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SHADOW OPEN MARKET COMMITTEE
(SOMC)
Policy Statement and Position Papers
September 11>12,1994
PPS 94-02
BRADLEY POLICY
RESEARCH
CENTER
Public Policy Studies
Working Paper Series
W I L L I A M
E.
SIMON
GRADUATE SCHOOL
OF BUSINESS ADMINISTRATION
UNlVEKSriYOFRCXHESnTER
ROCHESTER,
NEW
YORK
14627
Shadow Open Market Committee
TABLE OF CONTENTS
Page
Table of Contents
i
SOMC Members
ii
SOMC Policy Statement Summary
1
Policy Statement
3
The Cost of Go-Stop-Go
H. Erich Heinemann
9
Budget Progress?
Mickey D. Levy
29
Economic Outlook
Mickey D. Levy
39
M2 and Base Growth
Allan H. Meltzer.
61
A Note on Recent U.S. Productivity Growth
William Poole
65
Recent Behavior of M2
RobertH. Rasche
73
Myths in the Report of the Bretton Woods Commission
Anna J. Schwartz.
77
i.
September 11-12,1994
SHADOW OPEN MARKET COMMITTEE
The Shadow Open Market Committee met on Sunday, September 11,1994 from 2:00 PM to 6:30
PM in Washington, D.C.
Members of the SOMC:
Professor Allan H. Meltzer, Graduate School of Industrial Administration, Carnegie Mellon
University, Pittsburgh, Pennsylvania 15213 (412-268-2282 phone, 412-268-7057 fax); and Visiting
Scholar, American Enterprise Institute, Washington, DC (202-862-7150 phone)
Mr. H. Erich Heinemann, Chief Economist, Ladenburg, Thalmann & Co., Inc., 540 Madison
Avenue-8th Floor, New York, New York 10022 (212-940-0250 phone, 212-751-3788 fax)
Dn W. Lee Hoskins, Chairman and CEO, Huntington National Bank, 41S. High Street, Columbus,
Ohio 43287 (614-480-4239 phone, 614-463-5485 fax)
Dr. Mickey D. Levy, Chief Financial Economist, NationsBank, 7 Hanover Square, New York,
New York 10004 (212-858-5545 phone, 212-858-5741 fax)
Professor Charles L Plosser, William E. Simon Graduate School of Business Administration and
Department of Economics, University of Rochester, Rochester, New York 14627 (716-275-3754
phone, 716-461-3309 fax)
Professor William Poole, Department of Economics, Brown University, Providence, Rhode Island
02912 (401-863-2697 phone, 401-863-1970 fax)
Professor Robert H. Rasche, Department of Economics, Michigan State University, East Lansing,
Michigan 48823 (517-355-7755 phone, 517-336-1068 fax)
Dr. Anna J. Schwartz, National Bureau of Economic Research, 269 Mercer Street - 8th Floor,
New York, New York 10003, (212-995-3451 phone, 212-995-4055 fax)
ii.
Shadow Open Market Committee
SOMC POLICY STATEMENT SUMMARY
Washington, D.C., September 12—The Shadow Open Market Committee warned the Federal
Reserve today not to "overreact to a short-term increase in inflation." The SOMC, a group of
academic and business economists who regularly comment on public policy issues, predicted that
inflation would increase "near-term as a delayed response to the excessive money growth of the
past." The Federal Reserve's goal, the SOMC said, "should be to achieve stable prices over time
as a means of promoting real economic growth."
The Shadow Open Market Committee meets in March and September. It was founded in
1973 by Professor Allan H. Meltzer of Carnegie-Mellon University and the late Professor Karl
Brunner of the University of Rochester.
In its policy statement, the Shadow Committee stated that "inflation is caused by excessive
aggregate nominal demand, not by real economic growth. The main reason for current concern
about inflation is, as always, past growth of money and the monetary base—the excessive monetary
stimulus that we criticized in 1992 and 1993."
The SOMC rejected the theory that the Federal Reserve should wait until the economy was
close to full employment before acting to reduce inflation. This recommendation is not new, the
Committee said. "It calls for a return to the policies that failed in the 1960s and 1970s...Rising
inflation was the unintended consequence of a policy program to trade higher inflation for temporary
increases in growth and employment"
The committee also criticized Federal Reserve chairman Alan Greenspan for using "a shifting
series of indicators to describe monetary policy. Gold, commodity prices, real interest rates, the
neutral interest rate, and other measures are put forward as guides to past or future policy. The one
measure that is hardly ever mentioned is the one the Federal Reserve controls—MONEY. We
continue to urge the Federal Reserve to control growth of monetary aggregates and to use the
information about future inflation provided by sustained growth of the monetary aggregates."
The SOMC reviewed the performance of the World Bank and the International Monetary
Fund, now 50 years old. "The two institutions could be eliminated or replaced by a single smaller
agency with limited functions: (1) certification and information gathering, and (2) making transfers
or concessional (subsidized) loans to the poorest countries.
1
September 11-12, 1994
"The Fund and the Bank are able to obtain information from member countries more readily
than private lenders. Certification is relied on by private lenders and investors. Governments,
acting together, make transfers and concessional loans to the poorest countries in the world.
Although such loans often delay reform, they are likely to continue. An institution with information
about the countries and their policies can play a modest role by combining transfers with advice
and encouragement of reform."
2
Shadow Open Market Committee
SHADOW OPEN MARKET COMMITTEE
Policy Statement
September 12,1994
The Federal Reserve has moved decisively to sustain long-term growth and reduce future
inflation. The Shadow Open Market Committee applauds the Federal Reserve's actions this year
and President Clinton's support of its actions.
Since March, year-to-year growth of the monetary base—bank reserves and currency—has
fallen from above 10 1/2 percent to about 9 1/4 percent. For the past six months the base has
increased at an 8 percent annual rate. This is the maximum rate we recommend at our meetings in
September 1993 and March 1994. We are now on a path that, if sustained, is consistent with inflation
of 2 to 3 percent. Modest further reductions are necessary if price stability is to be achieved.
Therefore, the Federal Reserve should reduce base growth to 7 percent in 1995.
MONETARY POLICY
The effects of current policy actions on inflation will not be fully evident for months. We
expect inflation to increase near-term as a delayed response to the excessive money growth of the
past The Federal Reserve should not overreact to a short-term increase in inflation. The goal
should be to achieve stable prices over time as a means of promoting real economic growth.
Inflation is caused by excessive aggregate nominal demand, not be real economic growth.
The main reason for current concern about inflation is, as always, past growth of money and the
monetary base—the excessive monetary stimulus that we criticized in 1992 and 1993. The Federal
Reserve was slow to respond to the prospect of inflation. The first response in February was a small
and hesitant step. But the cumulative impact of Federal Reserve actions in 1994 has lowered base
growth to a more appropriate range.
A year ago we warned that more rapid growth of the monetary base relative to growth of
nominal GDP would remain compatible with low inflation only if the public continued to add to
cash balances at a 5.5 percent annual rate. This would have required a continued decline in long-term
3
September 11-12,1994
interest rates. We were skeptical that this would occur. We expected interest rates to rise and
growth of average cash balances to slow relative to nominal GDP. For the year ending June, growth
of average cash balances (Ml/GDP) slowed almost to zero and long-term interest rates rose.
We remain concerned, however, about the Federal Reserve's analysis and discussion of
monetary policy. There are two principal issues. One is reliance on the alleged relation between
inflation and unemployment or real growth. The other is the reliance on an ever-changing set of
indicators to guide monetary policy.
Some have urged the Federal Reserve and other central banks to rely on the relationship
between inflation and unemployment known as the Phillips Curve. They argue that a central bank
can reduce unemployment for as much as two or three years without risk of inflation. On this theory,
the time for action to reduce inflation is when the economy is close to full employment.
This policy recommendation is not new. It calls for a return to the policies that failed in the
1960s and 1970s. Policymakers in that period did not intend to create rising inflation. Rising
inflation was the unintended consequence of a policy program to trade higher inflation for temporary
increases in growth and employment.
Attempts to exploit this tradeoff have always failed. It has taken many years to rid the economy
of the effects of a decade or more of mistaken policies. A main lesson of the recent experience is
that estimates of a Phillips curve tradeoff are unreliable guides for policy.
In his testimony to Congress and in public statements, Chairman Greenspan uses a shifting
series of indicators to describe monetary policy. Gold, commodity prices, real interest rates, the
neutral interest rate, and other measures are put forward as guides to past or future policy. The one
measure that is hardly ever mentioned is the one the Federal Reserve controls—MONEY. We
continue to urge the Federal Reserve to control growth of monetary aggregates and to use the
information about future inflation provided by sustained growth of the monetary aggregates.
THE ECONOMY, THE BUDGET AND THE ADMINISTRATION
The budget deficit has fallen. The basic budget, net of interest payments, is again in surplus.
The administration boasts about the decline in the budget deficit and takes credit for the change.
Its claim, repeated many times, was that deficit reduction lowered interest rates and stimulated the
economy.
4
Shadow Open Market Committee
Competent economists know that this argument is false. Tax increases do not increase growth.
Changes in the deficit have, at most, modest effects on interest rates. Interest rates typically rise
and fall with economic growth and expected inflation.
Interest rates were lower a year ago because economic growth was slow and inflation was
subdued. Since that time, the average growth rate has more than doubled. Growth has been about
4 percent for the last four quarters. As we expected, interest rates rose with growth and with increased
concern about future inflation.
Recent reductions in the deficit have resulted from the unwinding of the Resolution Trust
Corporation (RTC), reductions in defense spending, and legislated tax increases. The RTC spent
$66 billion in 1991 to bail out failed thrift institutions. In 1993, the RTC made a net contribution
of $28 billion by selling assets, a contribution of $94 billion toward a lower deficit. Net contributions
from the RTC will continue this year and next.
Since 1989, defense spending has fallen from 27 percent to 19% of government outlays.
However, the administration has increased our current or future military commitments as it has
reduced military spending. This inconsistent strategy can lead to an inability to fulfill commitments.
Legislated tax hikes reduce saving and investment and lower long-term economic growth.
Long term, higher taxes reduce economic activity. They should not be confused with fiscal
responsibility.
THE LONGER-TERM OUTLOOK
The administration assumes that long-term growth is about 2 1/2 percent a year or slightly
higher. To sustain this growth rate, productivity growth must return to a growth path that has not
been sustained since the early 1970s. We doubt that this will be achieved. With current labor force
growth about 1 percent a year, the economy's long-term growth path is not much more than 2
percent
Slower productivity growth will reduce taxrevenuesbelow projections. By 1998 at the latest,
budget deficits will start to rise as a share of GDP. The principal reasons are well-known—rising
spending for entitlements, particularly health care. After 1998, caps on discretionary spending
expire. These caps are estimated to reduce discretionary spending by 2 percent of GDP between
1993 and 1998. Removing the caps may be followed by a new surge in discretionary spending.
5
September 11-12, 1994
It is irresponsible to offer new entitlements for health care, welfare, and other social purposes.
These expenditures will increase consumption at the expense of investment and slow long-term
growth. The costs will be paid by the our children, and their children, because we will save and
invest less and leave them a small capital stock.
The budget problem is a spending problem and an allocation problem. More than 100 percent
of the rise in budget deficits corresponds to the rise in transfer payments. Until growth of these
programs is controlled, the programs will continue to be financed either by future generations or
by selling assets to foreigners.
THE FUND AND THE BANK AT FIFTY
The International Monetary Fund and the World Bank were conceived at Bretton Woods in
1944 and began life after World War II. The Fund was given responsibility for supervising the
operation of the fixed exchange rate system. The Bank was to be responsible for lending to
reconstruct wartime damage and for development.
The fixed exchange rate system ended in 1973. Since that time, the IMF has looked for tasks
to perform. It took responsibility for lending and credit certification during the debt problems of
the 1980s. It stretched out the problem and delayed its resolution. Most recently, the industrialized
countries gave the IMF a leading role as a lender to Russia and other former members of the Soviet
bloc. Most the funds lent to these governments has been offset by capital flight from Russia. IMF
lending thus helped to finance capital flight.
The Bank was organized on the presumption that markets would supply few loans to
developing countries. The debt problems of the 1980s showed that, for many countries, this presumption was wrong. A number of countries borrowed more than they were able to repay. The
availability of loans from the World Bank and other international agencies at reduced interest rates
encouraged developing countries to borrow, to close their markets to equity investors, and to restrict
foreign ownership of domestic assets.
The policy of relying on government borrowing was not in the interest of the borrowing
countries. Several countries have recognized their previous mistakes and changed their policies.
Private capital is now welcome in Mexico, Chile, Argentina, Peru, and in much of Asia.
6
Shadow Open Market Committee
The success of a market-based approach to lending and borrowing raises questions about the
appropriate roles of the Bank and the Fund. What do these institutions do that cannot be done as
efficiently, or more efficiently, by private lenders? Although the Bank has a subsidiary to lend to
private investors, the Bank and the Fund lend mainly to governments. The functions of the two
institutions overlap much more than in the past; there is duplication without the gains from competition. Both continue to lend for stabilization or adjustment Many of the short-term loans, in
which the Fund specialized at an earlier time, roll over and are extended for longer terms. They
are, in fact, long-term loans. The Bank no longer concentrates on projects such as dams and roads.
It, too, lends to facilitate adjustment
The two institutions could be eliminated or replaced by a single smaller agency with limited
functions: (1) certification and information gathering, and (2) making transfers or concessional
(subsidized) loans to the poorest countries. The Fund and the Bank are able to obtain information
from member countries more readily than private lenders. Certification is relied on by private
lenders and investors. Governments, acting together, make transfers and concessional loans to the
poorest countries in the world. Although such loans often delay reform, they are likely to continue.
An institution with information about the countries and their policies can play a modest role by
combining transfers with advice and encouragement of reform.
THE BRETTON WOODS (VOLCKER) COMMISSION
These proposals differ from the recent report of the Bretton Woods Commission chaired by
Paul Volcker. The Commission offers myths about both the past the present and misguided policies
for the future.
The Bretton Woods system of fixed but adjustable exchange rates broke down because the
system was flawed. The main flaws in the system were: (1) no effective restriction on U.S. inflation,
(2) no mechanism for devaluing the dollar when the U.S. inflated, and (3) no recognition of changes
in the real terms of trade. The result was inflation in all major countries and misaligned exchange
rates. Years of meetings and official discussions never resolved the system's problems. All the
policymakers were able to agree on was creation of some useless pieces of paper called special
drawing rights.
The present international monetary system is not ideal. Improvement will only come about
if each major country chooses to pursuefiscaland monetary policies to achieve sustained growth
and price stability. No shortcuts or clever schemes for coordinating actions can substitute for
7
September 11-12, 1994
disciplined policies. Attempts to block market adjustment of exchange rates by government policy
are disruptive and costly. The Commission's proposals for "better international policy coordination
aimed at stabilizing exchange rates" deserve the neglect they will surely get.
8
Shadow Open Market Committee
THE COST OF GO-STOP-GO
H. Erich HEINEMANN
Ladenburg, Thalmann & Company, Inc.
Action by the Federal Reserve System to boost the discount rate and the Federal funds rate
to 4 and 4.75 percent, respectively, will make a tight monetary policy even tighter. While the Fed's
money squeeze is not likely to put a noticeable dent in the economy in 1994, it will increase the
risk of recession in 1996.
Business activity has already slowed, but our work suggests that the deceleration was more
a result of fiscal drag from higher marginal tax rates than from monetary restraint. Productivity
was down in the second quarter, as we predicted last spring.
Inventories of electronic gear have started to build, and producers of heavy construction
equipment say they see signs of softening in their order books particularly for publicly funded
projects. Real retail sales fell in July. Total vehicle sales have dropped substantially. Single family
housing starts have been flat since October.
Exports remain an area of remarkable strength. Real merchandise exports were a record $484
billion at a seasonally adjusted annual rate in the second quarter, up more than 9 percent from 1993.
That was almost double the growth of 5 percent one year earlier. We doubt that U.S. export sales
can grow at this rate for an extended period. More likely, real exports will continue to rise along
the 7 percent trend line typical since 1989.
American producers regularly achieve trade surpluses in four major sectors: services,
industrial materials other than oil, capital goods other than automobiles and agriculture. In the
nation's overall balance of trade, these areas of comparative advantage are more than offset by
ongoing deficits in oil, consumer goods and automobiles.
In the wake of the Federal Reserve's rate action, officials may postpone the next increase in
their interest rate target until after the mid-term elections in November. Meanwhile, bonds are
oversold. The trading rally in bonds could bring yields close to 7 percent.
9
September U-12, 1994
Assuming the monetary authorities continue on their current course over the next 18 to 24
months, then theriskof a recession during the 1996 Presidential campaign shouldrisesubstantially.
The longer the money squeeze continues, the deeper that downturn is likely to be. Conventional
wisdom notwithstanding, we believe that higher inflation is on the way—not because employers
hired too many low-skill workers, but because the Fed printed too many high-powered dollars.
We think inflation is likely to accelerate to a range of 4 to 5 percent in 1995, regardless of
actions that the central bank may or may not undertake in 1994. Aftereffects from easy money in
1991, 1992 and 1993 have already put their price structure into motion.
The Federal Reserve conducts monetary policy by setting a target for short-term interest rates.
Since Fed officials cannot control day-to-day demand for short-term credit (or even know what that
demand may be), they must supply whatever amount market players want at that target price.
Incoming economic data suggest that the Fed's current target of 4.75 percent for overnight
money market loans (the Federal funds rate) is above market equilibrium. Consequently, the money
managers must reduce the supply of bank reserves to prevent rates from falling.
Total bank reserves, the high-powered money that is raw material for the money supply,
dropped sharply in thefirsthalf of August to a level $ 1.4 billion below that of last February. Since
last fall, reserve growth has declined substantially (Chart 1). At present, reserves are slightly lower
than they were in October 1993. By contrast, from July 1992 to October 1993, reserves rose at a
16 percent rate. The abrupt closing of the monetary faucet has been a principal factor triggering
the slump in the prices offinancialassets thus far in 1994.
There is little that monetary policy can do to prevent inflation from accelerating, but the
central bank could do a lot of damage by forcing an unsustainable contraction in the money supply.
That course would continue the go-stop-go pattern of Fed policy. Policy that is too tight begets
policy that is too easy, just as policy that is too easy begets policy that is too tight. There is a golden
mean, but the Fed has not found it.
