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Remarks of
Paul A. Volcker
Chairman, Board of Governors of the Federal Reserve System

before the
60th Annual Conference of the
National Association of Mutual Savings Banks
Lake Buena Vista, Florida

May 14, 1980

I don't know whether it was by design or accident that those
who arranged this donvention chose to place its locale in the land
of fantasy.

But it must have occurred to some of you, as it has

to me, that perceptions in the economy and in financial markets
in recent months have rivaled that mixture of illusion and reality
of shadow and substance —


so characteristic of the fertile imagination

of Walt Disney*
The critical difference is that what is going on outside this
land of Disney World in no way

resembles entertainment.

against inflation is at a crucial point.

The fight

Just when considerable

sentiment developed that the long heralded recession would be
further delayed, the business climate changed abruptly.

As spring

approached, interest rates moved to levels not seen in our lifetime*
Financial markets and financial institutions were coming under
heavy strain,

Some feared the long-term bond markets could be

permanently crippled*

But, today, less than two months later,

some short-term interest rates have dropped almost by half, the
public bond markets are absorbing near record amounts of new issues,,
and some have even questioned whether in some sense markets are not
too "easy."
With professional judgments shifting so fast, with different
definitions of what is "restraint" or "ease" in policy competing for
attention in the press, with simultaneous concern about inflation
and recession, is it any wonder that the public is confused and
concerned about our prospects and the appropriate policy approach?
That confusion can be itself one of the major hazards we face, for
perceptions affect behavior.

Our fears can have elements of self-



Impatience for almost instantaneous results and

simple answers can detract from the persistence and continuity
in policy we need.
For all those reasons, I welcome this opportunity to lay
out as clearly and concisely as I can some of the principal
elements in my own thinking, particularly as it affects the conduct
of monetary policy.
The first quarter of this year apparently represented the
culmination of five years of economic expansion.

It has been

our longest period of peacetime expansion, an expansion accompanied
by unprecedented growth of over 14 million (or

19%) in employment*

There have been enormous strides in female, and ,to a lesser extent,
minority participation in the labor force.

The highest proportion

of our working age population has been at work since those statistics
have been kept.
In ordinary circumstances, these achievements might have
been hailed with a sense of widespread satisfaction.

But instead

we have had a sense of unease and disappointment, a sense that,
somehow, things are out of kilter.

And the fact is those concerns

have indeed been justified.
They have been justified in major part by the instinct of our
people that lasting prosperity —
and sense of social stability —

to say nothing of our security
cannot be built on the shifting

sands of inflation and a weak currency.

At the same time —

phenomenon is in part related to the inflationary process —

and the

in productivity has been dismal, whether measured by our own past


standards or performance abroad.

Meanwhile, however much we

as a nation have tried to resist the inevitable, the escalation
of energy prices and recurrent threats of oil shortage have forced
harsh adjustments and new ways of thinking on the average citizen,
calling into question a style of life dependent on cheap and
abundant energy.

Taken together, the higher energy prices and

actual declines in productivity have inexorably cut into the real
income of most workers over the past year and more —

a matter

hard to square with our expectations and our economic behavior.
None of these problems are new.
rising trend for 15 years.
for a decade or more.

Inflation has been on a

Productivity growth has trended lower

The energy crisis hit with force in 1974.

Together they helped account for the severity of the recession in
1974 and 1975.

Now, five years later, the economic distortions,

the imbalances, and the adjustments that flow from these developments have again threatened to undermine our economy, and even our
sense of direction and confidence.
Yet, I also believe we can see now much more hopeful omens.
Approaches have begun to be put in place that, in time, can lay
the foundation for renewed stability and growth —
stick with them.



Progress may often appear slow and halting.

As the adjustments are underway, the threat of recession has

In our impatience for quick results, we can be tempted

to strike out in new directions even if over time the proposed
measures are likely to be counterproductive.

And all of this


puts a high premium on our economic understanding and on our
ability to explain our purposes and policies.
The point has been made, again and again, that dealing with
inflation must be a first priority of economic policy.


of ever accelerating prices is simply inconsistent with business
planning, orderly financial markets, adequate savings, and in the
last analysis, social cohesion.
Monetary policy has a central role to play in the effort to
restore stability.

I will not argue that we should "go it alone"


that persistent close control over the supply of money and credit
can, all by itself, assure quick, painless, and precisely predictable

The inflationary process is too deeply rooted in our society,

too complex, too bound up in attitudes and institutional behavior to
permit that degree of optimism.

