Full text of Statements and Speeches of Edward Watson Kelley, Jr. : "Policy Challenges" : Before the 1988 Economic and Agricultural Outlook Conference, North Carolina State University, Raleigh, North Carolina

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For release on delivery
l :p.m .e .s .t .
December 1, 1988

"POLICY CHALLENGES"
by
Edward W. Kelley, Jr.
Member
Board of Governors of the Federal Reserve System
before the

1988 Economic and Agricultural Outlook Conference
North Carolina State University

Raleigh, North Carolina
December 1, 1988

As we approach the last year of this decade and
prepare to enter the 1990s,

it may be an appropriate

time to take a close look at the challenges that will
face our nation and

its policymakers in the upcoming

era.

like

I would

crucial

role

also

of

the

to take

private

brief

note

of

the

sector

in meeting

these

I see

to be

basic

challenges.
Let me

start with

what

objective of public financial policy,

the

then proceed to

take a look at where we are today and, with those two
viewpoints in mind, proceed to speculate on what needs
to be done.
The basic objective public financial policy needs
to strive for, in my view, is stability.

Let me hasten

to say favorable stability as, after all, comatose is a
stable

state.

reason

stability

economies
economy

to
is

And

that

is

operate
working

so

obviously will
important

at

maximum

well

it,

is

not do.

that

it

efficiency.
in

turn,

The

allows
If

opens

an
up

opportunities to make progress in all of the different
facets of national concern.

If it is not, it will be

very difficult to make progress anywhere.
What
stability?

then
It

are
is

the

desirable

characteristics
to

oscillations of economic activity.

smooth

the

of

this

cyclical

It is desirable to

have low real rates of interest to facilitate a strong

-2flow

of

products

from

producer

to

market

and

to

encourage productive investments at a reasonable cost
of capital.

It is desirable to have an inflation rate

that is slowing over time towards zero and that also is
not constantly threatening to rise up and bite us like
an

untrustworthy

pet.

Last,

but

not

least,

it

is

desirable to have international trade conditions that
expedite rather than impede flows of economic activity,
and in the area of financial management this primarily
involves exchange rate stability.
Before examining how to move toward this state, we
must

first

today.
joyful

reach

some

understanding

of where we

are

Let me use the analogy of a happy group on a
summer

picnic

who,

as

they enjoy

themselves,

notice a thunderstorm coming across the horizon.
First

the

picnic.

We

are

entering

the

seventh

year of an expansion that still appears to be healthy.
Jobs are being created in the United States at a rate
that is unique in the world.
below 5-1/2

percent and

Product has

been growing at

Unemployment is now well

falling.

The

Gross

a healthy rate

will close out meaningful above 1987.

National
and

1988

Inflation over

the '80s has fallen dramatically and many industries,
indeed entire geographical regions, have been restruc­
turing and renewing themselves and promise to be strong­
ly

competitive

in

wonderful picnic —

the

years

but that

ahead.

It

is

indeed

thunderstorm is brewing.

a

-3The

thunderstorm,

of

course,

consists

of

the

twin

deficits that we are running in the area of balance of
payments and the fiscal budget.
It may be appropriate to take a look at each of
these, as some say that they do not matter and should
not be a source of public concern.
deficit.

Regardless of one's

First, the fiscal

view of whether or

not

the absolute level of the United States public debt is
significant,

surely several things do matter.

First,

this debt must be serviced and interest now amounts to
almost 15 percent of the Federal budget.

This clearly

introduces an element of fragility in times of pressure
and serves to reduce the flexibility of public policy.
Second,

it clearly diverts capital that is needed for

investment and other socially desirable uses.

Lastly,

deficits induce an inflationary bias to the economy and
large ones,

particularly those financed externally as

ours' are, introduce a large bias.
The balance of payments deficit largely consists
of our trade deficit.

Here the concern, once more,

is

the need to finance it and we are dependent for this
upon foreign capital.

Much of this capital is held in

the form of financial instruments and as such it can
potentially be withdrawn at will or, at the very least,
foreign

holders

can

decline

to

continue

to

invest

additional sums except at higher and higher cost.
conditions

are

clearly

damaging

to

the

quest

Such
for

-4stability.
exchange

Second,

value

through

this deficit puts pressure on the

of

the

speculative

pressures

could

dollar,

and

activity,

be

aroused

should

important
with

it plummet
inflationary

possible

adverse

affects on interest rates and the creation of a boom
and bust type of atmosphere.
In light of the above, it is my opinion that these
clearly

are

problems

that

must

be

dealt

with

and

constitute the major policy challenges we will discuss
next.
How

can

environment

we

with

reach
these

a

more

twin

stable

imbalances

economic

in

the

way?

There are enormous incentives to succeed in this effort
as there are very powerful economic forces at work in
the economy, and in our social system, which could move
us

toward

However,

a
it

percentage
dealing

very

favorable

era

in

near

is unlikely that we will achieve
of

with

this
the

promise

twin

and

deficits.

Sooner,

and proactively,

potential
Indeed,

later, purposefully or willy-nilly,
with.

the

future.
a high
without

sooner

or

they will be dealt

is clearly the better

way as the economy will be held back until progress is
made in this area.
severe

setbacks

Selecting

the

represents

a

so
best

major

Indeed,
long

we will continue to risk

as

ways

they remain

unaddressed.

to

the

challenge

attack
in

itself.

problem

There

are

Draconian ways which could result in cures that might

-5be as bad as the disease.