The mantra in Manhattan is that rising employment leads to higher wages and that higher
wages fuel inflation. We believe that the analysis is wrong, but that the conclusion is right Higher
inflation is on the way. However, rapid growth in payroll jobs suggests weakness as much as
strength. In July, as has been the true since 1991, most the new jobs were low-productivity,
short-hour and low-pay.
10
Shadow Open Market Committee
Moreover, since January the number of jobs has risen by 1.9 million, but the number of
workers has gone up only 556,000. This indicates that people are taking second and third (presumably part-time) jobs to maintain family income. Growth in full-time employment has indeed
been sluggish.
The low quality of the ongoing growth in jobs shows clearly in the data on personal income.
Real after-tax income per job declined from March to June and has grown at an annual rate of less
than 1 percent over the past two years—indeed over the last 20 years. That indicates a weak
foundation for sustained expansion in consumer spending.
The rapid rise in the employee headcount in a relative handful of industries (generally with
the lowest productivity) implies that profit margins in these businesses are—or soon will be—under
downward pressure. If profitability declines, then hiring will soon slow—most likely before the
mid-term elections this fall.
At the national level, productivity dropped during the second quarter. Total hours worked
rose at a rate of 6.47 percent, the highest in a decade, but output of goods and services went up
only 3.7 percent The Commerce Department said gross real product per hour in the nonfarm
business sector fell at a rate of 1.4 percent this spring, in contrast to a 3.3 percent gain in the first
quarter. This negative swing implied substantial negative pressure on profit margins.
Consumer spending rose at a $ 10.8 billion rate in the second quarter down from the $40 billion
increase during the winter months. Most of the slowdown was in durable and nondurable goods,
but service spending also rose at a slower pace.
Total vehicle sales were at an annual rate of 13.8 million units in July, down by almost 1
million units from the prior month—the fourth consecutive monthly drop. Vehicle sales averaged
14.4 million units at seasonally adjusted annual rates in the last three months, down at a 21 percent
rate from the comparable period ending in March.
Consumption has been rising faster than real income for more than two years. This cannot
continue—income will pick up, spending will slow, or some combination. This spring, both
incomes and spending were slower, but spending slowed more than income.
Sales of new homes fell sharply in June. Leading homebuilders say a substantial recovery
from the June sales level is not likely. A slump in home sales will likely translate to lower housing
starts and cuts in construction jobs during the summer and fall. "Normal" links between housing
starts and bond yields appear to support this conclusion.
11
September U-12, 1994
Investors should recognize that the current expansion is narrow and therefore vulnerable to
a setback. Since 1991, real GDP hasrisen$441.3 billion. Volatile, cyclical sectors of the economy
—consumer durables, business plant and equipment investment, housing and inventories
—accounted for $376.2 billion or 85.2 percent, of the gain.
Normally, the cyclical sectors are about one-quarter of the economy. Currently, these
chronically unstable industries make up 27.7 percent of GDP, the highest since data were first
compiled in 1929. Relatively stable noncyclical sectors (about 75 percent of the economy) have
accounted for less than 15 percent of the expansion.
In capital goods, demand has focused narrowly on information processing and related
equipment and trucks and buses. Other types of investment are at a 35-year low as a share of GDP
(Chart 2).
Inflation accelerated in the second quarter. The fixed-weight deflator for gross domestic
purchases rose at a rate of 3.2 percent, up from 2.5 percent. Ladenburg's Baseline Forecast indicates
inflation will accelerate to a 5 percent rate in 1995, a delayed response to the Federal Reserve's
easy money from 1991 through 1993.
Consumer spending was surprisingly soft in the second quarter. Real personal consumption
goods rose at an annual rate of only 1.8 percent during the April-June period, down from 5.4 percent
in the first three months of the year and 6.3 percent in the fourth quarter of 1993. A drop in auto
sales played a major role in the slump, but real outlays for nondurables were down too.
Other major sector of GDP—fixed investment, net exports and government—either slowed
or exerted a drag on economic activity. The real value of business investment in equipment was
up at a rate of 6.5 percent in the second quarter, down from 10.6 percent last winter and 27.5 percent
during the final three months of 1994.
The only big uptick in the second quarter was business inventories. Stocks of unsold goods
accounted for $31 billion of a total second-quarter gain of $49 billion in real GDP. Real final sales
to domestic purchasers appear to haverisenat a rate of 2 percent, down from 3.9 percent in the first
quarter and 6 percent in late 1993.
Much of the inventory surge was in imports. Nevertheless, cutbacks in production seem
inevitable. That should set the stage for more sluggish expansion during the second half of 1994
in a range of 2.5 to 3 percent (see the attached Baseline Forecast). You should note the anomaly
12
Shadow Open Market Committee
of the surging job count this spring, accompanied by a slowdown in final demand ("A Million Jobs
in a Slowing Economy"). Four business sectors accounted for the bulk of the hiring both in the
second quarter and the expansion that officially started in the second quarter of 1991.
Construction, retailing, business services (including temp jobs) and health services were
responsible for 67 percent of the 930,000 jobs that private employers added in the April-June period.
That was somewhat below the average of 75 percent over the last three years.
We believe these employers are not beginning to add new workers at a marginal loss. Put
simply, if a firm adds 100 people to its payroll, the unit profit on their additional output will be less
than average unit profits on the output for the previous, smaller work force. This pattern appears
to be a replay of 1988 and 1989, when marginal losses in private services set the stage for the
1990-1991 recession.
The service sector has dominated U.S. employment for a half century. Service producing
industries account for more than 90 of every 100 jobs that employers have added since World War
II—more than 71 in private firms and 19 in government
Construction and non-production jobs in manufacturing accounted for the balance. Production
employment in manufacturing hasn't changed since 1946, even through output is up more than 500
percent.
The growth rates of population, the labor force and total employment all slowed markedly in
the 1990s. In the last five years, the number of payroll jobs rose 3.97 million, compared to average
five-year growth of 6.1 million since 1946. A total of 3.75 million (95 percent) of these new jobs
were in the Big Four sectors—construction, retailing, business services (including temp jobs) and
health services.
More than 62.3 percent of the civilian population over age 16 was working during the second
quarter, just seven-tenths of a point below the record in the first quarter of 1990. There were 122.4
million workers in June, 66 million men and 53 million women. More than 100 million workers
had full-time jobs. The bulk of the 22 million people working part-time (17.3 million or 78 percent)
were doing so voluntarily.
Large-scale displacement in the workplace of older, experienced men by younger, less
experienced women appears to be coming to an end. Women aged 25 to 44 were 13.6 percent of
the civilian workforce in 1960, 24.9 percent in 1991 and 24.5 percent today. Men aged 45 to 64
13
September 11-12,1994
were 23.3 percent of workers in 1960,14.7 percent in 1991 and 15.3 percent today. The change in
the age and sex composition of the work force coincided with a slowdown in growth of productivity
and real income per worker.
Most employment gains since 1991 have been in smaller states. Total employment in California, New Jersey and New York averaged 25.7 million in the second quarter, down 969,000 from
the peak in second quarter of 1990. Elsewhere employment is up.
All three states have relatively high taxes and government regulation. The European community has the most comprehensive system of social services and taxes to match. It now has average
unemployment of more than 11 percent, compared to 6 percent in the U.S.
As a result, productivity and profitability were down in the handful of industries that have
done most of the hiring. The implication is that the second quarter spike in hiring won't continue.
This conclusion is supported by our analysis of the main reasons why the economy slowed.
One, in recent months, real retail sales have averaged more than 51 percent of real after-tax
income, by far the highest since 1959. As a result, the personal savings rate slumped to a 45-year
low during the past year. Against this setting, consumers were bound to cut back.
Two, the basic federal budget (exclusive of net interest payments) moved to a substantial
surplus in the first half of 1994 compared to a peak deficit of $ 103.1 billion in third quarter of 1992.
Our data suggest the basic budget is the best measure of the impact of the sharp reduction in deficit
spending.
Three, the Federal Reserve has shifted to tight money. To date, Fed actions have had little
effect on the real economy. The central bank must sustain a restrictive policy for an extended period
to change spending patterns. Obviously, however, the longer tight money persists, the greater the
risk of an economic downturn.
Conventional wisdom is that a slower growth rate signifies a corresponding drop in the risk
of inflation. We disagree. The rate of inflation rose 50 to 75 basis points in the second quarter of
1994. The consumer price index, the CPI minus food and fuel (so-called core inflation) and the
overall producer price index all showed faster rates of increase during the spring quarter than last
winter.
While the rates of increase in these broad-based indices are still modest (mostly about 3
percent or less), they show clear signs of having bottomed for the current business cycle. The most
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Shadow Open Market Committee
dramatic change was the consumer price index for commodities, which rose at a 2.1 percent annual
rate. Over the prior 10 months, this measure of the prices people pay for goods rose a rate of
nine-tenths of one percent. Higher oil prices are likely to add to the acceleration.
Both the timing and the amount of the pickup in prices are consistent with our forecast of
stagflation in 1995 (see the Baseline Forecast). We believe inflation is caused by government
printing too many dollars, not by employers hiring too many workers. Thus, despite 8 million
unemployed workers, prices are moving higher. Long-term rates have gone up almost 200 basis
points as market participants hedge the pending erosion in the real value of their principal.
During 1991,1992 and 1993, the Federal Reserve increased total reserves in the U.S. banking
system by almost 50 percent. Total reserves, the raw material for the money supply, are the best
indicator of Federal Reserve policy. Recently, sustained accelerations and decelerations in the
growth of total reserves have influenced price behavior with a lag of about three years (Chart 3).
We believe that the low rate of inflation in the last year and one half was a direct result of an
exceptionally tight monetary policy from 1987 through 1990 (Chart 3). We also believe that the
inflationary influence of easy money from 1991 through 1993 will be increasingly apparent in the
months ahead.
Leading indicators of inflation are easy to see. Commodity prices have gone up as they always
do at this stage of the cycle. The price of gold is flirting with $400 an ounce. However, these
indicators are symptoms of the inflation process. The underlying cause is record growth in domestic
spending money, fueled by expanding bank reserves.
Rapid money growth lies behind the increase in national income to an average of $5.3 trillion
in the first quarter. That represented a 7 percent rate of gain during the past one and one-half years
—more than double its growth from 1990 through 1992. More dollars are chasing the available
supply of goods.
15
i. THALMANN / HEINEMANN ECONOMIC RESEARCH
Baseline Forecast - September 1994
THE ECONOMY:
Gross Domestic Product ($87)
PctChg
Personal Consumption ($87)
PctChg
Business Investment ($87)
PctChg
Structures ($87)
Prod. Dur. Equip. ($87)
Residential Invest. ($87)
PctChg
Change in Inventory ($87)
Net Exports ($87)
Government Purchases ($87)
Pel Chg
Final Domestic Sales ($87)
Pet Chg
Gross Dom. Prod. ($ Current)
Pet Chg
Disposable Income ($87)
Pet Chg
Savings Rate (Percent)
Operating Profits ($ Current)
PctChg
Industrial Prod. (1987=100)
PctChg
Housing Starts (Mill. Units)
PctChg
Tot Vehicle Sales (MiU Units)
Pet Chg
Nonfarm Payroll Jobs (Mill)
Pet Chg
Unemployment Rale (Percent)*
Comp. Per Hour Non-Farm Bus**
PctChg
Productivity Non-Farm Bus**
PctChg
Unit Labor Cost Non-Farm Bus**
PctChg
G D P Deflator (1987= 100)
PctChg
CPI Less Energy (1982-84= 100)
PctChg
F e d ! Deficit ($ Current NIA)
FINANCIAL MARKETS:
Federal Funds Rate
Three-month Bills (Discount)
Prime Rate, Major Banks
30-Year Treasury Bonds
Money Supply (M-l, $ Current)
PctChg
Velocity (Ratio: G D P to M-l)
Trade-Weighted $(1973=100)
IV'93 A
194 A
11*94 A
HI'94 F
IV'94 F
T95F
H'95 F
IIF95 F
IV95F
1993 A
1994 F
1995 F
$5,218.0
6.26%
$3,506.2
3.97%
$627.2
21.09%
$148.7
$478.5
$224.5
28.16%
$10.8
($82.2)
$931.5
-0.13%
$5,289.4
6.02%
$6,478 1
7.69%
$3,747.8
4.32%
4.0%
$533.9
36.99%
112.90
6.76%
1.476
61.00%
14.546
32.49%
111.363
2.21%
6.53%
160.4
2.5%
117.2
4.9%
136.9
-2.3%
124.1
1.35%
151.6
3.07%
($220.1)
$5,261.1
3.35%
$3,546.3
4.65%
$643.6
10.88%
$144.1
$499.4
$229.9
9.97%
$254
($104.0)
$919.9
-4.89%
$5,339.7
3.86%
$6,574.7
6.10%
$3,779.2
3.39%
3.6%
$508.2
-17.9%
115.20
8.40%
1.364
-27.07%
15.540
30.27%
111.976
2.22%
6.57%
162.8
6.1%
118.0
2.8%
137.9
3.0%
125.0
2.67%
152.6
2.75%
($176.2)
$5,310.2
3.79%
$3,558.6
1.39%
$657.9
9.19%
$150.7
$507.3
$234.0
7.33%
$56.3
($112.9)
$916.3
-1.56%
$5,366.8
2.05%
$6,685.5
6.91%
$3,804.7
2.73%
3.9%
$547.3
34.5%
116.40
4.23%
1.41
15.42%
14.880
-15.94%
112.993
3.68%
6.16%
163.1
0.7%
117.2
-2.7%
139.1
3.5%
125.9
3.01%
153.7
2.91%
($145.0)
$5,344.6
2.6%
$3,577.7
2.2%
$675.5
11.1%
$151.9
$523.6
$240.6
11.7%
$51.3
($120.1)
$919.7
1.5%
$5,413.4
3.5%
$6,792.3
6.5%
$3,819.8
1.6%
4.1%
$553.3
4.5%
117.3
3.2%
1.37
-12.2%
14.0
-21.9%
113.3
1.1%
6.1%
165.1
4.9%
117.8
2.1%
140.1
2.9%
127.1
3.8%
155.2
4.0%
($134.9)
$5,374.8
2.3%
$3,606.0
3.2%
$688.4
7.9%
$153.5
$534.8
$240.1
•0.8%
$48.3
($128.7)
$920.7
0.4%
$5,455.2
3.1%
$6,898.9
6.4%
$3,838.9
2.0%
3.9%
$560.0
4.9%
118.4
3.9%
1.35
-5.9%
14.1
2.4%
113.7
1.2%
6.0%
167.1
$5,407.3
2.4%
$3,625.6
2.2%
$702.5
8.5%
$156.5
$546.1
$243.1
5.2%
$46.7
($132.5)
$921.9
0.5%
$5,493.2
2.8%
$7,012.7
6.8%
$3,654.8
1.7%
3.8%
$566.7
4.9%
119.1
2.3%
1.35
2.0%
14.3
8.2%
114.1
1.7%
5.9%
169.2
5.2%
118.9
1.5%
UZ4
3.6%
129.7
4.2%
158.4
4.4%
($128.0)
$5,438.9
2.4%
$3,645.9
2.3%
$713.3
6.3%
$158.5
$554.8
$245.5
4.0%
$50.5
($139.2)
$922.8
0.4%
$5,527.6
2.5%
$7,122.8
6.4%
$3,873.3
1.9%
3.7%
$572.3
4.1%
120.1
3.2%
1.32
-9.6%
14.2
-3.9%
114.3
0.7%
5.7%
171.5
5.4%
119.4
1.9%
143.5
3.4%
131.0
4.0%
160.1
4.5%
($137.2)
$5,469.7
2.3%
$3,666.9
2.3%
$725.8
7.2%
$159.9
$565.9
$244.7
•1.3%
$55.5
($147.5)
$924.2
0.6%
$5,561.7
2.5%
$7,250.9
7.4%
$3,888.9
1.6%
3.6%
$578.0
4.0%
121.2
0.6%
1.34
6.1%
14.3
^4%
114.6
0.8%
5.6%
173.7
5.5%
120.0
1.9%
144.8
3.6%
132.6
5.0%
162.2
5.1%
($148.6)
$5,497.4
2.0%
$3,682.7
1.7%
$736.3
5.9%
$163.3
$573.0
$247.2
4.1%
$59.5
($153.4)
$925.1
0.4%
$5,591.3
2.1%
$7,374.2
7.0%
$3,902.5
1.4%
3.5%
$581.3
2.3%
121.8
2.0%
1.27
•18.5%
14.1
-5.7%
114.8
0.9%
5.5%
176.2
5.7%
120.5
1.6%
146.2
4.0%
134.1
4.8%
164.3
5.3%
($163.9)
$5,134.6
3.12%
$3,458.7
3.26%
$591.6
12.49%
$147.7
$443.9
$213.1
8.17%
$15.3
($73.9)
$929.8
-0.76%
$5,193.1
3.67%
$6,343.3
5.37%
$3,704.1
1.54%
4.13%
$485.8
19.91%
111.03
4.19%
1.295
7.21%
13.887
8.24%
110.521
1.77%
6.75%
158.9
3 4%
115.5
1.6%
137.6
1.7%
123.54
2.18%
150.1
3.10%
($241.4)
$5,322.7
3.7%
$3,572.2
3.3%
$666.3
12.6%
$150.1
$516.3
$236.1
10.8%
$45.3
($116.4)
$919.1
-1.1%
$5,393.8
3.9%
$6,737.9
6.2%
$3,810.7
2.9%
3.9%
$542.2
11.6%
116.8
5.2%
1.37
6.1%
14.6
5.3%
113.0
^2%
6.2%
164.5
3.6%
117.9
£0%
139.5
1.5%
126.6
2.5%
154.6
3.0%
($145.7)
$5,453.3
2.5%
$3,655.3
2.3%
$719.5
8.0%
$159.5
$560.0
$245.1
3.8%
$53.1
($143.2)
$923.5
0.5%
$5,543.4
2.6%
$7,190.1
6.7%
$3,879.9
1.8%
3.6%
$574.6
6.0%
120.5
3.2%
1.32
-3.7%
14.2
-2.6%
114.45
1.3%
5.7%
172.65
4.9%
119.70
1.6%
144.23
3.4%
131.84
4.2%
161.23
4.3%
($144.5)
2.99%
3.06%
6.00%
6.13%
$1,121.4
9.80%
5.78
94.83
3.21%
3.24%
6.02%
6.56%
$1,138.2
6.13%
5.78
95.56
3.94%
3.99%
6.90%
7.36%
$1,144.9
2.4%
5.84
92.93
4.6%
4.3%
7.4%
7.7%
$1,157.4
4.4%
5.87
89.7
5.1%
4.8%
7.8%
8.1%
$1,168.1
3.7%
5.91
89.4
5.5%
5.2%
8.0%
8.2%
$1,176.2
2.8%
5.96
91.2
6.0%
5.6%
8.2%
84%
$1,182.5
Z\%
6.02
90.9
6.3%
5.9%
8.4%
8.6%
$1,192.9
^3.6%
6.08
91.8
6.6%
6.3%
8.6%
8.8%
$1,201.4
2.9%
6.14
91.6
3.02%
3.01%
6.00%
6.60%
$1,077.9
11.52%
5.89
93.17
4.2%
4.1%
7.0%
7.4%
$1,152.1
6.9%
5.82
91.9
6.1%
5.6%
8.3%
8.5%
$1,188.3
3.1%
6.05
91.4
A=Actual F=Forecast Billions of dollars unless noted.
