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Re a d i n g Co p y DEFICITS AND INFLATION: THREATS TO A SUSTAINED RECOVERY Re m a r k s of Jo h n J. Ba l l e s , Pr e s i d e n t F e d e r a l Re s e r v e B a n k Me e t i n g and with of San Fr a n c i s c o Co m m u n i t y Le a d e r s D i r e c t o r s , Los A n g e l e s B r a n c h F e d e r a l Re s e r v e B a n k of San F r a n c i s c o Ba k e r s f i e l d , Ca l i f o r n i a No v e m b e r 23, 1982 De f i c i t s Th a n k time I you am S u s t a i n e d Rfcovfry to a f or t h i s o p p o r t u n i t y Ba k e r s f i e l d I visit growth that In f l a t i o n : T h r e a t s and to meet with y o u . Ea c h impressed with the vigor and C e n t r a l Va l l e y . is e v i d e n t t h r o u g h o u t t h e Ev e n WHEN YOU ARE SUFFERING AN ECONOMIC DOWNTURN, ALONG WITH THE REST OF THE NATIONAL ECONOMY, THERE IS A SENSE OF PROGRESS AND OPTIMISM IN THIS AREA. I APPRECIATE THE TIME I HAVE WITH YOU TODAY. I WOULD LIKE TO SHARE WITH YOU SOME THOUGHTS ABOUT WHAT THE FED HAS DONE AND IS TRYING TO DO, AND TO POINT OUT SOME OF THE THINGS THAT MUST BE DONE FURTHER — IMPORTANT INSTITUTIONS — BOTH BY THE FED AND BY OTHER TO IMPROVE THE ECONOMY OF OUR NATION AND OF THIS AREA. Ro l e of D irectors Bef o r e i nto t h a t , h o w e v e r , we get I'd like to pay TRIBUTE TO AN OUSTANDING GROUP OF INDIVIDUALS -- LOS ANGELES' own B r u c e Sc h w a e g l e r and his c o l l e a g u e s Los A n g e l e s B o a r d of Directors. a former director is w i t h is a p r o m i n e n t b u s i n e s s m a n and banker D irector was a very valuable member. T he D i r e c t o r s involved with to the at our also of t h e in Re s e r v e Ba n k 's like to note that us t o d a y a s w e l l . as served two terms I'd on o u r Ra y D e z e m b e r Ba k e r s f i e l d . Los A n g e l e s B r a n c h five offices each of the ma j o r tas k s are He and personally d e l e g a t e d by Co n g r e s s F e d e r a l Re s e r v e . Th e s e tasks T he include: provision of 'w h o l e s a l e ' banking services, SUCH AS COIN, CURRENCY, AND CHECK PROCESSING; 2 - - SUPERVISION AND REGULATION OF A LARGE SHARE OF THE NATION'S BANKING SYSTEM; ADMINISTRATION OF CONSUMER-PROTECTION LAWS; AND, IN PARTICULAR, PARTICIPATION IN THE DEVELOPMENT OF MONETARY POLICY. W e ON THE DAILY FIRING LINE ARE FORTUNATE IN THE QUALITY OF ADVICE AND COUNSEL WE GET FROM EACH OF THEM IN THESE IMPORTANT AREAS. O ur D i r e c t o r s constantly help us improve the l e v e l of CENTRAL-BANKING SERVICES, IN THE MOST COST-EFFECTIVE MANNER. T his is a c r u c i a l role, because Mo n e t a r y Co n t r o l A c t the F e d e r a l Re s e r v e ENVIRONMENT. 1980 of is under the terms and other recent in a n e w a n d c h a n g i n g of t h e legislation, operating FOR OVER A YEAR NOW, THE FED HAS BEEN MAKING ITS SERVICES AVAILABLE TO ALL DEPOSITORY INSTITUTIONS OFFERING TRANSACTION (CHECK-TYPE) ACCOUNTS AND NONPERSONAL TIME DEPOSITS -- AND THOSE SERVICES ARE BEING PRICED EXPLICITLY FOR THE FIRST TIME... Ye t , above a l l , our D irectors help us improve the WORKINGS OF MONETARY POLICY. AS ONE MEANS OF DOING SO, THEY PROVIDE US WITH PRACTICAL FIRST-HAND INPUTS ON KEY DEVELOPMENTS IN VARIOUS REGIONS OF