View original document

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

For release on delivery
Wednesday, January 2, 1980

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

before the
National Press Club
Washington, D. C.

January 2, 1980

The last time I met with the Washington press en masse
was on the evening of Saturday, October 6.

At that time, I

outlined the elements and objectives of certain policy initiatives
adopted by the Federal Reserve that day.
not sc extraordinary.

Today, the occasion is

But the time does seem appropriate, three

months later, for some accounting of what has —

and has not


been accomplished by the measures then undertaken, and how that
approach fits into the more general economic and financial landscape.
The inflation rate is quite obviously about the same now as
in September —

nor could we reasonably have anticipated improve™

over that relatively short period.

Contrary to most expectations,

we know new that overall economic activity held up during the summer
and fall, despite pronounced adjustments in the auto and housing

Nevertheless, the tendency to project declines "next

month" or "next quarter" is still evident, and, for all their quality

QfDJL YB' these projections reflect realistic awareness of the

vulnerabilities built into the economy after one of. the longest
periods of business expansion on record.
The vulnerabilities, both on the side of inflation and business
activity, have now been increased by the economic and financial
fallout from the Iranian situation and by the partly related matter
of oil pricing and supply.

Perhaps it would be more to the point

to insist that the economy will remain vulnerable to forces like
these so long as we remain so heavily dependent on imported oil,


and recent events only underscore the need to come to grips with
that problem.

The reactions to oil prices and to the events in the

Middle East in psychologically sensitive markets for precious
metals, and to some extent in markets for other commodities and
for foreign exchange,have interrupted the more favorable movements
induced by the October actions. They are only the latest illustration
of the extent to which we have permitted ourselves to become hostage
to our energy dependence.
If I cannot yet record more striking progress in those areas,
I can say that looked at from a different focus —

that of our

immediate objectives in taking the October 6 actions with respect
to monetary and credit developments —

the overall results have

been remarkably in line with intentions.

Specifically, there has

been a clear and significant moderation in the growth of money and

September to December growth in M^, for instance, has been

well within the interim target of 4-1/2 percent or lower set by
the Open Market Committee in October, and virtually all the aggregates
have subsided markedly from the excessive pace of the spring and
There may well be an element of coincidence in that performance*
We did not believe in October, and I do not believe now, that the
new tactics of monetary control are so precise as to avoid some
sizable fluctuations on a month-to-month or even a quarter-toquarter basis.

Nor, for that matter, is very short-term precision

in regulating the money supply necessarily desirable, given the
complexities and uncertainties of domestic and international factors
bearing on the demand for money and economic performance.


But, after all the caveats, I cannot help but be encouraged
by what has happened on the monetary and financial front.

To be

sure, there was a period of turmoil and unsettlement as the markets
appraised and adjusted to the new approach.

Perhaps reactions were

exaggerated at first, but at least they reflected appreciation of
the seriousness with which we approached the problem of containing

Now, banking and financial markets appear to be functioning

in an orderly way-

Indeed, against the background of the events in

the Middle East, it is worth pondering just what the state of financial
markets, domestically or internationally, would be today had monetary
and credit expansion not been brought under control.
Our policy, taken in a longer perspective, rests on a simple
premise —

one documented by centuries of experience —- that the

inflationary process is ultimately related to excessive growth in
money and credit.

I do not mean to suggest that the relationship

is so close,, or that economic reality is so simple, that we can
simply set a monetary dial and relax.

Changes in spending and

saving habits, the shifting characteristics of different financial
instruments having some of the characteristics of money, and the
inflationary process itself, all affect the observed relationship
between money and economic activity.

The increased openness of

our economy in general, and the growth of international financial
markets in particular, has long since ended illusions of autonomy
in policy.

Spending and tax policy, a whole range of government

regulatory policies, and the behavioral patterns of business and
labor all affect the performance of the economy, and the relationship


between money, inflation and economic activity.

But, with all

the complications, I do believe that moderate, non-inflationary
growth in money and credit, sustained over a period of time, is
an absolute prerequisite for dealing with the inflation that has
ravaged the dollar, undermined our economic performance and prospects,
and disturbed our society itself.
In looking back at events since October 6, I cannot help but
be encouraged by the understanding and broad base of support for
our actions that has emerged.

