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REFLECTING ON RECESSION, ENERGY, AND IN FLA TIO N Rem arks to A tla n ta R o ta ry C lub A tla n ta , G eorgia J a n u a ry 28, 1980 by Monroe K im b re l, P re sid e n t Federal R eserve B ank o f A tla n ta A t th e tu r n o f a decade, tra d itio n su ggests p o lis h in g th e c ry s ta l ball w ith e x tra ca re . T he last decade p ro ve d d iffic u lt fo r th e w o rld economy. Many major e ve nts o f th e 1970's w ere not seen b y economic fo re c a s te rs ten ye a rs ago. o f tim e. I t is u n lik e ly o u r c la irv o y a n c e has im proved w ith th e passage Who, fo r exam ple, could have p re d ic te d th e re c e n t e ve nts in Ira n and A fg h a n ista n ? Even one y e a r ago, fo re c a s te rs believed 1979 w ould be a recession y e a r. B u t real economic a c tiv ity increased in th e th ir d q u a r te r and e a rly in d ic a tio n s are th a t a c tiv ity also increased in th e fo u r th q u a r te r . I f tr u e , th a t w ould leave o n ly th e second q u a rte r show ing a d e cline la st y e a r. In my re m arks to you last J a n u a ry , th e like lih o o d o f a recession was d is co u n te d . H ow ever, I d id e xp e ct th e economy to w eaken. Now, th e g ro w in g num ber o f persons laid o f f and th e weakness in in d u s tria l p ro d u c tio n to w a rd th e end o f 1979 g iv e credence to those who th in k a recession is n e a r. R ecessionary fo rce s are s c a tte re d , b u t show th e ir g re a te s t s tre n g th in th e M idw est and N o rth e a st sections o f th e c o u n try and in th e autom otive and re s i d e n tia l c o n s tru c tio n sectors o f th e economy. th e fo u r-y e a r-o ld boom; S tre n g th in these se ctors fed now , th is s tre n g th has de clin e d and th e boom is s ta rv in g . We know th e reasons: th e s u b s ta n tia l increase in autom obile p ric e s , especia lly small autom obiles, encouraged d r iv e r s to keep th e ir old c a rs . The escalating cost o f gasoline tu rn e d th e romance A m ericans had w ith b ig autom obiles in to som ething more on th e o rd e r o f d is a s te r. Small, g a s - th r if ty A m erican ca rs are n o t y e t p le n tifu l enough to fu lly accommodate th a t m a rk e t. - 2 - T h e n , th e re is th e s tu b b o rn decline in housin g a c tiv ity . M ortgage ra te s and p rice s o f homes rose beyond th e reach o f many firs t-h o m e b u y e rs . C on s id e rin g th e h ig h cost o f m ortgage money and th e s la cke n in g am ount o f m ortgage fu n d s a va ila b le , a c u tb a c k in re s id e n tia l c o n s tru c tio n was in e v ita b le . T h is se cto r is n o t lik e ly to show s tre n g th u n til th e d e p re ssa n ts are rem oved, and th a t m ig h t n o t happen b e fo re late in 1980. L ooking to th e fu tu r e , tw o q u estion s s u rfa ce most o fte n : th e recession be? How long w ill it last? How m ild w ill Forecasters almost unanim ously e xp e ct th e c u r r e n t d o w n tu rn to be m ild e r and s h o rte r th a n th e 1974-1975 slum p. d o w n tu rn was th e most severe and lo ngest since W orld War I I . m onths; That I t lasted 16 and GNP, a d ju sted fo r in fla tio n , fe ll 5 p e rc e n t d u rin g th e p e rio d . T h e re is ample reason to e xp e ct h is to ry w ill n o t re p e a t its e lf. Then, th e m a rke t fo r condom inium s and a p artm ents was s a tu ra te d , and sp e cula tio n was ra m pa n t. T o d a y , b u ild e rs are b e tte r p o s itio n e d . In v e n to rie s o f unsold homes are low , and th e demand fo r homes as a hedge a g a in st in fla tio n is s tro n g . A ll in d ica tio n s are fo r a modest decline in h o u s in g , not a collapse. T h e re are o th e r d iffe re n c e s . F ir s t, th e re was a c re d it c ru n c h in 1974. Now, business c r e d it is a v a ila b le , th o u g h c o s tlie r and less p le n tifu l th a n b e fo re O ctob e r 6 when th e Federal R eserve s ta rte d to r e s tr ic t b a n k re s e rv e s . in 1974-1975 in v e n to rie s w ere excessive th ro u g h o u t th e economy. Second, T h is tim e, businessm en have k e p t in v e n to rie s lean a n d , w ith m inor e x c e p tio