OUR NINE-STATE DISTRICT AND IN VARIOUS SECTORS OF THE WESTERN ECONOMY. - O ur D i r e c t o r s thus help 3 - us a n t i c i p a t e changing trends in THE ECONOMY/ BY PROVIDING INSIGHTS INTO CONSUMER AND BUSINESS BEHAVIOR WHICH SERVE AS CHECKS AGAINST OUR OWN ANALYSES OF STATISTICAL DATA. THEIR ADVICE HAS BEEN ESPECIALLY VALUABLE TO US THESE LAST SEVERAL YEARS, WHEN WE'VE HAD TO FACE PROBLEMS OF HIGH INFLATION, HIGH INTEREST RATES, AND SHARP FLUCTUATIONS IN BUSINESS ACTIVITY. Th u s , D irectors our s e r v e a ke y r o l e in m a k i n g t h e F ed SENSITIVE TO THE WIDE-RANGING INTERESTS OF OUR VAST AND DIVERSE ECONOMY, JUST AS THE CONGRESS ENVISIONED WHEN IT ESTABLISHED THE SYSTEM DURING PRESIDENT WOODROW WILSON'S TERM IN OFFICE. THAT VITAL ROLE IS REALLY APPRECIATED BY ME AND MY STAFF, AND I APPRECIATE THIS OPPORTUNITY TO PUBLICLY EXPRESS IT. H igh In f l a t i o n , H igh In t e r e s t Ra t e s Fo r a long t i m e , too and H igh Un e m p l o y m e n t l o n g , our national economy has BEEN PLAGUED BY A HIGH RATE OF INFLATION, HIGH INTEREST RATES, AND HIGH UNEMPLOYMENT. THANKFULLY, WE HAVE SEEN A DRAMATIC DROP IN INFLATION OVER THE PAST YEAR, AND WE HAVE SEEN A DRAMATIC DROP IN INTEREST RATES OVER THE PAST FEW MONTHS. Bo t h are still too Un e m p l o y m e n t , the land. h i g h , but the on t h e o t h e r Mu c h improvement is t h e r e . h a n d , is s p r e a d i n g h a s b e e n d o n e to a l l e v i a t e our gloom all over economic ills, BUT MUCH MORE NEEDS TO BE DONE. Mo n e t a r y policy since late 1979 has been primarily CONCERNED WITH REDUCING THE LONG-TERM UPWARD TREND IN THE - RATE OF INFLATION. 4 - IN VIEW OF THE DRAMATIC DECLINE IN INFLATION RATES OVER THE PAST YEAR — OF THAT POLICY — EVIDENCE OF THE SUCCESS IT IS WORTHWHILE TO REMIND OURSELVES OF WHAT IS NOW HI STORY, BUT WHICH, IN FACT, WAS A VERY REAL AND IMMEDIATE FEAR ONLY THREE YEARS AGO, THAT IS, THE FEAR OF DOUBLE-DIGIT INFLATION. In the Fa l l of 1979, inflation was r a t e d as t h e number ONE CONCERN OF THE CITIZENS OF OUR COUNTRY -- AND WITH GOOD REASON. WE WERE LOOKING AT INFLATION RATES EXCEEDING TEN PERCENT. WITH RATES OF THIS MAGNITUDE, AND HIGHER ONES IN PROSPECT, THE AVERAGE CITIZEN FEARED A SUBSTANTIAL DECREASE IN THE PURCHASING POWER OF HIS DOLLAR. WHILE SOME LABOR CONTRACTS IN THE U.S. HAD BUILT-IN ADJUSTMENTS FOR INFLATION, MANY WORKERS FOUND THEIR REAL TAKE-HOME PAY DECLINING. NOT ONLY WERE REAL WAGE AND SALARY INCREASES REDUCED BY INFLATION, INFLATION PUSHED MANY CITIZENS INTO HIGHER REAL TAX BRACKETS -- GREATLY DECREASING REAL SPENDABLE INCOME. RISING INFLATION ALSO MEANT THAT THE AVERAGE AMERICAN WAS LOOKING AT A REDUCTION IN THE FUTURE REAL VALUE OF HIS PENSION, AND ALL ASSETS DENOMINATED IN NON-INDEXED DOLLARS. IN A NATION WHERE THE TOTAL NUMBER OF ELDERLY IS RAPIDLY INCREASING, THIS IS A GREAT PROBLEM. For t h e b u s i n e s s m a n , d o u b l e -d i g i t inflation meant SUBSTANTIAL DIFFICULTY IN PROJECTING FUTURE SALES, REVENUES 5 - AND COSTS. It became - p a r t i c u l a r l y d i f f i c u l t to d e t e r m i n e THE VIABILITY OF CONTEMPLATED INVESTMENTS. INFLATION CONTRIBUTED SIGNIFICANTLY TO THE 2.2 PERCENT DECLINE IN REAL BUSINESS-FIXED INVESTMENT BETWEEN 1979 AND 1980. IN OTHER