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release on delivery
10:30 AM PST (1:30 PM EST)
Monday, January 25, 1982

Remarks by
Paul A. Volcker
Chairman, Board of Governors of the Federal Reserve System
at the
National Association of Home Builders
38th Annual Convention & Exposition
Las Vegas, Nevada

January 25, 1982

I welcome this opportunity to speak to you today.
These are difficult times for many, and most particularly
for the homebuilder.

Your industry, and those dependent upon

it, has had the most depressed year in decades.

And there are

insidious, if partly hidden, social costs as housing construction
falls behind the needs of our growing population•
Nothing I can or want to say can gloss over those hard
facts.

What I can do -- and what I will try to do -"- is

it as it is,11 as we see it from the Federal Reserve.

tf

tell

And, for

all the evident difficulties today, I believe there are also
signs of promise for the future.
Vulnerability to tight money and cyclical forces has
been a recurrent story in your industry.

At other times, and

particularly when inflation took hold in a serious way in the
1970 f s ? you seemed -- for a time —
process.

to benefit from the inflationary

Home prices rose twice as fast as the general price level.

For a long while, interest'rates didn!t Really keep up with inflation
and interest costs are, of course, tax deductible.

In the circum-

stances, house purchases for many began to be looked on as a good
inflation hedge or as a kind of speculation as well as shelter.
The houses got bigger and second homes, if far from a norm, became
less exceptional.
In retrospect, itfs easy to see that such artificial stimuli]
couldn't last forever.
as a whole.




And there are parallels for the economy

After a while, when.people conie to expect inflation,
it no longer acts as a kind of stimulant or pep pill.

Instead,

the distortions, uncertainty, and fear it generates undercut
efficiency and growth.

If homeowners seemed to benefit as

inflation accelerated, residential real estate lenders turned out
to be among the big losers; it was natural that they, along with
other long-term lenders, came to demand, by historical standards,
extraordinarily high interest returns.

The pressures on thrift

institutions, and financial markets generally were bad news for
housing, and for the economy generally.
Years of growing concern about inflation and related
poor economic performance led to a kind of national consensus
that restoring price stability had to be a matter of high national
priority -- that success in that effort was a key to restoring
sound and sustainable growth.

The job3 in effect, fell to monetary

policy.
In one important sense that was appropriate, because
restrained growth in money and credit is necessary to turn back
inflation.

But 1 think it's also fair to say that absence of

consistent help from other policies can make the job more difficult,
with more pressures and risks for financial markets than otherwise
necessary.
Whatever the particular instruments, with the inflationary
momentum so strong and so deeply embedded in behavior and expectations, turning the tide could not be a quick or easy matter.
There has been a profound skepticism -- founded in past experience -•




about the ability and the will of the government to see an antiinflation effort through.

That skepticism has been reflected in

part in a reluctance in wage bargaining or pricing policies to,
in effect, "take a chance" that inflation will subside.

Too often,

bets have in fact been placed in the opposite direction -- that
inflation would accelerate, and that kind of behavior can for a
while be a self-fulfilling prophecy.

Of direct and immediate

concern to you, that thinking has led to a great reluctance to
commit funds for long-tern investment.

Interest rates have

remained extraordinarily- high, even relative to the current
rate of inflation.

In effect, the widespread, ass amption or

fear that inflation would continue tends to maintain its momentum.
But now we can see multiplying and encouraging signs
that inflation has begun to subside -- that we are turning the
corner.

It is far too soon to claim victory.

Any slackening

of our commitment to see the effort ;/Hrough could only jeopardize
prospects for full success.

But with that continuing commitment,

1 also believe we 'can look forward to fundamental changes in
expectations and in behavior that will work to unwind the inflationary process, perhaps faster than most economists have assumed.
That prospect in turn will build a solid foundation for sustained
growth in the years ahead, and unlock the impasse in financial
markets.

No industry, in my mind, has more at stake in the

success of that effort than yours,, just as you have borne the
brunt of the transitional pain.




As you are well aware, no sector of the economy is
more sensitive to conditions in the credit markets.

Strong

inflationary expectations, against a backdrop of monetary
restraint and large Federal deficits, have produced high and
volatile interest rates in all markets and across the maturity
spectrum.

For you the situation has been further aggravated by

the particular problems of the long-term markets, and by the
extraordinary pressures impinging on a key source of mortgage
financing -- the thrift institutions.

The lending and deposit-,

gathering practices of those institutions have been dependent,
as no others, on a- relatively stable financial environment, and
therefore particularly vulnerable to inflationary distortions.
1 must add that financing problems are not the only
element in the calculation of the affordability of a home;
the inflationary process seems to me to have contributed to
your problems in other ways.

In the years of strong demand,

house prices persistently rose faster than most other prices,
and the units got larger.
Lack of growth, or actual declines, in the real income
of the average wage earner in the late 1970fs didn't help.

