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R e a d i n g Co p y INFLATION AND GOVERNMENT POLICY Re m a r k s of J o h n J. B a l l e s , P r 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 with and Co e u r d of Sa n Fr a n c i s c o 'A l e n e C o m m u n i t y L e a d e r s D i r e c t o r s , Po r t l a n d B r a n c h , F e d e r a l Re s e r v e B a n k of Sa n Fr a n c i s c o Coeur d'Alene, Idaho August 6, 1981 In f l a t i o n It 's great to be G o v e r n m e n t Po l i c y and here G o d 's C o u n t r y , in for the first COMMUNITY-LEADERS LUNCHEON THAT WE'VE EVER HELD HERE IN N o r t h e r n Id a h o . Fo r my talk today, I bring you a combination OF GOOD NEWS AND BAD NEWS ABOUT THE NATIONAL E C O N O M Y . TOO MUCH OF THE LATTER, THERE'S I'M AFRAID, BUT THE GOOD NEWS SHOULD PREDOMINATE IN LATER YEARS IF WE CONTINUE TO STRENGTHEN OUR I'LL GET TO THE GOVERNMENT POLICIES AS WE HAVE RECENTLY. DETAILS IN A MINUTE -- BUT FIRST LET ME PAUSE TO DISCUSS ANOTHER PURPOSE OF THIS MEETING, WHICH IS TO GIVE THE DIRECTORS OF OUR Po r t l a n d office a chance to get together with the leaders of OUR DIRECTORS ARE AN ABLE AND DIVERSE GROUP THIS COMMUNITY. OF INDIVIDUALS, AND THEY HELP IN MANY IMPORTANT WAYS TO IMPROVE THE PERFORMANCE OF THE FEDERAL RESERVE SYSTEM, THE NATION'S CENTRAL BANK. Ro l e of Th e D irectors directors at our five offices are involved with each OF THE MAJOR TASKS DELEGATED BY CONGRESS TO THE FEDERAL RESERVE. Th a t encompasses such as the provision coin, currency regulation of administration a large of and check share of "w h o l e s a l e " of banking services p r o c e s s i n g ,- s u p e r v i s i o n the n a t i o n 's b a n k i n g c o n s u m e r -p r o t e c t i o n THE DEVELOPMENT OF MONETARY POLICY. LAWS; and in AND system; particular, W e ARE FORTUNATE IN THE ADVICE WE GET FROM THEM IN EACH OF THESE AREAS. O u r DIRECTORS CONSTANTLY HELP US IMPROVE THE LEVEL OF CENTRAL-BANKING SERVICES, IN THE MOST COST-EFFECTIVE MANNER. - Th i s is a crucial role at the 2 - present time, because under the TERMS OF THE NEW MONETARY CONTROL ACT, THE FEDERAL RESERVE IS MOVING INTO A NEW OPERATING ENVIRONMENT. THIS YEAR, THE FED IS 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. Y et ABOVE ALL, OUR DIRECTORS 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 directors thus help 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. F i s c a l P o l i c y Ro l e Let's consider the steps that policymakers are now taking to solve these problems. In this connection, the President's mastery of the political process gives us hope that fiscal policy will play a stronger role in getting the economy back on a non inflationary growth path. In his view, many of the nation's woes stem from excessive tax rates that retard productivity and growth, and so last week he pushed through - SUBSTANTIAL PROBLEM, 3 - CUTS IN INCOME AND OTHER TAXES TO SOLVE THAT BUT HE PRECEDED THAT MOVE, MORE THAN A MONTH AGO, BY STEPS TO REVERSE THE TREND OF FEDERAL SPENDING, IN AN ATTEMPT TO CURB THE INFLATIONARY POTENTIAL OF CONTINUED Fe d e r a l massive deficits. The tax measures passed by Congress last week are designed to cut taxes by nearly $38 billion in fiscal 1982 and by perhaps $200 is billion the by 1985. 