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FEDERSL RESERVE'S FIRST MONETARY POLICY
REPORT FOR 1984
HEARINGS
BEFORE THE
COMMITTEE ON
BANKING, HOUSING, AND URBAN
AFFAIES
UNITED STATES SENATE
NINETY-EIGHTH CONGRESS
SECOND SESSION
ON
OVERSIGHT ON THE MONETARY POLICY REPORT TO CONGRESS
PURSUANT TO THE FULL EMPLOYMENT AND BALANCED GROWTH
ACT OF 1978
FEBRUARY 8 AND 9, 1984
Printed for the use of the Committee on Banking, Housing, and Urban Affairs
U.S. GOVERNMENT PRINTING OFFICE
WASHINGTON : 1984
COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS
JAKE GARN, Utah, Chairman
WILLIAM PROXMIRE, Wisconsin
JOHN TOWER, Texas
ALAN CRANSTON, California
JOHN HEINZ, Pennsylvania
WILLIAM L. ARMSTRONG, Colorado
DONALD W. RIEGLE, JR., Michigan
PAUL S. SARBANES, Maryland
ALFONSE M. D'AMATO, New York
CHRISTOPHER J. DODD, Connecticut
SLADE GORTON, Washington
ALAN J. DIXON, Illinois
MACK MATTINGLY, Georgia
JIM SASSER, Tennessee
CHIC HECHT, Nevada
FRANK R. LAUTENBERG, New Jersey
PAUL TEIBLE, Virginia
GORDON J. HUMPHREY, New Hampshire
M. DANNY WALL, Staff Director
KENNETH A. McLEAN, Minority Staff Director
W. LAMAR SMITH, Economist
(ID
CONTENTS
WEDNESDAY, FEBRUARY 8, 1984
Page
Opening statement of Chairman Garn
Opening statement of Senator Proxmire
1
2
WITNESSES
Paul A. Volcker, Chairman, Board of Governors, Federal Reserve System
1983 actual growth on target
Foreign trade deficit
Protectionism in the foreign trade situation
Prepared statement
Monetary policy targets for 1984 and economic projections
The opportunity and the risks
Sources of strength
The problems
The implications for monetary policy
Toward a positive solution
Tables:
Table I: Federal Reserve objectives for money and credit growth
in 1984
Table II: Federal Reserve objectives for money and credit in 1983
and actual growth
Charts:
Chart 1: Ranges and actual money and credit growth (Mi)
Chart 2: Ranges and actual money growth (Ma, Ma)
"Monetary Policy Report to Congress Pursuant to the Full Employment and Balanced Growth Act of 1978
Budget cuts could have favorable climate on economy
Implementation of contemporaneous reserve accounting
OMB projections show nominal decline in GNP
Need to improve horrendous trade imbalance
Presidential line item veto power
Country needs to overcome trade deficit
Reduce defense spending and increase revenues
Hefty corporate profits anticipated
Savings recommendations needed
Hope for bipartisan compromise
Effects of the inflow of foreign capital
$50 billion Figure seems realistic
Risks of putting off legislation until 1985
Restrained wage settlements and reduced prices
Decline of corporate taxes
Tax increases have never solved the deficit problem
Shift in tax structure could be useful
United States on verge of being international debtor
Revenue sharing with States
Response to written questions of Senator Riegle
3
4
5
6
8
8
11
13
16
21
26
30
30
31
32
33
88
90
92
94
96
98
100
101
104
106
108
110
113
115
119
122
125
128
130
132
THURSDAY, FEBRUARY 9, 1984
Opening remarks of Chairman Garn
(ill)
143
IV
WITNESSES
Beryl Sprinkel, Under Secretary for Monetary Affairs. Department of the
Treasury
1 J8
Prepared statement
111
The progress in reducing inflation
145
The importance of a longrun commitment to price stability
150
The problem of monetary variability
15-1
Improving monetary control
157
Conclusion
160
Charts:
Chart 1: Money leads inflation by 2 years
161
Chart 2: Short-term and long-term interest rates
162
Chart 8: Comparative behavior of interest rates and monetary
volatility
168
Chart -4: Correlation between money growth and real GXP
164
Reason for slowdown in money growth
165
Discussion on Secretary Sprinkel's charts
1(57
Improvement in the inflation rate
169
Gradual slowing of rate of growth
172
Slow growth could lead to another recession
175
Overvaluation of the dollar
178
Response to written question of Senator Proxmire
180
Martin Feldstein, Chairman, Council of Economic Advisers
181
Prepared statement
182
Monetary policy, budget deficits, and the economic outlook
1^8
Monetary policy
188
Budget deficits
189
Spending cuts must accompany tax increase
191
Tax revenue should be proportional with Gi\P
198
Growth rate of-1 percent is projected
194
Major corporations having good revenues in 1988
197
Robert Parry, executive vice president and chief economist, Security Pacific
Corp., Los'Angeles, Calif
199
Prepared statement
200
The economy in 1988
200
Stabili/ation policies
202
Fiscal policy
202
Monetary policy
208
Prospects for the economy
205
Concluding comments
206
Tables:
Table I: Selected economic indicators
208
Table II: Selected components of the Consumer Price Index
208
Table III: Prospects for the U.S. economy
209
Allan H. Melt/er, professor, Carnegie-Mellon University. Pittsburgh, Pa
210
Prepared statement
211
What is our monetary policy?
211
Table 1: Targets for M.'growth 1976-88
212
Chart 1: Monetary v a r i a b i l i t y and GNP fluctuations
218
Panel discussion:
Can the Federal Reserve hit the 1-percent target
218
Relational issue of deficits and interest rates
220
Four budget items cause 80 percent of the deficit
222
Politici/ing the Federal Reserve
224
FEDERAL RESERVE'S FIRST MONETARY
POLICY REPORT FOR 1984
WEDNESDAY, FEBRUARY 8, 1984
U.S. SENATE,
COMMITTEE ON BANKING., HOUSING, AND URBAN AFFAIRS,
Washington, D.C.
The committee met at 9:30 a.m., in room bD-538, Dirksen Senate
Office Building, Senator Jake Garn vchairman of the committee)
presiding.
Present: Senators Garn, Heinz, Gorton, Mattingly, Hecht, Humphrey, Proxmire, Riegle, Dixon, Sasser, and Lautenberg.
OPENING STATEMENT OF CHAIRMAN GARN
The CHAIRMAN. The Banking Committee will come to order.
On Monday of this week the Federal Reserve announced a major
upward revision to the money growth numbers for the second half
of 1983, but even with this revision money growth slowed markedly
during the third and fourth quarters.
On Monday, the Federal Reserve also announced 1984 target
ranges for growth in Mi. M-, and Ms that are lower than the 1983
targets.
In accordance with the Humphrey-Hawkins Act which requires
these hearings to be held on a semiannual basis, our principal responsibility this morning is to assess the appropriateness of these
two developments. The second responsibility, of course, is to examine the entire context in which monetary policy must operate. I
certainly understand Chairman Volcker that as we trade with the
House over who is first to hold these hearings that they become
rather anticlimactic the second time around.
Nevertheless, it's important that each body have an opportunity
to question you during these hearings or your conduct of monetary
policy. As i have said so many times when you have been here
before, \ve must include, in my opinion, discussion of the deficits
that must be dealt with no matter who is Chairman of the Federal
Reserve or what the policies are in the Federal Reserve. Never in
the history of this country has the Federal Reserve Board had to
deal with deficits of the size that we are now forcing on the country. When I say we. 1 mean the Congress of the United States. I
think we have to considei them together. To do otherwise, to assert
that all you have to do is push some button and control of the MS
will take care of it all, that is an insult, at least to this Senator's
intelligence. That we can have $200 billion deficits, carry a $1.4
trillion debt, have interest on that debt in excess of $130 billion—
•1)
which exceeds by $24 billion the entire budget of John Kennedy for
1962 to run the entire country and defend it just 22 years ago—just
amazes me. We can't try and shift all of the burden away from
that and indicate that we have no responsibility whatsoever in this
body.
I, for one, do not believe that we can ever solve this problem
until there is better coordination between fiscal and monetary
policy. That certainly means that Congress has got to do a great
deal better job. The evidence is absolutely clear that, as these deficits continue to mount, that is our responsibility and no one else's.
The Constitution is very clear on who has the responsibility and
the obligation in our three-part system of government for appropriations. The Constitution does not allow the Federal Reserve to appropriate money. It does not allow the President to appropriate
money. And it's time that the Congress started matching its rhetoric with its votes. I don't know of any fiscal liberals any more and
certainly not in the Senate. Everybody is for reduced deficits. It is
the big topic. And I would suggest that the American people this
fall ought to go home and look at their Senators and Congressmen
and see if their rhetoric matches their voting records and if it does
not, then I suggest they get somebody else to represent them.
Anyway, we are pleased to have you before us once again to discuss monetary policy.
Senator Proxmire, do you have any comments you wish to make
before the Chairman begins?
OPENING STATEMENT OF SENATOR PROXMIRE
Senator PROXMIRE. Well, I'll just make a slight political rejoinder. I have got admiration, respect, and affection for our distinguished Chairman. First, I'd like to say, as I said when you came
before this committee for confirmation—and we recommended your
confirmation, Chairman Volcker—I said, "Alas, poor Volcker," and
I say it again with more emphasis today because of the terrible
budget the President of the United States has sent to us.
The fact is, in the last couple years the Congress has not significantly exceeded the President's request for spending. We have
shifted it a little bit, exceeded it by maybe 1 percent last time. But
the President must take the initiative. The President and the Congress have to work together on the kind of spending we engage in.
The President has sent us a $180 billion monstrosity from which
his advisers seem to be backing away—even Secretary Regan yesterday said we've got to do something with that. The budget is the
President's document, it is what he has asked us to do, it is a fundamental priority document of this country and I think we have to
work with it. But I don't think that the President or the Congress
should escape unscathed, and this is certainly—we're both sinners,
grievous sinners, and I hope that St. Paul will help us move out of
this terrible purgatory we find ourselves in.
The CHAIRMAN. Well, certainly the President sent us a budget
that I don't like. I don't like the recommendations, but I think the
Senator misses my point. It doesn't matter what this President or
any other President sends us; we don't have to accept it. Congress
is the only one under the Constitution that can appropriate, and to
lay it back to this President or any other is wrong. We don't like
these recommendations. That's where we need to separate the rhetoric from our votes. We can totally reject it. We can start with our
own budget. We can ignore it. Congress has not done so with this
President or the other two Presidents that I have served with since
I have been here and I would suspect—not suspect, I know you
have served with far more Presidents than I have, and the same
has been true.
In most years Congress has spent far more than Presidents have
recommended, but we do need to get our house in order.
Before I turn to other Senators for any opening comments they
would like to make, I would like to welcome to the committee a
new member. Senator Humphrey is the newest member and sits on
the far right, where I started from many years ago. It's a good seat
and it takes a little while to work around, but we are very happy
to have you on the committee, Senator Humphrey, and although
this is a violation of our rules of seniority, because you are brand
new, I think I will turn to you first to see if you have any comments that you would like to make.
Senator PROXMIRE. Would the chairman yield?
The CHAIRMAN. Yes.
Senator PROXMIRE. Just to make this bipartisan, I want to welcome Senator Humphrey too, especially in view of the fact that this
subject is so appropriate for Senator Humphrey. There's nobody
who's been more of a bearcat in trying to hold down spending than
Gordon Humphrey and I'm grateful to have Senator Humphrey on
the committee.
Senator HUMPHREY. In that vein, does anybody else have any
compliment they want to make? [Laughter.]
Thank you, Mr. Chairman. I am glad to be here. When do I get a
permanent name tag?
The CHAIRMAN. Give us a day or two and we'll have one made
for you.
Rather than going down the line, are there any other members
of the committee who wish to make an opening statement? Obviously, after the Chairman has finished his comments we will have
questions. Senator Heinz, do you have anything?
Senator HEINZ. Well, I was told we are going to lose our name
tags if we do, Mr. Chairman. No, I don't have an opening statement.
The CHAIRMAN. Senator Dixon.
Senator DIXON. I have nothing, Mr. Chairman.
The CHAIRMAN. Any others?
[No response.]
The CHAIRMAN. Mr. Chairman, the floor is yours, at least temporarily.
STATEMENT OF PAUL VOLCKER, CHAIRMAN, BOARD OF
GOVERNORS, FEDERAL RESERVE SYSTEM
Mr. VOLCKER. Mr. Chairman, you have the statement that I delivered before the House Committee yesterday. I won't read that,
but I might just make some of the points in it in a somewhat different order briefly.
1983 ACTUAL GROWTH ON TARGET
As far as monetary growth is concerned, we ended 1983 pretty
much on target in terms of actual growth compared with target
ranges.
We have subsequently revised some of the figures, as you indicated, and the benchmarks we have issued are fractionally higher on
all the monetary aggregates, with Ma for the fourth quarter slightly above the target range. The other aggregates were well within
the target range after revision. That did occur with slower growth
in the second half of the year, as you indicated.
The other side of that slower growth in the aggregates during
the second half of the year while the economy was continuing to
grow was generally rising velocity. I point that out because we
went through about 18 months of an abnormally sharp decline of
velocity for a variety of reasons analyzed in our Humphrey-Hawkins report.
As we look at the situation now, and in setting the new targets
for 1984, we see signs of velocity returning to more normal patterns, as you might expect, which means, particularly for M 1( a
rising pattern of velocity during a period of business expansion.
That still has to be a somewhat tentative judgment against abnormalities that we have had in the past couple of years and we still
feel somewhat tentative about the judgment about Mp We tend to
evaluate growth in Mi against wider targets that will have substantial weight in our operations.
As far as the actual targets for 1984 are concerned, they are essentially the same as those we announced in a preliminary way
last July. The one difference is one-half of 1 percent further decline
in M2, which is partly influenced by technical considerations.
Broadly, they are very similar to those we announced earlier.
In terms of our immediate operations, the amount of reserves
being provided, the degree of pressure on bank reserve positions,
that posture has been essentially unchanged for some months. It
remains unchanged. That reflects a view of the growth in the aggregates being reasonably in line with our intentions. It also reflects the view that the economy has continuing momentum and
that price performance has been in line with expectations and satisfactory, certainly looking backward.
In that operational sense, what happens to interest rates as the
year wears on is going to be determined in large part by what happens to the economy and the strength of demands or the lack
thereof.
We, meaning members of the Open Market Committee and the
other presidents of the Reserve banks, have set forth some economic projections which I think fall generally in line with those of the
administration and indeed those that the CBO announced yesterday, and in line with the prevailing view of outside economists, and
which show the growth at a slower rate of speed than Last year.
You typically get the most rapid growth immediately coming out of
a recession, as we did 3last year. We still show a very healthy rate
of growth in the 4- to 4 A-percent area.
We also assume some increase in the rate of price increase. That
would not be unusual during a period of business expansion, during
the second year of expansion.
There are some special factors affecting prices, but obviously that
is a sensitive area. I think you can get a small rise in the rate of
increase next year without being contradictory to a general trend
toward price stability, but if that got large and raised a doubt, that
basic trend would have an influence on the marketplace and an influence on the prospects for orderly economic development over a
period of time.
Price performance last year was as good as could have been expected and perhaps better than most people expected.
When we put together an analysis of 1983 and try to do that in a
little longer perspective, I think there are very considerable signs
of progress that augur well for the future of the economy. We seem
to be having productivity growth again. We have a lot more emphasis on restraining costs. Real incomes have been rising at the
same time that nominal wages and salaries have been increasing
more slowly. That's the kind of pattern you have to maintain
through expansion, and that kind of pattern would have a great
deal to do with this expansion being continued for a long period of
time and leaving us with good economic performance over the
decade as a whole.
There are all sorts of signs that we have a great opportunity to
extend the economic progress, but at the same time, as you well
know—and you have already alluded to one aspect of it—there are
real risks in current imbalances as we move ahead. You can see
some of those in the fact that while certain types of investment expanded pretty well in 1983, the investment sector of the economy is
relatively low, given the total size of the economy currently. Housing has leveled off at levels below those characteristic of some earlier periods. The amount of net while rising, remains relatively
low, and that reflects back on the outlook for capacity and the outlook for productivity over a period of time.
FOREIGN TRADE DEFICIT
In a way, the most striking and disturbing aspect of developments last year was the increase in the foreign trade deficit. I was
reading in the paper this morning that that reached the neighborhood of $60 billion last year and there are many projections that
the trade deficit will rise to over $100 billion during the current
year. The trends are certainly in that direction. While we have a
surplus in other items in the current account, the current account
picture reflects that pattern, with a deficit of $40 billion last year,
and if the trade deficit is over $100 billion, it could be double that,
in the neighborhood of $80 billion, this year. That obviously has
implications for industry that is concerned with exports and with
import competition. That has been a sector of the economy that has
not at all shared in the same degree in the rapid recovery we have
had.
Looking at that same phenomenon from another direction—from
the other side of the same coin—we are becoming increasingly dependent upon importing foreign capital. The projections suggest
6
that we will import foreign capital net equal to about 2 percent of
our GNP or more in 1984. That has its good aspects, in the sense
that it is becoming an important element in keeping interest rates
where they are in the face of the budget deficit, in the face of the
economic recovery. Interest rates have not gone up; they are being
moderated by an inflow of foreign capital. But you have to ask
yourself how long we can count on increasing amounts of foreign
capital to, directly or indirectly, finance our budget deficit.
It takes pressure off some areas of the domestic economy, but it's
also reflected in strong pressures on the export sector of the economy and on the import competing sector. It certainly does not give a
balanced picture, and it is a source of some considerable concern,
because one wonders what the sustainability of that picture is.
I think it gives a picture of risks that become greater as the
economy grows and of an enormous stimulus in one direction from
the budget deficit. That budget deficit, in turn, as I say, is indirectly or directly being financed abroad, removing some of the pressures on the market, but impairing greatly the external sector of
the economy. As soon as the capital inflow stops, all that pressure
will come back and have to be financed internally. Then you have
to ask yourself, what happens to investment? What happens to
housing? What happens to the future of the economy, which otherwise looks to be so promising?
Interest rates certainly remain high relative to the inflation rate.
I think it's hard to say, looking backward, they have been too high.
We have had a very good recovery and certainly the recovery has
succeeded despite that level of interest rates. But looking ahead,
these interest rates are too high for the continuing health of the
economy, much less can we tolerate an increase. We'd like to see
decreases not only to maintain housing but, even more importantly, to provide the environment for the kind of investment we need
domestically. That's easy to say. It's a question of how it can be
achieved.
Certainly when you look at the alternatives before us in terms of
economic policy and raise the question of what to do, it does not
seem to me the answer lies in increasing the money supply to rates
that would be potentially inflationary and destroy the progress we
have made against inflation. It seems to me pretty clear that that
policy, whatever its intent, would not be consistent with lower interest rates over time. It would, instead, mean higher interest rates
over time, and if people had that suspicion, that we were embarked
on a course of reinflation, it would produce higher rather than
lower interest rates very quickly.
At the same time, I think it's hard to say right now when there
are some signs of a somewhat slower rate of economic growth, a
satisfactory rate of economic growth, that there's any point right at
the moment to further restriction on the monetary policy side.
That all depends on how the total outlook develops as the year progresses.
PROTECTIONISM IN THE FOREIGN TRADE SITUATION
When one looks at the foreign trade situation, a quick reaction
may be that's an excuse for protectionism. I don't think that that's
going to help anything. It will only harm things over time. It would
be an inflationary factor. It might shift the pain to some degree in
the short run, from one industry to another, but it doesn't deal
with the basic problem of our dependence upon an inflow of foreign
capital. And so long as that is true, so long as the exchange rate
implications of that are such as to damage our foreign trade position, I think there's no answer, except a damaging one, from the
protectionist solution.
I think also, as you already suggested, Mr. Chairman, that there
is one obvious constructive change that could be made in our mix
of policies and our general approach toward economic policy, and
that would be to move more aggressively to reduce the budgetary
deficits that put pressure on our internal markets and that contribute directly and indirectly to our dependence upon the foreign
inflow of capital and that have undermined our international trade
position. That is not a startling conclusion, and I know it is a lot
easier to state that conclusion than to arrive at the political compromises and arrangements that are necessary to actually implement that kind of conclusion. But I can only urge upon you that
time is passing; that the risks seem to me to increase. Those risks,
ironically, get greater the better the economy does in an overall
sense. The more rapidly the economy moves forward, the greater
demands will be placed upon our credit markets from other sources
arid the more urgent it becomes to deal with the deficit.
We have made a lot of progress, but the time is here—maybe in
some sense it's passed—to begin dealing with this. Certainly looking ahead, I think that the risks and hazards become progressively
greater. It certainly is time to act, and I can only hope that
through the vehicle of the task force that the President proposed,
or otherwise, that prompt action can be taken to make significant
inroads on the budgetary problem.
Mr. Chairman, I am prepared to answer your questions.
[The complete statement and report follow:]
Statement by
Paul A. Volcker
Chairman, Board of Governors of the Federal Reserve Systcrr,
I am pleased to be meeting w i t h this Committee once
again to discuss the Federal Reserve's monetary policy
object)^es for the year ahead.
You have before you the
official monetary policy report that is required under
the Humphrey Hawk i np Act.
That report, which was released
Monday, describes rather fully the current economic situation and sets out our decisions w i t h respect to monetary
policy in detail.
My prepared remarks this morning will
focus mainly on some broader cons iderat ions that seem to
me to bear crucially on our approach to monetary policy,
on the interaction of monetary policy with other policies,
and on our economic prospects.
j^cnotary Pol icy "Targets" for 19R4 and Ecorio_rn_ic Projections
At its meeting last week, the Federal Open Market
-Committee essentially reaffirmed the ranges for money and
credit growth tentatively established in July of last year.
Those new target ranges are set out in Table 1 attached,
against the background of last year's targets.
As there indicated, the target ranges for M3 and for
nonfinancial debt were lowered by 1/2 percent from the 1983
ranges to 6-9 and 8-11 percent, respectively, as tentatively
set in July.
The M2 range was reduced by 1 percent from
the 1983 range to 6-9 percent.
That is 1/2 percent lower
than anticipated in July, reflecting in part technical
considerations bearing on the appropriate relationships
among the broader aggregates.
The Ml range was set at
4-8 percent, 1 percent lower than during the second half
of 1983, as had been anticipated.
These targeted ranges envisage that the relationships
between the monetary aggregates and the nominal GNP -t h a t is, "velocity" —
w i l l return to patterns much closer
to historical norms than was characteristic of 1982 and
early 1983.
Developments as 1983 progressed pointed in
that direction.
At year-end, all the targeted aggregates
appeared to be within the 1983 ranges;* a tendency for
velocity to rise -- in contrast to historically large
declines in 1982 and early 1983 -- was more in line w i t h
past cyclical experience.
Further experience w i l l be
necessary to confirm the v a l i d i t y of that judgment, and the
Committee recognizes that recent regulatory and institutiona:
changes may be reflected in some changes in the underlying
trends of velocity, particularly for Ml.
For that reason, substantial weight w i l l continue to
be placed on the broader aggregates for the time being, and
growth in Ml will be evaluated in the light of the performance of the other aggregates.
All the aggregates will be
interpreted against the background of developments in the
economy, current and prospective price pressures, and
cond it ions in domest ic credit and international markets.
* Subsequent benchmark revisions increased growth of
all the monetary aggregates fractionally, bringing M3
slightly above the targeted range during the fourth
quarter. The revised data are reflected in Table II
and the charts attached.
10
More deta i 1 about the new targets and 1983 performance
is provided in the Humphrey Hawkins Report itself, and I
will De glad to address any questions you have about them.
In setting the new target ranges, the Committee members
generally felt that economic activity would continue rising
through 1984 and into 1985 at a more moderate -- and potent i ally more sustainable -- pace of 4 to 4-3/4 percent.
That" growth is expected to be accompanied by some further
decline in the unemployment rate to the area of 7-1/2
"7-3/4 percent.
to
Cyclical factors and special ci rcumstances -•
i n c J u d i n g the effects of bad weather -- are expected to be
reflected in a little larger price increase on average,
f'ol lowing the remarkably good progress of 1982 and 1983,
Taken together, those projections resemble those set
out by the Administrat ion and many others, and they suggest
a generally satisfactory economic performance is probable
in 1?84.
But those summary
forecasts should not divert
out attention from certain serious problems that have
emerged.
As I assess the outlook, there are clear hazards
and risks before us.
Unless dealt with forcefully and
effectively/ they will jeopardize the good prospects
for 1984 and beyond.
11
The Opportunity and the Risks
A year ago, in appearing before you on this occasion,
I emphasized that, after too many years of pain and instability, we had an enormous opportuni ty to sustain
growth for years ahead in an environment of much greater
price stability.
Today, after a year of strong recovery,
that sense of the opportunities before us has only been
reinforced.
The simple fact is that the economy moved ahead
faster, and unemployment dropped more sharply, than we
or most others thought at all probable.
At the same
time, the i nflat ion rate dropped further, to the point
"that producer prices were almost unchanged over the year
as a whole and consumer prices rose by less than at any
time over the past decade.
The fact that we were able
to combine strong growth with good price performance is
what is so encouraging.
It is the key to lasting success,
With job opportunities, real incomes, and profits
all rising, so has the sense of optimism among both
families and businesses.
That widely shared impression
is confirmed statistically in the results of "attitudinal 1
indices that attempt to measure confidence, expectations,
and buying plans
-- they are mostly at the highest* or
near the highest, levels in many years.
12
I realize that improvement must be measured from where
we started.
There was a lot of room to grow, and the
early stages of recovery typically see rapid growth and
less price pressures.
Any satisfaction with what has
been happening has to be tempered by the knowledge there
is still a considerable way to go to reach satisfactory
levels of employment
and before we can claim to have
restored reasonable price stability.
In particular,
should inflationary trends and fears again take hold,
prospects
for the lower interest rates and orderly credit
markets we need to support investment and productivity
growth would be shattered.
I hardly need to remind you that inflation has tended
to worsen during periods of cyclical expansion.
need not be inevitable.
But that
Out of hard experience, I believe
we can shape disciplined policies -- indeed, we have already
gone a long way toward shaping policies and attitudes
—
toward dealing with the threat.
What we have not done in this past year is face up
to other hazards to our prosperity and to our stability —
hazards that are new to our actual experience but which
have been long identified.
our twin deficits:
1 am referring, of course, to
the structural deficit in our Federal
budget and the deficit in our external accounts —
at unprecedented levels and getting worse.
both
Both of those
deficits carry implications for the prospects of reducing
our still historically high levels of interest rates.
13
So f a r , the strains have been masked by other factors
of strength and by the rapidity of growth from the
depths of recession.
But w i t h the passage of tin^e and
full recovery, the predictable effects have become
more obvious.
They pose a clear and present danger to
the s u s t a i n a b i l i t y of growth and the stability of markets,
domest ic and international.
We still have time to act --
but -in my judgment, not much time.
Sources of
Strength
I can summarize briefly why I think the developments
of the past year are, in key respects, so promising -why, potentially, what has been going on can be not "just
another" cyclical recovery, but the start of a long
process of growth and renewed stability.
Looking back, it is now apparent that the trend of
productivity growth had practically stopped in the late
1970's.
But productivity began to increase again during
the recess ion and rose rapidly during most of last year.
One or two years do not make a new trend, and relatively
good product ivity growth is typical of the early stages
of recovery.
qualitative —
But the evidence -- quantitative and
suggests something more than cyclical
forces are at work in important areas of the economy.
Under the pressure of adversity —
and with the seemingly
"easy pickings" of speculative and inflationary gains
14
diminishing -- management and labor alike have turned their
ef forts and their imagination toward ways to increase
efficiency and to curtail overhead.
That, together with growing markets, accounted for
the speed of the rebound in total profits and improvement
in profit margins last year from long-depressed levels,
even as prices for many goods and services tended to
stabilize.
The cash flow of businesses has been further
rei nforced by the liberal treatment of depreciation and
other tax changes enacted in recent years, and after-tax
economic profits, only a year after recession, are
approaching the highest levels of the 1970's relative to
GNP.
Strong expansion in some types of investment during
1983 -- particularly electronic equipment where technological
-change has been so rapid -- carries promise for future
productivity.
We should not claim too much.
Profits remain well
below rates typical of the prosperous 1960's.
Recent
employment increases, while highly welcome in themselves,
have been eo large relative to output growth that they
raise some questions about whether rapid productivity growth
is being maintained.
Long-1ived investment -- new plant
for expansion of capacity —
still lags.
High interest
rates, the uncertainty bred by years of disappointment,
and strong competition from abroad all have restrained
15
heavy investment.
Already, a few industries are
close to, or even at, sustainable capacity.
But, on
balance, the evidence and the omens are more favorable
than for several years.
That is certainly true of the longer-term outlook
for costs and prices.
I am well aware that slack markets
and excessive unemployment, the appreciating dollar
together with the ready availability of goods from abroad,
and the decline in world oil prices all helped account
for the rapidity of the drop in the general inflation
rate and the degree to which cost pressures have subsided.
To that extent, progress toward stability has had a
sizable "one t ime," or cyclical, component.
But we also
now have a clear opportunity to "build-in" that improvement
—
the best opportunity in many years.
As the increase in average wages and salaries, which account for some two-thirds of all costs, has declined in nominal
terms, the real income of the average worker has increased.
That reverses the pattern as inflation accelerated during much
of the 1970's when escalating wages often lagged behind more
rapidly rising prices.
The more favorable pattern should be
assisted by greater stability in energy prices, where the
outlook (barring political turmoil) appears favorable, and
by stronger productivity growth.
With real wages again
rising on average, and with prices more stable, the logic
points toward much more moderate new wage contracts than
became the norm in the inflationary 1970's.
The competitive
16
pressures associated with the process of deregulation in
some important industries also have been a factor working
to contain costs and prices, and happily we can begin to
see some signs of more restrained cost increases in areas,
such as medical care and education, that have been slow
to reflect the disinflationary process.
To the extent we can build confidence in the outlook
for more stable prices, the process could, potent ially,
feed on itself.
Incentives for speculation in commodi t ies,
and for speculative excesses, would be greatly reduced
and poss i b i l i t i e s of another burst in oil prices d i m i n i s h e d ,
It could provide the best possible environment for declines
in interest rates over time -- nominal and real -- and
interest rates are themselves an element of costs.
Lower
interest rates could, in turn, be a powerful factor
support ing and encouraging housing and the business
investment that we need to maintain economic momentum and
to support productivity growth.
The Problems
Nonetheless, as I suggested
a few minutes ago, the
prospects for sustained growth and stability must rema in
condit ional.
There is another, and bleaker, reality.
are faced with two deficits -- in our budget and in our
international accounts -- unprecedented in magnitude.
Those twin deficits have multiple causes, but they are
We
17
not unrelated.
Left, unteruled, each, rather than i m p r o v i n g ,
w i l l tend to c u m u l a t e on i t s e l f , until f i n a l l y they w i l l
undercut
all that has been achieved with so much effort
and so much pain.
Looking bdck, the rising budget d e f i c i t provided a
large and growing stimulus to purchasing power as we
emerged from recession.
It helped account
for the vigor
of consumpt ion in the face of historically high interest
rates.
The other side of the coin is that financing the
deficit last year amounted to three quarters of our net
new domestic savings.
That was tolerable -- we obviously
have tolerated it -- for a limited period of time when
other demands on those savings were limited.
Business
inventories actually declined on balance last year, and
housing and business investment were recovering from
recession lows.
Even then, d e f i c i t s were a factor keeping interest
rates higher than otherwise, and the implications become
much more serious as the economy grows closer to its
potential.
succeeded
The hard fact is that for many years we have
in sa.'^ng (net of depreciation) only some 7 to
9 percent of cur GNP.
Despite the efforts to raise it,
the domestic savings rate remains within that range now and
foreseeably.
Tf the budgetary deficit absorbs amounts
equal to 5 percent or more of the GNP as the economy
grows -- and that is the present prospect for the "current
18
services" or "base line" budget -- not much of our
domestic savings will be left over for the investment
we need.
Over the past year, our needs have been increasingly
met by savings from abroad in the form of a net capital
inflow.
That money has come easily; amid world economic
and political uncertainty, the United States has been a
highly attractive place to invest.
But part of the
attraction for investment in dollars has been relatively
high interest rates.
In effect, the growing capital
inflow has, directly or indirectly, helped to finance the
internal budget, by the same toKen helping to moderate
the pressures of the budget deficit on the domestic
financial markets.
At the same time, the flow of funds
into our capital and money markets pushed the dollar
higher in the exchange markets even in the face of a
growing trade and current account deficit -- and the
dollar appreciation in turn undercut our world-wide
trading posit ion further.
We simply can't have it both ways —
on the one
hand, look abroad for increasing help in financing the
credits related to our budget def icit, our housing, and
our investment, and on the other hand, expect to narrow
the growing gap in our trade accounts.
At the end of the
day, the counterpart of a net capital inflow is a net
deficit on our current account -- trade and services -with other countries.
19
Most forecasts suggest that we, as a nation, will
have to borrow abroad (net) about 2 percent or more of
our GNP this year to meet projected domestic needs.
That
pace does not appear sustainable over a long period. Faced
at some point with a reduction in the net flow of capital
from abroad, the burden of financing the budget deficit
would then be thrown back more fully on domestic sources
of savings.
If our Federal financing needs remain so h i g h ,
housi ng and investment will be squeezed harder.
I must also point out that, in the same way that the
interest costs of this year's d e f i c i t add to next year's
requirements -- and compound over many years thereafter -the interest and dividend payments related to the net
capital inflow builds up future charges against the
current account of the balance of payments.
Skept icism
about our ability to account accurately and fully for all
the flows of funds into or out of the country
is justified;
it is nonetheless ominous that the recorded net investment
posit ion of the United states overseas, buiIt up gradually
over the entire postwar period, will in the space of only
three years —
1983, 1984, and 1985 —
be reversed. If
the data at all reflect reality, the largest and richest
20
economy in the world is on the verge of becoming a net
debtor internationally, and would soon become the largest.
Looking at the same development from another angle,
it is the exporter, and those competing directly with
imports, that have not shared at all proportionately in
the recovery.
the point.
Developments in the fourth quarter illustrate
There has been much comment about the slowing
in the rate of GNP growth to a rate of about
percent.
4-1/2
But, judging from the preliminary f igures ,
domestic demands were quite well maintained, increasing
at a rate of almost 7 percent.
Much of that increased
demand flowed abroad, adding to income and production
elsewhere.
It was domestic product ion, not demand, that
grew appreciably more slowly.
For a time, as with the budget deficit, that kind of
discrepancy is tolerable.
Indeed, from one point of
view, it has provided a welcome impetus toward stimulating
the growth process in other countries of the industrialized
world, and the strength of our markets assisted the
external adjustments necessary in the developing world.
We can also take pride in the fact that others find the
United States an attractive place to invest; good
performance and policies can help sustain those flows.
But we simply can't afford to become addicted to
drawing on increasing amounts of foreign savings to help
21
finance our internal economy.
Part of our domestic
industry -- that part dependent on exports or competing
w i t h imports -- would be sacrificed.
The s t a b i l i t y of
the dollar and our domestic f i n a n c i a l markets would become
hostage to events abroad.
If recovery is to proceed else-
where, as we want, other countries will increasingly need
their own savings.
While we don't know when, at some point
the process would break down.
The^Implications for Monetary Policy
In the abstract, the ultimate objective of monetary
policy is simple to state and widely agreed:
to provide
just enough money to finance sustainable growth —
not so much as to feed inflation.
and
In the concrete, issues
abound.
Some of them are more or less technical —
how we
define and measure money and its relationship to the
nominal GNP.
These questions are dealt with in our formal
report describing our decisions on the targets.
I want
here to concentrate on some broader implications of the
current situation for the conduct of monetary policy.
There is no instrument of monetary policy that f in
any direct or immediate sense, can earmark money only for
expansion and not for inflation, or vice versa.
The
distribution of any given nominal growth of the GNP
between real growth and inflation is a product of many
22
factors —
the flexibility and competit iveness of product
and labor markets, the exchange rate, and internal or
external shocks (such as the oil crises of the 1970'si.
Expectations and attitudes developed out of past experience
are critically important.
In that respect we have not inherited a sense of
stability.
Quite to the contrary, the legacy of the
1970's was deeply ingrained patterns of behavior -- in
pricing, in wage bargaining, in interest rates, and in
financial practices generally -- built on the assumption
of continuing, and accelerating, inflation.
Starving an
inflation of the money needed to sustain it is a difficult
process in the best of circumstances; it was doubly so
when the continuing inflationary momentum was so strong.
Now, after a great deal of pain and dislocation,
attitudes have changed —
restraint
there is a sense of greater
in pricing and wage behavior, a greater
recogni tion of the need to improve efficiency, less alarm
(at least for the short run) over the outlook
for prices,
and relative confidence by others in the outlook for the
United States.
In this setting, we can assume that, within
limits, more of any given growth in the money supply will
finance real activity and less rising prices than would have
been the case when the inflationary momentum was high.
23
But we also recognize that the battle against
inflation has not yet been won —
that skepticism about
our a b i l i t y , as a nation, to m a i n t a i n progress toward
stability is still evident.
That is one of the reasons
why longer-term interest rates have lingered so far above
current inflation levels.
After so many false starts in
the past, the skepticism is 1ikely to remain until we can
demonstrate that, in fact, the recent improvement is not
simply a temporary matter -- that the Federal Reserve is
not prepared to accommodate a new inflationary surge as
the economy grows.
The doubts are rei nforced by concerns
that the pressures of the huge budget deficit on financial
•markets may, willy-nilly, push us in that direction, as
has happened in so many countries.
The des ire to see interest rates lower, or to avoid
increases, is natural.
But attempts to accomplish that
desirable end by excessive monetary growth would soon be
counterproduct ive.
By feeding concerns about inflation,
the imp licat ions for interest rates themselves would in
the end be perverse —
later.
and likely sooner rather than
As things stand, credit markets are already faced
with potential demands far in excess of our capacity to
save domest ically; to add renewed fears of inflation to
the outlook would only be to reduce the willingness to
commit funds for long periods of time and for productive
24
investment.
Inflationary policies would also discourage
the continuing flow of funds from abroad, upon which, for
the time be i ng, we are dependent.
In the last analysis,
wil lingness to provide those funds freely at current or
lower interest rates is dependent on confidence in our
stability and in our economic management.
Depreciation
of the dollar externally as a result of inflationary policies
will not, in the end, help our exporters, or those competing
with imports, because that depi.ecia t ion would be accompanied
by inflated domestic costs.
In a real sense, the greatest contribution that the
Federal Reserve itself can make to our lasting prosperity
is to foster the expectation
-- and the reality —
that
we can sustain the hard-won g a i n s against inflation and
build upon them.
In my judgment, against a background of more stable
prices, interest rates are indeed too high for the longterm health of the United States or the world economy.
I have repeatedly expressed
the view that, as we maintain
the progress against inflation, interest rates should
decline -- and they should stay lower.
Much is at stake.
We w i l l need more industrial
capacity, and relatively soon.
Even after the sharp
declines in interest rates from earlier peaks, many thrift
institutions and businesses remain in marginal profit
positions and with weakened financial structures; lower
25
rates would bring much faster progress in repairing the
damage.
The ccope rat ive efforts of borrowers, banks, and
the governments and central hanks of the i n d u s t r i a l i z e d
world have managed to conta in the strai ns on the
internetional financial system, but the pressures are
still strongly evident.
Both economic growth and lower
interest rates are needed as part of more fundamental
solut ions.
But wish and desire are not the same thing as
reality -- we have to deal with the situation as it is.
In setting the targets for the various monetary and credit
aggregates for 1984 as a whole, the FOMC had to remain
alert to the danger of renewed inflation as well as to
the need for growth.
It also decided that, operat ionally,
it would for the time be ing be appropriate to maintain
essentially the same degree of restraint on the reserve
positions of depository institutions that has prevailed
since last autumn.*
That judgment reflects the fact that
growth in the various measures of money and credit now
appea rs broadly consistent with objectives, that the momentum
of economic expansion remains strong, and inflationary
tendencies contained.
That operational judgment will, of
course, be reviewed constantly in the weeks and months ahead.
* In the very short run, account will be taken of poss ible
increases in the level of excess reserves occasioned by the
trans it ion to contemporaneous reserve account ing.
26
Those decisions will reflect continuing appra isals
of the rate of growth of money and credit, interpreted in
the light of all the evidence about economic activity,
prices, domestic and international financial markets,
and other relevant considerations.
All those factors
will, in turn, be affected by other public and private
policies.
In that context, it is the strength of economic
activity, the demand pressures on the credit markets, and
the willingness of others to invest in the United States
that will influence the course of interest rates.
In approaching our own operational decisions, the
actual and prospective size of the budget deficit inevitably
complicates the environment within which we work.
By feeding
consumer purchasing power, by heightening skepticism about our
ability to control the money supply and contain inflation, by
claiming a disproportionate share of available funds, and by
increasing our dependence on foreign capital, monetary policy
must carry more of the burden of maintaining stability and
its flexibility, to some degree, is constrained.
Toward a Posit ive Solution
Monetary policy is only one part of an economic
program.
it is an essential part, but success is dependent
on a coherent whole.
I have tried to demonstrate that we have come a long
way -- that we have much upon which to build sustained
prosperity.
27
Many of the portents are favorable.
Public policy has encouraged greater competition,
removed harmful regulatory restraints, and provided
greater incentives.
There are hopeful signs that
productivity is again growing, and a healthy concern
about costs and efficiency.
Energy prices have stabilized.
We have had a strong recovery, and the progress toward
price stability has been gratifying.
Prospects for extending that success rest in part on
continuing discipline by business and labor.
We cannot
afford to return to the syndrome of the 1970's, with
prices and wages chasing each other amid fears of inflation,
amid erosion of productivity and real incomes.
The
experiments in the private sector with profit sharing,
with quality circles, and with other forms of labormanagement cooperation —
efforts born in adversity —
can bear fruit in prosperity.
If they are to do so —
if a sense of discipline is
to be maintained -- those of us responsible for public
policy must be able to demonstrate that inflation will
not again get the upper hand -- that productivity and
restraint will be rewarded, not penalized in favor of
those seeking i nflationary or speculative gain.
28
The contribution that monetary and other policies
make to that environment is critical.
As the expans!on
proceeds, and as some of the temporary factors restraining
prices recede, we as a nation simply cannot afford to permit
inflation to attain a new momentum.
Our monetary policies are,
and in my judgment must continue to be, geared to avoid that danger,
But for all that progress and promise, something is
out of kiIter.
Our common sense tells us that enormous and potentially
rising budget deficits, and the high and rising deficits
in our trade accounts, are wrong -- they can not be i n d e f i n i t e l y
prolonged.
That common sense is conf irmed by simple observat ion.
Some of our proudest industries -- potent ially capable of
competing
strongly in world markets -- are in trouble,
tempted to shift more operations abroad for sheer survival
or demand protectionist walls.
Interest rates remain
historically high, threatening housing and investment.
And, in this instance, economic analysis bears out,
and amplifies, the judgments of common sense and simple
observation.
Our two deficits are related.
The budget
deficit, by outrunning our ability to save, damages
prospects for housing and for investment, and makes us
dependent on foreign capital.
That capital from abroad,
for the present, alleviates the pressure on our money
29
markets, but it complicates our trade posit ion.
And
if and as our trade account improves, the brunt of
financing excessive budget d e f i c i t s would fall back more
fully on domestic savings, squeezing domestic capital
spendi ng harder.
We can, of course, sit back and wait awhile longer,
hoping for the best.
I certainly have some understanding of the difficulties
of achieving a consensus on difficult budgetary choices
when a sense of immediate crisis is lacking -- when for
the moment things seem to be going so well.
But I also know to wait too long would be to take risks
"with the American economy.
It is already late. The stakes are large,
Markets have
a mind of their own; they have never waited on the convenience
of kings or Congressmen -- or elections.
The time to take the initiative is now, when we can
influence markets constructively -- when we can demonstrate
that we are in control of our own
financial destiny.
Real
progress toward reducing the budget deficit is needed to
clear away the dangers.
I sense a fresh opportunity in the proposals of the
President for a joint effort to attack the deficit -- for
a sizable "down payment" on what is ultimately needed.
Certainly, that kind of demonstrat ion that we are
beginning to face up to our budgetary problem would m a k e
it easier for monetary policy to do its necessary
work.
And, in the larger scene, it would be tangible evidence
to our own people that we can do what is necessary to
seize the bright opportunities before us.
30
Table I
Federal Reserve
Objectives for Money and Credit Growth in 19841
for 1984 ( % )
Tentative
ranges for
1984 set
in July 1983 ( % )
Ranges
for 1983
established
in July 1983 ( % )
M2
6 to 9
6-1/2 to 9-1/2
7 to 102
M3
6 to 9
6 to 9
6-1/2 to 9-1/2
Ml
4 to 8
4 to 8
5 to 93
Domestic
Nonf incial
Sector Debt
8 to 11
8 to 11
New ranges
8-1/2 to 11-1/2
1.
Ranges apply to periods from fourth quarter to fourth quarter, except
as specified.
2. Range applies to period from February-March 1983 to fourth quarter
of 1983.
3. Range applies to period from second quarter of 1983 to fourth quarter
of 1983.
Table II
Federal Reserve Objectives for Money and Credit in 1983
and Actual Growth
Ranges
for 1983
established
in July 1983 ( f t )
H2
M3
HI
Donestic
Nonfinancial
Sector Debt
1.
7 to 101
2
6-1/2 to 9-1/2
5 to 9
3
8-1/2 to 11-1/2
Actual growth^ ( % )
Revised
jjata
Old
data
8.3
7.8
9.7
9.2
7.2
5.5
10.5
10.5
Range applies to period from February-March 1983 to fourth quarter
of 1983.
2. Range applies to period from fourth quarter of 1982 to fourth quarter
of 1983.
3. Range applies to period from second quarter of 1983 to fourth quarter
of 1983.
31
chart i Ranges and Actual Money and Credit Growth
M1
Billions of dollars
— — Ranges adopted by FOWC for
19B2 Q4 to 1983 Q2 and
1983 02 lo 1983 04
Rales of Giowfh
(annual rate j
1982
520
04 lo 1983 02
1 2 4 percent
1983 Q2 to 1983 Q4
7.2 percent
500
480
O
1 N
|
D
|
j
|
F
|
M
|
a
|
M
1982
|
J
|
J
|
A
t
S
|
O
|
N J_O_
1963
Total Domestic Nonfinancial Sector Debt
Billions ot dollars
Range adopted by FOMC '01
Dec 1982 to Dec 1983
Rate of Growtti
5200
— 5000
— 4600
1982
Dec 1982 to Dec 1983
10 5 percent
32
Ranges and Actual Money Growth
Chart 2
M2
Billions of dollars
Rale of Growtn
(annual rate)
— — Range adopted by FOMC lor
Feb 'Mar 1983 to 1983 04
Feb
2200
Mat 10 1983 Q4
8.3 percent
H 2100
O
l
N
I
D
J
I
F
|
M
I
A
I M
I
J
I
J
I
A
I
S
I
O
.1
N
ID
M3
Billions of dollars
— — Range adopted by FOMC (or
Q4 to 1983 04
Rate of Growth
1982 O4 to 1983 Q4
2650
2550
2450
0
|
N
|
1982
o
|
j
j
F
j
M
|
A
|
M
_
j
J
| J
1983
O
I N
I
0
9.7 percent
33
FOR USE AT 9:15 A.M., E.S.T.
MONDAY
FEBRUARY 6, 1984
Board of Governorsof the Federal Reserve System
Monetary Policy Report to Congress
Pursuant to the
Full Employment and Balanced Growth Act of 1978
February 7, 1984
Letter of Transmittal
BOARD OF GOVERNORS OF THE
FEDERAL RESERVE SYSTEM
Washington, D.C., February 7, 1984
THE PRESIDENT OF THE SENATE
THE SPEAKER OF THE HOUSE OF REPRESENTATIVES.
The Board of Governors is pleased to submit its Monetary Policy Report to the Congress pursuant to the
Full Employment and Balanced Growth Act of 1978.
Sincerely,
Paul A. Volcker, Chairman
34
Summary of Federal Reserve Monetary and Credit Growth Objectives
and Economic Projections for 1984
Objectives for Money and Credit Growth 1
Hew ranges
for 1984 (Z)
Tentative
ranges for
1984 set in
In July 1983 (Z)
Ranges
for 1983
established
in July 1983 (Z)
6-1/2 to 9-1/2
7 to 102
M2
6 to 9
113
6 to 9
6 to 9
Ml
4 to 8
4 to 8
5 to 93
Domestic
Nonf Inancial
Sector Debt
8 to 11
8 to 11
8-1/2 to 11-1/2
1.
2.
3.
6-1/2
to 9-1/2
Ranges apply to periods from fourth quarter to fourth quarter,
except as specified.
Range applies to period from February-March 1983 to fourth quarter
of 1983
Range applies to period from second quarter of 1983 to fourth quarter
of 1983.
Economic Projections for 1984
FOMC members and
other FRB Presidents
Central tendency
Range
Administration
Change, fourth quarter
to fourth quarter (Z)
Nominal GNP
Real GNP
GNP deflator
Average unemployment
rate In the fourth
quarter (%)
8 to 10-1/2
3-1/2 to 5
4 to 6
9 to 10
4 to 4-3/4
4-1/2 to 5
7-1/4 to 8
7-1/2 to
7-3/4
9.8
4.5
5.0
35
Federal Reserve Objectives for Money and Credit In 1983
and Actual Growth
M2
Domestic
Nonfinancial
Sector Debt
3.
Old
data
7 to 101
8.3
7.8
9.7
9.2
5 to 9
7.2
5.5
8-1/2 to 11-1/2
10.5
3
Ml
2.
