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OF

SHADOW OPEN MARKET COMMITTEE

Policy Statement and
Position Papers

September 13-14,1987

PPS 87-02

CENTER FOR
RESEARCH IN
GOVERNMENT
POLICY &
BUSINESS
Public Policy Working Paper Series

U N I V E R S I T Y

OF

ROCHESTER

TABLE OF CONTENTS
Table of Contents

i

Shadow Open Market Committee Members

ii

Shadow Open Market Committee Policy Statement

1

Position Papers

9

The Federal Budget Tangle
Mickey D. Levy, Fidelity
Bank

9

Recent Behavior of Ml Velocity
Robert H. Rasche, Michigan State

Economic Outlook
Jerry L. Jordan, First

25
Interstate

Monetary Policy and the Outlook
Jerry L. Jordan, First Interstate
Tables
H. Erich




19
University

Bancorp

33
Bancorp
41

Heinemann,

Moseley

Securities

Corporation

i

SHADOW OPEN MARKET COMMITTEE MEMBERS
The Committee
September 13, 1987.

met

from

2:00 p.m.

to

7:00

p.m.

on

Sunday,

Members of the SOMC:
PROFESSOR KARL BRUNNER, Director of the Center for Research in Government Policy and Business, William E. Simon Graduate School of
Business Administration, University of Rochester, Rochester, New
York.

PROFESSOR ALLAN H. MELTZER, Graduate School of Industrial Administration, Carnegie-Mellon University, Pittsburgh, Pennsylvania.

MR. H. ERICH HEINEMANN, Chief Economist, Moseley Securities Corporation, New York, New York.

DR. JERRY L. JORDAN, Senior Vice President and Economist, First Interstate Bancorp, Los Angeles, California.

DR.

MICKEY D. LEVY,
Pennsylvania.

Chief Economist,

Fidelity

Bank,

Philadelphia,

PROFESSOR WILLIAM POOLE, Department of Economics, Brown University,
Providence, Rhode Island.

PROFESSOR ROBERT H. RASCHE, Department of Economics, Michigan State
University, East Lansing, Michigan.

DR. ANNA J. SCHWARTZ, National Bureau of Economic Research, New York,
New York.




ii

SHADOW OPEN MARKET COMMITTEE
Policy Statement
September 14, 1987
AN OPEN LETTER TO ALAN GREENSPAN

Dear Mr. Chairman:
Congratulations
Governors.

Board

of

You have inherited an organization that will soon have its

75th birthday.
new

on your appointment as chairman of the

Organizations,

chairman, particularly

like people, get set in their ways.

one who is knowledgeable

about

A

economic

policy and new to the Federal Reserve, has an opportunity to make some
needed changes.
We

recommend major changes in three areas:

(1) monetary policy,

(2) international debt, and (3) financial regulation and reform.
MONETARY POLICY
For

the

year

ending

in August 1987, the growth

rate

of

the

monetary base was 7.5%, very near the recommendation of the Shadow Open
Market Committee.
the

The excessive growth during the two years ending in

fall of 1986 has been followed by relatively slow

after January.

of

growth

Real output has continued to grow at or slightly above

the long-term average for the U.S.
year.

average

economy.

Inflation has risen this

To limit further increases, we urge that the annual growth rate

the monetary base be reduced to 6% as the next step in a policy

of

achieving sustained price stability.
We

are

rate

of

urge

you




pleased that the Federal Reserve has reduced

the monetary base in 1987 from the high levels of
to

avoid

the

errors

that have

1

produced

the

growth

1986.

volatile

We
and

unpredictable changes in monetary growth.
compatible
fall

with

economic stability.

Monetary instability is not

The faster money growth in the

and the slower money growth this spring were both a result

policy to adjust the dollar exchange rate.
produced
slower

devaluation

money

First, faster money growth

of the dollar against

growth

boosted

of a

other

the value of the

currencies;

dollar

or

later

prevented

further declines.
This was a mistake.

Devaluation achieved by faster money

and

inflation will have little lasting effect on exports,

the

trade balance.

growth

imports and

Faster money growth to push the dollar down

not move toward a long-term solution but,

instead,

does

produces a short-

lived expansion, higher inflation and a lower standard of living.
Trying

to

maintain

the

dollar exchange rate

in

the

face

of

international differences in productivity, economic growth, real aftertax rates of return on investment,
is

no

less mistaken.

saving rates and rates of inflation

If the exchange rate is held within

major currencies,

adjustment of prices and

a narrow

range

against

production

costs

to real differences in productivity and saving rates in various

countries will occur through other, no less costly, adjustments.
Monetary
Raising

policy

interest

short-term

money growth.

on

short-term

objectives.

rates to stabilize the dollar and improve the

balance is a mistake.
the

should not be based

trade

Higher interest rates strengthen the dollar

mainly by slowing economic expansion and

by

in

reducing

Slower growth of output lowers imports. This effect on

trade is short-lived.
The
real.

problem with U.S.

trade and payments is not monetary;

Required adjustments in trade and payments can be achieved by a

fall in the real exchange rate, by increasing saving and




it is

2

productivity

or some combination of the two. Monetary policy can do little to force
or prevent a permanent decline in the real exchange rate.
Adjustment
real

of

the payments and trade balances by a fall

exchange rate will raise the U.S. price level.

one-time

increase

in

level,

not

a

return

of

in the

This rise is a

inflation.

This

distinction, often neglected, is important. The price rise following a
devaluation

will

not persist if the Federal

Reserve

maintains non-

inflationary policies.
Intervening
dollar

will

Allowing
way

to

not

prevent

avoid

a decline in the external value

an adjustment

in

the

real

of the

exchange rate.

exchange rates to adjust in response to market forces is one

to adjust U.S. prices and costs of production relative to foreign

prices and costs of production.

The main alternative to exchange rate

adjustment is to force prices, wages and other costs of production
fall

relative to prices and costs abroad.

to

This approach would likely

require a severe recession and will prove more costly.
The task you face is a hard one --to resist the pressures to
to

try

solve problems that you cannot solve and to concentrate on policies

that restore stable prices. The latter is something that only you and
your

colleagues at the Federal Reserve can accomplish.

succeed

if you avoid the attempt to set interest

You will only

rates

or

exchange

rates.
The alleged disadvantages of fluctuating exchange rates are widely
advertised;

the advantages are neglected.

fluctuating

rates

both

to

variability of real growth.

achieve price

Germany and Japan have used
stability

They have done this,

and




reduce

in part, by adopting

and following medium-term strategies for monetary policy.

3

to

The United States has taken a different approach to policy and has
experienced
Many

in

less stability of prices and output than Germany or Japan.

the marketplace refer to the U.S.

Standard."

approach as

the

A standard of this kind substitutes the decisions

person or a small group for predictable monetary policies.
lower

"Volcker
of one

The way to

the uncertainty and variability that people face is to

adopt

a

predictable monetary policy.
You

have

inherited

an

inflation rate

that has

been

reduced

substantially since 1981. However, inflation remains at rates that are
high by past standards.
rate

of inflation.

strategy

of

We urge you to adopt a policy of reducing the

This is best accomplished by adopting a long-term

consistently

lowering

the annual

growth

rate

of

the

monetary base and maintaining the fluctuating exchange rate system.
A
step

6% growth rate of the monetary base in the next 12 months is a
in

a program to achieve price stability.
They

talk about testing

Others urge

different

directions.

your

inflation

you

in

opposition

to

or your commitment to current exchange rates.

It is a mis-

take to be driven by the changing views of day traders and

speculators

in the markets. You cannot prevent changes in the value of the dollar,
you can only delay them.

It is a mistake to try.

INTERNATIONAL DEBT
For

five

years,

the

international

debt

resolving it.

Fortunately,

to

the

U.S.

government

talked

problem but has failed to develop a

about

the

strategy

for

the Baker Plan that calls for more lending

debtors appears to be moribund.

plans and opt for a market solution.




has

4

You should avoid

government

In

the

summer of 1982, when the problem first

came

to public

attention, the World Bank estimated the total outstanding external debt
of

developing

year,

the

countries at about $800 billion.

face value

nearly $1.1 trillion.
Mexico,

Brazil

faster.

By the end

of

of the debt will have grown more than

this

30% to

Even with relatively rapid growth of exports by

and some other debtor countries,

the debt has

grown

The ratio of the debt to exports is now higher in most debtor

countries

than

in 1982.

The table shows these data for

four

large

debtors.
Foreign Debt as a Percentage of Exports
1982
405
339
299
84

Argentina
Brazil
Mexico
Venezuela

1986
536
425
413
322

Source:

debtor

554
471
366
278

Morgan Guaranty Trust

A

1987 estimate

real

depends

on

costs.

The

existing

real

country1s

internal growth rates and

debt-to-exports

debt.

ability to service

ratio

real

its

foreign

external

often summarizes

the

debt

borrowing
burden

Each 1% increase in debt at a constant interest

requires a permanent increase in exports of 1% to prevent the

of

rate

debt- to-

export ratio from rising further.
A
reduced

common rule of thumb is that the debt-to-export ratio has to be
to

marketplace.
on

about

two before countries can return

A successful

financial

strategy

for

periodic rescheduling crises must encourage countries to foster

internal growth and limit the role of government.




the

In practice, a country's ability to service debt depends

its rate of growth and other factors.

ending

to

5

This will not occur

under
to

a policy of concessional lending and pressuring reluctant

lend.

borrows
could

The

U.S.

cannot lend to developing

more or sells assets to foreigners.

countries

unless

Even if these

pay the interest on their current debts,

it would

banks
it

countries

make

little

sense for the U.S. to sell its assets so as to lend more.
Large

creditor

banks have recently recognized that many of these

debts sell at a discount.
solution
Reserve
a

of

the debt problem.

