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Monet~ Policy Objectives for 1982 Summary of Report to the Congress on Monetary Policy pursuant to the Full Employment and Balanced Growth Act of 1978. With excerpts of testimony presented by Paul A. Volcker, Chairman, Federal Reserve Board, February 10, 1982. https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Contents Section Page Monetary Policy in 1982 2 The Federal Reserve'• Objectives for the Growth of Money and Credit 2 Ml Growth 3 Growth in the Other Aggregates 3 The Outlook for the Economy in 1982 4 Prospects for Economic Recovery 4 Economic Projections 5 Monetary Policy and the Performance of the Economy in 1981 6 The Growth of Money and Credit in 1981 6 Economic Performance in 1981 8 Excerpts from testimony of Paul A. Volcker, Chairman, Federal Reserve Board https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 12 Monetary Policy in 1982 The Federal Reserve's Objectives for the Growth of Money and Credit The Federal Reserve remains committed to restrained growth in money and credit to exert continuing downward pressure on the rate of inflation. Such a policy is essential if the groundwork is to be laid for ·sustained economic expansion. There was a distinct slowing of inflation during 1981, and the prospects for further progress are good. Failure to persist in the effort to maintain this improvement would have long-lasting and damaging consequences; inflationary expectations would again deteriorate, with potentially adverse effects on financial markets, particularly long-term rates, and the next effort to curb inflation would be associated with still greater hardship. Progress toward price stability can be achieved most effectively-and with the least amount of economic disruption-through a combination of monetary, fiscal, regulatory and other economic policies. But it is quite clear that inflation cannot persist over an extended period unless financed by excessive growth of money. Targets for money growth have therefore been set with the aim of slowing the expansion over time to rates consistent with the needs of an economy growing in line with its productive potential at reasonably stable prices. The speed with which the trend of money growth can be lowered without unduly disturbing effects on short-run economic performance depends, in part, on the credibility of anti-inflation policies and their effects on price expectations, as well as on other forces influencing interest rates and credit market demands, including importantly the fiscal position of the federal government. Given these considerations, the Federal Open Market Committee reaffirmed the ranges of monetary expansion shown in the table below for the .year ending in the fourth quarter of 1982. These ranges are the~ same as those tentatively set last July for 1982 and confirm the Federal Reserve's commitment to reduce inflationary forces. Ranges of Monetary Growth1 1981 Actual 1982 Projected Mt• 2 ½ to 5 ½ percent M1B 5.0 percent M 1B (shift adjusted) 2.3 pecent2 M2 6 to 9 percent M2 9.4 percent M3 6 ½ to 9 ½ percent M3 11.4 percent Commercial Bank Credit3 6 to 9 percent Commercial Bank Credit4 *Formerly M1B. See footnotes page 11. https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 2 8.8 percent Mt Growth Growth in the Other Aggregates At its meeting in February, the Committee recognized that the recent rapid increases placed M 1 in January well above the average level during the fourth quarter of 1981, the conventional base for the new target. Experience has shown that Ml growth can fluctuate rather sharply over short periods and these movements may be at least partially reversed fairly quickly. The available analysis suggested that the recent increase reflected in part some temporary factors, rather than signalling a basic change in the amount of money needed to finance nominal GNP growth. During 1981, MlB (shift adjusted) rose relatively slowly in relation to nominal GNP. On the assumption this relationship is likely to be more normal in 1982, and given the relatively low base for the MlB range, the Committee felt that growth in Ml (formerly MlB) 1 this year in the upper half of its range would be acceptable. At the same time, the FOMC elected to retain the 2 ½ percent lower bound for M 1 growth tentatively set last July in recognition of the possibility that financial innovations-especially techniques for economizing on the use of checking account balances included in Ml-could accelerate, with restraining effects on Ml growth. The actual and potential effects on M 1 of ongoing changes in fmancial technology and the greater availability of a wide variety of money-like instruments strongly suggest the need to give careful attention to developments in the broader money measures. The range for M2 growth is the same as in 1981, when actual growth slightly exceeded the upper bound of the range. The Committee felt that M2 growth in 1982 would be somewhat below the 1981 