25-p e r c e n t The centerpiece a c r o s s -t h e -b o a r d cut of this in individual program of course i n c o m e -t a x RATES, BEGINNING WITH THE 5-PERCENT CUT THIS OCTOBER 1 AND FOLLOWED BY THE 10-PERCENT REDUCTIONS OF JULY 1982 AND JULY 1983. But the bill has many other important features -- most IMPORTANTLY, FASTER DEPRECIATION WRITE-OFFS FOR BUSINESS FIRMS. At long last, Co n g r e s s has replaced the old jumble of depreciation SCHEDULES WITH FOUR BASIC CATEGORIES — A 3-5-10-15 SCHEDULE WHICH, ESSENTIALLY, PROVIDES FOR VEHICLES TO BE WRITTEN OFF IN THREE YEARS, EQUIPMENT IN FIVE YEARS, AND LONGER-LIVED PROPERTY IN TEN TO FIFTEEN YEARS. Th e earlier decision to match tax cuts with spending cuts WAS EQUALLY IMPORTANT — INDEED PERHAPS MORE IMPORTANT IN THE LONG RUN, BECAUSE IT REVERSED A 50-YEAR TREND IN THE GROWTH OF the Federal government. About $730 billion would have been SPENT IN THE 1982 FISCAL YEAR IF CURRENT PROGRAMS HAD CONTINUED UNCHANGED. B U T THAT FIGURE WAS REDUCED TO $695 BILLION BY THE BROAD-SCALE CUTBACKS MADE IN A HOST OF FEDERAL PROGRAMS IN THE BUDGET-RECONCILIATION PROCESS AT MIDYEAR. By THAT PROCESS, - !\ - the Administration and the Congress added real meaning to THE TERM "CONTROL" IN THE BUDGET CONTROL ACT OF 1974. Th e Ad m i n i s t r a t i o n , in its midyear budget review, estimated THAT THE RESULTANT OF THESE TAX AND EXPENDITURE DECISIONS WOULD BE A $56-BILLION DEFICIT IN THE FISCAL YEAR ENDING NEXT MONTH, AND A $43-3ILLION DEFICIT IN THE 1982 FISCAL YEAR. I_AST-MINUTE CHANGES IN LAST WEEK'S TAX BILL COULD PUSH THE 1982 DEFICIT HIGHER, PERHAPS TO ABOUT $50 BILLION. MOREOVER, WE SHOULD REMEMBER THAT ACTUAL SPENDING TOTALS HAVE FAR OUTPACED INITIAL SPENDING ESTIMATES IN MOST RECENT YEARS, PERHAPS BY A MARGIN OF $45 BILLION THIS YEAR. THOSE FIGURES ONLY ADD MORE URGENCY TO THE FUTURE NEED TO KEEP SPENDING UNDER CONTROL, ESPECIALLY IN VIEW OF THE FACT THAT REVENUES WILL BE HELD DOWN IN THE MID-1980'S BY THE INFLATION INDEXING OF INCOME-TAX BRACKETS. M o n e t a r y P o l i c y Ro l e Now the Federal Reserve, through its monetary policy, has A PARALLEL TASK TO PERFORM BY KEEPING MONEY-SUPPLY GROWTH IN LINE WITH A NON INFLATIONARY GROWTH PATH FOR THE NATIONAL ECONOMY. B ut t h e r e 's a great deal of misunderstanding about its role, WHICH IS FREQUENTLY DISMISSED AS SIMPLY A "HIGH INTEREST RATE" policy. So let's pause to review some of the CONFLICTING VIEWS ABOUT MONETARY POLICY, ESPECIALLY SINCE THEY OFTEN LEAD TO CONFLICTING POLICY