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SHADOW OPEN MARKET COMMITTEE
P o l i c y s t a t e m e n t and
P o s i t i o n Papers
March 2 4 - 2 5 ,
1985
PPS-85-1
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CENTER FOR
RESEARCH IN
GOVERNMENT
POLICY
& BUSINESS
Gradijate School of Management
University of Rochester
SHADOW OPEN MARKET COMMITTEE
Policy Statement and
Position Papers
March 24-25, 1985
PPS-85-1
Shadow Open Market Committee Members - March 1985
SOMC Policy Statement, March 25, 1985
Position papers prepared for the March 1985 meeting:
Confusion of Language and the Politics
Brunner, University of Rochester
of
Uncertainty,
Karl
Guidelines for Deficit Policy, Mickey D. Levy, Fidelity Bank
Economic Outlook, Jerry L. Jordan, First Interstate Bancorp
Forecasts of the Ml - Adjusted Monetary Base Multiplier for 1985,
Robert H. Rasche, Michigan State University
International Trade Policy:
Switzerland
The Two Main Tasks, Jan Tumlir, GATT,
Shadow Open Market Committee
The Committee
1985.
met from 2:00 p.m. to 7:30 p.m. on Sunday, March 2,
Members of SOMC:
PROFESSOR KARL BRUNNER, Director of the Center for Research in
Government Policy and Business, Graduate School of Management,
University of Rochester, Rochester, New York.
PROFESSOR ALLAN H. MELTZER, Graduate School of Industrial Administration, Carnegie-Mellon University, Pittsburgh, Pennsylvania.
DR. JERRY L. JORDAN, Senior Vice President and
Interstate Bancorp, Los Angeles, California.
DR. MICKEY D. LEVY, Chief Economist,
Pennsylvania.
Economist,
Fidelity Bank,
PROFESSOR WILLIAM POOLE, Department of Economics,
Providence, Rhode Island.
First
Philadelphia,
Brown
University,
PROFESSOR ROBERT H. RASCHE, Department of Economics, Michigan State
University, East Lansing, Michigan.
DR. ANNA J. SCHWARTZ, National Bureau of Economic Research, New York,
New York.
DR. BERYL SPRINKEL, Executive Vice President and
Trust and Savings Bank, Chicago, Illinois.*
Economist,
Harris
DR. JAN TUMLIR, Research Director, GATT, Geneva, Switzerland.
*0n leave from the SOMC, currently Under Secretary of the Treasury for
Monetary Affairs.
POLICY STATEMENT
Shadow Open Market Committee Meeting
March 25, 1985
Economic
economic
recovery
policies.
continues
The
despite
the
absence
of
Federal Reserve concentrates on
coherent
short-term
policy decisions and lurches from excessive money growth to slow money
growth and back to excessive money growth, with no long-term
to
achieve non-inflationary money growth.
program
It is disappointing
that
the Administrtion projects essentially no change in the inflation rate
in
the rest of the decade.
The Congress concentrates on
short-term
budgetary adjustments and avoids developing a long-term fiscal program
to
maintain
growth
counterproductive
Administration
achieve
These
its
that
and
the
increase
economic
Federal
Reserve
stability.
and
favor currency market intervention,
intended effect and destabilizes
the
It
members
of
is
the
since it does not
exchange
actions increase uncertainty and reduce efficiency.
market.
They make
private planning more difficult.
During the last five years, the United States has made
progress in improving economic fundamentals —
lower inflation,
interest rates, increased output and productivity growth.
should not be squandered.
important
lower
These gains
To maintain and extend these gains, present
fiscal and monetary policy uncertainties must be resolved.
Fiscal Policy
The
shifts
and
central fiscal issues are the degree to which the
government
resources toward current consumpiton and away from
investment
the
way the budget is financed.
1
A rising share
of
government
spending
toward
typically
means that the government is
shifting
current consumption and away from investment.
lower
investment and eventually lower output.
resources
The result
If higher
spending is financed by increasing money growth,
is
government
inflation rises. If
spending is financed by higher income taxes, the government's spending
for
consumption crowds out private spending and
saving.
Investment
and future output are reduced.
Excessive
attention
to the size of the deficit
away from these central issues.
about
the
relationship
of the budget deficit to the
foreign
government
trade
between
There is no valid
for believing that a reduction in the budget deficit
followed by a fall in the dollar exchange rate.
in
statements
There is no simple connection
current exchange rate and the budget deficit.
reason
attention
Misleading and incorrect
deficit misinform the public.
the
draws
will be
In fact, a reduction
spending for consumption that shifts resources
toward
investment and lowers the risk of future inflation may be followed
further
appreciation of the dollar against other
currrencies.
by
This
should not be an excuse for failing to act on the deficit.
The
effects of budget policy depend on the details of the
package.
Current
All
use
reductions
of
price
in spending do not have the
controls
expenditures
under
medicare
efficiency.
It.is not a part of,
on
medical
same effect.
services
is a short-term stop-gap
fiscal policy to reduce spending.
fiscal
or a substitute for,
to
reduce
that
reduces
a
long-term
Reduction in defense appropriations
often are followed by reductions in manpower that reduce efficiency by
reducing
equipment.
the
labor
available
Reductions
in
to
operate
planned
available
spending for maintenance of highways
other social capital postpone spending to a later date.
or
2
and
Discussion of fiscal policy puts too much emphasis on the size of
projected budget deficits and too little emphasis on the efficient use
of
resources.
proposed
We
urge
Congress to
support
the
Administration's
spending cuts and indeed enact additional cuts.
We propose
five principles of budget policy to contribute to growth and stability
and reduce uncertainty.
1.
Congress should reduce the ratio government spending to
total output, initially, at least 2 percent below
current levels and thereafter maintain the ratio as
part of a long-term fiscal plan.
2.
Spending reductions should take precedence over tax
increases.
These reductions should not be at the
expense of public goods such as defense in order to
maintain transfer outlays. Both must be reduced.
3.
Spending reductions should be made in ways that increase
efficiency in the use of resources.
4.
Short-run action to reduce the deficit should
be
consistent with long-term structural reform of spending
programs.
Postponements masked as reductions should be
avoided.
5.
Any revenue increases agreed upon as part of a budget
compromise should fall on consumption spending.
Full
indexation of the income tax should be retained.
To
make a fundamental change in the government's fiscal
policy, it is essential to put a cap on total federal
spending.
Monetary Policy
The Federal Reserve cannot change the government's fiscal
The
policy.
responsibility of the monetary authorities is to maintain
stable
monetary conditions consistent with a return to full price stability.
Unfortunately, confusion and uncertainty surround monetary policy.
The Federal Reserve announces targets for monetary aggregates and, at
the same time, urges more intervention in the exchange market.
seem
unaware that,
They
if they achieve their monetary targets, the only
3
effect of exchange rate intervention is to shift the risk of
rate
changes
ultimately,
from
to
private speculators to the
the
taxpayers.
Federal
exchange
Reserve and
Further, the Federal Reserve uses
control procedures that increase the variability of money growth.
long as current procedures are used,
interest rates, exchange
As
rates
and output will vary excessively.
At
our last meeting, we praised the Federal Reserve for keeping
average money growth near the mid-point of the target range. We urged
them
to reduce the uncertainty created by erratic money growth and to
announce a program to end inflation by the end of the decade.
The Federal Reserve, instead, announced a very modest reduction of
1/2 percent in average money growth for 1985 and increased the shortterm
variability of money growth.
inflation,
they
have
postponed or abandoned any
inflation.
This
present
adopt a long-term
to
is
Although they talk about reducing
a mistake.
effort
to
reduce
There is no better time than
policy to reduce
the
trend
the
rate of
inflation.
A year ago the FOMC set a target for 1984 money growth centered on
6 percent.
The Shadow Committee preferred a lower target for 1984 but
emphasized
the paramount importance of instituting a long-run
of achieving non-inflationary money growth.
policy
Actual Ml growth in 1984
was 5.2 percent, below the center of the Fed's target.
In
order
framework
for
to
eliminate "base drift"
and
establish
a
steady progress towards lower money growth,
coherent
the
SOMC
urges the Federal Reserve to increase Ml in 1985 by 5 percent from the
mid-point
of the original target range for 1985.
This policy
would
result in an increase of 5.75 percent over the four quarters of 1985,
or
a
5.5 percent average increase for 1984 and 1985 taken
4
together.
In
the
event that money growth in 1985 exceeds this
think highly likely,
target,
as we
the target for 1986 would still be based on
the
target level for year-end 1985, rather than the actual level of fourth
quarter 1985.
Chairman
of
Volcker acknowledged to Congress that the present method
announcing
neglected
the
generated
by
monetary targets
is unsatisfactory.
two most unsatisfactory
the
aspects
—
use of multiple targets and a
His
the
statement
uncertainty
shifting
base
for
announced monetary growth.
Eliminating
policy
plan.
base
A
drift is one component of a
second
long-run
key component is to announce
a
monetary
multi-year
projection for expected money growth. The rate of money growth should
not shift about haphazardly but should decline regularly.
long-term
strategy
reduces uncertainty,
A credible
particularly in an
era
of
large budget deficits. Reducing uncertainty lowers interest rates and
raises real output.
Many
announce
countries
announce montary targets
a single target,
than the Federal Reserve.
procedures
are
or
projections.
and some achieve the target more
The reason is that the
archaic and inefficient.
Federal
The Fed
is
Most
reliably
Reserve's
unjustifiably
complacent about the intra-year volatility that results.
The
stability
third
and
step
end
in developing
a monetary
inflation is to require the
policy
Federal
choose a single monetary target and improved control
again
achieve
Reserve
procedures.
to
We
urge the Congress to require the Federal Reserve to announce a
multi-year strategy for reducing inflation.
to
5
Exchange Rates
The
recent
central
interventions
banks
have been
by
the Federal
counterproductive,
Reserve
and
destabilizing
foreign
exchange
markets.
The Federal Reserve cannot simultaneously control the growth
of
money
and
manage
the
exchange
rate.
Proposals
for massive
intervention or coordinated intervention are misguided.
short-term
response
to slower money growth is a rise
market rates and a rise in the exchange rate.
rate
The expected
in
short-term
The longer-term effect
will be lower market interest rates on short- and long-term assets and
no
effect on the real exchange rate —
the exchange rate adjusted for
differences in anticipated rates of inflation at home and abroad. The
only way that the Federal Reserve, or other
lasting
effect on the exchange rate is by
expected
rate
without
of
changing
inflation
fail.
inflation.
central banks, can have a
changing
their
Efforts to change the
exchange
the rate of money growth and the expected
This
is the finding of
every
country's
careful
rate
rate
of
study
of
exchange rate policy.
There
dollar
are many factors affecting the exchange rates between
and
other
unmistakable.
States
currencies,
First, the
but
two
principal
expected rate of inflation
forces
and
Germany
Second, the expected after-tax
return to capital has increased in the United States both in
terms
are
inthe United
has fallen relative to other countries, particularly
and Japan, during the past four years.
the
relative to other countries.
absolute
This is a real change
that
cannot be offset by Federal Reserve actions.
Proponents of exchange rate intervention mislead the public.
dollar
has
risen
because holders anticipate a
6
higher
return
The
from
holding dollar assets than from holding foreign assets. The principal
change
been
in U.S.
a
shift
investment
international capital movements in recent
by
U.S. citizens
and
financial
years
institutions
abroad to investment in the United States.
has
from
Americans are
repatriating their foreign assets to take advantage of the improvement
in investment opportunities at home. Foreigners are investing more in
the United States for the same reason.
