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http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  r  I  Money Marketeers of New York Univ. May 25, 1982  Collection: Paul A. Volcker Papers Call Number: MC279  Box 13  Preferred Citation: Money Marketeers of New York University, 1982 May 25; Paul A. Volcker Papers, Box 13; Public Policy Papers, Department of Rare Books and Special Collections, Princeton University Library Find it online: http://findingaids.princeton.edu/collections/MC279/c239 and https://fraser.sdouisfed.org/archival/5297 The digitization ofthis collection was made possible by the Federal Reserve Bank of St. Louis. From the collections of the Seeley G. Mudd Manuscript Library, Princeton, NJ These documents can only be used for educational and research purposes ("fair use") as per United States copyright law. By accessing this file, all users agree that their use falls within fair use as defined by the copyright law of the United States. 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Policy on Digitized Collections Digitized collections are made accessible for research purposes. Princeton University has indicated what it knows about the copyrights and rights of privacy, publicity or trademark in its finding aids. However, due to the nature of archival collections, it is not always possible to identify this information. Princeton University is eager to hear from any rights owners, so that it may provide accurate information. When a rights issue needs to be addressed, upon request Princeton University will remove the material from public view while it reviews the claim. Inquiries about this material can be directed to: Seeley G. Mudd Manuscript Library 65 Olden Street Princeton, NJ 08540 609-258-6345 609-258-3385 (fax) muddaprinceton.edu   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  •  For release on delivery 8:00 PM, EDT May 25, 1982  , Remarks of  Paul A. Volcker  Chairman, Board of Governors of the Federal Reserve System  before the  Money Marketeers of New York University ' New York City  May 25, 1982   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  I  %  y I am pleased to be in New York tonight with the Mone s Marketeers, even though it's problematical whether it help trying the digestive process to have dinner with people who are to outguess what the Fed is doing from minute to minute and hour to hour.  I have had some concern that whether I ate  t be rapidly or slowly, or with the right hand or left, migh presumed to have some occult market significance.  At any rate,  still going no matter how long or attentively you listen, you are et will open to have to make up your own minds about how the mark tomorrow, or next month, or next year. ncial Instead of looking at the nitty gritty of the fina suggest markets tonight, I'd like to step back a few paces and a framework some perspective about what we are trying to do as for evaluating the market.  I need not tell this group that we  made all the are in a serious recession in this country today, not been performing more difficult by the fact that our economy has up to expectations for a very long time.  We'd like to have some  ,unfortunately, marvelous painless cure for our troubles but that is not the case. process, because We have been going through a difficult an accumulation of we have been suffering from the effects of have been developing some economic and financial problems that for a very long time.  Those trends were ultimately unsustainable  and they have had to be turned around. the past decade We let our productivity growth erode during we were getting no and more, so that by the end of the 1970's   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  productivity growth at all.  At the same time we wanted to see  -2-  our incomes keep ahead of inflation, even if we weren't is the achieving the productivity improvement that in the end only source of growth of real income.  And as costs rose faster  than prices, profit margins declined.  After a while, we came  to take inflation for granted.  We can see more clearly now  ed in that many businesses and individuals overborrowed, tempt it in cheaper part by the easy assumption that you could repay cred dollars if you waited long enough.  And, as society saw less point  ised in financial assets as a way to hold savings, we were surpr and disconcerted that interest rates tended to rise.  The whole  gy thing, I think, left us ill-prepared to cope with the ener crisis and other economic shocks that came from outside. trends The one thread, in my mind, that underlay all those and all those attitudes was inflation.  We used to think in the  t be a good immediate postwar period that a little inflation migh thing.  It produced pleasant little surprises along the way --  anticipated; more often than not profits turned out to be higher than of our we could all feel a little richer when we saw the price new one; house go up, particularly if we didn't have to buy a ed by we could see that our business mistakes could be cover when price increases and all of that was particularly nice interest rates lagged way behind the inflation rate. ent What's different, it seems to me, about our curr lasted so experience with respect to inflation is that it's expect it. long and it's been so high that people began to cularly in We've had inflations before in this country, parti   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  War when prices went up war time -- a period in the Civil War I and during and after pretty fast, during and after World periods lasted very long, and World War II -- but none of those assumed that we'd return to a I think most people legitimately er a while. I suspect that kind of norm of price stability aft an climbing after the midwas the thought when inflation beg . But what's.unique about iod per war m tna Vie the ing dur 1960's two or three or four years inflation is that it didn't last for with some ups and downs in but it went on for 15 years, and rising trend. rate of speed -- it went on at a human animal that after a It's a characteristic of the while he learns from experience.  And soon people began to  ir thinking expect inflation -- and even exaggerate it in the pened some time in the second and in their behavior. That hap   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  half of the 1970's.  no longer At that point, inflation could  level of interest rates that be considered fun, and the higher for their own inflationary lenders began demanding to make up t. anticipations was one symptom of tha in the memory of many Now I think, for the first time changing that trend and that people, we have a fair prospect of kind of thinking.  period of transition I believe we can make this a  to a much brighter future.  aim That, of course, has to be the  icy generally. of monetary policy, and public pol quite plainly so. Certainly inflation is down and  I know  whether the improvement ut abo ty ain ert unc of lot a there's still accept this stage to be reluctant to will last -- it's natural at  is coming down and to te ra n io at fl in e th the evidence that . improvement will last e th on ti ic nv co e th change behavior in vely lieve that the relati be to on as re y nl There is certai dexes and consumer price in er uc od pr e th th bo good performance of rring factors. cu re nno or y ar or mp ect some te in recent months refl rong increases remains st ge wa d an e ic pr d st an The momentum of co nce in in price performa ga e th of ch Mu ors. in a number of sect ion. And the market ss ce re of t ds mi e th has been achieved in arts flation and false st in of s ar ye 15 at th place seems to feel r we ticism about whethe ep sk a y if st ju cy poli in anti-inflation g price stability. in or st re in t is rs pe really are going to stay liquid. Longer to ed nt wa ve ha s er lend Consequently, many vel traordinarily high le ex an r fe of to d inue term bonds have cont and the businessman r ye bu me ho e th d ly, an of yield historical ney at rates that mo m er -t ng lo ch mu raise haven't been able to   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  look reasonable.  signs of progress -g in ny de no is e , ther At the same time g g costs and settin in in ra st re in -progress potentially lasting at is particularly Th t. en em ov pr im uctivity the stage for prod and wages have s st co e er wh y om on of the ec evident in sectors d international an ic st me do th wi out of line been more clearly d ogress is exaggerate pr r ou of d ee sp ies. If the competitive realit the reduction at th te no so al d istics, I woul in some price stat wage feed back into the so al n ca x de in ice in the consumer pr d be hard to deny a ul wo it g, in tt se In this setting process. at the very least, , is d en tr ry na io c inflat change in the basi within our grasp.  that with cost containment, is ry sto the of e sid er oth The the declining inflation rate, perhaps inevitably, lagging behind s are squeezed. The combination and with volume sluggish, profit creates a poor investment s fit pro low and es rat st ere int of high tax and other encouragements climate at the moment, despite the s is reflected in some acute that have been adopted. All of thi iness, and severe financial bus k wea , ent oym mpl une h hig problems -erstand the sense of uncertainty strains. It's very easy to und feel in this situation. The and concern that so many people llenge for all of us -- is to challenge for policy -- the cha uctive direction, building str con a in s tie ain ert unc se resolve tho on what has been achieved. of important steps have In that connection, a number already been taken.   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  oo  in constructive The fiscal structure is moving to help investment directions to help savings and ives; all that will and to provide greater incent the framework is take time to be effective, but in place.  oo  of a more stable There is a clear possibility turbulence of the last energy picture, after the weakness in prices decade, even though the recent med to have come to has, for the time being, see an end.  oo  den is being attacked. The excessive regulatory bur  oo  the very least, And inflationary assumptions, at d and seem to have been challenged and questione be in the process of change.  opportunity -It is this process that provides an reverse the pattern of the the best opportunity in years -- to ned period of rising pro1970's, to look forward to a sustai t of a return to price stability. ductivity and growth in the contex should be able to see his In that context, the average worker t hasn't happened for five real income increase, something tha years or so. the sky, I can understand Now if that sounds like pie in the skepticism.  am. But I don't think it is just a dre  After  is supposed to operate. all, this is the way the economy  But,  uely about the more distant vag g kin tal ng thi one is it , rse of cou recovery actually start, and future, and another thing to see a to see it sustained. in terms of policy I would emphasize three elements critical to help make the approaches that seem to me to be e a bearing on conditions in objective a reality. They all hav   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  ions in financial markets that financial markets, and it's condit are one key to recovery, and keep  it going over time.  at all if I say one of It's not going to surprise you get. those factors is the federal bud and won't belabor the point.  I am among experts,  You know the potential deficit  numb the mind. figures are so big they kind of  The problem is  1982 deficit -- a number in the not so much the current fiscal lion. Relative to the size of the general magnitude of $100 bil  7  in a recession period the economy today, that kind of a deficit is not unprecedented.  But what is new, what is really unique  is the outlook over in our fiscal history so far as I know it, coming fiscal years. g the If we make some simple assumptions, includin year after year assumption that business will get be,Ler we will have steady that the recession will end right away and little more -- and if growth of four to five percent or even a e as they are now, we assume all government programs in plac lt in spending over with all the automatic increases that resu not fall -- as we the years ahead, the deficit would lise -come out of the recession. amount.  It would rise by a very substantial  billions as the Your projections may diffem by tens of  the estimates center time horizon lengthens, but the point is -- not very far away. around $200 billion or more by fiscal 1984 fiscal years beyond that. They rise well above $200 billion in the we would be To put that in perspective, with "nu action" or more of the facing deficits equal to as much as five percent   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  perity, not gross national product in periods of business pros nt years. so much less than the rate of net savinys in rece  We  tax and financial would like to see the savings rate increase, and n. market changes, I believe, point in that: directio  But the clear  the potential implication of the budgetary pictuLe is that, if would absorb an deficits are not sharply cut, those deficits projection of our historically large fraction of any realisLic  wth and prosperity. savings potential for a period of gro way of savings to go There wouldn't be very much in the economy -- for homearound for the private sectors of the t so desperately need buyers, and farmers and industries tha credit to support their own growth.  Left unresolved, the  the financial markets, deficits could only mean pressure on relatively high real pressure that would be reflected in interest rates.  y As the markets look at the prospect, the  today. are more cautious about lending money  And, the analysis  sustained expansion -calls into question the prospects for ity-inducing expansion. certainly an investment-led, productiv budgetary situation Now the encouraging thing about that magnitude. is, in a sense, the flip-side of its  The threat is  gery is much better underso evident, the need for drastic sur es of the aisle in the stood in Washington today, on both sid elsewhere. Congress, in the Administration, and  Once one under-  is a kind of compelling stands the size of the problem, there matic effort to deal with need to deal with it. A rather dra President and the Congressional the budget was made recently by the failed and that was disappointing. leadership. That particular effort ough the more usual budgetary But the effort is continuing -- thr cesses may not offer the processes. By its nature, those pro   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  ial. same dramatic or catalyzing potent  A budget resolution  targeted savings will, in leaves open questions aLout how the tion, combined with reconciliation olu res a But ed. ent lem imp be t, fac and the will of the Congress p, ste d war for a be ld wcu s, lre cea pro  revenue to implement the program in actual spending and increases will soon be tested.  