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SILAS KEEHN: Monetary Policy Perspectives June 1991 Michigan Economic Forums 6/11/91 -- Lansing (breakfast) 6/11/91 -- Kalamazoo/Battle Creek (P.M. reception) 6/12/91 -- Grand Rapids (breakfast) Slide 1 -- Title slide: Monetary Policy Perspectives I. https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis INTRODUCTORY REFLECTIONS. A. HARD TO RECALL A TIME IN THE LAST FEW YEARS WHEN THE OFTEN CITED CHINESE CURSE "MAY YOU LIVE IN INTERESTING TIMES" HAS BEEN MORE APPLICABLE. 8. AS KARL NOTED: 1. NOW CLEAR THAT WE HAVE HAD A FEW QUARTERS OF NEGATIVE ECONOMIC GROWTH. 2. BUT THE RECESSION APPEARS TO BE NEARING AN END, ALTHOUGH CLEAR SIGNS ARE SPARSE. 3. GROWTH WILL RESUME LATER THIS YEAR, BUT IT IS NOT EXPECTED TO BE A STRONG RECOVERY. C. THIS PERIOD OF RECESSION MIGHT BE VIEWED AS A TRANSITIONAL PHASE FOR THE ECONOMY. 1. AN ADJUSTMENT TO SOME UNUSUAL DEVELOPMENTS OVER THE LAST FEW YEARS. \<t1L)\n ~~..,~ 6--~• - • - 1 V'v ~ ~ ~ Slide 2: (transition) The legacy of the 1980s II. https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis NEED TO LOOK BACK ON THE LAST DECADE. A. RECOGNIZE THE LEGACY OF THE l 980s. 8. SO WE CAN LOOK FORWARD TO 1. WHAT'S IN STORE FOR US FURTHER IN THIS DECADE. ~ 91 Page 2 615/91 Page3 Slide 3: The 1980s - a rewarding period Ill. https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis REFLECTING BACK ON THE DECADE OF THE 1980s --A REWARDING PERIOD -- BUT THAT PARTY NOW OVER A. WON'T SPEND A LOT OF TIME REVIEWING THE NUMBERS. 1. ALREADY SEEMS LIKE A LONG TIME AGO. 2. MOST ARE WELL KNOWN TO ALL OF YOU. (Chart: Real GNP) B. LONGEST PEACETIME EXPANSION IN OUR HISTORY. 1. 92 MONTHS, OR 7-2/3 YEARS, LONG (NOVEMBER 1982 TO JULY 1990) 2. C. a. ACCORDING TO OFFICIAL NBER STATS b. AVERAGE LENGTH IS LESS THAN 3 YEARS. EXCEEDED ONLY BY THE 1960-69 EXPANSION. a. FUELED BY THE VIETNAM WAR. b. AND OUR THEN GUNS AND BUTTER POLICY. NOT ONLY LONG, ALSO PERIOD OF VERY STRONG GROWTH. 1. REAL GNP INCREASED 32% FROM 82Q4 TROUGH TO 90Q3 PEAK. a. EQUAL TO A COMPOUNDED ANNUAL GROWTH IN REAL GNPOF3.6%. b. IN INFLATION-ADJUSTED TERMS, AN INCREASE OF OVER $1 TRILLION OVER THE 82Q4-90Q3 EXPANSION. https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 6/5/91 Page4 (Chart: Industrial production) D. INDUSTRIAL PRODUCTION PEAKED IN AUGUST 1990 1. AT A LEVEL 39% ABOVE ITS DECEMBER 1982 TROUGH. 2. OUR MANUFACTURING FACILITIES PRODUCED MORE PRODUCTS THAN EVER BEFORE. (Chart: Payroll employment) E. EMPLOYMENT - PERHAPS THE MOST EXCITING PART. 1. ADDED OVER 22 MILLION NEW JOBS FROM EMPLOYMENT TROUGH IN DECEMBER 1982 TO ITS JUNE 1990 PEAK 2. PAYROLL EMPLOYMENT POOL - PEAKED AT 110.829 MILLION IN JUNE 1990 (FELL TO 109.162 MILLION BY APRIL 1991) 3. CONTRAST WITH OTHER INDUSTRIALIZED COUNTRIES UNPARALLELED EXPERIENCE (Chart: CPI) F. INFLATION - ALTHOUGH STILL HIGHER THAN IN 1950s AND 1960s 1. CAME DOWN FROM DOUBLE-DIGIT PACE OF 1970s AND EARLY 1980s 2. HAS BEEN RELATIVELY STABLE INFLATION RATE, ESPECIALLY WHEN VOLATILE FOOD AND ENERGY COMPONENTS EXCLUDED. 