The recent decision

by

the

Federal

to permit ownership by bank holding companies of up to 100% of

non-bank

step

This is a useful first step toward a market

toward

foreign subsidiary for up to five years is a
enhancing

the opportunities for

constructive

debt-equity

swaps

and

resolution of the international debt problem.
Markets

are

now working to develop debt-equity swaps

types of exchanges that lower the amount of the debts.
committee

the

other

Since 1982 this

has urged the Federal Reserve and the Treasury to

exchanges of debt for equity at market prices.

and

encourage

Exchanges will

shrink

value of the debt denominated in dollars and move debtor countries

in the direction of a return to the marketplace.
FINANCIAL DEREGULATION AND REFORM
The

Federal Reserve has been one of the roadblocks on the way

financial deregulation.

to

This has had two unfortunate consequences.

First,
the U.S. financial system has been hampered in its efforts
to adapt to changing conditions in the world marketplace.
Second,
adjustment and adaptation have come piecemeal, either in
response to particular problems, often bank insolvency, or through
state action.
The

Federal Deposit Insurance Corporation (FDIC) has now proposed

a complete restructuring of financial regulation.
for

Its proposal

repeal of the Glass-Steagall Act, which separates commercial




6

calls
and

investment

banking, and repeal of the Bank Holding Company

Act, which

sets the structure within which banks can expand into other activities.
The Federal Reserve should support this approach.
These are first steps.
past policies.
vent.

The financial system has been weakened by

Many thrift associations,

and some banks, are insol-

They continue to operate only because deposits are guaranteed by

government

agencies.

These technically insolvent

institutions

make

large, risky loans and investments knowing that losses will be borne by
the taxpayers.
The

Federal Reserve should press for reform of the deposit insur-

ance system to remove the incentive for weak financial institutions
make

high-risk

loans

and investments.

placed on market-based measures of risk.
risk-based capital requirements.

Greater reliance

to

should be

However, we do not

endorse

Greater attention should be given to

the development of market measures of valuation.
Financial reform and deregulation are urgent.
that

suggest

the Federal Savings and Loan Insurance Corporation (FSLIC) faces

losses

of

$40 billion, far in excess of the $10 billion

scheme that

recently

became law.

prolonged economic recovery.
risk

Estimates

of

larger

refinancing

Losses have been rising

during

a

Recognition of these large losses and the

future losses reveals the weakness

in

the present

system.
We

urge that saving association assets be valued at market, that

insolvent

association be closed as soon as possible to prevent

losses

that

mounting

thrift

are

institutions

should

associations

to

day by day.
be

retire

financed

The cost of
by a

surcharge

any debt incurred by the

process of closing insolvent institutions.




closing

7

on

failed
the

regulators

remaining
in the




THE FEDERAL BUDGET TANGLE
Mickey D. LEVY
Fidelity Bank
The

Fiscal Year 1987 deficit will dip below $160 billion,

billion

decline from the FY1986 deficit.

However,

this

a

$62

improvement

reflects one-time boosts to tax revenues and cuts in government outlays
that

will

not

legislation,

be sustained.

Without enactment

of pending

budget

the deficit will rise into the $180-$200 billion range in

FY1988-1989 before gradually declining again.

Faced with this outlook,

Congress attempted this summer to reach a compromise on deficit cutting
legislation, but failed.
The political battle over the FY1988 budget is resuming this fall.
In

order to keep the federal government functioning,

current

budget law,

Congress has to pass any appropriations

budget reconciliation bill,
gress

and another debt ceiling bill.

bill,

FY1988

budget,

or GRH).

including separate and very complex skirmishes on each

Clearly,

political

upcoming

Presidential

current

is

Presidency,
fiscally

(Gramm-

There is a heated political battle over the

these budget initiatives, which have important

ments.

a

Also, Con-

is trying to fix the ailing Balanced Budget Act of 1985

Rudman-Hoilings,

of

and to abide by

the

elections.

general

countered

maneuvering

interlocking

is being influenced

The most common

attempt

by

Democrats

ele-

by

the

political under-

to

embarrass

the

by Republican efforts to appear to behave in a

responsible manner while avoiding undesired tax increases

or

spending cuts in an election year.
The
requests
billion




President's budget (Mid-Session
a

Review of the FY1988

$35.1 billion deficit cut in FY1988, yielding

deficit.

It

includes the same requests made in
9

Budget)
a

$123.3

the

FY1988

Budget

presented

adjusted

by

in January 1987, with

the

revised economic assumptions and

magnitude
technical

of

savings

reestimates.

Approximately half of the requested savings would come from non-defense
spending

cuts.

The

remainder

of

savings would

come

from

higher

revenues achieved through tighter compliance, user fees, credit reform,
privatization

and other loan asset sales.

Included is a request

for

increased budget authority for defense, which declined in real terms in
both FY1986 and FY1987.

The Presidents projected deficit exceeds the

original $108 billion GRH deficit target for FY1988.
A

Congressional

Concurrent

Resolution

on

the

FY1988

Budget

(HConRes 93), passed in June 1987, calls for budget deficit targets of
$146

billion in FY1988, $140 billion in FY1989, and $108 billion

FY1990.

The

$146 billion target was based on a CBO baseline

in

deficit

estimate of $183 billion and would require $37 billion in deficit cuts.
The

resolution included $19.3 billion in tax increases for FY1988.

A

reconciliation bill detailing how the cuts in the concurrent resolution
would

be achieved was due July 28, but a compromise has not yet

been

reached.
Meanwhile,

a

GRH

progress

report issued

August

19, prepared

jointly by the CBO and 0MB, estimated the FY1988 deficit, calculated on
a

so-called "Gradison base," to be $153.4 billion. •
!

GRH law, this

Under

original

would mean $45.4 billion of across-the-board cuts.

would require cuts of approximately 13% in

This

FY1988 defense spending and

•"The "Gradison base" essentially calculates the deficit without the
effects of inflation from the previous fiscal year.
The CBO deficit
estimate was $169.9 billion while 0MB's deficit was $136.8 billion.
Some policymakers believe the huge $33.1 billion difference, and the
averaging technique used to determine the magnitudes of across-theboard cuts, argues for an established cut in each year that does not
depend on such a base.




10

19%

in non-defense spending.

across-the-board
and,

in

However,

the process of the

cuts imposed by GRH has been

any case,

found

automatic

unconstitutional

the Administration and Congress oppose such

large

cuts.
Consequently,
GRH,

recent

Congressional efforts have sought to "fix"

making its sequestration process constitutional and relaxing

deficit

targets.

promise

on a "fix." However,

The House and Senate have not reached a final comthey agree generally to a modified

that would involve a substantially smaller deficit cut in FY1988
is required in Congress's concurrent resolution.
GRH
or

its

GRH
than

The House's proposed

fix would either raise the FY1988 deficit target to $144 billion,
cut

a maximum of $23 billion from the FY1987

deficit, while

the

Senate has proposed a $150 billion deficit.
The

Administration has stayed on the sidelines as the

House

and

Senate debate specific provisions of a modified GRH, repeating only its
standard

call for a balanced budget and expressing concern about main-

taining its defense authorization requests. One key issue of disagreement between the House and Senate is the amount of flexibility given to
the
have
the

President on defense spending.

While both the House

and

agreed to exempt military personnel outlays from automatic

Senate
cuts,

Senate also would allow the President to propose reducing cuts for

specific

defense spending accounts, while the House would

not

allow

this flexibility.
Earlier

Congressional initiatives to fix GRH were tied to federal

debt-ceiling limitation legislation (HJRes 324). Apparently, President
Reagan's rejection of a $23 billion deficit cut in FY1988 as part of a
GRH fix forced a breakdown of the compromise proposal.

The Administra-

tion asserted that the proposed GRH fix would "front-load" deficit cuts




11

into

FY1988

increase

in

or

order to force Republicans into

an undesirable

spending cut in an election year.

tax

This failure to com-

promise led to a temporary rise in the statutory debt ceiling, which is
scheduled to expire September 23, 1987.
Consequently,
the

Congress must immediately pass a bill that

debt ceiling limitation and a reconciliation bill that details the

deficit cuts established by the concurrent resolution.
ciliation

Pending recon-

instruction proposals by the House and Senate would

approximately $30.5 billion of the required $37 billion in
remainder must come from the appropriations process.
lies ahead.
President's

cuts.

debt

ceiling legislation.

added weight if the reconciliation bill is
Also,

some of the

Such

attached

actions

to

appropriating

and do not see eye-to-

legislation.

Moreover, proposed

appropriations are significantly different than those requested by
Administration.

a

the House and Senate disagree about

important details in the concurrent resolution,

tion

The

Much negotiating

opposition to tax increases may generate a veto.

carries

on

achieve

The concurrent resolution includes tax increases, and the

veto

eye

extends

the

For example, the House, which must initiate appropriain Congress has passed an authorization bill that would

provide $289 billion in defense budget authority in FY1988, compared to
$302.9

billion in the Senate bill,

and $312 billion requested by

the

21
President. J

21These differences involve substantive policy issues: for example, the
J
House bill would ban tests on space-based anti-ballistic missile
systems (ABMs), require the U.S. to resume observance of the SALT II
limits, and ban nearly all nuclear weapons tests, if the Soviet Union
observes the same restraints. In contrast, the higher budget authority
requested by the Administration and favored by Senate Republicans is
based in part on the belief that more testing should be acceptable
under the 1972 U.S.-Soviets treaty limiting ABMs.




