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September 26,1975 O n e World? The world's finance ministers and central bankers dicussed a num ber of topics at the recent meetings of the World Bank and the International Monetary Fund, but one of the strongest themes was the call for the United States to adopt stimulative policies to pull the rest of the world out of recession. This discussion aptly illustrates the growing interdependence of the world economy. It has long been recognized that developments in the U.S. can affect other countries, but one of the most important lessons of the past several years has been the degree to which developments in the rest of the world can also affect the United States. The 10-percent-plus U.S. inflation rate in 1973-74 was accentuated by a 25-percent rise in prices of worldtraded goods. Since the underlying monetary expansion in the U.S. probably would have supported no more than about a 6-percent rate of inflation, a significant share of our actual inflation apparently was “ imported". A rise in prices of world-traded goods during this period directly impacted on U.S. agriculture, raw-materials produc tion and many industrial-goods sectors. Developments in the rest of the world also added to the length and severity of the U.S. recession. First, world inflation reduced the real purchasing power of U.S. consumers more than would otherwise have been the case. Second, the slowing in world de1 Digitized for FRA SER mand led to a slower growth of U.S. exports in real terms (though not in nominal terms). Both elements, but especially the for mer, contributed to a large de cline in the real demand for goods and services in the U.S. The same factors also worked in the other direction, helping to account for the recessions in other major industrial countries. Thus, the level of industrial production in Western Europe is far below a year ago—9 percent lower in West Germany and 7 percent lower in France—while the num ber of unemployed has doubled in a year's time. Simultaneous world cycles The simultaneous worldwide boom and bust since 1971 has added a new dimension to the economic scene. Until recently, each major industrial country marched to its own business-cycle drummer, thereby contributing to world economic stability. When one country was expanding anoth er country was contracting, and as a result the demand on internationally-traded goods re mained fairly stable, in line with the growing capacity to produce such goods. Prices of worldtraded goods thus increased at a modest 1.3-percent average an nual rate between 1962 and 1969. Relative stability in the interna tional sphere helped to soften business-cycle fluctuations in any one country. During the expansion phase of the cycle, a country (continued on page 2) Opinions expressed in this newsletter do not necessarily reflect the views of the management of the Federal Reserve Bank of San Francisco, nor of the Board of Governors of the Federal Reserve System. could acquire imports at stable world prices, and therefore would suffer only from the price conse quences of its own internal expan sion. In the declining phase, a country's export demand typically would hold up because of expan sion elsewhere, thus mitigating the effects of a softening domestic demand. This relatively stable environment was thrown out of equilibrium by the shock associated with the breakdown in the international monetary system in the early 1970's. The accelerating U.S. inflation had already eroded private market confidence in the dollar as an international currency. This trig gered a flight from the dollar which culminated in suspension of dollar convertibility into gold in August 1971. Then, by overstaying fixed exchange rates, foreign cen tral banks purchased in excess of $68 billion in dollar-denominated assets in the two years ending March 1973. The overall effect was equivalent to a simultaneous easing of mone tary policy and acceleration of domestic money growth in all major industrial countries. The resulting worldwide businesscycle boom led directly to accel erating world inflation. However, the movement to flexible ex change rates in March 1973 permit ted a sharp slowing in money 2 Digitized for FRA SER growth, which then contributed to the current worldwide recession and the easing of inflation. Repeat of boom and bust? Perhaps the overriding question for the second half of the 1970's is whether the major industrial coun tries will continue on a largely synchronized and unstable path of boom and bust, or return to the less synchronized but far more stable business-cycle patterns which existed in the 1950's and 1960's. The possibility of another interna tional monetary shock may be fairly remote. As long as the major industrial countries continue to maintain reasonably flexible ex change rates, with moderate exchange-market interventions, foreign central banks should be able to avoid massive flows of capital and internationally-induced expansions in domestic money. However, the