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Robert T. Parry, President
Federal Reserve Bank of San Francisco
UCLA Center for Finance and Real Estate Advisory Board, Los Angeles
for deliver~~ebruary 26, 1991
. ., ...... 091~~5 p.m. EST)
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1991
I.
Recession, Recovery, and War:
Prospects and Policy Issues in 1991
As the title of my speech suggests, the key elements of any
l'Bia~fl~c outlook for 1991 are the recession, the recovery,
~the war.
II.
A.
Although the NBER has not officially made the call, it
is pretty clear that we are in a recession.
B.
How did we get into it? How long will it last?
kind of recovery can we anticipate?
c.
The answers to these kinds of questions are never easy
to come by, and adding the uncertainties of war makes
it all the more difficult.
D.
In my remarks today, I'll touch on these and other
major uncertainties that will help determine the path
to recovery, and on how those uncertainties affect
monetary policy.
What
Let's begin by putting our current economic situation in
perspective.
A.
From 1982 to '89, economic growth was vigorous
averaging 3~ percent a year.
B.
But after the beginning of 1989 the economy slowed
substantially.
C.
Last quarter, the sluggish growth turned into an
outright contraction, hitting nearly every sector of
the economy.
D.
By now, as I said, it is pretty clear that this decline
will last long enough to qualify as a recession.
III. California, too, is feeling its share of the decline-including Southern California, which has been such an
economic powerhouse over the past decade. Let's review some
basic facts.
A.
Southern California has been an engine of economic
growth with national impact.
1.
In the 1980s, on net, one out of every 11 new jobs
in the nation was created in the greater LA area
1
and in San Diego.
2.
B.
Because the nation consumes much of Southern
California's output, however, the area is not immune to
national slowdowns in demand.
C.
While the Southern California economy continued to
expand long after regions like New England and New York
had slipped into recession, it now feels the effects of
the national slowdown.
1.
D.
IV.
Population growth also was strong, at 25 percent.
Job growth here, which was at a 2 percent annual
rate as recently as August, dropped to a 0.7
percent year-over-year rate in December.***
a.
Manufacturing has lost 3.2 percent of its
jobs, and construction employment has fallen
7 percent.
b.
Other hard-hit sectors include the high-tech
computer industry and defense-related areas.
But the story a lot of us are focusing on is real
estate.
1.
Sales activity is off by over 20 percent in most
areas, with Los Angeles suffering a 23 percent
decline and San Diego a 39 percent drop from a
year earlier.
2.
The number of residential building permits is off
37 percent, led by a 48 percent decline in singlefamily permits.
With the downturn being felt in many areas, it's not
surprising that a number of possible causes have been
proposed.
I'll say a few words about some major candidates.
A.
First, the credit crunch. There is concern that slow
growth in bank loans and the monetary aggregate M2 is
contributing to the current downturn, and that it
portends continued weakness in the economy.
1.
To me, "credit crunch" refers to a situation where
money is not available to broad groups of
creditworthy borrowers at any reasonable price.
2.
It's not clear that this is a major factor in
today's economy.
2
a.
It's true that the depository institutions,
especially S&Ls, have been in turmoil.
b.
Even sound institutions have grown more
cautious.
(l)
c.
3.
4.
B.
C.
But that's a normal and healthy response
to a riskier economic environment.
Research at the San Francisco Fed does
suggest that bank lending nationwide has been
somewhat lower than would normally be
observed at this stage of the business cycle,
though not in the Twelfth District.
At the same time, though, other credit markets
have been growing.
a.
Households have channeled larger amounts of
money directly to the credit markets through
increased holdings of government and private
securities.
b.
And nonbank intermediaries, like insurance
companies and mutual funds, have supplied
more credit.
Thus it remains to be seen how much of an effect
reduced bank lending is having on overall economic
activity.
Second, higher oil prices contributed to the economic
decline last year, although I doubt they are a full
explanation.
1.
There's no telling how long Iraqi and Kuwaiti oil
supplies will be off the world market, but
alternative sources of oil appear to be ample at
the present time.
2.
If the war drags on, we could be in for a bout of
higher oil prices, which could stunt growth in the
u.s. and abroad, and raise inflation for a time.
3.
However, based upon analysis of the much larger
oil shocks in the 1970s, the oil price hikes we've
seen to date are not big enough to explain the
recession.
The final factor I'd like to mention is sagging
consumer and business confidence.
3
1.
Two major surveys show very large declines in
confidence since the invasion of Kuwait last year.
2.
