Full text of Statements and Speeches of Robert P. Forrestal : Perspective on Monetary Policy (Outline) : Remarks to the Seminar on Monetary and Fiscal Policy, Vanderbilt University

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PERSPECTIVE ON MONETARY POLICY
Remarks by Robert P. Forrestal, President
Federal Reserve Bank of Atlanta
To the Seminar on Monetary and Fiscal Policy, Vanderbilt University
February 3, 1988

Introduction: I've been asked to talk about the Federal Reserve System and monetary
policy.

Feel it would be worthwhile to provide some context by looking first very
briefly at the range o f functions our central bank performs.

Then I'll talk about the mechanics o f policy formation and execution.

Finally I'll discuss recent monetary policy actions and the economic factors
that will shape monetary policy in the year ahead.

II.

Monetary policy is one o f the three businesses o f the Fed and is, perhaps, the most
difficult fo r the public to grasp.

The Fed's other businesses are providing financial services for banks and
supervision and regulation o f the activities o f bank holding companies and
certain commercial banks.

In its financial services businesses, the Fed is involved in and oversees a large
portion o f the payments system.

This includes clearing checks, and transferring funds and securities
electronically.

Private clearing systems do net settlements at the Fed.

This function

involves facilitating the movement o f money in our

financial system.

As this system becomes more complex and as transactions volume grows,
we need to keep in mind that the risks o f its failure grow as well.

The Fed also serves as fiscal agent for the U.S. Treasury.

Maintains the Treasury's "checking account" and clears checks
drawn on that account.

Issues and redeems government securities.

Supervision and Regulation o f commercial banks and bank holding companies
is, if anything, increasing in importance in the wake o f the deregulatory moves
o f this decade and the internationalization o f financial markets.

Banks have acquired several new powers and are asking for still more
flexibility

in order to

enhance their competitiveness against non

regulated institutions.

For example,

we are

moving toward full national interstate

banking;

Other powers, such as the underwriting o f certain securities and

the sale o f insurance, are now allowed in some states and are under
consideration for attention in national regulations.

A t the same time, U.S. banks must compete with foreign institutions that
operate in differen t—and often less stringent—regulatory frameworks.

Thus regulators must be careful that either banks or their customers or
both are not driven offshore by regulations that are out o f step with the
changing environment.

The Fed's role in defining bank powers is pivotal because it writes
regulations that spell out the precise details o f federal banking laws
enacted by Congress.

As a bank regulator, the Fed decides on, subject to legislative
restrictions, the product lines banks may offer.

We can also mandate capital requirements, and we must approve or
oppose proposed bank mergers and acquisitions.

Along with the Federal Deposit Insurance Corporation (FDIC), the O ffice
o f the Comptroller o f the Currency (OCC), and state banking authorities,
the Fed assumes the responsibility o f supervising banks.

By regular examinations these agencies determine whether the
regulations are being complied with and if banks are operating in a
safe and sound manner.

The Fed examines all bank holding companies, all state-chartered
banks that are members o f the Federal Reserve System, and
various international banking operations in the United States.

We are responsible for supervising and regulating U.S. activities o f
foreign banks as well as foreign activities o f U.S. banks.

This type o f supervision keeps track o f banks by monitoring the
competence o f management, the quality o f their assets, and their
levels o f capital.

It is important to note, however, that regulation can’t prevent individual
banks from failing—we have no intention o f removing one o f the ultimate
sanctions o f the marketplace.

Our concern

the

industry as a

whole

rather than single

institutions—except, o f course, when these might pose some risk to
the entire system.

Lately the number o f bank failures has risen, and in 1987, 184 banks
failed—a post-Depression record.

These failures occurred in particular among agricultural banks and
banks with energy-related assets.

The Fed's role here has been to ensure orderly failure and maintain
local banking service.

Supervision and Regulation has some abstract

aspects due to the

subjective nature o f evaluating bank soundness, but its general principles
and practices can be understood along the lines o f other regulatory
agencies.

However,

because

the

necessarily

confidential

atmosphere

in which

monetary policy is decided upon and because the process is complex, many
people have little idea o f the nature of this third business the Fed conducts.