The manner in which that test  me some grounds is passed will be crucial, but there seems to for encouragement. d emphasize revolves The second policy element that I woul more directly around monetary policy.  Even with a highly  tary policy can be sophisticated audience, discussion of mone what we mean by "tight" confused by semantic difficulties -g substantive interor "easy" money -- as well as by differin pretation of the data.   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  , linger over the In any event, I need not, before you rates are determined point that the process by which interest pulling a single monetary is a lot more complicated than simply lever.  is still only one Monetary policy is important, but it  act of our actions of many influences, and the immediate imp doesn't tell the whole story.  More important, over time, is  economy and inflation, the climate of expectations about the and the balance of savings and investment. n that today's The point has been made again and agai relative to current interest rates are extraordinarily high . But the relevant question, inflation. That is a statistical fact what people expect, and in assessing real interest rates, is ared to act forcefully on when those with money will be prep trend will remain subdued. the conviction that the inflationary  -10-  s may be beginning There are a number of signs that attitude to change in that respect.  I wish I had a magic wand to speed  the result, but I don't. over the money What we do have is some degree of control al prospects for a supply, and, therefore, over both the actu of that prospect. return to price stability and expectations restraint.on money Theory and experience both tell us that bringing down inflation and credit growth is an essential part of and keeping it down.  And if we are to get interest rates down  down -- we have to be and do it in a way that they will stay concerned about excessive growth of money.  That approach, in  well understood. general terms, it seems to me, is pretty n, when an overBut, in this age of instant communicatio istics are thrown at us whelming number of poorly digested stat using and difficult process practically every day, it can be a conf th from week to try to follow the trend of money and credit grow ce around so much. to week or month to month when the numbers boun we have to be alert And, apart from the sheer statistical noise, ers and to changing to the impact of financial innovation on the numb a period of months behavior patterns in evaluating movements over or years.   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  the various In setting particular targets for growth of g them periodically, monetary and credit aggregates, in reviewin in the general framework and in conducting our actual operations e factors affecting of those objectives, we need to assess thos nd of conditions in the monetary aggregates against the backgrou ets, the federal budgetary money, capital and foreign exchange mark posture, and other factors.  -11-  Market On the basis of its analysis, the Federal Open we felt, Committee last February adopted targets for 1982 that y to on the basis of experience, should provide enough mone d progress support economic recovery, consistent with continue against inflation. most observers.   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  That judgment, I believe, was shared by  It is, of course, a judgment that should be,  and is, reviewed from time to time. year, In making our judgment at the beginning of this ht -- or anything we did not, and do not now, put exclusive weig like it -- on one measure of the money supply.  M1 gets a lot  the only of attention in the market, partly because it is aggregate published weekly. the only measure we watch.  But I would emphasize it's not It may not always be the most  institutional important, particularly when it is sensitive to change. tively new, but For instance, NOW accounts are still rela are now a significant share of Ml.  While M1 is defined only to  accounts also have include transactions balances, we know NOW some characteristics of a savings account.  If there is a tendency,  of their savings in at the margin, for individuals to hold more by recession uncertainties, that highly liquid form, induced in part the M1 totals will be affected.  At the time we set our targets,  have the full story -we had some evidence -- and we don't yet public's desire to hold of a noticeable temporary change in the accounts. part of their financial assets in NOW  At this point,  -12-  year has taken the form of nearly all the expansion in M1 this believe, reflects partly a NOW accounts, and that increase, we ition to the ordinary savings or precautionary motive, in add transactions motivation.  I would note that, at the same time,  -- for precautionary the sharp decline in savings accounts was reversed. purposes, a closely comparable asset -M1 so far this Reflecting the surge in NOW accounts, target range may seem year has grown slightly faster than our ts a savings or precautionary to imply. To the extent this reflec and for money, we do not motive rather than a transactions dem find this terribly troubling.  That judgment is strengthened  es of money, liquidity, against the background of other measur other target ranges. or credit expansion, reflected in our ' on current results seem to me reasonably the er, eth tog Taken entions. track with respect to our policy int w relatively slowly, You may recall that last year M1 gre of our target range. while M2 expanded around the upper end reflection of financial We believe that this divergence was a rapid growth of money innovations, including prominently the ent serve the function market funds, which to some limited ext   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  of transactions balances.  Taking all this into account, we  M1 so disagreeable didn't find the pattern of slow growth of so long as M2 and other as to take vigorous action against it y. measures were growing relatively rapidl  Similarly, at the  growth in M1 so far this moment we don't find the pattern of the other aggregates reasonably year -- combined with behavior of  -13-  consistent with intentions, and given the evidence of some shift in public savings patterns -- to be out of line with our purposes.  I would also note that, with economic recovery,  the "precautionary" element in Ml or other aggregates could subside. Looking through these technicalities, the basic problem -and objective -- remains. to support recovery.  We want to have enough 'financial growth  But we also must make sure that monetary  policy remains concerned with, and directed toward, restoring that price stability, and we don't believe that's an objective effort we can turn on and off like a faucet -- not if we want the to be successful.  To attempt to push interest rates down by  fears excessive money creation at the expense of inflationary would, it seems to me, be shortsighted.  In a practical sense,  ronment, when it wouldn't work for very long in the current envi the sensitivity to inflation remains so strong. the The third area I would touch upon is to point out once started inflationary process is nurtured by a state of mind; s, in wage it tends to maintain its own momentum in interest rate bargaining, in pricing policies, and all the rest.  You know, if  since you you're under the age of 35 and you've been working known anything graduated from college or high school, you've never but higher prices in your whole working career.  Along the way  wages year after you got used to annual increases in salaries and year that partly reflected inflation.  You got used to accumulating  house. financial resources by capital gains in your   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  Price stability  -14-  the market, always seems nice when you are on the "buy" side of keep the but as sellers there is a strong inclination to try to process going. nt Today there is not enough money to finance real investme and inflation at the earlier rate of speed.  That process is  business making inflation subside, but in a transition period activity can be affected as well.  You can try to solve that  ly -dilemma by sharply accelerating growth in the money supp by a willingness to finance inflation.  But in my judgment,  use it will that will not prove to be a solution at all, beca only perpetuate the process.  The dilemma ultimately has to  s, restraining be solved from the other direction, by reducing cost vity. nominal wages and salaries, and by increasing producti to accept It's easy to understand the reluctance of many coming as a premise of their own behavior that inflation is for so long. down, because they've seen the opposite experience ation in their But I also have to say that those who plan on infl ct bet against management and labor practices -- those who in effe -- should think the nation's success in restoring price stability e expectations about the consequences of their actions when thos turn out to be unwarranted. eve, In time, the process of disinflation can, I beli can breed conattain a kind of momentum of its own -- success fidence and further progress.   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  In that context, I think we would  appear absurdly agree, interest rates at today's levels would high -- a kind of historic aberration.  -15-  I know we're not over the hump to that happier world, despite the visible progress we can see on inflation.  But I  do think we can begin to sense the necessary change in attitudes. And I do think we have the best chance in memory of reversing the adverse trends of these past years  of making this  recession not another wasted, painful episode, but a transition to something better.   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  %  For release on delivery 8:00 PM, EDT May 25, 1982  Remarks of  Paul A. Volcker  Chairman, Board of Governors of the Federal Reserve System  before the  Money Marketeers of New York University  New York City  May 25, 1982   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  0  ‘  I am pleased to be in New York tonight with the Money Marketeers, even though it's problematical whether it helps the digestive process to have dinner with people who are trying to outguess what the Fed is doing from minute to minute and hour to hour.  I have had some concern that whether I ate  rapidly or slowly, or with the right hand or left, might be presumed to have some occult market significance.  At any rate,  no matter how long or attentively you listen, you are still going to have to make up your own minds about how the market will open tomorrow, or next month, or next year. Instead of looking at the nitty gritty of the financial markets tonight, I'd like to step back a few paces and suggest some perspective about what we are trying to do as a framework for evaluating the market.  I need not tell this group that we  are in a serious recession in this country today, made all the more difficult by the fact that our economy has not been performing up to expectations for a very long time.  We'd like to have some  marvelous painless cure for our troubles but that,unfortunately, is not the case. We have been going through a difficult process, because we have been suffering from the effects of an accumulation of some economic and financial problems that have been developing for a very long time.  Those trends were ultimately unsustainable  and they have had to be turned around. We let our productivity growth erode during the past decade and more, so that by the end of the 1970's we were getting no   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  productivity growth at all.  At the same time we wanted to see  -2-  our incomes keep ahead of inflation, even if we weren't achieving the productivity improvement that in the end is the only source of growth of real income.  And as costs rose faster  than prices, profit margins declined.  After a while, we came  to take inflation for granted.  We can see more clearly now  that many businesses and individuals overborrowed, tempted in part by the easy assumption that you could repay credit in cheaper dollars if you waited long enough.  And, as society saw less point  in financial assets as a way to hold savings, we were surprised and disconcerted that interest rates tended to rise.  The whole  thing, I think, left us ill-prepared to cope with the energy crisis and other economic shocks that came from outside. The one thread, in my mind, that underlay all those trends and all those attitudes was inflation.  We used to think in the  immediate postwar period that a little inflation might be a good thing.  It produced pleasant little surprises along the way --  more often than not profits turned out to be higher than anticipated; we could all feel a little richer when we saw the price of our house go up, particularly if we didn't have to buy a new one; we could see that our business mistakes could be covered by price increases and all of that was particularly nice when interest rates lagged way behind the inflation rate. What's different, it seems to me, about our current experience with respect to inflation is that it's lasted so long and it's been so high that people began to expect it. We've had inflations before in this country, particularly in   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  il War when prices went up war time -- a period in the Civ ld War I and during and after pretty fast, during and after Wor periods lasted very long, and World War II -- but none of those assumed that we'd return to a I think most people legitimately after a while. kind of norm of price stability  I suspect that  began climbing after the midwas the thought when inflation ut period. But what's.unique abo 1960's during the Vietnam war rs t for two or three or four yea inflation is that it didn't las with some ups and downs in but it went on for 15 years, and a rising trend. rate of speed -- it went on at   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  human animal that after a It's a characteristic of the while he learns from experience.  And soon people began to  it in their thinking expect inflation -- and even exaggerate happened some time in the second t Tha or. avi beh ir the in and nt, inflation could no longer poi t tha At . 