6/5/91 Pages Slide 4: ... but uneven performance IV. BUT EVEN BEFORE CURRENT NATIONAL RECESSION, CERTAINLY WAS AN UNEVEN EXPERIENCE · (Chart: Regional employment) A. GEOGRAPHICALLY -- CAN SEE IN EMPLOYMENT TRENDS. 1. SOUTHWEST -- STILL RECOVERING FROM 1986 OIL PRICE DROP SHOCK. 2. NEW ENGLAND -- IN DECLINE AFTER EXCEEDING U.S. EXPERIENCE FOR MOST OF EXPANSION. 3. B. MIDWEST -- STILL BELOW U.S. AND INDIVIDUAL COMPONENTS OF OUR ECONOMY HAVE ALSO HAD A VERY UNEVEN EXPERIENCE. (Chart: Auto sales) 1. PRIME EXAMPLE -- AUTOMOTIVE SECTOR. a. ADJUSTMENTS TO COMPETITION FROM IMPORTS, THEN TRANSPLANTS. b. RESTRUCTURING AS RESULT OF THESE MARKET CHANGES. (Chart: Industrial production) C. AND OUTPUT OF OTHER SECTORS ALSO UNEVEN. 1. BUSINESS EQUIPMENT -- GENERALLY VERY STRONG, BUT WITH ITS UPS AND DOWNS. 2. https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis CONSUMER PRODUCTS -- NOT AS ROBUST, BUT STEADIER. https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 6/5/91 Page6 3. DEFENSE -- COMING DOWN NOW AFTER STRONG GROWTH. (Chart: Construction spending, current dollars) D. UNEVEN PERFORMANCE IN CONSTRUCTION SPENDING AS WELL. 1. COMMERCIAL AND RETAIL -- THEY STAYED AT THE PARTY A VERY LONG TIME AND AS WE ARE NOW LEARNING, PERHAPS TOO LONG. 2. RESIDENTIAL -- SINGLE-FAMILY AS WELL AS APARTMENTS -- ON ANNUAL AVERAGE BASIS -- CONTINUED TO RISE THROUGH 1988. 3. NONRESIDENTIAL -- OFFICES, STORES, HOTELS AND MOTELS, ETC. -- COOLED SOME IN 1986-87 BY ANTICIPATED AND ACTUAL 1986 TAX LAW CHANGES, BUT THEN RESUMED RISING THROUGH 1990. 4. PUBLIC SECTOR SPENDING -- RISING THROUGHOUT UP UNTIL 1991. E. BUT DESPITE THIS UNEVENNESS, IN A BROAD AGGREGATE SENSE. 1. AND FROM A MONETARY POLICY PERSPECTIVE, THAT'S HOW WE HAVE TO LOOK AT IT. 2. WE HAD A VERY STRONG EXPERIENCE DURING THE LAST DECADE -- OR CERTAINLY FROM END OF 1982 THROUGH MID1990. 6/5/91 Page 7 Slide 5: . .. and imbalances developed V. https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis LIKE THAT LAST DRINK --WE TRIED TO FORGET SOME OF THE PROBLEMS -THE DEVELOPING IMBALANCES -- OR AT LEAST PUT THEM IN THE BACK OF OUR MINDS. (Chart: Federal deficit) A. FEDERAL BUDGET DEFICIT 1. A PROBLEM THAT SPEAKS FOR ITSELF. 2. HISTORY-- NEVER HAVE WE GONE THROUGH AN ECONOMIC EXPANSION WITH A BUDGET DEFICIT RELATIVE TO THE SIZE OF THE ECONOMY AT THESE LEVELS. (Chart: Net international investment position) B. TRADE DEFICIT 1. A HISTORY OF RUNNING OUR TRADE ACCOUNTS WITH A SLIGHT SURPLUS -- FELL OVER THE EDGE OF THE CLIFF IN 1982. 2. IN THE PROCESS OUR NET INTERNATIONAL INVESTMENT POSITION SHIFTED - WENT FROM BEING THE WORLD'S LARGEST EXTERNAL CREDITOR TO THE WORLD'S LARGEST EXTERNAL DEBTOR. 3. AND BECAME ABSOLUTELY DEPENDENT ON THE FLOW OF CAPITAL FROM ABROAD. https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 615191 PageB (Chart: Corporate debt to net worth) C. ALSO SAW A MASSIVE BUILD-UP OF CORPORATE DEBT -CORPORATE RESTRUCTURING$. 