12

If

Congress passes a GRH fix with lower required deficit cuts for

FY1988 before a reconciliation bill is passed, then the new GRH deficit
target will dominate. A GRH fix currently under consideration includes
a

$23 billion deficit cut in FY1988.

tax

required

revenue increase in FY1988 to approximately $11-12 billion, com-

pared

to

proposed
It

This would reduce the

$19.3 in the Congress's concurrent

resolution.

Whether

a

GRH fix is passed before a reconciliation bill is uncertain.

depends

in part

on whether a GRH proposal

is

attached

required debt ceiling legislation -- also an uncertainty.
Congress fails to compromise on a GRH fix,
tion dominates.
vetoed,

However,

budgeting

in

to

the

Moreover, if

then the concurrent resolu-

since it includes a tax increase and may be

FY1988

may be

conducted

under

a

continuing

resolution.
The
highly

bottom

line

uncertain,

is the final outcome for the FY1988

and this affects future budgets.

budget

Simply the

is

fact

that all of the major required initiatives may be bunched into a single
bill

reflects

a

faulty

political maneuvering.

process bogged

down by

pre-election

year

Is this any way to conduct fiscal policy?

BUDGET REVIEW
The budget deficit of $160 billion in FY1987 will be approximately
4.0%

of GNP,

1986.

This

down from 5.3% in FY1986 and an average 4.8% for FY1982will

be achieved by a rise in spending of only

2% from

FY1986, and a very rapid 11% increase in revenues.
This pattern reflects several special, one-time impacts that will
not

persist.

Economic

and

The Congressional Budget Office's baseline budget
Budget

OUtlook:

An

Update,

August

(The

1987) forecasts

deficits of $183 billion in FY1988 and $192 billion in FY1989 (3.6% and




13

3.2%

of

GNP).

The Administration,

using more

optimistic

economic

assumptions, also forecasts a rise in its current services deficit (see
table 1).
Several special factors generated the temporary improvement in the
FY1987 budget.

The Tax Reform Act of 1986, which boosted personal tax

revenues approximately $20 billion in FY1987, will reduce them approximately $12 billion in FY1988 and $18 billion in FY1989.

Additionally,

the tax reform generated an unanticipated surge in capital gains realization, which
future

provided added tax revenues.

capital

approximately

gains

taxes.

That will take away from

Consequently,

revenues

5% in FY1988, less than half of their FY1987

Also, spending growth will accelerate in FY1988.
repayments

Furthermore,

rise

increase.

Asset sales and loan

under the reconciliation bill of 1986 provided

saving to the FY1987 budget.
of

should

a

one-time

including the last payment

revenue sharing into FY1986, and postponing certain military pay-

checks

and Medicare payments into FY1988 have also temporarily lowered

FY1987 outlays.
Recent legislation will also add to higher deficits.

The Supple-

mental Appropriations Act of 1987 reflects the Administrations
trophic health insurance proposal,
several

other policy proposals.

provides

the

failing

banks

catas-

the timing of Medicare outlays, and
Recently enacted banking legislation

FDIC with alternative financing

methods

for

assisting

and contributes additional funds to the FSLIC fund

for

failing savings institutions.
A

sizeable

significant
Interest




rise

rise

rates

in

interest rates will

in net interest outlays

and

result

in

a

further

deficit projections.

have risen significantly since January 1987, and

14

the

Administration

and CBO have revised up their interest rate

forecasts,

particularly for the 10-year government bond (see table 2).

Presently,

rate yields are above 1988 forecasts and, unless they recede, will add
to deficits.

Moreover, higher inflation has raised outlay and deficit

forecasts by raising COIAs for social security and certain
programs.

entitlement

The Administration forecasts peak rates of CPI inflation to

occur in 1987.

If CPI inflation accelerates in 1988, as the CBO fore-

casts, outlays for indexed federal programs will be higher.
Under

current law,

FY1989, but
healthy

at

least

economic

the deficit should resume its
two caveats apply to

growth

must

continue,

adversely affect the budget outcome.
forecasts
though

include

since

forecast.

any

removing

deficit

First,

weakness would

and

benefits, even

the social security accounts will be removed from

surpluses,

after

Secondly, these declining budget

social security payroll taxes

budget beginning in 1990.

the

this

decline

the unified

Since social security is accumulating large

it from budget calculations adds significantly to

(the social security surplus will

be

approximately

billion in FY1988, and will rise to over $60 billion in FY1991).
implies

$38
This

that without deficit cutting legislation,the on-budget deficit

(excluding

social

security) will remain above

$220 billion

through

FY1992 (see table 1).
Clearly the budget outlook is not encouraging.
rise

in

federal debt and avoiding potentially adverse

sequences requires more deficit cutting legislation.
depend on political, not economic, considerations.




Stemming the rapid

15

economic con-

The outcome will

Table 1
Budget Projections
(in billions)
Fiscal Years
1989
1988

1990

1991

1032
1064
1080

1085
1131
1146

1129
1186
1212

1176
1244
1280

858
858
853

909
903
897

973
965
954

1049
1040
1036

1131
1121
1115

-158
-158
-157

-123
-161
-183

-113
-166
-192

- 80
-146
-176

- 45
-123
-165

Memo:
Deficit, On-Budget (Excluding
Social Security)
President's Current Services
CBO Baseline

179
177

-200
-221

-214
-236

-206
-229

-195
-227

Off-Budget (Social Security
Surplus)
President's Current Services
CBO Baseline

20
19

38
38

48
44

60
54

71
63

1986

1987

Outlays
President's Proposal
President's Current Services
CBO Baseline
CBO Estimate of President

989.8
989.8
989.8
989.8

1017
1017
1010

Receipts
President's Proposal
Current Services
CBO Baseline
CBO Estimate of President

769.1
769.1
769.1
769.1

Deficit ( )
President's Proposal
Current Services
CBO Baseline
CBO Estimate of President

-220.7
-220.7
-220.7
-220.7




16

Table 2
Administration and CBO
Economic Projections
1987

1988

1989

1990

1991

Real GNP
Administration
CBO

3.2
3.1

3.5
2.6

3.4

3.4

3.3

Nominal GNP
Administration
CBO

7.6
7.2

7.6
6.8

7.3

7.0

6.4

CPI-W
Administration
CBO

4.7
5.1

4.4
5.2

4.0

3.5

3.0

6.1
5.9

7.5
6.9

7.4
6.7

7.1
6.8

6.6
6.8

Real GNP
Administration
CBO

2.6
2.6

3.3
2.7

3.4
2.6

3.4
2.7

3.3
2.7

GNP Deflator
Administration
CBO

3.3
3.3

4.1
4.1

3.9
4.0

3.6
4.0

3.2
4.0

Interest
rates,
percent,
calendar year
averages:
3-Month T-Bill
Administration
CBO

5.7
5.9

5.5
6.6

5.3
5.8

5.0
5.7

4.5
5.7

10-Year Government Bond
Administration
CBO

8.0
8.1

7.6
8.5

7.0
7.8

6.3
7.4

5.5
7.1

Memo: January 1987 Estimates
3-Month T-Bill
Administration
CBO

5.4
5.6

5.3
5.6

4.7
5.5

4.2
5.3

10-Year Government Bond
Administration
CBO

6.7
7.2

6.1
6.6

5.5
6.2

5.0
5.9

Percent change, fourth quarter
over fourth
quarter:

Percent change, calendar
Nominal GNP
Administration
CBO




years:

17




RECENT BEHAVIOR OF Ml VELOCITY
Robert H. RASCHE
Michigan State University
At

our

research

last meeting,

on Ml velocity that I had prepared for

Carnegie-Rochester
behavior
since

I presented some updated results

Public Policy Conference.

the

of

November,

I concentrated

the
1986

on

the

of the monthly values of the ratio of personal income to Ml,

the relatively few post-sample observations on quarterly (3) and

annual (1) available at that time provided little information about the
great

velocity slowdown of 1986.

trate

on both annual and monthly data.

because
are

My present discussion will concenThe former

are

interesting

revised estimates of annual personal income for 1985 and

now available.

The latter are interesting,

that the month to month wiggles tell us much,
possible

to

because

1986

not because I think

or that it will ever be

forecast these wiggles with great

accuracy,

but

rather

they provide a larger sample of data with which to assess

the

question of whether the old relationships are stable.
You

will recall that last March I presented some
that

beginning

around the end of 1981 was probably part of a change in the

change

"shift in velocity drift" that I had

that

suggested

long-run

the

estimates

relationship between Ml velocity and

interest

can be characterized as an increase in the

elasticity

of velocity

rates.

long-run

brought about by a rotation of

velocity-interest rate relationship.

identified

the

This

interest
long-run

My conclusion was that since late

1981 Ml velocity will be roughly constant in the absence of trends

in

interest rates, but will respond with greater sensitivity to changes in
interest rates. You will also recall that at that time the latest data
available




were

through October 1986, and that
19

extrapolation

of my

estimated

relationship through the first ten months of 1986

indicated

large forecast errors for the period May through October.
The 1987 revisions of the money stock data have now been released,
and

apart from changes in the seasonal adjustments appear to have very

little effect on the estimates of the money stock.
of

The 1987 revisions

personal income were announced at the end of July

Wall

Street

Journal)

interpretation
interesting.

of

recent

and

appear

to be

(July

28, 1987

significant

velocity behavior.