WORDS, INFLATION WAS IN THE PROCESS OF DESTROYING JOB FORMATION AND PRODUCTIVITY IMPROVEMENTS. THE DOLLAR WAS DECLINING IN STRENGTH. buy only 1.63 Swiss francs in INTERNATIONALLY, FOR EXAMPLE, IT WOULD Oc t o b e r , 1979, a decline 29 of PERCENT FROM ITS LEVEL JUST TWO YEARS EARLIER. A MAJOR BENEFICIARY OF INFLATION — OF WHICH THERE ARE VERY FEW -- IS THE FEDERAL GOVERNMENT. THE FEDERAL GOVERNMENT IS A NET DEBTOR TO THE PRIVATE SECTOR. HENCE, INFLATION HELPS REDUCE THE REAL VALUE OF GOVERNMENT DEBT HELD BY PRIVATE citizens. Ho w e v e r , In f l a t i o n it is t a x a t i o n w i t h o u t en o u g h , inflation Th i s is, quite s i m p l y , a t a x on a l l of representation. us. Ca r r i e d far can d e s t r o y a s o c i e t y . uncomfortable OCCURRED OVERNIGHT. and distressing situation had not IT HAD CREPT UP ON THIS NATION OVER A PERIOD OF MANY YEARS, ESPECIALLY IN THE 1970'S — INFLATIONARY DECADE IN OUR PEACETIME HISTORY. THE MOST UNLIKE THE INFLATIONARY PERIOD OF 1973-74, DOUBLE-DIGIT INFLATION IN THE LATER 1970'S CANNOT BE BLAMED ON OIL PRICE SHOCKS. IT MUST BE BLAMED PARTLY ON OVER-OPTIMISTIC NATIONAL POLICY OBJECTIVES IN THE MID-1970'S AND PARTLY ON PROCEDURES BY which the F e d e r a l Re s e r v e a t t e m p t e d to c o n t r o l inflation. - In response to these 6 - p r o b l e m s , the Fe d e r a l R e s e r v e UNDERTOOK MAJOR CHANGES IN OCTOBER, .1979, IN BOTH ITS LONG-RUN POLICY GOALS AND ITS TOOLS FOR ACHIEVING THOSE goals. Po l i c i e s w e r e d e s i g n e d to b r i n g down the rate INFLATION GRADUALLY OVER THE NEXT SEVERAL YEARS. THE Fe d e r a l Re s e r v e changed its o p e r a t i n g procedures of for MONETARY CONTROL BY PLACING MUCH GREATER EMPHASIS ON THE RATE OF GROWTH OF MONEY AND CREDIT AND MUCH LESS EMPHASIS ON THE LEVEL OF INTEREST RATES. T he In results the year by the of t h e s e ended changes have been dramatic S e p t e m b e r , 1982, personal consumption BY ONLY 5.3 PERCENT — consumer expenditure prices indeed, (as measured d e f l a t o r ) increased DOWN SHARPLY FROM THE PEAK OF 14 PERCENT REACHED IN 1980. WHOLESALE PRICE INFLATION FELL FROM 13.1 PERCENT IN THE YEAR ENDING OCTOBER, 1980, TO 3.6 PERCENT FOR THE YEAR ENDING OCTOBER, 1982. T he improvement in o u r d o m e s t i c price performance BEEN MIRRORED IN THE INTERNATIONAL MARKET. has THE U.S. DOLLAR IS NOW WORTH MORE THAN 2 SWISS FRANCS, AN APPRECIATION OF MORE THAN 29 PERCENT SINCE THE FALL OF 1979. BOTH DOMESTICALLY AND INTERNATIONALLY WE SEE SIGNS THAT THE VALUE OF OUR CURRENCY, which the F e d e r a l Re s e r v e had d i r e c t responsibility fo r PRESERVING,HAS IMPROVED. St r u c t u r a l D e f i c i t s Th e r e are associated with costs that any central banker recognizes following a gradual a n t i -inflationary - MONETARY POLICY. 