1. FINANCED BY INCREASES IN DEBT WITH ABSOLUTE REDUCTIONS IN EQUITY. 2. WE ENDED THE DECADE WITH A VERY HIGH DEBT-TO-NET WORTH RATIO. (Chart: Household debt) D. PERSONAL DEBT LEVELS ALSO ROSE TO A RECORD POINT. 1. TOTAL HOUSEHOLD DEBT AS A PERCENTAGE OF DISPOSABLE INCOME ROSE TO DISTURBINGLY HIGH LEVELS. E. AS A CONSEQUENCE OF THESE TRENDS, WE ENDED THE DECADE IN A VERY LEVERAGED POSITION. F. THE U.S. ECONOMY BECAME ABSOLUTELY DEBT DRIVEN. G. TO A CONSIDERABLE EXTENT THE SIGNIFICANT INCREASE IN DEBT THAT WE EXPERIENCED FUELED THE STRONG EXPANSION OF THE 1980s. 1. IN THAT ASPECT, THE AWKWARD ANALOGY WITH THE PARTY OVERLY-ENJOYED. 2. REALISTICALLY, WE COULDN'T HAVE EXPECTED IT TO LAST FOREVER. 615191 Page9 Slide 6: The 7980s -- a decade of consumption, much financed by foreigners VI. IMPORTANT TO REMEMBER THAT THE 1980s WAS A CONSUMPTION DECADE. (Chart: Domestic spending vs. output) A. WHEN WE LOOK AT OUR PURCHASES RELATIVE TO WHAT WE MADE, WE SEE THAT 1. WE SPENT FAR MORE THAN WE PRODUCED AND 2. AND AS I NOTED BEFORE, THIS WAS LARGELY FINANCED WITH DEBT. (Chart: Foreign capital inflow) B. MOREOVER, MUCH OF THAT CONSUMPTION WAS FINANCED WITH CAPITAL FROM ABROAD. (Chart: Debt owed foreigners) C. AND, WITH A RISE IN THE PROPORTION OF TOTAL DEBT OWED TO FOREIGNERS. 1. THIS LEAVES US WITH AN ENORMOUS BAR BILL TO PAY. 2. AND LIKE A HANGOVER, WE MAY WELL SUFFER FOR OUR EXTRAVAGANCE. https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 615191 Page 10 (Chart: Net interest paid by U.S. nonfinancial firms) D. WHEN WE LOOK AT NET INTEREST PAID BY OUR NONFINANCIAL CORPORATIONS, WE SEE THAT 1. SERVICING THE DEBT HAS BECOME AND WILL CONTINUE TO BE A DRAIN ON BUSINESS SAVINGS. 2. AS A CONSEQUENCE, WE COULD HAVE LOWER INVESTMENT BY INDEBTED FIRMS THAN OTHERWISE WOULD HAVE BEEN THE CASE. 3. THIS WILL RESULT IN SLOWER ECONOMIC GROWTH. 4. AND MORE MODEST GAINS IN PRODUCTIVITY WHICH WILL HAVE UNFORTUNATE IMPLICATIONS FOR OUR COMPETITIVE POSITION. 6/5/91 Page 11 Slide 7: ... but flow of funds from abroad won 't continue VII. https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis MOREOVER, WE CAN'T EXPECT THE FLOW OF FUNDS FROM ABROAD TO CONTINUE AS AN ABSOLUTE GIVEN. (Chart: Trade weighted dollar) A. THE VALUE OF THE DOLLAR -- GENERALLY DECLINED AND THEREFORE DOLLAR ASSETS BECAME LESS ATTRACTIVE. (Chart: Government bond rates) B. THE INTEREST RATE DIFFERENTIALS WHICH GAVE US AN ADVANTAGE HAVE NOW REVERSED. 1. U.S. GOVERNMENT BOND RATES, WHICH WERE SUBSTANTIALLY ABOVE GOVERNMENT BOND RATES IN GERMANY AND JAPAN, FOR EXAMPLE, 2. ARE NOW BELOW GERMAN RATES AND ONLY MARGINALLY HIGHER THAN RATES IN JAPAN. (Chart: Current account and foreign capital inflow) C. BY DEFINITION, THE DESIRED IMPROVEMENT IN OUR CURRENT ACCOUNT BALANCE IS MATCHED BY SMALLER CAPITAL INFLOWS. 