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EEDERAL RESERVE'S FIRST MONETARY
POLICY REPORT FOR 1982
HEARINGS
BEFORE THE
COMMITTEE ON
BANKING, HOUSING, AND URBAN AFFAIRS
UNITED STATES SENATE
NINETY-SEVENTH CONGEESS
SKCOND SESSION
ON
OVERSIGHT ON THE MONETARY POLICY REPORT TO CONGRESS
PURSUANT TO THE FULL EMPLOYMENT AND BALANCED
GROWTH ACT OF 1»T8
FEBRUARY 11 AND 25, 1982
Printed for the use of the Committee on Banking, Housing, and Urban Affairs
[97-48]
U.S. GOVERNMENT PRINTING OFFICE
WASHINGTON : 19S2
COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS
JAKE GARN. Utah, Chairman
JOHN TOWER, Texas
HARRISON A. WILLIAMS, JR., New Jersey
JOHN HEINZ, Pennsylvania
WILLIAM PROXMIRE, Wisconsin
WILLIAM L. ARMSTRONG, Colorado
ALAN CRANSTON, California
RICHARD G. LUGAR, Indiana
DONALD W. RIEGLE, JR., Michigan
ALFONSE M. D'AMATO, New York
PAUL S. SARBANES, Maryland
JOHN H. CHAFEE, Rhode Island
CHRISTOPHER J. DODD, Connecticut
HARRISON SCHMITT, New Mexico
ALAN J. DIXON, Illinois
M. D-4NNV WALL, Staff Director
ALBKRT C. EISENRERG, Acting Minority Staff Director
W. LAMAR SMITH, Economist
(111
CONTENTS
THURSDAY, FEBRUARY 11, 1982
Page
Opening statement of Chairman Garn
Opening statements of:
Senator Schmitt
Senator Riegle
Senator Lugar
Senator Dixon
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4
5
7
8
WITNESS
Paul A. Volcker, Chairman, Board of Governors of the Federal Reserve
System
Panel discussion:
Entitlement programs
Near-term problem
Contemporary reserve accounting
Letter proving information on the fluctuation in growth rates of money
in the United States compared with other industrial countries
Reappraisal of targets
Work practices
Potential turnaround
Budget key to reduction of interest rates
Reserve requirements on MMFs
Weekly statement
Freeze on entitlements
Two-step fiscal plan
Reduction of interest rates
Growth rate
Unemployment up-^inflation down
Trillion dollar deficit
Deficit during recovery
Recession bottoming out
Establishing a trust fund
Prepared statement
Monetary policy in 1981 and targets for 1982
The course ahead
Table 1—Monetary growth 1981
Table 2—Growth of money and bank credit
Table 3—Monetary growth targets
Chart 1—Growth ranges for 1981 and actual
Chart 2—Growth ranges for and behavior of Ml, 3981 and 1982
Letter of transmittal, submission of monetary policy report to the
Congress
Answers to subsequent written questions of Senators Heinz and Riegle
Staff evaluation of Milton Friedman Newsweek column
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THURSDAY, FEBRUARY 25, 1982
WITNESSES
George W. McKinney, Jr., senior vice president, Irving Trust Co., New York,
N.Y
(in)
121
IV
George W. McKinney, Jr., senior vice president, Irving Trust Co., New York,
N.Y.—Continued
Prepared statement
Monetary strategy for 1982
Fiscal policy considerations
Deficits could scuttle anti-inflation program
Monetization of deficits
Public perceptions are important
Proposals for technical change
Mandated fixed targets
Monetary policy choices for 1982
Answer to subsequent written question of Senator Riegle
Beryl Sprinkel, Under Secretary for Monetary Affairs, Department of Treasury, Washington, D.C
Prepared statement
Trends and fluctuations of money growth
,
Annual rates of change
Annual rates of change of Ml
Chart 1—Money and GNP growth
Chart 2—Quarterly growth rates based on 4 week averages
Jerry L. Jordan, member, President's Council of Economic Advisers, Washington, D.C
Slow money growth
Financial market participants
Prepared statement
Panel discussion:
Weekly reporting of money supply
Starting a cottage industry
Business decisions
Weekly monetary base
Effects of stagflation
Personal savings
Henry Schechter, director, Office of Monetary Policy, AFL-CIO, Washington,
D.C
Prepared statement
Chart 1—Mortgage yields vs. prime interest rate
Chart 2—Prime rate, Federal interest burden, and interest share of
personal income
The need to supplement tight monetary policy
Michael Sumichrast, chief economist, National Association of Home Builders,
Washington, D.C
Longest recession in housing on record
Administration vs. Fed
Prepared statement...
Housing situation
Housing prospects
The need for higher money growth rate
The deficit must come down
A need to change the Fed's policies
Tables and charts:
Money stock measures
U.S. housing starts, 1900-83
Sale of new homes
Seasonally adjusted consumer price index for all urban consumers:
U.S. city average, 1978-81
1981-82 producer price indices
Credit market funds raised, 1946-81
Total mortgage funds advanced
Savings flows into thrift institutions, monthly, 1978-81
Unemployment rates: All workers and construction workers, 1971-82.
Number of unemployed among all workers and construction workers,
1971-82
Failure rates in the construction industry, 1974-80
Failure rates in the construction industry, monthly, 1979-81
Housing starts and housing-related economic indicators, 1981 actual
and 1982 forecasted, using two scenarios:
Scenario 1
Scenario II
P»W»
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V
Michael Sumichrast, chief economist, National Association of Home Builders,
Washington, D.C.—Continued
Magazine article entitled "Prices of Real Estate Declines"
Panel discussion:
Credit controls
Penalty discount
Entitlement programs
Progressive income tax system
Pa e
«
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FEDERAL RESERVE'S FIRST MONETARY
POLICY REPORT FOR 1982
THURSDAY, FEBRUARY 11, 1982
U.S. SENATE,
COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS,
Washington, D.C.
The committee met at 10 a.m., in room 5302, Dirksen Senate
Office Building, Senator Jake Garn (chairman of the committee)
presiding.
Present: Senators Garn, Schmitt, Lugar, Proxmire, Cranston,
Riegle, Sarbanes, and Dixon.
OPENING STATEMENT OF CHAIRMAN GARN
The CHAIRMAN. The committee will come to order.
Chairman Volcker, we are pleased to have you with us today. I
recognize it is difficult under the law requiring you to report every
6 months on monetary policy to have to go before the House one
day and the Senate the next day and we will reverse that process
so next time you will be before the Senate first. I recognize it is
difficult for you from the standpoint that you have the same message and have to do a replay 2 days in a row. I certainly would not
ask you to go through your full statement again as you did yesterday but summarize as you see fit, and then be responsive to questions from the committee.
Before we start, I would like to make a few opening remarks and
offer a little bit of background. Over a period of several years, far
before I became chairman of the Banking Committee, we have had
the opportunity to privately discuss monetary and fiscal policy
many times across this table. As you know, as interest rates have
been high for some time and we have had a great deal of problems
in the economy, the normal tendency, particularly in Congress,
both in the House and the Senate, has been to look for scapegoats,
to look everyplace but within to find the source of the problems.
I have been a persistent commentator and defender of the Fed in
many ways, not that we always agreed on various aspects of monetary policy. But I've said from this bench dozens of times that you
can't separate monetary and fiscal policy. That they had to go
hand in hand. And that the Fed had a very difficult time when
fiscal policy was out of control, which I believe it has been for
many, many years, through several administrations, through many
different Congresses.
I think the proof of that is a $1 trillion debt and $115 billion of
interest on the national debt. Congress is continually unwilling to
(1)
get its fiscal house in order. I have also stated many, many times
that I felt that that was, without doubt, at least in this Senator's
opinion, the major cause of inflation—not the only cause, but the
major cause, and the major source of high interest rates.
Yet we have seen a perfect example. After the August recess we
came back in and I was faced with I don't know how many—12, 13,
14 bills, all kinds of speeches, prairie popularism rhetoric like I
could not believe. After Members had been home during August
talking about high interest rates and had heard from their constituents, the convenient scapegoat was the Fed. Let's dump it all
on the Fed. Let's not let the people of this country know we had
anything to do with it in Congress. Let's just say it's all the Fed's
fault through its monetary policy. There were all sorts of bills to
restructure the Fed. Let's put a farmer, let's put a businessman,
let's put a one-eyed, one-toed South African diving bird on the
board at the Fed. If we had passed all those bills, every one that
has come before this committee, I don't think the legislation would
have had one bit of impact on the economy or on interest rates.
It may make people feel good and compel Senators and Congressmen to put in bills and say we're doing something about the Fed
and we're going to solve the problems. Sometimes I feel like combining all of them and passing them so we can show the world that
those kind of solutions aren't going to help the problem.
Well, that's past history and I just wanted to repeat it so everyone understood where I have been coming from all along. I still feel
very strongly that the major problem is the Congress. We hear all
the talk about the President's budget right now. I would remind everybody that a President can recommend a budget, he can plead,
he can yell, scream, shout, threaten, he can veto, but he cannot
spend one dime not appropriated by the Congress of the United
States.
That is the constitutional responsibility of the House and the
Senate and no President has ever spent a dime not appropriated by
Congress. So if Congress doesn't like the budget, if they don't like
trillion dollar debts, if they don't like deficits, Congress is the only
one that can do anything about that. That is a constitutional fact
of life.
So if I sound angry, I am angry. I'm sick and tired of Congress
trying to find everybody else to blame. The President, this one or
Carter or some other President, or the Fed—to find everybody to
blame except the Congress of the United States so they look good
at home. I repeat, only Congress has control over fiscal policy, no
one else. If we don't like Ronald Reagan's budget, we can change it.
Instead of just trying to assess blame, we can change it. We can do
anything we want with it. That power lies only here.
Having said all of that, trying once again to pinpoint at least
where I feel the major responsibility lies, in these halls and in this
body. Nevertheless, the Fed has a part in it and certainly monetary
policy does influence interest rates. I have been critical of not
going to contemporaneous reserve accounting. I also would hope
you would address today the matter of reporting the monetary aggregates. As I have said many times to you privately, I don't even
understand why we report them on a weekly basis. I don't think
the Fed can accurately measure the money supply on a weekly
3
basis, let alone manage it. I don't think that's a possibility. Yet
every week when those figures come out we see great ripples in the
stock market and money markets of this country. Then a few days
later we revise it and we find out that very rarely is it accurate. I
don't see why we even report the monetary aggregates more often
than once a month. I think we cause false psychological signals in
the economy that are damaging simply because we are reporting
them more frequently than we can accurately measure those figures.
So I think there's contemporaneous accounting I would like
you to address and the matter of how often we report and collect
the data.
Then there's one other thing that I'm beginning to be extremely
concerned about, despite all I've said about where the major blame
is. I don't want that misunderstood; I want that very carefully understood where I think the major blame is. Nevertheless, with the
continual policy of the Federal Reserve and the tight money
policy—I don't want it opened. I don't want to see what happened
in 1980 and see rates drop to 12 percent and then immediately
after the election go to 21.5 percent as they did. I don't want to see
that kind of fluctuating market, but I'm really wondering if the
Federal Reserve Board sitting here in Washington is aware of what
is going on in the country.
I feel there's a great deal of insensitivity to the problems in the
business community and what I'm essentially saying is, fine, inflation is down; what if we get it down to 4 or 5 percent? We haven't
got any business community left, because in my own State, where
the economy is much better than most of the States of this country,
where the unemployment rate is not nearly as high as it is in
Michigan—in fact, it's dramatically lower. Yet there's a softness in
the business community that is going to show up very rapidly
where it isn't just businesses that are undercapitalized or those
that have been in business 4 or 5 years that are on the verge of
bankruptcy, but some of the most stable businesses in my community and my State, some of them family-owned businesses—one
that has been in business through 4 generations for over 105 years
will be in receivership within 1 month for one reason—high interest rates. That's all. They simply can't carry their inventory any
more, after 105 years of being very successful.
We all know the homebuilders' story. We all know the problems
of the thrifts. I'm simply asking you to address, if you can today, is
the Board sensitive to those problems? Are you going to be so
persistent on your tight money policy and say that, fine, we will
get 5 percent inflation but there are 1 million people unemployed, a
few old-line businesses that have been around 75 or 100 years that
aren't here any more—where is our industrial base?
Again, I think I have assessed rather adequately where I think
the major problem is, but I'm wondering if the Fed is aware and
recognizing the real world or are you so set on a policy, so persistent on it, that you can't bend regardless of the real world consequences of that policy, at least whatever part the Fed plays in
that?
I will continue, Mr. Chairman, to do everything I can to see that
Congress does its job on fiscal policy because I realize yours can't
be successful unless there is a responsible fiscal policy. But I think
it's time maybe the Fed reassessed those targets, to see whether
they are adequate or not, and particularly how often you report
those. At least we could cut down some of the psychological impacts that are part of interest rates and the problems it's causing.
Well, I took longer than I intended to, but I'm sure we will have
time to discuss at great length some of the points that I have made.
Senator Proxmire.
Senator PROXMIRE. No statement.
The CHAIRMAN. Senator Schmitt.
OPENING STATEMENT OF SENATOR SCHMITT
Senator SCHMITT. Thank you, Mr. Chairman.
I congratulate you for your statement and concerns and it's good
to see Chairman Volcker with us again.
Chairman Volcker apparently yesterday hit a good middle
ground. I see by the New York Times that they are quoting you as
going to maintain a tight-money policy, whereas the Washington
Post says you're going to ease controls. So maybe later in the day
we will find out exactly what you're going to do.
The CHAIRMAN. They're in the same position in both papers. The
New York Times says you are going to tighten it and the Post says
you are going to ease it. Do we have anybody that's in the middle?
Senator SCHMITT. You know, what happens when you're in the
middle of the road? You get run over by both sides.
So, again, I'm sure that you will enlighten us further.
Mr. Chairman, the Republicans as well as others have done a
good job in recent years of selling the proposition that deficits are
inflationary. Clearly, there is a competition for credit when the
Government must go into the private markets to finance their
debts. That raises interest rates. And this does contribute to inflation, depending on how you calculate interest rates into the calculations of the Consumer Price Index.
However, when I look at the historical curves, which are certainly more accurate than current curves, there is no strong correlation between an actual deficit and an increase in inflation taken
solely by themselves. There is a correlation, as you're well aware—
a historical correlation between increases in the money supply and
increases in inflation.
Now that correlation is shifted by eight quarters. That is, the
peak of inflation will appear about eight quarters after the peak in
the increase in money supply, but it's a very, very strong historical
or empirical correlation.
This suggests that what happens and the reason deficits appear
to contribute to inflation is that we have monetized these deficits;
that is, we printed money effectively in order to finance them.
So one of the things that I hope that you will address is whether
or not you believe that the Federal Reserve System can avoid monetizing or printing money in order to finance the large deficits that
are forecast for the next few years.
Clearly, interest rates will be affected by those deficits to some
degree, if only that it's going to be more difficult for them to come
down with the Government in the marketplace borrowing money,
but still we can avoid major increases in inflation if we avoid monetizing the debt. That will be the thrust of my interest and I hope
that you can cover that.
Welcome again to our hearing.
The CHAIRMAN. Senator Riegle.
OPENING STATEMENT OF SENATOR RIEGLE
Senator RIEGLE. Thank you, Mr. Chairman.
Chairman Volcker, we have had occasion before this committee
and on other occasions to get into these issues, so today is just a
further step in the discussion that's been continuing over a period
of time.
But in terms of an initial statement, Mr. Chairman, I want to
relate what I'm about to say to some of the things that you, yourself, said a minute ago.
First of all, Mr. Chairman, the economy of this country simply
cannot tolerate the continuation of these high interest rates. You
are doing massive, permanent damage to the economy and, yes,
while we have made some progress on inflation—and I think that's
important—we also have on our hands now a major recession
that's getting worse. We now have in our country about 30 percent
of our plant capacity idle, unused. We've got at least 10 million
people in this country unemployed that want to go to work and
can't find work. We are seeing tremendous damage to the automobile industry and to other heavy industry in this country, to
small business, to agriculture. The construction business has shut
down. The savings and loans are failing at a rate, according to Mr.
Pratt, of essentially one a day. We just had a run on a savings and
loan, as you know, in Connecticut.
In my State of Michigan, the unemployment rate last month
jumped to 16 percent. It went up a full point and it's still rising.
We've got 677,000 people in my State that are unemployed that we
know of by name. There are easily tens of thousands of others unemployed in Michigan that we don't even count any more because
they have exhausted their unemployment benefits.
So we have a disaster on the scale that rivals the 1930's, as I see
this spreading out across the country, through the tier of Northern
States, out in the far Northwest, in the Northeast, and beginning
to penetrate even into the Middle Atlantic States and down into
the Sun Belt and into States like Alabama and Tennessee.
Now something has got to be done about this. As I look around
my State, we've got not only the disaster in the automobile industry but we've got a major company close to chapter XI at the present time. I can cite for you hundreds of cases of examples of small
businesses that have been in families for two, three, and four generations, well managed, that have exhausted their working capital
and can't function at a prime rate of 16.5 percent, and many of
them, by the way, can't even borrow at that rate, as you well know,
and basically the answer that comes back is that nothing can be
done about it in the short run, that nobody can do anything about
interest rates. The Federal Reserve apparently can't do anything
about interest rates, but I just can't accept that. I think you do
have some responsibility to find a way to take specific actions that
6
can bring down the interest rates and if you need help, if in fact
you do, both from the Congress and importantly from the Reagan
administration, I trust you will ask for it bluntly here and I hope
you are going to ask for it bluntly at the White House if you find
you need additional operational authorities within the Fed to bring
these rates down, to create a two-tier system or try to get some
credit into the sectors that are starving to death. The President has
the power to see that you do have it under the Credit Control Act
and he could do it within 24 hours. If you feel there's a need for
that, then I don't think you should be reluctant to ask for it, and if
you're reluctant to ask for it, then I think perhaps there's a need
for you to take a closer look as to what's actually happening
around the country and the scale of damage that's piling up here.
Now these interest rates I think are unfair, they are unsound,
and they are unjustified.
Another problem mentioned is that the deficits are too high, they
are too high, and they have to come down, and I pledge—and most
of the Members of the Senate are pledged to get these deficits down
below the $100 billion range. But it is important what the President of the United States does. If he comes to Congress with a
budget, as he has, which projects deficits of $100 billion or more as
far as the eye can see into the future, it is very difficult, very difficult as a practical matter to substantially reduce those deficits.
So what the President thinks, what he proposes, is profoundly
important, especially so when his party controls the U.S. Senate. I
don't know, for example, how you feel about the size of those deficits in terms of your testimony here today, but if you think they
are too large, as I happen to think they are too large, it's important that you say that to the President and that you say that to the
Director of the Office of Management and Budget and to the other
people who put the budget together and present it to Congress. I
think the deficit is too high and it has to come down, but if it
comes down and there's no monetary easing, if interest rates don't
come down, I think we run the risk of the real possibility of a depression in this country. I don't even like to mention that people
like Helmut Schmidt have been talking about it here in this country within the last several weeks, have been raising the possibility
as more and more people do, and I think we've got to be realistic
about what we are facing.
There has to be a recognition of what's happening to the country
and I think you've got to find a way to engineer a response within
the next 90 days and I would feel within the early part of the next
90 days, and not let the current situation drift on for an additional
series of months. I have been out, not only across my State and in
cities like Detroit, but across the country talking to people at all
levels, and what I'm finding is this: that the level of economic and
social stress that's building up in this country is such that we are
going to have a very hard time holding this country together the
remainder of the year.
We've got to get interest rates down, that has to be a common
goal among us. I'm very interested not only to see what plans the
Federal Reserve has for accomplishing this objective this year and
quickly, but I also want to ask you some specific questions in
regard to that and I will when my chance comes.
7
Thank you, Mr. Chairman.
The CHAIRMAN. Senator Lugar.
OPENING STATEMENT OF SENATOR LUGAK
Senator LUGAR. Chairman Volcker, I appreciate your coming this
morning and I appreciate the testimony that you have given in the
past and the work that you're doing. It seems to me that you have
analyzed correctly, at least in recent statements, the fact that a
collision course may be ensuing as the growth policies of the present administration and the present congressional dictates collide
with restraint of inflation.
It seems to me that in defense of the course that we are on—and
it's one that I voted for—it's important that we appreciate that we
cannot pay our bills in this country unless we have dynamic
growth, that there is no way that we can pay for social security or
the transfer payments or defense without substantial new growth,
that the rationale for tax cuts was to offer opportunities for people
to bring about that growth in the private sector and I think both
parties are united in praying that that will be so.
It also appears that in order to get to the promised land of the
Tax Recovery Act the barrier of interest rates must be surmounted
and they are too high. As a result, that investment is not occurring
and income is falling and the deficits become larger.
It's in that context that I did make a constructive suggestion
that is not unique but simply, I suppose, in the spirit now in which
alternative ideas are offered if one has some change of course in
mind. It appeared to me that it would be advisable either as a
public statement or as a private policy for the Federal Reserve
Board to adopt a policy of pegging interest rates 3 percent above
the perceived rate of inflation in this country. There could be disagreement as to what that perceived rate is, but presently, for the
sake of argument, let us say that it is somewhere between 8 and 9
percent. That would mean that the prime rate ought to fall somewhere between 11 and 12 percent. It seems to me that ought not to
occur in a precipitous fashion, if it's now at 16.5 percent, and that
the policy of the Fed ought to be for an incremental reduction of
approximately one-half percent per month until such a time as we
get into the general range of that inflation plus 3 percent formula.
There are any number of technical problems in making that
occur and I'm mindful of that, in case anybody would charge that
this idea is simplistic. But at the same time, it appears to me that
that needs to be our goal, that we need to have a real rate of interest that is roughly 3 percent and not 6 or 7 percent, and it probably
needs to occur during calendar year 1982 in the foreseeable future.
This may require a certain degree of negotiation with the President of the United States and I have no doubt that you are prepared for that and I'm very hopeful that he will be too. It appears
to me that it is in the best interest of our country for us to get on
with the recovery and that the degree of investment that we wish
to have must come soon and that the relief that I'm suggesting
must be timely. I offer this fully mindful of the fact that in the inflation the genie is still barely in the bottle and the possibilities of
it escaping are enormous, but I also think that we are dealing in
futility in discussing deficits without thinking of revenue coming
in, and that in order for revenue to come in we shall have to have
fuller employment, much greater investment, and that the barriers
of interest rates prevent this.
I'm certain that we will do our part, as all members have
pledged, on the fiscal side, and will entertain alternative ideas
hereto in the same spirit that I offer an alternative with regard to
monetary policy.
Thank you, Mr. Chairman.
The CHAIRMAN. Senator Dixon.
Senator DIXON. Thank you very much, Mr. Chairman.
I'm delighted to welcome you back again, Chairman Volcker.
One of the prices one pays for being the low man on the totem pole
in a committee is that many of the things you might say are somewhat repetitive of what your colleagues have already said.
May I first ask leave, Mr. Chairman, at the appropriate time to
put some remarks in the record that I prepared for this occasion?
The CHAIRMAN, Certainly.
[Statement follows as though read:]
STATEMENT BY SENATOR DIXON
Senator DIXON. Last Friday afternoon the administration's fiscal
year 1983 budget was delivered to the Congress. The new budget
embodies the President's proposals for restructuring the Federal
Government and reordering our priorities, and lays the groundwork for his "New Federalism" proposal.
On Monday, the stock market reacted to the budget proposal—it
dropped over 17 Vs points. I want to highlight the market's reaction
to make it clear that it is not just the poor, not just the minorities
in this country, not just small business, not just homebuilders, not
just labor, not just the auto industry, not just Democrats, who have
concerns about the administration's fiscal year 1983 budget—Wall
Street also appears to have serious concerns!
I share their concerns. Like the financial community, I am extremely concerned about the size of the projected fiscal year 1983
deficit—$91.5 billion—and by the absence of any indication as to
when the budget will be balanced. Like many other Illinoisans, I
am disturbed by the scope, the extent, and the complexion of the
budget cuts in social programs while military spending increases
by almost 20 percent.
As we all know, the economy is in serious trouble. Unemployment is currently 8.5 percent and will, unfortunately, probably go
higher. Inflation is declining, but the prime rate recently rose to
16 "/2 percent suggesting that interest rates are starting to climb
again.
The administration, it seems to me, has not yet reconciled the inherent conflicts that underlie its policies, and the budget itself provides clear evidence of the impossibility of simultaneously financing large increases in military spending, balancing the budget, and
cutting taxes by huge amounts. Tight monetary policy, when combined with large Federal deficits, has proven to be a recipe for continued high interest rates and economic stagnation.
I do not mean to be critical of the Federal Reserve Board for
holding to a tight money policy. I tend to agree that restraint in
the rate of growth of the money supply was and is necessary to
bring down the inflation rate. I do not agree with those, including
some officials in the executive branch, who put prime responsibility
on the Board for the too-high interest rates that are causing such
damage to our economy.
It is time to stop casting around for villains, and to begin working together to solve the problems facing our economy. Last year,
the Congress gave the President the program he wanted. However,
it is becoming increasingly clear that policies put into place last
year need to be adjusted, need to be modified, in order to reduce
unemployment and bring down the high interest rates that are
paralyzing the auto and housing industries.
Our budget priorities need to be reconsidered. We need to bring
the budget into balance as soon as practicably possible. I have supported substantial budget cuts in the past, and I will support reasonable and appropriate cuts in the future. Budget cuts, however,
are only a partial answer to the deficit problem we are facing. We
must also look at the revenue side of the budget.
Starving the Federal Government of the revenues necessary to
fund legitimate and appropriate government activities will not
solve our economic problems. Supply-side economics, using the
administration's own figures, does not appear to be generating
enough economic growth to permit us to balance the budget using
the present tax base. Tax cuts enacted last year for business, in
particular, may be larger than appropriate. As recently as 1975, 16
cents out of every revenue dollar came from corporate taxes. In
1982, however, the estimate is that only 9 cents will come from corporate taxes. Elimination of undesirable and inappropriate tax provisions, therefore, such as the safeharbor leasing provisions, must
be a high priority. Other tax breaks enacted during last year's bidding contest should also get careful review.
The third year of the individual across-the-board tax cut may
need to be deferred in order to help close intolerably high Federal
deficits.
Further we need to carefully review the proposed budget cuts to
insure that essential Government activities are continued. I am
very concerned about the impact, to take just a few examples, that
the cuts in housing, education, and transportation will have on my
State.
The proposed housing program cuts could make it difficult for
most Americans to obtain financing for their homes, while making
it virtually impossible for many poor Americans to obtain adequate
housing.
Education cuts could result in forcing many of our college students to leave school, a shortsighted approach which could hurt our
ability to compete in a fast-paced, high-technology world.
Transportation cuts increase the difficulties facing States and
local communities in maintaining essential highway and public
transportation systems, systems which are wearing out much more
rapidly than they are being maintained.
It is difficult to see how the budget is to be brought into balance
by cutting social and infrastructure programs that account for less
10
than 35 percent of the budget while simultaneously increasing the
defense budget by almost 20 percent. I strongly support a strong
national defense posture, and I agree that increases in defense
spending are necessary. It sometimes seems to be forgotten,
though, that our national security does not solely depend on our
military budget. Our security is also related to the strength of our
economy. Without a strong economy, we can never be secure.
Our first priority, therefore, must be restoring our economy to its
former healthy state. We need to put Americans back to work. We
need to improve our productivity, which has stagnated in recent
years.
Continued high interest rates caused in no small part by unending Federal deficits make achievement of these objectives difficult,
if not impossible. Fiscal and monetary policy must work in concert.
I hope we can work together toward a program that brings fiscal
policy into harmony with monetary policy—a program that will
enable us to make progress toward a balanced budget, while insuring that essential Federal programs are continued.
I would like to make, if I could, Mr. Chairman, three points that
I think are worth making, even if parts of them are repetitious.
The first would be that I'm growingly concerned—and I think I
sense that in the Congress and in this committee—about what
might be a perception in some places that the policies that we have
are only affecting those who are operating perhaps ill-managed
concerns, those who are in marginal situations.
I would like to report, as all of us do, about my experience back
home in my State of Illinois, where clearly I think it's evident that
the policies are affecting well-managed, good business concerns.
First of all, I find that the farmers are in desperate situations in
Illinois, as has been indicated by others here. Just the other day a
friend of mine who's a hog farmer told me he's losing $20 a head
on his hogs, and that a neighboring farm sold for one-half the
value of another farm near at hand over a period of less than 18
months. In talking to a friend of mine who's a very affluent man in
housing, who incidentally heard you recently, Mr. Chairman—I
think you must have spoken in Nevada to their group—this man is
wealthy enough to live in the country club section of town and
drive an expensive automobile and send his children to the finest
colleges. He's now laid off his firm, including his superintendent
and all of his employees.
A friend of mine in the Chevrolet business told me he can't make
it any more. A group of thrifts from my State came in and told me
that July is the deadline, that 85 percent of the thrifts in my State
are in desperate circumstances.
That's the first point I wanted to make about this situation we
have now.
I think the second is this, and I would wonder if at some appropriate time in the period today you might address this. I think
clearly some things need to be done on the revenue side as well. It
seems clear to me that there are not the possibilities available in
this budget for cuts that can approach the kind of a benign—if
there is such a thing as a benign—budget deficit situation that will
encourage the money markets. I think we have to look at the third
year of the tax cut. I think we have to look at the lease provisions
11
of the bill. I think all of those things are necessary to work towards
a balanced budget in the next several years, and then finally, I'd
like to share with my colleague, Senator Lugar of Indiana, that the
last time I was home I met with three economists in my Chicago
office of different political and philosophical persuasions. The one
thing that they were unanimous about was that they felt the Fed
has to look at the interest side as well as the supply side, as has
been done in years past. I don't know what formula would be a
proper one. Senator Lugar has suggested 1 of 3 percent over the
inflation rate, but certainly something that would bring us back
into a sense of understanding of what's occurring because we have
these interest rates going back up again now, this feeling of desperation among the folks back home in the business community,
and apparently now, at least at this stage, no hope for the immediate future. I think we have to give them at least some hope about
what's going to occur shortly or we're going to have, as Senator
Riegle, my friend from Michigan, has suggested, some very desperate things occurring in this country shortly.
Thank you, Mr. Chairman.
The CHAIRMAN. Thank you.
Mr. Chairman.
STATEMENT OF PAUL A. VOLCKER, CHAIRMAN, BOARD OF
GOVERNORS OF THE FEDERAL RESERVE SYSTEM
Mr. VOLCKER. Mr. Chairman, I think my prepared statement
which I gave yesterday before the House reviews in general terms
some of the concerns that have been addressed by members of the
committee. I won't repeat it here, but let me summarize some of
the points in the statement; I actually commend it to you.
[Complete statement of Mr. Volcker and the report from the Federal Reserve are printed at the conclusion of this day's proceedings.]
Mr, VOLCKER. As far as the specifics of monetary policy that occasion these hearings are concerned, the Open Market Committee
did adopt the targets that they tentatively adopted last July and
reported to you at that time; that is, 2,5 to 5.5 percent for Ml, 6 to
9 percent for M2, and 6.5 to 9.5 percent for M3.
I think that appropriately reflects the continuing thrust of our
policy. We won't resolve all the semantic difficulties that are reflected in the varying newspaper stories I'm sure, but I think those
targets are meant to convey the message that the basic thrust of
our policy is the same, and we have to continue to restrict the
growth of money and credit.
As you know, we came out a bit on the low side on Ml last year.
We told you in July we wanted to be near the low point. We were
about 1.25 percentage points below the low point of that target.
The performance
of that target ran low partly, in our judgment, because of technical reasons; the rise in the use of money market
funds, in particular, depressed the demand for Ml.
Looking ahead, and knowing that that target is based upon the
actual fourth quarter figure for 1981 as has been the convention, I
indicated that at this time we felt an outcome in the upper half of
the range would be acceptable, and I also indicated that the bulge
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that we had in January could well and appropriately mean at this
point that we will run somewhat above the growth track for a
while. For M2, I think the targets are consistent with some reduction in M2 growth from what we had last year. Both of those numbers, particularly Mi, have to be evaluated in terms of what we,
perhaps not informatively, call technological change in the markets that cause shifts in the use of various kinds of accounts; that
needs constant surveillance to make sure the targets mean what
we want them to mean in terms of reductions over time in the
money supply.
We do believe those targets are consistent with progress on inflation, and we believe that they are consistent with some economic
recovery later this year.
In assessing the extremely difficult current situation that we are
in—that all of you have referred to in one way or another—we are
aware of the problems. I want to emphasize that they are part of a
larger problem. I don't think we have just another recession in a
series of recessions. The situation has some of those characteristics
of an ordinary recession, but it also seems to me to represent the
culmination of increasingly unsatisfactory economic performance
over a series of years—whether you look at inflation, which is in
considerable part responsible, in our judgment, or whether you
look at lower productivity, or whether you look at the fact that unemployment has been trending higher for a decade apart from recession. If you look through the cyclical developments, we have an
economy that is performing less satisfactorily over time.
We are not going to build a permanent or lasting improvement
in the inflation rate on an economy in recession. The object has to
be built in some forces in the economy that can be consistent with
recovery and declining inflation at the same time; we think those
are two sides of the same coin. If, indeed, we are not successful in
doing that, the prospects—whatever they are for the near term—
would be a prolongation and maybe an acceleration of the trend of
unsatisfactory economic performance over a period of time.
Reducing inflation is really the object of the policy, and it's not
and can't be a matter of monetary policy alone. If you rely on monetary policy alone to achieve it, there's going to be much more
trouble and difficulty than would otherwise be the case.
We have seen some considerable improvement on inflation in the
past year, and I could cite you a lot of price indices that reflect
that. You're familiar with those indices. The point I would make is
that we realize some of that improvement could be of a temporary
character if we just abandon the policy direction now—temporary
in the sense that some of it reflects cyclically weak markets, and
some of it reflects the impact of high interest rates on inventories,
and other matters.
The most heartening thing is that I think we see signs of improvement of a more permanent character. We are just beginning
to see those, but I think we are seeing them. You see some of the
evidence as well I'm sure: The basic cost-wage-productivity nexus is
being attacked by business; there are signs of improvement particularly in the manufacturing area. The signs are less clear elsewhere,
but this process seems to us to be beginning and the general progress on inflation is important, even though it may have temporary
13
elements, because it provides a platform for more permanent improvement to ensue. The vision that I would like to offer to you is
an economy that, as it recovers, shows improvement in productivity; that improvement in productivity, for the first time in a
number of years, will permit real earnings and real profits to increase, consistent with lower nominal wages and restraint on costs;
it will help keep the disinflationary process going; it will contribute
to a reduction in these extraordinary levels of interest rates that
we see, which will, in itself, promote the investment process. As
the investment process is promoted, the productivity side of the
equation will be improved and help keep the process going.
Against the performance of the last decade that may seem like
quite a vision to you, but I would point out that we saw something
like that in the early 1960's. Indeed, I think we began to see something like that in the mid-1970's when we came out of that recession. We went 18 months or 2 years into that recovery with declining prices; we went into that recovery at sustained lower interest
rates for quite a while. Then we got off track and fell back into the
morass of inflation and poor performance that had begun building
up in the mid-1960's.
When one looks toward that kind of future, one obviously has to
think about the ingredients that make it possible. We think the
continuing restraint on monetary and credit growth is a necessary
part of the disinflationary process. You have heard me speak to
that point many, many times, and I won't elaborate further right
now.
I think there are some other problems and needs out there as
well. I refer to the fact that we are beginning to see progress on
the productivity-wage-cost side, I realize that productivity is not
improving in the midst of a recession, but I think we see things
going on in industry that augur increases in productivity as the
economy recovers, and, of course, last year's tax bill was aimed in
that direction as well. It's terribly important that that process proceed as fast as it can, because that will help the financial markets;
it will help the inflation and give us more room for recovery.
The other major question mark—and in this case hazard—that I
would emphasize, is the budgetary situation. So far as I know, we
are in a budgetary situation that has no parallel—in my memory
anyway—in history. I say that in this sense: Whether one looks at
the administration figures for the current services deficit with adequate defense—in other words, unchanged nondefense programs
and an unchanged tax position—or at the figures produced by the
CBO or by a number of outside analysts, we have a situation where
if one makes the assumption of a healthy, continuing recovery,
with the impact that that has on revenues, you have a widening
deficit year after year beginning at a high level.
The deficit this year in the neighborhood of $100 billion is in
very considerable part a symptom of the recession. I don't focus my
attention on that particular deficit because it is very much recession-influenced. Indeed, in the midst of a recession, when you
expect some slackening of credit demands, when the economy
needs support, the deficit is not inappropriate—even a relatively
large deficit.
14
What does greatly concern me is that the deficit doesn't decline
as the recovery proceeds and as you get the impact of revenues
from a recovery. It increases. The administration has projected on
that basis a deficit close to $150 billion, and the CBO has projected
a deficit of over $150 billion. The administration projects a deficit
of $165 billion in the following year and $168 billion in the following. The CBO figures, I think, run higher than that.
If you put those figures in any kind of a context—deflate them or
relate them to GNP—they are historically very high. They are extremely high for a period of recovery and imply a kind of draft or
preemption of our sayings ability that simply doesn't leave much
room for the revival in homebuilding or the revival in investment
that we want to see. Nobody can separate out the weight of all the
influences, but certainly a very considerable weight lies on the financial markets at present. When one invests in a financial
market, one always is looking to the future. The weight lies very
heavy on the financial market of that potential future competition
for money out there in the years lying ahead.
It does seem to me essential that as we work, and work urgently,
not simply toward recovery in 1982 but, more importantly, toward
sustaining that recovery year after year, that we have to deal with
that very large and looming financial problem reflected in the figures that I just summarized.
The President has made proposals in that direction. One can
argue about whether those proposals in themselves are large
enough. I would certainly urge an even larger program in that direction. Just what is necessary depends upon assumptions about
the savings rate and other factors, but what stands out—apart
from any debate about precisely how big the program needs to be
in 1983-85 and the years beyond—is the very large nature of the
numbers, however one puts them together. The administration has
proposed some very sizable cuts. The only question there can legitimately be is whether they are big enough. I leave that with you as
a major point of hazard for the financial markets today, for the financial markets in the future, for our ability to finance the growth
and investment that we need, and as part of the outlook for monetary policy and, more importantly, for the economy as a whole for
a recovery that is combined with productivity and disinflation.
With that, we can turn to your more specific or general questions
if you wish, Mr. Chairman.
The CHAIRMAN. Thank you, Mr. Chairman.
First of all, before we talk about monetary policy, I would like to
pursue the fiscal policy more in specific terms than I talked about
in my opening remarks. Again, it's very easy to find someone to
blame and as far as short-term interest rates, I do believe that you
can have considerable effect on short-term interest rates. On longterm interest rates, I don't think it makes much difference what
you do as Chairman of the Fed or what the Federal Reserve Board
does, regardless of what some of my colleagues may want to indicate that you can run down and talk to the President and all
you've got to do is talk about it and decide on where you're going
to put the interest rates and monetary policy and make it all come
out. That's a shortsighted and naive thinking about how the economy works as I've ever heard.
15
It may be good in a political election year, in 1982, to say we've
got a Republican Senate and Republican President, and that's true
for a year, and don't look back at the fact that we had a Democratic Congress for 26 years. I don't think it makes any difference one
way or another. This country is in a big enough problem that I'm
to the point I don't care who's Republican or who's Democrat or
who's in power. I want to know if my kids are going to be able to
buy a house in the future. I've six and three-fourths of them and I
don't know whether they can answer that question or not.
But the point of the short-term versus long-term interest
rates
Senator SCHMITT. Don't blame the Fed for that.
ENTITLEMENT PROGRAMS
The CHAIRMAN. I'm not blaming anybody but myself. But the
point that Congress, both Republicans and Democrats, and this administration will not face up to or have the political courage to
face is where the real fiscal problem is, and that's in the entitlements programs. I want to see if you agree with this.
Forget this year's budget deficit and forget next year's budget
deficit. The money market managers that I talk to, what they are
looking at is not the short years; 1984 is not an outyear to them.
They are looking at 1988 and 1989 and 1990 and 1991 and 1992,
and all they see is the Federal budget that is expanding automatically, outside the control of Congress, and they are not dumb
enough to say we are going to loan money on a 20-, 25-, or 30-year
basis with that kind of a projection. So we cut $50 billion out of the
1981 and the 1982 budget and $14 billion rescissions in 1981. That
didn't impress the money markets, not the long-term money markets, because, again, that has no impact whatsoever on the outyears because essentially, in very round numbers, about 70 percent
of the budget is uncontrollable. That simply means in the Appropriations Committee we can't control that, like food stamps. We
can't cut back the money unless the eligibility requirements are
changed by an authorizing committee. So essentially where we
have taken most of that money is out of discretionary programs,
essentially one-time savings per year.
The uncontrollable part of the budget is growing at about 16 percent per year compounded. As an example, in my HUD Subcommittee, I could eliminate NASA, just wipe them out, say we are not
going to have a space program any more and save $6 billion a year.
I don't mean to minimize the $6 billion. That's a lot of money. But
that's all it would save. You can delay a cost of living—to show you
the magnitude of the numbers—the cost of living increase, social
security, for 3 months—not cut it, not reduce it, just delay it for 3
months, and save almost as much as you would save by eliminating
NASA completely. So that part of the budget has been virtually
untouched.
The Reagan administration is afraid to touch it. Congress is
afraid to touch it. And unless we are willing—not to cut—I don't
want to have anybody say I'm advocating cutting social security,
please understand that—I don't want all the mail I would get from
that kind of report going out
16
Senator SCHMITT, It's too late.
The CHAIRMAN. But if we're not willing to look at federal pensions, military pensions, social security and slow the growth, not
cut anybody—slow the growth, we will not solve that problem. You
could take every proposal that exists—cut the military $30 billion,
take off the third year of the tax cut, delay the 10 percent next
July to January—every proposal you've heard of, and I submit to
you that budget would never be balanced if all those proposals
were put in. You would not reach a balanced budget. It's impossible if that continues to expand 70 percent of the budget at 16 percent per year. The end will never meet—now are you in accord
generally with that—unless Congress and this administration is
willing to start telling the American people the truth that all these
others are not going to solve the problem unless we slow that tremendous growth in the automatically indexed programs?
Mr. VOLCKER. I think you have obviously put your finger on a
major part of the budgetary problem. Some of that 16 percent
growth that you referred to is a reflection of inflation, and I hope
we correct that over a period of time. But there are some basic demographic factors at work that push those programs higher over a
period of time, even if benefits are not changed.
The CHAIRMAN. As you noted, Mr. Chairman, I said "slow the
growth." I understand what you're saying. There is going to be
growth. It is the rate of growth that has to be slowed to show those
money market managers in the out-years that that curve is going
to level off and start down. I don't believe you're going to have any
permanent change in long-term interest rates until that is done, regardless of all the short-term palliatives we try to take for an election year.
Mr. VOLCKER. I'm not sure our problem is quite as impossible as
your statement may imply. I think you obviously have pointed to a
very major problem. It goes, in part, to the basic financing of those
programs, how they're financed, and the relationship is between
revenues and the rising benefit levels for demographic and other
reasons. Those have to be studied; they are being studied and I
hope some constructive proposals will come out in terms of the
very problem that you cite.
I would not be so optimistic, if that's the right word, as to feel
that the Congress in the next few months can fully deal with the
problem that exists 5, 10, or 15 years from now. But I would be
more hopeful perhaps than your statement suggests.
The CHAIRMAN. Mr. Chairman, let me interrupt you there because if I haven't learned anything else on this Committee after 7
years it's how important psychology is in the marketplace. Don't
misunderstand me that I'm saying if we start to slow down the increase in those entitlements we're talking about a problem 10 or 15
years down the road. No, I'm not at all. I'm saying if those signals
are sent to the marketplace that that is going to be coming down 5,
10, and 15 years from now, you're going to see an immediate
impact on long-term interest rates now, not 10 or 15 years from
now.
17
NEAR-TERM PROBLEM
Mr. VOLCKER. I think you're anticipating the point that I was
about to make. I think what you can do in the near-term perspective, whether in entitlements or elsewhere—and entitlements are a
part of the problem—is to attack the near-term problem. By near
term, I'm certainly not talking about 1982; I'm talking about 1983
and 1984, which are immediately in the market sight. What you do
for 1983 and 1984 is going to have immediate spillovers into the immediately following years. By attacking that problem sufficiently
boldly, I think you give the kind of market signal that you suggest,
and an implication, at the very least of a followthrough for that
longer term period. If you're not concerned about 1983-84, it's a
little hard to be convincing to the market that you're going to be
concerned about 1987, 1988, 1989, or 1990. Of course, there are,
apart from the psychological effects, which are very important, the
more immediate—over a 2- or 3-year time horizon—market effects,
that is, the direct impact of that kind of financing on the market.
I think the best signal you can give, keeping very much in mind
the longer term perspective that you have usefully given, is a bold
attack on the immediate 1983-84 problem.
The CHAIRMAN. Mr. Chairman, before my time is up, let me turn
to monetary policy and some of the things I mentioned about contemporaneous accounting.
Writing in the February 15, 1982, issue of Newsweek magazine,
Milton Friedman points out the Fed's October 1979 announcement
that henceforth the focus of monetary policy would be on controlling the aggregate growth rates as follows: Not by steadier growth
in the aggregates but by unprecedented volatility, how do you explain this unprecedented volatility and would you please restate
your position on Friedman's thought in the same article, the replacement of lag reserve accounting by contemporaneous reserve
accounting, which I've encouraged you to do for sometime—I agree
with Mr. Friedman on that—selection of a single monetary target
to replace the Fed's juggling between targets equalization, reserve
requirements on all the deposit components of a selected target,
and linking the discount rate to the market rate?
Mr. VOLCKER. You have made quite a few points which I'll try to
remember and take up.
The CHAIRMAN. Do you want the issue of Newsweek to reply to?
Mr. VOLCKER. Not really. As far as the volatility issue is concerned, we can talk at some length about that. I think it might be
useful if I submitted for the record, just so you could have it in perspective, the record of volatility in the American money supply as
compared to the volatility in other countries. (See pp. 20-21.)
The CHAIRMAN. Because of limits of time, I would appreciate it if
you could give me a more detailed written accounting of this whole
area Mr. Friedman discussed.
Mr. VOLCKER. I would be glad to. (See pp. 114-119.) I would just
summarize that evidence by saying that in terms of these international
comparisons with countries which I suppose you would think have very
good monetary policies—maybe some countries you think have less
good monetary policies—in the international league, the American
fluctuations stand out as extraordinarily stable. I find the only
18
country that seemed in the last couple of years to have a more persistently stable money supply is Italy, which has had some rapid
expansion but where money supply seems to proceed month after
month fairly steadily.
I constantly get comments from my foreign central banking colleagues that we pay too much attention to stability in the short
run. What counts is the trend over time. I think what counts is the
trend over time, too, and I don't know of any economic analysis
that suggests that the short-term ups and downs have any real
effect on the trend of economic activity or the trend on inflation.
We could, theoretically, for purposes of discussion, adopt some
techniques to try to enforce greater rigidity in the movements from
month to month. Is that a good idea or a bad idea? I think you
have a trade-off between short-term instability in interest rates—
and you have plenty of that as things stand—and short-term rigidity of the money supply.
The American money supply is a quantity of about $450 billion
or so. An enormous number of every day transactions are reflected
in that and run through that money supply, and at the end of the
day you run some cash balances which are collectively reported to
us; we have about half a trillion transactions a day. How much do
you want to enforce constancy on the cash balances that emerge at
the end of every day given the natural fluctuations and the cash
management practices—the desire to hold cash and all the rest?
I would say you want to leave a little breathing room there. You
don't want to enforce absolutely stability—I'm speaking in extreme
terms now; the practical problem is one of degree—on a particular
quantity that's buffeted and affected by technical changes, by passing desires to hold more or less cash, by the number or volume of
transactions going through the market, by motivations that may be
short term in character. You arrive at some judgment as to where
the appropriate compromise is, where you can bend without giving
in terms of the trend, which I think is preferable and certainly reflected in the figures, and that seems to me the appropriate position to be in. I don't think we could enforce perfect stability under
any circumstances.
CONTEMPORARY RESERVE ACCOUNTING
You raised the question of contemporary reserve accounting.
That's something we have studied for a long period of time. We put
out a proposal a few months ago that, in my judgment—I have not
yet seen all the comments; we are about at the end of the comment
period—seem more promising as a technical, operational matter
than some of the earlier proposals. It has some advantages as an
operational matter, given the way we now operate. If we adopted
Senator Lugar's interest rate approach, it would be irrelevant in
that kind of an operating technique.
