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EHESglj FEDERAL RESERVE BANK OF SAN FRANCISCO Office of the President For Release at 12:00 p.m. PST, Thursday, March 13, 1986. PLEASE GUARD AGAINST PREMATURE RELEASE A PERSPECTIVE ON THE OUTLOOK FOR THE U.S. ECONOMY Robert T. Parry President Federal Reserve Bank of San Francisco Presented at Community Leader’s Luncheon San Francisco, California March 13, 1986 1 We are EXPANSION, THIS AT in fourth year U.S. of the current UNDER A 4 1/2 PERCENT RATE 10 1/2 PERCENT, HAS AND business ECONOMY HAS PERFORMED WELL OVER THE PRODUCTION OF GOODS AND SERVICES U N E M P LOYMENT OVER the AND GENERALLY THE PERIOD. JUST The now AVERAGE DROPPED ANNUAL RATE S I GNIFICANTLY EMPLOYMENT HAS HAS INCREASED SINCE FROM INCREASED 1982. A PEAK 3Y MORE OF THAN 9 MILLION. AT PRICE THE SAME INDEX, DRAMATIC TIME, WAS DECLINE INFLATION, 3 3/4 PERCENT FROM AS OVER ITS ALARMING MEASURED THE PAST PEAK OF BY THE TWELVE THE RELATED DECLINE RATES HAS BEEN WITH RATE, FOR EXAMPLE, FALLING FROM TO BELOW 8 1/4 PERCENT But TRADE there AND been INTERNATIONAL HEALTH OF THE has U.S. DRAMATIC, THE A PEAK OF MONTHS, 14 1/2 PERCENT TWELVE MONTHS ENDING APRIL 1980. EQUALLY CONSUMER IN THE IN INTEREST 30-YEAR T R EASURY MORE THAN A 30ND 14s* PERCENT FOR THE FIRST TIME IN 8 YEARS. a darker side FINANCIAL to this IMBALANCES AND WORLD ECONOMIES good news . Seri o u s HAVE THREATENED THROUGHOUT THE THE EXPANSION. My basic message is that although THESE IMBALANCES HAVE IMPROVED, JOB THE Fed HAS TO DO. TO GIVE MY PERSPECTIVE OUTLOOK FOR THE Domestic Federal interest rates enormous capital U.S. for in prospects for correcting THEY HAVE GREATLY COMPLICATED THE AS A NEW MEMBER OF THE FED, ON THESE I WOULD LIKE ISSUES AND TO FINISH UP WITH MY ECONOMY OVER THE NEXT YEAR OR SO. In t e r n a t i o n a l and Massive demand U.S. the Im b a l a n c e s budget this inflow deficits country from dollars, since that 1981, followed, abroad, generating Between 1931 and and high prompted in turn 1985, the the an a large Federal budget deficit as a share of GNP more than doubled to 5 percent, and e xceeded 1985, THE FACTORS VALUE ALSO MY VIEW, $200 billion OF in 1985. From m i d - 1980 through THE DOLLAR ROSE ALMOST C O NTRIBUTED TO THE STRENGTH 85 PERCENT. OF THE DOLLAR, THE BUDGET DEFICIT WAS THE SINGLE MOST early OTHER BUT, IN IMPORTANT FACTOR. 3 W ith a d o l l a r , our strong INTO LARGE DEFICITS, GROWTH ABROAD exports. COMMUNITY, T R ANSLATED has WHERE and current accounts swung A D DING TO THIS PROBLEM WAS LAGGING ECONOMIC WHICH T his trade been GROWTH INTO SLUGGISH especially OF REAL GROWTH true GNP HAS in European the AVERAGED U.S. IN ONLY ABOUT 1 1/2 PERCENT PER YEAR OVER THE PAST THREE YEARS. These U.S. and imbalances world CAPITAL INFLOW have had economies. HAS MEANT both On LOWER good and bad effects the positive