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U .S. ECONOMIC OUTLOOK AND MONETARY POLICY Remarks by Robert P. Forrestal President and Chief Executive Officer Federal Reserve Bank of Atlanta To the Economic Roundtable of Jacksonville Jacksonville, Florida April 13, 1993 I am delighted to be here today as the Economic Roundtable of Jacksonville honors Billy Walker, chairman of the First Union Corporation of Florida. From the size of the audience, I can see that he has many friends in this part of the world. No doubt, many of the economists and business people in this group would like to hear from me where interest rates are headed, since I represent the central bank. No doubt, you understand that I must disappoint you in this regard. However, I would like to speak about monetary policy if for no other reason than to point out that some of its successes in the past few years have not been fully appreciated—chief among these, the progress made on inflation. Our nation has also embarked upon an interesting time for policy since we may be on the threshold of new fiscal policy. What will this change mean for monetary policy? I cannot answer that question directly, but it does give me the chance to share with you the complexities of making monetary policy in a changing environment. The U.S. Economy To set the stage for that discussion, let me turn first to the economic outlook for the United States. Because monetary policy is made in real time, it is best to start with the current reality. What we have is an economy that is doing moderately well, though its rate of growth for the early stages of an expansion is relatively slow. This slower-than-normal recovery means 2 that employment is also rising at a disappointing pace. I expect the overall economy to do better this year than it did last year when gross domestic product, or GDP, expanded by around 2 percent. This year, total output should expand, on an annual average basis, by close to 3.5 percent or maybe a little less. Inflation, as measured by the consumer price index, may creep slightly higher than the 3 percent level of last year to a little less than 3.5 percent. The unemployment rate could move slightly below an annual average of 7 percent. Although that figure is down nearly half a percentage point from the 1992 annual average of nearly 7.5 percent, the unemployment rate still remains stubbornly hard to budge compared with other recoveries. The main sources of strength underlying the U.S. economy as it moves forward into an expansion phase will be consumer spending, particularly on durables; residential construction; and capital investment by businesses, especially on computers and other equipment. Lower interest rates are a factor in all of these areas. Most importantly, they have enabled households and businesses to restructure their balance sheets. Consumer debt service as a percent of income, for example, has fallen to levels not seen since 1986. As a result, households are in a better position to purchase goods that are typically financed with credit. Also on the consumer side, several additional factors are at work. Although the unemployment rate has not moved below 7 percent over the past 12 months, civilian employment has been rising. More importantly, productivity rose quite dramatically in the latter part of last year, indicating higher value added by labor, which leaves scope for income to rise. 3 With their improved balance sheets and potential for rising income based on increased productivity, consumers should have the wherewithal to spend in a number of significant areas. First of all, there is pent-up demand in that many consumer durables such as televisions and air conditioners simply wore out during the period of slow growth. Second, lower mortgage interest rates have helped to create a greater demand for housing. In fact, sales of single-family houses have already been rising for more than a year. Moreover, this increased activity in the housing sector boosts demand for construction materials and major appliances and furniture. At the same time, however, the aging evident in most of our population, despite the recent uptick in births, will constrain any jump in demand for either housing or consumer durables. Thus, it seems certain that demand for cars, household appliances, and the like will not rebound as sharply as it did during other post-recession expansions in the past two decades. These demographics will also delay the turnaround in construction of multifamily housing in most cases, a sector that remains overbuilt. While there are still too many apartments and condominiums on the market, the good news is that this component of the construction industry may be approaching its trough. On the business side, capital spending will be enhanced by the reduction in borrowing costs and an improvement in business cash flow. Businesses are likely to use this newfound spending power on efficiency-promoting equipment like computers. As the pace of growth accelerates, expenditures for industrial machinery will also pick up. 4 Since an economic outlook would not be complete without mentioning areas of weakness, let me briefly enumerate a few: commercial construction, government spending, and, for the first time in many years, international trade. Commercial spending is not likely to turn around soon because excess office and retail space remains substantial. Nevertheless, nonresidential building should be less of a drag on growth than in the past few years. With the new Administration having been in office for only two-and-a-half months, it is somewhat risky to forecast government spending, even knowing what spending cuts and increases President Clinton has proposed. Clearly, though, there are well-defined plans in place to reduce defense expenditures. Thus, on balance, I believe that in 1993, as in 1992, government purchases will not add to growth. More troubling is the shift in the international trade area from the positive to the negative side of the growth ledger. The main factor in this weak net export performance is that growth in most other major industrial nations has been slowing, and some countries have been verging on recession. Poor conditions have been limiting demand in Europe, and central banks have begun to lower short-term interest rates significantly. Japan is going through a protracted adjustment to the drop in its very high asset values and the aging of its economy, and its rates, too, are declining. This weakness is not likely to be completely reversed in 1993, nor is slackened demand for U.S. products in the advanced economies likely to be offset by rising demand in Latin America and the Pacific Rim. Their rapid growth rates are not enough to make up for their relatively small share of U.S. exports. At the same time, a pick-up in GDP growth in the United States usually leads to a rise in imports. As a result, the merchandise trade gap 5 has begun to widen—it grew by nearly 30 percent in 1992, widening to $84 billion—and will continue to widen after narrowing steadily since the late 1980s. The proposals made by the President to reduce the deficit have not prompted me to make any major changes in my overall economic outlook for the nation. Depending on the particular form they take, the proposals could cause spending to shift among the consumer, government, and investment categories. Generally speaking, though, while the new fiscal policy should have an impact on the economy, significant effects probably will not be felt in 1993. By the way, since we are gathered here in Jacksonville, let me also add a few notes about