Revised
data
6-1/2 to 9-1/22
M3
1.
Ranges
for 1983
established
in July 1983 (2)
Actual growth (%)_
10.5
Range applies to period from February-March 1983 to fourth quartet
of 1983.
Range applies to period from fourth quarter of 1982 to fourth quarter
of 1983.
Range applies to period from second quarter of 1983 to fourth quarter
of 1983.
36
Section 1:
The Outlook for the Economy in 1984
Conditions In the national economy took a decided turn for the
ter In 1983.
bet-
Real gross national product rose 6 percent over the four quarters
of the year, close to the experience during the first years of past cyclical
recoveries but well above earlier projections.
Although unemployment remained
painfully high, rising production spurred gains in employment large enough to
cut the unemployment rate by 2-1/2 percentage points over the course of the
year.
At the same time, most broad measures of prices and wages recorded fur-
ther progress toward lower inflation.
In short, the performance of the economy
in 1983 suggested that the immediate objective of permitting sufficient growth
in monetary and credit aggregates to foster a solid economic recovery, while
not encouraging developments that would rekindle inflationary pressures, was
achieved.
But success cannot be measured by performance during any one year,
and in some respects the f i r s t year of recovery—beginning In the context of
excess capacity and high unemployment—provided the most favorable environment
for combining economic growth with progress toward price stability.
The more
stringent and meaningful test will come as we seek to maintain the momentum of
expansion and the progress toward stability while the margin of unemployed
resources diminishes.
Moreover, developments in 1983 were marred by certain
structural imbalances, particularly in the federal budget and in foreign trade,
that represent risks to orderly progress.
At present, the prospects for extending the economic gains of the
past year into 1984 appear, by and large, to be good.
Economic growth slowed
in the final quarter of 1983, with real GNP up 4-1/2 percent at an annual
rate.
A continuation of growth in that general range would be consistent with
37
significant progress toward lower unemployment this year and with sustained
expansion in a framework of greater price stability in the years beyond.
As is typical, the composition of output is likely to change as the
cyclical expansion moves through its second year.
Business investment in plant
and equipment can be expected to provide a greater share of the impetus to economic growth, reflecting continuing gains in sales, rising capacity u t i l i z a t i o n ,
and improved profitability.
Conversely, 1984 probably will see smaller contri-
butions to growth frora those sectors that lent early strength to the recovery.
Housing a c t i v i t y surged early in 1983, largely in reaction to the sizable
decline in mortgage rates that started in mid-1982; absent an appreciable movement in mortgage rates from current levels, homebuilding can be expected to be
more stable this year.
Consumption spending, whose upswing s t r o n g l y boosted
aggregate demand in 1983, is likely to decelerate in the coming year: for the
f i r s t time in several y e a r s , spendable income will not be enhanced by a major
federal tax c u t , and any considerable f u r t h e r decline in the saving rate appears
improbable.
Inventory behavior is always uncertain; however, with the liquida-
tion and Initial-accumulation phases of the cycle complete, inventory investment in 1984 Is likely to add less to economic growth than in 1983.
Stocks
will probably remain low relative to sales, since high financing costs and new
methods of inventory control are a restraining I n f l u e n c e .
The prospects for continued progress against i n f l a t i o n have been
improved by better productivity performance, more realistic wage bargaining,
and a more competitive environment for price decisions.
The supply-demand
situation in the oil market suggests that another inflationary shock from that
source is unlikely, and indicators of inflation expectations have remained t t
38
lower levels thus far in Che recovery.
These factors all provide favorable
portents for the future, hut they will be tested as economic expansion continues.
The firmer labor and product markets that are normally associated
with the second year of an economic recovery could cause some cyclically sensitive prices to rise; a social security tax Increase for employers will
boost labor costs; food prices are likely to be higher than they otherwise
might because of the e f f e c t s of last summer's drought on [neat prices.
While these latter forces need not in and of themselves mean the
underlying trend toward lower rates of Inflation has ended, they could, if
associated with other factors, tend to increase Inflation expectations and
generate broader pressures on prices and wages.
One of the possibilities is
that the competitive forces associated with the appreciation of the dollar and
the ample availability of goods from abroad—which have been exerting downward
pressures on the rate of Inflation—could recede.
More fundamentally, as mar-
gins of excess capacity diminish—to the vanishing point in a few industries—
and as the availability of experienced labor declines, there may be temptations
to revert to the pricing and wage bargaining patterns characteristic of earlier
years of rapid Inflation.
Furthermore, as time passes, the imbalances associated wlch the current expansion will pose increasing risks.
The second year of an expansion of
economic activity is likely to bring with it growing business credit demands.
At the same time, unless decisive action Is taken, the federal government
deficit will continue to drain off an extremely large portion of available net
saving in the economy.
With no easing of the tensions in credit markets, inter-
est-sensitive sectors, such as housing and long-term business Investment, In
all probability will continue to operate well below their underlying potential
39
and below the levels consistent with sustained, balanced economic growth and a
strong productivity performance.
The large federal government deficit has had repercussions for the
international economy as well.
By adding to pressures on domestic credit mar-
kets, it has helped induce an inflow of capital from abroad, exerting upward
pressure on the dollar, even as our trade and current account balances have
deteriorated.
Further deterioration in the external balance is expected this
year, and that trend and level of imbalance cannot be sustained indefinitely.
Under these circumstances, it certainly is questionable whether we can count
on the continuing eagerness of foreigners to Invest in Increasing amounts of
dollar-denominated assets, and this has significant Implications for potential
developments in credit and exchange markets.
Even if the recent trends in the
trade balance could be sustained, it is not at all clear that the consequences
for American industry would be acceptable.
Moreover, the federal deficit and associated high U.S. interest rates
will continue to aggravate the debt servicing problems of major international
debtors.
To be sure, the approval of funding for the International Monetary
Fund, the support of official creditors, and the widespread cooperation of the
private banking community have been constructive.
But t while key developing
countries have put in place economic adjustment policies that have resulted in
necessary reductions in their imports, such progress has been achieved at high
cost to their domestic economies.
Thus, countries with heavy debt burdens
still confront the task of restoring growth of real income as structural adjustments proceed.
An important contribution to this effort, as well as to our own
long-run economic health, is the continued access of these nations to the financial and goods markets of industrial countries.
40
The Economic Projections of the FOMC
While recognizing the risks implicit in the budgetary and international circumstances outlined above, the members of the Federal Open Market
Committee (together with other Reserve Bank presidents) believe the most probable course of developments during 1984 is further growth, significant reduction In unemployment, and only modest—and essentially cyclical—increases in
price pressures.
The central tendency of forecasts shows real GNP growth in
a range of 4 to 4-3/4 percent this year.
This growth rate is similar to the
ECONOMIC PROJECTIONS FOR 1984
(Percent)
Economic indicator
FOMC laerabers and
other FRS Presidents
Range
Central tendency
Administration
Change, fourth quarter
to fourth quarter
Nominal GNP
Real GNP
GNP deflator
Average unemployment
rate in the fourth
quarter
8 to 10-1/2
3-1/2 to 5
4 to 6
9 to 10
4 to 4-3/4
4-1/2 to 5
9.8
4.5
5.0
7-1/4 to 8
7-1/2 to 7-3/4
7.7
first view expressed by the members last sunnier, but, of course, would follow
significantly faster growth in 1983 than anticipated.
The unemployment rate
is expected to continue to decline in 1984, and given the progress in reducing
Joblessness last year, the expected level of unemployment in the fourth quarter
of this year—generally between 7-1/2 and 7-3/4 percent—is substantially lower
than had been anticipated.
41
FOMC members expect the GUP implicit d e f l a t o r to rise a bit more
rapidly this year than in 1983—generally in the range of 4-1/2 to 5 percent.
While some members have expressed concern that recent labor force trends and
pressures on capacity In a few Industries could lead to a more significant
pickup in i n f l a t i o n , such a development generally is perceived to be only a
risk rather than the most likely outcome.
Section 2:
The Federal Reserve's Objectives for the Growth of Money and Credit
At its meeting of January 30-31, the FOMC modified only slightly the
tentative ranges for the monetary and credit aggregates for 1984 established
last July.
The ranges for M2 and M3 were set at 6 to 9 percent, 1 percent
and 1/2 percent, respectively, below the ranges for 1983.
The tentative Ml
growth range of 4 to 8 percent was confirmed for the same period.
A monitoring
range of 8 to 11 percent, as anticipated in July, was established for growth
in the outstanding debt of domestic nonfinancial sectors.
The ranges for 1984 are Intended to be consistent with the basic
policy objective of achieving long lasting economic expansion in a context
of continuing control of inflationary pressures.
They assume that relation-
ships between monetary and credit growth and economic activity and inflation
will be broadly consistent with past trends and cyclical developments.
There
is reason to expect that the special considerations a f f e c t i n g monetary growth
rates last year—including important Institutional changes in the financial
system—will be less significant in 1984.
Specifically,
the large-scale
shifts of funds associated with the Introduction of money market deposit
accounts (MMDAs) and Super NOW accounts appear, for all
be completed.
practical purposes, to
Some of the other influences that had special e f f e c t s particu-
larly on the demand for Ml last year—uncertainties about the economic and
financial outlook early in the year and the lagged effect of the sharp decline of interest rates in late 1982—are behind us.
No further regulatory
or s t a t u t o r y changes that would significantly a f f e c t growth rates of the
monetary aggregates appear imminent.
Some proposals—such as payment of
interest on demand deposits or on required reserve balances—would have
42
important impacts on the aggregates and would require reconsideration of the
ranges, especially for Ml, if they were enacted to be effective in 1984.
A 1/2 percent further reduction in the growth range for M2 for 1984
from that tentatively set in last July was influenced by technical considerations.
Last year's range—though it was based on February-March to abstract
from the bulk of distortions connected with the introduction of MMDAs—
necessarily had allowed for some residual shifting Into such accounts as the
year progressed, which in fact took place.
In any event, M2 in 1983 was
maintained well within its target range, and growth in 1984 should not be
influenced by that special factor.
The Committee anticipates that both M2 and M3, which will continue
to receive substantial weight in policy implementation, may well fluctuate
in the upper part of their ranges in the current year.
The actual growth of
M2 and M3 will depend in part on the strategies and aggressiveness with which
depository institutions seek deposits in a deregulated deposit interest rate
environment.
Growth of the broader aggregates will also be influenced by the
pattern of net capital inflows from abroad.
For example, nonresident holdings
of Eurodollars are not included in M2 or M3, and should banks bid aggressively
for funds through that channel, as seems possible, growth in those aggregates
would be tend to be restrained relative to growth in bank credit and nominal
GNP.
Limited allowance was made for that development in setting the ranges.
As tentatively agreed in July, the range for Ml was reduced by 1 per-
centage point from the range set for the last half of 1983.
Growth around the
midpoint of the range would appear appropriate on the assumption of relatively
43
normal velocity growth; if velocity growth remained weak compared with historical experience, Ml growth might appropriately be higher in the range.
In recent quarters, the velocity of Ml has shown a moderate rising
tendency, in contrast to sharp declines in 1982 and early 1983.
Still, the
rise in Ml velocity in the first year of the current economic recovery was decidedly less than In earlier post-World War II cyclical expansions.
Velocity behav-
ior over the past 18 months appears to have reflected responses to the declines
of Interest rates In the latter part of 1982, the subsequent leveling off of
rates, changing precautionary attitudes, and to some degree, perhaps, more
lasting changes in motives for holding Ml as the composition of the aggregate
has shifted.
Since their introduction on a nationwide basis, interest-bearing
accounts with full checking privileges {NOW accounts) have become an increasingly
important element in Ml.
Most of these accounts are subject to a ceiling rate,
though a growing proportion (Super NOWs) pay market rates.
All of the accounts
contain funds placed for long-term savings purposes as well as funds used primarily for transactions.
In light of these structural changes, it is not yet
clear how the public's demand for Ml might be a f f e c t e d , for any given level
of Income, by variations in credit market or other conditions that affected
savings preferences, or how it might be affected by variations in the level
of income itself; nor is it clear how quickly or in what ways depository
institutions might themselves respond to such variations by altering terms
on deposit offerings.
While there Is evidence of more "normal" and predictable patterns
reappearing, the Committee felt that more time would be required for assessing
the Impact of recent structural changes on public and Institutional behavior
44
before full or primary weight could be placed on Ml as a policy guide.
Thus,
the Committee decided, in setting a range for Ml, that its behavior should
be evaluated in the context of movements in the broader monetary aggregates,
which for the time being would continue to be given substantial weight in
policy implementation.
The FOMC also considered whether the procedures of System open
market operations should be altered in light of the shift to the new contemporaneous reserve requirement system (CRR) on February 2, a system that
potentially would permit somewhat closer short-run control of Ml.
It was
the Committee's view that adaptation of open market procedures does not
depend on the technical characteristics of the reserve requirement system
in place but rather on broader policy Judgments about the relative weight to
be given to Ml as a target and the desirability of seeking close short-run
control of that aggregate.
Taking account of policy judgments about the
role of Ml and other monetary aggregates under current circumstances, as
well as uncertainties In the period of transition to CRR, the Committee agreed
to make no substantial change In current operating procedures at this time. 1
The Committee set a monitoring range of 8 to 11 percent for growth
in the debt of domestic nonflnancial sectors during 1984.
This range is 1/2
percentage point below the corresponding range for 1983, reflecting the
moderating trend that, based on historical relationships, would be expected
to accompany progress toward price stability and sustainable growth In production.
The range allows for growth of debt in 1984 that might outpace expansion
In nominal GNP, as often occurs in the second year of a cyclical recovery.
1.
A statement Issued on January 13 on the policy Implications of CRR appears
as appendix A to this report.
45
Implications for Cre_dit Jterkets
Developments in credit markets and interest r a t e s , as always, will
be subject to a v a r i e t y of influences at home and abroad.
The ranges specified
for the monetary and credit aggregates, which are f e l t to be broadly c o n s i s t e n t
with the expectations of members of the FOMC about the course of economic activity and prices, will not in and by themselves determine the course of i n t e r e s t
rates and the degree of credit market pressures.
Whether i n t e r e s t rates f a l l or
rise—or remain stable—will depend importantly on the strength and conpasLtlcm
of demands on the economy, actual and anticipated price pressures, and credit
demands.
Dominating the outlook for credit flows In the year ahead is the
prospect that—in Che absence of immediate action by the fiscal a u t h o r i t i e s —
the federal d e f i c i t will approach the record level of the past y e a r . The
federal d e f i c i t was nearly 6 percent of CUP in 1983, the high for the post-World
War II years, and Is likely to be only slightly lower in 1984, the second year
of cyclical expansion.
In the comparable stage of earlier cyclical recoveries,
this percentage generally dropped rapidly or was at much lower levels—providing
room for additional borrowing to support expanding business capital outlays
and housing.
While debt formation by the private sector may proceed at a soneuhat
more rapid pace this year than in 1983, the expected pickup is modest by
standards of e a r l i e r recoveries.
That expectation is p a r t l y a r e f l e c t i o n of
the f a c t that the massive federal presence in the credit markets, unlike the
p a t t e r n in previous expansions, will continue to absorb the bulk of. the net
saving available to the domestic economy.
As illustrated in the shaded area
in the Cop panel of the chart on the next page, the f e d e r a l d e f i c i t over the
46
Demands on Available Saving (Net)
As a percent of GNP
— Federal Budget Deficit Plus Investment
Deficit
Sources of Available Saving (Net)
As a percent of GNP
Total Saving
Domestic Saving
1983
1984
47
past two years absorbed an unusually large proportion of the saving available
to the domestic economy, and this will continue into 1984.
The availability
of domestic saving to finance the growing federal deficit and expanding private
investment has remained limited, and expansion of total saving in line with
financing needs last year was dependent on large increases In net funds obtained
from abroad.
Further such increases will again be required this year, as
shown in the bottom panel of the chart.
And if present trends continue, the
government will continue to drain off much more of the nation's domestic saving
than at any time in the preceding three decades, apart from the f i r s t year of
recovery of 1973-75 recession.
The persistence of large deficits in the face of strengthening p r i v a t e
credit demands would tend to exert pressures on domestic credit markets, keeping
interest rates higher than they otherwise would be.
Put another way, they are
an offset to other forces working toward lower interest rates.
These pressures
stemming from the federal deficit work to restrain expansion in areas of the
economy that are more sensitive to Interest rates—such as housing, autos, and
long-term business capital spending.
They also—to the extent higher Interest
rates lead to a strong dollar on exchange markets—retard our export industries.
And, finally, high interest rates contribute to strains on the domestic and
international financial system from the lingering heavy indebtedness incurred
during i n f l a t i o n a r y expansion of earlier years.
Actions taken to reverse the upward trend In the structural budgetary
deficit clearly would work to reduce potential credit market pressures, to
help assure a balanced and sustainable economic expansion, and to pronote a
more orderly readjustment of our balance of payments position.
The timing
and magnitude of the favorable impact naturally would depend on the scheduling,
48
force, and prospective "carry through" of any action to reduce the budgetary
d e f i c i t as well as on the surrounding economic environment.
Ordinarily, Che principal e f f e c t of a lower budget d e f i c i t on credit
n.i>rkets and the economy would be expected to occur as the programs—whether
on the spending or tax sides—actually become e f f e c t i v e .
Gains could occur
e a r l i e r , however, in a n t i c i p a t i o n of reduced federal credit demands.
For
example, actions taken this year that would clearly reduce s t r u c t u r a l federal
a i i f i c i t s beginning in f i s c a l years 1985 and 1986 could work in some degree in
19P4 to lower interest rates, p a r t i c u l a r l y longer-term r a t e s .
This would
result from favorable e f f e c t s on i n f l a t i o n expectations as well as Che
a n t i c i p a t e d relief
f r o m the weight of governmental pressure on credit markets.
A decline in the s t r u c t u r a l federal d e f i c i t would in the f i r s t
Instance reduce one source of economic stimulus.
However, any such effects
should he associated w i t h lower interest rates than otherwise, encouraging
o c t s e t c t n g I n c r e a s e s in spending by businesses and households for c a p i t a l
goods, horaes, and consumer durables.
The positive e f f e c t s f r o m small reductions in the f e d e r a l d e f i c i t
•«rould be d i f f i c u l t
to isolate In our large, active credit markets.
However,
ns s t r u c t u r a l d e f i c i t s are reduced by substantial accounts—say by 550 billion
to $100 billion—the counterpart rise In private credit may be most noticeable
i n i t i a l l y in mortgage m a r k e t s at the lower long-terra I n t e r e s t rates that are
likely to evolve.
In addition, businesses would be in a position to increase
bond and stock offerings as they take advantage of the riore f a v o r a b l e capital
market atmosphere to improve their liquidity and balance sheet positions.
Prospects for business spending for plant and equipment would be improved—
an important f a c t o r in maintaining growth and p r o d u c t i v i t y over the years
ahead.
As time went on, the export sector of the economy also should benefit
as an aspect of the readjustment in our present unbalanced external position.
49
Section 3:
The Performance of the Economy in 1983
Output and employment registered sharp gains In 1183, l i f t i n g the economy out of one of the most severe recessions since World War II.
These gains
brought a conslrteraM; reduction jLn the unemployment r a t e , whlf-h fell 7-1/2
percentage points over the year to %.2 percent by year-end.
The f i r s t ye-^r of
recovery was marked by broadly based increases in spending by consumers and
businesses; these advances ware stronger than generally anticipated, given the
low confidence and h i s t o r i c a l l y high credit coses that prevailed as the year
began.
The i m p r e s s L v e progress in reducing I n f l a t i o n In 1982 extended into
1983,
The consunver pric.o index cose 1-3/4 percent in 1983, the smallest in-
crease in more than a decade.
The continued slowing in i n f l a t i o n was aided by
favorable price developments in energy markets and by the damping effect on
food prices of abundant supplies of livestock products.
However, 1983 also saw
improvements in broader forces a f f e c t i n g prices and wages.
W i t h important lags,
business and labor involved in key contract settlements seemed to be adapting
constructively to the less i n f l a t i o n a r y environment, and overall wage and compensation increases were considerably smaller t"rtan during the previous year.
At
the same time, productivity improved, thereby helping to limit increases in unit
labor costs, and average real Incomes rose.
While the performance of the economy in 1983 marked a strong and encouraging advance toward the goal of sustained, n o n l n f l a t i o n a r y growth, several
areas of concern remained.
Although labor market c o n d i t i o n s improved markedly,
unemploymsnt continued to be unacceptably high—especially for younger job seekers and minorities.
the federal d e f i c i t .
In addition, 1983 saw a sharp—and worrisome—increase in
For the fiscal year ending in September, the d e f i c i t (not
50
Real GNP
Percent change, Q4 to Q4
1972 Dollars
1978
1979
1980
1981
1982
1983
Unemployment Rate
Percent
10
1978
1979
1980
1981
1982
1983
51
including off-budget programs) climbed to almost $200 billion.
This d e f i c i t
represented about h percent of GNF; the highest d e f i c i t so measured In the previous three decades had been 4 percent In 1976.
The borrowing necessary to
finance the d e f i c i t , in combination with continuing huge prospective government
credit demands, exerted pressures on market Interest r a t e s — o f f s e t t i n g the
e f f e c t s of lower i n f l a t i o n and other factors—thereby tending to temper expansion of credit-sens i t i v e private sectors of the economy.
Firms tied closely to world markets also did not share proportionately in the U . S . economic recovery in 1983.
Large federal deficits and asso-
ciated high domestic interest rates helped induce sizable inflows of foreign
capitai to the United States throughout the year and contributed to a f u r t h e r
rise in the exchange value of the dollar.
The strong d o l l a r , in t u r n , put
pressures on industries facing competition from foreign imports and, in an
environment of sluggish economic growth in other countries, made it
for U.S. industries to sell their products abroad.
difficult
Consequently, imports
increased dramatically relative to exports in 1983; this s h i f t had a significant moderating influence on the growth in domestic output.
The international debt situation remained a major concern in 1983.
Some countries with serious debt problems made considerable progress in formulating and implementing internal adjustment policies, and they continued to
receive a moderate flow of new financing.
Nonetheless, historically high
interest rates In the United States continued to place heavy burdens on the
many developing countries with outstanding debt concentrated in dollars.
Financ 1 a 1 Ma rket B
Partly reflecting the ready availability of funds from abroad, financial markets absorbed ehe increase in demand for credit associated with both
52
the financing of the record federal deficit and the upturn in the economy in
1983 without undue stress.
In fact, interest rates were lower on average, and
lesa variable, in 1983 than during the preceding few years, although most rates
were somewhat higher at the end of the year than at the s t a r t .
Short-Eera yields were relatively stable early in 1983, following a
marked decline during the second half of 1982.
In late spring, economic growth
accelerated sharply, and the monetary aggregates, looked at as a whole, were
continuing to grow at a relatively rapid pace.
In those circumstances, the
Federal Reserve began to restrain somewhat its provision of reserves to depository institutions, and short-term Interest rates rose moderately during the
summer months.
For the remainder of the year, most short-term rates f l u c t u a t e d
in a generally narrow range, ending 1983 around 1 percentage point higher than
a year earlier.
The decline in long-term interest rates that had commenced in mid-1982
continued through the early months of 1983.
These rates also began moving up in
the spring, climbing f a i r l y steadily through Auguat.
Thereafter, long rates fluc-
tuated in a range somewhat above that of the f i r s t half of the year.
of 1983t long rates generally were 1 to 1-1/2
levels of a year earlier.
At the end
percentage points above their
Exceptions to this pattern were mortgage rates and
yields on municipal bonds, which were down on balance from their levels at the
close of 1982.
Long-term interest rates remained quite high relative to the
current rate of inflation throughout 1983; continuing uncertainties regarding
the speed of the economic expansion and its
possible Implications for f u t u r e
Inflation, as well as concerns about the outlook for federal d e f i c i t s , were
factors.
53
Short-term Interest Rates
Percent
— 6
1978
1979
1980
1981
1982
1983
Long-term Interest Rates
Percent
Home Mortgages
Fixed Rate
18
14
30-year Treasury Bond
1978
1979
1980
1981
1982
1983
10
54
Household S_e_e_tor in 1983
Most households experienced financial and econonic gains in 1983.
With unemployment down and gains in employment sizable, growth in personal
income rebounded smartly during the past year.
F u r t h e r deceleration of infla-
tion, lower interest rates, and the cumulative 25 percent reduction in federal
tax rates on personal incoae during the past three years all helped raise the
purchasing power of household income.
In addition, household net worth rose
substantially in 1983, primarily reflecting the surge in stock market prices
that began in 1982 and carried into 1983.
These gains no doubt were instrumental in boosting consumer confidence, which surveys Indicated rose sharply in 1983 to Its highest level in
a decade.
This improved mood encouraged households to finance major purchases
by borrowing and to devote a larger proportion of current income to consumption rather than saving, fts a result, the personal saving rate fell from 5.8
percent of disposable income in 1982 to 4.8 percent in 1983.
The improved economic and financial status of households fostered a
substantial upswing in consumer spending.
Much of the strength came in the
automobile sector, as sales recovered from several years of sluggish performance.
Sales of domestic nwdels quickened in the f i r s t half of the year,
spurred by financing incentives from dealers and lower rates on bank loans.
Lower gasoline prices and the Introduction of new and b e t t e r American products
also appeared to help.
The recovery In domestic automobile sales continued
through the second half of the year, despite the withdrawal of financing incentives.
Sales of imported models, still constrained by Import restrictions on
Japanese models, edged up a bit In 1983, regaining their pre-quota (1980) level.
Consumer spending for other goods and services also strengthened, paced by large
55
Real Personal Income and Consumption
Percent change. Q4 to Q4
1972 Dollars
Hfl Real Disposable Personal Income
—
[~] Real Personal Consumption Expenditures
1978
1
1979
1980
1981
1982
1983
Total Private Housing Starts
Annual rate, millions of units
2.0
1.5
1 0
1978
1979
1380
1981
1982
1983
56
gains In housing-related Items such as furniture and appliances as well as
brisk advances In general merchandise and apparel sales.
Demand for housing surged in 1983, as early in the year long-term
mortgage interest rates fell below 13 percent for the f i r s t time since the
suisraer of 19BO.
The sharpness of the upturn reflected the considerable volume
of demand postponed from the preceding feu years of high credit costs and
uncertain economic conditions.
Hew housing construction rose considerably in
response to rising sales during the f i r s t three q u a r t e r s of the year. The
rate of housing starts levelled off In the f i n a l q u a r t e r , influenced by the
backup in mortgage interest rates during the second half of the year.
However,
for the year as a whole, total private housing s t a r t s rose 60 percent, the
shar7est annual increase in alraost 40 years.
The construct Jon a c t i v i t y gen-
erated by the Increase in starts was an Important factor in GNP growth, as is
typical In the f i r s t year of an economic recovery.
The expansion In housing construction In 1983 was supported by
Increased lending by t h r i f t institutions ("here deposit growth was nuch
improved) and by continued growth of secondary mortgage m a r k e t s .
The gains
also reflected the popularity of financing techniques that provided homebuyers
with i n i t i a l interest rates lower than those quoted for fixed-rate, conventional
loans.
The record volume of tax-exempt, revenue bonds issued by states and
localities last year to finance single-family nortgages provided many homebuyers
with reduced-cost mortgage f i n a n c i n g .
F u r t h e r , as market rates rose d u r i n g the
year, homebuyers increasingly switched to adjustable-rate mortgages.
Many such
i n s t r u m e n t s offered an initial rate advantage of 2 percentage points or more.
By year-end, 55 percent of all
able-rate feature of some kind.
conventional mortgage loans closed had a variVhen mortgage rates were at their recent low
57
point In the spring of 1983, only 30 percent of conventional loans closed were
adjustable.
In addition, such Interest-reducing mechanisms as builder buydowns
and seller financing remained Important features of housing finance during the
year.
The Business Sector
Economic and financial conditions in the business sector also improved
markedly In 1983, as finas started the process of rebuilding their balance sheets
from the recession.
Sales and production rose sharply, bringing Increased capac-
ity u t i l i z a t i o n and productivity.
These gains helped propel before-tan p r o f i t s ,
which had been depressed in the early 1980s, to an unusually rapid increase for
the f i r s t year of an economic expansion.
With e f f e c t i v e corporate tax rates
lower, businesses were able to retain a larger proportion of their p r o f i t s than
in previous recoveries.
Much improved cash flows and lower interest rates put
firms in a much better position to service their outstanding debt in 1983.
Fur-
t h e r , the corporate sector improved its overall capital position in 1983 by Issuing new stock In vastly improved equity markets.
During the f i r s t half of the
year finis strengthened their balance sheets by s h i f t i n g borro\jing toward longer
maturities.
However, historically high interest rates limited this adjustment,
and rising credit costs later In the year sharply reduced the volume of long-term
debt financing.
A marked shift in inventory investment from liquidation to accuraulation took place In 1983, f u r t h e r boosting GNP.
reductions in stocks during 1982 and early 1983.
Firms had undertaken massive
With f i n a l demands strength-
ening, Inventory reduction slowed markedly in the second q u a r t e r of the year;
and, a f t e r midyear, firms began to rebuild their inventories.
With sales and
shipments quite strong during the second half of the year, the actual stocks of
58
Change in Beat Business Inventories
Billions of 1972 dollars
10
10
H1
1978
1979
1980
1981
H2
1982
H1
H2
1983
Real Business Fixed Investment
Percent change, Q4 to Q4
1972 Dollars
OD Producers' Durable Equipment
[J Structures
20
10
10
H1
1978
1979
1980
1981
1982
H2
1983
59
inventories remained quite lean, and inventory-salea ratios fell to historically
low levels.
Rusltiess spending ot\ plane and equipment did not reach its
cyclical
trough until the first quarter of 1983, but such expenditures grew rapidly
throughout the rest of the year.
Overall, business fixed investment increased
almost 11-1/2 percent in real terms between the fourth quarter of 1982 and the
fourth quarter of 1983,
At year-end rising new orders and surveys showing that
businesses planned higher investnient spending suggested that the recovery in
investment had developed monentum that would carry it
into 1984.
The strength in investment spending was concentrated in the equipment
sector eacly ia 1983, especially in raotot vehicles, high-technology office equipment, and computing machinery.
The recovery in equipment spending became more
broadly based as the year progressed, as it spread to traditional heavy equipment.
Expenditures for new structures also turned up in the second half of the
y e a r , led hy Investment in stores and warehouses.
Construction of new office
buildings declined sharply during the f i r s t half of 1983 and held at that reduced
pace d u r i n g the second half of the year, as vacancy rates remained quite high.
International Trade
The rising exchange value of- the dollar 'wae a major influence on U.S.
exports and imports in 1983.
On a weighted-average basis, the dollar rose an
additional 10 percent during the course of the year, bringing the cumulative
appreciation since 1980 to 50 percent.
The sustained strength of the dollar
has reflected economic policies here and abroad as well as the attractiveness
of dollar investments In a tiiae of international political and financial uncertainty.
Despite a comparatively good inflation performance, the competitive
position of firms in the United States eroded further in 1983.
After declining
60
Exchange Value of the U.S. Dollar
Index. March 1973=100
1978
1979
1980
1981
1982
1983
United States Real Merchandise Trade Volume
Billions of 1972 Oollars
Exports
Imports
1978
1979
1980
1981
1982
1983
United States Current Account
Billions of dollars
Surplus
1978
1979
1980
1981
1982
1983
Merchandise tiaae volume for 1 BBS O4 and cuiienl account lor 1983 are estimated
61
by more than 15 percent in 1982, the volume of U . S . exports remained weak last
year.
Exports Co Industrial countries, which account for almost two-thirds
of the U . S . t o t a l , recovered somewhat in response to a moderate pickup In
aggregate demand abroad.
However, economic growth In many developing nations
was limited by their debt service problems, and demand by those countries for
imports from the United States remained depressed.
In contrast, the vigorous
expansion In the U.S. economy and the strength of the dollar pushed both the
volume and the value of Imports significantly higher.
As a result, the U.S.
trade d e f i c i t increased from an annual rate of about $45 billion in the
fourth quarter of 1982 to a rate of about $75 billion In the fourth quarter
of 1983.
The U . S . current account registered a corresponding s h i f t , with the
deficit for the year reaching about $40 billion.
Essentially, rapid increases
in demand In the U.S. were partly satisfied by increasing imports, limiting
gains In U.S. output.
The Government L Sector
Government purchases of goods and services were lower in real terms
In 1983 than in 1982.
However, this decline stemmed largely from a reduction
in crop inventories held by the Commodity Credit Corporation (CCC)—associated
in part with the Payraent-in-Kind (PIK) program.
Excluding CCC, real federal
purchases In 1983 were up 4-1/2 percent, led by a 5-1/4 percent increase In
defense spending.
Purchases by state and local governments picked up a
bit,
a f t e r two years of weakness Induced by the recession and cutbacks in federal
support.
An especially important development in the government sector in
1983 was the shifting fiscal positions of governments.
The federal deficit
ballooned to $195 billion in the fiscal year ending in September 1983.
This
62
Federal Government Deficit
Billions of dollars
Fiscal Years, Unified Budget Basis
1978
1979
1980
1981
1982
1983
State and Local Governments
Operating Budgets. N!A Basis
Surplus
Deficit
1978
1979
1980
1981
1982
1983
63
figure was nearly twice as large as the previous year's deficit, which Itself
was of record proportions.
In p a r t , the increase in the d e f i c i t in fiscal year
1983 reflected the lagged e f f e c t s of the recession on receipts and transfer
payments, but other f a c t o r s also were important.
Revenue growth was limited
by the cumulative e f f e c t s of three years of sizable tax reductions, and spending was buoyed by increases in outlays for defense, social insurance expenditures, and interest payments on national debt.
At the state and local level, operating budgets (excluding social
insurance f u n d s ) moved dramatically fron deficit into surplus.
This shift
resulted largely from the combination of tax increases and cost-cutting e f f o r t s
adopted during the recession as well as an unanticipated increase in the tax
base as the economy expanded at a surprisingly rapid pace.
Labor Markets
The recovery of production in 1983 was translated into an impressive
Improvement in labor markets.
Three million workers were added to nonagrlcul-
tural payrolls In the 12 months ending in December 1983.
The most rapid gains
were registered in durable goods manufacturing and In construction, the sectors
hit hardest during the recession.
Service jobs also contributed importantly to
overall employment growth during the year.
Despite the rapid expansion In job opportunities, the rise in the
labor force was relatively moderate, damped by the long-term slowing in the
growth of the younji adult population and by stability in labor force participation rates.
As a result, the f i r s t year of the recovery was marked by an
unusual concentration of hiring from the pool of those who reported that they
had permanently lost their last job.
Because such workers typically are Out
of work for extended periods, the number of long-term unemployed workers also
fell sharply last year.
64
Nonfarm Payroll Employment
Millions of persons
92
90
1978
1979
1980
1981
1982
1983
Compensation Per Hour
Percent change, Q4 lo Q4
Nonfarm Business Sec or
-
_
I
1978
I
1979
I
1980
I
1981
Output Per Hour
I
1982
1983
Percent change,Q4 lo O4
Nonfarm Business Sector
1978
1979
1980
1981
1982
1983
65
Nominal wage increases continued to decelerate in 1983.
Hourly
compensation rose at a rate of 5 percent over the four quarters of 1983—the
slowest pace since 1965.
The easing of wage Increases reflected slack in
labor markets in general as well as adjustments in several major collective
bargaining agreements.
Nearly 40 percent of workers who negotiated major
union settlements during 1993 accepted wage freezes or outright pay cuts for
the f i r s t year of their new contracts.
As a result, the size of the "new
settlements" component of union wage increases slowed to less than 1 percent.
At the same t i m e , cost-of-Hving adjustments slowed, reflecting the continued
moderation in prices.
On average, however, wage gains in 1983 exceeded price increases, so
t h a t most workers experienced improved purchasing power.
mirrored improvements in labor productivity.
Rising real wages
Although a good deal of the gain
In output per hour worked was attributable to the pickup normal during the
early stages of an economic recovery, there Is reason to believe that longerrun improvements also were in train.
Revisions in work rules at many estab-
lishments during the recession contributed to efficiency, and in 1983 both
business and labor appeared to sustain their e f f o r t s to trim costs and improve
quality.
Reflecting wage and productivity developments, unit labor costs rose
only 1-1/4 percent in 1983.
This was the best performance since the mid-1960s.
The continued moderation in labor costs, a principal determinant of
price movements, helped to unwind further the wage-price spiral that fueled
inflation throughout the 1970s.
Household surveys during 1983 revealed that,
despite some increase in the second half of the year, expectations about inflation throughout 1983 remained lower than they had been in some time.
Ample
66
Consumer Prices
Percent change, December to December
16
12
1978
1979
1980
1981
1982
1983
Producer Prices
Percent change, December to December
12
1978
1979
1980
1981
1982
1983
67
productive capacity and a strong dollar also contributed to f u r t h e r progress
in reducing the rate of i n f l a t i o n .
That progress was reflected In most key price measures.
Increases
In the consumer price Index remained in a much reduced range In 1983.
brighter I n f l a t i o n p i c t u r e In part reflected transitory f a c t o r s .
The
Slack demand
and large worldwide inventories caused a sharp decline In petroleum prices
early in the year, and prices of food at the consumer level were relatively
s t a b l e throughout 1983.
However, the agricultural picture turned less favor-
able In ("tie wake of the summer drought.
The resulting depletion of grain
s t o c k s , coning on top of the e f f e c t s of the federal government's PIK program
designed t<> reduce aprlctiltural production, put upward pressures on the prices
of rnany agricultural commodities in the latter part of the year that can be
expected to a f f e c t consumer food prices In 1984.
In addition, severe December
weather promised to adversely a f f e c t the supply of fresh fruits and vegetables
e a r l y Irs 1984.
The deceleration of prices In 1983 was not United to tfie food and
energy sectors.
The consumer price index excluding those sectors rose less
than 5 percent—about half the pace of j u s t three years earlier.
Producer
prices In general were l i t t l e changed in 1983, as price Increases of capital
equipment an well as of consumer goods slowed markedly.
68
Section 4:
The Growth of Money and Credit In 1983
In Ics reports to the Congress in February and July 1983, the Federal
Reserve indicated that monetary policy during that year would be conducted with
the aim of fostering a recovery in economic activity and encouraging further
progress toward price stability.
Establishing specific objectives for growth
in the monetary aggregates was fraught with difficulties, however.
Beginning
in 1982, the behavior of Ml in relation to economic activity had diverged
sharply from historical trends, raising doubts about the usefulness of that
aggregate—at least over the near term—as a policy target; the e f f e c t s of
newly Introduced Super NOWs and money market deposit accounts (MMDAs) on the
behavior of Ml also were subject to considerable uncertainty.
In addition, it
was evident early in 1983 that M2 was being swelled by massive s h i f t s of funds
from outside that aggregate Into MMDAs, but it was impossible to predict the
precise timing and volume of such shifts.
Reflecting these special factors and uncertainties, in early 1983 the
Federal Open Market Committee departed from past practice In establishing monetary objectives for 1983.
The Committee agreed that the uncertainties regarding
Ml continued to warrant the practice, began in October of 1982, of placing principal weight on the broader monetary aggregates—M2 and M3—in the Implementation of monetary policy.
Although the demands of the public for those aggre-
gates night be affected by shifts In asset preferences that were rooted in
regulatory changes or other causes, It seemed that such effects would be smaller
and more predictable for the broader aggregates than for Ml.
In the case of M 2 , an annual target range of 7 to 10 percent was
established.
The FOMC believed that performance of the aggregate would most
appropriately be measured over a period when it would be less influenced by
69
the initial, highly aggressive marketing of MMDAs.
Thus the Committee chose
the average level of February and March as the base for measuring growth,
rather than the fourth q u a r t e r , the period that generally had been used in
the past.
It was anticipated that the range for M2, which was 1 percentage
point higher than the range for 1982, would allow for some residual shifting
of funds to MMDA accounts over the remainder of the year.
The range for M3, to be measured as usual from the fourth quarter to
the f o u r t h q u a r t e r , was established at 6-1/2 to 9-1/2 percent.
This range was
the same as that established in the previous year, but encompassed growth below
the actual outcome in 1982.
In adopting this range, the Committee assumed that
any net s h i f t of funds during the year Into the new types of deposit accounts
from market instruments would be largely o f f s e t by reductions in managed
lia-
bilities (such as large CDs) included in M3.
In light of d i f f i c u l t i e s in gauging the relation between transaction
balances and economic activity, the range for Ml was set in February at 4 to
8 p e r c e n t , a band 1 percentage point wider than usual.
As noted above, the
Committee agreed t h a t , In implementing monetary policy, less than customary
weight would be assigned to Ml; Instead, the Committee would rely primarily on
the broader aggregates, at least until Ml had evidenced nore regular and predictable behavior.
Moreover, the Committee emphasized that, In implementing
policy, the significance
It attached to movements in the various monetary mea-
sures necessarily would depend on evidence about the strength of economic
recovery, the outlook for prices and Inflationary expectations, and emerging
conditions in domestic and international financial markets.
The Committee also set forth for the first time its expectations for
growth of the total debt of domestic nonfinancial sectors, indicating that a
70
Ranges and Actual Money Growth
Range adopted by FOMC for
Feb / Mar. 1 983 in 1 983 Q4
Rate ot Growth
(annual rate)
Feb. Mar. to 1983 Q4
8.3 percent
1982
1983
M3
Range adoo'ed by FOMC for
1982 Q4 to 1983 Q4
Rale ot Growth
71
Ranges and Actual Money and Credit Growth
Ranges adopted by FOMG for
1982
1983
Total Domestic Nonfinancia! Sector Debt
Range adopted by FOMC lor
1982
72
range of 8-1/2 to 11-1/2 percent, measured from December 1982 Co December 1983,
would be appropriate.
This range was thought to be about in line with expected
growth in nominal GNP, reflecting the historically similar growth trends of
each.
It was recognized that, in the early stages of other postwar recoveries,
growth in GNP had exceeded growth in debt by an appreciable margin; but in the
current circumstances—including the financial condition of the private sector
as the recession ended and the prospective huge volume of fed-aral borrowing—
expansion in the debt aggregate might run In the upper half of the stated range
during 1983.
The behavior of Ml In early 1983 continued to diverge from precedents.
(The analysis here—as elsewhere in this section—is based on recently revised
data for the monetary aggregates, but the same finding holds for the data that
were available during 1983.)*
As apparently was the case during the second
half of the previous year, precautionary motives stemming from highly uncertain
employment and income prospects evidently continued to swell demands for liquid
balances relative to the rate of spending on goods and services; in addition,
the lagged effects of earlier declines in interest rates contributed to increased
demands for money.
Ml expanded rapidly through late spring; growth was dominated
by its highly liquid. Interest-earning other checkable deposit (OCD) component.
Growth in OCDs during tbe first half of the year accounted for more than half of
the expansion in M l , a contribution well out of proportion to the importance of
this component.
In turn, inflows to Super NOW accounts, which had been autho-
rized in early January, exceeded growth in OCDs during the year as a whole.
Even
so, the introduction of the new deposit accounts appears in retrospect to have
1.
Appendix B to this report provides detailed information on the recent benchmark and seasonal adjustment revisions of monetary data for 1983, as well as
on the impact of a redefinition of M3 to include term Eurodollars.
73
had little e f f e c t on the overall growth rate of Ml, as Inflows from outside MI
into Super NOUs probably were roughly o f f s e t by outflows from Ml to MMDAs,
In light of the rapid expansion in Ml through midyear, and referring
back to its
recognition that appropriate growth rates for the aggregates would
depend on judgments about unfolding economic and financial developments, the
FOMC in July established a new monitoring range for Ml for the second half of
1983.
This range of 5 to 9 percent was based on the average for the second
quarter, rather than that for the fourth q u a r t e r of 1982.
The decision to adopt
a new base for monitoring Ml growth reflected a Judgment that the recent rapid
growth of Ml would appropriately be treated as a one-time phenomenon which was
expected to be neither reversed nor extended.
Zt appeared, in retrospect, that
the surge in Ml might largely have reflected an adjustment by the public of its
cash balances in response to the pronounced drop in the opportunity cost of
holding low-yielding demand deposits and regular NOW accounts.
The FOMC empha-
sized that it still regarded the behavior of Ml as subject to substantial uncertainties, and it reaffirmed its decision to place principal weight on the broadeu
aggregates in the Implementation of monetary policy.
A f t e r midyear, precautionary demands for liquid balances apparently
began to abate, reflecting improved confidence arising from the recovery; a
moderate rise in interest rates, which began in late spring, also curbed demands
for money.
Demand deposits peaked in July and edged down, on balance, during
the second h a l f ; the growth of OCDs fell to a fraction of the rapid f i r s t - h a l f
pace.
Thus Ml entered Its newly established monitoring range in late summer
and finished the year in the middle of that range.
During the first quarter of 1983, the velocity of Ml continued to
decline at nearly the extraordinary rate of 1982.
These declines exceeded
74
Growth in Velocity*
Velocity of M1
Percenl change. Q4 to Q4
75
GROWTH OF MONEY AND CREDIT 1
Percentage changes
Domestic
nonfinsncial
sector debt 3
M2
M3
8.3
9.7
10.5
8.0
8.2
8.1
7.5
9.0
7.4
4
5.1 C2.5} 9.3
9.5
8.7
12.1
10.0
11.8
10.3
9.6
12.3
10.5
9.7
13.0
12.0
9.5
9.6
9.2
10.5
20.5
10.6
6.9
8.5
10.8
9.3
7.4
10.0
8.8
12.0
9.9
9.8
Base to f o u r t h q u a r t e r
1983
7.2
Fourth q u a r t e r
to f o u r t h q u a r t e r
1978
1979
1980
1981
1982
1983
Quarterly growth rates
1983—01
Q2
03
04
12.8
11.6
9.5
4.8
M l , M 2 , and M3 incorporate""effects of benchmark and~ Yeas tmal~~ad j u s Ement revisions. M3 incorporates a definitional change as well, the Inclusion of term Eurodollars. See appendix B to this report for detailed
information.
2. The base for measuring growth in Ml was the second quarter of 1983;
for M 2 , February-March 1983; for M3, the fourth quarter of 1982; and for
domestic nonfinancial sector debt, December 1982.
3. Growth rates of domestic nonfinancial sector debt tire measured between
last months of periods.
4. Ml figure in parentheses is adjusted for shifts to NOW accounts In
1981.
76
those implied by models of past behavior, even talcing into account the effects
of the large reduction in the opportunity coat of holding money balances brought
about by sharp drops in market rates and the introduction of ceiling-free Super
NOW accounts.
As the year progressed, the velocity of Ml began to increase,
slowly at f i r s t but more rapidly by the last quarter.
Even with this accelera-
tion, growth in HI velocity in the f u l l year following the business cycle trough
in the fourth quarter of 1982 was well below the experience typical In a recovery ,
As was evident when the target ranges were f i r s t established early in
1983,
the dramatic response to the authorization of HMDAs substantially boosted
M2.
Competition for these funds was Intense:
and,
in some regions, introductory interest rates were far above yields on mar-
ket investments.
promotional activity was heavy
Inflows to MMDAs in January alone totaled $147 billion, and
by March outstandings had reached $321 billion.
However, most of the inflow to
MMDAs appears to have corae from other instruments included in M2.
Analysis by
the Board's staff suggests that as much as four-fifths of that inflow may have
been transferred from savings deposits, small time deposits, and money market
mutual funds.
(Over the course of the year, assets of money market mututal
funds dropped 25 percent.)
Still, a sizable volume of funds came from outside
MZ and had an evident impact on growth in that aggregate.
In the face of the heavy deposit Inflows and relative sluggishness of
business loan demand at commercial hanks, Institutions dropped their aggressive
promotion of MMDAs.
The aggregate level of MMDAs barely increased a f t e r June,
reflecting a sharp drop In interest rates offered on these accounts.
At the
same time, the less liquid sraall time deposit component of M2 increased quite
rapidly over the second half of the year, as a result of the steepening yield
77
curve and more attractive rates on such deposits.
October 1 of all
However, the removal on
remaining restrictions on small time deposits with original
maturities or notice periods longer than 31 days had little noticeable impact
on deposit flows.
Reflecting MMDA inflows, M2 growth from the fourth quarter of 1982
through the f o u r t h quarter of 1983 was 12 percent.
March period used by the FOMC as the base for its
However, from the Februarytarget growth range, expansion
through the fourth quarter was at an 8-1/4 percent annual rate, well within its
range.
A f t e r declining at a record rate in the first quarter, M2 velocity
rose during the rest of the year; over the year as a whole, velocity f e l l
slightly, fts was the caae for Ml, the velocity of M2 failed by a wide margin
to keep pace with the average increase during the firat year of a business
recovery.
However, correction for the volume of funds thought to have been
attracted to MMDAs from outside M2 suggests that velocity movements were In
reasonably close correspondence with experience,
M3 growth picked up a bit in the first quarter from its
late 1982
pace, owing to the explosion in M2. But until the closing months of the year,
expansion in this aggregate was restrained by sharp runoffs in managed liabilities—especially large CDs—in response to the rapid buildup early in the year
of MMDA balances and limited loan demand at commercial banks.
On the other
hand, t h r i f t institutions continued to Issue large CDs at a rapid pace in
response to robust mortgage demands and a cost incentive to pay down advances
from the Federal Home Loan Banks.
upper end of ita
On balance, M3 moved on a track near the
target range during 1983; growth from fourth quarter to fourth
quarter was 9-3/4 percent, just outside the target range.1
1. M3 has been redefined to Include term Eurodollars, previously Included
only in the aggregate L.
