View original document

The full text on this page is automatically extracted from the file linked above and may contain errors and inconsistencies.

For use at 6:30 PM E.S.T.
Wednesday, December 3, 1980

A Rare Opportunity
Remarks by
Paul A. Volcker
Chairman9 Board of Governors of the Federal Reserve System

before the
43rd Annual Dinner
of the
Tax Foundation
New York City

December 3, 1980

I am honored and grateful in receiving the Public Service
Award of the Tax Foundation, a group that through the years has
done so much to encourage dispassionate study and analysis of
critical aspects of public policy.

I must confess that upon

first being approached about this occasion, it struck me as
anomalous that, with all the debate and rethinking about tax
strategy now going on, the Tax Foundation turned to a man
principally concerned with monetary policy.

But perhaps it's

appropriate that we not get into the details of tax policy
this evening.
Any incoming Administration needs the opportunity to
fully develop and present its specific proposals in the
context of a comprehensive, long-term, coherent economic
program at a time of

its choosing.

Little can be gained,

and much can be lost, in developing the necessary policy
consensus and support by gratuitous speculation by others
about the precise shape of the proposals before they are
Obviously, the same strictures need not apply to a
discussion of monetary policy.

Moreover, the monetary and

financial environment provides an important backdrop in any
consideration of the fiscal and other critical economic issues
that face the nation.
At the very outset of my remarks, I want to emphasize
two points.


First, I believe we have a rare opportunity in the
months immediately ahead to come to grips, in a fundamental
and decisive way, with the inflationary problem that lies at
the heart of so much of our economic malaise.

One dimension

of that opportunity lies in the widespread public appreciation
of, and concern about, the inflation problem.

The political

dimension is inherent in the taking of office of a new
Administration and a new Congress, seized with a sense of
urgency/ with energy and with new ideas.

And I am convinced

the intellectual dimension will not be lacking; the main outlines of necessary and appropriate policies can be reasonably
distilled from elements of thinking common to most of the
leading schools of economic thought.
My second point seems to me at least as important,


us not be beguiled into thinking there are quick and painless
solutions to a set of economic problems that have been decades
in the making, that in greater or lesser degree have become
endemic to Western industrialized nations, and that grow out
of deeply ingrained public and private policies, attitudes
and expectations.

Success will have an enormous payoff in re-

building a solid foundation for growth and prosperity.


it cannot be achieved by a nation pulling back from hard choicesIn emphasizing the central nature of the inflationary
problem, I do not suggest that inflation is our only problem.
Nor would 1 claim that unemployment, declining productivity/
low savings and investments, energy dependence, points of strain


in the domestic and international financial fabric, and the
weakened competitiveness of some industrial sectors will somehow all smoothly recede as we successfully deal with inflation.
To the contrary, those problems in some instances have specific
causes and have themselves significantly aggravated inflationary
pressures; each will need to be approached and dealt with on
its own merits.
What I would suggest is that the inflationary process is
today, as one wise man has said, more than the sum of those
separate parts.

With all its built-in momentum and self-

sustaining expectations, it has come to have a life of its
own, and the distortions and instability it breeds undercut
all our efforts to deal effectively with the more specific
I am, of course, aware of the concern or perception
that a frontal assault on inflation can in the short-run
(and we all live in a succession of short-runs) threaten
other aspects of economic performance or our sense of well

We tend to associate monetary and fiscal restraint

with low growth and productivity and with high unemployment
and interest rates.

Moreover, after decades of inflation,

many of us, more or less comfortably, have adapted our business
and personal lives to the prospect of more inflation.

We count

on capital gains from inflating house and land values as a
substitute for real savings.

We assume our competitors will

match our aggressive pricing policies, and will also accede to
high wage demands.

