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0.44.14 .0mis   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  Collection: Paul A. Volcker Papers Call Number: MC279  Box 13  Preferred Citation: Joint Economic Committee Testimony, 1982 June 15; Paul A. Volcker Papers, Box 13; Public Policy Papers, Department of Rare Books and Special Collections, Princeton University Library Find it online: http://findingaids.princeton.edu/collections/MC279/c237 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   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  For release on delivery 10:00 A.M., E.D.T. June 15, 1982  Statement by  Paul A. Volcker  Chairman, Board of Governors of the Federal Reserve System   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  before the  Joint Economic Committee  June 15, 1982  N •  cpg, c r--)  http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  I am pleased to appear before this Committee to discuss the conduct of monetary policy.  In particular, I would like to  focus on the monetary aggregates targeting framework in light of recent experience. The Federal Reserve began reporting to the Congress specific numerical "targets" for the growth of the monetary aggregates in 1975.  You will recall Congress had urged such  an approach in House Concurrent Resolution 133.  Subsequently,  the reporting of growth targets for the aggregates was formalized in law with the enactment of the Full Employment and Balanced Growth Act of 1978, commonly referred to as the Humphrey-Hawkins Act.  That law requires the Federal Reserve to present annual  targets for monetary and credit aggregates to the Congress each February, and to review those targets and formulate tentative objectives for the coming calendar year each July.  The choice  of the appropriate measures to "target," as well as the qua tative expression of those targets, are, of course, a matter for the Federal Reserve to decide. The development of this formal reporting framework, focusing on the growth of certain monetary and credit variables, was a reflection in part of changes in attitudes toward monetary policy that occurred in the 1970s, and in part of a desire to improve communications and reporting about our intentions and policies.  The worsening inflation problem focused increased  attention on the critical linkage over the longer run between money growth and prices.  There was a growing sense among some   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  2-  that earlier "conventional" views of a trade-off between inflation and growth were no longer compatible with actuality, at least over the medium and longer run, and that inflation had emerged as a major economic problem.  A number, including  some members of Congress, placed increased emphasis on restraining growth of the monetary aggregates over time as a means of dealing with inflation, and urged establishing our intentions in that respect over a longer period of time ahead.  More generally,  aggregate targeting was thought to provide the Congress with a more clearly observable measure of performance against intentions, which in turn implied that targets should not be changed frequently, or without clear justification. The formulation of specific monetary aggregates targets also has been consistent with the goals and approach of the Federal Reserve.  A basic premise of monetary policy is that  inflation cannot persist without excessive monetary growth, and it is our view that appropriately restrained growth of money and credit over the longer run is critical to achieving the ultimate objectives of reasonably stable prices and sustainable economic growth.  While other policies must be brought to bear  as well, the specific annual targets announced periodically by the Federal Reserve have reflected efforts to reconcile and support these goals. It seems to me implicit in an aggregate targeting approach, as urged by the Congress, that interest rates in themselves are not  % r   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  -3-  the dominant immediate objective or focus in assessing the posture of monetary policy, even though that remains the instinct of many.  Interest rates are, of course, highly important economic  variables, and they are intimately involved in the process by which the supply of money and other liquid assets are reconciled in the market with the demands for liquidity derived from the growth of the economy, inflation, and other factors.  But interest  rates are also importantly influenced by other forces as well, including expectations about inflation, about future interest rates, the budgetary posture, and other factors.  The experience  of the seventies emphasized some of the pitfalls and shortcomings of using interest rates as a guide for policy, particularly in an environment of generally rapid and rising inflation and correspondingly uncertain price expectations.  In those circumstances,  it is especially difficult to gauge the stimulative or restrictive influence associated with a given level of nominal interest rates. Recognition of these difficulties was an important element in the decision by the Federal Reserve to adopt procedures in October 1979 that placed emphasis, even in the shorter-run, on the supply of reserves rather than primarily on short-term interest rates as operational guides toward achieving an appropriate degree of monetary control. While all these considerations have suggested the use of the framework of monetary aggregates targeting, we need also to be conscious of the fact that the world as it is requires elements of judgment, interpretation, and flexibility in judging   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  4-  developments in money and credit and in setting appropriate targets.  One reason for that is the impact of financial  innovations on the growth of particular measures of money and the relationships among them.  In recent years, generally high  and variable interest rates, and the continuing process of technological change and the deregulation of depository institutions have provided powerful stimulus for far-reaching changes in the financial system.  The proliferation of new financial instruments  and the development of increasingly sophisticated cash management techniques have created a need to adjust the definitions of the monetary aggregates from time to time and to reassess the relationship of the various measures to one another and to other economic variables.  A somewhat separable matter conceptually (but in  practice hard to distinguish) is that businesses or families may shift their preferences among various financial assets in a manner that may alter the economic significance of particular changes in any given measure of "money" or "credit." Use of monetary targeting procedures is justified on the presumption that "velocity" -- that is, the ratio between a given measure of money and the nominal GNP -- is reasonably predictable over relevant periods.  At the same time, it can be  readily observed that, in the short run of a quarter or two, velocity is highly variable.  Those short-run deviations from trend need  to be assessed cautiously, for they commonly are reversed over a period of time.  However, we cannot always assume a rigid relation-  ship between money and the economy that, in fact, may not exist  % . 5-  -  6   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  over a cycle or over longer periods of time, especially when technology, interest rates, and expectations are changing.  Conse-  quently, it is appropriate that the Federal Open Market Committee reconsider on a continuing basis, both the appropriateness of its annual targets and the implications of shorter-run deviations of actual changes from the targeted track. The introduction of NOW accounts nationwide last year was illustrative of some of the difficulties arising from a changing financial structure.  To some degree, the Federal  Reserve was able to anticipate the impact.  It was obvious,  for example, that the rapid spread of NOW accounts, by drawing some money from savings accounts as well as demand deposits, would have important effects on the Ml aggregate, and last year's targets allowed for such effects.  However, after  accounting for these shifts into NOW accounts, the growth of the several aggregates was considerably more divergent than was anticipated, with Ml running relatively low while the increase in some of the broader aggregates was a bit above their annual objectives.  Taking into account all of the financial  innovations affecting the aggregates -- particularly the depressing effects on Ml of extraordinarily rapid growth in money market mutual funds -- and the relatively rapid growth of M2 and M3, we found the pattern of slow growth in Ml acceptable. Indeed, last year's experience seems to me a clear illustration of the need to consider a variety of money measures, rather than focusing exclusively on a single aggregate such as Ml.  %  •   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  6-  Thus far this year, the monetary aggregates have behaved more consistently, although Ml is running a bit stronger than anticipated relative to the other aggregates.  With the major  shift into NOW accounts, in terms of new accounts opened, mostly behind us, one source of distortion has been removed from the data.  But I would also note that, as a result of that "structural"  shift, NOW accounts and other interest-paying checkable deposits have grown to be almost 20 percent of Ml, and there is evidence that the cyclical behavior of Ml has been affected to some extent by this change in composition. While Ml is meant to be a measure of transactions balances, NOW accounts also have some characteristics of a savings account (including similar "ceiling" interest rates).  This year there  has been a noticeable increase in the public's desire to hold a portion of their saving  in highly liquid forms, probably  reflecting recession uncertainties.  As a result, NOW accounts  have grown particularly fast, accounting for the great bulk of the growth in Ml, and at the same time the rapid decline in savings deposits has ceased.  Overall, Ml growth so far this year has been  somewhat more rapid than a "straight line" path toward the annual target would imply.  To the extent the relatively strong demand  for Ml reflects transitory precautionary motives, allowing some additional growth of money over this period has been consistent with our general policy intentions.   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  7  In arriving at such a judgment, the pattern of growth in the broader aggregates should be considered.  There also  have been important institutional changes in recent years affecting the behavior of M2 and M3.  For example, an in-  creasingly large share of the components of M2 that are not also included in Ml pay market-determined interest rates. This reflects the spectacular growth of money market funds in recent years as well as the increasing availability at banks and thrift institutions of small-denomination time deposits with interest rate ceilings tied to market yields.  An important  consequence is that cyclical or other changes in the general level of interest rates do not have as strong an influence on the growth of M2 as in the past. The broader aggregates are presently at or just above the upper end of the ranges of growth set forth for the year as a whole.  In February, we reported to the Congress that M2 and  M3 would appropriately be in the upper half of their ranges, or at or even slightly above the upper end, should regulatory changes and the possibility of stronger savings flows prove to be important. In that regard, I must point out we have yet to go through a full financial cycle with such a large money fund industry or with the regulatory and legal changes recently introduced. In these circumstances, it is clear that interpreting the performance of the monetary and credit aggregates must be assessed against the background of economic and financial developments generally -- including the course of and prospects for business activity and prices, patterns of financing, and liquidity in various sectors, the international scene, and interest rates.  It is in that broader context that we have   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  8-  _  not believed that the growth of the various Ms has been unduly large so far this year. The point I am making is that a large number of factors have impinged -- and in all likelihood will continue to impinge on the growth of the monetary aggregates, possibly in the process modifying the relationship of any particular measure of "money" to economic performance.  The relationships have been good enough  over a period of time to justify a presumption of stability -but I do believe we must also take into account a wide range of financial and nonfinancial information when assessing whether the growth of the aggregates is consistent with the policy intentions of the Federal Reserve.  The hard truth is that  there inevitably is a critical need for judgment in the conduct of monetary policy. Looking back at the last  .ew years, money growth has  certainly fluctuated rather sharply from time to time in the United States (and, I might note, in other countries as well). As I earlier noted, relationships have also been affected by a variety of financial innovations.  But the trend over reasonable  spans of time has generally been consistent with the announced targets of the Federal Reserve, and the restrained growth has, in my judgment, contributed importantly to the now clear progress toward reducing inflation.  This longer-run and broader perspective  is what should be kept in mind when considering growth in the   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  9-  aggregates.  The tentative decision (not yet implemented)to publish  the Ml data in the form of four-week moving averages is designed to divert undue attention from the statistical "noise" in the weekly movements in Ml and to encourage knowledgeable observers to focus on broader trends in the whole family of aggregates. One obvious frustration in the current circumstances is that interest rates, particularly longer-term rates, still are painfully high despite the protracted weakness in the real economy and a marked deceleration in the measured rate of inflation. With the unemployment rate currently at a new postwar high, there is an understandable inclination to want to get interest rates down quickly to encourage a rebound in activity. Nothing would please me more than for interest rates to decline, and the progress we are making on inflation, as it is sustained, should powerfully work in that direction.  But, I  also know that it would be shortsighted for the Federal Reserve to abandon a strong sense of discipline in monetary policy in an attempt to bring down interest rates.  It may be that the immediate  effect of encouraging faster growth in the aggregates would be lower interest rates -- particularly in short-term markets.  But  over time, the more important influence on interest rates particularly longer-term interest rates  is the climate of  expectations about the economy and inflation, and the balance of savings and investment.  In that context, an effort to drive  interest rates lower by money creation in excess of longer-run needs and intentions would ultimately fail in its purpose and would threaten to perpetuate policy difficulties and dilemmas of the past.   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  -10• , it When long-term interest rates decline decisively udes about will be an indication of an important change in attit the prospects for the economy.  One essential element in this  will be process must be a widespread conviction that inflation contained over the long run.  The decline in inflation evident in  all of the broadly based price indices over the past year is highly encouraging.  