6/5/91 Page 12 (Chart: Income receipts from/payments to foreigners) D. AND ON TOP OF THIS, WE ARE HAVING TO BEGIN SERVICING OUR VERY LARGE EXTERNAL DEBT. 1. BY SOME ESTIMATES, SERVICING THIS DEBT IN TERMS OF INTEREST AND DIVIDENDS PAID MAY RUN ABOUT $75 BILLION A YEAR. 2. IN OTHER WORDS, ROUGHLY 1% OF GNP OR AS MUCH AS 1/3 OF EACH YEAR'S INCREASE IN THE OUTPUT AND INCOME OF OUR ECONOMY DEDICATED TO SERVICING OUR INTERNATIONAL DEBT. https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 615/91 Page 13 Slide 8: The 1980s -- chose consumption over investment VIII. IF WE HAD UTILIZED THE PROCEEDS OF THESE FUNDS TAKEN FROM INTERNATIONAL SOURCES TO INCREASE OUR PRODUCTIVE INVESTMENTS TO PROVIDE INCREASED INCOME TO SERVICE THE DEBT -- THAT WOULD HAVE BEEN FINE. (Charts: Consumption and investment) A. BUT TO A LARGE EXTENT, THE FUNDS WERE USED FOR CONSUMPTION RATHER THAN INVESTMENT. 1. CONSUMER SPENDING PROPORTION OF REAL GNP ROSE IN THE 1980s. 2. THE PROPORTION OF REAL GNP GOING TO NET PRIVATE DOMESTIC INVESTMENT, HOWEVER, FELL. B. AND THEREFORE WE ARE LEFT WITH THE DEBT BUT WITHOUT THE IMPROVED MEANS TO REPAY IT. Slide 9: (transition) 1990/91: a period of transition IX. https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis EARLY TO JUDGE, BUT 1990/91 MAY WELL TURN OUT TO BE THE TRANSITION PERIOD. A. NOW GOING THROUGH THE ADJUSTMENT TO THESE FORCES 8. THE TRANSITION PHASE. 615/91 Page 14 Slide 70: 7990/91 --private debt adjustment underway X. https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis BEGINNING TO SEE THE PRIVATE SECTOR DEBT ADJUSTMENT (Chart: Net funds raised by nonfinancial corporations) A. CORPORATE DEBT -- SHOWING SIGNS OF IMPROVEMENT -- RAISING LESS THROUGH DEBT -- LESS EQUITY BEING RETIRED. 1. WE ARE RETURNING TO THE BASICS. 2. BORROWERS AND LENDERS ALIKE HAVE RECOGNIZED THAT EQUITY AND CAPITAL DO MATTER. 3. AND THEY ARE RETHINKING THEIR ATTITUDES WHICH HAVE SEEMED VERY DEBT-ORIENTED FOR TOO LONG. 4. IN THE CASE OF LENDERS, CREDIT STANDARDS HAVE BEEN TIGHTENED. a. CREDIT CRUNCH -- NOT SO IN A LIQUIDITY SENSE. b. WHILE AT THE MARGIN THE SUPERVISORY ELEMENT MAY HAVE STRENGTHENED THE DISCIPLINE. c. IT SEEMS TO ME THAT A SELF-CORRECTING PROCESS, WHICH I THINK IS JUST THE WAY THAT THIS SHOULD HAPPEN, IS, IN FACT, OCCURRING. https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 615/91 Page 15 (Chart: Consumer installment debt) B. AS I HAVE NOTED, CONSUMER DEBT LOADS ARE STILL VERY HEAVY. 1. THIS IS WORRYING, PARTICULARLY AS UNEMPLOYMENT RISES AND DISPOSABLE INCOME GAINS MODERATE. 2. WE ARE GOING TO HAVE SOME TROUBLE -- THERE WILL BE SOME LOSSES. 3. BUT ULTIMATELY THE CONSUMER IS PRETTY CAUTIOUS AND CAREFUL. a. INSTALLMENT CREDIT AS A PERCENTAGE OF DISPOSABLE INCOME LEVELED OFF b. 4. AND HAS STARTED TO DECLINE. BUT REMEMBER THESE LOANS HAVE BEEN USED IN MANY CASES TO FINANCE CONSUMPTION. a. AS THE DEBT LEVELS COME DOWN SO ALSO DOES CONSUMPTION WITH AN IMPACT ON OUR ECONOMIC PERFORMANCE. 