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For release on delivery
9:30 A.M., E.S.T.
Tuesday, March 8, 1983

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

before the
Committee on the Budget
House of


March 8, 19 8 3

I appreciate the opportunity to appear before this
Committee today to discuss with you directly ~

as I have with

other Committees -~ the current economic and budgetary situation
and the Federal Reserve's goals for monetary policy,,

A few

weeks ago I presented to the Senate Banking Committee the
specific numerical targets for the growth of money and credit
in 1983 set by the Federal Open Market Committee (FOMC) and I
believe you have the Monetary Policy Report to Congress before

Therefore, I would like to focus this morning on the

broad issues confronting monetary policy and their relationship
to other aspects of domestic and international economic policy*
In order to put these issues in context, I should begin
with a few cojnments on where the economy stands today.


a long period of recession, activity is showing signs of
increasing strength in several sectors.

Meanwhile, we have

made impressive progress against inflation over the past year,
and the underlying trends, combined with the weakness of oil
prices, suggest that progress can be extended.


much of the stage has been set for a sound recovery in business
activity that will bring with it the increases in job opportunities and real income that we all desire.

But the setting is

not complete; more needs to be done to provide reasonable
assurance that the present signs of recovery in fact evolve into
a long-lasting non-inflationary expansion.

A key element in the improved outlook is the change in
financial market conditions.

Short-term interest rates are

now as much as 10 percentage points below their cyclical peaks,
while long-term rates are down about 4 to 5 percentage points•
Bank loan rates —

particularly rates for consumer credit,

which are typically less flexible -- have tended to lag behind
market rates, but they have come down further in recent weeks.
Reflecting these developments, activity has been improving,
especially in the credit-sensitive sectors of the economy.
The most notable turnaround has been in the housing

Production and sales of new single-family homes have

now risen substantially over the depressed levels of late 1981
and the first half of 1982.

With personal debts relative to

income lower than in several years and with liquid assets
rising, activity in consumer markets also has shown some
signs of improvement.

Auto sales, responding in part to the

lower interest rates offered under special programs and greater
pricing restraint, are running above the recession lows, although
still far below pre-recession norms.

Moreover, orders and

consumer purchases of other "big-ticket" items also appear to be
improving, partly in association with the upturn in home sales.
As is usually the case, the inventory cycle has played
a large role in the recession, and will be a determinant of the
speed of the recovery in its early stages.

Businesses made

vigorous efforts to control the accumulation of unwanted stocks

early in the recession and again in the final months of 1982
when the previously anticipated upturn in sales failed to

With further liquidation in January, inventories

generally are now back to the levels of early 1981c


as final sales strengthen more broadly, increases in production
could be more than proportionate.

Nonetheless, tight inventory

management —- against a background of declining inflation,
ample production capacity, and relatively high interest rates is likely to remain a factor making this recovery more moderately
paced than most past upturns.
For the time being, with excess capacity substantial and
profits depressed, business investment in new plant and equipment
is also likely to lag.

Some delay in the recovery of capital

spending is not out of line with previous cyclical experience,
as many firms initially intensify the use of existing capital
rather than invest in new plant and equipment.


there are some encouraging signs in this sector.

In particular,

new orders and appropriations for capital goods have firmed in
recent months.

Moreover, lower costs for long-term borrowing and

the surge in stock prices have encouraged firms to begin restructuring their balance sheets —

thereby putting the business

sector on a sounder footing for expansion.
The U.S. economy has become increasingly integrated into
the world economy over the years.

In contrast to most earlier

recessions, exports dropped sharply in 1982, reflecting both the
recessionary tendencies in the rest of the world and substantial

appreciation of the dollar in 1981 and much of 1982*


sluggishness of business activity abroad is an important
reason that recovery here is likely to be less rapid than
after most previous recessions.
The Outlook for Inflation and Interest Rates
Ultimately much more important than the speed of the
"start up" is the staying power of the recovery.

A long

sustained expansion in the economy will depend in major part
on our success in maintaining the progress against inflation
in the years ahead, not least because of its implications for
interest rates.
Interest rates and inflation rates frequently do not
bear a close relationship to each other for short time periods,
and those periods can sometimes extend over several years.


longer periods, however, there are strong analytic reasons to
expect a closer relationship because borrowers and lenders alike
are interested in real returns —

that is, in assessing the

costs or returns oil investments after allowance for changing

What counts, in this respect, is expected prices,

which we cannot measure directly.