7 - THESE COSTS INVOLVE THE LOSS OF REAL OUTPUT AND INCREASE IN UNEMPLOYMENT. BUT THE DEPTH OF THIS RECESSION AND THE LOSS OF JOBS ASSOCIATED WITH IT WAS NOT ANTICIPATED. IN FACT, AS LATE AS SEPTEMBER OF LAST YEAR, THREE MONTHS AFTER THE RECESSION IS NOW RECOGNIZED OFFICIALLY TO HAVE BEGUN, NO MAJOR FORECASTER ANTICIPATED MORE THAN A MODEST DECLINE. Wh a t dinarily was not anticipated beforehand was the extraor HIGH AND STUBBORN RESISTANCE OF INTEREST RATES. Historically we have observed a close and positive RELATIONSHIP BETWEEN CHANGES IN INTEREST RATES AND INFLATION. A n d , GENERALLY, INTEREST RATES FALL IN RECESSIONS, SETTING THE FOUNDATIONS FOR THE RECOVERY. OUR EXPERIENCE THROUGH LAST SUMMER IS UNUSUAL IN LIGHT OF THIS HISTORICAL BEHAVIOR. DURING THE FIRST TWELVE MONTHS OF THE RECESSION, RATES GENERALLY ROSE RATHER THAN DECLINED. FOR INSTANCE, THE AAA CORPORATE BOND RATE BETWEEN JULY, 1981, AND JUNE, 1982, ROSE FROM 14.38 PERCENT TO 14.75 PERCENT, AND ONLY IN THE PAST SEVERAL MONTHS HAVE BEGUN TO DECLINE. T h is unusual behavior is a s s o c i a t e d , in m y v i e w , w i t h THE MARKET'S PERCEPTIONS OF MONETARY AND FISCAL POLICIES. Let ME SPEND A MOMENT ON THIS POINT. In J u l y , 1981, Co n g r e s s IN U.S. ECONOMIC HISTORY. passed the largest tax cuts THAT TAX CUT WAS ASSOCIATED - 8 - WITH ONLY A MODEST REDUCTION IN FEDERAL EXPENDITURES, Wh i l e there was a major reduction in s o c i a l programs, that REDUCTION WAS ALMOST MATCHED BY AN INCREASE IN DEFENSE spending, He n c e , the tax cuts were not paralleled with SIMILAR REDUCTIONS IN FEDERAL EXPENDITURES. THE END RESULT WAS THE PROSPECT FOR MAJOR INCREASES IN THE FEDERAL DEFICIT OVER THE NEXT SEVERAL YEARS. SOME COMMENTATORS EVEN SUGGESTED THAT THE COMBINATION OF LARGE TAX CUTS, COUPLED WITH SIGNIFICANTLY SMALLER EXPENDITURE REDUCTIONS, MEANT THAT THE FEDERAL BUDGET WAS GOING TO BE STRUCTURALLY UNBALANCED. THAT IS, THE FEDERAL BUDGET WAS EXPECTED TO BE IN DEFICIT EVEN IF THE ECONOMY SHOWED A SIGNIFICANT RECOVERY OVER THE NEXT FEW YEARS. T he p r o s p e c t of large federal deficits over a several YEAR PERIOD TENDS TO RAISE LONG-TERM INTEREST RATES. EFFECT CAN OPERATE IN SEVERAL WAYS. THIS FIRST, AS THE PRIVATE DEMAND FOR CREDIT RISES WITH THE BUSINESS CYCLE EXPANSION OVER THE NEXT FEW YEARS, AND THE GOVERNMENT DEMAND FOR CREDIT REMAINS HIGH, TOTAL DEMAND PRESSES UPON THE AVAILABLE SUPPLY OF NATIONAL SAVINGS, RAISING INTEREST RATES AND CROWDING OUT SOME PRIVATE SPENDING. Se c o n d , structural government deficits over the next FEW YEARS CREATE GREAT CONCERN IN THE MINDS OF FINANCIAL MARKETS THAT THE FEDERAL RESERVE WILL EVENTUALLY BE FORCED TO MONETIZE THE DEFICITS BY EXCESSIVE AND HENCE INFLATIONARY GROWTH - IN THE MONEY SUPPLY. 9 - THE ASSOCIATED INCREASE IN INFLATION EXPECTATIONS ADDS TO THE INFLATION PREMIUM INCORPORATED IN INTEREST RATES. La s t l y , uncertainty about the s i z e of federal deficits AND CONSEQUENTLY ALSO ABOUT THE FUTURE COURSE OF MONETARY POLICY ADDS TO THE RISK PREMIUM IN LONG-TERM RATES EVEN WHEN THE CURRENT INFLATION RATE IS DECLINING. MARKETS REMEMBER THAT THE SHARP DECLINE IN INFLATION IN 1975-76 WAS ONLY TEMPORARY. THE SUBSEQUENT EASING OF MONEY LED TO ANOTHER ROUND OF DOUBLE-DIGIT INFLATION IN THE LATE 1970'S. Th e s e d e f i c i t -r e l a t e d factors increase l o n g -t e r m r a t e s AND GREATLY REDUCE THE ABILITY OF BUSINESSES TO FUND LONG TERM DEBT. T h is REQUIRES THE FUNNELLING OF s o m e of t h e DEMAND FOR FUNDS INTO THE SHORT-END OF THE MARKET, TENDING TO INCREASE SHORT-TERM INTEREST RATES. T he Au g u s t federal deficit when Co n g r e s s picture passed the has been $98.3 modified billion tax since last increase SPREAD