We take comfort in our purchases of precious


metals, art, and more exotic "collectibles" —
those who did buy —

or envy

and are tempted to project essentially

speculative price movements into the great beyond.
But none of this

sense of accommodation to inflation

can be a valid excuse for not acting to deal with the disease.
Experience amply demonstrates that years of temporizing in the
presumed interest of sustaining growth, productivity, and
employment have borne bitter fruit instead.

We find ourselves

with more inflation, more unemployment, and less growth.


fact is the idea of a sustainable "trade off" between inflation
and prosperity, however valid in particular circumstances for
a time, broke down as businessmen and individuals learned to
anticipate inflation, and to act on this anticipation.


expectations sometimes seem to me to run ahead of the reality.
The result is that orthodox monetary or fiscal measures designed
to stimulate can potentially be thwarted by the self protective
instincts of financial and other markets.
Quite specifically, when financial markets jump to
anticipate inflationary consequences, and workers and businesses
act on the same assumption, there is room for grave doubt that
traditional measures of purely demand stimulus can succeed in
their avowed purpose of enhancing real growth for any significant
period of time.

And it seems to me a certainty that, whatever

the short-run effect, we would be left in the end with still
more difficult dilemmas —

still more congestion in credit

markets and still higher interest rates; still less incentive


to save; and still more of our citizens preoccupied with
beating inflation rather than with efficient production.
If the public instinct is right that beating back
inflation is the first economic priority, I cannot escape
the corollary that monetary policy has an essential role to
play in that process.

I do not intend to linger tonight over

the intriguing questions about how best to define money and
to control it, precisely how fast money and credit should
grow consistent with a return to price stability, and how
much weight should be given to each of the various money
measures or to interest rate stability.

Those issues are

likely to remain matters for debate among specialists.
I do want to be unambiguous about the basic point:


no anti-

inflationary program can be successful if monetary policy
stands ready to accommodate passively, through the process of
money and credit creation, whatever financing demands flow
from the inflationary process.

Put more positively, the

Federal Reserve must act, as best it can, to contain persistently the growth of money and credit, by controlling its
supply, to amounts commensurate with a return to price stability,
How fast, by what methods, and over what time period, may
be matters of judgment.

In the midst of economic turbulence,

some volatility in money growth may be inevitable over short
time periods.

But it seems to me analytically beyond doubt

that the job of restraint can be done over reasonable time


frames and within the necessary limits of precision, and
that the job must be done if we are to deal with inflation.
The relevant question is at what cost in terms of other

The answer to that question will not be determined

by monetary policy alone, or even primarily.

A central bank

does not control, or directly influence, the demand for money,
or how much of the available supply of credit is used to finance
real growth and investment as opposed to the turnover of goods
and services at higher prices.

Put another way, within a broad

range, restraint on the supply of money sets limits on the
growth of the nominal gross national product.

Whether that

nominal growth is absorbed by inflation and public spending,
or whether real growth in the private sector can proceed, will
depend in large part on other policies and attitudes, public
and private.
Recent experience illustrates the problem.

Growth in the

various money measures is currently running close to or slightly
above the upper edges of the ranges we set for ourselves at the
start of the year; measured against our stated intentions
(intentions that were widely thought appropriate) we have not
been unduly restrictive.

Yet, in real terms, the GNP actually

fell slightly over the course of 1980.

The sizable growth of

almost 10 percent in the nominal GNP over the same period was
swallowed up by inflation.


I take some satisfaction, limited as it must be, from
the fact that the almost explosive inflationary pressures
early this year, associated in part with the oil price increases,
were contained and diffused; the fears that inflation would
accelerate sharply were not borne out.

But I need not emphasize

that 1980 has been a difficult year, marred by recession and
rising unemployment and depressed activity in key industries.
Moreover, in recent weeks and months, as an otherwise welcome
and surprisingly strong revival of business activity has
generated sharply increased demands for money and credit,
we have had to lean increasingly hard on the supply of bank
reserves to slow excessive money growth.

