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INFLATION AND INVESTOR AT TITU D E S A n Address to the Annual Conference Life Office M a n a g e m e n t Association Atlanta, Georgia September 28, 1976 by M o n r o e Kimbrel, President Federal Reserve B a n k of Atlanta INFLATION AND INVESTOR ATTITU D E S Your p r o g r a m suggests m y r e m a r k s will be on economic, social, and legislative forces affecting the operations of your business in the future, but listening to s o m e of the splendid speeches yesterday and this morning, I think it appropriate to focus essentially on inflation and investor attitudes. Perhaps the switch is not so strange. At the Federal Reserve, w e spend m u c h of our time thinking about and acting on w a y s designed to influe nee ^credit and inflation. A n d good information about investor atti tudes is i m m e n s e l y helpful in explaining the ups and downs of the economy. These subjects are constantly on our minds and sometimes other subjects of undisputed importance m a y be temporarily pushed to the back burner. Inflation and investor attitudes are equally important to the insurance industry, too. Inflation is a particularly serious p r o b l e m for you. It reduces the return and value of your investments and loans, m a n y of which are to be repaid at s o m e future time. M y o w n experience is representative of the effects of inflation on your policyholders. In 1945, I bought a $4, 000 policy for m y daughter's education, thinking this am o u n t would be fully adequate for the basic expenses. B y the time she got to college, the $4,000 scarcely paid her board and room, m u c h less her tuition. W o u l d you care to estimate the n u m b e r of policyholders w h o have suffered and are suffering the s a m e disappointment? - 2 - Credit is another subject of mutual interest to the Federal Reserve S y s t e m and the life insurance business. Historically, life insurance c o m panies have been heavy investors in real estate, large suppliers of business credit, and active purchasers of federal, state, and local government securities. A s a whole, the life insurance business is the fifth largest institutional lender. In 1975, it lent and invested at a record $18 billion clip. Y our credit policies, collectively and individually, contribute substantially to the question of whether this nation's capital needs are met. The n e w investments you will m a k e during the rest of this year and next; the c o m m i t m e n t s you will undertake; the balance sheet restructuring you will do--these actions will play a part in Federal Reserve monetary policy decisions. If you will consider the problems of inflation and the questions about the supply and cost of credit and then tangle t h e m up with the m y s t e r y of investor attitudes, you will have s o m e idea of the complexities faced by economic forecasters. At the Federal Reserve, w e k n o w about the defaults, foreclosures, losses, and other painful experiences that life insurance companies have h ad in the last two years. It is what w e don't k n o w that will reflect in the clarity of our predictions for the future. have you decided to a s s u m e ? W h a t risks Will you a s s u m e m o r e than the usual risks? Will you reduce your investments, or will you follow a course of moderation? - 3 - Subjective answers to these questions would provide us m u c h m o r e confidence in m a k i n g predictions about the economic and financial outlook. Believe m e , your investment decisions influence the general outlook far m o r e than you realize. So far, you have the general t h e m e of m y r e m a r k s today; now, to s o m e specifics. Inflation is a less serious p r o b l e m today than it w a s two years ago. N o w , inflation is 6 percent; then, 12 percent. This i m p r o v e m e n t represents a m a j o r accomplishment, m u c h of which reflects reduced price increases for fuels and stable-to-lower food prices. The United States, in fact, is n o w a comparatively cheap place to live, as has been so quickly discovered b y recent travelers to Europe. Aside f r o m G e r m a n y , W e s t e r n Europe's inflation rate remained well above ours, though there, too, it has c o m e down. F r o m a different perspective, our price performance represents progress, but not unqualified success. Inflation is usually mild after a recession, and w e are n o w only eighteen months into economic recovery. Prices this time rose faster than in comparable recovery periods. We still have a troublesome task to even m a t c h the 2 percent inflation rate achieved in the early 1960's. W e cannot afford the luxury of being complacent about the p r o b l e m of inflation. Suppose the 6 percent inflation rate continues. O u r price level would double, and the purchasing p o w e r of savings and assets would - 4 - shrink b y 50 percent in twelve years. N o n e of us want this to happen. A n d yet, looking toward 1977, the evidence is less than convincing that the inflation rate is