ADVICE. To THE AVERAGE NEWSPAPER READER OR LEGISLATOR, EASY MONEY MEANS LOW INTEREST RATES, AND TIGHT MONEY MEANS HIGH INTEREST RATES. To THE AVERAGE ECONOMICS PROFESSOR OR FINANCIAL ANALYST., EASY MONEY MEANS RAPID MONEY GROWTH, AND TIGHT MONEY MEANS SLOW MONEY GROWTH. A t TIMES OVER THE PAST TWO YEARS, WE'VE FOUND OURSELVES CRITICIZED BY ONE SIDE AS BEING TOO EASY, AND BY THE OTHER SIDE FOR BEING TOO TIGHT. SO HOW SHOULD WE RESPOND? To THE INTEREST-RATE WATCHERS, WE WOULD SUGGEST THAT INTEREST RATES ARE DETERMINED BY MANY FACTORS — INCLUDING BUT NOT EXCLUSIVELY THE ACTIONS OF THE F e d e r a l Re s e r v e , which NOT THE DEMAND. CERTAINLY THE FED HAS SOME EFFECT ON RATES can control only the supply money, of IN THE SHORT RUN, AS IT WORKS TO CONTROL THE AMOUNT OF RESERVES IN THE BANKING SYSTEM AND MONEY IN THE HANDS OF THE PUBLIC. Ho w e v e r , as credit b u s i n e s s -c y c l e demands rise and conditions fall with the also influence cycle. And rates, above all, PRICE EXPECTATIONS HEAVILY INFLUENCE RATES, FREQUENTLY OFF SETTING OTHER MARKET INFLUENCES. TODAY, FOR EXAMPLE, IF PEOPLE EXPECT PRICES TO RISE BY (SAY) 10 PERCENT A YEAR, LENDERS WILL DEMAND THAT 10-PERCENT INFLATION PREMIUM PLUS THE "REAL'" UNDERLYING RATE OF INTEREST OF 3 OR 4 PERCENT, SO THAT THEY'LL BE PROTECTED AGAINST AN EXPECTED LOSS IN THE PURCHASING POWER OF THEIR MONEY. THIS SUGGESTS, THEN, THAT CURBING INFLATION IS THE ONLY LONG-RUN SOLUTION TO HIGH INTEREST RATES. TO THE MONEY-SUPPLY WATCHERS, WE WOULD SAY THAT MONETARY POLICY IN RECENT YEARS HAS BEEN DIRECTED TOWARD REDUCING MONEY GROWTH — ESPECIALLY SINCE WE SHIFTED OUR OPERATING PROCEDURES NEARLY TWO YEARS AGO TO EMPHASIZE MONEY-GROWTH CONTROL RATHER THAN INTEREST-RATE CONTROL. OUR EXPERIENCE HAS CLEARLY DEMONSTRATED THAT DURING PERIODS OF HEAVY PRIVATE PLUS GOVERNMENT CREDIT DEMANDS,, ATTEMPTS TO DAMPEN RISING INTEREST RATES RESULT IN RAPID MONEY GROWTH. AND HISTORY ALSO HAS SHOWN THAT RAPID MONEY GROWTH EVENTUALLY LEADS TO INFLATION., A C C OMPANIED BY HIGH INTEREST RATES. THIS SUGGESTS, THEN, THAT THE FED SHOULD CONTINUE TO FOLLOW THE PATH OF GRADUAL DECELERATION ADOPTED in October 1979. S t i l l , w e h a v e t o r e c o g n i z e t h a t t h e F e d 's s h i f t in EMPHASIS AWAY FROM TRYING TO C O N TROL INTEREST RATES CAN INVOLVE SHORT- T E R M COSTS. HOME BUILDERS, FARMERS, SMALL BUSINESSES, A N D OTHER INTEREST-SENSITIVE BORROWERS CAN BE B ADLY HURT BY HIGH AND FLUCTUATING LEVELS OF INTEREST RATES. T h e F e d t h u s m u s t s t e p in a t t i m e s t o d a m p e n e x c e s s i v e r a t e SWINGS, EVEN AT THE COST OF TEMPORARY DEVIATIONS IN THE GROWTH PATH OF THE MONEY SUPPLY. ON BALANCE, THE FEDERAL RESERVE HAS NO CHOICE EXCEPT TO CONTINUE WIT H ITS POLICY OF REDUCING MONEY-SUPPLY GROWTH OVER TIME, TO HELP THE NATIONAL ECONOMY RETURN TO A NON-INFLATIONARY GROWTH PATH. I MIGHT ADD THAT THE ADMINISTRATION HAS STRONGLY ENCOURAGED THE FED IN THIS POLICY OF MONETARY DISCIPLINE. Ml-B THE MEASURE OF THE MONEY SUPPLY — CURRENCY PLUS TRANSACTION (CHECK-TYPE) ACCOUNTS — DECELERATED SLIGHTLY IN EACH OF THE PAST TWO YEARS, AND NOW IS NEAR OR EVEN BELOW THE BOTTOM OF ITS TARGET RANGE FOR 1981. THAT GROWTH RANGE IS 3% TO 6 PERCENT, A F T E R A D J U S T M E N T FOR SHIFTS OF SAVINGS INTO CHECK-LIKE NOW - accounts. 