It is a process that engages the energies o f a goodly number o f system
employees who process a great amount o f information—both statistically
and analytically.

And not even experts in the field agree on how it should be conducted or
what elements should be taken into consideration in deciding upon a
course o f action.

It is only one tool o f macroeconomic policy and yet people expect us to
achieve multiple targets—fast growth, low inflation, low unemployment.

For this reason, it tends to be controversial, and the Fed is surrounded by
critics ranging from the Congress to economists and journalists.

I hope to leave you with an objective view o f the process and how it fits into

the other duties o f the Fed, and that way if you become one o f our critics, at
least you will have a degree o f understanding on which to base your objeetions-unlike some o f the Fedbashers we read about these days.

III.

Brief overview o f System

As you've probably discussed in your classes on money and banking, the Federal
Reserve System is best understood as having a dual nature that makes it at
once public and private in its operations

This dual nature is partially reflected in the differences between the
Board o f Governors in Washington and the District Banks like ours in
Atlanta.

The Board members are appointed by the President with the advice and
consent o f Congress; hence, the System has a public service component.

The District Banks are organized along the lines of private corporations.

They are governed by their own boards o f directors and sell services to
banks through our financial services business.

Though the more private o f the Fed's operations take place at the District
level, the public service activities—supervision and regulation o f banks and
monetary policy formation are jointly carried out by the Board and the District
Banks.

IV.

Monetary Policy Formation and Implementation

Monetary policy is one such jointly administered function.

Through monetary policy, the Fed seeks to influence anticipated economic
activity by affectin g demands fo r and supplies o f money and credit.

Monetary policy decisions are made as to how much, if at all, pressure on
bank reserve positions should be increased or decreased.

The Fed has three tools for implementing its strategy, all o f which have
their first impact on banks by affectin g the cost or the quantity o f
reserves in the market.

Banks

must hold

reserves

as a percentage

their

deposit

liabilities.

Clearly

reserves

are

made

more available,

banks will be

encouraged to lend out more funds, thus expanding the supply of
money and credit in the economy, and vice versa.

One tool is is the power to change the reserve requirements.

By forcing banks to hold a larger percentage o f their deposits on
reserve, the Fed would clearly restrict banks' capacity to lend
money and extend credit.

However, this is a rather blunt or extreme tool and is rarely used as
a short-term measure.

The best-known tool we use is the discount rate, which is the rate o f
interest charged to banks who need to borrow from the Fed to make
short-term adjustments to their reserve positions.

Generally the higher the rate is, the more costly it is for banks to
borrow reserves to meet reserve requirements.

A rise in the discount rate, then, encourages tighter (closer)
reserve management and leads to a slower rate o f bank loan
expansion.

On the other hand,

when the Fed lowers the discount rate,

commercial banks can have more funds available to lend.

This tool is the one over which directors o f the district banks have
the most influence because they can propose changes in the
discount rate at any time to the Board o f Governors.

The press pays special attention to the discount rate because
increases or decreases have a direct and immediate e ffe c t on the
cost o f bank reserves.

On a day-to-day basis, open market operations is the most significant o f the
three policy tools.

These operations consist o f buying and/or selling large quantities of
government securities—either on an outright basis or for short periods of
time.

When the Fed adds to its holdings o f securities it pays for them by
crediting banks with reserves.

Similarly, a sale o f securities drains reserves.

You need to keep in mind that some—in fa ct most—o f our open market
activity is seasonal.

We generally provide more reserves at Christmas time, for example,
because merchants and shoppers demand more money at that time.

But a component o f open market operations is policy-oriented and seeks
to a ffe c t pressures on bank reserve positions.

Any policy has short-term implications—mostly in the money market.

When we provide banks with more reserves than they need, we are easing
policy.

As in the cases o f the reserve requirement and the discount rate, when
pressure o f banks reserve positions is eased they become more willing to
supply credit and interest rates fall.

Conversely when we provide few er reserves, we push them toward
borrowing at the discount window.

