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Some Perspectives on Interest Rates E. Gerald Corrigan, President Federal Reserve Bank of Minneapolis Presented to the Southern Minnesota Farm Forum Lake Crystal, Minnesota January 24, 1981 I welcome this opportunity to address the Southern Minne sota Farm Forum, but I will confess to a certain trepidation about appearing here with you this afternoon. The apprehension arises in part because I suspect that many of you look upon the Federal Re serve as the cause of the current high level of interest rates. In that light, I hope to use this occasion to put the current interest rate situation in its proper perspective and, in the process, shed some light on the causes and cures for high interest rates. But in the spirit of the frankness that I know will be a hallmark of our dialogue, I have to own up: the real reason for my sense of trepidation in meeting with you this afternoon is that I know full well that as an Eastern "city-boy," my limited knowledge of your business and, in some cases, your problems will be all too transparent. I am, however, beginning to learn about your business and from what I have already seen and learned, I can tell you that from the vantage point of Wall Street in New York or Constitution Avenue in Washington, it is virtually impossible to appreciate and under stand the contribution that you in the agricultural sector make to our economy and our well-being as a nation. The magnitude of agri cultural production just can't be captured by reading in The Wall Street Journal that corn production bushels. high The and growing in 1980 productivity totaled of our 6.65 billion agricultural sector can't be captured by looking at comparative statistics. extent to which agricultural years, contributed to our The exports have, particularly in recent strengthened balance of payments— OPEC 2 - - notwithstanding— can't really be appreciated by looking at the num bers, impressive as they are. However, it is not my purpose to speak to you today about the agricultural economy as such, but rather to use this occasion to discuss with you some of the more general economic problems, the economic challenges and the economic opportunities that are facing all of us today. I say all of us because I strongly believe that the core issues and the core problems facing this nation truly do face all of us— farmers and bankers, consumers and producers. Some of the symptoms of those problems are seemingly con flicting and certainly confusing: the simultaneous occurrence of high inflation and high unemployment; the simultaneous occurrence of low and, in some instances, declining real incomes in virtually every sector of the economy; the simultaneous and self-defeating effort of all groups to escape the dilemma by striving to increase their real income— their "share of the pie"— at the expense of others. Other symptoms are less ambiguous. The "buy now" atti tude that we see so plainly is, in one sense, an understandable re sponse more to the fact of inflation. therefore ductivity. inflation and to the expectations of still But that same attitude produces low investment, low savings and low capital formation and sluggish pro Similarly, our markets, whether the market for precious metals, for corn, or for Treasury bills, are buffeted by short-run price variability that, in my view, illustrates forcefully the heightened sensitivity of market participants to changes in infla tion and expected inflation. - 3 - Surely some part of this churning we see in our markets is a reflection of the inflationary process as both buyers and sel lers try to outwit each other in the drive for that one extra basis point— that one-hundredth of a percent margins of profits are so thin. that looms so large Again, in this case, we lose sight of the fact that unless we can achieve again sustained nomic growth, when the market churning we see real eco is a "zero sum game" — a game in which today's winners could be tomorrow's losers. What we need, not just in our markets, but in our economy at large, is to re create the conditions in which we can all be winners! At the risk of a gross oversimplification, I think it is fair to say that the symptoms of which I speak— those that are am biguous and those that are clear— can all find decade and a half of essentially accelerating would submit sively higher to you that the experience of their roots inflation. 15 years in a And, I of progres inflation was not altogether an accident or an out growth of OPEC. In part, it was a reflection of the fact that many, if not most of us, convinced ourselves that we could somehow live with a "little" more inflation. We could somehow isolate or in sulate, we could somehow index or subsidize, we could somehow mu d dle that through. the We accepted "little more" that thinking because we also believed inflation seemed to buy so much more in terms of lower unemployment and increased availability of goods and services. Unfortunately, we, like many before us, were wrong. In deed, in retrospect it is now clear that had we been willing to look hard enough and had we been willing not to delude ourselves, we - 4 - would have recognized that accelerating inflation is not something that can be lived with. inflation. There is no such thing as a "little more" Inflation is inherently debilitating, and as it grows, the resulting distortions and inequities grow with it. escape— there is no haven. and it must be rooted out. the problem and the process. In short, There is no inflation must be attacked Avoiding that reality only intensifies increases the pain and discomfort associated with That is why I believe it is so important that we, as a nation, come to grips with inflation now— now before both the prob lem and its ultimate solutions reach proportions that could make our current difficulties look mild by comparison. I do not mean to suggest for one minute that this implies that our national priorities and our national policies need be or should be designed to the exclusion of other pressing mate concerns. ities— energy Certainly there independence and legiti is a long agenda of other prior to name one— which must be addressed. However, I do mean to suggest that as we approach these other prob lems we should keep one steady eye on the manner in which our ef forts to solve those problems will either contribute to or detract from the ongoing effort to control inflation. Nor do I mean to suggest that the task of rooting out in flation will be easy. It will not be. that we have the knowledge, the tools, the opportunity to get on with the job. But I do very much believe and above all, we now have Indeed, the only issue is whether we have the will. All of which brings me to the role of monetary policy. I know full well that monetary policy and the Federal Reserve are not 5 - easily understood. - Monetary policy— particularly in a day-to-day operational sense— is highly complex and is subject to many of misunderstandings. I'm sure you appreciate that just from read ing the financial press. It's also subject to many technical prob lems and— I would some short-run miscalculations issues kinds freely acknowledge— it may on our part even now can and should be matters of concern, be and subject then. to These but they should