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For release on delivery
10:30 A.M., E.D.T.
October 20, 1983

Statement by
Paul A. Volcker
Chairman, Board of Governors of the Federal Reserve System
before the
Joint Economic Committee

October 20, 1983


I am pleased to have the opportunity to meet with
this committee to discuss the current economic situation
As you know, the Federal Reserve's most recent official monetary
policy report was submitted to the Congress in mid-July,
Because that report treated the economic situation in considerable detail, my remarks on the current economic and
financial situation will be limited mainly to an updating*
More importantly, I also would like to reemphasize a number
of concerns that I expressed at the time that the midyear
report was submitted to the Congress.
At that time, it was evident that the current economic
recovery had gained considerable momentum and was following
in many respects a typical cyclical pattern*

Advances i

residential construction had been large; consumer spending had
registered exceptional increases in the spring; and business
investment spending also was beginning to strengthen*


ment gains were substantial through the first half, and the
unemployment rate ~

though still high —

had moved steadily


By midyear, only the export sector remained a major

depressant on growth of real GNPf reflecting the further
widening of this country's foreign trade deficit.
By and large, the economic trends evident at midyear
have continued through the third quarter.


production has continued rising at a rapid pace through

Payroll employment increased nearly two-thirds

of a million during the three months ending in September,
and the unemployment rate fell three-fourths of a percentage
point over that same period.

Preliminary indications

suggest growth in real GNP remained fairly close to the
exceptionally high rate in the second quarter.

On the

whole, I believe that the data indicate that the economy
remains firmly on the path of expansion.


Moreover, the recent price information continues
underscore the gains made against inflation over the
past two or three years*

During the first eight months of

1983. the consumer price index rose at about a 3-1/2 percent
annual rate, somewhat less than the rate achieved in 1982,
and the producer price index, on balance, has showed virtually
no change over that same period*

This price information is

better than we have experienced in a decade or moref in sharp
contrast to the racheting upward of prices in the 1970's.
Because labor inputs account for about two-thirds
of total GNP, an easing in growth of labor costs is crucial
if our gains against inflation are to prove sustainable.


this score, we have made further progress so far this year.
The rate of increase in nominal wage gains has trended down;
the hourly earnings index, the most current wage measure,
has risen at a rate of less than 4 percent this year.
easing of cost pressures has been reinforced by rapid


oductivity gains that appear to reflect not only the
cyclical gains normally associated with the early stages of
expansion/ but also some apparent improvement in the trend
rate of productivity growth.

It is this kind of pattern,

that sustained/ can keep the underlying inflation rate moving
lower -- and real wages rising.
Overall/ these recent indicators of economic
activity/ inflation and productivity provide a strong start
toward a much more satisfactory economic performance than we
have seen for many years.

At the same time, as I have said

many times before, what counts is not the rate of economic
growth over a short time span of a few months, or even a few
quarters/ but rather the performance of the economy over time.
The current expansion, though more robust than generally
expected at the beginning of the year, still is less than a
year old.

And/ on the surface, it could be said that recent

events do not differ dramatically from the early phases of some
earlier business cycles that also began with strong growth and
improved price performance —

but later deteriorated into


accelerating inflation and stagnating real activity*


past record should be warning enough to resist any temptation to sit back and let events take their course,, hoping
that the momentum of expansion and the progress already made
against inflation will be sustained pretty much on their own.
Moreover/ there are obvious potential obstacles in
the path to sustained progress.

Most importantly/ the current

prospect that federal budget deficits will remain exceptionally large into the indefinite future is a major factor propping
up interest rates and continues to pose a serious risk to the
stability of financial markets in the future, threatening the
balance and ultimate sustainability of the recovery itself.
The economic and financial problems of many developing countries -- aggravated by the high level of dollar interest rates


remain a dark cloud over the international financial system^
and unless contained could jeopardize our own economy.


despite our substantial progress against inflation, doubts about
the sustainability of that process, and temptations to revert to
attitudes and behavior characteristic of the 1970 f s, could


undermine prospects for continuing economic expansion*
these respects, we are in a period of testing.
It is well within our capacity to pass these tests.
But it will take a positive approach, not a wait-and-see

Data for the past fiscal year provide some sense of

the budgetary problem; in fiscal 1983 the federal budget
deficit, not counting Treasury financing of off-budget programs , apparently reached close to $200 billion, nearly twice
as large as the previous year's deficit, which itself had
been of record proportions.