n s , in v e n to rie s seem much b e tte r balanced re la tiv e to sales. These c o n tra s ts between th e 1974-1975 slum p and p re s e n t c o n d itio n s in d ic a te th e 1980 recession may be less h a rs h . -3- Many a n a ly s ts foresee th e 1980 d o w n tu rn as m ild , o r , a t w o rs t, a ty p ic a l p o st-W o rld War II rece ssio n : th a t is , it w ould last eleven m onths, and real GNP w ould fa ll a bout 2 p e rc e n t between peak and tro u g h o f th e economic cycle . Is th is p ro s p e c t re a lis tic ? g e th e r unreasonable. A t q u ic k g lance, it is appealing and n o t a lto S till, th is p re d ic tio n o f a v e r y m ild recession has some s k e p tic s . Changes have o c c u rre d in o u r economic s tr u c tu r e and la b o r fo rc e size since th e F iftie s and S ix tie s , when recessions w ere ju s t small in te rru p tio n s to ra p id g ro w th . T h e p re s e n t economy is much more d e p e n d e nt on w o rld tra d e and has g re a te r lin k s to in te rn a tio n a l e v e n ts . More com plex and h e a v ily s e rv ic e - o rie n te d , its dem ographic com position is d iffe r e n t. T h e c o u n try 's p o p u la tio n is g e ttin g o ld e r, w ith fe w e r y o u th s and more re tire e s . Those who do have fe w e r c h ild re n . many more w o rk in g women. Fewer people m a rry . More are g e ttin g d iv o rc e d . T h e re are T he lis t o f changes is lo n g . Two o ve rsh a d o w in g components o f th e c h a n g in g economic e n v iro n m e n t are e n e rg y and in fla tio n . T he a larm ing fa c ts about o u r e n e rg y s itu a tio n are th a t o u r o il im p o rts have increased d u rin g th e S e ve nties, b u t o u r own o il p ro d u c tio n has d e clined d e sp ite A la ska 's o u tp u t. E a rlie r it to o k 4-1/2 ye a rs fo r gasoline p ric e s to d o u b le , b u t o n ly re c e n tly th e y doubled in 18 m onths. T he gas mileage o f th e average A m erican ca r on th e road to d a y increased o n ly e ig h t-te n th s o f a mile from s ix ye a rs ago. Compared to o th e r c o u n trie s , o u r o il needs are so large b u t o u r s tra te g ic petroleum re s e rv e is so small th a t we are v u ln e ra b le to even modest c u to ffs in o il s u p p ly . 1980's. These problem s are not lik e ly to be solved in th e No am ount o f c o n s e rv a tio n , s y n th e tic fu e ls , o r e n e rg y a lte rn a tiv e s w ill g iv e us r e lie f in th e s h o rt r u n . N or can we e xp e ct any d ra m a tic r e lie f from th e ravages o f in fla tio n th is y e a r. Besides in e v ita b ly h ig h e r gasoline, h e ating o il, and u t ilit y b ills , in 1980 we face th e p ro s p e c t o f a wage c a tc h -u p . T w o - fifth s o f all c o lle c tiv e b a rg a in in g c o n tra c ts are up fo r renew al, and unions u n d o u b te d ly w ill w o rk h a rd a t o ffs e ttin g th e loss in consum er b u y in g p o w e r. T he minimum wage h ike also w ill pu sh up la bo r co sts. A n o th e r p a rt o f th e in fla tio n problem — ris e . th e fe d e ra l d e fic it — is c e rta in to Federal b u d g e t d e fic its always w iden in recessions as ta x re c e ip ts slow down and unem ploym ent com pensation and p u b lic w o rk s sp e n d in g e x p a n d . The e ffe c t o f in fla tio n on persons w ith fix e d incomes is w ell kn o w n ; e ffe c t on savers is less obvio u s b u t e x tre m e ly s e rio u s . in c e n tiv e and a b ility to save. cent o f his income — th e In fla tio n d iscourages th e T he average A m erican now saves less th a n 4 p e r th e lowest level since th e Korean w a r. He has been b o rro w in g a t re c o rd -b re a k in g ra te s , u s in g c r e d it c a rd s and num erous o th e r d e vice s. More and m ore, he e xp ects his sa ving s to come from p r o fits on real e s ta te , g o ld , and com m odities. I f he is a homeowner, he can u s u a lly ta ke advantage o f c a p ita l gains on his old house, spend some o f th e p ro ceeds, and g e t a new, in fla te d m ortgage. A n in d iv id u a l may p o s s ib ly succeed b y th is process i f his assets keep ris in g in v a lu e . A n a tio n c a n n o t. Less sa v in g means less in v e s tm e n