•Break in series, January 1994. * Compensation, productivity and unit labor costs
Sources: Haver Analytics; Heinemann Economic Research
5.1%
116.4
Z1%
141.1
2.9%
128.4
4.1%
156.7
3.9%
($126.8)
index numbers, 1982=100.
193 A
$ Change
$14.6
PctChg
1.16%
$ Change
$30.1
PctChg
2.39%
$ Change
$34.2
PctChg
2.69%
$ Change
$78.4
PctChg
6.26%
$ Change
$155.3
PctChg
3.12%
Personal Consumption ($87)
$13.8
1.10%
$22.0
1.75%
$33.0
2.60%
$34.0
2.71%
$109.2
2.19%
Business Investment ($87)
Structures ($87)
Prod. Dur. Equip. ($87)
$19.4
$0.9
$18.4
1.54%
0.07%
1.46%
$20.7
$0.1
$20.7
1.65%
0.01%
1.65%
$16.9
$0.2
$16.6
1.33%
0.02%
1.31%
$29.3
$12
$28.2
2.34%
0.10%
2.25%
$65.7
($21)
$67.7
1.32%
•0.04%
1.36%
$2.7
0.21%
($41)
-0.33%
$4.7
0.37%
$13.5
1.08%
$16.1
0.32%
$11.9
($19.1)
($141)
0.94%
-1.52%
-1.12%
$0.4
($117)
$2.8
($59)
($170)
$2.5
•0.46%
-1.34%
0.20%
($22)
$4.1
($03)
•0.18%
0.33%
-0.02%
$12.9
($415)
($7.1)
0.26%
•0.83%
-0.14%
$21.8
1.73%
3 19%
$41.4
$56.9
4.48%
2.98%
Change In Inventory ($87)
Net Exports ($87)
Government Purchases ($87)
Final Domestic Sales ($87)
GDP ($87) Four qtr chg (%)
ill
THE ECONOMY:
Gross Domestic Product ($87)
Residential Invest ($87)
3.29%
3.19%
$76.7
6.12%
3.11%
$183.9
3.69%
1994 F
IV94 F
111*94 F
1194 A
THE ECONOMY:
Gross Domestic Product ($87)
$ Change
$43.1
PctChg
3.3%
$ Change
$49.1
PctChg
3.8%
$ Change
$34.4
PctChg
2.6%
$ Change
$30.2
PctChg
2.3%
$ Change
$188.1
PctChg
3.7%
Personal Consumption ($87)
$40.1
3.1%
$12.3
0.9%
$19.1
1.5%
$28.4
2.1%
$113.5
2.2%
Business Investment ($87)
Structures ($87)
Prod. Dur. Equip. ($87)
Hi
194 A
1.3%
-0.4%
1.6%
$14.3
$6.6
$7.9
1.1%
0.5%
0.6%
$17.6
$1.2
$16.3
1.3%
0.1%
1.2%
$12.9
$1.7
$11.3
1.0%
0.1%
0.9%
$74.7
$2.4
$7£4
1.5%
0.0%
1.4%
$5.4
0.4%
$4.1
0.3%
$6.6
0.5%
($05)
•0.0%
$23.1
0.4%
III
1.1%
-1.7%
-0.9%
ill
2.4%
-0.7%
-0.3%,
($50)
($7.2)
$3.4
-0.4%
•05%
0.3%
($30)
($85)
$0.9
•0.2%
•0.6%
0.1%
$30.0
($42.6)
($10.6)
0.6%
•0.8%
•0.2%
$50.3
3.9%
3.7%
$27.1
2.1%
4.0%
$46.6
3.5%
4.0%
$41.7
3.1%
3.0%
Residential Invest ($87)
Change In Inventory ($87)
Net Exports ($87)
Government Purchases ($87)
Final Domestic Sales ($87)
GDP ($87) Four qtr chg (%)
III95F
II95 F
195 F
$200.7
3.9%
1995 F
IV95 F
THE ECONOMY:
Gross Domestic Product ($87)
$ Change
$32.5
PctChg
2.4%
$ Change
$31.6
PctChg
2.4%
$ Change
$30.8
PctChg
2.3%
$ Change
$27.7
PctChg
2.0%
$ Change
$130.6
PctChg
2.5%
Personal Consumption ($87)
$19.6
1.5%
$20.3
1.5%
$21.0
1.6%
$15.7
1.2%
$83.1
1.6%
Business Investment ($87)
Structures ($87)
Prod. Dur. Equip. ($87)
$14.1
$2.9
$11.2
1.1%
0.2%
0.8%
$10.8
$2.0
$8.7
0.8%
0.2%
0.7%
$12.5
$14
$11.1
0.9%
0.1%
0.8%
$10.5
$3.3
$7.1
0.8%
0.2%
0.5%
$53.2
$9.5
$43.7
1.0%
0.2%
0.8%
$3.0
0.2%
$2.4
0.2%
($08)
•0.1%
$24
0.2%
$9.0
0.2%
($16)
($39)
$1.2
-0.1%
-0.3%
0.1%
$3.8
($66)
$0.9
0.3%
•0.5%
0.1%
$5.0
($83)
$1.4
0.4%
-0.6%
0.1%
$4.0
($59)
$0.9
0.3%
•0.4%
0.1%
$7.7
($26.7)
$4.4
0.1%
-0.5%
0.1%
$38.0
2.9%
2.8%
$34.4
2.6%
2.4%
$34.1
£5%
2.3%
$29.6
2.2%
2.3%
$149.7
2.8%
Residential Invest ($87)
1
1993 A
IV93A
III93A
1193 A
Change in Inventory ($87)
Net Exports ($87)
Government Purchases ($87)
Final Domestic Sales ($87)
GDP ($87) Four qtr chg (%)
GROUTH IN TOTAL BANK RESERVES HAS SLOUED SHARPLY
00
Notes:
The chart shous year-ouer-year changes in total bank reserves adjusted for shifts in reserue requirements. Federal
Reserue Board data in millions of current dollars. First
half August 1994 plotted. Uertical lines shou recessions.
Sources: Hauer Analytics; Heinemann Economic Research
FEDERAL RESERUE POLICY IMPACTS INFLATION UIH A LONG LAG
C
H 20x
A
N
G 16x -I
E
I
Bank Reserues (Left)
Core Inflation (Right)
6.GOX
5.Z5X
\2y.
I
N
8* A
P
E
R
C
E
N
T
N
P
E
R
C
E
N
C
H
A
N
G
E
4x.
0
I I I I I I I I I i I I I I I
Jan
1985
Notes:
Jan
1987
Jan
1989
Jan
1991
Jan
1993
Jan
1995
Jan
1997
The chart shous three-year annualized rates of change in
total bank reserues, lagged 36 months (left scale, line)
and one-year changes in core inflation (CPIU less food and
fuel, right scale, dot). Uertical lines shou the recession.
Sources: Hauer Analytics;
I 'I I I I I I I 1 I I I 1 I I 1 I I I I I I I 1 l i f
Heinemann Economic Research
THE BASIC FEDERAL BUDGET IS IN SURPLUS
P
E
R
C
E
N
T
—
Basic Federal Budget Balance
o
Ql
1976
Ql
1978
Ql
1980
Ql
1982
Ql
1984
Ql
1986
Ql
1988
Ql
1999
Ql
1992
Ql
1994
Notes: The chart shous the basic surplus (+) or deficit (-) in the
federal budget as a percent of GDP (revenues less expenditures
other than interest). Underlying data in current dollars,
SAAR. NIA basis. The vertical lines show recessions.
Sources:
Ha tier Analytics;
Heinemann Economic Research
PRODUCTIUITV IS UP IN MANUFACTURING, FLAT ELSEUHERE
I
N 150.0
D
E
X 137.5^
a
s
TT
Nanuf actur i ng Product i u i ty
Nonmanuf actur i ng Product i u i ty
9 125.0-1
8
2
= 112.5
1
0
0 100.0
IN
87.5-Lr
Ql
977
Notes:
T
Ql
1979
Ql
1981
Ql
1985
Ql
1987
I
I
Ql
1989
Ql
1991
I
I
I
I
Ql
1993
The chart shous indexes of output per hour of all persons
in manufacturing (line) and nonnanufacuturing (dot). Nonmanufacturing calculated from Bureau of Labor Statistics
data, SA. Log scale. The uertical lines shou recessions.
Sources: Hauer Analytics;
Ql
1983
1
Heinenann Economic Research
I
Ql
1995
CHANGES IN THE STRUCTURE 8F THE CAPITAL GU8DS MARKET
P
E
R
C 9.75X
E
N
T 9.00*
Inuestnent less Computers and Trucks (Left)
Computers and Trucks (Right)
8
F 8.25/. ]
G
D 7.50*
P
6.75* A
Ql
1959
Notes:
Ql
1967
Ql
1971
Ql
1975
Ql
1979
Ql
1983
Ql
1987
Ql
1991
Ql
1995
The chart shous fixed inuestment less information processing
and related plus trucks and busses (line) and information
processing and related plus trucks and busses (dot) - both
as a percent of GDP. The uertical ljnes show recessions.
Sources:
Ql
1963
Hauer Analytics;
Heinemann Economic Research
NONFARM PAYROLL EMPLOYMENT
Patterns of Recession and Recovery
en
cs
Months from Cyclical Peak
7 Prior Recessions
+ 1990-91 Recession
Zg
IPE
3
^ 9 5.
EEg
4
s
|l i
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o'
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Shadow Open Market Committee
Table 1 - Part 2
Federal Reserve Action and Monetary Growth
(11)
(12)
(13)
(14)
(15)
(16)
(17)
Large
Time
Deposit
Ratio
Nondeposit
Uabll.
Ratio
Foreign
Deposit
Ratio
(18)
Savings
Adjusted
Reserve
Date
[ Ratio
(3/10)
Jul 91
Aug
Sep
Oct
Nov
Dec
Jan 92
Feb
Mar
Apr
May
Jun
Jul
Aug
Sep
Oct
Nov
Dec
Jan 93
Feb
Mar
Apr
May
Jun
Jul
Aug
Sep
Oct
Nov
Dec
Jan 94
Feb
Mar
Apr
May
Jun
Jul
AugPE
0.0140
0.0141
0.0141
0.0142
0.0144
0.0147
0.0148
0.0153
0.0155
0.0157
0.0159
0.0159
0.0159
0.0161
0.0166
0.0169
0.0172
0.0174
0.0175
0.0175
0.0176
0.0177
0.0180
0.0180
0.0182
0.0183
0.0185
0.0188
0.0190
0.0190
0.0189
0.0190
0.0190
0.0190
0.0189
0.0188
0.0188
0.0188
Currency
Ratio
(2/4)
& Small
Time
Deposit
Ratio
(5/4)
0.4364
0.4361
0.4365
0.4351
0.4304
0.4280
0.4237
0.4182
0.4148
0.4147
0.4110
0.4139
0.4134
0.4116
0.4104
0.4058
0.4027
0.4033
0.4031
0.4066
0.4084
0.4094
0.4031
0.4035
0.4026
0.4030
0.4033
0.4031
0.4019
0.4022
0.4063
0.4107
0.4145
0.4194
0.4236
0.4264
0.4278
0.4328
(6/4)
3.5622
3.5335
3.5114
3.4757
3.4163
3.3753
3.3128
3.2461
3.2011
3.1731
3.1215
3.1154
3.0698
3.0214
2.9777
2.9183
2.8670
2.8352
2.7989
2.7896
2.7691
2.7467
2.6847
2.6587
2.6217
2.5964
2.5682
2.5431
2.5189
2.5042
2.4988
2.4896
2.4853
2.4922
2.4906
2.4782
2.4615
2.4718
(7/4)
(8/4)
0.3492
0.3511
0.3405
0.3436
0.3420
0.3306
0.3221
0.3190
0.3158
0.3057
0.2969
0.3005
0.2980
0.3060
0.2990
0.2964
0.2920
0.2861
0.2757
0.2830
0.2944
0.2931
0.2847
0.2864
0.2872
0.2889
0.2917
0.2925
0.2957
0.2955
0.2925
0.2906
0.2983
0.3021
0.3048
0.3170
0.3221
0.3219
0.7776
0.7612
0.7472
0.7249
0.6988
0.6803
0.6598
0.6387
0.6215
0.6096
0.5917
0.5828
0.5660
0.5569
0.5430
0.5237
0.5072
0.4973
0.4835
0.4793
0.4705
0.4731
0.4611
0.4535
0.4444
0.4407
0.4353
0.4336
0.4269
0.4242
0.4267
0.4188
0.4126
0.4141
0.4184
0.4184
0.4204
0.4275
25
0.0160
0.0157
0.0154
0.0151
0.0154
0.0160
0.0161
0.0144
0.0140
0.0145
0.0142
0.0145
0.0151
0.0137
0.0147
0.0144
0.0139
0.0146
0.0138
0.0140
0.0135
0.0129
0.0131
0.0129
0.0133
0.0125
0.0128
0.0426
0.0126
0.0135
0.0126
0.0122
0.0118
0.0125
0.0119
0.0123
0.0125
0.0119
Money
Treasury
Deposit
Ratio
Multiplier
0/4)
(2+4/1)
0.0350
0.0285
0.0447
0.0471
0.0463
0.0405
0.0521
0.0389
0.0307
0.0268
0.0314
0.0376
0.0290
0.0327
0.0411
0.0308
0.0230
0.0269
0.0453
0.0404
0.0237
0.0275
0.0269
0.0348
0.0333
0.0307
0.0367
0.0217
0.0161
0.0268
0.0386
0.0400
0.0249
0.0350
0.0358
0.0165
0.0166
0.0171
j
2.7804
2.7828
2.7823
2.7881
2.8048
2.8108
2.8301
2.8447
2.8566
2.8571
2.8717
2.8611
2.8681
2.8743
2.8722
2.8879
2.8991
2.8982
2.9026
2.8867
2.8782
2.8768
2.9007
2.9023
2.9058
2.9051
2.9026
2.8985
2.9021
2.9039
2.8888
2.8701
2.8571
2.8382
2.8243
2.8154
2.8142
2.7943
September 11-12, 1994
Table 2
Federal Reserve Action and Monetary Growth
(Compound Annual Rates of Change)
This Is accounted for by changes In the:
Date
Jul 91
Aug
Sep
Oct
Nov
Dec
Jan 92
Feb
Mar
Apr
May
Jun
Jul
Aug
Sep
Oct
Nov
Dec
Jan 93
Feb
Mar
Apr
May
Jun
Jul
Aug
Sep
Oct
Nov
Dec
Jan 94
Feb
Mar
Apr
May
Jun
Jul
AugPE
Monetary
Growth
(M-1)
Federal
Reserve
Actions
(Monetary
Base
Growth)
Contribution
of the
Money
Multiplier
Adjusted
Reserve
Ratio
Currency
Ratio
Savings
& Small
Time
Deposit
Ratio
Large
Time
Deposit
Ratio
NonDeposit
Liability
Ratio
Foreign
Deposit
Ratio
Treasury
Deposit
Ratio
0.14
0.53
0.17
0.60
-0.02
0.57
1.00
0.22
-0.07
0.01
0.51
-0.59
0.81
0.39
0.01
-0.07
0.65
1.05
-0.09
0.01
0.03
0.92
2.12
0.06
-0.01
0.20
0.66
1.46
-0.02
0.40
-0.45
-0.00
0.80
2.46
0.33
0.47
0.06
0.76
2.41
0.11
0.35
0.73
0.14
1.92
0.01
-1.62
-5.05
-11.89
0.22
-4.27
-0.19
0.37
0.75
2.18
0.01
-0.26
0.38
-0.01
-0.16
0.26
0.34
0.67
-0.02
0.10
1.85
-0.18
0.07
-0.39
0.45
2.40
-0.60
-0.07
0.99
0.50
3.12
0.44
0.81
0.01
0.11
2.53
0.38
0.81
0.02
2.54
0.22
-0.10
0.26
-0.02
0.15
0.83
-0.78
0.03
0.44
0.59
1.55
0.27
-0.01
-0.39
0.23
0.50
0.75
0.02
0.39
-0.51
0.92
-0.08
0.01
-0.06
0.03
0.49
0.03
-0.01
0.41
0^58
3.04
•0.38
0.01
0.37
-0.09
1.27
0.06
-0.02
-0.03
0.36
1.46
0.11
0.03
-0.07
0.16
1.12
-0.28
-0.01
-0.13
0.26
1.35
0.97
0.01
-0.06
0.11
1.63
0.49
-0.00
0.58
-0.28
2.13
-0.80
-0.07
0.20
0.02
1.10
-0.69
0.05
0.17
-0.14
0.31
-0.08
0.02
0.45
0.11
0.53
0.79
0.02
-0.40
0.32
0.22
-0.45
-0.03
-0.17
-0.06
-0.31
-0.04
0.03
-0.24
-0.15
0.09
0.95
•0.02
0.00
-0.61
0.61
-0.00
-0.00
-0.09
-0.03
0.29
•0.02
0.03
0.01
-0.33
•0.48
1991
1991
1991
1991
1991
1991
1991
1991
1991
1991
0.01
-0.01
0.22
0.79
-1.23
0.60
0.34
8.28
0.49
8.88
1992
1992
1992
1992
1992
1992
1992
1992
1992
1992
0.20
0.02
-0.12
0.88
-0.23
3.52
3.65
•0.88
10.66
14.18
1993-IH
1993-IH
1993-IH
1993-IH
1993-IH
1993-IH
1993-IH
1993-IH
1993-IH
1993-IH
-0.03
0.01
0.17
1.30
0.35
•0.02
0.53
-154
10.18
10.72
1993-IIH
1993-IIH
1993-IIH
1993-IIH
1993-IIH
1993-IIH
1993-IIH
1993-11H
1993-IIH
1993-IIH
0.09
-0.01
0.59
1.47
0.28
-0.09
9.84
-2.20
0.12
9.96
1994-8 Month! 1994-8 Month* 994-8 Month! 1994-8 Month! 1994-8 Monthf 1994-8 Month! 1994-8 Month? 1994-8 Month! 1994-8 Month!1994-8 Months
0.06
-6.33
0.16
-0.00
-0.14
0.01
-6.10
0.14
9.23
3.13
-0.04
-6.92
-1.31
-0.28
-0.05
0.02
-0.61
-6.83
•6.22
2.35
6.24
8.91
6.31
10.46
16.71
11.58
18.03
21.04
12.41
8.05
15.10
0.51
14.61
17.02
17.21
19.68
16.15
10.34
10.25
2.85
5.63
8.32
26.57
10.68
12.20
10.00
11.49
9.23
10.22
6.66
5.49
5.69
3.89
-1.37
1.71
3.98
7.86
-2.20
7.76
7.82
6.51
7.76
8.62
8.75
8.71
13.82
6.92
7.79
8.28
5.10
11.26
14.04
18.26
12.09
10.89
10.73
8.26
9.89
9.41
8.97
14.61
9.95
10.56
10.33
12.66
11.08
8.59
5.86
12.33
14.24
9.71
6.80
7.87
8.03
8.37
6.51
-1.52
1.09
-0.20
2.70
8.09
2.83
9.31
7.22
5.49
0.26
6.82
-4.59
3.35
2.98
-1.05
7.59
5.26
-0.39
1.98
-7.04
-3.78
-0.65
11.95
0.73
1.64
-0.33
-1.17
-1.85
1.63
0.80
-6.85
-8.55
-5.82
-8.17
-6.16
-4.05
-0.51
-8.71
-1.40
-1.23
-0.69
-0.71
•2.88
-3.73
-1.52
-5.67
-3.90
25.13
-2.87
0.19
-0.49
-3.09
-8.29
-4.27
-4.88
-0.91
-0.12
-0.82
-2.38
-0.28
-4.08
0.24
-1.40
-1.03
-1.87
-5.04
-5.04
1.15
1.45
-1.27
-0.26
0.10
1.46
-0.29
0.11
-0.15
-1.54
0.59
-0.65
1.86
7.85
3.85
7.69
9.08
6.25
-2.25
6.56
-4.99
0.91
3.73
3.30
7.96
6.16
-0.60
0.26
-6.81
-2.97
-0.76
11.98
-0.70
1.21
-0.67
-0.47
0.52
3.75
-0.81
-8.00
-8.31
-6.51
-7.25
-7.31
-4.70
-0.79
-7.76
26
Shadow Open Market Committee
Table 3
Federal Reserve Action and Monetary Growth
(Compound Annual Rates of Change)
THREE-MONTH MOVING AVERAGES
This Is accounted for by changes In the:
Date
Jul 91
Aug
Sep
Oct
Nov
Dec
Jan 92
Feb
Mar
Apr
May
Jun
Jul
Aug
Sep
Oct
Nov
Dec
Jan 93
Feb
Mar
Apr
May
Jun
Jul
Aug
Sep
Oct
Nov
Dec
Jan 94
Feb
Mar
Apr
May
Jun
Jul
AugPE
Monetary
Growth
(M-1)
Federal
Reserve
Actions
(Monetary
Base
| Growth)
10.35
9.32
7.16
8.56
11.16
12.91
15.44
16.88
17.16
13.83
11.85
7.88
10.07
10.71
16.28
17.97
17.68
15.39
12.24
7.81
6.24
5.60
13.51
15.19
16.48
10.96
11.23
10.24
10.31
8.70
7.45
5.94
5.02
2.74
1.41
1.44
4.52
3.22
5.70
7.00
7.37
7.37
7.63
8.38
8.69
10.43
9.82
9.51
7.66
7.05
8.21
10.13
14.52
14.80
13.75
11.23
9.96
9.63
9.19
9.42
11.00
11.18
11.71
10.28
11.18
11.35
10.77
8.51
8.93
10.81
12.10
10.25
8.13
7.57
8.09
7.64
Contribution
of the
Money
Mult)pller
Adjusted
Reserve
Ratio
4.65
2.33
-0.21
1.20
3.53
4.54
6.74
6.45
7.34
4.32
4.19
0.83
1.86
0.58
1.76
3.18
3.93
4.15
2.28
-1.82
•2.95
-3.82
2.51
4.01
4.78
0.68
0.05
-1.12
-0.46
0.19
-1.47
-4.87
-7.07
-7.52
-6.72
-6.13
-3.57
-4.42
-1.36
-1.27