OVER THE NEXT THREE YEARS, ALONG WITH FURTHER SPENDING CUTS SOUGHT BY PRESIDENT REAGAN. THE POSITIVE RESPONSE OF THE FINANCIAL MARKETS -- THE RISE IN STOCK PRICES AND THE FALL IN INTEREST RATES — WAS GRATIFYING. THIS WAS CERTAINLY A STEP IN THE RIGHT DIRECTION. Ho w e v e r , there is c o n s i d e r a b l e w o r k a h e a d if f e d e r a l DEFICITS ARE TO BE BROUGHT UNDER CONTROL AND LONG-TERM INTEREST RATES FURTHER REDUCED TO REASONABLE LEVELS. FOR, EVEN WITH THESE TAX INCREASES AND SPENDING CUTS, DEFICITS - 10 - REMAIN HIGH BY HISTORICAL STANDARDS AND A GOOD DEAL OF UNCERTAINTY REMAINS IN REGARD TO THEIR SIZE. T he FEDERAL DEFICIT FACING US NEXT YEAR ALONE IS ENORMOUS. Ac c o r d i n g to estimates from the Co n g r e s s i o n a l B u d g e t O f f i c e , THE 1983 UNIFIED BUDGET DEFICIT MAY SWELL TO $175 BILLION. TO PUT SOME PERSPECTIVE TO THE DEFICIT PROBLEM LET ME STATE THE EFFECTS ANOTHER WAY. TOTAL FUNDS RAISED BY THE FEDERAL Go v e r n m e n t p e r c e n t of n e t a m o u n t e d to 23 savings available FROM THE PRIVATE SECTOR AND STATE AND LOCAL GOVERNMENTS DURING THE 1970'S, WITH THE SHARE INCREASING DURING RECESSION YEARS. BUT NOW, ACCORDING TO MY STAFF, THE SHARE COULD RISE FROM 35 PERCENT IN THE 1980-81 PERIOD TO 62 PERCENT IN 1983. T he Key to Ec o n o m i c Re c o v e r y T he U.S. trends. T he economy markets now is d o m i n a t e d b y h i g h l y d i v e r g e n t in w h i c h people sell their labor and THEIR GOODS ARE DEPRESSED, WHILE THE MARKET IN WHICH THEY SELL THEIR FINANCIAL ASSETS IS STRONG. AS ONE HEADLINE WRITER PUT IT, "STOCKS JUMP AS JOBS SLUMP". THE UNEMPLOYMENT RATE IN OCTOBER, OF 10.4 PERCENT, IS a 42-year high. Perhaps a more realistic measure of the WEAKNESS IN THE ECONOMY IS THE EMPLOYMENT RATE. EMPLOYMENT STANDS AT 56.6 PERCENT OF THE ADULT POPULATION, WHICH IS DOWN FROM 59 PERCENT IN 1979, AND NOT QUITE AS LOW AS THE 55 PERCENT IT REACHED IN THE TROUGH OF THE 1974-75 RECESSION. Th u s , the e conomic weakness we currently face is s e r i o u s . - Ho w e v e r , it disaster that we is n o t in a n y w a y faced in t h e 11 - in t h e same 1930' s , n a t u r e as t h e Fo r t y -t w o years AGO, THE EMPLOYMENT RATE WAS 47.6 PERCENT. In c o n t r a s t to THE WEAKNESS in t h e MARKETS for g o o d s AND LABOR, THE FINANCIAL MARKETS HAVE SHOWN DRAMATIC STRENGTH SINCE LAST SUMMER. STOCK PRICES HAVE RISEN BY 40 TO 50 PERCENT, 30-YEAR GOVERNMENT BONDS HAVE FALLEN FROM 14.6 PERCENT TO 10.0 PERCENT. IHREE-MONTH TREASURY BILLS HAVE FALLEN FROM 12.5 PERCENT IN JUNE TO LESS THAN 8 PERCENT IN EARLY NOVEMBER. T he key t o e c o n o m i c recovery in 1983 and beyond is CRITICALLY DEPENDENT ON MAINTAINING A MOMENTUM OF DECLINE IN THE LONG-TERM INTEREST RATES. THE DECLINE WE'VE HAD UP TILL NOW CLEARLY SIGNALS THAT THERE WILL BE SOME STRENGTH IN THE ECONOMY IN THE MONTHS AHEAD. WHETHER THAT STRENGTH IS SUSTAINABLE DEPENDS UPON WHETHER THE DECLINE IN RATES IS ALSO SUSTAINABLE. Th e r e are two factors which are important in a SUSTAINABLE REDUCTION IN LONG-TERM INTEREST RATES. THE FIRST IS TO REDUCE THE FEDERAL GOVERNMENT DEFICIT. MY STAFF ESTIMATES THAT FOR EVERY $25 TO $30 BILLION REDUCTION IN DEFICITS OVER THE NEXT THREE FISCAL YEARS THAT LONG-TERM INTEREST RATES