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Community Leaders Salt Lake City For delivery on August 4, 1994 ECONOMIC CONDITIONS IN UTAH AND THE NATION I. Good afternoon. A. As you know, since the beginning o f the year, the Fed has raised short-term interest rates four times—for a total increase of 1V* percentage points. 1. B. II. Not surprisingly, some of the reaction to these moves has been pretty negative. a. Two of the strongest reactions have focused on the timing. b. The first complaint is, "Why is the Fed raising rates when states like California and Hawaii are still in the doldrums?" c. The second is, "Why raise short-term rates now when there’s little sign o f inflation heating up?" In my remarks today, I’ll try to address these questions and explain the rationales for the short-term interest rate hikes. Let me start with a little background. A. After the recession, the national economy didn’t boom as it so often has. Instead, the recovery was pretty sluggish. 1. B. p:\parry\slc\slc8-2.1 The Fed did its part to keep things going by lowering short-term interest rates substantially. a. By the end of last year, short-term rates were about a third of what they were in early 1989. b. In fact, real short-term rates-that is, adjusted for inflation-were around zero levels throughout the year. These low short-term rates stimulated rapid growth in the interest-sensitive sectors of the economy-consumer durables, housing, and business investment. 1 1. C. III. And they led to average growth rates of anywhere from 3 to 3% percent for ’92, ’93, and the first half of ’94. This growth has brought us to the point where a good deal of the excess capacity that built up during the 1990 recession has evaporated: 1. Both the unemployment rate and the rate of unused industrial capacity have fallen rather sharply over the past year and a h a lf- 2. --within range of levels that most economists think represent "full" utilization. D. These circumstances suggest that continuing to stimulate the economy with such low short-term rates would lead to higher inflation. E. Now, as I said at the beginning, not everyone agrees that it was the right time to reduce the monetary stimulus. So let me address the first question: Shouldn’t the Fed keep stimulating the economy until the weaker regions gain more strength? Doesn’t the Fed care about regional performance? A. Part of the answer is that the Fed places great importance on understanding economic conditions in the various regions of the country. 1. p :\pany \slc\slc8-2.1 In this Federal Reserve District-the largest both in terms of geography and population—we have five o fficesa. -o u r headquarters in San Francisco, and four branches, including one right here in Salt Lake— b. each with its own set o f directors. 2. We rely on the directors to give us a good regional perspective on economic conditions, which is often quite different from what we hear from Wall Street or Washington, D.C. 3. For example, back in the fall o f 1987, a lot of people thought the stock market crash would reverberate throughout the country, and signal a major downturn. 4. But our directors told us it simply wasn’t having that big an effect on their business or geographic areas. 2 a. And they were right. b. The economy didn’t come to a screeching halt. B. In addition to providing assessments o f the region’s performance, the Directors also vote on the discount rate recommendation, which is then forwarded to the Board of Governors in Washington. C. Finally, the Research staff at each Bank uses the Directors’ input—as well as survey responses from local people and regional data—to prepare a report on regional conditions for the meetings o f the FOMC, the Fed’s monetary policymaking body. D. Here in the Twelfth District, these reports cover a lot o f territory- literally and figuratively-and a wide variety o f economic performance. 1. E. Here in Utah, job growth has been strong across a broad spectrum of industries. There are at least a couple o f good reasons for this performance. 1. 2. 3. p: \parry\slc\slc8-2.1 Right now, we have the nation’s three fastest growing states-Utah, Nevada, and Idaho—as well as its two poorest performers—Hawaii and California. One is that technological changes have made it easier to serve a huge market base from cities such as Salt Lake. a. This helps explain the rise in airline reservations activities, telemarketing, and credit card processing. b. And software-one o f the area’s fastest-growing industriesbenefits from being a high value-added product with low transportation costs. Another is that Utah has some notable attractionsa. its positive "lifestyle" characteristics, b. its welcoming business climate, c. and its productive workers. These attractions-together with the job growth-have drawn a lot of people from other states, especially from California. 3 4. 5. F. IV. This kind of growth doesn’t come without some unpleasant consequences, though. a. The boom has generated higher real estate prices, which have eroded Salt Lake City’s cost advantage somewhat. b. Still, the median house price here is only 80 percent o f the national average—and less than half that in major California cities. So, while the pace o f growth in Utah has to slow down at some point6 to 7 percent growth each year just isn’t sustainable for a long time— I’m quite optimistic about the overall prospects in this area. This kind of regional information plays an important role in determining the course of monetary policy. 1. In fact, it’s the subject of a good portion o f each FOMC meeting. 2. And we use it to fit together a picture of how the whole economy is doing. And that’s where the Fed’s emphasis has to be—on the nation as a whole. The Fed can ’t conduct monetary policy based mainly on helping out a particular state or region. A. The reason is simple: monetary policy works through national credit markets. 1. And, in the U .S ., credit markets are very efficient, a. B. 2. Therefore, monetary policy affects the economy as a whole. 3. That’s why it’s sometimes called a "blunt" instrument. Above and beyond the practical difficulties, there’s also a real danger in focusing too much on any one region of the economy that’s having a hard time. 1. p :\parry\slc\slc8-2.1 processing transactions from coast to coast in no more than a split second. Often enough, some state or region is going through a recession of its own while the national economy is humming along. 4 a. 2. If the Fed stimulated whenever any state had economic hard times, we’d be stimulating almost all the time. 3. And the upshot of that would be a very pro-inflationary environment, a. V. It’s simple arithmetic. If the nation is growing at, say, 3 percent, then some states are growing faster, and some are growing slower. and ultimately a deteriorating economy as well. Now let me turn to the second reason some people think the Fed should have maintained a stimulative policy: Inflation just doesn’t seem to be a problem now. A. The trouble with this view is that monetary policy is not only "blunt," as I’ve already mentioned, but it’s also subject to "delayed reactions": 1. It takes a long time for a policy action to produce results against inflation-probably from IV2 to 2 years. 2. This kind o f time lag means that we can’t wait until the problems show up in the data-a. 3. B. Instead, we have to anticipate problems, and pay attention to the warning signs. The current situation is a good example. It’s true that we haven’t seen an acceleration recently in the important inflation statistics, like the consumer price index. 1. C. In fact, recent inflation news has been favorable. But for a couple o f reasons, some action was warranted to prevent an increase in future inflation. 1. First, short-term real interest rates were near zero from late 1992 through 1993. a. p: \parry\slc\slc8-2.1 —by then w e’re likely to be too late. The last time these rates stayed at low levels for a long period was in the 1970s, just before the run-up in inflation in the late 70s and early 80s. 5 b. 2. Although the recent situation wasn’t nearly as dire as that one was, we didn’t want to risk even a small part o f that kind of problem again. Second, there’s much less slack in labor and product markets. a. In fact, we can’t be certain that any slack remains (1) D. because these things are notoriously hard to measure. b. This raises the chance that extra stimulus to the economy would sow the seeds of inflation in the future. c. Historically, once the economy has moved beyond its potential levels o f production and employment, the result has been higher inflation, with no long-run improvement in the unemployment rate. As a consequence, I think the steps w e’ve taken to raise rates are appropriate: 1. They guard against getting into this "no-win" situation by fostering stable, sustainable economic growth with low inflation. 2. Such forward-looking monetary policy helps avoid the "go-stop" economic environment o f the 1970s, and it’s much more likely to produce a lasting economic expansion. wc 1440 p :\parry\slc\slc 8-2.1 6
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