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For release at 8:30 P.M. E.S.T.
October 28, 1985

Remarks of
Paul A. Volcker
Chairman, Board of Governors of the Federal Reserve System
at a
Joint Dinner Meeting
of the
Empire Club of Canada

The Canadian Club of Toronto

Toronto, Canada

October 28, 1985

I greatly appreciate this opportunity to meet with so
many leaders of Canadian life.

And it's both a special honor

and reassuring to have close to my side two of those responsible
for conducting your own financial policies.

Michael Wilson has

played a constructive role in our international deliberations
from his very first days in office, and my central banking
colleague/ Gerry Bouey, is dean of the Group of Ten central
bank governors.

His good sense, his good will, and long

experience have long greatly facilitated our cooperative efforts.
I know that up here in Canada it's sometimes said that
running economic policy is akin to the hazards of sharing a
canoe with an elephant.
Well, that's an example of how perspectives can differ, even
across the most open border in the world.
Ever since my family first exposed me to Barnum and Bailey,
I have seen the place of the elephant in the scheme of things rather

He is usually a placid, friendly beast, with his

feet on solid ground.

Lots of times he is driven around in circles.

-2But when necessaryf he's also asked to lead the parade.

In both

roles, he's expected to carry heavy burdens and plod along
predictably and quietly, providing a steady platform for the
acrobatics of others and oblivious to all the distractions around him.
Now, I realize the United States may not always bear out
my more benign view of an elephant, and there's much more at
stake in the world economy than any circus.

But the thrust of

my remarks tonight on the world economy has one point common to
any complicated performance —

the success of the entire enterprise

is dependent upon all the participants playing a constructive role.
The United States, simply by virtue of its size, is typically
the focus of attention.
Canada most of all.

What we do measurably affects others, perhaps

We would forget that at our own peril, not least

because of what an economist calls "feed back" effects on our own

Naturally, domestic pressures, economic and political,

as in any country, sometimes divert our attention.

But I think it

is also true that our basic and continuing economic interests —


-3stability and growth, in open markets, and in effective competition


coincide with the broader international interest.
But I must also emphasize the United States is not the
whole of the world economy -- far from it.

In fact, our relative

weight has tended to diminish steadily over the years.

Measured by

GNP f at the end of World War II we were more than 40 percent of the
whole; today the fraction is less than a quarter.
Obviously, the cumulative effects of what other countries are
doing on the world scene are even more important than what we do.
The reality of that cumulative impact may be obscured because,
individually, other countries have less economic weight, and they
may discount the effects of their actions on others.

But recent

developments illustrate clearly what we should know anyway -- even
the United States is not an island unto itself.
Why, for awhile this fall, I even feared that you here
in Toronto might intrude on that great American institution, the
World Series. It inspired me to do a little research about the
National Hockey League.

I couldn't find out for sure what nation

-4the word "National" in that name is supposed to refer to.


I did find out that it took nine American players, on the average,
to equal the point production of one Wayne Gretzky.
The imbalances in the world economic league may be less
striking, but they are evident nonetheless.

And they won't be

corrected without complementary action by a number of countries.
Looking at the industrial countries as a group, there
has been good progress over the past three years, particularly
when measured against the turmoil and instabilities of the 1970s
and at the start of this decade.

Employment is now growing almost

everywhere, and inflation has been halved or more, from the two-digit
range early in the decade to less than 5 percent this year and last.
Happily, both Canada and the United States have had better than
average experience both in reducing inflation and in growth.
Moreover, that progress toward price stability has been
extended through a period of economic expansion about to enter
into its fourth year.

I believe sustained expansion over time

(and, I might add, lower interest rates) depends crucially on

our collective ability to maintain greater price stability.
Fortunately, there are favorable signs in that area.


in world markets is intense; capacity is readily available? raw
materials, including petroleum, are in ample supply; and wage and
other cost pressures are much more moderate.

Policy makers virtually

everywhere, against the experience of the 1970s, are properly more
sensitive to the inflationary threat in the conduct of monetary policies
In that sense, we have a good foundation upon which to build.
But itfs also plain that unemployment is still far too high
in most industrial countries, and progress is threatened by
increasing strains and distortions within national economies and
between them.

By and large, economic growth has been less than

earlier in the postwar period, and it will probably be slower this
year than last, even though unemployment remains in most countries
at exceptionally high levels.
That is, of course, true of the United States itself.
But in our case, after two years of particularly rapid expansion
and sharp declines in unemployment, some slowing was perhaps natural.