likely to c o m e d o w n significantly. F o o d is the only m a j o r item for which the n e a r-term price outlook is favorable for the consumer. There, w e are reasonably optimistic. Crops are expected to break or approach records. sector, however, w e m u s t not be too confident. E v e n in the food Drought in W e stern Europe, uncertainty about weather, and a history of having the unexpected happen are good reasons to suggest caution. M o r e predictable, but less optimistic, is the price outlook for industrial products. In recent weeks, higher prices w e r e announced for steel, aluminum, passenger cars, and clothing. covers products in a m ple supply. This incomplete list If m a n y such price increases remain firm, imagine what could happen if shortages should develop. K e e p in m i n d that the shortages experienced in 1973-74 w e r e an evil gremlin contributing to the double-digit inflation in 1974. Serious shortages are not likely to develop soon because of slack in product markets generally. its expansion. But w e look for the e c o n o m y to continue That m e a n s the productive capacity for m a n y materials and commodities will eventually fail to m a t c h demand. A s a consequence, precautionary buying, shortages, and bottlenecks can be expected in the long run, thus intensifying price pressures. The chance that these and - 5 - other problems will reappear m a k e s m e pessimistic about a sharp reduc tion in the inflation rate. F o r example, significant reductions in inflation appear impossible without a substantial drop in labor cost increases. prospect? H o w realistic is this C a n w e anticipate smaller w a g e increases or larger productivity- gains, or both? So far this year, w a g e increases have m o d erated to about 7 percent; productivity rose to about 4 percent; labor cost increases went d o w n to about 3 percent. Nevertheless, recent w a g e contracts and the u p w a r d w a g e pressures usually accompanying later stages of economic expansion m a k e it doubtful that these w a g e trends will continue indefinitely. In addition, productivity, though increasing, is still well below postwar rates. F o r these reasons, I a m pessimistic about achieving less inflation f r o m the labor cost side. The federal budget, which has been in deficit in nine of the last ten years, gives further encouragement for reflection. These deficits have not only been c o m m o n and huge, but they have been part of the inflation problem. billion. Federal spending in fiscal year 1976 exceeded revenues b y $65 Considerable red ink is again expected in fiscal 1977--probably close to $58 billion. Deficits m a y be regarded as only mildly inflationary as long as our capacity to produce remains large and the e c o n o m y h u m s along, as in our present situation. But in a m o r e ebullient economy, deficits can cripple - 6 - progress against inflation. H o w we'll even approach price stability unless w e keep m o r e restraint on federal spending or increase taxes is difficult to foresee. H uge federal deficits, moreover, have a w a y of derailing m o n etary policy. The U. S. Treasury, of course, covers its deficits b y borrowing in credit markets. If massive deficits a c c o m p a n y large business and con s u m e r credit demands, private credit gets squeezed and interest rates escalate. Admittedly, the Federal Reserve is not powerless in such a situation. W e can counterattack by taking actions directed toward lifting the rate of mo n e t a r y expansion. But a d i l e m m a is presented b y such action. The long-range effects of a high m o n etary expansion rate are inconsistent with subsequent price stability. Therefore, Federal Reserve policy during the past year has been to lower gradually its long-run monet a r y growth targets, hoping that this will help reduce the inflation. While keeping a w a r y eye on prices, w e are not unmindful of the need to encourage business expansion. W e have sought a pace of mo n e t a r y growth that w a s adequate to facilitate a sustainable economic recovery without aggravating inflation. During the past year, the narrowly defined m o n e y supply (Mq) g r e w about 5 percent. by about 10 percent. The broader m e a s u r e ( M 2 ) rose In general, liquidity in the e c o n o m y is ample. I feel comfortable with these m o n e y growth rates. They fit the goal of moderate monetary stimulus, serving both short- and long-term - 7 - objectives. A lesson w e have learned, and in which w e had a refresher course in the early Seventies, is that a sustainable recovery is far better than a quick recovery. If recovery can't be sustained, inflation is aggra vated rather than eased and the next recession is pushed forward. Like a change in musical tempo, the rh y t h m is quickened. U n e m p l o y m e n t remains untolerably high. About 4 million persons have been added to payrolls since the end of the recession. Nevertheless, the e c o n o m y did not expand fast enough to absorb the extra large n u m b e