-1.11
-0.88
-1.42
-2.44
-2.71
-3.64
-3.70
5.18
6.12
7.48
-1.06
-1.13
-3.96
-5.22
-5.81
-3.35
-1.97
-0.62
-1.11
-1.16
-2.25
-1.37
-1.75
-0.73
-1.43
-2.64
-3.98
•2.98
-0.81
0.44
-0.03
-0.48
0.43
0.42
0.43
-0.11
Currency
Ratio
Savings
& Small
Time
Deposit
Ratio
1.13
1.05
0.80
0.95
1.33
1.54
2.02
2.11
2.27
-2.52
-2.60
-3.15
1.43
1.50
2.46
2.68
2.73
1.97
1.64
0.96
0.99
0.64
1.48
1.60
1.93
1.29
1.31
1.37
1.70
1.62
1.18
0.65
0.35
0.15
•0.00
0.13
0.33
0.14
3.97
1.78
-0.53
0.60
3.02
4.52
6.46
6.87
7.67
4.36
3.52
-0.23
0.83
-0.12
2.65
5.00
5.81
4.51
1.94
-2.39
-3.17
-3.51
2.75
3.51
4.17
-0.05
0.02
-0.21
1.26
1.15
•1.69
-5.71
-7.61
-7.36
-7.03
•6.42
-4.27
-4.42
27
Large
Time
Deposit
Ratio
NonDeposit
Liability
Ratio
0.58
0.57
0.54
0.58
0.70
0.75
0.79
0.74
0.76
-1.19
-1.19
-1.31
0.60
0.50
0.70
0.75
0.87
0.63
0.55
0.36
0.40
0.19
0.31
0.30
0.44
0.30
tf26
0.18
0.32
0.30
0.21
0.17
0.21
0.24
0.01
-0.10
-0.09
-0.12
0.30
0.12
0.15
0.08
0.12
0.12
0.26
0.28
0.19
-1.34
-1.25
-1.35
0.10
-0.15
0.07
0.07
0.27
0.16
0.27
0.07
-0.15
•0.29
-0.02
0.12
0.10
-0.06
-0.08
-0.09
-0.16
-0.10
-0.03
0.10
-0.04
-0.15
•0.24
-0.31
-0.28
-0.23
Foreign
Deposit
Ratio
0.02
0.01
-0.00
0.01
0.00
-0.01
-0.01
0.01
0.02
0.10
0.08
0.07
-0.01
0.01
-0.01
0.00
-0.01
0.01
0.01
0.00
0.02
0.01
0.01
0.00
•0.00
0.01
0.00
0.01
0.00
-0.02
-0.01
0.00
0.03
0.00
0.01
-0.01
0.00
0.00
Treasury
Deposit
Ratio
|
0.00
0.06
-0.06
-0.14
-0.21
0.05
-0.07
0.08
0.12
-0.27
•0.49
•0.69
-0.04
-0.03
-0.14
-0.11
0.07
0.24
-0.17
-0.20
0.08
0.31
0.23
-0.14
-0.10
-0.07
-0.04
0.27
0.39
0.22
-0.33
-0.52
0.01
0.09
0.10
0.15
0.30
0.31
September 11-12, 1994
Table 4
Date
Federal Reserve Action and Monetary Growth
(Compound Annual Rates of Change)
(Memo)
Reserve
Growth Rate
Reserve
Three-month
Growth Rate
Moving Average
Month to Month
Jul 91
Aug
Sep
Oct
Nov
Dec
Jan 92
Feb
Mar
Apr
May
Jun
Jul
Aug
Sep
Oct
Nov
Dec
Jan 93
Feb
Mar
Apr
May
Jun
Jul
5.41
6.08
3.30
8.88
20.62
21.64
10.46
47.68
17.55
7.92
16.29
-2.97
1.10
21.20
39.70
30.66
22.62
5.61
0.60
6.01
7.96
1.55
35.66
1.99
12.29
7.12
15.23
23.77
14.61
-1.37
-0.78
6.66
-2.67
-3.94
-4.97
-1.97
-3.36
-0.64
Aug
Sep
Oct
Nov
Dec
Jan 94
Feb
Mar
Apr
May
Jun
Jul
AugPE
8.12
6.79
4.93
6.09
10.93
17.05
17.57
26.59
25.23
24.38
13.92
7.08
4.81
6.44
20.67
30.52
31.00
19.63
9.61
4.07
4.85
5.17
15.05
13.06
16.64
7.13
11.55
15.37
17.87
12.34
4.15
1.50
1.07
0.02
-3.86
•3.62
-3.43
•1.99
1991
7.72
1992
18.15
1993-IH
8.96
1993-IIH
11.94
1994-8 Months
-1.46
-13.40
Source: Federal Reserve Board; Helnemann Economic Research
28
Shadow Open Market Committee
BUDGET PROGRESS?
Mickey D. LEVY
NationsBanc Capital Markets, Inc.
Washington policymakers, still fixated on budget deficits, see great "progress" in the budget.
From a peak of $290 billion in Fiscal Year 1992, the deficit will be approximately $205 billion in
1994 (which concludes this September) and is projected to fall to approximately $170 billion in
1995. Thus, excluding net interest outlays, the budget will be in surplus for the first time since
1989.
But when evaluated from other equally important fiscal policy considerations, this progress
is illusory. The deficit reduction has been generated by a reversal of the earlier cash-flow outlays
for the Savings and Loan bailouts, legislated tax hikes, and stronger economic growth. Spending
for entitlement programs continues to rise sharply, while spending for investment-oriented activities
and defense shrinks. Tax policy continues to discourage private saving. These policies dampen
long-run economic growth. Policymakers leave untouched the structural flaws that are the sources
of the fastest growing spending programs. The structural (standardized employment) budget deficit
is projected to resume its rise in 1996, even with no new spending programs, and jumps sharply in
1999 when the spending caps on discretionary programs are lifted. And there is a mounting backlog
of pending legislation that is potentially very expensive, including health care reform, the crime
bill, and welfare reform.
Crucially important to economic performance is how the budget allocates national resources,
regardless of whether spending is financed by taxes or borrowing, and how that allocation affects
long-run economic growth as well as how it achieves redistributive goals. In this light, progress
on the budget is unidimensional and unbalanced.
RECENT BUDGET TRENDS
On the surface, the recent deficit reduction has been impressive. The deficit will be 3.1 percent
of GDP in 1994, compared to an average of 4.8 percent in 1991-1992. It is projected to fall below
2.5 percent of GDP in 1995, its lowest level since the late 1970s. This would help stabilize the
public debt-to-GDP ratio at approximately 51 percent; this ratio soared from 26.8 percent in 1980
to 44 percent in 1990 and exceeded 50 percent in 1992 for the first time since 1958 (see Chart 1).
29
September 11-12,1994
But a dissection of the deficit reduction reveals a less impressive pattern—one that has
negative implications for economic performance. The largest source of the recent deficit reduction
has been the reversal of government spending for the S & L bailouts. Those outlays, which rose
to a peak of $66.1 billion in 1991 as the Resolution Trust Corporation (RTC) acquired assets of
failed depository institutions, shifted to negative outlays of $28 billion in 1993 as these assets were
sold (proceeds from the RTC asset sales are counted as negative spending.) More net asset sales
by the RTC are expected to generate negative outlays of a lesser magnitude in 1994 and 1995.
Excluding deposit insurance, the rise in government spending and deficits from 1988 to 1991, and
the subsequent improvement, were much less dramatic.
The continued decline in defense spending has been another source of deficit reduction. With
the exception of the Gulf War, defense spending has declined continuously since 1989. Its average
annual decline from 1990 to 1993 was slightly less than 1 percent; that pace accelerated to a 4.1
percent decline in 1994. Measured in terms of shares of national resources, these declines have
been even more dramatic: since 1989, defense spending has fallen from 26.6 percent to 19.0 percent
of total federal spending, and from 5.9 percent to 4.2 percent of GDP.
Net interest outlays have stabilized since 1992, as the lower interest rates since 1990 have
temporarily offset the debt service costs of the rising publicly-held debt. However, they will resume
rising in 1995; in fact, virtually all of the upward revision of spending projections in the Administration's Mid-Session Review of the 1995 Budget (July 1994) were due to the impact of the rising
interest rates on net interest outlays.
Meanwhile, spending on domestic programs has continued to soar (see Table 1). From 1990
to 1994, spending on entitlements and other mandatory programs has risen approximately 8.8 percent
annually, even faster than in the 1980s. The fastest growth occurred in Medicaid, which has risen
at a whopping 19.6 percent rate. All means-tested entitlements, including Medicaid, have risen
15.7 percent annually. This reflects in part the early 1990's recession-related increase in welfare
recipients. During this same period, spending on nonmeans-tested entitlements, including social
security, Medicare, and other retirement programs, has grown at a 7.1 percent pace, more than
double the rate of inflation.
Tax revenue growth has accelerated dramatically in 1994, increasing nearly 10 percent. This
surge reflects the tax hikes legislated by Omnibus Budget Reconciliation Act of 1993 (OBRA93)
and a sharp pickup in economic growth and taxable incomes. This compares with the 2.8 percent
average annual rise form 1990 to 1992, and the 5.7 percent increase in 1993.
30
Shadow Open Market Committee
THE CURRENT SERVICES BUDGET OUTLOOK
The deficit is projected to recede substantially in 1995. The Administration projects a deficit
of $167 billion, the lowest level since 1989. It projects 7.4 percent growth in revenues—more than
twice the rate of inflation—and only 2.3 percent growth of spending. Individual income taxes are
projected to rise 8.6 percent, thanks to the tax increases and continued healthy economic growth.
The slow spending growth stems from continued declines in defense spending, net asset sales from
the RTC, and only 0.7 percent rise in spending on nondefense discretionary programs, which assumes
adherence to the OBRA caps. Continued rapid growth in entitlement and other mandatory spending
is anticipated. The Congressional Budget Office is even more optimistic, projecting a deficit of
$162 billion.
Under current law, the budget deficit is projected to level off in 1996 and then increase
throughout the remainder of the decade. Once again, rising spending is the culprit. In recent decades,
revenues have remained in a very narrow range around 18 to 19 percent of GDP. All of the deficit
increase has been attributable to spending rising as a share of GDP. Current services tax revenues
will remain very close to 19 percent of GDP through the 1990s, while spending will be between
21.5 and 22 percent of GDP. Thus spending rises faster than taxes in dollar terms. Beginning in
1999, when the he OBRA caps on discretionary spending expire, current services projections of
deficits rise sharply.
Ironically, the Administration's decision in 1993 to alter the Treasury's debt management
strategy and shorten the duration of government debt—essentially betting that short-term interest
rates would stay low—may prove costly to taxpayers. The Administration has raised its projections
of net interest outlays, and uncertainty about future costs have heightened, particularly as the Federal
Reserve pursues a disinflationary monetary policy.
Based on these projections, structural deficits persist. The CBO's standardized-employment
deficit, which excludes deposit insurance, remains around 2.5 percent of potential GDP and begin
rising late in the decade.
A MORE REALISTIC VIEW
The vastly improved deficit outlook is based on several heroic and unrealistic assumptions
about economic policymaking; first, that the increasingly stringent spending caps on discretionary
spending imposed by OBRA are adhered to, and second, that none of the pending legislation for
31
September 11-12,1994
health care reform, welfare reform, or crime prevention are even enacted, or if health care reform
becomes law, the Administration's projected cost savings, not the CBO's deficit-widening estimates, are correct. So much for rosy budget forecasts.
Beginning in 1994, OBRA imposed a single cap on the three categories of discretionary
spending, i.e., defense, international, and domestic discretionary (from 1991 to 1993, separate caps
applied). Spending for these discretionary programs requires action by Congress's appropriation
committees, in contrast to spending for entitlements that are automatically paid to beneficiaries that
meet certain requirements.
The OBRA spending caps through 1998 become increasingly stringent, and adhering to them
will require increasingly restrictive cutbacks by the appropriation committees. This will generate
increasingly contentious tradeoffs among the programs vying for the shrinking budget resources.
In 1994, the cap was achieved by cuts in defense spending sufficient to offset increases in outlays
for domestic programs. The caps require freezing 1995 outlays at 1994 levels and then reducing
inflation-adjusted outlays by approximately $51 billion by 1998. Many of these domestic discretionary programs, including education, training and social services, transportation, income security,
and natural resources and the environment, are important and visible. The same, of course, is true
of defense. Accordingly, the probability of legislative slippage in adhering to these spending caps
is high. Also at issue is the potential tradeoff between national security needs and the magnitude
of the defense downsizing necessary to achieve budget objectives.
Pending initiatives for health care reform, welfare reform, and crime prevention—all in
various stages of legislative consideration—are potential budget-busters. The cost of a health care
package is highly uncertain; as evidence, the Administration originally projected its proposal would
save $38 billion over 5 years, while the CBO estimated the same proposal would raise the deficit
by $67.8 billion. Since then, leading alternative proposals have emphasized universal coverage
over cost containment. While the Administration supports leading universal coverage alternatives,
its latest budget projections continue to assume the large savings estimated in its earlier optimistic
projections.
The leading health care proposals are all open-ended entitlements that would raise the demand
for medical services and rely on various kinds of market and nonmarket mechanisms to constrain
costs. The cost-containing ability of these mechanisms are at best uncertain, and at worst, ineffective
and economically distorting. While leading proposals may minimize projected effects on the budget
32
Shadow Open Market Committee
deficit, they involve hidden taxes and costs by shifting the burden directly to the private sector.
