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Statement by
Paul A. Volcker
Chairmanf Board of Governors of the Federal Reserve System
before the
Subcommittee on Domestic Monetary Policy
Subcommittee on International Trade, Investment and Monetary Policy
of the
Committee on Banking, Finance and Urban Affairs

House of Representatives

November 13, 1979

I am pleased to participate in these hearings on the
goals and conduct of monetary policy.

As you know, this is

a subject that has been the focus of considerable public
attention and debate recently.

That attention is symptomatic

of the widespread concern and uneasiness about the performance
and prospects of our economy.

All of us —

members of this

Committee, members of the Federal Reserve Board, and citizens
generally —

would no doubt prefer more equable economic conditions,

with the performance of financial markets and financial policies
relegated to the back pages of the newspapers.

But conditions

being what they are, I can only welcome this opportunity to
contribute to general understanding of the problems we face
and the approaches we are taking to their solution.
I would like to set the stage for our dialogue this morning
by reviewing briefly the decisions taken by the Federal Reserve
on October 6 r indicating both the circumstances that prompted
those decisions and the objectives of our actions.

in the

process, it stauld be possible to address in a fairly concrete
way some of the broader issues of monetary strategy that you
have indicated you wish, to examine.
Viewed from virtually any vantage point, economic developments in the weeks and months immediately preceding the Federal
Reserve's October 6 announcement were disturbing*

The level of

business activity had dropped in the second quarter, and virtually


all economists were either predicting a recession or felt a
recession had already started.

As the summer ended, however,

signs began to emerge of a surprising degree of strength in

Subsequently available information, such as the

2-1/2 percent annual rate of increase in real GNP for the third
quarter, the large increase in retail sales in August and
September, and the record increase in consumer installment
credit for September, has in fact confirmed this assessment.
In retrospect, the suspicion that the second quarter
performance was heavily affected by the shortage of gasoline
seemed confirmed.

But the subsequent burst in spending was

troubling because it seemed to reflect in considerable part a
"buy now" attitude spurred by an intensification of inflationary

Savings dropped to historically low levels, and

some inventory imbalances seemed to be developing.

Such a

pattern could temporarily provide some strength to business

But, if extended, the clear threat was that the

ultimate result would be to deepen and prolong anticipated
adjustments in production and employment —

adjustments that

in part are related to the oil price shock.
These unsettling developments were plainly related to the
inflationary situation.

The most widely watched price index

had advanced to the range of 13 to 14 percent increase at an
annual rate.

Many Americans, as they struggled to balance their

family budgets and suffered a continuing erosion in the value of


their savings, began to doubt the prospects for a return to
greater stability.

While the acceleration of inflation this

year has in large part been a reflection of a surge in energy
prices*,, the question remained as to whether the higher rate of
inflation would not be built into wage and other cost elements
in the economy, defeating the prospects for some relaxation in
price pressures as the bulge in energy prices passed.


in the absence of firm action to deal with inflation and inflationary
•expectations, there was a clear risk that the run-up in energy
prices would work its way into wages and prices generally, thereby
raising the nation's underlying inflation rate and, among other
things, contributing to pressures on oil prices.
That risk was underscored by an apparent build-up of
speculative pressures in commodity markets in September,
•carrying with it the potential of aggravating economic instability.

Rapid price movements in gold and silver markets,

while not of critical importance in themselves, seemed to
reflect discouragement over our ability to deal with inflation,
and the atmosphere began to affect movements in the prices of
other metals.

The danger was that the bidding up of prices in

commodity markets not only would in itself reinforce the inflationary trends, but that it would lead to a brief and unsustainable surge of buying.
These same expectational forces were reflected in an
atiitosphere of increasing uncertainty in foreign exchange markets,
and in September the dollar weakened against a niraber of other
major currencies.

The external value of the dollar is sensitive

to perceptions and expectations about our economic prospects
and policies, and especially to concern about our ability to
deal with inflation.

And, given the central position of the

dollar in international financial markets, as well as the
direct impact of a decline in the value of the dollar on the
prices of imports, renewed instability in foreign exchange
markets could undercut prospects for dealing withinflation
generally and for achieving moderation in oil prices in particular.
Under these circumstances, there was in early October no
conflict or meaningful "trade-off1' between the domestic and
international objectives of economic policy.

Nor was there

any real trade-off between inflation and unemployment.


clear and present danger was that failure to deal with inflation
and inflationary expectations would in time produce more —
less —


economic instability, ultimately with higher prices and

greater unemployment.
In that setting, the priority for policy was decisive action
to deal with inflationary pressures and to defuse the dangerous
expectational forces that were jeopardizing the orderly
functioning of financial and commodity markets.