In one sense, of course, policies

of restraint are never calculated to win popularity contests.
of us would like to see interest rates as low as possible.



what is impressive to me is the growing understanding that the
exceptionally high levels of interest rates are ultimately an
outgrowth of the inflationary process itself.

We are learning

that money creation cannot substitute for the productivity, savings,
and resources we need to support economic growth but rather, in
excess, will only impair prospects for sustained growth.


I am acutely conscious that the question I receive most frequently
is not why did you do it, but rather, "Will the Fed stick with it?"
My own short and simple answer to that question is yes.
I do not intend to qualify that answer.
But I do want to be clear —
that we intend to stick with.

clear about what the "it" is

There are two analytical points

that seem to me essential to that understanding.


"It," in the sense of our October 6 actions, is restraint
of the money supply, reducing its growth over time toward levels
consistent with price stability.

There is really nothing new

about the concern of monetary policy with the monetary aggregates.
What is new is the method we are using to control the rate of
monetary growth, which we believe, in present circumstances at
least, provides greater assurance that our goals can be reached*
For a number of years, the Federal Reserve developed the
practice of focusing attention in its daily operations largely
on short-term interest rates, not to the exclusion of concern
about the money supply but rather in the expectation that changes
in those interest rates would influence the demand of the public
for money.

However, in recent years, institutional, technological

and market forces have rendered the relationship between interest
rates and money balances substantially less predictable.


the significance of a particular level of interest rates is more
difficult to interpret during a period of accelerating inflation*
Banking and other institutions grew accustomed to only relatively
small and predictctble policy and interest rate adjustments.


always seemed available at a price not very far removed from before.
As a result, more aggressive lending policies may have developed


policies that could only be sustained over a long period by accelerating
increases in the money supply.


Ultimately the Federal Reserve was not prepared to validate
those increases.

That was the background for one important element

in our October 6 actions.

We changed our operating procedures in

a manner to emphasize control of the supply of money by means of
restraining the volume of reserves available to support deposits
in the banking system*

In turn, this approach necessarily implies

less direct influence over movements of interest rates.
Against the pattern of large credit and money growth in
earlier months, the immediate result was sharply higher interest
rates and lower stock prices in the weeks immediately after
October 6 as institutions, in effect, moved to cut the suit to
fit the cloth.

In more recent weeks, perhaps partly in reaction

to calmer appraisals of the balance of credit demands and supplies^
some market interest rates have moved significantly below the
earlier peaks.

This took place during a period when money growth

was comfortably within our intentions.

Yet, no sooner did some

interest rates fall than questions arose whether the Fed was in
some sense backing off*
What should be clear in the context of our new operating
procedures is that interest rates can and will respond to credit
demands, to economic conditions, and over time to inflationary
expectations without any change in the basic thrust of a monetary
policy directed toward bringing the growth of money and credit
toward sustainable, non-inflationary levels.

Indeed, assuming

the downward adjustment in economic activity so widely predicted
for 1979 does occur in 1980, historical patterns would suggest some
moderation in interest rates would naturally accompany this process<

The basic point is that whether, when, and to what extent
interest rates move lower will depend basically on market forces
they reflect trends in economic activity, and over time,

If rates do move lower, that eventuality should not

be misinterpreted or misconstrued as a weakening of our resolve
to contain inflation*

Indeed, the prospects for sustaining declines

in Interest rates beyond any cyclical adjustment will ultimately
reflect the success of the fight against inflation.

In that context,

lower interest rates would not only be appropriate in facilitating
recovery, they'would be evidence of a healthier economic situation
and certainly consistent with a stronger dollar internationally*
Progress in our efforts., I must point out, will not be reflected
in the price data for the next few months*

Those statistics are

bound to reflect cost and price trends already built in to the
economy, the new oil prices, and not least (in the case of the
consumer price index) the higher level of mortgage rates reached
in the fall.

Lags in turning the price statistics are inevitable.

Meanwhile, in judging our policies,, our results against our
intentions —

indeed in judging the prospects for inflation over

a period of time —

1 would urge you to keep at least one good

eye on the money supply ball.

That is "it.98

My second point is an outgrowth of the first.


if money is "it,11 we must be able to define and measure it«


a world of rapid financial innovation, ever changing laws and
regulations, and heightened interest rate sensitivity by individuals
and businesses, there is a widespread consensus that our current


statistical measures are not adequate.