Combined with the

effects of large deficits and continued strong inflationary
expectations, the credit markets are again under heavy pressure,
raising renewed and understandable concern about the sustainability of the recovery.
In these circumstances, an intellectual consensus rightly
remains that the growth of money and credit must continue to
be curbed in the interests of encouraging price stability.
This is our intent and purpose.
the question —

But that does not dispose of

given the apparent inflationary momentum •—

about the extent to which the restraint necessary to curb
inflation will, in the short-run, squeeze out real growth as

That will, in the end, depend upon the speed with which

we can make progress on inflation.


Inflation persisting at around 10 percent —
rate of the GNP deflator —

the current

in 1981 would imply nominal GNP

growth of, say, 12 percent or more if we are to have significant
real growth.

Is that nominal growth consistent with an increase

in the narrowly-defined money supply on the order of 3 to 6 percent , or in the broader aggregates of 6-9 percent, our tentative
targets for 1981?*

Years of research and seemingly endless

computer simulations have not identified relationships among
nominal GNP, money, interest rates, and other variables so
close and unvarying, particularly for periods as short as a
year, as to permit a certain judgment.

But the likelihood

of a squeeze is apparent; we see a taste of it now.


essential purpose, of course, is to squeeze out inflation,
not growth.

*These figures represent an average of target ranges
for 1981 tentatively set by the Federal Reserve in July,
abstracting from the distorting effects on M-lA and M-1B
from the introduction of NOW accounts — in effect interestbearing checking accounts — on a nationwide basis at the
beginning of next year. Tentative targets for M-lA and M-1B
were set 1/2 percentage point lower than their 198 0 ranges
of 3-1/2 to 6 percent and 4 to 6-1/2 percent, respectively.
It was recognized at the time that the introduction on a
nationwide basis of NOW accounts would distort measures of
these aggregates by causing shifts of funds out of demand
deposits and other assets into NOW and similar accounts.
A crude tentative estimate was that, consistent with the
above targets, such shifts might reduce growth in M-lA to
0 to 2-1/2 and raise M-1B to 5 to 7-1/2 percent. Growth
ranges for 1981 for M-2 and M-3 were set at 5-1/2 to 8-1/2
percent and 6-1/2 to 9-1/2 percent, respectively.


In a purely arithmetic sense, if the inflation rate
begins to decline appreciably, there should be room for
significant real growth.
more relevant:

But the economic question is

what can we do, as a nation, to maximize

the progress against inflation, in the process relieving
pressures on financial markets and enhancing prospects
for an early resumption of sustained growth.
One prominent element in recent discussions has been
to note the potential importance of expectations in this

Certainly, expectations, as they are reflected

in wage bargaining, in pricing policies, and in financial
decision-making, have in the past few years both fed the
inflationary process and tended to increase pressures on
financial markets.
be changed —

To the extent those expectations can

to the extent that the safer bet and the wiser

money begins to anticipate lasting progress against inflation
the easier our job will be.
in restraining money —

Our own sense of conviction

and even more a demonstration of

success measured realistically over a reasonable period of
time —

will be among the crucial ingredients in changing

those expectations.
But I don't want to encourage unrealistic hopes.
Expectations grow mainly out of experience over a considerable period of time.

It took years of gradually rising

levels of inflation for behavior to change importantly;
now inflation is institutionalized in three-year wage


contracts, in enormous built-in resistance to price
declines in many economic sectors even in slack markets,
in widespread indexing and public policies designed to
protect the competitive positions and incomes of those
sectors with political power, even when productivity
performance cannot support that protection.
At this point, skeptical Americans are all too likely
to claim Missouri residence; they will want to be shown that
policies adequate to the job will not only be proposed/ but
they will be sustained, and will be sustained through nearterm difficulties, before the established behavior patterns
are broken*

And I sincerely question whether monetary policy

by itself can or should be asked to carry the entire load.
I know that, in concept, a case can be made that
restraint on money and credit alone, sustained long enough
and strongly enough, could control inflation, and thus lay
the ground for renewed growth.