As a result, the net capital
flow to the United States is high relative to previous
current
periods.
account deficit is the counterpart of the capital inflow
The
and
will remain as long as the capital inflow continues.
Many
deficit.
States
people view this process as a means of financing the
This view is misleading.
The flow of capital to the United
is the result of many private decisions to invest in
denominated assets.
budget
dollar-
Unlike the 1960s and 1970s, when foreign central
banks supported a weak dollar, U.S. government debt held by
foreign
central banks has fallen.
We urge the Administration to reject the policy of exchange market
intervention.
Federal
The Administration and Congress should demand that the
Reserve ignore exchange market fluctuations and
institute
stable policy of controlling money growth to end inflation.
7
a
CONFUSION OF LANGUAGE AND THE POLITICS OF UNCERTAINTY
Karl Brunner
University of Rochester
I.
Confusion of Language
Interest rates fell throughout the second half of last year.
dropped
They
by the middle of January 1985 below the level from which they
started to rise early in 1984.
The Federal Funds rate fell about 3 00
basis points and the discount rate was lowered in repeated steps
last
year.
policy
So
turned
apparently
public
"Wall Street" and the media decided
"increasingly
endless
easy".
Once
again
repetition of an old story.
that
we
late
monetary
observe the
The experts
of the
arena persist in interpreting the stance of policy in terms of
the prevailing movements of interest rates.
Declining interest rates
reveal
"tight
an
expressions
movements
signal
"easy policy" and rising rates a
policy".
are moreover not just meant to summarize
of
interest rates.
These
the observed
These movements are understood
as a
indicating that monetary policy conveys a stimulative ("easy")
or retarding ("tight") effect on economic activity.
This story has a long history.
Depression
done
During the first year of the Great
in 1930 the Fed assured itself and the public that it had
everything possible to stimulate the economy.
after all, were falling.
Interest
rates,
There was nothing more to be done.
Events
had moved beyond the control of the Fed.
Early
policy.
in the year 1960 the Fed announced a shift
Free reserves rose and the Federal Funds rate fell.
apparent stimulus failed to affect the economy.
mild
recession.
toward
Naturally,
voices
y
were heard
easier
But the
It still slid into a
claiming
that the
economy had moved beyond the influence of the Fed.
money
stock
declined
In particular, the
throughout this period in spite
of
an
"easy
policy".
More
examples
experiences.
could
be
collected
from
old
or
more
recent
But the point requires no further elaboration and we had
better examine its basic fallacy.
We note first that the Fed
exerts
in the short-run a very limited influence on market rates of interest.,
These
interest
actions
effect
operate
are dominated by
market
forces.
on market rates to a large extent
via
The
the
Fed•s
signal
these actions convey to the market about the future course
policy.
cannot
rates
of
But contrary to widely held beliefs among politicians the Fed
persistently lower interest rates
with an expansionary policy
against prevailing market forces. The longer-run consequences of such
a policy have been clearly demonstrated for many years.
inflation
correspondingly high
and
It follows that over
ongoing
inflation.
indeed
substantially
interest
as
interest rates
shape
rates with large
monetary
adjusted
the longer
interest rates.
expansion
It
of low monetary expansion.
to the
run the Fed
can
can
high
produce
and low interest
in the early part of the 1960s, with a credible
policy
They produce
rates,
non-inflationary
Mr. Volcker understood this fact
very clearly and made this point repeatedly during the first years
of
his stewardship.
The
horizon
first
over a
shorter
manipulated
against
point made above thus emphasizes that
interest
rates
cannot be
effectively
market forces and the market's dominant evaluation.
horizons
the
behavior
is
And over
longer
Fed's influence on the broad contours of interest
just
the
reverse
of
10
the
belief
expressed
by
rate
many
politicians.
Interest rates provide thus very poor information about
the thrust of monetary policy.
A
wide
range of experience drawn from many different
times
and
countries informs us that economic activity responds to the variations
in monetary
growth.
In particular,
monetary
accelerations
or
unexpected monetary expansions stimulate activity for a few quarters.
Monetary
decelerations or unanticipated monetary contractions
on the other hand activity for a short period.
interest
panied
We note thus with some
that the phase of rising interest rates last year was accom-
by a strong monetary acceleration.
deceleration
This
retard
was
behavior
The
subsequent
accompanied by a large decline of
monetary
interest
rates.
is not consistent with an explanation attributing
changes in interest rates to a "restrictive policy" in the first
and
an "easy policy" in the second half.
expands
half
This linguistic regulation
increas-
would otherwise mean that policy is "tight" whenever the Fed
ingly
the
the money stock and the supply of credit.
mean that policy is "easy" whenever the Fed lowers
It would also
monetary growth and
credit supply.
The
noting.
change
in monetary growth experienced last
year
is
Monetary growth dropped from the first to the second
Period
M-l
Monetary Base
1/11/84 - 7/11/84
8.1%
10.3%
7/11/84 - 1/ 9/85
3.0%
4.6%
worth
period
by more than half. We also note that the deceleration of the monetary
base was the major cause of the monetary retardation.
sensible
1984
to describe this shift from the first to the second half
as a move toward "easier policy".
It seems hardly
11
of
The monetary retardation and
the
associated
slower
supply of bank credit reflected
to
a
large
extent the Fed's behavior.
The same pattern prevailed in 1930 and 1960. The fall in interest
rates
tary
was accompanied throughout 1930 by lowered growth of the monebase
actually
I960
and the money stock.
a
The apparently
"easy
policy"
policy fostering continued economic contraction.
"Wall Street" and the media just concentrated on
was
And
free
in
reserves
and the federal funds rate. They failed to notice the actual behavior
of
the Fed expressed by the persistent decline of the monetary
Contrary
stock
to
did
an opinion voiced at the time in the
not
become
(actual) policy.
media,
uncontrollably disconnected
from
base.
the money
Fedss
the
It effectively reflected this policy imitating
the
recession.
The
annual
instructive
reports of the Fed for 1949 and 1950 also offer
examples.
The report for 1949 advises us that
essentially pursued an "easy policy",
dominated
monetary
report
by
sales.
growth
for
and
Massive open market purchases in 1950
credit supply were represented
that year as an expression of a
ago Allan H.
Federal
rhetoric
Reserve
the
in
"tighter"
annual
policy.
The
More than 20
prepared for Congress that
and actions were negatively correlated.
raising
the
Meltzer and I emphasized in a detailed
Policymaking
Fed
but open market operations were
history of the Fed exhibits thus a singular phenomenon.
years
some
study
on
the
Fed's
The problem
still
persists today, but mostly located in the media and "Wall Street".
II.
The Creation of Uncertainty as a Matter of Policy
Monetary policy has been riding a roller coaster over the past six
years.
In 1979 until the fall of that year monetary growth spurted at
10.2%.
It dropped to 2.2% from the fall 1979 to the spring of 1980.
12
This
slow phase was followed until the spring of 1981 by another go-
phase
with a growth rate of 10.1%.
A slowdown to 5.4% emerged
from
the spring of 1981 to the late summer of 1982. There appeared at this
time
a go-go episode until the fall of 1983 with a monetary growth of
almost
13%.
This rapid acceleration ultimately subsided to a
lower
growth of 5.6% over most of the winter 83/84 well into 1984.
This behavior of monetary growth reveals the basic problem of the
Fed's strategy and tactics. It did manage in the average over the past
five
years
summarized
above
conveys the erratic and uncertain sense of our monetary policy.
This
uncertainty
to
lower inflation.
But the record
was reenforced by contradictory statements intermittently
supplied by various Fed officials. Monetary policy thus appeared more
and
more as a "random walk through history".
tainty
The prevaiing
uncer-
contributed to the high level of the real rate of interest and
most particularly to the remarkable variance of nominal interest rates
observed over the past five years.
It is noteworthy that the variance
of both monetary growth and interest rates increased over this period.
Table I shows the large increase in the standard deviation of monetary
growth over the levels observed in the 1950s, the 1960s and the 1970s.
Standard Deviations of the First Difference of the Logarithm
of the Percentage Change in Velocity and Ml
(Quarterly Data, Seasonally Adjusted)
Period
VBase
1952.3-1960.1
1960.2-1970.1
1970.2-1979.3
1979.4-1984.4
1952.3-1984.4
VM1
MB
1.333'
0.759
0.931
1.286
1.196
0.734
0.904
1.475
0.462
0.502
0.287
0.576
0.534
0.608
0.504
1.157
1.072
1.050
0.771
0.849
Table I
13
Ml
There
seemed
to
be no anchor to our monetary
affairs
which would
provide a stable and predictable performance.
It
is
important
unavoidably
from
to
the
recognize
that
Fed's tactical
this
uncertainty
procedures
and
institutional
choices expressed most particularly by the nature of reserve
ments.
Policy
implementation
involves
a shifting game
varying combinations by the federal funds rate,
of the economy,
tude
of
require-
guided
the Fed's
in
perception
its views about recent monetary growth and the magni-
borrowed reserves.
conception
follows
The emergence of this borrowed
revived in recent years old views and
reserve
procedures
guiding
Fed policymaking during the 1920s. The Fed sets under this conception
a
target
market
for borrowed reserves and proceeds subsequently
operations
designed to adjust the actual volume
reserves to its target level.
with
of
open
borrowed
It follows under the circumstances that
whenever borrowed reserves exceed their target level the monetary base
tends
to
opposite
changes
be accelerated.
case.
We
The monetary base is decelerated
need to recognize at this stage
that
in the
short-run
in borrowed reserves are dominated by an evolution of
shocks
affecting credit markets and banks' positions.
The "borrowed
reserves tactic" thus converts these random shocks modifying
reserves
random
borrowed
into erratic and unpredictable movements of monetary growth.
A similar argument extends to the case of federal funds targeting.
A
reliable assessment of the future course of monetary policy is further
impaired by the shifting combination of guide posts noted above
which
are used by the Fed.
A policy of uncertainty is not innocuous.
of
output and investment.
higher
real
rates
It affects the evolution
The pronounced uncertainty contributed to
of interest.
14
It
also
explains
the
remarkable
volatility
policy
of
over
prepared
interest
rates which accompanied our
the past six years.
This result was shown
by Bomhoff, Mascaro-Meltzer and others.
uncertainty
produces
operating
some more pervasive
problem.
But a
studies
policy
consequences.
of
Agents
a
serious
They must set prices and plan their activities
facing an uncertain course of monetary affairs.
link
coaster
in
in the economy confront under the circumstances
information
ences
roller
This context
influ-
a price setting behavior which effectively establishes a causal
between
monetary
shocks and real
variables.
Prices
do
not
respond in general to all the passing variations in market conditions.
Many prices adjust to more permanent changes in the underlying
state.
A policy of uncertainty obscures however the recognition of the actual
conditions.
unavoidably
price
setting behavior
Agents find it in
are
thus
particular
to distinguish between transitory and permanent aspects of
monetary affairs.
partly
guiding
erroneous to some extent.
impossible
our
Perceptions
misinterpreted
Comparatively more permanent
as transitory events barely
conditions
justifying
are
major
adjustments of prices. They affect under the circumstances output and
employment.
tions
A
politics of uncertainty thus produces
misinterpreta-
of current and expected monetary conditions which foster short-
run variations in output and employment.