But given the way we now do operate, there may be some technical advantages. There are some operational difficulties imposed
both for us and the banks. My major concern is in the way that
this issue is blown up out of all perspective. It is not going to make
any significant difference, in my judgment, in terms of economic or
market performance over any relevant period of time. There is,
19
perhaps, some danger of simply overestimating some magical result
of a change in technical operating procedures, and I wouldn't want
to create the impression that it's more important than it, in fact,
is, although it may have some technical advantages in the context
of our current method of operating.
So far as the single monetary target is concerned, there's no
question in my mind that would be a mistake. You're then at the
mercy of every particular influence that may influence one aggregate in a way that does not have economic significance, and that
would lead you on a course contrary to the underlying course you
wanted to take.
Last year provides as good an example as any. We had relative
weakness in Ml compared to some of the other aggregates. We had
relative strength in M2 relative to Ml, to put it the other way
around. You're left with some judgment as to what's causing that
divergence which is a little greater than we expected. What is the
economic significance of that?
We had, in the first place, to make some adjustment last year for
the introduction of NOW accounts. That's a dramatic kind of example. We had a big change in various measures of Ml earlier in the
year simply because a lot of money was shifting into NOW accounts from accounts outside of Ml. And if we had focused on one
particular target and misjudged that shift or ignored that shift, we
might end up with a substantive result at wide variance with what
we really wanted to achieve.
Throughout the year we had explosive growth in money market
funds, which have some of the characteristics of transactions balances. Economically speaking, you would put those funds in Ml,
but we can't put them in Ml because there's no statistic that
jumps out from a money market fund and raises its hand and says,
"I'm a money market fund account that's a transaction balance,"
or "I'm a money market fund balance just like a savings account
and I don't belong in Ml." We get the statistic in one undifferentiated mass. But, in analyzing them, it is clear that some fraction—
some fairly small fraction of those accounts—is used as transaction
balances and we should appropriately make some allowance for
that in evaluating what's happening in Ml.
At the same time, that money market fund phenomenon is
counted in M2. We drew money into M2 that otherwise might have
been in Treasury bills or elsewhere, but not in M2. We'd better
keep that in mind also in evaluating these trends.
I think there is the danger of getting a misleading signal by adhering to just one target without evaluation of anything else going
on in financial markets; it would be a mistake, and we are not prepared to adopt that approach. Indeed, a great many analysts—you
mentioned only one—would then say which one target? You referred to Milton Friedman; unless he's changed his mind, he's often
emphasized in the past, and as recently as last spring, that we
should forget about Ml and look at M2. What do you do when you
get different signals from Ml and M2? You referred in your opening statement to this question of reporting the money figures
weekly; we have had a number of conversations on that point, as
you indicate.
20
The CHAIRMAN. Mr. Chairman, if I could cut you off, I finished
my question at the end of my 10-minute time, but your answer is
lasting considerably beyond that. I do need to turn to my other colleagues, so I'd like your answer to that when it gets back to me.
Mr. VOLCKER. I can only say that you had quite a few questions.
The CHAIRMAN. I understand. I'm not blaming you. I'm just
trying to give my colleagues an opportunity and I will be back to
you and let you finish the answer to my questions.
[The following letter was ordered inserted in the record at this
point:]
BOARD OF GOVERNORS,
FEDERAL RESERVE SYSTEM,
Washington, D.C., February IS, 1982.
Hon. JAKE GARN,
Chairman, Committee on Banking, Housing and Urban Affairs,
U.S. Senate, Washington, B.C.
DEAR CHAIRMAN GARN: In my recent appearance before the Senate Banking Committee, 1 agreed to provide for the record information on the fluctuation in growth
rates of money in the United States compared with other industrial countries,
which I am pleased to enclose. The data can be presented and analyzed from a
number of perspectives. Even allowing for the technical difficulties involved in
making such international comparisons, they all appear to demonstrate the same
point: U.S. monetary aggregates rank at or near the top of the league in terms of
low variability.
The enclosed two tables illustrate this point. The first table presents the lowest
and highest monthly growth rates for Ml in 1980 and 1981. It also shows the range
covered by those rates. The second table presents the same information for the same
years using quarterly observations. In both tables the growth rates are presented at
annual rates, as is unfortunately customary in the United States. This presentation,
of course, tends to exaggerate differences.
The monthly results show that U.S. Ml-B (shift adjusted) showed a narrower
range of fluctuation in 1980 and 1981 than did the most nearly comparable aggregate in any other country except Italy. In the quarterly results, which in general
exhibit much lower variability, only France and Germany had a range in 1981 approximating that in the United States. In 198D, France and Italy had a much narrower range of quarterly fluctuation in Ml growth, while the range in most of the
other countries, with the significant exception of Switzerland, was close to that in
the United States.
In interpreting these results, it is important to remember that complete stability
in the growth of monetary aggregates is not an objective of monetary policy in the
United States or in any of these major foreign countries. On the other hand, slower
medium-term growth in the monetary aggregates (and monetary authorities abroad
are increasingly looking at more than one aggregate even though they continue to
target on at most one) is widely recognized as a necessary condition for a sustained
reduction in inflation. In this connection, one might note that Italy, the one country
that does "better" than the United States in three out of the four comparisons presented in the enclosed tables, has had one of the highest rates of growth of Ml
(measured, for example, over 12 months or four quarters) and one of the highest
rates of inflation in recent years.
I hope that these comparisons help the Committee to appreciate the difficulty of
short-term aggregate control and the absence of an obvious link between our current economic problems and the short-term variability of our monetary aggregatesSin cerely,
PAUL A. VOLCKER, Chairman.
Enclosures.
21
TABLE 1,-MONTHLY CHANGES IN NARROW MONEY IN SELECTED INDUSTRIAL COUNTRIES, 1980-*
(Percentage change from p'evious month annual rates]
TABLE 2.-QUARTERLY CHANGES IN NARROW MONEY IN SELECTED INDUSTRIAL COUNTRIES,
1980-81
1961
Canada
France..
The CHAIRMAN. Senator Proxmire.
Senator PROXMIRE. Mr. Chairman, one of the most astonishing
parts of the economic dilemma we are in at the present time is the
fact that we are in a very serious recession, real GNP fell, as you
know, at a rate of 5.2 percent the last quarter of 1981, it appears to
be falling at an annual rate of about 5 percent in this quarter; it's
continuing; corporate profits were down 21.8 percent, a very sharp
drop. We are operating at 73 percent of capacity overall. The homebuilding industry is operating at less than 50 percent capacity. The
automobile industry is at less than 50 percent capacity. And unemployment, of course, at 8.5 percent is very, very high.
With all that, interest rates are rising. They have been going up
for the last 3 months, since early December.
Now supposing this continues. Suppose interest rates rise this
year and next year while GNP continues to sink and corporate
profits continue to drop. We continue to have excess capacity at a
very high level, unemployment rates high. What reaction will the
Fed have, if any? What will you do?
Mr. VOLCKER. Of course, we do not expect that to happen.
Senator PROXMIRE. Of course not, but it may happen.
22
Mr. VOLCKER. We think our targets are consistent with some recovery, so you're citing a contingency and outlook that we don't
think is a reasonable analysis of what is likely to happen.
If that happened, consistent with our monetary targets, we would
look around and say, "Why is that happening?" You referred to
this interest rate problem, in the short-term sense of an increase
during a recession——
Senator PEOXMIEE. It's very rare, isn't it? We have rarely had interest rates right in a recession.
Mr. VOLCKER. I think it's rare to have a combination of a rising
money supply and rising interest rates with production and income
falling for any period of time. I think that's quite right; that is a
rare phenomenon. And among the influences in that area and one
of the influences in the market situation, I just want to point out,
is that budgetary situation. You didn't indicate just how that was
being resolved in your scenario, but I just want to point out that
that is an influence that is obviously beyond our competence and
control, and it's an important influence and one would have to look
at that.
Senator PROXMIRE. That's the most predictable part of it at least.
It's not perfectly predictable, but we know deficits are going to continue at a very high level, no question about it, maybe $100 billion.
REAPPRAISAL OF TARGETS
Mr. VOLCKER. In those circumstances interest rates would continue at extraordinarily high levels, because you get an addition to
these already very large deficits. The only general answer I think I
can give you, if you portray that kind of scenario, is that obviously,
among other things, we would have to go back and see whether
something fundamental isn't going on that suggests that the kind
of calculations that one bases the money supply target on are
wrong, that there's some fundamental change in behavior that
would require reappraisal of these targets. I think it's quite clear
we would do that if for some reason they seemed fundamentally
off. I don't expect that to happen.
Senator PROXMIRE. Under those circumstances you would reconsider your targets and possibly change them. Is that right?
Mr. VOLCKER. If you had a situation, let's say, where inflation
was declining and the economy was declining too, and the inflation
thing was showing a lot of progress, but for some reason—I don't
think this is going to happen—individuals or corporations wanted
to keep much higher cash balances relative to economic activity
than has been the record over a long period of time, obviously you
would have to question the targets.
Senator PROXMIRE. Well, now, let's take the more likely situation—or we hope it's more likely. Supposing real GNP picks up,
corporate profits increase, homebuilding and autos revive to some
extent. What is there to make us think we won't have exactly the
same problem we had in 1980 and 1981 with high interest rates
rising more rapidly and choking off that recovery before it's becoming healthy and before it gets to a sustainable period?
Mr. VOLCKER. I think I'd make two or three points. You're starting this from an extraordinarily high level of interest rates relative
23
to what I think is a reasonable outlook for inflation. The market is
reflecting a lot of short-term uncertainty, a lot of instability in the
short run, a lot of skepticism about the inflation outlook. All of
those things, as they get resolved—and resolved in a favorable direction—will help belie those pessimistic outlooks for interest rates.
We also have the major problem of the budgetary deficit looming
out there. If that problem is not dealt with, then the risks of precisely the scenario that you're talking about seem to be very high.
Those risks are essentially in your hands. If we can begin to get
that budgetary risk out of the way, then I think it is quite possible
to have a recovery, a sustained recovery, in the context of declining
interest rates.
Senator PROXMIRE. Unless we do something about fiscal policy,
unless we have an effective way of reducing the deficits, then the
prospect of a sustainable recovery are not good?
Mr. VOLCKER. That is correct. I think, then, you would have to
count on such an extraordinary increase in savings it would clearly
not be prudent to contemplate.
Senator PROXMIRE. You talk about improvement of a permanent
character in productivity and particularly in manufacturing. I just
can't see that at all, for the life of me. I have the figures here and
the figures show in 1981 we had a steadily declining productivity.
In the second quarter it was 1.4, in the third quarter it was minus
1.6, in the fourth quarter it was minus 7.2, and in manufacturing
even worse. In manufacturing we had a decline of something like
11 percent in productivity at an annual rate in the fourth quarter.
Where do you see this permanent improvement? There are givebacks, sure, and maybe they are encouraging, but they are givebacks because of the savage effects of recession. People are desperate. In order to hold on to their job they are willing to give up pay
increases or even take pay cuts, but that certainly isn't going to
continue. That's not permanent. I think you would have to agree
that's not permanent. I would think as soon as we begin to recover
there would be a very strong sentiment to recover some of those
give-backs.
Mr. VOLCKER. I'm not so pessimistic, if we recover in the right
way. The productivity figures that you referred to are the dismal
record of the past. You can go back to the midseventies or before
and show declining rates of productivity that aren't affected by cyclical problems. You have to look at those data with rose-colored
glasses, I guess, to see a 1-percent trend as improvement in productivity during this period compared to what we used to think of as
the normal 2.5 to 3 percent. The latest figures that you cite are the
immediate reflection of the recession.
When you've got a sharp decline in production, that's what happens. What I'm looking toward is the upswing. You would see in
the early stages of an upswing presumably sharp increases in productivity that aren't lasting either; they are just the inverse of the
decline that you cited. But what I sense—and I can't prove this in
the numbers; you can only prove it after the fact—apart from the
examples that you can cite of wage give-backs and freezes and so
forth under extreme pressure, is something going on in this area
beyond what's reflected in the wage packages themselves.
Senator PROXMIRE. What? What's some hard evidence?
24
Mr. VOLCKER, You ask for hard evidence.
Senator PROXMIRE. What is the soft evidence then—the evidence?
WORK PRACTICES
Mr. VOLCKER. I can't give you evidence in numbers because it's
obviously not there amidst the recession, but I get a good number
of reports from businessmen and labor leaders about changes in
work practices, for instance, in a very specific way.
Senator PROXMIRE. Can you give us an example?
Mr. VOLCKER. I know a number of company executives will tell
me that they are quite satisfied in such things as the type of
worker that has to do a particular job and can't do another job,
that they've gotten considerable relaxation of that kind of a restriction, so there's much more flexibility in using their labor force.
Senator PROXMIRE. Isn't that exactly the kind of response you
tend to get in a recession when workers are desperate, when they
see the layoffs coming up and they are willing to share the work
and make sacrifices to keep their job and it won't continue?
Mr. VOLCKER. That's the question, whether it will continue.
Senator PROXMIRE. It never has before.
Mr. VOLCKER. I don't want to limit it to that labor negotiation
context. I think the businessman, under the same pressures that
you're talking about, is having to look at his own operations and
his own methods of production entirely apart from labor, and
there's much more concentration on efficiency and productivity
now, I suspect, in many industries, than there was a couple years
ago.
I can't give you statistical evidence for that, but the crucial question is precisely the one that you posed: Will that continue during
a period of recovery?
I don't think memories of this period are going to disappear right
away for one thing, but let me also point out that when we get increases in productivity, and when we see the fruits of some of the
things being done now, we will see a payoff; we should see a payoff.
I'm excluding another explosion in oil prices and a terrible crop
year and this kind of thing. You would expect to see a payoff from
that kind of measure in higher real incomes, in a lower inflation
rate relative to the rate of nominal wage increase. As people see
that, as they see their real incomes rising, really for the first time
in a good many years, I think you will have a climate where you
cannot see that kind of development disappear with the first
breath of recovery, but where it will continue; I think you can
point to episodes in the past where that is true.
If you can maintain a disciplined recovery, if there's a sense of
discipline in national financial policies, then I think there is that
prospect. If there's not that prospect, you're telling me that our
economic problem is insoluble.
Senator PROXMIRE. My time is up, Mr. Chairman.
Mr. VOLCKER. I don't think it is insoluble.
The CHAIRMAN. Senator Lugar.
Senator LUGAR. Chairman Volcker, try to think through with me
why any recovery ought to come at all. The thing that strikes me is
that maybe I'm taking a look at it in a very parochial sense of the
25
State of Indiana, but I think it has some of the characteristics that
are common to the whole problem in which the automobile industry has been in a recession for at least 2 years, unemployment has
been substantial, and there are predictions that maybe 100,000
people will never return to the industry, not all of them in Indiana,
but a good amount of permanent displacement. The agriculture implement industry, which is large in our State, is similarly afflicted
for different reasons, partly because farmers have had a decline in
income and are not buying additional machinery. There is weakness even in land prices. There are some estimates of maybe a
4-percent decrease across the board in land prices after a very
sharp escalation, and I think in your testimony you pointed out
that this is also true in the homebuilding area and in residences.
But it would appear that residential values are declining but this
decline is not showing up as yet, for various reasons, in the cost of
living indexes. In part they do, but not perhaps as substantially as
the real declines in value.
The steel industry is weak because of international competition,
the modernization problems, and less demand for steel, whether it
be automobiles, agricultural implements or a lot of other situations
and, in short, the government of the State of Indiana has a revenue
problem, as does the Federal Government, because individual incomes and corporate incomes are all declining precipitously.
But there is not in that picture any reason why that is going to
change. Now the thing that I look at with amazement are bland
predictions that the second quarter will be a warming trend and
the third quarter will be better still, and I don't see any evidence
at all as to why this might be so. As a matter of fact, I see a larger
deficit in Indiana and therefore, because we can't have a deficit,
really savage declines in services will occur.
In the Federal case where we can have a deficit larger—quite
apart from what we do in Congress—I think we are going to cut
spending, but I don't see any prospects for increased revenue, and
that means we may have even larger deficits just through declining
productivity.
It's for this reason that some persons have suggested, for example, as opposed to forgetting the individual tax cut in July, that we
ought to accelerate that. Some have suggested, as a matter of fact,
that if that is not a good idea, we ought to think at least of a substitute because the promised recovery appears to be linked in part
to new revenues coming from consumer activity after that tax cut
of July 1. I'm not certain that that will make a large difference in
my State. It may make a difference in the country as a whole, even
when the tax cut comes, given this decreased productivity.
This is why I proposed what I did earlier on in the sense that I
think that some type of responsible or more immediate stimulus is
required. I would not argue at all that in the long-term rates investors are taking a look at the future and what they want to risk. In
the short-term situation, it seems to me to be one in which either
we'll have a breakout through a very small window of opportunity
or we could sink into a good bit of despair that leads to all sorts of
options that are undesirable.
In other words, I would think after a while that what Senator
Proxmire discussed in his scenario might turn out to be true, that
26
interest rates might continually rise, that unemployment might
continually rise, that income might be falling, and that without a
new game plan or at least some semblance of that, there are no
breaks in sight.
Can you comment on that generally and why you see any potential for a turnaround and, if you don't, what you advise us to do?
POTENTIAL TURNAROUND
Mr. VOLCKER. I do see that potential, and let me offer you some
rays of hope, or more. We are partly in a normal—if that's the
right word—recession pattern. I don't think, as I said before, that
this situation is just a "normal recession," but it has some of those
characteristics. What you have seen recently are very sharp drops
in production. The automobile industry is a good example. They
have depressed levels of sales, but, in fact, production levels are
below sales levels. That's true in a number of industries, so you're
beginning to see declines in inventories.
You get a normal reaction to that if the assumption holds up
even reasonably well in a rebounding production which, in turn,
generates some income. You've got two industries that you cited in
particular, the automobile industry and housing, both of which
have problems of their own that are beyond interest rates, particularly the automobile industry, which has been in a depressed state
for a couple of years. You could well have a situation where you
had some recovery in automobile sales; the most recent figures
show some—they may not last—but you could have a recovery, if
recovery is the right word for inadequate levels of automobile sales
historically. You could go above the current level and well above
the production level, and that brings increases in production in a
normal recovery pattern. That's a dramatic example, but you could
see the same thing in other industries.
You asked whether consumption is going to be maintained. The
Government, as things stand, is running a very large deficit which
directly and indirectly supports income and consumption. You referred to the tax cut on the horizon which will amplify that in the
second half of the year and provide support for consumption and
reinforce the view that there can be and will be economic recovery;
that is our general expectation.
If you ask me whether there are any hazards in that prospect, of
course there are. The major hazards revolve around the conditions
and prospects in financial markets, and that is why I keep coming
back a lot to the same point: What you do with the budget has, perhaps as much as anything else, to do with that prospect in the financial markets. It is important not only during the period when
you will be actually affecting the budget, but it also feeds back directly into financial market conditions. The most dramatic thing
that can be done and the most effective thing that can be done in
terms of the financial uncertainties that exist is for you to give the
right signal as soon as you can about the budgetary problem.
Senator LUGAR. How much of a signal is required? In other
words, when you talk about doing the right thing, clearly now we
have as a target $91 billion of deficit the President has suggested.
27
What should the deficit be and what kind of a signal would be encouraging to people?
Mr. VOLCKER. I've said repeatedly I would feel much more comfortable with, and I really think you should aim for, a lower deficit
in 1983; and I think you really have to have your mind on 1984 as
well.
Senator LUGAR. How much lower, though?
Mr. VOLCKER. If anything, I think the basic budgetary situation
has deteriorated from what I thought it was 6 months ago. You
have a $100 billion plus problem for fiscal year 1984, and I would
think it is definitely important at this point to put the deficit so
firmly on a declining trend that you could reasonably look forward
to balancing it in a reasonably prosperous year. That's a large
amount of action, and I think that's a size and measure of the challenge. You put together that kind of program and I think it would
have an electrifying effect on financial markets.
Senator LUGAR. But you're talking now about a program without
specifying figures. You've left the $91 billion alone in 1983 and you
said something less than $100 billion in 1984.
Mr. VOLCKER. The President's program adds up to about $83 billion for 1984, so I'm saying I would recommend to you to go another $20 billion or more.
Senator LUGAR. But that you have to have a program that comes
out balanced at some point in the future?
Mr. VOLCKER. Yes. You won't balance it in 1984, but a program
assuming a steady, healthy recovery, that would be consistent with
restoring balance. Obviously, it would require some action thereafter. It would be consistent, in my judgment, with restoring a rough
balance, when the unemployment rate got down to 6 percent or a
little lower.
Senator LUGAR. In this particular year's term, your judgment is
that through inventory reductions in the classic way we move
through recessions, we are going to come to a point at some stage
in which we begin to turn around and that is the engine of bringing us out of it?
Mr. VOLCKER. It's not just the inventory reduction; it's that plus
the income support that the budget has already provided, plus the
additional income support that the budget will provide at midyear.
The key question is the extent to which the financial markets—you
emphasized that—clear up. Again, coming back to the kind of scenario that Senator Proxmire set forth and that you raised a question about, completely consistent with our monetary intentions,
you would expect that if the economy began to be anything like
that weak you would get a lot of easing in the money markets
simply because there would be much more money per dollar of
GNP. That easing in the money market would counteract the depressing effects, and your scenario would not build on itself unless
something very fundamental went on in the relationship between
money and the economy.
If something that fundamental went on, which I wouldn't expect,
obviously we would come back and look at our targets.
Senator LUGAR. My time is up, but I think that's very important—what you have said—that is, if that scenario does follow,
you're prepared to take a look at the targets and at change?
28
Mr. VOLCKER. I really don't expect the scenario of a fundamental
change in the relationship between money and the economy to develop.
Senator LUGAR. Thank you.
The CHAIRMAN. Gentlemen, before I call on the next Senator, I
would like to explain the policy again for members of the committee that I have adopted, which is to call on Senators on both sides
of the aisle on the basis of when they were here. So although Senator Cranston is senior, Senator Riegle has been here since the beginning and I would call on Senator Riegle unless you two want to
arm wrestle for the next position, and then Senator Dixon would
be next, having been here from the beginning as well on that side.
So that's my policy. If you gentlemen want to do it differently, fine.
Senator RIEGLE. I appreciate the chairman clarifying that. Let
me just ask another question because I would like to find a way to
accommodate my colleagues who have other committees and just
arrived and haven't had a chance yet to speak or ask questions.
The CHAIRMAN. You haven't had an opportunity to ask questions
yet either.
Senator RIEGLE. No, I have not questioned yet, although I was
able to make a statement.
The CHAIRMAN. You can do it any way you want to. I just prefer
to do it that way. Both you and Senator Dixon have been here
since the beginning and I want to accommodate you.
Senator RIEGLE. Let me say both to Senator Cranston—we have
10-minute slots. Let me say to both Senator Cranston and Senator
Sarbanes, if either one would like to make an initial comment on
my time, they are welcome to do so, while in terms of questioning I
would like to reserve what's left.
The CHAIRMAN. Just don't use all your 10 minutes deciding who's
going to go next.
Senator CRANSTON. I have to be somewhere at 12 and I'd like to
get one question in before I go. If you will take care of me in that
way, Mr. Chairman, I will patiently wait. I think it's much fairer
to go the way you want to go. I have a lot of questions, but there's
one question that I wanted to be sure to ask today.
As Senator Garn referred to election year pressures when the
Fed might be persuadable to ease the tight money momentarily,
there's been a lot of uncertainty as to the responsiveness of the
Federal Reserve Board historically and potentially now or in the
recent months to an administration that may want something different from what the Fed is doing.
How responsive is the Fed in election years or election months
and not in election months to the views of an administration when
those views are different from the views of what the Fed feels
should be done in monetary policy?
Mr. VOLCKER. I think you will find the unanimous feeling in the
Federal Reserve that the Congress deliberately set us up with an
insulation from that kind of political pressure, and that that is a
trust that you have given us and that we mean to discharge.
Senator CRANSTON. So, in effect, you're saying that in times of
election and in times when we're fairly far away from elections,
the Fed will exercise its own independent judgment on what it
29
should do in regard to the money supply and other policy decisions
that the Fed has responsibility or power to make?
Mr. VOLCKER. Yes, sir.
Senator CRANSTON. Thank you very much.
Senator RIEGLE. Mr. Chairman, let me quickly ask you some
questions and then I will defer to my colleague from Maryland.
This is a serious question and so I would like you to try to give
us a serious answer, as difficult as it may be. What, in your opinion, would have to happen in order for us to see interest rates to
come down 2 or 3 percentage points in the next 90 days or perhaps
even more than that, but at least that much?
BUDGET KEY TO REDUCTION OF INTEREST RATES
Mr. VOLCKER. Dealing with the budgetary problem.
Senator RIEGLE. Your answer is deal with the budgetary problem?
Mr. VOLCKER. Yes, sir.
Senator RIEGLE. How much would it have to be dealt with, in
your view, to get that kind of a response? I think the interest rates
have to come down at least 2 or 3 percentage points within the
next 90 days, and you're saying the budget is the key. We've got to
take the next step in terms of defining more precisely what kinds
of actions might be taken on the budget within the next 90 days
that would give that kind of response.
Would you see us having to have a new budget? If we passed the
budget we have here before us, will that get the job done in your
view?
Mr. VOLCKER. You're dealing in relationships that are not mechanical; they are a matter of great judgment. There's no numerical answer that I could give you that says each $20 billion of the
budget deficit is worth x in interest rates. There's just no way I
can make that kind of judgment.
I would say if Congress got together a dramatic package of the
size that the administration proposed in numerical terms—and I
recommended a bigger one to you—that in itself would have an
impact, because there is a great deal of skepticism out there as to
whether anything of that magnitude will be done.
Senator RIEGLE. If Congress, on a bipartisan basis—and presumably with the President being welcome to meet and work with all
of us—could come up with a budget looking particularly to 1983
and 1984, which you stressed, which could get the deficits down to
the level of the budget and hopefully $20 billion or more below
that, as you said a moment ago
Mr. VOLCKER. Right.
Senator RIEGLE. You think the response might well be a reduction of interest rates of 2 or 3 percentage points within the next 90
days?
Mr. VOLCKER. It could well be. That's a matter of judgment.
Senator RIEGLE. Is that your judgment?
Mr. VOLCKER. Talk to the market. My judgment is that you
would have a dramatic influence in that direction, yes, sir.
Senator RIEGLE. So if we could pull that off, we could anticipate
an almost immediate effect in response, at least within 90 days,
30
and you feel we would see a down trend in interest rates that we
could count on? That's your best judgment?
Mr. VOLCKER. That is my judgment.
Senator RIEGLE. Well, I think that's an important point because
then we ought to try to do that. I think it ought to be the mission
of both parties and the President.
Now let me ask you this. When this budget was put together
with these large deficits—there is a bipartisan consensus I think
that they are too large that's clear now—and you tactfully today
have said that you think they are too large and they need to be
reduced, were you asked your opinion on this? Did the OMB or the
administration ask you what you thought the impact would be on
interest rates if budget deficits are the size they are in this budget?
Mr. VOLCKER. It wasn't put exactly the way you're putting it, but
I offered my opinion.
Senator RIEGLE. Can you give us the same opinion?
Mr. VOLCKER. My opinion is the same privately as publicly.
Senator RIEGLE. So, in other words, the deficits need to be lower
than what's in those documents? Mr. Volcker.
Mr. VOLCKER. I would like to see them lower, yes.
Senator RIEGLE. I have noticed that both Germany and England
have eased upon their monetary policies just within the last couple
weeks. Why is it that monetary policy is easing in Europe and not
here?
Mr. VOLCKER. You're measuring "easing" in terms of some small
changes they made in their discount rate, but their monetary
growth may not be reflecting anything; I just want to make that
distinction. They have taken action consistent with some decline in
interest rates because the industrial world, generally, has the same
kind of problems that we have in greater or lesser degree; they
have had rising levels of unemployment and slow growth. The
United Kingdom shows some signs of expansion, but it's pretty
slow, and they had a couple of years of very large recession. The
German economy, I think, shows some favorable signs in some directions, but they also have had rising levels of unemployment and
excess capacity.
I might say that a limitation on their ability to have policies as
expansionary as they might like, in their own judgment, is the
pressure on their exchange rates and, in a sense, the international
level of interest rates. In my contacts with foreign central bankers,
they very strongly share the view that the most constructive thing
we could do to help them and help the world economy is deal with
our budgetary deficit.
Senator RIEGLE. Well, that may well be right. I just want to let
you know I'm concerned about the fact that our interest rates are
rising and theirs are dropping, and I think it's going to create
other pressures on the trade side.
Well, let me just ask you another question quickly. If the tax cut
were accelerated for 1982, which is being suggested, and brought
forward in time—and you seem somewhat less concerned about the
immediate year's deficit than the out-years' deficit—what effect
would that have on monetary policy or your ability to operate at
this time?
31
Mr. VOLCKER. I don't think it would have any real effect on monetary policy in terms of our targets. It might put a little more pressure on markets, but I really don't think the game is worth the
stakes in the sense that it probably would raise more questions in
the market and you might have an adverse psychological effect
from the appearance of going in a different direction on the basic
budgetary problem. We are in the month of February now and it
takes a while to gear up in terms of withholding tables and all the
rest, so I don't think it would be worth giving a confusing signal.
Senator RIEGLE. So if we were going to do that, it might have
been well to do it 90 days ago rather than 60 days from now. It
seems to me what you have said is very important in terms of how
we can get a near-term improvement and lowering of interest
rates—to summarize that we need a credible budget plan; we need
to get the out-year deficits down measurably, by an amount larger
than what's in the budget today; and it has to be real. People have
to believe it. The financial markets have to believe it. I think that's
a very constructive suggestion that you have made and we ought to
do it and we ought to be deadly serious about it because the stakes
we are playing with are not partisan stakes. I think what we are
talking about are business firms that are failing in Utah just as
they are failing in Michigan, and the prospect of giving people
some realistic hope in this country that we can pull things together—but we are off course and if we don't have that kind of midcourse correction now in a serious way and to act a lot faster than
the Congress normally does, we're not going to see the improvement in interest rates that's desperately needed at this time.
So I would hope that we could somehow, as a committee and as a
Senate, start to move in a bipartisan way in that direction.
The CHAIRMAN. Thank you, Senator Riegle.
Gentlemen, we have a vote going on. I might suggest that I'd like
to start moving over to vote on the floor of the Senate. I'm sure
there are many more questions and we will come back. Senator
Schmitt is next. He does not have time to come back, so I would
turn the time to him until the halfway bell rings and I will leave,
Mr. Chairman, and go over and vote so I can get back and we can
continue the hearing.
Senator SCHMITT. Thank you, Mr. Chairman.
I'm somewhat more optimistic than some of my colleagues. I
think the economy is going to do quite well this year as long as we
don't get in the way and so long as we do follow the basic premise
outlined in the President's budget message. The leading indicators
seem to be turning upward in housing and inventories and productivity investments, as you have mentioned, Mr. Chairman. Inflation
is decreasing, for the first time in recent recessions. We have had
inflation going down instead of up during the recessionary period.
Take-home pay for the vast majority of Americans who are working has increased because the value of that pay has increased because of the reduction in inflation and the stabilization of tax
rates.
Maybe more importantly, the American people, according to all
survey information, seem to be very much with the President and
willing to be patient in seeing that we get economic recovery.
32
As to the Fed's efforts, I compliment you and the Fed, Mr. Chairman, for what you're trying to do.
My main arguments are, as some others have mentioned, in your
ability to fine-tune what you're trying to do and the technical capability that the Fed has to fine-tune. Is there anything that we could
do quickly to enhance your capability to hit the monetary aggregates? I want you to err on the lower side. I'm not one of these that
want you to err on the upper side. But you have to admit there
have been some violent swings in money supply growth, and is
there anything we can do in the short term to help you manage
those aggregates?
RESERVE REQUIREMENTS ON MMp's
Mr. VOLCKER. If you wanted to pass a law rationalizing the
system of reserve requirements, putting reserve requirements on
transaction balances or money market funds and some other technical things of that sort, it would help, yes. I would like to see reserve requirements on the money market funds, but I wouldn't put
great priority on the others, and I couldn't urge you to make it a
piece of emergency legislation because I don't think it makes that
much difference.
You referred to the instability. Let me return to the point that I
made to Senator Garn. I think it would be useful to go on the
record via a letter to him, but I can give you monthly or quarterly
figures for fluctuations in other countries. Canada had a monthly
annual rate of minus 40 percent one month and plus 80 percent in
another, an annual rate that's far in excess of anything we had.
France went from a miniscule minus 6.5 percent in one month to
plus 36 percent in another month. Germany went from a minus 32
percent annual rate in one month to a plus 28 percent in another
month. Japan went from minus 44 percent in one month to plus 93
percent—both annual rates—in another month, and similarly quarterly. I don't want to suggest that we're going to answer any of our
fundamental problems by achieving stability month to month in
the money supply or that that's necessarily desirable to that
extent.
Senator SCHMITT. Mr. Chairman, you've made an important
point about what you see as investments in productivity so when
recovery occurs it's going to occur with the potential for increased
productivity in a number of industries.
Do you see that there's a danger that that might be temporary
based on the longer term investments in new technologies that the
Government and the private sector are making, or are not making
which tends to be more of the problem today in this budgetary
system?
Mr. VOLCKER. I certainly am not an expert on the expenditure
side of the budget and what it does to support research and technology and so forth, and I really can't comment in that area because I don't have enough expertise. But in terms of a general
fiscal strategy on the tax side as well as on the expenditure side,
it's obviously helpful and useful to take into account and stimulate
those things that do encourage investment, research, technological
33
change and all the rest, and, of course, that was the basic rationale
for the tax bill passed last year.
Senator SCHMITT. Mr. Chairman, I hope that we won't do anything for very long anyway that jeopardizes our ability to sustain
an economic recovery. Certainly I don't want you to let the money
supply grow too fast because that is what makes deficits inflationary, as I indicated earlier, and I also hope that the administration
and the Congress will not do anything to seriously deplete the reservoir of new science and technology that must always be rejuvenated if we are going to sustain an economic system in our particular type of political system.
There may be other types of political systems, but I find them
unacceptable and I think the vast majority of Americans find them
unacceptable, and certainly the vast majority of people in the
world who wish to have freedom in their future would find them
unacceptable.
Mr. VOLCKER. I think your premise is fundamentally important.
We want a recovery that's consistent with inflation going down.
We can try to pump up the economy in the short run, but surely
what we learned in the past is that recovery isn't going to last very
long; it's going to last less and less long, because the markets are
more and more sensitive to precisely that kind of policy, and they
think a game is being played, and they are going to react to what
they see as the long-run prospect rather than the short-run effect.
Senator SCHMITT. Thank you, Mr. Chairman. Hang in there and
we will recess briefly for the vote and Senator Garn will return.
[Recess.]
The CHAIRMAN. The committee will come to order.
With all the difficulties you have, Mr. Chairman, you don't get
summoned by lights and bells. I start to feel like Pavlov's dog and
start to salivate when we hear all the noise.
WEEKLY STATEMENT
While all the rest of the committee members are returning, I
might go back to what we were discussing earlier and you were attempting to answer about weekly reporting, and perhaps in our discussions about that maybe we focused it too narrowly and maybe it
isn't just an issue of weekly reporting but whether or not the
weekly statement is adequate.
There simply hasn't been, in my opinion, if you do go with the
weekly statement, enough expansion of it and enough explanation
of it. Currently, the Fed statement gives only movement in the
money supply figures and other bank data, but does not contain
any analysis or statement of the Fed's interpretation of the data as
it relates to, as an example, the preceding 4 weeks data, an estimate of potential noise and confusion in weekly data money supply
figures for the year, and so I'm wondering if you would comment
not only as you were starting to about the frequency, but if we do
continue with weekly statements, some further explanation might
dampen those ups and downs.
Mr. VOLCKER. Let me respond to that very directly. In the context of your question, I'm interpreting you to mean putting it in
34
the right statistical perspective rather than trying to explain why
last week's figure went up or down.
The CHAIRMAN. Within that context. In other words, rather than
just here is a weekly figure.
Mr. VOLCKER. A very fair question, which I scratch my head
about. We have made some changes; I think it's fair to say we will
make additional changes—and maybe we should have made them
sooner—precisely so as to publish the figures in a little longer perspective.
The reason I suppose we haven't done that more aggressively is
innate skepticism on the part of many of us, that no matter what
perspective we try to put it in statistically, the headline in the New
York Times and the Washington Post on Saturday morning will be,
"The money supply dropped or rose x billion dollars last week."
They will never look at the moving average or anything else.
Some of them do attempt to put it in a little more perspective.
But we can probably do a better job—I would hope we could do a
better job—in trying to do that kind of thing. We have thought
about putting a footnote on the thing, putting on a warning like on
a cigarette package, saying, "Taking these figures too seriously on
a weekly basis may be dangerous to your health." We have, as you
know, provided a lot of analysis, in statisticians' terms, about the
amount of noise on a weekly basis or on a monthly basis. Reciting
from memory, it's plus or minus $3 billion which is the statistical
test of being meaningless in any particular week. Obviously, the
figures are useful when they are accumulated steadily over a
period of weeks, and that's what we try to watch out for. From necessity, I think the market—the sophisticated people in the
market—realize that and they tend not to react weekly, but you're
never quite sure when they are going to react. Sometimes you will
print a big figure and they will say, "Maybe that's an aberration,"
and there isn't much reaction, particularly if it interrupts a quiescent trend; and then they will react later on because they are disappointed that it wasn't reversed right away or whatever.
I think they try to make intelligent judgments, but there is a
real problem when so much hangs on one figure which has its own
statistical vagaries.
One of the real problems with publishing a figure weekly—
whether it's department store sales or the money supply or automobile sales or anything else—is that a weekly seasonal is almost
impossible to compute in a reliable way. It's got statistical properties that mean that any weekly seasonal adjustment factor is not
very good, not very stable from year to year, essentially because
the weeks end up in a different part of the month every year. If
you didn't publish a weekly figure, you would avoid that statistical
problem of the inherent noise in a weekly series. We have felt—not
as a final judgment—that if we don't publish them weekly a certain burden of proof falls on us as to why not. Legally, in terms of
the Freedom of Information Act, we collect the figures and so the
burden of proof is on us to publish them. And, of course, it is
pressed upon us by many people in the market that any scrap of
information they can get—and sometimes I think however irrelevant, but that's an ungenerous comment—enables them to provide
a more efficient marketplace, that if they know everything that is
35
possible to be known, the market will perform better. That's a
normal presumption of an economist; I don't know whether it's
always true, but that's a common presumption.
The CHAIRMAN. I understand the pressures to report it weekly
and if you were collecting the data obviously there's an obligation
to report it, and the next question I think that is logical is, why
collect it? And I recognize there are plenty of private organizations
who would run around and call the banks and ask for the figures
and try and have it unofficial. I can't imagine that those unofficial
reports would have the impact of the reports the Fed did.
So, as you have stated very clearly it's very difficult to report accurately weekly figures, why not go the next step and not collect it
on a weekly basis? Then you can't be criticized for not reporting it
and do it on a monthly basis, and if private individuals want to run
around guessing, let them.
Mr. VOLCKER. You're about at the point in your thinking where I
am in mine. I, at least, wonder whether we should collect all these
figures weekly. As you can imagine, there's a certain amount of
tension between the desire not to collect them weekly and our natural curiosity about what's going on in the course of a month too.
If we did adopt the kind of contemporaneous reserve accounting approach that we ourselves propose there might be some logic in collecting figures every 2 weeks; it is a 2-week reserve averaging
period that is proposed and, as you know, there would be, perhaps,
some natural conformity there—maybe it's a halfway house.
Whether it's a satisfactory one or not, I don't know. At least our
preliminary considerations suggest we should not go so far as to
have a reserve averaging period only once a month, which would
be the logical accompaniment to collecting the figures once a
month, but which potentially creates other problems.
The CHAIRMAN. I understand, but it seems to me if we, some
way, whether it's 2 weeks, whether it's a month—if a weekly average sends signals to the market, which it obviously does, it certainly will hear about it every week from all sorts of sources that are
inaccurate. Why, with all of the difficulties in the market, are we
publishing inaccurate figures and not changing that process?
Mr. VOLCKER. I think it's fair to say the concentration on these
figures—not just in the United States but around the world—is a
symptom of the uncertainty the markets feel. They want to find
this out. They haven't anything else to cling to. They should
wonder about deficits and inflation and all the rest, this should be
fundamental to the market in the midst of all this, and they cling
to something that may give some direction in the next few days.
The CHAIRMAN, How is that logical to make business and investment decisions on a figure that is inaccurate? I just don't understand that at all, that they are so anxious for something that they
will take what they know is probably wrong rather than waiting
another week.
Mr. VOLCKER. All I can say is they are a little bit better with
them than without them. We have canvassed them and we have
talked with a good many people. Interestingly enough, those who
have commented on publishing the weekly figures are split pro and
con 50-50. About 50 percent of the commentators said, "Oh, it
would be a terrible thing to stop publishing them weekly." That
36
comment tends to come more from the technically oriented people
and the marketing people. The other half have a variety of suggestions. It's not that 50 percent suggest we do it weekly and 50 percent suggest we do it monthly; it's around 50 percent suggesting we
do it weekly, 10 percent suggesting we do it daily, 15 percent suggesting we do it without seasonal adjustment, and 20 percent suggesting we do it every 2 weeks. The opinion is very well split
among consumers of the data.
The CHAIRMAN, Mr. Chairman, thank you. Unfortunately, there's
another vote going on and I will have to leave. I would ask the
staff when the first Senator appears, so we are not unduly delaying
you and we can complete the hearing as expeditiously as possible—
Senator Dixon's turn was next, but whichever Senator appears first
after this vote, either Republican or Democrat, have them start the
hearing and continue the questioning, and I will jog as rapidly as I
can.
Senator Dixon, you're the temporary chairman. It's yours to do
as you will until I get back.
Senator DIXON. That's an awesome responsibility, Mr. Chairman,
and I will do my very best.
I want to thank you, Chairman Volcker, for being so patient with
us while we are casting our votes. I have only three questions I'd
like to ask you.
The first is this. You were talking earlier with Senator Lugar
about the proper signal to send to the money market managers. I
ask you in reference to what the President has suggested to us
whether in your opinion anything we might do in connection with
budgetary cuts within the framework of his budget will be adequate to send the right signal if we don't do anything at all on the
revenue side and if, in fact, we do pass a military appropriations
somewhere in the area of what he's suggested, which is approximately around 18 or 20 percent up for this fiscal year?
Mr. VOLCKER. You would have to give me the bottom line, I suppose, in terms of what cuts you could get; your judgment is going to
be better than mine. If you can't do it in the proportions he's proposed or go beyond that, it would be more valuable, in my way of
thinking—if you can't do it by the expenditure side—to do it on the
revenue side.
Senator DIXON. I don't mean to put you in an embarrassing position. I wouldn't ever consider doing that with reference to the
President's position vis-a-vis your own position, Mr. Chairman, but
what I'm asking you is whether you envision a circumstance in
which the cuts could be adequate here by the Congress to make the
proper response regarding the budgetary deficits if we increase military spending at the rate suggested in this budget by the President, and if we don't do more on the revenue side? Now that is my
question.
Mr. VOLCKER. I'll give you my practical judgment. I don't know
what it's worth because you're better able to judge what Congress
can do and cannot dp. I would think it is very tough to do it solely
on the expenditure side.
Senator DIXON. Well I would certainly be inclined to agree with
you. I just came from the floor and
37
Mr. VOLCKER. Even the President doesn't have it solely on the
expenditure side.
Senator DIXON. I appreciate that fact, although I think there's a
very large question about what part of that is——
Mr. VOLCKER. I agree. It's in your ballpark, not mine, but I can
say I have a good deal of skepticism as to whether you can do it on
the spending side and, therefore, I think you need some revenue
measures and you need revenue measures beyond what he's proposed.
FREEZE ON ENTITLEMENTS
Senator DIXON. I just came from the floor where I was visiting
with a colleague, the Senator from South Carolina, Senator Fritz
Rollings. There's been a considerable amount of publicity in the
country concerning his discussion on the floor of the U.S. Senate
yesterday and his suggestions about what we might do. It's simplistic in nature and, again, to even oversimplify what he's already
suggested, I would be interested in your comments concerning his
suggestion about a freeze, particularly in the entitlements, something on the revenue side, some adjustment in the budgetary area
of the military, which I think in his case is—I don't have the figure
in front of me—I believe it would have been a deficit of somewhere
in the $44 or $45 billion area as distinguished from the even rosy
figures the administration indicated of $91.5 billion.
Mr. VOLCKER. By some strange coincidence, a number of the
members of the press were interested in my response to that question while you were out, and I can only tell you what I told them.
I have seen some reference to that plan. I read all of two paragraphs about it, I think, in the paper, and I really can't comment
on the composition and nature of the plan.
To the extent that it is an aggressive attack on the deficit—and I
can't comment on either the realism or the appropriateness of the
components—I welcome it and I take it that's what it's designed to
be.
Senator DIXON. In other words, your bottom line here, what
you're telling this committee, is that without any regard to who is
the author of the idea, you suggest very substantial intrusions
upon the outstanding budgetary deficit, particularly in the outyears, is manifestly important if we're going to get the right response from the money market managers on interest rates?
Mr. VOLCKER. That is exactly what I'm saying.
Senator DIXON. One final question and then I'll yield to my colleague from Michigan.
Last year, Mr. Chairman, on one occasion, we had the Secretary
of the Treasury, Mr. Regan, here, and in the course of some questioning I was carrying on with him at that time we discussed the
prime. May I first ask, am I correct, the prime is 16.5 percent
today?
Mr. VOLCKER. Yes.
Senator DIXON. We were discussing the prime rate and I asked
him at that time whether he saw any light at the end of the tunnel
and his response was, "Yes, and it's not a speeding train," but, of
course, he was wrong, Mr. Chairman. It was a speeding train.
I'm wondering whether in this year, as a message to the folks
back home, those many groups who talk to us—the farmers, the
thrifts, the auto people, the housing industry, the appliance dealers, every merchant really on Main Street—whether you can suggest if we do the responsible things budgetarily this year whether
you would see in perhaps the third or fourth quarters light at the
end of the tunnel?
Mr. VOLCKER. Yes, and you put on the qualification that I put on
it. You ought to direct your actions—in a larger sense, all of us can
be directing our actions—toward the kind of economy and the kind
of psychology that will reduce these extraordinarily high levels of
interest rates. I think that's what we're trying to do. If you move
in that direction, you lay the groundwork not only for a period of a
few weeks, let's say, but for continuing movement in the right
trend, by dealing with the inflationary problem and dealing with
the budgetary problem. Between us, I think that's what we should
be trying to do, and that's where the effort must be directed or it's
not going to be successful.
Senator DIXON. Thank you very much, Mr. Chairman.
Senator Riegle, I was annointed with the responsibility of being
chairman since I was the only one here, and having tasted of this
heady wine, I now yield time to you.
Senator RIEGLE. Thank you. I think maybe we are getting somewhere today in this discussion in terms of how we work out of this
bind we're in.
It seems to me what we've got to do is commit ourselves to both
winning the long-term fight against inflation and high deficits, insufficient savings, investment and growth, and we have also got to
do something about the short-term problem. We've got to do both
of these things.
I think what you've heard around the table today is many of
us—we're living in the first person with the short-term effects.
We've got real disasters on our hands and they are spreading. So I
hope the sense of urgency that you're picking up here today—and I
assume in your other appearances—is linked to things that are
happening in places we could take you so that you could see first
hand what a tremendous toll is occurring both in terms of human
damage and suffering as well as economic damage.
In terms of how we work our way out of it, it seems to me today
that maybe it's possible to see a way. That is, that we have got to
deal with the problem of these out-year deficits, bring them down.
It seems to me we've got to have a bipartisan consensus to do that.
You apparently were consulted when the budget was put together
and it sounds to me as if you fought for lower deficits and didn't
win. At least you were consulted. We were not consulted, those of
us who were Democrats in Congress. We have not been part of that
planning process. We would like to be in terms of sitting down now
and reworking the numbers, reworking the fiscal plan and the outyear deficits, so we can, in turn, get this 2- to 3-percentage-point
drop in interest rates over the next 90 days because that has to be
the goal that we set ourselves to achieve, and at the same time
work to achieve long-run goals that there's agreement on.
39
If we can make some progress with that idea, I take it that the
Fed is willing to play whatever constructive part it can play if
those dynamics are set in motion. Is that right?
Mr. VOLCKER. Yes. I think the constructive part we can play is
laying the groundwork, increasing the confidence and building on
the growing confidence that we will deal with this inflation problem, because the short-term plan is going to fail if there isn't that
background.