The 1983 federal deficit amounted

to about 6-1/2 percent of nominal GNP:

prior to 1983, there

had been only one year in the past three decades in which
federal deficits were as much as 4 percent of GNP.
Obviously, the magnitude of the federal deficit
in future years will depend on both the actions of Congress
and on the strength of the economic recovery.
of the 1983 deficit —

A large portion

perhaps half -- reflected the influence

of the business cycle on federal receipts and expenditures.
As the economy improves this "cyclical" element in the deficit

will become
Federal Reserve Bank of St. Louis



" u given currently existing legislation, the non<t
cyclicalF or "structural11 part of the deficit is all too likely
rise further*

Indeed, under even the most optimistic economic

assumptions now being made, the federal deficit appears likely
"O remain at levels, relative to the size of the economy, that
"^ without historical precedent during periods of economic
A year ago there appeared to be a growing commitment in the Congress to address the problems associated with
federal deficits.

Today, I fear the sense of urgency has

Instead, with the economy growing again, there

may be a temptation to try to live with historically unprecedented
peacetime deficits.
That course implies great hazards.
period just completed —

Even in the

during which private credit growth

was reduced substantially by the recession —- the influence of
heavy federal borrowing contributed to the persistence of high
interest rates,

Maintaining large deficits in coming years

makes it far more likely that interest rates will remain
historically high well into the recovery, and posing a risk
to the sustainability of the expansion.
The progress we have made against inflation if sustaine

is one fundamental force that should tend to

make interest rates lower over time.

But the huge budget

deficits have an impact in the opposite direction*

One result

is to dampen prospects for business investment, particularly
for long-lived investment with relatively slower "pay-out."
But that investment is what is needed to revitalize some of
our basic industries, and to support productivity generally.
Some of those same industries also suffer from
depressed exports or strong import competition.

To the extent

that large capital inflows are induced by pressures on our
domestic capital and credit markets, those inflows have contributed to maintaining the dollar at "artificially" high levels,
viewed from the perspective of the current competitive position
of our industry. In the short-run, those capital inflows may

help to moderate pressures on the financial markets.


viewed in a longer perspective, we have the irony of the
largest and richest country in the world JLn effect turning tc
foreign investors to help finance its government deficits
while, by the same process,, draining vitality from the firms
and industries that in the past have been important exporters.
As I noted earlier^ exports have been a weak element in the
business picture, and our trade and current account deficits
are growing toward levels that would be unsustainably large.
The longer that process lasts, the greater the potential instability for the UoS« and for the world economy.
The persistence of large federal deficits and a
high interest rate environment also complicates the effort to
deal with the international debt situation.,
countries ~

The developing

excluding those that are members of OPEC —

a total indebtedness of about $575 billion*


Of that total,

about $285 billion is owed to banks around the world, with
more than $100 billion owed to U.S. banks.

The level of in-

debtedness is high relative to the current income-generating

potential of those economies, and the great bulk of the debt
is in dollars, paying dollar interest rates.

As you know,

difficulties in servicing these debts have been widespread.
Thus far, problems have been contained through an
extraordinary degree of cooperation among borrowers, private
creditors, national authorities, and international organizations.
The borrowing nations themselves have undertaken strong adjustment measures to restore financial stability, increase debtservicing capacity, and improve their credit-worthiness.


also has been a major cooperative effort among the lending banks
to agree upon financing programs involving the restructuring of
existing debts and provision of some new loans.
At the center of this process have been the coordinating efforts of the International Monetary Fund.

On several

previous occasions when I have testified before the Congress, I
have urged prompt action to bolster the resources of the IMF.
However, as you know, the work on that important legislation
has not been completed.

International understandings look toward action
before the end of next month, so time is growing short.
Apart from the actual funds involved, our failure, alone among
nations, to participate in this effort would send a strong
message around the world that we do not support the cooperative
efforts to manage and contain the debt problems of the developing

Put positively, participating in the proposed increase

In IMF resources is a necessary and prudent investment in our
own future.
Another important element to dealing with the
current external financing problems of developing countries is
a concerted effort to maintain the flow of bank credit to these

The question is sometimes raised whether such lending

will be at the expense of lending to domestic bori'owers and the
expansion of our own economy.