You

know the statistics better than I about how the average payment
on a new mortgage -- because both interest rates and principal
were higher -- came to require an ever larger share of the typical
family budget.

For too many, the "dream" of home ownership has

had for a time to remain just that.




-5-

But you and I
from the past —

are more interested in what we can learn

how housing can again become more affordable

and competitive -- than in reciting the history.

You are the

experts in the design of your product - - i n the type, size and
location of the house; in construction methods; and all the rest.
My comments are directed elsewhere -- toward the external factors
that affect the cost and financing of the house.
Slack demand has been reflected in dramatically lower
prices for some materials.

Land prices in some localities have

softened, and certainly rapid increases are no longer common.
But I realize that a part -- and perhaps a large part - - o f
those more favorable cost trends at this point can be attributed
to the pressures of general recession and depressed building
activity.

No anti-inflation program can be successful if it

rests on recession and slack; the key test will be sustaining
the gains during a period of recovery and expansion.

That, in

turn, is dependent on bringing down the trend of costs over time.
The challenge to business managers - - t o find ways to
improve productivity, to take advantage of new technology, and
to design and produce more efficiently -- is evident in homebuilding as elsewhere.

And, of course, the process of wage

bargaining and negotiation is critical, too; in the economy as
a whole, wages and salaries account for two-thirds of all costs.
As a matter of analysis, higher wage costs did not spearhead
the inflation of the past decade.

Labor and management were in

large part reflecting inflationary forces originating elsewhere,




-6-

and many workers had fallen behind in real income.

But once

strongly underway, the momentum of higher wages is a powerful
force keeping the inflationary process going.

And in a number

of areas, faced with strong domestic and international competition,
exceptionally rapid wage and cost increases have directly jeopardized
jobs.

In the construction area itself, major union contract settle-

ments were as large, if not larger, in 1981 as in more prosperous
and higher inflation years.

I realize those contracts may not

have been characteristic of homebuilding generally.

But they

are symptomatic of the difficulty of changing an inflationary
process that has been underway so long, and obviously pose an
obstacle to making the product more competitive.
Now, as we look across the economy, we do see multiplying
signs that business and labor are beginning to deal more realistically with the cost and price problems afflicting many industries.
You, I am sure, can cite as many examples as I.

The faster that

process spreads, the brighter will be the prospects for sustaining
the progress against inflation -- and for financial markets.

And,

the fact is, paradoxical as it may seem on the surface, a slowing
trend in nominal wages through the economy offers the prospect
of higher real wages.

The reason is that slowing of cost pressures

and inflation will help immensely in speeding the recovery process,
and unlocking potential gains in productivity.
It is the changing trend in this area that provides the
strongest evidence that we are, indeed, turning the corner on
inflation, and setting the stage for continued improvement.




In




-7-

that respect, as others-, 1982 will be a critical year for
"building in11 a clear trend toward reducing inflation.

A

number of key collective bargaining agreements are being
negotiated now, or will be negotiated in coming months.
Restrained settlements not only would do much for the
fortunes of the particular industries involved and help
maintain their employment levels, but would also establish
healthier norms for wage decisions throughout the economy.
No one can be satisfied that these favorable changes
in the inflationary trend have been accompanied by such severe
costs in unemployment and output.
recovery begin.

We all would like to see

But even more crucial than the precise timing

of that recovery is that growth be sustainable for years ahead.
It is in that context that I am convinced we cannot let up now
in our anti-inflation effort.

To do so would only jeopardize

the gains against inflation that we see.

The pain we have

suffered would have been for naught .-- and we would only be
putting off until some later time an even more painful day of
reckoning.

The early stages of recovery must not be a signal

that it is an "open season" on expansionary policy or aggressive
pricing.

Indeed, I believe a sense of retreat on inflation would

jeopardize prospects for recovery even in the relatively short run.
My conviction on that score reflects the fact that
improved conditions in credit markets are a key to recovery
and sustained growth.

That is most obviously true in those

areas of the economy that have been most hard pressed by high
interest rates -- with hotising at the head of the line.

-8-

In a direct sense, high .interest -rates are ?a-major
element In your difficulties.

They are also a symptom -- a

symptom of concern and uncertainty about whether inflation will
in fact be brought under control, and whether the constellation
of public policies necessary to restore price stability and
avoid market congestion will be sustained.

It is those deeper

concerns that need to be addressed -- and I believe are being
addressed -- to assure the more favorable financial outlook
you need.
The central point is that inflation needs to be brought
down if lenders are to return in force -- and remain - - i n the
long-term markets.
score.

I have already reviewed the progress on that

But policy directed toward that end cannot be an

l!

on again-

off again11 thing.
The fact is the burden of that antI-inflation effort has
fallen on monetary policy and the Federal Reserve.

In the circum-

stances, few would question the need for the central bank to
prevent excessive growth of the money supply if inflation is to
be stopped.