side, U.S. INTEREST RATES HAVE BEEN ABLE TO TAP FOREIGN SAVINGS BOTH TO FINANCE DEFICIT AND TO AND HOUSING. HAS PROVIDED PROVIDE FINANCING AT THE SAME TIME, A READY MARKET FOR FOR BUSINESS THE REST ESPECIALLY THOSE OF SOME HEAVILY INDEBTED OF THE COUNTRY. ESTIMATES THAT THE THE RESEARCH INCREASE IN STAFF THE large BECAUSE OUR WE BUDGET SPENDING IN OUR IMPORTS WORLD'S GOODS, DEVELOPING COUNTRIES. A S T RENGT H E N I N G DOLLAR ALSO HAS MEANT LOWER IN THIS the CAPITAL THE STRONG GROWTH on the AT THE DOLLAR INFLATION RATES SAN FROM F R ANCISCO 1930 TO FED 1984 REDUCED THE INFLATION RATE, AS MEASURED BY THE GNP DEFLATOR, BY ABOUT 1 PERCENT PER YEAR BELOW WHAT IT WOULD HAVE 3EEN OTHERWISE, ON THE NEGATIVE WITH OVERSEAS B U S I N E S S E S HAVE BEEN PUT AT A SEVERE COST DISADVANTAGE. WHEREAS JOBS IN SIDE, GROWTH IN STRONG, MANY MANUFACTURING INTERNATIONALLY, THE U.S. PRIVATE HAVE FIRMS COMPETING SERVICES INDUSTRIES, REDUCED SECTOR HAS BEEN QUITE WHICH TEND TO COMPETE THEIR WORK MORE FORCES. THE AGRICULTURAL AND MINING SECTORS ALSO HAVE BEEN HIT HARD. Ye a r s of strains in the industrial HAVE LED TO W I D E S P R E A D PRESSURES Al t h o u g h responsive LEG I S L A T I O N TRADING POSES PARTNERS. to A ACTIONS TO of FOR RESTRICTIVE genuine THREAT sector OUR local IN THIS AREA AND economy TRADE POLICIES. concerns, ECONOMY our TO protectionist THOSE INEVITABLY WOULD OF OUR LEAD TO HIGHER INFLATION AND TO RETALIATORY ACTIONS ABROAD. Finally, THE U.S. an ECONOMY increasing MORE VULNERABLE A T TITUDES ABOUT THE DOLLAR. dependence TO on foreign SUDDEN A LESS FAVORABLE savings SHIFTS IN makes FOREIGN ATTITUDE COULD LEAD TO BOTH A DROP Besides HIGHER their IN THE DOLLAR AND A SHARP RISE impact on housing and IN INTEREST RATES, business spending home, at INTEREST RATES WOULD ADD TO THE BURDENS OF L E S S - DEVELO P E D C O UNTRIES ALREADY TRYING TO COPE WITH LARGE D E 3 T S , Po l i c y In i t i a t i v e s In the initiatives ECONOMIES Five past have THAT overall and months, reduced which West economic domestic the I DISCUSSED, countries, France, six risks LAST consists Germany, policies for international policy U.S. WORLD THE SEPTEMBER of agreed to to 22ND, U.S., the in order dep r e c i a t i on of the dollar, and THE coordinate GROUP OF the U.K., better their Japan, encourage AND further orderly and to support such c o ordination with F OREIGN EXCHANGE MARKET INTERVENTION WHERE APPROPRIATE. B etw e en WEI G H T E D VALUE AGREEMENT, F e b ruary THE 1985 and OF THE DOLLAR FELL DOLLAR HAS the BY DECLINED G-5 agreement, 12 PERCENT. A FURTHER the THE G-5 PERCENT. A SINCE 13 trade- Q UESTION THE REMAINS, DECLINE EVIDENCE HOWEVER, IN THE THAT WHAT VALUE OF INTERVENTION EFFECTS ON EXCHANGE RATES. EPISODE IN THE HAS BEEN RESPONSIBLE FOR THE DOLLAR? BY ITSELF THERE DOES VIEW, DIRECTION THE THAT IS CONSIDERABLE NOT MY INTERPRETATION IS CONSISTENT