0's 197 the of f hal level of interest rates that her hig the and , fun d ere sid be con their own inflationary for up e mak to ing and dem an beg lenders that. anticipations was one symptom of e in the memory of many tim st fir the for nk, thi I Now changing that trend and that of ct spe pro r fai a e hav we people, tion make this a period of transi can we e iev bel I ng. nki kind of thi course, has to be the aim of t, Tha . ure fut er ght bri to a much policy generally. of monetary policy, and public quite plainly so. Certainly inflation is down and  I know  ther the improvement whe ut abo ty ain ert unc of there's still a lot be reluctant to accept to ge sta s thi at l ura nat will last -- it's  is coming down and to te ra n io at fl in e th the evidence that provement will last. im e th on ti ic nv co e th change behavior in ly lieve that the relative be to on as re y nl ai There is cert dexes and consumer price in er uc od pr e th th bo good performance of ctors. y or non-recurring fa ar or mp te me so t ec in recent months refl strong ge increases remains wa d an e ic pr d an The momentum of cost nce in in price performa ga e th of ch Mu s. in a number of sector et ssion. And the mark ce re of t ds mi e th has been achieved in arts flation and false st in of s ar ye 15 at place seems to feel th we ticism about whether ep sk a y if st ju cy li in anti-inflation po price stability. g in or st re in t is rs pe really are going to erto stay liquid. Long ed nt wa ve ha s er nd Consequently, many le vel traordinarily high le ex an r fe of to d ue in term bonds have cont and the businessman r ye bu me ho e th d an ly, of yield historical ney at rates that mo m er -t ng lo ch mu e rais haven't been able to   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  look reasonable.  signs of progress -g in ny de no is e er th At the same time, g costs and setting in in ra st re in -progress potentially lasting ularly t. That is partic en em ov pr im ty vi ti uc the stage for prod s have ere costs and wage wh y om on ec e th of evident in sectors international d an ic st me do th wi out of line been more clearly ress is exaggerated og pr r ou of d ee sp ies. If the competitive realit the reduction at th te no so al d ul istics, I wo in some price stat wage feed back into the so al n ca x de in e ic in the consumer pr be hard to deny a d ul wo it g, in tt se this setting process. In ast, end is, at the very le tr ry na io at fl in c si change in the ba within our grasp.  t with cost containment, The other side of the story is tha declining inflation rate, perhaps inevitably, lagging behind the squeezed. The combination and with volume sluggish, profits are s creates a poor investment of high interest rates and low profit and other encouragements climate at the moment, despite the tax that have been adopted.  te All of this is reflected in some acu  business, and severe financial problems -- high unemployment, weak d the sense of uncertainty strains. It's very easy to understan s situation. and concern that so many people feel in thi  The  for all of us -- is to challenge for policy -- the challenge structive direction, building resolve those uncertainties in a con on what has been achieved. important steps have In that connection, a number of already been taken.   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  oo  constructive The fiscal structure is moving in help investment directions to help savings and to s; all that will and to provide greater incentive framework is take time to be effective, but the in place.  oo  more stable There is a clear possibility of a ence of the last energy picture, after the turbul weakness in prices decade, even though the recent to have come to has, for the time being, seemed an end.  oo  den is being attacked. The excessive regulatory bur  oo  least, And inflationary assumptions, at the very seem to have been challenged and questioned and be in the process of change.  rtunity -It is this process that provides an oppo rse the pattern of the the best opportunity in years -- to reve period of rising pro1970's, to look forward to a sustained return to price stability. ductivity and growth in the context of a ld be able to see his In that context, the average worker shou 't happened for five real income increase, something that hasn years or so. the sky, I can understand Now if that sounds like pie in the skepticism.  But I don't think it is just a dream.  After  osed to operate. all, this is the way the economy is supp  But,  about the more distant of course, it is one thing talking vaguely very actually start, and future, and another thing to see a reco to see it sustained. s of policy I would emphasize three elements in term to help make the approaches that seem to me to be critical objective a reality.  in They all have a bearing on conditions  in financial markets that financial markets, and it's conditions are one key to recovery, and keep   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  it going over time.  all if I say one of It's not going to surprise you at those factors is the federal budget. and won't belabor the point.  I am among experts,  You know the potential deficit  the mind. figures are so big they kind of numb  The problem is  deficit -- a number in the not so much the current fiscal 1982 Relative to the size of the general magnitude of $100 billion.  deficit in a recession period the economy today, that kind of a , what is really unique is not unprecedented. But what is new w it, is the outlook over in our fiscal history so far as I kno coming fiscal years. including the If we make some simple assumptions, better year after year assumption that business will get away and we will have steady that the recession will end right n a little more -- and if growth of four to five percent or eve place as they are now, we assume all government programs in t result in spending over with all the automatic increases tha   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  rise -- not fall -- as we the years ahead, the deficit would rise by a very substantial come out of the recession. It would by tens of billions as the amount. Your projections may differ nt is the estimates center time horizon lengthens, but the poi 1984 -- not very far away. around $200 billion or more by fiscal the fiscal years beyond that. They rise well above $200 billion in ion" we would be To put that in perspective, with "no act percent or more of the facing deficits equal to as much as five prosperity, not gross national product in periods of business recent years. so much less than the rate of net savings in  We  and tax and financial would like to see the savings rate increase, ection. market changes, I believe, point in that dir  But the clear  t, if the potential implication of the budgetary picture is tha icits would absorb an deficits are not sharply cut, those def listic projection of our historically large fraction of any rea  ty. savings potential for a period of growth and prosperi go There wouldn't be very much in the way of savings to around for the private sectors of the economy -- for home need buyers, and farmers and industries that so desperately credit to support their own growth.  Left unresolved, the  ets, l deficits could only mean pressure on the financia mark pressure that would be reflected in relatively high real interest rates.  As the markets look at the prospect, they  are more cautious about lending money today.  And, the analysis  nsion -calls into question the prospects for sustained expa expansion. certainly an investment-led, productivity-inducing situation Now the encouraging thing about that budgetary is, in a sense, the flip-side of its magnitude.  The threat is  better underso evident, the need for drastic surgery is much e in the stood in Washington today, on both sides of the aisl Congress, in the Administration, and elsewhere.  Once one under-  of compelling stands the size of the problem, there is a kind need to deal with it.  A rather dramatic effort to deal with  the Congressional the budget was made recently by the President and leadership.  ppointing. That particular effort failed and that was disa  usual budgetary But the effort is continuing -- through the more processes.  By its nature, those processes may not offer the  same dramatic or catalyzing potential.  A budget resolution  savings will, in leaves open questions about how the targeted fact, be implemented.   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  on But a resolution, combined with reconciliati  will of the Congresv procedures, wculd be a forward step, and the  -9-  to implement the program in actual spending and revenue increases will soon be tested.  The manner in which that test  is passed will be crucial, but there seems to me some grounds for encouragement. revolves The second policy element that I would emphasize • highly a more directly around monetary policy. Even with can be sophisticated audience, discussion of monetary policy "tight" confused by semantic difficulties -- what we mean by e interor "easy" money -- as well as by differing substantiv pretation of the data. In any event, I need not, before you, linger over the determined point that the process by which interest rates are e monetary is a lot more complicated than simply pulling a singl lever.  one Monetary policy is important, but it is still only  actions of many influences, and the immediate impact of our doesn't tell the whole story.  More important, over time, is  inflation, the climate of expectations about the economy and and the balance of savings and investment. y's The point has been made again and again that toda to current interest rates are extraordinarily high relative inflation.  That is a statistical fact.  But the relevant question  e expect, and in assessing real interest rates, is what peopl efully on when those with money will be prepared to act forc remain subdued. the conviction that the inflationary trend will   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  -10-  ning There are a number of signs that attitudes may be begin to change in that respect.  I wish I had a magic wand to speed  the result, but I don't. y What we do have is some degree of control over the mone for a supply, and, therefore, over both the actual prospects prospect. return to price stability and expectations of that money Theory and experience both tell us that restraint .on inflation and credit growth is an essential part of bringing down and keeping it down.  And if we are to get interest rates down  to be and do it in a way that they will stay down -- we have concerned about excessive growth of money.  That approach, in  rstood. general terms, it seems to me, is pretty well unde overBut, in this age of instant communication, when an thrown at us whelming number of poorly digested statistics are icult process practically every day, it can be a confusing and diff to try to follow the trend of money and credit growth from week . to week or month to month when the numbers bounce around so much t And, apart from the sheer statistical noise, we have to be aler ging to the impact of financial innovation on the numbers and to chan months behavior patterns in evaluating movements over a period of or years. In setting particular targets for growth of the various odically, monetary and credit aggregates, in reviewing them peri framework and in conducting our actual operations in the general g of those objectives, we need to assess those factors affectin in the monetary aggregates against the background of conditions   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  ral budgetary money, capital and foreign exchange markets, the fede posture, and other factors.  -11-  Market On the basis of its analysis, the Federal Open 2 that we felt, Committee last February adopted targets for 198 gh money to on the basis of experience, should provide enou inued progress support economic recovery, consistent with cont against inflation. most observers.  That judgment, I believe, was shared by  It is, of course, a judgment that should be, •  and is, reviewed from time to time.  this year, In making our judgment at the beginning of e weight -- or anything we did not, and do not now, put exclusiv ly. like it -- on one measure of the money supp  M1 gets a lot  it is the only of attention in the market, partly because aggregate published weekly.   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  the only measure we watch.  But I would emphasize it's not It may not always be the most  e to institutional important, particularly when it is sensitiv change. tively new, but For instance, NOW accounts are still rela are now a significant share of Ml.  While M1 is defined only to  accounts also have include transactions balances, we know NOW some characteristics of a savings account.  If there is a tendency,  of their savings in at the margin, for individuals to hold more part by recession uncertainties, in ced indu m, for id liqu ly high t tha time we set our targets, the At . cted affe be will ls tota M1 the yet have the full story -we had some evidence -- and we don't the public's desire to hold of a noticeable temporary change in NOW accounts. part of their financial assets in  At this point,  -12-  year has taken the form of nearly all the expansion in M1 this eve, reflects partly a NOW accounts, and that increase, we beli tion to the ordinary savings or precautionary motive, in addi transactions motivation.  I would note that, at the same time,  for precautionary the sharp decline in savings accounts -was reversed. purposes, a closely comparable asset -so far this Reflecting the surge in NOW accounts, M1 target range may seem year has grown slightly faster than our a savings or precautionary to imply. To the extent this reflects for money, we do not motive rather than a transactions demand find this terribly troubling.  That judgment is strengthened  of money, liquidity, against the background of other measures r target ranges. or credit expansion, reflected in our othe to me reasonably on Taken together, the current results seem ntions. track with respect to our policy inte tively slowly, You may recall that last year M1 grew rela our target range. while M2 expanded around the upper end of ection of financial We believe that this divergence was a refl d growth of money innovations, including prominently the rapi serve the function market funds, which to some limited extent of transactions balances.  Taking all this into account, we  M1 so disagreeable didn't find the pattern of slow growth of long as M2 and other as to take vigorous action against it so dly. measures were growing relatively rapi  Similarly, at the  growth in M1 so far this moment we don't find the pattern of   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  other aggregates reasonably year -- combined with behavior of the  -13-  ence of some consistent with intentions, and given the evid of line with shift in public savings patterns -- to be out our purposes.  very, I would also note that, with economic reco  aggregates could the "precautionary" element in M1 or other subside. basic problem -Looking through these technicalities, the and objective -- remains. to support recovery.  