If substantial fears exist

that the progress against inflation may not be maintained
and those concerns do remain —


interest rates, and

particularly long-term rates, will remain higher than otherwise

That situation is greatly aggravated, as I will

discuss in a few minutes, by the prospect of outsized federal

budget deficits in future years.

Since high interest rates

can be an obstacle to the financial health of households and
firms and to well-balanced recovery generally, we must deal
with these doubts and concerns*
Looking back, the gains in the fight against inflation
are striking*

All broad measures of prices rose less than 5

percent last year, the slowest rate of increase in a decade.
Part of the rapid improvement reflected unusually favorable
food and energy price developments, abnormally low commodity
prices generallyr the effects of the sharp appreciation of
the dollar*, and more broadly, the cyclical weakness of the
The need is to "build in" a trend toward more stable
underlying costs even as the economy recovers its upward

One encouraging element is the recent and prospec-

tive behavior of productivity.

After languishing in the late

1970s and early 1980s, labor productivity turned up last year,
somewhat unusual in the midst of recession.

Beyond those

statistics, which at this point can only be suggestive of a
changing trend, there is increasing evidence of efforts by
both workers and management ** under the pressures of competition
-and recession —

to increase efficiency.

The fruits of those

efforts should become more apparent as recovery takes hold.
Increases in worker compensation slowed to about 6%
percent last yearf and the pace currently seems to be slowing

Given the increases in productivity and the other

factors that contributed to lower prices last year, that
slowing of nominal wage increases has been fully consistent
with a significant increase in real wages for those working;
in fact, the real income of the average worker rose in 1982
for the first time in four years•
With real wages rising,, one source of pressure for
aggressive wage bargaining should subside*

For the time being,

the high levels of unemployment and intense competitive pressures
point in the same direction.

Some industries, characterized by

major structural as well as cyclical problems and wage levels
far above national averages,

have negotiated concessions from

previous compensation patterns, potentially improving their
competitive position and outlook for reemployment of those laid
Plainly, success in dealing with inflation cannot be
based on an economy that stays in recession, with unacceptable
levels of unemployment.

But neither can we anticipate continuing

improvement in the economy and lower interest rates if fears of reacceleration in inflation are stimulated and justified by events*
Continued moderation in wage settlements and pricing policies
as the economy expands will be a key signal of success in the
effort to maintain the disinflationary process.
The favorable near-term outlook in that respect is
reinforced by the current softness in the price of oil.
Petroleum prices are important because they, directly or indirectly, affect the cost of so much that we buy -— finished

petroleum products account for 8-9 percent of the GNP.
Furthermore, a decline in the price of those products, which
led the inflationary process in the 1970s, is highly visible
to every citizen, and can help symbolize the fact that the
climate of inflation has in fact changed —

that prices are a

two-way street.
But a favorable break in oil markets must not distract
us from the larger truth.

Continued moderation in pricing and

wages and attention to cost-cutting and productivity is dependent
on a sense of conviction that financial discipline will be maintained, and that aggressive pricing or neglect of costs will not
"pay off'1 —

that it will instead threaten markets, profits and

In other words, government policy will need to remain

demonstrably alert and forceful in dealing with inflationary
threats as the economy expands.

With that conviction, interest

rates can be both lower and less volatile, helping to support
the expansion in investment and sustained growth we need.
Monetary Policy in 1983
As you well know, the long years of accelerating inflation
after the mid-1960s undermined any sense of confidence that
stability would be restored.

Nor did the inflationary process,

in the end, "buy" us more employment and production; instead we
harvested the bitter fruits of rising unemployment, instability
in financial markets and the economy, and historically high
interest rates.

Now, after attaching high priority to the

effort over several years, we have a clear opportunity to
restore a more stable environment and a climate for growth indeed, we have come a long way in that direction.


inevitably, a year or two of progress against inflation has
not erased the skepticism rooted in the events of a decade
and more; the battle is not over.