These shorter run patterns do not exhaust the consequences of
uncertainty
prospects
evaluation
created
by
the monetary
authorities.
of prices are difficult to assess in such
a
longer-run
regime.
The
of costs and returns of projects with a long payoff period
suffers therefore even greater risks.
The resulting increase in risk
lowers the incentive to invest in such projects.
The
the
15
Recent
discussions revealed additional consequences of the uncer-
tainty associated with some monetary regimes.
istics
of the regime, expressed for instance by the
imposes,
run*
conditions
It
appears
characterizing
the
The general character-
stochastic
different
uncertainty
trend and variability of output over the
that
the properties of
the
stochastic
the regime contribute to determine the
process
levels
governing output.
of built in uncertainty
thus
longer
process
properties
Different
it
of
regimes with
produce
different
patterns for the evolution of output.
A
preliminary and still crude examination of this important issue
may be useful.
A recent study by Kormendi and Meguire in the Journal
of Political Economy listed data from 47 countries describing standard
deviation and mean of monetary and real income growth based on
values
some
over twenty years.
These data were explored with the aid
simple regressions presented in table II.
that
ciated
is
a larger average monetary growth is
with a higher standard deviation.
highly significant.
suggests
tional
It confirms
systematically
the
asso-
The regression coefficient
The constant term is
non-significant
which
that the standard deviation of monetary growth SM is propor-
to
average
monetary growth
MM.
This
implies
a
constant
coefficient of determination equal to the regressive coefficient.
also
of
Regression 1 attends
to a question frequently discussed in recent years.
view
annual
We
note that 73% of the cross-country variation in SM is associated
with variations in MM.
The
association between the standard deviation SY of real
growth and its average MY is in contrast quite weak.
coefficient is barely significant at standard levels.
The
regression
The low corre-
lation also suggests absence of any systematic connection.
16
income
Only 4.5%
of
the
variation
standard
deviation
in SY is reducible to the variation
of real growth appears, relative
in MY.
The
to the mean real
growth, as a constant plus a random term.
Correlation Between Mean and Variance of Money Growth and GNP
MM
SM
MY
SY
=
=
=
=
Mean Growth Rate Ml for 47 Countries
Standard Deviation Growth Rate Ml
Mean GNP Growth Rate for 47 Countries
Standard Deviation Growth Rate GNP
Regressions
1.
+
SM - 0.008
(.822)
0.665 MM
(11.13)
(.)=T-Value
Adjusted R-Square=0.73
F=123.84
DW=2.07
Standard Deviation Residuals .03711
2.
SY = 0.021
+
(3.68)
0.201 MY
(1.78)
(.)=T-Value
Adjusted R-Square=0.045
F=3.18
DW=2.04
Standard Deviation Residuals .011278
3.
SY - 0.024
+
(9.15)
0.07 SM
(3.22)
(.)=T-Value
Adjusted R-Square=0.17
F=10.36
DW=2.10
Standard Deviation Residuals .010521
Table II
The
It
last regression is of particular interest for
our purposes.
regresses the standard deviation SY of real growth on the standard
deviation
SM of monetary growth.
coefficient are quite significant.
terms
Both constant term and
It is noteworthy that the constant
in regressions 2 and 3 are not
correlation
coefficient
in
regression
significantly
the last regression is
different.
however
The
modest.
Only 17% of the total variation in SY is associated with corresponding
17
cross country variations in SM or ultimately in MM.
This implies that
real
shocks and real conditions dominate the pattern of real
growth.
Even
an average monetary growth of 100% p.a. would raise SY only by
about 20% from .024 to approximately .029.
Some
further interpretation is needed at this stage.
shocks"
reflected
in the constant and random term
of
The
"real
regression 3
include the real effects of the realizations generated by the stochastic
process
shorter
controlling
run aspects.
monetary growth discussed above
under
the
The regression coefficient associated with
SM
reflects on the other hand regime characteristics.
The total
tary effect" on SY consists thus of two components,
one operating via
the
regression
coefficient and the other via portions of the
"mone-
random
term.
An
issue
requires
our
perceived
are
the
depend
emerging
in monetary analysis
attention.
in
recent
It has been argued that
years
the
larger
aggregate shocks relative to allocative shocks the
real effects of monetary shocks.
This analysis and
crucially on the existence of a substantial
also
the
smaller
result
information
lag
for aggregate information relative to allocative or local information.
This
information
lag hardly exists in the USA but may
operate
with
substantial force in most of the 47 countries used in the sample. But
an
alternative
available.
larger
We
monetary
proportion.
interpretation underlying our short run
analysis
obtain the same conclusions with the assumption
shocks are perceived to contain a
higher
is
that
permanent
This assumption forms essentially a hypothesis about the
stochastic characteristics of prevailing monetary regimes.
Either one
of the two interpretations implies that the relation between SY and SM
is non-linear involving a decreasing sensitivity of SY with respect to
18
SM
as
SM increases.
linear
Such a non-linear relation would imply that a
approximation
seriously
underestimates
the
regression
coefficients in the lower levels of monetary growth. The regression in
table
III
including
the square of
SM
examines
this
issue.
The
Non Linear Regression of SY on SM
SDY = .013 + .257 SDM - .524 SDM Squared
(2.7)
(3.2)
(-2.4)
R-Squared = .251 F » 8.7 Standard Deviation Residual=.00998
Table III
coefficient
of
SM2
.
is
negative
second
supports
the
moreover
substantially
. ..
significantly
negative and
derivative of SY with respect to
contention advanced above.
raised
thus
SM.
implies a
This
result
The coefficient of
from .07 in table
II
to
SM
is
.257.
An
average
monetary growth of .1 (i.e. 10% p.a.) would raise SY in the
average
to
about .031 which is more that double the
level
of
.013
associated with a zero level of SM. We note finally that the constant
term
The
is still significant but smaller than in the linear
"explanatory
regression.
power" has also been raised from 17% to 26% of
the
total variation in SY.
III. Excuses
The
results
occurrence
The
argument
which
accelerations
than
two
reveal
of real consequences associated with a politics of
tainty.
innocuous.
support prior and ongoing studies which
Fed
typically justifies its policies however
denies such consequences.
or
decelerations
It asserts that
over less than
three
the
uncer-
with
an
monetary
quarters
are
Variations in monetary growth need be maintained over more
quarters
before a monetary shock operates
19
on
the
output
market.
The potential real effect of a shorter run monetary shock can
always be offset under the circumstances by a suitable reversal. Such
shorter-run variability may indeed generate no serious uncertainty and
corresponding inference problem for agents whenever they occur in the
context
of
policy.
The case of Switzerland offers some interesting experience in
this
a well understood and generally
respect.
But
uncertainty
believed
pre-committing
unavoidably mounts with
short run
variability of monetary growth in the absence of any constraining
and
credible institutions pre-committing the behavior of the Central Bank.
Agents
setting prices and planning activities confront in this case a
burdensome problem of interpreting monetary evolutions.
inferences
affect
the
economy and so does the
Misconceived
recognition
of
the
inherent risk.
The immunization of established discretionary policymaking against
its
critics
objections
control.
does not rely on a single argument.
A wide variety
has been addressed to a policy of pre-committing
monetary
The idea that "nobody knows what money is" was discussed in
a previous position paper and is really embarrassingly silly.
noteworthy
irrelevance
that
it
circulates
mostly
among
It
non-economists.
is
The
of this idea is easily recognized by the falsehood of its
central implication.
would
of
randomly
transactions.
If people would not know what money is then they
select
objects to settle
obligations
This clearly has not happened.
monetary control is technically not feasible.
arising
from
Others maintain
that
But the examination of
this
issue pursued by James Johannes and Robert Rasche over the
past
six
years demonstrates that control of monetary growth over one
year
within a 2% band centered on the target level is quite feasible.
This
20
conclusion
of
one
is confirmed by studies prepared by the staff at the Board
Governors of the Federal Reserve System.
The control level
over
year indicated is quite sufficient for all practical purposes
of
policymaking.
The
potential
nation's
worthy
money
errors
associated with
the
measurement
stock raises a more respectable issue.
data
with
larger measurement error is not voiced (e.g. trade deficit,
current account deficit, price indices as inflation
Concern
the
It is note-
however that a similar concern about publicly used
probably
of
was
increased
particularly
measure,
voiced whether the measurement
or especially become more volatile.
The
etc.).
error
has
implications
of
this event coincide with the consequences of another problem I wish to
address with my final comments.
A chorus of voices stresses potential effects of deregulation
financial innovation.
the
relation
and
These effects are expected to "loosen" somehow
between monetary policy and monetary
growth,
and
the
latter's relation with aggregate nominal demand or national income. A
paper
recently published in the Review of the Federal Reserve Bank of
Boston
exemplifies the typical thrust of this literature.
Two
more
ambitiously designed papers were published over the past years in the
Brookings Papers on Economic Activity.
The general content and nature
of the argument offers however no additional material.
The
general
sense
of
the
"deregulation
cum
innovation"
critique can be discerned from the following quote:
As a result of recent banking deregulation and continuing
innovations in communication and data processing technology,
the relationship between the growth of money stock and the
course of economic activity may become less dependable in the
future.
Therefore, forecasters may discover that the growth
of the money stock is a less reliable indicator of GNP
growth.
Furthermore, policymakers may find that smooth
21
targets for the growth of monetary aggregates, which change
slowly over the years, are less reliable guides for monetary
policy unless perhaps the funding strategies of depository
institutions can be anticipated well in advance.
A
detailed
pervasive
what
no
examination of the papers mentioned above
sense of inconclusiveness and vagueness.
conveys a
It is not
clear
the nature of the problem precisely involves. There is moreover
logical
policy
link
between negative conclusions
bearing
and the discussion of financial innovations.
remains
an
exercise in impressionisms.
on
The
There seems to
monetary
discussion
be
little
perception that financial innovations proceeded over the centuries and
shaped
monetary evolution over a long time.
more
than
loan
associations
policy.
Shaw
argued
twenty years ago that the explosive growth of savings
during the 1950s erodes the
potency
of
and
monetary
The subsequent evolution discredited such fears or hopes.
The
consequences of deregulation and financial innovation can be
usefully
sively)
under
Gurly and
organized
for our purposes in one or the other (not exclu-
of two groups.
In order to condition the
relevant
process
consideration (i.e. the link between policy and nominal
gross
national product) they must modify the behavior of the monetary multiplier
or
velocity.
These two magnitudes fully define the
relation
between monetary policy and nominal gross national product.
encounter
Here we
a difficult obstacle however for any serious investigation.
A general assertion that deregulation cum innovation modifies behavior
of multiplier and velocity somehow yields no assessable
implications.
This remains an empty but politically suggestive exercise.
of
modifications
in
behavior are moreover quite compatible
continued effective application of monetary control policy.
A variety
22
with a
Consider
include
first the monetary multiplier.
since
1979
The
the statistical analysis and
by Johannes-Rasche.
The
Shadow
statement
forecasts
multiplier
prepared
statistical
reveals
a
remarkable stability of the process governing
plier.
Changes
of
the
analysis
the multi-
in monetary regime from the 1979-82 episode to
the
subsequent interest targeting phase of deregulation and innovation did
not
modify
stochastic
years.
the tracking record
of
the
analysis.
Similarly,
the
properties of forecast errors hardly changed over the
six
There is simply no evidence of "loosening" or lessened relia-
bility in this portion of the overall relation linking monetary policy
with nominal gross national product.