78
Domestic nonfinancial sector debt increased 10-1/2 percent In 1983,
a bit
above the pace of the previous year.
The outstanding debt of the federal
government grew almost 20 percent, about matching the pace of 1982; this expansion accounted for about 40 percent of the increase in all domestic nonfinaneial
debt last year.
State and local government f i n a n c i n g a c t i v i t y surged to a new
record; soiae of the borrowing reflected e f f o r t s on the part of the issuers to
market debt before the I m p o s i t i o n of anticipated c o n s t r a i n t s , including requirements for bond registration and proposed limits on revenue bond issuance.
A
stepped-up pace of investment in housing and consumer d u r a b l e s led to a neardoubling of borrowing by the household sector.
But issuance of nonfinancial
business debt slowed to a quite low pace, as internal cash flows of corporations
exceeded capital expenditures for much of the year and r e l a t i v e l y high stock
prices encouraged issuance of new e q u i t y shares.
The proportion of credit Interaediated by depository i n s t i t u t i o n s grew
substantially, rising from about one-third in 1982 to about one-half in 1983.
This increase reflected both the impact of MJWi intlnws and a surge in mortgage
demands.
Funds advanced by t h r i f t I n s t i t u t i o n s , in p a r t i c u l a r , rose sharply
from a depressed
1982 pace.
Commercial bank credit also expanded more r a p i d l y
in 1983; purchases of government securities accounted for more than tine-third
of net credit extended by banks.
A t t r a c t e d by r e l a t i v e l y high U . S . interest
r a t e s , funds advanced by the foreign sector also increased s u b s t a n t i a l l y during
1983.
Thus each of the monetary and credit aggregate*! f i n i s h e d the year close
to or within the ranges set
by the FOMC.
recent benchmark, seasonal, and definition
( I n d e e d , for the d a t a p r t o r to tho
revisions, all
sures were well within their ranges at the end of 1983.)
of the money stock meaAchievement of these
79
objectives and the broader goals of the Federal Reserve was brought about by
relatively small changes In the reserve position of the banking systaai and was
accompanied by generally stable conditions in financial markets.
r a t e s f l u c t u a t e d far less than in the previous few years.
Interest
Moreover, although
most i n t e r e s t rates rose moderately during the year as the economic recovery
progressed, on average interest rates were substantially lower in 1983 than in
1982.
For e x a m p l e , rates on level-payment honie mortgages averaged nearly 3 per-
centage p o i n t s belou their 1982 levels; business borrowing costs, likewise,
declined s i g n i f i c a n t l y .
Other indicators attested to a greater degree of stability and confidence in f i n a n c i a l markets and the economy.
increased about 20 percent.
Broad measures of stock prices
The balance of bond downgradings and upgradings
by the principal rating agencies became much more favorable.
Spreads between
interest rates on p r i v a t e and federal government debt obligations narrowed
d r a m a t i c a l l y during 1983, as did spreads between yields an lower- and higherr a t e d private securities.
The strong stock market enabled many large firms
to s t r e n g t h e n their balance sheets and many young companies to make initial
public o f f e r i n g s of their shares.
Commercial banks adapted to important changes In their environment
in 1983.
The new deposit accounts were successful
banks and t h r i f t I n s t i t u t i o n s .
In a t t r a c t i n g funds to both
At the same t i m e , banks experienced relatively
s o f t demand for business loans—especially in the f i r s t half of the year—and,
h e n c e , invested heavily in government securities, other market instruments, and
loans to consumers.
However, credit problems intensified in energy-related busi-
nesses, and the f i n a n c i a l condition of a number of foreign borrowers remained
• _ r c i u b l i iig.
A widespread increase, relative to historical experience, occurred
80
In loan-loss provisions.
A sizable number of banks—mostly small—experienced
credit-quality problems so severe that they were closed or merged into other
institutions.
Nonetheless, earnings of commercial banks in general appear to
have been well maintained ID 1983.
The condition of the thrift industry began to improve last year as
lower average Interest rates significantly reduced operating losses.
As a
result of the MHDA, these institutions have enjoyed a substantial increase in
core deposits, and their improved profit position has enabled them to expand
large time deposits at reasonable cost.
In contrast to commercial banks,
thrift institutions saw a heavy demand for loans last year.
For the f i r s t
time, In 1983 a large proportion of mortgages that they made carried adjustable rate features, thus repairing some of the severe mismatch in asset and
liability durations.
Nevertheless, profit positions remain marginal and highly
sensitive to changes In interest rates.
81
Appendix A
Federal Reserve Press Release
of January 13, 1984
Regarding Contemporaneous Reserve Requirements
Beginning Thursday, February 2, the new contemporaneous reserve
requirement
(CRR) system will become effective.
In that connection, questions
have been raised about the implications of this change for the Federal Reserve's
open market operating procedures.
Federal Open Market Committee.
This issue has been considered by the
Taking account of technical transitional
uncertainties as well as policy judgments about the role of Ml and other
monetary aggregates under current circumstances, the Committee agreed to
make no substantial change in current operating procedures at this time.
Background
The new CRR system d i f f e r s from the present lagged reserve requirement
structure in two principal ways.
First, required reserves against transactions
deposits will have to be held on an essentially contemporaneous basis, instead
of being lagged by two weeks.
Second, the reserve holding period has been
lengthened from one week to two weeks (with the relevant period for deposits
also lengthened to roughly the some two weeks—the 2-week deposit period
running from Tuesday to the second Monday, end the reserve period running
from Thursday to the second Wednesday).
This structural change in the reserve accounting system has
tightened the linkage between reserves and the current behavior of transactions
deposits—demand deposits and interest-bearing accounts with full checking
privileges (NOW and similar accounts).
These deposits, along with currency,
held by the public, comprise Ml, the measure of noney most nearly related
to the transactions needs of the economy.
But because of NOW and similar
accounts, vhich have grown substantially in volume over the past few years,
Ml is also affected by saving propensities *r»d patterns.
The Conmitt«e
82
has been placing less weight than formerly on Ml because of the institutional
changes that have altered its composition, affected its behavior, and increased
uncertainties about its relationship to the economyOther, broader aggregates—M2 and M3—encompass Ml plus other highly
liquid assets and forms of saving, such as money market funds accounts and time
and savings deposits held at banks and thrift institutions.
Some of these
other assets also, in one degree or another, serve transactions purposes,
though they are not, by law, subject to transactions reserve requirements.
In general, the bulk of the assets in the broad aggregates are not subject
to reserve requirements, although nonpersonal time deposits bear a relatively
small lagged requirement.
Open market operations and CRR
Adaptations in open market operating procedures to CRR must take
account of certain technical and transitional issues as well as the policy
issue about the weight to be given Ml and other monetary aggregates in
operations.
The more technical and transitional issues involve how the
depository system as a whole adjusts to the new reserve requirement system—
which may influence demands for excess reserves, attitudes toward the
discount window, and the speed of asset and liability adjustments generally.
It can be expected that some time will elapse before banks and other depository
institutions have fully adjusted their reserve management, as well as portfolio
and liability management, to the new system.
accustomed
Money managers have to become
to operating without certain knowledge of their required reserves
for a full reserve averaging period during most of that period.
In addition.
83
usual start-up problems with new data systems w i l l probably add to
at least for a w h i l e .
uncertainties
Such data problems would also a f f e c t the timing and
reliability of f i g u r e s available to the Federal Reserve.
Tht;se technical
issues aside, the new reserve requirement s t r u c t u r e
would p o t e n t i a l l y permit somewhat closer short-term control of Ml in p a r t i c u l a r .
Wit-h CRR. if
open market operations were geared primarily to M l , an "automatic"
t i g h t e n i n g or easing of reserve positions that worked to bring Ml under
control
would t e n d to occur somewhat more promptly than w i t h lagged reserve a c c o u n t i n g .
Whether operating procedures should be adapted for this purpose
•ices not depend on the technical c h a r a c t e r i s t i c s of the reserve requirement
system in p l a c e but r a t h e r or. broader p o l i c y j u d g m e n t s about the r e l a t i v e w e i g h t
to be ijiveri to M l as ^ target and the d e s i r a b i l i t y of seeking rlose s h o r t - r u n
control of that aggregate.
To the extent less weight continues to be placed
on Ml, and relatively more on broader aggregates les^ closely r e i a i e d to
reserves,"automatic" changes in .reserve pressures in response to short-run
nioverae^ts in Ml alone may not be appropriate.
In liyh- of these various c o n s i d e i u t ions, ti;e Coiwiittee agreed that
no s u b s t a n t i a l change woulci be made in open m a r k e t operating procedures at
this tirie.
These operating procedures w i l l be ieviewed a f t e r a t r a n s i t i o n a l
period in the context of the role played by the monetary aggregates,
particularly M l , in policy implementation and the potential i m p l i c i t in CRR
for achieving closer short-run control of M l .
84
Appendix B
Money Stock Revisions
Measures of the money stock have been revised to reflect annual
seasonal factor and benchmark revisions, as well as a definitional change
affecting M3.
This appendix discusses these revisions and presents tables
comparing growth rates of the old and new series.
Definitional Change
The definition of M3 has been changed to include term Eurodollars
held by U.S. residents in Canada and the United Kingdom, and at foreign
branches of U.S. banks elsewhere,
A recent reporting change provides data
on term Eurodollars at a panel of branches of large U.S. banks on a schedule
similar to other M3 elements.
The inclusion of term Eurodollars raised the
level of M3 by about $90 billion but had a minimal effect on M3 growth in
1983.
Benchmark Revisions
Deposits have been benchmarked to recent call reports; f u r t h e r
revisions to deposits stem from changes to System reporting procedures made
ifi 1983, largely related to reduced reporting under the Garn-St Germain Act
of 1982.
In addition, the currency component was revised to reflect
sions to figures on the amount of coin in circulation.
revi-
The net impact of
these revisions was to raise the levels and boost the growth rates of each
of the aggregates in 1983.
Seasonal Revisions
Seasonal factors have been updated using the X-ll ARIMA procedure
adopted In 1982.
No titcansactIons H2 has been seasonablly adjusted as a
whole—instead of being built up from seasonally adjusted savings and small
time deposits—in order to reduce distortions caused by p o r t f o l i o shifts
arising from financial change in recent years, especially s h i f t s to MMDAs
in 1983.
A similar procedure has been used to seasonally adjust the non-
M2 portion of M3.
85
COMPARISON OF REVISED AND OLD Ml GROWTH RATES
(percent changes at annual rates)
Revised
Ml
U)
Old
Ml
(2)
1982--0ct.
Nov.
Dec.
17.3
15.8
10.3
14.2
13.6
10.6
1983— Jan.
Feb.
Mar.
Apr.
1L.5
14.8
13.0
Difference
Difference
due to
Benchmark Seasonals
(1-2)
(3)
(4)
(5)
3.1
2.2
0.5
0.8
2.6
1.4
0.1
-0.3
-0.4
9.8
1.7
-2.4
4.1
22.4
15.9
-7.6
-2.9
-7.8
-2.9
9.4
5.8
3.5
6.2
3.2
5.3
8.9
2.8
0.9
1.9
0.9
6.5
0.0
0.5
3.0
2.6
4.3
2.3
0.2
0.0
1.7
0.5
1.4
0.9
0.0
0.6
1.6
0.0
-1.2
-1.0
1982 — QIV
15.4
13.1
2.3
0.2
2.1
1983— QI
QIT
QIII
QIV
12.8
11.6
14.1
12.2
-1.3
-0.6
-0.7
9.5
4.8
8.9
2.1
0.6
2.7
0.8
0.8
0.6
-0.6
-1.4
-0.2
2.1
10.0
9.6
QIV '82 to
QII '83
12.4
13.3
-0.9
0.0
-0.9
QII '83 to
QIV '83
7.2
5.5
1.7
0.7
1.0
May
June
July
Aug.
Sept.
Oct.
Nov.
Dec.
3.6
2L.O
10.2
-2.7
6.3
26.3
10.2
-5.3
4.6
-5.8
-1.4
-0.4
3.0
2.0
2.7
2.3
-0.2
Quarterly
Annual
1983— QIV '82 to
QIV '83
Semi -Annual
86
COMPARISON OF REVISED AND OLD M2 GROWTH RATES
(percent changes at annual r a t e s )
1
Revi ed
1)
M2
Old M2
(2)
1
| Difference
|
(1-2)
|
(3)
Difference
due to
Benchmark
Seasonals
(4)
(5)
Monthly
1982— Oct.
Nov.
Dec.
9.3
10.5
12.1
7.9
9.5
8.9
1.4
1.0
3.2
-0.1
0.4
1.5
0.6
0.5
2.7
1983— Jan.
Feb.
Mar,
Apr.
May
June
July
Aug.
Sept.
Oct.
Nov.
Dec.
31.9
1.1
7.S
8.4
11. R
8.4
5.4
4.9
7.1
10.8
8.2
8.2
30.9
24.4
11.2
2.8
12.4
10,4
6.8
6.0
4.3
9.1
7.2
5.5
1.0
-2.7
-3.4
5.6
-O.f-2.0
-1.4
-1.1
2.3
1.7
l.,l
2.7
-0.6
l.b
-0.9
-1.8
1982 — QIV
10. b
9.3
1983—-Ql
20. S
20.3
10.6
10.1
o.s
6.9
8.5
7.8
7.0
-0.9
1.5
8.3
7.3
0.5
0.0
1.1
0.1
-O.I
0.0
0.0
0.6
0.9
0.0
-3.4
3.7
-0.7
-1.9
— 1
''
-1.1
1.7
0.3
0.8
1.0
2.4
1.3
0.3
1.0
0.2
-o.;
0."
0.4
0.0
-1.0
l.i.
0.6
-0.1
Quarterly
qn
Q1II
QIV
0.5
0.1
Annual
1982 — QIV '82
to
QIV '83
Feb/Mar. '83
to
QIV '83
87
COMPARISON OF REVISED AND OLD M3 GROWTH RATES1
(percent changes at annual rates)
r
Revised
(i)
M3
Old M
i ~T2T
Difference
(1-2)
(3)
Difference
Due to
Benchmark
Seasonals
(4)
(5)
Monthly
198Z-- Oct.
Nov.
Dec.
11.7
7.7
5.7
9.3
9.3
3.7
2.4
-1.6
2.0
0.0
-0.8
-0.3
1983— Jan.
Feb.
Mar.
Apr.
May
Jane
July
Aug.
Sept.
Oct,
Nov.
Dec,
14.4
13.1
7.2
8.7
9.6
10.3
5.1
6. 1
8.8
9.4
14.1
8.8
13.0
13.7
8.1
3.3
10.9
11.0
5.5
8.3
7.6
8.6
11.9
6.6
1.4
-1.2
2.6
-0.6
-0.9
5.4
-1.3
-0.7
-0.4
-2.7
1.2
0.8
2.2
2.2
1.4
1,2
2.8
0.5
0.2
-0.2
-0.3
-0.5
-1.0
2.7
0.3
-2.0
-2.1
2.6
-1,8
-0.9
-0.2
-2.4
1.7
1.8
-0.5
1.9
2.4
-0,8
2.3
Quarterly
1982 — QIV
10.0
9.5
0.5
-0.3
0.8
1933— QI
QII
QIII
QIV
10. 3
9-3
7.4
10.0
10.2
8.1
8.4
9.0
0.6
-0.1
0.7
1.2
-1.0
1.0
1.5
-0.1
0.1
-0.3
-0.9
0.9
9.7
9.2
0.5
0.5
D.O
Annual
1982— QIV '82 to
QIV ' 8 3
1. Revised M3 includes term Eurodollars; the inclusion of term Eurodollars boosted M3
growth in 1983 by no more than 0.1 percentage points.
The CHAIRMAN. Thank you very much.
As I already mentioned, the Federal Reserve's target ranges for
growth of M1( M2, and M3 during 1984 are lower than the target
ranges for 1983. Given the perspective of the Federal deficit that
we both talked about, do you believe that tightening money to that
extent will push interest rates up?
BUDGET CUTS COULD HAVE FAVORABLE CLIMATE ON ECONOMY
Mr. VOLCKER. These target ranges, which are one-half to 1 percent lower than last year, are calculated to be consistent with the
kind of economic projection that we have. The projections, while
they are a summary of the individual projections of different
people, assume a budget deficit for 1984 of the overall magnitude
that is reflected in the President's budget—slightly higher—and
the President's budget assumes some action would be taken.
As I suggested, the implications for interest rates, in the first instance, really depend upon the degree of demand pressure on the
economy. If the underlying demand pressures are stronger than assumed by this projection, I think the targets might imply a tendency for interest rates to rise, and that would be a restraining influence on economic growth. If, in contrast, as some people believe,
the underlying demand pressures in the economy tend to be at a
slower rate than this, interest rates should decline, and that decline in interest rates will buoy the economy, and tend to keep it
on track.
I don't think the targets themselves should be looked at as an
independent influence on interest rates. Too much depends upon
what happens in the rest of the economy, and the budget, of course,
is one factor in that. If the deficit turned out even worse, that's a
factor pushing interest rates up; but if progress were made on the
deficit, that would clearly be a factor pulling interest rates down.
The only other point I would add is that, in looking at budgetary
action, I would assume that the markets have already discounted
or expected the budgetary situation to be pretty much as it exists.
If there can be really concrete progress and a sense of direction,
even if the measures were not effective in any substantial amount
during the course of calendar year 1984 the changed expectation
could begin to have a favorable impact on the markets in 1984.
The CHAIRMAN. Obviously, we are already into 1984. What we
are talking about is 1985 budget levels.
Mr. VOLCKER. Right.
The CHAIRMAN. So let me give you some figures and see how you
would respond to some specifics. I certainly am hopeful that the administration and the Congress can get together on some sort of a
budget reduction package; from my standpoint, hopefully more
than a downpayment.
Let's assume that we could and that you had a $30 to $50 billion
reduction in the deficit. Then what would your recommendations
be, not only on your targets for monetary aggregates
Mr. VOLCKER. $30 to $50 billion in 1985?
The CHAIRMAN. In the 1985 budget.
Mr. VOLCKER. From the current services budget?
89
The CHAIRMAN. From the budget reduction package. In other
words, we can all talk in generalities, as we do, but just to pin it
down more, if we had that kind of budget reduction in the 1985
budget—in others words, now we're talking about getting down to
$120 or $150 billion, then what would the Fed's recommendations
be?
Mr. VOLCKER. I have no doubt that if you got down to that
budget area with some degree of assurance and that had the clear
implication of continuing savings in future years beyond 1985, that
that would have a favorable effect on the market climate and you
should see some noticeable reactions, in my judgment, on interest
rates—particularly longer term interest rates—even if the actual
demands of 1984 are as projected.
I don't think, in the first instance, it should imply any change in
our monetary targets. Within those monetary targets you would
have a more favorable interest rate outlook and you would have a
more favorable economic outlook, in the sense that you would have
been laying the foundation for a more balanced and sustained recovery.
The implications would be totally favorable, but I don't see why
they would necessarily change the monetary targets.
The CHAIRMAN. Why not? Usually the Fed's response, at least
since I've been here, the bigger the budget deficits, we're the only
ball game in town on inflation and therefore we're tightening up
and trying to counteract. So if we're finally, assuming we did, going
in the other direction, why wouldn't that imply that there wasn't
as much pressure, as you just said, a much more rosy outlook if we
did that and so on, then why wouldn't it also follow that there
should be an easing?
Mr. VOLCKER. I don't think we've tightened up the targets in the
past in response to budget deficits. These targets are set in terms of
what seems appropriate for an overall end product of growth in the
economy without inflation, the mixture of those two things.
What it does change is the market environment. It changes what
people think of as ease or tightness of policy, measured by the way
interest rates go. It may well have implications for the degree of
reserve pressure, which influences interest rates in the short run;
if you take out one source of demand pressure in the economy—
and you're talking about taking it out in 1985 not in 1984—even
prospectively, that might change the market climate. It should
change the market climate as I've suggested; you're not changing
the deficit at all in 1984, so the immediate demand pressures are
the same. But even then, you might get a situation in the economy
where to achieve these targets required less pressure on bank reserve positions which would be a good thing in terms of interest
rate outlook. But that does not say that because you have a lower
budget deficit you want to have a money supply increase that
would be judged over time to be inflationary. That's the balance we
have to find and, given your assumption, my first reaction would
be that there would be no reason, for that reason alone, to change
these monetary targets, which are set to achieve a balance between
enough money to keep the economy going but not enough to refeed
inflation, to the extent we can judge that balance.
90
The CHAIRMAN. I understand the balance you're trying to
achieve. It's certainly not the deficit alone but the other factors,
the more optimistic picture, it would seem to me then there would
be less pressure.
Mr. VOLCKER. There would be less pressure on the markets.
The CHAIRMAN. Less pressure which would allow you to have
somewhat higher—and I'm not picking figures of where that balance should be.
Mr. VOLCKER. In a technical sense that should lead us to let's say
raise the targets if we thought something was going on that was
leading even temporarily—I mean over a period of 1 year or so—or
more permanently to a reduced rate of velocity growth. If the relationship between the growth in the economy as a whole and inflation is changing, we ought to change our targets; we make our best
judgment on that. But it's not apparent to me that changing the
deficit assumption would change that velocity assumption. If it did,
then we ought to change the targets, but it's not apparent to me—
certainly in the short term
The CHAIRMAN. Well, I wish Congress would produce that for you
and then we would see in actuality what would happen.
Mr. VOLCKER. Let me give you one hypothetical example, which I
stretched out over a longer period of time. Suppose such progress
were being made on the deficit that interest rates within this kind
of framework moved very decisively lower. That might be a factor
inducing people—particularly now that we pay interest on NOW
accounts and supposing we were to pay interest on demand deposits—to hold more cash relative to economic activity than they have
in the past. That would be reflected in a slowdown of velocity, and
we ought to allow for it.
But I think that's hanging out some distance in the future as a
possibility, rather than as a current matter of debate under the
kind of assumptions you make. If you carried through that policy
for a few years, and it may indeed be that velocity would change.
IMPLEMENTATION OP CONTEMPORANEOUS RESERVE ACCOUNTING
The CHAIRMAN. I'm going to change the subject to another one
quickly before my time is up on this round.
Last week the Fed finally implemented the contemporaneous reserve accounting, a procedure that I have advocated and other
members of this committee for a long, long time, which I believe
should improve the Fed's control over the monetary aggregates,
and I won t get into that whole discussion of the validity of weekly
reporting and all of that.
But how do you feel contemporaneous reserve accounting will
impact on bank behavior and how much will the switch from the
lagged reserve accounting dampen the volatility of Mi?
Mr. VOLCKER. I have a very rather cautious and restrained approach toward that. I always have. I don't think it's going to make
a big difference. But technically, if your objective is to exert close
control over MI in the short run, there are advantages in the contemporaneous reserve accounting.
We have, for the time being, as reflected in our report, decided
not to change our operating technique because of the introduction
91
of contemporaneous reserve accounting in an effort to achieve a
very close control over Mi. We have not done so partly because we
don't think that technique should drive policy and we have enough
tentativeness about the relationships between Ms and the rest of
the economy and Mi and the other aggregates that we don't want
to, in effect, put all our money on controlling that particular aggregate tightly.
If we wanted to do that, then contemporaneous reserve accounting would be a help, and we will be evaluating that as time passes;
it's basically a judgment as to whether the velocity of Mi is returning to the degree of predictability and stability that's necessary to
rely upon it that heavily. We see some signs in that direction, but
they're still tentative, so we are going to continue to look at it.
On a more purely technical front, the change to contemporaneous reserve accounting and related changes in reporting inevitably,
for a short-transitional period, introduce some uncertainty as to
how banks themselves will react and how many excess reserves
they want to hold—that is, how they will react in the money markets on a day-to-day basis, while they are adjusting to what is a
factor of uncertainty for them. They no longer know their reserve
requirement as the week progresses with the certainty that they
did before, so that introduces some transitional questions, I don't
think they will last very long, but nonetheless, we're right in the
midst of those at the moment, and for that reason alone we would
be quite cautious about putting a lot of weight on contemporaneous
reserve accounting in order to achieve a given money supply objective during this transitional period.
We may have some problems in getting all money supply figures
together with the degree of accuracy and speed that we like to
achieve, simply because during this transitional period both the
banks and Federal Reserve System have to adjust to a new reporting system.
The CHAIRMAN. Thank you, Mr. Chairman.
Senator Proxmire.
Senator PROXMIRE. Chairman Volcker, some have argued that
the Federal Reserve has historically tried to help the incumbent in
the White House during a Presidential election year by easing
monetary policy. There's one conspicuous exception to that. In October 1979, the new Chairman of the Federal Reserve Board instituted a policy of slowing down the rate of increase in the supply of
money and I don't think anybody could argue that Paul Volcker
was a big help to Jimmy Carter in 1980.
Do you have any understanding with the administration, explicit
or tacit, that you will follow an accommodative policy in 1984?
Mr. VOLCKER. No, sir.
Senator PROXMIRE. Will you agree to report to this committee
and to the House Banking Committee any instances of the administration bringing pressure on the Federal Reserve to relax its policies?
Mr. VOLCKER. I don't know what context you're thinking of exactly. I keep in close contact with administration officials and we
fiiscua? fiscal policies and we may occasionally discuss monetary
policy. 1 don't interpret that as pressure, and i don't assume that
you would interpret those continuing discussions as pressure.
Senator PROXMIRE. Well, what I'm talking about is if they talk to
you privately as distinguished from any public statements they
might make.
Mr. VOLCKER. For political purposes? I suppose that's the distinction.
Senator PROXMIRE. Well, as to political purposes, let us judge
that. I mean, it's 1984. It's hard to find something that isn't political.
Mr. VOLCKER. I understand, but I don't want to make a commitment that every time I have a conversation with somebody in the
administration that I have to report the nature of those conversations; we have continuing discussions, as I say, on various aspects
of economic policy.
Senator PROXMIRE. Well, Chairman Volcker, you obviously
weren't born yesterday. I think you know political pressure when
you see it.
Mr. VOLCKER. That's right. That's why I make a distinction between a kind of continuing discussion, which I think is normal, and
something one would interpret as part of an election campaign. I
think I can tell the difference between those.
Senator PROXMIRE. Well, how about letting us in on it? Will you
do that?
Mr. VOLCKER. If I can see the distinction.
Senator PROXMIRE. You can see the distinction.
Chairman Volcker, the February 1 budget of the President was
sent to the Congress with economic projections that predicted that
if we adopted the budget as set forth over the next 5 years we
would have the following economic consequences: No. 1, steadily
falling interest rates with the Treasury bill rate coming down from
9 to 5 percent by 1989; mortgage rates falling from about 12.5 to 7
percent; steadily falling unemployment with the unemployment
rate declining to 5.5 percent in 1989; moderate inflation with the
inflation rate staying close to 5 percent through 1989.
Now these OMB projections assume accommodative monetary
policy. Could you recommend a monetary policy consistent with
those objectives within the constraints of the budget that's being
recommended?
OMB PROJECTIONS SHOW NOMINAL DECLINE IN GNP
Mr. VOLCKER. I don't have those projections in front of me, but
they would imply, as I recall, some fairly steady declines in the
overall nominal GNP and some declines in the inflation rate after
1984 or 1985. I think those projections would be broadly consistent
with a reduced rate of growth of the various monetary aggregates
through that period.
Obviously, in saying that, I'm assuming more or less historical
patterns of velocity.
Senator PROXMIRE. Well, let me be more precise. If we adopt
these budgets, do you think that there's any prospect that we could
expect to have interest rates decline over the next 5 years? Is there
any kind of monetary policy that could achieve that, in your view?
Mr. VOLCKER. Very clearly, those deficits work in the other direction. You get declines in interest rates if the economy is bad
enough, but that's not consistent with other parts of the projection.
I agree with the thrust of what you're saying and I think those are
highly optimistic projections in the context of no further action to
deal with the budget deficit.
They do assume further actions to deal with the budget deficit. I
do not consider those estimates out of the ballpark in any sense in
the context of what I would see as the need for an improved budgetary picture and the actions to achieve that.
Senator PROXMIRE. In other words, if we had a different budget,
a different deficit, then it's possible that we might get a decline in
interest rates, but these deficits that are recommended, would you
say that it's not possible or is that going too far?
Mr. VOLCKER. I think that may be going too far.
Senator PROXMIRE. This combination of falling unemployment
and declining interest rates?
Mr. VOLCKER. With the inflation forecast that they have, I don't
think that you can say it's impossible. The risks that we could be
quite off course increase drastically unless some improvements are
made in the budgetary picture.
They have assumed some improvements in the budgetary picture. I think there's a real question as to whether they have assumed enough in order to assure that kind of outlook.
Senator PROXMIRE. The President sent us a budget. It was his
budget. He can do anything he wants to.
Mr. VOLCKER. But that budget included assumptions of some expenditure savings and, indeed, some revenue increases through
new actions.
Senator PROXMIRE. But it had the net effect of a deficit that they
projected at $180 billion in 1985.
Mr. VOLCKER. That is correct. The deficit would be even bigger if
they didn't assume those actions.
Senator PROXMIRE. Exactly.
Mr. VOLCKER. We're operating from the baseline according to the
budget ceiling.
Senator PROXMIRE. And you say that it's possible under those circumstances, even with that kind of a deficit, to have interest rates
fall but only if you had less growth in which case you'd have increased unemployment; is that right?
Mr. VOLCKER. Certainly interest rates would fall under those assumptions. Those estimates are optimistic, in my judgment, because they don't allow for the risks and pressures arising out of the
budget deficit. I don't think they would be unduly optimistic, certainly not on interest rates, with a different budgetary picture.
Senator PROXMIRE. I'm really surprised. In fact, I'm astounded. I
would think that you would tell us that it is absolutely impossible
with a $180 billion deficit in 1985, almost as high a deficit in 1986,
almost as high a deficit in 1987, to find any kind of monetary
policy that would give us a decline in interest rates over that
period to 9 percent and 5 percent inflation. It doesn't make sense.
Mr. VOLCKER, What they're assuming is that the inflation rate
will rise in 1985.
Senator PROXMIRE. Well, slightly.
Mr. VOLCKER. Slightly, and then begin declining and get down to
3.5 percent. If you make that assumption, I think that is the kind
of environment in which interest rates would be lower.
Senator PROXMIRE. Can you make that kind of assumption with
deficits of that size?
Mr. VOLCKER. There is considerable doubt about our ability to
meet those kinds of projections—to put it mildly—under the current kind of budgetary projections. But, putting it positively, if we
took action—let's say along the lines that Senator Garn is suggesting, with a followthrough in subsequent years so that that deficit is
knocked down further—then this terrible picture that we have
before us of deficits compounding upon themselves and keeping interest rates up and leading to the $300 billion deficit that the CBO
outlined yesterday—need not materialize. If you could get the
budget deficit down, keep inflation under control, interest rates
will in fact begin coming down in that climate. Then your future
budget deficits out there in 1988, 1989 and 1990 reflect the favorable effects of lower interest rates than anticipated, and lo and
behold you find the budget deficit decreasing more rapidly than
you expected. But you've got to get the process started.
It can either explode on you or it can gain momentum in a favorable direction. Whether it explodes or builds in a favorable direction depends upon how quickly and how forcefully you take some
action, in my opinion.
NEED TO IMPROVE HORRENDOUS TRADE IMBALANCE
Senator PROXMIRE. I want very much to agree with you and I believe very deeply in you as Federal Reserve Board Chairman, as
you know, but 1 think there's a momentum here that all of us are
caught up in and I just wonder if we shouldn't be a little more cautious.
Let me put the question this way. As an economist, would you
expect that the increase in the Federal deficit in the past 2 years
during which it rose about $58 billion in 1981 to $109 billion in
1982 and to $195 billion in 1983 played any part in stimulating the
economy? And if it did, would not a sharp reduction in the deficit,
lowering it by say $60 or $70 billion a year, cause a slowdown in
the rate of recovery?
Mr. VOLCKER. I don't think we're going to get a cut that big.
Senator PROXMIRE. Well, say a $50 billion reduction.
Mr. VOLCKER. We're not going to get $50 billion in a year as a
practical matter. But the impact of that would be, yes, to take
some purchasing power out of the economy and presumably, in the
first instance, to slow consumption.
I think the effects of that on financial markets, the climate for
investment, the interest-rate level, would quickly produce forces in
the economy that would yield offsetting expansion, and you would
end up with a far better balanced picture than what you have now.
Senator PROXMIRE. Have you got any kind of 3 model you can
put this into to determine whether or not yon uould be able to get
that.
Mr. VOLCKER. You can put it in a very standee r .ode-i.
Senator PROXMIRE. Have you done that?
Mr. VOLCKER. Our economists run these models all the time. I'm
suspicious of these models, but
Senator PROXMIRE. So am I, but it just seems to me
Mr. VOLCKER. They never take care of the unexpected, but the
general direction is precisely as I've described it. What would you
end up with? You would end up with relatively less consumption.
You would end up with more investment, more capacity, more productivity. You would certainly end up with more housing and you
would end up with an improving trade position instead of a deteriorating trade position.
The major point of imbalance in the economy right now is that
horrendous and growing trade deficit. That's the pressure. It's
coming out on housing and investment; it's implicit in the high interest rates. But where you actually see the forces of the economy
knocked on the head, so to speak, in a clear cut way is in the trade
sector, and that is the place where you would expect to get improvement.
All those adjustments in the model take time. On the other
hand, a model does not reflect, in my judgment, the real risks that
we are running in the economy now by keeping the deficit high.
What do those models show? They show the opposite of what I just
said. They show high consumption, low investment, deteriorating
trade picture, low housing, higher interest rates than you would
otherwise get, and bad growth over a period of time, but it doesn't
look like any great crisis.
Models never predict a crisis. They don't allow for instability in
exchange rates and fears about the dollar. They don't allow for the
pressures on the thrift industry. There's nothing in those models
that talks about the presures on the international financial system
growing out of international indebtedness and the pressures that
high interest rates put on Mexico, Brazil, Argentina, Chile, and
Venezuela and so on, and the risks that poses to the banking
system. They're not in a model, but they're in the real world, and
those are the risks that we are running of adverse financial and
therefore economic consequences. They aren't reflected in these
models, but those are the risks I'm worried about, together with
the problems that are reflected in the model.
Senator PROXMIRE. My time is up.
The CHAIRMAN. Senator Mattingly.
Senator MATTINGLY. Thank you, Mr. Chairman.
I agree with the chairman of the committee when he said the
reason why Congress talks about monetary policy is because they
don't have anything to do with it. Now, I've noticed a lot of your
comments since you've been coming before us for the last 3 years
about Federal spending and the different sides of the economic
equation. Maybe you ought to be chairman of the Council of Economic Advisers. I'm saying that as a plus to you.
But no matter how many times you come down here and testify,
I'm not sure whether anybody is listening to you, especially about
the need to reduce Federal spending. We in Congress keep talking
about monetary policy, but we keep ignoring the fiscal side of the
economic equation. You do it in a more eloquent way than the way
I do in labeling this place as a "big, fat cow." That's what the
budget is, and it needs further restraint. We can't ignore that.
96
When Congress passed TEFRA in 1982, there was a decline in
the Fed's funds rates and an expansion of the money supply, as I
recall. Now recognizing the current restrictive stance that the Fed
has taken with respect to the expansion of the money supply, is the
Fed trying to tell the Congress to pass TEFRA II? In other words,
are you requesting a downpayment before the Fed expands credit?
Mr. VOLCKER. I'm certainly advising you to take whatever steps
you can take to reduce the budget deficit. But if you are suggesting
that we are following some policy with respect to credit or monetary expansion that is different from what we would otherwise
follow, that we are tighter than we otherwise would be, to make a
political impression on the Congress, that's entirely wrong.
PRESIDENTIAL LINE ITEM VETO POWER
Senator MATTINGLY. All right. You and I have talked before, and
it's no big secret in this room that this place spends too much
money. All I'm asking is if we reduce the spending, and thus the
deficit, interest rates will start declining?
Mr. VOLCKER. If you make the kind of move that the chairman
talked about, I think you will see the results in interest rates.
Senator MATTINGLY. You're talking about the $100 billion downpayment?
Mr. VOLCKER. I was thinking of his $30 to $50 billion in 1985.
Senator MATTINGLY. OK. Well, even if we achieve the $100 billion downpayment, that's sort of a patch.
Mr. VOLCKER. I think that's the first step.
Senator MATTINGLY. Let me just give you a couple of proposals so
we can get your input.
Do you think that we ought to try to grant a line-item veto for
the President?
Mr. VOLCKER. Obviously you're getting out of my technical expertise.
Senator MATTINGLY. No, I'm not, I'm only trying to control the
budget.
Mr. VOLCKER. It's a big political issue. I have expressed earlier in
testifying on the balanced budget amendment, that I thought the
Congress ought to look at something like a line-item veto. If there
is a bias toward spending, which seems to be apparent, that's one
way to approach it and it seems to me appropriate constitutionally.
Senator MATTINGLY. Well, in other words, we need to enact it
right away so it will have some impact. By going the Constitution
route, which both Senator Dixon and I would like to see happen, it
would take a lot longer to do it. We, therefore, should approach it
by a statute so we can get it done right away, even though it will
potentially only impact 15 or 17 percent of the budget.
Mr. VOLCKER. Then that's your judgment. I'm generally sympathetic toward a line-item veto. I don't think it's going to revolutionize the budgetary picture in the short run, precisely for the reason
you suggested.
Senator MATTINGLY. OK, Senator Dixon, that's one more on our
side.
Now, if we have the $100 billion downpayment, and what it may
be composed of can be looked at later
97
Mr. VOLCKER. It's a question of what it's from, too.
Senator MATTINGLY. That's right. In order to really have the fundamental reform that's necessary to get through this—you know,
everybody is looking for 1985 and the election year cycle—but what
do you think about establishing some type of a spending reform
commission to look at just strictly the spending side of the budget.
Not taxes because we ve already got Secretary Regan looking at
the issue of tax reform for the tax side; but just a spending reform
commission? In other words, do you think this would help, in your
viewpoint, if you knew we were going to enact some type of $100
billion reduction over the next 3 years and at the same time that
we were going to establish a spending reform commission so we can
really get into the spending side of the budget.
Mr. VOLCKER. If you're asking me for a technical judgment as to
how the market would react to that, I would be surprised to see
much of any reaction. I think they are cynical, or jaded, or whatever. We have a spending reform commission, in effect, in the
Grace Commission.
Senator MATTINGLY. Now what I'm talking about is a group to go
out and put together a package of reforms, taking into consideration all programs, even the 1984 index programs in the Federal
budget
Mr. VOLCKER. What kind of reporting date?
Senator MATTINGLY. Say a year would be fine. I'm just saying
that they need to get to work in order to come up with a total
package, one that makes substantive spending reforms.
Mr. VOLCKER. Let me say, first of all, I would think it would be
terribly important that that kind of thing not be used as an excuse
for not carrying through in the short run.
Senator MATTINGLY. That's what I said. I'm saying that we go
ahead and begin consideration of fundamental spending reform
now.
Mr. VOLCKER. I understand you said that. I just want to reiterate
that I think it would be counterproductive if it were interpreted as
a substitute.
Senator MATTINGLY. I think if we passed TEFRA II, or whatever
you want to call it and even the $100 billion package, you'll be
back here next year saying the same thing and the year after because we will not have approached the fundamental cause of
what's wrong with the Federal budget.
Mr. VOLCKER. Right. That's one way of approaching it, with a
close enough deadline, if it's your political judgment that the way
to approach some of these tough positions is to get further enlightenment. Maybe it's helpful, but I do not feel that you should count
on a lot of market reaction to it.
Senator MATTINGLY. Well, I'm not really looking at the market
reaction so much as I'm trying
Mr. VOLCKER. I'm talking about interest rate reaction. I would
not oppose that. I have no reason to oppose it. I think it is basically
a political judgment as to whether that's an effective key to unlock
these very difficult decisions; you would have a better judgment on
that than I would.
Senator MATTINGLY. Well, you've been up here in Washington
longer than I have and you see what the Congress does. They get
9S
sort of in a box and they pass little things like dairy bills and everything else that locks you into more Federal spending as time
goes on. All I'm saying is I think that we can make the minor restraints in the budget, but in order to get fundamental reforms, we
have to have a different approach or we need to do the same thing
next year and the year after that.
Mr. VOLCKER. I agree completely. It's just a question of how you
get there.
COUNTRY NEEDS TO OVERCOME TRADE DEFICIT
Senator MATTINGLY. One last comment. I was glad to see you
really begin talking about the trade issue. I think Senator Heinz
will agree with me, you know, we talk about monetary policy, fiscal
policy, and defense policy in this country, but we have not driven
the issue of trade policy up to the level that it should be. And I'm
glad to see that you bring this issue up to that level. You and I
both know that our trade deficit is not all due to the uverevaluation of the dollar.
I know this may be a little bit out of your ballpark, but what
would you consider helpful in expansion of trade, other than reduction of the overvalued dollar?
Mr. VOLCKER. I think, as always, there's a lot of work to be done
in terms of opening other markets fairly to our goods, and that requires more force in some countries than in others. But in a very
practical way, I suppose the greatest challenge now is to prevent
closing, rather than to open; we have been guilty of some of that
ourselves. I think we are in a very dangerous area of retreat on the
side of opening of markets here and abroad, ; nd that that will rebound to our disadvantage over time unless we can correct the
bias.
I do think a lot of the fundamental difficulties come out of two
things. It's partly interest rates or the mix of policies here. Also,
the fact is, we've buen growing more rapidly than other countries.
In the short run that's fine. It has affected our trade position adversely, but we hope it's corrected by more growth
abroad. But the
mix of policies, the budgetary situation, the !ev,=l of interest rates
that emerges out of that has a very pervasive and fundamental influence on our trade patterns in an adverse way.
This is the principal manifestation right now of the tensions we
have in the domestic economic policy.
Senator MATTINGLY. But as we notice now the projections for the
foreign trade deficit is being pushed another $30 billion.
Mr- VOLCKER. Sure
Senator MATTINGLY. Now in order to help our people here at
home, outside of trying to make understandable laws that thev can
go by, do you think there ought to be greater consideration of
barter?
Mr. VOLCKER. Of barter, no.
Senator MATTINGLY. Why?
Mr. VOLCKER. Basically, over time, that goes in the wrong direction. I think we are going to be be?t off in trade with relatively
open markets, freely competitive situations. There may be very
specific instances where barter is useful, but moving the system
toward barter implies to me, in the end, a lot less trade. I suspect,
in the sheerest sense of self-survival and maneuverability, we are
not very well equipped for that as compared to some other countries that are more used to barter and have more centralized economies.
I think we have to have an international trading system that fits
with our perception of the way the economy works, which is open
and competitive. I suspect if we ended up with a barter system we
would get out-bartered pretty consistently.
Senator MATTINGLY. I'd like to pursue that, but my time has expired. Thank you.
The CHAIRMAN. Senator Dixon.
Senator DIXON. Mr. Chairman, my distinguished friend from
Tennessee has some serious time constraints, I wonder if I could
step back one from him and accommodate him?
The CHAIRMAN. It's your choice.
Senator SASSER. Mr. Chairman, I want to express my appreciation to Senator Dixon for allowing me to go first this morning.
Mr. Chairman, there's a lot of talk about doing something about
the budget deficit and indeed something has to be done about it.
It's not easy for a politician to advocate a tax increase and a reduction in defense spending, but I think it's clear to anybody who's
studied the situation that if we are going to have a meaningful reduction of the deficit, a tax increase and a reduction in defense
spending are going to have to be part of the overall mix to bring thai
deficit down.
Now before the American public is going to accept either measure, they're going to have to be absolutely certain that it's necessary and, in my opinion, the President of the United States has
given us absolutely no help in this regard.
The American people need to hear a clear and unequivocal message
from public servants whom they trust that indeed we are going to have
increased revenue, that indeed we are going to have to have some curtailment of defense spending, and there's where you come in, Mr. ("hairman. You've got some credibility there with the people out in the country.
Given the current political and economic situation and taking
into account the cuts that have already been made in nonmilitary
spending, means-tested entitlements, social security, are you prepared to say unequivocally that tax increases ought to be enacted?
Are you prepared to say unequivocally that reduction in defense
spending will hold the administration's budget as needed?
Now if you're not prepared to be forthright and unequivocal
about these matters, how in the world can you expect the American public to be persuaded that they are needed? If you decline to
be forthright about the economic and budget situation that we face
and to support those of us in the Congress who are trying- to do something about it, how can you come here and ask for our support for
a continued tight money, high interest rate policy that we appear
to be embarking upon again?
Mr. VOLCKER. Let me make several comments. I will be forthright and unequivocal: I think that this country needs a reduction
in those budget deficits; there are simply too many risks involved
100
in delaying action on that score, and you need action in a sizable
way as a first step toward still more sizable reductions over time.
REnUCE DEFENSE SPENDING AND INCREASE REVENUES
Senator SASSER. But aren't increasing revenues and cutting
defense spending vital ingredients in getting this deficit under control?
Mr. VOLCKER. Let me simply say all I can say on that subject. In
my judgment, you've got to make a sizable dent on the deficit, in
political terms at least. It's not all that huge in terms of total
spending, but nonetheless, it is difficult. I can't tell you and it's
not appropriate for me to tell you in what areas to make those cuts
or how to increase revenues.
I do have a judgment, as a general observer that reductions of
the size necessary are going to have to deal with many aspects of
the spending side of the budget. If you can't do it on the spending
side, you've got to do it on the revenue side, and I've listened to
enough talks that I suspect you can't do it all on the expenditure
side. You've got to find some combination touching on all those
areas of which you speak, that produces that deficit. But I can't tell
you how much has to be in any particular area or whether, unambiguously, any or every particular area has to be touched. My sense
certainly is that it's got to be a broad attack on the problem.
Senator SASSER. But we all need to get together and address this
thing. You know, it's not the Congress role to write the budget
either. The President of the United States normally does that and
has done it in prior administrations, but in this crisis year I think
everybody is being asked to assume roles that they're not accustomed to, primarily because the No. 1 one actor has left the stage—
or it might be more appropriate to say he's left the set—and I, for
one, am not optimistic that anything is going to be done about the
deficit this year. And you've indicated that the markets have already discounted the budget situation as it presently is and I think
the market has accurately discounted it.
This bipartisan commission, in my judgment, is not going to
make a significant contribution in doing something about the
budget deficit. We are going to end up with some finger pointing.
It's clearly a political ploy^ in my judgment. And what we need
here is some leadership to try to do something about this deficit.
And what I hear people saying, coming before other committees
that I'm on or appearing on the Sunday afternoon talk shows, is that
nothing can be done about this deficit until after the election, until
1985, and you come here and tell us that something has got to be
done now—and I think you're absolutely right about that. I think
something has to be done or we're going to be in very, very serious
difficulties and I don't see any way out of it. Perhaps others do.,
But, Mr. Chairman, we need some leadership here and we need
to have voices heard speaking with precision that are respected in
the financial community and on Main Street in this country.
Mr. VOLCKER. I will speak with as much precision as I can, but I
don't think I can tell you how to make those political judgments
that are involved or which sector of the budget should be dealt
with specifically.
101
Let me just make one further comment about your comment.
You referred, I think, to a high interest rate or tight money policy.
I don't interpret it as a high interest and tight money policy. I interpret it as a high interest result, given the conditions of the economy and given the conditions of the budget. I would like to see interest rates lower; the question is how to get them lower. I don't
see any way, by some manipulation of monetary policy alone, to do
that. I think that is perhaps the most important reason I can give
you as to why we are so utterly dependent upon prompt budgetary
action to unlock what was referred to yesterday as a gridlock on
interest rates.
Senator SASSER. So we agree it must be prompt action.
Mr. VOLCKER. Yes.
Senator SASSER. And it cannot be postponed until after the election?
Mr. VOLCKER. I agree with that fully.
Senator SASSER. Thank you, Mr. Chairman.
The CHAIRMAN. Senator Hecht.
Senator HECHT. Thank you, Mr. Chairman.
Mr. Chairman, last week in the Wall Street Journal—I just want
to read one line—"Dow Chemical fourth quarter operating profits
surged 362 percent." In this morning's Washington Post, "General
Motors earnings quadrupled the company's 1982 income," and it
went on to say, "The fourth quarter was eight times 1982 fourth
quarter profits."
How come you never brought out the revenue side on reducing
the deficit? You never speak about the revenues coming in.
HEFTY CORPORATE PROFITS ANTICIPATED
Mr. VOLCKER. I don't mean not to speak of the revenues coming
in. I think the problem we have, Senator, is precisely that with
rapid economic growth, with a good increase in profits, there is no
prospect that those revenue increases, which are in response to economic growth, are going to be sufficient to narrow the deficit over
time.
That is a measure of how difficult this budgetary problem is. The
underlying deficit—if we standardize the deficit for the state of the
business cycle and we allow for full employment—is still very large
and it's getting worse; that is the budgetary problem. It's nice to
have revenue growth, but we're not going to close the gap, in my
judgment, by that alone.
Senator HECHT. How can you just say that? I mean, did you anticipate these type of profits 6 months ago?
Mr. VOLCKER. The economy has grown more rapidly than we expected, so the profit picture has done better than we expected. The
profit picture has been better than we expected, and we picked up
all those extra revenues, and you assume some more cuts in the
President's budget, but you're left with a $180 billion deficit. That
is precisely the problem.
Senator HECHT. Just a minute. We don't know what the profit
side of revenues are going to be until after April 15 when the tax
returns come in.
102
Mr. VOLCKER. We don't know, but we've got some projections,
and that's been allowed for. Those profits, Senator, and tax receipts, have been allowed for in the administration estimates and
other estimates.
Senator HECHT. What are the estimates?
Mr. VOLCKER. They are already there.