TWO-STEP FISCAL PLAN
Senator RIEGLE. What if we were to do it in two steps? The hard
part will be to move the machinery in a hurry, although I think we
have to do that. Whatever we design has to be something that we
can accomplish quickly rather than having it stretch out over a
period of months. The Congress, for example, on a bipartisan basis
and in cooperation with the administration, could work out a fiscal
plan that gave us deficits that began to go down more sharply and
a signal could go out to the financial markets that would in turn
lead to a quick drop in short-term interest rates. I'm wondering if
we could agree on the total numbers necessary and lock those in so
that we had a fix on the deficit, and perhaps in the second stage—
it might take another month or two—deal with the question of how
you actually assign the spending priorities within those ceilings. In
other words, by taking it in two steps, it wouldn't get paralyzed on
the question of what the spending choices were per se. We would
concentrate first on getting the aggregate numbers locked in place.
It seems to me if we were to do that, if we were to set the overall
spending levels to give us those deficits, a pattern of deficits that
were lower and would work in terms of bringing down interest
rates, perhaps that's the thing we should concentrate on now,
trying to get that done within the next 30 days and in the next
stage go ahead and work the details into place that would support
the aggregate numbers already agreed on. I'm not saying that's a
perfect approach, but as I try to think about what is the practical
way to resolve this dilemma so we don't just end up with partisan
bickering or with people throwing up their hands and saying that
nothing can be done, that something of that sort needs to happen.
And I believe that's the most logical way to approach it.
So if we would within the next 30 days get any kind of a momentum rolling here in a bipartisan consensus on overall fiscal numbers and lower deficits stretching out into the future, with a second
stage effort to work out the details that would come within those
spending ceiling figures, would it still be your view that the shortterm interest rates would show an improvement in the next 90
days?
Mr. VOLCKER. You describe a process that may indeed be constructive. Just how the market would react in these interim periods, I don't know. It would react better than otherwise, but I don't
think you've got a problem that you can solve by stating an expenditure goal. The market is very well aware that's been done in
the past. You had an expenditure goal incorporated in the budgetary resolutions last year of $695 billion and the latest estimate is
$725 billion and rising, and I don't think you can expect you're
40
going to revolutionize the world by stating a goal. That may well
be an essential part of the process and a constructive part that
you're talking about, but just how the market would take it, what
degree of conviction they would receive it with, is going to depend
on a lot of intangibles. That doesn't bear upon the reasonableness
of the process that you're describing, but perhaps upon the difficulty of combating years of doubt in performance.
Senator RIEGLE. Well, I believe if there was a bipartisan aspect
and both the legislative and the executive branch worked together
on this, it would have a degree of credibility that it wouldn't have
otherwise.
Mr. VOLCKER. Always,
Senator RIEGLE. That approach is the best one that I can see at
the moment, and if we don't find one like that, it seems to me what
we are left with is an impossible situation. Just looking at the calendar right now and the difficulty of working these basic dilemmas
on through it is obvious that we are not going to get it done. We
are not going to get it done in time and we are going to be faced
with a situation where interest rates stay too high and in fact may
even go higher, and we are not going to see an economic recovery
of any consequence.
Mr. VOLCKER. I think the premise of your comments would not
be the same as the premise of my comments. We are both talking
in terms of probabilities. Nobody knows, but the probability seems
to me that the economy is today somewhat stronger and less weak
than you fear, but there are risks there. In saying that, I don't in
any sense want to remove the sense of urgency that you feel, which
seems to me terribly constructive, but I don't think we face the
kind of hopeless situation in which we've got to have a magical
result in the next month or the roof will fall in. Your sense of urgency seems to me entirely appropriate; your sense of extreme
doom maybe is a bit overdone.
Senator RIEGLE. Well, you know, I look at you out there and
what comes to my mind is that ad you see in the magazines that
the insurance company puts out with the fellow sitting there and
thinks everything is fine but a piano is just coming out of a 70story building and is about to land on his head, and that's what's
happening in the country. And you have heard it from people on
both sides of the aisle.
Mr. VOLCKER. I understand your feeling very well. We are living
in a period of uncertainty and there are very great risks out there.
I can only tell you that I think there are somewhat, in a sense, at
the bottom of every recession
Senator RIEGLE. This one is different. You have to go back literally to the 1930's to find situations that are comparable to many
that we see today. I'll tell you how serious it is. Although it didn't
come up today, we've got serious people in Congress on both sides
of the aisle that are now talking about restructuring the Fed, about
changing the arrangements because of the impossibility of getting
the interest rates to respond. That's how advanced this debate has
become. We haven't gotten into that today because I like to talk
about more immediate, practical things, but I don't think there's
an immediate appreciation of the scale of the disaster that's building here.
41
Mr. VOLCKER. Let me say that I get around a bit. I don't feel as
insulated as I'm sure that you fear I am or other members of the
Board are. We have some very real sense, I think, of just the concerns that you have. We have a real sense of concern not only
about what's going on, but about the possibilities of various hazards in the future. Our basic feeling is that we will have some recovery, and we think the entire weight of economic analysis, not
our own but other people's, is in that direction. But I quite agree
with you that the function of these hearings and other discussions
is to focus on all those things to make the most favorable outcome
more certain and the least favorable outcome less certain. There is
just no question that we have identified and agreed upon a major
hazard that has to be removed.
I can't be optimistic about the future if you're not going to take
action on the budgetary side.
Senator RIEGLE. But the financial markets are voting "No" on
this fiscal plan. This budget is stretching out into the future. In a
nice way, you are voting "No" on it. You're saying you've got to get
these deficits down further. All I'm saying is that to the extent
that doesn't happen, we are not going to see things improve, and
you're saying the same thing, and I'm saying time is running out.
Mr. VOLCKER. Exactly. I'm fully with you on that. Let's get to
work on it.
The CHAIRMAN. Senator Proxmire.
REDUCTION OF INTEREST RATES
Senator PROXMIRE. While I was gone I understand that you indicated that if we could cut the deficit by $20 billion or so that would
be very helpful to you and would result in a reduction in interest
rates of 2 or 3 percent.
Mr. VOLCKER. I don't want a lot of weight put on a precise
number.
Senator PROXMIRE. I know that.
Mr. VOLCKER. I'm formulating an order of magnitude. The $20
billion you refer to was a concept of $20 billion less than the President was proposing for 1984, which is more than $100 billion from
where you now stand.
Senator PROXMIRE. The reason I suggest that is I have worked
out a series of tax increases and spending reductions that would
cut the budget by $30 billion in 1983 and far, far more in 1984 and
1985.
Mr. VOLCKER. All the better.
Senator PROXMIRE. As you know, any initiative we take this year
has relatively little effect in 1983 compared to what it will have in
the out-years, particularly with respect to confidence.
Mr. VOLCKER. All the better.
Senator PROXMIRE. Then I understand, as you may know, Senator Rollings has made a very interesting suggestion and one that
has great simplicity. I couldn t support it, at least not in its present
form, but maybe some modification of it. He suggests we freeze everything in 1983 at the 1982 level. In other words, no increase in
social security, no increase in defense, no increase anywhere, have
everybody make the same sacrifice. In other words, nominal ex
42
penditures would be the same in 1983 as in 1982. He argues that
this would actually balance the budget because it would result in a
$100 billion reduction in the deficit, and I think it would be close to
that if we could do it, but it seems to me almost impossible to do
that in defense. In fact, in defense, we've got the contracts, you
would have to repudiate contracts and at the same time pay a very
large settlement when you did that, but at any rate, what do you
think of that general notion of that attempt?
Mr. VOLCKER. I haven't had any chance to examine it. This came
up while you were out, and I don't want to comment on the specifics of it, but I greatly respect and admire that kind of aggressive
thinking about how to deal with this problem. I don't think I can
make any comment on the specifics of the approach.
Senator PROXMIRE. Let me ask you this.
Mr. VOLCKER. If you've got a plan to do $30 billion more, let's get
that on the table, too.
Senator PROXMIRE. You're the expert. If there is an expert,
you're certainly it, on the interest rates and the monetary policy.
What effect would the Rollings proposal have, in your judgment,
on the credit markets if we could put something like that or approaching that into effect?
Mr. VOLCKER. It comes down to the bottom line. I assume that
would have a very dramatic effect and, if it was considered realistic
and attainable, would have the kind of effect that I indicated earlier to Senator Riegle. I think it would have a galvanizing effect on
the markets, but I'm using to the assumption that this would be a
marked and realistic movement in the right direction; I'm talking
theory. I've not seen his particular proposals so I don't know
whether they would be realistic. You raised some questions about
them yourself, and some of those questions would immediately
come to my mind. I have been through some of these budgetary exercises before on a smaller scale. They seemed big at the time, in
earlier administrations; and freezing is harder to do than to say,
for the reasons you suggested, because you get the problem of differential impacts on different sectors and so forth.
GROWTH RATE
Senator PROXMIRE. Now I understood or I heard what I thought
was a very interesting and very necessary response that you gave
the chairman to the argument that the volatility of the Fed has
been responsible for high interest rates. I thought your response
was very logical and especially when you compare it with performance of other countries. But I'd like to ask you about the failure of
the Fed last year to come in with a growth rate, particularly in the
first three quarters of the year, that was anywhere near its range.
In 1981, the M,- range was 3 to 5.5 percent. The actual growth was
1.3 percent. The Mi- B was 3.5 to 6 percent and the growth was 2.3
percent. Why did the Fed miss its mark by such a big margin, particularly for three successive quarters? Nine months is a reasonably long time. Why were you so far below it and wasn't that
really a factor in pushing us into a recession?
Mr. VOLCKER. That's a matter of judgment, but I can tell you
generally how it came out the way it did. It was relatively low,
using the adjusted figures, for the first few months of the year,
which, to say the least, did not disturb us because, as many have
commented, it was high late last year and that was a period of declining interest rates, too, you may recall. Seeing a lull in money
supply at that time was not in any sense a contradiction of what
we wanted to see, both in terms of the earlier growth and in terms
of what was going on in the markets.
Senator PROXMIRE. Except here you have a wide range of 3 to 5.5
percent and you were way below it.
Mr. VOLCKER. It's not wide
Senator PROXMIRE. For quarter after quarter after quarter and,
of course, as you say, at that time interest rates weren't rising, but
with the lag involved, it seems to me you could make a strong case
that the Fed was responsible for the sharp increases that came
later and for choking off the recovery.
Mr. VOLCKER. I don't see it that way.
Senator PROXMIRE. And the recession we are now in.
Mr. VOLCKER. You say we have a wide range. The range isn't so
wide in terms of the normal fluctuations. If you draw one of these
conventional cones, the range is miniscule at the beginning of the
year. You can't possibly be inside it. It's an unrealistic kind of picture to draw because by its nature it is infinitely small when it
begins. As I recall, the previous year we ended up just at the high
side of our range, a quarter percent above it I think. I drew pictures through the range for the next year from the high side of last
year's range and said, "Well, let's leave ourselves some leeway
below the very narrow, early part of the cone because we ended up
higher last year and we like to see some decline, particularly in the
context of declining interest rates." That was true at that time.
Then we had a bulge in late March or April, as I recall. We sat on
that pretty hard because we didn't want the trend to get out of
hand. As the year progressed, we also observed two things which
influenced our precise posture for the rest of the year. We observed
week after week—it would have been the same month after
month—this growth in money market funds which appeared to be
influencing the trend of Ml; and we also observed that M2, which is
a much steadier figure I would note, was hovering around the
upper side of the range all during that period. And some outside
commentators at that time were putting more emphasis on M2
than Ml. We put some emphasis on M2. So, taking a balanced view,
considering that M2 was at the top of the range and some of the
other aggregates, including M3, were showing rather rapid expansion, we were reasonably satisfied with the development.
I can't remember the date right now, but beginning in early
summer, you will note that we consistently supplied more and
more reserves to the market through our Open Market operations.
In fact, short-term rates reached their peak either in late spring or
early summer and, all during summer and fall—until mid-November or December when the money supply began rising more sharply—short-term rates were falling. We had looked at it in general.
We announced to you in July that we would find it desirable to
come in around the low end of the range. We would have been
happy to see the money supply a little higher. We were tempted to
push the Mi money supply in terms of what was happening to the
44
other aggregates, what was happening to credit generally: shortterm rates were declining; interestingly enough, long-term rates
were rising right through the end of September or early October,
despite the decline in short-term rates.
I think this has a lot of bearing on the kind of economic problem
we face. You have to speculate as to why long-term rates reached a
new peak in September if that was the date when short-term rates
had been declining for 3 or 4 months? That was a period, you will
recall, of very considerable concerns about budgetary problems.
UNEMPLOYMENT UP—INFLATION DOWN
Senator PROXMIRE. Let me quickly, because I don't have much
time, change the subject and ask you about the feeling on the part
of many Americans that any success we've had in bringing down
inflation can be attributed to increased unemployment. That's
what's doing it and the references you made earlier to the improvements in productivity seem to be unemployment. Is unemployment
the price, in your judgment, the Nation must pay to get inflation
down and keep it down? Do we have to have unemployment at this
level, 8.5 and 9.5 percent?
Mr. VOLCKER. I think there was always a substantial risk—I
would stop short of inevitability—of economic dislocation, recession, when restrictive monetary policies and rather liberal budgetary policies came up against an entrenched inflationary rate,
with the momentum of inflation, the momentum of wage increases,
the unsatisfactory productivity trend. You can look back in my
statements of 2 years ago; I consistently noted I did not think this
was going to be a painless process and that the more that you
relied upon monetary policy alone, the greater the risk of dislocations in the short run.
Having said that, we can't reduce the inflation on the backs of
the unemployed for the future; that's an unsuccessful policy.
Senator PROXMIRE. A lot of people feel that's exactly what we're
doing.
Mr. VOLCKER. They may feel that, but that's obviously not sustainable or appropriate. We have to get together a set of policies, a
set of attitudes, that are consistent.
Senator PROXMIRE. Now what, above and beyond fiscal and monetary policy, both of which are designed to achieve their end by
slowing the rate of growth in the economy, reaching out for incomes policy, for antitrust policy, for free trade and so forth, policies that will supplement and make it possible for us to do this
with a lower rate of unemployment?
Mr. VOLCKER. All those policies are relevant. We tend to concentrate on monetary and fiscal policies. Those are the nice, big dramatic sounding Federal policies. They come in nice big packages
and people love to discuss them. What you do in regulatory policy,
what you do in free trade policy, what you do in competitive policy,
is very important. I point out some of those things are not painless
either. Competition from abroad brings pressure on industries.
Senator PROXMIRE. But we're not getting any real force from the
administration on any of those policies, none of them.
45
Mr. VOLCKER. I won't respond to that comment. I think those elements of policy are terribly important and the way, in the end, to
reconcile the growth and the lower levels of employment with the
disinflation is that you build a different set of attitudes so that
people restrain themselves, let's say, on excessive wage demands.
That encourages productivity growth. It encourages cost restraint.
It's not going to encourage you if you've got a record of 15 years of
inflating and every time you run into a problem you inflate some
more. Obviously, it's quite natural that nobody is going to respond
in a way that's disinflationary then. You've got to build a whole
different set of motivations. We have a whole generation growing
up that's never seen price stability. It takes them a while to change
their thinking. There have been references to housing prices leveling off or declining. Well, housing prices haven't leveled off or declined for who knows how many years. Housing prices increased
twice as fast as the general inflation rate in the 1970's. Everybody
thought it was great to commit themselves as far as they could on
a house, or a bigger house, or a second house, because that was the
way to beat inflation. If we don't have any inflation, it's not a way
to beat inflation, but it does make your attitude toward home
buying a little different. Eventually—you can see it very clearly in
the homebuilders; there's quite a few I have visited recently who
trying their best to build a house more cheaply, to build it more
efficiently, to build it smaller—you have to change. We have had a
great expansion in the size of houses in the last decade. You see
great distress in Michigan and Ohio and other places where the
auto industry is centered. They have many problems in that industry. It's a high wage industry. It should be a high wage industry;
it's a tough job. The fact is, it's become, relatively, a much higher
wage industry over the past 10 years. They have a competitive
problem, and I think there's greater understanding of that.
The regulatory problem is part of it. Management attitudes, I'm
sure, are part of it. This is all in the process of changing. That's
where I'm expressing optimism. I really think it is in the process of
changing and it is only through that kind of change that we will be
successful in combining recovery with movement toward price stability. If there's no way of doing it, you're telling me, as I said
before, that we've got an unsolvable problem in this country, and I
don't think we've got an unsolvable problem.
The CHAIRMAN. Mr. Chairman, let me go back and follow up on
what Senator Proxmire and others have said on fiscal policy and
the major thrust of what you hear today in attempting to balance
the budget. Everybody agrees, yes, we should have additional
spending cuts, but also we should rescind parts, or in some cases,
all of the tax cuts.
TRILLION DOLLAR DEFICIT
The question that I would ask you is, isn't the drag on the economy tremendous from carrying a trillion dollar deficit, even if we
started to balance the budget immediately, the mere carrying of a
trillion dollar debt—and also turning that over at roughly a onethird of it per year, refinancing it—a tremendous drag on the economy?
46
So my point is this: We could have balanced budgets by raising
taxes. Certainly that is an option. At least it is my feeling, as much
as I have always been in favor of balanced budgets—I'm not a new
convert to balanced budgets like many in the Congress. I have supported balanced budget amendments in the past, constitutional
amendments. But I would rather have an unbalanced budget at 18
or 19 percent of GNP in taxation than $1 trillion balanced budget
at 26 or 27 percent of GNP.
So the question really, I suppose, is twofold. Isn't the debt a tremendous drag on the economy? It's still in competition for private
sector capital. It's still creating shortage of money in the private
sector and, in addition, if you want to balance the budget by increasing tax rates and absorb that much more out of the private
sector, you could still have the tremendous dislocations, high-interest rates, and problems we see today, and we would all be saying
we balanced the budget.
Now isn't it necessary to balance that budget with fiscal policy
with a declining percentage of the national income being absorbed
by government as well as expenditures, a balanced policy rather
than just saying let's increase the load on the taxpayers once again
and balance the budget?
Mr. VOLCKER. Strictly from the economic standpoint, I think
you're better off balancing the budget in the context of declining
expenditures and taxes relative to the rest of the economy, but
that's not the end of the story. You mentioned the load of the existing debt. What stands out so dramatically in these new budgetary
projections is the way a deficit feeds upon itself. When you get deficits of this size and then you have to pay the interest on it the next
year, and the interest rates are above the inflation rate, you've just
built a machine for making the deficits bigger and bigger and getting in a bigger hole. We have never quite been there before, partly
because when interest rates were below the inflation rate it looked
like a nice game. It doesn't look so good when the interest rate is
above the inflation rate and the compounding of that interest, in
itself, makes the budgetary problem that much harder next year
and the following year and the following year. The degree of taxation you have to levy to pay the interest becomes a hazard in
itself.
If you let this thing get out of control you're just going to be
faced with a worse problem down the road. You say it's nicer to
have smaller taxation at the expense of a higher deficit. The best
thing—I'm sure we would agree—is to cut down the deficit and cut
down the taxes and the spending at the same time.
The CHAIRMAN. Don't misunderstand what I said. I agree with
what you just said. I said the choice between a very balanced
budget at very high levels.
Mr. VOLCKER. I think that is certainly correct, but then you're
left with the question that we're speaking of in economic terms.
You've got to put in all those ingredients which you can make a
judgment about and I can't; that you must make a judgment about
how big the defense program should be and all the rest.
The CHAIRMAN. All I'm saying is we need a balanced approach in
taxation and spending cuts and not just attempt to do it one way or
another.
47
Mr. VOLCKKR. Right.
The CHAIRMAN. Senator Sarbanes.
Senator SARBANES. Mr. Chairman, I understand that the policy
you have been pursuing is, as you understand it, a policy which the
administration wishes you to follow. Is that correct?
Mr. VOI.CKER. The general thrust of the policy is, I think, supported by the administration. I would note that we started before
this particular administration came into office.
Senator SARBANES. But this administration's position, as you understand it, is that you're pursuing the policy lines which they
think you should be pursuing?
Mr. VOLCKER. In general terms, yes.
Senator SARBANES. When did you last meet with President
Reagan to discuss economic policy, substantively discuss economic
policy?
Mr. VOLCKER. In December.
Senator SARBANES. This past December. And that discussion, I
take it, included the question of the policy the Fed should be following?
Mr. VOLCKER. Yes. There was no extended discussion of that. As
I recall, we discussed budgetary problems probably more than monetary policy.
Senator SARBANES. Had you met with the President periodically
prior to that understanding that the Fed is independent, with respect to the question of coordinating monetary and fiscal policy?
Mr. VOLCKER. We have met from time to time.
Senator SARBANES. What do you understand the relationship to
be between the money supply and the interest rates?
Mr. VOLCKER. Complex. If you have a stable expectation in economic terms, it's a simple demand-and-supply analysis. If you push
up the money supply, you would expect short-term interest rates to
come down, at least for a while. If the money supply increases because the impetus comes from the demand side, you expect interest
rates to go up. You have to look at where the impetus comes from.
That's a very static analysis. You also have to look at what the further consequences are of the change in the money supply; if the ultimate influence is inflationary you get a different answer.
What we have today is not, obviously, a very stable situation
within the economy or with respect to inflation, and we run a considerable risk—to understate it—that a policy of expanding the
money supply that is interpreted as inflationary will increase interest rates and particularly long-term rates.
Senator SARBANES. So you would say that today, in order to get
interest rates down, you should diminish the money supply. Is that
right?
Mr. VOLCKER. I think in some circumstances you could argue, if
that were your single-minded intention, that you would decrease
the money supply. Now you carry that to a ridiculous
Senator SARBANES. Are you, in effect, telling us that you really
don't know how to get the interest rates down?
Mr. VOLCKER. I don't know how to get the interest rates down by
manipulating the money supply over the next 3 weeks or 3 months,
that is true; I don't think that's possible. I know how to get interest
48
rates down ultimately. I don't know how to manipulate them in the
short run.
Senator SARBANES. Jim Tobin in testimony before the Congress
said that when interest sensitive investments are discouraged—
that would obviously be autos and housing, among others—workers
lose jobs and wages; businesses lose sales and profits; governments
lose revenues but acquire new spending obligations. The Federal
deficit is higher, witness the sudden drastic upward revision of the
estimates once the administration acknowledged the recession.
Now isn't it a fact that the high-interest rates which have provoked the downturn in economic activity in certain sectors of the
economy which causes people to be laid off and businesses either to
go bankrupt or to suffer losses, has helped to contribute to the increase in the size of the deficit?
Mr. VOLCKER. If you look at the 1982 deficit, yes, it's got a cyclical component that moves that deficit up, whatever the cause of it.
Senator SARBANES. Did the high-interest rates help to contribute
to that cyclical component?
DEFICIT DURING RECOVERY
Mr. VOLCKER. In an immediate sense, yes, but you have to look
beyond what caused the high-interest rates to what the situation in
the economy was generally. I'm not referring, I might point out, to
the harm of the deficit this year. What does concern me is not the
point you have just made or that Professor Tobin has made. The
prospect is that the deficit will increase and increase, substantially,
during a period of recovery. That is what is unique about this situation.
Senator SARBANES. Well, now, were you supportive of the
President's budget proposals last year?
Mr. VOLCKER. I repeatedly expressed reservations about the combination of tax cuts and expenditure plans, and I could submit for
the record, if you like—the question came up yesterday—some of
the comments I made earlier and my concerns about the possibility
of congestion in markets and the damage to investment incentives
if the budgetary consequences and the tax reductions were not recognized on the spending side or otherwise. I can quote some of my
statements to you if you would like.
Senator SARBANES. This movement toward a tighter fiscal
policy—from your perspective in reacting with monetary policy,
does it matter much to you how a tighter fiscal policy is achieved?
Mr. VOLCKER. It matters as a second approximation, I suppose.
The first thing I would focus on is what the relationship is between
expenditures and revenues, assuming good business conditions
Senator SARBANES. I was very interested in an assumption with
Senator Proxmire. You were talking about what's going to happen
in the future, about the inflation rate coming down, and getting a
sustained period of recovery and you said then, assuming that we
did not have a problem with energy sources, or bad weather for
crops—and we have been fortunate in those two areas. Obviously,
those are two major components of your Consumer Price Index and
one of the reasons that we have been getting a fairly good perform
49
ance on inflation has been our good fortune in those two areas. Is
that not the case?
Mr. VOLCKER. Yes; I don't think the movement of energy prices
and food prices is entirely uninfluenced by other policies, but it's
certainly true that
Senator SARBANES. Is it influenced by your high-interest rates?
Mr. VOLCKER. In the short run, yes.
Senator SARBANES. By provoking a recession?
Mr. VOLCKER. No, by, among other things, provoking oil companies not to hold excessive inventories, for instance.
Senator SARBANES. How about on the food side?
Mr. VOLCKER. On the food side, I think it would be less true
apart from the recession effects. It's a restraint on any speculative
market and even the grain markets have speculative elements in
them.
Senator SARBANES. Is it your view that inflation ought to be cornbatted by recession?
Mr. VOLCKER. No; I just made the point that we haven't got a
palatable policy in this country if the only way we can achieve
price stability is by having extended recessions. We've got to build
in something more fundamental than that.
Senator SARBANES. I understand yesterday that you made the
point in the House that a number of European countries had lower
inflation and lower interest rates but larger swings in the money
supply. Is that correct?
Mr. VOLCKER. Virtually all have larger swings in the money
supply. I didn't add the point about interest rates and the other
point you made.
Senator SARBANES. Let me quote the article and maybe you can
misquote it. "Volcker reeled off a string of figures snowing that
other countries with low inflation and low interest rates have had
bigger swings in the money supply."
Mr. VOLCKER. I think that was an editorial comment that happens to be correct for a good many countries, and I could reel off
the figures again if you would like. They included countries that
had lower inflation rates and lower interest rates and higher inflation rates and higher interest rates.
Senator SARBANES. Why should the Fed be pursuing a policy that
focuses on the money supply as a significant indicator rather than
the interest rates, which after all are the indicators that business
activity has to work from? The small businessman doesn't work off
of a money supply figure. He works off of an interest rate. If you
put it out of his reach you're driving him out of business, and I'm
hearing from people—not marginal people, you know—who have
been driven out, well-established, longstanding business enterprises.
Mr. VOLCKER. I think you're right; the thing that affects the
fellow out there, the small businessman, the farmer, the homebuilder, is interest rates. That's what he sees and that's what motivates him in an immediate sense. The problem is that it's become
increasingly difficult through the years, with the inflationary process, to rely on your judgment about what the appropriate level of
interest rates is. The alternative is to rely upon these quantitative
indicators and, as I said earlier, I would not go all the way on any
50
single one of them. I think you have a variety of indicators that
you have to assess in terms of what's influencing them and what is
not. As you know, a very basic economic relationship that has been
studied over literally centuries is the relationship between the
supply of money, or the things we call money, and inflation.
Senator SARBANES. How much worse do you expect the recession
to get?
RECESSION BOTTOMING OUT
Mr. VOLCKER. Our analysis is like that of many others, that we
think we are in at least the beginnings of the bottoming out and
the prospects are good for some recovery before midyear.
Senator SARBANES. Do you expect the unemployment figures to
worsen?
Mr. VOLCKER. In the very short run that seems to be likely, certainly since the January figure was a little flukish, but the unemployment figure lags recovery in ordinary circumstances.
Senator SARBANES. How high do you expect the unemployment
figure to go?
Mr. VOLCKER. I gave you some projections for the members of the
FOMC in general. The range for the fourth quarter that was cited
by FOMC members was 8.25 to 9.5 percent.
Senator SARBANES. What page?
Mr. VOLCKER. Page 25.
Senator SARBANES. Of course, that's the highest unemployment
since World War II.
Mr. VOLCKER. 9.5 would be the highest rate, I believe, since
World War II.
Senator SARBANES. That's not a very satisfactory economic performance.
Mr. VOLCKER. Clearly not.
Senator SARBANES. I come back to the point that to some extent
the high interest rates have contributed to the downturn and to
throwing people out of work. You have put us in a catch-22 situation. You express the concern over the deficit and yet the high interest rates contribute to the deficit by causing a slackening of economic activity, and every point on the unemployment rate is, what,
$25 to $30 billion on the deficit?
Mr. VOLCKER. We are caught up in a vicious cycle that we have
to get out of, but I have not expressed, I repeat, great concern
about the deficit this year insofar as its cyclical component is concerned.
Senator SARBANES. The viciousness of that cycle is not being felt
by you or by me directly. It's being felt by countless men and
women out there who have lost their jobs, who are unable to find
work, who have used up all their savings. They are selling off
whatever capital assets they have—businessmen who are going
bankrupt and small businesses that have got out. These people will
never be able to come back.
Mr. VOLCKER. I could not agree with you more, and that's why it
seems to me absolutely essential that we develop policies and programs that are going to get us out of this vicious cycle. This thing
was not invented in July 1981. Economic performance has deterio
51
rated literally, with some cyclical ups and downs, for 5 or 6 years.
If we were to just project that trend 10 years into the future, we
would have unemployment rates of a lot more than 9 percent. Let's
make this the finale to that unsatisfactory performance and get
some programs and policies in place that promise sustained recovery for all those people over a period of time.
Senator SARBANES. Well, we re not going to be able to do it as I
perceive it with your interest rates.
Mr. VOLCKER. They are not my interest rates.
Senator SARBANES. No, they're not. I take that back. It's a concerted policy, as I understand it, and obviously flows out of the discussions you have had with the President, but you've got one foot
on the accelerator and one foot on the brake.
Would you say that fiscal and monetary policy are working in a
complementary fashion today?
Mr. VOLCKER. Not with the budgetary deficits that loom out
there in the future.
Senator SARBANES. Well, thank you, Mr. Chairman.
The CHAIRMAN. Mr. Chairman, you have been very patient. I
only want to make one remark and I'd like Senator Sarbanes to
stay long enough to hear it. I don't disagree with anything anybody
has said today about the difficulties of the economy or how critical
it is. I think there's enough blame to go around for anyone. The
only disagreement I would have with Senator Sarbanes, or what
appeared to me to be at least some attempt to indicate this has all
been caused since Ronald Reagan became President, and my purpose is not to start a partisan debate or say there aren't some problems during this year. I don't like the $100 billion deficit, but I
would only say and reiterate what you just said, this has been
building for a long time. Both Republicans and Democrats have
served in this Congress. Lots of us voted different ways. I don't
think it adds to a solution of the problem to attempt to indicate
that its yours or Ronald Reagan's fault in 1 year. I seem to remember in November 1980, prior to the man being sworn in, the prime
rate was 21.5 percent. It was high during all of 1980—18, 19 percent except for a brief blip, and I certainly don't intend or think
it's useful to go back and suggest that was all Jimmy Carter's fault
and yours during 1980. There may be some sort of the blame, but I
really believe it's not useful to assess blame backward, forward, or
anything else, but attempt to get together, as you have said and
many others, and try to come up with a coherent, coordinated
fiscal and monetary policy that will attempt to get us out of this
cycle that has occurred during both Democratic and Republican administrations and Democratic and Republican Congresses.
So I just—Paul, I'm not trying to start anything.
Senator SARBANES. Well, you have started something, Mr. Chairman. Let me say I don't deny that we face tou'gh economic problems and we need to address them. The only point I'm making is
that the policies that are being pursued are compounding those
problems rather than easing them.
The CHAIRMAN. Well, I'm not going to get started.
Senator SARBANES. I don't see anything the chairman has said
here today that really differ with that. What we have had is an unemployment rate that was 7 percent in July that is now predicted
52
to go above 9 percent. That's $60 billion additional to your Federal
deficit, simply by that two-point increase in the unemployment
rate.
The CHAIRMAN. Senator, the statement you just made is quite
different than what you have been making. You said compounded.
I don't argue that one way or another. I don't think it's useful to
take the chairman's time to argue how much compounding has
gone on. I'm not satisfied with this budget, but the indication was
somehow that this has all occurred in 1 year, and that is the point
that I was trying to make. You're an economist. I'm not. And you,
better than anybody else, should know things in an economy like
this do not happen in a few weeks or months. They build over a
period of years and any attempt to blame it on anybody—I think it
would be terribly unfair if I, as a Republican, went back and tried
to say we have inherited every bit of this; it's all somebody else's
fault; it's all Jimmy Carter's fault. That's ridiculous. It isn't all
Jimmy Carter's fault and it isn't all Ronald Reagan's fault at this
point and I don't think trying to establish partisan blame is helpful
in the solution of the problem and that's all I'm saying, that I don't
think Paul Volcker and Ronald Reagan are conspiring to do this
any more than Jimmy Carter and Paul Volcker were conspiring to
do it, and this fiscal policy has been building for a long time before
you and I even served in the Congress.
ESTABLISHING A TRUST FUND
The last question I wanted to ask the chairman was on this debt.
It wasn't built by Jimmy Carter or Ronald Reagan. It had been
building for a long, long time. I want to ask you a hypothetical
question, not that I'm advocating this, but I've heard it discussed.
Because of the drag—to address how much impact even if we balance the budget immediately, that drag on the economy of carrying
and financing the trillion dollar debt, more than 13 percent of the
budget, is interest on the national debt? And second, the proposal
that's been talked about by some in establishing a trust fund such
as the national highway trust fund and imposing a 5-percent gross
receipts tax, not a value-added tax at all levels, excluding food and
drugs and necessities of that kind. It would raise close to $200 billion a year for the sole purpose of reducing the debt—apart from
attempting to reduce current additions to that debt, to reduce that
national debt over a period of several years to reduce the interest
cost and to reduce the drag on the private sector. Is that a feasible
thing to even consider?
Mr. VOLCKER. Let me respond quite quickly. I think the carrying
of the present debt, the carrying of a somewhat bigger debt in the
context of the kinds of things you would like to happen, would
present no great problem. In a disinflating world, we would certainly get interest rates down. Those interest payments would not
loom historically large in the context of the postwar period, if we
could curtail the debt and see interest rates come down. I don't
have the exact figures in front of me, but I think carrying the present debt is not a major problem, all other things being equal. We
would like to see it reduced, but we haven't done that for a long
time and that doesn't, in itself, present a great problem.
These proposals that you occasionally see for revenue segregated
to a trust fund to reduce the debt—and I don't know the particular
proposal you may be referring to—often have an aspect of evading
the problem. It doesn't do much good to run some revenues
through a trust fund dedicated to reducing the debt when, on the
other hand, you're running a bigger deficit and increasing the
budget.
The only thing that really affects the debt in the end is the surplus or deficit in the budget as a whole.
The CHAIRMAN. I don't disagree with you and, again, I want you
to understand that was not my proposal. I was just asking your
opinion. I'm not advocating that, but certainly if I were, it would
have to be a coordinating approach to balancing the budget to go
beyond and reduce that drag, to have additional tax revenues much
more rapidly than you could handle the individual budget to balance, and have some surplus, to actually have large reductions in
the total debt as rapidly as possible to reduce that drag too. So they
are talking about a double approach.
Mr. VOLCKER. Obviously, the problem strikes me as less urgent
than dealing with the deficit. I think you're really posing the question of do you go beyond that?
The CHAIRMAN. Well, less urgent, but $115 billion—you've got a
debt of $91 to $115 billion or so and if you start to eliminate some
of that interest, that's $115 billion in interest.
Mr. VOLCKER. Professor Tobin, whose name was raised by Senator Sarbanes, has in the past, I think, often made a point very close
to yours, that if we're worried about savings and private investment in the economy, a big source of savings would be a government surplus. That would be a better mix of policy—having a government surplus and freely available credit in the market would
support the private investment side of the economy and ultimately
the growth of the economy.
There's obviously a great deal to be said for that view. It sounds
to me more like the challenge of the next decade than this one, as
things stand at the moment, but I think it's useful to keep that
point of view in mind. If you're worried about a shortage of savings
in this economy, if you're worried about a shortage of business investment, productive investment, if you're worried about a shortage of housing, then running a government surplus and retiring
the debt releases savings for other purposes and relieves some pressures on the budgetary situation itself.
The CHAIRMAN. I couldn't agree with you more. I used to be
mayor of a city in a State that said, "Mayor, thou shalt balance thy
budget or thou shalt go to jail," so we balanced the budget.
I appreciate very much your patience. You have been here more
than 3 hours. You have been very kind to put up with all of these
questions, and the committee will stand in adjournment.
[Whereupon, at 1:10 p.m., the hearing was adjourned.]
[Material received for the record follows:]
54
I appreciate the opportunity to meet with members of
this distinguished committee today to discuss the direction
of monetary policy and the prospects for the national economy.
I have submitted for the record the official report from the
Board in accordance with the Humphrey-Hawkins Act.
I would
now like to take a few minutes to underscore and amplify some
of the points in that report, as well as 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.
55
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 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, arid 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 the sense of
commitment to deal with inflation.
To speed the transition to
56
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 -- to, in fact, 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, 3-1/2 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.
Expec-
tations 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 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.
57
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 competitively 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.
Quite obviously, policies that encourage that process of cost
moderation will have a large "pay off" in future economic performance .
I am acutely aware that progress on the inflation front
has been accompanied by historically high levels of interest
rates and heavy strains on financial markets.
Those sectors
of the economy particularly dependent on borrowing -- especially
long-term borrowing -- have been hard hit.
The pattern of economic activity last year shows the
picture clearly.
Over the course of 1981, the overall level
of production of goods and services -- real GNP -- posted a
slight increase.
But at the same time, home building dropped
to the lowest level in decades.
Sales of consumer durables -
car sales in particular — fell markedly.
And now capital invest-
ment by businesses also appears to be adversely affected, running
contrary to longer-term needs.
58
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 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 deep-seated
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 obviously are not.
It is
whether our policies, and our policy mix, promise to achieve the
59
needed results over time.
Monetary Policy in 1981 and the Targets for 1982
It is against that background that I would like to
review monetary policy last year and discuss our intentions
for 1982.
As you know, the main responsibility for dealing with
inflation has fallen on monetary policy.
I would emphasize
that the process of restoring stability will proceed more easily
and effectively, with less strain on financial markets and on
credit-sensitive sectors of the economy, to the extent the
effort is complemented and supported by other policies.
But,
in the end, history and theory alike confirm that no effort to
turn back inflation can be successful without appropriate
restraint on the expansion of money and credit.
I believe
the record of the past few years amply reflects the needed
monetary discipline.
The Humphrey-Hawkins Act specifically requires that we
translate our broad objectives into quantitative monetary and
credit targets.
More broadly, those targets have become one
means of communicating our intentions to the public in a comprehensible way.
The judgments involved in setting appropriate
targets are never simple, and they have been increasingly
complicated by the rapid pace of innovation in financial
markets.
Those innovations sometimes blur the precise meaning
of the various monetary and credit aggregates, complicate
their measurement, or change the economic significance of a
particular target.
In the circumstances, elements of judgment
60
are necessary in interpreting behavior of the aggregates,
particularly when their movements diverge somewhat.
The events of 1981 surely reflect those facts, but they
also seem to me to provide an unambiguous record of persistent
monetary restraint.
The targets we set for the year pointed
toward a reduction in the growth of the monetary aggregates
from the rates of expansion in 1980.
In our 1981 report to
the Congress, setting forth those targets, we also suggested
that changing preferences of the public for different types of
financial- assets —
influenced by regulatory developments and
new "products" offered by financial institutions -- might tend
to push the broader aggregate M2 to ttie upper part of its
specified range, and that judgments about the course of the
narrow aggregates -- Ml-A and B -- would require taking account
of shifts into NOW accounts, particularly during the early part
of the year when they were newly introduced nationwide.
These
expectations were borne out, but as the year progressed the divergences among some of the aggregates became even wider than expected.
Measured by comparing fourth quarter averages in 1980
and 1981, Ml-B growth {adjusted for the estimated shift of funds
into NOW accounts)* in 1981 was 2.3 percent, a little more than
*The "adjustment" allowed for shifts of funds into NOW accounts
and similar instruments included in Ml-B from sources outside of
Ml-B. The shift-adjustment was estimated on the basis of various
surveys of depository institutions and individuals, as well as
by statistical techniques. ML-& without adjustment rose by 5
percent, also below its indicated range. While the adjustment
was necessarily estimated, we believe the "adjusted" data are
more appropriate for assessing the trend in the money supply,
particularly during the early part of the year when shifts
were large.
61
one percent below the lower end of the target range specified
a year ago (see Table 1 attached).
You will recall that I
reported to you in July that an outcome near the lower end of
the range would be desirable.
Measured in the same way, M2 slightly exceeded the
upper end of its range after rather closely following the
upper bound as the year progressed.
The subsidiary target
range for M3 was exceeded by a greater margin, reflecting
in considerable part some changes in the composition of
commercial bank financing patterns toward domestic sources
that had not been anticipated, while bank credit fell within,
but toward the upper part of, its range.
In judging trends over a period of time, annual averages
may be more meaningful.
As Table 2 illustrates, average annual
Ml-B (adjusted) growth has declined by an average of 1.1 percentage point since 1978, to a rate of 4.7 percent in 1981.
On the same basis, M2 growth was steady in 1979 and 1980, but
actually rose by more than 1 percentage point in 1981.
Over
those years, both aggregates have been affected by institutional
change.
Relaxation of interest rate ceilings applicable to time
deposits of depository institutions and the enormous growth of
money market funds (both included in M2) tended to raise the
trend of M2 over the period as individuals had incentives to
lodge a larger proportion of their assets in these instruments.
Assets in money market mutual funds are not included in Ml, but
the enormous growth of those funds, providing virtually immediate
62
availability of funds and check-writing privileges, diverted
some money away from checking accounts in depository institutions
which are included in Ml.
Given the technical and institutional
changes bearing on Ml and its relative volatility, its movements need to be assessed in the light of developments
with respect to the other aggregates.
Indeed, a number of
analysts attach greater weight to M2.
Experience during 1981 also illustrates the variety of
forces impinging on interest rates and credit market conditions.
Over long periods of time, there should be a relationship between
interest rates and inflationary expectations -- that is, both
lenders and borrowers might reasonably anticipate a small positive
return on loanable funds in "real" terms, after allowing for
inflation.
When economic conditions were relatively stable in
the postwar period and inflation low, that relationship with
respect to long-term interest rates was fairly steady.
But
history is replete with deviations for a time in either direction,
and high levels of income taxation distort the comparison.
Before taxes, "real" interest rates (measured on the base of
actual inflation) were negative during part of the 1970's, but
recently have been extraordinarily high.
One factor, particularly
in long-term markets, appears to be concern about whether public
policy will, in fact, "carry through" the fight on inflation.
Even with inflation subsiding, the threat of prolonged
large Federal deficits
as the economy recovers points to a
more imminent concern -- direct government competition for a
63
limited supply of savings and loanable funds.
The clear
implication is greater pressure on interest rates than
otherwise, with those interest rates serving to "crowd out"
other borrowers.
The most vulnerable, of course, are home-
buyers and others particularly dependent on credit.
But the
consequences for business investment generally are adverse as
well.
Monetary policy, of course, influences interest rates,
but the relationship has several dimensions.
As monetary
restraint reduces and eliminates the risk of inflation over
time, it will work powerfully toward a more favorable climate
for longer-term borrowing, and in the credit markets generally.
In the short-run, should inflation, economic growth or other
factors increase the need and desire to hold money, restraint
on the supply of money will ordinarily be reflected in pressures
on short-term rates.
However, to accept inf1atipnary increases
in the money supply in an attempt to lower interest rates would
ultimately be self-defeating; even in the short-run, market
sensitivities might well give the opposite result.
Some of these inter-relationships were evident in 1981.
Short-term interest rates fluctuated over a wide range, but
generally trended down from peak levels in the spring or early
summer, falling particularly sharply as the recessionary forces
became apparent in the fall.
That was a period when pressures
on commercial bank reserve positions were easing, consistent
64
with our monetary and credit targets.
However, longer-term
interest rates continued to rise for months after the peak
in short-term rates, influenced in substantial part by growing
concern about prospective budgetary deficits.
As growth in the money supply rose more rapidly late
las t year, and a very sharp increase developed early in January,
the reserve positions of banks came under some renewed pressure
as Federal Reserve open market operations constrained the supply
of reserves.
At the same time, there were scattered signs
recessionary forces might be waning.
Short-term interest rates
rose from early November lows, although they remain well below
levels prevailing during much of 1981.
Some long-term interest
rates -- notably those on government securities -- returned
close to earlier peaks, suggesting the impact of current and
prospective Treasury financing.
This was the setting for the decision on the monetary
and credit targets taken by the Federal Open Market Committee
last week.
The sharp increase in the money supply in January
carried the level well above the fourth quarter 1981 average,
the conventional base for the new target, and somewhat above
the lower end of the range specified for 1981.
A large increase
in the money supply, accompanied by higher interest rates, is
unusual during a period of declining production and economic
activity.
Moreover, the composition of the money supply increase
in the past three months is heavily concentrated in a rather
small component of Ml -- HOW accounts, which are held by individuals.
65
That increase in NOW accounts has been accompanied by a
reversal of earlier sharp declines in savings accounts -another highly liquid asset -- and by declines in small time
deposits, which provide a less liquid outlet for personal
funds.
Taken together, the evidence suggests some short-
term '-- and potentially "self reversing" -- factors may be
ac work, inducing individuals to build up highly liquid balances
at a time of economic and interest rate uncertainty.
Taking those circumstances and others into account, the
Federal Open Market Committee decided to adopt the tentative
targets discussed last July:
for Ml, 2-1/2 to 5-1/2 percent;
for M2, 6 to 9 percent;
for M3, 6-1/2 to 9-1/2 percent.
The associated range for bank credit is 6 to 9 percent.*
The Ml target is lower than the range specified a year
ago for Ml-B (3-1/2 to 6 percent shift-adjusted), but it is
consistent with somewhat larger actual growth than experienced
last year with the "adjusted" measure.
The lower end of the
range would now appear appropriate only if the pace of financial
innovation again picks up -- for instance, a rapid spread of
*While all of the monetary ranges were set, as in previous years.
on a fourth-quarter to fourth-quarter basis, the range for bank
credit is measured from the average level in December 1981 and
January 1982 to the fourth-quarter 1982 level. This adjustment
in the base for bank credit is necessitated by the opening of
International Banking Facilities on December 3, 1981, which led
to a shifting of certain bank assets, formerly included in the
domestic bank credit data, from U.S. offices to the IBFs.
66
arrangements for "sweeping" temporarily excess checking account
balances into money market funds or other liquid assets not
included in Ml.
Given Che present level of Ml and the relatively
slow growth last year, the FOMC at this time feels that an outcome in the upper half of the range would be acceptable, and
that Ml could acceptably remain somewhat above the implied
"growth track" during the period immediately ahead.
In that connection, I would point out that an outcome
in the upper part of the range specified for 1982 would be
roughly the equivalent of a rate of growth of 4 percent from
the lower end of the range targeted in 1981, as illustrated on
Chart
i^
Such a result would be entirely consistent with
the objective I stated to your Committee in July.
The FOMC anticipates somewhat slower growth in M2 than
a year ago, when the target was slightly exceeded.
At present,
an outcome in the upper half of the range appears more likely
and desirable.
Assets included in M2 account for a significant
part of individual savings.
Should total savings increase sub-
stantially more rapidly than now anticipated in response to tax
incentives or other factors-- or if legal or regulatory changes,
such as the wider availability of IRA accounts, result in a
substantial volume of funds shifting into depository institutions
from other sources -- growth might logically reach (or even
slightly exceed) the upper limit.
67
Identifiable "structural" influences of that sort on M2,
or other aggregates, must appropriately he taken into account in
formulating policy steps and judging actual developments.
For
example, should developments in coming months provide solid evidence
that the recent exceptional growth of Ml is indicative of some
more fundamental and lasting change -- such as a desire by individuals to continue to hold more liquid "savings" in the form of
NOW accounts -- the FOMC would, of course, reconsider that growth
target at or before the regular mid-year review.
These technicalities should not confuse a simple message:
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
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
it be sustained over a long period.
-- that
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.
The Course Ahead
In approaching the future, the lessons of the past bear
repeating.
We cannot buy or inflate our way out of recession --
not without ratcheting up both inflation and unemployment over
68
time.
We cannot Curn the effort to deal with inflation "on
and off" -- not without adversely influencing the decisions
of those in the marketplace who commit funds for investment,
with consequences for the recovery and productivity we want.
What we can do is set the stage for a much more favorable
outlook -- a future in which progress toward price stability,
lower interest rates, greater productivity, slower growth in
nominal wages but higher real wages, all benignly interact to
support growth and reduce unemployment.
That's a process we
have not seen sustained in this country for many years.
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 turn, will permit' prices to rise more slowly than wages -more modest wage and salary increases in dollars will then be
consistent with more 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 turn support
the continuing growth in investment and productivity.
With
appropriate budgetary and monetary discipline, the process
could be sustained for years.
69
That is not an impossible vision.
of it in the early 1960's.
We saw something
As recently as the mid-1970's,
coming out of a deep recession, we seemed to be moving in
the right direction -- and then lost our way.
Some of the
essential elements of a brighter future -- as well as some of
the hazards on the way -- are reflected in the longer-term
projections of both the Administration and the Congressional
Budget Office now available to you.
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.