6/5191 Page 16 Slide 11: 7990/91 -- international adjustment proceeding XI. https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis THERE HAVE BEEN SOME SIGNIFICANT IMPROVEMENTS IN THE INTERNATIONAL ASPECT OF OUR CONSIDERATIONS AS WELL. (Chart: Real net exports and trade weighted dollar) A. THE LOWER DOLLAR, WHICH ADMITTEDLY HAS SOME NEGATIVE ASPECTS, 1. CONTRIBUTED TO IMPROVEMENT IN OUR TERMS OF TRADE a. THAT IS, OUR EXPORT PRICES RELATIVE TO PRICES OF GOODS AND SERVICES WE IMPORT CAME DOWN 2. WHICH, IN TURN, EVENTUALLY HELPED OUR NET EXPORTS. (Chart: Imports and exports of goods and seNices) 8. OUR REAL EXPORTS OF GOODS AND SERVICES HAVE BEEN RISING RAPIDLY 1. WHILE OUR REAL IMPORTS LEVELED OFF AND THEN FELL 2. THIS COMBINATION OF DEVELOPMENTS LED TO THE CLOSING IN THE GAP BETWEEN OUR EXPORTS AND IMPORTS OF GOODS AND SERVICES IN THE FIRST QUARTER OF 1991. https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 615/91 Page 17 (Chart: Average U.S. productivity growth) C. OUR MANUFACTURING SECTOR HAS ACHIEVED EXCELLENT PRODUCTIVITY GAINS. 1. THE OVERALL PRODUCTIVITY NUMBERS ARE BLURRED BY THE SERVICE COMPONENT. 2. THE PRODUCTIVITY GAINS IN MANUFACTURING DURING THE 1980s SURPASSED THOSE OF PREVIOUS THREE DECADES. 3. AND MY IMPRESSION FROM TALKING TO PEOPLE WHO RUN MAJOR MANUFACTURING OPERATIONS IS THAT a. WITH THE LOWER DOLLAR AND PRODUCTIVITY GAINS b. WE HAVE ONCE AGAIN BECOME COMPETITIVE IN THE WORLD'S MARKETS. (Chart: Merchandise trade balance) D. AND THIS IS SHOWING UP IN AN IMPROVEMENT IN THE MERCHANDISE TRADE NUMBERS ESPECIALLY WHEN WE EXCLUDE OIL IMPORTS. 6/5191 Page 18 Slide 12: 1990/91 -- Federal budget deficit adjustment, a step in right direction XII. https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis ONE OF THE KEY QUESTIONS IS WHETHER WE HAVE OR WILL MAKE THE TRANSITION ON THE BUDGET DEFICIT PROBLEM. A. DEFICIT IN FISCAL 1990 WAS $220.4 BILLION, JUST SHY.OF THE RECORD $221.2 BILLION IN FISCAL 1986. B. MOREOVER, THE BUDGET NEGOTIATIONS LAST YEAR WERE A ·GUT· WRENCHING" EXPERIENCE. 1. RAISED CONCERNS DOMESTICALLV AND INTERNATIONALLV ABOUT U.S. GOVERNANCE. 2. HIGHLIGHTED THE WIDE DIVISIONS ON NATIONAL OBJECTIVES, HOW THEY ARE WEIGHTED AND HOW WE CAN ACHIEVE THEM. (Text: October 1990 budget deficit package and Chart: October 1990 deficit reduction package) B. BUT, THE BUDGET PACKAGE FINALLY ENACTED LAST OCTOBER SHOULD BE VIEWED AS A STEP IN THE RIGHT DIRECTION. 1. ALTHOUGH MANY QUESTION VALIDITY OF UNDERLYING ECONOMIC ASSUMPTIONS, AND RESULTING PROJECTIONS. 2. RECENT CBO ESTIMATES SHOW THE PACKAGE REDUCING DEFICIT BY ALMOST $500 BILLION OVER FIVE YEARS. a. OUTLAVS ARE EXPECTED TO BE ABOUT $325 BILLION LESS THAN THEY WOULD HAVE BEEN, https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 6/5/91 Page 19 b. REVENUES ARE SEEN ABOUT $160 BILLION ABOVE WHAT THEY WOULD HAVE BEEN. C. BUT, MORE IMPORTANT PERHAPS THAN THE PROJECTED NUMBERS ARE THE CHANGES IN THE BUDGET PROCESS INCLUDED IN LAST OCTOBER'S PACKAGE: 1. THE BUDGET FOCUS WAS CHANGED FROM TRYING TO ACHIEVE SPECIFIC DEFICIT TARGETS TO HOLDING SPENDING WITHIN