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
9;0Q A.M., E.D.T,

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

before the
Joint Economic Committee

July 16, 1981

I appreciate the opportunity to appear before this
Committee to present the Federal Reserve's views on the
international implications of U.S. macro-economic policies,
and particularly monetary policy.
Inevitably questions arise abroad, as they do in this
country, about particular techniques and implications of U.S.
ecomomic policies.

After all, nearly all of the nations

represented at the Ottawa Summit, and most others, are faced
with difficult problems and choices in developing economic
policy, and external influences on their interest rates and
exchange rates inevitably raise new complications for some
just as at times external developments
own policy-making.


complicate our

However, the expression of such concerns

should not be taken as disagreement with the basic intent or
thrust of our policies, certainly not among those most closely
concerned with financial policy.

I base that judgment on my

own discussions with central bankers and finance ministers
abroad as well as on the conclusions reached in May at the
meeting of the IMF f s Interim Committee in Gabon and more
recently at the OECD Ministerial meeting.
Accordingly, I expect that the President will hear a
general endorsement of the broad purposes and objectives of
U.S. economic policies when he meets next week with other
heads of state and governments.

Specifically, I believe that

the priority the United States has attached to the fight against


inflation is widely appreciated.

Indeed, the leaders of

these very nations, along with many others, have long urged
us to adopt rigorous and convincing anti-inflation policies,
and I do not believe they will change that attitude now.
Foreign officials do rightly stress that, in our interdependent world, U.S. economic developments and policies have
ramifications for the policies and performance of other economies
Our weight in the world economy, while relatively smaller than
in the early postwar years, is still very significant, and
leaders abroad have to take U.S. economic policies into account
when they formulate their own programs.

They do want us to be

aware of the external implications of high dollar interest rates
and a rising dollar, as we should be.
abroad as well as at home —

The short-run effects

can indeed be discomforting.



we should also have a sense of proportion about those effects.
The United States should not and can not assume the
responsibility for all the economic difficulties of particular

In some instances —

for example, countries with

sizable balance-of-payments deficits —

&ome depreciation of

their currencies relative to the dollar may have been natural,
and a number of countries have internal reasons for following
firm monetary policies.

Changes in exchange rate relationships

within Europe have been relatively small recently, and most of
the trade of those countries is not affected by the substantial
appreciation of the dollar.

The point is often made in the

context of the dollar's appreciation that oil and other


commodities are priced in dollars/ but it should also be
pointed out that monetary restraint in the United States has
contributed importantly to squeezing out inflationary excesses
in those markets.
In general, it is rarely easy to trace through the
relative weight of different forces impacting on the economic
policy problems of different countries.
including the United States —

We all —


must guard against a temptation

to assign undue responsibility to external forces.

I would

remind you that any exchange rate involves two national currencies;
a change in that exchange rate may reflect policies or developments in either country, or more likely both at the same time.
The recent "strength" of the dollar vis-a-vis some currencies
headlined in the press has been relative; it may be —
has been —


influenced by conditions abroad, as well as in the

United States.

I would note that short-term interest rates in

the United States are a bit lower today than at the turn of the
year, and interest rate differentials are narrower with respect
to continental European currencies.

Yet the dollar has appre-

ciated substantially against those currencies over the past six
Because of the potential for misunderstanding, and because
developments and policies here do have effects on other countries
whose leaders face difficult economic problems and choices, we
have a clear responsibility to listen closely to their views,
to explain our policies carefully, and to respond to constructive,


substantive criticism.

Prolonged misunderstanding is always

dangerous, for economic and political friction could impair
the fabric of the open international economy that serves us

My perception is that, fortunately, there is broad

understanding of our objectives and policies —

combined, of

course, with a good deal of impatience in awaiting results,
just as is sometimes the case at home.
The essential point about U.S. economic policies
monetary, fiscal and other —


is our commitment to reducing

inflation. Most of the foreign leaders with whom I have talked
readily agree that it is in their countries1 fundamental interest,
as well as ours, that the United States make significant progress
against inflation.

Because of the dollar's role in world

financial markets and because of the U.S. prominence in the
world economy, a necessary condition for the restoration of
stability in currency markets and for the resumption of sustained,
worldwide economic growth is the restoration of greater price
stability in the United States.
Obviously, they,as we, would like to see lower and more
stable U.S. interest rates and less variation in exchange rates.
Everyone would agree that reduced inflation and a clear sense
of movement toward price stability must be the basis for maintaining such stability over time.

Against that background,

international discussions raise questions of means, not ends.
As you know, Federal Reserve monetary policy has been
directed at restraint in the rate of growth of the monetary



Some observers — a n d they are not confined to

those outside our borders —

believe we are following a policy

deliberately directed at achieving high interest rates and
dollar appreciation.

Such views are mistaken; the Federal

Reserve has neither an interest rate nor an exchange rate

We do take the view that persistent restraint

in the growth rates of the monetary aggregates is necessary
to ensure lower inflation —
rates —

over time.

and therefore lower interest

I find no disposition among my colleagues

abroad to question that necessity.
In the short run, interest rates are a function of the
many factors that influence the demand for money and credit,
including the budgetary position of the government, the strength
of business activity, and the inflationary momentum.

So long

as actual and expected inflation and nominal demand remain
strong, high interest rates should not be surprising.


when inflation slackens significantly, and markets believe the
slowdown will be sustained, can we look forward to meaningful,
sustained declines in dollar interest rates, consistent with
growth in real activity.
Relative interest rates can and do influence exchange

But that influence has to be judged in the context

of other influences working at the same time.