Senator HECHT. I'm just pointing out that when you have a company like General Motors making many times more in the fourth
quarter over the year previous, who can anticipate anything like
that?
Mr. VOLCKER. I think, in general, the profits picture was anticipated. I don't know about precise levels for Dow Chemical and General Motors, but there are estimates of corporate profits. We've all
assumed that corporate profits in 1983 were sharply higher, as
indeed they were. We expect further improvement in 1984. Yet you
are still left with those deficits.
In fact, corporate profits taxes as a percentage of tax receipts has
been declining because those reflect in part some of the measures
that were enacted by the Congress earlier to relieve corporate profits taxes. So, you've got an inflow from higher profits, and you've
got loss of revenues from tax laws that are already on the books.
All of that is taken into account in these deficit projections.
Senator HECHT. On what basis do you anticipate revenue or what
percentage do you anticipate on the deficit projections coming in?
Mr. VOLCKER. I haven't got that figure right in front of me. I
would be glad to provide that to you, but I know in our own internal projections we allowed for a large -ncrease in corporate profits,
and I have no reason to believe that is widely off the mark. In fact,
we have preliminary data for 1983—which could be changed—but
to the extent we have data it's already been allowed for. It's not
just us. The Treasury has certainly allowed for it in their new estimate. There seem to be others who certainly allow for it in theirs. I
don't have the absolute number here, but corporate income taxes
are right now, because of cyclical factors, estimated to increase the
estimate I have here—this is the administration estimate—is that
profits would go up 10 percent as a whole, from only 6.2 percent
last year. That reflects that profit growth you're talking about.
You get a kind of one-time boost in corporate profit tax receipts
reflecting the speed of recovery. My major point is it's already been
allowed for; it is in those estimates.
Senator HECHT. Of course, I'm questioning the estimates.
Mr. VOLCKER. Profits could be higher than what has been estimated; that's obviously a possibility if the economy continues to
grow, but I would suspect the difference between the increase already estimated and what may materialize may account for a few
billion dollars. It's not going to be terribly significant in the context of the overall budgetary picture.
Total corporate profit tax receipts these days must run about $60
billion or something like that a year. If you had a 10-percent miss
in the estimate, which would be large, you would have another $6
billion; that's not going to revolutionize the budget picture.
Senator HECHT. But if we dropped unemployment down, these
people are paying into the Treasury.
103
Mr. VOLCKER. The faster the economy grows, all else being equal,
the better the budget picture would look in the short run. But what
I come back to is the point that even if you magically assume full
employment and the level of profits that goes along with that, you
would still be left with a large and growing deficit. And, if you
magically assume full employment, you also must be assuming a
high level of investment. Where are the savings going to come from
to finance that high level of investment at full employment if the
Government is still running a deficit?
Let me put it another way. We don't have a $200 billion problem
in my judgment, for the very kinds of reasons that you're suggesting. But we have a $100 billion-plus problem and it's getting worse.
Take away $100 billion of the deficit and ascribe it to growth. We
still have got $100 billion left and it's getting worse.
Senator HECHT. Of course, I'm questioning that it's getting worse
when I see the fourth quarter earnings coming in and I still feel
you're not taking into account the revenue that could come in. I've
spoken to business people in my own State and around the country
and not one did not have a better year in 1983 than 1982—not one.
Everyone has hired more people. More people are working.
Mr. VOLCKER. I have one set of estimates that shows a steady increase in corporate profit tax receipts. There was a large increase
in 1983—this is on the national income accounts basis—from $48.5
billion at an annual rate in the first quarter to $62 billion at an
annual rate in the fourth quarter. That is allowing for the profits
increase you're talking about. It's a big increase in 1 year—$14 billion, about 25 percent or a little more than 25 percent over the
course of the year.
Another 10 percent increase is expected based on these projections over the course of the next four quarters. That is already in
these estimates.
Senator HECHT. It's been said by different people running for
President that a 1-percent drop in unemployment cuts $30 billion
off the deficit. Is this a true figure?
Mr. VOLCKER. In the short run, that is right. And that is why I
say if you imagine that we were suddenly at 6- or 7-percent unemployment, you wov'' d have a budget deficit that was, say, $60 billion
less. I agree with that.
What troubles me is, yes, it would be $60 billion less, but it
would still be $120 billion, and it's that $120 billion that I'm worried about.
Senator HECHT. Of course, I like to reserve all my analysis until
the revenues start coming in in April because I still don't—I feel
you have underestimated the revenues, forgetting the corporate
profits which are very important which you have agreed to, the individual businesses and the people working
Mr. VOLCKER. They're not my estimates. They're the administration's estimates. I don't say that in disparagement in any sense;
they make the best estimates they can I'm sure, but they certainly
have allowed for the increase in corporate profits and they may
well be understated—that's always possible—but they're not going
to be understated by enough to fundamentally change the budget
outlook.
Senator HECHT. Thank you, Mr. Chairman.
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The CHAIRMAN. Senator Riegle.
Senator RIEGLE. Senator Dixon is next.
Senator DIXON. I don't mind.
The CHAIRMAN. Well, we shifted with Sasser and I'm trying to be
fair to you, however you want to do it. You were here before Senator Sasser.
SAVINGS RECOMMENDATIONS NEEDED
Senator RIEGLE. I appreciate your courtesy. I think Senator
Dixon was here before me and should go next.
Senator DIXON. You're very kind. I thank my friend from Michigan. I appreciate that.
Mr. Chairman, I've seen you in the ring a long time. I've never
really seen anybody lay a glove on you, so I'm not going to try to
do that, but I would like to ask you one general question and then
offer what I hope might be three specific positive things to take
under consideration and see what you think about them.
In the first place, I've heard everything you said early on about
demand in the marketplace and the uncertainty of it with respect
to predicting what interest rates would do, but would it not be true
that most reasonably prudent people would feel that if this Congress passes the $925 billion budget that the President has asked
for and if you adhere strictly to the monetary growth policy that
you've indicated to this committee at slightly less than the monetary growth rates in 1983, that interest rates will almost certainly
rise?
Mr. VOLCKER. I think they almost certainly will rise in the sense
of reporting
Senator DIXON. In the sense of what?
Mr. VOLCKER. In the sense they report what people's attitudes
are, as I understand it.
Senator DIXON. Well, wouldn't it really be what you expect, Mr.
Chairman, if we pass a $925 billion budget with an 18-percent increase in defense, an increase of $48 billion, and you stick to the
monetary growth rate lower than last year that you have indicated
to the chairman of this committee, wouldn't you personally expect
interest rates to rise?
Mr. VOLCKER. I would anticipate that you couldn't count on that
not happening. [Laughter.]
Senator DIXON. That's the closest anybody ever got to you, my
friend.
Well, let me talk about three things with you. I would be very
interested—and I respect your judgment very much. I want you to
know that. I want to talk about three specifics.
Mr. VOLCKER. I would just repeat what I said before.
Senator DIXON. As an old trial lawyer, once I've had that, that's
all I want.
Let me try three things on you for size. My friend from Georgia
talked about the line-item reduction veto power of the President. I
enthusiastically support that. I have on file in the Senate down
now, laid down Senate Joint Resolution 26 which would give this
power to the President. Now, 43 of the 50 Governors have it. Mr.
Chairman, in my own State of Illinois, experience last year trans-
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lated to the Federal budget, we could save between $15 and $20 billion in this budget by giving the line-item reduction veto power to
the President of the United States, and I ask you whether that
would be good news to the money markets, Wall Street, and the
stock markets?
Mr. VOLCKER. That kind of reduction would be. I don't think the
reduction is enough.
Senator DIXON. I understand that now. All right. Now the President has asked for a bipartisan commission. The greatest laugh we
had in the state of the Union address was when he suggested they
report back in December after the election. I'll ask you this question.
If some kind of a bipartisan commission would look at this problem and make some solid recommendations to the Congress by let's
say June of this year, this being February 8, some solid recommendations on savings, on some specific revenue enhancement taxes,
and some savings in this budget that would save substantial billions of dollars so we all had to really belly up to the bar and do
something significant before this year is finished, would that be
good news to the money markets, to Wall Street, and the stock
markets?
Mr. VOLCKER. As a substitute for this current effort?
Senator DIXON. Well, this current effort if they report back in
time so we can do something this year before the session is over.
Mr. VOLCKER. My sense is that this current effort, while it's
much more informal than what you're proposing, is what is on the
table, so to speak. I believe the administration people have said
that everything is on the table and it seems to me the practical
thing is to seize upon that initiative and do exactly what you're
talking about.
Senator DIXON. Good. Now let me pursue that without any
regard to where you cut because there are places you could cut I'm
sure in domestic and in defense spending, but let's just a moment
talk about defense spending that my friend from Tennessee referred to.
In requesting this budget for $313 billion for defense, up over the
$265 billion request last year by $48 billion, an increase of 18 percent, 13 percent in real terms.
Now the last bill we passed was five, so I'll ask you
Mr. VOLCKER. That's authorization.
Senator DIXON. All right, authorization. If we could save $20 billion in that area, that's good news, is it not, for the money markets, Wall Street, and the stock markets?
Mr. VOLCKER. Yes. I don't know when you use an authorization
figure—just to illustrate how difficult this all is—how quickly that
gets translated into lower levels of spending.
Senator DIXON. Well, then let's relate it to lower levels of spending. If the spending growth is 13 percent in real terms and I'm advised that it is, and for instance last year the House authorized 4
and we authorized 6 and we conferenced 5 and we got 5 as related
to 13 this year, a savings there of a very substantial amount would
be dramatic and noticeable, would it not?
106
Mr. VOLCKER. Yes, as part of a package, it would be important,
but I'm not commenting on all the other elements that go into the
spending package.
Senator DIXJ\ T . 1 understand that. Let me pursue it with one
more thing. There's a pending bill in the Senate by Senator Danfortli. a distinguished Member who's a Republican from Missouri,
Senator Boren, a distinguished Member who's a Democrat from
Oklahoma. Some of us refer to it euphemistically as the 3-percent
solution, in which they suggest, when indexing goes in in 1985—I
voted for indexing and many here did—it would go in at 3 percent
less than the inflationary experience and the COLA's would rise at
3-percent less for a marriage of 6 percent.
Now I don't know what that translates to in dollars. I knew at
one time frankly but I've forgotten. But that would be good news,
would it not, for the money markets, Wall Street, and the stock
markets?
Mr. VOLCKER. Yes. It seems what you're telling me, Senator,
which I fully agree with, is you ought to be able to get together and
take a variety of these measures and make the substantial impact
that's necessary, and I would encourage you to do so.
Senator DIXON. I understand that and all I'm suggesting to you
is if it is really doable this year in a real sense, many of these
things, if distinguished leaders in the Government like yourself
and others will continue to call as well as you have the last several
days for that—and I congratulate you for the headlines you're getting. People say don't pay attention, but you're in large black print
here and we would like to be back in black ink and I would simply
suggest that if you continue to carry this message to the country it
would help in connection with the national debate that's taking
place right now in the Congress.
Mr. VOLCKER. I'll try.
The CHAIRMAN. Before I turn to Senator Heinz, if I could make
one small technical correction. I would agree that the suggestion
we wait until December was in error. The President should not
wait. But that only applies to Secretary Regan analyzing tax loopholes and recommendations there. The bipartisan commission that
was recommended of Congressmen and Senators is meeting and the
intent was for them to make some recommendations as soon as
they could for this budget process. So it was only from the tax loophole standpoint, but I would still agree with your comment. It was
a laugh. Why December? Why not June? Why not July?
Senator Heinz.
Senator HEINZ. Mr. Chairman, thank you.
HOPE FOR BIPARTISAN COMPROMISE
Mr. Volcker, we have accomplished a great deal in the last 2 or 3
days of having you testify on the House side and here, having the
administration up, and having our colleagues on both sides of the
aisle speak. We've agreed that the deficit is bad. We've agreed that
there are terrible consequences for trade, for investment, for the
recovery that can flow from it. We have agreed that action needs to
be taken. That's the good news.
107
The fact is, however, that in terms of an action plan we don't
have one. The President's budget is a retreat from last year's
budget when it comes to dealing with the deficit. We hold out the
olive branch of a bipartisan compromise, but I note that if you take
the President's proposed $73 billion in deficit closure over 3 years
in his present budget and the hoped for $100 billion over 2 years
that if we're fortunate—indeed, one might say extremely fortunate—might materialize out of a compromise downpayment bipartisan plan, we will have over 3 years reduced the budget deficit
$173 billion to the tune of $55 to $60 billion. I seem to recollect
that the last time the members of the Finance Committee tried to
do that last year we were told by everybody to go away and forget
it because it couldn't be done.
The President himself has said that there are a lot of things that
he doesn't want to do this year. It's an election year. When asked
whether we should attempt any restructuring of the entitlement
programs for which we should all read retirement program, such
as social security, Federal retirement, military retirement, the
answer is, well, we really did that last year and it's off limits.
Now I don't want to be the skunk at the garden party, but it
seems to me there's no party, and there's not a lot of leadership.
And if our experience in this body is anything to go by, before
there's going to be leadership or compromise there's going to have
to be a crisis. That's what caused us to tackle social security 2
years ago. We barely made it, but we did make it and we got a solution. And this I think leads directly back to you.
We will have a crisis in this country if, and only if, the Federal
Reserve maintains its second half of last year policy of making sure
the money supply grows at a steady and slow rate. We will avoid a
crisis in this country if when push comes to shove in the credit
markets as the Government borrows more money the Federal Reserve eases credit, however imperceptibly and however obscurely.
And my question is, are you prepared to help bring about the
necessary crisis through your continued restrictive monetary policy
so that we deal with the deficit?
I hear one of my colleagues chuckling and I agree with him. It
would be funny if it weren't true.
Senator RIEGLE. We're not all chuckling, I might say.
Senator HEINZ. While there may be a humorous overtone to that
question, you've been in Washington long enough to know that
when it comes to getting Congress to bite the tough bullets—in this
case, spending—and when it comes to getting the President to bite
for him a tough issue—taxes—there's going to have to be a critical
reason for the two aforementioned players to do it. And you're the
only person by following a restrictive, noninflationary monetary
policy who can create that crisis.
My question then again is, are you prepared through thick or
thin to continue to pursue tight monetary policies?
Senator GORTON. Senator, could I interject?
Senator HEINZ. I don't know. I was hoping for an answer from
Mr. Volcker rather than from you.
Senator GORTON. I simply would like to add to the question, is it
not the view of the Chairman that if he should go to a much less
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restrictive monetary policy we would have the crisis all right, but
it would just be a different one?
Mr. VOLCKER. You gave him part of the answer, but let me say,
as a matter of general philosophical approach—and I feel very
strongly about this—it is not our job to artificially provoke a crisis.
We are not going to go out there and conduct a tight-money policy
for the sake of trying to bring leverage on the Congress or the administration.
Senator HEINZ. Mr. Chairman, I never intimated that that was a
part of your thinking.
Mr. VOLCKER. I wasn't absolutely positive about that.
Senator HEINZ. It might be an inevitable consequence.
Mr. VOLCKER. All right. I just wanted to make that absolutely
clear because we would not touch that with the proverbial 10-foot
pole.
What we do feel very strongly about and what I feel very strongly about, is that whatever shape that budget deficit is in—and for
some reasons this becomes more imperative if the budget deficit is
feeding inflationary expectations—that we adhere to a policy that
we think is in the best long-term interests of the country to avoid a
resurgence of inflationary pressures.
There's no doubt that that produces the risk that the pressures
on the money market, which are already evident, would continue,
and creates at least a risk that they could get worse depending
upon a lot of other things that happen. It doesn't necessarily mean
that, but that risk is inherent in the situation. That is what I'm
warning about.
The final point I would make is the point Senator Gorton already
made
Senator HEINZ. Well, he gets his time later.
Mr. VOLCKER. I was going to give you this answer, that some
kind of an attempt to, as you put it, head off crisis by increasing
the money supply in a way that's interpreted as inflationary is not
going to put it off very long. It will produce pressures in maybe a
slightly different form, maybe slightly later, maybe not.
Senator HEINZ. I have no quarrel with Senator Gorton's question
or the implicit answer to it that you get a different kind of problem
which is just as bad.
EFFECTS OF THE INFLOW OF FOREIGN CAPITAL
Mr. VOLCKER. The aspect of that that I would just want to amplify is that we are dependent now, and increasingly dependent, upon
this inflow of foreign capital. That's there for a variety of reasons,
including relatively high interest rates, including uncertainties
abroad, political and economic. I would like to think it's partly
there because of some sense of relative confidence in our economic
policies.
If the Federal Reserve is interpreted as following irresponsible
policies, we face a potential for a bigger disturbance, to use a polite
word, on the international side simply because of the enormous
vulnerability that we have permitted ourselves to build up over a
period of time.
109
Senator HEINZ, Let's talk about that because you raise a good
point. Two percent on an annual basis of our gross national product is being supplied by foreign credit. You mentioned that in your
opening statement.
Mr. VOLCKER. That's still a projection, but it's a pretty good projection.
Senator HEINZ. Not a bad projection. Were the money supply to
include—and it does not—but were the money supply to measure
let's say in Ma include the importation of foreign funds instead of
growing at 7.5 percent or whatever it was M2 grew at, what would
that equivalent be?
Mr. VOLCKER. It depends upon the form that the inflow takes;
some of it might be in M2 or M3.
Senator HEINZ. I'm just trying to get-—I'm not trying to pin you
down to a specific number, but would that add 2 points to the M's
or would it add 10 points to the M's?
Mr. VOLCKER. No, I don't think it would have added a significant
amount to those particular M's in 1983, with an exception. We do
not include, as a matter of definition, time deposits that banks acquire abroad from foreigners. We expect that that will become an
increasingly large source of funds to the banking system. There's
been some reversal there in 1983. We expect it will become an increasingly large supply of funds in 1984. That enables us, in a
sense, to live with a lower M2 and Ms and it bears upon the technical reasons as to why we reduced the M2 targets. We are counting
on some of that supply of foreign capital to relieve pressure on the
aggregates and relieve pressure on the money markets. It doesn't
appear in the numbers, but if we didn't have that channel there
would be more pressures on the domestic money markets. It's just
another way of illustrating our vulnerability to the inflows of foreign capital now.
Our accounts will be balanced by an inflow of foreign capital, by
a large inflow of foreign capital. Any way you look at it, that's not
a comfortable position for the Nation to be in.
Senator HEINZ. Would you also agree that the continued deterioration of our trade deficit which was $30 billion last year, $70 billion this year, apparently by estimates headed to $110 billion, that
one of the consequences of that besides loss of employment is that
that affects some of our most competitive industries?
Mr. VOLCKER. Yes.
Senator HEINZ. The ones that are traditionally able to compete?
Mr. VOLCKER. Yes.
Senator HEINZ. And that we take a very large long-term cost in
those industries, would you agree with that?
Mr. VOLCKER. Yes. I think that's one reason why this situation is
basically unsustainable.
Senator HEINZ. My time has expired. I just want to comment
that with your usual and understandable artistry you have answered my questions with great skill, but I didn't hear you deny
the fact that perhaps in order to get the Congress to act, it will be
necessary for you
Mr. VOLCKER. Well
Senator HEINZ. Excuse me. I will yield to you as soon as I finish
my sentence. That it will be necessary for you to pursue your cur-
110
rent careful, moderately restrictive monetary course, which by the
way most members of this committee, with some possible exceptions, probably feel is the right and responsible course for you to
pursue, but I think it would be a mistake if we left the impression
that only if you do pursue such a course are we going to create the
political pressures to really get the congressional commitment to
deal with the deficit.
Now you may not want to admit that. You may not want to
agree with it. I'm not asking you to agree with it.
Mr. VOLCKER. Let me amplify. 1 think we have no choice but to
pursue that kind of course, but I think what you implicitly hold out
as an alternative—a more accommodative course—isn't going to
avoid any crisis. It may make it worse.
Senator HEINZ. What makes you think I hold that out as an alternative?
Mr. VOLCKER. I just don't think you can escape this problem.
Senator HEINZ. The President may hope that that is your alternative.
Mr. VOLCKER. I don't think it is a real alternative. It doesn't fit
with the economics of the situation.
Senator HEINZ. We're going to have a very interesting hearing in
this room 1 year from now.
Mr. VOLCKER. I always find them interesting.
Senator HEINZ. And I'm going to make a note and reference the
testimony here about how Paul Volcker said 1 year ago that he
wasn't going to do anything to liberalize the monetary policy and it
would be very interesting in February 1985 when Ronald Reagan is
reelected and there's been a good economic performance, unemployment has continued to come down—it will be a fascinating
hearing. And I don't want to prejudge it.
Mr. VOLCKER. Since you're recording all this, it's in no way contradictory to anything I have said, in my judgment. I would refer
back to the earlier colloquy with Senator Garn; I think the one
technical reason for raising the targets would be if, in fact, the relationship between monetary growth and the nominal GNP, to put
it in the jargon, deviated from the basic assumptions that in setting forth targets in the first place.
In other words, if we had a continuation of no change in velocity
or a decline in velocity, and we knew that was happening, these
monetary targets would be too low, but not for any reason you're
suggesting; they're too low in terms of what is appropriate in terms
of our own goals over a period of time. That assessment has to be
made as the year progresses.
Senator HEINZ. Thank you, Mr. Chairman.
Mr. Chairman, my time has more than expired.
The CHAIRMAN. Unless Senator Lautenberg has talked Senator
Riegle out of his turn, once again we now turn to the ever-patient
Senator Riegle.
Senator RIEGLE. Thank you, Mr. Chairman.
I want to make an observation related to some of the earlier discussion. That is with respect to this meeting today of the so-called
Ill
bipartisan group to try to find a way to move toward this downpayment, as it's called, in reducing the deficit. And I'm concerned
about the fact in my mind that it's not a serious effort.
The Wall Street Journal today in its summary piece on this indicates the group is meeting at Blair House and the two Democratic
people present have said they're there "only to listen to Republican
proposals," and then it goes on "but White House and Republican
congressional aides say they don't have any proposals to make
yet." So it sounds to me like we're a long way from coming to grips
with this thing.
Just to contrast that, I was thinking about it today as I was listening to your earlier discussion with Senator Sasser and some of
the others, I was thinking to myself, well, where's the President in
all this? Well, the President is on vacation today out in California,
and he is entitled to vacation, but I think it paints a picture of
stark contrast to the one of urgency in coming to grips with this
problem.
I don't detect a real sense of urgency at the moment from the
President on this, quite frankly.
Let me give you a different picture to think about and then I
want to ask a question of you. If today the meeting were taking
place in the Cabinet room, if the President was there with his coat
off and his shirt sleeves up, if Tip O'Neill was there with his coat
off and his sleeves up, and they were starting in in a serious way to
come up with some deficit reduction package, and they were determined to meet over a period of days or even 2 or 3 weeks if necessary to hammer this thing out, I'm convinced we could reach an
agreement. The sense of alarm today in the Congress in both parties is now high enough and there is a real desire here to find that
kind of package, and I think it can be found.
I think last year in the Budget Committee people like Senator
Gorton, myself, and others were able, despite some difference, to
work out deficit reduction packages that came forward in the
Senate. They didn't pass by much, but they did pass by bipartisan
majorities, and I think today the sense of urgency is even greater.
But I just want to say to you that if the President, who is the keyleader in the country, is going to be both uninvolved and disconnected in any active leadership way along with the leader in the
House and the Senate, it won't be real and it can't move very far,
and I think the financial markets sense this. I think generally it's
understood that there is not a real sense of urgency. Otherwise, the
President would not be in California today while this rather lame
effort starts down at the Blair House.
Now let me try to ask an entirely different question than I've
heard asked today and I want to stay out of the question of tradeoffs and how we reduce the deficit as between cutting defense or
revenues, or domestic spending, or entitlements, or what have you.
But as you look at the 1985 fiscal year picture in terms of the size
of the deficit reduction that you would like to see, recognizing that
we should try to shoot for some number, and we don't want to have
too little and we obviously don't want to try to go so far in one step
that we tip the economy over into a recession—I'm wondering, just
from a macroeconomic point of view, what is the size of the deficit
112
redaction for fiscal 1985 that you think would best strike that balance?
Mr. VOLCKER. I expressed a view yesterday and earlier today that
you can't just pick a round number out of the air, a figure that
makes an impact on psychology and events in a very visible way. I
threw out the figure of $50 billion and Senator Garn said $30 to
$50 billion. That's a pretty good range the first year. It's not a
range that delights me as the end of the process, but begins to
make an impact and carries a promise of more in the future, I
think.
Senator RIEGLE, So you would like to see for fiscal 1985 the
number that you select as being the one that would dp the most
[,ood in terms of striking this balance would be $50 billion; is that
correct?
Mr. VOLCKER. In that neighborhood; I would certainly like to see
that and more as you get beyond 1985.
Senator RIEGLE. The reason that I want to pin down your best
ostimg.se is that if you could pick a different number—you could
say S40 or you could say $60. You've elected to say $50. I assume
that's because you think that really is the size we ought to be
:. hoc-'.ing for in 1985.
Mr. VOLCKER. I think that's a very hard number to get, practically by fiscal 1985. You're only 9 months off from the beginning of
^ivjtt fiscal year. As a practical matter, I'll accept Senator Garn's
range.
Senator RIEGLE. Well, that's a politic way to do it.
Mr VOLCKER. It's not only politic, it's a practical matter.
Senator RIEGLE. We don't know right now what is the practical
mattt'r. If the risk of a crisis down the road is as great as you think
it is and I agree with your view on that, it may well be possible
that if $50 billion is your notion of what is really the number we
should be shooting for that gives that number a lot more weight
and Credibility. I'm willing to shoot for that target if that's your
oest judgment.
Mr. VOLCKER. It's something in that area, yes.
Senator RIEGLE. How about fiscal 1986?
Mr. VOLCKER. It should get progressively bigger. As I see it, you
would want to be aiming against the current projections of the current services budget or the baseline budget and by the time you get
GUI to the end of the decade you're probably talking $150 billion or
more You can get some help when you go out that far from this
compounding effect of lower interest rates.
Senator RIEGLE. I understand that and I agree with you on that
and the trick is to get to 1989.
Mr. VOLCKER. You have to begin getting that momentum so it
feeds on itself.
Senator RIEGLE. Well, you've given us your best judgment on
fiscal 1985. What would you think the number for fiscal 1986
should we shoot for? Let me just say this, in the Budget Committee, as you know, we'll be reporting out a 3-year budget, so we'll be
trying to set targets, including deficit targets, for the 3 years. So
what would you like to see us reduce it by in fiscal 1986. *
Mr. VOLCKER. I just have not sat down and looked at these figures specifically enough to give you any figure.
113
Senator RIEGLE. But something more than $50 billion.
Mr. VOLCKER. Certainly more than $50 billion. I've been sitting
here and feeling that what would really satisfy me is something
somewhat greater than any target you're going to get practically
speaking. I want to encourage you to get all you can get.
Senator RIEGLE. Let me just say to you, if the potential crisis is
as large as many of us think it is, I think that may create a possibility to do what we should do for a change. So don't give up the
game before we play the game.
Mr. VOLCKER. I don't want to give it up and I'm not giving it up.
What I see is a magnitude of $50 billion in the first year, and then
you've got to get up to $150 billion or maybe considerably higher
than that by the end of the decade; taking account
of the savings
you can make on interest and on the aefi'' f " that is the kind of
path you're going to be on.
Senator RIEGLE. So then, if we do that, then over say a 5-year
period you're saying something like a deficit reduction of $150 billion in the last year, in 1989. It would probably be up around
maybe $75 billion in fiscal 1986, something like that?
Mr. VOLCKER. I would think in that neighborhood, yes.
Senator RIEGLE. And maybe $100 billion by 1987?
Mr. VOLCKER. You would have to be up there, but you would
then begin getting the benefits of the lower interest rates.
Senator RIEGLE. I understand. But if that's the track, if your best
judgment as the person who is sort of in the center with having to
manage and help sort of construct the monetary policy, if that's
the kind of guidance that we're getting from you, I think those of
us who are on the Budget Committee can be helped greatly by
trying to lay out a spending path, or a revenue path, or a path
with respect to entitlements that can produce that kind of deficit
reduction over that period of time.
Mr. VOLCKER. There are a lot of errors in estimates when you get
out that far. But what I'm saying, to put it another way, is that I
would like to see—and by the end of the decade there's a reasonable prospect—is, if not a full employment balanced budget, ther, a
deficit that's not so big that it's a drag on our investment potential
and our foreign trade accounts and all the rest. You get down to
either zero—I'm talking now about a full employment deficit—or 1
percent of the GNP, or 1.5 percent of the GNP. Nobody at this time
can say that that figure is devastating compared to where we are,
but that's the kind of range which one ought to be shooting for.
RISKS OF PUTTING OFF LEGISLATION UNTIL 1985
Senator RIEGLE. Let me ask you a different question and I ask
this question not to shake up the financial markets because they
are nervous enough but to try to create a sense of the stakes involved here in the Congress so that we take the steps we should
take and that you're encouraging us to take.
If we don't get any material deficit reduction this year, we don't
get the $50 you'd like to see or the $30 billion that's been talked
about, what do you see as the risks that we're running? In other
words, in 1985 some economists have said that they see the possibility that a recession might come along somewhere in there and
11-1
they come on a cyclical basis and the deficit might go up ev-: r
above $300 billion.
As you know, OMB has said that they can see that kind of ihmg
happening. I'm just wondering, without being an alarmist, it you
can help us understand the risks involved if we sidestep this problem for 1 year, 1 ¥2 years, or 2 years.
Mr. VOLCKER. Let me put it in two categories, if I may. The first
category doesn't seem to me in the nature of a risk but much more
in the nature of a certainty. If nothing is done, the good news, so to
speak, is that we'll have rather lackadaisical or depressed housing:
we will make little progress toward expanding our plant capacity;
the corporate balance sheets will remain somewhat strained; the
thrift institutions will remain on the margin of profitability, not in
a very good position; the economy will continue to grow simply
under the force of ail this purchasing power; and the foreign trade
picture would remain poor and the dollar vulnerable. All of that is
the good news.
On top of that you're talking about risks. I don't think you're
talking about a certainty by any means, but I think you are talking
about the progressive possibility of loss of confidence in the dollar
abroad and a pulling back of that voluntary inflow of capital and
the shock to inflationary prospects that that sudden drop in the
dollar implies. Without the flow of foreign capital coming in freely,
you're talking about pushing all of that financing load onto the domestic markets and the domestic saving capacity isn't big enough
to take it. So, under those conditions, you are talking about the potential of further pressures on interest rates and dislocations in the
economy that could even produce a recession, despite all the purchasing power, because of the degree of financial disruption.
Another one of the risks that's tied in with that is aggravating
this foreign debt problem in such a way that you create a lot of
uncertainty about the flow of funds through the American banking
system.
Those are the kinds of risks that you pile on to what I call the
good news, which is not entirely good news from the standpoint of
the sustainability of the growth of the economy.
I suppose one way of putting it is that you haven't got a very
good basic outlook; you've got some imbalances; and you're playing
a kind of Russian roulette the longer this goes on.
Senator RIEGLE. I gather you're saying to us that time is running
cut.
Mr. VOLCKER. That's right, These are the kinds of things that
nobody can predict with accuracy. If you're lucky, you avoid them.
The longer it goes on the greater the risks, and you don't want to
wait until a crisis before you take action.
Let me put it positively. I think the situation is so obvious. We
can deal with these risks. It's within our capacity. And the way to
approach it is to take the action that's so clearly necessary to capitalize on what otherwise is a very bright picture, it seems to me. A
lot of progress has been made, and there's every reason to foresee
the possibility of crisis and to act to avoid it; we're in a position
where we can do that.
Senator RIEGLE. As long as we do it now?
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Mr. VOLCKER. That's right. The longer you wait, the greater the
risks. Why wait?
Senator RIEGLE. Thank you, Mr. Chairman.
The CHAIRMAN. Senator Gorton.
Senator GORTON. Thank you, Mr. Chairman.
I'm sorry that I missed a great deal of this hearing and I do not
wish to duplicate questions, so I'll only have one or two. I do want
to thank Senator Riegle for the compliment with which he began
his point that, unfortunately, the victory we had last year was par
liamentary only and was not turned into substance and it is tb;it
substance that we're here now discussing today.
Mr. Chairman, you emphasize in your testimony the importance
of the international balance-of-payments deficit at least as much
and perhaps more than any other commentators do, and you state
that the current rate of capital inflow is not sustainable, which
seems quite evident over the long run.
Directing your thoughts to the members of this committee and
the jurisdiction of this committee, should it be focusing its attention on specific policies aimed at correcting the balance-of-payments deficits or, in your view, are they so overwhelmingly impacted by the Federal budget deficit problem that from a governmental
standpoint that's the only way or the chief way with which we
must deal with it?
Mr. VOLCKER. I think that there are other things that are structurally important over a period of time and should always be
worked on, but I can't think of any particular measures that carry
anything like a promise of a quantitative impact over the time
period we're talking about of 2 or 3 years.
The temptation, I think, is to go in a nonconstructive wayf and
that is to say the trade problem is terrible, it puts a lot of pressure
on some of our very good industries as well as on some of our
weaker industries, so we will protect them all. I think that is a
snare and a delusion, not only because it will invite retaliation, increase inflationary pressures—and all the standard arguments,
which I think are very valid—but also because by not going to the
basic part of the problem the pressures will pop out in another direction. Theoretically, you can improve the trade balance for Caterpillar tractor, or the steel industry, or the textile industry and so
on by taking specific, protectionist measures. But then, if the capital continues to flow in because our interest rates are high, I presume the dollar would go still higher and that would hurt another
industry. You would have to then chase your tail and end up with
nothing but a lot of protectionism. You haven't dealt with the basic
problem, and you've got all the disadvantages of the inflationary
pressures, the lack of competition, and all the rest.
Senator GORTON. So basically, it doesn't matter what aspect of
our fiscal challenge we look at, our international trade deficits, the
budget deficits, high interest rates, the value of the dollar—they all
bring us right back to those budget deficits.
RESTRAINED WAGE SETTLEMENTS AND REDUCED PRICES
Mr. VOLCKER. I think we're all caught in a circle, or a maze, or a
grid lock—however you want to express it—and we're all looking
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for some way to get out of the box. To deal with these hazards and
risks that are arising, you have to look around to where you've got
some leverage. I think monetary policy is consistent with the longterm needs of the economy. What about the fiscal side? Is there
something there that we should be taking and doing and inevitably
will have to do sooner or later in our own best interest? Does it
help this problem? Does it help us get out of this box? It seems to
me the answer to that is obvious. Sooner or later we're going to
have to do something on the fiscal side anyway, because the situation is basically unsustainable.
Can it break this logjam? If it's done right, sufficiently, forcefully, I think the whole of economic analysis and the whole economic
sense says, yes. So let's do it.
Senator GORTON. One other question. In your written testimony
you emphasized the necessity of discipline on the part of both business and labor and keeping both wages and prices down. If the rate
of inflation is, in fact, subject in any degree to our will in this way,
does that imply some kind of jawboning policy on the part of the
Federal Reserve Board as well as on the President? Do you intend
or will you in the future specifically comment on industry wage
settlements which you regard as excessive?
Mr. VOLCKER. I will tell you the kind of jawboning policy that I
think it does imply; it implies that jawboning is only the preliminary. It implies a sense of conviction that through monetary policy
we will not provide the financial or inflationary environment that
makes it worthwhile to engage in inflationary, cost-increasing wage
settlements or other practices.
I think it's essential that we provide that environment and conviction, because that should encourage—to the degree we can influence this through our actions—that kind of response. But I think
you have to recognize the danger arising out of history; the history
of the 1970's was inflationary and that kind of wage demand paid
off. It didn't pay off in the last couple of years, but there's still a
lot of feeling around that that was all temporary and things are
going to change again, so let's go back to what is considered
normal. What's considered normal is the 1970's.
I observe that many restrained wage settlements these days are
called concessions. Some of them are true concessions in the sense
that an old contract was opened up; but I don't think we ought to
be in the habit of calling a moderate wage settlement a concession.
That should be normal.
What should be abnormal was what was considered normal in
the 1970's when the increased in wages was 10 percent. If that's
considered normal, then we've got an awful problem. I think we've
got to encourage an environment in which moderate wage settlements are the norm as they were in the 1960's, and we get some
productivity increase and real incomes will go up. During the majority of years after 1973 or 1974 real wages went down, despite
very rapid increases in nominal rates, because they were always
trying to catch up to prices. In the last couple of years we've had
the situation where with prices coming down and coming down
sharply in terms of rate of increase, wages have also been coming
down nominally; but, lo and behold, we've had an increase in average real wages both in the last 2 years. That's what it's all about.
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Let's get moderation on that side. Let's get some productivity
growth, increase in real wages, and some more employment on top
of it.
I think that lesson ought to be reiterated frequently—ought to be
shouted from the housetops, in my opinion. In a very general sense,
I see some promise in the practices that have developed in the recession, under a lot of pressure. Doesn't it make sense to have more
profit sharing; otherwise you build in a great big base wage when
General Motors profits are good 1 year, and then they're stuck
with a high cost structure. Why can't you get some arrangement
where those benefits can be extended to the workers so they share
in the prosperity without building in a high level of cost? That's a
controversial thing, but it seems to me it has some promise.
There have been other initiatives along that general line. I think
it's a good idea to encourage that kind of initiative. If that's jawboning, so be it.
Senator GORTON. Thank you, Mr. Chairman.
The CHAIRMAN. Senator Lautenberg.
Senator HUMPHREY. Mr. Chairman, if the Senator from New
Jersey would yield, are we under some kind of rule? I'm trying to
make some plans here. I have to preside at 12.
The CHAIRMAN. We have a 10-minute rule.
Senator HUMPHREY. OK. Thank you.
The CHAIRMAN. Senator Lautenberg.
Senator LAUTENBERG. Thank you very much, Mr. Chairman.
Chairman Volcker, it's always interesting to hear your points of
view and the question raised these days is whether they're yours
or, despite your acknowledgement of independence, whether there
isn't some pressure coming from higher sources. Obviously you disagree with present fiscal policy because you're not at all satisfied
with what we're doing at this point with the deficit projected—at
least the deficits—forget the projection. As for the model, I was
going to recommend you go to a company I know that does economic modeling, that does very good programs and sold very cheaply,
but I'm not out to do that here.
Mr. VOLCKER. I have nothing against economic modeling. I think
it is useful. I don't think models capture all the extraordinary
things going on in the economy.
Senator LAUTENBERG. Before I oversell my former company, I
would suggest there's some good ones out there if they happen to
catch your eye.
On a more serious side, your view of present policy is that it's
insufficient, doesn't approach the debt reduction that you feel is essential and obviously you would take some measures to change
that. You implied or suggested several revenue enhancements
though you don't want to pick out on the expenditure side where
things ought to be cut back, and I respect that.
Is a tighter monetary policy required at this juncture, do you
think? Let me start from a different perspective. How long do you
think that this recovery can go on without bumping flush into an
expanding deficit?
Mr. VOLCKER. In a sense, it's probably bumping now, but I think
my basic view is that we have a lot of the ingredients for keeping
this expansion going on indefinitely—although expansion does stop
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at some point. 1 think we have the kind of potential change in productivity. Most importantly, I think we have an actual and potential change in the financial environment and the inflationary environment in the direction of more stability. And, we have the background that should permit declines in interest rates that would
help to keep the expansion going.
What you're asking is, against all those favorable factors, how
damaging is the budgetary deficit and its effects in terms of the
trade deficit and all the rest?
I don't think I can give any different answer than I gave before.
If everything works out very smoothly, the optimistic view is that
we could have a recovery or expansion that continues for quite a
period of time but would be lopsided. It wouldn't be a good housing
recovery and it wouldn't be a good trade recovery. It would be a lot
of consumption recovery. That's not our ideal kind of economic environment, but I can't say that's what most economic models would
show.
Senator LAUTENBEEG. Is the purchasing power there to continue
consumption?
Mr. VOLCKER. The purchasing power comes out of the budget
deficit in that kind of environment. You've got an economy where
the purchasing power is fed by the budget deficit and the rest of
the economy doesn't do very well.
Senator LAUTENBERG. The definition in this case of consumption
is Government consumption or individual consumption?
Mr. VOLCKER. That depends on the rate of Government spending,
but both Government consumption and individual consumption are
certainly included. Government expenditures themselves, of course,
are Government consumption; so you have a lot of defense expenditure under present plans. You have a lot of personal consumption,
basically being fed by the deficit, and relatively restrained investment and housing and an unfavorable climate for international
trade.
Senator LAUTENBERG. It doesn't seem like that's a sustainable
thing.
Mr. VOLCKER. You can raise that question. It's certainly not sustainable to the same degree that a more balanced recovery would
be. But then, if you trigger some of these financial problems, international or domestic, then indeed you have the threat of cutting
the recovery short.
Senator LAUTENBERG. Do you think that the $180 billion projection for 1985 for the deficit size is realistic?
Mr. VOLCKER. That already rests upon some proposed savings. Is
it realistic?
Senator LAUTENBERG. Would you think it's optimistic?
Mr. VOLCKER. I suppose in a sense it's optimistic if nothing is
done. I don't minimize the political problem; as I see it, you have a
political problem, which is very real of getting a consensus on difficult measures. The problems are not insuperable. There's nothing
that says that you can't take either revenue or spending action in
an amount necessary to cut the deficit to $180 billion or significantly below, as I would like to see. It takes action, but it doesn't take
impossible kinds of action.
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What it takes is a consensus and it is getting that consensus that
I see as the difficulty.
Senator LAUTENBERG. I haven't been here long enough to forecast the political realities in a national election year, but I'm not
optimistic about the ability to get the revenue side of this thing
bolstered in any way and frankly it's my view that spending reductions are very limited also as a result of the election climate.
If we had an ability to increase the revenue side, could you
project what size tax bite, if one were to be developed, would be so
significant that it might restrain or abort the recovery?
Mr. VOLCKER. I don't think you can look at the revenue piec:- •'--.
ii in isolation. I think it is true that if one attempted to do ; t u\l on
the revenue side it would involve either such increases in general
tax rates, or such widespread loophole or special provision closings
that it's hard to conceive.
Senator LAUTENBERG. I like special provision closings.
Mr. VOLCKER. Yes. I shouldn't use the word loophole, but you
would have to go back and ^OOK at the depreciation
Senator LAUTENBERG. But that's the one that everybody understands so well.
Mr. VOLCKER. But it would involve rather sweeping changes in
those provisions. Entirely apart from the political practicality of
that—which you would be a better judge of—it might involve a
question as to the degree of shock in a short period of time from
eliminating provisions that a lot of people have been counting on; I
don't think that's entirely desirable. That's one of the reasons I
wouldn't like to see this all done on the revenue side. In fact, quite
the contrary, just looking at it from the economic standpoint, without denying there are very other important considerations, the
more that can be done on the spending side, the better.
As you know, our revenues are running more or less in line with
historical peaks relative to the GNP. It's the spending side that's
sharply higher.
DECLINE OF CORPORATE TAXES
Senator LAUTENBERG. We talked before for a moment about the
corporate contribution to revenues and I think in your statement it
says that the rate of increase of corporate income tax is behind
that traditionally seen in a recovery or at least not seen even going
as far back as the 1960's.
Mr. VOLCKER. We've had a very good growth in profits, helped by
both the economy and by tax changes. In terms of the general levei
relative to GNP, we are approaching what was typical of the best
years of the 1970's. But the best years of the 1970's weren't very
good in historical perspective; we are still well below the peak
years of the 1960's which extended over a period of time.
As I remember the numbers, the after tax profit share of GNP is
running around 5 percent now, which is about where it was in the
best years of the 1970's; back in the 1960's it ran 7 percent or
higher, which would be 40 percent more.
Senator LAUTENBERG. You're talking now about the percentage
of profit?
Mr. VoLCKEit. Percentage of after tax profits to GNP.
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Senator LAUTENBERG. I'm talking about the contribution to the
Federal revenue of corporate income tax.
Mr. VOLCKER. That's been declining over the years. It may be up
this year with the recovery, but in general a lot of changes have
been made in corporate taxes, as you know, and that's reflected in
a lower share of corporate tax receipts.
Senator LAUTENBERG. OK. Even though the corporate profit recovery has been consistent?
Mr. VOLCKER. The estimate I have in front of me to get perspective, shows that back in 1970 corporate income taxes were 23 percent of total revenues. Then they began declining. By 1970, they
were 17 percent. Last year they were only 6 percent of the total
revenues, a little more than a quarter of what they were in 1970.
This year, the projection I have in front of me, which is the administration projection, shows it growing close to 10 percent—that's recovering from the cyclical low—and it kind of hovers around 10 or
11 percent looking ahead. That's less than half of what it was in
1960 and it's well below what it was during the 1970's.
It's been on a generally declining trend; the estimate has it up to
11 percent assuming the economy is back more or less to full employment.
Senator LAUTENBERG. Again, 1 second, Mr. Chairman. Just so I
understand clearly, are you talking about percentage of after tax
profits?
Mr. VOLCKER. I'm now talking about percentage of Federal revenues flowing from corporate income taxes.
Senator LAUTENBERG. You're saying it could be as high as 11 percent?
Mr. VOLCKER. That's the administration projection. That's in
1987, when the economy based on their projections is operating
close to a 6-percent unemployment level, so that's at a full-cyclical
recovery.
Senator LAUTENBERG. That's 11 percent in 1987 and this year, do
you have that number?
Mr. VOLCKER. This year it shows 9.9 percent; last year, 6.2 percent, the bottom of the recession. One of the problems was that the
corporate tax receipts were reflecting the recession last year.
The CHAIRMAN. Senator Humphrey.
Senator HUMPHREY. Thank you.
Mr. Volcker, let's get something out of the way right at the beginning. I think fiscal policy stinks in this country and we can
assign the blame for that as we will. I agree with the chairman
that under the Constitution the blame lies with the Congress.
But putting aside fiscal policy and monetary policy, there's been
a lot of talk in the press lately and a lot of nervousness in the financial markets about the degree of restraint or otherwise in the
monetary system policies of the Fed.
Is the Fed pursuing a monetary policy at this juncture that is
tight, loose, or just right?
Mr. VOLCKER. I obviously will answer just right in my best
judgment.
Senator HUMPHREY. If it's just right, why is there all this talk
and why is there enormous nervousness in the financial markets
about why the press reports to the effect that the minutes of the
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December meeting of the Open Market Committee indicated that
the Fed might tighten monetary policy in the months ahead?
Mr. VOLCKER. I don't know when I could have been sitting here
when you couldn't have made the same comment. There's always a
good deal of concern whether money is too tight or too easy.
Senator HUMPHREY. Yes, but is there a special reason for that?
Mr. VOLCKER. I don't sense that it's much more a matter of concern than it usually is, with one exception. There is one school of
economic thought which is particularly concerned about the rate of
slowdown in Mj growth in particular in the second half of last
year. At least some monetarists have been quite concerned that
that was slower. That ingredient is not always there.
Senator HUMPHREY. Right. But with respect to the minutes of
the December meeting of the Open Market Committee, is there any
reason to suppose—I haven't read the minutes, but you know about
them—is there any reason to suppose or speculate there's going to
be tighter monetary policy in the next months,
Mr. VOLCKER. That December meeting has been reported. The
minutes are released. The committee decided to maintain the
degree of reserve restraint that it had, but it also suggested that, if
things developed in a certain way before the next meeting, some
slight tightening might be in order.
As it turned out, nothing was done, and I think we take a more
balanced look at things at the moment.
Senator HUMPHREY. Well, you always have that caveat, stated, or
implied, that if things change, you're going to change policy.
Mr. VOLCKER. It's always implied, but these directives give, in
effect, a basis for instruction to the people who actually do the operations inbetween meetings. You can always have another meeting; that right is always reserved, and we're always flexible in that
sense. But the committee in effect gave some instructions to the
manager of the Open Market Account as to how to deal with some
contingencies; and that's what they were doing in that meeting.
The contingencies did not arise.
Senator HUMPHREY. Let's assume that the stock market has tumbled on the basis of these pressures. With that assumption and that
assumption only, do you think that was a justified reaction to the
minutes of the committee?
Mr. VOLCKER. I don't think so. What motivates the stock market
is not always very clear from day to day.
Senator HUMPHREY. I know that. I'm aware of that.
Mr. VOLCKER. The stock market had declined for at least 1
week—I think 2 weeks—before that was released.
Senator HUMPHREY. Yes, but it began to descend with real alacrity just a few days ago.
Mr. VOLCKER. It descended with alacrity 1 day after that report
was released and then yesterday it went up; I don't know what it's
doing today.
Senator HUMPHREY. I'm trying to influence it by these questions.
Well, my last question, on page 14 of your testimony you state
that: "the objective of monetary policy is simple to state and widely
agreed: to provide just enough money to finance sustainable growth
and not so much as to feed inflation."
Mr. VOLCKER. A nice textbook definition.
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Senator HUMPHREY. Yes, it's nice, clear, terse stuff. So you try to
moderate between these two extremes.
The problem is you really never know when you're testing either
extreme.
Mr. VOLCKER. Precisely.
Senator HUMPHREY. I would urge you and I will end with a statement because I don't have time for an answer—I would urge you
and your colleagues in testing those limits as the months go by
that you keep in mind we have descried the irresponsibility of
fiscal policy of the Congress, but as to monetary policy I would
urge over the next few months that you test these limits on either
side. The one good tool that we have going for us now in narrowing
these deficits and the only tool at the moment is growth in the
economy. I hope that you're not going to damage or destroy that
one good tool we have and I worry very much at least there's a perception that you will and that counts.
Mr. VOLCKER. Perhaps we have more interest than anybody else
in seeing in some sense the economy follow an orderly growth path.