pace, although probably in the upper part of the range. However, should personal savings-responding to recent changes in tax law or other influences-grow substantially more rapidly in relation to income than now anticipated, or should depository institutions attract an exceptionally large inflow to IRA accounts from sources outside M2, growth of M2 might appropriately reach-or even slightly exceed-the upper end of the range. The 1982 ranges for M3 and bank credit are unchanged from those for 1981. These aggregates again will be influenced importantly by the degree to which credit demands tend to be focused in short-term borrowing and are funded at home or abroad. https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 3 The Outlook for the Economy in 1982 Prospects for Economic Recovery Economic activity still appeared to be contracting in _early February: industrial production and employment certainly declined further· in January, with the extent of the fall worsened by exceptionally bad winter storms. Demand in the key sectors that had led the decline-housing and consumer spendingshowed some signs of leveling off as the year began, and the recent cuts in production likely have helped to relieve some of the remaining inventory imbalances. It would appear that the economy is in the process of bottoming out and a perceptible recovery in business activity should be underway by midyear. One element supporting final demands in the economy is the federal government. Part of the recent expansion in the deficit reflects the cushioning effects of reduced taxes and increased government expenditures that result from declining income growth and rising unemployment. In addition, however, the build-up in defense spending is a continuing source of stimulus. The second phase of the tax reductions scheduled for July will provide another ex- https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis pansionary impetus to the economy. At the same time the deficit-particularly if expected to continue at exceptionally high levels in later years.-adversely influences current financial market conditions. The Federal Reserve's objectives for money growth ·in 1982 are consistent with recovery in economic activity. The expansion is likely to be concentrated initially in consumer spending. Given the substantial margin of excess capacity, outlays for business fixed investment may remain weak, particularly if longterm interest rates continue to fluctuate near their current high levels. A continuation of high levels of long-term rates also would inhibit the recovery in residential housing, although demographic factors will continue to buttress demands in that sector. The effort to deal with inflation is at a critical juncture. The upward trend in inflation clearly has been halted and the process of reversal is underway. There are signs that price setting, wage bargaining, and personal spending decisions are being made that will serve to moderate, rather than intensify, inflationary pressures. Nonetheless, the behavior of fmancial markets and other evidence strongly suggest that there continues to be considerable skepticism that progress in reducing inflation will be maintained. Lasting improvement in fmancial markets-particularly for longer-term instruments-is dependent on. confidence that progress against inflation will continue; looming federal deficits have served to shake that confidence. Prospects for lower interest rates and for sustaining recovery over a long period-indeed for the timing of recovery-are thus tied to prospects for a more stable price level. 4 Economic Projections improvement in inflation during 1982 comparable with the Administration's, as well as a similar outlook for the labor market. The Administration's projection for real growth falls at the high end of the FOMC consensus. Should prices and wages respond more rapidly to anti-inflation policies than historical experience suggests, or should more favorable productivity trends develop, then the recovery could be faster without adverse pressures developing on prices, wages, and interest rates. Given the current circumstances and in light of the monetary targets for the coming year, the individual members of the FOMC have projected economic performance in 1982 that generally falls within the ranges listed in the table below. The members of the FOMC expect inflation to continue to moderate in 1982. At the same time, real activity is expected to accelerate with most of the growth coming in the second half of the year. With inflation continuing to be substantial and the prospect that the federal budget deficit will remain large even as the recovery gathers momentum, demands for credit should intensify as the year progresses. In these circumstances, the recovery is likely to be somewhat restrained, with unemployment probably substantial at year-end 1982. The projections generally encompass those that underlie the Administration's recent budget proposals. The