For example, in the 12-month period ending in April,  2 percent compared to 10 percent over the previous / the CPI rose 61 12 months.  Over the past few months, the CPI has been virtually  stable. But it is also evident that some particular elements inable; accounting for the sharp reduction in inflation are not susta markets, they have been achieved in a period of recession and slack s that and have reflected some sizable declines in energy price now appear behind us.  Progress toward reducing the underlying  trend in costs, while real, has been slower.  We have seen some  polls that suggest many Americans do not in fact appreciate that inflation has slowed at all. to fact.  That impression is plainly contrary  But it is perhaps indicative of how deep seated impressions  it and expectations of inflation had become by the late 1970s, and is suggestive of the concern of renewed higher inflation rates as economic activity recovers.  No doubt those concerns continue to  affect investment judgments and interest rates. In this situation, one key policy objective must be to in "build in" what has so far been a partly cyclical decline  -11-  inflation, to encourage further reductions in the rate of increase in nominal costs and wages, and then to establish clearly a trend toward price stability.  That approach seems  to me essential to encourage and sustain lower long-term interest rates, which will, in turn, be important in sustaining economic growth. While monetary policy is only one of the instruments that can be brought to bear in restoring price stability, it is both necessary to that effort and widely recognized to be such.  These  circumstances emphasize the need to avoid excessive monetary growth, with the threat it would bring that the heartening progress against inflation would prove only temporary. I think that it also is quite clear that the prospect of huge and rising budget deficits as the economy recovers has been another element in the current situation rag concerns about long-term pressures on interest rates.  I take encouragement  from the efforts of the House and Senate to begin to come to grips with this problem.  At the same time, we are all aware of how much  remains to be done, not only to reach agreement on a budget resolution for fiscal 1983, but to take the action necessary to implement such a resolution in appropriation and revenue legislation.  Moreover,  as you well know, further legislation will be needed beyond that affecting fiscal 1983 to assure elements in the structural deficit are brought more firmly under control. Let me emphasize that a strong program of credible budget restraint will itself w5rk in the direction 5f l5wer interest rates.   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  -12-  The perception that future credit demands by the Federal Government would be lower would reinforce the emerging expectations of less inflation.  The threat that huge deficits  would preempt the bulk of the net savings the economy seems likely to generate in the years ahead -- with the likely consequence of exceptionally high real interest rates continuing -would be dissipated.  Confidence would be enhanced that monetary  policy will be able to maintain a non-inflationary course, without squeezing of homebuilding, business investment, and other interest-sensitive sectors of the economy, and without excessive financial strains in the economy generally.  And by  dealing with very real concerns about the future financial environment, budgetary action would be an important support to the recovery today. In summary, casting monetary policy objectives in terms of the aggregates has been a useful discipline and also has been helpful in communicating to Congress, the markets, and the general public the intent and results of the Federal Reserve actions. At the same time, we must retain some element of caution in their interpretation; the monetary targets convey a sense of simplicity that may not always be justified in a complex economic and financial environment.  There is far from universal appreciation  of the fact that the economic significance of particular aggregates is constantly evolving in response to rapid changes in financial markets and practices.  Consequently, the Federal Reserve is  continually faced with difficult judgments about the implications for the economy.   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  -13-  As you know, the Federal Open Market Committee soon will be meeting to review the annual targets for the monetary aggregates for 1982 and to formulate tentative targets for 1983. I would not presume to anticipate the precise decisions that will be made by the Committee.  A wide array of financial and  nonfinancial information will be reviewed in the process of considering the specific objectives.  And, while I do not  anticipate any significant change in our operating procedures in the near term, we will also continue to assess and reassess the means by which our policies are implemented.  However, I do  believe that you can assume that the decisions that do emerge from this review will reflect our continued commitment to disciplined monetary policy in the interest of sustaining progress toward price stability -- and, not incidentally, of encouraging a financial climate conducive to achieving and sustaining lower interest rates. We can not yet claim victory against inflation, in fact or in public attitudes.  But I do sense substantial progress  and a clear opportunity to reverse the debilitating pattern of growing inflation, slowing productivity, and rising unemployment of the 1970s.  The challenge is to make this recession not another  wasted, painful episode, but a transition to a sustained improvement in the economic environment. Central to that effort is an appropriate course for fiscal and monetary policy -- a course appropriate, and seen to be appropriate, for the years ahead.   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  Critical elements in that effort   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  -14-  are the commitments to gain control of the federal budget and to maintain appropriate monetary restraint.  Those policies  provide the best -- indeed the only real -- assurance that financial market conditions will be conducive to a sustained period of economic growth and rising employment and productivity. In the long years to come, we want to look back to our present circumstances and know that the pain and uncertainty of today have, in fact, been a turning point to something much better.  GRowTH OF TARGETED MRY AGGREGATEs (PERCEN CHANGE)  COUNTRY *********** ***CANADA  TARGETED AGGREGATE *********  TARGET PERIOD **************  N:1  PRESENT AUG.-OCT. 1980  4-6  DEC. 1982 DEC. 1981  12.5-13.5X  FRANCE  TARGET **********  FROM TARGET BASE PERIOD ***********  OVER LAST 12 MONTHS *********  OVER LAST 6 MONTHS *********  OVER LAST 3 MONTHS *********  LAST OBSERVATION ***********  .7  -2.5  2.9  -4.0  MARCH  20.8  12.5  11.2  20.8  MARCH  9.6  APRIL  GERMANY  CBM  Q4 1982 Q4 1981  4-7%  7.5  4.7  6.2  JAPAN  M2*  Q2 1982 Q2 1981  10%  7.0  9.8  6.7  APRIL  SWITZERLAND  ADJUSTED CB%!  1982 1981  3%  -.5  1.6  7.0  APRIL  UNITED KINGDOM  ml  APR. 1983 FEB. 1982  8-12%  -3.6  3.9  3.5  APRIL  Lm3  APR. 1983 FEB. 1982  8-12%  6.8  12.6  7.0  APRIL  PSL2  APR. 1983 FEB. 1982  8-12%  6.7  11.4  7.2  9.7  MARCH  Ni  Q4 1982 Q4 1981  2.5-5.5%  8.9  4.4  9.3  3.6  APRIL  M2  04 1982 Q4 1981  6-9%  10.0  9.1  10.4  8.8  APRIL  UNITED STATES  *****************************************A******************************  *FoRECAST GROwTH OF ki2.  TARGETS ARE NOT SET.  ALL DATA SEASONALLY ADJUSTED EXCEPT FOR SWITZERLAND. ALL GROWTH RATES COkTOUNDED AND ANNUALIZED.  ***As a result of statistical reporting problems in the calculation of the Canadian aggregates, particularly with respect to Ml, the Bank of Canada has decided not to publish the seasonally monetary adjusted monthly averages for the  various monetary aggregates for kpril unitl they discover the sources of reporting discrepancies. http://fraser.stlouisfed.org/ r Federal Reserve Bank of St. Louis  -6M.4  4: Rates of Growth of Alternative Monetary Aggregates: 1974-1981 (percent change, fourth quarter to fourth quarter)  Aggregate + M1 M1B M2 M3  1975 1974  1976 1975  1977 1976  1978 1977  1979 1978  1980 1979  1981 1980  21.10 16.81 14.89 13.78  2.43 1.71 13.28 19.20  10.19 9.13 12.04 14.21  10.66 8.51 12.32 16.21  4.22 2.34 17.29 18.53  9.37 8.41 16.45 10.77  -3.81 -5.33 15.39 16.87  France  M1+ M2  15.26 17.70  10.69 14.16  9.35 13.03  12.05 12.74  10.84 13.60  8.78 10.41  15.34 12.27  Germany  M1 M2 M3+ CBM  15.17 -0.39 8.90 9.47  6.47 8.37 9.72 9.07  10.38 9.51 10.25 9.44  13.39 13.77 11.31 11.94  4.42 7.60 5.78 6.38  4.49 9.25 5.92 4.76  -1.73 9.73 5.34 3.55  M1 M2  10.25 22.28  21.25 21.28  20.33 20.62  24.98 22.76  25.12 21.21  11.95 11.49  8.63 8.99  M1 M2  10.90 14.51  14.74 14.34  5.92 10.53  12.29 12.61  5.61 10.26  -1.43 7.82  9.51 10.38  Adj. CBM+ M1 M2  3.64 5.46 n.a.  2.33 7.49 n.a,  7.43 5.13 6.93  30.04 22.74 8.81  -13.80 -2.38 11.25  -0.48 -4.35 14.92  -2.45 -7.34 14.54  23.92 9.37 8.78 n.a.  13.50 13.16 10.79 11.75  19.03 6.92 7.48 8.81  15.29 14.89 13.95 14.51  10.89 12.65 12.99 14.46  4.03 18.14 19.13 13.08  9.50 21.46 14.64 12.28  4.98 12.17  6.19 13.60  8.17 11.45  8.22 8.24  7.41 8.43  7.33 9.16  2.28 9.48  Country Canada  Italy  Switzerland  United Kingdom  United States  + *  + M1 M3+ LM3 PSL2 +* M1 + M2  Currently targeted aggregate. 1981 data are Ml-B, shift adjusted.  •  http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  June 11, 1982  To:  Board of Governors  From:  Don Winn A Li  o The Budget Resolution adopted yesterday by the House contains language about monetary policy identical to that adopted earlier by the Senate: "Sec. 310. It is the sense of the Congress that if the Congress acts to restore fiscal responsibility and reduces projected deficits in a substantial and permanent way, then the Federal Reserve Open Market Committee shall reevaluate its monetary targets in order to assure that they are fully complementary to a new and more restrained fiscal policy."  o Attached is a copy of the letter that the trade groups have sent to Senator Garn.  o The House Securities Subcommittee yesterday, in connection with the CFTC reauthorization bill, adopted an amendment putting the Federal Reserve in charge of a major two-year study of financial futures and stock index futures. The CFTC, SEC, and Treasury are to assist in the study. The Subcommittee also adopted an amendment requiring joint approval of stock index futures by the SEC as well as the CFTC. Attached is a copy of the amendment prescribing the study to be conducted by the Federal Reserve.  Attachments cc: Messrs. Axilrod, Bradfield, Coyne, Kichline, Schwartz, Soss, Wiles, Kohn, Plotkin   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  June 9, 1982  The Honorable Jake Garn Chairman Committee on Banking, Housing and Urban Affairs 5300 Dirksen Senate Office Building Washington, D.C. 20510 Dear Mr. Chairman: Banking, Housing and Urban ate Sen the on s gue lea col r you and We urge you process on the major financial ve ati isl leg the ue tin con to tee mit Can Affairs lly we request you to schedule ica cif Spe . you ore bef ues iss ons uti instit 2531, and S. 2532. promptly a meeting to vote on S. 1720, S. , but we are confident that the We may not be able to agree on all issues work, produce a result that all of political process can, if permitted to common threat to the institutions us will be able to accept. The greatest the status -quo. There nge cha to e don be l wil g hin not t tha we represent is is no better time to act than now. Sincerely, 7  ) Lt  Roy G. G U.S. L  •1 -  en, Chairman f Savings  Llewellyn Je American Banker  sociations  si ent ociation  N. Cugini, Chairman Union National Association  'resident Robert B. 0 ien, National Savings and Loan League  irman Bruning, Charles l Community Banking Leaders Counci American Bankers Association  ames F. Aylward,esident America Mortgage Bankers Association of  Aesr• Anderson, President og Ass ciation of Reserve City Bankers  -Furlong Bal an, Chairman ies Association of Bank Holding Compan •  /1„, 7 ,1 Herbert W. Gray, Chainnan National Association of NUt Savings Banks  tchinson, President J. tional Association of Federal redit..Unions  en a o Board of Directors Dealer Bank Association  JH412  AMENDMENT TO H.R. 5447 OFFERED BY  (References to pages and lines are references to pages and lines of the bill as reported by the Committee on Agriculture)  Page 72, strike out line 13 and all that follows through line 19 on page 74, and insert in lieu thereof the following new section:  1  2 3 4  STUDY OF THE COMMODITY FUTURES INDUSTRY  SEC. 237.  The Commodity Exchange Act is amended by  adding at the end thereof the following new section: "SEC. 23. (a)(1) The Board of Governors of the Federal  5  Reserve shall organize and conduct, with the assistance of  6  the Commodity Futures Trading Commission, the Securities and  7  Exchange Commission, and the Secretary of the Treasury, a  8  study and investigation of the structure, participation,  9  uses, and effects on the economy, of trading in contracts of  10  sale of commodities (including commodities which are rights  11  and interests in evidences of indebtedness, foreign  12  currency, securities, any group or index of securities,  13  other financial instruments, and related instruments, such  14  as options) for future delivery, including--  15   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  "(A) the number, types, and characteristics of  JH412 2 1  speculators, arbitrageurs, and hedgers engaged in such  2  trading, the purposes for which such persons utilize  3  such trading, and the financial resources devoted to  4  each of these trading activities;  5  "(B) the impact of speculation in such trading on  6  the accuracy, liquidity, and stability of cash and  7  contract prices, and the conditions under which such  8  speculation may have adverse effects on these  9  objectives, particularly with respect to the increased  10 11  volume of such trading; "(C) the consequences that present and anticipated  12  volumes of trading in such contracts and related  13  instruments have, if any, on formation of real capital  14  in the economy (particularly that of a long-term nature)  15  the structure of liquidity in credit markets, interest  16  rates, and inflation;  17  "(D) the sufficiency of the public policy tools  18  available to the Commission or other agencies to limit  19  or curtail any such trading activity which is found  20  likely to have a harmful effect on national economic  21  goals;  22  "(E) the economic purposes, if any, served by such  23  trading, including the extent to which such contracts  24  and related instruments are utilized for hedging and  25  risk aversion purposes or for speculation;   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  JI-1412 3 the adequacy of investor protections afforded 2  to participants in designated markets for such trading; the impact, if any, of such contracts and  4  related instruments on the markets for evidences of  5  indebtedness, foreign currency, and securities and on  6  the formation of real capital; the extent to which such contracts and related  8  instruments may be utilized to manipulate, or to profit  9  from the manipulation of, the markets for evidences of  10  indebtedness, foreign currency, and securities; the nature and consequences, if any, of  12  perceived disparities between the regulation of such  13  contracts and related instruments traded in contract  14  markets regulated by the Commission and the regulation  15  of functionally equivalent instruments traded in markets  16  regulated by the Securities and Exchange Commission; and the operation of the pilot program established  18  under subsection  19  "(2) Not later than March 31, 1984, the Board of  20  Govenors of the Federal Reserve shall submit to the Congress  21  and transmit to the Commission a preliminary report  22  describing the results of the part of such study relating to  23  trading in contracts of sale of commodities which are rights  24  and interests in any group or index of securities and  25  related instruments, for future delivery. The Board of   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  JH412 4 1 2 3  Governors shall include in such report-"(A) findings with respect to the economic benefits, if any, that have resulted from such trading;  4  "(B) a description of any adverse effects on the  5  underlying markets in securities, on the formation of  6  real capital, and on investor protection, that may have  7  resulted from such trading; and  8  "(C) recommendations as to Whether such trading  9  should be permitted to continue after the termination of  10  the pilot program established under subsection (b)(1),  11  and, if continuation of such trading is recommended,  12  whether any legislation or regulatory action applicable  13  to such trading is necessary to mitigate any adverse  14  effects found to have resulted from such trading or is  15  necessary to eliminate any perceived disparities between  16  the regulation of such trading and the regulation of  17  trading in other comparable instruments.  