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For R e l e a s e on D e l i v e r y
15:00 Central European Time
9 : 0 0 A . M . E a s t e r n S t a n d a r d Time
F r i d a y , J a n u a r y 2y, 1 9 8 8


H. R o b e r t H e l l e r
M e m b e r , Board of G o v e r n o r s of the Federal R e s e r v e S y s t e m

World E c o n o m i c Forum
Davos, Switzerland
January 29, 1988


It is a great pleasure to speak to you oh the topic of "U.S.
Monetary Policy and International Bank Regulation" because it
combines the two main responsibilities of the Federal Reserve

I have been allotted 10 minutes for my remarks, but

I trust we all recognize that this is barely enough time to
introduce topics of such enormous breadth and depth.

Let me therefore summarize some of the key issues to kick
off the debate —

which I trust will be lively indeed.

First, I believe that U.S. economic growth will exceed two
percent this year. This is not at all unsatisfactory for an
expansion that is'now over five years old. Although a
recession is not evident in the numbers, the quarterly
pattern may well be a bit uneven.

Second, the economy is becoming more balanced because the
sectors that were leading the growth parade in years past are
slowing down markedly, while the formerly sluggish sectors
are now expanding more vigorously.

Looked upon in a different way, we must shift resources from
the domestic sector to the international sector, and our
domestic growth will have to be somewhat subdued to free
these resources for international sector expansion. That is


the game plan.

Among the sectors that are slowing down are governmental
and consumer spending. Also the construction sector is
showing considerable sluggishness.

The key growth sector is now foreign trade. Agriculture and
energy are also showing new life, and business investment
soared in the second half of last year. Let me briefly
highlight these developments.

Government Spending Slows to Cut Deficit

The current restraint in governmental spending is desirable
for several reasons: one, governmental spending grew too fast
during the early eighties and had begun to absorb an
increasing percentage of GNP. Two, the budget deficit needs
to be further reduced, and three, the entire domestic economy
must slow down to make room for export expansion.

The key to budget consolidation has been strict spending

Last year, the federal deficit was reduced by

one-third to $148 billion. Of course, we all agree that even
that deficit is still too large and must be reduced further.
The Gramm-Rudman legislation ensures that we will continue to
hold our feet to the fire.


It is also important to keep in mind that we are now in the
last year of a federal income tax reform of unprecedented
magnitude. Marginal income tax rates were cut from 80 percent
in 1980 to 28 percent this year. The top corporate tax rate
is now 34 percent. It stands to reason that these tax rate
reductions helped in the creation of 14.5 million new jobs
during the current expansion. These important long-term
incentives to work should not be sacrificed to achieve shortterm goals.

Better Domestic Economic Balance

Consumer spending is slowing considerably after a rapid
expansion during the last few years. The result of this
spending boom was that the personal saving rate dropped below
3 percent in the fall.

We all agree that a slowdown in

consumer spending accompanied by higher savings rates is
needed for domestic as well as international financial
reasons —

and such an increase now seems certain.


other sector that shows a significant decline in activity is
the construction industry.

Agriculture and energy are two domestic sectors that were
rather depressed and are now doing better. Agriculture, in
particular, has benefitted from federal spending programs,
so that real farm income is now at the highest level in over
a decade.

Energy prices are now declining somewhat as a result of
unused OPEC capacity, but we expect that the contractionary
phase in energy should be largely behind us. While one
should not expect a return to the boom conditions of the
seventies, there is again room for well-planned and
carefully implemented energy projects.

Foreign Trade Stimulus to the Economy

The key growth sector is now foreign trade. About half of the
overall growth impetus in 1988 should come from this sector

Much of the rejuvenation of foreign trade is due to the
exchange rate changes that we have witnessed since the spring
of 1985.

We are now in a position where the average

exchange rates prevailing in 1979 and 1980 have been
approximately restored.

As you will recall, in those years

the U.S. current account was balanced, and it stands to
reason that U.S. producers are no longer as handicapped in
world markets as in recent years.

Our non-agricultural exports are now growing near 20 percent
annually in volume terms.

While this is an encouraging

development, it is clear that the legacy of the dollar
overvaluation is still with us in the form of record trade

imbalances. The U.S. is now running an estimated current
account deficit of $160 billion, while Japan runs a surplus
of about $85 billion and Germany shows a $45 billion

It should also be kept in mind that our export growth rate
has to be about two-thirds higher than our import growth
rate just to keep the trade deficit from rising in absolute
dollar terms. We still have a long way to go to rectify the
existing imbalances, but we are determined to do so.

I stated earlier that the exchange rate changes that have
already taken place will help to restore a better balance in
the international accounts. But it would be wrong to assume
that this process will be entirely automatic and painless.

For the United States, this implies enormous domestic
adjustments that include a sharp reorientation of the entire
economic structure towards the foreign trade sector. For many
American producers —
manufacturers —

especially the small and medium-sized

this will be a period of unprecedented

challenges. Some of them may even have to learn a few
foreign languages to succeed in the new environment.