What we must search for is

the existence of alternatives wherein everyone will be
a winner.
What should be the proper order of attack?

This

is a particularly important question today in light of
the fact that we now have an economy that is operating
at, or near, full capacity even as these twin deficits
are

being

generated.

We

have

made

very

substantial

progress on our balance of trade deficit over the past
year and a half but we may soon be confronted with a
dilemma if we
area alone.

continue to pursue

a solution

in that

If we keep pushing for export growth,

in

the hope that this will enable us to grow out of both
problems simultaneously without any demand restraint on
our already very full economy, we may soon risk over­
heating

with

pressures.

an

attendant

increase

of

inflationary

This danger could be heightened by a sub­

stantial further decline in the exchange rate of
dollar.

the

If, on the other hand, we choose to attack the

problem on the import side through cuts in demand, we
could run the risk of an unnecessary early recession.
Thus it seems to me that it could be counter-productive
for us to continue to single-mindedly attack the trade
deficit in isolation, hoping it will lower the budget
deficit as growth rolls along.
our dollar

is very competitive

Let me quickly add that
in world

trade

today

and, thus, we can look for continued improvement in our

-6balance
rate.

of

trade

deficit,

albeit

at perhaps

Under today's full economy conditions,

a

lower

that may

be just as well.
The reverse approach will work.
our fiscal

If we can attack

deficit problem correctly,

the

balance

trade deficit should shrink along with it.
deficit

can

atmosphere

be
of

reduced

slowly

impeccable

if

it

The fiscal

is done

credibility,

of

as

the

is. an
inter­

national financial community must see and accept that
the United States is on an irreversible path towards a
balanced budget.

I am a strong believer in trends and

I feel that if it is very clear that a favorable trend
is in place,

then that

is far preferable

absolute deficit figure which
again on-again manner.
deficit,

we

should

encourage a higher

the

level

coupled

with

domestic

consumption.

is achieved in an off-

As we slowly reduce the budget

use

capacity

to any one

a

slack

so

of investment
slowing

As

in

expanded

the

generated

to

in productive
increase

of

capacity comes

on

stream, some of it will be directly export oriented and
with

the dollar

now

competitive

and other

economies

strong, opportunities for sales expansion will clearly
be there.
consumption

Some of it will be slanted toward domestic
and

this

will

help

to

imports, which is equally important.

slow

the

rate

of

Thus, the fiscal

and balance of payment deficits can improve together in
a symbiotic manner, if appropriately pursued.

-7So here is the challenge for the policymakers in
the

upcoming period.

In economic

terms

it does

not

appear to be terribly difficult but in political terms
there is

no doubt that

struggles

lie ahead.

But

to

repeat myself, if we are able to succeed here we will
have every opportunity to succeed in a wide variety of
desirable

initiatives

whereas

to

fail

here

will

severely reduce such chances and may soon result in our
economy facing unwanted and unnecessary problems.
Monetary

policy

role to play.

will

clearly

have

an

important

If we get the type of policy initiatives

enumerated above, it will represent a sea change in the
financial environment.
and perceived
activity,

inflation

both

and

and the

important

than

enumerated above,

have changes

pressures;

domestic

rate structures;
More

We will

flows

of

economic

international;

dynamics of

any

of

the

in real

interest

exchange

rates.

individual

items

will be how they will interact

one

with another.
The precise

impact on Federal Reserve

difficult to foresee.

policy

is

I suspect that as these shifts

evolve, it will give a new look to old problems.

If

policy

of

remains

too

tight,

there

aborting a beneficial process.
loose,

and

pressure

thus

could

recreate
reemerge

abort the beneficial process.

be

a

risk

If it should become too

excess
which

will

demand,

could,

in

inflationary
turn,

also

It will be necessary to

-8-

sort out what of the familiar and well understood is
still in place and functioning, what is new, and what
to do about it.

My fondest hope is that these are the

sorts of problems we will face.
Let me close with a word about the pivotal role
the private sector will play in this drama.

It seems

to me we must regain our long-term perspective on what
constitutes

true

economic

value.

I

fear

we

have

slipped into a "quick buck" mentality in this country,
which I would suspect was born in the late unlamented
inflationary era.
of

speculative

activity

financial world,
gyrations

It is manifested in a wide variety

and

can

that

permeates

the effects

be

devastating

much

of

our

of

these

financial

on

the

operating

businesses that we depend upon to make our economy go.
Real economic
strength:

well

value is

trained,

found in

motivated

solid

and

loyal

long-term
employee

groups; market acceptance earned through offering good
products at reasonable prices; new products developed
through
nurtured;
These

research

and

then

carefully

low cost efficient

things

and

economic value.

many

and

patiently

plants to produce

others

are

the

In the final analysis,

stuff

them.

of

real

regardless of

what public policies may be in place, it will have to
be the private

sector that

world market and it

gets the job done in

is only through concentration

the
on

-9these

traditional

elements

of

good business

practice

that this can be achieved.
Let me end where I began.

What our economy needs

from public financial policy is a climate of stability
on favorable

levels.

If we

can move toward

this we

have a great opportunity to make important progress and
could,

indeed,

favorable era.

very
This

quickly

move

toward

a

highly

is clearly worth working

toward

and I am confident that it is the way that we will go.