WITH THAT PUSHED THE DOLLAR REALLY HAVE LASTING OF THE MOST RECENT INTERVENTION PROBABLY WAS DICTATED BY CHANGES IN FUNDAMENTALS. OF GREAT IMBALANCES the U.S. the IMPORTANCE IN GENERAL Unit e d St a t e s . TO THE HAVE BEEN First, it DOLLAR CHANGES became AND TO IN ECONOMIC apparent D E CLINING THREAT OF Reserve did not need to be overly POLICIES 1935 in ECONOMY WAS IN A PERIOD OF SLUGGISH GROWTH. Federal INTERNATIONAL INFLATION. IN OTHER the THIS MEANT THAT concerned INTEREST RATES OVER THE PAST YEAR AND ONE HALF RE-IG N I T I N G that IN WORDS, THE that the POSED A FED WAS ABLE TO PROMOTE THE CONTINUATION OF THE ECONOMIC RECOVERY WITHOUT THE RISK OF LOSING ANY GROUND ON INFLATION. 7 Se c o n d , the outlook IMPROVED, T he BUDGET SIG N I F I C A NT DEFICIT R E INFORCED BY LEGI S L A T I ON S PENDING DESIRED THE LAST PROGRAMS, A RESOLUTION REDUCTION, PASSAGE OF FEATURE METHOD OF Federal reducing PASSED AND THE DECEMBER. REDUCTION AS for THIS OF PUT SOME PART, BECAUSE COURTS, But TO DEFICIT EXTENT THE LAW ITS NO MATTER REDUCTION, WHAT HAPPENS has MANDA T E D TREND WAS GRAMM-RUDMAN-HOLLINGS "ACROSS-THE-BOA R D " LEAVES "TEETH" A WILL BE BEING TO THIS LOT BE CRUCIAL IT IS DIFFICULT IMPLEMENTED, CHALLENGED PARTICULAR IT APPEARS THAT THE TIDE TO GOVERNMENT INTO THE OF COURSE, IS YEAR ALTERNATIVE ACTUALLY CONSTITUTIONALITY deficits BUDGET THE AMONG PROCESS OF REDUCING OVERALL SPENDING, TO TELL TO WHAT NEW G R A MM-RUDMAN CHOOSING THE LEGIS L A T I O N DOES LAST LANDMARK ALTHOUGH budget IN IN THE APPROACH IS TURNING ON THE DEFICIT. Mo n e t a r y Po l i c y Last TO year F A CILITATE , the THE most pressing TRANSITION TO concern MORE of monetary MODERATE BUT policy was SUSTAINABLE 3 RATES OF GROWTH, UNEMPLOYMENT, HAD BEEN CONSISTENT WITH GRADUAL AND AT THE SAME TIME TO MAINTAIN MADE AGAINST INFLATION. THIS DECLINES IN THE PROGRESS THAT "SOFT-LANDING" SCENARIO, AS THE RESEARCH STAFF AT THE SAN F R ANCISCO FED LIKES TO CALL HAS THE ADDED ATTRACTION THAT IT OFFERS A REASONABLE A VOIDING THE SHARP MOVEMENTS IN EXCHANGE RATES AND CHANCE IT, OF INTEREST RATES THAT I DISCUSSED EARLIER. Choosing policies S I M U L T A N E O USLY EVEN THE MORE DOLLAR SINCE satisfy IS ALWAYS TRICKY, SO THIS IMPRESSIVE that YEAR, DECLINE I REFER 1985. OF OIL, THESE THEIR FINAL OUTCOME OR, WITH AND FACTORS MAKE IT TO o R A M M - R U D M A N , THE DROP PRESENT IT IS NOT MUCH considerations DEVELOPMENTS IN PARTICULAR CHA L L E N G E S FOR MONETARY POLICY BECAUSE GAUGE many BUT RECENT IN THE PRICE F E B RUARY so IN THE ADDITIONAL YET POSSIBLE PRECISION, TO TO MEASURE THEIR IMPACTS ON THE ECONOMY. T hese LAST YEAR uncertainties OF THE FED'S are compounded NARROW by MONETARY the unusual AGGREGATE, behavior Ml, WHICH 9 CON S I S T S BEEN OF CURRENCY A MAJOR AND CHECKABLE INDICATOR USED BY M ONE T A R Y POLICY ACTIONS LAST R E LATIONSHIP YEAR, ITS DEPOSITS, THE