Complementarity in Global Adjustment Needed

We should also keep in mind that the restructuring of

American industry towards the foreign trade sector and the
complementary reorientation of Japanese and European
industries will be much easier to accomplish in an
environment of economic growth —

rather than stagnation.

Instead of fighting over market shares, growth will permit
everyone to move forward.

In that connection it is important to emphasize that the
adjustment of the trade imbalances should not be brought
about by protectionism or a recession in the United States.
While this would surely lower U.S. imports, it would also
lower European and Asian exports. That would be the
prescription for global stagnation and maybe even global


Instead, the global adjustment should come about through a
surge in imports by the surplus countries —

a surge brought

about by growth and market-opening measures.

But time is passing and with it opportunities for forwardlooking and growth-oriented measures on behalf of the surplus
countries are being foregone.

As a result, the pressures for

adjustment by the deficit countries are mounting and are
becoming increasingly difficult to resist and to cope with.

In particular, it is important that the current period of
dollar stability is not seen as an excuse for complacency,

but as an opportunity to put economic policies in place that
will bring about the needed adjustment in the trade
accounts and thereby alleviate exchange rate pressures.

Monetary Policy Carefully Balanced

In such an environment, U.S. monetary policy needs to be
carefully balanced. On the one hand, we need to supply enough
liquidity to sustain the economic expansion; on the other
hand, domestic growth needs to be sufficiently constrained so
that resources can be shifted to the foreign sector.

At the same time, we have to be mindful of the inflationary
impetus emanating from the foreign trade sector in periods
when foreign currencies —

and with it foreign goods —


becoming more expensive. We must avoid the spreading of these
price pressures to the domestic economy.

That inflation can be successfully contained during periods
of currency depreciation has been demonstrated by Japan and
Germany, which managed to cut their respective inflation
rates during the period from 1980 to 1985 from 8 percent to 2
percent and from over 5 percent to 2 percent.

I believe that U.S. monetary growth last year has been
appropriate to support this complex set of objectives of
continued growth with price stability and room for external


But it is also clear that monetary policy alone cannot be
held responsible for the achievement of these multiple
objectives. Other policy tools and, in particular, fiscal
policy, must carry their proper share of the adjustment
burden as well.

In sum, I am convinced that our monetary policy stance has
been appropriate, and we will do our best to continue this

Banking Reform Needs To Be Implemented

Let me close with a few remarks about banking reform. Two
highly significant changes in the regulatory environment for
banks are now in the offing.

For one, the U.S. Congress is now considering a far-reaching
modification and modernization of our banking laws. The draft
legislation submitted by Senators Garn and Proxmire will
permit the linkage of commercial and investment banking
activities within the United States for the first time in
over 50 years. I realize that for most of the European
members of this audience this is a just a catch-up to your
everyday practices. But for us in the United States it
represents a most significant reform that was unthinkable

only a few years ago. This reform will finally allow American
banks to compete across the same product spectrum to which
you have long been accustomed. Needless to say, I
wholeheartedly support this reform legislation and hope that
it will be enacted speedily.

The second regulatory change is truly global in scope. I am
speaking, of course, of the new international risk-based
capital standards that were agreed to in draft form by the
supervisory agencies of 12 industrialized countries meeting
at the Bank for International Settlements in Basle. Given
the complexity of the topic and the various national
practices involved, this accomplishment is truly

The draft agreement, if ultimately adopted, will go a long
way in harmonizing regulatory practices in the 12 countries
and thereby contribute significantly to a high degree of
competitive equality among virtually all internationally
active banks.

There are three key elements to the


First of all, there is agreement on a common definition of
capital. The role of common stockholders equity capital is
given central importance. This equity capital can be
supplemented at the option of the national authorities by
various types of preferred stock, perpetual and subordinated

debt, mandatory convertible securities, general loan-loss
reserves, and even unrecognized capital gains in buildings
and stock holdings.

Second, there is a general framework for assigning assets and
off-balance sheet items into several broad risk categories.
The classification scheme recognizes the varying degree of
risk involved in holding cash, Treasury securities, interbank
claims, and regular bank loans and assigns various weights to
these asset classes. The scheme also converts off-balance
sheet items, such as forward foreign exchange contracts,
standby letters of credit, performance bonds, and various
types of credit facilities into balance-sheet equivalents.
The key accomplishment here is to adjust the banks' exposure
for the actual risk involved and to remove the disincentive
to hold liquid and secure investments.

Finally, the proposal specifies a minimum risk-based capital
ratio of 8 percent, of which 4 percent must be in the form of
shareholder equity, by year-end 1992. Banks are expected to
achieve minimum interim targets of 7.25 and 3.25 by the end
of 1990.

While such ratios will be easy to achieve for banks in some
countries, there will be other countries where banks will
have to add considerably to their capital in order to be in
compliance. As a result, competitive equity should be greatly

increased and the safety of the international banking system
further enhanced.

Just two days ago, the Federal Reserve Board voted to put
these proposals out for public comment prior to final


To sum up, both on the monetary policy front and the
regulatory front we face numerous challenges in the year
ahead. The necessary decisions will have to be carefully
considered, but there is no reason why we should not succeed
in maintaining non-inflationary growth and a healthy and
competitive banking system.