The only other comment that I would add to that is we have to be
worried about not just what happens in 1984, but what happens in
1985, and what happens in 1986, and that is the reason why we are
as sensitive as we are to the inflation side of the equation as well.
Senator HUMPHREY. Yes. Well, I just wanted you to be sensitive
about growth because if we damage that, then it's all over. Thank
you.
Thank you, Mr. Chairman.
The CHAIRMAN. Thank you, Senator Humphrey.
TAX INCREASES HAVE NEVER SOLVED THE DEFICIT PROBLEM
Mr. Chairman, there's been a great deal of discussion today
about how we achieve deficit reductions and certainly you well
know my attitude for a long number of years about deficits. Some
of us who are here, notably one Republican and one Democrat at
this point, have voting records that match our rhetoric about deficits. That is not true of some of our other colleagues on both sides
of the aisle who make great speeches now about how we've got to
reduce deficits but their past voting records have been the reason
that we have the deficits. They are suddenly born again converts to
balanced budgets, and most of those, interestingly enough, talk
about solving the problem with tax increases.
You have stated many times that you thought a mix was desirable and have stated here again today that it would be desirable to
have more on the spending side. I have challenged a lot of other
people with this question and I would ask you at least in the time
I've been in the Senate, which is 9 years, can you give me any indication of where a tax increase, of which we've had many over those
9 years, has resulted in a reduction in the deficit?
Mr. VOLCKER. I'm trying to remember right now when we had
tax increases. We had one back in 1968, but it was much delayed.
The CHAIRMAN. That's prior to my time. Let me give you an example. I sat on the floor of the Senate in 1977 and was told that if I
would vote for the social security tax increase at that time, which I
did not, it would fix the system for 75 years. Even by congressional
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standards, to miss our estimates by 70 out of 75 years is a little bit
gross. I also sat on the floor of the Senate and listened to the
debate over windfall profits, a tax which admittedly because of the
fact energy prices and usage have gone down has not produced as
much as they estimated; but nevertheless, still one of the biggest
tax increases in the history of this country, and you can go back
and look in the Congressional Record and what you will find is
debate over how we would spend the surplus from that revenue increase, and there have been others since I have been here, including TEFRA in 1982 which is the only one that I have voted for on
the basis that, look, I didn't like tax increases; I preferred spending
cuts just like you, but the deficits were so important to me that I
would swallow that feeling and vote for $98 billion on the basis
that we would either get anywhere from $1 to $3 of expenditures
for each $1 in additional revenues and if you took the minimum,
most conservative figure, that would give you $196 billion of deficit
reduction over a 3-year period. That sounded like a good deal to
me. What did we get? We got a $98 billion tax increase and for
each dollar of revenue increase we got about $1.04 or $1.05 of
spending increase.
It reminds me of a brother-in-law of mine who was making
$12,000 a year. He answered all of his financial problems, rather
than chapter XI, with an increase in pay. He was fortunate enough
to get a $40,000 a year job, but he spent $50,000. He now makes
over $100,000 and he's constantly on the verge of bankruptcy because he's never disciplined his spending side, even though his revenue has increased dramatically.
Now it's exactly the same picture in the 9 years I have been in
the Senate. We have increased revenue dramatically. We've had
tax increase after tax increase.
So forgetting the philosophy, the practicality, if my colleagues
would look at them, when they say let's increase taxes to solve this
problem, it hasn't worked before. It didn't work in 1982. And so
that's why I'm not in favor of a tax increase. If I could be guaranteed even if we would not get 1 dollar of expenditure reduction, if
we would just hold spending so whatever we increase taxes would
reduce the deficit I would be willing to swallow my feelings about
how much taxation as percentage of GNP, whether it's too high or
not, or what it sucks out of the private sector. But it just hasn't
happened My colleagues are entitled to their own opinions, but
they are not entitled to their own facts. I guess it's nice to talk
about doing it easily, don't cut anybody's programs, but increase
taxes.
So I don't think you can find—I have researched it rather carefully and at least in the last 9 years we have had several tax increases, and none of them have had any impact on the deficit reduction because in each case we have spent more money than the
tax increase raised, and that was true in 1982 as well.
Mr. VOLCKER. I suppose the question is whether you would have
spent that money anyway.
The CiiAfriMAN. You're right. I would agree with you that the
deficit would have been somewhat higher. But nevertheless, we are
talking about deficit reductions. We have slowed with those tax in-
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creases probably the rate of increase, but we still have a $180 billion deficit and it continues to grow.
Mr. VOLCKER. There's no question that we're not going to solve
this problem without discipline on the spending side.
The CHAIRMAN. That's where I get back to my point. We can try
and blame this administration, or the Carter administration, or
any other administration and talk about the need for leadership
and whether they're in California or whether they're not. The
point is, damn it, Congress can change it if they want to. It doesn't
make any difference what Ronald Reagan sends up, a $300 billion
deficit, or I can remember when he sent up one for $45 billion. He
could have gone either way, there's no doubt about that, because
then his estimates were unrealistic and so he sends up one that is
realistic and that's too high and everybody says it's bad. So I realize that whatever he sends up would be criticized by certain people.
But the point is, remove Ronald Reagan from it and look at the
Office of the Presidency and look at the Constitution and if my colleagues, the majority of them in both parties, really mean all this
rhetorical baloney that is going on in an election year, then they
can change it. What about the leadership in the Congress? When
are we going to get some here to reduce spending? That is the
point of this debate. I will vote for a tax increase once again when
we devise a method in this body that in one \ote the expenditure
reductions are tied with the tax increase so that I won't be lied to
again. That's the major reason the President is opposed to tax increases, because he was conned just like the rest of us with some
promises which were not fulfilled by the legislative body in 1982.
So these people that are meeting today, if they come up with
some kind of a compromise that entails both at the same time—
maybe we ought to do it the other way—maybe we ought to have
the spending cuts and promise them we'll come up with tax increases and see if they will trust us. I doubt it. Well, some of us
aren't going to trust them the other way.
From a very practical, pragmatic standpoint, tax increases
simply will not solve the problem. They never have. And that is
the fact, not fantasy, or opinion, or partisan rhetoric. They haven't
and no one can show me an example. Just the reverse. In 1962,
John Kennedy's tax cuts produced far more revenue than they lost
because they stimulated the economy. So Senator Humphrey's
point is very well taken. All of these things we're talking about are
not going to solve the problem unless we get growth in the economy and continue to have the unemployment rate go down.
I guess after that speech, without getting into the priorities,
would you agree that in order to solve this problem we have got to
cut out the rhetorical baloney—or I could use another word that
also starts with "b" and the first word is "bull"—or are we going to
get going with expenditure reductions and tax increases so that
deficits come down rather than taking more money off the American people?
Mr. VOLCKER. I would suspect that's the only way you're going to
get an unlocking of this gridlock. But I would go further and start
from the position—again, economically speaking—that if you do it
all on the expenditure side that would be even better. That ought
to be the predisposition from which you start, as far as the econom-
125
ics. As a practical matter, I think you're going to end up with a
combination.
The CHAIRMAN. Let me ask you one more question about taxation and reducing deficits. Let's take $200 billion so I can subtract
more easily, and assume we had a $30 billion tax increase, no increase in expenditures, and we say, isn't that great; we've achieved
$170 billion deficit which is progress, a good downpayment the first
year. OK. We saved the interest on that $30 billion, but if you do it
with taxation alone, isn't it true that we're still taking $200 billion
out of the private sector, that we're still crowding out money that's
available for mortgage loans, automobile loans, consumer finance,
venture capital, investment in new plant and equipment, and creation of jobs? What will you take? $170 by borrowing and $30 billion more by taxation and you still remove $200 million less the interest on that $30 billion from the private sector.
But if you reduce it by $30 billion expenditure cuts, that $30 billion is out in the economy, is it not? And at least if you get a combination of $30 billion and $30 billion, then you've got $140 billion
deficit, but much more positive results because you have left $30
billion in the private sector. True or false?
Mr. VOLCKER. True and false, I guess I would say. In a sense, it
all comes out of the private economy. The spending does, too, but
the interest point is important here. It's not only $3 billion the
next year extra from borrowing; that compounds on itself. You've
got the next $3 billion plus the interest on the first $3 billion, so
the second year it's $6.3 billion and the following year it's $9 billion, and so forth, just in terms of interest. With the amounts we're
talking about, unfortunately, that is not unimportant.
Apart from that, depending on the taxes you increase, you get
different effects on the economy. If you tend to take it out of the
consumption stream, then you end up, I think, with a better balanced economy in the end. You end up with an economy that will,
percentagewise—let's say the total is the same—have less consumption and more investment, more room for a better trade balance.
The CHAIRMAN. Are you advocating a value-added tax?
SHIFT IN TAX STRUCTURE COULD BE USEFUL
Mr. VOLCKER. I'm not advocating a value-added tax at this point.
It's clear that this kind of change isn't going to be done this year;
this is more in line with the Treasury reporting out in December. I
think a consideration of a shift in the tax structure is very useful
at this point. I'm wandering outside of my province obviously, in
talking about present tax structure. It is still characterized by high
marginal rates and shot through with a lot of exceptions, justified
or not, and has some sense of breaking down. I think it deserves a
look from the viewpoint of a broader-based, maybe consumptionoriented, tax.
A value-added tax is one form of that; there are other forms as
well. It seems to me, if we are going to end up spending 23, 24, 25
percent of our GNP, we're probably going to have to find a different kind of tax base to help support that, because our present one
doesn't seem to be able to.
326
The CHAIRMAN. In general terms, you would agree that the
impact on the economy, the positive impact on the economy would
be much greater if deficits were reduced by spending reductions.
On the other side of the coin, though, I assume you would agree
with me that politically, not economically, the best solution in
order to have it realized is a combination of tax increases and expenditure reductions.
Mr. VOLCKER. That's the way it appears to me. I would only add
that in saying I'd like to see it on the spending side from an economic standpoint, I have not weighed in any judgment on how
much defense spending we need, what the social priorities of the
country are, and all the rest. Those are obviously relevant. But
from an economic standpoint, I agree with the first part of your
comment. My judgment, for what it's worth—and it may not be
worth much because this isn't my bag, so to speak—is that the
second part of your statement sounds right, too.
The CHAIRMAN. I didn't ask you specifics on where the cuts
should come because I recognize that that is not your bailiwick,
that is our judgment, and we can't pass it on to someone else, as
much as we would like to do so. That is not your responsibility. It's
ours.
Senator Proxmire.
Senator PROXMIRE. Chairman Volcker, you argued yesterday and
today too that the investment by foreigners in this country investing in our deficit has its good side as well as its bad side, and you
argued that on the good side is the fact that this provided more
capital for various uses in housing and automobile purchasing and
so forth.
One of the bad sides obviously is that foreigners don't like to see
their capital absorbed by this country. It drives up their interest
rates and it's difficult for them.
It seems to me that one easy solution which I'd like you to hit is
that the Federal Reserve Board can provide that capital and you
wouldn't have to borrow from abroad; instead of borrowing from
Japan, or France, or Germany, you have a bottomless pit there and
you can provide as much as you want to.
Mr. VOLCKER. There's one little flaw.
Senator PROXMIRE. You can provide as much as we need to replace that foreign capital.
Mr. VOLCKER. The Federal Reserve Board has no capital whatsoever. It's very limited, $1 billion or so. We have a bottomless pit in
supplying money, but that's quite a different thing from supplying
capital. And, people can go out and play with the money, but the
money isn't going to be worth very much if they think it's a bottomless pit.
Senator PROXMIRE. Does it make any difference from that standpoint whether we borrow from Europe and Japan instead of borrowing from the Federal Reserve?
Mr. VOLCKER. Sure.
Senator PROXMIRE. What difference does it make?
Mr. VOLCKER. When you borrow from abroad, you're getting real
resources. We are importing $100 billion more than we are exporting; that's what we are borrowing. Take the trade balance. Say the
127
current account is in deficit this year by $80 billion: that's what we
are borrowing; that's something real. We haven't got $80 billion.
Senator PROXMIRE. The trade deficit is about $61 billion.
Mr. VOLCKER. Last year.
Senator PROXMIRE. That's right, last year. The current account is
in deficit by what?
Mr. VOLCKER. $40 billion or so last year.
Senator PROXMIRE, Very little.
Mr. VOLCKER. $40 billion.
Senator PROXMIRE. The current account?
Mr. VOLCKER. Yes, last year. This is a new phenomenon. For 2 or
3 years it was in balance or surplus; then it was $15 or $20 billion
in deficit the year before last.
Senator PROXMIRE. That's the kind of favor I would think that
our own domestic manufacturers and so forth don't want and what
you do is we're importing real resources. We're importing cars
from Japan.
Mr. VOLCKER. That is exactly right.
Senator PROXMIRE. And steel from Germany.
Mr. VOLCKER. That's the distinction I'm making. That's the contribution in real terms that this foreign capital is making.
Senator PROXMIRE. That's not much of a contribution if you're a
steelworker or an autoworker.
Mr. VOLCKER. But it's the contribution that takes the pressure
off the savings. The Federal Reserve doesn't own 2 million cars, it
doesn't own any steel, and it doesn't own any oil. Those are the
real resources that are the counterpart of this capital inflow. All
we have is money, and money isn't worth much if you supply too
much of it.
Senator PROXMIRE. Well, I'd like some.
Mr. VOLCKER. We supply greenbacks, but people don't eat those.
The CHAIRMAN. I also would add that a lot of people still don't
recognize that, in addition to providing for all of your own operating expenses, that you contribute about $14 billion in excess.
Mr. VOLCKER. $14 to $15 billion.
The CHAIRMAN. $14 to $15 billion of excess to the general fund of
the Treasury, and whatever else people feel about the Fed, I can't
find any other agency that reduces the Federal deficit by $14 or
$15 billion.
Mr. VOLCKER. I think that's a
Senator PROXMIRE. I'm not criticizing the Fed.
The CHAIRMAN. I know. I just wanted to make that point.
Mr. VOLCKER. That is the measure of the real resources that we
command, that surplus. We already turn it over to the Treasury.
Senator PROXMIRE. You point out that we're borrowing about 2
percent of our GNP.
Mr. VOLCKER. That's the estimate for this year.
Senator PROXMIRE. And you say that pace is not sustainable.
Could you elaborate on that and tell us why that level of borrowing
is not sustainable and how much time we have left?
128
UNITED STATES ON VERGE OF BEING INTERNATIONAL DEBTOR
Mr. VOLCKER. Well, I can't tell you how much time because that
depends upon a great many things, but I don't think it's sustainable from two directions. One is that the counterpart of that deficit
is the pressures on particular industries that you just mentioned. I
don't think it's sustainable that we run all our import-competing
industries and exporting industries into the ground. Also, this flow
rests upon confidence; I don't think you can assume that that confidence will be maintained indefinitely if we're building up our debts
at the rate of $80 billion a year.
I noted in my statement, and I must say as a preliminary that
our statistics on international capital flows are not necessarily the
strongest statistical series in the world. They are hard to add up.
But if you just take them at face value and take the recorded flows,
we are on the verge of turning into an international debtor. I'm
saying that this big and rich country, that typically, through the
postwar period, has invested abroad, is now borrowing from abroad.
We are borrowing at a rate of speed that in a couple of years will
wipe out our whole positive international net investment position.
If continued, it very obviously gets negative, and then it builds on
itself. We now have a trade deficit this year of let's say $100 billion
or so and a current account deficit of $80 billion or so; that $20 billion difference is partly net capital receipts from abroad, interest
and dividends.
Senator PROXMIRE. That's been a tremendous turnaround in the
investment account, isn't it?
Mr. VOLCKER. Yes, yes.
Senator PROXMIRE. That was very highly positive a few years
ago.
Mr. VOLCKER. We built it up gradually over the years and blew it
all in 3 years.
Senator PROXMIRE. This is the case as I see it for those who
argue that you ought to take it a little easy in easing up on monetary policy.
The economy slowed steadily since the second quarter of 1983
when it grew at more than a 9-percent annual rate; the third quarter, 7 percent; the fourth quarter, 4 percent. We still have 9 million
Americans out of work. Unemployment last month had indeed
fallen sharply since the peak in November 1982, but it's still at 8
percent and 8 percent is higher than it's been for any year except
one in the last 30 years, so historically it's very high.
We are operating, according to the Federal Reserve Board statistics, far below capacity. We have a glut of oil and other energy
fuel. We still have gigantic food surpluses. Other commodities are
also in big supply.
Where is the threat of inflation? If you should follow a policy of
easing monetary policy over the next 2 or 3 years, why do you feel
this would be inflationary?
Mr. VOLCKER. Let me make a couple of comments on the assumptions you made which I think are part of answering that question.
You say the economy has slowed and domestic production has
slowed, although the latest figures were quite favorable for January. But that slowing has to be interpreted in the light of what we
129
were just talking about. Demand has slowed very little; what's
slowed is production. And the difference between those two numbers is the increasing trade deficit. More of the demand is spilling
out abroad, not that the demand is down very much, which we
affect, but more of it is spilling out abroad and that's not a very
sustainable picture.
You say we are far below capacity. We have come up very rapidly on the capacity numbers, although I don't disagree that we are
still below capacity.
Senator PROXMIRE. We're still about 80 percent,
Mr. VOLCKER. These are not the best figures in the world, but
they're reasonably consistent over time. The capacity figure is running about 80 percent now, as I recall the latest numbers. It may
have moved above that in January, but its in that neighborhood.
The figure that sticks in mind as kind of a norm for the area
where we typically run into problems is 83 to 85 percent. It doesn't
take very many months of rising industrial production to get up in
that range. You see it now in some particular industries. We've got
a paper industry that's operating full blast. The aluminum industry is operating at a very high level. Even in some areas of the
steel industry they are
Senator PROXMIRE. But in all those industries in the economy
you still have a big labor surplus.
Mr. VOLCKER. I think, in general, in these areas there's a bigger
labor supply because of efficiencies.
Senator PROXMIRE. And that constitutes about 70 percent of our
cost, doesn't it? It's a big element.
Mr. VOLCKER. Yes, no question about that. I think we have got
some room for capacity growth, but part of the reason that we're
worried about the investment side is that we have not been growing much in capacity recently. Our net investment in business is
very low historically now. Net investment after depreciation is low
in postwar history. Investment has been rising pretty rapidly in
1983, but it's in very short-lived things. We hope that helps, but it's
not the same as new factories.
You mentioned labor. Clearly, there's still a lot of unemployment. There's excessive unemployment. The wage performance has
been good on the average, but typically this begins to be the stage
of the cycle when you wonder about that. Profits are good. We had
the indication of big General Motors profits. They look good, at
least against recent experience. We do have old jobs, people who
were laid off are pretty much back at work. There's still some
excess labor capacity out there, but you wonder whether the bargaining climate will change.
I would be less concerned if we came off a long record of stability, but we've come off a long record of inflationary psychology and
inflationary expectation. We expect prices to move up somewhat
more rapidly, a little more rapidly in 1984 than in 1985.
The question is, can we create an environment in which that's a
minor cyclical blip or do we create an environment in which people
take that as an indication to go back to the inflationary habits of
an earlier day? I don't think we know the answer to that fully yet.
But put all these things together—that demand is still running
quite rapidly, that we have a potential investment problem and ca-
130
pacity problem, that we have the question of whether the trend
toward more stability will be psychologically embedded or not—and
they make you cautious about the inflation outlook.
These all come down to a matter of judgment, and it's obviously
important to debate, within a range, precisely the posture of monetary policy. But, in my mind, that debate does not range over an
area so wide as opening up all the gates because there is just a lot
of room to grow rapidly with no inflationary potential for a couple
of years; that is not the way I see the picture.
You can make that finer judgment as to where all these things
are balanced—and we try to do that to the best of our ability all
the time—but it is a situation in which both the potential and the
dangers are balanced, we think pretty evenly, or we wouldn't be
following the policy we're following.
Senator PROXMIRE. I just have two more questions that the chairman has graciously permitted me to go ahead.
In your report to Congress last July you revealed that Mi would
merely be monitored rather than targeted. In your current report
Mi seems to be restored to its former status as a target rather than
something to be monitored.
Was that a deliberate change by the Federal Open Market and, if
so, what is the significance? Does the target mean you're going to
be stronger in achieving that Mi target?
Mr. VOLCKER. I think it's somewhere in between. I suppose what
I would say is Mi has been restored to probationary status. We
think there is some question as to precisely how velocity will develop, but it looked more normal in the second half of last year. It did
not look normal for a business expansion. It looked more normal in
the sense that velocity was increasing but ordinarily we would
expect it to increase even faster.
We were assuming, in setting this range that is obviously fairly
wide, that velocity this year may look fairly normal for this stage
of a business cycle, and we've allowed ourselves a little room on
either side of that assumption.
If that assumption turns out not to be right, we obviously have to
look at it again. What we said is that for the time being we don't
put full weight on M: because we will evaluate it. If it doesn't
seem to give us sensible answers relative to the other ends and relative to credit or relative to what's going on in the economy, we
will have a certain skepticism about it. We expect it to give more
sensible answers.
REVENUE SHARING WITH STATES
Senator PROXMIRE. My final question relates to the State and
local surplus compared to our deficit. The chart following page 22
of your report shows that in 1983 State and local governments enjoyed a surplus of $15 billion in their operating budgets while the
Federal Government had a deficit of nearly $200 billion. At the
same time we've provided State and local governments with $4.5
billion in revenue sharing funds and are going to provide $5 billion
a year over the next 5 years.
131
Does it make sense, in your judgment, that the Federal Government share its revenues when it has a huge budget deficit and
State and local governments are enjoying comfortable surpluses?
Mr. VOLCKER. I used to think revenue sharing made a lot of
sense. I must say that this budgetary picture casts some doubt
upon it. I think you've got to justify revenue sharing on more
structural considerations. Is it relatively easier over a long period
of time for the Federal Government to raise revenues and avoid
some of the competitiveness among the States? Is it just simply a
structural difference between the ability of the Federal Government to raise money and the ability of State and local governments? I thought that was the case 20 years ago when I was in the
Treasury and I was certainly a supporter of revenue sharing. I
have to confess that current developments, at least at this point in
time, don't bear out the feeling of a structural difference. I say that
reluctantly, given my earlier views.
Senator PROXMIRE. So that could be a downpayment on the
downpayment.
Mr. VOLCKER. That's one way of going about it. I don't know how
happy it will make the mayors or Governors.
Senator PROXMIRE. It won't make them very happy.
Well, thank you very much, Mr. Chairman.
The CHAIRMAN. I didn't intend to get involved, but a former
mayor cannot resist that one. Looking at the economic numbers
you may have a case, but one of the justifications for Federal aid to
States and localities is Federal requirements imposed on them. So I
would only add that if you want to take away that, then you'd
better also take away many of the mandated programs that we in
the Congress said you must do, and many of those Federal funds
are used for services that are required by the Federal Government
to be performed that would not have been performed and did not
exist. So there's that combination. You've got to have that caveat,
Mr. Chairman.
Mr. VOLCKER. A perfect illustration of why I should not get into
this kind of a conversation.
The CHAIRMAN. Senator Riegle has some additional questions he
would like your response in writing.
[Response to Senator Riegle's written questions follows:]
132
Chairman Volcker's Responses to Senator Riegle's
Written Questions Submitted at the Hearing on 2/8/84
1.
Trade_peficit
0-
Chairman Volcker, earlier this week you called attention to
the risk posed by 2 deficits, the budget deficit and our
international trade deficit. How do you propose we attack
our international trade deficit when your policies, which
have sustained the highest real rates of interest in our
history, make American goods more expensive regardless of
how efficiently they are produced, and foreign goods
cheaper?
A.
I have emphasized that the deficit in our external
accounts —
more precisely, the current account deficit
—
is related to the budget deficit, and have urged a serious
attack on the budget deficit in the very near t^rro.
The high real interest rates that you mention should be
analyzed in the context of our monetary ancl fiscal policies
taken together.
While monetary policy plays an important
role in encouraging the growth of demand in nominal torvis,
fiscal policy has a strong influence on the level of real
interest rates as the budget deficit absorbs a larger or
srtiallor proportion of private domestic savings.
Thus, in
1934 the federal government is projected to spend in excess
of its income nore than 5 percent of i:he gross national
product.
High real interest rates are part of the proc-iaa
of inducing private U.S. residents ^nd foreigners to increase their savings and reduce their spendinq, in order to
finance, in real terras, the large excuss of government
spending over government revenue.
Looked at from the perspective of our international
accounts, the current account deficit is a reflection of
133
this net lending to U.S. residents from abroad.
the trade and current account deficits —
net inflow of capital from abroad —
To reduce
and thereby the
without reducing the
budget deficit would require an increase in the excess of
private domestic savings over private domestic investment,
which would require additional upward pressure on real
interest rates, other things equal.
That is, the current
account deficit (net capital inflow) has allowed the United
States to finance its budget deficit at lower real interest
rates than otherwise would have been the case.
Interest-
sensitive sectors of the U.S. economy have suffered less
because exchange rate-sensitive sectors suffered more.
If
we want to escape from the continuation of high real
interest rates and a larger trade deficit, wo noed,
therefore, to attack the budget deficit.
2.
Trade and Delndustrial^izatipn
Q.
By your own testimony (paycs 21-22 of Monntary Policy
Report), the dollar has appreciated by r>0% since 1930 and
the trade deficit has increased from an annual rate of about
$45 billion in the fourth quarter of 19^2 to a rate of about
$75 billion in the fourth quarter of 1993.
Our country's exports are clearly suffering drastically and
in the process effecting our industrial infrawtiuoture and
employment.
Al 1 signs point to continuing and signi Eicantly escalating
trade deficits in the future. Some would say that th<5se
trade deficits are already loading to the deindustrialization of America.
'.That is your reaction and what is your opinion of the immediate consequences of thene deficits on our industrial
infrastructure, and if these deficits continue, what will the
consequence's be in the future?
134
Is the dollar overvalued with respect to other currencies —
such as the yen?
A.
The widening of the U . S . trade d e f i c i t in 1983 was
attributable to two main factors:
the strong dollar, which
made it more d i f f i c u l t for U . S . tradeable goods industries —
export industries and import-competing industries — to
compete with foreign producers; and the relative rapid
expansion of the U . S . economy, which increased U.S. demand
for tradeable goods.
The rapid expansion of aggregate demand
in the U n i t e d States led to a rebound in n . S . m a n u f a c t u r i n g
employment d u r i n g 1983 to a level that is now about 5 percent
below its
level at the end of 1980, whon the dollar was
beginning to appreciate.
The industrial production index for
m a n u f a c t u r i n g has risen to nearly 5 percent above its
level
at the end of 1980.
Such evidence suggests that on average America's
industrial sector to date has not s u f f e r e d irreparable damage
F
ro'ii the strong d o l l a r , although it is equally clear that not
all
industries have shared equally in the economic expansion
because of its
unbalanced development.
However, an u n d u l y
strong d o l l a r , and the high real interest rates with which
it
m i g h t be associated, could pose sorious risks for the structure of the Amrican economy in the f u t u r e — for tradcable
goods industries, for tha housing sector, and for private
invariant expenditures throughout the economy.
For reasons
developed .in Tiy testimony, real progress toward reducing the
budget deficit
is needed to clear away these risks.
135
There is no uniformly-accepted way to measure how much
the dollar may be "overvalued", or indeed on the concept of
"over" or "under" valuation.
One can try to make certain
calculations, but the results should not be interpreted as
indicating how exchange rates will or should move.
Two
popular calculations suggest that the dollar could be as much
as 25 percent higher on average against the currencies of the
other Group-of-Ten countries and Switzerland than might in
the past have been regarded as "norms"!".
The first
calculation involves looking at the average level of real
dollar exchange rates, or nominal exchange rates adjusted for
national price levels, ovor the. entire floating rate period
since 1973.
On this standard, which can be applied on a
bilateral basis, the evidence is that the dollar is
significantly loss "overvalued" against the yen than it is
against the major European currencies.
A second calcula-
tion involves an assessment of the value of the dollar that
would eliminate the D.S. current account deficit.
This
measure is Much more difficult to apply since it requires an
assessment of relative cyclical positions, as well as the
outlook for wages and productivity in this country and
abroad.
It also implies a cacront account deficit of ^?ro is
appropriate.
More generally, the value of the Collar relative fco
other currencies will be influenced by the relative degree of
136
confidence in the economic and political outlook here and
abroad.
3.
Possibility of Renewed Recession
0.
What assurances,
tary targets you
and loose fiscal
into a recession
\.
if any, can you give us that with the monehave outlined, and with existing deficits
policies, we will not be headed right back
later this year or in 1985?
No one can offer absolute assurances about the future
course of the economy.
The experience of recent years has
demonstrated that shocks arising from natural or political
causes can be of' such dimensions as to throw things out of
kilter even if policies of unexceptionable character have
been put in place before hand.
And, given the lags and
uncertainties associated with policy actions, the ability to
offset such shocks as they occur is distinctly limited.
In the present circumstances, as we have indicated, it
appears that the most probable pattern of developments for at
least this year is continuation of good growth in real
economic activity and only a slight —
largely cyclical
—
pickup in the pace of inflation relative to what was
experienced in 1983.
A decline in activity does not seem
likely, given the configuration of monetary and fiscal
policies and "basic trends in the economy, even though the
composition of output and our foreign trade position is far
froTi ideal . Wf: have emphasized that the present trajectory
of fiscal policy —
which implies continuing huge budget
137
deficits and mounting federal debt service burdens —
carries
with it great risks of economic and financial dislocation and
thus could at some point jeopardize the smooth, balanced
expansion of the economy in the period ahead.
4.
Election Year Politics
Q.
Mr. Volcker, you are a nan of high principle. In 1980 you
refused to let the exigencies of an election year deter you
from your adherence to your tight money and high interest
rate principles. Will you show similar principle during the
election year in 1984, particularly in light of the massive
deficit which has been created since 19HO?
A.
I would not characterize our policies as being ones of
tight money and high interest rates.
Rut we believe that
appropriate restraint on the expansion of money and credit is
a necessary ingredient in shaping sustained, noninflationary
economic growth and in restoring Cull employment and real
prosperity —
principle.
and we have every intention of adhering to chat
Action to remedy our deep structural budgetary
imbalance is of the utmost urgency to provide greater assurance that the nation will achieve its longer range economic
objectives.
5.
Growth of Debt vs. Growth inJjNP
Q.
How would you compare the early staqos of this recovery with
other postwar recoveries? Specifically with respect to
growth in GNP versus growth in debt?
A.
During the past year, nominal CMP and the total debt ot
domestic nonf inaricial sectors of the economy both grew 10-1/2
138
percent.
This is something of a departure from the average
pattern in the first years of earlier recoveries in the
postwar period:
debt typically has grown a couple of
percentage points slower than GNP.
The rapid growth of
federal debt was particularly notable last year, as it ran at
almost twice the pace of GNP expansion.
6.
Lesser Developed jioun tries
Q.
Vfhat effect will continually high interest rates have on the
many developing countries with outstanding debt concentrated
in dollars?
A.
High interest rates, especially relative to the rate of
inflation, are a groat burden for developing countries with
large external debts.
A one percentage point increase in
dollar interest rates raises interest payments due on the
floating rate debt of major debtor countries by roughly
52-1/2 billion.
Those countries have been forced to generate
large trade surpluses to cover a major part of interest
payments due.
Up to now, those surpluses have usually
resulted from sharp cuts in imports and have boon accompanied
by substantial declines in economic activity.
Studies done by the Hoard staff and others indicate
that, at interest rates near current levels, the debt burden
of major debtor countries should decline gradually as
economic growth in developed countries and the lagged affects
of adjustment at home stimulate developing country exports.
The danger, of course, is that these high interest rates nay
139
not be compatible with continued economic recovery in
developed countries.
Lowering real interest rates through higher D.S. inflation might temporarily help debtor countries.
However, a
burst of U.S. inflation would also likely lead ultimately to
higher real interest rates and another recession, leaving
these countries worse off than now.
Lower real and nominal
interest rates as a result of lower inflationary expectations
and reduced pressures of federal budget deficits on U.S. and
international credit markets would be of the most help to
developing countries, through lower interest payments and
through assuring sustainable, non-inflationary economic
growth in developed countries.
7.
Effects of Decline on Connunntion Spend ing
Q.
On page 2 of the Monetary Policy Report you say that "consumption spending . . . is likely to decelerate in the coming
year." By how much and what sectors of the economy do you
anticipate will be most directly effected?
A,
I should emphasize that wo generally foresee a slowing
in the growth of real consumption spending, not a decline in
the level.
Tn 1933, there were very largo gains in a nu-nbar
of components of consumption spending, especially in
housing-related goods and in other durable goods such as
autos.
To some extent this reflected the marked decline in
interest rates after mid-1932; there was as well an element
of "pent-up demands" deferred during the recession; and
soaring stock market wealth and further tax rate reduction
gave further impetus to consumption outlays.
140
with the proportion of disposable income going to consumption already at an historically high level, and with the
extraordinary factors I noted unlikely to be repeated,
overall consumption spending in all probability will expand
more moderately this year.
Many of the industries that
experienced dramatic increases in sales last year will enjoy
good, and perhaps better, sales in 1984 (indeed, domestic
auto sales have been in a distinct uptrend of late) —
but in
many cases the gains last year were so sharp that they simply
could not be compounded at those rates in 1984.
The CHAIRMAN. I just have one final question. When you came to
Salt Lake City to testify before the first hearing on my financial
restructuring legislation and also Senator Proxmire's bill, I asked
you a question about monetary policy as well as fiscal policy in
that hearing. So, I think it's only fair in view of the fact that this
is about the monetary policy that I ask you a question about financial restructuring.
That would simply be if you would restate what you said in that
Salt Lake hearing about the need for financial restructuring bills
this year.
Mr. VOLCKER. Certainly nothing has happened in that short intervening period to change my view that it is a matter of real urgency for Congress to express its view and tell us, the regulators,
and the banks and the others what national policy is, in terms of
sorting out what banks can'do and what they can't do. I find—and
there have been instances even in this last 2 or 3 weeks, since we
were together in Salt Lake—that whenever an innovation takes
place, we approve of some of it and some of it we don't, depending
on our interpretation of what can or cannot be done and what congressional intent was under existing law. But one thing I know for
sure is that existing law is just not fitted to the circumstances that
we have to make decisions about, to put it very directly, and the
system is being warped and changed—certainly changed and
maybe, in fact, warped—by the mere fact that you have arbitrary
limits under existing law. The system is evolving in ways that are
going to be very hard to change and repair unless Congress gives
us—and I'm not just talking about the regulators, but the country—a fresh mandate as to what public policy should be. I also do
believe, as I said at Salt Lake City, that I think there is a hardcore
of issues upon which a high degree of consensus has already been
reached. There are some things, clearly, when consensus has not
been reached, but I think you have something upon which to build,
and the opportunity for constructive legislation seems to me to be
here this year.
Ml
I don't argue it won't be without controversy, but I do argue that
the core of the legislation, while it may not have a perfect consensus, has a wide degree of support among affected financial institutions, and others.
The CHAIRMAN. Well, I was certain your answer had not
changed. It was just that I candidly did not expect too many people
to read the hearing record so I wanted you to repeat it again.
Mr. VOLCKER. I think it is very important. It doesn't match, I
suppose, the budgetary deficit and monetary policy in terms of
short-run significance, but it is a very significant matter in terms
of the structure. I'm afraid inaction is a decision, because the structure is going to be warped without it.
The CHAIRMAN. Thank you very much, Mr. Chairman.
The committee is adjourned.
[Whereupon, at 12:30 p.m., the hearing was adjourned.]
FEDERAL RESERVE'S FIRST MONETARY
POLICY REPORT FOR 1984
THURSDAY, FEBRUARY 9, 1984
U.S. SENATE,
COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS,
Washington, D.C.
The committee met at 9:30 a.m. in room SD-538, Dirksen Senate
Office Building, Senator Jake Garn (chairman of the committee)
presiding.
Present: Senators Garn, Heinz, Gorton, Hecht, Humphrey, and
Proxmire.
OPENING REMARKS OF CHAIRMAN GARN
The CHAIRMAN. The Banking Committee will come to order.
This is the second day of hearings conducted on monetary policy.
Yesterday we had before us the Chairman of the Federal Reserve
Board.
Today we are honored to have the Honorable Beryl Sprinkel,
Under Secretary for Monetary Affairs, Department of the Treasury; he will be followed by the Honorable Martin Feldstein; then
we will have a panel with Dr. Robert Parry and Dr. Allan Meltzer.
Secretary Sprinkel, we are happy to have you with us today and
if you would like to proceed with your testimony.
STATEMENT OF BERYL SPRINKEL, UNDER SECRETARY FOR
MONETARY AFFAIRS, DEPARTMENT OF THE TREASURY
Mr. SPRINKEL. Thank you.
[Complete statement follows:]
144
For Release Upon Delivery
Expected at 9;3Q__a_.m.
STATEMENT BY BERYL W. SPRINKEL
UNDER SECRETARY OF THE TREASURY FOR MONETARY AFFAIRS
BEFORE THE
SENATE COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS
WASHINGTON, D . C .
Thursday, F e b r u a r y 9, 1984
C h a i r m a n G a r n , Senator P r o x m i r e , d i s t i n g u i s h e d Members o f
the C o m m i t t e e , it
is as always a p l e a s u r e to be here to represent
the A d m i n i s t r a t i o n ' s v i e w s on c u r r e n t and p r o s p e c t i v e monetary
policy.
I would l i k e to b e g i n t h i s m o r n i n g by m a k i n g some
comments about the b u d g e t d e f i c i t because I know it
is the
economic issue t h a t i s c u r r e n t l y d o m i n a t i n g most p e o p l e ' s m i n d s .
Then I w i l l t u r n to monetary policy — w h i c h is,
of c o u r s e , the
subject and purpose of these h e a r i n g s .
The d i f f i c u l t problem of the b u d g e t d e f i c i t m u s t be
a d d r e s s e d and resolved.
As P r e s i d e n t Reagan has i n d i c a t e d , the
p r o j e c t e d size o f b u d g e t d e f i c i t s are u n a c c e p t a b l y h i g h ,
r e g a r d l e s s of whose f o r e c a s t is used.
While i n d i v i d u a l s may
not agree on the precise q u a n t i t a t i v e e f f e c t s of b u d g e t d e f i c i t s ,
the t i m i n g of those e f f e c t s or the b e s t approach to r e d u c i n g
d e f i c i t s , everyone recognizes t h a t large prospective b u d g e t
deficits
have s e r i o u s , adverse i m p l i c a t i o n s f o r f u t u r e c a p i t a l
f o r m a t i o n , p r o d u c t i v i t y a n d economic g r o w t h .
Even if one accepts the argument that there is a clear and
v e r i f i a b l e c o n n e c t i o n b e t w e e n large d e f i c i t s a n d r i s i n g
interest
145
r a t e s , there is no reason for current and projected d e f i c i t s
cause a d d i t i o n a l
increases in i n t e r e s t r a t e s .
to
The projected
size of f u t u r e budget d e f i c i t s has already been largely d i s c o u n t e d
by the f i n a n c i a l m a r k e t s and those e x p e c t a t i o n s are
incorporated
into the c u r r e n t level of long-term interest r a t e s ,
W i t h respect to monetary policy, h o w e v e r , the c r i t i c a l
concern is t h a t we not allow monetary policy to stray off
course b e c a u s e of concerns about the b u d g e t d e f i c i t .
budget d e f i c i t
problem.
The
is a f i s c a l problem, not a monetary policy
The present and f u t u r e goal of monetary policy should
be to provide stable and moderate money growth at a rate t h a t
is c o n s i s t e n t w i t h both price s t a b i l i t y and s u s t a i n a b l e r e a l
economic g r o w t h .
That is as true w i t h record-high d e f i c i t s as
it would be if the b u d g e t were b a l a n c e d ,
A f u n d a m e n t a l f e a r in the f i n a n c i a l markets is t h a t large
d e f i c i t s w i l l lead to i n f l a t i o n a r y money g r o w t h as the Federal
Reserve " m o n e t i z e s " the d e b t .
That f e a r , and the g e n e r a l
u n c e r t a i n t y a b o u t the b u d g e t s i t u a t i o n , he i g h t e n s the need for
an a n n o u n c e d c o m m i t m e n t to n o n i n f l a t i o n a r y m o n e t a r y policy t h a t
is backed up by a p p r o p r i a t e monetary a c t i o n s .
The Progress In Reducing
Inflation
A g r o w i n g number of e c o n o m i s t s -- and I t h i n k the p u b l i c
in g e n e r a l to d". i n c r e a s i n g e x t e n t — now r e c o g n i z e t h a t i n f l a t i o n
is
f u n d a m e n t a l l y a monetary phenomenon.
A necessary p r e r e q u i s i t e
for price stability is that money growth be constrained to a
n o r i i n f l a t i o n a r y pace over the long r u n .
b e t w e e n money growth and i n f l a t i o n
The r e l a t i o n s h i p
is a long-term o n e ; money
146
growth a f f e c t s the rate of i n f l a t i o n w i t h a lag of 1-1/2 to 2
years.
It is therefore the l o n g - t e r m or trend r a t e of money
growth that determines the rate of i n f l a t i o n .
C h a r t 1 illu-
strates this r e l a t i o n s h i p since the early 1960's; here the
year-over-year growth rate of Ml is plotted w i t h a two-year
l a g , along w i t h a n n u a l changes in the GNP d e f l a t o r .
As can be
seen in the c h a r t , not only are f l u c t u a t i o n s in i n f l a t i o n
closely correlated w i t h lagged changes in the long-term rate
of money g r o w t h , the secular rise in i n f l a t i o n over the past
two d e c a d e s corresponds to a g e n e r a l upward d r i f t
in money
growth.
But m u c h of the p u b l i c and m e d i a d i s c u s s i o n s of the c a u s e s
of i n f l a t i o n f o c u s on the short run and have t h e r e f o r e , at
least u n t i l r e c e n t l y , o f t e n not e m p h a s i z e d the role of money
growth as the root cause of i n f l a t i o n .
When we focus on month-
to-month movements in price i n d i c e s , it
is a l w a y s possible to
i d e n t i f y the p a r t i c u l a r
items t h a t c o n t r i b u t e d to a g i v e n rise
in a composite price index.
Such c h a n g e s in r e l a t i v e p r i c e s
--
the prices of s p e c i f i c goods or ca tegories of goods r e l a t i v e to
other goods -- should not be c o n f u s e d w i t h g e n e r a l i z e d i n f l a t i o n ,
D u r i n g the 1 9 7 0 ' s , the tendency to c o n f u s e r e l a t i v e price
changes w i t h i n f l a t i o n provided a series of a n e c d o t a l e x p l a n a tions or justifications for a rising inflation rate.
short-run increase in the price i n d i c e s was a t t r i b u t e d
Each
to
increased energy costs, increased food p r i c e s , r i s i n g wage
r a t e s or some other d e v e l o p m e n t ; such a n a l y s i s i m p l i e d , d i r e c t l y
or i n d i r e c t l y , that the general rise in i n f l a t i o n was somehow
147
beyond our control because it was the sura-total
r e s u l t of OPEC
a c t i o n s , w e a t h e r c h a n g e s and other u n c o n t r o l l a b l e e v e n t s .
Such incomplete a n a l y s i s c o n t r i b u t e d
importantly,
I believe,
to the p u b l i c ' s g r a d u a l a c q u i e s c e n c e — or at l e a s t acceptance
— of an i n f l a t i o n w h i c h rose f r o m an a n n u a l average of less
than 1 . 3 % d u r i n g the 1961-65 period to an a n n u a l average of
nearly 9% in the f i v e years e n d i n g in 1980. Blaming the accele r a t i o n of i n f l a t i o n in the 1 9 7 0 ' s on u n c o n t r o l l a b l e e v e n t s
such as oil embargoes and d r o u g h t is a k i n to i d e n t i f y i n g as
the c a u s e of W a s h i n g t o n ' s hot summer w e a t h e r , the r i s e of the
mercury in the t h e r m o m e t e r .
H i s t o r y h a s repeatedly d e m o n s t r a t e d t h a t i n f l a t i o n i s n o t
s o m e t h i n g t h a t is
forces;
it
imposed upon us by m y s t e r i o u s and u n c o n t r o l l a b l e
*
the r e s u l t of excessive money g r o w t h .
is i n e v i t a b l y
It is no a c c i d e n t t h a t w h i l e i n f l a t i o n
rose s e c u l a r l y , money
growth increased f r o m an a n n u a l average of 3 . 5 % in the 1961-65
period to an a n n u a l average of 7 . 4 % in the f i v e y e a r s e n d i n g
in 1980. J u s t as e x c e s s i v e money g r o w t h l e a d s to r i s e in the
i n f l a t i o n rate, price stability, conversely is the inevitable
r e s u l t of n o n i n f l a t i o n a r y money g r o w t h .
Price s t a b i l i t y does not mean there are no c h a n g e s in the
prices of s p e c i f i c goods or s e r v i c e s .
To the c o n t r a r y , r e l a t i v e
price c h a n g e s are the essence of the m a r k e t system; it
is
t h r o u g h i n c r e a s e s or decreases in i n d i v i d u a l p r i c e s t h a t c h a n g e s
in demand or supply conditions are resolved by the m a r k e t .
But one-time c h a n g e s in r e l a t i v e prices ( e v e n t h o u g h they may
be s u b s t a n t i a l and may a f f e c t the price i n d i c e s over a period
148
of many months or even y e a r s ) do not provide an e x p l a n a t i o n or
j u s t i f i c a t i o n for ongoing — let
alone accelerating — i n f l a t i o n
like t h a t of the late 1 9 6 0 ' s and the 1 9 7 0 ' s .
Only unsound and
i n f l a t i o n a r y monetary policy can c o n v e r t i n c r e a s e s in r e l a t i v e
prices of s p e c i f i c goods i n t o g e n e r a l i z e d , ongoing i n f l a t i o n .
Just as our short-run myopia about economic e v e n t s tended
to d e - s e n s i t i z e us to a r i s i n g i n f l a t i o n rate in the 1 9 7 0 ' s , I
t h i n k we now tend to u n d e r s t a t e or " u n d e r - r e c o g n i z e " j u s t how
far we have come in r e d u c i n g i n f l a t i o n in a r e l a t i v e l y
period.
short
In j u s t three y e a r s the a n n u a l increase in the CPI has
f a l l e n from 1 3 . 5 % in 1980 to 3 . 3 % in 1983.
Three y e a r s ago, i n f l a t i o n had become a s e e m i n g l y - p e r m a n e n t
aspect of our e c o n o m i c l i v e s .
For e x a m p l e , it
is
interesting
to compare i n f l a t i o n r a t e s in the past three y e a r s w i t h those
p r o j e c t e d by the Carter A d m i n i s t r a t i o n in the 1981 A n n u a l Report
of the C o u n c i l of Economic A d v i s e r s .
On a f o u r t h q u a r t e r - t o -
f o u r t h q u a r t e r b a s i s , those projections were 1 2 . 6 % , 9 . 6 % , a n d
8 . 2 % , for 1981, 1982 and 1983, r e s p e c t i v e l y , compared to a c t u a l
r e s u l t s o f 9 . 6 % ,4 . 5 % , a n d 3 . 3 % .
Over t h e three y e a r s , t h a t
a m o u n t s c u m u l a t i v e l y to a 13% slower r i s e in prices t h a n was
anticipated
in 1981.
I know of no economic f o r e c a s t e r who
foresaw the rapid d e c l i n e in i n f l a t i o n and few e c o n o m i s t s
would have seriously believed t h a t such r e m a r k a b l e progress
was possible, let alone probable.
There are
for
those who contend t h a t the price we have paid
the progress on i n f l a t i o n --
in terms of a s h o r t - r u n loss
149
of jobs and o u t p u t — has been too great.
But it
is not rele-
vant to compare the economic d i s l o c a t i o n associated w i t h r e d u c i n g
i n f l a t i o n to some ideal of economic performance that i n c l u d e s
continued high real growth and low u n e m p l o y m e n t .
comparison is between the e f f e c t s
The r e l e v a n t
of the a n t i - i n f l a t i o n a r y
monetary policy t h a t b e g a n in 1981 and the likely outcome of
its a l t e r n a t i v e — continued i n f l a t i o n a r y
money g r o w t h .
It
is
highly u n l i k e l y that a period of d e c l i n i n g o u t p u t and employment
could have b e e n avoided by t a k i n g no action a g a i n s t an a c c e l e r a t i n g
inflation rate.
-- t h a t is,
Failing to deal e f f e c t i v e l y w i t h r i s i n g
inflation
an a t t e m p t to provide c o n t i n u e d economic s t i m u l u s
through i n f l a t i o n a r y
money g r o w t h — would l i k e l y also have
r e s u l t e d in a r e c e s s i o n , as i n t e r e s t rates rose w i t h i n f l a t i o n
and i n f l a t i o n a r y e x p e c t a t i o n s .
H i s t o r i c a l experience is not c o n s i s t e n t w i t h the v i e w t h a t
a recession would have been avoided by postponing a c t i o n s to
control i n f l a t i o n .
The n o t i o n t h a t i n f l a t i o n can be permanently
m a i n t a i n e d at some stable r a t e , w h i c h becomes h a r m l e s s once
the public a d j u s t s to it,
is a myth.
If the underlying goal
of monetary policy is not price s t a b i l i t y , then the
inflation
rate and i n t e r e s t r a t e s w i l l r a t c h e t upward over time and the
p r o b l e m of unemployment w i l l grow worse.
The l e n g t h and d e p t h of the 1981-82 recession p r o v i d e s a
valuable
lesson for the A m e r i c a n p u b l i c : once i n f l a t i o n and
inflationary
e x p e c t a t i o n s become e m b e d d e d , r e t u r n i n g a n economy
to a n o n i n f l a t i o n a r y path is an e x t r e m e l y d i f f i c u l t and a
p o t e n t i a l l y costly task.