The

for
data

annual

the
are

A comparison of old (March 1987) and new (September 1987)

annual estimates of personal income velocity is:
Old Estimates

New Estimates

Percent Change

Velocity

Percent Change

Year

Velocit

1983

5.5779

1984

5.7120

2.38

5.7161

2.33

1985

5.5800

-2.34

5.6020

-2.02

1986

5.1832

-7.38

5.2503

-6.48

5.5779

It is clear from these numbers that the 1984 and 1985 estimates are not
affected

to

any

significant

degree,

but

that

almost

an entire

percentage point of the great velocity decline of 1986 has been revised
away.
With

these

equation
for

a

that




it

is possible

to

reestimate

the

I constructed in the Carnegie-Rochester paper

change in the interest elasticity beginning

extrapolate
income.

estimates

in

annual

allowing

1982, and

to

the equation through 1986 on both the old and new personal

The resulting estimates are:

20

1986 Revisions

1987 Revisions

Constant

.0321
(.0024)

.0321
(.0024)

D82

-.0321
(.0024)

-.0321
(.0024)

AlnRTB

.0033
(.0008)

.0033
(.0008)

D82*AlnRTB

.0064
(.0031)

.0059
(.0031)

R2
se
d-w

.68
.0130
1.67

.67
.0130
1.68

.0218
.0531

.0207
.0442

Predicted (86)
Error (86)

This equation is estimated with the post 1981-drift constrained to
zero because of the limited degrees of freedom (4) in the annual data.
Clearly the equation did not catch all of the great velocity decline of
1986,

though

it did predict a decline in velocity from

the annual

from

1985 as a result of the decline in Treasury

bill

rates

from an average of 7.48 in 1985 to an average of 5.98 in 1986.

Since

average

the

estimates

revisions,

are essentially

the forecast

unaffected

by the personal

income

error has been reduced by nine-tenths

of a

percent by the data revisions.
As

of this writing sufficient data are available to extrapolate

the

monthly equation that I presented last March through

The

revised money stock data leave the estimates for the sample period

ending

in December

coefficients
period

1985 essentially

The

estimated

of the monthly velocity equation over the 53-85

sample

with the revised money data but unrevised personal income

are:




unchanged.

April 1987.

21

data

1986 Revisions

1987 Revisions

Constant

.0310
(.0024)

.0306
(.0025)

D82

-.0305
(.0071)

-.0297
(.0075)

AlnRTB

.0053
(.0006)

.0053
(.0006)

AlnY/P

.8351
(.0385)

.8225
(.0403)

D82*AlnRTB

.0122
(.0024)

.0114
(.0026)

R2
se
d-w

.62
.0434
1.84

.59
.0455
1.74

The

actual

velocity

and predicted

values

of monthly

personal

and the prediction errors for monthly velocity are shown in

the attached Figures for January 1985 through April 1987.
from

income

both

graphs

that

the equation

systematically

It is clear
overestimates

velocity changes for the period May 1987 through November 1987.
not

known at this time how the personal income revisions

will

It is
affect

these

forecast errors though from the annual results presented above I

expect

that the average forecast error over the twelve months of 1986

will be reduced.
Whatever is going on in the May through November 1986 period
is

that

not captured by our specification appears to have come to an end in

December.
given

Personal

income velocity dropped remarkably

the large jump in Ml at that time.

predicts that drop almost perfectly,




22

However,

in December,

the specification

and since November seems to have

tracked the behavior of velocity quite well.
am

prepared

namely

Based on this evidence I

to stick with the conclusion that I reached

last March,

that we should expect that over the long-run in the absence

of

significant interest changes that Ml velocity will exhibit zero drift.




23




Percentage Change in M1 Velocity
January, 1 9 8 5 -

April, 1 9 8 7

Time
Predicted Velocity

Velocity

M1 Velocity Errors
Jonuary, 1 9 8 5 -

time

2k

April, 1 9 8 7

ECONOMIC OUTLOOK
Jerry L. JORDAN
First Interstate Bancorp
I.

ASSUMPTIONS AND CONCLUSIONS
The disparity in the performance of world economies --by

by

region,

sector,

and by industry -- that was so pronounced in 1985 and 86,

began to narrow in 1987. In 1988 -- the sixth year of the current U.S.
economic

expansion

-- further

recovery in the

sectors,

regions and industries will be accompanied by further slowing

of the previously strong segments of the economy.
of performance continues through the next year,

previously

depressed

As this convergence
the current

expansion

will become increasingly vulnerable to potential destabilizing shocks.
Further ahead, the odds of a mild recession occurring in 1989 have
risen

substantially,

expansion
forecast

to
of

and

we do not expect this longest

reach its seventh birthday.
a modest

non-war-time

The primary reason

decline in economic activity

in

1989

for

a

is an

expectation that monetary policies will become sufficiently restrictive
after

inflation passes the 6% rate in the second half of next year

to

produce a downturn.
Vulnerable Expansion
Although
output

our

"most likely" forecast is for continued

at about a 3% rate in 1988, there is an increasing

growth
risk

of

that

some type of shock will throw the national economy into a nose dive. A
sudden

tightening

of monetary policy to "save the dollar" on

foreign

exchange markets, another "supply disruption" of oil flowing from

the

middle east, or a puncturing of one or more of the speculative bubbles
in a few of the world1s major financial and real estate markets, could




25

bring an end to the expansion before 1989, even if in the middle of a
presidential election year.
Debt. Debt, and More Debt
It

is well known that Federal budget deficits in the 1980s

pushed
debt

the national debt to the $2 trillion level.

stock

of

has risen relative to national income, and "real" interest rates

have trended higher,
risen,

the burden of servicing this mountain of debt has

as interest expense has become the fastest growing component of

the Federal budget.
to

As the

have

Not unrelated, the U.S. became a net debtor notion

the rest of the world in 1985 for the first time in over 70 years.

In 1986, the U.S. passed both Brazil and Mexico combined as the world1s
largest
early

debtor,
1989,

and by the time a new administration takes office

the U.S. will owe the rest of the world

trillion dollars.

about

in

one-half

Since we have been borrowing to finance consumption

of

other countries output, we have added greatly to foreigners claims

on

our

future

output without adding to our

ability

to meet

these

obligations.
Within the country,

the restructuring of corporate balance sheets

-- sometimes

as a result of and sometimes to head off

outs

added

-- has

corporate sector.

leveraged buy-

significantly to the debt-service burdens

of the

Furthermore, the consumer-spending led expansion of

1983-86 resulted in net consumer indebtedness rising to a record

share

of personal income.
While
of

the

economy,
that

the existing levels of debt incurred by the various sectors

U.S.economy
the

are still serviceable by

trends are not encouraging.

it has no fiscal discipline,




a

$5

dollar

The U.S. has demonstrated

and consequently

26

trillion

is unlikely

to

achieve

and maintain a non-inflationary monetary discipline.

world's

numeraire

biggest

debtor,

obligations
increase
1989.

the

reserve currency country,

and

now

the

also

the

the

real

temptation to attempt to inflate away

includes

an

of inflation from about 5% in 1987 to 5.5% in 1988 and 6%

in

We

of

and

As

debtors

expect

is considerable.

Our forecast

that once the 6% threshold has

been

reached,

monetary authorities will adopt a restrictive monetary policy,

the

even at

the expense of a relatively mild recession.

II.

U.S. ECONOMY -- SUMMARY POINTS

•Current expansion is already of record length for peacetime.
•Nearly 16 million jobs have been created so far in the expansion.
*U.S. is approaching
below 6%.

full employment as unemployment

drops

further

*Real GNP growth will average 3.2% in 1987-88, versus 2.75% in 1985-86.
--Consumers less dominant.
Auto sales average 10.4 million in 1987-88
vs. 11.2 million in 1985-86.
--Housing minus instead of plus. Housing starts average 1.6 million in
1987-88 vs. 1.77 million in 1985-86.
--On the other side, revival in business spending for new equipment.
--Narrowing rather than widening of trade balance.
--Moderate building of inventories instead of cutbacks.
•Revival of U.S. manufacturing key element in 1988 picture; disparity
among sectors, industries, and regions to remain, but less than in
1985-86.
•"Misery Index" of 11% in
inflation and unemployment.

1988

-- split

roughly

evenly

between

•Inflation moves from low point of 1986 to 4.8% in 1987, 5.5% in 1988,
and 6.2% in 1989.
--Important prices will be rising at rate of about 10% during all three
years, and employee costs will start to increase more rapidly.




27

^Increases in short-term interest rates with faster economic growth,
higher inflation, and stronger credit demand.
One percentage point
rise between end of 1987 and 1988.
*Much smaller increase in long-term rates as financial markets
already incorporated a higher long-run expectation of inflation.

III.

have

INTERNATIONAL ECONOMIC OUTLOOK -- SUMMARY POINTS
The mirror image of rising U.S. exports and declining real imports

is

an opposite shift within the Japanese and European economies.