We want to have enough 'financial growth  But we also must make sure that monetary  toward, restoring policy remains concerned with, and directed 's an objective that price stability, and we don't believe that if we want the effort we can turn on and off like a faucet -- not to be successful.  To attempt to push interest rates down by  of inflationary fears excessive money creation at the expense would, it seems to me, be shortsighted.  In a practical sense,  ent environment, when it wouldn't work for very long in the curr strong. the sensitivity to inflation remains so to point out the The third area I would touch upon is e of mind; once started inflationary process is nurtured by a stat interest rates, in wage it tends to maintain its own momentum in the rest. You know, if bargaining, in pricing policies, and all   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  working since you you're under the age of 35 and you've been ve never known anything graduated from college or high school, you' career. Along the way but higher prices in your whole working salaries and wages year after you got used to annual increases in You got used to accumulating year that partly reflected inflation. in your house. Price stability financial resources by capital gains  -14-  the market, always seems nice when you are on the "buy" side of keep the but as sellers there is a strong inclination to try to process going. nt Today there is not enough money to finance real investme and inflation at the earlier rate of speed.  That process is  business making inflation subside, but in a transition period activity can be affected as well.  You can try to'solve that  y supply -dilemma by sharply accelerating growth in the mone by a willingness to finance inflation.  But in my judgment,  it will that will not prove to be a solution at all, because only perpetuate the process.  The dilemma ultimately has to  s, restraining be solved from the other direction, by reducing cost vity. nominal wages and salaries, and by increasing producti to accept It's easy to understand the reluctance of many is coming as a premise of their own behavior that inflation ce for so long. down, because they've seen the opposite experien ation in their But I also have to say that those who plan on infl ct bet against management and labor practices -- those who in effe y -- should think the nation's success in restoring price stabilit e expectations about the consequences of their actions when thos turn out to be unwarranted.   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  believe, In time, the process of disinflation can, I can breed conattain a kind of momentum of its own -- success fidence and further progress.  In that context, I think we would  d appear absurdly agree, interest rates at today's levels woul high -- a kind of historic aberration.  .t  ••••  -15-  I know we're not over the hump to that happier world, despite the visible progress we can see on inflation.  But I  do think we can begin to sense the necessary change in attitudes. And I do think we have the best chance in memory of reversing the adverse trends of these past years  of making this  recession not another wasted, painful episode, but a transition to something better.   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  For release on delivery 8:00 PM, EDT May 25, 1982  Remarks of  Paul A. Volcker  Chairman, Board of Governors of the Federal Reserve System   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  before the  Money Marketeers of New York University  New York City  May 25, 1982  Money I am pleased to be in New York tonight with the her it helps Marketeers, even though it's problematical whet le who are trying the digestive process to have dinner with peop te to minute and to outguess what the Fed is doing from minu hour to hour.  I have had some concern that whether I ate  or left, might be rapidly or slowly, or with the right hand ificance. presumed to have some occult market sign  At any rate,  , you are still going no matter how long or attentively you listen the market will open to have to make up your own minds about how tomorrow, or next month, or next year. the financial Instead of looking at the nitty gritty of a few paces and suggest markets tonight, I'd like to step back to do as a framework some perspective about what we are trying for evaluating the market.  I need not tell this group that we  today, made all the are in a serious recession in this country has not been performing more difficult by the fact that our economy   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  up to expectations for a very long time.  We'd like to have some  that,unfortunately, marvelous painless cure for our troubles but is not the case. t process, because We have been going through a difficul of an accumulation of we have been suffering from the effects that have been developing some economic and financial problems for a very long time.  nable Those trends were ultimately unsustai  and they have had to be turned around. e during the past decade We let our productivity growth erod 1970's we were getting no and more, so that by the end of the time we wanted to see productivity growth at all. At the same  weren't our incomes keep ahead of inflation, even if we end is the achieving the productivity improvement that in the only source of growth of real income.  And as costs rose faster  than prices, profit margins declined.  After a while, we came  to take inflation for granted.  We can see more clearly now  tempted in that many businesses and individuals overborrowed, it in cheaper part by the easy assumption that you could repay cred dollars if you waited long enough.  And, as society saw less point  surprised in financial assets as a way to hold savings, we were . and disconcerted that interest rates tended to rise  The whole  the energy thing, I think, left us ill-prepared to cope with ide. crisis and other economic shocks that came from outs those trends The one thread, in my mind, that underlay all and all those attitudes was inflation.  We used to think in the  n might be a good immediate postwar period that a little inflatio thing.  way -It produced pleasant little surprises along the  er than anticipated; more often than not profits turned out to be high the price of our we could all feel a little richer when we saw buy a new one; house go up, particularly if we didn't have to d be covered by we could see that our business mistakes coul nice when price increases and all of that was particularly rate. interest rates lagged way behind the inflation current What's different, it seems to me, about our it's lasted so experience with respect to inflation is that to expect it. long and it's been so high that people began particularly in We've had inflations before in this country,   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  when prices went up war time -- a period in the Civil War I and during and after pretty fast, during and after World War s lasted very long, and World War II -- but none of those period d that we'd return to a I think most people legitimately assume while. kind of norm of price stability after a  I suspect that  mbing after the midwas the thought when inflation began cli 1960's during the Vietnam war period.  But what's unique about  two or three or four years inflation is that it didn't last for h some ups and downs in but it went on for 15 years, and -- wit trend. rate of speed -- it went on at a rising   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  animal that after a It's a characteristic of the human while he learns from experience.  And soon people began to  ng expect inflation -- and even exaggerate it in their thinki some time in the second and in their behavior. That happened half of the 1970's.  ger At that point, inflation could no lon  of interest rates that be considered fun, and the higher level their own inflationary lenders began demanding to make up for anticipations was one symptom of that. the memory of many Now I think, for the first time in nging that trend and that people, we have a fair prospect of cha kind of thinking.  of transition I believe we can make this a period  to a much brighter future.  That, of course, has to be the aim  generally. of monetary policy, and public policy te plainly so. Certainly inflation is down and qui  I know  about whether the improvement there's still a lot of uncertainty stage to be reluctant to accept will last -- it's natural at this  -4-  to te is coming down and ra n io at fl in e th the evidence that . e improvement will last th on ti ic nv co e th change behavior in tively believe that the rela to on as re y nl ai There is cert umer price indexes ns co d an er uc od pr both the good performance of recurring factors. nno or y ar or mp te ect some in recent months refl s remains strong se ea cr in ge wa d an and price The momentum of cost nce in in price performa ga e th of ch Mu s. in a number of sector rket cession. And the ma re of t ds mi e th has been achieved in starts inflation and false of s ar ye 15 at th place seems to feel r we epticism about whethe sk a y if st ju cy li in anti-inflation po ing price stability. or st re in t is rs pe really are going to erto stay liquid. Long ed nt wa ve ha s er nd le Consequently, many level extraordinarily high an r fe of to d ue in term bonds have cont n r and the businessma ye bu me ho e th d an , of yield historically money at rates that m er -t ng lo ch mu e is ra haven't been able to   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  look reasonable.  -g signs of progress in ny de no is e er th At the same time, g costs and setting in in ra st re in -progress potentially lasting at is particularly Th t. en em ov pr im uctivity the stage for prod have ere costs and wages wh y om on ec e th of evident in sectors d international an ic st me do th wi ne t of li been more clearly ou d ogress is exaggerate pr r ou of d ee sp e ies. If th competitive realit the reduction at th te no so al d ul istics, I wo in some price stat wage feed back into the so al n ca x de in e ic in the consumer pr d be hard to deny a ul wo it g, in tt se this setting process. In at the very least, , is d en tr ry na io inflat change in the basic within our grasp.  that with cost containment, is ry sto the of e sid er oth The the declining inflation rate, perhaps inevitably, lagging behind s are squeezed. The combination and with volume sluggish, profit profits creates a poor investment of high interest rates and low tax and other encouragements climate at the moment, despite the this is reflected in some acute that have been adopted. All of weak business, and severe financial problems -- high unemployment, erstand the sense of uncertainty strains. It's very easy to und l.in this situation. The and concern that so many people fee llenge for all of us -- is to challenge for policy -- the cha uctive direction, building str con a in s tie ain ert unc se resolve tho on what has been achieved • of important steps have In that connection, a number ' en already been tak •   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  oo  ing in constructive The fiscal structure is mov to help investment directions to help savings and ives; all that will and to provide greater incent the framework is take time to be effective, but in place.  oo  of a more stable There is a clear possibility bulence of the last energy picture, after the tur weakness in prices decade, even though the recent med to have come to has, for the time being, see an end.  oo  den is being attacked. The excessive regulatory bur  oo  s, at the very least, And inflationary assumption stioned and seem to have been challenged and que be in the process of change.  vides an opportunity -It is this process that pro the -- to reverse the pattern of the best opportunity in years sustained period of rising pro1970's, to look forward to a urn tq price stability. ret a of t ex nt co the in wth ductivity and gro his worker should be able to see e rag ave e th t, ex nt co at th In ve g that hasn't happened for fi in th me so , se ea cr in me co in al re years or so. in the sky, I can understand Now if that sounds like pie nk it is just a dream. After thi t n' do I t Bu . sm ci ti ep the sk y is supposed to operate. But, nom eco e th way the is is th all, t vaguely about the more distan g kin tal ng thi e on is it , se of cour a recovery actually start, and see to ng thi r the ano and , future to see it sustained. ements in terms of policy I would emphasize three el be critical to help make the approaches that seem to me to ring on conditions in bea a e hav l al y The y. it al objective a re financial markets that in ns io it nd co 's it and s, financial market   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  ep are one key to recovery, and ke  it going over time.  you at all if I say one of It's not going to surprise get. I am among experts, bud l ra de fe the is s or ct fa those know the potential deficit You nt. poi the r abo bel t and won' the mind. The problem is b num of d kin y the big so figures are deficit -- a number in the 82 19 al sc fi t en rr cu the ch not so mu Relative to the size of the n. lio bil 00 $1 of ude nit general mag  a deficit in a recession period the economy today, that kind of t is new, what is really unique is not unprecedented. But wha I know it, is the outlook over in our fiscal history so far as coming fiscal years. tions, including the If we make some simple assump get better year after year assumption that business will ht away and we will have steady that the recession will end rig if or even a little more -- and t cen per e fiv to r fou of wth gro ms in place as they are now, gra pro t men ern gov all ume ass we that result in spending over ses rea inc tic oma aut the all h wit ld rise -- not fall -- as we wou t ici def the ad, ahe rs yea the al would rise by a very substanti It . ion ess rec the of out e com differ by tens of billions as the may ns tio jec pro r You . unt amo point is the estimates center the but , ens gth len n izo hor e tim y. cal 1984 -- not very far awa fis by e mor or n lio bil 0 $20 und aro that. n in the fiscal years beyond lio bil 0 $20 ve abo l wel e ris They   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  h "no action" we would be To put that in perspective, wit five percent or more of the facing deficits equal to as much as business prosperity, not gross national product in periods of savings in recent years. We so much less than the rate of net increase, and tax and financial would like to see the savings rate that direction. market changes, I believe, point in  But the clear  e is that, if the potential tur pic ary get bud the of on ati lic imp deficits would absorb an deficits are not sharply cut, those realistic projection of our historically large fraction of any  and prosperity. savings potential for a period of growth savings to go There wouldn't be very much in the way of nomy -- for homearound for the private sectors of the eco desperately need buyers, and farmers and industries that so credit to support their own growth.  