And it is in that context

that we have to shape our monetary and fiscal policies.
In concept, the role for monetary policy is simple:
build on the progress against inflation by avoiding excessive
growth in money and credit, while providing enough liquidity to
meet the needs of recovery.
with, obstacles;

In practice, the path is strewn

indeedf the possibility of meeting both criteria

simultaneously will be a function of policies and circumstances
beyond the scope of any monetary policy, however wisely conducted.
In the best of circumstances, the line between too much
money and too little cannot be plotted with mathematical precision.
Rapid institutional change., reflected in the development of new
deposit accounts and the payment of market rates on existing
accounts, huge Federal financing needs, and the close linkage
of financial markets internationally, all complicate the job

Elements of judgment are inevitably involved.


in making those judgments, we are guided by one fundamental:
renewed inflation —- or policies that seem likely to lead to
that result -^ is neither a satisfactory nor a practical option.
The sensitivity of the public and the markets to signs of resurgent
inflation would be all too likely to produce precisely the reactions
in financial markets ~

and in wage bargaining and pricing policies


that would soon weaken or abort recovery*

The result would be

a re-play of the past decade or worse.
The prospect of Federal deficits that, as things now stand,
will preempt a large portion of available credit and savings as
the recovery proceeds threatens a "no win" situation.

There is

no monetary policy that can successfully resolve the economic
and financial tensions that would arise from the clash of demands
in the money markets from excessive deficits in a growing economy the kind of economy that would generate growing credit demands for
investment, for housing, and for other purposes.
present budgetary outlook —

until corrected —

Moreover, the

can only maintain

skepticism about our success in dealing with inflation, narrowing
the flexibility for monetary policy now.
The specifics of Federal Reserve policy with respect to the
various monetary and credit aggregates are contained in the material
that has been made available to you with this statement.

I would

only note now that the relationships between money and economic
activity did not follow "normal" cyclical and trend patterns last
year, partly because of the introduction of new types of deposit
accounts but also because of broader economic reasons.

Demands for

money and liquidity appeared to be enlarged by the.uncertainty of
individuals and businesses about the economy and financial developments.

There is also the clear possibility that the combination

of declining inflation, lower market interest rates, and the increasingly common practice of paying interest on transactions
accounts may have a lasting impact on trends in "velocity" —
working to lower the postwar trend increase —
appropriate growth of money over time.


and therefore on the

Looking through all the complications and taking account
of institutional distortions, our targets for money and credit
growth in 1983 are similar to those in 1982*

Because actual

growth last year generally exceeded the target ranges, the
effective growth this year should be less than in 1982.


on present evidence and allowing to some degree for usual
cyclical patterns, that amount of liquidity should be fully
consistent with anticipated growth in the economy.

In a context

of declining_inflation, the monetary targets themselves should
be consistent with somewhat greater growth than the Administration
projected in February (and probably with the somewhat higher projections of the Congressional Budget Office as well) and with further
reductions in interest rates.

But I must immediately add that

other factors, importantly including the present and prospective
budget deficits, impinge strongly on interest rate levels.
The variety of monetary indicators we use and the
rapidity of institutional change are potentially confusing.


the circumstances, there is an understandable yearning by some
to encompass all policy considerations in a simple, relatively
rigid rule.

But I know of no such rule reliably suited to our

present circumstances*

Elements of judgment seem to me inevitably

necessary in interpreting the data, and the targets will need to
be judged and reviewed at suitable intervals in the light of
developments with respect to economic activity and prices and
conditions in the domestic and international financial markets.
At the same time, the targets do provide a needed discipline,
and we mean to be within them over relevant spans of time.



will be changed only if evidence for such change is strongly
As I have already suggested, we do take as a point of
departure in our judgments the critical importance of maintaining
the momentum against inflation•

In fact, most members of the

Federal Open Market Committee believe that, measured by the
broader price indices, the inflation outcome in 198 3 should be
better than projected by either the Administration or the Congressional Budget Office.

The recent developments with respect

to oil prices are consistent with that outlook.

Within a given

supply of money and credit, such an inflation outlook implies
lower interest rates than otherwise and more room for real growth.
The more difficult question may be whether the momentum
toward price stability can be maintained in later years.

As you

know, both the Administration and the Congressional Budget Office
project that inflation will "settle down at a rate within one
percent of recent levels.

While a vast improvement from the

1970s, that, to me, would be an unsatisfactory result.


increasing at four to five percent a year is large enough to
have distorting influences on financial markets, the budget,
and the economy, and it would tend to keep alive fears of a
resurgence as unemployment and excess capacity decline.

