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Robert T. P a rr y , P r e s id e n t
Federal Reserve Bank o f San Fra
I n t e r n a t i o n a l Bankers A s s o c ia tio n
Carmel, C a l i f o r n i a
For delivery November 5, 1993 , 5:00 p.m. PST
The Global Slow down, Deficit Reduction, and the U .S . Economy:
A M onetary Policym aker’s Perspective
I.
Today I ’d like to give you my views on the U.S. economy.
A.
I want to start by focusing on the short run.
B.
Three major factors now dominate the U.S. economic outlook:
C.
1.
the U.S. government’s fiscal policy
2.
conditions in the global economy,
3.
and finally, our own monetary policy.
In the short run,
1.
the government’s fiscal policy is having a contractionary effect on the
economy, as we work to reduce the budget deficit.
2.
Global economic conditions are mixed.
3.
D.
a.
In the Pacific Rim, we’re seeing strong growth, which creates
demand for U.S. exports.
b.
But among most of the developed countries, there’s significant
weakness—enough to create another major contractionary effect.
In the plus column is monetary policy, which has cut short-term interest
rates substantially—if cautiously—in the past few years.
Taken altogether, this probably adds up to
1.
moderate real GDP growth of between 2Vi to 3 percent through the end
of next year,
2.
small reductions in the unemployment rate,
3.
and some modest reductions in inflation.
E.
This short-run picture isn’t what’s usually considered "normal."
1.
F.
If we take a longer view, though, we’ll see that the current situation isn’t
"normal" because we’re actually in a period of transition.
1.
II.
The recession has been over for two years, but output has grown by
only about half the average for the previous five recoveries.
The adjustments being made today in fiscal and monetary policies here
and abroad are "building the bridge" toward a healthier economic
environment in the future.
Let me begin by looking at fiscal policy and the effects of the new budget plan.
A.
W e’ve seen cutbacks at all levels of government for a while now, both because
of deep cuts in defense and because of budget deficits at all levels of
government.
B.
As I’m sure you know, the new budget plan promises even more cuts, as well
as higher taxes,
1.
C.
So long as Congress and the Administration follow through, it looks like the
plan will trim the deficit.
1.
2.
D.
both of which will weaken demand.
According to recent estimates from the Congressional Budget Office,
a.
the budget plan will knock about $50 billion off what the deficit
would have been in 1994
b.
and cumulatively a little more than $475 billion over the next
five years.
And surprisingly, it manages to do so by balancing the tax increases
with roughly equal spending cuts.
Now, I certainly could argue over some of the provisions.
1.
For example, I would have preferred more emphasis on spending cuts
and on consumption taxes rather than income taxes.
2.
Furthermore, some of the scheduled cuts in federal health costs may
not all come through—depending on how the debate shakes out on
i
health care.
3.
III.
Now let me turn to the effects of the economic performance of our trading partners,
which, as I said, has been mixed.
A.
IV.
But I do think overall this budget plan does represent a serious attempt
at deficit reduction, which will be contractionary in the short run, but
good for long-run growth.
The good news is that we’ve had a boom in exports to developing countries in
Asia and Latin America.
1.
Robust growth in U.S. exports to Asia is likely to continue because
these countries are booming economically.
2.
The potential for continued robust export growth to Latin America is
less clear.
a.
It depends importantly on whether this region continues to enjoy
easy access to the markets of the major industrial economies.
b.
If the Uruguay round of GATT trade negotiations and the North
American Free Trade Agreement are approved, then the boost
that gives Latin American economies could benefit the U.S.
Unfortunately, for now these positive ('actors are outweighed by the contractionary
effects of the industrial economies.
A.
For a couple of years, economic activity among these countries has been
lackluster, or worse.
1.
If we look at the other G-7 countries—Canada, France, Germany, Italy,
the UK, and Japan—we see that
a.
collectively, their output expanded by only Vh percent in 1991,
and by only 1/4 percent in 1992.
B.
What’s going on? Well, for different reasons, both Japan and Germany have
been following fairly tight monetary policies, especially in the last few years.
C.
First, Japan:
1.
After years of strong expansion and phenomenal growth in asset values,
in 1989 the central bank put on the brakes to head off inflation.
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2.
D.
E.
In Germany,
1.
the high costs of reunification begun in 1990 created inflationary
pressures,
2.
and the central bank has been insistent about keeping inflation under
control.
3.
The result is that in the past year, the German economy has been in a
recession.
The downturn in Germany also led to slow growth or recession in some of the
other members of the European Community—largely because the European
Exchange Rate Mechanism committed them to following Germany’s lowinflation policy.
1.
F.
V.
but they haven’t weakened the commitment to maintaining low-inflation
policies for EC member countries.
Why the emphasis on low inflation?
1.
H.
But for some countries, the tight policies were far too tight, and so, as
you know, we saw more than one exchange rate crisis in Europe over
the past year.
These crises have weakened the Exchange Rate Mechanism,
1.
G.
The result was a collapse in money growth, which led to a big dive in
asset values and sent the economy into recession.
The reason, I think, is that there’s widespread recognition that high
inflation doesn’t make economic problems better—it makes them worse.
So, even though it’s a hard pill to swallow, most developed countries have
tried to reduce their inflation rates in recent years.
Finally we come to US monetary policy, which has worked to offset the
contractionary effects of our fiscal policy and slow growth abroad, while continuing
to make progress on the inflation front.
A.
Since the economy turned sluggish about four years ago, the Fed has lowered
short-term interest rates substantially—
1.
to about a third of what they were in early 1989.
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2.
B.
That’s helped bring down long-term rates—to a record low in the case
of 30-year Treasuries.
Though the drop in rates was substantial, the Fed proceeded cautiously.
1.
First, we were concerned about the message w e’d send to financial
markets.
a.
2.
C.
Second, w e’ve had the same concerns about inflation that Japan,
Germany, and the other EC members have.
That’s why the Fed has made clear that over the long run, its goal is to move
gradually towards price stability.
1.
VI.
If we had moved too rapidly, markets would have worried about
a possible rise in inflation, which would have raised long-term
interest rates and harmed the recovery.
My best guess is that we will see some further improvement in inflation
in 1994, since there’s still slack in labor and product markets.
To sum up, prospects for the U.S. economy over the next year or so are for moderate
economic growth and some downward adjustment of inflation.
A.
This isn’t the boom some people might like to see.
B.
But it is respectable growth.
C.
And it’s also consistent with taking steps toward stronger, less volatile
economic growth in the long term—through
1.
better prospects of reducing the federal budget deficit
2.
and continued progress in reducing inflation in the U.S. and in most of
our major trading partners.
D.
Although we have a long way to go in achieving our goals in both of these
policy areas, we are making progress.
E.
And these are steps we’ll have to cross if we’re to realize the maximum
growth potential of our economy.
wc 1240
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@FedFRASER