-6Moreover, demand in the United States has been relatively well

Domestic demand over the past 15 months has continued

to rise at a rate of more than 3-1/4 percent a year, in contrast to a
rate of increase in output of only 2-1/4 percent.

Final sales to

consumers, to government, and for investment and housing have been
still larger, running to about 4-1/2 percent over the period.
The difference between growth in U.S. demand and U.S.
output is a reflection on our rising trade and current account

In effect, while we have created more than 9 million

jobs in three years within the United States, we have also
turned to importing (net) well over 3 percent of our gross
national product.

The effect has been to create export opportunities

and stimulate job creation elsewhere, more in Europe and Japan than
in Canada because your imports have also been rising.
employment increases have been much slower abroad.

Even so,

As a result, the

unemployment rate has, as you are well aware, remained over 10 percent
in Canada, and it is at about the same level in Europe, where some 20
million are jobless.

-7If we look to the south of us, to the hundreds of millions
living in the heavily indebted countries of Latin America and elsewhere, the challenges are even more pressing.

About three years ago,

a potential financial crisis burst on the world scene as one developing
country after another faced an inability to service its debts in a
timely way.

Strong efforts by the borrowing countries themselves,

and cooperation among creditor countries, the IMF, and the involved
commercial banking community, have helped diffuse and manage that

Most of the borrowing countries have made enormous progress

toward achieving a better balance in their external accounts.
of them have begun to grow again.


The continuity of debt service

has been largely restored.
But amid that progress, the strains and frustrations are

Much of the growth achieved by the borrowing countries

so far -- and it's far from uniform or satisfactory —


gone into improving their external positions; domestic living
standards have not recovered fully, or at all.



doubts have arisen about the continued availability of a
margin of external finance needed to support growth, inflation
remains rampant in some countries, and the structural reforms
required to sustain growth are, at best, only beginning,
I might point out, too, that the remarkable progress
that the indebted countries have made toward balancing their
external trade position has as its counterpart increased exports
to, and decreased imports from, the United States.

Our trade

balance with Latin America has deteriorated by $20 billion since
1981, accounting for considerably more than half of their
collective improvement.
Plainly, the economic elephant of the United States is
carrying a heavy load.

With a trade and current account deficit

approaching $130 billion overall, it's showing the strain, in
political as well as economic terms.

Under the pressure of

rising imports, manufacturing activity as a whole has been
stagnant for a year, and some industries are losing jobs.


individual farmers, with exports diminishing and prices low, face

-9financial crisis.

And/ as you are well aware, the strongest tide

of protectionist pressures is running since the ill-fated 1930s,
despite the continuing growth of total jobs and economic activity.
To put it simply, the pattern of progress in the world
economy over these past three years is being undermined.

It's not

just a matter of economic strains -- huge trade deficits in the
United States and counterpart surpluses elsewhere, stagnant employment
in Europe and elsewhere, and the pressures of debt in the developing
world -- but also the political frustrations they breed.


precisely the wrong response would be to permit those frustrations
to boil over in short-sighted approaches —
and inflation —

protectionism, defaults,

that could only aggravate the situation, undermine

the progress that has been achieved, and set back prospects for
years to come.
Happily, I believe those dangers are fully recognized by
the responsible leaders in almost every country.

What we have

neglected, at least until now, is dealing with the imbalances

-10at their source with a sufficient sense of urgency, and with
adequate recognition of the complementary roles for all the
leading countries.
No doubt there is a human tendency to look to the other
fellow, or to the other country, to do its part, and hope that's

No doubt, the needed measures are also politically difficult,

But there is also no doubt that, if we are to be successful, it will
have to be a joint effort.
The broad directions that the effort must take were pretty
well summed up in the communique issued by the Group of Five at its
special meeting in New York a few weeks ago.

The speeches and

communiques at the recent World Bank-IMF meetings in Seoul reiterated
the same themes.
In the United States, where the expansion has been so
relatively strong, and which has provided so much of the impetus
for world growth, the trade deficit has now reached a level that
cannot be sustained, threatening to undercut our stability and
implying less stimulus to others.

Despite a relatively accommodative

-11monetary policy, interest rates remain high historically, aggravating
the strains on our own financial system and the developing world and
drawing capital from abroad.
The clear policy prescription boils down to meaningful and
assured progress against our record budget deficit.