We can

do, and have done, better, and a clearer path toward price
stability would, in my judgment, provide a sounder footing for
financial stability and sustained expansion.
Current interest rates, particularly long-term rates,
still appear to carry a large premium against the risks of higher

Whatever you or I —

or the Administration or the


Congressional Budget Office —

may judge a realistic forecast,

the false starts of the past in dealing with inflation have
understandably left a residue of skepticism about the progress
that has been made.

Like it or not, the market's assessment

of the future will be judged by performance now, and a strong
sense of conviction that inflation will stay down will emerge
only over time and with consistent effort to keep non-inflationary
policies in place.
That is one reason why a number of public policies,
apart from general monetary and fiscal policies, will be important
beyond their more specific effects.

For instance, a retreat to

protectionism is both directly inflationary and indirectly a
signal that moderation in pricing and wage behavior and productivity is not essential to maintain competitiveness.


on indexing betrays a lack of conviction in the effort to deal
with inflation and offers an illusion of escape from its consequences.

At a time when the budgetary deficits ahead already

threaten to clog the money markets, building in still more spending
programs —

certainly those with an added "spend out" into 1984

or beyond —- raises more questions about whether offsetting cuts
can be made, and the benefits to one group can potentially be
swamped by adverse effects elsewhere.
The Federal Budget and Monetary Policy
In the last fiscal year, the Federal deficit was a record
$111 billion.

The President's new budget projects a deficit in

the current fiscal year nearly double last year's figure —



about 6h percent of the GNP.

Further increases are projected

into the foreseeable future in the absence of determined action
to alter that outlook*
The members of this Committee, of course, are well aware
of the magnitude of these projected deficits.

In fact, numbers

in the $200 billion plus range have become so familiar in recent
weeks —

while interest rates have declined and the economy has

shown signs of recovery —

that a temptation may arise to "wait

and see/ 1 to step back for now from hard choices of where to
cut or where to tax, and to look to monetary policy to solve
the interest rate problem.

But a passive approach just won't

In the midst of recession, we can manage a big deficit,
even though it does keep interest rates higher than they would
otherwise be.

But over time, we can*t expect "real" interest

rates to revert to a low range historically, house our citizens
the way they wish, invest what we need to support growth and
productivity, and avoid drawing on the savings of other countries
(at the expense of an abnormally strong dollar and a huge trade
deficit) if Treasury financing absorbs half to three-quarters
of the net domestic savings we are capable of generating in a
more prosperous economy.
To put the point in its starkest form if no action is
taken, deficits in the general range projected by the Administration
and the Congressional Budget Office —

which broadly encompass

those of other informed analysts, including those in the Federal


Reserve —

do not seem to me compatible with the assumption

of a smoothly growing economy upon which the projections are

No conceivable manipulation of monetary policy provides

an escape; to the contrary, the implication is that monetary
policy would need to carry a still heavier burden to demonstrate
the government's resolve to follow a non-inflationary course.
The converse is equally true:

meaningful action to

demonstrate the government's economic discipline on the fiscal
side would reinforce confidence that monetary policy over the
years ahead can do its job in maintaining an appropriate degree
of restraint on the growth of money and credit without intolerable
pressures on the private sector.

Reducing the threat of rising

structural deficits stretching out to the end of the decade, by
damping concerns about future interest rate increases, should in
and of itself have favorable effects on current interest rates.
In that real sense, setting a firm course toward future budgetary
restraint should have immediate benefits, as well as safeguarding
prospects for future investment.
I am not suggesting there is a simple tradeoff between
growth in the money supply and budget deficits.

If monetary

policy were to abandon its continuing and necessary concern with
restoring reasonable price stability, the benefits of budget
restraint in encouraging confidence would be lost.

What can

be said is that a better fiscal outlook, with all it implies
about less pressure to monetize the Federal debt and reduced


concern about strong pressures on interest rates as the recovery
is extended, would provide an environment in which monetary policy
could better reconcile the goals of economic growth and financial
As you know better than I, basic budget trends take time
to change.

The size of the needed reduction in the deficit

increases progressively over a number of years, but the effort
must start now, and with energy and force.

The amounts involved

are large, but certainly not beyond our control.
It is obviously beyond my competence, or the province
of the Federal Reserve, to deal with all the particular priorities
that must be balanced.

The Administration has set forth its

program in that respect.

The general order of magnitude of the

cuts in the structural deficit proposed by the Administration
running to $125 billion and more for fiscal 1986 and beyond
seems to me appropriate at this time.



