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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
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•

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




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




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




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




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




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.




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




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




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




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.




, 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.




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.




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




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




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.




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.




%

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




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




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




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




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




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.




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




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




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.




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




-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




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.




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




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




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.




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.




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

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




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,




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




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




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 •




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




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




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




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




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.




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.




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.




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




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




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.




%

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



A..




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




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




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




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.




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.




-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




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




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




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.



Al..




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,




-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

%

%




-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

•




-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.




-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.

•




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,

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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.




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.



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.




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




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




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.




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.







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
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.ft
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-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




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.



-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.







-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.




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




-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.




-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.




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.




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.