Relative to the

size of our economy, our ?200 billion deficit happens to be little or
no larger than the deficits of a number of other industrialized
countries —
of your GNP.

Canada's as you know, is a significantly larger portion
But this is one area in which absolute size counts,

and counts greatly.

Our deficit not only looms large relative to

our own limited propensity to save, it represents a significant
drain on world savings.

It has implications for interest rates

abroad as well as at home.
In a real sense, we have been fortunate that funds have
flowed so freely to the United States in recent years, reflecting
to a considerable extent widespread confidence in our prospects.
We would not have been able to finance the federal deficit, on top
of rising expenditures for plant and equipment and housing, without

-12that net capital inflow.

But it is clearly not healthy for the

largest and richest country in the world —
that of others —
a budget deficit.

in its own interest or

to use up so much of the world's savings to finance
Our lending abroad has practically stoppedf we are

becoming a debtor nation, we have less investment and housing than
would otherwise be possible, and our trading position is deteriorating.
Sooner or later, the process is unsustainable, and it had better be
approached constructively rather than in crisis.

That is why so

much is riding on the current debates in the Congress aimed at
finding a constructive approach.
But, important as it is, further action on our budget deficit
cannot be the entire answer, even if, contrary to the fact, it could
be implemented immediately.

It's also true that our trade deficit,

the enormous trade and current account surpluses of Japan, and the
growing surpluses elsewhere, are directly influenced by the relative
sluggishness of growth in most other countries.

What is needed, in

particular, is more "home grown" expansion in some other industrialized

-13countries, rather than such heavy dependence on the United
States or other foreign markets for stimulus.
I realize a key factor inhibiting action to promote greater
growth at home has been concern over inflation, particularly
against the background of depreciating domestic currencies vis-a-vis
the dollar, and relatively large budget deficits.

But in some key

countries -- especially Japan and Germany —

a remarkable degree of

stability has been achieved for some time.

Certainly, that progress

needs to be consolidated.

But that process is now being assisted by

the more recent tendency for their currencies to strengthen.


in some cases remaining budget deficits reflect in good part the
sluggishness of economic activity rather than a structural imbalance
between receipts and expenditures or the deficit could be readily
financed from savings now going abroad.

The case for domestically

led expansion seems particularly strong in Japan, given its
enormous trade surplus and high level of domestic savings.
Japan is the second largest economy.
characteristic, it should also be able —

By every economic

in its own interest —


-14help lead the world toward more open markets rather than feeding
protectionist instincts in the United States and elsewhere.


without in any way wanting to intrude upon your own debate about
the wisdom of a free trade area with the United States, let me
suggest that the direction of that initiative -- looking toward
reducing rather than increasing trade barriers —
highly constructive.

seems to me

Specifically, it seems to me wholly

consistent with the larger concept that, rather than yielding to
protectionist pressures, we look toward means for widening and
reinforcing the area for liberalizing the world economic order.
In that context —

a reduced budget deficit in the United

States, greater growth elsewhere, and open trade and investment —
exchange rates can and should play a role in adjusting external

That is the point made by the Finance Ministers and

Central Bank Governors of the G-Five in New York recently, and
there has been close cooperation in recent weeks among them in
encouraging some appreciation in other leading currencies
relative to the dollar through exchange market intervention.

-15Important as that effort can bef however, it is no substitute
for more fundamental measures.

Indeed, large changes in exchange

rates, without dealing with the underlying sources of imbalance,
are not an easy or painless solution —

they carry risks of their

I suspect no part of the world would reap greater benefits
from a sustained growth in the industrial world, from more open
trade, from lower interest rates, and from better aligned and
more stable exchange rates than the middle-income countries
of the developing world.

But, to take advantage of that benign

economic climate abroad, they will also need to make reforms at
By and large, those countries, concentrated largely in
Latin America and on the western rim of the Pacific, maintained
exceptional growth records in the 1970s and early 1980s.


in a large number of instances, that growth entailed very heavy
borrowing from abroad —

and much of that capital, rather than

contributing to productive investment, in effect only replaced a

-16chronic outflow of their own savings.

It cannot be entirely

coincidental that countries that did manage to create a hospitable
environment for investment and for effectively utilizing the savings
of their own citizens are those that, in the 1980s, have been able
to manage their debts most easily and have continued to grow.
I cannot help but be encouraged by the sense that many of
the most important leaders of Latin America -- and they are
democratically elected leaders —

have spoken out forcibly about

the need for structural change —

for more competition to spur

efficiency, for more private initiative and investment and
fewer government enterprises, and for more "openness," at home
as well as in trade.
I know there is a long distance from recognition of a
problem and from generalized statements of intent to practical
policy changes -- changes that mean more competition and departure
from deeply embedded ways of doing business.