consensus view of the FOMC anticipates an Economic Projections for 1982 1981 Actual 1982 Projected FOMC Members Administration Changes, fourth quarter to fourth quarter, percent Average level in the fourth quarter, percent https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Nominal GNP 9.3 8 to 10½ Real GNP 0.7 ½ to 3 3.0 GNP Deflator 8.6 6½ to 7¾ 7.2 Unemployment Rate 8.3 8¼ to 9½ 8.4 5 10.4 Monetary Policy and the Performance of the Economy in 1981 The Growth of Money and Credit in 1981 In its report to Congress last February, the Board of Governors indicated that the System intended to maintain restraint on the expansion of money and credit in 1981. The specific ranges chosen by the FOMC for the various monetary aggregates anticipated a deceleration in monetary growth that would encourage further improvement in price performance. Measured from the fourth quarter of 1980 to the fourth quarter of 1981, the ranges adopted are shown in the table below. credit placed these aggregates above the upper bounds of their ranges at midyear. After reassessing its objectives for 1981 at midyear, the FOMC elected to leave unchanged the previously established ranges for the aggregates. However, in light of the reduced growth in Ml-type balances over the first half of the year-with indications that this weakness might reflect a lasting change in cash management practices of individuals and businesses related to the growth of alternative means of holding highly liquid funds-and given the relatively strong growth of the broader aggregates, the FOMC anticipated that growth of M1B might likely and desirably end the year near the lower bound of its annual range. At the same time, the FOMC indicated that M2 and M3 might well end the year around the upper ends of their ranges. This expectation also reflected the possibility that regulatory and legislative actions as well as the popularity of money market mutual funds might intensify the public's preference to hold assets encompassed in the broader aggregates. The table on the next page puts the performance of the aggregates during 1981 into a somewhat longer-term perspective, showing two measures of annual growth. In both cases, a marked deceleration in M1B is apparent since 1978. The table also clearly illustrates that growth rates for the broader aggregates have been maintained around a higher level Review of the Aggregates Even after accounting for shifts into NOW accounts, and reflecting the rapid pace of institutional change in financial markets, the behavior of the aggregates in 1981 was more divergent than anticipated. Average growth in adjusted M1B over the first half of 1981 was well below that which would have been expected on the basis of historical relationships among money, GNP, and interest rates. On the other hand, despite the weakness in M1B, the broader aggregates expanded quite rapidly in early 1981. M2 growth over the first half was near the upper end of its annual range, while the expansion of M3 and bank Monetary Growth 1981 1981 Ranges 1981 Actual 1981 Q4 Levels• MlB 6 to 8 ½ percent 5.0 percent 436.7 MlB (shift-adjusted) 3 ½ to 6 percent 2.3 percent 425.3 M2 6 to 9 percent 9.4 percent 1806.9 M3 6 ½ to 9 ½ percent 11.4 percent 2171.0 Bank Credit 6 to 9 percent 8.8 percent4 •Billions of dollars, seasonally adjusted. https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 6 1320.56 Growth of Money and Bank Credit (percentage changes) Fourth quarter to fourth quarter Annual average to annual average Year M1B 5 M2 M3 Bank Credit 1978 8.3 8.3 11.3 13.3 1979 7.5 8.4 9.8 12.6 1980 6.6 9.1 9.9 8.0 1981 2.3 9.4 11.4 8.84 1978 8.2 8.8 11.8 12.4 1979 7.7 8.5 10.3 13.5 1980 5.9 8.3 9.3 8.5 1981 4.7 9.8 11.6 9.44 and larger divergences have developed from M1B growth. In considerable part, these differences can be explained by structural changes in financial markets. funds and instruments offered by depository institutions that pay market-related interest rates have been accounting for an increasing proportion of M2, as such assets have become much more competitive with open market instruments. Indeed, the attractiveness of small time deposits was enhanced last year by the liberalization of the interest rate ceilings on small savers certificates and, late in the year, by the introduction of all savers certificates. Even so, two-thirds of the increase in the nontransactions component of M2 was accounted for by money market mutual funds which grew 140 percent last year. Changing Financial Practices As indicated, the growth of the narrow aggregates adjusted for shifts into NOW accounts was low in 1981 compared with the other aggregates and also in relation to income and interest rates. Continued high interest rates provided a substantial incentive for businesses to pare narrow money balances and to make increasingly widespread use of sophisticated cash management techniques. At the same time, explosive growth of money market mutual funds (MMMFs) appeared to prompt