Obviously,  entirely apart from questions of economic doctrine and contending approaches to monetary control, so long as M1 is   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  -12-  subjected to strong institutional distortions our techniques must be adapted to take account of that fact. An alternative operating approach suggested by some of supplying and withdrawing reserves with the intent of achieving a particular interest rate target would suffer from several fundamental defects.* o  The body of theory or practice does not provide a sufficiently clear basis for relating the level of a particular interest rate to our ultimate objectives of growth and price stability.  o  The implication that the Federal Reserve could in fact achieve and maintain a particular level of relevant interest rates in a changing economic and financial environment is not warranted.  o  The very concept and measurement of a "real" interest rate, as called for in some proposals, is a matter of substantial ambiguity.  o  As a practical matter, attempts to target and fix interest rates would make more rigid and tend to politicize the entire process of monetary policy.  *That was not, as sometimes mistakenly thought, the operating approach used prior to October 1979. Then, reserves were provided with the aim of achieving and maintaining a particular Federal funds rate thought to be consistent with targets for the monetary aggregates. The Federal funds rate was a means to achieving a monetary target and in principle was to be handled flexibly. In practice, among other difficulties, there appeared to be a reluctance to permit rates to vary rapidly enough to maintain control of the aggregates.   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  -13-  In current circumstances, with huge budget deficits looming, a requirement that the Federal Reserve set explicit interest rate targets is bound to be interpreted as inflationary, and the rekindling of inflationary expectations will work against our objective. I realize the several legislative proposals addressed to targeting interest rates would, on their face, seem to call for interest rates as only one of several targets.  But interest  rates would certainly be the most obvious and sensitive target, and those targets would be difficult to change.  Other evidence  for a need to "tighten" or "ease" would be subordinated, if not ignored. As we approach the target-setting process for 1983, our objectives will -- indeed as required by law -- continue to be quantified in terms of growth in relevant money and credit aggregates.  We will have to decide how much weight to  place on M1 and other aggregates during a transitional period, assuming new accounts continue to distort the data.  In reaching  and implementing those decisions, the members of the FOMC necessarily rely upon their own analysis of the current and prospective course of business activity; the interrelationships among the aggregates, economic activity, and interest rates; and the implications of monetary growth for inflation.  In other words,  the process is not a simple mechanical one, and it seems to me capable of incorporating -- within a general framework of monetary discipline -- the elements of needed flexibility.  We will also,  as part of that process, review whether technical adjustments   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  -14-  in procedures for establishing and changing the reserve paths are appropriate.  I will be reporting our conclusions to the  Congress in February. Mr. Chairman, you have suggested that our monetary targets might reasonably be specified as a single number, with a range above and below.  At times we have debated  within the FOMC the wisdom of such an approach (or setting forth a single target number without a range).  My own feeling  has been, and remains, that a single number, with or without a range, would convey a specious sense of precision, with the result of greater pressure to meet a more or less arbitrary number to maintain "credibility," even if developments during the year tend to indicate some element of flexibility is appropriate in pursuit of the targets. To me, our present practice of setting forth a range is preferable.  Where appropriate, we can and should suggest  the probability of being in the upper or lower portion of the range, or suggest what conditions could evolve in which something other than the mid-points (or even an over or undershoot) would be appropriate.  That approach seems to me to  provide more information -- and more realism -- than a single number and is broadly consistent with present practice. For similar reasons, I believe we need to measure and target a variety of aggregates because, in a swiftly changing economic environment, any single target can be misleading:. In that connection, I believe an indication of total credit flows broadly consistent with the monetary targets could be helpful.  As you know, we now provide such estimates for bank  credit alone.  -15-  Given the limits of forecasting and analysis, and the volatility of the data, I would question the usefulness of further sectoral estimates.  Even with respect to total credit  flows, there is considerable looseness in relationships to economic activity for periods as long as a year -- and still more for shorter periods.  The theoretical framework relating  credit flows to other variables such as the GNP or inflation is less fully developed than in the case of monetary aggregates, and credit flows are less directly amenable to control.  The  enormous flows across international borders pose large conceptual and statistical problems.  Our credit data are typically  less complete and up-to-date than monetary data. However, so long as those difficulties and limitations are recognized -- and some of them are relevant with respect to the monetary aggregates as well -- I share the view that analysis of credit flows can contribute to policy formulation. To assist in that process, Iwill propose to the FOMC that estimates of the expected behavior of a broad credit aggregate be set forth alongside the monetary targets in our next report. I do strongly resist the idea of the Federal Reserve as an institution forecasting interest rates.  