t; means less chance o f re d u c in g in fla tio n . are among th e lowest in th e w o rld . less in ve stm e n t O u r ra te s o f sa vin g s and o f investm e nts O th e r na tio ns have surpassed us in research and developm ent and in ve stm e n t b re a k th ro u g h s , w hich are th e p a th to low er co sts. O u r p r o d u c tiv ity gains in 1979 w ere e xtre m e ly low, o r even n e g a tiv e , and o u r in fla tio n was above much o f W estern E u ro p e 's . make fo r a vic io u s c y c le o f in fla tio n . Less s a v in g and less in ve stm e n t - 5 - N e ve rth e le s s , th e re is a chance in fla tio n w ill ease o f f la te r th is y e a r, pe rha p s even to a s in g le -d ig it fig u r e . In fla tio n ty p ic a lly slows d u rin g re cessions since these are p e rio d s o f sla cken in g dem and, m aking p ric e rise s d if f ic u lt . Employment fa lls o f f , cau sin g those w ith jobs to w o rk h a rd e r. P ro fits are reduced e n c o u ra g in g management to a dopt more c o n s e rv a tiv e business p ra c tic e s . Last O ctob e r th e Federal R eserve to o k v a rio u s c r e d it- tig h te n in g steps because excessive money and c re d it w ere h in d e rin g th e a n ti- in fla tio n s tru g g le . These actions met w ith some success: money and c re d it g ro w th d im in ish e d . So, a s lig h t lo w e rin g in th e in fla tio n ra te as th e y e a r u n fo ld s is a p o s s ib ility . I f oil p ric e s could be b ro u g h t down o r m oderated, these p ro s p e c ts w ould be much b r ig h te r . I am less o p tim is tic th a n most o f th e fo re c a s te rs when c o n s id e rin g th e fu tu r e o f business a c tiv ity . T he c u r r e n t d o w n tu rn could go somewhat deeper th a n most a n tic ip a te , e sp ecia lly g ive n a n o th e r o il c u to ff o r huge OPEC p ric e in crea se . Money we pay fo r im ported o il means th a t much more money goes a b ro a d , le avin g less to spend in th is c o u n try . Reduced consum er sp e nd in g on n o n -o il p ro d u c ts a t home, in t u r n , means less goods are p ro d u ce d dom estically. T he re s u lt: fe w e r jo b s , th re a te n in g a deeper recession. T h e consum er p ric e ris e has o u ts trip p e d income g ro w th , re s u ltin g in 5 p e rc e n t less real disposable income fo r th e average consum er from one y e a r ago. T he modest wage increases la st y e a r fo r th e average Am erican w ere more th a n w iped o u t b y in fla tio n and h ig h e r ta x e s . fo rce consum ers to trim th e ir b u y in g . T h e s ig n ific a n c e is th a t it could I f indeed consum ers do become less in clin e d to in c u r d e b t and s ta r t sa v in g more o f th e ir p a y c h e c k s , re ta il sales could s u ffe r . Goods w ould p ile up on shelves q u ic k ly , cau sin g in v e n to ry c o rre c tio n s , o rd e r ca n cellations and la y o ffs . - 6 - C ap ita l sp e n d in g fa lls s u b s ta n tia lly in a severe rece ssio n , a lth o u g h it holds up well in a m ild slum p. T h u s , we could see a sca ling back in c a p ita l o u tla y s as business e xe c u tiv e s delay sp e n d in g plans — ment — e sp ecia lly fo r equipm ent replace u n til re ta il sales re c o v e r. I f consum er sp e nd in g fa lte rs in th is election y e a r, fis c a l stim u lu s is almost a c e rta in ty . O u r elected o ffic ia ls w ould be re lu c ta n t to re s is t a ta x c u t and s te p p e d -u p go vern m e n t sp e n d in g . B u t election day is less th a n ten m onths away, and i t may be too late fo r fis c a l s tim u la tio n to have more th a n minimal im pact on jobs and income d u r in g most o f 1980. O u r economy d iffe r s from past decades. T r a d itio n a lly , we a p p ly m onetary d is c ip lin e to c u rb in fla tio n , and fis c a l s tim u lu s to fig h t recession. weapons have se riou s d ra w b a cks fo r a p p lic a tio n to d a y . These p o lic y B oth w o rk p rim a rily on th e demand side fo r goods and s e rv ic e s . A tig h t m onetary p o lic y is a p p ro p ria te in th e c u r r e n t e n v iro n m e n t. C re d it re s tric tio n s reduce demand p re s s u re s a n d , th e re fo re , w ill n o rm a