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3:00 P.M. C.D.T. (9:00 P.M. E.D.T.)


Remarks by

Lyle E. Gramley

Member, Board of Governors of the Federal Reserve System

Beloit College
Beloit, Wisconsin
October 21, 1981


Two years ago this month, the Federal Reserve set forth on a
course of monetary policy designed to increase our chances of ending the
inflation that has plagued our country for nearly two decades.


I want to give you a progress report on the struggle to regain stable
prices, to lower interest rates, and to create a more stable and prosperous

To state my conclusions at the outset, I think we are making
progress -- substantial progress -- in reducing inflation.

Moreover, the

prospects are encouraging for a further decline in inflation during 1982.
The price we are paying to achieve these results is, however, extremely

Interest rates have risen to painful levels, and some sectors of

the economy are suffering enormous anguish.

There is now an urgent need

for prompt action to relieve financial markets of the pressures from continuing huge deficits in the Federal budget, so that businesses and individuals
can meet their needs for credit at reasonable interest rates.

October 6, 1979 marked an historic event in the history of monetary
policy in the United States.

On that day, the Federal Reserve announced

that it would henceforth conduct its monetary policy operations with an
eye to providing a supply of reserves to the banking system consistent with
a long-term slowdown in the rate of monetary and credit expansion.


counterpart of that decision was to free up interest rates to be determined
by the balance between demands for, and supplies of, credit expressed in
the money and capital markets.


The relationship between money growth and inflation is very
imprecise in the short run.

Yet, almost everyone acknowledges that

restraint on the expansion of money and credit is an essential


in the fight against inflation.

To an inflation-weary public, the Federal Reserve's announcement
came as a welcome development.

But a number of questions remained in the

minds of ordinary citizens as well as sophisticated financial analysts.

.First, did the Federal Reserve really mean what it said?
Proclamations of firm intent had been heard previously.

Indeed, the

Federal Reserve had for a number of previous years announced annual targets
for money growth, but often permitted actual money growth to exceed its
announced objective.

Second, could targets for money.and credit growth be achieved any
better under the new procedures than under the old ones?

possibly dramatic —

Or were further

changes required in our monetary system?

Third, would the Federal Reserve persist when the pressures of
monetary restraint began to bind?

When letters of protest began to pour

in from those adversely affected?

When the Congressional Record began to

fill with angry words of irate Congressmen?

Fourth, would success in slowing the growth of money and credit
really achieve the intended result of slowing inflation in a modern and
complex economy characterized by inflexible wages and prices -



one in which inflation had been building for nearly a generation, so that
inflationary expectations had been deeply entrenched in business and consumer

Final answers to these questions have yet to be written in the book
of history.

But the chapters transcribed to date indicate, I believe, that

most of the doubts were not well founded.

Let us look, first, at the behavior of some financial variables
of major importance.

The money supply measure on which the Federal Reserve

has focused its principal attention (Ml-B, adjusted for the effects of
shifts of funds into NOW accounts from sources other than demand deposits)
has increased

since the fourth quarter of 1979 at an annual rate of between

4-1/2 and 5 percent.

In the three years prior to the fourth quarter of

1979, that measure of money balances had increased at an annual rate of
around 8 percent.

The growth rate of this measure of money consistent with price
stability is probably around 2 percent, or possibly even lower.

A further

slowing of growth from the average pace of the past two years is therefore

But we have accomplished a large and important first step.

The Federal Reserve has thus demonstrated its capacity to control
and limit the growth of money over periods that are meaningful from the
standpoint of economic performance.

It has also begun to convince many

citizens of its intentions to stick to its announced course of monetary

Just last week, the Journal of Commerce published the results


of a survey of 38 corporate treasurers and financial officers.

Only one

expected an easing of Federal Reserve policy during the next six months.

Monetary restraint during the past two years has led to a marked
deceleration in the growth of private debt.

All nonfinancial sectors other

than the Federal Government increased their outstanding debt by 13 percent
or more in each of the years 1977 through 1979.

In 1980 the increase fell

to 8-1/2 percent and in the first half of this year to an annual rate of
8 percent.

High interest rates have obviously created serious financial
problems for many businesses and individuals.

But as a result of the slow-

down of growth in debt, the financing of economic activity is now on a
sounder basis.

The financial balance sheets of households are also

In May of 1979, individuals were devoting 18-1/4 percent of

their after-tax incomes to repayments of instalment debt.

That figure

has recently declined to almost 15 percent.

More important than these signs of progress in the financial area
is the evidence that inflation itself is moderating.

In fact, the rise in

prices has slowed more substantially this year than almost anyone had

During the first 8 months of 1981, consumer prices rose at a

9-1/2 percent annual rate, compared to 12 percent during the corresponding
period of last year.

Even more improvement is evident in prices at the

producer and wholesale levels.

Some of the gain against inflation results from special factors
unrelated to monetary policy.

For example, the weather has been kind to

us this year, and has given .us bountiful harvests.

Conservation of energy,

in response to deregulation of oil prices and a range of other government
programs, is also finally taking hold.

Oil supplies are now readily avail-

able, and crude oil prices are several dollars a barrel lower than was
widely forecast a year ago.

Nevertheless, progress against inflation goes beyond the effects
of special factors.

Prices of goods and services excluding food and energy

are rising less rapidly this year than last.

Troublesome sectors in which

prices appeared earlier to have been particularly responsive to strong demand
are showing the effects of restraint.
rise of prices for capital goods.

There has been some slowing in the

Spot prices of industrial raw materials

have actually fallen since late last year, and are now back to early 1979

And house prices, whose earlier wild escalation contributed sig-

nificantly to the upward spiral of consumer prices, have slowed markedly.