The Federal

Reserve clearly had a key role to play in this situation.
Although the solution to the problem of inflation should not
reside with monetary policy alone, control over money and
credit is an essential part of the overall policy framework.
In the long run, inflation can continue only if it is nourished


by excessive monetary expansion; in the short run, it was
clear by early fall that the growth in money and credit was
threatening to exceed our own targets for the year, and was
nourishing inflationary expectations.
Efforts had been made during the summer to slow this
excessive rate of money and credit expansion, largely by
permitting money market interest rates to rise, a process
accompanied by several increases in the discount rate.


October 6 actions involved a change in instruments and tactics
to reinforcef and underscore, our intention to achieve moderation
in the growth of money and bank credit.
The new steps taken did not reflect any change in our basic
targets for the various monetary aggregates for 1979; they did
provide added assurance that those objectives will be achieved.
In doing so, the new measures should make abundantly clear our
unwillingness to finance an accelerating inflationary process
and our desire to mwi'nd down" inflationary pressures.
One component of the October 6 package was a change in our
operating procedures.

In recent years, with the support of this

Committcze and othersr explicit targets for the growth of money
have been a central feature of our approach 'toward monetary

However, the operational guide from day-to-day in

conducting open market operations has typically been the socalled federal funds rate —
trading of reserve balances.

the rate established in inter-bank
Translation of money stock

objectives into day-to-day management of the federal funds rate


is effective if the relationship between the public's demand
for cash balances and short-term market interest rates is
relatively stable and predictable.

But in an environment of

high and relatively volatile inflation rates# the relationship
between, interest rates, and money (or for. that ..matter, between
interest rates and economic activity) Is more difficult, to., appraise,
Moreover, the operating techniques over time may have contributed
to excessive supplies of credit by encouraging a view by banks
or others that they could count on access to liquidity at interest
rates reasonably close to whatever levels were currently prevailing.
Consequently, we are now placing more emphasis on controlling
the provision of reserves to the banking system —

which ultimately

governs the supply of deposits and money -— to keep monetary
growth within our established targets.

In changing that emphasis,

we necessarily must be less concerned with day-to-day or weekto-week fluctuations in interest rates, because those interest
rates will respond to shifts in demand for money and reserves.
I would emphasize that, in an important sense, our objective has
remained the same:

to achieve the growth of money that we believe

suitable to the nation's economic goals.

What is involved is a

tactical change in the approach to control of the money stock.
We did not before, as we do not now, attempt to maintain a fixed
or predetermined pattern of interest rates over time.

But changes

in interest rates will necessarily be observed and evaluated over
time, along with the entire array of economic and financial
variables, in reaching policy judgments.

We took two other actions on October 6.

The Board

approved a 1 percentage point increase in the discount rate
so that restraint on bank reserves would not be offset by
excessive borrowing from the Federal Reserve Banks.

Und me

placed a special marginal reserve requirement of 8 percent on
increases in managed liabilities of larger banks (including
U.S. agencies and branches of foreign banks) because that
source of funds (which is not included in the usual definition
of the money supply) has financed much of the recent excessive
build-up in bank credit.
Let me highlight a few points about our current approach,
particularly as they bear on the broad issues of monetary
strategy raised in Chairmen Mitchell and Neal's letter of

Firstr the effort to restrain monetary expansion

in the face of strong credit demands and rising levels of economic
activity has initially entailed increases in market rates
of interest*

Whether those increases persist, or whether they

subside rather promptly, will in the end be determined largely
-by the course of "the economy and inflation.

Control of the money

'supply is not synonymous with rising .Interest, rates; it all .depends

upon^ the "performance of the economy .itself,

In the long run, only

the prospect of a lower inflation rate can create the environment
for a sustained and substantial reduction in interest rates.
Second, some other important industrialized countries have
recently experienced increases in their interest rates.


-aevents have been interpreted by some observers as implying
the existence of an "interest rate war" in the pursuit of
conflicting exchange rate objectives.

That interpretation

seems to me unwarranted in circumstances where those countries
are responding reasonably to inflationary pressures in their
own economies.
There is, of course, always the possibility that national
economic goals and policies will not mesh.

I know of no

protection against that possibility, other than working continuously with our partners abroad to ensure that policies
take into account our mutual interdependencies and don't move
in mutually damaging directions.

Within limits, all major

industrial countries have several tools of economic policy at
their disposal, and particular elements can be emphasized or
deemphasized at particular times.