But, of course, for the process to get fairly started
we need to resolve some large outstanding questions as well -questions that hang heavily over financial markets and prospects
for interest rates, inflation, and early recovery.
I have referred on many occasions 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
70
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 marke ts
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, 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 pass 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.
were.
The latest economic indicators are not so weak as they
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.
71
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.
*******
Table 1
Monetary Growth 1981
1981 Ranges
Ml-B
Ml-B (shift adjusted)
M2
M3
Bank Credit
6 to 8-1/2 percent
3-1/2 to 6 percent
6 to 9 percent
6-1/2 to 9-1/2 percent
6 to 9 percent
1981 Actual*
5.0
2.3
9.4
11.3
8.8
percent
percent
percent
percent
percent**
^Fourth quarter to fourth quarter
**December level used for calculating this 1981 growth rate
incorporates an adjustment to abstract from the shifting
of assets from domestic banking offices to International
Banking Facilities.
72
Table 2
Growth of Money and Bank Credit
(percentage changes)
Ml-B*
M2
H3
Bank Credit
8.3
7.5
6.6
2.3
8.3
8.4
9.1
9.4
11.3
9.8
9.9
11.3
13.3
12.6
8.0
8.8**
8.2
7.7
5.9
4.7
8.3
8.5
8.3
9.8
11.8
10.3
9.3
11.6
12.4
13.5
8.5
9.4**
Fourth quarter to
fourth quarter
1978
1979
1980
1981
Annual average to
annual average
1978
1979
1980
1981
*Growth rates for 1980 and 1981 adjusted for shifts to other
checkable deposit accounts since the end of the preceding year.
**December level used for calculating these 1981 growth rates
incorporates an adjustment to abstract from the shifting of
assets from domestic banking offices to International Banking
Facilities.
Table 3
Monetary Growth Targets 1982
Ml*
M2
M3
Bank Credit
2-1/2 to 5-1/2 percent
6 to 9 percent
6-1/2 to 9-1/2 percent
6 to 9 percent**
*The objective for growth of narrowly defined money
over 1981 is set in terms of Ml. 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 Ml-B.
**The bank credit data after December 1981 are not
comparable to earlier data because of the introduction
of International Banking Facilities. Thus, the targets
for 1982 are in terms of growth from an average of
December 1981 and January 1982 to the fourth quarter
average of 1982.
73
Growth Ranges for 1981 and Actual
M1-B SHIFT-ADJUSTED
Billions of dollars
January 1 992 estimated on a basis comparable to sh IK-adjusts a M1-B in 1 981
1
1
.L.^l.^J
1980
I
I
1
1
I
I
I
I
1981
M2
Billions of dollars
— 1650
_!..__ I
I
1
[
I
I
I
I
I
74
Growth Ranges for and Behavior of M1, 1981 and 1982
Billions ot dollars
47O
75
Letter of Transmittal
BOARD OF GOVERNORS OF THE
FEDERAL RESERVE SYSTEM
Washington, D.C., February 10, 1982
THE PRESIDENT OF THE SENATE
THE SPEAKER OF THE HOUSE OF REPRESENTATIVES.
The Board of Governors is pleased to submit its Monetary Policy Report to the Congress pursuant to the
Full Employment and Balanced Growth Act of 1978.
Sincerely,
Paul A. Volcker, Chairman
TABLE OF COHTEHTS
Page
Section 1:
Monetary Policy and the Performance of the
Economy In 19R1
1
Section 2:
The Growth of Honey and Credit in 1981.
10
Section 3:
The Federal Reserve's Objectives for the Growth of
Money and Credit
,
..,,..
19
The Outlook for
23
Section 4:
trie Economy in
1982
76
Section 1:
Monetary Policy and the Performance of _the _Egouotty ifl 1961
The economy was growing rapidly as 1981 began, continuing the sharp
cyclical rebound that started in mid-1980.
spring and summer, however, and it
Activity leveled out during the
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 eate rose sharply to near postwar record levels.
While economic activity was disappointing last year, there were
emerging signs of progress in reducing Inflationary pressures.
The rate of
price inflation slowed from the extremely rapid pace of the preceding two
years, and as 1981 progressed there also were indications of an easing in the
rate of wage increases, particularly in some key pattern-setting Industries.
Confidence in the restoration of reasonable overall price stability is needed if economic growth is to be resumed on a sustained basts. The
accelerating inflation of earlier years had been eroding the foundations of
the nation's economy:
capital formation had slowed; productivity was sagging;
the functioning of basic market mechanisms was being impaired; and inequitable and capricious transfers of wealth were harming many of the weakest
among us.
The task of reversing the inflationary trend of earlier years was
made more d i f f i c u l t because a decade of escalating prices and unsuccessful
anti-inflation
policies had led to firmly held expectations of continued
high—if not accelerating—rates of inflation.
Thus, it was recognized that
reducing inflation would take time and that anti-Inflation policies would
77
Gross Business Product prices
Ctenge. from Q4 ID Q4. percent
Fixed-Weigh ted Index
1981
Qt
10.5
Q2
82
Q3
99
Q4
71
1977
—
1981
Real GNP
Change from Q4 to Q4, percent
1972 Dollars
1981
1977
1978
1979
1980
Q1
8.6
Q2
—1-8
Q3
1.4
Q4
-52
1981
Interest Rales
1981
78
have to be applied with persistence if they were Co he e f f e c t i v e In altering
expectations and slowing the rate of price IncreasesWhile fiscal policy and decisions made in the private sector have
much to do with the course of economic developments, economic theory and
experience alike Indicate that progress toward price stability cannot be
obtained without adequate restraint on the growth of money and credit.
tary policy was conducted in 1981 with this crucial fact in mind.
Mone-
The Federal
Reserve set objectives for the growth of the monetary aggregates that it
believed would help to damp inflation and would lead to movement over time
Coward trend rates of monetary expansion consistent with the growth of potential output at stable prices.
Short-term market rates of interest began 1931 at record levels, as
rapid growth of economic activity in the second half of 1980 had pushed up
the demand for money and credit faster than could be accommodated within the
target ranges for growth of the monetary aggregates and bank reserves.
Early
in 1981 these demands began to subside, pressures on bank reserve positions
were relieved, and money market r a t e s declined for a time.
A bulge in money
demand early in the second quarter w3S steadily resisted by restraining the
supply of reserves, and in the process short-term interest rates moved back
to their earlier highs.
By midsummer, short-term interest rates wete declin-
ing, as demands for money and credit slackened while the Federal Reserve
expanded nonborrowed reserves in an e f f o r t to maintain adequate monetary
growth.
Those Interest rate declines accelerated in October and November
as the recession took hold.
On balance, short-term interest rates—although volatile—moved
down considerably over the course of 1981.
In contrast, long-term rates
79
rose s u b s t a n t i a l l y over the period, despite declines in the last quarter of
Che year.
The pressure on long-term rates appeared to reflect a combination
of factors.
Anticipations that continued large federal budget deficits would
clash with private credit demands particularly as the economy expanded, putting strong pressures on credit markets, were a continuing strong investor
concern.
Despite reductions in the growth of many federal spending programs,
federal borrowing tn calendar year 1981 siphoned off roughly a quarter of the
total funds available to domestic nonffnancial borrowers.
In the background
were continuing doubts and skepticism that anti—inflation programs would be
carried through.
Moreover, the volatility of the markets nay have Inhibited
aggressive buying of longer-term securities.
The tensions In credit markets In 1981 had their greatest impact
on business and household capital formation.
Housing construction fell to
Its lowest level in the postwar period; only 1.1 million new housing units
were started in 1931.
The weakness in real estate markets last year
reflected
a number of influences.
Of paramount Importance, In the short run, was the
cost of mortgage f u n d a .
The average rate on mortgages closed for new hones
was 15.3 percent in the fourth quarter of 1981, up from 12.6 percent a year
earlier.
demand:
But it was not higher mortgage rates alone that cut into housing
high prices also adversely a f f e c t e d the ability of those seeking
new homes to a f f o r d 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 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.
80
Slow income growth and r i s i n g unemployment, alan.£ uith the increased
cost of c r e d i t , combined to damp consumer spending in 1981—particularly for
more discretionary, large t i c k e t itoffls such as a u t o s , f u r n i t u r e , and appliances.
Since the mid-1970s, household real a f t e r - t a x income has only been
rising at a 1/2 percent annual rate, compared with a long-run trend of 1 percent.
At the sane time, the prices of essential items such as food, gasoline,
heating f u e l , u t i l i t i e s , and medical services—as a group—have been rising
faster than the overall inflation r a t e , and the share of disposable income
devoted to these items has been increasing.
The resulting squeeze on family
budgets led many households to overextend themselves during the last half of
tne 1970s, taking on more and more debt to finance their purchases.
With household balance sheets debt-laden and credit costs rising, a
retrenchment in consumer borrowing began in 1980, and continued through 19B1.
As the year progressed, it appeared that household balance sheets were improving.
Consumer debt burdens (the ratio of monthly debt repayment obligations
to Income) declined to their lowest level in more than five years.
Moreover,
partly In response to the higher after-tax income following the tax cut on
October 1, the saving rate rose from about 5 percent In the f i r s t three
quarters of 1981 to 6 percent in the fourth quarter.
In real terms, personal consumption expenditures rose 1-1/4
over the four quarters of 1981.
percent
The gain was concentrated in the early months
of the year as real consumer spending fell, on balance, over the final three
quarters of 1931.
Purchases of new automobiles were hardest hit.
Sales of
domestically produced cars totaled 6.2 million units in 1931, the poorest
formance in 20 years.
per-
The depressed conditions in the auto sector were related,
81
-5-
in part, to the typical cyclical volatility in the demand for motor vehicles
and to credit market conditions, which affected the cost of financing new car
and truck purchases.
However, the current problems in the industry appear to
be related mainly to longer-term trends in automotive demand.
These include:
the rapid increase in the price of new cars, high gasoline and other operating c o a t s , sluggish real income growth, intense foreign competition, and
government regulations that have necessitated large investments to comply with
emission control standards and to improve fuel efficiency.
As 1981 was ending,
it appeared that the auto industry was taking aggressive actions to reduce
costs and to improve the competitiveness of its productsBusiness f i r m s , like households, restrained their spending on investment goods in 1981.
Demand was damped by a substantial degree of excess capa-
city and by the rising trend in corporate bond rates throughout much of the
year, which boosted the real cost of capital.
In real terms, expenditures for
new plant and equipment rose only 1-1/2 percent over the four quarters of 1981,
Although spending for new structures increased during the year, real equipment
outlays fell for the second year in a row; the biggest declines were for electrical machinery and transportation equipment, while spending for most other
capital goods remained weak.
In contrast to fixed investment outlays, sizable unintended inventory accumulation boosted business financing requirements.
As the year went
on, unexpectedly weak demand led to a build-up of excess stocks in several
industries.
The most pronounced problem was In autos, but other manufacturers
and retailers also found their inventory levels uncomfortably high relative
to sales.
On balance, total nominal business capital spending—fixed invest-
ment and inventories—rose about 20 percent above the 1980 average.
82
Early in 1981, strong economic growth helped boost corporate Internal funds, greatly reducing corporate needs for external financing.
But as
the economy slowed, corporate p r o f i t s turned sluggish and businesses were
forced to rely more heavily on credit markets to satisfy their rising capital
needs.
The bulk of business borrowing last year was in short-term markets,
as most firms felt it best to defer making long-run commitments In the current
financial environment-
With the accumulation of additional short-term debt,
however, corporate balance sheet positions deteriorated f u r t h e r , and the ratio
of short-term to total debt of the nfmfinancial corporate sector rose to a
record high.
Real purchases of goods and services at all levels of government
rose only moderately during 1981 as 3 sharp increase in purchases by the
federal government was partly o f f s e t by curtailed spending at the state and
local level.
The rise in federal spending on goods and services reflected
another large increase In defense purchases, while federal payroll reductions
helped to contain Increases in nondefettse outlays, fct the state and local
level, real purchases fell 2 percent owing to a combination of the withdrawal of federal support for many activities, the continued impact of tax
limitation measures, and the e f f e c t s of a sluggish economy on tax revenues.
The weighted-average value of the dollar against major foreign
currencies rose by nearly one-fourth during the period from January to
August.
The dollar eased somewhat In the last part of 1981, but at the end
of the 'year atlll remained well above Its year-earlier level.
The Improve-
ment in the Inflation outlook in the United States was a factor in the appreciation of the dollar.
Moreover, at various times during the year changes in
83
the d i f f e r e n t i a l between interest rates on dollar assets and rates of return
on foreign currency assets also had a noticeable impact on exchange rates.
Real exports of goods and services Increased in the first quarter
of 1981, in part because of strong GNP growth in one of our major trading
partners, Canada.
But for the next three quarters, real exports declined in
response to a slowing of economic growth abroad and the effect of the appreciation of the dollar in 1980 and 1981.
oil,
The volume of imports, other than
rose f a t r l y steadily throughout the year.
The current account, reflect-
ing this weakened trade performance, shifted from a surplus in the f i r s t
quarter to a deficit by the fourth quarter.
Employment grew at a moderate rate during the f i r s t three quarters
of 1981 and the unemployment rate edged down.
In the service and trade sectors.
Job increases were strongest
As economic activity began to contract In
the autumn, the demand far labor fell sharply and the unemployment rate
climbed to 8.8 percent In December—only fractionally below its postwar high.
L a y o f f s in the durable goods and construction industries accounted for much
of the drop in employment.
As a result, the unemployment rate of adult men—
who tend to be more heavily employed in these industries—jumped to a postwar
record of 7,9 percent in December of 1981.
Labor productivity (output per hour worked) showed considerable
fluctuation during 1981, reflecting the course of economic activity.
Produc-
tivity rose at a 1-1/4 percent annual rate in the first three quarters of
1981.
However, as often happens at the beginning of a cyclical downturn, out-
put fell more than employment in the fourth quarter and productivity declined,
o f f s e t t i n g the gains earlier in the year.
Averaging across short-run cyclical
84
-S-9-
movements, productivity has shown little improvement *n recent years, anil thus
has provided virtually no o f f s e t to the impact of rapidly rising compensation
on unit labor costs.
Compensation and wage increases did decelerate during 1981—with
continuing progress observed throughout the year.
But the slowing was moder-
a t e , reflecting the basic inertia of the wage determination process, where
many union contracts last three years or more and nonunion wage agreements
visually are set annually.
By the second half of 1981, however, some changes
in those traditional wage-setting practices were under way In several important industries:
management and workers alike began to reconsider planned
wage adjustments, some expiring contracts were renegotiated well in advance
of temination dates, and labor agreements at a number of firms were modified
in an effort to ease cost pressures and to enable them to compete more effectively.
These adjustments, coupled with the progress seen in reducing infla-
tion during 1981, suggest that the nation's anti-inflation policies have set
the stage for a sustained unwinding of wage and price increasesThe trend in inflation Improved noticeably during 1981, and by yearend virtually all aggregate price indexes were advancing well below doubledigit rates for the f i r s t 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 excep-
tionally favorable agricultural supplies and declines, after the first quarter,
in world oil prices.
Inflation In areas other than food and energy—particu-
larly consumer commodities and capital equipment—also began to abate, although
price pressures persisted in the consumer service sector, notably for medical
care.
As the year progressed, surveys of consumer expectations suggested that
the inflationary psychology, which had Increasingly permeated many aspects of
economic behavior in earlier years, appeared to be subsiding.
85
-10Section 2:
The Growth of Money and Credit in 1981
The Board of Governors in its report to Congress last February indi-
cated that the System intended Co maintain restraint on the expansion of money
and credit in 1981.
The specific ranges chosen by the Federal Open Market
Committee (FOMC) for the various monetary aggregates anticipated a deceleration In monetary growth that would encourage f u r t h e r Improvement in price performance.
Measured froa the fourth quarter of 1980 to the f o u r t h quarter of
1981, and abstracting from the e f f e c t s on deposit structure of the authorization of NOW accounts nationwide, the ranges adopted Were as follows:
for Ml-A,
3 to 5-1/2 percent; for Hl-B, 3-1/2 to 6 percent; for H2, 6 to 9 percent; and
for M3, 6-1/2 to 9—1/2 percent.
The associated range for commercial bank
credit was 6 to 9 percent.
In formulating its objectives for 1981, the FOMC knew that the growth
rates of the narrow aggregates would be a f f e c t e d markedly by shifts Into NOW
accounts which for the f i r s t time became available on a nationwide basis in
January,
Transfers into NOW accounts, which are included in Ml-B, from savings
deposits and other asset holdings not included In Ml were expected to be particularly large in the early months of the year.
Thus, in order to avoid confu-
sion about the intent of policy and to facilitate comparisons with previous
years, the objectives announced for Hl-B abstracted from such shifts.1
Even
after accounting for such s h i f t s , however, the FOMC anticipated that the growth
rates of the various aggregates were likely to diverge more than usual, reflecting the rapid pace of institutional change in financial markets.
The FOMC indi-
cated that if Ml-B growth (adjusted for shifts into new NOW accounts and other
1. The shift adjustments were estimated on the basis of survey evidence and
were published regularly over the past year.
86
checkable deposits) was about in the talddle of its annual range, the growth
of M2 was likely to be in the upper part of its
range, given the popularity
of the nontransactions components of M2 that pay market-related interest
rates.
It also was noted that the relationship of M3 and bank credit: to their
respective ranges would be Influenced importantly by the pattern of credit
flows that would emerge, and particularly by whether financial conditions
would be conducive for corporations to refinance short-term borrowing in the
bond and equity markets.
It soon became apparent as 1981 unfolded that the behavior of the
aggregates was turning out to be even more divergent than had been anticipated.
Growth rates of the shift-adjusted narrow aggregates were low in the opening
months of the year, a development that was welcome following rapid growth in
the latter part of 1980. A strong surge in April was o f f s e t by weakness over
the remainder of the second quarter-
On the whole, average growth in adjusted
Ml-B 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 Ml-B, the broader aggre-
gates expanded quite rapidly in early 1981. M2 growth over the f i r s t half was
near the upper end of ics annual range, while the expansion of M3 placed this
aggregate above the upper bound of its
range at midyear.
A f t e r reassessing its objectives for 1981 at midyear, the FOHC
elected to leave unchanged the previously established tanges for the aggregates over the remainder of the year-
However, in light of the reduced
growth in Mi-type balances over the first half of the year, indications that
this weakness might reflect a lasting change in cash management practices of
87
i n d i v i d u a l s and businesses related to the growth of a l t e r n a t i v e means of holding highly l i q u i d f u n d s , and given the relatively strong growth of the broader
ap>g r esates, the FOMC anticipated t h a t growth of the narrow aggregates might
likely and desirably ent! the year near the lower bounds of their annual
ranges.
Even so, given the sluggishness early in the year, this decision
implied that growth of Ml-A and Ml-8 would accelerate over the balance of the
year.
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
in part 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 the type of assets encompassed tn the broader aggregates.
Although growth of narrow money in the second half of the year was
on average about the same as in the first half, Ml-B strengthened appreciably
in the final two months of the year.
This acceleration appeared to reflect
in part a lagged response to large short-term interest rate declines in the
summer and fall and in part a shift in preferences for very liquid assets In
an environment of heightened economic and financial uncertainty.
Similarly,
M2 growth in the second half was about In line with expansion In the f i r s t
half, although growth in this measure also picked up at the end of the year.
The expansion In M3, on the other hand, decelerated from the rapid pace of
the first half", as sales of large CDs slowed In concert with a slackening in
bank credit growth and stronger growth in core deposits.
Measuring growth for the year from the fourth quarter of 1980 to
the fourth quarter of 1981, Ml-B growth adjusted for s h i f t s into NOW accounts
was about 2-1/4 percent—1-1/4 percentage points below the lower end of
its
Growth Ranges and Actual Monetary Growth
M1-A Shift Adjusted*
Billions at dollars
Annual Rate pi Growth
Range adopted by FGMC for
1980 Q4 to 1981 Q4
19800410 1981 O4
1.3 Percent
390
M1-B Shift Adjusted*
Bil'ions at dollars
Annual Rate of Growth
Range adopted by FOMC tor
1980 Q4 to 1981 Q4
450
19BO O4
to 1981 Q4
2.3 Percent
440
430
420
410
1980
M1-B
Billions of dollars
Annual Rate ol GroMh
Range adopted by FOMC for
1980 Q4 to 1981 Q4*
1980 Q4 to 1981 O4
5.0 Percent
1980
1981
Ad] us is a for irnpfld of naiinnwiae NOW account?
Growth Ranges and Actual Monetary and Bank Credit Growth
M2
Billions of dollars
Annual Rale of Growth
Range adopters by FOMC for
1980 Q4 to 1981 Q4
1980 Ql to 1981 Q4
1800
9 4 Percent
M3
Billions of Hollars
Annual Rate of Growth
Range adopted by FOMC tor
1980 Q4tO 1981 Q4
1980 O4 to 1981 Q4
11 A Percent
1980
Bank Credit*
Billions of dollars
Annual Rate of Growth
flange adopted by FOMC for
1960 Q4 to 1981 Q4
1980 O4 to 1981 O4
B.8 Percent
1200
December figure ia ad|ua*ed
90
-13targeterj range.*
Growth r a t e s , of course, are affected by the particular
pattern of variation that develops over the course of the year.
Measuring
expansion from December to December, "adjusted" Ml-B growth in 1981 was at a
3-1/2 percent rate.
On a yearly average basis, which reflects movements
through the year as a whole relative to the level of the previous year, the
increase was at a A—1/4 percent r a t e .
At the same time, measured from the
fourth quarter of: 1980 to the fourth quarter of 1981, growth of M2 was 9.4
percent, 0.4 percentage point above the upper limit of its range.
Also,
growth of M3 exceeded the upper end of Its range by 1.9 percentage points,
while bank credit growth was just Itiaide the upper end of Its annual range.
The table on page 14 puts the performance of the aggregates during
1981 into a somewhat longer-term perspective, showing two measures of annual
growth.
No matter which of the measures of annual growth is used, a marked
deceleration in Ml-B is apparent since 1978.
The table also clearly illus-
trates that growth rates for the broader aggregates have been maintained
around a higher level, and larger divergences have developed from Ml-B
growth.
In considerable part, these differences can be explained by struc-
tural changes in financial markets.
As noted earlier, It was already obvious last February when the
FOMC was meeting to set its objectives for 1981 that shifts into NOW accounts
following their nationwide authorization at the beginning of 1981 would alter
the behavior of the narrow aggregates.
Data for early January had pointed
to a very large movement of funds at the beginning of the year.
However,
1. Unadjusted for shifts into NOW accounts, Ml-B increased 5-0 percent from
the fourth quarter of 1980 to the fourth quarter of 1981.
91
Growth of Money and Bank Credit
(percentage changes)
Hl-B1
M-2
M-3
Bank
Credit 2
Fourth quarter to
fourth quarter
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
8.8
1978
8.2
8.8
11.8
12.4
1979
7.7
8.5
10.3
13.5
1980
5.9
ft. 3
9.3
8.5
1981
4.7
9.7
11.5
9.4
Annual average to
annual average
1. Growth rates for 1930 and 1981 adjusted for shifts to other checkable
deposit accounts since the end of the preceding year.
2. December level used for calculating these 1981 growth rates Incorporates
an adjustment to abstract from the shifting of assets from domestic banking
offices to International Banking Facilities.
92
-15-
the pattern and magnitude of subsequent movements could not be predicted with
any certainty.
As events unfolded, the s h i f t s Into NOW accounts were more
concentrated in the early part of 19S1 than was anticipated by the working
assumptions of the Board's s t a f f .
Through June, the adjustments made to the
aggregates to correct for such s h i f t s had the e f f e c t of raising tfl-A by $28
billion and lowering Ml-B by $9-1/2 billion.
Over the second half of 1981,
f u r t h e r adjustments for shifts Into NOW accounts raised Ml-A by only another
$6 billion and lowered Ml-B by about $2-1/2 billion more.
While these adjust-
ments are imprecise and based on evidence from a variety of sourcesi data on
the number of NOW accounts coupled with other available information confirm
that the shifting of funds from demand deposits to new interest-bearing checking accounts tapered off considerably by the fall.
A surge in HOW account
balances near the end of the year and early in 1982 appeared to reflect
pri-
marily the precautionary savings behavior noted above rather than shifting
of funds into new accounts.
As was indicated above, the growth of the narrow aggregates adjusted
for shifts into NOW accounts was low in 1981 compared with the other aggregates
and also relative to past relationships with income and interest rates.
Con-
tinued high interest rates provided a substantial incentive for businesses to
intensify e f f o r t s 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), many of which o f f e r
check-writing or other third party payment services comparable to conventional checking accounts, appeared to induce some households to minimize
checking account balances.
Also, the broader availability of NOW accounts
93
may have stimulated households to reconsider In a more general way thetr
habits of cash management.
Likewise, the strong growth of M2 over the past few years reflected
changing financial practices.
Money market 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 attractive-
ness of small time deposits was enhanced last year by the liberalization of
the interest rate ceilings on small savers certificates and to a limited
extent by the introduction of all savers certificates.
Even so, three-fourths
of the increase in the nontransactions components of M2 was accounted for
by MMMFs which grew 140 percent last year.
The distortions in the aggregates resulting from the expansion in
MMMFs are d i f f i c u l t
to quantify.
Surveys of household behavior and data on
account turnover suggest that most shareholders of money funds have nade
little or no use of their accounts for transactions purposes.
Thus, the
direct substitution effect of MMMFs on the growth of Ml has appeared small,
perhaps on the order of 1 percentage point on the rate of growth for the
year.
However, indirect effects may have been larger as the potential avail-
ability of such a highly liquid asset may facilitate holding less funds in
demand and MOW accounts.
The direct e f f e c t of MMMFs on M2 appears more substantial in dollar
terms.
Presumably, the great bulk of the $20 billion inflow in 1981 to MMMFs
catering only to institutional investors was funds that otherwise would have
been invested in assets not included in M2. In addition, It seems likely
94
-i/that a small portion of the $90 billion growth in other types of MMMFs also
reflected diversions from assets not in M2.
In light of the sizable distortions created by the growth of institution-only MMMFs, M2 has been revised to exclude such funds but they will
continue to be a component of M3.
In addition, M2 has been revised to include
retail RPs. Retail RPs, which previously had been a component only of M3,
were promoted on a substantial scale in 1981, likely attracting funds mainly
from household small time deposits and MMMF holdings and thus resulting in a
downward bias on M2 growth.
The net e f f e c t on M2 growth of reclassifying
institution-only MMMFs and retail RPa, along with other minor revisions, was
small.
M3 increased more rapidly than M2 last year largely because of the
substantial expansion in large CDs, particularly over the first half of the
year.
With growth of core deposits weak on balance over the year, depository
institutions increased their managed liabilities to support expansion in
loans and Investments.
Bank credit growth accelerated somewhat in 1981 but stayed just
within the upper end of its
annual target range.
growth was concentrated in business loans.
The pick-up in bank credit
Growth in this category was bol-
stered by the high level of corporate bond rates through most of the year,
which tended to focus business credit demands on short-term borrowing such as
bank loans and commercial paper.
Although merger activity contributed signifi-
cantly to the growth of loan commitments over the year, actual takedowns for
this purpose influenced loan growth only slightly.
Real estate loans at banks
in 1981 grew at about the same moderate pace as in the prior year, while
95
-13consumer lending strengthened a l i t t l e from 1980.
Security holdings at banks
grew somewhat more slowly than loans in 19S1.
The bank credit data in December were a f f e c t e d by the shifting of
assets to accounts In the newly authorized International Banking Facilities
(IBFs).
It is estimated that about $22 billion of loans to foreign customers
were s h i f t e d from U . S . o f f i c e s to IBFs in December.
report are adjusted for this s h i f t .
The data presented In this
Without this adjustment, the increase in
bank credit from the fourth quarter of 1980 to the fourth quarter of 1981 was
8-1/4 percent, one-half percentage point less than shown by the adjusted
data.
Broader measures of credit flows reflected the slowing pace of production and Income In 1981 and the e f f e c t s of high interest rates.
Households
and businesses continued to increase their borrowing over the first three
quarters, but their use of credit contracted in the fourth quarter in response
to the weakening of the economy.
In view of the high level of long-term
interest rates during most of 1981, virtually all of the Increase in funds
raised was In short-term debt instruments.
Overall, net funds raised by
nonfinancial sectors rose 7 percent In 1981 and continued to fall relative
to fiNP for the third consecutive year.
96
-19Sectlon 3:
The Federal Reserve's Objectives for the Growth of Honey and Credit
The Federal Reserve remains committed to restraint on the growth of
money and credit in order 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 f u r t h e r progress are good.
Failure to persist in the e f f o r t to
maintain the Improvement would have long-lasting and damaging consequences.
Once again, underlying expectations would deteriorate, with potentially adverse
e f f e c t s on financial markets, particularly long-term rates.
The result would
be to embed inflation even more deeply into the nation's economic system—with
the attendant debilitating consequences for the performance of the economy. A
failure to continue on the current path would mean that the next e f f o r t would
be associated with stll.1 greater hardship.
Progress toward price stability can be achieved most effectively
and with the least amount of economic disruption by the concerted application
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.
Thus, a policy of restraint on the growth of
the monetary aggregates is a key element in an anti-inflation strategy.
Targets for the monetary agB re S ate s have been set with the aim of
slowing the expansion of money over time to rates consistent with the needs
of an economy growing in line with its
stable prices.
productive potential at reasonably
The speed with which the trend of monetary growth can be
lowered without unduly disturbing e f f e c t s on short-run economic performance
depends, in part, on the credibility of anti-inflation policies and their
97
e f f e c t s on price expectations as well as on other forces i n f l u e n c i n g interest
rates and c r e d i t market demands, I n c l u d i n g importantly the f i s c a l position of
the federal government.
More technically, financial innovation or other fac-
tors a f f e c t i n g the demand for specific forms of money need to be monitored.
In its deliberations concerning the target ranges for 1582, the
Committee recognized that the recent rapid increase in Ml placed the measure
in January well above the average level during the fourth quarter of 1981, the
conventional base for the new t a r g e t .
Experience has shown t h a t , from time to
time, tfl. growth can fluctuate rather sharply over short periods, and these
iiovements may be at least partially reversed fairly quickly.
The available
analysis suggested that the recent increase reflected in part some temporary
f a c t o r s of that k i n d , rather than signalling a basic change in the amount of
snoney needed to finance nominal GNP growth.
In the light of all these considerations, the FOMC r e a f f i r m e d the
following ranges of monetary expansion—tentatively set out in mid-1981—for
the year ending in the fourth quarter of 1982:
for Ml, 2-1/2 to 5-1/2
cent; for M2, 6 to 9 percent, and for M3, 6-1/2 to 9-1/2 percent. 1
per-
The FOMC
also adopted a corresponding range of 6 to 9 percent for commercial bank
credit.
These ranges are the same as those agreed to in July and r e a f f i r m the
1. The objective for growth of narrowly defined money over 1982 is set in
terms of Ml only. Last February, when the FOMC set its targets for narrow
money, it was recognized that regulatory changes allowing for the establishment of nationwide NOW accounts would distort the observed behavior of Ml-A
and M-B. Accordingly, the targets were set on a basis that abstracted from
the shifting of funds into Interest-bearing checkable deposits. Based on a
variety of evidence suggesting that the bulk of the shift to NOW accounts had
occurred by late 1981, the Federal Reserve reaffirmed In December its previously
announced intention that starting in January 1982 shift adjustments would no
longer be published and only a single Ml figure would be released with the
same coverage as Hl-B.
98
Federal R e s e r v e ' s commitment to reduce I n f l a t i o n a r y forces.
As has been
typical in the p a s t , these changes are measured from actual f o u r t h quarter
levels ftfom the previous y e a r . ^
During 1931, Hl-B ( s h i f t - a d j u s t e d ) rose relatively slowly in relation to nominal GNP. 2
On the assumption that the relationship between growth
of Ml and the rise of nominal G'JP Is likely to be more normal in 1982, and
given the relatively low base for the Ml-B range, the Committee contemplated
that growth in Ml this year may well be In the upper part of its range. At
the sane t i m e , the FOMC elected to retain the 2-1/2 percent lower bound for
Ml 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, w i t h restraining e f f e c t s on Ml growth.
The actual and potential e f f e c t s on Ml of ongoing changes in
finan-
cial technology and the greater availability of a wide variety of money-like
instruments and near-monies strongly suggest the need for also giving c a r e f u l
a t t e n t i o n to developments with respect to broader money measures in the Implementation of monetary policy.
The range for M2 growth is the same as In 1931
when actual growth slightly exceeded the upper bound of the range.
The Com-
mittee contemplated that M2 growth in 1982 would be somewhat below the 1981
1. Because of the Introduction of International Banking Facilities, the bank
credit data after December 1981 are not comparable to earlier data. Thus, the
targets for 1982 are in terms of growth from an average of December 1981 and
January 1982 to the average level In the fourth quarter of 1982.
2. ML-B velocity, before shift adjustment, rose at a rate closer to historical
experience. However, the shift of funds from savings accounts or other sources
of funds not included in measures of the narrow money supply temporarily
depressed that velocity figure, particularly early in the year.
99
-22pace, a l t h o u g h probably In the upper part of the range.
However, should per-
sonal saving, 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 a t t r a c t an exceptionally large inflow to IRA
accounts from sources outside measured M2, growth of M2 might appropriately
reach—or even slightly exceed—the upper end of the range.
The ability of
depository institutions to compete for the public's savings will, of course,
also be a f f e c t e d In part by deregulatory decisions that may be made by the
Depository Institutions Deregulation Committee.
The 1982 ranges for M3 and bank credit were left unchanged from
those for 1981.
These aggregates again will he influenced importantly by
the degree to which credit demands tend to be focused on short-terra borrowing
and are funded at home or abroad.
100
-2V
Sectlonfr:
The Outlook for the Economy in 1982
Economic activity still appears to be contracting; industrial pro-
duction 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 spending—showed 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.
Recent weather-related disruptions may a f f e c t the incoming data for a time,
but it would appear that the economy is in the process of bottoming out, and
a perceptible recovery In business activity seems likely before midyear.
One element supporting final demands in the economy Is the federal
government.
Part of the recent expansion in the deficit reflects the cushion-
ing effects of reduced taxes and increased government expenditures that result
ftoa 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 that occurs in July will provide another
expansionary impetus to the economy.
At the same time, the deficit—particu-
larly if expected Co 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 vith 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 long-term interest rates continue to fluctuate near their
current high levels.
A continuation of high levels of long-term rates also
101
would I n h i b i t Che recovery in r e s i d e n t i a l h o u s i n g , although d e m o g r a p h i c factors will continue to buttress demands in that sector.
The e f f o r t to deal with I n f l a t i o n Is at a critical j u n c t u r e . The
upward trend In i n f l a t i o n clearly has been halted and the process of reversal
is underway.
There are signs that price setting, wage bargaining, and per-
sonal spending decisions are beginning to be made that over time will serve
to moderate, rather than intensify, inflationary pressures.
Nonetheless, the
behavior of financial markets and other evidence strongly suggests that there
continues to be considerable skepticism that progress in reducing Inflation
will be maintained.
Lasting improvement in financial markets—particularly
for longer-term Instruments—Is dependent on confidence that progress against
i n f l a t i o n 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.
How we emerge from the current recession will be crucial to further
curtailing inflation.
The recovery phases that have followed recent reces-
sions have sometimes been associated with an acceleration of inflation.
How-
ever, if monetary and fiscal policies are appropriately disciplined, this
pattern need not recur; and recovery from the current recession will be consistent with f u r t h e r progress towards achieving sustainable growth, price
stability, and lower levels of interest rates.
Given the Current circumstances and in light of the monetary aggregate objectives for the coming year, the individual members of the FOMC have
formulated projections for economic performance in 1982 that generally fall
102
-25within the ranges indicated in the table below.
expect inflation to continue to moderate in 1982.
The members of the FOMC
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 of the federal budget deficit remaining large even as the recovery
gathers momentum, demands for credit should intensify as the year progressesIn'these circumstances, the recovery is likely to be somewhat restrained,
with the result that unemployment probably still will be substantial at
year-end-
Economic Projections for 1982
Actual 1981
Projected 1982
Administration
FOMC members
Changes, fourth quarter to
fourth quarter , percent
Nominal GNP
Real GNP
GNP deflator
9,,3
0,.7
8..6
8 to 10-1/2
1/2 to 3
6-1/2 to 7-3/4
10 .4
3 .0
7 .2
8..3
8-1/4 to 9-1/2
8 .4
Average level In the
f o u r t h quarter , percent
Unemployment Rate
The FOMC member's projections generally encompass those that underlie
the Adminstration's recent budget proposals.
The consensus view of the
FOMC anticipates an 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.
I f , in the event, prices and wages should respond more
rapidly to anti-inflation policies than historical experience would suggest
or should more favorable productivity trends develop, then the recovery
could be faster without adverse pressures developing on prices, wages, and
Interest rates.
103
Chairman Volcker subsequently submitted the following responses
to questions from Senator Heinz in connection with the hearing
held before the Senate Banking Committee on February 11, 1982:
Question No. 1: Have wire transfer and money market funds
expanded the marketing of U.S. savings to foreign customers?
Answer:
U.S. money market funds hold about $22 billion
of deposits at foreign branches of U.S. banks, mostly in the
form of negotiable Eurodollar certificates of deposit.
Foreign
branches have used funds raised from these deposits to help
finance their overall banking operations.
Such deposits have
been increasingly important sources of funds to foreign branches
over the past few years—in part substituting for financing
obtained from U.S. offices.
In 1981, net financing by U.S.
banks of their foreign branches was reduced by about $5 billion,
and in addition the branches extended credits amounting to almost
$10 billion to nonbank customers in the United States.
As the
question implies, the development of wire transfer facilities
has improved the ability of money market funds to offer
attractive services,
Question No. 2: Is the demand for U.S. savings asserted from
abroad affecting availability of funds and the interest rates
in the United States?
Question No. 7: Does foreign demand for U.S. savings have an
impact on U.S. residential mortgage rates to the extent that
foreign demand for U.S. savings drives up mortgage rates in
the U.S.?
Answer:
U.S. international transactions on merchandise
trade and services (the current account) have been roughly in
104
balance in the past three years, indicating a near balance in
the capital, account on a net basis.
Within this net balance
there have been sizable increases in U.S. private assets abroad
(capital outflow) and in foreign assets in the United States
(capital inflow).
The latter includes a new inflow on unidenti-
fied transactions, which may in part represent foreign credits
to U.S. residents that are not recorded in our statistics.
This net balance on capital account is the most
appropriate statistical measure of the extent to which the
United States is a net exporter or importer of savings.
As
noted above, the United States has not been investing substantial
amounts abroad on a net basis in the past three years, and in
1977 and 1978, the United States had deficits on current account,
which were financed through net foreign investment in this
country.
More generally, net capital flows to or from abroad
{less than $10 billion annually in recent years) are relatively
small compared to total U.S. credit flows ($400 billion in 1981),
and net foreign demand for funds would not be expected to have
a significant effect on interest rates or overall availability
of credit in the United States.
Thus, foreign demand does
not appear to be a significant factor affecting U.S. mortgage
rates.
Question No. 8: Does this adversely affect the economic recovery
in the U.S. and the flow of revenue to the Treasury?
Answer:
Economic recovery would be assisted by an
increase in U.S. exports and an improvement in our current
105
account position, and recovery would contribute to U.S. Treasury
revenues.
However, the outlook is for rising U.S. current
account deficit. As noted in the answer to questions 2 ans 1,
this deficit would be associated with a rise in the flow of net
foreign investment into the United States.
Question No. 3: Are foreign governments borrowing directly in
the U.S. through the issuance of bonds and notes? Are these
bonds and notes being purchased by tax free pension funds?
Answer:
Yes, foreign governments borrow directly
in U.S. capital markets, as they have for many years.
In 1981
bonds issued by foreign governments and businesses together
represented less than 3 percent of total long term borrowing
in the U.S. market in that year.
Available information shows
small holdings of foreign government securities by pension funds.
Question No. 4: Are foreign banks and businesses borrowing
directly in the U.S. and is their debt being sold to pension
funds?
Answer:
Foreign banks and businesses (including
government-owned businesses) do borrow in the United States
through issuance of bonds and notes and of commercial paper.
Foreign borrowing in the form of commercial paper has been
growing, but it is still less than 10 percent of the total
amount of commercial paper issued in the United States.
Present information suggests that pension funds are not
active purchasers of such short-term debt instruments.
106
Question No. 5: Are U.S. and foreign branches of Money Center
Banks using certificates of deposits sold to money market funds
as a source of funds for foreign loans?
Answer:
Money market mutual funds currently hold
about $45 billion in domestic CDs and approximately $22 billion
in Eurodollar CDs.
Since banks raise funds from a variety of
sources and make loans to a wide range of customers, it is not
possible to trace the specific uses of a particular source of
funds to the banks.
However, the following data can help put
these figures in perspective.
As of September 1981, U.S. chartered banks held about
$400 billion in total claims on foreigners, mainly in the form
of loans and credits extended by their foreign branches.
This
is an amount six times as large as their sales of domestic
office and Eurodollar CDs to money market mutual funds.
Most
of the funding for these foreign loans has come from foreign
deposits and interbank borrowings from foreign banks.
Question No. 6: Is the consumer of shelter in the U.S. now
competing in an international money market for the use of U.S.
savings?
Answer:
Over the last several years participation
by U.S. residents in international financial markets has grown,
and U.S. and international money markets have become more closely
integrated.
The closer integration of these markets has meant
that all users of funds, including those who seek new mortgages,
now compete for funds more actively than before.
The more
significant effect on the cost and availability of mortgage
107
credit in the U.S., however, has come from the effects of inflation on interest rates, especially long-term rates, and the
greater competition and deregulation in our domestic financial
system.
Question_N_g_. 9: Are foreign governments transferring their
deficits~and the expenses of their social programs to the U.S.
economy by borrowing in the U.S. capital market and by borrowing
from foreign branches of banks dollars raised in the U.S.?
Answe_r:
Foreign governments finance budget deficits
through borrowings in both domestic and foreign markets.
Generally, the amount of governmental borrowing undertaken
in external markets is related to the external position of the
country in question.
A country with a large deficit on current
account (perhaps attributable in part to sizable purchases of
oil) will have to borrow abroad net in order to finance the
current account deficit if it is to avoid drawing on its international reserves; some of the external borrowing may be private
and some may be governmental.
Foreign governments borrowed $10 billion in 1981
from U.S. banking offices compared with $7 billion in 1980.
(Their total borrowing from foreign branches in the two years
combined was about $1 billion.)
These figures are small in
relation to the aggregate budget deficits of the borrowing
countries, and also small in relation to the total external
borrowings of these countries.
Foreign governments have also
borrowed relatively small amounts in U.S. capital markets.
Net U.S. investment abroad in 1980 and 1981 increased by less
than the above-cited figures on foreign government borrowings,
reflecting net capital inflows on other transactions.
108
Chairman Volcker subsequently submitted the following responses
to questions from Senator Riegle in connection with the hearing
held before the Senate Banking Committee on February 11, 1982:
Question Mo. 1: Mr. Chairman, you are quoted in this morning's
Wall Street Journal as desiring to continue "a steady trend of
diminution"in growth of the money supply in order to reduce
inflation. If this is your long term objective wouldn't it be
desirable to have a 3-year target for money growth rather than
a 1-year target?
Wouldn't that create greater stability—if your long
run goals were numerically explicit?
Answer:
As you noted, I believe that money growth
must moderate over a period of time in order to achieve a
lasting reduction in inflation.
However, I do not think that
it would be wise for the Federal Reserve to establish or announce
numerical goals it would pursue for several years into the
future to achieve this goal.
Within the context of a basic
policy to slow money growth, the Federal Reserve needs to
maintain flexibility in setting each year's targets for monetary
expansion so that it can adjust for developments in the economy
and financial markets.
For example, innovation in financial
instruments and practices in our economy, that is, in the way
people choose to hold their money, makes it difficult to formulate monetary targets over extended periods that can be relied
on confidently to achieve their intended effects.
If multi-
year targets were established, inevitably it would be necessary
to revise them if financial practices evolved (in response to
changing incentives or regulations), a process that could confuse the public about the basic thrust of monetary policy.
109
Question Ho. 2: What would be the practical and economic consequences of following the type of stable money growth policy—
week-to-week—desired by Mr. Regan and Mr. Sprinkel? Would
interest rates behave differently? Would real economic activity
be affected?
Answer:
Efforts to achieve stable week-to-week or
even month-to-month expansion in money growth would in my view
give rise to even more sizable short-term swings in interest
rates than we are now experiencing.
The Federal Reserve recognizes
that money stock growth has been volatile over short periods,
and WQ are constantly reviewing suggestions for changes in our
techniques or regulations that would help improve our control
over money.
For each suggestion, we weigh the gains from the
potential for greater stability of short-run money growth against
the possible drawbacks to financial markets or the economy.
The weekly money stock numbers are a highly erratic series,
subject to substantial revision, heavily influenced by uncertain
adjustment fr
seasonal patterns, and influenced by a variety
of short-tern- factors, including shifts in demand for money,
that often are subsequently reversed.
To force this series
to follow a rigid path might necessitate wrenching adjustments in financial markets to counteract inherently short-term
fluctuations.
Moreover, movements in money generally must
persist for some period of time to have a lasting effect on
economic activity or inflation, so there would seem to be little
to be gained in terms of improved performance of the economy
from strict adherence to a fixed weekly or monthly path for
money.
110
Question No. 3: It is my understanding that you have a choice
of controlling money growth or short term interest rates, and
that prior to October 1979 you paid more attention to interest
rate stability. Have your new procedures helped to stabilize
overall economic performance? What effects have they had on
the real—as opposed to the financial economy?
Answer:
October 1979 did not mark a change in the
targets the Federal Reserve was trying to achieve; both before
and after that date we were trying to meet our nation's economic
goals by attaining growth rates for the monetary aggregates
within specific - target ranges.
Prior to October 1979, however,
we were attempting to attain our money stock targets by
manipulating short-term interest rates; since then we have put
primary emphasis on changes in the volume of bank reserves to
achieve our money stock objectives.
The former method did tend
to be associated with fairly smooth patterns of short-run
movements in money market interest rates, but it also tended
to produce growth in money and credit that sometimes deviated
appreciably from Federal Reserve intentions.
The new technique
increases the probability that the Federal Reserve will achieve
its money growth objectives, but at some cost in greater shortrun volatility of interest rates.
The effects of the Federal Reserve's new operating
procedures on aggregate economic activity are difficult to
assess.
Many other factors have also had an important impact
on activity in the last two years, and it is not possible to
separate the effects of one or another of these influences.
By speeding the response of interest rates to changing conditions
in the economy the new procedures should help to damp fluctuations
Ill
in economic activity—allowing rates to decline more rapidly
when conditions weaken and to pick up faster as the economy
expands.
The new procedures have contributed to the welcome
slowing in inflation we have experienced in recent months
because they have enhanced the Federal Reserve's ability to
achieve desired money growth.
Further moderation in cost and
price pressures will be necessary to establish the noninflationary environment that is a precondition for sustained
growth in economic activity.
By making progress toward this
goal more likely, the new techniques contribute to enhancing
our prospects for sustained growth in incomes and living
standards.
112
Question No. 4: Mr. Chairman, monetary policy has had rather
severe effects on housing and autos and the types of products
that are complementary to them. Manufacturing capacity is now
at 73 percent. Unemployment is at 8.5 percent. We have some
evidence that from July to December of last year while the
number of jobs in goods-producing industries declined, the
number in service industries actually increased. A pattern
similar to this—decreasing jobs in goods and increasing jobs
in services—occurred during each of the previous three recessions .
Does your analysis of the intended effects of monetary
policy on the economy—your judgment or your models—take into
account the structural shift in the economy from manufacturing
to services? Does tight monetary policy have the same effects
on goods production as on service production?
Answer:
In analyzing the effects of monetary policy
on the economy, the Federal Reserve pays close attention to the
varying responses of different sectors of the economy.
noted, goods-producing
As you
industries have experienced much wider
swings in activity than service industries through recent business
cycles—expanding more rapidly in upswings and contracting more
severely in recessions.
In the case of recessions, for example,
when consumers experience sluggish income growth, they postpone
purchases of many goods to the extent they can continue to use
previously purchased items; consumption of most services
generally cannot be so readily put off.
Second, houses and
durable goods are more often purchased on credit than are
services, so that the rise in interest rates that often occurs
as inflation accelerates in the late stages of a business cycle
tends to discourage subsequent sales of these goods relative
to services.
Because of their sensitivity to interest rate
movements, goods-producing industries have been especially
affected in recent years by the over-reliance on monetary policy
to curb inflationary pressures.
A more balanced policy mix
that included a less expansionary budget posture would help
moderate interest rate pressures and permit the burden of
reducing inflation to be borne more equitably by different
sectors of the economy.
