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The Interaction of Domestic and International Conditions
Remarks by
Frederick H. Schultz
Vice Chairman, Board of Governors of the Federal Reserve System

at the
NAM International Economic Affairs Committee Meeting
Washington, D.C.
Thursday, December 13, 1979

The Interaction of Domestic and International Conditions
Remarks by
Frederick H. Schultz
Vice Chairman, Board of Governors of the Federal Reserve System
at the
NAM International Economic Affairs Committee Meeting
Washington, D.C.
Thursday, December 13, 1979

I am pleased to participate in the 1979 meeting of the NAM
International Economic Affairs Cornnittee.

Your Chairman has developed

a challenging list of subjects for your agenda, not the least challeng­
ing being the topic assigned to me for discussion, "U.S. monetary

the interaction of domestic and international conditions."
It is clear that there remain substantial gaps in our under­

standing of how the world economy functions.

Not infrequently, even

in a country such as the United States where statistical information is
generally reliable and current, our knowledge of even the present state
of the economy is subject to significant uncertainties.

One striking

illustration was provided earlier this year, when economic analysts
generally believed that a recession had begun in the first half of 1979.
This did not prove to have been the case.

Now, the common view is to

assign the beginning of a recession to the fourth quarter of 1979.


slowdown in the U.S. economy does seem to be underway, but it is remark­
able that, halfway through the final month of the year, there remains




some doubt as to whether the U.S. economy is well into a downturn or
still in anexpansion phase.

Yet economic decisions, both private and

public, must be made if only by default, and the challenge is to do
one's best on the basis of available information.
The importance of taking full account of information on
international developments is becoming increasingly obvious.


experience has reemphasized the interrelated nature of the domestic and
international economic issues that we face -- in the Federal Reserve
System and, more generally, as a nation.

The influence of international

factors on the economy is demonstrably important» and sometimes, as in
the present situation where the balance between supply and demand in
the energy sector is so delicate, may be a dominant factor.
The need to consider carefully the international environment
when examining the needs of the U.S. economy would exist even if one
could identify a single objective at which policy should be aimed.


course, we have a long list of such objectives, including price stability,
high employment and a reasonable balance in our external accounts.


times in the past, and maybe at times in the future, conflicts among our
objectives may appear.

It is my view that, at least at the present time,

this is one problem we do not have.

Our overriding concern must be to

get the inflationary forces now at work in our economy under control.
We have registered important economic gains in recent years.
On the domestic side, many of our recent accomplishments have derived from
the long and vigorous economic expansion we have experienced.

During the

course of that expansion there have been dramatic increases in the number


of Americans employed.



On the international side, substantial progress

Mas been made in reducing the sizable external imbalances that emerged
among the industrial countries several years ago.

The large and growing

current-account surpluses of countries such as Germany and Japan in
1977-78 exacerbated the already difficult problems posed by high oil
prices and large surpluses of OPEC nations.

In 1979, the German and

Japanese surpluses have disappeared and better balance introduced into
the pattern of international transactions of the industrial countries.
As one consequence, we have seen more stability in exchange markets.
Such progress, as well as our aspirations for the future, would all be
jeopardized by a failure to deal with the inflationary pressures that
have become so pervasive in the U.S. and the world economy.
Thus, in early October it was clear to the members of the Federal
Open Market Committee that both the domestic and international objectives
of the United States were firmly interconnected» and that both required firm
action in reducing the sources of inflation in our economy.


aggregates and bank credit had been growing very rapidly in the third
quarter,and speculative activity was spreading to a number of commodity

These factors threatened to exacerbate the inflationary psychol­

ogy already present in the nation and, if allowed to continue, would only
have made more painful the ultimate process of economic adjustment.
I might note that a number of other industrialized countries
reached similar conclusions in recent months.

Some have interpreted

their actions, which have also resulted in higher interest rates, as an
attempt to compete with us.

All the world's nations have a common interest




in steps that will bring inflation under control.

We believe this has

been the motivation for the monetary actions taken abroad and we believe
that there is broad understanding on this point.
As you know, our actions of October 6 included a change in
operating procedures to give more day-to-day emphasis, in trying to
achieve our longer-run money supply targets, to the supply of bank re­
serves -- and less to the level of interest rates.