The

strong currency countries have experienced a significant contraction of
net

exports

in 1987, and that trend is expected to continue

forecast period.
in most

other

in the

Meanwhile, strong monetary and fiscal "pump pricing"
countries is causing faster growth

in

real

domestic

purchases.
Better
been

consumption

accompanied

internationally

by

levels in a strong currency

a substantial increase

traded commodities.

in

environment

foreign

demand

The firming of dollar prices

has
for
of

most world-traded goods is, in part, a reflection of the sharply lower
foreign currency prices of such goods.
commodities

traded

The dollar prices of goods and

on world markets are expected to continue to

rise

from their 1986 lows.
industrial-country real GNP growth (large countries) continuing in the
2-3% range through 1988.
*However, this masks major shifts in the composition of growth. The
drop in the $ is hurting export industries, but domestic demand in
1986 grew more strongly in Germany and Japan than did GNP.
This
should continue, and implies major structural changes for those
economies.
*U.S. recession, if it were to occur by 1989, would cause some slowdown
in other industrial countries, but may not be severe. Countries will
allow currencies to depreciate rather than follow U.S. interest rates
upward.
They have lower inflation than the U.S. and therefore won't
mind a mild acceleration resulting from currency depreciation.
(This
is during the second half of 1989.)




28

^Effects of expansionary monetary policies followed in most industrial
countries (partly due to currency-market intervention) will cause
inflation to rise, but not by as much as in the United States.
^Dollar will continue to decline through 1988 and early 1989.
Could
lose another 15% against the yen during the coming 18 months.
Reasons:
U.S. inflation risking more than in other major countries;
trade deficit has remained large, implying further build-up of foreign
debt.
*U.S. trade deficit will fall in 1988 and 1989, after risking slightly
in 1987.
Continued large increases in the deficit in next external
investment position of the United States.
Japan will continue to be
the major source of funding.
*Developing-country debt:
Lack of new funds from commercial banks;
increasing resistance to making debt service payments under existing
conditions in a number of countries. Implies that banks may be forced
to use at least part of the reserves recently established.
However,
on balance, because of relatively good financial position of some
countries (Mexico and Chile), reserves are probably adequate for the
near term.
1989 recession likely to cause more problems. Demand for
paper in secondary market to pick up, but prices may remain weak.




29

GROWTH OF M1 NET OF OTHER CHECKABLES
(Percent change, annual rate)

-21
82:1




83:1

84:1

85:1

86:1

87:1

3e

GROWTH OF MONETARY BASE
(Percent change, annual rate)

82:1




83:1

84:1

85:1

86:1

87:1

3e




MONETARY POLICY AND THE OUTLOOK

U)

n>




Jerry L. Jordan
Senior Vice President & Chief Economist
First Interstate Bancorp
Shadow Open Market Committee
Harmonie Club
New York
September 13-14,1987

1
MONETARY BASE AND Ml NET OF OTHER CHECKABLES

MONEY GROWTH AND INFLATION

(Quarterly percent change over year ago)

(Four-quarter percent changes of four-quarter average levels)

-6.0 II111II tl H t II ft It I lift fit It ftl H III II It 1 It It W t It I I H I tt ft It Hf » ft t tf H It t It H MIH It III H ttt W III II
80:1

81:1

82:1

83:1

84:1

85:1

86:1

87:1

64

67

70

73

76

79

82

85

88 89

* Consumption fixed-weighted price Index

M\ narrowly defined to include only currency and demand deposits, has
tracked the monetary base relatively closely in recent years.

(JO

Money growth has tended to predict changes in the inflation rate which would
occur two years later. The acceleration in money growth during the past two
years points to higher inflation in *88 and '89.

NUMBER OF FAILURES PER 10,000 & THE INFLATION RATE

WAGES, IMPORT PRICES AND CONSUMER PRICES
(Percent changes, fourth quarter to fourth quarter)

1926 1931

The low point for inflation in terms of consumer prices was reached in 1986.
Import prices are climbing at a 10% annual rate and employee costs are also
expected to rise more rapidly.




1936 1941

1946 1951

1956

1961 1966 1971

1976 1981 1986

Business failures tend to be inversely related to inflation. During periods of
low inflation rates, failures per 10,000 concerns are higher.

2
REAL GNP

SPENDING VS. PRODUCTION
(Cumulative change from 2nd qtr. 1984, lndex»1.G0)

(Percent change, 4th quarter to 4th quarter)
ST

Real Domestic Final Sates

S

1.02
1.00
|i

III

IV

84

The current expansion will be of record length for a non-war period. GNP is
expected to be fairly strong through 1988 before the economy slips into a
recession in 1989.

I

II

85

III

IV

I

II III
86

IV

I

II III
B7*

IV

I

II III
88f

IV

I

II III IV
89f

The growth of spending has outpaced the increase in production
significantly since the middle of 1984. Expansive fiscal and monetary
policies have fueled domestic demand, which has been met in sizable part
by rising imports. Output growth, however, is now outpacing the increase in
domestic spending.

DOMESTIC FWAL SALES & LAGGED MONETARY BASE

SECTORAL CONTRIBimONS TO GNP GROWTH

(Quarterly percent change over year ago)
(Percent share of two-year real GNP growth, fourth quarter data)

Monetary Base
Lagged 2 Qtrs.

2.0 I I I I | | | i | | | | | | | | | | | t | | | | | | i l | | | | | | | i | | | | | |
80:1

81:1

82:1

83:1

84:1

85:1

86:1

87:1

88:1

Inventories

89:1

Domestic final sales is a good indicator of demand and it generally tracks the
monetary base lagged two quarters. The recent divergence reflected the
inpact of lower inflation and interest rates on money holdings during the past
two years. That pattern is now reversing.




Consumer

The consumer will be a much less dominant contributor to GNP growth in the
1987-88 period compared with 1985-86.

3
FEDERAL DEFICIT
(Billions of dollars, fiscal years)

NET INTEREST EXPENSE AS A PERCENT OF TOTAL FEDERAL OUTLAYS
(Fecal years)

86

The federal deficit reached a peak in 1986 of $221 billion. Deficits are likely
to remain large during 1988-89, exceeding significantly Gramm-RudmanHollings targets.

88(f)

The amount of federal outlays that is required to finance the debt has grown
at a rapid rate since the mid 1970s, reaching 14% in 1986, with a further
increase expected.

LO
PUBLICLY H a D DEBT OUTSTANDING AS A % OF GNP

NET INTEREST EXPENSE AS A PERCENT OF GNP

(Fiscal years)

(Fiscal years)

3.5

34

2.5 4

1.5

1 1 I I I I I I I 1 I I I I I I I I I I I I I I I > I I t
79

80

01

82

83

84

85

86

87e

88f

89f

Publicly held debt will continue to climb to nearly 40% of GNP by 1989.




62

64

66

68

70

72

74

76

78

80

82

84

86 88(f)

The share of GNP that is required to finance the deficit reached 3.4% in
1986, up from only about 1% in the early 1960s.

4
YIELD CURVE, ANNUALLY 1 TO 30 YEARS

1 YEAR TREASURY BILL & INFLATION RATE*
(Percent)

10.00 T

Percent

0.00 +

0.0 l l l l l l l t l l H I I I H I I I I I i l l l l l l l l l l i n H l l l l l l l l H H I I I I I H U l l l l l H I H t l l l t H l l l i n i l H I I I I I
80:1
81:1
82:1
83:1
84:1
85:1
86:1
87:1
* Percent change In CPI over year ago

The yield curve has steepened considerably since last year, as well as risen
over 200 basis points.

The one-year T-Bill rate also follows the trend rate of inflation. The increase
in prices over the previous year is here used as a proxy for the expected
inflation rate in the year ahead.

3-MOMTH TREASURY BILL & INFLATION RATE*

10 YEAR TREASURY BOND & EXPECTED INFLATION *

(Percent)
20.00

T

15.00

(Percent)
16.00

T

10 Year Bond

14.00 +

10.00 4

5.00

0.00

-5.00 IniiiiiiiiiiiiiiiiiiiniiniinwimHHuiiiiiiiiiiiwiniwiiiiniiiiiiiiiiiiiiitiiiiH
80:1
81:1
82:1
83:1
84:1
85:1
86:1
87:1
* Percent change In CPI from 3 months ago, annual rate

The 3-month T-Bill rate tends to track the 3-month inflation rate. With policy
actions that allow inflation to increase, interest rates also move upward.




4.00 11 im t m t ti 11 im n w t tt it i • m i ii imt 11111111 m m H i tt i m 111 m i it 11 H m i tt i tt t n t H
80:1

81:1
82:1
• Drexel Bumham Poll

83:1

84:1

85:1

86:1

87:1

The spread of the 10-year bond rate over the inflation rate expected for the
next ten years has been abnormally high over much of the 1980s. Some
narrowing occurred in 1986, but renewed uncertainty has caused the
difference to again widen in 1987.

U.S. NET INVESTMENT

M1 GROWTH AND THE TRADE-WEIGHTED DOLLAR
(% change from
prior year)
18

(Billions of dollars)

82

63

84

85

86

87e

881

891

The net position of the U.S. in international investment markets turned
negative in 1985 and 1986 after reaching a peak in 1981. For the first time
since 1914, the U.S. became a net debtor, the largest debtor in the world.
This trend will continue in 1987,1988, and 1989.