SPECIFIED LIMITS OR CAPS, 2. IN THE NEW BUDGET PROCESS, DISCRETIONARY SPENDING IN EACH OF THREE CATEGORIES -- DEFENSE, INTERNATIONAL, AND DOMESTIC -- IS ON A "PAY AS YOU GO" BASIS. a. MEANING THAT IF SPENDING WITHIN ONE OF THESE AREAS IS TO BE INCREASED, b. THEN REVENUES MUST BE INCREASED AND/OR OTHER SPENDING IN THE SAME CATEGORY MUST BE REDUCED AT THE SAME TIME, c. 3. SO THAT THERE IS NO NET IMPACT ON THE DEFICIT. IN ADDITION, IF APPROPRIATIONS DO LEAD TO SPENDING ABOVE CAPS, THEN "MINI SEQUESTERS" ARE IMPOSED WITHIN THE DISCRETIONARY SPENDING CATEGORY TO BRING SPENDING BACK TO THE IMPOSED LIMITS. https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 6/5/91 Page20 (Text: Deficit outlook better with package, and Chart: The deficit outlook) D. DESPITE SIZABLE REDUCTIONS MADE IN THE DEFICIT AS RESULT OF LAST OCTOBER'S BUDGET PACKAGE 1. DEFICIT THIS YEAR AND NEXT STILL SIZABLE. a. PART DUE TO IMPACT OF ECONOMY ON REVENUES AND BUILT-IN STABILIZERS LIKE UNEMPLOYMENT INSURANCE. b. PART DUE TO DEPOSIT INSURANCE COSTS ASSOCIATED WITH RESOLVING THRIFT SITUATION. c. PART DUE TO COSTS OF GULF WAR, ALTHOUGH SOME OF THIS WILL BE OFFSET BY CONTRIBUTIONS FROM OTHER NATIONS. 2. STILL MEANS A CONTINUED PRESENCE OF THE TREASURY IN THE CAPITAL MARKETS TO FINANCE THE DEFICIT a. PUTS UPWARD PRESSURE ON OUR INTEREST RATE STRUCTURE. b. AND IN ITSELF, THIS IS AN INHIBITOR OF ECONOMIC GROWTH. 3. BUT, AS ECONOMISTS WOULD SAY, a. THAT UPWARD PRESSURE ON INTEREST RATES IS LESS THAN IT WOULD HAVE BEEN b. WITHOUT FISCAL POLICY ACTIONS TAKEN LAST OCTOBER. 615/91 Page21 Slide 73: Key to successful transition: Price stability XIII. https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis FROM A MONETARY POLICY PERSPECTIVE, A TRULY SUCCESSFUL TRANSITION WILL BE DEPENDENT ON OUR PROGRESS TOWARD PRICE STABILITY. A. AN INFLATIONARY ENVIRONMENT WON'T HELP THE ADJUSTMENT PROCESS. 8. 1. WILL ONLY EXACERBATE THE DEBT PROBLEMS. 2. AND CREATE NEW PROBLEMS ON THE INTERNATIONAL SIDE. THERE IS THE GROWING INTERNATIONAL COMPONENT TO OUR ECONOMY. 1. OUR ECONOMY FORMERLY OPERATED IN A SOMEWHAT SELFCONTAINED ENVIRONMENT. a. OUR VARIOUS IMBALANCES WERE NOT EXPOSED TO THE WORLD MARKETS. b. WE ARE NOW INTER-TWINED IN A GLOBALIZED ECONOMY. c. AND THE INDIVIDUAL ASPECTS OF OUR ECONOMY, BOTH GOOD AND BAD, ARE RIGHT IN THE CRUCIBLE OF THE WORLD'S FOCUS. C. HAVE BEEN MAKING PROGRESS ON INFLATION, ALBEIT SLOWLY. 1. OUR COMMITMENT CONTINUES TO BE TO PROVIDE AN ENVIRONMENT OF REASONABLE PRICE STABILITY. 6/5/91 Page22 Slide 74: 7990/91 --some monetary policy considerations XIV. https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis MAKING MONETARY POLICY IN 1990 AND 1991 CERTAINLY HAS BEEN A CHALLENGING EXPERIENCE. A. TO A LARGE DEGREE, LEANING AGAINST THE WINDS OF INFLATION. (Chart: Growth and inflation) B. THE GROWTH vs. INFLATION TRADE-OFF -- A PERENNIAL MONETARY POLICY ISSUE. 1. BECAME MORE DIFFICULT AS 1990 PROGRESSED AND WE MOVED INTO 1991. 