households to minimize checking account balances; the broader availability of NOW accounts also may have prompted them to reconsider the way they handle cash assets. Likewise, the strong growth of M2 last year reflected changing financial practices. Money market https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 7 Economic Performance in 1981 Gro11 Bu1ine11 Product Prices The economy was growing rapidly as 1981 began, continuing the sharp cyclical rebound that started in mid-1980. Activity leveled out during the spring and summer, however, and it fell in the final quarter of the year. As a result, the rate of production of goods and services-real GNP-was only slightly higher at the end of 1981 than it had been a year earlier. With the weakening of output late in the year, the margin of unutilized plant capacity widened and the unemployment rate rose sharply. While economic activity was disappointing last year, there were emerging signs of progress in retarding inflationary pressures. As 1981 progressed there Q.4 1981 Ql 8.6 Q2 -1.6 Q3 1.4 Q.4 -5.2 1979 1980 12 1981 also were indications of an easing in wage inflation, particularly in some key pattern-setting industries. 8 Slowing of Inflation The trend in inflation improved noticeably during 1981, and by year-end virtually all aggregate price indexes were advancing well below double-digit rates for the first time since 1978. The consumer price index rose 8.9 percent over the course of 1981, down from the nearly 13 percent average rate in 1979 and 1980. Important factors in the slowing of inflation were exceptionally favorable agricultural supplies and declines, after the first quarter, in world oil prices. Inflation in areas other than food and energy-particularly consumer commodities and capital equipment-also began to abate, although price pressures in the consumer service sector persisted. As the year progressed, surveys of inflation expectations suggested that the inflationary psychology, which had permeated many aspects of economic behavior in earlier years, appeared to be subsiding. 4 0 -4 https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 1978 10.5 8.2 9.9 7.1 Change from Q4 to Q4, percent 1972 Dollars 1977 1981 Ql Q2 Q3 Fixed-Weighted Index 1977 Real GNP Change from Q4 to Q4, percent 1978 1979 1980 1981 Credit Markets On balance, short-term interest rates-although quite volatile and at record highs as 1981 began-moved down considerably over the course of the year. In 8 contrast, long-term rates rose substantially. The pressure on long-term rates appeared to reflect a combination of factors. Anticipation that continued large federal budget deficits would clash with private credit demands, particularly as the economy expanded, were a continuing strong investor concern. Despite substantial reductions in the growth of many federal spending programs, federal borrowing in calendar year 1981 siphoned off roughly a quarter of the total funds available to domestic nonfinancial borrowers. Also in the background were continuing doubts and skepticism that anti-inflation programs would be carried through. average family disposable income needed to service the monthly payment on a typical new mortgage rose from 21 percent in 1976 to nearly 40 percent last year. Labor Market Employment grew at a moderate rate during the first three quarters of 1981 and the unemployment rate edged down. As economic activity began to contract in the autumn, the demand for labor fell sharply and the unemployment rate climbed to 8.8 percent in December-only fractionally below its postwar high. The unemployment rate of adult men jumped to a postwar record of 7.9 percent in December 1981. Labor productivity (output per hour worked) rose at a 1 ¼ percent annual rate in the first three quarters of 1981. However, output fell more than employment in the fourth quarter and productivity Housing Market The tensions in credit markets in 1981 had their greatest impact on household capital formation. Housing construction fell to its lowest level in the postwar period; only 1.1 million new housing units were started in 1981. The average closing rate on mortgages for new homes was 15.3 percent in the fourth quarter of 1981, up from 12.6 percent a year earlier. High prices also adversely affected the ability of those seeking new homes to afford the monthly payments. Although house prices changed little in 1981, over the preceding 5 years prices of new and existing homes had risen half again as fast as the overall rate of inflation. As a result, the share of https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 9 to enable them to compete more effectively. These adjustments, coupled with the progress seen in reducing inflation during 1981, suggest that the nation's anti-inflation policies have set the stage for a sustained unwinding of wage and price increases. declined, offsetting gains earlier in the year. Averaging across short-run cyclical movements, productivity has shown