18  "(3) Not later than September 30, 1984, the Board of  19  Governors of the Federal Reserve shall submit to the  20  Congress a report describing the results of such study. The  21  Board of Governors shall include in such report an  22  assessment of the impacts of the activities studied and  23  recommendations for any legislation and regulatory action.  24 25   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  "(b)(1) For the period beginning on the date of the enactment of the Futures Trading Act of 1982 and ending  JH412 5  1  September 30, 1984, all boards of trade designated, before  2  or after the date of the enactment of the Futures Trading  3  Act of 1982, as contract markets for trading in contracts in  4  rights or interests in a group or index of securities for  5  future delivery shall be subject to a pilot program with .  6  respect to such trading, to be established by the Commission  7  by rule, regulation, or order. Under such pilot program, the  8  Commission shall closely monitor such trading and shall make  9  an assessment of the impact, if any, of such trading on the  10  markets in the underlying securities and on the process of  11  forming real capital.  12  "(2) If the Board of Governors of the Federal Reserve  13  recommends, in the preliminary report transmitted under  14  subsection (a)(2), that trading in such contracts be  15  terminated or that other regulatory or legislative action be  16  taken, then the Commission shall submit a report to the  17  Congress, not later than September 30, 1984, containing a  18  plan to implement the recommendations of the Board of  19  Governors or a statement of reasons in support of the  20  Commission's opinion that such recommendations should not be  21  implemented.".   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  •  -8-  LABOR PRODUCTIVITY AND COSTS, NONFARM BUSINESS SECTOR (Percent change at annual rates; based on seasonally adjusted data)  Compensation per hour From From previous year period earlier  •  Output per hour From From previous year period earlier  Unit labor costs From From previous year period earlier  1979-QI QII QIII QIV  9.2 9.8 9.8 9.9  10.9 10.4 8.6 9.7  -.1 -.8 -1.0 -.9  -.9 -1.6 -1.1 -.2  9.3 10.7 11.0 10.9  11.9 12.1 9.7 9.9  1980-QI QII QIII QIV  9.7 9.9 10.1 10.1  10.3 11.3 9.0 9.8  -.6 -1.0 .2 .2  .3 -2.9 3.6 -.2  10.4 11.0 9.9 9.9  9.9 14.6 5.3 10.1  1981-QI QII QIII QIV  10.5 10.0 10.2 9.3  11.7 9.6 9.5 6.3  1.2 2.3 .9 -.8  4.4 1.4 -1.7 -6.9  9.2 7.6 9.2 10.1  7.0 8.1 11.5 14.1  8.3  7.9  -1.7  .5  10.2  7.3  1982-QI  Peak-to-peak changes: 1 1948-Q4 1953-Q2 1957-Q3 1960-Q2 1969-Q4 1973-Q4  -  1953-Q2 1957-Q3 1960-Q2 1969-Q4 1973-Q4 1980-Q1  5.7 4.6 4.2 4.9 7.0 9.0  2.7 1.7 2.3 2.5 2.5 .7  1. These time periods represent the intervals between NBER-designated business cycle peaks.   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  2.9 2.8 1.8 2.4 4.4 8.3  June 7, 1982  -9Average Hourly Earnings Index* Production workers private nonfarm industries Per cent changes; based on seasonally adjusted indexes Mir  Total private nonfarm  Period 1  Manufacturing _  Changes over year 1973 1974 1975 1976 1977 1978 1979 1980 1981  •  5.0 8.0 5.0 6.8 4.1 7.6 6.7 7.7 8.1  6.4 10.4 8.7 7.4 8.3 8.5 8,7 10.9 8.8  6.3 9.1 7.4 7.3 7.5 8.4 8.0 9.6 8.4  Transportation and public utilities  Contract construction  Total trade  Services  _  7.4 8.8 9.0 8.1 9.2 7.3 8.9 9.3 8.5  6.3 8.8 6.5 7.1 7.4 9.6 7.5 8.8 7.1  6.2 8.3 7.0 7.6 7.1 7.6 7.6 9.5 9.1  Half-yearly changes at compound annual rates 1979:  1st half 2nd half  7.6 8.4  9.0 8.3  7.4 6.1  6.4 11.6  7.5 7.5  6.1 9.2  1980:  1st half 2nd half  9.5 9,7  10.9 10.9  7.4 8.1  8.3 10.4  8.8 8.7  9.4 9.6  1981:  1st half 2nd half  8.9 7.9  9.4 8.2  7.4 8.9  10.0 7.0  8.1 6.1  9.0 9.3  III Quarterly changes at compound annual rates 1980-Q1 Q2 Q3 Q4  9.0 10.0 9.2 10.3  10.2 11.6 12.0 9.8  4.6 10.2 7.4 8.8  7.6 8.9 7.0 13.9  9.7 7.9 9.1 8.4  8.5 10.2 7.4 11.8  1981-Q1 Q2 Q3 Q4  9.3 8.5 8.5 7.3  9.4 9.4 8.7 7.7  9.2 5.7 8.9 8.8  9,1 11.0 6.4 7.7  9.1 7.1 8.0 4.3  9.1 8.9 9.3 9.2  1982-Q1  6.5  8.7  9.1  7.4  3.8  5.1  6.4 10.0 6.5 10.1 4.0 2.6 .2 9.9  -4.5 6.7 4.0 3.4 3.0 2.7 7.3 9.4  9.6 11.3 3.5 6.7 2.7 1.3 11.3 10.7  i Monthly changes at annual rates 1981:  1982:  October November December January February March April May  4.7 9.0 3.9 11.6 .9 3.5 6.6 9.4  5.5 8.1 4.1 16.3 2.0 6.4 6.5 6.8  11.1 8.5 8.1 29.3 -17.5 1.6 2.3 5.6  , __,..._ *Excludes effects of fluctuations in overtime premiums in manufacturing and of shifts of workers between industries. 1 For periods of longer than one month the changes are based on quarterly averages of final quarter of preceding period to final quarter of period indicated.   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  FR 712-N Rev. 4/81  t=  •  itt  •  > ‘`) **--  uh,  •\ vN  tN)  • - .1.1k,01  "C7  11111111.1  P111111111111111111111LIEMIPII IIMVII  11_ ll!l IMINlie i>i7 ,;:iFAItZriN  j.  ri  •  I 11111111 ill11111111111111111111 11111.1111111111111 111111111111111 111111111111111131111111z.1111111An r;l1n 111 111116111111111111M11111111 1111111111111111111111 111111111.11111111111111111111111111111111111111LIM 3111111;2611 MU 1111 1111 uur1 niui111111 iivaiuiu11111M 11111111111111111111111111111111 ill111111111111111110111111111111111411111111111 fl 1111111111 1111111111111111111111111g1MININI MEM 111111111111111114111111111 MIME 11111111111111111111111111111111111111111111111111111111111111111111111 11111111111111111111 11111111111111111111111111 111 111111111111111111111111 11 1111111 1111111 1111111111111111111111111111111J tp is• a; 11111111E MM 11111111111111111111111CO 1111111111111111 111111111111111111111111111111illill BIM E11111111111111111111111111111 I NMI 1111111111111111111t,t.;) 11111111111111 111111111111111111111111111111111 1111111111111111111111111111 111111111111NOIIIIIIII ammtim MI 1111111111111111111101: --c:F• 111111111111111111111111111111111111111111111111111111 1111111111111111111111M11111111111111111111111111111111111111111111 u :T= zip 7:3-t) 1111111=1E_ 11=111111111111111 I 11=1111111 111111111111its ,,,s illetz;1111i14„111 ilm111 mm 11111111 o11111111 l 1111111M6 i i 1111111111111111111111 i  RH i1  ••••••  44*  111111111111111111011111110111110  111111111161111111111111111 ' -1 4 11111111111111   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  GROWTH RATES OF KEY BANKING AND MONETARY AGGREGATES  (Daily averages, percent annual rates, seasonally adjusted)  June 11, 1982 ,  QIV '81 YEAR OVER YEAR 4 TO 1 LATEST LATEST:LATEST YEAR TO LATEST MONTH 4 WKS.I3 MOS. DATE MONTH  RESERVE AGGREGATES MONETARY BASE* NONBORROWED RESERVES* TOTAL RESERVES*  (May) (tM d i(MaTi. av-i5.9 7.6 4.3  i  q1-11 ZY  MEMORANDA: ANNUAL GROWTH QIV TO QIV r ,  (May)  1979  1980 i 1981  1  YEAR OVER YEAR  1979  1980  1  1981  6.1 7.7 4.5  5.7 5.0 4.5  7.7 4.8 4.8  7.7 4.0 5.4  7.6 0.0 2.5  8.8 7.8 7.1  4.9 6.8 4.3  7.6 0.3 1.6  8.3 5.8 5.8  6.8 6.9 6.5  MONETARY AGGREGATES AND BANK CREDIT M1  5.1 (4.5)  5.3  5.0 (4.3)  5.8 (4.7)  6.7  7.4  7.3  5.0 (2.3)  7.7  6.3  7.0 (4.7)  M2  9.4  n.a.  9.4  9.7  9.7  8.4  9.2  9.5  8.5  8.3  9.8  M3  10.2  n.a.  10.3  10.5  9.6  9.8  10.0  11.4  10.3  9.3  11.6  8.4  n.a.  8.8  8.5  1/ 8.5-  12.6  8.0  8.8  13.5  8.5  9.6  6.6  6.9  6.2  6.3  8.5  9.4  9.4  5.6  9.8  BANK CREDIT  MEMORANDUM CURRENCY  9.2 7.3 I I I NOTE: FIGURES IN PARENTHESES REPRESENT GROWTH ADJUSTED FOR SHIFTS FROM NON-M1 SOURCES TO OCD ACCOUNTS IN 1981. * RESERVES SERIES ARE ADJUSTED FOR CHANGES IN REGULATIONS D AND M. N.A.--NOT AVAILABLE.  1/  LATEST MONTH OVER THE DECEMBER-JANUARY BASE.   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  -13-  MONETARY AGGREGATES AND BANK CREDIT (Percent annual rates of change)  M1 Fourth quarter to fourth quarter 1978  Monetary Aggregates M2  M3  Bank Credit  8.3  8.2  11.3  13.3  7.4  8.4  9.8  12.6  1979  7.3  9.2  10.0  8.0  1980  5.0 (2.3)1  9.5  11.4  8.82  1981  8.2  8.8  11.7  12.4  7.7  8.5  10.3  13.5  1979  6.3  8.3  9.3  8.5  1980  7.0 (4.7)1  9.8  11.6  9.6 2  1981  .3  8.3  11.2  8.7  5.7  8.8  9.2  5.82  10.4  9.7  8.6  9.52  April  11.0  9.7  11.4  9.32  -2.7  9.5  9.9  8.82  May  6.7  9.7  9.6  8.54  Annual average to annual average 1978  Recent Periods 1981--QIII QIV 1982--QI  1981 QIV-May Longer-run ranges 1979 QIV-1980 QIV 1980 QIV-1981 QIV  23 / 4 to 61 2 to 61 1 3/  6 to 9  to 91 61, 2  6 to 9  6 to 9  2 / 2 to 91 1 6/  6 to 9  6 to 95 2 1 6. 5 to 9/ 6 to 9 2 1 2 to 5/ 1 2/ 1981 QIV-1982 QIV out of savings deposits into other 1. Adjusted for the effects of shifts checkable deposits. domestic offices to International 2. Adjusted for shifts of assets from Banking Facilities (IBFs). o other checkable deposits in 1980 3. When this range was set, shifts int effect on M1 growth. As the year prowere expected to have only a limited checkable deposits more actively, and gressed, however, banks offered other to these accounts. Such shifts are more funds than expected were directed over 1980 by at least 1/2 percentage estimated to have increased M1 growth point more than had been anticipated. wth from the base period through 4. May over December-January base. Gro domestic offices to IBFs since May adjusted for shifts of assets from January is 9.8 percent. m the December 1981-January 1982 5. Range for bank credit is growth fro 2. average level through fourth quarter 198   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  Removal Notice The item(s) identified below have been removed in accordance with FRASER's policy on handling sensitive information in digitization projects due to copyright protections.  Citation Information Document Type: News service reports Citations:  Number of Pages Removed: 5  Associated Press. "Bank for International Settlements Sees Difficulties in Cutting Budget Spending." June 14, 1982. Associated Press. "BIS Calls for Wage Curbs to Check Rise of Unemployment." June 14, 1982.  Federal Reserve Bank of St. Louis  https://fraser.stlouisfed.org  "V  For release on delivery 10:00 A.M., E.D.T. June 15, 1982  Statement by  Paul A. Volcker  Chairman, Board of Governors of the Federal Reserve System   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  before the  Joint Economic Committee  June 15, 1982  I am pleased to appear before this Committee to discuss the conduct of monetary policy.  In particular, I would like to  focus on the monetary aggregates targeting framework in light of recent experience. The Federal Reserve began reporting to the Congress specific numerical "targets" for the growth of the monetary aggregates in 1975.  You will recall Congress had urged such  an approach in House Concurrent Resolution 133.  Subsequently,  the reporting of growth targets for the aggregates was formalized in law with the enactment of the Full Employment and Balanced Growth Act of 1978, commonly referred to as the Humphrey-Hawkins Act.  That law requires the Federal Reserve to present annual  targets for monetary and credit aggregates to the Congress each February, and to review those targets and formulate tentative objectives for the coming calendar year each July.  The choice  of the appropriate measures to "target," as well as the quantitative expression of those targets, are, of course, a matter for the Federal Reserve to decide. The development of this formal reporting framework, focusing on the growth of certain monetary and credit variables, was a reflection in part of changes in attitudes toward monetary policy that occurred in the 1970s, and in part of a desire to improve communications and reporting about our intentions and policies.  The worsening inflation problem focused increased  attention on the critical linkage over the longer run between money growth and prices.   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  There was a growing sense among some   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  -2-  that earlier "conventional" views of a trade-off between inflation and growth were no longer compatible with actuality, at least over the medium and longer run, and that inflation had emerged as a major economic problem.  A number, including  some members of Congress, placed increased emphasis on restraining growth of the monetary aggregates over time as a means of dealing with inflation, and urged establishing our intentions in that respect over a longer period of time ahead.  More generally,  aggregate targeting was thought to provide the Congress with a more clearly observable measure of performance against intentions, which in turn implied that targets should not be changed frequently, or without clear justification. The formulation of specific monetary aggregates targets also has been consistent with the goals and approach of the Federal Reserve.  A basic premise of monetary policy is that  inflation cannot persist without excessive monetary growth, and it is our view that appropriately restrained growth of money and credit over the longer run is critical to achieving the ultimate objectives of reasonably stable prices and sustainable economic growth.  While other policies must be brought to bear  as well, the specc annual targets announced periodically by the Federal Reserve have reflected efforts to reconcile and support these goals. It seems to me implicit in an aggregate targeting approach, as urged by the Congress, that interest rates in themselves are not  3_  _  the dominant immediate objective or focus in assessing the posture of monetary policy, even though that remains the instinct of many.  Interest rates are, of course, highly important economic  variables, and they are intimately involved in the process by which the supply of money and other liquid assets are reconciled in the market with the demands for liquidity derived from the growth of the economy, inflation, and other factors.  But interest  rates are also importantly influenced by other forces as well, including expectations about inflation, about future interest rates, the budgetary posture, and other factors.  The experience  of the seventies emphasized some of the pitfalls and shortcomings of using interest rates as a guide for policy, particularly in an environment of generally rapid and rising inflation and correspondingly uncertain price expectations.  In those circumstances,  it is especially difficult to gauge the stimulative or restrictive influence associated with a given level of nominal interest rates. Recognition of these difficulties was an important element in the decision by the Federal Reserve to adopt procedures in October 1979 that placed emphasis, even in the shorter-run, on the supply of reserves rather than primarily on short-term interest rates as operational guides toward achieving an appropriate degree of monetary control. While all these considerations have suggested the use of the framework of monetary aggregates targeting, we need also to be conscious of the fact that the world as it is requires elements of judgment, interpretation, and flexibility in judging   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  -4  developments in money and credit and in setting appropriate targets.  