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Federal Reserve Bank of St. Louis
Collection: Paul A. Volcker Papers
Call Number: MC279
Box 13
Preferred Citation: Joint Economic Committee, 1982 June 15; Paul A. Volcker Papers, Box 13;
Public Policy Papers, Department of Rare Books and Special Collections, Princeton University
Library
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https://fraser.sdouisfed.org/archival/5297
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https://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
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
s-
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.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
There was a growing sense among some
I
\
_
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
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
or
•
-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
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
I
-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
https://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 M1 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.
https://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.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
•
vo.
_
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.
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Federal Reserve Bank of St. Louis
It is in that broader context that we have
•
-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
that
there inevitably is a critical need for judgment in the conduct
of monetary policy.
Looking back at the last few 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 sh5uld be kept in mind when considering gr5wth in the
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
9-
•
aggregates.
The tentative decision (not yet implemented)to publish
the M1 data in the form of four-week moving averages is designed
to divert undue attention from the statistical "noise" in the
weekly movements in M1 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.
also know that it would be shortsighted
But, I
ora 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.
https://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.
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
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
•
One essential element in this
I
-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.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
•
-121
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 dpated.
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.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
-11-
i
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.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
I
4
-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.
https://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.
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Federal Reserve Bank of St. Louis
Critical elements in that effort
-14k
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.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
r
p
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
https://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
.•que
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.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
There was a growing sense among some
https://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
-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
https://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
https://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.
https://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.
https://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.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
0
It is in that broader context that we have
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
that
there inevitably is a critical need for judgment in the conduct
of monetary policy.
Looking back at the last few 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
https://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.
https://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
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
i
-11-
4
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.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
i
-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.
https://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 transon 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.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
Critical elements in that effort
%
https://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.
%
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
https://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.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
There was a growing sense among some
https://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
-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
https://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
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
5-
i
•
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.
https://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.
https://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.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
It is in that broader context that we have
-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
that
there inevitably is a critical need for judgment in the conduct
of monetary policy.
Looking back at the last few 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
https://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.
https://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
https://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.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
e
-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 homebung, 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.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
-134
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.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
Critical elements in that effort
\
https://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.
%
•
,
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 Syste
m
https://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
o•ade
The development of this formal reporting framework,
fS cusing 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 crcal linkage over the longer run between
money gr5wth and prices.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
There was a growing sense among some
https://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
-3-
I
•
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
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
-4
developments in money and credit and in setting appropriate
targets.
One reason for that
sa 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.
and
e•aop
The proliferation of new financial instruments
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 faes 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
https://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.
https://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.
https://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.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
It is in that broader context that we have
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 few years, money growth has
cSrtainly 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
https://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.
https://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
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
S
-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.
https://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.
https://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.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
Critical elements in that effort
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
-14til
,
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
IS
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.
f
U
•
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
https://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.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
There was a growing sense among some
https://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
-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
https://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
https://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.
https://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.
https://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.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
It is in that broader context that we have
•
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 few 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
https://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.
https://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
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
e
%
4
-11-
r
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.
https://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 homebung, 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.
https://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.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
Critical elements in that effort
https://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.
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
https://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 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.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
There was a growing sense among some
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
-2
1
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 5y the Congress, that interest rates in themselves are n5t
-3-
.
6
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
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
4a
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
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
5-
-
4
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.
https://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.
https://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.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
It is in that broader context that we have
-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 few 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
https://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.
https://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
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
i
-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.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
o'
•
-
-12i
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.
https://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.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
Critical elements in that effort
https://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.
S
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
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
V
before the
Joint Economic Committee
June 15, 1982
•
I
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.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
There was a growing sense among some
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
S
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
%
-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
https://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
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
•
T
-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 MI 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 MI 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.
https://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.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
a
-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.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
It is in that broader context that we have
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
s that
there inevitably is a critical need for judgment in the conduct
of monetary policy.
Looking back at the last few 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
https://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.
https://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
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
I
t
-111
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.
https://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.
https://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.
anticipate any signcant change
And, while I do not
nSur 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
grS wing inflation, slowing productivity, and rising unemployment
of the 1970s.
The challenge is to make this recession not another
wasted, painful episode, but a transon 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.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
Critical elements in that effort
https://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 condons 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 IS
to something much better.
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
https://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 ResolutionSubsequently,
the reporting of growth targets
ra aggregates was formalized
in law with the enactment of the Full Employment
Balanced
•and
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
oae
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.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
There was a growing sense among some
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
I
-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
-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
https://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 faes may
shift their preferences among various financial assetsmanner
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 n5t exist
https://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 M1 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.
https://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.
https://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.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
It is in that broader context that we have
-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 fs that
there inevitably is a critical need for judgment in the conduct
of monetary policy.
Looking back at the last few 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
https://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.
https://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
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
•
e
%
-110
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.
https://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 jused 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.
https://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.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
Critical elements in that effort
https://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.