Importantly, whether or not these costs are reflected in the federal budget, they certainly raise the
costs of business and employment.
The Administration's crime bill, still facing House-Senate reconciliation, would raise
spending an estimated $33 billion over 5 years if enacted. While well-intended—almost everybody
wants lower crime—some of its good provisions are overwhelmed by numerous other provisions
that would (re)institute costly urban programs that have failed in the past. The Administration did
not include the cost of its proposed crime bill in its Mid-Session budget projections. The initiative
to reform welfare programs is still pending, and its potential budgetary impact is uncertain.
GOVERNMENT PURCHASES, TRANSFER PAYMENTS, AND TAXES:
IMPLICATIONS FOR RESOURCE ALLOCATION AND ECONOMIC PERFORMANCE
The mix of government spending and the burden of taxes have both direct and indirect impacts
on the allocation of national resources, with important implications for economic performance.
Government purchases of goods and services, including defense purchases, nondefense purchases
for transportation, infrastructure, natural resources, etc., and state and local purchases for education,
police, etc., directly consume resources, making them unavailable for private consumption. In
contrast, transfer payments do not directly absorb resources, but instead redistribute claims on
resources from taxpayers to beneficiaries. As such, transfer payments, including social security,
Medicare, net interest costs, income security programs, etc., are counted as negative taxes in the
National Income and Product Accounts.
Whereas purchases directly allocate national resources and affect economic performance,
transfer payments have significant indirect economic impacts through their influence on decisions
to work, save, and invest In general, therisingtide of transfers that redistribute income from savers
and investors toward consumption-oriented activities have had a significant and cumulative
depressing affect on long-run potential growth. This trend of taxing and redistributing income
constrains long-run standards of living.
A comparison of two trends, tax receipts minus transfers (net receipts) illustrates the extent
of the ongoing shift in the uses of national resources through the government's budget (see Chart
2). Tax receipts net of transfers have continued their long decline as a share of GDP; while gross
tax revenues have not changed materially as a percent of GDP, transfer payments have continued
to rise rapidly, driven by soaring entitlements and net interest outlays. (The sharp fall of taxes less
33
September 11-12,1994
transfers relative to GDP in the early 1990s reflected in part the temporary surge in RTC's outlays
for deposit insurance). Meanwhile, total government purchases continue to recede, as government
purchases for defense have fallen while spending on domestic discretionary programs (infrastructure, science and technology, transportation, natural resources, etc.) have risen.
The implications of these trends are the following: more than 100 percent of the rise in federal
spending and deficits has been attributable to the rise in transfers, while the government's direct
absorption of private resources has been declining in real terms; taxpayers are receiving fewer and
fewer goods and services from the government for the taxes they pay, while a larger portion of their
taxes are redistributed through transfer programs; and this redistribution reduces national saving
and investment while adding to consumption. Moreover, the increasing reliance on income-based
taxes (personal and corporate income taxes and FICA taxes on wage income) further discourages
saving and investment
The budget process itself reinforces these trends, while enactment of pending legislation
would add significantly to them. Beginning in 1986, the Budget Control Act (Gramm-RudmanHollings) excluded from sequestration social security and other transfer programs, thereby forcing
cuts in the investment-oriented discretionary programs. Amended by OBRA93, higher spending
now is allowed for entitlement programs if they do not raise deficits (pay-as-you-go), while discretionary programs face increasingly stringent, binding caps on spending. These artificial
restrictions reflect and reinforce the deficit bean-counting mentality on federal budgeting that has
resulted in a reduction of resources allocated to investment-oriented activities and the ever-growing
volume of redistributive transfer payments. This hampers the long-run capacity to grow.
Enactment of health care reform, welfare reform or a crime bill would only add to therisein
transfer payments. Either these legislative initiatives add to the deficit or arefinancedby taxes, or
do not show up in the budget because their costs are shifted directly to the private sector through
employer mandated health insurance has no bearing on the general issue of resource allocation or
economic performance. Similarly, higher entitlement spendingfinancedby higher taxes (to comply
with OBRA's pay-as-you-go provision) is not costless just because it does not raise deficits.
These important issues of resource allocation have taken a back seat to the narrow focus on
the budget deficit While Congress is unwilling to address glaring structural flaws in the fastest
growing entitlements, it is more than willing to add expensive and wasteful amendments to pending
legislation to raise the probability of enactment This is not sound fiscal policy, regardless of the
temporary favorable deficit trend.
34
Shadow Open Market Committee
Chart 1
Federal Budget Trends
Federal Spending and Tax ReceiDts
(Percent of GDP. Fiscal Years)
1962
1964
1966
1968
1970
1972
1974
—
1976
1978
Revenues
1980
1982
1984
1986
1988
1990
1992
1994
Outlays
Federal Budget Deficit
(Sum of past 12 Months)
-100
-350
Publicly-Held Debt-to-GDP Ratio
70% r
52
54
56
58
60
62
64
66
68
70
72
74
35
76
78
80
82
84
86
88
90
92
94
September] 1-12, 1994
Table 1
The Mix and Growth of Federal Spending
(Fiscal Years)
1990
1994
1990-1994
Level in Bil $
% of Total
Level in BH $
Discretionary
501.7
40.1
545
37.2
11
202
Domestic
182.5
14.6
244
16.6
7.5
28.7
19.1
1.5
20
1.4
1.2
0.4
Defense
300.1
24.0
280
19.1
-1.7
-9.4
Mandatory
567.4
45.3
794
54.1
8.8
105.7
Social Security
246.5
19.7
317
21.6
6.5
32.9
Medicare
107.4
8.6
158
10.8
10.1
23.6
Medicaid
41.1
3.3
84
5.7
19.6
20.0
59.9
4.8
72
4.9
4.7
5.7
112.5
9.0
163
11.1
9.7
23.6
58.1
4.6
-5
•0.3
•
-29.4
Net Interest
1842
14.7
202
13.8
13
8.3
Offsetting Receipts
•58.8
4.7
•68
-4.6
•3.7
-4.3
12517
100.0
1467
100.0
4.0
100.0
International
% of Total Avo. Annual % Change % Share of $ Change
Other Retirement &
Disability
2
Other
Deposit Insurance
Total
' Estimates for FY 1994are from the Congressional Budget Office, The Economic and Budget Outlook: An Update. August 1994.
Includes food stamps, family support, supplementary security income, veterans pensions, child nutrition, earned income tax
credit, student loans, unemployment compensation, farm price supports, and other programs. Most of the increase in outlays in
this category occurred in the means-tested programs, which jumped from $58.8 Bil. in 1990 to a projected $95 Bil. in 1994. In
addition, unemployment compensation increased by approximately $10 bttlion.
2
36
Shadow Open Market Committee
Chart 2
Government Purchases and Tax Receipts Net of Transfer
Percent of GDP
Total Government
24%
.
,
68
70
—
,
72
74
76
78
,
.
.
80
82
84
Total Government Purchases (Federal and State & Local)
—
r
86
88
90
92
94
92
94
Total Tax Receipts Net of Transfers
Federal Government
68
70
72
—
74
76
Federal Purchases
78
80
82
84
86
88
90
—— Federal Tax Receipts Net of Transfers
37
September 11-12,1994
38
Shadow Open Market Committee
ECONOMIC OUTLOOK
Mickey D. LEVY
Nationsbanc Capital Markets Inc.
The rate of economic growth is beginning to moderate following a period of robust expansion.
Real GDP is projected to expand at an approximate 3.0 percent rate in the second half of 1994 and
2.5-3.0 percent in 1995. Inflation is expected to rise modestly, even as economic growth slows.
The Federal Reserve's recent anti-inflation policy will constrain inflation pressures and limit the
rise in inflation expectations. The structure of the economy remains strong, pointing toward sustained economic expansion, although the government's fiscal and regulatory policies constrain
long-run potential growth.
APPROACHING A MORE TYPICAL EXPANSION
As the expansion has matured, it has become more similar to recent cycles. The economy
recovered slowly from the April 1991 recession trough, as the many structural adjustments in various
sectors, particularly the defense downsizing, inhibited the rate of growth. As a consequence, during
the first two years of rebound, cumulative rises in nominal and real GDP, employment, and real
disposable income were anemic relative to recent recoveries.
The expansion accelerated in mid-1993. Real GDP grew 4 percent from second quarter 1993
to second quarter 1994, and many key measures of economic performance are starting to catch up
with the patterns of recent expansions. Although the expansion is now in its fourth year, its characteristics in the last year have been similar to the early stages of recent recoveries. From second
quarter 1993 to second quarter 1994, real domestic demand grew 4.8 percent Consumption growth
of 3.5 percent exceeded the 2.8 percent growth of real disposable income, suppressing the rate of
personal saving below 4.0 percent Business investment advanced robustly (13.2 percent), particularly in information processing equipment The net export sector has deteriorated and subtracted
0.8 percent from domestic production, as imports of consumer and producer goods have soared
with the stronger economic growth.
Analogous to the early stages of recent recoveries, a cyclical jump in productivity suppressed
unit labor costs. In the year ending first quarter 1994, productivity in the nonfarm sector jumped
39
September 11-12, 1994
3.1 percent, compared to its 1.0 percent average annual rise in the 1980s. While compensation
increases have leveled off about 3.0 percent, unit labor costs actually declined in the second half
of 1993 and have increased only 0.7 percent year-over-year.
These developments have contributed to receding inflation and building corporate profits and
cash flows. Through Spring 1994, all broad measures of inflation—the CPI, PPI, and GDP deflator
—receded gradually; since then, they have begun to tilt up modestly. The widening margins and
rising product demand have lifted after-tax operating profits 14.8 percent in that last year.
Since Fall 1993, interest rates have also behaved similarly to recent early-recovery spurts in
real economic growth, as the yield curve hasflattenedmodestly with short-term rates rising faster
than long-term rates.
Employment has also played catch-up. Whereas the economic rebound through 1993 was
attributable primarily to productivity gains, job growth has jumped significantly in 1994 while
productivity growth has slowed. So far this year, monthly payroll increases have averaged 269,000
compared to 160,000 in 1993, and the unemployment rate has fallen to 6.1 percent from 6.7 percent
a year ago.
DISTINGUISHING CHARACTERISTICS
Several characteristics distinguish this expansion from previous ones, and these distinctions
hold the key to future economic performance. The government's fiscal policy has remained
restrictive, in sharp contrast to the stimulative fiscal thrust in all recent recoveries. Taxes were
raised substantially in 1990 and gain in 1993, the latter pushing maximum marginal tax rates above
40 percent The federal defense downsizing has generated reductions in real government purchases.
These trends have significantly reduced the cyclically-adjusted budget deficit
Another general characteristic of this cycle has been the many noncyclical adjustments,
beginning well before the recession, that have affected the growth and mix of output during the
recovery. More accentuated than in recent cycles, these adjustments made the recession seem more
severe than aggregate statistics indicate, and clearly have inhibited the gains during the subsequent
expansion.
Reflecting these factors, the rebound of nominal GDP has been significantly slower than in
previous cycles. During the first two years of recovery, nominal GDP grew 5.2 percent annually,
in contrast to an average of 9.6 percent in recent cycles. In the last year, nominal GDP has accelerated
40
Shadow Open Market Committee
to 6.1 percent growth. At the same time, increases in the GDP deflator have fallen slightly. This
change in the mix of nominal GDP between real output and inflation has contributed significantly
to the recent period of strong economic growth.
One may also argue that the Federal Reserve's move to a tighter monetary policy has been
more timely than in previous cycles, when delayed responses to accelerating nominal spending and
price pressure allowed inflation to rise significantly. Just as the Fed has tended to ease for too long
in expansions, it has invariably followed such periods with overly tight policy, generating recession.
While the Fed has tightened aggressively so far in 1994, this followed an overly accommodative
stance in 1992-1993. Nevertheless, the Fed now seems committed to lower inflation, has become
more aware of the costs of its past mistakes, and has taken appropriate steps to limit any rise in
inflation.
THE OUTLOOK FOR ECONOMIC PERFORMANCE AND INFLATION
The pace of domestic demand growth is projected to moderate toward year-end and throughout
1995. The factors underlying this slowdown are the building impact of the monetary tightening
and higher interest rates, the higher taxes and restrictive fiscal policies, and the general maturing
of the expansion that will bring growth toward its long-run trend.
The Fed's shift toward monetary restrictiveness is clear in the trend of bank reserves and the
narrow monetary aggregates. Bank reserves have declined since February and are now at the same
level as October 1993. This follows two years of 16.6 percent average annualized growth. Ml
growth has slowed similarly, expanding at a 3.0 percent pace since February, while its year-over-year
growth has fallen to half of its previous 12 percent rate. The slowdown in the monetary base has
been much more modest—it has continued to grow at a 7.5 percent rate—reflecting the persistently
rising demand for currency from abroad. Meanwhile, M2 growth has remained very modest, less
than 2.0 percent in the last year, and has been decelerating gradually. Associated with this monetary
slowdown has been a significant rise in short-term interest rates and a flattening of the yield curve,
both symptoms of monetary tightening.
The timing of this monetary restrictiveness on domestic demand is uncertain in part due to
the excess liquidity that has been provided previously. Moreover, bank reserves and Ml have been
suppressed by the sharp reduction in mortgage refinancing that has accompanied the change in the
Fed's posture. At issue is the extent to which the sharp declines in income velocities when the Fed
was easing in 1992-1993 will be retraced as the Fed tightens and short-term interest rates rise.
41
September!1-12, 1994
Clearly, however, the shift toward monetary restrictiveness has had a telling financial market
response, with a marked shift in the level and term structure of rates and a reallocation of assets
among different asset classes. This suggests that some impact on aggregate demand and output is
to follow.
To date, the impact of the sizable tax increases on income and capital, as well as the ongoing
defense downsizing, has been overwhelmed by the tailwinds of monetary ease. As the monetary
restrictiveness absorbs the excess liquidity, the higher taxes may begin to bite into economic activity.
In fact, selected evidence of slower economic growth has begun to merge, although it is
measured against the earlier unsustainable spurt of activity. Consumption growth has slowed since
the Spring. In particular, automotive sales have receded, although some of this decline has been
the result of insufficient inventories. Department store sales have weakened modestly. Surveys of
consumer confidence have drifted lower from their peaks, although they remain high. Housing
activity is firm, but slightly below Spring levels. Only business investment has continued to rise
robustly. As a result, domestic final sales have slowed to a 1.4 percent growth rate in second quarter
1994 from 6.5 percent in fourth quarter 1993. They are projected to reaccelerate through most of
the remainder of this year, averaging 3.0-3.5 percent, and grow approximately 2.5-3.0 percent in
1995.
The deteriorating trade deficit is expected to stabilize toward year-end and improve in 1995,
adding to GDP growth. Import growth is projected to decelerate in response to slower domestic
demand growth and the higher relative cost of imports (import prices rose about 10 percent annualized in second quarter 1994, and prices of nonpetroleum imports are beginning to pick up). Exports
are expected to accelerate in 1995 from their already rapid pace (real exports grew 7.1 percent in
the last year), benefiting from economic recovery in Europe and Japan.
Inflation is projected to increase modestly, even as real economic growth slows. Through
1995, the CPI is projected to accelerate gradually to approximately 3.5-3.75 percent from its current
year-over-year pace of 2.8 percent, while the GDP deflator should tend toward 3.0 percent from its
present 2.0 percent rate.
To date, several factors have kept inflation low. First, inflation is caused by the excess of
nominal spending over productive capacity, not by strong economic growth. Rapid increases in
business investment have expanded industrial capacity, while the modest acceleration of product
42
Shadow Open Market Committee
demand and nominal GDP has constrained the ability of business to raise prices. Accelerating price
increases have been limited to selected products in strong demand but these have been offset by
slower price increases or outright decline for products in weak demand.
Secondly, strong increases in productivity have offset wage increases to constrain unit labor
costs, and labor markets are only selectively tight. Thirdly, on average, increases in nonwage costs
of production have remained low as decelerating increases in nonwage compensation (including
health and pension benefits) have offset accelerating prices of certain commodities and industrial
materials.
But now inflation is tilting modesdy upward. Unit labor costs are rising as employment and
aggregate hours worked jump and productivity gains abate. In recent months, producer prices have
accelerated at both the intermediate and finished goods levels The recent acceleration in GDP and
product demand will allow price increases across a broader array of consumer goods and services.
In recent cycles, as expansions have matured, the inflation portion of nominal GDP has risen
gradually while real growth has tended toward its long-term trendline. Nominal GDP growth of
5.5-6.0 percent in 1995—a modest slowdown from its recent trend—would generate a rise in the
GDP deflator to approximately 3.0 percent while real growth slows to about 2.75 percent. More
rapid nominal spending growth would strain industrial and labor capacity and push inflation higher.
However, the Fed's recent monetary tightening limits any sustained acceleration of aggregate
demand.
THE OUTLOOK FOR INTEREST RATES
Short-term interest rates have risen to reflect the acceleration in economic growth and the
associated monetary tightening. The Fed's two recent half-point hikes in the funds rate have
increased its inflation-fighting credibility andflattenedthe yield curve. Thus, a higher portion of
interest reflects expected real return and a smaller portion reflects expectations of inflation and
other risks. Whereas most of the curveflatteningthrough July occurred in maturities beyond 5
years, the Fed's half-point more inraid-Augustgenerated a substantial flattening in the shorter
maturities (up to 2 years).
This terra structureflatteningand the failure of bond yields torisemore significantly, despite
the earlier erratic decline in the U.S. dollar, clearly signals the heightened credibility of the Fed.
This sets a positive tone forfinancialmarkets, limiting the negative impact of inflation pressures.
43
September 11-12, 1994
However, the Fed is expected to raise the funds rate further, to around 5.25-5.5 percent, as it continues
to constrain inflation. As long as economic growth remains strong, further curve flattening is likely
to occur primarily by short-rate rising.
The present 7.7 percent yield on the long Treasury bond embodies either expectations of
stronger potential economic growth or risk of a significant rise in inflation. The former seems
unlikely in light of the thrust of fiscal policy, which discourages saving and investment and constrains
potential capacity. As the Fed continues to pursue a low inflation objective and economic growth
moderates to its long-term trendline, a further curve flattening will occur as bond yields recede
towards 7.0 percent. However, this may not occur until 1995, as bond yields remain around 7.5-7.75
percent as they digest modestly higher inflation.
