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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.