We can, of course, debate what the precise monetary

targets should be.

But the notable thing about that debate, to

me, is that the range of "advice11 we get has been relatively
narrow«

The record now seems to me clear, in any event, that

the Federal Reserve has been applying restraint to monetary expansion.
In doing so, I believe we are also laying a major part of the
essential groundwork fox, lower interest rates on a sustainable
basis.







But I would also emphasize conditions in financial
markets are determined not just by monetary policy, but by
the interaction of all policies.
in recent developments.
as last July*

Some evidence can be found

Short-term rates peaked as long ago

But long-term rates continued to rise for a time,

at least in part out of investors' fears about potentially large
future deficits.

All interest rates fell sharply as the recession

took hold last fall.

But renewed concern about deficits remains

one factor in market concerns and hesitancy..
Your Association has been in the forefront of those
recognizing that the outlook for interest rates -- and for
those sectors of the economy that rely on credit - - i s dependent
on discipline in fiscal policy.

A temporary swing toward deficit

is expected and natural during a recession.

The real question

is the extent to which heavy Federal financing demands extend
well into a period of business expansion, preempting the money
you and others require to finance your business.
The Federal Reserve has no way of offsetting the
financial market pressures associated with excessive deficits.
Pushing more money into the system simply to finance the Treasury
would only serve to heighten fears about inflation and the future
course of interest rates.

But restraint on the money supply implies

there will not be enough to finance both huge deficits and the
financing needs of business during recovery.

The straightforward

way -- and ultimately the only effective way - - t o escape the
dilemma is to reduce the size of the deficit significantly

- 10-

an d strongly as the economy expands.

Indeed such a development

seems to me a key to producing the financial environment that
will make recovery possible.

The Administration and the Congress

will need and deserve all the support that you can muster to
assure that result.
Disciplined monetary and fiscal policies are crucial to
your Industry and financing prospects.

But you are well aware

that we are also in the midst of tremendous changes in the nature
of mortgage instruments and lending patterns, reflecting in part
the desire of lenders to protect themselves from uncertainty and
volatility.

You and I may prefer the older way of doing business -

and with success in our anti-inflationary efforts, we can see it
again.

But in the practical circumstances we face, new forms of

financing are a simple necessity, and can make a real contribution
to your recovery.

Indeed, it is virtually impossible now to con-

ceive of insulating the mortgage market from forces elsewhere in
credit markets -- and those forces reflect international as well
as domestic developments.
To take one major example, the current problems of the
thrift institutions have raised questions about their ability
to play their historic role in housing finance.

I realize, too,

that the discussion of sweeping changes in the regulatory and
statutory framework within which such specialized intermediaries
have operated has raised doubts among some of you about the
financial support for housing, even when more stable conditions
return to the credit markets generally,




I have repeatedly




-11-

expressed my own view about the need to move forward with
legislation that would betted equip the Federal agencies to
deal with the difficulties of troubled thrift institutions.
I also believe that technological and market developments
require some changes in institutional powers.

Nonetheless,

it has not appeared either desirable or likely to me that we
move now to the total "homogenization" of financial institutions.
But if relatively specialized lenders are to survive and protect
themselves from risk, those institutions will have to adapt and
innovate, including the use of "alternative" mortgage instruments
those with adjustable rates or shorter maturities.
I know that homebuyers are not uniformly enthusiastic
about this development; they are naturally concerned about the
risks potentially shifted to their shoulders.

The recent

volatility of market interest rates --• not to mention their
pronounced uptrend through the years '-- is fresh in their minds.
The experiments with different methods of smoothing changes in
monthly payments are still somewhat confusing to the general
public, but more uniform and acceptable approaches are likely
to develop out of experience.

In the end, there is reason to

believe that these instruments can help importantly to place
housing finance on a more solid foundation, especially compared
to the limited availability or relatively high rates on fixedrate mortgages.
In the end, the development of new mortgage instruments
to finance housing can, of course, only be secondary -- and

-12-

distinctly secondary -- to the effort to relieve the strains
and volatility plaguing the credit markets generally today.
That will only be achieved by restoring a sense of conviction
that we can -•- and will --- return, to price stability.
I would repeat that the role of monetary policy is
essential to that effort,

I know of no "quick fix.IT

And

any sense that we are abandoning control of money could only
raise fresh questions about inflation, and undermine the prospects
for the very progress on the price front and lower interest rates
upon which you depend.
Monetary policy is no panacea.

There are some who would

assert that monetary control alone is sufficient to restore
price stability and low interest rates.

The fact is we need

a broader prescription if the burden is not to fall exclusively
on industries like yours.
I know this all may sound like an old refrain to many
of you.

You want ^- and need -- results.

Let me say, for the

first time in years, we are now seeing the kind of turn in
inflation that can lay the base for a more hospitable financial
environment and sustained recovery.

That's the setting in which

I would rather be addressing you —

and I firmly believe we can

achieve it.




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