r of w o m e n and teenagers looking for jobs. So, the u n e m p l o y m e n t rate dropped m o r e slowly than w e would have liked and over the last three months even rose somewhat. At times, debates over u n e m p l o y m e n t and inflation have b e c o m e so emotionally charged that the Federal Reserve's independent status has been questioned. Proposals have been m a d e to bring mo n e t a r y policy under closer control of either the Congress or the Executive Branch. There are those today w h o advocate reducing the protection of the Federal Reserve f r o m political pressures. The Federal Reserve Act established an independent status for the country's central bank within a governmental framework. This concept fits the basic principles of our Constitution, and it has kept the Sy stem free of the political arena with its constant pressures. It gave the S y s t e m strength to fight inflation and gives us n o w the opportunity for lasting success. - 8 - Effectively reducing inflation is a long-term process, and, at times, unpopular policies are necessary. U n der persistent political pressures m a k i n g the s a m e decisions would be extremely difficult if not impossible. It is not surprising to find countries with w e a k central banks have the m o s t debilitating inflation, and countries with independent central banks have the best anti-inflation records. This strikes us as convincing evidence that the independence originally granted the Federal Reserve continues to augur well for the best economic environment for our country. Today, credit is certainly not in short supply. is an abundance of credit. If anything, there Borrowing costs have not increased in this economic recovery phase, despite massive Treasury financing. This is remarkable--interest rates usually rise in the second year of economic recovery. There are at least three m a j o r explanations for the recent relative interest rate stability. Corporations have enjoyed a large cash flow, thus holding d o w n credit demands. The cash flow of life insurance companies, pension funds, and savings intermediaries has been enormous. s u m s b e c a m e available. Large All this together with an accom m o d a t i v e m o n e tary policy, reluctance to lend, and relatively slack credit d e m a n d s (except for short-term refinancing) produced an unusual interest rate phenomenon. L o w e r inflation rates and reduced inflationary expectations helped. enjoy a bright spot in the economy: interest rate plateau. So w e no credit squeeze and something of an - 9 - Probably that statement should be qualified slightly. Borrowers can take advantage of interest rates that are not double-digited. Lenders, on the other hand, ha d to accept a lower nominal return than in s o m e time and, if they wanted to extend credit, m o r e often ha d to go out looking for opportunities. The adjustment has been difficult because earlier losses instilled a conservative lending mood. This w a s a natural reaction. It follows that a look at investor attitude is appropriate. Lenders and investors have experienced a trauma, and this is easily understood. The widespread emphasis on caution, the necessity of reflecting on our exposures, and on getting our o w n shop in order, including the restructur ing of balance sheets, w a s not misplaced advice. But n o w that corporations have significantly rebuilt their liquidity, the time for reassessment has come. Lenders should not neglect their vital role in financing the economic recovery n o w in progress. T o fail would h a m p e r the recovery as well as retard the long-term growth of the country. Will there be enough funds available to m e e t the large capital needs? The question has been and will be debated in financial circles. ready answer, but on one point w e can be certain: There is no If life insurance c o m panies and other institutional investors fail to m e e t the public's expectations, the federal government is sure to step into the breach and a s s u m e the responsibility. History has s h own all too clearly that the federal govern m e n t s e e m s willing and ready to fill any existing v a c u u m in lending. Even - 10 - if the government does not b e c o m e a direct lender, it has stern alterna tives: it could legislate controls or allocate credit a m o n g competing demands. Obviously, these are not palatable to anticipate. W h a t does all this m e a n to you? Well, traditionally, life insurance companies have provided c o m m e n d a b l e economic leadership and pr o m o t e d practices contributing to success. International inflation, domestic unemployment, and shifting investor attitudes provide a kaleidoscope of opportunities. A s fluid as these baffling circumstances m a y b e , the approach m u s t be aggressive. B a s e d on your illustrious history of creditable performance, I a m persuaded you and your associates in the life insurance industry will accept the risks of prudent leadership.
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