In time, this affects economic activity.

But Fed policy is not the only factor influencing the economy at any given
time.

The government's fiscal policy-budget and taxation-carries its own
consequences;

In our global economy, the policies o f foreign governments have an
impact on the U.S. economy, albeit small.

And other factors whose e ffe c t is very difficult to foresee, such as oil
supply shocks and demographic shifts, also add to the mix.

Thus two

major points about the process o f devising this strategy bear

emphasizing at the outset.

The environment o f the policy maker is dominated by uncertainty.

From the standpoint o f economic research, one can project ideal
conditions and devise models to deal with them;

But in the real world o f markets, no model can cover all the myriad

possibilities that might occur.

Successful policy reflects dealing with uncertainty in the short run in a
way that makes sense in the long run.

In other words, we maintain a vision o f the economy in terms o f
optimal performance under the conditions we project 6 months to
18 months down the road;

Then enact day-to-day decisions with that vision in mind.

Thus I'll try to give you a sense o f how our daily, weekly, and monthly
decisions fit together—even though on the surface they may appear to
conflict.

Long-term objectives are desirable values for real income—usually expressed
in terms o f real gross national product (GNP)—and for employment and prices.

In general, we want GNP to grow as much as possible without bringing on
inflation; and we want unemployment to be as low as possible.

These

are

objectives

that

few

could

disagree

with—kind o f

motherhood.

And in general, we work on the assumption that the more ease there is in
the amount o f available money and credit, the more stimulus is provided
for GNP growth, and the reduced unemployment results growth.

Excess ease in money tends to be associated with inflation.

If the economy is overstimulated, excess demand drives up prices.

So the Fed's policy makers must walk a very thin line in striking a
balance among these objectives.

Thus making monetary policy is rather like flying an airplane in the fo g —
you have a good idea where you want to go and you have instruments to
help you get there, but you can't see your objective clearly or anticipate
hidden obstacles that might suddenly force you to correct your course.

The "instruments" that allow us to plan long-term strategy are barometers o f
the relative ease or tightness o f money in the economy.

These barometers provide information on how the economy is doing
before data on ultimate objectives—GNP, etc.—are available.

Policy makers assume that the relationship between these barometers
and ultimate policy objectives are stable and adjust policy instruments in
a way that generates desired behavior in the barometers.

During the late seventies, one group o f barometers—the monetary
aggregates, M l, M2, and M3--became institutionalized as intermediate
targets for monetary policy.

The

Humphrey-Hawkins

legislation

1978 requires

the

Fed

Chairman to report ranges for growth o f the three Ms in his
semiannual testimony to Congress.

Economists of the monetarist persuasion believe that monetary
policy can be linked to the monetary aggregates, especially M l, in
a fairly mechanical way, and for a while Fed policy was structured
somewhat along that line of reasoning.

Because o f deregulation and financial innovation, these measures no
longer provide reliable guidance.

The growth o f interest-bearing transactions accounts like NOW and
money-market accounts in the mid-eighties, however, M l—which had
been the most important o f these targets—stopped behaving in the way it
previously had and lost much o f its value as a barometer.

For this reason, in 1986 we stopped setting targets for M l.

We still watch M l, o f course, and still set targets for M2 and 3.

The

monetary

aggregates

still

provide

valuable

vehicle

for

communicating our objectives with Congress and the nation.

They cannot be used as the predominant intermediate target by which to
put long-term goals into practice, however.

Instead, policy is determined through an extensive examination of current and
projected economic conditions—including the monetary aggregates and interest
rates along with other indicators.

The group that examines information about the economy and sets policy is the
Federal Open Market Committee (FOMC).

FOMC members are the Board o f Governors and the presidents o f the District
Banks.

Along with the Board, the the president o f the New York Fed, where
policy is effected , and 4 o f the remaining 11 Fed presidents vote on a
rotating basis on policy decisions.

I will be a voting member again this year.

A ll presidents participate in policy discussions, however, and provide the
regional input that makes the System representative o f the nation as a
whole.

A t its meetings, the FOMC assesses an elaborate forecast o f the economy
prepared by the Board's staff.