Left unresolved, the  financial markets, deficits could only mean pressure on the vely high real pressure that would be reflected in relati interest rates.  As the markets look at the prospect, they  today. are more cautious about lending money  And, the analysis  tained expansion -calls into question the prospects for sus cing expansion. certainly an investment-led, productivity-indu getary situation Now the encouraging thing about that bud ude. is, in a sense, the flip-side of its magnit  The threat is  y is much better underso evident, the need for drastic surger of the aisle in the stood in Washington today, on both sides ewhere. Congress, in the Administration, and els  Once one under-  a kind of compelling stands the size of the problem, there is need to deal with it.  A rather dramatic effort to deal with  sident and the Congressional the budget was made recently by the Pre and that was disappointing. leadership. That particular effort failed the more usual budgetary But the effort is continuing -- through   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  processes.  offer the By its nature, those processes may not  same dramatic or catalyzing potential.  A budget resolution  geted savings will, in leaves open questions aL,out how the tar fact, be implemented.  onciliation But a resolution, combined with rec  and the will of the Congress' procedures, wculd be a forward step,  9-  -  to implement the program in actual spending and revenue increases will soon be tested.  The manner in which that test  nds is passed will be crucial, but there seems to me some grou for encouragement. revolves The second policy element that I would emphasize more directly around monetary policy.  Even with a highly  can be sophisticated audience, discussion of monetary policy ht" confused by semantic difficulties -- what we mean by "tig interor "easy" money -- as well as by differing substantive pretation of the data. the In any event, I need not, before you, linger over determined point that the process by which interest rates are le monetary is a lot more complicated than simply pulling a sing lever.  one Monetary policy is important, but it is still only  actions of many influences, and the immediate impact of our   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  doesn't tell the whole story.  More important, over time, is  inflation, the climate of expectations about the economy and and the balance of savings and investment. today's The point has been made again and again that current interest rates are extraordinarily high relative to inflation.  That is a statistical fact.  But the relevant question I  le expect, and in assessing real interest rates, is what peop forcefully on when those with money will be prepared to act remain subdued. the conviction that the inflationary trend will  4  -10-  s may be beginning There are a number of signs that attitude to change in that respect.  I wish I had a magic wand to speed  the result, but I don't. over the money What we do have is some degree of control al prospects for a supply, and, therefore, over both the actu of that prospect. return to price stability and expectations restraint.on money Theory and experience both tell us that bringing down inflation and credit growth is an essential part of and keeping it down.  And if we are to get interest rates down  down -- we have to be and do it in a way that they will stay y. concerned about excessive growth of mone  That approach, in  well understood. general terms, it seems to me, is pretty n, when an overBut, in this age of instant communicatio istics are thrown at us whelming number of poorly digested stat using and difficult process practically every day, it can be a conf th from week to try to follow the trend of money and credit grow ce around so much. to week or month to month when the numbers boun we have to be alert And, apart from the sheer statistical noise, numbers and to changing to the impact of financial innovation on the a period of months behavior patterns in evaluating movements over or years.   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  the various In setting particular targets for growth of g them periodically, monetary and credit aggregates, in reviewin in the general framework and in conducting our actual operations e factors affecting of those objectives, we need to assess thos nd of conditions in the monetary aggregates against the backgrou ets, the federal budgetary money, capital and foreign exchange mark posture, and other factors.  -11-  eral Open Market On the basis of its analysis, the Fed gets for 1982 that we felt, Committee last February adopted tar vide enough money to on the basis of experience, should pro with continued progress support economic recovery, consistent against inflation. most observers.  That judgment, I believe, was shared by  uld be, It is, of course, a judgment that sho  and is, reviewed from time to time.   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  ing of this year, In making our judgment at the beginn ive weight -- or anything we did not, and do not now, put exclus supply. M1 gets a lot like it -- on one measure of the money ause it is the only of attention in the market, partly bec aggregate published weekly. the only measure we watch.  But I would emphasize it's not It may not always be the most  sensitive to institutional important, particularly when it is change. ll relatively new, but For instance, NOW accounts are sti are now a significant share of Ml.  While M1 is defined only to  know NOW accounts also have include transactions balances, we account. If there is a tendency, some characteristics of a savings d more of their savings in at the margin, for individuals to hol part by recession uncertainties in d uce ind m, for uid liq hly hig that s, At the time we set our target ed. ect aff be l wil als tot M1 the yet have the full story -'t don we and -ce den evi e som we had public's desire to hold the in nge cha ary por tem e abl ice of a not nt, in NOW accounts. At this poi part of their financial assets  -12-  this year has taken the form of nearly all the expansion in M1 we believe, reflects partly a NOW accounts, and that increase, in addition to the ordinary savings or precautionary motive, note that, at the same time, transactions motivation. I would ounts -- for precautionary the sharp decline in savings acc et -- was reversed. purposes, a closely comparable ass ounts, M1 so far this Reflecting the surge in NOW acc than our target range may seem year has grown slightly faster y lects a savings or precautionar ref s thi ent ext the To ly. imp to demand for money, we do not ons cti nsa tra a n tha her rat ive mot That judgment is strengthened find this terribly troubling. measures of money, liquidity, er oth of d oun kgr bac the t ins aga our other target ranges. in ted lec ref , ion ans exp dit cre or , ults seem to me reasonably on res t ren cur the er, eth tog en Tak intentions. track with respect to our policy M1 grew relatively slowly, You may recall that last year er end of our target range. while M2 expanded around the upp was a reflection of financial We believe that this divergence ly the rapid growth of money innovations, including prominent d extent serve the function market funds, which to some limite of transactions balances.   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  Taking all this into account, we  growth of M1 so disagreeable w slo of n ter pat the d fin n't did it so long as M2 and other t ins aga ion act us oro vig e tak as to y rapidly. Similarly, at the measures were growing relativel n of growth in M1 so far this moment we don't find the patter other aggregates reasonably the of or avi beh h wit ed bin year -- com  1  -13-  of some consistent with intentions, and given the evidence line with shift in public savings patterns -- to be out of our purposes.  I would also note that, with economic recovery,  es could the "precautionary" element in M1 or other aggregat subside. c problem -Looking through these technicalities, the basi and objective -- remains. to support recovery.  We want to have enough 'financial growth  But we also must make sure that monetary  toward, restoring policy remains concerned with, and directed an objective that price stability, and we don't believe that's we want the effort we can turn on and off like a faucet -- not if to be successful.  To attempt to push interest rates down by  inflationary fears excessive money creation at the expense of would, it seems to me, be shortsighted.  In a practical sense,  environment, when it wouldn't work for very long in the current ng. the sensitivity to inflation remains so stro point out the The third area I would touch upon is to of mind; once started inflationary process is nurtured by a state rest rates, in wage it tends to maintain its own momentum in inte the rest. bargaining, in pricing policies, and all  You know, if  working since you you're under the age of 35 and you've been never known anything graduated from college or high school, you've   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  er. but higher prices in your whole working care  Along the way  ries and wages year after you got used to annual increases in sala got used to accumulating year that partly reflected inflation. You house. Price stability your in s gain tal capi by s urce reso l financia  -14-  of the market, always seems nice when you are on the "buy" side try to keep the but as sellers there is a strong inclination to process going. investment Today there is not enough money to finance real and inflation at the earlier rate of speed.  That process is  od business making inflation subside, but in a transition peri activity can be affected as well.  You can try to solve that  money supply -dilemma by sharply accelerating growth in the by a willingness to finance inflation.  But in my judgment,  because it will that will not prove to be a solution at all, only perpetuate the process.  The dilemma ultimately has to  costs, restraining be solved from the other direction, by reducing productivity. nominal wages and salaries, and by increasing to accept It's easy to understand the reluctance of many ation is coming as a premise of their own behavior that infl rience for so long. down, because they've seen the opposite expe on inflation in their But I also have to say that those who plan   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  in effect bet against management and labor practices -- those who stability -- should think the nation's success in restoring price those expectations about the consequences of their actions when turn out to be unwarranted. I believe, In time, the process of disinflation can, ess can breed conattain a kind of momentum of its own -- succ fidence and further progress.  In that context, I think we would  would appear absurdly agree, interest rates at today's levels high -- a kind of historic aberration.  -  -15-  ,  I know we're not over the hump to that happier world, despite the visible progress we can see on inflation.  But I  do think we can begin to sense the necessary change in attitudes. And I do think we have the best chance in memory of reversing the adverse trends of these past years  of making this  recession not another wasted, painful episode, but a transition to something better.   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  %  NI  For release on delivery 8:00 PM, EDT May 25, 1982  Remarks of  Paul A. Volcker  Chairman, Board of Governors of the Federal Reserve System  before the  Money Marketeers of New York University  New York City  May 25, 1982   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis A..   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  I am pleased to be in New York tonight with the Money Marketeers, even though it's problematical whether it helps the digestive process to have dinner with people who are trying to outguess what the Fed is doing from minute to minute and hour to hour.  I have had some concern that whether I ate  rapidly or slowly, or with the right hand or left, might be presumed to have some occult market significance.  At any rate,  no matter how long or attentively you listen, you are still going to have to make up your own minds about how the market will open tomorrow, or next month, or next year. Instead of looking at the nitty gritty of the financial markets tonight, I'd like to step back a few paces and suggest some perspective about what we are trying to do as a framework for evaluating the market.  I need not tell this group that we  are in a serious recession in this country today, made all the more difficult by the fact that our economy has not been performing up to expectations for a very long time.like to have some marvelous painless cure for our troubles but that,unfortunately, is not the case. We have been going through a difficult process, because we have been suffering from the effects of an accumulation of some economic and financial problems that have been developing for a very long time.  Those trends were ultimately unsustainable  and they have had to be turned around. We let our productivity growth erode during the past decade and more, so that by the end of the 1970's we were getting no productivity growth at a.A  the same time we wanted to see   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  2-  our incomes keep ahead of inflation, even if we weren't achieving the productivity improvement that in the end is the only source of growth of real income.  And as costs rose faster  than prices, profit margins declined.  After a while, we came  to take inflation for granted.  We can see more clearly now  that many businesses and individuals overborrowed, tempted in part by the easy assumption that you could repay credit in cheaper dollars if you waited long enough.  And, as society saw less point  in financial assets as a way to hold savings, we were surprised and disconcerted that interest rates tended to rise.  The whole  thing, I think, left us ill-prepared to cope with the energy crisis and other economic shocks that came from outside. The one thread, in my mind, that underlay all those trends and all those attitudes was inflation.  We used to think in the  immediate postwar period that a little inflation might be a good thing.  It produced pleasant little surprises along the way --  more often than not profits turned out to be higher than anticipated; we could all feel a little richer when we saw the price of our house go up, particularly if we didn't have to buy a new one; we could see that our business mistakes could be covered by price increases and all of that was particularly nice when interest rates lagged way behind the inflation rate. What's different, it seems to me, about our current experience with respect to inflation is that it's lasted so long and it's been so high that people began to expect it. We've had inflations before in this country, particularly in   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  3  war time -- a period in the Civil War when prices went up pretty fast, during and after World War I and during and after World War II -- but none of those periods lasted very long, and I think most people legitimately assumed that we'd return to a kind of norm of price stability after a while.  