not stand in the way of an appreciation of the core and essence of our policy. Essentially, that policy is one that says that we in the Federal Reserve intend to restrain the growth in money and credit and bring the growth in money and credit into line with that com patible with a sustained and continuing inflation. you, reduction in the rate of That policy and that realization over time, I submit to is a necessary prerequisite to rooting out inflation. plain from history— both here It is and abroad— that inflation cannot be turned around in an environment of rapid and undisciplined growth in money and credit. This is not to suggest that the appropriate mon etary policy can or should do the job by itself, but it is meant to say that without that policy other efforts will surely fail. Specifically, we must have a compatible and credible fiscal policy as well as a disciplined monetary policy. policy is a necessary but not a An appropriate monetary sufficient condition for con trolling inflation. What claim that then about the Federal interest Reserve is rates? What the cause of then the about current the high level of interest rates that I know is such a concern to all of you? - 6 - There is, I must confess, an element— and I emphasize, only an ele ment— of truth to that supposition. our policy of restraining It is true, for example, that the growth in the supply of money does imply that only a certain amount of credit demands can be satisfied at any interest rate level. When credit demands are sizeable— and especially when they are fueled by inflation and inflationary ex pectations— interest rates will rise, as they did so markedly in the fourth quarter. I wish I could tell you that there was some easy way to avoid that result or to somehow get around that result. In fact, economic tives. and in the short run and given some set of overall financial conditions, I can see only three alterna First, the Federal Reserve could back off. It could speed up the printing press and push enough new money out into circula tion to validate all of the credit demands. That could be done. But I think you recognize as readily as I that such a response would only fuel more inflation, higher inflationary expectations and, in very short order, higher, not lower, interest rates would result. In short, I don't think much of that alternative. A second approach might be to try to somehow structure a program of credit controls or interest rate ceilings. face, at least, that idea may seem to have appeal. On the sur However, on re flection, it too, I believe, is fraught with problems and doomed to failure. massive Experience has shown all too vividly that controls entail governmental bureaucracies counterproductive allocations, and arbitrary and sometimes and they are fundamentally in con flict with our system of markets and free enterprise— a system that you farmers may well more fully appreciate than do many. But there 7 - is another - and perhaps even more fatal practical flaw with credit controls and interest rate ceilings. high technology in the money That is, with the advent of transfer business, trying to impose artificially low lending rates by law or regulation would only en sure that markets, money— which is highly fungible— would even to foreign markets. flee to From where I stand, other those are not the results we want either. There is a way, however, that can help to pressures on interest rates, even in the short run. lessen the For example, it is clear that pressures on interest rates would be relieved if the demands for money and credit were more moderate. Unfortu nately, such a softening in credit demands is often associated with a fall-off in economic activity— a process that we saw very clearly in the second quarter of 1980. credit demand need not entail However, achieving a moderation in that kind of circumstance larly when we recognize that the government itself, particu and its spon sored agencies, are by far the largest single source of credit de mand. Obviously, large and persistent patterns of government bor rowing work to place upward pressures on interest rates and in the process work to limit the amount of credit private borrowers— small and large. cannot tolerate successive and that is available to Stated differently, we simply large federal deficits— with all they imply for the borrowing needs of the Treasury— and at the same time expect to meet the legitimate credit demands of businesses, households and farmers in a climate of moderate interest rates. Achieving improved performance in our fiscal affairs will not be easy, but I have the clear sense that we are now at the point - 8 - where we have both the recognition and the opportunity to achieve that objective. In my judgment, the first and most necessary step in that process is to achieve meaningful and credible reductions in federal spending. I do not claim to know how large such cuts can be; nor do I claim to know how and where they should fall. But I do sense that Congress and the American public will more readily ac cept spending cuts if the associated burden of short-run adjustment is shared across industry and interest groups. No group should be singled out, but no group should escape scrutiny. In that light, I think we must be frank and recognize that farm programs— either the direct spending should, in the interest of a balanced program of federal restraint, programs or the off-budget be subject to the same scrutiny. lending programs— spending My point, of course, is that unless our nation's producer and consumer groups, including farmers, can compromise their narrow interests and unite behind a broad program of fair and equitable reductions in federal spending, then I fear we will all be losers. Achieving that broad-based discipline in federal spend ing is necessary and desirable in its own right, but it also has a bearing on the related question of tax policy and tax reductions. There is, for example, no questioning the proposition that the tax burden on households and businesses has become stifling. case for tax reduction is strong. our tax reductions Thus, the But I believe that we must earn by spending restraint. As importantly, I be lieve that, in tandem, spending restraint and tax reduction can, if properly balanced and structured, play a positive role in recreat ing the conditions needed for sustained economic growth and a sus tained reduction in inflation. - 9 - I said earlier that none of this will be easy. are successful get in these efforts, the appropriate legislation Even if we it will take time and effort through the Congress to and it will take more time for the resulting programs to work their way through a large and complex economy. That period of transition will difficult and it will test the strength of our conviction. be How ever, I must confess that I have a sense of optimism that we now are prepared to get on with the job. That sense of optimism grows in part out of my belief that we have learned from our past mistakes and it grows out of my strong conviction that there is a widespread recognition that prosperity— true prosperity— can only be achieved in a noninflationary environment. to that true prosperity. terest rates. Thank you. Our efforts now can pave the way That is the only sure road to lower in