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For release on delivery
January 10, 1984
9;00 a.m. EST




The Transition from Recovery to Expansion in 1984

Remarks by Preston Martin

Vice Chairman
Board of Governors of the Federal Reserve System

at the

International .Management and Development Institute

Washington, D.C.

January 10, 1984

Never

has

scrutinized for flaws

entanglements,

such a strong economic recovery been so

and

failures.

Oil

shocks,

foreign

and overseas "sourcing" by consumer and busi­

ness impel our search for risks to economic expansion.

almost

all

From

quarters of the financial world comes the plain­

tive cry, "Shouldn't there be something wrong?"

Our concerns have been heightened

failures

in

forecasting

the

business

recovery in 1983 was a surprise.

erations

of

a

consisted

most

cases

The strength of the

I am reminded of the delib­

one

here

year

ago.

The

keynote

to

stay

because

of

flawed

processes and a monetary policy implemented in the

absence of a simple, fixed rule.




in

of a logical and persuasive argument that

high level inflation was

political

Economists

conference of distinguished economists which

took place in Washington just

address

contemporary

cycle.

underestimated in some cases the depth, and

the duration of the 1979-1981 recession.

by




2

Hew comfortable should forecasting's past

make

you feel about the current consensus of business econo­

mists that real grewth in 1984 will be

that

failures

inflation will

nan

between

of

percent

and

address

the

diffi­

determining the effects of the new relationships

endogenous to economic activity.

difficulties,

it

is

Within the context of these

quite rational to voice continued con­

cerns about the sustainability of

possibility

5

5 percent and 6 percent?

Serious efforts are being undertaken to

culties

near

of

a

renaissance

economic

of

growth

yesterday's

and

the

destructive

inflation rates.

Hie economic process is in transition from recovery

to

expansion:

play

an

growth.

business fixed investment expenditures will

increasingly

important

role

in

generating

real

However these expenditures must be made in the face

of today's high cost of

credit markets.

capital, both

in

the

equity

and

3

High

capital

costs,

in

part,

reflect

a market

environment in which the federal government1s high

spending,

high taxing and mega-deficits constitute a terrible troika of

impediments,

in

tt have an enormous rebuilding task
oe

before

us

revitalizing both the industrial and the service capacity

of our economy'.

crowding

out

As

business

expansion

further,

will occur through the displacement of capital

credit demands by an increasing

financed

proceeds

through

the

equipment, and research

level

markets.

and

of

Every

development

federal

deferral

spending

of plant,

expenditures

sub­

tracts from future productivity and economic growth.

Capital

several

years:

industries

push

short

might

inflationary

economic




investment

well

run

has

been

capacity

relatively

constraints

low for

in

be reached this year or next.

effects

are

increasingly

many

Cost-

probable

in

sectors that are at or, in some senses, beyond what




4

has

hitherto

Recovery

been

regarded

as

"100

percent

capacity."

in 1983 was aided by the thrust of industry and the

services trades to reequip and modernize

achieving

competitiveness.

in maintaining

or

However, the next stage of sub­

stantial increases in "plant"— which may well

be

an

office

building for a consumer services firm— will be harder to come

by in the face of aggressive corpetition for credit resources

from the public sector.

Production

industries

recovery.

has

been

and

a

employment

major

weakness in our export

inhibiting

factor

in

Export expansion is weak in markets represented by

the less-developed countries, as those countries struggle

service

to

their debts, restructure their external accounts and

finance their own

also

the

are

economic

hamstrung

by

recoveries.

Export

industries

weaknesses in the currencies of our

trading partners: sterling, the French franc,

the

cruzeiro,




5

the

peso, and even the Deutschmark at times.

when the major foreign currencies

Unfortunately,

strengthen,

perhaps

sud­

denly, against the dollar, our export industries will benefit

only after a lag.

temporarily,

Meanwhile, financial markets may

undergo,

wide fluctuations from any sudden major fall of

the trade-weighted value of the dollar.

The present economic expansion is

to

the

threat

that

expanding

the

vulnerable

market demand and continued

profitability may cause management and

abandon

also

labor

leadership

attitudes of cost containment, work rule flexi­

bility and productivity which served us so well in

1983.

Our

to

experience

with

1982

and

high inflation, lew growth and

rising unemployment in the 1970s shews that we cannot promote

business

policies

that result in continued loss of domestic

market share to more efficient foreign

not

competitors.

It

is

a problem that will be cured by erecting the barriers of

6

protectionism— our economic health depends too heavily on the

maintenance of open world markets.

The

sustainability of an economic expansion is, of

course, aided by the

widespread

other possible pitfalls.

recognition

of

these

The private sector has utilized its

cash flow in the initial expansion of equipment spending.

addition,

we

may

derived

from

the

of the long recession, particularly in the impor­

tant services sector which now is our primary source

employment.

In

be underestimating the productivity gains

and the efficiency frcm changed attitudes

experience

and

Those

of

new

word processors, personal computers, and

other carmunications equipment are beginning at long last

to

have a positive effect on productivity.

Price

responses

in

this

upturn may be different

frcm those which have characterized the first years of previ­

ous




postwar

recoveries.

In

part,

this

is a function of




7

foreign "sourcing" by a

retailers— "the

other

wide

side

spectrum

of

firms

including

of the coin" regarding the weak

cruzeiro or French franc.

Deregulation

financial

transport,

communication,

and

institutions has also had seme positive effects in

pricing responses.

kets

in

That is, the functioning of domestic mar­

is now toward inhibiting price increases and indirectly

affecting the collective bargaining process.