Monetary
verbal
noise
years.
velocity
has
describes the second portion of the link
indeed been addressed to it over
We indeed observed,
the
past
Much
three
as indicated in the graph, the most pro-
nounced decline in velocity ever recorded in the postwar period.
this
reflects probably the large decline in the inflation rate
occurred over this period.
of
increase
But
which
We also observe in table IV that the rate
in velocity (for both V
and V^) over
the
first
eight
quarters of the cyclic recovery proceeded at the lowest level recorded
over
the
postwar
period
in spite of
the
rigorous
upswing.
increase of the standard deviation of AV. (i.e. of the first
ence
the
The
differ-
in M-l velocity) since 1979 noted in table I appears to support
idea of a "loosened connection".
The standard deviation of
V
o
(i.e. in the first difference of base velocity) also listed in table I
denies however this conclusion.
The link between monetary policy and
national income did not deteriorate in the past six years relative
the 1950s.
whether
to
More importantly, the arguments advanced never make clear
deregulation
and innovation raise or lower
23
the
level, the
trend,
noted
tion
or the variance of the velocity innovation.
The observations
above yield so far little information about a reliable
to
the three possible components of
arguments
tutes
velocity
imputa-
behavior.
emphasizing a wider menu of interest bearing money
appear to suggest a rise
observations
are
in level or trend,
their underlying notions.
substi-
or both.
difficult to reconcile with such
Some
But our
implications
and
Perhaps more important is the circumstance
that modification of trend or level does not impair the quality of the
link.
in
Changes in level pose at most a transition problem and changes
trend can be incorporated into the non-inflationary benchmark
for
monetary growth.
Changes
in the variance of velocity innovations do indeed
the quality of the link.
the nature of the problem may be
modify
presented
with the aid of the following relation
m
+
t-i
p
+
+
\
v
t-i
+
6
<L>Avt-i
+
e
t
-
v
t
where y = level of nominal GNP, n. , " money stock in (t-1),
y = the
current desired rate of increase in n, v = white noise in money supply
process,
process
v
-j-_i ~ P a s t value of velocity, 6(L)AV,_ 1 = an autoregressive
in
AV and e =a white noise component
change.
All
Suppose
first
first
log
Monetary
the
level data (i.e. y,
in
current
m and v) are
in
that velocity is approximated by a random
difference AV coincides thus with e and
growth
p
velocity
log
form.
walk.
( L ) Av t-i
The
=
0s
can be set at a level ~ expected to realize a target
level y where p = y - ^-^^^ ~ vt-i*
The variance of the error (y-y) is then given by
- 2
E(y-y)
= variance v + variance e + 3 covariance of e and v .
This variance is also the minimum achievable under the
24
circumstances.
There exists no strategy for setting u which will lower this variance.
Arguments
developed in detail on other occasions determine a constant
u as an optimal solution.
It remains optimal even
substantially
But consider now the case when velocity is
increased.
not a random walk.
tunities
to
authorities
This
scheme.
to
assures
the
variance
Serial correlation of Av offers potential
forecast
autoregressive
if
current velocity changes with the
oppor-
aid
of
an
Knowledge of this scheme allows the monetary
set y in response to the optimal
prediction
of
again a minimum variance around the target level
A v.
irre-
spective of the deterioration of "the link" expressed by a rise in the
variance
of
component).
velocity
A
to estimate it.
based
than
a
show
(i.e.
its
random
The reliability of
this estimate is
constant
v.
It is just as likely to
raise
the
moreover
nominal
GNP
the variance.
of an activist period by period adjustment of
that
noise
There is consequently no assurrance that setting
on such estimates yields a smaller variance of
Advocates
to
innovation
But we do not know the autoregressive scheme and we
highly questionable.
y
its
constant setting of u would not be optimal under
circumstances.
need
or
the forecast error of velocity based on
would
an
have
estimated
serial correlation scheme possesses a smaller variance than the change
AV.
They
would
persistence
of
also have to show some good grounds to
this pattern over time.
The crucial
however
independent of activist or non-activist setting
growth.
In either case the advantage of a monetary
not
expect
conclusion
of
25
is
monetary
control policy is
destroyed by a deterioration of "the link" expressed by a
variance of the random component in velocity.
some
higher
Growth Rates of Velocity After a Recession
Over the First Eight Quarters
(Per Quartsr in Percentage)
Y(r)
Y(n)
Ml
VM
B
VB
=
*
*
=
=
Growth
Growth
Growth
Growth
Growth
Growth
Rate
Rate
Rate
Rate
Rate
Rate
Real GNP
Nominal GNP
Ml
Velocity Ml
Base Money
Velocity Base Money
Recession Year
Y(r)
Y(n)
Ml
VM
1954.2(7)
1 ©3 o
X ® 82
0.62
JL> O M
1958.1(6)
le4 /
1.95
0.64
1960.4(8)
1.20
1970.4(8)
1.20
2.15
1975.1(8)
1.09
2*28
1980.2(6)
0.72
2.54
1982.4(8)
XcJ J
2.18
Percentage Growth Per Quarter
U
B
VB
0.24
1.58
0.56
JL e -3 i?
Wo DJ>
X © UU
0.59
0.92
1.54
0.61
JL ft O ib
0.53
1
1.01
1.64
0.64
JL e / O
0.78
1.40
1.14
1.76
0.42
1.90
0.28
B»«
(.)=# of Quarters Used
Table IV
26
VELOCITY (1947.2-1984.U
quarteriy data, aeaaortaty adjusted
VELOCITY
to
il I I
I I I I 1 , 1 I I. L. t . J ) I 1 1 1 1 , 1 - ^ L t I I I
M W ) « 3 f i S I 1 9 n f l S 1 9 6 8 S a B f l n
» I I
«W
I I I I i l l
«7
OO
YEAR
VHJCOTY*NOM?NAL
GNPSA/M1SA
SOURCE FEDERAL RESERVE BULLETIN
1
«3
GUIDELINES FOR DEFICIT POLICY
Mickey D. LEVY
Fidelity Bank, N.A.
According to the Budget,
basis
the
Fiscal
Year 1986,
on a current services
FY1985 deficit now will be $223.6 billion and
the
FY1986
deficit approximately $230.3 billion. This is sharply higher than the
estimates
Budget
the Administration's Mid-Session
in
(August
1984),
half
of
the
FY1985
which forecast deficits of $172.4 billion
FY1985 and $174.2 billion in FY1986.
FY1985
Review
in
The higher estimated deficit in
reflects in part the slowdown in economic growth in the second
of
1984
and
in part the impact
accounting of HUD loans.
outlays
to
of
the
shift
to
on-budget
Given the heightened sensitivity of federal
changes in interest rates, deficit projections would
even
higher if actual and projected interest rates had
from
mid-1984 levels. '
not
be
declined
Nevertheless, the projected rise in outlays
(7.7% average annually from FY1985 to FY1988),
the climb in
deficits
to the $250 billion area, and the associated sharp rise in the federal
debt-to-GNP ratio
proposed
FY1987,
that
are striking.
In response, the Administration has
spending cuts of $50.8 billion in FY1986,
and
$105.3 billion in FY1988.
$82.7 billion
in
The Administration forecasts
these cuts would reduce the deficit in FY1988 to $144.4
billion
or 2.9 percent of GNP.
'Aided by faster-than-forecast economic growth and a shortfall in
spending, the year-to-date deficit (October 1984 to February 1985) is
consistent with a FY1985 deficit below $200 billion.
However,
interest rates have risen recently, economic growth should moderate
from its current pace, and the shortfall in spending outlays will
probably narrow, and the FY1985 deficit should end out close to the
Administration's estimate.
29
The
Administration's
percent
real
GNP
long-run
budget
growth through 1988
forecast is
and
somewhat
based
slower
on 4
growth
thereafter (see Table 1).
Economic Assumptions Underlying Administration's Budget Forecast
GNP (% chg. 4th Qtr-4th Qtr)
Real $
Nominal $
CPI (% chg. Year-over-Year)
Unemployment Rate (%, annual
average)
Interest Rates (%, annual
average)
90-day Treasury Bill
10-year Treasury Note
Source:
Budget,
1985
1986
1987
1988
1989
4.0
8.5
4.0
8.5
4.0
8s3
4.0
7.9
3,8
7.4
4.1
4.3
4.2
3.9
3.6
7.0
6.9
6.6
O e 3
feel
8•X
11.0
7.9
10.3
7.2
9.3
o ®y
7.3
5.1
5.7
FY1986.
According to Administration estimates, a permanent one percent slowerthan-expected
annual
rate of real growth
would reduce receipts dramatically,
billion in FY1986,
Perhaps
more
beginning in January
1986
and increase the deficit by
$4.1
$16.9 billion in 1987, and $33.4 billion in 1988.
troublesome
to
the
budget
outlook
are
the
Administration's interest rate assumptions, particularly for 1987 and
beyond.
The Administration
assumes the 3-month Treasury bill
rate
will average 7.2 percent in 1987, 5.9 percent in 1988, and 5.1 percent
in
1989.
Budget
In
Outlook:
contrast, CBO budget
Fiscal
projections (The
Years 1986-1990,
Economic
February 1985) assume the 3-
month Treasury bill rate to average 8.2 percent each year after
The
and
Administration's assumptions of healthy economic
growth,
198 6.
little
change in expected inflation, and continuously declining real interest
30
rates, may
be
inconsistent. ' Higher-than-expected interest
would have a dramatic impact on interest outlays and would
rates
exacerbate
the difficulty of stabilizing the federal-debt-to-GNP ratio.
Based on
the Administration's proposed deficit forecasts, one percentage point
higher-than-projected
interest rates would raise net interest outlays
and deficits by $8.2 billion in FY1986, $11.7 billion in FY1987, and
$14.8 billion in FY1988.
Guidelines for Deficit Policy
Deficit
First
cutting efforts should be guided by
several principles.
and foremost, budget proposals should be conceived and debated
within a context of a fiscal (deficit) policy whose primary goal is to
create
past
run
an environment conducive to long-run economic
growth.
Given
failures of fiscal policy in managing aggregate
demand,
short-
stabilization
While
there
policy
on
growing
the short-run pattern of economic
spending
sector
of
fiscal
substantial uncertainty about the impact
consensus
government
private
is
goals should not be the focus
activity,
of
activity
The reallocation of
to the public sector
fiscal
there
about the long-run adverse consequences of
and debt.
policy.
is a
rising
resources
generated
by
from
higher
'Under these circumstances, a decline in nominal interest rates,
given what appears to be little change in inflationary expectations
(the Administration projects the percentage change in the CPI to
recede from 4.3 percent in 1986 to 3.9 percent in 1988 and 3.6 percent
in 1989), implies a sizeable decline in real interest rates.
There
does not seem to be sufficient changes in the capital stock, nor is
there any proposed change in tax policy, that would substantiate a
decline in real rates.
If, however, real rates were to fall as the
Administration's budget projections assume, one could expect a decline
in the exchange value of the U.S. dollar, which would drive up
inflationary expectations (and nominal interest rates).
31
government spending tends to reduce private investment,
how
it is financed.
Also, the sharply rising
regardless of
federal
debt-to-GNP
ratio eventually will constrain the availability of credit for private
investment, although the timing of this impact is uncertain.
