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For release on delivery
9:00 A.M., E.S.T.

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

before the
Committee on Ways and Means
House of Representatives

March 3, 1981

Mr. Chairman:
I am pleased to be here this morning to discuss with
ycu some considerations relevant to your deliberations about
economic policy.

The Ways and Means Committee of course

carries the responsibility for originating tax legislation and
has large spending programs under

its immediate purview.


responsibilities of the Federal Reserve lie in the area of
monetary policy.

Mutual understanding of our purposes and

policies seems to me critical to achieving more satisfactory
economic performance and to the success of the program outlined
by the President.
The economy entered 1981 on an upward trajectory,
extending the recovery in activity from last year's brief but
sharp recession.

January saw further gains in retail sales,

employment, and industrial production and —

despite high

interest rates —- continued stability in housing starts.


the whole, the demand for goods and services has continued to
prove more buoyant than most analysts had expected.
However, as we all know, unemployment and inflation
remain at unacceptably high levels.

There have been

strong pressures in financial markets.

Moreover, as things

stand, the outlook is far from satisfactory.

In particular,

it is clear to me that we will be unable to have sustained
economic expansion unless we are successful in bringing


inflation down.

Monetary policy is and will remain directed

toward that priority objective.

But, in my judgment, to

continue to rely on monetary and credit restraint almost alone
to deal with inflation would pose large and unnecessary risks —
risks of financial strains and>of excessive costs in terms of
growth and investment.
Last year, monetary restraint was the key factor in
keeping inflation from accelerating in the face of rising
oil prices and other factors.

Important as it was, that

"holding action" was accomplished only at the expense of
historically high interest rates, impinging strongly on some
areas of the economy and on investment generally.

In these

circumstances, the monetary restraint essential to deal with
inflation urgently needs to be combined with other effective
actions to relieve pressures on financial markets, to reduce
costs, to spur investment and productivity, and to encourage

In the best of circumstances, it will take time

to bring results, and the process of change almost inevitably
will involve some pain.

But, with the new President seizing

the initiative, I also believe we have a virtually unparalleled
opportunity to achieve a consensus for effective action in a
number of directions.
As you know, I testified last week before the House and
Senate Banking Committees, presenting the Federal Reserve
intentions with respect to monetary and credit growth for



Without repeating the details, those targets are con-

sistent with further reduction in the growth of money and
credit this year.

Against the background of the strong

inflationary momentum in the economy, the targets are frankly
designed to be restrictive, as they must be if we are to look
toward a winding down of the inflationary process.

And, while

we only look a year ahead in setting out specific growth ranges
for the various money and credit aggregatesv further reductions
will be necessary in the years ahead to return monetary growth
to amounts consistent with the capacity of the economy to grow
at stable prices.
The narrow money aggregates, M-1A and M~1B, are currently
distorted by rapid institutional change —

the introduction of

NOW accounts and other interest-bearing transactions accounts

Abstracting from the impact of shifts into those

accounts, our intentions are reflected in a reduction of targeted
growth ranges by one-half percent (to 3-5^ percent and 3%-6 percent)
for M-1A and M-1B, respectively.

Growth last year from the

fourth quarter 1979 average to the fourth quarter 1980 average
(when adjusted for shifts into HOW accounts) approximated 6-1/4
percent and 6-3/4 percent/ just over the top of the target range.*

*Growthf as statistically recorded and published/ was 5
percent for M-1A in 1980 and 7-1/4 percent for M-lB. Available
evidence suggests about 2/3 of the transfer into interest-bearing
checking accounts in 1980 reflected shifts from MKlAf ''artificially"
depressing M-1A and about one-third reflected shifts from savings
or other accounts/ "artificially" raising M-1B« The data and the
targets cited in the text are calculated as if such shifts did
not take place»
For 1981 the target ranges for growth of M-1A and M-1B
before adjustment for these shifts are - 4 % to -2 and 6 to Bhf
respectively. See pp. 39-41 of the Federal Reserve Boardss
Monetary Policy Report to Congress Pursuant to the Full Employment and Balanced Growth Act of 1978 for a complete discussion

of the impact on the 1981 targets of nationwide NOW account growth.