64
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
https://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.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
There was a growing sense among some
https://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
-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
https://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 faes 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
https://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 M1 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.
https://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.
https://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.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
It is in that broader context that we have
•
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 .1's that
there inevitablycritical need for judgment in the conduct
of monetary policy.
Looking back at the last few 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.
B•ut 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
https://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.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
It is in that broader context that we have
%
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
that
there inevitably is a critical need for judgment in the conduct
of monetary policy.
Looking back at the last few 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
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
9-
aggregates.
The tentative decision (not yet implemented)to publish
the M1 data in the form of four-week moving averages is designed
to divert undue attention from the statistical "noise" in the
weekly movements in M1 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.
https://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.
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
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
•
One essential element in this
,
..
-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.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
4
-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.
https://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.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
Critical elements in that effort
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
-14-4
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.
•
-136
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.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
Critical elements in that effort
•
https://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.
•
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
https://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.
of the appropriate measures to "target
The choice
as well as the quanti-
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 .IS
policies.
our intentions and
The worsening inflation problem focused increased
attention on the critical linkage over the longer run between
money growth and prices.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
There was a growing sense among some
https://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
-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
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
-4
D
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 definons 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 faes 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
https://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.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
-6
Thus far this year, the monetary aggregates have behaved
more consistently, although M1 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 M1 has been affected to some extent
by this change in composition.
While M1 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, M1 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 M1 reflects transitory precautionary motives, allowing some
additiS nal growth of money over this period has been consistent
with 5ur general policy intentions.
https://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
s
at or even slightly above the upper end, should regulatory change
ant.
and the possibility of stronger savings flows prove to be import
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.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
It is in that broader context that we have
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
modng 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 few years, money growth has
certainly fluctuated rather sharply from time to time in the
United Statesmight 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 sh5uld be kept in mind when considering 5rowth in the
https://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.
https://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
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
-111
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.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
S.
b
-12t
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 homebung, 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.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
-13-•
As you know, the Federal Open Market Committee soon
ri
will be meeting to review the annual targets for the monetary
aggreaates 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
anpate 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 debating 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 transon 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.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
Critical elements in that effort
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
-14b
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.
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
https://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 ResolutionSubsequently,
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
na 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.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
There was a growing sense among some
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
0
1
.
_ 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
%
D
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
https://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
https://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 MI 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.
https://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.
https://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.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
It is in that broader context that we have
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 few 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
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
9LI
•
aggregates.
The tentative decision (not yet implemented)to publish
the M1 data
na form of four-week moving averages is designed
to divert undue attention from the statistical "noise" in the
weekly movements in M1 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 5ast.
https://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
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
I
-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.
https://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 homebung, 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 discne 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.
https://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.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
Critical elements in that effort
%
-14-.1
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.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
e
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
https://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.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
There was a growing sense among some
https://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
-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
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
-4a
developments in money and credit and in setting appropriate
targets.
One reason for that
sa 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 m5ney and the economy that, in fact, may not exist
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
-5-
•
8
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 M1 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.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
0
%
-66
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.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
.
a
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.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
It is in that broader context that we have
S
-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 few 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
https://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.
https://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
https://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.
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.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
•
That approach seems
•
-12g
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.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
-13-
A s 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
=MO
and a clear opportunity to reverse the debating 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 transon 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.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
Crcal elements in that effort
https://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.
•
•
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
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Federal Reserve Bank of St. Louis
before the
Joint Economic Committee
June 15, 1982
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I am pleased to appear before this Committee to discuss
the conduct of monetary policy.
In particular, I would like to
focus on the monetary aggregates targeting framework in light of
recent experience.
The Federal Reserve began reporting to the Congress
specific numerical "targets" for the growth of the monetary
aggregates in 1975.
You will recall Congress had urged such
an approach in House Concurrent Resolution 133.
Subsequently,
the reporting of growth targets for the aggregates was formalized
in law with the enactment of the Full Employment and Balanced
Growth Act of 1978, commonly referred to as the Humphrey-Hawkins
Act.
That law requires the Federal Reserve to present annual
targets for monetary and credit aggregates to the Congress each
February, and to review those targets and formulate tentative
objectives for the coming calendar year each July.
The choice
of the appropriate measures to "target," as well as the 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
m5ney growth and prices.
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There was a growing sense among some
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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
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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
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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
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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.
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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.
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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.
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It is in that broader context that we have
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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 f s that
there inevitably is a critical need for judgment in the conduct
of monetary policy.
Looking back at the last few 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
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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.
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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
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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.
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Federal Reserve Bank of St. Louis
I'
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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.
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Federal Reserve Bank of St. Louis
$
-11-
3
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.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
a
-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
likSly 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.
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_A
-133
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.
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Critical elements in that effort
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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.
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@FedFRASER