A long-term growth-oriented fiscal policy requires stabilizing the
federal
what
debt-to-GNP ratio.
level
Empirical research does not
indicate at
or when the debt ratio should be stabilized in
achieve an investment/economic growth goal.
order to
However, substantial cuts
are necessary merely to stabilize the federal debt-to-GNP ratio.
Administration's
proposed spending cuts would stabilize
the
The
federal
debt-to-GNP ratio at slightly above 40 percent, but only if those cuts
were
accompanied by the Administration's anticipated declines in real
and
nominal
budget
interest rates.
In stark contrast, the
projection, which assumes 3.4 percent real GNP
1987,
4.2
Treasury
percent annual rise in the CPI after 1986,
bill rate of 8.2 percent after 1986,
CBO
baseline
growth
after
and a
3-month
forecasts the
federal
debt-to-GNP ratio to climb to 49.7 percent by 1990.
Second,
take
to
preserve production incentives,
the lead in any deficit-cutting effort.
spending cuts should
From 1983 through
the
end of the decade, all of the rise in the cyclically-adjusted deficit
as
a
percent
of
benchmark
GNP is
attributable
to
the
rise
in
cyclically-adjusted outlays. Cyclically-adjusted revenues in 1989 are
projected
Many
to be nearly the same percent of benchmark GNP as in 1983.
spending
projected
require
tested
programs
are well intended, but in
some
case
sharp increases in outlays are due to structural flaws that
corrective action.
This is particularly true
of
entitlement programs, which have grown dramatically
general, have been spared from recent budget cutting efforts.
their
32
non-means
and,
in
Third,
should
as
be
a practical matter, all government spending
considered
candidates for budget
cuts.
programs
In particular,
social security and other non-means tested entitlement
programs,
defense,
cannot be excluded from the outlay-trimming exercise.
programs
constitute
composition
subjective
However,
that
of
62.5
percent
government
of
spending
total
budget
has evolved from
preferences, and is not derived from
simple
economic
The
series
of
analysis.
arithmetic takes us a long way toward the conclusion
"everything should be on the table." Allowing non-means
entitlement
These
outlays.
a
and
outlays to remain sacrosanct severely constrains
tested
efforts
to stabilize the debt-to-GNP ratio. Also, these transfer programs are
a source of economic inefficiency to the extent that they reduce labor
supply and/or savings.
of
The defense program must be analyzed in terms
national security as well as budget
goals; nevertheless,
it
is
doubtful that a judiciously chosen, modest slowing of scheduled growth
in
defense
Ultimately,
cuts,
on
outlays
would
severely
hamper
national
security.
resolving the thorny issue of the composition of spending
for example, as between defense and non-defense programs, rests
the
ability
of
elected
officials
to
compromise.
Therefore,
common-sense suggests that all budget programs should come under close
scrutiny
in
an
efficient
and fair effort to
slow
the
growth
of
spending and debt.
Fourth,
short-term
deficit-cutting efforts should be
with long-run program reform.
package
Enacting a "quick fix" deficit-cutting
is not necessarily good public policy if it does not generate
long-run savings or if it fails
some
of
consistent
the
structural
to address,
flaws
33
of
or precludes addressing,
government
spending
programs.
Temporary
reductions in the armed forces would not generate permanent
long-run
that
savings
those
freeze
in defense outlays if military
discharged must be rehired in the
on
social
security COLAs may preclude
readiness
future.
much
A
requires
one-year
needed
program
reform.
And, attempts to limit Medicare outlays by strictly limiting
doctors'
compensation would generate some short-run saving but
costs and perpetuate inefficiencies in
increase long-run
industry.
(Providers would
Medicare participants.
less
efficient
and
respond
by
restricting
would
the
health
services
to
Meanwhile participants may respond by seeking
more
costly
types
of medical
care,
i.e.,
substituting in-patient care for a routine ailment that normally would
require
an
out-patient
visit.
Instead,
phasing
in
changes
in
financial incentives for hospitals and Medicare recipients would be an
important step toward Medicare reform, even though it may not generate
any short-term cost-saving.)
The fifth principle concerns the fact that since the deficit
required
to
political
stabilize the federal debt-to-GNP ratio
compromise may
Therefore,
any
should
assessed
be
disincentives
income
on
consumption so that
to save and invest,
These
are very large,
in
reflect
are
and (2) the indexing
is now in place,
rules
there
should not be
the fact that
a
that suppresses productive output would be
to the effort to stabilize the debt-to-GNP ratio.
considered
difficult
(1) they
no
of
further
personal
delayed
or
deficit-cutting
counterproductive
The real difficulty
with this guideline for taxation is practical in nature:
are
tax revenues.
increases should abide by two rules:
taxation, which
eliminated.
package
tax
result in some increases
cuts
"open game" in deficit-cutting efforts,
once
taxes
it would
be
politically to limit tax increases only to higher taxes
on
34
consumption.
So while the rule to avoid higher taxes on investment or
saving stands as an important guideline, the key point is that slowing
the
rise
in federal debt should be accomplished largely
by
slowing
spending growth.
FY1986 Budget Proposals
The
Reagan
Administration's proposed substantial
spending
would reduce outlay growth to 1.5 percent in FY1986, and 4.5
cuts
percent
annually from FY1985 to FY1988. If enacted, they would be the largest
in recent history.
eventually
must
However, the cuts would be small relative to what
be done to correct the current
unstable
situation.
Nevertheless, the size of the proposed cuts represents a major step in
the right direction.
Importantly, the FY1986 Budget
did not recommend
tax increases, and Congress's current primary deficit-cutting focus is
on spending cuts rather than tax increases.
The most striking characteristic of the proposed cuts is that they
are
imposed
largely
on programs whose outlays
portion of the total spending
cuts
budget (see Table 2).
are proposed for social security (OASDI),
$199.8
billion
in
constitute
a
small
Specifically, no
whose cash outlays of
FY1986 and $641 billion during
the
three
years
FY1986 to FY1988 constitute nearly one-fifth of total current services
outlays.
to
Cuts of $5.4 billion in FY1986 and $25.5 billion in
FY1988 are proposed for all non-means tested entitlement
FY1986
programs
(social security; Medicare; railroad, military, federal employee, and
other
retirements
and disability;
and
unemployment
compensation) ,
whose
$345.5 billion outlays in FY1986 and $1,112.1 billion in FY1986
to FY1988 constitute over one-third of all current services
spending.
Proposed
to
cuts
in
defense outlays also are small relative
35
total
defense outlays.
cuts
would
be
A disproportionately large portion of the proposed
imposed
on the broad
range
of non-defense, non-
entitlement programs, with the largest chunks coming out of farm price
supports,
general
revenue sharing,
civilian agency pay raises, and
strategic petroleum reserves.
TABLE 2
Composition of Administration's Proposed Outlay Cuts for
the Combined Three Year Period FY1986 to FY1988
Current
Service
Outlays
f$ bill
I. Defense
Saving as a portion of
Portion
Total
Current
of
Proposed
Proposed Service
Total
Saving
Saving
Outlays
f%)
(S bil)
£%J
(%)
993.5
29.8
28.2
11.8
2.8
II. Entitlements?
A. Non-Means Tested
Social Security
All Other a .
B. Means-Tested
1112.1
(641.0)
(471.1)
216.0
33.4
(19.2)
(14.1)
6.5
25.6
(0.0)
(25.6)
11.0
10.7
(0.0)
(10.7)
4.6
2.3
(0.0)
(5.4)
5.0
III. Other Non-defense,
Non-entitlement
outlays
660.8
19.8
134.3
56.2
20.3
IV. Offsetting Receipts
-213.7
-6.4
9.6
4.0
4.5
565.4
17.0
30.2
12.6
5.3
3,333.9
100.0
238.8
100.0
7.2
V. Debt Service
Total
NOTES:
a
'Includes railroad, military and federal employee
retirement,
other
retirement
and
disability,
Medicare, and unemployment insurance.
'Includes Medicaid, AFCD, foodstamps, child nutrition,
guaranteed student loans, SSI, earned income tax
credit, and veterans pensions.
c
'Includes programs identified in Budget
FY1986
as
other
mandatory outlays,
dedicated funding
and
business operations, outlays for forward-funded and
related programs, outlays for slow-spending and fastspending discretionary programs, and discretionary
loan outlays.
36
Considered
above,
would
in terms
of the fiscal policy
guidelines
mentioned
the Administration's proposals in general are admirable:
they
modify spending programs and in many ways eliminate sources
of
inefficiency (for example, the farm subsidies) and address the rising
costs
of
certain
retirement),
pension
programs
(for example,
civil
they would generate substantial immediate
service
savings, and
they avoid tax increases. As expected, the deficit-cutting package is
controversial.
eliminating
By
some
cutting
some programs
and
not
others,
programs altogether (for example, general
and
revenue
sharing) , the proposal effectively redefines the role of government in
certain types of economic activity.
"fair"
Whether these proposed cuts
are
is largely subjective; cutting spending in some programs
and
not others is not necessarily unfair.
Similarly, the "fairness" of an
across-the-board freeze on all government spending programs depends on
whether
the
current size and distribution of government spending
considered "fair".
On the other hand, the skewed distribution of the
cuts does point to the enormous potential
proposed
cuts
that could be achieved if all government programs,
means
is
in
spending
including the non-
tested entitlements, were part of a comprehensive spending cut
package.
The
following recommendations are samples of the
type
of
program reforms that deserve consideration.
Social
freeze
in
employees
benefits.
Security.
The Administration proposed a one
retirement
benefits
for
former
military
year
and
COLA
civilian
and the industrial pension component of railroad retirement
This
provision
should
be extended
to
social
security
benefits.
Social security participation should be extended to all new
state
and local government employees, the only major group of workers still
37
excluded from the program.
program
would
Extending coverage for this redistributive
reduce a source of inequity between
participants and
non-participants.
Currently,
recipients
half
of
social
security
benefits
are
taxed
whose total income, including social security and
for
income
from tax exempt bonds, exceeds $25,000 for individuals and $32,000 for
married couples filing jointly.
retirement
benefits
that
Instead, social security and railroad
exceed
household
lifetime
contributions
should
be taxed,
similar to tax treatment of private pensions.
For
equity
reasons, households with total incomes below $12,000 would
be
excluded. This tax treatment would not affect the lower income elderly
and
would tax other recipients roughly in proportion to their
and
marginal
tax
rates.
It
also
would
reduce
some
income
of
the
intragenerational inequities caused by spouse benefits, and narrow the
wide
differential
between
after-tax rates of
return
on
household
contributions received by current and future retirees.
Three
would
benefit
persons
actuarially
(AIME)
social security changes should be
no
generate
security
1990,
other
reduced
saving:
retire
between ages 62
benefits,
and
(a)
growth
65
the
(this provision
should
inflation
would
be
that
social
beginning
(b) average indexed monthly
be calculated by indexing for
wage
liberalizing
short-term
structure should be modified so that
who
should
average
additional
implemented
in
receive
earnings
rather
complemented
than
by
IRA and Keogh provisions, by raising maximum limits and
reducing penalties for withdrawal), and (c) the current spouse benefit
provision
whereby
should
spouses
be
replaced by
an
earnings
sharing
would divide evenly covered household
38
arrangement
earnings
and
benefits would be based on his or her own earnings base.
recommended
that
These three
changes would be part of a broader social security reform
must be implemented gradually and would not generate any
short-
term savings.