The list of political and economic uncertainties
affecting confidence is long enough to put quite a
chill on plans for big purchases or investment;
I'll just name a few:
3.
V.
a.
the war and the oil supply;
b.
the almost daily news of trouble--or just
change--in the financial industry;
c.
the climbing unemployment rate;
d.
and, the budget deficit.
Preoccupation with these uncertainties may go a
long way toward accounting for the unusual
weakness we've seen in consumer spending and
business investment.
But, there are some rays of hope in today's generally gloomy
economic environment.
A.
B.
The steep drop in the dollar since mid-89 should give a
substantial boost to our economy.
1.
A lower dollar makes our exports more attractive,
and should help to improve our trade balance.
2.
Growth in most of our major trading partners has
been more rapid than here, giving an added impetus
to demand for our products abroad.
a.
In contrast to most other sectors of the U.S.
economy, exports rose at a robust 8 percent
annual rate last quarter.
b.
However, that demand could be dampened if the
oil shock and tight monetary policy in some
countries slow growth abroad.
Second, inventories now are at relatively low levels,
especially in the manufacturing sector.
1.
Even in the face of last quarter's weak overall
demand, nonfarm inventories dropped by $20
billion.
2.
This is good news.
If inventories were high, then
we'd expect significatit further production cut4
backs, a typical scenario that has intensified
most other downturns.
C.
D.
Last, Fed policy has become more accommodative.
1.
Since July, short-term rates have dropped about 2
percentage points, in part in response to a series
of easing moves by the Federal Reserve. Most
recently, we reduced our discount rates 1/2
percent on February first, the second 1/2
percentage point since mid-December.
2.
Lower interest rates should begin to boost the
monetary aggregates and add strength to economic
activity in the next few months.
Thus, weighing the pluses and minuses, my best guess is
that we'll see a modest rebound in the latter half of
this year.
1.
But, given the war in the Middle East, we must be
prepared for a wide range of developments.
2.
A quick resolution of the conflict probably would
boost real GNP growth in the u.s. through improved
consumer and business confidence and lower oil
prices.
3.
The effects of a prolonged conflict on u.s.
economic activity are more difficult to gauge.
a.
VI.
High oil prices and consumer and business
uncertainty could reduce real GNP.
Let me turn now to inflation.
A.
There are signs that bode well for inflation later this
year and beyond.
1.
For example, some market indicators of inflation
have begun to look positive.
a.
Commodity prices are down from their peak in
the middle of last year, and growth in the
monetary aggregates has been slow.
b.
Long-term interest rates now are
substantially lower than in September,
perhaps suggesting an easing of inflation
expectations, as well as weakness in the
economy.
2.
3.
More importantly, the inflationary effects of the
oil shock are beginning to dissipate.
a.
The annual consumer inflation rate, which had
jumped to 9 percent between August and
October, dropped back to around 4 percent
between November and January.
b.
Of course, if the war goes on for long, we
may see higher oil prices and inflation. But
assuming the war·is fairly short, the worst
effects of the oil shock may be behind us.
Finally, there are signs that underlying inflation
has peaked, and may even be on a slightly downward
trend.
a.
The latest figures show some slowing in the
growth of wages, salaries, and benefits.
b.
This may reflect the recent slackening that
has developed in labor markets, as the
unemployment rate has risen by nearly 1
percent since early 1990.
c.
Although the lower dollar is raising the cost
of our imports and temporarily pushing up
prices, improvements in underlying inflation
should be felt by year-end.
VII. Given these possibilities, probabilities, and uncertainties,
what are the appropriate directions for monetary policy?
A.
B.
Maintaining sustainable economic growth is one of the
Fed's most important concerns, and we have responded to
to the wide-spread signs of weakness in the economy.
1.
The series of moves ~ince July to lower interest
rates should help to prevent a prolonged downturn.
2.
We estimate that the decline in interest rates
since then is likely to add about 1 to 1~ percent
to real GNP growth this year.
At the same time, we've got to be careful not to reignite inflation.
1.
Monetary policy affects the economy with a
considerable lag. Today's actions to offset
current weakness will'be felt mainly after midyear, when the economy already may be picking up .
6
2.
C.
We don't want to over-react to the downturn, and
thereby lose or even reverse hard-won gains on
underlying inflation.
Thus the present environment requires that the Fed do a
delicate balancing act: guarding against the risk of a
prolonged downturn, while maintaining a longer-term
perspective, so that we do not lose sight of our
ultimate goal of eliminating inflation.
(word count = 1622)
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@FedFRASER