the notable growth potential of the Florida economy. Although the state has lagged behind the rest of the region during the recovery, it began to show signs of doing better in the latter part of 1992. Despite the effects of defense cuts on manufacturers in Florida, improved tourism and exports to Latin America will probably be enough to put growth in the state on par with other southeastern states in 1993. Added to those forces, rebuilding after Hurricane Andrew will provide an additional boost for jobs and incomes. Thus, Florida is likely to grow at a rate above the national average, but this margin may begin to narrow by year-end. The Role of Monetary Policy Now that we are familiar with the current reality as I see it, I will turn to a discussion of the complexities of making monetary policy. The most important role of monetary policy is to provide an environment in which the most productive outcomes will occur. Such an 6 environment is one that allows for a focus on the longer run; it is one in which resources are not distracted or diverted to deal with short-term distortions and temporary imbalances. In such circumstances, resources, both physical and financial, can be used to their greatest efficiency and yield their highest output and reward. I am well aware of the loss, inefficiency, and waste that is behind the human tragedy of unemployment, and I am equally aware of the terrible cost of inflation. It is the role of monetary policy to put some credible bounds on expectations about inflation and unemployment. Thus, the Fed not only must provide assurances that inflation, now or in the future, will not be allowed to rise enough to become an important consideration in private decisions but must support expectations that disruptions to the economy in the presence of unforeseen and unwelcome shocks will be mitigated. In this sense, I see the role of the Fed as promoting stability, not just in prices but in income and employment growth as well. This setting is a critical ingredient in the creation of sustainable growth because a stable environment will support the long-term planning horizon necessary for the investment that will create jobs and nurture high value-added firms. Of course, the Fed must seek to create and maintain these conditions in a world of uncertainty. We all know that history does not, in fact, usually repeat itself. In addition, the Fed must bring to bear on its decisions an understanding of the social preferences of the American public. Given the uncertainty inherent in policymaking and the difficulty of assessing risks, monetary policy may sometimes have to steer the economy gradually to the desired 7 conditions of price stability and output growth. In most advanced economies, policy institutions were created over the last century to mitigate the transition costs of economic corrections. In the nineteenth century, business cycle fluctuations were much sharper than they are today. Imbalances were corrected by sharp implosions in financial markets, severe contractions in output and money wages, and costly dislocations of resources. Prices also tended to fall across the board, sometimes quite dramatically. Then economic growth began afresh. Although such swift and clean adjustments have a certain theoretical attractiveness, these abrupt changes were often unnecessarily costly for those adversely affected. Sometimes, in the rush of a collapse, sound businesses, banks, and households were financially ruined because their assets were not liquid and they lacked the time to find the means to liquidate them. Over time, a variety of economic policy institutions and measures were established to mitigate and attenuate this process. This broadly ameliorative aspect of macroeconomic policy is still the mandate of the Federal Reserve. I believe the Fed, like other policy institutions that act on behalf of society, must keep public preferences in mind when pursuing social goals. As a practical matter, this social obligation means that none of the transitions should be excessively traumatic. Currently, the economic situation is by no means ideal, given the large number of 8 unemployed. However, we must not discount the important foundation for growth that has been laid by the Fed in reducing inflation. The current degree of price stability we have achieved positions the United States to reap enormous and real, not inflationary, gains in output and incomes. The Re-emergence of Fiscal Policy Summing up the outlook for 1993, economic growth promises to be somewhat better than in 1992. Nonetheless, I recognize that certain sectors will decelerate and others still have excess inventories to be worked off. Moreover, moving from 2 percent to between 3 and 3.5 percent GDP growth is not the typically booming acceleration we usually see in the early phases of an expansion. It is clearly not fast enough to push unemployment down quickly. In addition, there are other pressing economic problems like health care and education that affect all of American society in some way. While the Federal Reserve has been grappling with the problems of the economy in recent years, it is appropriate and necessary for the nation to develop broad approaches to economic policy. It is important to reestablish fiscal policy as a useful instrument, one that can target particular areas of the economy in addition to acting as a countercyclical tool. During the past recession, monetary policy bore virtually all the responsibility for restoring economic growth. The reason was that huge deficits made it nearly impossible to use fiscal policy. From my perspective as a central banker, until a sound and credible deficit reduction plan is implemented, monetary policy will continue to bear an unfulfillable burden. Now, however, it appears as if 9 the public is finally willing to discuss and debate how to reduce the deficit. I urge our politicians to take advantage of this attitude and come to an agreement soon. While I do not have comments on particular aspects of the proposals, the Administration should be commended, in my view, for bringing these deficit concerns to the front burner. Conclusion In conclusion, even in the best of times, setting monetary policy is a complex matter. The effects of easing-as the Fed has done over the past two years-have made some people happy and others not so happy. Need I mention the many retirees living in this state who have not been pleased with lower rates on their CDs, for instance. On the fiscal policy side, the hue and cry is likely to be louder still as Congress settles on specifics for reducing the deficits. It should not be at all surprising to hear complaints coming from almost everybody for the simple reason that we all must share the burden. Very few will be able to say that they were not affected by the efforts to cut the deficits. It seems clear to me that any proposal-whether made by a Democratic or a Republican administration—is destined to be heavily criticized. But I remind you that this endeavor will succeed only if we realize that we all must take the medicine this time. The recent changes in the attitude toward cutting the federal budget deficits mean that the difficult tasks confronting the nation may now be worked on by both monetary and fiscal policy. I believe the nation today is ready and able to tackle the tough problems we have been avoiding for so long. If we can do so, then 1993 will be remembered as the year when the United States began to develop a policy framework to prepare us for the challenges of the twenty-first century.
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