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2:30 p.m. E.S.T.


Remarks of

Philip E. Coldwell

Member, Board of Governors of the Federal Reserve System

before the

Washington Forum's Tenth Annual Symposium

Washington, D, C.
October 25, 1979

T he E c o n o m y and the C o u r s e o f M o n e t a r y P o l i c y

The developments in the United States economy in the first
eight months of 1979 were such as to raise questions in some p e o p l e s 1
minds that we had topped out the post-war's seventh business cycle after
a sustained upswing from early 1975, and that some forerunners of
recession might be appearing on the horizon.

It is interesting to note

that since January of this year gross national product, industrial pro­
duction, and retail sales have been virtually unchanged on a real basis.
The GNP declined in the second quarter of the year but the gains in the
first and third quarters would appear to have virtually eliminated the
effect of the second quarter's decline.

Industrial production similarly

climbed slowly in the early part of the year, fell sharply in the second
quarter, and then rebounded in the third quarter.

Retail sales on a

seasonally adjusted real basis were down modestly in the first three
quarters of 1979.

But total employment showed continued evidences of

growth during 1979 and the unemployment rate hovered just below 6 percent.
Total employment in the United States expanded to record levels of nearly
100 million people.

Construction activity slowed in the early part of

1979, hit hard by the winter weather and by the effects of the trucking
strike and shortages of gasoline.

But overall the nation's economic

activity has remained at a high level so far in 1979.
On the other hand, the financial side of the nation's economy
during 1979 has shown high volatility and engendered great caution as
to the future outlook.

In the early part of the year there

-2was a flat to declining money supply and strength in dollar foreign
exchange relationships, but these factors reversed to a rapid rate of
money supply growth and a deterioration in exchange rates in the second
and third quarters.

Of special difficulty were the unusually large

declines in the exchange rate of the dollar against the Deutche-mark
and the large gain of the dollar against the Japanese yen.


the period, but accelerating in the third quarter, was a strong bank
credit demand, especially from consumers and business.
Also through the entire period there was a high rate of in­
flation in the United States, fed partly by the increases in oil prices
and partly by the impact of demand.

In the retail area inflation hedge

buying persisted in the housing market, and developed in other hard goods
and hard metal markets.

On average, the inflation rate moved from about

9 percent in 1978 to more than 13 percent in 1979, and no evidence of
easing in such price levels has yet surfaced.

The economy began to

suffer from business and consumer decisions on inventories, borrowing,
advance buying, and basic speculation, fed by expectations that prices
would either maintain their current rate of advances, or perhaps even
Thus by the end of September the nation was faced with an
economy still operating at near-record levels with high employment levels,
a declining rate of productivity, a fairly steady rate of unemployment,
and growing speculation against the dollar, both at home and abroad.
policy continued in a deficit position, though the deficit was reduced



somewhat during 1979.

At the end of the third quarter, it was evident

that speculation in gold and metals markets was rising and was spreading
to commodity futures and other means of obtaining a hedge against future

This speculative activity reinforced that which had been

evident in the housing markets for some time.

All of the above

accentuated the need for economic policy moves toward restraint.
Finally, the more than ample availability of credit despite
high and rising interest rates, was a factor in calling for intensified
restraint on the U.S. economy.

Businessmen and consumers were making

economic decisions based upon expectations of further inflation, and were
willing to borrow even at steadily higher interest rates.
Why do we find ourselves in such an economic bind?
prices rising so rapidly?

Why are

And why can't we take hold of our own economic

We all look for scapegoats.

problem is the OPEC pricing for its oil.

To some, the cause of the whole
To others, the problem lies

in the hands of foreign nations who have bid down the price of the American
dollar against their own currencies, and have been able to mitigate the
problems of rising oil prices by an appreciating currency.

To still

other observers, the problem lies at home, with government budgets in
deficit and the central bank providing too many reserves.

And finally, to

some, it is just the sign of the times that over a long period we have
overspent and have underproduced.
It is probably a useless exercise to attempt to assign the
blame for our current economic malaise.

But to the extent that it does

shed light upon our problems, one should at least consider a few of the


following points„

First, it is true that the petroleum exporting countries

have raised their prices rather dramatically, both in 1974 and now in 1979.
In reviewing these increases, one must recognize that the price of oil
scarcely moved at all for many years before 1974, and moved very little
from 1974 to 1978.