Medicare.
paid
Medicare Supplementary Medical Insurance (SMI) premiums
by beneficiaries currently cover 25 percent of average
benefits
for an elderly enrollee (they are estimated to be $17.30 per month
1986)
and their increases after 1985 are limited to increases in
CPI.
These
of income,
in
the
premiums should be increased and graduated as a function
so that by 1990 the average premium would equal 35 percent
of average costs, with higher income elderly paying premiums up to 50
percent and lower income elderly having their premiums remain tied
to
increases in the CPI.
Medicare
hospital
Part
feature
ability to pay.
A
should be redesigned to include a
catastrophic
and an adjusted cost-sharing arrangement
Currently,
based
on
participants pay for the first day of a
hospital stay, incur zero costs for days 2 through 59, and then co-pay
25 percent of costs after 59 days.
"stop-loss"
patients.
through
limit
A catastrophic plan would place a
on out-of-pocket costs incurred by long-term
Short-stay patients would pay more than they do
a modest (15 percent) co-payment schedule, which
care
currently,
would
be
graduated with income, for in-patient care for days 2 through 15.
An
additional
reform
for Medicare
involves
transforming
the
current prospective payment system to hospitals and HMOs more toward a
medical
insurance
voucher
system
by:
(1)
relaxing
some
of
the
burdensome eligibility requirements for HMO and hospital participation
in Medicare, (2) allowing hospitals and HMOs to rebate cost savings to
Medicare
participants
(rather
than being only able
39
to
offer
more
services),
and (3) allowing individuals to take actuarial
equivalent
values
premiums
that best
of
suits their needs.
cost-effective
and choosing the private health plan
These reforms would encourage more innovative and
medical
delivery systems and also
provide
financial
incentive to participants to be more cost-conscious in their choice of
medical provider.
Military
with
Retirement.
approximately
Currently,
military employees may
half-pay after 20 years of service
retire
(the
initial
benefit is 2 1/2 percent of final base pay per year of service).
this
financial
incentive,
it
is not surprising
retirement age for non-disability,
years
old.
schedules
Military
are
pensions
that
the
With
average
active-duty service members is 43
should be
modified
so that benefit
a function of years of service and age of
retirement,
with younger retirees receiving reduced pensions.
Unemployment
portion
of
threshold
married
are
Insurance and Workers
unemployment
income
exceeds
Compensation.
insurance is taxed
only
$12,000 for individuals
Currently, a
if
and
a
taxpayer's
$18,000
couples filing jointly, while workers compensation
tax exempt.
for
benefits
All unemployment insurance and workers compensation
benefits should be taxed as ordinary income.
These
the
proposals would generate substantial additional savings
non-means tested entitlement programs —
FY1986 to FY1988.
over $60 billion
in
during
Combined, these modifications would encourage work
effort and saving, and to discourage excessive and unnecessary uses of
medical services by the elderly.
The recommended phased-in changes in
social security and Medicare are not geared to generate short-run cost
savings but instead form the basis for necessary long-run reform.
40
Prospects for Responsible Fiscal Policy
The
Administration
FY1986,
and
has recommended sizeable
spending
For example, postponing the COLA
for social security has emerged as one possible cost-cutting
current
for
Congress has taken initial steps to broaden the scope of
sources for potential spending cuts.
although
cuts
its
eventual
political
acceptance
maneuvering
is highly
measure,
questionable.
around the budget issue
While
in
Congress
seems to be following the same path as previous unsuccessful
efforts,
a note of optimism can be found in the perceived immediacy of the need
to cut deficits. Nevertheless, the magnitude of the budget imbalance
is staggering,
and sharply rising interest costs constrain efforts to
stabilize the debt-to-GNP ratio. A note of caution is appropriate: a
spending
cut
proposal
would
even
close in total size
to
be a major first step toward
the
Administration's
fiscal
responsibility,
if it is not large enough to eliminate the primary
stabilize
long
the federal debt-to-GNP ratio.
time
to
importantly,
was
package
generated
1970s.
lay
the
by
the
foundation
for
Remember,
such
recent growth of the non-means tested
The unwinding process may be equally as long.
41
and
it has taken
large
legislation enacted in the late
deficit
a
deficits
entitlements
1960s
and
early
ECONOMIC OUTLOOK
Jerry L. JORDAN
First Interstate Bancorp
It
appears that the FOMC has assumed that Ml velocity will rise 2
to 2 1/2 percent in 1985, given their intention to increase the money
stock
by 5 1/2 percent by year end.
However, they have
emphasized
that money would grow faster if velocity appears to be growing slower,
or money would grow slower if velocity is growing faster.
be
That could
taken to imply that there is a current year target for nominal GNP
that is more important than the Ml target.
Table I shows the various "official" numbers for this year:
TABLE I
1985 Projections
(Fourth Quarter to Fourth Quarter)
FOMC
Administration
GNP
8.5%
Output:
4.0
Prices:
4.3
Unemployment:*
6.9
Congressional
Budget Office
7.7%
3.4
4.2
7.0
Range
7 - 8 1/2%
3 1 / 4 - 4 1/4
3 - 3 3/4
6 1/2 - 7 1/4
Central
Tendency
7 1/2 - 8%
3 1/2 - 4
3 1/2 - 4
6 3/4 - 7
*Year end
All
of
these
projections compare with actual results
for
1984
as
follows:
1984
GNP:
Output:
Prices:
Unemployment:
9.7%
5.9
3.6
7.1
Since actual Ml growth for 1984 was 5.2 percent, the Fed's central
target for 1985 is slightly faster, which is hard to understand.
As
long
of
as
there
is
supposed to be a
43
long-run
policy
objective
reducing monetary growth to a non-inflationary rate, there is
justification
for
little
targeting monetary growth that is faster than
the
previous year.
It is worth noting that the Administrations inflation
is
higher than the CBO and the Fed.
assumption
That is undoubtedly due to the
desire on the part of the Administration to show a smaller deficit (as
a
percent of GNP) that is associated with faster nominal GNP
growth.
For the second year in a row, the Fed has a lower inflation projection
than just about anyone else inside or outside government.
Current
thinking by the Fed is more optimistic than last
summer.
The comparison of projections for 1985 is shown on Table II.
TABLE II
1985 Projections
(Fourth Quarter to Fourth Quarter)
July '84 Projections
Central
Range
Tendency
6 3 / 4 - 9 1/2
8-9
2-4
3-31/4
3 1 / 2 - 6 1/2
5 1 / 4 - 5 1/2
GNP
Output;
Prices;
Looking
February '85 Forecast
Central
Range
Tendency
7-81/2
7 1/2 - 8
3 1/4 - 4 1/4
3 1/2 - 4
3 - 4 3/4
31/2-4
back over the past year-and-one-half,
the Fed's optimism
about inflation has been borne out, while the SOMC did not anticipate
the
favorable effects on inflation of a strong dollar
energy
prices.
and
declining
While the lower inflation has been very welcome, it
has been accounted for by transitional factors that cannot be expected
to continue.
In both 1974 and 1979-80, the monetary approach to inflation used
by
the SOMC underestimated the acceleration of major
44
price
indices.
The
transitory
relative
effects of the "oil shocks" were causing
price
shifts, and a transitory increase
inflation rate.
in
the
past
suggested.
trend
the
reported
For similar reasons, the reported rates of inflation
two
years have been less
than
a monetary
approach
Declining energy and imported goods prices cause the rate
of inflation to temporarily
emphasis
in
significant
is
rate
fall below the monetary rate. The correct
on the long-run trend rate of inflation implied
of
monetary
growth,
recognizing
that
by
there
the
will
be
deviations due to measurement errors and non-monetary factors.
While
the
FOMC's record on inflation was very good in
1984, they underestimated real growth.
when
and
Their biggest miss was in 1983
they projected output growth of 3.5 to 4.5 percent, versus
actual of 6.3 percent.
is
1983
Now,
the
for 1985 the FOMC projection for output
slightly lower than the CBO and Administration,
but in line
with
most business economist forecast.
The SOMC was more optimistic (and more accurate) on output
in
1983, and also projected a strong 4 to 5 percent real growth
1984.
the
growth
for
The 10.1 percent real GNP growth recorded in Ql/84 ensured that
annual figures would be quite high even though the third
quarter
came in at only 1.6 percent.
Monetary
similar
growth
in 1985 is destined to be very high for
to the high output growth recorded in
growth will be 11 to 12 percent a.r.,
quarters
is going
1984.
In
reasons
Ql/85,
Ml
which means the remaining three
can average only 3 to 4 percent if money growth for the year
to fall near the middle of the 4 to 7 percent
range.
The
longer the rapid money growth persists, the sharper the
deceleration
necessary
range.
to
illustration,
"average
out"
anywhere
in
the
target
For
if Ml growth in the first half averaged 11 percent, the
45
second
half would have to be zero in order to get 5.5 percent for the
year.
Obviously, (to us) , such sharp fluctuations are undesirable.
There
about
may be a basic disagreement between the SOMC and
the
growth.
significance
Some
of large intra-year
fluctuations
the
FOMC
of
money
Fed staffers have argued that they are unimportant
long as the average is maintained.
as
Our position should be that there
are
two important adverse effects of the intra-year go-stop
pattern.
One
is
for
that
sharp accelerations and decelerations lasting
six
months or more do have a significant effect on output growth, as seems
to
have been the case in 1984.
creates
Second,
the volatile
uncertainty about the underlying trend,
money
and market
growth
interest
rates must compensate for this heightened uncertainty.
Language
suggests
but
is
higher
from
that
in
the
February 1985 Report of
the
Fed
the erratic quarterly pattern is not only
deliberate.
The FOMC is said to believe
that
to
Congress
acceptable,
"a
somewhat
rate of money growth than implied by straight line projections
the
fourth
quarter 1984 base to the
targets
for
the
fourth
quarter of 1985 may be appropriate early in the year, but growth of Ml
would be expected to slow, and velocity growth to rise, as the current
adjustments are completed."*
Thus, the Fed has defended "front-loading," and is counting on the
lagged
slow
growth of money at a later time.
output
the
relationship between money and GNP rising (velocity) to permit
effects
of such fluctuations of money, the Fed might be able to
uncertainties
such
a policy creates
*Page 4.
If there were no
46
for
the
private
on
allay
market
participants.
impasse,
However,
especially
in view
of the
fiscal
policy
it is likely that market participants will guard against the
possibility
that
the
initial rapid money growth
will
persist
and
inflation will accelerate.
In view
probability
monetary
far
is
the
11 to 12 percent
money
growth
in
Ql/85
rising that '85 could see a repeat of '83 as
targeting is concerned.
above
second
of
already been
and did not try to offset.
signaled
by
Vice
as
Two years ago, money growth was so
target by mid-year the FOMC reset the base period
quarter
far
the
Chairman
Such a
Preston
to
the
possibility
has
Martin
when
acknowledged the possibility that Ml might be allowed to grow 8 to
he
10
percent in 1985, with the justification that velocity growth might be
low.
The Outlook
The
1985
growth of nominal income and real output in the first half of
will exceed the respective growth rates recorded in
the
second
half of 1984. Most likely, money growth will be at the top end of the
Fed's target range for all of 1985, so nominal GNP can be expected to
grow faster than the Fed's projection.
of
this
subdued
year,
as
Especially in the second half
inflation can not be reliably expected to
the FOMC has indicated.
The trend growth of Ml and
monetary
base
have
remained at historically
reported
rate
of inflation will eventually rise
trend.