CAN BE REDUCED APPROXIMATELY ONE PERCENTAGE POINT. THE SECOND IS TO MAINTAIN PROGRESS IN A FURTHER REDUCTION OF THE ACTUAL INFLATION RATE, AS WELL AS PRESENTING A RENEWED RISE IN INFLATION EXPECTATIONS. IN LARGE PART ON FED CREDIBILITY. THE LATTER DEPENDS 12 - - I DEFINE THE REQUIREMENTS OF FEDERAL RESERVE CREDIBILITY AS SETTING VIABLE AND NON-INFLATIONARY RANGES OF GROWTH FOR MONEY AND CREDIT AND HITTING THOSE RANGES ON A YEARLY BASIS. If NOT, OUR ONLY ALTERNATIVE IS TO HAVE A JUSTIFIABLY GOOD AND UNDERSTANDABLE REASON FOR DEPARTING FROM THEM. THIS REASON CANNOT SATISFY CENTRAL BANKERS ONLY; IT MUST ALSO SATISFY SKEPTICS IN THE FINANCIAL MARKETS. IN THIS MANNER, THE PUBLIC'S EXPECTATIONS OF INFLATION WILL COME DOWN AND LEAD THEM TO REDUCE THE INFLATION RISK THEY MUST FACTOR INTO TODAY'S INTEREST RATES. LONG-TERM RATES WILL THEN TEND TO DECLINE. T he recent temporary overshooting of Ml targets has THREATENED THE FEDERAL RESERVE'S HARD-WON CREDIBILITY. IN THE LAST FEW MONTHS, THE MONEY SUPPLY LOOKS LIKE IT WILL BE GROWING WELL IN EXCESS OF THE FEDERAL RESERVE'S TARGET. BUT THERE ARE GOOD REASONS FOR THIS. In Ju l y , C h a i r m a n Vo l c k e r alerted Co n g r e s s to the POSSIBILITY THAT THERE MAY BE SOME OVERSHOOTING OF Ml IN THE MONTHS AHEAD IF THE RECESSION CAUSES PEOPLE TO HOLD MORE PRECAUTIONARY MONEY BALANCES. THAT SEEMS TO HAVE BEEN A MAJOR FACTOR IN THE RAPID GROWTH OF Ml IN AUGUST, SEPTEMBER, Oc t o b e r . and Be g i n n i n g in Oc t o b e r , there have also been TECHNICAL PROBLEMS WITH INTERPRETING THE Ml MEASURE OF MONEY supply. of Th e s e problems include the m a t u r a t i o n A ll Sa v e r s Ce r t i f i c a t e s t e m p o r a r i l y as Ml in which Oc t o b e r and have been No v e m b e r . of $35 classified billion 13 - Mo r e o v e r , institutions starting (m o s t l y in - De c e m b e r , banks and the deposit taking savings and l o a n s ) w i l l be ALLOWED TO CREATE DEPOSIT ACCOUNTS THAT COMPETE DIRECTLY WITH MONEY MARKET MUTUAL FUNDS AND CAN BE USED FOR WRITING CHECKS. T he NEW FINANCIAL INSTRUMENT WILL TEND TO DRAW FUNDS FROM TRADITIONAL CHECKING ACCOUNT BALANCES (COUNTED IN Ml) INTO THE DEPOSITORY INSTITUTIONS' RELATED MONEY MARKET FUNDS (WHICH MAY NOT BE COUNTED IN Ml). Cl e a r l y , the financial market has reacted TO THE TEMPORARY OVERSHOOT OF Ml TARGETS. positively THE STOCK MARKET SURGED TO NEW HIGHS AND LONG- AND SHORT-TERM INTEREST RATES HAVE DROPPED SUBSTANTIALLY SINCE EARLY OCTOBER. THE FINANCIAL MARKET IS COGNIZANT OF THE ISSUES FACING THE FEDERAL RESERVE AND ITS VOTE OF CONFIDENCE IS REASSURING. THAT THIS VOTE IS NOT MISPLACED — I CAN REASSURE YOU WE HAVE NOT ABANDONED OUR LONG-TERM GOAL OF GRADUALLY REDUCING INFLATION. WITH A RECESSION CONTINUING INTO THE SECOND HALF OF 1982, IT IS IMPORTANT THAT THE FED AVOID EXCESSIVE RESTRICTIONS REGARDING THE PROPER MEASURE OF MONEY. IT IS IN THIS CONTEXT THAT ONE MUST INTERPRET THE RAPID GROWTH OF MONEY SINCE AUGUST. T he Ec o n o m y -- St a t u s In Ec o n o m i c t e r m s of t h e signals in and Ou t l o o k national Se p t e m b e r INDICATIONS OF RECOVERY. e c o n o m y , the and Oc t o b e r outlook point toward MIXED. few WE HAD A SLUGGISH GROWTH RATE OF 0,8 PERCENT IN REAL GNP IN THE THIRD QUARTER. RATE OF 10,4 PERCENT EMPHASIZED THAT WEAKNESS. is THE UNEMPLOYMENT 14 - On goods in the other rose Oc t o b e r 4,7 h a n d , new orders percent in FOR Se p t e m b e r . 