In that connection, I would

emphasize the new bank lending to these countries will, in the
aggregate, be at a substantially reduced pace from that of recent
years and, as I have noted, we are on balance currently large net

borrowers from the rest of the world.

In the absence os

these cooperative lending efforts by banks and the IMF, I do
not believe we could be successful in avoiding widespread
defaults or worse.

The clear threat would be that such an

international financial disturbance would have major repercussions on our own credit markets, our interest rates, and our
growth prospects —

far outweighing any effects on our markets

of the limited foreign lending required to maintain stability
Finally, I must emphasize the crucial importance
of maintaining the progress against inflation.

As I noted

earlier, looking back, the recent data on prices and wages is

However, it is also true that some temporary factors

for a while caused measured rates of inflation to exaggerate
the slowdown in underlying rates of inflation.

As temporary

factors have subsided, there has been some increase in reported
monthly rates of price increase from the essentially flat record
of the first half.

That is not, in itself, surprising, but it

does warn against any sense of complacency.


-13The fact is there continue to be deep-seated
concerns both in financial markets and among the general
public that more strongly inflationary trends could soon resume.
The experience of the 1970fs with accelerating inflation, despite
some cyclical "pauses," is still deeply ingrained in people's
minds, and, looking ahead, there is concern about whether
appropriate restraint will be maintained over money and credit
growth in the face of sustained huge deficits.
There are strong grounds for believing that these
attitudes and expectations may be lagging behind reality and
that underlying inflation rates are lower —
to move lower —

than is generally perceived.

and can continue
Indeed, with the

period of low inflation still lengthening, with spare capacity
still extensive in many sectors, and with strong domestic and
international competition, and with labor amply available, there
is a rare opportunity to "build in" greater stability.
Whether that optimistic view will, in the end,
prove correct depends in part on the attitudes and behavior of

business and labor*

We currently see strong efforts to contain

costs and improve efficiency in industries subject to the most
intense competitive pressure, whether because of depressed
markets or other factors.

In some other areas, new wage

contracts or pricing policies appear out of touch, both with
our recent experience with inflation and with current conditions
in labor or product markets generally.
of a kind of carryover —

Rather, we see symptoms

or a "hangover" —

in a more inflationary environment.

of attitudes instilled

Should those attitudes be

reinforced and generally prevail, our effort to move toward sustainable economic growth with greater stability would be greatly
Experience suggests expectations developed over a
lengthy period of accelerating inflation are rarely suddenly

But they will change over time, so long as public

policy remains steadfast in its commitment to an environment
of greater price stability*



Monetary policy inevitably must play a central
role in that process, essentially by containing growth of
money and credit to amounts consistent with containing
inflation over time.

I doubt that such efforts can ever be

reduced, in a complex changing economy like ours, to a simple
mechanical formula to govern growth in one measure of the
money supply or another.

For instance, in the midst of both

institutional and economic change last year and during the
early part of 1983, the Federal Reserve accommodated faster
growth in some of the various monetary aggregates than it
had planned earlier, responding in part to the visible evidence
of a pronounced slowdown in the turnover or "velocity" of

With some indications that more normal patterns may be

returning, and with the momentum of recovery strong, limited
steps were taken to resist monetary and credit growth during
the spring and early summer.

In a real sense, in a climate

sensitive to inflation and the possible future inflationary


implications of current policy, timely steps to pre-empt
excesses can avert the need for much stronger action later.
In recent weeks, all the monetary and credit aggregates have moved comfortably within the target ranges,
easing concerns of a surge in liquidity growth.

In addition,

interest rates, for the most part, have edged slightly lower
in recent weeks, following moderate increases in late spring
and early summer.

But the looming budget deficits remain as

a focus for doubts about the future.
In conclusion, the economic situation, in its
broadest terms, does not differ dramatically from the situation
that was apparent at midyear.

Current economic indicators

have continued to show a strongly growing economy coupled
with only moderate rates of inflation.

At the same time,

concerns about the longer run outlook that were apparent at
midyear are still with us today*

Now, as then, we broadly

know what policies are needed to provide greater assurance



of sustained economic growth and lasting price stability,
What remains to be done is to implement those policies.

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