OD

(Monthly averages)

M l GROWTB-U.S., JAPAN, AND GERMANY
(Quarterly, percent change over year ago)

The Fed trade-weighted dollar on an inverted scale has been closely
correlated with monthly M1 growth in the past four years. More rapid money
growth in the U.S. has contributed to a weaker dollar.

GOLD PRICES AND THE TRADE-WEIGHTED DOLLAR
(Monthly averages)

(1973=100)
80

250 lit I H I I H H I M III II II III I III II II III I tit II II M i l III II I III 160
83
84
85
86
87

Monetary growth trends in Germany, Japan and the U.S. have followed
similar patterns in the past four years. It is difficult for other countries to
follow monetary policies independent of the U.S. because of the impact on
their exchange rates and export sectors.




Monthly average gold prices and the trade-weighted dollar (inverted scale)
have continued to move in tandem following a trough in early 1985.
Expansive money growth and a declining dollar have driven gold prices
higher.

6
GROWTH OF TOTAL BANK RESERVES

FEDERAL RESERVE DOLLAR INTERVENTION
IN FOREIGN EXCHANGE MARKETS

Four-Week Moving Average, Percent Change from 13 Weeks Ago, SAAR

(Positive denotes dollar purchases)

50

T

Week 2,1987

4,034

3,911

-7,502
-9.000 '
1/81 7/81 1/82 7/82 1/83 7/83 1/84 7/84 1/85 7/85 1/86 7/86 1/87 4/87 7/87
Period ends the last day of the month cited

Dollar intervention in foreign exchange markets under most of the Reagan
Administration has been minimal, with the exception of the latter portion of
1985 and the more recent interventions of 1987. In 1981 and 1985, the U.S
was selling dollars. In 1987, the U.S. has tried to support the currency.

-10-H1 5

I I I 1 1I I I I I I

I I I I I t I I I I I I I I I I I I I
9

13

17 21 25 29 33 37
1986

41 45

49

53

4

8

12 16

20 24 28 32
1987

Total bank reserves increased at an explosive rate during the first two
weeks of 1987, on a four-week moving average basis. They then slowed
abruptly over the next 14-week period and again in the most recent weeks,
indicating a tightening by the Fed to support the dollar.

u>
vo
EXCHANGE RATES - D M * , Y E W

U.S. BANK RESERVES AND FOREIGN EXCHANGE PURCHASES
(Weekly)

(Millions of Dollars)

(Weekly averages)
2.5 T

210.00

2.25 t

($Bill(ons, seas, ad).)
T59

f 180.00

$3,000

f 150.00

175 MiwiiiiiiiummmimtiiHiHiitHiiniiiHiininiiiiiiiiniiiiiiiiiiwiiiiitniil 120.00
J F M A

M

J J
1986

A

S

O

N

D

J

F

M

A M

J J
1987

A

The dollar has generally trended tower against the yen and the DM
throughout 1986 and 1987, with recent episodes of rapid decline causing
turbulence in financial markets.




87:2

87:6

*= Dollar Sates

Heavy U.S. purchases of dollars starting late in March could have caused a
contraction in bank reserves, but the official policy is "sterilization".

7.
QUARTERLY

MAJOR ECONOMIC INDICATOR 9

1

1988
II

III

4815.1

4712.2

4807.7

4905.1

5203.5

5250.8

2.8

3.7

3955.9

3936.0

0.0

-3.0

-2.0

4064.3

4050.4

4020.9

0.3

I

IV

3986.1

IV
Forecast
5004.3

III

6.2

III
Ettimatt
4524.4

1989
II

5167.5

1987
II

IV

4th QUARTER

7.6

-1.4

% Change
% Chsngs
88/87
1989
89/98
Forecast
5004.3
8.4 5250.8
4.9

3.4

3976.2

3.0 3936.0

-1.0

1.8

-2.9

1987

4061.2

2.4 4020.9

-1.0

% Change
•87/,08

Estimate
5090.4

GROSS NATIONAL PRODUCT
(Billions of $, annual rate)
% Change, annual rate

4377.7
8.6

6.6

7.1

8.3

8.7

8.4

8.4

8.3

7.1

REALGNP
(Billions of 1962 S. a.r.)
% Change, annual rate

3772.2

3793.7

3824.6

3858.6

3894.7

3925.5

3952.7

3976.2

3986.1

4.4

2.3

3.3

3.6

3.8

3.2

2.8

2.4

1.0

REAL FINAL DOMESTIC SALES
(Billions of 1982 $, a.r.)
% Change, annual rate

3859.7

3889.3

3934.2

3966.7

3992.9

4017.3

4038.0

4061.2

4060.9

1988

REAL CHANGE IN
INVENTORIES
(Billions of 1982 $, a.r.)

-3.8

4447.7

3.1

4.7

3.3

2.5

2.7

2.1

2.3

4615.1

3858.6

3966.7

0.0

47.6

37.8

16.0

10.0

17.0

20.0

23.0

18.0

24.0

16.0

-7.0

-2.0

10.0

N/A

18.0

N/A

-2.0

N/A

116.1

117.2

118.3

119.6

121.0

122.5

124.1

125.9

127.7

129.6

131.5

133.4

119.6

4.1

125.9

5.2

133.4

6.0

4.2

3.8

3.8

4.5

4.7

5.0

5.4

5.8

6.0

6.2

6.0

5.8

335.0

339.0

342.4

346.5

350.8

355.4

360.2

365.5

371.1

376.9

382.7

388.3

346.5

4.8

365.5

5.5

388.3

6.2

5.3

4.9

4.1

4.9

5.0

5.3

5.6

6.0

6.2

6.5

6.2

6.0

ALfTOSALES
(Millions, annual rate)

9.5

10.0

11.7

10.1

10.5

10.5

10.8

10.1

9.8

9.3

8.7

8.5

10.3 '

-9.8

10.5*

1.5

9.0*

-13.1

HOUSNGSTARTS
(Millions, annual rate)

1.79

1.62

1.61

1.60

1.60

1.58

1.57

1.50

1.38

1.35

1.37

1.50

1.65 '

-8.4

1.56*

-5.5

1.40*

-10.4

127.0

128.2

129.9

131.4

133.1

134.5

135.7

136.6

136.9

136.4

134.3

132.7

3.2

3.7

5.5

4.7

5.1

4.4

3.5

2.8

0.7

-1.4

-5.9

-4.8

101.1

101.7

102.3

103.1

103.8

104.5

105.2

105.8

106.3

106.8

106.5

6.6

6.1

6.0

5.9

5.8

5.8

5.7

5.8

6.0

6.2

294.0

296.5

298.0

300.0

305.0

307.0

308.0

309.0

309.0

306.0

2.1

5.0

4.1

6.7

3.7

3.5

3.4

3.0

1.3

NET CASH FLOW
(Billions of $, annual rate)
% Change over year ago

378.7

384.6

386.5

391.0

393.0

397.0

398.0

399.0

3.9

5.9

4.2

3.8

3.8

3.2

3.0

2.0

MONETARY BASE
(Billions of $, a.r.)
% Change, annual rate

243.7

247.8

250.8

254.8

259.5

263.3

267.8

11,8

7.0

5.0

6.5

7.5

6.0

7.0

GNP DEFLATOR
(1982-100)
% Change, annual rate
CONSUMER PRCE
INDEX
(1967-100)
% Change, annual rate

4w
O

INDUSTRIAL
PRODUCTION
(1977-100)
% Change, annual rate
NONFARM
EMPLOYMENT
(Millions)
UNEMPLOYMENT
RATE. ALL WORKERS (Percent)
CORPORATE
OPERATING PROFITS
(Billions of $. annual rate)
% Change over year ago

NOTE: All quarterly series are seasonally adjusted; % change, annual rate calculated from prior quarter;
calculations based on unrounded data; a.r. - annual rate; e - estimate.




131.4

4.3

136.6

3.9

132.7

-2.9

106.3

103.1

2.7

105.8

2.6

106.3

0.5

7.0

5.9

N/A

5.8

N/A

7.0

302.0

299.0

300.0

6.7

309.0

3.0

299.0

-3.2

-0.3

-1.9

-3.2

399.0

396.0

392.0

389.0

391.0

3.8

399.0

2.0

389.0

-2.5

1.5

-0.3

-1.5

-2.5

272.7

276.0

277.4

280.8

285.6

254.8

7.6

272.7

7.0

285.6

7.5

5.0

2.0

5.0

7.0

'Annual total; N/A • Not applicable.




Tables
H. Erich HEINEMANN
Moseley Securities Corporation

41

H-SOP-87

Table 1 - Part 1
Federal Reserve Action and Monetary Growth

M Billions)
(2)

(31

Monetary
Base

Currency

Total
Adjusted
Bank
Reserves

218.6
221.2
221.5
222.1
224.2
225.7
227.4
229.6
230.8
232.0
233.0
234.9
235.7
237.7
238.7
239.9
242.3
243.4
245.7
247.7
248.7
250.8
252.8
255.3
258.9
259.0
260.1
262.2
263.4
263.4
264.3
266.2

15°.5
160.6
161.3
161.9
163.1
164.5
165.3
166.9
167.8
168.7
169.9
170.6
171.8
172.7
173.8
174.4
175.8
176.7
177.6
179.0
179.7
181.2
182.4
183.5
186.0
187.2
187.7
188.9
190.2
191.1
192.1
193.2

(1)

Date

Jan 1985

Feb
Mar
Apr
May
Jun
Jul
Aug
Sep
Oct
Nov
Dec
Jar. 1986

Feb
Mar
Apr
May
Jun
Jul
Aug
Sep
Oct
Nov
Dec
Jan 1987

Feb
Mar
Apr
Hay
Jun
Jul
Aug P

(4)

59.1
60.6
60.2
60.2
61.1
61.2
62.1
62.7
63.0
/?