7 - B u t the M-2 measure ~ primarily currency plus al l d epository-institution deposits (except large CDs ) and moneymarket FUND SHARES — HAS BEEN RUNNING NEAR THE TOP OF ITS 6-TO-9 PERCENT T A R G E T RANGE THIS YEAR, ALTHOUGH BELOW LAST THE DIFFERENCE IN GROWTH TRENDS CAN BE YEAR'S ACTUAL GROWTH. T R A C E D ULTIMATELY TO THE IMPACT OF HIGH INTEREST RATES ON H OUSEHOLD A N D B U S INESS CASH-MANAGEMENT PRACTICES, MINIMIZING T HEIR USE OF T R A D I T I O N A L TRANSACTION BALANCES AND STIMULATING THE GROWTH OF M O N E Y - M A R K E T MUTUAL FUNDS AND OTHER COMPONENTS OF THE BROADER M O NETARY AGGREGATES. For THE REMA I N D E R OF recent Co n g r e s s i o n a l 1981, ACCORDING TO CHAIRMAN VOLCKER'S testimony, the T HAT IT W O U L D BE ACCEPTABLE TO HOLD F e d e r a l Re s e r v e M-1B believes GROWTH NEAR THE B O T T O M OF ITS RANGE, A N D TO HOLD M “2 GROWTH NEAR THE TOP OF ITS RANGE. And for 1982, the Fed tentatively has again reduced its projected GROWTH RANGE FOR M-]B, TO BETWEEN 2k AND 5 h PERCENT, WHILE MAINTAINING A 6-TO-9 PERCENT RANGE FOR M-2. THUS, BY CARRYING OUT OUR "GAME PLAN" OF REDUCED MONEY GROWTH IN 1981, A ND PROJECTING SIMILAR DISCIPLINE NEXT YEAR, WE SHOULD ADD CREDIBILITY TO THE NATION'S A N T I “INFLATION PROGRAM, AND HELP TO REVERSE LONG-STANDING EXPECTATIONS OF CONTINUED HIGH INFLATION. Im p l i c a t i o n s The for Production combination of monetary and fiscal measures that I' v e OUTLINED SHOULD LEAD, WITHIN SEVERAL YEARS' TIME, TO A PERIOD OF GROWTH WITH PRICE STABILITY. BUT THE NEAR-TERM OUTLOOK, FOR THE MOST PART, HAS ALREADY BEEN DETERMINED BY EARLIER - 8 - DEVELOPMENTS — PRINCIPALLY BY THE SEVERE INFLATION OF THE PAST DECADE AND BY THE RECENT POLICY MEASURES TAKEN TO BRING THAT INFLATION UNDER CONTROL. THUS THE CONSENSUS FORECAST, WHICH IS SHARED BY MY RESEARCH STAFF, CALLS FOR A FAIRLY FLAT LEVEL OF BUSINESS A C TIVITY UNTIL ABOUT THE MIDDLE OF NEXT YEAR, FOLLOWED BY A SIGNIFIC ANT UPTURN IN LATE 1982. AS ALWAYS, MUCH DEPENDS UPON CONSUMER BUYING DECISIONS, I SINCE HOUSEHOLD SPENDING ACCOUNTS FOR ALMOST TWO-THIRDS OF GNP. (Indeed, for three years in a row, 1979-81, business activity DROPPED SHARPLY IN THE SECOND QUARTER BECAUSE OF A FALL-OFF IN C O N SUMER SPENDING.) IN SUMMER 1981, CONSUMERS ARE CONTINUING TO BUY CAUTIOUSLY, BECAUSE OF A SLOWDOWN IN REAL INCOME, RESTRICTIVE THE NEW TAX CREDIT CONDITIONS, A N D A MIXED EMPLOYMENT OUTLOOK. CUTS SHOULD EVENTUALLY BOOST CONSUMER SPENDING TOO, AND SAVING I