In both instances, the prices of other materials,

goods, and services were moving upward with a considerable cumulative impact.
To the oil-producing country, the irreplacibility of the raw material
which they can produce and sell to the world means that their source of
export earnings will eventually dry up, and they wish to maintain at
least a current equality of ¡'.irchasing power for their primary export.
But perhaps

more rundamental to the basic cause of inflation in

the United States has been its steady increase in government activities, paid
for partly by taxation, but also by heavy deficit spending, which eventually
meant inflation.

Over various periods of time, the central bank did pro­

vide too much money to encourage price stability.

But the unevenness

of money supply growth could scarcely have been the continuing cause of
the inflation of the United States.

Nor could it be the short-run impetus

that we have seen in the past few months.

Indeed, we in the United States

are attempting to live at the high end of the standard-of-livin£ spectrum
without providing for future energy sources and without providing the
wherewithal for significant expansion in our productive capacity.
wherewithal must come from basic savings and capital spending.


But savings

in the United States are averaging only about five percent, whereas in
other major industrial countries such savings are significantly higher, even


above 20 percent.

These savings provide the basic funds in a non-inflationary

manner to enable businessmen to borrow for capital expenditure purposes.
We not only do not save enough, but we put roadblocks of regulation and
legal challenges in the way of our businessmen who wish to enlarge their
capacity, or improve their technology.

We almost penalize the entre­

preneur who wishes to improve his business and indeed indicate to him that
such expansion may be third or fourth in the total priorities of this nation.
Finally, we as an American people share the blame also, for we
are the ones who send our problems to Washington, who demand a central
government solution, who demand that the central government take the funds
to meet most of our problems, and have left the problem-solving to the
federal, not the state, local, or even personal level.

We seem to have

lost some of our self reliance, some of the capacity for problem-solving
at our own level, and instead are looking more and more at the Federal
Government to solve our problems.
Regardless of the cause of the current situation, most of us
are interested in the fundamental question of how can we extricate
ourselves, and at what cost.

In other words, what policies can be adopted

which will restrain inflation, permit the continued expansion of the U.S.
economy, permit high and rising levels of employment, enlarge job
opportunities, provide continued growth in personal incomes, and protect
the value of the dollar abroad.

Traditionally, in the United States and

in virtually all economies the methods of restraint to curtail inflation
are those tied to the monetary and fiscal policies of the nation.


the United States, fiscal policy has been a slow and cumbersome weapon available

-6 -

really only for long-term correction to improve the balance in the economy
and to encourage long-run goals, not as a weapon against

Thus, the usual front-line soldier against

short-run in­

inflation is the

central bank, and in the past month it has performed its traditional role
with particular forcefulness.
Why haven't we been able to curtail this monster of inflation
before it got out of hand?

Why were we willing to accept the steady

increases in demand and the pressures on capacity in our industries,
and the rising level of debt and consumption before they created such
inflationary pressures?

Why have we been willing to continue our wasteful

ways in energy consumption, and why haven't we curtailed that consumption,
voluntarily, or through mandatory action?

Some of the answers must be

found in the policies of our government, policies designed for long-run
correction of the problem, policies which procrastinated with the impact
of inflation, policies which attacked the problem slowly without careful
measurement of the cost of such gradualism.

Had we, for example,

increased our restraint on the American economy in 1978, we might not
have had the very large run-up in oil prices in early 1979, and might have
held our level of inflation below the double-digit point in this year.
But in 1978 people were already talking about the possibilities of a
recession, about the possibilities or potentials of future increases in
unemployment, and about the problems such a recessionary tendency would

And the political answer was to approach the restraint needed

on a gradual basis.

Gradualism permitted the further growth of inflation,

and the nation's economy expanded at more than a five percent rate of
growth in gross national product in the fourth quarter of 1978.


-7meant more inflation, which sparked another round of higher OPEC prices.
Gradualism meant that the expectations of further inflation were to grow
rapidly and those who until early 1979 had hopes for a return to stability,
began to speculate to protect themselves against inflation.

And so the

momentum of inflationary expectations grew, and the decisions being taken
by businessmen and consumers began to feed upon themselves enlarging .the
price response.
And so here we are in the fall of 1979, with expectations of higher
prices and higher interest rates, and an economy whose rules, regulations
and pattern of life are built on stability, but which is suddenly challenged
by a problem of rapid inflation.