Can we really expect progress to continue?
we stick to policies of restraint.

We can, I think, if

There are several reasons for optimism.

First, the prospects for energy prices have been greatly improved by
major alterations in the balance between supply and demand.

U.S. domestic

consumption of petroleum products has fallen by more than two million barrels
per day since 1979; other countries have also reduced their consumption.
Production of oil by non-OPEC countries, moreover, has risen substantially
in recent years.

Oil stocks are now so ample that OPEC no longer has the

latitude for increases in oil prices well above the general inflation rate.


The Administration, with the assistance of the Congress, has taken
a number of important steps that will contribute to curbing inflation.
The depreciation and investment tax credit provisions of the Economic
Recovery Act of 1981 will help to stimulate investment and, after some
time, to raise productivity.

Progress is also being made in enhancing

competition through regulatory reform in such industries as airlines and

Strong efforts are underway to reduce the inflationary effects

of government regulations -- for example, by modifying anti-pollution
regulations and reforming the administration of the Davis-Bacon and ServiceContract Acts, which raise costs in the construction and service industries.

Progress against inflation will continue, however, only if we
succeed in reducing the rise in unit costs of production -- particularly
labor costs, which amount to roughly two-thirds of the total.

For the

past several years, wage increases have exceeded the very sluggish rise
of productivity by 8 to 9 percentage points a year.

There is little reason

to be very hopeful that our economy will break out of its productivity doldrums
at any time soon.

But we can make headway against rising costs by reducing

wage increases, and that process has gotten underway.

Average hourly earn-

ings of production and supervisory workers in nonfarm businesses rose at an
8-1/2 percent annual rate over the first 3 quarters of this year.
about 1 percentage point less than in the same period of 1980.

That is


of union contracts in some industries have contributed to the moderation of
wages, as well as helping to preserve jobs for workers.

The list of industries

in which concessions by unions have occurred is impressive, ranging from such
well-known examples as autos and airlines, to less widely-publicized cases as
meat packing, glass, printing and newspapers.
flexible approach toward work rules.

Workers are also taking a more


Next year, a new round of union contract settlements will occur in
some troubled industries.

Workers in such industries as trucking, construc-

tion, rubber and automobiles must, surely recognize that pay increases on
anything like the scale of recent years would inevitably lead to the loss
of an enormous number of jobs.

Wage and work-rule concessions, the recent

decision by the Teamsters to begin bargaining early, and reports that a
number of companies and unions are modifying national agreements to fit local
situations all suggest that a new, less inflationary, pattern of wage settlement may emerge next year.

If that happens, it will help to set the stage

for substantial further reductions in inflation in the years to come.

We are, I believe, at a critical stage in our fight against inflation.

It is within our means to consolidate our recent gains and move

forward toward price stability.

But let there be no mistake:

either we

bring the rate of inflation down further, or we will see it turn up decisively
again; there is simply no middle ground.

Across our country, however, concern is growing over the economic
and social costs of bringing down inflation.

High interest rates are

creating great structural damage to our economy, and the burdens are not
being borne evenly.

Thrift institutions are in deep distress; the housing

industry has been devastated; auto dealers face severely depressed sales
and very high costs of financing inventories; small firms in many other
lines of activity are going out of business.

The energy and defense in-

dustries, meanwhile, are booming, as are the high technology industries.


And so we have the anomaly of strong economic growth in the Southwest while
economic conditions in the industrial heartland are perhaps at their worst
in 40 years.

It is not surprising, therefore, that pressures are growing

for the Federal Reserve to depart from its policies of monetary restraint
in an effort to bring interest rates down soon.

Such a change in the stance of monetary policy might bring temporary
symptomatic relief from the pain of high interest rates, but it would surely
worsen the underlying inflationary disease that is the principal cause of
high interest rates.

A lasting reduction of interest rates will only be

accomplished if we adhere to a monetary policy that permits us to regain
price stability.

The return to price stability and lower interest rates can be
speeded up substantially, however, if the Congress and the Administration
work together to eliminate the prospects for alarmingly large Federal
deficits in the years just ahead.

The Economic Recovery Act of 1981 provided

reductions in taxes on an unprecedented scale; the Congress also reduced
Federal expenditures, but by nowhere near as much as the reduction in taxes.
Consequently, we face the prospect of continued large, and perhaps even growing, Federal deficits in the years to come.

For example, the Congressional Budget Office has estimated that the
Federal deficit would continue to be at least $50 billion through fiscal
1984, even if federal outlays in that year were reduced by $50 billion more
than the savings thus far enacted into law.

Furthermore, the CBO's estimates


of the deficit are premised on relatively optimistic projections of real
growth in the economy.

If those additional $50 billion in expenditure

„ reductions were not achieved, and if economic growth were less robust than
the CBO projected, the Federal deficit in fiscal 1984 could reach or even
exceed $100 billion.

Small wonder, then, that participants in financial

markets are deeply worried.

They know that unless the Congress and the

Administration address this problem forthrightly, we may face intolerably
high interest rates for the foreseeable future.

Our long-run battle to invigorate the economy by ridding it of
inflation would be enhanced, I believe, if a substantial part of the steps
to reduce these large prospective deficits came from further cutbacks in
Federal outlays.

That may or may not prove feasible.

If not, some of the

loss in Federal revenues that resulted from this year's tax law will simply
have to be restored.

I would hope that the Congress and the Administration would act
promptly, so that fiscal and monetary policy will be working together to
bring down Inflation.

Interest rates would then come down sooner, and the

burdens of fighting inflation would be spread more evenly.

Rest assured,

however, that the Federal Reserve will stay with its policies of monetary
restraint for as,long as is necessary to win the battle against inflation.
We have come a long w a y , and we certainly have no intention of turning back