113
Answer:
One important difference between 1975-76
and the current situation is the outlook for federal government
borrowing in the foreseeable future.
Although the deficits
in the earlier periods were very high, there was every expectation that they would decline substantially as the economy
resumed expansion.
In contrast, today many are predicting
even higher budget deficits for coming years even on the assumption of a resumption in economic growth.
Concern that massive
federal government borrowing will continue even as private
credit demands once again begin to climb as a result of economic
recovery has contributed significantly to the current elevated
level of interest rates, especially long-term rates.
A second difference is in investor attitudes towards
future inflation.
Currently, investors have not yet been con-
vinced that we have made lasting progress against inflation—
that a reemergence of price pressures will not occur in
association with renewed economic growth.
This skepticism
was not as evident in the mid-1970s, and steins I believe
largely from past developments when gains against inflation
were subsequently reversed, and the pace of price increases
rose to new heights.
Because of this experience, savers and
borrowers apparently do not believe that the government will
carry through on its anti-inflation policies.
Lasting declines
in interest rates therefore seem to require that we demonstrate
our intention to persist on our policy course.
In this context,
a more responsible budget policy would help to reduce rates
both by directly reducing actual and prospective credit demands
and also by demonstrating that all facets of economic policy
were working towards the same goals.
114
BOARD OF G O V E R N O R S
FEDERAL R E S E R V E S Y S T E M
WASHINGTON, D. C. 3 0 5 5 1
C A U L A. V O L C K E B
March 11,
1982
CM*.**..*
The Honorable Jake Garn
United States Senate
Washington, D. C. 20510
Dear Senator Garn:
As promised during my February 10
appearance before the Senate Banking Committee,
I've attached a staff evaluation of the column
by Milton Friedman that appeared in the
February 15 issue of Newsweek. Hope this proves
helpful to you.
Sincerely,
115
Evaluation of Friedman Newsweek Column
Thomas D. Simpson
In assessing v a r i a t i o n s in narrow money growth in recent years it
is
important to note t h a t the narrow money stock has been s u b j e c t to a number of
highly unusual influences.
In p a r t i c u l a r , Ml c o n t r a c t e d sharply following the
imposition of credit controls in March 1980 and l a t e r rebounded.
to this p a t t e r n was a large c o n t r a c t i o n in money
Contributing
demand stemming from the drop
in income and the subsequent jump in money demand associated with the resurgence of income folloving Che removal of credit c o n t r o l s .
In addition, growth
in Ml over the f i r s t several months of 1981 was raised s i g n i f i c a n t l y by the
new availability of NOW accounts nationwide as the public shifted balances
from savings accounts and o t h e r non-demand deposit sources to neuly-opened NOW
accounts.
More g e n e r a l l y , money demand is h i g h l y v o l a t i l e , especially over
short periods of time, and in recent years there have been times during which
sustained downward s h i f t s in the detnand for transactions d e p o s i t s have occurred,
r e f l e c t i n g more intensive application of sophisticated cash Management techniques .
A number of measures are suggested by Mr. Friedman to reduce variability in monetary growth.
These are: adopting contemporaneous reserve require-
ments; selecting a single monetary t a r g e t ; imposing equal reserve ratios on the
monetary aggregate to be c o n t r o l l e d ; linking the discount rare to a market r a t e ;
and reducing defensive open market operations.
An evaluation of each of these
measures follows :
1.
Contemporaneous reserve requirements (CKR).
This proposal has
the p o t e n t i a l for strengthening the relationship between reserves and the money
stock in the very short run of a week or month.
Departures of money from p a t h
would give rise Co more immediate pressures in the reserves market that would
more p r o m p t l y tend to return the money stock toward path.
However, the degree
116
of improvement o f f e r e d by CRR is open to d i s p u t e among e x p e r t s and w o u l d be h e a v i ly dependent upon w h e t h e r it was combined w i t h o t h e r c h a n g e s , such as those l i s t e d
below.
P o t e n t i a l gains in m o n e t a r y c o n t r o l from a d o p t i n g CRR a l o n e can be exagger-
a t e d , and lead to u n w a r r a n t e d a s s u m p t i o n s as to its
e f f e c t i v e n e s s . Over a l o n g e r per-
iod of t i m e , such as a q u a r t e r or m o r e , the c o n t r i b u t i o n of CRR to monetary
trol w o u l d l i k e l y be s m a l l e r .
con-
The Board has expressed a d i s p o s i t i o n to r e t u r n to
CRR—pending i n v e s t i g a t i o n s o f i t s f e a s i b i l i t y — a n d soon w i l l take o p t h i s m a t t e r
again.
2.
A _$_L_tigle monetary target.
In vieu of the v u l n e r a b i l i t y of the v a r i -
ous m o n e t a r y a g g r e g a t e s to h i g h l y u n p r e d i c t a b l e i n f l u e n c e s in an era of rapid
fi-
n a n c i a l c h a n g e , f o c u s i n g on j u s t a s i n g l e m e a s u r e of Che noney stock would lead to
much d i f f e r e n t outcomes for f i n a n c i a l m a r k e t s and the economy depending on the measure s e l e c t e d .
For example, in 1981 Ml-B a d j u s t e d for s h i f t s to BOW a c c o u n t s ran
below the lower end of its
target
range o v e r most of the y e a r , w h i l e H2 and M3 ran
at or above the upper end of t h e i r r a n g e s .
The weakness of Ml in 1981 is believed
to r e f l e c t e x t r a o r d i n a r y e f f o r t s by the p u b l i c — in response to high interest r a t e s —
to s t r e a m l i n e procedures for m a n a g i n g narrow money balances.
U n u s u a l l y rapid
growth of W2 was in p a r t r e l a t e d to the s h a r p l y r i s i n g share of this m e a s u r e h a v i n g
market determined yields.
E f f o r t s to restore Ml growth to its
range l i k e l y w o u l d
have been associated with both even faster M2 and W3 growth and adverse expectat i o n a l e f f e c t s , w h i l e e f f o r t s to ensure that M2 and M3 growth f e l l within t h e i r
ranges would have been a s s o c i a t e d w i t h a Z a r g e r s h o r t f a l l of HI
and canter f i n a n -
cial c o n d i t i o n s .
3.
A s i n g l e reserve r a t i o on the aggregate to be controlled.
it
is
w i d e l y agreed t h a t a single reserve r a t i o on d e p o s i t s in the monetary aggregate
to be c o n t r o l l e d
and no reserve r e q u i r e m e n t s on o t h e r deposits would reduce slip-
page between the s u p p l y of reserves and this a g g r e g a t e .
Tte Monetary Control Act
117
r e p r e s e n t s an i m p o r t a n t s t e p i n che d i r e c t i o n o f i m p r o v i n g c o n t r o l o v e r t h e n a r r o w
money s t o c k b y e s t a b l i s h i n g u n i f o r m r e s e r v e r e q u i r e m e n t s o n t h e t r a n s a c t i o n s d e p o s i t s of all
depositor)' i n s t i t u t i o n s — 3 p e r c e n t on an i n i t i a l reserve tranche
(S2G m i l l i o n per i n s t i t u t i o n
posits-
i n 1982) and 1 2 p e r c e n t o n a l l
o t h e r t r a n s a c t i o n s de-
By the terms of the A c t , d e p o s i t o r y i n s t i t u t i o n s are p h a s i n g in over time
to the new reserve s t r u c t u r e , and thus u n i f o r m i t y w i l l be a c h i e v e d when t h i s phasein process has e n d e d .
In a d d i t i o n , the Board is given a u t h o r i t y to lower to zero
the reserve ratio on other lia.biliti.es.
A.
Linking the discount r a t e to a m a r k e t r a t e .
r e l a t i o n t o market rates a f f e c t s
The d i s c o u n t r a t e in
t h e w i l l i n g n e s s o f d e p o s i t o r y i n s t i t u t i o n s t o bor-
row reserves from the d i s c o u n t windou a n d , in the case of a nonborrowed reserves
o p e r a t i n g t a r g e t , the o v e r a l l s u p p l y of reserves and the money s t o c k .
In view of
a d m i n i s t r a t i v e c o n s t r a i n t s on b o r r o w i n g and a general r e l u c t a n c e of depository
s t i t u t i o n s t o borrow reserves from t h e d i s c o u n t w i n d o w , l i n k i n g t h e d i s c o u n t
in-
rate
to an open market r a t e c o u l d , w i t h a nonborrowed reserves o p e r a t i n g t a r g e t , lead
to m u c h s h a r p e r swings in inteveet rates and the money s t o c k .
An expansion in
re-
serve needs of d e p o s i t o r y i n s t i t u t i o n s t h a t was not met t h r o u g h open market operat i o n s , f o r e x a m p l e , w o u l d l e a d to more i n t e n s i v e b i d d i n g for reserves in the
serves m a r k e t — a s i n s t i t u t i o n s
re-
i n i t i a l l y a t t e m p t e d to avoid t u r n i n g to the window —
and the federal funds rate and other money market rates would rise.
Higher money
rnarket r a t e s a c c o r d i n g to the f o r m u l a w o u l d lead to a h i g h e r d i s c o u n t rate w h i c h
w o u l d put s t i l l f u r t h e r upward p r e s s u r e on money m a r k e t rates and so f o r t h .
Such
a p o l i c y w o u l d run the risk of excessive r a t c h e t i n g of the r a t e s t r u c t u r e upward
and downward in. response to temporary disturbances to money demand or supply s i d e
s h o c k s and of c o n t r i b u t i n g to c y c l e s in the money s t o c k .
W i t h a t o t a l reserves or m o n e t a r y base o p e r a t i n g t a r g e t , changes in the
w i l l i n g n e s s to borrow reserves would not a f f e c t the s u p p l y of t o t a l
reserves as
118
c h a n g e s in borrowed r e s e r v e s w o u l d , in concect . be o f f s e t c o m p l e t e l y by open m a r ket operations.
T h u s , w i t h a t o t a l reserves o r m o n e t a r y base t a r g e t p r e s s u r e s
in the reserves a n d - m o n e y m a r k e t s arid m o n e t a r y c o n t r o l w o u l d be about the same
r e g a r d l e s s of discount window p o l i c y .
W i t h a t o t a l reserves or monetary base
t a r g e t , t h o u g h , i n t e r e s t rate v o l a t i l i t y w o u l d b e g r e a t e r a s h i g h l y v o l a t i l e
money demand movements would be r e f l e c t e d more f u l l y in interest r a t e f l u c t u a t i o n s .
5.
Reduce d e f e n s i v e open m a r k e t o p e r a t i o n s .
Defensive open market op-
e r a t i o n s a r e i n t e n d e d t o m i n i m i z e t h e impact o n t h e s u p p l y o f
reserves o f f l u c t u a -
t i o n s i n n o n t o r i t r o l l e d f a c t o r s a f f e c t i n g reserve s u p p l y , such a s F e d e r a l Reserve
f l o a t and Treasury d e u o s i t s .
In the a b s e n c e of such defensive a c t i o n s , the s u p p l y
of reserves w o u l d f l u c t u a t e w i d e l y on a day-to-day and weelt-to-week b a s i s , thereby
c a u s i n g f l u c t u a t i o n s in the stock of money and money market c o n d t i o n s .
The m e a s u r e s s u g g e s t e d by Mr. Friedman w o u l d lead to more v a r i a b i l i t y in
interest r a t e s .
Their i n f l u e n c e on the precision of monetary control w o u l d , on
b a l a n c e , be u n c e r t a i n , over a longer h o r i z o n of a q u a r t e r or so, a l t h o u g h c o n t r o l
m i g h t be improved in the short run.
In g e n e r a l , m e a s u r e s to s t r e n g t h e n m o n e t a r y
c o n t r o l in the short r u n , such as a d o p t i o n of CRR and more emphasis given to
con-
t r o l l i n g t o t a l r e s e r v e s , w o u l d also give rise to larger f l u c t u a t i o n s in i n t e r e s t
r a t e s , r e f l e c t i n g the h i g h l y v o l a t i l e n a t u r e of money demand in the short
run.
119
j
The Yo-Yo Economy
MILTON FRIEDMAN
I
he present recession is notable not monlhsby an acceleration in spendable in- through bank reserves—was welcomed by
for its severity, but for its timing Its come, output and employment; and each many of us. Unfortunately, howtvel. the
onset cut short an expansion that had lasted decline in monetary growth, by a retarda
actual changes in procedures, though faronly twelve months (from July 1980toJu[y lion. Consider the following pattern, which reaching,didnotgofarenoughloena'ble the
1981)—the second shortest expansion in averages out some of the gyrations:
new procedures lo produce the desired re1. From Oct. 3,1979. to April 30, 1980, suits. Aslnotedinrnyearliercolumn.it was
the more than 100 years of U.S. history for
which economists have dated business cy- MI.B (currency plus checkable deposits, one step forward, two steps backward
The technical steps needed to end yo-yo
cles. Moreover, that expansion followed the now relabeled M t ) declined at an average
shortest recession, on. record—the six- annual cat* ot ,1 percent, A. cyclical recev monetary growth w* well known and the
month recession that lasted from January to sion came three months later, from January Fed has the authority to take (hem. They
have the support of most monetary econoJuly 1980. If the current recession also 1980 toluly 1980.
proves to be brief—as most economic fore1 From April 30,1980, to April 22,1981, mists inside and outside Ihe Federal Recasters anticipate—we shall have experiI.B grew at the annual rate of 9.9 percent
serve System. They include: replacement of
enced by far the shortest triplet of recession- A cyclical expansion came three months lagged reserve accounting by contemporary
later, from July 1980 to July 1981
expansion-recession.
reserve accounting: selection of a single
monetary target to replace the
Gyrating InttrtM RtttK
What accounts for this unprecFed's juggling between targets,
INTEREST RATES FOLLOW MONEY
depending on which one gives.
edented ly erratic behavior of
the U.S. economy? The answer
the most favorable picture of
Annul RiW ThiH-Honth Traiwry BHi
Monty
that leaps to mind is the correFed policy; imposition of equal
Ttir*t
Four
Fin
Turning
Dttt
Inttnnl of Clung*
WMkiUltr
InWMti *>«n
spondingly erratic behavior of
Point
percentage reserve requireinterest rates. Short-term interments
on all deposit compo11.6% «-t* (2^%
P*ak
Oct3,1979
tM rates had already hit histor- ' Trough
nents of the selected target;
12.1
Nov. 28. 1979
t
11.0
•1.4%
111
ic highs in 1979. In the next two 1 PMK
linking
the discount rate to a
16.6
14.1
+12.1
15.3
Fab. 20, 19BO
12
years, the rate on three-month
market rate; reduction in the
8.2
7.5
Trough April 30, 18SO
7.7
-12.4
10
Treasury bills bounced up and
churning that the Fed engages
Nov. 26. 1980 30
14.3
14.6
+15.0
16.J
P«ak
down between a high of nearly
13.B
in (so-called "defensive open14.4
14.2
Feb. 4, 1981
10
Trough'
-13.1
1E.6
16.6
1B.B
April 22. 1991 11
17 percent and a low of a triF>«ak
+23.8
tnwfcrt operations").
1S.4
-10.*
15.1
1S.S
July 1,1981 10
fle over 6 percent—gyrations i Trough
Lip Service The Fed knows
13.4
13.4
13.1
Sept. 16. 19B1 11
*7.a
wilhout precedent during the , PM*
how to produce more stable
10.4
10.3
Trough
10.2
•5.1
Oct. 28. 1991
6
monetary growth. The probmore than a century f°r which
+24.6
Jan. 13. 19B2
11
, Peak
19.2t
lem B th»t, despite the lip servwe have data.
rougnfr k* MOW •ecovn
H"*1"•**i
What produced the unprece- t
ice Ait they pay to that objecttiei. Ihe key policymakers of
dented volatility in interest
rates? The accompanying table suggests the
1 From April 22, 1981, to Oct. 28. 1981, the Fed do not regard the achievement of
answer: unprecedented volatility in mone- MI.B declined at the annual rale if 1.3 stable monetary growth as sufficiently imtary growth. The first pan of the table up- percent, A cyclical recession started three portant to justify the bureaucratic disrupdates one that I recently published in my months later, in July 198!.
lions required.
column (NEWSWEEK, Dec. 2l)and records
If this pattern continues, and the moneMost discussions of monetary policy centhe volatility in monetary growth. The sec- tary explosion from Oct. 2B, 1981, to Jan. teron whether pobcy is 'loo tight" or "loo
ond pan shows what happened to short- 13, 1982, is not fallowed promptly by a easy." That is MM my complaint. Average
term interest rates some weeks after each up decline of comparable size, this recession monetary growth over the past two years
and down of the monetary yo-yo. The evi- too will be a short one. Indeed, it may has been fairly good—decidedly lower than
dence is dramatic. Four out of five surges in already have passed what will subsequently earlier. That is why inflation has been dethe quantity of money were followed by a be recognized as a trough.
c lining. However, the average conceals the
rise in the Treasury-bill rate; all five declines
As in a good mystery story, we now know erratic alternation of "too tight" and "too
in the quantity of money were followed by a what happened but not yet who—or, in this easy." That ahertution has put the econodecline in the bill rate. It is notable also that case, whal—triggered these developments, my through > dismaying roller coaster. It
the one exception—after the Sept. 16,1981, The crucial clue is given by the dating. The must be replaced by steady monetary
peak in monetary growth—followed the unprecedented volatility of the money sup- growth in order for the Fed to regain the
smallest rise in monetary growth.
ply followed the Federal Reserve's Oct. 6, confidence of the financial community and
The yo-yo swings in monetary growth
1979, announcement of a major change in for President Reagan's economic program
affected the economy directly, as will as its operating procedures. The objective of to succeed in botii ending inflation and prothrough interest rates. Each surge in mone- the change—to move from operating viding a stable basis for healthy, noninGatary growth was followed after some through an interest rate to operating tionary economic growth.
FEDERAL RESERVE'S FIRST MONETARY
POLICY REPORT FOR 1982
THURSDAY, FEBRUARY 25, 1982
U.S. SENATE,
COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS,
Washington, D.C.
The committee met at 9:30 a.m. in room 5302, Dirksen Senate
Office Building, Senator Jake Garn (chairman of the committee)
presiding.
The CHAIRMAN. The Banking Committee will come to order. We
don't have our witnesses yet, but that doesn't stop me from starting the committee on time and breaking my own unbroken record
of being punctual.
Mr. Schechter, would you like to come up and start your testimony? You are on the second panel but you're here on time and I see
no reason why you and I should wait. Is either Mr. Sumichrast or
Mr. McKinney here? Mr. McKinney, will you come up, too?
We are happy to welcome you two gentlemen here not only on
time but way ahead of your time scheduled to speak. Mr. McKinney, would you like to begin?
STATEMENT OF GEORGE W. McKINNEY, JR., SENIOR VICE
PRESIDENT, IRVING TRUST CO., NEW YORK, N.Y.
Mr. MCKINNEY. Well, we are pleased and honored to be here, sir.
I will have to find my piece of paper before I begin but I've got it.
[Complete statement follows'.]
PREPARED STATEMENT BY GEORGE W. McKiNNEv, JR., SENIOR VICE PRESIDENT IRVING
TRUST Co., NEW YORK CITY
Mr. Chairman, members of the Committee. I am George McKinney, senior vice
president, of the Irving Trust Company, New York City, and chairman of the bank's
Economic Advisory Committee.
One subject for comment today is Federal Reserve policy since mid-1981. In my
opinion, the Federal Reserve has done an unusually fine job in a very difficult environment. Inflation has slowed markedly and will likely improve even more. The
Federal Reserve's actions have been critical in achieving that result. The Federal
Reserve is to be particularly commended for not trying to fine-tune money growth.
The Federal Reserve started moving to an easier money policy last summer, just
about the time the recession got under way. Ml growth was sluggish, and the Federal Reserve wanted to get it back on track. Policy eased progressively but moderately
until near year-end, when money growth picked up again. In spite of the Federal
Reserve's moderate actions, though, money growth surged in December and January. Again, the Federal Reserve took the appropriate course of moderation. Instead
of slamming on the credit brakes and forcing interest rates to much higher levels, it
chose to move gradually, to tolerate for a while what appeared to be a temporary
aberration. The sizeable decline in Ml reported last week gives supportive evidence
that the right decision was made.
(121)
122
The Federal Reserve could have taken a more extreme, doctrinaire course by
trying to fine-tune money growth. Visualize what would have happened, though, if
the Federal Reserve had tried to force money growth to stay in a narrower range
throughout this period: Last fall, at a time when rates were already dropping from
the 18 percent range to the 12 percent range, a fine-tuning policy would have called
for aggressive ease. When money growth subsequently speeded up, and moved above
targets, as it did anyway, fine-tuning would have required very aggressive tightening,
The result would have been more severe disruptions in financial markets, a much
sharper decline in interest rates than actually occurred, a subsequent very sharp
rise in rates to levels well above where they are now. There's no way that such a
policy could have benefited the economy. In fact, the uncertainties engendered by
such extreme market instability probably would have caused businessmen to cut
back more sharply on their investment plans, and the present recession would likely
be deeper than it is. The prospects for recovery would be less favorable.
Throughout this period, the Federal Reserve has followed a consistent course of
moderate, tenacious resistance to inflation. That program was well conceived and
has been well executed.
MONETARY STRATEGY FOR 1982
Circumstances severely limit the Federal Reserve's options in setting and pursuing policies today. The fight against inflation is one that must be pursued steadily
over a period of years, Of course there should be room for flexibility, for give and
take in the execution of policy as business and financial conditions change. But that
flexibility must be structured around a basic, continuing policy of moderate restraint.
FISCAL POLICY CONSIDERATIONS
Such a policy of restraint would be more effective if it were accompanied by a less
expansionary fiscal policy. Large structural deficits threaten severe damage to the
economy, and the most enlightened monetary policy can't prevent it.
Let me distinguish between structural deficits and those that are caused by recessions. A substantial part of the near-term deficit now in prospect will happen purely
because of the recession. Government tax receipts will fall because incomes are off;
public benefit outlays will rise because more people are out of jobs. Such recessioninduced deficits should not be cause for concern. They cushion the impact of the
recession, and then they go away when the recession is over. Most of the 1982 deficit
will be due to the recession. That is not the deficit I'm talking about.
The real problem is the structural deficits—those that are caused by overt policy
actions, deficits that will be around in 1983, 1984, 1985, after the recession is behind
us. Those deficits threaten serious harm to the Nation's economy.
The conflict between a moderately restrictive monetary policy, necessary to
combat inflation, and heavy Federal borrowing to finance the deficit sets up an unavoidable sequence of events that compresses the business cycle, shortens and intensifies it. We are looking at the results right now: high and volatile interest rates,
cash flow problems for thrift institutions and other industries, rising bankruptcies,
rising unemployment.
Large Treasury deficits take a big share of the total funds available in credit markets. Funds raised under Federal auspices took a third of the total last year, and
will take something like that share again this year. That doesn't leave much room
for private credit. Yet, if business is to expand, it must have funds to carry inventories and to finance capital outlays. Those growing private demands for credit have
to be met from a supply of funds severely depleted by Treasury borrowing, so interest rates rise disproportionately. Rates quickly reach levels that make it too costly
to finance inventories. Businesses liquidate the inventories, pull back on capital
spending plans. Interest costs cut into cash flow so sharply that some firms go out of
business. Production is cut back. Unemployment rises. That's the process that put
us in the current recession.
Yet the deficit has another side. It adds to after-tax incomes of consumers and
businesses as government pays out more than it takes in. Thus it stimulates spending. Sooner or later, this stimulus wins out over the inventory and capital spending
cutbacks. Business begins to rebuild inventory, capital spending picks up. Borrowing
needs increase. But, because the deficit soaks up so much of the available funds,
interest rates rise disproportionately. And the stop-go business cycle starts over
again.
123
Thus large structural deficits have two extremely damaging characteristics. They
drive up interest rates and make them more volatile. They shorten the business
cycle and make it more violent.
nKFK'lTS COUUl SCUTTLE ANTI-INFLATION PROGRAM
The structural deficits now in prospect could thwart the Administration's resolve
to slow government growth and stop the. inflation. That could come about in either
of two ways.
One: backlash. If short-run pain from high interest rates and high unemployment
gets too bad, people may despair of ever being able to stop inflation, and vote for the
old ways of demand stimulus. The result would be what we had in the (ids and 70s:
accelerating inflation, unemployment stairstepping up to ever-higher levels, a
nation progressively weakened by living off its own capital.
Two: large deficits and tight money could hold interest rates above expected profits for an extended period of time, causing a severely protracted recession or depression.
Interest rates will respond to the decline in the inflation rate, and when they do
the change may be rather abrupt. But it doesn't always happen as quickly as we
would like. Interest rates can be stubborn. Sometimes they give up current levels
only reluctantly. It might be useful to review two periods when the inflation rate
declined sharply, but the response of interest rates was quite limited.
First, the early 1920's. For the 3 years 1918-1920, inflation averaged a compounded 1(5,0 percent. Over the next 3 years, the average was minus 5.2 percent—a swing
of 21.2 percent in the inflation rate. The decline in interest rates was much smaller.
AAA corporate rates dropped from an average 6.12 percent in 1920 (the peak year)
to 5.12 percent in 1923.
Results in the period after 1929 were similar. Inflation averaged a minus 1.1 percent from 1927 through 1929. By 1933, though, the three-year compound inflation
rate was minus 8.1 percent—a decline of 7 percent in the rate of inflation. But interest rates declined very little, from 4.8 percent in 1929 to 4.5 percent in 1933—off
only 0.8 percent.
Rates tend to decline reluctantly, even when the inflation rate declines sharply.
Large deficits unnecessarily compound that problem by giving a further upward
kicker to rates.
MONETIZATION OF DEFICITS
Deficits, when monetized by the Federal Reserve, are inflationary. If the government runs a deficit and the Federal Reserve, in effect, prints the money to finance
it, inflation follows inexorably. If a deficit occurs because of an increase in, say, defense spending, the government spends more, but nobody else spends less. Or, if the
deficit results from a tax cut, government spends the same and others spend more.
It's the same principle.
But deficits can also be inflationary without any increase in the money supply.
Money-substitutes can do anything that money can do, and money substitutes are
growing fast these days. Credit cards, computer technology, money market funds,
and other fast-breaking developments are making money, as we once defined it,
nearly obsolete. Deficits financed by growth of these and other money substitutes
are just as inflationary as those financed by money growth per se.
A recent study by Victor Kung, an associate of mine, gives statistical confirmation,
of the impact of deficits on inflation. At my request, Mr. Kung studied the relationship between Federal deficits and inflation over the past two decades. His study replicates the results of other studies that conclude that money is the most important
single factor in inflation. With his econometric model, however, the five most recent
quarters of Federal deficits (adjusted to remove the effects of recession-induced deficits) explain some 43 percent of all variations in inflation, without including money
or any other factor as causal variables.
The implications for monetary policy are clear. The Federal Reserve cannot complacently assume that large deficits, even if they do not lead to faster money
growth, are innocuous. To achieve a given degree of overall policy restraint, monetary policy must necessarily be tighter to the extent that fiscal policy is easy.
PUBLIC PERCEPTIONS ARE IMPORTANT
It has been said that the high level of current interest rates reflects two concerns
in the financial community. Some fear that the Federal Reserve will revert to the
124
inflationary policies of the past. Others are concerned about the need to finance
large structural Federal deficits.
Two weeks ago, Banking Magazine put this question to the investment officers of
the nation's commercial banks, at the annual meeting of the Bank Investments Division of the American Bankers Association. Of those who responded one way or the
other, a majority of more than four to one felt that it was the prospects of large
deficits, not a fear of monetary policy change, that was scaring the bond markets.
They are convinced that the Federal Reserve will hold to its policies of moderate
restraint. This group of active market participants probably gives fair reading of the
level of concern in markets generally.
We cannot expect monetary policy to bring interest rates down to desired levels
unless there is some reduction in prospective structural deficits. As long as the
public is aware that deficits contribute to high rates, deficits will cause an upward
bias in market rates. This fact, too, limits the Federal Reserve's policy options.
PROPOSALS FOR TECHNICAL CHANGE
Several suggestions have surfaced recently, directed at technical changes to make
it easier for the Federal Reserve to hit its money targets in the short run. Yet the
basic assumption that short-run stability in money growth is achievable, and, if
achieved, is desirable, is highly questionable.
The benefits that might accrue from the suggestions I have seen for technical adjustments have been highly overrated. While in theory some short-run benefits in
precision of money control might be achieved, it is not clear that such a result
would have any long-term benefits whatsoever. The economy responds to money
growth only after a highly variable time lag, and money growth responds to Federal
Reserve actions only after a variable time lag. Further, random fluctuations in
money growth over short periods of time are considerably larger than the trend or
the targeted rate of money growth. If, over time, money growth should vary from
desired rates, the best policy is to move with deliberate caution to correct the unwanted variance. To move aggressively in response to what may be transient, unimportant movements in the money supply can be highly destabilizing.
MANDATED FIXED TARGETS
One suggestion made recently is that the Congress should require the Federal Reserve to adhere to a fixed rate of money growth. This could prove to be a very serious error.
For one thing, "money" is continuously changing. If we had been able to define
money perfectly 100 years ago, or 5 years ago, that definition would not hold today.
Financial markets are changing too rapidly. A long list of money substitutes serve
the functions of money today but didn't even exist a few years back. Specific targets
for money are almost certain to be obsoleted by technological change.
If, for example, a money target had been mandated in 1860, it would quite likely
have excluded checking accounts, which were then little in evidence. To have forced
expansion of currency and coin to meet pre-ordained targets at a time when unanticipated growth of new checking accounts was meeting the nation's needs for transactions balances would have been highly inflationary.
Or, if Congress had required a fixed money target beginning in 1979, the most
likely candidate for control would have been the old definition of Ml, which excluded NOW accounts. Yet it would have required a colossal expansion of credit to
keep money (by that definition) in its target range in 1981, because of the transfer
of huge amounts from regular checking accounts to NOW accounts. In both instances, mandated targets set in good faith would have forced an enormous monetary inflation, because of the continuing evolution of money.
Mandatory targets would not remove the need for discretion in monetary policy;
they would merely transfer policy discretion from the Federal Reserve to the Congress. Because money functions change, no fixed target can be set that would always
be a useful target. Discretionary changes wil) have to be made from time to time. If
the Federal Reserve is not permitted to make those changes as the need arises, then
the Congress as a body will have to do it.
However, the Congress is too large to make timely changes. It is not well constituted to deal with the continuing day-to-day responsibility for specific monetary
policy. That should continue to be delegated to the central bank, under the supervision of the Congress. The Federal Reserve is well designed to keep monetary policy
free from short-run or narrow-interest political pressures. That purpose is being
well served and should be continued.
125
MONETARY POLICY CHOICES FOR 1982
No matter what policies the Federal Reserve follows, interest rates are likely to
be relatively high and volatile as long as the outlook is for large, sustained structural Federal deficits. Any significant relaxation of monetary policy under these conditions would set off another inflationary spiral. And it would be much harder to get
the next spiral under control than to keep the present policies in effect while they
are getting results. Yet, as the deficit crowds private borrowers out of the market,
continued slowing of money growth is likely to trigger frequent recessions and will
slow real growth.
The choice is difficult, but obvious. Continued moderate monetary restraint will
subject us to intermittent short-run economic problems. But it will also slow the inflation and set the stage for sustained real growth in future years. That is the only
policy stance the Federal Reserve can really consider. What does that imply for
targets?
In the long run, the Federal Reserve and the Congress to which it reports should
try very hard to find some way to break away from rigid money targeting. Markets
have become so sensitized to money growth data that random swings and seasonal
aberrations elicit exaggerated, destabilizing reactions. It would be far better to
target nominal GNP, total credit, or perhaps some other broad objective.
In the short run, though, there seems to be little choice other than to select a
money target and adhere to it—with a considerable amount of discretion. A wider
target range would give the Federal Reserve leeway needed to adjust policies to
changing financial and economic conditions in the course of the year, and should be
considered. Thus I conclude that, with the exception of broadening the target bands,
the targets proposed by the Federal Reserve seem quite appropriate for today's economy.
The CHAIRMAN. Thank you very much, Mr. McKinney. I appreciate you filling in. If both of you would just continue to sit there at
the table, our first panel is now here. Secretary Sprinkel and Mr.
Jordan, if you would like to come up and occupy these two chairs,
Beryl Sprinkel, would you like to proceed with your testimony?
STATEMENT OF BERYL SPRINKEL, UNDER SECRETARY FOR
MONETARY AFFAIRS, DEPARTMENT OF THE TREASURY
Mr. SPRINKEL. Thank you, Mr. Chairman. I apologize for being 5
minutes late. We ran into an unanticipated traffic jam.
The CHAIRMAN. I understand .that. You would not anticipate a
Senate committee starting on time, so I'm not critical. Usually you
could be 20 minutes late and not have missed anything, but not
with this committee.
Mr. SPRINKEL. I understand that. If I have your permission, I will
submit the complete text for the record and present a shorter version.
The CHAIRMAN. Certainly. Mr. Schechter and Mr. McKinney,
your full statements will be placed in the record also.
[Complete statement of Mr. Sprinkel follows:]
STATEMENT OF BERYL W. SPRINKEL, UNDER SECRETARY OF THE TREASURY FOR
MONETARY AFFAIRS
It is a distinct pleasure to be here this morning to offer you the views of the Administration on monetary policy. While the Federal Reserve is an independent institution which is accountable to the Congress, the Administration considers monetary
policy to be a crucial element in the economic recovery program. Without actions to
ensure a steady moderate pace of monetary growth, inflation would continue to
plague the economy, severely blunting efforts to restore growth of production and
employment. As President Reagan stated last week, "I have confidence in the announced policies of the Federal Reserve Board." Their stated policy is gradual reduction in money growth.
While the various schools of economic thought often differ on the particular
causes of inflation, I believe that all serious analysts would agree that inflatLon can
126
persist only when it is accommodated by monetary expansion. The policy implication is that the elimination of inflation requires that the rate of money growth must
ultimately be reduced from the rapid pace of recent years to a level in line with the
expansion of real economic activity. This is the foundation of the Administration's
anti-inflation program and is the basis of the current policy of the Federal Reserve.
I reemphasize the point—a permanent reduction in the rate of monetary expansion is a necessary requirement for reducing inflation. The Administration also believes that a steady, moderate pace of money growth is sufficient to ensure long-run
price stability. With a moderate pace of monetary expansion, the effect of factors—
such as oil price shocks—that can cause temporary price changes, would not be
translated into an ongoing general inflation. But even those who would rely less on
monetary policy to fight inflation or, who argue that the current effort is too intense, recognize that any effort to control inflation ultimately requires, at a minimum, slower money growth.
We must keep this long-term requirement in mind as we consider the more immediate problems in the economy. The implementation of an effective anti-inflation
program has been delayed for many years by continually focusing on immediate
conditions and futile attempts to provide quick and painless solutions to stagflation.
Ironically, the perceived costs of fighting inflation were not avoided, but instead
only postponed, to grow larger each year. At last, we have an opportunity to make
significant progress in permanently reducing inflation; and the key is to continue
the effort to restrain the rate of monetary expansion.
The task of monetary policy is to reverse the rising trend of money growth that
has produced similar trends of accelerating inflation and rising interest rates. This
goal focuses, by necessity, on relatively long-term relationships, which unfortunately
often appear to clash with concern for the immediate economic situation. The attention of the monetary authorities cannot be diverted, however, to providing shortterm expedients. The focus must remain on reducing the trend of money growth.
Every journey must begin with the first step and the Federal Reserve took that
step in 1981, holding the rate of money growth to 5 percent. If that step had not
been taken last year, inflation would have become more deeply entrenched in the
economy. In addition, the problems of unemployment and financial stress associated
with moving to a noninflationary monetary policy would have grown larger. These
are problems that must ultimately be faced—the longer we procrastinate, the longer
inflation continues, the larger these problems become.
The Administration's support for the policy of reducing the trend of money
growth is complete. It is of critical importance that the growth of money—Ml—be
held within the announced target range this year. In particular, concerns for the
budget deficit should not interfere with actions to control money growth. The Administration does not expect the Federal Reserve to make any concessions on its
monetary targets for the purpose of monetizing the deficit.
Deficits are not a monetary problem. Instead, the prospective government borrowing bears on the competition for savings in the economy. Budget deficits over the
next several years would indicate excessive growth of government spending, which
would be financed in competition with private investment. While we expect the
supply of savings to increase sharply, allowing expansion of private investment,
large deficits would, nevertheless, represent a substantial absorption of credit by the
government. Thus it is important that the Administration and the Congress work
together to restrain the growth of government spending, with the clear intention of
balancing the budget.
We should recognize that the immediate or short-run effects of slower money
growth are quite different from the ultimate impact. In the long run, slower money
growth would result in less inflation, thereby reducing the growth of nominal
income and the level of nominal interest rates. The transition to slower money
growth—as we move from the excessive 8 percent growth of recent years to a noninfiationary pace—can have temporary but substantial effects on real economic
activity.
In a sense, the restriction of output and employment that we now feel is the inevitable payment for past monetary excesses. At the same time, however, it is possible
to reduce these transitional costs and it is desirable to do so, since they involve the
real burdens of unemployment and loss of income. Thus, a policy of achieving a noninflationary rate of money growth addresses half of the problem. Equally important
is the way in which that policy is implemented.
The problem is that economic policymakers are not starting with a clean slate.
We all wish that someone could wave a magic wand, wipe out the effects of past
failures and allow the economy to start from scratch with the assurance that inflation is finished. Unfortunately, the effects of past policy failures are deeply imbed
127
ded in all aspects of economic activity and that legacy has a dramatic effect on the
public's reaction to current and future policy actions. In terms of monetary policy,
the Federal Reserve faces the task of establishing the credibility of the policy to
reduce the rate of monetary expansion.
Policy failures of the past are now a major factor determining the economic
impact of current efforts to reduce money growth. Prior attempts to slow money
growth over the past 15 years resulted in several short-lived periods of monetary
restraint, but in each case money growth was subsequently reaccelerated to a
higher, more inflationary pace. As a result, the immediate impact of monetary restraint on real economic activity—in terms of lost output and employment—has
been intensified. In addition, the financial markets have become extremely sensitive
to short-term variations in money growth as potential indicators of yet another
monetary explosion. This sensitivity is reflected in high and volatile interest rates.
TRENDS AND FLUCTUATIONS OF MONEY GROWTH
The implications of current monetary policy and Federal Reserve policy actions
are influenced greatly by the economic trends that have developed over the past
several decades. As shown in the table below, the average rate of monetary expansion has accelerated steadily from the mid-1960's, This rising trend of money growth
was associated with a similar acceleration in the average rate of inflation.
1950 to 1965
1965 to 1970
1970 to 1975
1975 to 1980
1965 to 19SO
Note, however, that persistent monetary stimulus did not result in lasting gains
in output. Comparing the 15 years before and after 1965 reveals that average money
growth and inflation more than doubled, while the average growth of output declined slightly. The average rate of unemployment was almost one point higher in
the second period.
The relationship between money growth and economic activity has remained
fairly constant, as indicated by the accompanying chart (Chart I). Growth of nominal income continues to be related closely to the pattern of growth of Ml. Despite
widespread financial innovations, which offer a variety of alternative types of deposits, the basic underlying demand for money in the economy continues to be satisfied
by the narrow class of currency and deposits which comprise Ml. We are confident
that efforts to control the growth of Ml will be reflected in lower inflation and less
variation in nominal income.
The reduction of money growth to a 5 percent rate in 1981 was just the first step;
persistent action is required to reverse the trend of money growth and inflation over
the nest several years. The target for Ml growth which the Federal Reserve has
adopted for 1982 is another step in that direction. Holding money growth to 5 percent again this year would consolidate the gains which have already been made and
would ease the immediate costs of transition to a noninflationary path.
This moderate pace of money growth would provide the appropriate monetary environment for renewed economic expansion. It is not the cure-all for economic problems, but instead is the prudent nest step in establishing a permanent, noninflationary rate of money growth, while contributing to an environment which encourages
real economic growth.
As shown clearly in the table above, a secular acceleration of money growth did
not give us more real economic growth. We should keep this in mind in considering
the current economic recession. An effective anti-inflationary monetary policy will
not require sustained or unrelenting restriction of output and employment. Reducing inflation and stimulating economic growth are mutually consistent goals.
The notion that relying on monetary policy to fight inflation necessarily involves
an ongoing restriction of production and employment is based on a very short-sighted and incomplete view of economic relationships. Frequent references to the current situation are a case in point, but this situation is far from unique.
128
Monetary restriction in 1981 was a major factor contributing to the current economic recession. The slowing in money growth was abrupt and substantial, exceeding both the expectations of the Administration and the targets of the Federal Reserve. Given the prevailing trends, it was inevitable that such a sudden shift in
money growth would have a significant depressive effect on real economic activity.
While this effect involves real hardship for many sectors of the economy, it is, nevertheless, temporary and we would expect these depressive effects to wear off quite
soon. This is part of the basis of our expectation that the economic expansion will
begin this spring.
While some temporary restriction of production and employment is inevitable,
given the persistence of inflationary trends of the past 15 years, the severity and
duration of the restriction can be reduced substantially through prudent monetary
actions. In formulating the economic recovery program, for example, the Administration opted for a gradual slowing of money growth over several years. We saw this
approach as offering the economy time to adjust to a noninflationary environment.
The inflationary experience had become deeply embedded in all aspects of economic
activity—including wage negotiations and contracts, investment programs, financial
contracts and international currency markets. We thought that moving abruptly to
end inflation would probably result in severe short-term disruptions, as economic
activity would have to be reordered quickly.
In addition to reducing money growth gradually, the costs of transition to less inflation can be reduced if money growth is slowed steadily and smoothly. Following
years of volatile but ever-accelerating money growth, the financial markets are now
very cautious of large changes in money, even on a weekly basis. While it is certainly true that such short-term fluctuations should have no economic meaning or
effect, they do now have economic consequences because the financial markets react
to them.
Sudden swings in money growth, which persist for several months, have therefore
proven to be extremely disruptive to financial markets and the effect has spilled
over into real economic activity. The most visible symptom of the disruptive effects
of volatile money growth is high and volatile interest rates. While long-run monetary trends are ultimately the important consideration, short-term monetary fluctuations can be a potent force during the transition from an inflationary to a noninflationary trend of monetary expansion.
The problem is not that these very short term variations per se have fundamental
effects on economic activity. Instead, their importance stems from the environment
in which they occur. As shown by the experience in several foreign economies, variations in money growth can be absorbed with little disruption, once a basic noninflationary trend of monetary expansion is firmly established. Low inflation countries, such as Germany, Japan and Switzerland, have had smoothly declining monetary trends in recent years, even as they have experienced substantial short-term
monetary variability.
The history of monetary actions in the United States since the mid-1960's is very
different. As I have mentioned, prior efforts to control money growth were soon
abandoned and rapid money growth was reestablished. The table below presents the
major episodes of monetary restriction over the post-war period. Notice that each of
the severe economic recessions was preceded by an abrupt slowing of money growth
(column 2) and that this restraint was maintained into the recession (column 3).
Typically, however, money growth was then increased sharply (column 4).
Peaks
19481V
1953111
1957111
196011
19691V
19731V
19801
.
Iran gh
19491V
195411
195811
19611
19701V
19751, , .
196011
iKession1
0.4
3.3
1.0
2.1
6.9
7.9
8.2
•"""'
(2)
-0.5
H
0.1
-1.0
21
4.9
5.8
(31
<«)
- 07
OS
44
13
1.1
42
53
5.4
45
32
67
38
57
9.9
129
Prior to the mid-1960's, these cyclical variations in money growth Kad little effect
on underlying monetary trends. Despite frequent and large variations, the money
stock increased at an average rate of less than 3 percent from 1950 to 1965. Since
19ti5, however, the cycles of money growth have been around an increasing trend—
the rate of monetary expansion following a period of restraint was typically faster
than it had been prior to the restraint. Money grew 5 percent per year from 1965 to
1.970, at more than 6 percent over the next 5 years, and accelerated to over 7 percent per year from 1975 to 1980.
The only exception to this cyclical pattern came after the 1973-75 recession.
While money growth was increased somewhat following the recession, the pace was
in line with the prevailing trend. As a result, the economic expansion was accompanied by general decreases in interest rates and an easing of inflationary pressure. In
addition, this occurred despite a substantial increase in the Federal deficit. It was
not until late in 1976 that the Federal Reserve began to inject money at a rapid
pace, resulting in an 8 percent annual rate of money growth over the next four
years.
This experience of a rising trend of money growth, punctuated by several periods
of restraint, has had a profound effect on financial markets. The influence is evident in the markets' reaction to recent monetary variability. The cycles of money
growth since the mid-1960's have been accompanied by similar cycles in long-term
interest rates. Each period of monetary restraint led, after a short lag, to decreases
in long-term interest rates. The evidence indicates that these decreases reflected
easing of inflationary expectations. The subsequent monetary explosions, however,
proved these expectations to be premature and long-term interest rates rose accordingly. The result was a series of cycles in long-term rates, with each low point at a
level above the preceding low and each expansion leading to a new high in rates.
From this experience, the long-term credit markets have become very skeptical
about the prospects for inflation, and thus interest rates, in the future. Each time
that market conditions have generated downward pressure on long-term interest
rates, a sharp acceleration of money growth aggravated concern about the impending monetary trends, leading to a rise in rates. While financial markets are well
aware that trends in money growth are the dominant factor in inflation, experience
has led them to doubt that several months of monetary restraint is a clear signal
that the trend of money growth is downward.
This fear is evident in the markets' reaction to the surge in money growth that
has occurred since October. On the one hand, the surge led to the expectation that
the Federal Reserve would tighten money market conditions in an effort to restrain
money growth. This concern causes short-term interest rates to rise, On the other
hand, however, the persistence of the bulge in money growth has lent credence to
the view that the restriction of money growth last year might be just another temporary downturn, to be followed by accelerated money growth, as in the past. This
view has led to significant increases in long-term interest rates.
It is obvious that projections of the Federal deficit also play a role in this process.
During periods of heavy government borrowing in the past, monetary actions designed to offset the resulting short-term pressures on interest rates contributed to
rapid money growth. While both the Administration and the Federal Reserve are
firm in their commitment to avoid monetization of the debt and to reduce the trend
of money growth, the combination of history and the recent erratic swings in money
growth have been sufficient to raise serious doubts in credit markets. These doubts
are reflected in the level of interest rates.
These fears aggravate problems for specific sectors of the economy, which were
already in considerable trouble. The continued problems of the housing and the
automobile industries are a drag on the entire economy, and the persistence of high
interest rates would seriously endanger the prospects for economic expansion.
The Federal Keserve can make a significant contribution to easing this problem
through efforts to dampen the systematic variations in money growth, such as have
occurred over the past two years. Random variations in money growth are to be expected and there is no reason to attempt to offset such changes. However, monetary
actions can ensure that these random changes do not persist and lead to several
months of either very rapid or very slow money growth. The accompanying chart
(Chart III shows the short-term growth of the money supply, as well as the monetary base, which is a summary measure of the actions of the Federal Reserve. As
this chart illustrates, current control procedures have produced swings in growth of
the monetary base which have caused and exaggerated variation in the money
growth.
I believe that the variability of money growth would be reduced if the Federal
Reserve targeted and controlled the monetary base, rather than the money supply.
130
While control of the base would certainly not remove the temporary and random
changes in the money supply, it would take the Federal Reserve out of the difficult
business of distinguishing between changes in money that are random and self-correcting and those that are not temporary and should trigger a policy response. Since
growth of the monetary base is closely correlated with money growth in the long
run, a moderate and steady rate of growth in the monetary base would be expected
to produce a similar growth pattern for money. While the short-run fluctuations in
money growth would still occur with steady growth of the base, these changes would
tend to be self-correcting and would be canceled out quickly.
With a policy that provided for steady growth of the base, short-run fluctuations
in money would not be answered with explicit policy actions. This would remove
pressures on interest rates that now result from speculation in financial markets
about how the Federal Reserve may react to a particular wiggle in the money data.
An announced policy of steady growth in the base would reduce the uncertainty
that now surrounds monetary policy and contributes to instability in the financial
markets and volatile interest rates.
To complement a policy of controlling the base, I believe the Federal Reserve
should eliminate lagged reserve requirements and tie the discount rate to a market
interest rate so that it would be changed with market conditions. These administrative changes would improve the precision of the Federal Reserve's policy actions.
The ability of the economy to adjust to lower inflation would be enhanced by
dampening the systematic swings in money growth. The transition to less inflation
would be smoother and the costs—in terms of output and employment—would be
less.
The Administration supports completely the stated policy of slowing the average
rate of money growth and we believe that the announced target of 2.5-5.5 percent
for 1982 is appropriate. However, in view of the severity of the current recession, we
recommend monetary expansion in the upper one-third of the range. We hope that
the actions by which this policy is implemented would produce a more even pattern
of money growth, thus reducing the temporary, but very real, costs of the transition
to less inflation.
63
64
CHART 1
MONEY AND GMP GROWTH
MVCV CMVTH
PLUS MCHME
ucucm
66
68
70
72
74
76
78
8d
83
131
CHART 2
Percent
• Monetary
Base
;ist. Louis
MM
I I I
II I I I I I I I +-IMl
Ml
I I I
M I t
Weekly
•Quarterly growth rates based on four-week averages compared with four-week
averages thirteen weeks earlier, at annual rates. Latest week plotted:
Feb. 10 for Ml and Feb. 17 for monetary base.
Note: The Ml data, .series ia beinq revised, but all historical data are not
yet available." Therefore, f9 8'I'and 1982 data are not atrictlv comparable to earlier years.
The CHAIRMAN. Thank you, Secretary Sprinkel.
Dr. Jordan.
STATEMENT OF JERRY L. JORDAN, MEMBER, PRESIDENT'S
COUNCIL OF ECONOMIC ADVISERS
Dr. JORDAN. Thank you very much, Mr. Chairman. It's a pleasure to appear before your committee once again. I will not read my
statement, but rather summarize the main points in it.
The CHAIRMAN. Before you do that, I will caution you that a few
weeks ago the Chairman of the Fed was here and he requested permission to summarize his statement, and when he finished I told
him next time I would require him to read the entire statement because it took Chairman Volcker 1 hour and 10 minutes to summarize a 20-minute written presentation. So just be careful before you
start.
I would also apologize for the lack of attendance this morning.
First of all, Secretary Sprinkel should know the first reason. The
Secretary of the Treasury is testifying before the Appropriations
Committee this morning in their oversight hearings. We have, besides myself, several other members of the Banking Committee
who are also members of the Appropriations Committee. So you're
being upstaged by your boss downstairs and that accounts for a
good number of our membership not being here. And then, if you
were not aware, we were in session until nearly 2 o'clock this
morning on the filibuster on the floor of the Senate. So 1 did want
132
you to know that none of you were being ignored deliberately and
why many of the members of the committee are not here is principally because of the hearings in the Appropriations Committee.
Dr. Jordan.
Dr. JORDAN. Thank you. Just about 1 year ago when I met with
this committee before joining the administration, the main point of
my testimony was the fundamental issue of credibility of long-run
monetary policy. I stressed that this, in turn, hinged on the credibility of fiscal policy. We would not be able to convince the financial
market participants that we would be able to sustain in the long
run a slow and noninflationary growth of the money supply if we
did not make progress on controlling the rise of Government spending as a share of the national income. The markets understand
that spending is the ultimate test of taxation, that all Government
spending has to be financed by either current taxes, future taxes,
or inflation; and they fear inflation, rightly, given our experience.
Making progress on monetary control alone in the short run, even
for a period of a year or so, while very important, is not sufficient.
We must be making progress on the fiscal side to convince financial market participants that they can count on a noninflationary
environment for the 10- and 20-year time horizons that they are operating in. I think today that uncertainty is still what is haunting
the marketplace.
SLOW MONEY GROWTH
All of us want lower interest rates. We want them to come down
for the right reasons, and to stay down, rather than just being artificially depressed. But more rapid growth of the money supply
would not produce lower interest rates. It would produce higher interest rates. So all of the homebuilders, realtors, the business
people, small businesses, and large businesses, the car dealers—
that we have been hearing from and I suspect you and all of the
Congress have been hearing from—who want lower interest rates
should join us in supporting the Fed in trying to achieve a slow,
steady growth of money, while the Congress works with the administration on trying to solve the fiscal problem. I think slower
growth of money is as necessary a condition to get interest rates
down as progress on the fiscal side.
If there was anybody that by last fall still believed that faster
money growth would produce lower interest rates, the experience
of the last 3 months should have finally convinced them that that
simply isn't true. Interest rates were dropping sharply in the fall
as we were moving into a recession. The money supply was quite
slow compared to the year before and compared to the growth that
had occurred in the spring of last year, but interest rates were
dropping. It was a very welcome decline in interest rates, about 7
percentage points in the short-term interest rates, and we had
hopes that it would continue into this year and provide a basis for
a sustainable economic expansion.
But then we had an unanticipated and very rapid growth in the
rate of the money supply—a 15-percent annual rate of increase—
from October to January that is much higher than the Federal Reserve targets for this year. They didn't expect it, we didn't expect
133
it, and the markets didn't expect it. As interest rates rose, most of
the decline of interest rates in the fall were erased by what happened.
Now in the past 2 weeks or so this acceleration in monetary
growth has been halted. It's on the decline. There also has been a
rally in the financial markets. I think if the monetary growth stays
under control—the money supply returns to the Fed's announced
target range and stays there—this will help to restore confidence
in the market and interest rates will continue declining.
I think over the next several weeks, with monetary growth behaving better, interest rates will be in a general downward pattern
even while the markets are watching Congress very closely to see
whether the fiscal policy is brought into line with this downward
trend in monetary supply.
A year ago the No. 1 problem clearly was inflation. We just had
completed 1 year of 13-percent inflation. The people wanted it
stopped. This morning the Bureau of Labor Statistics has reported
that the Consumer Price Index rose in January three-tenths of 1
percent, less than a 4-percent annual rate. We've made good progress on inflation. We still expect for the full year that the Consumer Price Index will probably run something like in the 6- to 7-percent range. That will be down 2 or 3 percentage points, and other
major inflation measures will be down 2 or 3 percentage points
from last year and down several percentage points from the year
before. That's good progress.
FINANCIAL MARKET PARTICIPANTS
We also had been expecting that slower rates of inflation would
be accompanied by declining interest rates. For a while that was
true, but financial market participants believe that all we're
having is a cyclical decline in inflation. They worry that we may
still have a secular rising trend, and when you're investing for 10
or 20 years you want to know what inflation is going to be over
that whole period, not just for a year or two. So they are waiting
before they come all the way down to what the recent inflation
numbers would imply.
The experience with money growth and interest rates is quite
clear over the last several years. In 1977 and 1978 we had a sharp
acceleration in the growth of the money supply compared to what
had been the case on average during the prior 2 years, and interest
rates rose sharply. As a result, confidence was eroded regarding
the longrun inflation outlook. In 1979 and 1980 we had several periods of sharp accelerations and decelerations of monetary growth
and also highly volatile interest rates. As money growth would accelerate very sharply, confidence would erode about the longrun
outlook and interest rates would rise. Then as money growth would
lurch the other way and come down sharply, interest rates also
would be coming down, and that pattern has continued into 1981
and now into early 1982.
In the early months of 1981 money growth slowed sharply compared to what had happened in the second half of 1980 after credit
controls came off, and that was encouraging. Interest rates declined, and the administration projected that interest rates would
134
continue declining during all of 1981. We were optimistic. We were
hopeful about declining interest rates, along with a much slower
growth of money. Then in March and April, monetary growth suddenly accelerated very sharply, and interest rates promptly rose to
very high levels. By midyear, monetary growth started coming
back down rapidly, and interest rates also declined. That continued
into the late fall, and then the last 3 months of unexpected, unwelcome monetary growth occurred and immediately interest rates
rose sharply once again.
We are looking forward to a 4- to 5-percent growth in the narrow
measure of money this year. With that we would expect nominal
income growth of GNP to increase about 10 percent from the end
of 1981 to the end of 1982. The GNP deflator measure of prices will
rise about 7 percent, and real growth will be on the order of 3 percent. In the second half of 1982 we would have much higher real
growth than that 3 percent for the full year, providing a basis for
continued high growth of output and employment and declining inflation in 1983.
So if the Fed's announced target range for this year is sustained
on average for the year in a fairly steady way, which we think is
the proper monetary policy, and this is combined with a fiscal
policy that is reducing Government spending as a share of GNP,
we would start to reduce the Federal deficit and establish the basis
for a sustainable economic expansion with lower inflation and
lower interest rates.
Thank you, Mr. Chairman.
[Complete statement follows:]
135
Testimony
by
Dr. Jerry L. Jordan, Member
Council of Economic Advisers
Thank you Mr. Chairman and Members of the Committee.
The main point I want to make in my opening remarks this
morning is that it would be impossible to sustain a healthy
growth of output and employment if a high rate of monetary
growth were to occur this year.
The experience of the last few-
years has demonstrated repeatedly that financial markets are
highly sensitive to whether or not the Federal Reserve is
achieving a growth rate of the money supply consistent with
their announced target ranges.
If there was anyone around last
fall who still believed that faster growth of the money supply
would produce lower interest rates, the experience of the last
three months should convince them once and for all that that is
wrong. Confusion about the relationship between money growth
and interest rates arises to a large extent because of a common
failure to distinguish between money and credit.
From October to January of this year the narrow measure
of money (Ml) expanded at a 15 percent annual rate and was
accompanied by a very rapid increase of interest rates.
If
interest rates were to remain at the levels reached in January,
or rise to even higher levels, it would not be possible toachieve a high rate of real growth.
It would be naive to think
that central bank operations to provide reserves at an even
more liberal rate and promote even more rapid growth of money
would have prevented this run-up in interest rates.
On the
contrary, more rapid growth of money, or a continued high rate
136
of increase of money, would produce even higher interest
rates.
The only way to achieve and maintain a lower level
of interest rates that makes it possible to promote expansion
of output and employment is to return the money supply to the
originally announced target range and maintain it for the
balance of this year.
The relationship between the growth rate of the money
supply and movements of interest rates has been quite clear in
recent years.
In 1977 and 1978 growth of money accelerated
sharply compared to what had been observed on average during
the prior two years.
As a consequence, interest rates rose
sharply as credit demands increased and expectations of rising
inflation intensified.
During 1979 and 1980 there were several periods of sharp
accelerations and decelerations of monetary growth as well
as highly volatile interest rates.
Money growth declined
sharply late in 1978 and during the first quarter of 1979,
then reaccelerated sharply in the spring and summer when
it appeared to many observers that the economy was starting to
slip into recession.
Rapid monetary growth once again
increased fears of higher future inflation.
The dollar
promptly began to weaken on foreign exchange markets, gold
prices shot up and the stock market weakened.
Then in October
1979 Chairman Volcker announced that the Federal Reserve was
137
adopting new operating procedures designed to achieve lower and
steadier growth of the money supply on average.
However,
several dramatic events created very considerable uncertainty
in the financial markets.
In November, Americans were taken
hostage in the Embassy in Tehran, in December the Soviets
invaded Afghanistan, and in January 1980 former President
Carter announced a budget that indicated that very high rates
of increase of government spending and taxation could be
expected during the first half of the 1980s.
Interest rates
rose very sharply during the early months of 1980 until the
Carter Administration pursuaded the Federal Reserve to invoke
the powers of the 1969 Credit Control Act.
During the spring of that year, the money supply declined
absolutely for the first time in many years as credit demands
dropped sharply as a result of the credit controls and interest
rates plummeted.
Then in July of 1980 credit controls were
removed, the economy began to rebound from the artificial
constraints, credit demands increased, interest rates came
under renewed upward pressure and the money supply accelerated
to the highest rate of growth over a 6 month period that has
ever been recorded.
By the end of 1980, we were experiencing
the highest levels of interest rates in recent history, and I
doubt that many people
believe that even more rapid -growth of
bank reserves and the money supply during that period would
have prevented or slowed the rise in interest rates.
138
Late in 1980 and early in 1981, growth of the money supply
slowed sharply and interest rates also declined.
And declining
short-term interest rates early last year occurred even though
nominal GNP rose at a 19.2 percent annual rate, real output
increased at an 8.6 percent rate and Treasury borrowing was the
largest amount recorded for a single quarter until that point.
But, unfortunately, there was a spike upwards in money growth
in March and April in 1981 that unsettled the financial markets
and was acornpanied by renewed upward pressure on market
interest rates.
By mid-year money growth had returned to a
slower and less inflationary
declining once again.
rate and interest rates began
From their peaks in the summer until
late fall, short-term interest rates declined about 7
percentage points. This was a very encouraging development and
provided the basis for optimism that with inflation continuing
to fall and interest rates declining further, the recession
would be fairly short and recovery would get underway during
the first half of 1982.
Unfortunately, however, another period of accelerated
monetary growth occurred and both short- and long-term interest
rates came under strong upward pressure in December and
January.
No one wanted interest rates to rise again during the
past two months and no one wants them to remain at these
levels.
It is our strong belief that the way to achieve a
near-term reduction in both short- and long-term interest rates
is to return the growth of the money supply to a slow and
steady rate.
139
Last week in his press conference. President Reagan
indicated his confidence in the announced policies of the
Federal Reserve and also stated that "We also support the
Federal Reserve's 1982 money growth targets which are fully
consistent with the Administration's economic projections for
the coming year."
I firmly believe that if money growth
promptly is reduced to the announced target ranges, and a rate
of increase in the 4 to 5 percent range is maintained on
balance through the remainder of 1982, interest rates will
decline, growth of output and employment will increase, while
inflation will continue to decline.
The public perception of the relationship between money
growth and interest rates is the reverse of what actually takes
place because of the confusion between money and credit.
Money
is an asset that people generally accept as payment for goods
and servics.
deposits.
It consists of coins, currency, and checkable
Credit, in contrast, is one party's claim against
another party, which is to be settled by a future payment of
money.
Confusion about the difference betwen money and credit
arises because people can increase their spending either by
reducing their money balances or by obtaining credit.
The market for money is distinct from the. market for
credit.
The supply of and demand for credit influence
primarily the interest rate, which is the price of credit.
The
supply of and demand for money, on the other hand, determine
the purchasing power of money.
Additional confusion about the
140
difference between money and credit arises because the monetary
authorities create money primarily by purchasing credit market
instruments.
These actions tend to increase the supply of
available banX credit and consequently tend to lower interest
rates, at least initially.
Over a longer period of time,
however, the creation of money has important effects on
economic activity that tend to raise interest rates.
Monetary
expansion leads to an expansion in nominal income and economic
activity, which, in turn generates an increased demand for
credit, thus reversing the initial decline in interest rates.
In addition, a sustained higher rate of monetary growth will
soon produce higher nominal interest rates to compensate
lenders for the expected decline in the real value of their
wealth.
When interest rates are high, credit is often said to be
"tight," meaning that it is expensive.
This does not
necessarily mean that money is tight in the sense that its
quantity is restricted.
Indeed, quite the opposite is likely
to be the case. "Easy" money, in the sense of rapid growth in
the stock of money/ may very well be the underlying reason for
a tight credit market.
Conversely, tight money in the sense of
slow growth in the stock of money is likely to lead eventually
to a fall in nominal interest rates as inflation expectations
subside.
But it is credit, not money, that is easy.
Over the
long run, the effect of the growth of money on the real volume
of credit is essentially neutral.
Monetary expansion can
succeed in driving up the nominal supply of credit as well as
141
other nominal magnitudes.
But it cannot significantly alter
the real supply of credit or the real interest rate (the
nominal rate adjusted for inflation), except indirectly through
the uncertainty associated with inflation and because of the
effects of an unindexed tax system.
Monetary expansion can
permanently reduce the purchasing power of money, but not the
real price of credit.
It is often stated that such financial innovation as
money-market funds undermine the conduct of monetary policy.
Statistical support for this assertion is dubious.
What would
have to be demonstrated is that financial innovation —
is to a large extent the result of policy-imposed
on the financial system in an inflationary
which
constraints
environment—has
made it more difficult to achieve a given monetary target, and
that the link between changes in nominal GNP and changes in the
monetary aggregates —
that is, changes in velocity — has
become less predictable.
either proposition,
The evidence does not seem to support
A study recently published by the Federal
Reserve suggests that the monetary authorities have the ability
to control the measure of transactions balances known as Ml
with a reasonable degree of precision.
Furthermore, changes in
velocity do not appear to be any more volatile than they have
in the past.
Indeed, changes in the trend of the growth rate
of nominal GNP over the period 1960 to 1981 are almost entirely
attributable to changes in the trend of the growth rate of the
money stock (Ml), as opposed to changes in the trend of the
growth rate of velocity (Chart).
142
Money and GNP Growth
PERCENT CHANGE (ANNUAL RATS'
oliJli .
1961
63
65
87
71
73
75
77
79
1
PERCENT CHANGE IN *-QUARTER MOVING AVERAGES Of SEASONALLY ADJUSTED MONEY
STOCK (Mi) AND GNP.
' AVERAGE VELOCITY GROWTH IS AVERAGE ANNUAL PERCENT CHANGE OVER THE PEWOO
1958 TO 1981
In conclusion, this Administration has emphasized the
importance of a long-run reduction of monetary growth to a
steady, non-inflationary rate.
The Federal Reserve has
maintained its commitment to such a policy.
Slower growth of
money will mean less inflation and lover market interest rates.
In addition, as we have observed recently, short-run
volatility of monetary growth, especially in an environment of
considerable uncertainty about the ultimate fiscal actions of
Congress, has been associated with highly volatile interest
rates.
Market uncertainty about long-run monetary and fiscal
actions of the government has been reflected in an unusually
large "risk premium" in interest rates.
steadier growth of the
money supply, plus progress on achieving fiscal discipline,
will result in lower interest rates and provide a foundation
for sustainable growth of output and employment.
143
The CHAIRMAN. Thank you, Dr. Jordan.
WEEKLY REPORTING OF MONEY SUPPLY
Secretary Sprinkel, I asked Chairman Volcker this question a
couple of weeks ago, and that was simply about the frequency of
reporting the money supply. It has been my feeling that weekly reporting is ridiculous at best. I don't even believe the Fed can properly account or measure the money supply on a weekly basis, let
alone manage it. I'm not one who believes as a monetarist that
one-tenth of 1 percent here or there can be achieved. I think the
economists are kidding themselves when they talk about that kind
of fine tuning of the money supply.
He admitted that it was not accurate and that as long as they
were collecting it they were forced to publish it, and I said, well,
then, why collect it on a weekly basis; and he said, "Because someone else will call the banks and try to determine it and they will
publish it." But that's unofficial. I don't think it would have the
impact, at least in my opinion. But we send out false signals that
affect the market and it does affect interest rates when the Chairman of the Federal Reserve Board admits they are highly inaccurate.
From your position in Treasury, what do you think? Do you
think we ought to change that reporting frequency and collection
and try to be more accurate so in this volatile situation we're not
sending out false signals and false information?
Mr. SPRINKEL. Well, this issue is widely debated, as you are
aware. There are good arguments on both sides.
The CHAIRMAN. I'd like to hear the arguments on the side of the
weekly reporting.
Mr. SPRINKEL. I will give you mine in just a moment. I have been
in this business a long time and I remember 20 years or so ago arguing that we should pay more attention to what happens to the
money stock every quarter or every 6 months but nobody was interested. Now we have gone to the preposterous extreme of placing
massive importance on what happens in any one week. That is just
nonsense. 1 really don't care what happens in any one week, but
the market cares.
STARTING A COTTAGE INDUSTRY
My fear is that if the Federal Reserve would cease to publish
weekly money data a new cottage industry would start—George
McKinney and his colleagues in New York and others in Chicago
would immediately get in the business of estimating a weekly
series. We would be right back where we are, except that valuable
resources in the private sector would be used to do a nonsense job.
In my judgment, the solution is to focus on growth in the monetary base and then there would be little reason to pay so much attention to swings in the money supply in any one day or week. The
base is controllable. There is just no doubt about that. The money
supply in the short run is not precisely controllable and there is a
lot of noise in it. So I am not strongly impressed with the argument
that we should suppress weekly information or refuse to release information, but I think there are other ways of achieving the same
144
objective. But I confess there is an argument in favor of not publishing weekly money data. As far as I know, the United States is
the only nation that does. We really should put the emphasis on
the average rate of money during a quarter or 6 months. That is
much more significant.
The CHAIRMAN. Mr. Sumichrast, you're not late, so don't worry.
The second panel really hasn't done their thing yet. But inasmuch
as you mentioned Mr. McKinney, I would like to divert away from
your questioning at this point and ask him why are the markets
concerned—if you would be concerned to start a cottage industry
and try to estimate what the Fed had not done—why are you so
interested in figures that everybody says are not accurate?
Mr. McKiNNEY. Because the Federal Reserve is paying attention
to them and is pressured by Mr. Sprinkel, among others, to pay attention to money growth, and as long as we are paying attention to
short-run money growth because others in authority are paying attention to it, we will have to watch what they are doing in order to
stay alive. It would be a cottage industry. There would be a tremendous growth in computers. Beryl is entirely correct that every
money market analyst with computers would have fair estimates of
the money supply out. You know, I think the point is that as long
as the Federal Reserve is trying to control money growth, they are
not going to achieve steady money growth.
The Federal Reserve is only going to be successful in achieving
steady money growth when it stops trying to control it, and markets will stop paying attention to short-term money growth only
when the Federal Reserve stops paying attention to short-run
money growth.
The CHAIRMAN. I know, but that really doesn't answer my question because Beryl said that he thought it was ridiculous and the
reason he was doing it was because you wanted it, and you just
said you wanted it because they wanted to give it out.
Mr. McKiNNEY. That's right.
The CHAIRMAN. Now which came first, the chicken or the egg
here?
Mr. McKiNNEY. The targets came first. As long as the Federal
Reserve is targeting money growth, as long as that's a known
factor in their monetary policy, central to their policy, then we will
try to keep as close an eye on it as they do in order to understand
what it is that they are doing.
The CHAIRMAN. Again, that still isn't responsive to my question.
If everybody admits—and I have yet to have anybody tell me anything else—that the weekly figures are not accurate, why are you
all fighting over having some figures that are apparently meaningless? Everybody uses terms like "ridiculous." I don't know why
we're doing it.
Mr. McKiNNEY. I do know why we're doing it. We're doing it because one of the important things for us is to determine what the
Federal Reserve policy is in the short run.
The CHAIRMAN. In that short a run, in a 1-week period?
Mr. McKiNNEY. Sir, as long as we are told that the Federal Reserve should be holding money growth within a narrow band over
short periods of time—short being defined as the swings that occurred during the last half of last year—then we will necessarily
145
have to pay attention to those things that make up the short-run
swings in money growth.
BUSINESS DECISIONS
The CHAIRMAN. But are you making business decisions in your
bank on the basis of admittedly inaccurate figures on a weekly
basis?
Mr. McKiNNEY. Of course we are, because that is the reality of
life. If that is what determines what the Federal Reserve will be
doing, then it is exceedingly important for us to know what the
Federal Reserve will be doing; and if the Federal Reserve is following meaningless figures and if the administration wants the Federal Reserve to follow meaningless figures for short periods of time,
then people who buy and sell securities have no choice but to try to
figure out what they will be doing that will be influencing the
price of those securities.
The CHAIRMAN. Maybe I'm terribly naive, but I really don't understand why this is controversial. I have never heard as much
talk about fantastic amounts of money and people—Government
and business making decisions on admittedly very poor information
when we're talking about short run—to say they are targets for a
quarter or semiannually or something and maybe 2 weeks might
smooth that out a bit or a maximum of a month of reporting would
give you more accurate figures on which to base your decisions. I
guess it's because I'm not an economist and I don't understand this
whole argument. It just baffles me and I can't imagine any little
business saying I'm going to operate my business on some phony
figures that come out every Friday.
Mr. McKiNNEY. May I run in an analogy of the camel and the
straw; that one more straw breaks the camel's back; and regardless
of the validity of any particular straw—and that's a very poor analogy—you have to watch as the individual straws go on. Each
week's figures makes some difference in the total. They may be
right; they may be wrong; but that moving average that you're
talking about—Beryl was talking about earlier—that moving average is influenced by each week's figures as they come out, and if, in
my opinion, following an erroneous perception, the Federal Reserve
does in fact try to target money growth on a slow average change,
then I'm acting irrationally if I do not consider each one of the
straws, each one of the weekly figures that contributes to that
average change.
The CHAIRMAN. Except every time the Chairman of the Fed or a
member of the Fed comes in here and they are being criticized for
not hitting their targets, what they say is, "Don't worry about
those blips. They are unimportant. They are meaningless."
Mr. McKiNNEY. That's right.
The CHAIRMAN. "Look what we did over a period of a year."
They talk in terms of 1 year or 6 months to explain all these phony
ups and downs.
Mr. McKiNNEY. Sir, I would agree most fully. I think it's entirely
proper that the Federal Reserve should pay no attention to those
blips and if it were possible to assume that the Fed were in fact not
paying attention to those blips, if it were possible to assume that
146
pressure would not be placed on the Federal Reserve to follow
those blips, then the market would logically be less concerned
about those blips. But as long as we are told that the swing in
money growth that happened last summer and the swing in money
growth that happened in December and January are in fact important, as long as we are told that by the administration officials,
then we know that the Federal Reserve will be subjected to the
same kind of pressure. They will perhaps think along the same
lines and we can do nothing
The CHAIRMAN. Again, you're talking about last summer and last
spring, not a particular week in last summer or last spring. Well,
I m taking their time. Dr. Jordan.
Dr. JORDAN. I agree that the weekly figures don't mean anything, especially the seasonally adjusted figures. Statisticians
simply can't defend them. But the market participants will always
try and figure out what it is that the central bank is trying to control, and former Fed officials like myself will be paid by commercial banks, as I was, to second-guess them because you can make
money—and you can also lose money if you guess wrong. In the
last couple months millions of dollars were made and lost by dealers and traders based on some figures that a few years from now—
after several revisions of the seasonal factors and benchmark adjustments—will have never happened. By 1985, there will not have
been a 15-percent rate of money growth from October to January.
The point is that as long as the central bank itself seasonally adjusts the figures and internally uses them in any small way of adjusting their own operation, the market participants have an incentive to second-guess them. At one time it was free reserves. At another time it was simply the Federal funds rate. At still another
time they used a concept called reserves available for private deposits. They said that was the target and the market participants
tried to figure it out.
If the truth ever got out that the key to what monetary policy is
actually is whether or not the Board of Governors has green peas
for lunch on Thursday, you would have all of these people down
there checking out the garbage cans of the Federal Reserve and
watching the delivery trucks.
The CHAIRMAN. That may be as good a system as what we're
doing now.
WEEKLY MONETARY BASE
Dr. JORDAN. It's no different really because the weekly money
numbers are a random number. So what I have been proposing—
and I join Secretary Sprinkel on this—is that the weekly monetary
base be used as an internal target for the Fed because that is their
balance sheet and balance sheets have a habit of balancing. They
can control their asset side and therefore they can control the liability side.
On the weekly monetary data, what I would suggest the Fed
might consider doing is publish the raw components on a not seasonally adjusted basis, but publish the 4 weeks compared to the
same 4 weeks a year earlier. A lot of European data are reported
in this fashion. Each time they get a new week's figure demand de
147
posits and all the various components would be published unadjusted, unrnassaged. They don't have to worry about seasonality when
they're reporting the percent change from the same period a year
earlier. Let the cottage industry analyze those figures. Let all the
investment banking houses and commercial bankers and Wall
Street and Chicago and other places compete with each other to see
who can do the best job of massaging or seasonally adjusting these
figures.
But for that to work and not have the effect the weekly numbers
have on the marketplace, the central bankers themselves would
have to not react to it. They would have to focus either on total
reserves or the monetary base in their own daily and weekly decisions.
The CHAIRMAN. If the monetary base is so good, why doesn't the
Fed use it?
Dr. JORDAN. There's a continuing discussion about whether or
not that's desirable. Economists have different opinions on that.
The German central bank or the Swiss national bank have used
their version of the monetary base for almost a decade now. The
Federal Reserve Board of Governors only started publishing the
monetary base, a version of it seasonally adjusted by them, about 2
years ago, whereas the Federal Reserve Bank in St. Louis has been
publishing the monetary base for the United States since 1968.
There have been differences of opinion in the profession as to what
would be the implications of that, and it's an ongoing debate.
The CHAIRMAN. Why don't we go to contemporaneous reserve accounting too?
Dr. JORDAN. It would improve shortrun monetary control, assuming shortrun monetary control is desirable. Even if the improvement in control is very minor in a narrow statistical sense, or not
important in terms of overall effects on the economy, such a move
might serve as a signal to the marketplace of the serious intentions
of the central bank to improve shortrun control, and that might
have a salutary effect.
Mr. SPRINKEL. I believe that one reason we have not moved in
that direction—it is not the only reason—is the very widespread
opposition by George's industry and the commercial banking industry. They look upon it as involving an increase in high costs of operation and they are correct. I have talked to many bankers and
there is no doubt that this would in the short run at least add to
the cost of operation.
However, that is not an impossible obstacle to overcome. Clearly,
if this were accompanied by some equitable reduction in reserve requirements, there need not be a net increase in costs, and yet we
would tighten the monetary control mechanism. It has been my
judgment, as I indicated in my testimony, that moving toward both
contemporaneous reserve requirements and a much more flexible
administration of the discount window would improve monetary
control. I do not believe the Federal Reserve should be in the business of subsidizing borrowing banks and yet that is what happens
when you have a low discount rate and high market rates of interest. Banks will always seek the cheapest money on the block and
they will borrow from the Federal Reserve when they believe that
it is profitable to do so. Every time they borrow from the Federal
148
Reserve that adds to total reserves and complicates the process of
monetary control.
The CHAIRMAN. Well, I guess we can get off this and we can beat
it to death, but I'm still absolutely puzzled. Your testimony was
that 20 years ago nobody cared about the money supply over a
period of 6 months or a year. Now we're complaining about it on a
weekly basis. Every witness admits it's a silly system and yet
you're all going to stick with it. I'm sorry. I just don't understand
why we continue operating on a system that everybody says doesn't
work very well.
But be that as it may, Secretary Sprinkel, do you believe that the
Fed's announced targets for money growth are adequate to finance
a recovery if we get one this summer?
Mr. SPRINKEL. Yes, sir, I do. As you know, there is a widespread
view that there is an inconsistency between supply-side measures
taken by this administration and slower growth in money measures urged by this administration. That view of inconsistency is
dead wrong. It results, in part, from looking at the world through
what I would call Keynesian colored glasses, viewing tax cuts as
stimulative to total spending. Of course, that has not been true
historically nor would it be true in the future unless it is accompanied by a sharp increase in the money supply; that is, unless the
deficit is financed by increasing money.
Our approach of supply-side action—that is, tax cuts, cutting
Government spending as a percentage of GNP, and deregulation, is
to tilt the decisionmaking process, not to increase total spending.
We want to tilt decisions toward more emphasis on saving, investing, and working through increases in incentives. That is on the
supply side—the capacity of the real economy to grow.
EFFECTS OF STAGFLATION
But stagflation has two aspects. One is slow growth or no growth
and the other is inflation. The evidence for this and every other
nation that I have looked at—and I have looked at a lot of them—
is that there is no alternative for bringing inflation down except by
slowing growth in money. There is no inconsistency between monetary policy and the other aspects of our economic program. The
proof will be in the pudding, and when this administration completes its first 4-year term, I can assure you that we will be known
as a low interest rate, low inflation administration, but at the same
time the economy will be performing much better than it has been.
The CHAIRMAN. I guarantee you, if that isn't the case, there will
not be a second Reagan administration.
If the Fed is determined to target monetary aggregates, Mr.
Sprinkel, which one should they use?
Mr. SPRINKEL. As I indicated in my testimony, my own preference is that they concentrate on the monetary base. The important
thing is that they not concentrate on three or four different targets. It is impossible under any reasonable set of circumstances to
hit three or four targets simultaneously, especially when you have
institutional changes such as those which took place last year.
These changes are not finished because we are proposing, with
your aid, to move further along the deregulatory route. And conse
149
quently, the "Ms" will probably continue to have a lot of noise in
them.
The base can be controlled, since it is the balance sheet of the
Federal Reserve Board and it would be my preference that it be
the target.
The next choice would be Mi. Certainly we do not want four or
five targets.
The CHAIRMAN. Dr. Jordan, as you're very well aware, Chairman
Volcker as well as I and many others have been very critical of the
budget deficits as well as the fact that credit markets—Government credit—the off-budget deficit is not really talked about. As
large as the on-budget deficit is, it's much larger. Do you really
think there's any way, regardless of what we do, that monetary
policy can be effective until we start controlling those deficits?
Dr. JORDAN. No. I think in the long run, control of spending, including the off-budget credit program for the Government, is absolutely essential to a monetary policy. The financial markets understand that. The international markets understand that. And a lot
of academic studies have been done, theoretical analyses and empirical work, to show if you're increasing interest-bearing Government debt, on-budget or off-budget, while trying to have a slow,
noninflationary rate of money supply, what you do is raise real interest rates. Interest rates have to rise in order to equate credit demands and credit supplies.
In my testimony I mentioned this confusion between money and
credit that causes people—the general public—to think that slow
money growth causes high interest rates, and that's just not true.
If the demand for credit goes up, then certainly the price of credit
interest rates goes up, other things the same. But a slower growth
of the money supply doesn't mean there's less credit available, and
if the demands for credit by the Government sector continue to be
as large as they have been in the past and as they are this year
and that they appear they may be in the future, then it would be
unrealistic to think that the price of credit—interest rates—would
come down and stay down.
The CHAIRMAN. In your view, do you think the anticipated increases in savings and investment will occur under present economic conditions due to the tax reductions?
PERSONAL SAVINGS
Dr. JORDAN. The personal savings rate, I think, will continue to
be quite a bit higher than it has been in the past, but that may be
as much a result of monetary policy as tax cuts and fiscal policy in
the short run. The main reason the savings rate dropped dramatically in the last several years was that the only form of real savings a lot of people had was increased equity in their home because
of inflation. They would borrow against their house. They would refinance or take out a second mortgage or just generally carry more
consumer credit than otherwise because of having a better balance
sheet and that increased indebtedness by the consumers. It was a
large part of what drove the savings rate down.
The reason the consumer went into debt was inflation and inflation fears—buy now before the inflation goes up and you deduct
150
the interest from your income taxes so you get a negative real interest rate on consumer credit. Now if the inflation outlook continues to improve, people are less willing to go into debt and also
we're starting to have some marginal changes in the tax structure—the incentives about interest income versus interest expense.
Then I think that consumer installment and mortgage credit will
not be driven by inflation psychology.
So the personal saving rate will be higher. The lower marginal
tax rates—the small cut we had in October and, the 10-percent cut
we will have in July—raise the real cost of borrowing to the consumer because his tax deductibility of interest expense is not worth
as much to him as it was before. That will also help raise the savings rate.
The CHAIRMAN. Would you advocate moving that July 1 tax cut
up to January 1?
Dr. JORDAN. I think by the time anything was accomplished, was
debated and enacted, it would have very little positive economic
effect. I'm generally oppposed to what I would consider to be sort of
fine-tuning type actions.
The CHAIRMAN. The reason I asked that is that I was rather surprised from the news magazines last week that former Vice President Fritz Mondale suggested that the third installment of the tax
cut be removed, not the business cuts, the individual cuts, but this
year's be made retroactive to January 1, which rather surprised
me.
Dr. JORDAN. That's a view that the tax cut will stimulate consumer spending. It's the basic idea that you raise disposable income
and the consumer will go out and spend that tax cut and stimulate
the economy. That's what I consider to be an old-fashioned type of
pump priming that I don't believe in. I think a private property,
market oriented, economy is inherently resilient. It doesn't need
that kind of shot in the arm to get it moving. It doesn't need us to
artificially push down interest rates, to rapidly increase money, to
bust the budget with new kinds of spending programs, and other
things to get the economy expanding. I don't think it would work if
we tried it. So I think it's best to leave the personal tax cuts alone.
There's great virtue in having a multiyear personal tax cut that
people can count on and plan on, and look to other aspects of the
tax structure that need to be reformed and worked on.
The CHAIRMAN. Secretary Sprinkel, let me ask you one of the
same questions I asked Dr. Jordan. You have been long involved in
monetary policy. Do you think it can work unless we get the deficits under control?
Mr. SPRINKEL. I agree with everything Dr. Jordan said; that is, I
think we need to operate on both the fiscal and monetary side to
get the kind of real growth that all of us want in the period ahead.
Now that should not be interpreted as saying that we can make
no progress on getting interest rates down until we balance the
budget. Sometimes it gets interpreted that way. It is true that the
higher the deficit, other things being the same, the higher the real
rate of interest and such an increase is a deterrent to long-term
capital formation. It is also true, however, that the most important
components of current nominal interest rates are not the real rate
of interest. That is relatively low, 3 or 4 percent and is related to
151
the marginal productivity of capital. The largest portion of those
interest rates that exist today reflect both inflation expectations
plus what I would term an uncertainty premium brought on by
volatility in monetary growth. It is my judgment that continued
progress in pulling inflation down, while achieving a more stable
monetary growth pattern, would reduce nominal rates even though
the deficit would tend to drive the real rate up. It is very important in the long run, even if we do not finance the current deficit
with new money, to get the deficit down because if we use savings
to finance Government spending those savings are not available to
finance private capital formation. That is really the heart of our
program. We must encourage private capital formation up and, in
my opinion, that will not happen in a significant way with a 15
percent nominal rate of interest.
The CHAIRMAN. Mr. Secretary, when our factories are only operating at about 70 percent of capacity on the average, if a recovery
should begin as predicted, would it be possible to tolerate Mi
growth above the targets without reigniting inflation?
Mr. SPRINKEL. No, I do not think so. The historic relation between money and inflation does not have to be adjusted for the
degree of capacity utilization. In 1976, 1977, 1978, and 1979 there
was a lot of excess capacity, and the argument was made, therefore, that we could afford to stimulate money growth; we could
afford to have an expansive fiscal policy because we had all this
excess capacity and stimulus would not cause inflation. Well, it did
cause inflation.
We inherited that inflation and we certainly do not want to see
the mistake repeated. We can not fine-tune and release the restraints on money growth, release the restraints on fiscal policy
stimulus because we have a lot of excess capacity. Inflation would
certainly increase.
The empirical work that has been done for most countries suggests that the lag is \Vz years or 2 years between a change in
money growth and its full effect or inflation. More money inevitably causes more inflation, irrespective of the amount of excess capacity existing on the economy. So I would not want to see us finetune on the assumption that under present circumstances we can
afford to follow a stimulative policy. That approach would only aggravate the mess that we were in and we are trying to get out of
stagflation, not make it worse.
The CHAIRMAN. Dr. Jordan and Secretary Sprinkel, I appreciate
you being here today. I have no more questions for you. There may
be some from other members of the committee that may wish to
have you respond in writing.
[Additional material received for the record follows:]
MR. MCKINNEY'S ANSWER TO SUBSEQUENT WRITTEN QUESTION OF SENATOR RIEGLE
Question. Mr. McKinney, did you say that it would be a good idea for the Federal
Reserve to use selective credit controls to combat the inflation?
Answer: No, sir. I strongly oppose the use of selective credit controls. They have
uniformly done more harm than good. They made the 1980 recession deeper and
more severe than it would have been, and they added to inflationary pressures
when we tried them in 1971.
What I meant to say is that it would be better for the Fed, instead of targeting
money growth, to target growth of total credit. This is a much larger number than
152
money as such, and the relation between total credit and nominal GNP is much
closer and more meaningful than that between money and nominal GNP. To shift
to the broader target of total credit (or maybe some other broad target) would dissipate the present focus of attention on money growth. It would reduce the market
reactions to blips in money growth, and it would let the Fed get on with the really
important job it should be doing—influencing overall conditions in money and credit
markets as a means of contributing to stable, noninflationary growth.
The CHAIRMAN. You are all welcome to stay here if you like;
however, I understand your schedules and if you would like to
depart you're welcome to do that as well. So I do thank you for
coming.
Dr. JORDAN. Thank you, Mr. Chairman.
Mr. SPRINKEL. Thank you.
The CHAIRMAN. Mr. Schechter, would you like to proceed?
STATEMENT OF HENRY SCHECHTER, DIRECTOR, OFFICE OF
MONETARY POLICY, AFL-CIO
Mr. SCHECHTER. With your permission, I'd like to use a couple of
more minutes, Mr. Chairman, to comment on some of the things I
heard earlier this morning.
The CHAIRMAN. Yes, go ahead.
Mr. SCHECHTER. The emphasis on the relationship between inflation and money supply in my mind is unreal; the greater growth of
inflation in the 1970's was due in no small respect to the great increase in energy prices resulting from the OPEC quadrupling of oil
prices which had to be paid and it's spread throughout the entire
economy. It was due to the fact that we had—not we so much, but
Russia had drastic crop failures during the 1970's and the world
prices of grains went up, including U.S. grain, and that had to be
paid and caused inflation. It was due to the fact that we had a population growth composition, that is, we had a post-World War II
baby boom coming into household formation age, and at the other
end an increased longevity with people living longer, so we needed
more housing units than we ever had, and there was a housing
shortage and inflation in housing. Also, population factors caused
increased demand for medical and hospital care and those were the
major causes of inflation.
And to overlook that and say that money supply was everything,
was a control over everything, is I think quite misleading.
[Complete statement of Mr. Schechter follows:]
TESTIMONY OF HENRY B. SCHECHTER, DIRECTOR, OFFICE OF HOUSING AND MONETARY
POLICY, AMERICAN FEDERATION OF LABOR AND CONGRESS OF INDUSTRIAL ORGANIZATIONS ON MONETARY POLICY
Thank you for this opportunity to present the views of the AFL-CIO on monetary
policy at this time.
The Federal Reserve has been pursuing its goal of restraining money and credit
with the endorsement of the Reagan Administration. As repeated experience has
shown, high interest rates stemming from tight money contribute to inflation, as
higher interest rates are passed along to consumer purchasers and taxpayers. The
various effects which lead to a painfully debilitated economy were well illustrated
during 1981.
Home sales plummeted and total new housing units started during the year were
at the lowest level in 35 years, less than 1.1 million. By January 1982, unemployment in the construction industry was 18.7 percent; and 946.000 construction workers were jobless.
153
High interest rates for consumer financing also depressed new car sales as new
U.S. output for 1981 dropped to 6.2 million new passenger cars, down one-third from
1978. Hundreds of thousands of auto workers became unemployed. The many supplier industries for housing and automobile production also had to cut back.
As workers lost buying power, businesses had to carry larger than normal inventories for longer periods than had been anticipated, at interest rates ranging from
15 to over 20 percent, causing rapid increases in bankruptcies. The number of business failures increased by 44 percent in 1981; and in the first month of 1982, the
number is up 43 percent over the same month in 1981.
At the same time, the higher interest rates increase the value of the dollar relative to foreign currencies. Prices for U.S. goods become less competitive in international trade. Further economic deterioration is developing as other industrialized
countries raise interest rates to prevent outflows of funds, bringing on worldwide
recession and reduced international markets.
As economic demand weakens further, supposedly interest rates should drop. It is
doubtful, however, whether interest rates would decline to permit a significant reversal of economic trends. Businesses will try to restructure their short-term debt to
long-term. A pent-up housing demand would surge forward as soon as a reasonable
reduction in rates appears, and would soon again raise rates.
The federal government will also have to be borrowing more, because it has to
meet high interest rates and because of the huge tax reductions enacted in 1981 to
benefit primarily wealthy individuals and corporations.
By having an unemployment level 4 or 5 percentage points above a practical full
employment level, the loss in national GNP, at an annual rate, is $300 to $400 billion. There is also a loss of hundreds of billions in income and tens of billions in
savings and capital formation. The nation falls behind in providing an adequate
housing stock to keep up with population growth and replacement of lost units, in
modernization and expansion of its basic industrial plant and equipment, and in
maintenance of an adequate public infrastructure. When an economic upturn
occurs, the retarded economy suffers from an inflation-producing housing shortage
and a national plant that functions at a lower productivity growth rate than competitors that have not relied upon the painful and debilitating tight money policy to
fight inflation.
Thus, in the long run, the periodic use of tight money policy as the means of combatting inflation becomes counterproductive.
Personal interest income as a percentage of total personal income has been on the
rise as the use of all types of credit expanded. Thus, between 1950 and 1960, the
percent of personal income accounted for by personal interest income rose from 4.3
to 6.2. The percentage moved up more rapidly along with interest rates in the seventies, and in 1979 it was 10.8 percent. By 1980 the percentage of total personal
income that was interest income rose to 11.9 percent and continued to accelerate in
1981, reaching 13 percent by the third quarter.
The higher income families have the purchasing power to bid away scarce resources from others by a capability to pay higher prices for end products and services. By early 1981, the relationship between the supplementation of high incomes
by high interest rates and the purchase of higher priced products and services was
becoming quite apparent.
The effects of repeating the pattern of tight-money/high interest rates, high unemployment and recession have been to help create a two-tier economy with an
upper tier that can indirectly or directly pay for high interest rates and support productive capacity for luxury type goods and services. However, basic industries, such
as steel, glass, aluminum, and lumber, which must supply mass market products
such as housing and automobiles, cannot be sustained or modernized because they
cannot pay competitively high interest rates.
We should turn away from the disastrous reliance on tight money as the sole
policy to fight inflation. Because tight money results in rationing through high interest rates, thereby often favoring unproductive uses of credit such as corporate takeovers, excessive commodity speculation, speculation in international exchange,
and expanding capacity for production of luxury goods and services, the President
should authorize the "Fed" to use selective credit controls to channel credit for productive purposes.
There has been a growing number of authoritative voices that have indicated the
need to control the growth of credit.
Experience both here and abroad demonstrates the credit controls provide a
viable alternative to slowing down the money supply. The brief implementation of
controls in 1980 proved helpful in rapidly bringing down interest rates. As a result,
the decline in home building and general economic activity was reversed. Japan has
154
used credit regulation in recent years to help keep inflation and unemployment at
levels well below those of the United States and has also guided capital flows into
high priority industrial investments. Japan has had lower interest rates, lower inflation, lower unemployment, and greater industrial production growth than most
countries. On the other hand, the United Kingdom which has been following a monetarist policy similar to that of the United States, has a very poor economic record.
If selective credit regulations are used to defer capital investment that is not
urgent and bring interest rates down to affordable housing levels, depository institutions specialized in home financing could remain in business, a needed higher level
of residential construction could again be achieved, and the economy as a whole
would be in a healthier condition.
The Credit Control Act of 1969 provides the authority to use flexible credit controls as a supplement to general monetary policy. The AFL-CIO strongly supports
making this authority permanent before its scheduled expiration in June 1982 and
using it now to bring down interest rates and revive housing and key sectors of the
economy.
Thank you for this opportunity to present the views of the AFL-CIO on monetary
policy at this time.
The Federal Reserve has been pursuing its goal of restraining money and credit
with the endorsement of the Reagan Administration. High interest rates have reduced purchasing power and caused steep increases in unemployment and record
numbers of business failures. These consequences, along with the gutting of programs which help maintain purchasing power during an economic downturn,
threaten to push the economy into a deep, prolonged depression.
Tight money policies do not deal with causes of inflation, such as OPEC-dictated
oil price increases, shortage-induced inflationary house price increases, runaway
medical costs, and food price increases related to poor crop years. As repeated experience has shown, high interest rates stemming from tight money contribute to inflation, as higher interest rates are passed along to consumer purchasers and taxpayers. The various effects which lead to a painfully debilitated economy were well
illustrated during 1981.
Throughout 1981, interest rates remained at a relatively high rate. The prime
business loan rate, for example, fluctuated between 15.75 and 21.5 percent. Conventional home mortgage rates which generally move more slowly, rose from 14.8 percent in January 1981 to above 17 percent in January 1982. As a result, home sales
plummeted and total new housing units started during the year were at the lowest
level in 35 years, less than 1.1 million.
By January 1982, unemployment in the construction industry was 18.7 percent;
and 946,000 construction workers were jobless.
High interest rates for consumer financing also depressed new car sales as new
U.S. output for 1981 dropped to fi.2 million new passenger cars, down, one-third
from 15)78. Hundreds of thousands of auto workers became unemployed. The supplier industries for housing and automobile production had to cut back and lumber
mills, steel mills, copper mills, and other production and distribution activities had
to lay off workers.
As workers lost buying power, businesses had to carry larger than normal inventories for longer periods that had been anticipated. The burden of financing such
inventories at interest rates ranging from 15 to over 20 percent caused rapid increases in bankruptcies. The number of business failures increased 44 percent in
1981; and in the first month of 1982, the number is up 43 percent over the same
month in 1981.
At the same time, the higher interest rates increase the value of the dollar relative to foreign currencies. Thus, in the third quarter of 1981, the exchange rate
index of the U.S. dollar against the average for currencies of 14 industrial countries
was up 16 percent over a year ago. As a result, prices for U.S. goods become less
competitive in international trade. Further economic deterioration is developing as
other industrialized countries raise interest rates to prevent outflows of funds,
bringing on worldwide recession and reduced international markets. During 1981,
U.S. merchandise imports exceeded exports by $40 billion.
The recession thus gathered momentum. As the economy weakened, interest rates
declined, but only briefly. In fact, the decline in short-term rates starting in October
was hailed as a beginning of a downturn in interest rates. However, the downturn
was reversed in November, and both short-term and long-term rates rose significantly until last week.
Despite the one-month reduction in the unemployment rate to 8.5 percent in January, there is a strong concensus, based on various economic indicators, that unemployment levels will rise in future months. As economic demand weakens further,
155
supposedly interest rates should drop and the economy should enter a recovery
phase. It is doubtful, however, whether interest rates would decline to permit a significant reversal of economic trends. Businesses have been doing their debt financing in large measure on a short-term basis and will try to restructure their debt to
long-term when interest rates begin to decline. A pent-up housing demand, related
to the age composition of the population, that is now restrained by high interest
rates, would surge forward as soon as a reasonable reduction in rales appears, and
would soon again raise rates.
The federal government will also have to be borrowing more, because it has to
meet high interest rates and because of the huge tax reductions enacted in 1981 to
benefit primarily wealthy individuals and corporations. Between September 1980
and September 1981, the average interest rate on the outstanding interest-bearing
public debt of the U.S. Treasury rose from 9 percent to 11.5 percent. The annual
interest charge in dollar terms rose from about $80 billion lo $112 billion or about
40 percent, although the debt itself rose only about 10 percent.
Given that outlook for pressures on the long-term capital market, it is unlikely
that there will be any marked reduction in long-term interest rates that would stimulate a high level of housing market demand. Business investment also is unlikely
to pick up if long-term bond rates don't go below a range of about 15 percent and
the manufacturing capacity utilization rate is at about the current 70 percent level.
The likelihood is that unemployment will reach a level between 9 and 10 percent
during 1982. If a short-lived recovery should then ensue and be rising by high interest rates, as seems likely, unemployment would tend to remain at an above 8 percent level. Every one percent of unemployment leads to about a 2Ms percentage
point reduction in GNP, or a loss of roughly $75 billion. By having an unemployment level 4 or 5 percentage points above a practically full employment level, the
loss in national GNP, at an annual rate, is $300 to $400 billion, There is also a loss
of hundreds of billions in income and tens of billions in savings and capital formation. The nation falls behind in providing an adequate housing stock to keep up
with population growth and replacement of lost units, in modernization and expansion of its basic industrial plant and equipment, and in maintenance of an adequate
public infrastructure. When an economic upturn occurs, the retarded economy suffers from an inflation-producing housing shortage and a national plant that functions at a lower productivity growth rate than competitors that have not relied
upon the painful and debilitating tight money policy to fight inflation.
Thus, in the long run, the periodic use of tight money policy as the means of combatting inflation becomes counterproductive.
The frequent, prolonged periods of high interest rates have also altered the distribution of income in the country in a way which tends to support inflationary private demands that are Jess affected by high interest rates than other demands. A
movement toward greater inequality of income distribution since 1967 followed the
upward trend of interest rates and of the increasing share of personal income payments accounted for by interest income. As can be seen on Chart 1, during the fifties, interest rates remained at relatively low levels. It was not until the mid sixties
that they began to move up sharply and, despite some cyclical downturns during
recessions, had an upward tilt through the seventies and into the eighties.
156
MORTGAGE YIELDS VS PRIME INTEREST RATE
Av^rag* y I o J d 01-1 FHA H0<m mor t^**e* 1 oanv
Av^raQm bank pr Tm* rot* 0n •H0i-1 t*rm Joe
49 61
S3 65 67 69 61
£3 6& 67 63 71
DATE QUARTERLY.
73 76 77
78
1/49 - V80
Throughout the post-World War II period, personal interest income as a percentage of total personal income was on the rise as the use of all types of credit expanded. Thus, between 1950 and 1960, the percent of personal income accounted for by
personal interest income rose from 4.3 to 6.2. The percentage moved up more rapidly along with interest rates in the seventies. By 1970 it had reached 8.6 percent, and
in 1979 it was 10.8 percent. Then the upward movement of that percentage accelerated in the last two years as interest rates reached record high levels. By 1980 the
percentage of total personal income that was interest income rose to 11.9 percent
and continued to accelerate in 1981, reaching 13 percent by the third quarter.
Chart 2 shows the rising proportion of total personal income accounted for by interest income over the past three decades, following the long-term upward trend of
interest rates. It also shows the acceleration in recent years of the interest incometo-total income ratio and of federal interest payments as a percent of total budget
expenditures.
157
PRIME RATE, FEDERAL INTEREST BURDEN,
2. INTEREST SHARE OF PERSONAL INCOME
rat 4 on
Net
Int pd by T«d
\t>-v\.
X
49
El
S3
56
57
59
61
63
65
DATE QUARTERLY-
a-f
67
a*
cH0r~i
X *^
ta^a)
68
tor-m
"fvct
ermf-f^rtol
71
73
I0><
^ovt i
75
Jj
77
78
1/49 - 4/83
High-income families with substantial discretionary income have more savings
and other financial assets than others, as has been shown consistently in periodic
surveys of consumer finances conducted over three decades by the University of
Michigan Survey Research Center. The accelerating proportion of total personal
income accounted for by interest income was bound to be reflected in the income
distribution. In 1979, the families in the top 20 percent of the income distribution
had incomes above $31,600 and the top 5 percent above $50,300. In 1980, the comparable benchmarks of $34,500 and $54,000 were above a year ago by 9.2 percent and
7.6 percent, respectively, while the median income rose only 7.3 percent.
Detailed data available for 1979 also show a correlation between the share of the
total amount of education and the share of aggregate income received by each quintile in the family income distribution.
Thus, the higher income families had a greater educational background, which
lent itself to self-interest deployment of funds to obtain the highest yields. This they
did, as shown by the strong upward trend in direct investments in securities plus
money market fund shares. They would also have the purchasing power to bid away
scarce resources from others by a capability to pay higher prices for end products
and services.
They were also increasing consumer expenditures in a pattern to cause and
enable certain product and service sectors to expand their capacity. The evidence
with regard to the types of consumer expenditures made by the high income fami
158
lies is more fragmented than the data on household investments. However, by early
1981, the relationship between the supplementation of high incomes by high interest
rates and the purchase of higher priced products and services was becoming quite
apparent, as reflected in the following excerpt from an article in Business Week of
March 9, 1981.
Although high interest rates have increased the costs of consumer borrowing,
they have also become an increasingly important source of income to growing numbers of consumers who put money in high-yielding money market funds or cash
management accounts. Interest income as a percentage of total personal income increased by more than one-third from 1973 to 1980, going from 8.8 percent to 11.9
percent.
The two-tier consumer market is "almost the sole reason consumer spending has
outpaced forecasters' estimates," says Albert G. Matamoros, vice-president and chief
economist of Armstrong World Industries Inc. The weight of the top tier of the
market in determining the strength of overall consumer spending is staggering. According to economist Carol Brock Kenney of Shearson Loeb Rhoades Inc., the
richest 40 percent of all households account for 60 percent of all retail sales and
two-thirds of all spending on such highly discretionary durables as automobiles and
color TVs.
Data from a 1980 survey of markets of affluence indicated demands for other
types of discretionary expenditures that were also largely supported by high income
households. For the survey (by Monroe Mendelsohn Research, Inc.) adults in households with incomes of $40,000 or more were denied as affluent. It found, first, that
affluent households accounted for 70 percent of household securities. Some examples
of the types of consumer expenditures found to be dominated by affluent households
included the following.
The affluent are eighteen times more likely to travel on a domestic airline than
the nonaffluent; more than one-third of the affluent take seven or more round trips
a year.
The affluent spend four times as much for jewelry and watches as the nonaffluent.
Better than nine out of ten affluent adults stay at a foreign hotel or motel during
a year.
Historical data on total annual personal consumption expenditures and on selected "discretionary income" components for luxury goods and services are shown in
Table 1 for the years 1947 through 1980. The five selected categories of expenditure
are for (I) recreation including toys, sports equipment, bikes, boats, and pleasure
aircraft; (2) "other recreation" including bowling alleys, riding, skiing, and swimming places; amusement parks, golf courses and sightseeing buses; (3) foreign travel
and expenditures overseas; (4) airline travel; and (5) jewelry and watch expenditures. The proportion of total personal consumption expenditures accounted for by
these five categories in some benchmark years were:
2.5 percent in 1947.
2.9 percent in 1960.
3.3 percent in 1965,
3.7 percent in 1970,
4.0 percent in 1975.
4.1 percent in 1976.
4.2 percent in 1977,
4.0 percent in 1978.
3.9 percent in 1979.
4.1 percent in 1980.
4.0 percent in 1981.
The dollar amount of these expenditures in 1981 was £74 billion.
The effects of repeating the pattern of tight-money/high interest rates, high unemployment and recession have been to help create a two-tier economy with an
upper tier that can indirectly or directly pay for high interest rates and support productive capacity for luxury type goods and services. However, basic industries, such
as steel, glass, aluminum, and lumber, which must supply mass market products
such as housing and automobiles, cannot be sustained or modernized because they
cannot pay competitively high interest rates.
The volatility that is created in the economy, and particularly in financial markets, also encourages credit-supported industry acquisitions, instead of modernizing
and expanding basic industries.
159
THE NEED TO SUPPLEMENT TIGHT MONETARY POLICY
In addition to auto production and home building, capital formation, employment,
and the entire economy have suffered as a result of the tight money policy which is
supposed to combat inflation.
The solution to the problem of economic instability and retardation must be
sought in a more effective means of fighting inflation. The record of recent decades
shows that reliance upon the Federal Reserve's policy of tightening up the money
supply to control inflation is ineffective.
It is ineffective because the resultant high interest rates add to inflation both directly and indirectly. The cost of goods and services that must be financed rises as
interest expenses are directly rolled into prices. The skyrocketing cost of purchasing
a home is perhaps the most striking example of this process. Because high interest
rates discourage demand, the manufacturing capacity utilization rate declines, and
businesses can't operate at levels of peak efficiency. This increases the cost of production. In addition, low capacity utilization rates, in combination with high interest rates, discourage investment. This retards productivity growth, adding to cost
pressures.
A longer run effect results from the increased unemployment of men and machines. Hundreds of billions of dollars of national product and income are foregone.
Tens of billions of dollars of savings and capital formation are also lost. The economy is left with less adequate stocks of housing and industrial equipment than could
have been produced and is more susceptible to the next round of inflation.
We should turn away from the disastrous reliance on tight money as the sole
policy to fight inflation. Because tight money results in rationing through high interest rates, thereby often favoring unproductive uses of credit such as corporate
takeovers, excessive commodity speculation, speculation in international exchange,
and expanding capacity for production of luxury goods and services, the President
should authorize the "Fed" to use selective credit controls to channel credit for productive purposes. Examples of these include: home mortgages; new residential, industrial, and commercial construction; farming; financing of capital equipment,
cars, and trucks; and industrial and state/local government bonds for necessary
public capital. By making credit less accessible for nonproductive uses, interest rates
for productive uses would tend to decline.
There has been a growing number of authoritative voices that have indicated the
need to control the growth of credit including Henry Kaufman of Salomon Brothers
and Professor Benjamin Friedman of Harvard. Albert Wojnilower of First Boston
Corporation has written at length about the need to have some forms of credit controls.
Experience both here and abroad demonstrates that credit controls provide a
viable alternative to slowing down the money supply. The brief implementation of
controls in 1980 proved helpful in rapidly bringing down interest rates. As a result,
the decline in home building and general economic activity was reversed. Japan has
used credit regulation in recent years to help keep inflation and unemployment at
levels well below those of the United States and has also guided capital flows into
high priority industrial investments. It regularly has restrictions upon total Credit
growth and also guides capital fun flows into long-range development of basic industrial capacity in selected industrial sectors. Japan has had lower interest rates,
lower inflation, lower unemployment, and greater industrial production growth
than most countries. On the other hand, the United Kingdom which has been following a monetarism policy similar to that of the United States, has a very poor
economic record. Comparison of a few most recent key economic indicators for the
three countries is noteworthy:
United States
United Kingdom
+5
-8
1
+45
+9
+ 12
n
66
8.5
14.6
15.9
12.7
If selective credit regulations are used to defer capital investment that is not
urgent and bring interest rates down to affordable housing levels, depository institu
160
tions specialized in home financing could remain in business, a needed higher level
of residential construction could again be achieved, and the economy as a whole
would be in a healthier condition.
The Credit Control Act of 1969 provides the authority to use flexible credit controls as a supplement to general monetary policy. The AFL-CIO strongly supports
making this authority permanent before its scheduled expiration in June 1982 and
using it now to bring down interest rates and revive housing and key sectors of the
economy.
The CHAIRMAN. On that point I guess I would disagree with both
of you. I think you're right about them blaming it all on monetary
policy, but looking back at that, you're correct. I disagree only to
the extent that the component of OPEC and so on and housing increases were about 4 percent of the 13- or 14-percent inflation
during those years. So I think you're both overestimating inflationary causes for your point of view, and I still feel the prime fault
lies right here with Congress—neither monetary policy or OPEC.
It's Congress and that trillion dollar debt, and I'd like to get back
more into that with you.
Mr. Sumichrast.
STATEMENT OF MICHAEL SUMICHRAST, CHIEF ECONOMIST,
NATIONAL ASSOCIATION OF HOME BUILDERS
Mr. SUMICHRAST. Mr. Chairman, I would like to sum up my testimony in order to save time. I don't want to really get into the conceptual argument. I will leave it to other people to discuss that.
I'd like to simply state that the result of monetary and fiscal
policies is obviously very high interest rates.
The CHAIRMAN. We will put your detailed statement in the
record.
Mr. SUMICHRAST. Interest rates kill housing. It's that simple.
From the very practical point of view, this is where we are. We
simply cannot build houses with the prime at 20, 21, and 22 percent. We cannot. There's no way in the world you can do that and
you cannot sell them when the auction price is at 18.2 or 18.3 percent. You cannot sell houses.
As a result, we cannot function in a climate of interest rates as
volatile as we have seen since 1979. We have had an increase and
decline in a short period of time such as we have never seen. There
must be something fundamentally wrong with policies that create
that sort of upheaval.
Now we have an industry which functions in a planning stage of
not months but years. How can you ask anybody to make any kind
of a plan for 1983 and 1984 in order to get any project underway
when you cannot even guess what the rates are going to be tomorrow? We live under the pressure of what changed Friday at 3
o'clock that wasn't there at 2:30 before the money supply was announced. It's totally ridiculous.
LONGEST HOUSING RECESSION ON RECORD
I think, as a result, we are facing a major decline. We have had
the longest recession in housing on record. We have had 6 months
of activity below 1 million units, something we have not seen since
1945. We ended up 1981 with the lowest production level since 1946
and we had 19 million less people in 1946. We cannot sell houses.
161
We have about half a million new unsold houses, about 5 million
houses sitting there with a "For Sale" sign and we can not move
them. It's just totally devastating to our industry.
Henry mentioned that we have a very high unemployment rate.
We have 946,000 construction workers out of work, but that doesn't
really take into consideration about 40 million more single individuals who are out of work.
What I would suggest we need—and we need very fast—is some
decline in interest rates because, as I said, we cannot function in a
climate where the interest rates are going the wrong direction.
Right now the prime is at 16.5, but it's way too high. You asked me
what I suggest we do on the side of monetary policy. I have a
couple of ideas.
Last summer I wrote a short analysis of the Fed's policy and my
suggestions. I still think they are pretty valid and I included them
in my testimony. What I would really urge you to do is have some
discussion about the wide range of targets. I looked at some of the
other countries—Henry was in Japan and we examined some other
countries in Europe and looked at their monetary policy and how
they function. I think there's a very great need to really say what
the targets should be and whether they should be tied to growth.
Second, I'm not so sure that the monetary policy itself works. I
don't even know if it can work in this kind of framework. There
was a discussion about the money growth. Well, watching the Federal funds rate probably is a better way than watching the money
supply.
I think also we should take a look at the makeup of the Fed.
Some other countries have an entirely different makeup of the Fed
than we have. I know when I talked with Chairman Miller when I
was being considered for Board membership a couple years ago he
told me that one of the problems we have is that we're supposed to
control the commercial banks through the monetary policies and
yet we don't have a banker on the Board. I think it's one of the
weaknesses of the whole setup. Some countries have a different
sort of an attitude toward setting up the board.
ADMINISTRATION VERSUS FED
Probably the most disturbing thing from where I sit is the bloody
fight between the administration and the Fed itself. I just heard
Mr. Sprinkel say they're all in one corner; they're not fighting; but
really it's a bloody fight. It's a conceptual fight. It's a political
fight, and I think we're right in the middle of it and the country is
not gaining anything by that.
I think one of your functions is to try to be an arbitrator between
these two bodies.
The CHAIRMAN. I have been trying to do that on my legislation
between the banks, savings and loans, the realtors, homebuilders
and the securities industry. That's why I'm so bruised and beaten. I
don't think being an arbitrator works too well.
Mr. SUMICHRAST. I would suggest that the targets which they
suggest are probably too low. I made some suggestions. I don't
really know what the targets should be. I have no idea. I don't
think the Fed does. I don't think they even know what money is.
162
I'm certain now that nobody can really define money. As my
friends in Wall Street tell me, is it a state of mind; is it my potential credit that I can get as a businessman; or is it something else?
And I think everybody probably would agree with me—maybe not
on many things—but in the whole spectrum of the thing I think
the movement toward the targeted money growth did more
damage, at least for our industry and also the small business.
That's about all, Mr. Chairman.
[Complete statement of Mr. Sumichrast follows:]
STATEMENT OF THE NATIONAL ASSOCIATION OF HOME BUILDERS
Mr. Chairman and Members of the Committee: My name is Michael Sumichrast
and I am Chief Economist and StafC Vice President of the National Association of
Home Builders. I am testifying today on behalf of the more than 116,000 members
of the National Association of Home Builders (NAHB). NAHB is the trade association of the nation's home building industry. I am here at your invitation to testify
on the conduct of monetary policy during the latter half of 1981 and on what the
monetary policy strategy should be during 1982.
Mr. Chairman, I appreciate the opportunity to appear here today.
I have prepared a detailed situation report concerning the housing industry which
I would like to include in the record. I did this simply to bring to your attention the
impact of monetary as well as fiscal policies on the housing industry. In short, they
have almost devastated housing.
The expansionary fiscal policies, with record deficit financing and very high monetary policies, resulted in record high interest rates- Never before has the nousing
industry faced a run up of interest rates of such magnitude.
These policies resulted in the decimation of housing—with the longest post war
recession, the lowest production year, drastically reduced sales and unparalleled
bankruptcies.
The critical point of my presentation is the need to reduce all interest rates.
If they do not decline, we cannot survive. Neither can many others. I voiced my
concern to Chairman Volcker and told him that I can not imagine a scenario with a
run up in interest rates such as that suggested by Henry Kaufman. Not that Kaufman is wrong, he is looking at the current budgetary situation. But, because it is
inconceivable that we might have a re-run of the 1980s with massive defaults in the
thrift industry as well as bankruptcies of scores of major manufacturing companies,
not to mention thousands more construction companies.
HOUSING SITUATION
Our industry just experienced one of its most difficult years.
In 1981 we built only 1,1 million new housing units, the lowest level since 1946. In
1946 the United States had a population of 141.9 million—that's 86.9 million less
people than we have in the U.S. today.
Even in 1946 our rate of housing starts was 7.21 per 1,000 population—compared
to 4.79 last year. This, by the way, was the lowest rate since 1945, when we only
started 326,000 new units.
Our current level of production is 56 percent below the 1977-78 period.
January was the sixth straight month in which the seasonally adjusted annual
rate of starts was below one million. That has not happened in housing since 1945.
This is a single family housing recession: for the one million units we are not
building, 78 percent are in single family homes.
Single family sales in 1981 were the lowest on record—426,000 units.
1981 was the lowest year in the resale market since 1974.
Existing sales in December 1981 were down 33 percent from one year ago, and
down 52 percent from the November 1978 peak of 4,060,000.
Delinquency rates for 1-4 unit residential loans are up 6.4 percent from third
quarter 1980 to third quarter 1981,
The construction failure rates through August 1981 are up 41 percent over 1980.
Unemployment in the construction industry in 1981 (15.6 percent) was much
greater than in 1980 (14.1 percent) and 1979 (10"3 percent).
946,000 wage and salary workers were out of work in January 1982 compared to
712,000 last year.
Construction unemployment in January 1982 (18.7 percent) was significantly
higher than the depressed market of one year ago (13.7 percent).
163
The January unemployment figure is the highest since August 1975 (19.1 percent'.
The thrift institutions recorded record net outflows of $39.3 billion in 1981, compared to inflows of $5.8 billion in 1980 and $8.1 billion in 1979.
New commitments made by savings and loans in 1981 ($55.9 billion) were down 28
percent from 1980 and 45 percent below 1979.
HOUSING PROSPECTS
1982 will not be a good year for housing. There is, however, some hope that some
improvement will occur in the latter part of the year.
Why do I think we will do marginally better in 1982 and better still in 1983? Because I am convinced that all interest rates will decline. And, if I am right—and I
hope and pray that I am—we will start selling more homes than we are selling
today.
It won't be too difficult to sell more. The level of sales could hardly go any lower,
in spite of all kinds of help which builders are currently providing to reduce their
inventory.
I am suggesting a marginal recovery at best this year because we will miss most
of the first part of the year—instead of selling we will be sitting and watching interest rates which are still very high. For a while last fall it looked like we might take
good news to our annual convention in Las Vegas in January and tell our builder
members that the FHA rate was 14 percent. Instead, the FHA rate was increased by
one hundred basis points from 15.5 to 16.5 percent, and the increase just happened
to coincide with Secretary Pierce's arrival in Las Vegas to speak to our Board of
Directors. That's rather like being hit over the head with your own size 13 shoe,
The Administration blames the FED for high interest rates. The FED blames the
Administration, saying that expected deficits congest the financial markets and
keep all interest rates high. We, unfortunately, are caught in the middle.
We are in the midst of one of the deepest post war recessions. Interest rates
should be declining, not increasing. Historically, they always did, as demand for private credit decreased. But not now.
Also, the drop in the inflation rate should have lowered all interest rates. First, it
did. Now, even though we have more evidence than ever of declining inflation, rates
are still climbing.
Why?
No one knows for sure. Last fall all indicators pointed to a deepening recession
and al] interest rates started to come down. Then the money supply started to increase. Not even the FED is sure why. Some claim that the economy started to
revive a bit, but that contention proved to be false. On the contrary. After an
anemic growth rate of 1.5 percent (annual rate) in the Gross National Product in
the third quarter of 1981, GNP dropped like a lead balloon in the fourth quarter by
4.7 percent. The unemployment rate jumped to nearly 9 percent with a new record
number of people out of work: 9.5 million.
The economy continued to weaken in January. Industrial production declined
sharply by 3 percent, capacity utilization dropped further to its lowest level in seven
years and housing, as well as automobiles, continued to decline.
Again the FED blamed the Administration. Deficits are too high and prospects for
deficits down the pike are messing up the financial markets. And the Administration kept repeating that the FED policies should be somewhat more accommodating.
The Administration now realizes that unless we have a turnaround in interest
rates, the proposed turnaround (on which all of the economic assumptions are
based) will not happen.
Most people, in and out of government, agree on that score, including the President, who said: "High interest rates present the greatest single threat today to
healthy, lasting recovery."
THE NEED FOR HIGHER MONEY GROWTH RATE
Those who criticize the FED have a point. The present targets for money growth
do not give enough room for the economy to grow to the levels suggested by the
President, When the recovery begins, we will certainly bump against the monetary
growth rates set by the FED. These growth rates are arbitrary and considerably
lower in order to accommodate such projected growth. The result will be another
round of rising interest rates. Why? Because demand for credit will increase, but
will be cut off because the rates will go up again.
Clearly, the FED is in the driver's seat. Their tight money policies are working
very effectively to curb demand. This is done at the expense of unparalleled suffer-
164
ing in the labor force, and by business—both large and small. If continued, it will
absolutely curb any growth by allowing interest rates to remain high.
And if Congress should resolve to try to increase the growth through more deficits, interest rates will rise even more. Thus we are caught in a Catch-22 situation.
We must bring the deficit down and stop the pressure on the credit markets. This
can be done by cutting expenditures even more, or by raising taxes. But both of
these will result in less consumer expenditures by reducing the money available to
the consumer, thereby dampening economic growth.
There is no single, simple solution to this dilemma. The policies of the past two
decades—or more—are responsible for the staggering deficit, with the national debt
now over $1 trillion.
The Federal Reserve Board could be blamed for high interest rates and the recession, but they are, in a sense, only responding to a difficult situation created by
many years of loose fiscal policies. In today's financial climate it is no longer possible to convince the financial markets overnight that they can expect to get a reasonable return on their investment in real terms—excluding inflation. It takes much
longer, and needs much more persuasive evidence.
Such evidence has been apparent for some time. We are definitely winning the
race against inflation. And that is a prerequisite to lower interest rates.
THE DEFICIT MUST COME DOWN
Congress must help take the pressure off the financial markets by drastically reducing the deficit.
Record deficits can have nothing but a negative impact on housing. They "crowd"
out private demand for capital, keep interest rates high, and tell the financial markets that inflation will continue.
It doesn't matter what the Government spends money for, or where the money
comes from, a deficit is a deficit. Put in perspective, this is what has happened to
the deficit in the past 50 years:
Fifty years ago the Federal debt was at less than $17 billion; it increased to $1,004
billion by the end of 1981. By fiscal 1985 it is expected to be nearly $1,5 trillion.
During the 25 years from the end of 1956 to the end of 1981, the national debt
increased at an average annual rate of 5.3 percent. But that rate of increase in the
debt pales in comparison with the burden of the interest cost: the interest cost we
are paying has been growing much faster than the Gross National Product. In the
late 1950's, the interest cost was equal to 1.4 percent of GNP, rising to 1.6 percent in
1970 and to a record 2.8 percent in 1981. By fiscal 1983 this share of GNP is expected to increase to 3.3 percent, or $133.2 billion. As a comparison, in fiscal 1981 we
paid $96 billion for interest on the national debt, while the total expenditures for
new housing units were $61.9 billion and for single family units the amount was
$43.8 billion.
Combining direct government borrowing with federally assisted borrowing represents a record 36 percent of total borrowing, compared to only 21 percent in the first
half of the 197G's and 17 percent during the decade of the 1960's.
It's no wonder we don't have enough money for housing when the Government is
taking such an enormous share of the capital markets,
In the struggle for available funds, housing is definitely the loser. In 1979 residential mortgages absorbed $120.2 billion, or 25.3 percent of the total credit market
funds raised ($475.8 billion). In addition, other mortgages accounted for 7.5 percent
of the total with $35.7 billion, for a total of 32.8 percent.
Last year the residential mortgage share dropped to 14.4 percent ($73.5 billion).
Even more dramatic has been the change in the suppliers of mortgage money funds.
In the mid-1970's, the thrift institutions provided over 55 percent of all mortgage
money. In 1978 their share dropped to just under 40 percent and in the third quarter of 1981, that share fell to a mere 8.8 percent. The share of the sponsored credit
agencies, FNMA, Freddie Mac, etc., increased during the same time period from 8.2
percent to 22.7 percent.
The question, therefore, is not so much concerned with what has already happened, rather it is the need to ascertain what types of policies we must have in
order to prevent us from perpetuating our mistakes.
For 1982-83 I would like to see higher monetary growth, I say this because I don't
believe that the suggested monetary growth is going to be sufficient for any meaningful recovery.
Yet, on the other hand, what do I care what the rate of the money supply is? My
primary concern is that we have a sufficient amount to provide us with economic
growth and enable interest rates to decline to reasonable levels.
165
Housing is dying. You have it within your power to heal the patient and help him
on the road to recovery. If housing recovers, then perhaps the economic growth we
so desperately need will follow.
Attached are numerous tables and charts which clearly illustrates the demise of
housing. Also included are NAHB's new forecasts for housing based on the assumption that interest rates will decline (prime to 13 percent in the fourth quarter of
1982)—and a second scenario which assumes that interest rates will not decline
(heaven forbid). Further, I have appended an article I wrote last July which outlines
my feelings on the "Need to Change the FED's Policies."
A NEED TO CHANGE THE FED'S POLICIES
(By Michael Sumichrast)
There is little outcry from the business or financial communities about the devastating impact of the Federal Reserve Board's policies on the economy. As a matter
of fact, there is a great deal of support for the "tight" money policies as one of the
main cures of inflation.
However, with interest rates now at record levels—for nearly two years—there
are increasing voices heard about the wisdom of the monetarist approach. These
voices are particularly strong from the financial community.
Even financial expert Henry Kaufman of Solomon Brothers has some misgivings
about the FED's current policies:
"The need is also to recognize that mechanical monetarism should not be the
main bulwark against inflation."
The arguments center on the changes in the FED's policies as of October 7, 1979
when the FED virtually abandoned the control of interest rates, and concentrated
on controlling the money supply.
Monetary policies have had ample time since then to prove themselves. However,
there is sufficient evidence now that these policies are now working well.
In a broad sense, these are the problems:
Money supply, as a target and chief tool of this policy, has been all over the place
as the FED cannot hit the money supply target it set for itself.
It's not clear whether the FED knows what the right target should be. Some
people think that the growth of money should have a direct relation to the growth
of the economy, some think otherwise. What is the right target?
It's not sure whether the FED can clearly define what money is (see box for the
current definition of the various money supply measures).
Is money simply that description? Or is it what Bill Gribbs of J. Henry Schroder
Bank & Trust Company of New York says it is: "Money is a state of mind. Not what
we have on the balance sheet, or in the bank, but how much and can we borrow."
Is the money supply definition more in line with "liquidity," rather than the dollars deposited, or credit?
In a narrower sense, the monetarist approach, combined with a restructuring of
the financial intermediaries, has resulted in:
Unprecedented financial instability.
Record high interest rates,
The greatest interest rate fluctuations on record.
Devastating credit sensitive industries and businesses such as housing, farming,
small business, auto dealers, etc.
The creation of Friday hysteria—and speculation—on Wall Street in trying to
read the money supply figures. Result: financial markets are starting to behave like
the stock market with all the irrationality; decisions are precision made, like a
finely tuned instrument, and they are made by the minute rather than by the
month or the quarter. What possibly could have changed the underlying direction of
a huge economy such as ours each Friday afternoon?
This is not the way to go.
How could we have reached a point where we believe that a straight statistical
measure of the money supply could possibly be the answer to all our problems?
There's more, much more, to it in a complex society like ours. Treating this as a
hard science is sheer nonsense. At best, it is an art, requiring a lot of judgments.
For years I have supported the FED's policies. My reasoning was based on the fact
that while the U.S. Government tried to spend itself into prosperity, the FED, in
many cases, refused to validate this nonsense by restrictive monetary policies. Now,
I find that I can no longer support these policies.
At the heart of the current dilemma and controversy is the question of whether
or not the FED should have abandoned control of interest rates.
166
It is not so much a conceptual agreement; most people now would agree that less
control is better than more control- It is, however, the enormous impact on real life
that such policies have.
If the October 7th experiment had been done in a laboratory, that would have
been fine. But it wasn't. These are real people being experimented with: they do or
die, just as surely as the mice in the lab who were given the wrong medicine.
The monetarist approach doesn't find any converts overseas, either. The European
central banks have followed a dual approach of controlling monetary aggregates
(mostly M3) as well as interest rates. The more we stick with controlling the aggregates, the more they would tend to be forced to control rates as a result of the high
rates and wide fluctuation in interest rates in the United States.
Nobody is advocating the removal of money supply controls. But a better way of
providing more stability in the financial market would be to return to the dual
system of controlling interest rates as well as aggregates.
Even setting targets for money supply may be looked at as rather narrow and too
simplistic. A more encompassing system may be to look at the total volume of credit
availability as a better measure.
The economy should be examined as a mosaic of many parts—a lot of individual
sectors. Each of these needs and requires a different approach, and each reacts differently to monetary policies.
It doesn't make much difference to most defense industries what the interest rate
is, but it certainly makes a lot difference to a small farmer who needs to buy a tractor on time.
The running of such a massive economy without making some judgments as to its
parts, letting it all hang on an imprecise definition of money aggregates, defies
common sense.
Currently there is no reality to interest rates. The reason is that not many banks
will take a chance to speculate on the downside in a climate of such uncertainty
and volatility.
Short term rates should be in the 11-12 percent range, looking strictly at the underlying rate of inflation. Yet, the prime is now at 19.5 percent.
What banks are doing is running for protection by indexing on a weekly or even a
daily basis. That alone defies the fundamental working of a free economy. Why
should one sector be immune to risks? Why not farmers—or builders? What kind of
free competitive system is it if you set interest rates in unison?
Henry Kaufman said: "Financial intermediaries should experience the penalties
of monetary restraint and not just pass them along to others. Otherwise, the real
world will become the hostage of financial institutions."
MONET STOCK WTA5URES
(in billion* of dollars, and percent of total money supply, for April 1981, *t seasonal rate*)
$365.1
15.11
$429.5
17. 7Z
$1,733.6
71 .63
$2,421.2*
100.01
$2,028.1
83 .«
Currency
Currency
Currency
Currency
Currency
?
119.0
Checking
Checking
+
Checkable Deposit^
(include* HOW,
automatic transfer*, credit
uilon shares, and
demand deposit*
at mutual saving a
banks)
Checking
+
Checkable Deposits
Checking
+
Checkable De-
Checking
+
Checkable Dej exits
$
264.1
S
64.4
Small denomination CD*
Small denomination CD*
Small dentalnation CD*
$1.137.2
Eurodollar*
Eurodollar*;
Eurodollar*
$
4.7
Overnight repurchase agreements
Overnight repurchase agreements
Overnight repurchase agreement*
$
27.1
Honey market
mutual fund
shares
Honey market
mutual fund
shares
+
Large denomination time
deposits
Honey market
mutual fund
share*
+
Large dettomination time
deposits
$
117.1
Term repurchase
agreement* at
commercial banks
and SSLs
Term repurchase
agreements at
commercial bank*
and S4L*
+
$ 258.4
S
* Data for February 1981
** other liquid asset*: term Eurodollar*, savings bond*, *hort term Treasury securities, bankers
acceptance*i cmmserclal paper.
Source: Board of Governor* of the Federal Reserve System
36.1
U.S. HOUSING STARTS RATE PER 1,000 POPULATION, 1900-1983
(with 10 year averages)
Housing
Starts
Tear
1900
1901
1902
1903
1904
1905
1906
1907
1908
1909
1900-09
tT)
189
275
240
253
315
507
487
432
416
492
361
Population
(H)
76.1
77.6
79.2
80.6
82.2
83.8
85.4
87.0
88.7
90.5
83.1
Starts
Pec 1,000
91.4
93.9
95.3
97.2
99.1
100.5
4.19
4.21
4.47
1910
1911
1912
1913
1914
1915
1916
1917
1918
1919
1910-19
387
395
426
421
421
433
437
240
118
315
359
103.3
103.2
104.5
99.1
1920
1921
1922
1923
1924
1925
1926
1927
1928
1929
1920-29
247
4 49
716
871
893
937
849
810
753
509
703
106.5
108.5
110. 1
112.0
114.1
115.8
117.4
119,0
120.5
121.8
114.6
102.0
Persons
2.48
3.54
3.03
3.14
3.83
6.05
5.70
4.97
4.69
5.44
4.34
4.33
4.25
4.31
4.28
2.32
1.14
3.01
3.62
2.32
6.14
e.so
7.78
7.83
8.09
7.23
6.81
6.25
4.18
6.13
1930
1931
1932
1933
1934
1935
1936
1937
1938
1939
1930-39
Housing
Starts
(1)
330
254
134
93
126
221
319
336
406
515
273
1940
1941
1942
1943
1944
1945
1946
1947
1948
1949
1940-49
603
706
356
191
142
326
1,023
1,268
1,362
1.466
744
1950
1951
1952
1953
1954
1955
1956
19 57
1958
1959
1950-59
1,952
1,491
1,504
1,438
1,551
1.646
1.349
1,114
1,382
1^554
1,509
Ye»t
Popula- Starts
Per 1,000
tion
fear
Persons
00
Housing
Starts
(T)
1,296
1,365
1,492
1,635
1,561
1,510
1,196
1,322
1,545
1,300
1,442
Population
W
180.7
183.7
166.6
189.2
191.9
194.3
196.6
198.7
200.7
202.7
192.5
Percooa
7.17
7.43
8.00
8.64
8.13
7.77
6.08
6.65
7.70
7.40
7749
123.1
124.1
U4,a
2.68
2.05
1.07
125.6
0.74
126.4
1.00
1.74
2.49
2.61
3.13
3.93
2.15
1960
1961
1942
1963
1964
1965
1966
1967
1968
1969
1960-69
4.55
5.27
2.63
1.39
1.02
2.32
7.21
8.76
9.25
9.79
i.31
1970
1971
1972
1973
1974
1975
1976
1977
1978
1979
1970-79
1,469
2,085
2,379
2,018
1,353
1,171
1,547
2,002
2,036
1J6Q
17786
205.1
207.7
209.9
211.9
213.9
216.0
218.0
220.2
222.6
225.1
215.0
7.16
10.04
11.33
9.71
6.33
5.42
7.10
9.09
9.15
7.82
8.31
12.82
9.63
9.54
8.98
9.52
9.92
7.99
7.12
7.90
8.74
1980
1981
1982*
1983*
1984
1985
1986
1987
1988
1989
1960-89
1,313
1,101
1,074
1,497
227.7
229.8
232.0
234.2
5.77
4.79
4.63
6.39
127.3
128.1
128.8
129.8
130.9
126.9
132.6
133.9
135.4
137.3
138.9
140.5
141.9
144.7
147.2
149.8
140.2
152.3
154.9
157.6
160.2
163.0
165.9
168.9
172.0
174.9
177.8
164.8
9.16
Code: (T)-Jn thousands; (M)-In millions
* Forecasted
Source: Bureau of the Census; NAHB Forecasting Service; cc ipllatlon by NAHB Economics Division
Starts
Per 1,000
OS
00
169
February 2, 1982
SALE OF NEW HOMES
(percent of respondents)
Single Family Detached
Good to
Poor
Excellent Pair
Townhouse
Good to
Excellent Fair
Poor
Condominium
Good to
Excellent Fair Poor
Next Six Months
IX
32X
67Z
2X
39X
59X
5Z
34X
61X
Jan 1982
OX
12Z
88Z
20X
SOX
IX
25Z
74X
Hov
Aug
May
Apr
Har
Fab
Jan
*z
94Z
88
84
73
79
85
80
3
5
11
0
0
3
13X
19
31
35
32
29
26
87Z
78
64
54
68
*z
2
4
5
3
0
3
62
10
12
22
18
15
17
oz
ox
71
6
13
10
4
0
9
16Z
23
20
43
50
33
32
84*
71
67
47
46
67
59
20
38
35
41
36
25
11
12
44
29
77
56
53
49
59
70
83
87
56
61
7
12
15
8
11
8
2
4
1
7
26
44
45
46
35
20
22
10
49
31
67
44
40
46
54
72
76
86
50
62
6
12
14
7
12
5
3
6
0
12
37
52
43
44
34
29
28
11
50
35
57
36
43
49
54
66
69
83
40
53
Jan 1962
Current
1981
1981
1981
1981
1981
1961
1981
Nov 1980
Oct 1980
71
Aug
Jul
May
Apr
Mar
Feb
Jan
1980
1980
1980
1980
1980
1980
1980
3
6
12
11
5
5
2
1
0
10
Dec
Oct
Aug
Jul
Jim
May
Apr
Feb
1979
1979
1979
1979
1979
1979
1979
1979
7X
11
29
26
28
53
55
31
211
36
44
46
37
26
25
51
72X
53
27
28
35
22
20
18
7X
12
27
28
24
60
55
20
27X
35
50
39
42
25
15
46
66X
53
23
33
34
15
30
34
141
12
37
37
25
60
48
20
25Z
44
40
33
48
26
30
42
61X
44
23
30
27
14
22
38
Sep 1978
Jun 1978
Mar 1978
kf>%
64
68
391
28
27
13t
8
5
381
26
31
40X
44
38
22X
30
31
32X
25
21
36X
36
40
30Z
39
39
Nov 1977
Aug 1977
Mar 1977
69Z
79
72
29X
17
21
21
4
7
28X
23
20
401
44
49
32*
33
31
17X
21
12
32X
33
35
51Z
46
53
Nov 1976
45Z
44X
11Z
111
22X
67X
9Z
17 Z
74X
Sep 1980
* Less than 1 percent
Source:
BEG Survey, NAHB Economics Division
170
SEASONALLY ADJUSTED CONSUMER PRICE INDEX FOR ALL URBAN
CONSUMERS: U.S. CITY AVERAGE, 1978-1981
(1967 - 100)
Consumer
Price Index
187.9
188.9
190.2
191.5
193.1
194.8
196.2
197.5
199.3
201.1
202.5
203.8
205.5
207.6
209.5
211.5
213.7
215.9
218.4
220.7
223.3
225.7
228.4
230.9
234.1
237.1
240.3
242.4
244.5
246.9
247.1
249.0
251.6
254.2
257.0
259.5
261.4
263.9
265.5
266.7
268.4
270.3
273.5
275.8
279.0
280.0
281.3
282.6
SOURCE:
Monthly Rate
of Change
0.61
0.5
0.7
0.7
0.8
0.9
0.7
0.7
0.9
0.9
0.7
0.6
0.8X
1.0
0.9
1.0
1.0
1.0
1.2
1.0
1.2
1.1
1.2
1.1
1.4Z
1.3
1.4
0.9
0.9
1.0
0.1
0.8
1.0
1.0
1.1
1.0
0.71
1.0
0.6
0.4
0.7
0.7
1.2
0.8
1.2
0.4
0.5
0.5
Annual Rate of Change
Compounded Not Compounded
7.2Z
7.5X
6.0
6.6
8.4
8.6
8.4
8.5
9.6
10.5
10.8
11.1
8.4
9.0
8.4
8.2
10.8
11.5
10.8
11.4
0.4
8.7
7.2
8.0
10. 5Z
13.0
11.6
12.1
9.61
12.0
10.8
12.0
12.0
12.0
13.2
12.0
14.4
13.2
14.4
13.2
18. OZ
16.5
16. 8%
17.5
11.0
10-9
12.4
1.0
9.6
13.3
13.1
14.0
12.3
16.8
10.8
10.8
12.0
1.2
9.6
12.0
12.0
13.2
12.0
9.1Z
12.1
7.5
5.6
7.9
8.4Z
12.0
7.2
4.8
8.4
13.2
13.1
14.8
13.4
15.1
13.7
15.3
14.0
15.6
8.8
8.4
15.2
10.6
14.8
4.4
5.7
5.7
14.4
9.6
14.4
4.8
6.0
6-0
Bureau of Labor Statistics; Compiled by NAHB Economics Division
1981-62 PRODUCER PRICE INDICES
(unadjusted, 1967-100)
1982
1981
All CoBBodltles
All Const. Materials
Prepared Paint
Softwood Limber
Douglas Fir
Southern Pine
Other Softwood
General Millwork
Prefab Struct. Members
Softwood Plywood
Insulation Board
Steel Mill Products
Structural Shapes
Bars, Reinforcing
Nails, Wire 8D Cowton
Mill Shapes
Copper/Brass Mill Shapes
Hardware NEC
Builders Hardware
Plunb. Pint./Brass Fitngs.
Vitreous China Fixtures
Brass Fittings
Heating Equipment
Water Heaters-Bonestic
Pab. Strut. Steel, Bldgs.
Plat Glasn
Portland Cenent
Concrete Block & Brick
Ready-Mix Concrete
Building Brick
Clay Tile
Prepared Asphalt Roofing
GypsuB Products
Paving Mixtures & Block
Major Appliances
Source:
Jan
Apr
Hay
Jun
Jul
Aug
-§££-
Oct
283.5
276.7
243.3
353. A
349.5
292.3
380.8
283.6
236.0
325.2
230.7
322.7
343.8
276.0
346.6
297.2
224.3
237.0
249.4
255.5
245.4
259.0
215.4
215.5
284.7
203.9
319.1
263.4
295.4
291.1
187.8
374.8
259.6
522.1
183.6
292.8
283.4
248.5
352.5
333.7
299.0
384.0
287.3
237.2
322.5
242.4
331 .8
371.0
293.7
294.5
284.8
250.4
296.0
296.2
285.6
295.5
284.4
251.0
296.0
284.5
251.0
324.8
276.1
271.4
367.0
279.4
237.9
278.3
244.1
348.7
388.5
273.7
365.8
308.9
222.8
247.5
262.3
272.8
259.7
277.8
226.4
223.1
310.4
218.5
327.1
272.9
300.9
304.1
203.3
349.7
252.4
597.0
192.5
279.0
284.1
250.4
356.4
328.7
307.0
392.9
284.8
237.2
314.9
246.7
332.0
371.0
278.5
354.5
302.5
222.5
239.0
252.8
265.6
253.3
270.8
221.7
215.9
298.9
208.1
329.1
270.6
300.5
302.2
191.2
358.1
261.1
345.0
301.1
220.9
238.4
251.1
265.2
252.8
270.6
218.8
215.8
298.9
208.1
328.9
266.6
299.7
301.1
187.8
367.2
256.8
616.9 610.7
185.8 186.1
356.1
333.4
304.6
391.4
282.2
237.2
319.2
248.0
332.1
370.0
277.8
354.5
304.5
221.6
239.4
253.6
268.2
256.7
273.9
222.9
216.9
300.2
208.1
328.9
270.6
303.2
302.2
191.2
370.8
260.7
610.1
186.9
Department of Labor, Bureau of I^bor Statistics.
285.4
251.0
349.0
320.4
289.9
389.6
283.3
236.6
312.7
241.8
344.9
369.4
276.2
365.8
305.7
220.3
242.2
256.6
270.3
259.6
275.2
225.7
218.5
300.2
216.2
329.4
270.5
301.8
303.7
191.2
367.4
259,7
608.6
189,9
251.0
347.7
318.2
287.8
390.9
280.3
239.8
303.0
245.1
344.9
369.4
275.6
365.8
307.4
222.0
242.5
257.4
271.0
260.4
275.1
227.2
222.6
300.2
218.8
329.4
273.8
301.1
303.8
191.2
365.9
255.3
607.0
190.3
335.2
295.3
277.0
378.6
278.8
239.6
294.6
243.4
345.3
369.4
275.1
365.8
307.2
222.2
245.4
260.1
271.4
259.8
275.7
227.9
222.6
302.3
218.8
328.8
273.8
300.7
304.2
203.3
348.2
232.9
599.1
191.3
Nov
Dec
Jan
295.5
295.9
284.1
254.8
285.1
298.2
286.4
259.3
322.3
269.1
278.0
360.0
288.1
236.2
283.2
246.3
350.6
389.5
268.7
367.7
304.9
216.8
250.5
268.9
274.4
261.8
279.5
232.2
224.2
319.9
268.2
271.2
357.9
280.5
237.9
277.7
244.4
348.6
388.5
270.2
365.8
306.4
219.3
248.6
265.0
273.0
260.0
277.8
227.6
217.2
310.4
218.5'
327.0
273.5
300.2
304.8
203.3
359.4
251.3
597.5
192.8
256.7
321.4
269.3
277.0
357.7
283.7
235.9
289.3
246.5
348.9
389.5
270.2
367.7
305.5
217.7
249.2
266.1
273.9
260.8
279.1
229.2
216.7
HA
218.5
327.0
274.3
300.4
305.1
203.3
353. 5
249.7
597.7
193.1
Jan 81
Jan 82
l_Chg^
Dec 81
Jan 82
5.2J
3.5
6.6
-8.8
-23.0
-4.9
0.81
-5.5
1.6
0.1
-12.9
6.8
8.7
13.3
-2.6
6.1
2.6
-3.3
5.7
7.8
7.4
6.7
7.9
7.8
4,0
HA
HA
216.0
336.3
274.4
302.1
305.1
203.3
347.8
250.4
596.0
195.1
5.9
5.4
4.2
2.3
4.8
8.3
-7.2
-3.5
14.2
6.3
Compilation and analysis by NAHB Economics Division.
Z Ch_3.
0.5
1.0
0.3
-0.1
0.4
0.6
1.6
0,1
-2.1
-0.1
0.5
0.0
-0.6
0.0
-0.2
-0.4
0,5
1.1
0.2
0.4
0,1
1.3
3.5
NA
-1.1
2.8
0.0
0.6
0.0
0.0
-1.6
0.3
-0,3
1,0
CREDIT MARKET FUNDS RAISfiD, 19*6-1981
(In billions of dollar*)
DOLLAR VOLUME
Slate * L<ac«l
1950
1955
1960
1965
1970
1971
1971
1973
197*
1975
1976
1977
1978
1979
1980
MSI*'
Market Debt
S* curl!lei
OblUatl ana
S -*..*
27.0
41.*
39.6
S-li.1
-0.
0.
-1.
S o.
ao.»
108.*
154.5
191.3
239.0
225.1
210.9
186.*
382.2
*7[.l
*75.8
*17.*
511.0
3.
5.
5.
7.
11.
17.
1*.
1*.
3.
21.
30.
23.
38.
31.
9*.
84.
79.
90.
B5.
122.
129.
16.
15.
21.
26.
21.
26.
23.
Corppr ite
Bond
5
I.
2.
3.
5.
«.
2).
2*.
20.
14.
24.
36.
41.
36.
31.
32.
38.
1*.
Re. i Jen Ill
3
4.
9.
13.
13.
20.
25.
3*.
56.
*0.
41.
69.
106.
US.
120.
89.
73.
Other
5
Bank
Open
Credi [
N.E.C.
Pip*i
S 2.
*,
7.
S
Loan*
4-0
*.
6.7
4.0
12.7
20.3
2*.6
10.
5.
1*.
19.
2*.
*B.a
8.
!.
1.
1.
3.
6.
7.
3.
8.
10.
15.8
LT-i
2*.6
2».7
35.7
31.7
31.0
9.
Z5.
40.
47.
*6,
2.
31.
-12.2
6.1
29.}
59.0
51.0
*«.*
70.4
-1.
B.
15.
26.
*0.
21.
69.!
t.
11.
ZJ.
41.
*1.
36.7
6J.»
l*nk
Lo*Aa
Opao
Murtet
Other
H/M
0.71
-0.
S.
*/«
4.81
4.
l.»
1.1
2.8
1.3 » 0.
5.9
0.
7.3
-0.
3.6
2.
15.8
0.
7.3
Z.
11.0
-0.
26. 1
1.
S
PERCENT _PISTM BUT IOH
Total Cnd It
19*6
1950
1955
1960
1«S
1970
1971
1972
197)
1974
1«S
1976
1977
1978
1979
1980
100.01
100.0
100.0
100.0
100 .0
100.0
100.0
100.0
ioo.o
100.0
iOO.O
100.0
100.0
100.0
100.0
mi*•
N/N
*
100.0
100.0
U.S. Go»t.
State t Loeil Corporate
Co*crna«nt
* Po«ign
N/M
2.9*
0.5
-4.2
*.9
20.0
20.0
12.3
11.8
14.2
1<,.0
19. 5
20.9
19.2
18.0
29.3
25.3
H/H
12. «
12. 8
13.
9.
10.
11.
7.
6.
7.
7.
5.
5.
5.
*.
6.
4.
H/M
8.11
8.
13.
LO.
21 *
16.
10.
6.
11.
17.
1 .
N/M
N/H
N/M
H/K
33.31
32.
33.
15.
23.
35.
29,
23,
17.
*.1I
6.
10.
17.81
17.
11.
13.
21.91
17.6
9.1
19. b
6.7
7.1
13.6
10.*
18.1
-5.8
2,2
7.7
12.5
10.7
11.6
13.8
19,
2*.
27,
.9
.2
.1
Conauavr
Hortguaa
25.
25.
21.
14.
B.:
3.
8.
10.
10.
9,
7.
6.
6.
6.
7.
7,
6.
5;
10.
10.
*.
4.
8.
10.
10.
9.
0.
6.
1.
1.
0.
3.
7.
-0.
2.
3.
5.
8.
5.
13.
a.
).
6.
J.
4.
8.
10.
*.
(,.
7.
«.
fl.
d.
1J.9
Hot MMunble
Irn than one-ten th of one pe rccnt
larten of 1981 at ieiunally adjusted annual [atea.
by NAHB Ecano•Ici Dlvltloi.
'
to
A. Tmal Dollar tol«
4.
0.
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0.6
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CO
174
SAVINGS FLOWS INTO THRIFT INSTITUTIONS, MONTHLY, 1978-1981
(In Millions of Dollars)
Set New SavingB Received
S&Ls
1978
Jan
Feb
Mar
Apr
May
Jun
Jul
Aug
Sep
Oct
Nov
Dec
Annual
MSBs
S 2,877
2,073
2,592
401
2,145
1,744
2,812
2,069
1,606
2,534
1,897
710
$23,462
S
$ A , 377
2,580
3,146
-1 ,490
1,627
1,469
1,455
717
-198
1,314
732
-700
$
Total
-59 S 2,818
170
2,243
338
2,930
-553
-152
97
-90
38
-75
-41
48
-59
-405
$ -591
2,242
1,654
2,850
1,994
1,565
2,582
1,838
305
$22,871
4-Mth Moving Avg
$1,941
1,861
2,189
1,960
1,816
Net Savings Gain
HSBs
Total
S&Ls
$ 3,071 $
2,259
7,033
603
2,340
6,545
238
476
1.712
-264
436
1,303
1,649
3,020
341
2,185
2,274
260
$ 3,309
2,735
8,745
339
2,776
7,848
3,361
2,534
2,016
2,248
6,349
1,354
7,703
354
275
1.213
$ 7,698
3,109
2,391
_7_J_024
551,873
1,669
1,995
_ 1 ,420
N.A.
2,755
2,116
__5_tjjll
$44,175
1979
Jan
Feb
Mar
Apr
May
Jun
Jul
Aug
Sep
Oct
Nov
Dec
annual
$15,029
-118
342
463
-1,192
-341
-635
-733
-504
-1,072
-1,421
-765
-986
$-6,962
S 4,259
2,922
3,609
-2,682
1,286
834
722
213
-1,270
-107
-33
$2,094
2,179
2,621
2,027
1,284
762
40
764
$ 4,661 $
218 S 4,879
2,834
3,516
682
10,181
8,210
1,971
-1
,948
-1,130
-818
2,007
6.751
1.985
1,183
4,779
1,843
1,315
4,460
61
1,009
-337
2,068
7,760
1,648
1,091
5,266
815
990
5.290
$41,556
-1 .686
$ 8,067
125
-111
-299
-774
N.A.
$38,898
-92
487
-1,028
-325
830
$ 2,658
$ -269
536
-1,375
-1,024
-1 ,841
242
2,027
-176
-345
246
1.207
1
1,286
-460
-454
-169
2,381
-227
1,234
-639
1 t4 16
$-4,864 $ 5,804
$ -524
-363
-699
-737
-163
-384
262
1,044
424
1,151
1,112
1,144
N.A.
$ 2,035
1,823
4,345
321
3,004
5.210
2,355
2,481
5,513
3,827
2,476
7.563^
$40,953
$ 1,107
1,744
5,275
-128
3,865
6,926
3,198
3,091
610
1,377
6,890
4,230
403
2,788
312
8,818
1,255
$ 6,851 $47,804
1980
Jan
Feb
Mar
Apr
May
Jun
Jul
Aug
Sep
Oct
Nov
Dec
Annual
S 1,167 S-1,436
1,079
-543
-696
-679
-817
1,785
-169
961
1,285
6
2,550
1,461
2.055
$10,668
N.A, - Not Applicable
$ -928
-79
930
-449
861
1,716
843
175
SAVINGS FLOWS INTO THRIFT INSTITUTIONS, MONTHLY, 1978-1981
(In Millions of Dollars)
S&LB
1981
Jan
Feb
Mar
Apr
May
Jun
Jul
Aug
Sep
Oct
Nov
Dec
Annual
Het Hew Savings Received
MSBs
4-Mth Moving Avg
Total
599 $ -979 $ -380
879
-385
494
-2,137
-75?
-2,894
-4,638
-2,025
-6,663
-70
-676
-746
-5,739
-1,387
-7,126
-5,538
-1,935
-7,473
-3,290
-1,542
-4,832
-3,799
-1,679
-5,478
1,601
- 65
1,536
-1,530
-1,060
-2,590
-1.809
-1,300
-3.109
$-25,471 $-13,790 $-39,261
$
$ 1,163
691
-341
-2,361
-2,452
-4,357
-5,502
-5,044
-6,227
-4,062
-2,841
-2,410
N.A.
Net_S«yingB Gain
S&La
MSBfi
Total
$ 2,060 $ -365
2,276
296
3,694
1,224
-2,857
-1,234
1,696
148
317
542
-3,491 -1,133
-1,343
-672
2,172
319
3,688
789
482
-188
4.656
800
$13,350
$526
$ 1,695
2,572
-4,918
-4,091
1,844
859
-4,624
-2,015
2,491
4,477
294
5.456
$13,876
1982
Jan
Feb
Mar
Apr
May
Jun
Jul
Aug
Sep
Oct
Nov
Dec
Annual
1983
Jan
Feb
Mar
Apr
May
Jun
Jul
Aug
Sep
Oct
Nov
Dec
Annual
e - estimate
SOURCE:
Federal Home Loan Bank Board,, National Assoclat:ion of Mu tual Saving
Banks; Compilation by NAHB Economics Division.
UNEMPLOYMENT RATES: ALL WORKERS AND CONSTRUCTION WORKERS, 1971-1982
(Seasonally Adjusted Annual Rates)
Sep
Oct
Hov
Dec
6. 11
9.6
6. OX
9-4
5.8X
9.8
6.03
10.3
5.6Z
5.51
8.9
5.61
5.31
10.1
5.2Z
Annual
1971
All Workers
Const. Workers
1972
All Workers
Const. Workers
1973
All Workers
Conit. Workers
1974
All Workers
Const. Workers
1975
All Workers
Const. Workers
1976
All workers
6.01
11.1
5.91
10.1
5.93
9.9
5.91
10.5
6. OX
9.5
5.81 5.7X
10.3
10.3
5.81
10.3
5.71
10.5
5.71
10.9
5.71
9.7
5.6Z
10.4
4.91
9.4
5.01
9.3
4.91
8.9
5.01
9.1
4.93
8.8
4.93
8.0
4. 8t
9.1
4.83
8.4
4.83
9.0
4.6t
8.9
4.8t
9.0
4.93
8.4
4.9X
8.9
5.11
9.5
5.21
8.5
5.1%
8.6
5.11
9.9
5. It
9.5
5.4t
9.9
5.5t
10.2
5.5Z
10.9
5.9t
11.6
6.0Z
12.1
6.6t
13.6
7.23
15.3
5.6t
10.7
fl.lt 8.11 8.6X
15.7
16.3
17.8
8.83
19.2
a. at
8.63
19.5
8.43
19.1
8.4t
18.5
8.43
17.8
8.3t
17.4
8.23
16.8
18.0
7. 61 7.61
14.7
16.3
7.81
16.8
7.6X
7.81
15.7
16.6
7.7Z
14.7
15.4
11.5
7.7X
Const . Workers 15.5
1977
All Workers
Const. Workers
1978
All Workers
Const. Workers
1979
All Workers
Const. Workers
1980
All Workers
Const. Workers
1961
All Workers
Const. Workers
1982
All Workers
7.61
15.4
7.71 7.«
15.6
15.7
7.51 7. 61 7.41
14.6
14.7
13.9
9.03
21.5
19.8
7.23
12.5
7.03
13.4
7.23
12.6
6.93
12.0
11.3
7.03
10.1
9.7
7. at 7.az
14.3
5.61
10.3
8.53
7.7Z
15.5
6.83
10.5
6.81 6.81 6.43
11.4
11.8
10.8
7.0Z
12.7
6.03
10.9
5.83
11.2
5.91 6.03
10.8
12.3
6.03
10.6
6. OX
10.0
5.91 6.03
10.5
11.2
5.83
10.3
6.41 6.31
11.6
11.1
6.33
11.0
6.11
9.8
6.01
9.7
5.93
9.6
6.23
9.8
5.93
9.2
5.91 5.91
10.9
11.4
5.83
10.2
5.81
10.4
5.71
9.6
5.71
9.6
5.73
9.7
6. OX
9.2
6.21 6.31 6.93
13.1
14.6
11.3
7.53
16.1
7.53
15.2
7.83
15.8
7. 73 7.5X
15.8
16.7
7.53
14.2
7. 51 7.33
13.8
14.5
7.13
14.1
7.53
15.7
7.43
16.1
7.23
15.2
7.33
16.2
7,63
16.3
8.03
17.6
8.33
17.8
7.63
15.6
6.31
11.7
7.41
13.7
7.41
13.7
7.31
14.7
7.31
14.5
5. at
9.2
8. 51
18.7
1983
All Workers
Const. Workers
Source: Bureau of Labor Statistics; compilation by NAHB Econonics Division.
6. OX 5.93
10.9
10.4
5.91
11.1
5.93
11.5
8.83
18.1
HUHBER OF UNEMPLOYED AMONG ALL WORKERS AND CONSTRUCTION WORKERS, 1971-1982
(Seasonally Adjusted Annual Kates In Thousands)
1971
All Workers
Const. Workers
1972
All Workers
Coost. Workers
1973
All Workers
Const-. Workers
1974
All Workers
Gcmtt, Workers
1975
All Workers
Const. Workers
1976
All Workers
Const. Workers
1977
All Workers
Const. Workers
1978
All Workers
Const. Workers
1979
All Workers
Const. Workers
1980
All Workers
Const. Workers
1981
All Workers
Const . Workers
1982
All Workers
Const. Workers
1983
All Workers
Const. Workers
Source:
Apr
Jan
Feb
Mar
4.986
4,903
4,987
457
436
443
402
4,928
5,038
4,959
5,019
Ha£
Jun
Jul
Aug
Sep
Oct
Nov
Dec
Annual
4,949
5,015
5,134
5,042
4,954
5,161
5.154
5,016
398
429
395
404
379
411
4,922
4,923
4,913
4,939
4,849
4,875
4,959 4,996
440
462
454
461
478
419
448
497
385
4,326
4,452
4,394
4,459
4,329
4,363
4,305
4,305
4,350
420
416
401
4,644
4,731
4,634
451
7,501
397
400
7,520
7,978
414
4,618
458
8.210
403
377
429
384
412
411
4,705
4,927
5,063
5,022
5,437
5,523
447
445
436
8,433
8,220 8,127
6B9
406
7,744
7,929
313
779
750
807
7.380
7,430
7,620
7,406
712
668
685
663
M4
6,925
6,751
6,763
6,815
6,386
535
477
551
546
5L3
591
6.314
6,077
6,121
5,947
6.074
6,250
6,202
495
468
564
568
541
628
530
6,137
969
993
879
871
7,053
7,053
7,322
7,490
681
681
694
683
646
729
755
764
7,280
7,443
7,307
7.059
7,134
6,829
675
674
645
581
598
567
6,488
6.304
6,304
5.995
557
532
535
479
6.148
594
6,660 6,635
630
601
6,108
532
6,714
697
6,076
537
5,913
492
5,913
5,985
6,298
407
507
479
844
7.518
6.173
483
6,409
572
614
541
7,899
7,637
8,059
8.024
8,330
8,239
8,024
869
800
812
867
814
744
8,004
7,824
7,978
8,236
6,669
826
796
853
852
916
7,965
7,958
7,899
712
712
759
758
823
9,298
946
Bureau of L»bor Statistics, Compilation by HAHB Economics Division.
6,255
541
759
8,022
6.991
6.293
7,370
8.248
407
5,156
615
850
566
386
6,636
7,794
7.330
6,106
413
6,140
565
787
480
450
4,365
7.897
7,230
6,161
429
4,489
528
718
491
447
4,396
7,923
7,326
630
4,882
487
691
6,911
428
4.602 4,543
7,928
7,534
6,188
445
4,144
472
433
8,109
8,066
767
711
740
9,100
9,571
8,273
933
809
916
178
FAILURE RATES IK THE CONSTRUCTION INDUSTRY, 1974-80
(In thousands of dollars)
NUMBER OF FAILURES
General
Building
Contractors
714
942
716
608
508
631
1974
1975
1976
1977
1978
1979
1980
Other
Contractors
1,023
1,202
103
118
940
764
631
687
114
1,164
1,071
Percent Changes
1974/75
1975/76
1976/77
1977/78
1978/79
1979/80
Building
Subcontractors
31 .9X
17. 5X
-21.8
-18.7
-17.4
-24.0
-15.1
-16.4
24.2
69.7
8.9
69.4
91
65
60
120
Total
Construction
1,840
2,262
1,770
1,463
1,204
1,378
2,355
14. 6X
-3.4
-20.2
-26.6
-7.7
100.0
22. 9X
-21.8
-17.3
-17.7
14.5
70.9
$32,829
36,819
30,075
42,168
42,376
41,525
83,868
$526,598
640,845
428,737
420,220
328,378
291,323
752,109
12. 2Z
-18.3
40.2
21. 7%
-33.1
-2.0
-21.9
-11.3
158.2
DOLLAR LIABILITIES
$367,643
461,987
261,613
168,926
145,643
147,287
334,908
1974
1975
1976
1977
1978
1979
1980
Percent Changes
1974/75
1975/76
1976/77
1977/78
1978/79
1979/80
25. 7%
-43.4
-35.4
-13.8
1.1
127.4
datreet,
Source:
Division
$126,126
142,039
137,049
209,126
140,359
102,511
333,333
12.6%
-3.5
52.6
-32.9
-27.0
225.2
0.5
-2.0
102.0
Monthly Failures; compiled by NAHB Economit
FAILURE RATES IN THE CONSTRUCTION INDUSTRY, MONTHLY, 1979-81
(In thousands of dollars)
Nunber of Failures
General
Building
Contractors
1979
Jan.
Feb.
Mar.
Apr.
May.
Jun.
Jul.
Aug.
Sep.
Oct.
Nov.
Dec.
63
45
52
57
55
5ft
36
66
50
61
45
47
Building
Subcontractors
58
54
71
70
63
53
53
73
53
66
41
32
Other
Contractors
6
127
5
104
129
132
125
113
93
142
107
133
91
82
6
5
7
6
4
3
4
6
5
3
1980
Jan.
Feb.
Hat.
Apr.
May.
Jun.
Jul.
Aug.
Sep.
Oct.
Nov.
Dec.
99
100
101
103
107
96
105
78
102
10
4
19
12
10
108
82
80
161
77
100
13
9
10
Jan.
Feb.
107
78
Mar
Apr
May
14
18
13
153
108
132
118
180
171
Source:
61
56
70
97
102
68
89
89
97
132
104
Total
Construction
5
11
6
11
15
11
122
149
192
214
202
210
215
General
Building
Other
SubContractors contractors Contractors
515,065
7,448
14,460
10,271
13,837
11,830
7,223
20,608
10,559
17,799
6,662
11,525
315,934
21,886
33,318
35,677
32,267
33,186
29,006
221
190
282
168
190
30,218
14,203
23,217
229
543,304
228
26,963
20,855
31,292
38,272
228
327
355
Dollar Liabilities
Building
42,639
23,357
S 6,980
9,788
10,544
7,518
15,502
9,676
7,515
10,669
6,842
8,039
4,748
4,690
S 2,608
2,146
786
524,653
7,767
5,371
3,292
25,556
5 6,603
10,061
9 7,883
5,223
1,647
4,669
12,845
93,679
22,214
95,776
12,306
15,368
13,710
25,352
13,282
12,137
708
1,610
768
15,564
211
694
29,924
1,729
7,767
2,671
4,251
4,401
2,337
11,366
S17.527
22,095
27,488
S 8,199
24,790
24,721
2,719
1,179
Dun (, Bradatreet, Monthly Fallutea; compiled by NAHB Ecanwalce Division
Total
Construction
5,343
3,510
19,382
25,790
34,710
24,798
15,446
32,887
18,169
41,402
11,621
16,909
530,420
37,170
47,810
134,025
84,405
130,691
49,079
60,678
41,318
59,971
29,822
46,720
$69,030
54,401
51,853
58,801
63,722
180
February 23, 1982
HOUSING STARTS AND HOUSING-RELATED ECONOMIC INDICATORS,
1982 FORECASTED, USING TWO SCENARIOS
1981
ACTUAL AND
Scenario I
B2-QI
Interest Rates (X)
3 Month T-Bllln
Prime Rate
AAA Bonds
13 .801
16.50
15.40
Forecasted Data
62-Q3
62-Q2
14.201
17.50
15.50
12.20X
15.00
14.50
Annual Data
1982
1981
10. SOX
13.00
13.00
14.082
16.87
14.17
12 .681
15.50
14.60
Personal Income (B/$)
$ 2,531 S 2,579 $ 2,631 5 2,691
$ 2,404 $ 2,608
Total Population (000)
Consumer Price Index
(1967-100)
Unemployment Rate (Z)
230,809 231,342 231,883
284.3
293.6
289.0
223,438 231,615
291.3
272.3
FHLBB Advance* (M/S)
FNMA Purchases (M/S)
HUD Subsidized Units
6.8Z
9.2X
9. 11
232,425
298.1
8.9Z
S -200 S -100 $ -400 $ -200
$ 800 $ 400 $ 600 $ 800
1,300
9,200
5,000
6,100
Housing SUrts-SAAR (000)
Total
Single Family
Mult1family
2-4 Units
5 + Units
859.7
514.1
345.6
100.3
245.3
998.6 1,128.3 1,258.2
847.5
770.0
626.1
410.7
358.3
372.5
89.1
84.6
86.5
321.6
273.7
286.0
Housing Starts-Actual (000)
Total
Single Family
Multlfamlly
2-4 Units
5 + Units
157.3
91.2
66.1
18.8
289.6
169.0
100.6
23.6
77.0
312.9
217.8
95.1
23.7
71.4
50
180
53
183
Mobile Home Shipments (000)
Actual
SAAR
47.3
37
189
313.9
201.9
112.0
23.3
88.7
44
185
16.231 16.711 16.83* 16,391
S69.030 $69.839 $69,365 $71,952
Source: Various governmental agencies; NAHB Forecasting Service.
7.6Z
9. OX
$15,682 $ -900
$ 6,111 $ 2,600
21,600
76,256
1,085.3
706.0
379.3
91.2
288.1
1,073.7
699.9
373.8
89.4
284.4
1,085.3 1,073.7
699.9
706.0
373.8
379.3
89.4
91.2
284.4
288.1
241
241
184
184
14.741 16.54Z
$68,800 $70,047
181
February 23, 1982
HOUSING STARTS AND HOUSING-RELATED ECONOMIC INDICATORS, 1981 ACTUAL AND
1982 FORECASTED, USING TWO SCENARIOS
Scenario II
Forecasted pate
82-0^3
JJ2-Q1 JJ2-Q2
Interest Rates (X)
3 Month T-Bills
Prlae Rate
AAA Bond a
13.802
16.50
15.60
82-OJL
Annual Data
1982
1981
14.201
18.00
15.70
13 .80S
16.50
15.10
14.20J
20.00
15.60
14. 08*
18.87
14.17
14.00?
17.75
15.50
Personal Income (B/$)
$ 2,531 $ 2,579
$ 2,630
$ 2,683
$ 2.404
$ 2,606
Total Population (000)
Consumer Price Index
(1967-100)
Unemployment Rate (Z)
230,809
284.3
231,342
289.0
231 ,883
293.6
232,425
296.4
223,438
272.3
231,615
291.3
8.8%
9.2X
9.5Z
9. 61
7.6Z
9.32
FHLBB Advances (M/$)
FNMA Purchases (M/$)
HUD Subsidized Units
S -200
$
800
6,100
5
$
-400 S -200 $ -300
200
600 $
300 $
1,300
9,200
5,000
$15,682 $-1,100
$ 6,111 $ 1,900
76,256
21,600
Housing Starts-SAAR (000)
Total
Single Family
Hultlfamlly
2-4 Units
5 + Units
859.8
514.2
345.6
100.3
245.3
969.0
601.2
367.8
86.1
281.7
1,015.8
677.9
337.9
83.4
254.5
1,054.1
698.3
355.8
86.9
268.9
1,085.3
706.0
379.3
91.2
288.1
983.0
630.9
352.1
88.3
263.8
Housing Starts-Actual (000)
Total
Single Family
Multlfamlly
2-4 Units
5 + Dnlts
157.3
91.2
66.1
18.8
47.3
280.9
181.5
99.4
23.5
75.9
281.5
191.8
89.7
23.3
66.4
263.3
166.4
96.9
22.7
74.2
1,085.3
706.0
379.3
91.2
288.1
983.0
630.9
352.1
88.3
263.8
Mobile Home Shipments (000)
Actual
SAAR
37
189
50
180
51
177
41
174
241
241
179
179
Effective Mortgage Rate (X)
Median Mew House Price ($)
16.23*
569,031
16.80Z
$69,640
17.111 17.131
$68,697 $70.006
14.74S
$68,800
16.821
569,344
Source: Various governmental agencies; NAHB Forecasting Service,
182
The CHAIRMAN. Thank you very much. And again, I have read
through your testimony and all the charts and the problems of
your industry which will be valuable information in the printed
record.
CREDIT CONTROLS
First of all, let me say, Mr. Schechter, that you and I have discussed credit controls before and we disagree, so I doubt if again
today you could convince me or I could convince you. I certainly
believe in your sincerity in your advocacy of those positions and
maybe if we just got back to monetary policy—well, let me ask one
question about credit controls.
Assuming that you're correct that they did have an effect in
1980, then is it an assumption from what happened after they were
taken off that it would be necessary to have permanent credit controls to have them work?
Mr. SCHECHTER. No, I don't think it has to be permanent. At a
time, though, when the economy gets a shock, which happens once
in a while—the OPEC effect certainly was an example—or there
are mistakes in terms of money supply growth, people can't control
those factors, especially since we have a large Eurodollar market
and any large firm can pick up a phone and talk to Germany and
say, "Transfer some money to our account here." So it happens
very quickly. So at that time, when that happens, or we have a big
upsurge in corporate takeovers which lines up a total, like during
1981, of about $81 billion of commitments. Not all of it was used.
We had some big ones like the Conoco takeover by Du Pont, $3 billion; United States Steel bought Marathon with $3 billion in credit.
So there are times I think when we would want to have credit controls applied even sometimes to a specific—say no takeovers this
year, fellows, because the situation is tight. I think it could help a
great deal.
It doesn't have to be permanent. It doesn't have to be, by any
means, across the economy.
The CHAIRMAN. Let me return to operating techniques of the
Fed, a discussion that I had earlier with members of the administration in which I certainly indicated—all of you were here—my
lack of understanding about some of those operating procedures
and contemporaneous reserve accounting and possibly penalty discount rate, approved definitions of money, and we discussed at
great length the stopping of weekly reporting and calculating monetary aggregates.
First of all, Mr. Schechter, how do you feel about that discussion,
having heard it? You did not have an opportunity to reply at that
time about these mechanical operating procedures.
Mr. SCHECHTER. I agree that the Fed cannot get an accurate
count every week of what actually happened. At the same time, I
know this mania has sprung up of watching the weekly numbers.
It's the way the market is going to behave. I don't know how you
get around it by telling the Fed don't publish something, because
as has been discussed
183
The CHAIRMAN. I was so hoping you would be practical and on
my side and say it's ridiculous and give me a different analysis
other than it's ridiculous but we've got to keep doing it.
Mr. SCHECHTER. Let me suggest, as Mr. Sprinkel did, using the
monetary base, everybody would soon figure out the relationship
between the monetary base and what is happening between the
total supply, and you would get the same effect.
The CHAIRMAN. Mr. Sumichrast?
Mr. SUMICHRAST. I think we should dump it. It doesn't make any
sense. It never made any sense to me. How could that possibly justify changing a portfolio or making an investment? I think either
cut it out entirely weekly or go to monthly reporting or seasonal
adjustment. I know my friends tell me seasonal adjustment is horrible. It just can't be done in any good way. Publishing it monthly
or publishing it on a 6-month moving average of some sort would
be better. We prepared some charts and when you look at these it's
incredible. It zig-zags like crazy, goes up and down, and as I say,
the economy is still here. One week has passed by. What has
changed? I don't understand it really. It never made any sense to
me.
Mr. SCHECHTER. I think though, this has a much more important
point; that is, there is monetary policy being conducted on the
basis of those figures and it's not just—although they say, well,
wait for the long-term adjustment, actually the open market operations which are carried on every day are changed in accordance
with those figures within the targets. There are changes from day
to day and people watching not just the numbers, who can tell
when the Fed has intervened to buy or sell securities in the
market. And even when on that basis the conclusion is reached the
Fed is tightening, and therefore everybody goes out and anticipates
and borrows or tries to borrow.
My point is, I think we really need to start using other tools for
monetary policy besides this one.
Mr. SUMICHRAST. It's a lot of speculation. It's like in housing, the
same thing. Do you think I like the idea of having a piece of junk
sitting in Georgetown for $180,000 that would be sold for $75,000 or
so in California? It's the same thing. Everybody is looking for all
kinds of gimmicks on how to make money and that's probably the
institutional setup. They start to dream up how to make a little
more on what happened Friday afternoon. I think it's wrong. I
think it's entirely wrong to have it, but it's the kind of situation
we're in. I don't know how you can get out of that sort of thing. We
got out of it in housing. Housing is in deflation right now. It's in
deflation for the first time in 50 years—deflation in prices of
homes—and the reason is we have so much invested in it. I guess
the financial market will have to go through the same sort of cycle
before they realize there is no virtue or money to be made on that.
PENALTY DISCOUNT
The CHAIRMAN. Mr. McKinney, what about penalty discount?
Mr. McKiNNEY, I think that clearly a discount rate that is more
sensitive to market interest rates and doesn't permit as wide a
spread to develop between market interest rates and the discount
184
rate would be more productive because the incentive to find the
cheapest source of funds would not be focused so strongly on the
discount window. To move to a penalty discount rate as opposed to
keeping the discount rate shortly below other interest rates would
involve an awful lot of mechanical troubles and difficulties and I
think it would probably lead to explosive changes in interest rates
unless the Federal Reserve changed its operating policies considerably.
I think it's a good case for holding it much closer to market rates
than it is now held, but it would change our system of money control markedly to let it move above and keep it there.
The CHAIRMAN. Mr. Schechter, how do you feel about the penalty
discount?
Mr. SCHECHTER. I would like to see something that does keep
some relation to the rates of interest so it doesn't become a means
of using the discount window simply to make a buck and at the
same time defeating whatever monetary policy is in effect.
Mr. SUMICHRAST. I would support that.
The CHAIRMAN, Mr. Schechter, let me get back to what we started to discuss, and certainly Mr. Sumichrast has pointed out there's
deflation right now in the housing industry. That's an understatement today. And I have long been involved in housing because of
being a mayor and the problems associated with it, and I don't
know of anything that troubles me more unless it's the automobile
industry. But housing is even more basic to the way people live
than an automobile.
And when I became chairman of this committee the prime rate
was 21.5 percent. I had been chairman a couple of days and people
wanted to know why it hadn't gone down. And it has gone down
somewhat and I never thought I would live long enough to say that
12 percent prime would be just fantastic, if we could get it down to
that, and having left a 5-percent conventional mortgage when I
moved here from Salt Lake City and complaining about a 9-percent
mortgage on my home, and now that's almost like giving money
away.
So I want you all to understand I understand the problem very
well, not only from my public service but as an individual, and I
don't know how my kids are ever going to buy a house with the
current conditions.
Mr. SUMICHRAST. You'll have to buy one for them. That's what
you have to do.
The CHAIRMAN. On my Senate salary, when I'm paying for one
in Salt Lake City and one here? They can live with me but I'm not
buying one for them.
In any event, what you say is true. OPEC has been part of the
inflationary problem; the housing market has. There are a lot of
factors that make up these high interest rates and yet with deflation in a lot of the economy now, interest rates are still high. So
I've puzzled over that for the last year and I've studied and listened to everything I can and economists from all different points
of view trying to figure out why. You're supposed to have interest
rates come down when there's deflation, particularly in basic industries like housing and automobiles and so on, and the normal
rules of the economy are not being followed.
185
So I can only come to one conclusion: that the major reason that
interest rates are staying high, particularly long-term interest
rates, is because of the fact that these long-term money market
managers are not particularly concerned—and that's an overstatement—about 1982's deficit. They are concerned, but what they are
more concerned about is not what we talk in outyears when we
talk about the 1983 and 1984 budget, but they are looking at 1988,
1989, 1990, and 1991. They are not looking at Ronald Reagan or
this Congress or Republicans or Democrats, liberals or conservatives. All they can see, regardless of who is here, is we have been
building such obligations for the future with Federal spending that
they are looking far, far beyond what any discussion is in the press
or anything else in those outyears, and they are not going to be
stupid enough to be caught, as many times they have been, borrowing short and lending long.
My point is, even if we somehow eased upon the money supply
right now, as many people want to, if we removed the third year of
the tax cut as a basic suggestion and cut the one for July in half
and cut military spending by $20 to $30 billion, which would only
have about a $5 billion impact on outlays on this year's budget because that's longer outyear spending, at least it's my opinion everybody would be shocked and say, "Hey, nothing happened. We've
still got 16 or 17 percent prime. We balanced the budget. What's
wrong with that theory?"
I think what is wrong with that theory is because they are still
looking and saying, "Those guys in Congress haven't done anything
about 1990."
ENTITLEMENT PROGRAMS
So in your testimony—I can agree with a lot of it, but there's
practically no mention of fiscal policy in your testimony at all, and
it seems to me if we don't address those outyears far beyond the
immediate discussion, I don't expect that we're going to have lower
interest rates other than cyclical ups and downs a little bit, and
that means to me that we simply have to address the problem of
entitlements because I don't have to be an economist to get out my
calculator and look at the budget as a member of the Appropriations Committee and see that in round numbers we've got about
53 percent of the budget that is increasing at about 16 percent compounded per year and another 47 percent of the budget or so that's
been decreased at about 8 percent. Yet we have proposals from the
administration that basically say, cut the same piece of pie over
and over and over again, which you can't do. I could eliminate
NASA in my Appropriations Subcommittee and save $6 billion a
year and have no space program at all, and that's not an insignificant amount of money, but the dollars in these automatic indexed
programs are so fantastic.
I've got a friend who's a retired brigadier general who makes
more now that he's retired than if he had stayed on duty. And
those kind of things—in fact, the former Speaker of the House of
Massachusetts, at the time he died, was making $90,000 a year
from his Federal civil service retirement, $30,000 more than a current Congressman.
186
So you look at that situation, particularly when the vast majority of the people in this country and in your unions don't have
automatically indexed programs at all and Federal employees that
are working don't have automatically indexed programs, and yet to
put it bluntly, we are gutless to attack that situation and say that
we've got to do something about that longer term situation.
That's a long speech, but I'd like all of your reactions to that.
And when I kept asking the question, can monetary policy be effective until we do something about that, they said, yes. I don't agree
with that. I think all of these things we talk about are toying with
the problem until we convince those money market managers that
those trendlines are going to level off in those outyears a decade
down the road and start downward, and until we do, I think we are
going to have continued high inflation rates regardless of what
happens with OPEC, and I think we are going to have continued
high interest rates unless we have the intestinal fortitude to address that problem. And so far, the administration has not and certainly Congress has been unwilling to address those automatically
indexed programs.
Mr. SCHECHTER. Mr. Chairman, I think you're really getting into
a broader subject, and I don't mean just broader than monetary
policy. The subject you're getting into is incomes distribution, after
taxes perhaps, and I would say the brigadier general or former
Speaker of the House probably had rather high retirement income.
That is not true of the great majority of people on social security or
on Federal civil service retirement.
The CHAIRMAN. Well, you're correct. They certainly don't have
those kinds of incomes. But to say that a social security recipient,
who is probably the one hurt the most by inflation, that they can
have pensions regardless of what level they are—not the $90,000
like the Speaker of the House—but accelerated more rapidly than
inflation when your workers and the Federal workers and other retirees on private pension plans that have not even come close to
keeping up with inflation—and those are big dollars there.
What I'm suggesting, as an example, is with civil service pensions, social security, things of that nature, that we put those back
under the control of Congress. Like Federal employees this year got
4.8 percent. We decided that's what we could afford. And maybe
you have a 10-percent inflation rate and you tell all the retired
people you're still going to get an increase but all we can afford is
7 percent, and that difference is 3 percent in those outyears which
is a lot of money, and if that signal is sent and it brought down
interest rates so that people can buy homes—my kids and others—I
think that's a valuable step to take.
Mr. SCHECHTER. But we're not talking other people with increased incomes, maybe even greater increases, that we want them
to, for the good of the country, hold their income increases down—
private professionals let's say.
The CHAIRMAN. You're talking about two different things. I'm
certainly not advocating that any members of your union, any of
your working people, have Government limitations on their
income. That's private sector and whatever you can negotiate in
your contracts, that's fine with me. That's your job. And whatever
187
profession—it doesn't matter what profession you're in. I'm talking
about taxpayers' dollars that create a deficit.
PROGRESSIVE INCOME TAX SYSTEM
Mr. SCHECHTER. But let me make two points. We did have something called the progressive income tax system, and what happened
in 1981 took away taxpayer dollars. In other words, it took away
revenue and increased other people's tax payments over the long
run. So what we are dealing with here—that's why I said it's a
broader matter of incomes distribution—now the people who went
to work for the Government or were on social security have the
notion of a contract, if you will, based on what the entitlements
were at that time. So in a way
The CHAIRMAN. There was never any contract in social security
that guaranteed people automatic increases. There is a contract to
guarantee them the pension and the benefits set out.
Mr. SCHECHTER. Plus a cost of living. But my point
The CHAIRMAN. Not plus the cost of living. That was only added
about 10 or 12 years ago.
Mr. SCHECHTER. All right. The people who've worked since then
expected it. But forgetting about that for the moment, I think the
reason we put in a progressive income tax is a matter of equity and
what we have created here between the monetary policy and reduction of taxes is really, as I indicated, a two-tier system, because the
people who have the high incomes also get the greatest advantage
of the high interest rates. Their income goes up and at the same
time they can then go out and buy what they want and bid up
prices. So they have a sort of thing going for them and the rest of
us pay, and I think if we overlook that—and we can even see what
happened to the income distribution.
Since 1967, up to then it had been going more toward, let's say,
equality, if you want to call it that, but since then the share going
to the upper 20 percent—to the families who are in the upper 20
percent of the income distribution went up from 40.4 percent to
41.6 percent. Now that's about $20 billion that shifted, roughly, in
round numbers. They have discretionary income more than ever
and things have gone up. I put some figures in my statement on
the percentage of total personal income which went to five categories of expenditures, including things like boats and airplanes and
airline travel and other things which are really for high-income
folks. That has gone from 2.5 percent in 1947 of total personal
income to 4 percent in 1981. So what we are doing is the more we
cut high income taxes particularly—and that's what happened last
year—the more we are creating the machine for inflation in the
economy and more high interest rates.
The CHAIRMAN. I've got to go vote. I would like a quick comment
from each of you, but I do want to hurriedly say for Henry—and I
consider him a good friend of mine and we have talked over this
table for many years—the other side of that coin is that, first of all,
we still have a very progressive income tax. Second, there is no
real overall tax cut. There was a reduction in the increase last
year. The Federal revenues are still higher. Third, I would say, to
give you a situation on this spending by these people who are
188
rich—I don't happen to be one of them that can afford a half million dollar condominium in Park City, Utah, right now, but if you
go out there, the homebuilding industry is dead. Most of the construction activity is in the resort area where all these rich people
from Texas or wherever can come in, but I guarantee you that the
carpenters and the plumbers don't care who's buying that. The
people building those things for rich people at least have a job and
they are tickled to death they are working. They don't care if it's a
single-family dwelling or not, as long as they are working. So I suggest the other side of the coin of what you're saying is there is
some benefit from people who have money to buy boats and condominiums that produce jobs for people who otherwise would not
have them.
Mr. McKiNNEY. Mr. Chairman, would you spare 1 minute?
The CHAIRMAN. I'm going to give each of you a chance quickly
because I've got to go vote and I will not be coming back. We had
21 votes yesterday and I'd just be wasting your time to run back
and forth.
Mr. McKiNNEY. One point I would point out is that distribution
of income has very little directly to do with inflation. Inflation is
what we're talking about. Inflation is what the Nation and the
present administration and most of the people in Congress should
get rid of. Inflation has to do with the Nation as a whole trying to
spend more than it produces, and the biggest swinging factor in
that is the Congress. The size of the deficit is an important factor
in this. As detailed in my testimony, 43 percent of the inflation
since 1960 can be accounted for by the Federal deficit alone.
Now the solution to inflation will not be reached until the
Nation has delivered on some of those promises that were made to
reduce inflation.
The CHAIRMAN. Would you quickly agree or not agree that those
out-year deficits are a driving force in the long-term interest rates
and the problems that Mr. Sumichrast's organization is having?
Mr. McKiNNEY. I agree fully.
Mr. SUMICHRAST. There are three issues and I'll take only 30 seconds. One issue is the differentiation of prices of housing. I would
like to include this material into the record which shows this.
The CHAIRMAN. We would be happy to include it.
[The information follows:]
189
(LAND REVIEW
% VOLUME 2, NO. 3 MARCH 1982
0
Dr. Marika
rika E. Sumichrast. Vice President Development & Editor
Land Cost Market Reporting Service
Prices of Real Estate Declirie
There is mounting evidence showing a decline in
real estate prices, the first such evidence in 50 years.
Bolh home and land prices have turned down. This,
of course, is not true oi all real estate everywhere.
But. the information available offers sufficient proof
of some degree of deflation. One can no longer
assume that real estate holdings can be sold for more
than paid for one or two years ago.
The documentation comes from different sources
and is to be evaluated separately. Some data show a
straight decline while other data show only a lesser
rate of increase than in the past. The data covers
existing homes, new homes and land. The analysis
reveals a big change from past years of rapid
appreciation.
!n some cases, concessions do produce sales.
"Reducing prices rather than buying down mortgages
seems to be producing some results," said a builder
from Hilisborough Court. Florida.
But another builder from Wisconsin had a different
opinion: "We own 300 lots and can't even sell them
a I discount prices."
A builder from Clermont County. Ohio wrote. "Inventory situation is a disaster, it is possible to seli
houses al 50 cents on a dollar, but even that will not
move the inventory much. I don't know what the
depression of the thirties was like, but it could not
have been any worse."
[Conunuefl on Page S)
Summary of price changes
Percent change between
Q1V-80 to Q]11-81 to
QIV-81
Q1V-81
Cost price data
Homes in 32 cities'
New homes;
hew homes FHA!
Mew homes—index1
Existing homes'
Existing homes FHA3
Cost per SF. finished lots'
Land index6
Consumer Price Index'
Construction materials inde!
Producer Price Index'
+ 10.5%
+ 4.6
+ 5.1"
+ 8.0
+ 47
+ 1.0"
+ 5.7
- 0.8
+ 9.5
'+ 4.7
+ 6.4
Ml qu
- 1.2%
-0.4
+ 3.5
+ 0.9"
-2.9
-0.5
-1.8'
-1.2
+ 1.9
-0.2
0
III1990IOIM 1981
This month s Land Review examines the mounting
evidence of price changes resulted from record interest
rates, overall recession and the slump in housing.
Most of the data does not include all of the price
concessions offered by sellers eager lo dispose of
their inventories: price cutting, giveaways, paying the
buyer's closing expenses, as well as widespread buydown mortgages for the prospective buyer. These
concessions are estimated to cost the seller between
6 and 10 percent of the sales price. If we include
these costs, deflation would be considerably higher
than our data indicate.
HOMER
Hovr
INSTITUTE
1133 Fifteenth Street. N.W., Suite 1250. Washington. D.C 20005 (202) 822-9729
190
Housing Prices (Continued From Page !>
There are several ways to measure trends in home
prices. One way is to examine the cost per square
foot. Another is to use the Bureau of Census Price
Index of New One Family Houses Sold. Less acceptable methods use median or average prices. Probably
the most useful, and most accurate, is the cost per
square foot measurement.
The FHA. reports that, in 1981, the cost of existing
homes sold under FHA section 203(b) program
increased 1 percent (third quarter 1980 to third
quarter 1981), This is a dramatic change from the
increases in the two previous years: 16.2 percent in
1980 and 13 percent in 1979. The cost per square
foot of new homes built under the same program in
the same period increased only 5,1 percent. This
compares to a 15.5 percent increase in new houses in
1980 and an 18 percent increase in 1979. The 1981
figure is the lowest rate of increase per square foot
Since 1973. when the cost of new homes built under
the FHA section 203(b| program increased 4.6
percent.
The Price Index of Mew Family Houses Sold m
1981 rose 8.0 percent, down from 11 percent in 1980
and considerably below the 14.2 percent rate of 1979
or the 14.5 percent rate of 1978.
The major problems with this index is that it
ignores the price market in the recession years of
1980 and 1981. It does not Consider the buy-downs
and all of the other concessions that are being made
in the marketplace in order to sell homes. Many
builders are selling homes below what they cost
simply to get rid of them. For example, the U.S.
Homes Corporation reported selling homes—as well
as land—at as much as 15 percent below cost. But not
all can do that. "Developers are going bankrupt one
after another. No one in his right mind will enter the
development business in this area again," said a
developer from Michigan.
Another builder from West Virginia added: "After
building 1,000 houses in the past 10 years, we are
giving serious consideration to leaving home building
. . . Reagan Administration is an unmitigated disaster
for builders."
Land Costs
According to the Homer Hoyt Institute land cost
data, the rate of increase in the cost per square foot
of finished residential lots in 1981 was 5.7 percent,
well below the 10.5 percent rate in 1980 and the
average 8.5 percent increase between 1978 and 1981.
Yearly increases were: 1978, 8.8 percent; 1979. 9.1
percent; 1980, 10.5 percent and 1981, 5.7 percent.
The 1981 increase of 5.7 percent is 3.3 percent
below that year's inflation rate of 9 percent In only
13 states last year did land prices increase more than
inflation. In 1981. 29 states showed an increase in lot
prices, 20 declined, and one remained unchanged.
In contrast, in 1980 only four states showed a
decline: Montana. — 1.9 percent; North Carolina,
-2.1 percent; South Carolina, -4.7 percent and
West Virginia. 8.1 percent and one state. Alabama,
was unchanged. The current softening in land prices
is the result of record interest rales.
A builder from West Virginia wrote; "Virtually no
money is available at any price. We have laid off 80
percent of our production workers, almost oil of them
remain unemployed."
States showing a decline In lot prices In 1981.
Alabama
Arizona
Hawaii
Illinois
Iowa
Louisiana
Maryland
Michigan
Mississippi
Nebraska
- 1.8% North Carolina
- 6.3
North Dakota
-26.1
Ohio
- 3.3 .RhodeIsland
- 1.0
South Dakota
- 5,3
Tennessee
- 4.7
Utah
-27.1
Vermont
.- 5.5
Virginia
- 5.3
Wyoming
-
6.4%
-40.7
- 2.5
-31.0
- 4.8
-27.9
- 6.9
-24.3
—11.3
- 2.8
Washington, D.C., Hawaii, California, and Alaska
lead in land costs. In general, the North Eastern and
Southern states (plus North Dakota) have the lowest
land costs. The average for the North East is low
because of the environmental and zoning restrictions
on small lots. (The cost of an acre or two of land in
the suburbs-exurbs of Washington. D.C. would be
much lower lhan land in the heart of the city which
runs as high as S615 a square foot. (See page 5.)
The Homer Hoyt Institute Land Index also reflects a
change in the Cost of finished lots in 1981. See Chart,
page 1).
Why are prices of homes and land of such concern?
Because the housing component of the Consumer
Price Index accounts for 44 percent of the index. The
major categories under the housing component, with
their share of the overall CPI. are: shelter (29.8 percent), fuels and other utilities (6.3 percent], and
household furnishings and operations (8.1 percent).
Homeownership accounts for 24 percent of the CPI.
It includes the following elements:
Homed wnersh I p
As a Percent
of CPI
Home purchase
Contracted mortgage interest rate
Property taxes
Property insurance
Maintenance and repairs
10.6%
7.3
1.8
0.6
3.7
24.0%
Thus, the price of housing strongly influences the
rate of inflation. Inflation in turn determines interest
rates, including mortgage rates. When home prices
moderate, inflation drops and interest rates decline. •
Homer Hoyt IntUtule
1133 Fifteenth Street, N.W.
Suite 1250
Washington. D C. 20005
Dr. Mirlki E. Sumlchrut
Editor-Lund Rc.ie»
• I Sub ic rip 11 on: 595 (U.S. and Canada)
Telephone: 2021822-9729
1133 15th Street. Suite 1250. Washington. D.C. 20005
191
Mr. SUMICHRAST. Second, you raised the issue of indexing. I think
it just has to go. Something has to be done. It doesn't really help
anybody.
The CHAIRMAN. I would go on to say that we need a whole tradeoff to do away with the indexing we put into the income tax as well
aT these others.
Mr. SUMICHRAST. Your point is well taken. There's no question
you just can't do it.
Third, I forgot to mention a point which is included in my testimony. I believe that the reason we are in this mess is because of
the deficits. I spent 3 months on the budget and I perused the document—which was never published "Because people told me I would
probably get shot—and really went through it. I think it should be
required reading in high schools. Of course, nobody would take the
time to do it, but it's a most incredible document. It's the U.S.
budget and what we have done to ourselves trying to solve our
problems by spending ourselves into posterity.
The CHAIRMAN. Mr. Sumichrast, Mr. McKinney, and Mr.
Schechter, thank you very much for coming today.
The committee is adjourned.
[Whereupon, at 11:25 a.m., the hearing was adjourned.]
O
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