-4Consequently, the new target ranges imply a significant
reduction in the monetary growth rates.
The Committee did not change the targets for the broader
M~2 or M-3 aggregates, which include various types of savings
and time deposit accounts.

The relationship between M-2, M-3

and the narrower aggregates has changed over recent years and
this year's targets are consistent with further restraint across
the entire range of monetary measures.

Indeed, because actual

growth in 1980 was 3/4 percent or more above the upper end of
the indicated range, success in reaching the target range in 1981
implies significantly lower growth.
I cannot emphasize too strongly the need for care in
interpreting the actual data for monetary and credit growth
as the year progresses.

As I indicated, both M-l series are

currently distorted by the shift into interest-bearing transaction accounts.

As the year progresses, we anticipate the

distortion will diminish, and we will provide estimates from
time to time of the effects of the shifts on the data.


beyond that particular source of distortion, the data are
subject to considerable volatility from month-to-month or

What counts is the trend over a reasonable

period of time.
Those technical considerations should not obscure the
basic thrust of our policy posture.

Our intent is not to

accommodate inflationary forces but rather to continue the
restraint on growth in money and credit that is necessary to
squeeze out inflationary pressures.

While there can be debate

— 5—

about timing and degree, the need for that basic discipline
is common to virtually all schools of economic thought and
is, of course, recognized in the Administration's program for
economic recovery.
Restraint on monetary expansion does place broad limits
on the potential growth of the nominal GNP —

that is, the

combined result of changes in real output and the price level.
It implies that all the demands for money and credit potentially
generated by an economy both growing and inflating cannot be

So long as inflation continues unabated or rises, real

activity is likely to be constrained.

But as inflation begins

noticeably to abate, the stage will be set for stronger
and sustained —

real growth.


Monetary policy is, of course,

designed to encourage and speed that disinflationary process.
But the success of such a policy —

particularly the extent

to which it can be pursued without great pressure on interest
rates and aggravating strains in financial markets —

also will

depend upon other public policies and private attitudes and
I must emphasize the risks and difficulties of dealing
with inflation entirely by monetary policy —

of failing to

bring other policies into support of that objective.


budgetary and other policies pull in the opposite direction


if those policies feed inflationary expectations, propel the
cost and wage structure upwards, add unnecessary regulatory
costs, and fail to reduce and in time eliminate deficit financing
then the danger of a kind of collision in financial markets
between public and private borrowers will be intensified.


But that risk can be minimized in the short run, and the
groundwork laid for renewed prosperity in the 1980 's, by forceful coordinated actions.

Fortunately, there appears to be

broad recognition of the nature and urgency of our problems
and a willingness to bring to bear a new discipline in fiscal
and regulatory policy.
To that end, the new Administration has set forth a
sweeping new program of action encompassing an array of
spending cuts and tax reductions.

There will properly be

debate about the specific components of that program.


of its precise impact on the economy this year and next will vary,
just as such estimates would be challenged for any program.
The simple fact is that we have not been able to count on any
economic forecasting technique to provide consistently reliable
results in recent years in the face of the virtually unprecedented
nature of our economic problems, severe energy shocks, and
volatile expectations.

In these circumstances, I personally

would be cautious in interpreting the results of any economic
model so far as the precise timing and magnitude of future
economic developments are concerned.

But that does not mean

that valid judgments cannot be reached about the general shape,
size,and direction of needed policy changes»

Economic analysis

seems to me to point clearly to the following conclusions:


Against the background of the Federal tax burden
reaching the highest level in our history, tax cuts
are needed to encourage greater investment, productivity, and work effort.