One reason for that is the impact of financial  innovations on the growth of particular measures of money and the relationships among them.  In recent years, generally high  and variable interest rates, and the continuing process of tutions technological change and the deregulation of depository insti have provided powerful stimulus for far-reaching changes in the financial system.  The proliferation of new financial instruments  ement and the development of increasingly sophisticated cash manag techniques have created a need to adjust the definitions of the relationmonetary aggregates from time to time and to reassess the mic ship of the various measures to one another and to other econo variables.  A somewhat separable matter conceptually (but in  may practice hard to distinguish) is that businesses or families r shift their preferences among various financial assets in a manne in that may alter the economic significance of particular changes any given measure of "money" or "credit." Use of monetary targeting procedures is justified on the presumption that "velocity" -- that is, the ratio between a given measure of money and the nominal GNP -- is reasonably predictable over relevant periods.  At the same time, it can be  veloreadily observed that, in the short run of a quarter or two, city is highly variable.  Those short-run deviations from trend need  over a to be assessed cautiously, for they commonly are reversed period of time.  However, we cannot always assume a rigid relation-  ship between money and the economy that, in fact, may not exist   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  5-  _  over a cycle or over longer periods of time, especially when technology, interest rates, and expectations are changing.  Conse-  quently, it is appropriate that the Federal Open Market Committee reconsider on a continuing basis, both the appropriateness of its annual targets and the implications of shorter-run deviations of actual changes from the targeted track. The introduction of NOW accounts nationwide last year was illustrative of some of the difficulties arising from a changing financial structure.  To some degree, the Federal  Reserve was able to anticipate the impact.  It was obvious,  for example, that the rapid spread of NOW accounts, by drawing some money from savings accounts as well as demand deposits, would have important effects on the Ml aggregate, and last year's targets allowed for such effects.  However, after  accounting for these shifts into NOW accounts, the growth of the several aggregates was considerably more divergent than was anticipated, with Ml running relatively low while the increase in some of the broader aggregates was a bit above their annual objectives.  Taking into account all of the financial  innovations affecting the aggregates -- particularly the depressing effects on Ml of extraordinarily rapid growth in money market mutual funds -- and the relatively rapid growth of M2 and M3, we found the pattern of slow growth in Ml acceptable. Indeed, last year's experience seems to me a clear illustration of the need to consider a variety of money measures, rather than focusing exclusively on a single aggregate such as Ml.   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  -6-  Thus far this year, the monetary aggregates have behaved more consistently, although Ml is running a bit stronger than anticipated relative to the other aggregates.  With the major  shift into NOW accounts, in terms of new accounts opened, mostly behind us, one source of distortion has been removed from the data.  But I would also note that, as a result of that "structural"  shift, NOW accounts and other interest-paying checkable deposits have grown to be almost 20 percent of Ml, and there is evidence that the cyclical behavior of Ml has been affected to some extent by this change in composition. While Ml is meant to be a measure of transactions balances, NOW accounts also have some characteristics of a savings account (including similar "ceiling" interest rates).  This year there  has been a noticeable increase in the public's desire to hold a portion of their saving  in highly liquid forms, probably  reflecting recession uncertainties.  As a result, NOW accounts  have grown particularly fast, accounting for the great bulk of the growth in Ml, and at the same time the rapid decline in savings deposits has ceased.  Overall, Ml growth so far this year has been  somewhat more rapid than a "straight line" path toward the annual target would imply.  To the extent the relatively strong demand  for Ml reflects transitory precautionary motives, allowing some additional growth of money over this period has been consistent with our general policy intentions.   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  0  7  In arriving at such a judgment, the pattern of growth in the broader aggregates should be considered.  There also  have been important institutional changes in recent years affecting the behavior of M2 and M3.  For example, an in-  creasingly large share of the components of M2 that are not also included in Ml pay market-determined interest rates. This reflects the spectacular growth of money market funds in recent years as well as the increasing availability at banks and thrift institutions of small-denomination time deposits with interest rate ceilings tied to market yields.  An important  consequence is that cyclical or other changes in the general level of interest rates do not have as strong an influence on the growth of M2 as in the past. The broader aggregates are presently at or just above the upper end of the ranges of growth set forth for the year as a whole.  In February, we reported to the Congress that M2 and  M3 would appropriately be in the upper half of their ranges, or at or even slightly above the upper end, should regulatory changes and the possibility of stronger savings flows prove to be important. In that regard, I. must point out we have yet to go through a full financial cycle with such a large money fund industry or with the regulatory and legal changes recently introduced. In these circumstances, it is clear that interpreting the performance of the monetary and credit aggregates must be assessed against the background of economic and financial developments generally -- including the course of and prospects for business activity and prices, patterns of financing, and liquidity in various sectors, the international scene, and interest rates.  http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  It is in that broader context that we have  has been not believed that the growth of the various Ms unduly large so far this year.  factors The point I am making is that a large number of have impinged  -and in all likelihood will continue to impinge  ibly in the process on the growth of the monetary aggregates, poss ure of "money" modifying the relationship of any particular meas to economic performance.  The relationships have been good enough  stability -over a period of time to justify a presumption of wide range of but I do believe we must also take into account a g whether financial and nonfinancial information when assessin policy the growth of the aggregates is consistent with the intentions of the Federal Reserve.  The hard truth is that  the conduct there inevitably is a critical need for judgment in of monetary policy. has Looking back at the last few years, money growth time in the certainly fluctuated rather sharply from time to s as well). United States (and, I might note, in other countrie affected by a As I earlier noted, relationships have also been variety of financial innovations.  But the trend over reasonable  the announced spans of time has generally been consistent with ed growth has, targets of the Federal Reserve, and the restrain clear progress in my judgment, contributed importantly to the now toward reducing inflation.  This longer-run and broader perspective  growth in the is what should be kept in mind when considering   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  9-  aggregates.  The tentative decision (not yet implemented)to publish  the Ml data in the form of four-week moving averages is designed to divert undue attention from the statistical "noise" in the weekly movements in Ml and to encourage knowledgeable observers to focus on broader trends in the whole family of aggregates. One obvious frustration in the current circumstances is that interest rates, particularly longer-term rates, still are painfully high despite the protracted weakness in the real economy and a marked deceleration in the measured rate of inflation. With the unemployment rate currently at a new postwar high, there is an understandable inclination to want to get interest rates down quickly to encourage a rebound in activity. Nothing would please me more than for interest rates to decline, and the progress we are making on inflation, as it is sustained, should powerfully work in that direction.  But, I  also know that it would be shortsighted for the Federal Reserve to abandon a strong sense of discipline in monetary policy in an attempt to bring down interest rates.  It may be that the immediate  effect of encouraging faster growth in the aggregates would be lower interest rates -- particularly in short-term markets.  But  over time, the more important influence on interest rates particularly longer-term interest rates  is the climate of  expectations about the economy and inflation, and the balance of savings and investment.  In that context, an effort to drive  interest rates lower by money creation in excess of longer-run needs and intentions would ultimately fail in its purpose and would threaten to perpetuate policy difficulties and dilemmas of the past.   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  -10-  When long-term interest rates decline decisively, it will be an indication of an important change in attitudes about the prospects for the economy.  One essential element in this  process must be a widespread conviction that inflation will be contained over the long run.  The decline in inflation evident in  all of the broadly based price indices over the past year is highly encouraging.  For example, in the 12-month period ending in April,  2 percent compared to 10 percent over the previous / the CPI rose 61 12 months.  Over the past few months, the CPI has been virtually  stable. But it is also evident that some particular elements accounting for the sharp reduction in inflation are not sustainable; they have been achieved in a period of recession and slack markets, and have reflected some sizable declines in energy prices that now appear behind us.  Progress toward reducing the underlying  trend in costs, while real, has been slower.  We have seen some  polls that suggest many Americans do not in fact appreciate that inflation has slowed at all. to fact.  That impression is plainly contrary  But it is perhaps indicative of how deep seated impressions  and expectations of inflation had become by the late 1970s, and it is suggestive of the concern of renewed higher inflation rates as economic activity recovers.  No doubt those concerns continue to  affect investment judgments and interest rates. In this situation, one key policy objective must be to "build in" what has so far been a partly cyclical decline in   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  -11-  inflation, to encourage further reductions in the rate of increase in nominal costs and wages, and then to establish clearly a trend toward price stability.  That approach seems  to me essential to encourage and sustain lower long-term interest rates, which will, in turn, be important in sustaining economic growth. While monetary policy is only one of the instruments that can be brought to bear in restoring price stability, it is both necessary to that effort and widely recognized to be such.  These  circumstances emphasize the need to avoid excessive monetary growth, with the threat it would bring that the heartening progress against inflation would prove only temporary. I think that it also is quite clear that the prospect of huge and rising budget deficits as the economy recovers has been another element in the current situation raising concerns about long-term pressures on interest rates.  I take encouragement  from the efforts of the House and Senate to begin to come to grips with this problem.  At the same time, we are all aware of how much  remains to be done, not only to reach agreement on a budget resolution for fiscal 1983, but to take the action necessary to implement such a resolution in appropriation and revenue legislation.  Moreover,  as you well know, further legislation will be needed beyond that affecting fiscal 1983 to assure elements in the structural deficit are brought more firmly under control. Let me emphasize that a strong program of credible budget restraint will itself work in the direction of lower interest rates.   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  -12-  The perception that future credit demands by the Federal Government would be lower would reinforce the emerging expectations of less inflation.  The threat that huge deficits  would preempt the bulk of the net savings the economy seems likely to generate in the years ahead -- with the likely consequence of exceptionally high real interest rates continuing -would be dissipated.  Confidence would be enhanced that monetary  policy will be able to maintain a non-inflationary course, without squeezing of homebuilding, business investment, and other interest-sensitive sectors of the economy, and without excessive financial strains in the economy generally.  And by  dealing with very real concerns about the future financial environment, budgetary action would be an important support to the recovery today. In summary, casting monetary policy objectives in terms of the aggregates has been a useful discipline and also has been helpful in communicating to Congress, the markets, and the general public the intent and results of the Federal Reserve actions. At the same time, we must retain some element of caution in their interpretation; the monetary targets convey a sense of simplicity that may not always be justified in a complex economic and financial environment.  There is far from universal appreciation  of the fact that the economic significance of particular aggregates is constantly evolving in response to rapid changes in financial markets and practices.  Consequently, the Federal Reserve is  continually faced with difficult judgments about the implications for the economy.   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  0  %  -13-  As you know, the Federal Open Market Committee soon will be meeting to review the annual targets for the monetary aggregates for 1982 and to formulate tentative targets for 1983. I would not presume to anticipate the precise decisions that will be made by the Committee.  A wide array of financial and  nonfinancial information will be reviewed in the process of considering the specific objectives.  And, while I do not  anticipate any significant change in our operating procedures in the near term, we will also continue to assess and reassess the means by which our policies are implemented.  However, I do  believe that you can assume that the decisions that do emerge from this review will reflect our continued commitment to disciplined monetary policy in the interest of sustaining progress toward price stability -- and, not incidentally, of encouraging a financial climate conducive to achieving and sustaining lower interest rates. We can not yet claim victory against inflation, in fact or in public attitudes.  