No institution or  individual is capable of judging accurately the myriad of forces working on market interest rates over time.  Expectational  elements play a strong role -- fundamentally expectations about the course of economic activity and inflation, but also, in the _  short run, expectations of Federal Reserve action.   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  We could not  -16-  escape the fact that a central bank forecast of interest rates would be itself a market factor.  To some degree, therefore,  in looking to interest rates and other market developments for information bearing on our policy decisions, we would be looking into a mirror.  Moreover, the temptation would always be present  to breech the thin line between a forecast and a desire or policy intention, with the result that operational policy decisions could be distorted. While it seems to me inappropriate for a central bank to regularly forecast interest rates, analysis of key factors influencing credit conditions and prices can be helpful at times. past.  On occasion, we have provided such analysis in the My concern about the outlook for fiscal policy is rooted  in major part in such analysis because the direction of impact on interest rates seems to me unambiguous.  I have also, on a  number of occasions, indicated that the recent and even current level of interest rates appears extraordinarily high, provided, as I believe, we continue to make progress on the inflation front.  Perhaps, in our semi-annual reporting, we can more  explicitly call attention to major factors likely to influence short or long-term interest rates and the significance for various sectors of the economy.  But I do not believe interest  rate forecasting would be desirable or long sustainable, and would in fact be damaging to the policy process. ;   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  .   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  -17-  Finally, Mr. Chairman, you have requested a "single composite forecast" of the major economic variables by FOMC members.  As you are well aware, our present practice is to  set forth a range of forecasts of individual FOMC members of the nominal and real GNP, prices, and unemployment.  The fact  is we have no single "Federal Reserve" forecast, and there is no mechanism, within a Committee or Board structure, to force agreement on such a forecast by individual members bringing different views, typically backed by separate staff analysis, to the table.  A simple average -- possibly supported by no  one -- seems to me artificial.  The process of attempting to  force a consensus would certainly dilute the product. I would put the point positively.  A range of forecasts  by individual FOMC members more accurately conveys the range of uncertainty and contingencies that must surround any forecast.  The seeming neatness and coherence of a single forecast  too often obscures the reality that a variety of outcomes is possible; the very essence of the policy problem is to assess risks and probabilities -- what can go wrong as well as what can go right.  A point forecast would likely be treated more  reverently than it would deserve, and could even distort policy judgments in misguided efforts to "hit" a forecast. I can understand your concern that a range of forecasts may be misleading if strongly influenced by "outlying" opinions rather than reflecting a more even dispersion of views.  For  that reason, I would be glad to explore with the Open Market  •   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  -18-  Committee a procedure by which we indicated the "central tendency" of members' views -- assuming such a central tendency exists -- as well as indicating the range of opinions.  Conversely, if the forecasts were evenly  distributed within the range, we could so indicate.  I  believe that approach would meet the objectives you seek in a realistic and helpful manner. In concluding this already long testimony, let me say that we share the common goals of achieving, in the words of the Employment Act of 1946 and the Humphrey Hawkins Act of 1978, "Maximum employment, production, and purchasing power" and "full employment . . . (and) reasonable price stability." Those objectives have eluded us for too many years.  We meet  again today in particularly difficult circumstances, and there is a sense of frustration and uncertainty among many. But I also happen to believe we have come a long way toward laying the base for economic growth and stability; economic recovery should characterize 1983, and that recovery can mark the beginning of a long period of stable growth. Obviously there are obstacles -- interest rates are still too high; inflation is down but not out; there are strains in our financial system; we face budget deficits that are far too high; we are tempted to turn inwards or backwards for quick solutions that ultimately can not work.  But it is  also plainly within our capacity to deal with those threats provided only that we have a strong base of understanding among   https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis  -19-  us, that we resolve to act where action is necessary, and that we have the patience and wisdom to refrain from actions that can only be destructive. You are leaving the Congress after 28 years, Mr. Chairman. Through that time, you have consistently provided constructive leadership to the effort to raise the level of economic discussion in general -- and of the dialogue between the Congress and the Federal Reserve in particular.  I happen to believe  strongly in the independence that the Congress has provided the Federal Reserve through the years -- but also in the need for close and continuing communication with the Congress and the Administration.  I presume that this is the last time I  will appear before you personally in this forum, but the dialogue will continue to benefit from your efforts, your initiative, and your sense of commitment in more ways than you may realize.  ;
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