little improvement in recent years and thus has provided virtually no offset to the impact of rapidly rising compensation on unit labor costs. Compensation and wage increases did decelerate during 1981, with steady progress throughout the year. Also, by the second half of 1981, changes in traditional wage-setting practices were underway: management and workers alike began to reconsider planned wage adjustments; some expiring contracts were renegotiated well in advance of termination dates; and labor agreements at a nuinber of firms were modified in an effort to ease cost pressures and https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis IO Footnotes 3 . Because of the introduction of International Banking Facilities, the bank credit data beginning in December 1981 are not comparable to earlier data. Thus, the targets for 1982 are in terms of growth from the average of December 1981 and January 1982 to the average levd in the fourth quarter of 1982. 4. December levd used for calculating 1981 growth rates for bank credit incorporates an adjustment to abstract from the shifting of assets from U.S. banking offices to International Banking Facilities. 5. Growth rate for 1980 and 1981 adjusted for shifts to other checkable deposit accounts since the end of the preceding year. 6. Level for December 1981. Because of the introduction of International Banking Facilities, this figure is not comparable to earlier data. January 1982 level is not yet available. 1. The objective for growth of narrowly defined money over 1982 is set in terms of Ml only. Based on a variety of evidence suggesting that the bulk of the shift to NOW accounts had occurred by late 1981, the Federal Reserve is publishing only a single Ml figure in 1982 with the same coverage as the former MlB. M1 is currency held by the public, plus travder's checks, plus demand deposits at commercial banks net of deposits due to foreign commercial banks and official institutions less cash items in the process. of collection and Federal Reserve float, plus other checkable deposits (i.e., negotiable order of withdrawal accounts, accounts subject to automatic transfer service, credit union share draft balances, and demand deposits at thrift institutions). M2 is Ml plus savings and small denomination time deposits (including retail RPs) at all depository institutions, shares in non-institutional money market mutual funds (MMMFs), overnight repurchase agreements (RPs) issued by commercial banks, and overnight Eurodollar deposits held by U.S. residents at Carribean branches of U.S. banks. M3 is M2 plus large time deposits at all depository institutions and large denomination term RPs issued by commercial banks and savings and loan associations, and shares in institution-only MMMFs. Bank. credit is total loans and investments of commercial banks. 2. MlB vdocity, before shift adjustment, rose at a rate closer to historical experience. However, the shift of funds from saving accounts or other sources of funds not included in measures of the narrow money supply temporarily depressed the velocity figure, particularly early in the year. A copy of the full Report to Congress may be obtained from Publications Services, Board of Governors, Washington, D.C. 20551. https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 11 Excerpts from Testimony of Paul A. Volcker, Chairman, Federal Reseive Board I have submitted for the record the official report from the Board in accordance with the HumphreyHawkins Act. I would like to offer some more personal views on the problems-and equally important, the opportunities-that are before us. As you know, the economy has been in recession for some months. The recession has some of the characteristics of earlier downturns. But it seems to me plainly wrong to think of the current state of the economy as simply reflecting "another" recession. Rather, we are seeing the culmination of a much longer period of unsatisfactory economic performance extending well back into the 1970' s-performance marked by poor productivity, growing unemployment, much higher interest rates, and pressures on the real earnings of the average citizen and on the real profits of our businesses. A number of factors have contributed to that deterioration in our performance, not all of them completely understood. But one pervasive element-an element particularly relevant to monetary policy-stands out: we found ourselves in the midst of the most prolonged inflation in our history, and that inflationary process had come to feed on itself. Incentives were distorted. Too much of the energy of our citizens was directed toward seeking protection from future price increases and toward speculative activity, and too little toward production. Increasingly depressed and volatile capital markets reflected the uncertainties. Effective tax rates increased as inflation carried taxpayers into higher brackets. But, in a sluggish economy, those revenues did not keep up with our spending