The reactions of consumers, businessmen,

and government alike have been too slow.

And so in the fall of the year

we are now taking those hard actions which, if not supported by all elements,
especially the banking system, will condemn this economy to further
inflationary pressures, and ultimately a boom-and-bust psychology.
Since the Federal Reserve announced its restraining measures on
October 6, I have been most interested to listen to the reactions of
individual industries as they sought to find ways to protect themselves
against the impact of these restraining measures.

The home building

industry talks as if it were the end of home building, because interest
rates are going up again.

But the construction of a home is a long-term

asset and can be purchased on a long-term basis.

The deferral of some

purchases for a few months would scarcely seem to me to be in the category
of a crisis.
slow down.

True, the real estate and home building industries are likely to
At the same time, the pressures on the American financial structure

will be reduced, and interest rates should ease, but only if those who are
seeking the enlargement of their industry are willing to accept slower
growth for a time.

To the banks, too, that have reacted by saying that they

will meet all commitments made in the past, that they will take care of their
regular customers, that they will continue their lending abroad, let me say
that they, too, are a part of this American scene.
are in dollars.

Their fundamental assets

If they adopt short-sighted policies which lead to further

inflation and deterioration of the value of our currency tomorrow, I
question whether they have made a very good bargain.
None of us want to go through a period of restraint, or see higher
levels of unemployment, or lower incomes, especially discretionary incomes,
but if this is the penalty for a free American economy, geared to a free
enterprise system in which we as individuals have the right of choice of
what we buy, the amount we buy, or when we buy it, then to me a modest
slow-down is worth it.

One must look over longer periods of time to

measure the cost of recessions.

It is doubtful that many could say

that we in this country do not have a higher standard of living than
at the end of World War II.

We certainly have more people at work,

we have higher incomes, we have more housing and we have more consumer

What we lack, and have lacked for the last 15 years, is the drive

to improve our own productivity, to save our money for new capital ventures,
and to improve job opportunities in production.

Very few of us would

like to see the United States only a consuming nation with all of the


problems that it would entail, especially the lack of power in world
economic and political life.
of consumption, not production.

And yet the road we arc on is the road
So let us go foi th to a new America in

the 1980's, go forth over this period cf difficulty with restraint, with
less complaining, with rcduced standards cf livir.f. for a uliilc to get
higher standards of living later on.

Let us reducc our special

interest demands on the Federal Government.

Let us take back some

of the problems we have sent to Washington.

Let us accept the respon­

sibility of meeting cut prcfclcmf. and wcrl :'n;j their out ccoror: tively.
The 1980's offer a substantial challenge rvvl a subctcntial increase
in responsibility, if we are to avoid the imbalance cf a consuming nation
by enlarging the product ion side of our eci n\:ny.
Finally, let me exprccs a persons 1 vicv r.loul our c u n v n i
monetary policies.

I have been in fp.vor oi cnrt-ci restraint for more

than a year and sc I d e a r l y favorcd the Ecc.rd'c action on October 6.


ever, I am still skeptical about targeting our policy actions on the monetary
aggregates ever through a surrogate.

Ov<_r tho pai,t nine years we have

moved steadily tovrrd greater uec cf mcncta.y aggregates as a guideline to

I submit that the problems of measurement, interpretation,

forecasting, rc\icionr ?nd trackinf these »uidee on weekly, monthly,
and quarterly b uS es have cast a significant cloud cn their usefulness.
Personally I war Id pay attention to such data cnly on a scsni-annual time
period and use our traditional measures of reserves, bank credit, and
interest rates to provide the guidance as tc the need for Federal Reserve

-1 0 -


I am particularly disturbed by the attention given to weekly

money supply data recognizing all of its frailties of composition and

Thus in the current context, I would pay scant attention to

currently published money supply data, because the turmoil in the market
in recent days can scarcely provide a reasonable guide to the future.
One should not expect the monetary policy actions of October 6-less than three weeks ago--to correct instantly all of the accumulated
protlems and imbalances of our domestic economy or its relationships

What I hope we have done already is to create uncertainty in

the minds of those who expected continuously higher prices and uncertainty in
financial markets

as the availability of funds to meet all demands,

whether productive or not.

Down the road we will find out whether the

restraint is sufficient to slow the growth of bank credit, to curtail
speculative endeavors, and to lower the rate of inflation.

It is my

hope that it works, for the alternatives are certainly very unattractive.