But all of economic history does

demonstrate with clarity that the inflationary process is nurtured
by excessive monetary growth, and that that process cannot be ended
without monetary discipline as a key policy ingredient.
It is that discipline to which the Federal Reserve is committed


a discipline that will be reflected, over time, in restraint on growth
in the money supply and credit.
I am acutely conscious of the fact that monetary discipline
is often associated in the public •— or even the professional —•
mind with high and rising interest rates, with pain and suffering.
Indeed, that can be the case when the demands we place on our
economy tend to approach or exceed our capacity to produce, and
when money and credit demands burgeon.

But we have by now learned


that, when inflationary anticipations are deep seated and
volatile, interest rates —
rates —

particularly longer term interest

can be driven up by the fear of inflation itself; in

those circumstances, few want to commit their money for fixed
returns, and increasing numbers of our citizens would rather
"spend now" and "pay later" in depreciated dollars.
For a time, those attitudes can support spending, and
provide a kind of false glow to economic activity.

So it was

last year, when consumers depleted their savings.

But that is

the weakest kind of foundation for sustained growth and productivity,
And when high and rising levels of economic activity, and fears of
accelerating inflation are combined, we have a potent —
explosive —

brew at work in the credit markets.

an almost

So it was last

These market strains and historically high interest rates •—
as in the past —
of the economy•

had a strong impact on the more vulnerable sectors
Homebuilding, dependent on mortgage money, has

been particularly hard hit.
reduce inventories —

There have been strong incentives to

generally a healthy reaction, but in this

case aggravating the deeper-rooted problems of an auto industry
struggling to adjust to a new mix of demand for fuel efficient

Small businesses, farmers, consumers, and —

not least


savings bankers have felt the pain of higher costs of credit and,
worse, uncertainty about its availability.


It seemed clear to those of us responsible for monetary
policy that there could be no easy escape from that pain through
pumping up the supply of money and credit in an effort to keep
interest rates down.

The result could only be to confirm the very

inflationary expectations that, in a fundamental sense, gave rise
to the market strains in the first place.

We would have been

racheted to a still higher level of inflation, with still more
fears of what the future might bring.
country under greatest pressure —

The very groups in this

the homebuilder and homebuyer,

the smaller businessman, the financial intermediary locked into
long-term securities —• would ultimately have the most to lose;
instead of being able to look for a surcease from pressure, those
pressures would be sustained.

Then, as now, a policy course that

seemed to point toward more inflation could only induce lenders to
pull back from the credit markets in favor of current spending and
more speculative outlets for funds.
Instead, as you know, in the past six weeks or so, market
pressures have relaxed dramatically.

The sharp decline in interest

rates has demonstrably reflected a fall in the demand for money and
credit, not an increase in supply.

Part of the explanation undoubtedly

lies in the decline in economic activity as consumers have attempted
to restore their financial positions at a time when the homebuilding
and auto industries were already depressed.

But I suspect there has

also been some tempering of the extreme inflationary fears so prevalent
only a few months ago.

That change in sentiment has been related to

some degree to the stance of monetary and fiscal policy.


It is in that sense that the linkage in the popular mind
between monetary discipline and high interest rates, as an
historical generalization, is simply wrong.

Look around the

it is the countries that have been most successful in

curbing monetary growth and inflation that have the lowest
interest rates.

In Switzerland, to take the extreme, mortgage

money in this inflationary age is still available at 4.15%
and the money supply has been growing hardly at all!
The fact is the precipitous decline in interest rates in
the United States has been accompanied by less monetary growth,
not more.

Indeed, the money supply dropped sharply in April.

I am at least as suspicious as any of you about interpreting any
single month 8 s figures.

We know that some technical factors

probably helped account for part of the April decline; the data
are, in any event, inherently volatile.
But, with ail the qualifications, the point remains; money
and credit growth have slowed appreciably.

Indeed, there is now

considerable room for growth, consistent with the targets we set
for ourselves for all of this year —

targets that have been widely

accepted as appropriate and consistent with reduced inflationary
pressures over time.

My point is that interest rates have not in

any sense been "forced" lower —- nor will they be at the expense of
excessive growth in money and credit, at the risk of a resurgence
in inflation and inflationary expectations.
These are circumstances in which we can legitimately begin to
look forward to dismantling the more direct measures taken in midMarch, some of which had their genesis in October of last year, to


curb excessive growth in bank lending and consumer credit.


special reserve requirements and the call to confine growth of
loans of individual banks within a simple guideline were and are
clearly extraordinary measures, in important ways disruptive of
normal market processes.
we will not —

We have not wanted to move prematurely


at the risk of false signals about our intentions to

maintain control of monetary and credit growth.

We want banks and

other institutions during this critical period of transition to
respect in their lending behavior the priorities reflected in the
special program.