FED ON ECONOMIC GAUGE ACTIVITY GNP WITH TO THIS AGGREGATE AND THE HAS IMPACT AND INFLATION, INFLATION OF BUT SEEMED TO BREAK DOWN — AT LEAST TEMPORARILY, T he ABOVE AT NEARLY ITS TARGET, MID-YEAR, DANGERS OF CONCERN, THE 12 PERCENT But RATE AT OF Ml EVEN AFTER THE TARGET UNDER SUCH GROWTH A NORMAL RAPID RATE LAST Ml GROWTH THE ACCOMP A N Y I N G SHARP DECLINE WHICH MONEY CIRCULATES — PUT IT WELL ITSELF WAS REVISED UPWARD CIRCUMSTANCES, OF YEAR WAS THE WOULD INFLATIONARY BE CAUSE FOR IN MI'S VELOCITY — UNUSUAL, RAISING THE QUESTION OF WHETHER MI'S HISTORICAL RELATIONSHIP WITH THE ECONOMY COULD BE RELIED ON. IN THIS ENVIRONMENT CONCLUDED THAT GROWTH IN BE THE ACCEPTABLE. 1986 THIS TARGET FOR Ml, Ml OF HEIGHTENED UNCERTAINTY, ABOVE ITS TARGET RANGE FOR UNCERTAINTY CARRIED OVER TO THE THE 1935 FED WOULD CHOICE OF 3 TO WHICH WAS LEFT AT A RELATIVELY WIDE 10 8 PER C E N T ANNUAL M ONETARY 9 GROWTH RANGE, M2 AGGREGATES, BY M3, AND COMPARISON, WERE GIVEN THE BROADER 6 TO relationship to NARROWER PERCENT RANGES, G iven increased THE ECONOMY, COURSE OF AS WELL FISCAL THE M ONETARY THE CONTEXT uncertainty AS THE POLICY, AGGREGATES OF CREDIT MARKETS, SIMPLE POLICY ONGOING AND RULE UNCERTAINTIES OIL PRICES, WILL FOREIGN THAT THE TO BE IN THE EXCHANGE WILL S U R ROUNDING AND CONTINUE DEVELOPMENTS IN m o n e y 's about WORK DOLLAR, GROWTH INTERPRETED ECONOMY, MARKETS, IN THE FUTURE IN WITHIN IN DOMESTIC THERE TODAY'S IS NO UNCERTAIN ENVIRONMENT. Ec o n o m i c Ou t l o o k Let ME OUTLOOK. I CONCLUDE BY EXPECT ABOUT SAYING 3 1/2 1985 WOULD SIGNIFICANT A FEW WORDS ABOUT PERCENT GROWTH IN REAL THE FOURTH QUARTER OF BE A AND THE FOURTH QUARTER OF IMPROVEMENT THE 6NP ECONOMIC BETWEEN 1986, OVER THIS THE 11 2 1/4 PERCENT GAIN PERF O R M A N C E FOR Ec o n o m i c growth FURTHER INCREASES OF THE this LAST YEAR, FOURTH year AND YEAR OF should IN EMPLOYMENT be BUT A A VERY IMPRESSIVE BUSINESS EXPANSION, strong ONLY enough MODERATE to produce R E DUCTIONS IN THE U N E M P L OYMENT RATE, T he S T RENGTHENING OF THE ECONOMY THIS BY SEVERAL FACTORIES BUSINESS CROSS CURRENTS, AND WIDE S P R E A D EXPENDITURES IN ADDITION, WEAK FOR GROWTH A RELATIVELY VACANCIES PLANT GROWTH THIS YEAR, IN LOW IN OFFICE AND O P ERATING SPACE EQUIPMENT IN GOVERNMENT THE G R A M M - RUDMAN LEGISLATION, YEAR SHOULD BE SHAPED WILL SPENDING, RATE SUGGEST BE DUE FOR THAT SLUGGISH, IN PART TO ALSO WILL RESTRAIN OVERALL ECONOMIC ADDITION, PROSPECTS FOR THE AGRICULTURE, ENERGY, AND MINING INDUSTRIES ARE NOT ALL THAT ENCOURAGING, AT THE SAME LIK E L Y TO TIME, PERFORM HOWEVER, WELL. CONSUMER RESPECTABLE, I N F LATION-ADJUSTED THIS THE YEAR. NEGATIVE OTHER SECTORS OF THE ECONOMY ARE SPENDING RATE EFFECTS ON OF SHOULD APPROXIMATELY CONSUMER GROW 3 SPENDING AT A PERCENT OF HIGH DEBT LEVELS AND A PUSH BY HOUSEHOLDS TO BUILD UP DEPLETED SAVINGS ARE EXPECTED TO BE MORE THAN