47
remain
high
to
levels,
the
so
as
the
the
underlying
TABLE III
.Ml
MB
Prices
GNP
Q4/76-Q4/80
Q4/80-Q4/84
Q4/76-Q4/84
7.8
7.4
7.6
8.7
7.3
8.0
Os2
6.7
8.3
9.9
Q4/83-Q4/84
™? © £s
7.3
3.6
9.7
Output
3.0
3.0
«5 e v*
5. 9
*H^ O
6. 4
Q1/84-Q1/85*
asp
7.4
*estimated
The growth of MB in 1984 was the same as the four-year average for
Q4/80-Q4/84.
the
trend,
recorded
The Ml growth reported for '84 looks like a break with
but
the
so
Once the rapid Ql/85
Ml
figure
year-over-year increase in Ml is half way back
longer-term trend.
Since
did 1981.
to
is
the
By year end, it will probably be all the way back.
inflation can be expected to average about 1 percent slower
than money and base growth,
a sustained 6+ percent inflation rate
is
consistent with the underlying monetary trends.
The economic projections
(but not preferences) for 1985 are:
TABLE IV
Q4/84-Q4/85
A
GNP
8 1/2
to
9 1/2
Output
3 1/2
to
4 1/2
Prices
4 1/2
to
5 1/2
Ml
6
to
7%
VI
2
to
3%
MB
6
to
7%
VB
2
to
3%
half-year breakdown of these projections would show real growth
more rapid in the first half and slower in the second half,
but
less
of a change in 1984. The inflation rate is expected to be rising more
rapidly late in the year, possibly reaching into the 6+ percent range.
48
Money growth of no more than 7 percent for the year requires a slowing
from
the first quarter's rapid pace to only about 5.7 percent for the
final three quarters.
Recommendation
The
continued
slowing
into
of
'85.
the base and money from *83 to
This
year
the monetary base
permitted to rise by more than 6 percent.
is
adequate
«84
should
should
A range of 5 to 6
for continued real growth with sustained low
not
be
be
percent
inflation.
An objective of reducing the growth of the base and money to the 2 to
3
percent range before the end of the decade should be adopted by the
FOMC.
49
FORECASTS OF THE M - ADJUSTED MONETARY BASE
MULTIPLIER FOR 1985
Robert H. Rasche
Michigan State University
We are presently in the middle of the annual round of revisions of
the
monetary
revisions
of
but
and
reserve
aggregates.
The
announcement
of the data for the monetary aggregates in the H.6
of
the
release
February 14, 1985 indicated a change in the levels of M., and
M_,
showed little change in the growth rates from the unrevised data,
prior
to
changes in the seasonal adjustment
Table 5 from the H.6 release).
Appendix
revised basis were released in mid-March.
factors
(see
attached
The historical data on
the
The Federal Reserve Bank of
St. Louis has not yet revised either the Adjusted Monetary Base or the
seasonal factors for the base.
Thus we have a mixture of revised and
unrevised data available on which to base our current forecasts.
At
to
our
have
analysis
last meeting,
not
of
it was suggested that it would be
only the forecasts for the coming
the
year, but
source of the projected changes from
year.
In
an attempt to present this information,
Tables
1 and 2 below.
I
helpful
also
the
previous
have
prepared
The technique used to construct the forecasts
in Table 1 is to use the revised not seasonally adjusted data for
monetary
an
aggregates, the
revised seasonal factors for the
unrevised
seasonal
the
monetary base.
The data for January and February are the actual data
we
for
the
monetary
aggregates, and
for those months as presently estimated.
factors
the
The forecasts suggest
will observe a decline in the multiplier on a seasonally
basis
adjusted
that
adjusted
through the middle of the year from the present value estimated
for February,
but that this decline will be reversed during the third
51
quarter of 1985, and that in the fourth quarter the multiplier will be
essentially unchanged from the February level.
In
Table
2 we compare the not seasonally adjusted forecasts
for
the
remainder of the year with the actual value of the multiplier
the
corresponding month of 1984.
year-over-year
forecast
percentage
percentage
Column 3 of Table 2 indicates
change
change
(for January
(for March
and
through
February)
December).
in
the
or
The
remaining columns of Table 2 indicate the allocation of the percentage
difference
between
component
actual
ratios
and
relative
the
1985
and 1984
of the multiplier.
forecast
increases
numbers
These
among
columns
in the t. and
t_
the
various
indicate
ratios
that
for
1985
to 1984 work systematically to reduce the value of the
1985
multiplier below 1984 levels. Conversely, a lower actual and forecast
value of the adjusted reserve ratio works to increase the value of the
1985
multiplier
relative to the corresponding month
in
1984.
The
contribution of changes in the currency ratio varies considerably from
month to month,
the
and in several months is quite small.
Changes in all
other ratios show little influence on the year-over-year
changes
in the multiplier.
Finally, we
linear
have
been experimenting with forecasts from
approximation to the multiplier model.
This model
a
log
uses
the
same component ratio ARIMA models as in Tables 1 and 2, but instead of
using
the
together
exact
non-linear formula to put the
into a forecast of the multiplier,
approximation is employed.
Monetary
of
the
a linear
multiplier
with
forecasts
Taylor
series
In this case, the log of the M.. - Adjusted
Base Multiplier is expressed as the sum of the
multiplied
component
respect to each
of
the
component
by the appropriate components, plus an error
52
elasticities
term.
ratios
The
elasticities
ratios
for
are
evaluated
at the geometric means
the sample period.
of
the
various
The sample period residuals of
this
expansion are modeled by an ARIMA process. The component models, plus
the residual model form a log-linear system which can be solved for
forecast
that
of the multiplier.
The advantage of this linearization
a
is
if we assume that the innovations of all of the ARIMA models are
jointly normally distributed, we are able to construct standard errors
for
the
multiplier
from the covariance
Since
matrix
the
linear
approximation
of the innovations of the
the M 2 and M_ multipliers are functions of the
ratios,
this
multipliers
the
forecast from
several
linearization
technique
at the same time,
forecasts
can
can
if desired,
be
be
ARIMA
same
applied
given
Table
in Table 3.
constructed.
Forecasts
component
to
these
from
the linearization is highly accurate.
53
the
interval
A comparison of the linearized forecasts
3 with the exact non-linear forecasts in Table 2
models.
confidence ellipsoids for
linearized model together with estimates of a 95% confidence
are
model
reveals
in
that
APPENDIX TABLE 5
Comparison of Revised and Old Ml Growth Rates
(percent changes at annual rates)
Difference
Revised
(Ml)
(1)
Old
Ml
(2)
Difference
(1-2)
duei to
Benchmark
Seasonals
(3)
(4)
(5)
xoy
0.2
0.2
JL © /
Monthly
1983—Oct
Nov
Dec
8.1
5.0
4.1
3 eJ
1984'—Jan
Feb
Mar
Apr
May
June
July
Aug
Sept
Oct
Nov
Dec
7.7
10.7
6=3
7,0
4.2
7.3
10.6
-0.9
6.2
3.2
X©8
-1.2
-1.3
-3.1
-0.7
X2 a O
*"D o O
0.1
0.4
0.6
0.1
0.0
cju « B
-0.7
"0.1
-0.6
0.2
0.0
2.8
0.8
0.5
2.8
6.6
5.2
0.4
D
<an?
-3.0
'xa\J
a
J
leO
3.8
w
8.6
0.2
2.6
0.7
0.7
3.4
10.4
11.1
9.2
9.7
6.3
6.2
6.5
4.5
3.4
4.8
7.2
6.2
4.5
2.0
1 9 8 4 — Q I V «83 to
QII '84
6.4
4.4
1.6
KJ O aL
-1.1
o ©/
1.8
5.0
-6.7
-7.4
-0.2
-0.1
JL 3 <&
3.7
cj e 3
-0.7
0.2
0.6
0.1
-0.8
-0.5
0.3
-0.8
JL e ««#
0.3
0.0
1.4
0.3
0.3
0.2
0.0
0.2
6.7
-0.3
0.2
-0.5
QII '84 to
QIV '84
3.9
3.3
0.6
0.1
0.5
(QIV tc> QIV)
10.4
10.0
5.2
5.0
0.4
0.2
0.3
0.2
0.1
0.0
1 9 8 5 — Jan p
„fc £e «
Quarterly
1983—QIV
1984—QI
QII
QUI
QIV
-1.0
1.2
-1.3
0.1
0.0
1.2
Semi-Annual
Annual
1983
1984
p—preliminary
54
TABLE 1
M,
- Adjusted Monetary Base Multiplier Forecasts
x
1985
Seaonally Adjusted
Month
January
February
March
2.5705
2.5955
2.5831
April
May
June
2.5916
2.5883
2.5725
July
August
September
2.5849
2.5937
2.5886
October
November
December
2.5874
2.5936
2.5891
January
February
2.5868
2.5920
Seasonal factors for monetary aggregates published in February, 1985.
Seasonal factors for adjusted monetary base published in March, 1984.
55
TABLE 2
M
l ~ Adjusted Monetary Base Multiplier Forecasts
February, 1985 Base, Not Seasonally Adjusted
Month
1985
1984
% change
k ratio
t 1 ratio
% change due to changes in the:
g ratio z ratio rl rati
t_ ratio
A, a D O ! J
2.6175
2.5835
2.5871
-1.10
- .25
- .22
-.48
-.20
-.11
-.74
-.59
-.59
-.72
-.57
-.46
.02
.00
.03
.00
.00
.00
.82
1.03
.89
Apr
May
June
2 .6269
2.5694
2.5848
2.6203
2.5688
2.5838
.25
.02
.03
-.02
-.24
-.20
—. 56
-.64
-.69
-.35
-.27
.01
-.01
.00
.00
.00
.00
1.15
1.20
1.18
July
Aug
Sept
2.5837
2.5724
2.5823
2.5688
2.5539
2.5588
.58
.72
.91
.04
-.58
-.50
-.48
-.19
-.21
-.22
-.02
-.01
.01
.00
.01
.02
1.31
1.16
1.29
Oct
Nov
Dec
2.5920
2.5900
2.6019
2.5589
1.29
1.21
.86
-.30
— .26
-.28
-.12
-.14
-.17
-.04
.00
.00
.02
o %J &>
1.17
1.19
.01
le &1
Jan
Feb
Mar
2.5889
2.5770
dC s «3 3 © =#
2.5796
Year over year percent change.
in
* 26
• b
/
.53
.36
.05
a «J X
TABLE 3
M.. - Adjusted Monetary Base Multiplier Forecasts
1985
February, 1985 Base
Not Seaonally Adjusted Linear Approximation Models
Month
Forecast
95 % confidence interv
January
February
March
2.5889*
2.5769*
2.5807
2.5517
2.6100
April
May
June
2»6263
2.5693
2.5840
2.5820
2.5146
2.5191
2.6714
2.6251
2.6507
July
August
September
2.5830
2.5724
2.5822
2.5095
2.4916
2.4936
2.6587
2.6559
2.6738
October
November
December
2.5915
2.5905
2.6021
2.4960
2.4888
2.4936
2.6907
2.6964
2.7153
*Actual
57
INTERNATIONAL TRADE POLICY:
THE TWO MAIN TASKS
Jan TUMLIR
GATT, Switzerland
International
unknown
many
since
trade
policy
exhibits
the end of the 1940s.
directions
a
degree
instability
The repercussions are felt
but in most of them they represent
deterioration, a growing burden on the world economy.
which
of
only
a
in
gradual
The one area in
the general growth of protection could produce dramatic results
soon
is international financial relations.
crisis
is
acceptable
far
to
from
both
The
international
over and I would argue that a
sides must include
an
solution
international
debt
of
it
agreement
stabilizing the conditions of trade.
