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For release on delivery
Friday, September 25, 1981
1:00 PM EDT

No Time for Backsliding

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




National Press Club
Washington, D. C.

September 25, 1981

I am delighted to be back at the Press Club again,
most particularly during the tenure of Joe Slevin as your
President.

He has the deserved reputation of knowing as

much about what the Federal Reserve is doing as we do
ourselves -- and sometimes I fear he is even a little ahead!
In any event, I think I can take it for granted by
now that all of you are familiar with the basic premise of our
monetary policy -- that a lasting solution to our economic
problems of slow growth and poor productivity performance,
of exceptionally high interest rates and severe strains on
credit-sensitive sectors of the economy, is dependent on
success in the fight against inflation.
see scattered signs of progress —

We have begun to

a beginning.

But the battle

is far from won -- indeed, I believe we are just entering the
crucial stages.
As we do so, let's be clear about what is at stake, and
realistic about what's require^ for success. We are dealing
with an inflationary momentum, and patterns of thinking and
behavior, that have developed over decades.

Something like

half the working population -- those under age 35 -- have never
known price stability in their working experience.

During that

period, we have seen repeated attacks on inflation, launched
with sincerity and real concern — but, unfortunately, we have
also seen those efforts fail in whole or in part when they seemed
to conflict with other objectives.




We have become accustomed to

—2 —

living

with

more. And
forces

that

inflation,
as

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demonstrates

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growth

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a

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if we

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-3-

And finally, we have come a long way in putting
in place the essential elements of an effective
program to deal with the problems.

To be sure,

important elements in that program still need to
be implemented.

In political terms, those elements

may be among the most difficult.

In economic terms,

the evident strains, pressures, and pain in some
sectors of the economy try our patience.

But I

also believe the American people recognize that
the problems of decades cannot be cured overnight;
that we, in fact, have now the opportunity to change
direction if we only stick with it.

One crucial element in "carrying through" is persistence
in monetary policy -- continuing to bring down excessive growth
in money and credit to the point where the supply of our dollars
does not outrun the supply of real goods and services.
When I last spoke to the Press Club, I was inevitably in
a position of talking more about our intentions than our performance,
At times over the past two years, the money supply and interest
rates have fluctuated sharply, sometimes raising doubts among
the legions of Fed watchers whose professional life is to scrutinize
and provide instant analysis of -- the latest financial news.
But with the perspective of time, I also believe there is now
ample evidence that we mean what we say, that the trend of
monetary and credit growth is slowing, and that our purposes
are clear in our actions.




-4-

There are a few who would be inclined to say that is
enough -- that sooner or later reduced monetary growth will
cure inflation, and little more need be said on the subject.
And that is, indeed, one textbook model.

But it is far too

limited a model to capture today's reality.
The inflationary process, after continuing for years,
is embodied in a whole pattern of economic, social, and
political behavior that tends to sustain -- and accelerate -its own momentum.

We see the process at work in the pattern of

three-year wage bargaining, building in rising levels of costs
into the future; in aggressive pricing policies, justified by
the proposition that everyone is doing it; in attempts to protect
one f s own position by indexing, usually to a consumer price
index that is itself distorted; in demands for inflation
premiums in financial markets and interest rates; in the search
for inflation hedges in real estate or elsewhere.

To be sure,

starving the inflationary process by restraining money and credit
long enough can ultimately curb that behavior -- and there are
signs it is beginning to do so now.

But to rely on that course

alone would surely delay the process of correction, and pose
more risks and exact more pain than a balanced approach.
Do not misunderstand me.

Restraint in growth of money

and credit must be a cornerstone of successful policy -- without
it the anti-inflation efforts would fail.

Monetary policy has

a heavy -- and inescapable -- responsibility.
that responsibility.

We mean to discharge

At the same time, let us, as a nation,

recognize the logical consequences if monetary restraint is not
supported and complemented by other policies.



~5-

Today, we face extraordinarily high interest rates.
Those interest rates are a particularly heavy burden on
credit-dependent sectors of the economy -- the homebuyer
and builder, the car dealer, many small businesses and
farmers.

Financial markets are distorted, bond financing

impaired, and part of our institutional structure under heavy
strain.

Other sectors seemingly are able to shrug off high

interest rates, at least for a time -- the rapidly expanding
energy sector, high technology and defense industries, to take
some examples.