It is based on a large scale model o f the economy—but we also need to
consider

other

predictable.

possible

factors—exogenous

ones—that

are

not

What will Congress do.

Will OPEC successfully curtail production?

A full-scale simulation is done about 4 times a year and the estimates
are updated prior to each FOMC meeting in response to new data.

The simulations project for a period o f 4 to 8 quarters.

They usually assume an unchanged monetary policy during the
forecast period, although the impacts o f alternative scenarios is
readily predictable.

The forecast indicates the income, employment, and inflation that are
expected to be consistent with a particular policy and assumptions about
exogenous factors.

Twice a year there is a full-scale look at the outlook 2 years ahead.

As I mentioned, all reserve bank presidents participate—along with their
research directors—whether or not it is their turn to vote.

District bank research staffs conduct their own discussions o f the
economy prior to the FOMC meeting.

We debate the exogenous variables and ask a lot o f "what if"
questions

We also have a small mathematical forecasting model that projects
GNP, employment, and prices.

We conclude with a go-round at which each economist expresses his
thoughts about what policy option should be exercised.

My research director and I carry this input with us to Washington as
we evolve our position.

A t FOMC meetings there is an extensive discussion o f the district banks*
forecasts along with discussion o f the Board's forecast.

The discussion is open with the same kinds o f "what if" questions coming
up.

A t each meeting, the FOMC typically reaffirm s the objectives for the
monetary aggregates.

These ranges reflect the leverage the FOMC wants to exert on the
economy in the long run.

For several years—starting in the late 1970s up until 2 years ago
the FOMC steadily reduced the ranges for the aggregates to signal
its desire to reduce inflation.

However, since inflationary pressures develop or abate slowly, the

com m ittee was not necessarily indicating that it expected to
achieve lower inflation in the months ahead.

As I mentioned a moment ago, in recent years the relationship between
the aggregates and the economy has changed.

It does appear, however, that money demand, for example, is more
sensitive to interest rates than prior to deregulation.

Since there are so little data available for the post-deregulation period,
our estimates o f money demand are still tenuous.

Consequently, we did not specify a range for M l in 1987.

Ranges for M2 and M3 were set at 5 1/2 to 8 1/2 percent compared
to 6 to 9 percent for the year before.

A t our meeting next week, we will consider 1988 ranges.

Because o f uncertainties about the behavior o f money and because it is an
intermediate as opposed to a final objective, the FOMC does not aim to
achieve the growth within the specified ranges irrespective o f what is
happening in the economy.

A t times, the FOMC has indicated that it is willing to accept growth that
is above or below the ranges because actions to achieve growth within
the range would run counter to the short-term thrust o f monetary policy.

In the fa ll o f 1982, for example, we purposely did not respond to above
range money growth.

The country was in the deepest recession o f the post-World War II
era and actions to restrain money growth would have meant greater
pressure on bank reserve position and rising interest rates.

I'm sure you'll agree that was the right decision.

This past year M2 ended up below its specified range, while M3 was at
the very bottom o f its range.

While policy did ease in late October—which I'll get to in a
moment—our earlier move to a more restrictive stance was taken
in light o f estimates showing that economic growth was becoming
more rapid than was likely to prove sustainable, thereby creating
the potential for inflation to accelerate.

The rise in market rates o f interest in the spring and summer of
1987 negatively impacted on money growth.

Thus, in the short run, we fe e l reasonably comfortable in taking action that—as
I noted—may, on the surface, seem to conflict with long range objectives.

This brings me to the next step in policy formulation—developing a short-term
response function to guide the manager o f the System Open Market Account in

New York.

The manager, who is an o fficia l at the New York Fed, reports directly to
the FOMC.

He and his s ta ff—about 60 people all told—are responsible for executing
policy decisions.

As I noted we may be willing, in the short run, to tolerate more rapid or
slower growth in monetary aggregates than we have specified.

But that is only a portion o f the short-run response—since there are an
infinite number o f ways to reach long-run goals.