7

63.1
64.3
63.«
65.0
64.9
65.5
66.5
66.7
68.1
68.7
69.0
69.6
70.4
71.8
72.9
71.8
72.4
73.3
73.2
72.3
72.2
73.0

Detand
Deposits

397.4
403.8
406.3
409.2
413.5
420.3
425.0
431.3
437.8
439.5
443.7
450.5
451.2
453.4
460.6
467.6
477.7
484.6
492.7
501.6
506.9
513.8
523.7
540.6
545.2
543.7
545.0
554.6
556.1
548.6
548.7
550.8

(b)

(5)
Savings
I Stall
Tise
Deposits*

787.8
795.2
799.3
802.6
806.6
Sit."
822.8
826.0
828.7
831.6
836.1
841.0
847.6
849.1
854.0
859.7
862.8
869.0
873.8
878.8
884.1
888.4
892.0
898.2
906.2
905.5
906.5
905.1
900.5
903.2
905.2
907.3

* Includes Honey Market Deposit Accounts
« (445*647+8+9)
Source: Federal Reserve Board:tieineaannEconoiic Research




k2

(?)

(8)

(9)

110)

Large
Tiie
Deposits

Nondeposit
Liabil.

Foreign
Deposits

Treasury
Deposits

Total
Deposits

267.1
267.4

171.1
175.6
178.3
170.6
173.0
170.1
168.0
173.0
174.5
173.8
176.3
179.0
178.6
183.4
187.3
185.3
184.1
180.1
183.2
185.9
189.8
189.8
192.9
195.2
201.7
200.8
197.4
195.8
199.6
199.6
193.8
205.1

18.5
15.8
12.8
15.4
20.9
14.9
23.1
13.4
16.9

lt.S^.G
3668.6
1&78.».
1604.:'
l6g8.°
1705.1
171°.4
1726.4
1745.2
1741.1
1756.8
1779.8
1805.4
1815.1
1820.5
1834.6
1847.0
1850.3
1867.6
1878.7
1900.5
1907.3
1925.6
1956.7
1988.5
1986.1
1976.2
1994.6
2009.4
2003.5
1999.5
2009.8

•>T> 0

276.8
274.8
272.9
270.3
272.6
276.6
280.3
282.3
284.1
292.9
294.8
292.7
293.5
289.9
289.4
289.5
290.1
289.8
288.3
290.0
291.8
295.7
296.0
299.0
305.9
310.7
314.9
313.5
313.6

10.9
10.8

9.7
9.6
10.1
10.0
10.2
10.1
10.7
J0.5
10.6
10.7
11.0
10.1
10.1
10.6
10.8
11.1
11.6
11.2
11.7
11.8
11.7
11.7
12.2
11.6
11.2
11.6
11.7
11.8
11.7
11.4

5.4
7.8
14.5
24.1
24.3
15.8
17.9
21.7
16.1
16.8
11.1
18.2
15.2
15.3
19.2
27.5
28.5
17.1
21.6
30.8
25.4
26.6
21.6

Table 1 - Fart 2
federal Reserve Action and Honetary Growth

(11)

112)

(13)

Hi'

(15)

do)

(1?)

US)

Large
Tise
Deposit
Ratio

Nondeposit
Liabil.
Ratio

Foreran
Deposit
Ratio

Treasury
Deposit
Ratio

'.Honey
Multiplier
(2+4/1)

3an 1985
Feb
Har
Apr
May
Jun
Jul
Aug
Sep
Oct
Nov
Dec
Jan 1986
Feb
MatApr
May
Jun
Jul
Aug
Sep
Oct
Nov
Dec
Jan 1987
Feb
Hat
Apr
Hay
Jun
Jul
Aug

Currency
Ratio

(3/10)

Date

Adjusted
Reserve
Ratio

Savings
I Stall
Tiie
Deposit
Ratio

(2/4)

(5/4)

(6/4)

(7/4)

(8/4)

(9/4)

0.4014
0.3977
0.3970
0.3957
0.3O44
0.3914
0.3689
0.3870
0.3833
0.3838
0.3829
0.3787
0.3808
0.3809
0.3773
0.3730
0.3680
0.364o
0.3605
0.3569
0.3545
0.3527
0.3483
0.3394
0.3412
0.3443
0.3444
0.3406
0.3420
0.3483
0.3501
0.3508

1.9824
1.9693
1.9673
1.9614
1.9507
1.9436
1.93*0
1.9151
1.8929
1.8922
1.8844
.1.8668
1.8785
1.672?
1.8541
1.8385
1.8062
1.7932
1.7735
1.7520
1.7441
1.7291
1.7033
1.6615
1.6621
1.6654
1.6633
1.6320
1.6193
1.6464
1.6497
1.6472

(U72!
0.6622
O.t.69"
0.6764
0.6646
0.6493
0.6360
0.6320
0.6318
0.6378
0.63o2
0.6306
0.6492
0.6502
Q.b355
0.6277
0.6069
0.5972
0.5876
0.5783
0.5717
0.5611
0.5538
0.5398
0.5424
0.5444
0.5486
0.5516
0.5587
0.5740
0.5714
0.5694

0.4305
0.434"
0.4388
0.4169
0.4184
0.4047
0.3953
0.401!
0.3986
0.3O54
0.3973
0.3973
0.3958
0.4645
0.4066
0.39o3
0.3854
0.3716
0.3718
0.3706
0.3744
0.3694
0.3683
0.36.1!
0.3700
0.3693
0.3622
0.3530
0.3589
0.3638
0.3532
0.3724

0.0274
0.0267
0.0239
0.0235
0.0244
0.0238
0.0240
0.0234
0.0244
0.0239
0.0239
0.0238
0.0244
0.0223
0.0219
0.022?
0.0226
0.0229
0.0235
0.0223
0.0231
0.0230
0.0223
0.0216
0.0224
0.0213
0.0206
O.O209
0.0210
0.0215
0.0213
0.0207

0.0466
0.0391
0.0315
0.0376
0.0505
0.0355
0.0544
0.0311
0.0386
0.0123
0.0176
0.0322
0.0534
0.0536
0.0343
0.0383
0.0454
0.0332
0.034!
0.0221
0.0359
0.0296
0.0292
0.0355
0.0504
0.0524
0.0314
0.0389
0.0554
0.0463
0.0485
0.0392

0.0358
0.0363
0.0359
0.0357
0.0360
0.0359
0.036)
0.0363
0.0361
0.0364
0.035"
0.0361
0.0354
0.0358
0.0356
0.0357
0.0360
0.0360
0.0365
0.0366
0.0363
0.0365
0.0366
0.0367
0.0367
0.0362
0.0366
0.0367
0.0364
0.0361
0.0361
0.0363

Source-. Federal Reserve Board; Heineaann Econoaic Research




43

2.54/t.
2.5515
2.5625
2.5714
2.5718
2.591!
2.5959
2.6054
2.6239
2.6216
2.6335
2.644!
2.6432
2.6340
2.6577
2.6761
2.6971
2.7169
2.7281
2.747?
2.7608
2.7711
2.7931
2.83o3
2.8243
2.8220
2.8170
2.8356
2.8333
2.8083
2.8029
2.7949

Table 1 - fari

3

federal Reserve Action and Hcnetary Growth

This is accounted for by changes in the:

Date

Jan 1985
Feb
Mar
API

May
Jun
Jul
Aug
Sep
Oct
Nov
Dec
Jan 1*86
Feb
Mar
Apr
May
Jun
Jul
Aug
Sep
Oct
Nov
Dec
Jan 1987
Feb
Har
Apr
Hay
Jun
Jul
Auq P

Federal
Reserve
Actions
Monetary (Monetary
Growth
Base
Growth)
IH-l)

10.5
17. 4
7.0
7.7
12.2
18.S
11.9
17.3
15.9
5.3
11.2
15.7
3.7
6.1
17.1
15.4
23.7
15.3
17.6
20.1
11.1
15.7
20.9
35.3
12.4
-0.5
3.0
19.2
4.6
-10.J
1.8
5.3
1983
9.56
1984
S.87
1985
12.54
1986
16.84
1987
4.4?