SUSTAINABILITY OF THE EXPANSION
The structure of the economy is solid and points toward sustained expansion, although risks
exist Inflation remains low and the Fed's monetary policy is expected to limit inflation pressures.
The significant restructuring of business finances and production processes has eliminated many
of the potentially disruptive excesses in the economy. Debt burdens have been lowered. Unit labor
costs have been reduced below inflation, generating strong profits and cash flows that provide a
base for permanent job gains. Rapid business investment has raised capacity, while inventories are
low relative to sales and output Household balance sheets are vastly improved, as more than half
of the 1980's sharp rise in debt burden has been retraced. The defense downsizing is well underway,
and its primary impact will be regional and sectoral, and not threatening to the overall expansion.
U.S. unit labor costs are at or below those of other industrialized nations, and exports continue to
rise, even as major trading partners struggle to recover from recession. Exports are receiving an
additional boost from NAFTA and should continue to strengthen with overseas economies, shrinking
the trade and current account deficits.
There are no immediate threats to expansion. Given past Fed patterns, the risk of excessive
monetary tightening is of some concern. The Fed may target the funds rate too high and in doing
so drain real money balances over a sustained period, in an overzealous attempt to slow real growth,
maintain its inflation-fighting credibility, or stem a disorderly decline in the U.S. dollar. Responding
to the dollar would be particularly bothersome insofar as the recent fall in the currency, amid
monetary tightening and a flattening yield curve, seems clearly to be a nonmonetary phenomenon.
While the Fed's funds rate targeting is a recipe for monetary policy excesses and recent money
growth has slowed sharply, the previous accommodative policy provides a cushion.
44
Shadow Open Market Committee
The recent thrust of fiscal policy—tax increases, cuts in defense purchases, an ongoing
reallocation of spending toward consumption-oriented entitlements and away from investmentoriented activity, as well as the systematic tax bias against saving—has not unhinged the recovery
and is unlikely to do so. It does, however, reduce long-run potential growth. Similarly, enactment
of potentially costly pending legislation for health care reform, the crime bill, or welfare reform,
may change the mix of output, but its short-term impact on economic growth would likely be minor
relative to its cumulative impact on long-run potential output.
45
Senior Vice President
Chief Financial Economist
September 11-12, 1994
NationsBank
NationsBanc Capital Markets. Inc.
7 Hanover Square - 15th Floor
New York. NY 10004-2616
Tel 212 858-5545
Fax 212 858-5741
ECONOMIC AND FINANCIAL PERSPECTIVES
MICKEY D. LEVY
CHIEF FINANCIAL ECONOMIST
NATIONSBANC CAPITAL MARKETS, INC.
SHADOW OPEN MARKET COMMITTEE
WASHINGTON, D.C.
SEPTEMBER
12,1994
46
A subsidiary of NationsBank Corporation
Shadow Open Market Committee
p.
S
QUARTERLY DATA
1 Nominal GDP
GDP
Domestic Demand
Final Sales
Domestic Final Sales
Disposable Personal Income
I Residential Investment
9 Business investment
1 Inventory Investment
| Government Purchases
1 Exports
| Imports
I Current Account
| GOP Deflator
I Employment Costs (Private)
| Unit Labor Costs (Non-Farm)
1 Productivity (Non-Farm)
1 Compensation (Non-Farm)
8 Corporate Profits ATT
I Operating Profits A/T
1 Net Cash Row
I
I 1993
111
1 6359.2
J 5139.4
1 5225.8
1 5126.5
1 5212.8
1 3708.4
1
1
1
1
I
1
(ci
J
1
1
1
1
(al
(al
(al
^
211.0
597.9
13.0
931.8
595.3
681.6
-27.9
123.7
118.9
137.7
115.8
159.4
288.9
323.6
540.6
N
A
Levels
1994
1
rv
6478.1
6574.7
5261.1
5218.0
5365.1
53005
5235.7
52075
5339.7
5289.4
37795
3747.8
3546.3
229.9
224.5
6275
643.6
25.4
10.8
919.9
931.5
619.6
6255
723.6
707.4
-31.9
-30.6
124.1
125.0
120.7
119.9
137.9
136.9
118.0
1175
162.8
160.4
299.4
3105
324.1
342.4
565.5
5725
levek
S
P
H
O
[
T
I
Quarterly % Change (annualized)
1994
1993
II
1
II
• l 111
IV
6685.5
6.9% I
6.1%
3.8%
7.7%
3.8%
3.3%
2.7%
53105
6.3%
4.4%
5.0%
5423.1
5.8%
4.0%
1.4%
5253.9
6.4%
35%
25%
5366.7
3.9%
2.0%
4.5%
6.0%
3.4%
0.8%
3804.7
2.7%
4.3%
1.4%
4.7%
4.0%
3.9%
3558.6
7.3%
10.0%
9.4% 285%
234.0
10.9%
657.9
125% 21.1%
9.2%
N/A
N/A
N/A
56.3
N/A
-4.9%
-1.6%
-0.1%
916.3
1.1%
15.8%
-3.5%
-3.2% 21.7%
642.7
9.5% 18.9%
7.4% 16.0%
755.6
-2.7
NA
NA
-1.3
-2.3
1.3%
1.0%
2.9%
2.9%
125.9
3.7%
2.7%
3.4%
3.4%
121.8
139.1
3.5%
3.0%
-2.3%
-15%
-2.7%
2.8%
4.9%
4.3%
1175
0.7%
6.1%
2.5%
2.8%
163.1
7.4%
-3.5%
7.4%
1.4%
321.6
6.7%
-5.3%
5.8%
7.4%
345.9
1.2%
4.6%
582.5 I 2.9%
1.8% I
Monftfy% Change
fI
Yr-to-Yr% Change
1994
1993
111
5.2%
3.0%
3.9%
2.8%
3.8%
2.0%
3.4%
7.2%
12.6%
N/A
-0.7%
2.5%
10.0%
-9.2
2.1%
3.7%
13%
1.7%
3.0%
23.0%
35.6%
12.2%
IV
1
5.0%
5.4%
3.1%
3.7%
3.9%
4.5%
3.0%
3.5%
3.9%
4.4%
0.5%
33%
3.0%
3.8%
8.1%
93%
16.0% 14.9%
N/A
N/A
-1.0%
-0.7%
5.8%
55%
12.4% 11.9%
-65
-12.1
1.8%
1.7%
3.6%
3.3%
0.6%
0.3%
1.9%
3.1%
2.5%
3.4%
17.1%
9.7%
20.6% 14.6%
13.9% 12.6%
12 Month% Change
_n
1
6.1% |
4.0%
4.8%
3.3%
4.1% I
2.8%
3.5%
13.4%
135%
N/A
-1.4%
7.1%
12.8%
NA
2.0%
33%
0.7%
i
|
I
I
I
[
2.3% I
3.0%
12.9%
14.8%
10.9%
|
I
I
I
j
MONTHLY DATA
Jut-94 Aup>94 May-94
Jun-94
May-94
1
0.0%
57.8
57.7
57.5
565
(bi 112.951 113.334 113.585 113.764
252
18.077
2
6.1
1 Unemployment Rate
(ci
6.1
6.0
6.0
-0.4
0.3%
34.5
34.7
34.6
34.8
1 Average Workweek (sa)
1
11.11
11.08
11.09
1 Avg. Hourly Earnings (sa)
0.4%
11.13
-3.4
NA
13.7
14.4
14.6
1 Total Vehicle Sales, ind. LL Trucks!
7.1
1 Domestic Unit Auto Sales
6.5
7.4 ! -4.1%
6.9
1 Industrial Production
0.3%
NA
116.9
116.3
1175
0.0%
NA
83.9
83.9
83.7
1 Capacity Utilization
120.6
120.4
119.9
05%
1215
PPI
0.4%
137.1
137.1
1 PPI Ex. Food & Energy
1375
1375
148.1
NA
148.6
147.7
05%
CPI
156.3
1 CPI Ex. Food & Energy
157.0
03%
NA
156.7
183.4
1 Retail Sales
-0.0%
NA
184.8
184.9
1 Housing Starts
NA
1415
1.4%
1351
1491
-1.7%
NA
1357
1 Permits
1337
1316
1 Federal Budget Surplus/Deficit (dl
4.9
NA
14.9
-335
-32.1
1.4%
NA
144.8
149.4
j Durable Goods Orders
1515
0.8%
NA
1 Manufacturing Orders
2733
279.8
! 277.4
0.4%
NA
5692.9
1 Personal Income ($87)
5663.0
5655.7
0.3%
NA
3562.8
3570.1
3558.7
1 Consumption ($87)
NA
NA
1 Personal Saving Rate
(c)
0.0
4.0
3.9
0.1%
NA
101.5
101.5
101J
1 Leading Economic Indicators
15%
NA
NA
889.8
8855
1 Total Business inventories
0.01
NA
NA
1.41
1.41
1 Inventory/Total Sales
(c]
-1.0
NA
NA
-9.4
-9.5
1 International Trade
JcJ
047~
4.61
4.50
459
1 3 Month Bill
(cj
435"
0.42
6.18
6.13
5.93
5.97
I 2 Year Note
(c]
754
7.30
051
7.10
7.18
1 10 Year Note
(c]
0.14
7.49
7.58
7.40
7.41
1 30 Year Bond
(c)
1.3%
3797.5
3718.3
3737.6
3708.0
1 DJIA
0.8%
46454
451.40
454.83
450.90
1 SAP 500
-1.7%
8956
89.06
91.60
92.79
1 U.S. Dollar (FRB)
0.3%
100
98
103
104
I Yen/$
1.56
-2.5%
1.57
1.63
1.66
1 DM5
NA
05%
1153.7
1146.4
1142.9
I M1
0.1%
NA
3601.9
3587.9
35955
1 M2
-0.7%
59819
59532
59708
59910
1 Bank Reserves
1 C*l Loans & Non-Financial CP
I Consumer Credit
I K H L ^| 8 4 9 £ B ^8553
NJ^J ^ J L ^
(a) Quarterly % changes are not annualized
(b) Monthly changes are in levels
(c) AW changes are in levels or basis points
(d) Monthly: change from same month last yean Annual: sum of past 12 months
1 Purchasing Managers Index
1 Non-Farm Payrolls
1
1
Mickey D. Levy, Chief Financial Economist (212) 858-5545
Jun-94
-0.3%
383
35
0.0
-0.6%
-0.1%
-1.3
-2.9%
0.5%
05%
0.4%
-0.1%
0.3%
0.3%
0.8%
-9.4%
-3.0%
3.8
15%
0.8%
0.1%
0.3%
0.1
05%
0.5%
0.00
0.1
-0.01
-0.04
-0.08
-0.01
0.8%
0.9%
-1.3%
-15%
-1.8%
0.3%
-05%
-03%
13%^
Jul-94 Auq-94 May-94
-2.8%
0.5%
13.6%
2.4%
179
251
-0.1%
1
32
0.1
0.0
-0.9
03%
-0.6%
0.3%
03%
05% I 2.6%
NA
-5.0
23
2.7%
14.8%
-65%
5.7%
NA
03%
3.3%
NA
0.0%
05%
0.5%
05%
0.4%
0.1%
0.0%
2.4%
NA
03%
2.8%
NA
05%
6.6%
NA
-0.1%
20.1%
NA
4.7%
21.9%
NA
1.6%
-2083
NA
6.4
17.8%
NA
-4.3%
NA I 11.7%
-23%
55%
NA
0.5%
3.5%
NA
-05%
-0.7
NA
NA
33%
NA
0.0%
3.5%
NA
NA
-0.04
NA
NA
-4519
NA
NA
158"
0.11
051
1.99
0.05
050
1.14
-0.06
050
0.49
-0.09
0.18
6.6%
2.1%
-0.5%
1.3%
2.8%
-0.8%
2.8%
05%
-2.8%
-6.0%
1.5%
-4.0%
3.1%
-3.7%
-05%
7.0%
NA
0.6%
2.1%
NA
0.4%
5.6%
-0.5%
05%
Jun-94
17.8%
2.7%
0.3%
•0.9
0.6%
2.5%
4.4
1.9%
5.9%
3.5%
0.8%
0.6%
2.6%
2.9%
7.3%
9.1%
17.3%
-204.5
14.3%
9.5%
5.6%
3.4%
-0.1
3.5%
3.9%
-0.04
-1716
1.12
1.77
1.14
0.59
6.4%
1.5%
-05%
-4.5%
-1.7%
6.5%
1.7%
4.7%
Jul-94:
16.8%
2.7%
0.4%
-0.7
0.6%
2.7%
-0.0
-1.7%
5.7%
35%
15%
0.5%
2.8%
2.9%
6.6%
13.7%
14.4%
-1985
12.6%
9.1%
6.3%
2.9%
NA
3.7%
NA
NA
NA
138
2.06
1.49
0.95
5.4%
0.9%
-5.8%
-8.6%
-8.6%
65%
1.9%
3.9%
Auq-94 '
13.8%
2.8%
0.7%
-0.6
-03%
2.5%
NA
10.1%
NA
NA
2.1%
1.9%
NA
NA
NA
NA
NA
NA
NA
NA
NA
NA
NA
NA
NA
NA
NA
1.49
2.18
1.56
1.17
5.6%
25%
-5.4%
-3.7%
-7.7%
NA
NA
2.6%
^ T J ^ M M L 1MM-L mvsm± 1 2 5 ^ ^ * J A
09AWW
47
Peter E. Kretzmer, Economist (212) 858-5
09/06/94
September J1-12, 1994
Chart 1
Selected Indicators: Employment and Earnings
Non-Farm Payroll Employment
Manufacturing Jobs
2%
20000
V
19500
0%
|
o
|
19000
__Y_*tJ
/ ^
o
-2% "§
i
§ 18500 -
i
©
3
"i
-4%
18000 h
89
90
91
92
93
94
17500
95
— Total Nonfarm Estab.: All Employees (Sa, Thous)
— Year/Year
; uninini IIIUIIIII iiiiniiiiiii,ii " • " " • "
89
90
91
i
•
i
i
i
i
90
91
92
93
94
89
95
90
-
©
! •
/Ar^
l/V M i
4.5%
0.64
4.0%
-~- H
i
0.62
! i
10.50
l^-VV i
- 1 10.00
9.50
9.00
\\^j^
I
I
I
I
I t
i
1
:
I
l,..i^Lt.....lMi.iiiMii.iiiiiinilniinininiii.iiiifii
89
90
91
92
3.5%
_ 0.60
i
M 3.0%
I IVArtfV
93
t
1
2.5%
2.0%
i j
IIHIUIIIII i
94
1.5%
95
j
1
i
1
1
91
92
93
94
95
0.54
,
1
1 1 1
1
1
1
h I ! 1i ! ! ' A
1 , j j i • | !y 1
i
0.58
0.56
p
/i
!V!\f!
11 . M '
•
Vi
!
!
!
/•
j
1
I
]
i
i
\\\\ 1
! i 11 !
70 72 74 76 78 80 82 84 86 88 90 92 94
— Total Private Nonfarm Establishments: Avg. Hourly Earnings
—Year/Year
NationsBanc Capital Markets, Inc.
;
Employment/Population Ratio
11.50 ,
i
j
— Civilian Labor Force: Unemployment Rate, (SA, w/break)
Average Hourly Eamings
I Y\i\. A !
/
r\ \^v
" ""
i i 11 n n m i i 11111 n i i i n 1111 11 n 111111 n 11 n n 1111,
"
— Manufacturing Average Weekly Hours (NSA)
11.00
-6%
95
ys
i l l
i i i n i i t m m i i t n n i m m i n n n i l t m m n i i t i m i m t i i l . n i i n i i . i l
89
94
Unemployment Rate
I i
'
93
- Manufacturing: All Employees, (SA, Thous)
— Year/Year
Average Workweek in Manufacturing
39
92
r• • " " • • " ' u n n m n
|
— Civilian Labor Force: Employment Ratio (SA, w/break)
48
09/08/S4
Shadow Open Market Committee
Chart 2
Selected Indicators: Income and Profits
Real Disposable Personal Income
89
90
91
92
93
94
Real Per Capita Income
95
89
90
91
92
— Real Disposable Personal Income, ($87)
— Real Per Capita Income, ($87)
— Year/Year
— Year/Year
Personal Saving
The Mix of Profits
60
&
40
c
O 20
c
J£
Q\
PV$c\£
^SXI
T ^ j . A.
a
S
^
^
£ -20
'^
-40
89
90
91
92
93
94
— Personal Saving Rate (%)
90
— Domestic
1
I I I
t
91
— i
i
92
—Non-Financial
i
i
»
.
A.
k
cf
500
I 450
400 h
\KJ
\ *
350 F
\\y
89
i i i
90
£• W
1i i i
91
,
92
i, i
f
1 130
20
f
i .„ 1,
93
c
CO
JZ
o
10
1
8
Q.
i i i L,, • i i 1
94
-10
95
- Corporate Profits with IVA & CCaadj ($BH)
— Undistributed Corporate Profits
— Year/Year
—Year/Year
NationsBanc Capital Markets. Inc.
49
94
i
»
i
l
95
^ Rest of the World
40
600
550
1 > i .
93
Undistributed Corporate Profits
Corporate Profits
300
—1
89
09/08/94
September 11-12, 1994
Chart 3
Indicators of Production
Industrial Production
Industrial Production: Durable & Non-Durables
120
8
115 _
/ v r^J
/
105
/v/
y
f v
*\
S 110
r~
\
. / \
£y i ^
V*\ /
v
^
r
6
f
lllllllllll
89
milium
90
Z
0)
0 £
^r
8 0%
a.
-2
w
^
-5%
iniiiiini
92
liiiiiiiiii
93
iiuitinii
94
-10%
-6
95
M
s;<H
V-»
/
\^\» _ ^
^y
\~^.
•*x~
/
•
V"
-4
IIIIIIIHHI
91
5%
4
V
100
10%
iiiiiinin iniiiiini iiiiiiiiin iiiimiiii iniiiiini iiiiiiiiin
89
90
— Industrial Production Index (SA, 1987 = 100)
—Year/Year
91
92
93
94
95
— Durable Goods, (SA, 1987)
— Non-Durable Goods, (SA, 1987)
NAPM - Composite Index
Capacity Utilization
95
90
I85
I
Q- 80
75
AN
I /f U U n j i
II I H I I M I I I I I I
H
\\\\ \ \ A v\ M
70 72 74 76 78 80 82 84 86 88 90 92 94
70 72 74 76 78 80 82 84 86 88 90 92 94
— Capacity Utilization: Total Industry
—NAPM, Composite Index
Aggregate Hours Worked
Durable Goods Orders
20%
89
90
91
92
93
94
89
95
NationsBanc Capital Markets. Inc.