T h i s is a p r i n c i p l e t h a t has b e e n
150
demonstrated to us in the p a s t , most recently in the 1973-75
r e c e s s i o n ; in that period money growth was slowed s u b s t a n t i a l l y
and i n f l a t i o n and i n t e r e s t r a t e s f e l l .
We u n f o r t u n a t e l y d i d
not learn f r o m -that e x p e r i e n c e ; the progress on i n f l a t i o n was
soon thrown away when money growth was allowed to reaccelerate
to highly i n f l a t i o n a r y r a t e s for the next f o u r y e a r s .
The severity of the last recession should lead us not to
the conclusion t h a t the process of r e s t o r i n g price s t a b i l i t y
is too c o s t l y , but t h a t it is so costly that we c a n n o t a f f o r d
to go t h r o u g h it a g a i n .
The secular rise in i n f l a t i o n since
the 1960's had p e r v a s i v e , h a r m f u l e f f e c t s on economic i n c e n t i v e s
and p e r f o r m a n c e ; there should be no d e b a t e about the f a r - r e a c h i n g
beneficial e f f e c t s of permanently controlling inflation.
The Importance of a j^ong-Run Commitment to Price Stability
Moving an economy from an i n f l a t i o n a r y path to a n o n i n f l a tionary one r e q u i r e s a p r o f o u n d r e a d j u s t m e n t of p e o p l e ' s behavior
and t h i n k i n g .
By the late 1 9 7 0 ' s there were many s i g n s of the
e f f e c t s of i n f l a t i o n on our economic b e h a v i o r .
A "buy-now-
b e f o r e - t h e - p r i c e - r i s e s " psychology had become p r e v a l e n t .
W a g e - e a r n e r s were d e m a n d i n g large wage increases on the b e l i e f
that they were needed j u s t to "stay even" w i t h i n f l a t i o n .
Borrowers were w i l l i n g to b o r r o w money at r e c o r d - h i g h i n t e r e s t
rates b e c a u s e they b e l i e v e d t h a t they could repay the d e b t in
depreciated dollars.
For many households, saving consisted
only of i n f l a t i o n - r e l a t e d increases in the value of real e s t a t e
holdings.
These are all e x a m p l e s of i n f l a t i o n - i n d u c e d b e h a v i o r
151
t h a t had to be a l t e r e d , and m u s t c o n t i n u e to be a l t e r e d , if
p e r m a n e n t v i c t o r y over i n f l a t i o n
is to be achieved.
The economic d i s l o c a t i o n — lost jobs and o u t p u t -associated w i t h r e d u c i n g i n f l a t i o n
occurs w h e n such p u b l i c
behavior collides with a n o n i n f l a t i o n a r y m o n e t a r y policy.
is,
That
once money g r o w t h is reduced to a n o n i n f l a t i o n a r y pace,
there is i n s u f f i c i e n t money in the economy to f i n a n c e c o n t i n u e d
inflationary
activity.
b e h a v i o r as well as r e a l , productive e c o n o m i c
Even though money growth is ample to support real
economic a c t i v i t y , it w i l l be i n s u f f i c i e n t
to support a level
of n o m i n a l economic a c t i v i t y t h a t presumes a c o n t i n u e d h i g h
rate o£ i n f l a t i o n .
Something has to g i v e a n d , in the short
r u n , i t i s t y p i c a l l y real e c o n o m i c growth.
However, the faster
the p u b l i c a d j u s t s its b e h a v i o r to a n o n i n f l a t i o n a r y e n v i r o n m e n t ,
the shorter and the smaller w i l l be the r e a l economic d i s l o c a t i o n .
T h u s an i m p o r t a n t aspect of a policy d e s i g n e d to r e d u c e
inflation
is t h a t the p u b l i c be convinced of the F e d e r a l
R e s e r v e ' s d e t e r m i n a t i o n to make it succeed.
F e d e r a l Reserve
o f f i c i a l s have repeatedly r e a f f i r m e d their commitment to a
policy of g r a d u a l l y r e d u c i n g money g r o w t h to a r a t e
w i t h price s t a b i l i t y .
consistent
R e c o g n i z i n g the need for the p u b l i c to
believe in that commi t r n e n t , t h i s A d m i n i s t r a t i o n has alway s
publicly endorsed the Federal R e s e r v e ' s money growth t a r g e t
ranges and has c o n t i n u a l l y
targets.
urged the Fed to achieve those
While we have been c r i t i c a l of the F e d ' s a c t u a l
policy at particular times -- primarily when money groxth
strayed well-above or w e l l - b e l o w its
prescribed growth range
152
— our support for their b a s i c , n o n i n f l a t i o n a r y policy has
never f a l t e r e d and we have tried to convey t h a t commitment to
the Federal Reserve, the Congress and the public.
But w e l l - m e a n i n g s t a t e m e n t s of
o f f i c i a l s are not e n o u g h .
targets be achieved
It
i n t e n t i o n s from public
is i m p o r t a n t t h a t money growth
so t h a t the Federal R e s e r v e ' s a c t i o n s also
convey t h e i r l o n g - r u n commitment to a n o n i n f l a t i o n a r y policy.
In a d d i t i o n to the m o n e t a r y d i s c i p l i n e they are d e s i g n e d
to
impose, money growth t a r g e t s t h a t are c o n s i s t e n t l y a c h i e v e d
can help a s s u r e the p u b l i c -- and in p a r t i c u l a r f i n a n c i a l
market p a r t i c i p a n t s -~ t h a t we w i l l not r e v e r t to i n f l a t i o n a r y
policies.
The money g r o w t h t a r g e t s announced by the F e d e r a l Reserve
*
t h i s week are a p p r o p r i a t e and c o n s i s t e n t w i t h a c o n t i n u e d
d e c l i n e in i n f l a t i o n .
We urge the Federal Reserve to take the
policy a c t i o n s needed to a c h i e v e those t a r g e t s .
to the Congress,
In its report
the Federal Reserve has i n d i c a t e d t h a t " g r o w t h
around the m i d - p o i n t of the range
( f o r M l ) w o u l d appear
a p p r o p r i a t e , on the a s s u m p t i o n of r e l a t i v e l y n o r m a l v e l o c i t y
g r o w t h . . . " (Board of Governors of the Federal Reserve System,
Monetary Policy Report to the C o n g r e s s , February 7, 1 9 8 4 ,
8-9).
pgs.
That judgement is also, I b e l i e v e , an appropriate one,
and the m i d - p o i n t range for Ml should be the goal of Federal
Reserve policy a c t i o n s d u r i n g 1934, unless c o n v i n c i n g e v i d e n c e
emerges t h a t i n s t i t u t i o n a l or other c h a n g e s have a l t e r e d the
r e l a t i o n b e t w e e n money growth and economic a c t i v i t y and a
153
r e c a l i b r a t i o n of our monetary goals is j u s t i f i a b l e .
In a d d i -
t i o n , I urge the Congress to v o i c e t h e i r s u p p o r t for the F e d e r a l
R e s e r v e ' s stated policy and to urge the Federal Reserve to
achieve the t a r g e t r a n g e s , so t h a t all
b r a n c h e s of the govern-
ment would send a clear message to the p u b l i c t h a t our c o l l e c t i v e
resolve to r e - e s t a b l i s h price s t a b i l i t y has not w a i v e r e d .
In February 1980, the Monetary Policy report of t h i s
C o m m i t t e e , p u r s u a n t to the H u m p h r e y - H a w k i n s A c t , c o n t a i n e d a
number of important r e c o m m e n d a t i o n s a b o u t monetary p o l i c y .
in p a r t i c u l a r ,
I b e l i e v e , deserves r e i t e r a t i o n .
One
That recommen-
d a t i o n was t h a t the F e d e r a l Reserve set m u l t i - y e a r money g r o w t h
targets.
T h i s would be an e x c e l l e n t step toward a clearer
e n u n c i a t i o n of our l o n g - t e r m goals and e x p e c t a t i o n s for p r i c e
s t a b i l i t y w h i c h could h e l p reduce the s k e p t i c i s m t h a t is now
a s s o c i a t e d w i t h l o n g - r u n monetary control.
Some would a r g u e t h a t such long-term money t a r g e t s would
r e d u c e the F e d ' s f l e x i b i l i t y .
The s e t t i n g of longer term
money t a r g e t s would n o t , h o w e v e r , r e d u c e t h e F e d ' s f l e x i b i l i t y
to deal w i t h unforeseen developments or institutional changes.
Such c o n t i n g e n c i e s can be met w i t h i n the context of a long-term
commitment of monetary policy i n t e n t i o n s .
There is no
i n c o n s i s t e n c y b e t w e e n s e t t i n g and f o l l o w i n g monetary t a r g e t s
and m a i n t a i n i n g b a s i c f l e x i b i l i t y
t u t i o n s or d e v e l o p m e n t s .
to respond to c h a n g i n g i n s t i -
If c h a n g e s in monetary t a r g e t s can
be j u s t i f i e d by the f a c t s , those c h a n g e s can be made and e x p l a i n e d
to the p u b l i c , w i t h no d e l e t e r i o u s i m p l i c a t i o n s for long-run
monetary d i s c i p l i n e .
154
The Problem of Monetary V a r i a b i l i t y
The importance of public c o n f i d e n c e
in a n t i - i n f l a t i o n a r y
policy is one of the bases for the A d m i n i s t r a t i o n ' s concern
about the v o l a t i l i t y of money g r o w t h .
When the F e d e r a l Reserve
allows money g r o w t h to accelerate to a rapid pace for a period
of many m o n t h s or several q u a r t e r s , s k e p t i c i s m increases t h a t
a n o n i n f l a t i o n a r y policy w i l l be adhered to over the long
run.
W h e t h e r or not such a period of more rapid money g r o w t h
represents an intentional
run policy s t a n c e ,
it
shift
i n t h e Federal R e s e r v e ' s long-
inevitably raises the u n c e r t a i n t y sur-
rounding any forecast of f u t u r e
together w i t h expected f u t u r e
inflation.
inflation,
Such u n c e r t a i n t y ,
is an important deter-
m i n a n t of i n t e r e s t r a t e s , and t h a t is why v o l a t i l e and u n p r e d i c t a b l e money g r o w t h a d d s to the level of n o m i n a l i n t e r e s t
rates.
W h i l e i n t e r e s t r a t e s r e m a i n h i g h e r than most of us w o u l d
prefer,
it
is
i m p o r t a n t to r e c o g n i z e t h a t we have a l s o made
i m p o r t a n t progress in b r i n g i n g r a t e s down in the past t h r e e
years.
C h a r t 2 shows the p a t h s of a r e p r e s e n t a t i v e short-ter;n
and a long-term i n t e r e s t r a t e for
the period since 1981.
While
t h e i r d e c l i n i n g p a t h has been uneven -- as is t y p i c a l l y the
case — s h o r t - t e r m r a t e s are now 800-900 b a s i s p o i n t s below
t h e i r 1980-81 peaks and long r a t e s have f a l l e n about 2 5 0 - 3 0 0
basis p o i n t s from t h e i r peak l e v e l s .
There is room for i n t e r e s t r a t e s to f a l l f a r t h e r as
inflationary
expectations continue to a d j u s t downward.
Nominal
interest rates remain high relative to current i n f l a t i o n rates.
155
If,
f o r e x a m p l e , t h e c u r r e n t i n f l a t i o n rate i s s u b t r a c t e d f r o m
t o d a y ' s l o n g - t e r m r a t e s in the 11-1/2 - 12% r a n g e , the r e s u l t
is the 7 - 8 % rate that is f r e q u e n t l y labelled the h i g h "real"
interest rate.
The correct c a l c u l a t i o n of a real i n t e r e s t
r a t e , h o w e v e r , is to d e d u c t expected
i n f l a t i o n , and t h e r e f o r e
the r e s u l t i n g m e a s u r e of the real rate depends c r i t i c a l l y on
how e x p e c t e d i n f l a t i o n is m e a s u r e d .
i n f l a t i o n have c l e a r l y d e c l i n e d
W h i l e e x p e c t a t i o n s of
i n recent y e a r s , i t
i s also
c l e a r t h a t they have n o t d e c l i n e d a s m u c h a s h a s a c t u a l i n f l a tion.
The l a t e s t Blue C h i p survey of economic f o r e c a s t e r s
shows t h a t tney e x p e c t i n f l a t i o n t o average 5 . 5 % over t h e
1985-39 p e r i o d .
Uncertainty about f u t u r e i n f l a t i o n raises the risk associate:
w i t h any c o m m i t m e n t of f u n d s , p a r t i c u l a r l y over a long period of
ti^ie.
This is commonly r e f e r r e d
to as the r i s k p r e m i u m b u i l t
i n t o the level of i n t e r e s t r a t e s .
It e x i s t s d e s p i t e the a c t u a l
d e c l i n e in i n f l a t i o n , because investors remain highly u n c e r t a i n
t h a t i n f l a t i o n will remain low for the f u l l
assets.
life of f i n a n c i a l
An i m p o r t a n t source of t h a t u n c e r t a i n t y is v o l a t i l e
money g r o w t h ; w i t h each u p s w i n g in money g r o w t h , i n v e s t o r s
become a g a i n wary t h a t n o n i n f l a t i o n a r y m o n e t a r y polcy
is not a
p e r m a n e n t par t of our macroeconomic p o l i c i e s.
E m p i r i c a l r e s e a r c h i n d i c a t e s t h a t d u r i n g 1980-81, m o n e t a r y
v o l a t i l i t y has added 2 - 3 percentage
i n t e r e s t rates.
points to the level of
T h i s e f f e c t is i l l u s t r a t e d in C h a r t 3 w h i c h
r e l a t e s a s t a t i s t i c a l m e a s u r e of monetary v o l a t i l i t y , the
156
degree of d i f f i c u l t y associated w i t h f o r e c a s t i n g money g r o w t h ,
to a short-term and a long-term i n t e r e s t r a t e .
In a d d i t i o n to the i m p l i c a t i o n s for i n t e r e s t r a t e s , varia b i l i t y in money growth i n d u c e s corresponding
real economic activity.
fluctuations
in
In the snort r u n , money growth is
closely correlated w i t h real GNP g r o w t h , even t h o u g h over the
long r u n money growth d e t e r m i n e s
inflation.
This short-term
e f f e c t of changes in money g r o w t h on r e a l GNP is
since 1979 in Chart 4.
illustrated
As can be seen in the c h a r t , s h a r p
f l u c t u a t i o n s in money g r o w t h are closely associated w i t h
s i m i l a r f l u c t u a t i o n s in r e a l GNP g r o w t h ,
It is t h i s s h o r t - r u n c o r r e l a t i o n between money and real
a c t i v i t y t h a t makes the m o n e t a r y d e c e l e r a t i o n since l a s t summer
p a r t i c u l a r l y troublesome.
The r e c e n t r e v i s i o n s in the Ml d a t a
r e s u l t in a more moderate d e c e l e r a t i o n t h a n was o r i g i n a l l y
recorded;
n e v e r t h e l e s s , money g r o w t h slowed s u b s t a n t i a l l y
d u r i n g the last half of 1983.
This slowdown in money growth
S J b j e c t s the real economy to the r i s k of an u n a c c e p t a b l e slowdown
or d o w n t u r n in the f i r s t half of 1984.
That t h r e a t
and g r o w s , the longer money g r o w t h is c o n s t r a i n e d
continues,
to a slow
rate .
Because of the close r e l a t i o n s h i p in the short run b e t w e e n
money g r o w t h and real G N P , the A d m i n i s t r a t i o n has r e p e a t e d l y
urged the Federal Reserve to provide for a s m o o t h e r , more s t a b l e
and predictable path of money g r o w t h .
T h i s recommendation does
not mean t h a t we expect the Federal Reserve to achieve precise
157
week-to-week or month-to-month monetary c o n t r o l ; t e c h n i c a l
problems preclude
such s h o r t - t e r m p r e c i s i o n .
R e l a t i v e l y smooth and stable money growth on a q u a r t e r l y
b a s i s i s , however, t e c h n i c a l l y a c h i e v a b l e ; Federal Reserve
has estimated
staff
that quarterly Ml growth could be controlled
w i t h i n a range of _ r l % .
That r e s u l t would be a g r e a t i m p r o v e m e n t
over the recent record and would have two i m p o r t a n t b e n e f i t s .
F i r s t , i t would dampen t h e policy-induced
economic a c t i v i t y .
f l u c t u a t i o n s in real
Second, i t would reduce t h e u n c e r t a i n t y
about; l o n g - r u n m o n e t a r y control and thereby help h a s t e n the
downward a d j u s t m e n t o f i n f l a t i o n a r y
expectations and interest
rates.
I m p r o v i n g Mgne tary _CX-r. trg^l
I am not o p t i m i s t i c , h o w e v e r , t h a t money g r o w t h w i l l become
more s t a o l e as long as the F e d e r a l Reserve uses its
operating procedure.
Those who b e l i e v e in the
current
i m p o r t a n c e o£
inoosrate and p r e d i c t a b l e mor.t-y g r o w t h have long a d v o c a t e d soirc
t e c h n i c a l c h a n g e s in tht= way the Fed operates on a day-to-day
or week-to-week b a s i s in order to improve the p r e c i s i o n of
monetary c o n t r o l .
The Fedc'.al Reserve has adopted one of the?e r e c o m i r . e n d a t i o n :
by re i n s t a t ing c o n t e m p o r a n e o u s r e s e r v e r e q u i r e m e n t s in place o£
the s y s t e m o£ lagged reserve r e q u i r e m e n t s .
It has b e e n argued
t h a t lagged reserve r e q u i r e m e n t s r e d u c e d the p r e c i s i o n of
s h o r t - r u n monetary c o n t r o l by c a u s i n g a two-week lag b e t w e e n
d e p o s i t c r e a t i o n and a b a n k ' s need to hold added r e q u i r e d
reserves.
The new r e s e r v e r e q u i r e m e n t r e g i m e e s s e n t i a l l y
158
reduces t h a t lag to two days and could help r e d u c e the shortterm s l i p p a g e
in money stock c o n t r o l .
it is u n l i k e l y , h o w e v e r ,
t h a t much improvement i n m o n e t a r y control w i l l m a t e r i a l i z e ,
if
the F e d e r a l Reserve does not also adopt other t e c h n i c a l c h a n g e s
t h a t are needed to complement the new c o n t e m p o r a n e o u s reserve
sy stem: f o c u s ing day-to-day open marke t opera tions on con t r o l l ing
a reserve aggregate
(or the monetary b a s e ) , and i n s t i t u t i n g a
m a r k e t - r e l a t e d , penalty d i s c o u n t r a t e .
Since late 1982, the d a y - t o - d a y o p e r a t i n g p r o c e d u r e s of
the F e d e r a l Reserve have b e e n d e s i g n e d to p r o v i d e a p r e s c r i b e d
degree of r e s t r a i n t or ease in money market c o n d i t i o n s and bank
reserve positions.
This is f u n c t i o n a l l y e q u i v a l e n t to a p o l i c y
of targeting the Federal f u n d s r a t e , which was the F e d ' s
operating procedure d u r i n g the 1970's.
S i n c e trie r e l a t i o n s h i p
b e t w e e n i n t e r e s t r a t e s and money g r o w t h is n o t a d e p e n d a b l e or
pred ictable o n e ( p a r t i c u l a r l y a s e c o n o m i c c o n d i t i o n s v a r y ) ,
targe t i n g the Federal f u n d s r a t e g e n e r a l ly y ield s ve ry i m p r e c i s e
c o n t r o l of the mone tary a g g r e g a t e s .
T h i s w a s r e c o g n i z e d by
t h e F e d e r a l Peserve w h e n i t a b a n d o n e d t h a t c o n t r o l p r o c e d u r e
in 1979.
Because there is no r e l i a b l e r e l a t i o n b e t w e e n money g r o w t h
and interest rates on which the Fed can d e p e n d , an o p e r a t i n g
technique t h a t f o c u s e s o n c o n t r o l l i n g
interest rates by d e f i n i t i o n
i n t r o d u c e s large errors i n t o the money growth p a t h ; as long as
it
is an i n t e r e s t rate t h a t is d e l i b e r a t e l y c o n t r o l l e d by the
Fed, money g r o w t h is largely r e s i d u a l or a c c i d e n t a l .
In a d d i -
t i o n , there is no systematic or a u t o m a t i c procedure by w h i c h
error. 3
;
.r
3 i:c j
t-r JH • ,oney crow:'" an1 c o r L - c ^ o 1 ! -
.-.lii'ir t - > 'in ("ievi;= r. l o c b 3*
H i s t o r i c a l Iv ,
have- not bee n
c ;•;,..- : , i r. .Tiori'jy g r o w til
of fse c , r 'j t h a v e De-_•? ai 1 ow ^:3 to o --cu^- i J _>. r e ove r t ime .
t e x m de v i s t ion '= av- sy f r o m t bt
Shor t-
t a r q r - 1 pa t i\ -- wh i c'r. in and of
th^mse 1 ve s ;• j v e no -.ia" c i c u l a r c j c : > n o n i ' j m e a n in'; or consequence
-- th 1 : i ' i ^ r s be'MT''H pr olO'V-j-'o per 10-.':; or to.3-rap id or too-slow
money q r o w t h — ' v M . - l . dc h a v e very r e a l e c o n o m i c c o n s e q u e n c e s .
The r e s u l t - is not = pc>licy
performance;
t h a t m i n i r r . i j e s t h e r i s k to e c o n o m i c
i .is tead , the economy
is L i n n e c e s s a r i ly s u b j e c t e d
to
the p o s s i b i l i t y of policy-related f l u c t u a t i o n s in real economic
a c t i v i ty .
The d i s c o u n t r a t e , a s i t
is c u r r e n t l y a d m i n i s t e r e d by the
Federal R e s e r v e , a l s o i n t r o d u c e s a s i g n i f i c a n t m a r g i n - o f - e r r o r
i n money
stock c o n t r o l .
C h a n g e s i n the d i s c o u n t r a t e t y p i c a l l y
lag b s n i n d changes in market i n t e r e s t rates.
to b o r r o w r e s e r v e s at
Banks'
incentives
the Fed depend d i r e c t l y on the
difference
b e t w e e n the d i s c o u n t r a t e a n d m a r k e t i n t e r e s t r a t e s .
Changes
in m a r k e t rar.es, with a s l u g g i s h or unchanged d i s c o u n t r a t e ,
therefore alter banks'
i n c e n t i v e s to b o r r o w r e s e r v e s .
As a
c o n s e q u e n c e , a n i m p o r t a n t p a r t of re serve g r o w t h ( o r g r o w t h
of the monetary b a s e ) s l i p s o u t s i d e d i r e c t c o n t r o l of the
Federal Reserve .
In my j u d g e m e n t -- and t h a t of many e x p e r t s — the p r e c i s i o n
of m o n e t a r y c o n t r o l wouiJ be improved if
wo'jld f o c u s i t s
the Federal Reserve
short-run operations d i r e c t l y on controlling
some monetary a g g r e g a t e , i d e a l l y the monetary base
aggregate measure of bank reserves) and if
(or some
the discount r a t e
160
were tied to a market interest r a t e .
Evidence indicates
that the result would be a smoother, more predictable path of
money growth which would reduce uncertainty about f u t u r e i n f l a tion and m i n i m i z e the policy-related disturbances in real
economic a c t i v i t y .
Conclusion
The uncertainty that clouds the outlook in the f i n a n c i a l
markets is well summed up by a recent statement in Bondweek.
It r e a d s , "Though dealers say investors are cash r i c h , they add
that rates a r e n ' t h i g h enough to compensate r e t a i l buyers for
t h e i r u n c e r t a i n t y about economic performance and Federal Reserve
policy."
(Bondweek, January 30 , 1984, pg. 1)
I do not mean to imply that monetary policy is c u r r e n t l y
the source of all economic u n c e r t a i n t y .
C l e a r l y , progress in
resolving the b u d g e t d e f i c i t s i t u a t i o n would help reduce the
uncertainty about prospective economic performance and could
improve conditions in the f i n a n c i a l m a r k e t s .
But our unresolved
f i s c a l issues heighten the need for a w e l l - a r t i c u l a t e d and
p r e d i c t a b l e , n o n i n f l a t i o n a r y monetary policy.
A fundamental
fear of f i n a n c i a l market participants is that prudent monetary
control w i l l be abandoned in the f u t u r e as the Federal Reserve
"monetizes" large budget d e f i c i t s .
The best way to allay those
fears is for the Federal Reserve to establish and achieve
n o n i n f l a t i o n a r y money growth targets and for the rest of us —
the A d m i n i s t r a t i o n as well as the Congress — to support a
Federal Reserve policy of long-run, n o n i n f l a t i o n a r y monetary
control.
oOo
CHflRT 1
MONEY LEflDS INFLflTION BY TNO YEflRS
Growth Rates in GNP Price Deflator and Money Supply*
60
62
62
64
63
I
66
65
1
68
67
H
68
i
70
70
1
72
71
1
73 75
1—-H
74
76
78
76
H
80
78
1
80
1
82
81
1
84
83
86
( G N P P r i c e D e f l a t o r Scalel
•Quarterly figures.
Growth measured from one year earlier.
SHORT TERM RND LONG TERM INTEREST RfiTES
Meekly, since 1981
20-
18-r
16-
,- t*>J
14-
10-H--I I I 1+-H-+ 1 [ I t + 1-4HH-
1381
1982
1983
1984
i Vt
H I H A v ' i l l R 01 I N n K
MOrtF r A R T v O l . A T ['. ' TV.
'J 1MT K . A T F
I V'H
10 Y F A R
LlN>MGNf T A R Y V i l l . A ' l ! ! ' Y
—2
• M O N t ^ A R V V [ i | M i L 1 T ' j S A M P A S U R T Gf" THL" D E C R F F
D J i - r I f l J L ' Y I N r "LI4t"'' a .Sl ] NO MllNi-'i' ( ! R H W r H
AS [ i r c r K i r i t ; 1 m A ^MPY HY M A S C A R O -MM r/:i R.
S N T T R f 1 ; ! T\]f-, I N A R i ' - . K Y U()l(l [ i
IJf-" M I ^ J T T A H Y ' " i ri'lut-'.i i •-' . NiiVFi-.i'M; 1 'j;i ••>
; N II I I" ;i '• A - [ ' - A'i 1 " i;.•.'•'-; ' ( ^ - »...'! i-;.'.i'i
CORRELATION BETWEEN MONEY GROWTH AND HEAL 6NP
(Semiannual rate of growth In Ml and real GNP)
Oi
1979
I960
1961
1982
1963
1984
*Money growth is plotted with a one quarter lag.
The CHAIRMAN. Thank you, Mr. Secretary.
Yesterday Chairman Volcker said that the slowdown in money
growth during the second half of last year was the consequence of
an upturn in velocity. Would you comment on his statement?
Mr. SPRINKEL. Was a consequence of an upturn in velocity in the
last half?
The CHAIRMAN. Right.
REASON FOR SLOWDOWN IN MONEY GROWTH
Mr. SPRINKEL. In the earlier money series reported by the Fed,
there was a significant rise in velocity in the last half of the year.
However, as you know, they have just revised the series and much
of the velocity increase suddenly disappeared. So I would have to
see the statement within context; but it seems to me a much clearer statement of what happened was that there was a very sharp
contraction in the growth of adjusted reserves and the monetary
base.
For example, I will read you some numbers. With respect to adjusted reserves in the first quarter of last year, they rose at an
annual rate of 11.5 percent; in the second quarter, at 10.4 percent;
the third quarter, 3.8 percent; the fourth quarter, 4.5 percent. If
you prefer the monetary base, the same pattern is evident—11.4,
10.9, 6.8, 8 percent.
So the real reason, in my opinion, for the slowdown in monetary
growth in the last half of last year was that open market operations were conducted in a way that reserve growth slowed substantially. There is no way the system can expand the money
supply with a sharp contraction in reserve growth.
The CHAIRMAN. Again, you repeated what you said in your statement that due to the slowdown in monetary growth in the last half
of 1983 that you expect a slowdown in the economy in the first half
of 1984.
Mr. SPRINKEL. Yes, sir.
The CHAIRMAN. Now other economists argue that the economy is
slow because this is natural and in fact desirable in the second
year of expansion, that we were growing too rapidly, that inflationary pressures and the fact that there was a slowdown is not only
natural and but also desirable.
Mr. SPRINKEL. I agree with both statements. It is indeed to be
hoped that the rates of rise in total spending and real output will
not soar at the rates that were evident in the early part of last
year when we were in the very early stage of the recovery.
The rate of rise in economic activity, of course, did slow throughout 1983 and in the fourth quarter, as I remember, was rising at
about a 4.5-percent rate.
The risk is that either growth could become negative—I don't
know that that will happen—or that the rate of growth will be substantially below our real capacity for growth. That would mean,
unfortunately, rising, not declining, unemployment. We have made
enormous progress in getting the unemployment rate down and I
do not want to see it reversed.
The CHAIRMAN. Mr. Secretary, I'm troubled by a general theme
of your testimony and I don't mean that personally because I'm
166
troubled by almost all the testimony that I've heard lately, or the
questions from some of my colleagues or the public comments from
those who are not members of this committee, and that is that it
seems obligatory that everybody comes here and decries the deficit
and how they are damaging and we simply must do something
about them. But then, it ends and everybody seems, some much
more than others, some more blatantly than others, to shift it to
monetary policy. And this is true of the administration; it's true of
Secretary Regan; it's true of your testimony. It was true yesterday
in most of the lines of questioning.
I'm not a trained economist, but just since I have been in the
U.S. Senate in 9 years, the first year I was here, President Ford's
budget recommendation was for $295 billion and we passed $318
billion. So in a relatively brief period of time I have been here to
see budgets of $300, $400, $500, $600, $700, $800, and now $900 billion, $1.4 trillion of accumulated national debt, $130 billion of interest on the national debt which is in excess of what John Kennedy ran the whole country for and defended for just 22 years ago,
and although everybody touched on it, it is basically lip services,
that somehow that doesn't have anything to do with it and if we
could just make the Fed have a stable monetary growth that somehow that's the big answer to inflation, and interest rates, and everything else.
Now that's what I'm hearing day after day after day and I know
you, Secretary Regan, the administration, and Congress all decry
the deficit, and then we all seem to get the shift, whether it's
subtle or whether it's really overt for political reasons, that somehow this enormous increase in spending—look at U.S. News and
World Report put it in graphics and when they put it in graphics
and look at the last several years and those big blocks of red and
this accumulated deficit, I just have to take the opposite view that
certainly monetary policy has something to do with it, but we are
essentially trying to make somebody else the scapegoat for the
problems of the executive and legislative branch, everybody else,
and ourselves.
We've got testimony later—I was reading the testimony of one of
our private sector witnesses and he's going to have a recommendation that Congress require the Fed to have certain targets and if
they miss them by 1 percent they are required to submit their resignations to the President.
Now if we placed those kind of standards on Congress for our
missing estimates in the budget, nobody would be here and we
would have no Congress, It would turn over instantly.
So maybe it would be a good idea to apply it to Congress, but I'm
really troubled by all of this testimony. And maybe that is not your
intent, but that's the way I continually take it from almost everything I hear is that none of us are responsible. It's just that
damned Fed. I can't buy that argument. I just cannot buy it in
light of the evidence of the fiscal performance of Congress and the
recommendations of several administrations.
Mr. SPRINKEL. I have been very careful, in this testimony, public
statements, and prior testimony, to avoid scapegoating the Fed. I
have given them public commendations, as I did again this morning, for getting the rate of growth in money down, I explicitly
n>7
stated that even if we had a balanced budget we should have
stable, moderate growth in the money supply. If we have a massive
deficit, which is what we have, we should still have stable growth
in money. That is all that I am asking.
That doesn't solve the fiscal problem. There is a relation between
the two. There are risks associated with large deficits; they are
that—not automatically—but it could through political pressure or
otherwise, lead to inappropriate monetary policy. That need not be,
but it could happen. These hearings, of course, as you suggested to
me, are on monetary policy. I certainly have strong views about
getting that deficit down. It, creates very real problems. They have
to do with capital formation. It has to do with productivity improvement. It has to do with improved standards of living. It has to
do with growth in jobs into the future. It is extremely important
that we permit that capital formation pattern to proceed without
the Government absorbing a high percent of total credit, and that
is a real problem.
But the problem is compounded if at the time we are unable to
exert fiscal discipline, we at the same time have extremely volatile
monetary policy. All that I am saying is that we need both. From a
monetary policy point of view, we need a slow, predictable rate of
growth that people have confidence in, so we can get interest rates
down.
The CHAIRMAN. I don't disagree with you, but I don't think it is
possible for the Fed to be able to even predict monetary growth ac
curiteiy enough—I know we have talked in the past about going to
con "i iporaneous accounting rather than lagged and improving
some of the mechanisms and getting away from weekly reporting
which everybody agrees is not accurate and all of that. But hov,
can you expect that to be done with the irrational behavior of fiscal
policy in this country? They have to go together. They have to
work together and we have had the Fed the only actor in town for
many years attempting to do what you're suggesting they do and
admittedly sometimes not very well, but our performance is unbroken. Nobody ca i say that we in Congress on the fiscal policy have
even come close o any stability or reasonableness or any commonsense at all.
That's where I get; we're trying to scapegoat it over here. I
almost wish, to prove my point, that we could find an Open Market
Committee who was so perfect that they could run the type of
growth that everybody wants to be run, do it perfectly, and, boy,
then would we highlight what is going on over here or what is not
going on over here.
Mr. SPRINKEL. I would be glad to settle for what the technical experts in the Federal Reserve System say is doable, that is, they will
hit their target within plus or minus 1 percent on average per
quarter. That would be marvelous. That's not perfect, but it's very
good and much better than what they have done in the past.
The CHAIRMAN. Senator Proxmire.
DISCUSSION ON SECRETARY SPRINKEI/S CHARTS
Senator PROXMIRE. Secretary Sprinkel, you're an ideal witness
because you've had a lot of practical experience as a banker; you
168
taught at the University of Chicago, you're recognized all over the
country as one of the outstanding monetary experts in the country,
and you've had solid experience in Government with the Treasury
Department for the last 3 years. So I certainly welcome you as an
expert on this and I'm intrigued by the charts you give us showing
the relationship between the change in the money supply and
growth in prices.
It's an astonishingly close match on growth and it's reasonably
close on prices. You say there's a 2-year lag, I take it, between a
change in the money supply and the corresponding change in
prices; is that right?
Mr. SPRINKEL. Yes, sir. Most of the evidence says IVb years to 2
years.
Senator PROXMIRE. And you see a 3-month lag in the relationship
between the change in the money supply and economic growth?
Mr. SPRINKEL. If you use a 6-month average of money growth,
you come out with about a 3-month lag. But from the time the first
action is taken, it is something on the order of 6 to 9 months before
a change in money has an important bearing on real output.
Senator PROXMIRE. All right, 6 to 9 months. Now what effect
would it have on unemployment inasmuch as employment is a lagging indicator and inasmuch as employers normally don't hire or
lay off until they have to. Would you say there might be a 9- to 12month spread or something like that?
Mr. SPRINKEL. Maybe even less. It's true that when orders go
down for whatever reason they don't immediately lay people off
and there might be a little additional lag; but there's a fairly close
relation to total output as measured by either real GNP or initial
production and employment.
Senator PROXMIRE. Well, this has fascinating political implications.
Mr. SPRINKEL. Yes.
Senator PROXMIRE. Because it means that Paul Volcker and the
Federal Reserve Board can now get off the hot seat as far as the
1984 elections are concerned, that's it. Everything is in the bag because the growth you say is 6 to 9 months and unemployment will
be closer to 9 probably, prices at 2 years. So whatever policy they
follow in March isn't going to elect or defeat President Reagan in
the election. Is that right?
Mr. SPRINKEL. Sir, that's your conclusion.
Senator PROXMIRE. Well, I'm arguing on the basis of what you
tell us here. As far as the budget is concerned, it's certainly your
conclusion.
Mr. SPRINKEL. What I hope I conveyed to you was that the monetary path in the immediate future now, tomorrow, the next few
months, is critically important as to whether we have a severe
downturn in the economic activity or a modest one. To me that
means jobs and, hence, we want to continue to see what has happened in December and January: growth in money of moderate
proportion.
Senator PROXMIRE. Secretary Sprinkel, I agree with that. All I'm
saying is that the timing that you have given us this morning
shows a lag and
Mr. SPRINKEL. That's right.
169
Senator PROXMIRE. And then you've just changed horses by
saying from the time the Open Market Committee makes a decision until the time that is felt in economic growth and employment
and the time it's felt in prices is a considerable number of months,
in the case of growth, from 6 to 9, in the case of prices, it's 2 years.
Mr. SPRINKEL. Yes, sir. We might be talking about the effect on
the late second or third quarter if we continue to get more money
starting today.
Senator PROXMIRE. Now, as I look at this first chart of yours on
prices, it appears that there was a big increase in the supply of
money in 1982 and therefore that should result in some sharp increase in prices in 1984 if this holds; is that,right?
Mr. SPRINKEL. There was a very substantial increase in the rate
of growth in money starting approximately August, if I remember
correctly, of 1982 and extending through the spring of 1983, perhaps as late as June. Raising the average rate of money growth for
the past 2 years, as indicated by this chart, does imply some increase in the inflation rate in 1984 and our official projections, of
course, allow for that.
Senator PROXMIRE. They allow for as much of an increase as is
indicated here? This is a very, very big increase in 1982.
Mr. SPRINKEL. You'll notice from the most recent numbers that
the average growth in the money supply has been dropping and
that's what I ve been concentrating on; it depends on future action
starting now.
Senator PROXMIRE. There's a 2-year lag. What happened in 1982
was that you had a sharp increase in the money supply and therefore you may have a sharp increase in prices this year,
Mr. SPRINKEL. In the latter half of this year, I expect some
upward movement of prices above what they were in 1983,
Senator PROXMIRE. Now do you agree with the projections that
accompanied the budget document of interest rates declining and T
bills declining from 9 to 5 percent, and the mortgage rate declining
from 12.5 to 7 percent between now and 1989?
Mr. SPRINKEL. That's over a considerable number of years. If we
conduct the kind of monetary policy that I talked about today and
the kind of monetary policy the Federal Reserve is talking about,
and make progress on the budget, then yes, it is possible.
Senator PROXMIRE. Doesn't that assume a tremendous improvement in the confidence of the public that inflation is under control?
Mr. SPRINKEL. Yes.
Senator PROXMIRE. You now have a difference between an inflation rate of about 4 percent and the T bill rate at around 9 percent;
that's a 5 percent difference. The assumptions here say we'll have
an inflation rate of 3.6 percent in 1989 and a T bill rate of 5 percent. That's only 1.4 percent. That means you've got a tremendous
improvement in confidence. With the colossal deficits we're running it's hard for me to agree with it.
IMPROVEMENT IN THE INFLATION RATE
Mr. SPRINKEL. It's based on what I believe is a valid assumption:
that statements by leading public officials that they're going to get
inflation down mean very little, whether it is coming from the ex-
170
ecutive branch, or Congress, or the federal Reserve. What does
mean a lot is what actually happens. If, in fact, over a period of
several years, the inflation rate continually comes down, we'll
begin to believe it, and there will be some improvement—as there
has been already—in inflationary expectations. If we keep inflation
reasonably low over the next few years, I expect a lot more people
will believe it. I might even believe it.
Senator PKOXMIRE. You just conceded we'd probably have a
sharp increase in inflation this year on the basis of the increase in
the money supply in 1982.
Mr. SPRINKEL. I said that I expected the inflation rate to be moderately higher in 1984 than in 1983.
Senator PROXMIRE. Now on the basis of your professional experience and your experience in the Treasury, would you agree or disagree with the argument that monetary policy is responsible for
tnost, perhaps 90 percent, of the changes in prices over the years?
Mr. SPRINKEL. Yes, sir; I do.
Senator PROXMIRE. It was a principal factor?
Mr. SPRINKEL. Yes. This is true, not only in our country. It's true
hi every other country I have looked at. I—and many others—I have
never been able to find—and if you have the data or your staff has
the data, I'd like to see it—I've never been able to find a country
with high inflation and low money growth; nor have I been able to
find a country with high money growth and low inflation. They go
together as far back as data are available.
Senator PROXMIRE. I'm not going to argue with you. You make
my point. The point is that we've had a remarkable improvement
in inflation in the last couple of years?
Mr. SPRINKEL. Yes, sir.
Senator PROXMIRE. It's amazing. And the credit for that therefore should not go to the administration. It ought to go to the Federal Reserve Board. The administration has nothing to do with
monetary policy.
Mr. SPRINKEL. I think they deserve a lot of credit and I have
given it to them this morning and I've given it to them on other
occasions as I will in the future. But we have supported that policy
instead of fighting it. I think we both deserve credit.
Senator PROXMIRE. Well, you have supported the policy, but it's a
policy that the Federal Reserve Board under the constitution is obligated for to the Congress, so I don't think either one of us, either
the Congress or the President, can take much credit for this in
view of our fiscal performance.
Do you agree with the following propositions: No. 1, the Federal
Reserve monetary targets are about right for 1984?
Mr. SPRINKEL, I think they're reasonable. What I hope happens
over time is a very gradual notching-down of the targets. Until
eventually, gradually, we get money growth growing in line with
zero inflation and 3.5 or 4 percent real GNP growth; and that is
doable. We have already paid the big price for reducing inflation
and it wasn't costless. We don't want to let that genie out of the
bottle again.
If we can gradually pull money growth down and hit the targets—I'm not just talking about targets; I'm talking about hitting
the targets. If we do that over time, I'm very confident that we can
171
go back to zero inflation. I can remember zero inflation. Most
young people I know can't possibly imagine it.
Senator PROXMIRE. I can remember deflation, too.
Mr. SPRINKEL. I can remember that too, but it's rather painful.
Senator PROXMIRE. Well, let me ask you: No. 2, do you agree with
the proposition that the Federal Reserve really cannot bring down
interest rates from monetary policy without risking a resurgence of
inflation?
Mr. SPRINKEL. They cannot bring rates down by rapid growth of
money. That would have exactly the opposite effect.
Senator PROXMIRE. Therefore, the problem of high interest rates
will have to be met through fiscal actions, that is closing the Federal budget deficit, given the kind of monetary policy that you already defined and that I would accept?
Mr. SPRINKEL. I expect that if we have moderately slow and
stable growth in money over time with a gradual ratcheting down,
then inflation and inflationary expectations will come down and so
will interest rates. We have looked very hard—we've looked at the
academic literature, I've had my own staff work on it—trying to
find the relationship between interest rates and deficits. Intuitively, I believe it's there. Theory says it should be. I have yet to find
that evidence.
There is a good relationship between inflation and inflationary
expectations and interest rates. If there is a good relation on deficits and interest rates, I have not found it and I would appreciate
receiving any evidence that anyone else has.
Senator PROXMIRE. Thank you. My time is up.
The CHAIRMAN. May I note for the record that I can't remember
deflation. [Laughter.]
Senator Gorton.
Senator GORTON. Mr. Sprinkel, on page 7 of your written testimony you make the dramatic and I think dramatically true statement
that the severity of the last recession should lead us not to the conclusion that the process of restoring price stability is too costly but
that it is so costly that we cannot afford to go through it again, and
am I fair in characterizing your whole message as essentially being
that, that if we allow inflation to recur once again we will once
again be faced with the terrible prospect of tight money controls
and a recession in order to wring that inflation out of our economy?
Mr. SPRINKEL. Yes, sir; because I believe political pressures will
build, as they did over the last decade, to limit inflation and that is
painful. It is painful in terms of jobs and lost opportunity.
Senator GORTON. Is it fair to say that that represents a change in
your point of view or the point of view of the administration between 1981 and today?
Mr. SPRINKEL. No, sir, I can remember testifying essentially to
that point on earlier occasions before I came into this Government.
Once there is get price stability, it is a priceless phenomenon and
we should not let it get away from us. We are not there yet, but we
are getting there.
Senator GORTON. Was it not the position of the administration in
1981 that we could control inflation and limit it without a recession?
172
Mr. SPRINKEL. We had a strategy of very gradual reduction in
money which had a good shot at getting inflation down over a long
period of time without causing a recession. Unfortunately, we did
not get a gradual deceleration of money. We got a "cold turkey"
adjustment and every economic theory I know says that if you
have a quick deceleration of money growth after high money
growth, the result is a recession.
Senator GORTON. So whatever the general support you expressed
in answering Senator Proxmire's question about supporting the
monetary policies of the Fed, it does not go far enough to include
the policies of the Fed in 1981?
Mr. SPRINKEL. That's right, and we so stated at Treasury during
that period.
Senator GORTON. You also stated, I believe, not only in your written statement but in answer to Senator Proxmire, that inflation
will be higher in your expectation—the rate of inflation will be
higher in 1984 than in 1983?
Mr. SPRINKEL. Yes, sir.
Senator GORTON. Why?
Mr. SPRINKEL. Well, partly because of the monetary expansion in
1982-83 which we have discussed. That is, the 2-year rate of money
has turned up somewhat, even though it has been weak more recently. Also, if you look at the pattern of a typical economic recovery in the first year of a recovery, inflation rates frequently go
down. That's what happened this last year. After that they have
typically gone up.
Now I do not think it has to continue rising. It all depends on
money policy. But both from the cyclical view and from the higher
rate of money growth, we admit that we will have somewhat
higher inflation this year. I do not expect it to be dramatically
higher, but I could be wrong.
Senator GORTON. Is it possible to adopt economic policies which
would prevent the rate of inflation being any higher this year than
last year? If so, what would those policies be and what economic
consequences would they have?
GRADUAL SLOWING OF RATE OF GROWTH
Mr. SPRINKEL. It is too late to do that. But it is not too late to
prevent another repetition in 1985 and 1986. Responsible policies
mean setting targets similar to the ones set by the Federal Reserve
this week and attaining those targets; that means over time a very
gradual slowing of the rate of money growth.
Senator GORTON. Would the adoption by the Congress of fiscal
policies which sharply reduced the deficit from what it will be
under our current services budget or even under the President's
proposed budget have any impact on the rate of inflation or on interest rates?
Mr. SPRINKEL. I would not expect it to have a dramatic effect on
the rate of inflation, but it would have many other highly desirable
effects.
Senator GORTON. What would those other effects be?
Mr. SPRINKEL. Well, primarily, that we release savings that I
absorb in my role of financing the deficit and permit those savings
to be utilized in the private sector of the economy, which '& njuoii
more efficient. Then we can get real growth of greater magnitude,
more jobs, higher real income—that is my concern about a nercrtually large deficit. So it is critically important that we reduce the
deficit and I think that is generally agreed upon by most of the
Congress and certainly by this administration. There i= so.ao
debate about how we do it. There is quite a debate about how we do
it, and that entails some difficult choices.
Senator GORTON. Let's ask the reverse of that question. Yesterday before the Senate Budget Committee, Mr. Penner testified that
in fiscal 1983 the Federal deficit amounted to 107 percent of domestic net savings and will still be at 80 percent of domestic net savings in 1984.
If we don't do anything about budget deficits, if the country continues to use such a large share of its savings to finance that deficit, must not a real economic growth inevitably fall nearly to z^ro
or at least be sustained only by foreign capital inflows?
Mr. SPRINKEL. It will certainly put a damper on real economic
growth. It is hard to measure how much. I think it is important to
recognize that the real problem is that Government spending as a
percent of GNP has gone up very substantially, while taxes a« a
percent of GNP have been quite flat. We are already allocating
those resources to Government. And from my point of view, the important thing is to get better control over spending over time so
that we can close the gap that the deficit clearly represents.
Senator GORTON. Did the tax cuts of 1981 increase the rate of
savings in the United States?
Mr. SPRINKEL. It's a little difficult to answer because I am a little
suspicious of the data. If you look at the national income data,
there is no evidence. If you look at some indirect data such as the
Federal Reserve flow of funds—and you cannot reconcile the two,
unfortunately—there is rather clear evidence that holdings, liquid
assets have gone up very substantially.
Now I believe that when you cut marginal tax rates and deregulate the financial system, giving savers more options and higher
rates of return, I would expect that to have an effect on savings in
a positive way; and I believe it did, but I certainly cannot prove it
because of the data problems.
Senator GORTON. But in spite of the uncertainty of the answer to
that question, are you convinced that a tax increase this year
would reduce the rate of savings?
Mr. SPRINKEL. Yes. I think all tax increases have an adverse
effect on incentives, but some kinds of tax increases have more adverse effects than others.
Senator GORTON. Thank you, Mr. Chairman.
The CHAIRMAN. Senator Humphrey.
Senator HUMPHREY. Mr. Secretary, I'm new to this committee
and I think I agree with what I've heard you say here today in
large measure and likewise with what Mr. Volcker had to say yesterday, and you seem to agree on one important point—the two of
you—that the monetary policy should be to provide a stable and
moderate monetary growth at a rate consistent both with price stability and sustainable real economic growth, and the implication is
that if the rate of monetary growth is too high, then we would reap
174
inflation; and if it were too low, then we would reap high interest
rates and economic slowdown.
The question is how do you or we decide what is the proper monetary policy at any given time? How do we know, for instance,
right now at this critical juncture, with lots of worrisome things
happening in the financial marketplace at the moment—how do we
know that monetary policy isn't too restrictive for these particular
circumstances pertaining today and for the next couple weeks?
You noted in your testimony that departures from goals can be
justified under certain circumstances. Are we at one of those junctures where we can justifiably depart?