Restoring
credit
worthiness
is
not
primarily
a
question
of
increasing the export earnings the indebted countries can realize from
existing production capacities.
the
Such an increase goes, of course, in
right direction, but it is only a minor contribution
magnitude of the problem.
given
the
A number of indebted developing countries,
including the two main ones, Brazil and Mexico, achieved large current
account
the
surpluses last year which led to a widespead perception
debt crisis was easing and coming under control
however,
unlikely
again.
It
in
government
reappear
in
three
digits
two
decades
in the
and
rising,
taking
power.
and
the
Crisis
first
59
with
civilian
headlines
business, perhaps even on the front, pages
newspapers.
is,
that the 1984 current account achievements of most
debtors can be repeated in 1985, certainly not those of Brazil,
inflation
that
of
will
our
A
solution
improvement
that
is
of
the
debt
problem
must
involve
a
substantial
in the overall performance of the indebted economies
beyond
the
possibilities
of
financial
policy
and
alone.
Rescheduling the principal, manipulating the interest, riding herd on
the hundreds of nervous banks involved are all necessary measures
far from sufficient.
cannot
but
The reason is simple. We know that all the debt
be repaid or even serviced but nobody is in a position to
today what proportion of it can be salvaged.
say
That depends entirely on
more general economic policies in both creditor and debtor countries.
The
political
squeeze
Latin
a
problem,
economies
are obvious.
microeconomic
performance
on macroeconomic
policy,
"sufficient" external surplus for debt
American
efficiency,
constraints
of
operating
on
their
trying
to
from
the
level
of
service
present
Yet in the international discussion of the
policy reforms needed to improve the
overall
the indebted economies, have been given but
minimal
attention so far.
Not just more investment is needed to improve economic performance
but a more efficient allocation of it.
The average rate of return on
investment
debtor
cannot
be
raised
substantially improved pattern
in
the
of investment
economies
incentives.
without
a
Rising real
rate of return on investment would ease the interim financing problems
by
increasing
repatriation
most
of
indebted
investment
the voluntary inflow of capital,
inducing
even
the private assets held abroad by nationals
countries.
incentives
But
how
is
the level and
to be improved in economies where
some
of
pattern
the
the
of
public
sector accounts for more than a half of aggregate gross investment and
the allocative role of the market has been correspondingly weakened?
60
Trade
policy appears to be the logical starting point,
as it was
instrumentally involved already in the emergence of the debt
It
problem.
should be recalled that the large-scale borrowing by the now over-
indebted
countries coincided with rising protection
everywhere. The
increasing uncertainty of trading conditions could not fail to further
distort investment incentives in the borrowing countries.
a
safe
conclusion
conditions
of
investment
that a credible long-term
international
opportunities
to
It is thus
stabilization
of
the
trade would
allow
attractive
new
emerge in the
debtor
economies.
The
presence of such opportunities would be an additional, possibly quite
effective,
political
argument
for privatization of
the
industrial
enterprises now inefficiently operating in the public sector.
Only
trade
the
large creditor countries
conditions
should,
of
important
course, act
that
discipline
sufficiently
the
can
for these
unilaterally
stabilize
effects
in
to
debtor countries also agree to
in the conduct of their trade policy.
to eliminate or phase out existing
At
here
is
that
tariffs do not insulate
They
but
accept
quantitative
replacing them perhaps by higher, but bound,
point
occur.
this respect
have an almost unlimited freedom to restrict imports.
urged
international
it
a
is
basic
present, they
They should be
restrictions,
tariffs. The important
an
economy
from
the
international price system as quantitative restrictions do. Moreover,
once
tariffs
are bound and the government's freedom
of
interfering
with import transactions effectively constrained, most of the "purely"
domestic policies distorting resource allocation (such as subsidies or
enforcement of private cartel agreements) cease to be feasible,
least
lose much of their effectiveness.
61
Liberalization of
or at
imports
thus can be said to compel internal liberalization,
strengthening the
allocative role of the market.
The
debt
problem
is, of
course, only
one
argument
for an
international action to restore stability in the conditions of trade.
The cost of protection to the protecting economies is another,
long
run
even
more
important one;
and there
political costs of interfering with foreign
for
the
United
States with its global
are
many
transactions,
political
in the
indirect,
especially
responsibilities.
Governments are becoming aware of these costs of allowing the
present
drift in trade policy to continue. Our diplomacy is now engaged in an
effort to get a new round of trade negotiations underway.
It
is at the moment impossible to say whether the effort will
be
successful.
It may be useful, however, to point out the two dangers
it entails.
The Administration has proposed,
authorization,
Canada,
and
interpreted
to negotiate free trade area arrangements with Israel,
the
as
countries of the Caribbean Basin.
between
probably
a
This is widely
a stratagem to induce the European Community
wide-ranging trade negotiation.
trade
and obtained statutory
A genuine free-trade area, with all
the partner countries relieved of
good thing?
as it eliminates the
all
obstacles, is
political
impinging on transactions between the partner countries,
investment
are
and
however,
that
uncertainty
it
growth by virtue of which the trade creating
likely to dominate
into a
the trade diverting
ones.
The
promotes
effects
danger
is,
the free-trade area arrangements negotiable under
the
present trade policy conditions, conceptions and practices will
considerably short of genuine free trade.
an
agreement
to
eliminate
There may be, for example,
tariffs accompanied
by
administrative "management" of trade in "sensitive"
62
fall
provisions
sectors.
for
Should
that
occur
the
system
of internationally agreed
rules
to
govern
national trade policies would be weakened futher and the chances of a
productive multilateral trade negotiation would grow even more remote.
The second danger inheres in the habitual approach of trade policy
makers to international negotiating rounds.
They are conceived of in
terms of bargaining for concessions on the basis of reciprocity.
technique
This
was developed specifically for tariff negotiations where it
proved useful.
It cannot, however, cope with the present difficulty
which stems from advanced erosion of the very principles on which
system
of
rules was
based.
Approaching
these
problems
adversary,
bargaining
mode would be not only pointless but
the
in the
in
fact
counterproductive.
The
destabilization
which
occurred mainly in the 1970s
can
traced to two specific breaches of the trade policy rules agreed
after World War II.
conditions
of
have
if
the international trade system,
it
had not been possible
for
governments
negotiated,
little
international trading system.
rules
exports
fortiori.
a
else
to
grant
can
be
though incomplete, is
done
to
stabilize the
The practice is clearly contrary to the
which prohibit quantitative restrictions on
in general, and discriminatory quantitative
imports
and
restrictions
a
The restraint is a bilateral agreement, however, and where
there is no plaintiff, rule breaking cannot be prosecuted.
only
While bilateral export restraints
remain available as a form of protection which,
GATT
and requires
Protection levels could not have risen as much as
protection in a discriminatory way.
easily
upon
One is flagrant, concerns the main principle and
brief explanation.
they
be
63
There
is
a way of permanently remedying this defect.
viewpoint
of
trade
revolution.
It
discrimination
transformed
policy makers,
would
consist
of
it would
amount
a legal act by
commitment (the unconditional
MFN
to
From
the
a virtual
which
the non-
clause)
would
be
from a diplomatic convention to a requirement of national
law, effectively binding the governments of at least the major trading
countries.
The
second
major breach concerns issues of
a
highly
technical
nature, well beyond the attention and understanding of general public;
administrative procedures for handling subsidy and dumping complaints.
If
sufficient
political support is to be maintained
nationally
for
an international trade system, there must be provisions against unfair
competition.
unfairness
second.
legal
Subsidies and dumping are the two main forms here, the
being
real in the first case, widely
suspected
in the
Firms required by law to compete against each other must have
recourse when they find themselves competing with firms
backed
by public subsidies.
As economists we may find it difficult to understand why a country
should
refuse to accept subsidized imports.
Indeed,
if the foreign
subsidy could be expected to stay in place for a sufficient length
time,
it would be equivalent —
country
it has
become
investment-inhibiting
is
importing
— to a change in comparative advantage to which it would
efficient to adjust.
as
from the viewpoint of the
of
be
When subsidization becomes widespread, however,
in
the
last
decade,
it
cannot
but
generate
uncertainty in the importing countries.
an additional, more practical argument.
When we
maintain
There
that
subsidized imports are a benefit, we assume that only some governments
are
foolish enough to subsidize, the importing country's
64
government
being fully rational,
government?
to
impervious to the temptation.
International
protect
Is there such a
rules against subsidization were intended
all governments against domestic
political
demands
for
subsidies.
The traditional procedure in these cases was that firms exposed to
such
a
competition
instituted
and
if
would
complain,
investigation
a significant margin of subsidy
ascertained,
an
offsetting
merchandise.
A
logically
duty would be imposed
equivalent
"price undertaking" from the exporters,
price
an
or
on
would
dumping
the
remedy might be to
i.e.,
was
imported
demand
that they raise
export price and the true cost of production.
a third remedial practice has become
established,
an
agreement
by the
exporting
legally
country
restrict exports of the challenged merchandise to a given amount
quantitative
restaint
—
the
From the end
of the 1970s, however,
in which
a
their
by the amount of the officially established margin between
original
be
is an acceptable alternative settlement
to
— a
of
complaints against subsidized or dumped imports.
This practice has fundamentally changed trade
firms
and industries fear perhaps nothing more than an
for subsidies or dumping.
lasts,
The
policy.
the
exporter
Exporting
investigation
The investigation can drag on and while it
is paralyzed as to reacting to market
changes.
particular market, established through substantial investment
of
both finance and effort, may be lost to competiton while the official
decision on a subsidy or dumping complaint is pending.
therefore
their
strongly predisposed to settle for a quantitative limit
sales
investigation.
Exporters are
when
such
an
agreement
terminates
Export restraint settles the complaint
65
the
on
official
quickly; but
then,
too,
Remedy
a fundamental principle of legal procedure is sacrificed.,
is imposed (punishment meted out) without any proof of wrong-
doing . Indeed, there is a glaring logical inconsistency:
a restraint
is
subsidy
agreed
to
offset the harmful effects of a
putative
dumping the extent of which has not been established.
the
viewpoint
or
Looked at from
of the complaining domestic firms, protection is now
available practically for the asking.
As
as
long as this easy road to protection remains open — that is,
long
as the authorities administering the two
markets of the world,
rollback"
measures,
agreement
even
if
important
the US and the EC, have legal power to
unfair competition complaints in this way —
and
largest
settle
the hope of a "standstill
on new and recently
all trading nations agree
imposed
protectionist
on
desirability,
its
cannot lead to any practical results.
The
correction
theoretically
of
this
simple, though
defect
of
the
trading
it will be difficult
to
system
is
achieve
in
political practice. Where subsidization is involved there is no other
solution
than
completed.
a legal requirement that all
investigations
must
be
That ultimately means that governments will have to stop,
or at least radically limit, subsidization of exportables. As regards
dumping,
markets
predatory
it
is
should
a
be recognized that price differentiation
normal and efficient pricing practice
form of competition,
and that it
official intervention in the market.
66
rather
across
than a
should not give rise
to
@FedFRASER