I also know that

even in the best of circumstances, sustained growth by developing
countries will require some margin of external financial support.

-17And the better assured that necessary support, the easier it
should be for the borrowing countries to marshall the will and
the effort to make the fundamental policy changes needed.


frustrations and uncertainties implied by crisis management
of debt can too easily divert attention from that effort.
Recognition of those interlocking needs of the heavily
indebted developing countries —

for structural change at home and

for a margin of external financial support —

is the essence of the

proposals set out by Secretary Baker a few weeks ago.

He called

upon the World Bank and the official regional development institutions
notably the Inter-American Development Bank in which Canada is a
leading participant -- to more actively provide some of the needed
finance in the form of relatively quick disbursing loans.
Those institutions are financially capable of responding
to the need.

But the finance can only prudently be made available

as countries in fact undertake the policies needed to encourage and
sustain growth -- growth that over time will ease the job of
servicing the debt.

The needed structural change could affect many


-18different aspects of economic life —

modernization of agriculture,

privatizing government enterprises, liberalizing imports, marketoriented pricing —

depending upon the needs and circumstances

of individual countries.

Moreover, close attention will

continue to be required as well to the need to contain excessive
budget deficits and to maintain appropriate monetary and
exchange rate policies -- the kind of thing with which the
IMF has been so active.

And both policy changes and finance

will have to be tailored, case by case, to the specific
requirements of particular countries.
In such circumstances, the international banking community
could be expected to do its part as well.

The banks with large

loans already outstanding, have, of course, a lot at stake.


of good growth -- growth that can be sustained without the kind of
massive injections of new money characteristic of the 1970s and
early 1980s —

would be the best possible solvent of the debt

It would, at one and the same time, reduce the interest

burdens of the borrowers, relative to the size of their own
economies, and reduce the exposure of banks, relative to their

-19capital and assets.

But for a timef that growth in most of the

indebted countries will require some moderate availability of
loans beyond what can reasonably and equitably be supplied by
official sources.
The challenge is clear.

Each part of the overall effort

by borrowers, by international institutions, and by banks —
essential to the success of the whole.


And it would be unrealistic

to anticipte that any part could proceed for long without the
support of the others.
All of that implies a very large cooperative effort.


a large number of banks from many countries, with different
exposures and particular interests, develop a common approach
responsive to the needs and reflecting their basic community of
interest? Can the borrowing countries themselves develop
policies that will first of all command the confidence of
their own citizens, stop capital flight, and build sustained

Can the international institutions effectively

encourage and assist that process, acting in the interests of
world development and growth?


-20It's obviously a tall order —

but neither are we starting

with a blank piece of paperf building from scratch.

We have by

now a lot of experience in dealing with the debt problem, and some
concrete successes.
The initial responses to Secretary Baker's initiative
are encouraging.

Clearly, much more must be done.

But we also know that adversity clarifies choices, and

The yeast of change is at work, in Latin America and

The enlightened self-interest of borrowers and lenders
alike seems to me to point fundamentally to the benefits of a
cooperative effort.
In the end, the success of that effort, like so much else,
will depend upon the world economic climate.

The prospect for

sustaining growth and working toward lower interest rates in
the United States —

and in Canada, too —

the progress against inflation.

rests on maintaining

The prospect would be greatly

-21assisted by clear and effective action to reduce our budget
deficit in the United States, and by yours as well.
But other industrial countries need to help carry the
torch of growth.

And those in the strongest external position

can, by opening markets, help us all resist the siren song of

All of that, more certainly than any intervention

in exchange markets, would help assure a better international
balance and well-aligned exchange rates.
This is a time of opportunity —

but of danger as well.

We can't expect perfection in the timing and execution of every
policy -- the world is too uncertain, and our abilities too frail,
for that.
But we don't need perfection.
sense of the right direction —

What we do need is a strong

and I think we have that.

We need to realize how the actions of each country fit into
a coherent whole —

and I think we are gaining that.

-22And, of course, we need practical action.
the hardest part.

That's sometimes

But there is too much at stake to fail to carry

And so long as we understand that we are dependent on each
other -- that seizing the opportunities requires complementary
action by us all —

I will remain confident of our success.