But I would emphasize

that our basic monetary targets were not changed and that in a sense the
Federal Reserve actions announced on October 6 were but a further step in
a continuing effort to exert effective control over money and credit expan­

The special marginal reserve requirement on increases in "managed

liabilities" of larger banks was decided upon in view of the fact that
those sources of funds have financed much of the recent buildup in bank
The experience of recent weeks has been hopeful but the new
technique for conducting open market operations will not be a panacea.
Over the longer run, the principal effect?, will occur through the impact
of the new procedures on inflation.

Of course, monetary policy by itself

cannot eradicate the deep-rooted inflation problem that we are experienc­

Complementary policies, particularly in the energy and tax areas,

are required to restore price stability and to assure that the dollar
maintains its strength.

Certain aspects of our tax structure, for example,

have increasingly been recognized as being less conducive to savings and
investment, and thus to the growth of U.S. productivity, than we might

I do not come here today with specific proposals in these areas but


I know that we can do better.



It is possible that careful study of policy

approaches of our major trading partners could reveal some interesting
options for discussion in this country (as, I hope, others may from time to
time learn from us).

The Federal Reserve, for its part, will be monitoring

financial developments closely and will adapt our approach as changing
economic needs may suggest.

For one thing, we recognize that the definition

of money itself requires review and we are well along in the process of such
a review, recognizing the need to take into account both the existence of
new domestic financial instruments and the availability of liquid assets
at offshore banking centers.
Fundamentally, I think our new approach should be judged by the
extent to which we are able over time to reduce the rate of growth of
relevant monetary and credit aggregates and, thereby, to reduce inflation

As these rates of increase come down, interest rates can also come

down and in a context of sustainable economic growth.

I firmly believe

that we must resist the tendency to overinterpret the very latest data or
react to each twist and turn in the economy and instead must maintain a
longer-term view of the needs of the economy.

Such a steady approach

will, I believe, advance, not postpone, the day when significant and
sustained declines in interest rates will be possible and will be consistent
with a healthy U.S. economy.
As we all know, and as I have alluded to earlier in these remarks,
a responsible pricing policy on the part of oil-exporting nations is essen­
tial if the world is to get inflation under control.

We, other oil-importing

both in the industrial world and in the developing world, and




the OPEC nations themselves, have an obvious and important interest in
attaining this objective.

The foreign currency value of the dollar is

another important element in the picture.

An erratic performance of

the dollar in exchange markets has at times threatened the effectiveness
of our basic anti-inflation program.

We remain alert to any need for

official actions to deal with such developments though we recognize that
improvements in fundamental factors are central to the longer-run health
of the dollar.
One factor that should be providing support to the dollar as the
new year progresses is our current-account position.

The U.S. current

account is expected to be approximately in balance for the year 1979 after
having registered a $14 billion deficit in each of the past two years.
Even assuming some further increases in the value of petroleum imports, a
surplus in our current account seems likely for 1980.

Continued expansion

of U.S. exports may be expected while increases in payments for non-oil
imports should be moderate.

This scenario is influenced, to be sure, by

the prospect for a slackening in U.S. economic growth that is widely antici­

What often goes unappreciated is the substantial underlying improve­

ment in our external accounts that may be attributed to the improved com­
petitiveness of U.S. goods resulting from the significant exchange rate
adjustments of 1977 and 1978.

For example, from the fourth quarter of 1978

to the fourth quarter of this year, we expect an increase of about 10 percent
in the volume of exports of manufactures and other non-agricultural goods.
Over this same period, while our economy has expanded at a respectable rate,
the volume of non-oil imports has declined.




U.S. producers have thus demonstrated once again their capacity
for recognizing and seizing opportunities.

This is not to deny that we

must continue to work at maintaining and improving U.S. competitiveness
in manufacturing, selling, financing and servicing our products.

It is

perhaps not surprising that, in such a large country, we have sometimes
tended to explore less fully than might be desirable the potential of
foreign markets.

There may continue for some time to be a useful role

both for government agencies and trade groups to assist in heightening
awareness of foreign marketing opportunities.
The major role for the Federal Reserve will be to exercise all
its influence in the effort to address our inflationary problem.


in this endeavor, as I have tried to emphasize this morning, is a pre­
requisite to a satisfactory resolution of a great number of pressing
economic problems that face us.