lly slow in fla tio n . B u t when so much o f th e in fla tio n is caused b y OPEC and cost tre n d s , i t m ig ht ta ke a b o n e -c ru n c h in g , s u p e rtig h t m onetary p o lic y to reduce demand enough to ch eck in fla tio n . deep recession — T h e p ric e fo r such a p o lic y — nam ely, a p ro lo n g e d , w ould be unacceptable to all o f us. A n o th e r tra d itio n a l to o l, fis c a l s tim u lu s , is used to pu sh th e economy ahead, s tim u la tin g dem and. An a c ro s s -th e -b o a rd ta x c u t w ould increase consum er sp e n d in g , b u t inadequate demand is not o u r major problem to d a y as it was in th e d epression o f th e T h ir tie s . In fa c t, consum ers have been b u y in g ahead o f th e ir needs, a n tic ip a tin g h ig h e r p ric e s . Some s till do. - 7 - T he wisdom o f s tim u la tin g consum ption w ith a ta x c u t fo r consum ers is d o u b tfu l. In tim es o f little in fla tio n , personal ta x c u ts can be defended be cause o f th e ir s h o rt-te rm b e n e fits to em ploym ent. need. B u t th a t is not th e c u r r e n t As a w hole, o u r so ciety has been h u r t too s e v e re ly b y in fla tio n to r is k re v e rs in g a n ti- in fla tio n a r y policies now. O u r g re a te s t concern should be w ith s u p p ly ra th e r th a n dem and, e sp e cia lly in th e fie ld o f e n e rg y . T he concern w ith s u p p ly s p o tlig h ts lo n g -ra n g e problem s th a t have o n ly lo n g -ra n g e s o lu tio n s . consensus. A p p ro p ria te pro gra m s m ust be fo u n d on w hich th e re is a T h is is always d if f ic u lt . Here are some s u g g e s tio n s : a re d u c tio n in burdensom e go vern m e n t re g u la tio n s , a m o d ification o f laws and ru le s th a t s tifle co m p e titio n , and a b a lancing o f th e fe d e ra l b u d g e t. T a x re fo rm s , w hich w ill s u p p o rt c a p ita l fo rm a tio n , could be added to th is lis t. A lso , th e re is a need fo r d is p la c in g obsolescence in o u r economy. P ro d u c tiv ity im p rove m e n t, w hich u ltim a te ly leads to low er costs and p ric e s , can come o n ly from more e ffic ie n t m achinery and fa c ilitie s . A lth o u g h it may be d iffic u lt in an election y e a r, we m ust ta k e a lo n g -ra n g e p e rs p e c tiv e in d e a lin g w ith o u r economic problem s and w o rry less about the near te rm . B a s ic a lly , we need an e ffe c tiv e lo n g -ra n g e e n e rg y p ro g ra m . A reduced dependence on im p orted o il and increased e ffic ie n c y in use o f e n e rg y could reduce in fla tio n s u b s ta n tia lly . For those o f us re sp on sib le fo r m onetary p o lic y , th e message is c le a r. T he Federal R e se rve , w ith o u t w a v e rin g from its p o lic y sta n ce , should stand firm a g ain st th e p h ilo so p h y th a t in fla tio n w ill fo re v e r remain a way o f life in o u r s o c ie ty . means re je c tin g ra p id money g ro w th to boost th e economy d u rin g recession. T h is An e xp a n sio n a ry m onetary p o lic y increases in fla tio n in th e long ru n and could b rin g fre s h assaults on th e d o lla r in th e fo re ig n exchange m a rk e ts . a ffo r d . T h is we can ill - 8 - A steady re d u c tio n in money and c r e d it g ro w th in 1980 is a p ru d e n t p o lic y . Acceptance o f th is p o lic y also means acceptance o f some r is k fo r a p a in fu l rece ssio n , b u t it w ould be a step to w a rd o u r goal o f g ra d u a lly b rin g in g down in fla tio n . T he message is sim ple. T he recession p ro b a b ly w ill be m ild e r th a n the 1974 d o w n tu rn , and th e in fla tio n a ry fe v e r should d im in is h s lig h tly . O ur re c o g n itio n th a t in fla tio n and e n e rg y d e serve h ig h e s t p r io r it y means hope fo r a so lu tio n to these v e x in g economic p roblem s. T h e y are deep seated and tenacious. S o lvin g them w ill re q u ire tim e , patience and a few modest s a c rific e s . P a rt o f th a t p ric e may well be a w illin g n e s s to fo re g o some s h o rt-te rm gain in exchange fo r a more se cu re , more stable and h e a lth ie r economy.
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