2. WITH ECONOMIC GROWTH SLOWING SHARPLY AND INFLATION TURNING UP. (Chart: Oil prices - West Texas int. crude) C. THE EVENTS IN THE MIDEAST ADDED TO PRICE PRESSURES. 1. WITH RISE IN OIL PRICES REFLECTED IN INCREASED INFLATIONARY PREMIUMS IN LONG-TERM MARKETS. 2. FORTUNATELY, RELATIVELY QUICK RESOLUTION. a. MAKING OIL PRICE INCREASES TEMPORARY. b. AND WITH SLOWER ECONOMIC GROWTH, OIL PRICE SHOCK APPARENTLY DID NOT BECOME INGRAINED. (Chart: Total debt and bank credit) D. A MAJOR CONSIDERATION OF MONETARY POLICY IN 1990 AND 1991 --THE SO-CALLED "CREDIT CRUNCH" https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 615191 Page23 1. AS NOTED EARLIER, IN A CLASSIC LIQUIDITY SENSE NOT A "CREDIT CRUNCH." a. BUT A TIGHTENING IN THE EXTENSION OF CREDIT, PARTICULARLY COMMERCIAL CREDIT, BY BANKS. b. A SHIFT IN LENDING ATTITUDES FOLLOWING STRONG CREDIT EXTENSION DURING THE 1980s. c. BANKS TOOK STEPS TO DEAL WITH DETERIORATING ASSET QUALITY AND THE RECESSIONARY ENVIRONMENT. d. 2. A LOGICAL AND APPROPRIATE RESPONSE. WHILE SLOWDOWN IN TOTAL DEBT GROWTH SEEN AS DESIRED PART OF ADJUSTMENT/TRANSITION PROCESS. 3. BECAME CONCERNED WITH SHARP DROP IN BANK CREDIT GROWTH THAT WAS PARTICULARLY EVIDENT FROM LATE LAST SUMMER THROUGH EARLY THIS YEAR. a. CHANGES IN LENDING ATTITUDES AND PRESSURES ON BANK CAPITAL b. PART OF REASON THAT BANK CREDIT GROWTH SLOWED MARKEDLY. https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 6/5/91 Page24 (Chart: M2) E. ALTHOUGH WE RECOGNIZE THAT THE RELATIONSHIP BETWEEN MONEY GROWTH AND BANK CREDIT GROWTH IS LESS THAN PERFECT. 1. CONCERNED WITH SLUGGISH MONEY GROWTH LAST FALL AND EARLY WINTER. 2. SEEMED TO SUGGEST THAT BANKS WERE NOT MAKING SUFFICIENT CREDIT AVAILABLE. a. AND MONETARY POLICY EXERTING MORE RESTRAINT THAN DESIRED. 3. M2 PICKUP SEEN IN FEBRUARY/MARCH PERHAPS SIGN THAT BANKS BECOMING LESS STRINGENT IN EXTENDING CREDIT. a. APRIL SLOWDOWN APPARENTLY ONLY PAUSE RELATED TO DIFFICULTIES IN SEASONALLY ADJUSTING FOR TA)5RELATED PAYMENTS. b. EARLY MAY DATA POINT TO A REBOUND IN M2 AND, HOPEFULLY, BANK CREDIT GROWTH. 615191 Page25 Slide 15: 1990/91 -- monetary policy response XV. https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis IN RESPONDING TO THE CHALLENGES OF 1990 AND 1991, ALL THREE MONETARY POLICY TOOLS HAVE BEEN USED. (Text: All three monetary policy tools used) A. RESERVE REQUIREMENTS HAVE BEEN CUT, 8. THE DISCOUNT RATE HAS BEEN REDUCED, C. AND OUR OPEN MARKET OPERATIONS HAVE BEEN DIRECTED TOWARD AN EASIER POSTURE. (Chart: Required reseNes of depository institutions) D. ON DECEMBER 4, 1990, THE BOARD OF GOVERNORS ANNOUNCED A REDUCTION IN RESERVE REQUIREMENTS ON NONPERSONAL TIME DEPOSITS AND NET EUROCURRENCY LIABILITIES FROM 3% TO ZERO 1. AS A RESULT, THE AMOUNT OF REQUIRED RESERVES THAT DEPOSITORY INSTITUTIONS MUST HOLD IN NON-INTEREST BEARING FORM FELL FROM ABOUT $60 BILLION LAST YEAR TO $48 BILLION IN THE FIRST FOUR MONTHS OF 1991. E. F. THE DISCOUNT RATE HAS BEEN LOWERED THREE TIMES 1. FROM 7% TO 