But I do sense substantial progress  and a clear opportunity to reverse the debilitating pattern of growing inflation, slowing productivity, and rising unemployment of the 1970s.  The challenge is to make this recession not another  wasted, painful episode, but a transition to a sustained improvement in the economic environment. Central to that effort is an appropriate course for fiscal and monetary policy -- a course appropriate, and seen to be appropriate, for the years ahead.   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  Critical elements in that effort  -14-  are the commitments to gain control of the federal budget and to maintain appropriate monetary restraint.  Those policies  provide the best -- indeed the only real -- assurance that financial market conditions will be conducive to a sustained period of economic growth and rising employment and productivity. In the long years to come, we want to look back to our present circumstances and know that the pain and uncertainty of today have, in fact, been a turning point to something much better.   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  FOR RELEASE UPON DELIVERY EXPECTED AT 9:30 A.M. THURSDAY, JUNE 10, 1982  STATEMENT OF BERYL W. SPRINKEL UNDER SECRETARY OF THE TREASURY FOR MONETARY AFFAIRS BEFORE THE JOINT ECONOMIC COMMITTEE WASHINGTON, D.C. Thursday, June 10, 1982  Congressman Reuss, Senator Jepsen, and distinguished members of the Committee, I am pleased to be here today to discuss interest rates and monetary policy.  Monetary Policy and High Interest Rates  The Federal Reserve's announced policy to reduce the rate of money growth is absolutely necessary in order to assure that the progress made to date on inflation will continue into the future. The Administration supports completely the Federal Reserve's policy which calls for a deceleration of money growth.  Their announced  policy and money growth target ranges are appropriate and consistent with our goal of achieving noninflationary economic growth.  The economy has borne the burden of high interest rates for many years. late 1978.   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  The prime rate has been in double digits since  We are all well aware of the extreme hardship these  .  1  -2ly in rates have imposed on the economy in general and particular interest—sensitive sectors. should they be minimised.  These hardships cannot be denied nor  To the contrary, we understand and  the economic share the concerns of the Congress and the public about distress caused by high interest rates.  Sympathy, however, does not solve the problem.  Nor does  political rhetoric about the evils of high interest rates.  We are  ngful all certainly eager to have interest rates fall, but a meani underlying and permanent decline is possible only when we remove the at causes of the pressures which have maintained interest rates high levels.  The fundamental cause of high nominal interest rates is inflaof tion and inflationary expectations and the fundamental cause inflation is excessive monetary expansion.  This is why a credible,  permanent deceleration of money growth is imperative.  Monetary  discipline is a prerequisite to the price stability and lower essential interest rates that we all desire and all recognize as for real economic growth.  Despite a dramatic decline in inflation over recent months, market interest rates remain high.  It has therefore become common-  inflation place to compare current market interest rates to current than rates and to conclude that real interest rates are higher they have been since the great depression.   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  •  -3It is true that the difference between current interest and inflation rates is higher now than since 1933.  It is not, however,  the difference between current interest and inflation rates that is relevant to economic activity.  Business and investment decisions  are based on the rate of inflation that is expected to occur over the life of an investment.  In an ideal world of price stability,  the expected and current rates of inflation would be equal, or nearly so.  In the current environment this is not the case, as  financial market participants have not adjusted their inflationary ed. expectations downward as rapidly as actual inflation has declin  Similarly, during the mid-1970's, inflationary expectations were not adjusted upward as rapidly as actual inflation accelerated. Despite rising inflation rates, future inflation rates were for several years consistently underestimated.  The difference  between market interest rates and actual inflation rates was, therefore, negative.  This experience, coupled with the  effective repeated failure of government to deliver on promises of markets' anti-inflationary policies, had a profound effect on the expectations about future inflation.  inflation in Just as the markets' failure to anticipate rising relative to the 1970's kept market interest rates artifically low, high actual inflation rates at the time, the expectation that factor inflation rates will continue in the future is a primary in keeping interest rates high now.   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  This is the legacy of a deca:1L  a -.4-  logy and expectaof accelerating inflation -- inflationary psycho utions. tions are deeply embedded in our economic behavior and instit Interest rates will fall only when financial market participants become convinced that inflation will not resurge and therefore adjust their inflationary expectations downward, in line with p.  current inflation rates.  The task before us -- the Administration, the Congress and the Federal Reserve -- is to pursue policies that will hasten the downward adjustment of inflationary expectations and allow interest rates to fall.  This will require economic policies and actions  but that, not only yield continued progress on actual inflation, also minimize uncertainty about future policy.  If we want interest  rates to fall -- and we most certainly do --- then three things are vital.  First, the Federal Reserve must continue to pursue its  l policy of noninflationary money growth; to reiterate, the Federa that Reserve has the unqualified support of the Administration in policy.  Second, the Federal Reserve should make a stronger effort  to reduce the significant, sharp swings in money growth which have slowed the adjustment of market expectations to the basic antiinflationary monetary policy.  Third, the Congress and the Adminis-  tration must come to a meaningful agreement on the budget; by meaningful, I mean actions which clearly indicate that the Federal spending. government has the discipline to limit the growth of public will foreWithout that discipline, the credit and investment markets see ongoing government revenue and financing problems. imply higher taxes and/or more inflation in the future.   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  These prol,leTs-  -5The Proposals to Accelerate Money Growth  Any reacceleration of money growth would have disastrous effects on our long-run goal of price stability and permanently lower interest rates.  Instead, faster money growth would soon  rekindle inflationary pressures and refuel inflationary expectations. •  Interest rates would rise quickly and rapidly, reducing greatly the potential for future output and employment growth.  The Administration,  therefore, strongly opposes any proposal to increase the rate of money growth or to raise the money growth targets.  The record of the 1970's clearly shows that a little more inflation cannot be traded for more production and employment over the long run.  Any boost to production and employment that comes  from accelerating money growth is temporary because faster money growth causes inflation and pushes interest rates up. effects of excessive money growth  The lasting  accelerating inflation,  escalating interest rates and a deterioration of the incentives to save and invest -- are powerful and pervasive deterrents to sustained economic growth.  Sustainable economic expansion requires a financial  system based on a reliable dollar.  That means monetary discipline.  Over the past year uncertainty about economic policy in general factor and long-run monetary policy in particular has been an important in keeping interest rates high, even as inflation has fallen. Reaccelerating money growth or raising the money growth targets would only add to that uncertainty.  It would signal to the finan-  cial markets that their worst fears and doubts are true -- that the   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  OP  -6Government cannot be relied on to adhere to noninflationary monetary policy over the long run; that anyone who bets on inflation coming down and staying down (that is, anyone who lends money ;at a lower interest rate) can count on losing that money.  This is the skepti-  cism that has worked to keep rates high as inflation has declined. A sgstained increase in the rate of money growth or an increase in the money growth targets would reinforce and justify that skepticism, add to the intransigence of inflationary expectations, and thereby Push rates higher than they already are.  Furthermore, the fact that suggestions to increase money growth are being offered and discussed adds to the uncertainty and skepticism about future monetary policy intentions.  Discussions, proposals and  political pressures to increase money growth are themselves contributing to the problem of high interest rates by adding to the markets' fears that the Fed will give in to the pressures and return to inflationary money growth.  It is useful, I believe, to review why it is that we set targets for monetary growth.  In the first instance, the purpose of money  growth targets is to provide discipline and an explicit measure against which to judge a central bank's performance.  In addition,  effective money growth targets tell the financial markets, and business and investment planners, what they can expect from the central bank in the year or years ahead.  In countries that have  been successful at long-term money growth targetting -- such as   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  -7-  Switzerland, Japan and West Germany -- the certainty and stability associated with setting and consistently achieving announced money targets has contributed to high rates of saving, investment and ecS nomic growth.  In those countries, the targets have become a  meaninSful policy statement on which the business and investment coMW1unities can rely; predictable monetary trends minimize uncertainty anI provide a stable economic background in which savers and investors can more confidently plan and commit resources.  When they began to implement the current policy of slowing the trend growth of money, the Federal Reserve unfortunately had no such record of consistency.  While signcant problems remain,  the Federal Reserve has been able over the past year and a half to build the credibty of their commitment to achieving a nonThat gain in credibility  inflationary rate of monetary expansion. would quickly be eroded by an  increase in the money targets, or  actions to allow above-target money growth over the long run.  The value of money growth targets  •••  in imposing discipline  and acting as a messenger of the Fed's intentions  alm  is greatly  diminished if they are consistently not achieved or if they are chanI-d at will.  This was recognized by the Congress and  acknowledged in the provisions of the Humphrey-Hawkins Act, which requires the Federal Reserve to set annual monetary targets at the beginning of each year.  This move ended the prior practice of  "base drift," where targets were reset every three months, and provided no discipline on monetary creation.  In the current  environment, the continuing n --d f5r stable and credible monetary   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  4  policy cannot be overstated.  Monetary targetting can be an important  •  device for promoting credibility and reducing uncertainty, but it cannot serve that function if we consistently excuse errors and redefine the targets.  _Those who advocate reaccelerating money growth or raising the targets are misinformed when they assert that these changes are the route to lower interest rates.  Anyone who still believes that  high interest rates are the result of "tight" monetary policy has When the prime  not been paying much attention to recent history.  rate first broke the 20% level in the spring of 1980, money had increased 7.8% over the preceding year.  During the second half of  1980, money grew at an annual compound rate in excess of 13% -the highest rate ever recorded for a six-month period -- and in December the prime rate reached its all-time high of 21-1/2%.  In the six months ending in April of this year, M1 grew at an annual compound rate of 9.1%, well above the Fed's announced targets. This cannot be characterized as "tight" money; by historical standards, this is an extremely rapid rate of money growth.  Yet interest  rates have not fallen since last fall; in fact, they began to rise in November when the accelerated pace of money growth became evident. By comparison, in the preceding six-month period ending last October, M1 actually fell slightly; interest rates began to fall last summer and fell dramatically during the fall.  Excluding the  period of time in 1980 when interest rates were artificially depressed by credit controls, the longest and largest decline in interest   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  November 1981; that rates since 1974-75 occurred from July to monetary restraint. decline coincided with a period of sustained notion that high interest The record clearly contradicts the common policy. rates are the result of 'tight' monetary  ce interest rates 'The belief that faster money growth will redu between money and is based on a fundamental and common confusion credit.  want to Those who advocate faster money growth really  increase real credit growth.  The Administration shares that goal  to achieve that aim and the economic recovery program is designed saving. by providing incentives for increased real growth will not do it.  Faster money  Faster money growth would not provide more  ce the interest rates real credit to the housina market or redu which a small business must pay to borrow.  Faster money growth  provides only more money, not more credit.  Indeed, faster money  it would be available, growth would probably mean that less real cred The way to  rates. and it certainly means higher nominal interest ng. increase credit availability is to stimulate savi  The government  ng and by removing can contribute through tax -incentives to savi the greatest disincentive to save of all  4=,  inflation.  y growth would Thus, the proposed "solution" of increasing mone it situation worse. make our high interest rate-tight cred  The  ed by an actual or inflation and inflationary expectations caus d, first, push interest threatenP1 acceleration of money growth woul her erode incentives to save rates higher; second, it would furt   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  and thereby further restrict the supply of credit flowing into financial markets and institutions.  ;  The Budget Deficit  •••  Concern about the size and resolution of the deficit problem is also adding to financial market uncertainty and reinforcing sensitivity in the credit markets to any indication that monetary discipline might be relaxed.  In this sense, the deficit issue  is helping to keep interest rates high.  Despite the now-common  belief that any method for reducing the budget deficit will assurc that interest rates fall, we cannot count on that happening unless the budget resolution is a meaningful one.  That is, a budget  resolution that acknowledges the burden that the uncontrolled growth of government spending imposes on society and the economy.  