A balanced view

of

our

international

trade

and

credit vulnerabilities admits 18 months of progress in coping

with international debt exigencies.

Extremely complex

nego­

tiations have taken place between governments, central banks,

governmental agencies, international bodies and thousands

commercial

banking

operations all over the world.

tion, major debtor nations in the less-developed

adjusted

domestically— changing

governments

policies— to cope with po.'L ical tensions at home.

In addi­

world

and

of

have

altering

8

Today's global financial environment gives substan­

tial

premise

that

the

major

debtor countries may have at

least gained the necessary time to adjust their policies

position

their

economies

growth for the future.

imilti-year workout

up

on a plane of rising economic

It is to be hoped

period,

and

markets

that,

and

after

this

institutions will

evaluate the potential of developing economies with increased

realism,

recognizing

the

limitations

to

their ability to

absorb capital and economic change.

This is not to

say

that

the

accomplishments

of

refinancing international trade and credit, having worked for

us in the past critical period, will provide a tried and true

financial

and development methodology that will forever suf­

fice in complex world markets.

Indeed I would argue that our

limited success domestically and internationally has in truth

given us merely a breathing space in which

approaches to policy.




to

consider

new




9

We

must

continue

meeting the challenges.

current

Thus

discussions

approaches, such as

presidency

to develop additional tools for

of

it

U.S.

providing

(a proposal

encouraging

fiscal

a

which

is

line

would

policy,

that

in

creative

item veto

for

the

have been given short

shrift even a year ago), are now being seriously considered.

In international matters, there have been construc­

tive

discussions

regarding

alternative

financing

including the possibility of swaps of debt held

country for another with some cash to boot.

tools,

against

one

Another proposal

of merit in this area is the idea of rolling over

or

origi­

nating foreign credits into part new credit and part equity.

An

extended

important

to

private

portion of the LDC debt is in credit

enterprises

partially-owned

corporations.

everywhere, the

more

and

Like

successful

and

to

state-owned

or

productive enterprises

profitable

of

these

10

organizations

will

tional credit over

examine

time.

suggestions

Mellon University

existing

continue to be good candidates for addi­

debt

and

I

believe

frcm Allan

others

could

should

Meltzer

that

the

carefully

of the Camegie-

rollover

of

seme

and even the evidences of indebtedness on new

credit could be part new equity

credits

we

bear

arrangements.

lower

Caimercial

and

part

interest

banks

in

new

rates

debt.

than

their

Such

debt-only

international

operations in a few countries such as Brazil already can hold

equity positions.

To the extent that

this

process

fosters

the establishment of secondary market values for the equities

and possibly for debt instruments, its

extension

throughout

the spectrum of LDC lending could have the salutary effect of

attracting nonbank equity investors

enterprises.




into

the

stronger

DDC




11
This

experience,

if favorable, would mitigate the

difficult question as to whether the process

could

structively

existing debts.

There are,

utilized

of

difficulties

course,

to

in

the

obvious

rollover

of

accounting

and

be

con­

regulatory

be overcome regarding this kind of restruc­

turing and refinancing.

It would seem only

prudent

banking

policy that creditors avail themselves of the opportunity for

divestiture of the equities acquired as

for

them.

a

market

developed

National pride is deeply involved in "giving up"

equity or revenue participation attached to debt instruments.

However, we face several difficult years in which governments

and institutions will be dealing with

credit

workout

situations

which

solutions.

The vital need of developing countries for growth

after

t

will

these

refinancing

worthy alternatives.

demand the consideration of creative
,

or restructuring demands our attention to

12

In collective bargaining situations, it may be that

management

has learned to involve labor more in locating new

plants and expansion of existing ones as well as the

consid­

erations which go into the downward adjustments of their pro­

ductive capacity,

pressure

of

ünion leadership in industries

very

low

beyond concessions

changes

in work

capacity

in wages

and

or

under

the

deregulation have gone

benefits

and

agreed

to

rules and other prerogatives lying outside

compensation.

I

the

believe that monetary policy has

reduction of inflation and even of inflationary expecta­

tions to sane degree.

contributed

economic

In this regard,

importantly

designed to make

a

expansion.

to

similar

I

possible to implement the




contributed

the

economic

positive

cannot

advice

monetary

recovery

impact

tell

you

of

last

policy

upon

has

and is

today's

that it has been

year's

Monetary

to

13

Policy Conference to seek a simple rule to guide policy.

But

policymakers are aware of the new financial

and

new

behavior

instruments

of old instruments that have characterized the

past few quarters, and

their

impact

is

being

taken

into

account.

In 1984, the Federal Reserve will work with ccxtmer-

cial banks in a transition to

reserve

requirements

and

a

will

system of

pursue

contemporaneous

additional

efforts

regarding the effective canmunication of developments in

monetary

and

credit

aggregates.

In all of this, it is our

hope to increase the knowledge and awareness of

gers

in

the

money

mana­

the banks, other financial institutions, and finan­

cial markets at large as to

the

directions

and

goals

for

monetary policy.

In

short,

the

answer

there be something wrong?" is




to the question "Shouldn't

"Not

so

likely

this

time."

14

There

cire great avenues of opportunity before us to be built

upon the foundation of our

inflation

and

toward increasing the productive capacity of our nation.

The

problems facing us are

addressed.

recognized

against

and

can

be

effectively

What it will take, however, is a continuation of

the cooperative

private

progress

sector,

efforts

labor,

between ^the

and

the

financial

economic

community,

policymakers to

foster and promote a concrete transition to economic strength

and expansion.