1 i n c r e a s e d by o n l y 18 s h o w e d an - percent g a i n . nondefense Wh i l e capital housing starts pe r c e n t , new building In f l a t i o n permits c o n t i n u e d to m o d e r a t e AND THE INDEX OF LEADING ECONOMIC INDICATORS, A HISTORICALLY VALID INDICATOR OF ECONOMIC RECOVERY, ROSE .5 PERCENT IN Se p t e m b e r f or t h e Co n s u m e r s fifth generally increase in s i x m o n t h s . supply the initial impetus to a RECOVERY, AND THEY HAVE SHOWN SOME SIGNS OF ACTIVITY. Re t a i l sales have shown slight improvement. Ho u s e h o l d BUYING POWER HAS BEEN ENHANCED BY THE $37 BILLION ADDITION TO THE INCOME STREAM FROM THE COMBINATION OF THE 10 PERCENT INCOME TAX REDUCTION AND THE 1\ PERCENT INCREASE IN SOCIAL Se c u r i t y benefits Co u p l e d decline in purchasing with effective recent inflation power. last J u l y 1. increases in t h e Re l a t i v e in p e r s o n a l last year to has i n c o m e , the increased income, household real credit is NOT EXCESSIVE, AND HAS CONSIDERABLE ROOM FOR EXPANSION. T he recent decline in interest rates should provide some ADDITIONAL BOOST TO THE DEMAND FOR DURABLE GOODS BY HOUSEHOLDS. Be c a u s e of t h e unusually high real interest rates we HAVE SEEN IN THE LAST TWO YEARS, THE U.S. DOLLAR HAS BEEN VERY STRONG IN THE FOREIGN EXCHANGE MARKETS. WHILE THIS HAS MADE FOREIGN IMPORTS CHEAPER AND HAS ATTRACTED CAPITAL FROM ABROAD, IT HAS ALSO MEANT THAT OUR INDUSTRIES HAVE HAD A ROUGH TIME COMPETING BOTH AT HOME AND ABROAD. THE FOREIGN TRADE PICTURE SHOULD IMPROVE AS INTEREST RATES DECLINE AND THE - 15 - EXCHANGE VALUE OF THE DOLLAR APPROACHES THE VALUE DETERMINED BY RELATIVE INTERNATIONAL PRICE LEVELS. OVERALL, IT IS EXPECTED THAT THE RECOVERY WILL BE A slow o n e . Ex c e p t for d e f e n s e s p e n d i n g , the consumption SECTOR SHOULD BE THE FIRST TO SHOW ANY MAJOR IMPROVEMENT THIS YEAR. RESIDENTIAL INVESTMENT WILL BE AIDED SOMEWHAT BY THE REDUCED LONG-TERM RATES AND GROWTH IN PERSONAL INCOME. Ho w e v e r , b u s i n e s s -f i x e d investment is n o t e x p e c t e d t o s h o w POSITIVE GROWTH UNTIL THE SECOND HALF OF 1983. Im p l i c a t i o n s T he Ba k e r s f i e l d f or economic situation and the in t h e THE KEY POINTS I HAVE JUST MADE. at Ke r n C o u n t y because it C e n t r a l Va l l e y C e n t r a l Va l l e y exemplifies I WILL DIRECT MY COMMENTS is c o n s i s t e n t l y o n e of t h e t h r e e MOST PRODUCTIVE AGRICULTURAL COUNTIES IN THE UNITED STATES AND IS ALSO THE LEADING PETROLEUM PRODUCING COUNTY IN THE NATION. T he four main employers in Ke rn Co u n t y are government, AGRICULTURE, THE RETAIL TRADE, AND THE SERVICE INDUSTRIES. Go v e r n m e n t jobs a c c o u n t for a b o u t 19 p e r c e n t of a l l EMPLOYMENT IN POSITIONS AT THE FEDERAL, STATE, COUNTY, AND LOCAL LEVELS. THE FEDERAL GOVERNMENT HAS CUT BACK IN ALL AREAS EXCEPT THAT OF DEFENSE AND IT IS IN THIS AREA THAT Ke rn Co u n t y Ba s e and may stand to b e n e f i t . Bo t h Ed w a r d s A ir Fo r c e Ch i n a La k e Na v a l W e a p o n s Ce n t e r are located in HERE AND SHOULD BENEFIT SHORTLY FROM INCREASES IN DEFENSE SPENDING. b o o s t to THIS SPENDING WILL, IN TURN, PROVIDE A Ke rn Co u n t y 's general e c o n o m y . 