Intervention in foreign

exchange markets can sometimes be helpful —

although experience

illustrates clearly that intervention alone cannot substitute
for more fundamental actions over time if stability in exchange
markets is to be maintained.

We continue, on a day-to-day

basis, to monitor developments in foreign exchange markets,
and I am satisfied that, if and when intervention is necessary,
our actions can be closely coordinated with those of key monetary authorities abroad to maximize their effectiveness.
Meanwhile, we shall continue to consult with our trading partners
to assure mutual clarification of our policy objectives and


In that connection, I do not anticipate, in practice,
the sharp dichotomy between "foreign exchange" and "money
supply" oriented monetary policy strategies outlined in your
recent letter.

The fact is that, for the foreseeable future,

a policy looking toward attaining and maintaining a noninflationary growth in money at home would appear broadly compatible
with our concern about the international position of the dollar.
I do not, in any event, view our domestic and international
problems as distinct and separable.
shown —

all too clearly —

Recent experience has

that weakness in the value of the

dollar Internationally is symptomatic of basic problems here
at- toiae*
It is fundamentally inflation that raises questions about
the stability of holdings of dollar-denominated assets or the
outlook for our balance of payments, thereby prompting recurrent
downward pressures on the dollar in exchange markets.

And it

is inflation and the distortions it creates that constitute a
major impediment to the resumption of balanced, sustainable
economic expansion at home.

In that sense, the problems con-

fronting is on the domestic"and international fronts demand a
comment response> and an essential element in that response must
be a firm and credible monetary policy, seeking and attaining
appropriate^ restraint on growth in money and credit over time.


The suggestion has been made that this process could be
speeded by setting out a specific target path for growth in
the money stock over a number of years ahead.
would incorporate such a strategy in law.

Mr. Meal's bill

In examining this

question, members of the Federal Reserve Board remain of the
view that there are decisive drawbacks to setting out so precise
a growth target over so many years ahead*
We recognize that approach is rooted in a central element
of truth —

that a return to price stability will require, over

time, a substantially reduced rate of monetary and credit growth.
Indeed, the Federal Reserve has often reiterated in the past the
need to reduce growth in money over time if we are to deal with

Moreover, some observers would go furtherr arguing

that by clarifying our intentions in a numerically precise and
simple way we could more decisively change expectations about
inflation, assist in achieving a national consensus, and thus
change behavior in a constructive way.
However, experience shows that many forces can affect the
financial requirements of the economy at any time.

Other govern-

mental policies, institutional changes, exogenous shocks to the
economy —

emanating from both domestic and foreign sources


and changes in the public's money preferences can alter the
relationship between money and economic performance.


adherence to a fixed money stock path set for years ahead might
therefore turn out to be inappropriate, sometimes needlessly


wrenching financial markets or unduly constricting our
flexibility in responding to some cyclical or other disturbances.

If, on the other hand, the targets are changed,

or interpreted more flexibly, unnecessary confusion could
arise, and the basic rationale would then be undermined.
Furthermore, even though we hope that our new operating
procedures will bring some improvement, we must recognize that
monetary control will always be imprecise-

Recent events

indicate quite clearly that even the problem of specifying
precisely the monetary variable that should be controlled
over a period of years is a very knotty one; what serves as
money in our rapidly changing financial system is far from a
For all of these reasons —

and despite the underlying

element of truth in the broad proposition relating inflation
to excessive monetary growth —

1 think that it would be a

mistake to attempt to set rigid and narrow long-range monetary

A legislative approach -- even one with some built-in

leeway —

would raise the further basic question as to whether

Congress would want to inject itself so directly into these
judgments9 filled with technical complexity and doctrinal

It does not seem to be consistent with the approach

taken by the Congress in establishing the Federal Reserve System
§5 years ago, and consistently adhered to since, that these
decisions should emerge from a dispassionate, professional,
deliberative process and be shielded from partisan


I would suggest strongly that the present system, under
which the Federal Reserve reports its intentions and its targets
to the Congress within the framework of the Humphrey-Hawkins
Act, is a much more promising approach.

It preserves a necessary

degree of flexibility in monetary management, while providing
a good basis for communication.

While our experience has been

limited, the present arrangement seems to be working well.


line of responsibility and accountability is clear*
I am sure other members of the Board, as myself, have
profited from your attention to these important issues of
monetary policy.

We particularly welcome your concern with

developing policies appropriate to the longer term future, and
look forward to working with you as we develop and announce new
monetary targets.