I suspect that  was the thought when inflation began climbing after the mid1960's during the Vietnam war period.  But what's unique about  inflation is that it didn't last for two or three or four years but it went on for 15 years, and -- with some ups and downs in rate of speed -- it went on at a rising trend. It's a characteristic of the human animal that after a while he learns from experience.  And soon people began to  expect inflation -- and even exaggerate it in their thinking and in their behavior. half of the 1970's.  That happened some time in the second  At that point, inflation could no longer  be considered fun, and the higher level of interest rates that lenders began demanding to make up for their own inflationary anticipations was one symptom of that. Now I think, for the first time in the memory of many people, we have a fair prospect of changing that trend and that kind of thinking.  I believe we can make this a period of transition  to a much brighter future.  That, of course, has to be the aim  of monetary policy, and public policy generally. Certainly inflation is down and quite plainly so.  I know  there's still a lot of uncertainty about whether the improvement will last -- it's natural at this stage to be reluctant to accept   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  4-  -  the evidence that the inflation rate is coming down and to change behavior in the conviction the improvement will last. There is certainly reason to believe that the relatively good performance of both the producer and consumer price indexes in recent months reflect some temporary or non-recurring factors. The momentum of cost and price and wage increases remains strong in a number of sectors.  Much of the gain in price performance  has been achieved in the midst of recession.  And the market  place seems to feel that 15 years of inflation and false starts in anti-inflation policy justify a skepticism about whether we really are going to persist in restoring price stability. Consequently, many lenders have wanted to stay liquid.  Longer-  term bonds have continued to offer an extraordinarily high level of yield historically, and the home buyer and the businessman haven't been able to raise much long-term money at rates that look reasonable. At the same time, there is no denying signs of progress -potentially lasting progress -- in restraining costs and setting the stage for productivity improvement.  That is particularly  evident in sectors of the economy where costs and wages have been more clearly out of line with domestic and international competitive realities.  If the speed of our progress is exaggerated  in some price statistics, I would also note that the reduction in the consumer price index can also feed back into the wage setting process.  In this setting, it would be hard to deny a  change in the basic inflationary trend is, at the very least, within our grasp.   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  5-  -  The other side of the story is that with cost containment, perhaps inevitably, lagging behind the declining inflation rate, and with volume sluggish, profits are squeezed.  The combination  of high interest rates and low profits creates a poor investment climate at the moment, despite the tax and other encouragements that have been adopted.  All of this is reflected in some acute  problems -- high unemployment, weak business, and severe financial strains.  It's very easy to understand the sense of uncertainty  and concern that so many people feel in this situation.  The  challenge for policy -- the challenge for all of us -- is to resolve those uncertainties in a constructive direction, building on what has been achieved. In that connection, a number of important steps have already been taken. oo  The fiscal structure is moving in constructive directions to help savings and to help investment and to provide greater incentives; all that will take time to be effective, but the framework is in place.  oo  There is a clear possibility of a more stable energy picture, after the turbulence of the last decade, even though the recent weakness in prices has, for the time being, seemed to have come to an end.  oo  The excessive regulatory burden is being attacked.   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  -6  oo  And inflationary assumptions, at the very least, have been challenged and questioned and seem to be in the process of change.  It is this process that provides an opportunity -the best opportunity in years -- to reverse the pattern of the 1970's, to look forward to a sustained period of rising proity. ductivity and growth in the context of a return to price stabil In that context, the average worker should be able to see his real income increase, something that hasn't happened for five years or so. Now if that sounds like pie in the sky, I can understand the skepticism.  But I don't think it is just a dream.  After  all, this is the way the economy is supposed to operate.  But,  of course, it is one thing talking vaguely about the more distant future, and another thing to see a recovery actually start, and to see it sustained. I would emphasize three elements in terms of policy approaches that seem to me to be critical to help make the objective a reality.  They all have a bearing on conditions in  financial markets, and it's conditions in financial markets that are one key to recovery, and keep  it going over time.  It's not going to surprise you at all if I say one of those factors is the federal budget. and won't belabor the point.  I am among experts,  You know the potential deficit  figures are so big they kind of numb the mind.  The problem is  not so much the current fiscal 1982 deficit -- a number in the general magnitude of $100 billion.  Relative to the size of the   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  7-  _  the economy today, that kind of a deficit in a recession period is not unprecedented.  But what is new, what is really unique  in our fiscal history so far as I know it, is the outlook over coming fiscal years. If we make some simple assumptions, including the assumption that business will get better year after year that the recession will end right away and we will have steady growth of four to five percent or even a little more -- and if we assume all government programs in place as they are now, with all the automatic increases that result in spending over the years ahead, the deficit would rise -- not fall -- as we come out of the recession. amount.  It would rise by a very substantial  Your projections may differ by tens of billions as the  time horizon lengthens, but the point is the estimates center around $200 billion or more by fiscal 1984 -- not very far away. They rise well above $200 billion in the fiscal years beyond that. To put that in perspective, with "no action" we would be facing deficits equal to as much as five percent or more of the gross national product in periods of business prosperity, not so much less than the rate of net savings in recent years.  We  would like to see the savings rate increase, and tax and financial market changes, I believe, point in that direction.  But the clear  implication of the budgetary picture is that, if the potential deficits are not sharply cut, those deficits would absorb an historically large fraction of any realistic projection of our   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  8-  savings potential for a period of growth and prosperity. There wouldn't be very much in the way of savings to go around for the private sectors of the economy -- for homebuyers, and farmers and industries that so desperately need credit to support their own growth.  Left unresolved, the  deficits could only mean pressure on the financial markets, pressure that would be reflected in relatively high real interest rates.  As the markets look at the prospect, they  are more cautious about lending money today.  And, the analysis  calls into question the prospects for sustained expansion -certainly an investment-led, productivity-inducing expansion. Now the encouraging thing about that budgetary situation is, in a sense, the flip-side of its magnitude.  The threat is  so evident, the need for drastic surgery is much better understood in Washington today, on both sides of the aisle in the Congress, in the Administration, and elsewhere.  Once one under-  stands the size of the problem, there is a kind of compelling need to deal with it.  A rather dramatic effort to deal with  the budget was made recently by the President and the Congressional leadership.  That particular effort failed and that was disappointing.  But the effort is continuing -- through the more usual budgetary processes.  By its nature, those processes may not offer the  same dramatic or catalyzing potential.  A budget resolution  leaves open questions aL'out how the targeted savings will, in fact, be implemented.  But a resolution, combined with reconciliation  proceures, wculd be a forward step, and the will of the Congress   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  9-  to implement the program in actual spending and revenue increases will soon be tested.  The manner in which that test  is passed will be crucial, but there seems to me some grounds for encouragement. The second policy element that I would emphasize revolves more directly around monetary policy.  Even with a highly  sophisticated audience, discussion of monetary policy can be confused by semantic difficulties -- what we mean by "tight" or "easy" money -- as well as by differing substantive interpretation of the data. In any event, I need not, before you, linger over the point that the process by which interest rates are determined is a lot more complicated than simply pulling a single monetary lever.  Monetary policy is important, but it is still only one  of many influences, and the immediate impact of our actions doesn't tell the whole story.  More important, over time, is  the climate of expectations about the economy and inflation, and the balance of savings and investment. The point has been made again and again that today's interest rates are extraordinarily high relative to current inflation.  That is a statistical fact.  But the relevant question,  in assessing real interest rates, is what people expect, and when those with money will be prepared to act forcefully on the conviction that the inflationary trend will remain subdued.  -10-  There are a number of signs that attitudes may be beginning to change in that respect.  I wish I had a magic wand to speed  the result, but I don't. What we do have is some degree of control over the money supply, and, therefore, over both the actual prospects for a return to price stability and expectations of that prospect. Theory and experience both tell us that restraint on money and credit growth is an essential part of bringing down inflation and keeping it down.  And if we are to get interest rates down -  -  and do it in a way that they will stay down -- we have to be concerned about excessive growth of money.  That approach, in  general terms, it seems to me, is pretty well understood. But, in this age of instant communication, when an overwhelming number of poorly digested statistics are thrown at us practically every day, it can be a confusing and difficult process to try to follow the trend of money and credit growth from week to week or month to month when the numbers bounce around so much. And, apart from the sheer statistical noise, we have to be alert to the impact of financial innovation on the numbers and to changing behavior patterns in evaluating movements over a period of months or years. In setting particular targets for growth of the various monetary and credit aggregates, in reviewing them periodically, and in conducting our actual operations in the general framework of those objectives, we need to assess those factors affecting monetary aggregates against the background of conditions in the money, capital and foreign exchange markets, the federal budgetary posture, and other factors.   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis Al..   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  I.  -11--  On the basis of its analysis, the Federal Open Market Committee last February adopted targets for 1982 that we felt, on the basis of experience, should provide enough money to support economic recovery, consistent with continued progress against inflation. most observers.  That judgment, I believe, was shared by  It is, of course, a judgment that should be,  and is, reviewed from time to time. In making our judgment at the beginning of this year, we did not, and do not now, put exclusive weight -- or anything like it -- on one measure of the money supply.  M1 gets a lot  of attention in the market, partly because it is the only aggregate published weekly. the only measure we watch.  But I would emphasize it's not It may not always be the most  important, particularly when it is sensitive to institutional change. For instance, NOW accounts are still relatively new, but are now a significant share of Ml.  While M1 is defined only to  include transactions balances, we know NOW accounts also have some characteristics of a savings account.  If there is a tendency,  at the margin, for individuals to hold more of their savings in that highly liquid form, induced in part by recession uncertainties, the M1 totals will be affected.  At the time we set our targets,  we had some evidence -- and we don't yet have the full story -of a noticeable temporary change in the public's desire to hold part of their financial assets in NOW accounts.  At this point,   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  -12-  nearly all the expansion in M1 this year has taken the form of NOW accounts, and that increase, we believe, reflects partly a savings or precautionary motive, in addition to the ordinary transactions motivation.  I would note that, at the same time,  the sharp decline in savings accounts -- for precautionary purposes, a closely comparable asset -- was reversed. Reflecting the surge in NOW accounts, M1 so far this year has grown slightly faster than our target range may seem to imply.  To the extent this reflects a savings or precautionary  motive rather than a transactions demand for money, we do not find this terribly troubling.  