The Federal government will face continuing budget crises until we move effectively to contain the growth of government spending.  In the past decade, government spending has grown more  rapidly than the economy as a whole, rising as a share of GNP froT 20% in 1970 to 23% in 1981, and to over 24% in early 1982.  We must face the fact that any government spending -- no matter how well-intentioned its goals or beneficial its impact costs on the economy.  imposes  In the short term, government spending car,  be financed three ways -- through taxation, by creating new money or by borrowing.   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  Ultimately, however, only two sources of revenue  -11--  can erode are available -- direct taxation or inflation. Taxation tives of incentives of individuals to work and save and the incen business to produce and invest.  Not only does this decrease the  , but it also ability of the economy to support government spending . increases pressure for even more government spending  Money creation  also erodes causes inflation and inflationary expectations, which incentives to save and invest. result is the same.  The method is different, but the  In addition, excessive money growth leads to  growth. high interest rates which choke-off real economic  are to Therefore, the situation can be stated simply: if we the allow government spending to grow unchecked as it has over erating past several decades, we must be willing to accept accel it) inflation (and the escalating interest rates that go with and/or high and rising tax rates.  There are no other choices and  heeded as a the current situation in financial markets should be sign that the public is aware.  ist, The financial markets fear that if large deficits pers ing" the deficit the Federal Reserve will be pressured into "monetiz y. and thereby financing spending by creating new mone  These fears  need for are aggravated by Congressional statements about the faster money growth.  The financial markets are already extremely  money growth. concerned that the Fed will revert to inflationary to Any signals that the Fed is coming under political pressure h again do so only adds to the concern that inflationary money growt   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  very. will, be used to boost an economic reco  That skepticism helps  keep interest rates high.  al Policy There is No Trade-Off Between Monetary and Fisc  •  y growth rest Some proposals to reaccelerate the rate of mone  al restraint can be on the premise that a greater degree of fisc traded for some degree of monetary ease.  This implies that monetary  other and that a and fiscal policies can be substituted for each monetary policy. budget compromise can be paired with an easing of and distinct The role of monetary policy in the economy is separate from the role of fiscal policy. versus less of the other.  It is not a matter of more of one  Instead, prudent noninflationary monetary  viewed as complepolicy and disciplined fiscal policy should be economic growth. mentary policies to promote price stability and  and fiscal The division of responsibility between monetary policies is clear.  The role of monetary policy is to restore the  on, to eliminate soundness of the dollar or, in the popular jarg inflation.  supply That requires holding the growth of the money  l of the economy. in line with the long-term growth potentia  The  is to encourage role of fiscal policy, in the current environment, stment, in order a shift in resource use from consumption to inve potential. to stimulate growth of the economy's productive  Reduc-  the two together provide tion of inflation reinforces that effort and job opportunities and the necessary ingredients for expanded increased standards of living.   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  During the past year the Federal Reserve has made progress toward establishing a credible, noninflationary monetary policy. They have not yet totally achieved that goal and their record could be improved.  Money growth continues to be extremely volatile.  Given the current budgetary uncertainty and the history of monetary policy in the 1960's and '70's, such erratic money growth has encouraged skepticism about long-run monetary control.  The Treasury has  gathered substantial evidence that the markets' reaction to variable money growth has been a major factor in maintaining the high levels of interest rates.  In my view, the Federal Reserve  could reduce monetary volatility by making technical changes in their operating procedures.  But with these caveats aside, the Federal Reserve has, on balance, reduced the rate of money growth toward a noninflationary pace.  Monetary policy is moving in a direction that is consistent  with sustained, noninflationary economic growth.  It is now up to  those of us who are responsible for the rest of economic policy to follow suit.  That means we must persevere in bringing the growth  of government spending under control.  It also means that we must  stop cajoling the Federal Reserve to return to the inflationary policies of the past.  While the transition to lower inflation has  been made more costly than necessary, the odds are that the worst is behind us.  It is now imperative that we not throw away the  gains, by repeating the same mistake that has been made frequently on the in the past -- the mistake of presuming that turning ills. monetary spigot provides the cure for all our economic   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  The problem in the financial markets is basically one in which es a policy of an undisciplined government spending, which requir inflation to be sustained, is colliding with a mormtary policy that is no longer providing inflationary money growth.  In the past  a tax decade, government spending has been financed by inflation and system that guaranteed ever-rising tax revenues.  As long as infla-  ed tion accelerates, proliferating government spending can be financ without prospective large budget deficits.  But the Federal Reserve  has now curtailed inflationary money growth and the Government can no longer count on inflation to finance increased spending.  Proposals to reaccelerate money growth are equivalent to a,ivocating a return to accelerating inflation.  It is important  derina that we recognize, and remember, the economic costs of surren The very sectors that are suffering now  to continued inflation. 41Mk.  farmers, the auto industry, small businesses, home builders,  and the thrift industry -- would only be damaged further by a There is evidence of the insidious effects  resurgence of inflation.  of inflation all around us.  Our lagging saving rate, declining  productivity, and our inability to compete with many foreign producers  these are all legacies of a decade of inflation.  We will never cure these fundamental problems by continuing to pursue the inflationary policies of the past.   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  4 4  ft  June 10, 1982  To: Thru: From:  Chairman yorker Don Winni4 Tony Cole_„4  The JEC continued its hearings on "The Future of Monetary Policy" this week with testimony from a panel of economists on Tuesday and from James Pierce and Beryl Sprinkel on Thursday. Mr. Richmond was the only member joining Chairman Reuss for the hearings. A brief summary of the testimony follows. All of the witnesses, with the exception of Secretary Sprinkel, were very critical of the Federal Reserve.  Tuesday Albert T. Sommers (Chief Economist, The Conference Board) o There are rates of credit creation that would clearly represent a monetary inducement to inflation. However, monetary Policy cannot stop an inflation whose causes are upstream from money itself; and the effort to do so can be immensely costly. o That a certain amount of inflation is required for a developed mixed economy to maintain satisfactory levels of output, employment, and growth begins to be a responsible conclusion. o High rates are caused by the present budget situation, rate volatility (which is a result of the way the Federal Reserve conducts policy), and the expectation of restraint, rather than the actual growth of Ml. o Suggests a program including (1) a pragmatic monetary policy directed toward the maintenance of growth in jobs and output, allowing for some persistent, non-cumulative inflation; (2) a revised tax program increasing the burden on consumption; and (3) restoring the deficit to a sustainable level (2% of GNP).  Harvey D. Wilmeth (VP--Northwestern Mutual Life Ins. Co.) o The simple monetary cure for inflation requires a full scale deflationary depression to do its job. Current monetary policies are on a collision course with any material recovery. o It is time to reconsider the decision to let market forces discipline the money and credit system. o Presents the "Monetary Policy Index" (the ratio of the increase in debt to the money supply--states that in 1952 this ratio was $.25 of credit expansion per $1.00 of money and in 1981 there  http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  r  2-  was $1.10 of new debt per dollar of money supply) to explain high rates.--'The higher the Monetary Policy Index, the higher the interest rates needed to clear the new issues markets . . . Any permanent reduction in interest rates requires a permanent reduction in the Monetary Policy Index." o Suggests a new program for separate control of money and "near money" (such as savings accounts and other interest-bearing liabilities) by the Federal Reserve in order to control both interest rates and inflation.--"It must be possible to limit credit expansion at the same time that the growth rate of the narrow money supply is increased. Japan, Germany and Switzerland appear able to do this." o Predicts that short-term rates would fall to single digits within 60 days and long-term rates could reach that level in less than a year if his proposal were adopted.  John H. Hotson (University of Waterloo, Ontario) o All Reaganomics and monetarism have to offer us is depression. Rising interest rates are accelerating the economy into financial collapse. Nominates Paul Volcker as the foremost candidate for recall (to Princeton) and "retrofit." We need easy monetary and fiscal policies now to avert a depression. o Cites Canadian experience as evidence that U.S. policies do not work. The C.P.I. rise in April fell to 6.6% in the U.S., but continued at 11.3% in Canada. "Since Canada has even more ferocious interest rates (which are non-deductible for house owners and consumers) than the U.S. and a negative growth of Ml, Canada should have less inflation than the U.S." o Suggests the need to design income policies that will give us full employment and stable prices. o Proposes a combination of tax and interest rate cuts combined with credit and incomes controls to channel expenditure into real investment rather than consumption and price hikes.  The questions Chairman Reuss posed to the above panel were identical to those he pursued at the first day of hearings last week. Reuss described the Federal Reserve as practicing a modern version of bloodletting and asked each witness to condemn the Federal Reserve both for setting an unrealistically low M1 target and for over shooting the target. Each was also asked to comment on the monetary policy language contained in the budget resolutions.--"If you were a member of the FOMC would you have any trouble responding with a mild raising of the target? Is   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  3-  _  there any doubt about the ability of mortal men and a woman to do that?" Chairman Reuss also asked rhetorically--"Since the FOMC is composed of 12 people of honesty, integrity and intelligence, how do you explain their failure with one exception, Governor Nancy Teeters, to confess error? How can these fine gentlemen remain so much in error?" Mr. Richmond, stating that capital investment is down 50% and that high interest rates is the big problem, commented "I don't blame the Federal Reserve as much as everyone seems to blame them. I blame the Federal Government policies. The Federal Government should reduce deficits by raising taxes to get interest rates down."  I  Thursday James L. Pierce (University of California, Berkeley) o Current monetary policy is u•nsustainable and is not the appropriate means for promoting economic growth and price stability. Current budgetary • policies have made the situation even more untenable. o The change in operating procedures in 1979 was a serious policy error. o Growth of M1 of 2-1/2 to 5-1/2% is too low to produce a meaningful economic recovery. o The longer that monetary policy remains so restrictive, and the harder that it must battle against the effects of tax cuts, high military spending and rising deficits, the more unbalanced the economy becomes. Eventually monetary policy will have to be more expansionary. The longer that the inevitable is postponed, the larger is likely to be the ultimate expansion of money and credit growth. This could easily lead to a resurgence of rapid inflation.  Beryl Sprinkel The Federal Reserve's announced policy to reduce the rate of money growth is absolutely necessary in order to assure that the progress made to date on inflation will continue into the future. The Administration supports completely the Federal Reserve's policy which calls for a deceleration of money growth. Their announced policy and money growth target ranges are appropriate and consistent with our goal of achieving noninflationary economic growth. I  -4-  o If we want interest rates to fall, three things are vital: (1) the Federal Reserve must continue to pursue its policy of noninflationary money growth; (2) the Federal Reserve should make a stronger effort to reduce the significant, sharp swings in money growth which have slowed the adjustment of market expectations to the basic anti-inflationary monetary policy; and (3) the Congress and the Administration must come to a meaningful agreement on the budget. o The Administration strongly opposes any proposal to increase the rate of money growth or to raise the targets.  Reuss asked Mr. Pierce his standard question concerning the failure of the Federal Reserve to hit the M1 target, but did not receive the standard response. Pierce commented that this failure was the inevitable consequence of Congress demanding and the Federal Reserve establishing targets that it cannot really achieve no matter how hard it tries ("Although it doesn't always try real hard."). Chairman Reuss responded that the Congressional directive is not at fault, but rather the Federal Reserve has picked unrealistically low targets, and that, in any event, he did not want to get into an argument over who shares the guilt. Reuss next asked Pierce how he would respond to the monetary policy language contained in the budget resolution if he were on the FOMC ("A consummation devoutly to be wished."). Pierce responded that he'd be "delighted" with the resolution and that he was very disappointed with Chairman Volcker's statements that there would be no compromise. Reuss replied--"I thought that Volcker said he'd obey a resolution, but the Wall Street Journal editorial writers who have access to his mind others don't have say that's not so." Pursuing this line, Reuss next commented--"Suppose at the next FOMC meeting Governor Teeters, a very right minded person, states that the FOMC has now heard from Congress that the targets are bad and that the FOMC has to raise them. What would you say?" Pierce responded that he would agree and that the Federal Reserve should publicly announce that decision. Pierce further stated that the Federal Reserve should not be ordered by Congress to do this, but should do it on its own initiative in view of the new budget policies. By the time Reuss got to Mr. Sprinkel, he seemed to have run out of energy. Perhaps he felt that it would be useless to pursue his standard line of questioning with Sprinkel. In any event, questions directed to Mr. Sprinkel focused on foreign exchange intervention. Sprinkel did, however, agree with Reuss that the failure to stay within the M1 target range is disquieting to the markets.   