But capturing the essence

of the reality of money in a simple statistic or two in the midst
of institutional change is a difficult process; in a sense we
have a moving target.
The Federal Reserve has had this matter under study, with the
help of outside experts, for some considerable amount of time.
We will be prepared to publish new definitions of the monetary
aggregates shortly.

They may not be the last, for the pace of

financial innovation, if anything, seems to be accelerating.


have no choice but* to recognize that the Congress has not finally
resolved important questions related to A.T.S* and NOW accounts.
All of this will, inevitably, pose problems of communication
and understanding.

Some of the new M's may rise more slowly,

while others may rise more rapidly, than present measures relative
to GNP.

We will proceed as carefully and as intelligently as we

can in changing definitions and explaining differences.

But, in

the final analysis, reality is too complicated to pick out a single
figure at this single point in time that can fully capture the
essence of money and will not behave somewhat differently than the
numbers relative to economic activity.
All of this raises the specter of misinterpretation of our
actions and objectives.

To avoid confusion, we will need the

help and understanding of all of you that follow and help interpret
the numbers.
Beyond this maze of technical and definitional questions
lies the more fundmental question:

is restraint on the money


supply really adequate —
to deal with inflation?
answer —

or for that matter really necessary


Theory and experience permits only one

it is necessary, and in concept, it can do the job.

But the real question, the harder question, is how fast, with
what pain, at what cost to other objectives in the short run
and here the answers, as you know, are not so simple.


depend crucially on other forces and other policies —



whether those forces are working at cross purposes or as part
of a consistent, coherent pattern.
I have already referred to the disturbances related to
energy prices and supplies.

What has happened in that area in

the past month or two has at best set back the timetable for visible
and sustained relief from inflation by a quarter or two, while
complicating the process of business adjustment.

But predictable

effects of that kind would be mild relative to the domestic and
international strains implicit in still further spiraling of international oil prices —

a process that ironically has seemed to be

encouraged not by any current shortage, but by uncoordinated stockpiling out of fear and uncertainty.
if we only fully seize it.

But therein lies an opportunity -

Catalysing support for the long-term

effort toward conservation and developing alternate energy supplies,
is one dimension.

But even more immediately, no work seems to me

more crucial today than the renewed efforts among consuming countries
in the IEA and other forums to find coordinated means for relieving
market pressures here and now.

-laEnergy is, of course, not the only source of concern.
agenda of needed and possible actions —


public and private


to restrain costs, to improve productivity, to shed excessively
costly and redundant regulations is as familiar as it is difficult.
I will comment on only one element of that long agenda now —- the
need for prudence in our fiscal decisions.
I know a strong case can be made for well-structured tax
changes —

but only at the right time.

If we have learned anything

in these recent years, I hope we have learned the consequences of
undertaking policies that, with the best will in the world, anticipate
the worst in terms of the business outlook and weigh lightly in the
balance potential inflationary consequences of budget deficits.
Most of all, I hope we resist temptations that could arise simply
to pump fresh purchasing power into the economy at the first sign
of recession.

It would forestall altogether subsequent opportunities

for a coherent tax reduction program —
by expenditure restraint over time —

a program that can be earned

to help deal with the urgent

underlying problems of productivity and costs.

The discipline shown

by the Administration and the Congress in resisting the temptations
to move too early on the tax question has been reassuring.
In the final analysis, economic performance is conditioned
by the nature of our expectations and our understanding.


the past decade or more, one expectation that has come to be
almost universally shared is that prices would move higher


and so long as that expectation is held it tends to become a


self-fulfilling prophecy.

Meanwhile, insidiously our real economic

performance, in the sense of productivity growth, has deteriorated.
The one problem has contributed to the other.
To break that cycle, we need to change expectations.


indispensable element in the process is singularly in the domain
of the Federal Reserve —

we must have a credible and disciplined

monetary policy that is characterized by sustained moderation of
growth in money.

Alongside that policy we need to understand that

real growth will depend on real performance -- most of all to promote
productivity, savings and investment.

When those approaches are

built into our expectations and into our decision making, then
our present intentions can more easily become tomorrow's realities.
We would truly have in place the elements of "sticking with it,"
not just in 1980, but for many years beyond.

* * * * * *