HOPE — BUT MOST OF THAT IMPACT MAY NOT BE FELT UNTIL LATE 1982. Business spending for plant and equipment also may remain SLUGGISH, EXCEPT OF COURSE FOR THE VERY STRONG ENERGY SECTOR. Re c e n t surveys PLANS, WHILE indicate new little strength in c a p i t a l spending EQUIPMENT ORDERS AND CAPITAL-CONSTRUCTION CONTRACTS HAVE SHOWN DECLINES RECENTLY, IN REAL TERMS. MEAN WHILE, THE DOWNTURN IN HOUSING STARTS SHOULD BE TRANSLATED, AFTER THE USUAL LAG, CONSTRUCTION. INTO A CUTBACK IN SPENDING FOR NEW-HOME BUSINESS-INVENTORY SPENDING ALSO COULD WEAKEN, SINCE MUCH OF THE SECOND-QUARTER BUILDUP REPRESENTED AN UNWANTED ACCUMULATION OF STOCKS. AND IN ADDITION, THE EXPORT - 9 - TRADE COULD WEAKEN IN COMING MONTHS, IN VIEW OF THE RECENT APPRECIATION OF THE DOLLAR, ALONG WITH THE SLOWDOWN IN ECONOMIC GROWTH ABROAD. Go v e r n m e n t expenditures, SLOWLY OVER THE NEXT YEAR. in terms, may real rise relatively OUTSIDE THE DEFENSE AREA, FEDERAL- GOVERNMENT SPENDING SHOULD CONTRACT IN REAL TERMS, GIVEN THE BUDGET CUTS S CHEDULED FOR FISCAL 1982. STATE AND LOCAL G O VERN MENTS MEANWHILE ARE TRYING TO HOLD DOWN SPENDING, IN RESPONSE TO REDUCED INCOME FROM FEDERAL GRANTS AND TO SLOWER GROWTH OF THEIR OWN T A X RECEIPTS. So ON BALANCE, WE MAY EXPERIENCE LITTLE STIMULUS FROM EITHER THE PRIVATE OR PUBLIC SECTORS IN COMING MONTHS, EXCEPT OF COURSE FOR THE DEFENSE AND ENERGY INDUSTRIES. Outlook for Prices O n THE PRICE FRONT, THE OUTLOOK HAS BRIGHT E N E D CONSIDERABLY SO FAR IN 1981. A n d EVEN THOUGH SOME bad MONTHS MAY LIE AHEAD, WE APPEAR AT LEAST TO BE MOVING OUT OF THE DOUBLE-DIGIT INFLATION RANGE. THE CONSUMER-PRICE INDEX INCREASED AT A 8^-PERCENT A N N U A L RATE IN THE FIRST HALF OF 1981, COMPARED TO A 12%-PERCENT INCREASE IN 1980, AS A REFLECTION OF REDUCED MONEY GROWTH AND UNEXPECTEDLY FAVORABLE DEVELOPMENTS IN THE VOLATILE FOOD AND ENERGY SECTORS. ALSO, SCATTERED SIGNS APPEARED OF A SLOWING IN COST PRESSURES, AS PRODUCTIVITY SPURTED IN THE FIRST QUARTER A N D AS WAGE PRESSURES DECREASED DURING THE SPRING MONTHS. Ca n we expect ARE SOMEWHAT MIXED. further deceleration in prices? Th e indicators On THE ONE HAND, THE CURRENT WEAKNESS IN W O R L D OIL MARKETS ARGUES FOR PRICE STABILITY IN THAT SECTOR, - 10 - A L T HOUGH THE ECONOMY WILL CONTINUE TO SUFFER FROM THE DOUBLING OF OIL PRICES OF THE PREVIOUS TWO YEARS. MOREOVER, WE SHOULD CONTINUE TO BENEFIT FROM THE RECENT IMPROVEMENT IN THE FOREIGNEXCHANGE VALUE OF THE DOLLAR, WHICH HAS REDUCED THE PRICE OF IMPORTS AND ALSO CURBED INCREASES IN PRICES OF DOMESTIC GOODS TH A T COMPETE WITH IMPORTS. ON THE OTHER HAND, FOOD PRICES MAY RISE MORE RAPIDLY IN COMING MONTHS AS SUPPLY CONDITIONS TIGHTEN IN SOME AREAS. ALSO, LABOR-COST PRESSURES COULD INTENSIFY, REFLECTING THE WEAK E N I N G OF PRODUCTIVITY THAT ALWAYS ACCOMPANIES ANY SLOWDOWN IN BUSINESS ACTIVITY. St i l l , we should emphasize again that inflation trends