6-1/2%, EFFECTIVE DECEMBER 19, 1990; 2. FROM 6-1/2% TO 6%, EFFECTIVE FEBRUARY 1, 1991; AND 3. FROM 6% TO 5-1/2%, EFFECTIVE APRIL 30, 1991. IN ADDITION, OPEN MARKET OPERATIONS HAVE BEEN PROGRESSIVELY EASED SEVERAL TIMES SINCE LAST JULY. https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 615/91 Page26 1. REFLECTING THESE ACTIONS, THE FEDERAL FUNDS RATE IS NOW AROUND 5-3/4%, DOWN ABOUT 250 BASIS POINTS FROM THE 8-1/4% FUNDS RATE THAT PREVAILED OVER THE FIRST HALF OF 1990. 2. LONGER-TERM INTEREST RATES, LIKE THE 30-YEAR TREASURY BOND RATE, HAVE NOT COME DOWN AS MUCH. a. CURRENTLY AROUND 8-1/4%. b. WAS AROUND 8-1/2% IN MID-JULY, 1990, WHEN FIRST MOVE TO LOWER FUNDS RATE MADE. c. MOVED UP TO ABOUT 9-1/8% IN LATE SEPTEMBER WITH GULF CRISIS, BUDGET DELIBERATIONS. d. THEN, TRENDED DOWNWARD IN IRREGULAR FASHION. 6/5/91 Page27 Slide 76: Until recently, real GNP above potential XVI. https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis I CAN'T ANSWER THE OBVIOUS QUESTION -- WILL THESE MONETARY POLICY ACTIONS BE ENOUGH -- NO ONE KNOWS FOR SURE. A. BUT NOT LIKELY THAT ECONOMIC GROWTH, WHEN IT RESUMES, WILL REPEAT THE 1980s EXPERIENCE. B. BUT FRANKLY, THAT MAY NOT BE ALL BAD. 1. THE POST-WORLD WAR II GROWTH HISTORY-- 3% BUT SUBDIVIDES INTO 3-1/2% AND 2-1/2%. 2. THE 1982-90 EXPANSION RATE OF 3.6% -- WELL OVER. 3. THE PARTY -- WITH GROWTH ABOVE POTENTIAL -- COULD NOT HAVE GONE FOREVER. a. 4. WITHOUT INCURRING RISING INFLATION. IT WOULD HAVE BEEN UNREALISTIC TO HAVE EXPECTED THAT IT WOULD. C. WE ARE EXPERIENCING THE HANGOVER FROM THE PARTY NOW BUT IT NEED NOT BE A LONG ONE. 1. THE IMBALANCES THAT HAVE DEVELOPED IN THE RECENT YEARS FUELED OUR STRONG GROWTH TEMPORARILY. a. BUT CREATED AN UNSTABLE AND UNSUSTAINABLE SITUATION. b. THEY ARE ALL CORRECTABLE. https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 6/5/91 Page28 2. IF WE DON'T CONTINUE TO DEAL WITH THEM, IN MY VIEW, WE COULD HAVE A VERY DIFFICULT EXPERIENCE AHEAD OF US. 3. BUT I JUST DON'T THINK THAT SUCH A NEGATIVE VIEW IS A REALISTIC OR A REASONABLE EXPECTATION. 6/5/91 Page29 Slide 17: After 1990/91 transition, move toward growth with price stability XVII. WE HAVE A LONG RECORD OF BEING ABLE TO WORK OUR WAY THROUGH THESE KINDS OF ISSUES. A. THE RECORD IS CLEAR THAT WE HAVE DONE IT IN THE PAST AND I SEE NO REASON TO EXPECT THAT WE WON'T DO IT AGAIN. B. WE ARE EXPERIENCING A TRANSITIONAL PERIOD WITH UNEVENNESS (A EUPHEMISM FOR A RECESSION) IN THE NEAR TERM. C. BUT ONCE THROUGH THE TRANSITION OR ADJUSTMENT, WE COULD WELL BE ESTABLISHING A BASE FOR CONTINUING AND POSITIVE ECONOMIC RESULTS. D. VERY LIKELY NOT IN THE MAGNITUDE OF THE 1980s WHICH I HAVE FREQUENTLY REFERRED TO -- THAT PARTY REALLY IS OVER. E. BUT GROWTH IN A MAGNITUDE MORE CONSISTENT WITH OUR AVERAGE EXPERIENCE OVER THE LAST TWO DECADES. F. THIS GROWTH NATIONALLY WILL BE CONSISTENT WITH ACHIEVING AND MAINTAINING PRICE STABILITY. THANK voO: https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis