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FEDERAL RESERVE'S FIRST MONETARY POLICY
REPORT FOR 1983
HEARINGS
BEFORE THE
COMMITTEE ON
BANKING, HOUSING, AND URBAN AFFAIRS
UNITED STATES SENATE
NINETY-EIGHTH CONGRESS
FIRST SESSION
ON
OVERSIGHT ON THE MONETARY POLICY REPORT TO CONGRESS
PURSUANT TO THE FULL EMPLOYMENT AND
BALANCED GROWTH ACT OF 1978
FEBRUARY 16, 18 AND 22,
Printed for the use of the Committee on Banking, Housing, and Urhan Affairs
U.S. GOVERNMENT PRINTING OFFICE
WASHINGTON : 198S
COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS
JAKE GARN, Utah, Chairman
JOHN TOWER, Texus
WILLIAM PROXMIRE, Wisconsin
ALAN CRANSTON, California
JOHN HEINZ, Pennsylvania
WILLIAM L. ARMSTRONG, Colorado
DONALD W. RIKGLE, JR., Michigan
ALFONSE M. D'AMATO, New York
PAUL S. SARBANES, Maryland
SLADE GORTON, Washington
CHRISTOPHER J. DODD, Connecticut
PAULA HAWKINS, Florida
ALAN J. DLXON, Illinois
JIM SASSER, Tennessee
MACK MATTINGLY, Georgia
CHIC' HECIJT, Nevada
FRANK R. LAUTENBERG, New Jersey
PAUL TRIBLE, Virginia
M. DANNY WALL, Staff Director
KENNETH A. MCLEAN, Minority Staff Director
W. LAMAK SMITH, Economist
CONTENTS
WEDNESDAY, FEBRUARY 16, 1983
I'a^e
Opening statement of Chairman Garn ..................................................................... 1
Opening statement of:
Senator Proxmire ..................................................................................................... 2
Senator Riegle ........................................................................................................... 3
Senator Hawkins......................................................................, ............................... 4
WITNESSES
Paul A. Volcker, Chairman, Federal Reserve System .............................................. 5
Prepared statement.................................................................................................5
The prospects for stable growth ..................................................................... 6
Obstacles and threats to progress .................................................................. 8
The Federal deficit ........................................................................................... 9
International economic and financial situation ......................................... 9
Attitudes toward pricing and wage behavior .............................................. 10
Monetary policy in 1982 .................................................................................. 1]
Monetary policy in 1983 .................................................................................. 13
Tables:
I. Velocity of the monetary aggregates .............................................. Hi
II. Money and credit ranges and actual growth, 1982 ...................... Hi
III. Money and credit growth ranges for 1983 ..................................... 16
Panel discussion:
Interest rates versus inflation rates ..................................................................... 17
Inflation impact on short-term rates....................................................................IS
Distinction between two interest rates ................................................................ 21
Impact of increased money supply ........................................................................ 22
Progress against inflation gains momentum ...................................................... 25
Improvement in productivity ................................................................................. 26
Cut spending or raise taxes .................................................................................... 28
Following a more restrictive monetary policy .................................................... 30
Lower interest rates for sustained recovery ....................................................... 32
Reducing the discount rate.....................................................................................32
Expanding profit margins ....................................................................................... 34
Reasons for interest rate drop...............................................................................36
Protectionist policies ................................................................................................ 39
Long-term loan availability .................................................................................... 41
Recovery depends on consumer spending ............................................................ 43
Selecting members of the Board ............................................................................ 45
Stimulate growth expectations .............................................................................. 4G
Continue credit to debtor nations.........................................................................48
Banks keeping interest rates high........................................................................49
Real interest rates....................................................... ............................................. 52
Impact of high interest rates ................................................................................. 53
Need for fiscal tightening ....................................................................................... 54
Need for lower interest rates ........................................................................ 56
High technology industry booming ...................................................................... 57
Major problems are political — not economic ....................................................... 59
Monetary policy report to Congress ...................................................................... 63
ill
FRIDAY, FEBRUARY 18. 11188
WITNESSES
Pace
Martin S. Feldstein, Chairman, Council of Economic Advisers .............................. 110
Prepared statement................................................................................................Ill)
Stable monetary policy ................................ ........................ .............. 110
Money growth rates.......................................................................................I l l
Interest rates .................................................................................................... 113
Monetary policy ............................................................................................... 114
Panel discussion:
Continued high short-term interest rates............................................................114
Leniency in bankruptcy laws.................................................................................UK
Impact of additional money supply ....................................................................... 121
Future of the price of the dollar ,, ......................................................................... 123
Long-term rates coming down ...................... ......................................................... 124
Unemployment forecast too pessimistic ...............................................................
Variable rate mortgages........................................................................................
Seven hour work day...............................................................................................
Andrew F. Brimmer, president, Brimmer & Co., Washington, D.C .......................
Prepared statement .................................................................................................
Outlook for economic activity........................................................................
Outlook for major sectors ................................................................................
Prospects for jobs..............................................................................................
Further abatement of inflation ......................................................................
Federal Government fiscal policy ..................................................................
Federal Reserve policy and interest rates ...................................................
Concluding observations ..................................................................................
John D. Paulus, chief economist and vice president, Morgan Stanley & Co.,
Inc., New York..............................................................................................................
Prepared statement .................................................................................................
I. The monetary aggregates as unreliable indicators of monetary
policy ...............................................................................................................
II. Some key nonmonetary indicators of policy .........................................
III. Concluding comments: Whither Rates? .................................................
J. Richard Zecher, chief economist. Chase Manhattan Bank, New York .............
Prepared statement ......................... ................................................... , ....................
Disinflation........................................................................................................
Alternative courses ..........................................................................................
Real economic activity .....................................................................................
Summary ............................................................................................................
Panel discussion:
Monetary policy must walk tight line ..................................................................
Money growth opinions ...........................................................................................
Competitive inequities within financial services ...............................................
M2 is a big mistake ...................................................................................................
TUESDAY, FEBRUARY 22, 19X3
WITNESS
Beryl W. Sprinkel, Under Secretary for Monetary Affairs, Department of the
Treasury ......................................................................................................................... 171
Prepared statement.................................................................................................171
Monetary policy in 1983 .................................................................................. 171
The general situation.......................................................................................172
The danger of being overly restrictive ......................................................... 173
The danger of excessively stimulative monetary policy ............................ 174
Where do we go from here? ............................................................................ 176
Conclusion .......................................................................................................... 177
Chart 1— Representative short-term and long-term interest rates ......... 179
Chart 2 — Long-term money growth and interest rates............................
180
Panel discussion:
Further decline in interest rates...........................................................................181
Jobs bills are too late ............................................................................................... 183
Impact of falling oil prices ...................................................................................... 185
Institutional changes not responsible for ballooning money supply .............. 187
Consequences of restructuring ............................................................................... 189
All loans by IMF repaid .......................................................................................... 192
FEDERAL RESERVE'S FIRST MONETARY
POLICY REPORT FOR 1983
WEDNESDAY, FEBRUARY 16, 1983
U.S. SENATE,
COMMITTEE ON BANKING, HOUSING AND URBAN AFFAIRS,
Washington, D.C.
The committee met at 9:30 a.m. in room 538, Dirksen Senate
Office Building, Senator Jake Garn (chairman of the committee)
presiding.
Present: Senators Garn, Heinz, Hawkins, Mattingly, Hecht, Proxmire, Riegle, Sarbanes, Dixon, Sasser, and Lautenberg.
OPENING STATEMENT OF CHAIRMAN GAKN
The CHAIRMAN. The committee will come to order.
Chairman Volcker, we're pleased to have you before the Senate
Banking Committee this morning. This hearing on monetary policy
is occurring at a critical time for our economy.
An increasing number of indicators point to an incipient economic recovery, but most analysts agree that this recovery remains
very fragile. To a large extent the continuation of the recovery is
contingent upon a continuation of the recent upturn of housing, an
industry for which this committee has a special responsibility. A
continuation of the upturn in housing, in turn, is dependent on
what happens to interest rates.
This committee held very extensive housing hearings on Monday
of this week, some 4 Vz hours. Everybody was in agreement on one
point, and there was a wide diversity of groups testifying. Everybody was in agreement that interest rates are the key to the continuation of the upturn in housing starts, and although the witnesses certainly differed on how we should achieve a reduction in
the Federal deficit, they agreed that deficits are the key to the reduction of interest rates.
There are recent developments that must give us some concern.
Treasury bill rates are no lower than they were in late August.
Long-term Treasury yields are higher than they were in November
and December. Many analysts blame this failure of interest rates
to continue to decline on the acceleration of growth in the monetary aggregates. Over the last 6 months Mi has grown at an annual
rate of over 12 percent and M2 has grown at an annual rate of over
13 percent. On the other hand, some acceleration in the aggregates'
growth rates clearly was justified by the maturing of all-savers certificates, the availability of new market rate deposit instruments,
and declining interest rates.
(1)
Fears have been expressed that the fourth-quarter acceleration
in the aggregates' growth rates has been more than justified by
structural changes. Whether or not these fears are well founded,
we now know that such psychological factors can have major impacts on the financial markets.
Our No. 1 priority must be to resume the downward trend in interest rates. To accomplish this, we must return to monetary aggregate growth rates that will convince the financial markets that the
Federal Reserve and this Government remain committed to the
fight against inflation.
Mr. Chairman, you and I have had many discussions over the
past several years. I would repeat only briefly that you know how
strongly I feel that the major blame for high interest rates lies
with the Congress of the United States. Rates are held high by the
need to refinance one-third of a trillion, $300 billion outstanding
debt every year; our continually increasing deficits, year after year;
and the unwillingness to come to grips with these deficits despite
all of the rhetoric. Once again we probably are facing a $200 billion
deficit, and each one of the deficits over the last 3 or 4 years has
always been considerably larger than the initial estimates. Regretably I have no reason to believe that that will not be the case
again.
I certainly have not always been complimentary or uncritical of
the performance of the Fed. But I do think that monetary and
fiscal policy have to be coordinated and work together. No matter
whether it was you or someone else as Chairman of the Federal Reserve Board, if you have to plan to monetize 150 to 200 billion dollars' worth of deficit each year, you have no choice in that matter.
That is the responsibility of Congress for continuing to send those
large deficits to you. I think we have to do a better job on both
fronts with Congress bearing the major portion of the blame, no
matter how much people may wish to use the Fed as a scapegoat
for all the problems. I wish they would direct more of their criticism at where I believe it really belongs, and that is at the House
and the Senate of the United States. I do hope in these hearings
that we can have some enlightenment where you think interest
rates are going and what you expect your policy as Chairman of
the Fed will be in light of the difficulties of fiscal policy, how we
best can work together to lower those deficits, and hopefully have
interest rates continue to go down, not just stay at the level of a
lower rate than they have been but continue to go down so that
this recovery, however much it is in its infancy, is not aborted.
Senator Proxmire, do you have an opening statement you wish to
make?
OPENING STATEMENT OF SENATOR PROXMIRE
Senator PROXMIRE. Thank you, Mr. Chairman.
Mr. Chairman, in the 25 years I have been on this committee, I
don't think I've ever seen this room as completely filled as it is
now. You said that you were asked why we couldn't get a bigger
hearing room and that was a pretty good question, but I think the
reason why we have this turnout is because, Chairman Volcker, I
think you recognize that you're the key man in what's going to
happen to our economy and the world economy for that matter in
the next year or so.
The head of the IMF just said the other day that the most serious obstacle to worldwide recovery is the size of the Federal deficit
in the United States, a statement with which I very enthusiastically agree. We simply have to act on that and, of course, corollary to
that, is that we face the prospect of very, very high interest rates
which will not only, as the Chairman so ably said, press our economy and keep us from having a bigger recovery, but is likely to
affect the whole world economy and pose a very, very serious problem.
Let me just say in connection with your appearance this morning
that in its 1982 report to the Congress, the Board substantially
overestimated the underlying strength of the economy and substantially underestimated the demand for money and other liquid balances. Because of the sharp increase in the demand for Mi balances, the Board's original monetary growth targets were well
below the level required to finance the economy.
For example, if the Fed had stuck with its original target for
holding the growth of Mi to an upper level of 5.5 percent, nominal
GNP would not have grown at all while real GNP would have declined even below the — 1.2 percent growth actually experienced.
The problem of selecting the appropriate guideposts for monetary
policy will be even more difficult in 1983 because of the new deposit accounts that became available from deposit institutions in December and January. As of January 26, 1983, $213 billion was
placed in the new money market deposit accounts and $17 billion
in Super NOW accounts.
Another problem concerns the divergence between the Fed's announced targets and what it actually does. When the Fed shifted to
a more accommodative policy in the latter part of 1982, it did not
formally notify the Congress it was raising its target even though
the law specifically provides such an opportunity each July. One
reason may have been a desire to avoid raising inflationary expectations through a formal increase in the official targets. Nonetheless, this flexible approach raises questions about the relevance of
the targets that are set forth and the accountability of the Fed to
the Congress in meeting them.
I might add that in spite of all the criticism, the country is lucky
to have you as Chairman of the Fed. I think you've done a remarkable job under the most difficult circumstances and I hope you can
continue.
The CHAIRMAN. Senator Heinz.
Senator HEINZ. Mr. Chairman, I'm not going to make an opening
statement. I have a lot I want to ask Mr. Volcker about.
The CHAIRMAN. Senator Riegle.
OPENING STATEMENT OF SENATOR RIEGLE
Senator RIEGLE. Mr. Chairman, thank you, I'll be very brief.
There are signs of a limited economic recovery perhaps starting
now and we all hope that that is the case, but over the last few
weeks, as you well know, there's been an uptake in interest rates
which has really given everybody a bad case of the jitters. We have
had people in from the housing industry before this committee in
the last couple days and they are nervous.
We spoke just before the hearing started about auto sales and as
you know they are described in today's paper by the analysts as
being mediocre. There's been some improvement there but a lot of
that has been due to special financial incentives that the companies themselves have offered.
The concern I have is that it looks like interest rates may have
bottomed out and may bump along at about correct interest levels
for a period of time and, if so, that makes me very apprehensive
because I don't think interest rates at current levels will let us get a
real and sustained economic recovery going.
Now I think almost every Member of the Senate would say that
we need a fiscal tightening the budget. The problem is that it will be
at best a few months before the budget process is finished and in the
meantime, it looks to me as if interest rates have to go lower. Given
all of the slack in the economy, a third of the plant and equipment
sitting idle, 12 million people out of work—we need fiscal tightening
with monetary easing. The Board lowered the discount rate in a
series of steps last year and helped get interest rates down, but there
have been no further changes or reductions in the discount rate. I
would hope there would have been, with the thought in mind that
the Congress is committed to the fiscal tightening that we need.
1 would hope today you will give us reason to believe that they
may go lower, at least somewhat lower, in the near term so that we
could really start to get some momentum on the upside in terms of
recovery.
The CHAIRMAN. May I just say to my friend from Michigan that
with all of my children we are doing our part. We have six cars
among us and if we get more people to do their part it would help
the Senator from Michigan considerably.
Senator Mattingly.
Senator MATTINGLY. No comment at this time.
The CHAIRMAN. Senator Dixon.
Senator DIXON. No opening statement, Mr. Chairman.
The CHAIRMAN. Senator Lautenberg.
Senator LAUTENBERG. No.
The CHAIRMAN. We have a statement of Senator Hawkins which
we'll insert in the record at this point as though read.
[Statement follows:]
OPENING STATEMENT OF SENATOR HAWKINS
Senator HAWKINS. Chairman Volcker, it is a pleasure to have
you before the Senate Banking Committee today. As you know, I
have always been very interested in the Federal Reserve System.
In October 1981, I introduced legislation to reform the Fed System
by restructuring the Board of Governors and requiring that the expenditures of the Federal Reserve System be approved by Congress
as part of the annual appropriations process. At least 8 other bills
were introduced in the 97th Congress calling for a restructuring of
the Board of Governors. Senator Garn, as chairman of the Senate
Banking Committee, held hearings on the Federal Reserve Board
membership and structure. Senator Garn said at that time that he
did not believe that recent appointments to the Board created a
membership that, as is intended in the Federal Reserve Act, represented the broad range of geographical and economic interests of
this country. I hope this is an issue which will receive further attention in the 98th Congress.
Now, I look forward to the Monetary Policy Report for 1983.
The CHAIRMAN. Mr. Chairman, it's all yours.
STATEMENT OF PAUL A. VOLCKER, CHAIRMAN, FEDERAL
RESERVE
Mr. VOLCKER. Mr. Chairman, I am pleased to be meeting again
with this committee to discuss the Federal Reserve's objectives for
monetary policy and their relationship to the prospects for the
economy. You already have received the official monetary policy
report to Congress that is required under the Humphrey-Hawkins
Act, My comments today will expand upon some of the points
raised in that report, focusing in particular on our objectives with
respect to monetary policy and the obstacles that, unless dealt with
effectively, could deflect the economy from the path of sustained
expansion we would all like to see.
Our economy has been going through wrenching adjustments
during the past year and a half. With production falling into sharp
recession, the unemployment rate rose to a postwar high. A large
share of our industrial capacity is idle. Profits are depressed, and
there have been exceptionally large numbers of business failures.
Conditions in most other industrialized countries, in greater or
lesser degree, have paralleled those in our own economy, and large
sectors of the developing world have faced the need for forceful
measures to deal with internal and external imbalances. All of this
has been reflected in, and accompanied by, pressures on domestic
and international banking markets.
At the same time, out of this turmoil and stress we can see elements of change and returning strength that bode well for the
future. In particular, striking progress has been made in reducing
inflationary pressures. The measured rate of inflation in 1982 was
the lowest in a decade, and forces are at work that, carefully nurtured, can continue that progress during recovery. Interest rates
have fallen substantially from the high levels of the past couple of
years; as confidence builds that inflation can be held in check, further declines should be sustainable. Business and labor have responded to the market forces by taking measures to cut costs and
improve efficiency, and those measures should have a healthy
effect long after the recession has passed.
At the turn of the year, signs appeared that the decline in economic activity was ending and that recovery might soon develop.
Housing construction, auto sales, and factory orders have all improved in recent months. The sharp downturn in unemployment
reported in January should be interpreted cautiously in the light of
the month-to-month volatility of those estimates, but indications of
some firming in labor demand are heartening.
In sum, this has been a time of disappointment and strain—but
also a period of great potential promise. That promise lies in the
prospect that, under the pressure of events, we—in Government, in
business and labor, and in finance—are facing up to what is needed
to sustain recovery into long years of healthy growth.
I know that this has also been for many a time of frustration and
doubt. Unemployment of a willing worker is always a threat to personal and family stability; on a wide scale it is an affront to our
sense of social justice. To a generation grown accustomed to accelerating inflation, a year or two of progress toward price stability
simply isn't enough to quell fears that the earlier trend will
resume as the economy picks up speed. We have been disappointed
before when early signs of recovery faded away. Federal deficits
persisting at levels beyond any past experience are unsettling to
more than financial markets. We have been jarred to the realization that a serious international financial disturbance is not just
something we read about in books of economic history but could
recur unless we are alert to the dangers and deal aggressively with
them.
Uncertainty and confusion are perhaps inevitable in a period of
change—even constructive change. But they can easily be destructive without a clear conception of where we want to go and how to
get there. My conviction is that much of the stage has been set for
long lasting, noninflationary expansion. But we also have to be realistic and clear-sighted about the threats and obstacles that
remain, confident that being known, they can be cleared away.
THE PROSPECTS FOR STABLE GROWTH
The unchanging goal of economic policy, embodied in the Employment and Humphrey-Hawkins Acts, has long been growth in
employment, output and productivity at relatively stable prices.
That goal for a decade and more increasingly eluded us, not least
because of an illusion for a time that the stability side of the equation could be subsidiary. Once inflation gained strong momentum,
it was doubly hard to contain without transitional pain. But after
several years in which the effort against inflation has had high priority, there are today solid grounds for believing the signs of incipient recover can be the harbinger of performance much more in
line with our goals.
We approach our discussion on monetary policy with the intent
of fostering that result. But, of course, monetary policy alone
cannot do the job; other instruments of policy and the attitudes of
business and labor will be crucial as well.
The latest price statistics confirm the progress against inflation.
But the fact that all the major inflation indices increased by 5 percent or less during the course of last year—or that the producer
price index actually dropped in January—does not mean that the
battle is won.
Those gains have been achieved in the midst of recession, with
strong downward pressures on prices and costs from weak markets.
We cannot build a successful policy against inflation on continued
recession. The question remains as to how prices will behave as the
economy recovers—after 6 months or a year of rising orders, employment, and production.
In recent weeks, increases in some highly sensitive commodity
prices have been cited as a danger sign. Those commodities are subject to speculative influences, but, surely, an increase in some
prices that have been severely depressed during recession is not
itself a signal of change in more basic price trends.
One widely used index of sensitive industrial commodity prices—
excluding oil—declined by about 35 percent from the end of 1980
through late 1982, carrying many of those prices to levels that
could not justify new investment or even maintenance of existing
output. Within limits recovery in those prices would be a natural,
and probably necessary, part of any expansion and will not dominate more general price statistics.
In fact, the single commodity of major importance to the general
price level—oil—is in surplus supply, and the price in real terms
has been declining. I cannot prophesy the degree to which the
nominal price of oil might decline in coming weeks or months, if at
all. But barring a major political upset, prospects appear exceptionally good that stable or falling real prices for finished petroleum
products—which account for 8-9 percent of the GNP—can reinforce progress against inflation for some time ahead. We also have
large stocks of basic food commodities, providing some assurance
against a sharp runup of prices in that area.
It is labor costs that account for the bulk of the value of what we
produce, and our success against inflation in the longer-run will
need to be reflected in the interaction of wages, productivity, and
prices. It is also in this area that recent signs of progress can prove
most lasting.
The upward trend of nominal wages and salaries slowed noticeably last year, with average wages rising by about 6 percent from
the fourth quarter of 1981 to the fourth quarter
of 1982; total compensation, including fringes rose just over 6]/2 percent. The trend
during the year seemed to be declining, and in the midst of pressures on profits, markets, and employment, could well show further
declines. The sharply lower inflation figures—below the rate of
wage increase—moderate one source of upward pressures on new
wage agreements, Longer-term union agreements negotiated in earlier more inflationary years are expiring, tending to further moderate the wage trend.
The slower increases in nominal wages have been fully consistent with higher real wages for the average worker precisely because the inflation rate has been declining. Continuation of that
benign interaction among lower inflation, lower nominal wages,
and higher real wages—combined with recovery in profits—must
be a central part of noninflationary recovery—and thus to sustaining expansion.
Those prospects will be greatly enhanced by improved productivity performance; over time, only an increase in productivity can
assure higher real wages and profits. Happily, after dwindling
away to practically nothing during the 1970's, the signs are that
productivity is rising once again. Tentative evidence can be found
in preliminary data suggesting productivity rose by almost 2 percent last year in the midst of recession, an unusual development
when production is declining. Those statistics are consistent with
8
reports from business that significant progress has been made in
improving efficiency and in reducing "break-even" points.
During the early part of recovery, productivity usually grows
more rapidly. Consequently, a combination of rising cyclical and
"trend" productivity with more moderate nominal wage gains
should reduce the increase in unit labor costs further as a recovery
takes hold. For example, a rise in hourly compensation of less than
6 percent this year would appear consistent with recent trends.
Should productivity increase by 2-2 ^ percent—an expectation that
would appear modest in the light of recent experience—unit labor
costs would rise by significantly less than 4 percent, low enough to
maintain and reinforce progress on the price front.
As confidence grows that the gains against inflation are sustainable, an expectation of further declines in interest rates should be
reinforced. Today, short and particularly longer-term, interestrates, despite the large declines last year, remain historically high
in nominal terms and measured against the current rate of inflation. A number of factors contribute to that, including the present
and prospective pressures from heavy Treasury borrowing. But concerns that recent gains against inflation may prove temporary are
checking the decline in interest rates.
We will certainly need higher levels of investment and housing
as time passes to maintain productivity, to support real income
gains, and to keep supply in balance with demand. Lower interest
rates are certainly important to that outlook, but what is essential
is that those lower levels can be sustained over time. That is one
reason why policies need to remain strongly sensitive to the need
to maintain the progress against inflation—uncertainty on that
point will ultimately be self-defeating in terms of the interest rate
environment we want.
An improved climate for work, for saving, and for investment—
the objective of the tax changes introduced in 1981—should also
materialize in an economic climate of recovery and disinflation,
helping to keep the process going. Rising real incomes will also be
reflected in consumer demand—an area of the economy already
supported by the large deficits. As living standards rise and fears
of inflation fade, pressures for excessive and catch-up wage demands should subside.
In sum, there are strong analytic reasons to believe that the incipient recovery can develop into a long self-reinforcing process of
growth and stability. The challenge is to turn that vision into reality.
OBSTACLES AND THREATS TO PROGRESS
Of course, there are obstacles to that vision; some need to be
dealt with promptly, and some will need to be guarded against as
we move ahead. The more firmly we move to deal with those
threats—by action now and by setting ourselves clear guidelines
for the future—the faster we can end the doubts and restore the
confidence necessary to success.
THE FEDERAL DEFICIT
The most obvious obstacle that looms ahead is the prospect of
huge Federal deficits even as the economy expands. I have spoken
to the point on a number of occasions, and will soon be testifying
before the Budget Committee.
Today, I will only summarize the problem in a few sentences,
and I'm not even sure that it's necessary to do that after listening
to your comments and those of the other Senators. I think the
hopeful thing that remains here is the problem is so well understood. What remains is the need to take action. I know that's difficult and sensitive, but I do think that is a critically important
matter to the success of our economic policy in the years ahead.
The bulk—but far from all—of our present $200 billion deficit reflects high unemployment and reduced income. At a time of recession and relatively low private credit demands, the adverse implications of the current deficit for interest rates and financial markets may be muted. But the hard fact is that the deficit, as things
now stand, will remain in the same range, or rise further, as recovery proceeds and private Credit demands rise. In other words, the
underlying imbalance between our spending programs and the revenue-generating capacity of the tax system at satisfactory levels of
employment ("the structural deficit") promises to increase as fast
as the "cyclical" deficit declines.
That prospect, essentially without precedent in the past, threatens a clash in the financial marketplace as huge deficits collide
with the needs of business, home buyers and builders, farmers and
others for credit. The implication is higher real interest rates than
necessary or consistent with our investment needs in the future
and expectations of that future "clash" feeds back on markets
today. The adverse consequences are reinforced and aggravated by
the widespread instinct in financial markets and among the public
at large that such large deficits will feed inflation by creating pressures for excessive money creation or otherwise, leading to doubts
about the success of the disinflationary effort.
That outlook and analysis is essentially agreed by the administration, the Congressional Budget Office, by citizen groups that
have expressed alarm about the budgetary situation, and by independent budget analysts. It is that broad consensus on the nature
of the problem that provides a base for the necessary action. What
remains to be done is to take those actions. I fully realize the sensitivity and difficulties of the choices to be made. But I am also
aware, as I am sure you are, that a great deal depends on a successful resolution of those efforts.
INTERNATIONAL ECONOMIC AND FINANCIAL SITUATION
The risks and uncertainties in the present situation are compounded by the fact that so much of the world is in recession, and
adverse trends in one country feed back on another. For instance,
falling exports have accounted directly for some 35 percent of the
decline in our GNP during the recession; in past recession, in contrast, our exports have typically grown, cushioning other factors
depressing production and employment. After earlier periods of exaggerated weakness, the great strength of the dollar in the ex-
10
change markets over the past 2 years contributed to the progress
against inflation—but it also depressed our exports. We cannot
build the stability of our economy on extreme exchange rate fluctuations.
Another dimension of the risk is the danger that nations will try
to retreat within themselves, insulating their economies by protectionist measures. But, as we learned in the 1930's, such policies
only aggravate the mutual difficulties. Another aspect is instability
in foreign exchange markets,
But today, we face another more immediate threat in the international financial area. I will reserve detailed comment for my appearance before you tomorrow. Suffice it to say now that the potential for an international financial disturbance impairing the functioning of our domestic financial markets at a critical point in our
recovery is real. I firmly believe the major borrowers and lenders,
with the understanding and support of governments, central banks,
and international institutions, can face up to and deal with those
problems constructively. But the cooperative pattern we have seen
emerge in managing these problems is absolutely dependent on the
capacity of the International Monetary Fund to continue to play a
key role at the center of the international financial system. Early
congressional approval of the enlargement of IMF resources,
agreed by the Interim Committee of the Fund last week, will be essential to that effort.
ATTITUDES TOWARD PRICING AND WAGE BEHAVIOR
I have already described the pricing restraint and the trend
toward more moderate increases in wages that have developed in
the midst of recession. As best as I can assess it, the mood today is
consistent with maintaining that momentum. There is realization
that competitors at home and abroad have large potential capacity,
and after all the efforts to cut break-even points, expanding volume
will itself produce satisfactory profits as well as larger employment
opportunities. The smokestack industries, hit so hard in the period
of recession while already faced with the need for structural
change and with particularly high wages by domestic or international standards, have particularly strong incentives for caution.
But there is, of course, another possibility. Business and labor—
habituated to inflation in the 1970's, highly sensitive to the failure
to sustain past efforts to restore stability, and eager to restore past
price or wage concessions—may be tempted to test their bargaining
and pricing powers much more aggressively as orders and production expand. If they were to do so, sensitivities of consumers and
financial markets to the possibility of reinflation would only be aggravated, tending to keep interest rates higher and greatly increasing the difficulty of maintaining the economy on a noninflationary
path of growth.
This is an area where Government policy can greatly contribute,
by resisting protectionist pressures externally, and by removing or
relaxing obstacles to competition in product or labor markets.
Areas of the economy that have seemed almost impervious to the
disinflationary trend and market pressures—such as health care
and higher education—seem to me to deserve special attention.
11
Through all those particulars, however, restraint in price and
wage setting can reasonably be expected only if Government financial policy remains plainly oriented toward containing inflation,
Without a sense of conviction on that score, the temptation to jump
ahead of the pack—to anticipate the worst—as employment and
orders are restored may become irresistable. The fact is both labor
and business have much to gain from stability, and moderation in
pricing and wages within a framework of financial discipline will
be consistent with higher real wages, profits, and employment.
The skepticism that had been built up over many years about
the resolve to deal with inflation has been reduced but not eliminated. There is little or no leeway at this stage for mistakes on the
side of inflation. Policies designed with the best will in the world to
stimulate, but perceived as inflationary, may, unfortunately, produce more inflation than stimulus.
MONETARY POLICY IN 1982
It is in that broad framework and context that monetary policy
has been implemented in 1982 and that we in the Federal Reserve
look ahead to 1983 and beyond. Our objective is easy to state in
principle—to maintain progress toward price stability while providing the money and liquidity necessary to support economic growth,
In practice, achieving the appropriate balance is difficult—and a
full measure of success cannot be achieved by the tools of monetary
policy alone. The year 1982 amply demonstrated some of the problems facing monetary policy during a period of economic and financial turbulence, and the need for judgment and a degree of flexibility in pursuing the objectives we set for ourselves.
As you know, policy with respect to the growth of money and
credit has been rooted in the fundamental proposition that, over
time, the inflationary process can only continue with excessive
growth of money. Conversely, success in dealing with inflation requires appropriate restraint on growth of money and liquidity.
Those broad propositions must, of course, be reduced to specific
policy prescriptions, and for some years the Federal Reserve had
followed the practice, now required by the Humphrey-Hawkins
Act, of quantifying its objectives in terms of growth ranges for certain measures of money and credit for the year ahead. In doing so,
we have known that for significant periods of time the relationships between money and spending may be loose, that there are recurring cyclical patterns, and that the mix of real growth and inflation can and will be affected by factors beyond the control of
monetary policy. But we also count on a certain predictability and
stability in the relationships over time between the monetary and
credit aggregates and the variables we really care about—output,
employment, and prices.
In 1982, however, those relationships deviated substantially from
the patterns characteristic of the earlier postwar period. The simplest reflection has been in movements of velocity—the relationship between measures of money and credit and the GNP. As
shown on table I attached, the velocity of Mi, which had been tending higher throughout the postwar period, dropped at a rate of
almost 4 percent over the past five quarters. The broader monetary
12
aggregates and broad credit aggregates as well also behaved typically in relation to the economy; that velocity dropped during the
recession by larger amounts than usual. More sophisticated statistical techniques, taking account of lags, interest rates, and other variables, confirm the fact normal relationships did not hold in 1982.
In establishing its various target ranges at the start of 1982, the
Federal Open Market Committee specifically noted that a number
of factors, institutional and economic, would affect the relationship
of monetary and credit growth to the GNP, and contemplated that
MI in particular could deviate from expected patterns for a time in
the event economic and financial uncertainties fostered desires for
liquidity. In reporting to you in July of last year, I emphasized the
committee was prepared to accept higher periods of Mi growth for
a time in circumstances in which it appeared precautious or liquidity motivations, during a period of economic uncertainty and imbalance, were leading to stronger-than-anticipated demands for
money.
In the event, Mi, after moving close to and within the target
range around mid-year, grew much more rapidly later, ending the
year with growth of about 8V2 percent, substantially higher than in
1981 and above the target range (see table II). Both M2 and Ma
tended to rise through the year somewhat more rapidly than the
targets contemplated, averaging in the final quarter about threequarters of 1 percent above the upper end of the target range. (Revised "benchmark" data and some partially offsetting definitional
changes since the end of the year have reduced the overshoot to
about one-four to one-half percent.)
In the light of the clear indications that velocity was declining
more rapidly than in earlier recession periods, the absence of recovery during 1982, and recurrent strains in financial markets,
above target growth was accommodated in the conviction that
policy, in practical effect, would otherwise have been appreciably
more restrictive than intended in setting the targets. The rapid declines in interest rates during the second half of the year—encouraged in part by some actions to restrain the deficit and more broadly by growing realization of the degree of progress against inflation—were clearly welcome. Credit-sensitive sectors of the economy, as noted earlier, tended to strengthen. But after leveling off in
the second and third quarters, economic activity dropped again in
the final quarter in the face of heavy inventory liquidation. In all
these circumstances, strong efforts to confine Mi growth to the
target range seemed clearly inappropriate, particularly with the
broader aggregates running quite close to their ranges.
An important further consideration during the final quarter was
that some of the monetary aggregates were greatly influenced by
purely institutional factors. The maturity of a large volume of allsavers certificates in October temporarily led to large flows into
transaction balances counted in Mi. Subsequently, highly aggressive marketing of new "money market deposit accounts" by banks
and thrift institutions led to enormous inflows into the highly
liquid instrument, which is classified within the M2 aggregate.
In the first 7 weeks after the introduction of that account, which
combines some characteristics of a transaction account with savings, more than $230 billion of money has flowed into the new in-
13
strument. The shift of financial resources is without precedent in
amount and speed. While the great bulk of those funds simply reflected movements from lower interest accounts already included
in M2, a sizable fraction—estimates range to about 20 percent—was
derived from large certificates of deposit or market instruments
not included in that aggregate. The result has been a gross distortion of the growth of M2 in December and, more importantly, in
January.
No statistical or survey technique available to us can identify
with precision the impact on M2 of these shifts of funds. The available data do suggest, however, that—taking December and January
together—the underlying growth in M2 (that is, excluding shifts of
funds formerly placed in non-M2 sources) was not markedly different from the general range established earlier. In other words, the
exceptionally strong growth of M2 in January could most reasonably be treated as having no policy significance.
MONETARY POLICY IN 1983
In setting out our monetary and credit objectives for 1983, the
Federal Reserve has had no choice but to take into account the fact
that "normal" past relationships between money and the economy
did not hold in 1982, and may be in the process of continuing
change. Part of the problem lies in the ongoing process of deregulation and financial innovation that has resulted in a new array of
deposit and financial instruments, some of which lie at the very
border of "transactions" and "savings" accounts, defying clear statistical categories.
Perhaps more significant over longer periods of time, both economic and regulatory change may affect trend relationships. Both
declinining rates of inflation and the growing availability of interest on transaction accounts at levels competitive to market rates
could induce more holdings of cash relative to other assets over
time. The payment of interest rates on transaction accounts could
also affect the cyclical pattern of Mi. The broader aggregates, by
their nature, should be less sensitive over time to innovation since
they encompass a much broader range of assets, but the phased
elimination of rigid ceiling interest rates has changed cyclical characteristics.
All of this has greatly complicated the job of setting targets for
1983. In setting the ranges, the committee believed that monetary
growth during the year would need to be judged in the light of developments with respect to economic activity and prices, taking account of conditions in domestic credit markets and internationally.
At the same time, the FOMC is well aware that past cyclical expansions have typically been accompanied by sharp increases in velocity, particularly for the narrower aggregates. We assume that, to
some degree, that pattern will emerge again. There is a strong presumption that the target ranges will not be exceeded or changed
without persuasive evidence, as in 1982, that institutions or economic circumstances require such change to meet our more basic
objectives.
As set out in the formal Humphrey-Hawkins report, members of
the Federal Open Market Committee and other Reserve Bank
presidents participating in our discussions generally look toward
moderate recovery in 1983 in a context of declining or stabilized inflationary pressures. While the individual forecasts vary over a
considerable range, the majority anticipates real growth in the 3.5to 4-percent area over the four quarters of 1983, fractionally higher
than the administration forecast. Nearly all expect the GNP deflator to rise less rapidly than the 5.6 percent projected by the administration. Projections of nominal growth are mostly in the 8- to 9percent area. In approaching its policy judgments, I believe the
committee recognized the desirability of achieving and maintaining
a lower level of interest rates to encorage growth, but felt that this
could only be realistic in a context of building on the progress already made against inflation. Efforts to force interest rates down at
the expense of excessive liquidity creation could not be successful
for long.
Against all this background, the committee decided that, for the
time being, it would place substantial weight on the broader aggregates, M3 and Ma, in the belief that their performance relative to
economic activity may be more predictable in the period ahead (see
table III),
The target range for Ma, which is least affected by institutional
change, was left at 6Mj to 9Va percent, measured from the fourth
quarter of 1982 to the fourth quarter of 1983.
The target for M2 was set at 7 to 10 percent and the base was
shifted to the February-March average of this year to minimize
the institutional distortions. Our assumption is the flow of funds
into M2 from other savings media will have sharply subsided in
coming weeks. However, the My target range does take account of
staff estimates that residual shifting will probably raise M2 growth
by 1 percent or a little more over the remainder of the year; abstracting from such anticipated shifts, the M2 target, in practical
effect, is the same or slightly lower than the target for 1982. Consistent with these targets, effective growth, that is, abstracting
from the influence of shifts into new accounts, in both M2 and Ma
is expected to be somewhat lower in 1983 than in 1982.
The Mi target was widened and set at 4 to 8 percent. Less emphasis has been placed on the Mi target in recent months because
of institutional distortions and the apparent shift in the behavior
of velocity. The degree of emphasis placed on Mi as the year progresses will be dependent upon assessment of, and the predictability of, its behavior relative to other economic measures, and the
range may subsequently be narrowed. Over the year, growth in the
lower part of the range would be appropriate if velocity rises
strongly, as has usually been the case during recoveries. An outcome near the upper end would be appropriate only if velocity does
not rebound sharply from the declines last year, and tends to stabilize close to current levels. Only modest allowance has been made
for the new Super NOW accounts drawing funds into Mi from
other sources, and the target would clearly have to be reassessed
should the depository institutions deregulation committee permit
depository institutions to pay market rates of interest on business
accounts.
In addition, the committee set forth for the first time its expectations with respect to growth of total domestic nonfinancial debt,
15
and felt that a range of 8V2 to II Vz percent would be appropriate.
Data for such a broad credit aggregate are not yet available monthly, nor are the tools available to influence closely total flows of
credit. While the credit range during this experimental period does
not have the status of a target, the committee does intend to monitor developments with respect to credit closely for what assistance
it can provide in judging appropriate responses to developments in
the other aggregates. The range would encompass growth of credit
roughly in line with nominal GNP in accordance with past trends;
the upper part of the range would allow for growth a bit faster
than nominal GNP in recognition of some analysis suggesting a
moderate increase in the ratio of debt to GNP may develop during
the year. Now I know, Mr. Chairman, all of these numbers and
qualifications can create a bit of confusion, so let me put aside all
the nuances that we use in the trade. In practical effect and taking
account of institutional change, these new targets seem to me directly comparable to those we had last year and we intend to be
within them. Money in its various definitions should grow less this
year than last and, of course, we are operating in the context in
which inflation is down, in which the economy is operating below
its potential, and in these circumstances targets seem to me fully
compatible with easier market conditions, lower interest rates
during the year insofar as monetary policy is an influence. But, of
course, other factors influence interest rates as well, including that
deficit factor that we have discussed.
I appreciate the complexity—for the Federal Reserve and for
those observing our operations—of weighing performance with respect to a number of monetary and credit targets, of taking account of institutional change, and of assessing the possibility of
shifts in relationships established earlier in the postwar period—a
possibility that can only be known with certainty long after the
event. But we also can sense something of the dangers of proceeding as if the world in those respects had not changed.
I neither bewail nor applaud the circumstances that have put a
greater premium on judgment and less automaticity in our operations; it is simply a fact of life. In making such judgments, the
basic point remains that, over time, the growth of money and
credit will need to be reduced to encourage a return to reasonable
price stability. The targets set out are consistent with that intent.
I understand—indeed to a degree, I share—the longing of some
to encompass the objectives for monetary policy in a simple fixed
operating rule. The trouble is, right now, in the world in which we
live, I know of no such simple rule that will also reliably bring the
results we want.
The basic rule we must observe is that the sustained forward
progress of the economy is dependent on a sense of price and financial stability—and without it, we will undercut the growth we all
want. That objective, as I have emphasized, will require that we
avoid excessive growth of money and credit because, sooner or
later, that growth will be the enemy of the lower interest rates and
stability we need.
I have given you our best judgment on the appropriate role for
monetary policy in 1983. But, success in achieving our objectives is
not in the hands of monetary policy alone—and we look forward to
16
all elements of policy moving ahead in pursuit of those common
goals.
[Tables accompanying statement follow:]
TABLE I—VELOCITY OF THE MONETARY AGGREGATES
TABLE II.—MONEY AND CREDIT RANGES AND ACTUAL GROWTH, 1982
Bank Credit
1
Base 1m ranee was ttie average tor December 19S; and January 1982 lo atetraci from trie diverting eflects on Dank credit of shifts of
banks' loans ana investments to the new International Banking Facilities, which had been authorized beginning in early December
s
The definitional changes were to eiclude IRA-Keogh accounts from Ms and M., and to include in those aggregates tax-exempt money markel
funds. These changes were made to maintain consistency in tne treatment of similar financial assets witti IRS-Keogh accounts held in depository
institutional, like other IRA-Keogh's and regulai pension funds, now excluded from monetary aggregates and with all money market funds, taxexempt ot nol. DOW included in the aggregates The exclusion ol IRA-Keogh accounts lowereo growth of M3 and M, by about 1 percentage point
Inclusion of tax-exempt money market Hinds raised giowth of these two aggregates by about '-2 percentage point
TABLE III.—Monetary and credit growth ranges for 1983 (QIV over QIV basis, except
as noted I
M,
' 4 to 8
M2
2 7 to 10
M3
BMi to lOVy
17
Total credit 3
1
This range allows for a modest amount of shifts from sources outside M, into super-NOW
accounts. Thus far, growth in those accounts has been relatively small. The range also assumes
thai authority to pay interest on transactions accounts is not extended beyond presently eligible
accounts.
'' Represents annual rate of growth from the average level of M 2 outstanding in FebruaryMarch 1983 to QIV 1988. The February-March 1983 base was chosen, rather than QIV of 1982,
so that growth of M, would be measured after the period of highly aggressive marketing of
money market deposit accounts (MMDA's) has subsided. These accounts, introduced in mid-December, rose to over $280 billion by early February, with a substantial amount of funds transferred into them from sources outside Ms, such as market instruments and large CD's. The 7 to
10 percent range for Ms allows for some residual shifting from market instruments and large
CD3 s into MMDA's over the balance of the year.
Represents domestic nonfinancial debt.
The CHAIRMAN. Thank you, Mr. Chairman.
Before we begin the questioning, may I once again respond to the
question asked before the hearing started: That is why we didn't
get a bigger hearing room. My response was it had not occurred to
me frankly. It did occur to my staff and I have been informed since
that they did attempt to get a larger hearing room. There were
only two that were larger than this room and neither one of them
were available. So, although it did not occur to me that we should
have a bigger hearing room, I admit this is home and this is where
the Banking Committee resides, the staff was brighter than I,
which is not unusual in the Senate. They did anticipate that and
were unable to find one.
In my opening statement I noted that Treasury bill rates were
about what they were in late August and long-term Treasury yields
are higher than they were in November and December. Could you
explain for us the failure of interest rates to continue falling along
with the decline in the inflation rate?
INTEREST RATES VERSUS INFLATION RATES
Mr. VOLCKER. Interest rates went down very sharply over the
summer as you know. I think at that point there was a growing
realization that the inflation rate had moved sharply lower and
was likely to stay lower for a while, and there was a return in confidence in that respect that helped to propel interest rates lower.
Markets tend to anticipate and they move very rapidly, and after
moving by 5 or 6 percent below their highs in a very limited period
of time, I think there was some feeling of pause—stop, look, listen,
let's see what's happening.
The CHAIRMAN. But what's happened is: inflation continued to go
down.
Mr. VOLCKER. I agree what's happened is the inflation figures
continue to look good. There is also a kind of growing realization—
after some satisfaction with the action that Congress took last
summer with respect to the deficit— that you were still left with a
huge deficit problem. Those numbers began to seep into consciousness more fully and clearly have had an effect on the market.
I also think, more recently, as signs of the economy turning have
developed, that there has been a certain amount of skittishness,
with people saying, well, that's fine; the economy is going to turn;
but can we maintain this good inflation performance in an expanding economy? I think we can, but there is a certain amount of questioning about that in the market and a kind of catch-22 situation.
18
They see the economy beginning to recover and they say that's
good, but what's that going to mean for inflation and what's that
going to mean for financial markets down the road?
I don't think this is at all the unanimous feeling in the market,
but some of them have looked at the monetary aggregates that you
referred to and asked, "Does that reinforce my concern that after
all this great progress on inflation some time down the road inflation is going to come back?" I think you cited a figure of M2 growth
of 13 percent over several months. You can only get a figure like
that by including the January increase, which was enormous. I
would just again make the point that I made in my statement, that
I think that January figure in economic terms is not enormous at
all. That is an institutional deviation because of the introduction of
the new money market deposit accounts. Its economic significance
is close to zero.
We cannot identify with absolute precision what impact MMDA's
had on the figures but we don't have any particular reason to
think that that January figure was indicative of a sudden change
in the M3 growth pattern, which in the last quarter has been running in the 9-percent area.
The CHAIRMAN. Mr. Chairman, you and I have discussed many
times the psychological impacts on the market. We have also discussed the fact that over the years Presidents and Congress alike
have promised a balanced budget. Every new President comes in
and says he's going to balance it by the end of his term and so we
can easily understand why the markets don't believe that. It never
happens. We can understand why they are skittish now, why they
worry about inflation being reignited.
INFLATION IMPACT ON SHORT-TERM RATES
The thing that I personally don't understand—I understand the
impact on long-term interest rates because of that fear, but with all
the good things that are being reported now on the inflation rate
and—particularly the wholesale rate down so low, even negative in
some months—I wish somebody—you or someone else—could explain to me why the inflationary expectations have an impact apparently on short-term rates.
Now if people want to be reasonable out there in the marketplace short-term rates, in my opinion—real short-term rates ought
to be a lot lower. I can accept their explanation of, OK, long-term
rates are going to stay up because we don't trust Congress and we
don't trust the Fed and we don't trust anybody in the longer term.
But I'm wondering if there isn't just some profiteering out there in
short-term rates because inflation is not going to go up quickly,
nobody thinks that it's going to go back up this year to any significant degree. Well, somebody wants a 90-day loan or an automobile
loan of a couple years or so and nobody can answer that question
for me. Maybe you can today as to what's the psychological bit—
excuse, in my opinion, has got to do with the continued high level
of real short-term interest rates.
Mr. VOLCKER. I think you're right that the fears about future inflation ought to logically have a bigger impact—and I think they
do—on the long-term rates than the short-term rates.
19
The CHAIRMAN. A lot bigger impact.
Mr. VOLCKER. But the two rates are related and the market arbitrages back and forth between them. Let me say that as far as
short-term rates are concerned, Treasury bill rates were down to
7.5 percent; they're more than 8 percent now. What do you think
the inflation rate is now? On the face of it, I accept it as 4 percent
or so. The Consumer Price Index shows that's been affected by
The CHAIRMAN. And the automobile companies are bragging
about advertising 11.9 percent. You've got a big spread there.
Mr. VOLCKER. You always have a big spread on consumer loan
rates. That may be abnormally high now. If you take the Treasury
bill rate, it's high, but it's not out of sight relative to what a lot of
people think the inflation rate is. Beyond that, let me say that obviously in the short run the pressures on bank reserve positions
which we influence, have an effect on short-term rates. We have
had growth in the aggregates that I don't think have been inappropriate, but somewhat on the high side relative to our targets, and
we have made allowance for the liquidity demands and all the rest.
But if we were to provide more reserves, which would have an
influence presumably in the very short run on interest rates declining, we would get more growth in those aggregates; you expressed
some concern about the rate of growth already. That's part of the
problem with short-term rates.
The CHAIRMAN. Well, maybe there is not an answer to my question. It just still seems to me
Mr. VOLCKER. If the suggestion is that we should push down
short-term rates, you can only do that by getting more monetary
growth, and it's a matter of our judgment as to how much monetary growth we want. You can't have it both ways.
The CHAIRMAN. As I say, apparently there's a much looser relationship between long-term rates and short-term rates and I just
don't see—I can justify—not like, but understand—the inflationary
expectations for long-term rates, mortgages and all of that. But the
shorter term consumer rates and so on, I still think they are abnormally high and well above what they ought to be from the past experience I've had in looking at the economy.
Mr. VOLCKER. Consumer rates can be affected by these expectations. Take a car loan. It's typically for 3 to 4 years and at a fixed
rate. In making that loan, a bank is going to anticipate how rates
will behave over a considerable period of time. Apart from the cost
and other normal rate relationships, I think you definitely do have
the consideration in consumer loan rates of what the future interest rate pattern will be, and not just the pattern over the next 3
months.
The CHAIRMAN. There is an incredible difference, Mr. Chairman,
from 2-, 3-, or 4-year loans and somebody risking a 30-year mortgage and tying up their money for that period of time.
Mr. VOLCKER. There is a difference between those two.
The CHAIRMAN. There's a great deal of predictability in that
short time.
Mr. VOLCKER. I agree with that, but it's a matter of degree. It's
not black and white.
The CHAIRMAN. I agree it's not black and white, but I think
there's a lot more gray in between and we are not
20
Mr. VOLCKER. Let me make that basic point: I agree that consumer loan rates have been slow to come down in line with market
rates. But if you go back some years when you had normal relationships established over a period of time, there would be a very
considerable margin between consumer loan rates and let's say, the
Treasury bill rate; you would have consumer loan rates in the 10and 12-percent area for years when the Treasury rate was in the
high or medium single digits.
The CHAIRMAN. The reason I'm concentrating so much on shortterm rates, because you know how I feel—the long-term rates I
think can only be solved when Congress gets its act together. Those
outyear deficits are so horrendous that you, as Chairman of the
Fed, and the Open Market Committee can't do anything about the
1990 deficit and 1985 and those projections. I don't see how longterm rates can reasonably be expected to come down and stay
down until the fiscal house is in order.
The short-term interest rates could have a dramatic impact on
getting us out of this recession. Every time the auto industry offers
12, 9, 10.9, 11.9, it's even more helpful than rebates in selling automobiles and getting those automobile workers back to work. I think
those short-term rates could really have an impact on whether we
come out of this recession, whether the unemployment rates start
to go down and therefore takes some pressures in relationship,
however loose it may be, over the long-term rates as well because
the impact there obviously as we put more people back to work and
they pay taxes, those deficits start going down because of the recovery and then you have an impact. So I think short-term rates could
help lead us to lower long-term rates as well.
Mr. VOLCKER. Let me just draw the policy conclusion from your
comments. You say you would like to see short-term rates lower.
Presumably the policy approach toward that would be for the Federal Reserve to put more money in the market. That's what we can
do in concept to try to get short-term rates lower. The reflection of
that will be in higher money growth than otherwise would take
place, and what we have to balance is the concern that you expressed—too strongly, in my judgment, frankly—earlier that monetary growth is too rapid. I don't share that view, but obviously, as a
matter of judgment, we have decided not to push it higher aggressively.
The CHAIRMAN. Well, I guess you misunderstand the point I'm
trying to make. I am not and never have been and am not now an
advocate of you dumping a lot of money into the economy. I would
not do that. I don't want to reignite inflation. I don't want high interest rates as a result of that. I have never been one to use the
Fed as a scapegoat.
Mr. VOLCKER. I understand that.
The CHAIRMAN. What I'm trying to say is within your current
monetary targets that short-term interest rates are entirely too
high and the answer I can't get from anyone is why. I think they
are much too high considering the amount of money in the money
supply, in the monetary aggregates at this time, and that's why I
used the term profiteers—people out there taking advantage of this
situation where some of them are doing very well. At the same
time, from the new money market account, I'm hearing a com-
plaint from all those people that demanded of me that in our bill
we've got to mandate this new account, that they are awash with
money and they don't know what to do with it and they can't loan
it fast enough. So if they are awash with money—the excuse before
was they had a shortage of money and the interest rates were high.
Now are they high because they are awash with money and they
don't know where to loan it?
Mr. VOLCKER. Let me try to clarify that if I can. Let me make a
distinction between two interest rates, the Treasury bill or the
open market rate and the consumer loan rate. As to the open
market rate, I don't think profiteering is a relevant consideration;
it's a highly competitive market and, as a matter of simple analysis, based upon some past relationships, you would say with this
much money relative to the economy and inflation, those rates
should be lower. But they're not. Why not? It leads us to believe
that there has been more demand for liquidity than you would ordinarily expect, which is why we have been accommodating that
demand to some degree.
If you shift over to the consumer loan rate, an administered rate,
I think, as I said, that there has been caution in reducing those
rates for a number of reasons: In part, cautions about whether they
would go back up again; in part, I think, concern and nervousness
at times in the banking system about the potential cost of credit
losses, either domestically or internationally; I think, more recently concern over the possible costs, clearly in the short run of this
new money market deposit account which has increased costs. It's
an aggressive market; there's no doubt about that. It's not unnatural to be a little hesitant, I suppose, in reducing your lending rates
in the face of all that.
At the same time, the MMDA has provided a lot of funds. You're
absolutely right about that. Some banks are, as you say, awash
with liquidity. I think in time—and I think there is some evidence
it is happening now—that will get pushed out into the market and
this sluggishness in the rate decline may be overcome. We do regular surveys of consumer lending rates, but the last regular survey
we did was in November. There's one going on now but we don't
have the results. My sense is that those rates have begun to come
down faster.
The CHAIRMAN. Thank you, Mr. Chairman. My time is up and I
apologize to Senator Proxmire for going over but they handed me
the note that my time was up to Senator Proxmire. I couldn't see
it.
Senator PROXMIRE. To follow up on what the Chairman has been
saying, I don't think the Chairman has been indicating any dissatisfaction with the rate of increase in the money supply as much as
the fact that you, as Chairman, have not done what Arthur Burns
did, for example, which was to jawbone the bankers when he
thought that the rates were sticky and too high and couldn't be justified. At least I don't think you have. I don't mean to be unfair to
you. I suppose there are questions as to how effective Chairman
Burns was, but he did at times say that he thought that the banks
22
were maintaining a rate higher than could be justified. Isn't that
right?
Mr. VOLCKER. He was for a time operating in the context of—I
can't remember the title
Senator PROXMIRE. The Committee on Interest and Dividends.
Mr. VOLCKER. The Committee on Interest and Dividends; that
was part of the general control program that was in effect at that
time.
Senator PROXMIRE. But you have a bully pulpit here just like the
President. When you talk the bankers really listen.
Mr. VOLCKER. Sometimes, yes; sometimes, no.
Senator PROXMIRE. I'm sure they listen all the time.
Mr. VOLCKER. I have indicated that these spreads have tended to
be pretty wide, but I haven't attempted to lecture the banks; I
think that's fair to say on that point. I'm not sure that would be
productive during this period. I will be interested in seeing the statistics when we get them, but I do have some sense that consumer
loan rates are falling now; maybe they are not falling as fast or as
far as we would like, but I think the most recent movement has
been in the right direction. I think it's important that we do not
convey the sense that we think there is an easy answer, other than
instilling greater confidence that the inflation improvement not
only can continue but will show further progress.
Senator PROXMIRE. We do get hit so often with the argument
that real interest rates are very, very high and if you compare the
short-term inflation with the short-term rate of interest, there is a
terrific discrepancy and it just stands out, as the chairman pointed
out.
Mr. VOLCKER. That's true, if you compare interest rates. I think
frankly, that is a price, that we have paid for a decade or more in
which we undermined confidence that we would be successful in
dealing with the inflation problem. I think that confidence is returning. I think the atmosphere is quite different from what it was
2 years ago in that respect, but I suspect expectations haven't
caught up with what I think is the reality; we will only be able to
tell 2 years from now.
IMPACT OF INCREASED MONEY SUPPLY
Senator PROXMIRE. Mr. Chairman, I thought the most significant
statement you made is when you departed from your regular text
and said that the money supply in all its definitions will increase,
as I understood you to say, less this year than last year.
Mr. VOLCKER. That is what our targets would imply, yes.
Senator PROXMIRE. In previous appearances you argued that
faster money growth might lower the interest rate in the very
short term temporarily but that inflationary expectations would be
raised and interest rates would go back up perhaps higher than
before. That was your principal argument against talk about congressional efforts to require the Fed to target interest rates. Now
let's examine that argument in the light of what actually happened
in 1982.
The Fed was under strong pressure to be more accommodative.
You had a very restrictive policy in the first 6 months of the year.
23
Then, beginning in July, you were more accommodative. Mi grew
extremely fast in the second half and yet interest rates, at least
until November, dropped and dropped sharply. They seemed to stabilize in the last 2 or 3 months. But the results of that easier policy
seemed to be that the interest rates came down.
Mr. VOLCKER. In looking at the actual figures, Senator, the
broader aggregates show some fluctuations from quarter to quarter
but tend to be running around the higher end of our range all year
long; there wasn't much difference between the first half and the
second half; there was a little bulge in the third quarter.
Senator PROXMIRE. If you look at interest yields on corporate
AAA bonds, for example, and mortgage rates, they all dropped very
little in the first half of the year and then they dropped sharply in
July.
Mr. VOLCKER. I agree. I don't think you can trace that precisely
to these changes in money. We had a bulge in Mi in the first quarter and then it was much lower in the next quarter, continuing
into the third quarter; in the last 4 or 5 months of the year it was
much higher.
We had a bulge in the last quarter of 1982 and interest rates
were low; we had had a bulge in the first quarter of 1982 and interest rates were high. That tells you some other things were going on
at the same time these money supply numbers were changing. Obviously, the economy was declining late in the year. But I think
part of the reason—and even more important when you get to the
long-term rates, as Senator Garn suggested—was that, as the year
wore on, the progress against inflation became much more convincing and the market was psychologically right for a decline in interest rates in the summer.
Senator PROXMIRE. Well, the figures show in the first 6 months
of last year the money supply growth was 1.2 percent and the last
6 months it was 14.3 percent. That's pretty jarring. These are the
St. Louis Federal Reserve figures. I've got them here. That's what
they report.
Mr. VOLCKER. The only figures I have here are quarterly figures
and the quarterly figures don't show that. You may be looking at
figures for some particular week.
Senator PROXMIRE. No; that's for the period ending July 28, 1982,
and then
Mr. VOLCKER. That's a weekly figure I think. There was a drop
for a couple weeks right in that period. The quarterly average figures were 10.5 in the first quarter, 3.2 in the second quarter, 6.1 in
the third quarter, and 13.2 in the fourth quarter.
Senator PROXMIRE. Well, for the record, we'll give you the figures
we have.
Mr. VOLCKER. All right.
[Chart follows:]
24
E
'6.2
:e
Senator PKOXMIKE. Let me give you a scenario that is a nightmare for a lot of people. Assume that the recovery proceeds more
or less in line with the 4 percent real growth you predicted for
1983. By the middle of the year inflation begins to pick up slightly
and we begin putting more of our unused capacity back to work.
Wall Street gets the jitters about inflation and in response the Fed
exerts tighter control over the growth of the money supply, thereby
choking off the recovery. Instead of a healthy 4- or 5-percent increase in real economic growth, we get an anemic 2- or 3-percent
increase. You indicated this morning you expected a lower rate of
money growth this year. Would this be a realistic scenario?
Mr. VOLCKER. I think it's a scenario some people worry about,
but all I can say concerning that scenario and other scenarios is
that the progress that we've made against inflation should continue. I really hope and expect it will be amplified during this period,
that we will see a further downward trend, that this will take place
in the midst of the kind of recovery you foresee. In those circumstances, the kinds of targets that I've set out would, in our judgment, be consistent with lower interest rates, if you look just at
that variable.
Senator PROXMIRE. But some of our gains on inflation may be
temporary windfalls and not sustainable. We've had a drop in commodity prices that has been severe. Food prices have stayed down.
Mr. VOLCKER. Right.
Senator PROXMIRE. And there's no indication it would seem that
that's likely to continue.
PROGRESS AGAINST INFLATION GAINS MOMENTUM
Mr. VOLCKER. There is no doubt that we picked up windfall
gains, if that's the right term, in the midst of a recession. But the
point I tried to make in my statement is that I think we have done
a lot more than that. I think we have put forces in place that have
a certain momentum of their own, that can feed upon themselves,
and that should continue to keep that inflation rate down and even
improve it. The most important price trend or combination of price
trends in the economy is that wage/productivity interaction. It is
hard for me to put together a likely set of figures for 1983 that
does not suggest moderation in wage costs, taking account of productivity.
I talked about labor costs accounting for the bulk of the value of
what we produce. Another big element of cost in the economy is
energy and oil. That looks like it's going to be on the favorable
side; it's a question of how much on the favorable side, so long as
we don't have war or some other political disturbance.
As I see it, in this basic unit labor cost outlook, in the energy
outlook, we've got some very favorable signs for continuing the momentum against inflation. I don't think we can look for a lot of
help in farm price declines. They're obviously low; but we have big
surpluses there and that gives some protection on the upside.
Against that, you asked about the likelihood that we will see some
increase in commodity prices if we have recovery, because it's a
natural part of recovery. Those amounts account for a very small
portion of the total prices in the economy.
26
A bigger question over time is, I think, the exchange rate part of
the equation, where we have benefited by the windfall gain—if
that's the right term—from this enormous appreciation of the
dollar in the past couple years. You certainly cannot look for another upward appreciation of the dollar of that sort. We have
gotten some gains that are partly temporary from that side but, on
the other hand, our analysis and I think most econometric analyses
of this subject, suggest that the forces restraining prices from the
exchange rate side tend to persist over a couple years. They're not
sharply reversed in a period of a year or so.
While that will not be nearly as favorable as we look ahead, I
don't think it's an area that, by itself, is going to threaten the more
favorable outlook.
I think the chances are good for continuing downward momentum in the labor cost side of the economy. I could be wrong about
that. If I'm wrong about that, our problems are much more serious.
Historically, that has not been at all unusual in the first year of
recovery. In fact, it would be the typical pattern. My concern in
looking ahead is the danger that might arise in the second and
third year of recovery. I think we ought to be focusing policy—and
this has implications for monetary policy and for fiscal policy,
too—such that the Government demonstrates that it really cares
about inflation, that it's going to do its best, it's going to be successful in its financial policies in keeping down inflationary forces. I
think that is the atmosphere in which we ought to be able to sustain this improvement on the labor cost side. Don't forget, that if
we're right about productivity, then when I talk about a lower
trend in wage costs, real wages would be rising, which is what the
game is all about. You will get increases in real wages consistent
with moderation in nominal wages. That's obviously what we
would like to see. That's what we have to play for. That's what the
aim is. We are not home free yet but we are a long ways, I think,
in setting the stage for that kind of a recovery.
Senator PROXMIRE. Mr. Chairman, my time is up, but may I ask
unanimous consent to have the chairman answer questions from
Senator Cranston who had to depart?
The CHAIRMAN. Certainly, and there are other Senators who
cannot be here who wish to have the same privilege, so we will
submit questions to you for your response in writing.
Senator Heinz.
Senator HEINZ. Thank you, Mr. Chairman.
IMPROVEMENT IN PRODUCTIVITY
Chairman Volcker, one of the things you said in your remarks
was that you were very pleased by the improvement in productivity. Doesn't improvements in productivity, the kind that we have
experienced, mean that we have been closing inefficient plants and
that the workers whose jobs have been sacrificed are unlikely to
get them back?
Mr. VOLCKER. I think there's been some closing of relatively inefficient plants. That would be natural in a recession. But I think
there have also been efforts both by labor and management to
change work rules and to cut overhead, which tends to get swollen
27
during" an inflationary and more prosperous period, and I think
some of that can last.
One would rather, I suppose, see inefficient plants close than
new investments in them. There is, in the short run, better productivity that way. If you assume a 4-percent rate of growth in the
economy, then productivity is higher in the short run. It's true that
creates a lag in getting employment to go up.
Senator HEINZ. But aren't you, in your statement suggesting that
industries like the steel industry and the auto industry are really
not going to see their plants reopen if those improvements in productivity are going to be maintained?
Mr. VOLCKER. No. Over time, clearly, they have to make improvements in productivity so that they can have the profits and
the markets that are necessary to support those plants. In the very
short run—I'm talking about a year or two—a rapid increase in
productivity will reduce the amount of reemployment during that
recovery period, all else being equal. But I don't think we can say
we don't want gains in productivity for that reason, because the
long-term future of the industry rests upon those gains.
Senator HEINZ. Let's pursue that a little further. You quite correctly single out the chances of rising protectionist pressures in
this country and you're right. There's a tremendous amount of protectionist pressure in the countryside at large and in the Congress
and I'm thinking, for example, if the Japanese do not follow
through on the variety of promises they have made both recently
and, frankly, in the past—you're likely to see legislation such as
the local content bill, pass not just the House but the Senate. It
probably won't fare too well down at the other end of Pennsylvania
Avenue, but I think that's a measure of the spirit of the country.
One of the reasons that I asked you the question about productivity and I note the protectionist pressures is that virtually every
country in the world—Japan, Western Europe, West Germany,
France, England, Italy—all the developed countries have an adjustment policy for industries. Sometimes it works. Sometimes it
doesn't. Sometimes it's backwardlooking. Sometimes it's forwardlooking. The Japanese are the most forwardlooking and the Germans next. For better or worse, the EEC has been trying to rationalize their policy.
In this country there is absolutely no commitment on the part of
our Government or as far as I can tell on the part of Congress to a
meaningful adjustment program. Would you agree?
Mr. VOLCKER. I think our presumption is that the Government
isn't going to try to outsmart business. You're in an area where I
don't have particular expertise, but I sense that Germany does not
have a specifically thought-out reallocation process in these areas
where Government brings to bear a strong influence on employment.
Senator HEINZ. At some risk of correcting you, they do, because
of the Common Market Committee such as the coal and steel community, such as the special commission they have on steel directly,
Mr. VOLCKER. They can involve themselves.
Senator HEINZ. And on paper some of the things they do look
pretty good.
Let me move to probably the major concern I think many of us
have. You have mentioned it yourself. You skipped over it because
it is obvious. It's the Federal budget. Let me ask you the bottom
line.
If Congress does everything that President Reagan has asked it
to do, is that going to bring down the budget deficit enough first;
and second, is it going to bring it down enough so that real interest
rates, instead of apparently on the long term picking up as they
are right now, will go down?
Mr. VOLCKER. As a matter of general judgment, the dimensions
of the program that the President has suggested in the outyears
looks reasonable to me and in proportion to the size of the job. The
only thing I'd say about that is I would like to see some of it
phased in earlier.
Senator HEINZ. You're talking about the proposed increased
taxes?
Mr. VOLCKER. The combination of measures that he has proposed. I'm just looking at the bottom line of fiscal effect, the effect
on the deficit with those measures. I haven't got anything particular to say about the composition of those measures.
Senator HEINZ. I'm going to ask you about the composition.
Mr. VOLCKER. Let me not comment about the composition right
now. Just looking at the sheer budgetary impact, I think it's in the
right proportions. I'd like to see it come a little earlier.
Senator HEINZ. Do you think the President's program that maintains having a deficit close to or above 5 percent of GNP for the
next 2 to 3 years is in fact an acceptable level for the deficit?
Mr. VOLCKER. When you say within the next 2 or 3 years. I get to
the point of liking to see an impact a year earlier or so.
CUT SPENDING OR RAISE TAXES
Senator HEINZ. Let's talk about how we can do it. There are two
ways we can do it—cut spending or raise taxes. Which do you
prefer on top of what the President proposed?
Mr. VOLCKER. It doesn't have to be on top. We're talking about
the timing.
Senator HEINZ. Well, to you it's timing. To the people out there,
it's a cut in spending or an increase in taxes. Which do you prefer?
Mr. VOLCKER. I think his proposal is of the right general proportions.
Senator HEINZ. Which do you want us to accelerate, spending
cuts or tax increases?
Mr. VOLCKER. From the general economic standpoint—from the
standpoint of what increases the prospects for economic growth,
productivity, investment, and all the rest—I would prefer to see as
much as possible on the spending side.
Senator HEINZ. All right. Let's talk about where we can cut it.
Mr. VOLCKER. You're getting into your business rather than
mine.
Senator HEINZ. Let me give you a for instance, Secretary Weinberger says that the defense budget is going to create a lot of jobs;
the last thing we should do is fool around with the defense budget
Of)
because this ;'•- ih<- principal means lo create jobs. Do you agree
with that?
Mr. VOLCKF.R. I would not look at the defense budget as a principal means to create jobs. 1 look at the defense budget as something
for national security. That Is the kind of consideration you have to
balance: The needs for national security against the needs for
social security I haven't got anything in particular to suggest to
you on those grounds. Those are very hard decisions, but they are
not in my domain.
Senator HEINS. Now you guessed it. Now let's talk about the tax
side for a moment. The fact of the matter is that anything we do,
as demonstrated by the social security reforms proposed, probably
are going to be, as we say around here, a balanced package, which
is to say it's going to be some of one thing and some of another. To
the extent there are increases in taxes that are going to accompany
any cuts in spending, beyond those proposed by the President, we
have some choices. We can increase taxes on income. Everybody is
talking about the third year indexing. We can increase taxes on
consumption. The President has proposed, as you know, a $5 per
barrel tax on oil. Or we can put taxes on jobs, savings, and investments. If you had to choose between those three categories which
I've loosely lumped together, where should we increase taxes if we
have to increase taxes; not that anybody wants to?
Mr. VOLCKER. I would try to put the emphasis on measures that
have the least effect on incentives for savings and investment.
Senator HEINZ. All right. So taxes on jobs, payroll taxes, cutting
back on depreciation allowances, or things that affect savings you
would try and stay away from. I think most of us would agree with
you on that.
That leaves us a choice between taxes on consumption and taxes
on income.
Mr. VOLCKER. in some versions those come very close to the same
thing. It depends on how you put the taxes on income.
Senator HEINZ. You're saying that really there's not much to
choose from between those two?
Mr. VOLCKER. There are a lot of other considerations here, too, of
course, considerations of equity and balance in the tax code. As a
general proposition I——
Senator HEINZ. But from the standpoint of achieving economic
growth, you find those are fairly similar?
Mr. VOLCKEU. That's right, but there are other considerations
you obviously have to deal with. From an economic standpoint, I
think there's a lot to be said for moving the tax structure toward
taxing income or consumption very broadly and cutting down on
some of the special exemptions and deductions. That's not a very
fresh thought, but I think it makes sense.
Senator HEINZ. We made a start on that in the Finance Committee last year.
Now the reason I've asked you these questions about the
budget—and you have been very forthright in saying we really do
need to do more than even the President anticipates
Mr. VOLCKER. Earlier.
Senator HEINZ. To move faster, to move more definitively, I
think you would probably agree, is that there's a lot of fear I think
30
reflected in the movement of interest rates that you may, as you've
said today, be planning to hold the growth of the monetary aggregates within ranges below that of last year, but I think there's a
fear not so much of what you're going to do in 1983 but what
you're going to do in 1984. People remember in 1971 and 1972
Arthur Burns, who many people somehow remember as a high
priest of fiscal conservatism—certainly that's what he preached to
the Congress—in fact followed policies in 1971 and 1972 where, for
a variety of reasons, the amount of money available to the economy actually increased dramatically.
How can we rest assured that notwithstanding what you say
you're going to do in 1983 you're not going to abandon it in 1984?
Mr. VOLCKER. I'm not going to have a perfect answer for that
question except by casting a lamp on experience, I suppose; one has
to make his own judgment. I could not be more concerned about
and sensitive to—and I think the Federal Reserve generally shares
this—defending the progress we have made on inflation and supplementing that further. I don't know how I can give you a mechanical law that forecasts the future and gives you the assurance
you want. I can only give you our conviction that after having gone
through all the pain that we've gone through, and having seen the
signs of progress that we see on inflation, we don't want to give it
up.
FOLLOWING A MORE RESTRICTIVE MONETARY POLICY
Senator HEINZ. Well, my time has expired, but maybe I could
just get a sense of this. Are you saying that in 1984, as you have
said very correctly for 1983, you're going to follow a more restrictive policy than you followed in 1982?
Mr. VOLCKER. You're interpreting restrictive in terms of the
growth in money supply as "restrictive"?
Senator HEINZ. Yes.
Mr. VOLCKER. The committee hasn't discussed this. As I personally would look at this, with the kind of economy that I would foresee, particularly the progress on inflation that I would foresee, I
think it would be logical that the money supply would grow less
rapidly in 1984 than in 1983—as nearly as one can see now.
But take an institutional situation. Suppose interest is paid on
demand deposits across the board at market rates. You've then
changed the institutional setting, and that could affect the appropriate rate of monetary growth.
You say more "restrictive" policy. It's more restrictive in terms
of the money supply. It's not at all inconsistent with lower interest
rates when you have an economy with less inflation over that
period of time. It would be perfectly consistent with lower interest
rates.
Senator HEINZ. Thank you very much.
The Chairman. Senator Riegle.
Senator RIEGLE. Mr. Chairman, I want to start with a very
narrow question and then work out from there. I'd just like your
best judgment on this issue.
If today's interest rates essentially stay where they are for the
next 8 to 6 months, will that enable us to have a strong and sustained economic recovery in your view?
Mr. VOLCKER. I don't think I can say it's necessarily inconsistent
at all. It depends, obviously, upon a lot of other things, but we have
seen, for instance, a very sizable rise in housing in recent months
from very low levels at these interest rates or higher interest rates.
I suspect—although I can't prove this because evidence is anecdotal—that we are seeing right now declines in consumer borrowing
rates, even while some of these sensitive market rates are rising a
little bit. I can't sit here and say that these rates are inconsistent
with the kind of recovery you would like to see. I don't know that
for sure. Only time will tell. I would feel more comfortable overall
if interest rates were lower, but I've got to look at all those things
in making that judgment.
Senator RIEGLE. If I understand what you're saying, you're
saying that if interest rates stay at current levels that you think
that a strong and sustained recovery can take place?
Mr. VOLCKER, I think that's possible, yes, but
Senator RIEGLE. Do you think it's likely?
Mr. VOLCKER. I think your question was in terms of the next few
months. Expand your time horizon to a couple years. Let me
assume that inflation continues to improve as I hope. In that context, just guessing, I would think that environment would be conducive to lower interest rates; indeed, I think those lower interest
rates might be very important in sustaining the rise that we're
seeing in homebuilding. We haven't got a rise in business investment yet; we're going to have to see a rise in business investment.
During that kind of a time period, with that kind of inflation outlook, it would both be very important and quite a natural expectation that interest rates would decline.
Senator RIEGLE. Well, I don't want to diminish the importance of
the long-term outlook, however, most people that I talk to seem to
feel that what happens in the next 6 months here from this day
forward is really the critical period for several reasons.
One, we have been in a long, deep recession. There's been a lot of
stress applied to the system. There's a lot of damage that's been
done. You've got an international financial problem of some very
considerable dimension as you well know. And the feeling that I
get is that we need to get a recovery going now that we can depend
upon, that in fact it happens, and that it gains speed as we go out
over the next 3 to 6 months. And what I hear you saying is that
you think interest rates at current levels will let that happen and
that your expectation is that we will see things pick up steam here
if interest rates stay where they are without in fact going up.
Mr. VOLCKER. I'm not predicting the level of interest rates.
Senator RIEGLE. I'm not asking you to predict them. I'm saying if
they stay here, will that give us recovery?
Mr. VOLCKER. I think that is quite possible. I said that if you're
interested in recovery—and we're all interested in recovery—the
lower the interest rates, the more assurance you have about that.
That doesn't lead you to a direct conclusion that you should do
what you can to get interest rates down over that period because
you've got a risk on the other side.
LOWER INTEREST RATES FOR SUSTAINTED RECOVERY
With respect to that judgment, I'm hearing a lot of opinion from
professional finance people that interest rates in fact will have to
go somewhat lower than they presently are for a strong and sustained recovery to take place, and that they would say that if rates
have leveled out now and if we have hit an interest rate floor at
the current level that that is not sufficient to get that job done.
You've not expressed that view, but I'm reporting to you that's a
view that I'm hearing with increasing frequency from others, and I
must say I share that view.
If you look, for example, at what the Fed did last year with lowering the discount rate, because that's one specific step that you
can take which is a judgmental step, and you lowered the discount
rate in a series of steps and the rest of the rates came along and
followed in a parallel pattern, but then that set of moves stopped
and it gave the impression that perhaps the Fed thought that interest rates had come as low as they need to come at this stage of
the game in order for recovery to take hold and to begin,
Now we see rates edging up again. If you take the new Treasury
bill rates on January 17 they were 7.6; on the 24th, up to 8 percent;
the 31st of January, up to 8.1; February 7, 8.2; February 14, 8.3 and
rising. So we have seen an uptake in interest rates.
If your judgment is that interest rates at current levels are sufficient to kick off a recovery of some strength and there's a large
body of opinion of others who feel in fact these rates are still too
high and they need to be lower—then we've got a very tough contradiction here that has to be resolved, and that's why I really
want to understand precisely your own thinking.
Mr. VOLCKER. I know that some people express that view and
that's one side of the story, but let me use the same facts about last
year and let me describe them a little differently.
REDUCING THE DISCOUNT RATE
We were certainly reducing the discount rate on seven occasions
in the second half of last year. We were reducing it, generally, in
line with the reductions in market rates. I don't think those discount rate reductions were generally leading the market, but we
had no desire to impair a decline in interest rates during that
period.
The last change we made in the discount rate was rather interesting. If any of them led the market, there was some interpretation that that one might be leading the market, but interest rates
didn't go down. We reduced the discount rate and market rates
were going kind of irregularly—we're talking about fairly narrow
movements here—but interest rates today are higher than when
we reduced the discount rate. That may tell you something about
our ability to influence interest rates for any period of time
through the discount rate.
If you just were looking at the recovery in the short run, obviously, the lower interest rates are, the more assurance you have of recovery. But, at the same time, we have to look at what's going on
in monetary growth, what's going on with respect to inflation—
which is good at the moment—what's going on in terms of the con-
viction and the assurance people have that inflation will stay
down. And when we balance all those factors, then we have to
make a judgment about the discount rate. I'll just have to let our
actions speak for themselves in that respect.
The only point I make is that we have to balance the considerations that you rightfully put on the table and that we would put
on the table and try to look as far ahead as we can to see what the
ultimate effects will be.
Senator RIEGLE. Well, that's understandable. The problem is, as I
read your statement and as you have delivered it, there's a clear
inflation-fighting tilt to it. You really hit that bell over and over
again and we all want to fight inflation, but I don't detect any kind
of equal sensitivity in terms of the need for recovery,
Mr. VOLCKER. I
Senator RIEGLE. Now if I just could finish, I'm not saying that
you don't have that concern. I'm just saying the flavor of your document leans much more heavily on the inflation-fighting theme
than it does on the economic recovery theme and that concerns me
because I think at this point we need a recovery and we can get
one without setting off some great spurt in inflation.
Mr. VOLCKER. Let me explain lest there be some misunderstanding. I put a lot of emphasis on this issue of inflation because I
think it is important. What I tried to say in the statement is that I
think it's important in itself, but it is important precisely in the
terms you put the question, in terms of sustaining this recovery. I
think we have a great opportunity for this recovery to extend years
ahead, and I think in all probability that's going to take lower interest rates. I think the way to get there is by maximum assurance
that we are not going to lose this progress that we've made on inflation. You have to get the lower interest rates and sustain the
lower interest rates that you want, and that I see, in this environment, as being healthy, probable, necessary.
Senator RIEGLE. Well, it would be very valuable if we could continue right now but my time is up. I hope we will get a second
round a little later.
The CHAIRMAN. Thank you, Senator Riegle.
Before I turn to the next questioner, I would explain particularly
for the benefit of the new members of the committee the procedure
that we have used in questioning, and it relates back to 1975 when
I sat over where Senator Trible sits and I would come and sit for
the entire hearing and senior Senators would waltz in for a minute
or two and about 3 or 4 hours later, after having been there the
whole time, I would finally get to question. So when I became
chairman and Senator Riegle ranking minority member, we talked
about changing that procedure and have followed an early bird
rule where, regardless of seniority, those who have arrived early
and are patiently sitting here, get to question first.
So with that explanation to my colleagues, particularly the new
ones, Senator Hecht, you're next, regardless of the fact that you're
sitting way, way over there.
Senator HECHT. Thank you very much.
Mr. Volcker, how can businessmen expand to create tax revenues
when the profit margin is not there with present interest rates?
34
EXPANDING PROFIT MARGINS
Mr. VOLCKER. I think the major thing that will determine their
profit margins and their profitability is the recovery that we have
been talking about and expanding volume. As that recovery gets
underway for a while, I would be hopeful that business investment
will begin turning up. But business investment is going to be declining for a while, I'm afraid, because there's a certain momentum
in that present situation. For the months immediately ahead I suspect you're going to see further declines in business investment.
The interest rates interact with many other factors. I think we
can go back to the discussion with Senator Riegle. As I've indicated, in a noninflationary economy, I think lower interest rates will
be desirable and necessary to sustain that increase in investment.
Senator HECHT. But as a businessman the profit margins are not
there. Let's talk about prime rate, 11 percent. Obviously, the average small businessman is borrowing at two or three over prime
plus perhaps one or two points along the way. There just is not any
incentive to go out and expand.
Mr. VOLCKER. There's not an incentive now for a variety of reasons, but I accept the point that we'd like to see interest rates
lower over time; there's no argument about that. The question is
how you get them there and how you sustain them.
Senator HECHT. But to follow up on that, how can we increase
our tax revenues for the Treasury if business does not expand?
Mr. VOLCKER. You need an expansion in the total economy to
help increase revenue. Let me say that with any conceivable expansion in the economy over the next few years you're still going
to be left with a big deficit in the budget unless some other action
is taken.
Senator HECHT. No further questions.
The CHAIRMAN. Senator Dixon.
Senator DIXON. Chairman Volcker, you have suggested in your
testimony today that you believe that we are in a process of recuperation so far as the economy is concerned. In your appearance
here last year you inferred that things were getting better, yet unemployment rates are much higher than you suggested then.
Though you predicted some nominal growth, there was a 1.2 percent drop in GNP last year, I would share the concern of some
members here that interest rates have still not come down far
enough. If you recall in our questioning at this time last year, I
asked you whether you weren't suggesting more of the same as you
had with reference to the prior year when you suggested the 2.5 to
5.5 percent growth in Mi and the facts indicate that during the
course of the year you improved on that.
Mr. VOLCKER. Not everybody thinks it's an improvement.
Senator DIXON. Certainly the interest rates responded to what
you did. You had a growth at a rate of 2.5 to 5.5 percent in Mi.
Your actual growth was 8.5 percent.
Mr. VOLCKER. That's correct.
Senator DIXON. You had 6 to 9 in M2. Your actual rate was 9.7.
You had 6.5 to 9.5 in Ma and your actual rate was 10.3.
Mr. VOLCKER. Correct.
Senator DIXON. Now while not much happened in the first part
of the year, I think it's clear that after July you have pursued a
less restrictive monetary policy in the second half of the year and
market interest rates also fell correspondingly during the second
half of last year.
Now don t you believe that the second phenomenon is a direct
result of the first?
Mr. VOLCKER. Not entirely, no. I think a lot of other factors were
at work in the market. If you take those broader aggregates, in
general terms you will find a growth in the second half of the year
pretty close to what it was in the first half of the year. If you just
look analytically at those aggregates, something else must have
been going on. A lot of other things were going on, also progress on
inflation, but including obviously the fact that the economy relapsed back into recession after there was a lot of leveling off in
the spring and summer and quite a lot of anticipation that recovery would take place at that time.
Those expectations were disappointed and the fallibility of economic forecasting has been demonstrated once again in 1982.
Senator DIXON. Mr. Chairman, I think we all agree that there
are a lot of factors that enter into what comes about as a final
result, but I think it is clear that in connection with all your monetary targets you were substantially above the high side of those
monetary targets. You indicated earlier you don't recall how many
times you dropped the discount rate. I believe you dropped it five
times. It was 12 percent in June and 8.5 percent at the end of the
year. So you couple the fact that your growth in every one of the
areas MI, M2, and Ma, was substantially over the high side, and you
dropped the discount rate five times. And I would suggest all of
those things married together in the second half of last year had a
substantial impact on the reduction in interest rates.
Mr. VOLCKER. We did not press to get those numbers within the
target range. I think that accommodative view, if you want to call
it that, was consistent with the interest rates declining but I do
think there are other factors. You could have looked at midyear
and seen that both M2 and Ma were above their targets if I recall
the numbers correctly. In fact, they were probably about as much
above the target in midyear as they were at the end of the year.
That went along more or less as it had been.
There were other factors. We did let Mi increase more rapidly—
there's no doubt about that—in the first quarter when interest
rates didn't decline.
Senator DIXON. I notice you're increasing your targets this year.
Mi would be increased from 4 to 8 percent; is that correct?
Mr. VOLCKER. Yes.
Senator DIXON. And M2 7 to 10 percent, and Ma 6.5 to 9.5 percent.
Mr. VOLCKER. The Ms target is the same. Let me just put an important footnote on the Ma. The increase in the Ms target range reflects an institutional fact, a projection, which is subject to review,
that simply because of the introduction of this new account, M2
will run about 1 percent higher than it did last year. That's not of
economic significance, so I think in a sense that target is the same
as it was last year.
Senator DIXON. May I say I'm not being critical.
Mr. VOLCKER. No. I just didn't want any misunderstanding.
Senator DIXON. I would hope you would increase every one of the
three targets this year.
Mr. VOLCKER. I don't think it's a real increase in the case of M2.
I'm not suggesting ——
Senator DIXON. It's a one-half of 1 percent. That's arguable as to
whether that's a real increase. You've gone from 6 to 9 to 6.5 to 9.5,
according to your testimony.
Mr. VOLCKER. Let the testimony explains why. Let me make a
point that I made in the testimony. The same target, with a lower
inflation rate, all other things equal—which they never are—
means less pressure on the money markets.
Senator DIXON. I would only suggest to you, Mr. Chairman,
predicated upon the experience of last year, that an increase in the
target on all three levels—Mi, Ma, and Ms—and a reconsideration
of possible further lowering of the discount rate, all of which
worked well in my view in the last half of last year would be better
medicine to consider for this year.
Mr, VOLCKER. We keep these things under review all the time
and we will continue to do so.
The Chairman. Senator Mattingly.
Senator MATTINGLY. Thank you, Mr. Chairman.
REASONS FOR INTEREST RATE DROP
Mr. Volcker, what percent do you think of the interest rate drop
was due to either poor economic conditions, your policies, or to the
deficit?
Mr. VOLCKER. I'm inclined to say all of the above.
Senator MATTINGLY. Well, that's right, but when you factor them
out?
Mr. VOLCKER. Most important things, by the middle of the year
was that the progress on inflation had become convincing. There
was still doubt, still questions about how long it will continue, but I
think the atmosphere has changed a lot from what it was.
Senator MATTINGLY. Was progress on inflation by the economy
getting weaker or by what we did here in the Congress or by what
you did?
Mr. VOLCKER. I would like to say by what you did in the Con^
gress, I think the fact that you passed that budget bill last
summer—if that's what you're thinking of—was a factor at the
time in tipping the psychology toward lower interest rates.
Senator MATTINGLY. In other words, you say the tax increase had
an impact?
Mr. VOLCKER. Right.
Senator MATTINGLY. I'm sort of in disagreement on that. I think
last year we were looking at a $90 billion deficit in our country so
we came along and had a $99 billion tax bill and came on later
with another $14 billion tax bill and we got a $200-plus billion deficit.
Mr. VOLCKER. I don't agree with that. I think the deficit was underestimated last year, but I think you would be worse off if you
hadn't taken action.
37
Senator MATTINGLY. It's underestimated every year.
Mr. VOLCKER. It's underestimated maybe more frequently than
it's overestimated.
Senator MATTINGLY. To follow what Senator Heinz was talking
about about taxes and spending and not trying to pin anybody
down about where we ought to be going to and what Senator Hecht
maybe commented on and you didn't hold much hope out for what
he was saying and you were talking about some taxes, tell me how
that $99 billion tax bill—did the 10 percent withholding or the pension reform encourage savings and investment? Was it a stimulative thing, those two?
Mr. VOLCKER. I think the total package
Senator MATTINGLY. I'm just asking you about those two.
Mr. VOLCKER. I can't make choices about the composition of the
package. I expressed that generally to Senator Heinz. I don't want
to get deeply into the composition.
Senator MATTINGLY. Do you think that's going to help you?
Mr. VOLCKER. I think if you're talking about interest rates,
within broad limits, anything that reduces future deficits is going
to be helpful.
Senator MATTINGLY. Does a withholding tax encourage people to
put money into savings which really helps the markets?
Mr. VOLCKER. I'm not sure that withholding tax will have much
of an impact on that. I suppose you would say to the extent it affects it at all, it's going to be negative.
Senator MATTINGLY. What brand new tax do you think of that
could be really stimulative for our economy?
Mr. VOLCKER. Nobody is suggesting you do anything in terms of
proposing the tax right now in January or February or in the
months immediately ahead. What we are talking about are those
deficits out there 2 or 3 years ahead, and I do think that action—
including, if it comes to that, increasing taxes—to close that structural deficit will have a stimulating effect on the economy today
because it will help interest rates today.
Senator MATTINGLY. Do you think a trigger tax—we're talking
about a trigger tax in 1986 and it's probably a little gray as to
what that means—is that going to be stimulative to the private
sector? Is that going to encourage the private sector?
Mr. VOLCKER. I think if it were credible to the private sector that
it was really going to take place, yes.
Senator MATTINGLY. Do you consider it credible, the proposal?
Mr. VOLCKER. I think it's one way of approaching it. I suppose,
given the budget figures, I'd rather see it a little earlier.
Senator MATTINGLY. Which gets back to a sustained recovery. We
all want a permanent recovery.
Mr. VOLCKER. Right.
Senator MATTINGLY. And you referred to a hope in the outyears,
which I do too, but you say what's been proposed is reasonable and
I say what's been proposed is unreliable. In the budget process,
anything that gets past the first year has not really been reliable,
at least in my association with the Federal Government for 7
years. Would you agree with that?
Mr. VOLCKER. I think you have put your finger on a problem.
How do you make a change out there in the future convincing. I
38
think you've got to worry about that and think about that in any
action you take.
Senator MATTINGLY. Which gets us to the—what impact will this
$200 billion plus deficit this year or the proposed $189 billion in
fiscal year 1984 have on interest rates?
Mr. VOLCKER. They would be higher than they otherwise would
be.
Senator MATTINGLY. Therefore, let me narrow you down to a specific. How much confidence would be created as far as the Federal
Reserve and everybody that sets interest rates if the budget were
frozen? I'm not asking you to decide where it's frozen. I'm saying if
we're going to spend $805 billion this year and we proposed spending $848 billion in 1984, what if we only spent $805 billion in fiscal
year 1984? What impact would that have on interest rates?
Mr. VOLCKER. I think it would have a constructive impact.
Senator MATTINGLY. How much impact? What do you figure in
points?
Mr. VOLCKER. I'm not going to
Senator MATTINGLY. How much confidence? It would be a lot of
confidence?
Mr. VOLCKER. If people thought you would carry through on that;
yes.
Senator MATTINGLY. What would happen if you did that for 2
years?
Mr. VOLCKER. More confidence. We're not talking about the practicality of it now.
Senator MATTINGLY. It really would have more impact than an
outyear discouraging tax increase then, right?
Mr. VOLCKER. Probably, but you're going to get
Senator MATTINGLY. Probably or really? It really would, wouldn't
it?
Mr. VOLCKER. Let me make a distinction between two things. I'm
not trying to be overly subtle. In terms of new impact on the deficit, they would have similar impact on the deficit and on interest
rates today. If you're looking also at structural considerations, lasting considerations, the spending cut would be better than the tax
increase or investment considerations over a period of time. I agree
with that; the spending cut would be healthier than the tax increase.
Senator MATTINGLY. Having been around this town longer than I
have, if you froze an agency budget it would force them to reform
the agency's budget?
Mr. VOLCKER. In some cases. I ask that question of my staff.
Senator MATTINGLY. But it is definitely an attention getter and
probably would happen, isn't that correct?
Mr. VOLCKER. Yes; but you know as well as I do that you get into
all kind of difficulties in freezing things.
Senator MATTINGLY. Yet, we have the private sector out there
frozen, like Senator Hecht was talking about, where a man cannot
make a decision.
Mr. VOLCKER. I don't want to disagree with you that moving on
the expenditure side is more favorable.
Senator MATTINGLY. I would take your comments as acceptance
that we ought to go more on the spending side than the tax side.
You brought up protectionism and I'm going to ask you something probably that could be related to your job.
PROTECTIONIST POLICIES
At the IMF, the IMF is encouraging the LDC's and other countries that have problems to reduce their imports and increase their
exports. Now if they ask them to reduce their imports, aren't they
going to have to go to more protectionist policies to do that?
Mr. VOLCKER. The IMF, as a matter of general basic policy, is
always in favor of open markets, reduced protectionism.
Senator MATTINGLY. How can they tell them don't bring in anything, but ship everything out?
Mr. VOLCKER. In brute force terms what they are basically saying
is cut your internal deficits and that will have an impact on how
many resources you're absorbing at home and the consequence of
that will be reduced imports. They are not saying put on import
control.
Senator MATTINGLY. Is that a good rule for any country?
Mr. VOLCKER. It's a good rule for countries that have a deficit.
Senator MATTINGLY. Can you name one that doesn't have a deficit?
Mr. VOLCKER. There may be a few around the world, but you're
talking about very big deficits here. You're talking about a Mexican deficit of 17 percent of GNP; the Brazilian deficit is 13 percent
or something like that. These are very tough programs. We talk
about our budget deficit of 6 percent of GNP as far too big, taking
too many resources, too many savings. Their deficits relative to
GNP are 2 or 2 Ma times what ours are; they're being asked to cut
them in half in a year and they have a real tough program.
Senator MATTINGLY. I was just a little bit concerned about
having that policy and whether that's consistent with what we're
talking about.
Mr. VOLCKER. I think it certainly is because open markets is a
fundamental principle of the IMF.
The CHAIRMAN. Senator Lautenberg.
Senator LAUTENBERG. Thank you, Mr. Chairman.
Chairman Volcker, we both have New Jersey roots, but that
doesn't mean we have to be kind to one another.
Mr. VOLCKER. No.
Senator LAUTENBERG. Just a few things to help me understand
the process a little better. First of all, productivity and jobs are tied
together in the situation that we see with the IMF, as Senator Mattingly has said. Is that part of the adjustment process we're asking
of the borrower: To increase exports so that they have a better balance which, in fact, may be resulting in a decline in imports from
the United States?
Mr. VOLCKER. It already has by large amounts.
Senator LAUTENBERG. So we will continue to see a reduction, will
we not, in the job market here?
Mr. VOLCKER. I think we will see a reduction in the export
market for some time for that and other reasons. The total job
market involves in a lot of other things, but in that portion of the
job market, yes.
Senator LAUTENBERG. It will be under pressure?
Mr. VOLCKER. Yes.
Senator LAUTENBERG. OK. Do we penalize ourselves in some way,
Mr. Volcker, as we finance these loans? I understand there's a
larger order of magnitude in terms of the stability of the international economy; but do we penalize ourselves as we shore up some
of these very shaky economies at the expense of investing further,
if we run into very serious risks in terms of delinquencies, default,
et cetera?
Mr. VOLCKER. I think it's quite the contrary. By shoring up their
financial position, as you put it, we are helping them make the adjustment that they have to make. What they are being asked to do
is severe, but it's less severe than if they didn't have this support.
If they had all credits cut off, they would have an even more difficult time internally and their imports would go down even more.
They simply wouldn't have any money to pay for them.
While we're talking about programs that have an impact on our
exports—even putting aside the financial side of the equation,
which you can't forget about because it's central—you would have
a more severe impact if you didn't have the shoring up through the
credit side, as you put it.
Senator LAUTENBERG. OK. I think there's testimony, if I'm not
mistaken, on that tomorrow.
Mr. VOLCKER. Yes.
Senator LAUTENBERG. In terms of the question on short-term interest rates, does the new type of short-term investment opportunity the NOW, super NOW, money market and so forth—force such
competition for funds that it would be very difficult for short-term
interest rates to fall because the liquidity that's required means
that that capital has to be constantly available—readily available?
Mr. VOLCKER. If you're getting to the point that this shifts a lot
of money into banks that's instantly available on demand, very
liquid money in that sense. I would not think it would make them
more cautious about extending loans in general but it could make
them more cautious about extending loans at fixed rates for any
period of time. I think that's quite possible.
That's the way it should work in some sense, to make it a little
harder to get fixed rate loans for a period of time, all other things
being equal. Against that, some banks become relatively flush with
funds and they have to look for someplace to put them and make
some money. But, in principle, the more the banks shift to very
liquid money on the liability side of the balance sheet, the more
cautious they may be on the asset side.
Senator LAUTENBERG. The thing I think we're going to be finding
is that with the premiums, with the services, with the transaction
volume and so forth, the banks are going to have actually less
return on their investments.
Mr. VOLCKER. There's no doubt there are quite heavy costs involved at least in the short run, and I think probably it's made
them more cautious about reducing lending rates during this
period of time which, again, over time, should be balanced by the
fact they've got more money and they've got to lend it someplace.
Senator LAUTENBERG. Yes, except I think it will continue to put
pressure on short-term interest rates because they are not going to
41
be able to recover a return on their investment that makes economic sense for them.
Mr. VOLCKER. We'll see how it works out. It could, all things
being equal, result in relatively higher short-term rates over a
period of time. I don't know how to measure that precisely, but it
may go in that direction.
Senator LAUTENBERG. Have we had enough experience with these
new kinds of money instruments to form any opinions as to whether they ought to be restricted in any way? Should they be encouraged? Should there be any legislative direction or regulatory direction?
Mr. VOLCKER. They are encouraged enough from my point of
view. There aren't any restrictions on them. It's no great secret
that I would not have designed the instrument exactly the way it
was designed. We've got a hybrid of transactions and savings elements in this instrument. I would rather have had a cleaner distinction between the two and not have had so much of it piled into
accounts available on demand. I don't think there are going to be
any changes in the foreseeable future. Congress legislated this
effect.
LONG-TERM LOAN AVAILABILITY
Senator LAUTENBERG. It does, though, doesn't it, compete directly
with longer term loan availability, mortgages, et cetera? We have
had testimony here from people in the housing sector and there is
a question about how much money is available for long-term fixed
rate mortgages.
Mr. VOLCKER. As I indicated, the more this money is highly
liquid and shiftable, everything else equal, the more cautious you
would think banks and thrifts would be about making longer term
commitments, but it's a matter of degree. Thrift institutions were
highly dependent on pretty liquid money for years and made longterm investments. I think the more important factor by far, over
time, would be the general climate of confidence about future interest rate levels and whether people have the confidence necessary to make a long-term commitment. So far as the mortgage
market is concerned, that is turning more and more into an instrument that is financed in the open market through GNMA securities or Government-sponsored means for converting a iionmarketable instrument into an instrument that can be sold in the open
market. There are private developments where mortgages are put
into more direct competition with bonds, so that you find mortgage
rates following bond rates more directly these days than they did 5
years ago or 10 years ago. It's no longer so much the captive of institutions.
I think this kind of institutional development probably pushed us
in the direction where mortgages have to compete more on the
open market, and the mortgage rate will depend upon what the
open market rates are.
Senator LAUTENBERG. Will that encourage, in your judgment, a
return to the more conventional long-term fixed-rate mortgage?
Will investors get burned along the way and take the loss as inter-
42
est rates increase—occasionally Finding people left holding the hot
potato?
Mr. VOLCKER. I think the future of a long-term fixed-rate mortgage is basically dependent upon the inflation outlook and the interest rate outlook that's derived from that.
Senator LAUTENBERG. It's hard to imagine that we will get back
to the kind of mortgage system that existed.
Mr. VOLCKER. I think it will be a different system, but we can
have a lot of fixed rate mortgages in a new system.
Senator LAUTENBERG. Fixed rate but long term as well?
Mr. VOLCKER. I think long term as well, if we can restore confidence on the inflation side. There's a surprising amount of longterm lending going on right now. I think our estimates show 60
percent of mortgage money is fixed term.
Senator LAUTENBERG. That's what they say, but it also means
that 40 percent is not. That's variable.
Mr. VOLCKER. Ten years ago, it all would have been fixed.
Senator LAUTENBERG. Absolutely. In terms of putting some
proper pressure on the deficit—and you may have said this
before—how do you feel about the tax cut coming up here in the
middle of the year? Do you think we ought to let it stand as it is?
Mr. VOLCKER. You've got to do something about the deficit in my
judgment. If I had my choice, and given the situation in the economy at the moment, I suppose that wouldn't be first on my priority
list in terms of its timing with regard to the budget.
Senator LAUTENBERG. Thank you.
The CHAIRMAN. Thank you, Senator. If I could just make one
comment on the issue of new money market accounts, I suppose
I'm constantly defending my child, but some comments that don't
seem to be made now that it is being much more successful than a
lot of people anticipated, and this point was made in hearings on
Monday or at least I tried to make it—the fact that on the daily
availability of this money far a good deal of it where a very large
proportion of it is coming from is traditional passbook savings that
was readily available on a daily basis as well.
Mr. VOLCKER. That's correct.
The CHAIRMAN. So that simply is not a change. I heard that comment made from some of the witnesses from financial institutions.
It's not any more readily available than it was.
Mr. VOLCKER. I think that's certainly very true. If you go back 10
years, thrifts were totally dependent on passbook savings. I think
they were operating in a different climate, where there was more
stability in those savings than there is in any instrument now, but
that's a reflection of the total economic climate not the instrument.
The CHAIRMAN. Second, about being expensive, isn't it true that
they are far simpler accounts to manage than the very complex
sweep accounts that certainly put an upward pressure on money.
Also, the money market funds in excess of $200 billion that were
being removed from these institutions were accomplishing two
things. First of all, taking away liquidity which was then not available at all for mortgage loans, automobile loans, consumer loans or
anything else, and being put into quite different purposed by the
money market funds, the new boys on the block, and also putting
S&L's in a failure mode where we faced a list of nearly 1,000 trou-
43
bled S&L's as a result of that lack of money and many of them not
making loans at all.
So I really reject—not just in a defensive manner, but I reject
that there is any more certainly upward pressure on interest rates
as a result of this new account compared to the struggles of these
depository institutions in the last 2 years to find enough money to
loan, sweep accounts, the administrative burden of that, passbook
savings—that whole scenario, which I do believe had a certain
upward pressure. But I'm intruding on Senator Hawkins' time.
Senator HAWKINS. Good morning. Mine will be a potpourri of
questions that have not been asked by others.
RECOVERY DEPENDS ON CONSUMER SPENDING
Many economists and commentators believe that the size of the
recovery will depend to a large degree on whether consumers start
spending. Interest rates on installment credit extended by banks
for durable assets remained at 18 percent through 1982. Credit
card rates stayed at 19 percent. Rates charged for car loans at year
end were 16 to 17 percent. Yet the CPI went up only 4 percent.
That means that the real or inflation adjusted interest rate for
consumers is 15 percent from the figures that I have.
Isn't it highly unlikely and almost impossible for consumers to
start a recovery if interest rates aren't cut? What is the Fed doing
to lower them?
Mr. VOLCKER. The interest rates you're referring to, of course,
are set by banks and other institutions and they are somewhat removed but certainly influenced by the interest rates in the market
that we talk about more commonly. You're certainly correct that
those interest rates have held at exceptionally high levels during
this period of declining rates.
There was clear statistical evidence that they were declining late
in the year, but not by very much. I don't have statistical evidence
beyond that.
I think perhaps before you came in, Senator, I said my sense is,
in an informal way, that those interest rates are declining more
rapidly now but still they are high.
To the extent they are reduced, you're going to help the consumer side of the economy. They are being reduced some. It comes back
in part to how confident people are, as I said earlier, about the fact
that interest rates will stay down, because once a bank makes a
consumer loan for 3 or 4 years it is on the books for 3 or 4 years
and the banker is interested not just in what the interest rate is
today on the market but in what it's going to be next year and the
following year. You get back to this confidence question in part.
The consumer rates are also sluggish. They are particularly sluggish now, but I would be hopeful, if market rates stay down, those
rates would continue to come down by very noticeable amounts.
Senator HAWKINS. How would you feel about setting a credit
card rate at 15 percent right now, to lower "real" consumer rates
to reasonable levels.
Mr. VOLCKER. I haven't any opinion about a particular rate. The
credit card rate over time has been the stickiest of all rates. Rates
are kept the same year after year, typically, unless there is a major
44
change in the interest rate picture over a long period of time.
Credit cards have a lot of operating expenses; there is a certain
amount of credit loss; and they don't like to change the rates frequently as a marketing or operational matter.
Senator HAWKINS. What has been happening to credit card rates
charged by commercial banks?
Mr. VOLCKER. Department stores probably have higher rates
than the banks, or equally high rates. That's going to be the last
area to make a change. When they make a change, it tends to be
more permanent.
I think you will find the data actually suggests that last year
credit card rates were going up during the year while other rates
were going down. I think the reason for that is probably that many
States were relaxing usury laws and banks and others were looking
to increase their rates to what they thought was the appropriate
level; you had declines in rates by some during the year, but others
getting a relief from the usury laws, were increasing rates.
Senator HAWKINS. In recent weeks both spot and long-term oil
prices have fallen rapidly placing downward pressure on inflation
and improving chances for economic recovery. How should the Fed
respond to this favorable development?
Mr. VOLCKER. I'm not sure that any particular response is required. I think to the extent that helps the inflation rate, it helps
us and it helps interest rates, and you will see some response in
the marketplace. And, of course, that affects, over time, the discount rate and other things. But I'm not sure that a decline within
a moderate range has direct implications for our actions today.
If you saw the collapse of the oil prices, then you'd have a series
of potentially good things and also a series of problems you would
have to worry about.
Senator HAWKINS. Well, there have been alarmists telling us
that banks will not be able to stand a dramatic fall in oil prices.
Mr. VOLCKER. I don't think you would say that about the banks
in general. There's certainly room there for some decline without
concerns about the financial system, but if you get an enormous decline, you've got problems in the energy industry here.
Senator HAWKINS. What did you do when they were going up so
rapidly, anything? When oil went from $2 in 1972 to $11 and then
$11 to $20 and $20 to $38?
Mr. VOLCKER. I think a lot of people say, in retrospect that the
Federal Reserve—I was not in the Federal Reserve at the time—
was too accommodative in permitting the money supply to increase
during that period of inflation. It, obviously, contributed to inflation, and it was a matter of judgment as to what extent that should
be accommodated.
Senator HAWKINS. There is talk—and I'll repeat it— that within
regulatory services; between the Federal Reserve and the Comptroller of the Currency about maintaining a 10-percent reserve
against perceived problem loans. Are you aware of that?
Mr. VOLCKER. We are working on a number of approaches in that
area. That, I suspect, will come up in the hearings tomorrow.
We've not got a plan or a position at this point, but various options
in that area are under most intense consideration so that we can
come back to you before you finally consider this IMF legislation.
45
SELECTING MEMBERS OF THE BOARD
Senator HAWKINS. That's tomorrow. The Federal Reserve Act
specifically states that the President, when selecting members of
the Board must show a due regard to a fair representation of financial, agricultural, industrial and commercial interests, and the geographical divisions of the country. Could you tell me how you give
due regard to those different interests as well as geographical divisions of the country regarding the present makeup of the Board?
Mr. VOLCKER. You ask how we give consideration to it. You're directing the question to the wrong person; I don't make those appointments. But that has been a matter of some discussion through
the years. I know Senator Garn has been very interested in getting
a variety of points of view on the Federal Reserve Board.
That is a general philosophy, which I happen to agree with. Senator Proxmire, at one point, had a somewhat different idea, maybe
not inconsistent with a variety of points of view. He has encouraged appointments of professional economists to the Federal Reserve Board. I like the idea of a certain amount of diversity on the
Board. It's hard to take account of that representation on any specific Board because you only have seven members and you've got a
lot of things to be taken into account.
Senator HAWKINS. All seven presently are monetary economists,
are they not?
Mr. VOLCKER. I don't know whether I would list myself as a professional economist; that leaves at least five Board members who
are economists. I don't know whether Governor Martin would or
not. He's had a career in the savings and loan industry and private
mortgage companies, but he started out as a professor of economics
30 years ago I suppose; he's been away from it.
Senator HAWKINS. So five economist and one practicing—you're
not a professional, but you're practicing
Mr. VOLCKER. I'll let myself be neutral at this point. All the
members of the Board have had professional economic training;
that is correct.
Senator HAWKINS. All members with the exception of Mr. Martin
have been former Federal Reserve Bank employees?
Mr. VOLCKER. Not all have been Federal Reserve Bank employees. I'm making a technical distinction. Mrs. Teeters was a Federal
Reserve Board employee at one point; that's a distinction without a
difference I suppose.
Senator HAWKINS. She was a staff economist for the Federal Reserve Board's Division of Research and Statistics, 1956 to 1966?
Mr. VOLCKER. That was Governor Partee, I think. Governor Wallich worked for the Federal Reserve Bank of New York 30 years
ago; Governor Partee worked for the Federal Reserve Bank of Chicago 20 years ago; Governor Teeters was a member of the Federal
Reserve Board staff; Governor Rice I think briefly, for a year or
two, worked for the Federal Reserve Bank of New York early in
his career; and Governor Gramley was an employee of the Federal
Reserve Bank of Kansas City in his career and he was on the
Board staff for a long while.
Senator HAWKINS. What about Governor Partee, did you mention
him?
46
Mr. VOLCKER. He was the first one I mentioned. Both Governor
Partee and Governor Gramley have been on the staff of the Federal Reserve Board.
Senator HAWKINS. Would you recommend that we rewrite the
law and say that all Federal Reserve Board members shall be
former Federal Reserve employees and economists?
Mr. VOLCKER. With great emphasis, no.
Senator HAWKINS. So would you say then that the present Federal Reserve Board that's been appointed by Presidents along the
way are not in compliance with the Federal Reserve Act?
Mr. VOLCKER. I wouldn't say that. They can have other experience as well as once having worked on the Federal Reserve. My
first permanent job was with the Federal Reserve Bank in New
York and I don't like to think that that left me scarlet-lettered or
illegal.
Senator HAWKINS. No, I didn't say it's illegal. I'm just saying
either you're all economists or former Fed employees.
Mr. VOLCKER. An ideal Board member in some sense would have
some experience of this sort, but other experience as well. If you
could combine the two, you've got an ideal situation.
Senator HAWKINS. I'm sympathetic with the view of our chairman who says the Fed should be broadly representative of diverse
industries and regions.
Mr. VOLCKER. So am I. Just to give you an example, Vice Chairman Schultz who left the Board a year or so ago had no experience
with the Board. He had some banking and other experience. He
brought a very valuable perspective to the Board of Governors, not
just from Florida but from a wider area. He was an excellent,
strong member.
Senator HAWKINS. Thank you. My time has expired.
The Chairman. Senator Sasser.
Senator SASSER. Chairman Volcker, you and I have been jousting
together now for about 3 years, first before the Budget Committee
and here before the Banking Committee. During that period of
time, we have had a lot of conversations about inflationary expectations, and the problem of inflation I think has been your principal concern and perhaps rightfully so.
I'm beginning to think now, though, that we have become fascinated or hypnotized by this serpent in the corner of the room we
call inflation while the house is burning down around us.
Now you have said time and time again that we needed to do
something to defeat this inflationary expectation, that we need to
quench this Fire. Well, what about growth expectations?
Now we've got inflation down to the lowest level in about 20
years, if I'm not mistaken.
Mr. VOLCKER. Ten years.
STIMULATE GROWTH EXPECTATIONS
Senator SASSER. And if you have to defeat inflationary expectations and that takes time, how do you stimulate growth expectations? Now this administration is predicting growth at the rate of 3
to 4 percent. If that is true, it's going to take almost 10 years just
to take up the slack in the idle industrial capacity that we have
now; and some economists tell us we have to grow at the rate of 3.5
percent a year just to take care of new individuals coming in the
work force and take care of more efficient productivity in the economy.
You were talking a moment ago in terms of what we might be on
the verge of if we stayed the course and didn't throw away the
gains that we had already made—that we might be on the verge of
a long and sustained recovery. I look here at 1982 business investment; it was down 8.4 percent. It's predicted to be down in 1983. In
the tax bill in 1981, we gave more liberal depreciation allowances
to business, all in an effort to stimulate business expansion and I
suppose recovery. But the Congressional Budget Office tells us that
real interest rates have eaten up or been twice as big as the decrease in real after-tax rates resulting from lower inflation and resulting from higher depreciation schedules that we gave for business. So that's been lost.
My question to you is, when do we get away from this focus
about feeding inflationary expectations and when do we start stimulating some growth expectations? I strongly suspect that we're
going to have to have 2 years at least of high-level sustained
growth before we are going to start getting an increase, getting
new plants built in this country, and making a significant inroad
in unemployment. How are we going to get this growth expectation
going with these continued short-term high interest rates?
Mr. VOLCKER. Basically you put your finger on it: Our economic
problem has developed as a result of 10 years of unsatisfactory performance which shook the basic confidence of the American people
in the inflationary outlook. That creates a very difficult dilemma
precisely for the reason that you suggest—it takes a long time to
deal with inflationary expectations.
The problem is—and I tried to deal with this in my statement—I
don't think we have a choice. The market will not permit us to say
let's forget about inflation now and create, as you put it, an expectation of a climate of growth. We've got to do both together, because if we don't I think we are doomed to failure precisely because
inflation expectations will feed back through the interest rates and
you will get a level of interest rates that won't be consistent with
the growth that you and I want.
People have varying views on this. I feel rather optimistic that,
given the progress we have made on inflation, given what seems to
me the clear case that can be made for this to continue and to continue consistent with the signs of recovery we now see, that we are
building a base in which, indeed, we can have both—lower interest
rates and recovery—as I think we must.
If I knew some buttons to push to hasten that process, I would
push them, but I don't think I have those buttons. To put it another way, we are doing the best we can, in my judgment, just to
create that kind of climate where we can have
Senator SASSER. Mr. Chairman, I would urge you to push the
button that would create some lower short-term interest rates.
Mr. VOLCKER. That's specifically
Senator SASSER. I think that's really what we need to get this
economy moving again.
Mr. VOLCKER. Nobody has given me the button to push to get
short-term interest rates free of any other consequences. I've got to
worry about that growth in the monetary aggregates; I've got to
worry about the expectations that sit out there. We've got to make
that judgment all the time. Maybe I've got a crippled computer or
something, but I can't just push a button and make everybody else
behave the way I would like them to behave.
CONTINUED CREDIT TO DEBTOR NATIONS
Senator SASSER. Let me shift gears here for just a moment.
You're deeply concerned about the strains on our international
system partly brought—in fact, largely brought on by the current
recession—the recession in the United States, in some areas a depression, and a recession in the economies of our trading partners
around the world—and the problems with the less developed countries. You stated in recent testimony before the House Banking
Committee that we ought to increase our support of the International Monetary Fund and provide continuing credit to those
debtor nations so they can maintain continuity of payment. Some
of them can't even pay the interest on their loans without help.
They can't pay the interest on their loans, I'm told. Quoting from
your testimony before the House, you said, "Failure to deal successfully with immediate international financial pressures that only
jeopardize prospects for our recovery"—talking about our domestic
recovery—"for our jobs, for our export markets and for our financial markets." Now I'm advised that 35 percent of our GNP lost in
the recent recession is due to a decline in exports and because the
high interest rates in this country have caused our currency to appreciate dramatically against that of a number of our trading partners. Since 1979 it's gone up 50 percent vis-a-vis the French franc,
53 percent vis-a-vis the German mark, 36 percent vis-a-vis the Japanese yen, which makes it much more difficult for our goods to
penetrate the export market abroad because they are more expensive and makes the importation of these other goods cheaper, displacing workers here at home with imported goods.
Now if it's important for us to stimulate the international
market or keep that international financial system by infusion of
funds in the International Monetary Fund so we can protect our
export markets, why isn't it just as important for us to bring interest rates down in this country so that we can also allow our business people to compete on a fair level with other businesses abroad
so we can have a significant penetration of the export markets and
have fair treatment with regard to imports coming into this country?
Mr. VOLCKER. I'd like to see interest rates in this country just as
low as we can have them, consistent with our objectives over time.
Senator SASSER. Well, I think that's the problem, Mr. Chairman.
I think there's a gathering view that maybe we ought to be going
about this in a different manner. Now I know that you want lower
interest rates consistent with what you think our monetary policy
ought to be.
Mr. VOLCKER. Right.
49
Senator SASSER. But there are some of us and I suspect some on
this committee, who respectfully disagree with that and feel that
what this economy needs now is lower interest rates, to get it
moving, and to get a solid recovery coming.
Mr. VOLCKER. I would be delighted to see that.
Senator SASSER. Without it, I don't see it coming. That's my problem.
Mr. VOLCKER. Just to repeat something that we all know, the
Congress can make an enormous contribution to that by dealing
with the budgetary problem, because that is one action that can be
taken that is entirely consistent with pur long-term and mediumterm goals as well as with what the situation requires today. It's
almost uniquely fixed in the sense that it's good in the long run
and it's good in the short run, so that's an action that 1 can recommend to you without any reservation at all.
On the monetary side, certainly, we have to have that consideration in mind, but I think we are in a little more ambiguous position
as to what to do today in terms of interest rates and our effectiveness over a period of time. Whether it's good or bad and whether it
will be productive or counterproductive is a matter of judgment,
and there's no escape from that judgment. We've got to make it,
and I'm giving you my best judgment as to how to balance this
thing out.
That doesn't say whether interest rates are going to go down or
not, because it depends upon other things, but those are the judgments we are constantly making.
Senator SASSER. Mr. Chairman, my time is up. I got a telephone
call from one of my constituents who asked me to ask Chairman
Volcker a question. He said, "Senator, will you ask the Chairman if
he is going to seek reappointment as Chairman of the Federal Reserve Board," and my constituent didn't express an opinion one
way or the other.
Mr. VOLCKER. I don't seek jobs.
Senator SASSER. Thank you.
The CHAIRMAN. Senator Sarbanes.
Senator SARBANES. Is the follow-on to that response that the job
seeks you, Mr. Chairman?
Mr. VOLCKER. In this particular instance?
Senator SAKBANES. As a general proposition, do the jobs seek
you?
Mr. VOLCKER. I think it's fair
Senator SARBANES. Is that the follow-on to that response?
Mr. VOLCKER. I suppose it's fair to say I interpret that to have
been the case in 1979.
BANKS KEEPING INTEREST RATES HIGH
Senator SARBANES. I notice in today's paper that Secretary of the
Treasury Regan, when citing reasons why interest rates have not
fallen closer to the levels that might be expected in a sluggish
economy with a low rate of inflation said—and I'm now quoting the
newspaper quote of him—"I think the third one, being very candid,
is bank earnings, Mr. Regan said. I think the banks faced with a
lot of problem loans both domestic and international are doing
50
their utmost to keep their earnings by keeping their interest rates
up."
Do you agree with that?
Mr. VOLCKER. I think banks have been cautious in reducing the
prime rate or some of the other rates partly because of those circumstances, partly because of the concern of the cost of this new
account. I think that was perhaps evidenced more on the credit
side some months ago than now, but the spreads between the
prime rate and other rates have been relatively wide and I think
that's part of the explanation.
Senator SARBANES. The American Bankers Association, in a
statement denying Mr. Regan's assertion about earnings and interest rates said:
There are no doubt data available to support a charge that banks are holding interest rates artificially high to build up earnings in anticipation of domestic and international bank loan losses.
What's your comment on that?
Mr. VOLCKER. I guess I could make the same comment I just
made. It's very hard to know how important a factor this would be.
I think it led to some caution at times. It's hard to measure what
effect that may have in the actual level for the prime rate. We do
know that the prime rate for a loan
Senator SARBANES. So you think banks are keeping interest rates
artificially high?
Mr. VOLCKER. You say artificially. For a variety
Senator SARBANES. Well, a direct conflict here between an analysis by the Secretary of the Treasury there is the factors causing
high interest rates and the response of the banking community.
You're the Chairman of the Federal Reserve Board. What's your
position?
Mr. VOLCKER. I have expressed the opinion that I think this was
a factor leading to a more cautious rate of reduction, a slower rate
of reduction in the prime rate than might have taken place in
other circumstances, given the level of market rates and all the
other things.
Senator SARBANES. So you think there was merit to Secretary
Regan's observation, is that right?
Mr. VOLCKER. To that extent; yes.
Senator SARBANES. OK.
Mr. VOLCKER. I don't think that's sustainable over a period of
time. I think you're talking about lags here. You're not talking
about
Senator SARBANES. We have been talking about lags and periods
of time for a long time.
Mr. VOLCKER. Right.
Senator SARBANES. The assurances you're giving now are the
same sorts of assurances you offered a year and 18 months ago.
You say you're optimistic about where things are going and yet
your own statement predicts an unemployment rate of over 10 percent for 1983 in this country. Now that's not optimism for the unemployed.
Mr. VOLCKER. No, that's true, and that's where we are.
51
Senator SARBANES. It certainly is true. What consultation has
there been between the Federal Reserve and administration officials recently and particularly, with respect to the monetary policy
accord?
Mr. VOLCKER. There wasn't any direct consultation on these targets that I was presenting today. I have had continual contacts
with members of the administration, as I always do.
Senator SARBANES. With the Secretary of the Treasury, for instance?
Mr. VOLCKER. Yes.
Senator SARBANES. Is that on a regular basis?
Mr. VOLCKER. It's regular and irregular. We usually try to meet
regularly but we can meet many more times than regularly scheduled.
Senator SARBANES. What's the regular schedule?
Mr. VOLCKER. We try to meet at least once a week.
Senator SARBANES. When did you last meet with the President
himself to discuss our Nation's economic situation and how we
ought to address it, and what our economic policies ought to be?
Mr. VOLCKER. A week or 10 days ago.
Senator SARBANES. With the President. When did you meet with
him prior to that?
Mr. VOLCKER. It's been
Senator SARBANES. That's about the first meeting in a year, is
that correct?
Mr. VOLCKER. Directly to discuss these problems, yes.
Senator SARBANES. But there was a meeting a week or 10 days
ago?
Mr. VOLCKER. That's correct.
Senator SARBANES. To go into these issues?
Mr. VOLCKER. Correct.
Senator SARBANES. Well, that's a step forward. The last time we
asked you that question there hadn't been a meeting in about a
year's time.
What is the relationship, if any, between monetary aggregates
and interest rates?
Mr. VOLCKER. Complex.
Senator SARBANES. Is there a relationship?
Mr. VOLCKER. Yes.
Senator SARBANES. So it does matter what you do with respect to
monetary aggregates as far as interest rates are concerned?
Mr. VOLCKER. Yes, but it matters in a complex series of ways. In
a completely static situation, expectations unchanged, you would
expect that the more money, the lower short-term interest rates.
But we obviously don't live in a static kind of world. The question
is how does any one of our actions affect expectations and other
elements in the economy over a period of time. That all influences
interest rates.
I pointed out earlier a slightly different facet of operations, but it
is tied in with the aggregates. Sometimes we can reduce the discount rate and interest rates will go down. Sometimes, like in December, we can reduce it and interest rates don't move down.
52
Senator SARBANES. Is it kind of a happenstance business? You
just do it and hold your breath to see which way you're going to
go?
Mr. VOLCKER. We make the best judgments we can.
Senator SARBANES. I know, but what are those judgments related
to?
Mr. VOLCKER. I don't consider that happenstance. We try to
assess what's going on in the business world. We try to assess the
inflationary situation. We assess all the indicators we can get and
even sometimes try to anticipate interpretations that others will
put upon our actions.
Senator SARBANES. You've got unprecedented real interest rates;
is that correct?
Mr. VOLCKER. No.
Senator SARBANES. You don't find the current real interest rates
way out of line to start with?
Mr. VOLCKER. I think they're very high. You asked me if they're
unprecedented.
Senator SARBANES. What's the problem with unprecedented?
Would you regard them as being historically as being very much
out of line?
Mr. VOLCKER. Historically, they are high; yes.
Senator SAKBANES. They are very high?
Mr. VOLCKER. When you say real interest rates, the relationship
between the current inflation rate and current interest rates is
high historically, no doubt about it.
Senator SARBANES. Do you think you can have the recovery to
speak of, a strong sustained recovery, which will reduce unemployment at the current levels of real interest rates?
Mr. VOLCKER. As I indicated earlier in discussions with Senator
Riegle, I think over time with the kind of inflation picture I see,
yes, I think interest rates
Senator SARBANES. I want to clarify when you were responding
to Senator Riegle whether you were talking about real interest
rates. That word was never in there.
Mr. VOLCKER. All right. Let me add it.
Senator SARBANES. Interest rates can drop, but if the real interest rates remain at a very high level you will continue to be confronted, in economic terms with the problem that Senator Hecht
identified.
REAL INTEREST RATES
Mr. VOLCKER. Let me respond to the question on real interest
rates. First of all, let me say you can only know what the real interest rate, in one sense, is after the fact. You can't even know
then for a fact—it presumably involves an expectation of the rate
of inflation. Let's compare it with the current rate of inflation and
take that shorthand for a so-called real interest rate.
Yes, I believe that over a period of time the real interest rates
should and probably will have to be lowered to sustain the kind of
recovery I would like to see over a period of time. Now let me say
in that connection
Senator SARBANES. In other words, we cannot have a strong, sustained recovery at the current levels of real interest rates?
Mr. VOLCKER. I think that's unlikely, for an extended period for
the kind of recovery I would like to see. If you tell me that the
Government is going to run deficits at $200 billion during this
period, you might have some kind of a lopsided recovery, because
you're going to be pouring out a lot of consumer purchasing power.
You're also going to have relatively high interest rates under those
conditions. It's not the kind of recovery I'd like to see. It's not the
kind of recovery this country needs. You asked me whether it's impossible; I don't know whether it's impossible to do that.
Senator SARBANES. The deficit is created by the soft economy. Do
you counsel the Congress to move to close that deficit by spending
cuts or tax increases?
Mr. VOLCKER. No. The problem is, if I may supplement that
answer, the deficit we're facing in coming years.
Senator SARBANES. I don't think we probably differ much over
whether there's something wrong in an economic policy that projects a 6-percent unemployment rate/assumes that in those economic circumstances that we're going to run a very large deficit because of the imbalance between spending and revenues. That could
be connected on either side but, nevertheless
Mr. VOLCKER. Nobody knows precisely what the numbers are,
but I think there's very wide agreement about that.
IMPACT OF HIGH INTEREST RATES
Senator SARBANES. What part of the deficit problem if you accept
the proposition that the high interest rates have contributed to the
economic downturn, has been created by the high interest rates,
the impact they have had on economic activity?
Mr. VOLCKER. A good part of the current deficit, I think probably
a majority of the current deficit, is related to the recession. You
can ask other questions about what created the recession.
Senator SARBANES. Do you think high interest rates have helped
to contribute to the slowdown of economic activities?
Mr. VOLCKER. In a direct sense, yes, but you have to go into
many questions about why that happened.
Senator SARBANES. My time is up.
The CHAIRMAN. At this point, I know Senator Riegle has requested time for additional questions. I'd just like to request that we adjourn at 12:30. Do other Senators wish to have additional questions? Let me turn to Senator Riegle and then Senator Hawkins.
Senator RIEGLE. Mr. Chairman, picking up where we were earlier, I want to refer to some items in the Wall Street Journal of yesterday and today. Yesterday I'm sure you probably read an article
on the front page and the headline reads as follows: "Despite Recovery Talk, People Don't Indicate Any Shift to Optimism. The
Wall Street Journal Survey Finds Joblessness Disturbing." In
today's they have a different feature story and it says "Firms Question Signs of Recovery and Worry About Another False Start."
And this is a survey of business people across the country and
there are a number of interest observations in here but one of the
paragraphs that relates to this discussion that we're having reads:
54
What would it take to convince skeptic executives that a genuine recovery is underway? Many say a further decline in interest rates is the most important signal.
Conversely, rising interest rates would convince some that the recovery will abort.
But they mention interest rates as their main thing.
We mentioned just briefly as you were coming into the room
about car sales and there's been a modest uptake in auto sales,
partly due to the fact that the companies have offered them at
below market rates, but the sales pattern is below what it was a
year ago at this time.
But perhaps more significantly, to those of us that follow the car
industry closely, is the fact that Chrysler Corp. announced yesterday that they're going to incentives and that's warmly seen as a
sign about concern in the weakness in the market and the feeling
that something more has to be done to induce sales activity.
So that is not necessarily an encouraging sign if one wonders
about the psychology and I cite those things but I could cite lots of
others to say that I think the dominant psychology at the moment
out there is one of skepticism with respect to whether or not we're
really on the road to recovery.
Earlier you said if interest rates stay where they are now that
you thought that we could in fact get a strong and sustained recovery going here and maintain it.
Mr. VOLCKER. You were talking in a narrower time frame.
Senator RIEGLE. I'm talking about the next several months. I think
this is the time period in which we kick off a recovery or we fail to
do it. I happen to think that's a very important time frame myself
and that's shared by most of the people 1 speak to in the business
community.
With that is part of the proposition that I'm putting to you. I am
concerned and I think it's a major miscalculation to think that interest rates at current levels will let strong recovery happen. In
other words, I think we have plateauecl out at an interest level
here that really is insufficient to ignite the kind of recovery we
need right now and I would describe that as a strong, sustained
recovery.
If you look at retail sales or the other things I mentioned, there's
still enough slackness there and weakness to support that notion,
and I dare say I think if the message goes out here today to the
business community and to people across the country that the Fed
in essence feels that we can get a recovery with intereest rates at
this level and not having to go lower, that that will really jolt an
awful lot of people. I don't think that will be seen as a positive
signal quite frankly. In fact, 1 think that will make people nervous
and justifiably so. I think you found that with respect to_ actions
that the Fed can take, the discount rate being a very specific one,
I think you have been able to demonstrate an ability to help move
interest rates down and I think the time may be ripe—in fact, I
think it is ripe for further reduction in the discount rate and I
think that would be helpful.
NEED FOR FISCAL TIGHTENING
But let me add one other point and then 1 welcome your comments on it. All this has to be said in the context of the fact that
we found we need fiscal tightening. There's no question about that.
The overhang of the deficits in the outyears will create impossible
problems for us. We've got to get those down. We've got two problems there. One is that we're not going to get a package of sufficient reductions in the deficit unless defense is a major part of
that. I mean, that just has to be one of the major areas in which
eventually we end up with a bottom line reduction in the deficit.
The President in the last couple days has given a strong signal that
they are going to mount a major public relations campaign in the
country against any further cuts of any consequence in their defense request. I would just say to you that I think that's kind of a
linchpin and we can watch that and if we're going to get the overall package of savings with revenue and spending, defense is going
to have to be part of it. So that's one of the concerns that I think
anybody analyzing this situation would have to raise right now.
The second thing is this. Under the best of circumstances, just
working out the fiscal decisions are going to take us period of
months just in the normal course of events. So if we're in a very
sensitive time period here where recovery needs to start and we
hope is starting and we hope will continue, it may not be until 4 or
5 months from now that you're going to get the precise fiscal
answer in the form of actions taken by the Congress.
In this interim, it seems to me I think we may need some monetary easing, some further monetary easing. And if that's not the
view of the Fed, then my feeling of apprehension goes up quite
sharply and I must say to you that I find that reflected in the
views of many people in the business community that I speak to,
including many in the New York City financial industry.
Mr. VOLCKER. Let me make a couple of comments, hopefully
short, to clarify my own position. The kind of comments you quote
from that article, I obviously hear very frequently, too. I think it's
a good characterization of many elements of opinion in the business community and elsewhere, I don't know whether you asked
me whether it was possible to have recovery at current interest
rates or whether I responded that it was possible. I didn't respond
that I was delighted by that prospect. I would like to see interest
rates lower. Obviously, the lower interest rates are, the more assurance you have for a good recovery.
What I did say is that we had to balance that kind of concern
against other concerns. That article you quoted from focuses on the
other concerns in a very precise way: It said some of the businessmen were worried not so much about the current level of interest
rates but about whether they would go up, and that that would
abort a recovery.
I tell you that we have to judge our current actions in a context
of whether we increase that risk, and I don't want to increase that
risk. I don't want to go back to the kind of interest rates we had
before. I want to take advantage of this situation, because I think
lower interest rates—real and nominal—are desirable and necessary over time and can be achieved.
Senator RIEGLE. Let me just stop you there for 1 minute because
I understand that distinction but that's why I put the question initially in a very narrow way, and that was to ask you if rates did
not go down lower which we would all like to see whether the re-
56
covery in fact would be able to take hold and continue, and I think
you clearly said that you thought it could and would.
Mr. VOLCKER. That's right, but with less assurance than if rates
were lower. When you get into balancing these factors, you say and
I understand that you can't deal with the deficit in the immediate
future, but that fact is hanging there. So long as that fact is hanging there it maximizes the possibility of getting adverse reaction—
of people thinking that the Federal Reserve is going to monetize
the Government debt or is not going to monetize the Government
debt—and either way it's an impossible situation because interest
rates will go up.
We can't deal with that directly. There's no way we can remove
that cloud from the market. It exists and narrows our flexibility by
its existence and may have an adverse effect on whatever we do
today.
Senator RIEGLE, Let me say this to you, and this will sound
strong, but it's a truthful assertion. I think I probably talk to as
many business people as any Senator. I have an enormous concentration of business activity in my home State. I have not found a
single business person in this country that would take the position
that if interest rates go no lower, stay where they are, that that
would be sufficient to set off a strong and sustained recovery. I'm
just telling you that I can't find anybody out there who would advance that proposition.
NEED FOR LOWER INTEREST RATES
What I'm hearing from them is in fact something quite different
than that and that is that through a combination of actions very
specifically including fiscal tightening that we've got to get the
rates lower in order to get the recovery. So that single point of difference of opinion I think is a very pivotal one.
Mr. VOLCKER. Again, we are not aiming at this level of interest
rates. If interest rates were lower, we would have more assurance.
Senator RIEGLE. I realize that, Mr. Chairman.
Mr. VOLCKER. But my own judgment doesn't coincide with yours
about prevailing opinion. There's no question that a lot of businessmen want lower interest rates. It's quite natural. 1 understand it,
and I'd like to see lower interest rates, too. But when you say that
it's impossible to have a recovery at this level of interest rates, I
think, on the contrary, we're probably at the beginning of a recovery now, at this level of interest rates. I see many economic forecasts, right or wrong—they were wrong last spring, let me hasten
to add—many business forecasts that show some recovery, and they
haven't necessarily pronounced a further decline in interest rates.
Many of them have interest rates pointing up a little bit.
I think the major forecasts are pretty much in that posture. That
doesn't deny what you say, that businessmen would feel a lot more
comfortable with a lower level of interest rates. Obviously, I would
feel more comfortable about the near-term prospects with lower interest rates, but that doesn't answer my question about how you
achieve that and sustain them, and that's what we're trying to do.
Senator RIEGLE. My time is up but I will have some questions for
the record and I think it's a matter of making sure that we get
through the short term and we get some strength here in the short
term and at the same time not lose sight of the long-term objectives.
Mr. VOLCKEK. I agree with that.
Senator RIEGLE. But I'd like to pull you a little more into the
near term because I think that's really critical right now in terms
of getting on the upswing and staying there.
Mr. Chairman, my time is up.
The CHAZRMAN. Senator Hawkins.
Senator HAWKINS. I'd just like to talk to you a little bit about
some of the statistics you used. Ten percent unemployment, deficits
of $200 billion, and so forth, out into the outyears. What if there
were 5 percent unemployment? What would happen to the deficit?
Mr. VOLCKER. I'm not sure just what aspect of this you're driving
at. If unemployment was 5 percent today and production was up,
with all that would imply, the deficit today would be certainly less
than $100 billion. It might be down—I haven't got the calculation
right in front of me—in the area of $50 to $75 billion.
HIGH TECHNOLOGY INDUSTRY BOOMING
Senator HAWKINS. Is it not true that the potential for growth for
new businesses, especially in the high technology industries that
are coming downline are mind boggling in terms of new jobs and
new wealth? Take the computer industry for one. It's expected to
grow from $50 billion to $100 billion in 1986, making it the biggest
business in America.
Mr. VOLCKER. I haven't got any projections of that, but it's been
an enormous growth industry and it employs a lot of people.
Senator HAWKINS. How about the long-distance communications?
It's supposed to be $50 billion today and growing at 18 percent a
year.
Mr. VOLCKER. No question that those kind of industries are the
cutting edge of growth.
Senator HAWKINS. Robots and other major new industries, the increased industrial productivity, but the construction of the robots
itself is showing phenomenal growth. I polled some figures that
showed from $200 million in 1980 and they're projecting over $2
billion by 1985. Fiberoptics companies—that is old to me but new
to a lot of people—that is going to take off again. AT&T is planning to use a telephone cable between Washington and Richmond
and the new cable would have taken 2 million pounds of copper
with the old-fashioned technology.
So it seems to me that there's little question that growth in the
high technology industries will more than make up for the slack in
the smokestack industries there.
Mr. VOLCKEH. I would agree with that, but I also think ,l;at the
slack in so-called smokestack industries can diminish or disappear
over time, too.
Senator HAWKINS. So if we had two more Hewlett-Packards and
one more Xerox
Mr. VOLCKER. It would be nice, wouldn't it?
Senator HAWKINS. We may not be seeing the projected problems
that you're foreseeing in 1985 and 1986.
58
Mr. VOLCKER. I think this country has great potential. My basic
view of the future is that we are going to have a very long and sustained expansion.
Senator HAWKINS. And in your view, they probably will come
from new companies?
Mr. VOLCKER. A lot of the growth will come from the new companies, new technology, as you're pointing out. The steel industry, the
oil industry, the metals industries are going to do a lot better too.
Senator HAWKINS. But the business firms that made the Fortune
500 like GE and IBM have created no new jobs since 1976 according to the information I have, yet digital equipment and data generally generated new jobs at the astonishing rate of 40 percent a
year in the same period.
Mr. VOLCKER. And, of course, we are getting a lot of jobs in the
service area, too. The long-term trend is very clear; the economy is
relying less on manufacturing and more on other areas.
Senator HAWKINS. And they generate wealth.
Mr. VOLCKER. And they generate wealth, too.
Senator HAWKINS. So creativity and the desire for wealth is
found in all nations. The big difference in America is venture capital.
Mr. VOLCKER. I think that's an important difference, and we
have to keep that alive.
Senator HAWKINS. So the Japanese may be our peers in technology and our superiors in education and industrial organization, but
in your opinion, do they lack venture capital?
Mr. VOLCKER. I'm not in a position to know whether they lack
venture capital. The Japanese have done pretty well.
Senator HAWKINS. What is their deficit?
Mr. VOLCKER. In the budget?
Senator HAWKINS. Yes.
Mr. VOLCKER. They have had a large deficit and they have been
trying very hard to reduce it. I can give you the figure.
Senator HAWKINS. I'd like to know. I'm asked so often. Do you
have Germany's, too?
Mr. VOLCKER. This is general government; this includes, in our
context, State and local governments, where we happen to have a
surplus. Japan's deficit is about 4 percent of GNP in 1981; in 1982
it is about 3.25 percent. It's coming down; it's on a declining trend.
Senator HAWKINS. So when we take all the figures that we get
from the CBO and from the Federal Reserve and from the OMB
and from the administration and all these other agencies that
bring so many figures to us, it seems to me a lot of those are based
on business as it is today.
Mr. VOLCKER. No, not these forward-looking budgetary estimates;
they are quite specifically based upon assumption of growth in the
economy. Another way of looking at them is to try to identify that
part of the deficit that has no relationship to the unemployment
level—structural deficit, full employment deficit, or whatever you
want to call it. Taking that into account and assuming we're not
going to have excessive unemployment, that unemployment will
return to the average levels of the 1970's, we have a very big deficit. That's the problem in the future years. The deficit right now
can be mostly traced to unemployment, not all of it but most of it.
59
That is not true in 1986 and 1987. I think the interesting thing is
that virtually everybody's analysis coincides on this point. People
have somewhat different numbers—they may differ by $25 billion
or they may differ by $50 billion—but they are all saying it's going
to be about $200 billion or $250 billion when you get out to 1986
and 1987, even if unemployment is down to the 6-percent level or
thereabouts. That is precisely the problem. If we get rid of the unemployment, we're still going to have the deficit.
Senator HAWKINS. But even if we have the new high technology
industries coming on line?
Mr. VOLCKER. They are taken account of in the economic projection. Let's assume all the high technology industries and all the
other growth elements in the economy get our unemployment rate
down to 6 or 6*/2 percent in 1986 or 1987. I hope you do something
about this, but as things now stand, you're facing a $200 billion
deficit or a $250 billion deficit in those years, and I've taken account of all the growth that you want to generate.
Senator HAWKINS. Even with the venture capital tax gains in
1978 and 1982?
Mr. VOLCKER. As the expenditure trends now stand and with
growth of 4 or 5 percent a year for the next 3 or 4 years, you will
end up with a deficit in the general magnitude of $200 billion.
Senator HAWKINS. If the growth were to exceed that
Mr. VOLCKER. If the growth were 10 percent a year, I think you
probably wouldn't have a deficit, but there's no reasonable prospect
that the economy is going to grow at 10 percent for the next 5
years. We haven't got the capacity, manpower, or anything else.
We have never grown at that rate of speed.
Senator HAWKINS. Thank you.
The CHAIRMAN, Senator Hecht, do you have any additional questions?
Senator HECHT. Mr. Chairman, my questions have been answered, not all to my satisfaction.
The CHAIRMAN. Well, that will never occur while you're in the
Senate.
Mr. Chairman, let me just make a few observations in closing.
There will be additional questions I'm sure by many of the members. I will have some additional ones, too, as I have not had the
time to ask you all I wish to.
MAJOR PROBLEMS ARE POLITICAL—NOT ECONOMIC
We can discuss the short-term interest rates and my concern
with them. But it's my feeling that having been here for 8 years
and not being a professional economist or an amateur economist
but simply looking at the economy in this country, it is my feeling
that the ups and downs of the business cycle are political, not economic.
I say that because, as I observe what is going on right now, we
have a tremendous desire on the part of Democrats to blame you
and Ronald Reagan for the condition of the economy and we have a
desire on the part of Republicans to blame past Democratic Congresses for the problem. It seems to me if we would look at the
arithmetic—whether Republicans, Democrats, liberals, or conserva-
60
tives—that there are solutions that would create a long-term sustained recovery for this country. But we are just so damned interested in assessing blame in many cases just for selfish individual
gain for the individual to look good for the next election. It seems
to me we now are starting to panic. We are going to have a large
jobs program just when we start coming out of a recession. I don't
share your optimism about the economy sustaining over a period of
time because of politics.
You look back at what Congress does in these situations and we
come up with a big stimulus and it makes you feel good for a short
period of time, certainly until the next election. Then you find you
have just lighted that slow fuse that's going to light up another explosion. That isn't an opinion by J. Garn. It's a fact. You're hearing
it from the press—you've got to do something.
I wish we could start taking longer term looks and be able to
weather out some of these storms to flatten out that cycle a little
bit. We are on the verge of that kind of panic once again just at the
beginning of the recovery. Every jobs program I have seen since
I've been here has been too late. If we're going to do jobs programs,
we ought to do them at the beginning of recessions rather than at
the end.
I think the major problem we have is politics: I also see us going
through the phase again of "Let's get the military." I would agree
completely with your statement that you shouldn't have military
spending for the purpose of creating jobs, that spending ought to be
determined on the basis of the threat. That is not being done in the
Congress by the Republicans or Democrats either.
Now it's politically popular again to say let's save all social programs and cut the military; don't determine the level of spending
on the basis of the threat. I'm one who thinks spending is below
the threat. Looking at statistics, it was all right for John Kennedy
to use 42 percent of his entire $106 billion budget to run the whole
country for the military. But now Ronald Reagan's attempt, if he
were to get every dime that he's asked for, he would spend 29 percent of the budget on the military. These numbers come from a
very reliable source, a couple weeks ago a chart from the front
page of the Washington Post. I think if people would objectively
look at military spending, most of it is butter; 57 percent of it is for
people, not for B-l's or jet airplanes or anything else. We've got a
threat. A side benefit from military spending is jobs, and when you
talk about cutting military spending $1 billion you eliminate about
35,000 jobs. Those people leave to go someplace. There may be more
efficient ways to create higher number of jobs with $1 billion—I
agree with that. But it certainly is true that a lot of those who lose
their jobs from military spending cuts are going to go on unemployment rolls. There is a cost. Would you agree with that even though
we both agree it isn't the most efficient way to create jobs, but the
net effect of reducing our ability to deter the Soviet Union is an
increase in cost in other areas, in unemployment benefits, welfare,
other sorts of subsidy programs that must take care of those
people?
Mr. VOLCKER. I think it's undeniable. If you reduce defense
spending by x billion and then have a jobs program at the same x
61
billion you may not increase jobs on a net basis because you've got
to lay off people in the jobs that are lost on the other side.
The CHAIRMAN. I don't know whether the net effect of a bill is a
half billion or a billion dollars.
Mr. VOLCKER. I don't either.
The CHAIRMAN. The point is those who so politically preach to
and leave this body—and hopefully some day we will return to a
more representative citizen legislative body—and to simply attack
the military budget and be unwilling to admit or at least portray
the position that that is an entire savings, which simply is not the
case at all, and those who will not admit that most of the military
budget is butter—it may not be the highest quality butter, but it
isn't weapons systems. You could eliminate the entire strategic
weapons program and only eliminate 13 percent of the military
budget and you can't save $15 billion in outlays in the 1984 budget,
It doesn't exist. The only place you can get those kinds of savings is
to eliminate people for operations and maintenance or fast spent
out items that spend money in the near term. So then you are
eliminating people to get those kinds of savings that people talk
about to go back on other types of Government programs in order
to take care of that cut.
I just wish there was some way to get people—if someone wants
to come to me and say, "Jake Garn, I disagree with your assessment of the threat. We can cut military spending this much,"
that's fine. That's a different opinion on the assessment of the
threat. But to indicate you get all these savings from the military
budget and it doesn't imply some increased cost in other areas of
the Government is simply not telling the truth or looking at the
arithmetic of that budget and the real growth item in the budget
over the last 20 years has dramatically been—totally apart from
political philosophy—has been in the social programs and primarily the transfer payments, but we haven't got enough guts to talk
about that. We're going to get the military and hope the Russians
turn the other cheek and hope that Mr. Andropov turns out to be a
real nice guy, protective, benevolent and doesn't continue to use
poison gas and other things in Afghanistan.
Well, I'm going far, far afield from the purpose of this hearing to
discuss monetary policy. It seems to me if we once again forget partisan politics, you simply cannot ignore the impact of the $1,303 billion national debt created under both Republican and Democratic
Presidents and with the approval of both Republic and Democratic
Members of the House and Senate for a period of three decades
and interest on the national debt of $125 billion this year. We talk
about debts of $200 billion. If we hadn't been spending excessively—to make the point about fiscal policy being the prime culprit in
this—if we hadn't all these years been spending far more than we
take in, we'd be pretty darned close to a balanced budget without
having that $125 billion interest on the national bill. That's a fact,
isn't it? May the record show that the nod was a yes.
Mr. VOLCKER. \es.
The CHAIRMAN. Again, in closing, let me express my frustration
at the inability of politicians of both political parties, liberals and
conservatives alike, to face the real problem, the fiscal policy of
this country is the primary driver of these high interest rates and
62
the high unemployment and my opinion is that has to be it. There
are other factors, but that has to be at a minimum 75 percent of
the problem, and until we in both parties quit looking for scapegoats and try to gain our own political gain—I don't share the optimism of you and some of the others. Until we can solve the political problem, I don't see how we can solve the economic problem
and my colleagues in both parties may be rather surprised that the
best politics is doing what is right. They may be amazed at the
margins they would achieve in their reelection bids if they had the
courage to look at these numbers and do something about fiscal
policy, because I would submit you wouldn't be very well known in
this country or the Federal Reserve would not be very well known
because you wouldn't have very much to do. Achieving your monetary targets would be relatively easy and you would be a quiet
agency in the background.
Mr. VOLCKER. I agree with you on that. You know, I do feel optimism, but I would simply conclude by saying the first qualification
to my optimism and the first threat and first obstacle is the deficit
problem.
The CHAIRMAN. And I suppose if I could do one thing—and I
have said this many times—one thing more to solve this problem
for future generations more than anything else is a constitutional
amendment to amend the terms of the President to 6 years so he
could really be a statesman, and Senators and Representatives to
for 3 to 4 years and send us all home. Howard Baker—and I agree
with his philosophy about a citizen legislative body. We do not
have that. We have a growing tendency of making our livings, our
entire lifetime—much as I hate to see Howard Baker go because of
his great leadership, boy, do I admire his courage to practice what
he preaches and to leave this body and hopefully some day we will
return to a more representative citizen legislative body that doesn't
desire to be professional politicians perpetuating themselves in
office until they're 90 or 95 years old.
Mr. Chairman, thank you very much for your patience and we
look forward to seeing you tomorrow before the International Finance Subcommittee.
The hearing is adjourned.
[Whereupon, at 1:05 p.m., the hearing was adjourned.]
[The report from the Federal Reserve Board follows:]
63
Letter of Transmittal
BOARD OF GOVERNORS OF THE
FEDERAL RESERVE SYSTEM
Washington, D.C., February 16, 1383
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.
64
TABLE OF
CONTENTS
Page
Section 1:
The Performance of the Economy in 19fi2
Section 2:
The Growth of Money and Credit
Section 3 r
The Federal R e s e r v e ' s O b j e c t i v e s f o r t h e Growth
of Money and C r e d i t
23
Section 4:
The Outlook for the Economy
29
APPENPIX:
Note on C r e d i t Aggregate
in
1982
!
1".
65
The recession t h a t bepar, in m t d - i 981 c o n t i n u e d t h r o u g h 1 9 8 2 ,
b r i n p i n% t h e c u m u l a t i v e 1 d e c l i n e i n real g r o s s n a t i o n a l p r o d u c t over t h a t
period t o ? - ! / 2 p e r c e n t .
Unemployment reached a postwar h i g h , w h i l e i n -
dustrial c a p a c i t y u t i l i z a t i o n f e l l to a postwar low.
A t t h e sane t i m e ,
h o w e v e r , i n f l a t i o n a r y p r e s s u r e s were g r e a t l y r e d u c e d ; a n d w h i J e some potent i a l o b s t a c l e s t o g r o w t h c l e a r l y need a t t e n t i o n , a n economic e n v i r o n m e n t
c o n d u c i v e to S u s t a i n a b l e r e c o v e r y and e x p a n s i o n seemed to be e m e r g i n g by
year-pad .
To a c o n s i d e r a b l e e x t e n t , the recession ami i t s a t t e n d a n t economic,
a n d f i n a n c i a l s t r e s s e s have r e f l e c t e d t h e d i f f i c u l t i e s
an i n f l a t i o n a r y t r e n d
inherent in reversing
t h a t had been gaining momentum for m o r e t h a n a d e c a d e .
Ry t h e late 1970s, t h e u n d e r l y i n g i n f l a t i o n r a t e h a d a c c e l e r a t e d to n e a r t h e
d o u b l e - d i g i t level , and e x p e c t a t i o n s of r i s i n g wages and p r i c e s had become
deeply embedded in t h e b e h a v i o r of c o n s u m e r s , b u s i n e s s e s , and i n v e s t o r s .
Growing f ir.anci al d i s l o c a t i o n s and economic i m b a l a n c e s made it plair. t h a t I n f l a t i o n was h a v i n g a d e b i l i t a t i n g e f f e c t on our economic p e r f o r m a n c e .
Althott.
p o l i c i e s t o curb the: i n f l a t i o n w e r e s t r e n g t h e n e d c o n s i d e r a b l y i n l a t e 1 9 7 9 ,
t h e i n f l a t i o n r a t e r e m a i n e d q u i t e h i g h t h r o u g h 1980 a n d slowed only a l i t t l e
in 1981.
In t h i s p a s t y e a r , h o w e v e r , t h e p r o g r e s s against
been more d r a m a t i c .
The r a t e of
onlv a t h i r d
the peak i n f l a t i o n r a t e s of
to h a l f
i n f l a t i o n has
i n c r e a s e in most price m e a s u r e s in
1982 was
1 9 7 9 and 1980, a m u c h f a s t e r
d e c e l e r a t i o n t h a n h a d g e n e r a l l y been t h o u g h t p o s s i b l e when t h e y e a r b e g a n .
66
Gross Business Product Prices
Change from Q4 to Qd. percent
Fixed-weigh ted Index
Real GNP
Change from O4 to Q4, percent
1982
O1 - 5 1
02
2 i
Q3 0 7
Q4 -2 S
rnrm
Interest Rales
3-month Treasury Bill
67
The slowdown was attributable to temporary influences to some extent, but
there also has been more fundamental progress.
In particular, expectations
of Inflation are being scaled down, productivity is improving, and there are
widespread indications of business and labor adapting tbeir price and wage
practices to the competitive realities of a new, less inflationary environment .
Reflecting both the sharp deceleration of price inflation and the
cutbacks in economic activity, nominal GNP grew only 3-1/4
pet cent over the
four quarters of 1982, little more than a third the race of growth in 1981.
Nevertheless, the demands for money remained quite strong, as exceptional
economic and financial uncertainties bolstered investors' desires to hold
liquid balances, and as the attractiveness of depository accounts was enhanced by the progressive liberalization of deposit race regulations.
The growth in aggregate debt outstanding also was quite strong,
with a particularly steep Increase in the credit needs of the federal government.
Federal borrowing was extraordinarily large in the second half of
1982, when the federal sector absorbed nearly half of the funds raised by
all domestic nor.financial borrowers.
State and local governments, too,
issued substantial amounts of new debt in 1982, especially late in the year.
Private credit demands, however, were curtailed sharply as economic activity
weakened.
Tnteiest rates fell appreciably in 1982, primarily in the second
half.
By the end of the year short-term rates were about half the peak
levels of 1981, and long-terra rates also had declined considerably.
In turn,
the declines in rates helped trigger ar, improvement in activity toward year-
68
end in the c r e d i t - s e n s i t i v e sectors of the economy.
In p a r t i c u l a r , automo-
bile sales have perked up in r e c e n t m o n t h s , and an u p t u r n in the housing
sector gained momentum as the year p r o g r e s s e d .
Following an e x c e p t i o n a l l y
rapid l i q u i d a t i o n of business i n v e n t o r i e s in t h e f o u r t h q u a r t e r , the p r e s s u r e s
to r e d u c e s t o c k s appeared to be easing early Lr. 1983 as both produr.ti.on and
employment i n c r e a s e d in J a n u a r y .
All t o l d , these and o t h e r recent d a t a
provide s t r o n g i n d i c a t i o n s t h a t r e c e s s i o n a r y f o r c e s are d i s s i p a t i n g a n d t h a t
the econony may be e n t e r i n g the i n i t i a l phases of a new e x p a n s i o n .
Interest^rates.
A year ago, as 1982 b e g a n , i n t e r e s t r a t e s were
moving higher ir, association with stronger demands for money and c r e d i t ,
reversing a p o r t i o n of the d e c l i n e t h a t occurred as the economy slipped
r e c e s s i o n in the second h a l f of 1 9 R 1 .
halted.
into
H o w e v e r , the rise in rates was soon
Short-term i n t e r e s t r a t e s showed l i t t l e n e t change f r o m late J a n u a r y
t h r o u g h J u n e , a n d C h e n f e l l s h a r p l y i n t h e t h i r d q u a r t e r , a s sluggish money
growth through the e a r l y p a r t of the summer reduced the demand for bank
reserves, easing pleasures in money m a r k e t s .
W i t h m a r k e t r a t e s f a l l i n g and
the economy s t i l l q u i t e s l u g g i s h , the Federal Keserve reduced its
discount
rate by 3-1/2 percentage points over t h e second h a l f of the year in s t v e n
s e p a r a t e s t e p s , t h e r e b y accommodat ing the downward m o v e m e n t in nioney m a r k e t
rates.
D u r i n g t h i s p e r i o d , t h e b r o a d e r monetary aggrcgati-s w e i e r u n n i n g at. o r
just above the annual t a r g e t ranges, but this did not seem i n a p p r o p r i a t e id
light of prevailing economic, and f ir,3i\cial conditions.
9y December snort-terra
rates had f a l l e n around 5 p e r c e n t a g e p o i n t s f r o m t h e i r average l e v e l s
June.
in
69
Lone-term interest rates also registered s u b s t a n t i a l declines in
the second half of the year, responding not o n l y to Che easing in money
m a r k e t s , hut a l s o to the s u s t a i n e d m o d e r a t i o n of i n f l a t i o n and weakness in
economic a c t i v i t y .
Or. b a l a n c e , yields on bonds and conventional mortgages
f e l l 3 to 4 percer.cape points between June and December.
The decline in
lor.jt-ter-m y i e l d s and the promise of a s u s t a i n e d pickup in economic a c t i v i t y
helped to m a i n t a i n a sharp rise in stock prices beginning in the summer,
w i t h several broad m a r k e t indexes reaching h i s t o r i c peaks late In the year
and r i s i n g to s t i l l higher levels in early 1983.
In addition
to the general cyclical f a c t o r s a f f e c t i n g interest
r a t e s , the structure of rates across d i f f e r e n t m a r k e t s t h i s past year
r e f l e c t e d , t o a n u n u s u a l d e c r e e , investor c o n c e r n s about t h e f i n a n c i a l h e a l t h
of b o r r o w e r s .
Severe stress was e v i d e n t in a high level of b a n k r u p t c i e s , as
well as in o t h e r d i f f i c u l t i e s experienced by many b u s i n e s s e s and f i n a n c i a l
i n s t i t u t i o n s in t h e l l . S . and a b r o a d .
In t h e s e circumstances, l e n d e r s began
to a s s e s s c r e d i t r i s k s more c a r e f u l l y , demanding larger rcttirns for e x t e n d i n g
c.redi t ro p o r f f r t i a l ly t r o u b l e d b o r r o w e r s .
Later in Che y e a r , h o w e v e r , these
r i s k p r e m i u m s d r o p p e d to more normal l e v e l s as an easing of o v e r a l l c r e d i t
c o n d i t i o n s and a n t i c i p a t i o n s (if a pickup in economic a c t i v i t y relieved some
o f the a n x i e t i e s ir. f i n a n c i a l m a r k e t s .
F,v'(=n w i t h t h e s h a r p d e c l i n e s of 19R2 , i n t e r e s t
f a t e s r e m a i n at
hijjh L e v e l s r e l a t i v e b o t h t o t h e i r h-isto-ric.fi levels and t o c u r r e n t i n f l a tion r f s t f s .
A m a j o r f a c t o r p r o p p i n g u p l o n g e r - t e r m r a t e s e s p e c i a l l y is t h e
p r o s p e c t i v e s i z e o f f e d e r a l g o v e r n m e n t d e f i c i t s , which t h r e a t e n t o r e m a i n
nassi'.'f even as the e r t m o m v r e c o v e r s , thereby c o m p e t i n g with the r i s i n g
70
demands of private borrowers for available savings.
Moreover, although
I n f l a t i o n moderated substantially In 1982, many potential investors, scarred
by the experience of the 1970s, remained cautious about the longer-range
look—and about the government's commitment to m a i n t a i n f o r c e f u l
out-
anti-infla-
tionary policies.
Residential construction.
So f a r , the housing sector has heen. the
main b e n e f i c i a r y of falling interest rates.
A gradual upturn in housing
activity that: began in late 1981 gained momentum in che second half of 1982
as mortgage rates moved sharply lower.
By last mouth the interest cate on
commitments for conventional f i x e d - r a t e mortgages had dropped to 13 percent
from a high of 18-1/2 percent in the f a l l of L981, and rates on many types
of variable r a t e loans had declined even more.
Homebuyers responded favorably to the rate reductions, and in the
f o u r t h q u a r t e r , sales of b o t h new and existing homes rose to their highest
levels since the recession began in mid-1981.
Because the inventory of
unsold new homes had been drawn down to a low l e v e l , the improvement in sales
in the second half provided a direct impetus for new construction a c t i v i t y .
S t a r t s of new single-family dwellings in Che f o u r t h q u a r t e r ware up almost
50 percent fron depressed y e a r - e a r l i e r levels, with most of that Rain coming
in the second half of the y e a r .
S t a r t s of new m u l t i - f a r a i l y u n i t s rose
through most of the year, s u p p o r t e d in p a r t by federally-subsidized uftits.
Consumer spending.
Consumers c o n t i n u e d to e x h i b i t cautious spend-
ing patterns through most of 1982.
Despite sharp r e d u c t i o n s in personal tax
l i a b i l i t i e s at m i d - y e a r , real a f t e r - t a x income rose or.ly .6 p e r c e n t d u r i n g
the y e a r , as r e d u c t i o n s in e m p l o y m e n t cut d e e p l y i n t o wage and s a l a r y
71
Real Income and Consumption
Change from Q4 to Q4. percent
[Real Disposable Personal Income
| Real Personal Consumption Expenditures
6
1978
1980
Real Business Fixed Investment
Change from O4 to Q4, percent
OH Producers' Durable Equipment
Structures
D.
1982
Total Private Housing Starts
Millions of units
72
payments.
At the same t i m e , c o n s u m e r s were r e l u c t a n t
hy taking on new d e b t .
to f i n a n c e purchases
Domestic auto sales remained depressed through most
of the y e a r , w i t h the pace for 1982 as a whole tlie worst in more than two
decades.
Foreign car sales also f e l l , but much less t h a n sales of domestic
makes.
N e v e r t h e l e s s , the economic s i t u a t i o n in the consumer sector appeared
to be i m p r o v i n g as the year ended.
W i t h l i q u i d i t y up and debt b u r d e n s down,
consumers' f i n a n c i a l positions, in the a g g r e g a t e , have improved considerably
f r o m the over-extended p o s i t i o n s of the late 1970s.
Consumer c o n f i d e n c e
began to perk up in the second h a l f of 1982 as i n f l a t i o n remained moderate
and as i n t e r e s t r a t e s on consumer loans began g r a d u a l l y to d e c l i n e .
Spend-
i n g , most n o t a b l y on d u r a b l e goods, s t a r t e d to grow more r a p i d l y toward
year-end.
Sales of d o m e s t i c a u t o s rose s i g n i f i c a n t l y in November and have
been maintaii-.ed at a higher level i n t o e a r l y 1583, a p p a r e n t l y r e f l e c t i n g
f i n a n c i n g concessions as well as changes in m a n u f a c t u r e r s '
policies.
design and p r i c i n g
Retail s a l e s e x c l u d i n g autos a l s o rose a l i t t l e in late 1982, and
i n t h e f o u r t h q u a r t e r , t o t a l cor.suraar s p e n d i n g r e g i s t e r e d i t s
strongest gain,
in real t e r m s , since l a t e 1980.
Business sector.
The p e r s i s t e n t weakness of economic a c t i v i t y in
19R2 led to considerable s t r e s s in the p r i v a c y b u s i n e s s s e c t o r .
Among non-
f a r m b u s i n e s s e s , low o p e r a t i n g r a t e s d e p r e s s e d corporate p r o f i t s , arid the
financial
c o n d i t i o n o f nanv f i r m s weakened under t h e b u r d e n o f reduced
a v a i l a b i l i t y o f i n t e r n a l f u n d s , heavy s h o r t - t e r m i n d e b t e d n e s s , a n d high
interest charges.
Credit r a t i n g s d e t e r i o r a t e d for many businesses, the
incidence nf dividend r e d u c t i o n s or suspensions increased, and business
b a n k r u p t c i e s rose to a fiosstwar h i g h .
73
Signs of growing f i n a n c i a l d i s t r e s s a l s o were evident in the f a r m
s e c t o r of the economy.
Because of weak demand and exceptionally large crop
h a r v e s t s ir. 1982, f a r m prices slumped and income was low for cJie t h i r d year
in a r o w .
T,ar,d prices in the farm sector have f a l l e n s u b s t a n t i a l l y in some
areas since mid-1981 , f a r m p r o p r i e t o r s '
e q u i t y has d e c l i n e d , and debt-Co-
asset ratios have risen noticeably in the past two years.
Tlifficulties
in s e r v i c i n g d e b t have increased, especially among Chose f a r m e r s who came
Co rely more heavily on credit financing in earlier years, and farm bankruptcies and foreclosures have become more numerous.
Confronted with weak demand ami f i n a n c i a l s t r a i n s , many business
f i r m s moved aggressively in 1982 to trim i n v e n t o r i e s and curtail capital
spending.
In real terms, total f i x e d investment e x p e n d i t u r e s in the! husi-
ness sector f e l l more t h a n 8 percent over the four q u a r t e r s of 1982.
backs in s p e n d i n g for equipment accounted for n e a r l y all
Cut-
of the decline;
purchases f e l l e s p e c i a l l y r a p i d l y for heavy i n d u s t r i a l machinery such as
engines, construction e q u i p m e n t , f a r m m a c h i n e r y , and t r a n s p o r t a t i o n
e(]ui p m e n t .
Business investment spending on n o n r e s i d e n t i a l s t r u c t u r e s slowed
in the f i r s t h a l f of
of
1982 and t h e n turned down in the second h a l f .
Much
the d e c l i n e was c o n c e n t r a t e d in o u t l a y s for o i l and };as d r i l l i n g , which
f e l l sharply over the year an d r i l l i n g ir.c.ent i ves w f a k p n p d in response to
worldwide reductions in energy demand ancf declir.es ir, p t t r o l e u R p r i c f s .
I;;
c o n t r a s t , h u a i n e s s spending f o r n e w b u i l d i n g s w a s w e l l m a i n t a i n e d t h r o u g h
1982, a l t h o u g h p a i t of t h i s s t r e n g t h p r o b a b l y r e f l e c t e d the r o n l i n u a t i o r . of
p r o j e c t s s t a r t e d some t i n e ago.
Forward-looking i n d i c a t o r s , such as the
74
c o n s t a n t - d o l l a r value of new c o n s t r u c t i o n c o n t r a c t s , f e l l s u b s t a n t i a l l y
during the year w h i l e vacancy rates for o f f i c e buildings climbed sharply.
These and o t h e r indicators suggest that capital spending by businesses,
especially for c o n s t r u c t i o n , could c o n t i n u e to weaken for some m o n t h s .
Depressed aggregate demand also caused businesses to liquidate inventories at a rapid pace in 1982.
h n l f of
The weakening of f i n a l sales in the second
]981 had led to an unintended buildup of i n v e n t o r i e s , and in early
1982 b u s i n e s s e s began l i q u i d a t i n g those excess s t o c k s at a rapid pace.
the r u n o f f
of
However,
i n v e n t o r i e s halted around mid-year, possibly because businesses
g e n e r a l l y a n t i c i p a t e d a m i d y e a r u p t u r n in sales.
When no such u p t u r n occurred,
.1 second round of i n v e n t o r y l i q u i d a t i o n began, and stocks were reduced at a
p a r t i c u l a r l y rapid pace in the f o u r t h q u a r t e r .
had reduced i n v e n t o r i e s to below pre-recession
By year-end many i n d u s t r i e s
levels, but stocks i f i
some
s e c t o r s s t i l l appeared l a r g e r e l a t i v e to the p r e v a i l i n g sales pace.
R e f l e c t i n g t h e r e d u c t i o n s i n i n v e n t o r i e s a n d capital s p e n d i n g ,
businesses reduced t h e i r credit
usage a p p r e c i a b l y In 1982.
The s t r o n g rally
ir. the stock m a r k e t t h a t began d u r i n g the summer also helped reduce b o r r o w i n g ,
as flirts started relying more h e a v i l y on e q u i t y f i n a n c i n g and r e l a t i v e l y less
on new d e b t i s s u a n c e .
F a l l i n g long-term i n t e r e s t races enabled businesses to
a c c o m p l i s h some l e n g t h e n i n g of t h e i r debt m a t u r i t i e s toward the end of 1982, but
even so, business balance sheets at year-end were h e a v i l y laden with short-term
debt.
Government sector.
Total government purchases of goods and services
cose 2-1/2 percent in Teal teims during 1982, about the same increase as in
the previous y e a r .
At the f e d e r a l level, real o u t l a y s for national
defense
75
expanded r a p i d l y for the second year in a row.
Spending also rose c o n s i d e r a b l y
f o r a g r i c u l t u r a l p r o g r a m s , a s t h e f e d e r a l government a c c u m u l a t e d f a r m i n v e n t o r i e s
under programs designed t o keep f a r m p r i c e s a n d f a r m incomes f r o m f a l l i n g f u r ther.
Federal purchases of o t h e r goods and s e r v i c e s , on b a l a n c e , were cut
back s h a r p l y .
The c r e d i t demands of the f e d e r a l government rose s t e e p l y in 1982,
and accounted for a l m o s t 40 p e r c e n t of total credit f l o w s to the d o m e s t i c
nonfiriancial
sectors of
from $87 b i l l i o n in
the economy.
Federal horrowing f r o m t h e public rose
J9S1 to Slfil b i l l i o n in 1982, as the f e d e r a l d e f i c i t
widened in response to weak g r o w t h in taxable i n c o m e s , r e d u c t i o n s in tax
r a t e s , the f u r t h e r r i s e in government purchases, and a recession-induced
increase in unemployment compensation and other t r a n s f e r payments.
R e a l p u r c h a s e s of goods and s e r v i c e s by s t a t e and local g o v e r n ments were l i t t l e changed over the f o u r q u a r t e r s of 1932.
faced w i t h a
recession-induced shrinkage in tax r e v e n u e s and c u t b a c k s i n f e d e r a l s u p p o r t ,
many state legislatures enacted increases ir, sales, income , or c o r p o r a t e
taxes t o h e l p m a i n t a i n service levels.
increased
I n a d d i t i o n , s t a t e a n d local b o r r o w i n g
s u b s t a n t i a l l y , not only to f i n a n c e t r a d i t i o n a l functions but a i a o ,
in a number of c a s e s , to s u p p o r t mortgage l e n d i n g in
local communities.
A
surge in new bond issues in tlie f o u r t h q u a r t e r was in p a r t an a t t e m p t by
s t a t e and local governments to r a i s e f u r . d s b e f o r e a r e q u i r e m e n t to r e s i s t o r
all
new i s s u e s of tax-exempt s e c u r i t i e s a f t e r year-end ( l a t e r postponed to
mid-1983} was scheduled to take e f f e c t .
I n t e r n a t i o n a l p a y m e n t s and t r a d e .
Following a s t e e p advar.ee in 1981,
the w e i g h t e d - a v e r a p e value of the d o l l a r a p p r e c i a t e d
a n o t h e r 20 percent
from
76
Foreign Exchange Value of the U.S. Dollar
Ttade-weighted index. March 1973=100
1978
1980
Current Account Balance
Annual 'ate. billions ol dollars
77
Che beginning of 1982 through early November.
The strengthening apparently
was in large pare a response to the progress made in reducing i n f l a t i o n and
the sense of a continuing commitment of U . S . authorities to ensure greater
economic s t a b i l i t y .
Moreover, during a period of m a j o r strains in the inter-
national f i n a n c i a l system and considerable economic uncertainty t h e r e e v i d e n t l y
was a view that dollar a s s e t s , especially U . S . assets, would provide a
" s a f e haven".
Since early November the f o r e i g n exchange value of the dollar
has f a l l e n a l i t t l e , on n e t , as market p a r t i c i p a n t s have reacted to the
prospect of very large deficits in 1983 in the U . S . merchandise trade and
current a c c o u n t s .
A movement towards d e f i c i t
in the U . S . current account was already
evident in 1982. R e f l e c t i n g the e f f e c t s of the strong d o l l a r , as well as
sluggish economic growth abroad, real exports of goods and services decreased
!3 percent over the f o u r quarters of 1982. The volume of imports of goods
and services also declined during 1982, but the decline was smaller than for
e x p o r t s ; the increasing price competitiveness of foreign goods, which resulted
in part from the strong d o l l a r , helped support import demand.
As a result
of these trade p a t t e r n s , net e x p o r t s , in real terms, f e l l S15 b i l l i o n over
the four q u a r t e r s of 1982; the trade sector thus made an a t y p i c a l l y large
contribution to the recession.
The U . S . current account, which was in small
s u r p l u s for 1981 as a w h o l e , recorded surpluses in the f i r s t h a l f of the
year but then swung into d e f i c i t in the second half as exports weakened.
The external financial position of several large borrowing countries
—notably A r g e n t i n a , B r a z i l , and Mexico—worsened in 1982. These f i n a n c i n g
problems have placed severe strains on the banking system and on international
78
markecs g e n e r a l l y , as the need arose Co r e f i n a n c e or reschedule existing
debt.
During the year t h e r e were repeated c o o p e r a t i v e e f f o r t s among
borrowers and p r i v a t e and o f f i c i a l leading i n s t i t u t i o n s to address these
p r o b l e m s , and the d e b t o r c o u n t r i e s , to gain c o n t r o l of rising debt b u r d e n s ,
are a d o p t i n g s t r o n g policies of I n t e r n a l and external a d j u s t m e n t .
As a
r e s u l t , t h e r e has been a reduction in t h e i r demand for e x p o r t s f r o m major
industrial
c o u n t r i e s , p a r t i c u l a r l y the United States because of i t s close
t i e s to L a t i n America.
Labor m a r k e t s .
Employment in t h e U n i t e d S t a t e s f e l l s t e a d i l y
throughout 1 9 8 2 , and by year-end total n o n f a r m p a y r o l l employment was more
than 2-3/4 million below its
J u l y 1981 p e a k .
As is
t y p i c a l in r e c e s s i o n s ,
the largest i o b losses were in the c y c l i c a l l y s e n s i t i v e m a n u f a c t u r i n g and
construction i n d u s t r i e s .
In a d d i t i o n , employment f e l l in the oil
and gas
d r i l l i n g i n d u s t r i e s , and t r a d e employment s u f f e r e d an u n u s u a l l y sizable
decline.
Employment in the service sector continued to grow in
1 9 8 2 , but
at a slower pace than in recent years.
The back-to-back recessions of the e a r l y 1980s were accompanied
by a rise in t o t a l unemployment of a b o u t 5 - 1 / 2 m i l l i o n , and by the end of
1982, the unemployment r a t e , at 10.8 p e r c e n t , was n e a r l y two percentage
points above its
previous postwar peak.
Increases in unemployment were
especially large among adult m e n , who hold a d i s p r o p o r t i o n a t e n u m b e r of j o b s
In the c y c l i c a l l y sensitive i n d u s t r i e s .
As the recession p e r s i s t e d t h r o u g h
1 9 R 2 , the number of workers unemployed for
to more than 2-1/2 million.
longer than a h a l f - y e a r i n c r e a s e d
To s u p p o r t the incomes of these long-term
79
Nonfarm Payroll Employment
1980
Unemployment Rate
80
unemployed, the period of eligibility for unemployment benefits was lengthened
twice, to as much as 55 weeks for some workers.
Nevertheless, a l i t t l e improvement in labor demand began to be evident
around the t u r n of the year.
The incidence of l a y o f f s appeared to be moderating
toward the end of 1982; unemployed workers have been recalled in some i n d u s t r i e s .
And in January of t h i s year, Che c i v i l i a n unemployment rate declined to 10.4
percent.
Wages and labor costs.
The falloff
in labor demand in 1982, along
with the general unwinding of i n f l a t i o n , led to a s h a r p slowing in the rise
of wages and labor c o s t s .
The wage r a t e s of p r o d u c t i o n workers increased
a b o u t 6 percent d u r i n g 1382, the smallest
advance in 15 years.
The m o d e r a t i o n
in wage i n c r e a s e s was e s p e c i a l l y s t r i k i n g among new c o n t r a c t s negotiated
under m a j o r c o l l e c t i v e b a r g a i n i n g agreements; in 1982, f i r s t - y e a r wage increases
under these agreements averaged "3-3/4 p e r c e n t , less than half the average
increases reached when these workers last n e g o t i a t e d .
In some p a r t i c u l a r l y
h a r d - p r e s s e d i n d u s t r i e s , workers agreed to new c o n t r a c t s t h a t e l i m i n a t e d
a l t o g e t h e r the f i x e d wage i n c r e a s e s t h a t had been c u s t o m a r y in p a s t wage agreem e n t s , ar.d in some cases t h e r e were o u t r i g h t wage r e d u c t i o n s .
Nevertheless,
w i t h p r i c e i n f l a t i o n s l o w i n g even more rapidly than nominal wages, teal wage
r a t e s i n t h e n o n f a r m b u s i n e s s s e c t o r a c t u a l l y rose f a s t e r t h a n In most r e c e n t
veats.
Labor costs per u n i t of o u t p u t were up o n l y 4 - 1 / 2 p e r c e n t over
the f o u r q u a r t e r s of 1982, as an i m p r o v e d p r o d u c t i v i t y p e r f o r m a n c e r e i n f o r c e d
t h e inpact o f s l o w e r n o m i n a l increases i n wages a n d b e n e f i t s .
Qualitative
l e p o r t s t h r o u g h o u t t h e year s u g g e s t e d t h r t business f i r m s , many o f them
81
Consumer Prices
|CPI
I—j CP! Excluding Food, Energy.
1—' and
i
Producer Prices
1978
Hourly Earnings Index
82
hard-pressed f i i i a n c i a l l y , were engaged in aggressive e f f o r t s to cut costs
and bolster e f f i c i e n c y .
Productivity gair.s ir; the second half of the year
were p a r t i c u l a r l y n o t e w o r t h y , given t h a t business o u t p u t w a s s t i l l declining
c y c l i c a l l y ; n o r m a l l y , p r o d u c t i v i t y tends t o s l u m p i n t h e c o n t r a c t i o n phase
of
the business cycle as f i r m s reduce o u t p u t by more t h a n h o u r s worked.
Prices.
In 1 9 R 2 , all
major p r i c e indexes advanced at
consider-
ably slower r a t e s than in 1981, and for some price m e a s u r e s , the increases
in 1982 were the smallest in more t h a n a d e c a d e .
The c o n s u m e r price index
rose 3.9 percent over the year, compared to a 12-1/2 percent a d v a n c e j u s t
two years e a r l i e r .
C a p i t a l goods prices were up less C h a n h a l f as much as
in 1981, and prices were l i t t l e changed f o r a broad range of mato.trials used
in m a n u f a c t u r i n g and c o n s t r u c t i o n .
In many ways the slowing of i n f l a t i o n this past year has r e f l e c t e d
the pervasive I n f l u e n c e of the recession on product and labor m a r k e t s .
In
a d d i t i o n , the s t r e n g t h of the dollar has helped to hold down the prices of
U . S . i m p o r t s ; b o u n t i f u l harvests have c o n t r i b u t e d to declines in agricultural p r i c e s ; and the worldwide recession has depressed the prices of oil
and other commodities.
Although thtse influences
themselves may prove to
be t e m p o r a r y , the f o u n d a t i o n is now in place for more l a s t i n g g a i n s a g a i n s t
inflation.
In p a r t i c u l a r , t h e wage-price i n t e r a c t i o n s t h a t served t o per-
p e t u a t e i n f l a t i o n through the
momentum.
1970s appear to have l o s t much of t h e i r
Workers g e n e r a l l y are agreeing to s m a l l e r pay i n c r e a s e t h a n in
e a r l i e r years, and in some s e c t o r s i n which l o n g - t e r m wage agreements are
p r e v a l e n t , t h e s e t t l e m e n t s concluded i n 1982 will h e l p ensure d i m i n i s h e d
labor cost pressures in c.oninp, years.
Lower labor costs are relieving
pressures on prices, a n d , in t u r n , an improved price performance is reducing
expectations of inflation and thus leading to a f u r t h e r slowing of labor
costs.
This cumulative process of disinflation still appeared to have
momentum at year-end, thereby providing solid grounds for continuing better
price performance in
1983,
84
.Section 2:
The Growth of Honey and Credit in 1982
The Federal Reserve has beer, seeking to provide enough liquidity
to facilitate an early upturn in economic activity, while maintaining the
monetary discipline needed to sustain Che progress toward lower rates of
inflation—a crucial element in satisfactory economic performance over
the longer run.
The specific monetary target: ranges chosen by the Federal
Open Market Committee last February and reaffirmed in July were as follows,
with growth measured from the fourth quarter of 1981 to the fourth quarter
of 1982:
for Ml, 2-1/2 to 5-1/2 percent; for M2, 6 to 9 percent; and for M3,
6-1/2 to 9-1/2 percent.
The associated range for bank credit was 6 to 9 per-
cent at an annual rate, measured from the average level of December 1981 and
January 1982 to the fourth quarter of 1982; the base period for bank credit
was selected to minimize distortions from the shifting of assets to newly
established
International Banking Facilities, first authorized in late 1981.
It was recognized when selecting these ranges that several factors
could affecC the relationship of monetary and credit growth to income and
expenditure In the economy.
In particular, the Committee contemplated that
Ml might deviate for periods of time from expected patterns of growth in the
event that economic and financial uncertainties fostered unusual desires for
liquidity.
Such desires had already been indicated by a surge in growth around
year-end 1981 , at which time it was believed that vigorous efforts to bring
money back within target ranges rapidly would not be appropriate when the economy was still quite weak.
In addition, the demand for Ml was seen as likely
to demonstrate a continuing sensitivity to changing financial technology and
the proliferation of new money and near-money type instruments.
The Committee
85
also a n t i c i p a t e d t h a t the b r o a d e r a g g r e g a t e s , M2 and M3, might be. a f f e c t e d
by l e g i s l a t i v e and regulatory
c h a n g e s , such as broadened e l i g i b i l i t y for
I n d i v i d u a l R e t i r e m e n t A c c o u n t s ( I R A ) and Keogh a c c o u n t s and the ongoing der e g u l a t i o n of d e p o s i t r a t e s , as well as u n u s u a l d e s i r e s for l i q u i d i t y .
Tn
J u l y , w h i l e t h e C o m m i t t e e d e c i d e d t o r e t a i n t h e ranges adopted e a r l i e r f o r
m o n e t a r y g r o w t h . It u n d e r s c o r e d i n i t s
report t o t h e Congress i t s willingness
to accommodate any u n u s u a l p r e c a u t i o n a r y demands for l i q u i d i t y t h a t might be
associated with unsettled economic and financial conditions.
The b e h a v i o r of the a g g r e g a t e s over the year indeed diverged subst a n t iall y f r o m n n r m a l h i s t o r i c a l p a t t e r n s .
Precautionary m o t i v e s e v i d e n t l y
boos
•osted demands for m o n e y and other h i g h l y l i q u i d assets r e l a t i v e to the exp a n s i o n of n o m i n a l GNP , w h i c h remained q u i t e s l u g g i s h .
Ml expanded 8 - 1 / 2 p e r -
cent on a f o u r t h - q u a r t e r to f o u r t h - q u a r t e r basis , 3 percentage p o i n t s above the
FnMf! ' s t a r g e t r a n ^ t , l a r g e l y r e f l e c t i n g r e l a t i v e l y r a p i d g r o w t h over the
course of the y e a r in i n t e r e s t - b e a r i n g checking accounts t h a t also serve a
s a v i n g s function.
Ir, a d d i t i o n , Ml growth was boosted by special developments
l a t e in the vt-ar In c o n n e c t i o n w i t h the l a r g e amounts of m a t u r i n g all
savers
c c r t i I" i c a t e s .
The b r o a d e r a g g r e g a t e s , M2 and M3, expanded at rates of 9.2 and
i n .. i1 ,p e r c e n t , r e s p e c t i v e l y , m u c h c l o s e r t o — though s t i l l somewhat above — t h e
u p p e r l i m i t s ot t h e i r r a n g e s .
be n o t e d , are
These growth r a t e s f o r M2 and M3 , it
should
lower t h a n those- o b s e r v e d p r i o r to some r e c e n t changes in money
s t o c k d e f i n i t i o n s , t h e p r e v i o u s f i g u r e s being 9 . 8 a n d 1 0 . 3 , r e s p e c t i v e l y .
To
m a i n t a i n consistency in the t r e a t m e n t of various kinds of f i n a n c i a l assets,
M2 and M3 now i n c l u d e b a l a n c e s in tax exempt money m a r k e t m u t u a l f u n d s , which
86
FOMC Ranges and Actual Growth
M1
Billions of dollars
Rate of Growth
flange adopted by FOMC for
1981 Q4 to 1982 Q4
1981 Q4 to 1982 O4
8 5 Percent
M2
Billions of dollars
Rate of Growth
Range adopted by FOMC fo
1981 Q4 to 1982 Q4
1981 O4 to 1982 Qd
1950
9 2 Percent
87
FOMC Ranges and Actual Growth
M3
Billions of dollars
Rale of Growth
1981 04 to 1982 04
10 1 Percent
2400
(P'i°r to redefmilion 10 3 DS'Li
1981
BANK CREDIT
Billions of dollars
Rate ol Growth
Range adopted by FOMC lor
Dec. 1981-Jan 1982 to
Dec. 1981—Jan. 1982 lo 1982 Q4
1982 Q4
7 1 Percent
_O
[
N I _D
I J
| F
|
M
|
f
l
|
M
|
J
)
J
)
A
|
S
|
O
|
N
|
D
have attributes very similar to those of the highly liquid taxable money
funds, and exclude balances in IRA and Keogh accounts, which closely resemble
pension funds and consequently are much less like money balances.
The table
on page 18 shows figures for M2 and M3 growth in recent years under both old
and new definitions.
The income velocity of various measures of money—defined as the ratio
of gross national product to measures of money—fell sharply in 1982.
The veloc-
ity of Ml dropped 4-3/4 percent and that of M2 5-1/2 percent, from the fourth
quarter of 1981 to the fourth quarter of 1982.
For M l , this was the largest
four-quarter decline in the postwar period, and in fact there have been very
few four-quarter spans in which Ml velocity declined at all.
In the case of M2,
no parallels for the steep velocity decline of last year are to be found since
the 1950s.
Although declines in velocity of M2 have not been uncommon during
periods of recession, in past periods they were explainable largely in terms of
reflows of funds from securities into M2-type balances when market rates of
interest fell below deposit rate ceilings---a factor of much reduced importance
in the present regulatory environment and with the emergence of money market
mutual funds as an important investment outlet.
The recent weakness in
velocity more probably reflects strong demands for relatively safe, liquid
assets on the part of the public because of uncertainties in the business
and financial outlook.
Further evidence of strong precautionary demands is to be found in the
particular types of monetary assets that the public chose to acquire last year.
Interest-bearing NOW accounts—which are included in Ml—continued to expand
rapidly, though growth was, of course, less rapid than in 1981 when they first
89
GROWTH OF MONEY AND CREDIT
(Percentage changes)
Outstanding Debt
of DomeHtlc
Ml
New
M2
8.2
7.4
7.2
5.1 ( 2 . 5 ) 1
R.5
8.0
8.1
9.0
9.4
9.2
Old
M2
Old
M3
Bank
Credit 2
Nonflnancial
Sectors
11.1
9.6
11.3
9.7
11.7
10.1
10.0
11.4
10.3
13.3
12.6
8.0
8.1
7.1
12.9
12.1
9.9
9.9
9.5
New
M3
Fourth quarter
to f o u r t h q u a r t e r
197R
1979
1980
1981
1982E/
8.2
8.4
9.2
9.5
9.8
9.8
Annual average
to annual average
p - Preliminary
1. HI figures in -parentheses are adjusted for shifts to NOW accounts in 1981.
2. Bank credit d a t a are not a d j u s t e d for shifts to International Banking Facilities
in 1981 and 1982. The 1982 growth ratu, however, is calculated from a December 1981
and Jar.uarv 1982 base to minimize distortions owing to such shifts.
.ew M2 and M3 figures incorporate minor effects of benchmark and
iPvisions. New M2 and M3 incorporate definitional changes as
90
Growth in Velocity'
Velocity of M1
Velocity of M2
Change from Qd (o O4 percent
91
became available nationwide.
Such deposits, while serving the transactions
needs of holders, have many of the characteristics of savings accounts, which
in the past have tended to grow during periods of economic adversity.
Indeed,
during the first half of last year, when interest rates on other investments were
still relatively high, individuals began once again to add to their savings balances following a long downtrend in such deposits; growth in savings deposits
surged once more in the final months of 1982, apparently buoyed in part by
deposits of proceeds from maturing all savers certificates.
The attractiveness
of NOW and savings accounts no doubt was enhanced after midyear as lower interest
rates reduced the earnings disadvantage of keeping funds in such highly liquid
form.
Other types of liquid assets included in the aggregates also grew rapidly
in 1982.
There was a sizable buildup of balances in the 7- to 31-day accounts
and ^l-day accounts at depository institutions, soon after these accounts were
authorized in May and September, respectively.
Shares of money market mutual
funds also increased substantially, albeit much less rapidly than in 1981 when
many people were first attracted to these savings vehicles.
Ry contrast, inflows
to longer-maturity tine deposits were moderate.
The apparent strong desire for liquidity, <ind the associated shifting
in asset demands, had an important bearing on the FOMC's assessment of the
behavior of the aggregates as the year progressed.
The Committee felt that
some growth in the aggregates above the lor;£er-rur. target ranges could bt
tolerated in the prevailing economic conditions which appeared to be giving
rise to greater precautionary demands for money than might be anticipated in
normal circumstances.
The lengthening recession and associated economic dislo-
cations prompted more cautious financial management on the parts of households
92
and businesses, arid this attitude of caution in financial markets was intensified fron time to time by concerns about strains on some financial institutions
and about the ability of private and governmental borrowers in a number of
foreign countries to meet their debt-service obligations.
The latter part
of the year, moreover, brought a number of institutional developments that
further complicated the interpretation of the movements in the money supply,
necessitating a more than ordinary degree of flexibility in responding to
incoming data on monetary growth.
It was recognized in the early fall that the behavior of Ml during
the final three months of the year would very likely be distorted by special
factors.
In particular, an extremely large volume of all savers certificates
matured beginning in early October, and this was expected to have sizable
temporary effects on HI.
Also of potential importance was the introduction
(mandated by the Garn-St Germain Depository Institutions Act of 1982) of new
deposit instruments for banks and thrift institutions that were to be competitive
with money market mutual funds.
In the event, the Depository Institutions
Deregulation Committee authorized, beginning December 14, depository institutions
to offer a "money market deposit account" (MMDA) that could be used to a
limited extent for transactions purposes and that would be free from interest
rate ceilings, and authorized Super NOW accounts free of interest rate ceilings
beginning January 5,
MMDAs, because of their more limited transactions feature, are
included only in the broader aggregates, while Super NOWs, which, have unlimited
transactions features but also include a savings element, are included in
Ml.
Clearly, these distinctions are not clear-cut, and they illustrate the
93
i n c r e a s i n g f u z z i n e s s of the d i v i d i n g line, between M l and non-Mi t y p e b a l a n c e s .
In f a c t , ir, making this ( i e f i n i t i o r . a l d e c i s i o n , t h e Federal R e s e r v e Board
noted that it
would he m o n i t o r i n g c a r e f u l l y
the b e h a v i o r of the new accounts
to d e t e r m i n e w h e t h e r some a l t e r a t i o n in their treatment m i g h t he a d v i s a b l e .
The s i z a b l e fur.d s h i f t s t h a t might result f r o m these d e v e l o p m e n t s in
the f o u r t h q u a r t e r — a n d , in the case of the new a c c o u n t s , p o s s i b l y even s h i f t s
in a n t i c i p a t i o n of t h e i r a v a i l a b i l i t y — s e e m e d l i k e l y to have d i r e c t and i n d i r e c t
e f f e c t s on Ml that would be large in magnitude and would, p a r t i c u l a r l y
case of the new a c c o u n t s , a f f e c t
the
the u n d e r l y i n g b e h a v i o r of n a r r o w money as
the puMi c r e a l l o c a t e d t r a n s a c t i o n s and savings f u n d s .
at its
in
October m e e t i n g decided t h a t it
As a r e s u l t , t h e FOMC
would give car.sideisbl y less weighr
to Ml in the conduct n t p o l i c y and r e l y more on the broader a g g r e g a t e s , M2
and M3.
I t u;is a n t i c i p a t e d i n t h i s d e c i s i o n t h a t t h e s p e c i a l f a c t o r s
Ml growth i n the
f o u r t h q u a r t e r would have a m u c h s m a l l e r
M3 since a m a j o r p o r t i o n of the s h i f t s
affecting
impact or. M2 ar.d
of f u n d s w o u l d o c c u r anonf* assets
c o n t a i n e d i n thsse broader aggregates; f o r e x a m p l e , p r o c e e d s f r o m m a t u r i n g
a l l s a v e r s c e r t i f i e y r . e s (a component o f M Z ) t h a t were d e p o s i t e d i n t r a n s a c t ions
balances w o u l d r e m a i n part of M 2 .
H o w e v p r , it
was r e c o g n i z e d thai, the a d v e n t
of the MMDA. m i g h t boost M2 e x p a n s i o n l a t e if. the
year.
In l a t e D e c e m b e r , M 2 g i n u t h i n f a c t w a s r a i s e d b y s i z a b l e i n f l o w s ,
to MMHAs from sources o u t s i d e M?—such as m a r k e t i n s t r u m e n t s and l a r g e CDs-and g r o w t h c o n t i n u e d a t ai. e x t r a o r d i n a r i l y r a p i d p a c e i n t o t h e e a r l y weeks o f
1983.
The new a c c o u n t s were h e a v i l v a d v e r t i s e d by the d e p o s i t o r y i n s t i t u t i o n s ,
and o f t e n were o f f e r e d
i n i t i a l l y tit i n t e r e s t r a t e s
t h a t were exceptionally
94
tiigh relative to prevailing rates on comparable Investments.
By year-end, MMDAs
outstanding had risen to a level of about S87 billion, and by the end of January
1983 were about S23D billion.
Super NOW account growth was much slower, reaching
about $18 billion by the end of January.
Commercial bank credit grew 7.1 percent in 1982, near the midpoint
of the FOHC's range.
The pace of bank loan growth during the year was consid-
erably a f f e c t e d by changes in the pattern of business financing.
During the
first h a l f , when the persistence of high long-term interest rates encouraged
firms to concentrate their borrowing in short-term markets, business Loans
at banks expanded rapidly.
But as interest rates moved lower over the second
h a l f , corporations increasingly s h i f t e d their financing to long-terra debt and
e q u i t y m a r k e t s ; in the third q u a r t e r business loan growth slowed s h a r p l y and
in the f o u r t h q u a r t e r showed no net increase, as corporations used the proceeds
f r o m bond sales Co avoid i n c r e a s i n g hank indebtedness.
Real estate loans at
banks also slowed as the year progressed a n d , for the year as a whole, increased
only 5-1/2 percent—a rate below that of rererit years.
weak, expanding only 3-1/2 p e r c e n t .
Consumer loans continued
While loan growth slowed, banks g r e a t l y
expanded the!r holdings of U . S . Treasury obligations during the y e a r , acquiring
close to S13 hillion in the f i n a l q u a r t e r alone.
95
S e c t i o n 3:
The F e d e r a l R e s e r v e ' s ^ O b j e c t i v e s for
the Growth of Money and C r e d i t
The economy over the past y e a r and a half has passed t h r o u g h a most
difficult
p e r i o d , one of hip.h u n e m p l o y m e n t , depressed incomes, and severe
d i s t o r t i o n s ir, financial
r e c e s s i o n is e n d i n g .
markets.
Forces seem to be in place that are consistent with
recovery in economic a c t i v i t y .
fiiimici.-il
There is s u b s t a n t i a l evidence t h a t the
One positive f a c t o r is the improvement in
market c o n d i t i o n s in the past six m o n t h s , which is s t i m u l a t i n g
a c t i v i t y ir, m a j o r c r o d i t - s e n s i t i v e sectors of the economy.
A b e t t e r balance
is heir.j* e s t a b l i s h e d between i n v e n t o r i e s and f i n a l d e m a n d s .
expect f i t ior.s , w h i l e s t i l l s e n s i t i v e , have a b a t e d .
Inflationary
There has been s u b s t a n t i a l
n r o g t e & s t o w a r d s r e s t o r i n g price s t a b i l i t y , and there is good reason to
h c > l i e v e t h a t t f u i t h e r p r o g r e s s can be achieved ever, as b u s i n e s s a c t i v i t y
u i c k p <K>.
,\,~ i m p r o v e m e n t ir. p r o d u c t i v i t y should b o l s t e r growth in real income
;ir,(l p r o f i t a b i l i t y d i n i n g r e c o v e r y , and can be a f a c t o r in s u s t a i n i n g b e t t e r p r i c e
IX-1 f o i m a n c i ' .
Siini ni shi r.g i n f l a t i o n and a l o w e r i n g of i n f l a t i o n e x p e c t a t i o n s ,
in t w r r , s h o u l d promote f u r t h e r
declines in interest rates.
Against t l i j s b a c k d r o p j monetary policy has been, and will continue
t o h e , eor.cet ;;ed w i t h f o s t e r i n g a l a s t i n g e x p a n s i o n i n b u s i n e s s e c o n o m i c a c t i v i t y
ir. a fraint'wrjrk of c o n t i n u i n g p r o g r e s s against i n f l a t i o n .
ar.d
M o n e t a r y expansion
1 i q i i u l i ty s h o u l d ht- a d u q i i a t e to s u p p o r t the m o d e r a t e r e c o v e r y t h a t a p p e a r s
to he ^ t n i L i r . ) ; .
At the same t i m e , a l t h o u g h the recer.t gains t h a t have h u e n
n r ide ,iy,;iir;St i n t ' l . i t i o n are l i i g h l y e n c o u r a g i n j ' , i t is clear that thu t e s t ot
the s u c c e s s of
our rint i-i r.f l a t i o n a r y ef f o r t is st ill
ahead .
Thus , t h e F e d e r a l
R e s e r v e r e m a i n s c o m m i t t e d t o a course ol K u n t t a r y d i s c i p l i n e that is t & s e n t i a i
to avoid a L e s u t g e n c - i ; ot ir.f l a t i u i . a r y p t e s s u v t s as economic e x p a n s i o n piocc<;cls.
96
In s e t t i n g g u i d e l i n e s for m o n e t a r y growth c o n s i s t e n t w i t h these
goals, the Federal Open M a r k e t C o m m i t t e e r e c o g n i z e d t h a t t h e r e l a t i o n s h i p
between growth r a n g e s and ult imate e c o n o m i c o b j e c t ives had d e v i a t e d substant i a l l y f r o m past p a t t e r n s during 19B2.
As noted e a r l i e r , m o n e t a r y g r o w t h was
q u i t e rapid r e l a t i v e to Income, and hy year-end exceeded the targets set
b y t h e C o n m i t t e e f o r 1 9 R 2 . This g r o w t h , h o w e v e r , a p p e a r e d f u l l y c o n s i s t e n t
with the needs of the e c o n o m y and progress against i n f l a t i o n , R i v e n the indications o f u n u s u a l demands f o r m o n e t a r y a s s e t s t h a t p e r s i s t e d d u r i n g t h e p a s t
year.
W i t h v e l o c i t y d e c l i n i n g s h a r p l y , rigid a d h e r e n c e t o t h e 1982 t a r g e t s
would have produced a much more r e s t r i c t i v e economic e f f e c t
than was a p p r o p r i a t e ,
The a t y p i c a l behavior of v e l o c i t y Last year w i l l likely prove at least
in p a r t t e m p o r a r y , to be f o l l o w e d by an u n w i n d i n g of the e x c e p t i o n a l
demands t h i s v e a r ; a p p r e c i a b l e
increases i n M l v e l o c i t y ,
common d u r i n g the early s t a g e s of e c o n o m i c r e c o v e r y .
t h a t the experience of 1982 r e f l e c t e d
in p a r t i c u l a r ,
However, it
in p a r t a more basic s h i f t
demands for m o n e y , at least as c u r r e n t l y d e f i n e d .
liquidity
are
may well be
in u n d e r l y i n g
I n s t i t u t i o n a l c h a n g e s have
led to the increased a v a i l a b i l i t y of transactions accounts that pay interest
tied t o m a r k e t r a t e s , a n d t h i s i s l i k e l y t o a f f e c t
the t i e n d g r o w t h of money.
The d e c e l e r a t i o n of p r i c e s may i n c r e a s e the i n c e n t i v e s to hold m o n e y over
tirae, e s p e c i a l l y a s t h e reduced i n f l a t i o n i s r e f l e c t e d
rates.
f u l l y in market interest
These c o n s i d e r a t i o n s suggest t h a t v e l o c i t y in 1983 may well f o l l o w a
pattern d i f f e r e n t
f r o m that of past recoveries.
In s e t t i n g t a r g e t s for 1983,
a c c o u n t had to be taken of the e x p e r i e n c e of 1982, past c y c l i c a l
behavior,
and the p o s s i b l e a l t e r a t i o n of u n d e r l y i n g r e l a t i o n s h i p s between moiiey arid
u l t i m a t e economic o b j e c t i v e s .
97
The members of the
FOMC also recognized t h a t thfe i n t r o d u c t i o n of
new d e p o s i t i n s t r u m e n t s very r e c e n t l y has a f f e c t e d , and would c o n t i n u e to
affect
for a t i m e , the g r o w t h r a t e s and behavioral c h a r a c t e r i s t i c s of the
various aggregates.
The extremely r a p i d b u i l d - u p of money market d e p o s i t
a c c o u n t s ( M M D A s ) , in p a r t i c u l a r , already has r e s u l t e d in a s u b s t a n t i a l f l o w
of f u n d s i n t o M 2 f r o m market i n s t r u m e n t s , g r e a t l y i n f l a t i n g t h e growth o f
this a g g r e g a t e in t h e c u r r e n t q u a r t e r .
Tt is a n t i c i p a t e d that t h e r e d i s t r i b u -
t i o n of f u n d s associated w i t h the MMDAs and, to a lesser e x t e n t . Super NOW
a c c o u n t s w i l l c o n t i n u e t o i n f l u e n c e t h e behavior o f t h e a g g r e g a t e s , t h o u g h
the p f f o c t
o f such s h i f t s o n growth r a t e s o f t h e d i f f e r e n t m o n e t a r y m e a s u r e s
c l e a r l y cannot bo d e t e r m i n e d w i t h a high d e g r e e of c o n f i d e n c e .
While e f f e c t s o f t h e s e n e w d e p o s i t
i n s t r u m e n t s o n M l seemed s m a l l e r
than m i g h t have been expected to d a t e , the r a p i d l y changing c o m p o s i t i o n of H I
s i n c e t h e i n t r o d u c t i o n of n a t i o n w i d e NOW accounts at
the beginning of
1981
s e f m s to h a v e a l t e r e d , and made less p r e d i c t a b l e , Cite behavior of Chat aggregate.
The MOW a c c o u n t s a p p e a r to behave p a r t l y l i k e savings a c c o u n t s and p a r t l y
like t r a n s a c t i o n s accounts.
Thus, the p a t t e r n of M l movements h a s come t o be
i n f l u e n c e d hy i n d i v i d u a l s ' a t t i t u d e s t o w a r d s a v i n g a s w e l l a s b y t r a n s a c t i o n s
needs and i n t e r e s t r a t e s .
As a r e s u l t , t h e r e l a t i o n s h i p of t h i s aggregate
to income may w e l l he in the process of char.ge t h a t , by the n a t u r e of t h i n g s ,
car. o n l y be a c c u r a t e l y d e t e r m i n e d as new behavior
the d a t a over t i m e .
p a t t e r n s are r e f l e c t e d
Though they have not grown r a p i d l y
in
in the e a t i y weeks
of the y e a r w h e n d e p o s i t o r y i n s t i t u t i o n s were p r o m o t i n g MMDAs so a g g r e s s i v e l y .
Super NOW a c c o u n t s , which can be o f f e r e d
f r e e of i n t e r e s t r a t e c e i l i n g s , have
t h e p o t e n t i a l f o r f u r t h e r d i s t u r b ! n g M l behavior r e l a t i v e t o h i s t o r i c a l t e n d e n c i e s .
98
All of these f a c t o r s contributed to th« compLexicy ot setting t a r g e t
ranges for
1983, and the Committee recognized t h a t an u n u s u a l decree of j u d g m e n t
w i l l be necessary In Interpreting the prowtli ot" money arid credit ir, coming mor.ths.
Some f l e x i b i l i t y In r e a s s e s s i n g the ranges could be i m p o r t a n t .
The Committee
decided to continue s e t t i n g target ranges f o r all three measures of money, but.
with some d e p a r t u r e s from past practice to deal w i t h the s p e c i a l u n c e r t a i n t i e s
it faces currently.
In the case of M 2 , It f e l t that performance of
t h i s aggregate
would be most appropriately measured fcatn a base period that would be less,
a f f e c t e d by the i n i t i a l , highly aggressive m a r k e t i n g of MMDAs.
expected growth of M2 ts
Thus, the
7 to 10 percent, measured from the average level
of February and March 1983 to the average level of the f o u r t h q u a r t e r of t h i s
year.
This range is one percentage point higher than that set for M2 last, y e a r ,
but it makes allowance for some f u r t h e r s h i f t i n g of f u n d s I n t o MMDAs f r o m non-H2
sources over the remainder of the year, although at a greatly reduced pace from
what evidently has occurred to d a t e .
The tanRe for M3 was set at 6-1/2 to 9-1/2 percent, measured in accordance with past convention on a f o u r t h - q u a r t e r to f o u r t h - q u a r t e r basis.
This
range is identical to t h a t set for L982, but contemplates growth below the actual
outcome last year.
In adopting the range, the C o m m i t t e e assumed that any net
shifts of funds over the year i n t o the new types of deposit accounts Eton market
instruments would be moderate.
It was thought t h a t M3 would be less a f f e c t e d by
the new accounts because many d e p o s i t o r i e s have the o p t i o n of reducing their
is-
suance of large CDs if
sizable i n f l o w s of MMDAs and other core d e p o s i t s s a t i s f y
their needs for f u n d s .
W h e t h e r t h i s in f a c t turns out to be the case w i l l de-
pend In part on the p u b l i c ' s perceptions of the r i s k s e n t a i l e d in uninsured
99
i n v e s t m e n t s and or. the a b i l i t y and d e s i r e of d e p o s i t o r y i n s t i t u t i o n s to use
t h e i r new l i a b i l i t y
powers to expand t h e i i market shares in f i n a n c i a l
inter-
ned! r-jf j on.
For Ml, a g r o w t h rnngi 1 of 4 to R p e r c e n t was s p e c i f i e d for
f r o n the f o u r t h q u a r t e r of
1982 to the f o u r t h q u a r t e r of
1983.
the p e r i o d
This rar.ge, while
p o i n t i n g to slower a c t u a l g r o w t h t h a n in 1982, is both w i d e r and higher than
the rafifie t e n t a t i v e l y set
last July.
p o s s i h le change ir. c y c l i c a l
The new range r e f l e c t s allowance for a
b e h a v i o r as well as for the e v o l v i n g c h a r a c t e r
of HJ as a ncire i m p o r t a n t repository for s a v i n g s , e s p e c i a l l y in a lower
f l a t i o n , lower i n t e r e s t rate environment.
in-
T h e c o m p a r a t i v e l y wide range set
f o i MJ a l s o r e f l e c t s the C o m m i t t e e ' s j u d g m e n t t h a t some allowance should be
made i n t h i s f a s h i o n f o r t h e u n c e r t a i n t i e s i n t r o d u c e d b y t h e existence o f
r h f i;ew d e p o s i t accounts.
Ar, a s s o c i a t e d range for
at 8-1/2
t o c a l d o m e s t i c n o n f i n a n c i a l debt was e s t i m a t e d
to 11-1/2 percent over the four q u a r t e r s of 1983.
This r a n g e encompasses
g r o w t h about in line w i t h e x p e c t e d growth of n o m i n a l G N P , in accordance w i t h
lonft-tcrm
t r e n d s ; however, Committee a n a l y s i s of the outlook suggested t h a t ,
in t h e p a r t i c u l a r
c i r c u m s t a n c e s of 1983, somewhat more rapid growth of c r e d i t
also might be consistent with its
overall o b j e c t i v e s .
O w i n g to the e x t r a o r d i n a r y
s i z e of the f e d e r a l budget: d e f i c i t , the share of c r e d i t f l o w i n g to the
sector is expected to be lower than experienced generally in the past.
private
It
is e x p e c t e d t h a t the commercial bank share of t o t a l debt expansion w i l l put
bank c r e d i t growth at between 6 and 9 percent
this y e a r .
The Committee members agreed c h a t the m o n e t a r y ranges should be reviewed in the spring in light of the a c c u m u l a t e d evidence available at t h a t
100
t i m e r e g a r d i n g the behavior of the aggregates and t h e i r r e l a t i o n s h i p to other
economic v a r i a b l e s .
For the time b e i n g , tr, i m p l e m e n t i n g m o n e t a r y p o l i c y , the
C o m m i t t e e agreed t h a t s u b s t a n t i a l we i g h t would be placed or, b e h a v i o r of
the
broader a g g r e g a t e s — M 2 and M3—in a n t i c i p a t i o n t h a t c u r r e n t d i s t o r t i o n s
from the initial adjustment
to the new deposit accounts w i l l abate.
The
b e h a v i o r of Ml w i l l be m o n i t o r e d , w i t h the decree of e m p h a s i s g i v e n to t h a t
aggregate over t i m e d e p e n d e n t o n e v i d e n c e t h a t v e l o c i t y b e h a v i o r i s r e s u m i n g
a more predictable p a t t e r n ,
Debt expansion, w h i l e not t a r g e t e d d i r e c t l y ,
w i l l be e v a l u a t e d in assessing behavior of the m o n e y aggregates and the
i m p a c t of m o n e t a r y p o l i c y .
The Committee e m p h a s i z e d t h a t p o l i c y i m p l e m e n t a t i o n in
1183 neces-
sarily w i l l involve a c o n t i n u i n g a p p r a i s a l of the r e l a t i o n s h i p s between each of
the measures of money and c r e d i t and economic a c t i v i t y and p r i c e s , p a r t i c u l a r l y
in the a f t e r m a t h of unusual b e h a v i o r of v e l o c i t i e s of b o t h moi.ey and c r e d i t
aggregates last y e a r .
TYiis will i n v o l v e t a k i n g account of p a t t e r n s of s a v i n g
b e h a v i o r and cash management among b u s i n e s s e s
and h o u s e h o l d s , and i n d i c a t i o n s
o f c h a n g i n g c o n d i t i o n s i n domestic and i n t e r n a t i o n a l c r e d i t m a r k e t s a n d i n
foreign exchange m a r k e t s .
101
Section 4.
The Outlook for the Economy
There are encouraging signs that the economy will soon he in
the early stages of an economic u p t u r n , If
already begun.
In its
Indeed the expansion has not
i n i t i a l phases, the economic recovery may be less
robust than the average postwar expansion, but, at the same t i m e , the
chances that the recovery can be sustained over the long run have been
c o n s i d e r a b l y enhanced by the s i g n i f i c a n t progress a g a i n s t i n f l a t i o n
in
the past ye.ir or so.
I n d i c a t i o n s that the economy is
in rrr.pnt weeks.
t u r n i n g up have been a p p a r e n t
The h o u s i n g s e c t o r appears to be w e l l along in the
r e c o v e r y p r o c e s s , as b o t h house sales and new c o n s t r u c t i o n have r e g i s t e r e d
s i g n i f icni.t a d v a n c e s .
R e t a i l sal es also picked up toward the end of 1982
and held s t e a d y in J a n u a r y ; a u t o sales in p a r t i c u l a r have been at improved
levels i r, r e c e n t m o r . t h s .
In t h e b u s i n e s s s e c t o r , i n v e n t o r y l i q u i d a t i o n
a p p a r e n t l y has become less of a depressant
of real a c t i v i t y , as b o t h
i n d u s t r i a l p r o d u c t i o n a n d e n p l o y m e n t showed a p p r e c i a b l e gains if: . J a n u a r y .
To he o i i r r : , because of the l e n g t h of the r e c e s s i o n and
the
s t r e s s e s a n d u n c e r t a i n t i e s i t h a s g e n e r a t e d , c o n s u m e r s a n d businesses m a y
f o l l o w c . - i i i t i o t i s e c o n o m i c s t r a t e g i e s i n coning q u a r t e r s .
Ln t h e business
sector a h i f l h decree of u n u s e d i n d u s t r i a l c a p a c i t y probably w i l l Jiscoiu.ijjp i n v e s t m e n t
sper.dir.j' f o r some t i m e , as
f i ms b o o s t t i l e o p e r a t i n g
r a t e s f u r e x i s t i n g p l a n t a n d e q u i p m e n t , r a t h e r than i n v e s t i n g i n n e w
p h y s i c a l c a p i t a l ; commercial c o n s t r u c t i o n i r . t h e o f f i c e b u i l d i n g area
may he p a r t i c u l a r l y weak for
a wftile.
The export sector may uel)
t i n u e to be a d r a g on U . S . economic a c t i v i t y w e l l i n t o 1983,
con-
Exports
102
f e l l sharply in the second h a l f of last y e a r , and given the widespread weakness in f o r e i g n economies and the s t i l l high value of the d o l l a r , there is
not l i k e l y to be a quick t u r n a r o u n d in export d e m a n d .
Although the January employment report p r o v i d e d e n c o u r a g i n g signs
of improved l a b o r d e m a n d , the gains in coming m o n t h s , on b a l a n c e , may be
r e l a t i v e l y m o d e r a t e given the u n c e r t a i n t i e s s t i l l p r e s e n t in the b u s i n e s s
environment.
As demands pick up i n i t i a l l y , b u s i n e s s e s a p p e a r l i k e l y to
boost o u t p u t in p a r t by l e n g t h e n i n g work schedules 01 i m p r o v i n g e f f i c i e n c y ,
rather t h a n by c o m m i t t i n g t h e m s e l v e s f u l l y to higher levels of e m p l o y m e n t ,
T h e r e f o r e , d u r i n g the e a r l y stages of the recovery, the unemployment r a t e
probably w i l l be slow to r e t r a c e the i n c r e a s e s s u s t a i n e d d u r i n g the past
recession.
The d i f f i c u l t i e . s of. b r i n g i n g u n e m p l o y m e n t down q u i c k l y may be
compounded by s t r u c t u r a l
changes now apparent in the U . S . e c o n o m y ;
al-
though the service s e c t o r and industries in the f o r e f r o n t of t e c h n o l o g y
will be adding employees, job opportunities in some t r a d i t i o n a l i n r i n s t r i e s
may be t r e n d i n g lower over a long period, and t h e r e is l e g i t i m a t e c o n c e r n
about the a b i l i t y of d i s p l a c e d workers r e a d i l y to f i n d new e m p l o y m e n t in the
expanding s e c t o r s .
N e v e r t h e l e s s , once the recovery is under w a y , t h e r e a p p e a r s a good
chance that it
car, be s u s t a i n e d .
Fiscal policy is p r o v i d i n g s i g n i f i c a n t near-
term support for the economy t h r o u g h a c o n t i n u e d rise in d e f e n s e s p e n d i n g ,
counteT-r.yclical transfer payments and further tax cuts.
p o l i c y , t o o , is c o n s i s t e n t w i t h an expansion:
gence of serious i n f l a t i o n a r y
The c u r r e n t monetary
barring some unexpected reemer-
pressures in 1983, the monetary growth targets
established by the FOMC should provide the l i q u i d i t y needed to s u p p o r t a
recovery in real a c t i v i t y .
103
A resurgence of i n f l a t i o n seems ur.likely in the near t e r m , over,
though some commodity p r i c e s may rebound f r o m c y c l i c a l l y depressed levels
as the recovery takes h o l d .
to have, moved down.
The u n d e r l y i n g trend in l a b o r costs appears,
In a d d i t i o n , the c u r r e n t s u p p l y s i t u a t i o n s in
sgr 1 cal tural and e n e r g y m a r k e t s a p p e a r conducive Co c o n t i n u i n g p r o g r e s s
against i v i f l a t i o n ; indeed,
recent developments in the international o i l
market seem L o p o r t e n d q u i t e f a v o r a b l e price movements l o r this key
commodi t v .
There s t i l l are,
o u t ] o o k for t h e e c o n o m y .
(.list federal
however, reasons [ o r concern a b o u t t h e lor.ger-rui,
One m a j o r source of c o n c e r n is t h e p r o s p e r t
d e f i c i t s w i l l c o n t i n u e to be m a s s i v e in the y e a r s a h e a d , eve?-,
as the economy Ls w e l l along in Che e x p a n s i o n .
T h i s suggests a serious
r i s k that p r e s s u r e s on c i e d i t m a r k e t s w i l l mount as the c r e d i t d e m a n d s
o f p r i v a t e b o r r o w e r s grow w i t h t h e r e c o v e r y .
I n a d d i t i o n , the p r o s p e c t i v e
d f f ici ts tt'.-xi to r a s r d o u b t on the c o m m i t m e n t of economi c p o l i c y t o
X a i n c o n t r o l of
i n f l a t i o n over t h e long r u n .
F o r these r e a s o n s , i h o
huclpf tary j u V t u r e r o n t i n u e a to have an ur.set t l inij i n f l u e n c e on f i r . a i . c i al
market:; , and l e n d e r s r e n a i n h e s i t a n t to commit f u n d s
r ^ c v ' p t fii.
for a Ion;; p e r i o d ,
Ii^trri'sL r a t e s L h a t a t e h i ^ h r e l a t i v e to the Ciirrer.r pace of
i.-f 1 a t i o n .
OvPM-.omir.;; f l i t - si: ill
effort
is
crucial
ecnr.oraic. g r o w t h .
inflation
(lt:tp s k e p t i c i s m a h o u t t h e ar.t I - L r . f l -itior;
i n o t h e r ways t o t h e a c h i e v e m e n t o f stror.ij a n r ] s u s t a i n e d
It is pet:eral ly r e c o g n i z e d t h a t p e r i o d s of s l o w i : ; ^
in t h e n a s t two decades have p r o v e d to be t e m p o r a r y , .'ind
unless t h e c o m m i t m e n t t o sye t h e p r e s e n t e f f o r t t h r o u g h i s made
fully
104
credible by the actions of the fiscal and monetary authorities, there
will be a danger that as markets Improve with recovery we will see a
reversion to aggressive patterns of wage and price behavior.
If this
came to pass, the viability of economic expansion would be severely
jeopardized.
We need, too, to deal with the strains existing in the international financial arena.
Timely action to enhance the resources of the
International Monetary Fund is essential.
But more generally, we must
maintain the spirit of cooperation among borrowers, lenders, and governmental authorities chat has been the hallmark to date of the effort
to resolve the difficult problems confronting us.
FOHC economic forecasts.
The members of the Federal Open Market
Committee, together with other Federal Reserve Bank Presidents who alternate as Committee members, believe that the economic expansion that now
appears to he starting will result in a solid gain in real Gt-P over the four
quarters of 1983.
The increases expected are moderate in comparison with
the first year of most past recoveries, and the consensus is that these
gains can be achieved without a resurgence ir. inflationary pressures,
especially in light of the favorable underlying trend of ur.it labor costs.
In formulating these projections for 1983, members of Che FOMC
and the Presidents took account of the target ranges established for the
various monetary and credit aggregates, and assumed that Congress and the
administration will make progress in the months ahead in reducing federal
deficits for corning years, thereby diminishing the threat those deficits
would otherwise pose to long-run price stability ar.d sustainable economic
105
growth.
No s p e c i f i c allowance was made for a lari;e d e c L l n p in oil
al RO , t h e s p e e i a l
prices;
r e s t r a i n i n g i n f l u e n c e on p r i c e s e x e r t e d b y t h e a p p r e c i a t i o n
of tlic d o l l a r in 1982 is not e x p e c t e d to be r e p e a t e d in 1983.
The rar.jies of J l i o w t h in money and c r e d i t s p e c i f i e d by the C o m m i t t e e
f o r 1 9 R 3 w o u l d a p p e a r c o m p a t i b l e w i t h some f u r t h e r d e c l i n e i n m a r k e t r a t e s
o f i n t e r e s t , as i n f l a t i o n a b a t e s .
d e c i s i o n s wi J 1 p i ay a ma jor
H o w e v e r , the- d i r e c t i o n o f f i s c a l
role.
policy
D e c i s i v e action to reduce the T r e a s u r y ' s
dona.-.ds o n t h e c r e d i t m a r k e t s i n Ltie y e a r s ahead w o u l d b e w e l l r e c e i v e d bv
i n v e s t o r s and would c o n t r i b u t e
p r e s s u r e s or. i n t e r e s t
rates.
g r e a t l y t o a r e l a x a t i o n ot t h e c o n t i n u i n g
O f c r i t i c a l i m p o r t a n c e t o t h e i n t e r e s t rate-
o u t l o o k — a n d one c e r t a i n l y r o t
h e h a v i o r of
d i v o r c e d from t h e budget p i e r u r e - - i s the
i n f 1 a t i o n and e x p e c t a t i o n s o f i n f 1 at i o n .
tion c o n t r i b u t e directly
Lower r a t e s of
i n i La-
t o t h e r e d u c t i o n o f demands f o r money a n d c r e d i t ,
nnd = ns f r i i i . i > d p r o j ; i e ^ f . i n s l o w i n g t h e
iTiucli i o r e 1 i eve t h e c o n c e r n s of
a d v a n c e o f waj>es a n d p r i c e s w o u l d d o
i n v e c t o r s as
to
the
f n t lire c o u r s e of
ir:t c r e s t
r a t e:;.
1't o j e o t i oi.s ol L he m a j o r i t y of t h e C o m m i t t e e m e m b e r s (and o t h e r
P r e s i d e n t s ) for sTrowfh in the r e a l GNP from the f o u r t h q u a r t e r of 1982 to
the f o u r t h q u a r t e r of
1983 were i n a r a n g e of
a l i t t l e h i g h e r than the recent
to
f l u ; p r o ] c c r i or. of
forecast
t h e Coi.fir !•-,'- i o o a l
s i g n i f i c a n t l y more piowth.
Nearly all
3-1/? i"o j u s t over 4 p e r c e . i t ,
o f t h e a r l m i i. ist r a t ior., a n d s i m i l a r
liucif-et ( } f f i c e .
believed
rtevpr.il
prospects
were
ox pi.-(-red
excellent
T o r less i n f l a t i o n t h a i ; t h e 3 . 6 p e r c e n t i n c r e a s e i n t h e C N t ' d e f l a t o r
projected
by t h e a d m i n i s t r a t i o n , w i t h t h e m a j o r i t y e x p e c t i n g a n i n c r e a s e o f 4 . 5 p e r c e n t
106
or less.
central
The combination, of real growth and i n f l a t i o n resulted in a
t e n d e n c y of
R to 9 p e r r e n t in n o m i n a l CXP « r o w t h .
Unemployment
was e x p e c t erf to r e m a i n h i g h d u r i n g Lhs> [ i r s t year of r c c o v e r v .
107
The s p e c i f i c m e a s u r e ot aggregate c r e d i t used by tiie KOMC i n
e s t a b l i s h i n g a range- of growth is t h e t o t a l d e b t of d o m e s t i c , nor.f i n a n c i a l
s e c t o r s , a s d e r i v e d f r o m t h e B o a r d ' s f l o w of
fui.ds accounts.
This measure
i n c l u d e s b o r r o w i n g b y p r i v a t e d o m e s t i c r.onf i n a n c i al s e c t o r s a n d b y the f e d e r a l
a,id s t a t e a n d l o c a l a o v e r n m e n t s , i n U . S . narks.'ts a n d f r o m a b r o a d ;
it
excludes
t j o r t s>wi E.L; b y f o r e i g n e i . t i t l e s i n t h e U n l t i ' d S t a t e s .
Various sratistii-.il
f c - s t s were used t o c o m p a r e t h i s m e a s u r e w i t h
citlii^r poter.t i<i 1 c r e d i t aRi',ref!ates--sucli a s t o t a l s t h a t
f o r e i g n e n t i t i e s o r bv f i r v a T i c i a l
etisiil ies.
i n s t i t u t i o n ! ; , ot
i n c l u d e d borrowir.>r by
Lliat w e r e a u g m e n t e d b y
C o n p a r i s o n s a l s o w o r r n.ade w i t h less corapt e h e n s i v e t o t a l s s u c h a s
ajj^reiviri-' p r i v a t e b o i r o w i r f t o r f i n a n c i a l a s s e t s otht:r t h a n e q u i t i e s h e l d b v
iionf inacc ial s e c t o r s .
Ir. t h e s e c o m p a r i s o n s , w h i c h i n v o l v e d exam i i, i rip,
the
s t , - ) b i 1 i C y f i n d p r e i l i c t a b i H L y of r e l a t i o n s h i p s t o GW and o t h e r e c o n o m i c
v a r i a b l e s , t h e d o i n e s t i c ,ionf i n a r . c i a l debt t o t a l r e n e r a l l y p e r f o r m e d os we 1 1
as or b e t t e r than the other s e r i e s considered.
^ato r l e a r l v periortned least w e l l .
T h e p r i v a t e b o r r o w i n g a^^re.-
108
FEDERAL RESERVE'S FIRST MONETARY
POLICY REPORT FOR 1983
FRIDAY, FEBRUARY 18, 1983
U.S. SENATE.
COMMITTEE ON BANKING, HOUSING,
AND URBAN AFFAIRS,
Washington, D.C.
The committee met at 9:30 a.m., in room 538, Dirksen Senate
Office Building, Senator Jake Garn (chairman of the committee)
presiding.
The CHAIRMAN. The Banking Committee will come to order.
I do note the hour of 9:30 when the committee was scheduled to
meet and the attendance of Senator Proxmire, Senator Gorton,
Senator Trible, and the Chairman. This is a continuation on the
hearings on current monetary policy and conditions.
Two days ago we had Chairman Volcker, Chairman of the Federal Reserve Board. This morning we are to hear Hon. Martin S.
Feldstein, Chairman of the Council of Economic Advisers; and after
he has completed, we'll hear from Andrew Brimmer, president,
Brimmer & Co.; John Paulus, chief economist and vice president,
Morgan Stanley & Co., New York City; and Mr. Richard Zecker,
senior vice president and chief economist, Chase Manhattan Bank,
New York City.
I do not note the presence of our first witness. I do note that our
Senate Banking Committee has started on time, as all Senate committees should, and now we will entertain any statement my colleagues wish to make awaiting the presence of Mr. Feldstein.
Senator PROXMIRE. Mr. Chairman, I have no opening statement
except to commend you on being so prompt in holding these hearings. I think, if not unprecedented, it's very rare. Once in a while a
chairman will be on time, but you're always on time and I think
that's a marvelous element that we can count on in this uncertain
world, and I see our witness is here so I will desist my filibustering
and join you in welcoming our distinguished Chairman of the Economic Advisers.
The CHAIRMAN. As soon as your bottom touches your chair, we
will be happy to hear your testimony.
Mr. FELDSTEIN. I can do that and start my mouth moving at the
same time.
no
STATEMENT OF MARTIN S. FELDSTEIN, CHAIRMAN, COUNCIL OF
ECONOMIC ADVISERS
Thank you very much, Mr. Chairman. I am please to be testifying
again before this distinguished committee.
This is an especially critical and confusing time for monetary
policy. It is a critical time because it is so important that the increase in money and credit during the coming year be consistent
with a sound recovery. Too little money growth could choke off the
recovery while too much money growth could fuel a destabilizing
increase in inflation.
It is a confusing time because many of the old verities of monetary economics no longer appear to be valid. For more than two
decades, the ratio of the money stock to nominal GNP moved only
within narrow bands. Last year, however, this velocity ratio declined sharply, leaving nominal GNP about 6 percent lower than
might have been anticipated on the basis of the money stock. And
now, as a result of the significant financial deregulation enacted by
Congress last fall, the broad measure of the money stock [M2] is increasing at an unprecedented rate.
Monetary policy at the present time cannot be guided by applying mechanical rules. The Federal Reserve must use its judgment
to adjust the money stock during the present temporary period of
transition while asset demands are adjusting to the new regulatory
arrangements. But it must also be clear that, when the transition
is finished, the Fed will return to the sound and disciplined rules
for controlling the growth of the money stock in a way that permits nominal GNP growth at a rate that is consistent with sustainable growth of real GNP and a moderating rate of inflation.
I believe that the Federal Reserve is trying at the present time
to keep monetary policy on the middle ground that can sustain recovery without rekindling rising rates of inflation. I know that the
President is confident that Chairman Volcker and the Federal Reserve Board are trying to pursue an appropriate policy and will
continue to do so in the months ahead.
I believe that the procedure for 1983 that Chairman Volcker announced earlier this week is commendable. It recognizes the fundamental uncertainty about the shifts in money stocks during the
first quarter of the year but then returns to the discipline implied
by the target rates of money growth.
This morning I want to look first at the broader issue of the principles that should guide monetary policy at a time when a purely
mechanistic application of money growth rules is inappropriate. I
will then discuss the rapid growth of Mi in the second half of 1982
and on the even more rapid growth of M2 in the past month. Finally, I will comment on the level of interest rates at the present time
and the prospect for lower interest rates in the future.
STABLE MONETARY POLICY
The administration has repeatedly indicated that the fundamental guiding principle for monetary policy in the 1980's should be a
gradual reduction in the rate of growth of the money stock until
the rate is consistent with price stability- This broadly monetarist
Ill
approach has also been enimicated in recent years by the independent Federal Reserve.
The basic challenge for monetary policy at present is to balance
this principle of stable money growth with the need to take account of changing asset preferences that may alter the velocity of
money. While maintaining the approach of setting target ranges
for money growth, the Federal Reserve will also need to use its
judgment to permit money growth rates to reflect changes in financial regulations and other lasting changes in asset demands.
When regulatory changes appear to be responsible for abnormal
growth of the demand for money, the Fed must examine the evidence on the changing composition of liquid assets and try to determine how much more or less money growth than usual may be appropriate. Although the difficulty of such calculations cannot be
overstated, there is no substitute in the medium term for such
evaluations.
Regulatory changes are not the only source of changes in velocity. Individuals and institutions may change their asset preferences
for other reasons as well. Any persistent change in velocity that is
not matched by a corresponding change in the money stock will
cause either a period of increased inflation or a period of weak economic performance. It is clear, however, that changes in the
growth of the monetary aggregates must not be made easily or
lightly since excess money growth will be inflationary while inadequate money growth will threaten economic expansion.
Although the monetary authorities must rely on their professional judgment in the short run, the observed behavior of nominal
GNP can be used over a longer period of time to guide a gradual
recalibration of the money growth targets. Basing the recalibration
of monetary targets on nominal GNP is consistent with the basic
principle of pursuing a stable monetary policy. Indeed, it is the relatively stable long-run relationship between the monetary aggregates and nominal GNP that justifies the Federal Reserve's policy
of setting targets for the growth of M t and M3- Thus the principle
of targeting money growth rates is not an end in itself but only a
means of achieving control of nominal GNP.
MONEY GROWTH RATES
The difficulties of pursuing a sound monetary policy are amply
illustrated by recent experience. By conventional standards, the
rates of growth of Mi since the middle of 1982 and of M2 in January are far too high and would seem likely to precipitate an inflationary surge of demand. More careful analysis, however, shows
that the money growth rates cannot be taken at face value. They
reflect changes in asset composition and therefore need not be inflationary.
Stated somewhat differently, monetary expansion causes inflation when the increase in the supply of money exceeds the increase
in the demand for money. Since money demand generally grows at
a rate that is equal to or less than the growth of nominal GNP, a
rapid growth of the money stock typically means that the supply of
money will exceed the demand for money and that an increase in
inflation is likely to follow. However, when there is an important
112
regulatory change or other reason for a substantial increase in
money demand, a corresponding shift in money supply will not be
inflationary.
Consider first the rapid growth of the Mi measure of the money
stock since last July. From the 4 weeks ending July 21, 1982, to the
4 weeks ending January 19, 1983, Mi grew at an annual rate of
14.2 percent. The Federal Reserve has explained that the termination of all-savers certificates was responsible for some of the abnormal increase, since the funds from the all-savers certificates were
temporarily held in Mi accounts. Even more important, I believe,
was the reaction of Mi demand to the sharp decline in interest
rates.
The currency and bank deposits that constitute MI earn either
no interest or interest at fixed rates. When the return available on
other assets like money market mutual funds is high, individuals
and businesses will economize on their M! balances. When those alternative rates are low, individuals and businesses will have less
incentive to economize on M] balances and the size of those balances will grow. There have been many statistical studies that confirm this relationship between the interest rate and the demand
for Mi.
Between June and December 1982, the interest rate on commercial paper fell from nearly 14 percent to less than 9 percent. This
fall in interest rates was in. line with the fall in inflation during
the previous months. If this 5-percent fall in the interest rate
caused the amount of Mi demanded to rise by 5 percent over 6
months, it would cause the annualized rate of growth of Mi to increase by 10 percent. Thus a one-time level shift of 5 percent in Mi
demand that is phased in over 6 months would make a 4-percent
rate of growth of Mj appear as a 14-percent rate of growth.
I have used round numbers to illustrate my point and do not
want my statement interpreted to mean that I believe that the
shift-adjusted increase in Mi during the past 6 months was at a
rate of 4 percent. But I do want to emphasize that the substantial
increase in Mi should be seen primarily as a level shift and not as
excessive monetary growth. If inflation stays at its current level
and short-term interest rates do not rise appreciably, there is no
reason for a subsequent reversal of this temporary period of high
Mi growth.
Although M! rose rapidly in the second half of 1982, the growth
of M2 during that period continued essentially unchanged at slightly above 9 percent. This was further evidence that the rise in Mi
was at the expense of the interest-bearing components of M2 and
thus represented only a predictable change of portfolio composition.
The major changes in banking regulation that went into effect in
December and January—the money market deposit accounts and
the super NOW accounts—have introduced a new and substantial
source of temporary instability in the relationship between the
monetary aggregates and nominal GNP. The money market deposit
accounts have given banks an opportunity to attract deposits of
funds that would otherwise be held outside the banks and outside
M2. The result is an increase in the measured value of M3 that reflects a shift of funds rather than an unwarranted increase in Mz
113
growth. Although the M2 stock rose at a 30-percent annual rate in
January, it is far better to see this as a 2.5-percent increase in the
stock of M2. Fortunately, the financial markets recognized the
nature of the M2 increase and did not reflect any fear of increased
inflation. Instead, long-term interest rates remained essentially
steady.
Although the surge in M3 is readily understood as the result of
deregulation, it does make it difficult to assess what is really happening to the growth of liquidity, that is, to the growth of Ma adjusted for the shifts induced by deregulation. The behavior of M2 is
not a useful guide since the regulatory changes are affecting Mi as
well: Some of the flow of business deposits into MMDA's is coming
from Mt while funds are also being attracted into Mi by the super
NOW accounts. As a result, the Federal Reserve must monitor
closely during the months ahead the sources from which the
growth of M2 may have originated. Ultimately, the Fed must also
monitor the behavior of nominal GNP itself. It is critically important during the early phase of the recovery to prevent an excess of
liquidity from rekindling the inflationary spiral.
INTEREST RATES
I have been talking for the past few minutes about the monetary
aggregates and mentioning interest rates only in passing. I recognize, of course, that interest rates are now of great concern to
many businesses and households. There is a justifiable concern that
interest rates—especially real interest rates—are now very high
and that such high rates threaten the economic recovery. At a
minimum, these high rates will produce a lopsided recovery in
which the interest-sensitive sectors of the economy do not share in
the general expansion. Housing, construction, and the capital goods
industries will remain weak. Moreover, the high real interest rates
will keep the dollar strong and this will depress our export industries and those industries that compete with imports from abroad.
The primary cause of the high real interest rates is the very
large budget deficits that still hang as a cloud over the economy for
the entire decade of the 1980's. Without legislative changes, the
deficit will remain at more than 6 percent of GNP for the indefinite future. Such deficits raise long-term interest rates in two
ways. First, financial investors anticipate that the Government in
future years will be competing with potential private borrowers for
the available pool of savings. Reducing the demand of the private
borrowers to the available residue of funds requires raising the real
rate of interest that such prospective borrowers will face.
Second, in addition to raising the real interest rate, the prospect
of large future deficits also increases the fear of inflation and
therefore the nominal interest rate. There seems little doubt that
the current high interest rates reflect the fear that inflation will
rise significantly in the future.
It is tempting to think that the Federal Reserve could reduce the
interest rates by an expansionary monetary policy. In reality, however, an expansionary monetary policy would only increase the financial market's fear of inflation and drive interest rates higher.
114
Now the emphasis of economic policy must be on reducing the
budget deficits in the years ahead. Let me add, however, that I also
believe that the idea of reducing the budget deficit by eliminating
(or "postponing") the indexing of tax brackets would be counterproductive. Everyone would soon recognize that deindexing the tax
law would produce relatively little additional revenue if the inflation rate was low but a great deal of extra revenue if inflation is
high. Deindexing the tax law would produce a powerful incentive
for Congress to force the Fed to follow an inflationary monetary
policy. I believe that the immediate effect of deindexing the tax
law would be a rise in long-term interest rates and a weakening of
the recovery.
The fundamental conclusion from these considerations is clear:
The only way to reduce long-term interest rates is to make legislative changes now that will assure that the outyear deficits will be
an acceptable fraction of GNP. Doing so will reduce both nominal
and real interest rates.
MONETARY POLICY
My comments have drifted away from monetary policy in order
to focus on the fundamental cause of the current high interest
rates. The critical task for monetary policy now is to permit the
monetary aggregates to expand at a pace that is consistent with
sound growth and moderating inflation. The difficulty is achieving
this at a time when major regulatory changes have temporarily altered the normal relationship between the monetary aggregates
and nominal GNP.
The combination of monetary rules and discretion must be applied with great care and judgment. The observance of rules must
not become a doctrinaire attachment to arbitrary standards, and
the exercise of discretion must not degenerate into unprincipled
fine tuning. Instead, the monetary rules must be understood as a
way of achieving an appropriate long-run path for the economy.
The exercise of discretion in recalibrating monetary targets must
be subject to the discipline that such revisions are ultimately compatible with the desired long-run path of nominal GNP. With rules
and discretion balanced in this way, monetary policy can support a
sound recovery that leads to sustained and noninflationary growth.
The CHAIRMAN. Thank you very much, Mr. Chairman.
Your statement appears to blame the persistent high interest
rates almost entirely on the prospect of continuing large Federal
deficits. In our hearings with Chairman Volcker and in other hearings we have held recently, I have stated over and over again how I
agree with that philosophy as far as long-term interest rates are
concerned.
People would be foolish to make reasonable long-term loans with
prospects of continuing $200 billion deficits.
CONTINUED HIGH SHORT-TERM INTEREST RATES
The question I asked him and would ask you now is I don't understand why we continue to have such high real short-term rates.
All of the testimony that I have taken before this committee, the
testimony we will hear today in addition to yours, is to the effect
115
that no one expects inflation to reignite in the short period, over
the next year or two.
Excess plant capacity and all sorts of other indicators seem to
say that now we've got it under control at least for a while.
I understand the fragile nature of the outyears and again the
long term, but I still have a very strong feeling that the short-term
rates are entirely too high from all of the evidence we have before
us and I can't seem to get an answer as to why the short-term
rates still stay up. There seems to be no risk with much more reasonable short-term rates with all the information that's come
before this committee.
Mr. FELDSTEIN, I think you're absolutely right in making the distinction between the long rate and the short rate in this context,
saying the long rate is easily understood in terms of inflation fears
coming from the budget deficit, while the short term is more of a
puzzle.
I thought about that question a lot in the early part of the
summer. Let me try to explain why I think those rates are high
and also I will submit for the record a short piece that I wrote for
the Wall Street Journal back in June, titled something like "Why
are the Interest Rates So High," but really addressed to the question of why the short-term rates were so high.
[Copy of article referred to follows:]
[From the Wall Street Journal, June 8, 19S2J
WHY SHORT-TERM INTEREST RATES ARE HIGH
(By Martin Feldstein)
Though the rate of inflation has fallen sharply since last year, interest rates have
shown no inclination to decline by anything like an equal amount. While the rate of
inflation as measured by the GNP price deflator declined from more than 97 percent last year to less than 4 percent in the first quarter of this year, short-term interest rates have declined less than 2 percent and long rates are essentially unchanged.
The result has been a rise in the real interest rate (the excess of the market or
nominal interest rate over the inflation rate) to a level that is without precedent in
the postwar period.
The high level of real short-term and long-term interest rates depresses investment, prolongs the recession and enlarges the government deficit.
Any change in Fed policy aimed at lowering interest rates would be a mistake.
The high rates are an inevitable consequence of the disinflation process. With time,
the nominal market interest rates and the corresponding real rates will return to
their normal range. Any attempt to hasten the process by expansionary monetary
policy would risk a reacceieration of inflation.
A CHANGE IN INFLATION RATE
Though the level of real interest rates is abnormally high, there is nothing unusual about a change in the rate of inflation causing a change in the real rate of interest. A change in the inflation rate ultimately induces a similar change in the nominal interest rate, but experience shows that the interest rate change occurs only
gradually. In the 1%0's and 1970's the interest rate rose too slowly and the real
interest rate fell. A similar delay in responding to the recent distinction has now
produced a high real rate of interest. The real level is unprecedented only because
the recent decline in the inflation rate has been so large.
It is easy enough to understand why Jong-term rates have not declined sharply.
The long rate depends not on the current rate of inflation but on the expected rate
of future inflation. Prospective bond buyers remember that the GNP price deflator
was rising at nearly 10 percent as recently as the final quarter of last year. They
are aware, moreover, that the Fed's relatively tough policy during the past 18
months is no guarantee that it will want to give primacy to fighting inflation during
116
the rest of the decade. And while these concerns have limited the potential decline
in long rates, the revised budget outlook that turned last year's projected budget
balance by 1985 into a forecast deficit of nearly 5 percent of GNP has given a countervailing upward thrust to interest rates. The net result has been a continuation of
high nominal rates.
The long-term rate will move down only as continuing experience confirms that
there will be a lasting decline in inflation and that large deficits will not require a
sharp rise in the real interest rate to curtail private investment. This decline in
long rates will be hastened when a drop in the short-term interest rate raises the
cost of not buying bonds.
The high level of short rates is thus important not only in itself but because it
contributes to the high level of long rates. To judge by what I've heard and read, the
basic reason for the persistence of the high short rate is not well understood. Explanations in terms of future budget deficits or inflation rates are relevant to the long
rates but not to the short. The argument that the increased volatility of short rates
induces an extra risk premium makes no sense, both because there is no investment
with less volatility risk and because the increased volatility of long rates should be
driving investors into short-term securities and thereby lowering their yields. Similarly, the argument that risks of bankruptcy and default have increased interest
rates cannot explain why the default-free Treasury bills should have high yields;
indeed, the flight by investors from risky private obligations to the haven of government securities should lower the Treasury biM rate.
There is one basic reason for the high short-term interest rate: The supply of
money is low relative to its demand. The short-term nominal interest rate is the
price that equates the supply and demand for non-interest-bearing money. While
the real interest rate regulates the supply and demand for credit through changes
in saving and investment, it is the nominal short rate that represents the cost of
holding Ml money balances that don't bear interest instead of holding T-bills, commercial paper, or interest-bearing time deposits in banks or money market funds.
Individuals and businesses therefore choose to hold less Ml relative to the level of
transactions when the nominal short-term interest rate is high than when it is low.
This implies that when the quantity of money that the Fed supplies is low relative
to the level of transactions, the interest rate must be high to bring money demand
into equality with the money supply.
The volume of Ml has been virtually unchanged since the beginning of this year
and grew at less than 3 percent last year. Because money has been relatively scarce,
the interest rate has remained high.
Many economists did not anticipate the sharp rise in the short-term real interest
rate but expected that the nominal interest rate would decline as the inflation rate
dropped. Their view was based on the simple frictionless economy of the textbook
world. In such an economy, a reduced rate of money growth not only lowers inflation but also causes a decline in the nominal interest rate that keeps the real interest rate essentially unchanged. Though the lower nominal interest rate increases
the demand for money, this is offset in the textbook world by an immediate drop in
the price level that reduces the demand for money to the available supply. Immediate and complete downward flexibility of prices in the textbook world permits disinflation to occur without higher real rates of interest.
In the real world, of course, the price level does not conveniently decline instantaneously by several percent to reduce money demand and permit a decline in the
nominal interest rate. Instead, the real interest rate rises and this high real rate
induces a decline in economic activity. The lower level of economic activity and the
decline in inflation that it causes both reduce money demand but not by enough to
permit an immediate return of the real interest rate to its natural level.
As long as the real interest rate is above its natural rate, there will be slack in
the economy and therefore downward pressure on inflation and interest rates. The
real interest rate is thus eventually self-correcting.
No one can say exactly how long it will take for the real short rate to return to
its natural level. Some simple arithmetic will indicate the nature of the adjustment
process. There has been a relatively stable trend that reduces money demand by
about 3 percent a year apart from changes in interest rates and the level of income.
A 5 percent rise in nominal GNP this year would raise money demand at current
interest rates by only 2 percent. If the Fed permits Ml to increase by 5 percent,
there will be a net increase in Ml liquidity of 3 percent. The result would be a decline in the nominal interest rate. Similarly, if 1983 Ml growth is 4.5 percent, a further decline in the nominal interest rate will occur if nominal GNP grows by less
than about 7.5 percent.
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FRAGILE C R E D I B I L I T Y OF FED
arithmetic makes it clear that it is the stickiness of the price level that keeps
the short rates so high and that causes a prolonged recession to accompany the
process of lowering the inflation rate. The faster inflation declines, even if that decline is only a temporary downward overshooting of the equilibrium inflation rate,
the faster will the subsequent real interest rate decline and the sooner will the level
of economic activity recover.
It is tempting to think that this painful process of reducing money demand byextra price deflation could be avoided if the Fed simply accommodated the additional money demand by providing an extra dollop of money supply. Unfortunately, the
Fed's credibility is so fragile that the financial markets and other Fed watchers
would almost certainly interpret the accommodation as evidence that the Fed has
abandoned its policy of gradually reducing the money supply. Long-term inflation
expectations would worsen, and the interest rate on bonds and mortgages would
probably rise even if the short rate was lowered. Moreover, such monetary accommodation would be a return to the notion of interest rate targeting that produced
inflationary money growth for the past 15 years. There is no reason to think that
monetary fine tuning would be more successful this time.
There seems little choice but to wait until the natural process of disinflation reduces the relative demand for money, thereby lowering the nominal interest rate
and bringing the real rate back to its natural level. The painful recession that accompanies this disinflation is the inevitable cost of correcting the inflationary excesses of the past decade and a half.
Mr. FELDSTEIN. Basically, the short-term nominal interest rate
has to clear the demand for money. The demand and supply of
money has to be equated using the nominal short-term rates regardless of the implications that that has for the real rate. So one
way of answering the question is to say that the amount of the real
money stock, the real Ml money stock that we have at the present
time, is relatively small in comparison to our level of nominal GNP
and the only way to equate the demand for that Mi stock with the
available supply is to have a high short-term nominal interest rate
because it is the short term nominal interest rate that is the cost to
the individual of holding Mj balances.
Now then the question is what makes that go away? What makes
that change? Let me answer it first withh my old professorial hat
on for a minute and then try to answer it more practicably.
In theory, the fact that inflation came down a great deal should
not have led to higher real interest rates. Instead, nominal rates
should have come down at the same time. The only way for that to
happen is for the real money stock to increase. For the real Mi
money stock to increase there are two things that might happen.
One is that the Fed could pour some more money into the system.
The other thing is the price level could drop.
In the theoretical world that I lived in before I came to Washington on my blackboard, that process
The CHAIRMAN. What makes you think you're in the real world
here?
Mr. FELDSTEIN. In that analytically simplified world, the way in
which real money balances adjust is for the price level to drop. In
other words, when the inflation rate comes down, the price level in
these little abstract models that economists like to think about,
drops substantially and immediately. If the price level were to drop
substantially, then we would, with the same nominal money stock,
have more real money balances and more real Mi. With more real
Mi, we would have a lower nominal interest rate now.
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Now that hasn't happened or at least it hasn't happened fast
enough to give us the larger MI balance. So there are two possibilities. We can have the Fed inject additional funds, try to increase
MI in order to bring down that short rate, or we can wait until
over time this process happens naturally. That is, that nominal
GNP grows more slowly than the money stock that the Fed is providing and that allows for interest rates to decline.
The risk in taking the first route, the risk in the Fed adding
more money now, is that it will increase the fear of long-term inflation. It runs the risk of increasing long-term interest rates, and I
felt 6 months ago and 8 months ago when I first started thinking
about this that the Fed was not in a position then to increase the
stock of money without forcing up long-term rates. It would drive
down short-term rates but would drive up long-term rates in the
process.
In fact, my speculation at that time was wrong and the Fed was
able to accommodate a natural decline in short-term rates without
long-term rates going up, and even long-term rates coming down.
My sense, talking to financial market people in September and
talking to them again now, is that the thinking in the financial
community has changed a lot and that people who were not nervous about an additional supply of money of M! 6 months ago are
very nervous about it at this time.
So I don't think the Fed is in a position where it can inject those
additional funds to try to bring down short-term rates without running very substantial risks that it will push up long-term rates further. I don't know whether I clarified or complicated matters with
that.
The CHAIRMAN. Well, let's get very practical then and let me ask
you—in the hearing with Chairman Volcker I used the term profiteering and that may have been too strong a word, but let me rephrase the questions.
Do you believe that there's a possibility that financial institutions are deliberately holding rates up?
Mr. FELDSTEIN. Not market rates certainly. Treasury bill and
commercial paper rates are set on a very competitive, worldwide
market, so that those are not in any sense administered rates.
When we start asking about things like the prime rate or specific
rates for a particular class of consumer loans or mortgages, banks
may have some more discretion over that, but frankly, I don't
think they have a great deal of discretion because, again, we have
a very competitive market. They may administer what they call
the prime rate, but then they will vary who gets to borrow at
prime and who gets to borrow above and below prime, so that ultimately I think the effective interest rates that people are paying
are determined by market conditions.
LENIENCY IN BANKRUPTCY LAWS
The CHAIRMAN. Do you think part of it might be due to the fact
that they are taking precautions against rising loan losses? Do you
think that the changes—the great leniency in the bankrupcy laws
have had anything to do with these increasing rates, protecting
themselves against those losses?
lilt
Mr. FELDSTEIN. Well, the changes in the risks associated with
any given loan clearly can affect the interest rates that they
charge. As the argument that they have taken losses on some of
their previous loans and would now like to make more profits to
help offset those loans—it's certainly true that banks would like to
make more profits to offset losses that they have accrued in the
past, but liking to doesn't necessarily make it possible. I don't see
the connection that says merely because they have incurred losses
they are now in a position to charge higher interest rates. It may
be that they are being more careful about the kinds of loans that
they make, that they would rather not make certain loans. In fact
they have reduced the supply and therefore the interest rate that
appears in the market is high.
The CHAIRMAN. Well, it's a different subject for another time,
but I do feel very strongly that we've got to change the errors we
made in the bankruptcy laws. It has become so incredibly easy. I
was brought up by a father that taught me if you borrowed money
you were supposed to pay it back. It was just that simple. I do
think the bankruptcy laws need to be changed dramatically in the
other direction, that we made a great error when we liberalized
them so much.
Let me ask you what your view is of the seriousness of the threat
to our economic recovery coming from the debt service problems of
the less developed countries. At the same time these hearings are
going on, Senator Heinz, the chairman of the International Finance Subcommittee, has been conducting hearings on that issue.
I'm specifically referring to those debt service problems, the request from the administration for an increase in the IMF quotas
and what your feelings are on that situation.
Mr. FELDSTEIN. Well, I think that the problems of the less developed country borrowers—Brazil, Mexico, Argentina, and many
others—are indeed very serious. To speak first about the IMF question and then about the impact on recovery, I think the IMF is
clearly playing a critical role in working out this debt repayment
problem. Without the IMF, I shudder to think about what the prospects are of successfully working out the complicated coordination
problem of getting this repayment done.
The IMF, of course, is not carrying the bulk of the financing of
it. That has to be borne and is being borne by the private banks,
but the IMF is playing a pivotal role and I very much support the
request for additional funds by this Government to join with all the
other governments in aiding the IMF in doing that job.
Even with the IMF, even given the role that the IMF can play in
allowing these countries to continue their current activities, they
will contribute to a reduced level of world trade and that will put a
further damper on the overall economic recovery. Experts tell me
that we are likely to have a merchandise trade deficit this year of
about $75 billion, about 2.5 percent of GNP, about twice last year's
level. That means that much final demand is being directed to foreign markets rather than to the domestic economy and that's clearly going to put a damper on the level of economic recovery in this
country.
Only a small part of this is due to the OECD debt problem, but it
is one of the contributing factors.
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The CHAIRMAN. Senator Proxmire.
Senator PROXMIRE. Chairman Feldstein, in the last 25 years,
every Chairman of the Federal Reserve Board—Martin, Burns,
Miller, and Volcker—have all told us about the very serious relationship between fiscal policy and monetary policy and monetary
policy is very, very hard to operate without a sound fiscal policy.
At the same time, we all know now that any recovery must have
an accommodative, supportive monetary policy.
I'm wondering, years ago there was what was known as a quadriad, as you know, consisting of the Treasury Department, the
Chairman of the Council of Economic Advisers, the head of OMB,
and the Chairman of the Federal Reserve Board.
It seems to me they met about once a month and I thought that
kind of meeting was constructive. Do you have that sort of formal,
regular discussion now?
Mr. FELDSTEIN. Well, we do in two different ways. I meet with
Paul Volcker on a regular basis.
Senator PROXMIRE. How often?
Mr. FELDSTEIN. Every 2 weeks regularly. We often meet in between, but there's a scheduled meeting every 2 weeks. Donald
Regan, I think, sees him on the same frequency. We each see him
separately on those occasions, but Paul comes to a working breakfast that includes Treasury, CEA, OMB and three others on an irregular basis. I'd say that group meets every week.
Senator PROXMIRE. Would you say that Stockman comes to that?
Mr. FELDSTEIN. Stockman, Don Regan, myself, Secretary Baldrige, Secretary Shultz, and Mr. Harper.
Senator PROXMIRE. That's a regular meeting?
Mr. FELDSTEIN. That group that I just described meets every
week.
Senator PROXMIRE. I see.
Mr. FELDSTEIN. And Paul Volcker comes some of the time.
Senator PROXMIRE. That's reassuring. I didn't know that and I
think that's most helpful. In fact, that's a more frequent meeting
than they've had in the past.
Mr. FELDSTEIN. This is scheduled this way now.
Senator PROXMIRE. Then I wonder if you can tell us how can the
Federal Reserve Board provide a monetary ease that will bring interest rates down in our recovery while permitting our credit
system to fluctuate between $150 and $200 billion a year for the
next 5 years at deficits that will absorb half or more of our net private savings? How can they do that?
Mr. FELDSTEIN. Well, you're not asking me about two quite different things. I think that the kind of target that Paul Volcker suggested and the FOMC approved are certainly consistent with economic growth at the rates that the adminstration and others have
forecast. That is, if we see M2 growth in the coming year at 7 to 10
percent range, that certainly is consistent with nominal GNP
growth in the 8 to 10 percent range, and therefore, with the real
growth and the relatively stable rate of inflation we have talked
about.
As far as the financing of the debt goes, the financing of the debt
is really quite separate from monetary policy. The financing of the
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debt is dependent on how much savings we have and on the crowding out that occurs.
IMPACT OF ADDITIONAL MONEY SUPPLY
Senator PROXMIRE. Let me follow up and ask this. If the Fed permits the money supply during the next year or so to rise by that
proportion, won't the expanded liquidity base constitute a potential
time bomb that may lead to a mammoth inflation in later years
and won't the anticipation of that be just what the Chairman was
implying a while ago? It would be recognition on the part of long
term investors that you have this dynamite of liquidity available,
won't that make people feel that we're going to have a very serious
inflation in 1985, 1986, and 1987?
Mr. FELDSTEIN. What you're talking about in that question is the
monetary aggregates increase rather than the debt?
Senator PROXMIRE. Well, yes. I'm talking about the fact that the
huge deficits must be financed and this will make it difficult for
people to buy homes and buy cars and buy the other things they
have to buy on credit.
Mr. FELDSTEIN. I think you're really talking about two separate
things.
Senator PROXMIRE. But they are interrelated, are they not?
Mr. FELDSTEIN. Not really.
Senator PROXMIRE. Why not?
Mr. FELDSTEIN. In the one case we're talking about Government
debt. We're talking about borrowing by the Government. We're not
talking about additional liquidity but changing the form. That is, if
I buy a Government bond rather than buying a corporate bond,
that doesn't change my liquidity. It does reduce the ability of the
corporate sector to invest. It does create the crowding out problems
that I alluded to in my testimony.
Senator PROXMIRE. If you buy them, yes; but if the Federal Reserve Board buys them through their open market operations?
Mr. FELDSTEIN. Absolutely.
Senator PROXMIRE. In order to make it possible for the economy
to fund both this colossal deficit and at the same time provide
credit for the private sector
Mr. FELDSTEIN. That is exactly the kind of thing that financial
markets are worried might happen in the future. There's no necessary reason for that to happen. We can have large deficits with all
of the problems that ensue from those deficits without having inflation. But if the Federal Reserve does go in and buy up those deficits or buy up more of those deficits and create more money, then
we'll have more problems.
Senator PROXMIRE. If the Federal Reserve does not step in and
finance those deficits, there will be crowding out, won't there?
Mr. FELDSTEIN. Absolutely. Indeed, the crowding out will
happen
Senator PROXMIRE. Ninety-four percent of the net private credit
could be absorbed by the deficit and off-budget credit programs.
Mr. FELDSTEIN. That's correct, and that crowding out will happen
essentially regardless of what the Federal Reserve does. It can
affect that crowding out ever so little by trying to monetize. You
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can create a lot of inflation, but it can't change the basic reality
that the Government is borrowing those funds and they're not
available for private use.
Senator PROXMIRE. Why not, if the Federal Reserve Board steps
in and buys it up?
Mr. FELDSTEIN. They don't create any more additional savings.
Senator PROXMIRE. Wright Patman, the old chairman of the
Joint Economic Committee, used to ask William McChesney
Martin, "Why doesn't the Federal Reserve Board buy up the whole
national debt?" Martin's reply was, "They could, but it wouldn't be
worth anything when they got it," indicating the tremendous inflationary effect of that kind of policy. But you're telling me now
there would be little or no inflationary effect if the Federal Reserve Board moves in and monetized the debt to the extent of
buying half of it or three quarters of it?
Mr. FELDSTEIN. Quite the contrary. There would be a lot of inflationary effect, but it wouldn't change the crowding out of private
investment. That is, if we have a certain amount of GNP, a certain
amount of real resources available, and the Government spends
more of it or by its tax policy induces consumers to spend more of
it, then those resources are not available for the investment in
plant and equipment and businesses.
The fact that the Fed comes along and prints some more money
doesn't change the face of reality that we have a certain amount of
GNP and the Government has spent what they've spent and the
consumers have spent what they have spent.
Senator PROXMIRE. But if the Federal Reserve Board comes along
and pumps enough money into the economic system, won't that at
least temporarily provide the basis for holding down interest rates?
Mr. FELDSTEIN. If the Fed put in more money, allowed MI to
grow, it might reduce short-term interest rates. An increased M t
might reduce short-term interest rates, but at the same time it
would run the risk that long-term interest rates would rise immediately and it's those long-term rates to which housing and other
kinds of investment are so sensitive.
Senator PROXMIRE. I understand that. But as I've read people
like Tobin and others, they seem to argue that if the Federal Reserve Board increases the available supply of money even with the
enormous deficits we're running, if they maintain the present level
of M2 for a while for instance, that that will permit us to maintain
not only short-term interest rates at a low level but it will help us
to hold down long-term interest rates because, as you have told us
and others have told us, the likelihood is we will not have inflation
for the next year or two anyway.
Mr. FELDSTEIN. The long-term rates are very sensitive to expectations out in the future.
Senator PROXMIRE. Yes, but we are converting some of our usual
long-term borrowing into a different kind of a situation with variable interest rates. For instance, we have variable mortgage rates
becoming the rule now so that the lenders are protected in that
way.
Mr. FELDSTEIN. To the extent that we are moving in that direction and all that matters is short-term rates, we are talking about
a different kind of problem; but if we're concerned about what is
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happening to conventional long-term mortgages and long-term
bonds, I'm afraid injection of additional liquidity would run the
risk of increasing those long-term rates.
Let me say a little more about the conversion problems you
talked about. Many borrowers are unwilling to make long-term
commitments on the basis of floating rates. Would-be homeowners
want to know what their monthly payments are going to be in the
future. Business that are putting up a new plant want to know
what their cost of funds is going to be. So they are reluctant to
make those kinds of outlays unless they can get long-term funds at
what they regard as reasonable rates.
At the same time, the people in the financial markets are looking into this murky future and saying with the deficits of the sort
that are out there there is a risk that we're going to have substantial inflation and we'll only buy those long-term bonds if we are
given enough of a risk premium, enough of an inflation premium,
to protect us against the risk of that extra inflation.
So what we have is a situation in which the financial investors
will only buy the bonds if they have high rates because they are
afraid of inflation. At the same time, the would-be borrowers are
saying, "We can't be sure we're going to have higher incomes to
pay off those mortgages with, or higher prices to justify the higher
rates for our business." So the buyers and sellers are not coming
together. I think that's really the serious problem. The home buyer
or the business investor will be unwilling to pay the kind of high
interest rates that the financial investors are demanding because
there is this, an uncertain amount of inflation out there in the
future.
Senator PROXMIRE. My time is up, but let me just see if I understand. You're saying that there's little or nothing that the Federal
Reserve Board can do by way of an easier monetary policy to hold
down interest rates which would coincide with the position that the
Chairman of the Federal Reserve Board has taken?
Mr. FELDSTEIN. That's correct, relative to what they are doing.
The Chairman. Senator Trible.
Senator TRIBLE. Thank you, Mr. Chairman.
The great strength of the dollar in the last year or so has been a
major factor in the decline in American production and jobs. Chairman Volcker said falling exports accounted directly for some 35
percent of decline in our GNP during this recession. I've seen how
the high price of the dollar affected my own State, for example. In
Virginia, the demand for coal and agricultural products has diminished and tourism is in decline, and we have increased competition
from foreign textiles and other products.
All of that means loss of jobs and income. I have two questions in
that regard.
FUTURE OF THE PRICE OF THE DOLLAR
Do you expect any reduction in the price of the dollar in the
near future and how will the new Federal Reserve policies articulated by Chairman Volcker the other day affect the price of the
dollar and American jobs?
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Mr, FELDSTEIN. There are two forces that affect how the dollar
moves in the coming year. One, is the trade deficit. Normally when
you have a large trade deficit, you would expect that to put downward pressure on the dollar; but at the same time we have very
high real interest rates from these deficits, very high long term interest rates, following from these budget deficits and they are putting upward pressure on the dollar.
So what will come out in 1983 will be a balancing of these two. I
would tend to think that despite these unprecedented trade deficits, we will see the dollar not falling sharply. Forecasting exchange rates is like trying to forecast what the stock market or interest rates will do. The dominant force will be the high real interest rates and the Government deficit keeping the dollar strong.
That means a continued adverse effect on our trade, both our
export industries and those industries that have to compete with
imports from abroad.
I think it's only as markets get confident that we are bringing
down inflation and that we are bringing down the Government's
need for funds in the outyears that we will see a decline in the
dollar relative to other exchange rates, and therefore strengthening, with a lag, of our trade position.
You asked what the impact of the Federal Reserve policy is going
to be on this. I would say relatively little. I would say the dominant
factor affecting our exchange rate is going to be those high long
term real rates, which reflect fiscal policy more than monetary
policy.
Senator TRIBLE. There's a great deal of concern, of course, about
the budget deficits projected for the outyears. The numbers are
staggering by any measure. As you know, the budget process moves
slowly—painfully slowly in this institution and the other body
across Capitol Hill. The next fiscal year's budget will not be resolved any time soon.
Since you have your projecting hat on today, recognizing the sensitivity of housing and auto sales and a whole host of activities to
interest rates, short and long term, given the recent pronouncement by the Federal Reserve on its policies and recognizing the uncertainties of the budgetary process here on the fiscal side, what
would you anticipate will occur on the interest rates front? Will
these interest rates stabilize now or can we hope that they may decline further?
LONG-TERM RATES COMING DOWN
Mr. FELDSTEIN. Well, I continue to believe that as we develop
confidence that inflation is not going to be allowed to increase we
will see long-term rates coming down. But I think it's going to be
hard over the next 2 or 3 months to have any kind of substantial
change in people's thinking about the longer term.
I think if the recovery is well underway, 6 months from now or 9
months from now, and inflation has not started going up at a significant rate, that will be very reassuring. But at the same time,
Congress must have made major progress in bringing down the
likely outyear deficits. The combination of those two things would
make for a substantial reduction in long-term rates.
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Senator TRIBLE. So are you saying then for the next several
months you would anticipate interest rates would be stable?
Mr. FELDSTEIN. I would anticipate that long-term rates would not
show any substantial movements over the next few months, but I
will repeat what I said about exchange rates—forecasting is dangerous like that.
Senator TRIBLE. Chairman Volcker also testified that the Fed expects nominal GNP, total spending, to grow 8 to 9 percent this year
with real growth in the range of 3.5 to 4 percent. Compare those
projections, if you will, to those prepared for the administration's
budget and tell us how the Fed projections would affect the Federal
budget and the Federal deficit.
Mr. FELDSTEIN. Yes. Our forecast for the same period is 3.1 percent real growth. You said Chairman Volcker has said about 3.5
percent and maybe a little higher than that. The difference is
really very, very small. The nominal GNP figure we have shows a
little more inflation than theirs and so our projection of nominal
GNP growth for the year is really very similar to theirs. The differences between these forecasts in terms of their impact on the
budget deficit are a few billion dollars, under $10 billion or so.
There's not enough difference to be worth thinking about at this
time.
Senator TRIBLE. Well, you know, my constituents believe a billion
dollars here and a billion dollars there still count, but I recognize
in terms of triple digit deficits
Mr. FELDSTEIN. Certainly in terms of the decisions that have to
be made, we would be delighted if there were a little more economic growth. It would reduce the deficit a little bit, but it wouldn't in
any way remove the requirement for the important changes that
have to be made on both the revenue and the spending side.
Senator TRIBLE. I understand. I thank you and I thank you, Mr.
Chairman.
The CHAIRMAN. Senator Sasser.
Senator SASSER. Thank you, Mr. Chairman.
The administration is predicting 3.1 percent in growth this year,
I think you told Senator Trible. I saw some figures the other day,
Dr. Feldstein, which indicated that the economy would have to
grow at the rate of 3.5 percent just to absorb new workers coming
into the work force and also to compensate for unemployment
caused by increased productivity—I suppose technological unemployment. Are those figures accurate?
Mr. FELDSTEIN. No. It's more like 2.5 percent that you need, 2.5
percent real growth to keep pace with productivity and the growing labor force. Our forecast of 3.1 percent indicates that there will
be declining unemployment so that 3.1 percent is more than
enough to offset the other.
Senator SASSER. But at 3.1 percent we're talking about a minimal
decline in unemployment in the coming year. What are the unemployment figures? Aren't you still predicting in your economic forecast for the coming year unemployment of 9.9 percent? Am I correct in that figure?
18-014 O—83
9
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UNEMPLOYMENT FORECAST TOO PESSIMISTIC
Mr. FELDSTEIN. The forecast that we have for unemployment already looks too pessimistic, given the recent unemployment, but we
have the unemployment rate only falling to 10.4 percent by the end
of this year. As you know, those recent figures that we have had
from the Department of Labor indicate 10.4 percent was the unemployment rate, by the old definitions, in January.
Now we have been warned and I'm sure you have heard that
that 10.4 percent may have a certain amount of statistical error in
it. Statistical noise frequently occurs during the winter months because of the difficulties of seasonal adjustments. So it's not out of
the question that we will see that number bounce back up again.
But if the recovery is indeed underway and if it continues at a
healthy pace, we would certainly expect to have a lower unemployment rate by the end of the year than we forecast, and certainly
lower than we have today.
Senator SASSER. What sort of economic growth are you predicting
for the outyears? In other words, my concern is if you're predicting
a 3.1 percent growth for this year—and I think it's generally conceded now that the administration's predictions are perhaps overly
pessimistic, which is refreshing after 2 years of unrealistically optimistic projections—but they are projecting 3.1 this year. Let's say
that is unduly pessimistic and say the Fed's figures are more accurate, that it does get up to 4 percent or even 4.5 percent as some of
the private prognosticates have been predicting. What are you
predicting for the outyears?
Mr. FELDSTEIN. Let me first comment on the current year where
we have emphasized that this forecast, like any forecast, reflected a
balance of probabilities. Certainly at the time we made the forecast
there was no evidence of a recovery having begun.
Now, a month and a half later, there is evidence that may turn
out to be an indication that recovery has begun. Certainly if the
recovery did begin in December or January then we would expect
more than 3.1 percent for the year as a whole.
Now looking to the outyears, we have tried to avoid making precise year to year forecasts, trying to guess just which years will be
up and which years will be down, and instead we have emphasized
the average growth over the entire period. The average real growth
that we're looking for over the entire 5-year period is 4 percent
real GNP growth a year.
I might add, just to put that in some context, by comparison,
over the last three decades the economy has grown at less than
that, at about 3 percent. In the 1970's, it was a little more than 3
percent. Of course, we are talking about growth coming out of the
bottom of a quite severe recession.
Six years from the trough of a recession, during the entire
postwar period overall, the recoveries have averaged 4 percent real
growth. What we are looking for is real growth which is about the
same as has happened on average over that period, although the
distinguishing feature is that we want to see that happen without
an increase in inflation. Sustained recoveries in the past have
always been spoiled by rising inflation.
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Senator SASSER. Well, my concern is, Dr. Feldstein, with these
growth figures that are being projected now, it appears to me that
we are going to be sitting here 5 years from now still with very,
very high unemployment figures. If we're going to grow here at the
rate this year as you're predicting of 3.1 percent, or as others are
predicting of 4 percent, and if we grow at the rate of 4 percent over
the next 4 or 5 years, what's this going to do to our unemployment
picture?
Mr. FELDSTEIN. We estimate that the unemployment out in 1988
will average about 6.5 percent, down to 6.2 percent by the end of
1988. Now I would certainly like to see lower unemployment than
that, but I'm afraid that given our current labor markets that 6- to
7-percent range for unemployment is about as low as you can get
without putting upward pressure on wages and prices.
Senator SASSER. At that unemployment figure, at 6.5-percent unemployment, if we just let things go the way they are now with
regard to the budget, if current policy remains in effect, what
would be the structural deficit built into this budget?
Mr. FELDSTEIN. The deficit out in 1988 would be essentially all
structural and it would be about $300 billion or 6 percent of GNP,
totally unacceptable.
Senator SASSER. Totally unacceptable—even if we get down to
your best unemployment figures there and the economy is as
healthy as you predict it can be, we are still going to be running
deficits of $300 billion a year?
Mr. FELDSTEIN. Those two things are incompatible. We could not
have this kind of economic growth and we could not have this kind
of recovery if we don't make the kind of changes called for in the
President's budget. We must shrink those deficits to something
down to something more manageable and more tolerable.
Senator SASSER. Throughout your testimony you state that monetary targets should be calibrated to the pursuit of a moderate GNP
growth. We have had the Fed monetary targets since 1979, and
GNP has remained virtually stagnant now for a period of 3 years
or almost 3 years.
What does this say about the Fed's monetary targets and their
impact on GNP growth?
Mr. FELDSTEIN. Well, let me emphasize that we are at nominal
GNP growth.
Senator SASSER. Let me just ask you this if I may. Would you
have stuck with these monetary targets that the Fed used between
1979 and 1982?
Mr. FELDSTEIN. I would say that basically the Fed has done a
good job. They haven't precisely stayed with their own targets.
They allowed both Mi and M2 to rise above target a bit last year
because they saw this very sharp change in velocity which was
keeping the nominal GNP growth much below what might have
been anticipated. And I would say that the targets that they have
set now for 1983, as best as we can tell at this point, are consistent
with a healthy growth in nominal GNP.
Senator SASSER. Thank you, Mr. Chairman.
The CHAIRMAN. Senator Lautenberg.
Senator LAUTENBERG. Thank you, Mr. Chairman.
128
I'm sorry, Dr. Feldstein, that we have not had a chance to say
hello. I missed your testimony this morning, and I was looking forward to it. I greatly admire your views and what you're trying to
accomplish under what I think are very difficult circumstances.
I will just take a minute, if I might, and search out answers to a
couple of things that I'm interested in. I did hear you say, and you
confirmed what we have heard from some and disputed by others,
that such things as long term fixed rate mortgages are going to be
difficult to borrow as in other times. Some have said that they see
a trend back to that kind of thing. Others like Chairman Volcker
said that 50 percent of the mortgages being issued were of that
character.
How do you feel about the future of the mortgages? Do you see
more money going into fixed-rate, long-term mortgages?
Mr. FELDSTEIN. Well, I think that, as I said before, borrowers still
like to have a sense of certainty about what their payments are
going to be.
Senator LAUTENBERG. What about lenders?
VARIABLE RATE MORTGAGES
Mr. FELDSTEIN. And lenders also like to have some sense that
they are going to be repaid in real terms in an amount consistent
with what they have lent out. And I have long favored moving
more in the direction of variable rate mortgages and tried to design
them in ways that gave more latitude than the current regulations
permit so that it becomes easier to have small changes in the year
to year fluctuation of payments while allowing substantial change
in the interest rates by changing the repayment period, for example.
Obviously, the more we have to live with inflation, with uncertain inflation, the more important it is to reshape financial instruments in that way. But it would be a lot better if we didn't have
the fear of inflation and if people could have the kind of instruments that both borrowers and lenders are more comfortable with.
Senator LAUTENBERG. Since forecasting is part of your profession
and your business, do you see us getting more into the long-term
fixed-rate market or less so?
Mr. FELDSTEIN. It depends very much on what happens to perceptions of inflation. The Europeans have moved further and further
away from fixed-rate markets, long-term fixed-rate markets, because inflation has become so unpredictable there. If we come back
to a more predictable inflation environment, I think we will see a
redevelopment of the long-term market of a conventional sort.
Senator LAUTENBERG. Those perceptions affect the security of the
lenders very significantly and very few of them, in my view, want
to be out for 25 or 30 years now on a 25-year rate. The reason I
asked about that is because I think that has a material effect on
the housing market which is a very serious part of our economy,
and although we are all buoyed somewhat by the encouraging statistics, I wonder how realistic they are and what the shape of
things in that market are. We have heard that there are small
units being built and that there's a lot of building going into areas
that are quite far removed from the place of employment thus ere-
129
ating problems of extra transportation. I wondered whether you
thought there was any influence on lending capability as a result
of the type of money instruments that are now available, the Super
NOW's and all that, and I'd just briefly like to see whether you
think these things are healthy in terms of being able to stabilize
our economic growth and thus have a kind of free flow of funds
toward a better inflation control or perhaps even lesser inflation
control, and thus the ability to forecast mortgage terms and things
of that value,
Mr. FELDSTEIN. Well, speaking of the mortgage market, I think
the development in the last few years has been a very healthy
trend, making the mortgage market more a part of the overall national capital market and breaking down some of the previous barriers. Developing the mortgage backed bonds, for example, gives
housing a chance to compete with bonds on a more equal basis and
not be subject to the problems of disintermediation that have occurred in the past.
Similarly, the regulatory changes will now keep the financial institutions in a position where we will not see these large disintermediating shifts of funds crunching down on the housing market. If
we combine that with floating rates, then we can have a more
stable housing industry than we have had in the past.
Senator LAUTENBERG. Fewer people, however, I think are able to
make the commitment to purchasing a home under that kind of
flexible arrangement. I do think that for the average home buyer,
for the more modest home purchaser, that it's very difficult for
them to take on a mortgage commitment that they know may vary
in terms of their costs.
Mr. FELDSTEIN. Well, I think that's what I was referring to
before. It's important to allow interest rates to move up two or
three points but we can't have a corresponding proportion of the
monthly payment go up. One way of dealing with that is to allow
the repayment period of the mortgage to change. As interest rates
fall, it s spread out shorter.
Senator LAUTENBERG. Someone with a 25-year mortgage winds
up with a 40-year mortgage?
Mr. FELDSTEIN, That's what the British have done. They have allowed the repayment period to vary. I think their ruling monthly
payments are allowed to go up with inflation, but not with the interest rate, and they are not allowed to be too small to keep current on interest. But they don't have to actually be amortizing the
mortgage at any time.
Senator LAUTENBERG. The smile came because I thought immediately of guaranteeing a lifespan that would correspond with the
length of the mortgage.
With regard to the unemployment statistics, those which you
offer, I believe 6.2 in 1988
Mr. FELDSTEIN. Again, I have to caution you about the uncertainty of forecasting what the unemployment rate is going to be in 4 or
6 years, but that's what's implied by our forecast of continuing at a
4-percent growth.
Senator LAUTENBERG. Before I obtained this responsibility in the
Senate, I was in a business that sold as part of its product economic
forecasting, both the Chase econometric products and then the
130
Townsend-Greenspan products, and there may be some philosophical difference along the way and I know some of the vagaries and,
therefore, I will not hold you to anything here on the public record,
but what about the growth of the work force as well? When we
look at 6.2 percent unemployment aspirations. For instance—and
that's not good enough we both acknowledge—is that the percent
of the work force that's about the same size?
Mr. FELDSTEIN. No; the work force is substantially higher. We
are talking about 15 million more people working in 1988 than are
working today. So part of that, about 4.5 million, I suppose, would
be a reduction in unemployment taking it from 10,4 to 6.2. The rest
of that 15 million growth would reflect growth of the labor force
and the ability to employ a larger labor force.
Senator LAUTENBERG. So those who are unemployed would be
structural?
Mr. FELDSTEIN. That unemployment would be structural.
Senator LAUTENBERG. Structural and longer term unemployed
workers. More than half of that would be the young people, people
under the age of 25, who are still in the process of trying to make a
permanent attachment to the labor force. I think we have to continue to develop labor market policies to reduce that kind of unemployment.
Senator LAUTENBERG. Fine. I've been trying to fish out from the
various witnesses over the past couple days—whether or not there
is any concern or negative view on the volatile money instruments
that are so readily available. The investors or savers are much
more sophisticated today and you see this rapid movement from
one type of monetary classification to another, and I sense that it's
a bit stabilizing for the institutions as well as the general management of the money supply and the economy.
Mr. FELDSTEIN. Well, there certainly are problems associated
with deregulation. But we have to pay a certain price in terms of
uncertainty and difficulty of monetary management to get out
from a set of regulations that it is widely agreed have outlived
whatever purpose they might have served. I think we are doing the
right thing and that the Congress did the right thing in adopting
the deregulatory changes that they made last year, even though
they do make monetary policy more difficult at this time.
Senator LAUTENBERG. Thank you.
The CHAIRMAN. I have many additional questions for you which I
will submit in writing, but I'm also aware that you have to testify
before another Senate committee shortly and so I will let Senator
Proxmire do the cleanup today.
Senator PROXMIRE. Well, I'm just going to ask a couple questions
very quickly. One follows up what Senator Lautenberg was asking
about.
7-HOUR WORKDAY
If we are going to have 6.5 percent of the work force out of work
after a 6-year recovery, it would be almost an unprecedented period
of recovery even though it's a recovery at a modest rate. I'm pretty
sure what your reaction is going to be to this, but it seems to me
we ought to think about sharing the jobs we have. You're right
131
about the increase in the work force. We haven't had a change in
hours of work per day for 50 years. We accommodated to that
pretty well after we modified the hours of work. If we gradually
went to a 7-hour day, obviously you would have more jobs. If we
had double time for overtime you would have, from the best documents I've seen, about maybe 4 or 5 million jobs depending on how
you figure it.
I realize that there are all kinds of costs you have to bear with
that and I'm not advocating it in any way, but I think it's something we might think about in view of the gloomy notion that
we're going to have a lot of people out of work 6 years from now
even.
Mr. FELDSTEIN. I'm glad you're not advocating it.
Senator PROXMIRE. I'm not opposing it. I think you ought to look
at it.
Mr. FELDSTEIN. Well, I would oppose that. I don't think it really
deals with the problem. The problem is that more than half of that
6.5 percent unemployed that are going to be young people for
whom we have to find a better way into the system. Many of those
are people looking for their first job, coming out of school, and the
transition from school to work just has to be improved. Many of
them find jobs, lose them, take a little time off, find another job,
lose it, rather than finding a way of getting into a job with more of
a future.
Senator PROXMIRE. Nobody has argued that 6.5 percent is a frictional level of unemployment. We had less than 1-percent unemployment, if we included the Armed Forces, in 1944. Of course, we
had a lot of controls. It seems to me that's a pretty high level.
Japan has 2 percent. 6.5 percent is a pretty high level.
Mr. FELDSTEIN. Absolutely. I'm not saying it's a necessary level.
I'm saying I agree with you that we ought to be devoting more resources and thinking harder about how to bring it down. I just
don't think job sharing in the conventional sense or shorter hours
will do it. I think it's improving the work in the labor market and
removing some of the disincentives and barriers that stop different
kind of workers from staying employed longer. Reducing our whole
system of temporary layoffs would substantially reduce what could
be called frictional unemployment, which is almost uniquely a
North American labor market characteristic. We need to find ways
to keep those workers employed such as better inventory methods
and better incentives for employers.
Senator PROXMIRE. Very good. The only other question I have is
that isn't it kind of ridiculous for us to talk about any kind of a
jobs stimulus program on top of what we have. We face a colossal
increase in the deficit. Talk about stimulus—we go from $108 billion to $200 billion, a perfectly enormous effect that way. It seems
to me that almost any other kind of stimulus is going to have extraordinary effects the other way. If anything, a stimulus in the
long run must be viewed, it seems to me, as much, much too big. If
John Maynard Keynes could be recreated and come back here and
take a look at this, he would say, "You folks have gone too far. I
was talking about stimulus in periods of recession. To go from $100
to $200 billion, that's just too much." What's your reaction?
132
Mr. FELDSTEIN. I agree completely. I go and testify next at the
Senate Finance Committee and talk about unemployment. I'll read
one sentence from that in which I argue against Keynesian stimulative measures at this point and say even the most ardent Keynesian is likely to feel that a budget deficit of more than $200 billion
in 1983 represents sufficient fiscal stimulus. I think there is no
case for additional fiscal stimulus at this time and the danger is
that anything that appears to add permanently to our deficit will
be interpreted by the markets as a sign that Congress is not serious
about reducing the outyear deficits. That in turn will lead to
higher interest rates and be counterproductive.
Senator PROXMIRE. Thank you.
The CHAIRMAN. May I say in closing that I agree with both of
you. Not only is $200 billion not stimulus but my experience in the
time I've been here and I'm sure Senator Proxmire's too who's
been here much longer, when we come up with stimulative jobs
program they're almost always at the end of the recession.
Mr. FELDSTEIN. It is one of the good leading indicators of recovery.
The CHAIRMAN. If we were going to do them maybe 2 or 3 years
ago might have been the time to do them.
Thank you very much.
Next we'd like to invite before the committee Mr. Andrew Brimmer, president, Brimmer & Co.; John D. Paulus, chief economist
and vice president, Morgan Stanley & Co. of New York; and J.
Richard Zecker, senior vice president and chief economist, Chase
Manhattan Bank of New York.
Gentlemen, we are pleased to have you before the committee
today. We would appreciate it if you would summarize your statements. Your entire statements will be included in the record and,
Mr. Brimmer, if you would like to start off we would be pleased to
hear you at this time.
STATEMENT OF ANDREW F. BRIMMER, PRESIDENT, BRIMMER &
CO., WASHINGTON, D.C.
Mr. BRIMMER. Thank you very much, Mr. Chairman.
Senator Garn, Senator Proxmire, and the committee, I did file
ahead of time a copy of my statement. If you would permit, Mr.
Chairman, if you would put that in the record, I would appreciate
it. I would summarize the content very quickly.
Let me say at the outset that I want to praise the Federal Reserve for the posture it's just taken with respect to the conduct of
monetary policy. I believe that the requirements of monetary
policy are clearly enunciated. What we need is a monetary policy
that continues to assure that we will not have a rekindling of inflation, but at the same time, also makes a contribution to the
strengthening of an economic recovery that is still quite uncertain.
The Federal Reserve has indicated that it would plan to do that.
I would also want to emphasize that the outcome of this recovery
will depend substantially—and I want to stress that—will depend
substantially upon the actual performance of the Federal Reserve—aside from the announced posture the Board has just taken.
[Complete statement follows:]
133
MONETARY POLICY AND THE ECONOMIC OUTLOOK
Testimony By
Andrew F. Brimmer*
Mr. Chairman and Members of the Committee, I Wan pleased
to receive the invitation to comment on Federal Reserve monetary
policy and its likely effects on the American economy during the
rest of this year.
Since these Hearings are being held under the
terms of the Full Employment and Balanced Growth Act of 1978
(also known as the Humphrey-Hawkins Act), I will focus particularly
on the target set by the Federal Reserve for the growth of the
monetary aggregates during the current year.
I will also give
my appraisal of the outlook for employment.
Before turning to that analysis, I wish to say at the outset
that I believe the recovery from the severe recession that has
burdened this country since mid-1981 is finally underway.
At
the same time, however, the underpinnings of the economic recovery
remain extremely fragile, and the
vigor of the expansion during
the remainder of this year continues to be uncertain.
Moreover,
whether the expansion will gain strength or begin to sputter
before the end of the year will depend substantially on the level
of interest rates and the availability of credit.
The latter, in
turn, will depend on the course of monetary policy adopted by the
Federal Reserve.
* Dr. Brimmer is President of Brimmer & Company, Inc., a Washington,
D.C. -based economic and financial consulting firm. From March, 1966,
through August, 1974, he was a Member of the Board of Governors of
the Federal Preserve System.
134
Outlook for Ecpn onij^c Activity
The accumulating evidence suggests that the American economy
is beginning to pull out of the worst recession since 1937.
In
the final quarter of 1982, gross national product corrected for
inflation (real GNP} fell by 2.5 per cent at a seasonally adjusted
annual rate (SAAR).
per cent.
Over the full year real output shrank by 1 .9
Actually, at the end of 19B2 , real output in Che
United States was no higher than it was at the peak of activity in
the first quarter of 1980.
Furthermore, when actual output is
compared with what could be produced when the economy is working
at full employment, the stagnation of the economy over the last
three years stands out dramatically.
The shortfall accumulates
to approximately $450 billion in real GNP.
On a per capita basis,
real GNP decreased from $6,707 per person in 1979 to $6,348 in
1982 - equal to a decline of 5.4 per cent.
In one sense,the 1980 and 1981-82 recessions really represent
a single episode.
The sharp decrease in output in 1980 was followed
by only a very modest expansion through the summer of 1981.
At
that juncture, the recession began and it extended through the
end of last year.
All major sectors contributed to the sub-par
performance of the economy, but those segments chat are highly
sensitive to interest rates (such as housing and automobiles) bore
the brunt of the adverse impact of the recession.
During the current year, it appears that real GNP might increase
by about 2.5 per cent compared with the level recorded in 1982.
From the fourth quarter of 1982 through the same period this year.
135
the rise in real GNP might amount to around 4.3 per cent.
Compared
with the rebound from previous recessions, the expansion that is
now expected during the first year of recovery would be rather
anemic.
For example, assuming that expansion in economic activity
does get underway during the current quarter, over the first
twelve months of recovery, the increase in real GNP may amount to
roughly 4.0 per cent.
This figure would represent just over half
the rate of expansion recorded during the first year of recovery
from previous recessions.
The strengthening of economic activity now anticipated
for the current quarter will be led by housing and the
consumer sector.
However, personal income adjusted for taxes
and inflation (real disposable income) is likely to show
very little strength until mid-year.
This is a mirror of the
adverse effects of widespread unemployment on the growth of
wages and salaries.
Any significant gain in real disposable
income will have to await the final phase of the income tax
reduction scheduled for July of this year.
Given that
prospect, real consumer spending might rise by just over
2% per cent in 1983.
Outlook for Major Sectors
As mentioned above, the housing sector has borne
the brunt of high interest rates over the last few years.
In 1982, 1.060 million new units were started.
drop of 3.6 per cent from the previous year.
This was a
To meet the
long-term housing needs of the country, roughly 2.0 million
136
units should be begun each year.
This means that, over the
last three years, the shortfall in home, production amounts
to about 2.5 million units - a loss equal to over two-fifths
of potential output.
The linkage between high interest rates and the housing
sector is widely understood.
The sharp rise in interest rates
resulting from the Federal Reserve's restrictive monetary policy
- pursued from October, 1979, into the summer of 1982 cut the inflow of funds to savings and loan associations
(S&L's).
These institutions still serve as the principal
source of home financing.
In response, mortgage interest
rates also rose dramatically.
The increase in the latter out-
stripped the advance in disposable personal income, so the
number of would-be home buyers who could qualify for mortgages
shrank appreciably.
During the current year - if the Federal Reserve maintains its essentially accommodative policy - deposits at
S&L's might expand by 12.8 per cent (from $554.2 billion
to about $625.0 billion).
This would be a considerable im-
provement over the 6.3 per cent gain recorded last year.
In that environment, the average interest rate on conventional
mortgage commitments would probably be in the range of 13.0 to
13.5 per cent.
cent.
The average for 1982 was just under 16.59 per
The somewhat lower rate in the current year should
permit new housing starts of approximately 1.45 million units.
At that level, homebuilding activity would expand by roughly
137
39 per cent in 1983.
The automobile induct ry will also benefit somewhat from
lower interest rates in the current, year.
Re tail sales of
new cars might come to 8.8 million this year.
About 6.6
million may be domestically produced, and 2.2 million may be
import;, .
This would put the import share of the U.S. market
at 25.5 per cent.
country .
In 1982, 8.0 million cars were sold in this
I'ni ted States manufacturers produced 5 . 7 million
units, and 2.2 million were imported
which gave the latter
28.2 per cent of the U.S. market.
The high interest rates over the last few years have had
a noticeably dampening effect on the rate of capital formation.
For example, over the three years ending in 1979, real expenditures for business fixed investment
rate of 2.8 per cent.
expanded at an annual
But over the following three years,
the level of real investment was essentially stagnant.
In
1982, real investment actually shrank by 3.8 per cent.
In addition to high interest rates, the. large backlog
of excess capacity in industry has also weakened the incentive to invest in new facilities.
At the peak of economic
activity in the first quarter of 1980, the capacity utilization rate in manufacturing was 83.4 per cent.
But, by
December, 1982, the utilization rate had decreased to a record
low of 67.3 per cent.
In January, 1983, it rose 0.5 percentage
point to 67.8 per cent.
In 1983, real outlays for fixed investment may decline further - by perhaps as much as 7^ per cent.
Spend-
138
ing for equipment might decline by approximately 6.0 per
cent over the full year - although positive growth may begin
in the third quarter.
However, outlays for commercial and
industrial construction will probably decline throughout
the current year.
For the year as a whole, the decline might
amount to more than 10.0 per cent . This deterioration is
probably a reflection of the large margin of unused space
left by the office building boom of the last few years.
Prospects for_ Jobs
The labor market will probably show very little
improvement during the current year.
From the fourth
quarter of 1982 through the same period this year, the
civilian labor force might rise by roughly 1.7 million
persons.
Over the same period, total employment might rise by
2.0 million (to 101.1 million).
This improvement would
reduce the level of unemployment by approximately 300,000
persons (from 11.8 million to 11.6 million).
This would
mean that the unemployment rate would decrease from 10.7
per cent in the fourth quarter of 1982' to about 10.3 per
cent at the end of this year.
Further Abatement of Inflation
In 1982, inflationary pressures in the economy abated
considerably.
For example, the gross national product (GNP)
deflator (the most broadly based of the various price indexes)
rose by6.0 per cent. The consumer price index (CPI) increased
by 6.1 per cent.
Moreover, in the closing months of last year,
139
the GKP deflator rose by 4.3 per cent (SAAR), and the CPI
rose by 2.6 per cent (SAAR).
In marked contrast, in 1981,
inflation was in the neighborhood of 9^ to 10% per cent.
To a considerable extent", the slowdown in inflation
can be traced to the recession-induced weakness in the economy.
The latter, in turn, can be traced to the policy of severe
monetary restaint followed by the Federal Reserve.
Over the next year or so, the recent abatement in
inflationary pressure, is not likely to be erased.
The
large measure of excess capacity in industry (which is
likely to remain for some time) means that production can
be increased substantially without running into the
type of shortages and bottlenecks which would generate
upward pressure on prices.
Moreover, the low level of"
economic activity (not only in this country but in the world
at large) will continue to dampen the demand for oil.
This
means that there is little prospect of a sharp boost to
inflation from this source.
In addition, the underlying rate of inflation (reflected
in the tendency for increases in compensation to exceed gains
in productivity) will probably remain moderate for quite some
time.
The major concessions on wages and benefits which
numerous strong trade unions have made over the last two years
are not likely to be withdrawn quickly.
Consequently, the
rate of increase in labor costs will also most likely remain
quite moderate.
This, too, will help to ease any upward
140
pressure on prices.
Given that outlook, the rate of Inflation will probably
moderate further during the current year.
Both the GNP
deflator and CPI might rise by roughly 5.0 per cent.
Whole-
sale prices might advance by about 4 per cent, and wages and
benefits might increase by 5.8 per cent.
The latter would mean
a further easing in the underlying rate of inflation - to about
6.2 per cent.
Federal Government Fiscal Policy
The outlook for the Federal Government's budget is
extremely discouraging.
In fiscal 1982, Federal budget
outlays rose by 10.8 per cent to $728.4 billion.
In the
same year, budget receipts increased only 3.1 per cent
to $617.8 billion.
So the deficit jumped by 91.2 per cent
to $110.6 billion.
These changes raised outlays to 23.8 per
cent of GNP while the deficit climbed to 3.6 per cent of total
output.
The budget as finally adopted by Congress far fiscal
1983 projects budget outlays at $805.2 billion and receipts
at $597.5 billion - leaving a deficit of $208.7 billion. These
estimates would leave budget outlays and the deficit at 25.2
per cent and 6.5 per cent of GNP, respectively.
During the period of substantially reduced economic
activity over the last two years, the Federal deficit helped
to prevent demand from falling, as much as cutbacks in private
spending would have brought about i.
At the same time, however,
the deficits have exerted considerable pressure on the money
141
and capital markets.
For example, in 1981 net borrowing by
the Federal Government amounted to $77.8 billion.
The amount
of funds raised by all sectors came to $408.7 billion.
So
the Federal Government absorbed 19.0 per cent of the total.
The magnitude of Federal Government deficit finances
increased dramatically in 1982. Net borrowing by the U.S.
Treasury came to $150 billion while the amount of funds
raised by all sectors is projected at $400 billion.
These
figures suggest that the Federal Government absorbed 37.5 per
cent of the funds raised in the capital market last year.
Furthermore, net Federal Government borrowing in 1983 is projected at $195 billion, and total borrowing is estimated at
$456 billion.
Under this
scenario, the Federal Government
would still be absorbing 42.3 per cent of the total funds
raised by all economic sectors.
Federal Reserve Policy and Interest Rates
As indicated above, the outlook for economic activity and
interest rates during the current year will be influenced greatly
by the monetary policy pursued by the Federal Reserve.
And in
that connection, it is well to note that the Federal Reserve
has just
reemphasized its commitment to continue its campaign
to check inflation and to eradicate inflationary expectations
that are still deeply-rooted in many sectors of the economy and not simply in financial markets.
At the same time, however,
the Federal Reserve has also indicated that monetary policy
142
will be used to help assure the strengthening of economic
recovery.
In the meantime, the central bank has also expressed its
willingness to tolerate the growth of the monetary aggregates
at rates in excess of their long-range targets (which must be
set each year as required by the Humphrey-Hawkins Act).
It
will be recalled that, from the fourth quarter of 1981 through
the fourth quarter of 1982, the range for the narrowly defined
money supply (Ml) was 2% to 5% per cent.
For the broader money
supply (M2) the target range was 6 to 9 per cent.
For M3, the
range was 6% to 9% per cent, and for bank credit the range was
6 to 9 per cent.
The record shows that the actual growth rates
for each of the money supply measures exceeded the targets - with
the excess growth in Ml being especially noticeable. Before the
statistics were revised (to take account of benchmark
revisions
and definitional changes), Ml rose by 8.3 per cent; the increase
in M2 was 9.8 per cent, and M3 rose hy 10.3 per cent.
After the
revisions, the growth rates were 8.5 per cent, 9.2 per cent,
and 10.1 per cent, respectively.
The expansion of bank credit
{both before and after revisions) was 7.1 per cent.
To a considerable extent, the expansion in the monetary
aggregates (especially a rise in Ml) reflected a number of
dramatic innovations
in the financial system.
For example, the
expiration of "All Savers" certificates led many households to place
the proceeds - at least temporarily - in their checking accounts.
The rapid deregulation of ceilings on interes t rates payable by
143
financial Institutions was matched by the proliferation of a
variety of high yielding deposit accounts.
This led to considerable
turmoil as funds were shifted from money market accounts to
banks and other depositary institutions - as well as among the
latter.
These developments created a great deal of distortion
in the statistical measures of the monetary aggregates, and the
adjustments are still underway.
Moreover, the high level of unemployment, strains in the financial
system, and general uncertainty associated with the long recession,
all combined to expand the public's demand for liquidity.
This
latter development also contributed to the growth in the monetary
aggregates in excess of the Federal Reserve's targets.
The Federal Reserve chose to accommodate the increased demand
for liquidity, and it also decided not to try to offset the growth
in the monetary aggregates induced by the financial innovations
described above.
Federal Reserve
Both of these were wise decisions.
If the
had attempted to force the growth rates of the
monetary aggregates back into the target ranges adopted in early
1982, the necessary restraint on bank reserves would have been
so great that the economy would have been pushed even more
deeply int-n rpression; the eventual recovery would have been
delayed further, and the subsequent expansion would have been
even more anemic.
For the current year, the Federal Reserve has widened the
target range for the growth of Ml from A to 8 per cent compared
with a range of 2% to 5% per cent set for 1982.
However, because
144
of the distortion described above - as well as because of a
marked change in the behavior of velocity - the Federal Reserve
has indicated that it will put less weight on Ml as a guide to
policy in coming months.
That too is a wise decision.
For the time being, the broader measures of the money supply
(particularly M2) will serve as the principal guides for the
implementation of monetary policy.
In the case of M2, the boundaries
for the growth rate were set at 7 to 10 per cent.
In addition, the
base against which growth is to be measured was shifted from the
fourth quarter of 1982 to the average of February-March, 1983.
This move was designed to avoid much of the distortion created
by the shifting of funds into newly authorized accounts in
December and January.
The growth targets for M3 were reestablished
at 6% to 9k per cent - the same as last year.
comparison remains the fourth quarter of 1982.
The base for
This decision
was made on the assumption that M3 would he less affected by the
statistical distortions described above.
Finally, the Federal Reserve has introduced a new measure
which will be given some weight as a guide to monetary policy.
This is a measure of total domestic nonfinancial debt.
The
target range for the growth of this debt was set at 8% to 11%
per cent for 1983.
Although this measure was not adopted as a
firm target, the Federal Reserve does plan to track it during
the course of the year.
A considerable body of research
conducted by private economists does suggest that nonfinancial
debt does expand roughly in line with nominal GNP.
Consequently,
145
the use of this measure should enable the Federal Reserve to tailor
its monetary policy to help meet the credit needs of the economy
during the years ahead,
Concluding Observations
In conclusion, the posture adopted by the Federal Reserve
with respect to the conduct of monetary policy during the current
year is appropriate.
The greatly improved prospect for inflation
- and the persistance of an uncertain outlook for economic
recovery - does give the Federal Reserve a considerable margin
of safety within which to carry out an accommodative monetary
policy through the balance of this year.
It also means that such
a policy is unlikely to spark the kind of strong inflationary
pressures which the Federal Reserve has sought to check over the
last several years.
On the other hand, the threat of rekindling inflationary
expectations still exists.
A number of market participants are
apprehensive because they fear that above-target growth of the
money
supply (which the Federal Reserve has tolerated since
last summer and appears willing to accept for some time into
the future) will eventually lead to inflation.
reason is the persistence
An additional
of large federal budget deficits
(in the neighborhood of $200 billion, per year) extending well
into the future.
The need to finance these deficits has cast
a shadow over the nation's financial market.
Anticipating the
enormous Government demand for funds, investors in long-term
securities (especially pension funds and other institutional
146
investors) have modified their portfolio strategy accordingly.
They are afraid that the large deficits will stimulate renewed
inflation and exert upward pressure on long-term interest
rates . This expectation has induced them to concentrate a
disproportionate share of their currently available funds in
short- and medium-term issues.
This action helps to validate their
expectations of higher yields on long-term securities.
These expectations have also contributed to an exceptionally high level of rea!! interest rates - that is, nominal interest rates minus the rate of inflation.
Over the last several
years, real rates have risen substantially.
If such rates are
measured by the differential between yields on long-term AAA
public utility bonds and the rate of inflation (measured by
the 12-month change in the implicit deflator for personal consumption expenditures), the real rate climbed from 3.4 per cent
in 1976 to 9.1 per cent in 1982.
The sharp rise in the real rate
resulted initially from the fact that interest rates (after
lagging for a while) eventually climbed much more than the
rate of inflation.
Subsequently, once inflation began to
abate in mid-1982, interest rates also receded, but the decrease was less than the moderation in inflation.
As a result, the
real rate on long-term corporate bonds was still over 7.0 per cent
at the end of last year.
147
Nevertheless , despite the pessimistic expectations of r.iarkf1_ participants, the Federal Reserve ought to stay with its accommodative
monetary policy through the current year.
It should keep in mind
the expectations currently held by other important elements in
the economy.
These are the key officials in industry and commerce
who make the decisions affecting real output, capital formation,
and the creation of jobs.
They need - and expect - lower long-
terai real interest rates to help stimulate and sustain economic
recovery.
To enhance the prospect of achieving this goal, the
Federal Reserve should stay with its policy of lessened restraint
for a while longer.
The CHAIRMAN. Thank you, Mr. Brimmer.
Mr. Paulus.
STATEMENT OF JOHN D. PAULUS, CHIEF ECONOMIST AND VICE
PRESIDENT, MORGAN STANLEY & CO., INC., NEW YORK
Mr. PAULUS. Thank you, Mr. Chairman.
[Complete statement follows:]
148
Testimony c£ John D. Fauius
Chief Economist, Morgan Stanley & Co., lac.
before the Committee on Banking, Housing and Urban Affairs,
'Jn.it.ed States Senate
February 16, 1333
I am pleased to have -he opportunity to ccrritent on the
conduct of mcne -ary policy before the Committee on Banking, Housing
and 'Jrban Affairs.
^-.iMtiun:
I will consider principally the fcllowing
now stimulative nas monetary policy become?
.he
related issue of the prospective level of interest rates that might
be consistent witn a sustainable economic recovery also is discu sse;
Evidence and arguments supporting the following statements
will be presented;
!lj in recent months the monetary aggregates
have been unreliable indicators of the
effect of monetary policy or. the economy.
Monetary _policy has_been less stimulative
then the aggregates would seem to imply.
with the process of cyclical recovery just
beginning, the likelihood of a significant
rise in interest rates over the next few
months, therefore, is small.
149
. 2; rhe Federal Reserve must rake account cf
tne difficulty of raising interest races
after recovery has begun, but un employ—.en t
is still high., in determining how low to
rr.cve rates before a recovery is assured.
Letting rates drift too lew couid Jock
monetary policy into too sti.T.ulati'/e a
stance if the economic recovery is
unexpectedly _st_rcrig..
i 3 ) D e sp i te .the f_ac_t _that real interest
rates still are hi_gh_by historj-cal
standards, they probably have dropped
enough to produce at least a modest
economic recovery.
This does not,
of course, rule out further declines
in snort-tern interest rates.
The upsurge in mor.etary growth in recent months has raised
concerns that mor.etary policy has become excessively stimulative.
This in turn has aroused fears in the credit markets that interest
rates soon could be moving significantly higher.
Ar. uncritical reading o- the performance of the monetary
aggregates would support the view that policy has rr.cved sharply towarc
stimulus.
Growth in the monetary base accelerated late i.", 1982, M-l
150
has grown at a double digit pace during tne last half dozer, months,
and M-2 had overshot its target in 1982 before exploding last in or. th.
Bat there are persuasive reasons for ignoring^ cr discounting, .T.uch
The monetary base has not been a reliable indicator of -he efrect
of ~onetary policy en the economy.
Shown in Figure 1 is the weekly
level of the base for 1932 and January, L9S3.
The free har.d line is
drawn to sraocth the week to week zigs and aags in the base.
of this line -- representing the growth rate of the base —
tially unchanged ever the 13 months shown.
The slope
was essen-
Indeed, base growth, as
shown in the chart, suggests that monetary policy was no dif ferer.t ir,
the secor.d half of 1982 than in the first half.
Giver, the inability
of the base to capture the significant alteration in policv that
began in August, base growth hardly can be tax:er. seriously as an
indicator of the degree of ease or restraint in monetarv oolicv.
190
IBS
151
Similarly the most reliable of the aggregates, M-l, has virtually
broken down as an indicator of monetary policy.
It is true that M-l
grew at a 17% annual rate in the fourth quarter of 1983 and grew
strongly last xionth.
But it appears that much of the growth in M-l
was due not to a build up of transactions balances (i.e. .T.cr.ey to be
spent), but to an inflow of investment funds ir.tc M-l.
After adjustin
for this inflow, recent M-l growth does not appear excessive.
Inflows of nontransactions balances into M-l can be estimated
by deterrr.inir.g hew fast the demand for transactions balances by the
public should have grown, giver, actual changes in spending and interes
rates, and comparing that growth rate with the actual.
real GXP, and short-term interest rates —
Such a
it appears that less than
half of the 17% growth in the fourth quarter can be attributed to a
buildup in transaction balances.
nontransactions balances
The rest represented inflows of
(such as maturing all-savers certificates
being rolled into NOW accounts and savings monies moving into SCWs) .
But that portion of the growth of M-l that was due to such ir.flows
where m/p is real -tioney balances, RTB is the 3-month Treasury
bill rate, RS is the rate on passbook savings, and y is real
GNP. The equation was fit from 1960, fourth quarter through
the second quarter of 1974. The "simulated" growth rates for
1982 shown ir. Table 1 are based on a dynamic simulation of this
equation.
152
TABLE 1
(Percent Growtn, Annual Rate)
1932 -I
10.3
7.1
3.7
1332 -II
3.3
7.1
-3.3
1932 -III
3.5
3.2
-4.7
17.1
7.9
9.2
3.7
7.6
1.1
1982 -IV
1932 (QIV-Q1V)
has little to do with current and future spending plans and, in
principle, should not be counted as a part of "true", M-l growth.
The outsi zed growth of M-2 in January, of course, was largely
attributable to a massive inflow of funds into the new money rr.arket
accounts (MMA's) from financial assets not included in M-2.
But even
before MMA's were introduced, M-2 had become an entirely unreliable
indicator of monetary policy.
Before six-month and small saver
certificates were introduced 1973 and 1979, and before money market
funds became popular in 1979, a tighter monetary policy could be
expected to result in a slowdown in M-2 growth, and an easing in policy
a speedup, as movements in market interest rates around bank deposit
ceilings produced either disintermediation or reir.termediation.
153
.-icwever, aespite the progressive tightening of -or.etary policy
and higher ir.terest ra^es in L379, 1980 ar.d 1931, M-2 growth acceleratec
fror. 5.2i ir, 1978 to 3.4% ir. 1979, to 9.2* in 19SG and to 9.5i in 1981.
In 1^32 M-2 grew by 9.34,
If anything M-2 has become a pervecsjs
indicator of monetary policy, rising r.ore rapidly wner. policy is
tightened.
Consequently, rapid growth in M-2 should not send chills,
as it seme times has of late, tnrough the financial market5.
Thus, the recent strong growth of the major monetary aggregates
does not necessarily imply that monetary policy has become excessively
stimulative.
In tact, there are good reasons for doubting the reli-
ability or the aggregates in recer.t months in reflecting the degree
of ease or restraint in monetary policy.
To obtain jiore ccncl-sive
evidence en j ust how stimulative monetary policy has become it is
necessary to examir.e other, nonir.one ta ry, indicators of policy.
II
Some Key Monroonetary Indicators Of ?olicy_
Ultimately, of course, the 310st meaningful .-teastire of the effect
of .TJO.ietary policy on the economy is tne growth rate of nominal GKF.
It now appears that real GMP will expand ir. the first quarter as botn
a .itos and housing rebound from their depressed fourth quarter levels
ar.d ir.ventcry liquidation abates.
Nominal GHP therefore should rise
"Growth in M-2 appears to be influenced by changes ir. the savings
rate and the unemployment rate. When che savings rate rises,
the pool of savings is enlarged and M-2 grows T.ore rapidly.
Wher. the unemployment rate rises, individuals, perhaps fearing
job losses, desire to increase their liquidity. This too raises
M-2 growth. But when monetary policy is tightened,both the
savings rate and the unemployment rate tend to rise, sending
M-2 -rcwth UD.
154
at its most rapid pace in over a year during the curre.it quarter.
However, the likely increase —
8* or 93 at an annual rate —
is not
particularly rapid for the first quarter of ar. economic recovery.
Moreover, only partial data are available for estimating GNP
growth.
Hence it is helpful to examine a trier noiroonet.3.ry indicators
that are available on a more timely basis ir. trying to come to a
judg.-nent on the current degree of stimulus in monetary policy.
Four such indicators are displayed in Table 2:
real interest
rates; private borrowing (divided by GMP'i ; percent changes in commodities prices; and the foreign exchange value of the dollar :March 1973=
100).
Current values of the indicators are shown in the first column
of the table.
For comparison, in the second column is shown the
average value of each ir.ciica.tcr during the trough quarter and the
first quarter of recovery of each of the last three recessions.
In
the third column are values of the indicators during the 1976 to 1979
period when monetary policy was excessively stimulative.
3y comparing
current values of the indicators with those in columns 2 and 3 we can
determine how stimulative monetary policy has become relative ^o
earlier recoveries and relative to the period of excessive stimulus.
Real interest races now are Higher than during comparable stages
of earli-er recoveries (column 2) and the period of excessive monetary
stimulus (column 3) .
This would suggest that policy is nowhere near
as stimulative as it was during the early stages of the last three
recoveries or in 1976 to 1979 when policy was excessively stimulative.
155
NOHMOHETARY INDICATORS OF MONETARY POLICY
Ave. Of Trough i First
Stimulative
Latest
Observation
Real Commercial
Paper Rate 1 1 J
3.4
Private Borrowing
(Divided by GrJP)
9.0
Commodities Price
Growth
6.7'
117.:
The ratio of private borrowing (i.e., by households, r.on-financial.
corporations and state and local governments) to GNP has been a reliable
indicator of monetary policy, generally being high when policy has been
easy and the economy has been growing rapidly, and low when the opposite
was true.
In the third quarter of 1982 the ratio was 3.3%.
Since then
it probably hag moved up, partly reflecting an increase in mortgage
and consumer installment
borrowing.
156
The current estimate c; the borrowing ratio, 9.0%, is close to its
average for similar stages of previous economic recoveries.
But it
is well below its average for 1976 to 1979 when policy was too
stimulative -
The credit markets thus are not yet signaling excessive
stimulus in monetary policy.
This is hardly surprising, giver, the
current relatively high level of real interest rates.
The last two indicators try to capture the effect of "J. S. monetary
policy on the external sector of the U.S. eccr.omy —
exports minus imports.
net exports, or
The first, commodities price growth, represents
aro.eaau.cecf world -demand for goods, and therefore for "J. 5. exports.
It is influenced by U.S. monetary policy.
When U. S. policy is tight,
wcrld demand weakens and commodities prices grow more slowly or decline.
The demand for U.S. exports weakens in concert with the drop in world
demand.
The second, the foreign exchange value of the dollar, measures
more directly the influence of U.S. policy on net exports.
Market sensitive commodities prices have moved up over the last
half dozer, weeks.
This is in contrast to their behavior during the
three earlier recoveries when they continued to decline.
The increase
in commodities prices, following a 35% decline over the previous two
years, is less robust than during the 1976 to 1979 period when such
prices grew at a 10% annual rate.
Nevertheless, the recent pericrmar-.ee
of commodities prices seems to suggest that the easing of U.S. monetary
157
policy is beginning to be f ei - around the world.
.-.1 i t.-.ir.gs sq-a
this should help to stimulate U.S. exports.
Despite its decline over the last three months, the dollar remains
nigh compared to its level during the early stages o: the recoveries
from the 137D, 1974 ar.d 1330 recessions and compared to its average
!
level fror:, 1376 tc 1979.' The strcr.g dollar thus will act as a brake
en the U.S. recovery.
The £our ncnflior.etary indicators present a mixed picture of t.ie
degree of stimulus in -.S. monetary policy.
On the one hand, the rise
in corriTTLodities prices implies policy has moved toward ease.
3ut, or,
the ether, the continuing lew level of private sector borrowing ar.d
the relatively nij-h level of real interest rates ar.d ;he high vaijc
of the dollar suggest monetary policy has not become excessively
sti~-jla~ive.
The stronger, but apparently still moderate, pace of
GUP growth in the current quarter supports this judgement.
The absence cf excessive stimulus in U.S. monetary policy
indicates that interest rates are unlikely to rise much if at ail 1.1
ziie next few months.
Moreover, a further decline in short-terx
interest rates would not appear to be inappropriate ir. the months aheac
""Of course the value oi the Cellar in 1385 is r.ot strictly
comparable to that of earlier periods because U.S. inflation
has been lower on average than that of the rest of the
developed wor U during c.ie -last decide. The dollar,_ there fore ,
should be nigher or, average against the currencies of other
inflation differential, the dollar still is vcrv sereno.
158
interest rates and the foreign exchance value of the doMar, decisions
to lower short-term interest rates must take account of an asymmetry
in the attitude of the public toward rate movements when unemployment
is iriieh.
It is always easy to move rates down, but difficult to move
them back up after even a strong recovery has begun.
An overzealous easing of interest rates runs the risk of "trapoinc
the Fed with rates too low in the event a surprisingly strong recovery
should suddenly emerge.
Even a strong recovery, it mast be remembered,
would leave the level of unemployment very high in 1983 and, as a
consequence, would not relieve pressures on the Fed tc held rates dcwr..
Indeed, as long as a surprisingly strong recovery cannot be ruled cut,
political constraints .-nay effectively prevent the Ted from. Lowering
rates to desired levels before the economic recovery is assured.
There is a second, strictly economic, reason for not rushing
to lower interest rates.
Although real rates still are high by
historical standards, they are much lower than they were on averacie
last year.
The significant decline in interest rates ever the last
few months probably is more important in determining the change ir;
economic activity than is the still high level of rates ^see
Stepnen Roach, "The 19S3 Recovery:
Its Evolution and Durability1',
Morgan Stanley Economic Perspectives, February S, 1933).
The drop
in rates to current levels may well be sufficient to assure a moderate
rise in economic activity in 1983.
159
Formally the effect cf a decline- 1.1 interest rates en real ^utpu:
can be see in Figure 2.
The downward sloping line indicates that the
higher the leve_l c£ real interest rates, the Icwer will be the j^evel
of real output, relative tc its potential.
Virtually everycr.e wo-1.1
accept this se.isiale relationship between the level o; real ir.-ersst
rates and t>.e level of output.
But interestingly the relations.Tip
implies thac lowering real interest rates from a very high level to a
lower bu^ s-ill high level raises the level of output -- i.e. i~
produces positive growth even chough the level of real ir.-ercst r-j_es
S-^-'-i is high.
This implies that rates of change in o_;-.: : '__.'.;
160
The analytics implicit in Figure 2 car. be applied tc the outlook
for economic activity ir. 1983, 51 yen f.-.e ~ jrren:: level of real in ceres'
rates.
Let "r^ be the "normal" level of real rates at the end of the
first year
of a recovery.
*
'
The dros~ in rates from " r~S -.to
"r'AD-snould
c.
->
induce a positive movement in real output, relative to potential,
real races during a recovery.
But, it is inheres ting to r.ote, the
level of output achieved in 1933, "y", still is well below tr.e ''r.cr™..
ii 3
This lower level 01 o jt^'Jt in
levej. "y" -cr an economic recovery.
1983 is the result cr real interest rates remainir.a abo'.-e aerial..
The situation depicted in Figure 2 in fact is ye:tfectl-_- consistent with Morgan Stanley' s 19 33 outlook for pasiti'.'e grc^tr. i.-. real
output, bu; co a level well below normal for the lirst year of an
economic recovery.
For example, capacity utilization now is about
5S%, well belcw normal for a business cycle trough.
If real GNF
should grow by 1 1/2 i (fourth quarter to fourth quarter; , as we are
forecasting, capacity utilization «iil rise only to about 72* by
the end cf 1933.
This wo^ild be well below the utilization rate
.-.crmally reached after tr.e first year of a recovery. This lower l_evej
cf economic activity at the snd of 198J, and not zero cr negative
growth for the year, is the price t::at will be paid for holdi.-.g real
interest rates above their norr^s duri-g 1933.
161
The CHAIRMAN. Thank you, Mr. Paulus.
Mr. Zecher.
STATEMENT OF J. RICHARD ZECHER, CHIEF ECONOMIST, CHASE
MANHATTAN BANK, NEW YORK
Mr. ZECHER. Mr. Chairman, in my written testimony which was
written before Wednesday, I laid out some options that I thought
the Fed faced this year in terms of conduct of monetary policy.
Since writing it, I have had the opportunity to study Chairman
Volcker's testimony on Wednesday—and I must say in agreement
with my friend Andy Brimmer that I'm in almost total agreement
with the statement of the policy goals for 1983 stated in that testimony. I think that if that policy is followed in 1983 with the degree
of agility that will be required within the parameters set out in
there that we have in prospect a strong sustainable noninflationary
recovery in 1983 and beyond with the prospect also of falling interest rates over that period.
However, I would point out that carrying out the policy has been
the biggest problem that we have faced with monetary policy in
these past 10 or 15 years. It's not that the statement of policy has
been inappropriate; it's been in the carrying out of the policies. So
I think we are not out of the woods yet, but I'm really delighted to
support Chairman Volcker's statement on Wednesday.
What I'd like to do is take my very brief time here to highlight
just a few points from my written testimony and then turn to a few
issues in Chairman Volcker's testimony with which I'm in very
complete agreement and also one with which I have some disagreement.
Let me first take just a minute to put monetary policy in some
historical perspective. I think it's always useful to look where we
have been when we are trying to figure out where we should go.
[Complete statement follows:]
STATEMENT OF J- RICHARD ZECHER, SENIOR VICE PRESIDENT AND CHIEF ECONOMIST,
CHASE MANHATTAN BANK
Mr- Chairman and members of the Committee, I am J, Richard Zecher, Senior
Vice President and Chief Economist of The Chase Manhattan Bank. I am pleased to
be here to testify on the extremely important matter of the conduct of monetary
policy. While rny remarks range over a number of issues related to monetary policy,
my main focus is on our recent monetary experience and the choices that we now
face.
Monetary policy has gone through three distinct regimes since World War II. The
first began shortly after the war and had, as a centerpiece, the fixing of the dollar
in terms of gold and the fixing of many other currencies in terms of the dollar. This
period, from the late 1940s to the late 1960s, was characterized by relatively low
inflation and interest rates and by a relatively rapid expansion in economic activity.
The second monetary regime was marked by the severance of the dollar from gold
in 1973, and by the two oil-price shocks of the middle and late 1970s. This period,
from the late 1960s to 1979, experienced considerably higher average levels of
money growth, inflation, and interest rates than were common during the earlier
regime. By 1979 the developing trends for money growth, inflation, and interest
rates—-and the associated decline in the international value of the dollar—forced a
change to a third regime.
The third monetary regime extended roughly from October 1979 to about midyear
1982. A commitment to reduce growth rates in the monetary aggregates, and to reverse the accelerating inflation of the 1970s, was made in 1979 and carried out in
large measure during the period extending to last summer. However, the implementation of the policy was far from smooth, intensifying the volatility in interest rates
and the extended period of slack in the economy that was expected to accompany
disinflation.
For a variety of reasons—discussed in my statement—money growth since last
summer has been very rapid. Given the events of this period, the Fed was faced,
with two choices: (a) accommodate this rapid expansion of monetary aggregates by
generating the required growth in the monetary base or (b) apply the monetary
brakes again, slowing growth tn the aggregates but in the process causing another
interest-rate cycle. The Fed chose in this case to abandon its aggregates targeting,
thus ending the third monetary regime since the War.
The question now is what policy regime will replace the old one. Will monetary
policy drift back toward the interest-rate targeting that led to the crises of the late
1970s? Will it return to a modified aggregates policy thai eliminates some of the
worst implementation problems of the 1979-82 period, but retains the critical longterm commitment to low inflation through low money-growth rates? Or will it
simply drift?
DISINFLATION
In October 1979 the Federal Reserve initiated a monetary policy designed to
reduce the rate of inflation in the United States. The policy was supposedly a "monetarist" strategy, i.e., a policy designed to set targets for long-term money growth
and to adhere to those targets. The cost of achieving these targets was expected to
be wider interest-rate fluctuations. The idea was that the Fed could pursue an aggregates targeting policy, allow for wider fluctuations in short-term interest rates,
and curb the inflation rate—providing eventually lower interest rates with a stable
growth path for nominal income.
The policy was stated to be monetarist, but its implementation did not please the
monetarists. All of the institutional mechanisms of money control that existed
before the implementation of the "monetarist" policy continued to function. The
methods used to target the aggregates were those developed under the interest-rate
targeting. One has to conclude from this experience that aggregates targeting
during 1979-82—given those institutional constraints—did not achieve its goal of
minimizing the fluctuations of money growth and did not achieve its goal of minimizing the fluctuations in nominal income. But it did achieve its goal of lowering
the rate of inflation.
An important corollary of U.S. disinflation, particularly useful for understanding
the global recession of 1980-82, was that other major OECD countries also have
sharply cut tbeir inflation rates since 1980. While U.S. inflation dropped from 13.5
percent in 1980 to a rate of 3.9 percent in 1982, inflation in the United Kingdom fell
from l(i percent to 5.5 percent, and Japan's from 8 percent to around 2.5 percent.
The markets did not believe until quite recently that these disinflationary policies
would be successful; even the central bankers initiating the policies around the
world did not expect them to be quite as successful as they were. In part because of
that gap between belief and reality, interest rates rose sharply while inflation expectations did not come down as rapidly as they otherwise might have. Long-term
interest rates consequently were too high to help soften the impact of the rise in
short-term rates. Uncertainty about future inflation increased, and high real interest rates contributed to the lower global output experienced during the disinflation.
The October 1979 experiment was a disinflationary policy. The abandonment of it
in late 198^ may mean an end to the process of disinflation. Given the institutional
arrangements under which the Federal Reserve operates, the rapid decline in interest rates experienced last summer guaranteed that there would be a rapid rise in
money growth that would eventually pierce the upper target. A major question was
whether the authorities would respond to above-target money growth by tightening
monetary policy. Recent experience indicates that the answer, so far, is no. But how
long they will be able to ignore the rapid rate of money growth, should it continue,
remains an unanswered question.
The view that money growth may be very moderate in the coming months is, fortunately, more than just wishful thinking. Given the Fed's operating procedures, a
period of very slow money growth is in fact highly likely. Three transient influences
explain most of the rapid growth in money since last summer. The first—the rapid
decline in interest rates and the Fed's response—ran its course by December. The
other two, involving the introduction of money-market and super-N.O.W. accounts,
have caused distortions in the monetary aggregates that we believe will be largely
dissipated by the end of February. Of course, if this analysis proves wrong and the
aggregates continue to grow rapidly, inflation will once again return to the center
stage of our concerns.
A L T E K N A T I V K COURSES
1
Having abandoned monetary targets in the last half" of 19*2. the Federal Reserve
is now perceived by many to be adrift. The problem with abandoning monetary targets is that there now is no guide for evaluating long-run Fed policy. Under aggregates targeting one knew something about the long run, even if there remained tremendous uncertainties about the short run. Today we have the opposite problem.
We have short-run stability in financial markets relative to recent experience, but
we are paying for it with greatly increased uncertainty about the long run.
The issue, then, is whether the Fed has a better alternative than the aggregates
policy that it pursued from October 197-9 to October l,f)&>. 1C the only other choice is
merely a return to interest-rate targeting as it was practiced in the 1970s, then
there is no viable option at all.
The recent behavior of the monetary aggregates is consistent with several possible
courses the Fed may have chosen to pursue. The market is now attempting to judge
which strategy will eventually be followed by the authorities. At least three interpretations are feasible: aggregates targeting, interest-rate targeting, or aimless drift.
First, money growth and the behavior of both short- and long-term interest rates
have been consistent with a monetary-aggregates policy predicated upon the belief
that inflation is under long-run control. In this view, inflation expectations, have
fallen sufficiently to allow the level of the money stock to increase once and for all,
for the temporary reasons detailed above. After a period of adjustment, a new set of
aggregates would be announced and a continuation of the earlier aggregates policy
could he reinstituted. Second, the recent rise in the stock of money—including the
monetary base—is consistent with an interest-rate targeting policy that may or may
not prove to be inflationary. And third, the recent experience is perfectly consistent
with no policy at all—that is, with a monetary authority adrift, searching for direction after abandoning an approach that was proving to be too costly.
Beginning with the last interpretation first, there is a danger that this view of a
floundering Federal Reserve may become the accepted wisdom of the market. Such
a course for the Fed—one dictated by fears of Congress, of the White House, or of
other political constituencies—is fraught with uncertaintly. It would open the economy to a multitude of problems. The most severe problem is similar to that of the
early 1930s; indecision during a time of perceived or real crisis. With the authorities
adrift, it is possible that the investing and saving public would have to deal with
uncertainties large enough to abort the incipient recovery and trigger another recession.
If the second interpretation--that the Fed has returned to interest-rate targeting—proves to be correct, this course could lead to any of three possible paths. Depending on how it is handled, it could prove to be inflationary, it could prove to be
deflationary, or it could prove to be neither. The trouble is that there is little basis
for forecasting the ultimate effects of such a strategy. Given the experience of the
1970s, one might expect this type of policy to be inflationary. But this conclusion
may prove to be wrong, just as the expectation (embodied in long-term interest
rates! that policy was not going to be inflationary during the 19COs was proved
wrong. In either case, the policy does not lend itself to predictable results beyond
the immediate period.
The first course—a return to some type of aggregates targeting—appears to be the
only logical long-run strategy for the Fed to pursue. The system needs to be firmly
anchored by a credible Federal Keserve anti-inflationary policy. The markets must
have information about the long-run direction of policy in order to make long-term
investment decisions. This does not mean a return to the experiences of the October
1979-October 1982 period, and it does mean an assurance to the public that an aggregates-targeting policy is being adhered to in the long run.
REAL ECONOMIC ACTIVITY
Because of the fragile state of the incipient economic recovery, the choice of a
proper course for monetary policy is now of the utmost importance. In 1979 there
were two major shocks to the world economy: a shift to disinflationary policies and
a dramatic increase in oil prices. Both shocks did much to contribute to the past
three years of stagnation in the U.S. and global economies. The oil-price increase
has had a more-permanent effect on U.S. economic activity, lowering our long-run
potential real growth path by reducing the economic efficiency of our capital stock
and our workers.
Nevertheless, there are growing signs that the economy at last is beginning to
pull out of the recessionary period of the past three years. In the industrial sector,
the stage is set for a fairly sharp upturn in production. New factory orders have
164
been on an upward trend for the past few months. At the same time, inventories
have been cut at a record pace. Thus, manufacturers are likely to meet any increase
in demand by quickly increasing production to replenish stocks for future sales. The
auto industry is a prime example. Sales of domestic makes in the last three months
are running 10 percent ahead of the previous three-month period, and production is
up more than 20 percent from its low in November. Construction has also shown
dramatic gains. Housing starts are about 20 percent higher than a few months ago,
and nearly 50 percent above their year-ago level.
To be sure, not all the news is so cheerful. Other than cars, retail sales have been
somewhat lackluster. And business spending for new plant and equipment continues
to fall. On the other hand, an unquestionably bright spot is the progress made
against inflation. January's record 1.0 percent decline in producer prices brought
the year-over-year gain down to just 2.1 percent, while consumer prices posted only
a 3.9 percent increase during 1982. For both measures, these rises were the smallest
in a decade. Taken as a whole, our reading of the current indicators of economic
activity suggests that this quarter should show positive economic growth, and that
the prospects are good for growth in real GNP of 4 percent or more between the
fourth quarter of 1982 and the fourth quarter of 1983.
As with all economic forecasts, events may unfold quite differently than assumed.
For example, there is one big positive risk to this forecast. We may now be seeing
that the oil-price shock, which we argued caused the United States to move to a
lower output path, was a temporary phenomenon. We may be learning that the
large and rapid responses of industry and consumers to the relative-price shifts
have been sufficient to ensure that relative oil prices in the United States during
the 1980s will be similar to those of the pre-1979 shock. If this is the case, then we
may be underestimating the U.S. potential-output path. The dynamic readjustment
to a higher potential output would mean that 1983 and 1984 taken together could be
a period of very strong real growth, compared with past recoveries from recessions.
Such an event is not totally unlikely.
On the other hand, the negative risks to our forecast are large as well. In fact,
those combined risks are greater than any risk of our underestimating the level of
potential output. First, as noted earlier, there is a great deal of uncertainty about
the course of monetary policy. Second, there is at least as great a level of uncertainty about the course of federal spending, taxing, and deficits in the United States.
Third, there is heightened uncertainty about the commitment of major trading nations to free trade. Fourth, there is uncertainty over the ability of the international
financial system to withstand additional shocks of the type experienced in 1982. Several of these risks have global implications.
First, a major risk is that a reignition of the world's economic engine could result
in a coordinated acceleration of inflation, much as the policies of 1980-82 resulted in
a coordinated disinflation. Just as the public was fooled about how quickly inflation
came down, the public could likewise be fooled about how fast inflation starts up
again. This would lead eventually to a rise in interest rates—both nominal and
real-—from their already high levels, and depress investment and other interest-sensitive expenditures.
Second, events of the past four years, particularly disinflation and the oil-price
shock, have been as debilitating to governments—in their abilities to manage spending, taxing, and deficits effectively—as they have been to the private side of the
global economy. Government deficits are everywhere large, and present serious
problems to virtually every national government. Public spending and revenue programs have deviated widely from budget plans both domestically and abroad, in
large measure because of unexpected disinflation and the extended worldwide recession. The degree of success in regaining control over government spending and borrowing requirements will become increasingly important as the private economy recovers.
A third threat to recovery concerns the cries for protectionism, which may abort
the recovery of world trade that is so critical to a healthy recovery in the United
States, as well as in the other OECD countries and the developing world. While the
threat of destructively competitive protectionist moves and countermoves has diminished somewhat in recent months, it continues to pose a serious problem for a
normal economic recovery.
A fourth downside risk is related to the possibility of an international liquidity
crisis. While any analysis of the prospects for economic recovery must take this possibility into account, much progress has been made in understanding the dimensions
of the risk and the steps that must be taken by each of the major participants in
order to contain this risk. As outlined by Chase Manhattan Bank Vice-Chairman
William B. Ogden before two Congressional committees recently, there is every
165
reason to believe that the international liquidity problems that became highly visible in 1982 can be contained.
SUMMARY
Monetary policy is at a crossroads. Policies of the past three or four years have
failed to bring stability and economic growth, but they have succeeded in breaking
the depressing cycles of ever-accelerating inflation of the 1970s. The economic costs
of breaking the inflationary cycle have now been paid in terms of high unemployment and lost output. By reaffirming the principle of aggregates targeting as a longrun strategy, the Federal Reserve can maintain its hard-won credibility and preserve the gains that have been made at so high a sacrifice.
Mr. ZECHER. I'd like to point out three things with which I am in
total agreement and support in his statement.
The first concerns his economic forecast for the assumptions
under which monetary policy is now being planned for 1983.
Certainly, I agree that the recent evidence suggests that the recovery is underway and that we should look for real GNP growth
in 1983 in the fourth quarter over fourth quarter base of at least 4
percent. I also agree with his inflation outlook which is lower than
many in the 4-percent range. I think those are the best planning
assumptions one can use right now.
MONETARY POLICY MUST WALK TIGHT LINE
Second, I also agree with him in terms of the dangers he sees in
conducting monetary policy in 1983. First of all, the economy is
well on a recovery path, though extremely fragile. Monetary policy
perhaps more than in any other time in recent history must walk a
very tight line in 1983. He points out and I certainly agree that
there are large short-term costs—and short-term is perhaps a flippant way to put this because it has to do with recovery—short-run
costs of either going too fast or too slow with money growth in
1983. Too fast a growth will lead to a runup of long-term rates and
I would expect also in short-term rates in 1983 which could abort
recovery that we now see developing. Too slow a growth, on the
other hand, would not supply liquidity to the economy to support
nominal income growth in the 8- to 9-percent range that he feels is
necessary.
In the longer run, of course, if this monetary growth is too fast
and inflation expectations are rekindled, and in fact materialize in
1984 and beyond, then the horrible price that we have paid since
1980 in terms of lost production, in terms of unemployment, will
have gone again for nought.
Third, the policy uncertainty that he sees and focuses on in his
testimony can be summarized essentially in one question. What
will velocity do in 1983? No one in this room I'm sure knows the
answer to that question. If he did, they certainly should share it
with everybody else.
Given the uncertainties about velocity and in particular whether
velocity will behave in this recovery as it has traditionally in the
past, that is increasing above its long-term current rate, remains a
very open question because of all the other things that are the subject of this hearing and you have been discussing and what effect
they will have on velocity in 1983.
18-014 O—S3
12
166
I think given these uncertainties that the ranges that the Chairman set out on Wednesday are entirely appropriate but again I
would say the important thing will be how they are carried out
over this year and for that reason I was particularly glad to see
that the Fed will be reviewing on an accelerated schedule the development of monetary policy this year from their normal 6-month
review.
The one issue—and this is my last point—on which I would raise
some disagreement with the Chairman concerns introduction of a
new target or new potential target for monetary policy guidance
and that was the broader credit aggregate. I have a number of
problems with this particular variable. Some are technical problems and some are problems in theory. I'll just mention a couple.
Technically, the numbers that Chairman Volcker pointed out on
Wednesday to support the measurement of this aggregate are not
now very good and they are not now very timely. That's a fairly
minor objection compared to the other.
The other is a theoretical objection which takes note of the fact
that the Fed doesn't really control this aggregate even though it
may be closely related to total nominal GNP growth over time.
In general, my views on this aggregate are summarized by an old
Chinese proverb which says the man that has one watch always
knows what time it is; the man who has two is always in doubt.
That's the conclusion of my statement.
The CHAIRMAN. Thank you very much.
Mr. Zecher, what's your opinion of postponing the contemporaneous reserve accounting until 1984?
Mr. ZECHER. Well, I think the operating procedures that I referred to in several places in my oral and written statement focus
on this issue in particular. I think this is a desirable change even
though it will impose additional costs on my institution as well as
banks generally. It is after all the way that we did run monetary
policy from roughly 1917 until 1968 when lagged reserve accounting was introduced. It would provide some significant, in my view,
increase in the ability of the Fed to control short-term fluctuations
in the aggregate and for that reason I think it's desirable and
should be implemented as soon as possible.
The CHAIRMAN. Then you would disagree with postponing it until
1984?
Mr. ZECHER. Yes, I would.
The CHAIRMAN. I've been jawboning for years to get them to do it
and was pleased when they finally made the decision and now disappointed that they are not going ahead with it as soon as they
originally announced.
Mr. ZECHER. Yes, sir. I totally agree with you and I wish they
had stuck with the original schedule.
MONEY GROWTH OPINIONS
The CHAIRMAN. Mr. Paulus, Mr. Brimmer believes that money
growth will continue to be rapid in the months ahead and Mr.
Zecher expects moderation. Would you explain the difference between the two positions for me?
Mr. ZECHER. Well, one will be right and one will be wrong.
167
The CHAIRMAN. I figured if I asked either one of them they
would just restate their position, so I'll take the middle ground.
Mr. PAULUS. Well, by money, I think you must be talking about
ML
The CHAIRMAN. Yes.
Mr. PAULUS. I don't think it's useful to talk about M2. A major
determinant of Mi growth is the rate of growth in nominal spending which has been moving up. Nominal GNP grew by 3 percent
last year. We think it will be growing in the 8- to 9-percent area in
the first half of this year, maybe a little more rapidly in the second
half. Most of the effect of declining interest rates, which does tend
to push money growth up, is behind us, as Mr. Zecher pointed out,
and I agree with that. The one-time shifts of funds, which quite
frankly perplex me—I don't understand why MI is attracting so
many nontransactions funds into things like Super NOW's—but I
think that shift is largely behind us.
I'm really in between these two. I think we will have moderate
growth in the 7-percent area for the first half of this year.
Mr. BRIMMER. Mr. Chairman, may I extend that?
The CHAIRMAN. Certainly.
Mr. BRIMMER. I believe I stressed that—despite the enunciation
of the new targets—I thought that, over the year as a whole, the
Federal Reserve would find it difficult to live within those targets.
Take, for example, the targets for M2. Although John Paulus
thinks it's unwise for the Fed to follow them—I believe they may
find it difficult to live within them. I had in mind a chart from the
Federal Reserve report to Congress which was with Chairman
Volcker's testimony. I was looking particularly at Mj. I believe that
there is no way whatsoever to get that enormous trajectory back
within the targets over the near term. For that reason, I think
that, if the Fed were to try to do that, it would be a mistake.
But I would not expect to see the growth rates in Mi continue. In
other words, I would not extrapolate that line so sharply upward
[indicating]. So it is quite interesting that you asked the question.
The CHAIRMAN. Mr. Zecher, your defense?
Mr. ZECHER. Well, I'm not going to defend, sir, but I would like to
point out that my statement says from the end of February forward, and I'm not suggesting that the bulge that we have seen
which I think is for the three temporary reasons that I mentioned—the two new accounts and the drop in interest rates last
summer—should be or will be reversed. I'm talking about the
period going forward from February and I believe this is very consistent with Chairman Volcker's testimony because he is going to
base his M2 targets forward from the first quarter which I think is
the very reasonable thing to do under the circumstances.
Mr. BRIMMER. February-March.
Mr. PAULUS. That's right.
COMPETITIVE INEQUITIES WITHIN FINANCIAL SERVICES
The CHAIRMAN. Mr. Zecher, a great deal has been said the past
few weeks and particularly this week about competitive inequities
that may result from the institutional restructuring and new accounts that are occurring within the financial services industry.
168
What do you see as the potential consequences of this restructuring on the credit markets?
Mr. ZECHER. Well, I think it's very healthy. I think the general
view of bankers, which I will try to represent here although it's
very difficult to do, is that after many decades of very comfortable
regulation they are beginning to understand both the cost and
benefits of competition. I think basically, as I talk to bankers, they
are ready to compete in this market even though they are not
going to always win. But learning to compete after a very long
period of being protected from competition is causing a little agony
certainly.
The CHAIRMAN. What about the effect on the Fed's conduct of
monetary policy?
Mr. ZECHER. I think obviously it has caused this period of very
difficult interpretation of monetary policy. I personally feel that's a
very small price to pay for the longer term benefits to the consumer of having a much more competitive financial system. I'm all for
it and my institution is all for it.
The CHAIRMAN. Mr. Brimmer, the Federal Reserve intends and
certainly in the immediate future to focus much more on M2 than
Mi, but with the newly authorized accounts that are going to tend
to concentrate savings and precautionary balances in M2, wouldn't
really making Mi a more exclusive transaction account—wouldn't
it be better to concentrate more on Mi than M2?
Mr. BRIMMER. No, Mr. Chairman, it would not be, if you mean by
"better," to concentrate on Mi as the most critical guide in the conduct and implementation of monetary policy. It would not be
better. Some of the funds in M2 are related to transactions. It is
impossible to distinguish so sharply between the balances in Mi —
and call those purely transactions—and the funds in M2 (some of
which are quite comparable). The presumption is that we should
have as a guide a monetary measure which is related fairly closely
to nominal GNP. The record will show that the broader the aggregate the more closely related to nominal GNP it is. For that
reason, unlike Dick, I would not criticize the Federal Reserve so severely for having introduced a measure of total nonfinancial debt.
The record shows that changes in that variable are associated very
closely with changes in nominal GNP. M2 is in between. M2 is related somewhat more closely to nominal GNP that is Mi. Since I do
not subscribe to the belief that it is necessary to relate Mi only to
nominal GNP, I would not subscribe to the view you just enunciated.
The CHAIRMAN. Would both of you gentlemen respond to the
same question, please?
M2 IS A BIG MISTAKE
Mr. PAULUS. I think M2 is a big mistake. I think moving to a
credit aggregate is a good idea, I wish they'd move to private nonfinancial private sector borrowing, borrowing by households. State,
and local governments which I put in the private sector because
they have a budget constraint, and nonfinancial corporations. Such
borrowing is a much better indicator of monetary policy than is
total credit.
But during periods like those we've experienced in the last 2
years, when the aggregates really have broken down, it would have
been useful, especially last spring when private sector borrowing
was so depressed, to have had an additional reading on monetary
policy outside the aggregates which at the time were looking relatively strong. I think we would have had a truer reading of what
monetary policy was doing to the economy had we had a credit aggregate. On Mu I would like to point out that the Fed's research
staff has some rather interesting work showing that two of the
major determinants of M^ growth are the savings rate and the unemployment rate. M 2 is positively related to the savings rate and
the unemployment rate: The savings rate because when it goes up
there's a bigger pool of savings, and the unemployment rate apparently because people get concerned when unemployment goes up
and they put a disproportionate share of their savings into M2 type
liquid assets. But what happens when monetary policy tightens?
The unemployment rate goes up and the savings rate goes up, so
that M 2 growth goes up. Possibly the reverse will happen when the
Fed eases off.
It doesn't make any sense to me to be targeting on an aggregate
that has such perverse properties. I think MI, despite the problems
with it, is clearly the best aggregate the Fed has now and over
time, aside from some temporary periods, it has been the most reliable indicator of monetary policy on the economy.
The CHAIRMAN. Mr. Zecher.
Mr. ZECHER. Well, let me start by asking you a question. What
are we really trying to accomplish with looking at aggregates? I
would argue that the most important thing—you were talking
about the real world earlier today. There's all kinds of real worlds.
There's the bond trading real world which means if it happened
more than 2 seconds ago it doesn't mean anything or if it's going to
happen 2 seconds from now it doesn't mean anything. There are
lots of realities and I think the reality that's most important for
monetary policy—and it can only be stated in a very vague way, I
agree—is that we want a stable, noninflationary environment
where contracts can be made with some reliance for periods longer
than 3 months.
Now if you accept that as the overall goal of monetary policy,
then I don't think it's going to make very much difference which of
these aggregates you look at over that long period of time. Where
it would make a difference is in the implementation of the policy
and Andy makes a very good point, that some of these aggregates
are more closely related statistically in the short run to nominal
spending than others.
In effect, I think he's absolutely right at least until the 1980
period that the broader the aggregate the more closely in the statistical quarter by quarter sense it is related.
There is another issue and that is what can the Fed do to control
it? If we can rank these various aggregates we talk about starting
let's say with the monetary base, which is the reserves and currency in circulation, the Fed has very precise control over that, but it
has a weaker statistical relationship to income.
What I'm saying is in the implementation policy there is a tradeoff between two statistical correlations. One is between what the
170
Fed actually does and what happens to one or another of those aggregates, and the second is between what happens to those aggregates and what happens to nominal income.
Finally, I would argue—and this is one of the points I made with
respect to this credit aggregate—is that the Fed in a world where
there are remaining private banks who make credit decisions and
in a world with open international trade, the Fed has very little
short term control over that aggregate.
Mr. BRIMMER. Just for the record, I think we ought to stress that,
while the Federal Reserve indicated it would monitor the behavior
of the debt aggregate, it is not on the same footing as are the targets for the monetary aggregate. So they will watch it, but it's my
impression they do not intend to gear policy directly to that.
Mr. PAULUS. If I could add, it's an indicator, not a target. You
don't have to be able to control an indicator. An indicator tells you
something about what your policy is doing to the economy. It
would be useful to have indicators even if you can't control them.
The CHAIRMAN. Gentlemen, I have no additional questions.
Others may be submitted to you for your response in writing. Do
any of you have anything to add before we close the hearing today?
Mr. ZECHER. I have none, Mr. Chairman.
Mr. BRIMMER. No.
Mr. PAULUS. None.
The CHAIRMAN. Gentlemen, thank you for your patience and
your testimony. We appreciate very much your willingness to come
before the committee.
The committee is adjourned.
[Whereupon, at 11:45 a.m., the hearing was adjourned.]
FEDERAL RESERVE'S FIRST MONETARY
POLICY REPORT FOR 1983
TUESDAY, FEBRUARY 22, 1983
U.S. SENATE,
COMMITTEE ON BANKING, HOUSING AND URBAN AFFAIRS,
Washington, D.C.
The committee met at 9:30 a.m. in room 538, Dirksen Senate
Office Building, Senator Jake Garn (chairman of the committee)
presiding.
Present: Senators Garn, Mattingly, and Hecht.
The CHAIRMAN. The committee will come to order.
This morning is the third day of hearings on the conduct of monetary policy. I believe the first 2 days were excellent and we had
good testimony and good question and answer periods, and I'm sure
that today will be no different.
We are happy to have the Honorable Beryl Sprinkel, Under Secretary for Monetary Affairs, Department of Treasury, to present to
the committee the Treasury's position on monetary policy.
Mr. Sprinkel, we are happy to have you before the committee
this morning.
STATEMENT OF BERYL W. SPRINKEL, UNDER SECRETARY FOR
MONETARY AFFAIRS, DEPARTMENT OF THE TREASURY
Mr. SPRINKEL. Thank you, Senator Garn. It's a pleasure to be
here.
Chairman Garn, distinguished members of the committee, it is
my pleasure to be here today to present Treasury's views on current monetary policy, and to discuss your concerns and questions
on the subject.
MONETARY POLICY IN 1983
The task for monetary policy in 1983 appears to be clear. Chairman Volcker stated it well in his testimony before this committee
last week when he said, "Our objective is easy to state in principle—to maintain progress toward price stability while providing
the money and liquidity necessary to support economic growth."
From my discussions with other administration officials, Federal
Reserve officials, businessmen and economists, and from my reading of the financial press, there appears to be widespread, general
consensus that this is the appropriate goal for monetary policy in
1983 and the targets set by the Federal Reserve are broadly consistent with that goal. But general agreement does not, in and of
itself, produce the desired results. If it did, we presumably would
172
not have had a decade and a half of rising inflation and interest
rates and the resultant economic stagnation; certainly no one
sought or desired those results.
The subtleties and complexities of monetary control are such
that achieving a particular desired policy path—regardless of a
consensus that it is appropriate—is never a certainty. Our knowledge of the exact magnitude and timing of the impact of monetary
actions is imperfect; the lag in their impact on the economy is variable. For either—or a combination of both—of these reasons, there
is always a risk that actual monetary policy will not match intentions or goals.
Without great care in the implementation of monetary policy in
the coming months, there is a risk that the Federal Reserve could
err in one direction and be too highly restrictive, or in the other
direction, and be overly expansionary. The danger to the economy
is that the economic recovery could be aborted, or the gains we
have made in reducing inflation could be lost, or both. It is these
risks and dangers that I would like to discuss with you today.
First, I believe it would be instructive briefly to review where we
are, and how we arrived where we are, with respect to monetary
policy.
THE GENERAL SITUATION
A deceleration in the trend rate of money growth is necessary to
reduce inflation; it is for this reason that the administration originally recommended that money growth be gradually and steadily
slowed. When I met with this committee last July, I emphasized
the importance of the gradual and steady aspect of that recommendation. Few believed that the slowing of money growth necessary
to control inflation could be achieved without some associated restraint on the growth of economic activity; but we did believe that
a gradual and steady deceleration would minimize the constraint
on the economy, and that that constraint might be offset in the
long run by the incentive effects of the tax cut. However it is difficult to characterize the slowdown in money growth that actually
occurred as either gradual or steady. As a consequence, while impressive progress has been made on inflation, the restriction of economic activity associated with that progress was magnified.
In 1981, money growth was abruptly and significantly reduced
relative to its previous growth path; after 4 years of money growth
that averaged 7.8 percent, Mi growth in 1981 was 5 percent. For
calendar 1981, Mi growth was therefore below the target growth
range set by the Federal Reserve. After a short period of rapid
growth in late 1981 and early January 1982, the restraint on
money growth continued until midsummer of 1982. By mid-1982,
the path of Mi was well below the deceleration path that had been
recommended by the administration. This severe and prolonged
monetary restriction was an important factor contributing to the
onset, severity, and duration of the recession.
By contrast, since July of 1982 money has grown at a very rapid
pace; during the last quarter of the year, Mi grew at an annual
compound rate of nearly
14 percent. As a consequence, Mi growth
in 1982 averaged 8J/2 percent, well above the 5l/2 percent path that
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was the upper bound of the Federal Reserve's money growth
target.
On the positive side, the monetary surge in the last half of 1982
can be viewed as an abrupt and belated adjustment for the previous, prolonged undershooting. The rapid pace of money growth in
recent months, in fact, brought the fourth-quarter, 1982 average of
Mj up to the level that was implied by the administration's originally recommended path for prudent noninflationary monetary
policy. Although we arrived at approximately the same average
level for Mi by the fourth quarter of 1982, the path by which we
did so was less than ideal.
An important lesson to be learned from the experience of recent
years is that we pay a very high and very real price for monetary
instability. The timing of the relationship between money growth
and real economic activity is affected by a variety of factors, including the public's expectations about fiscal and monetary policies. Because of the elusiveness of expectations, any exact quantification of the economic impact of erratic money growth could be disputed; however, the direction of the effect seems clear. In short,
while monetary policy seems to many to be academic and arcane,
the effects of monetary actions are neither. The impact of monetary actions is felt in very practical and real ways—as manifested
in inflation, interest rates, real economic growth, and the unemployment statistics.
Looking to the future, the monetary actions taken by the Federal
Reserve will, as they have in the past, be critically important to
economic performance in 1983-84. Obviously we can all agree that
nurturing an economic recovery is our primary concern. But it is
also vitally important that that recovery be a healthy and sustainable one, rather than either a recovery that stalls out quickly, or
one that consists of an inflationary burst of economic activity that
falters as inflationary expectations drive interest rates up and
choke off expansion.
The challenge is to pursue policies that will provide the atmosphere needed for a sustainable, noninflationary economic expansion. With the rapid rate of money growth that has occurred in the
last 6 months, the risks associated with monetary policy are that
either: One, the monetary expansion would be abruptly curtailed,
restraining output and employment growth as it did in 1981-82; or
two, the Federal Reserve would allow the monetary expansion to
continue too long, reigniting inflationary expectations, driving
long-term interest rates up and preventing a sustained recovery.
Great care in the implementation of monetary actions will be
needed if both these pitfalls are to be avoided.
THE DANGER OF BEING OVERLY RESTRICTIVE
It would be ill-advised for the Federal Reserve to attempt to reverse the bulge in money that has occurred in the last few months.
Such a monetary contraction would almost certainly stall any
meaningful economic recovery, and could, depending on its severity
and duration, plunge the economy into a deeper recession.
However, it is clear that money growth cannot continue at the
pace of the last quarter without precipitating economic disaster.
174
The risk, however, is that an attempt to slow money growth may
result in too severe, or too prolonged, a monetary squeeze. In the
past, periods of rapid money growth have typically been followed
by long periods of restriction. A prolonged period of slow money
growth would again curtail the growth of employment and output
as it did in 1981-82.
The challenge of reinstating noninflationary monetary policy is
to bring down the long-run trend of money growth gradually
enough that the restriction of economic activity is avoided. Permanent and continued progress toward lower inflation and interest
rates requires that we persevere in our efforts to bring the trend of
money growth back to a noninflationary pace. But, after 6 months
of very rapid money growth, great care must be taken that those
efforts do not result in another severe and lengthy restraint of
money growth. Economic expansion cannot proceed without the
support of adequate liquidity,
THE DANGER OF EXCESSIVELY STIMULATIVE MONETARY POLICY
An economic recovery based on highly stimulative monetary
policy is ultimately unsustainable, because the inevitable consequence of excessive money growth is inflation and rising interest
rates, both of which are powerful deterrents to the long-run real
economic growth we all seek. Rapid money growth does provide a
stimulus to nominal GNP growth; a crucial concern, however, is
whether that nonminal income growth consists of real economic expansion [growth of real GNP], or of inflation. Rapid money growth
may provide a temporary, short-lived stimulus to the economy, but
once inflation and inflationary expectations emerge, real growth is
choked off by rising interest rates. Once that point is reached, continued stimulative monetary policy is predominantly inflationary.
The key is the reaction of interest rates to the increase in money
growth. If the financial markets fail to recognize the implications
of rapid money growth, the rise in interest rates might be postponed, and the positive, stimulative effect of monetary expansion
could last longer. But the more quickly inflationary expectations,
and therefore interest rates, react, the more ineffective monetary
expansion will be in providing economic stimulus. As has been illustrated often in recent years, interest rates and money growth
can and do move in the same direction when market expectations
and uncertainty about inflation are sensitive to the inflationary
implications of increases in the money supply.
In this sense, recent developments in the financial markets contain some foreboding signals. Chart 1, accompanying my prepared
testimony, illustrates the recent course of a representative shortterm and long-term interest rate. While it is widely believed that
the decline in interest rates that occurred last summer was the
result of a more accommodative Federal Reserve policy, this is not
really an accurate portrayal of the timing of events. Money growth
began to accelerate in August and, as can be seen in the chart,
most of the decline in interest rates had already occurred by
August. Some short-term rates are now slightly lower than they
were in late August, but the 3-month Treasury bill rate is slightly
higher now than it was the last week in August. The decline in
175
long-term rates continued into the fall, but then leveled off; long
rates have risen slightly in the last few months.
Therefore while the rapid growth of bank reserves provided by
the Federal Reserve in recent months did push short-term interest
rates down to some extent, attempts to continue to do so are likely
to be self-defeating. We have already seen a leveling off of shortterm rates despite continued rapid reserve and money growth; the
last decrease in the discount rate did not elicit similar decreases in
short-term market rates. As Chairman Volcker has stated on many
occasions, the Federal Reserve has no button to push to cause interest rates to fall.
In terms of its long-run implications, the failure of long-term
rates to follow short rates down and the recent upturn in long
rates, despite continued rapid growth in reserves and money, is a
foreboding signal of the financial markets' expectations. The only
logical explanation of this development is that the financial markets are observing current reserve and money growth and making
some calculation about expected, future inflation—or at least some
calculation of their fear or skepticism about future inflation. Inflationary expectations is the only plausible connection between
short-run changes in money growth and long-term interest rates.
Thus, while it may be possible for the Federal Reserve to temporarily push down, or hold down, short-term interest rates by injecting
more reserves into the banking system, such actions are not likely
to generate the desired decreases in long-term rates; under certain
market conditions, even the desired declines in short-term rates
may not materialize.
A key element in the behavior of long-term rates is inflationary
expectations. In the current situation, the uncertainty about the
budget situation and about long-run inflation control has heightened the sensitivity of inflationary expectations. The uptick in
long-term rates in recent months may be the first signal that, from
the viewpoint of the financial markets, the monetary expansion
has gone too far.
This is the danger of using excessively expansionary money
growth in an attempt to stimulate the economy. There may be limited short-term success, as long as long-run inflationary expectations do not move adversely. But predicting the timing of those expectations with any degree of precision is impossible; helpful, stimulative money growth ultimately turns into excessive money
growth that drives inflationarty expectations and interest rates
upward and precludes continued, real economic expansion.
The path of long-term interest rates will be a critical factor in
determining whether or not the incipient recovery will evolve into
a period of sustained real economic growth. In my view, one of the
most troublesome developments over the past decade and a half
has been the successive upward drift of long-term interest rates.
Chart 2 illustrates the upward trend of long rates over the past 25
years and relates it to the rising trend rate of money growth.
While there have been many periods when long-term rates fell—
notably during or directly after recessions—the low point of each
downturn in long-term rates has been higher than the previous
one. Each upturn has taken long rates to new highs, and each
successive low point has been at a level higher than the preceding
176
low point. The rising trend of inflation and long-term interest rates
has most likely contributed to our Jong-run problems of lagging investment and productivity growth.
The most important message in chart 2 for the current situation
is that we have not yet broken this pattern. While long-term rates
are now well below their all-time highs reached in 1981, they have
not yet broken below their previous cyclical low, which, from a historical standpoint, was not particularly low. Despite the significant
decline in inflation, we have not yet succeeded in breaking the
trend of secularly rising long-term interest rates. The implications
of this for long-run, real economic growth are not encouraging.
The behavior of long-term rates and their reaction to money
growth is the immediate and practical danger of continuing rapid
money growth. Attempts by the Federal Reserve to push down, or
hold down, short-term interest rates would require continued rapid
growth of reserves and money. Particularly as the economy grows
more strongly and credit demand increases, upward pressures on
short-term rates will emerge; more and more reserve growth would
be required to hold down short-term interest rates in the face of
these market pressures. Ultimately, the resulting money growth
would aggravate inflationary expectations and cause long-term
rates to rise, thereby defeating the intended goal of encouraging
lower interest rates.
WHERE DO WE GO FROM HERE?
With economic dangers lurking both on the side of too much
money growth, and on the side of too much restraint, the safest
course is to provide moderate money growth. That is, of course,
easier to state than it is to achieve. The chances of achieving that
goal, however, would be maximized if the Federal Reserve would
move now to restrain the growth of bank reserves in order to slow
money growth gradually from the high rates of recent months. Efforts by the Federal Reserve to peg or reduce short-term interest
rates are not likely to produce that result.
Actions to return reserve growth to a rate consistent with moderate money growth may cause immediate, but temporary, increases
in short-term interest rates. Bank reserves have grown very rapidly for many months, so upward pressure on short-term rates is the
price we now may have to pay to restore more moderate growth
and to protect long-term rates from the large increases that are inevitable if reserve and money growth is not moderated.
There are many who contend that more rapid money growth now
is acceptable because of the weakness of the economy and because
it can be reversed later on, once the recovery is more strongly underway. This view presumes that sometime in the future will be
the "right time" for bank reserve and money growth to be easily,
conveniently and painlessly brought back under control. Furthermore, this analysis makes some heroic assumptions about the precision of monetary control and economic forecasting.
Continuing to allow rapid money growth in order to stimulate
economic recovery presumes that the monetary authority can
apply the appropriate dose of monetary stimulus for just long
enough to provide expansion, but neither too much, nor for too
177
long, to generate more inflation and inflationary expectations.
Given the inaccuracies of economic forecasting and the deficiencies
in our knowledge about the timing and impact of monetary actions,
it is extremely difficult to determine the moment when helpful
stimulus becomes harmful and inflationary. Furthermore, even if
that moment could be a accurately determined, such fine-tuning
policies presume a precision for monetary control that could, but
unfortunately, does not exist. Such monetary fine-tuning sounds
logical and reasonable in casual conversation, but it is extremely
difficult to achieve; it has not worked reliably in the past and the
attempts on average have been very destabilizing.
The money growth target ranges for 1983, announced by Chairman Volcker last week, are consistent with our goal of providing
enough money growth to support the expansion, without reigniting
inflationary pressures. While the ranges set for Mi and M2 for 1983
are higher than their 1982 ranges, these adjustments were made in
order to account for the effects of institutional change. Changes in
the money supply that are the result of institutional change have
no particular economic meaning. It is therefore appropriate to
adjust the money growth targets to take account of these changes,
as they can best be estimated at this time. The Federal Reserve has
stated that the new targets, after adjustment for institutional
change, are comparable to the 1982 targets in terms of economic
meaning.
With respect to the new targets, Chairman Volcker said in his
statement that "* * * the growth of money and credit will need to
be reduced to encourage a return to reasonable price stability. The
targets set out are consistent with that intent." The administration
agrees with that goal and intent. Since money growth exceeded the
targets in 1982, average money growth will be lower in 1983 if the
new target ranges are achieved; this is consistent with the goal,
shared by the administration and the Federal Reserve, of noninflationary money growth over the long run.
CONCLUSION
The sustained, noninflationary economic expansion that we all
desire—and that has repeatedly eluded us over the past 15 years—
is, I believe, now within our grasp. Whether or not it becomes a
reality obviously does not depend exclusively on monetary policy,
but the monetary actions taken in coming months and years will
be critically important.
On the one hand, another prolonged period of restricted money
growth as we had in 1981 and early 1982, would depress economic
activity and would likely interrupt, if not prevent, the recovery. On
the other hand, attempts to use excessive money growth as an economic stimulus carry a significant risk of backfiring. The key is
money growth that is supportive of economic expansion, but not so
stimulative that inflationary expectations move adversely. These
expectations, which are already sensitized by the projected budget
deficits, are the major factors that have held up long-term interest
rates even as the actual rate of inflation has declined.
The immediate contribution that monetary policy can make to a
sustainable economic expansion is to facilitate continued down-
178
ward adjustment of price expectations, to allow the entire structure
of interest rates to fall. Downward adjustment of long-term price
expectations over the course of this year is necessary to assure a
meaningful and lasting decrease in the cost of credit, which is a
vital element to meaningful economic recovery. Holding short-term
interest rates down by continuing to provide more reserves to the
banking system, however, is not likely to produce the desired downward pressures on longer term interest rates.
The risk of excessive monetary expansion early in 1983 is not an
immediate resurgence of inflation. It is unlikely that excessive
money growth would have an appreciable effect on the price indices for more than a year. Instead, the danger comes from the potential impact of expectations about the longer term prospects for
inflation.
[Charts accompanying statement follow:]
CHART 1
REPRESENTATIVE SHORT-TERM AND LONG-TERM INTEREST RATES
(weekly averages, January 1982 to February 11,1983)
Percent
16
"Short-Term Commercial
Paper Rate {4 months)
14
Long-Term Government
Bond Rate (10 years or more)
12
10
I I I I I I 11 I I I I 1 I I 11 I I I 1 I I I I I I I I I I I I I I I I I I I I I I I I I
JAN
FEB
MAR
APR
MAY
JUN
JUL
1982
AUG
SEP
OCT
NOV
DEC
Ill
JAN
FEB
1983
CHART 2
LONG-TERM MONEY GROWTH AND INTEREST RATES
Percent
00
o
Moody s Corporate Aaa
Bond Rate
"*•**
58
58
60
62
Long-Term Rate
of Money Growth*
64
66
68
70
"Money Growth It tlwritaof ch«ng» in Ml oirat thrM v«*ri, txprmcd M «n *nnual ntt.
72
74
76
78
80
82
181
The Chairman. Thank you very much, Mr. Secretary.
Senator Hecht, would you like to begin the questioning today?
Senator HECHT. Thank you Mr. Chairman. In your opening statement on the first page in the middle you said, "to maintain progress toward price stability while providing the money and liquidity
necessary to support economic growth."
Mr. SPRINKEL. Yes, sir.
Senator HECHT. Last week we met with the homebuilding industry, real estate people, mortgage bankers, critizing the high interest rates, it's impossible to support economic growth, roughly 11
percent prime rate, obviously no one borrows at that but it's 2 or 3
points over. At this rate they cannot sustain economic growth.
How can you address that?
Mr. SPRINKEL. Well, I agree that interest rates are too high, any
way you measure them. Especially if you try to deduct current inflation rates from the actual nominal rates, you get some very high
numbers. The only way I know to address them effectively over the
long run, and therefore encourage the investment that we all want,
is to gradually, over time, convince the marketplace that this time,
this Congress, this administration, and this Federal Reserve Board
plans to get inflation down and keep it down.
That means to me moderate growth in the money supply. It also
means efforts to get toward a balanced budget at some point in the
years ahead.
Senator HECHT. What in your opinion is the time frame on this?
FURTHER DECLINE IN INTEREST RATES
Mr. SPRINKEL. Well, it's very difficult, first, to predict that those
actions will be taken. But if they were taken, and taken consistently, I would expect that gradually over the next year or two we
would see further declines in interest rates.
If we do the opposite—that is, the Federal Reserve opts for rapid
growth in the money supply—that will certainly drive interest
rates up because expectations of higher inflation would increase. If
we make no progress on getting the deficit under control, that
would work in the same direction.
But assuming we can work together—the administration, the
Congress and the Federal Reserve—toward gradually slowing the
inflationary pressures from monetary and fiscal policy, I think we
can pull it off. We certainly have a great opportunity because
actual inflation has come down greatly. What we want to do is to
get expected inflation down in line with actual, and I do not believe
that it's there yet.
Senator HECHT. If these homebuilders cannot start building
again, and providing jobs and in reality bring money back into our
Treasury, how can our revenues come up? Where are we? Do we
want to get these people working again, producing, making profits,
paying taxes, or do we want to keep them out of work?
Mr. SPRINKEL. We want to get them working obviously and
paying taxes, and that's what most of them want to do. I'm quite
confident that we are in an upward expansion in the economy.
You're never absolutely certain until many months later, but the
odds are extremely high, based on what's happened to leading indi18-0)4 O—83
13
182
cators, what's happened including housing starts, which rose sharply as you know last month to 1.7 million—including what has happened in terms of money growth; including what's beginning to
happen on consumer spending; including what's probably happening on reversal of inventory liquidation. We're set for a significant
economic expansion. That means more jobs.
This also is reflected, as you know, in the data on unemployment
in the household survey, which went down last month. So I'm convinced that we are in an upward phase of the economy and our
challenge is to make sure it continues and therefore adds jobs,
without blowing it on the inflationary side or the restrictive side.
It's a narrow path unfortunately, but I think we can do it.
Senator HECHT. Getting back to the homebuilders, a major part
of our economy, they say that unless the prime rate, drop two more
points, it will be very difficult for them to have growth. When do
you see that happening?
Mr. SPRINKEL. If we avoid continued very rapid growth in money
in the months immediately ahead but continue to have some moderate growth, I would expect it would happen this year. We have
made enormous progress, as you know, in getting the prime rate
down, but not enough. It's come from 21 to 11. That's not insignificant, but 11 is very high by historical standards. Normally, if you
have a fully adjusted marketplace, you would expect to have a
short-term rate that might show something like 1 percent real rate.
That is, you subtract the inflation rate from the nominal rate and
you get something on the order of 1 to 2 percent.
Now you don't get that today. You get a number a lot higher.
But we don't know directly what inflationary expectations are. I
personally believe they are much higher than the recorded inflation numbers. So there is lots of room for further decline in the
prime rate, provided we can continue to gradually reduce inflationary expectations.
Senator HECHT. That's all for the moment, Mr. Chairman.
The CHAIRMAN. Thank you, Senator.
Let me just follow up on that, Mr. Secretary. Your statement has
been almost entirely concerned with monetary policy and your
answer to Senator Hecht is you would expect that this year if we
had a reasonably moderate growth in money supply. That does not
take into account the actions of the Congress on fiscal policy and
the $200 billion deficit, and I would disagree with you on that happening this year. Unless Congress in the fiscal 1984 budget starts
to send some signals, I really don't care what Mr. Volcker does; I
don't think you're going to see 2 percent lower interest rates; I
think you're going to see higher interest rates. Would you agree
with that, unless Congress starts to behave?
Mr. SPRINKEL. Well, I do not believe that either monetary or
fiscal policy alone is the sole determinant of inflationary expectations, but together they clearly are the most important. So I do
care what happens at the Fed, just as I care what happens on the
fiscal policy front.
I think most observers would agree that the $200-plus billion
deficit this fiscal year does not necessarily mean that we can't do
something about it in subsequent years, but if you delay and delay
183
the action, it gets more and more difficult. So I certainly agree
with you that we need to make progress on the fiscal policy front.
It turns out that historically, in most countries, nations that
have run large deficits inevitably at some point in time, decide to
finance it the easy way; that is, by creating more money. That is,
in the short run, it seems to be the easy way. There have been periods in our history when we had large deficits and low growth in
money. There have been other periods when we had low deficits
and high growth in money. But if you look around the world,
unless you get the deficits under some reasonable control, it typically does lead to excessive money growth.
The CHAIRMAN. Well, I agree that both must be addressed, but I
happen to be of the view that the fiscal policy has been far more
out of control. I would agree with you historically you can prove
just about anything you want, deficits relate to money growth and
so on, but you also—in talking about the interest rates going up
and down and the trend upward, the same thing has happened
with the deficits only at a much more rapid increase. I can't imagine 8 years ago when I first came to the Senate sitting here hoping
that we could get the deficit down to $150 billion. I mean it was
beyond my wildest expectations to even consider that because I
never considered we would have $150 billion deficit at the top.
Mr. SPRINKEL. Right.
The CHAIRMAN. When you consider that in my 8 years we have
gone—I was here when we surpassed a $300 billion budget in 1
year, so we have gone 3, 4, 5, 6, 7, 8 in the 8 years I've been here.
JOBS BILLS ARE TOO LATE
I would say that even Lord Keynes would be disgusted with what
we are doing because when he talked about priming the pump
during years of bad economic times he also talked about surpluses
during good times. We have only been practicing half of Keynesian
economics. The other half we haven't even addressed for years and
that's why I feel so strongly that Congress is out of control. And
I'm sorry, but I feel now the administration is yielding to that pressure once again with jobs bills that are too late. We're going to
have a jobs bill that should have been 2 or 3 years ago. This recession will prime the pump after the pump doesn't need priming,
after it's going by itself.
We had testimony on Friday that probably the best indicator
that we were coming out of a recession was a jobs bill, and I would
agree with that.
So I only emphasize how strongly I feel that, sure, they both
have to go together, but the one that has really been out of control
for a long number of years is Congress and apparently unwilling to
get their act together again, and it's a trend line, not those individual comparisons year by year, but if the expectations are that those
deficits are going to continue to grow over years, you haven't got a
chance of lowering interest rates. If they will level off, yes, we can
keep $200 billion deficits for a while if they are leveling off and
starting downward.
Don't you think that trend line in deficits is the most important
rather than individual years?
184
Mr. SPRINKEL. I certainly do, and there is no doubt in my opinion
that the higher the deficits, with any given growth in the money
supply, the higher the real rate of interest. The deficit has to be
financed.
One of my jobs is to make sure it is financed. We can finance it
by going into the marketplace and pushing away private borrowers. We 11 be able to finance the Federal deficit, but is there going
to be enough left for others to finance capital formation, to improve productivity? That's the real question and, of course, ultimately, unless we get the budget under control, there's a great risk
that it would also exert unfortunate pressures on the Federal Reserve to increase the money supply at an excessive rate. So either
way we lose. So I think it's important to move on both fronts. Yes,
I agree with you.
The CHAIRMAN. Well, I agree, but in further finishing up Senator
Hecht's questions, I just don't see that anybody, particularly in the
long-term money markets, is going to be silly enough to give us
reasonable stable lower fixed rate interest as long as they see that
trend line in deficits going up, and 1 just don't see any other choice.
They would be terribly foolish to continue to borrow short and loan
long, which has gotten them all in trouble in the past.
Mr, SPRINKEL. That's one of the reasons, sir, that I think we are
having some trouble in expectations reducing inflation. We have
had 15 to 20 years now of movements in the opposite direction, and
many investors in bonds remember the pain they suffered as interest rates went up and bond prices went down. They had a brief
flurry over the last year and did very well, but that doesn't mean
they're convinced that we're going to get inflation down and keep
it down.
The CHAIRMAN. I'm just surprised that the markets have been as
gullible for so long. I mean, you changed the faces. You changed
some of the people. The speeches are the same from every new
President and every new Congressman and every new Senator.
They run in here and say they're going to balance the budget.
They're all fiscal conservatives. We go through that every two
years and it never happens. After two decades you'd think the
market would have learned sooner.
So unless we start with actions, the words are cheap. We were
talking about $45 billion deficits 2 years ago and some of us
thought that was a little silly even to talk about those kinds of
deficits; we were not realistic; you believed in the tooth fairy if you
thought we were going to have $45 billion deficits in fiscal 1982.
But why should the markets, anybody that has half a brain out
there, believe these politicians that occupy the House and the
Senate of the United States, or Presidents or administrations, after
20 years of saying what they were going to do? We simply have not
matched our actions with our words. It's gotten worse and worse
every year and all you get at the beginning of this year is the same
old rhetoric that I ve heard every year I ve been in public office,
just empty words from politicians who like to get on TV and perpetuate themselves in public office.
I wish I shared some of your optimism on what we could do on
monetary policy, but I think the whole ballgame is with the fiscal
policy because if we weren't having those long term deficits in
185
trend lines, as I said to Mr. Volcker, he wouldn't be very well
known in this country and it would be easy to be Chairman of the
Fed if you didn't have to monetize those debts. It's very easy to sit
and do the things you have suggested we do today of taking a moderate monetary growth if you didn't have the wild fluctuations
with a fiscally irresponsible Congress of the United States. It would
be easy with the Fed. You wouldn't even have to have much training in economics. You could kind of guess and match up.
So I continue to try to establish who the real culprit is in this.
It's the Congress, Republicans and Democrats; it's both parties, administrations of both parties, who simply have not learned the
simple word "no" and so we continue to expand far, far beyond
what is reasonable in our budget and our budget deficits.
Senator Mattingly, it's your turn if you would like to begin.
Senator MATTINGLY. Good morning.
Mr, SPRINKEL. Good morning.
IMPACT OP FALLING OIL PRICES
Senator MATTINGLY. I just noticed on last night's news the action
taken by the OPEC dropping their oil prices. I would like to just
have your opinion on what impact that's going to have on the debt
servicing to a lot of countries in relation to the IMF funding,
whether it will have some impact about the request for new money.
Do you see a change possibly or will the request that we've put in
so far for IMF funding, knowing the impact this may have?
Mr. SPRINKEL. Well, it's a very significant development, I certainly agree with you. The net balance, bottom line, is that the United
States will benefit a great deal from this development. It makes
possible greater economic growth.
Senator MATTINGLY. I understand all that part. I want the other
part.
Mr. SPRINKEL. The other part, after the good things, there is
some redistribution involved, not only domestically but especially
abroad. Brazil will benefit a great deal. Mexico, of course, will have
to adjust more than would have been the case if the price of oil had
stayed where it was. There are other nations, such as Nigeria, that
have difficulties, and Venezuela that will have a lot of difficulties.
But most of, or all, of the nonexpert LDC's will benefit, as we will
benefit. But there will be other countries where the problem will
be more severe and Mexico is one of them.
Senator MATTINGLY. I want to talk about the severity. That's
what I was getting to. I know the good things. People will be happy
at the gas pumps.
What impact will it have on the request for borrowing? It seems
to me it's going to put any country who's a major oil exporter—
they're going to have a liquidity problem it would seem to me.
Mr. SPRINKEL. You're right.
Senator MATTINGLY. I assume there has not been an analysis
done yet. What would be your off-the-cuff analysis of what impact
it may have?
Mr. SPRINKEL. Well, remember that if they want to borrow from
the IMF—I believe that's what you were referring to
Senator MATTINGLY. Right.
186
Mr. SPRINKEL. The nations involved must work out with the IMF
a program and some of them that are going to be pained as a result
of the cut in oil prices—Mexico, for example—their IMF program
may have to be adjusted over time. It's not just a right that any
nation can go to the IMF and get money. They must first correct
their domestic economic policies take some time and in the event
they are willing to make those adjustments, presumably loans will
be made to them. But on the other hand, the nonoil LDC's should
over time be able to improve their condition sooner than originally
anticipated.
So it's very difficult to say off the top of my hat whether there
are going to be more LDC countries benefit from the cut in oil
prices than will be hurt. I suspect more will benefit, but there will
be some major exceptions.
Senator MATTINGLY. Major like Mexico?
Mr. SPRINKEL. Mexico, Venezuela, Nigeria, and a few others
around the world.
Senator MATTINGLY. Is there any idea about the number of countries that are going to be making requests to the IMF out of the
146 nations?
Mr. SPRINKEL. Well, we try to keep informed as well as we can,
both by contact with the IMF and some of the nations bilaterally.
It's practically impossible to predict with certainty. You can see
the trends developing out there, but frequently there's great reluctance on the part of independent nations to go to the IMF until
their access to funds are no longer available in the marketplace.
Then they will go. It's unfortunate they wait that long, but they do.
Therefore, to answer your question specifically, do we know
which countries are going to be coming? The answer is no. We have
a few guesses. We have made various scenarios the worst-case scenario, the not-so-bad scenario to see what implications it has for
IMF funding. I think the agreement we reached a couple weeks ago
with our counterparts is a reasonable one. I do not expect that
there will be the necessity of coming to Congress shortly and
asking for an increase. I do not expect that at all.
Senator MATTINGLY. I know that you don't want to discuss the
worst-case scenario and the best-case scenario for the borrowing
countries, and I think it ranges anywhere from $1 billion to $3 billion, $3 billion being the worst case, but I just wonder now with the
change in the price of oil, if that scenario has changed.
Mr. SPRINKEL. Some of them are going to be better off and some
worse off. I have not bottomed it out in terms of dollars, but we
would hope we could get some information on that fairly shortly.
Senator MATTINGLV. I hope you start doing that soon.
Mr. SPRINKEL. I don't know yet what the price of oil is.
Senator MATTINGLY. Everybody talks about the deficit. You still
are of the opinion, I hope, that we ought to cut spending rather
than raising taxes?
Mr. SPRINKEL. Yes, sir. I would like to slow down the rate of rise
in Government spending. That was the objective when we came
and I haven't changed that. It's difficult. As Senator Garn says, it's
impossible
Senator MATTINGLY. He says what?
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Mr. SPRINKEL. Well, he says it's very difficult to cut Government
spending and he almost said it was impossible.
Senator MATTINGLY. Senator Garn and I would agree.
The CHAIRMAN. You were lucky you missed my oration.
Senator MATTINGLY. I wasn't here, but maybe on entitlements?
The CHAIRMAN. Don't get me started on entitlements.
Mr. SPRINKEL. That reminds me of a statement that Mr. Churchill made many years ago and I can only paraphrase it, that democracy is a horrible system until you look at the alternatives.
Senator MATTINGLY. I haven't given up yet. I think he also mentioned something that's probably applicable to Government hearings. The two most difficult things to do or impossible—one was try
to kiss your nose leaning over backward and trying to resolve a
very difficult subject in 10 or 12 minutes, which sometimes is the
way we feel when we're asking questions, but I will postpone any
more questions at the moment.
The CHAIRMAN. Senator Hecht, do you have any more questions?
Senator HECHT. No.
The CHAIRMAN. Mr. Secretary, the overshooting of monetary targets is a broad and belated adjustment for the previous prolonged
undershooting, but in your statement you didn't make any mention
of the maturing and turnover of the all-savers certificates or the
new money market accounts.
What impact do you think those structural changes have had
and in any way are they ballooning up an apparent increase in the
money supply?
INSTITUTIONAL CHANGES NOT RESPONSIBLE FOR BALLOONING MONEY
SUPPLY
Mr. SPRINKEL. Well, they have a significant effect, there's no
doubt about that. There is some dispute about whether the recent
increase in money is mostly institutional change. But I do not believe most of the rise that's occurred in the money supply over the
last 6 or 7 months has been due to institutional change.
Referring to the data behind that kind of argument, is the best
way to look at what happened to the monetary base or to bank reserves. In either case, you find very rapid acceleration in recent
months in reserve creation brought on by the Federal Reserve
buying securities. So that was much of the money growth can be
contributed to reserve creation, but another portion was the institutional change in recent months I'm sure that, over time, if we
haven't seen the end of financial innovation, continue to make
progress in deregulation, we will be able to permit the banks to
provide even more attractive forms of deposits so that I don't know
what the next move will be, but there will be one.
We do find typically that after a given deregulatory change for
the first few months there is a large reallocation of the funds, then
it tapers off. Most of those actions are behind us far enough now
that I would expect that most of the adjustment has occurred. But
there will be other regulatory changes that will cause such shifts
in the future.
I think that the Federal Reserve has attempted to estimate what
portion was of the money growth due to institutional change and
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that's why they raised their targets. But they didn't double the targets, they raised them modestly. And by far the most important determinant of the rate of growth in the money supply in the immediate months ahead will be what they do through to open market
operations to alter total reserves in the banking system.
The CHAIRMAN. But at least part of it was necessary for the Fed
to accommodate during that transition period.
Mr. SPRINKEL. Yes, that's right.
The CHAIRMAN. Your background before you got into Government service is in banking and I asked the question twice in the
hearings and tried to get an answer to the difference between longterm interest rates and short-term interest rates. I made the point
very strongly that the expectation for inflation in the next year or
two—you said that in your statement today that you would not anticipate within the next year that things would go up. And I have
failed to understand why there is such a connection between shortterm rates. If that's true, you'd think during a year or two when
they don't expect it to change the short-term rates could be lower.
And I asked the question of the Chairman of the Fed last week if
he felt the banks were profiteering, and probably that was an unfortunate choice of words—profiteering leads into all sorts of connotations which are probably not fair. But let me change the question to, are they artificially holding up their short-term rates, to
make it sound nicer than profiteering?
Mr. SPRINKEL. Well, it's very difficult for an individual bank to
do that. There's always some price-cutter in their midst if, in fact,
there are sharp downward pressures or significant downward pressures on short-term rates. Unfortunately, short-term rates have not
been coming down lately. They have been going up a little bit.
It would be unusual for a particular short-term rate—that is the
prime rate—to be cut in an environment when others short-term
rates are rising because that's the cost of money, cost of funds to
them. They must, in essence, finance their assets through CD's or
some other instruments, some of the new instruments, and those
costs have not come down lately.
Now the higher the total cost of funds, including the perceived
loan losses that may occur in the future, the higher the prime rate.
It's mostly short-term financing costs that are the most influential
factor and they have not come down lately.
The CHAIRMAN. You've been intimately involved in the negotiations over the IMF quota increase and the GAB and to what extent
do you believe financial concerns over the international debt situation have kept interest rates higher than they should be?
Mr. SPRINKEL. It's very difficult to know, but it is a potential cost
and this may have had some indirect effect. The fact that the 146
nations were able to reach an agreement on a reasonably sized financing package and that it is now in the legislative process here
in the United States as well as elsewhere over time I would expect
this to be a factor working toward lower rates because it does
imply greater economic stability among countries and hence fewer
potential loan losses than otherwise.
The CHAIRMAN. So are you saying that if Congress would act
positively on the request of the administration, both on the IMF
and GAB, that this would have a positive impact on interest rates?
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Mr. SPRINKEL. I wouldn't want to make too strong a case for it,
but it would work in that direction. By far, the most important
things are the issues we talked about earlier; that is, trying to get
our overall deficit down and also keeping money growth under control.
The CHAIRMAN. What's your opinion of the Fed postponing for
another year going to contemporaneous reserve accounting rather
than lag?
Mr. SPRINKEL. Well, we have been on record—at least I have
been on record since being in Washington—urging that they move
off lagged reserve accounting as quickly as possible. We were very
pleased to see them moving toward contemperaneous reserve accounting, but it's now been delayed I gather until sometime next
year. The reason I personally and many others in the administration, were in favor of it was because it would give the Federal Reserve much more precise control over reserve creation and hence
over money creation. But they have chosen for various operational
reasons, I presume, to delay it.
The CHAIRMAN. Well, I have pushed them to do it too and I'm
very disappointed that they wouldn't go ahead with it, but to delay
it another year, I fail to see the reasoning beyond that where they
want to have more control.
Do you have any idea why they think it's too unsettling at this
time to make a change?
Mr. SPRINKEL. I'm not certain. It does indeed raise some costs in
the banking community and it varies of course by individual banks.
This may have been part of the reasons but I'm not certain. If it
were a part of the reason for not adopting contemporaneous reserves, this, in essence, is saying that a public objective is postponed because of the private cost involved. A way to prevent that
would be some very slight reduction in reserve requirements,
which are also costs to the banks. This in essence, would make it a
public cost and I, for one, would be in favor of a public cost being
incurred to achieve what I believe is an important public objective.
So even though that may have been part of the argument, it's not
a very persuasive one in my mind.
CONSEQUENCES OF RESTRUCTURING
The CHAIRMAN. There's been a great deal said in these hearings
not only from those on monetary policy but the housing hearings
we held a week ago about the competitive inequities which may
result from the restructuring we have been doing in the financial
community. What do you see as the potential consequences of restructuring to the efficiency of our credit markets and the Fed's
ability to conduct monetary policy?
Mr. SPRINKEL. Well, none of those changes have affected the
Fed's ability to create reserves or base money, whichever you
prefer. It does create noise in the money supply data and may
make it more difficult to know for sure, in the short run what's
happening. However, we should not lose sight of what our overriding objective is and that is to make this system more efficient. That
is to offer more and cheaper financial services to the American
public and I think that is clearly happening. I do not believe that
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very laudable objective should be derailed by concern about what it
may do to the M's in the short run because it does nothing to reserve creation; it does nothing to interfere with base control; It
does make movements back and forth between the various Mi, Ma,
M3, et cetera, a little more intense in the short run.
The CHAIRMAN. I assure you I'm not deterred.
Mr. SPRINKEL. I knew you weren't.
The CHAIRMAN. I'm just beginning. The bill last year was just beginning trying to modernize the system and obviously in transition
periods again there are some rough times.
Mr. SPRINKEL. Yes, sir.
The CHAIRMAN. But some of the worst critics, when you ask
them if they want to go back to what they were, to the sweep accounts and all the other maneuverings they were involved in
trying to survive and keep some money in their institutions,
nobody wants to go back. They just want to criticize.
Mr. SPRINKEL. Some of them would like to stop where they are
now perhaps.
The CHAIRMAN. Yes. That's probably true, but we will continue
to press forward.
Mr. SPRINKEL. We certainly will also.
The CHAIRMAN. Senator Mattingly, do you have additional questions?
Senator MATTINGLY. Getting back to the contemporaneous reserve requirements, in 1981 or 1982—I forget which committee—we
were proposing that they institute this tool. It seems to me the targets they set are never going to be any good until they implement
some additional tools and contemporaneous reserve requirements is
a tool.
What does it take to get them to utilize this tool?
Mr. SPRINKEL. Well, we have from the very beginning urged
them
Senator MATTINGLY. You mean the Treasury Department?
Mr. SPRINKEL. Yes. We urged it in public before this and other
committees. As you know, the Federal Reserve reports to the Congress, not to the Treasury, and I presume it's up to Congress and
their own decisionmaking process when they adopt it. The sooner,
the better, from our point of view.
Senator MATTINGLY. Well, let me ask the Chairman, can we get
the Congress to legislate the Federal Reserve to do it? I don't think
we can.
The CHAIRMAN. Well, we could, but as much as I would like to
see them make the change I would not want to do it by legislation.
I don't think that is the way to proceed. That opens the door to
when we start legislating to the Fed all sorts of little things and I
think that would be a disaster. Despite my problems with the Fed
over the years, I don't want Congress dictating every dotted "i"
and crossed "t" of how they operate. Then we would think that a
return to present Fed policy would probably be very desirable.
Senator MATTINGLY. Probably true. They have consistently overshot the targets which means obviously the targets
The CHAIRMAN. I might just say that the first year I was on the
committee and sat over there where Senator Hecht is, that there
were proposals in both the House and the Senate to set the money
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aggregates by legislation and Arthur Burns sat there chewing on
his pipe and said, "Now, Senator, you know better than that," and
I can't imagine what condition the economy would be in today if
rather than—I think the targets were 5 or 7 percent or something
like that and we were talking about mandating 12 to 15 percent, an
increase in the M's, and you would have thought a 21.5-percent
prime rate was giving money away, if Congress had gotten involved
in that. And you can imagine legislating the money supply on a
year-by-year basis or even in very general targets. So I'd like to see
them go to contemporaneous reserve accounting, but you could
open Pandora's box with Congress legislating and dictating to the
Fed that I would not favor.
Senator MATTINGLY. I agree with that. I don't think we should
legislate either. But if we've got everybody in agreement that
that's what they ought to do—and I haven't heard any disagreement about doing it other than the objections coming from the Federal Reserve itself—and saying that it's under consideration but we
may use it late—to me that's—we've been waiting a long time and
since they've not met their targets for so long, it seems to me they
may want to look at another tool. Maybe we should just send a
letter down once a week to them.
The CHAIRMAN. Well, I think one of the things obviously I was
asking Secretary Sprinkel, I do believe the industry itself feels that
to enact it rapidly would impose costs on them and they prefer to
have it—they don't disagree to going to it eventually, but they
prefer to stretch it out. So that may be one of the major reasons for
the Fed, because the financial industry itself not wanting to absorb
that change along with all the other changes that are happening
right now. But it's sort of like changing to the metric system. In
my opinion, if we had done it 50 years ago, nobody would care. The
longer you wait, the more difficult it becomes.
Senator MATTINGLY. I've spoken to some of the regions—I won't
say which ones—but some of the Federal Reserve regions and they
are all for it. So it's sort of surprising—not surprising but
I have one other question. I don't know whether your Department should do the analysis, but at what price of world oil do you
think would have to come down to where it's going to impact the
oil countries not being able to service their debt? Now I don't think
it's a complicated question because I think we've got the information here in our country about what percent oil is of the GNP of a
set country, so you would have a quick analogy. So I was wondering if there might be some way you could gather some of that information, some ballpark figures for us.
Mr. SPRINKEL. We have looked at it to some extent and the estimates indicate that a $5 cut in the price of oil would permit something on the order of a half of 1 percent more economic growth,
and that's an enormous amount. And I wonder if that's too generous myself because if the long-term trend in wealth is say 3 percent, increasing that to 3.5 percent is a high percentage increase
and I don't know whether it would be that much or not, but I've
seen estimates that high and higher. We would be glad to give you
what information we have, but 1 don't feel very comfortable with it
at this stage. We don't know how far oil prices are going to decline
for sure.
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Senator MATTINGLY. Well, we know they're on the way down.
Mr. SPRINKEL. Right. We think so.
Senator MATTINGLY. Now in the case of Mexico, owing something
like $80 billion or whatever it might be, what price does their oil
have to come down to to where they wouldn't be able to service
that debt, $20 or $25 a barrel?
Mr. SPRINKEL. Well, I'm quite confident, based on discussions
with them, they would not be much concerned about modest declines in oil prices, but if it gets to $5 or more per barrel it will
make a big difference.
Senator MATTINGLY. They're not going to get more; they're going
to get less.
Mr. SPRINKEL. That's right.
Senator MATTINGLY. If they get $5 less, where is the point where
they're not making any money in order to put it in the coffers in
order to service the debt?
Mr. SPRINKEL. I think what it means is that it will take longer
for that nation to restore economic stability and it will be somewhat more costly to restore economic stability, but at least they are
dedicated—the individuals that I have worked with—to doing just
that, even if the price of oil comes down.
Senator MATTINGLY. Is there a price in there where they
wouldn't be able to service their debt?
Mr. SPRINKEL. Well, it depends on an awful lot of things obviously on whether or not they are able to meet their targets with the
IMF and therefore get some financing from the IMF. It depends on
whether or not private credits
Senator MATTINGLY. If they're not making any money at all and
you get money from the IMF, all of the IMF money is going to do is
turn the money back and pay the interest, and that would be—I
think that's probably the scenario that we have to wonder whether
that's money being spent well.
ALL LOANS BY IMF REPAID
Mr. SPRINKEL. There's no record yet of a loan by the IMF that
didn't get repaid. That doesn't say it couldn't happen but the
reason that's never happened, I'm convinced, is that an IMF program is respected and highly regarded by the private market because they do their homework. They try to decide whether or not
this is a doable program and once they say it's doable, private
funds become available. Of course, if you did not pay off a loan to
the IMF, you're sort of doing the unpardonable. So they always pay
back the IMF. But there is no doubt that the decline in oil prices
will make it more difficult for Mexico to meet its obligations on the
private and the public sector debt. But I'm not willing to say yet,
based on our evidence, that this obviously means it's not going to
work. I think it will work. It will just take longer.
The CHAIRMAN. Senator Hecht.
Senator HECHT. I appreciate your comments and I hope interest
rates do come down two or three points by the end of the year.
Mr. SPRINKEL. I do, too.
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Senator HECHT, I have absolute confidence that the private
sector will revitalize our economy without a jobs bill and provide
the revenues, so I appreciate those comments.
Mr. SPRINKEL, Thank you, sir.
The CHAIRMAN. Senator Mattingly, did you remember your question?
Senator MATTINGLY. I sure did. I'm not advocating it, but with
the price of oil coming down, if it does come down appreciatively,
and people are unable to service their debts, would it then be plausible to consider using sort of barter type transactions? I don't
mean to keep pounding on this.
Mr. SPRINKEL. Well, of course, the barter system has been used
by some countries that have got into great difficulty. It's a very inefficient system. It's not nearly as efficient as the marketplace, but
nonetheless, if in the event the nation gets into great difficulty and
for some reason is unable or unwilling to adjust their exchange
rate to properly reflect reality—as the Brazilians did incidentally
over the weekend—then that's the next step. It's not something I
would encourage, but it's something that has developed on occasion
in the past and I'm sure it will in the future.
Senator MATTINGLY. By the way, have you analyzed the AFL-CIO
jobs program?
Mr. SPRINKEL- No, sir; I have not.
Senator MATTINGLY. $68 billion? I thought Senator Garn might
want to comment on that.
The CHAIRMAN. I'm glad to hear that. I heard $75 billion. That's
a reduction of $7 billion.
Senator MATTINGLY. It's a short year.
The CHAIRMAN. Do neither of you have additional questions?
[No response.]
The CHAIRMAN. Mr. Secretary, thank you very much for your
time before the committee today. There will be additional questions
for your response in writing.
Mr. SPRINKEL. Very good.
The CHAIRMAN. The committee is adjourned.
[Whereupon, at 10:35 a.m., the hearing was adjourned.]
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@FedFRASER