OVER THE LONG RUN LARGELY REFLECT PAST MONETARY-GROWTH TRENDS. B y THAT STANDARD, THEREFORE, THE PROSPECT LOOKS RELATIVELY FAVORABLE. HISTORY SHOWS THAT CHANGES IN MONEY-SUPPLY GROWTH DEFINITELY AFFECT THE INFLATION RATE OVER TIME, USUALLY WITH A LAG-OF A Y E A R - A N D - A - H A L F TO TWO YEARS. THE RECENT DECELERATION THUS SUGGESTS FURTHER PROGRESS ON THE PRICE FRONT OVER THE COMING PERIOD. Im p l i c a t i o n s for C r e d i t Ma r k e t s A MAJOR D I S T U R B I N G ELEMENT IN THE CURRENT PICTURE, HOWEVER, IS THE STATE OF THE CREDIT MARKETS. THE STOCK MARKET AND (ESPECIALLY) THE BO N D MARKET HAVE WEAKENED IN RECENT MONTHS, DESPITE THE B R I G H T E N I N G PROSPECTS FOR PRICES AND ECONOMIC POLICY. And THROUGHOUT THE ECONOMY, PEOPLE ARE DEMANDING TO KNOW WHY INTEREST RATES REMAIN AT SUCH STRATOSPHERIC LEVELS WHEN INFLATION RATES HAVE COME DOWN SO NOTICEABLY, THE ANSWER TO THIS PARADOX -11 MAY BE FOUND, FIRST, - IN THE AREA OF EXPECTATIONS, AND SECONDLY IN TERMS OF C REDIT-MARKET PRESSURES. Co n s i d e r the expectations TWICE SHY" PHENOMENON. argument — "o n c e the burned, CREDIT-MARKET PARTICIPANTS REMEMBER VIVIDLY THE HISTORY OF THE MIDDLE AND LATE 1970'S — WHEN THE INFLATION RATE D E C L I N E D BY HALF, AND INTEREST RATES FELL CORRESPONDINGLY, ONL Y TO BE FOLLOWED BY A SHARP REVERSAL OF RATES IN THE INFLATIONARY SPURT OF THE 1977-80 PERIOD. THIS TIME, MARKET PARTICIPANTS ARE HOLDING BACK, DEMANDING A CONTINUED LARGE INFLATION PREMIUM, UNTIL THEY SEE SUSTAINED PROGRESS IN THE FIGHT AGAINST INFLATION. Their fears have been reinforced by the continued pressures on credit markets from Federal financing demands. Net borrowing by the Federal government and federally-assisted agencies represented one-third of all funds raised by nonfinancial sectors last year, and the Federal share could remain almost that high THIS YEAR. For example, in the final quarter of 1981, THE Treasury plans to borrow a near-record $30 billion to $33 billion. Much of this borrowing may represent "crowding out" of other borrowers — households, businesses, and state and local govern ments, WHO CANNOT AFFORD TO PAY THE INTEREST RATES THAT THE Fe d e r a l government massive Fe d e r a l a major cause, along interest So m e continue is w i l l i n g presence and able in c r e d i t with high to markets pay. must inflation, of the Surely, be this considered high level of rates. market to observers undermine the fear that strength of large the Fe d e r a l market deficits will in coming years. 