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THE U.S. OUTLOOK IN A GLOBAL SETTING Robert T. Parry President Federal Reserve Bank of San Francisco Delivered to Asia/Pacific Business Outlook Conference International Business Education and Research Program University o f Southern California Los Angeles March 17, 1992 The U.S. Outlook in a Global Setting I. Thank you very much. It’s a pleasure to be here. A. B. C. II. My topic today is the U.S. economic outlook. I believe this will be a critical year, 1. not only in terms of moving the U.S. economy out of recession and into recovery, 2. but also in terms of how the international stage is set for growth in the long run. Policymakers worldwide face a difficult task. 1. At this point, downturns or slowdowns have hit virtually every major economy. 2. And, at the same time, some of the most important trade agreements to foster long-term growth are on the table. 3. The pressure to sacrifice long-term growth for short-term gains in this environment is tremendous. Keeping these concerns in mind, let me take a quick look at the U.S. economy. After expanding for eight straight years, the U.S. economy fell into recession in the fourth quarter of 1990 and the first quarter of 1991. A. The downturn certainly was related to the Gulf War. 1. B. By the summer of ’91, with the war over, it looked like the recession was coming to a halt. Since then, we’ve seen growth, but it has been "anemic" at best. 1. With the notable exception of housing, demand in domestic sectors either was sluggish or actually declined in the final three quarters of last year. 1 2. Fortunately, our exports expanded at a brisk clip. a. 3. Overall, this sluggish economic growth put upward pressure on the unemployment rate. a. C. III. In fact, if it hadn’t been for strong foreign demand for U.S. products, our real GDP would have declined by Vi a percent last year, compared with the slight xh percent increase registered. It now stands at over 7 percent, more than a full percentage point above the level considered consistent with full employment. Inflation, however, has been a bright spot in the picture: the slack in labor and goods markets has restrained growth in labor compensation and product prices, 1. For example, the core rate of consumer inflation, which excludes food and energy, was 4 xh percent last year. 2. Although far from acceptable, it’s better than the 5U percent rate in 1990. 3. Moreover, I wouldn’t be surprised to see actual and core inflation come in around 3 percent this year. In view of the recession and lower inflation, the Fed has had the latitude to reduce interest rates substantially to promote economic recovery. A. Since July of 1990, the federal funds rate has been cut in half, B. and other short-term interest rates have dropped by almost as much. 1. C. The discount rate now stands at Vh percent, its lowest level since 1964. Long-term interest rates also declined fairly sharply last year, but since then they’ve reversed course a bit. 1. I must admit that I find it curious to see long-term bond rates 2 jump at any sign of an economic turnaround—as if market participants feared that the economy suddenly would "overheat." IV. 2. I think Federal Reserve policy will stimulate a sustained recovery—indeed, we’re starting to see some healthy signs in the most recent retail sales and employment numbers. 3. But at the same time, I believe we’ve also been careful to preserve hard-won gains against inflation. Instead of "overheating," I expect the economy’s expansion this year will be only moderate. Several factors will restrain growth. A. B. First, government budget deficits, as well as the end of the cold war, are leading to cutbacks in government spending and, in many cases, to higher taxes. 1. Although the upcoming elections have stimulated a spate of proposals for tax reduction, we still expect fiscal policy to have a contractionary effect over the next few years. 2. More balanced budgets definitely are good for the economy in the long run, but they can present some short-run adjustment problems in a slow-growth period. Second, we have a huge commercial real estate "overhang." 1. C. It may take years before high vacancy rates are worked down far enough to stimulate spending in this sector. Third, the unusual weakness in credit flows in the economy seems to be a drag on the recovery. While it’s difficult to tell how important this factor is, or how long it might last, credit conditions may well be having some effect. 1. The main problem seems to be with business lending, which has been unusually weak at banks. 2. Although part of the weakness is due to the recession itself, part is also due to stiffer regulation, which has constrained lending as banks try to build their capital to meet new requirements. 3 a. D. Finally, it’s difficult to find an engine of growth anywhere abroad, and, unlike last year, we don’t project any significant contribution of exports to U.S. growth in 1992. 1. V. While these changes are necessary for the long-run health of the industry and the economy, they may exact some costs in the transition. Since early 1990 the industrial countries seem to have been going through a rolling world recession, with Canada, our largest trading partner, and the U.K. the first to fall. I’d like to take a minute to focus on the downturns in Germany and Japan because of the importance of their economies to the rest of the world, and because of the contrast in the way their central banks have responded to the recession. A. B. Germany’s economy cooled markedly during 1991, recording little or no growth since the first quarter of 1991. 1. Recessions in other industrial countries and domestic tax increases to finance unification with East Germany clearly have hurt. 2. Compounding the problem are inflationary pressures, caused by the costs of unification, the pent-up demand for consumer goods by residents of the former East Germany, and a wave of recent wage increases. 