For example, if we expect income growth to accelerate to an unsustainable
pace, we might want to make policy more restrictive to prevent a build up in
inflation.

Still, we have various ways o f doing this.

Could move to restrain bank reserve growth now;

Could restrain growth a little bit now, raising the possibility that
more might need to be done later.

Staff shows these alternatives to the FOMC, and members are thus
permitted to incorporate their own judgements o f the economy into their

decisions

Those who are fairly certain the economy is accelerating would
choose more restraint now.

Those less certain about the degree o f acceleration could opt for
gradual change.

Those who disagree with the forecast could favor no change or even
an easing.

Each alternative contains short-run specifications fo r the manager o f the
System Open Market Account at the New York Fed.

These specify a reaction function for the Desk—one that is related
to the policy thrust the committee has chosen.

They also condition the response to incoming information—this is
basically like letting a pilot alter the course as barometers give
information.

In some senses, these specifications define the conditions under which
the System will supply reserves.

For example, the Committee may choose a no-change policy—but
be somewhat more willing to tighten than to ease.

Thus they would want the manager to react to any signs that
economic growth or price pressures were accelerating but to make
no change unless signs o f unexpected weakness were widespread.

In regard to price pressures they might be especially concerned
about pressures on the dollar in the foreign exchange markets and
use that as a conditioning factor for the manager's response.

Suppose the Committee had selected, as it did in August o f this past
year, a modest firming o f policy—to be extended under the conditions
noted above.

The manager would undertake to increase the pressure on bank
reserve conditions.

He would seek to supply reserves at a pace that was slower than
the demand for reserves was expanding—thus forcing banks to meet
reserve needs at the discount window.

But, ordinarily, banks must use the discount window only for
temporary adjustments—they can't keep coming back.

So in fairly short order, they begin to bid more aggressively for
reserves in the overnight Federal funds market—driving the funds
rate up.

Ordinarily, the FOMC will indicate how much leeway the manager

has in increasing pressure on bank reserve positions, and it also
specifies a range of allowable variation in the Federal funds rate.

A firming o f pressures on reserve positions w ill spill over to other
interest rates thereby affectin g the demand for money and credit-and the economy.

The impact o f such actions is greatest on short term rates o f interest.

If, for example, market participants thought that we were being
"too tight" and that the economy would weaken significantly, then
long-term interest rates might decline relative to short term ones
and the yield curve would flatten.

If they thought we were "too easy" the yield curve would get
steeper, reflecting expectations that interest rates would need to
rise by more later on.

Procedures also allow for flexibility.

Clearly, after the decline o f the stock market, the manager was able to
quickly shift direction and provide for increased demands for liquidity.

Each FOMC directive contains provisions for the FOMC to be consulted
by the manager if important or unexpected developments arise in the
period between meetings.

Summary o f monetary policy procedure:

FOMC evaluates economic outlook, sets annual targets for growth
consistent with its ultimate objectives for the economy. Formal ranges
for M2 and M3 are agreed upon tw ice a year.

A t each meeting, Committee selects a profile for policy that derive from
short-term assessments and that seeks to be responsive to unfolding
information on the economy.

Using this, it establishes a response function for the Manager o f the
System Open Market Account.

VI.

How an FOMC meeting works.

Having discussed the mechanics o f monetary policy in this rather abstract
sense, 1*11 now try to provide a picture o f how committee meetings work in a
more concrete, human sense.

Open Market Committee meetings have been held in some form since the
1920s, but the FOMC as we know it today was established by the Banking A ct
o f 1935.

Meetings are held six times a year~the next meeting will be held Tuesday of
next week.

Members o f the Committee gather around a large table in the Board's

o ffic e building on Constitution Avenue in Washington with Board sta ff
aides. A lim ited number o f advisers line the outside o f the room.

The Chairman o f the Board o f Governors—Alan Greenspan presently—
enters at 9:30 and convenes the meeting.

Chairman asks to hear from the Foreign Desk.

Manager for Foreign Operations from the New York Fed describes
developments in foreign exchange operations.

I have not mentioned these in my discussion so far, in that they are
undertaken in concert with the Treasury and often other central
banks as well.

Any exchange market intervention is initially sterilized, though the
behavior o f the dollar may, as I did note, elicit a policy response.

There is usually discussion and, afterward, the manager's operations are
typically approved.

Chairman turns to the Manager for Domestic Operations who discusses
open market operations and financial market developments since the
previous meeting.

There is again a question and answer time and approval o f operations.

Board sta ff director o f research summarizes the sta ff outlook fo r the
U.S. economy and highlights risks and uncertainty.

The presentation would seem deceptively simple to one not aware o f the
thousands o f man-hours necessary to prepare it.

While the sta ff starts

with a large structural model o f the

economy, estimates are adjusted on the basis o f information that
cannot be incorporated mechanically.

For

example,

even

after

the

dollar

had fallen

significantly,

exporters to the U.S. were willing to reduce margins to maintain
market share.

Thus estimates o f how the dollar was affecting import prices,
domestic prices, and imports were likely to be o ff.

It is difficu lt to model this.

The s ta ff forecast is written up in what is called the "Green Book,"
which we receive in Atlanta the Thursday prior to the meeting.

10.

As his presentation comes to an end, several members nod unobtrusively
to the secretary, who notes for the Chairman's reference that they wish
to speak.

A lengthy period o f questioning and debate follows.

A district president may mention observations from his own district
that contradict the staff's presentation.

He may also refer to his own staff's forecast and what differences
it has.

(1)

In Atlanta, fo r example, we look at both a judgmental
forecast

and

one

generated

Bayesian

vector

autoregressive model.

(2)

My own staff prepares a "Gold Book" for me describing their
outlook and policy recommendations.

Someone else may point out historical cases that have similar
outlines or cases that have different ones fo r that matter.

Others may refer to conversations with business leaders indicating
their outlook and plans for their companies.

11.

The meeting usually breaks around 11:00, and individual conversations
continue over co ffee.

12.

When the group convenes again, the Director for Monetary Policy
presents the FOMC with three policy alternatives.

13.

These have been written up in a "Blue Book" that I receive the Saturday

or Sunday before the meeting.

14.

Then it is time to settle on the monetary policy course o f action fo r the
next six weeks.

Each o f the 19 people at the table has the opportunity to comment
on the information presented that morning and on the viewpoint to
which his own preparation has brought him.

Presidents and Governors may suggest changes to the policy
alternatives.

There is no particular order to the comments; can be quickly
concluded, or other times takes several hours, depending on how
much agreement there is.

The Chairman seeks to derive a consensus about policy from the
views that are expressed.

There can be a number o f informal tallies—sort o f asking voting
members if they can ’’live with” a particular policy as opposed to
being strongly in favor or opposed.

15.

Governors and voting members cast votes according to roll call.

16.

Dissenting votes carry an explanation that is recorded in the minutes and
are released later.

17.

Meeting adjourns.

Each president in turn is charged with monitoring the Fed's open market
operations.

Assisted by his staff, he will participate each day in a conference call
with the Director for Monetary Policy and the Open Market Account
Manager in New York and any Governors that may want to sit in.

The manager typically discusses current financial market conditions and
his proposed action for the day.

VII.

This experience adds a great deal to the perspective o f each participant.

Monetary Policy in 1987

The results o f FOMC meetings are released 13 days a fter the following
meeting.

The reason for the lag is to provide the System with flexib ility to alter its
course of direction if needed.

For example, after the stock market crash, we did have some concern
about financial market stability.

Announcing our deliberations on this as they progressed would not have
been helpful in my view.

Reading the records o f policy actions taken as printed in the Federal Reserve
Bulletin can give you a picture o f what data FOMC members considered to be
the most relevant economic data during a given period.

The most recent meeting that is a matter o f public record was the November
3, 1987 meeting.

A t that time, the economic outlook changed somewhat, given the
extraordinary financial market developments o f previous weeks.

However, it was too soon to have data on the economy's response to this.

In its discussion, the Committee generally agreed that the sharp drop in
stock prices and still unsettled conditions in financial markets portended
weaker economic growth—at least in the near term.