Mr. SPRINKEL. The real reason that I recommended moderate,
stable, predictable money growth is because of my ignorance and
other people's ignorance. No one can know with certainty what the
future will bring. There is no way to know with certainty. We
know something about the past, but we don't even know what is
happening to the economy today. Economic data is available with a
lag of a month or two; but then the preliminary data is often revised. So there's a great lack of timely knowledge.
Senator HUMPHREY. Yes.
Mr. SPRINKEL. Therefore, massive changes in money lead to even
greater uncertainty and what I'm recommending—and I believe
the Federal Reserve agrees with this—is that we shouldn't try to
fine-tune because we are not that smart; the prudent cause is moderate growth in money. Over time, you gradually, very slowly,
reduce the rate of money growth until it is consistent with our
long-term real economic growth potential, which might be 3.5 or 4
percent, depending on what we do about savings and investment
incentives in the months and years ahead.
Senator HUMPHREY. Yes, but if that stable growth is too low
under the circumstances, then it isn't so virtuous after all, is it?
Mr. SPRINKEL. Well, as I indicated in my testimony, I am concerned about the sharp deceleration in money growth that has occurred over the last 6 months or so. The reason for that concern is
that if you go back and look at history—I come from Missouri and
we have a motto around there that says "show me," so I don't believe things that I can't find some evidence for—if you go back and
look at that evidence, you find changes in real economic growth—
that is, things you and I are interested in—employment, jobs, profits, production—are related to sharp changes in money growth, not
levels, changes in growth rates. Even after the revised numbers
that were issued recently, there has been a very substantial deceleration in money growth from the first half of last year.
Historically, that has inevitably led to a slowdown, sometimes a
recession. In 1966 it led to a slowdown, but not a recession. We had
two quarters of essentially no change in real GNP. On other occasions it's led to a grinding downturn; I am not smart enough to
know what is going to happen this time, but I am quite confident
that we're in the process of slowing down. Certainly the equity
markets suggest that as well.
SLOW GROWTH COULD LEAD TO ANOTHER RECESSION
Senator HUMPHREY. Now you said earlier—I was only half listening when I was reading some of your testimony— you said earlier,
if I heard you correctly, that the only question about the future is
how severe the recession will be that is coming; is that correct?
Mr. SPRINKEL. No. I said there will be a slowdown, even a significant slowdown in the rate of growth is a possibility, but I wouldn't
call it a recession. But if we continued to get very slow money
growth for another 6 months, I certainly would expect a recession.
I am not predicting that we will—the last 2 months, December and
January, witnessed pretty good growth in money and I hope it continues.
Senator HUMPHREY. Getting back to this option of flexibility, on
page 10 of your testimony, you say, "There is no inconsistency between setting and following monetary targets and maintaining
basic flexibility to respond to changing institutions or developments."
Do you not see the action of the stock market over the last
couple of weeks—in fact, of the broad market over the last 4 or 5
months as a sign there's a changing development that ought to be
paid attention to and should be the cause of our changing course
somewhat in monetary policy?
Mr. SPRINKEL. I follow the markets very carefully and I wrote
three books on the relationship between money and equity prices,
so it's not a new idea to me. Inevitably when you get a severe
squeeze—a sharp slowdown in the rate of growth in money—you
typically get a weak stock market, and that weak market inevitably precedes a slowdown in economic activity.
Senator HUMPHREY. Well, the market is weak because people are
worried about decreased profitability and a slowdown in the economy. Isn't this reduction in growth of supply of money causing lower
stock prices? People worry about the economy, and profitability,
and so on?
Mr. SPRINKEL. Yes, I agree with that.
Senator HUMPHREY. Well, then are you supporting the presort
growth targets by the Federal Reserve?
Mr. SPRINKEL. Yes, sir; I am.
Senator HUMPHREY. You don't think they're too restrictive?
Apart from the stability, you don't think they're too restrictive?
Mr. SPRINKEL. No, sir; I do not. There was a very modest downward notching of targets. We have been fully supportive of all of
their targets since we have been in office, and I hope to remain in
that position. We urge that they attain those targets.
Senator HUMPHREY. I'm certainly not making excuses for sloppy
fiscal and irresponsible fiscal policy which this Congress is pursuing, but I hope that the Federal Reserve will not operate in an
ivory tower just to show how virtuous it thinks itself is. It's my
opinion that monetary policy is too tight. It's going to send us into
a situation of recession with Federal revenues falling, demand for
Federal expenditures rising, and that situation will just get very
much worse if we don't have easier monetary policy.
17(1
I'm not calling for monetization of the deficit, but I do think
we're erring on the side of being too low, too tight in our monetary
policy.
Thank you, Mr. Chairman.
The CHAIRMAN. Senator Heinz.
Senator HEINZ. Thank you, Mr. Chairman.
Beryl, thank you for your testimony. You're here presenting the
;H] ministration point of view. Part of what you've said is that
to the extent there are problems, much more have to do with the
way the Federal Reserve handles monetary policy than the way
Congress and the administration has handled fiscal policy. Is that
correct?
Mr. SPRINKEL. I didn't mean to say that, Senator Heinz. I was
asked to talk on monetary policy. I could have given different testimony on fiscal policy. I have great concerns about how we are handling fiscal discipline in this country.
All I said was that since we have not exerted discipline on fiscal
policy, it's even more important that we have a moderate, steady,
piudictable monetary policy. They are equally important, but for
somewhat different reasons.
Senator HEINZ. I think that's a helpful clarification. So that I understand you, you are saying that the Federal Reserve has just
been too unpredictable?
Mr. SPRINKEL. Yes, sir.
Senator HEINZ. Is the problem their inability to control from
week to week and month to month the aggregates and the other
outcorues of their methods, or is it that you think they should
pursue either higher or lower growth rate?
Mr. Sr-RiNKEL. I do not believe that they are unable to achieve
targets. The Federal Reserve staff—and they are the experts—have
said that if they chose to do it, they could hit a monetary target
within plus or minus 1 percent on average each quarter. I believe
it is improbable that such a good result would occur, however,
Kivev the Fed's present operating technique. We have suggested
some important changes, one of which has already been implemented and we applaud that.
Senator HEINZ. Contemporaneous reserve accounting?
Mr SFRINKEL. Yes, sir. But in addition to that, instead of focusing on the Federal funds rate, I would urge that they focus either
on bank reserve growth or on the monetary base—I don't much
care—and that we have a flexible discount rate.
Senator HEINZ. My question was not so much what you suggested. I asked you whether the problem with the Fed policy was its
periodic variability in hitting the center of its target range or
whether you thought the targets were, per se wrong?
Mr. SPRINKEL. No, it's the variability.
Senator HEINZ. And if you thought the targets were wrong,
whether they should be higher or lower.
Mr. SPRINKEL. It's the variability, not the targets.
Senator HEINZ. And therefore, if the Fed got pretty much the
same result that they got last year, which is in aggregate as I recollect Mr. Volcker's testimony, on a corrected basis, they hit pretty
much the middle of their target range for Mi, M2, and Ma, you're
saying that if on a week-to-week and month-to-month basis, if they
177
had been more consistent, real interest rates would be lower. Is
that right?
Mr. SPRINKEL. Not on a week-to-week or month-to-month basis,
because I don't think it is technically possible. I do believe it's possible on a quarter-by-quarter basis and I would expect that if we
get more stable money growth, that would reduce interest rates as
well as contribute to decreased inflationary expectations.
Senator HEINZ. So if they had done better on a month-to-month
basis, we would have lower real interest rates?
Mr. SPRINKEL. Quarter-to-quarter.
Senator HEINZ. Quarter-to-quarter, I apologize. If there had been
less variability in their performance we would have had lower real
interest rates?
Mr. SPRINKEL. That is my judgment. If i-, not a hip pocket estimate. We have done a lot of technical work or- it. Ft. we believe we
have good evidence supporting that statement.
Senator HEINZ. I understand. Now they did come in over the last
12 months aggregated about where I think you would want them to
come in; is that right?
Mr. SPRINKEL. Yes.
Senator HEINZ. If they had done it your way or as you have suggested within the technical limits of plus or minus 1 percent on
average quarter-to-quarter, how much lower might—I'm not expecting to get a precise forecast, but how much of a drop in real
interest rates might we have seen? Are we talking in the neighborhood of one-eighth of 1 point or 2 points or what are we talking
about here?
Mr. SPRINKEL. When we did the paper sometime asking tire Question—how much has monetary variability added to nominal interest rates—the numbers that came out in the range of 200 to 300
basis points. So it is not insignificant. There are some people that
think that's somewhat of an overestimate. Some people believe the
estimate is 100 to 200 basis points.
Senator HEINZ. Which is the same as 2 to 3 interest points, is it
not?
Mr. SPRINKEL. Yes, sir.
Senator HEINZ. That's a very large amount.
Mr. SPRINKEL. I think it's worth trying to capture a portion of it.
Senator HEINZ. If it's true, it certainly is. You may be right,
Beryl. I find it difficult to believe that the amount of variability
you re talking about—and I, like you would like to see less variability—but I find it difficult to believe that straightening the line out
on Fed quarterly performance would bring interest rates down
even 2 points. If it were true and you could do it, you'd be a genius.
It's not that. I don't think you're a genius, it's just that 1 don't
think it's true.
Mr. SPRINKEL. Well, Senator Heinz, I will be very pleased to
share with you the evidence that we have. That's all I can say.
Senator HEINZ. I hope that's not the same evidence that Don
Regan told us about in which all of the tax cut would go inro savings.
Mr. SPRINKEL. I don't remember that statement.
Senator HEINZ. Unfortunately, the Finance Committee has a
transcript of the hearing.
178
OVERVALUATION OF THV. DOLLAR
Let me turn, if I may, to the question of the trade defj ;!r '-,hKi
is $70 billion this year. You mentioned in your remark;- ^ruer
that you're very concerned about what's happening. A» L rer^uxi,
you indicated the problems with capital formation, p _:<]uci.u'>, >:;'.'
creation; and yesterday Mr. Volcker said that if the U'jiiar remaps
overvalued for much longer we're likely to see real Jong-tern) KU uc
tural damage to our most competitive U.S. indu^tri^. I gath , <,.
would agree with that?
Mr. CPRINKEL. I did not read the total statement. I do.;'L k:;cv
what it means to say the dollar is overvalued. We have a \un
large free market where buyers and sellers in a highly cor^pei. r,
situation representing $30 or $40 billion in New York City aloi.e-estimated over $100 billion a day worldwide—get together and bid
against each ether and the rates fall out. The usual computauoris
concerning whether it's overvalued or undervalued are based on
very slippery evidence from my point of view; that is, they use typi
cally purchasing power estimates and they find some period in the
past where it was magically correct—I don't know how they identify that period—and then they observe price changes since then and
they say today it is obviously x percent overvalued. But that leaves
out many other considerations—capital flows and other adjustments. Consequently, I just cannot buy the statement. I can certainly agree that the dollar is a lot higher vis-a-vis most other currencies, except the yen, over the test '2 or 3 years; but to say it is
overvalued, I cannot.
Senator HEINZ. One way of judging the overvaluation of the
dollar, I would suggest, is the trade deficit. If we had been running
a trade deficit somewhere in the range of zero to $30 billion and
suddenly it goes to $70 billion and it's projected to go to $130 billion, all during the 3 years that the administration has been on
block, there are two possible analyses.
Either, one, that in the last 3 years the country under Republican stewardship has lost its competitive ability inherently, or the
dollar is making a mess of our international competitiveness. It's
either happening overseas or it's happening at home. Now which i^
it?
Mr. SPRINKEL. I have views as to why the dollar rose and that's
essentially what you're asking.
Senator HEINZ. No. What I'm asking is, we've got a big trade
problem.
Mr. SPRINKEL. Yes.
Senator HEINZ. And it's $70 billion and it's going to be nearly
twice as much next year, this year is twice as much as last year,
and it means one of two things is wrong. Either in the last 3 years
things have gone to hell in the United States and we're getting less
competitive and we're going backwards in terms of our industries,
or for other reasons having to do with the interplay of fiscal and
monetary and market forces around the world the dollar is overvalued. Those are the only two reasons that it could be this way.
There's no third alternative.
Mr. SPRINKEL. I find it
Senator HEINZ. Other than taking the fifth amendment.
179
Mr. SPRINKEL. I find it very difficult to believe that the situation
in the United States is so dire when I recognize from all over the
world people are bringing money here because of high rates of
return, because of confidence that we are getting inflation under
control. This is what, in essence, is driving up the dollar. This, in
turn, has created a trade deficit and that is, of course, working
against a further appreciation of the dollar.
So it is good developments in the United States—respect for the
dollar, belief that a dollar will be a dollar—that causes most people
to value the dollar. That includes both profitable rates of return
here and it also includes political instability abroad.
Senator HEINZ. I would agree with much of what you just said. I
would perhaps be tempted to say that it's not so much a question
that the dollar is outstanding. After all, I think you and 1 both
learned as well as we're taught that when trade deficits get larger
and larger there is a day of reckoning at which point people who
are putting the money into your country with the trade deficit
says, "Say, I wonder how we're ever going to get paid back," and I
suspect, therefore, it's not so much that we're doing a terrific job
over here; it is, who wants to hold francs; who wants to hold crusaros; who wants to hold deutsche marks, especially with all the
people running around near the military bases?
Just because we are the best of the lot doesn't mean that we are
performing the way you or I would want to perform.
Mr. Chairman, I know my time has expired. I will just make this
one comment. I thank Beryl Sprinkel for his answers. I really
worry, Beryl, that the dollar in fact is overvalued and I think we've
discussed pretty much the dynamics. I think we can both be righi
in the context of the discussion as to why it is overvalued. In a
sense, thank God it is overvalued because if it wasn't interest rates,
instead of being 10, 11 or 12 percent, would be 15, 16, and 17 percent, and we wouldn't have the liquidity to finance what we've got
without the capital flowing in, but I worry that what we've got is
going to bring about the deindustrialization across the board in all
our capital intensive, high tech, and competitive industries. I worry
that we're going to experience a deindustrialization of the United
States. That is quite the contrary to what the administration and
all of us want. Indeed, the whole idea behind having tax incentives
for investment was to reindustrialize the United States. I believe
that the deindustrialization follows from a budget deficit that is
out of control, when the market reacts as it does, down 24 points
after yesterday's advance, Don Regan being a part of it, his statement being a part of it, but probably the reality of the President's
downpayment apparently isn't a downpayment; the $180 billion
deficit includes the downpayment, at least based on the events of
yesterday in the 14 measures submitted to the "Gang of—however
many they are. I think we have something very serious to worry
about and I know you worry about it, the question is I wonder if
we're doing enough about it.
I appreciate your testimony on the monetary policy side. I think
you have made some good suggestions, irrespective of whether it's
200 or 300 basis points or not, they probably should be pursued.
Thank you.
The CHAIRMAN. Thank you, Senator Heinz.
Mr. Secretary, we appreciate your willingness to testify before
the committee and, as always, you're very articulate and very
direct. The committee appreciates the fact that you do answer
questions in a manner that is not evasive and we're able to understand you. We appreciate that very much. Unfortunately, all witnesses that we have before this committee over a period of time do
not do that. So we especially appreciate your candor. Thank you
very much.
Mr. SPRINKEL. Thank you, sir; my pleasure.
The CHAIRMAN. Our next witness is the Honorable Martin Feldstein, Chairman of the Council of Economic Advisers.
May I say while we're changing that Senator Proxmire has a
question that we'll submit to you, Beryl, for a response from you in
writing.
QUESTION SUBMITTED BY SENATOR PROXMIRE FOR THE RECORD
Whether you believe budget deficits and high interest rates are the cause of misaligned currencies, I was delighted with the Agreement made in November during
President Reagan's visit to Japan that was aimed at strengthening the value of the
yen relative to the U.S. dollar by increasing international demand for the Japanese
currency.
I understand the Japanese made commitments to (1) eliminate the real demand
rule in forward exchange transactions; (2) reform their designated company system;
and (3) issue foreign currency denominated national bonds. Recently we have read
that the Japanese are reneging on some of those promises.
Can you give us a status report on where things stand? Do you expect that the
misaligned yen/dollar rate can be cured and if so when?
Answer. The Japanese have followed up on a number of the specific steps announced during President Reagan's trip to Japan last November.
The Ministry of Finance [MOF] has confirmed that measures to eliminate the real
demand rule will be published in the official gazette prior to April 1, 1984.
MOF has also confirmed that the inter-ministerial consensus has been reached to
eliminate the designated company system. Necessary legislative measures have been
incorporated in an omnibus bill which was approved by the Japanese cabinet on
February 28 and will be presented to the Diet in March.
The omnibus bill also contains measures to allow MOF to issue foreign currency
denominated national bonds abroad in conformity with foreign practices.
The minimum denomination of CD's was lowered from ¥500 million to ¥300 effective January 1, 1984. It has also been announced that the ceiling on issues of CDs
for Japanese banks will be expanded beginning in the April-June quarter of 1984
until the ceilings reach 100 percent of a bank's net worth in April 1985.
Foreign bank CD ceilings are to be raised to 50 percent of total yen assets from 30
percent, with the minimum ceiling allowed raised from ¥5 billion to ¥8 billion, both
effective April 1, 1984.
MOF has also confirmed to us its intention to ease the guidelines on issues of
Euro-yen bonds by residents, effective April 1, 1984.
We are hopeful for progress in the establishment of a banker's acceptance market
and revisions in the withdrawing tax on interest earnings on Euro-yen bonds held
by foreigners, although the November 10 announcement commits the Japanese to
neither.
As you know, we are continuing to hold discussions with the Japanese through an
Ad Hoc Working Group on yen/dollar issues which I jointly chair with Vice Finance
Minister Oba. 1 have just returned from the first such Working Group meeting,
which was held in Tokyo on February 23-24. We had extensive, frank discussions in
which I emphasized the need for a fundamentally new approach to internationalizing the yen and liberalizing Japan's capital markets, not just marginal changes in
one financial instrument or another. I believe our meeting was successful in conveying to the Japanese the importance we attach to significant change on their part, as
well as some concrete suggestions for going about it. Although no new steps were
announced at the first meeting, we have agreed to resume our discussions in Tokyo
on March 23-24.
Mr. SPRINKEL. Thank you.
181
Mr. Chairman, we are happy to have you before the committee
again and if you would like to proceed we are ready to hear what
you have to say.
STATEMENT OF MARTIN FELDSTEIN, CHAIRMAN, COUNCIL OF
ECONOMIC ADVISERS
Mr. FELDSTEIN. Thank you very much.
[Complete statement follows:]
182
FOR RELEASE UPON DELIVERY
10:30 A.M.
FEBRUARY 9, 1984
MONETARY POLICY, BUDGET DEFICITS AMD THE ECONOMIC OUTLOOK
Testimony
by
Martin Feldstein. Chairman
Council of Economic Advisers
before the
Senate Committee on Banking, Housing, and Urban Affairs
Washington, D.C.
February 9, 1984
183
Monetary P o l i c y , Budget D e f i c i t s and the Economic Outlook
Martin FeldPtein*
T h a n k you Mr. C h a i r m a n ,
I am pleased to appear again
b e f o r e t h i s D i s t i n g u i s h e d Committee.
by d i s c u s s i n g m o n e t a r y policy.
I w i l l b e g i n my r e m a r k s
I will then t u r n to the buc^jf.
d e f i c i t s and t h e e c o n o m i c outlook.
M o n e t a r y Pol icy
The f u n d amen till g u i d i n g pr v n o i p l e of the A d m i n i s t r a t i o n ' s
a p p r o a c h to m o n e t a r y p o l i c y is t h a t the rate of g r o w t h of
che
money stock s h o u l d he reduced g r a d u a l l y over the year:; u n t i l
tise rate
is c o n s i s t e n t tfith p r i c e s t a b i l i t y .
This p r i n c i p l e is
c o n s i s t e n t w i t h the g e n e r a l approach e n u n c i a t e d
i"-V the
in recent y e a r s
Independent Federal Reserve.
C o n t r o l l i n g the g r o w t h of the money stock s h o u l d not be
viewed as
"in end i:i i t s e l f but r a t h e r as a means of a c h i e v i n g a
d e s i r a b l e p a t h of n o n i n a l GUP.
Because the g r o w t h of n o m i n a l
CNF t e n d s to f o l l o w the g r o w t h of the money s t o c k , t h i s
strateyy of monetary policy can be expected to be consi;-:tentw i t ' i ;-. g r a d u a l d e c l i n e in the
rate of i n f l a t i o n ,
inflation
g r o w t h of n o m i n a l GNP and
in
a l t h o u g h t h e m i x o f real g r o w t h a n d
is s u b j e c t to o t h e r i n f l u e n c e s as well.
In the
* Ch<i i man , C o u n c i ! of E c o n o m i c A d v i s e r s .
Testimony
b e f o r e the Senate Committee on Bank i n g , Housing, and U r b a n
A f f a i r s , F e b r u a r y 9 , 1984.
the
184
remaining years of this decade, this decline in the rate of
growth of nominal GNP should be compatible with continuing
growth of real GNP and with a continuing decline in the rate of
inflation.
In previous testimony, I have discussed the difficulty of
applying the principle of steady monetary deceleration in a
time of rapid institutional change.
An appropriate monetary
policy must balance the principle of steady monetary
deceleration with the need to take account of changes in asset
preferences or institutional arrangements that cause sustained
shifts in the velocity of money, i.e., sustained shifts in the
ratio of nominal GNP to the money stock.
The year 1983 was a time of significant change in
financial regulations that substantially altered the nature of
the monetary aggregates (Ml, M2, and M3) and the pattern of
portfolio demand for monetary assets.
In December 1982 banks
were permitted to offer money market deposit accounts, a form
of small-denomination time deposit with no limit on the
permitted interest rate.
part of M2.
These deposits were classified as a
Within 4 months, these deposits grew to 5321
billion, or more than 15 percent of M2.
The funds that were
deposited in money market deposit accounts came from Ml
balances, from other components of H2, and from sources that
are not part of M2 but of either H3 or the broader liquidity
aggregate.
185
Between December 1932 and March 1983, savings deposits
declined $40 billion and small-denomination time deposits other
than money market deposit accounts declined $116 billion; both
of these are components of H2.
Honey market mutual fund
balances declined $35 billion and large-denomination time
deposits declined $37 billion.
In addition, the introduction
of money market deposit accounts encouraged some intermediation
of borrowing that might otherwise have occurred through direct
corporate borrowing and the direct public purchase of Treasury
securities.
The net effect of all of this on Ml and M2 could
not be evaluated with any reasonable degree of reliability.
A second regulatory change added to the fundamental
realignment of the monetary aggregates.
Beginning in January
1983, financial institutions were permitted to offer Super-HOW
accounts, a checkable deposit with no ceiling on the interest
rate.
These accounts, classified as part of HI, have grown to
nearly $40 billion.
They presumably attracted funds from other
types of HI deposits as well as from M2 and M3.
This added to
the difficulty of interpreting changes in the monetary
aggregates during the early months of 1983.
Between December 1982 and March 1983, Ml rose 3.3 percent
and M2 rose 5.2 percent.
Although these ace equivalent to
annual rates of increase of 13.9 percent for HI and 22.5
percent for H2, it would be inappropriate to interpret these
one-time portfolio shifts as part of the annual growth of the
monetary aggregates.
The rise in money market deposit accounts
and in Super-NOW accounts slowed considerably in the second
186
quarter.
Between March and September, Ml rose at an annual
rate of 9.3 percent and [12 rose at an annual rate of 8.0
percent.
The desirability of stable money growth rests primarily on
the stability of the demand for money relative to nominal GNP.
A change in the available mix of financial assets or in the
characteristics of the monetary aqgregates is likely to change
the equilibrium ratios of nominal GNP to the monetary
aggregates.
The Federal Reserve can in principle adjust the
supply of money to compensate
for the shift in demand without
altering the degree of liquidity in the economy or,
equivalently, the likely growth of nominal GNP.
The rapid
increases in the monetary aggregates in the early part of 1983
were consistent with an unchanged path of decelerating nominal
GNP to the extent that they only compensated for the changes in
money demand that resulted from the change in available
financial deposits.
Unfortunately, however, there is no way to know by exactly
how much the financial deregulation changed the demand for each
of the monetary aggregates.
The Federal Reserve appears to
have followed a relatively passive strategy during the early
months of the year, not putting pressure on bank reserves but
rather focusing primarily on those broad measures of money and
credit —
change.
M3 and L —
that were little affected by regulatory
The narrower monetary aggregates -- Ml and t12 -- were
allowed to grow at whatever rate was consistent with this
policy*
187
With the banking system's reserve position relatively
unchanged, short-term nominal interest rates also varied
little.
Between December 1982 and May 1983, the monthly
average of the 91-day Treasury bill rate varied between 7.9
percent and 8.4 percent.
After May, however, the Federal
Reserve became concerned that the narrow aggregate not rise too
quickly.
increase.
It permitted the short-term interest rate to
More specifically, in July the Federal Reserve
ind icated that the unusual expansion of Ml in the period of
transition seemed to be abating and that it would seek to
maintain Ml in a monitoring range based on the average level of
that aggregate in the second quarter of the year.
The Federal
Reserve also indicated that it would give primary attention to
M2 and H3.
The Federal Reserve approach to the very difficult task of
adjusting the money growth targets to the new regulatory
environment thus far appears
to have succeeded.
There are some
observers, however, who are less sanguine about the possible
delayed effects of recent monetary policy.
They worry that the
rapid expansion of the monetary aggregates in early 1983 may
lead to near double-digit inflation by the end of 1984.
They
fear also that the slow growth of Ml in the second half of 1983
may cause output to decline by the middle of 1984.
neither possibility can be ruled out completely.
Of course,
All that can
be said with certainty at this time is that monetary policy has
come through a very difficult year of substantial deregulation
without any apparent problem yet in either real growth or
188
inflation.
Moreover, the currently available
indicate that all three monetary
statistics
aggregates ended the year 1983
inside the ranges that the Federal Reserve had established
earlier in the year.
All too often at this stage of an economic recovery, as
growth slows from the unsustainable pace of the recovery's
first year, political pressures have built to try to reduce
interest rates through an expansionary monetary policy.
The
present high level of real interest rates and the rise in
interest rates since the beginning of the year have brought
forth calls from many quarters for easier money.
There are
some who want to hide the adverse effects of the budget
deficits on the interest-sensitive sectors of the economy by an
excessively expansionary monetary policy.
They are joined by
others who simply want t^ see faster economic expansion
this
year regardless of the inflationary consequences.
The Administration rejects these calls to abandon a sound
monetary policy.
The projected series of large budget defic its
has raised real long-term interest rates to high levels that
cannot prudently be lowered by an easier monetary policy.
The
Administration recognizes that if the Federal Reserve were to
try to maintain a strong recovery regardless of the other
economic consequences, the expansion of money and cred it might
be so rapid that the rate of inflation would rise and undercut
the prospect for a sustained expansion.
The Administration desires a steady growth of real GtIP and
a gradually declining inflation rate.
If there are no
189
unexpected shifts in velocity, the monetary policy
consistent
with this outcome would be gradually declining rates of growth
of the monetary aggregates.
Although no regulatory
changes
comparable to those of 1982 and 1983 are expected, future
shifts in asset preferences or institutional arrangements (such
as permitting interest on demand deposits) could cause changes
in velocity that would require a recalibration of the money
growth targets.
It is important that any such recalibration be
made only in response to a significant and persistent shift in
velocity.
The willingness to recalibrate money growth
targets
in response to sustained shifts of velocity must not degenerate
into either economic fine tuning or a misguided pursuit of
interest rate targets.
Budget Deficits
The most significant economic problem now facing the
Congress is the very large budget deficits that are projected
for the years ahead if no legislative action is taken.
These
budget deficits would have serious adverse consequences
in both
the near term and the more distant future.
In the near term,
budget deficits create a lopsided recovery that is inherently
slower, more fragile, and more prone to inflationary
pressures.
In the longer term, such large budget deficits
would raise the cost of servicing our national debt and would
crowd out investment in plant and equipment and in housing.
The result would be a greater tax burden and a lower level of
real income.
190
The bipartisan negotiations on the budget deficit provide
the best opportunity for making timely progress in bringing the
deficits under control.
A combination of spending cuts and
additional tax revenue that reduced the deficits of the next
three years by $100 billion or more would be a very helpful
downpayment.
It would, of course, be only a first step.
In
1985, Congress must enact further measures to put the deficit
on a sharply declining path.
If the current negotiations are successful and if they are
followed by larger steps in 1985, the major impediment to a
healthy economic expansion will have been eliminated.
I
believe that if deficits are shrinking appropriately and
monetary policy follows a sound course, the American economy
can experience years of solid growth with declining rates of
inflation.
The opportunity to negotiate and enact a downpayment on
the budget deficit is also the opportunity to enact a
downpayment on a healthy expansion in the years ahead.
fervently hope this opportunity will not be wasted.
I
191
The CHAIRMAN. Thank you very much.
Let me say, for one, I appreciate your courage in speaking out on
the deficits. Some may not, but this Senator does, and I think you
know that. We have had many conversations about it over the last
couple of years.
Mr. FELDSTEIN. Thank you very much.
SPENDING CUTS MUST ACCOMPANY TAX INCREASE
The CHAIRMAN. I discussed yesterday with the Chairman of the
Fed the economic and political problems with achieving reduced
deficits. I want to pursue the same line of questioning with you.
Obviously, there are those who, for whatever reasons, political or
otherwise, want to harp about solving the problem with only tax
increases. Then there are those who would only do it with spending
cuts, of which I am one. And then the political side of it is recognizing that neither is possible, I'm one who would be willing to vote
for a combination if it could be put into a package where the
spending cuts were guaranteed.
Over the 9 years that I have been in the Senate I have often
heard that tax increases are the way to reduce deficits; what we
need is more revenue. That has never turned out to be the case
and we have had many tax increases over those 9 years and I used
the example yesterday of a fellow—and this is a specific example—
of one who I know who is greatly in debt and had some very serious financial problems, was fortunate enough to get a job that increased his pay dramatically. It did not solve his problem because
he spent more and he's continued in that cycle. There are a lot of
people like that. It doesn't matter how much income they have,
they will spend more.
That has been true of the Congress and the Federal Government.
It has not made any difference how much revenue we could raise,
we have spent more. That was true of TEFRA in 1982. It's the only
tax increase that I've voted for since I've been in the Senate and I
regret it. If it had gone the way that we were promised, we would
have received expenditure reductions of at least $98 billion, hopefully more, to match the $98 billion of tax increases, that's a much
larger amount and we're talking about the downpayment now.
That's $196 billion over 3 years. To get the tax increases we got
more than a dollar's worth of spending increases for each dollar of
tax revenue.
So that's why I totally discount, at least politically, the prospect
of having any meaningful reduction in deficits if we have a tax increase. It hasn't happened before. I don't know what would change
the performance of Congress suddenly now.
Would you agree, in your experience of watching Federal budgets? Can you tell me of a single time in the last decade where an
increase of revenues from the backs and the pocketbooks of the
American people has reduced deficits, or has it just been spent
with a little added spending to go with it?
Mr. FELDSTEIN. Of course, Senator, it is very hard to know what
would have happened to spending in the absence of that tax increase.
192
The CHAIRMAN. As a member of the Appropriations Committee, I
can tell you what would have happened. Spending levels have not
been restricted. We simply sit in the Appropriations Committee,
even with all the rhetoric this year from every side, liberals, conservatives, Democrats, Republicans, and say we've got to do something about the deficits, and I have seen nothing but amendments
for add-ons over and over and over again and markups in the subcommittees and the subcommittee chairman the day that one of
my colleagues on that subcommittee walks in and says, "Senator,
I've got an amendment to reduce the HUD independent agencies'
budget," I will undoubtedly drop dead from shock. It simply has
not happened. So I don't think the expenditure levels are driven by
the amount of revenue. I doubt very much if they have any idea
what the revenue levels are. It's simply a need that they think
needs to be filled.
Mr. FELDSTEIN. If it is true that the spending goes on independent of the revenue, then TEFRA reduced the $98 billion accumulative deficit over those years by $98 billion because the spending
was going along on its own track.
The CHAIRMAN. I agreed with the Chairman yesterday that the
deficits could have been larger, but the intent was to reduce them,
not to reduce the rate of growth, but to reduce them.
Let's move on then to the second part of my concern with doing
it with tax increases, even though politically I'm willing to—because I'm so concerned about the deficits—to go with a mix if we
can get that. Maybe we ought to do it the other way. Maybe we
ought to cut spending and promise the taxers that next year we
will give the tax increases to go with it and see if they trust us because I don't trust them any more.
What about the situation of the impact on the economy?
Let's use the same hypothetical I did yesterday. Let's go to $200
billion deficit and say that we have a $30 billion tax increase, $170
billion deficit. Everybody says that's wonderful, we're glad that we
got that kind of reduction. But with the exception of the interest
saved, say if you're looking at 10 percent, $3 billion of interest on
that $30 billion, aren't we still taking $200 billion out of the private sector? Aren't we still crowding out money for the mortgage
loans, automobile loans, venture capital, and modernization of
plant and equipment? Isn't the impact on the economy of removing
that $200 billion
Mr. FELDSTEIN. If you take that hypothetical, it depends on how
the $30 billion in tax revenue is raised. There are obviously ways
that you can raise it that would make almost all of it come out of
savings, but the most likely thing is that a large portion of it would
come out of what otherwise would have been consumed.
Of the $30 billion that individuals would pay in extra taxes in
that example, perhaps $20 billion would otherwise have been consumed and $10 billion might have been saved. To that extent, the
extra taxes would yield a net increase of $20 billion for investment,
mortgages, and lending. Unless all the tax revenue comes out of
savings, there is some net increase out of that tax increase.
The CHAIRMAN. I understand there are different ways to raise
the tax money and different places that it comes from, but whether
you spend it—if you spend it and get that net reduction you're
193
talking about, somebody profits from that spending, somebody
builds a washing machine that's sold and there's revenues generated from consumption as well.
TAX REVENUE SHOULD BE PROPORTIONAL WITH GNP
Mr. FELDSTEIN. The easiest way to think about it is that the
amount of revenue that the Government collects for a given tax
structure does not depend on how our GNP is spent. Whether it is
spent on one kind of goods or another, it will create profits and
there will be tax revenues out of that, and it will create wages and
there will be tax revenues out of that.
I think about the tax revenue being proportional to our GNP,
and if we have more investment and less consumer spending, that
will not change the total amount of tax revenue.
The CHAIRMAN. Let's get to the overall general point I'm driving
at. You have been an advocate of increased revenues as well as decreased expenditures in order to get a reduced deficit and have a
positive impact on the economy, the financial markets, and the interest rates that we would like.
Is it correct that from strictly an economic standpoint that if you
had your choice you would much, much prefer to reduce those deficits with expenditure cuts rather than tax increases?
Mr. FELDSTEIN. In general that is true. Again, it depends on exactly what expenditure cuts we are talking about. But in general,
increasing taxes would add more adverse effects on the economy,
while reducing spending would not have that distorting effect on
savings incentives and work incentives. Therefore, I would prefer,
all other things being equal, to do it by reducing spending rather
than by increasing taxes.
The CHAIRMAN. Again, my point is, however you tax it, in my
opinion, it is better to have it go into saving, have it go into spending, whatever use the private sector wants to put it to is better
than having Government make those choices. So I assume that
your recommendation of tax increases, then, with expenditure cuts
has to be a political decision like mine, that that is the only realistic way, rather than a belief, as mine is, that it would be much,
much better to cut down spending rather than increase the tax
burden. So both of us are facing the political realities of trying to
achieve a compromise; is that correct?
Mr. FELDSTEIN, That is correct. Certainly if I were given the freedom to pick and choose the $30 billion of deficit reduction, I would
rather have the spending reduction than the tax increase. But I do
not have that choice and, as you said, the political process tells us
that we are not going to be able to do it just on the spending side.
The CHAIRMAN. Well, I agree with your political assessment. Unfortunately, it's probably worse than either one of us, even trying
to get that kind of a mix as we found in 1982 is difficult. I wish I
could also understand the philosophy that somehow it's politically
popular to advocate tax increases and that it is correct economic
theory as we come out of a recession to remove more money from
the economy for governmental purposes. I have not found too many
economists that normally advocate that that is a good thing to do.
194
It used to be the old pump-priming, that we need more money out
there, rather than less.
Mr. FELDSTEIN. What we do not need are not growing Government deficits as we come out of the recession. The cyclical deficit is
shrinking in the normal way, but we now have a growing structural deficit, and that is why people are concerned.
The CHAIRMAN. Senator Proxmire.
Senator PROXMIRE. Dr. Feldstein, do you agree or disagree with
Secretary Sprinkel?
Mr. FELDSTEIN. In general or in some specific area?
Senator PROXMIRE. Well, I'm sure there are many areas where
you agree with Secretary Sprinkel, as I do, but do you agree with
his observation that monetary policy alone determines the inflation
rate and that fiscal policy has no effect on inflation; or do you
think they both have some effect?
Mr. FELDSTEIN. Over a sustained period of time, rather than
what happens to the inflation rate in 1985 or what happen to the
inflation rate over the next decade, monetary policy is the overwhelming influence on it.
Senator PROXMIRE. But you would give some limited influence to
fiscal policy in the short run?
Mr. FELDSTEIN. I would give some limited influence to fiscal
policy in the short run. More generally, it is sometimes hard to
think about monetary policy as being completely separate from
fiscal policy and able to operate independently. But insofar as you
can think of it as being able to operate completely independently—
that is, not independent politically, but I rather mean independent
of fiscal stimulus and independent of what happens in the marketplace, such as what happens to oil prices and so on—then I would
say that except in the short term, monetary policy is the overwhelming determinant of price levels and inflation.
Senator PROXMIRE. Now you say in the next to the last paragraph, "If the current negotiations are successful and if they are
followed by larger steps in 1985, the major impediment to a
healthy economic expansion will have been eliminated. I believe
that if deficits are shrinking appropriately and monetary policy follows a sound course, the American economy can experience years
of solid growth with declining rates of inflation."
GROWTH RATE OF 4 PERCENT IS PROJECTED
Now the growth that is projected is about 4 percent for the
1980's in each year except 1989 where it's near 4 percent. In the
1970's it was roughly 3 percent; and in the 1970's, we did not have
deficits nearly as high as we have now. And it seems to me that
coming down off a very high level of the deficit would tend, at least
temporarily, to slow economic growth inasmuch as you're taking
more out of the economy and putting less into the economy. So how
can you conclude or do you conclude—do I interpret your statement correctly as expecting a more rapid rate of growth in the
1980's than we had in the 1970's?
Mr. FELDSTEIN. I do not think that the decade is the right period
of measurement. When you say 4 percent from here on out, I think
195
perhaps a useful way to look at it is from the beginning of the recovery.
Senator PROXMIRE. I'm talking about the projections that accompanied the budget itself and they said 4 percent.
Mr. FELDSTEIN. If you start with the fourth quarter of 1982 so
that we have last year's actual experience plus the projections that
come with the budget, it amounts to 4.3 percent real growth over
those 7-years. By comparison, starting at the beginning of past recoveries—that is the crucial point—the average growth over a 7year period has been 4 percent.
The trouble with the '3 percent figure that you offered is this:
whatever the exact figure for real growth from 1970 to 1979 or
1980, you are not looking at comparable periods relative to the
business cycle.
What we are talking about is not a sustainable 4-percent growth
once you have reached full employment. What we are talking
about is coming up at an average rate of 4.3 percent from a deep
hole.
Senator PROXMIRE. In 1983 we had a second quarter growth rate
of 9 percent, a third quarter of about 7 percent, and a fourth quarter of about 4. It seems to me we're down to 4 percent already.
Mr. FELDSTEIN. Real growth was 4.5 percent in the fourth quarter. That is what we are expecting this year.
Let me be very clear. I do not think one can be confident that
the number is going to be 4 percent for the decade. As we said, it is
conditional on bringing those budget deficits down.
Senator PROXMIRE. Well, maybe it's too much of the Keynesian
influence, the notion that if you have a stimulative policy it tends
to accelerate growth in the economy, at least temporarily for several years, and if you have a strained fiscal policy—in other words, if
you reduce your deficit, you tax more and spend less, thereby slowing growth. Reducing the deficit is what you and I both want to do
and so does the chairman of the committee. We all agree that we
should knock the deficit down. He doesn't want to do it with any
tax increase, but we all agree we want to reduce the deficit.
My point is, when you do that, hasn't our experience been that
you have the effect of slowing the economy. The most dramatic example was World War II when, of course, we had a colossal increase in spending, an enormous increase in spending, and a terrific increase in the growth of the economy. And in periods when
we've had a declining Federal spending we've had the economy decline or grow less rapidly.
Mr. FELDSTEIN. Let me make several points. Despite the shrinking of the deficit, one thing that will influence the overall rate of
growth for the next 6 years is whether we go through another business cycle. If we go through another business cycle especially a serious one we may end up much lower at the end of that period.
One reason to be hopeful about this is that by keeping inflation
under control, and avoiding the go-stop process that caused trouble
for the last decade, we may be able to get a higher average rate of
real growth.
Second, although the pure effect of shrinking the deficit is to
reduce demand, we would at the same time achieve lower interest
rates, which we would expect to stimulate more demand through
196
investment and net exports than we have. I think that this would
offset the shrinking of demand coming from reducing the budget
deficit.
Finally, over a period as long as a decade, you raise capital accumulation and affect the overall potential and actual growth. By
shrinking the deficits we can have more capital accumulation,
more introduction of more modern technology, as well as capital
deepening, and through all of this I think you could have a higher
rate of growth.
I think that the tax changes on the business side and on the savings side that were enacted in 1981 have a potential for giving us a
good rate of growth over the decade, if we do not waste it.
Senator PROXMIRE. Well, I hope you're right. I'm just concerned
of the possibility that as we come off—you said we have to pay the
price of a recession—as we come off of this high deficit, we are
somewhat more likely to go into a period of recession, which as you
say, would mean slow growth.
Do you agree with Secretary Sprinkel and Dr. Meltzer who will
follow you as a witness that the Federal Reserve should hit its
annual growth target within 1 percent in each quarter?
Mr. FELDSTEIN. A quarter is quite a short period of time.
Senator PROXMIRE. Let me add just one short note to that. Chairman Volcker indicated that the difficulty with that is that there
are times during a quarter when you if you follow that rigidly you
can send interest rates right through the roof so you have to use a
little discretion and flexibility.
Mr. FELDSTEIN. The principal argument for hitting the targets
quarter-by-quarter or month-by-month is that it builds confidence
that the Fed is serious about its targets. Again, this year the Fed
ended the year with all of its aggregates either in the target or
very close to the target, and I would hope that would contribute to
investor confidence and financial market confidence about the
Fed's behavior.
The argument about hitting the targets—frequently very shortterm targets—probably carried more force when monetary targeting was just beginning and there was a good deal of skepticism
about the Fed's willingness to hit targets and to do tough things in
1980 and 1981. But I think the Fed has convinced most observers
that it is prepared to do tough things. It might be just much too
much of a constraint on the Fed to try to do it quarter-by-quarter.
Senator PROXMIRE. Are the stock markets gyrating now because
of lack of confidence in the Fed or lack of confidence in Congress'
policy to control the deficit?
Mr. FELDSTEIN. I do not think that there is any change in the
Fed's policy or in their perceived policy.
Senator PROXMIRE. So there's a lack of confidence in fiscal
policy?
Mr. FELDSTEIN. I think that fiscal policy is the big worry on the
part of the business and financial community, although again, I do
not want to separate monetary and fiscal policy too much because I
think that market participants are worried about the problems
that the fiscal environment and the exchange rate environment
create for monetary policy. Along the same line, we create more
197
monetary policy uncertainty by the fiscal and exchange rate environment.
Senator PROXMIRE. To what extent and to what degree were the
Council of Economic Advisers consulted in the preparation of the
President's budget for fiscal year 1985?
Mr. FELDSTEIN. I personally was involved at every step along the
way.
Senator PROXMIRE. And your colleagues were involved to some
extent?
Mr. FELDSTEIN. They were involved in the sense that I discussed
this with them. They were not physically involved with meeting
with the President.
Senator PROXMIRE. There are some who argue that only spending
increases or decreases have a lasting effect on economy, that it
doesn't matter whether that spending is financed through taxes or
borrowing. Do you share that view and what's the effect on financing the deficit?
Mr. FELDSTEIN. The impact of spending depends upon how it is
financed. If it is financed by borrowing, then it primarily comes at
the expense of investment. I say "primarily" rather than "exclusively" because there will presumably be some increase in savings.
If it is financed by taxes—again, depending upon the particular
form of taxation—it is likely to come much more from consumption.
Senator PROXMIRE. Thank you. My time is up.
The CHAIRMAN. Senator Hecht.
Senator HECHT. Thank you very much, Mr. Chairman.
MAJOR CORPORATIONS HAVING GOOD REVENUES IN 1983
Dr. Feldstein, yesterday Chairman Volcker was here and I asked
him questions. I don't have my notes from yesterday, but basically,
the major corporations of America are producing much more revenue in the third and fourth quarters than they were anticipating.
There was quite an announcement yesterday by General Motors
that their fourth quarter earnings were eight times what it was a
year ago. These increased earnings will produce more tax revenues
to our Treasury.
Do you feel that we can whittle down the deficit by revenues
coming in without taxes?
Mr. FELDSTEIN. No. The estimates that the Treasury has made
and continually thinks about are that even with the kind of revenue we expect this year, we are going to end up with deficits of
over $180 billion for fiscal year 1984.
Senator HECHT. But as earnings increase, what were your projections 1 year ago of the earnings this year?
Mr. FELDSTEIN. Our estimate 1 year ago missed the revenue in
fiscal year 1983 by some $3 billion. I should say that the Treasury
missed it. They are really very, very accurate in making these calculations. We have built into our forecast of revenue a quite strong
economic growth of 4 percent real growth over these next 5 years
without any economic slowdown, with revenue roughly rising from
about $600 billion in total receipts last year to more than $1,000
198
billion by 1989. But even so, we anticipate budget deficits of nearly
$200 billion.
Senator HECHT. And down the line in 1985 and 1986 you see a
continuing with the increases in revenue will not cut it down at
all?
Mr. FELDSTEIN. The deficits are obviously much smaller because
of this additional revenue than they otherwise would be, and we
show substantial increases in corporate income tax receipts. The
corporate tax receipts will rise more than 50 percent between 1984
and 1988, but even so we are talking about these very, very large
budget deficits.
Senator HECHT. Well, how about every time you have a 1 percent
drop in unemployment, $30 billion off the deficit? As unemployment goes down—forget the corporate earnings—what effect will
that have?
Mr. FELDSTEIN. You're absolutely right. Every 1 percentage point
decline in the unemployment rate or, alternatively, every 2.2 percent increase in the level of GNP reduces the budget deficit by
about $25 billion, primarily by bringing in additional revenue. But
all of that is built in. That is, we have the unemployment rate forecast to come down to under 6 percent by 1989. We have 4 percent
real growth in GNP over the year, All of that and its revenue consequences are already in these calculations. Even more important
in terms of the size of the deficit, we have the assumption that interest rates will come down very sharply, and that Treasury bill
rates will be almost cut in half between now and 1989. They will be
only 5 percent. If that does not happen, every percentage point
that the Treasury bill rate, or the cost of financing Government
debt, rises will cost us about $25 billion a year in additional outlays
by the end of this decade.
Senator HECHT. Well, what if we do as you're suggesting, raise
taxes? Business expansion will be curtailed and maybe the employment will not be as your projections, then what would happen?
Mr. FELDSTEIN. First, I am not suggesting either taxes or revenue. I am here as the administration's witness. I am suggesting
only two things. One, the budget; and two, these negotiations. However, our belief is that if the negotiations produce a package which
reduces the deficit by $100 billion over the next 3 years or more,
and if that is combined with greater assurance in the financial
markets and by business investors, then this will be just the first
step, and there will be more done on the spending side and the revenue side in 1985 to really bring these deficits under control. Then
we think that interest rates will be lower, we will have more investment at home, we will have a stronger recovery, and we will
have a better path of economic growth.
Senator HECHT. If we were to adopt this, what would you think
within 2 years the long-term interest rates would come down to?
Mr. FELDSTEIN. That is too tough. What we are forecasting for
the Treasury bill rate, on the assumption that we make this substantial progress now and that is followed by larger cuts in the
deficits enacted in 1985, is 7 percent by 1986. That is a decline of
about 2 percentage points. Long-range rates, given this reason for
reduction in rates, would move more or less in parallel.
199
Senator HECHT. About 3 weeks ago I was at a National Homebuilders show in Houston and there's a tremendous pentup demand
around there for homes and basically the minute the interest rates
start dropping you will see a tremendous amount of new construction.
Mr. FELDSTEIN. Exactly. That answers the question you asked
before. If we get progress on bringing down the deficits, whether on
the revenue side or on the spending side, that is going to have a
deep effect in reducing interest rates. What follows will be the realization of potential demand for homebuilding, long-term corporate
investment, and business construction—all of that will take place.
Senator HECHT. Thank you, Mr. Chairman.
The CHAIRMAN. I thank you, Senator Hecht.
I think you've probably learned that being the second witness, or
third, or fourth witness as we get closer to lunch, the questions get
shorter and shorter. It's the first witness that gets the brunt of all
the Senators.
Mr. FELDSTEIN. This is my sixth hearing in 6 business days, and I
cannot complain.
The CHAIRMAN. I do very much appreciate you coming before the
committee today and I want to repeat what I said about your courage in speaking out about deficits. Many of us up here appreciate
it. Thank you very much.
Mr. FELDSTEIN. Thank you.
The CHAIRMAN. Next we have a panel composed of Dr. Robert
Parry, executive vice president and chief economist of Security Pacific Corp.; and Dr. Allan Meltzer, professor at Carnegie-Mellon
University.