But f equally, we are not interested in fostering

any impression that credit allocation, formal or informal, can be
any part of the basic continuing armory of monetary policy; the
special measures are, to put it most simply, no substitute for
general instruments of policy, and the side effects, if prolonged,
can be counterproductive.
At the moment, it is evident that it is lower interest rates
much more than any exhortations or controls that are beginning to
play a constructive role in unlocking flows of funds to the construction industry and elsewhere.

If sustained, those lower rates

should, of course, restore the earnings and competitive position of
the thrift industry, and enable you to resume your own accustomed
role in financing.
The actual course of interest rates will, of course, continue
to be influenced in the short run by the strength of economic
activity and credit demands.

Over time the Federal Reserve intends

to provide the reserve base for orderly, restrained growth in money,
consistent with unwinding ihflaitioB; our emphasis is not on a

particular level of interest rates*
caveat on the interest rate outlook:

And there must always be another
current or even lower interest

rate levels can be sustained only if we, in factf do make progress
on the inflation front.
Given the inevitable and often long lags in response in the
economy —: and the way some of the most popular price indices are
computed —

it is simply unrealistic to expect unambiguous, dramatic

progress toward price stability month by month in the period ahead.
The methods by which the consumer price index is calculated can
result in particularly misleading signals of current developments.
Forthcoming data should be heavily influenced by two events that
occurred in the first quarter —

the imposition of the oil import

fee, which (if upheld in the courts) will soon affect the price of
gasoline, and sharply higher mortgage rates *

While few Americans

purchased houses in the first quarter, and even fewer paid the
interest rates posted by traditional mortgage lenders, it is those
data that go into the index, with a heavy weight, as the commitments are taken down.
The last producer price index, rising at an annual rate of
only 6 percent, just as surely overstates progress so far, for it
reflected in part an exceptional decline in food prices*

In my

judgment, a more balanced view suggests there is indeed a reasonable
prospect for a decline in the inflation rate to or below 10 percent
before the year is out.

But that can only be a first step —


in some ways the easiest step -— on the road to price stability.


Even that prospect is dependent upon avoiding another steep
increase in the world price of oil.

The chances of that occurring

should, in theory and in practice, be markedly reduced by the evidence
of some surpluses at present in the world supply of oil and by the
relatively high stocks in consuming countries.
iron law of economics.

But OPEC follows no

It is a measure of our vulnerability

almost seven years after the 1973 episode —


that OPEC countries

still have the potential market power to upset even a short-term
forecast of relative oil price stability amid ample supply.
I will not dwell on the oil situation today, for you are as
familiar as I with the needs and frustrations in achieving coherent
and coordinated policies among consuming countries and a meeting of
minds with the producers.

There can be no denying the urgency of

the problem from every point of view.

It is that urgency that to

my mind fully justifies the progress toward deregulation at home
and the imposition of higher gasoline prices as a result of the oil
import fee*

In the short run, those policies may appear to impede

the fight on inflation,- for they do raise the price indices.
in a larger sense, I firmly believe they help«


Only as we are induced

to conserve and reduce our dependence on OPEC sources of energy can
we begin to feel more comfortable that our prospects and our stability
will not be at the mercy of pricing decisions of others.

Indeed, our

energy vulnerability remains the greatest threat, alongside inflation
itself, to our growth and prosperity.
The third problem I cited at the start —
ductivity —

the problem of pro-

also poses hard choices and difficult dilemmas.


all the causes and cures for our declining performance are clear.
But, I believe the suspicion is well grounded that a failure of our


capital stock to keep pace with the labor force, or to be renewed
as rapidly as it might, is an important part of the problem.
That analysis leads directly to questions of the tax treatment
of investment.

The tax code, in my judgment, has for many years

been biased against the savings/investment process.
absence of proposals for reform in that area.

There is no

But we also have to

recognize the hard reality that all the proposals have a common
characteristic •— they lose revenues for at least a period of

Consequently, we cannot escape the matter of budgetary

priorities —

or, at least for a time, acquiesce in still more

deficit spending.
You ladies and gentlemen are responsible for private financial
intermediaries, looking to individuals for savings and passing
those savings along to homebuyers and others.
a variety of institutions —

You compete with

and the most overpowering of those

can be the Federal Government itself when it comes into the market
for tens of billions of dollars; market congestion or not, low
interest rates or high, its needs will be satisfied.

That was,

of course, precisely what happened last winter, when market pressures
were at their greatest.
The plain lesson is that one contribution the Federal Government can and should make to capital formation is to avoid preempting so large a share of the available credit, year in and year
out, as has been the case in the past decade.
At the same time, we know taxes are too high for the sake
of economic growth and investment.