These developments also reduced the risks of any substantial pick up in
inflation.

Still, members stressed that while the direction o f the adjustment was
clear, it was too early to quantify these likely impacts.

The Committee reaffirm ed the 5 1/2 to 8 1/2 percent ranges fo r growth in M2
and M3 from fourth quarter 1986 to fourth quarter 1987.

For 1988, it agreed to tentative reductions o f 1/2 percent--to a 5 to 8 percent
growth range for both aggregates.

Regarding policy over the weeks ahead, the Com m ittee agreed that it was
appropriate to direct operations at maintaining the easier conditions that had
emerged on money markets in late October.

They also agreed on the need for greater accommodation and flexib ility
in the manager's day-to-day approach until financial markets settled
down.

As I noted, the switch to a more accommodative approach occurred when
the extent o f the market collapse on October 19 became clear.

The FOMC recognized that in addition to helping o ffset the impact o f
lower stock prices, the decline in interest rates that had developed could
also risk greater weakness in the dollar.

VIII.

There were no dissents; they fe lt this risk was manageable.

To round out my presentation~and set the tone for monetary policy in the year tc
come—I'll conclude with my outlook for the economy in the year ahead.

In the year just ended, real GNP grew 2.9 percent on a year-over-year average
basis.

This rate o f expansion helped lower the unemployment rate to 5.8
percent by December, the lowest in eight years.

A t year's end, prices as measured by the consumer price index were 4.4
percent higher than in December o f last year, largely due to he impact o f
higher energy prices.

Looking to 1988, I see a continuation o f expansion at a slower pace o f 2
percent or a little higher.

With decelerating growth, unemployment could possibly rise a little in
the first part o f the year.

Inflation is likely to be about.the same as last year.

My outlook fo r continued growth in GNP rests on three areas o f strength:
continued modest advances in consumption, further gains in capital spending on
new equipment, and a fairly significant improvement in the foreign trade
sector.

Consumer spending is likely to advance, albeit modestly, in 1988, in spite
o f the stock market crash last fall.

The main source o f momentum for growth will not be consumption but
rather net exports.

These have been trending up in real, or inflation-adjusted terms,

sinee late 1986.

The dollar's substantial drop in value against foreign currencies
makes our goods more attractive to foreigners.

This development has boosted production and employment in our
manufacturing sector.

In addition, Japan has recently begun to stimulate its economy,
though West Germany has been slower to do this.

Probably the weakest sector o f the economy during the coming year will
be commercial and residential construction.

Government spending will be sort o f neutral: the federal budget deficit
is likely to increase a little bit in 1988, due to the unwinding o f special
factors that temporarily increased 1987 revenues.

Together these factors suggest that GNP growth will continue in 1988,
but not quite as rapidly as in 1987.

Turning to inflation, oil prices are likely to stay in their present range or
maybe drift a little higher, depending on whether OPEC carries out on its
promise to cut production.

However, last year's further decline in the dollar should push non-oil
import prices up even more.

As this happens, the dollar-related increase in domestic manufacturing
could exert upward pressure on labor costs.

Unemployment is close to the point at which further efforts to stimulate
growth result in more wage pressures than job gains.

Still, with the economy likely to be a little slower in the first half o f the
year, inflation should not be any higher than it was in 1987.

In all, with slower but still moderate growth in GNP and no acceleration in
price increases in the offing, we can look forward to another year o f decent
economic performance.

IX.

I've tried to give a fairly thorough assessment o f the monetary policy function at the
Fed from defining its place among the three businesses o f a Federal Reserve Bank
through the mechanics o f decision-making to a look at the factors that will influence
monetary policy in the year ahead.

A t this point, then, I'd like to get some input

from you and spend the remainder o f our time together clarifying issues about which
you may have questions or exploring in more detail areas that you would like me to
develop for you.

Full text of Statements and Speeches of Robert P. Forrestal : Perspective on Monetary Policy (Outline) : Remarks to the Seminar on Monetary and Fiscal Policy, Vanderbilt University

FRASER