Dr. Parry, would you like to begin?
STATEMENT OF ROBERT PARRY, EXECUTIVE VICE PRESIDENT
AND CHIEF ECONOMIST, SECURITY PACIFIC CORP., LOS ANGELES, CALIF.
[Complete statement follows:]
200
Written Statement of
Robert T. Parry
Executive Vice President and Chief Economist
Security Pacific Corporation
to the
Senate Committee on
Banking, Housing, and Urban Affairs
February 9, 1984
Mr. Chairman and members of the Committee, I am pleased to have this
opportunity to present my views to this Committee concerning the economic
outlook, monetary policy, and related matters.
More specifically, I plan to comment on the performance of the economy
last year. Then I shall review recent stabilization policies, both fiscal
and monetary, and comctent on policy options for the economy in 1984 and
1985.
Thirdly, I intend to discuss prospects for the economy for the
remainder of this year and for 1985. Finally, I would like to offer a few
comments concerning the stabilization policies required to keep us on a
path of growth and lower inflation.
The Economy in l_983_
The general performance of the U.S economy last year was excellent,
particularly in relation t o - t h e overall poor performance of the economy
from the end of 1979 through the end of 1982. After getting off tc a slow
Start in the first quarter of last year, economic growth accelerated
markedly, and by the end of the year the level of output was 6.1 percent
above its recessionary low point. As indicated in Table I, the recovery to
date has been only slightly weaker than the average first year of expansion
in the previous seven economic upturns.
Most sectors of the economy performed well in the first year of
expansion. In spite of relatively high mortgage rates, housing was first
out of the starting blocks, and it grew strongly. Housing starts surged
from less than 1.0 million units in the first half of 1982 to just under
1.75 in the last half of 1983, and inflation-adjusted spending for residential construction rose 38.2 percent in 1983. Real personal consumption
expenditures also rose strongly, up 5.4 percent, led by a surge in spending
for durable goods, particularly for automobiles, furniture, and appliances.
A powerful force for growth last year was the switch by businesses
from large liquidations of inventories in 1982 and the first half of 1983
to moderate additions to their stocks of goods on hand in the last half of
1983. Inventory levels still are lean; therefore, additions to inventory
are likely to be a strong force for growth in 1984.
Two other sectors recorded strong increases last year. Real business
spending for equipment rose 18.3 percent, faster than in the first year of
recovery for any of the previous seven business upturns except for 1950.
This development was surprising because capacity utilization rates were
201
relatively low and because most observers of the business scene had originally expected an anemic recovery in 1983.
Not surprisingly,
inflation-adjusted defense spending recorded strong gains in 19S3. Defense
spending actually has been on an upward trend since 1979.
The remaining sectors of the economy — business spending for structures, federal government noiidefense purchases, state and local government
purchases, and net exports of goods and services — exhibited weakness.
Particular weakness was displayed by net exports which fell from an inflation-adjusted value of $23 billion in the final quarter of 1982 to $2.5
billion a year later. The negative trend in net exports began in the
fourth quarter of 1980, and it results primarily from the sharp rise in the
value of the U.S. dollar in foreign currency markets. Since the third
quarter of 1980, the trade-weighted value of the dollar has increased more
than 50 percent.
The strong growth of output has had a very favorable impact on the
employment situation. Last year employment grew 4.0 million, and unemployment fell 2.7 million. As a result, the unemployment rate fell from
10.7 percent in December 1982 to 8.2 percent in December 19S3. Although no
one would consider the current level of unemployment acceptable, 1983 at
least produced significant movement in the right direction.
Also, as
indicated in Table 1, the improvement in the employment picture in 1983
compares very favorably with the average experience in earlier recoveries.
Inflation represents one of the most impressive success stories of
1983. Last year consumer prices rose 3.8 percent, and producer prices
increased 0.6 percent.
These numbers are in stark contrast to the
double-digit price increases experienced as recently as 1982. As indicated
in Table I, the inflation experience of this recovery has been similar to
that of the average recovery experience. Also, the information in Table II
reveals that most of the major components of the Consumer Price Index
recorded lower inflation in 1983, including the previously intractable
medical care component.
Interest rates remained relatively high last year, particularly
considering the low rate of inflation.
In addition, after being flat to
down in the first half of the year, they trended upward in the second half.
Finally, interest rates were significantly less volatile than they had been
in the prior three years.
Several factors help to explain these developments. The economy was
growing rapidly, and private credit demands, particularly for consumer
credit and mortgages, expanded strongly. Also, the huge federal deficit
added greatly to the total demands for credit in 1983.
Moreover, the
generally accepted view that large deficits will persist for the foreseeable future has probably kept inflationary expectations higher than one
would have expected given the excellent performance of prices in the past
two years. In addition, the Federal Reserve seemed to be more concerned
about the re-emergence of inflation than it was in the past, and, as a
result, monetary policy was more stringent than was the case in the first
year of earlier recoveries. Finally, the monetary authorities paid less
attention to the growth of the monetary aggregates last year and focused
202
more on controlling the level of interest rates. This development explains
in part the significantly reduced volatility of rates last year.
Stabilization Policies
A review of stabilization policies in recent years indicates that both
fiscal and monetary policies have played important roles in ending one of
the longest and most severe recessions of the postwar period. Such a
review also indicates that the mix between fiscal and monetary policy has
been far from ideal with fiscal policy pursuing a course that is too
stimulative and, in response, monetary policy following a path that is more
restrictive than is in the long-term interest of the economy. To date,
this "mix problem" has not produced significantly adverse effects on the
recent performance of the economy, although it has generally played a
destructive role for more than twenty years. Unfortunately, it appears as
though the "mix problem" will intensify in the years ahead unless steps are
taken in the very near future. Failure to take these steps may begin to
affect the performance of the economy as soon as the second half of this
year and could produce significant impacts on the economy in 1985.
Fiscal Policy
As an economic stabilization tool, fiscal policy can be viewed from a
number of perspectives. Three popular ways of viewing the course of
federal budget policy are in terms of the unified federal budget, the
high-employment budget, and federal outlays as a proportion of the nation's
output of goods and services.
Not surprisingly, all three viewpoints
support the thesis that fiscal policy has been too stimulative and could
become more .of a problem in future years.
The unified federal deficit has been in deficit in 23 out of the past
24 years with no prospects of a surplus in sight. Just in the first four
fiscal years of this decade, deficits have totalled £423.5 billion and
off-budget outlays over the period add another $64.9 billion to the red
ink. This year the deficit will likely come in at close to $180 billion,
down slightly from fiscal 1983's $195.4 billion. Estimates for fiscal
years 1985 through 1989 vary greatly, but the Congressional Budget Office
estimates that the deficits would be staggering if no actions are taken to
rein in spending or raise revenues.
Viewed differently and to provide perspective, from 1947 through 1981,
federal budget deficits as a percentage of gross national product exceeded
3 percent only twice, in 1948 and 1976. However, in 1982 the number was
3.7 percent, 1983 6.1 percent, and probably close to 5 percent in the
current fiscal year. From 1984 through 1989, the percentage probably will
decline further, but it could easily remain too high to permit a healthy
performance of the economy.
Most economists question the use of the unified federal budget as a
measure of economic stimulus or restictiveness. The unified budget can be
a misleading indication of fiscal policy because it also reflects the
effects of cyclical changes in economic activity.
In contrast, the
high-employment budget may provide a better perspective on fiscal activities. The high employment deficit — or structural deficit as it is more
203
often referred to these days — rose from about $20 billion in fiscal 1981
to approximately $100 billion in 1983. In this fiscal year, the structural
deficit will expand further, and as a percentage of GN? it will be one of
the largest in the last 30 years. Greater stimulus for an economy that
already has a strong head of steam underway is dangerous policy.
The
structural deficit should be narrowed significantly as soon as possible.
A third way of viewing the recent course of fiscal activities is in
terms of federal outlays as a proportion of the nation's GNP. From 1960 to
1976, the proportion of federal outlays on a national income accounts basis
to GNP trended upward from 18.4 to 23.0 percent, but it then fell steadily
to 21.1 percent in 1979. It then rose each year to 25.0 percent in 1983.
The absolute level of the ratio is much too high. While the analysis
of federal outlays to GNP does not directly provide information on how restrictive fiscal policy is, it does illustrate a concern shared by many
economists. High federal outlays relative to the rest of the economy is
viewed by many as a threat to the private sector and also a factor contributing to slow growth in productivity and to inflation.
Monetary Policy
The monetary authorities pursued an expansive policy from raid 1982
through mid 1983. The monetary aggregates grew rapidly, and interest rates
fell sharply. Such a policy was appropriate considering that most of the
period coincided with a long, severe recession.
Some analysts question the
conclusion that policy was expansive during this period, citing the effects
of financial deregulation and a resulting weak performance of velocity —
the ratio of GNP to money — as invalidating such a conclusion.
Although
studies of this issue are by no means conclusive, most seem to support the
conclusion that financial deregulation did not greatly add to the growth of
the narrowly defined money supply (Ml).
As a matter of fact, the net
effect of the introduction of money market demand accounts in late 1982 and
super NOW accounts in early January of last year probably was to slow the
growth of Ml.
Thus, the strong growth of money appears to have resulted from two
influences. First, the monetary authorities were consciously attempting to
stimulate a declining economy. Second, the quantity of money demanded by
the public was increasing as a result of, among other things, the sharp
fall off of interest rates that occurred over the period. The failure of
the large decline in interest rates to stimulate the market for goods and
services — or stated differently, the failure of velocity to rise —
during this period does not yet seem to have been explained adequately.
Since the middle of last year, the monetary authorities have cinched1
up a bit on the credit reins. From the middle of 1983 to the end of the
year, Ml grew very little, and short-term interest rates, most
significantly the federal funds rates, edged upward. This move on the part
of the Fed to tighten just six months into the economic recovery is
unprecedented. It seems to indicate that the monetary authorities are
indeed serious about bringing the long-tens rate of inflation down. In the
past, particularly during the 1970s, anti-inflation rhetoric was always
more apparent than actions to reduce the rate of inflation.
204
Another interesting aonetary policy development was the decision by
the Fed in October 1982 to reduce its focus on Ml. Accordingly, the
monetary authorities paid more attention to the broader aggregates.
Perhaps more significantly, they focused more directly on interest rates
and on other indicators of economic performance. The reluctance of the
monetary authorities to focus narrowly on'Ml is understandable. First,
they vere concerned that the financial innovations of 1982 and early 1983
would reduce the analytical significance of Ml.
Secondly, they were
puzzled by the failure of velocity to grov in 1982 and early 1983.
In 1984, the Federal Reserve may encounter some difficulty hitting its
targets for the monetary aggregates. As discussed later, we expect nominal
GNP to rise approximately 10 percent; thus, the velocity of Ml will have to
increase 4 percent for the Fed to hit the midpoint of its 4 percent to 8
percent range in 1984.
Furthermore, the velocities of M2 and M3 must
increase by a percentage point or so in order for those aggregates to stay
within their respective targets.
In the second year of the last three recoveries, Ml velocity rose by
2.4 percent to 2.8 percent.* In other words, if history is a guide, Ml is
likely to come in above the midpoint of the Fed's target, but it is likely
to stay within the target range for the year.
M2 and M3, however,
experienced velocity declines during the second years of the last three
recoveries. Thus, using these rules of thumb, if nominal GNP does grow by
10 percent, K2 and M3 would be outside their target range of 6 percent to 9
percent.
Due to the prolonged decline of velocity during the last recession, it
is very possible that the growth of velocity next year will be stronger
than history would suggest. If that were to occur, the Fed could Eore
easily hit the midpoint of its Ml target, and K2 and M3 could end up the
year in the upper half of their respective targets instead of above them.
In either case, however, it appears that the Fed would have an easier time
keeping rates lower if it weights Ml more heavily than currently in its
policy deliberations.
An important question, then, is which aggregate the Fed will concentrate on in 1984.
It would appear that Ml will get increasing weight as we
move through this year. There are three good reasons for this shift in
focus back to Ml. First, velocity is again displaying more normal cyclical
behavior. Second, as mentioned previously, following Ml ought to provide
more latitude for lower rates in 1984.
Third, I doubt that the monetary
authorities are comfortable with their knowledge about how to interpret the
broader aggregates, nor how to control them.
My basic assumption about monetary policy for 1984 and also for 1985
is that the monetary authorities will resist a cyclical upturn in the rate
of inflation.
They will do this for several reasons. First, they probably
expect inflation to pick up in 1984, and they certainly know that inflation
t,ypically rises in the third year for those cycles that lasted more than
two years.
Second, Chairman Volcker and other representatives of the
Federal Reserve have made it perfectly clear on numerous occasions that
fiscal policy is too stimulative.
Finally, the monetary authorities
*The 1980-81 recovery is not included because it only lasted one year.
205
realize that if foreigners were to question the resolve of the Fed to
pursue an anti-inflationary policy, capital outflows would be massive. The
value of rhe dollar in foreigr. exchange markets would plummet, and a major
inflationary influence would be introduced into the U.S. economy.
For all of these reasons, I expect the monetary authorities to pursue
policies in 1984 and 1965 that are designed to prevent a large, cyclical
upturn in the rate of inflation. As is discussed in the next section of
this statement, these policies, combined with a fiscal policy that is
expected to be very stimulative, will leave significant imprints on credit
markets and the economy, particularly in 1985.
Prospects for the Economy
1984
As indicsted in Table III, this year is expected to be another good
year for the U.S. economy. The output of goods and services produced is
forecast to rise 4 to 4,5 percent over the course of the year, and by the
end of 1984, the level of economic activity will be 10.8 percent above its
recession low point.
Most sectors of the economy will expand rapidly. Consumer spending
will remain strong, and spending for residential construction will register
a sizable increase. Greater spending by businesses for plant and equipment
will provide follow-through to the expansion. Growth vill also result from
additional inventory accumulation, as businesses attempt to get stocks into
a better relation to sales. Finally, federal spending, particularly for
defense, will rise rapidly.
The remaining sectors of the economy are expected to -be weak.
Although the fiscal position of state and local governments is improving,
spending by these government entities is not likely to rise very much this
year. Ket exports of goods and services will decline further in 1984,
because the value of the dollar is expected to decline only slightly.
Continued expansion of the economy will result in further improvement
ir, the employment situation. Employment is expected to rise 3.5 million,
and the unemployment rate should end the year between 7 and 7.5 percent.
The best inflation news is behind us, but the expected pickup in the rate
of inflation should be moderate. By the end of the year, consumer prices
should be rising at a rate of close to 6 percent.
The general business climate this year should produce a sharp gain in
corporate earnings, and the growth of employment combined wi Ch moderate
gains in wage rates will add significantly to personal income. At the same
time, however, strong spending by both businesses and individuals is
expected to result in greater demands for credit from the private nonfinancial sector of the economy. Federal requirements for credit will remain
very large, although state and local governments will record a sizable
surplus. The monetary authorities are expected to be moving toward a
somewhat more restrictive stance by the second half of this year. Thus,
interest rates are likely to be trending upward in the second half of this
206
year. By year end, interest rates are forecast to be 50 to 100 basis
points above today's levels.
From today's perspective, caution lights should be turned on for the
economy in 1985. If significant progress is not made in closing the gap
between federal government spending and revenues before 1985, the imprint
on the 1985 economy could be significant.
More specifically, large
stimulus from fiscal policy is likely to be accompanied by a restrictive,
countervailing stance by the monetary authorities. The result is likely to
be higher interest rates and a significant slowing in economic activity.
As indicated in Table III, the growth of output is expected to slow to E
gain of only 1.7 percent. Weakness in the econoffiy is likely to develop and
center in the credit-sensitive sectors of the economy.
With the pace of economic activity slowing so markedly, further
improvement: in the employment picture would not be likely in 1985.
As a
result the unemployment rate actually would move up slightly. The rate of
inflation would move up but not by much as a result of the restrictive
stance of monetary policy and the resulting slowing of the pace of economic
activity. Early in the year interest rates would be higher than they are
expected to be at the end of 1984, but by the second half of 1985, the
pronounced slowing in the pace of economic activity could permit a small
decline in Interest rates.
Concluding Comments
An important objective for the stabilization authorities is to ensure
that inflation trends downward in the remaining years of this decade. At
this stage of the business cycle, such an objective makes it -imperative
that actions he taken to limit the inflationary pressures that could
develop as the economic expansion matures.
More specifically, it is
essential that the peak in inflation for this business cycle be far below
that of recent past cycles.
For the monetary authorities, a low inflation rate objective means
that the Federal Reserve should gradually attempt to reduce the growth of
the monetary aggregates. The aggregates grew very rapidly in the past year
and a half, although this growth was desirable considering its business
cycle context. This year the Federal Reserve should strive to achieve its
obj ectives of slower growth of the monetary aggregates. In 1985, it
probably will be necessary to reduce the growth rates of the aggregates
even further.
Achievement of stabilization objectives are being greatly complicated
by fiscal policy. However viewed, fiscal policy is and will likely remain
too stimulative unless corrective actions are taken soon. The deficit
should be trimmed by a combination of expenditure reductions and tax
increases. My own personal preference would be to emphasize expenditure
reductions in an effort to reduce further the size of federal outlays
relative to GNP. It is difficult to recotcnend specific cuts, but every
item in the budget should be considered a candidate for reduction,
including defense and entitlements. To the extent that tax increases are
207
needed, I would favor higher taxes on consumption. Every effort should be
made to avoid raising taxes in a mariner that would reduce incentives to
work, save and invest.
Failure to bring future deficits down significantly will produce one
of two outcomes, neither of which is acceptable. First, if the Federal
Reserve loses its resolve to pursue low rates of inflation in the face of
massive federal budget deficits, the debt will be monetized, and the seeds
of future high rates of inflation will be planted. The painfully-won
inflation successes of the past couple of years will be lost.
Unfortunately, history provides ample evidence that this outcome is
possible.
Second, if the monetary authorities retain their resolve, the clash
between massive Treasury requirements for funds and rising private needs
for credit will push interest rates to lofty levels. The result will be
that the credit sensitive sectors of the private economy will suffer, and
the proportion of private saving commandeered by the U.S. Treasury will
rise. Insufficient private investment will take place, and the growth of
productivity will suffer. High interest rates will push the value of the
dollar in foreign exchange markets even higher, and the trade deficit will
worsen.
What we will end up with is an economy that is too heavily
oriented toward government spending and spending for current consumption
and too little investment in plant, equipment, and housing.
208
Table I
Selected Economic Indicators
(Percentage changes)
1963*
Gross National Product
(constant 1972 dollars)
6.1
6.5
Employment
3.5
2.1
-19.3
-8.1
3.3
3.2
11.3
27.1
Unemployment
Consumer Prices
90-day Treasury Bill Rates
*Percentage changes from the fourth quarter of 1982 to the fourth quarter
of 1963.
**Average percentage changes for the first year of the past seven postwar
recoveries.
Table II
Selected Components of the Consumer Price Index
(Percentage changes)
1980*
1961*
1982*
1983'
12..4
8..9
3.9
3.8
9..3
4.,3
3.2
2. 8
Housing
12,.4
10,,2
3.1
2.5
Transportation
13.,8
11..0
1.7
4.5
9,.5
12,.5
11.0
5. e
All Items
Food & Beverages
Medical Care
*Year ending in Decenber.
209
for the U.S. Econocy
e in Constant 1972 Dollars)
1982*
1983*
1984*
1985*
-1. 7
6. I
4.4
1.7
2. 5
5. 4
3.5
1.5
Durables
6. 2
14. 3
6.7
-2.5
Nondurables
0. 6
4. 7
2.1
1.9
Services
2. 9
3. 2
3.5
2.5
Inves tcerjt
-6. B
16. 9
6.7
1.0
-9.0
11. 5
7,3
4.7
3. 0
38. 2
4.6
-U.2
-22. 7
7. 5
15.8
15.4
3. 5
-2. 2
4.3
3.4
Federal
8. 6
-6. 0
7.4
5.7
State & Local
0. 1
0. 6
2.3
1.8
23. 0
2. 5
-0.8
-0.8
0. 2
4. 0
3.9
1.8
Gross National Product
Consumption
Business Fixed
Residential
Change in Inventories**
Government
Net Exports**
Final Sales
*Percentage changes from the fourth quarter of the preceding year to the
year noted.
ges in Dollars.
210
The CHAIRMAN, Thank you, Dr. Parry.
Dr. Meltzer.
STATEMENT OF ALLAN H. MELTZER, PROFESSOR, CARNEGIEMELLON UNIVERSITY, PITTSBURGH, PA.
Mr. MELTZER. Senator Garn, it's a pleasure to be back here. I
have to start with a question which I direct to you. It is not a rhetorical question. What is the monetary policy of the United States?
Do you know, Senator Garn or Senator Hecht? Do any members of
the Banking Committee know? Or do I know, who studied policy
for 25 years? The answer is no. No one knows.
[Complete statement follows:]
211
What Is Oar Monetary Policy?
by Allan H. Meltzer
What is the monetary policy of the United States?
No one knows.
The
Federal Reserve does not knou because it does not have a policy than looks
ahead more than a few months, and it avoids any attempt to develop one.
It
announces annual targets but does not adopt procedures capable of achieving
them.
Part of the administration frets publicly about monetary policy from
time to tiae, but the administration has no authority to develop a monetary
policy.
The Congress has constitutional responsibility for money, but it
is
unwilling to require the Federal Reserve to announce and implement a long-term
policy.
It seems content to let the Federal Reserve announce its objectives
at public hearings and then ignore them.
Congress neither requires the
Federal Reserve to achieve its announced targets nor to explain why there
is little relation between what the Federal Reserve says and what it does.
Past history gives little reason to believe that the announcements are
a reliable guide to what the Federal Reserve will do.
for money growth have been announced since 1975.
Targets or objectives
They are rarely achieved.
Although the Federal Reserve staff has claimed publicly that it can hold
money growth within a narrow band around the announced growth rate, the
Federal Reserve has not done so.
Table t shows che difference between past
announcements of money growth and reported or actual money growth.
The table suggests that the Federal Reserve has an inflationary b i a s . The
average growth rate of money ( M t ) -- currency and checking deposits -7°i lor the eight year period.
Federal Reserve errors are typically positive
and average about 2 to 3 percentage points per year.
As long as the Federal
Reserve behaves as it h a s , inflation will be a recurring problem.
is above
Variable
212
Table 1
Targets for M; Growth 1976-1983
Year
ending in
4th Quarter
Target
Range
Target
Mid-point
Actual
or
Reported
Error
1976
4,5-7.5%
6.0%
5.87.
-0.207,
1977
4.5-6.5
5.5
7.9
42.40
1978
4,0-6.5
5.25
7.2
+ 1.95
1979
3.0-6.0
4.5
7.4
+2.90
1980
4.0-6.5
5.25
7.2
+ 1.95
1981
6.0-8.5
7.25
5.1
-2.15
1982
2.5-5.5
4.0
8.5
+4.50**
1st half
4-8
6.5*
9.6*
+3.10
2nd half
5-9
1983
1st half mid-point 6.0, actual
2nd half mid-point 7.0, actual
**
13.8;
5.4
target abandoned in October; error for f i r s t
three quarters is 2.8 at annual rates
Sustained periods of money growth at the average rate of 1982 and 1983,
if continued, will bring inflation back to the level of the 1 9 7 0 ' s , The
recession of 1981-2 will have no more than a temporary e f f e c t on the rate
of inflation.
The public will have paid the cost of recession without
receiving any durable b e n e f i t *
The widely noted decline in inflation
less than 47. in 1983 w i l l be followed by higher inflation j u s t as were
the relatively low rates of i n f l a t i o n in 1 9 6 7 , 1 9 7 2 and 1976.
to
to
t-t
CO
214
The absence of a policy is costly.
No one knows from quarter-to-quarter
or year-to-year whether money growth will be adequate Co sustain expansion,
so excessive that it restores inflation to previous rates or so low that we
experience another recession.
No one can look ahead with confidence that
monetary policy will contribute to stable growth for the next several years
or even for Che next several quarters.
The jagged pattern of recent money growth has left its mark on the growth
of GNP.
Chart 1 shows that quarterly changes in the growth rate of the
monetary base -- bank reserves and currency -- are followed within a quarter
by similar changes in the growth rate of nominal GNP.
amount of money produced by the Federal Reserve.
if the
The nonetary base is the
It is completely controllable
Federal Reserve choses to do so or is required to do so by law.
[Insert Chart 1 about h e r e ]
Chart 1 does not suggest that Federal Reserve action is the only
determinant of GNP growth.
GNP growth is influenced by many other f a c t o r s .
The chart shows, however, that for the past three years every peak or trough
in base growth has been followed within one quarter by a local peak or trough
in GNP growth.
Federal Reserve spokesmen have told Congress and the public that money
growth has little relation to GNP.
reasons why this is so.
They have offered explanations of the
But they have given no evidence.
Chart 1
suggests, contrary to these claims, that the relation has become closer in one
respect.
The lag between growth of the monetary base and the growth of GNP
appears to be shorter than in the past and more consistent.
All recent turning
points in base growth have been followed within a quarter by turning points
215
in GNP growth.
The magnitude of Che relative changes in base and GN? growth
vary, however, so quantitative forecasts of quarterly GNP growth based on
this relation are no more reliable than other f o r e c a s t s of quarterly GNP
growth.
Chart 1 shows that the excessive variability introduced by destabilizing
actions of the Federal Reserve has increased the variability of the economy,
Increased variability raises the risk that the economy b e a r s , " r a i s e s the
rate of interest, lowers investment In long-term capital and increases interest
payments on the government debt.
Estimates prepared for the Treasury Depart-
ment suggest that the increased variability of unanticipated changes in
money growth raised short-term interest rates in 1980 to 1982 by three
percentage points.
Variability declined in 1983, so the risk premium in
short-term rates is now smaller than in the previous three years.
But, the
risk preaiuin remains higher than in the sixties or seventies reflecting
heightened uncertainty about future money growth.
My calculations suggest that the excessive variability of money growth
raised short-term rates in 1983 by 2 to 2 - 1 / 2 percentage points and kept longterm rates more than one percentage point above the level they would have
reached if variability returned to the level of the 1 9 7 0 ' s .
Spokesmen for the Federal Reserve aad some administrative officials
try to explain the present levels of interest rates by referring to budget
deficits.
1 do not know a single study showing a relation between deficits and
interest rates for the United States.
The Congress should ask for evidence
to support these claims,
1 have commented on the problems posed by persistent deficits in previous
hearings and elsewhere, in the past, so I will summarize two main points here.
216
F i r s t , a principal problem with our fiscal policy is not the deficit
per se.
It is the high rate of consumption spending encouraged by government; and
sustained by government transfer payments and spending for defense.
programs shift resources from investment toward consumption.
These
Second, deficits
becone inflationary and raise market rates of interest when they are financed
by the Federal Reserve.
No one knows how much of the deficit the Federal
Reserve will finance because, as I have said, the Federal Reserve does not have
a policy.
But if the Federal Reserve continues to attempt to control interest
rates, they will, from time to tine, finance part of the deficit by inflating.
The d e f i c i t is not the only excuse o f f e r e d by the Federal Reserve.
Some,
including presidents of two of the Federal Reserve banks, blarae deregulation
of the financial industry for the variability of money growth and current and
p a s t levels of interest rates.
Such statements are d i f f i c u l t to reconcile
with research by the staff of the Federal Reserve Bank of San Francisco and
the s t a f f of the Board of Governors, the latter published in the May 1983
Federal Reserve Bulletin,
showing that Ml has not been much a f f e c t e d by the
introduction of the new types of deposit accounts.
The main cause of monetary variability is not deregulation or deficits.
It is the failure to have a stable, non-ir. flationary monetary policy.
tJo
one should expect to restore stable growth with low inflation until the Federal
Reserve adopts a policy and develops procedures that achieve the policy it
adopts.
Congress has constitutional authority for monetary policy.
It should
not permit the Federal Reserve to operate as it has.
Hearings such as this are not an e f f e c t i v e procedure for imposing monetary
discipline.
The comparison of announcements made at past hearings with actual
217
p o l i c y , in Table 1 above, shows little relation between words and deeds,
What point is there to having the Federal Reserve announce plans or
intentions than bear little relation to what they do?
I believe the Congress oust find a more effective procedure for aonitoring
the performance of its agent, the Federal Reserve.
Congress should require
the Federal Reserve to set a target for monetary growth.
If they miss the
targets by mere than one percentage point, the chairman and all members of
the Board of Governors should be required to offer their resignations to the
President of the United States, who appoints them, with an explanation of the
reason for the discrepancy.
The President would have the right to accept the
explanation, and with it the responsibility for the result of the policy, or
accept the resignations.
This proposal removes a principal obstacle to more stable, more reliable
monetary policy -- the absence of accountability.
It ends the separation of
authority and responsibility and gives an incentive to the Federal Reserve to
improve its
performance.
Without improved performance, we will continue to
pay the costs imposed by variable and uncertain monetary actions and the
absence of a coherent monetary policy.
218
The CHAIRMAN. Thank you, Dr. Meltzer. I plead guilty to neither
being an attorney or an economist. My business or my background
is in business. My degree in college was in banking and finance
and I don't disagree with a lot of what you said about the Fed and
I think everybody generally agrees that they have been rather up
and down over several years in hitting their targets.
But I am puzzled that you don't seem to relate that to fiscal
policy. I understand what you said about spending and all of that,
but I firmly believe if I made you Chairman of the Federal Reserve
Board tomorrow, with all that brave talk—and Beryl Sprinkel the
same thing and other economists—in the 9 years I've been here
I've had the opportunity to hear all the world's best economists—
Democrats, Republicans, liberals, conservatives, all different philosophies—the one thing that has been consistent in those 9 years of
testimony is that virtually all have been wrong, with all their
fancy econometric models at the beginning of the year and I guess
they hope we won't look again at the end.
CAN THE FEDERAL RESERVE HIT THE 1-PERCENT TARGET?
All I see is a little commonsense and being willing to listen, but
your suggestion that members of the Federal Reserve Board offer
their resignations if they miss their targets by more than 1 percent, that we ask academic economists if they err by a margin of 1
percent they be required to give up their tenure and submit their
resignations to the president of their university; and Senator Hecht
and I, if we do it, we submit our resignations to our Governors in
our States. I'm being serious about that question.
Whatever we may agree about the ups and downs, are you really
serious that if they miss by more than 1 percent with anything
that is as imprecise as trying to judge those monetary aggregates
on a monthly or quarterly basis that they should submit their resignations? Nobody would perform in any job of this country. Everybody would have to quit.
Mr. MELTZER. May I respond?
The CHAIRMAN. Oh, yes.
Mr. MELTZER. Let me make three points. First, it is annual, not
monthly or quarterly that I'm talking about. What we need to do is
have confidence in the annual targets.
Second, the staff of the Federal Reserve has claimed publicly
that they can hit those targets within 1 percent. If they can't hit
them within 1 percent, what is the point of giving you a moderate
range of 4 to 6 percent, as they have in the past. If they know they
aren't going to come within 4 to 6 percent, those statements are
meaningless.
What confidence can you or others have in their statements if in
fact you can't believe them? That's what you just said in your
statement to me. You don't believe they can come within 1 percent
of the target.
The CHAIRMAN. I certainly don't.
Mr. MELTZER. Third, we want to ask why can't they come within
1 percent of their targets? The answer is because they don't choose
an aggregate that they can control. They can control the size of
their balance sheet. Senator, I would be willing to take the gamble
that I would control the size of my balance sheet and you can control the size of your balance sheet and the Federal Reserve can control the size of their balance sheet within 1 percent on a monthly
basis, but I only ask them to do it on an annual basis.
The monetary base represents the size of the Federal Reserve's
balance sheet. Ninety percent of the monetary base is securities
the Federal Reserve purchases on the open market. All they have
to do to keep the size of that balance sheet within the limit is to
stop their purchases of securities or hold them to the rate which is
consistent with their target. The balance sheet will come into line.
That's really all I'm asking them to do. It is doable. They know
it's doable and I believe it is doable. Now I would like to take up
one last point.
Why are the forecasts so bad? I wouldn't want to be held to a
forecast from quarter to quarter. I think people are wrong to base
their decisions on those forecasts. The reason is shown by the chart
in my paper. People are forecasting what the monetary growth is
going to be. They have no idea. You can hear witness after witness.
Some will tell you they think the monetary growth is going to be
high in the spring and low in the fall. Some will tell you the Federal Reserve is going to have expansive policy through the years and
others think that it's going to have no growth. They don't know.
One reason—not the only reason, but one main reason why those
forecasts are so bad is because nobody knows what monetary policy
is going to do. Yet every forecaster has to make a judgment when
he makes his forecast about what the deficit is going to be, what
fiscal policy is going to be, whether we're going to have instability
in foreign exchange markets, and what money growth rates are
going to be. Those are judgments people have to make. Forecasts
depend upon those judgments. Those forecasts are unreliable in
large part because we live in an uncertain world.
My complaint is, it is more uncertain than it needs to be. Congress has responsibility for reducing that uncertainty and I believe
has failed to do it.
The CHAIRMAN. I agree with you. We can have more uncertainty
than we do. Again, to blame the lack of forecasting ability on the
basis that the Fed is uncertain, then why is it from that same data
I get a spread from noted economists, well known, that are so
vastly different in their forecasts from that same data. I think
that's trying to push the blame, just like everybody is trying to
push the blame—I know I've seen charts—I can produce a chart to
prove anything we want.
Mr. MELTZER. But I'm not trying to prove anything. What I'm
asking is that using anybody's forecast in advance, the pattern
shows these peaks and troughs in the last 3 years. That means that
the acceleration and deceleration cycle continues. Why would any
reasonable forecaster have predicted that particular pattern? It
looks like the path that would be followed by a drunk wandering
from lamppost to lamppost. It doesn't look like a sensible monetary
policy, and it isn't.
The CHAIRMAN. I can show you charts where the forecasts were
off when you didn't have that kind of pattern. I can also show you
that when we had stable fiscal policy in this country during periods
of time that the Fed was hardly existent. Nobody knew who the
•2-20
Chairman of the Fed was. The Board was not really evident public^So what I'm trying to tell you is that it s not my academic background but my commonsense that tells me these two have to be coordinated, and the Fed's job would be a lot easier if we had some
responsibility on the Hill. It would be a lot easier for them to hit
their targets and for them to be responsible and not try to put all
the blame on them for this irrationality without similar comments
about the fiscal policy of this country.
Mr. MELTZER. May I just say that I agree with you completely,
that the economy would be much improved if the fiscal policy in
this country were better, but that would require no further increases in taxes but cuts in spending.
The CHAIRMAN. But you would agree the Fed's job in hitting
their estimates would be a much easier job if we had a more stable
fiscal policy?
Mr. MELTZER. No. The Fed can control the base just as well
under any set of fiscal circumstances that you can describe within
the range that we have been talking about. There are some limits
to that, but they are not really critical for us.
What I am saying is that the economy's performance would be
better if there were less uncertainty about deficits and about who
is going to pay and who's going to benefit from Government spending.
RELATIONAL ISSUE OF DEFICITS AND INTEREST RATES
The CHAIRMAN. Well, I think the record shows that the Fed's
performance is better too and has an easier job. There aren't
nearly as many variables for them to adjust as well. Are you
saying here that you don't know of a single study showing the relation between deficits and interest rates in the United States. I
don't know either. I don't know of a single study.
But again, I suppose this repels people who are trained in a particular discipline more than anything else to have an amateur sit
up here and say, but my commonsense tells me something different. That's like the evidence in criminal cases. You know damned
well the guy committed the crime but you can't prove it, and that's
what you're telling me. You're telling me you can't show a study
that shows there isn't a connection, but there is nothing I believe
more firmly than that there is a very definite and significant connection—and you can't convince me with all the charts in the
world—that borrowing 70 percent of the net domestic savings of
this country doesn't crowd out money available for automobile
loans and everything else and tend to drive up interest rates.
Mr. MELTZER. Well, let me just
The CHAIRMAN. Let me finish. I'll give you plenty of opportunity
to reply. And I also over the last 9 years have had something to do
with the financial markets of this country from the standpoint of
rules and regulations about how the community works and how
that should be shaped and I have a great deal of contact with not
only economists but working money managers in this country, and
almost without exception, they will tell me that the reason real interest rates have stayed so high with relation to inflation has noth-
221
ing to do with a chart showing deficits, but they believe it does.
The psychology—if I haven't learned anything else about economics sitting on this committee, it's how important psychology is, and
they don't believe politicians. They don't believe a President because every President comes in and says that by the end of his first
term he's going to balance the budget. Every Congressman and
Senator is for reduced deficits and balanced budgets. How many
decades do they have to be lied to? They don't believe it now. Until
there are structural changes made in the authorization laws and in
the entitlement programs that prove to them that interest rates
are going to stay up.
Now this is the practical side of it, not the models, not the economic training, and that is reinforced in my mind every day.
There's never a day that goes by that I don't have contact with
some of those people that are out there working in the real world,
not in Congress and not in academia, but in the real world, and
that's what they're telling me.
So there is—all the economists in the world can tell me there
isn't a study that shows there is a connection between deficits and
interest rates, but there is, and I believe that as much as I am sitting right here. From a practical, commonsense world of it, there
is.
Mr. MELTZER. I agree with one statement, so as not to be contentious about everything. I would say I certainly support and agree
with your statement that we must cut the entitlement programs.
What is far more important than this issue about deficits and interest rates is the question about whether we are going to allocate
resources toward investment growth and the future of our children
and our grandchildren or whether we're going to continue to run
large budget deficits which primarily support consumption spending now at the expense of the future.
That's critical and we will not get the fiscal problem resolved by
arguing whether deficits affect interest rates or don't affect interest rates. We agree on the bottom line—I think you and I—which
is that the important thing to do is to cut the deficit mainly by cutting consumption spending financed by the Government, that is entitlements and to some extent military spending.
The CHAIRMAN. We do agree on that.
Mr. MELTZER. So we need not argue about the other.
Mr. PARRY. If I could make a comment on this issue, I think the
fact that you don't see a study equating upward pressures on interest rates and the deficit is a correct observation, but it's probably
irrelevant for what we're dealing with today.
In the past when we have had large deficits we have had expansive monetary policy which has often coincided with periods of economic weakness and interest rates in fact went down. In periods of
expansion, because of the tax structure and the way expenditures
have been growing, there was an automatic narrowing of the
deficit.
The problem we face today is unique. It's very different from the
past. We've got a situation, as indicated in the President's economic report and the CBO's recent report, where the deficit is huge on
a structural basis and will become larger as time goes on.
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At the same time, we have to believe—at least it's my own
belief—that the Federal Reserve will be more restrictive this time,
and I think the combination of those two factors makes your concerns very real concerns and makes the historical fact of a lack of
correlation between the deficit and interest rates completely irrelevant to the discussion.
The CHAIRMAN. Senator Hecht.
Senator HECHT. Mr. Meltzer, I enjoyed your testimony and I congratulate Chairman Garn for getting people who are not afraid to
speak up.
Mr. MELTZER. Thank you.
Senator HECHT. I've got a couple questions. You're a professor at
Carnegie-Mellon University, but you write in such a practical
manner that it's very enlightening to hear a professor talk practically. I've asked the same question often of Chairman Volcker, but
I might just give you one simple explanation. I haven't been here
very long. I've only been here 1 year.
If we had a complete monetary policy that everything would be
right down the line so everybody would know exactly—there would
be 10,000 people in Washington out of work the next day if that
would happen. There would be no need for all the economists in
Washington.
Mr. MELTZER. That would be an improvement.
Senator HECHT.
Probably one of the best explanations of the problem of spending
cuts was from Senator Tower not long ago when he said everybody
is talking about cutting the military, cutting the Pentagon, but if
the Pentagon ever mentions closing a military installation in some
Congressman's district all hell breaks loose. So Senator Garn and I
agree that you have got to cut spending. The only problem is under
our constitutional way it's not that easy sometimes. Anyway, if you
have some material from time-to-time I would appreciate you sending it to me.
Mr. MELTZER. Thank you, Senator. Let me say that I share your
view. The problem with deficits is, of course everybody is in favor
of closing the deficit gap but we all have different means by which
we want to do it. That's of course the nature of most political problems. There are some who would like to see it closed by taxes without any cuts in spending and some, like me, who believe it's in the
interest of the country to do it principally by cutting spending.
Some people would find themselves inbetween.
FOUR BUDGET ITEMS CAUSE 80 PERCENT OF THE DEFICIT
But it's well known that 80 percent of the deficit falls within
four items of the budget and we're not going to get substantial cuts
unless we cut those four items.
Senator HECHT. Thank you, Mr. Chairman.
The CHAIRMAN. Let me assure you, Dr. Meltzer, that I don't want
you to resign if you miss your estimates and the point I want to get
back to there is that I feel very strongly that the worse thing we
could do—whatever the Fed's performance is—is not to turn the
henhouse over to the wolf. We've had examples on this committee
where we were not only trying to dictate that they meet their tar-
223
gets but that we set them for them, and we sat before this committee when Arthur Burns was still Chairman of the Fed and suggested we had monetary targets, as I remember, they were in the
double figures, something like 13 to 16 percent. Arthur Burns sat
there and said, "Now, Senators, you know better than that." And I
would hate to think from 8 years ago if Arthur had yielded to that
or Congress had passed a law requiring that, what the inflation
rate would be, because the general tendency of this body is to flood
the market with money and constant demands.
Yesterday was an exception. Normally when Volcker is here the
demands of the majority of the members of this committee is to increase the money supply. So that's why I was digging into you
about having them resign if they didn't get within 1 percent. They
may not have done the job that you and I would want, but I would
hate to have turned over that responsibility. And I want you to
consider that. Whatever your faults with the Fed are, if you really
want to turn over jurisdiction or even a threat of resigning and all
of that to the Congress where we have failed so badly in fiscal
policy and when the evidence is overwhelming that our advice to
the Fed would only be one way, a greatly overexpanded money
supply year after year.
Mr. MELTZER. Let me say that I made my proposal, whatever its
merits or demerits, Senator, with the caution that you suggest.
What I suggested was that the Fed announce the guidelines. If you
don't like 1 percent, let it be within a band or range that they
think they can achieve.
First, what is the point of having them come in here in the full
glare of television and reporters and all the rest to announce to the
country they are going to have a growth rate—let's not take the
current one—let's take 1979—3 to 6 percent, and then produce
something like 7.5 percent. What point is there in that? Is there
some purpose being served there? All that does is bring discredit on
you and them.
The CHAIRMAN. Would you like to know what the point of it is?
Mr. MELTZER. Yes.
The CHAIRMAN. The original Humphrey-Hawkins bill was so intrusive and we watered it down in a compromise because it was
going to be passed to say come up and tell us what you're going to
do every 6 months. So I agree with you that it serves no useful purpose. It's a media event for Paul Volcker or any other Chairman to
come up. That was simply a political compromise to gut the original Humphrey-Hawkins bill.
Mr. MELTZER. But there is a merit in giving people information.
Fifty years ago when we had a gold standard, whatever its merits
or demerits, it had that advantage. People had some knowledge
about what the long-term rate of inflation was going to be. Now
why was that important to them? My answer is this. People have
to know whether they're going to invest in gold, or silver, or bric-abrac, or collectibles, or whether they want to invest in, plant and
equipment. In order to know that, they have to know something
about what the inflation rate is going to be because that's going to
tell them what taxes they're going to have to pay on investments
they make. Under the gold standard they had that long-term cer-
224
tainty, and I'm not an advocate of the gold standard, but it gave
them that.
Now we haven't the slightest idea what the monetary policy is
going to be 1 year or 2 years from now. How can people engage in
long-term investments to the same degree without that confidence?
The purpose of these announcements is to give people an idea of
what the Government plans for it.
Now if the hearings are not doing that, we need another mechanism. My mechanism is not nearly as incautious as you suggest. I
didn't say that the Fed has to resign. I said they had to offer their
resignations to the President. The President can then accept responsibility for the Fed policy and therefore be accountable for it.
You're accountable for the Fed policy to your voters. They don't
know all of this institutional detail. If things go bad, they blame
you and they blame the President of either party. What I'm asking
is that they be accountable so they also have some responsibility.
If they give the President an excuse and say, look, there was deregulation in the banking system and that's why we had to miss
the target by 3 percentage points this year, he could either decide
he wants to accept that and accept responsibility or he can say,
look, I want to get a new Chairman who s going to be able to do a
better job.
We trust the President to appoint the Secretary of Defense. We
ought to trust him to appoint the Chairman of the Federal Reserve
and enforce some kind of consistent policy on the Federal Reserve.
If we don't, we are going to continue to have this high variability
which taxes the American people.
The CHAIRMAN. Well, again* I don't disagree with you on the
variability. I very much oppose the idea of politicizing the Fed and
this is a modified proposal, Others want the President to have a
Chairman who's term is contemporaneous with his. We have proposals to put farmers and businessmen on the Board. There are
constantly 10 or 11 bills before the committee to do things to the
Fed, They all have the same effect—to politicize it.
POLITICIZING THE FEDERAL RESERVE
What would have happened—and the reason I want to—even
when I disagree with the Fed, and I often do—and that's why I said
I agree with a good deal of your criticism I do not want to upset
their independence and politicize it because it would only go one
way. This President or any other President that I have seen would
yield to political pressure to demand not what you're talking
about—stable monetary growth and all of that—start to get into
trouble and say, hey, we've got to put that money out there and
flood it, and I think you would have had an incredible—Republican
or Democrat—it doesn't make any difference—that would be the
tendency if the Fed was under the jurisdiction or even the pressure
of a President or the Congress. It would all go one way and then
you would really see inflation and high interest rates.
Mr. MELTZER. But they would never have to resign if they
achieved what they said. That is, there would be no change whatsoever from the present circumstances if they achieved what they
said they were going to. The only case in which there would be res-
225
ignations or political influence would be if they didn't do what they
said, in which case the President and Congress do bear responsibility. The only thing that keeps us from having a severe inflation
now is that the American public doesn't like it.
The CHAIRMAN. Well, in my realm of being a professional politician, which I am, and the way I see it again work in the real world,
the proposal you suggest would bring great political pressure on
the Fed and that is not your intention.
Mr. MELTZER. Certainly not.
The CHAIRMAN. But the practical application is that it would,
and I'd rather have the Fed performing badly by themselves than
incredibly badly from the pressure of politicians. We have failed
miserably. The major problem in this country is not an economic
problem, but it's the economic problem caused by politics, by gutless politicians who are buying themselves back into reelection
year, after year, after year without the courage to say no to anybody who wants a dime out of the Federal Treasury.
Mr. MELTZER. I believe that's a smaller part than you do, Senator, if I may say so. I think what the budget represents is the views
of the American public about who pays and who receives. Since the
country is very much divided on the issue of how to close the deficit, one should expect that their elected representatives would be
divided also. There's something called political courage.
The CHAIRMAN. There's something called leadership, too. The
representative form of government is a two-way street that you
don't just stick you finger in the air and see which way the wind is
blowing. That's like the guy leaned out the window of his car in
the middle of a crowd and asked, "Where are you going? I want to
lead you." That's what we have in Congress. I don't have any trouble going home and explaining some of these things that are controversial. I don't have any trouble explaining the social security
still needs some fixing without having to cut anybody off to reduce
their current pension. Simple little things like that—12 of us voted
on the Senate floor to change the retirement age from 65 to 68 at
the rate of 1 month a year for 12 years. That affects the guy who's
29 years of age. You could make those kind of changes in the entitlements programs very broadly over decades without hurting anybody, but you've got to have the courage to go home and say we're
not cutting you now. I have been to the senior citizens center, so I
can't blame it on the people as much as I can on the politicians
who are more interested in reelecting themselves and doing it
easily by yielding rather than trying to say, hey, there is a different way and going home and having the courage to talk about it.
Mr. MELTZER. Well, there's certainly enough blame to go around.
The CHAIRMAN. There's no doubt about that, but it primarily resides here. What I have said many, many times is that only Congress under the Constitution has the ability to appropriate money.
It doesn't matter what the President recommends. If Congress
really doesn't like Ronald Reagan's budget, rather than griping
and trying to politicize it or making hay out of it during an election year, all they have to do is change it, junk the whole thing.
We don't like a $180 billion deficit, but he's going to get it anyway.
I remember the first time when he came out with a $145 billion
deficit and we said, hey, that's a political deficit that isn't possible.
226
Now he comes out with one that's probably realistic and he's condemned that it's too big.
As you can tell, I'm not very happy with the legislative body and
if I could do one thing to solve more things for this country it
would be a constitutional amendment which would limit the President to one 6-year term and Senators to two 6-year terms and Congressmen to two 3-year terms, and then we'd get back to what the
Founding Fathers intended, that we have a citizen legislative body,
that citizens represent their constituencies during part of their
lives rather than making it their lifetime means of earning their
living. I think we've gotten far, far away from what they intended
as a representative government. We are becoming elected bureaucrats. The only difference between us and the boys downtown is
that we have to face reelection and be smart enough to con our
constituents into reelecting us every 6 years, and the bureaucrats
are locked in with their next closest thing to eternal life we'll ever
find on this earth which is civil service, that you're not in any
danger unless you so badly screw up that you're really in trouble
and you get removed.
So again, I'll get back to my statement that we've got more of a
political problem in this country that causes the economic problem
than all the econometric models in the world will show you. We
need backbone and courage from our public officials to attempt to
do what's right for all rather than what it looks good for us to do
during an election year.
Well, I appreciate you listening to my lecture. It's very kind of
you to sit there patiently and smile. I appreciate both of your testimonies very much. Do either of you wish to make a closing statement?
[No response.]
The CHAIRMAN. Thank you gentlemen, very much.
The committee is adjourned.
[Whereupon, at 12:25 p.m., the hearing was adjourned.]
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