11.0
15.2
1.6
3.3
12.0
8.3
9.4
12.2
6.5
6.4
5.3
10.2
4.2
10.7
5.2
6.2
12.7
5.6
11.9
10.2
5.0
10.6
10.0
12.5
18.3
0.5
5.2
10.1
5.6
0.0
4.2
9.0
1983
9.35
1984
7.15
1985
8.47
1986
8.73
1987
6.61

tontiibution
of the
Money
Multiplier

-0.6
2.2
5.4
4.4
0.2
10.1
2.5
5.0
9.4
-1.1
5.9
5.5
-0.4
-4.5
12.0
9.2
11.1
9.7
5.7
9.9
6.2
5.1
10.9
22.7
-5.9
-1.0
-2.2
9.1
-1.0
-10.1
-2.4
-3.7
1983
0.21
1984
-1.28
1985
4.07
1986
8.11
1987
-2.15

Adiusted
Reserve
Ratio

-1.4
-5.1
4.3
11
.
-1.8
0.7
-2.1
-2.0
0 -)

-2.6
4.3
-2.0
2?.7
-4.1
1.6
-0.5
-3.1
-0.4
-4.0
-1.1
2.6
-1.9
-0.7
-1.4
0.4
6.4
-4.8
-1.1
3.5
3.2
-0.2
-2.1
1983
2.29
1984
-0.01
1985
-0.37
1986
1.21
198?
0.65

Currency
Ratio

1.8
51
.
1.0
19
.
1.5
4.8
3.6
31
.
5.8
-0.*
14
.
6."
-11.5
-0.2
5.7
71
.
8.7
5.7
71
.
6.4
3.9
81
.
18.0
-3.2
-6.7
-0.2
7.1
-2.7
-9.8
-2.9
-1.1
1983
-0.80
1984
-0.65
1985
2.98
1986
5.18
1987
-2.43

Source: Federal Reserve Board; Heineiann Econotic Research



HU

Savinas
I Stall
Tite
Deposit
Ratio

-1.0
11
.
0.2
0.5
0.8
0.6
0.6
19
.
2.0
01
.
0.?
16
.
0f5

i?
.
14
.
3.1
1.2
1.9
2.1
0.7
1.5
2.6
4.5
-0.1
-0.4
0.2
3.3
1.4
-2.5
-0.3
0.2
1983
-2.10
1984
-0.41
1985
0.75
1986
1.46
1987
0.23

Large
Ties
Deposit
Ratio

1.2
0.8
-0.6
-0.5
0.9
14
.
11
.
0.4
0.0
-0.5
0.1
0.5
-6.1
-0.1
1.3
0.7
2.0
0.9
0.9
0.9
0.6
1.1
0.7
1.5
-0.3
-0.3
-0.4
-0.3
-0.8
-1.4
0.3
0.2
1983
1.21
1984
-0.49
1985
0.39
1986
0.37
1987
-0.3?

NonDeposi t
Liability
Ratio

0.3
-0.3
-0.3
1.8
-0.1
1.2
0.8
-0.5
0.2
0.3
-0.2
0.0
0.5
-0.8
-0.2
0.9
1.0
1.3
-0.0
0.1
-0.4
0.5
0.1
0.8
-1.0
0.1
0.7
0.9
-0.6
-0.5
1.0
-1.9
1983
-0.45
1984
0.30
1985
0.26
1986
0.32
1987
-0.14

Foreign
Deposit
Ratio

0.0
0.1
0.?
0.0
-0.1
0.1
-0.0
0.1
-0.1
0.1
0.0
0.0
-o.?
0.2
0.0
-0.1
0.0
-0.0
-0.1
e.i
-0.1
0.0
0.1
0.1
-0.1
0.1
0.1
-0.0
-0.0
-0.0
0.0
0.1
1983
0.03
1984
0.00
1*85
0.C3
1966
0.01
198?
0.01

Treasury
Deposit
Satio

-1.4
O.t.
O.o
-0.5
-0.9
1.4
-1.6
2.1
-0.7
2.4
-0.5
-1.3
-'.('

-0.0
i.7
-0.4
-0.7
11
.
-0.1
1.2
-1.3
0.6
0.0
-0.7
-1.6
-0.2
2.1
-0.8
-1.8
0.8
-0.2
0.9
1983
0.02
1984
-0.03
1*85

o.o:
i«8o
-0.44
l«lf.;7

-0.09

Table 1 * Part 3
Federal Reserve Action and Honetary Growth
THREE- IfdNTH H0VING AVERAGES
This is accounted for by changes in the:

Date

Jan
Feb
Mar
Apr
Hay
Jun
Jul
Auq
Sep
Oct
Nov
Dec
Jan
Feb
Har
Apr
May
Jun
Jul
Aug
Sep
Oct
Nov
Dec
Jan
Feb
Mar
Apr
Hay
Jun
Jul
Aug

1985

1986

1987

P

Federal
ReserveActions
Honetary (Honetary
Base
Growth
<H-1) Grctith)

9.43
12.49
11.63
10.70
8.95
12.77
14.18
15.88
15.03
12.82
10.79
10.72
10.21
8.52
9.00
12.87
18.74
18.14
18.89
17.66
16.27
15.63
15.92
23.97
22.88
15.73
4.98
7.23
8.93
4.57
-1.23
-1.00

6.53
9.70
9.31
6.73
5.63
7.86
9.90
10.00
9.38
8.37
6.06
7.32
6.57
8.3b
6.67
7.35
8.02
8.16
10.07
9.25
9.04
8.60
8.52
11.05
13.61
10.43
7.99
5.27
6.99
5.25
3.27
4.38

Cont
but ion
of the
Honey
Hult:iplier

?.%
2.7°
2.32
3.97
3.32
4.91
4.28
5.88
5.65
4.45
4.73
3.40
3.64
0.16
2.33
5.53
10.72
9.98
8.81
8.41
7.23
7.04
7.40
12.92
9.2?
5.30
-3.02
1.96
1.94
-0.69
-4.50
-5.39

Adjusted
Reserve
Ratio

1.63
-0.80
-0.73
0.13
1.21
0.02
-1.07
-1.14
-0.66
-0.80
1.31
-0.10
C^w7

7.16
8.38
-1.02
-0.6?
-1.35
-2.52
-1.84
-0.84
-0.12
0.00
-1.33
-0.59
1.78
0.66
0.16
-0.82
1.83
2.14
0.30

Currency
Ratio

1.83
3.30
2.62
2.66
1.4?
2.73
3.30
3.84
4.17
2.6'
2.09
2.41
-1.14
-1.68
-2.00
4.20
7.16
7.14
7.14
6.39
5.82
4.54
5.09
9.77
7.60
2.70
-3.36
0.10
1.43
-1.77
-5.12
-4.61

Source: Federal Reserve Board: Heineaann Econoaic Research




45

Savings
I Saall
Tiae
Deposit
Ratio

-0.90
-0.27
0.0c
0.5?
0.48
0.63
0.69
1.07
1.52
1.33
0.92
0.7?
-0.53
-0.59
-0!55
1.20
2.07
1.91
2.06
1.74
1.58
1.46
1.62
2.88
2.35
1.34
-0.09
1.02
1.62
0.72
-0.47
-0.85

Large
Tiae
Deposit
Ratio

0.75
0.80
0.44
-0.12
-0.10
0.57
1.12
0.96
.0.51
-0.05
-0.13
0.03
-1.81
-1.89
-1.61
0.64
1.34
1.20
1.26
0.91
0.81
0.87
0.81
1.09
0.65
0.32
-0.32
-0.33
-0.50
-0.83
-0.64
-0.32

NonDeposit
Liability
Ratio

0.13
0.10
-0.13
0.39
0.46
0.98
0.64
0.50
0.17
-0.01
0.12
0.04
0.11
-0.09
-0.16
-0.01
0.59
1.08
0.77
0.46
-0.09
0.09
0.08
0.46
-0.03
-0.04
-0.05
0.58
0.34
-0.05
-0.03
-0.43

.Foreign
Deposit
Ratio

-0.01
0.05
0.11
O.H
0.07
0.01
-0.01
0.03
-0.02
0.00
-0.01
0.02
-0.06
-0.00
0.00
0.05
-0.01
-0.03
-0.03
0.01
-0.00
0.02
0.00
0.05
0.02
0.04
0.04
0.06
0.01
-0.03
-0.01
0.01

Treasury
Deposit
Ratio

-0.53
-0.40
•\K'Jl

0.24
-0.2"
-P. 07
~0.3'"*
0.63
-0.04
1.30
0.44
0.23
-2/-'0
-2. ""5
-l.'A

0.46
C.24
0.03
0.13
0.75
-O.Ot
0.10
-0.21
0.00
-0.75
-0.84
0.09
0.37
-0.13
-0.56
-0.38
0.52

Federal Eeserve Action and Honetary Growth
(Heio)
Reserve
Growth
Three-tooth
Moving Average

Reset ve
Growth Rate
Month to Month
Jan 1985

Feb
Mar
Ar
p
My
a
Jn
u
Jul
Ag
u
Sp
e
Ot
c
Nv
o
Dc
e
Jan 1986

Feb
Hr
a
Ar
p
My
a
Jn
u
Jul
Ag
u
Sep
Ot
c
Nv
o
Dc
e
Jan 1987

Feb
Har
Ar
p
Hy
a
Jn
u
Jl
u
Aug P

Source:




Board: 1Hem

6.75
17.76
15.89
9.15
3.95
"Ut.
13.54
11.12
12.42
8.00
2.68
9.17
4.81
13.63
4.56
10.86

20.22
35.0"
-7.64
0.00
19.4"
1.98
19.15
1?.?3
5.90
5.87
-3.73
25.37
-7.21
22.73
-1.83
11.66
19.94
3.67
28.31
11.10
5.37
10.95
14.70
26.65
20.02
-16.68
10.50
15.96
-1.62
-13.80
-1.65
14.14
1983
7.17
1984
8.93
1985
11.16
1986
12.17
198?
3.36
1987
3.36

. . . V

11.76
L7.31
14.36
14.93
9.14
10.34
17.43
20.46
10.00
4.61
3.27
8.29
0.19
-5.69
-0.44

H6


Federal Reserve Bank of St. Louis, One Federal Reserve Bank Plaza, St. Louis, MO 63102