As I have

already suggested, it would be a mistake to attribute the
roughly 20 percent weighted-average appreciation of the dollar
since December of last year primarily to the behavior of nominal


interest rates on dollar assets.

The differential between

U.S. interest rates and short-term interest rates on average
in foreign industrial countries has declined about 2-1/2 percentage points since the end of 1980.

U.S. short-term interest

rates are now about 1 percentage point less than their December

Interest rates on the continent of Europe are appreciably

higher, yet their currencies have depreciated substantially
relative to the dollar.
countries —

Interest rates in two of the Summit

Japan and the United Kingdom —

have declined so

far this year, and in one of those countries —

Japan —


depreciation of its currency relative to the dollar has been
smaller than that of the continental European currencies.
The yen, as well as the Canadian dollar, has experienced a
weighted-average appreciation so far this year.
Obviously, one must look beyond absolute or relative
interest rates to explain the dollar's appreciation this year.
Among the other relevant factors in the United States have been
the first signs of some improvement in our relative inflation
performance, a continuation of a relatively favorable U.S.
current-account position, and favorable assessments of the
potential of the new Administration's economic program.


the other side of the Atlantic, balance-of-payments deficits
have been large, and there has been a sense of greater political
change and uncertainty.
A number of foreign observers, while not questioning
the need for monetary restraint in the United States have

Euggestect that monetary policy should not carry so much of
the burden of the stabilization effort either here or in their
own countries.

As you know, I have also often emphasized the

importance of fiscal restraint and regulatory and other policies,
alongside firm restraint on the money supply, in a comprehensive
program to reduce U.S. inflation.

At the same time, we all have

to recognize the difficulties in changing these policies dramatically and quickly.

We are in fact making progress in reducing

the strong upward trend in government expenditures —

and I

would remind you that the Administration has emphasized that
more will need to be done in future years, particularly if we
are to reap the benefits of tax reduction in a context of
reduced budget deficits.

The closer the budget is to balance,

all else equal, the less pressure will be felt in financial
markets, the lower interest rates will be, and the danger of
abnormal exchange rate pressures will be lessened.

But it would

be unreasonable to expect a balanced budget overnight, and I
believe there is a growing understanding abroad, as at home,
that fiscal policy cannot easily be shifted in the short urun.
After all, most other governments are grappling with fiscal
problems at least as difficult as our own.
It is equally important to recognize that there are no
"quick fixes" available through monetary policy to lower or fine
tune interest rates.

If the Federal Reserve, for example, were

to deviate from its policy of monetary restraint in an effort


to lower interest rates, any seeming short-run relief would
have to be balanced against the substantial risk —
United States and the rest of the world —

for the

of excessive credit

growth, a further hardening of inflationary expectations, and
still greater interest rate pressures in the future.
"Like others, I shall applaud lower interest rates in
the United States any day if they signal success in the battle
against inflation.

But I would look upon lower rates with

mixed feelings if they promised more inflation and hence
higher interest rates for the future."

Those words are not

mine, but those of a central bank colleague in Europe.*


seems to me they capture the essence of our policy problem.
Of course, as I suggested earlier, there is impatience
for results.

Monetary restraint is painful, and it cuts uneven!

at home as well as abroad.

Moreover, the burdens are not

restricted to the industrial economies; developing countries
are affected as well.

Some are experiencing slower growth in

their exports because of slack demand in the industrial world.
They are all facing much stiffer borrowing terms in internationa
markets than those to which they have been accustomed.

It may

be of little comfort to suggest that, in some cases, those terms
may well have been too easy in the past —

internationally as

well as domestically nominal interest rates have frequently

*Remarks by Karl Otto Pohl, President of the Deutsche Bundesl
June 12, 1981, before the Rqu&dtable of the International Be
Institute in Cannes.

been exceeded by actual inflation rates, encouraging excessive
indebtedness and the postponement of needed adjustments.


we would all like to see is a reasonable middle ground, and
more stability and predictability; we will not succeed unless
we keep at it.
If we cannot promise instantaneous and easy results


the answers do not lie in "fine tuning" fiscal or monetary
policies —

we can and must make the effort necessary to

explain our policies, formally and informally, in all the
forums available to us, and to consider carefully the views
of others.

In that connection, I have long felt that the

economic summits can help assure that our mutual economic
concerns are fully discussed and addressed at the highest
level, and the success of those meetings over time can be
measured less by any concrete agreements than by the degree
of understanding reached about our mutual problems and purposes,
Certainly we must all avoid the temptation to become
inward looking during this difficult period.


of trade restrictions would be damaging to the interest of
all countries.

Together we must seek effective ways to help

developing countries cope with their own serious adjustment
problems, not the least by maintaining and strengthening our
commitment to cooperation' and dialogue in the IMF and World
Most of all, it is crucial that we not fail in our
basic purpose of restoring stability and laying the base for


sustained growth.

One wise foreign official, widely

experienced in international affairs, recently put it to
me roughly as follows:

You cannot expect us to be enthusiastic

about the effects of your policies; we will all have different
opinions about just how you are going about it; but the fact
is we have no agreed better alternatives to offer you.


can only wish you success,
I wduld only add that with success the present international concerns will fade in memory.

We would do no one a

service, at home or abroad, if we were to take actions that
would jeopardize the prospects for that success.

* * * * * *