That judgment is strengthened  against the background of other measures of money, liquidity, or credit expansion, reflected in our other target ranges. Taken together, the current results seem to me reasonably on track with respect to our policy intentions. You may recall that last year M1 grew relatively slowly, while M2 expanded around the upper end of our target range. We believe that this divergence was a reflection of financial innovations, including prominently the rapid growth of money market funds, which to some limited extent serve the function of transactions balances.  Taking all this into account, we  didn't find the pattern of slow growth of M1 so disagreeable as to take vigorous action against it so long as M2 and other measures were growing relatively rapidly.  Similarly, at the  moment we don't find the pattern of growth in M1 so far this year -- combined with behavior of the other aggregates reasonably  %  %   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  -13-  consistent with intentions, and given the evidence of some shift in public savings patterns -- to be out of line with our purposes.  I would also note that, with economic recovery,  the "precautionary" element in M1 or other aggregates could subside. Looking through these technicalities, the basic problem -and objective -- remains. to support recovery.  We want to have enough financial growth  But we also must make sure that monetary  policy remains concerned with, and directed toward, restoring price stability, and we don't believe that's an objective that we can turn on and off like a faucet -- not if we want the effort to be successful.  To attempt to push interest rates down by  excessive money creation at the expense of inflationary fears would, it seems to me, be shortsighted.  In a practical sense,  it wouldn't work for very long in the current environment, when the sensitivity to inflation remains so strong. The third area I would touch upon is to point out the inflationary process is nurtured by a state of mind; once started it tends to maintain its own momentum in interest rates, in wage bargaining, in pricing policies, and all the rest.  You know, if  you're under the age of 35 and you've been working since you graduated from college or high school, you've never known anything but higher prices in your whole working career.  Along the way  you got used to annual increases in salaries and wages year after year that partly reflected inflation.  You got used to accumulating  financial resources by capital gains in your house.  Price stability  •   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  -14-  always seems nice when you are on theside of the market, but as sellers therestrong inclination to try to keep the process going. Today there is not enough money to finance real investment and inflation at the earlier rate of speed.  That process is  making inflation subside, but in a transon period business activity can be affected as well.  You can try to solve that  dilemma by sharply accelerating growth in the money supply -by a wngness to finance inflation.  But in my judgment,  that will not prove to be a solution at a•acause it will only perpetuate the process.  The dilemma ultimately has to  be solved from the other direction, by reducing costs, restraining nominal wages and salaries, and by increasing productivity. It's easy to understand the reluctance of many to accept as a premise of their own behavior that inflation is coming down, because they've seen the opposite experience for so long. B•ut I also have to say that those who plan on inflation in their management and labor practices -- those who in effect bet against the nation's success in restoring price stability -- should think about the consequences of their actions when those expectations turn out to be unwarranted. In time, the process of disinflation can, I believe, attain a kind of momentum of its own -- success can breed confidence and further progress.  In that context, I think we would  agree, interest rates at today's levels would appear absurdly hiI h -- a kind of historic aberration.   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  -15-  I know we're not over the hump to that happier world, despite the visible progress we can see on inflation.  But I  do think we can begin to sense the necessary change in attitudes. And I do think we have the best chance in memory of reversing the adverse trends of these past years  of making this  recession not another wasted, painful episode, but a transition to something better.  •   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  THE MONEY MARKETEERS OF NEW YORK UNIVERSITY 90 TRINITY PLACE NEN,/ YORK NEW YORK, 10006  March 22, 1982  The Honorable Paul A. Volcker Chairman Board of Governors of the Federal Reserve System Constitution Avenue & 20th Street, N.W. Washington, D.C. 20551  2r:3  Dear Chairman Volcker: On behalf of the Money Marketeers of New York University, I would like to thank you for honoring our group by accepting our Distinguished Achievement Award for 1982. The membership which consists of a broad cross section of decision makers in the money and capital markets, has been informed and is, of course, delighted. While we have had a number of distinguished recipients of the award in the past, none has been more uniquely "Man of the Year" than you. We look forward to sharing this evening with you. The award dinner will be held on May 25th at the City Midday Club, 140 Broadway (50th floor). Cocktails begin at 5:30PM followed by dinner at 6:45PM. The customary format is a brief presentation (25-30 minutes) by the recipient with a question and answer period to follow but this can be modified to any format you choose. I would appreciate it if you would have the appropriate member of your staff contact me at (212) 422-8708 to arrange the housekeeping details such as press coverage and transportation. Sincerely,  Harold W. Kurtz President  1-71  ' 11  •sa  NEW YORK UNIVERSITY Graduate School of Business Administration 100 TRINITY PLACE, NEW YORK, N. Y. 10006 AREA 212 285-6140  Robert A. Kavesh, Marcus Nadler Professor of Finance and Economics  Ja.44.. 22, /?if'2,  /da_44 digLi.`7 / ,014J J Ittti ,t4t.   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  /176,1 /14,tidiD1.2) 62dc(-,1 4(AtA2, 41‘i,..eze,  -(tk,  dbli-4e,  // eear  Al• /94 , ,,. 11.‘AAxIdzzu) <!1_15 (.;  NEW YORK UNIVERSITY Graduate School of Business Administration loo TRINITY PLACE, NEW YORK, N. Y. 10006 AREA 212 285-6140  Robert A. Kavesh, Marcus Nadler Professor of Finance and Economics  19E12 JON 15 rid, In* 71  41 January 13, 1982  Hon. Paul A. Volcker, Chairman Board of Governors Federal Reserve System Washington, D.C. 20551  Dear Paul: You know I never bother you for anything, but... The Money Marketeers (You've spoken to them) bestow an annual Distinguished Achievement Award " to a person who has made noteworthy contributions to the development and integration of the national and international financial system as thinker, practitioner ot policymaker." Previous awardees have been: William Simon, Pierre-Paul Schweitzer, Arthur Levitt, Otmar Emminger and Henry Kaufman. The Board of Governors (I'm one) would like to make this award to you this Spring. Please accept! We meet for a dinner meeting downtown. You could give a short acceptance speech on any topic you pick -- formal or informal.   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  Dates available: May 3,4,5,6, 10, 13, 17, 18, 24, 25, 26. Stop grumbling! Answer very soon, please, and say  yes".  Cordially,  Ro  rt A. Kavesh  Draft for Mbney Marketcers 5/24/82  I am pleased to be in New York tonight with the Money Marketoers.  It's always nice to have dinner with the people who are trying to outguess  what we at the Fed are going to do from minute to minute and hour to  hour.  And if you all stay attentive to my remarks I will tell you at  the end of the evening what interest rates are going to do in the future.  Instead of looking at the nitty gritty of the financial markets  tonight, I'd like to step back a few paces and provide some perspective  to what we are trying to do and to give you a framework for the many  questions that_Ilm_sure you must have.  I nced not tell this group that  we areseries recession in this country today, made all the more  dcult by the fact that our economy has not been performing up to  expectations for a very long time.  We'd like to have same marvelous  painless cure for our troubles but that unfortunately is not to be.  I can't resist telling you the comment of a good friend of  mine who fairly recently has a quadruple bypass heart operation.  He  said he thought it must be like going through the experience of curing  inflation.  His operation, he said, was a miserable experience, worse  than he anticipated. more than worth it.  http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  But once the recovery began, he realized it was  2 •  1/N)11, in a sense, our economic patient is still on the operating  table.  It has been a difficult process, because we have been suffering  from the effects of an accumulation of some economic and financial problems  that have been developing for a very long time.  Those trends were  ultimately unsustainable and they have had to be turned around.  We let our productivity growth erode during the past decade  and more, so that by the end of the 1970's we were getting no productivity  growth at all.  But, of course, /at the same time we wanted to see our  incomes keep ahead of inflation, even if we weren't achieving the productivity  improvement that in the end is the only source of growth of real income.  And as costs rose faster than prices, profit margins declined.  After a  while, we came to take inflation for granted -- probably—for_the_first  time in American history.  We can see more clearly now that many businesses  and individuals overborrowed, tempted in part by the easy assumption  that you could repay credit in cheaper dollars if you waited long enough.  And, as society saw less point in financial assets as a way to hold savings,  we were surprised and disconcerted that interest rates tended to rise.   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  3  The whole thing, I think, left us ill-prepared to cope with the energy  crisis and other economic shocks that came from outside.  The one thread, in my mind, that underlay all those trends and  all those attitudes was inflation.  We used to think in the immediate  postwar period that a little inflation might be a good thing.  It  produced pleasant little surprises along the way -- more often than not  profits turned out to be higher than anticipated; we could all feel a  little richer when we saw  a,  of our house go up, particularly if  we didn't have to buy a new one; we could see that our business mistakes  could be covered by price increases and all of that was particularly nice  when interest rates lagged way behind the inflation rate.  What's different, it seems to me, about our current experience  with respect to inflation is that it's lasted so long and  that people began to expect it.  s been so high  We've had inflations before in this country,  particularly in war time -- a period in the Civil War when prices went  up pretty fast, during and after Wbrld War I and during and after Wbrld  War II -- but none of those periods lasted very long, and I think most  people legitimately assumed that we'd return to a kind of norm of price   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  4  stability after a while.  I suspect that was the thought when inflation  began climbing after the mid-1970's during the Vietnam war period.  But  what's unique about this inflation is that it didn't last for two or three or four years but it went on for 15 years, and -- with some ups and downs in rate of speed -- it went on at a rising trend.  It's a characteristic of the human animal that after a while he learns from experience.  And as soon as people began to expect inflation --  and even exaggerate it in their thinking and in their behavior.  happened same time in the second half of the 1970's.  That  At that point, inflation  could no longer be considered fun, and the higher level of interest  rates that lenders began demanding to make up for their own inflationary  anticipations was one symptom of that.  Now I think, for the first time in the memory of many people, we  have a fair propspect of changing that trend and that kind of thinking.  believe we can make this a period of transition to a much brighter future.  That of course has to be the aim of monetary policy, and public policy generally.  Certainly inflation is down and quite plainly so.  I know there's  still a lot of uncertainty about whether the improvement will last -- it's   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  5  natural at this stage to be reluctant to accept the evidence that the  inflation rate is coming down and to Change behavior in the conviction the  improvement will last.  Lenders have wanted to stay liquid.  Longer-telln  14onds have offered an extra-ordinarily high level of yield, but they have 411110111011111ft  too often tended to go begging in the market place.  The home buyer and  the businessman haven't been able to raise much long-term money at rates  that look reasonable.  The market place seems to feel that 15 years of  inflation and false starts in anti-inflation policy justify a skepticism  about whether we really are going to persist in restoring price stability.  And, despite visible progress across a broad front, in many areas a momentum  of cost and price and wage increases still remains very strong.  As a result, profits are squeezed.  The combination of high interest  rates and low profits creates a poor investment climate at the moment,  despite the tax and other encouragements that have been adopted.  this is reflected in son  All of  acute problems -- high unemployment, weak  business, severe financial strains -- all doubly evident in areas of  heavy industry.  It's very easy to understand the sense of uncertainty  and concern that so many people feel in this situation.  But I do think  there is a much more promising side to the present developments.   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  In a  number of industries -- particularly where cost and wages have cicarly  been out of line -- there seems to be greater recognition of competitive  threats and new cooperation between labor and management, reflected in  changes in the wage trend and renewed emphasis on productivity.  We have  changed the fiscal structure in constructive directions to help savings  and to help investment and to provide greater incentives, all that will  take time to be effective, but the framework is in place.  We have the  clear possibility of a more stable energy picture after the turbulence  of the last decade.  We've at least begun to deal with.the excessive  regulatory burden./ And inflationary assumptions, at the very least, have  been challenged and questioned and seem to be in the process of change.  