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Remarks by
Henry C. Wallich
Member, Board of Governors of the Federal Reserve System
as Member of the Overview Panel
at the
Symposium on "The U.S. Dollar —
Recent Developments, Outlook, and Policy Options"
Sponsored by the Federal Reserve Bank of Kansas City
Jackson Hole, Wyoming
August 23, 1985

Remarks by
Henry C. Wallich
Member, Board of Governors of the Federal Reserve System
as Member of the Overview Panel
at the
Symposium on "The U.S. Dollar —
Recent Developments, Outlook, and Policy Options"
Sponsored by the Federal Reserve Bank of Kansas City
Jackson Hole, Wyoming
August 23, 1985

If I look at the dollar, which is the principal topic of this
panel, I think we can fairly say that, at considerable cost to the American
economy, considerable benefits have been achieved.

At home, inflation has

been cut to one-third or one-quarter of its earlier level.

Abroad, the

United States has acted as a locomotive, pulling the world economy out of
a recession.

The costs to foreign countries, in terms of higher interest

rates and higher prices, are less than the benefits.

Higher interest rates

are to some extent in the discretion of these countries since on a floating
exchange system they can allow their currencies to go down instead of raising
interest rates to prevent this.

The price increases resulting from the lower

value of the currencies evidently have not prevented an almost universal
reduction in inflation rates abroad.

The reason for this, I would think,

is that the prices of many of their imports, although invoiced in dollars,
are actually determined by world markets.

A strong dollar depresses the

-2price of world market commodities, especially oil.

As for higher interest

rates and the alleged draining of investment funds from foreign countries
to the United States, I would remind you that most foreign countries operate
with substantial excess capacity, unemployment, and, therefore, low utiliza­
tion of potential.

Bringing their economies up to full employment would

generate additional savings that could offset the drain to the United States.
For us at home, the benefits of the high dollar are, I think, over­
matched by its costs.

Inflation has been reduced, but some of this gain may

have to be given back if and when the dollar comes down.

We have had a good

investment performance, but not all that much better than in the past.

The

ratio of business fixed investment to GNF has increased only moderately over
past peaks on a gross basis and is lower on a net basis.

Meanwhile, the

domestic debt burden has increased substantially and the foreign debt of the
United States has increased to the point where we have become a debtor country.
We have largely lost the net investment income that used to be a great support
of our current account.
Even so, if there were a way of changing course now and stopping a
continuation of the adverse trends I have cited, one might say that we had
incurred an affordable cost in return for substantial benefits.

The difficulty

lies with the future.
Several of the earlier speakers have focused on the Fed and, in my
way of thinking, done us more honor than we deserve.
game in town; there are others.
we should play them all.

The Fed is not the only

But even if it were, that does not mean that

Neither can the Fed be held responsible for the

inability of the original administration program to deliver all it promised.

-3Rates of growth that would have raised revenues to the point of balancing
the budget after massive tax cuts were not prevented by the Fed.
view, they were unlikely to begin with.

In my

I was somewhat startled to hear

one speaker say that the administration was prepared to settle for an 8 percent
inflation in the near term, instead of the 4 percent that developed.

I had not

heard this from my Washington friends who stayed with the administration.

The

clear anti-inflationary stance of the administration, to my thinking, has often
been documented.
To underscore my comment that the Fed is not the only game in town,
let me draw your attention to some things that are going on with respect to
the international monetary system in which the dollar has had such a
spectacular career.

A study of the areas in which this system could be

inqproved was completed a couple of months ago and will be at the center of
discussion at the Seoul meeting of the International Monetary Fund and other
bodies hereafter.

I am surprised how little attention has been paid at our

meeting here to what, after all, constitutes the principal concerted effort
of the major industrial countries in the direction of monetary reform.
Granted that the results are modest, a fundamental question nevertheless
has been put on the table.

It is whether the present system of floating

rates, which has not performed satisfactorily in the opinion of most
observers, is inherently defective, tending to extreme fluctuations, or
whether this performance results from inappropriate use made of the system
and excessive pressures placed upon it.

In the former case, trying to change

the system in the direction of greater stability would merely have the effect

-4-

of pushing some of the inherent instability of the world economy into some
area other than exchange rates, for instance, into growth, inflation, and
employment.

If, on the other hand, the use made of the system was inappropriate,

then agreement on better use may be the remedy.
In the report, there is considerable discussion of "convergence"
as a means toward more stable exchange rates.

The question, not answered

very explicitly, is whether this convergence relates to performance or to
both performance and policies.

While the report was being developed,

increasing convergence of performance occurred, especially in the area of
inflation control.
inflation rates.