maintenance of flexi ble exchange rates is no guaran tee against the repetition of anoth er boom and bust. All foreign central banks are now faced with the same set of domestic econom ic problems: the worst recession in the postwar period, with a high rate of unemployment and a high but decelerating rate of inflation. If the major industrial countries re spond to this common economic phenomenon with a common desire to recover as quickly as possible, we could see a common set of stimulative policies, result ing among other things in a simultaneous expansion in their domestic money stocks. This could lead to a repeat of the worldwide business-cycle boom in 1976-77 followed by a recession in 1978-79. Such a scenario is analogous to the U.S. experience of the past decade. Prior to 1966 the U.S. enjoyed five years of growing prosperity and price stability. However, the shock of the Vietnam war, which was marked by Gov ernment deficit financing in a period of full employment and an acceleration in the U.S. money stock, disturbed this equilibrium and led to an accelerated inflation. The policy response from 1968 through early 1970 involved res trictive monetary and fiscal actions to counter the inflation. This led to a rise in unemployment and a subsequent reversal of policy, which in turn made the next round of inflation even more severe. Interdependence The U.S. is still suffering the consequences of the monetary and fiscal shock of 10 years ago be cause of the tendency for subse quent policy actions to amplify and reinforce that initial shock. If policy makers in other industrial countries were now to follow the same destabilizing reaction func tion, then a worldwide boom-andbust scenario might well continue through the second half of the decade. Probably the major threat of another worldwide boom and bust comes from sharply expan sionary policies designed to gen erate an overly rapid recovery from the current recession. The U.S. plays the key role in this situation. First, the U.S. economy by itself represents almost 50 percent of the income of the industrial coun tries of the world. Thus, a slow but stable growth in this country would contribute to a moderate growth in the demand for inter nationally traded goods and would thereby ease the pressure on their prices. Second, a moderate U.S. recovery policy would streng then the resolve of others not to follow excessively expansionary policies. Nonetheless, our trading partners may continue to press for strong ly expansionary policies on the part of the U.S. Most major industrial nations are looking towards an export-led recovery in their econo mies. They wish to avoid further deterioration in their own trade balances, in view of the adverse effects which higher oil prices have already imposed. Thus, they would like the U.S. to provide a strong market for their exports, through a more expansionary policy on our part. Michael Reran 3 Digitized for FRA SER uoj8u!qsE/v\ • qetn • uo S o jo • epeA9|s| . ogepi MEM EH 7!|B3 'o d s o u b jj • E J U J O P IE 3 • EUOZUy • B )jS E |V u i$ ON llWU3d aivd aovisod s n nvw SSV1D 1SMIJ ZSL p asrap M aQ isping®®®^ BANKING DATA—TWELFTH FEDERAL RESERVE DISTRICT (Dollar amounts in millions) Amount Outstanding 9/10/75 Change from 9/03/75 Loans (gross, adjusted) and investments* Loans (gross, adjusted)— total Security loans Commercial and industrial Real estate Consum er instalment U.S. Treasury securities O ther securities Deposits (less cash items)—total* Demand deposits (adjusted) U.S. Government deposits Time deposits—total* States and political subdivisions Savings deposits Other time depositsi Large negotiable C D ’s 86,066 65,278 2,287 22,536 19,560 9,998 8,138 12,650 86,258 24,245 358 59,877 5,832 20,709 29,548 15,714 + 1,044 + 1,217 + 1,315 100 + 29 2 153 20 + 915 + 658 + 58 + 115 33 + 9 + 129 + 118 Weekly Averages of Daily Figures W eek ended 9/10/75 + 1,742 1,777 + 1,000 1,671 279 + 350 + 3,832 313 + 5,769 + 2,202 47 + 3,742 98 + 2,979 + 485 105 - W eek ended 9/03/75 53 29 82 + 67 12 55 + 1,486 + + 915 + - + - - + - + + - + + - + - + + - 2.07 2.65 77.70 6.90 1.41 3.63 88.99 2.41 7.17 9.99 11.60 6.67 1.65 16.80 1.67 0.66 Comparable year-ago period - 6 249 255 1,236 u> o CO Member Bank Reserve Position Excess Reserves Borrowings Net free (+) / Net borrowed (-) Federal Funds—Seven Large Banks Interbank Federal fund transactions Net purchases (+) / Net sales (-) Transactions of U.S. security dealers Net loans (+) / Net borrowings (-) Change from year ago Dollar Percent + Selected Assets and Liabilities Large Commercial Banks - 351 + 695 *lncludes items not shown separately. ^Individuals, partnerships and corporations. Information Information Phone (415) Digitized for FRA SER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. on this and other publications can be obtained by calling or writing the Public Section, Federal Reserve Bank of San Francisco, P.O. Box 7702, San Francisco 94120. 397-1137. Louis
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