plans and programs. Against that background, the notion that we might comfortably live with inflation-or that we could accept inflation in the interest of strong growth-was https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis exposed as an illusion. I believe it is fair to say a clear national consensus emerged that turning back inflation had to be a top priority of economic policy-that a stable dollar is a necessary part of the foundation of a strong economy. Monetary policy has a key role to play in restoring that stability, and our policies are directed to that end. But recent developments have confirmed again that ending an inflation, once it has become deeply seated in expectations and behavior, is not a simple and painless process. The problems can be aggravated if too much of the burden rests on one instrument of policy. And the effort to restore stability will be more difficult to the extent policies feed skepticism and uncertainty about whether the effort will be sustained-a skepticism rooted in past failures to "carry through." Monetary, fiscal, and other public policies are constantly scrutinized-in financial markets and elsewhere-to detect any signs of weakening in commitment to deal with inflation. To speed the transition to lower interest rates and · healthier capital markets, to reduce the costly elements of anticipated inflation built into wage and price contracts, to permit more confident planning for the future-in fact, to lay the base for sustained recovery-credibility in dealing with inflation has to be earned by performance and persistence. That, essentially, is what public policy-and monetary policy in particular-has been about for some time, and there are now signs of real progress on the inflation front. That progress is reflected to greater or lesser degree in all the widely used inflation indices. Consumer prices rose 8.9 percent last year, 3 ½ percentage points less than the 1980 peak, and the inflation rate seemed to be trending lower still as the year ended. Finished goods producer prices have had an average increase at an annual rate of only about 4 percent for six months. Expectations cannot be so easily measured, but earlier fears that inflation might rapidly accelerate have plainly dissipated. Those gains, to be sure, have elements that may not be lasting. Some prices are depressed by recession-weakened markets, and some by the pressures of high interest rates on inventories and 12 major deterrent to new car sales as the industry comes to grips with long developing competitive and regulatory problems and the enormous ·challenge of adapting to the higher price of gasoline. In the best of circumstances, coping with deepseated inflation would pose difficulties. At the same time, we have had to adjust to the huge increases in the price of energy, to meet the need for a stronger defense, and to deal with the drag on incentives and investment resulting from rising marginal tax rates. All of that implies massive economic adjustments, the threat of a growing fiscal imbalance, and a difficult transition period. The high level of unemployment generally, and particularly distressing conditions in some of our older industrial centers, are one symptom. Lasting progress toward price stability-and other needed adjustments-cannot be built on prolonged stagnation, rising unemployment, and slow growth. The relevant question is not whether current conditions are satisfactory or tolerable-they obvious1y are not. It is whether our policies, and our policy mix, promise to achieve the needed results over time. It is against that background that I review monetary policy last year and discuss our intentions for 1982 in my official report ... speculative positions; exceptionally good crops last year have held food prices down; and surpluses have emerged in oil markets, following the enormous price increases of earlier years. But we also see evidence of potentially more lasting changes in the trend of costs as management and labor in key industries come to grips with ci>mpetitively damaging productivity.and wage trends. I am aware that this process has just begun, and it has been centered largely in areas where competitive pressures are most intense. But as the emerging patterns spread, we will have succeeded in establishing one of the major elements for success in the fight against inflation and for reconciling, as ·we must, a return to greater price stability with growth, reduced unemployment, and higher real wages. I am acutely aware that progress on the inflation front has been accompanied by historically high levels of interest rates and heavy attains on fmancial markets. Those sectors of the economy particularly dependent on borrowing-especially long-term borrowing-have been hard hit. It ,would be simplistic to cite high interest rates as the sole cause of the difficulties in these vulnerable sectors. Part of the problem arises from ·other, and longer-term, factors, themselves associated