And, of course, Federal borrowing continues

unabated.
Interest rates are ultimately set in the market -by individuals and businesses acting upon their own judgments
of their current needs and the future.

The influence of the

Federal Reserve on interest rates is limited and short-term -except as our policies bear on the future course of the economy
and inflation.

If anyone still doubts that proposition, look

at market developments in recent months.

Viewed broadly, the

money supply has been under satisfactory control in terms of
our basic policy objectives of restraint.

In those circumstances,

and consistent with the operating techniques I discussed with
this group last year, pressures on bank reserve positions have
been less intense in recent weeks.

The most sensitive short-

term interest rates are well below their peaks, by 2% percent
or more.

Yet, bond rates and mortgage rates during the same

period reached new peaks, and the prime lending rate of banks




-6-

has subsided only a bit.

Clearly, the markets have been

preoccupied with other concerns -- including the current
arid prospective volume of financing and questions about the
longer-term inflation outlook.
It would be fruitless and wrong to think those pressures
can be relieved simply by pushing more money into the system
than called for by our basic objectives.

Whatever temporary

effects there might be on money markets -- and even they are
problematical -- we would gain nothing if we induced more
concern about inflation.

The ultimate result would only be to

stimulate more borrowing and to increase the reluctance of
lenders to accept lower interest rates.

We can indeed increase

money and credit in nominal terms; we cannot, by simply manipulating
the tools of monetary policy, increase the pool of real savings
from which real investment and housing must ultimately be financed.
What we as a nation can do is to relieve the pressures
on the market from the Federal deficit -- and in the process
both reinforce the fight on inflation and lighten the burdens
on the most vulnerable economic sectors.
Less than two months ago, the Administration and the
Congress adopted a far-reaching fiscal plan, designed to reverse
the trends of the previous decade.

One major element in that

plan is in place, a stabilization and reduction of the Federal
tax take relative to national income.

The justification for

those tax cuts lies in the promise of improved incentives for




-7-

businesses and individuals alike for investment, savings,
work, and productivity.
But, of course, the cuts involve large revenue losses
in the years immediately ahead.

In recognition of that, a

sizable swipe has been taken at the rapidly rising trend of
government spending -- seemingly so inexorable during the
1970's.

That effort, as I have noted on many occasions,

exceeds anything I have seen in my Washington experience.
But the hard fact is that, as the President emphasized last
night, it goes only part way toward fulfilling the fiscal
plan, aimed at balancing the budget in 1984,

And it has

been doubts precisely on that score that lie behind much of
the financial market skepticism and behavior.
To illustrate the point, let me give you a few numbers.
This year, the Treasury will finance directly about $80 billion,
$60 billion or so of budget deficit and $20 billion or more
of "off-budget" programs.
of net savings.

We will generate about $170 billion

So the Federal Government will itself preempt;

about half of what is available to add to our capital stock,
to inventories, or to housing.

Is it any wonder, under the

circumstances, that the homebuyer or the small businessman feel
"crowded out"?
Of course, there is no simple co-relation between deficits
and inflation, or deficits and interest rates.

The significance

of a deficit in any particular year depends upon the state of
the economy -- including particularly our savings potential and




-8-

competing demands for credit.

For instance, Japan and Germany,

to take two examples, have been able to finance much larger
budget deficits relative to the size of their economies, and
more investment too, because their savings rate is a multiple
of our own.

But the hard fact is that our savings are limited -

and we are in effect leaving the most vulnerable sectors of the
economy with the crumbs from the national economic table.
The need for further spending restraint has been explicit
in the Administration's expenditure projections all along.

The

President has now outlined some of the further actions necessary
to close the budgetary gap, and emphasized that "holding down
spending must be a continuing battle for several years to come.11
That, it seems to me, is the challenge the Administration
and the Congress set for themselves in enacting the tax legislation.

In the nature of things, to meet that challenge requires

action now.

Any failure to do so has inevitable consequences

for conditions in credit markets or for taxes, or both -- and
for the success of the whole economic plan.
There is another challenge that must be met in moving
toward price stability.

How fast and how smoothly that process

proceeds -- in the interest of all of us -- will be related
critically to the rate of productivity and wage increases,
recognizing that labor costs account for some two-thirds of
all costs in the economy.
Let me put the point in the context of monetary policy.
Restraint on the supply of money and credit implies some rough
ceiling on the dollar value of t^afrs&cte&ons that can be financed -




-9-

reflected in the nominal GNP.

The relationship is loose,

because the velocity of money turnover can, of course,
increase, as it has been.

But, beyond a certain point, that

process is normally accompanied by high interest rates and
pressures on financial markets that restrain economic activity.
The aim of policy, of course, is to dampen inflation, not
real growth.

But monetary policy alone is a blunt tool; the

risks in the short-run of affecting real activity increases as
the upward momentum of costs continues.
I alluded earlier to the signs of progress on the
inflation front.

But I would be less than frank if I failed

to point out those signs have not yet been confirmed by clearly
visible and significant progress toward wage deceleration.
evidence this year is ambiguous.

The

We can indeed find signs of

restraint in some areas, but we see other areas where a kind
of "business as usual" attitude prevails, building past inflation
trends into future contracts.
1982 will be a crucial period in this respect,.

Unlike this

year, it is a major bargaining year for piattern-setting industries,
beginning with refinery workers and truckers and running through
the auto industry in the fall.

There is no escape from the reality,

paradoxical as it may appear, that the prospects for sustained
economic growth and increases in real wages for all Americans
will improve as we achieve greater productivity and moderation
in the demand for nominal wage increases.

It is at that point

that the signs of progress against inflation are reflected more




-10-

solidly in underlying cost trends that confidence in the
success of the entire effort is likely to strengthen enormously.
Those are the conditions in which we could look forward to
combining reduced inflation with strong growth and favorable
financial market conditions.
We can not achieve that result by government fiat.
But we can -- indeed, we have the clear responsibility to -conduct public policies in a way that encourages understanding
of what is at stake.

We can emphasize that, when growth in

nominal GNP is limited by monetary and credit restraint, large
cost increases could eat up much or all of the available dollars,
leaving little or no room for real growth.

That may seem an

abstraction, but in the concrete it can be translated into the
risk of profit and job loss for those industries leading the
pack in costs and prices.
The fact is a conflict may be brewing between high
nominal wage expectations and economic policies needed to curb
inflation.

It might be argued that conflict could be resolved

by creating money and more inflation -- but only at the expense
of a more severe dilemma next year, and the years beyond.
result would be less growth and lower real incomes.

The

That cannot

be a responsible answer.
What we can do, and do entirely consistent with our
basic commitment to free markets and competition, is to make
clear that markets will be permitted to work, that governmental
impediments to competition will be reduced, not increased; and




-11-

that costly governmental rescue operations are not the
answer.

Perhaps the greatest force for competition and

discipline lies in open markets internationally -- and
every retreat from that principle sounds a signal that
makes the job of fighting inflation harder.

Right at home

there is a full agenda as itfell, repealing or relaxing that
host of regulations and regulatory policies that impede
competition and add unnecessarily to costs.
In sum, we are in the midst of dealing with the
accumulated problems of decades.

It is inevitably a

painful process -- precisely because it has been put off so
long.

But the battle is fairly joined; we can already see

glimmerings of progress; and to procrastinate now would only
be to amplify the pain later.
As things stand, it is a fair point that monetary policy
carries too much of the burden -- that the consequence is more
strain and pressure on financial markets and credit-dependent
sectors of the economy than is desirable or would otherwise
be necessary.

But surely it would be no remedy to breech the

monetary dike, and flood the economy with more inflation.
Rather, the answer will be found in supplementing
monetary restraint with other actions —

actions that will

both speed progress against inflation and set a firmer
groundwork for growth.

Major parts of that program are

already in place -- and the rest entails no change in
philosophy or thrust from what has already been said.
As the President emphasized again last night, what
is required is action -- particularly action to reduce the



-12-

deficit and move toward budgetary balance.

We need to carry

through on regulatory impediments to cost reduction.

Perhaps

as important, we also need to resist pleas for new protection.
These are the elements that are crucial to success.
They obviously involve a certain amount of patience, a cleareyed realization of what is at stake, a recognition that there
is no

lf

magic pill11 to blissfully transport us suddenly to the

promised land of stability and growth.
But that land does exist -- and I am convinced we are
moving toward it.

This, it seems to me, is no time for

backsliding.




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