12 - Th o s e fears can be traced - in t u r n to the expansion of the INDEXING TECHNIQUE TO THE REVENUE AS WELL AS THE SPENDING SIDE OF THE BUDGET. In RECENT YEARS., LARGE BUDGET DEFICITS HAVE REFLECTED THE INFLATION-INDEXED UPSURGE IN PAYMENTS FOR SOCIAL SECURITY AND OTHER "ENTITLEMENT" PROGRAMS. (THESE PROGRAMS HAVE ACCOUNTED FOR MORE THAN TWO-THIRDS OF ALL BUDGET SPENDING, OUTSIDE OF DEFENSE AND INTEREST COSTS.) Fe d e r a l revenues cuts, and income later taxes, w eaken, first will because Th u s , of because inflation Co n g r e s s if In COMING YEARS, of indexing fails to the of keep new tax individual spending under CONTROL, DEFICITS COULD REMAIN HIGH — EVEN IN A GROWING ECONOMY " AND COULD CONTINUE TO KEEP CREDIT MARKETS UNDER PRESSURE. Im p l i c a t i o n s Before of all concluding, these national here in C o e u r with mixed A N o r t h e r n Id a h o for d 'Al e n e market good deal of that unstable that the may l a t e -1981 b u s i n e s s view the the a sluggish national could be market. (Of silver demand was bound correction extent residents 1970' s , late silver world boom the that to when sold lead to in it h a s a that bust, commodities . recall piece Texas means and of astronomical course, during scene lumber every at Pe o p l e economy fondly world necessary limited to for local of a N o r t h e r n Id a h o . developments many boom speculative implications of inflationary on a the r e g i o n 's o u t p u t that of assess this sure ounce to for B e s i d e s , I'm every like emotions, because weakening and I'd metals. the lumber prices accounted p e r i o d .) and markets w e 'r e has for B ut lucky been 13 - - AS THE WORLD'S LARGEST SILVER PRODUCER, THE COEUR D'ALENE DISTRICT IS BOUND TO BE AFFECTED BY THE UPS AND DOWNS OF THE PRECIOUS“METALS MARKET. SILVER PRICES OBVIOUSLY WERE FAR OUT OF LINE LAST YEAR, WITH AN ANNUAL AVERAGE PRICE OF $20,63 AN OUNCE — AND A PEAK PRICE MORE THAN DOUBLE THAT. EVEN WITH THIS YEAR'S SHARP DECLINE, PRICES ARE RUNNING CONSIDERABLY ABOVE THE 1978 AVERAGE OF $5,69 AN OUNCE. I'M NOT SURE WHERE THE MARKET-CLEARING PRICE SHOULD BE, ESPECIALLY IN VIEW OF THE LARGER SUPPLIES THAT WILL COME ON THE MARKET FOLLOWING THE SCHEDULED EXPANSION OF MINE AND REFINERY ACTIVITY IN THIS AREA. S h o r t -t e r m of other prospects industrial are also minerals hard where to assess Id a h o for holds a the long list dominant MARKET POSITION — LEAD, ZINC, COBALT, ANTIMONY, VANADIUM, MOLYBDENUM AND SO ON. BUT GIVEN THE NATIONAL GOAL OF DEVELOPING SECURE DOMESTIC SOURCES OF INDUSTRIAL MATERIALS, AND GIVEN THE NATIONAL GOAL OF EXPANDING AND MODERNIZING ITS INDUSTRIAL PLANT AND DEFENSE SYSTEM, THE LONG-TERM PROSPECT FOR IDAHO'S MINERAL PRODUCERS LOOKS BRIGHT INDEED. A DIFFERENT SET OF QUESTIONS FACES IDAHO'S LUMBER INDUSTRY, THE FOURTH-LARGEST IN THE NATION — AND NORMALLY AN EMPLOYER OF ONETHIRD OF THE STATE'S MANUFACTURING WORKERS. DURING THE 1970's, THE U.S. HOMEBUILDING INDUSTRY EXPANDED ITS DEMAND ON THE NATION'S RESOURCES, AS HOUSING STARTS FAR EXCEEDED POPULATION GROWTH, AND AS MORTGAGE BORROWERS INCREASED THEIR SHARE OF TOTAL CREDIT flows. Th a t trend reflected a growing public realization that HOUSING IN AN INFLATIONARY ERA REPRESENTS A VALUABLE INVESTMENT, AND NOT JUST