However, more of the

actions should, in my judgment, be brought forward into fiscal
1984 and 1985, with the objective of, at the minimum, keeping
the "structural" deficit well below $100 billion.
estimates of deficits

I recognize

a number of years ahead, "structural"

or otherwise, are subject to considerable margin of error, and
those projected by the Administration are considerably larger
than those of the Congressional Budget Office.

But the direction

and general magnitude of what is necessary seems clear enough;
there is, as a practical matter, no danger of "overshooting"
the mark.

And, finer adjustments can be made, year by year, as

more evidence accumulates.


The possibility of a large reduction in oil prices
could offer new options in dealing with the budget.

As I

noted earlier, the prospect for declining oil prices helps
to reinforce the outlook for further progress against
inflation in the near term.

It would also act, analogously

with a tax cut, to increase domestic purchasing power and
involve a direct loss of windfall profits tax revenues,
further complicating the structural deficit.

In the circum-

stances -•— and taking account of the effects on domestic energy
prices and conservation -«- a deep decline in oil prices would
suggest early reexamination of the case for energy taxes.


case would be reinforced to the extent a sharp oil price cut
now, and relaxation of the conservation and exploration effort,
implies the possibility of a strong rebound in oil prices in
the future.

One possibility would be to bring forward the kind

of oil tax proposed by the Administration on a standby basis in
fiscal 1986•
International Finance and the IMF
There is one other specific matter that I would like to
touch upon that has virtually no implications for the deficit
but great potential significance for our economic health.


item is the proposed increase in the resources of the International
Monetary Fund.
Our economic recovery is complicated by the fact that
the world generally has been mired in recession.

One reflection


of that has been to aggravate the strong pressures on the
financial position of developing countries that have accumulated
a large debt burden in the years since the first oil crisis.
For that and other reasons7 the past six months and more have
been characterized by interruptions in debt service by a number
of large international debtors and strong pressures on the
international financial system.
One danger has been that lending banks would attempt to
protect their individual positions by rapidly retreating from
new lending *

But borrowers who have built up large debts over

a period of years are not in a position to repay suddenly,,


uncoordinated attempt to force such repayment would undercut
the stability of the borrowers, the lenders, and the international
financial system alike.

We could not fully insulate our domestic

banking and credit system —
developments *

and our own economy —

from such

Consequently, we have the strongest kind of self-

interest in measures to contain and deal with the threat.
Management of that situation has required, and will continue
to require, the active cooperation of borrowing countries, banks,
central banks and treasuries of leading countries, and international financial institutions.

The International Monetary Fund

has a special, and indispensable, role to play.

In that connection,

I believe it is essential that the Congress approve an enlargement
of the IMF's resources at an early date so that it can, with some
assurance, proceed in the knowledge that its resources will be
adequate to meet its responsibilities.

As you know, that action

will require increased budget authority, even though the
operations of the IMF do not directly affect unified budget
outlays or the deficit,
I look upon the proposed increase in IMF quotas and
borrowing resources as a kind of insurance policy.

If the

need to draw on the added resources does not materialize,
there will be no cost.

But if the need does come about, we

must be prepared to deal with it expeditiously.

In that event,

the provision of funds to the IMF will be reflected in additional
borrowing needs by the Treasury.

The extent to which those needs

would be an additional net demand on credit markets is hard to
foresee, because some of the funds are likely to, temporarily
or more permanently, find their way back into dollar markets
for investment, and the U.S. would be providing only a fraction
of the funds required.

More important, I believe the policies

and performance of the IMF make clear that these funds would
only be called upon to meet a clear threat to the orderly
functioning of the international financial system.

In those

circumstances, the potential for disturbance to our domestic
markets —

which cannot be insulated from international markets —

would be far greater from failure to provide resources to the
IMF than from the limited amount of added Treasury borrowing.
In other words, a strong IMF, with resources adequate to do the
job, seems to me very much in our national interest.


I need not dwell on the fact that we are negotiating
a most difficult period in our nation's economic history.
But I also believe we are in the process of laying the base
for more vigorous, and lasting, non-inflationary growth.


looking to the rest of the decade and beyond, there are, in my
view, strong forces at work that can lead to a kind of selfreinforcing process of growth, greater price stability, higher
real income and profits, and declining unemployment.
There are, to be sure, obstacles in the way.


and fiscal policies alike need to be alert to those obstacles;
working together, I am confident that they can be removed and
that we can realize the bright opportunities before us.

* * * * * * *