It is this process that provides an opportunity -- the best  opportunity in years -- to reverse the pattern of the 1970's, to look  forward to a sustained period of rising productivity and growth, of higher  real income for the average worker -- something we haven't seen for five  years or so -- and see that in the context of a return to price stability.   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  7  Now if that sounds like pie in thecan understand the  skepticism.  But I don't think it is just a dream.  way the economy is supposed to operate.  After all, this is the  Of course, it sSne thing talking  vaguely about the more distant future, and another thing to s  actually start.  a recovery  I would emphasize three elements in terms of policy  approaches that seem to ne to be critical at the moment -- both in encouraging  early reco% Ty and in sustaining it.  They all have a bearing on conditions  in financial markets, and it's condons in financial markets that are a  key to recovery, and keeping it going over time.  It's not going to surprise you at all if I say one of those  factors is the federal budget.  You may be tired of hearing about it.  I'll ask you to be patient for a couple of minutes because  But  mSnt sure  the magnitude of the problem is still fully understood -- the figures are  so big and threaten to-be-so big they kind of numb the mind.  And I would  S ven say, in that context, that the current fiscal 1982 deficit -- a number in the general magnitude of $100 billion -- in and of itself is  not indicative of a major structural problem.  Relative to the size of  8  the economy today, that kind of a deficit in a recession period is not  unprecedented.  But what is new, what is really unique in our fiscal  history so far as I know it, is the outlook over coming fiscal years.  If we make same simple assumptions, including the assumption  that business will get better year after year -- that the recession will  end right away and we will have steady growth of four to five percent  or even a little more -- and if we assume all government programs in  place as they arenow, with all the automatice increases that result in  spending over the years ahead, the deficit will rise -- not fall -- as  we come out of the recession.  It will rise by a very substantial amount.  Careful analysts agree that it would be around $200 billion or more by  fiscal 1984 -- not very far away.  It would rise well above $200 billion  in the fiscal years beyond that. 14 You're talking about amounts equal to as much as five percent  or more of the gross national product in periods of business prosperity. 44.14 Iz Jr, ?1 / .ft •.` t ey-  -1111-44  1  That would be a large fraction of what our net savings potential has  been in the economy.  Of course, we'd like to see the savings rate increase,  and I think it will.  But the implication is that, if the deficits are that   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  9  big, there isn't going to be very much in the way of savings to go around  for the private sectors of the economy -- for homebuyers, and farmers  and industries that so desperately need credit to support their awn growth.  Left unresolved, deficits of that magnitude mean pressure on the financial  markets in the future, pressure that would be refelcted in relatively  high real interest rates.  And as the markets look at the prospect, they  are more cautious about lending money today.  Now the encouraging thing about that budgetary outlook is, in a  sense, an outgrowth of its very magnitude.  I think the nature of the  Problem is very well understood in Washington today, on both sides of the  aisle in the Congress, in the Administration, and elsewhere.  Once one  understands the size and magnitude of the problem there is a kind of  compelling need to deal with it.  A rather dramatic effort to deal with  the budget was made recently by the President and the Congressional leadership.  That particular effort failed and that was disappointing.  But there is  an effort that is continuing -- and certainly the problem remains.  Men  of good-will-are attacking that problem, and I remain hopeful -- more than  hopeful, expectant -- that that trend will be changed by actions in the  present Congress.  http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  -10 -  The second policy element that I would emphasize revolves more  directly around monetary policy.  You know there is a tendency to equate  monetary policy with interest rates.  I often hear the comment -- perhaps  not entirely in jest -- that interest rates will go up and down today  depending upon which side of the bed I or my colleagues get up in the  morning.  If we actually had that kind of control, I can tell you you  would have different interest rate relationships in the market today  because none of us are happy with current levels.  But we don't have  that kind of control.  Monetary policy is, of course, one factor, an important factor,  that can and does influence interest rates over time.  But the process by  which interest rates are determined is a lot more complicated than simply  pulling a single monetary lever -- monetary policy, however important, is  still only one of many influences.  Mbreover, the immediate impact of  our actions doesn't tell the whole story --/hore important, over time,  is the climate of expectations about the economy and inflation, and the  balance of savings and investment.   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  -11 -  The point has been made again that today's interest rates  are extraordinarily high realtive to current inflation.  statistical fact.  That is a  The question is when will those with money be  prepared to act forcefully on the convication that the inflationary trend  will remain subdued -- that the yields available in the market today  will in fact prove highly attractive over time.  There are a number of  signs that attitudes are beginning to change in that respect.  I wish  I had a magic wand to speed the result, but I don't.  What we do have is some degr  of control over the money supply,  and, therefore, over the prospects for a return to price stability.  Theory  and experience both tell us that restraint on money and credit growth  is an essential part of bringing down inflation and keeping it down.  And  if we are to get interest rates down -- and do it in a way that they will  stay down -- we have to be concerned about excessive growth of money.  approach, in general terms, it seems to me, is pretty well understood.  That  But,  it can be terribly confusing, and even disconcerting, in this age of  instant communication, when an overwhelming number of poorly digested  statistics are thrown at us practically every day, in trying to follow the  -12 -  trend of money and credit growth from week to week or month to month when  the numbers bounce around so much.  And, even in judging numbers over a  period of months or years, we have to be alert to the impact of financial  innovation on the numbers or Changing behavior patterns.  In setting particular targets for growth of the various monetary  and credit aggregates, in reviewing them periodically, and in conducting /4(4314,4414/ tc;q4,01 our actual operations in the general framework of those objectives, we  need to take account of the general economic environment -- including  conditions in the money, capital and foreign exchange markets, the federal  budgetary posture, and other factors.  On the basis of a thorough analysis, the Federal Open Market  Committee last February adopted targets for 1982 that we felt, on the  basis on experience, should provide enough money to support economic  recovery, consistent with continued progress against inflation.  judgment, I believe, was shared by most observers.  That  It is, of course, a  judgment that should be, and is, reviewed from time to time.  In making our judgment at the beginning of this year, we did  not, and do not now, put exclusive weight -- or anything like it -- on  one measure of the money supply.   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  M1 gets a lot of attention in the market,  -13-  partly because it is the only aggregate published weekly.  But I would emphasize it's not the only measure we watch.  It may not always be the most important, particularly when  it is sensitive to institutional change.  For instance, NOW accounts are still relatively new,  but are now a significant share of Ml.  While M1 is defined  only to include transactions balances, we know NOW accounts  also have some characteristics of a savings account.  If there  is a tendency, at the margin, for individuals to hold more  ed in part by recession of their savings in that highly liquid form, induc At the time we set our uncertainties, the Ml totals will be affected. yet have the full story -targets, we had some evidence -- and we don't c's desire to hold part of their of a noticeable temporary change in the publi , nearly all the expansion in financial assets in NOW accounts. At this point and that increase, we believe, Ml this year has taken the form of NOW accounts, motive, in addition to the ordinary reflects partly a savings or precautionary far this year has grown slightly transactions motivation. As a result, Ml so imply. But to the extent this reflects faster than our target range may seem to than a transactions demand for money, r rathe e motiv ary ution preca or gs a savin That judgment is strengthened against ling. troub bly terri this find not do we , liquidity, or credit expansion, money of res measu other of round backg the together, the current results seem Taken s. range t targe other our in reflected to our policy intentions. to me reasonably on track with respect   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  -14-  You may recall that last year Ml grew relatively slowly, while M2 expanded around the upper end of our target range.  We believe that this was a  reflection of financial innovations, including prominently the rapid growth of money market funds, which to some limited extent serve the function of transactions balances.  Taking all this into account, we didn't find the pattern of  slow growth of Ml so disagreeable as to take vigorous action against it so long as M2 and other measures were growing relatively rapidly.  Similarly,  at the moment we don't find the pattern of growth in Ml so far this year- combined with behavior of the other aggregates consistent with intentions, and given the evidence of some shift in public savings patterns -- to be out of line with our purposes.  qA•Nall(j'Ar -  7 /e  4.441.4t 4:4  Obviausl-y, 'O.e want to have enough financial growth to support recovery.  We also must make sure that monetary policy  remains concerned with, and directed toward, restoring price stability, and we don't believe that's an objective that we can turn on and off like a faucet -- not if we want the effort to be successful.  To attempt to push interest rates down by excessive  money creation at the expense of inflationary fears would, it seems to me, be shortsighted.  In a practical sense, it wouldn't work for  very long in the current environment, when the sensitivity to inflation remains so strong.   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  -15-  The third area I would touch upon is to point out the  inflationary process is nurtured by a state of mind; once started it tends to maintain its own momentum in interest rates, in wage  bargaining, in pricing policies, and all the rest.  You know, if  you're under the age of 35 and you've been working since you aduated from college or high school, you've never known anything Mintamys  but higher prices in your whole working career.  Along the way  you got used to annual increases in salaries and wages year after  year that partly reflected inflation.  You got used to accumulating  financial resources by capital gains in your house.  You—HI:aught_  /price stability would be nice when you went to the store, but on the other side of the coin, there's a natural reluctance to give up the increases in incomes that went along with the inflationary process -- or to lend your money on terms that used to be considered  reasonable.   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  Today, the price trend has changed.  But, as the momentum of cost  profits. increases moves down less rapidly, there is a squeeze on  There is not  the earlier rate of enough money to finance real investment and inflation at speed.  it In time, that process will make inflation subside -- we see  be affected as happening now -- but in the meantime, business activity can accelerating growth in . well. You can try to solve that dilemma by sharply tion. But in my judgment, the money supply -- by a willingness to finance infla it will only perpetuate that will not prove to be a solution at all, because from the other direction, the process. The dilemma ultimately has to be solved ies, and by increasing by reducing costs, restraining nominal wages and salar apparent in those productivity. The problem is most clearly and directly at home and abroad highlights areas of the economy where strong competition from more general. relatively high costs and prices, but the lesson is to accept as a It's very easy to understand the reluctance of many coming down, because they've premise of their own behavior that inflation is I also have to say that those seen the opposite experience for so long. But labor practices -- those who who plan on inflation in their management and restoring price stability -in effect bet against the nation's success in actions when those expectations should think about the consequences of their turn out to be unwarranted.  The-fact is restraint on all sides will pay enormous dividends. cfiTe process of disinflation will, I believe, attain a  kind of momentum of its own -- success can breed confidence and  further progress.   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis  In that context, interest rates at today's levels  -17-  would appear ridiculously high -- a kind of historic aberration -- '  and over time they would have no place to go but down.  More favorable  financial market conditions will, in turn, help keep the economy  growing, and provide the support for investment to encourage  further productivity.  I know we're not over the hump to that happier world,  despite the visible progress we can see on inflation.  But I do  think we can begin to sense the necessary change in attitudes.  And I do think we have the best chance in memory of reversing  the adverse trends of these past years -- of making this recession  not another wasted, painful episode, but a transition to something  better.   http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis
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