SHELTER. TODAY CONDITIONS ARE CHANGING, NOT LEAST 14 - - BECAUSE OF THE SQUEEZING OF THE INFLATION PREMIUM OUT OF THE MORTGAGE MARKET. Bo r r o w e r s are faced with the necessity of paying market- MORTGAGE RATES — AND THUS ARE LESS ABLE THAN BEFORE TO BUILD level UP AN INFLATION BONUS THROUGH LOW FIXED-RATE MORTGAGES. HENCE, THEY ARE LIKELY TO BE MORE CONSERVATIVE IN THEIR HOME-BUYING DECISIONS IN THE COMING DECADE. THIS COULD MEAN A LOWER AVERAGE LEVEL OF DEMAND FOR IDAHO'S LUMBER PRODUCTS IN THE 1 9 8 0 'S THAN IN THE 1970'S. BUT ONCE THE THRIFT INDUSTRY WORKS OUT ITS PRESENT PROBLEMS, THE FINANCING BASIS OF HOUSING SHOULD BE ON STRONGER GROUND, WITH THE INDUSTRY PAYING A MARKET RETURN ON ITS DEPOSITS AND EARNING A MARKET RETURN ON ITS MORTGAGE loans. That should mean the end of the vast swings in U.S. HOUSING ACTIVITY, WITH STARTS DECLINING BY HALF IN EACH INDUSTRY DOWNTURN. A n d THAT, IN TURN, SHOULD MEAN MUCH MORE STABILITY IN DEMAND — AND A MORE EFFICIENT LEVEL OF OPERATIONS — FOR THIS REGION'S LUMBER INDUSTRY. Co n c l u d i n g Re m a r k s To SUMMARIZE, WE'RE NOW SHOWING SOME PROGRESS IN FIGHTING INFLATION, PARTLY BECAUSE OF THE EASING OF OIL- AND FOOD-PRICE PRESSURES, BUT LARGELY BECAUSE OF SLOWER GROWTH OF MONEY AND CREDIT. But THE PROCESS OF SLOWING INFLATION THROUGH MONETARY RESTRAINT CAN LEAD TO STRAINS ON CERTAIN SECTORS OF THE ECONOMY, ESPECIALLY WHEN THE FEDERAL RESERVE CARRIES SO MUCH OF THE TASK OF DEALING WITH INFLATION. As LONG AS THESE STRONG DEMANDS PERSIST, AND INFLATIONARY EXPECTATIONS REMAIN INTENSE, RESTRAINED - 15 - MONETARY GROWTH MAY BE ACCOMPANIED BY HIGH INTEREST RATES AND FINANCIAL-MARKET STRAINS, Th e s e dependent financial pressures impose hardships upon credit- INDUSTRIES, SUCH AS HOUSING AND MUCH BUSINESS INVESTMENT " A N D UPON THOSE AREAS SUCH AS NORTHERN IDAHO THAT SUPPLY SUCH INDUSTRIES. W e USED TO THINK THAT WE COULD TEMPORARILY EASE THEIR PROBLEMS THOUGH A SWITCH TO MONETARY STIMULUS AND A CONSEQUENT DROP IN INTEREST RATES. BUT OUR EXPERIENCE LAST FALL, AND AGAIN THIS PAST APRIL, SUGGESTS THAT WE CAN'T EVEN COUNT ON THAT RESULT ANYMORE — THAT INCREASED MONEY GROWTH LEADS MARKET PARTICIPANTS TO PUSH RATES UP (RATHER THAN DOWN) BECAUSE OF INCREASED FEARS OF FUTURE INFLATION. Disciplined monetary policy thus is a key element THE NATION'S EFFORT TO CURB INFLATIONARY FORCES. in HOWEVER, FISCAL AND REGULATORY POLICIES MUST CONTINUE TO SUPPORT THE Federal Reserve's monetary efforts. In this regard, the Administration's success in getting tax and spending reductions through Congress is a very good omen. But continued vigilance is necessary to ensure that Federal spending is controlled and the budget brought closer to balance, Only then will we see reduced pressure on financial markets, lessened expectations OF inflation, and a long-awaited return to an environment of noninflationary growth. # £§
@FedFRASER