16 - A n o t h e r 19 - p e r c e n t of t h o s e employed WORK IN THE AGRICULTURE INDUSTRY. in K ern Co u n t y COTTON AND RAISINS ARE KEY CROPS, AND CITRUS FRUITS ARE EXPECTED TO BECOME MORE IMPORTANT AS LAND DEVOTED TO CITRUS CROPS ELSEWHERE IN the St a t e T he been year. declined over the in stability N et past 1983. TWO Fa l l i n g farm h a v e , in f a c t , incomes y e a r s , and little improvement interest rates and the farm expansion Fo r e i g n high operating costs are is relative in f u e l a n d c h e m i c a l c o s t s w i l l h e l p , b u t debt and current of t h i s f a r m s e c t o r , in g e n e r a l , h a s n o t o u t l o o k for the good this forecast expansion. is d i s p l a c e d b y r e s i d e n t i a l existing expected to c urb f or t h e r e s t of t h e y e a r . markets are also r e g i o n 's e c o n o m y . agricultural crops important Ab o u t harvested in for a n understanding o n e t h i r d of t h e t o n n a g e o f Ca l i f o r n i a is e x p o r t e d . A MAJOR EXPORT CROP, AND AN IMPORTANT ONE IN KERN COUNTY, IS COTTON. to the ElGHTLY PERCENT OF CALIFORNIA'S COTTON IS SHIPPED Fa r Ea s t EXPORTS WILL be to be p r o c e s s e d into c l o t h . Th i s year, HURT BY THE RELATIVE STRENGTH OF THE DOLLAR IN THE FOREIGN EXCHANGE MARKET. Fu t u r e employment gains are e xpected to come from the PETROLEUM INDUSTRY AS WELL AS THE DEFENSE INDUSTRY. 1981 WAS A RECORD OIL DRILLING YEAR AND YIELDED JOB INCREASES OF 18 percent. Pr o d u c t i o n increased 4.5 percent the first FIVE MONTHS OF THIS YEAR BUT DRILLING ACTIVITY HAS SLOWED SINCE THEN. THE EXPECTATION, NOW, IS THAT PRODUCTION WILL - 17 - STAGNATE FOR THE NEAR TERM BECAUSE OF LOWER OIL PRICES AND A WEAKENED DEMAND. NEVERTHELESS, DRILLING ACTIVITY SHOULD INCREASE OVER THE LONG TERM. Co n s o l i d a t i n g It h as b e e n a l o n g a n d have been sharply Ga i n s the made. In f l a t i o n reduced. Th e y hard and road to make the gains interest rates n eed to be reduced that have been further. Un e m p l o y m e n t HAS SURGED TO THE FORE AS THE MOST PRESSING PROBLEM. AS WE CONTINUE TO MOVE IN THE RIGHT DIRECTION, PUBLIC CONFIDENCE AND FAITH IN THE LONG-RANGE CREDIBILITY OF OUR MONETARY POLICY IS IMPORTANT. IMPORTANT TOO IS CONTINUING EMPHASIS ON REDUCTION OF THE STRUCTURAL DEFICITS. ONLY IN THIS WAY CAN THE PRIVATE SECTOR BE ENCOURAGED TO UNDERTAKE THE CAPITAL INVESTMENT NECESSARY TO CREATE JOBS. THE PRESSING CHALLENGE IS TO CONTINUE TO CUT PROSPECTIVE Fe d e r a l deficits a n d to c o n t i n u e to lower l o n g -ru n inflation EXPECTATIONS. A SUSTAINABLE RECOVERY REQUIRES BOTH MONETARY AND FISCAL DISCIPLINE. Y o u r UNDERSTANDING AND SUPPORT OF THESE REQUIRE MENTS IS IMPORTANT. WE IN THE FED MUST CONTINUE TO EARN YOUR RESPECT FOR THE CREDIBILITY OF MONETARY POLICY AND WE INTEND TO DO THAT. ONLY IN THESE WAYS CAN THE ENVIRONMENT BE CREATED IN WHICH BUSINESSMEN HAVE SUFFICIENT CONFIDENCE TO INVEST IN THE FUTURE AND THE U.S. ECONOMY CAN HAVE STABLE GROWTH WITHOUT INFLATION. # # #
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