Almost all major countries were coming below double-digit
The three largest countries were coming below four percent.

Nevertheless, as inflation performance converged, the dollar took off.

This

seems to suggest that convergence of performance must be supplemented by
convergence of policies.

This means, unfortunately, that even if the system

is not inherently flawed, improvements needed in its use are of a very demanding
kind.
Let me now turn to the area on which much of the discussion at this
meeting has focused —

the Federal Reserve's role with respect to the dollar.

The great problem that the dollar poses for monetary policy is that the dollar
is essentially unpredictable.

The papers presented to the conference make

clear that we have no reliable theory of exchange-rate determination.
other words, the dollar is a wild card.

In

It is indeed discouraging to find

that economics, having demonstrated its inability to predict the stock market
and interest rates, now also seems to have failed with regard to exchange rates.

5

-

The dollar seems to be determined by forces to which perhaps we can give
a name, but the workings of which we do not understand.
If we did understand them, it still is not clear in which way
policy should seek to influence them.
with both a high and a lower dollar.
push us toward protectionism.

There are risks and costs associated
A high dollar, if maintained, would

It would increase our foreign debt at an

exponential rate, reaching a trillion dollars within very few years.

It

would continue to erode the core of our economy, manufacturing industry.
As for the ultimate level of the dollar, if and when a rate consistent with
some sort of equilibrium is reached, that equilibrium rate would have to be
lower the longer it takes to reach it, as annual debt service charges build
up.
A lower dollar would cause inflation to accelerate.

By improving

the current account and so reducing capital inflows, it would drive up
interest rates unless the budget deficit had been meanwhile materially
improved.

The negative effects of a decline in the dollar would be the

bigger the less orderly a downward movement, and the more severe the loss
of confidence and credibility.

A substantial rise in interest rates would

carry the threat of recession.

Even though a rise in interest rates resulting

from smaller capital imports should be compensated to some extent by stronger
net exports, the timing probably does not match.

Markets might anticipate

the movement of interest rates, whereas the improvement in the current account
would take time.

Indeed, we may not have the productive capacity in our

weakened manufacturing sector to step up exports very fast without price

-

pressures.

6-

For these reasons, an improvement in the budget deficit that

would relieve pressure on capital markets is urgently needed as accompaniment
of any decline in the dollar.
It is in the light of these considerations that suggestions made
in some of the papers and at this meeting that the Federal Reserve should
somehow push down the dollar must be examined.

I believe that any such

deliberate action would be damaging to inflation expectations.

It might

be damaging to our prospects of getting long-term interest rates down.

The

markets would find it difficult to adjust to such a Federal Reserve departure.
Unpredictable and possibly disorderly movements in the exchange market could
follow.

I mention only in passing that a policy of pushing down a falling

rate is contrary to IMF rules for floating which to be sure are not very
closely observed in practice.

It might also bring us in conflict with foreign

countries whose views as to the proper dollar rate for their currency might
not accord with ours, if we operated so as to make them believe that we had
a rate objective.
Other speakers have commented on and, to some extent, criticized
the proposal by Ron McKinnon.

By this proposal, the Federal Reserve and

the central banks of Germany and Japan should coordinate their policies.
When one of them found its money supply contracting, the others should
expand, and vice versa, keeping the "world money supply" approximately
stable.

There may be situations in which such a procedure was feasible

and desirable.

But just to give a contrary example at this time, now that

the U.S. money supply has expanded strongly in the middle of 1985, should we
urge the central banks of the two other countries to engage in countervailing

7

contraction?

Would this not completely ignore the situation of the world

economy, which is one of slowing expansion both here and abroad, with
inflation still relatively modest?

McKinnon's suggestion to give attention

to the exchange rate as an indicator of the stance of monetary policy is a
good one.

It is already being followed by the Federal Reserve, as Federal

Reserve policy records and Congressional testimony make clear.

But the level

of the dollar can only be one indicator among others, although one of growing
importance.

Targeting on the dollar, especially with a downward bias, would

require giving up the existing money-supply targets and risk provoking a new
burst of inflation.
Monetary policy, now as on many occasions, is in the difficult posi­
tion of having to pursue several targets with only one instrument.

Except on

rare occasions where something is seriously amiss, such as the weak dollar in
the fall of 1978, and the acceleration of inflation in late 1979, policy cannot
ignore the multiplicity of objectives.

It can and must, however, bear in mind

that by its nature it can be fully effective only in the pursuit of one
objective —

that of price stability.

Its influence on growth and employment

is transitory, strong in the short run but with counterproductive side effects
in the longer run and eventual washing out of growth and employment effects.
Monetary policy will be most effective when it avoids overreaching itself.

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