91
92
93
— Nonfarm Business Sector —Year/Year
— New Orders, Durable Goods Industries
90
50
94
Shadow Open Market Committee
09/08/94
Chart 4
Selected Indicators: Consumption
Real Consumption
Consumer Confidence Index
3600
6%
A
J
k/
vu
VV\y
2 3400
I 3300
3200
90
91
92
% ta
£7o
>
O
il
(0
<D
0% >
uiuumi munuu
I1III1U.UJL l l l U M l l l l l , l u i U M U I I
.1JIIIIII.H1
89
4
" 11
tJ
3100
w
JA
vS is
93
94
-2%
95
89
— Total Personal Consumption Expenditures, (82, $Mil)
—Year/Year
I 1850 ph
V /y
\
1 1800
/ ^ /
1750
1700
, i „i
89
i—
i l l
90
<f
V
1
91
1
yw
3% !5
*•»
» i i
i
I
93
94
W
** 180 L
A
milium
140
89
95
/
h
^yy
J-
160
0%
1
92
i-
I 200
2% $
i i i
iMiiiniti
90
r
_ ^
92
93
(0
o
>
5%
o
$
0% >-
liinnniij. iininmii
I I I 11 l l l l I H
91
10%
94
-5%
95
12
550
500
/
450
5 400
rpvv L
\\\ A
300
250
v/ p
yvl
Nr
Retail Auto Sales
Light Truck Sales
350
ir-*\
—Furniture & Household Appliances - Personal Consump ($87)
—Year/Year
— PCE: Services ($87) — Year/Year
—I
95
15%
g 220 h
I
1 % >•
i
94
260
240
*
•
93
<*-"•
Ay
L
92
Real Consumption of Furniture & Household
Appliances
4%
1900
91
— Consumer Confidence Index, SA
Real Personal Consumption Expenditures
Services
1950
90
ver-
3500
l
luilliillll
89
K
y
J-W
^L
\..J
11
\
g 10
1
91
92
93
94
J
•
I I 11 I I I I I 11 l I I I I I I I 11 I 11 11 n I • I I • I • i I I I I I I i I m
89
95
90
91
92
93
i I i I n I I ll I I I 1 1 I I I I 1 I I I I I
94
95
—Total-Domestic and Imported Retail Unit Auto Sales, SA (Mil.)
51
NattonaBanc Capital Martcata. Inc.
tyVNWl/
8
- Domestic Unit Truck Sales - Light 0-10,000 lbs.. GVW
9
/ ^
l i i i M i i n u i i i i m i u i i i i i i i i n i i I i n ii m m i m i i i i i i i i l
90
fcrK
o
^>
09/09/94
Chart 4A
The Current Expansion in Perspective
Real GDP
Nominal GOP
Q1
Q2
Q3
04
Q5
Q6
Q7
Q8
Q9
Q10
Q11
Q12
Q1
Q13
Q2
Q3
Q4
Q5
1
r
Q6
Q7
Q8
Q9
Q10
Q11
Q12
Q13
,
•
Q12
Q13
Quarter of Expansion
Quarter of Expansion
m Average of Four Previous Expansions *» Current Expansion
Average of Four Previous Expansions • • Current Expansion
ft.
Real Disposable Income
Employment
20
1
—L^f
i
16
10
CD
>k
Q1
Q2
Q3
Q4
Q5
Q6
Q7
Q8
Q9
Q10
Quarter of Expansion
r
Average of Four Previous Expansions - • Current Expansion
NationsBanc Capital Markets, inc.
Q11
Q12
Q13
Q1
Q2
Q3
Q4
Q5
Q6
Q7
Q6
Q9
Q10
Q11
Quarter of Expansion
\ Average of Four Previous Expansions + Current Expansion
Mickey D. Levy, Chief Financial Economist
Shadow Open Market Committee
Chart 5
Compensation, Productivity and Unit Labor Costs
Compensation
12%
10%
2 8%
6%
to
CC
4%
2%
70
71 72 73 74 75 76 77 78 79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94
—
95
Labor Compensation Per Hour. Nonfarm Business Sector, Year/Year
Productivity
10%
i
8%
©
•
6%
:
2 AOL I
to 4%
§ 2%
o
B 0%
i
i
i
!
'•
i
I S\
1 f \
i
'
\
i
'
A
t^/K
M
i 1111 i i 111 11111 i
1
!
i i i .
!
I
'
i
1
j
i
1
1
•.:''•
;
y \ i x~ j
;
\i \y
\
s
!
j
i
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<
i /\
i l l
. yT
rvJL*i A
;\
i i
1 W i
.
1
1
!
'
1
!
1
I I
'
1
i
^
i !
i
'
;
1 1 1 1 1 1 1 1 1 1 1 1
90
70 71 72 73 74 75 76 77 78 79 80 81 82 83 84 85 86 87 88
-6%
1
|
A!
iy^^i
i
l
k\\ / H ^ W \[/"i^^R J^y'
I^VAI
I
j
!
j
i r ft A / I vy- i
— J
^r\
~i
.
i
7M
rm
,
i i M
I
•
!
*
1 '•/ i1 i! ii \\
-2%
-4%
•
' f\4r K
to
*
I
91 92 93 94
—
Manufacturing Sector Output Per Hour of An Persons (SA, 1987=100) Year/Year
—
Nonfarm Business Sector Output Per Hour of All Persons (SA, 1987=100) Year/Year
95
Unit Labor Cost Inflation
20%
j
15%
i
10%
*
5%
'
I
f
! 'i /
\
i
i \
j /
1
1
•
-5% r
I
i
!
^^^f
1 7
'
O
3 o%
-10%
!
I
\
1
!
I
i . i i i t i i i„j.i
|
: ! i
!
: i
A
'
'
!
1
i
i
i i i n
i
ii i i i i t 1 ii i
M I
i 1 i
l
l
;
-
• !
i
'
\/3f\
!
i ! ! 1!
i1
!
|
ij i Yk<
„ • i1
V; \
p4y /
w~t^K7M
^ V7r\l
i
!
:
!
i ~
1
1 L.L..I
!
i
i
'
1
u
!•••!... I
^
!
IT
'
.,;„.!.J...
70 71 72 73 74 75 76 77 78 79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94
NattomBanc Capital Marfcats, Inc.
—
Manufacturing Sector Unit Labor Costs (SA, 1987=100) Year/Year
—
Nonfarm Business Sector Unit Labor Cost (SA, 1987=100) Year/Year
53
i
1
i
Ij
95
09/06/94
September! 1-12, J994
Chart 6
Selected Indicators of Inflation
Consumer Price Index
Producer Price Index
8%
©
|
o
^
A
6%
'!
£ M l\
4%
(0
^
i 2%
©
>
o
\
is o% |
2%
89
90
91
92
93
94
*
\ /
1
|
lllllllllllllllll
89
95
J
90
- CPI-U, All items (SA)
— CPI-U, All items ex. food & energy (SA)
V-*^/7
I
"" "
I l l l l l ,u
91
u •utn ii n u n i m i n t i i i i n i i i i i i —
92
93
94
95
- PPI-U, All items (SA)
- PPI-U, All items ex. food & energy (SA)
GDP Deflators
Employment Costs
5%
©
c
4%
O
§ 3%
©
89
1%
89
90
91
92
93
94
95
90
80
20%
?
I
70
o
60
s
50
>-
s
i
40 I
30
91
92
93
94
»
94
1
95
1
1\:
^\
1
\ J \
i VJK \
i ii I I m m
89
95
• CRB Spot Market Index
— CRB Futures Price Index
- JOC Industrial Price Index
NattonsBanc Capital Markets, Inc.
93
NAPM: Survey of Prices
Commodity Prices
90
92
- Compensation. Pvt Industry — Wages. Pvt Industry
r Benefits. Pvt Industry
- GDP Fixed Weight Deflator -.GDP Implicit Deflator
89
91
-A
r v
91
r
fvj
V
i
i
1 :
i
i
i u m i t A H n u n ii n i t I I m n m m
90
r
'
92
l u i i i i i n 11
93
i niniiiu 1
94
— NAPM Survey-Diffusion Index. Prices. SA, (%)
54
95
Shadow Open Market Committee
Table 1
Federal Reserve Objectives and Monetary Policy
Federal Reserve Objectives a n d Actual Performance
Selected Economic Variables, Percent Change
Real GDP
CPI Inflation
Nominal GDP
Central Tendency Forecasts
Q4s93 - Q 4 : 9 4
Q4s94 - Q4r95
Feb* Forecast
July Forecast
July Forecast
3% - 3.25%
3% - 3.25%
2.5% - 2.75%
about 3%
2.75% - 3%
2.75% - 3.5%
5.5% - 6%
5.5% - 6%
5% - 5.5%
Actual Performance
4.0% yr/yr; 3.6% in 1 st half of 1994
2.8% yr/yr; (2.7% since 1993:1V)
6.1 % yr/yr; (6.5% since 1993:1V)
The Fed's Money Supply Targets a n d Actual Trends
Bank Reserves
Ml
M2
M3
Debt
Money Growth Targets
Q4r93 • Q4s94
Q 4 r 9 4 - Q4s95
Feb* Target
July Target
Target
not targeted
not targeted
1-5
1.5
1-5
04
04
04
48
48
3-7
55
Annualized % Change
Last 3 Months
-2.5
4.5
1.1
1.7
5.1
Last 6 Months
4.0
3.6
1.6
0.4
5.3
Yr/Yr
2.6
6.2
1.9
1.4
5.4
09/06/94
September 11-12, 1994
Chart 7
Bank Credit Conditions
Commercial & Industrial Loans
89
90
91
92
93
U.S. Government Securities
held at Commercial Banks
94
95
88
— Commercial & Industrial Loans
-Yr/Yr
89
90
91
92
93
94
95
— U.S. Government Securities — Yr/Yr
Real Estate Loans
Loans to Individuals
20%
15%
I
§> 10%
c
§ 5%
§
|
0%
£
-5%
I
k_i i
V- J
I
i
j
i
j J
^\
^A
i J 111111111111 n 111111 t k i m 11
-10%
89
90
91
m i n ii i t n i i i m i
92
93
illinium
94
95
— Loans to Individuals
Small Time Deposits
NonFinancial Commercial Paper
60%
c
40%
5
pi
1 i!
1200
;i
1
I
!
r*f\ i
i i il
i
i
cent
1000
:
!
o
20%
w.
<D
Q.
1
1100
t
: VAA j
i
900
1
800
0%
|!
>-
! ! VT i
!' ;|
700
90
91
92
93
94
95
h i,
i
•
i
lllllllllllllll
1 Inniiniuiiiii
89
90
\
I
i
1/
\
i
tmmmmiiiiitiiiiiiiiiiiiiii
91
92
93
10
c
CO
JZ
O
+*
c
-10 o
-20 °-
r
llllllllllllllllHII
94
95
— Money Stock: Small Time Deposits-Total (SA)
—Year/Year
— NonFinancial Commercial Paper
NattonsBanc Capital Martwta. Inc.
K I
!
88
-20%
89
^^qf^\.
| X sV^ \
20
56
.30
09/06/94
Shadow Open Market Committee
Chart 8
Selected U.S. Interest Rates
Federal Funds Rate
Inflation-Adjusted Federal Funds Rate
o *-*
70 72 74 76 78 80 82 84 86 88 90 92 94
70 72 74 76 78 80 82 84 86 88 90 92 94
Treasury Yields
Inflation-Adjusted Treasury Yields
20
15
10
15
I
10
CL
ll I I I I
0
!
U
i
•
i
'
•
hill
5 :;
1 ! !
M
l
0
1
I • i I i R I
I
;
i
r 'm
V
!
,
!
.
"i
i
I
1
!
!
J#^
^I \wm^,
\
^\&l J
'
mill
1
^ !1
!
1
* i
i 1
I
•
I
I
'
!
1 1
!' • i i l l
;
-10 ^
70 72 74 76 78 80 82 84 86 88 90 92 94
70 72 74 76 78 80 82 84 86 88 90 92 94
- 3 Month Bill
i
- 3 Month Bill
- 30 Year Bond
- 30 Year Bond
Treasury Yield Spread
Corporate Spread over Treasuries
r 3
a. 2
0
LJ
76
70 72 74 76 78 80 82 84 86 88 90 92 94
80
82
84
86
88
90
92
- Spread: 30 Year T Bond - 3 Month T Bill
— Moody's Baa Corporate - Treasury Composite Yield
NationsBanc Capital Markets, Inc.
78
57
94
Table 2
Trends in International Trade and Capital Flows
Merchandise Trade Deficit
Trends in Imports & ExDorts
o
700
600
<A
r>
<"/
ug HB
i
-50
500
o
m
c 400
o
S 300
nk
g -100
o
m
m*
>
^
-150
«u
/
^
^
ssL
1
200
111
100
til
i 111 111
111 i 1II
III!
i l l 1 III!
Ill
1 11
1 II
III
_u_u ±ixl
-200
\ iiuiniilimimtmuu mmnliiiium «MIMflMUiMli mamtpiiiiiijinMiui ttilWIi niMiiinuiMiilmuuiiiuiiiu
80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95
12 Month Trade Balance: Customs Value (SA)
— Imports (Annual Rate, SA) •— Exports (Annual Rate, SA)
00
I
U.S. International Trade & Capital Flows
U.S . Bilateral Merchandise Trade Flows
NSA, Bil $, Annual Rate
Q2:94
Q2:91
Imports
Exports
TrodeBolonco
Imports Exports TradeBalance 1
Canada
95.2
90.8
-4.4
130.8
118.8
-12.0
Mexico
31.6
34.4
2.8
48.4
50.4
2.0
Japan
83.6
48.4
-35.2
113.6
52.0
-61.6
China
16.0
6.4
-9.6
35.6
10.0
-25.6
European Union
86.0
107.2
21.2
111.6
101.6
-10.0
OPEC
32.0
18.8
-13.2
31.6
16.8
-14.8
Latin America
59.6
59.2
-0.4
82.8
85.6
2.8
Asia (NICS)
56.0
45.6
-10.4
68.0
57.6
-10.4
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
Current
Account
$2,316
5,031
(11,438)
(44,461)
(99,769)
(125,381)
(151,203)
(167,099)
(128,197)
(102,815)
(91,747)
(6,943)
(67,886)
(103,895)
Capital
Account
($28,854)
(31,113)
(29,917)
24,644
79,017
101,960
121,294
171,539
140,902
49,744
51,829
46,620
84,993
82,799
The first four columns ore in millions of dollars.
Financed
Privately
($31,035)
(25,801)
(22,414)
25,000
84,494
109,757
87,354
115,998
102.092
65,275
17,772
20,757
41,886
12,802
Financed by % Financed by
Central Bonks Central Banks
(7.6%)
$2,181
17.1
(5,312)
25.1
(7,503)
356
(1.4)
(6.9)
(5,477)
(7,797)
|7.7)
33,940
28.0
5S,S4\
38,810
(15,531)
34,057
25,863
43,107
69,997
32.4
27.5
(31.2)
65.7
55.5
50.7
84.5
Shadow Open Market Committee
Chart 9
09/07/94
Selected International Financial Trends
Inflation Adjusted Short-term Interest Rates
Inflation Adjusted Long-term Interest Rates
10
i u r—
i
A <\
u
0
LD
r
i
—
^
\PN^L
Y
1
P-.
i i.i., LULL. i n
LULJL _UUL JJUL. _l_l_l_ - U - L .
i u
± U M
u L U JLJJL l i t
* Japan
20
50
15
i
\
V v/"
AJ
M
-200 LJi-l 1 1 1 1 1 M1I Il l l l l l l l l l
80
83
86
V
92
.^Q I li ii ii ii ii ii li 11 I I ii n u l l i i i i i i i n i li m i I I n n I I m i M U M
95
80
160
2.00
140
1.80
v
M_^JJ
llllltlllll llllllllll! lumniiii tniiiiinil
1. m i n u n
90
91
http://fraser.stlouisfed.org/
NationsBanc Capital Markats, inc.
Federal Reserve Bank of St. Louis
92
83
86
DM/$
2.20
89
K
AH
&
180
80
v4
c
Yen/$
100
n
10
IIllllllllll
89
120
* Japan
\
\
-150
i A fci
kw
\
jt
%
Japan Current Account Surplus
100
V
t
r^. v_
— United States —Germany
The U.S. Current Account Deficit
o
g -50
o
-100
—V
7
Lit
k^M
i
fc
r £
f «f£
^^
* m^
-5 L- I I I ! XXX. xxx. XXX n i l J J U . JLJJL JULX J-UL XXX. XXX. XXX. 'ixxx. XXX.
80 81 82 83 84 85 86 87 88 89 90 91 92 93 94
III
80 81 82 83 84 85 86 87 88 89 90 91 92 93 94
— United States —Germany
i
CI
ercen
o
i
^
93
94
95
59
89
92
95
September 11-12,1994
60
Shadow Open Market Committee
M2 AND BASE GROWTH
Allan H. MELTZER
Carnegie Mellon University and American Enterprise Institute
We often differ about ease and tightness because some rely more on M2 growth and others
on base growth. The chart, labelled U.S. performance, compares the steady state rate of inflation
implied by the following rule:
"*r = ( / - v V i
where m is the four quarter growth rate of base or M2, y* is the 12 quarter moving average of real
output growth, and v*is the 12 quarter moving average of the relevant velocity growth.
The predicted inflation, PRPR1, uses the base. PRPR3 (or 6) uses M2 growth. The black
dots are 4 quarter rates of change of the deflator.
The chart suggests that the two again give very similar forecasts. The errors terms on the
following chart show that this has been true more often than not. (Errors are differences between
actual inflation and predicted.) The recent divergence, from 1990 to 1993, has now gone away.
Both predictions are for approximately 2.5 percent inflation as a steady state result of growth and
accumulation of cash balances at recent rates.
61
The Error Terms — US
P4-PRPRC) where i= 1.3,6
006
fr.
0.04
w
0.02
K;
\/
;#.