3. The Bundesbank has responded by tightening monetary policy, which has raised interest rates to their highest levels since World War II. Slow growth and higher interest rates in Germany have reduced the prospects for growth in the rest of Europe in 1992. 1. C. Since the U.K., France, and Italy have a commitment to maintain the values of their currencies fixed against the DM within the European Monetary System (EMS), they’ve been compelled to keep their own interest rates high. Japan is a somewhat different story. After five years of strong real GNP 4 growth—averaging over 5 percent a year—the economy began to slow in the middle of 1991. VI. 1. The slowdown resulted from the lagged effects of a tighter monetary policy in 1989 and 1990 that was intended to prevent the economy from overheating. 2. But there was a concern that the Bank of Japan may have braked too hard. a. As a result, the Bank of Japan recently reversed course and began following a somewhat easier policy. b. Nonetheless, the slowdown is expected to continue into the first part of 1992. The "rolling world recession" has left some areas relatively untouched. A. In the Asia-Pacific region, estimates for Korea, Malaysia, Thailand, Taiwan, Singapore, and Indonesia indicate growth at or above a healthy 6 percent pace in 1991 and 1992. B. In Latin America, and Mexico in particular, estimates indicate a 5 percent growth rate in 1991 and 1992. C. This performance contributed to U.S. growth in 1991, and should provide some boost to the world economy in 1992; 1. D. VII. but even as a group, these areas don’t have the size to be the engine of growth for a sustained world recovery. So, for the near term, sluggish growth abroad is darkening the U.S. outlook. Global economic conditions represent a risk of a different sort to the long-term outlook for the U.S.—and, indeed, for the rest of the world. A. As economies slump further or are slow to recover, the risk grows that individual countries or regional trading blocs will try to grow at the expense of others by erecting trade barriers. 5 1. So it’s all the more important to sustain the long-term trend of trade liberalization a. 2. through successful conclusion of the current Uruguay round of GATT trade negotiations which have been underway since 1986. If a cycle of retaliation and counter-retaliation sets in, everybody is worse off. B. Current proposals in the negotiations would lead to freer trade in services (which now make up more than a quarter of world trade), farm products, and textiles. C. The talks are currently bogged down on a number of issues. 1. D. In order to enhance the chances of reaching an agreement this year—especially before elections in a number of countries—an April 15th deadline has been set. No doubt stronger growth both in the U.S. §nd abroad would help overcome the protectionist interests that oppose agreement. VIII. While the GATT multilateral negotiations have been going on, there also has been a trend towards increased economic regionalism. A. B. Many feel that the world trading system is moving towards a three-bloc regional trading system: 1. a European bloc, a North American bloc, and an Asian-Pacific bloc centered on Japan. 2. The concern is that these blocs would dissipate the multilateral gains achieved through GATT. However, because free trade associations stimulate greater trade within regions, 1. they demonstrate the prosperity that comes with the elimination of trade barriers. 6 2. C. The prime example, of course is the European Community. Over the last 30 years the EC has worked to lower tariffs and trade barriers against member countries. 1. D. To the extent that this trend has spurred growth in Europe, it has increased the market for U.S. exports. The intention of the North American Free Trade Agreement (NAFTA), currently under negotiation, is to establish a free trade area among the U.S., Canada, and Mexico.1 1. E. Therefore, they can also stimulate further steps toward multilateral liberalization. I believe NAFTA would convey beneficial effects similar to those Europe has experienced. I know that ASEAN (Association of South-East Asian Nations) countries have considered forming an Asian-Pacific trade bloc.2 1. The aim is to counter what they fear is increased protectionism from trade zones being created or proposed by the EC and the countries of the proposed North American trade bloc. 2. There have been a number of proposals in the last year—some have included Japan, and some have not. a. 3. The most recent plan is to create a free trade zone among the ASEAN countries alone within the next 15 years. However, the proportion of exports from individual ASEAN countries to other members is only around 10 percent at this point, so the benefits of a free trade zone among members alone may not be as great as it is for Europe and North America. ’The U .S. and Canada signed a pact in 1989, which is to be implemented over ten years. Negotiations are now underway to expand the arrangement to include Mexico. 2ASEAN, established in 1967, comprises Brunei, Indonesia, Malaysia, Philippines, Singapore, and Thailand. At a January 1992 summit, the ASEAN countries announced plans to create an ASEAN free trade zone (AFTA) within 15 years, and to address broader regional trade concerns within the Asia Pacific Economic Conference (APEC). 7 F. Overall then, regional trade arrangements need not cause trade wars between competing blocs; 1. IX. in fact, they should make it easier to achieve greater multilateral trade liberalization and world prosperity. In conclusion, as I hope I’ve made clear, world prosperity is critical also for prosperity in the U.S. A. But, as the U.S. economy struggles out of the recession, it’s all too easy to focus only on short-term policies to promote recovery. 1. B. And focusing too much on the short term is always a hazard in economic policy, especially in 1992. This year, decisions will be made on trade relations that will have great long-term significance. 1. The gains from freer trade will accrue not just for this year or the next year, but for the long-term, by inducing a permanent increase in economic activity worldwide. wc 1796 8
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