At the same time, a continued need to finance
huge budgetary deficits in congested financial
markets into the indefinite future would threaten
the availability of funds to private borrowers,
including businesses that must undertake the needed
productive investment as well as to the homebuilding
industry and others heavily dependent on borrowed funds.
In these circumstances, the amount of tax reduction
that can be prudently undertaken is dependent on
cutting back the inexorable rise in Federal spending,
on and off budget.

The larger the spending cuts, the

greater the prospects for reducing the strains in
financial markets and for turning back inflation.

In the best of circumstances, there are limits to the
amount of revenues that, in the short run,can be
foregone as a result of tax cuts.

Thus, from the

standpoint of general economic policy, the emphasis
in tax reduction should, to the maximum extent feasible,
be placed on measures that promise to increase incentives
to work, to invest and to save.

At a time when we are fighting inflation, other governmental policies that increase costs, inhibit competition,
and impair the flexibility of the market economy need
urgent review.

Costs of regulatory policies must be

assessed against the benefits.

Our markets must be

open to competition from home and abroad to spur
innovation and productivity, and government should
reexamine policies that tend to place an excessively
high and rising floor under certain costs and prices.

This Committee is deeply involved in the crucial fiscal

I know that tax and spending cuts, by their

very nature, involve difficult considerations of fairness as
well as economic efficiency.

It is not appropriate for

the Federal Reserve to intrude on the details of that decisionmaking process.

But I would emphasize one point central to

economic policy generally and the relationship to monetary
policy in particular.
To me, the linchpin of the whole economic program is
early and, by past standards, massive progress on cutting
back the upward surge of Federal expenditures.


spending cutbacks are necessary to clear the way for sizable
tax reduction and to permit early progress toward the goal
of a balanced budget.
I know the difficulties and constraints —

the need to

increase defense spending, to protect the truly needy, to pay
interest, and to maintain strength and continuity in other
essential programs.

But the budget is huge and has increased

by more than a third in real terms over the last decade.
Surely, there is ample room for cutting if there is the will,
and the Administration proposals for specific cuts over a broad
array of programs point the way.
I must emphasize that, from the standpoint of general
economic policy, all the risks seem to me on the side of not
cutting back the rise in spending enough.

Every dollar of

added savings can only help head off tensions in financial
markets, make room for morjs private investment, and provide


an appropriate setting for prudent and needed tax reduction.
In that connection, I would remind you that even the specific
cuts proposed by the Administration, large as they are, are
only a kind of progress payment toward what needs to be done
to bring the budget into balance in reasonably prosperous
economic conditions*

Further very sizable reductions are

indicated in its program for fiscal 1983 and beyond*


sooner that process is started, the better will be the
prospects for changing public attitudes and economic
I would^like to make one last point before concluding.
The need to reduce inflation as part of any effective economic
program is now widely recognized, and the Federal Reserve has
an indispensable role to play in that process.

How soon our

efforts in that direction succeed, and how soon we can look
forward to healthy growth and reduced unemployment, will depend
in large measure on how quickly attitudes toward inflation
change in the private sector, and how those new attitudes are
reflected in pricing and wage decisions.

Strong upward

momentum in wage contracts and pricing policies will ultimately
be inconsistent with a commitment to monetary and fiscal restraint,
and inimical to the interests of both the nation and the particular
firms and workers involved.

After years of inflation, attitudes

and expectations are not likely to change easily.

That is why

our commitment to restraint must be strong, visible, and sustained.


I believe the monetary targets of the Federal Reserve
are consistent with that need.

Demonstrated progress on the

fiscal side is also a necessary ingredient-

And, in the end,

we will need to see visible progress toward price stability
an objective that for far too long has eluded us.
will inevitably require harsh choices.
feasible alternatives.


All of this

But I know of no

And, I am convinced the difficulties for

all of us will ultimately be much greater if these choices are
not squarely confronted now.

* * * * * *