But is that a realistic,

tolerable, believable course if_ other instruments of policy
and opinion are running counter to our purposes?

Will the

sustainability of the policy be credible if the costs in
growth and employment seem excessive, and the costs fall
unfairly on the industries and elements of the population
most dependent on credit?
Surely, the prospects for success will rest on visible
evidence that policies across the board are moving in a


coherent and mutually reinforcing way.

Then, indeed, the

potential collision between monetary restraint and growth
will be minimized and expectations will, sooner rather than
later, turn in a more constructive direction.
One of my distinguished predecessors, Arthur F. Burns,
distilled into a lecture after leaving office some of the
key lessons

of the inflationary experience.

The title,

"The Anguish of Central Banking," understandably struck a
responsive chord with me.
profound and simple.

The central theme was both

For decades, in this country and

elsewhere, a maze of governmental policies and private
practices have developed aimed, with considerable success,
at stabilizing incomes and employment and protection against
market pressures, in the process adding to the responsibilities,
costs and taxes of the Federal Government.
worthy and continuing.

The goals are

But one result has been to eliminate

or dampen some of the natural flexibility and balance of the
market economy, and to impart a strong inflationary bias to
the system by an upward racheting of prices.
I need not elaborate the analysis here.
should not turn our backs on valid goals.

We cannot and

But I would suggest

the relevance of reexamination of all those regulatory and
other policies that do add importantly to costs and prices,
that induce rigidities in wages that may be counter to the
long-run interest of workers themselves, to see if the
essential objectives cannot be met in more effective ways,


or at less cost.

Equally important and certainly feasible,

we can resist those efforts —
every day —

present today and virtually

to stake out new areas of protection from normal

market pressures, whether those competitive pressures originate
at home or abroad.
The list of entrenched rigidities is formidable; each
is defended by tenacious interests.

No single reform is

crucial, and the temptation is therefore strong to "leave
it to the other fellow."

But it is crucial, in the common

good, that we face up to the task.

And, indeed, in a few

areas, a fair start toward deregulation has already been
I have left fiscal policy to the end.

I will be brief

because my point can be made succinctly, not because the
fiscal dimension of our policies is in any way subsidiary.
Indeed, the pending fiscal decisions will send the strongest
kind of message to the American public, and the substance can
have a critical impact on the performance of the American
economy and the financial markets.
It has been rightly said that "well-structured tax
relief can have important favorable effects on incentives,
on investment, and thus ultimately on productivity.
before I join the


'taxpayers revolt1 in the name of anti-

inflationary policy, I must emphasize the necessary corollary.
We cannot proceed without concern about the size of the deficit.
Prudent tax reduction, in the end, depends on expenditure restraint.1


Those last four sentences were taken directly from
a speech I made in 1978.

Events since then have only re-

inforced the case for tax reduction; it is a powerful one.
But events have also confirmed the difficulties of
expenditure control; I remind you of the earnest efforts
of the current Administration and Congressional leaders to
that end earlier this year.

There is no area in which the

new Administration and the Congress will more need your
sustained support.
I am encouraged to believe the necessary understanding
and will is growing.

That is a key ingredient in the great

opportunity to which I referred at the start of these remarks


the opportunity to deal forcefully with inflation and to
restore a solid base for economic growth.
To capitalize on that opportunity, the Federal Reserve
for its part intends to maintain the restraint on money and
credit growth needed to wind down inflation.

But, monetary

policy should not alone be called upon to deal with inflation,
for the risks and costs would then be far greater than necessary,
We need a total effort —

a demonstration that all the major

instruments of economic policy are moving in a coherent and
mutually reinforcing way.

Then, we can indeed turn expectations

and reality in the direction of price stability, have solid
grounds for anticipating reduced pressures on financial markets,
and in the process enhance the prospects for growth.

I look

forward to working with the new Administration and the Congress
toward that result.