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  ,   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  -5-  Mr. Richmond asked Sprinkel a number of questions on the Administration's tax policies--once again focusing on his concern that rates will not come down until the deficit is reduced. Copies of the Pierce and Sprinkel testimonies are attached.  Attachments cc: Messrs. Axilrod, Prell, Soss  ,)   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  STATEMENT BY  JAMES L. PIERCE PROFESSOR OF ECONOMICS UNIVERSITY OF CALIFORNIA, BERKELEY  BEFORE THE  JOINT ECONOMIC COMMITTEE OF CONGRESS WASHINGTON, D.C. JUNE 10, 1982   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  I am here today to add my voice to those who are critical of current monetary policy.  I believe that this policy is  unsustainable and that it is not the appropria te means for promoting economic groWth and price stabil ity. Current budgetary policies have made the situation even more untenable. There has never been any doubt that monetary policy could dramatically reduce inflation. With suffic iently restrictive growth in the supply of money and credit , the housing market could be destroyed, consumers could be prevented fro m purchasing automobiles and other durable goods, business pro fits could be wiped out, and business fixed investment cou ld be depressed. This would throw millions of people out of work. The total effect of a sufficiently restrictive monetary policy would be a deep recession which would eliminate the enthus iasm of labor and management for raising wages and prices. This story, which became reality, demonstrates that inflation can be reduced relatively quickly. is at what cost and for how long?  The natural question, however, Social pressures mount to get  the economy out of its depressed state.  These pressures can  ultimately produce highly stimulative polici es such as those that followed the 1974-75 recession. The stimulati ve policies rekindle inflation and the economy ends up back where it started with high inflation. I fear that the Federal Reserve has sta rted the economy on just such a painful trip. A case could be made for a harsh monetary policy if it could be maintained long enough to wring inflation out of the economy   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  -2 and if the economy could grow at a sustained noninflationary pace thereafter.  This appears to be the hope of the Federal  Reserve and of the Reagan Administration.  I believe that it is  highly unlikely that the strategy will be successful. economy starts to  When the  recover, there must be some monetary  accommodation or the recovery will be very weak.  The monetary  growth targets of the Federal Reserve are simply not high enough to promote a sustained, healthy economy expansion.  Unemployment  will remain high and housing and other interest-sensitive sectors will remain depressed as the economy struggles against the effects of a highly restrictive monetary policy.  This, in  turn, will retard the growth of tax revenues and make budget deficits even larger. It is unlikely that this situation will be tolerated indefinitely.  The longer that monetary policy remains so  restrictive, and the harder that it must battle against the effects of tax cuts, high military spending and rising deficits, the more unbalanced the economy becomes. policy will have to be more expansionary.  Eventually monetary The longer that the  inevitable is postponed, the larger is likely to be the ultimate expansion of money and credit growth. a resurgence of rapid inflation.  This could easily lead to  This prospect is one  interpretation of why long-term interest rates have remained so high.  There is obviously massive uncertainty on Wall Street  about future monetary policy and there is a real fear of a resurgence of high inflation.   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  3 The Federal Reserve made a serious pol icy error when in late 1979 it embarked on its increasingly res trictive and nonsustainable policies. Its current monetary growth targets are simply a continuation of this policy . I believe that there must be an increase in money growth to a more sustainable level. Growth of M. of 21 / 2 to 51 / 2 percent is too low, to produce a meaningful economic recovery. I also bel ieve that there must be a better mix between monetary and fis cal policies. The stimulative effects of tax cuts and increases in def ense spending will push real interest rates higher, and the massive deficits will further these increases. The current mix of mon etary and fiscal policies makes no macroeconomic sense and this fact has not been lost on financial markets. Both the Federal Reserve and the Reagan Administration seem adamant about sticking to their guns. Steadfastness can be a virtue; stubbornness can be a vice. I fai l to see the public benefit from the government sticking to its guns if it ends up shooting off our feet. Whenever there is a proposal to increase the rate of money growth, the monetarist chorus chants tha t this will increase interest rates, not decrease them. This pre diction has become the new conventional wisdom espoused by the Administration, the Federal Reserve, and by some Wall Street pundits. It is important to see the element of truth in this assertion in order to see its fallacies. -It is true that a hig h rate of money growth that is sustained over a substantial period of time produces  •   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  -4 a high rate of inflation.  When inflation is high, nominal  interest rates are also high because lenders must be compensated for the declining purchasing power of their money.  Thus,  ultimately, and in the long run, high rates of money growth are associated with high interest rates.  This observation tells us  nothing, however, about the consequences of a rise in money growth from its current low level to one that is more consistent with sustained economic recovery. It is also true that under the Fed's new operating procedur week-by-week fluctuations in the quantity of money produce movements in interest rates in the same direction.  For example,  a non -Policy-induced bulge in Ml produces a temporary increase in interest rates.  This occurs because the Fed does not provide  sufficient nonborrowed reserves to support the bulge in money. Interest rates rise as banks are driven into the discount windol, Under the current operating procedures, market participants spend a fortune on forecasting weekly movements in Ml, and they react sharply to any large unexpected movements.  It is importa  to note that there is nothing irrational about this behavior. Substantial profits are earned by those who correctly anticipat short-term movements in money.  It should also be noted that th  market's response has nothing to do with inflationary expectations.  Participants realize that the bulge in money wil  produce a temporary rise in interest rates under the Fed's operating procedures and th_ey act on this knowledge. Now let me turn to the question ot why short-term interest rates are so high.  Here the answer is straightforward and it h   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  little or nothing to do with inflationary expectations.  Since  the Federal Reserve established its anti-inflation policy in late 1979, the growth - in M1 has, on average, been less than the rise in prices.  Money has not grown rapidly enough to support  even a constant level of economic activity.  The decline in real  money balances has produced high interest rates.  While economic  activity has declined, so have real money balances, and interest • rates have remained high.  Put another way, the supplies of  reserves and of short-term credit have not grown enough to support the high level of credit demand  in the economy.  This demand is  not the result of an economic boom and high inflation, but rather, it is a consequence of falling business profits and a liquidity squeeze.  The result is high interest rates.  Finally, the bulge in M1 growth that occurred earlier this year appears to be the result of an increase in the liquidity desires of the public stemming from the recession and from fear about the financial system.  Conventional economic theory  predicts that such an increase in money demand will raise interest rates unless there is complete accommodation by the Fed.  Since  the accommodation was not complete, the demand shift served to increase upward pressure on interest rates. The simple fact of the matter is that the financial system is starved for money and, as a result, interest rates are high. This means that a policy-induced increase in money growth will push down short-term interest rates.  Faster reserve and money  growth will increase the supply of credit and short-term interest rates will fall.   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  6 The issue ot long-term interest rates is mor e difficult to deal with.  There obviously is a great deal of uncertain ty  concerning the -long-run inflation rate, and the long-run performance of the economy.  Many borrowers and lenders are  unwilling to take long-term positions. It is important to note, however, to the ext ent that high long-term interest rates are the result of exp ectations of high inflation in the future, the market is implic itly assuming that future monetary policy will be highly expans ionary. If this is the case, a moderate easing of monetary policy at this time is hardly consistent with a further rise in lon g-term interest rates. It is double counting to assert that long-t erm interest rates are high because the market expects massive eas ing in policy, and then to claim that any easing of policy will raise interest rates further. I believe that long-term interest rates will com e down only as the government achieves balanced and sustai nable macroeconomic policies.  Uncertainty can be reduced by sensible polici es, but  there is little in current policy that builds pub lic trust.  FOR RELEASE UPON DELIVERY EXPECTED AT 9:30 A.M. THURSDAY, JUNE 10, 1982 STATEMENT OF BERYL W. SPRINKEL UNDER SECRETARY OF THE TREASURY FOR MONETARY AFFAIRS BEFORE THE JOINT ECONOMIC COMMITTEE WASHINGTON, D.C. Thursday, June 10, 1982 ers Congressman Reuss, Senator Jepsen, and distinguished Memb to discuss of the Committee, I am pleased to be hear today interest rates and monetary policy.  Monetary Policy and High Interest Rates  The Federal Reserve's announced policy to reduce the rate of money growth is absolutely necessary in order to assure that the re. progress made to date on inflation will continue into the futu cy The Administration supports completely the Federal Reserve's poli which calls for a deceleration of money growth.  Their announced  consistent policy and money growth target ranges are appropriate and th. with our goal of achieving noninflationary economic grow  rates The economy has borne the burden of high interest for many years. late 1978.   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  The prime rate has been in double digits since  We are all well aware of the extreme hardship thee  •  2-  rates have imposed on the economy in general and particularly in interest-sensitive sectors. should they be minimized.  These hardships cannot be denied nor  To the contrary, we understand and  .  share the concerns of the Congress and the public about the economic distress caused by high interest rates.  Sympathy, however, does not solve the problem.  Nor does  political rhetoric about the evils of high interest rates.  We are  all certainly eager to have interest rates fall, but a meaningful and permanent decline is possible only when we remove the underlying causes of the Pressures which have maintained interest rates at high levels.  The fundamental cause of high nominal interest rates is inflation and inflationary expectations and the fundamental cause of inflation is excessive monetary expansion.  This is why a credible,  permanent deceleration of money growth is imperative.  Monetary  disciplineprerequisite to the price stability and lower interest rates that we all desire and all recognize as essential for real economic growth.  Despite a dramatic decline in inflation over recent months, market interest rates remain high.  It has therefore become common-  place to compare current market interest rates to current inflation rates and to conclude that real interest rates are higher than they have been since the great depression.   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  -3It is true that the difference between current interest and inflation rates is higher now than since 1933.  It is not, however',  the difference between current interest and inflation rates that is relevant to economic activity.  Business and investment decisions  are based on the rate of inflation that is expected to occur over the life of an investment.  In an ideal world of price stability,  the expected and current rates of inflation would be equal, or nearly so.  In the current environment this is not the case, as  financial market participants have not adjusted their inflationary expectations downward as rapidly as actual inflation has declined.  Similarly, during the mid-1970's, inflationary expectations were not adjusted upward as rapidly as actual inflation accelerated. Despite rising inflation rates, future inflation rates were for several years consistently underestimated.  The difference  between market interest rates and actual inflation rates was, therefore, negative.  This experience, coupled with the  repeated failure of government to deliver on promises of effective anti-inflationary policies, had a profound effect on the markets' expectations about future inflation.  Just as the markets' failure to anticipate rising inflation in the 1970's kept market interest rates artifically low, relative to actual inflation rates at the time, the expectation that high inflation rates will continue in the future is a primary factor in keeping interest rates high now.   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  This is the legacy of a decade :  4-  of accelerating inflation  inflationary psychology and expecta-  . tions are deeply embedded in our economic behavior and institutions  'I  Interest rates will fall only when financial market participants become convinced that inflation will not resurge and therefore adjust their inflationary expectations downward, in line with current inflation rates.  The task before us -- the Administration, the Congress and the Federal Reserve -- is to pursue policies that will hasten the downward adjustment of inflationary expectations and allow interest rates to fall.. This will require economic policies and actions that, not only yield continued progress on actual inflation, but also minimize uncertainty about future policy.  If we want interest  rates to fall -- and we most certainly do --- then three things are vital.  First, the Federal Reserve must continue to pursue its  policy of noninflationary money growth; to reiterate, the Federal Reserve has the unqualified support of the Administration in that policy.  Second, the Federal Reserve should make a stronger effort  to reduce the significant, sharp swings in money growth which have slowed the adjustment of market expectations to the basic antiinflationary monetary policy.  Third, the Congress and the Adminis-  tration must come to a meaningful agreement on the budget; by meaningful, I mean actions which clearly indicate that the Federal ng. government has the discipline to limit the growth of public spendi Without that discipline, the credit and investment markets will fore-. see ongoing government revenue and financing problems. imply higher taxes and/or more inflation in the future.   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  These problems..  , The Proposals to Accelerate Money Growth  Any reacceleration of money growth would have disastrous effects on our long-run goal of price stability and permanently lower interest rates.  Instead, faster money growth would soon  rekindle inflationary pressures and refuel inflationary expectations. Interest rates would rise quickly and rapidly, reducing greatly the potential for future output and employment growth.  The Administration,  therefore, strongly opposes any proposal to increase the rate of money growth or to raise the money growth targets.  The recond of the 1970's clearly shows that a little more inflation cannot be traded for more production and employment over the long run.  Any boost to production and employment that comes  from accelerating money growth is temporary because faster money growth causes inflation and pushes interest rates up.  The lasting  effects of excessive money growth -- accelerating inflation, escalating interest rates and a deterioration of the incentives to save and invest -- are powerful and pervasive deterrents to sustained economic growth.  Sustainable economic expansion requires a financial  system based on a reliable dollar.  That means monetary discipline.  Over the past year uncertainty about economic policy in general and long-run monetary policy in particular has been an important factor in keeping interest rates high, even as inflation has fallen. Reaccelerating money growth or raising the money growth targets would only add to that uncertainty.  It would signal to the fir)an-  cial markets that their worst fears and doubts are true -- that the   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  -6Government cannot be relied on to adhere to noninflationary monetary policy over the long run; that anyone who bets on inflation coming down and staying down (that is, anyone who lends money at a lower interest rate) can count on losing that money.  This is the skepti-  cism that has worked to keep rates high as inflation has declined. A s'Ustained increase in the rate of money growth or an increase in the money growth targets would reinforce and justify that skepticism, add to the intransigence of inflationary expectations, anci thereby push rates higher than they already are.  Furthermoi-e, the fact that suggestions to increase money growth are being offered and discussed adds to the uncertainty and skepticism about fut,Ire monetary policy intentions.  Discussions, proposals and  political pressures to increase money growth are themselves contributing to the problem of high interest rates by adding to the markets' fears that the Fed will give in to the pressures and return to inflationary money growth.  It is useful, I believe, to review why it is that we set targets for monetary growth.  In the first instance, the purpose of money  growth targets is to provide dpline and an explicit measure against which to judge a central bank's performance.  In addition,  effective money growth targets tell the financial markets, and business and investment planners, what they can expect from the central bank in the year or years ahead.  In countries that have  been successful at long-term m5ney 5rowth targetting -- such as   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  -7  Switzerland, Japan and West Germany -- the certainty and stability associated with setting and consistently achieving announced money targets has contributed to high rates of saving, investment and economic growth.  In those countries, the targets have become a  meaningful policy statement on which the business and investment coffmunities can rely; predictable monetary trends minimize uncertainty and provide a stable economic background in which savers and investors can more confidently plan and commit resources.  When they began to implement the current policy of slowing the trend growth of money, the Federal Reserve unfortunately had no such record of consistency.  While significant problems remain,  the Federal Reserve has been able over the past year and a half to build the credibility of their commitment to achieving a noninflationary rate of monetary expansion. would Quickly be eroded by an  That gain in credibility  increase in the money targets, or  actions to allow above-target money growth over the long run.  The value of money growth targets -- in imposing discipline and acting as a messenger of the Fed's intentions -- is greatly diminished if they are consistently not achieved or if they are changed at will.  This was recognized by the Congress and  acknowledged in the provisions of the Humphrey-Hawkins Act, which requires the Federal Reserve to set annual monetary targets at the beginning of each year.  This move ended the prior practice of  "base drift," where targets were reset every three months, and . provided no discipline on monetary creation.  In the current  environment, the continuing need for stable and credible monetary   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  8  policy cannot be overstated.  Monetary targetting can he an important  device for promoting credibility and reducing uncertainty, but it cannot serve that function if we consistently excuse errors and redefine the targets.  .Those who advocate reaccelerating money growth or raising the targets are misinformed when they assert that these changes are the route to lower interest rates.  Anyone who still believes that  high interest rates are the result of "tight" monetary policy has not been paying much attention to recent history.  When the prime  rate first broke the 20% level in the spring of 1980, money had increased 7.8% over the preceding year.  During the second half of  1980, money grew at an annual compound rate in excess of 13% the highest rate ever recorded for a six-month period December the prime rate reached its all-time high of  In the six months ending in April of this year, M1 grew at an annual compound rate of 9.1%, well above the Fed's announced targets. This cannot be characterized as  ght" money; by historical standards,  this is an extremely rapid rate of money growth.  Yet interest  rates have not fallen since last fall; in fact, they began to rise in November when the accelerated pace of money growth became evident. By comparison, in the preceding six-month period ending last October, M1 actually fell slightly; interest rates began to fall last summer and fell dramatically during the fall.  Excluding the  period of time in 1980 when interest rates were artificially depressed' by credit controls, the longest and largest decline in interest   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  -9rates since 1974-75 occurred from July to November 1981; that decline coincided with a period of sustained monetary restraint. The record clearly contradicts the common notion that high interest' rates are the result of "tight" monetary policy.  ' The belief that faster money growth will reduce interest rates is based on a fundamental and common confusion between money and credit.  Those who advocate faster money growth really want to  increase real credit growth.  The Administration shares that goal  and the economic recovery program is designed to achieve that aim by providing incentives for increased real saving. growth will not do it.  Faster money  Faster money growth would not provide more  real credit to the housing market or reduce the interest rates which a small business must pay to borrow.  Faster money growth  provides only more money, not more credit.  Indeed, faster money  growth would probably mean that less real credit would be available, The way to  and it certainly means higher nominal interest rates. increase credit availability is to stimulate saving.  The government  can contribute through tax-incentives to saving and by removing the greatest disincentive to save of all -- inflation.  Thus, the proposed "solution" of increasing money growth would make our high interest rate-tight credit situation worse.  The  inflation and inflationary expectations caused by an actual or threatened acceleration of money growth would, first, push interest rates higher; second, it would further erode incentives to save   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  -10and thereby further restrict the supply of credit flowing into financial markets and institutions.  The Budget Deficit  Concern about the size and resolution of the deficit problem is also adding to financial market uncertainty and reinforcing sensitivity in the credit markets to any indication that monetary discipline might be relaxed.  In this sense, the deficit issue  .is helping to keep interest rates high.  Despite the now-common  belief that any method for reducing the budget deficit will assure that interest rates fall, we cannot count on that happening unless the budget resolution is a meaningful one.  That is, a budget  resolution that acknowledges the burden that the uncontrolled growth of government spending imposes on society and the economy.  The Federal government will face continuing budget crises until we move effectively to contain the growth of government spending.  In the past decade, government spending has grown more  rapidly than the economy as a whole, rising as a share of GNP from 20% in 1970 to 23% in 1981, and to over 24% in early 1982.  We must face the fact that any government spending how well-intentioned its goals or beneficial its impact costs on the economy.  no matter imposes  In the short term, government spending can  be financed three ways -- through taxation, by creating new money or by borrowing.   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  Ultimately, however, only two sources of revenue  1*-  -11-  are available -- direct taxation or inflation.  Taxation can erode  incentives of individuals to work and save and the incentives of business to produce and invest.  •  Not only does this decrease the  ability of the economy to support government spending, but it also increases pressure for even more government spending.  Money creation  causes inflation and inflationary expectations, which also erodes incentives to save and invest. result is the same.  The method is different, but the  In addition, excessive money growth leads to  high interest rates which choke-off real economic growth.  Therefore, the situation can be stated simply: if we are to allow government spending to grow unchecked as it has over the past several decades, we must be willing to accept accelerating inflation (and the escalating interest rates that go with it) and/or high and rising tax rates.  There are no other choices and  the current situation in financial markets should be heeded as a sign that the public is aware.  The financial markets fear that if large deficits Persist, the Federal Reserve will be pressured into "monetizing" the deficit and thereby financing spending by creating new money.  These fears  are aggravated by Congressional statements about the need for faster money growth.  The financial markets are already extremely  concerned that the Fed will revert to inflationary money growth. Any signals that the Fed is coming under political pressure to do so only adds to the concern that inflationary money growth again   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  -12-  will be used to boost an economic recovery.  That skepticism helps  keep interest rates high.  There is No Trade-Off Between Monetary and Fiscal Policy  Some proposals to reaccelerate the rate of money growth rest on the premise that a greater degree of fiscal restraint can be traded for some degree of monetary ease.  This implies that monetary  and fiscal policies can be substituted for each other and that a .budget compromise can be paired with an easing of monetary policy. The role of monetary policy in the economy is separate and distinct from the role of fiscal policy. versus less of the other.  It is not a matter of more of one  Instead, prudent noninflationary monetary  policy and disciplined fiscal policy should be viewed as complementary policies to promote price stability and economic growth.  The division of responsibility between monetary and fiscal policies is clear.  The role of monetary policy is to restore the  soundness of the dollar or, in the popular jargon, to eliminate inflation.  That requires holding the growth of the money supply  in line with the long-term growth potential of the economy.  The  role of fiscal policy, in the current environment, is to encourage a shift in resource use from consumption to investment, in order . to stimulate growth of the economy's productive potential.  Reduc-  tion of inflation reinforces that effort and the two together provide. the necessary ingredients for expanded job opportunities and increased standards of living.   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  -13-  •  V/ During the past year the Federal Reserve has made progress  toward establishing a credible, noninflationary monetary policy. They have not yet totally achieved that goal and their record could be improved.  Money growth continues to be extremely volatile.  Given the current budgetary uncertainty and the history of monetary poricy in the 1960's and '70's, such erratic money growth has encouraged skepticism about long-run monetary control.  The Treasury has  gathered substantial evidence that the markets' reaction to variable money growth has been a major factor in maintaining the high levels of interest rates.  In my view, the Federal Reserve  could reduce monetary volatility by making technical changes in their operating procedures.  But with these caveats aside, the Federal Reserve has, on balance, reduced the rate of money growth toward a noninflationary pace.  Monetary policy is moving in a direction that is consistent  with sustained, noninflationary economic growth.  It is now up to  those of us who are responsible for the rest of economic policy to follow suit.  That means we must persevere in bringing the growth  of government spending under control.  It also means that we must  stop cajoling the Federal Reserve to return to the inflationary policies of the past.  While the transon to lower inflation has  been made more costly than necessary, the odds are that the worst is behind us.  It is now imperative that we not throw away the  gains, by repeating the same mistake that has been made frequently in the past -- the mistake of presuming that turning on the monetary spigot provides the cure for all our economic ills.   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  . . -14, The problem in the financial  I is basically one in which  a policy of an undiscned government spending, which requires inflation to be sustained, is colliding with a monetary policy . that In the past  is no longer providing inflationary money growth.  decade, government spending has been financed by inflation and a tax system that guaranteed ever-rng tax revenues.  As long as infla-  tion accelerates, proliferating government spending can be financed without prospective large budget deficits.  But the Federal Reserve  has now curtailed inflationary money growth and the Government 'can no longer count on inflation to finance increased spending.  Proposals to reaccelerate money growth are equivalent to advocating a return to accelerating inflation.  It is important  that we recognize, and remember, the economic costs of surrendering to continued inflation.  The very sectors that are suffering now  -- farmers, the auto industry, small businesses, home builders, and the thrift industry -- would only be damaged further by a resurgence of inflation.  There is evidence of the  of inflation all aroUnd us.  dious effects  Our lagging saving rate, declining  productivity, and our inability to compete with many foreign producers -- these are all legacies of a decade of inflation. We will never cure these fundamental problems by continuing to pursue the inflationary policies of the past.   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis
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