OFFSET BY SEVERAL Con sumer spending EMPLOYMENT; RETAILERS; LARGE will be by further gains in BY THE PERSISTENCE OF INTENSE PRICE COMPETITION AMONG BY THE FAVORABLE DECLINES IN INTEREST EFFECTS OF HIGHER WEALTH encouraged POSITIVE FACTORS, EFFECTS ON BORROWING COSTS OF RECENT RATES; BOND AND AND BY STOCK THE STRONG PRICES, FAVORABLE THE IMPROVED FINANCIAL ENVIRONMENT ALSO SHOULD PRODUCE A ROBUST HOUSING SECTOR AND COULD RESULT IN THE HIGHEST LEVEL OF HOUSING STARTS SINCE 1978. The EFFECTS OF THE DEPRECIATION OF THE DOLLAR EVENTUALLY GIVE A BOOST TO THE ECONOMY THIS YEAR, SHOULD AS OUR EXPORTS BECOME MORE COMPETITIVE AND DOMESTIC PRODUCERS ARE 3ETTER ABLE TO COMPETE WITH IMPORTS. FINALLY, THIS BOOST TO GNP WILL 3E ENHANCED BY A MODERATE RESTOCKING OF INVENTORIES. W ith ECONOMY some SHOULD luck BE , these generally ACCOMPANIED BY favorable A HEALING prospects PROCESS for the IN THE 13 FINANCIAL SECTOR. AS MENTIONED, THE EXPECTED INCREASE PERSONAL SAVINGS AND THE HIGHER PRICES OF FINANCIAL PRODUCE AN TODAY'S INTEREST EXTEND SEEN THE IN IMPROVEMENT EQUITY RATES, MATURITY LON G - T E R M SIGNIFICANTLY, THE CAPITAL IN AN OF HOUSEHOLD THE ITS BUSINESS EXISTING MARKETS RECENT BALANCE IN SHARP ATTRACTIVE DEBTS WOULD AT SOURCE IN STOCK OF ALSO, AT ABLE TO BE THE 8 YEARS. RUN-UP ASSETS SHOULD SHEETS. SECTOR IN LOWEST COSTS PERHAPS MOST PRICES MAKES FUNDS FOR MANY C O R P O R A T I O NS FOR THE FIRST TIME IN YEARS. ON THE INFLATION FRONT, WILL ULTI MATELY INFLATION. FOR BE OFFSET BY THE AND THE THE EFFECTS OF A DEPRE C I A T I N G DOLLAR INEVITABLY TIME EFFECTS BEING, RESULT HOWEVER, OF DECLINING OIL IN UPWARD THESE PRESSURE PRESSURES PRICES. ON SHOULD As A RESULT, INFLATION THIS YEAR SHOULD RECORD A RATE SIMILAR TO THAT OF LAST YEAR. This optimistic outlook GUARD AGAINST INFLATION. should not lead THREE OR FOUR PERCENT us to lower INFLATION our IS ONLY A C CEPTABLE IN THE CONTEXT OF RECENT HISTORY AND MUST NOT BECOME A LONG-TERM OBJECTIVE, INFLATION CANNOT MOVES TOWARD A PRICE PRESSURES A C C O MPANIED MOREOVER, BE DISMISSED FULLER A WITH WILL T U RNAROUND IN OF ITS THE TASK OF COMBATING As DEVELOP. IF ENERGY PRICES INFLATION OF THE RESOURCES, INFLATIONARY EFFECTS OF A DEPRECIATING DOLLAR, WHEN DANGERS IMPUNITY. UTILIZATION EVENTUALLY BY SHORTER-TERM HIGHER ECONOMY WAGE THIS AND TREND AND IS BY THE THE TIME WILL COME AGAIN MOVES TO THE FOREGROUND. IN positive 1987 CONCLUSION, one . REVEALS Ho w e v e r , I OUTLOOK Mo r e o v e r , NO also IS A P P R O P R I A T ELY THE REASON think VERY TO OUTLOOK a very TO that HIGH. UNEXPECTED FOR AN ECONOMY preliminary RAISE the THE THE range of ABILITY DEVELOPMENTS look RED at FLAG TO REACT MAY TURN 1986 IS prospects OF uncertainty ESSENTIAL ELEMENT IN MONETARY POLICY THIS YEAR. IN A for RECESSION. around this QUICKLY AND OUT TO BE AN
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