with the inflationary process. In housing, for example, we have had a decade of increases in prices of homes almost double the rate of inflation in the economy generally and well in excess of the rise in average family income .. "Sticker shock" still seems to be the https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis ••••••• Consolidating and extending the heartening progress on inflation will require continuing restraint on monetary growth, and we intend to maintain the necessary degree of restraint. The monetary growth ranges specified are, we believe, consistent with an economic recovery later this year, although we do not anticipate, by historical standards, a sharp "snap back.'' What is more important is that the recovery have a firm foundation-that it be sustained over a long period. There will be more room for real growth-and much better prospects for sustaining that growth over many years-the greater the progress on inflation ... 13 Today, we are acutely aware of disturbed capital markets, high interest rates, economic slack, and a .poor productivity record. But, when the economy begins to expand, productivity should rise; tax and other measures already in place or under way should help reinforce a better trend. Productivity growth, in tum, will permit prices to rise more slowly than wages-more modest wage and salary increases in dollars will then be consistent with mQre growth in real earnings, encouraging further moderation in wage. demands and sustaining the disinflationary process. As confidence returns to securities markets, prices of bonds and stocks should rise, and lower interest rates and more favorable capital market conditions will in tum support the continuing growth in investment and· productivity. With appropriate budgetary and monetary discipline, the process could be sustained for years. That is not an impossible vision ... From the standpoint of public policy, much of the groundwork has been laid. I have spoken of the key role for monetary policy, and of our record and intentions in that regard.· The tax program enacted last year can, in the right context, have favorable effects on incentives and on investment. The excessive burden of regulation is being addressed ... ! have refel'Rd on many oc• casions to the key importance of winding down the cost and wage pressures that tend to keep .the inflationary momentum going. The process appears to be starting, and the faster it takes hold the better the ·outlook for growth and reduced unemployment. But, clearly, prospects for early and sustained expansion-an expansion that can be broadly shared by industries now severely depressed-is dependent on access to capital and credit on more favorable terms. Pumping up the money supply cannot be the answer to that problem-excessive money and the inflation it breeds are enemies of the real savings needed to finance investment. What we can do is relieve the concerns the markets understandably have-concerns reflected so strongly in the budgetary documents before you from both the Administration and your own Budget Office. Without action to cut spending-or, if that fails, https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis to raise new revenues-we would face the prospect of deficits rising to unprecedented amounts, whether measured in dollars, in relation to the GNP, or as a proportion of our limited· savings and the supply of loanable funds. We can debate among ourselves just what level of deficit is tolerable in coming years and what is not. We can be tempted to sit back and let a year pais as we discuss· what programs should be cut or where revenues can be raised. But I think we all know that, without action, we would be on a collision course between our need for new plant, equipment and housing and our capacity to save-and it would be more difficult to reconcile the requirements for a sound dollar with our desire to grow. It could be argued we have a little time. A large deficit in the midst of recession should be manageable; it indeed provides some support for the economy in a time of stress. There are also large potential sources of demand in the private economy. The latest economic indicators are not so weak as they were. We can see we are making some progress against inflation, perhaps. as fast as could reasonably have been anticipated. In all these circumstances, a degree of patience is needed-and justified. But delay is another matter. In my judgment, the more progress we can see in restraining costs, and the more resolute your budgetary action, the earlier we can be assured a prompt and strong recovery. The course of action we have set in the Federal Reserve seems to me consistent with that sense of direction and urgency. But no single instrument of policy can, alone, do the job. We look forward to working with you and your colleagues in the weeks and months ahead to meet these challenges constructively. ••••••• 14
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