Carefully constructed tax

reform and reduction can be an ally —

indeed, it may be an


indispensable ally ~
to sustain growth.

in the effort to restore productivity and
I yield to no one in my conviction that

intelligently constructed tax reform and tax reduction


addressing the problems of investment, productivity, and costs


is sorely needed.
But we can't simply wave away the budgetary constraint or
questions of timing.

And that timing seems to me, like it or not,

dependent on progress in reducing the rate of expenditure growth,
reductions not just in Administration planning or in initial budget
resolutions, but reductions that are signed, sealed, and delivered!
Only a few weeks ago, under the pressure of credit market
strains and inflationary fears, a broad consensus developed in the
Congress and without about the importance of cutting proposed
spending and balancing the budget.
prevailing mood.

I believe that is still the

But there is an obvious danger that the consensus

could fracture in the face of apparently discouraging business
news and the reduced level of interest rates.
I am not so concerned about one contingency that arises in
any budget planning —

that a major recession, should it develop,

will result in lower revenues than projected.

Such an outcome

would imply a very slack economy, some reduction in other credit
demands, and only temporary implications for revenues.

What would

gravely concern me would be to turn away from spending restraint
and budgetary balance as a matter of deliberate policy.

In the

short-run, the effects on financial markets so sensitized to

inflation concerns and, after decades of deficits, increasingly
skeptical of budget planning, could only be counterproductive.
Equally important over time, failure to carry through effective
expenditure restraints —

reducing the proportion of the GNP

absorbed by government —

can only undermine the case for, and

opportunities for, the tax reduction we need.
I recognize the uncertainties in the business outlook as
the budget is debated.

But inescapable uncertainty is not in my

mind synonymous with —

a euphemism for —

of the economy.

gloom about the course

I know of few economic analysts, in or out of

government, that can take much satisfaction from his forecasting
record during recent years; to commit ourselves today to policy
options that would make sense only if the worst happens is at least
as likely as not to be counterproductive.
Let us not be oblivious to the real risk that the rather sharp
decline in consumer spending over the past two months, coming on
top of the already serious problems of the auto and housing industries,
could precipitate further spending adjustments.

But let us be

conscious, too, of the strong possibility that housing could be
approaching its low point, with a considerable backlog of demands
that will become effective as the credit markets open up.


auto industry is bringing smaller cars on line, and larger models
available today may turn out to be a bargain as their production is
phased down.
Inventories —

Exports —

a larger sector than housing —

barring a cumulative downturn —

are doing well.

are not oppressively high.


It's inherently, as usual, a mixed picture.
What we can know with certainty is that inflationary sensitivities and pressures remain high —

and we no longer have a

realistic option of inflating ourselves out of recession.


mere effort could only be destructive of the chance for restoring
orderly credit flows at reasonable interest rates.
We can also be sure that the need for energy conservation and
production is essential to our stability.

And we know that, in the

end, we will need to improve productivity to support economic growth
and to help wind down inflation.
It is these three areas —

inflation, energy, productivity


that must remain the continuing focus of policy making.
I see no inconsistency with the new concern about recession.
I would indeed go further.

Without progress in these areas, efforts

to deal with recession will ultimately be doomed to failure,
This has been for me a rare opportunity to speak to savings
bankers in convention assembled.

I am conscious that I have only

touched in passing on the urgent problems —
of your industry,

short and long-term


I am, of course, well aware of the wounds left

by recent developments.

The healing process has just begun, and

your stake in maintenance of orderly credit market conditions
and in the priority given to the attack on inflation —


is obvious.

In the best of circumstances, I suspect you already realize
there can be no simple retreat to "business as usual."

The inherent

risks of borrowing short and lending long in an uncertain world
have been freshly exposed, and you will need a better balance among
your assets and liabilities.

New lending powers, new mortgage


instruments, new forms of deposits can all make a contribution,
and will need careful study and experimentation.
I am sure you have no illusions about the strength of competitive forces.

Those of us responsible for regulation of the

interest rates you pay (I perhaps would be more accurate if I said
responsible for the deregulation of those rates) are hard at work.
We are, of course, looking at the immediate situation and at today's
needs partly in the context of what approaches make sense in the
light of the ultimate objective of decontrol.

I can 8 t promise

our decisions will always make your life any easier —

but I think

I can promise it will be an interesting time for all of us as your
industry and others gradually move away from regulatory domination
of the interest rates you pay.
I am conscious, too, that you and we in the Federal Reserve
will have to become accustomed to living more closely together as
portions of your business become subject to reserve requirements.
From my perspective, that f s not all bad —

but I know tastes vary

in that respect!
Where I hope our views will always closely coincide is in the
endless battle for disciplined, consistent financial policies for
our country.

In the last analysis, that is the only environment

in which we both can do our job well.

* * * * * * *