0.02
i
I.
t^
\
\
/ /
\.,
\ I
if
* J. i
V,
"I
H%
/
\
//
\
-0X18
Jl
80
L_l_ J
81
I I t
82
w
/V
* *
I
y
LJ.J
83
I I i I I I I I i 1 • I I '
84
85
86
ERROR1
Disk 2: File:B:\US_RULE.WK3 Graph: RULE
N /\
y
-0.04
-0.06
VK
' .1 .1 . M
I I I I ? I I
87
-^-
88
B9
ERROR3&6
50
91
I 1 I I I I
92
L_J
L_!_
94
The U.S. Performance
Inflation
•112
0.03
-
0.06
en
0.04
0.02
-0.02 1—rir1
80
81
82
83
84
85
,
Actual Price Level Grovrth a
Disk2:File:B:vRULE19l9.WK3 Graph: INFLATION
87
PRPRl
88
89
90
-&- PRPR3&6
91
92
93
94
September 11-12, 1994
64
Shadow Open Market Committee
A NOTE ON RECENT U.S. PRODUCTIVITY GROWTH
William POOLE*
Brown University
U.S. productivity growth has risen over the last several years, creating hopes that the
longer-run performance of the U.S. economy is improving. A simple calculation makes clear how
important this issue is: if productivity growth had continued after 1973 at the same rate as from
1947 to 1973, productivity today would be 51 percent greater than it actually is. If the number of
hours worked were the same, GDP would be 51 percent larger than it actually is. The United States
could deal with its many problems a lot more easily if GDP were that much larger.
Figure 1 provides an overview of U.S. productivity performance since 1947; the upward bend
of the productivity line since 1990 show up clearly. Some questions:
•
How solid is the evidence that productivity growth has risen?
•
What are the implications of changes in productivity growth for monetary policy.
As for the first question, the evidence is not at all solid. Analysis of productivity is bedeviled
by measurement problems and the difficulty of sorting out long-run changes from short-run cyclical
patterns. Zvi Griliches, in his presidential address to the American Economic Association last
January, emphasized the importance of data limitations in tracking productivity changes and
understanding their causes.
Economists have not been very successful in explaining what has happened
to the economy during the last two decades, nor have they been able to
agree on what should be done about it I will argue that data and measurement difficulties may in fact be a major source of this failure. This
point will be made not to provide us with an alibi, but rather to temper the
pretentiousness of some of our pronouncements and to1 urge us toward the
more mundane task of observation and measurement.
It seems unlikely that mismeasurement can explain the decline in productivity growth of the
magnitude experienced after 1973, but smaller changes, such as the rise in productivity growth over
the last few years, might be partly or even mostly due to changes in measurement techniques. The
basic problem is that the division of total dollars spent on goods between quantities and prices is
highly suspect for many products. For complex products, with changing characteristics and quality,
65
September 11-12,1994
measurement of output (and therefore also price per unit of output) is subject to enormous conceptual
and practical difficulties. These problems are most severe in service industries, which have been
increasing as a share of total GDP.
Putting measurement issues aside, interpreting recent developments is difficult because
productivity has pronounced cyclical pattern. Over the business cycle, firms adjust output more
quickly than they adjust labor input. During a cyclical contraction, output falls more quickly than
employment and hours worked (as reported in official statistics, anyway), and so output per hour
—labor productivity—falls, or rises more slowly than normal. During cyclical expansions, firms
increase output more rapidly than hours of labor input, and so labor productivity rises.
The conventional wisdom is that the U.S. economy is now operating at or close to full
employment, given the structure of the labor market and size of the capital stock. The table shows
the annual rate of productivity growth from one cycle peak to the next and from each cycle peak
to 15 quarters after the cycle peak. If we knew the economy were now at a cyclical peak, we would
compare peak-to-peak productivity growth to see how the recent growth rate compares to previous
peak-to-peak growth rates. However, the growth rate of productivity over the 15 quarters from the
last cycle peak to 1994:1 probably overstates the peak-to-peak growth rate. From Figure 1 and the
table, it is clear that productivity growth usually slows markedly in the quarters before the cycle
peak. For example, the growth rate of productivity from the cycle peak in 1981:111 to the cycle
peak in 1990:111 was 1.06 percent, but the growth rate over the 15 quarters form 1981:111 to 1985:11
was 1.37 percent Comparing 15-quarter periods after cycle peaks, it is true that productivity growth
over the 15 quarters after the last cycle peak was higher than for any peak since the one in 1969,
and that is indeed a welcome development
Some analysts have also taken heart from the improved performance of manufacturing productivity, which shows up clearly in Figure 2. (The BLS series on manufacturing productivity
begins in 1977.) The problem with interpreting this series is that many manufacturing firms have
been restructuring by contracting out services. Service employees such as janitors and lawyers
within manufacturing firms are counted as manufacturing employees, but when manufacturing firms
contract out janitorial and legal services these same individuals are counted in the service sector
where measurement of output is extremely difficult Thus, the improvement in manufacturing
productivity may be totally spurious.
66
Shadow Open Market Committee
The rate of productivity growth has little direct implication for monetary policy. The Federal
Reserve's primary responsibility is maintenance of low inflation. Given the rate of money growth,
higher productivity growth will yield lower inflation. However, the Fed does not implement its
monetary policy by fixing the rate of growth of money.
The Fed's current approach to policy is to raise interest rates in response to actual or incipient
pressures toward higher inflation. Higher productivity growth might show up in less apparent
pressure toward higher inflation, as measured by early warning signs of inflation itself. A more
important influence on monetary policy is likely to be Fed attitudes toward the rate of growth of
real GDP. If real GDP seems to be growing "too" rapidly, given the Fed's estimates of productivity
growth and labor force growth, then the Fed will implement more restrictive policy actions. If
underlying productivity growth is really higher than the Fed's estimates, then the more restrictive
policy will prevent the economy from growing as rapidly as it could in the short run. Conversely,
if productivity growth is lower than the Fed's estimates, the policy will inadvertently be less
restrictive than it should be, and inflation will rise.
The Fed is, I believe, well aware of the dangers of trying to depend too much on uncertain
estimates of long-run productivity growth, and so is unlikely to base its policy on these estimates
to any significant extent. As the figures and table make clear, productivity growth varies so much
in the short run that any change in long-run productivity performance will not be clear for some
years.
As a final note, it is interesting that the slowdown in productivity growth after 1973—a
slowdown that now seems so obvious from Figure 1—was not generally accepted as a long-run
change until late in the 1970s. In the Economic Report of the President for 1977, the Council of
Economic Advisers lowered its estimate of productivity growth.2 This new estimate, however, was
not without controversy. In early 1977, in a Brookings Panel paper, George L. Perry argued that
the evidence for a trend break in productivity growth was unclear.3 He believed that 1974, a year
of sharp productivity decline, was very unusual, and he employed a dummy variable for that year
in his statistical analysis. When the Brookings Panel next took up the issue, in 1979, there was no
longer any doubt that productivity growth had declined substantially.4
This experience with judging productivity growth in the mid 1970s should serve as a warning
to policymakers today. Recent productivity growth does seem to be higher than before, but tying
policy in any close way to estimates of productivity growth is hazardous.
67
September 11-12,1994
NOTES
*I thank Data Resources, Inc. for providing access to its data bank, from which I drew the
data for the figures and tables.
1
American Economic Review 84 (March 1994), p. 10.
2
See especially pages 45-46,52-56 in the 1977 Economic Report, which was the final Report
by the Greenspan Council. The CEA reduced its estimates of productivity growth to 2.0 percent,
which in the event was too high.
3
"Potential Output and Productivity," in Arthur M. Okun and George L. Perry, eds., Brookings
Papers on Economic Activity 1977:1, 11-47. (See especially pp. 34-38).
4
J.R. Norsworthy, Michael J. Harper, and Kent Kunze, "The Slowdown in Productivity
Growth: Analysis of Some Contributing Factors," and Peter K. Clark, "Issues in the Analysis of
Capital Formation and Productivity Growth," in Arthur M. Okun and George L. Perry, eds.,
Brookings Papers on Economic Activity 1979:2, 387-431.
68
Shadow Open Market Committee
Figure 1
Output per Hour, Private Business Sector
1947:1-1994:11
1.2
Jj> 0.8
s
CO
O
s
3
•a
c
0.6
0.4
1950
1955
1960
1965
1970
69
1975
19B0
19B5
1990 1994
September J]-12,]994
Productivity Growth Rate
(percent per year)
1
1
Cycle Peak to Cycle Peak
|
Period
|
Number of
Quarters | Growth Rate |
|
Cycle Peak to Cycle Peak
Plus 15 Quarters
|
Period
|
Growth Rate
48:IV-53:II
18
4.24
48:IV-52:III
4.40
53:11-57:111
17
2.35
53:11-57:1
2.40
57:111-60:11
11
2.42
57:111-61:11
2.89
60:11-69: IV
38
2.92
60:11-64:1
4.08
69:IV-73:IV
16
2.51
| 69:IV-73:III
73:IV-80:I
25
0.64
73:IV-77:III
80:1-81:111
6
1.00
80:I-83:IV
1.03
1.06
81:111-85:11
1.37
81:111-90:111
36
|
1 90:111-94:11
70
2.45
!
1.52
1
2.02
|
Shadow Open Market Committee
Figure 2
Output per Hour, Manufacturing
1977:1-1994:11
71
September 11-12. 1994
72
Shadow Open Market Committee
RECENT BEHAVIOR OF M2
Robert H.RASCHE
Michigan State University
Two years ago I commented on the then mysterious behavior of M2 since early 1991. It was
noted that the slow growth of M2 principally was attributable to the decline in small time deposits.
One hypothesis then current was that this decline was associated with the thrift crisis; indeed
Chairman Greenspan cited that explanation in his testimony to Congress. I proposed an alternative
hypothesis, namely "that the recently observed behavior of small time deposit balances is a normal
portfolio adjustment in response to the prevailing structure of interest rates, and would have occurred
regardless of the severity or existence of the thrift crisis." I also suggested that further reductions
in the fed funds rate in an effort to stimulate M2 growth were likely to be futile; that a more productive
approach, if higher growth in M2 was desired would be to increase the funds rate target.
The Fed maintained the three percent funds rate target until February, 1994. From September,
1992 through February, 1994, the outstanding stock of small time deposits continued to fall from
911.0 billion to 774.5 billion, or by 16.2 percent. During the same period of time, savings deposits
increased from 1160.3 billion to 1220.9 billion, or 5.1 percent. Savings deposits were almost
constant from the middle to the end of 1993. Money market mutual funds reached a peak in mid
1991 then declined until early 1993 and remained almost unchanged throughout the rest of the year.
After the Fed increased the funds rate target, starting in February, 1994, the behavior of these
three components of M2 changed dramatically. Two months later small time deposits reached a
trough, and have risen in each of the following three months for which data are presently available.
Outstanding money market mutual funds jumped by about 3.7 percent from March to April, 1994
and have remained at the higher level since. In contrast, savings deposits reached a peak of 1221.9
billion in March, 1994 and have fallen each following month to 1202.2 billion in July, 1994, a
decline of abut 1.6 percent
All of these reactions appear consistent with the hypothesis that the "peculiar" behavior of
M2 resulted from predictable portfolio adjustments to the existing term structure of interest rates.
Available data indicate that CD rates and money market mutual fund rates have moved up sharply
with short-term market rates (see Figure). In constrast, average savings deposit rates appear to be
quite stable in the 2.5 percent range. Given the latest increase in the funds rate target, it is likely
73
September 11-12,1994
that money market mutual funds rates and small time deposit rates will again rise (if they have not
already done so by the time that we meet). My prediction is that growth in money market mutual
funds and small time deposits will accelerate, though if saving deposit rates continue to exhibit the
sluggishness that characterizes their historical behavior, then it is likely that this component of M2
will continue to exhibit negative growth in the near future. The net outcome of such portfolio
adjustments is that M2 growth will likely increase above recent past levels, but explosive growth
is not likely. M2 velocity, which has risen sharply in recent years (see attached figure) is likely to
remain at historically high levels in the immediate future.
74
17.5
2L
17.5-1
RTBMON
I RTBMON
RSTD6
RM1
15.0
RMMF
15.0-1
12.5
12.5
10.0
10.0
7.5
7.5 H
5.0-1
5.0
2.5-1
2.5
0.0
X
a
I ' ' ' I ' • ' I ' • • I • ' ' I • • ' I ' ' • I ' • ' I ' ' ' I ' • ' I ' ' ' l • ' ' I '
81
84
87
93
90
I
• i • I • • • I • • • I • • • I • ' • I '
84
1
_
I ' " • I • • • I ' ' • I • ' ' I ' ' • I • • • I ' • • I
87
90
l
93
r-
<§-
17.5
RTBMON
ROCD
15.0-1
12.5
10.0
7.5-1
5.0 J
2.5 J
0.0
i
'
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i
•
'
•
i
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81
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i
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i
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87
i
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r '
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i
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T
90
93
M2 Velocity, 59:1 -94:2
1.880
1.840
1.800 -\
1.760
1.720
SO
*
1.680
1.640
1.600
1.560 -I
1.520
i—i—i—i—i—i—s—i—m—i—i—i—i—i—i—i—i—i—i—i—r
61
69
77
Quarters
i—i—r
85
i—i—r
Shadow Open Market Committee
MYTHS IN THE REPORT OF THE BRETTON WOODS COMMISSION
Anna J. SCHWARTZ
National Bureau of Economic Research
A 43-member commission, convened by Paul Volcker and co-chaired by three international
bankers, has published a nine-page report—Bretton Woods; Looking to the Future—on the
occasion of the fiftieth anniversary of the original Bretton Woods Conference. Later this year the
commission will publish a volume including a staff review of its deliberations and a set of some 20
odd papers prepared by individuals as background for, but not endorsed by, the commission.
The commission was convened to review the Bretton Woods system and its institutions and
"to ask whether the present multilateral economic arrangements are up to the challenges ahead, and
to what extent they may need reform." It looks ahead but also looks back, and what the commission
offers are myths about the past and present.
My report organizes the commission's recommendations under two main headings: international monetary reform and the IMF, international development assistance and the World Bank
Group. I limit my comments to the report's observations about exchange rates and its international
monetary reform recommendations.
In reviewing the Bretton Woods system, the report's verdict on the IMF is that, "It was effective
in this role for both the industrial and the developing countries in its first two and a half decades."
A contradictory view, at least with respect to the industrial countries, has been expressed (Dornbusch,
1993): "In relations among the industrial countries, the IMF has been patently unsuccessful. In
the immediate postwar period, the Fund could not get itself to accept the European Payments Union
and as a result was left on the sidelines. It never recovered except for a brief moment in the
management of sterling crises. Since then the Fund has not been doing any better."
In reviewing the post-Bretton Woods period, the report deplores the absence of a "sustained
coherent approach to exchange rate management" The critique of existing arrangements states:
"Financial market volume and volatility have increased. Exchange rates have become sensitive
and their movements sometime extreme... There have been prolonged periods of misalignment
among the major currencies." The conclusion is that "the costs of extreme exchange rate misalignment and volatility are high."
77
September U-12, 1994
No paper is referenced as evidence for extreme volatility, prolonged periods of misalignment,
and high costs. In fact volatility has not interfered with an increase in the volume of international
trade. The core of the case for exchange-rate management and for target zones, however, is the
concern about misalignment. No specific cases are mentioned, and the report provides no clue on
how exchange rates consistent with the fundamentals will be determined, or how credibility of fixed
rates or target zones will be maintained if capital movements are not restricted. If costs are the
issue, why did the commission not assess the costs of exchange rate management?
The report compares the reduction in long-term growth in the major industrial countries from
about 5 percent a year under Bretton Woods to about 2.5 percent a year since the early 1970s, and
concludes that "the loss of exchange rate discipline has played a part" in accounting for the decline.
Again no evidence supports this assertion.
Exchange-rate arrangements did not cause Bretton Woods period prosperity. In the first place,
monetary and fiscal expansion accompanying full-employment policies worked until the public
caught on that increased spending produced price increases at the expense of output and employment
gains. In the second place, international trade grew thanks to GATT successes in reducing tariffs.
These were the important cause of Bretton Woods period prosperity.
To achieve more satisfactory performance, the report recommends "better international policy
coordination aimed at stabilizing exchange rates." Before that can happen, however, the major
industrial countries need to strengthen their fiscal and monetary policies for "greater overall
macroeconomic convergence." This, according to the commission, is the first of two steps to
international monetary reform. The second step is "a more formal system of coordination, involving
firm and credible commitments, to support these policy improvements and avoid excessive exchange
rate misalignments and volatility."
The report refers to "firm commitments," "coherent and credible" commitments, "explicit and
clear" commitments by major industrial country governments to "respond appropriately to changes
in international economic conditions with adjustments in macroeconomic policies and with currency
intervention." Intervention is to be limited to the dollar, the deutschmark, and the yen. In view of
the recent disarray in the EMS where, commitments notwithstanding, Germany failed to "respond
appropriately," what is the basis for the commission's recommendation? It seems to be empty
rhetoric.
78
Shadow Open Market Committee
In the commission's view, the central role in implementing monetary reforms should be played
by the IMF. It proposes restoring the Fund to its original focus on international monetary issues,
after having been diverted to provision of longer term assistance to developing countries, thus
duplicating World bank functions, and to structural transformation of the former communist
countries.
There is no detailed discussion, however, of the monetary reforms nor of their implementation.
Instead, the report merely urges the IMF to concentrate on short-term macroeconomic stabilization,
but does not make clear whether these stabilization efforts are to be directed to developing and
transforming economies or to the industrialized economies or both. Executive Directors are to
guide IMF management and "at the same time exert influence on their own countries."
The report suggests that IMF quota shares need to be reallocated in line with members' relative
economic importance, that the IMF should be less secretive, and should seek close ties with the
new World Trade Organization. It defends the Fund against charges that its conditions for financing
are harsh, but acknowledges that criticisms of the IMF "sometimes influence the attitude of member
governments toward the IMF in destructive ways."
The Bretton Woods Commission report is a reliable account neither of the Bretton Woods
experience and of its aftermath nor a usable blueprint for introducing a future fixed rate exchange
rate reigme, if that is what the commission longs for. Its advice for renewing the IMF is bland.
79
September 11-12, 1994
REFERENCE
Dornbusch, Rudiger, 1993, "Comment." In A Retrospective on the Bretton Woods System.
M.D. Bordo and B. Eichengreen (eds.). Chicago: University of Chicago Press, 102.
80
@FedFRASER